Asset-based finance (ABF) could more than quadruple to nearly $2.6tn (£1.94tn) in the US second-lien mortgage market as collateral-backed lending is a “sweet spot”, argues Davidson Kempner.
In a white paper, the investment firm said the asset-backed market in the US, excluding agency mortgages, now exceeds $20tn, with around $2tn represented by public securities.
The market spans bank balance sheets, insurance portfolios and private investor capital, at a time when investors are seeking to diversify their private credit allocations away from traditional direct lending, which currently dominates the market.
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The white paper highlighted three smaller, collateral-backed lending categories it described as “steady eddies”, offering “compelling risk-adjusted returns” within private ABF. These include US second-lien residential mortgage lending, European small and medium-sized enterprise asset-based lending, and US mid-ticket equipment finance.
“We estimate the current $590bn market for second-lien mortgages and home equity lines of credit could grow by more than $2tn due to the additional borrowing capacity homeowners have when taking current loan-to-value ratios relative to historic averages into account,” Davidson Kempner found.
The firm argued that rapid growth in direct corporate lending, which has expanded ninefold since 2015, has led to compressed spreads and declining recovery rates, while certain pockets of ABF, such as the three highlighted above, continue to offer “attractive opportunities”.
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Overall, the firm argued that collateral-backed financing expands access to credit at a lower cost for homeowners and businesses, while structural protections in ABF, including covenants, performance triggers and governance rights, can help mitigate downside risk and enhance credit quality.
“By focusing on market segments that remain relatively underfunded yet supported by strong collateral performance, disciplined structuring, and durable spreads, investors can earn attractive risk-adjusted returns,” the white paper said. “Just as an eddy provides calm within the turbulence of a river, these private ABF pockets can offer refuge from the crowded flow of direct lending, delivering stability, structure, and compelling returns in an increasingly competitive credit environment.”
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