Bruce Richards has been investing in credit markets for 35 years and thinks the growth of asset-based lending is the next big thing.
“The advent and development of asset-based lending is as big as the advent and development of corporate direct lending,” he told Pensions & Investments, a sibling publication of Crain Currency, at Marathon Asset Management’s New York office.
Richards, the cerebral chairman and CEO of the $23 billion global credit firm, brings sheets full of data points to describe the credit markets he has witnessed grow and change over his career.
Richards, 62, along with CIO Lou Hanover, 58, founded Marathon in January 1998. Marathon, which today invests in both public and private credit markets, about 15 years ago began setting up private credit teams in direct lending, asset-based lending and opportunistic credit, he said.
“The markets are merging between private credit and liquid credit … it’s one of the big evolutions that are happening. It’s not two separate markets. It’s one big credit market. And so this is how we’ve designed our firm,” he said. Marathon’s asset split between private and public credit is, by design, 50-50.
And Richards sees parallels to the past. He pointed to what the Basel III reform measures did for the growth of direct corporate lending in the aftermath of the global financial crisis, with the segment growing from $100 billion in assets to $1.7 trillion — a figure that Richards argues with leverage is actually $3 trillion.
He contends that could happen with asset-based lending.
“Basel III did for direct lending — and its growth as banks pulled back and the void was filled by fund managers — what Basel III Endgame, which start starts next year, will do for asset-based lending,” he said.
Marathon has been ramping up asset-based lending in anticipation of banks ceding market share, Richards said.
The firm invests in variety of asset-based lending, including transportation with aviation, maritime and ground logistics; health care; commercial and residential real estate finance; and consumer finance and specialty finance, which includes areas such as royalties, litigation and synthetic risk transfers, and credit risk transfers. Partner and portfolio manager Ed Cong leads the business.
“We believe asset-based lending, which is right now less than $1 trillion in fund size, will grow to $4 [trillion] to $5 trillion in the next 10 years,” Richards said.
‘FIRST INNING’
And Richards thinks institutional investors will take part in the growth.
“We believe that the pension plans, endowments and foundations are just in the first inning of allocating to asset-based lending, whereas they’re in the middle of the game of direct-lending exposure, corporate middle-market direct-lending exposure. And so that balance, I believe, is accretive because asset-based lending traditionally has generated a slightly higher return with less volatility with a lower loss rate. And that's the appeal of asset-based lending.”
At the same time, Richards said, Marathon has “never been more active than we are today in direct lending.”
Many other competitors have moved up market and are doing bigger deals, leaving a “bit of a void for the middle markets,” he said. Curt Lueker heads Marathon’s direct-lending team.
Credit markets have seen tremendous growth since the last huge distressed cycle in 2008-09. Back then, the size of the high-yield market in the U.S. and Europe, the leveraged-loan market and private credit market combined was $1.7 trillion. Today, Marathon estimates that total at $6 trillion, Richards said.
The current situation of higher-for-longer rates and economic strength means there will be selective defaults in what will be a long, drawn-out cycle, he said.
“There’s the have-nots because there’s a tale of two cities,” he said. “And so for 95% of the companies in the high-yield market, they’re doing fine in this market. There’s no stress. There’s no distress. But for ... 5% of the $6 trillion number, $300 billion, there’s a lot of pressure points, servicing debt.”
Marathon has 150 companies on its list now that are stressed or distressed and in need of capital solutions, Richards said.
“We’re incredibly bullish on the opportunity for capital solutions, opportunistic lending, given the degree of distress that’s in the marketplace,” he said.
Another area Richards is bullish on is the collateralized loan obligation market, especially CLO equity. Karen Lau is portfolio manager on leveraged loans and CLOs. (CLO equity means the investor has levered exposure to senior secured collateral of the CLO).
“We believe CLO equity is one of the underappreciated assets that have consistently, through the cycles, outperformed,” Richards said.
MORE REGULATION AND RISK FACTORS
With the swift growth in private credit assets in recent years, Richards sees more regulation coming.
“I think there’s going be more regulation in time. Is that a good thing? That’s a good thing. That the rules to the game should be clearly defined. And more regulation around those rules is better, rather than no regulation,” he said. “And the shadow banking system should not be a shadow but is mainstream now. It’s time for mainstream regulation, to better define any of the criteria they think is critical for our industry. And we welcome that.”
That's “inevitable,” Richards said, as “banks are further disintermediated from the lending community, and the private credit markets and the private credit fund managers are such a big part of finance and greasing the wheels of this economy.”
Richards points to two major risk factors he spends time thinking about: geopolitical risk such as a black-swan event and economic risk centered on inflation.
“I think we’re going to be in this market of higher for longer,” he said.
Another long-term risk factor Richards points to is big government deficits coming from both sides of the aisle.
“Given how strong our economy has grown, we should be running surpluses, not deficits,” he said. “The spending is too much. And so what that’s going to result in is most probably, most likely, higher taxes. But we also need to get our fiscal house in order because it's the strongest country in the world. And we want to remain that way.
“And to remain that way, I believe, you have to have fiscal discipline,” Richards said, adding that he sees this as a big risk factor for the next generation.