Bloomberg Terminal
PRIVATE CREDIT: Market Volatility Is Boon to Specialty Finance
By David Brooke
March 17, 2022

Investors drawn to returns from riskier revenue streams

Next could be loans to pay royalties to YouTube influencers

Rising volatility in traditional investments is fueling growth in so-called specialty finance, a niche market offering big returns to those open to riskier ventures like aircraft leases and YouTube influencers.

The trend is part of the growth in private credit, an asset class that data analytics provider Preqin estimates will double to $2.69 trillion in the next five years. Unlike the bulk of the market, where investors provide direct loans to small- and mid-sized companies often ignored by big banks, specialty finance serves a more obscure group.

For example, in December Northleaf Capital sold $303.8 million of asset-backed securities supported by publishing and sound recording rights, as well as other income streams, on almost 53,000 songs, including some by The Who and Tim McGraw.

Ivan Zinn, chief investment officer at Atalaya Capital Management, says the next area for lenders to explore could be YouTube content. The blossoming influencer economy is $16.4 billion in size, according to Influencer Marketing Hub, opening the door for non-bank lenders to deploy capital and find better risk-adjusted-returns.

“YouTube royalties is a new and upcoming space where we’re doing work and seeing opportunity,” Zinn said.

Investors are willing to take a chance on a relatively untested revenue stream because the yield on such a loan can generate a net return of 12% or more, without using leverage.

And buyers are looking for assets outside so-called sponsor-backed lending, the dominant lending strategy of non-bank firms, said Jess Larsen, chief executive officer of Briarcliffe Credit Partners, a placement agency dedicated to private credit. Sponsor-backed lending assets under management total $452 billion globally - about 40% of the total private credit market, according to Preqin.

Larsen said he recently had in-person meetings with customers nationwide to gauge their demand. Limited partners “are looking outside direct lending at specialty finance assets that comprise myriad colors and that offer higher returns,” said Larsen.

The range of investments being sought stretches from asset-based lending to aviation leasing to venture lending. In a show of high demand for aviation leasing investments, Castlelake Aviation offered an aviation leasing fund that raised a record $1.6 billion. The fund focuses on the sale and leaseback of aircraft, as well as providing loans secured against such assets.

Venture lending, that is, loans to late-stage companies backed by venture capital firms, continues to pop as well. A report published jointly by the National Venture Capital Association and Pitchbook reported a record 3,172 loans completed, driven by technology borrowings, with 2,600 loans financed. Hercules Capital, the largest non-bank venture lender, booked a record $2.64 billion commitments in 2021.

To be sure, specialty finance faces similar problems to direct-lending strategies. Market growth creates pressure to find opportunities, increasing the number of risky deals. And investors may perceive offerings that don’t have private equity sponsorship as lacking enough financing to weather downturns.

Not necessarily, says Carlos Mendez, co-founder of Crayhill Capital Management.

“There is always an educational element when it comes to how specialty finance debt structures work versus corporate loans,” Mendez said in a telephone interview. For Mendez, it is key to show investors how loans are structured correctly in relation to the collateral.

He also says that demonstrating the “sustainability of cash flows under various scenarios, and the ability to actively enforce risk-management processes, are helpful details for investors to understand.”

Part of the attraction of these assets is less dependence on current economic fundamentals than stocks, bonds and even traditional direct loans. All financial assets have fluctuated in value this year, buffeted by the fastest inflation in four decades, higher interest rates from the Federal Reserve and the economic disruptions caused by the Russia-Ukraine war.

For instance, the ICE BofA MOVE Index, a barometer of market turbulence that measures implied volatility on 1-month Treasury options, has risen more than 30% this year.

But private credit, and its specialty finance niche, escape much of the mark-to-market volatility and benefit from the floating-rate nature of the loans.

“Investors are looking for areas of corporate credit that are going to provide enhanced risk-adjusted-returns,” said Andre Hakkak, chief executive officer at White Oak Global Advisors.