Private Credit: Beyond Direct Lending

Asset-Based Lending

While headlines related to private credit’s direct lending sector have captivated market participants over the past month, there exists a meaningful investment universe, each with distinct characteristics, under this broader umbrella. Following direct lending, the asset-based lending (ABL) industry has experienced consistent growth and renewed investor interest.

ABL is a form of lending in which loans are primarily secured by a borrower’s tangible assets rather than by cash flow or earnings. Common forms of collateral include accounts receivable, inventory, equipment, and, in some cases, intellectual property. ABL is most often used by middle-market companies with meaningful working capital needs, seasonal cash flow patterns, or business models where asset values provide more reliable support than earnings. As many ABL borrowers are capital-intensive businesses, there exist working capital gaps and seasonality related to inventory builds that ABL lenders can bridge. This financing is not related to poor operations, rather, how certain firms convert assets into cash over time. The amount a borrower can access is typically determined by a borrowing base, which applies an advance rate to eligible assets and adjusts as collateral values change. From a structural perspective, ABL typically sits senior in the capital structure and benefits from first-priority liens on collateral. This seniority and asset coverage often results in lower loss severity and stronger recovery rates in stressed scenarios compared with unsecured or cash flow-based lending.

ABL vs. Direct Lending: Risk, Liquidity, and Cycle Sensitivity

Risk: At a high level, the main difference between direct lending and ABL centers on the type of risk a lender is underwriting. Direct lending focuses on cash-flow lending to middle-market firms, with credit risk primarily assessed on EBITDA, free cash flow, and margin stability. In contrast, ABL considers the age and quality of accounts receivable, liquidation value, and inventory turnover. Meaningful risk will always be present in both; however, the origins of any credit problems will be unique.

Liquidity: ABL portfolios feature shorter loan durations and self-liquidating structures. In contrast, direct lending is often characterized by longer-dated loans tied to sponsor-backed transactions, where exit timing depends heavily on refinancing or merger and acquisition markets.

Cycle Sensitivity: Earlier in an economic cycle, direct lending often benefits from expanding leverage capacity, stable or growing EBITDA, and accommodative refinancing conditions. In these environments, cash‑flow‑based underwriting can support returns as sponsors pursue growth and acquisition activity. However, later in a cycle, earnings volatility typically increases, refinancing windows narrow, and forecasting future cash flows becomes more challenging. While ABL may offer slightly lower yields than direct lending, it may provide more downside risk mitigation and greater resilience across economic cycles. As a result, ABL is often viewed as a defensive or stabilizing strategy within the broader private credit market, particularly during periods of economic uncertainty.

LPL Research Takeaway

From a portfolio construction standpoint, we believe both direct lending and ABL may provide attractive risk/return profiles for suitable investors and offer complementary characteristics. Neither is inherently superior; rather, investors should consider which private credit sector best aligns with their goals, provides portfolio diversification, and meets their liquidity needs. ABL may serve as a stabilizing complement to traditional direct lending, potentially smoothing volatility, and enhancing downside risk mitigation in late-cycle environments. ABL appears well positioned, not as a replacement for direct lending, but as a differentiated tool within the larger private credit universe.

Looking ahead, in the same manner that investors consider which public equity or bond styles/sectors are more appropriate at a given point in the market cycle; when investing in private markets, product development has evolved to the point where investors may tailor their desired exposure, rather than relying on one-stop solutions featuring broad private market beta.