What is Asset-Backed Finance?

In our posts on private credit and private equity, we touched on an important concept: asset backing. Now let's unpack it properly.

When someone asks "how do I know I'll get my money back?", asset-backed finance is a big part of the answer.

It's not complicated. The idea is simple: if a borrower can't repay a loan, the lender can take ownership of specific assets and sell them to recover the money. It's the same principle as a home loan, where the bank can repossess your house if you stop paying. But instead of houses, we're talking about commercial property, equipment, vehicles, solar panels, and other business assets.

This matters because it changes the risk profile of lending. Instead of just hoping a borrower pays you back, you have a claim on real things.

What is asset-backed finance?

Asset-backed finance is any lending where the loan is secured against specific assets owned by the borrower.

If the borrower defaults (can't repay), the lender has a legal right to take those assets and sell them. The proceeds go toward repaying the loan.

Here's the basic structure:

1. A business needs capital

2. They have valuable assets (equipment, property, vehicles, inventory, receivables)

3. A lender provides a loan secured against those assets

4. If the business repays, everyone's happy

5. If the business defaults, the lender takes the assets and sells them

The assets act as a safety net. They don't guarantee you'll get all your money back, but they significantly improve your chances compared to unsecured lending.

How is this different from unsecured lending?

The difference is what happens when things go wrong.

Unsecured lending: The lender has no specific claim on assets. If the borrower defaults, the lender joins a queue of creditors hoping to recover something from whatever the business has left. Recovery rates can be low, and the process can take years.

Asset-backed lending: The lender has a direct claim on specific assets. If the borrower defaults, the lender can seize those assets immediately (or relatively quickly through legal processes) and sell them. Recovery rates are typically much higher.

Here's a simple comparison:

According to iCapital research, direct lending loss rates are around 100 basis points (1%), while asset-backed lending is even lower at 10-20 basis points (0.1-0.2%). That's a significant difference.

What kinds of assets can secure a loan?

Almost any valuable asset can serve as collateral. The key questions are: how much is it worth, and how easily can it be sold?

Common examples include:

Accounts receivable. Money that customers owe the business. If a company has R10 million in unpaid invoices from creditworthy customers, a lender might advance 80-90% of that value.

Inventory. Products waiting to be sold. A lender might advance 50-70% of inventory value, depending on how easily it could be liquidated.

Equipment and machinery. Manufacturing equipment, agricultural machinery, mining equipment. Advance rates might be 20-40%, depending on how specialised the equipment is.

Vehicles and transport fleets. Trucks, buses, aircraft, ships. These have established resale markets, making valuation and liquidation relatively straightforward.

Commercial property. Buildings, warehouses, retail space. Property is a traditional form of collateral with well-understood valuations.

Infrastructure assets. Solar panels, wind turbines, batteries, telecommunications towers. These generate predictable cash flows and have resale value.

The more liquid an asset (the easier it is to sell quickly at a fair price), the more a lender will advance against it. Accounts receivable from blue-chip customers might support 90% advance rates. Highly specialised equipment might only support 20-30%.

Real examples of asset-backed lending

Let's make this concrete with some examples:

Solar panel financing. A company installs commercial solar systems on factory rooftops. They need capital to fund installations before customers start paying. A lender provides financing secured against the solar panels themselves. If the borrower defaults, the lender can take ownership of the panels, which continue generating electricity and revenue.

Trucking fleet finance. A logistics company needs to expand its fleet of delivery vehicles. A lender provides financing secured against the trucks. Each truck is registered in the lender's name until the loan is repaid. If the company fails, the lender takes the trucks and sells them through established commercial vehicle markets.

Invoice financing. A manufacturer has R5 million in outstanding invoices from customers like Pick n Pay and Woolworths. They need cash now, not in 60 days when customers pay. A lender advances 85% of the invoice value (R4.25 million) secured against those receivables. When customers pay, the money goes to the lender.

Equipment leasing. A construction company needs expensive earthmoving equipment. A finance company buys the equipment and leases it to the construction company. The finance company owns the asset throughout, so there's no need to "recover" anything if payments stop. They simply take back their equipment.

In each case, the lender's downside is protected by having a claim on something real that can be sold.

How does collateral protect investors?

When you invest in asset-backed private credit, you're not just hoping a business succeeds. You have a backup plan.

Here's how the protection works in practice:

Step 1: Valuation. Before making a loan, the lender values the assets being pledged. This isn't just taking the borrower's word for it. Independent valuers assess what the assets are actually worth, and what they'd be worth in a forced sale (typically lower than market value).

Step 2: Advance rate (loan-to-value). The lender doesn't lend the full value of the assets. If equipment is worth R10 million, the lender might only provide R5 million (50% advance rate). This creates a "cushion" that protects against the asset losing value.

Step 3: Ongoing monitoring. The lender monitors the assets throughout the loan term. Are they being maintained? Are they still there? Has their value changed? Regular reporting and sometimes physical inspections keep the lender informed.

Step 4: If things go wrong. If the borrower starts missing payments, the lender can act before the situation becomes hopeless. They might require additional collateral, restrict the borrower's use of assets, or begin recovery proceedings while assets still have value.

Step 5: Recovery. If the borrower defaults, the lender exercises their security rights. They take ownership of the assets and sell them. Because they only advanced a portion of the asset value, they're likely to recover most or all of the outstanding loan.

This layered approach (conservative valuation, advance rates below full value, ongoing monitoring, early intervention, and defined recovery rights) is what makes asset-backed lending lower risk than unsecured lending.

What happens when a borrower defaults?

This is worth understanding, because it's where asset backing really matters.

Let's say a transport company borrowed R8 million secured against a fleet of trucks valued at R12 million. The company hits hard times and can't make payments.

Week 1-4: The lender notices missed payments and contacts the borrower. They try to understand the situation and find a solution (restructured payments, additional security, etc.).

Month 2-3: If no solution is found, the lender issues formal notices of default and begins legal proceedings to enforce their security.

Month 3-6: The lender takes possession of the trucks. This might involve court orders, but because the security was properly registered, the lender's rights are clear.

Month 6-12: The trucks are valued and sold, either through auction or private sale. Commercial vehicle markets are reasonably liquid, so finding buyers isn't usually the problem. The question is price.

Outcome: If the trucks sell for R9 million, the lender recovers more than their R8 million loan. Any excess goes back to the borrower or other creditors. If they sell for R7 million, the lender takes a R1 million loss but recovers 87.5% of their capital.

Compare this to unsecured lending, where the lender might recover 20% or nothing.

The process isn't instant. It takes months. But the outcome is typically much better than unsecured lending because the lender has specific, valuable assets to sell.

What are the risks?

Asset backing reduces risk, but doesn't eliminate it. Here are the things that can still go wrong:

Asset values can fall. Property prices drop. Equipment becomes obsolete. Inventory goes out of fashion. If the collateral is worth less when you need to sell it than when you valued it, your recovery suffers.

Liquidation is messy. Selling assets quickly often means selling at a discount. A forced sale rarely achieves full market value. That's why advance rates are set conservatively.

Specialised assets are harder to sell. A general-purpose truck has many potential buyers. Specialised mining equipment has fewer. The more niche the asset, the harder (and slower) it is to liquidate.

Legal processes take time. Even with clear security rights, taking possession and selling assets involves legal processes that can take months or years, especially if the borrower contests.

Fraud exists. Occasionally, borrowers misrepresent the assets they're pledging. Due diligence and verification processes help catch this, but it's a risk.

Multiple claims on assets. Sometimes assets are pledged to multiple lenders (illegally) or have existing liens. Proper registration and legal checks mitigate this, but complexity can arise.

The key point: asset backing significantly improves your position as a lender, but it's not a guarantee. The quality of the assets, the loan-to-value ratio, and the lender's processes all matter.

How do you evaluate asset-backed investments?

If you're considering investing in asset-backed private credit, here are the questions to ask:

What assets secure the loan? Are they tangible, valuable, and saleable? Property and vehicles are generally more liquid than specialised equipment.

What's the loan-to-value ratio? If a loan is 50% of asset value, there's a bigger cushion than if it's 80%. Lower is generally safer.

Who valued the assets? Was it an independent valuer or the borrower? Independent valuations are more reliable.

How easily can the assets be sold? Is there an active market for this type of asset? How long would liquidation take?

What happens to asset value in a downturn? Some assets hold value better than others during economic stress.

What's the lender's track record? Have they successfully recovered assets before? Do they have the infrastructure and expertise to manage defaults?

Is the security properly registered? Legal documentation matters. Improperly registered security can be challenged.

These questions help you understand whether the asset backing is genuine protection or just window dressing.

The bottom line

Asset-backed finance is about having a backup plan.

When you lend money secured against real assets, you're not entirely dependent on the borrower's success. If they can't repay, you have a claim on things you can sell. That claim doesn't guarantee you'll recover everything, but it dramatically improves your odds compared to unsecured lending.

This is why asset backing is so important in private credit. Historical loss rates for asset-backed lending are a fraction of unsecured lending. The collateral cushion means that even when things go wrong, investors typically recover most of their capital.

For investors who want the higher yields of private credit but are concerned about downside risk, asset-backed structures offer a middle ground. You're still taking risk, but you're taking it with your eyes open and with something real standing behind your investment.