Specialty finance is a broad asset class comprised of lending activity that occurs outside traditional banking channels, secured by hard or financial assets. This includes consumer, SME and commercial debt as well as esoteric financial assets like buy-now-pay-later and litigation financing.

A burgeoning sector since the GFC, specialty finance firms provide funding to consumers and businesses that don’t fit into the traditional credit box of mainstream banks. This often involves assessing hard data on the borrower’s intention to pay and ability to pay rather than relying on ratio driven underwriting formulas. Specialty finance lenders also tend to have flatter organizational structures, with accessible investment committees and a willingness to perform a deep dive on each loan request rather than relying on a defined “credit box” as many larger banks do.

Rising interest rates and regulatory changes have made it more difficult for banks to offer credit solutions to small business customers, a key market segment for specialty finance. This has led to a sharp pick up in M&A in the industry as private equity acquirers look to take advantage of attractive valuations in the space.

From a risk mitigation perspective, the diversified pool of assets in specialty finance loans and the unique structure of these investments makes them more resilient to cyclical economic swings than other asset classes, providing an important diversification opportunity for investors seeking lower correlation with stocks and bonds. In addition, the majority of UK specialist finance deals are structured as self-amortizing specialized purpose vehicles, which separates performance of the underlying collateral from that of the operating company.