Dechert: Private debt making inroads in PE deal financing in Asia-Pacific

The consistent movement of market share from banks to credit funds has now spread in a big way to APAC.

Private equity’s use of private debt as a preferred source of deal financing is catching on in a big way in Asia-Pacific, according to a new report by Dechert, a global law firm whose largest office in in New York. The report addresses the state of the private equity industry in the second half of 2022.

In a section of the 2023 Global Private Equity Outlook specifically devoted to private credit, the Dechert report observes that traditional banks “have consistently lost market share to credit funds over the past decade, first in the US and then in Europe, with the trend now playing out in APAC”.

The report cites a survey conducted with Mergermarket of 100 senior level officials at large ($1 billion-plus in assets) private equity firms in North America, EMEA and APAC. Of those surveyed, only 35 percent of APAC respondents last year said that they use private credit more than traditional bank financing for their buyout deals. This year that share rose to 60 percent.

A full forty-two percent of the North American private equity respondents, and almost as large a share (40 percent) of the APAC respondents to a survey conducted with Mergermarket agreed this year that the availability and cost of leverage is one of the top two challenges now facing their industry amidst central bank tightening.

Clear majority shares (58 percent in North America and 65 percent in APAC) say that they have increased their use of private credit to finance buyouts.

The reasons PE firms cited for using private debt rather than traditional banks have shifted. The firms most frequently cite greater flexibility (via negotiated covenants) rather than the greater certainty of securing the credit or the higher leverage rates available. As an inference from the high value that private equity firms now place on flexibility, Dechert also says that there will over time be an “even greater focus on  the credit counterparties PE funds may have to negotiate with if if things turn south”.

In terms of strategy among credit funds, the Dechert report observes a “tilt toward distressed debt”, and cites as an example the closing of the Ares Special Opportunity Fund II.  But it also says that the Crescent Direct Lending III, which raised $6 billion, shows that senior credit funds are still being raised.

The paper also discusses NAV lending. NAV facilities (backed by the net asset value of fund assets) and subscription facilities (backed by the creditworthiness of the LPs) offer “readily available liquidity to support their portfolio companies with critical investments into their operations and to help finance bolt-ons”, the report says.

Subscription lines have the added value that they mitigate the necessity of LP capital calls in connection with buyouts. This, the Dechert report says, “is especially important in a competitive sales process when time is of the essence”.

Only 2 percent of fund managers report having reduced their use of NAVs over the last three years, while 60 percent have maintained a constant level of usage. The remainder, 38 percent, have increased their reliance on NAV loans.