Private debt’s popularity has grown dramatically in recent years among institutional investors in search of yield. However, it is likely to take some time for traditional fixed-income investors to embrace the asset class, owing to concerns about its use of leverage.
Liew Tzu Mi, GIC Private’s fixed-income CIO, raised a key issue about the changes she is seeing on the credit spectrum during a panel discussion at last month’s Milken Institute Asia Summit in Singapore: “With $15 trillion negative-yielding bonds, [are] investment-grade bonds becoming the new treasury [bonds], high-yield becoming the new IGs, and private debt becoming the new high-yield?”
If private debt is to become the new high yield, its use of leverage is a significant obstacle. Speaking on the same panel, Christian Stracke, a managing director and global head of credit research at PIMCO, expressed concern about the excessive use of leverage he has seen this year in private credit.
His fears about “leverage on leverage” are based on a practice he has seen among mid-market managers and CLO managers, many of which are using banks to make these loans. Stracke added that these banks were borrowing from other banks in order to make them.
“There has been a very aggressive leveraging down in the capital structure in lower-rated levered loans, and especially in the private markets … in terms of the deals [that] are getting done,” he noted.
One interpretation of this trend, according to the two panellists, was “late-cycle behaviour”, which they regarded as overly confident. Stracke sounded the alarm again on the amount of the leverage in place from some of the aggressive alternative lenders.
“We are all the children of above average,” he said.
The benefits of barriers
Not everyone is so wary. Opportunistic credit players, such as New York-based corporate credit and structured finance manager DW Partners and Hong Kong-based alternative credit manager Tor Investment Management, have been far more willing to participate in pockets of this private market, with their own covenants and shorter tenors.
David Warren, the CEO, CIO and founding partner of DW Partners, told the conference that his firm creates its own loans and covenants, and that it keeps the tenors short to get more control over the credit facilities. “Just because you write your own covenants all along, just because it is private, does not mean you are going to win,” he added.
Patrik Edsparr, CIO and co-founder of Tor, told attendees that he prefers areas in the credit market where there are barriers to entry, and where his team can originate, source and structure short-term loans, “which you cannot get from the public markets”.
As PDI reported in August, Tor acquires loans and bonds in the secondaries markets, makes private loans, and takes part in the syndicated loan markets.
Warren said DW Partners and Tor had co-invested in a loan backed by Australian land for a residential development project. He added that the facility had a 50 percent loan-to-value ratio and a short tenor.
In China, credit investors’ doubts over data transparency are stalling growth. Jonathan Hu, CEO of credit-related service provider Pengyuan International, told the conference: “In theory, you can only see three credit ratings: ‘triple-A’, ‘double-A plus’, and ‘two double-A’. This is because there is a regulation in China that companies [with credit ratings] below ‘double-A’ are not allowed to issue [any bonds there].” Hu added that onshore and offshore credit rating agencies were using two different rating scales.
In a further complication, this year’s new regulation on offshore borrowings further limits large Chinese firms’ ability to source credit. As PDI reported, Chinese residential developers can now only issue offshore bonds to refinance existing debt owing to a policy put in place this month by the National Development and Reform Commission, an agency under the State Council.
“I do not think this is a stage where we worry too much about Chinese corporates because if you understand China, [then you know that] the entire fixed-income market is still a baby,” Hu added.
Edsparr noted increasing competition in a strategy where, at present, the supply of and demand for capital are aligned. “[It is] because – guess what? – there are a lot of people with a lot of capital pretty much doing the exact same thing,” he added.