The report was stark when it was announced. “We believe that Asia’s credit boom is over; we are in a consolidation phase as credit growth slows. Governments and companies are dealing with the consequences of past booms,” read the statement from Standard Chartered.
But every cloud has a silver lining and as the credit boom and bust takes its toll on some of the traditional market players others are finding the opportunity set increasing.
“Overall, non-bank lenders have certainly been filling the gap in the market that is not covered by the traditional banks, a big segment of the market was under-served,” says Jan Bellens, global banking and capital markets emerging markets leader at EY.
The demand for non-bank lenders has long been there in the region with the shadow banking sector accounting for at least 30 percent of China’s total debt in 2013, according to S&P.
“Shadow banking is very common in China and it has been there for several years. The developers are getting that [capital] mainly because they cannot get loans from routine banks and they are willing to pay a higher interest rate for the money. Even big developers borrow from them,” says Paul Guan, a partner at law firm Paul Hastings.
Regulations are also limiting what banks can do. “Basel III’s added capital requirement is making the challenge worse for the already under-served segment, on the SME side and on the consumer side,” adds Bellens.
Although domestic bank lending remains the predominant source of debt, banks are becoming much more selective. This hits non-listed small and medium-sized enterprises or growth capital-reliant firms the hardest. Usually at an early stage of their lives, they lack qualifying collateral and credit repayment track records, and are unable to issue bonds for additional funding. The result is more opportunities for private debt lenders. Since the end of March, the International Finance Corporation has invested at least $240 million in senior secured loans in three Asia projects: affordable housing developments in China; commercial vehicle financing in India; and fast-growing companies in Vietnam. More deals are being negotiated.
Meanwhile, problems associated with too much leverage are also presenting an opening for distressed investors.
“Many large property developers have very serious concerns about leverage. They are worried about how much debt they can sustain on their balance sheets,” says Neil McDonald, a partner at law firm Kirkland & Ellis.
According to the China Banking Regulatory Commission, the country’s troubled loans, including non-performing loans, stood at 4.16 trillion yuan ($640 billion; €570 billion) in 2015. This has pressured Beijing to open up the distressed debt market to specialist players.
“There will be increasing opportunities for private debt to fill the gap for refinancings in restructuring. Opportunities will include loan-to-own strategies, and the provision of emergency working capital,” McDonald says.
As a consequence, large, well-capitalised alternative credit managers like KKR, Oaktree Capital Group and Clearwater Capital Partners have a role to play in the distressed debt market for sectors burdened by overcapacity, such as oil and gas, coal and cement, steel and real estate. Several institutions are teaming up with Chinese partners to invest in distressed debt in China.
“As the country’s corporate defaults and distressed debt continue to balloon, the presence of such specialised investors purchasing distressed debt from Chinese banks will help to offload it from traditional institutions,” says Bellens.
While private debt lenders have opportunities to source deals, they are also being sent deals by the banks.
“Banks regularly refer some of their borrowers to us when they are unable to finance certain of their specific transactions, typically when these deals are too small and do not fit banking mandates. They prefer to see their borrowers come to us than to another bank,” says Xavier de Nazelle, EFA Group’s head of corporate and asset-based finance.
On the face of it, prospects look rosy for private debt providers in Asia. But are things that simple?
One of the most challenging issues is the obscurity of market information, which makes it hard to attract investors. A recent survey by UBS showed that many limited partners are not yet ready to invest in the private credit market in Asia.
“LPs regularly contact us to ask which credit funds are raising capital,” Javad Movsoumov, a managing director in UBS Private Funds Group in Singapore, tells PDI. “Typically, LPs assessing a manager seek to meet multiple managers to assess their relative strengths.”
However, considerable effort has to be spent on meeting different managers as LPs often do not know the market well.
“There is a specific risk-return equation for private credit investment in which the return is more or less capped. However, the risk varies depending on quality of secured assets and enforceability of security documents,” Movsoumov adds.
Another problem is that the private debt market, in particular in the senior secured lending space, is dominated by a few blue-chip asset managers. The lack of transparency and track record in the market makes things tough for new entrants and smaller asset managers.
“The return dispersion of senior secured loans is small relative to that of private equity. In light of this, it may be difficult for a new manager to prove themselves by outperformance,” believes Movsoumov. “In the private credit space there are areas where return dispersion is greater, such as mezzanine debt, and therefore outperformance is more easily spotted.”
Standing out from the crowd in the senior secured loan market for smaller managers is difficult, but not impossible. Singapore-headquartered EFA Group recently raised $50 million for its new senior secured fund within six months. The asset manager has expanded its focus on trade finance to include asset-backed term loans to industries tied to the real economy.
“My advice is don’t cut corners even at the beginning because you don’t have the size, and to really stick to your sector of expertise,” says de Nazelle.
More and more investors are clearly refusing to cut corners. Capital raised for private debt funds in Asia Pacific has increased from $300 million in 2010 to $6.9 billion in 2015, according to PDI Research & Analytics.
Yet in Asia the space is still young and niche. This is a double-edged sword. On one hand, the immaturity of the market makes it difficult for investors to set foot in. On the other, the market enjoys limited competition. This indicates a more attractive risk-reward than that found in the more saturated markets of the US and Europe.
With concerns over the US economy and the many uncertainties in Europe, private debt in Asia has emerged as a viable alternative for investors looking to diversify.