Staying out of the bankers’ club

Amid tight pricing and terms, pan-Asian private credit managers are sourcing dealflow elsewhere, finds Adalla Kim

Nineteen private equity managers raised a total $24.2 billion for pan-Asian buyout funds, last year, almost touching the record-high of $25 billion raised in 2014, according to PDI data.

In theory, such high fundraising figures and corresponding dealflow should create more sponsored financing opportunities for private credit managers in the region, as in the US and Europe.

However, industry observers tell PDI that sponsored financing is yet to be a main source of private credit dealflow in Asia, partly because private lenders do not find it profitable.

Two of the largest private equity houses with a presence in Asia told PDI they hire banks to finance the debt element of their buyout transactions in the region, instead of opting for private debt finance.

“In Asian acquisition financing, there are a handful of deals which were financed with bonds, but most buyout deals were financed entirely with bank loans,” says William Chua, a Hong Kong-based partner at New York-headquartered law firm, Debevoise & Plimpton.

Chua worked on Focus Media, one of the largest private equity leveraged buyout deals in China. The display advertising provider was acquired by a consortium led by private equity giant, Carlyle Group, for $3.7 billion in 2012, with $1 billion financed by bank loans.

He says the original plan was to raise financing via both bank loans and high-yield bonds, but the lending terms banks were offering were so favourable that the bond piece was not needed.

He adds that private credit managers in Asia have so far tended to stick to secondary market trading strategies as opposed to direct lending, unlike the European markets where direct-lending funds have emerged as an alternative financing source to banks for acquisitions.

While pricing and fees for acquisition financing have remained consistent over the years, the terms are getting shorter, according to Peter Lee, a Hong Kong-based partner at financial advisory group Deloitte China.

“In terms of pricing and fees, they have not changed much for the last five to seven years. However, because of so much liquidity in the market, we see the duration of transactions getting shorter and a lot of bridge loan financing activities are being seen for acquisitions, M&A or even single share purchases in the region,” Lee told PDI at the HKVCA Asia Private Equity Forum 2018.

“Once investors decide to gain some exposure to Asian private credit, I think a two-track approach is viable – one is choosing a pan-Asia debt play, and the other a country-specific debt strategy.” Chris Choi

Specifically, in the case of China, until 2016, several Chinese acquisitions across North America, Australia, and South-East Asia, were backed by Chinese banks. ICBC, China Development Bank, The Export-Import Bank of China, China Minsheng Bank, CITIC and China Merchant Bank have been some of the Chinese financial institutions active in acquisition financing.

However, restrictions on capital flows from China into global markets, coupled with fluctuations in the dollar-yuan exchange rate over the past two years, has altered the acquisition financing landscape for Chinese outbound deals.

International acquisitions backed by Chinese sponsors have reduced since December 2016 because the issue of how to move their own money became more significant, including in relation to activities such as loaning capital from banks and spending it outside of China, according to Yinghao Lv, a Beijing-based partner at Hong Kong-headquartered law firm, King & Wood Mallesons.

Chinese sponsors now typically find it cheaper to borrow from overseas sources rather than banks within the mainland, given the exchange rate fluctuation between the dollar and yuan, as well as the variety of funding options provided by the overseas banks, Lv says. “As Chinese banks cannot debt finance more than 60 percent of a total transaction size, sponsors that invest in equities need to make up the shortfall by seeking co-investment partners either locally or through an overseas consortium controlled by them, for instance in Hong Kong, Singapore or one of the offshore markets.”

The current regulatory climate is also changing the nature of outbound deals sought by Chinese investors.

“Looking forward, a lot of power, infrastructure and resources deals with a Chinese state-owned background will happen in the global market, while there will be fewer acquisition deals in the real estate, hospitality, sports and entertainment industries because they are on the list of sectors that the Chinese government is not encouraging companies in China to buy,” Lv says.

Originating private debt

From global asset allocators’ point of view, diversifying their portfolios into the Asian market requires higher expected returns given the amount of risk that they are taking, according to industry observers.

Once investors decide to gain exposure to assets in emerging markets, they are typically looking for sub-segments of debt strategies that can deliver returns above high teens over the course of a number of years.

Some private lenders in the region are positioning themselves to take advantage of demand for special situations and distressed assets, especially in markets like India. According to PDI data, 13 private debt managers have garnered $14.5 billion in total over the last five years, targeting distressed debt, either for control or trading across the region.

Among managers with a strong presence in Asia-Pacific is Hong Kong-headquartered asset management firm, SSG Capital Management, a distressed debt specialist group that seeks to buy assets cheaply and turn them around. It held a final close of $1.7 billion for its latest distressed debt fund on 8 December and also hit a hard-cap of $800 million for its second direct lending fund at the same time.

Meanwhile, PDI recently learned that another Hong Kong-based alternative investment manager, PAG, is in the process of raising $750 million for its third pan-Asian loan fund.

“Once investors decide to gain some exposure to Asian private credit, I think a two-track approach is viable – one is choosing a pan-Asia debt play, and the other a country-specific debt strategy,” according to Chris Choi, Hong Kong-based senior vice-president at Portfolio Advisors, a Connecticut-headquartered investment firm specialising in private equity, private real estate and private credit investment solutions.

“The need for special situation credit is growing. Given tightening banking regulations, both global and local banks are retreating from traditional lending business towards small and mid-sized enterprises,” Choi adds. “This has led to a trend of new funds or managers joining the credit landscape across various strategies such as special situations, non-performing loans, distressed and private lending.”

In the case of India, Choi sees reduced political risks as a result of the improving legal framework creating a more creditor-friendly market. He estimates that private credit strategies will grow over the course of years given those positive factors. However, it may very well not be as dependent on the sponsor market as the US or Europe.