This article is sponsored by Huatai International
Historically, Asia-Pacific has seen few private debt GPs, is that changing?
Ryan Chung: Development of the private debt landscape in Asia has been intriguing. The early days were dominated by GPs from North America or Europe with a mandate to invest in OECD countries in Asia-Pacific. As time progressed, we have seen many local GPs were created through spin-offs from Western fund managers and new entrants like Huatai, which has been established since 2014. Within the past five years, Asia-Pacific private debt AUM has doubled to $60 billion as a result of LPs and GPs pivoting to the region.
The market was very competitive at the beginning of the 2010s as Asian banks that were less affected by the GFC began to expand their balance sheets. Corporates were also more familiar and receptive towards growth capital from private equity instead of private debt. For private equity sponsors active in the buyout market, the emphasis was on bank financing.
This started to change from 2015 onwards as company valuations increased causing private equity sponsors to further enhance their capital structure with the inclusion of mezzanine debt or “stretch senior” to increase IRR.
An increasing number of private debt GPs has also been fostered by LPs and financial institutions allocating more capital towards private debt managers due to its relatively superior risk-return profile and resilient nature compared to public capital markets.
What are the greatest challenges faced by private debt funds in Asia?
RC: One of the greatest challenges facing private debt funds in Asia is dealing across different jurisdictions. When the legal, regulatory and economic environments are not homogenous you need to understand each market you are operating in so you know how to structure each transaction. We also see different business cultures and levels of capital markets development across the region, which can affect the way you source transactions and manage portfolio companies.
Asia can be very dynamic. One industry might prosper in one country but not in another, so you need to know where each country is in terms of its economic development to be able to target the best opportunities. Due diligence can also be a challenge, with different legal issues and management styles across the region. There are also language differences, and this can be challenging for non-Asian GPs lending in the region as they may find it difficult to get a good read on a management team if you do not understand the culture.
What’s the competitive environment like? Are banks still major players in corporate lending?
RC: It has always been competitive. Asian bank liquidity for corporate lending in general remains very strong. For private debt providers that means we need to be able to offer a layer of capital not available from the banks in the form of mezzanine and subordinated debt or stretch-senior debt.
Isaac Wong: Due to the continued strength of the bank market in this region, we need to think carefully about how we can layer ourselves into the capital structure to achieve good, risk-adjusted returns. To put things in perspective, there was approximately $600 billion of new bank lending per annum in Asia-Pacific pre-covid, but private debt in the Asia-Pacific is still only about $60 billion. So, despite still being a very competitive credit market overall, private debt has grown significantly and passed an inflexion point to become a permanent part of a borrower’s financing options. There are still parts of the market, such as middle market companies, which have solid businesses, but are not serviced by the commercial banks.
RC: In Asia we are often in competition directly with growth private equity funds, so we need to be able to invest in private credit situations throughout the capital structure to remain flexible. While private debt in Europe and the US is often segregated into specific lending, such as receivable financing, direct lending and term loan B, we can be more nimble, allowing us to select the optimum risk-return opportunities.
Asian LPs are big investors in Europe and North America but do they have an appetite to back local teams?
RC: Historically, LPs would turn away from Asian private credit as public credit strategies with good leverage provide sufficient returns. However, volatility in the last two years has highlighted the risks involved with supposedly liquid credit strategies.
In 2021, Asian public bond prices across the spectrum have been severely hit, impacting the returns and capital preservation for investors, especially across high-yield bonds. As a private debt manager, public securities price movements do not affect us directly as we invest into situations where we have strong security and covenants for capital protection.
IW: As this private debt market has developed, Asian private credit now represents a product or strategy that did not really exist for LPs (Asian or non-Asian) before. From an Asian LP perspective, since we are a GP focused on Asia, we are backing companies that will help to develop the economies in the region, which in turn is beneficial for the beneficiaries that these Asian LPs serve. Also, for LPs that have longer term asset-liability matching objectives, private debt provides a very attractive investment strategy in providing strong cash yields without the volatility of public markets, or risks of being an unsecured creditor.
RC: Asset allocations have historically been focused on public debt, public equity and private equity. However, public debt and equity can exhibit extreme volatility and we also see a growing number of LPs now have dedicated private debt buckets in their allocation and in-house private credit desks. However, they are also looking for local GP partners with a proven track record for their Asian allocations.
How can the region develop its own private debt ecosystem and bring on board PE funds, advisers, etc?
RC: The whole community serving this market – the sponsors, advisers, commercial banks – all need to grow in tandem to ensure there are no bottlenecks in the financing process.
IW: Private equity sponsors have been instrumental in accessing private debt capital which utilises mezzanine and unitranche structures. We have seen unitranche deals in Australia being a viable alternative to traditional bank financing. And as PE activity has picked up again in Asia recently, we have seen and closed the first Asian unitranche deal. Corporate borrowers are also becoming more accepting of private debt, especially as banks in Asia continue to under-service middle-market corporates. We see private debt being instrumental in helping these companies to grow.
How is the future for Asian private debt managers?
RC: The future is bright. East Asia has approximately 40 percent of the world’s population contributing to 25 percent of its GDP so there is a lot of scope for growth. Development of this asset class in the region means there is far more on offer to borrowers than there was a decade ago and this is now a permanent investment strategy available for LPs to invest in. The downturn in 2020 due to covid-19 has also created an opportunity for firms with good fundamental underwriting knowledge to target companies in need of capital to recover and grow as we come out of the crisis.