This article is sponsored by Tor Investment Management
What are the macro trends currently driving demand for alternative lending in Asia-Pacific?
Patrik Edsparr: Credit markets are frozen to a large extent for a vast number of companies. The high-yield market is broken and companies that relied on that have no access to credit. Different groups of international and regional banks have also pulled back, greatly reducing credit available to many large, quality companies. I would argue this dislocation is more severe than in previous crises, such as in 2008, when Asia was one of the engines pulling the global economy out of the crisis. We have built our lending platform to capture exactly these market conditions.
The trauma from the Chinese property crisis that began in 2021 is still playing out and it is not clear yet which businesses sponsors will support and which will be allowed to fail. Regardless of a company’s longer-term outlook, if there is no access to credit, it will not survive.
We have never had a stronger pipeline or seen as broad a range of opportunities as we see today. Given that backdrop, the main question is then how do you build the best portfolios to address what has happened in the space?
What are the latest dynamics in relation to yields in the market?
Chris Mikosh: Of course, yields are notably higher due to global interest rate movements. However, more importantly for our market, absolute returns have outpaced this move in rates. We believe this is mainly due to the scarcity of capital and lack of alternatives for numerous borrowers. We are engaging with higher-quality borrowers and securing better terms and collateral across our products. The vast majority of the financings we are doing today are on a senior secured first lien basis.
In a steady market environment, we achieve excess returns through our ability to structure in a customised manner. We are now getting paid more for that today than ever before through elevated upfront fees, higher coupons and in some cases, equity upside, all of which enhance our overall returns.
How is the stress in China impacting the rest of the region?
CM: Clearly, China is under tremendous stress, especially within the real estate space, but also with respect to other industries and capital flows. In contrast, we don’t see the same type of collapse in other Asian economies; however, it is obvious that the credit capital flowing into the region has slowed, especially in the last two years.
Also, many investors have not realised the extent to which Chinese real estate development funding was actually equity in substance but credit in form, and how large a portion of overall flows it represented. Our portfolios have been persistently underweight to China at around 10 percent or less since inception because of concerns around structure, recourse and opacity. We are optimistic about the opportunity set that continues to exist in the rest of the economies in the Asia-Pacific region.
PE: If you were involved in lending directly or indirectly to developers or specific projects in China, you are now confronted with substantial issues in your portfolio and are making difficult decisions regarding additional cash injections or workouts. This is true for banks as well as credit funds. For many funds, their core business that was centred around Chinese property or share-backed financing deals does not really exist anymore, and lending at a new loan-to-value just is not possible.
For us, the exciting thing is that our opportunity set is stronger and our bartering position in terms of pricing and structure has radically improved. Most of the knock-on effects outside the region turn into a glass-half-full analysis. If you can lend to an interesting business in Hong Kong, Singapore or Europe as a result of a sponsor under stress from China or another Asian sponsor that has a hard time getting financing from banks in North America or Europe, then that presents a compelling opportunity on a risk-adjusted basis. These opportunities are coming to people like us. The truth is that there are very few people like us.
We are not betting on China having a rebound in the short run, because we don’t have to. Some investors see the difference between Asia as a region and China, while for others the whole region gets tarnished by the fear of China, which we feel is a mistake. The level of returns, and the credit quality of the deals we are pursuing in the region, are superior to anything we have seen, and clearly superior to what is currently available in Europe or North America.
What does it take for private credit managers to successfully operate across the Asia-Pacific landscape?
PE: Having experience through multiple cycles is key. Major portions of our investment team were not only committing capital through the 2008-09 crisis but also during the Asian/global crisis in 1997-98, when many credit teams were first set up. Investing is going to look a lot more like it did then than it has looked for the last decade. If you don’t have a team with experience to structure correctly and anticipate problems, then you are in for a rude awakening. Many of the large global firms that have raced into this space over the last few years are the same ones that arrived in the mid-to-late 2000s and then withdrew after a failed approach.
CM: There is a significantly higher risk premium available with much less leverage in credit in Asia than in other parts of the world; however, knowing how to approach the opportunity and structure accordingly with a large and sophisticated team is imperative. Our advantage in these markets is a deep senior team that has the necessary experience to operate in this environment. Our near 20-person investment team has an average of 20 years of experience at the director level and above.
“We have never had a stronger pipeline or seen as broad a range of opportunities as we see today”
Tor Investment Management
PE: It is also important to recognise that this is not an SME direct lending opportunity. The opportunity for us has always been more aligned with what Chris and I pursued at Goldman Sachs and JPMorgan respectively, which was targeted at larger, more robust companies in terms of their ability to withstand business cycles.
Engaging in these opportunities requires advanced structuring capabilities and the ability to analyse complex situations to develop solutions for credit investors. That is very different to providing working capital to hundreds of roughly similar growing smaller companies with the hope that they will grow to a point where they can refinance and delever. That is a fundamental difference between the opportunities we are pursuing and what is a large part of the Western credit markets.
What do you expect to see going forward when it comes to both LP and borrower appetite for private credit in APAC?
CM: We continue to see risk return at a far superior balance than in comparable situations in the US and Europe. Many LPs are underweight on Asia in their portfolios, while the penetration of private credit in Asia sits at around 5 percent of the overall market, and Asia represents more than one-third of global GDP. We think we will see more of a balance over the next decade.
There has been a growing appetite from LPs and those capital flows are intensifying. We had three years where LPs could not visit the region because of covid-related travel restrictions. However, this year we have seen renewed interest in the region and that continues to gather pace.
PE: The expected return landscape has shifted dramatically in favour of private credit globally. We are currently underwriting to gross returns exceeding 20 percent, which our latest fund is now tracking. That comes with a lot of downside protection as most of it is senior secured lending, so the returns can withstand some severe shocks. There are very few markets in the world where you can realistically expect equity to perform better. Equities have defied gravity under a unique macro backdrop for the last decade and that is now changing.
“Many LPs are underweight on Asia in their portfolios”
Tor Investment Management
We feel strongly that Asia-Pacific credit warrants inclusion in a larger portfolio. Diversification is more important than anything else right now, and Asia is less correlated to other global markets. Asia also offers different types of opportunities, with less leverage and less reliance on traditional sponsors who may or may not be there, as there isn’t enough capital to go around for private equity to support all the portfolio companies that are struggling. This will be the first time that many of the 2008 portfolios will be stressed when sponsors are not there. The growth story has fundamentally changed.
In short, the interesting part is that the relative value between equity and credit, particularly well-structured private credit, has radically changed. The correlation and diversification benefits of Asia-Pacific private credit have also improved to make it much more exciting.
Where are you putting the most capital to work in Asia-Pacific?
Patrik Edsparr: Approximately three-quarters of our portfolio is invested in developed Asia-Pacific countries or in cross-border deals where we can depend on assets or jurisdictions for enforcement outside the region, typically in Western Europe or North America. We favour ‘common law’ jurisdictions such as Australia, Singapore and Hong Kong over markets such as China, India or Indonesia. However, we may finance corporates or sponsors based in those countries if we can underwrite collateral in a different country.
Patrik Edsparr, chief investment officer, and Chris Mikosh, portfolio manager, are co-founders of Tor Investment Management