Asia-Pacific’s private debt market is set for exponential growth as banks are increasingly stepping back from lending to anything other than blue-chip and highly rated entities.
Private debt origination in APAC has long lagged its US and European peer group but that is set to change as non-bank entities such as hedge funds, specialist brokers and private equity funds assume the mantle of lending to the lower reaches of the credit curve and to unlisted medium-sized enterprises.
"Asia's private debt market is likely to experience the deployment of billions of dollars of capital in the coming years, and the landscape of the market stands in sharp contrast to the private market in the US and Europe which has become crowded-out, while vast sums have been raised for private debt funds in those arenas in recent years,” says Michel Lowy, founder and chief executive officer of privately-owned global banking group SC Lowy, which focuses on banking, asset management and sales & trading in distressed and high-yield fixed income markets globally.
According to financial data provider Prequin, as of June 2019 Asia-focused investments represented US$57 billion, or just 7%, of the global total of US$812 billion in global private debt assets. Nevertheless, a positive growth dynamic is on display: Asia-originated assets accounted for 6.2% of a total US$518 billion in private debt assets at the end of 2015, with overall private market growth driven by bank balance sheet conservation and risk aversion.
"Various Asia-focused funds, including hedge funds and private equity vehicles, have been stepping into the space vacated by banks and in the process originating high-yield bond private placements and bilateral loans,” says Lowy.
The credit backdrop has been anything but resembling “business as usual” in the face of widespread lockdowns, dramatically rising unemployment, severely reduced corporate cashflow, particularly in Asia in crucial sectors such as tourism, food and beverage, and airlines.
However, against this unprecedented economic landscape there has also been concerted government intervention in the form of asset purchases, furlough schemes, and debt service suspension.
This has been conspicuous in Asia in the form of stimulus packages, direct support from multilateral lenders such as the Asian Development Bank and Asian Infrastructure Investment Bank, and bank on-lending to small and medium-sized enterprises from proceeds raised through sustainability and social bonds.
"The advent of Covid-19 has if anything accelerated the growth dynamic in a market which began to appear on the radar screen in Asia around 10 years ago. That dynamic has been fuelled by a pushback from banks which are increasingly focused on serving the needs of their big blue-chip clients. The medium-sized corporate sector is being ignored and opportunities exist for lenders who are willing to put in the credit work and apply bespoke solutions to clients,” says Lowy.
Within the private debt market tenors tend to be reasonably short, at around the three-year mark on average, with borrowers keen to keep further funding options open given the underlying benchmark interest rate dynamic for rate compression with an eye on the likely possibility of access to cheaper financing at a later date. Refinancing has been a conspicuous driver of private market demand as well as the usual corporate growth ambition.
Deals have been printing in bullet form at around the 8%-15% mark with average sizes of between US$10 million and US$100 million, and a frequent feature is the inclusion of an equity kicker which is included in the form of warrants, which may take the internal rate of return on the investment to around the 20% area.
The most active areas in Asia for the growth of private debt have been Australia, Hong Kong/Singapore, India, and Indonesia, with a focus on a wide range of industries and within the real estate sector.
A classic recent example of reverse-enquiry derived private deal is the US$70 million five-year senior unsecured trade from Hong Kong-listed China Aircraft Leasing Group, which crossed the line this week at a decent 5.9% coupon and is scheduled to be issued in iterations – to an unnamed investor – beginning with a US$35 million issuance and a like-size tranche to be printed within one year at the issuer’s discretion.
"For our part, we recognize that those are not easy transactions, and that during the term of the lending we will be monitoring a borrower's critical ratios such as debt-to-ebitda closely and will keep a regular dialogue with our partners,” says Lowy.
A fear hanging over the private market is that it will submit to the forces of “Japanification” or a prolonged, systemic economic stagnation which relieves the market of its nascent dynamism and whose end-point is widespread debt service stress and restructuring.
Still, there is widespread market optimism, not least due to Monday’s publication of Pfizer’s success in the development of a Covid-19 vaccine, which threatens to bring normality back to the global economy early in 2021, the news of which drove US equity markets towards spitting distance of their all-time highs booked in February.