2023 preview: Private debt

LPs appear increasingly drawn to private credit. Coller Capita’s latest PE barometer survey found that institutional investors view private credit as more attractive than public credit given recent volatility. One in five plan to accelerate commitments to private debt funds in the next 12 months – only 15% expect to scale back – and senior direct lending and special situations are the most popular areas.

“Two-fifths of LPs view senior secured lending – a more secure position in the cap structure – as something that’s attractive,” said Will Year, a Hong Kong-based principal at Coller.

“Maybe there is an element of them trying to balance out how they think about different things in parts of their portfolio. They might have allocated more to riskier assets in recent years, and they see credit as a counterbalance. There is probably a liquidity aspect to it as well. LPs are looking at their portfolios and the level of liquidity being generated.”

Global private debt fundraising reached a record USD 213.7bn in 2021, and despite the upheaval in public markets, managers collected USD 93bn in commitments in the first half of 2022, according to Preqin. North America remains the number one market by some distance. In the second quarter, for example, it accounted for 95% of the USD 40bn raised globally.

Chris Mikosh, a managing partner and co-founder at Tor Investment Management, notes that US private credit players tend to be brand-name GPs who are constantly in the market. Their proximity and familiarity stand in stark contrast to Asia. Mikosh notes that regional credit funds were getting traction with mostly Western LPs in 2018-2020, but then travel restrictions curtailed the ability of LPs to conduct due diligence.

Time to shine?

With interest forming again and LPs back on the road, there are hopes that Asia will benefit from rising interest in private credit strategies globally. Mikosh believes investors are concerned about a looming recession and the potential impact on all asset values, so they are keen to build exposure to senior yield-friendly products. Private credit is well-positioned to command higher returns, given rising interest rates and widening spreads.

“Locking into something that’s now priced off a base of 4%-4.5% at a minimum is more attractive. Private credit is further protected by being mostly a floating rate instrument, so if rates rise by another 100-200 basis points, you are protected against that,” he said. “Many investors want to be in the senior secured portion of the cap structure because that’s where they most insulated from a potential downturn.”

Tor was established in 2013 and has more than USD 2bn in assets under management (AUM). Australia and New Zealand, Hong Kong, Singapore, China, and India have traditionally been its most active markets, plus cross-border Asia, which often involves working with Chinese corporates overseas. The appeal is that Tor gets Asian pricing with non-Asia jurisdictional recourse.

China is arguably Asia’s most dislocated jurisdiction. High-yield issuers have been severely hit by volatility in real estate, which has led to defaults and distress in the offshore bond market. While this behaviour has yet to spill over into other sectors, general sentiment on China is weak, resulting in bonds with yields to maturity of 12% to 25% trading in single-digit territory.

Tor is reluctant to participate, citing a lack of transparency around policymaking, recovery waterfalls, and whether borrowers can repay without trying to issue another high-yield bond. Yields are not attractive enough to make them worth chasing unless the counterparty is a reliable multinational.

There is a degree of scepticism around Southeast Asia over recourse rights; otherwise, the firm is positive about what it is seeing in most markets. Indeed, in markets like Hong Kong and Singapore, which are typically well-covered by banks and deliver lower returns for private debt investors, broader dislocations in the Asia market have created a new wave of opportunities.

Rates and spreads

Rising rates are a contributing factor, but not the only one. According to Mikosh, the 10-15% returns that were characteristic of the low interest rate environment of the past decade have generally seen bump of at least 500 basis points. Tor has completed deals in the past six months underwritten to returns ranging from 14% to 26%, although pricing is very idiosyncratic.

“Asia already commanded a risk premium over US markets. When US senior private credit was yielding 7-8% three years ago, in Asia we were getting 12-15% returns for similar risk. Now, both those needles have moved - the US has widened by 200-300 basis points and Asia has widened by 500-plus basis points,” he said.

“In Asia, we find ourselves in a lender’s market where we control the narrative on term sheets. We have been able to get equity upside in certain transactions, demand cash coupons, and maintain strict control via key covenants - the sort of things that borrowers negotiate away from in other markets.”

Other private credit strategies involve less risk, but Asia-based managers are still able to generate attractive yields versus comparable products in the US. CDIB Capital, for example, lends money to third-party financiers like consumer credit providers, takes security over the loans made to consumers, and then subordinates providers by asking them to absorb losses to an agreed level.

CDIB securitises the debt, sells a senior tranche and holds the rest, aiming for a loss-adjusted return of 13-15%. The emphasis is on the cash coupon. When there is equity upside, it tends to be small, lifting the return from 13% to 17%. Tor Trivers, the firm’s head of structured credit, notes that equivalent BB-rated bonds in the US trade at 6%, while US direct lending is around 10%.

He has also seen new loans in Asia reset higher, reflecting wider spreads as well as higher rates. However, some of the financiers that CDIB lends to have been slower to adjust.

“Five or six months ago, they wanted to increase the size of their facilities and decrease the cost,” Trivers said. “They were pretty tone-deaf, and maybe that’s because we aren’t the only lender to them, and the other lenders are slower to adjust. Now, though, borrowers are beginning to recognise that they will have to pay more.”

This rationalisation of expectations is playing out across geographies and strategies. Mikosh suggests that more high-quality borrowers will turn to private debt solutions because traditional capital providers are de-risking, so refinancing through the bank loan market or the high-yield bond market won’t be possible.

“They know they are overpaying but they want to bridge their current debt situation to a better place,” he said. “If they have a bond due this year, they might refinance with private credit in the hope of returning to the bond market in a year or two.”

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• Topics
• Credit
• Credit/Special Situations
• Fundraising
• Asia
• private debt
• Coller Capital
• Tor Investment Management
• CDIB Capital