Asian private credit shines as US, European covenants weaken

As covenants in US and European private credit become weakened from an increasing flow of lending capital, asset allocators and managers are eyeing Asia as the next frontier due to its relatively untapped yet sizable market.

At the Fiduciary Investors Symposium in Singapore, IFM Investors executive director and head of diversified credit Hiran Wanigasekera said Asian private credit is “underrepresented” in asset owner portfolios, given the region’s fundamentals and economic contribution to the world.

Asia-Pacific private credit represents only 5 per cent of the asset class, but the region accounts for 46 per cent of the world’s GDP, according to data from the IMF and Preqin.

“[Asian] private markets being an earlier stage place to invest in the development cycle means that it does create opportunities. You do have more conservative lending structures that’s quite standard. It is much more complex and that complexity premium is much larger in the region here,” he told the symposium.

“From a legal perspective, currency risk perspective, government regulatory structures perspective, they all add to that and deliver that.”

One thing that’s holding investors back from allocating more towards Asia is they are less familiar with the region compared to some developed markets and that it’s less commoditised, Wanigasekera said.

“Right now, given base rates are up, the yield actually can justify you taking a credit viewpoint and to making an entry via credit into this region where you have a lot more downside protection and get yourself comfortable,” he said.

While the US and Europe will continue to receive significant lending capital due to their size and maturity, Wanigasekera said some cracks are starting to show in covenant and payment-in-kind structures and leverage ratios.

“It’s not endemic. It’s not everywhere. We are starting to see that more and more, primarily because there are so many managers out there that are competing for the same assets,” he said.

“You do need to actually provide more favourable terms to the borrower to actually accept and win the deal.”

CPP Investments managing director and head of APAC credit Raymond Chan highlighted many international investors have tried and failed to apply their global investing approach to Asia, which shows the importance of finding local partners or a regional office.

The fund processes around $20 billion worth of investments through Asia annually, and credit accounts for roughly 5 per cent of it ($1 billion), Chan said. The average deal size it looks for is $200 million, but it is also willing to write smaller cheques of $50-30 million, which is more fitting for the size of some Asian economies.

Chan also observed that the banks, which already occupy a large part of the Asian credit markets, is trying to claw back some shares with a more stabilised capital reserve following the Basel reforms.

CPP Investments delivered an annual return of 16.5 per cent for its credit portfolio in the last financial year, and Asia delivered low double-digit returns, Chan said.

“In terms of the performing credit market, the banks are starting to come back aggressively,” he said. “That’s why I think the offer and the task have become more challenging in the past 12 months.”

“The luxury for us in Asia is for a lot of more complicated transactions, or transactions that you need a more bespoke solution, there aren’t – unlike the US market or European market – a lot of players that can write big cheques and deliver it in a very short period of time.”

The specific markets CPP Investments focuses on tend to be “scalable economies” which include China, Japan and Korea in North Asia, India in South Asia and Australia in the Pacific. India has a lot of investment potential but Chan said two factors are holding credit investors back.

“Number one is the currency drag. This year is really bad, I think it’s a five [percentage] point drag, which is quite painful for US dollar investors,” he said. “The other is tax.”

This means that after deducting tax and FX leakage, an alpha-chasing investor like CPP Investments needs to go up the risk spectrum to get the return it needs. “This is a very delicate balance that we have to make,” Chan said.

Head of Asia Pacific at Albourne Partners, an alternative investment consultant, Debra Ng said the Asian market tends to throw out a lot more different opportunities than in the US or Europe.

“In Asia, it’s more focused on opportunistic lending and capital solutions versus US direct lending and mezzanine [which] account for maybe two-thirds of the global private credit,” Ng said.

But she said the Asian governments are playing a more active role in fostering local private credit and equity managers as a way to grow the domestic economies.

“They’re really interested in… providing sufficient financing to grow better sovereignty. In Malaysia, they’re doing the same thing through the Khazanah Jelawang project [to grow] private equity managers and ideally, the whole ecosystem will grow. Then you’re less reliant on global flows or global companies and currency.”