Private credit avoids bank clash
Rather than taking market share away from banks, the influx of private credit funds into Asia is filling underserved parts of the market and creating new business for financial institutions.
In the US and Europe, private credit ate into the leveraged finance market, especially Term loan Bs in recent years, as issuers sought certainty with club-type deals during rates volatility – a trend that has since reversed.
In Asia Pacific, the dynamic has been different. While Australia and India are extremely competitive battlegrounds for banks and funds looking to provide credit, the rest of the region has more room for new players.
“In Asia, private credit is complementary as opposed to competing or substituting for loans,” said Joe Cheung, head of loan syndications for Asia ex-Japan ex-Australia in the leveraged capital markets and special situations group at UBS. “It provides capital that banks would not typically finance – high growth but negative Ebitda companies, underperforming companies that have crown jewel assets or challenging sectors for the bank market.”
Andrew Tan, CEO for Asia Pacific and head of Asia Pacific private debt at investment firm Muzinich & Co, said that regulatory trends have caused banks to focus their lending on the biggest names, creating a gap in the market for private credit in Asia.
“Banks are gravitating towards large and upper middle market companies, pushing them away from SMEs and low to core middle market companies which are the ones that will take up more regulatory capital,” said Tan.
Some global asset managers that have raised multi-billion-dollar funds and tend to write US$100m-plus tickets are heard to have struggled to deploy their funds in Asia, since they target the biggest companies.
“If you are a private credit fund focused on mainstream lending to larger companies, definitely you are going head-to-head with banks,” said Tan. “If you are focused on capital solutions, trying to do something banks are not able to get their heads around, like special situations and distressed debt, there’s more room.”
In some markets, like Singapore, government policies have encouraged local banks to lend to SMEs, but in others there is more room for credit providers.
“Hong Kong is an example where we are seeing some gaps forming,” said Tan. “Banks are distracted by the real estate crisis in China and pulling back on risk-taking, so that throws up opportunities in financing smaller businesses.”
Private credit funds may also be willing to take positions in subordinated debt tranches, while banks are only willing to provide senior debt.
“Banks in Asia are likely to view the rise of private credit as more an opportunity than a threat,” said Eng-Lye Ong, partner at law firm Dechert in Singapore. “Private credit lenders can participate in syndicated or club loans originated by banks and buy debt that banks no longer wish to hold. They will also be willing to look at lending junior debt where senior bank debt is already in place, and lending to companies introduced by banks that are unable to satisfy the bank’s lending criteria.”
Additionally, companies that once met banks’ lending criteria might no longer qualify.
“In a higher interest rate environment, asset valuations typically weaken and banks face loan-to-value limitations that might prevent them from lending or refinancing, which presents private debt with an opportunity to come in,” said Muzinich’s Tan.
Conversely, after smaller companies grow using private credit they might graduate to syndicated loans.
Companies can choose between the two sources of financing depending on whether they want to prioritise keeping interest costs low or paying in the region of 10%–15% but obtaining more flexible terms.
“If an issuer wants more leverage and flexibility, it might explore the private credit market for bespoke financings, such as unitranches,” said UBS’s Cheung. “If it wants a tighter financing cost, it goes to banks.”
Banks’ increasingly stringent ESG criteria restrict them from lending to companies in carbon-intensive industries, such as the coal sector. That creates a niche for some private credit funds.
“Even for metallurgical coal, a lot of banks will have guidelines saying they will only lend a certain amount to this kind of business, so every deal in Europe, the US and Asia has to compete for this finite pool of bank funding,” said a Singapore-based loan banker. “This is where private credit can be very competitive.”
However, many private funds – or the limited partners that invest in them – apply their own ESG standards, meaning that not all will be able to fund these kinds of companies.
“About 80% of private credit funds would have some kinds of ESG standards. Those that have no restrictions around coal are having a field day lending to coal at high rates,” said Muzinich’s Tan. Muzinich’s Asia private credit fund is an Article 8 fund, meaning it takes ESG factors into account.
New customer base
Some banks not only originate private credit deals to distribute to funds, but also gain other business from those same funds.
“We are looking into lending and providing leverage to private credit funds too,” said UBS’s Cheung. “In APAC, fund financing is a big growth area. Historically a lot of financing is done in subscription financing, but that is slowly moving into more non-recourse back leverage, hybrid financing and NAV financings. It’s a good example of how banks can be complementary to funds and not competitors.”
Subscription financing allows funds to draw on a revolver, meaning that LPs need to top up their fund contributions less frequently, while NAV funding, secured against a portfolio, allows funds to raise capital to support companies or pay dividends and usually costs borrowers more.
“A lot of credit funds also need FX and rates lines, and we can provide them, so that’s a source of new clients,” said the Singapore-based loan banker. “You might view that we are funding our competitors, but banks also fund each other.”
There remain some segments where banks and private credit funds will compete, such as leveraged loans and asset-backed financings, but the incumbents might have the upper hand.
“While some borrowers will find the speed and flexibility offered by private credit funds compelling, in many cases banks will continue to have the advantages of more attractive pricing, existing relationships and local knowledge,” said Dechert’s Ong.
In some cases, Asian banks are trying to win a piece of the private credit business, either directly or with partners.
“Banks in Asia are very well capitalised, so they want to grow their loan books,” said Avinash Thakur, head of capital markets financing for Asia Pacific at Barclays. “Some of them are also focusing on junior pieces to get yield enhancement. Some are setting up their own private credit funds, and some prefer to go through larger players in the market.”
Singapore’s DBS Bank in 2021 agreed to be an anchor investor in an Asia-focused private debt fund managed by Muzinich, which the bank said would allow it to extend and diversify its credit risk participation beyond its usual portfolio to include special situations. Singaporean brokerage UOB-Kay Hian this year partnered with European private equity firm Tikehau Capital, which was advised by Dechert, to launch an Asia Pacific private credit fund with commitments of US$50m each.
While high offshore rates have priced some companies out of the offshore bond market and made private credit seem a better option, bankers and funds say it will still have a place even when rates come down and the bond market becomes more conducive for issuers.
“This year is going to be a much more active year in high yield in Asia, and it’s not going to be at the expense of private credit,” said Barclays’ Thakur.
“It’s important to build a market where you can find a price for every kind of risk.”