Robust growth seen for Asia-Pacific private debt

MANAGERS of private credit funds in Asia-Pacific remain bullish on the asset class’ growth prospects, despite the shakeout unfolding in the US.

Sanket Sinha, Lighthouse Canton managing director and chief executive of global asset management, expects Asia’s private-credit market to grow by 15 to 20 per cent a year, a pace that could nearly double assets under management (AUM) in five years.

Andrew Tan, Muzinich & Co Apac chief executive and head of Apac private credit, is likewise optimistic about Apac’s growth prospects. “The fundamentals – rising demand for alternative financing, a maturing investor base, and a less saturated lending environment – continue to support a significant expansion of the market over the near to medium term.”

Tan said: “Apac private credit markets continue to offer certain advantages that are getting harder to find in more crowded Western markets – structural protections through asset collateral, maintenance covenants and higher returns in general.”

The US market for private credit, estimated at over US$2 trillion in size, is roiled by a surge in redemption requests which has caused several funds to impose gates on redemption.

Arguably more worrisome is the funds’ exposure to the software sector where the threat of artificial intelligence to their business models has cause a downward revaluation of both debt and equity. For lenders, this could magnify leverage and raise default risks.

Private credit in Apac, however, is shielded on both counts. Most funds in the region are closed-ended. And, exposure to pure-play software is “not meaningful”, said Sinha. “We remain very positive on the structural growth of private credit in Asia. We treat the headlines coming out of US markets as noise, not structural headwinds. We remain bullish.”

Exposure to software-as-a-service (SaaS) companies among US private credit funds is estimated at up to 20 to 25 per cent.

Growth drivers in Apac

Private credit’s AUM in Apac at end-2024 was estimated at US$59 billion, just a fraction of the estimated US$2 trillion in the US.

Sinha cites several growth drivers. One is Apac’s need for trillions of dollars for infrastructure investments and working capital which bank financing alone would not be able to satisfy. Two, Asian companies are becoming large corporates with more information transparency, which helps lenders in their due diligence.

Three, more Asia-centric asset managers have come into their own, attracting capital from institutions, family offices and high-net-worth individuals.

Sinha said private credit is able to extend into areas that banks may find challenging. These include holding-company financing and growth debt, typically sought by early stage companies in growth sectors.

Such companies, said Sinha, are asset-light and hence, find it difficult to secure bank funding. “Private credit players are able to structure deals … with bespoke covenants and credit enhancements.”

He estimates that spreads on private debt in Asia are 200 to 300 basis points higher than equivalent Western credit.

Muzinich’s Tan expects institutions to increasingly look beyond the US into Europe and Apac for opportunities. Investors in the wealth space, more specifically in the US, are turning cautious.

“But we have also observed that they have become increasingly sophisticated towards this space and are differentiating between deferring risk profiles, protection, pricing and quality of underwriting. In this regard, there are inquires around what alpha private credit in Apac can offer in the current environment.”

Apac’s private credit market accounts for less than 2 per cent of the region’s overall credit market. Banks account for 79 per cent of all lending in Asia compared to 33 per cent in the US.

As it is relatively nascent, the sector in Apac has not been subject to the US’ “extremely crowded” conditions which have led to a deterioration in underwriting discipline. Sinha said in Lighthouse’s newsletter: “In credit markets, where the upside is capped by a contractual return and the downside in default can be severe, that crowding creates real and lasting problems.

“You inevitably end up picking more losers than you can afford, when too much capital is chasing the same opportunities. At that point, deployment pressure begins to take priority over portfolio quality.”

In contrast, credit structures in Apac remain more conservative, reflected in full covenant packages and leverage rarely exceeding three times. Lenders also retain meaningful control rights – “none of the structural erosion that competition and capital abundance have driven in the West”.

Non-accrual rates, which reflect the percentage of loans where payment of interest or principal is 90 days past due, are significantly lower in Asian private credit compared to the US.

The majority of Apac private debt (90 per cent) tend to be unsponsored, or those without private equity backing. Unsponsored deals mean the onus is on the the private credit fund to conduct thorough due diligence; yields may be higher as well.

SaaS troubles

On software, SaaS companies’ subscription revenues were favoured by private credit for the predictability required to support high debt loads at leverage multiples of five to seven times Ebitda (earnings before interest, tax, depreciation and amortisation). But with the downward revisions in expected revenues, leverage ratios have spiked on a deteriorating Ebitda base, said Lighthouse.

Sinha said: “With lower valuation, the fall in security value leads to under-collateralisation or loan-to-value breaches. In exposures with back leverage, the challenges are more pronounced as back leverage providers seek margin top-up.” Back leverage refers to financing by third-party lenders, typically banks.

“In the absence of corrective actions, loan sale or security liquidation cannot be ruled out.”

Meanwhile, the upheaval in the private debt market due to SaaS exposure is likely to create opportunities in distressed debt, Sinha said.

Muzinich’s Tan also expects a revival in “opportunistic strategies”. “When SaaS loans are downgraded, CLO (collateralised loan obligations) managers typically look to exit those positions to avoid holding lower-rated ‘CCC’ loans. This may cause them to sell at discounts that at times might not reflect true fundamentals.

“At some point, that will create a compelling entry point for opportunistic and special situations investors who are looking to either restructure the capital stack or work with management to turn around the underlying businesses.”