By Hamlin Lovell, NordicInvestor
The market environment has helped private credit gain traction in Asia in recent years as companies seek out financing alternatives to listed bonds, bank loans and equity. This has opened a market opportunity for funding s outside the public credit, banking, and private equity industries, according to Sumit Bhandari, Lead Portfolio Manager, Asia Private Credit at Allianz Global Investors.
Traditional public market solutions such as syndicated leveraged loans and high-yield bonds mainly serve large-cap or larger mid-market corporates, which leaves a void for AllianzGI’s Asia Private Credit, a mid-market lending strategy focusing on high-growth companies in Southeast Asia, South Asia, Oceania and the wider Asia-Pacific.
Allianz Global Investors (AllianzGI) launched its first Asian private credit fund in 2019.The second Asian private credit fund, Allianz Asia Pacific Secured Lending Fund (AAPSL) had its first close in 2022, raising $476 million, and aims for a second close taking Fund 2 assets to $600-700 million in 2023.
Sumit Bhandari has been running the strategy since 2018, with a focus on performing credit rather than venture debt, distressed debt, or special situations. The target company size is mid-market, which in Asia Pacific is defined as enterprise values between $500 million and $2 billion, and EBITDA between $15 and $100 million with average EBITDA currently $40 million.
“This is a lot larger than the usual $20 million EBITDA mid-market definition cut off in the US. Moreover, mid-market companies in Asia have a much higher market share, which also provides barriers to entry and significant influence with customers and suppliers,” points out Bhandari.
The country focus is Asia Pacific excluding China, with the largest exposures being India and Australia at around 30% each; the remaining 40% of the fund is split between 4-5 ASEAN countries.
Between 8 and 10 industrial sectors are present. Cyclical sectors are avoided and there is some bias to long term growth in healthcare, technology and utilities.
“GDP growth, increasing digitization, supply chain diversification away from China, social infrastructure such as schools and hospitals, telecom towers and data centres, regional brand building and capital spending are all important themes that differentiate the strategy from listed high yield in Asia, which is dominated by China and real estate,” says Bhandari.
Secular and cyclical yields
The strategy targets a gross IRR of 13-14% in USD and has averaged 13.3% since 2010. Returns come from several sources. “Around 5-7% of returns are cash coupons. The other half are a mix of Payment In Kind (PIK) coupons, upfront fees, redemption premiums and some equity upside,” explains Bhandari.
The pickup over public markets is not easy to gauge on a like for like basis since over half of Asian high yield is in China, there is not much of a broadly syndicated loans (BSL) market outside Australia and public credit markets anyway cater mainly for larger companies. Relative to US markets, Bhandari estimates a pickup of 200 basis points over private debt and 300 over public corporate debt in early 2023, and this works out at 75-100 basis points per turn of leverage.
Increased yields on public paper have somewhat reduced the yield pickup from private credit globally, though the relative appeal of the two partly depends on investor time horizons. Bhandari, argues that, “public market debt is a more cyclical opportunity because once the spreads recompress, re-investments will be at lower yields. Our strategy is a more secular opportunity where we expect to earn low teens returns for multi-year periods, compounding up to multiples of capital”.
Risk mitigants
Yield pickups fluctuate with market cycles, but risk mitigation is always an important attraction of private credit. “Whereas high yield bonds are unsecured, we have security and collateral. Whereas bonds may have only incurrence covenants that prevent further borrowing if breached, we have maintenance covenants triggering default events so that we can take proactive action. We also have negative covenants, information rights and board seats,” points out Bhandari.
The strategy performed well in 2022 notwithstanding some minor issues with two loans. Recently, one borrower in Australia had temporary liquidity issues due to bad weather, and another borrower who is performing well breached covenants on capital spending. “We engage on a long-term basis, and we had some interaction and discussion to work out these bumps in the road,” says Bhandari.
Over the past 12 years, five deals out of 100 required restructuring, but never went through an insolvency process. “We like to work in a collaborative way. The worst loss was 19% of principal, but we might have broken even including coupon income. We have the right collateral and enforcement packages and legal and structuring capability within the team, so that we are prepared for restructurings,” he explains.
The big picture default forecast for listed Asian credit could be as high as 4-5% in 2023, but this is not as relevant for AllianzGI’s bottom-up approach, focused on 20 investments that are more company and sector specific.
Transition and de-risking
The strategy typically does 7-9 new deals per year. Most of them are held to maturity, which averages 4 years, but not indefinitely because private credit by its nature is transitional and transformational rather than permanent capital. “Borrowers want flexible credit structures and de-risking over time can come from cash coupons, cash sweeps and amortization of principal, which can also be adjusted for variations in cash,” says Bhandari.
Leverage
De-risking means that leverage can decline over the life of a deal. And in 2022, leverage multiples have also come down by 0.5 to 1 turns at the outset of a deal.
Leverage can be higher in private equity sponsored deals, since global private equity sponsors compare deals on a global basis. “We feel comfortable with the leverage in buyouts because PE firms are financially capable and carry out a large amount of diligence,” points out Bhandari.
Sponsored and non-sponsored deals
The strategy is typically exposed to 70-75% corporate and 25-30% private equity sponsored deals and is well placed to source a wide spectrum of PE related deal-flow “We work with both global and local private equity players. Our fund of funds, Alliance Capital Partners, invested in global and regional LPs, provides insight and access. Since we have no direct private equity business, we also avoid the perception of a conflict of interest,” explains Bhandari.
Uses of finance are typically split 40% refinancing, 30% growth and 30% acquisitions, but this can vary over business and credit cycles. “The share of acquisitions has gone down last year as companies delayed acquisition plans and PE firms could not get deals done,” observes Bhandari.
Sustainability and positive impact
The strategy is “returns first”. “The portfolio of 20 companies includes 4-5 in renewables and clean energy, where returns from solar and wind power in India and Vietnam are higher than in Australia,” says Bhandari.
Utilities can be exposed to some regulatory risk, and Bhandari has confidence in the regulatory framework in India which has attracted significant foreign investment: “of the top 10 players, 7-8 are owned by strategic private equity and there has been substantial influx of FDI capital in the sector”.
India now offers more regulatory clarity after settling a retrospective taxation dispute with several companies including a UK oil company, Capricorn Energy (formerly called Cairn Energy) in 2021. Meanwhile, an Indian High Court judgment against the state of Andhra Pradesh has set an important precedent that should prevent local states in India from trying to avoid paying full electricity tariffs.
There are also projects with positive social impact: “in Australia acquisition financing has been provided for a firm that offers employment services for minor disabilities,” says Bhandari.
The strategy applies Allianz’s firm-wide exclusion criteria, in areas such as coal and controversial weapons and is SFDR Article 6. AllianzGI contemplates launching a separate SFDR Article 8 Asian private credit strategy, which is likely to target lower and more stable returns and have higher exposure to sustainable infrastructure and energy transition.
