By David Chew (Partner, DHC Capital)
Introduction
Private credit continues to be in a boom phase and is experiencing rapid growth in terms of new fund launches and increasing deal sizes.
In this article, which follows on from our 2024 report, we examine the key trends in private credit and impact on Southeast Asian private credit, investment opportunities in the Southeast Asian private credit market and current challenges faced in private credit, including increasing defaults and managing defaults.
What is a private credit?
Private credit refers to privately negotiated loans between a non-bank lender and a borrower.
Private credit can be classed into 4 distinct sub-sets:
- Direct Lending: Sponsor backed; Corporate (typically mid-market companies); SMEs
- Mezzanine Debt: Junior debt that combines elements of both debt and equity with the expectation of higher returns than traditional senior debt holders
- Distressed and Special Situations: Rescue financing; Working capital financing; Bridge financing; NPLs; Event driven
- Specialty Finance: Equipment financing; AR financing; Real estate finance; Asset-based finance; Venture debt
Key trends and impact on Southeast Asian private credit
Rise of specialist lenders
The growth in the industry has seen a continued increase in specialist lenders focusing on private credit.
These include: (i) new fund launches from credit focused alternative asset managers (e.g. SC Lowy), (ii) small and mid-sized private equity funds expanding into private credit (e.g. Barings), (iii) large private equity firms expanding into private credit (e.g. KKR) and (iv) arms of sovereign wealth funds (e.g. Temasek).
There is also growth from non-traditional funds expanding into private credit. This includes (i) real estate firms partnering in Asian markets (e.g. Capitaland expands private credit in South Korea), (ii) insurance companies turning to private credit and (iii) Singapore government creating a new $1 billion fund to help high growth companies bridge financing gaps.
We highlight the following key takeaways:
- Despite new fund launches, private credit in Southeast Asia remains in its infancy and still relatively small compared to loans and private equity market
- Growth in private credit driven by regulatory changes. Banks retreating, pullback in risk appetite has resulted in banks focusing on top tier investment grade credits and corporate / SME clients with clear cash flow and collateral visibility
- Opportunity is for private credit to fill the gap left by the banks. Capitalise on borrowers with equivalent bank quality credits with higher returns and downside protection
- Strong demand for capital from borrowers in Southeast Asia due to need for capital in fast growing emerging markets
Traditional lenders fighting bank to expand foothold in private credit
The banks are fighting back to grab a bigger slice of private credit market via partnerships and joint ventures.
The banks are capitalising on internal strengths (vast origination platforms and teams and existing client bases) to offer clients a differentiated product from traditional bilateral loans, syndicated loans and bonds, whilst partnering with funds on an off-balance sheet basis does not expose new loans to same degree of regulation as traditional banking.
Scale matters in private credit
We have seen increased M&A activity involving private credit funds being acquired by large scale asset managers.
We expect to see more acquisitions, including in Southeast Asia as asset managers look for established global and regional platforms with large AUM to tap the growing private credit market, drive fee income and create synergies with existing business lines to offer integrated public and private market solutions to clients.
Liquidity
The private credit market has historically been illiquid and difficult to trade (it is called “private”).
We have seen increased activity to create liquidity in private credit. This includes creating a private credit marketplace, launching a private credit ETF and creating a more dynamic and robust private credit secondaries market.
We are at the start of this shift and expect to see further developments in creating liquidity and the expansion of the secondary trading of private credit loans.
Investment opportunities in the Southeast Asian private credit market
Current deal opportunities
The current deal opportunities include:
- Growth capital involving fast growing companies with limited track record for working capital, business expansion or strategic acquisitions
- Asset heavy, cash constrained companies
- Share backed financing
- SME financing
Increasing deal opportunities
We are seeing increasing deal opportunities in the distressed and special situations area in:
- Working capital and bridge loans to address short term liquidity needs (buy time; extend liquidity runway)
- Creditor buy outs to address difficult part of capital structure / loan to own / recap deals
- Court backed DIP super priority loans
Country specific
The country specific opportunities across Southeast Asia include:
- Malaysia: Offshoring from Singapore (particularly Johor-Singapore Special Economic Zone) focusing on logistics, manufacturing, food security, tourism, digital economy, green economy, financial and business services, healthcare, education
- Vietnam: Banking system facing increasing NPLs. The broader economy and real estate market facing difficulties in the recovery process. Credit has been cut back for borrowers
- Indonesia: Logistics, digital infrastructure, healthcare and green energy
Current challenges faced in private credit
Increased deal competition and macro uncertainty
The investment outlook is uncertain. Geo-political factors (trade wars and tariffs) loom large over the global economy. An uncertain interest rate environment (higher for longer) and recession fears are just a number of factors impacting the outlook for the global economy.
Managing risks in Southeast Asian credit
It is important to have good credit underwriting and documentation standards and staying true to these standards as deal competition increases. This reduces the risk of funding borderline credits and being exploited during negotiations to loosen deal documentation terms.
It is imperative to know the local market. Having local teams on the ground is a competitive advantage as legal regimes across Southeast Asia provide different levels of creditor protections and enforcement rights for onshore and offshore creditors (i.e. developed Southeast Asia and emerging Southeast Asia markets).
First signs of distress and managing defaults
We are starting to see an increasing number of private credit defaults in Australia and the United States. It is still early in Southeast Asia and we have not seen defaults permeate. We expect the default rate to rise on the back of a weaker global economy.
We highlight 3 key areas to effectively manage defaults:
- Pre-default: Stress test portfolio to identify early warning signs (e.g. short-term liquidity, headroom over covenants). Early identification of troubled credits gives optionality to preserve value
- Near default: Assessment of options: (i) new money from sponsors, (ii) restructuring options, amend and extend (and pretend) or resize the balance sheet, (iii) enforce over collateral or take ownership
- Availability of resources and skill sets to manage default situation: Key questions to ask. How prepared to engage in discussions with the borrower and other key lenders? How prepared to enforce over collateral or take the keys to the company? Does this skill set reside in house? Can we bring in specialists to allow the investment team to focus on core investing mandate?
