KKR, Babson to fill Asian lending gap left by banks

KKR & Co. and Babson Capital Management LLC are looking to take advantage of a pullback in lending by banks in Asia, after funds active in the region raised a record amount from investors.

While traditional banks dominate the lending business in Asia and financing by firms that lend privately is still small, KKR, Babson and Adamas Asset Management HK Ltd. expect it will grow in 2016. Funds focused on the region raised an unprecedented $5.5 billion of fresh capital from investors in 2015, according to figures from data provider Preqin.

With stricter capital and liquidity rules under the Basel framework curbing banks' ability to lend worldwide, other investors are stepping in to fill the gap. Slowing economic growth in China and other parts of Asia may also create more distressed debt that private funds can profit from, as shrinking returns globally on fixed-income portfolios fuel demand for private-credit strategies. While the U.S. and Europe have led the development of such investments, Asia is now getting in on the act, according to Barry Lau, managing partner at Hong Kong-based Adamas.

“Banking regulation has already had an impact on global lenders and will increasingly have more of an impact on Asian banks' ability to lend across Asia,” said Adam Wheeler, Sydney-based co-head of Asia Pacific private credit at Babson, an investment manager that oversees more than $200 billion in assets globally. “We definitely see the market opportunity for private debt growing here.”

The scope for expansion in Asia comes as authorities globally must make sure their crackdown on risky lending by banks doesn't just push such financing into less regulated areas of the financial system. “Regulators should pay close attention to the movement of risk throughout the entire financial-services industry,” Thomas Curry, the U.S. Comptroller of the Currency, said last year.

Meanwhile, firms struggling to access financing from banks are fueling expectations that demand will strengthen. In China, small companies are facing a tough time getting credit through more traditional channels as local banks deal with an increase in non-performing loans, and cash-starved firms have turned to trust financing as well as private debt funds.

“There are 50 million companies and only about 4% have access to bank lending,” said Mr. Lau at Adamas. The firm, which focuses on lending to Greater China, managed $630 million in assets as of the end of 2015. “Bank financing only goes to very big state-owned enterprises.”

Adamas in November established a $500 million joint venture with a unit of Ping An Insurance Co. to provide loans for small-to-medium sized businesses, while KKR in January partnered with China Orient Asset Management Corp. and China Orient Summit Capital to invest in distressed assets in the world's second-biggest economy.

There is also likely to be room for debt funds to expand their presence in India, according to B.V. Krishnan, a member at KKR in Mumbai. He said lenders in India are facing pressures from non-performing loans and regulation, and that has combined with a lack of corporate bond issuance to provide an opening for private debt funds. The New York-based investment firm has deployed about $3 billion of capital in India since 2010 and the country is now the company's biggest market in Asia for private lending.

“The real estate sector and the mid-market corporate sector will have meaningful credit needs in the years to come, between refinancing and growth capital needs,” said Mr. Krishnan. “Not all of them will have easy access to banks.”

Among the investments KKR has made in the South Asian nation is a loan of about $50 million to help a family business buy out its private equity partner and a stake in bad loans manager International Asset Reconstruction Co.

“Between buying loans from banks and providing rescue capital to companies directly, there will be a pretty active special situations and distressed business in India for the years to come,” said Mr. Krishnan.

In contrast to KKR and Adamas, Babson focuses on developed Asia-Pacific markets because the legal structures make it easier to enforce and recover debts. The firm typically backs private equity-sponsored companies and has a loan book in the region of more than $700 million. Mr. Wheeler said that Babson focuses on senior and mezzanine debt.

“We are getting good traction with private equity firms for flexible deal structures,” he said. “I expect to see more deals completed using those structures rather than traditional banking loans.”