COVID-19 stress hasn’t derailed private debt’s Asia growth story

Money managers are ramping up their private debt business in the Asia-Pacific region this year even as they work to ensure the companies they've already lent to can fight through the coronavirus crisis.

Industry veterans say to the extent they can navigate the COVID-19 storm, anchored by first-lien exposures that limit downside risks, the recent growth of allocations from investors in the region should continue to accelerate.

Times like these are "the reason to be in the senior secured lending business," offering investors protection in periods of turbulence and uncertainty, said Marc S. Lipschultz, co-founder and president of Owl Rock Capital Partners LP, a New York-based alternatives credit manager with $18.1 billion in assets under management.

Analysts and consultants see that message resonating with institutional investors in the region now.

"Our clients are pretty comfortable with the secure nature of private debt," and the number allocating to that market segment in recent years has "grown tremendously," said Valerie Wong, a Hong Kong-based principal with Mercer Investment Consulting, focused on private debt.

For example, a lot of insurance clients in Australia are moving now to make private debt allocations, "many of them for the first time," she noted.

Investors based in the Asia-Pacific region accounted for 11% of the $812 billion in global private debt assets as of June 30, 2019, up from 6% of $518 billion in assets at the end of 2015, according to a Singapore-based spokeswoman for Preqin, the London-based alternatives financial data and information provider.

Market veterans predict that interest will continue to grow despite this year's wild ride for private debt valuations.

U.S. and European loan indexes went from par to about 75 cents on the dollar in the space of four weeks spanning February and March but have since recovered to between 90 and 95 cents on the dollar on the back of unprecedented policy support, noted Edward Tong, Singapore-based managing director and head of private debt Asia with Partners Group AG. The operating environment has improved as well. In general, "the deals we're buying into (now) come with better returns" as well as tighter terms and conditions, lowering portfolio risk on balance, he said.

Limited partners likewise report manageable fallout for their portfolios thus far.

Dong Hun Jang, chief investment officer of the 15.6 trillion won ($13.1 billion) Public Officials Benefit Association, Seoul, said POBA's roughly $500 million in private debt exposure was only "slightly underwater" at the end of June, with some late interest payments but no defaults. With global markets recovering since then, Mr. Jang said his team is hoping for a better appraisal by the end of September.

For the most part, said Nam Tran, a consultant with Melbourne-based investment consulting firm Frontier Advisors Pty. Ltd., the impact on private debt portfolios is limited, and "we're still comfortable recommending that clients make a strategic allocation to direct lending."

The assets Owl Rock manages on behalf of Asia-Pacific-based investors only come to $700 million currently, or less than 4% of the firm's total. But with growing interest in the region on making strategic allocations to private debt, Owl Rock is focusing on Asia now "as an area of meaningful growth," Mr. Lipschultz said.

Meanwhile, the number of overseas managers planting their flags in the region continues to grow.

Allianz Global Investors hired Sumit Bhandari in 2018 as lead portfolio manager, Asia private credit, alternative investments, to build out a private debt capability in the region.

Mr. Bhandari said in an interview he assembled a seven-person team and, focusing on midmarket companies in the region with EBITDA of between $15 million and $100 million, has deployed more than $300 million of capital provided by Allianz Global Investors over the past 18 months.

On July 6, Muzinich & Co., a New York-based credit manager with $38 billion in assets, announced it hired Andrew Tan in Singapore as managing director and head of Asia-Pacific private debt to build a pan-Asia capability, with four to six deal origination professionals, for the $2 billion private debt platform Muzinich launched in 2014.

Glenn Clarke, a managing director and institutional portfolio manager with Hayfin Capital Management LLP, a London-based alternatives firm with more than €17 billion ($20 billion) in assets under management, said in an interview that Hayfin is looking to open a Singapore office in late 2020 to expand its global reach and private debt offerings. The office will source investment opportunities and service an expanding Asian investor base that accounts for 20% of Hayfin's assets.

And Schroder Investment Management announced Aug. 14 it had appointed its first head of private debt for Australia, with plans to build a five-person team for the asset class.

Meanwhile, ADM Capital, a Hong Kong-based Asia-focused private credit manager with roughly $2.4 billion in assets under management, has added three professionals to its investment team this year, bringing its size to 17, with plans to hire one or two more, noted Christopher Smith, the firm's head of investor relations and marketing.

Those build-outs come even as managers have had to work to ensure their existing portfolios of mostly U.S. and European-based small- and midsized companies don't get tripped up by the coronavirus crisis.

On July 29, Proskauer Rose LLP released a second-quarter tally for the New York-based law firm's recently launched private credit default index, showing the overall default rate for 546 active senior secured and unitranche loans made in the U.S. rising to 8.1% from 5.9% for the prior quarter.

Peter J. Antoszyk, a Proskauer partner and co-head of the firm's private credit restructuring group, said in an email he isn't seeing the general partners Proskauer advises losing sleep. "Private credit lenders have been preparing for a downturn well before COVID hit," and with "tight" loan covenants, it's more a matter of lenders in these deals having the opportunity to be more proactive and address problems sooner, he said.

For KKR Asia Ltd. this year, working to ensure its invested capital remains resilient has been a priority, demanding both time and "a lot of heavy lifting," said Soon Jin Lim, a Singapore-based managing director and head of Southeast Asia credit.

"We dove deep into each position in the Asia portfolio to triage for COVID impact and map action plans for worst to best scenarios," Mr. Lim said.

Meanwhile, there have been coronavirus winners, such as digital services, as well as losers this year.

"A lot depends on portfolio construction," ADM Capital's Mr. Smith said. ADM has worked to put together a portfolio well-diversified across countries and sectors but "if you have a predominantly hospitality, tourist-related portfolio, you're going to be facing a vicious next few quarters," he said.

A number of managers expressed confidence on that score. "We have limited exposure to manufacturing and cyclicals," sectors which have been hit hard this year, Hayfin's Mr. Clarke said. Of the more than 100 companies in which Hayfin has made senior-secured private credit investments, at present there are only a very small percentage that "we feel we're going to have to enforce or take action to protect our capital," he said.

Allianz Global Investors' Mr. Bhandari said his portfolio has emerged from this year's volatility relatively unscathed, helped by a focus on companies tied to health care, specialty chemicals, telecom towers, infrastructure services and data centers.

Still, if the economic fallout from COVID-19 leaves managers facing challenges, the emphasis now is really on how they work with their portfolio companies "to get to the best outcome possible for the company as well as for investors," noted Muzinich's Mr. Tan.

"We see a lot of loans being restructured — what we call 'amend and extend,'" said Mercer's Ms. Wong, a situation where, for example, a lender could allow a portfolio company to skip a quarterly interest payment in return for agreeing to a higher yield going forward.

Owl Rock CEO Craig W. Packer, on the listed firm's Aug. 5 second quarter earnings call, said his team "executed eight significant amendments during the quarter" out of a broader portfolio of 102 companies, in return for "an additional 120 basis points of spread on those investments."

If managers, on balance, can avoid major pitfalls this year, Asia-Pacific demand for private credit — which remains far off the pace enjoyed by private equity, infrastructure or real estate — should continue to accelerate, analysts say.

With exposures relatively high in the capital stack, private credit as an asset class is really about downside protection and to the extent managers do their job well that should "provide some impetus for more allocations," KKR's Mr. Lim said.

The forces that drove pension funds, insurance companies and other big investors to private credit over the past 10 years, such as rock-bottom sovereign bond yields, haven't gone away with the coronavirus crisis; they've become more protracted, said Brian Coleman, New York-based managing director with the portfolio management group of J.P. Morgan Alternative Asset Management.

Managers predict that on balance the coming year should be a good one for them and clients alike.

Muzinich's Mr. Tan said he thinks it's "a fantastic time" to be launching a direct lending business. With no legacy exposures to tend to, the focus can be on making new loans in an environment where the market "reset" in March has paved the way for stronger covenants, portfolio protections and returns — a recipe for strong vintages in coming years, he said.