Private credit may have reached a tipping point in Asia as alternative asset managers flock to this fast-growing asset class, snatching shares from traditional banks and providing much-needed bloodline to the region’s COVID-ridden businesses.

During a panel discussion at DealStreetAsia’s Asia PE-VC Summit 2022 in Singapore, seasoned alternative asset investors pointed to “a sea change” in Asia’s private credit market over the past decade or so amid robust economic growth across emerging countries in the region.

Investors said Asia has moved away from the previous generation of private bankers hawking unsecured bonds to their high-net-worth clients to a new phase of more rigorous due diligence offered by private credit players.

“Where private credit excels is that we read all documents, make sure of the security, and make sure that we kick the tires, visit the factory, and talk to the borrower,” said Wei Hsien Chan, managing director at Singapore-based investment management firm SeaTown Holdings, which is a wholly owned subsidiary of Temasek Holdings.

Although private credit is still at a nascent stage, the market is expected to grow from an estimated $1.2 trillion in total assets under management (AUM) last year in the wake of rising capital costs and valuation drops amid a global market downturn.

While demand for capital continues to be strong in Asia, Nitish Agarwal, CEO and CIO of Singapore-based private credit firm Orion Capital Asia, said that an inflow of more sophisticated investors, “significantly improved” legal frameworks, and a maturing ecosystem are among the key factors driving the region’s adoption of private credit.

“What we have seen changed in 10 years is really the supply side. We see a lot more sophisticated institutional investors coming to Asia, both for diversification and for relative value,” said Agarwal. “I think typically, Asian private credit has given anywhere from 300-400 basis points over what you could get in other markets.”

Demand is increasing as fund managers such as buyout funds look for private credit to support their transactions, and startups and unicorns look for fundraising alternatives to avoid a down round. To plug these funding gaps, some of the world’s largest fund managers have raised their stakes in Asia’s private credit market in the recent few months.

Blackstone announced in May its goal to increase assets in its Asia-Pacific credit business tenfold in the “near term”. The US alternative asset manager aims to expand its private credit assets to at least $5 billion from the $500 million committed as of the fourth quarter of 2021. In the same month, Allianz Global Investors held the first close for its Asia-Pacific private credit fund at 450 million euros ($437.5 million). It targets to reach the final close of 650 million euros ($632 million) by the end of this year.

Singapore-based private equity (PE) firm Navis Capital Partners, which manages about $5 billion and focuses on the Southeast Asian market, earlier this year launched a new Asia private credit platform and hired former BlackRock executive Justin Ferrier as its managing partner.

US alternative asset management firm Apollo is also making strides in this area. It announced in June the formation of an Asia-Pacific credit strategy in partnership with Australian pension fund Hostplus with $1.25 billion in assets. In August, it established a 50-50 joint venture with Belstar Group to offer a range of private credit solutions in South Korea.

“There is an insatiable thirst for safe yield among clients out in Asia,” said Matthew Michelini, CEO of Apollo Asia-Pacific, during the panel discussion. “I think the demand for credit will continue to grow in Asia.”

Alpha generator

Across the Asia-Pacific region, investors are zooming in on private credit strategies, including direct lending, venture debt, special situations, and other segments that have seen a pullback from commercial banks.

Direct lending, a form of corporate debt provision in which non-bank creditors extend loans to businesses without using an intermediary, is seen taking off in Asia at a time when its growth across Western economies is faltering.

“[The increase of direct lending] will be across a couple of different, very investable geographies, including Australia, South Korea, India, and probably even, to some extent, Japan, over the medium term,” said Apollo’s Michelini.

He said that “a good start” for private credit providers like Apollo to source deals is where traditional banks have missed out as more Asian companies are seeking well-structured, customised, flexible, and appropriately priced credit products to match their capital demand. He then pointed to trade finance, mortgages, climate & energy transition funding, as well as GP-LP exit repositioning solutions as some of the exciting areas to look out for opportunities.

Among its recent landmark transactions in Asia, New York-headquartered Apollo is said to have increased its loan to SoftBank Group Corp to $5.1 billion, according to a Bloomberg report in March. It lent an additional $1.1 billion backed by holdings of SoftBank Vision Fund 2 after it had granted the Japanese investment group $4 billion last December.

For developing Asia, venture debt is gaining more traction as venture capital (VC)-backed, high-growth startups grow more accepting of alternative financing solutions.

Agarwal’s Orion Capital Asia, whose backers include Canadian public pension fund OMERS, in September closed its first venture debt deal in Southeast Asia by participating in an investment in Indonesia-based online travel app Traveloka. It backed a financing facility of $300 million in Traveloka alongside other investors, including Indonesia’s sovereign wealth fund INA, BlackRock, and Allianz Global Investors.

“A lot of these companies have done really well. They’ve raised a lot of equity [financing], and it’s the right time for them to think about whether the next dollar of capital should come from equity or debt. Clearly, what’s going on with the equity market is not helpful on the equity-raise side,” said Agarwal.

He predicts that venture debt will become “a lot more prominent and dominant” moving forward.

Other credit strategies, including special situations transactions, are expected to stay in Asia to complement direct lending, although investors may continue to have limited interest in the region’s non-performing loans (NPLs).

NPLs – in which the borrower is in default and has not made any scheduled payments of principal or interest for a certain period of time – have never attracted much interest, even during the Asian financial crisis, said Denny Goenawan, managing partner at Indies Capital Partners.

Indies Capital Partners is one of the earliest private credit-focused fund management firms in Southeast Asia, with about $800 million in AUM across strategies from private credit to PE. Its private credit business has a strong focus on the Indonesian market.

“It [NPL portfolio] has never taken off in places like Indonesia and so on, largely because there is no structural or regulatory pressure from the government for the banks to clean up… The banks ended up just amortizing the losses over time instead of selling,” said Goenawan. “Because of that, there is not enough of an ecosystem.”

Orion Capital Asia’s Agarwal concurred, saying that NPLs could go up in India but not in a dramatic way that delivers any “outsized opportunities”.

As geopolitical uncertainties, global inflation, supply chain disruption, and other macro market risks loom on the horizon, private credit investors believe that Asia is now in a better position to embrace future market impacts.

“In Asia, we’ve learnt a lot of lessons the hard way from the Asian financial crisis over 20 years ago. I think Asia has grown a lot in terms of strengthening the balance sheets and the reserves,” said SeaTown’s Chan. “But the stress will come. It’s just a matter of time.”