Private Credit – from the inside – JMES talks to the Experts

There has been so much mixed commentary around Private Credit we thought we would take the time to speak with those actually in the market – some highly credentialled and experienced practitioners versus others merely commenting from the sideline - to understand what private credit is, who the players are, how it works, and where the activity is.

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Some of those who were generous with their time and thoughts included:

• Andrew McDermott – MD Head of Corporate & Leveraged Finance @ Credit Agricole

• Mr X – a leading private credit investor

• Nicole Kidd – Head of Private Debt APAC and MD of Schroders RF, Schroders Capital

• Martin McConnell, CEO of Assetinsure, a major international participant providing credit risk insurance to banks

• Bob Sahota, CEO & Founder of Revolution Asset Management

We asked them questions regarding how people/firms are defining private credit, as well the current state of and (potential) future of this continually growing market – and we found some quite interesting and diverse views.

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Are we at the top of the market in private credit – Yes/why or No/why not?

McDermott feels the lending market is still dominated by banks, thus the private credit market is still evolving and has more to run. When we see a liquid secondary loan market in Australia, then a case can be made that the private credit market is well developed.

Mr X was of the opinion that there is still a healthy level of activity across the private credit landscape, funds have returned some capital and continue financing new transactions.

Kidd feels the increasing probability of higher for longer cash/floating rates will continue to drive investor demand for this asset class. From a borrower perspective, with a likely slowdown in growth and higher interest burdens, borrowers will be less attractive for banks to continue to fund and private credit could provide more flexible capital. However, she would naturally expect defaults to uptick compared to the very benign/low interest rate environment in the previous cycle.

From a different lens, McConnell suggested the market had more to run and isn’t done yet. With plenty of capital/more funds than deals, this poses the question - can private credit funds find enough transactions - especially in the Asia Pacific region where banks have traditionally dominated.

Sahota said there is no simple answer - a number of deals and firms will come into problems in the not too distant future. Not all funds are created equal.

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How is the Bank vs Fund/Investor mix?

Per above, McDermott felt that this is still bank dominated but funds are definitely growing, with McConnell in agreement.

Whereas Kidd suggested funds/investors appear to be increasing their market share in transactions in both the sub-investment grade and investment grade space, although banks are showing some additional appetite presumably in the attempt to win back some sub-IG market share - and in the case of one bank, cement their position as a leader in leveraged finance. She also observes borrowers are looking to reduce overall leverage to avail of cheaper pricing typically on offer from banks who may subsidise loan pricing with ancillary revenues from the wider relationship.

Sahota confirmed that the mix is definitely changing – with a swing from heavy bank led to more private credit funds participating. Banks have tightened credit so private credit funds have been starting/growing/establishing local platforms (globals) – and showing more flexibility on terms and structures.

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How challenging is current access to capital?

Balance Sheets

McDermott held that companies with strong credit profiles have no trouble accessing capital in both the debt and equity markets – NEXTDC’s recent equity raisings is a great example in equity markets while the many transactions that have been oversubscribed (upsized) in the loan market demonstrates that Australian companies have access to strong liquidity in debt (loan) markets.

McConnell noted that it depends on jurisdiction and reg/Basel 3 requirements in terms of how banks can allocate capital - there is more to play out, particularly in the UK and the USA. This will also impact on how banks use tools such as credit risk insurance and their participation in the private credit market.

Funds/Capital (insto vs wholesale)

McDermott was of the view that it depends on the credit with a few examples where debt and equity raising was well supported by its institutional investors, yet Mr X said a number of global funds were still allocating their last funds and not raising new funds yet with less deals to invest in locally.

In a somewhat challenging market (depending on specific sub-segments targeted) Kidd felt that it has started to get somewhat saturated given limited issuance in market but Sahota didn’t see any difficulty in raising capital with a broad split across ~2/3 insto 1/3 wholesale and record inflows.

Deployment

Kidd said opportunities still exist but with a still limited M&A financing market, there remains excess demand versus supply with investors going into the same transactions, which has compressed terms and pricing. The prognosis for an expected uptick in issuance should spread out the field and lead to better lender outcomes. The fact remains – we need more private credit investors in the market to support borrower capital needs.

McConnell said banks were definitely keen to deploy/lend more with credit risk insurance continuing to play a strong role – but is of the opinion that private credit is participating at greater levels and in more diverse areas.

With base rates increasing, banks tightening credit and margins up (currently), there has been strong demand for debt – Sahota held that private credit was even at times operating more like equity replacement funding, albeit debt.

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Breaking private credit down: Is there a strong view in appetite and activity across the sub-markets?

Bank Debt

As a banker, McDermott confirmed liquidity is very strong as evidenced by the number of syndicated financings oversubscribed/upsized this year to which Kidd concurred that there was still pretty strong appetite, and McConnell confirmed that banks still have appetite and capital to lend albeit risk is tighter than it was, especially in LBO deals.

Direct Lending

Sahota confirmed lots of active involvement in direct lending (started in bank syndicates before moving to more club and bi-lateral but still more syndicate led for large jumbo deals)

Mr X was moving away from the traditional direct lending space and now leaning to the more complex (and higher performing) financings for yield and growth.

Whereas McConnell was of the view that banks were still competing on most deal types including leverage transactions. APAC is traditionally more bank relationship led however we are now seeing more and more traction in this market by private credit funds and McDermott suggested that strong appetite exists amongst private credit to grow their books where yield is available c10%+ and strong interest exists outside the bank market for good credits. Kidd also confirmed strong appetite in this space.

Special Situations

Australia is a less developed market (more efficient and elastic than others in the region) with a large proportion of (dis)stressed credits held by the major banks. Kidd has a clean book and has avoided some of the obvious situations in the market but felt some pockets of softness/activity were starting to show up in certain sectors. She says now is the time that those with appetite for opportunistic/special situations could really capitalise.

Others were of the opinion that selective opportunities exist with strong appetite where there is perceived value, but are reliant on stressed/distressed situations.

Asset Back Securities (ABS)

Sahota is seeing strong opportunity in his space - yes there has been lots of activity in direct lending, but now ABS is very active, attractive and continuing to grow … watch this space.

Real Asset (debt)

McDermott said banks still had strong appetite but in some sectors (infrastructure) volumes are low (abundance of liquidity but few transactions) and McConnell felt a lot of activity from private credit funds is making it difficult for banks to deploy. Consequently, there has been more traction with banks in bi-lateral and club type transactions.

Sahota has seen a lot of real estate debt deals but not participating in construction development deals.

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If some deals start to distress/default, how will you/your firm react?

Work out internally (local or offshore) or appoint external specialists.

Kidd said they would manage internally to start and move to external appointment if required.

Sell distressed (local or offshore)

It depends on the situation, but McDermott suggested banks would look to work out internally to try and maximise value. External specialists may be appointed to assist with this. If the cost/benefit of going through a workout is unfavourable and there is a liquid market for the distressed asset, then there may be a good case to sell the asset.

Mr X said it would depend - but they would start with the investment team initially and Sahota said his team already had the expertise and experience in-house to deal with situations.

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So - private credit is not all the same.

We can see that there is a range of views, appetites and approaches – no one bullet solution or approach – everyone is trying to navigate their way through this changing and growing market. If nothing else, we find it fascinating with more to evolve and play out in this market.

Questions or further discussions? If in doubt speak to the specialists at JMES.

Contact Patrick Everest on this and other Debt/Capital Markets/Private Credit related topics at peverest@jmes.com.au