A near-shutdown in Asia’s high-yield US dollar bond market and a continued scale-back in lending by global banks in the region amid mounting regulatory constraints have revived optimism of a spurt in private credit activity, particularly to finance time-sensitive leveraged buyouts and M&A.

This kind of non-bank lending has grown considerably in recent years. Global private credit assets rose from USD 875bn in 2020 to USD 1.4trn at the start of 2023, and are expected to reach USD 2.3trn by 2027, according to Preqin. Rising interest rates – which can mean higher returns without a commensurate increase in risk – have further stoked investor appetite for the asset class.

Asia’s 6% share of the global private credit market reflects the dominant role of banks as credit providers in the region. According to a report published by KKR at the end of last year, banks account for 79% of the credit market in Asia, compared to 54% in Europe and 33% in the US.

The same report claimed that private debt providers were responsible for financing about 5.5% of the total value of leveraged buyouts in Asia in 2022. Australia is the exception to the rule, with KKR estimating that private credit makes up 60% of the direct lending market, primarily through unitranche and other stretched senior structures.

Private credit has gained traction in part because Australian banks have reduced leveraged lending to sponsors due to capital requirements. Confidence in the prospects for private credit Asia-wide is rooted in the region’s strong economic growth and a wider pull-back by banks.

“What has fundamentally changed in the past two to three years is that US banks have pulled back from lending in this region, mainly due to regulatory reasons that constrain how much leverage they can give,” said Siddhartha Hari, a partner and co-head of Elham Credit Partners, a Singapore-based private credit firm established late last year by Hillhouse Investment.

“European banks have similar issues around capital treatment for on-balance sheet lending, with the new Basel requirements. This applies especially to inorganic growth by private equity portfolio companies, where lending has become a lot more prohibitive than it used to be. It gives private lenders space to grow.”

Regional drivers

Asia’s own unique market movements have also brought change. Corporate borrowers previously had the option of taking out short-term bridge loans for M&A in the high-yield bond market. However, stress in China’s property sector – which historically has accounted for a large part of Asia’s high-yield debt market – has put these structures out of favour.

Sentiment has also soured for Asia’s nascent term loan B market, which relies heavily on distribution to investors in Europe and the US. With institutional investors nursing losses due to the volatility caused by rising interest rates and climbing inflation over the past year, appetite has diminished.

Additionally, M&A activity is becoming more sophisticated. A market once characterised by multi-million-dollar deals that could be financed by a handful of banks now sees more multi-billion-dollar acquisitions that challenge banks in terms of capacity and cross-border complexity. This could translate into more opportunities for alternative financing.

“The sweet spot for private credit firms is acquisition financing,” said Clifford Lee, global head of fixed income at DBS Bank. “They are able to offer PE firms more flexible terms than banks and PE firms are happy to pay 2% to 3% more [than for a bank loan] for that flexibility.”

Private credit’s 5.5% share of Asian LBOs in 2022 is based on volumes of USD 17bn out of USD 380bn. This compared to USD 24bn in 2021 and USD 22bn in 2020, according to Preqin, but the contrast with pre-COVID levels is stark. LBOs supported by private credit averaged USD 12.3bn during the three years ended 2019.

Australian influence on this uplift is profound. The country’s first unitranche deal – whereby senior and mezzanine facilities are combined into a single debt piece – was announced as recently as late 2017. Since then, credit providers have proliferated, including global players that in some cases are raising Asia dedicated funds. Coverage is not limited to LBOs.

According to data compiled by Debtwire, AUD 12.48bn (USD 8.15bn) worth of private credit loans were issued in Australia in 2023, supporting 83 deals. Of this, AUD 4.01bn, or 32%, was for private equity buyout transactions, AUD 5.8bn went to the real estate sector, mostly for construction, and the remaining AUD 2.67bn was used for refinancing and capital expenditure.

Elsewhere in the region, India is seen as having potential. IT services buyouts are a popular target, not least because the target companies often have blue-chip multinational clients and US dollar revenue streams, so financing can be secured via the US markets.

There are expectations of increased buyout activity in other sectors, notably healthcare and financial services, and with local banks banned from financing acquisitions by non-Indian institutions, sponsors must rely on international banks or private credit. Middle-market corporates represent another opportunity. They are eager to grow through M&A but are often not favoured by banks.

India’s Torrent Pharmaceutical might have become a test case. Late last year, when evaluating financing options for a USD 7bn acquisition of rival Cipla, the company reportedly considered an equity investment from CVC Capital Partners combined with loans from international banks, a mezzanine piece from Brookfield Asset Management, and a loan from Apollo Global Management.

Korea, too, could see some action. KKR observed that blue-chip Korean borrowers are “seeking flexible and unconventional capital solutions that local financiers consider too complex”.

Growing relevance

Sanchit Jain, an executive director at Orion Capital Asia, a private credit manager that spun out from Olympus Capital Asia in 2020, identified PE buyouts as a key source of deal flow. He noted that private credit players can get loan approvals much faster than banks, so they are good options in situations where timelines are compressed, and counterparties need certainty of financing.

Hari of Elham Credit added that, for loan modifications, PE firms prefer working with a handful of private credit providers to dealing with large syndicates of banks that could delay approvals. This proved to be the case during COVID. Private credit can also accommodate higher leverage levels and greater loan customisation – albeit at higher yields to compensate for the additional risk.

This view was endorsed by a Singapore-based private credit investor. “Private lenders tend to be more relevant in times of dislocation, when a solution is needed,” he said. “And for esoteric sectors that are hard for banks to accept – where it’s not really about pricing or leverage – private lenders are very important.”

The investor pointed to Australian miner Whitehaven Coal, which raised a USD 900m bridge loan in October 2023 to finance its acquisition of metallurgical coal mines in Queensland from BHP Group and Mitsubishi Development. Last month, Whitehaven reportedly attracted more than 10 private credit lenders to join a USD 1.1bn refinancing.

“Banks have policies around ESG [environment, social, and governance] that means they can’t fund deals around coal,” he said. “So the refinancing was done by private credit lenders.”

Private equity firms are also likely to target private credit providers when seeking dividend recapitalisations. This is another area where banks are less comfortable, either because financing needs are highly bespoke or because proceeds are used to make distributions to investors rather than to support companies.

“If you unable to exit a portfolio company because IPOs are not possible, private credit becomes really relevant for a dividend recap,” Hari said. “They are more flexible and are able to take a forward-looking view on the credit and can work with sponsors for a more holistic solution, including subordinated or holdco-style debt, if needed, to reflect a different business case.”

Plugging the gap

At the same time, the emergence of private credit in Asia creates healthy competition among debt providers, leading to better terms for borrowers.

“Funds are being pushed to bring pricing down to compete better, while banks are starting to get pressure to be more flexible in their lending terms and credit considerations, say for example, accepting slightly higher leverage,” said Lee of DBS.

In a high interest rate environment, the floating rate yield of private debt gives investors some downside protection. This is also a key factor when private credit providers serve middle market companies that are normally overlooked by international banks because deal sizes are too small, Orion’s Jain explained.

Private lenders manage the downside risk by putting together well-collateralised, tight loan structures and, in some cases, give themselves some potential upside by including an equity kicker.

Jain cited the example of an INR 4.5bn (USD 54m) loan provided by Orion, alongside Kotak Mahindra Bank and IndusInd Bank, to JC Flowers Asset Reconstruction – an India stressed asset investment joint venture created by US private equity firm JC Flowers – in late 2022 to support the acquisition of a loan portfolio from Yes Bank. This kind of deal would not have appealed to international banks.

“Asia is still in a place where we can get tight structures done [for private credit deals],” said Jain. “As more issuers and more private lenders come to the market, structures and their nuances are likely to evolve; one needs deep local experience as Asia is not a homogenous market and the legal enforcement rules differ in every country.”

Legal frameworks will influence how and where private credit grows in Asia. Sponsor financing and corporate-to-corporate private M&A lending are expected to continue growing in more developed markets like Japan and South Korea, where there is greater certainty around enforcement regimes.

Emerging markets are more challenging, although India’s insolvency and bankruptcy code – which was introduced in 2016 and since proved workable – has encouraged investors. In China, onshore private credit is mainly used to finance indebted property developers shut out of public markets.

However, when investors look at opportunities in Asia more broadly, they are enthused by the increasingly diversified borrower base. Private credit is not just a mainstay of indebted property companies; it is spreading into renewable energy and the new economy, as well as into the real asset space and businesses such as data centres.

“The private credit market is here to stay,” said a Hong Kong-based private credit investor. “It’s more a question of how quickly it grows and evolves.”