Amidst increased regulations and tightening liquidity in the banking market, more investee companies have turned to non-bank debt capital as a credible source of solutions-based debt capital with customizable terms, tailored for their specific needs.
Private credit, which refers to debt investments in companies or institutions by non-bank funds or investors, has emerged as an increasingly popular alternative to bank capital. This asset class invests across the capital structure via debt and/or hybrid instruments of the issuer - direct debt investments, mezzanine financing, distressed debt, or asset-backed lending. The structuring flexibility of these instruments allows the issuers to tap into additional liquidity pools to finance business and growth opportunities which would otherwise be out of reach, accelerating their business plans and providing increased shareholder value.
Globally over the last 20 years, private credit has shown compelling growth as an asset class. Closer to home, the pan-Asian private credit market has grown by 30 times from US$ 3.2bn at the turn of the millennium to US$ 90bn in 2022. More excitingly, this alternative asset class still has significant room to grow, if you look at where US markets were 20 years prior. Having said that, we believe private credit in Asia has a larger and more complementary role to play, providing growth and solution capital to a faster growing corporate sector alongside a significant banking sector in the region.
Private credit’s swift rise in Asia, as an alternative to bank capital for certain end uses, is in part due to its compelling value proposition to issuers:
1. Providing wider access to financing to underserved segments not adequately covered by the banking sector for reasons not related to credit or risk such as collateral or regulatory capital;
2. Flexible and highly tailored financing solutions which align better to underlying sector and business model far more than a banking solution can ever provide;
3. A non-dilutive and consistent source of capital that can adapt to the changing needs of a growing business;
4. Certainty and speed of execution.
Wider access to capital
Traditional banks are often constrained by regulations and capital requirements, leading to a greater allocation to collateral-based lending and large cap companies. In our view, this inherently results in an under-allocation to (1) asset-light businesses (e.g. business services, healthcare, tech) and (2) mid-cap firms, with compelling and demonstrably resilient business models.
Private credit investors / fund managers are subject to different regulations as they tap into sophisticated, closed ended, long term pools of capital (as opposed to retail depositor capital for banks), allowing them to partner with issuers, providing a wider access to capital to pursue growth opportunities these companies would otherwise have forgone. The benefits are multi-fold; for the issuer it supercharges next-stage growth into market leading organisations, while for private credit investors, this segment provides compelling risk-adjusted returns.
Ascertis Credit, with our strong sourcing networks and methodical underwriting, have built strong capabilities in identifying companies with strong creditworthiness in need of more flexible capital options to fund growth and other related end uses. We recently provided a long-term financing solution to a financial sponsor backed road express logistics player in India which was unable to tap into a traditional solution due to its asset-light business model. Nonetheless, the business had significant scalability, an established cash accrual model and attractive, resilient cashflows from existing customers. While there were no hard assets available as collateral, Ascertis Credit was able to structure its facility to align with cash flows of the business as well as requirement of the financial sponsor with an in-built ability to generate upside returns linked to expansion and equity events.
Flexible, customizable and a consistent source of capital
Private credit can provide capital solutions across the entire capital stack of the issuer (senior, junior, unitranche, mezzanine, preference shares, convertibles, other specialty credit solutions), giving immense flexibility to sophisticated businesses. Private credit investors can offer significantly tailored capital solutions that align with the unique needs of each borrower, in addition to normal investment parameters related to risk. These include:
· Instrument: Financing in the form of one or more instruments with different terms for various situations (e.g., senior / junior tranche, tranches with different end use, interest and repayment profile)
· Tenor: Flexibility on deal tenor to align with various streams of cash flows / exit mechanisms
· Security: Flexibility on collateral types and security structure
· Return Structure: Structured as fixed return, upside linked return as well as return profile matched with the earnings of the business
In line with our investment philosophy, Ascertis Credit is a strong proponent of flexible, customizable financing suited to issuer’s needs. One case in point which highlights this is the three rounds of financing solutions provided by Ascertis Credit to a leading solar module manufacturer in India. Through these multiple rounds, Ascertis Credit provided solutions for capital structuring (consolidation of non-promoter stake in a group entity), growth capex and long-term working capital. Each round required a structuring solution at different growth stages for the company (10x+ revenue growth during the 5-year period of Ascertis Credit’s investment) with different cash flow profile, security package and return structure.
Funding certainty and quick approvals
Private credit deals are typically managed by a single investor or small group of like-minded investors. Focused purely on mitigating credit risks associated with the transaction, this results in quick turnaround negotiations and approvals, benefitting issuers facing time-sensitive opportunities or addressing urgent financial needs. On an ongoing basis, benefits are compounded with incremental requirements or amendments being managed more efficiently with a single investor.
One such example is a long-term financing solution provided by Ascertis Credit to a leading industrial gears manufacturer that helped unlock value from a large one-off order that it was in the process of executing. While the company had established track record of more than 6 decades, Ascertis Credit’s solution provided the company with timely and adequate liquidity for financing its growth requirements.
Risks and return considerations
While private credit can come with a higher cost compared to traditional solutions, its benefits when utilized correctly are well documented. Such solutions often put the borrower on a higher growth trajectory, or optimally align the business to capture the market opportunity at lower than the equivalent cost in the equity markets.
Traditional debt cost while lower will likely provide a partial solution for such situations. More importantly, companies have recognised the means to have a more diversified funding mix comprising a mix of traditional working capital and project finance facilities as well as solution-based funding solutions to meet the needs of a more dynamic business.
The opportunity and the way forward
For investors, private credit returns have been cycle tested as it has delivered consistent returns with lower volatility compared with similar fixed investment strategies. As an asset class, private credit’s ability to provide flexible and customizable solutions to underserved segments means it provides access to opportunities that may otherwise be inaccessible via traditional public markets products.
Fund managers have the necessary sourcing channels and expertise to structure solutions for issuers, manage the relationship and pool capital for this purpose.
March 18, 2024
