What's new in private credit?

The latest developments in Asia

The prospect of lowering interest rates has done little to dampen investor enthusiasm for private credit, but how is the market evolving as average fund sizes continue to creep up? And how is Asia’s private credit scene developing?

The higher interest rate environment of the past two years and further retrenchment of the banks from more areas of lending has led many to claim that we’re in a golden age for private credit. The asset class grew rapidly in the decade to 2023, with firms raising ever-larger funds and institutional investors increasingly making direct investments.

Fundraising fell in 2023 and 2024 from the highs of the previous two years, but the scale of this decline has been far smaller in private credit than for its cousin, private equity. Yet, like many other areas of private markets, capital is increasingly concentrated among larger funds, with average fund sizes at $1.5bn for those reaching a close in Q2 2024, according to Preqin data. The market is also highly concentrated in the US and Europe, while Asian private credit funds raised just $1bn of the $50.4bn global total for the second quarter of 2024.

So how will lowering interest rates affect the market? And will we see more defaults as we move further through the current cycle? GPs and LPs offer their views on private credit trends.

In the second quarter of 2024, 88% of private debt capital raised went to senior debt strategies, according to Preqin – and that, says Raheman Meghji, CIO of DB Investment Partners, presents an opportunity.

“Private credit spread is determined by supply and demand,” he says. “If you consider that most investors are allocating more capital to senior direct lending strategies, there is less going into junior debt. That means, regardless of interest rates, if you’re able to structure and create good deals where risk is managed well, you should be able to generate a 400 to 600 basis points premium in junior or structured equity strategies versus senior debt.”

Junior debt is getting more attention, even though investors allocate largely to senior debt.

“Junior debt had a tough time as a financing solution from 2010 to 2020 when interest rates were low,” says Leo Fletcher-Smith, Head of European Private Credit Strategy at Aksia. In the mid-market in particular, low rates meant you could have heavily levered senior structures with thick equity cushions. Now we’re in a different world. You can’t lever senior structures to the same extent, and you have to have non-cash pay, intermediate tranches as a tool to bridge between senior debt and equity. The last time we saw this was in pre-GFC capital structures.”

Asia’s credit markets are different from those in the US – and that doesn’t necessarily mean more risky.

“If you look at private credit from a regional perspective, many investors would say there are certain markets in Asia where you would expect a premium over US and European markets,” says Meghji.

“But that only takes into consideration a broad brush risk-return calculation. Actually, when you dig in and you look at the protections you have in Asian deals, the type of LTV, the leverage in absolute terms, they look very interesting. We see very few deals in Asia with an apples-to-apples comparison with European credit because a business that is financed at five to six times in Europe will only get three to four times in Asia.”

A managing director at a private credit fund agrees. “Asia’s opportunity set is not deep, but it's pretty wide,” he says.

“You can still find a lot of value compared with the US market and you're typically getting 150 to 100 basis points of premium, without taking that much more risk because the quality of documentation in Asia is significantly better than what you typically see in the US.

You get personal guarantees in addition to assets and cash flows. You can lend to companies that are quasi-investment-grade and get a similar return to a true middle market company in the US, but with lower leverage levels and much better protections.”

Defaults may not rise, but that doesn’t mean capital won’t be lost.

This is partly to do with funds needing to keep their LPs on side, according to Fletcher-Smith. “Reported defaults going forward definitely will not tell the whole story,” he says. “That’s because if you have a debt structure where there’s one lender and one borrower and something goes wrong, the last thing the lender wants to do is declare a default because it will have to tell its LPs. So we’ll see lenders amending structures to preserve the optics of a pristine track record.”

It's also to do with looser terms, such as cov-lite. “You’re going to see fewer defaults than you would have in the past because documentation standards have evolved,” says Antoine Lourtau, Partner at Park Square Capital. “But recovery rates will also be lower because, by the time a company defaults, it will be too late. The only thing that is going to protect you is credit selection.”

Private credit is now a broad asset class

“Investors need to think of private credit as a spectrum,” says Meghji. “It's not a discrete component of the capital structure. Private credit spans everything from bank lending to private equity. So pick where you want to be in that spectrum. It’s also much broader than corporate direct lending. It includes real estate lending and asset-based finance, and much beyond these. Private credit finances anything; it's just that it's being done in the private market.”

…and that makes selection and diversification more possible.

“At the top end of the market, there are too many players and too much money chasing deals,” says Jae Yoon, CIO and Chairman of NYLIM. “That means covenants get lighter – something that will become relevant later in the cycle, when we’re likely to see recovery rates come down. Investors also need to be aware that mega-funds often do deals together, so if you have a portfolio of just large managers, you may end up concentrated in the same deals across different funds. All this makes it important for investors to diversify when building out a private credit portfolio – by manager, strategy and place in the capital structure.”