Keeping private credit on a sustainable growth path

As a committed specialist in this space, we’re confident it will play an integral role in helping individuals, businesses and entire economies weather the impacts of the pandemic, and pursue the opportunities that will come with recovery. Here are the main reasons why.

Bridging a gap

The first is the retrenchment of banks from the lending market since the 2007-2008 financial crisis, a trend that the pandemic looks set to accelerate^[1] With small and mid-market firms in particular struggling to access financing from traditional sources, private credit assets under management (AUM) globally surged from US$275 billion in 2009 to over US$800 billion in 2019.^[2] The Alternative Credit Council has forecast the total could hit US$1 trillion this year.^[3]

With this growth has come recognition that private credit is not a niche concern, but an essential element of the global financing landscape. Around a third of committed capital goes to small and medium-sized companies. These are the lifeblood of most economies, accounting for 90 percent of businesses and 50 percent of employment worldwide.^[4]

Another reason for optimism is that private credit still has plenty of room to expand, particularly in Asia. While private credit AUM in Asia doubled from 2014 to last year, such assets still represent a mere sliver of AUM worldwide, a proportion vastly out of kilter with the region’s role in global economic growth.^[5]

Research also points to significant untapped demand among Asian borrowers. One recent poll by Acuris found 68% of mid-market firms in the region viewed financing from non-traditional lenders as critical to their business, and that 82% planned to seek such financing in the year ahead.^[6]

A flexible funding source

This appetite brings us to the third major success factor for private credit: its inherent flexibility. As Acuris points out, traditional lenders contend with bureaucratic processes and are typically confined to providing loans in defined formats and under certain conditions. Such arrangements are not always optimal for enterprises or entrepreneurs with distinct business models or funding requirements.

While any reputable provider of private credit must also be mindful of regulation and a borrower’s risk profile, in general non-bank lenders are able to disburse capital more efficiently and have more room for maneuver to meet borrower needs.

Private credit also benefits from its diversity. It is a vast space spanning strategies from mezzanine financing to direct lending, each offering its own means to manage risks and mobilize capital. This means funding can be generated in all kinds of market conditions, and that there are options for virtually all would-be borrowers and investors.

Our area of expertise, private asset-based finance, alone is a US$4.5 trillion market globally, forecast to rise to US$6.9 trillion over the next five years, according to KKR.^[7]

As traditional lenders face even more constraints in the wake of COVID-19, asset-backed lending is expected to become a ‘go-to’ source of credit. Like other types of private credit, it is versatile, since virtually any asset, from real estate to aircraft, even contracts, can serve as a basis for funding.

Though loans need to be structured carefully, in general risks are limited by the lender’s ability to recover this collateral, and by the increasingly sophisticated, technology-based processes being applied to deal origination, underwriting and risk management.

Bright prospects for equity-backed lending

Drilling down further within asset-based finance, we see equity-backed lending emerging as a prominent funding source as it ticks so many boxes for both lenders and borrowers.

Equity markets have proven to be massive engines of value in recent years and the untapped potential being unlocked in emerging markets shows this is set to continue. Particularly in Asia’s dynamic economies, a rising middle class, growing ranks of entrepreneurs and vigorous listing activity will all help expand the pool of stock owners.

Flourishing businesses and wealth will fuel demand for funding to drive the next stage of growth, or meet personal ambitions. Equity-backed lending is ideally situated to meet this demand, as unlike margin lending it is typically non-purpose. That means the borrower is free to deploy the capital however they see fit. Equity-backed loans are also generally non-recourse, meaning the borrower’s liability is limited to the collateral.

Furthermore, equity-backed loans offer the borrower an opportunity to tap into the value of their investments without sacrificing the potential for market appreciation. Once a loan is repaid, the securities used as collateral are returned in full. If they have appreciated during the term of the loan, the borrower is still in a position to benefit. Meanwhile, having a relatively liquid asset as collateral allows the lender to offer highly competitive terms and rates, and to gain from temporarily adding the stock to their own portfolio.

Equity-backed lending is therefore arguably unmatched in its ability to serve both lender and borrower interests. Our faith in the model and its potential is the reason we have chosen to focus exclusively on this space, and worked to perfect our approach to it over the last two decades.

While we see significant potential for near-term growth in asset-backed lending, we are also conscious that, like the rest of private credit, it cannot simply grow; it needs to do so sustainably.

This is why in addition to bringing our solutions to more borrowers, and extending our capabilities to areas like digital assets,^[8] we are investing heavily in building local networks, and forging close relationships with regulators and institutional partners.

Demonstrating commitment, and working closely with other stakeholders to enhance the range of funding options available without compromising standards or governance, is key to ensuring private credit is no longer viewed as an ‘alternative’ form of lending, but as a vital and vibrant part of the spectrum of solutions channeling capital where it is needed to fund future prosperity.

[1] www.allianzgi.com/en/insights/investment-themes-and-strategy/private-lending-post-covid-19

[2] www.simmons-simmons.com/en/publications/ckecj9sk3182c09430t4lsd0i/private-credit-in-asia-report

[3] www.aima.org/article/acc-sees-private-credit-market-reaching-1-trillion-by-2020.html

[4] www.worldbank.org/en/topic/smefinance

[5] www.simmons-simmons.com/en/publications/ckecj9sk3182c09430t4lsd0i/private-credit-in-asia-report

[6] www.acuris.com/asian_mid-market_direct_lending_report

[7] www.kkr.com/sites/default/files/Asset_Based_Finance_Q2_2020.pdf

[8] osl.com/en/in-the-news/press-releases/20200616efhpressrelease

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