HOW to AVOID the PITFALLS in PRIVATE CREDIT Steer Clear of Mezzanine in Asia and China NPL Funds, Says Hamilton Lane

INVESTOR DIALOGUE HOW TO AVOID THE PITFALLS IN PRIVATE CREDIT Steer clear of mezzanine in Asia and China NPL funds, says Hamilton Lane. The ideal credit portfolio is a blend of special situations and direct lending By Alison Tudor-Ackroyd rivate markets promising these yield-hungry within a year, up from 37% in China. Bain Capital, KKR, investor Hamilton investors higher returns for the previous year’s survey. Hong Kong-based PAG, and P Lane sees traps lying unearthing deals outside of Private credit is one of Baring Private Equity Asia in wait for the herd of publicly traded markets. those alternative strategies. are all in the market raising institutional investors That has crushed the “It [private credit] is the funds to invest in NPLs in rushing to buy private debt premium investors usually fastest-growing area where Asia. instruments. expect as a form of hazard pay we need to answer to our However, as yet there are There is too much cash for backing riskier clients,” said Delgado- slim pickings and there is no waiting to be deployed into companies. “Now when you Moreira, outpacing buyouts guarantee that there will ever distressed debt in China allocate to credit in Asia you or growth strategies. “Around be a full-blown bad debt crisis while mezzanine in Asia is are much more focused on the four years ago we were seeing in China, where the state too risky for the slim reward absolute return than on the only about 90 funds a year, continues to dominate the the product offers, Juan spread to developed markets,” today we see over 140 funds a economy. Instead it may Delgado-Moreira, a managing Delgado-Moreira said. year, just in credit.” happen in the European director at the Pennsylvania- The migration is global but Hamilton Lane advises fashion, with a trickle of headquartered firm, told across the Asia-Pacific region investors on allocating about NPLs over time. FinanceAsia in an interview. many conservative funds are $320 billion into private China also has asset His advice is to pick fund switching out of traditional markets globally. In credit, management companies in managers who can source asset classes for the first time Hamilton Lane has advised place to absorb toxic loans complex special situations or and the movement is on $15 billion worth of from its biggest commercial have found a lucrative way of snowballing. In mid-2016 investments and manages $4 banks: Cinda, Huarong, Great lending directly to Asia’s AsianInvestor surveyed the billion itself. Wall and Orient. And these rising middle class or to top-300 institutional so-called bad banks have smaller, privately owned investors headquartered here ALWAYS THE enough spare capacity still to companies struggling to and found that 60% of these BRIDESMAID be lending out their balance secure a loan from a bank. pension funds and insurers One investment strategy sheets to healthier, growing In short, investors need to planned to raise their dominates investor choices in companies. be highly selective as they allocations to alternatives credit right now: distressed So there is lack of deal flow, ponder the growing array of debt. In a typical credit increasing the pressure to put private credit funds on offer. portfolio, investors have money to work before “The explosion of different allocated 38% to distressed investors lose patience and types of credit in Asia is debt, according to alternative increasing the potential for happening in front of us. “ Special sits assets data provider Preqin. ill-judged investments. There is more special At 134% of GDP, China’s [situations], there is more is the credit corporate debt ratio is the DON’T MEZZ AROUND direct lending, more mezz,” highest among large Among the more risky credit Hong Kong-based Delgado- strategy par economies globally, according investments in Asia is Moreira said. to credit rating agency mezzanine, said Asset owners are switching excellence” Standard & Poor’s. So the Delgado-Moreira. out of publicly traded fixed betting is on non-performing Mezzanine has appeared – Juan Delgado- income markets into private Moreira, Hamilton loans rising. more frequently of late across credit at a time when more Lane To meet this demand from Asia Pacific region. It was than $7 trillion of sovereign investors, fund managers are used to help finance the joint bonds offer yields below zero. rapidly raising capital to buy acquisition of Wharf T&T by Private credit funds are non-performing loans in private equity firms TPG 60 FINANCEASIA NOVEMBER / DECEMBER 2017 FINANCEASIA.COM 60 27/11/17 3:10 pm INVESTOR DIALOGUE Juan Delgado- Moreira FINANCEASIA.COM NOVEMBER / DECEMBER 2017 FINANCEASIA 61 61 27/11/17 3:10 pm INVESTOR DIALOGUE well,” Delgado-Moreira said. their own home but struggle Elsewhere Aion Capital to secure a mortgage and have Partners, a joint venture to resort to expensive between ICICI Venture and short-term consumer finance Apollo Global Management, lenders. has had some success in “It’s easier for a Chinese India, backing companies worker to get margin finance across their capital structure to open a brokerage account in the form of equity, debt or than to get a mortgage,” hybrid instruments. Delgado-Moreira said. As a result, some funds are DIRECT LENDING stepping in to lend directly to The retreat of banks across consumers in China at rates the region in the wake of the that are cheaper than in the global financial crisis left shadow banking sector. many borrowers without The trend looking forward access to credit. And the is that global managers are banks that remain often moving more resources to favour large, often state- Asia to invest directly in owned enterprises. In China, credit themselves. the region’s dominant Hamilton Lane has been The buyout of Korea’s Homeplus used mezzanine economy, SOEs produce encouraging global managers one-fifth of economic output to think of Asia as a much while taking out 40% of bank more diverse and fertile Capital and MBK Partners for SPECIAL SITUATIONS loans, according to S&P ground, and to build teams in HK$9.5 billion ($1.22 billion), Some private credit strategies research. the region. as well as Permira’s purchase have better risk-return So fund managers have Some are heeding the call. of business services firm tradeoffs than others. been stepping into the breach, The Canada Pension Plan Tricor. “My ideal portfolio such as Asia-based SSG Investment Board for one is A mix of debt and equity, it construction in credit Capital Management and bulking up its Asia credit tends to appear in developed straddles direct lending in Minneapolis, Minnesota- team as a long-term play on markets in Asia in the most some markets and special headquartered Värde the fast-developing debt highly priced deals as an [situations] in others,” Partners, and lending directly markets in the region, people incremental point of leverage. Delgado-Moreira said. to borrowers. familiar with the moves said. “Beware of mezzanine Special situation funds look That includes China’s “Don’t just wait at the gates positions in Asia,” said to help companies over the swelling middle class ranks of China for distress,” Delgado-Moreira. “You are in hump during say a liqudiity who increasingly want to own Delgado-Moreira said. FA the danger zone.” crunch and make a handsome Investors are attracted to profit for their investors at the the instrument because it same time. Direct lending promises a bit more return funds, as the name suggest, than the senior debt in a act almost like a bank, THE TYPICAL PRIVATE DEBT PORTFOLIO buyout. South Korea’s extending loans directly to Venture debt National Pension Service borrowers. 2% provided the mezzanine In China special situation finance in private equity firm funds have been helping Special MBK Partners’ purchase of refinance developers, whose situation Tesco’s Korean discount buildings perhaps have taken 13% Direct Lending retail chain Homeplus. longer to sell than expected or 22% In many markets across where the borrower needs Asia banks are keen to offer more capital to grow but is Mezzanine leverage finance as it pays a considered a bad risk by 25% bit more interest compared banks. with straight loans. There is “Special sits is the credit less investor protection too strategy par excellence Distressed debt compared with the US. because you do need to find a 38% “Mezzanine is best played borrower in a certain amount where capital supply is of stress, but [which] has an constrained,” Delgado- underlying quality, and there Moreira said. needs to be a bit of a mess as Source: Preqin 62 FINANCEASIA NOVEMBER / DECEMBER 2017 FINANCEASIA.COM 62 27/11/17 3:10 pm.

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