Private credit refers to non-bank lending, in the private market to companies in the form of bonds, loans, or structured private credit funds allowing investors in these bonds, loans and structured credit funds to gain a yield above risk-free rates and investors’ cost of capital.
Sometimes, these yields can be in the high single-digit or low double-digit when fees and commissions from the borrower are included.
As an example of the yield uplift, in June 2021, CapitaLand Investment (CLI) closed a HK$1.15 billion ($188.2 million) real estate debt fund to provide mezzanine financing backed by a residential development project in Hong Kong.
In November 2021, CLI’s debt team negotiated an early repayment for the mezzanine financing and its investors achieved a net internal rate of return of over 25% because of early redemption by the borrower.
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For borrowers, private credit provides access to capital in sectors where bank loans are constrained. Lenders receive interest payments and their principal back on maturity. For investors, private credit provides higher yields without equity risk. A private credit investment should comprise just a small part of a portfolio’s alternatives, which in themselves are likely to be less than 10%.
Fund managers structuring private credit deals would ensure legal recourse, enforcement and so on. “Every jurisdiction has certain rules and regulations on what external or offshore capital can do onshore. Those regulations exist for Hong Kong, Singapore and other development markets. Within emerging Asia, private credit is a relatively new phenomenon and the structuring may not be equivalent to capabilities in developed markets,” Chen says.
Nonetheless, with the higher yields, robust structuring and risk mitigants, the global private credit industry has grown from US$500 million ($642.1 million) to US$2 trillion over the past decade, according to a September 2024 report by McKinsey, using data as of Dec 31, 2023.
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Private credit products are structured for institutional investors. “Because private credit tends to be longer-term than public credit, illiquidity is an embedded feature. That's also why you get slightly higher returns compared to public bonds,” Chen says.
During a capital markets conference in Paris in May, JP Morgan had a survey for global investors. Just 48% of investors from Asia expressed a willingness to advocate more to the private sector.
Investing in private credit depends on whether your capital is patient capital that can withstand redemption. For retail investors and private banking high net worth individual oriented funds that could face redemption requirements, private credit funds may not be appropriate.
“Private credit capital comes from longer term capital such as sovereign wealth funds or pension funds. Usually the tenor of private credit funds are three years and above, and is for capital which doesn’t require daily liquidity, but you can potentially get a few hundred basis points pick-up by having a more efficient structure, governance and slightly longer investment cycle,” Chen says.
JP Morgan started building the private credit business in Asia in 2019. “Now we have origination, structuring, distribution and trading capabilities in all of the major countries,” Chen says. Investment opportunities are from infrastructure including renewables, toll roads and corporate capex expansion in Emerging Asia. A newly emerging sector is fintech-related, Chen points out.
Credit fund origination is likely to be in places such as Australia and India (where the rule of law is amenable). Investors may need time to feel comfortable with Chinese onshore assets. “Australia is a very interesting destination for many global guys, as is Hong Kong, Singapore and a selection of Southeast Asian countries. Japan is slowly opening up,” Chen says.
She believes there is an organic need for private credit, which can provide borrowers with more flexible solutions, enable complex transactions, and is an additional provider of capital.
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“When the company gets more mature, they go from private equity, private credit, then eventually to the public market,” she adds.
With an influx of capital and a rise in competition, a potential risk would be customers underwriting standard deterioration and covenant lightening for a lower return, Chen cautions. “That happens with any asset if there’s too much money chasing for it,” she says.
On the other hand, lowered interest rates could lead to borrowers returning to public markets, reducing demand for private credit.
