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Home>Events>Fixed Income and Private Credit Forum>Private Credit Forum
2024>Private credit opportunities shine amid macro-factor minefields

PRIVATE CREDIT FORUM 2024


PRIVATE CREDIT OPPORTUNITIES SHINE AMID MACRO-FACTOR MINEFIELDS


L-R: Marianna Fassinotti, Matthew Turner, David Selznick, Peter Graf and Matthew
Cohen
Darcy SongMay 6, 2024 | 4.57pm
Save Article


If you believe the critics, the private credit bubble is bound to burst any day
now. However, for institutional investors, the asset class still tells a story
that seems too good to be true.  

Despite its illiquidity, private credit offers attractive returns and relatively
low volatility. With interest rates at their highest levels in more than a
decade, the asset class’s yield has become more enticing.  

Right now is a time where opportunities and challenges co-exist in private
credit, at least in the Australian market, ICG head of Australian senior debt
Matthew Turner told the Investment Magazine Private Credit Forum. 

Higher rates are certainly good news, and the future deal environment is also
looking healthy, he said.  



“Higher base rates means that your total returns should remain higher for longer
on a gross basis,” Turner said. 

“There’ll be lower leverage in deals going forward just by the fact that the
cash flows are constrained by the higher base rates.   

“As we get more funds into this market, there’ll be larger market deals, and
that will be because there’s more capital to go around and provide [for them].
We’ve got more international PE funds coming here, so we’ve got a chance to do
bigger and better deals for bigger and better companies.” 

However, there are also a few risks at play for the asset class, and Turner said
the market might be focused on the wrong thing.  

L-R: Aleks Vickovich, Jessica Melville (AustralianSuper), Seamus Collins (Mine
Super), John Lucey (Resolution Life) and Matthew Turner (ICG)

“Everyone talks about interest rates, interest rates, and interest rates, but
they are extraordinarily boring compared to what’s actually happening with
labour inflation,” he said.  

“If you want to go and sit there and have a look at what is going on in
portfolio companies across all of Australian credit, labour cost is the number
one concern.  

“One thing I’ll tell you is the healthcare sector is no longer as defensive as
it once was. We have seen the most extreme labour price inflation, there is a
lack of supply of medical professionals that cannot be actually brought to
market in any time soon.” 

Deals in the Australian market are also running on higher leverage than they
historically have as the nation moves from a low-interest environment. This
reality would pose challenges to portfolio companies, Turner said, but he said
he is confident about private credit’s resilience.  

“What I would say…is this hurts equity way more than it hurts debt. We have
generally a 50 per cent embedded subordination in our deals from a capital
perspective, so they [portfolio companies] have to pay their interest bills
first. If they don’t do that, they’ll make their business at risk,” he said.  

“What tends to happen is they will ration their cash in other parts and how they
run their business.” 

NET ZERO LANDSCAPE 

Apart from macroeconomic factors, private credit investors are also grappling
with their strengths and limitations in key thematics such as net-zero
transition finance.  

Opportunity-wise, IFM Investors associate director of debt investments Matthew
Cohen said a diversified asset manager is in a prime position to facilitate a
broader discussion of transition finance.  

“We think about the sort of economic activities that happen in the wide-open
spaces, and there are transition opportunities that exist outside of that pure
power generation segment,” he said, suggesting areas including real estate,
transport and real estate. 

L-R: Haresh Sampat (QIC), Kristy Graham (ASFI) and Matthew Cohen (IFM Investors)

“We pay very close attention from investment diligence to how we manage
portfolios, and then how we set investment strategies and the investment
lifecycle. That all feeds into informed capital allocation. 

“As private credit managers, we love risk mitigation…and a big part of that is
managing transition risk and managing climate risks.” 

However, while debt investors intend to play a bigger facilitation role in the
net-zero transition, a big challenge is that their voice is weakened in the
boardroom, Cohen said.  

“We don’t have board seats. Depending on the type of transaction, we can be one
of 10 or 20 lenders, so your scope to have influence to compel investee
companies to transition is diluted somewhat,” he said. 

“As a debt investor, your investment horizon is three to five years, maybe
slightly longer for certain sectors. But what sorts of transition can you compel
over that timeframe to still fit within investment objectives and
considerations?” 

In these conversations, the key for debt investors is to both have a balanced
approach and investment expectations, Cohen said. 

“The utopia for us is that we can execute on investment strategy and get paid
commensurate rates of return relative to the credit risk and sustainability
risk,” he said. 

“Having an investment investor base that is very informed and understands the
practicalities of these challenges and understands what that means for
investment strategy [is important].” 

SYNTHETIC RISK TRANSFER 

The global private credit is now estimated to be worth US$2.1 trillion (3.2
trillion) and about three quarters of that lies within the US market, according
to the International Monetary Fund (IMF). And within this huge market, asset
manager the D. E. Shaw group has spotted opportunities in synthetic risk
transfers (SRTs) amid banks’ search for capital relief.  

The strategy is sometimes referred to as significant risk transfer, regulatory
capital trades or credit risk transfer. SRTs allow banks to essentially transfer
the underlying risk of their exposures, such as a book of corporate loans, to
investors, but retain that exposure on their balance sheet. 

Marianna Fassinotti (The D. E. Shaw Group)

The group’s New York-based head of private credit investments Marianna
Fassinotti said the strategy has seen some favourable regulatory developments in
the US recently, after the Federal Reserve clarified how SRTs may relate to its
capital rules. This could jumpstart the growth of assets and the number of
securitisation issuers, she said, and the potential increase is substantial.  

“This [SRTs] was really a technology that was adopted much earlier by European
banks than by US banks,” she said. 

“There have been transactions in the US for five or six years, but in earnest,
it’s just beginning in the US today. 

“If every large bank globally issued as much regulatory capital relief as part
of their risk weighted asset planning as the top five banks that exist today
that are doing this, you would see about 250 per cent increase in the issuance
of synthetic risk transfer notes.  

“I’m not saying that that’s what’s going to happen, but the penetration of the
technology at banks both in the US and more generally is still pretty low.” 

For asset owners looking to jump onto the bandwagon now, Fassinotti said they
can expect desirable traits including high-yield return profiles, exposure to
“core” banking assets, floating-rate instruments, and alignment with issuing
banks. 

“Looking forward, we definitely think that consumer finance will continue to be
an asset class that gets folded into more synthetic risk transfer issuance,” she
said. 

“The public credit markets and even the private credit markets, specifically
direct lending, don’t usually intermediate the assets that the banks are using
to achieve regulatory capital relief. 

“These are not loans that the bank is looking to sell or move off balance sheet
from a relationship perspective. 

“So this [SRTs] is the tool to get access to that level of credit exposure.” 

THE ASIA OPPORTUNITY 

Some other asset managers, meanwhile, have set their eyes on the budding private
credit scene in Asia, even though Asia Pacific’s private credit market only
stood at US$81 billion as of 2021 and somewhat dwarfed by North America and
Europe.  

“What’s been incredible over the last five to 10 years in particular, is the
amount of capital that has gone into support larger and larger businesses [in
Asia Pacific],” said Ares Asia head of sponsor direct lending Peter Graf. 

L-R: Aleks Vickovich, Shikha Gupta (Future Fund) and Peter Graf (Ares Asia)

“In India, of the 25 big global private equity firms, almost all, if not all of
them, have been active in the country for 10-plus years already. 

“If you look at pricing as a whole that’s on offer on private credit in
Asia…most of the time, you’re getting a premium. That could be 75 basis points
to 100 basis points on developed market risk, and then on emerging market risk,
it could be 200 basis points plus. 

“The real opportunity over the next 20 to 30 years is Asia.” 

From an asset owner perspective, Future Fund director of credit Shikha Gupta
said the $272 billion sovereign fund has a healthy appetite for private
credit.  

Over the years, the fund’s strategy has shifted from real estate-backed lending
and distressed lending to performing credit more recently in emerging markets.  

“Quite frankly, it makes me sleep better at night,” Gupta said of the pivot. 

“I think these [emerging] regions…are all maturing. 

“For us, the important thing is making sure we are getting a premium for it and
making sure it stacks up on a relative value basis versus everything else that
we’re seeing globally.” 

With that said, Graf warned of the risk that lies in a “fly-in fly-out” approach
to investing in Asia debt.  

“You need to be on the ground living and breathing the credit, the culture and
the country to really understand what’s going on and what your protections are
if things don’t go well,” he said.  

Gupta echoed the sentiment and reiterated the consequent importance of sourcing
in Asia.  

“It’s a very different type of sourcing – it tends to be more proprietary in
places like India… you don’t have a broker calling all the private credit
managers, so you really need to know the person intermediating the deal,” she
said. 

“So really strong sourcing capability that is tailored to the individual markets
is important.” 

REAL ESTATE PLAY 

Meanwhile, many investors have turned to real estate in search of downside
protection within private credit.  

Speaking of the US market specifically, alternatives asset manager Kayne
Anderson’s real estate chief investment officer David Selznick said there will
be plenty of opportunities for private credit investors to buy loans from
regional banks. 

Close to half of the US real estate banking system is made up of regional banks,
Selznick said, and after interest rates jumped, their “underlying loan covenants
are being busted”. 

L-R: David Selznick (Kayne Anderson), Belinda Chain (Future Fund), Domien
Beckers (VFMC) and Chris Grogan (Qantas Super)

“You have all these banks that were supporting the real estate market in the US
that are now on the sidelines, and there is a huge opportunity to fill that gap
with private credit,” he said. 

However, Selznick also stressed that the process won’t be easy and is like to be
a “tactical game”, since many of the regional banks still have a wait-and-see
mindset and aren’t willing to sell their loans at a discount or an attract level
for a buyer. 

“But I will tell you, this higher-for-longer situation that we have is now
forcing decision making. It’s starting to become a reality that interest rates
are not going to save these banks,” he said.  

“[Buying the loans] is relationship-oriented. None of these banks are going to
be broadly marketing their portfolios, because they don’t want to air their
dirty laundry.  

“Bankers are very proud people, so they have a hard time admitting that their
portfolio might be impaired in some degree. 

“Any of the bank failures, like Signature Bank, those obviously get marketed
widely, and the big guys like Blackstone or Brookfield will compete on buying
the big portfolios. We actually think there’s way more value in the US$250
million to US$2 billion portfolio range with these [other regional] banks. 

“But again, it’s a ground game,” he said.  

All photo credit to Jack Smith. 



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