Accessing Opportunities in Asia Insight

Pacific Private Debt

July 2021
While private debt is firmly embedded in the US and Europe, the asset class is
playing catch up in the Asia Pacific region, offering a raft of potential
opportunities for investors looking for higher yields and protection from
interest rate risk.
The Asia Pacific region is home to around 150 million small and medium-sized
enterprises (SME).1 However, disproportionately, they only benefit from Andrew Tan
approximately 20% of all bank lending. In a similar vein to the US and Europe, Asia
middle-market companies are underserved by lenders due to regulatory changes. Head of Asia Pacific
Fig.1 Breakdown of Small and Medium-Sized Enterprises in Asia Pacific Private Debt
Andrew has close to 20 years of industry
40 to 60% of
Sources of Finance² experience in Private Debt. Prior to joining
GDP1 Muzinich, Andrew was Head of Global Loans
and Special Situations Asia Pacific at HSBC In
Non- this role, Andrew was responsible for building
bank up the private debt business and was involved
lending in sourcing, structuring, execution, risk taking
9%
and distribution of private debt. Andrew also
managed HSBC’s Asia Pacific secondary loans
Bank
and distressed debt investing businesses.
96% of all lending
SMEs Previously, Andrew worked at Nomura and
enterprises4
18% Merrill Lynch in various investing and trading
capacities involving private debt, syndicated
loans and distressed debt. Andrew is a graduate
of the University of Melbourne. He served as
Bank lending - large the chairperson of the Asia Pacific Loan Market
corporates
73% Association Secondary Loan committee from
December 2018 to June 2020.

67% of
employment3

Sources:1 -Asia Pacific Economic Cooperation (APEC) Policy Support Unit Report titled: Overview of the SME Sector in the APEC Region: Key
Issues on Market Access and Internationalization as of April 2020. 2 - McKinsey, Asia Pacific Banking Review, 2019. SMEs are those with EBITDA
range between USD$5-50 mn. 3 - Asian Development Bank, The Role of SMEs in Asia and their difficulties in accessing finance, December 2018.
4 - Private Credit in Asia Report 2020 by Alternative Credit Council.

FOR PROFESSIONAL CLIENTS AND QUALIFIED/ACCREDITED/INSTITUTIONAL

1
INVESTORS ONLY - NOT FOR RETAIL USE OR DISTRIBUTION – CONFIDENTIAL
Post-Pandemic Financing Need We believe private debt can bridge this funding gap and
the asset class is starting to gain traction in the region. In
A joint report released in 2017 by the International
2020, the Asia Pacific private debt assets under
Finance Corporation (IFC) and SME Finance Forum
management totaled US$65.6bn versus US$595.6bn in the
estimated that SMEs in Asia face a funding gap of around
US and US$289.5bn in Europe.3
US$2trillion, a sum we believe is likely to increase due to
the global pandemic. 2
Overall, we have seen a 15% per annum growth rate in
private debt AUM in the region since 2014. We expect this
We are focused on the middle market (i.e., companies trend to continue and for growth to pick up further,
with EBITDA of between USD$5-50mn) and where we similar to the experience in Europe and the US.
believe there is less competition with a greater ability to
get better deal terms and covenants.

In this segment, we are seeing a reduction of risk appetite

Fig. 2 - Asia Private Debt AUM, 2008 to Sep-2020
by banks to make new loans to middle-market companies
along with an increased willingness to dispose of existing
non-core, middle-market loans.

Assets Under Management ($bn)

We are encountering middle-market companies who are
either not able to get bank financing, or only short-term
working capital financing from banks. In the case of the 45.6 46.3
latter, such financing is typically only made available 34.7
when they allow the banks to take security against 24.9
16.6 20.8 23.4
accounts receivables from their largest, most credit 16.0 19.2
worthy international customers. 10.8 13.5
4.9 6.2 14.6 10.3 15.2 16.9 18.1 19.3
4.6 6.0 5.8 6.8 9.4 7.6 9.7

These companies are not able to get term financing for 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Sep-20
growth, capital expenditure, business expansion or Dry Powder ($bn) Unrealised Value ($bn)
acquisition, or even to help turn their business around.
Source: Preqin, as of May 2021. Reference to $ is USD.
This is where private debt from alternative lenders comes
in to fill the lending gap, with the ability to provide term
financing in the 2-5 year tenor range to help these Asia Pacific versus US and Europe
companies reach their growth potential.
There are differences in the Asia Pacific region compared
We believe there is a raft of opportunities for specialist, to the US and Europe. Firstly, the Asia Pacific private debt
middle-market lenders. Pipelines appear healthy, and we market is still in the early stages of its growth trajectory,
expect we will continue to see good supply dynamics for therefore, in our opinion, there is less competition, and it
new middle-market loans across the region. We are is more fragmented.
already seeing an increase in companies considering
private debt as a financing alternative. Local funds are focused on specific markets while
international funds, not specialised in Asia, are only
This is not just as an alternative to traditional bank looking for larger deals.
lending, but even as a cheaper alternative to raising equity
capital, especially for example with entrepreneurs who In terms of structures, we generally aim for a security
might not be as willing to dilute their holding in a package which is a combination of shares and hard assets
company. that are at times complemented by corporate or personal
guarantees.
There is also the opportunity to replace existing bank
lending to SMEs where the banks are looking to exit, not There is also room for collateral top-up mechanisms where
for credit reasons, but due to requirements to reduce risk lenders require more collateral or cash to maintain a
and increase return on risk weighted assets (RWA). minimum of, for example, 2.5x collateral coverage on our
lending.
Middle-market companies tend to take up more regulatory
capital and therefore drag down the return on RWA The overarching theme is to be able to make use of
calculations for banks. structures to mitigate some of the perceived risk in Asian
jurisdictions. In Asia, we have seen covenant discipline,
particularly financial covenants.

FOR PROFESSIONAL CLIENTS AND QUALIFIED/ACCREDITED/INSTITUTIONAL INVESTORS ONLY - NOT FOR RETAIL USE OR
DISTRIBUTION – CONFIDENTIAL

2
Covenant-lite transactions are not usual practice. We also These findings are incorporated into our investment
typically have review events in place should anything memorandums and are key items in investment committee
unusual arise such as a potential loss of a major contract decision making in the Asia Pacific.
or customer, where we can work with the company early
on to find a solution.
Conclusion: Financing Gap Creates Opportunities
Net Leverage Ratios tend to be in the 3-5x EBITDA range. The Asia Pacific region is home to a large and growing
The average tenor of the loan is also shorter at around 2-3 middle market with an estimated US$2 trillion financing
years compared to 5-7 years in Europe/US. CAPEX cycles gap.4
are generally shorter in Asia, allowing us to incorporate
principal amortizations into the structures. Private debt is still in its early stages of growth and is
therefore less competitive than the US and Europe,
In the jurisdictions in which we operate, liens and the offering the opportunity to take advantage of a
enforcement of collateral is possible. fragmented and underserved market.

The region can offer good credit quality and collateralised

Environmental, Social and Governance
security packages, and we believe we can look to achieve
Considerations higher, risk-adjusted returns than other regions.
As lenders, we believe it is critical to have an in-depth
understanding of the risks and opportunities facing the Risks can be mitigated with transactions having good
businesses to which we lend. covenant protection and deals being shorter dated.
Overall, we believe the private debt opportunity in Asia
This is as much about the financial circumstances of a looks set to continue its growth trajectory and we
business as the way it manages environmental, social and continue to see a lot of demand from companies and
governance (ESG) factors. We believe companies with sponsors seeking financing.
robust governance structures and policies, with engaged
workforces, and the ones which manage their All things considered, over a year into the COVID-19
environmental impacts well are more likely to be pandemic, we are seeing a number of good
financially resilient over longer time horizons. opportunities emerge from several themes: the
middle-market funding gap, banks de-risking, certain
Historically, while a certain degree of ESG consideration
sectors being able to reposition their business in
has likely been part of most lenders’ due diligence
procedures, ESG due diligence and ongoing monitoring is
response to COVID-19 conditions, and even some
only now coming to the fore as a key element of best benefiting from this unfortunate event.
practice.
We believe that it is a potentially attractive time to
ESG considerations in Asia Pacific middle market start deploying capital into the private debt markets
companies are not always straight forward to comprehend to capture these opportunities that have emerged to
and are typically context specific. achieve what we believe compelling risk-adjusted
returns in Asia Pacific.
With patience and careful diligence, we work on applying
ESG frameworks such as the Sustainability Accounting
Standards Board (SASB) Materiality Map to identify the ESG
issues most relevant to financial performance in specific
This material is not intended to be relied upon as a
industries.
forecast, research, or investment advice, and is not a
recommendation, offer or solicitation to buy or sell any
Questions we ask as part of our diligence for example are:
securities or to adopt any investment strategy. The
Does the business have good strong financial and operating
opinions expressed by Muzinich & Co are as of June 2021
controls? Will the sponsor be introducing an independent
and may change without notice.
chairman? Does the company have robust backup
procedures or disaster recovery plans, and how is the
company addressing local environmental laws?
1. Asia Pacific Economic Cooperation (APEC) Policy .
Support Unit Report Titled: Overview of the SME Sector
Our findings are summarized into an ESG scorecard to in the APEC Region: Key Issues on Market Access and
cover ESG considerations that can include transparency Internationalization as of April 2020.
and accountability, anti-bribery and corruption, climate
2. International Finance Corporation (IFC) World Bank
change, environmental degradation, employee
Group, Micro, Small and Medium Enterprises (MSME)
engagement and welfare, equitable stakeholder
Finance Gap Report 2017. Most recent data used.
interactions, diversity and inclusion and any UN
Sustainable Development Goals that would specifically be 3. Preqin, as of May 2021. Reference to $ is USD
supported by Company actions/measures. 4. IBID

FOR PROFESSIONAL CLIENTS AND QUALIFIED/ACCREDITED/INSTITUTIONAL INVESTORS ONLY - NOT FOR RETAIL USE OR
DISTRIBUTION – CONFIDENTIAL

3
 Important Information

Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. This material has been
produced for information purposes only and as such the views contained herein are not to be taken as investment
advice. Opinions are as of date of publication and are subject to change without reference or notification to you.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of
consideration when selecting a product or strategy. The value of investments and the income from them may fall as
well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may
cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for
a variety of reasons, including but not limited to, increased political, social and economic instability, heightened
pricing volatility and reduced market liquidity. This material and the views and opinions expressed should not be
construed as an offer to buy or sell or invitation to engage in any investment activity; they are for information
purposes only. Opinions and statements of financial market trends that are based on market conditions constitute
our judgement as at the date of this document. They are considered to be accurate at the time of writing, but no
warranty of accuracy is given and no liability in respect of any error or omission is accepted. Certain information
contained herein is based on data obtained from third parties and, although believed to be reliable, has not been
independently verified by anyone at or affiliated with Muzinich and Co., its accuracy or completeness cannot be
guaranteed. Risk management includes an effort to monitor and manage risk but does not imply low or no risk.
Issued in the European Union by Muzinich & Co. (Dublin) Limited, which is authorized and regulated by the Central
Bank of Ireland. Registered in Ireland No. 625717. Registered address: 16 Fitzwilliam Street Upper, Dublin 2,
D02Y221, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-
389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by
Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore.
Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in
all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the
Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street,
London W1S 1YQ, United Kingdom. 2021-06-25-6667

www.muzinich.com www.muzinichprivatedebt.com [email protected]

www.muzinich.com www.muzinichprivatedebt.com [email protected]

New York London Dublin Frankfurt Geneva Hong Kong Madrid Manchester Milan Palm Beach Paris Singapore Sydney Zurich
New York London Dublin Florida Frankfurt Geneva Hong Kong Madrid Manchester Milan Paris Singapore Sydney Zurich