Adam Wheeler, Barings
Investors will continue to be drawn to the private credit asset class, which offers an attractive risk-adjusted return, Barings co-head of global private finance group Adam Wheeler told FSA.
Private credit is a relatively young asset class (20-30 years old), but it is growing rapidly, as banks are retreating from lending to small- and mid-market companies. Meanwhile, there is strong demand for yield from investors after more than a decade of low interest rates, Wheeler explained.
The middle market refers to companies generating annual earnings in the $25m to $75m range, but not big enough to raise financing in the larger liquid capital markets.
The yield premium comes from the complexity and resource intensity of the asset class as well as its illiquidity. Senior secured loans to performing middle market companies can generate floating rate returns and incomes in the range of 6% to 9%; in more stressed opportunities, these returns can rise into the teens, he said.
The asset class is now fast approaching $1trn but encouragingly, the opportunities are growing as fast. There are record levels of private equity looking for debt to support them in their investments. With the banks retreating, this is an exciting opportunity for private debt lenders, according to Barings.
However, “our philosophy is to be as conservative as possible in underwriting the loans we make. We structure the loans and focus on the more defensive sectors,” said Wheeler.
Private credit is an illiquid asset class – the loans are difficult to trade and so in underwriting a loan, the expectation is that investors will hold that loan to maturity (typically six or seven years).
Alleviating risk
Barings looks to lend to companies that will be resilient through an economic cycle and these tend to be within the more defensive sectors such as healthcare, technology and business/software services, according to Wheeler.
“We avoid the more cyclical sectors and focus on industries which demonstrate predictability, resilience and high cash flow conversion,” he added.
The main goal as an investor is to minimize the number of defaults in a portfolio and, if they occur, the investor should have the ability to recover as much value as possible.
Hence, Barings aims to structure deals with lower leverage and higher equity cushions to protect their downside, and build diversified portfolios.
Looking ahead
In 2022, greater geographical diversification in private credit allocations is expected. Historically, most investors started by allocating to the US direct lending makets, and in recent years have diversified into Europe. Asia, as a destination for private debt investment, has lagged.
“But given the scale and relevance of the region to the global economy, a growing allocation to Asia into 2022 and beyond is expected,” said Wheeler.
