PEI Forum: Asian companies way under-levered

A mismatch in supply and demand has created big opportunities for credit and distressed lending in Asia, delegates heard at the PEI Global Alternatives Investment Forum in Tokyo.

China has 49 million SMEs that account for 65 percent of the GDP and 75 percent of tax receipts, but only a small percentage of them can get loans, said Conor MacNamara, partner at Adamas Asset Management, speaking on a panel at the PEI Global Alternatives Investment Forum in Tokyo.

“Banks prefer to lend to state-owned enterprises. It creates a huge shortfall that will take many years to cover.”

According to David Creighton, president and chief executive officer of Cordiant Capital, 39 percent of global growth comes from emerging markets, yet that same region makes up only 14 percent of world debt. 

“What drew us to this business was the dynamics of world output,” Creighton said. “Emerging markets are highly under-levered and the opportunity for growth is significant.”

[Chinese] entrepreneurs desperately believe in their own cooking. If you’ve got two amounts of the same money and the competitor is private equity, the
entrepreneur will tend to overvalue the equity he’s giving away and undervalue the collateral package because he will never [envision] trouble coming

Christopher Botsford
CEO and co-founder
ADM Capital

In addition, the mandate of Western bank loans in emerging markets is down by 20 percent over the past year, widening the gap between capital need and availability. 

“Emerging markets have growing requirements for financing and the money is not there,” Creighton said. “We’ve seen a significant move into corporate bonds in emerging markets, but the loans, the private debt, have been left on hold.” 

The panel also discussed lending risk in Asia. Christopher Botsford, chief executive officer and co-founder of ADM Capital, said it’s necessary to go and verify what is on documents.

“Make sure the assets are there, the collateral is there. In our experience of unwinding deals that went wrong in Asia in 1998, there are a lot of things people take for granted. So a note of caution.”

Botsford said there are not many barriers to getting money out there, but there are barriers to getting the money back. The key, he believes, is having allies in the local market. He cited an India deal ADM did, helping restructure India Cement, a company listed on the Bombay stock exchange. The company was rehabilitated and the founder became a strong ally. 

“Not just for referring people, but what we found to be valuable was he told us who not to deal with,” Botsford said.

Adamas, which also lends in China, asks for 1.5x collateral in the form of personal guarantees, real estate or business assets, though it must be offshore, said MacNamara. 

Chinese owners typically hedge their companies by holding 25 percent of their assets offshore, so it is not difficult to get. “If we can’t get offered 100 percent offshore collateral, we move on.”

Additionally, the panelists highlighted some points that they believe encourage private debt strategies over private equity in Asia. 

ADM, which has done 36 deals in China, works with Chinese entrepreneurs and they typically would rather give collateral than an equity stake, Botsford said.

“Entrepreneurs desperately believe in their own cooking. If you’ve got two amounts of the same money and the competitor is private equity, the entrepreneur will tend to overvalue the equity he’s giving away and undervalue the collateral package because he will never [envision] trouble coming. He tends to think his shareprice will go up 10-fold in the next few years.”

MacNamara added that Chinese SMEs typically don’t want private equity to take a 30-40 percent stake, but are happy to work with private debt lenders who demand 20-25 percent coupon for 1 year or 18 months.

“If they are in an expansion phase and profitable, they know they can repay that loan before the end of the term.”