You're listening to Strictly Business Podcast with Lindsay Williams.
I received a very interesting article which says the following, the headline
that is,
Emerging market private credit stands apart as cracks appear in US private
credit.
It goes on to say, strains are building in US private debt as underwriting weakens
and defaults rise.
In contrast, investors in emerging markets can access higher senior secured yields
with stronger...
protection.
It's an unusual situation.
With me now is Alper Kilic, who is head of alternative credit at 91 in London.
The reason I say it's unusual, Alper, is because you normally think of stability in
developed markets, not emerging markets.
But in this case, it's gone 180 degrees, I think.
This is true.
First of all, I think it is the perception.
And I guess the way that I define it is that perception versus reality.
Understandably, emerging markets, more difficult markets, more risk.
versus more stable, more established developed markets.
But I think what we have been seeing in relation to specifically the private
credits over the last few months
is proving that actually it is wrong.
And I guess we have been making the point as
91 and also personally myself for a long time that this was bound to happen
because I guess we've been watching the market very closely and we were due to see
some...
credit defaults and losses.
And it has happened.
And we do expect that it will continue to happen.
Whereas the story in the emerging markets is different.
And I'm sure we'll talk about the details of it.
But actually, in terms of the quality of the credit deals defaults,
we have seen a great stability in the emerging markets despite the challenging
market conditions.
So that's why we made that statement.
There was a very well-known CEO of a very well-known Wall Street bank that was
quoted from a conference.
In fact, I saw the interview, and he sort of gave us a warning about developed
market credits, particularly
U.S., and he didn't say that it was going to cause the market to crash.
But I have seen headlines saying, is U.S. private credit debt the next subprime?
Surely it hasn't gone that far, has it?
I don't think it has gone that far, and I don't think if the You know,
if the real question is that we expect a systematic risk here, I really don't think
so.
But I think in between, there will be some winners and losers.
And I think it's going to get worse before it gets better.
I mean, you know, the well-known CEO of a well-known bank is not liked by many in
the private credit sector in the U.S.
at the moment.
I do quite like him, actually.
You know,
what he is referring to is a beer-prudent lender and use common sense.
And I think there's nothing wrong with that.
I think what we are seeing in the U.S., we've seen the results of it,
but I guess the causes for it is that there's so much liquidity, there's so much
funding,
and there is huge pressure for deployment from the large U.S. private credit houses.
And they have defined U.S.
as their core market, and in particular, they have further defined...
a category in terms of where their lending activities will take place.
And they define to say that most of the activities happening in the
sponsor-backed,
non-banked, mid-tier direct lending.
That's how defining their market.
And when you have billions and billions and billions of dollars chasing that
particular market,
what has started to happen is that losing underwriting conditions, creditors chasing
the same deals.
no concentration risk or you know forgotten and in terms of the you know
security
dynamics in terms of the covenants we started seeing a really loose practice and
all of that
combined together you
know force the cracks to appear and and and that's why you know with the high
profile
defaults whether it's tricolor or or first brands that
which made the headlines.
That's caught people's attention and then made the investors worried, and therefore
investors started demanding their money.
So I think the underlying is really bad credit decisions driven by a huge amount
of
liquidity and dry powder chasing the same market and same kind of
underlying borrowers and here we are.
Yeah, and here we have an asset class which wasn't that well known a couple of
years ago, private credit that is.
It's grown into roughly a US$3 trillion global asset class.
It's become crowded in the United States, as you've said.
And from what you're suggesting, it has prompted slack practices.
Is that a little bit too simplistic?
I think it is exactly what happened.
And the way I define that is that it's almost like I started...
My background is I'm a banker.
I've done basically structured debt and credit all my life, close to 30 years.
And a long, long time ago, when I started banking, we had the first, if you will,
the training, credit training.
That was Credit 101.
And the concept was be a prudent lender.
Use common sense.
Use your tools available in your toolbox, which is your security, which is your
governance.
That's how you stay on top of the credit situation.
Choose your borrowers carefully.
Credit 101.
And I think, you know, that principle hasn't changed.
So the asset class itself as private credit,
it is there for a reason.
And the reason has been that the banks have also been
stepping back, especially when...
comes to term lending,
because there is a lot of pressure and challenges and restrictions for the bank
to
maintain their capital base, especially in relation to Basel III and Basel IV
regulations coming through.
And they have been focusing more on the short-term lending space, more working
capital, trade financing.
It's not that they don't do term financing.
They do, but their capital requirements are much higher.
So therefore, the banks have kind of...
pullback and you have institutional investors such as your insurance companies
such as your pension
companies and basically they they they have from their own clients
uh term long-term uh financing and liquidity capabilities so essentially it's
all about the long-term
assets matching the long-term liabilities and so the private credit players
are basically using that capability to work with their institutional investors,
and therefore,
they match their assets and liabilities, and they raise those liabilities through
their clients,
and they place them into the term assets.
There is nothing wrong with it, and I think it works.
It's a working model.
And I don't think in that space, if everyone plays their roles carefully, I
don't think there will be losers.
the big because the borrowers are benefiting from it.
They need long-term financing because whether it may be CapEx, new investments,
acquisitions and whatnot,
and the creditors are matching their assets and liabilities, and they're also
supporting a viable,
sustainable business model.
Cracks start to happen when people move away from what they're doing, what they're
supposed to be doing.
And that's why, I guess, we are facing this issue right now.
And also the US market, the participants chase software as a service and business
services,
where in emerging markets, you've got, as you put it,
an opportunity set dominated by asset-heavy,
cash flow generative borrowers with limited exposure to sectors most
vulnerable to AI disruption.
So in other words,
solid institutions that generate cash flow with far less risk than the US business
model, I would say.
That's exactly true.
I think I can understand the headlines again, because there is not a day that
goes by, you know,
with us not talking about AI, AI growth, technology, absolutely.
But when it comes to credit, when it comes to lending to those entities,
we look for established business models, we look for stable revenues, we look,
we try to understand from our borrowing clients who their clients are, do they
have contracts?
how sustainable those cash flows are.
And as we all know, cash is king.
We do pay attention to cash flows and revenue.
So on the contrary, when you look at the story in the U.S.
vis-a-vis the growth of AIs, yes, there is a lot of growth potential.
There is a lot of growth, I guess, expectations.
We all understand it.
We all get it.
But then it is also very volatile.
The dynamics change a lot.
technology change a lot clients move around a lot so if you are entering into a
credit relationship
with a name software name like that without establishing the fact that their
revenue and cash flow
generation model is stable before
you know it actually market dynamics may change and you find your borrower not
being able to repay your debt
In emerging markets, the approaches we are taking is asset-backed,
stable revenues.
Also, a significant majority of what we do is secured lending.
So we put charge on those fixed assets.
We put charge on the assignment of the receivables from our clients.
We work with them.
We agree with the covenants with them.
But the concept of covenant light, To be honest with you, it doesn't exist in EM.
We've never done it.
You do negotiate your covenants, of course, but there is always covenants.
There's always security.
There's always plan A and plan B.
There's always concentration risks.
So the underwriting standards in EM, and that's pretty much across the board,
and has been pretty stable.
And as a result of that, while of course we do see three credit issues,
it will be naive to say that there's no credit issues.
It is far more manageable compared to what we are seeing in the US in particular.
So what do you see happening?
Do you see the US now sort of stabilising because no new participants will come into
the market because it's a crowded market and
because the pickings are rather slim?
And on the other hand, do you see the emerging market being targeted by the same
sort of players that
might play in the US and therefore the situation comes full circle?
What would you say?
rotation.
But the dynamics are very different.
I guess rather than the players coming into emerging markets and changing the
market dynamics,
in emerging markets, the credit standards and credit behavior has been pretty
established.
Second of all, and there's an important differentiation here, in the asset class
that I highlighted to you at the moment in the US,
a lot of that is non-bank.
Therefore, private credit players are not working with the banks.
They are basically working outside of the banks and going directly to those
borrowers.
Now, it's a business model.
It may work for some.
But in emerging markets, and we refer to emerging markets, of course, it's huge.
I mean, if you look at it, depending on how you define it, right, it may go from
anywhere from, you know,
120, 30 to 200-odd markets.
The way that we define it, and when I look at it, I define it as where the big flows
are,
where the big infrastructure needs are, where the big...
established economists are, probably we've identified for 91's purposes about 15
markets,
that is Asia, Latin America, and it's SEMIA, that's basically Middle East,
Central, New East, Europe, and Turkey.
So out of those 15 markets,
the banks are active in terms of their origination model, in terms of their
network.
And the differentiation I'm trying to make here is that In emerging markets, we still
work with the banks.
We work with the banks because we partner with them in origination.
We do syndicated deals, we do club deals, and despite that,
we are still able to generate very sustainable returns.
And as a result of that and that market dynamic,
I think trying to displace the emerging market credit standards
and follow the examples of what's happened in the U.S.
will not be realistic any time soon.
And then the second point is that while it is perhaps not 200 markets, it's 15
markets,
it is still 15 different markets.
So it is still the understanding of those dynamics locally, those borrowers,
those regulations.
It requires a lot of effort and hard work.
Therefore, I don't think it is.
Easy to replicate to say that I have a huge amount of dry powder and I'm going to
go and change the credit standards.
And third of all, I think it will be almost a recipe for disaster, having seen
what happened in the U.S.
And if they try to replicate the same model once again,
I don't think how much investor support and investor appetite those institutions
will get.
That's why I think it's quite limited to see this similar deterioration in the
emerging markets.
I'm just looking at the 91's platform and some of the deals that it's done.
Very diverse indeed, Alper.
You have done a deal with a Vietnamese renewable company in South Africa.
This is an interesting one.
Infrastructure development to facilitate the building of apartments targeting low
to middle income homeowners.
And also you go to Latin America, a cold storage logistics supplier.
Are you still seeing lots of opportunities in emerging markets?
We are seeing tons of opportunities.
We are seeing tons of opportunities and our focus is basically in two main areas.
One is infrastructure and the way that I define infrastructure is it is pretty much
from energy, generation,
transmission, distribution to transportation.
Roads, motorways, railways, telecoms, that is fiber,
that is towers, that's data centers, healthcare, hospitals.
So the entire universe of infrastructure is where the demand is.
There are different numbers, but I think it was through
World Bank that they've announced that the annual infrastructure gap in emerging
markets is
about...
two trillion dollars.
Two trillion dollars, right?
So if you look at the low and middle income countries, China, Indonesia,
Brazil,
Turkey, and India,
those five markets make 70 percent of that infrastructure kind of a demand.
So our focus is infrastructure because there is a lot of need
and the growth story of those economies.
compared to developed markets is about 2% more.
So according to the World Bank's numbers, the expectation is about, in those
markets,
average growth rate is about 3.4%, 3.5%, whereas in developed markets,
you have about 1.4%, 1.5%.
So economies are growing.
Infrastructure is leading this growth, and it's wide-based, driven by energy, but
other sectors as well.
And we are seeing a lot of opportunities.
And the second area where we are seeing a lot of opportunities is well-established
local corporates in those markets.
And the reason for that is that infrastructure demand is not going to be
supplied
miraculously, you know, on its own.
So you need local entities, those corporates to deliver that infrastructure
growth,
and perhaps even outside of the infrastructure specifically.
So our focus is where there's an infrastructure.
Related project or corporate and the entities,
local corporates who are champions in their countries, in their regions,
who will deliver that growth story.
So when I look at that main area, we see a lot and a lot of opportunities.
We can almost still choose the right opportunities we want and decline the ones
that we don't feel comfortable.
That could be because of structuring.
That could be because of the...
Track record of the companies or projects, it could be yield driven.
We have a pretty specific target in our mind.
And with that target in mind,
we are still seeing a lot of deal flow coming directly from our borrowing clients
through
our partner banks.
We are working a lot with the advisor.
We are working a lot with the DFI, the likes of IFCs, AFDBs, AIBs, EBRDs.
They're all very good partners of us.
So, you know, deal flow is abundant and we are able to, you know, choose and focus on
the ones that work for our cities.
It's such an interesting subject and it's a subject we wouldn't have been talking
about, as I said in my introduction a few years ago.
Alper, thank you very much for your insights.
Alper Kilic is Head of Alternative Credit at 91 in London.
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