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The Asset Class: Alper Kilic · Strictly Business

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  You're listening to Strictly Business Podcast with Lindsay Williams.
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  I received a very interesting article which says the following, the headline
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  that is,
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  Emerging market private credit stands apart as cracks appear in US private
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  credit.
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  It goes on to say, strains are building in US private debt as underwriting weakens
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  and defaults rise.
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  In contrast, investors in emerging markets can access higher senior secured yields
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  with stronger...
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  protection.
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  It's an unusual situation.
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  With me now is Alper Kilic, who is head of alternative credit at 91 in London.
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  The reason I say it's unusual, Alper, is because you normally think of stability in
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  developed markets, not emerging markets.
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  But in this case, it's gone 180 degrees, I think.
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  This is true.
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  First of all, I think it is the perception.
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  And I guess the way that I define it is that perception versus reality.
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  Understandably, emerging markets, more difficult markets, more risk.
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  versus more stable, more established developed markets.
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  But I think what we have been seeing in relation to specifically the private
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  credits over the last few months
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  is proving that actually it is wrong.
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  And I guess we have been making the point as
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  91 and also personally myself for a long time that this was bound to happen
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  because I guess we've been watching the market very closely and we were due to see
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  some...
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  credit defaults and losses.
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  And it has happened.
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  And we do expect that it will continue to happen.
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  Whereas the story in the emerging markets is different.
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  And I'm sure we'll talk about the details of it.
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  But actually, in terms of the quality of the credit deals defaults,
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  we have seen a great stability in the emerging markets despite the challenging
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  market conditions.
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  So that's why we made that statement.
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  There was a very well-known CEO of a very well-known Wall Street bank that was
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  quoted from a conference.
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  In fact, I saw the interview, and he sort of gave us a warning about developed
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  market credits, particularly
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  U.S., and he didn't say that it was going to cause the market to crash.
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  But I have seen headlines saying, is U.S. private credit debt the next subprime?
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  Surely it hasn't gone that far, has it?
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  I don't think it has gone that far, and I don't think if the You know,
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  if the real question is that we expect a systematic risk here, I really don't think
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  so.
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  But I think in between, there will be some winners and losers.
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  And I think it's going to get worse before it gets better.
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  I mean, you know, the well-known CEO of a well-known bank is not liked by many in
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  the private credit sector in the U.S.
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  at the moment.
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  I do quite like him, actually.
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  You know,
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  what he is referring to is a beer-prudent lender and use common sense.
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  And I think there's nothing wrong with that.
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  I think what we are seeing in the U.S., we've seen the results of it,
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  but I guess the causes for it is that there's so much liquidity, there's so much
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  funding,
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  and there is huge pressure for deployment from the large U.S. private credit houses.
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  And they have defined U.S.
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  as their core market, and in particular, they have further defined...
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  a category in terms of where their lending activities will take place.
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  And they define to say that most of the activities happening in the
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  sponsor-backed,
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  non-banked, mid-tier direct lending.
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  That's how defining their market.
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  And when you have billions and billions and billions of dollars chasing that
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  particular market,
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  what has started to happen is that losing underwriting conditions, creditors chasing
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  the same deals.
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  no concentration risk or you know forgotten and in terms of the you know
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  security
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  dynamics in terms of the covenants we started seeing a really loose practice and
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  all of that
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  combined together you
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  know force the cracks to appear and and and that's why you know with the high
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  profile
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  defaults whether it's tricolor or or first brands that
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  which made the headlines.
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  That's caught people's attention and then made the investors worried, and therefore
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  investors started demanding their money.
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  So I think the underlying is really bad credit decisions driven by a huge amount
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  of
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  liquidity and dry powder chasing the same market and same kind of
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  underlying borrowers and here we are.
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  Yeah, and here we have an asset class which wasn't that well known a couple of
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  years ago, private credit that is.
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  It's grown into roughly a US$3 trillion global asset class.
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  It's become crowded in the United States, as you've said.
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  And from what you're suggesting, it has prompted slack practices.
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  Is that a little bit too simplistic?
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  I think it is exactly what happened.
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  And the way I define that is that it's almost like I started...
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  My background is I'm a banker.
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  I've done basically structured debt and credit all my life, close to 30 years.
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  And a long, long time ago, when I started banking, we had the first, if you will,
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  the training, credit training.
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  That was Credit 101.
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  And the concept was be a prudent lender.
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  Use common sense.
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  Use your tools available in your toolbox, which is your security, which is your
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  governance.
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  That's how you stay on top of the credit situation.
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  Choose your borrowers carefully.
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  Credit 101.
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  And I think, you know, that principle hasn't changed.
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  So the asset class itself as private credit,
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  it is there for a reason.
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  And the reason has been that the banks have also been
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  stepping back, especially when...
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  comes to term lending,
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  because there is a lot of pressure and challenges and restrictions for the bank
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  to
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  maintain their capital base, especially in relation to Basel III and Basel IV
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  regulations coming through.
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  And they have been focusing more on the short-term lending space, more working
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  capital, trade financing.
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  It's not that they don't do term financing.
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  They do, but their capital requirements are much higher.
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  So therefore, the banks have kind of...
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  pullback and you have institutional investors such as your insurance companies
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  such as your pension
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  companies and basically they they they have from their own clients
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  uh term long-term uh financing and liquidity capabilities so essentially it's
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  all about the long-term
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  assets matching the long-term liabilities and so the private credit players
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  are basically using that capability to work with their institutional investors,
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  and therefore,
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  they match their assets and liabilities, and they raise those liabilities through
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  their clients,
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  and they place them into the term assets.
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  There is nothing wrong with it, and I think it works.
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  It's a working model.
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  And I don't think in that space, if everyone plays their roles carefully, I
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  don't think there will be losers.
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  the big because the borrowers are benefiting from it.
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  They need long-term financing because whether it may be CapEx, new investments,
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  acquisitions and whatnot,
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  and the creditors are matching their assets and liabilities, and they're also
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  supporting a viable,
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  sustainable business model.
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  Cracks start to happen when people move away from what they're doing, what they're
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  supposed to be doing.
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  And that's why, I guess, we are facing this issue right now.
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  And also the US market, the participants chase software as a service and business
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  services,
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  where in emerging markets, you've got, as you put it,
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  an opportunity set dominated by asset-heavy,
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  cash flow generative borrowers with limited exposure to sectors most
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  vulnerable to AI disruption.
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  So in other words,
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  solid institutions that generate cash flow with far less risk than the US business
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  model, I would say.
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  That's exactly true.
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  I think I can understand the headlines again, because there is not a day that
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  goes by, you know,
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  with us not talking about AI, AI growth, technology, absolutely.
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  But when it comes to credit, when it comes to lending to those entities,
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  we look for established business models, we look for stable revenues, we look,
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  we try to understand from our borrowing clients who their clients are, do they
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  have contracts?
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  how sustainable those cash flows are.
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  And as we all know, cash is king.
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  We do pay attention to cash flows and revenue.
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  So on the contrary, when you look at the story in the U.S.
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  vis-a-vis the growth of AIs, yes, there is a lot of growth potential.
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  There is a lot of growth, I guess, expectations.
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  We all understand it.
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  We all get it.
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  But then it is also very volatile.
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  The dynamics change a lot.
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  technology change a lot clients move around a lot so if you are entering into a
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  credit relationship
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  with a name software name like that without establishing the fact that their
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  revenue and cash flow
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  generation model is stable before
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  you know it actually market dynamics may change and you find your borrower not
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  being able to repay your debt
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  In emerging markets, the approaches we are taking is asset-backed,
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  stable revenues.
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  Also, a significant majority of what we do is secured lending.
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  So we put charge on those fixed assets.
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  We put charge on the assignment of the receivables from our clients.
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  We work with them.
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  We agree with the covenants with them.
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  But the concept of covenant light, To be honest with you, it doesn't exist in EM.
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  We've never done it.
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  You do negotiate your covenants, of course, but there is always covenants.
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  There's always security.
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  There's always plan A and plan B.
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  There's always concentration risks.
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  So the underwriting standards in EM, and that's pretty much across the board,
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  and has been pretty stable.
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  And as a result of that, while of course we do see three credit issues,
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  it will be naive to say that there's no credit issues.
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  It is far more manageable compared to what we are seeing in the US in particular.
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  So what do you see happening?
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  Do you see the US now sort of stabilising because no new participants will come into
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  the market because it's a crowded market and
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  because the pickings are rather slim?
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  And on the other hand, do you see the emerging market being targeted by the same
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  sort of players that
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  might play in the US and therefore the situation comes full circle?
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  What would you say?
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  rotation.
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  But the dynamics are very different.
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  I guess rather than the players coming into emerging markets and changing the
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  market dynamics,
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  in emerging markets, the credit standards and credit behavior has been pretty
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  established.
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  Second of all, and there's an important differentiation here, in the asset class
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  that I highlighted to you at the moment in the US,
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  a lot of that is non-bank.
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  Therefore, private credit players are not working with the banks.
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  They are basically working outside of the banks and going directly to those
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  borrowers.
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  Now, it's a business model.
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  It may work for some.
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  But in emerging markets, and we refer to emerging markets, of course, it's huge.
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  I mean, if you look at it, depending on how you define it, right, it may go from
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  anywhere from, you know,
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  120, 30 to 200-odd markets.
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  The way that we define it, and when I look at it, I define it as where the big flows
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  are,
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  where the big infrastructure needs are, where the big...
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  established economists are, probably we've identified for 91's purposes about 15
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  markets,
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  that is Asia, Latin America, and it's SEMIA, that's basically Middle East,
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  Central, New East, Europe, and Turkey.
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  So out of those 15 markets,
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  the banks are active in terms of their origination model, in terms of their
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  network.
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  And the differentiation I'm trying to make here is that In emerging markets, we still
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  work with the banks.
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  We work with the banks because we partner with them in origination.
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  We do syndicated deals, we do club deals, and despite that,
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  we are still able to generate very sustainable returns.
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  And as a result of that and that market dynamic,
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  I think trying to displace the emerging market credit standards
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  and follow the examples of what's happened in the U.S.
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  will not be realistic any time soon.
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  And then the second point is that while it is perhaps not 200 markets, it's 15
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  markets,
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  it is still 15 different markets.
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  So it is still the understanding of those dynamics locally, those borrowers,
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  those regulations.
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  It requires a lot of effort and hard work.
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  Therefore, I don't think it is.
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  Easy to replicate to say that I have a huge amount of dry powder and I'm going to
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  go and change the credit standards.
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  And third of all, I think it will be almost a recipe for disaster, having seen
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  what happened in the U.S.
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  And if they try to replicate the same model once again,
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  I don't think how much investor support and investor appetite those institutions
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  will get.
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  That's why I think it's quite limited to see this similar deterioration in the
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  emerging markets.
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  I'm just looking at the 91's platform and some of the deals that it's done.
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  Very diverse indeed, Alper.
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  You have done a deal with a Vietnamese renewable company in South Africa.
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  This is an interesting one.
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  Infrastructure development to facilitate the building of apartments targeting low
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  to middle income homeowners.
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  And also you go to Latin America, a cold storage logistics supplier.
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  Are you still seeing lots of opportunities in emerging markets?
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  We are seeing tons of opportunities.
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  We are seeing tons of opportunities and our focus is basically in two main areas.
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  One is infrastructure and the way that I define infrastructure is it is pretty much
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  from energy, generation,
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  transmission, distribution to transportation.
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  Roads, motorways, railways, telecoms, that is fiber,
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  that is towers, that's data centers, healthcare, hospitals.
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  So the entire universe of infrastructure is where the demand is.
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  There are different numbers, but I think it was through
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  World Bank that they've announced that the annual infrastructure gap in emerging
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  markets is
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  about...
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  two trillion dollars.
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  Two trillion dollars, right?
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  So if you look at the low and middle income countries, China, Indonesia,
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  Brazil,
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  Turkey, and India,
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  those five markets make 70 percent of that infrastructure kind of a demand.
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  So our focus is infrastructure because there is a lot of need
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  and the growth story of those economies.
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  compared to developed markets is about 2% more.
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  So according to the World Bank's numbers, the expectation is about, in those
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  markets,
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  average growth rate is about 3.4%, 3.5%, whereas in developed markets,
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  you have about 1.4%, 1.5%.
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  So economies are growing.
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  Infrastructure is leading this growth, and it's wide-based, driven by energy, but
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  other sectors as well.
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  And we are seeing a lot of opportunities.
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  And the second area where we are seeing a lot of opportunities is well-established
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  local corporates in those markets.
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  And the reason for that is that infrastructure demand is not going to be
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  supplied
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  miraculously, you know, on its own.
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  So you need local entities, those corporates to deliver that infrastructure
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  growth,
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  and perhaps even outside of the infrastructure specifically.
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  So our focus is where there's an infrastructure.
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  Related project or corporate and the entities,
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  local corporates who are champions in their countries, in their regions,
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  who will deliver that growth story.
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  So when I look at that main area, we see a lot and a lot of opportunities.
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  We can almost still choose the right opportunities we want and decline the ones
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  that we don't feel comfortable.
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  That could be because of structuring.
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  That could be because of the...
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  Track record of the companies or projects, it could be yield driven.
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  We have a pretty specific target in our mind.
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  And with that target in mind,
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  we are still seeing a lot of deal flow coming directly from our borrowing clients
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  through
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  our partner banks.
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  We are working a lot with the advisor.
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  We are working a lot with the DFI, the likes of IFCs, AFDBs, AIBs, EBRDs.
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  They're all very good partners of us.
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  So, you know, deal flow is abundant and we are able to, you know, choose and focus on
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  the ones that work for our cities.
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  It's such an interesting subject and it's a subject we wouldn't have been talking
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  about, as I said in my introduction a few years ago.
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  Alper, thank you very much for your insights.
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  Alper Kilic is Head of Alternative Credit at 91 in London.
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  The views and opinions expressed in these podcasts are those of Lindsay Williams and
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• 18:42
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