Image: Reuters
A funny thing happened on the way to the financial crisis. For years analysts have watched the explosive growth of private credit in America with a combo of awe and dread. Here was a vast, opaque pool of lending by funds to companies, operating in the shadows of the banking system. It swelled during an era of cheap money, fuelling private-equity buyouts with increasingly flimsy terms. The reckoning, when it came, would surely be brutal. That reckoning is now under way as defaults rise and the industry retrenches. Yet look elsewhere and a very different trend is unfolding. From an office park in Bangalore to a solar project in Senegal, private credit is not contracting. It is booming. The epicentre of activity has shifted, with startling speed, from the developed world to emerging markets.
That divergence reveals a fundamental split in the global financial cycle. America is in the late, messy stages of a credit binge. Emerging economies are just entering their own. The catalysts, however, are inverted. In America private credit grew as a complement to a permissive banking system. In emerging markets, it is exploding because the banking system has effectively withdrawn. Faced with stubborn inflation, central banks from Brazil and Turkey to Nigeria have kept interest rates at punishing levels. That has made traditional lending expensive and capital-intensive for local banks, which now prefer parking money in government bonds. A financing vacuum has appeared. Private funds, wielding foreign capital, are rushing to fill it.
The maths is compelling. In America, middle-market private-credit deals now yield roughly 9-10%, a meagre premium for the risks involved after years of fierce competition. In emerging markets, returns of 15-20% are normal. For global pension funds and insurers, that differential is impossible to ignore. Yet the higher yields do not simply reflect greater danger. In some ways the emerging-market landscape is more conservative. The typical loan is structured at three times a company’s debt-to-earnings ratio, compared with four or five times in America. Interest-coverage ratios are stronger. Crucially about 80% of borrowers are not owned by private equity, which lessens the risk of financial engineering for a quick exit.
There is a whiff of nostalgia to the underwriting, too. The covenant-lite lending that dominates America, where borrowers operate with few constraints, never really took hold in emerging markets. Loan agreements retain strict controls on performance, as well as collateral packages and step-in rights for lenders. Many deals are structured under English or New York law, using offshore special-purpose vehicles to give foreign investors clearer recourse. “What we have today in many emerging markets resembles the American private-credit market of 15 years ago,” points out a managing director at Gramercy, an investment firm. “There is actual discipline.”
This discipline is reinforced by the nature of the borrowers. Companies in India, Mexico or Vietnam have long operated amid inflation swings, political risk and currency gyrations. They prize long-term funding certainty and tend to maintain balance-sheet cushions as a matter of survival. Their developed-market counterparts, by contrast, grew accustomed to a decade of near-zero interest rates. Many are now untested by a world of normalised borrowing costs. The recent collapses of First Brands and Tricolor in America exposed fragility that had been papered over by easy money. In emerging markets, the shock absorbers are already built in.
The scale of ambition is also changing. Private credit is no longer confined to niche loans for family-owned manufacturers. It is financing entire infrastructure projects. Consider the $3.4 billion loan to the Shapoorji Pallonji group in India, one of the biggest private-credit deals ever in Asia, which helped the conglomerate restructure its debt. Or consider the €1.3 billion financing for a Romanian natural-gas producer, arranged by a consortium of international funds. Across the Gulf private credit is backing fintech ventures and diversification schemes. In Africa it is funding energy and logistics expansions. These are not opportunistic bets. Rather they are strategic allocations into economies where public debt markets are shallow and domestic banks are sidelined.
Global investment giants have taken note. Firms like PIMCO, Ares Management and Apollo now pitch dedicated emerging-market private-credit strategies, arguing they provide diversification and less correlation to the saturated, jittery markets of the West. This shift is also geopolitical. As Western development finance and bilateral lending contract, private funds are stepping into the breach, sometimes controversially, to fund quasi-sovereign projects. The line between impact investing and plain old profit-seeking has blurred.
Perhaps the brutal difference is in systemic risk. In America private credit has become deeply enmeshed with the traditional banking system through partnerships, as well as risk transfers and fund-financing lines. Regulators warn that its opacity and leverage could amplify a future crisis. No such entanglement exists in emerging markets. The industry there is still a collection of discrete, bespoke arrangements, insulated from the shadow-banking networks that worry Washington and Frankfurt. Its greatest risk is not contagion but the old-fashioned kind: a borrower who cannot repay.
Two markets then are moving in opposite directions. In America private credit is a maturing industry confronting its first real downturn, its earlier excesses now painfully apparent. In emerging markets it is a nascent industry enjoying its first genuine boom, propelled by a scarcity of capital rather than a surplus. One man’s distress is another’s opportunity. Global capital has a habit of flooding into new territories just as it abandons old ones. For the borrowers in Jakarta or Lima who can finally access long-term financing, and for the lenders earning double-digit yields, this particular migration makes cold, hard sense. The trick will be remembering what the Americans forgot: that easy money is never really easy. ■
