Private credit cash shifts from the 'risky West' to emerging markets

Angola has a complex network of pipelines that snake along the Atlantic coast. They lead to a new refinery, which signals Angola's drive for energy independence. It also shows how private lenders are being used instead of banks to finance a large-scale project.

"We are not the lender last resort," said Felipe Berliner. He is the co-founder and CEO of Gemcorp, a emerging markets asset management company that provided the majority of the funding for the refinery using private capital. "Sometimes, we are the sole lender." Veteran investors said that private credit for emerging market countries -- driven by investors’ hunt for yields, and saturation of developed Western markets -- may grow exponentially. This could provide tens or hundreds of billions as bilateral lending, and foreign aid, shrink.

Pramol Dhawan is the head of emerging market portfolio management at PIMCO. "The need to global reallocate isn't a hedge - it's a long-term thesis."

PIMCO expects to increase annual lending to $10 billion by 30% in this year. Other investors also aim to increase their investments.

RAPID GROWTH BUT SQUEEZED Yields

According to the Bank for International Settlements, private credit has skyrocketed in the last 20 years. Global assets under management have risen from $200 million to more than $1.2 trillion, up from $200 millions at the beginning of the 2000s.

This funding helped fill a gap in financing for businesses, especially those based in the U.S.

Today, emerging market countries receive less than 10%. The U.S., Europe and other developed markets are saturated. Margins have been eroded by competition and bets become more risky. The IMF and JPMorgan CEO Jamie Dimon both warn that private credit is shaky.

Investors say that emerging markets have projects that are so eager for money, they can choose from a wide range of options.

Matt Christ, portfolio director at Ninety One Global Investment Manager in London, said that emerging market companies are now more conservative. The developed markets are "priced to perfection", while the emerging markets offer greater upside.

He said EM rates are 150-300 basis points higher than those of developed markets, and that risk is often lower as ratings suggest.

Christ, whose global private credit portfolio is currently around $8 billion, believes that it has the potential to grow to $15 billion. He said that EM firms are accustomed to political and economic instability, unlike Western firms.

He said: "Developed market firms are entering a new era, one they have never known before. But emerging market firms have been doing it for a very long time."

Gustavo Ferraro is the head of capital solutions for Gramercy Funds, a fund manager that focuses on emerging markets. He also stated that EM returns and risk profiles are better than those in developed markets.

He said that the U.S. stock market was no longer the benchmark. "Our (investors') desire yield and uncorrelated exposure."

Gramercy's private credit investment has doubled in five years, to $4.8 billion. It is focused on Latin America and Turkey, as well as parts of Africa.

Ninety One stated that private credit fills the gap in Turkey where banks are limited to lend due to the authorities' efforts at reducing inflation.

From Sovereigns to Saudi Companies

The majority of EM private credits are asset-backed, giving investors everything from shares in the company to control over a project.

Structure favors infrastructure but funding is going to the sovereign budgets of Turkish cities and their transport networks.

Angola will be able to refine 60,000 barrels of oil per day with the new refinery. Gemcorp and Sonangol, which are both funding sources, have contributed a large portion of this investment. The No. 2 oil producer in sub-Saharan Africa will be less dependent on expensive fuel imports. The first phase of the plant, which costs $475 million, should be operational by the end this year.

Gemcorp also funded an wind farm on Lake Turkana, in Kenya. It also funded water sanitation projects in Angola as well as power transmissions between Angola & Namibia.

Gemcorp's survey revealed that 67% of EM Private Credit went to large and medium corporations, while 22% was allocated to sovereign or quasi-sovereign project.

Gemcorp has launched a fund of $1 billion aimed at mid-market Saudi firms.

Berliner stated that "they are underfunded and they do not have the flexibility capital they need to sustain growth from the fiscal push of the government."

The firm also finances Central American commodities exported to the U.S.A., West African prepayment fuel deals and gold producers. Private credit, according to Berliner and other experts, is fast, flexible and customizable. It can be tailored for any business, from upstarts to lower-rated sovereigns.

"We are not replacing banks any more." Ferraro stated that "we're creating something new." This is custom financing for custom problems. "EM is a company with a wealth of experience."

Some bond investors are privately concerned that private credit, which is more flexible and less burdensome than bonded debt, could hurt their business. Some bond investors fear that borrowers who run into trouble will have bigger problems. How does private credit handle a situation where something goes wrong? Daniel Cash, an associate professor of law from the UK's Aston University said, "We don't know." He added that the "much opaquer" lending could create problems.

(source: Reuters)