Regulatory changes have opened an opportunity for institutional investors to partner with banks in offering corporate loans to mid-sized companies, to create a diversified, defensive asset class of scale, HPS Investment Partners managing director Gary Stead said.
With an independent fiduciary – such as HPS, for example – between investor and bank that assesses credit risk and builds a suitably diversified portfolio, both investor and bank stand to benefit from this new asset class, Stead told the Investment Magazine Fixed Income and Credit Forum in late July, during a panel session titled “Australian mid-market loans – accessing a new asset class”.
“From the investor’s perspective, we think this is an ideal way to build a domestic, floating rate, fixed income asset class that can actually address…the need to diversify into another defensive [Australian dollar] asset class,” Stead said.
HPS is a global investment firm with about $46 billion of assets under management as at June 2018.
Mid-market loans include BB and BBB-rated loans under $150 million to companies with annual revenue typically below $400 million. They are much more profitable than loans to the big end of town, Stead said.
The ‘big four’ Australian banks conduct about $155 billion a year of new loan origination in the mid-market sector, which is about three-quarters of the Australian total; that level of concentration is unheard of in other markets around the world, which provides the opportunity to achieve scale.
These are mostly bilateral deals, which have the advantage over syndicated deals of being able to influence terms and pricing. By partnering with the bank at the point of loan origination, the independent fiduciary is able to reduce the risk of adverse borrower selection.
“The bank will be at least 50 per cent of every loan so these are customers the bank wants to retain,” Stead said.
These loans also offer a range of structural protections. They are leveraged at 2-2.5 times the investment compared with the Term Loan B (TLB) market, which is “creeping up to four to five times leverage”, Stead said. They are typically asset-covered rather than based on cash flow, giving them a high level of collateral.
While some might liken this asset class to leveraged loans or TLBs, Stead argued it should be considered among the ranks of defensive asset classes, such as government bonds, BBB corporate bonds and BBB syndicated loans.
“Now clearly the LGD [loss-given default] history and liquidity are not equivalent to those [defensive] asset classes, but I would argue that the premium more than compensates for that,” Stead said.
Unlike other alternative credit opportunities, corporate credit that banks originate is characterised by a flow of “many, many loans per week”, rather than episodic loans, Stead explained.
This asset class has never been accessible to institutional investors in Australia but increasing regulation has changed this, Stead said. Situations arise where a customer wants to increase a loan but regulated capital requirements prevent the bank from going ahead.
It is not in the bank’s interest to go to another competing bank to solve the client’s problem. Rather, partnering with an independent fiduciary – which is not competing with the bank and has no interest in any of the associated customer business – is a much more compelling solution.
For institutions building optimal diversified portfolios, it is crucial to maintain a “multi-bank strategy”, Stead warned, so they can choose which bank’s offering is most suited to their portfolio’s needs at that point in the economic cycle.
Mark Wang, head of global private asset group at Commonwealth Bank of Australia, was also on the panel. He said CBA’s corporate financial services group, which caters to the middle market, had an addressable market “north of $50 billion and definitely north of 5000 customers. Most banks will be loving to partner with institutional investors to provide that extra layer of capital.”