Private debt can help drive African growth

  • Written by  Runa Alam and Ibrahim Sagna

Private debt is recognised as an institutional asset class and as an alternative source of risk-adjusted returns for institutional investors globally. While some investors have specific, fixed allocations to private debt, others allocate from fixed income or private equity.

In Africa, there has been a convergence of some parts of the direct lending, opportunistic credit, equity and real estate markets. This is the result of factors such as structural and economic reform and poor access for many companies to well-developed capital markets.

There are a large number of public and private African companies with strong operations that are poorly capitalised due to limited access to developed, sophisticated financing instruments.

Such companies are often unable to obtain appropriately structured financing to meet their business objectives and are reliant on securing local deposits. Alternatively, they need to raise expensive equity capital which is unsustainable over the medium to long term.

This situation has created an opportunity for alternative sources to provide capital using creative structures that meet the needs of the borrowing company while simultaneously generating highly attractive returns for investors. Moreover, institutional investors (such as sovereign wealth funds and pension funds) are seeking higher returns than those of mainstream bonds.

This investor appetite has helped drive a boom in specialist private debt vehicles with the ability to provide finance to specialised financial institutions, trade finance providers and small and medium-sized firms, and also to invest in distressed assets or infrastructure project finance.

According to Aksia, a specialist global investment consultant, large private equity players and other alternative investment managers have raised private credit funds across the globe as more companies seek non-dilutive (that is, debt) financing. Credit funds have been an important source of capital as traditional banks and other forms of capital have retrenched. Private debt assets under management were $595bn in June 2016, having increased fourfold since 2006.

Target returns for private debt funds in developed markets typically range between 8 and 14 per cent. For example, opportunistic credit typically covers investment strategies that fall within leveraged credit (5-7 per cent returns), direct lending (8-12 per cent returns) and distressed, which involves purchasing public or private senior debt (generally 20 per cent-plus returns).

The current strong economic growth trends and sound macro fundamentals of Africa present a significant opportunity for debt investors. Private debt can invest in assets, infrastructure and institutions that will in turn support economic growth. While the amount of private equity capital raised for Africa totals more than $25bn in the past 10 years, there is a significant supply and demand mismatch between the need and availability of debt across Africa. Africa is growing exponentially, but the average debt level is still less than 50 per cent of GDP.

According to RisCura, a leading global investment consultant, only one-third of unlisted investment capital in Africa comes in the form of debt, whereas in the developed world it is typically two-thirds of capital structures. One of the main drivers for this is that banks are small (South Africa aside), have conservative lending practices and lack sufficient capital to participate in big deals.

Data from the Overseas Private Investment Corporation (OPIC) shows that only 2.8 per cent of the population in Africa has access to bank loans compared with 24.5 per cent across developing countries and 80 per cent in high income countries.

Furthermore, African banks tend to generate high returns at low risk from lending to their governments, so the appetite for risk capital to fund the growth of corporations is restricted.

There has been limited focus on improving access to private-sector debt capital for African financial institutions. DFIs are the primary lenders to medium to large-size financial institutions in Africa.

For example, a multilateral investment grade-rated institution such as the African Export-Import Bank (Afreximbank), capitalised by African governments, financial institutions, corporates and a few non-African institutions, already allocates more than 60 per cent of its $11bn balance sheet to credit and risk-bearing transactions with financial institutions across the continent.

Access to debt capital will allow African financial institutions to leverage their existing balance sheets, which will have a trickle-down effect on improving intra-continental trade, financial inclusion and access to credit.

A private debt portfolio can produce a strong current rate of return, provide downside protection and allow for significant long-term capital appreciation. We believe that as private debt emerges as a distinct asset class in Africa, it provides investors with de-risked exposure to the African growth story.

Runa Alam is chief executive of Development Partners International (DPI). Ibrahim Sagna is director for advisory and capital markets at African Export-Import Bank (Afreximbank).

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