Cerberus Capital Management has been making private credit investments in emerging markets since 2017. What makes these markets, and Latin America specifically, an attractive destination for credit strategies?
Cerberus has been investing globally across credit strategies for nearly three decades. Our first foray into emerging markets dates back to the late 1990s when we expanded our non-performing loans (NPL) practice into Asia following the Asian Financial Crisis. After tracking the more recent years of emerging market GDP and debt growth, we established a dedicated investment strategy in 2017.
The combination of meaningful growth and lack of private capital creates a favorable backdrop for long-term investors with flexible mandates. The team that I lead is focused exclusively on emerging market opportunities, particularly in Latin America, and leverages the firm’s entire platform and global infrastructure.
We believe Latin America presents a number of compelling dynamics. First, the region’s GDP, while smaller now following COVID-19 and the currency depreciation, was approximately USD5.7t in 2019 and credit markets were well in excess of USD2t. Therefore, we expect that there will always be ample size, scale and diversity in investment opportunities. Second, the banking systems are reasonably sophisticated; however, there is still limited lending to small- and medium-sized companies. The region has far fewer non-bank lending options compared to the United States and Europe, which means that there is room for lenders with the resources, infrastructure and ability to conduct the proper diligence. Third, banks have become much more eager to offload NPL portfolios from their balance sheets. Finally, the annualized cost of currency hedging remains at, or near, historic lows in most Latin American markets, which is attractive for international investors like us that will seek to hedge out those risks.
Within the private credit space, what strategies have proven most successful for you and where do you see the biggest opportunities going forward?
Our main areas of success to date have been in providing debt financing to companies and purchasing NPLs and NPL portfolios. The NPLs have primarily been in the corporate space, but more recently are real estate secured loans. These will continue to be important areas for us going forward, particularly as the region emerges from the pandemic.
On the financing side, Latin American and international banks were already limited in their lending practices and have pulled back even more in providing financing during the pandemic, leaving solid companies that are too small for traditional bond markets in need of capital. We have been able to provide creative financing solutions, typically with attractive pricing, solid collateral and embedded equity upside optionality.
For NPLs, there was already a robust pipeline pre-pandemic. Banks now have a growing backlog and will be seeking to offload NPL portfolios to strengthen their balance sheets. Cerberus is one of the world’s largest and most experienced investors in NPLs and we are able to leverage our global infrastructure and platform to be a trusted partner to the region’s banks.
Please describe your investment strategy. How do you source your deals and what is the risk profile of the businesses to which you lend?
We source deals from traditional bank and broker channels, proprietary methods, and long-standing relationships and, in general, we like to have an on-the-ground presence in our markets. We often find attractive opportunities through our global, multi-strategy teams and their networks as well.
In terms of risk profile, we focus on fundamentally strong businesses that require creative solutions and stable, decisive partners. Our extensive diligence typically enables us to lend at appropriate spreads to the market, but at low loan-to-values, which we believe reduces overall investment risk.
Please describe the impact of private credit investments in emerging markets and in Latin America for SMEs that may suffer from a lack of banking finance.
Increasing access to capital for SMEs in Latin America is critically important for the region. According to a 2019 report by the OECD/CAF1, over 99% of companies in Latin America are SMEs and they account for an average of 60% of formal productive employment. Despite the size of the market, SME financing is only a small portion of Latin American bank loan portfolios. On average, large Latin American banks have 12.1%2 of their financings allocated to SMEs. This, among other factors, has created an estimated financing gap of over USD1t3 for SMEs in Latin America.
Cerberus has a long history of providing financial solutions to companies that are too small to access large bank lines, syndicated loans or public bond markets. In Latin America specifically, we partnered with a Colombian company, Bayport S.A., that provides vital access to credit for many people not served by the traditional banking system. Our facility, along with our lending partners, provided USD100m of structured debt, on attractive commercial terms, to assist Bayport on its mission of financial inclusion in Colombia. We are also proud to help in supporting the company’s local growth and Bayport Colombia’s management team.
The onset of the COVID-19 pandemic has generated a greater need for capital for distressed companies and banks worldwide. How have you been adapting your strategy to address this need in emerging markets?
Like other regions around the world, there has been an increased demand for financing during the pandemic in Latin America. Similarly, as the formation of NPLs has increased, there will be a growing need for private capital to assist in working through the new stock of bad debt over the coming years.
With many international market participants pulling back or retreating from Latin America, we see an opportunity to further broaden our efforts to provide capital and operating solutions in the region. In summary, we have not so much adapted our strategy as much as we have redoubled our efforts to push it forward.
1 – OECD/CAF (2019), Latin America and the Caribbean 2019: Policies for Competitive SMEs in the Pacific Alliance and Participating South American countries, SME Policy Index, OECD Publishing, Paris, https://doi.org/10.1787/d9e1e5f0-en.
2 – S&P Global Intelligence, October 15, 2020, “Brazil’s top banks have highest loan exposures to vulnerable SME segment”.
3 – “MSME Finance Gap.” SME Finance Forum, International Finance Corporation, www.smefinanceforum.org/data-sites/msme-finance-gap.