One size doesn’t fit all: why specialisation matters in this market

• Australia's major banks are structured with dedicated and segregated risk management teams which focus on lending to segments such as commercial real estate, agricultural lending, providing financing to non-bank funding vehicles, and providing funding to private equity owned operating companies to support acquisitions
• Private credit fund managers may take an approach which sees them gain exposures spread across multiple sectors, whilst other private credit fund managers specialise in a single segment
• Australia’s major banks have developed their approach having realised through time dedicated and highly specialised skill sets are required for individual segments. The banks’ prudential regulator APRA enforces this segregation across segments

Sector-Specific Risk in Private Credit: Why Specialisation Matters

Lessons from Offshore

It is well known that US private credit markets are more mature than Australia. During the decades of expansion which saw US private credit funds take significant market shares at the expense of banks, the vast majority of funds specialised in private equity buyout funding across large companies (aka syndicated lending) and medium sized companies (aka direct lending). It’s only in recent years that some US private credit funds have branched into new lending segments such as equipment finance, commercial real estate lending, agricultural lending and infrastructure lending. 

Those that have done so successfully have built substantial operations with dedicated teams and risk management functions for each new strategy vertical.

Our belief is that a specialised approach is both prudent from a risk management perspective, and time-tested given the evolution of the US markets and the strong long term track records built by those funds that have dedicated resources and capabilities to a single specialised vertical.

Lessons from Australian Major Banks

Australia’s major banks have long recognised the differences in risk among sectors such as agriculture, financial institutions' funding vehicles (commonly referred to as warehouse funding), and property and construction lending. Banks structure their corporate lending divisions to manage agricultural clients, real estate and financial institutions through dedicated teams. 

This approach ensures that risk assessment, underwriting, and credit management are aligned with the unique characteristics of each sector. 

For instance, agricultural lending is subject to unpredictable variables such as climate conditions, commodity price fluctuations, and disease outbreaks. Likewise, warehouse lending involves exposure to structured finance, interbank markets, complex regulations and complex capital structures, distinct from traditional corporate lending risks.

Yet, despite these well-documented sector distinctions, private credit funds can take a broad-brush approach, bundling these different industries into a single generalist lending strategy. This has the potential to create blind spots in risk assessment—particularly when teams lack specialised expertise in managing sector-specific risks. 

Investors in such funds may not fully appreciate the extent to which this exposure can affect performance, especially during economic downturns when the weaknesses of a generalist risk framework become more apparent.

The Lure of Generalist Lending

We believe private credit funds have gravitated toward a generalist strategy due to the relative ease of loan origination across agriculture, non-bank lender funding vehicles, and property and construction lending. Intermediaries such as brokers are particularly active in these markets, making opportunities more accessible to Lenders. While this creates efficiency in capital deployment, it does not necessarily translate to better risk-adjusted returns.

Generalist credit strategies may be easier to originate, but that does not make these loans inherently lower risk. In fact, they often require more specialised oversight, particularly in times of stress. Funds that build large exposures in these sectors without the necessary expertise may be taking on risks they are not adequately equipped to manage.

Looking Beyond Origination Convenience

As private credit continues to expand in Australia, investors would do well to question not just where funds are deploying capital, but why. Sectors with a high volume of intermediated deal flow may make it easier for lenders to build portfolios, but convenience should not be mistaken for quality. 

True risk-adjusted returns depend not just on ease of access to lending opportunities nor necessarily portfolio size, but on understanding and managing the underlying risks effectively.

Concluding thought

Major banks have already drawn a clear distinction between different lending sectors, organising their teams accordingly to ensure risk is assessed with appropriate expertise. The private credit industry should take note.