The emergence of Private Debt – what's fueling Australia's lending landscape shift?

An exploration of Private Debt vs Listed Fixed Income
  • Private debt is gathering pace in Australia as traditional lenders and big banks turn their attention to large-scale corporate entities, leaving smaller borrowers high and dry.
  • The conditions that led to surging private debt in the US and Europe at the beginning of the millennium are all present in Australia now – high volumes of mergers and acquisitions, vast amounts of leveraged capital.
  • The Royal Commission's report, APRA's change in lending guidelines, and spiking interest rates are coming together to accelerate the shift in the lending market.
  • Banks are no longer able – and in some cases no longer willing – to service the needs of small-scale borrowers. This is leaving small businesses and homebuyers frozen out of the market, as traditional lending channels dry up. Instead, investors and private lenders are entering the frame, keen to plug the gap in the sector and to reap the potential rewards of consumer lending. As a result, Australia's private debt market is surging.

What Got Us Here

It's November 2021, more than two years after the banking royal commission submitted their report to the treasury with 76 recommendations to reform the sector, and little has changed. Earlier in the year, it was revealed that the majority of the report's recommendations had been either abandoned or delayed. And now, with the end of the year looming, spiralling debt-to-income ratios are still putting borrowers at risk. The Australian Prudential Regulatory Authority (APRA) decides to act, raising the mortgage stress test threshold from 2.5% to 3%, essentially raising the bar of entry for borrowers seeking loans.

Fast forward six months to May 2022, and inflation is soaring. The Reserve Bank of Australia (RBA) announces the first cash rate rise since 2020, and the end of a historic low of 0.1%. Skip ahead another six months to November 2022 and the cash rate moves up again, hitting 2.85% for the first time in over a decade.

This basically brings us up to date – a sort of perfect storm in which stricter regulation, higher stress testing requirements, and increasing interest rates combine to threaten traditional borrowing channels. To put it simply, banks and mainstream lending institutions are no longer equipped to provide loans and mortgages to many of their would-be clients, while many of these would-be clients can't meet the requirements anyway.

The Conditions Are Right for Private Lenders

The private debt sector could be about to step in and fill the gap, thanks to market conditions that feel very familiar indeed. Back in the early to mid-2000s, a shifting and tumultuous market led to a surge in non-bank lenders in the US and Europe. First, the 1990s and a shift of focus, as banks began to look to larger-scale corporate borrowers as their ideal clients. Then, the 2000s and the global financial crisis, along with tightening regulations and institutional caution. But, here in Australia, we didn't experience this – these conditions never really emerged.

At least, they didn't emerge until now. Leveraged buyouts, and mergers and acquisitions transactions, are on the up in Australia. Of the 10 biggest M&A deals in the last 10 years, half have taken place since 2021, with three of those involving a significant amount of borrowed capital. This mirrors the situation in the United States in the '90s, and is driving that shift in focus away from smaller borrowers to high-level corporate enterprises.

The groundwork is in place. The conditions are just right. But we're not there yet. Australia's private credit market still lags far behind the rest of the world. On average, 12% of the world's credit is provided by private investors and non-bank lenders. In Australia, it's 2%. The idea that Australia is becoming a private credit hotspot is not quite right, but we could be moving in that direction. According to the Australian Investment Council (AIC), the country's private debt market grew to $1.4 billion in 2021, an increase of more than 100% in only 12 months. Why is this? Because of what we've discussed above – banks are either turning away voluntarily, or they are being driven away from smaller-scale business owners and residential property buyers. Private lenders are stepping in to fill the gaps.

Private Credit and the Gap in the Market

What makes private lenders able to service the needs of borrowers when traditional banks can't? As well as the market conditions, there are a few other aspects that are fuelling the growth in private lending.

Looser Regulation

Any entity operating in Australia's financial services market is bound by regulation, and will need to toe the line when it comes to how they operate. However, private credit organisations and peer-to-peer lenders are not hampered by such strict controls as those imposed on banks, giving them a little more leeway when it comes to lending.

Better Connection with the Needs of Borrowers

Some of the more traditional lending options offered by banks are unsuitable for the needs of modern Australian homebuyers and business borrowers. In the past, borrowers essentially had to 'grin and bear it', taking on debt with a product not necessarily ideal for their situation. Private lenders tend to offer more flexibility, providing lending options that meet the diverse needs of Australia's borrowers.

Limited Lending Scope

We can also flip the situation on its head. Private lenders and investors are in fact precluded from high-level corporate lending simply because they do not have the means to provide this sort of capital. They can't follow banks into the world of leveraged buyouts and M&A, so they focus on small businesses and homebuyers instead.

Looking to the Future...

Interest rates won't rise forever – if the RBA's moves can help to bring inflation under control, we can expect to see the cash rate start to fall by Q2 of 2023 according to some projections. Nor will banks and traditional lenders wholly abandon small businesses and homebuyers, instead offering recalibrated home and business loans that meet the developing needs of these borrowers. It's also important to remember that traditional lending is still the dominant force in Australia, with the vast majority of smaller-scale borrowing still conducted via these channels.

In the short term, however, we can expect to see private credit continuing to strengthen against the banks, as investors seek to exploit the market gaps left behind by this perfect storm of market conditions, sector reform, and stricter regulation.

........
This information is general information only and is not intended to as financial advice. It does not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making any investment, financial, taxation or other decisions. FC Funds Management Pty Ltd ACN 161 055 152, AFSL 431245 and its related bodies corporate, their directors, employees, consultants, or affiliates (FC Capital) do not make any representations or warranties (express or implied) that the information contained in this article is complete or accurate. To the extent permitted by law, FC Capital accepts no liability for any loss or damage caused in connection with the use of this information. FC Capital has no responsibility to update this information. Investors should obtain and read any relevant disclosure documents before making investment decisions. Any taxation information described is a general statement and should only be used as a guide. Before making any investment decision, you should seek independent financial or taxation advice and consider whether an investment is appropriate for your particular investment needs, objectives and financial circumstances. Past performance is not an indicator of future performance. Investing in financial products carries risks, including potential loss of capital. The value of investments can rise and fall. FC Capital does not guarantee capital or income returns. An investment with FC Capital is not a bank or term deposit, and is not covered by the Australian Government’s deposit guarantee scheme, or any other such scheme.

Christian Brehm
Chief Executive Officer
FC Capital

Christian has over 17 years of experience within financial advisory, infrastructure, funds management, investment banking and structured finance. Throughout his career he mainly focused on advisory and investment mandates of institutional funds....

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.

Comments

Sign In or Join Free to comment