Australian private debt primed for growth
The Australian private debt market presents attractive direct lending opportunities in almost every industry sector, as borrowers looking to access credit diversify away from the banks. In this webcast Nicole Kidd, Head of Private Debt Australia, provides an overview of private debt, how market dislocation is opening the opportunity set in private debt in Australia and why access to these types of investments is crucial.
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Australia’s institutional private debt market has existed for more than 20 years, lending to corporate borrowers on a non-public basis via broadly syndicated loans (BSL), club loans and direct loans. Collectively, the country’s loan markets are worth about A$2.85 trillion, of which the corporate loan market component is worth about A$1 trillion.
Private debt is historically a tightly held market dominated by the major banks. It remains very immature today and there are currently few institutional providers. However, it is becoming an increasingly popular avenue for borrowers to access credit, reflecting a shift away from the banks as traditional loan providers.
For non-bank lenders, the market can provide attractive risk-adjusted returns in what is now a 'lower for longer' environment where fixed income alternatives are proving to be lacklustre.
Dislocation means opportunity
The shift away from the incumbent players marks the start of true dislocation in local private debt markets. Regulatory pressures, including BASEL capital requirements, APRA oversight and the Royal Commission into financial services, are forcing banks to rethink the way they lend.
This market dislocation is giving non-bank lenders greater opportunities to participate in and capture rewarding business across a wide range of sectors in this growing space.
For example, increased regulatory oversight over the past few years has seen APRA focus on how banks are lending in the commercial real estate space. Consequently, several real estate focused debt funds have benefited from the banks pulling back from that space.
Similarly, the Royal Commission examined the social licence of the banks’ activities which gave institutional capital an opportunity to step in and fill the gap left by the banks in the non-investment grade space.
Relationships trump cheap debt
Since banks operate as one-stop shops with the ‘originate to distribute’ model – where they seek to own the transaction process and all relationships from start to finish – their attention goes to the bigger deals. This allows them to maximise the revenues generated from using their large teams and resources.
But banks don't get the same benefit from this model in the middle market space. That’s because there's just as much work required to execute a loan of a smaller size as there is to complete a larger transaction.
This creates opportunities for institutional capital to step in for the smaller deals. The non-bank lenders can have the one-on-one conversations to foster strong relationships, making the transactions more customised and bespoke. Direct lending can be more time intensive, but by removing the intermediary, there’s potential to capture more yield while also tailoring the transaction to better suit all needs.
These advantages have seen a burgeoning middle market landscape develop locally for direct lenders. It’s also further evidence that relationships trump cheap debt.
Bespoke solutions
The private debt market contains a variety of different loan structures and instruments that can provide bespoke solutions to accommodate many different risk and return objectives for institutional investors.
The higher the risk, the higher the premium received for that risk. This can range from investment grade to non-investment grade debt, non-leveraged to leveraged debt, and senior secured debt to subordinated or mezzanine debt (which earns a higher coupon for sitting behind senior debt).
In terms of maturities, a variety of different tenors are available, but most are inside of 5 years. There is also a small but growing proportion of opportunities beyond 5 years, particularly in the infrastructure sector.
Benefits for borrowers and lenders
While the private debt market is often bespoke, highly structured and illiquid, with little to no secondary market and significant barriers to entry, it provides many benefits to both lenders and borrowers.
Private markets can offer access to debt issued to smaller Australian borrowers – something that’s difficult to obtain through the public market – thus creating portfolio diversification benefits. As a result, the private debt universe can offer direct lending investors exposure to a greater variety of borrowers, sectors and income sources.
The associated debt transactions can be structured to offer counterparties additional protection through bespoke loan terms and covenants, improving credit quality.
Borrowers can be closely analysed and collaborated with, permitting a greater focus on factors that are important to all parties, such as ESG and sustainable investing. Also, borrowers may prefer to diversify their funding sources and relationships, giving them multiple avenues of financing in times of stress.
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