Australian Private Credit Introductory Guide

Foreword

The Alternative Credit Council (ACC) and Alternative Investment Management Association (AIMA), in conjunction with EY, and BondAdviser, is pleased to present this inaugural Australian private credit market primer. This paper brings together information from a range of sources to support investors’ understanding of this growing market sector. The paper will cover the history, context and key investment considerations of the market in Australia, and present the findings of a credit fund manager survey, conducted to better understand current mandates and views in the private credit market.

Growth in the global private credit market has accelerated following the GFC when increased regulations forced banks to reduce their lending to some market segments, creating an opportunity for asset managers and non-bank financial institutions to deploy capital. Participants in this market now include a broader range of fund managers, as well as superannuation funds, insurance companies and institutional investors.

Private credit delivers benefits to both borrowers and investors. It gives borrowers access to growth capital and simultaneously provides investors with access to assets within the lending market that offer them attractive returns and diversification in a direct and efficient manner. Over the past ten years private credit managers have helped the industry evolve into a distinctive alternative asset class. The continued capital allocation to private credit, at levels continues to exceed expectations. This is testament to its success as an increasingly important pillar of the Australian financial sector. The appeal of the asset class is simple: it provides higher and non correlated yields for investors and provides borrowers with more flexibility than traditional forms of debt. As the asset class gains more recognition in Australia, it will expand and diversify into emerging and niche sections of the market, with fund managers developing newer strategies and expanding their product offerings.

The ACC would like to acknowledge the extraordinary amount of work done in pulling this introductory guide together. In particular the team at BondAdviser and EY, headed up by Nicholas Yaxley (BondAdviser) and Sebastian Paphitis (EY) and a special thanks to Travis Schoenleber (Cambridge Associates whose input was invaluable, we hope you the reader enjoy the paper and as usual appreciate your feedback.

Michael Gallagher

Managing Director, Head of Australia
Nicholas Yaxley

Managing Director, BondAdviser
Sebastian Paphitis

Partner and Joint National Head of Capital & Debt Advisory, EY

Executive Summary

Within this introductory guide, and with the benefit of our inaugural Australian credit fund manager survey, a number of important key themes have emerged as outlined below. These themes reflect the development of the private credit market here in Australia and how it has matured into an important participant in the global trend towards private credit investment.

A. Continued strong market growth

Reflecting the trend being seen in global debt markets, the development of the private credit sector in Australia continues to grow at a remarkable pace, with new managers entering the market, existing managers building their platforms and the opportunity for investors remaining compelling. Per EY analysis, there is now over A$109bn in allocated corporate private credit, accounting for roughly 9%¹ of the total corporate debt market with our inaugural survey of credit fund managers seeing a very positive outlook for the market.

B. Diversity of lender mandates

Whilst the majority of respondents to our inaugural survey invest in direct lending, this covers a range of core strategies. These include sponsored, mid-market and commercial real estate and most are looking at target loans between $10 – 100m. Local credit managers are seeing good investor interest in the stable and reliable incomes available from the asset class, and a strong pipeline of lending opportunities as the Australian economy emerges from the COVID-19 pandemic.

C. Comparable relative returns to international markets

Most Australian managers surveyed are operating lending strategies with target gross rates of return for respondents centred around 5 - 10%. Such strategies are typically seen as lower risk on a relative basis. This compares well with the 10-year horizon pooled return of CA senior debt index over the same horizon of 6.76%.² This shows that local credit fund managers are able to deliver returns at or above the index, and at comparable rates to international managers. In addition, many local managers are also enhancing returns through mezzanine and unitranche strategies, and the equivalent CA Index inclusive of these strategies delivered 8.56%.

D. Emergence of ESG considerations

With sustainability, climate and social considerations now a priority for global investors, we are seeing Australian credit managers adapt their policies to accommodate these requirements and take a more proactive stance. Many managers have adopted market parameters such as the UN Principles for Responsible Investment and embedded these principles and drivers as key components of their approval considerations and terms offered to borrowers. Many private credit strategies also involve direct relationships with the underlying business or project that reduces agency problems and can offer investors more control over ESG or sustainability issues than in other markets.

E. Favourable regulatory and legal environment

While private credit managers and non-bank lenders in Australia remain subject to a number of legal standards and industry codes, they do benefit from some flexibility in comparison to the banks. The Australian regulatory environment also provides a robust supervisory framework for the sector, supporting high standards of investor protection and well developed risk management practices. The efficient, trusted and dependable credit protection inherent in the Australian legal systems, which includes its creditor friendly insolvency regime, also promotes investor confidence to support lending to Australian businesses.

^{1 EY’s Australian Private Debt Market Update for 2020 (2021). Available from: https://www.linkedin.com/posts/sebastian-paphitis-5a82a51b_eys-australian-private-debt-market-update-activity-6762582187599642624-pn14}

^{2 Cambridge Associates, Private Credit Strategies: An Introduction (2017). Available from: https://www.cambridgeassociates.com/insight/private-credit-strategies-introduction/ Returns quoted are net of fees, and does include leverage at the fund level.}