Does a slowing economy increase the risk of loan defaults in private debt?

Well-run private debt funds use rigorous scenario testing and real-time monitoring to mitigate risks. Historical net write-offs by banks peaked at just 0.68% during the GFC and were 0.04% in September 2024, demonstrating strong resilience across economic cycles.

Does a loan default always result in a credit loss?

No. Private debt investors are protected by their seniority in the capital structure. Senior debt holders get repaid first, before subordinated debt, preferred equity, and common shareholders. Covenants and controls act as early warning signals allowing lenders to engage with borrowers to mitigate financial loss.

Are all private debt managers the same?

No. Private debt managers differ significantly in scale, credit skills, and experience. Quality managers need sizable assets under management, bank-level credit skills, extensive networks, and the ability to directly originate and diversify loans across borrowers to achieve optimal outcomes.

Does commercial real estate debt put capital at risk in a property downturn?

Property owners face greater risk than lenders. With typical loan-to-value ratios of 60%, owners' equity acts as a buffer. Even if property values fall significantly, lenders can compel borrowers to restore their position or pursue asset sales to maximize recovery without necessarily incurring losses.

Are non-bank lenders lenders of last resort?

No. Competent private debt managers lend to quality companies and often compete with banks or work alongside them in lending syndicates. Post-GFC regulations requiring banks to hold more capital have created financing gaps that private debt fills for established companies with sound fundamentals.

Finding income in a low-rate world

For the best part of a decade now, income hungry investors have battled to find a decent yield. Thankfully, the capital gains from falling rates have offset the lack of income. But with rates around the world close to zero, it seems there’s limited room left for more capital gains.

Let me share an example. According to the ATO, the average super balance for a 65-74-year-old man is $446,800. Meanwhile, the average super balance for a 65-74-year-old woman is $378,600. So, let’s say our couple has a combined super balance of $825,200. Quite a healthy nest-egg. But with term deposit rates at around 1.75%, that will produce just $14,441 of income over the course of a year.

It should come as no surprise then that private credit, with its chunky yields, has seen a boom in popularity in recent times. Once purely the domain of institutional investors, these products are increasingly available to retail investors through listed structures on the ASX. Offering returns in the mid-to-high single digits, they attract a premium for the higher risk nature, while generating additional fees from deal origination.

Andrew Lockhart, Managing Partner of Metrics Credit Partners, has been a pioneer in this sub-sector in Australia. He worked for decades at a Big Bank on these deals, and then nine years ago decided to start Metrics with his business partners. In this week’s episode of The Rules of Investing, we discuss how the GFC shaped his investment philosophy, how Australia’s big banks have changed the way they’re funded, and the sectors he’d be avoiding if the market closed for 5 years.

Livewire | February 7, 2020

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