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.

Landmines to look out for in the hunt for yield

In the ‘lower for longer’ interest rate environment, investors are naturally being drawn to investments that suggest high yields for relatively low levels of risk.

There is no shortage of them on the market – from funds that include exotic Queensland islands to LITs that invest in a complex collection of high yield global bonds.

However, when considering any investment it is important to remember that high returns can come with higher risk, the nation’s leading non-bank lender Metrics Credit Partners has cautioned. (After eight years and $8.5 billion of lending, Metrics understands the opportunities and risks in fixed income investments.)

For example, Andrew Lockhart, Managing Partner of Metrics, said staying with local fixed income could be a safer strategy for investors.

“Investors often include international bonds in their portfolios to take advantage of higher interest rates or yields and to diversify their holdings. However, the potentially higher rate of return is accompanied by increased risk arising from adverse currency fluctuations, which can cause investment volatility and ultimately impact returns,” he said.

Mr Lockhart said not only does investing in Australian assets remove foreign exchange risk from the equation, but investors were also protected by Australia’s strong corporate insolvency laws.

“Australian law is focused on giving priority to the interests of creditors, especially secured lenders, in comparison to other developed nations such as the US and UK, which are now perceived to be much more focused on the rights of the debtor company.”

Mr Lockhart said credit markets were now at a point in the cycle where risks were becoming more apparent.

“Over the past 10 years businesses across the globe have loaded up on debt, credit quality is deteriorating and compensation for credit risk has declined as yields have collapsed. In short, global credit investors now face a lot more risk, for a lot less return,” he said.

Investors seeking capital stability and reliable income should aim for diversification, he added.

“While corporate loss rates in Australia are low, diversified funds help to manage downside risks by spreading funding across a range of sectors, risk profiles and investment terms. So do your homework before undertaking any investment and remember – if it seems too good to be true, it probably is.”

by AdviserVoice | January 29, 2020

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