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.

Non-bank lenders to provide a greater share

One of the hallmarks of the Australian corporate lending market has been the bank dominance of the sector, with the domestic banks currently holding around 70% market share. Due to the large balance sheet capacity and accompanying capital required to operate in the market, barriers to entry are significant.

However, Andrew Lockhart, Managing Partner at Metrics notes “banks are under significant regulatory pressure to reign in their loan portfolios to meet stricter capital requirements, which has opened up opportunities for non-bank lenders to claim a greater share of the >$900 billion market.

“For this reason, expect the proportion of non-bank lenders to grow modestly over the coming year.”

Mr Lockhart adds that institutional capital is also driving this corporate loan growth. “The asset class is a key component in institutional portfolios, particularly for those seeking income-producing assets at a time of low yields, and over 80% of managers expect to raise more capital from pension funds and insurance companies in the near future.

“Outside of the institutions, however, there is also significant interest in investing in corporate loans from Australian retail and self-managed superfund investors, drawn by the attractive risk-adjusted returns of 4-10% on offer.”

Given continued uncertainty for equities markets resulting from geopolitical issues and the ‘lower for longer’ rate environment impacting cash and term deposits, this is a trend expected to continue into 2020.

Mr Lockhart notes that raising capital for property developments can be a long and expensive process. “The property sector is an attractive opportunity to build a relationship with a lender, rather than relying on commoditised lending products offered by the banks.

“Given the pullback in bank funding in Australia, along with the appetite we are seeing from borrowers of all sizes for alternative sources of funding, we could well see more sizeable transactions in the Australian market in the years to come.”

by Metrics | January 22, 2020

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