Senior secured corporate loans – that is, private debt obligations between a company and a group of lenders, historically a group of banks – are becoming increasingly recognised in Australia as an attractive asset class.
In the current low-yield environment the attractions include relatively high yield, high security – its first-ranking debt stationed above all other debt and equity, and low duration risk.
Like so many markets worldwide, the senior secured lending market in Australia was also dramatically impacted as a result of the GFC, after exhibiting rapid growth since the turn of the century.
From a base of only $324 million in 2003 the Australian senior corporate debt market had grown 2,300 per cent to more than $7.7 billion in 2007.
Deal volumes hit the wall in the GFC, dropping by 90 per cent (or more than $10 billion) to $1.3 billion in 2009.
By 2012 it was almost back to pre-GFC levels at $11.3. billion – the last time it topped $11 billion was 2007.
The GFC caused local banks to drastically shrink their lending levels in all sectors, including corporate senior debt. In addition, a slew of foreign banks exited the market as they literally left our shores as a result of domestic problems/failures of their parents in their respective domiciles: think RBS/ABN Amro, HBOS, Soc Gen, BNP Natixis, BOI, AIB, West LB, UniCredit and many Asian banks.
In March 2012 the Bank of International Settlements reported an exodus of some $7.5 billion from the Australia economy in the third quarter of calendar year 2011 alone, with French banks accounting for $4.5 billion.
At the same time, Australian banks were busy reducing their exposure to European markets and repatriating funds back home.
Concurrent with this activity has been the move by banks worldwide to adjust their capital structure in preparation for the introduction of the new Basel III regulations in all their different national permutations.
The impact of these changes has been a slightly lower risk appetite, which has often translated into a desire to lower the proportion, and therefore quantum, of exposure to any one deal by the banks.
If we are to compare the shape of the Australia senior debt markets to those of the US and Europe, we can glean a trend that is likely to play out here, though I suggest in a much more subdued form.
In the US, non-bank lenders fulfilled 43 per cent of senior corporate debt lending in 2002, compared to the banks’ 57 per cent. By 2013 non-banking had risen to 84 per cent compared to the banks’ 16 per cent, according to Allens Linklaters.
In Europe over the same period it was a similar but less dramatic story, with non-bank lending rising from 22 per cent in 2002 to 46 per cent on the market in 2013.
The picture in Australia sits in stark contrast to these figures, with non-bank lending in 2013 accounting for only five per cent of Australian senior corporate debt activity.
Now there are many and varied explanations for this difference and we don’t believe the Australian market will ever replicate these figures, but there is every reason to believe the proportion of this market occupied by non-bank lenders is likely to slowly but steadily rise over the coming years.
In addition to a landscape featuring more rigid capital rules for the fewer banks operating, there is an increasing hunger by institutional and large super fund investors for low-risk, high-yield investments. This is leading to the development of products that respond to the needs of both the investors and the major banks.
For example, our new senior debt fund will marshall debt that is a small proportion of a corporate’s exposure, providing a top-up, or ‘complementary capital’ (even though it is debt financing we are providing), to the banks’ much larger and usually dominant share. The banks are increasingly welcoming the opportunity to share risk, given the new regulatory environment.
This form of investment in debt by institutions and super funds also comes with minimal duration risk, since the interest rates are adjusted to market quarterly.
In an environment of low interest rates and uncertain economic outlook, senior loans offer investors a new way to achieve yield in a portfolio offering high and stable cash flows. These assets have a low correlation to equities and a low beta to market volatility, which provide diversification benefits and improve the overall risk adjusted return of an investment portfolio. Expect to see increased activity in this space.
Matthew Turner is the director of Intermediate Capital Group.
