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Is private debt on an upward swing as banks cede territory?

By Rhea Nath
5 minute read

The asset class is gaining popularity as investors strive for more resilient portfolios, a trend further bolstered by increased regulatory pressure on banks.

Regulatory pressures, increased funding costs, and a focus on shareholder returns are driving banks to re-evaluate their lending strategies, particularly in corporate and institutional lending.

Speaking on an InvestorDaily webcast, Metrics Credit Partners managing partner, Andrew Lockhart, forecast that banks will progressively cede market share, a trend that is creating opportunities for private credit providers to fill the gap and cater to borrowers seeking alternative finance options.

Lockhart explained that regulatory pressures pushing banks to bolster their financial standing have limited their large-scale lending capabilities, prompting a shift towards consumer home loans and small to medium-sized business lending, while private capital fills broader financing demands.

“Whenever you hear a regulator say that they want the banking sector to be unquestionably strong, it means that the banks are going to hold additional capital, which means it becomes very difficult for a bank to be able to generate the required return on shareholders’ funds for lending for corporate and institutional purposes, and as a result of that, they’re ceding market share,” he said.

“And let’s face it, Australia doesn’t have a corporate bond market where most borrowers can easily access alternative sources of financing, and most borrowers don’t have credit rating, so the ability to access financing away from the banks is of real value to borrowers.

“And as a result of that, you’re able to deliver a great outcome for investors because you’re giving them diversification across a whole range of borrowers. But we certainly are of the view that the market will continue to move towards private investors, private credit providers, and the regulated banks will probably continue to move more and more towards consumer home loan financing and lending for small and medium sized businesses,” Lockhart told InvestorDaily.

In recent years, investors have significantly shifted towards alternative investments, driven by a desire for diversification, risk mitigation, and enhanced portfolio resilience.

Joining Lockhart on the webcast, AltX co-founder and co-chief executive officer Nick Raphaely said private capital has gained prominence as a key component of these modern investment strategies.

“The old notion of it’s a choice between equities and bonds, or a combination thereof, no longer really holds equally. We saw at the start of the pandemic in 2020, equities fell by over 35 per cent and bonds only rallied 5 or 6 per cent. So they’re not really doing their job in the way that they used to be doing. So that really, I guess, introduces the question or the issue of what fills the gap and where are the opportunities in investing today?

“I think alternatives is really the space which is kind of stepped in as almost as the third pillar to provide investors with a range of choice. Now, obviously, alternatives as an asset class capture a lot. Our focus area is private real estate debt. So providing investors the opportunity to participate in first mortgage-backed loan transactions, that’s our area of speciality. But there’d be others, too. Private equity, hedge funds, etc. But I think the overarching point is that investing has become more sophisticated. There’s more choice for investors, more options. It’s not just about bonds or equities today.”

Unlike public markets, private capital offers unique advantages such as longer investment horizons, greater control over assets, and potential for higher returns, Raphaely explained. And, as such, institutional investors and high-net-worth individuals are increasingly allocating capital to this asset class.

In Australia, private capital assets under management grew by over a third (33 per cent) last year to reach $139 billion, according to latest figures from Preqin and the Australian Investment Council this month.

The report also pointed to the increasing popularity of private debt supported by robust deal activity and tighter lending conditions among traditional debt providers. As of June 2023, private debt AUM stood at $1.8 billion.

Lockhart finds private capital appealing due to its ability to provide capital stability for the defensive portion of investors’ portfolios, coupled with an attractive source of income.

“[Investors are] looking for reduced correlations across asset classes, and private debt delivers that,” he remarked.

“We’ve seen situations where people have invested historically in more traditional fixed income asset classes, like bonds, and they’ve just not performed, and so they’re looking at how to reduce that duration risk and how to get a more direct exposure.”

Ultimately, he said, private credit stands out to retail investors due to its appeal in providing stability of capital, an attractive income source, and reduced correlations across asset classes.

“The benefits of private credit is obviously through the mechanisms that a lender can put in play to protect investor capital – through appropriate governance and controls, the reporting, the access to private information to access and manage risk, and the taking of security, [they] are all designed to protect the capital or the lender. As a result of that, [it] passes through to the investor in terms of improved capital protection,” Lockhart said.

“Other asset classes might claim to provide greater degrees of stability of capital, but lenders actually take direct action to mitigate risk of principal loss or capital loss, and the actions of those lenders are designed to protect investor capital.

“I think, from that perspective, it’s an asset class that very much appeals to investors.”

To hear more from Lockhart and Raphaely, watch our free webcast here.