Not only nature abhors a vacuum. The expression applies equally to finance where unfilled spaces are eventually filled with something.
So it is with lending, where providers of private credit have stepped in to provide loans to businesses unable to obtain traditional borrowings as banks have retreated due to the regulatory changes affecting them since the global financial crisis (GFC).
The private credit market has boomed in recent years, particularly in the United States and United Kingdom, with Australia catching up.
Private credit is defined by the Reserve Bank of Australia (RBA) as bilaterally negotiated lending to businesses arranged by non-banks.
In this market, lenders like asset managers, intermediate between investors and borrowers, and in some cases, they lend directly to borrowers, the RBA said in an article in its October 2024 Bulletin.
The Australian Investment Council (AIC), the peak body for private capital, said private credit providers often worked alongside traditional banks if a loan was too large for one bank to underwrite.
“In addition, private lending is used where traditional bank lending may not be accessible such as where there are complex business structures in need of bridging finance, where start-up or fast growth companies have difficulty borrowing from established banks or where companies are restructuring,” the AIC said in a fact sheet.
Management consultancy McKinsey has estimated the global private credit market to be worth almost US$2 trillion (A$3 trillion) at the end of 2023, about 10 times larger than in 2009, while JPMorgan has put the value at $3.14 trillion.
North America accounts for around 70% per cent of global private credit raised since 2008, while Europe represents about one-quarter, according to PitchBook.
Estimates of the size of the market in Australia vary from $1.8 billion (Preqin and Australian Investment Council), which captures the assets under management of closed-ended private credit funds, to $188 billion (EY), which includes the assets under management of private debt funds and other non-bank investors.
Although the Australian private credit sector has grown strongly over recent years, it represents a small share of total business debt.
The RBA said private credit provided an attractive risk-return trade-off for some investors, paying a higher interest rate than similar assets and with low volatility.
“Non-bank lenders have played an increasingly large role in lending to risky companies, in part because some business lending has become more expensive for banks; regulatory reforms after the global financial crisis raised banks’ capital requirements and made them more sensitive to risk,” the central bank said.
Private credit loans are like syndicated loans in that they are usually senior secured, variable rate, larger than bank loans, and might be made up of multiple credit facilities, but they are mostly not traded in secondary markets or publicly rated, and lenders tend to hold them to maturity.
The key participants in the private credit market are:
- investors such as pension funds, insurance companies, family offices, sovereign wealth funds and high net worth individuals
- intermediaries, such as private credit funds, business development companies (BDCs) and off-balance sheet securitised loan pools, which source funds from investors and lend to borrowers, and
- borrowers, which are typically highly leveraged medium-sized businesses with often have irregular cashflows or limited collateral.
The risks include leverage; with investors, intermediaries and borrowers able to borrow to increase return on equity; liquidity, as funds adopted close-end structures to manage cash flows; and the interconnectedness of private credit and private equity markets.
“The Australian private credit market is growing rapidly. Due to its small size, direct risks to financial stability from the private credit market in Australia appear low,” the RBA said.
The AIC said private credit was an important alternative form of finance for private capital investment and for small to medium-sized businesses.
“The increased demand for alternative lending structures was catalysed by the global financial crisis. Tighter regulations on banks created demand for private credit as an alternative source of finance from sectors of the market seeking more flexible capital,” the AIC said.
Disclaimer: This article provides general information and does not constitute financial advice. Always consult a professional advisor before making investment decisions.