PDI Magazine - Expert Q & A With Christian Brehm

How has the Australian private credit market matured in recent years? What trends have you observed?

The Australian private credit market is still maturing. The market started to experience growth in 2018, triggered by changes in global and local banking regulations with the Basel Committee on Banking Supervision requirements. Australian banks were similarly required by local regulators to hold additional capital towards their mortgage books, forcing them to either raise new capital or relocate existing capital. The latter left a gap in the market for corporate borrowers that are considered riskier. This led to an increase in opportunities and borrowers actively seeking private lenders, which has been steadily growing since. We are also seeing higher quality and larger corporate lending opportunities after Covid-19 as local banks tend to favour residential mortgages which has been experiencing a boom.

There has historically been a strong real estate lending market in Australia, but this sector is now facing problems amid rising costs and labour shortage. This has resulted in the highest rate of construction insolvencies ever seen. There are private credit lenders specialised in property construction who are capitalising on the funding gap left by banks amidst the heightened risk.

We are also seeing challenges in the market regarding environmental, social and corporate governance (ESG) issues. The mining and material sectors, in particular, require capital, but the majority of institutional capital are no longer interested. This is also creating a gap representing an opportunity for private credit.

We see many new funds in Australia targeting the PE-sponsored space. However, there is not enough capacity here to meet that demand, unlike in the US. Where we see substantial deal flow is in the small to middle market, which is less likely to attract the attention of these firms.

In terms of accessibility of credit, how challenging is the Australian market? 

For borrowers, accessibility can be a challenge in some sectors. As mentioned earlier, ESG criteria can be an issue in sectors like mining or mining services. Australian banks as well as local superannuation funds do not have appetite for these opportunities.

Generally speaking, accessing credit is not a straightforward process in Australia. Other private credit markets are mature and liquid, but we are still in the early stage and probably a decade behind the US. We need to improve access for private markets here, especially for small to medium corporate borrowers who do not have easy access to public markets.

For private credit lenders, a local presence is necessary to gain access to lending opportunities. They need to be entrenched in the local market to understand the borrowers and how the markets work. It is not particularly a relationship-driven game, but it is important to be known in the market. To be successful in Australia, you need to have boots on the ground and an established team that can execute opportunities quickly within a few weeks.

We launched in 2012 and it took us a decade to establish a presence and achieve the kind of deal flow we have now. That does not happen overnight.

What do you see as the biggest challenges for private credit funds operating in Australia?

Many Australian credit funds are finding capital-raising to be challenging. In the US and Europe, there is an active participation of investors in their local markets, for example, US credit investors and funds actively lend to US borrowers. We have the opposite happening here. Most superannuation funds participate offshore credit funds only with limited appetite for Australian funds. The Australian market and superannuation funds also don’t have support programs which you find overseas for example in the US market.

We have found that offshore investors generally like Australia, however there is a lack of GPs and fund products that suit them. Some investors only want to get involved with large opportunities, which there are not many of them.

There is still an educational problem on the borrower side, too. They need to understand that private credit lenders are not banks, so there are differences. We can provide capital quickly, which is attractive, but it comes at a greater cost. Deal structure and legal documentation can be different, and personal guarantees can sometimes be required. These are all things that borrowers need to expect, and we appreciate that it is often not a simple process. We take borrowers on a journey and explain to them how the market works and why it is different to bank lending.

Market stress tests have been mooted by the Australian banking regulator with regards to the recent growth in private credit - to what extent do you expect the space to become more regulated? Could this potentially stifle growth in the space? 

There have been talks about more regulation in the sector. The main question is, what more will be regulated? This is an industry that is fairly transparent, at least at the moment. There is limited scope for more regulation to be enforced on capital providers other than what has already been done through financial services licensing rules.

Obviously, banks want private credit funds to be more regulated because we are their competitors. Personally, I think private credit should be given more time to grow before the regulators gets more involved. If the industry is not large enough, regulations could dampen activities, ultimately reducing capital available and increasing funding costs to local SMEs and borrowers who are not well serviced by banks. Perhaps single asset funds where people invest in equity without diversification benefit should receive more attention.

Generally speaking, what is your outlook for the Australian private credit space over the next 12 months? Where are you bullish, and where are you bearish? 

There are challenges but they are all good ones and I am quite bullish about the Australian market. There are segments, such as consumer discretionary, where defaults may tick upwards over the coming months, but overall corporate lending volume is increasing. I expect the lending environment in Australia continues to be lender friendly.

Based on what Australia has achieved in the past as an economy, with a robust debt-to-GDP ratio and AAA rating, we expect contrary to the US and Europe to have a more robust economy even there are headwinds in some sectors. Australia has a good chance to  continue its growth, even though on a lower growth rate while the US and Europe will likely go through a recession with challenges for highly levered borrowers or funds using leverage to achieve attractive returns for investors.

I’d expect in the long-term that Australia will have an interest rate premium of up to 100bps in, going back to a pre-GFC normalised global interest rate environment.