June 2024: Is private credit’s strong run likely to continue?
The debt market in Australia is estimated to total A$3 trillion, with banks accounting for approximately 90% of that i.e. A$2.7 trillion. At only 10% of market share currently, there is a lot of potential for the growth of non-bank lenders. Even if we allow for private credit to only account for a third of total lending in the future, the addressable market is a significant A$1 trillion thus providing a lot of room for competition. [For further reading on the structural shift driving the growth of private credit markets, see our end note.]
The key for investors is to understand that private credit providers are not a homogenous group. Real estate focused credit is possibly the best-known speciality but there are many different styles of private credit funds.
At Keyview, we focus on a part of the lending market known as opportunistic credit or special situations. These types of transactions are distinguished by the borrower requiring a lender that can manage complexity, is nimble in its decision making and/ or has the expertise to tailor the lending structure. Outside of the large borrowers looking for $100+ million transactions, few to no private credit firms can offer this to Australian and New Zealand mid-market companies. As a result, we’re not competing in a very crowded market for these types of transactions which makes our investments less susceptible to market movements or even interest rates. The alternative, which we avoid, is looking for deals in more popular segments of the market because tougher competition for a deal forces lenders to accept lighter covenants and therefore increased risks of capital loss. Compromising on protections does not pass our capital preservation mandate.
Our funds are made up of a diverse array of tailored loans, across industries, all structured specifically for the needs of the borrower given their unique circumstances but without the need for us to lower our risk provisions.
Where we see pockets of opportunity
Currently, we are in a particularly attractive phase. There's robust demand for capital across various sectors but without worrying signs of excessive exuberance that result in too much available capital. The key drivers of this demand are a strong economic environment and a manageable level of market distress. This creates a favourable backdrop for our transaction pipeline which is one of the strongest pipelines we've seen.
Central banks are combatting continued government spending making it difficult for them to reduce inflation. This makes high interest rates and therefore market strain more likely.
However, we are not currently seeing a lot of distress across borrowers but are relatively comfortable should conditions shift into a more distressed environment. Our portfolio is well-positioned given its conservative loan-to-value ratio (currently sub-50% loan to value ratio), diversity across sectors and robust deal flow. Additionally, Keyview actively manages our investments meaning we can, and have, moved swiftly to work with a borrower’s management team when required to ensure our investors’ capital is protected.
Where we are keeping a watching brief is in the disparity of spending behaviour between consumer cohorts, the end of Covid-induced pent up demand and central banks aiming to tame inflation despite governments’ fiscal stimulus.
We are aware older demographics are less impacted by employment and are benefiting from higher interest rates while the younger demographics are feeling the pinch. Overlaid with this is the normalising of consumption following a surge once Covid restrictions eased and now governments favouring spending despite inflationary pressures. So, while we are macroeconomics and industry sector agnostic, we stay aware of issues as drivers of our cautiousness.
Outlook for the Keyview funds
Keyview’s funds have delivered strong returns. The Keyview Flagship Fund has returned 12.26% p.a. net of fees since inception and performed in different rate and macroeconomic environments. The Keyview Credit Opportunities Fund is similarly tracking well with a since inception (1 year) return of 11.66% p.a. versus its target of 8-10% p.a..1
What’s particularly exciting about the outlook for the funds is the diversity and strength of the deal pipeline. We are seeing a breadth of opportunity - across sectors, counterparties’ structural need for capital and deal size. They are all deals we would want to do as individual investments which makes it even more exciting to put them into a portfolio that consequently benefits from diversification.
As outlined above, strongest returns have come from opportunistic credit deals but also from selectively chosen performing credit transactions. We expect strong performance to continue given the nature of our investment approach, regardless of the economy, thanks to external shocks and idiosyncratic events that specifically impact a company’s capital requirements. Under that scenario, the cost of private equity rather than the prevailing cash rate becomes the benchmark for the cost of the required capital which translates into strong returns for our investors.
For more information about Keyview and our funds, visit keyviewfinancial.com.
End note:
Structural shifts driving the private credit market
With the asset class attracting increasing attention, many investors wonder if the space is becoming overcrowded and if strong performance to date can be replicated in the future. To answer the first part of this question, let’s look at three things:
1. What we can learn from more mature private markets offshore
2. Structural shifts in Australia’s bank lending landscape
3. Changes in investor behaviour and asset allocation strategies
1. Non-bank lending offshore
Approximately 15-20 years ago, the US private credit landscape mirrored what we're witnessing in Australia today. The banks provided the majority of loans to corporates with the balance provided by smaller non-bank lenders. The tightened regulatory framework introduced post-GFC meant US banks became more conservative thereby limiting their lending activity. The resultant gap allowed the smaller lenders, which quickly consolidated into meaningful market forces, to take market share from the banks. Today, non-bank lenders account for almost 90% of all corporate lending in the US, the inverse of Australia’s system which is still dominated by the banks. While it’s not always true that Australia follows the US’s trajectory, there are signs that make this likely, as outlined below.
2. Structural shifts in Australia
Australia has one of the best-in-class lending frameworks allowing creditors to create legally binding borrower protections. This has a two-fold impact:
a. Offshore creditors are attracted to Australia as a robust destination for their investors’ capital. This, coupled with home-grown non-bank lenders, provides strongly competitive alternative capital sources.
b. Local banks, driven by the likes of the Australian Prudential Regulation Authority (APRA) to comply with stricter capital requirements post GFC, are focusing on reallocating their capital towards more straightforward segments such as residential mortgages and consumer lending. As in the US and elsewhere, this provides an opening for non-bank lenders to serve borrowers outside the banks’ areas of focus.
The result is that these twin forces of retreating bank lending in certain parts of the Australian corporate lending space and increasing interest from capital allocators is driving strong growth in the private credit market.
3. Changes in asset allocation
Factors such as a high interest rate and inflation environment naturally drive investment towards private credit because it can act as a hedge against these economic conditions. Additionally, investors increasingly understand the illiquidity premium from private market investments can help optimise investment returns and compound capital in a tax efficient manner. Investors’ appetite for private markets’ returns often come at the expense of public markets and cash investments, the former looking increasingly over valued to many and the latter eroded by inflation.
1Disclaimer: Data as of 30 June 2024. Keyview Investment Management Services Pty Ltd (ABN: 15 667 825005) is a Corporate Authorised Representative (CAR No: 001304647) under the Keyview Investment Management Pty Ltd ABN: 24 665 351726 (AFSL No: 546 246). Keyview Investment Management Services Pty Ltd is the trustee of the Keyview Credit Opportunities Fund. Keyview Investment Management Pty Ltd (AFSL: 546 246) is the trustee of the Keyview Flagship Fund. The information is of a general nature only and does not take into account the objectives, financial situation or needs of any person. Before acting on this information, investors should consider its appropriateness having regard to their own objectives, financial situation and needs and obtain professional advice. No liability is accepted for any loss or damage as a result of any reliance on the information. Past performance is not a reliable indicator of future performance. Future performance and return of capital is not guaranteed. A copy of the Information Memorandum for each fund can be obtained at clientrelations@keyviewfinancial.com.
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