The long period of easy money is at an end. In a new era of higher interest rates, liquidity and diversification are a primary source of concern for all investors.
Global private credit offers Australian investors the opportunity to access deep, diverse, and mature international credit markets. What makes global private credit a compelling alternative and why is now the right time to invest?
A once in a generation opportunity?
Conditions for floating rate private credit are the best they have been for a generation.
Rising interest rates and banking stress (in the US) led to a minor credit crunch. The full implications of the record increase in the cost of capital will continue to play out across the credit spectrum as the shifting gears of rate rises work through the real economy and credit markets.
Diverging conditions across global credit markets (both structural and cyclical) present a range of unique opportunities for non-bank lenders and investors.
Global private credit offers defensive portfolio diversification and robust characteristics to safeguard capital – asset collateral, security dynamics, bespoke structures, terms and covenants, equity and income buffers, control rights and triggers.
For Australian investors, it provides access to some of the best opportunities in specialty finance, and unique products currently not available in the domestic credit market.
How is global private credit different?
Credit markets operate within similar limits across global regions, although the maturity, depth, and range of securities on offer varies widely. In the US, despite familiar investment fundamentals, there are important structural differences compared with Australia’s relatively nascent (but rapidly expanding) private credit sector.
The US operates a vast, mature, and highly liquid credit market with considerable funding efficiency. Non-bank lenders account for 80% of the credit market in some segments.1 US credit markets are designed around an ‘originate to distribute’ model. Loan originators sell loans to third party funders (in exchange for fees) with no retention risk.
There is a vast array of US private credit products as well as a diverse selection of more niche asset types. In contrast, the domestic private credit market remains small, with non-bank lending accounting for a relatively minor, but fast-growing, proportion of overall credit in Australia.2
The full implication of the differences between US and Australian private credit markets varies depending on the type of credit, although the sheer size, complexity and liquidity in US credit provides significant scope in both traditional lending and specialty finance.
US credit markets in the spotlight
The US is the world’s largest private credit market; a vast, innovative, and mature asset class encompassing a wide range of traditional corporate lending, asset-backed lending, and specialty finance opportunities.
Since the US Federal Reserve began raising rates in mid-2022, ~US$1 trillion in deposits have exited the banking system. Combined with tight lending standards, consolidation and credit contraction across the US banking sector has resulted in credit growth shrinking. Credit availability has had its largest decline in 20 years, at the same time as interest costs are at a 15-year high.3
The US regional banking turmoil in early 2023 (triggered by mismanagement of interest rate risk as opposed to increasing credit risk) is set to create, to some extent, a credit vacuum for quality, mid-size corporate borrowers and an array of asset-backed, real world economy lending verticals seeking capital for growth as banks re-focus on managing deposits and their balance sheet.
Exacerbating the specific issues facing US regional banks around liability (liquidity) management was the takeover of Credit Suisse in March 2023 and the fallout from the complexities and concerns around risk for specific hybrid debt instruments.
As US regulators reassessed deposit insurance guarantees and banking capital requirements, the appetite for risk from traditional sources of funding, i.e. banks, has declined. Small and medium-sized US banks will face increasing competition and rising funding costs with year-over-year deposit and credit growth turning negative.4
In this new era of investing, amidst the rising cost of credit, there are exceptional opportunities for US non-bank financiers to fund the emerging gap in the provision of critical funding to high-quality, middle market borrowers.
The secular shift to global private credit shows no signs of slowing
Rising rates have bolstered relative returns for global private credit at the same time as stress in the US banking sector has increased demand for credit – a demand/supply imbalance means a range of deal metrics are now firmly in the lender’s favour.
Astute global private credit investors are positioning for an extended period of macro uncertainty and higher interest rates, curating capital preservation and long-term performance by prioritising high quality borrowers and cash flow.
For more information about our private credit solutions, please get in touch.
1 S&P LCD Quarterly Index. Non-bank includes institutional investors as well as non-bank finance companies.
2 MA Financial analysis, RBA D2 – Lending Aggregates (Dec 2022), S&P LCD Quarterly Index. Non-bank includes institutional investors as well as non-bank finance companies.
3 Morgan Stanley, Credit crunch in the US equity markets, 18 April 2023, www.morganstanley.com
4 The Economist, ‘Why America will soon see a wave of bank mergers’, 20 April 2023, www.economist.com; Morgan Stanley, ‘The warning signs investors should not ignore’, April 26, 2023, www.morganstanley.com
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