Private credit surges past $1.5 trillion globally, challenging traditional banks

One of the fastest growing asset classes is private credit, which has rapidly grown to more than $1.5 trillion globally.

Those Preqin numbers have had a huge boost in Australia, with increasingly risk-averse banks now being bypassed as traditional debt is replaced by private credit.

For investors, the rapid growth in private credit is certainly a great opportunity but given the commercial real estate loans and loans to heavily indebted individuals and companies have often been overlooked by bankers, there are obvious risks as well.

A recent report by Citi identified the rise of private credit as a big competitive threat to traditional banks and a chance for investors to earn higher rates.

Private credit outstripping traditional debt

With private credit easily outstripping the growth in traditional debt, the risk averse banks are creating a “structural change” in the market that could have far-reaching effects.

In Citi’s view, it is quickly leading to a situation in which fund managers and others will use private credit to provide loans at higher rates, particularly for commercial real estate and for already indebted companies that need extra capital.

Already Australia has seen superannuation funds and the country’s richest families are flocking into many private credit opportunities, looking for juicy returns that have risen alongside interest rates.

“The private credit sector has provided strong risk-adjusted returns in recent years. Higher for longer rates … provide for double-digit gross returns, which will likely continue to attract capital into the sector,” said Citi’s Brendan Sproules.

“We think this is a sector to watch for the banks, as a competitive threat in pockets of commercial lending.”

Lower regulation spurs activity

Citi estimated local private credit, or non-bank financing, had ballooned by about 45% since July 2019, even with warehouse financing excluded from the metric last year.

At the same time traditional bank credit had grown by some 25% over the last five years, reduced by the fact that the banks had to stick to higher capital requirements and reduced risk by staying away from smaller and riskier companies.

“Heightened regulatory oversight of particular exposures has seen banks overcompensate in tightening credit,” Mr Sproules said in a client note.

“It is unlikely we will see a reversion in the banks’ behaviour. As a result, it is likely private credit will continue to grow, particularly as higher base rates make gross [investor] returns more attractive.”

Part of that increasing demand for private credit has been driven by family office and high-net-worth investors.

There are now about 2000 family offices working in Australia, with many private credit opportunities being tailored to fit their needs.

Likewise, super funds with large amounts of capital to employ are able to negotiate favourable terms for pushing their investment capital into private credit.

Regulators warn they are monitoring the sector

There have been some warnings about the rapid expansion of private credit, with some of the newer players in the space not having weathered a major stress event like the GFC as yet.

Australia’s prudential watchdog, the Australian Prudential Regulation Authority, has warned the country’s major superannuation funds that their investments in private credit are “opaque”.

APRA has said it is stress testing the $3.9 trillion superannuation industry for “any potential contagion sources”.

APRA deputy chair, Margaret Cole, said that just because super fund exposure to the booming asset class was low in terms of overall portfolio allocation, it would still be closely scrutinised in stress testing to begin next year.

She said APRA expected that private credit investments by super funds would have a level of safety rather than being exposed to speculative, niche areas.

Ms Cole also warned that APRA continued to closely supervise unlisted asset valuations, to check that funds were not inflating these figures to offset falling commercial real estate prices.

The Australian Securities and Investments Commission has also stepped up its supervision of private equity and private credit funds, setting up a dedicated private markets unit.