The size of the Australian private credit market rose by 9 per cent in 2025 to $225 billion, driven by increased appetite for the asset class from family offices, high-net worth individuals, retail investors and superannuation funds, Szekely said. Increased demand too from commercial real estate borrowers and small to medium corporate borrowers also contributed to the growth of the market.

“Looking forward, sentiment towards private credit remains positive, with structural tailwinds continuing to support growth. However, increased allocation to the asset class is driving heightened competition, which has led to margin compression and more flexible terms for borrowers, which capped yields in 2025,” he said.

“Over the course of the past 12 to 18 months, we have seen a tightening of spreads by 50 to 75 basis points for the same credit quality, predominantly in larger syndicated transactions. Mid-market and lower midmarket deals have not experienced the same level of contraction,” he said.

Still higher interest rates for longer will support returns from private credit investments, with the asset class providing a reliable source of income, according to Szekely. The RBA in February raised official interest rates to 3.85% per cent from 3.60 per cent.

“Interest rates are likely to remain elevated for the remainder of 2026 given sticky inflation. With inflation remaining above the RBA’s 2 to 3 per cent target, coupled with a still tight Australian labour market, we could further see another potential interest rate rises from the RBA to bring inflation back below 3 per cent,” he said.

“This positions the Australian private credit market well to offer attractive returns versus overseas markets such as the US, where the US Federal Reserve cut interest rates in 2025 by 75 basis points and further cuts are possible in 2026,” he said.

“This highlights an important point; while rising interest rates and persistent inflation can negatively impact equity markets and erode the return on fixed-rate bonds, private credit investments typically benefit from rate rises as they feature floating-rate structures, with total returns rising on increases in the RBA cash rate.

“This floating-rate profile provides natural inflation protection, allowing investors to maintain benefit from higher yields as rates adjust upward in response to inflationary pressures,” he said.

According to Szekely, demand for private credit is expected to remain strong this year, most notably from Australia’s $4.3 trillion superannuation funds.

“Superannuation continues to attract capital due to the strong labour market, and leading funds achieved double digit growth in assets under management in financial year 2025. The percentage of total investments allocated to private credit has grown to 1.1 per cent in the 2024-25 financial year from 0.8 per cent in 2021-22  If this trend continues, an additional $5.5 billion could be allocated to private credit in financial year 2026, taking the total private credit allocation by superannuation funds to around $35.5 billion from $30.0 billion over that period.”

Importantly for the sector, there is an expectation that the increased regulatory focus could continue into 2026, according to Szekely.

“Poor private credit practices are one of ASIC’s stated enforcement priorities this year. Increased regulatory oversight is a positive step toward safeguarding investor confidence as the industry continues to mature and attract capital from new channels, including retail investors,” he said.

“In 2025, ASIC commissioned and released a report which identified material concerns around opaque fees and remuneration structures, weak valuation processes, concentrated allocation to real estate development, inconsistent reporting and related party transactions.

“We consider our processes and procedures to be in line with best practice as outlined by ASIC and have an independent top-tier Australian law firm to complete a review of policies, procedures and governance practices as we seek to continually uplift our standards,” he said.

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Peter Szekely

The increased regulatory oversight by the Australian Securities and Investments Commission (ASIC) should not scare investors away from private credit but give them more confidence in the product – it remains an attractive asset class with valuable diversification benefits, says Tanarra Credit Partners managing partner, Peter Szekely.

He says there is good opportunity for investors in the middle market segment of private credit from a risk return perspective.

“Private credit continues to be an attractive option for investors, particularly given the volatility we have been seeing in equity markets of late. It provides an excellent hedge against portfolio risk when building a diversified portfolio.”

Mr Szekely says ASIC’s scrutiny of the market is a positive step that will bring greater confidence to an asset class that is growing rapidly.

“ASIC has been focused on a few key areas of concern in the local private credit market, including what sectors funds are invested in, how managers value portfolios, the potential conflicts that exist, and the importance of transparent reporting for investors.”

He says there are four factors that investors should consider when assessing whether to invest in a private credit fund.

“Investors should be aware of the sector and its prospects. Whether it be residential property, corporate debt, technology, healthcare or some other sector – it is important to ensure that your private credit exposure is well diversified.

“Valuations are key. There is a wide array of evergreen and open-ended funds that investors can allocate their private credit exposure to, and valuation methods vary. It is important to understand, and be comfortable with, the valuation method your chosen manager uses to confirm you receive a fair value upon investment or redemption,” says Mr Szekely.

Indeed, valuations have been of particular interest to ASIC during its investigation, and there is a large discrepancy in how managers value their funds, and whether or not they employ an independent valuer, according to Mr Szekely.

“For example, if everything is going fine in a portfolio, a fund manager can value the loan at par. But if there’s underperformance in the portfolio, there is an increased likelihood that the investment won’t return the principal or interest accrued in the future.

“In this case, we would expect a fund manager to change the valuation to account for the potential future default risk. However, in practice fund managers often leave valuations at par, which is not best practice.

“This means investors may be paying an elevated price for a new investment.

“ASIC’s aim is to ensure the disclosure is transparent and the valuation is clear for investors.

“This means funds should use two independent external agencies – one to sign off on all valuations, and another to sign off on the annual audit.

“Unfortunately, not all fund managers adopt this best practice approach, and they use the same deal team when investing and valuing.

“What is needed is independent valuations to ensure investors are treated fairly and are buying and selling at an appropriate price,” says Mr Szekely.

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Peter Szekely

As valuations continue to reach record highs, investors should be cautious of concentrating too much of their portfolio in listed equities, according to Tanarra Credit Partners (TCP) managing partner, Peter Szekely.

He says investors should consider corporate private credit which offers structural features that help insulate portfolios from market volatility.

“With equity valuations stretched, corporate private credit offers a compelling alternative investment opportunity. It provides investors with active management and an underwriting discipline supported by structural protections and rigorous selection standards, unlike passive exposure to index-heavy equities.”

He says listed equity P/E ratios remain at all-time highs, prompting concerns about whether these valuations are sustainable.

“As of September 2025, the S&P 500 was trading at a trailing price-to-earnings ratio of 27.29, well above its rolling five-year average of 22.17 and its twenty-year average of 16.13. The MSCI World was trading at a P/E ratio of 23.94, also above its five-year average of 20.41.”

Mr. Szekely also points to the equity market domination in the US by the 10 largest stocks by market capitalisation, which account for approximately 40 per cent of the S&P 500.

“This is the highest concentration level in the past thirty years. These ten include the big techs, or hyperscalers, Microsoft, Apple, Amazon and Alphabet.”

And although not completely dominated by tech, he says the Australian equity market is displaying similar trends with its trailing price-to-earnings ratio also well above historical averages in September at 20.87. In addition, the ASX/S&P 200 surpassed 9000 for the first time last quarter.

“This rally has not been driven by earnings growth, with the median ASX 200 consensus earnings-per-share steadily declining and FY25 consensus earnings growth forecast standing at -1.7 per cent. Instead, growth in the market appears to be driven by a mix of optimism around further interest rate cuts increasing the attractiveness of equities, and international investors looking to decrease their US market exposure.

“Investors that put all their eggs in the equity basket expose themselves to a variety of risks, the most obvious of which is volatility. They are also vulnerable to limited return upside if they buy equities at stretched valuations and correlation risk. Even if stocks are diversified across sectors and industries, all equities can exhibit high levels of correlation during an economic downturn.

“In contrast, mid-market corporate private credit loans have characteristics that can insulate a portfolio from the risk of stretched public equities. For a start, value is derived from credit fundamentals, not market sentiment,” says Mr. Szekely.

He says many mid-market corporate private credit loans are underwritten based on the financial performance (specifically, cashflow) and credit worthiness (for example, leverage and interest coverage) of a company. While future growth is considered, private credit valuation and returns centre around business fundamentals rather than volatile factors such as public trading multiples.

“Most loans also include at least one financial covenant, such as a leverage ratio, which provides an early warning sign of underperformance. This provides investors with the ability to work with management and restructure the loan if required. Listed equities provide no similar remedy for investors to preserve value.

“Loans that are senior secured over the cashflow and assets of the company, and supported by a more than 50 per cent equity first-loss position, also offer an extra layer of protection.

“In these scenarios, recovery value on invested capital is primarily tied to the cashflows and assets of the company and overall enterprise value. With an equity first-loss position, a borrower’s enterprise value would need to decline by over 50 per cent before the investor’s debt is at risk of impairment, providing significant downside protection.

“In the case of the TCP Private Debt Income Fund we take a disciplined approach to capital preservation by taking a senior secured position in loans, having a significant equity first-loss position (50 per cent plus), and maintaining financial covenants that provide important downside protection to investors,” he says.

The fund invests in a diversified loan book with a focus on mid-market Australian and New Zealand corporates in defensive sectors with strong tailwinds, such as childcare, IT and financial services and has no exposure to real estate.

“Regardless of how they invest, the combination of diversification benefits, and attractive risk adjusted returns, makes corporate private credit a compelling option for investors seeking stable cash yields in an uncertain economic environment, marked by heightened volatility and stretched valuations,” says Mr Szekely.

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Peter Szekely

The Australian private credit market is poised to reach new heights in 2025, with strong business lending growth supporting the market’s growth and attractive returns for investors, with the Reserve Bank of Australia (RBA) likely to cut interest rates one more time in 2025 after Tuesday’s action, according to Peter Szekely managing partner of Tanarra Credit Partners.

Private credit has grown rapidly in popularity among investors, offering yields higher than those on Australian investment grade corporate bonds, as measured by the S&P Australia Investment Grade Corporate Bond Index, which returned just 6.3 per cent over the year to 7 February 2025.

Private credit consists of privately originated, largely comprised of higher yielding, loans across a range of risk/return profiles. These loans are not traded on the public markets, unlike corporate bonds, which are actively traded.

“Private credit offers investors an attractive opportunity in 2025. Investors currently benefit from regular income and yields of around 10 per cent a year-with strong investor protections and low volatility in an uncertain economic and political environment with less volatility than shares or corporate bonds,” Mr Szekely said.

“The market continues to pay close attention to US President Trump’s policies on trade, immigration and taxes with greater economic uncertainty reflected in increases in US Treasury yields despite last year’s interest rate cuts.

“At the same time, equity and residential property valuations appear stretched and at risk from continued, higher interest rates, both in the US and Australia. This risk could push investors into private credit, which offers lower volatility compared to stocks and higher yields than residential property. In this environment, private credit can make an important addition to investors’ portfolios.”

The Australian private credit market is predicted to see continued deal activity in 2025, building on the momentum from late 2024, offering additional investment opportunities, according to Mr Szekely.

“Interest rates too could remain elevated. The consensus is the RBA will cut rates twice in 2025. With above-target inflation resulting from higher energy and food prices, coupled with a tight labour market, the RBA will likely remain cautious about cutting rates too deep,” he said.

“This positions the Australian private credit market to offer attractive returns versus overseas markets such as the US, where the US Federal Reserve has already cut rates by 100 basis points, with an additional 50 basis points priced in for 2025,” he said.

“With Australian inflation remaining above the RBA’s targeted 2 per cent to 3 per cent band, the RBA is unlikely to drop rates as far or as fast as other central banks. In the US, there is also a risk of inflation accelerating given tariffs and tax cuts. A trade war, in particular, would be inflationary,” he said.

“As tight bank lending conditions endured through 2024, borrowers continued to appreciate the speed and adaptability of private credit solutions and so we expect the local market to exhibit robust growth this year,” he said.

“Australian investors value the role private credit can play to diversify portfolios, as well as the high cash income and low volatility of a senior secured credit product. Consequently, the private credit sector finished 2024 with strong performance. Strong business lending will also support the local market,” he said.

He said credit growth gradually accelerated through 2024 despite many economists’ prediction of a slowdown.

“RBA data shows both home and business lending are gaining strength, showing growth in business credit of 8.9 per cent over the year to December 31, 2024, the highest since May 2023, and up from 8.6 per cent in November.

“While the Australian private credit market is not entirely immune to global economic forces, it exhibits a degree of insulation from the volatility experienced in larger markets such as the US.

“This stability, coupled with the attractive yields offered by private credit, makes it an attractive investment proposition irrespective of the prevailing economic conditions in 2025,” Mr Szekely said.

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Peter Szekely

The Australian private credit market is poised to reach new heights in 2025, offering investors attractive yields and resilience amidst a backdrop of global economic uncertainty and more volatile share markets, according to Peter Szekely, managing director of Tanarra Credit Partners.

“As interest rates have risen in recent years, so too have the yields on floating-rate loans, which has made private credit an attractive investment proposition compared to other asset classes,” said Mr Szekely.

“While the Australian private credit market is not entirely immune to global economic forces, it exhibits a degree of insulation from the volatility experienced in larger markets like the US. This stability, coupled with the attractive yields offered by private credit, makes it a compelling investment proposition in the current environment,” he said.

This positive outlook is reinforced by recent reports from the International Monetary Fund (IMF) and the US Federal Reserve, both of which have highlighted the strong historical returns and low volatility of private credit. “Indeed, the IMF has reported^[1] that private credit funds have delivered comparatively higher gross returns than other asset classes historically have delivered,” Mr Szekely said.

Private credit offers a compelling alternative to traditional investments, particularly in times of economic uncertainty. Private credit investments typically involve loans secured by tangible assets, offering a degree of downside protection compared to more volatile equity investments.

Furthermore, private credit can enhance portfolio diversification by providing exposure to a different risk and return profile than traditional asset classes. Direct lending, a key segment within private credit, allows investors to participate in financing businesses directly, often with greater protections and transparency.

While the outlook for private credit is positive, Mr Szekely acknowledged potential challenges. The recent US presidential election outcome and the anticipated policies of the incoming Trump administration could create global economic volatility and encourage some investors to move into private credit to avoid volatility in share markets.

“In this environment, it will be important for investors to focus on industries with inherent resilience and domestic support within the private credit market.”

Mr Szekely identified several sectors within the Australian economy that are likely to remain resilient despite potential economic headwinds.

“Despite potential headwinds from rising interest rates, the financial services sector remains a cornerstone of the Australian economy, offering opportunities for private credit investments in areas like non-bank lending and specialised financial services,” said Mr Szekely.

“Education and childcare also enjoy significant government support, providing a stable demand base. Healthcare, as Australia’s largest and continually growing industry, offers long-term growth potential and relatively stable cash flows. Infrastructure benefits from government investment and long-term contracts, providing stability and reducing exposure to economic fluctuations,” he said.

The Australian private credit market is predicted to see continued deal activity in 2025, building on the momentum from late 2024.

“I expect this momentum to continue into 2025, with a robust pipeline of deals in the sponsor-backed market, where Tanarra Credit Partners primarily focuses,” he said.

According to the Reserve Bank of Australia, the size of the local private credit market is around $40 billion, or about 2.5% of all business lending, based on data collected by the APRA and London Stock Exchange Group. He also noted that work by the regulator ASIC to improve transparency will assist in monitoring growth in private credit.

While acknowledging the small size of the Australian private credit market relative to global markets, Mr Szekely said its stability and insulation from international volatility. He sees particular opportunities in the middle market, where Tanarra Credit Partners operates, due to its reliance on domestic capital and potential for attractive yields.

——–

Notes:
[1] https://www.elibrary.imf.org/display/book/9798400257704/CH002.xml

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Peter Szekely

The Australian private credit market is positioned for continued growth in 2025, driven by robust demand and the attractive yields it is offering investors. Rising volatility stemming from the US election of Donald Trump combined with global economic uncertainty could encourage investors to allocate to the stable credit sector away from equities in 2025.

The Reserve Bank of Australia’s (RBA) commitment to curbing inflation has resulted in a series of interest rate hikes beginning in 2022, pushing the cash rate to 4.35%. The RBA’s hawkish stance, coupled with persistent inflationary pressures, suggests that interest rates could remain elevated for some time, with market expectations pointing towards cuts no earlier than February 2025, and potentially later in the year.

This sustained higher interest rate environment bodes well for private credit, particularly given the debt is floating-rate, or linked to market interest rates. As interest rates have risen in recent years, so too have the yields on floating-rate loans, which has made private credit an attractive investment proposition compared to other asset classes.

Indeed, the International Monetary Fund (IMF) recently reported that private credit funds have delivered comparatively higher gross returns than other asset classes historically have delivered. Specifically, the IMF pointed out in its report, The Rise and Risks of Private Credit, that private credit funds’ returns were some of the highest across debt markets and seem to have relatively low volatility.

In addition, according to the US Federal Reserve^[1]: “Over the past decade, the asset class, particularly direct lending, has generated higher returns than most other comparable asset classes.”

That is why Australian superannuation funds are increasing their allocations to private credit assets significantly, led by AustralianSuper, Australian Retirement Trust and Hostplus. They are being drawn by the lure and relative stability of higher returns from private credit and the fact that it is less risky than equity investments.

However, the IMF also cautions that the rapid growth of private credit, coupled with competition from banks, may lead to a deterioration in pricing and non-pricing terms. This deterioration could involve lower underwriting standards and weakened covenants, potentially resulting in higher credit losses in the future and impacting returns.

The IMF recommended earlier this year that regulators closely watch the sector so private credit funds more comprehensively assess risks, including leverage, and enhance reporting requirements for private credit funds and their investors. We have already seen ASIC act on this and the regulator may introduce greater regulation of private credit funds in coming times, possibly as soon as next year. This could help to boost the transparency of the sector and draw investors.

The Shadow of the incoming Trump government

While the RBA’s monetary policy plays a pivotal role in setting local interest rates and the Australian economic landscape, the recent outcome of the US presidential election also has significant implications for global growth and, consequently, the Australian economy.

The incoming Trump administration is expected to be more protectionist, introducing new tariffs with a heightened focus on domestic economic interests. The US president elect wants to impose universal tariffs (ranging from 10% to 20%) on all imports, and a much higher tariff – 60% – on all Chinese imports and has threatened to revoke China’s ‘Most Favoured Nation’ status. This could lead to robust growth within the US but create headwinds for the global economy, particularly for China, a key trading partner for Australia. As a result, Australia could experience a slowdown in export growth and heightened economic volatility.

At the same time, a more inflationary outlook for the US will exert upward pressure on interest rates globally, leading to increased volatility in Australian markets. In this environment, it will be important for investors to focus on industries with inherent resilience and domestic support within the private credit market. For example, financial services is likely to remain resilient. Despite potential headwinds from rising interest rates, the financial services sector remains a cornerstone of the Australian economy, offering opportunities for private credit investments in areas like non-bank lending and specialised financial services.

Education is also a defensive sector. These sectors enjoy significant government support through funding and subsidies, providing a stable demand base and mitigating the impact of economic downturns. Likewise, the healthcare sector is Australia’s biggest industry and is likely to keep on growing with an ageing population and increasing healthcare needs. This sector presents a compelling investment opportunity, offering long-term growth potential and relatively stable cash flows given government backing. The infrastructure sector also benefits from government investment and long-term contracts, offering stable cash flows and reduced exposure to economic fluctuations.

In the technology sector, businesses within this space, particularly those with strong contractual revenue streams from service contracts and proven profitability offer attractive risk-adjusted returns. However, caution is warranted when considering investments in more cyclical sectors, such as hospitality which is exposed to discretionary spending. Construction too has been hit by inflation and higher interest rates and mining services is susceptible to global commodity price fluctuations and economic downturns, so makes private credit there potentially riskier.

A resurgence in deal-making activity

The Australian private credit market witnessed a surge in deal activity in the latter part of 2024, driven by several factors, including greater certainty around interest rates, reduced inflation, particularly in the US, and a more realistic approach to valuations by both buyers and sellers.

I expect this momentum to continue into 2025, with a robust pipeline of deals in the sponsor-backed market, where Tanarra Credit Partners primarily focuses. While the Australian private credit market is not entirely immune to global economic forces, it exhibits a degree of insulation from the volatility experienced in larger markets like the US. The smaller size and lower liquidity of the Australian market has resulted in less pronounced swings in spreads compared to the US, creating a more stable investment environment.

Furthermore, the abundance of domestic capital available for private credit transactions has reduced the reliance on offshore funding, further enhancing the local private credit market’s growth. This dynamic will allow Australian private credit investors to capitalise on attractive yields without being overly exposed to the vagaries of international markets. According to the Reserve Bank of Australia, the size of the local market is around $40 billion, based on data collected by the APRA and London Stock Exchange Group, as the chart below shows.

While the local private credit market is small relative to other business lending, it is growing rapidly. The RBA is closely monitoring its growth and potential risks, which is welcome news for the market.

“Due to its small size, direct risks to financial stability from the private credit market in Australia appear low. Risks stemming from overseas private credit markets also appear contained .. Liquidity risks are low, and so far in the most recent tightening phase, default rates have been lower than leveraged loan or high-yield bond markets. However, private credit markets remain opaque and are expected to continue to grow rapidly. Work by regulators to improve transparency will assist in monitoring growth in private credit and the potential risks to financial stability,” the RBA recently said^[2].

For investors, by focusing on domestically resilient sectors with strong government support and leveraging the relative stability of the Australian middle market, they can position themselves to capitalise on the opportunities presented by private credit. The large-scale deal segment, which often attracts international investors and is more closely aligned with global market trends, is expected to experience downward pressure on spreads. In contrast, the middle market, where Tanarra Credit Partners operates, is characterised by greater stability due to its reliance on domestic capital and it will represent some good opportunities for investors in 2025 to yield relatively high income.

By Peter Szekely, Managing director

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Notes:
[1] https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html
[2] https://www.rba.gov.au/publications/bulletin/2024/oct/growth-in-global-private-credit.html

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Peter Szekely

Private credit investment is gaining in popularity in Australia with returns sitting above 10 per cent for senior secured debt. Tanarra Credit Partners expects robust growth in this asset class over the remainder of 2024 with potentially greater merger and acquisitions activity (M&A) pushing businesses to seek private credit funding while investors seek lower volatility.

Assets under management for the global private debt market sit at almost $2 trillion and this number is set to grow as banks continue to pull back from financing. Investors too are realising the benefits of this fixed-income asset class given less volatility compared to publicly traded corporate bonds, according to Tanarra managing partner, Peter Szekely.

“Private credit such as senior secured debt offers investors gross yields above 10 per cent and this represents an attractive opportunity for investors to benefit from regular income, irrespective of the prevailing economic conditions.

“Compared to share markets, which are fully valued and at risk of falling, private credit provides investors with attractive all-cash returns and low volatility, in a more senior part of the capital structure, so they are arguably an important addition for investors’ portfolios,” Mr Szekely said.

“The additional appeal to investors is that direct lending to companies potentially provides investors with higher returns and greater influence over loan structure, terms and conditions compared to lending into large syndicated deals or publicly traded bonds,” he said.

The private credit sector has been on a strong growth trajectory worldwide, as traditional lenders tighten lending to companies. Globally, total assets in private credit have nearly doubled since 2020 to US$1.6 trillion in 2023 and the asset class is projected to increase to US$2.3 trillion by 2027.^[1]

“In Australia, private credit has gained popularity among institutional investors. Superannuation giant AustralianSuper, for example, has invested more than $4.5 billion in private credit globally and it expects to triple the exposure to private credit in the coming years.^[2]

“In addition, we expect greater M&A activity this year, which could add to demand for private credit. Generally, private credit follows M&A activity, as buyers such as private equity groups often use private credit to finance deals. M&A activity fell in 2023 with higher inflation and rates, but corporate M&A activity has picked up in the last six months. The private equity community is looking at a lot more transactions and we expect that dry powder to create greater demand for private credit,” Mr Szekely said.

“Lower volatility will be increasingly sought by investors given rising geopolitical uncertainties in the Middle East and what is a huge election year for many economies, including the US. We are still seeing inflationary pressure and historically high asset valuations when compared to more traditional investment products, so private credit offers investors the potential for downside protection, as well as attractive returns in this higher inflation environment.”

Tanarra Credit Partners formed a partnership late last year with GSFM to provide retail investors in Australia with access to Australian private debt assets. These assets typically offer investors a complementary exposure alongside traditional fixed income products, with a higher yielding, floating rate cash return profile.

“With so much uncertainty, it remains a challenging environment for investor allocations. While cash rates at around 4 per cent arguably offer a reasonable return, it is less attractive in real terms considering inflation in many nations is around that level. In this environment, private credit offers investors diversification into an attractive, defensive asset class with features and characteristics that mitigate several investor concerns.

“However, it is important to invest with an experienced fund manager to maximise the benefits offered by the asset class. A manager with a strong focus on deal selection will be key to success in 2024 and beyond as higher interest rates challenge some sectors of the economy,” Mr Szekely said.

———-

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Graham Lees

Private credit funds will offer investors an attractive opportunity to benefit from regular cash income and low volatility regardless of which economic conditions prevail during 2024, a year which brings much uncertainty, according to the managing director of Tanarra Credit Partners (TCP), Graham Lees.

According to a new Insights paper from Tanarra Credit Partners (TCP), “TCP Outlook for 2024: Risk of Inflation Lingers”, the private credit asset class finished 2023 with a strong performance. The JPM Credit Research: Leveraged Loan index gained 13.2 per cent in 2023, with BB loans returning 10.2 per cent and B loans gaining 14.6 per cent.

“These were the second strongest returns for loans on record. We expect another strong year in 2024 despite a possible increase in financial market volatility, given the rise in official interest rates, which has raised the cost of credit generally. This flowed through to returns with the JPM Leveraged Loan index above 8 per cent in January,” said Mr Lees.

“Private credit as an asset class is likely to benefit from higher floating interest rates on corporate loans, and it is a low volatility option for investors against a backdrop of a very uncertain economic outlook,” Mr Lees said.

Geopolitics risks are high with ongoing conflicts in Ukraine and the Middle East. In addition, with elections in 60 countries in 2024 including in major markets such as India and the US, and a possible Donald Trump victory, 2024 is likely to be a volatile year for financial markets.

“With so much uncertainty, it remains a challenging environment for investors. While cash rates at around 4 per cent offer investors a reasonable return in nominal terms, the return is much less attractive in real terms, or after inflation which in most developed nations sits at more than 4 per cent.

“We believe private credit offers investors a more attractive opportunity to benefit from higher interest rates and regular income, as well as strong investor protections which are built into corporate loans,” Mr Lees said.

Unlike bonds, private credit is not issued or traded in public markets. Loans are organised by the lending partner according to the individual borrower’s needs. Corporate loans deliver a regular income stream for lenders, and the floating rate structure helps hedge against inflation. Corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and are reset regularly by the lender.

“Importantly, private credit offers investors attractive risk-adjusted when compared to equities, and returns in-line with the long-run returns on shares.”

“Furthermore, we anticipate higher refinancing demand during 2024 from private equity sponsors facing challenges in exiting portfolio companies due to the low level of IPO activity.”
Private credit as an asset class has enjoyed strong growth in recent years with total global assets under management (AUM) rising over US$1.4 trillion in 2022. Within Australia, there is growing demand for private credit from Australian borrowers as it offers greater flexibility and access to credit compared to bank loans.

Borrowers frequently benefit from the greater speed of execution compared to traditional bank loans. In addition, there are several downside protections available for private credit investors.

“For instance, for those that largely invest in senior secured loans, the investment equity capital sits underneath the debt financing in the capital structure. This means significant value would need to be eroded before investors’ capital is at risk,” Mr Lees said.

“While borrowers typically do pay a higher interest rate for private credit financings versus regular bank loans, many borrowers are prepared to pay the higher cost in return for the benefits offered by private credit.”

According to Mr Lees, private credit has strong downside protection features that help fund managers mitigate the risks of underperforming borrowers during economic downturns. TCP investments typically feature the following protections. Senior ranking security provides first right to cashflows and assets of borrowers hence providing a buffer against any deterioration in corporate earnings.

“In addition, maintenance financial covenants are tested quarterly, which provides an early warning signal against any deterioration in the credit quality of a borrower, enabling us to take action if required to protect our investment,” he said.

“While private credit is clearly under the spotlight for investors as an asset class well-suited to navigate the complex economic environment ahead in 2024, we believe it is important to partner with an experienced fund manager to maximise the benefits offered by the asset class.”

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Graham Lees

It is a myth that only uncreditworthy borrowers who cannot access bank loans will seek private credit financing, and the asset class also attracts quality corporate businesses, says managing director of Tanarra Credit Partners (TCP), Graham Lees.

According to a recent whitepaper from Tanarra Credit Partners (TCP), Private Credit – higher returns vs. bank lending does not always equate to outsized risk., there are several tools that lenders can use to mitigate the risks of private credit financing. When combined with the returns available, this creates an appealing risk-return proposition for investors.

Private credit as an asset class has enjoyed strong growth in recent years with total global assets under management (AUM) rising to over US$1.4 trillion in 2022. Within Australia, there is growing demand for private credit from Australian corporate borrowers as it offers greater flexibility and access to credit.

Mr Lees says borrowers frequently benefit from greater speed of execution compared to traditional bank loans and more importantly the risks of investing in the asset class can be reduced through diligent lending practices.

“When it comes to private credit, investors should seek out those providers experienced in structuring deals that have experience investing through cycles, and that conduct detailed due diligence on prospective borrowers including review of third party financial, legal and commercial due diligence reports, and detailed financial modelling to assess a range of downside scenarios.

“These checks enable lenders to better understand the credit profile of the businesses they may finance, and it gives a high degree of comfort around the ability of the cashflows of the business to service their debt.”

He says there are several downside protections available for private credit investors, and that not all private credit funds are the same.

“For instance, for those that largely invest into senior secured loans as we do, there is meaningful equity capital sitting underneath the debt financing in the capital structure. This means significant value would need to be eroded before the senior debt is at risk,” he says.

“Our loan investments also typically have maintenance financial covenants that are tested quarterly and provide early warning signs if there is any deterioration in the credit quality of borrowers. This means the lender can take quick action to protect investor capital and increase pricing, if warranted.”

Mr Lees says it is important that loan documentation is structured to impose restrictions on the borrower that protect the lender’s position. “This includes provision for cashflow sweeps to repay debt should the business underperform, restrictions on the borrower’s ability to make acquisitions and sell assets without debt repayments, and not allowing distributions to be made to shareholders until debt has reduced.”

“While borrowers typically do pay a higher interest rate for private credit financings versus regular bank loans, the higher cost is compensation for the benefits offered by private credit.

“Bank loans typically require more restrictive terms and conditions, and borrowers may prefer to pay a higher interest rate in return for greater flexibility offered by private credit finance,” he says.

“Private credit financiers also typically offer faster and more transparent decision-making compared to a bank’s credit process.

“Borrowers are often prepared to pay more in return for the greater certainty and speed of execution. This is particularly important for borrowers who are under a strict deadline to conclude a corporate activity such as a borrower seeking financing to complete an acquisition.

“We believe that private credit as an asset class will continue to benefit in a world of high benchmark interest rates with its floating-rate yield profile, and is a low volatility option against a backdrop of an uncertain economic outlook,” Mr Lees said.

Unlike bonds, private credit is not issued or traded in public markets. Loans are negotiated and structured according to the individual borrower’s needs. These private corporate loans typically have floating rate coupons, which are linked to the bank bill swap rate and are reset regularly.  This helps provide investors with a hedge against inflation, and means that the capital value of the investment is not at risk from movements in interest rates, unlike traditional fixed rated corporate bonds which are exposed to that duration risk.

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The Asian private credit market remains a small segment comprising of only 7 per cent of the total global private credit market. However, it is rapidly growing, with private credit assets under management (AUM) in Asia doubling to US$95 billion since 2018.

“Fundraising in Asia has increased significantly, and several global private credit managers have announced plans to expand in Asia in recent months.”

Mr Szekely says this increasing focus on Asia is a result of the strong economic growth and favourable demographics that are driving demand for capital in the region.

“Today, Asia is the fastest growing economic region in the world contributing to over two-thirds of total global growth.

“This strong growth outlook is also supported by favourable demographics, as there are large, young growing populations who are increasingly skilled.

“There is a corresponding need for significant capital in order to continue to finance the businesses that are driving this growth.”

Another factor driving this growth is the regulatory changes, increasing the burden on Asian banks, and driving the search for alternative financing sources,” Mr Szekely says.

“Banks in Asia are facing higher compliance requirements and increased funding costs in order to adhere to Basel III/IV requirements, making it difficult for many businesses to access bank loans.

“Private credit lenders are stepping in to fill this gap, providing capital to businesses that are struggling to access traditional sources of financing, including small and mid-sized companies.”

Mr Szekely says that the lending space for small and mid-sized companies has been particularly hard hit by its over-reliance on the bank market. While this segment comprises of more than 96 per cent of all Asian businesses, banks have generally turned their focus away from them, providing yet another opportunity for private credit lenders.

“Banks in Asia are looking to take advantage of the use of scarce regulatory capital and extract efficiencies and we are seeing more banks pivot towards larger relationships.

“For private credit lenders this creates opportunities. They are able to provide the much-needed capital for Asian small and mid-sized companies to continue their strategic objectives and growth.”

Mr Szekely says that an allocation to Asian private credit in an investment portfolio offers several benefits.

“The Asian private credit market is under-penetrated making it an attractive investment. It also offers investors a stable regular cash income with lower volatility compared with traditional fixed income products. In addition, the floating rate structure provides a hedge against inflation and high interest rates.

“Asian private credit markets have attractive risk-adjusted returns with strong downside protection features including senior debt ranking, security and covenants.

“The geographic diversification and exposure to dynamic growth and demographic tailwinds in Asia is another factor making Asian attractive to investors.

“For Tanarra Credit Partners the Asian market stands out as a key focus region as private credit’s centre of gravity shifts to this area,” says Mr Szekely.

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