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Private credit growth needs to be balanced with the sector’s capacity to manage problem loans when they arise

  • Private Credit has experienced sustained growth over the last 10 years and increasingly plays a significant part in global asset allocation as returns are perceived to be higher on a risk-adjusted basis.
  • Since 2010, the sector has sustained a 12.8% compound annual growth rate.
  • Whilst the attractive returns and secured nature of loans is buoying investors to support existing and new lenders the ability of different participants to deal with the recovery of loans is going to play out over the cycle.

At Merricks Capital we pride ourselves on the ability to deploy capital prudently but also recover it when there are problems.

This week, a smaller loan outside the Partners Fund for a medium apartment development in Kew is facing challenges. Various media outlets including, the Australian Financial Review have reported that the builder may be insolvent.

Our team along with Debuilt, our partly owned, real estate due diligence team have been working with the borrower to activate our pre-planned recovery program.  This should enable the builder to be replaced relatively quickly and the pre-purchased apartments delivered to buyers within a reasonable time frame.

At 65% loan to value and a building that is well advanced, there is significant protection for investors in these types of loans but only if the investment manager can do what it takes to deliver the building and a loan refinance.

As we examine different sectors within private debt our starting proposition is always “do we have the skill set in that sector to step in and take over the orderly exit of a loan in that industry if things go bad”.

At a time when there is excess liquidity in the world and private debt has an attractive return, we are trying to grow our lending book as fast as possible but only if our ability to manage both the financial and physical risk of the underlying collateral grows faster.

The investment opportunity to deploy private debt continues to grow from both a borrower and investor perspective. In the USA and Europe, the equilibrium of private debt provision is around 50-50 with the traditional banks. In Australia and New Zealand, non-banks still only account for a fraction of the real estate debt market still between 15-25% and 5-10%, respectively according to JLL. Our assessment of other debt sectors, such as agriculture, shows an even lower market share.

Merricks Capital diversified private credit strategies have delivered strong risk-adjusted returns with a five-year track record. With senior security over assets and minimalisation of operational risk, risk exposure is reduced relative to private equity.

According to Private Debt Investor, senior secured loans have outperformed other types of debt on a relative basis for over 30 years. In 2020, senior secured loans outperformed all other strategies by 1.7% or almost 33% on a relative basis.

As the appetite for private debt grows, investors continue to see the benefit of inclusion into their broad portfolio to diversify their exposure outside of equity markets. Low correlation with the broader market improves the volatility of the underlying portfolio significantly.

The evolution of the private debt market has allowed it to cater to a broader range of debt markets. Private debt funding of construction is a long-standing part of the industry; increasingly, however, private debt is creating platforms in a broader range of sectors in Australia. Merricks Capital is currently focused on Commercial Real Estate, Agriculture, Infrastructure, and corporate loans in related subsectors as the major strategies in the private debt space. These sectors continue to offer attractive returns and are matched by our expertise to manage the financial and physical risk associated with each loan.

 

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