Australian Private Credit: Opportunities and Risks in a Growing Market

The Reserve Bank of Australia (RBA) recently assessed the Australian private credit market, noting promising growth indicators. Currently, private credit in Australia stands at about $40 billion—small relative to other lending sectors, comprising only 2.5% of total business debt. This growth is fuelled by domestic private credit funds, which now represent around 70% of private credit outstanding.

The rapid expansion of private credit compared to traditional business debt has drawn interest from investors and regulators. While the report identifies certain risks, it concludes that the sector remains too small to pose a systemic threat. As the market matures, Australian regulators may look to the U.S. and EU for strategies to protect investors.

Risks and Mitigants

The report outlines four key risks as private credit continues to grow. Firstly, leverage could increase as investors and borrowers pursue higher returns. However, even in North America where private credit is more mature, private credit funds’ debt-to-assets ratios are approximately 35% compared to issuers of leveraged loans and high yield corporate bonds at 50%.

Secondly, liquidity risks may arise during economic downturns if investors are required to redeem their investments.

The final two risks relate to transparency in private markets. The degree of interconnectedness between banks and private credit providers can be difficult to assess as banks are some of the leading providers of leverage to private credit funds. Though the RBA maintains that bank lending to private credit funds in Australia is well collateralised and at moderate levels. The final risk is transparency of asset quality, where we have more recently seen a regulatory push from APRA to strengthen valuation practices in relation to unlisted assets.

Regulatory Responses

The current structure of the Australian private credit market has minimised risks to the financial system. The RBA has determined there is a low probability that these risks will cause financial instability due to the small size of the sector. Performance of private credit in the recent tightening phase has been relatively strong compared to the leveraged loan or high-yield markets and liquidity risks have also been low. The Australian Securities and Investments Commission (ASIC) has increased oversight, especially regarding superannuation funds’ exposure to unlisted assets. Additionally, the Australian Treasury is revisiting the regulatory framework for managed investment schemes to better protect investors.

Aura Private Credit’s Approach

In response to sector growth and the RBA’s findings, the Aura Private Credit Team is enhancing its portfolio management and investor reporting. While new entrants are drawn to this growth, Aura’s team leverages a seven-year track record and specialised credit expertise. We prioritise transparency, investor protection, and monthly liquidity.

Enhancing Asset Transparency

Recognising the potential for limited reporting on asset quality, Aura has partnered with a third-party firm known for developing APRA-approved expected credit loss (ECL) models. Through this collaboration, investors can access monthly ECL and credit ratings, improving both risk management and due diligence. Not only has this project enhanced our risk management in monitoring the asset performance of our current non-bank lenders but has also bolstered our due diligence process when screening potential new lenders.

Mitigating Liquidity Risk

Aura’s Private Credit strategies have a high concentration of short duration loans, with 76% of loans maturing within 3 months. This approach enhances liquidity and adaptability to market conditions, allowing Aura to offer monthly liquidity without lock-up periods for greater investor control.

The RBA’s report has helped ease public concerns over private credit. Whilst there are risks in the sector, the Aura Private Credit Team see a great opportunity to offer investors increased oversight of the level of risk in their portfolio. The team is continually working to maintain a portfolio of high-quality assets giving consideration to portfolio stability in light of potential shocks to the wider economy.

Learn more about Aura Private Credit and request for the report below for a more in-depth insight into the industry.