From Nascent to Necessary: Reflections on Seven Years in Private Credit

Seven years ago, the Aura’s Private Credit Income Strategy was born out of a vision that had been brewing in my mind for years. I had observed two significant trends that I believed could be addressed through a new financial product. The first was the chronic under allocation to fixed income assets in Australian investment portfolios—a problem that was only going to worsen as the population aged and the number of self-funded retirees increased. The second was the retreat of major banks from business lending, driven by the Basel III regulatory capital changes. These trends laid the foundation for the Aura Private Credit business case, aiming to provide stable income returns for investors while offering debt capital to strong Australian businesses.

Major Banks Retreat

The implementation of Basel III, a global regulatory framework introduced after the 2008 financial crisis, required banks to hold more capital against their loans. This made Australian banks more risk-averse, particularly in business lending. As a result, many businesses found themselves unable to secure the debt capital necessary for growth. This gap in the market presented an opportunity for private credit to step in as a viable alternative.

Chronic Under Allocation to Fixed Income

In my previous role at Macquarie Bank's Fixed Income team, I noticed a chronic under allocation to fixed income assets in Australian investment portfolios. This issue was exacerbated by the aging population and the rise of self-funded retirees . Traditional fixed income assets had become less attractive in the low-interest-rate environment, making private credit, with its potential for higher yields, an increasingly appealing option.

A Fund is Born

These two trends were the key to the Aura Private Credit business case. We aimed to provide income returns for investors who were under allocated to fixed income assets, while offering debt capital to strong Australian businesses. At the time, the private credit market in Australia was relatively nascent compared to Europe and the US. However, since we established our first fund in 2017 (known then as the Aura High Yield SME Fund), the market has undergone significant transformations.

The Shift Towards Non-Bank Financing

One of the most notable developments in the private credit market has been the growing preference among businesses for non-bank financing. According to research by ScotPac,¹ the number of Australian small and medium-sized enterprises (SMEs) planning to borrow from non-bank lenders doubled to 31% between 2019 to 2023. Traditional banks, with their rigid lending criteria and slower decision-making processes, are increasingly seen as less attractive options for SMEs. Non-bank lenders, on the other hand, offer more flexible and tailored solutions that better suit the specific needs of businesses. This ability to provide bespoke financing solutions has been a key factor in the growth of the private credit market in Australia.

The Growing Importance of Private Credit in Investment Portfolios

When we first established the Aura Private Credit Income Strategy , there was less interest from financial advisors and institutional investors in this asset class. However, as the market matured, so did the recognition of private credit as a core component of a well-diversified portfolio. The ageing population and the need for income streams, coupled with the breakdown of traditional portfolio allocations, have driven interest in private credit. Investors are now looking for alternative sources of return, and private credit, with its lower correlation to traditional asset classes, offers a compelling opportunity.

The Entrance of New Players and the Need for Due Diligence

As the private credit market in Australia has grown, it has attracted a wave of new entrants, including both domestic funds and international players. This influx of new funds, particularly in the post-COVID environment, is a testament to the growing recognition of private credit as a viable investment strategy. However, this proliferation of new players has also raised concerns about the standards of due diligence and credit assessment. Poor underwriting practices and insufficient risk management could lead to defaults, which could tarnish the reputation of the entire sector. For the market to continue its growth trajectory, it is essential that all participants maintain rigorous standards of due diligence and credit assessment.

Increased Regulatory Oversight

The expansion of the private credit market has captured the attention of regulators. The Australian Securities and Investments Commission (ASIC) has become more focused on the sector, particularly in terms of transparency and investor protection. This increased oversight is welcomed by many in the industry, as it helps to ensure that the market develops in a sustainable and responsible manner. Ensuring that private credit funds operate with transparency and adhere to high standards of conduct is critical to maintaining the integrity of the market.

Looking Ahead

The Australian private credit market has made significant strides over the past seven years, evolving from a fledging sector into an increasingly important component of the financial system. While it remains in its early stages, the growth of private credit has been driven by a combination of regulatory changes, shifts in investment strategies, and the entry of new market participants. As the market continues to mature, it will be essential for all stakeholders to maintain high standards of due diligence and transparency to ensure its long-term sustainability. The ongoing shift towards non-bank financing, coupled with increased regulatory oversight, suggests that private credit will continue to play a vital role in the Australian economy in the years to come. We look forward to the next seven years as fiduciaries of capital for our investor base. Thank you all for your support in our first seven years.

Learn more about Brett Craig and Aura Private Credit.

Source:

¹ Why non-bank lending is on the rise, ScotPac, 27 June 2023.