Abundant capital, falling rates and refinancing dependence are weakening credit discipline, says Semper Secured director Andrew Way.
Australia’s private credit market has grown rapidly, bringing competition and much-needed alternatives to bank lending. It has also attracted a great deal of relatively undisciplined capital.
The immediate danger is not simply that private lenders are writing bad loans. It is that too much money is chasing too few properly priced transactions, creating a race to the bottom on rates while encouraging lenders to stretch leverage, soften covenants and accept increasingly optimistic exits.
Cheap funding does not make a risky loan less risky. It merely makes it easier to write.
When price replaces discipline
The abundance of warehouse funding and managed investment scheme capital has changed the behaviour of parts of the market.
Warehouse-funded lenders must originate enough loans to cover facility costs, maintain utilisation and produce their required margin. Fund managers must deploy investor capital to generate returns and avoid holding excessive cash. Originators are rewarded for settlements, while the consequences of weak structuring may not become apparent for another year.
The resulting competition is increasingly expressed through price.
A lender quoting 11 per cent is undercut at 10 per cent. Another responds at 9 per cent. Establishment fees are compressed and servicing requirements loosened. Eventually, the discussion is no longer about whether the risk is properly understood and priced. It becomes a contest to win the transaction.
This is where “dumb money” becomes dangerous. It is not necessarily unintelligent capital. It is capital operating under an imperative to be deployed.
A private lender without treasury pressure has the freedom to decline a loan. A warehouse-dependent lender may face a more complicated commercial decision. Sometimes the discipline to say no is worth more than the apparent sophistication of the funding structure.
Residential security can disguise business risk
Many private business loans are secured by residential property. That security can make the resulting risk appear more mortgage-like than it actually is.
But residential security does not convert business risk into residential mortgage risk.
Repayment may still depend on a development sale, business sale, asset realisation or a capital raising or refinancing event. The property might also be the secondary repayment source - not the commercial engine producing the exit.
A low LVR provides comfort only if the valuation is current, the security is enforceable and the property can be sold within a reasonable period. When the exit depends on another lender accepting the same valuation and refinancing the same risk, the loan is not self-liquidating. It is migrating through the market.
The warning signs
When we are taking calls from other privates asking if we have “loans seeking an exit”, you can rest assured the money-go-round is in full play. When we were asked to quote on a loan already under offer from a private lender, paying out another private lender, each with the same bank warehouse and where the new loan presents with a higher LVR but at a lower offered rate of interest, then you know credit madness has set into warehouse world. I asked the representative of the bank whether they have the means to track these transfers of risk for no material benefit, and the answer was “not unless we do it manually”.
It is no surprise then that warehouse funders and market participants are reporting prolonged exits, stretching LVR limits and diminishing refinancing alternatives. They are unwittingly refinancing their own positions.
A six-month bridge becomes a 12-month facility. Interest is capitalised. Another valuation is obtained. Additional fees are added and the loan is refinanced by another private lender - sometimes at a higher exposure and with substantially the same underlying exit and sometimes residing within the same warehouse.
On paper, the original lender has been repaid. Economically, the risk has merely been transferred (or not!).
The market can therefore create the appearance of liquidity without producing genuine repayment. Capital circulates between lenders, funds and in and on warehouses while the borrower remains unable to repay from operations or asset realisation.
This is the approach to an illiquidity cliff.
The cliff does not require a collapse in property values. A warehouse provider reduces its advance rate. A fund experiences redemptions. Valuers become more cautious. Credit committees tighten their LVR limits. Refinancing that appeared routine three months earlier is suddenly unavailable.
The loans may remain recoverable, but recovery takes time. Warehouse facilities and investor withdrawals do not necessarily allow that time.
Liquidity is not capital
Bank warehouses are conditional sources of liquidity. They carry eligibility criteria, concentration limits, valuation requirements, arrears triggers and rights to reduce or withdraw funding. They can accelerate growth, but they can also transmit a change in institutional risk appetite directly into a lender’s loan book.
Managed investment schemes face another version of the mismatch. Investors may expect income and liquidity while the fund owns concentrated, bespoke and inherently illiquid loans.
A loan maturing in six months is not liquid if the borrower cannot repay it in six months.
Regulation will follow
ASIC’s work on private credit has identified concerns involving disclosure, governance, conflicts, valuation, liquidity and credit-risk management. Its proceedings against Oak Capital also demonstrate its willingness to challenge lending structures allegedly designed to avoid consumer-credit protections. The allegations remain before the Court, but the direction is clear.
ASIC has also examined risk-tiered reporting for larger or higher-risk private funds and more consistent sector data.
The post-GFC debenture experience suggests that opacity and weak capital alignment eventually invite benchmarks, disclosure requirements and scrutiny. Private-credit managed investment schemes may face their own RG69-style moment - not necessarily bank regulation, but clearer reporting of liquidity, valuations, loan performance, related-party exposure and capital alignment.
The real advantage
The strongest private lenders will not be those with the cheapest warehouse or the largest pool of deployable money. They will be those with experienced credit teams, meaningful capital alignment and the freedom to reject loans that do not make sense.
Private credit exists because it can exercise judgment where banks cannot. If it replaces that judgment with volume targets and a race to the lowest rate, it gives away its principal advantage.
The next credit cycle will distinguish genuine private credit from capital distribution dressed up as credit discipline.
Andrew Way is the director at private credit lender and mortgage-backed securities manager, Semper Secured
Want to see more stories from trusted news sources?
Make The Adviser a preferred news source on Google.
Click here to add The Adviser as a preferred news source.
