Private Debt/Credit Basics

Nayef Perry, Head of Direct Credit – Hamilton Lane

Why choose private credit?

Investors typically choose to invest in private credit based on consistency of performance over long periods, downside protection, and cash yield.

Characteristics of global private credit

Geographically, private credit AUM tends to be concentrated in North America and Western Europe where private markets activity tends to be most robust. Middle market lenders tend to gravitate towards stable companies and sectors, which demonstrate strong free cash flow characteristics. Specific to Hamilton Lane, our credit investment process centers on backing leading General Partners in their areas of expertise, recession resilient sectors, market leading companies (typically #1 or #2 in their space), and conservative capital structures that can successfully weather different market cycles.

Australian and Asia Pacific perspectives on the sector

Australia is an active market where banks remain very active and private credit capital is growing. Specific to Asia Pacific, the market is very diverse and gaining greater attention from private markets lenders. Being local matters and investing in lender-friendly jurisdictions is important. Asia can be an attractive market where investors can earn attractive yields, however, US Private Credit is gaining significant investor interest at present given the rising rate environment and the floating rate nature of private credit.

Outlook for private credit with respect to current market conditions.

Private credit has experienced a “lender-friendly” market since the beginning of 2022 with increased spreads, better documentation, rising interest rates, and lower levels of competition from the banks. While we anticipate interest rates to soften into next year, our expectation is that rates will remain elevated, and investors will continue to enjoy enhanced yield.

Craig Bannister, Executive Director – Distribution, Pallas Capital

Why choose private debt?

The primary benefit to a private debt investment is generally higher returns comparative to other traditional public markets offering similar (or even higher) levels of risk and volatility. A private debt investment will be more illiquid in nature given it is not available on tradeable markets, however, the rate of return compensates for this, and as such most investors in private markets will be rewarded by a high risk-adjusted reward.

Key attractions for Australian investors

The key attraction of private debt to Australian investors is the capital preservation qualities due to the senior position in the capital structure. Pallas Capital specialises in CRE (Commercial Real Estate) debt (which is a subset of Private credit/debt). These loans are secured by real property assets to ensure priority of repayment in the event of any default by the borrower.

Benefits of CRE debt

Commercial Real Estate debt is a subset of private debt that is commonly being used by investors and advisers. CRE debt is any debt where the monies borrowed are used for commercial purposes. So a mortgage to purchase a residence is not CRE debt, by a mortgage over the same residence to purchase an investment property (or for any other commercial purpose) is CRE debt.

The key benefits of CRE debt are:

  • Attractive risk adjusted returns with low volatility given loans are typically secured by real first mortgages.
  • CRE debt provides investors secure and consistent income on a monthly or quarterly basis.
  • As interest rates go up – investor returns increase – as Pallas Capital provides fixed rates over BBSW to investors.
  • CRE debt is no longer only available to institutional / family office investors – Investors and Financial advisers are able to access these investments through non-bank lenders like Pallas Capital
  • Portfolio diversification due to low or negative correlation to direct real estate and equity markets.

What is the outlook for private debt/credit with respect to current market conditions?

Given the uncertainties in the global economies, we can expect to see subdued growth in the Australian and overseas economies. Prices in the Australian residential property sector have generally increased every month since February this year, due to various factors including Australia’s population growth over the next 5 years.

As per CBRE, forecasts indicate that approximately 570,000 additional apartments will be required in the next three years across all major cities in Australia. Currently the national supply is around 55,000 apartments which shows a significant gap. Sameer (Head of Research, Pacific & ESG, Asia Pacific at CBRE) also highlighted there will be a need of 75,000 to 80,000 apartments in Sydney alone to keep vacancy rates at current levels which suggests a more solid property outlook for Australia.

Given these statistics, we believe that investors will continue to seek property backed investment opportunities that provide consistency of income and return. Private debt and, in particular, CRE debt will provide these outcomes to investors. Pallas Capital offer first mortgage debt opportunities that yield an investor returns currently upward of circa 10% p.a. with low volatility given all first mortgage investments are secured by underlying Australian property.

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