Hundreds of home buyers across Sydney’s suburban fringes have been left hanging after this week’s $3 billion collapse of property developer Bathla Group.
But looming over the crushed dreams of would-be apartment owners is a bigger story which has raised the alarm from Wall Street to western Sydney: the rapid rise of the private credit market – essentially loans made to businesses from financial institutions outside the traditional banking system.
For businesses in sectors like construction, real estate and hospitality that are more exposed to the boom and bust of the business cycle, private credit, or shadow banking, has been a vital source of finance. In the post-global financial crisis era, banks became more reluctant to lend to such risky borrowers. The regulatory shackles were also tightened in Australia after the conclusion of the banking royal commission in 2019.
“About 10 to 15 years ago, the banks would’ve been up to their eyeballs in this lending, and their bad debts would’ve been climbing,” said Hugh Dive, chief investment officer at Atlas Funds Management.
As banks retreated, private credit funds stepped into the void.
“It’s [private credit] been an important escape valve for the major banks because they have a watch list of concerns. Private credit has helped them manage those watch lists,” Jarden analyst Matthew Wilson said.
To account for the risky nature of those loans, funds typically charge higher interest rates to borrowers than those offered by banks. Buoyed by the possibility of higher returns, investors poured money into private credit funds, and the sector’s growth has turbocharged in the post-pandemic era into a $US3 trillion ($4.19 trillion) global market.
“For investors, it’s higher risk and higher reward,” said Nathan Zaia, a senior equity analyst at Morningstar.
In Australia, where the private credit sector is worth about $200 billion (a 500 per cent increase since 2015), lenders have convinced a growing class of investors including superannuation funds that those rewards are too big to ignore
“We’ve been hearing in presentations for a couple of years about the huge growth potential, how ‘we’re much more nimble than the slow and boring banks’,” Dive said.
Now, thanks to a changing economic climate, those risks are starting to become too big to ignore. The Australian Securities and Investments Commission has been ringing alarm bells about the sector for some time now.
“When done well, private credit provides an important source of funding and supports economic growth and innovation,” the corporate watchdog said in a recent note.
“But weaknesses in governance, disclosure, valuation practices and conflicts management become more pronounced as conditions tighten.”
What makes private credit attractive to an investor – like high interest rates and relatively loose regulations and lending standards – are precisely what can cause risk to build up.
“In an environment where you’ve had rates going up, inflation, the costs rising, and delays to your project as well, if the price of the asset falls, that’s what catches these construction firms,” Zaia from Morningstar said.
On Tuesday, Bhart Bhushan, the former taxi driver who co-founded Bathla in 1997 with his brother Rajinder Mohan, blamed the company’s collapse on a “perfect storm” of factors – weakening demand, rising construction costs and the impacts of the Albanese government’s tax changes unveiled in the May budget.
But the dark clouds are gathering above the entire private credit sector. This month, Centuria Capital, an ASX-listed fund, paused redemptions (in other words, stopped investors getting some of their money out) over concerns about exposure to Bathla. On Tuesday, MA Financial, the firm co-founded by Sydney Swans chair Andrew Pridham, limited redemptions on its $2.3 billion fund, citing changes to the property market and “press speculation” about other private credit managers.
The firm does not have any exposure to Bathla, and has rejected proposals to lend to the company in the past.
Private credit is the golden thread that links Bathla’s collapse to so many of the biggest business stories of the past month. Failed pub baron Jon Adgemis, who declared bankruptcy owing $1.8 billion to creditors last year and whose business interests are being picked over in the Federal Court, had attempted to build a hospitality empire fuelled by private credit loans. Freight giant ACFS Port Logistics, which is owned by the billionaire Tzaneros family, was tipped into administration by private credit lender ScotPac, and owes nearly $300 million to various creditors.
Fears about private credit surged into the foreground in the United States last year, thanks to the collapse of car parts manufacturer First Brands and subprime auto lender Tricolor.
“When you see one cockroach, there are probably more,” JP Morgan chief executive Jamie Dimon warned, in a now viral soundbite which has come to symbolise Wall Street’s fears about the underlying health of the shadow banking sector, and the global economy at large.
Bloomberg
Fears that the private credit sector could, like the subprime loan market in 2007, build up dependence on high-risk debt that spirals into a full-blown financial crisis are likely overblown.
“It’s not that systemic, it largely involves sophisticated investors’ money, so it’s a different dynamic,” Jarden’s Matthew Wilson said of the sector.
Even so, Dive warns that there could be more unpleasant defaults like the Bathla story during the years to come.
“This is not the same as the GFC. It will be very unpleasant for the people investing, but it doesn’t damage the pipes of the financial system,” he said.
Dive also warned that, unlike during the 2000s crash, and the COVID-19 pandemic, the government was unlikely to provide the sector with a sweeping compensation package.
“Private credit funds are shit out of luck,” he said.
So too are the punters, who bought off-the-plan properties from the Bathla Group.
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Kishor Napier-Raman is a senior business writer for The Sydney Morning Herald and The Age. Previously he worked as a CBD columnist and reporter in the federal parliamentary press gallery.Connect via X or email.From our partners
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