Growth in private credit surges higher for mid-market companies

Non-bank lenders and credit funds are quickly gathering momentum in Australia and New Zealand, particularly in the mid-market, according to BDO director of debt and special situations advisory, Tom Hogarth.

A contraction in traditional bank financing from the big four banks has been driving this trend for some time but the recent pandemic has further accelerated the growth in private credit, said Mr Hogarth.

“Australia-focused private debt Assets Under Management (AUM) more than tripled to $1.9 billion between 2020 and 2021, and continued to grow by 10 per cent between December 2021 and September 2022 to stand at $2.1 billion,” said Mr Hogarth.

“With private credit sitting at c.12% of local lending globally, Australia (at just 2%) is positioned for significant growth.”

The past year in particular has seen a significant rise in corporate debt opportunities in the mid-market lending with private credit which has been driven by a range of factors.

ESG considerations are one factor that has significantly impacted debt financing in Australia.

Commercial banks have retracted their activity in certain sectors due to integration of ESG metrics in credit analysis, according to Mr Hogarth.

“This trend is reshaping how businesses access capital and can make it difficult for borrowers and lenders alike in sectors with exposure to ESG risks,” he said.

The current state of the economy is also impacting lending confidence across multiple sectors and has resulted in hesitancy from commercial banks in lending to businesses reliant on discretionary spending including sectors such as retail, tourism and hospitality.

“Even more generally, tighter lending conditions have resulted in challenges for mid-market companies to borrow from traditional banks,” he said.

An increase in borrowers facing distress or special situations is also seeing a rise in the use of private credit.

“Businesses heavily impacted by the pandemic may be carrying legacy accrued ATO debt or aged creditor balances, financial covenant breaches with banks, and cash / working capital constraints,” said Mr Hogarth.

“Borrowers facing financial stress or distress may struggle to obtain finance from commercial banks or refinance with their existing lender, requiring a more flexible capital solution to transition out of their position. This solution can be provided by private credit.”

Benefits of private credit

One of the key benefits of private credit is increased access to capital.

“The pool of alternative capital providers has grown significantly in Australia and New Zealand, all offering unique solutions across different segments of the market whether it be a particular industry / sector or providing funding support at a specific stage of the businesses lifecycle,” said Mr Hogarth.

“With greater alternative capital providers comes greater optionality for businesses when it comes to financing solutions. This opens doors for growing businesses that may face challenges in obtaining financing from commercial banks.”

Non-bank lenders and credit funds offer a more flexible approach to lending, said Mr Hogarth, considering factors beyond strict credit scores and criteria.

Domestic and overseas lenders outside the commercial banks in Australia and New Zealand can also provide more flexible funding while offering competitive rates.

“Unlike regular loans, private credit providers have the flexibility to structure financing arrangements that align with the specific requirements and growth strategies of the businesses they support,” said Mr Hogarth.

“This flexibility extends to amortisation and repayment profile, key covenants, interest rates and collateral options (such as intellectual property, future cash flows or unencumbered assets). This is critical to the delivery of a successful business growth strategy.”

The less restrictive and flexible nature of private credit also allows non-bank lenders and credit funds to generate faster debt solutions for borrowers by applying learnings from prior transactions to allow for quicker assessments, generation of indicative terms, due diligence and approvals, according to Mr Hogarth.

This can be important where businesses require fast capital to fund short-term working capital constraints or to take advantage of time-sensitive opportunities to support business growth.

“Private credit providers often take a strategic relationship-based approach to lending with the aim to develop long-term partnerships with businesses, aligning their success with that of their borrowers,” said Mr Hogarth.

“These lenders often bring industry expertise and insights, strong access to networks, and deep understanding of the sectors they operate in, providing value beyond financing. The key to a successful partnership with any lender includes alignment of key goals and objectives, early and transparent communication and quality financial reporting.”