Non-bank business lenders remain positive as business conditions deteriorate

Non-bank business lenders are finishing the year strongly, with a number of recent capital raising initiatives by lenders operating through managed investment schemes and a recovery in the securitisation market in the second half of the year

Debt fund managers report that lending conditions remain positive, while their settings have become more cautious, and that investor sentiment is still positive.

Business lender Metrics Credit Partners launched a unit purchase plan this week for its listed trust, Metrics Master Income Trust, offering unitholders the opportunity to subscribe for up to A$30,000 of new units.

The offer follows completion of a wholesale placement for the trust, which was completed earlier this month with bonding commitments for more than 98.2 million new units at $2 a unit. When the placement was launched, Metrics was expecting to issue 87.5 million new units.

The proceeds will be invested in accordance with the trust’s investment mandate. Metrics Master Income Trust has a portfolio of 301 loans and has returned the Reserve Bank cash rate plus 4.47 per cent a year since it was listed in 2017.

Epsilon Direct Lending has recently expanded its market presence, with its Epsilon Direct Lending Fund being added to the Praemium platform. Since it was launched in 2019, Epsilon has done 10 loans, which sit in two funds, the Epsilon Direct Lending Fund and the Epsilon Direct Lending Senior Loan Fund.

A couple of months ago GCI Funds launched a real estate capital division, specialising in bridging finance for property acquisition or sale, diversifying its business from its established asset backed finance and strategic capital lending divisions.

According to the April issue of the Reserve Bank’s Financial Stability Review, non-bank business credit growth has grown strongly, reaching an annual growth rate of 25 per cent in early 2023.

“In recent years, banks have been pulling away from some forms of higher risk business lending, such as construction, property and vehicles, while non-banks have increased their market share in these sectors,” the RBA said.

The relative riskiness of non-banks’ business lending is reflected in the interest rate charged by non-banks, which the RBA said was 270 basis points higher on average than the rate charged by banks.

The RBA looked at whether the non-bank sector presented any systemic risks for the Australian financial system. “Non-bank lending can be more concentrated, riskier and more pro-cyclical than bank lending. This can amplify credit and price cycles, particularly for property,” it said.

But the key issue for the RBA is that non-bank lending does not account for a large share of overall financing in Australia. Non-banks account for around 5 per cent of total lending for housing and the non-bank share of total business credit is around 8 per cent.

Investors in funds that lend to business are probably also asking whether the growth of non-bank lending is getting riskier at a time when the economy is slowing and business failures are increasing.

Epsilon Direct lending founder Joe Millward said one way to assess risk was to look at the credit quality of the portfolio.

Millward pointed to a recent NAB disclosure, which showed that 49 per cent of its $236 billion corporate and SME loan book fell within the B+ to BB+ credit rating range.

“For regulated banking giants like NAB, which operate under the watchful eye of the Australian Prudential Regulation Authority, the use of credit models is highly regulated, with meticulous oversight and auditing to ensure accuracy and reliability in assessing credit quality,” Millward said.

“Private credit funds operate in a different realm.”

Epsilon uses tools provided by ratings agencies to assess the credit quality of loans in its portfolio using the same methodology as public ratings.

“Our target range is at the upper end of sub-investment grade, and we come out roughly where NAB is. The average rating is BB-,” he said.

“We are a little more cautious but still looking to lend. Our deal settings are a little more conservative.”

Epsilon’s focus is on companies that are performing well and are in non-cyclical industries. It is attracted to companies in education, healthcare, consumer staples and IT services.

It looks for companies that have a clear use for the funds. That might be growth through acquisition, geographic or product expansion, or a change in ownership. Loans are fully secured and we look for sustainable cash flow.

“What we hear in our discussions with investors is that it is still a good place to invest in the capital structure, with good security and less volatility than equity.”

GCI Funds managing partner Gavin Solsky said investors were not shying away from credit.

Solsky said: “Our deals are well covered. We have had workouts and our structures have held up.

“If I was an investor and I wanted to be reassured about an investment in a debt fund I would ask whether the principals are invested in it. I would also ask whether the fund is leveraged. We invest in our funds and we don’t lever them.”

GCI has a mid-market focus, it originates all its loans (apart from one syndication), it offers only senior debt and it does not buy public debt for its portfolios.

Solsky says GCI looks for deals in the $10 million to $50 million range that will allow the borrowers to transform their businesses. “If you have a business with an unusual business model, that may be on a steep growth curve or has had problems in the past you are in private credit land.”

He said there was an opportunity for fund managers like GCI to work with banks, which are currently happy to extend credit to businesses where a relationship exists but are much less likely to take on a new client.

“We are not long-term capital for businesses. Our cost of capital is high. We are not looking for long-term relationships but the banks are. Companies can move between the types of lenders over time. It is even possible that different lenders could fund separate parts of the corporate structure.”