Quality Private Credit Minds the Default Gap

Opportunity

• Attractive Risk-Adjusted Returns: Private credit offers stable, income-generating opportunities with strong downside protection. The floating rate nature aligns with interest rate changes and will generate superior returns in a more inflationary environment.

• Capital Preservation & Stability: Senior secured lending provides a buffer against losses, with robust covenants and risk mitigation strategies. Due to these mechanisms defaults often do not necessarily result in a credit loss.

• Diversification Benefits: Private credit reduces reliance on limited Australian public credit markets and reduces volatility in a portfolio. This is increasingly being recognised and implemented by institutional and private wealth investors.

• Manager Skill as a Competitive Advantage: Managers with deep market expertise, strong origination capabilities, and resources for rigorous credit analysis and active loan management can exploit market inefficiencies and achieve superior returns. They can also achieve better results when loans don’t go to plan with capability to handle complex restructuring or recovery scenarios.

Risks & Areas of Concern

• New Market Entrants & Competition: The rise of inexperienced lenders and poor credit structuring skills with “covenant-light” deals could weaken underwriting standards and result in higher risks for private credit investors.

• Credit Defaults & Workouts: Defaults do not necessarily translate into capital loss; however, can create liquidity issues as situations may take a long time to sort out especially during a weak economic environment.

• Regulatory Scrutiny: ASIC is investigating the private credit sector, which may result in new compliance burdens or lending restrictions.

• Transparency & Governance: Opaque markets can create investor uncertainty, and many funds have very limited disclosure of portfolio information making it difficult to assess risk. Also, many private credit funds lack independent third-party oversight which creates governance risks.

• Valuation: A lack of mark to market valuation may not price the increasing risks in loans fairly for new investors in a mature portfolio of loans.

Portfolio Implications Across Different Scenarios

• Continued Economic Growth

  Strong borrower fundamentals support stable returns and low default rates. Yields may compress slightly but remain attractive relative to traditional fixed income assets.

• Mild Recession

  Selective private lenders with strong covenants and senior security protections mitigate risks. Default rates may rise but remain manageable, cyclical sensitive industries more vulnerable.

• High Inflation & Rising Rates

  Floating-rate private credit loans outperform fixed-rate bonds, maintaining purchasing power and income stability. Rising rates do create issues for borrowers as it becomes more difficult to service loans which can contribute to some stress and increased defaults.

• Severe Economic Downturn

  Stress testing and active risk management become crucial. Lenders with robust underwriting and workout strategies can manage through distress and limit losses, however some less experienced managers with higher risk loans may start to suffer significant defaults and losses. Investors should prioritise senior secured debt, low LVR or less leveraged companies (in resilient sectors) and avoid areas such as mezzanine lending.

Conclusion

Private credit offers compelling risk-adjusted returns and capital stability, particularly when managed by experienced lenders with disciplined risk oversight. While the asset class faces increasing scrutiny and competition, strategic allocation to high-quality private credit could enhance portfolio returns and resilience across various economic conditions.

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