Real estate is greatest area for improvement in private credit: ASIC
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The news: The concentration of higher-risk real estate construction and development investments in private credit is the greatest area ripe for improvement for investors and market integrity, according to the Australian Securities and Investments Commission (ASIC).
ASIC will today release its interim report into private credit authored by infrastructure investment executive Richard Timbs and former Commonwealth Bank chief risk officer Nigel Williams.
The numbers: ASIC estimates the private credit sector to be at $200 billion, of which half is estimated to be in real estate. ASIC interviewed 30 parties involved in, or with knowledge of, private credit.
The context: Private markets have been under the surveillance of ASIC since the asset class started to boom over the past couple years.
ASIC’s report said when private credit was “done well” it was good for investors and borrowers and complemented the banking system.
However, the concentration in real estate could present as a systemic risk for small and self-managed superannuation funds and sophisticated investors in a downturn.
“This market segment has a higher concentration of investors using the wholesale sophisticated investor exemption, and with less transparency on conflicts of interest, manager remuneration disclosure, and valuations and portfolio reporting,” ASIC said.
Other areas ASIC found Australia was vastly different to international markets included:
- The relative lack of transparency in fund disclosure from many funds in relation to portfolio mix, impaired assets, income-producing versus non-income-producing loans and related party transactions;
- The lack of funds obtaining independent loan valuations on a quarterly basis. It should be noted that there is a link between valuations and management fees; and
- The fee structures of many Australian private credit funds, which include fees paid by borrowers directly to the manager and which are retained by the manager in some proportion, generally in the range of 50–75% in the case of upfront fees.
Areas that ASIC said warranted closer inspection and potential action were:
- Management and disclosure of conflicts of interest;
- Valuation practices;
- Fee arrangements – disclosure (including quantum relative to size of fund) and alignment of interest between managers and investors;Liquidity facilitation;
- Investment report information;
- Distributions paid out of capital without confirmation of this nature; andDefinitions of key terms.
However, ASIC noted that, given the “relative small size” of the sector, systemic risk was unlikely to be a major concern today.
It said areas that could warrant attention in the future included the exposure of property construction and development to retail and less sophisticated investors, managers that held sector concentration and in particular property, and increased bank exposure to private credit through partnerships and funding.
What they said: "We note the concentration in real estate construction and development finance, which has represented the majority of credit losses in past economic downturns in Australia and overseas," the report said.
The source: ASIC
