Understanding Private Lending
Private lending offers businesses the chance to secure capital with fewer restrictions than major banks. This flexibility is crucial for borrowers who may not meet traditional bank criteria or need funds quickly. Typically, these loans are short—to medium-term and used for business transactions or property development.
The scope of private lending is broad, encompassing mortgage-backed lending, invoice financing, and asset finance. Essentially, it involves creating debt instruments against various asset classes.
Borrowers benefit from private lending by saving time, seizing business opportunities, and minimizing opportunity costs. However, this convenience comes at a higher price, as private lenders assume a more significant risk than traditional banks.
Even borrowers with excellent credit histories might face challenges if their loan is against non-traditional assets like petrol stations or land banks. Additionally, banks can take months to approve loans, while private lenders can often settle within days. This agility is crucial for businesses needing urgent funds that banks may be unable to provide.
Australia’s banking system relies heavily on the private lending market, also known as the shadow banking market, for liquidity. This support helps reduce default rates, provides banks with exit strategies, and ensures customers can access funds when traditional avenues are unavailable. Unlike typical consumer home loans, this liquidity is vital for higher-risk business ventures.
What is Private Credit?
From an investor’s perspective, private credit involves providing funds to a business for a private loan. In Australia, most private credit deals are mortgage-backed, meaning property serves as security, either through a first or second mortgage.
Understanding Returns on Private Credit
Returns on private credit vary depending on the underlying asset class, borrower nature, and transaction type. Deals can range from simple property-backed credit to complex mergers and acquisitions (M&A) financing.
First mortgages often yield 8% to 14% annually for mortgage-backed transactions, while second mortgages can potentially offer 18% to 26% annually, depending on various factors. These returns depend on factors like the prevailing BBSY rate, risk, borrower history, loan size, loan-to-value ratio (LVR), loan duration, and security type. Thus, outcomes vary and are not guaranteed.
Private credit offers several advantages over public debt transactions. Besides the risk-adjusted rate, there is also an illiquidity premium, as private credit involves private transactions requiring active management and skill to identify opportunities. This scarcity of competition for these deals can lead to potentially higher yields.
Additionally, there is an “inconvenience premium” where borrowers are willing to pay above the risk-adjusted rate for urgent credit to capitalize on market opportunities or solve immediate business problems. Investors may earn a premium by providing urgent liquidity without assuming much additional risk, a key advantage of private credit.
Returns also vary based on whether an investor lends directly, uses an agent, or invests in a fund. Smaller investors (under $500k) are often better off investing in a fund, while larger investors might consider direct lending.
Royce Stone Capital specializes in mortgage-backed private credit for family offices and professional investors with liquid assets of $1M to $10M. It does not operate a fund model but represents its investors, handling deal origination and loan management.
The company’s direct lending model ensures the investor’s name is on the mortgaged property, providing deal oversight and control. This model has the potential to yield better net returns than a fund model, making deals more competitive, attracting more borrowers and ensuring mutually beneficial outcomes. It should be noted that outcomes vary and are not guaranteed.
Disclaimer: This content is for informational purposes only and is not intended as financial advice, nor does it replace professional financial advice, investment advice, or any other type of advice. You should seek the advice of a qualified financial advisor or other professional before making any financial decisions.
Published by: Khy Talara
