Private credit has quietly revolutionised the lending landscape, growing from a US$200 billion niche market in the early 2000s to a US$2.5 trillion global force. This dramatic expansion occurred as tighter banking regulations post-Global Financial Crisis reduced traditional lending appetite, creating funding gaps that alternative lenders eagerly filled.

The Private Credit Ecosystem

The private credit market operates outside traditional banking channels, with three key participant groups driving its activity. Investors—including pension funds, insurance companies, family offices, and high-net-worth individuals—supply capital through direct lending or fund investments. Intermediaries manage these funds, with business development companies (BDCs) and private credit funds dominating globally, while Australia sees more open-ended fund structures than the closed-end vehicles prevalent overseas.

On the borrowing side, mid-sized companies with annual earnings between US$10-100 million represent the primary client base. These businesses often carry significant leverage after private equity acquisitions and frequently exhibit irregular cash flows or limited collateral—characteristics that make them unsuitable for public markets or traditional bank financing.

The private lending model thrives on direct negotiations between borrowers and lenders. This direct approach allows customised terms, higher yields to offset reduced liquidity, and often faster execution times than conventional banking channels.

Loan Structures Filling Market Gaps

Private credit has developed specialised loan products addressing specific market needs:

Pre-construction Loans: Bridging financing gaps between land acquisition and construction start, these 16-18 month facilities fund site preparation, architectural plans, permits, and pre-development costs. Once building permits are secured, these typically convert to construction facilities.

Construction Loans: During active building phases, these loans disburse funds based on construction milestones rather than upfront payments. They feature higher loan-to-value ratios (70-80%) than bank alternatives (50-60%), with processing times of 3-6 weeks versus 2-3 months through traditional channels.

Residual Stock Loans: Developers use these 6-24 month facilities to finance completed projects with unsold inventory, avoiding discounted bulk sales while maintaining liquidity. Loan-to-value ratios typically range from 60-70%, with repayment structures tied to individual unit sales and minimum release prices protecting lender interests.

Mezzanine Finance: Sitting between senior debt and equity, these higher-risk instruments bridge funding gaps when senior facilities fall short. They typically feature interest-only structures with balloon payments at maturity.

Investment Loans: Funding operating businesses or income-producing assets, these facilities span 3-7 years with financial covenants tied to business performance metrics.

Most private loans carry floating interest rates, creating natural inflation hedges as rates adjust with market conditions. Limited prepayment flexibility, with “make-whole” provisions or penalties, protects lender yields.

Regional Dynamics and Sector Focus

The private credit landscape shows distinct regional patterns. North America dominates with approximately 87 per cent of global activity, Europe accounts for roughly 9%, while Australia’s market has grown substantially, reaching an estimated AU$188 billion in 2023.

Sector exposure has diversified significantly over the past decade, with notable regional specialisation:

– Real estate leads in Australia and throughout Asia-Pacific

– Software and technology represent the largest U.S. direct lending sectors

– Healthcare claims a growing market share across most regions

– Business services maintains consistent allocation globally

– Manufacturing, traditionally a major focus, now represents a smaller percentage than in the past

Private credit managers often specialise in specific sectors, applying industry expertise to assess risks more effectively than generalist lenders. This specialisation creates potential concentration risks but enables deeper market insights and more accurate risk pricing.

Risk-Return Profile

Private credit generally offers distinctive risk-return characteristics compared to public market alternatives. Returns typically range from 7-8% for senior secured strategies to 12-15% for more opportunistic approaches. The illiquid nature of these investments creates both challenges and opportunities, such as limited mark-to-market volatility and reduced exit flexibility.

Valuation practices present unique considerations. Private credit assets appear more stable than public markets because valuations occur less frequently and follow more subjective methodologies. While funds adhere to accepted accounting principles, regulatory standards don’t mandate specific valuation techniques. This creates potential stability risks during economic shocks when broad reassessments might suddenly impact asset valuations across the sector.

Default rates in private credit have historically remained relatively low, with lenders maintaining greater capacity to postpone losses and defaults through flexible lending agreements. When defaults do occur, recovery rates typically run lower than in traditional lending, reflecting collateral values often falling below anticipated sale prices.

Regulatory Environment

Compared to consumer credit, private credit operates with less prudential regulation and disclosure requirements governing leveraged loans. This regulatory gap has drawn increasing attention from financial authorities worldwide.

Overseas regulators have implemented measures to enhance transparency and competition within the sector. In Australia, the regulator ASIC conducts surveillance and industry engagement to identify potential issues affecting market integrity and efficiency. Meanwhile, APRA has heightened supervision of superannuation funds’ investments in unlisted assets, testing for possible contagion sources during market stress.

The Road Ahead

Fund structures continue evolving to meet diverse investor needs, from closed-end vehicles with defined investment periods to semi-liquid interval funds offering limited redemption windows. The investor base has expanded beyond traditional institutional allocators, with retail participation growing through various fund structures.

Data transparency remains more limited than in public markets, with performance reporting conventions still developing. This information asymmetry creates both potential inefficiencies and challenges for comprehensive risk assessment.

As private credit expands into new segments, its importance to overall financial stability grows proportionally. The sector now represents a critical funding source for middle-market businesses and commercial real estate developers increasingly underserved by traditional banking channels.

For borrowers seeking flexible capital and investors pursuing yield in a volatile market environment, private credit continues redefining the boundaries between traditional banking and alternative finance—one customised loan at a time.

To discover more call 1300 683 106 or email us on investordesk@nab.com.au

The information contained in this article is believed to be reliable as at April 2025 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article.

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