Senior debt: Australia's banks burst the bubble

The Australian debt market experienced something of a watershed last month when Visy Industries, the Melbourne-based packaging giant led by billionaire Anthony Pratt, secured A$150 million ($114 million; €105 million) in long-term debt from the country’s biggest superannuation fund Australian Super and fund manager IFM Investors.

The 10-year loan, arranged by Westpac, is one of the first to involve a super fund investing in a large, privately owned Australian company. It is also indicative of a larger trend whereby non-bank lenders are taking a more prominent role in the market.

“If you look at the size of the Australian loan syndications market, 5 percent of that is contributed by non-bank lenders. If you look back five years ago, their share would only have been 2-3 percent. Their share is growing and will continue to grow,” says John Corrin, global head of loan syndications at Australian banking group ANZ.

Although the Australian senior debt market has been dominated by the four major banks – National Australia Bank, Commonwealth Bank, ANZ and Westpac – which claimed around 80 percent of loan market share in 2016, according to Moody’s, non-bank lenders are finding more opportunities as banks take a more conservative stance in a tightening regulatory environment.

“They [non-bank lenders] see that the regulatory burden of the banks has been increasing, and so the amount of capital they have to set aside against debt is also increasing. This is making it more expensive for banks to lend, which gives opportunities for other financial institutions to offer more competitively priced debt,” says Steve Smith, a Sydney-based partner at international law firm Ashurst.

Meanwhile, banks are not seeing lending as a primary business but rather as something that’s done to win other business such as transactional banking and hedging.
“Many banks want to underwrite and arrange loans but they are very happy to lend a little bit less,” says Corrin. “Many want to focus on business that generates fees and requires less capital.”

Corrin adds that banks and non-bank lenders are not competitors because the latter only offer one product and do not compete with banks in any other way. Moreover, when the banks are unable to lend due to capital requirements, they would rather refer their clients to non-bank lenders than lose clients to competitor banks.

“We see them as partners and very complementary to what we are doing. The more non-bank lenders we have in the market, it will be good for the banks, good for the arrangers and good for the borrowers,” Corrin says.

The Australian market is relatively small, with the four big banks and a handful of foreign counterparts able to serve the requirements of most domestic corporates. In a bid to claim market share in the senior debt space, Corrin sees many non-bank lenders, such as the superannuation funds, starting to provide longer-term financing.

Most banks in Australia only provide four- to seven-year short- to medium-term senior financing to corporates as the cost of long-term finance for them is high. By contrast, the likes of superannuation funds can easily provide a 10-year loan.

“They have lots of money to put to work, and they are looking for different areas to invest in. They have an obvious interest in infrastructure, but I think they see debt as having a similar risk-return profile; they can get 8-9 percent in leveraged credit with relatively acceptable risk,” says Smith.

He thinks the current regulatory environment makes it more expensive for banks to lend, while at the same time making some super funds and private debt funds more competitive.

Future Fund, the A$140 billion Australian sovereign wealth fund, increased its commitment to Australia from 1 percent in 2015 to 4 percent last year, according to the fund’s 2015-16 annual report. Private debt is the biggest portion of Future Fund’s debt portfolio, taking up around 30 percent. The idea is that private lending and structured credit provide a stable base for income in the current volatile environment and can help to buffer the mark-to-market pressure seen in more liquid sectors.

“If Super Fund does five deals with a bank directly for $20 million each, they will have to do all the credit analysis themselves and monitor the loans,” Corrin notes. Most of the super funds prefer to use managers to participate in syndications, rather than go directly, due to the lack of a dedicated team to do the deep credit analysis.

Void to be filled

One area where non-bank lenders are seeing opportunities is commercial real estate debt. In February, the Australian Prudential Regulation Authority said banks should be “under no illusion” that it will intervene if limits on real estate lending growth are breached.

“The view is that the regulator would like to see the banks come back to a normalised market share. From my understanding, that means two-thirds of the market share which equates to a $40 billion potential funding gap,” says Wayne Lasky, founding partner of Australian commercial real estate debt investment manager, MaxCap Group.

MaxCap raised A$50 million at the first close of MaxCap First Mortgage Fund, the firm’s debut commingled closed-ended vehicle last year. The manager has traditionally focused on mezzanine debt investment prior to the launch of its new fund.

According to Lasky, the commercial real estate debt market in Australia has grown from $160 billion in 2008 to $220 billion, with banks now taking up 80-85 percent market share, bringing what is perceived by the regulator to be concentration risk.

“It is not a case of the banks pulling back of their own volition as their provisions are below historical averages. The key step-change in the market is the tightening in regulation from APRA,” says Lasky. “We anticipated this and have been playing a key funding role in first-mortgage lending, but due to the market dislocation we are often providing senior lending at a double-digit return.”

Lasky adds that investors understand there is limited value in mezzanine positions at mid-teen returns when they can access low-teen returns in senior debt. The mezzanine market has also contracted as more equity is often required in the capital stack.

“We are also often taking the whole loan via our separate account mandates and closed-end funds,” he says. “Expect to see expansion in mezzanine pricing over the coming months.”