Large Australian superannuation funds are building direct-lending programs as banks create opportunities by partially retreating from the sector.
First State Super credit income portfolio manager Ross Pritchard says about four to five large super funds are directly lending to borrowers in light of regulatory pressures on banks to back down from certain exposures.
Banks have been retreating from private debt markets since the global financial crisis forced them to repair their balance sheets and, more recently, Basel III mandated stronger capital adequacy obligations.
Pritchard, formerly infrastructure debt manager at Hastings Fund Management, has worked with First State Super for the last year to establish a direct-lending program. The fund has made two such transactions, has board approval for a third, and is working on a fourth.
“From our perspective, with any credit portfolio, there is a desire to diversify the risk,” Pritchard says. “We have a relatively broad mandate and within that we’re looking to build up a good quality portfolio of diversified credit exposures.
“The majority of credit investments for First State Super are international, certainly initially we will be doing our direct lending within Australia.
First State Super manages $90 billion in assets and has credit exposure of $4 billion, including corporate loans and bonds. Its direct-lending program is set to grow in line with its assets over time.
“What we’re seeing is the implementation of regulatory changes on the banks that have dominated Australian credit markets for some time,” Pritchard says. “They are changing the way they lend and the way they participate in the market, which is creating opportunities for non-bank lenders. I think it’s an easier time for organisations like First State Super to enter the market, in terms of sourcing opportunities and finding partners.”
A handful of Australian super funds now have direct-lending exposures and in-house expertise, he says, and are seeking opportunities in syndicated lending, bonds and bilateral loans.
He expects smaller funds to enter the market eventually, using external credit managers.
Pritchard says regulatory changes have forced banks to price their own capital differently, making them less interested in riskier, sub-investment grade assets and less able to provide long-term funding.
“We are regulated differently to banks but fundamentally…with the discipline, systems and processes, we have a lot to learn from them in how they measure risk and return, portfolio structure and credit exposures,” he says. “Super funds would do well to learn from that.
“It’s about measuring risk and being appropriately rewarded for that. I don’t think (First State) will be more conservative than banks but we are starting out reasonably conservatively.”
Compared with in the US, where pension funds and insurers control two-thirds of the market, Australian non-bank direct lending’s market share is small – about 10 per cent.
But that will grow, Pritchard says.
“Super funds will take some time – and it has been talked about for some time – to lift their exposure to direct lending,” he says. “There are four to five institutions doing it. I expect that to increase but it’s difficult to predict the pace.”
Investment Magazine spoke with Ross Pritchard ahead of the 2018 Conexus Financial Fixed Income and Credit Forum in Healesville, Victoria, on July 24-25, when he will speak with Challenger leveraged finance director David Hoskins on the topic “Direct Lending: What are institutional investors doing?”