Scapegoat Private Credit!?
A Sydney property developer entered voluntary administration on 25 August. By early September, Bathla’s reported debts were around A$3.4 billion. So whodunit? An overleveraged developer? A cooling housing market? Inflation? Squeezed consumers? Conservative banks? Too much regulation? There is no shortage of suspects.
I started reading because developer failures are horrible for the people waiting for homes and always kickstart a loop for politicians to find a solution. Interestingly Private Credit has an curious role in this case.
The industry already has enough trouble in the US, where fears about AI undermining software borrowers have prompted investors to ask for their money back and funds had to restrict withdrawals. Different market, different underlying credit troubles, same problems with redemption gating. Another reason to be suspicious of the asset class?
Except I think we should give it some credit for being there. Someone has to finance construction before the homes can be handed over. Private credit has found an attractive business doing that. I am less convinced by its efforts to make the investment convenient for everyone who might buy it.
A quick dive into property development financing:
Development finance covers the gap between starting a project and getting paid for the finished properties. The developer puts in equity. The lender advances money as construction progresses, checks the work before releasing more, and takes security over the site. Repayment comes from sales or refinancing. For smaller projects, the construction loan commonly runs for 12 to 24 months.
Where are the banks?
That should be interesting business for a bank. But regulators found that a compelling angle to cool the housing market and avoiding banks loading up on exposures to the hottest part of the market. Under the standardised framework introduced in early 2023, development and construction loans generally attract a 150% risk weight. There are some carve outs (presales > 100% of loan) but in general this regulation has done exactly what it intended to do: Get banks out of the property development stage. Intro the law of unintended consequences: financing is still needed, after all property is hot… enter the white knight: private credit.
For a private lender, the calculation is different: there are no capital requirements, only risk-return calculations. A relatively short loan, first-mortgage security, developer equity absorbing losses first, and decent interest and fees are an attractive combination. The job is to assess execution: can this developer finish the buildings within budget and sell them for enough to repay? Get that judgment and the pricing right, and it is good business. It also gets homes built that might otherwise struggle for financing.
Do your structuring right, set up an SPV for each project, ringfence the collateral and you have nothing to worry about. Enter the law of unintended consequences (again!?). For a large developer with a lot of projects, each under their own SPVs this makes a rescue package extremely difficult. Each project with its own lender, everyone on their own terms, everyone protecting their capital. It becomes an unwieldy task to work through. Media / politicians will happily blame the broader ‘private credit industry’ for not cooperating.
In reality each (project) lender has a different decision to make. The one financing a nearly finished project may happily put in more money. The one facing years of work may prefer to sell the site. Both are protecting their investors. Neither has to be incompetent or heartless for a collective rescue to become difficult.
How did we get here with private credit?
Follow that money one step back and the next problem comes into view. Private credit has actively pursued growth beyond institutions, opening more funds to wealthy individuals and retail investors. Regular withdrawal opportunities help sell those funds to people reluctant to lock their money away. The loans remain illiquid, so managers include limits and the ability to suspend redemptions. They know perfectly well that they cannot pay everyone back on demand.
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This is where I think the industry has made life unnecessarily difficult for itself. It wants capital that will stay through a troubled loan, while attracting investors with opportunities to leave. The qualifications are in the terms. But the withdrawal window is part of the appeal, and the restriction is what people remember when they finally need it.
The same goes for the reassuringly smooth returns. I have always found that argument a little cheeky. If you price an investment less frequently, you will see fewer price movements. The borrower’s ability to repay can deteriorate all the same.
The extra yield is payment for accepting something. Credit risk, illiquidity and the work of recovering a difficult loan are all candidates. If you cannot explain what you are being paid to accept, the investment deserves another look.
The details matter
When projects finish on schedule, repayments can fund withdrawals and everyone is happy. When loans need extending, the cash arrives later. Word spreads, rumor mills work and nervous investors ask to leave (rightly so), and the manager has to enforce the redemption restrictions. Centuria Bass and CVS Lane have suspended redemptions for their private credit funds. We have already seen this in U.S. private credit, those redemption requests will keep coming now. Even for funds that are doing well and do not have bad loan exposures. That’s how bank runs work as well, once the confidence is lost, there is no easy turn back.
That does not tell us what investors will ultimately lose. A gate can protect them from assets being sold cheaply to pay the first people out. Clearly disclosed restrictions are part of the investment they bought. Disliking their enforcement is not, by itself, evidence of having been wronged.
Still, I would rather the industry were firmer at the point of sale. If the strategy needs committed capital, sell it on that basis. It might raise less money. It would spend less time explaining why the access investors thought they had is unavailable.
So, all clear then for the managers?
Managers also need to earn their defence. Regulators have found weaknesses in valuations, disclosure and conflicts management. A useful lending business does not excuse poor underwriting or a misleading sales pitch. Those are proper grounds for criticism, and Bathla will give plenty of opportunity to examine them.
I expect the broader argument to be less discriminating. Buyers want homes, fund investors want withdrawals, and politicians want somebody to resolve the mess. Private lenders will be conspicuous both when they refuse more financing and when they refuse to release cash. Explaining that they are protecting their investors will not make them popular.
For all the attention, Australian private credit is a roughly A$200 billion market, about 3% of the size of the banking system. In a country with trillions in bank assets and listed equities, that is a modest pool of capital. Yet in development finance it punches above its weight, funding projects that struggle to attract bank lending. Making that capital harder to provide will not make the need for it disappear.
But I do think the industry deserves a fair hearing. A failed developer does not make development finance a bad idea. Enforcing withdrawal limits does not, on its own, mean investors were cheated. And protecting a lender’s claim can be reasonable even when it complicates a rescue.
For private credit funds, I will be watching whether repayments allow withdrawals to resume and what investors actually recover. Those outcomes will tell us more about the lending than the announcement of a gate. Private credit earns its place by financing risks others are less willing to take. We should judge how well it takes them.
