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The benefits of scale for private debt investors

In private debt funds – unlike in boutique equity funds – there is a big payoff for investors from having a bigger loan book. Scale makes private debt providers more relevant to borrowers and investors, says Metrics Managing Partner Andrew Lockhart.

Conventional wisdom says that by staying small, boutique managers can deliver superior returns. They are nimble and can move in and out of stocks without the burden of having to invest, even when conditions are not favourable.

But what is true of equity managers does not hold for private debt providers. Increased scale makes a private debt manager more relevant to both the borrowers and the investors and provides more consistent returns. In this article we look at the reasons why, using the Metrics Credit Partners experience to illustrate the benefits.

Metrics was established ten years ago, a pioneer in non-bank lending in Australia, by a team of three partners who worked at NAB and who had extensive experience in lending and portfolio risk management. Since then, Metrics has grown to a team of ~100 people with AUM of ~$10 billion. Metrics has not grown just for the sake of getting bigger, but because there are clear benefits for investors.

Having scale makes Metrics more relevant to borrowers because access to non-bank debt finance can help them grow. With increased funding, Metrics can lend larger volumes to clients to help realise their plans. A smaller lender may not always have the capacity to match the needs of some borrowers and they don’t have the certainty of capital that a larger lender provides.

Metrics is not a bank. It is a minnow compared to the balance sheets of any of the Big Four. But  it does not have their cost structure or rigid business practices, either. As one of the largest non-bank providers of debt finance to Australian businesses Metrics has the capability to match the needs of borrowers in a way that banks cannot. There are regulatory restrictions which impose a higher level of capital to be retained on balance sheets for banks that lend to business compared with lending for consumer purposes where the loan is secured against a residential property. This reduces the returns that a bank can generate from lending to companies which reduces their appetite to do so. But Metrics is focused on business and real estate lending. It has a highly skilled and a professional team with a deep understanding of each borrower, which means they can assess risk and price it accordingly.

Through the recent wave of lockdowns that began in June 2021 Metrics again demonstrated its commitment to business borrowers. In the September quarter alone, Metrics financed in excess of $1.2 billion. By December, as the economy re-emerges from lockdowns, Metrics expects to finalise another $2 billion. It’s unlikely any of our non-bank fund competitors can provide this volume of finance to Australian companies.

All through this period Metrics has further added depth and breadth of expertise, increasing its team ~100 people. By resourcing teams in origination and risk assessment it has a larger more diverse team to consider more lending opportunities. That in turn delivers more attractive returns and capital preservation for investors.

Contrast that with small private debt providers who claim to have the same benefits of a boutique equity investor. Their small scale means they can only do a handful of loans for a small number of clients before they reach capacity. That limits the potential of their borrowers. It also limits the managers ability to create diversified portfolios for their investors, increasing concentration and single large counterparty credit risk.

The big global credit players setting up shop in Australia have a similar scale problem. On the face of it they have huge resources and big, well-known brand names to offer the local market. But the reality is that their local teams are small and lack the capacity to originate many good lending opportunities. When they do find one, the credit decisions are usually taken offshore, away from the relationships and understanding of local nuances that a larger, local private debt manager like Metrics provides.

Being more relevant to borrowers has several important benefits for investors. Scale provides access to better deal flow, giving Metrics a better understanding of the market and the ability to focus on the best quality lending opportunities coming through. Having the ability to lend in larger size also means more negotiating power when determining the terms and conditions on the financing. It allows Metrics to tap sources of income – such as origination fees – that those smaller players cannot, generating better returns for investors.

Scale also provides important risk management capabilities for investors, by allowing diversification across a wide range of industries and sectors. A larger portfolio of loans, where each exposure represents less than 1% of the total, provides cover against any one loan having an outsized impact on the returns to investors. This is also important in preserving investor capital, reducing concentration risk from any one borrower.

Scale is only useful when it delivers better outcomes for borrowers and investors. Metrics’ continued growth and performance reinforces this. This year alone, both listed funds have undertaken significant capital raisings to expand their capacity and continue to trade at a premium to their NAV. New additions to the Metrics suite of funds have and will continue to come to market to ensure those benefits of scale are realised for borrowers and investors alike.

22 November 2021