Investors Urged to Vet Private Credit Managers After ASIC’s ‘more failures’ Warning

“That seems to have happened in some instances, but not in all instances… It’s not a systemic issue.”

Ng said private credit valuations are less transparent than public markets, where valuation methodologies are standardised. In private markets, valuation assumptions can be adjusted in internal models — sometimes making assets appear healthier than they are.

“How do you know at the time someone defaults that they’re going to have the ability to turn around? That’s the question,” Ng said.

“Sure, they could turn it around but you won’t actually realise the benefits of the turnaround until much later, potentially years later. You have to think about what’s the likelihood of being able to turn that company around?”

Frontier Advisors senior consultant Nam Tran told Capital Brief that when debt held by private credit funds was converted to equity, as a general rule the valuation of the investment should decrease.

“As a general rule, if you initially invest in debt and the borrower defaults, the valuation should come down as it would have taken time to deteriorate,” he said.

Metrics soothes concerns

One of the booming asset class’ pioneering managers in Australia, Metrics Credit Partners, found itself at the centre of growing market jitters this year towards the asset class.

In January, it sought to correct media articles on a $41.9 million loan on a vacant block of land in Melbourne.

The loan defaulted following the introduction of a new subordinated loan of $9 million by another private credit lender which resulted in receivers being appointed and enforced on the security held.

A number of Metrics funds contributed equity to establish a special purpose corporate entity which bid in a subsequent sale process and acquired the property for $53.35 million.

Metrics said prior to the acquisition a number of independent third-party valuations for the asset were in the range of $50 million to $71 million.

Metrics chief executive Andrew Lockhart has consistently downplayed broader concerns towards the asset class, and his own funds.

He said Metrics will convert debt positions into equity when it makes sense to do so to protect, and maximise, investor returns.

“You’re buying it and taking control of the low end of the cycle with a view that you want to profit and participate in any increase in value and increase in earnings,” Lockhart told an industry summit attended by Capital Brief in February.

“… To have the ability to convert debt to equity is done as a means to protect investor interest. If you have no ability to convert debt to equity, or you have no skill set to be able to do that, then others in the market will see you as weak hands and they’ll take advantage of that and offer you a low price and force you to be a seller and take a loss.”

Metrics Credit Partner’s ASX-listed Income Opportunities Trust has the ability to convert debt to equity. It is also able to invest in equity and equity-like investments.

According to ASX statements, the portion of equity in the fund has increased from 5% in 2019 to 25% at the end of 2024. Metrics did not disclose how much of the 25% was due to debt to equity swaps but told Capital Brief that it was a low portion.

As of December 2024, there were four loans under restructure in the fund which accounted for 6.7% of assets under management at restructure. Seven loans were on the fund’s watch list for issues with three of those under enforcement action.

Defaults rising

Frontier’s Tran said that defaults had been rising from a low base at an absolute level over the last three years since interest rates started to increase, which led to higher input costs across the economy. However, at this stage the level of loss and defaults had been relatively modest and manageable by the private credit funds Frontier monitors.

“Performance has been fairly solid so far because the amount of loss is low compared to the income that the funds can generate,” Tran said.

He said that private credit funds would likely take advantage of their ability to convert debt into equity positions if the economy worsened.

“If you see a lot of that, it ultimately means the fund performance will suffer. If it’s a relatively small portfolio and a large portion of it is in default, then that’s an issue,” he said.

However, Tran stressed that when analysing funds that did this there was a clear distinction between what portion of the fund’s equity exposure was from converted debt and what portion was from the fund’s ability to hold equity from day one.

Ng said the real risk came when a fund marketed itself as senior secured debt but lacked the systems and processes to manage an equity position — yet still pursued one.

“Some of the headlines in the media have been a bit of a beat-up in the sense that there are various fund debts being converted to equity, but you’ve got to peel back the layers and understand what the actual funds were trying to do in the first place”, he said.

Case by case basis

Asteri Asset Management head of core and opportunistic portfolios, Eitan Nevo, said it was important to view things on a case by case basis.

“Under certain circumstances, certain managers are well within their mandate of finding themselves in this position. But this should really be considered on a manager by manager basis and almost on a position by position basis when these things happen,” Nevo said.

“In some cases it’s 100% in the interest of the credit holders to convert into equity holders.”

However, it was critical that investors chose fund managers with the expertise to manage that process and kept an eye on overall equity exposure across their portfolios, he said.

Ng said investors should closely examine the methodologies used by fund managers to value loans and portfolio companies.

“The worst thing that can happen is they don’t actually manage to turn around the company, and the company goes under, and there’s a complete 100% loss,” he said.

“If they can work it out it’s less of a problem but in the end, it’s the money that comes back into invested hands that matters most.”