Australian private credit markets have been growing fast, particularly the commercial real estate (CRE) sub-sector that accounts for the lion’s share of the Australian market.
There’s much to like about private credit, investments have security over real assets and investments can hold a range of positions in the capital structure. There are covenants requiring minimum performance and maintenance standards, and borrowers pay monthly interest, ensuring minimum future cashflows. Yields can be attractive as they should incorporate an illiquidity premium.
When there’s plenty of liquidity, the illiquidity premium, that is how much you get paid to take on the extra illiquidity risk is often forgotten and declines as investors reach for yield. Liquidity takes a backseat until you need it.
I wanted to highlight a case this week where Merricks Capital backed by Regal Partners, according to the AFR, has told investors in its flagship Merricks Capital Partners Fund, it will have to delay redemptions because there is no ‘unallocated cash’ to distribute to them.
Instead, investors who want to redeem funds will be offered a new class of unit and aren’t forced to back any new loans. They will continue to receive distributions, but redemptions would likely only start being processed in December 2025 and then in six-monthly increments.
There’s little information about the fund on the website. I was hoping to read the product disclosure statement to understand the fund’s redemption process.
If a CRE private credit fund becomes illiquid, the portfolio managers have a few possible remedies. Most obvious is to either try and sell the debt, probably at a deep discount, particularly if a project is mid-completion. Or more likely, defer redemption and hold out for completion and sale of the building. There are other avenues, like raising debt, which would be expensive or additional equity, which isn’t always an option.
Also read: The Return of Credit: Quality, Yield, and the Case for Going Global
In any case, it’s a good reminder that things don’t always go to plan, and capital may be tied up for longer than expected, particularly in an open-ended credit fund. Given the Merricks example, before you invest in private credit, please consider how capital is returned to you, if there are any penalties to borrowers if the issue resides with them, and if investors are compensated or additional fees go back to the fund manager. Also, importantly, for future investors, what is the additional margin needed over public debt to jump the illiquidity hurdle?
Merricks’ move to defer redemptions should raise questions over management and performance of underlying loans and construction timetables. It’ll be interesting to see if the company has done enough to placate the current investors, or whether they’ve decided to join the exit queue.
Just last week, we began a three-part series on lessons to be learned from historical examples of funds that have failed investors through poor credit portfolio construction, publishing an excellent paper, Credit Portfolios, Valuations and Liquidity (Part 1) by Richard Quin, CIO at Bentham Asset Management. Part 2 is now available.
We have many other articles that may help if you are interested in the sector. Here are just a few:
Caution – Investors need to assess private credit quality
Growth in Global Private Credit
Filling The Lending Void In A Post-GFC World: Private Credit
Public and Private Credit: Where Investors Should Focus
Does Private Credit Still Have The “Rizz” Factor?
Private Credit – The Risks and The Returns
4 Things You Need To Know About Investing in Private Credit
