Posted on 30 April 2021

Growth Opportunities for Private Credit In Australia

Australia has recently experienced growth in its private credit sector – addressing demand and opportunities currently underserved by the traditional banks. Peter Zanapalis, Country Executive Australia at Alter Domus, recently spoke to Joe Millward, Founding Partner of Epsilon Direct Lending, to give Sensus readers deeper insight into Australia’s burgeoning private credit scene.


With over 20 years of expereince in banking and lending with companies like Commonwealth Bank of Australia, Bank of America, and Royal Bank of Scotland, what was the driving factor behind the decision to set up Epsilon Direct Lending in 2019 with your fellow co-founders?


There are plenty of commonalities between our three founding partners. For me, the current situation is like betting on a replay. What we’re seeing in Australia today is a replay of what happened in Europe and the US 15-20 years ago, in terms of a transition of lending market share from banks to non-banks.


I was involved in the start of the non-bank movement in Europe and witnessed the evolution in that market over the years. As recently as five years ago, the conditions weren’t right in Australia, as the banks were still reasonably efficient. However, in recent years, customers began mentioning that their counterparts in the US and Europe were finding it much more efficient to obtain non-bank funding – and they were highly supportive of us to set up our own shop. In that respect, it’s really been a customer-led effort.


On the eve of your first fund launch, what have the biggest challenges you have faced so far?

Aside from the Covid-related challenges everyone is facing, I think understanding the needs of the investment community, and establishing and building relationships with them has been really interesting. Through our previous work with banks and funds, we’ve built a good understanding of what investors are looking for, and we’ve made some great progress in securing cornerstone investors over the past few months.


There are three core components that every fund manager has to consider: assets, liabilities and the things that make the two sync. Assets are a strength because of our market relationships and our direct lending strategy, while liabilities are going to be a longer journey, but we’ve had good help navigating the market. For the last piece, we’ve chosen to work with Alter Domus, as very few service providers in the Australian market truly understand private credit – from fund administration all the way to legal and taxation.


The private credit market in Australia has been growing at a quick rate over the last 5 years. How long can you see this thematic continuing?


Australia’s market is still in its infancy. We’re around 15- 20 years behind Europe and the US; and from a historical standpoint, accessing Australian corporate loan investments has been difficult as 90-95% of the segment was dominated by banks. Compare that to a market like the US, where 20% of corporate debt is financed by banks and 80% by non-banks. It will take some time, but the proportion of non-bank lending will increase.


At the same time, banks have been looking to lower the cost of servicing customers – which means they are seeking to increase automation and standardisation across the board. Covid-19 has only accelerated this trend, and banks are seizing the opportunity to make seismic shifts due to the pandemic. This opens the door for more bespoke lending opportunities, where non-banks can thrive.


When looking at the current private credit landscape, which segments or asset classes are outperforming? 


here are two key ingredients from a market perspective that drive outperformance in private credit: a large and stable segment, and strong supply/demand dynamics. The largest segment is vanilla bank debt, and customers looking for a standardised product will do well here. The next biggest segment is real estate – and while banks are not retreating from real estate, they have always been focussed on a confined definition of the asset class, leaving non-banks to compete on credit risk, terms and conditions for the rest of the segment.


Middle market direct lending is a large, stable segment worth AUD70 billion. This is not distressed lending, but lending for growth and event-driven financing including leveraged buyouts and acquisitions. It’s a very stable segment, which has much lower volatility embedded than real estate lending or special situations lending. With many banks retreating from the middle market, we see an opportunity here – and Epsilon is the only Australian fund manager that focusses purely on this space.


Why is Epsilon specifically targeting the middle market direct lending segment? 


Relative to offshore, focusing on the mid-market allows us to offer a better risk/return ratio to investors. Contributed equity is higher in Australia, sitting at around 60% versus 40% offshore, and investors are able to access the same returns as European and US investments, which sit around 6%. Additionally, cov-lite loans are non-existent in the Australian middle market.


We also offer a unique strategic option in that we don’t lend to large caps, meaning we have different exposure on the books compared to other domestic fund offerings.


Most importantly, the middle market offers lower volatility. In the event of a default, investors are more likely to recover more of their loans from a medium cap than a large cap, as large businesses tend to be more complex and have more moving parts. It’s much easier to work out deals in the middle market.

In this segment, you need to have strong relationships and to know who the players are, both good and bad. Historically, very few banks had dedicated mid-market cash flow lending teams, and as a result there aren’t too many professionals in Australia with this type of experience. Aside from Epsilon’s partners, I know very few private credit fund managers in Australia who have managed a credit fund through an actual recession or built a mid-market lending team from scratch and grown it to over AUD4 billion.


What attributes do you look for when choosing a fund administrator and other third-party service providers? 


Investors don’t get paid for operational risk. I have managed funds before, which is different from a big bank where everything gets taken care of behind the scenes. We’ve seen what happens when you try to do things by yourself and run your business off of spreadsheets. There are so many administrative tasks that it’s difficult for fund managers to stay on top of everything.


At the end of the day, we are fund managers – and we don’t pretend to be a specialist fund administrator. We strongly believe that when you need help, you should partner with the best. Although it may cost a little more upfront, the cost of getting it wrong is potentially much, much greater. Alter Domus appealed to us because they have global experience and a strong track record, and the local team has been in the market for a long time.


This article was originally published in Sensus Magazine. Download the latest issue below. 




Zanapalis Peter 215 145

Peter Zanapalis

Country Executive Australia

+61 2 8330 6867