Making sense of non-bank lending: five questions for private credit investors

Investing in private credit can be a great option for investors, provided it matches their portfolio objectives and risk tolerance. However, having a solid understanding of how non-bank lending works can help investors gain comfort with this growing asset class.

Private credit is gaining traction among Australian investors seeking income, diversification, and access to alternative lending opportunities. One of the most dynamic areas within this space is non-bank lending; a sector that’s grown rapidly but is still not well understood by many. For those considering exposure to this sector, understanding how non-bank lenders operate, manage risk, and generate returns is key. Below, we unpack five key questions to help investors become more comfortable with this growing market.

1. What is non-bank lending?

Non-bank lending is a well-established but still growing segment of Australia’s credit market. Non-bank lenders are more flexible in lending to borrowers such as small businesses, self-employed borrowers, corporate entities, property investors, and others who may fall outside the criteria of mainstream lenders such as the major four banks.

Instead of taking deposits from the public, as a bank does, these institutions raise capital from private investors, global wholesale funding (including securitisation) markets, and other large financial institutions.

Non-bank loans provide access to capital for borrowers who value flexibility, and for investors, the sector offers exposure to private credit opportunities with a target yield above cash and term deposits – although investors should note this often comes with higher credit and liquidity risk.

It’s also worth understanding that the Australian private credit market is relatively small when compared to the global private credit market. It is estimated that there is around $40 billion in private credit outstanding in Australia. Compare this to global private credit assets under management, which are reported to have quadrupled over the past decade to US$2.1 trillion in 2023.

So, while non-bank lending has been getting a lot of attention recently, it has been around for decades and is highly sophisticated in a global context.

2. Why has the non-bank lending space been expanding?

The non-bank lending sector in Australia has grown in recent years for a number of reasons.

Firstly, following the GFC and Banking Royal Commission, prudential regulator APRA introduced stricter lending criteria especially on residential mortgages, strengthening lending standards and increasing oversight. This was reflective of the shift in global prudential lending standards, which tightened worldwide following the implementation of Basel II and III, requiring banks to hold more capital and prompting them to curb lending activity.

As a result, many borrowers such as SMEs, self-employed individuals, and property investors have found it harder to access credit through mainstream banks.

Non-bank lenders have stepped in to fill this gap, offering more flexible terms, faster approval processes, and niche lending solutions.

At the same time, the sector has benefited from growing investor appetite for private credit, which has provided the capital needed to support expansion. As Baby Boomers enter retirement, there’s soaring investor demand for income, yet traditional fixed-income returns haven’t always lived up to expectations. This has spurred interest in more diverse asset allocation, including to alternative asset classes such as private credit. In response, a broader range of private credit solutions is now available to investors.

This shift has seen non-bank lenders move from the periphery to occupy a more mainstream role within Australia’s financial ecosystem.

3. How is a portfolio of loans constructed?

It’s also helpful to understand how reputable non-bank lenders construct a portfolio of loans in a way that seeks to mitigate risks.

For example, a way of managing risk is to secure the loans against real, income producing assets, such as Australia’s ubiquitous residential properties or commercial properties like offices, shops, factories and warehouses.

A key safeguard is the loan-to-value (LVR) ratio, which reflects the size of the mortgage relative to the property's value. A lower LVR provides a cushion in the event of a market downturn, ensuring there is a margin between the loan amount and the underlying asset value.

Finally, it’s important to remember that non-bank mortgage lenders operate with rigorous and ASIC regulated credit assessment processes, independent valuations and ongoing monitoring of loans by multiple institutional stakeholders.

4. What are the different ways investors can invest in loans originated by non-bank lenders?

Private credit funds offer a way for investors to access loans originated by non-bank lenders. These funds can be pooled whereby investors have exposure to a diversified pool of borrowers, or they can be single assets where investors can choose which loans to participate in.

It’s also possible to invest directly in loans or in residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS) or asset-backed securities (ABS) issued by non-bank lenders.

These direct investments, however, are traditionally issued to institutional investors. Private investors can in turn invest in these loans via a credit fund or third-party bond provider.

5. How can you assess the quality of a non-bank lender?

It’s essential to know how to identify a well-run non-bank lender and, if applicable, the investment fund you are using to access this asset class. First, does the lender have a strong reputation, experienced team and track record of delivering and being disciplined in their lending practices?

Second, is to look at the structure of the non-bank lender. For example, Thinktank works with a number of institutional investors, such as global and domestic banks, with independent auditors (Ernst & Young,) trustees (BNY Trust Company) and back-up servicer (AMAL Asset Management) rated as ‘Strong’ by Standard & Poors.

Finally, investors can look for external research to provide more information on the fund, its structure, underlying assets, performance and management. For example, SQM Research has rated Thinktank’s Income Trust as ‘favourable’ and its report provides investors with detailed information on the fund’s characteristics, philosophy, investment processes, performance and comparisons with peers. In addition, Thinktank’s Residential and Commercial Mortgage-Backed Securitisation term deals are independently rated by Standard and Poor’s (and by Fitch for the AAA tranche of RMBS transactions).

Non-bank lending has become an increasingly important part of Australia’s credit and investment landscape, offering borrowers more flexible financing and investors access to income-generating private credit. In recognition of this, regulators including ASIC, are looking more closely at the sector with a view to ensuring investors are well informed on their investment options and associated performance. Thinktank welcomes this expected uplift in regulatory oversight.

All investments carry risk, and all things being equal, a higher returning product carries higher risk. Hence, sophisticated investors should understand where their portfolio is invested and the circumstances in which the fund or asset base would come under pressure to repay investor income or capital. Like any investment, it’s essential to understand the structures, and safeguards, and to choose managers with a clear process and disciplined approach. With the right knowledge and due diligence, investors can confidently explore this sector as part of a well-diversified portfolio. Investors should also be aware that private credit funds may have limited liquidity or withdrawal rights compared to traditional investments.

Thinktank’s Income trust may be suitable for investors seeking passive, secured, and regular income derived from residential and commercial property mortgages. Prospective investors should consider whether this investment aligns with their objectives. Please contact us if you’d like to know more.

Disclaimer: This article is for general information only and does not constitute financial advice. It has been prepared without taking into account your objectives, financial situation or needs. Past performance is not a reliable indicator of future performance. Thinktank’s investment products are available to wholesale investors only (as defined under the Corporations Act 2001 (Cth)).