The Australian private credit market has grown to an estimated $200 billion, with approximately half of that concentrated in real estate financing. This rapid expansion, fuelled by growing superannuation assets and the search for yield, has attracted increasing regulatory scrutiny. The recently published ASIC report (named REP-814 Private Credit in Australia)  on private credit authored by Nigel Williams and Richard Timbs represents a landmark regulatory assessment of the sector, examining operational practices, conflicts of interest, fee structures, and valuation methodologies across the market.

We have been closely monitoring the private credit sector and the ASIC report provides important validation of our concerns that that have been building for years. However, while the report identifies critical issues requiring attention, it also reveals gaps in understanding of the deeper structural vulnerabilities that could emerge when the credit cycle turns. This article compares observations in ASIC’s report with Rhizome’s research, highlighting areas that should also be considered and were not covered in the scope of ASIC’s review.

Key convergences: where ASIC validated our concerns

Conflicts of interest: a systemic issue

The ASIC report appropriately identifies conflicts of interest as a Priority Issue, highlighting how these can manifest across fee structures, valuations, and related party transactions. The report notes that some managers retain 50-100% of upfront and borrower-paid fees, creating potential misalignment between manager and investor interests.

This validates longstanding concerns about the industry’s fee structures. As our research has consistently highlighted, these arrangements can create perverse incentives where managers benefit from transaction churn, loan extensions, or even defaults—all at the potential expense of investor returns. The ASIC report correctly identifies that “non-disclosed remuneration can be a multiple of up to three to five times the publicly disclosed fund management fees.”

    The use of Special Purpose Vehicles (SPVs) to capture net interest margins—where managers lend to borrowers at higher rates than paid to investors—represents another area where ASIC’s findings align with our observations. This practice effectively sees managers acting on both sides of transactions, manufacturing arbitrage that may not be fully transparent to either borrowers or investors.

    Valuation opacity and methodology concerns

    ASIC’s identification of valuation practices as problematic echoes concerns detailed in our analysis of unlisted asset valuations. The report highlights that many funds fail to conduct quarterly independent valuations, with some relying on internal processes that create inherent conflicts where “fees depend on those same asset values.”

    The report’s focus on real estate lending practices is particularly important. ASIC correctly identifies that quoting loan-to-valuation ratios (LVRs) on completion value rather than development cost understates risk throughout the construction period. This practice can show a seemingly conservative 70% LVR while the actual exposure during construction may be closer to 80-90% of cost.

      The observation that some funds report no impairments despite high sub-investment grade exposure is striking. With rating agency expectations suggesting 1-year probability of default ranging between 0.5% and 15% for BB+ to CCC rated loans, the absence of provisions raises serious questions about valuation methodologies.

      Concentration to construction risk: the elephant in the room

      ASIC’s report appropriately identifies the concentration in real estate construction and development as representing “the greatest potential risk of impairment or credit loss.” With an estimated 40-60% of the Australian private credit market focused on real estate, and much of this in higher-risk construction and development, the systemic implications are significant. Private credit investors are taking on heightened construction risk when the construction industry is facing it worst failure rates in decades.  

      The ASIC report also calls out that “Construction finance requires specialist skills and management of finance, funds release and costs management”. Even sophisticated larger banks have struggled with effectively managing and mitigating the construction risks in residential development projects in past downturns. This is notable given their prudent risk profiles and substantially greater ability to manage construction risk compared to private credit.

        Fee disclosure gaps 

        The report’s findings on fee disclosure validated our concerns about market opacity. The report identifies that “many funds do not quantify total manager remuneration, particularly from borrower-paid fees and net interest margins.” This inconsistency makes direct comparisons between funds difficult and may leave investors unaware of the true cost structure.

        International managers typically pass all borrower fees to investors and charge transparent management fees. In contrast, many domestic funds—particularly in real estate—retain substantial portions of borrower fees while advertising lower headline management fees. As ASIC notes, this creates a situation where “headline management fees [are] significantly understated to investors for the total manager remuneration.”

          Important considerations not covered in the scope of the review

          While the ASIC report provides valuable insights into current market practices, it does not fully examine several critical dimensions that become particularly relevant when considering how the market will perform under stress.

          Equity risks for debt returns: Many problem loans historically exhibited longer tenors and higher risk profiles while earning relatively low returns. The banks learned that providing leverage against personal and corporate guarantees created exposures that “typically became worthless when defaults occurred“. Current private credit portfolios increasingly contain equity-like risks—including structures dependent on sales growth, margin expansion, or continued asset price appreciation—while offering limited upside to investors.

          The disconnects between risk profile and expected return highlights the potential for significant investor losses if market conditions deteriorate. Furthermore, the prevalence of complex inter-creditor arrangements and layered capital structures can obscure true risk exposure (as highlighted in ASICs report), making it difficult for both investors and regulators to assess the likelihood and scale of potential losses. In an environment where asset valuations are increasingly sensitive to economic headwinds, these issues pose heightened challenges for transparency and prudent credit risk management.

          Many private credit development finance loans are based on projects with poor feasibilities that have insufficient buffers to cover unexpected costs overruns

            The Centre for International Finance report  prepared for NSW Treasury in August 2024, further investigated the feasibility of mid-rise apartment projects in Sydney finding that, on average, 2023 project costs exceeded sales prices for the first time in recent years They provided analysis that showed that this decline was primarily due to higher land, construction and financing costs, with similar factors likely impacting feasibility in other states. We have observed private credit finance for development projects with single digit margins. This is unlikely to be sufficient to cover cost overruns and construction delays especially if the builder was to get in to trouble. There are a number of recent examples of builders becoming insolvent during construction and work stopping until a replacement builder can be contracted.

            Another important recent trend to also consider is that construction companies are resisting arrangements for fixed price contracts. Rather lenders and construction companies are starting to share the risks and profit associated with construction. This further heightens the risks for lenders and in turn private credit investors where they will need to provide additional capital to cover cost overruns in order to finance the project through to completion. In the past, this was a risk that was materially passed through to the construction company.

            Mezzanine, equity finance and risk tranching participations by private credit not only masking leverage but introducing risks to bank lenders

            Whilst risk structuring may reduce headline senior debt to construction costs ratios for senior secured bank lenders to meet underwriting standards, we are starting to see the re-introduction of capital structures with mezzanine and equity loans provided by private equity lenders.

            Whilst this results in bank debt that complies with bank underwriting metrics for gearing it does not mitigate the risks associate with financing developments including construction risks. In most of these cases there is minimal hard equity provided by the project sponsor to ensure an alignment of interests to complete the project and repay the loans at completion should the project get into trouble.  APRA’s Letter to All ADIs regarding Commercial Property Lending – Thematic Review Observations dated 7 March 2017 noted the expectation that ADIs ensure a sufficient level of ‘hard equity’ is at risk from equity sponsors.

              The cash flow analysis myth

              ASIC’s report doesn’t adequately address the gap between stated practices and reality in credit analysis. While “everyone apparently uses cashflow analysis techniques,” the reality is that most private credit lenders have been observed using earnings-based measures rather than analysing operating cash flows available for debt servicing. This is particularly relevant with income producing commercial property investment loans.

              The resilience of structures and leverage sizing depends heavily on thorough scenario testing.

              Yet subjective “severe but plausible” scenarios contain built-in biases from transaction originators. Better practice involves breakeven and worst-case scenarios to identify sensitivities. Postmortems of problem loans consistently reveal reliance on optimistic projections, including directional plays with unpredictable timeframes and unrealistic price assumptions.

              The case for independent credit assurance

              The ASIC report’s findings reinforce the case for independent credit assurance beyond standard governance structures. As outlined in our research, despite established practices, lenders with high conviction during benign conditions often face unexpected losses when markets turn.

              Independent oversight should:

              • Challenge underlying assumptions in credit risk strategy and appetite
              • Assess whether credit approval and exposure management are truly effective
              • Provide portfolio insights to senior executives, investment committees, and boards
              • Facilitate risk culture alignment between origination teams and oversight functions

              This independent perspective becomes increasingly valuable as alert fatigue may desensitize internal teams to building risks.

              For assistance with portfolio deep-dives, lending culture assessments, and independent credit assurance, market participants can benefit from experienced specialists who understand both the opportunities and risks in this evolving market.

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