The 14 issues prompting SQM Research’s ‘Watch’ on private credit

Having placed the private credit sector on ‘watch’, SQM Research has listed the issues which underpinned its controversial decision.

And one of those issues has been listed as “dubious marketing strategies involving advisers”.

As well, SQM Research managing director, Louis Christopher noted that over the past 12 months the firm had screened out approximately 20 fund offerings with the private credit sector, the majority of which were in wholesale.

“We are taking this precautionary measure in response to increased issues observed in the sector and in response to recent announcements by our financial sector regulators. This action doesn’t necessarily mean that a fund rated by SQM will be automatically downgraded or placed on hold. However, it is viewed as a necessary step to ensure appropriate oversight of an asset class that has been growing in relevance and size over recent years,” Christopher said.

“We have an expectation that wholesale funds provide the same transparency as retail funds. On that front there is no question there has been a rapid increase on wholesale fund offerings which we think has been driven in part by a rapid increase in the number of Australians who now qualify as a sophisticated wholesale investor/high net worth individual; the threshold of which is still set at $2.5 million dollars in net assets or a gross income of $250,000 per annum.”

SQM said issues it had observed with increasing frequency have included.

Lack of transparency on who borrowers actually are.

▪ Questionable categorisation of asset holdings (illiquid/liquid/fixed income/convertible equity/equity).

▪ Lack of transparency on sub fund holdings.

▪ Lack of transparency on group financials.

▪ Highly leveraged balance sheets.

▪ Overall inadequate disclosure within information memorandums

▪ Information memorandums that give too much latitude to the manager in terms of asset allocation weights.

▪ Elevated Loan to value ratios, calculated on end of completion developments.

▪ Vertical and horizontal related party structures (same Trustee, Responsible entity, Custodian, development/real estate agency divisions attached) that may give rise to aconflict of interest.

▪ Increased loan arrears and an increasing frequency of refinancing of existing loans that were scheduled to be exited.

▪ Sizeable interest rate margins not being passed onto investors.

▪ Lack of independence at board/ investment committee level.

▪ Dubious marketing strategies involving advisers.

▪ An increasing number of products being offered with a mismatch between stated liquidity and the underlying liquidity of the loan assets.

The formal statement by SQM said that it wanted to stress that the issues “are not endemic within the sector but do appear with more frequency within wholesale funds and in particular, new fund products offered to the market”.

“Some of these issues have been observed beyond the private credit sector,” the research house said.