Private credit issues ‘not endemic’, but failures spark concern for SQM

SQM Research has put the private credit sector on watch – essentially flagging that it will increase its ongoing monitoring of the sector and has “made adjustments to its ratings scoresheet to place a greater weighting towards governance factors”.

As a result, the firm has “strongly encouraged” advisers to monitor SQM’s daily ratings notifications.

The move comes after reports this week that Count Financial had recommended its advisers exit three Metrics Credit Partners funds. The $22 billion non-bank lender subsequently pushed back on the news, stating it does not understand the reasoning behind the decision.

However, the decision raised eyebrows, given Lonsec’s Highly Recommended rating on the Metrics Direct Income Fund and claims that Count made the call without meeting with Metrics.

In a comment to ifa sister brand InvestorDaily, Count said the information published by The Australian Financial Review was sourced from a confidential email that was shared with its adviser network. Count’s policy, however, is not to publicly comment on its investment and research decisions.

According to SQM, the change in stance was driven by an increase in issues that it has observed and recent statements from both the corporate and prudential regulators.

Of particular note in the issues that SQM highlighted is that there have been instances of “dubious marketing strategies involving advisers”.

In his opening address to Senate estimates last month, Australian Securities and Investments Commission (ASIC) chair Joe Longo included court action against an adviser and former director in connection with its investigation into the Shield Master Fund among its “strong enforcement outcomes” already in 2025.

Following applications made by ASIC, the Federal Court made interim orders freezing certain assets of Melbourne-based financial adviser Ferras Merhi and Osama Saad, former director of Aus Super Compare and Atlas Marketing, which are both in liquidation.

“ASIC is investigating Mr Merhi and various entities associated with him, in connection with its investigations concerning certain managed investment schemes including the Shield Master Fund. These investigations are ongoing,” ASIC said, adding in a separate announcement that the same is true of Saad.

Merhi controls Venture Egg Financial Services and United Financial Advice, trading as Venture Egg and Financial Services Group Australia Pty (FSGA).

Earlier this week, the Federal Court also made orders freezing assets of Rashid Alshakshir, director of Lion & Horn, Nohap and Indigo Group, all of which are in liquidation.

ASIC said it is investigating Alshakshir and “various entities associated with him in relation to the provision of marketing services (including lead generation) and the payment for those services”, in connection with its investigations into the Shield Master Fund and the First Guardian Master Fund.

While the Shield Master Fund was not a private credit structure, its failure may have spooked SQM, which had provided a rating to the fund before downgrading it to a “hold” in December 2023 and subsequently suspending its rating in February 2024 – the same month that ASIC halted offers of Shield.

Other concerns that SQM noted, such as vertical and horizontal related party structures that may give rise to a conflict of interest, were also a feature of the Shield collapse.

SQM Research managing director Louis Christopher said the ratings house was taking a “precautionary measure”.

“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.

Broader private credit concerns

While SQM Research said it expected the bulk of its existing ratings to not be impacted by this watch, it “cannot rule out” some funds being downgraded or discontinued.

The firm currently has ratings on about 70 private credit funds across both the wholesale and retail space that represent around $33 billion in funds under management, which SQM said makes it the “largest researcher of private credit funds” in Australia.

According to the ratings house, the issues it has observed are “not endemic within the sector”, however they are more frequent within wholesale funds and newer fund products offered to the market, and also include:

• Lack of transparency on who borrowers actually are, on sub fund holdings, and on group financials.
• Questionable categorisation of asset holdings (illiquid/liquid/fixed income/convertible equity/equity).
• 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.
• 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.
• An increasing number of products being offered with a mismatch between stated liquidity and the underlying liquidity of the loan assets.

“We have an expectation that wholesale funds provide the same transparency as retail funds,” Christopher said.

“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.

“As our financial regulators have stated in recent months, there is a clear link between weak governance and poor outcomes for investors.”

This, the MD added, has led to SQM to put an even greater emphasis on reducing the risks for investors through an increasingly “cautious approach to potential governance issues”.

“It must be stated there is no imminent event that SQM Research is aware of that may trigger a series of fund failures and that overall, SQM Research expects the sector to weather current challenges. The private markets sector has a positive future in front of it as there are genuine opportunities for investors,” Christopher added.

“What we are observing to date is nothing like what was experienced back in 2008 when a large number of mortgage trusts were forced into redemption suspensions. However, I think the risks within the sector have increased in recent times and so increased diligence is required.”