Jon Adgemis and the private credit reckoning in Australia's property market

Jon Adgemis raised the white flag last October.

With forces closing in from all sides, he declared himself bankrupt to avoid the ignominy of being compelled by his long list of creditors into a life of penury.

His hospitality dream in ruins, the former Maserati-loving playboy somehow managed to rack up $1.8 billion in debt — much of it from private credit firms — over a hotel portfolio that cost less than $300 million to assemble.

Liquidators will attempt to unravel the mystery behind Adgemis's incredible rise and spectacular fall later this week when they begin examinations in the Federal Court.

A conga line of former business associates and love interests have been requested to produce records of their dealings with the one-time KPMG high-flyer.

But there are broader implications.

The examinations of the Adgemis property downfall may well shed light on the extent to which private credit firms, essentially a shadow banking industry with little or no regulation, have their hooks into the economy.

Born out of the tighter regulatory climate after the global financial crisis, they blossomed in Australia in the wake of the Hayne royal commission into banking misconduct.

The Adgemis hearings come at a crucial inflexion point.

The Australian property market appears to be on the cusp of a prolonged downturn, the first since 2017.

That is likely to plunge property developers, the group that overwhelmingly relies upon non-bank loans, into a world of pain that could ripple through to builders and subcontractors.

And it follows warnings from Australia's corporate regulator, the Australian Securities and Investments Commission (ASIC), about the dangers building within this largely unregulated arena.

Marketed with limited regulatory oversight, the industry has attracted cash from retirees and investors seeking high returns in what many mistakenly believe are safe mortgages.

From tiny amounts just a decade ago, ASIC estimates that close to $250 billion in loans are outstanding, an amount that could inflict serious pain on the economy if large numbers of these loans soured.

When friends fall out

Jon Adgemis was the consummate networker.

A deal maker who cultivated an image of success, he advised some of the nation's biggest firms and befriended billionaires in his quest for success.

WIN TV owner Bruce Gordon was once a fan. So too was Jan Cameron, the force behind Kathmandu. Both severed ties with him after disputes over money six years ago.

He bought his first pub in 2015 in Balmain, Sydney, adding another three in the trendy inner-west over the next two years.

But from 2020 on, right through the COVID-19 lockdowns, he added another 14 establishments, mostly in Sydney with a few in Melbourne.

Many needed extensive renovations, and, while work was started on some, few were ever completed, and some stood idle.

It is expected the liquidators will examine how Adgemis was able to continue raising cash, given the limited earnings the properties generated.

One avenue of inquiry will centre on whether the property valuations, many of which were increased shortly after purchase, were reasonable.

Investors who tipped money into the acquisitions generally had little idea where their cash was being deployed.

In most cases, they had invested in a private credit fund that had promised double-digit returns on properties with claims they were protected by strong mortgage backing.

In some cases, the credit funds were charging upwards of 20 per cent interest on loans to developers, indicating the loans were high-risk.

Many developers have difficulty getting loans from traditional sources given the huge outlays required for construction and the long lag times before sales begin to generate revenues.

By the time his Public Hospitality Group collapsed, many of the properties had multiple mortgages.

The private debt trap

The red lights have been flashing for more than a year.

Operating outside the banking system and largely unregulated, private credit is an industry that has many worried, particularly if there is a severe stock market correction or economic downturn.

ASIC has been concerned for some time about the incredible growth in private credit, not just local funds but international funds seeking cash from Australians.

A fortnight ago it issued warnings, advising funds to ensure their valuations were "current, accurate and grounded in realistic assumptions".

"The sector is facing its first real test," it warned.

The Reserve Bank of Australia is also concerned.

A sustained property downturn could impact the financial sector while the rupture of a major global fund could also have spillover effects here.

Globally, private credit is huge.

In the US, the Financial Stability Board estimates the market has ballooned to be worth upwards of $US2 trillion ($2.85 trillion), a system that essentially flies under the radar.

"In the past, private credit mostly focused on medium-sized businesses and was available only to institutional investors, such as pension funds and insurance companies," it notes.

More recently, it has been accessed by mega technology companies in their quest to finance their high-risk ambitions in the race for artificial intelligence superiority.

What could go wrong?

"Private credit at its current size and scope has not been tested during a severe economic downturn, which could expose leverage and borrower credit quality vulnerabilities," it notes.

High returns, high risk

This isn't the first time property developers have been caught in a credit vice that has then flowed through to investors.

As the global financial crisis hit in 2007, a wave of property developers that had been raising cash from retail investors at interest rates substantially higher than term deposits all hit the wall.

Bridgecorp, Fincorp, Westpoint and Banksia Securities were raising cash via what's known as debentures with investors mistakenly believing they had first mortgage protection over the properties to which they were lending.

This time around, investors may be even less well-informed about the ultimate destination of their funds.

Ratings Agency SQM Research recently downgraded a local private credit fund run by investors Centuria Capital.

It downgraded the Centuria Bass Credit Fund, which has $300 million in investments, describing it as uninvestable because of lending to a Sydney apartment developer, Bathla.

SQM has previously highlighted problems with transparency in the sector.

Aggressive marketing and a lack of clarity about the borrowers' exact identity were high on the list of concerns.

As the real estate downturn gathers pace, the pressure on developers will only increase.

According to property monitoring firm Cotality, price falls are accelerating in the two big markets of Sydney and Melbourne and widening to include Brisbane, Adelaide and Canberra, while gains in the remaining capitals are slowing.

That puts a squeeze on developer profit margins, making it tougher to continue funding half-finished projects.

Those losses would then begin to back up into self-managed super funds and private investors who have jumped aboard the private credit express.

In the meantime, many are eagerly awaiting the public hearings for Public Hospitality, and are keen to hear from Adgemis personally when he takes the stand in the liquidator's hearing.