Australia | Sep 18 2020
A Listed Investment Company (LIC) is a listed investment vehicle that offers investors access to a diversified portfolio of shares in other companies also listed on the stock market.
Note: For comprehensive comparative data tables for LICs and ETFs please see attached. The story below is part of IIR's monthly update on Listed Managed Investments (LMIs) on the ASX which in its entirety is attached to this story.
Analyst Rodney Lay puts ASX-listed commercial real estate (CRE) private lending providers under scrutiny
Australian CRE Private Lending - State of Play
This is a lengthy thought piece but given the dislocation created by Covid-19 it is important that every identified material risk and opportunity for non-ADI alternative private debt lenders is given due discussion so that investors can make informed investment decisions.
With the possible exception of the industrial property sub-segment, no segment will be left unscathed by the ructions caused by Covid-19. But this does not mean there are not opportunities for astute, through cycle experienced and well-resourced private debt investment managers.
The larger alternative private debt managers that have focused on quality assets with non-cyclical cash flows, lent to strong asset-backed landlords and developers, and lent on conservative LVRs will do well. The market has already seen an increase in the interest rate premium for the same level of risk. Private lenders will undoubtedly gain market share with the further retreat of banks and foreign lenders to their respective home markets.
The key conclusion is risks and opportunities abound, but investment manager selection is key. As Warren Buffet famously said: “It’s only when the tide goes out that you learn who’s been swimming naked.”
In the current environment we believe there are a number of key qualities a manager must have to avoid the risks and capitalise on the opportunity set. In turn, for investors this relates to manager selection. IIR believes the important components are as follows:
1) track record of performance;
2) risk management capability and evidence of historical workout / corporate restructuring experience;
3) relationship management and borrower origination track record;
4) risk management / distribution and exit skills;
5) investor appropriate fund terms (risk, returns and liquidity), fees and costs of the investment product, scale and credit risk diversification;
6) size of team and breadth of market coverage; and,
7) investment in IT and portfolio risk management functions.
Investors are also seeking the manager to originate transactions and negotiate the appropriate fees and lending margins i.e., direct borrower relationships versus passive buy side bank ‘stuffee’. Therefore, if a manager has a small origination team or is reliant upon other originators or brokers for deal flow then the returns available to investors will be inferior.
Metrics, for example, often says that it seeks to bring investors closer to the point of origination. The benefit? The lender who originates the transaction charges the borrower 300bps fee, for example, and then sells down the risk to a new lender. The originating lender keeps 250bps points of the fee and shares or pays away 50bps to the secondary lender to participate in the transaction. Therefore, if a private lender can not originate transactions it incurs lower returns.
Finally, IIR believes that private credit is one of the few asset classes where the skillset of the manager can actually demonstrate the managers capacity to ‘preserve investor capital’. That is, when a manager originate a transaction and negotiate the terms, conditions, controls, covenants and security the manager is taking active steps to mitigate downside risk of loss of investor capital. Therefore, appropriate due diligence is undertaken to assess the risk to ensure appropriate lending terms are documented.
Each economic downturn creates opportunities and challenges in the credit markets for private credit and special situation investors. During and in the wake of Covid-19, the opportunity arises from the fact that lending in Australia has historically been driven, to a large extent, by banks and, as borrowers’ revenues plunge, a significant number of them will have to look to private credit to refinance their existing amortising bank debt.
Furthermore, banks are currently under significant workload stress and are likely to be for the next few years, which is likely to lead to deteriorating service levels and prolonged debt issuance time frames for existing and potential new borrowers.
Additionally, Over the last 10-year bull market banks have shed and reduced their workout capability internally quite drastically as well - there is likely to be an inability from a resourcing and skills perspective to work through deteriorating credits, opening up further deal flow to non bank lenders in potentially heavily discounted credits. In short, the private credit market will have a real role to play in ensuring that there is still liquidity in the system for some of those borrowers.
The ability of private credit investors to deliver greater flexibility than typically seen with financings from banks, with bespoke solutions and the ability to be more responsive will be a huge differentiator.