Wholesale lending, a new frontier of income investing

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Non-banks are turning the retail lending space on its head, and it’s not just consumers who are benefiting from the disruption. For Realm Investment House, this burgeoning market represents a fertile investment opportunity.

You might’ve heard of Athena and Nano. These non-banks don't have normal retail depositors, so they depend on wholesale funding. And it’s here, in the wholesale funding space, where Realm Investment House has found strong relative value.

“Wholesale banking offers really strong security, you get really strong covenants, and the tenor is noticeably different – typically 12 months versus a private debt or a syndicated loan which could be five or ten years,” says portfolio manager Rob Camilleri.

Realm Investment House provides this wholesale funding alongside major banks or primary lenders.

The result is a return of 4.75% per annum over cash, making for a strategic income allocation that looks compelling in the low rate world we live in.

In this wire, you’ll hear about how wholesale funding can piggyback the stellar growth of non-banks, and how fixed income investors can take advantage of it. 


Edited transcript

Where are you finding opportunities in the current environment?

Rob Camilleri

We see lots of opportunities come and go through the rate cycle and the credit cycle. But one part of the market that's been fairly consistent, particularly in this low interest rate environment, is the area of wholesale banking.

Some participants could draw comparisons to private debt markets or private credit markets, but we see that there's a number of differentiations that note the differences for both a return profile and a risk profile.

So what is wholesale banking? Wholesale banking is really just the financing that's provided in conjunction with a major bank or a senior lender to help finance companies run their business.

That also extends to some parts of the market where the small ADIs (authorised deposit-taking institutions) or credit unions might need some regulatory assistant in running their mortgage business as well.

What we do like about this wholesale banking market and the differentiation between private credit and private debt is that you get really strong security; you get really strong covenants.

The tenor is notably different, typically about 12 months versus a private debt or a private credit syndicated loan, which could be five to 10 years in its own right.

The return and risk profiles are quite different as well, because of the underlying nature of the security and the relationship where we sit in these transactions.

You get enhanced credit enhancement in terms of real equity that sits underneath you to cater for loss absorption. You've got real diversity. Rather than sitting in a facility that has a single asset, our portfolio could have as much as 150,000 different obligors, and we can structure within our transactions our own covenants.

So we really like the security and the credit enhancement features in this space and they are a notable difference to the private debt and private credit market.

Why is there a proliferation of new lenders?

Theo Calligeris

There's funky names coming out of the woodwork at this stage. It's getting pretty crazy in terms of the names of different lenders coming to market.

Effectively, all these lenders are looking to either service existing parts of the market or service new parts of the market that haven't already been serviced by incumbents.

There's a couple of different kinds of firms that are entering this space here. I think a really good example is the fintechs more so than anything. Athena and Nano Home Loans, it's all the names that come to mind in this space.

But effectively, what they're looking at doing is servicing prime mortgages to prime customers in the Australian space, but they're looking at doing it more efficiently, more scalably, and using technology as a base to do it better than the incumbents already do it. The idea is to be able to do everything more efficiently and more cheaply.

Now, in terms of the other side of the spectrum, which is loans that haven't already been serviced by incumbents, really good examples in this space included the SMSF sector.

Self-managed super funds never really got too much in terms of servicing capability there. You only had a handful of lenders who sat in that space and serviced it. It was really specialised. That seems to be more diverse now. More and more lenders are starting to branch into this space.

We've seen the same in terms of the buy-now, pay-later sector with new lenders coming in left, right, and centre. We've also seen non-resident lenders start to really pick up. Solar-powered lends, commercial lends.

And one of the last things we've seen is pivots. So, people leveraging off the data that they've already used to create in prime mortgages to write into auto loans and other kinds of loans as well.

So in short, really robust space in this sector, and what you've got is the data being created by these new lenders, allowing even further new lenders to start to come into the space, and assist in writing more and more loans. So, the space really starts to expand as more and more lenders come too.

What is the opportunity for investors?

Theo Calligeris

The opportunity here is the relative value play available in these private markets over the public markets.

Now, what we found here, for example, is the Realm Strategic Income Fund plays in these private markets. It looks to partner with some of these issuers and the best of breed banks.

It looks to bring it all together and bring existing programs to market, or bring new programs to market. While doing that, it aims to deliver 4.75% over cash, net of fees.

Now, in doing that, what it's looking at doing is managing the risks of collateral, so effectively looking into what makes up a pool.

Ideally, you want to be really well diversified across a range of different borrowers, across a range of different cohorts. You don't want any idiosyncratic or concentrated risk starting to creep into the pool.

The other thing that we found really timely, especially with a lot of these new borrowers here, is the business risk that's coming through. A lot of these borrowers will come to the market and say, "Hey, we've got this really good idea. We want to fund this part of the market."

But they won't have the capital or the expertise to fund themselves or their growth part or profile. That's something that we put a lot of time into internally, really assessing that the business has the ability and the capitalisation to fund themselves, not just now, but the growth that they want to do down the track there.

So again, really diverse range here, and I think being able to manage the risk really allows you to extract the yield comparison from private markets over public markets at the moment.

How do you filter for the best opportunities?

Rob Camilleri

There's a really strong pipeline of opportunities within this wholesale banking space. The filtering process is actually a really important one, because as Theo has alluded to, we see a lot of ideas or business models that need to tick all the boxes.

Before we even start our due diligence process, we enact a screening process that really looks at the opportunity that's in front of us. One — will it succeed, has it got scale?

Then we spend a lot of time working on the actual firm and their business model. For example, are they well capitalised? Do they have enough capacity? Do they have an organisation chart? All of these questions really become a filtering tool for us across the whole market.

It doesn't mean that everybody gets through. Even the large incumbents get screened out on occasions. And it's not because they've got weak balance sheets, it's just the program that they're trying to fund sometimes doesn't make sense.

For example, you might see a well-established issuer wanting to write mortgages in that $3 million plus space. They might have some great expertise in servicing, origination and underwriting. But from a program perspective, it fails because you can't get enough diversity. That's just one example around how we sort of filter and screen in.

There are lots of opportunities out of the incumbents. We call them the tier one issuers. They've all got $10 billion plus balance sheets or funds under management.

And then, in the tier two space, that's really the growth sector where they've probably got one or two banking facilities. They've done a couple of term outs, and now they're looking to grow into that tier one space.

And really, that sort of tier three space for us are those younger firms that have only been around for a few years. They've got some banking facilities, they've got a program, and they're riding to that next milestone where they want to go and get some term funding.

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