(Pictured: Michael Holm)
A confluence of both market and demographic trends looks like providing a perfect storm for Michael Holm after 31 years at the helm of his alternative debt funds management business, Balmain Investment Management. With the help of Brookvine, he has launched a “Secured Private Debt Fund” focused on mid-cap secured commercial real estate loans and the two have produced some weighty research to support their cause.
At the centre of this perfect storm – the principal catalyst of the structural changes going on in the market for various fixed interest strategies – is the global financial crisis. At a time when investors would like a lot of protection from market volatility, they are getting the lowest return from the asset class which traditionally gave them that protection.
As previously reported, super funds and other fiduciary investors have already started to reduce their core fixed interest allocation to Australian Government bonds as yields continue to drop. Global bonds, with the complication of currency risk and their tilt to the US and Europe where interest rates led the way down, have come in for the same attention. But the Australian market has a shortage of alternative debt strategies compared with the US or Europe.
Michael Holm says that he has never seen conditions like this before. For the first time in the recorded history of the Australian lending market, for instance, there has been a decline in overall commercial lending for a five-year period. In the area of his specialty, commercial real estate (CRE), the major banks, which have always been the first tier lenders, have pretty much taken over the second and third tiers too, consisting of the smaller Australian banks, foreign banks previously in the sector, mortgage trusts and other lenders. Balmain estimates the big four banks currently account for 95 per cent of all CRE lending.
Holm says: “Australia has traditionally been an over-banked country. In my 30 years I have never seen so few participants… The second tier has been taken over or exited the market, the third tier has typically gone back to residential and the foreign banks have packed up and gone home. The mortgage sector has gone from $30 billion to less than $500 million.”
Balmain has become Australia’s largest non-bank commercial loan/asset manager. It is also the largest shareholder in Australia’s largest non-bank commercial loan servicer (backoffice services), AMAL Asset Management, which administers about $9 billion in loans.
A problem for the sector is that the major banks are typically short-term lenders, because of the nature of their balance sheets. But for investors, this provides an opportunity in long-term debt.
The demographic story is well known. The baby-boomer retirement bubble means there are about 4.5 million people moving into retirement over the next 20 years. And they will live longer than ever before, requiring more security and more income. The big fund managers are already launching specific strategies to cover this trend (see SSgA report this edition).
Steve Hall, the CEO of Brookvine, a boutique funds management incubator and marketer, said that from the conversations he’s had with super fund investors, most see the secured private debt fund as sitting within their defensive income-producing part of the portfolio. He says there is increasing acknowledgement that floating rate debt has a role to play.
Brookvine has bought into and acts as marketer for Balmain Investment Management. The new fund is targeting about $250 million and is expected to close late this year. Balmain will also consider discrete mandates for larger allocations. The return target is 3-3.25 per cent above the cash rate after all fees and charges. Hall says fees for these strategies are above traditional bond fund fees but much lower than private equity management fees. In the event of a default, Balmain takes the first part of the hit within its fee structure, thereby providing a form of co-investment. Brookvine also tends to co-invest in the funds it represents where possible.
The mid-cap market in CRE is generally considered to be loans of between $3-30 million. They have several advantages over the big end of the market: they allow for greater diversification through more loans in a portfolio; they are often underpinned by single businesses; losses from default are lower and balances easier to recover; borrowers usually provide personal guarantees; margin pressure is lower due to the need for high loan origination infrastructure and early repayments are less likely to detract from portfolio returns.
Holm observes: “The personal guarantee from the borrower won’t necessarily recover a shortfall but it will influence the borrower’s behavior. Owners often consider the building important to them, especially if they operate a business from there.”
Balmain and Brookvine have produced a 20-page white paper: “A Fresh Take on Australian Commercial Real estate Debt”, which Hall believes is the first comprehensive study on the subject undertaken in Australia, where information has been difficult to collate. He thinks that lack of information has been one reason Australian institutional investors have been slow to participate in the CRE debt opportunity.
This is not the case in the US, however, where insurance companies in particular consider CRE debt should typically make up between 10-15 per cent of their investment portfolios. The paper says that US life companies held 13 per cent of all outstanding US commercial mortgage loans in 2012 and, on average, the life companies which invested in CRE debt allocated 11 per cent of their total investments to the commercial mortgage asset class.
At last year’s ASFA conference, Steven Carew, head of research at JANA Investment Advisers, spoke about work his consulting firm had done on what it terms “direct debt”. He asked the question: “Can super funds offer a strong alternative to traditional corporate financing from banks?”
He said that new regulatory requirements, less competition and higher funding costs were opening up the mid-part of the credit curve to non-bank investors.
Note: The author is a non-executive director of La Trobe Financial, a funds manager specialising in credit, particularly in residential real estate.