4 key considerations all investors in private credit should be thinking about

Coming next we have Henry Elgood, Executive Director at Trilogy Funds.

Henry's knowledge and experience are across governance and risk management.

He carries a successful track record of corporate transactions onshore and offshore.

He will tell us four key considerations all investors in private credit should be thinking about.

Welcome Henry.

Thanks for having me Angelina.

So today what I'm going to talk around is real estate private credit and some things to consider when you're looking at an investment, either as an existing investor or someone who has a current investment and wanting to step in and broaden their array of private credit options.

So we at Trilogy Fund specifically focus on real estate private credit, and that is the provision of funding to developers for various stages, either a construction, a land bank or residual stock phase of their real estate development phase.

That can be in any state around Australia, so we have a very broad mandate in that sense, but we have a current focus on the Australian seaboard in Queensland, New South Wales and Victoria.

So stepping through a number of key aspects and I guess highlights we think around the private credit space.

Firstly, it's growing.

We're considering to see more and more transactions pop up in this space, particularly as we've seen traditional lenders such as major banks step out of that space and want to broaden.

I guess the investor in terms of who it could be, such as non-banks, such as ourselves, in providing more competitive terms and flexible finance to the right clients.

In terms of the return profile of a private credit to other areas in traditional investments, private credit has been able to demonstrate a good risk-adjusted return on the investments and underlying loans that it can be exposed to, particularly in the real estate sector as we have been.

Part of this is through the consistent and reliable cash flow, particularly through capitalised interest and working with key borrowers who continue to service the loan throughout the life of it, or if it's a development phase, appropriately adjusting the LVR on any loan such that it still sits within a reasonable limit once the project has been completed and begins to start the sell-down phase.

The other aspect around real estate private credit is the security over the tangible asset base.

You can sit there, look at the house or development or townhouses that have been built and sit there and look at, I guess, that saleability in terms of that market.

So it's good to have that as an underlying security base, we believe.

There's protection against volatility, particularly around that market where there's lower volatility typically seen in real estate private credit returns as you've got a relatively stable loan term.

and a consistent interest rate that will be charged to finance that loan.

The contractual obligations and underlying security, while there's a sitting underlying the general mortgage, there's also personal guarantees, corporate guarantees, and other forms of security that a lender such as ourselves can take.

Diversification is also something important as any portfolio.

We, through running our flagship private credit trilogy monthly income trust fund, we have a pooled exposure.

So we have loans across Queensland, Victoria and New South Wales currently with that split roughly around a third in each state.

The yield potential, as I mentioned earlier, is something that's attractive and something that given the variable nature of some of these underlying loans where you can pass through

any increases in interest rate to underlying borrowers which then pays out to investors makes it attractive in the sense that it can adjust to inflationary pressures or market pricing pressures given competitive tension plus also any other market dynamics that might be going on.

The investment oversight as well is we believe is important.

We at Trilogy have a lending committee who look each week at the lending portfolio and run through any loans

There's further discussion required, but also new potential deals and how that will blend with the existing book.

That's something we do focus on with a pooled structure, where at this point in time, we have around 130 loans in the portfolio.

It's good to make sure that there isn't any sponsor overexposure or geographic overexposure in any one LGA or even suburbs or streets.

The other side around lower competition is something that we've seen historically in this space.

However, more recently, we're seeing more and more competitors come into this space.

And that's good for borrowers.

That's good for financiers.

Again, the major banks have stepped out of that space and we're seeing more non-traditional lenders enter.

What we want to make sure and highlight from a trilogy perspective is that we have been doing this since 2007 with our flagship fund, and that's something that's important, particularly around wanting to look at the longevity of being able to work through credit cycles, work with sponsors over various transactions, and also work with the right sponsors on multiple and repeat deals.

That's something that we feel is important to maintain from a deal-flow perspective, but also knowing the quality of product that will be delivered at the end.

Navigating the real estate private credit market is important because there's various options that can be presented.

And that's because there's various areas in what we call the capital stack that an investment opportunity can be positioned in.

At Trilogy, we focus through our main product at the senior debt level.

So we take a first mortgage.

Over any property security property and then other underlying personal guarantees and corporate guarantees through that that first mortgage sits at the highest security level.

So if there was a position in terms of repayments us as first mortgagee gets paid out before the developer themselves as equity.

Again, we're providing the funding, we're taking that risk in terms of giving that financing and that's then rewarded through paying that back.

Typically, however, you'd see on a return profile that there is a lower interest rate associated with this compared to a mezzanine position or preferred equity position even.

However, it's important to note that during times of stress that capital and finance is sitting at the highest level within the capital stack does have the ability to control and dictate how a workout solution might be.

But also from a repayment perspective, it's the first money paid out of the project.

And that's something that we've been conscious of not wanting to blend.

any types of other risks such as mezzanine or preferred equity risk through our structure.

With our first mortgage only fund, we continue to provide that senior financing to various developers over the years.

And that's something we'll continue to do in that strategy.

with respect to market and economic risk.

That's something that has heightened over the last couple of years, obviously, through various interest rate rises.

Together with more competitors coming into the space, we haven't gone outside our preferred lending terms in that sense.

We want to make sure that we can provide a consistent, steady product to developers, and through their performance, that'll in turn mean that we can provide a competitive return and a well-adjusted risk return to our underlying investors at that point in time.

So key considerations around what we look at in terms of low-fund LVR, we have around a blended 63.8% weighted LVR in our portfolio at the moment.

Again, there's some deals that are higher than that, some deals that are lower than that.

That, again, is a deal-by-deal decision that's assessed internally by our lending committee.

It's important to understand what the maximum LVRs are that certain funds and investors can go to because that will dictate, again, the risk and the degree of price adjustment that can be built in

If, for example, there's overruns in the building, that means that the cost of construction increases, or if there's a drop in security where real estate prices might soften in any one market or for a specific project.

In terms of loan priority, as I said earlier, we do want to focus on the senior end of the capital stack, and that's something where we have focused on for the last several years and will continue to focus on since 2007.

With respect to due diligence, that's important upfront to make sure you're looking at both the borrower and the asset level.

The asset can be a great performing asset, but if you don't have faith in the borrower being able to deliver your project, that may provide obstacles at the very end to completing such project and getting repaid as a financier, irrespective of where you are with the capital stack.

So understanding the project and borrower and sponsor risk is important, we feel, both at the outset and monitoring and regularly reviewing that throughout.

Liquidity is also important.

We at Trilogy have run a very conservative position in terms of liquidity, giving up to four months to pay withdrawals out of our fund.

The reason for that is, at any point in time, there can be delays through Council, there can be delays through sales not occurring quick enough.

And while the sales rates might be slowing, it doesn't mean the project's underperforming, it just means the project might take a bit longer to deliver, albeit there's still going to be comfort getting repaid as a senior secured lender, as we are through our fund here.

So our areas of focus typically where we look at is the residential construction space, the commercial construction space.

Industrial's also been a big area over the last four to five years, and we've planned that space from a construction lending perspective as well.

To a lesser degree, there's also retail and healthcare funding at times from a senior secured lender.

We work with several sponsors on.

One key project that we wanted to touch upon briefly is a private medical centre that was built in Springwood here in Queensland.

This facility was one that came to us through a very well-regarded sponsor, and it had a pre-sale in place with an unlisted healthcare fund in Australia here.

We felt that this was a great project in the sense that it was an area that needed this type of supply in that region.

It was an attractive LVR, initial LVR at under 60%, and the loan term at 10 months meant that there was going to be a consistent and very

deliverable construction program that was put forward that we thought and again was looked at and checked by QS.

In terms of trilogy funds as a whole, trilogy has been around since 1998 and with our key fund launched in 2007.

With respect to our staff, we've got staff across Brisbane, Sydney and Melbourne in terms of where our current lending portfolio is.

We have an investor relations and distribution base here in Brisbane as well as in Sydney and Victoria.

They can help both advisors and non-advised clients through the application process as well as monitoring their account going forward.

We've always had a high focus on risk management, both at a corporate business level and also at a lending level, as well as other areas and business units within our group.

Our products are available on multiple platforms as well for certain investors, and there's also obviously available for direct investment.

We do have several research houses as well that rate several of our products, including the Trilogy monthly income trust as well, and we continue to work with them to talk through our advancements in evolution as a business, as well as our lending practices, risk management, et cetera.

As I said, Trilogy has been doing this for a long time.

We certainly have focused on capital preservation for our investors, and that's something that won't change moving forward.

The diversification we also offer through the Trilogy monthly income trust is important to our investors in that space, but we also have a broad range of income-focused investment options that our business does offer, both in direct property as well as the mortgage and alternative income space as well.

Thank you.

Thanks, Angelina.

Thanks, Henry.

Do you have time for two questions?

Sure.

Can you explain the dynamics behind a wide range of return profiles across private credit offerings?

Absolutely.

So what we see out there and what again our borrowers speak to us around is how there is the ability for senior lenders and developers to obtain not just senior financing but also be supported by mezzanine financing, preferred equity or other alternative equity partners in certain projects.

So you've got various stakeholders at play there with those various investment options.

Some of those investment options can be presented to investors where there are higher rates of return on offer, but obviously it's understanding the higher risk with that as well.

So that's where there's a difference around return profiles from various private credit, including real estate private credit investment options in the market.

As I said, we at Trilogy, we focus on the senior secured space, so we don't have any mezzanine or preferred equity exposure in our flagship fund, the Trilogy monthly income trust.

The Trilogy Monthly Income Trust has a 17-year trade record of maintaining a $1 unit price.

How has it been able to achieve this?

Yeah, our lending philosophy has always been one to be conservative.

We have a very broad range and skill set on our lending committee in terms of QSs, builders, construction managers, lawyers, accountants.

So that skill set and understanding that level means that there's various aspects of each loan submission which each of them comment on and review, which makes it a very thorough and detailed review at the outset, as well as the ongoing monitoring that's done by our team.

Again, combined on that, part of that conservative nature comes through our LVR parameters.

So our LVR sitting around the 63%, 64% weighted average LVR for the portfolio shows that we aren't wanting to take any LVR exposures that are higher, given that there is propensity at times for building costs to shift, time delays to occur, as well as repayment profiles to not occur as expected.

So in terms of the overall...

ethos of the business in terms of wanting its lending strategy.

We take one of a conservative approach and working with strong sponsors and strong developers and not working on large complicated projects.

We prefer to do smaller projects and then do many of those again supported by each of our lending teams in each of the major states on the eastern coast.

Thanks Henry.

No worries, thanks Angelina.