How investors generate returns through the debt capital stack

Our next speaker is Lauren Ryan from Think Tank.

Her presentation topic is how investors generate returns through the debt capital stack.

Think Tank has provided over $9 billion of commercial, residential, and SMS lending solutions, which has enabled thousands of borrowers to achieve their goals of acquisition, right finance, and equity release.

They recently introduced two mortgage secured investment fund options for Australian wholesale and sophisticated investors.

Lauren is the BDM investment for Think Tank Property Finance, a property investor herself, and has invested in mortgage funds in the past, as she believes it's very important to practice what you preach.

Welcome to the presentation, Lauren.

Thanks so much, Angelina.

Thank you all for joining us today.

I'm going to do a quick presentation on how investors can generate income through the debt capital stack.

Just a quick disclaimer before we get started that everything I discussed today is general in nature.

I don't know you, I don't know your personal circumstances.

And if you do, if you're looking for personal advice, please go and speak to your your financial advisor about that.

So Think Tank, we are a non-bank property lender.

We've been in the market since 2006, providing finance to self-employed borrowers, looking to purchase commercial and residential property, all existing assets.

And since 2013, we've been originating loans for SMSF borrowers, again, commercial and residential.

We obtain the majority of our funding through the debt capital markets.

So our investors are institutional investors who are looking to gain access to the Australian credit market.

They like the borrowers, they like the asset class, they like the underwriting style, and they can deploy quite large amounts of capital in doing so.

And then Think Tank is the lender on record, we go and originate those loans.

We've originated over 9 billion since we started in 2006 institutionally and through the private funds and we're quite active in the debt capital markets issuing commercial mortgage-backed securitizations and residential mortgage-backed securitizations.

We've got about 200 people across the business and we've been going since 2006 so we're a relatively large business and have been around for about 17 years now.

So this just quick data as at the end of September, you can see that we write lots of little loans.

And when I talk about the debt capital markets, our senior funders provide us with like half a million dollars, half a billion dollars, sorry, in a tranche.

And then as we originate loans every month, we draw down on that funding.

And this is just a quick snapshot of what the portfolio looks like.

And this information is available for investors if you're interested at the end.

Again just a quick preso on some of the metrics there.

So looking at the debt capital stack and where can investors generate their return.

So the debt capital stack this is all a first mortgage stack and some people might say well why do the big banks invest with you in the first place?

Why do they provide you with this funding?

And the answer is essentially subordination.

So subordination is where somebody else invests underneath you and they take a higher return and they take a higher risk if loans in that portfolio become delinquent and potential capital losses.

So you can see there that the A node at the top, they receive the lowest return and as you go down the stack,

the return will increase, the risk also increases which you would expect.

We received funding from three of the four major banks in Australia and we have since we started in 2006.

That mezzanine funder level you might

You might find insurance companies or annuities companies or credit funds invest in that space.

So for investors who are looking to reduce their risk profile, there are quite a lot of third party credit funds that we work with that have experience and relationships with many non-bank and private credit.

providers out there in the market and by investing through these third-party credit funds you can gain access to these mezzanine tranches here.

Obviously if you go through a third party then you're paying fees for working with that third party so that might dilute your return a little bit but it does allow you access to those B, C and D notes in the diagram there.

And for investors that are comfortable going direct, then you can gain exposure to the senior equity note, which is the E note.

You can see there at the IT-HYT, that's the income trust and the high yield trust that Think Tank offers, and Think Tank's capital sits below.

so that's all considered the equity tranche and we split that into a senior tranche and a junior tranche and you can see from the diagram that the the first loss starts at the bottom so that's think tank so think tank's money needs to get exhausted before the income trust and high yield trust investors could be exposed and think tank generally funds about two to three percent of the overall warehouse in that equity tranche there um

Because we are able to obtain so much of the funding from the banks in the ANO at quite a tight price, we're able to offer our investors a return well and truly above what the average borrower is paying, and that's due to that subordination.

So you're taking on slightly higher risk, but you're getting rewarded for that risk.

and for investors who would prefer to invest in a lower risk profile we also have a direct first mortgage fund where you can invest directly in the in the black tranche there at the top that's that's all the first mortgage and then the owner's equity sits underneath so there's no subordination there's no tranching if you want to invest directly through that fund as there is in the warehouse structure that I mentioned.

And this is just a quick overview of the two funds that we offer.

The income trust, as I said, first mortgage funds, the returns are linked to the BBSW 30.

So we're filming this on the 8th of November, as many of you will know from the 7th of November, the cash rate increased.

So on the 10th of November, when the BBSW 30 gets reset for think tanks returns,

the return will go up so it is a floating rate investment and all of our the majority of our loans to borrow is a floating rate as well so as the as the rates go up investors return goes up but also so does the risk because the rates the borrower are going up and it's up to think tank to manage our arrears and hardships

there so that we can maintain that return to investors and protect investors capital.

On the flip side once rates start to get cut investors will see their return getting cut as well but the risk will also reduce because the borrower's return is getting cut.

So that's just a quick snapshot into how investors can achieve returns through the debt capital stack depending on your risk profile there are a few different options available to you and if please if you've got any questions I'd love to hear from you.

Thanks so much.

Thank you, Lauren, for the presentation.

Now we have some questions for you.

Go ahead.

How is Think Tank able to offer the returns they do with existing property first mortgage exposure?

It's a great question.

With the income trust, it's solely exposed to the first-to-first mortgages.

So the loans in that fund, they return a little bit higher.

We charge the borrower a little bit more because

the asset might be deemed a little bit riskier or the borrower might be considered a little bit riskier than if we funded that loan through a securitization model.

In the High Yield Trust, the exposure in the High Yield Trust is to equity notes in our first mortgage debt warehouse and the way that subordination works is

the lower down the debt capital stack you are, the higher your risk of capital loss is if the loans in that particular portfolio default and you're unable to regain that capital.

So,

you're looking at two structures both of which that have first mortgage exposure but because in the high yield trust you're exposed to the ex-senior equity notes in the warehouse essentially if something goes wrong with with all of those loans in the portfolio if something goes really wrong then your risk of losing potentially losing capital is greater in the high yield trust because you have

you're at the bottom of the debt capital stack and you have less subordination than you would if you were at the top which is why the institutions often take those tranches compared to the income trust where potentially the risk of something going wrong is a little bit greater but your potential loss if something does go wrong is lower.

In the market, you might call it loss given default versus probability of default.

So what's the chance of something going wrong?

It might be a little bit lower in the in the debt warehouse, but if something does go wrong, then your chance of losing money is a little bit higher than it would be in the income trust.

that's how we're able to generate those 10 and a half returns through that first mortgage structure because you're taking a higher risk in the equity piece.

So for investors who aren't comfortable with that extra risk then potentially a first mortgage direct fund like the Income Trust might be more suitable.

And why do borrowers come to Think Tank instead of the banks?

You mentioned that the banks invest with you.

Why don't they just write these loans themselves?

Yeah, it's a great question.

Many of our borrowers are self-employed, so they derive their income from their business or they're looking to purchase a property through an entity like an SMSF or a company or a trust.

And over the years, the banks have spent a lot of resources building out automated credit systems, essentially to target prime residential mortgages, because when you're self employed, you're generally not paying yourself a big wage.

So the actual actual taxable income looks a lot smaller, because you're generating the revenues and keeping it within the business.

And the bank systems are just unable to recognise that there is more

potential income to draw to pay the mortgages it's just not feasible for the borrower to pay that them to that as a wage themselves.

So the banks it kind of falls into the too hard bucket for them.

Also when it comes to an entity the common tier equity that the banks have to hold on their own balance sheet jumps up quite a lot and because our average loan size is $650,000

average LBR is 65%.

So you're looking at a million dollar property, it's just not worth it for the big organisations who've got very large amounts of capital, but their costs, their fixed costs are the same to be writing lots of $650,000 loans on their balance sheet that incur a slightly higher

percentage of common tier equity so the banks invest in the non-bank space and they provide us a half a billion dollar credit facility and they say you guys go and write the individual loans so it comes down to common tier equity requirements and it also comes down to that the banks have got larger amounts of capital to deploy so it makes more sense to deploy that capital in one big

one big investment and it's just not their expertise when it comes to underwriting those kind of loans.

So that's sort of where Think Tank and many non-banks have been able to take up that market opportunity.

Yeah that makes sense.

Well thank you Lauren for the presentation and Q&A.

Great to see you, look forward to seeing you next time.

Thanks so much, I really appreciate it.