Not all private credit funds are the same

You're now watching the Property and Income perspective of the Investment Markets July 2023 Investor Seminar.

Coming up, we have a speaker from the Woodbridge Private Credit Fund.

The fund provides investors with direct and indirect exposure to first mortgage, meaning senior security.

In Australia and New Zealand, the real estate owners with an ESG integrated investment process and philosophy.

All loans in the portfolio have a valuation prepared by an independent, qualified, and registered value, but does not provide exposure to high-risk loans, such as preferred equity loans, less mean finance, second mortgage loans, or corporate loans.

Our speaker today is Mr. Andrew Torrington.

He's a founder and managing director

of the British private credit farm.

Welcome Andrew.

Great, thank you.

So yeah, so as the title gives away, I'd like to probably spend my time this evening talking about, not talking about how good private credit is or telling you how investors can super earn in this asset class.

It's probably more to focus instead on investors who are looking to invest in private credit to understand three important things.

And really those are that

Not all loans are the same in private credit.

Not all private credit funds are the same.

And of course, not all managers are the same.

And really, you know, we're just encouraging investors in this asset class to think differently about private credit.

There's an absolute opportunity to invest in private credit.

But investors need to understand the asset class.

So a good place to start, of course, is, you know, we should call it upfront that this industry suffers from a little bit of lack of transparency and what we call opaqueness.

And there's a lot of lack of transparency around loan portfolios in the industry about where the risk of loans are and, of course, fees.

So what we're doing really this evening is just running through the loan types.

So the place to start with loan types really is

There are four main loans in private credit that these funds are doing.

Of course, we've got the Woodbridge private credit fund, which is a first mortgage strategy, and that sits lowest on the risk curve of loans.

And the fund's currently doing 9.72 net to investors.

These are asset backed loans with a first mortgage on them.

The next type of loan class you'll see is corporate loans.

These are typically backed not by assets, but backed by balance sheets and cash flow.

Those loans are typically in the market earning 8% to 12%.

You then got second mortgage loans, which are subordinated loans to the first mortgagee.

So they sit between the first mortgage and equity holder.

Those loans in the market typically are earning 15% to 20%.

And then you've got what's called preferred equity loans, which are earning plus 20% in the market.

So four very different loan types, four very different loan risks and four very different loan returns.

So with that in mind, when you look at private credit, you need to take those four different loan types and ask when you're investing in private credit, what type of fund is it?

So what's most typical in the market at the moment are what's called blended funds.

So blended funds are a mix of first mortgage senior secured loans that are first on the cap stack, second mortgage loans that are junior to the second, corporate loans.

So as I just showed you in that previous graph, all three of those loans have three different risk profiles and they all have three different return profiles.

So when you invest in a fund that's blended, what you get is blended risk and returns.

what I call in here as hidden returns, because you really can't get to see the underlying loan risk you're taking.

But I think importantly for investors and certainly wealth advisors investing in product, you can't measure the spreads in a blended fund, because the spread is a blended spread.

So of course, what we're selling at Woodbridge is a non blended fund.

And this is a first mortgage only single strategy fund.

that gives investors one single loan type.

And obviously we believe the best risk adjusted returns in credit at the moment are in first mortgage, but it gives what's called a non-blended fund.

So single loan type, it's transparent, investors can measure the risk and the returns they're getting on these type of funds.

And of course they can measure the spreads.

So what I would encourage investors to think about in private credit is think alternatives for blended funds.

and that the risk and return profile sits in that bucket.

And for first mortgage funds, think fixed income, as in low volatility, capital reserves spitting out returns of sub 10%.

So that's the way that we cut through blended and non-blended funds, and we obviously encourage investors to do the same.

The next slide's not particularly favourable with my peers in the industry,

There's really 10 questions that investors need to ask these funds as they come in.

The first one is, as I just pointed to, is it a blended fund?

Do you have multiple loan types in the fund?

And if you do, you know, tell me what the split of those first mortgage loans, second mortgage loans, corporate loans are.

Give me the math of it and show me the LVRs of those first mortgage, second mortgage corporate loans.

and show me the limits then of the fund in each loan type.

So what that gives investors is transparency of the blend.

It's much easier to see the transparency in a non-blended fund because you have a single loan type.

The third question to ask, of course, is, and specifically to the fund, is that if the fund is non-blended, does the IM allow it to invest in other types of loans?

And specifically that's important because some funds will say, no, no, no, we don't invest in this type of loan, but the IM will say they can.

And if they can, they probably will, and they certainly won't come back and ask your approval.

So once again, it's transparency of what the IM is saying that the fund can do.

Number four is important in private credit, and as I mentioned, private credit suffers from a distinct lack of transparency in this piece, which is, can the investors see the loans in the loan book?

Can you actually see what loans are in the portfolio, what the LVRs are?

what the values of the loans are and the status of the loans.

If you can see the loans and you can see the loan types, then you can assess spread.

If you can't see the loan book, then assessing spread is impossible.

And of course, the risk associated with it.

Number five is not common in this industry, but very important is that does the fund have an external trustee?

What's been quite normal in the industry is that funds are their own trustee.

But I think we're certainly pushing investors to make sure that the fund has an external trustee, make sure they're independent, because if they are, then they're there to represent the interests of investors, not of the investment manager.

Leverage is an important issue, and we've seen it with a few banks in the US, but does your fund have leverage?

And I don't think investors ask this enough in this asset class, because if the fund has leverage,

it's probably using it to spice up returns.

But importantly, if that leverage changes, the fund could be locked up.

So once again, ask the manager, do they have leverage and does the fund IAM allow them to put leverage in?

Obviously we're talking about a loan book.

So the loans typically may go in and out of default.

They may be good defaults, they may be okay defaults, they may be bad defaults.

Ask the fund,

what loans they have in default, specifically ask them if any are in receivership.

And if you can't see the loan book, then I would politely say, don't trust the answer.

And in terms of loans in default, there's multiple reasons why loans can be default for a fund.

Is that, you know, ask why, and investors just need to get used to asking this, but ask the investment manager how long they've been in default.

You know, is the fund earning default interest?

If not, why not?

Is there any impairment risk on the loan?

But drill through the questions.

Don't just, you know, just don't take the manager's word for it.

I think it's also important just in terms of being transparent.

Ask the fund manager or indeed the investment manager whether they have any related party interest in loans, i.e.

are there any loans in the loan book that the fund is lending to itself?

I think, once again, unless you can see the loan book, you can't see who the ultimate borrower is.

And finally, you know, for investment managers and funds that have multiple funds, you know, are they moving loans from fund to fund?

Can they do it?

And are they doing it?

So once again, for investors, just transparency around loan books, what you see is what you get, and that you know exactly what's in there.

So of course, for Woodreach, we say we're different.

And of course we say we're different as a business and we say our fund is different.

So for us, you know, we are a fully transparent fund.

We don't hide loans, we don't hide fees.

We're generally trying to be transparent with our investors about our loan books.

We do monthly reports on all our loans.

We're what's called a non-blended fund, as I mentioned.

So we have single loan types and we are first mortgage only.

The reason we are first mortgage in this market

is predominantly because of asset price stress, so we believe the place to play for the returns we're getting for investors.

We have an external trustee, so the external trustee actually also sits on our credit committee.

The external trustee is there to make sure that our investment strategy is held and that we don't invest in loans that our IAM says we can't invest in and or we take a risk above what our investors are expecting.

you know, external trust is important to protect investor interests.

We run a ESG framework, so we've got a fully integrated ESG framework.

I understand some wholesale investors don't probably know what this is or know why they need to care about ESG.

I would explain ESG and private credit as responsible lending, responsible investing, so investors know what they're lending in.

For example, we can't lend in petrochemical petrol stations, we can't lend

in poker machine venues, taking advantage of low associated economic areas.

So there's some pure things like that.

But for investors, it gives you confidence that we're not investing in assets that you wouldn't want to ethically be invested in.

And of course, you know, we would say that we know our asset class very well.

We've got a long history in asset ownership, equity and lending.

And we've done first mortgage and second mortgage strategies before.

As I mentioned, we believe first mortgage investing at the moment is the absolute place to be for investors in private credit.

And for a fund currently doing 9.72 net to investors, we're 100% senior secured first mortgage fund governed by an external trustee.

100% of our book has floating interest rates with a floor, which obviously gives investors a hedge against inflation in this market.

And we've got a pretty low LVR across the book of 58% in the fund.

So for the fund itself, so the benefits for investors really are that, you know, high single digit, that's an attractive risk adjusted return and first mortgage portfolio, stable monthly income for investors, 100% of distributions paid monthly to investors, low capital volatility.

We say that because we're a first mortgage fund.

So at an LVR of 58%, for example, what you are protecting yourself is a 42% hit on the asset price.

So nothing's capital guaranteed, but

Capital preservation is certainly at the heart of a first mortgage fund.

Fully floating rates, so obviously it gives investors a hedge against inflation.

I think when rates start to fall, investors need to turn their attention to making sure that fund managers have flaws in their loans, that the returns don't go backwards, which we do.

Experienced investment team, we don't invest in high-risk loans, second mortgage, corporate loans, pre-equent loans.

The fund has a low management fee of 50 bips to investors and our minimum investment is $25,000.

So liquidity is monthly best endeavours to investors and quarterly by redemptions.

And just to repeat really, so for investors in these type of funds, we think of ourselves as fixed income, not alternatives because we're a first mortgage pure fund.

So that's where we think we sit with the investor portfolios.

Thank you.

Thanks, Andrew.

I've got a question for you here.

You mentioned first mortgage.

Why are first mortgage loans better in this macro environment?

There's a lot of press in the market at the moment about falling asset prices in commercial real estate and in particular in office as an asset class.

And obviously, if you're an asset owner, that is a concern for you, given the high interest rates, the lending rates you've got as an asset owner.

I think people need to understand that we're not asset owners, of course, we're asset lenders, and that we don't own the asset, we're lending money into the asset.

So when an asset falls by 10 or 20%, as we've seen in some office assets, is that as an owner, that's very concerning to you, and you're obviously losing pure equity.

As a lender, we're not.

It means our headroom has shrunk, but we absolutely have not lost any money if an asset falls by 20%.

For example, as I said before, the OVR of the fund is at 58%.

We're talking about a 42% hit on an asset price before we would ever have a loan impairment.

So for investors, just separate REITs, asset owners, very different to private credit funds that are taking short term credit risk, typically of 18 months versus asset owners that are in there for the long term and the full asset cycle.

Yeah, and we see a lot of press on falling asset prices, for example, on offices.

How does the Woodbridge Fund protect itself on falling asset prices?

So the fundamental protection for falling asset prices is first mortgage.

So, and what that gives us is we completely control our assets.

So at any time, if we want to step in on the asset, or we think the asset price is falling to a level we're uncomfortable with, we can step in on a loan.

Stepping means that we can put the borrowing receivership, we can sell the asset on the market, and then we can get our money back.

So the asset protection or falling asset prices is the first mortgage protection, which in Australia is absolute.

And they're all we are, we run

barrier conservative LVRs across the fund.

So, you know, we're talking about hits to assets of plus 40% for us to have a loan impairment.

So at any time, the asset value shrinks by 10, 20%, we're protected.

And if for any reason it starts to hit 25%, we would simply sell the asset, recoup our investment money earnings, and then the borrower gets the residual.

Thank you, Andrew.

Great to see you.

Have a good night.