Trade and Debtor Finance in Australia (and the opportunity for Private Debt Investors)

Our next speaker is Gary Segal from Oceana Funds.

His presentation topic is trade and debt to finance in Australia and the opportunity for private debt investors.

Oceana is a leading Australian alternative investment management firm with expertise in private credit and specialty property equity strategies.

Oceana Australian Fixed Income Trust is a private debt asset-backed securities securitization program.

The underlying assets are short-term receivables, corporate lending, SME loans, and supplier finance.

Gary joins Oceana Funds as a COO and General Counsel, bringing more than 17 years of industry experience to the role.

Previously, he worked in HSBC,

He has extensive experience in cross-border acquisition, distressed debt transactions, corporate and real estate acquisition financing.

He also has broad M&A and structuring company secretarial experience for investment syndicates.

Welcome, Gary, to the presentation.

Thanks very much for that introduction.

Thanks for having me here today.

As you mentioned, trade and debt of finance.

a sector of the private debt market that we've lived and breathed since Oceana's inception eight years ago, and a part of the market that at least in my experience is not that easily accessible to private debt investors.

The investment markets team has kindly invited me here today to share some insights into the space, which is the core asset class of our fund.

And this is something we think private debt investors should set up and take notice of when it's done right, of course.

All right, so this is the run sheet for today.

I'll briefly run through these terms from my perspective and what they mean, provide a couple of practical examples of case studies that our fund is familiar with, which you should find helpful.

I'll also explain what I view as the unique characteristics of this asset class, which make an appealing investment for private debt investors.

All right.

Quick background on who we are, and some of this was already covered.

Oceana Funds is a funds management platform offering funding and partnership opportunities through a range of asset classes, including our flagship private credit strategy, the Oceana Australian Fixed Income Trust, or OFIT as we call it, which was established eight years ago with just under 1 billion of funds under management.

Oceana is essentially classified as an alternative credit strategy with fixed income characteristics, meaning investors invest in our fund via loan notes,

with fixed interest rates for up to five years.

Effectively, in terms of the underlying business, we're a non-bank lender that gives investors access to a highly diversified credit portfolio, the bias towards trade and data finance, focusing on providing technology-enabled trade and data finance solutions to the SME and MME markets in Australia.

Okay, so just working through the key concepts.

First, what do I mean when I say trade finance?

For the purpose of this presentation, when I talk about trade finance, I'm really talking about supply finance, which very simply put is the funding of an amount owing or payable that is due from our borrower to its supplier, which allows buyers to pay their payables and suppliers to receive their receivables earlier.

So this allows the borrower to effectively extend its payment terms to its supplier, which from 30 days, which is quite typical, to anywhere between 60 and 180 days.

depending on the borrower's credit worthiness.

So when it's done right, it's win-win for both parties.

Borrowers can negotiate better pricing in terms.

Suppliers receive their debts faster, assisting their own working capital.

As I mentioned before, we use technology-based methodologies from initiation to completion to automate most aspects of these transactions, including tracking invoice approval, verification procedure settlement processes.

In terms of economics,

The terms are generally quite standard in the market with advanced rates ranging from 60 to 90% depending on the borrower's credit worthiness.

Interest rates range from about 12 to 15% per annum.

Quick aside here, the 90% advance rate corresponds to the maximum insurable amount under our trade credit insurance.

And I'll go into that in a little bit more detail shortly.

So I thought it'd be worthwhile running through an actual client example on the pharmaceutical industry, which is one of the key industry concentrations in our supply finance book.

Quick industry snapshot.

For context, pharma sector for this type of financing.

It's one of the last protected industries in Australia.

The Pharmacy Guild has a rolling five-year exclusivity of the Australian government, prohibiting major retailers like Coles or Woolwheels from selling pharmaceutical products.

So there are over 5,500 pharmacies in Australia and 3,000 in New South Wales alone, which translates from our perspective to continuing growth and opportunity in this space.

Previously, the major suppliers offered interest-free loans and payment terms to pharmacies, but they withdrew from financial services in 2015 and created a funding issue for pharmacies.

Thanks to a relationship with the leading accountancy practice, we were introduced to the Pharmacy Guild and

began offering supply finance terms to individual pharmacies and pharmacy groups.

That's what actually kick-started our supply finance program in 2015 prior to the launch of our fund.

So looking at the transaction flow in the screen, this is a typical supply finance transaction in our business, all of which is facilitated through an IT platform connecting all stakeholders.

So once a buyer places an order and receive the goods, steps one and two, the invoice is approved and provided to us, step three.

Steps four and five, we reach out to the supplier directly to verify the invoice.

Once they verify to us that the invoice is valid, step six, we will then pay the supplier directly, never to the borrower directly, and that's important.

Finally, the borrower will then repay principal and interest to us.

Typically in the pharma sector, this tenant can be up to 180 days and interest is in the range of 12 to 15%.

So this is how a supplier finance transaction can be optimally structured in our view to mitigate fraud and misuse risk.

A, building in initial verification steps so that the supplier confirming the invoice in conjunction with giving the money to the supplier directly, never to the borrower.

And I'll discuss this in more detail.

All right, moving on to debtor or invoice finance.

Invoice finance, simply put, is funding against receivables.

Whereas the supply finance, our borrower is due to pay payable.

In debt of finance, our borrower is due to receive receivable.

So pretty straightforward.

It's the opposite end of the spectrum.

So for the purpose of this presentation, when I talk about debt or invoice finance, I'm really talking about the form of receivables or invoice discounting we use in our fund, which is primarily either hold of book or selective invoice debt discounting.

So this means the borrower is selling a pool of receivables to us instead of a single invoice.

or to the lender, this is on a short term basis for an agreed advance rate.

Similar to supply finance, the advance rates range anywhere from 60 to 90%, depending on the credit worthiness of the debtor.

Again, this advance rate ties into 90% maximum with under our trade credit insurance.

So we've utilized trade credit insurance since inception of our fund.

So as a quick example in the agri space,

Wolves, Aldi, Coles invoices will get close to 90% of their advance rate on their invoices, and it reduces from there as credit worthiness of the buyers decrease.

Okay, again, I thought it'd be worthwhile running through an actual client example, this time in the agricultural sector, which is one of the key industry concentrations in our data finance book.

So looking at the transaction flow again on the screen, I've chosen an actual client case study involving one of our customers,

a banana grower who supplies produce to a range of supermarkets, including the three majors.

In this example, steps one and two, our banana supplier receives a range of orders from various supermarkets and delivers those bananas.

They then provide the pool of invoices to us, step three, which would be done through a tech-enabled platform where they upload the various invoices into our system.

Step four, a white-labeled notification generated by our system

from the banana grower is sent to Woolworths or Coles seeking what we call a debtor acknowledgement, i.e.

they confirm receipt and acceptability of the goods.

For instance, if they confirm 100% of the goods are acceptable, that's perfect.

But generally, that's not the case.

They will usually confirm a certain lower percentage is acceptable, noting they will only fund on the approved and accepted amount to the project.

So for example, if they turn around and say 20% was ruined in transit, we know at that point that they're only going to pay 80% of the invoice.

So once this is confirmed, we'd advance the blended advance rate across the invoice pool to the seller, that's 85% for the purposes of today's discussion.

The buyer then will pay 100% of the accepted invoice 30 days later into a controlled bank account within our system architecture.

We then return the remaining 15% to the borrower less fees, which is in the range of 1.5% to 2% per month.

So that's 18% to 24% annualized.

In terms of economics, it's important to think about the interest rate in the form of dollar-cost lending, i.e.

from a borrower's perspective, they're paying $1,500 to $2,000 to access up to $90,000 early in a $100,000 invoice example.

Okay, so the final topic.

We should now have a general understanding of what these terms mean and what these finance products are.

The key question now is why investors in private debt should seriously consider this asset class.

There are a number of key attributes of these types of debt assets, which in my opinion, make this an appealing addition to a diversified credit portfolio.

First and foremost, probably the number one attribute to highlight returns.

As I've already touched on, when we're working through the case studies, there's potential to end consistently strong risk adjusted returns.

On the supply side, in our experience,

The range is typically anywhere from 12 to 15% per annum.

On the debt to finance side, this can be 12 to 24% per annum.

On the latter, this is largely driven by the fee structure we touched on earlier, which is that form of dollar cost lending, paying a fee to access capital early.

Just to give a frame of reference here, our fund since inception has averaged just over 14% annualized returns on our underlying assets, which we are maintaining in the current environment, which is a bit more stressed according to most experts.

Second,

The nature of the underlying transactions can offer a natural hedge against recessionary pressures due to the nature of receivables and receivables and payables finance.

What do I mean by this?

Well, for trade and debt of finance to actually be utilized, there has to be a payable owing for supply of finance or receivable due for debt of finance.

In other words, the businesses actually have to be operating and doing business in order to use these types of facilities.

This is distinct from traditional lines of credit or working capital where a lender advances a pool of cash to the borrower and the borrower has control over it.

This is much more likely to be misused in a recessionary environment.

Thirdly, underlying liquidity.

What I mean when I say this is that if you look at an overall portfolio comprised of these assets, it's built up with short duration assets in a range of 60 to 180 days with self liquidating characteristics, i.e.

exposes a rate

paid down on a short-term basis and then reused.

From a fund manager's perspective, this allows the manager to offer much greater liquidity to its investors, as there would never be a tenor mismatch between investment, which would be up to five years, and the underlying assets, which would be short-term and rolling consistently.

So this is why we're able to offer investors 60-day liquidity because of the liquidity of the underlying assets.

Fourth, low default rates.

Also very important, of course, one of the key questions investors ask.

When done in conjunction with a robust stringent underwriting standard and a focus on defensive and uncorrelated sectors, a manager can achieve very low statistical default probabilities.

For context, in our funds, defaults have never exceeded 2% since inception on a static basis.

And in fact, our annual average arrears since inception is close to 1.7%.

And our actual annual write-offs are about 48 basis points per annum, so 0.48%.

strong diversification benefits, noting average loan sizes of about 90,000, number of borrowers and debtors in our fund sits at about 7,000, short tenors up to 180 days, and imposing industry and single obligor caps in the fund, i.e.

for example with us, we can't have a greater exposure of 30% to a single sector, and the top five sectors together have to be less than 80% of the fund.

This presents a strong case for investors looking to diversify away from typical credit funds in Australia, which tend to have a property finance focus.

Finally, and I've touched on this already, a very unique characteristics of this asset class, trade and supply finance and debt of finance is the eligibility for trade credit insurance.

This is insurance that covers defaults and insolvencies of the borrower.

So for example, in our fund, we have trade credit insurance covering 75% of our exposures.

It's important to note this is a credit enhancement tool which we've used since inception that we have there as a fallback.

We don't rely on it in place of good underwriting.

We don't rely on it as a BAU cost recovery tool.

It's really there to give investors comfort that we have a large pool of potential insurance proceeds there to protect them if we do need it.

Okay, look, that's it from me.

I realize we've covered quite a bit of information, dense information in a very short time.

Please feel free to reach out to me with any questions or if you'd like to discuss our strategy.

Thanks very much for your time.

Thanks, Gary.

Can you tell us how important is diversification in a more challenging economic environment?

Yes, of course.

And look, I did touch on this already in my presentation, but diversification is always very important to investors in a recessionary environment.

It's absolutely paramount.

I touched on other credit funds or the majority of credit funds in Australian market being property finance focused.

A lot of those would have much larger single exposures that would eat into loss reserves of investors if there was a single loss, for example.

So when you're looking at a fund that is focused on trade and supply finance, for example, there's

It's diversified not only by borrower number, so 7,000 in our portfolio, but it's diversified across industries, diversified across products, and it's particularly diversified in terms of how, if you're looking at the size of the exposure.

So instead of having an 80% exposure in a syndicated corporate facility where that is taken up by one borrower or a single borrower group,

We, you know, across a billion dollar or just under a billion dollar credit strategy, our average loan size is one hundred thousand.

So that does give investors a lot of comfort that we can, you know, we mitigate concentration risk to a large extent.

And can you provide some context to the broader SME lending sector and the types of companies that you are lending?

Yeah, absolutely.

But the SME and the MME, I should say, lending sector, because probably most of our companies are in the middle market as opposed to the very small end of the market in Australia.

It remains a huge opportunity for non-bank lenders such as ourselves.

Annual credit demand in the SME and MME space, about 240 billion, of which a hundred

100 billion is trade credit.

So looking at the size of our fund, which is probably about 650 million in those asset classes, we feel that there's still a lot of room for growth.

in those sectors.

There's 2.2 million SMEs in Australia that make up about 35% of GDP.

So they really are the engine of the economy and access remains an issue for these companies.

Traditional banks, the big four banks, while they do do these products, the SME in the smaller end of the market and smaller end of the MME markets struggle to get bank financing, either whether it's a track record issue, it might be a timing issue, but

That access is what gives non-bank lenders such as ourselves a big opportunity in Australia.

In terms of the borrowers that we focus on, so I mentioned that primarily it's the middle market space.

We focus on borrowers in defensive industries, so industries that focus on essential goods and services.

We avoid cyclical industries like tourism, hospitality, travel.

focus on industries, as I mentioned in my presentation, pharmaceutical, healthcare, agriculture.

We've expanded to look at wholesale trade, seed containers and logistics, enterprise, software, financial services.

And these remain the core kind of borrowers that we lend to.

And obviously underwriting is important.

So if you're looking at, and I mentioned, we've got just under 7,000 borrowers and obligors in our book.

across the entire book, our weighted average Equifax rating is good and above.

So we really have a focus not just on the industry in the sectors that our borrowers are operating in, but the credit quality of the underlying borrowers as well.

Thank you very much, Gary.

Thanks for your time again.

I appreciate it.