Realm Investment House | REALM CAPITAL SERIES 2018-1 Units
One of Realm’s flag ship products, the Realm Capital Series 2018-1, will be closing its doors to all new investors at the end of this month after what has been a successful raising. Last week the RBA slashed rates by 25bps to 1.25% with most economists tipping another rate to come, so we can quite confidently say, Australian interest rates aren’t rising anytime soon. With rates tip to go lower, traditional term based investments aren’t as appealing. That’s where the Realm Capital Series 2018-1 investment fund comes in, returning a Gross running yield of 8.36% before fees. Even even amid concerns of a prolonged property downturn causing major headwinds for economic growth, the country’s mortgage bonds remain attractive to many investors. Realm Investment House thinks now is the perfect time to be buying and there is no reason to be fearful as low interest rates are keeping borrowers from running into trouble.
Why is the opportunity available to investors now?
Realm Capital Series 2018-1 will take advantage of a new regulatory environment driven by APRA’s Policy Statement 120. APRA’s new policy impacts the capital requirements around Residential Mortgage Backed Securities (RMBS) that are funded by lines of credit in the private bank funding market. This is called bank warehousing facilities or warehouse funding. Bank warehouse facilities are lines of credit that are extended from banks to small banks and non-bank financial institutions. These facilities assist in the aggregation of loans, otherwise known as securitisation. This process occurs before the loans are funded in the ‘term market’, which is funding obtained for a period greater than one year. Banks are the current senior funders for mortgage debt facilities. Realm Investment House (RIH) research indicates that most current Residential Mortgage Backed Securities (RMBS) warehouse facilities might need as much as 25% of additional capital for the major banks to continue to support current providers (estimated to be around $3bn).
- At the same time the bank levy is likely to drive the major banks to issue more RMBS to reduce their liabilities and this will create a crowding out in public markets. While there are some systemic concerns, RIH expect the regulatory environment will drive supply side conditions that will create real value for risk.
Securitisation is a pooling of assets with predicable cash flows.
- A process by which assets or receivables are acquired, classified into pools and offered as supporting collateral for issue of debt securities in the Term Market.
- The assets’ cash flow stream must excess the interest and principal paid to the investor purchasing the debt securities.
- The debt security is called an asset-backed security. The assets are sold (assigned) into a Special Purpose Vehicle (SPV), in simple terms a trust, to ring fence them from the originator/sponsor and protect creditors (funders or bond holders).
- This also allows securities to be rated on their own merits, rather than with reference to the originator’s balance sheet.
- The securities are backed by the loans i.e. the assets, hence the name Asset
- A Warehouse is the ‘street name’ for the new loans that are written, as the loans are in transit to being funded in the Term Market. Warehouse funding facilities typically a revolving for around 12 months.
- When Warehouse facilities reach critical mass, the bank and/or the sponsor/originator seek long term funding in the Term Markets by the issuance of ABS.
- In the case for residential mortgages these are called RMBS.
- The Realm Capital Series 2018-1 investment strategy focuses on balance sheet funding and bank warehousing deals. RIH will partner with the four major banks and best of breed non-bank corporate lenders, to acquire exposures in these newly capitalised facilities. RIH’s assessment of the opportunities will generate good risk adjusted returns, when compared to the public term out market for the same level of risk.
- Diversification within the fund will be achieved by diversity of banking partner, facility sponsor and the number of individual facilities. RIH risk management and assessment overlay are used in assessing eligible exposures. This process is described by researchers as superior to RIH competitors. RIH will actively manage & monitor the risk of each funding facility exposure during the term of the fund.
What is the opportunity?
- Access to an invitation only/institutional style investment opportunity – due to the products complexity these assets are typically only available to specialist fund managers, investment banks and institutional investors.
- Short Term and Optionality – the term of these facilities is generally 12 to 18 months. The loans in the facility are refinanced regularly in the public markets i.e. the Sponsors and the Banks term out the loans in a traditional multi tranche RMBS structure. These notes would generally have a maturity profile of 3 to 5 years. In addition, with the short-term nature of the facilities, the funders have the option to roll over into the public market if they see fit and/or not roll the facility.
- Liquidity Premium = Higher return for illiquid – the rate of return on these instruments is higher than the returns for equivalent public RMBS securities and bank risk. The reason for this is not additional risk, but the complexity of the facilities documentation and the challenging nature to assign or move the owners of the facility. Even though this would not be impossible to cash out, it would be time consuming and cannot be done quickly. This is unlike the public markets, where all the securities are tradeable subject to the state of the markets.
- Comparative lower risk – almost identical with unsecured financial risk. The key risk investors are exposed to is a macro system wide weakness i.e. economic recession. The law of large numbers means a large enough pool of loans will provide an outcome broadly in line with the whole market. The investment alleviates idiosyncrasies of any one loan and is the strength of securitisation not available to individual investors. The nature of the closed ended structure provides some protection for investors against adverse credit spread movements, which are akin to a credit cycle and the relative illiquidity of the underlying facilities.
What are some of the assets held in the fund?
- The manager will manage a diverse pool of facilities across banks, pools and Sponsors.
- RMBS & ABS warehouse funding facilities.
- Public RMBS & ABS securities and RIH managed credit offerings (where the manager identifies the best investment opportunities to meet the return objective, while ramping up and divesting the portfolio).
- Where funds are invested in an existing RIH offering, RIH will rebate the management fee less the admin costs.
- The average shadow rating of the portfolio will be targeted at BBB-.
Is the domestic RMBS Market different to that of the US Market?
- There has been plenty written around the enormous fraud perpetrated upon the American people in popular culture, The Big Short and Margin Call. Short termism and greed coupled with regulatory ambivalence created what was written about as a housing crash. Housing just doesn’t crash, especially not in a stable financial system.
- In the US non-prime mortgages made up over 20% of the economy in 2006. In Australia, they are currently less than 5%. In addition, the product of choice was the Adjustable Rate Mortgage (Variable Rate). Research shows that a “Cliff Effect” was created by the financial system making available financing to borrowers who should never have been lent money. This increased speculation and drove overbuilding in the economy. This created a perfect storm. This is what crashed the US housing system and almost the global banking system (see Demystifying RMBS research paper).
- The Australian financial system is stable. Regulatory oversight is strong and asset quality is solid. While a lot is made of the un-interrupted run in Australian property performance, property strength does not portend property weakness. Market structures are made to weather cyclical volatility, even deep recessions.
- APRA, the RBA and ASIC have maintained an elevated level of vigilance since the US housing crisis. Be it higher capital requirements, more stringent lending criteria or limits around speculative forms of lending. It is fair to suggest that the current level of regulatory oversight is unprecedented. It is difficult to construct a scenario which drives any kind of meaningful loss in Australian property markets in the shorter to medium term.
- 2017 saw an increase in the number of domestic and international players in the domestic RMBS market which is a positive for investors in the asset class.
Current Default levels in Australia
- It is important to note that the quality of loan contracts in Australia will continue to increase via the new focus on items such as ‘net income coverage’ by the regulator and the capping of Interest Only loans economy wide.
What is the loss experience of RMBS?
- There has never been a charge off to a funding note in the Australian RMBS market.
- The table below shows the total amount of loans on issue and funded via securitisation markets at present. The loss on sale of loans across the whole market and its sub-sectors is expressed as basis points.
- Lenders Mortgage Insurance (LMI), has covered most of losses, with the balance cover by the sponsor and/or the Excess Spread.
- Warehouse funding will have limited insurance coverage, as this is a feature of the Term Market, even though it is becoming less prevalent.
- Excess Spread is the net margin that is generated by the funding facility, i.e. the profit left over from each loan after financing costs. This ranks as protection to funders, after the owner’s equity is exhausted (First Loss).
- Non-Bank Financial Institutions, who are the regular uses of Warehouse Funding, experience less Loss on Sale that Major Banks. Warehouse facilities have additional covenants over the Term Markets. All Losses within the facility not covered by Excess Spread must be met by the Sponsor via additional capital. In some cases, there are also corporate guarantees on junior notes for the investors.
Source S & P Quarterly Industry States as at September 2017
Despite the concerns that various investors have expressed, there has never been any losses on a rated Australian RMBS bond, especially during the GFC. In-fact these securities have become even more secure.
|Loss data in the Australian RMBS Market||Current Loan Balance ($Bln)||Loss On Sale||LMI Claims Paid to Date||Loss Covered by Excess Spread||Loss Covered by Seller||Charge Off To Rated Notes||Charge Off to Unrated Notes|
|RMBS – Prime||$122.06||0.19%||0.16%||0.02%||0.00%||0.00%||0.00%|
|Credit Unions & Building Societies||$6.19||0.15%||0.14%||0.01%||0.00%||0.00%||0.00%|
|Non-Bank Financial Institutions||$13.22||0.17%||0.14%||0.03%||0.00%||0.00%||0.00%|
|RMBS – Non-Conforming Mortgages||$3.82||0.25%||0.23%||0.02%||0.00%||0.00%||0.00%|
What is the return profile over the five-year period expected to look like?
- The manager will target a return over cash of 4.75%.
- All income received will be paid quarterly.
- Capital returned from the four-year mark (see previous section).
- Volatility of the fund’s unit price is expected to be zero, due to the closed end nature of the fund.
- The underlying volatility of the assets is expected to be low. This is due to the buy and hold nature of the facilities
- If the Australian economy was to enter an economic downturn, akin to a recession, then the volatility of the underlying facilities value may increase. However, it is expected that the short time frame of the facilities and additional subordination provided by the Sponsors in the form or hard collateral and corporate guarantees is sufficient to mitigate capital losses on our investments.
- Management Fee – 1.25% p.a plus GST of NAV paid quarterly in arrears.
- Placement Fee – 1% plus GST (rebatable to unit holder into form of cash if required).
- The fee will reduce to a care and maintenance fee if any capital remains unpaid after 5 years.
If you do have any questions about Real Investment House products please see the website http://www.realminvestments.com.au/ or contact the Realm Team on Tel: 03 8560 7297 .