Innovating securities in Australia

In Australia over the last 30 years within the securities market, the major investor interest has been to stick with Bank notes, RMBS, ABS and CMBS offerings.

The first issuance of RMBS (Residential Mortgage-Backed Securities) in Australia was issued in the mid-80’s which offered investors access to invest into residential home loans. Without going into the economics, these securities are packaged into various note categories or bonds (A-1, A-2 etc) aligned with investor credit risk appetites and rated by ratings agencies.

During the 80’s and 90’s is when the securitisation market began being creative and innovating. After all, there is more out there in financial products than just Mum and Dad home loans or Fish n’ Chip shop loans.

An example is the Channel Tunnel between the United Kingdom and France issued securities whereby investors can buy notes which dates back to the mid-00’s and just released another one in 2022.

The access and appetites for these sorts of products is not exactly well known or well considered with most fixed-income or securities investors in Australia sticking to the RMBS or CMBS since it’s more well known and it provides returns usually against underlying Australian property collateral.

CDOs (Collateralised Debt Obligations) during the GFC became the poster-child for bank greed and instruments that you need a white-board and a microscope to understand. These securities were opaque to investors, had few little reporting clarification or obligation and due to an insurance bond on these, investors felt safe. For the majority, residential mortgages were still the underlying security of CDOs. RMBS is the same and no one issues these anymore.

CLOs (Collateralised Loan Obligations) were around at the same time as CDOs, but focused on commercial loans and collateral not Mum and Dad’s home loan. The reporting was required to be transparent and easier to analyse and most investors now have a higher ‘first loss’ or equity requirement, therefore making them more secure.

Oaktree gives a good summary of the CLO market.

Over the last ten years, the CLO market in the US and Europe has continued to increase at rapid rates. Investors who buy these do get the benefit of purchasing notes based on their risk appetites similar to a RMBS. CLOs can be mortgage-based similar to a RMBS, with a pool of commercial loans being the obligation and the collateral can be hard assets or equivalent. Credit Ratings Agencies like S&P, Moodys or Fitch also provide guidance and research for CLOs.

CLOs and other securities offer both investors access to securities aligned with their risk appetites, and businesses access the capital they need. In Australia, most of the best businesses are now getting their capital from overseas markets and the CLO market is solving a fair amount of this need.

In Australia, there has never been a CLO market, and this is for a few reasons.

• 1 — The Investor market here is not familiar with them.
• 2 — The reporting and operations behind a CLO is complex. The technology systems most issuers would use are not sufficient, particularly in mortgage-backed CLOs.
• 3 — A middle-market CLO is usually over US$500m which is required to be deployed usually within 2–3 quarters.
• 4 — Knowledge of this market is limited in Australia, even for most Banks whose treasury departments will know of them, but only a few have purchased notes or issued one.
• 5 — The Regulatory environment is not yet as established as other overseas markets.

As the Private Credit market continues to grow in Australia, which is now $188bn up from $35bn in 5 years, the vacuum being created needs to be fulfilled and from a Gallantree standpoint, we’d rather this is done by an Australian company. While we don’t think we can fill the vacuum completely, handling this correctly is very important, and should not be taken lightly as the consequences will be sobering should international players fumble or mismanage this.

The knowledge, skills and experience generated from issuing these sorts of securities is lacking in Australia as Banks continue to ‘go back to core’.

For Gallantree, building a destination for businesses to access the capital they need without having to go overseas has been very much the mantra from day zero.

Additionally, for talented finance professionals who want to grow their own skills, knowledge and capabilities, this is difficult to do in the current banking landscape. For local Banks, it’s not in their DNA. Therefore, we aim to provide a destination for willing finance professionals and aim to grow an ecosystem and an industry at the same time.

(Nothing in this memo is financial advice and if you are investing in securities, we’d recommended speaking to a financial specialist or planner first).