As part of the Eureka Report CEO profile series, Nick Raphaely chatted with one of Australia’s most respected business commentators, Alan Kohler, from the Eureka Report.
Alan was keen to hear more about the AltX business model, how a “Bricks and Mortar” lending model is drawing in investors whilst Nick explained how AltX is well-positioned in a climate of low-interest rates.
Hear the interview
Nick, do you mainly lend to property developers, apartment developers?
Alan, our business model lends to all company borrowers, so we don’t lend to individuals as in mums and dads, the borrower needs to be a company. A very substantial portion of the book is actually property developers…
I would say, in excess of 50 per cent.
But these are all borrowers who can’t get a loan from the bank, is that right?
People have this misconception that if you get blocked by the bank there must be a problem with your deal or with you as a borrower. The truth is, a lot of borrowers who come to us can actually get money from the bank, but for various reasons they choose to borrower from AltX because the things which we offer are the things which are important to them, things like speedy decision-making, things like in commerciality around due diligence, things like access to decision-makers, people who understand what they’re trying to do and get to arrive at a matter pretty quickly.
What do you mean by commerciality around due diligence?
Well, I would argue that it’s the more pertinent due diligence that we focus on. For example, you hear stories about how you want to get a loan from the bank you need to have three years of payslips and if one of them is out of order or missing or whatever, go all the way back to the back of the queue, when in truth substantially you’re a qualified borrower but the bank is just ticking every single box under the sun in order to get you the money. We form a view that if we’re talking to someone who’s got their own money going into the transaction, they’ve got experience in what they do, the end product they’re building in the case of developments is priced right and appropriate for the area and they’re motivated to get the job done, there’d be no reason not to do business with them. The same as any other corporate transaction – lending is very similar to business, right? It’s just a form of business. If we’re aligned with the person we’re giving the money to, they have the experience and what they’re building makes sense, there’s no reason why we wouldn’t want to give them the money as long as we could satisfy all the related conditions.
What’s your default rate?
The default rate is low…
But it’s not zero though?
Banks don’t have a zero default rate either…
I know, I’m not saying they do.
Perhaps if you put it this way, we fund the book, Alan, through capital that we get from investors. In a decade of operating the business, we have always returned 100 per cent of capital and interest to our investors. That’s not to say that you don’t get arrears from time to time from borrowers or on the very odd occasion you might end up going and mortgaging your position to setup a property, no different to the CBA or the ANZ. The point is, people shouldn’t think that non-bank lending is a risky proposition because at the heart of it, the track record speaks for itself in that we’ve always returned capital and interest to investors, so we haven’t lost money…
Does that mean that you’ve worn the defaults yourself?
The defaults have already been collected. We’ve had arrears, so a borrower may fall behind in payments, you might have to thump the table to get the capital back. But no, we haven’t lost money either, I think is the question that you’re asking. It’s not like we’ve taken the hit to protect the investors, we’ve recovered as well, so there’s been full recovery. You need to come to office to see it, but at the heart of it we’ve got a team of 40-plus people and we operate very similar to a bank. We’ve got a credit manual, we’ve got credit processes, we’ve got people out of the banks who work in our credit area. We’ve got loan servicing, we’ve got loan management, we’ve got investor servicing, we’ve got collections and arrears. The nuts and bolts of our business in terms of the functions of the business, are very similar to what you would expect any responsible and sophisticated lending organisation.
What loan to value ratios do you operate?
We are more conservative than the banks – people also sometimes misperceive this. The maximum we go to on residential security is 70 per cent, that’s 7-0. On commercial security, it’s generally up to 60 per cent and land is generally in the 50s or below.
Why is land so much lower than the others?
Land has no inherent value, the value in land is what you can do with the land and that depends on what approvals you can get for the land. If you’re building apartments, for example, what would the apartment market be like when you’ve finished building? All of that links to the liquidity in the market, liquidity of the assets. For example, if you go to a house in Chatswood and you put it on the market, if you drop the price by 5 or 10 per cent on any given day you could get 40 to 50 people turning up to try and scoop up that property at a discount. Land is a different proposition, the market to buy it is only developers, each one will run their own feasibility, there may or may not be permits. They’ll form different views on what they can do with it, where the market will be at the end, all these sorts of things so it completely narrows the buyer universe. From a lender’s perspective, you want to make sure your exposure is way lower on something like land as compared to very liquid residential security in the metro area.
Now, you fund the loans yourself to begin with and then you take them to investors, which I think makes you quite unusual, is that right?
Correct. We describe ourselves as a managed marketplace. We’re a marketplace in the sense that we’re connecting investors on the one hand who have capital and want to invest in transactions, but borrowers on the other side who need access to capital. We’re a managed marketplace in the sense that we fund the deals and take them on balance sheet first before we offer them up to investors and that’s important for a few reasons. Number one, in order to get the quality deals, AltX needs to be able to move quickly and to move quickly you’ve got to have the money in your hand, you’ve got to be able to speak for the money, so we need our balance sheet to be able to do that, so we secure the deals with the house as capital.
Then secondly, when we take the deals to the investors, Alan, we’re saying two things. We’re saying, number one, the deal is done, there’s a certainty of the transaction so the borrower has the money, the mortgage is registered, the deal is set. Number two, we’re eating our own cooking, we believe in the deal, we funded the deal and even if the investors don’t want the deal, we feel comfortable enough to hold it for ourselves. It’s a model we’ve run since the beginning and it seems to resonate well both with the borrowers and with the investors.
Are the loans always secured by mortgage?
Correct. The model is always based on doing loans, always secured by a registered first mortgage over the property in Australia. At the heart of it, every single loan has a registered mortgage and a guarantee from the sponsor or the borrower to repay the loan at the end of the term, as well as obviously the usual covenants to pay monthly interest during the life of the term. What we say to investors is you’re getting security with income and guarantee security as it’s backed by bricks and mortar. Income is the monthly interest that the borrower pays and the guarantees is ultimately — it’s not a lot like the US where the borrower can just walk away — the borrower is personally guaranteeing the repayment of the loan above and beyond the security they’ve offered up for the loan. So, it’s quite a competitive proposition for investors.
Do you only make money out of the interest rate margin or do you also charge a fund management fee?
We charge the borrower some form of establishment fee or loan establishment peers that call in the industry and we also make a spread, which is the difference between what the borrower pays and what the investor earns. We charge a nominal funds management fee, I think it’s 0.25 or 0.5 per cent, but the guts of the revenue comes from fees paid by borrowers and the spread which is the difference, as I said, between what the borrower pays and what the investor earns.
What’s the spread, what do you charge borrowers typically…?
It varies across deals, but as a general statement it’s about 1 per cent, the spread’s about 1 per cent, then it moves as the market dynamics move. Sometimes the spread is a bit bigger, other times the spread is very competitive and the spread is smaller. It’s just quite a sophisticated market, Alan, so investors have a range of choices, whether they invest with AltX or with others. Once they do their due diligence, they realise that we’re offering them a first mortgage, as I say, in Chatswood, 70 per cent LVR, we’re paying a net return to investors of 6.85 per cent per annum. They tell you not to get too fixated on what the spread is and kind of what happens beyond their return and what they say is, I’m getting this return for this risk, for a transaction managed by this group of people who have been doing it for a decade and have done over a thousand deals and I’m happy to proceed.
So you’re making money three ways. You charge the borrower an establishment fee, you’ve got a spread and you’re charging what you call a nominal fund management fee, but 0.5 per cent is not nothing.
Correct, but there’s an enormous amount of work that goes into it. This is not like you invest in an equities fund and they just buy some more BHP or some more Rio and just kind of add it to the pile. There’s an enormous amount of work that goes into every transaction in terms of – and covering the transaction, being first to get on it, locking down the borrower, getting the terms correct, registering the mortgage, getting the covenants of the loan correct, all those sorts of things.
Ultimately, as I say to investors which I speak to often, I say, “You need to look at the AltX proposition in the whole and you need to say, “Do I feel that I’m getting a satisfactory return for the risk that I’m taking and for the service which is being offered to me by the AltX team?” If you feel comfortable investing your capital with us, then we’re delighted to have you as an investor. If you feel you can go somewhere else where the fees are skinnier or the returns are higher or the promises are more outlandish, then you need to go where you’re comfortable because that’s what this game really is about.”
You’ve got a bunch of funds. Do you fund each deal individually or it goes into a permanent fund that’s ongoing, is that how it works?
It’s a good question. We offer investors the choice, so investors can either choose the deals themselves directly, which we call the ‘deal by deal model’. Almost every day we’re publishing the deal to investors and they get to evaluate the deal, the security that could reap the valuation and they can call the office and ask questions about the deal and then pick that deal. They can build a portfolio that way themselves, or if they prefer they can invest in one of our funds and what the fund does, is essentially it gives them exposure to a spread of deals, almost as if they’ve done it themselves and that’s where the fund management fee comes in. If they’re picking the deal directly, there’s no fund management fee, they are their own fund manager. We have some investors who prefer to pick deals, we have some investors who prefer funds and we have some investors who like earnings.
Whatever you do, do you get the monthly distribution?
Correct. Interest is paid monthly on all the deals and that’s back to back to the borrower, the term is back to back to the borrower as well so interest is paid to investors, I think, the third or fourth business day after month-end and I think investor statements come 48 hours after that. The proposition to an investor in an environment where, as you know, yield is very difficult to come by, it’s an attractive yield between 5 and 8 per cent, backed by security income and guarantees. And again, overarching all of that is a team of 40-plus people built up over a decade, focusing on delivering these products to investors every single day.
Can you explain to us the difference in risk between 5 and 8 per cent?
Sure. Our most conservative product is actually one of the funds that we offer, it’s called the Horizon Fund and that attracts a lower return to investors for two main reasons. One is that the manager actually has the first loss position in there, so what I mean by that is there’s a 10 per cent slice where the manager, which is ourselves, will lose capital before the investor’s capital is impaired. For example, if it was a 70 per cent exposure loan, the first 10 per cent hits if there was one would be taken by the manager, so it’s really 90 per cent of 70 per cent, so it’s really 63 per cent exposure at the highest exposure for investors in that category. There’s the manager first loss provision, also in that category of loans that the Horizon Fund invests in there’s a greater level of scrutiny as to the borrowers capacity to service. So, we’d run more detailed service calculators, almost approaching what the banks do to make ourselves comfortable that the borrower can actually satisfy the monthly interest, as I said, with more scrutiny than, say, in some of the other products. Those two reasons are why that product would attract the lowest rate.
The highest interest rates, on the other hand, Alan, is related to our construction products and the reason for that is, in addition to all the traditional risks associated with lending to a company secured by first mortgage, you’re also taking on the operational risks associated with construction, so things like delays due to COVID, rain, builder risk, supply risk, subcontractor risk, any unforeseen issues that happen in the day to day running of a construction site. Those are also risks inherent in lending to a developer for the purpose of construction. The higher rate compensates investors for those risks.
It’s also true that even your higher rate funds, the construction funds, have not lost any money.
That’s correct. Important to point out, our niche in business is not funding mega transactions. You’ll never find AltX providing funding for a 40 or 50-storey high-rise on the Gold Coast. The typical deal that we like to fund from a construction perspective would be a dozen townhouses, 20 apartments, duplexes, maybe a luxury home. It’s smaller-style transactions where if anything were to go wrong, both from a financial and an operational perspective, we’d have the muscle to get in there and get it fixed. We like to sprinkle the book with lots and lots of smaller transactions as opposed to having fewer banner headline transactions.
It’s a bit counterintuitive actually because you think it’s sexy to fund a big building, but from a risk perspective you sleep much better at night knowing your risk is spread over many projects, each one of which if anything were to go wrong, you don’t have massive placement risks, you’re not 30 storeys up by the time you figure out there’s a crack in the concrete, those sorts of things if there are rectification issues that can be attended to, etc., etc. That, again, we’ve learnt over time and I think also that’s informed, Alan, by the fact that we put our own capital in. Nothing focuses the mind quite like writing your own cheque. It’s far easier to lend $50 million by doing two $25 million deals, as opposed to trying to find 10 $5 million deals. But what we found is that diversification gives us a lot more comfort on the risk side.
Its also true in that the period you’ve been operating the past few years has been a period of declining interest rates, record low-interest rates and a fantastic time for developers and people like you. That’s changing now, right? I mean, interest rates are about to go up. You’re heading into a period when your risk processes are really going to get tested.
Look, I’ll be the first to acknowledge that a large portion of the past decade the market has been very benign from a lender’s perspective. At the extreme, you would almost say that almost all mistakes were forgiven because if you’re a lender secured against property, a rising market forgives all mistakes and I would never be so presumptuous as to say that as a business we have all the answers or we know everything or we’re not learning new things every day.
But what I would say is that over the decade, through doing hundreds and hundreds of loans, we’ve learnt a lot of things in terms of how to structure loans, what attributes to look for in borrowers, we have problems potentially that arise, the best way to solve the issues, etc., etc., so that when we see situations today which look good on the surface, our knowledge reminds us and our experience reminds us that, oh, this one reminds me of that one from three years ago where it looked good on the surface but when we asked a few more questions we realised that there was this latent issue which may arise, etc., etc…
So, that’s by way of looking backwards. Looking forward, as rates start to rise, obviously property prices, generally speaking, are inversely correlated to rates, so property prices we would expect to moderate or potentially come down. As I mentioned at the start, our exposure’s only to 70 per cent LVR on a resi security, so we’ve got a decent buffer in there. Again, this is not on random valuations. We outsource valuations to third-party valuers, we also have an in-house property research team that corroborates and confirms valuations, so we’re pretty comfortable on our valuations. Also, our exposure is fairly short-term. We’re not giving credit for five, 10, 15 years. The longest term of our loans is generally 24, at the absolute extreme 36, months.
So, the exposure that we have on the book is generally short on an ongoing basis and that gives us some comfort too. But look, we’ve got to be fast on our feet, we’ve got to be alive to the changing circumstances. We’ve got to begin to manage risk as the market conditions change.
How much of the loans do you keep, by the way? I presume you retain some exposure so that you’ve got skin in the game as well?
Correct. It’s between 5 and 10 per cent. We’ve got a book of approximately $1 billion at the moment. We’ve got over $100 million of house capital in loan transactions, which is a substantial number.
Do you and your two co-founders still own the business? Is that your capital or have you got other investors in?
We’ve got a group of approximately half a dozen investors, it’s mainly the founding investors plus one or two key staff members, they form the investor group. We’ve never taken substantial third-party capital, it’s really been a process of investing and reinvesting in the business. I have to say, we’ve always felt it was quite a good place to park our own money and so, as the business has been fortunate to be successful, reinvesting in the business from a personal selfish point of view, it’s always felt like a good thing to do. It’s almost been natural that we’ve reinvested in our business.
Are you thinking of an exit at some point?
One of my fellow shareholders once said to me, “Don’t worry about the exit, just build a good business because every good business has opportunities and they will come to you and bad businesses will hit the wall.” So, it’s not like we go forward with our eyes closed, but we like to think if we build a good business and continue to be valuable in the market, the right opportunity will come along at a point in time.
Is your business planning, as you think about the future now with higher rising interest rates and possibly a soft market, are you thinking that your business will have to pivot to some extent away from property and development, more towards business lending?
I think it’s in our DNA to be secured lenders. We know successful players in the market that do unsecured business lending. The market almost bifurcates, you’re either going on secured or the unsecured route, I think it’s in our DNA to be secured lenders. I think there will always be a market for borrowers who present creditworthy deals, but which the bank for their own reasons chooses not to fund. I think for the foreseeable future, we can continue to grow the business by making it our business to seek out those borrowers and be as compelling, as attractive and really being the first choice provider of capital to them. You’ve got a structure in Australia, Alan, where it’s almost like that, an oligopoly of the big four banks plus a scattering of others, both from a coverage point of view and from a concentration point of view they’re just not able to cover the whole market. As Australia continues to grow, as immigration hopefully gets going again when the borders open, we believe there will always be pockets of opportunity where the banks don’t play, where private capital can step in and fill the gap. That’s where we see the immediate future of the business.
How do you market your loans, do you use brokers?
Yes, so it’s mainly for intermediaries, mortgage brokers, finance brokers, lawyers, accountants, estate agents… If you think about our business, our business comes alive where the need for finance intersects with being able to offer bricks and mortar security as a first mortgage. We look for every possible intersection in the market where those two, as I say, intersect. A borrower is no good to us if they’ve got an asset but don’t need money, or if they need money but don’t have an asset, so we look for all the junctions where those two collide. As I say, real estate agents, lawyers, accountants – people always go to their accountants for advice – mortgage brokers, finance brokers, equipment finance brokers and some direct as well, but it’s mainly through intermediaries.
Great to talk to you, Nick, thanks very much.
No worries, thank you, Alan.
That was Nick Raphaely, who is the co-founder and co-CEO of AltX.
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