Securitisation plays a pivotal role in the global financial landscape, providing investors access to diversified pools of loan exposures, while allowing lenders to optimise their capital structure. Among the various types of securitisation products, residential mortgage-backed securities (RMBS) and private warehouse securitisations stand out as prominent categories in the Australian market. The Aura Private Credit strategy structure and invest in the latter, partnering with Australian small and medium sized business lenders. This week, we delve into the high-level differences between these two investment options.

Understanding residential mortgage-backed securities

Residential mortgage-backed securities are financial instruments representing an ownership interest in a pool of residential mortgages. In this system, mortgages from multiple homeowners are bundled together and sold as publicly tradable securities, initially in the primary market and subsequently in the secondary market. The inherent stability of residential real estate valuations, coupled with the familiarity of the assets can make RMBS a desirable choice for risk-averse investors in the Australian market.

Aura Private Credit: SME private warehouse securitisations

SME private warehouse securitisations, on the other hand, represent a more specialised approach to securitisation. These assets are not traded in public markets and can be structured away from the banking system. These instruments encapsulate a broad spectrum of SME loans secured by an array of assets. For instance, the Aura Private Credit strategies hold exposure to:

• Equipment & machinery finance;
• Property (non-development) backed finance;
• Livestock finance; and
• Invoice finance (credit insured)

Comparing RMBS to the Aura Private Credit strategies

1. Active vs passive management

In an RMBS investment, investors, particularly those outside of the big 4 banks or investment banks providing the majority of the funding, are largely passive investors, faced with a take it or leave it investment opportunity. Public RMBS deals are generally structured by banking teams who act as an intermediary between the lender and the investor. The bank will take a fee for the provision of this service. The investors, unless they are underwriting a significant portion of the transaction, will have little input into the key characteristics of the underlying pool of loans or triggers in the transaction. The investor will be able to undertake due diligence on a lender, however, may not have significant influence over how the lender operates.

A key feature of the Aura Private Credit strategies is the active management and influence of the investment team across all elements of the partnership with the SME non-bank lenders, including:

• Credit assessment inputs, policies, methodologies, and systems
• Loan servicing methodology and systems, including arrears and recovery management
• Loan portfolio management and systems
• Lending authorities
• Oversight
• Reporting format and frequency
• Risk profile of borrowers
• Lenders risk management frameworks
• Required security on underlying SME loans
• The level of equity capital the lender must contribute to the deal, which acts as a first loss absorption piece
• Investment structure
• Covenants, such as the maximum percentage of loans which are in arrears or default before a breach is declared.
• Loan book composition, such as; borrower risk profiles, geography split, loan sizes, borrower serviceability measures, etc.

1. Liquidity

RMBS offers two primary forms of liquidity:

1. Amortisation of the investment with principal repayments on the underlying mortgages flowing through to investors; and
2. Secondary market liquidity (subject to minimum parcel size, or number of securities to trade in one transaction, which may be out of reach for some investors).

Secondary market liquidity is a positive consideration for investors looking to exit an investment in a timely fashion, although, investors may not receive principal back in full due to broker fees/commissions and market price movements between the initial purchase and sale dates, regardless of the performance of the underlying mortgages.

The securitisation warehouses the Aura Private Credit strategies invest in are revolving in nature. However, if liquidity is required, there are two primary methods of exiting an investment:

1. Amortisation, where the revolving period can be called to an end and principal repayments of the underlying SME loans will flow back to the fund. This is why careful consideration is placed on the duration of underlying loans the Aura Private Credit strategies finance through warehouses. As at 31 August 2023, the percentage of underlying assets of the Aura Private Credit strategies with duration of less than 3 months were 49 per cent and 78 per cent; and
2. Refinance, where capital provided by the Aura Private Credit strategies is repaid via refinanced capital provided by an alternate investor.

However, investors in private credit funds with specialised and active management, such as the Aura strategies, are investing in a fund, not directly in the warehouses themselves. Investing this way provides additional liquidity management at the fund level.

1. Return profiles

Due to the vast amount of capital which can be invested into and size of RMBS investments, these instruments are typically rated with returns largely dictated by the credit rating assigned to each investment with limited scope for return premiums.

Private SME warehouse securitisation facilities on the other hand are typically non-rated and provided by private credit funds. There are only a handful of private credit fund managers with the specialised knowledge and capital required to underwrite and fund these facilities, resulting in a complexity and scarcity premium, with the potential to generate alpha for investors in these funds. 

Conclusion

In a financial landscape that demands adaptability and resilience, private credit funds that specialise in private SME securitisation warehouses emerge as an attractive option for investors looking to access the non-bank securitisation asset class. Their ability to leverage the strength of small to medium sized business loans secured by varying assets, combined with the flexibility to respond to macro-economic and market dynamic shifts, positions investors seeking income and downside protection well, with curated, specialised and actively managed exposure.