In the wake of the collapse of Australian Capital Reserve (ACR), Fincorp and Westpoint, the chief executive officer of fund manager and professional commercial mortgage lender Mirvac Aqua has defended the mezzanine asset class.
“Australia’s economy’s going well, the property markets are going well and the credit market is in good shape. If property’s good and credit’s good, but companies like these are facing problems, it tells you the issue is not property or credit, it’s structural,” Tunley said.
“If you look at the problems and failures, it appears that it’s either a cash-flow driven issue or it’s a structural issue within their offer. In some cases what happens is that they’re seen as offering a mezzanine debt product and in fact they’re not at all, they are often lending well into equity territory.”
There are three mezzanine debt markets in Australia. The first, where Mirvac Aqua operates, is used by sophisticated corporate or high net worth borrowers who want to limit their equity in a particular transaction so they can use their money across a number of other property transactions and therefore diversify their business risk. It is more about harnessing capital and managing risk than anything else Tunley said.
Typically these transactions are structured as second mortgages with a loan to valuation ratio in the range of 70 per cent to 90 per cent.
In the case of construction, loans are advanced as a percentage of construction costs, not the end value of a project, which is the more conservative methodology.
The second market is for borrowers who use mezzanine debt because they have insufficient capital, and they see mezzanine as a short-term solution to a more fundamental problem.
This is a considerably riskier proposition and not one that any professional mezzanine lender would contemplate, Tunley said.
“In the third market are those who raise money, as we saw in the likes of say Westpoint, which are perceived as secured debt, but in fact the offer goes beyond even mezzanine debt into equity. Typically these companies raise the monies from the public direct, avoiding the scrutiny of professional research used by financial planners, and lend it direct to themselves or another related party,” Tunley said.
“You have to ask given the competition between lenders, why do they do this? The answer is usually because it gives them some form of favoured treatment either in terms, interest rate charged or a combination of both – clearly there is a potential for conflicts of interest in this situation.”
In Tunley’s view, investors’ alarm bells should start ringing if they see one of three things on the offer document – related party lending, unfunded construction, when future fund inflows, repayments of loans and interest due are relied upon to make progress payments to borrowers, and end-value lending, where the estimated end value for a completed project is used in calculating the amount of funds to be lent.
In Australia, there are a number of mezzanine lenders, the market leaders being Mirvac Aqua, Macquarie Bank, Babcock and Brown, and Investec.
“To be successful in mezzanine lending, the key is to not be seduced by return, but driven by comprehending and the controlling risks. We want to understand where the risks are and how we can better manage those risks so we get a beneficial distortion between risk and reward outcomes,” Tunley said.
