The recent bond market sell-off and ongoing global uncertainty have investors increasingly concerned about volatility and searching for reliable income solutions. Residential whole loans can offer a stable, secure and liquid alternative to traditional fixed income instruments like bonds.
So what exactly are whole loans?
In some ways whole loans are a typical fixed income investment. They’re a debt instrument where an investor receives a set amount of regular interest payments over a set repayment period, with a set maturity date.
But in other ways they’re different.
With traditional fixed income assets like bonds, the loan is from the retail investor to the financial institution.
With whole loans, it’s the reverse – the loan is from the financial institution to the individual borrower.
Compared with fixed income investments on public markets, whole loans can offer capital stability, high levels of security and credit quality, and higher levels of income.
However, like many types of investment, whole loans encompass a wide range of potential risk levels and returns.
At one end of the spectrum is unsecured and unregulated corporate lending on assets such as high-risk property developments.
And at the other end is secured and regulated lending on very low-risk assets in Australia’s $2.4 trillion residential mortgage market [1].
Low LVR, high quality, low arrears…how?
Residential home loans represent Australia’s largest market so there’s healthy competition for borrowers between banks and other non-bank lenders (NBLs), which account for a small but growing proportion of the market.
As an asset manager, RAM uniquely differentiates itself through its ownership of Brighten Home Loans, a wholly owned NBL that originates around $250 million worth of home loans every month predominantly via mortgage brokers.
Brighten effectively acts as a filter at the front end with full underwriting by experienced credit officers based in Sydney. It only accepts fully verified loans with high quality borrowers who meet strict credit requirements. The average loan-to-value ratio (LVR) is around 64% and loan arrears are historically lower than major banks.
One of the key differences between regulated home lending and corporate lending or commercial real estate direct lending funds is the need for greater verification and serviceability tests, as well as 100% secured lending.
This means if the loan does default there is a simpler and well-worn path to take possession of the property and sell the house, compared to the risks of taking possession of half-completed developments or operating corporate businesses.
Breaking it down | Whole loans v mortgage-backed securities
So now these home loans are on Brighten’s books, how are they packaged up for investors?
One option is to break the loans down into residential mortgage-backed securities (RMBS). These debt securities are structured into different tranches with different levels of risk and returns, which are sold to investors.
Another option is to keep the mortgages intact as ‘whole loans’. You can still sell these original unbroken, unsecuritised loans to investors, you just need to have a large scalable business to support the origination, servicing and accounting – a business like Brighten.
Whole loans currently make up 35% of total assets in our Real Income Fund. But all the loans are portable across the funding platform and suitable for conversion into RMBS, which provides RAM with a unique competitive advantage.
If we need more liquidity for our portfolio, there are a few options – package up the whole loans into RMBS via an in-house Treasury team or simply sell the whole loans to a $2bn-plus funding platform of bank-funded warehouses.
It all adds up to a compelling package – contracted monthly income with a low LVR and secured first mortgage position and liquidity from investing as part of a large and diversified funding platform.
Managing credit risk | The 5Cs – tick, tick, tick, tick, tick
The global financial crisis (GFC) has cast a long shadow, and some investors may still feel concerned over risks from investments related to property loans.
The strength of Australia’s regulatory environment should act as one form of reassurance. If you look at the 5Cs of credit – character, capacity, capital, collateral and conditions – whole loans are one of the few investments that tick all the boxes.
At RAM, we have a robust credit policy at the front end to review the character of the borrower and verify their capacity to pay based on regulatory requirements.
We also set conditions at the start that borrowers need to meet. These include income verification, mortgage insurance if the LVR is above 80%, insuring the property and having capital upfront. And the collateral comes from the 100% secured position in the property.
The funding that Brighten uses to offer these loans comes from wholesale RAM funds as well as top-tier banks and institutional capital, who conduct their own regular strict due diligence on the entire lending operations and policies.
Higher income, lower risk, higher ranking…
So how secure are whole loans in terms of investment risk?
One way of measuring risk is to look at Tier 1 and Tier 2 bank regulatory capital, which are used to absorb losses and ensure financial stability.
Let’s see how whole loans match up against AT1 and T2 bank hybrid investments.
- HIGHER INCOME | Loans benefit from cumulative income, hybrids don’t.
- LOWER RISK | Hybrids can convert into equity market exposure with uncertain value. Loans trade at face value plus accrued interest.
- HIGHER RANKING | As secured lenders, whole loan investors rank highest in thecapital structure, while hybrid investors rank with equity holders or below. So they’d be first to receive their money back before other creditors.
Stress test | Navigating market turbulence
From a risk perspective we’re also mindful of the increasing global uncertainty from a possible recession in the US and across the globe.
Recent market turbulence has acted as a stress test for different types of assets, with President Trump’s tariffs causing convulsions on investment markets.
Equity markets were up and down as investors reacted to daily – and even hourly – updates on tariff changes and carve-outs. And there was a sell-off on bond markets, with prices down and yields up, prompting a 90-day tariff pause.
Meanwhile, over in the private residential whole loan space things were comparatively serene.
The reason behind this is that the terms of whole loans are set at the front end and based on the competitive lending environment. So market movements have less of an impact.
And as we’ve seen, the good thing about home loans is that they trade at face value plus accrued interest – unlike Tier 1 and Tier 2 bank capital, which come with market price risk.
So as public markets have fluctuated, we haven’t needed to adjust our portfolio or asset allocation in response to volatility or interest rate cuts and capital stability has continued at 100%.
As for rate cuts, they have started to flow through to mortgage rates, which improves asset quality, but whole loans are still offering a very healthy premium compared to base rates. Strong asset quality is a positive for the credit quality of the loans. Refinancing may step up as rates start to cut and major banks move to offer what looks like ‘cheap’ fixed rate offers due to the shape of the yield curve.
Opportunity knocks | Public v private
As a large investor with extensive $2bn-plus funding facilities in place, whole loans are a highly liquid investment. This means we can move quickly to adjust the Real Income Fund portfolio if there’s an opportunity.
A key theme over 2024 and early 2025 was the ongoing rally in public market credit spreads across all RMBS and other asset-backed security (ABS) tranches. This resulted in private market whole loans and securities improving even further in terms of relative value.
Then as global uncertainty and volatility spiked public markets, credit spreads moved around 10-20 basis points wider in the AAA segment, and around 20-30 basis points wider in the mezzanine segment.
If the sell-off continues, we may get the opportunity to reallocate a portion of the portfolio to more attractively valued deals – although they still look expensive compared to private markets.
We’re currently looking at BBB tranches which have recently traded at a margin of 180 basis points but are now available for 200 or more.
Suits you | Income + stability + liquidity
As a result of their risk framework and high quality, whole loans can suit investors such as retirees, who are looking for regular and consistent income.
Our Real Income Fund offers an 8.1% target yield with capital stability and monthly liquidity.
By offering equity-like returns for a lower level of risk, whole loans can fit neatly into the defensive income component of a portfolio.
Sincerely,
Michael Frearson
Director, Head of Fixed Income
About the Real Income Fund
The Real Income Fund aims to provide investors with an enhanced income stream through Australian secured credit.
Why Invest in RIF?
- Reliable, enhanced monthly income stream
- Conservatively average LVR across the portfolio of 63%
- Diversified, secured Australian first ranking mortgages on property and other assets
- Monthly liquidity provided through access to a $3bn funding pool
- Conservatively managed portfolio with no development finance or unsecured finance
