Assessing loan risk

• A core tenant of our lending strategy is ensuring there is a healthy buffer between our loan levels and the sworn independent values of assets securing this financing.
• Valuations reflect what the market is prepared to pay for an asset based on the mosaic of many economic variables that drives market participants at the time.
• Generally, valuations are stable and dependable but in the current environment they can be wide ranging. In contrast replacement cost of a building is a much more tangible base line during uncertain times.
• Our commitment to finance office development has been anchored by our assessment of the “implied cost” at which we would inherit an asset if we were required to step in in on a defaulting loan
• Two recent office construction loans added to the Partners Fund have a significant risk buffer as the implied default cost is well below the construction cost of the completed assets.
• As discussed last week construction costs and the resulting “replacement” costs of assets have limited downside risk, due to the nature of the construction industry and labour cost pressure that is ever present in Australia.
• In the current non-bank lending market, we are finding ongoing opportunities to lend against office buildings at in “implied loan value of” of $3500-4000/sqm vs building replacement costs in excess of $4000/sqm and market values of $7000-8000/sqm

In last week’s update we explained why the running income or measures of loan serviceability were the backbone of bank lending where as “replacement cost” of an asset at loan maturity was instead a key factor in assessing loan risk in our investment process.

This week we are providing some current loan examples to show the practical application of this comparison. Looking specifically at the office sector, we have financed the construction of two Melbourne office developments over the last 12 months and are undertaking due diligence on several new opportunities. These loans have helped to diversify the Partners Fund by increasing the office exposure to ~15% from zero 12 months ago.