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26 Jun 24 Insight Fixed Income Challenger Investment Management

The Opportunity in Securitisation Warehouses

Private securitisation warehouses, the pre-curser to public asset-backed securities, present a compelling opportunity for investors. Offering a substantial yield pickup over public markets due to their illiquidity and complexity, investors can gain attractive risk-adjusted returns and meaningful portfolio diversification benefits from this sub-asset class. Given its complex nature, it is critical to choose a manager with extensive experience in this market to ensure risks are managed appropriately.  

What are securitisation warehouses?

The term “asset-backed securities” refers to a pool of loans/receivables which are securitised and tranched into bonds of different risk/return profiles and issued in public markets. The underlying assets may be mortgages, auto loans, consumer loans or other types of debt. However, before the pool of assets can be securitised into public RMBS/ABS, the lender must accumulate a sufficient volume of loans to pool together. Warehousing, or pre-securitisation finance, allows a lender to accumulate a sufficient volume of loans before they are securitised and issued in public markets. As a result, they tend to be relatively short tenors, usually between 12-24 months.

The warehouse is tranched into the top senior tranche, the mezzanine tranche and the originator 1st loss/equity tranche. The senior financier of the top tranche is typically a bank who will also act as the arranger of the public transaction once sufficient loans have accumulated and the pool is ready to be securitised and publicly issued (step 3 in the diagram below). The lower equity tranche is usually funded by the originator of the loans.


Where has the warehouse lending opportunity come from? 

Prior to the GFC, banks were willing to fund the senior and mezzanine tranches of a warehouse. However, in the period after the GFC, regulation and increased capital requirements have discouraged banks from funding anything other than the senior tranche. This left a structural gap in funding for the mezzanine tranche and alternative lenders like Challenger IM have stepped in to fund this space.

Why are warehouses such an attractive investment?

Warehouses provide an attractive pickup over public markets due to their illiquidity and complexity. Originators, or issuers of the loans, wish to get to public markets as quickly and efficiently as possible. To ensure this speed and efficiency, originators need to compensate the warehouse financiers. For alternative lenders like Challenger IM providing the mezzanine finance, the margins in warehouses are generally around 2% per annum higher than the margins in public term transactions of the same implied credit ratings.

How does Challenger IM approach warehouses?

While being an attractive investment, warehouses are highly complex structures where mezzanine tranches have capital at risk and 100 cents in the dollar can be lost in the case of default. Therefore, a manager needs to be highly experienced and skilled in this space to minimise risk of losses. Challenger has over a decade of experience investing in and structuring warehouse deals and is well versed in the appropriate intercreditor terms that are needed to reduce the risk to the lender if the underlying assets start to underperform. 

Beyond investing as a lender, the team also has prior experience on the bank side structuring securitisation deals and the legal side working at law firms to document these warehouses. Challenger also has experience assessing an originator’s platform including their credit processes and regularly review their originators. 

Furthermore, there are high barriers to entry for lenders, with scale and relationships key. Challenger has been in the market since 2010, building strong relationships with originators across Australia and New Zealand. Challenger also has the scale to grow the warehouse over time and even provide incremental capital to de-risk the senior tranche if required.

The Challenger IM Global ABS Fund provides clients access to private securitisation warehouses as part of a diversified portfolio of asset-backed securities. The Challenger IM Credit Income Fund and Challenger IM Multi-Sector Private Lending Fund also invest in private securitisation warehouses, with allocations of approximately 4% and 16% respectively as at February 2024.

The devil is in the detail

Separate from the general risk of default in the facility, there are several aspects of a warehouse that the lender must understand in detail. Challenger examines the precise terms of each warehouse deal to ensure it adequately protects the mezzanine lender, asking the below questions of each transaction.

  • Intercreditor terms: What can senior agree to without mezzanine consent? More aggressive documentation can cede all consent rights around document amendments, waivers and audits to the senior financier only, disadvantaging the mezzanine lender.

  • Enforcement rights: If the warehouse is not performing as expected, what are the rights of the senior financier? Can they enforce without mezzanine consent and if so, in what circumstances? What rights does the mezzanine financier have in an enforcement scenario?

  • Financial strength of the originator: If there is deterioration in the performance of the warehouse, what is the ability of the originator to rectify by adding subordination or buying back receivables?

  • Exit: How does the mezzanine lender exit the facility in the event that they need to without triggering an amortisation of the warehouse where senior is repaid in priority?

Given the complexity of private securitisation markets, it is important to take a detailed approach to assessing originators, underlying loan pools, as well as the structure and terms of a deal. Challenger IM has been investing in warehouses for over 10 years and is today a leading provider of private ABS solutions within Australia and New Zealand.

Challenger leverages its strong capabilities and experience in this space to offer investors access to its many benefits while seeking to minimise downside risks. 


Important Information
This document is prepared by Challenger Investment Partners Limited (ABN 29 092 382 842, AFSL 234678) (Challenger Investment Management or Challenger) the investment manager of the Challenger IM Global Asset Backed Securities Fund (Fund). The Fund is a sub-fund of the FundRock QIAIF Platform I ICAV.

In the United Kingdom this document is issued and approved by Fidante Partners Europe Limited (“Fidante Partners”). Fidante Partners is authorised and regulated by the Financial Conduct Authority in the conduct of investment business in the United Kingdom. In the European Union this document is issued and approved by Fidante Partners AB ("Fidante Sweden").  Fidante Sweden is an investment firm authorised by the Swedish Financial Supervisory Authority (Finansinspektionen). Fidante Sweden is authorised to provide investment advice, reception and transmission of orders and execution of orders on behalf of customers. Fidante Partners and Fidante Sweden are sub-distributors of the Fund and are issuing in this capacity only. Fidante Partners, Fidante Sweden and Challenger Investment Management are members of the Challenger Limited group of companies (Challenger Group). Information is intended to be general only and not financial product advice and has been prepared without taking into account your objectives, financial situation or needs. You should consider whether the information is suitable to your circumstances.

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Registered Office: Bridge House, Level 3, 181 Queen Victoria Street, London, EC4V 4EG. Registered in England and Wales No. 4040660.
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