HONG KONG, Aug 30 (LPC) - Australian superannuation fund First State Super is planning to ramp up its domestic loan investments in the next two to three years, adding to the growing pool of non-bank investors as the country’s institutional investor base continues to grow.
First State Super is planning to boost its domestic direct lending book to around A$2bn–$3bn (US$1.35bn–$2.03bn), the fund told Basis Point, rebalancing a A$5bn credit income portfolio that is mostly invested overseas.
The strategic change comes in response to a gradual pullback in lending by domestic Australian banks as a result of higher capital requirements and recent regulatory scrutiny, including a Royal Commission into the financial sector.
First State Super is poised to become Australia’s second-largest superannuation fund with about A$120bn in funds under management from 1.1m Australians after its proposed merger with Victorian Superannuation Fund, which is expected to be completed by mid-2020, further cementing its position in the Australian institutional market.
“The money we gave to our managers has historically been invested internationally so from the outset, there was a desire to try and bring the centre of gravity back to Australia,” said Ross Pritchard, portfolio manager for credit income at First State Super.
Pritchard joined First State Super in June 2017. Later that year the Royal Commission was set up to inquire and report on misconduct in banking, superannuation and financial services in Australia.
Since joining, Pritchard has grown First State Super’s direct lending portfolio to around A$620m through 10 loans and bonds and is looking to double his team’s headcount to six in the next few months.
First State Super is flexible in its lending strategy and keen to build a diversified direct lending portfolio, which currently spans nine industries – healthcare, packaging, logistics, carparks, data centres, industrial real estate, childcare, transportation and retail and grocery. Nearly a quarter of its portfolio comprises exposure to the healthcare sector.
Its most recent loan was a refinancing for a carparking business, to which First State Super lent A$55m alongside banks.
This year the superannuation fund also joined two syndicated acquisition financings – the A$2.15bn five-year loan backing Brookfield Capital Partners’ leveraged buyout of hospital operator Healthscope, which was completed recently, and a A$405.68m five-year loan completed in July for AAT for its purchase of Transport Australia Group.
The direct lending group typically invests in sub-investment grade and mid-market companies with Double B credit ratings, and has declined more than 100 loans and bonds since its inception 18 months ago. Around 80% of the transactions it has participated in so far are senior secured.
“We are saying no to deals that we feel are too risky,” Pritchard said. “We do see some elements of aggressive structures in the market at the moment and we will decline such deals if we feel they exceed our risk appetite or do not offer good risk-adjusted returns.”
Leveraged loans and property financings typically offer the returns First State Super is targeting. For instance, Healthscope’s LBO loan pays interest margins of 400bp over BBSY for the amortising term loan and revolver tranches and 425bp over BBSY for the bullet and capex portions.
First State Super typically lends an average A$50m−$75m, although it can consider larger commitments, and is less focused on long-term assets than many other pension funds and insurers. The average maturity of its direct lending assets is around 5.5 years.
“Most Australian super funds, ourselves included, are substantially defined contributions, so there’s not the same focus on matching your calculated defined benefit liabilities,” Pritchard explained. “It’s more about achieving good risk-adjusted returns for a specific sector that you participate in.”
First State Super also has a buy-and-hold strategy and does not actively trade its loans in the secondary market, although it has bought some paper to increase its exposure to existing credits.
“The secondary market for credit exposures in Australia is not very deep and there are not a lot of high-yield bonds or liquid loans that you could trade. Our job is to get good returns for our members so we will always consider opportunities based on their merit, including exiting transactions, but I think our starting point would be to buy and hold,” said Pritchard.
First State Super’s direct lending team has not participated in Green loans or bonds, although screening for environmental, social and governance metrics is built into its credit approval process.
“We have looked at several opportunities but we haven’t invested in Green bonds, partly because such deals come from high-grade borrowers and offer lower returns,” said Mike Cowell, senior investment analyst in Pritchard’s team. “However, if they meet our return hurdles, we would be very keen to lend.”
Daniel Barnett, another senior investment analyst at First State Super, added, “What are called ESG concerns are valid underwriting and due diligence concerns that need to be considered as part of any analysis regardless of whether they have the ESG label or not.”
Reporting by Apple Lam and Prakash Chakravarti; Editing by Chien Mi Wong and Tessa Walsh