Loan Book Commentary: Q4 2023

Loan Origination

We are pleased to report that the expected uptick in new loan settlements in the last quarter of 2023 did eventuate.  Pallas Capital settled $272 million of loans in the quarter, with a particularly busy December.

Borrower demand remained high for refinancing loans by other lenders as a lot of developers required additional tenure on development assets to allow more time for re-working schemes, re-working feasibilities and obtaining the requisite level of pre-commitments (sales and/or leases) to commence a project.

Pleasingly over the quarter acquisition funding increased and the general sentiment from developers is that conditions are modestly improving.  With the market expecting that we are at or near the high point for the official cash rate, and with inflation in construction costs and labour normalising, we expect to see a modest increase in site demand in early 2024.

Q4 also saw strong performance in loan repayments with $133 million in loans coming back, the majority of which were legacy construction projects that reached completion during a difficult period.  Origination for construction loans was modest throughout 2023, however we expect this to change in 2024 with development conditions improving. We have won several recent mandates for construction loans and these transactions represent strong credit quality, so we will be selective but more active in this market this year.

Market Outlook

Natural market order will sort the wheat from the chaff with the strong borrowers (and lenders) toughing out conditions to get through the other side. The past twelve months has seen significant pressure on borrowers’ capital required to meet liquidity events (reduce LVRs, prepay interest etc.) and broadly borrowers’ balance sheets have been able to meet these requirements.

We raise the point on the availability of borrowers’ equity for two important reasons. Firstly, this is a key feature of our credit analysis, and we monitor a borrowers’ wholistic liquidity capacity and obligations very closely when assessing our loans. Secondly, this liquidity dynamic creates strong lending demand and deployment for non-banks like Pallas Capital who may offer additional leverage than a bank (our first mortgage LVR typically sit at 65%, where the banks are around 55-60% LVR). Lenders with a strong credit focus will avoid the trap of illiquid borrowers but enjoy the strong lending demand.

A trend that we highlighted in our last commentary and continues to be a significant risk to borrowers, is lenders failing to fulfill funding mandates to settle loans. Pallas Capital settled several loans in December for clients that had been left at the altar by their other lender. Although we have been a beneficiary of these missteps, liquidity for the smaller non-bank lenders remains a strong risk for SME borrowers.

At the end of the quarter, Pallas Capital had approx. $380 million of approved but undrawn funding for new loan opportunities.

Status of the Loan Book

At the end of the quarter Pallas Capital had 33 construction loans and 154 other loans on foot.  The loan book performance remained strong through the period.

We saw a small increase in default loans with four loans in default during the quarter.  One sponsor group (representing three of the four loans in default) entered into receivership, with the receiver commencing a sell down of the security assets.  Pleasingly the receiver has now sold three of the four security assets (with sale prices averaging 11% above loan underwrite valuations) and these three loans are expected to be repaid in the second quarter of 2024 with zero impairments forecast (loan principal, interest or fees).

The other default loan is for a Queensland retail property.  The borrower has now exchanged a contract for a sale of the asset. The default loans represent 1.16% of the loan book (by value).  Again, we are confident we will suffer no impairments on this loan.

If you are looking to deploy capital into any of our current Open for Investment debt opportunities, please contact your Pallas representative or contact