Loan Book Commentary: Q4 2024

Loan Origination

We finished 2024 on a high with a total of $807 million of new loans settled for the December quarter, our most active quarter ever.

A strong outcome in a tough market, as we are starting to see an uptick in lending volumes resulting from our new warehouse funding lines (Goldman Sachs in Australia and Westpac in New Zealand) which has reduced our cost of capital and allowed us to sharpen terms offered to borrowers. This has enabled us to expand our lending operations without compromising in terms of credit quality.

We settled 62 new loans in the quarter, made up of 44 first mortgage loans and 18 second mortgage loans. Our weighted average LVR across the loan book (first and second mortgages) is 65.2%.

For the quarter we had over $300 million of loans fully repaid, which takes Pallas Capital’s grand total of fully repaid loans and investments to over $4.4 billion since inception.

The natural churn rate of the loan book (8.3 months average term to maturity) allows us to review the credits frequently, retain the superior loans and exit any exposures we believe may have deteriorated.

Market Outlook

The market remains subdued for new property acquisitions and property development starts. Headwinds include softening valuations and, partly as a consequence, delayed project starts. We will see if there is any interest rate relief in Australia in coming months, which may encourage the developer market.

In Australia our lending remains focused on mature metro markets on the eastern seaboard. Of these markets, the Sydney loan market is the strongest, particularly the market segments on which Pallas Capital is focused (lending against downsizer residential and industrial properties). Subdued real estate activity in Victoria (typically 40-50% of our loan portfolio) has impacted capital deployment in that State, and we see this market being subdued for at least the next quarter. Similarly, the Brisbane loan market is slow, and we are writing limited new construction loans there, due to the difficulties in securing appropriate builders.

The New Zealand market is also subdued, but with interest rates falling borrower confidence is improving. We have now written three construction loans in New Zealand (out of 140 loans in total), although our credit underwriting standards remain relatively tight in that market.

In these market conditions borrowers are seeking highly tailored and structured funding. For example, over the past two quarters we have seen high borrower demand for leverage, with approximately 40% of loans settled requiring second mortgage funding (by contrast, second mortgage loans only make up 8% of our total loan book).  We do not see this demand for leverage abating in the near term.

The construction lending market remains very competitive as low deal flow sees excess liquidity chasing the strong development loans. This competitive tension has seen pricing for construction loans pushed down significantly, with the tightest interest rate spread between construction and non-construction loans we have seen for several years.

With some risk still in the market we remain selective with new construction loans, of the eight loans we settled last quarter seven are advanced to existing or repeat developers and the projects located in preferred suburbs.

Status of the Loan Book

At the end of the quarter the loan book consisted of 46 construction loans and 235 non-construction loans (made up of investment properties, pre-development sites etc.), including 78 loans in New Zealand. The loan book continued to perform well through the last quarter with no additional loans in default status for the period, though one additional loan has been included in the watchlist (a $25 million construction loan) and we continue to closely manage this exposure.

The four loans in default include:

  • two New Zealand pre-development loans, one that has a contract of sale exchanged for sale of the security property and another where the security property will be taken to market for sale in Q2 2025;
  • a construction loan in Melbourne, which we expect will be refinanced in Q1 2025; and
  • a vacant land site in Melbourne that will be taken to market for sale in Q1 2025.

We remain confident that all monies owed on these exposures will be recovered in full.

The challenging market has emphasised the need for active portfolio management, and this continues to be a key area of focus for Pallas Capital. We have recently bolstered our loan management and construction risk teams with new hires to ensure we maintain keen oversight of our growing loan book.

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