Middle America Provides The Income For Middle Australia
The NB Monthly Income Trust - to be listed on the Australian Securities Exchange next month - is offering Australian investors an initial forecast yield of 6 per cent a year, free of currency risk, generated from a selected portfolio of US home loans.
Australian investors who are looking for consistent income are the target market for a new listed trust being offered by global fund manager Neuberger Berman, and the underlying asset class will certainly be familiar to those investors – it is residential property.
But it is US residential property, a market that blew up spectacularly in the Global Financial Crisis (GFC), and which, in fact, was a major cause of the GFC.
In a slump that spectacularly demolished that cherished Australian investment adage of “you can never go wrong in bricks and mortar,” the Americans went very wrong in bricks and mortar. By the old (quarterly) Case-Shiller Index, US house prices fell by 35 per cent between 2006 and 2012, with the “sand states” – Nevada, Arizona, California and Florida – which had seen the highest population growth, falling the most.
But solid recovery in the US home-loan market – at A$19 trillion, the largest debt market in the world – has “created an attractive opportunity to invest in US home loans,” says Nick Hoar, managing director and head of Asia Pacific at Neuberger Berman. The firm’s NB Monthly Income Trust – to be listed on the Australian Securities Exchange (ASX) next month – is offering Australian investors an initial forecast yield of 6 per cent a year, free of currency risk, generated from a selected portfolio of US home loans.
“From discussions we have had with Australian advisers, we see the target market as any investor – self-managed super funds (SMSFs) included – who wants regular income,” says Hoar. “The big anomaly in the Australian market is that income-oriented investors, SMSFs and retirees, have effectively been forced to take equity risk, in dividend-paying shares and bank hybrids, to generate income,” says Hoar.
“We wanted to offer these investors a product that generates income from very sound assets, and gives their portfolios diversification away from that domestic equity risk and bank-hybrid risk. Clients can put some of their cash into this, to get better than cash rates, and also put some of their equity risk and bank-hybrid risk into this.”
Hoar says the investment opportunity behind the fund is based on a “highly selective approach” to the US housing market. He says the US government responded to the well-publicised US housing crash with a flurry of regulation, which has “cleaned up the market.” In fact, he argues, regulation has swung from too loose prior to the crash, to “too tight” currently. This has left a large swathe of the US home-loan market under-served, and it is from this swathe that Neuberger Berman will populate the loan portfolio of the NB Monthly Income Trust.
“You can think of the US home loan market as comprising three sectors. The first sector is where the borrower qualifies for a US-government-sponsored mortgage, through Fannie Mae - the Federal National Mortgage Association (FNMA) – or Freddie Mac, the Federal Home Loan Mortgage Corporation (FHLMC). The maximum amount you can borrow under those programs is $417,000.
“The second sector is the $400,000–$1 million loan, and the third – what is known as “jumbo prime,” is loans of $1 million and above.”
The big US banks prefer to play in “jumbo prime,” he says – leaving the middle sector “very under-served.”
“That’s the section we target. It’s is Middle America – wanting to borrow $400,000–$1 million. It is very under-served by the big banks. You have a huge part of America that is under-served, and therefore not able to fulfil the great American dream, which is fairly similar to the great Australian dream – to own your own home. So private lenders, like ourselves, are the main lenders active in that market.”
This is the majority of America, says Hoar. “Obviously, if you want to buy in Manhattan or Menlo Park (San Francisco Bay), $400,000–$1 million is not going to buy you a lot of property. But in most of America, that buys you a substantial six-bedroom home on a 0.5-hectare plot, with garage and all the rest of it. So the target borrowers are middle-class Americans – professional people, self-employed people, new graduates, wanting to love in good properties in good neighbourhoods.”
The “key statistic,” says Hoar, is the unemployment rate. In the US, this has come down from 10 per cent at the end of 2009 to 4.9 per cent. In Australia, it is 5.8 per cent.
“On house price grounds, Australia has had 12.5 times growth since 1980, while the US has had four times growth. There’s no question which is the hot market and which is not. House prices in the US appear to be good value and fundamentals are improving. But it’s the unemployment rate that is critical to a portfolio of home loans, and the employment fundamentals in the US are strong,” he says.
Terry Glomski, Senior Portfolio Manager, talks about the NB Monthly Income Trust
The borrowers in the NB Monthly Income Trust portfolio pay home-loan rates of roughly about 5.75 per cent. To this Neuberger Berman applies what Hoar says is “modest” gearing – between two to four times net asset value (NAV), with a bias to the low end. The return expectation is about 6 per cent a year.
At the outset, home loans will be 62 per cent of the portfolio: these loans will be screened for asset quality and credit quality – a FICO score (the main US consumer credit score) of 700-plus – and mostly, where borrowers have positive equity.
About 36 per cent of the portfolio will be liquid, short-dated residential mortgage-backed securities (RMBS), secured by home loans. On these, the return expectation is 3 per cent–4 per cent a year. Cash is 2 per cent of the initial portfolio.
From these assets, Australian investors will receive monthly income distributions forecast to equate to a net yield of 6 per cent a year (based on the subscription price of $1.10.) There is no currency risk, as distribution payments will be fully hedged back to A$.
The closed-end trust is intended to raise between $75 million and an upper limit of $250 million. Neuberger Bermann is tipping in $35 million, which results in a net tangible asset (NTA) value of $1.085 at listing. Neuberger Bermann will re-invest its monthly distribution into the trust, through buying the listed units. The management fee is 1 per cent a year, and there is no performance fee.
The NB Monthly Income Trust offer closes on April 14, with ASX listing scheduled for April 26.
James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au