Currently all our investments in the Stable Income Fund are through investments in warehouse structures. When talking to some clients there has been some confusion over what a warehouse structure is, so we have included a description below to clear up any confusion.
What is it?
A Warehouse Special Purpose Vehicle (SPV) is basically a separate vehicle or structure set up to hold loans for a lender. All security and collateral for each loan is retained in the structure. It is a commonly used way for lenders, especially Non-Bank Financials Institutions (NBFIs) to fund loans out to clients. Examples of large Non-Bank Lenders in Australia include Pepper Money (residential property), MaxCap (development property), Scottish Pacific (corporate loans), and Latitude Financial Services (personal loans, car finance, and credit cards)
Imagine a very simple scenario:
1. Martin needs a loan.
Martin borrows $100 from James and agrees to repay $105 next month.
2. James doesn’t want to fund it all himself.
James would prefer not to use all his own cash, so he borrows $80 from Dillon and uses $20 of his own money to make up the $100 for Martin.
3. James promises Dillon a return.
James agrees that when Martin repays the $105, he will pay Dillon back $82 (the $80 capital plus $2 interest).
4. How the cash flows work at the end:
a) Martin repays James $105.
b) From that $105, James first pays Dillon $82.
c) James keeps the remaining $23 ($105 – $82) as his own return (this covers his $20 capital plus $3 profit).
In this simple example:
- Dillon is providing most of the funding and gets paid back first, with a fixed return.
- James provides a smaller amount of funding and gets whatever is left over after Dillon is repaid.
- Martin is the underlying borrower.
That priority of payments—where outside funders like Dillon are paid first, and James takes the residual—is exactly how a basic warehouse funding structure works.
Below we have shown 3 scenarios that may happen in this example and the consequences of each.
In practice, a warehouse is more complicated with more than 1 lender in the structure all with different “slices” in the warehouse. In addition, a warehouse would not be just 1 loan, it would be many loans that are all pooled together and added to as the business grows. In the warehouse shown below, the Senior Funder at the top is the lowest risk, i.e. they get paid first, therefore they get the lowest return, the senior mezzanine funder gets paid back next and get a higher return, the junior mezzanine funder comes next with more risk and more return and finally the first loss provider, usually the original lender putting money is as a first loss protection (a bit like how a bank makes you put a deposit down for a home) comes last. Any interest that is left over after all the funders have been paid goes to the originator of the loans (the NBFI). The SPV doesn’t run the business or take risks on its own. It’s only job is to own the loans and pass repayments through in a clear, controlled way.
Why use a warehouse?
A warehouse allows loans to be funded as they are originated, while the portfolio builds and performance is observed. We use a warehouse because it gives investors comfort that:
1. Loans are held separately from the NBFI’s day‑to‑day business, protected in a bankruptcy remote vehicle.
2. Funding is backed by real assets and repayments, not just reliant on the NBFI’s Balance Sheet.
3. The NBFI provides first‑loss capital, meaning losses are absorbed before debt capital providers are affected. Furthermore, the warehouse is structured such that anticipated losses may be remediated by the warehouse structure cash flows over time.
4. Only loans that meet strict eligibility rules can enter the structure.
5. Performance is monitored closely as the portfolio grows.
How it works (in simple terms)
1) Loans are written: An NBFI makes loans to customers (such as mortgages, leases or invoices).
2) Loans move into a trust: Each loan is sold into a separate legal trust (the warehouse). The trust only exists to hold the loans.
3) Funding is provided: Investors lend money to the trust. Their investment is secured against the loans inside the warehouse.
4) Borrowers repay their loans: Repayments flow into the trust and are used to:
- pay interest to investors
- cover costs
- repay funding
5) Originator Net Interest Margin (NIM): The originator earns income from the difference between the interest paid by borrowers and the cost of funding the loans.
6) The pool grows over time: New loans are added, subject to eligibility rules and limits based on the providers of capital risk appetite.
Simple structure diagram
Why a Warehouse is useful (from an investor perspective)
1. Bankruptcy‑remote protection: The loans sit in a separate trust, not with the lender. If the lender fails, the loans are still protected in a bankruptcy remote vehicle.
2. Asset‑backed security: Funding is secured only against the loan pool itself and all the collateral and securities of each loan, secured in the trust structure. Investors rely on borrower repayments and the security and collateral of the underlying pool of assets, rather than just the financial health of the lender. The pooled structure also offers the lender significant diversification. In some cases, warehouse structures can hold thousands of obligors.
3. First‑loss protection from the issuer: The lender typically provides a junior or first‑loss position. Losses are absorbed by the lender first, before senior investors are affected, providing a strong buffer.
4. Strict controls on lending quality: Only loans that meet pre‑agreed eligibility criteria can enter the warehouse. This prevents weaker or out‑of‑policy loans from being added.
5. Ongoing monitoring and early intervention: The warehouse includes performance tests and limits. If loan performance deteriorates, new lending can be restricted or stopped to protect investors.
