Matthew Macreadie
Following the successful completion of Finexia Financial Group Limited (“FNX”) inaugural Childcare Trust in October of last year, IAM Capital Markets has been mandated to arrange an additional A$12,500,000 of funding via a “tap” of the existing Childcare Trust. Transaction proceeds will be utilised to fund Finexia’s Q4 loan pipeline, supporting the business in its quest to become the premier non-bank player in Australia’s burgeoning Childcare market.
The Notes offered are Class B notes, with a current coupon of 13.85%. This credit enhancement at the portfolio level is in addition to the equity buffer within the underlying loans which are ≤ 65% loan to value (“LVR”).
Sales Note Summary:
- Finexia only lends to high-quality childcare operators and has a pristine track record. Even during COVID-19, Finexia had no arrears or losses, something few companies (let alone) childcare lenders can note.
- Tailwinds are great for the childcare industry – it’s a government backed industry, highly regulated, with high profit margins (important as that’s many childcare operators do not go under). Childcare is actually one of the few policies which governments agree on. More parents working also bodes well for childcare occupancy rates.
- The operators are industry leaders in the childcare sector. Operators typically have more than 10 centres under operation and have exceptional ‘centre level’ sale value. The average is 4.7x EV/EBITDA which shows high cashflow generation.
- However, what makes this investment idea [Finexia B Notes] more appealing is not only do you earn an above average return [13.85% or 9.50% spread/margin] there is a very low risk of loss on the B Notes. We go into this in more detail below. But essentially, the asset value would need to deteriorate by 57% (i.e. above 56%) from the valuation before B note holders are at risk of a charge off of $1.
FINEXIA B NOTES
From the outset, there is low default risk associated with childcare centre loans due to the high-income buffers (yields 20-30%) that to date have meant Finexia have not had to undertake any recovery proceedings at any time for any childcare centre loan(s). This is very important to note from the beginning and a major reason why we like the underlying credit risk. Another significant factor is that a “Formative” centre valuations include adjustments for trade up opportunity cost that range between 15-20% from what the centre would be if it were “Established” which has not been adjusted/allowed for in the chart/analysis below, meaning there is yet another 15-20% buffer on top. Formative loans are additionally supported by 12 months of pre-paid interest.
The below chart/analysis shows the level of deterioration of individual primary asset value that would need to occur before a dollar charge off is at risk in the respective A and B Notes. We have included the A and B notes, but our analysis really focuses on the B notes because that’s where we see the real value.
As you can see below the asset value would need to deteriorate by 57% (i.e. above 56%) from the valuation before B note holders are at risk of charge off of $1.
This is a function of several things:
- 6 months of interest on A & B notes which is held as a liquidity reserve ($1,083,988.20 as per the latest Finexia Childcare Finance Trust for the March Quarter);
- First loss provision via C Note Equity of 20%; and
- All loans have a Current Approved LVR and/or Current LVR of 65% or less.
- Whilst loan amounts and balances are concentrated, it would take a hypothetical catastrophic event for more than half the asset value to be wiped out. A very rare, unlikely event.
A lender can enforce its registered mortgage over the lease by taking possession of the leased property and selling/assigning the lease to recover the outstanding debt as a going concern. We should point out it’s not just the leasehold interests only either. Across all childcare loans, there is a:
- GSA over the borrowing entity; and
- Personal Guarantees over the directors of the borrowing entity
Leasehold interests are generally more favourable in sectors that are classified as “non-discretionary” (like childcare) because there tends to be a strong uptake of selling/assignment of lease to maximise recovery.
About Finexia’s Childcare Business
Finexia Childcare Finance Unit Trust (“Childcare Finance Trust” or the “Trust”) is a bankruptcy remote, special purpose entity, established to fund the growth of the Finexia Childcare Income Fund (“Childcare Income Fund” or “Fund”), a specialist lender to established Australian Childcare operators. The Childcare Income Fund was established in October 2022 to address the gap in the bank market for providing market leading non-bank funding solutions for experienced and successful childcare and early learning centre operators to acquire, open and trade-up centres across Australia.
The team at Finexia have been lending to Childcare operators for the last 7 years and has a deep knowledge of the Childcare sector and its underlying businesses. Moreover, in terms of the credit quality of Finexia’s origination to childcare to date, all lending remains unblemished, with no impairments or bad debts to childcare operators. The investment thesis for supporting business operators remains strong given the clear tailwinds in the sector being generated by an ongoing supply-v-demand imbalance, substantial government support via family subsidies, and rising living cost pressures forcing parents back into the workforce. The security consists of 1st mortgage over the lease, a general security agreement over the business, and personal guarantees from directors. Taking a 1st mortgage over a leasehold interest in a property is not dissimilar to that over a freehold interest and provides the lender with an asset to rely on as collateral. Childcare centres return between 19-30% providing a significant buffer to default whilst also having a very liquid secondary market. The Commercial Real Estate (CRE) yield of 6% underwhelms versus Childcare centres return of 25%.
At a group level, Finexia has a strong pipeline that is founded on making childcare more accessible for all. 400 New Centres are being built each year, with 2,000 new centres forecasted by 2028. The average loan size is around $1.36 million per centre, providing an annual funding opportunity of $544 million.
