Royce Stone urges credit investors to test repayment

Royce Stone Capital has urged private credit investors to focus on loan repayment, rather than relying on headline returns or property security alone. The guidance comes from analysis published by the Melbourne-based private capital and advisory firm.

The analysis centres on a basic question in direct lending: what has to happen for investors to get their money back. It argues that a mortgage over property does not, by itself, explain repayment, particularly if the borrower's planned exit does not go ahead.

"The first question is how the borrower pays you back. Saying you have a mortgage doesn't answer it. You still need to understand the borrower, what the security could sell for and what happens if the planned exit falls over," said Tarek Omar of Royce Stone Capital.

Valuation tests

One focus of the analysis is how investors interpret loan-to-value ratios. Omar argues that a headline ratio can obscure the difference between an asset's current value and a value that depends on a project being completed, planning approvals being secured or a different use being realised.

The issue can be particularly acute in development lending. A site may carry permits that suggest substantial value, but any eventual sale price can still depend on building costs, market demand and whether another developer would be willing and able to take on the project.

Meeting a target lending ratio, the analysis says, does not prove the security could be sold for that amount if recovery becomes necessary. It also highlights the effect of time on recoveries: if a borrower stops making payments and a sale drags on, interest and recovery costs continue to build.

Those added costs can erode the protection that appeared to exist when the loan was first written. In practice, a buffer based on initial equity may look less substantial once delays, expenses and market changes are taken into account.

"You need to ask who would buy the asset, what they would pay for it and how long that sale could take. Those questions matter just as much as the valuation figure," Omar said.

Repayment route

Royce Stone Capital also draws a distinction between business lending secured against completed assets and construction lending tied to an unfinished project. Under the approach it describes, repayment is expected to come from a business liquidity event or refinancing, while the completed asset serves as security if the borrower cannot repay.

The key point is that repayment and security are separate questions. An asset may support recovery in a downside scenario, but investors still need to assess whether the business event or refinancing plan is realistic.

That distinction matters because setbacks in a construction project can hit both sides of the equation at once. They may undermine the expected repayment plan while also weakening the value of the property securing the loan.

Fund or loan

The publication also compares the choices facing investors in pooled private credit funds with those investing in individual loans. In a fund structure, investors rely on the manager to select borrowers, monitor performance and make recovery decisions if a loan runs into trouble.

Direct investors, by contrast, may be able to assess the borrower, the intended use of funds, the security package and the proposed exit before deciding whether to participate. According to Royce Stone Capital, that can give investors greater visibility into a particular transaction.

It also notes the limits of that visibility. An investor's actual enforcement rights and decision-making authority depend on the loan structure and the underlying documentation, while selecting single loans can create concentration risk that diversified funds are designed to reduce.

Those trade-offs mean professional management and diversification remain valid reasons for some investors to prefer a pooled fund. The broader message is that investors should understand the transaction behind a quoted return, including the borrower, the repayment plan, the support for recovery and who has authority to act if the original plan fails.

Royce Stone Capital describes itself as a Melbourne-based private capital and advisory business and says its direct-lending offering is aimed at wholesale investors.