Balmain Discrete Mortgage Income Trusts · CONTENTS Summary 2 Fund Summary 3 SQM Research’s...

Balmain Discrete Mortgage Income Trusts

Superior

This report has been prepared for financial advisers only

INTRODUCTION

Key PrinciplesThe underlying principles of the assessment process are to:

- identify the long term commercial potential of the Responsible

Entity/Investment Manager;

- evaluate management’s capabilities, previous performance in the

specific industry and the stability of the organisation;

- evaluate identified markets (domestic and international existence,

stability and growth potential);

- benchmark key performance assumptions and variables against

industry peers;

- weigh up the relevant risks of the Responsible Entity/Investment

Manager;

- assess structure and ownership;

- determine if the Responsible Entity/Investment Manager is

structured in such a way as to protect investor’s interests; and

- allow an opinion to be formed regarding the investment quality of

the Responsible Entity/Investment Manager.

AssessmentSQM Research conducts a detailed site inspection of the projects/properties within the Responsible Entity’s/Investment Manager’s managed funds.

- The site assessment considers the following areas:

- sustainability of the site for the purpose intended;

- management skills, qualifications, capabilities and experience; and

- associated property risks and their management.

4½ stars and above

Outstanding Highly suitable for inclusion on APLsThe fund most often outperforms its peers and benchmark. In all cases the fund is operating to its mandate and product disclosure statement (PDS). There are no corporate governance issues. Management is extremely experienced and skilled and has access to significant resources.

High Investment grade rating

4 stars to 4¼ stars

Superior Suitable for inclusion on most APLsThe fund outperforms (or is likely to) its peers and benchmark the majority of the time. The fund most of the time has been operating within its mandate and PDS. There are very little to no corporate governance concerns. Management is of a very high calibre.

High Investment grade rating

3¾ stars Favourable Consider for APL inclusionThe fund may outperform its peers and benchmark the majority of the time or SQM believes this is a fund that has potential to be an outperforming fund over the medium term. Management is of a quality calibre but may not yet be fully tested. There are no corporate governance concerns or they are of a minor nature.

Approved

3½ stars Acceptable Consider for APL inclusion, subject to advice restrictionsThere is some degree of additional risk attached to the fund by way of performance. The fund may periodically underperform its peers and benchmark or it has not been fully tested. There may be some additional concentration risk. Management is generally experienced and capable. There might be corporate governance issues of a mid-level or corners over the Responsible Entities/Parent Entities financial position/performance.

Low investment grade rating

3¼ stars Caution required Not suitable for most APLsPerformance has been significantly under-benchmark and peers. There is a greater than average risk of underperformance over the medium term. There is a risk of the fund not operating to mandate or to its PDS. There are corporate governance concerns. Management has been operating in an average manner.

Unapproved

3 stars Strong Caution Required

Not suitable for most APLsThe fund is unlikely to perform to its mandate over the near term. There might be some greater than average corporate governance concerns. SQM has a number of concerns of management.

Unapproved

Below 3 stars Avoid or redeem Not suitable for most APL inclusion Unapproved

Star Rating*Investment products are awarded a star rating out of a possible five stars and placed on the following websites: www.sqmratings.com.au

Licensed Investment AdviserSQM Research is licensed as an Australian Financial Services Licensee, Licence No. 421913, pursuant to section 913B of the Corporations Act 2001. The licence authorises SQM Research to carry on a financial services business to provide general financial product advice only.

Privacy PolicySQM Research collects only a limited amount of personal information from its clients. Our privacy policy can be viewed at www.sqmratings.com.au. This will enable you to understand your rights, our obligations and what SQM Research does with any information it collects about you.

Fees charged for ReportSQM Research has received a fee from the fund manager for this report and rating.

General Financial Product AdviceThis advice will not take into account your, or your clients, objectives, financial situation or needs and will not be provided in respect of any other financial products. Accordingly, it is up to you and your clients to consider whether specific financial products are suitable for your objectives, financial situations or needs.

Report Date: 31 January 2018

Hold – The rating is currently suspended until SQM Research receives further information. A rating is typically put on hold for a period of two days to four weeks.

Withdrawn – The rating is no longer applicable. Significant issues have arisen since the last report was issued, and investors should avoid or redeem units in the fund.

Not rated – The fund has not been rated by SQM.

Star Rating Description Definition Investment Grading

CONTENTS

Summary 2

Fund Summary 3

SQM Research’s Review 4

Strengths of the Fund 6 Weaknesses of the Fund 6 Other Considerations 7 Key Changes Since the Last Review 7

Investment Process & Portfolio Construction 8 Process Description 8

Corporate Governance/Business Strategy 11 Key Counterparties 11 Parent Company 11 Investment Manager / Fund Manager 11 Responsible Entity 11 Management Risk 12 Funds under Management (FUM) 12

Management & People 13 Investment Team 13 Staffing Changes 14 Remuneration and Incentives 14

Product Features - Fees & Redemption Policy 15 Entry / Exit Fees 15 Ongoing Fees 15 Performance Fees 15 Overall Fees 15

Quantitative Analysis 16 Quantitative Insight 16 Returns 16 Historical Trends 17 Portfolio Statistics 18

Asset Allocation & Risk Parameters 20

Balmain Discrete Mortgage Income Trust

SUMMARY 2

SQM Rating


Superior. Suitable for inclusion on most APLs

Mortgage Trust Details

Trust Name Balmain Private (Balmain Discrete Mortgage Income Trusts)

Manager Balmain Funds Management Pty Limited

Location Level 14, 60 Castlereagh Street, Sydney, NSW 2000

Responsible Entity Balmain Fund Administration Limited

Custodian Perpetual Corporate Trust Limited

Investment Details

Trust Inception 5 November 2012*

Trust Type Unlisted Trust

Trust Structure Mortgage Trust

Property Sector Diversified

Loan Type First Mortgages

Market Value as at 31-Oct-2017 $169m (includes both Cash and Loan Units)

Target Loan Term One to five years

Number of loans available as at 31-Oct-2017

47

Return Objective 5.00% to 8.00% p.a. depending on the individual Sub Trust

Investment Specifications

Minimum Application Cash Units: $50,000 Loan Units: $10,000

Minimum Withdrawal Cash Units: Nil Loan Units: Investors are not entitled to withdraw from Loan Units in individual loans during the investment term

Redemption Policy Cash Units: Daily Acceptance facility, with funds paid within seven business days Loan Units: Investors are not entitled to withdraw from Loan Units until expiry of the Investment Term

Management Expense Ratio Cash Units: Nil Loan Units: up to 1.65%

Distributions Frequency Cash Units: Monthly Loan Units: Monthly

SUMMARY 2 SUMMARY 3

Fund Summary

Description

The Balmain Discrete Mortgage Income Trusts (Balmain Fund) is managed investment scheme aimed at investors seeking direct exposure to commercial mortgage loans. By initially investing into the Trust’s Cash Units, investors will be able to personally select the mortgages they wish to hold. The Trust is structured so that individual mortgages are packaged into a Sub-Trust – a series of discrete mortgage income trusts that each hold no more than one first mortgage loan. Investors are under no obligation to invest in any underlying Sub-Trust and can withdraw from their Cash Units at any time. However, once Cash Units are converted into a new class of units which relates to a specific loan (Loan Units), investors will be required to hold their Loan Units for the full investment term of that loan.

The Trust is unique compared to other Mortgage schemes in that it is in effect an on-line, integrated investment and reporting platform designed for investors that seek to invest in individual first mortgages directly.

Investors should read both the Trust’s Product Disclosure Statement (PDS) and accompanying Supplementary PDS (SPDS) for each Sub-Trust before making an investment decision.

About the Manager

Balmain currently manages over $6 billion of private debt portfolios, comprising of distressed debt, portfolios in the late stage of wind-up as well as more traditional mortgage investment schemes such as the Balmain Private initiative. Balmain is one of Australia’s largest non-bank mortgage originators, having originated over $20 billion of loans over the last 10 years.

Balmain has a prudent lending process in place which is viewed favourably by SQM Research. All loans made available to the Trust must be approved unanimously by the Credit & Investment Committee (CIC). While the Chief Credit Officer has a delegated authority to authorise fully complying credits of up to $1m, the Manager has stated that it will continue to adopt the stringent policy of passing all loans through the CIC. SQM Research believes this rigorous process is ideal. Moreover, SQM Research examined the lending policy and has observed that it is detailed and comprehensive.

The Trust under review is a unique investment scheme, legally operating as a pooled mortgage scheme but sharing characteristics similar to contributory mortgages schemes. Investors in the Trust adhere to the same administrative and


legal processes as pooled mortgage schemes, however, investors access individual mortgages (or a portfolio of mortgages) by investing in a Sub-Trust (or a series of sub-trusts) that holds no more than one first mortgage over the property. Investors will have full discretion over the mortgages they wish to hold and unlike pooled mortgage schemes, each investor can choose unique exposures and investment returns. Investors should be aware that they must first hold Cash Units before being able to convert them into Loan Units. Cash Units are designed such that investors are no worse off by holding their funds there. Investors will be paid interest on their Cash Units and will not be charged a management fee. Once Cash Units are converted to Loan Units however, the investments in an individual Sub-Trust become illiquid till the underlying loan matures and is repaid. At loan maturity, investors’ Loan Units are converted back into Cash Units. If during the term of the loan (or at maturity), the specified loan goes into monetary default, the investors holding those particular Loan Units may stop receiving distributions in respect of that loan. Moreover, if there are insufficient proceeds for the repayment of the investors’ funds in that loan, then monies will be distributed on a pro-rated basis. As such, SQM Research would advise investors to read thoroughly through the Trust’s Product Disclosure Statement (PDS) and each supplementary PDS (SPDS) to gain a full understanding of the characteristics and risks associated with the Trust’s structure.

SQM Research has also examined Balmain’s proprietary information systems and has been impressed by the level of sophistication offered by the various systems. Data is validated and cross-checked, strong risk controls are in place, and internal as well as remote access to information allows Originators and the Credit team to monitor the performance of all loans. In addition to this, the Credit team and CIC have access to an array of information to help them form an opinion on a particular loan before settlement. The Manager has further expanded access to its information systems to its adviser base. The portal now allows the advisers to manage their client’s investments by allowing them to view an aggregate of their clients’ portfolios or drill down on individual investment details on a client-by-client basis. Regarding the practicality of Balmain’s investor user interface, SQM Research believes it to be convenient and logical. Also, the Trust offers investors access to a transparent and accessible investment platform – a distinct feature of the Trust.

The flexibility of the contributory structure enables the Trust to offer commercial loans with variations between loan sizes, borrower rates, maturity dates and interest type. By offering these variations, investors can select individual mortgages most suited to their risk and liquidity profile. The structure also allows investors to individually control their investments and invest only

SUMMARY 4

in a Sub-Trust that matches individual risk and return profile. The trade-off for investor control over investment decisions is a potential lack of diversification as investors only have access to loans that are open for investment. To achieve diversification, investments need to be made to multiple Sub-Trusts which, when compared to pooled mortgages, can require a larger investment as the minimum investment for each Sub-Trust is $10,000, with investors able to spread multiples of $10,000 across a number of Sub-Trusts/Mortgages.

The key advantage of a contributory trust model is that loan assets and liabilities (the borrower and the investors) are perfectly matched and the likelihood of the Trust shutting due to a run on liquidity (a key issue for many mortgage funds in the GFC) is remote. Furthermore, as the Manager does not need to carry excess cash in the individual sub-trusts (to meet potential liquidity calls) the Trusts’ returns are not diluted by low cash interest rates as is the case in a pooled mortgage fund.

Fund Rating

The Fund has achieved the following rating:

Star Rating

Description DefinitionInvestment

Grading

4.00 stars SuperiorSuitable for inclusion

on most APLsHigh Investment

Grade Rating

SQM Research’s Review & Key Observations

The rating reflects a wide variety of factors, including consideration of the following:

1. People and Resources

Size & Resources of the Fund Management Company

The company can leverage off the broader resources of Balmain NB Corporation Limited (Balmain). The broader Balmain Group employs over 120 employees across its offices in Australia and New Zealand. Furthermore, Balmain is one of the largest non-bank commercial loan organisations in Australia with operations spanning across loan origination, funds management, credit underwriting, asset management and loan servicing. As such, Balmain has now developed a reputable origination and loan servicing platform (through its 42.00% holding of AMAL Asset Management Ltd) which is utilised by leading financial organisations. The resources available to the Trust are considered to be a key positive attribute associated with the Trust and is rated “Strong” by Standard & Poor’s.

Investment Team

The Trust is managed by an experienced investment team with a track record in mortgage lending, distressed debt management and funds management. Executive Director and CEO of Balmain Funds – Michael Holm has prime responsibility for the management of the Trust. Mr Holm is a highly experienced commercial property lender and fund manager with 37 years’ industry experience. Operations Manager - Caroline Crocker is in charge of the day-to-day management of the Trust’s operations. The Funds Management Team including Tom Sherston and new recruits Amanta Shankar and Andrew Laing, along with the rest of the Balmain Private Sales team, are responsible for the administrative and operational functions associated with the Trust as well as customer relations (financial advisors and investors). The Origination and Credit team also plays a critical role in the Trust. The Origination team operates one of the largest and most established sources of secured private debt loan origination outside the major banks. Operating across Sydney, Brisbane, the Gold Coast, Canberra and Melbourne, the loan origination team is comprised of over 40 Business Development/Origination and analyst staff with an average tenure of 13 years.

2. Investment Process / Philosophy

Investable Universe / Process / Philosophy / Style

The Balmain Discrete Mortgage Income Trusts (Trust) is a managed investment scheme aimed at investors seeking direct exposure to commercial mortgage loans. By initially investing into the Trust’s Cash Units, investors will be able to personally select the mortgages they wish to hold. The Trust is structured so that individual mortgages are packaged into a Sub-Trust – a series of discrete mortgage income trusts that each hold no more than one first mortgage loan. Investors are under no obligation to invest in any underlying Sub-Trust and can withdraw from their Cash Units at any time. However, once Cash Units are converted into a new class of units which relates to a specific loan (Loan Units), investors will be required to hold their Loan Units for the full term of the loan.

The Trust is unique compared to other Mortgage schemes in that it is in effect an on-line, integrated investment and reporting platform designed for investors that seek to invest in individual first mortgages directly.

Investors should read both the Trust’s Product Disclosure Statement (PDS) and accompanying Supplementary PDS (for each Sub-Trust) before making an investment decision.


SUMMARY 4 SUMMARY 5

Risk Management

Funding will only be provided for first registered mortgages over property in Australia. Loan terms of up to five years can be offered, however currently, all loans are less than 24 months in duration. The Trust also applies constraints relating to LVRs and borrower specifics.

3. Performance & Risk

Return Objective & Performance

The Trust’s investment objective is to provide investors with access to regular and stable income returns, along with capital stability. The target return of the Trust is 5.00% to 8.00%, depending on the individual Sub-Trust. Till date, individual Sub-Trust returns have ranged from 5.60% to 10.10% depending on the underlying term and structure of each Sub-Trust. Each investor in the Trust will have unique income streams and returns, which differs from investors of pooled mortgage schemes.

The Fund does not apply an official benchmark; therefore comparison purposes SQM Research will apply the Bloomberg AusBond Bank +2%pa TR AUD index.

Fund Excess Returns % : Half-yearly (net of fees)

Length of Track Record

The Trust has a history just short of 6 years. Observations and analysis of returns will have reasonable statistical meaning.

Risk Objective

The Trust offers investors exposure to mortgages with differing loan characteristics. As such, investors can select mortgages most suited to their risk and liquidity profile.


4. Other Features

Fees

As a result of Future of Financial Advice (FoFA) reforms, effective 1 July 2013, no contribution fees or trail commissions can be charged on new investments. In addition to this, the Trust (including both Cash and Loan Units) and peers do not charge a buy/sell spread.

No management fees are charged on the Trust’s Cash Units.

However, the Trust does charge a Management Fee on its Loan Units of up to 1.60% p.a. on the Principal Amount in respect to each loan. This management fee is comprised of an Investment Management Fee of 0.80% p.a. calculated and paid quarterly in arrears from the Trust’s assets and a Deferred Management Fee of 0.80% p.a. which will only be paid in full when the loan attached to the Sub-Trust has been fully recovered, and its Target Return (as disclosed in a Supplementary PDS) has been achieved or exceeded. If the Actual Return is less than the Target Return, the Investment Manager will only be entitled to a proportion of the Deferred Management Fee. The amount received is based on a percentage of the Target Return that was actually achieved multiplied by the Deferred Management Fee. A reserve will be kept to retain Deferred Management Fees until loans are recovered in full and paid out.

The Trust’s indirect cost ratio increases to 1.65% after expense recoveries. This cost includes the normal recovery expenses relating to the operation of the Trust, although it does not take into account abnormal expenses which may also be payable from assets of the Trust. The indirect cost ratio is above the pooled mortgages peer average of 1.36%, however below the contributory mortgages peer average of 2.39%.

Governance

Balmain Funds Management Pty Limited (Balmain Funds) is the Investment Manager of the Trust. Balmain Funds was founded in 2004, and its line of business includes managing investment funds and mutual fund sales.

The Board of the Balmain Funds is comprised of two directors, none of whom are independent.

Balmain Fund Administration Limited (BFAL) is the Responsible Entity for the Trust. BFAL is a wholly owned subsidiary of Balmain.

The Board of BFAL is comprised of four directors - three Balmain executive directors including Michael Holm, Andrew Griffin and John Robles, and independent Director Steven Hall - who have significant funds management and financial services experience.

SUMMARY 6


Strengths of the Fund

• The team is comprised of very knowledgeable and high calibre professionals across origination, credit, funds management and asset management.

• A proprietary information system that aggregates the origination to fund management process allowing for efficiency and effective compliance.

• A strong track record of credit performance with no monetary arrears or capital losses experienced since the inception of the trust.

• Investors have control of the mortgage investment made, complimented with an intuitive online platform which provides transparent access to their investment reports.

• 50% of the Trust’s management fee is deferred and is only paid when the investors’ full capital is returned and the Target Return is achieved.

• The Trust’s ability to leverage off the resources of the broader Balmain Group.

• The Trust can fill the gap in the market where major banks cannot provide the lending to certain borrowers.

Weaknesses of the Fund

• Growth in investor numbers means there is significant competition for loan units when a new sub-trust is issued, therefore Investors may experience an initial lack of diversification as they build portfolio diversity via investing in multiple sub-trusts. Further sub-trusts are made available for investment consistently throughout the year.

• There may be a degree of concentration risk relative to pooled mortgages schemes.

Growth of $10,000 Annual Returns

Fund Performance to 31 October 2017 (%) Jun-2012

Returns 1-Month 3-Month 6-Month 1-Year 3 Year 5-Year Inception

Fund1 0.64 1.91 3.86 7.97 7.56 7.26 7.29

Benchmark2 0.31 0.93 1.88 3.81 4.17 4.46 4.55

Peer Average 0.34 1.01 2.05 4.12 4.31 4.63 4.76

Excess 0.32 0.98 1.98 4.16 3.39 2.80 2.73

1. Fund return assumes dividend reinvestment. Returns for periods greater than one year are annualised.

2. Benchmark is Bloomberg AusBond Bank +2%pa TR AUD

FUM (Funds under Management) / Capacity

The Trust currently has FUM of $168.7 million, as of Oct-2017.

SUMMARY 7


Other Considerations

• The Trust does not charge a management fee on its Cash Units.

• Investors must hold Cash Units before investing into the Trust’s Loan Units. But investors in Cash Units are under no obligation to invest in Loan Units.

• The Trust charges a performance fee on its Loan Units of 50.00% of any surplus recovery but this is only received by the Manager once the investors receive full return of capital in each individual loan and the Target Return is achieved.

• While a daily redemption facility is offered for Cash Units, the Trust’s Loan Units are illiquid until the end of each individual loan term.

• The Trust offers investors exposure to mortgages with differing loan characteristics. As such, investors can select mortgages most suited to their risk and liquidity profile.

• Strict rules are in place to ensure differing loan profiles between institutional and retail investors.

Key Changes since the Last Review

• Mr Sam Scardilli has left his role in Dealer Sales and has been replaced by Mr Andrew Laing.

• Ms Amanta Shankar has joined the operations team.

INVESTMENT PROCESS & PORTFOLIO CONSTRUCTION 8

Process Description

Universe

Investable Universe The Trust aims to provide investors with regular income and stability of capital through its flexible structure. The Investment Manager believes it can provide investors with attractive and competitive income returns by seeking to mitigate risks via loan selection, loan conditioning and post-loan management processes.

The Trust will only offer investors exposure to loans through its Sub-Trusts, by approving only registered First Mortgages over a variety of different property sectors. This includes property in Australia across office, retail, industrial, residential, hotels, specialist property, land, construction and developments.

Investment Process

Research and Portfolio Construction Process

The Trust utilises research conducted internally as well as sourcing information from a range of external property resources. The investment process consists of five distinct stages; origination, evaluation, submission, approval and management.

Origination

The initial stage of the process involves identifying loans and pre-qualifying the loans and borrowers.

At this stage of the process, the mortgage originators will source potential loans and be the initial point of contact. Origination staff, while not responsible for or able to influence credit decisions, are held accountable for and required to assist and remediate any defaulting loan. This responsibility goes beyond financial cost (cessation of the trail, claw back of fees, etc.) as all origination staff face disciplinary action for not complying with their obligations to Balmain’s lending instructions.

Balmain has a process in place to review the performance of originators. This review focuses on the credit performance of an originator’s portfolio. Balmain’s loan origination and settlement software system (BOSS) informs both origination staff and management of expired or defaulting loans on their system login on their ‘home page’. The origination team operates one of the largest loan origination networks outside the major Australian banks across offices in Sydney, Brisbane, the Gold Coast, Melbourne, Canberra, Central Coast and Parramatta.

Evaluation

This is where proper due diligence is performed in accordance with credit policies and procedures. Balmain’s Credit team of eight is responsible for this phase. The Credit team will assess each loan, with key attention paid to:

Loan to Value Ratio – When advancing money against a security property, the loan amount is assessed against underlying security value. Asset values are initially underwritten internally and then externally valued by an independent valuer. The LVR establishes the amount of equity the borrower must contribute and is stressed for depreciation in market values.

Debt Servicing Ratio – Assessed to establish the capability of the borrower to meet the monthly contractual obligations to pay interest. The assessment of income is rigorous to ensure servicing meets the criteria (e.g. annual net income is at least 1.25 times annual interest repayments) or interest paid in advance.

Asset Type/Acceptable Security – Identification of the acceptable security ensures funds are lent against properties where the value is likely to be preserved, are readily saleable in the open market and that there are alternative exit strategies.

Borrower Type/Sponsor Support – The assessment of the borrower’s experience is conducted to identify the extent to which borrowers can deal with unexpected issues.

The Lending Policies and Procedures Manual sets out the definitive process.




Investment Process

Research and Portfolio Construction Process...continued

Submission

Loans that meet the lending criteria and are viewed as attractive by the Credit team, on a risk-return basis, are submitted by the Credit team to the Credit and Investment Committee.

Approval

The Credit and Investment Committee will review the data submitted and decide whether or not to approve the loan. The approval process must be unanimous and documented. To date, the Credit and Investment Committee have been responsible for authorising all loans in the Trust and Balmain Funds, even while the Chief Credit Officer has a delegated authority to authorise fully complying credits of up to $1m.

Management

This involves the on-going management of the investment until timely repayment, which is discussed further below.

Valuers and Valuations

Valuations from qualified and independent valuers are employed on all of the Trust’s loans before the loan being made.

Balmain has specific guidelines that must be met before a Valuer can become a member of the panel of Valuers. The Valuer must be a qualified/registered/licensed Valuer (not a trainee or cadet) in the State where the subject property is located, be a member of the Australian Property Institute and hold a Continuing Practice Development Certificate. In States where there is no registration, the Valuer must be a member of the Australian Property Institute.

All valuations must conform to Balmain’s Valuation Guidelines and Report Content Requirements.

A Valuation Report no older than 90 days as at the date of loan approval must be obtained from a Panel Valuer for each property offered as security. Valuation Reports will be required to be updated at the Borrower’s expense if they become “out of date” before settlement. All Valuation Reports are to be personally signed off by the individual Panel Valuer and a Director of their company.

Each valuation is assessed by the Credit Manager in detail for completeness, accuracy and any adverse features, which prudent lending would suggest that a lower LVR should apply.

Loan Administration and Management

Balmain’s ‘sister company’ AMAL is responsible for the Trust’s loan administration and servicing. Balmain and AMAL have entered into a service agreement, which sets out service standards for each function AMAL performs and how Balmain will monitor AMAL’s performance during the life of the agreement.

AMAL will provide Balmain with a range of reports throughout the month to allow the Credit team to monitor the loan portfolio on a daily basis. These reports include, but are not limited to, information such as loan balances, arrears and length of time they have been in arrears, interest balances and maturity dates.

Data from AMAL is fed through to BAM – an in-house proprietary system which is only accessible by the credit team and Balmain executives.

Balmain believes the independent servicing of loan receivables adds value to portfolios through the granular and independent scrutiny of the on-going performance of each loan receivable. SQM believes that independent loan servicing, or at the very least back-up servicing, provides significant protection to investors in the event of any Manager disruption.



Investment Process

Research and Portfolio Construction Process...continued

Arrears Management

The Trust’s arrears management process is well defined; with the originator and Credit team involved in the initial stages, and the Asset Management and Recovery team involved if the issue is not resolved typically within 30 days.

In the first instance loans that are not paid on time are dealt with at the loan servicer level. Initially, contact is instigated within seven days. Both the Credit team and the originator is contacted by the servicer and advised of the issue. Often the originator may be able to resolve the issue quickly and easily due to their commercial relationship with the borrower. If the matter is not remedied within the allotted time, the loan file moves to Credit.

When a loan file moves to a Credit Officer, the loan file is put on credit watch and enters into a regular credit review process where the Credit Officer manages the progress of correcting the situation but overseen by the Credit and Investment Committee.

If the issue cannot be corrected through the credit oversight process, then the loan will be moved to Asset Recovery. The rationale for removing the Credit Officer from the loan file and placing the matter with Asset Recovery is to provide a dedicated focus to the loan file by a recovery and property specialist. It also serves to remove the Credit Officer from any conflict that the officer may have or any relationship formed with the borrower and also to impress on the borrower the seriousness of the situation.

The Asset Management and Recovery team of 15 are led by Balmain Asset Management CEO Murray Offord. Balmain’s Asset Management division manages multibillion-dollar distressed debt portfolios for four global institutions.

CORPORATE GOVERNANCE / BUSINESS STRATEGY 11

Key Counterparties

Parent Company

Balmain NB Corporation Limited (Balmain) is a broad-based financial services organisation specialising in a full range of commercial real estate debt services. Being one of Australia’s largest non-bank commercial real estate loan organisations, Balmain has operations spanning across loan origination, funds management, credit underwriting, asset management and loan servicing. Balmain commenced business as an originator of commercial loans in 1979 before expanding its commercial lending operations. Since its inception, Balmain has originated over $20 billion of commercial mortgage loans. In addition to this, through AMAL (Balmain owns 42.00% of AMAL), Balmain services over $10 billion commercial loan receivables.

Balmain employs over 120 staff, located in eight offices around Australia. Impressively, Balmain operates one of the largest non-bank commercial loan origination networks in Australia. Along with its origination network, through its major share-holding of AMAL, Balmain offers a well-recognised servicing platform for commercial mortgages. Both the origination and servicing functions provided by Balmain/AMAL are often utilised by major financial institutions.

Balmain also operates a large and reputable Credit Underwriting and Asset Management team. The Asset Management team have been involved in the takeover of a

number of high-profile portfolios, in particular, the much- publicised takeover of City Pacific, which was severely distressed during the Global Financial Crisis. Moreover, in 2013, Balmain was appointed as special servicer, trust manager and asset manager for a number of commercial mortgage portfolios that traded in the Australian market.

Investment Manager / Fund Manager

Balmain Funds Management Pty Limited (Balmain Funds) is the Investment Manager of the Trust. Balmain Funds was founded in 2004, and its line of business includes managing investment funds and mutual fund sales.

The Board of the Balmain Funds is comprised of two directors, none of whom are independent.

Responsible Entity

Balmain Fund Administration Limited (BFAL) is the Responsible Entity for the Trust. BFAL is a wholly owned subsidiary of Balmain.

The Board of BFAL is comprised of four directors - three Balmain executive directors, including Michael Holm, Andrew Griffin and John Robles and independent Director Steven Hall - who have a significant funds management and financial services experience.


CORPORATE GOVERNANCE/BUSINESS STRATEGY 12

FUM for Fund under Review ($mill)Management Risk

Funds management encompasses not only the operational capabilities of project counterparties but also the corporate ability of the Responsible Entity to monitor operational performance and to meet the regulatory and statutory responsibilities required. For all mortgage funds, there is a risk that financial position and management performance deterioration may temporarily or permanently compromise asset condition, project and regulatory outcomes.

SQM Research believes that Balmain and related entities are appropriately qualified to carry out their assigned responsibilities. Given the breadth of experience in all key skill sets and the strong focus on Commercial Real Estate lending, Management risk is rated as being above its peers.

Funds under Management (FUM)

Total Market value of all loan and cash units equate to $169m as at 31 October 2017.

FUM

Dec-11 $0.0

Jun-12 $5.5

Dec-12 $8.4

Jun-13 $14.3

Dec-13 $13.5

Jun-14 $16.0

Dec-14 $11.8

Jun-15 $14.6

Dec-15 $24.5

Jun-16 $32.0

Dec-16 $66.8

Jun-17 $148.1


MANAGEMENT & PEOPLE 13

Investment Staff

Name Responsibility / Position LocationYears with Company

Years with Industry

Michael Holm Member of the Credit and Investment Committee/Balmain Founder and CEO Sydney 38 38

Andrew Griffin Member of the Credit and Investment Committee, CEO Balmain Sydney 14 32

Robert Taylor Member of the Credit and Investment Committee, Director Balmain Melbourne 20 26

Caroline Crocker Operations Manager – Client Services Sydney 8 13

William Davis Member of the Credit and Investment Committee/Head of Credit Sydney 12 43

Tom Sherston Head of Sales Sydney 13 29

Amanta Shankar Operations Assistant Sydney 1 7

Michael Finlayson Senior Credit Manager Sydney 9 18


Investment Team

Executive Director and CEO of Balmain - Michael Holm has prime responsibility for the management of the Trust. Mr Holm is a highly experienced commercial property lender and fund manager with 37 years’ industry experience. Operations Manager - Caroline Crocker is in charge of the day-to-day management of the Trust’s operations. The Funds Management Team is responsible for the administrative and operational functions associated with the Trust as well as customer relations (financial advisors and investors). The Origination and Credit team also plays a critical role in the Trust. The Origination team operates one of the largest and most established sources of secured private debt loan origination outside the major banks. Operating across Sydney, Brisbane, the Gold Coast and Melbourne, the loan origination team is comprised of over 40 Business Development/Origination and analyst staff.

The Credit team is responsible for the credit assessment and structuring as well as the on-going monitoring of the Trust’s assets. The Credit team is based in Sydney and operates separately from the Origination team. William Davis heads the team of eight, who display a broad range of experience and include two lawyers and one paralegal. Mr Davis has significant experience in all facets of commercial mortgage lending throughout multiple real estate cycles. The Credit team is separated into two broad functions, an acceptance desk that reviews loans for fit and accuracy of data, before determining if they should proceed to a credit underwrite (pricing, conditioning and loan term).

The Credit and Investment Committee also has a pivotal role in the Trust and is comprised of Head of Credit - William Davis, Head of Asset Management and Recovery - Mr Murry

Offord and Executive Chairman of Balmain NB Corporation Limited and CEO of Balmain Funds – Michael Holm, CEO of Balmain NB Corporation - Andrew Griffin and Executive Director Balmain Melbourne - Robert Taylor. The Credit and Investment Committee is responsible for:

• Recommending and approving investments for the Trust

• Managing and delegating lending authorities in relation to approving loans of the Trust

• Monitoring loan positions and individual loan performance

• Monitoring loan covenants and ensuring borrowers compliance with specific loan conditions

• Developing and reviewing the credit policies and procedures

• Monitoring implementation of credit policies and procedures

• Setting risk limits, benchmarks and ranges

• Undertaking any interest collection and loan recovery action as and when requires

• Reviewing and amending the overall investment strategies

The CIC meet formally every second Wednesday. Ms Crocker attends the CIC meetings if and when required. All credit decisions made by the CIC relating to credit matters must be unanimous and documented. To date, the CIC has been responsible for authorising all loans in the Trust, even while the Chief Credit Officer has a delegated authority to authorise fully complying credits of up to $1m. The Manager has stated that it has all intention to continue this stringent process.

The Trust anticipates sourcing the majority of its loans from the Origination team. However, a small number of loans have been

MANAGEMENT & PEOPLE 14


originated from other Balmain funds. Since 1st January 2015, no loans have been sourced from other Balmain funds.

The Asset Management and Recovery team may be employed by the Trust should a loan need to be recovered. The team of 15 will undertake a detailed review of an asset and likelihood for recovery once a loan is more than 30 days in arrears. The Asset Management and Recovery team possess a wide range of skills, from debt workout, property development management, lawyers, property asset managers and construction supervision. The Asset Management and Recovery team manage multibillion dollar distressed debt portfolios for four global institutions.

Balmain’s subsidiary AMAL is responsible for administering and managing the Trust’s loans once they have been settled. A range of reports is provided by AMAL to the Credit and Origination team to allow them to monitor the loan portfolio on a daily basis. AMAL holds S&P’s highest servicer rating, “Strong”.

SQM Research believes the practice of constant communication and the broad-based inclusion of team members in decision-making is a vital ingredient to the success of the process. Interactive peer review and collaboration across a tightly knit group of experienced investors will likely make the best use of their combined intellectual property and shared history.

SQM Research believes the practice of constant communication and the broad-based inclusion of team members in decision-making is a vital ingredient to the success of the process. Interactive peer review and collaboration across a tightly knit group of experienced investors will likely make the best use of their combined intellectual property and shared history.

Staffing Changes

Since the last review, Balmain Private has had some turnover in staff.

Mr Sam Scardili - Dealer Sales departed the firm. Throughout 2017, a number of hires were also made.

Departures

Date Responsibility Reason for Departure

Sep-17 Dealer Sales Left company

Additions

Date New Responsibility

Jan-17 Credit Manager

Apr-2017 Account Executive

May-2017 Account Executive

Jun-2017 Operations Assistant

Oct-2017 Dealer Sales

SQM Research observes that the levels of investment experience and company tenure are strong across the entire investment team. The levels and nature of staff turnover are not an issue of concern, in SQM’s view.

Remuneration and Incentives

Balmain aims to pay market-based compensation and supplements base remuneration with performance related bonuses directly linked to business objectives. The main business objective is to accept, approve and manage high-quality first mortgage portfolios that deliver their stated target returns to investors.

As an organisation, Balmain offers a career progression that enables the business to attract and retain talent in competitive markets. Origination staff have a defined path of progression that can see graduate analyst resources progress to business partners and shareholders via a series of agreed milestones over a one to five-year timeframe. Funds Management and Credit staff equally have an opportunity at Balmain to progress in either a specialised skills area or to expand on their experience by undertaking special projects within the various divisions of Balmain. Through a combination of ‘on the job’ training and external training development initiatives, staff in Funds, Credit and Asset Management achieve objectives set for them through co-ordinated and formalised performance assessment programs.

Staff incentives and remuneration policies appear to be in line with industry peers and to provide an effective way of aligning staff performance with the on-going performance of the business.

PRODUCT FEATURES - FEES, REDEMPTION POLICY 15

Entry/Exit Fees

As a result of Future of Financial Advice (FoFA) reforms, effective 1 July 2013, no contribution fees or trail commissions can be charged on new investments. In addition to this, the Trust (including both Cash and Loan Units) and peers do not charge a buy/sell spread.

Ongoing Fees

No management fees are charged on the Trust’s Cash Units.

However, the Trust does charge a management fee on its Loan Units of up to 1.60% p.a. on the Principal Amount in respect to each loan. This management fee is comprised of an Investment Management fee of 0.80% p.a. calculated and paid quarterly in arrears from the Trust’s assets and a Deferred Management Fee of 0.80% p.a. which will only be paid in full when the loan attached to the Sub-Trust has been fully recovered, and its Target Return (as disclosed in a Supplementary PDS) has been achieved or exceeded. If the Actual Return is less than the Target Return, the Investment Manager will only be entitled to a proportion of the Deferred Management Fee. The amount received is based on a percentage of the Target Return that was actually achieved multiplied by the Deferred Management Fee. A reserve will be kept to retain Deferred Management Fees until loans are recovered in full and paid out.

The Trust’s indirect cost ratio increases to 1.65% after expense recoveries. This cost includes the normal recovery expenses relating to the operation of the Trust, although it does not take into account abnormal expenses which may also be payable from assets of the Trust.

Entry/Exit Fees Trust

Buy Spread (%) 0.00%

Sell Spread (%) 0.00%

Ongoing Fees Trust

Management fee (% p.a.) 1.60

Expense recoveries (% p.a) 0.05

MER (% p.a.) 1.65

Performance Fee 50.00% of any surplus recovery


Performance Fees

The Trust charges a performance fee on its Loan Units of 50.00% of any surplus recovery. This performance fee is payable to the Responsible Entity for managing the investments. The performance fee is calculated and only paid once investor capital in that loan has been fully returned and the Target Return outlined in the Supplementary PDS has been received.

Overall Fees

If held and redeemed within 12 months, total transaction costs would amount to 1.65% of investment in the Fund. This figure includes the MER, expense recovery and the buy/sell spread. It does not take into account rebates or negotiations or any potential performance fee.

QUANTITATIVE ANALYSIS 16

Returns 1-Year 3 Year 5-Year Inception

Tracking Error (% p.a.) - Fund 0.05 0.23 0.27 0.27

Tracking Error (% p.a.) - Peer Average 0.04 0.08 0.11 0.12

Information Ratio - Fund 88.55 14.60 10.39 10.17

Information Ratio - Peer Average 10.28 -0.22 -0.17 1.56

Sharpe Ratio - Fund 173.55 52.24 47.95 48.94

Sharpe Ratio - Peer Average Not Applicable 58.91 30.96 25.92

Volatility - Fund (% p.a.) 0.05 0.14 0.15 0.15

Volatility - Peer Average (% p.a.) 0.05 0.08 0.17 0.21

Volatility - Benchmark (% p.a.) 0.02 0.10 0.13 0.16

Beta based on stated Benchmark 0.37 -1.14 -0.89 -0.49

Quantitative Insight1

Note: All return and risk data reported in this section are after-fees and for periods ending Oct-2017 unless otherwise stated.

The low volatility nature of mortgage portfolios reduces the meaningfulness of traditional measures of risk and return. Fund metrics such as volatility, Tracking Error, Information Ratio, and Sharpe Ratio have relatively low statistical value given the low volatility of returns.

Returns

Since inception, in November 2012, the Balmain Discrete Mortgage Income Trust has returned 7.29% p.a. as compared to a return of 4.55% p.a. from the Bloomberg AusBond Bank Bill Index +2%pa. This represents alpha of 2.73% p.a. The peer group average over this period was 4.76%. (Note that all Fund returns referenced in this report are net of fees).

The return achieved over the past year was 7.97% compared to the benchmark of 3.81%, generating an excess return of 4.16%. The peer average was 4.12%

The Fund’s return for the past three years was 7.56% compared to the benchmark of 4.17%, generating an excess return of 3.39%. The peer average was 4.31%

These returns are in line with the PDS objective, and are are consistent with SQM’s expectations for the Fund relative to its fee level and volatility.


1. Note: Sharpe and Information Ratios are not reliable comparison tools in periods where both the Trust and its peers/benchmark record a negative result

Fund Performance to 31 October 2017 (%) Jun-2012

Returns 1-Month 3-Month 6-Month 1-Year 3 Year 5-Year Inception

Fund1 0.64 1.91 3.86 7.97 7.56 7.26 7.29

Benchmark2 0.31 0.93 1.88 3.81 4.17 4.46 4.55

Peer Average 0.34 1.01 2.05 4.12 4.31 4.63 4.76

Excess 0.32 0.98 1.98 4.16 3.39 2.80 2.73

1. Return assumes dividend reinvestment. Returns for periods greater than one year are annualised.

2. Benchmark is Bloomberg AusBond Bank +2%pa TR AUD

QUANTITATIVE ANALYSIS 16 QUANTITATIVE ANALYSIS 17


Weighted Avg LVR Average Loan (principal, million)

Largest 20 Borrowers (million)

Historical Trends


Portfolio Statistics - 31 October 2017

Market Value ($m) $140.6

No. Positions 47

Weighted Avg Borrower Rate 9.29%

Years to Maturity 0.14

Maturity (years) Weight

0-2 100.00%

3-6 0.00%

7-10 0.00%

10+ 0.00%

100.00%

Interest Credit Risk Grading

Weight

Strong 55.77%

Fair 34.68%

Medium 9.55%

100.00%

Interest Rate Type Weight

Fixed 100.00%

100.00%


Portfolio Sector

Loan Purpose

Economic Sector



Average Yield

Top 10 Holdings Balmain Private (Balmain Discrete Mortgage Income Trusts)

Weight WAL Rating Country Industry

Loan 1 6.39% 0.0 Strong Commercial Equity release

Loan 2 5.88% 0.0 Strong Commercial Refinance

Loan 3 5.46% 0.0 Strong Residential Equity + project costs

Loan 4 4.19% 0.0 Fair Residential Refinance

Loan 5 4.04% 0.0 Fair Commercial Refinance

Loan 6 3.66% 1.0 Medium Vacant Land Refinance

Loan 7 3.53% 0.0 Fair Vacant Land Bridging facility

Loan 8 3.31% 1.0 Strong Vacant Land Refinance

Loan 9 3.20% 0.0 Strong Residential Purchase

Loan 10 3.16% 0.0 Strong Vacant Land Working capital

42.80%

ASSET ALLOCATIONS & RISK PARAMETERS 20


The table below outline limits on the Fund’s asset allocation and other risk parameters: -

Fund Constraints Permitted Range or Limit

Maximum LVR 70.00%

Maximum loan size $5m

Minimum loan size $250,000

© SQM Research 2018

DISCLAIMER

Although all reasonable care has been taken to ensure that the information contained in this document is accurate, neither SQM Research nor its respective officers, advisers or agents makes any representation or warranty, express or implied as to the accuracy, completeness, currency or reliability of such information or any other information provided whether in writing or orally to any recipient or its officers, advisers or agents.

SQM Research and its respective officers, advisers, or agents do not accept:

- any responsibility arising in any way for any errors in or omissions from any information contained in this document or for any lack of accuracy, completeness, currency or reliability of any information made available to any recipient, its officers, advisers, or agents; or

- any liability for any direct or consequential loss, damage or injury suffered or incurred by the recipient, or any other person as a result of or arising out of that person placing any reliance on the information or its accuracy, completeness, currency or reliability.

This document contains statements which reflect current views and opinions of management and information which is current at the time of its release but which may relate to intended or anticipated future performance or activities. Such statements and financial information provided have been estimated only and are based on certain assumptions and management’s analysis of the information available at the time this document was prepared and are subject to risk and uncertainties given their anticipatory nature. Actual results may differ materially from current indications due to the variety of factors.

Accordingly, nothing in the document is or should be relied upon as a promise or representation as to the future or any event or activity in the future and there is no representation, warranty or other assurance that any projections or estimations will be realised.

By accepting the opportunity to review this document the recipient of this information acknowledges that:

- it will conduct its own investigation and analysis regarding any information, representation or statement contained in this or any other written or oral information made available to it and will rely on its own inquiries and seek appropriate professional advice in deciding whether to further investigate the business, operations and assets of the business; and

- to the extent that this document includes forecasts, qualitative statements and associated commentary, including estimates in relation to future or anticipated performance, no representation is made that any forecast, statement or estimate will be achieved or is accurate, and it is acknowledged that actual future operations may vary significantly from the estimates and forecasts and accordingly, all recipients will make their own investigations and inquiries regarding all assumptions, uncertainties and contingencies which may effect the future operations of the business.

In providing this document, SQM Research reserves the right to amend, replace or withdraw the document at any time. SQM Research has no obligation to provide the recipient with any access to additional information or to release the results of or update any information or opinion contained in this document.

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Requests to reproduce or use an SQM Research assessment review should be sent to [email protected]

Disclosure

SQM Research has no involvement in this fund or any of the organisations contained in the product disclosure statement. This assessment does not constitute an investment recommendation. It is designed to provide investment advisers with a third party view of the quality of this fund, as an investment option. SQM Research charges a standard and fixed fee for the third party review. This fee has been paid under the normal commercial terms of SQM Research.

SQM Research, under its Australian Financial Services Licence (Licence number 421913) operates under the provisions set down under ASIC Regulatory Guide 79.

Please note a Financial Services Guide and a Conflicts of Interest policy is available on our website. Subscribers to SQM Research receive access to the full range of fund research, ratings and fund updates.

This report has been prepared for Financial Advisers Only.

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ContactsLouis Christopher 02 9220 4666Rob da Silva 02 9220 4606

Central ContactsPhone 1800 766 651Email: [email protected]: www.sqmresearch.com.au www.sqmratings.com.au

Balmain Discrete Mortgage Income Trusts · CONTENTS Summary 2 Fund Summary 3 SQM Research’s...

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