Qualitas Limited (QAL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Qualitas 1H 23 results briefing. [Operator Instructions]. I would now like to hand the conference over to Mr. Andrew Schwartz, Group Managing Director and Co-Founder. Please go ahead.

Thank you, and good morning. Welcome to the Qualitas First Half FY '23 Financial Results Presentation. I'm Andrew Schwartz, Group Managing Director, Co-Founder of Qualitas. Presenting with me today is Kathleen Yeung, Global Head of Corporate Development; and Philip Dowman, our Chief Financial Officer. Firstly, I would like to acknowledge the traditional custodians of the lands that we're meeting on today. And for us, that is the Wurundjeri people of the Kulin Nation, and I pay my respects to elders past and present. I'll commence our presentation with the first half highlights and then provide an update on our funds management business. Kathleen will present an update on our ESG initiatives, which is very much at the forefront of what we do as a business. Philip will present our financial summary for this period. The presentation will run for about 30 minutes and will then follow by Q&A. Turning to Slide 5. Qualitas has marked just over 1 year since we listed on the ASX. The period has been characterized by continued rising interest rates. In our view, the market for real estate private credit continues to experience a general withdrawal of competition and liquidity, allowing for a rising risk margins, which benefits our fund investors. The benefit of these market tailwinds is seen in the significant growth in our private credit platform. Both deployment and new committed FUM reflects the growing attractiveness of this sector. We deployed $1.76 billion in the first half, all in private credit. At about fresh $1.5 billion of new committed FUM for the half year, about 75% of it relates to new private credit mandates. This is the committed equity FUM for the firm and the quantum of this increase is particularly implied and pleasing in light of a softer capital raising environment generally for real estate. We are positioning the business in line with our key investment thematics to take advantage of market megatrends. I will further discuss these megatrends later in the presentation. We recently executed a fresh mandate for our second BTR equity fund, adding a further $350 million of FUM to our group. The foundation of the business has been the deployment in our income credit strategy, which has been the key driver of the first half year funds management earnings growth. Group EBITDA, preperformance fees has grown by 66% since this time last year, and we've seen a commensurate increase in the widening of our operating margin by 6% over the same period. At a headline level, group EBITDA is lower compared to prior comparable period due to lower performance fees recognized. We have consistently noted performance fees are not linear. In general, they are linked to the relevant fund maturity and performance is not measured on a yearly basis. Within our funds, we have accrued more performance fee expense relative to the performance fee revenue we have recognized at the Qualitas manager level. This demonstrates our conservative approach to performance fee recognition. We have provided a further update in regards to the pool of theoretical embedded future performance fees, which has increased to $80 million over a 7-year outlook period, up from $75 million in August last year. We based this on deployed capital only as at today. In other words, committed FUM that also has performance fees attached but is not yet deployed is not included in this calculation. Embedded and unrecognized performance fees are based on numerous assumptions. During the half year, we have strategically deployed our balance sheet capital for the benefit of our fund and corporate investors. This brings greater certainty to the transaction closure and underwriting our FUMs, asset growth and pipeline. Our strategy to scale the platform through larger investment sizes and larger capital mandates has been proven in this half year. Our average transaction size has increased to $71 million which is a 54% increase on this time last year, and I will provide further details later in this presentation. Now turning to Slide 6. Qualitas Group recorded a normalized EBITDA of $16 million in the first half of 2023. As noted earlier, the lower performance fee accrual has meant the headline group EBITDA is lower than prior period. However, the underlying core business has shown strong growth on a preperformance fee basis. Group EBITDA preperformance fees grew by 66% on prior year. The additional $1.5 billion of FUM raised in this half year has brought total FUMs under management to $5.8 billion, up 36% on the first half 2022. Of this total FUM, $4.5 billion is eligible for performance fees. Strong deployment in our income credit strategies generated $20.7 million of funds management fees recognized this half, which is up 21% on first half 2022. Significant deployment occurred in December, which will come through in the second half of financial year 2023. This translates to a pro forma net profit before tax of $14.6 million, which is up 77% before performance fees on a prior comparable period. An instrumental factor in our earnings is the strategic use of our balance sheet for underwriting purposes, which I will elaborate on shortly. The company retained $122 million in net cash, providing flexibility to reach investment opportunities for new or existing funds while earning attractive returns for cash on balance sheet. During the period, we underwrote $328 million, and we recycled $220 million back to the balance sheet this first half. Our well-capitalized position, along with our deep bench of experienced professionals is what sets us apart in the market. We don't take our people for granted and maintain a value-driven approach to talent acquisition, management and retention. As briefly mentioned earlier, the first half also saw an acceleration of interest rate rises in Australia. These conditions can favor our business as an experienced investor throughout the cycle. We remain vigilant in assessing risks and converting existing fixed loans to variable at the earliest opportunity so that increases are passed on to investors through higher distributions. Moving now to a summary of our progress on strategic initiatives during the first half of this financial year. To build on the momentum from our ASX listing just over 12 months ago, we have been focused on 2 key areas: growing top line funds management revenue and improving efficiencies and scalability of the platform. Both objectives have been met first half '23. There's been a lot of activity during the first half as we continue to deliver on our strategy for shareholders and investors. I will now focus on some of those highlights. First, market tailwinds helped drive strong deployment in the first half, representing 91% of financial year 2022 deployment. Around 40% of first half '23 deployment was settled in December 2022, with the full benefit of $1.6 million in management fees to be realized in the second half of '23. As I mentioned earlier, the significant increase in the average size of our transactions has improved the scalability and efficiency of our platform. It has also brought a commensurate increase in the quality of investment opportunities in our pipeline. This allows us to handpick premium opportunities not accessible to other market participants, providing us with strong competitive advantage in both debt and equity financing. The average growth size of our investments was $71 million for the period, which excludes the $600 million AURA by Aqualand property development we announced in October 2022. This is a very important indicator for the efficiency of our operations that we closely track. The second highlight that I would like to draw out is the strong investor conviction in Qualitas investment strategies, driving FUM growth and resulting in a more diversified investor base. 3 mandates awarded during the first half of 2023 deserve particular mention not only due to the impact on FUM growth but also because each illustrates the strong interest from large local and global institutional investors. As announced in August 2022, there was a $700 million commitment from the Abu Dhabi Investment Authority carried out through the special created Qualitas diversified credit investments fund. This fund is progressing well, and deployment is ahead of the forecast we set ourselves together with ADIA, reflecting the momentum of our origination and investment team. In September, we announced a $440 million [indiscernible] commitment from a global institutional investor for the Qualitas construction debt fund #2. In December, we received a second mandate for the build-to-rent equity with gross capital commitment of $2 billion, resulting in $3.2 billion in total gross assets under management for this strategy. In terms of our committed FUM, this translates to $350 million increase being our 50% share of the jointly owned BTR platform adjusted to NAV post our anticipated leverage. These mandates demonstrate our growth is not linear at times. It's important we carefully absorb new capital over time. The final highlight I want to cover in the strategic deployment of balance sheet capital for future growth, which includes warehouse facilities totaling $125 million created for our ASX-listed QRI fund and the Qualitas senior debt fund. In addition, further co-investment was committed for BTR Equity Fund #2 and QREOFIII funds. We view our warehousing capability, which allows us to place multiple assets on balance sheet, whilst our funds cycle through existing loans and growing size, a key strength of the Qualitas business model. We'll now move to Slide 8 to discuss some of the macroeconomic landscape. Here, I will cover several macroeconomic tailwinds benefiting the alternative CRE sector and our business. We are likely to see the following trends continue to intensify during 2023. Elevated interest rates with further rate hikes signaled by the RBA, further widening of credit risk margin as liquidity tightens, long-term housing supply shortages exacerbated by the return of pre-COVID levels of migration and record low vacancies not seen since 2006. With approximately 71% of our FUM in private credit, increases in the base rate will directly benefit the returns of FUMs. As interest rate increases at the fastest pace we've seen in decades, asset security values are likely to adjust. Real estate typically has lagged a response to changes in the macroeconomic environment than any other asset class. Navigating the current market conditions requires a dedicated team with expertise in both CRE credit and equity with experience investing through different cycles. It requires a forward-looking lens. We anticipate credit spreads to widen further this year as alternative real estate investors are spoiled for choice in this market cycle. Those with capital are able to demand better risk-adjusted returns and these are favorable markets in this regard. We continue to have conviction in the outlook for multi-dwelling residential sector in Australia. Vacancy rates across capital cities are at or below 1% in comparison to what we believe is market equilibrium at around 3%. We expect the return of migration to further elevate pressure on the supply of housing. Different to organic growth in population, skilled labor and international students will require immediate supply of housing. A dislocation has occurred in the Australian market. As Australia on boards 195,000 new migrants a year, we scope for another 100,000 overseas students to resume in-person study over the next 3 years. This equates to approximately 260,000 to 300,000 incremental housing demand in aggregate over the next 3 years, assuming average number of people per household is 2.35 for new migrants and 3 for students. This excludes demand from organic growth. We see the supply of new apartments in the 55,000 to 60,000 range per annum from -- for 2023 and -- 2022 and 2023, representing 40% below peak levels in 2017. Prima facie increasing interest rates suppressed demand for new housing stock. However, the significant unmet demand is considered to be the primary cause for the increase in rents that we are observing in the multi-dwelling residential sector. As has been widely reported, rents in our major capital cities such as Melbourne and Sydney have climbed some 15% to 20% this year, which is an unfortunate consequence of COVID, lack of new supply and softening of end values of residential property. The current economic environment provides the perfect setup for the build-to-rent sector, which is a key investment thematic of Qualitas and gives us ongoing conviction in terms of extending private capital for development of residential property. Against this backdrop, we believe our investment thematics are well positioned in the current economic cycle. Private credit opportunities in Australia are growing rapidly. The CRE credit market in Australia, which is funded by the banks is approximately $417 billion in 2022. As their regulatory changes continue to increase and APRA continues to time lending policies, we can see the traditional sources of financing reducing their participation in this sector, especially in residential. Increased borrowing costs and market uncertainty have further accelerated the bank's retreat from CRE lending. This opens a gap in the market as borrowers seek more efficient and flexible financing solutions. As a result, we've seen increasing institutional allocations into private credit. To highlight the opportunity, a 1% pullback by major banks is a circa $4 billion gap in funding, which is the opportunity for firms like Qualitas. In addition to this, the CRE total bank's lending market has grown at 6% CAGR in the last 10 years. As a leader in the commercial real estate credit market in Australia, we see opportunities to maximize our ESG impact by integrating ESG considerations into our financing and due diligence process. As mentioned on the previous slide, we believe the potential for the build-to-rent sector is unparalleled by any other real estate subsector in Australia. It's a new asset class in Australia that it is well established offshore given it can provide the investor with a recession-proof income strength. This is evidenced by the second build-to-rent equity fund, which I mentioned earlier. This thematic is widely recognized by institutional investors. The key thematic of our BTR platform is combining track record of property management, development and specialized commercial real estate financing with proven domestic real estate network and expertise. These are all key factors contributing to the success of our BTR platform. As part of our income equity strategy, we will continue to look for commercial real estate assets that are inflation proof with strong fundamentals, irrespective of the market cycles. In regards to opportunistic, we anticipate potential opportunistic investments will emerge in our pipeline in the second half of this year in both credit and also equity. In summary, given the broader economic environment where cap rates and hence asset values are recalibrating, we prefer to be in the private structure credit where we see greater relative return for risk. Certainly, this has been the most dominating thematic being requested from our pipeline of institutional investors. Moving to Slide 11. The chart on the left further illustrates the market tailwinds we -- which are driving investor allocations into private credit, with circa 75% of the new committed FUM for the half year in private credit. Our overall FUM growth is in line with historical CAGR. During the first half of '23, we deployed $1.76 billion in capital, which represents a 68% increase compared to first half '22, reflecting the expanding pipeline of opportunities for firms such as Qualitas. In line with my comments on the previous slide on relative risk and return, the deployment for the first half was 100% in private credit. Our pipeline is the strongest that I've seen in several years, and we are in a fortunate position to be able to selectively transact on those investments, which we feel are appropriately priced for risk with sponsors well known to us. Due diligence for any new investment is extensive. In regards to our income credit strategies, we're focused on borrower serviceability and material erosion of underlying security values. To date, we do not have any assets which are impaired, which is a testament to our investment due diligence and our proven intensive asset and portfolio management process. We do not take our track record for granted, and we remain vigilant in this regard, especially in an upward moving interest rate environment. The result of the significant capital inflows this period has greatly benefited the quality and diversity of our institutional investor base. Capital sourced from global and domestic institutions now make up 76% of our FUM up from 69% this time last year, which is a reflection of increasing allocations by global investors into private credit generally and also sector tailwinds. Our institutional investor mix has increased by type and geography. On par with my comment earlier about the strength of our deployment pipeline, it's the same with the capital pipeline. Having the balance sheet capital and securing the ADIA mandate has put us in the consideration set for a number of global institutional investors that would not have engaged with us pre-IPO. Qualitas is highly transparent in the eyes of our LP investors in what has been a relatively opaque market in Australia. The FUM from these investors is considered to be long-term capital and they have the funding capacity to recommit to the same strategy and across strategies in material amounts. I will now hand over to Kathleen to speak about our ESG initiatives and the outcomes for this period. Thanks, Kathleen.

Thanks, Andrew, and good morning. Our ESG initiatives for this half year have covered the breadth of the E, S and the G. Firstly, we initiated and received conditional endorsement by Reconciliation Australia for the Qualitas Reflect Reconciliation Action Plans or Reflect RAP. Our immediate focus is to move to final approval of our RAP and to commence cultural training and awareness for our people. This is an area which resonates deeply with the team, and we feel that given what we do, we can make a meaningful contribution, and this is just the start. Secondly, we remain committed to reducing carbon emissions and increasing our influence with our sponsors and borrowers in this regard. We are doing this via our ESG risk assessment tool, which is now looking to incorporate climate risk and further refinement of the social criteria. Currently, this tool is being used for our education of where our sponsors and borrowers are at the [ fair ] ESG journey with the aim of developing it to allow us to undertake portfolio and asset reporting from an ESG lens. And finally, we're very excited by the recent formation of the Qualitas ESG Advisory Group. This group has been set up to help shape ESG best practice within the firm, identify and report progress against objectives and advise how Qualitas leverages its strength to maximize this impact. ESG reporting and measurement is an ongoing piece of work and we're carefully watching the outcomes of recent updates here in Australia and offshore to ensure we're prepared for any new reporting frameworks. I'll now hand over to Philip to speak to our half year financial results.

Thank you, Kathleen, and good morning. I am pleased to report a strong underlying trading performance in the half year ended December 2022. The core funds management operating contribution of $8.6 million was up 25% on the prior corresponding period. And the funds management gross operating margin improved from 40% to 42%, attributable to strong deployment of existing and new committed FUM. As Andrew mentioned, 40% of our deployment volume occurred late in the half, providing a solid platform for further growth in funds management revenue in the second half of FY '23. Overall, funds management revenue was up 21% and importantly, ahead of employee cost growth compared with the December half driving that favorable increase in the gross operating margin to 42%. The contribution from net performance fees was significantly less than this latest half year at $1.5 million compared with $9 million in the previous corresponding period. All of our performance fees are payable at the end of their fund life or at set intervals. And as such, the actual performance fees are not linear. Accordingly and under our performance fee policy, less performance fee revenue has been recognized this half until we either exit or move to a near exit on assets, which have near-term performance fees accrual. We have also refreshed our estimated pool of embedded and as yet unrecognized performance fees, which we first communicated in August 22. And is totaling $75 million to a revised $80 million over the next 7 years as a result of new capital now deployed. This remains based on a theoretical estimate of the performance fee potential of currently deployed FUM. It is important to highlight that the calculation is derived on assumptions about future markets and the occurrence of events that are outside our direct control and endure for a number of years. Actual results could vary materially due to these factors, but we recognize that investors require insight into our book of potential future performance fee revenue. Another key feature of our operating result this half is the significant growth in co-investment and other income, a direct benefit of the IPO proceeds and our ability to utilize these to co-invest and underwrite fund transactions. Total income of $7.5 million this half was up from $1.2 million in the prior corresponding period, benefiting from higher interest rates and increased use of balance sheet funds to underwrite transaction flow for our income credit funds, in particular. Corporate overheads this period reflects marginally higher costs versus June '22, but an increase on our pre-listing cost base reported in the December '21 half year. The other segment of our business is Arch Finance, our direct lending business. Arch Finance contributed $2.5 million to normalized EBITDA in the period, up from $2.2 million, a lift of 14%, largely driven by an expansion in interest margin. This business maintains strong credit quality. Overall, our normalized group EBITDA was $16 million and $14.5 million, excluding the contribution from net performance fees. This core earnings measure, excluding performance fees, was up a substantial 66% on the prior corresponding period, again, reinforcing the strong earnings momentum of the Qualitas platform when performance fees are removed. Statutory NPAT was $10.7 million for the period, up 117% on the corresponding period, which included one-off listing costs. An interim dividend of $0.02 per share has been declared and will be paid in early April, representing a payout ratio for the period of 55%. Turning now to a review of our operating performance in a little more detail. Our Funds Management segment delivered strong revenue growth in the half year, as shown by the chart on the left, underpinned by funds management fees up 21% to $21 million and a very strong contribution from other income of $7.5 million reflecting the earnings on our balance sheet liquidity through co-investments and underwrites. The low level of performance fees recognized in the current period is the core reason for the top line revenue being less than recent periods. Our approach to performance fee recognition remains prudent and the gap between fund performance fee expense and the revenue recognized by the corporate has remained largely unchanged this half, pending final asset realizations, which are expected to exit later this calendar year. The strong core underlying revenue growth reflects the continued support we enjoyed from our investors itself a reflection of our track record of delivering attractive returns over the long term. The chart on the right provides a little more detail on the key drivers of our funds management revenues. Base management fees grew by 18% compared to this time last year. Transaction fees increased by 31% versus the December '21 half year, driven by the strong deployment through the year and particularly in the last quarter of the '22 calendar year. The scalability of our business is evidenced by the decline in employee cost as a percentage of FUM to 0.9% of average invested FUM compared to the previous corresponding period. A larger average transaction size of $71 million compares to $51 million average for FY '22, and this is a key driver of ongoing operating efficiency within the platform. Turning to the next slide. Given the significance of the higher earnings reported as other income, we have set out more detail on this slide, highlighting the earnings on our historical co-investments and principal earnings. And separately identifying incremental revenue from our use of the additional balance sheet liquidity arising from the IPO. A significant $3.7 million was earned through the ability to underwrite or warehouse investment assets on behalf of our funds, especially the recently structured liquidity warehouse to support investment flows into our flagship credit income strategies, our ASX-listed QRI fund and the unlisted wholesale Qualitas senior debt fund. A key feature of our use of balance sheet is how funds are able to be recycled with positions held for short periods, up $328 million of underwrites put in place in the 6 months, $220 million was recycled within the period. Turning now to the balance sheet. The main change is in the reduction in cash and cash equivalents from 30 June to now through a number of short-term underwrites and longer-term co-investments, which are classified as either loan receivables or investments in our accounts as summarized on the slide. The current cash balance means the business remains well positioned to take further advantage of opportunities that may arise in both our credit and equity investment streams, providing the business with the financial strength to facilitate fund growth through co-investment and fund warehousing and bridging activities. As Andrew noted, we remain very focused on the strategic deployment of these proceeds. The Arch lending book has declined modestly by 3.8% since 30 June, reflecting a strong push by the trading banks on small ticket property finance. Our loan book has been reduced as borrowers seek refinancing with those traditional banks. This does demonstrate the strength and quality of the underlying loan book. This has also been matched with a reduction in the investor loan notes funding the warehouse facility, which has limited recourse to Qualitas' balance sheet. I will now hand back to Andrew.

Thanks, Philip. To wrap up, the business is capitalizing on sector tailwinds and consolidating its position as a leading CRE credit financier with a differentiated ability to transact at scale, coupled with agility and flexibility. Our ability to close significant capital mandates is a testament to the expertise of our people. We remain cautiously positive in our outlook for FY '23 and therefore, we reaffirmed previously stated guidance of $30 million to $33 million net profit before tax. That concludes our formal presentation, and we're now happy to move into Q&A.

[Operator Instructions]. Your first question comes from Michael Peet from Goldman Sachs.

Just the first one, Andrew, are you seeing any signs of stress out there in the market at the moment? And I guess I'm also referring to any potential sort of change in the way that the stack is structured in refinancings coming up potentially across equity, mezz or senior debt.

Look, firstly, I would say we're not seeing any stress at the moment in -- certainly not in our book, and we're certainly not hearing it in terms of competitor portfolios. And I think what's interesting is that we've been through 9 consecutive interest rate rises. And one would expect in this type of environment that there is some element of distress that would come through. But so far, we're not seeing it. And so yes, so far, the answer is no to that aspect. In terms of the capital stack, I just think groups like ours are developing more of an ability to undertake unitranche financing. So the days of having highly structured transactions with senior mezzanine and preferred, whilst that's still going on to some extent, it's not as great as it was. If you sort of wind back 10 years ago, more at the inception of the industry. But these days, it's much more unitranche-type financing as a general comment.

Okay. Just on Slide 16, I'm just looking at the performance metrics on the right and just annualizing the base funds management fee. Just -- I'm assuming it's probably a little bit misleading just to sort of annualize that and come up with the sort of average fee because potentially, I'm thinking maybe there's some undrawn capital that's not generating a fee. But the question is, are you seeing any sort of -- is there any change in the mix in base management fee that we should be aware of as you sort of grow your FUM?

Yes. Thanks, Michael. Maybe I can take that question. So as we said, there was a large amount of deployment quite late in the half. So to your point, taking the half year, we would expect a stronger base management fee lift in the second half.

Your next question comes from Stuart McLean from Macquarie.

First question is just around guidance. Just noting the comments at the AGM around sort of prudent to maintain guidance back at the AGM, given the uncertain macro, we're now in 4 months on. I was just wondering if that comment still was relevant or any updated thoughts around that comment you made and reaffirming guidance today.

Thanks, Stuart. I think that it just is prudent of Qualitas to maintain its guidance given the environment that we're all facing into at the moment. I think it's fair to say we are -- take this in an orderly way. We're absolutely inundated with one of the strongest pipeline of opportunity that I think I've ever seen since we started the firm. And equally, we are seeing very large capital mandates looking to get set in the Australian marketplace at this point in time. And I'd also say we're seeing that at a level that I think it is quite unprecedented, certainly in the 15 years that we've started Qualitas. But I think you want to stay orderly in these markets and choose your transaction flow carefully. I don't think that this is a market environment where you would look to step out and chase a higher guidance at this particular point of time. So I think for really all of those reasons, lots of positive momentum in the business. But let's stay orderly and cool headed about the future outlook, we've landed on maintaining guidance.

Okay. And then the second one is maybe just leading to -- of some of your comments there around the pipeline. I appreciate that your build-to-rent and FUM has been started. But is there anything else on the horizon that you can talk to regarding new opportunities, please?

I think the main one that we're really focused on at the moment outside of the build-to-rent is really capitalizing on the private credit opportunity. From our point of view, we're very much a client-led investment firm, the client being the capital investor. And I want to say this in a balanced way, but we are seeing tremendous inbound inquiry from some of the globe's largest investors looking for Australian real estate private credit. And so I think for us, it's about going deeper on existing thematics, really capitalizing on the track record, the brand, just the tailwinds that the sector is being presented with at the moment. And so I think that in terms of general answer to your statement, I would say one should probably be expecting that future news is more about just further mandates on core areas of expertise at this point, which is really in that private credit sector. I hope that answers the question.

Yes. Next question, just with the warehousing yield of 9.9%, is that roughly what you're achieving across the book in terms of the returns to the unitholders there in the various funds. So you kind of implied 750 basis point spreads for BBSW. Is that what you're saying? And what are you expecting for that margin on a go-forward basis over the BBSW place.

Yes. So the short answer is correct what you just said. And -- we're mainly underwriting income credit transactions through the warehouse facility, as Philip noted, mainly in regards to both QRI and our senior debt funds. So they're both predominantly first mortgage income credit strategies. And that is generally where we're seeing the market at the moment. It's generally around that 500 to 650 basis point type margins over BBSW at the moment. So that's really coming through in that 9.9% or 10% return on our warehousing. I think that we're in an environment at the moment where there's less competition in the market. I think that alternative credit providers and capital allocated into real estate, we're just inundated with good opportunity, and we're spoiled for choice. It's not just Qualitas. I think the sector, when you go through these recalibrating times, the premium on moving capital increases and we're going through one of those periods at the moment. So I think -- this is a subjective statement. But I think one should expect risk premiums continue to move in our favor on a short- to medium-term outlook basis. I continue to hold a view that we're in an upward moving interest rate cycle where, again, our funds recalibrate every time the RBA moves it's official cash rate. And so I do believe that those sort of levels should be capable of being maintained, if not improved.

And just a final one, if I may. Just regarding -- I noticed that there's plenty of opportunities out there to deploy as well due to lack of competition. Just wondering how your risk assessment process is also maybe shifting as well given the potential stress out there for developers. And just comment on that risk assessment process, how that's evolving, that would be great.

Yes. Again, just to reiterate, we're not actually seeing any signs of distress. And I sort of say that as at 10:45 a.m. on Wednesday, the 22nd of February. But I do think that when you go through a series of interest rate rises, one has to be eyes wide open to the fact, and I don't need to tell you, [indiscernible] of all people. But asset prices do recalibrate with interest rate moves at the equity level. And so really, our extensive due diligence is really all about looking at the specific asset that we're taking security over and really saying how will that asset behave in a higher interest rate environment from a valuation point of view, but also an interest serviceability point of view as well. So I think it's extensive, our due diligence. I wouldn't necessarily say it's more extensive. I feel that one of the reasons why we've got a strong track record in private credit at Qualitas is because we've always had a very strong risk management process about what we do. But I think we are moving into a cycle where equity values are recalibrating on some transactions, you're pulling back your loan-to-value ratios at the moment as well. And really just looking at the sustainability of income as these rate rises start to take bite. And as I noted earlier, they do have a lag effect as well.

Your next question comes from Matt Nacard from EP.

Good morning, everyone. Obviously, really strong FUMs under management and committed results. Can we just understand whether the kind of percentage of invested FUMs committed is kind of generally in line with traditionally what Qualitas has achieved for the half?

Sure. Thanks, Matt. Yes, the answer is yes, it is still in line with our traditional gap between committed and invested.

Okay. Great. And just second question on the slide there, you talked about 40% kind of deployments occurred in December, obviously setting up a really strong second half. Just trying to understand, is that 40% of the $1.76 billion or is that 40% of kind of the incremental over and above the [ PCP ], just so I get that right?

Yes. Matt, that's 40% of the $1.76 billion.

Your next question comes from Oliver [ Collin ] from E&P Financial.

Yes, I may have missed when you addressed it, so I apologize in advance. But is there any color you can give us on performance fee recognition and/or I guess, the factors or the opportunity set in the second half? Obviously, it's come right back down in the first half, but the pool of unrecognized performance fees has lifted modestly apparently from FY '22 to the first half '23. Maybe a discussion as to what are the assuming factors for recognizing or not recognizing performance fees in the second half?

Sure. Thanks, Oliver. Look, the key recognition criteria now around our current fund centers, exit of the assets and the ultimate windup of the fund. So -- it is purely a timing question on those assets being realized out of the fund. And that will be the key determinant of the performance fee that we recognized in the second half and/or into FY '24.

And I guess the nature of those assets, are they kind of real assets or are they loans? Or is there a mix.

it's a mixture of both.

Yes. Okay. All right. No, that's appreciated. And then just on the co-invest income. I mean, it's obviously pleasing to see you've put the balance sheet to work at pretty accretive levels. Is there a view that, that kind of increases in the second half, I suppose, what was the average capital employed during the first half relative to where you think the second half will lie?

Good question, Oliver. And we do expect greater utilization in the second half than the first half as part of that same timing on deployment -- was later in the half. That will flow through into a stronger second half.

Okay. And then just a final one for me on Arch. I noticed you pulled back a little bit the deployments there. Is that a deliberate strategy on your part or just less demand from those smaller developers?

Well, I think it's just really reflecting competition in that sub $5 million market. So -- whereas at Qualitas as I noted, our average check size was $71 million ignoring the AURA transaction. Arch using that sort of less than $5 million transaction, and that is actually one area that the banks are particularly competitive on. We run quite a bank-like loan book in Arch. And really, what's happening there is that as the borrowers themselves gain track record, the banks are aggressively looking to effectively refinance those clients when their loans come up from maturity. So I think it really just reflects a net outflow relative to the gross inflows within Arch itself. And I think the positive of it is it shows what a great loan book it is and high quality that the banks do actively look at those types of loans as a feeding ground for their own loan books. That's the positive side. But the conclusion is it's a competitive segment of the market that it operates in.

Yes. Okay. And is there any forward indicators? I know you -- you said, overall, you're not seeing much signs of stress, but I guess some of those smaller players can have weaker or more lumpy kind of cash flows. Any signs of stress that you're seeing on the forward indicators in that book?

No, not really. So again, we risk rate that particular portfolio as well. And it's historically had very low levels of problem loans. And it's a business that we've now owned for probably about 13 or 14 years. I don't feel that there's been any marked change in the level of doubtful loans or problem loans in that particular portfolio. But it is a portfolio where you're dealing in average -- they're all first mortgages. You're dealing in average loan-to-valuation ratios of the mid-50% type level debt service cover ratios of 1.5 to 1.75x, and it's quite a bank like due diligence review of the various loans in that portfolio, which is actually why you're under sort of competition from the banks themselves in that type of portfolio. But so far, we're not seeing any significant change, deterioration in the loan portfolio and -- it's one that we'll continue to closely monitor but I do just highlight that -- it is relatively modest LVRs that sit within the Arch portfolio.

Your next question comes from Christopher Cahill from Quest Partners.

My question is in relation to Slide 15, corporate costs. Obviously, with the growth of the business, there's an escalation over the various 6-month periods here. But I wonder if you're getting closer to what I might call an equilibrium where you're establishing a cost base, I won't say, fixed cost base, but close to fixed cost base. And thus, you're able to leverage on the increased FUM that is approaching in the next few years?

Absolutely, and that is the case. We've established post listing an infrastructure, which is reflected in the cost base today. And we certainly see the ability to leverage off that going forward.

So Philip, is that growth is expected, the next half figure will be a bit higher, but these quantum fairly large percentage increases half-on-half, you must be getting to the point where the number of FTEs supports the profile of the business.

Yes. We would not expect the same growth in the second half that we've had in the first half. And just to reiterate, the comparison to December '21 half was pre-IPO. It's also COVID impacted. So we had -- there are higher costs associated with travel and other overheads, which you would expect in a normal operating environment.

Chris, the other point I would add to it is the business is growing, and our overheads will grow with the business it needs to, but it won't be linear. So as you're starting to see come through our operating margin, which was up 6% over corresponding period. We are now getting efficiency through the platform. So I would answer the question by saying, yes, we're going to have to continue to put on resources to match the opportunity. It's not just the fiduciary side of the business, but it's also responding to -- just to give you an example, the inbound inquiry that we're getting from international investors that require significant follow-up as each one approaches you or the investment team itself, who as I said, spoilt for choice on what is an excellent opportunity. So you should expect overheads to go up, but not in a linear fashion. And my expectation is that we should continue to see some earnings efficiency come through our margin, forward margin would be my personal view.

You have a follow-up question from Michael Peet from Goldman Sachs.

I just had a follow-up, sort of a higher level in the past, you've spoken about inorganic opportunities. Just wondering what you'd need to see in any opportunity or asset I guess, I'm picking at the business level, but I guess at the investment level as well to sort of pursue that opportunity?

Yes. I think there are 2 types of -- I'll broaden the question to M&A generally. And I think there are 2 types of M&A that Qualitas can look at. There's M&A that's strategic to the platform. And then there's M&A that's less strategic, it's more opportunistic. And I think we're set up for both. It's fair to say some of our very large institutional mandates have set to Qualitas that to the extent you can find and being hypothetical for the moment, but to the extent you can find good public to private transactions that's in your core expertise of real estate, then their investments that they are open to working with Qualitas on. And I would put that really in the opportunistic-type basket. I think that -- and again, you know this and the other analysts on the call know this as well as I do, that there's a lag effect between valuations, NTA and public market prices and a dislocation that occurs there. And it feels to me, to be frank, that we're a bit early in the cycle for that type of opportunity just at this particular point in time. But the second one, which I think is more the heart of your question is really around platform M&A. And for us to really consider inorganic growth at the platform level, it would need to be an opportunity that Qualitas could not otherwise build and access itself with existing resources. So it would need to be something that just brought forward a whole other strategy that was in line with our existing business, which is private credit for real assets. And it gave us a push in a direction that would just be too hard for us to otherwise organically build it. So that's how we think about it. And we're always -- we're always open to that type of opportunity. But I do want to just highlight that we're a busy organization, and we've got a lot of opportunity right in front of us at the moment. And there's a lot of things one can get distracted on. And I think just staying focused on what is absolutely in front of us and capitalizing on that is really where the main game is being played for us at the moment.

There are no further questions at this time. I'll now hand back to Mr. Schwartz for closing remarks.

Great. Thank you very much. I'd like to thank all the participants on the call for your continuing interest in Qualitas and also the very good questions that were asked through the Q&A. I'd also like to take the opportunity of thanking the entire Qualitas team for really what is very dedicated focus and work in really creating and strengthening this great organization. So thank you to the team, and I'll conclude the call at this point. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.