In this episode of the Invest Like A Billionaire, host Ben Fraser welcomes Nelson Chu, the Founder and CEO of Percent, to share his insights into the unique world of private credit. Nelson delves into the current state of credit markets, exploring the implications of potential down cycles and credit tightening. Listeners can expect to gain valuable insights into asset-based lending and the advantages of private credit. Join us for this episode as we gain valuable insights into private credit.
Connect with Nelson Chu on LinkedIn https://www.linkedin.com/in/nelson-chu/
Connect with Ben Fraser on LinkedIn https://www.linkedin.com/in/benwfraser/
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Transcription
Ben Fraser: Hello, Future Billionaires! Welcome back to another episode of our podcast. Today we brought on Nelson Chu, who’s the CEO of Percent.com, which is an online marketplace for debt investments. And if you’ve been listening to the podcast for a while, especially the past few months, we’ve been talking about the capital stack and understanding as an investor where you are in the capital stack, right?
And investing in debt. It’s something a lot of people haven’t thought about but it’s something that should be considered probably. And in this conversation we talk about the role of these non-bank lenders. And especially right now as credit is tightening from traditional banks the role that they play in helping keep our economy going and lending different businesses.
A whole host of other questions and thoughts. I think you’re really gonna appreciate this interview. And as always, when we have a guest on here that is potentially raising capital, we have to make the caveat and disclaimer that you need to do your own due diligence. We bring folks on our podcast that we think have an interesting story to tell, have something that we’re curious about, to talk about but does not, we’ve done any due diligence.
We’re not promoting them and that is the case in this interview. So do your all due diligence if you’re interested. And please enjoy this episode with Nelson Chu. This is the Invest Like a Billionaire podcast, where we uncover the alternative investments and strategies that billionaires use to grow wealth.
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We focus on macro driven alternative investments, so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. Welcome back to the podcast. I’m your host, Ben Fraser, and today we’re joined by Nelson Chu of Percent. Nelson, thanks for coming on.
Nelson Chu: Thanks for having me. It’s gonna be fun.
Ben Fraser: That’d be great. So those that aren’t familiar with Nelson, he is the c e o of Percent. Percent like the like the symbol and it’s pretty cool. They’re doing, they’re building a platform for borrowers and investors to invest in asset-based lending or private credit.
And been scaling quite a bit. So you guys have placed, I think it’s over $1 billion in capital through your platform, which is a nice big number. And especially right now it’s a really interesting time to be looking at credit, right as we’re entering into maybe a down cycle, maybe a credit tightening.
We’re already seeing that pretty aggressively in kind of the banking world. Private credit plays a very integral role in continuing to finance and capitalize businesses through all credit cycles. So Nelson, thanks so much for joining us. Give us a little bit of your background and how started this company and how you guys got to where you are today.
Nelson Chu: Yeah, absolutely. Since we are firmly in the capital market space, I’d be remiss if I didn’t have a little bit of a finance background. So yes, I do have a slight finance background. I started my career at Merrill Lynch. That kind of dates me in terms of how old I am. I was the last summer analyst class for Merri Lynch, so I’ll hold onto that badge of honor.
It became Bank of America after that. So I was on the business intelligence side for the wealth management business. And then, there’s a lot of rumblings of oh, sell side’s not as good as the buy side, as should join the buy side. So I was like, all right, fine. I will join the largest buy side shop on the street in BlackRock and I’ll see how it goes.
And so I was on the operations side for fixed income portfolio management, and I realized very quickly that the buy side is not better than the sell size. As a matter of fact, no side is good and I’m just gonna leave finance altogether. So I left finance about 20 12, 20 13 ish, around there, and I decided to do my own thing, right?
So the tech startup ecosystem was taking off in New York at the time, and I was stumbling around a little bit, trying to figure out what I wanted to be when I grew up. And what I ended up creating was really a strategy consulting firm that helped other founders build their startups on the ground up.
And so we built out a team of expert product managers, designers, engineers, et cetera. And gave these early stage founders everything they needed to be able to get off the ground essentially. And we had a really, couple really good case studies coming outta that as clients. Some of them became unicorns, which was fantastic, but that really got me thinking, right?
We have a team that knows how to build product. We have good access to VCs. I think we have good ideas. And so for the right idea, the right time, we should do something, the old-fashioned venture backed way. And that’s really how Percent came to be. So Percent really was. The initial incarnation of a confluence of different things going around in the FinTech space at the time, but really it was just seeing alternative investments just take off in 20 17, 20 18.
Yep. And we’re recording this on May 15th. We actually just celebrated our five year anniversary today as a company, which is lovely. Oh, cool. Yeah. But yeah, we saw the opportunity there to just build something that was honestly better for investors. Shorter duration, investments, lower minimum investments, comparable yielding investments focused on an asset class that we thought was poised to take off.
We were maybe four years ahead of our time in terms of the asset class POIs to take off, this is the year of private credit, that’s for sure. And excited to talk more about that. Yeah. Awesome.
Ben Fraser: Thanks for sharing that. I think, I’m probably a little biased towards the debt side of investing cuz that’s what we’ve been doing at our private equity firm, Aspen Funds for the past 10 years.
Buying discounted debt on mortgages and, as we’ve been doing this podcast and exploring, how do the ultra wealthy invest, what are they doing differently than maybe the average retail investor? One of the things that I’ve seen is, as you go up the scale of net worth or, portfolio that you’re investing and what we’ve seen in talking with some pretty big institutional investors, A lot of them think a little bit differently as far as risk mitigation, right?
They don’t wanna necessarily go and swing for the big home runs in every deal. They want to actually preserve portfolio becomes a bigger goal. And they start thinking a lot more about the capital stack, right? I’ve talked a lot about capital stack on. This podcast. And so basically, where are you in the priority of repayment?
If you know something doesn’t go right with whatever you’re investing in, right? Where are you in that stack, right? Are you first to get paid? Are you lost to get paid? And most investors, if they’re investing in these kind of private investment alternatives, most of them are investing in common equity, right?
Which generally has the most upside. There’s a lot of good deals. I love common equity. I love the big returns. But they’re also the last to get paid, right? So it’s important to have balance in your portfolio, not just putting all your eggs in the basket of common equity, so to speak, but spread it out across the capital stack.
And I think you’re alluding to, I want to hit in on, on, why now? Why does private credit make sense now? And we’re seeing. This economic cycle is starting to turn potentially as the banks are starting to tighten their underwriting standards. They’re not lending as much.
And that creates a big need, right? For these businesses that continue to have operational needs while they wanna continue to grow they need capital to do that, and banks aren’t doing that. So this is where this, market operates. And talk a little bit about what types of deals are you guys originally, what types of investments.
Are you guys making through the platform? And maybe differentiate too. Cause I think, when I first heard about Perent, I was initially thinking, oh, it’s another peer-to-peer lending kind of platform. Like we’ve heard of Lending Club and I forget the other ones that kind of really had a big heyday, maybe even eight or 10 years ago.
I forget when they really blew up. But this is different than that, right? This is not peer-to-peer landing. So talk a little bit about the types of deals that you’re doing and why now Makes sense.
Nelson Chu: Sure. And I think you, you did a great segue there into. Really the history of private credit gives us a guide as to where it’s headed, right?
Private credit has been around for decades at this point, but the reality is it really took until a global financial crisis for it to really come into the spotlight. And it came to the spotlight because the regulators came down hard on the banks to say, you know what? If you’re gonna do this type of lending for small businesses, for consumers, it’s gonna cost you a lot more.
The reserve requirements are a lot higher to be able to do that. And so naturally, post gfc. All these banks pulled back and they said, yeah, you know what? Not that interesting anymore. Don’t wanna do this. That’s what really led to the rise of non-bank lending, and you saw the likes of Lending Club come up as a result of that as well, which is much more on the peer-to-peer side, as you said.
Now we’re seeing the same story play out right now as well, right? You had a lot of banks that were in trouble, a lot of banking crises that have been happening, banks getting shuttered or going to receivership. All that is. What that means is in the next coming months, you’re gonna see the regulators once again cracked out on the banks the way they’re doing the lending practices.
This time SVB was firmly in the corporate debt venture debt space, right? I think you’re gonna see some rules come down around that as well. And so with that being said you’re gonna leave or there is a huge void in the market that these banks are leaving once again. Because there’s no money to support the ecosystem and the companies that desperate are looking for this.
So that’s really where we come in. And we are not a lender, right? We are a infrastructure provider for private credit. We help facilitate the transaction between the borrowers who need debt capital. The underwriters who actually structure these deals and their keyword there is structure, right?
So it’s not peer-to-peer lending and the investors who invest in these products that these underwriters are structuring. So looking back and breaking down the asset class into kind of its two component parts. You have the asset backside, which you alluded to, right? Which means that you’re essentially backing a portfolio of loans, for example, or portfolio is something that’s generating yield.
Or you go on the corporate debt side, which is literally just, you are advancing money to a company specifically. So our platform does do both. Historically, we started with the asset backside cuz it is a much harder transaction to do. You’re essentially structuring at the asset level and the underlying asset performance.
As well as the company itself and
Ben Fraser: like how it’s doing. And Nelson pause there and dig into what is asset-based lending, right? So we’re throwing a lot around a lot of terms that maybe Sure, sure. Lot of folks aren’t familiar with. So talk a little bit about what you’re lending against
Nelson Chu: on those.
Yeah, I’ll give examples. That’s probably the easiest way to do it. Think about the ones that people have probably interacted with the most. Buy now, pay later. I think we’re seeing various sort of shades of what’s gonna happen to B MPL L over the next few months. But at the very least, it is something that was very popular and has consistently been very popular.
So you as a consumer take out a buy now pay later loan. Effectively, you are one of like tens of thousands of people that did it with this lender, right? Could be a firm back in the day. Could be any of these guys. Now a firm has zero interests in selling this loan individually, one by one to somebody, right?
They’d rather actually take the entire pool of loans that they have across 10,000 different consumers who are borrowing from them and say, yeah, can somebody take over this position? And essentially, Give me capital to be able to finance these loans that I’m making. And so they’re gonna be basically what’s called securitizing the loans themselves creating a structure around it to be able to protect the investor who wants to give them the money to finance this low portfolio.
So when you say asset backed or asset based, It literally is there are assets underneath there that you’re pulling together that are designed to generate yields effectively. So it ex encompasses things like consumer loans, like buy, not pay later. Small business loans. Same concept, right? It’s just for business, small business versus consumer.
You have like equipment leasing, you have factoring invoices, you have litigation finance, like the list goes on and the reality is, Most individuals and investors may not know what private credit is, but they probably interacted with a private credit product in one way, shape, or form. They just didn’t really realize it.
Ben Fraser: Got it. So on the consumer side of things, you have kind of two broad categories, right? You have commercial, you have consumers, so consumer, it’s the buy now pay later, and you’re taking out those loans and we’ve all seen those like, Hey, you don’t wanna pay this all right now, you can spread it out.
Or we’re, yeah,
Nelson Chu: there’s also earned wage access as well, right? So being able to basically advance a paycheck. So those are all things that are. If it didn’t come from a bank which doesn’t have a, which has a balance sheet to be able to lend against, then it’s probably a non-bank lender. And if it’s a non-bank lender, then they’re definitely firmly in the private credit space looking for debt capital to finance this portfolio loans that they have.
Got it. And so
Ben Fraser: What’s the asset and that scenario on a consumer loan, the asset is just a person sign on it and you can go after them in a collection scenario. If they don’t if they don’t
Nelson Chu: pay. So the lender, the non-bank lender would do that, right? That’s their job effectively to essentially underwrite a specific consumer feel, whether they’re credit worthy or not.
And then if they don’t pay, then it’s on them to be able to chase. Our job is to be able to essentially take not just that one consumer, but the tens of thousands of consumers that non-bank lender has and the loans that they have out there, and essentially leverage our platform and our technology to create essentially an investible product off of that.
So let’s, just as a hypothetical let’s say the, this is very basic. We do a lot more than this, but let’s say there’s a loan pool of like 10 million, right? And historically the loan portfolio defaults like oh, 10%, something like that. Then in that scenario, realistically we as a capital infrastructure solution would never create a structure that gives them more money than 90% of the loan portfolio, cuz 10% defaults, right?
So theoretical will probably give them 85%, and that’s called an advanced rate. Essentially, there’s a, there’s about 52 different attributes that we play with as a technology provider to give these underwriters the tools. To be able to kinda adjust the structure in a way that protects the investors for investing in these products.
Ben Fraser: Okay. And then on the commercial side, you mentioned factoring, invoicing, there’s a lot of kind of providers around this side as well. So I come from a commercial banking background and it’s, I have mixed feelings about this because a lot of times they see these like small businesses get into these kind of merchant capital type products.
And it sometimes borderlines along predatory versus now you get a small business owner that needs to make payroll and they’re, maybe you have a gap between the receivables and the payables, right? So how much they owe now for payroll versus the, receivables that they got coming in from future sales.
And so they make a bridge loan, but they only get a certain amount of that future ar the future accounts receivable. They’re giving up a hundred percent of it to whoever’s doing it. So it effectively becomes a pretty high effective interest rate. And you can get into this negative spiral where it’s difficult to get out of it.
But at the same time, it’s also, coming from working with a lot of small businesses, cash flow is the lifeblood of small business. And actually, I forget the stat exactly when I was in banking, but it was something like, I think it was over two thirds of businesses. Don’t go out of business because of lack of customers.
It’s actually a lack of managing cash flow. So basically they have the customers coming in, but they can’t meet the difference between when they have to make payroll or send funds out versus, because when the funds are coming in, and that actually causes a lot of business to go out of business.
So there, there’s a real true need for it. I talk about that space a little bit of how does, how do you guys look at that space? Especially now I would imagine. With the banks, pulling back, advance rates, pulling back, lending, these businesses still need to operate, they still need these kind of services.
So there’s actually a pretty big gap to fill. Talk about that, the commercial side a little bit.
Nelson Chu: Yeah, it’s important. And you brought up a good point as well, right? The truth is the actual, if you were to normalize the a p y out to a full year, yes, it probably is a little bit expensive, but most of these situations are like 30 day loans or 60 day loans, right?
So the actual impact is significantly less. But it’s also an opportunity cuz if you play that example forward, let’s say, there is a, let’s say there’s a granola bar manufacturing company, right? Something like that. Like that’s what they do. Let’s say they can invoice from Whole Foods for a million dollars that they want to get an inventory right?
The reality is that Granola Bar company does not have the $700,000 it’s probably gonna take to create that product and give it to Whole Foods, right? So this is essentially an opportunity for them to actually create the product because they’re taking a, they’re factoring the invoice. It’s a real purchase order, right?
They’re creating the product and then they’re gonna be able to sell it, and they’ll lose a little bit. But this is revenue they would’ve never been able to generate on their own because they would have just normally throw the PO away, basically. Because it’s I would never be able to create this.
So this really private credit as an asset class kind of helps. Keep the economy going. It’s the real economy. It’s not the, the one on the public stock markets. This is the one that actually powers the real engine o of the US ecosystem. So in to that end I think private credit is a necessity and it’s something that actually is primed to take off in this environment.
Like you mentioned because the banks have stepped back, there were definitely. Back in the day, at least banks that could factor, right? Banks that could do regular small business lending, they’re just not doing it anymore. And in a tight credit environment like this these companies need the capital now more than ever.
And it’s made a lot of tailwinds for us as a company to be able to support that. Even unlike, for example, like the SVB situation, right? That weekend we had several hundred startups reach out to us saying they need bridge financing, they need senior secure terminal financing. Sure. They gotta make payroll, right?
And the reality is, No bank is gonna step in over a weekend and help you with that, at the very least, right? We had dozens of underwriters that were ready to go. We had dozens of investors that wanna support the ecosystem. By the end of that weekend, before the Treasury Department probably literally bailed out the global banking system we had, do about two dozens of startups.
Was about 50 million in capital ready to go by Monday morning if no, nothing came through, right? And There is no world where any of the outside of private credit will be able to support that type of activity over the course of 36 48 hours. And that’s a testament to the power of the asset class and also the power of what we’ve built as a technology solution to be able to move that quickly.
Ben Fraser: Yeah, absolutely. That, that, that’s super helpful to lay in the landscape there. And just one other quick question on these asset baselines with on the commercial side. Are these generally secured loans or are they unsecured?
Nelson Chu: Usually they’re secured loans. Yeah. We always do it on our side.
There’s no unsecured loans on the platform itself. That’s part of the requirements. Okay. Very cool.
Ben Fraser: And then shifting to the corporate desk we’re talking about svb, Silicon Valley Bank. Obviously, if you haven’t been watching the news, what was the, how out there, what the. Fifth largest bank to ever fail, or second largest bank to ever
Nelson Chu: fail.
Some, something like that. Yeah. Yeah. But they left a $6.7 billion hole in the venture debt ecosystem. So there’s that.
Ben Fraser: So talk about what venture debt is, right? Because this is an area that, I was newer to coming from the commercial banking side of things. But an area is very, been very fascinating to learn about and and very attractive actually from an investment standpoint.
But all of a sudden in svb, they were the 800 pound gorilla in this space. They owned, probably 80% of the market, or something close to that. And now they’re just gone. And to your point, these are venture backed companies. These are bootstrap companies that are the lifeblood of our economy because two thirds of our employment is produced by small businesses.
It’s not just the big. Apples and Amazons of the world that keep the economy going. It’s mostly small businesses, mostly, entrepreneurs and small businesses. And if they don’t have the capital that they have access to that they expect and are building their businesses on, that’s very damaging, right to the lifeblood of of our economy.
So talk about that whole world a little bit cuz that’s a really interesting thing that’s happening there and. I’m sure folks like you are excited, right? Cuz it creates opportunity when this huge player now creates this big vacuum.
Nelson Chu: It does for sure. It’s venture debt is just honestly a subset of corporate debt, right?
It’s like very simple. So you’re literally just essentially providing capital to a single borrower. It could be, it’s probably a company. There are EBITDA profitable companies, in which case you’re literally just. Loaning them money to be able to actually, based on their existing cash flows, expect that they can support the loan that you’ve given them.
The interest is not too crazy, and it’s just more for them to be able to grow. For venture debt, it is the smallest side corporate debt, right? So it is gonna be, Earlier stage companies, probably not EBITDA profitable or positive, but you’re betting on the fact that they have great investors, they have a business that will be able to scale, they’ll be able to raise more money, and that’s the bet you’re willing to make.
So yeah the A P Y that you’d be doing for venture debt, Is likely significantly higher than somebody who’s EBITDA positive, right? It just naturally makes sense. Now, venture debt, prior to all this going on and prior to the Fed raising rates, prior to the current environment that we’re in for just venture equity in general used to be much more opportunistic.
It was essentially, oh, I raised a great big equity round. Why don’t I tack on some more venture debt to be able to just extend my runway without being too dilutive? And look, I’m so flush with cash. The interest doesn’t really matter to me, right? So non-dilutive, A little top up over their existing equity raise.
But that all changed in 2022, right when the venture equity market dried up. You had so many of these companies, which were reach, reaching the tail end of their runway and realizing that, geez, like we’re not gonna make it unless we get more capital into the door. And I think most of these venture debt lenders, including svb are not in the business of saving and salvaging companies.
But they are in the business of trying to find diamonds in the rough and be able to pick the ones that they think will be able to succeed and survive and raise another round of equity financing. I think we’ve seen. A ton of demand for venture debt coming through. But the quality is like all over the spectrum, right?
Sure. You have definitely companies that are probably on the last two months of life. And to be perfectly frank, I wish they had reached out when they had six months of life left or nine months of life left. That would’ve been very nice. We probably could help them but the ones who are, in a good cast position, but realize that this may take longer than they expect.
The next round may not be as fast as they think. Then if that’s the point, they’re still well capitalized. They’re worthy of taking on more venture debt just to be able to kinda survive and weather whatever comes their way. So we’re seeing a lot of the underwriters in the ecosystem just say they’re inundated with deal flow, but it’s just hard to pick and choose your battles in that instance, because there is a lot of, I would say, more distressed deal flow coming their way than ever before.
Ben Fraser: I think this is a good segue too. We’ve been talking about kind of the ecosystem of why this makes sense, from a borrower’s perspective, taking out these loans. Let’s shift to the investor side of things, right? So how should an investor be thinking about this, right? In my mind, this is, these are little me riskier loans than maybe if you’re investing in debt that’s secured by real estate or something, obviously, right?
It has a hard asset that has a, more fixed value. But at the same time, you’re also maybe a little bit less risk than you’re talking about common equity position in, venture capitalized firm or even, a heavy value add real estate project or something. There’s it’s kind of risk reward raise levels.
There, there’s levels, right? And so talk about it from an investor’s standpoint. A risk in this scenario, right? This is different than a lot of our investors say real estate investors predominantly. And you understand the asset, the location, the rents, the market, but these are businesses.
This is different than just real estate. So how do you quantify the risks in the business and how do you mitigate a lot of that from an investor’s standpoint?
Nelson Chu: Sure. Absolutely. And I will say the one caveat is, Real estate’s looking a little shaky right now too as well for sure. Given everything going on, especially c r e, right?
That, that day of reckoning will come given this concept of work from home is probably here to stay not fully, when you have occupancy rates under 50%, 40%, that’s gonna put a lot of stress. On the banking system as well, since a lot of them are the ones holding a lot of these loans.
So And you’re referencing the office? Yes. Senior East side. Yes. But yeah,
Ben Fraser: that definitely gonna be some major turbulence
Nelson Chu: there. Yes. And so we’ll see how that, that, how that goes. But to your point common equity is the lowest on the cap stack. It’s gonna be the last to get paid.
Private credit tends to be either in the senior position or in the junior position. If you’re a senior, then you just get paid faster, right? But you’re also gonna get a lower rate inevitably from an a p y standpoint, if you’re junior, you’re taking on higher risk. Senior has to get paid first before you get paid.
And so you take on more a p y cuz you want that kind of extra juice essentially. Now when you think about what’s going on in private credit and why it’s so interesting right now, it’s really because the rates are where they are, right? So public credit or public market fixed income tends to have much longer durations.
These are companies that most of them probably took advantage of. The low rate environment took on a ton of debt, but it’s. They’re paying like two to 3% in investment grade interest, right? So they can let that ride all day every day. There is zero reason for them to come back out right now and refinance, and so you’re just not seeing a lot of activity on that side to even be able to invest in it.
On the private debt side, the durations are significantly shorter. These aren’t 25, 30 year maturities, right? These are like three year maturities with built-in structures that force them to come back out to market. So when you do that, you’re effectively, it’s not floating rate, but it’s close, right?
You’re seeing realtime reactions to the fed, to the market and things like that’s causing it to all kind of change. So when you think about it the Fed funds rate, is where it is today. Private credit on average, this is just a literal general average. Don’t take my word for it, but it is about 10% higher than the fed funds rate on average, right?
And so that’s the risk premium that investors feel they deserve to be able to be compensated for the risk they’re taking in this environment. For private credit. That’s not bad in this environment where that means you’re tracking 15, 16, 70% right now in this market. I most people would probably take that in the grand scheme of things.
Yeah. That,
Ben Fraser: that’s what a lot of equity investors were happy to make, thanks On on the other side of it. Yeah,
Nelson Chu: exactly. Exactly. So again, does not come without risks though, right? Like in the event of a default? There is a usually somewhat lengthy, depending on how it defaulted workout process to try and get the money back.
There’s like legal that gets involved. There’s bankruptcy court that sometimes get involved. It can get messy, right? And so you have to make sure that you’re partnered up with the right group to be able to facilitate that recovery and workout process. We’ve gone through ourselves a few times.
We have, the ability, and we’ve had instances recently where the workout actually worked out very well. And so it is part and parcel with what you get when you’re in private markets versus public markets, which are effectively liquid in the grand scheme of things. But to your question around how do you protect investors and mitigate risk, it is what I was mentioning earlier around, if the portfolio of loans defaults 10%, just don’t ever give them 95%.
That’s just a very bad idea. So those levers that we have at our disposal, it’s part of our infrastructure package, right? We have all these different underwriters who can take advantage of all those attributes, the levers they can pull up, down, left, right? To be able to create a structure they think based on historical performance will protect investors the best they can.
And so versus I would say common equity. If you’re investing equity in a startup, for example, you’re just, praying it goes well and hopefully it goes well, but you’re expecting a bunch of zeros in your portfolio. Inevitably. That’s just what happens. That’s the risk that you take with the debt side.
If you structure the risk away and you structure it properly, you should have a fairly decently performing portfolio in good times and bad. Yeah, that, that makes
Ben Fraser: sense. And I think, coming again from a banking background, defaults were the ultimate dirty word, right? You didn’t want to have any defaults.
And as we’ve shifted, I’m on the private equity side, buying distress debt a lot of times. That’s expected. And a lot of times we’re actually buying non-performing loans, but you buy ’em at enough of a discount to where you can, you liked it. We love it. We project a certain level of probabilities of what is our exit gonna be, and what, if they reinstate, et cetera, et cetera.
And we expect, a certain level of default, but we’re underwriting to a much more conservative number that we would never come close to. So it’s all about, you gotta take it all in context, right? What’s your risk? Adjusted return, right? I always like to bring investors back to understand what the returns you’re getting, adjusted by the risk you’re taking.
And if you’re earning a 15 or 16% yield and you’re, in the secured debt position, that’s a pretty good trade off. And obviously, If def if we go into an a downing economic cycle and businesses start going out of business and higher unemployment and, these interest rates if they still hire longer, it’s gonna create some more turmoil.
So probably expect a higher default rate, but in a portfolio situation. You can mitigate a lot of that.
Nelson Chu: And the yield to go up in that instance. So then you’re getting paid 1920 if that’s the case, when you see that level of performance. So it is all upsetting. But to your point, this is just portfolio construction theory at the end of the day, right?
Yeah. Like in this instance, in the same way that let’s say you have 5 million to invest some people would put 5 million on Tesla, right? For sure. Would that, is that a recommended strategy? Probably not. And so they’re gonna want to diversify across 10, 15 different positions, and that’ll give them the kind of wait, waited, adjusted return that they probably expected.
A little bit of apple, a little bit of Amazon, a little bit of, yeah. Something in the Dow, things like that. In the same way here in private credit, if you have $5 million, you dump it all into one position. That’s. Probably not the right idea. So even for us, we know that. And so we actually offer investors the ability to invest in what’s called our blended notes.
And the blended notes give them essentially the ability to choose based on theme, whether it’s high yield only, so high risk US only senior positions only, whatever it may be, or total market. And they invest a little bit in every position. It’s a one-time investment to get 15, 20 different borrowers, different deals inside that.
And The yield is lower, but it, again, it’s the more diversified position you’d probably want in private credits. Begining with. Yeah.
Ben Fraser: How have you guys stressed, the default rate? So obviously if you’re expecting a 10% default rate, that’s the long term average. That’s get an ebb and flow, right?
It may accordion up to 20% or more, in a down economy how do you think about that right? When you’re Because the long-term averages can be deceiving when you have shorts.
Nelson Chu: We had Covid where literally you had companies that had never defaulted in a life and that just had no cash flows, and they just all wanted to default.
And so you don’t. Think and factor in those types of standard deviations cuz it’s just has never happened before. So just to be clear, that 10% obviously was just an example. Our platform default rates under 2%. We’ve weathered covid, we’ve weathered high rates, we’ve weathered a war, we’ve it’s been, there’s been a lot going on the last couple of years.
And so that has been, I think something that we’re pretty proud of. But having said that, there are plenty of borrowers on the platform who have loan portfolio default rates closer to 10%. But that’s okay. That’s totally okay because you can structure around that if you know that. And at the same time, because this is private credit, you also can generally see it coming from a mile away.
So we actually provide weekly reporting for all of our borrowers. And so investors who make that investment can see the underlying asset performance. Let’s say there’s a thousand loans in that portfolio, they can see how it’s doing. And if it’s starting to see, oh, this like default rate is ticking up, there’s like more da there’s more loans that are delinquent, like there’s something going on here.
The reality is that. Investment is probably gonna come due in the next, call it two months, three months, or something like that. And at that point, if that performance persists, rate’s gonna go up, structure’s gonna be more tight. Like all these things you’re gonna be able to do, to be able to almost like structure a way, that new risk that has come into the market based upon what you’re seeing, the underlying asset performance.
That’s the beauty of private credit, public debt, like. Good luck. You’re sitting on that for another couple years. But again, these are Fortune 50 companies. Generally, it’s probably fine, but still it’s not gonna be without stress on the public debt markets too in the coming months. Yeah.
Ben Fraser: What would you say is different about the types of products in portfolios you’re putting out there versus, the CDOs that were being promoted, before the great financial crisis, right?
Where they’re bringing all these collateralized debt obligations out to the market and creating tranches of these. Subprime mortgages and ultimately there’s a lot of, players at fault there, right? The radio radios, agencies weren’t accurately reflecting the risk.
But I think it left a very bad taste in investor’s mouths, right? Of well, that’s what caused this whole, huge, pretty severe recession is these kind of collateralized loans. And so how do you guys think you’re different than that? And how is this different if it is at all?
Nelson Chu: Yeah, it’s a great point.
I think this is actually in hindsight, the benefit of technology at this point. We are, you call it 15 years post that. And when you look at what’s out there today versus what was there back then from a tech standpoint, The reporting itself was so delayed, like you were shopping Excel spreadsheets back and forth.
You just didn’t have consistency, reliability, and even trust in the data that was coming out. And so your reaction time was significantly slower as a result of that. These days, with all the infrastructure that’s been built on the FinTech side, You can get effectively quasi realtime reporting if you really want to.
And so when you see this type of change is happening, if you see homeowners start to wanna not pay or whatever it may be like that inevitably is going to put you in a situation where you’re gonna be able to actually take advantage of, you’ll be able to seize the assets. You’ll do a lot of different things that just weren’t quite available back then because you were 45 days behind on what was going on.
And so that has changed the way we do things. On top of that I think there is just much more illegal frameworks here in place to be able to better protect both the investor and also better create a better product. Be perfectly frank. The ability to now actually confirm that there’s no like double commitments on the assets, right?
You can’t have a borrower commit and pledge these assets to that guy, but pledge those assets to the same guy somewhere else, right? You can’t do that anymore, and you can see that when that happens. There was definitely, I would imagine a ton of that going around in Oh and everyone just wanted to make money, right?
So I think 15 years of regulatory overhauls, 15 years of technology enhancements just in general have made this a better product. And the reality is the ability for that to happen again in the way it didn’t, oh eight probably just likely is much more difficult based on what’s been changed in that timeframe.
So it’s just time, honestly, for better or worse,
Ben Fraser: it makes sense. There’s a whole cottage farm of. Derivatives and everything else does create off these kind of based products. And you’re trading on who knows what you even own at this point. And I’d imagine in this, you, you’re not, investors aren’t investing in any type of derivative, you’re investing in the actual promissory notes that
Nelson Chu: Exactly. The actual assets Yeah. And the interests coming out. The assets.
Ben Fraser: Yeah. So talk about your model a little bit. So you’re a platform model. You’re not, taking you investors wouldn’t invest into your fund, but you’re investing directly with.
The providers of these loans. Talk, talk a little bit about the model.
Nelson Chu: Yeah. Yeah. This goes back into more of the history of the company. So at its core, the reason why we are venture backed and a tech company is because we’ve built capital markets infrastructure for private credit. So that means that everything from sourcing a deal to structuring something that’s investible, to syndicating out to an investor base, to the closing, post-close surveillance, monitoring, and servicing of that deal, that’s what we’re known for.
That’s what we actually do as a company. To get here though, has been an exercise in, I think resilience and futility, depending on what day you asked me. But the reality is we spent four years learning how to do these deals by underwriting deals ourselves, playing that role of that intermediary between the borrower and the investor and learning what it takes, right?
So fast forward to what you had mentioned earlier, over a billion dollars in deal flow. We did over 400 deals. We learned a lot about What is the market standard we can set in terms of a structure that everybody can use to make it that much more efficient? What is the data standard around reporting?
To be able to actually give investors confidence that after they make an investment, they understand what’s going on and what are the pain points and value props that the borrower feels, the underwriter feels and the investor feels. Those are all learnings that were used to be able to get to where we are today.
So historically, we underwrote all the deals. Investors could invest in it, and that was all good. These days because we’re much more of a technology solution and a platform, we actually don’t underwrite deals anymore for any kind of new borrowers coming to market. We have no shortage of underwriters who are, some of ’em are pretty well known, some of them less well known but they all have experience in the space.
They are private credit experts. At the end of the day, they’re bringing positions to market from borrowers that they may know, borrowers that they’re picking up from us and be able to actually leverage their skillset, expertise, and our technology to bring products out to market and get investors to invest in it.
So it is a, I would say a shift in our business model. Into what it is today. But it took four years to be able to get here. But now we’re pretty proud of sort of the scalability that we offer. And at the end of the day, for investors, the name of the game is really not every product on our platform is for you, like you should.
We do have, I think one guy who invested $500 in every single deal we ever came out with, which is. Definitely one strategy. But the reality is you should pick and choose the one that’s suited for you. And our job is to give you as much disclosure, transparency and tooling to be able to make that decision for yourself to be able to do that portfolio construction theory we were talking about earlier.
Got it. So do
Ben Fraser: you guys service all the loans in the portfolio or no.
Nelson Chu: We don’t service the loans cuz otherwise these non-bank lenders wouldn’t need to exist. Cuz we should just be the non-bank lender. But no, so the non-bank lenders are the ones who actually service the deal, the loans themselves. And then we service the actual investment product itself.
So all the cash flows, distributions, things like that come out of it, we’re the ones that facilitate, manage all that and have it go out to investors and vice versa. And the reporting, I’m assuming between borrower and all that? Yep. Yeah. Yeah. So we have an entire borrower portal that they can use to be able to provide us the information.
We standardize it and normalize it, ingest it, and then spit out the reporting on a weekly basis for investors to take a look at. Got it.
Ben Fraser: And then is this for accredited investors only or is this or reggae or?
Nelson Chu: Yeah, this is for accredit investors only. Reg D private placements kind of pretty standard.
I think the amount of work that would required to get reggae or Reg CF going was just way too much in terms of what we are offering. So we haven’t been able to do that at the moment. Having said that, the accredited investor rules have gotten a little bit more lax over time, like the s e C has.
Recognize that there’s ways to, if you are just well educated on the the markets, then you should be able to invest, right? So you can get serious licensed and then you can now invest in these products, right? Those are things that just were not available before, and that does open up the accredited investor market to be significantly larger than it used to be.
Yeah, absolutely.
Ben Fraser: Awesome. What’s the best way for folks to check out more what you guys are doing?
Nelson Chu: Yeah. So you said we are Percent the the icon or the logo We’re also Percent.com, so that’s not bad. So very easy to find us. Definitely take a look. We have no shortage of resources, no shortage of reports that we push out.
I think the reality is it’s one of those things that you just gotta get educated and learn more. But we’re. Trying to provide as much information as possible. And it’s also free to sign up. And so you can literally just sign up, take a look at all the deals we have, take a long look at all the reporting that we have, get comfortable with it, and the minimums.
A lot of these deals are actually $500. And so it’s a bit of a, try before you buy mentality. It won’t hurt you. Definitely encourage people to take a look and I’m always around if they wanna ask questions. Our client solutions team is always around to be able to answer any questions as well.
So feel free to reach out to us. Is there anything you wanna learn more about? Awesome. Thanks
Ben Fraser: so much, Nelson, for coming on and sharing about this market. Very cool stuff.
Nelson Chu: Thanks for having me.
