Episode 13 Show Notes
With interest rates near 0% these days and the stock market experiencing large swings in value, private credit is an asset class getting increased attention. In today’s episode, we speak to Colin Kilgour of Kilgour Williams Capital. Colin is the manager of the firm Kiwi Private Credit Fund, and he shares his knowledge of the private credit market, and in particular the marketplace lending niche within private credit. This area of private credit is less competitive, fast-growing, and can present very attractive risk-reward opportunities with income.
Key Points of this Episode:
- Colin’s investment background and how he developed his expertise in private credit investing
- Defining private credit and comparing it to publicly traded debt.
- Discussing the marketplace lending niche within private credit and how this is a new and evolving industry
- How marketplace lending opportunities can present very attractive risk/return profiles
- Why there is less competition in marketplace lending and why banks are not involved
- What types of borrowers access the marketplace lending platforms, and where the opportunities exist
- How Colin performs deep due diligence on both the lending platforms and loans to spot the right opportunities
- The effects of COVID on the asset class
- The importance of diversification in private credit
- Short duration investments and how that can insulate a portfolio from interest rate risk
- Other important trends and opportunities to watch for!
[INTERVIEW]
Hi, this is Andrew from Pitchboard. I had a great conversation with Colin Kilgour of Kilgour Williams Capital. He talked about the attractiveness of private credit and how fintech lending platforms have changed the game. I think you’ll enjoy our chat.
Hi, this is Andrew from Pitchboard, and I have the pleasure to introduce our listeners to Colin Kilgour of Kilgour Williams Capital.
Colin is a portfolio manager of the firm Kiwi Private Credit fund. He’s been active in the credit and structured finance market on a continuous basis since 2001. We’re very excited to hear some of his wisdom today, so with that welcome Colin, it’s great to have you on the podcast.
{01:36} Colin Kilgour
Thankyou for having me, it’s great to be here
{01:38} Andrew
Do you want to give our listeners a sense of your background? I gave a very quick synopsis there, but I think you probably know it better in a lot more detail.
{01:48} Colin Kilgour
Sure, my name is Colin Kilgour. I am one of the portfolio managers and a principal of Kilgour Williams Capital. We are a Toronto based credit investment management firm and while we are based in Toronto, Canada our investment fund, Kiwi Private Credit fund is invested in US based marketplace originated loans.
So, we invest in the Fintech space as Andrew mentioned, I have been in the credit space for about 20 years now as my partner Daniel Williams all over the map. We have a pre-fiscal crisis. I was involved in structured credit and the asset backed commercial paper world and when our firm was founded in 2007 it was really on the back of the global financial crisis, and we spent the early parts of our lives with Kilgour Williams.
Advising folks were stuck for lack of a better word with some of the various toxic assets that came out of that. So, we have been inside the bellies of the beast, but a lot of time in credit, and in 2017 we launched Kiwi Private Credit Fund, which is a marketplace lending fund.
{02:53} Andrew
How did you develop your expertise in private credit and what drew you to private credit? Really, it is the culmination of that 20 years of experience in this space, so in my previous business we provided working capital facilities to medium sized companies, and we did that.
We funded that with the securitization vehicle so that got us into credits. There was a credit analysis associate.
With, you know, looking at trade receivables, and providing a credit against that, my partner had been more in the corporate credit world, and he had been ahead of credit portfolio management at a large Canadian bank that led us into the structured credit world. You know, the wake of the credit crisis and then spending about 10 years, really digging through some of these very very toxic and complicated structured products led us to cut something which is really on the other side of that which is the marketplace lending model, which is very simple.
It has a lot of benefits that we didn’t see in the previous structured credit world prior to the financial crisis, so we looked at assets that are easy to understand.
Basic loans you lend out money. You make a good loan; you get paid back. Some of your principal and some interest on top of that, and that is profitable. It is easy to understand. It didn’t have systematic leverage.
That we saw it, you know, back in the global financial crisis, it is transparent, meaning there is lots of data available. You know what you own, you can understand the risks of what you are investing in. It was and remains a very attractive asset class for those reasons.
{04:24} Andrew
I think it might be helpful to just give it a quick definition of exactly what private credit is, opposed to, you know we are not just talking about credit in general, right? It is different from publicly traded debt, right?
{04:37} Colin Kilgour
So private credit very broadly defined is, a loan which is advanced to borrower where the lender is not a traditional bank, so it could be a specialty lender, it could be from an asset-based lender.
It could be from an investment fund.
You know the lender could be anything, but the broad definition is anything other than a bank. More specifically, we work in the marketplace lending community, which is a particular niche within private credit and all the lenders we work with.
Typically, are Fintech players who are specialized in online lending and we are in behind them, funding and buying loans.
{05:15} Andrew
How does that work? Who or what responsibilities do they have? What responsibilities or what is your role in the process?
{05:24} Colin Kilgour
The marketplace model is very interesting, and it really opens up attractive asset classes. Previously, unless you ran a lending business, you would not have been able to invest in. And we are talking about things like consumer loans and small business loans primarily.
There is a variety of different asset lending asset classes that have been opened by this. And the way it works and what may season asset class accessible is the marketplace lending model has bifurcated the kind of the traditional banking credit model, into its constituent parts, so these marketplace lending platforms or fintech lenders if you, if you wish, you know they specialize in in marketing loans they underwrite loans they do fraud checks.
They will be risk assessments, but price, the loans they will service the loans and do all the collections. But what they do not have is they do not have the balance sheet or the capital to provide the loans. And that’s where investors like us come in.
We do not have the capacity to do all those things that I just mentioned, but we do have the capacity to fund loans, evaluate loans and add them to a credit portfolio and manage a credit portfolio. We provide the capital, and we take the credit risk, and we get paid for taking the credit risk, whereas the marketplace lending platforms originate the loans.
They get paid typically by the borrower for originating loans and their service loans and they get paid by us or by our vehicle for servicing the loans on our behalf, so we are not getting involved in collections. We are not chasing delinquent accounts. They have teams of people who do that, and they have the technology in place to do that. Whereas we take the credit risk, we get paid for taking the credit risk and our Investors benefit from that.
{07:01} Andrew
And so, is this basically splitting up what a bank would traditionally do on its own right, that the bank would provide the balance sheet and they would be responsible for the operational elements of it, right? But and here you are, splitting that up into, you provide the capital, they do the fintech company. They are doing the operational aspect right?
{07:22} Colin Kilgour
Absolutely, and what that does is it really makes these asset classes investable for you. You Know whether it’s an accredited investor or an institution. But unless you wanted to actually set up your own brick and mortar lending business and hire staff and all, I can say you really couldn’t get access to these asset classes. Which are typically high yielding asset classes that are generating attractive risk adjusted yields. So you couldn’t get access prior to that. Now you can.
As an investor, you can work with… you could do it directly, you can actually go on to some of these platforms yourselves as a retail investor; set up an account and invest your own money. You can do it through a fund vehicle like ours, or there are some institutions that are doing it as well.
{08:07} Andrew
And so, who are your competitors in these marketplace loans?
{08:10} Colin Kilgour
Do you mean competitors in terms of competing for investment or competing for loans? ’cause there’s kind of variety of.
{08:14} Andrew
Sorry, competing for investment.
{08:16} Colin Kilgour
There are several investment funds, so we are the only fund in Canada that has pursuing this direct strategy, specifically in the United States there are somewhere between 15 and 20 other funds that we’re aware of that are pursuing a similar strategy, it’s a big space.
It is a rapidly growing space, so I do not know that we would necessarily consider them competitors, but certainly peers and folks that we look to it ranges from the large institutions so, Morgan Stanley has a fund in this space. Two more specialty providers that we see in places like California and the like Work for Fintech has really been strong. It is all over the map.
The some of the funds range, you know there are over 2 or $3 billion and then some are smaller, you know, and we are at the smaller end right now. But we are aspiring to be at that higher end.
{09:13} Andrew
And what would You say is, I think you may have answered this a bit already, but what would you say is the investment case for private credit?
{09:20} Colin Kilgour
It’s really an opportunity to get overpaid for credit risk that you’re taking. So It’s attractive risk adjusted yield. It’s avoiding correlation to public markets are really the kind of the two major things.
So, if you look at what happened in public markets. As Colbert came on last spring, springtime in March and April, well, all the public markets were whip side incredibly.
Now obviously there were opportunities to make money and lose money, but there is that volatility which many investors really are not super comfortable with, in something like a private credit. Whether it is our vehicle or some of the others.
We didn’t see that volatility and you don’t see that volatility ’cause we’re largely uncorrelated to the public markets. We are focused on credit performance, so as long as the credit performs are the net asset value of our fund is going to stay stable and that is essentially what we saw through Covid
and prior to Covid, and since Covid, so the non-correlation the other piece is the return. Because of this these are private loans and because you’re not typically competing with a bank, the price of those loans tends to be higher to the borrower.
The board tends to be higher than it would what it would be if bank was competing for it. The banks, as everybody knows, have the lowest cost of capital out there. So, if a bank chooses to compete on price, they’re going to win.
But these are areas typically where banks are not completely competing. In fact, almost by definition, these are areas where banks are not competing. So, the pricing tends to be a little bit more favorable relative to the risk.
{10:55} Andrew
And why is it that the banks aren’t competing?
{10:57} Colin Kilgour
Good question. Banks are driven by regulatory capital requirements, so particularly out of coming out of the global financial crisis in ‘08 – ‘09 there was increasingly stringent bank regulatory capital requirements put in place through things like Basel tree and every type of credit of bank advances will have some sort of capital requirement attached to it ranging from you know zero to something higher than zero.
Since that’s what drives bank activity is managing their return on capital. They tend to focus on the areas that require you know the least amount of regulatory capital. So, for a bank those includes things like first mortgages, residential mortgages, banks will love doing those. They will do those all day long because they are very friendly.
From a capital perspective, other things like investment grade credit. So, lending to an investment grade company that is very friendly to again from a capital perspective. Things that are not capital friendly are things like unsecured consumer lending or lending to a small business or lending to non-investment grade businesses. Those carry a higher capital requirement.
So, banks tend to shy away from those. It does not mean they do not do any of that lending yet.
Most banks will have some lending in all those verticals, but it is not really where they are going to focus their efforts because it is expensive from a regulatory capital perspective. So, if you are someone like us or a professional investment manager and you are using and you’re not subject to regulatory capital requirements, you can look at these asset classes for what they offer, which is attractive risk adjusted yield. And you’ll put capital towards it, and you can do that largely with the confidence that you know. A big bank isn’t going to come in and take your lunch from you tomorrow.
{12:38} Andrew
What sort of individuals or industries tend to be the borrowers with the loans you are involved with?
{12:47} Colin Kilgour
So, we deal three different types of loans.
We deal with consumers.
We deal with businesses, and we actually do some mortgage lending for developers.
But on the business side, we deal with small businesses, and we deal with one specifically that are cash flowing businesses where advancing loans against the cash flow of the business, and I will distinguish that from things like small business that might own.
And so just to set context, we are typically talking about loans that are under a half $1,000,000, so these are smaller balance loans, and where these loans are kind of distinguished from other things, we might be familiar with is if a business owns its property, it typically will had connect can access mortgage financing fairly inexpensively, so real estate can be funded. If a business has a fair amount of fixed assets in the business, they can often finance those, so it is if it is a fleet of vehicles or equipment or things like that
They can typically get asset-based finance if a business has trade receivables. So, they deal with their customers on terms of trade, they can often get financing against trade receivables.
But if you are a cash one business that rents your premises and does not have a lot of fixed assets, no lender wants to talk to you because they cannot put their hand fingers on collateral or on security, so that is where we will end, and we will end against the cash flows of the business. So, these things, types of businesses would be traditionally restaurants, were part of that. But also, any retail operations. So, walk down High Street in any city in America and those are the businesses you see are the businesses that would typically be funded by a facility that we would advance. So it could be doctors’ offices; It could be dentists; it could be physiotherapy clinics; It could be grocery stores; It could be liquor stores; It could be gas stations; It could be home renovation contractors and the like.
I get that all fit that same parameter. They don’t own the premise. It’s a cash business and they don’t have fixed access.
{14:47} Andrew
What’s your due diligence process like? I would say that the loan has already been, say, originated by the Fintech lender, but you’re coming into to see whether it’s something that you want to invest in, how do you go about that?
{14:57} Colin Kilgour
The great thing about this and you mentioned you asked earlier why we like this asset class is there’s transparency, and there’s a lot of data.
Our process, first and foremost is, before we buy any loans, is figuring out which lending platforms we want to work with, and we go through an extensive due diligence process on the platforms.
So how long have they been in business? How many loans? What does their loan volume look like? We review all their data tapes, so we asked them for a loan they have ever written and we run those through our analytics to see what their actual loan performance is and how they are underwriting performs.
We then do on site diligence with every single platform. So, we go and meet all the heads of all the business units we do a walkthrough of their facilities. We make sure that they have appropriate staff on board and that kind of stuff, so there is a full-on site diligence before we buy a single loan.
Once we have decided we are going to work with the platform, we’ll then provide them with the credit box that says that these are the types of loans that we will consider buying and putting on our portfolio, and that might have cut offs around industries, geographies, you know minimum credit scores. Things like that.
Then they will present us with deals that fit within that box. We will then use again because of the data richness of this, we will then run these through a filter that says, OK, let us lock out the ones that do not fit in our portfolio, and then we will score them using our own models.
And because there’s so much data out there, we have developed our own proprietary models just to re-score the loans. And you think about it, one of the big lenders in the US as a company is Lending Club and they do thousands and thousands of loans every day. And if they scored between A and F, essentially from highest to lowest. And say they originate a 100 C loan or already get 100 C loans. They probably evaluated 1000 applications. And 100 made it in and as far as lending clubs could not concern those hundred. C loans are all good.
But intuitively, we know that there’s probably going to be better C loans and worse C loans as not all those loans are going to pay off 100%, so we use our models to distill amongst those. 100 C loans. Which ones are most likely to pursue?
And we give them a percentile ranking and then we will try and buy the ones that are above a certain score. So typically, you know we only want the top 20% based on our scoring, so we will then attempt to buy the ones that are above, you know, the 80 – 81 percentile and higher and in the case of consumer loans this is done. In an automated way at machine speed, four times a day so the loans become available electronically.
{17:42} Colin Kilgour
We bring them down once we run the models, and then try and buy the ones that meet our criteria, and we gain that happens in machine speed, and it is all automated on the business side.
On the mortgage side, it is a similar process, but we will actually review the indirectly complete underwriting file, and we will put human eyes on it because there are more syncretic issues with businesses and mortgages than there is with necessarily with consumers. If you have enough data elements and we get about 150 columns of data on every borrower, or its consumers tend to be more homogeneous and more easily described by data, whereas businesses are more syncretic.
{18:19} Colin Kilgour
So yes, we will look at all the data and the data’s there, but there’s also things that you will see around a business. Whether it is the business, we will get things exciting as it reports. Are the business premises clean? Does it look like it has been washed, you know, recently? You know the things that might affect your credit decision. Does the signage on the building match the signage on the application? Things like that you might not pick up on an Excel spreadsheet, but you pick up when you put human eyes on or any you know any things that might pop up in the bank statements.
For instance, we review the bank statements because one deal with losing a great transaction. But then when we got in lots of cash flow locked to borrow against looked very strong. We looked into the bank statement and noticed that the proprietor was making multi $1000 withdrawals from the ATM at the local racetrack every weekend and, nothing wrong with that, he likes to gamble… we’re not really wanting to advance credit against someone who’s using their corporate bank account to finance a gambling habit, so we turned that down and you wouldn’t have seen that necessarily if you, So we do have a machine evaluation for the business loans, but we are going to put.
{19:33} Andrew
Human eyes on the underwriting files, and I guess, the more due diligence, the better, right?
{19:38} Colin Kilgour
Yeah yes, but you have to be efficient at it so and this is what makes this model so attractive is you can be very efficient in looking at credit deals. So, on the consumer side, it’s automated, so we can be very rigorous, and it happens in machine speed.
In the case of business loans, the real challenge with the fintax is can we present an under a complete underwriting file in such a way that we can review it very quickly, so we do not underwrite the deals?
Because that would be inefficient, but the files get presented to us. You know everything from their tax returns to their financial statements there. Their bank accounts personal credit scores, personal mortgages, where they live all that kind of stuff. Tax returns… all that we get, but we get it in such a manner that we can really go through it very quickly and make a decision because a lot of the underwriting work, the core underwriting work has already been done for us by the lender and presented it in a very friendly manner so that we can get through quickly.
{20:39} Andrew
And I think you mentioned you mentioned COVID briefly there, but let’s talk about that a bit more. How is COVID affected the credit markets that you invest in?
{20:48} Colin Kilgour
We’re largely through the worst of it, from a COVID perspective, and from a credit perspective. And there was a lot of uncertainty when stuff hit the fan in March of last year.
So, we saw a couple of different things, so in the consumer part of our bug there was really a bifurcation or a K shaped type recovery amongst consumers. So, there were those borrowers who lost their jobs as a result of the pandemic, and we all saw unemployment spike up.
Then there were those borrowers who, like many of us, were able to shift their employment to work from home or they were essential workers who were working at hospitals or frontline workers. They remained employed. So, for the folks that remained employed, which in our case was about 85% of our book, credit performance actually improved when compared to prior to COVID. It makes sense if you think people continue to earn money, but they weren’t eating out, they weren’t traveling, they weren’t going on vacation, they weren’t even commuting to work and putting gas in their cars, so they at the end of each month had more income leftover to service their consumer debt.
{22:03} Colin Kilgour
So, delinquency improved in about 85% of our consumer book in the 15% where Wolffian folks were affected from an employment perspective.
A couple things happened. One is the lenders in their capacity of servicing the loans were very effective at putting what they call hardship programs in place, so they offered borrowers the ability to skip a payment. Maybe go to interest only payments for a number of months or some other flavor of that and the intent on those is those types of programs is really the opportunity to A. keep in contact with the borrower.
’cause that’s key to getting your money back. ’cause making sure you don’t lose contact with, keeping in contact, giving them some flexibility. Ultimately when they get start to get back on their feet, they can start repaying the loans again.
What we saw for that 15% that went into hardship. The vast majority of those came back onside after a number of months, and so again we saw really strong performance. Things like government assistance programs kicked in, economies reopened, employment improved. all those things you know having bought them some time with hardship programs, they were able to come back on site.
{23:12} Colin Kilgour
So, our part again, our performance in the consumer side, it was largely very strong, even though it wasn’t particularly intuitive that it would be that way, and on the business side of it, you know we had we had some mixed results. We certainly had our share of white tablecloth restaurants that had had trouble, right? They, they got shut down and there’s very little they could do about it. But that’s only a small part of our portfolio. We have a very diverse portfolio.
So that was maybe 6% of our portfolio or 6% of our business portfolio. But we also had grocery stores. We also had liquor stores. We have gas stations. We have home renovation contractors, and those guys did very well in COVID.
So again, we had some challenges in the places that you would expect us to have challenges, restaurants and hotels, for instance, didn’t do very well with a wide with a widely diversified. Portfolio that’s only a small part of your book.
{24:02} Andrew
Is diversification more important in something like private credit and I guess another way of saying that is it important to be more diversified than you would be with publicly traded debt?
{24:14} Colin Kilgour
We think so, and I’ll walk into that a little bit.
We met a few years ago with a private credit fund manager, who has a very different strategy than we do, and we have people going some diversification as a way to manage risk.
and this portfolio manager said to us, quite haughtily, “diversification is for people who lack conviction” and we said, “OK, we lack conviction.” We’re not doing investment grade credit investment grade lending, so if I’m buying investment grade bonds, maybe I don’t need to be as diversified because I’m less convinced that you know a AAA company is going to go bust. I don’t need that. I don’t need 1000 AAA companies in My Portfolio, so I will accept that for me. Investment grade fixed income portfolio.
But we’re dealing with non-investment grade credits and typically when private credit will deliver unrated well, I said there’s attractive risk. Adjusted return available. It’s not lossless lending, so one of the ways you mitigate the effect of losses is by having a diversified portfolio.
So that there is no individual single name that keeps you up at night that you’re worried about. Is this guy going to go bust and it’s going to impact my fund results?
So, you manage that by having no what we call no Altree exposures. So, in our fund we have an Investment policy restriction that no individual credit can be more than 1% of the portfolio and as a practical matter about 1/4 of that is what our average would be. We have thousands of loans in our portfolio at any one time. Nothing keeps us up at night.
We worry about the portfolio and worry about you. No sector issues and thinking and overall credit performance. We’re not worried about individual losses. So. we’re big proponents of managing risk diversification and part of the mindset for that is again in private credit.
{26:06} Colin Kilgour
You are typically looking for kind of a high single digit return, so you’re looking to get income. You’re looking to replace fixed income results that are more abundant these days, but you’re not looking to be super aggressive.
Or you’re not looking to be the next Bitcoin trade or something like that, so with that as a back end with our investors, you know they are overwhelmingly looking to stay rich rather than get rich with us.
So, it’s they’ve made some money elsewhere and now they want to generate some income and they don’t want to see their capital at risk. So, our first focus is maintaining, and preserving the capital and the second focus is generating income. You know, in a high single low double-digit range. So that’s what we focus on. And if we had a concentrated portfolio, say we say we had ten names and think credits in the portfolio, and I’ve seen funds, little private credit funds like this.
and the H or 10% one of those names goes bad all of a sudden, you’ve lost 10% of your capital. And that to us is unacceptable in a stay rich fund.
{27:10} Andrew
And that sort of defeats the purpose of the whole exercise, right?
{27:12} Colin Kilgour
It absolutely does something with that. I’m not here for that. If I’m taking if I’m if I’m investing in equities or you know tech stocks made them prepared for the ups and downs associated with that. But what I’m looking for income in an income vehicle. I don’t want my principal, you know, getting whipsawed around. And diversification is one way we manage that.
{27:34} Andrew
What trends do you see right now in private credit? And I guess what I’m getting at, there in part, is interest rates have obviously been very low and remain quite low even though they’ve moved up a bit.
Is there a concerning reach for yield that you, see? Is there a lot of money in the private or too much money I should say in the private credit sector right now or and what other? What other trends do you see?
{27:57} Colin Kilgour
Well, there’s certainly a growth trend in private credit. Generally, interest rates have been low for some time, and they and they got lower last year with COVID. They’re going to stay low for a while, I think, particularly in the United States. So, we’re in Canada and we might see a bit of a rate hike here at some point
But in in the US I think we’re looking at a prolonged low interest rate environment, which means if you’re holding a bond portfolio which for income and you think of the traditional, you know 60/40 asset mix that many investors that have in many investment advisers recommend for their clients that 40% your fixed income allocation isn’t really doing anything for you. So, people are looking to private increasingly looking to private credit as a way to generate Income and it’s good at doing that and a good private credit investment.
You will not get website whipsawed by the market, so you won’t see the daily market fluctuations.
Hopefully it’s uncorrelated to public market returns and you can generate that income so there is a lot of money coming in. Is it too much? I guess the obvious answer is no.
{29:00} Colin Kilgour
But you need to be careful, and you need to be careful with the managers you work with, so an individual manager might see too much money coming in.
So, when someone’s very been very successful and everyone allocates more capital to them, the challenge in private credit, though, which is different from public markets investing.
Is when money comes in the door, and people invest with you so which we all love you then have to figure out a way to deploy it and that becomes a challenge, so these lenders, then these private credit fund managers now need to be in the business of lending money and lending money is hard.
You know you. You need to market. You need to find borrowers. You need to do credit analysis, you need your folder deals. That’s hard to do, and so if one is coming into the door, there’s a pressure sometimes to be more lenient or less discerning on your investment side. So, we need we need to get $10 million. We need out the door. We need to get $100 million out the door. Well finally someone. Who needs $100 million and sometimes?
You know the credit criteria slip. People stray off their strategy or they take on more concentrated positions. It’s just as easy to do a $100 million loan as it is to do a $10 million loan. So, let’s do $100 million loan and that gives you the concentration issues.
So, while overall I would say. Hey, no more money Commander spaces is obviously better. You need to be watching the managers you invest with and making sure that they’re staying on strategy and not veered off strategy by an influx of capital.
{30:30} Andrew
You don’t want to see a manager taking a bunch of money, not have anything to do with it other than lend to the guy at the racetrack right?
{30:36} Colin Kilgour
Yeah, exactly it makes bad credit decisions because you’ve got it for the capital ’cause sitting on cash as a fund manager is doesn’t generate anything for your investors so you do have to deploy it and that’s you know, quite frankly, that’s the benefit of the marketplace model is if you’re working with a portfolio of lenders who are already in this business and have are doing significant volume.
You can just allocate more to those specific lenders and say this I was doing. 2,000,000 a month with you all. Now I’d like to go to 5,000,000 a month with you and will be working with someone like a Lending Club. That’s an easy call to make.
{31:08} Andrew
So COVID was, you know, something about having a really abnormal recession, right? It was incredibly sharp, but compared to other recessions, pretty brief, and there was obviously a massive amount of government stimulus that came in.
Afterward, how would private credit be affected by a more traditional recession, and what are the what are the warning signs that you look for in that regard about how your portfolio could be affected and you know, how do you adjust your strategy?
{31:38} Colin Kilgour
Good question, you know, in the prior COVID we always used to get asked about how we would have performed in the global financial crisis and an economic recession is no different. Things we would look for, well, first of all, private credit generally
because it’s private and not generally correlated to public markets, you’re not going to get whipsawed by, you know the Dow dropping by 20%. So, you’re not going to see that whipsaw effect, but you are subjected to changes in credit performance and for us in the places we play, which is primarily business small business.
In consumer lending things, we look at our unemployment. So as unemployment starts to deteriorate, you can expect you know that’s going to have an effect on consumer credit and a small business credit, because that’s ultimately where the employment is
So that’s what we look at as we see unemployment tick up, we need to adjust our credit criteria. Maybe we’re only going to go to higher grade credits and kind of shy away from the more speculative free credits. But unemployment for us is the key from a credit condition perspective, rates are a different issue.
You know, so you may see changes in rates. So again, if you go into a recession, governments will typically try to lower interest rates. That really doesn’t have a knock-on effect in this type of lending we do, because overall it’s tends to be lending at the higher end in terms of price point. So, if our borrowers are paying, you know 10%. Interest if there’s a Libor kind of 50 basis points, that’s not going to move the needle on the type of lending we do.
{33:09} Andrew
Is your portfolio in general interest rate sensitive? Is there what sort of duration risk?
{33:17} Colin Kilgour
And then this is where we differ from a lot of what’s out there in the private credit world. A lot of the private credit world has kind of longer-term deals. Which is in long duration. We do shorter term transactions, so our business loans tend to be about six months to 18 months. Our consumer loans are 36 months and our mortgages are 12 months and in the case of our consumers loans and business loans, those were all amortizing loans, so they pay down a little bit of principal every month.
What that means from a duration perspective?
’cause our portfolio duration in the fund tends to run around 9 and 10 months so it’s not liquid, but it’s not a liquid either. We have cash coming in every day and again we turn over the turnover the portfolio very very quickly.
You know we are. Now 15 months past COVID, the vast majority of the investments in our fund right now are loans that have been originated. Since COVID and quite frankly have been done with a covert lands, so knowing that the guys have been remain employed, knowing that their business remains open knowing that their real estate project is going forward.
So that short duration really helps in times like this from an interest rate sensitivity perspective. Again, these are higher interest rate loans generally, so again, if there’s a 50 or 100 basis point Libor move, it doesn’t really move the needle on the prices. Our loans go out too. It’s borrowers.
It really doesn’t change the valuation much on how we value our portfolio, as it would say if it.
Was a bond portfolio.
{34:48} Andrew
So, is it fair to say that your portfolio is high? Interest rates tend to be higher interest rates, but also lower duration at the same time?
{34:56} Colin Kilgour
Correct, so and let’s say high interest rate. We’re not talking about anything approaching usury rates or anything like that. We tend to operate in that in that space,
Between where you might be borrowing against the equity in your home, so we’re higher than that, and we tend to be lower than what a credit card would charge.
So, we’re we. And this is where marketplace lenders have really, really done. Well, is they’ve implemented risk-based pricing to pick up that gap between home equity-based borrowing and credit card-based borrowing?
{35:26} Andrew
Is that a sector that you see continuing to grow that marketplace lending?
{35:30} Colin Kilgour
I do.
{35:32} Andrew
Is that still in the early stages?
{35:34} Colin Kilgour
Yeah, it’s been. I mean, the Lending Club has been around since prior to the degree financial crisis, but really, this space started to take off. Let’s say six years ago you know when lending clubs, when you went public, and you know there was a big. There was kind of hockey stick type growth. After the credit crisis.
I think that’s going to continue from quite frankly, it’s a more pleasant way to borrow money. If you’re doing it online, you can fill in all your information. You can scan your documents, sending electronic copies and signatures. It’s very efficient.
And quite frankly, it avoids the traditional process of borrowing money, which is quite uncomfortable for people. If you had to go sit in front of a bank person who you know is going to ask you your income and is asking you all kinds of personal questions and then you have to sit and look at this person while he taps it into his computer and then he gives you a thumbs up or thumbs down as to whether you’re going to get a loan or not. It’s uncomfortable. Nobody wants to do that right? Even if you have great credit score, you don’t want to sit there and beat, but yourself. Kind of out there exposed to have someone say yes or no.
You get a loan. It’s much more comfortable and much more convenient to do it. You know from the comfort of your own home, where you know there isn’t that awkwardness, so it is growing. It’s a much customer -friendly way to borrow money. People like it as people adopt technology. They’re going to continue to go that way.
{37:01} Andrew
So, this has been. This has been really insightful, so I’d like to thank you. Colin Kilgour of Kilgour Williams Capital for sharing your thoughts with us. It was extremely insightful and Pitchboard would like to thank our listeners for their continued interest. We’ll see you again next time. OK, take care.
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