Issue No. 19

One of the things we do at Pier is provide credit facilities to specialty finance companies as debt against their financials assets – such as loans, advances, or other contractual cash flow. We require our borrowers to commit to a Key Person clause within the credit agreement. The Key Person is typically the CEO and founder of the firm. It’s critical to have a stakeholder that is committed to taking the deal from start to payoff. There has to be someone at the borrower who OWNS this credit facility and takes the responsibility as a fiduciary for our capital.

The attitude of the key person is critical to assess in underwriting:

• Do they respect the responsibility of taking this debt on?
• Do they understand the severity of attesting to all terms in the credit agreement?
• Does this person have the ability to shepherd a servicing transition? Or help liquidate collateral in a downside?
• Is their word as good as written contract?
• Will this person be the last person standing and ensure every last dollar is paid off to preserve his/her honor?
• Will this person come to the table and have difficult conversations with honesty and integrity?

If the answer is “yes” to those questions, that is the type of borrower CEO we like to work with.

One nuance is when the borrower has a professional CEO, who isn’t the majority equity owner. In this instance, the CEO and equity owners need to be in complete lockstep. Unwillingness of the board to allow a key person clause on the CEO shows their lack of confidence or commitment to that manager.  The Key Person clause is a tool for ensuring alignment and accountability.

- Jillian

Chart-watch

The charts we are looking at to understand the world around us

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I've seen several economist predictions with the average being ~3.75% expected by the end of 2025.

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'Tis the season to listen to holiday music. While an annual anomaly, the stability of holiday music listening each year, starting around Thanksgiving, is fascinating to track.

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‍Here is a deal you all may find interesting. In December, Pier purchased a portfolio of $21.7MM of subprime auto loans for 57.7% of par (~$12.5MM). Using conservative default rate and recovery expectations in our DCF model, we priced this using a 20% discount rate. How did we get there?

First, some portfolio stats:

• Loans: 1,797
• Avg Balance: $12,545
• Avg Orig Bal: $17,470
• Avg Duration: 10 months
• Avg Term: 48 mo
• Avg Seasoning: 14 mo
• Avg APR: 23%
• Approximately 6.9% of the portfolio is greater than 30 days past due.
• The collateral consists of standard car makes and models: Chevy, Ford, Kia, Nissan, Dodge, etc., with an average model year of 2014 and ~115k miles.

Seller: The seller was a buy here pay here originator in the Midwest, whose desire was to pay of their lender due to the difficult origination limitations set on it and other onerous terms, such as personal guarantees. The seller services their loan portfolio and maintains close relationships with their customers, frequently handling maintenance or refinancing into new vehicles.

The seller has been in business for 35 years and we received performance history going back almost two decades. The seller will retain servicing, which means the borrowers will see no change in their day to day loan situation.

Performance: Cumulative loss curves the last decade have ranged from approximately 35% to 45%, averaging about 40% with 2022 as an outlier that is trending toward 47%. Approximately 15.6% of our portfolio was from 2022.

Recovery rates have varied historically, but they have been as low as 15% recently with this originator. Industry recovery rates have coming down, though 15% is at the low end of what we typically see in auto, especially since unsecured consumer defaults can generate as much as 8-12% in a bad debt sale.

Pricing: Given this information, we used cumulative default curves that average about 46%, and recovery expectations at 15%. We feel both of these numbers are conservative. Then, the cash flows from each modeled loan were discounted at 20%. Delinquent loans are marked down significantly based on our separate delinquency markdown curve. All of this resulted in that 57.7% bid and purchase price.

Diligence: Upon acceptance of the bid, we proceeded with a 3-week diligence process. We hired a third party subprime auto firm who we have worked with prior and know to be extremely thorough. We also conducted on site diligence and a compliance/regulatory review. The sellers proved to be very professional, which is not always the case in this asset class.

Co-invest: Finally, we syndicated out 25% of the deal to a few of our LPs with our main fund holding the bulk of it.

Projections: In the end, we believe a 20% gross IRR over a 10-month average duration to be very realistic, with potential for it to come in at 22-23% if defaults stay low or recoveries are a bit higher than modeled. The monthly performance will have some real volatility to it as these types of portfolios do, but with diversification through this amount of volume, we don't expect performance straying due to small sample size. In a downside stress case we model a 9% gross IRR.

- Conor

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