Issue No. 38

As a reminder, we provide senior secured credit facilities to specialty finance companies that use our capital to fund loans, advances, receivables and other contractual cash flows.

When underwriting a deal, we obviously spend a lot of time in the numbers. Over time, though, we have learned that the person across the table, usually the CEO or founder, is often the most important factor in how a deal performs.

A strong management team can often correct poor performance in the underlying collateral quickly enough to protect the overall portfolio. The borrowers who successfully navigate a rough patch tend to tell us early when something is off, explain what is happening and stay engaged while we work through it. We have far more confidence in a management team that is proactive than one that waits.

We also pay attention to how seriously a borrower treats the lending relationship. Are they responsive? Do they take reporting seriously? Do they treat repayment as a true obligation?

Some of our strongest relationships have been built during imperfect periods. When a borrower is direct and dependable, we are much more likely to continue supporting the business.

I’ll also say what everyone in lending knows to be true: if you have an A+ counterpart, the docs may not matter much. The problem is that you do not know who is truly A+ until you are already in the deal. So, the documents still have to stay buttoned up…and the lawyers still get paid.

— Jillian

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Private credit’s default rate is 2.51%. It is also 6.0%.

These recently released figures from Proskauer and Fitch, respectively, cover different loans, periods and definitions. Neither is wrong. They just show that a default rate is less objective than it sounds.

Pier monitors default and delinquency rates across our specialty finance deals. But our go-to performance trigger is the Minimum Cumulative Collections Rate, or MCCR.

MCCR asks a simple question: How much cash has actually come back and how quickly?

We group loans into monthly origination vintages and track each vintage by month on book. We calculate cumulative net collections and compare them with the minimum collection curve for the deal. If a vintage must reach 50% cumulative collections by month six but has collected only 45%, the trigger is breached.

Consider two loan originators that each report a 10% default rate. In the first, borrowers default after repaying most of what they owe. In the second, they default on their first payment. The reported rate is the same, but the economic return is not.

Definitions also vary. One originator may classify a loan as defaulted after 30 days while another charges off after 120 days. Some consider loans delinquent after 1 day of missed payment, others may consider loans current until 10 or 15 days late. Cash collections are harder to debate.

Vintage analysis prevents growth from masking deterioration. New, unseasoned loans can make aggregate default and delinquency statistics appear healthier. Comparing every vintage at the same month on book reveals whether newer production is actually performing better or worse.

There is no universal MCCR curve. A six-month advance should collect much faster than a two-year installment loan. The apples-to-apples comparison is not the raw collection rate, but actual collections relative to the curve underwritten for each deal.

Defaults and delinquencies help explain what may be changing. MCCR tells us whether the the return of cash is still on track. In lending, the return of cash is what matters.

- Conor

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