Episode Transcript
[00:00:00] Speaker A: Foreign.
It's Anthony Caprino. Welcome back to another session of Conversations with Anthony where we talk about the latest trends in private equity and M and A. So today we're going to get into the world of private credit and what's going on with private credit, the trends behind it. Today I'm here with J.P. james, the chairman and CEO of Hive Financial Assets. J.P. welcome.
[00:00:32] Speaker B: Hey Anthony, it's good to see you.
[00:00:34] Speaker A: Yes. So for everyone's benefit, JP and I are both YPO members. We've known each other for a number of years. It's great to have him here and he'll tell you a little bit about his business and we'll get into private credit. But before we get into the crux of it, JP why don't you give us a little bit of your background and your company.
[00:00:54] Speaker B: So great to see you. I'm a serial entrepreneur. I was talking to my five kids, I think a few weeks ago that there's only one regret I have which is not dropping out of middle school because I knew I wanted to be entrepreneur really young. And that's all I've done. I've done built 18 different companies, sold three different companies, plenty of failures as well. So it's not all rosy and fantastic. But I think through that process coming into dot com, Boom and bust, 2008 Boom and bust and very cyclical specific industry ups and downs. I have this bias towards building companies that do really well in down markets through all of that time frame. I've had a hedge fund background in commodities, in quant and modeling.
And it's very interesting. I have this adage with a lot of these companies where statistics work still it doesn't and then it's catastrophic.
I don't know the future, but I see a lot of people laying off a lot of people in every headline. Even this morning's Wall street journal had 15,000 people announced being let go from Verizon. And so for me, I've built companies that whenever I see negative headlines, I'm more excited and I think going to talk about private credit, I think that's really the thing is how do you build not only resilience but antifragile where performance actually goes up when volatility and market uncertainty and downturns happen.
And so that fundamental thesis has been really about analytics data, enormous amounts of data, not just high level corporate stuff, but getting into the weeds of consumer data.
So I co built a company called Lending Science in Atlanta. She became one of the largest underwriters in the United States. Specifically for consumer credit, we had about 400 lenders in the consumer space, six of the top 10 non bank mortgage lenders, all the big automotive lenders. So we built credit models, underwriting models, default models, marketing models, so got a huge perspective around the United States markets in all those different sectors.
Sold that company spun up high financial assets eight and a half years ago, be nine years old in March and it's been fun.
I don't know if everybody characterized the last eight and a half years as fun, but I love roller coasters because our business actually does better in volatility uncertainty in the markets where we provide balance sheet financing to consumer lenders all across the US we have six on the seven on the platform that we've funded so far, probably have three more coming up. But not just providing balance sheet financing and direct lending and lines of credit. We actually do the underlying asset management of risk. So we're supporting these lenders not just doing the due diligence on the front end like a lot of private credit does, but we actually manage the risk of the underlying asset working with the lenders. So we get a lot more granularity of Data. We've got 30 million Americans data, credit data, bank transaction data, real time feeds, behavioral data, texting, email, voice, all this information to build models around human behavior. I love data and we're really good at modeling human behavior.
[00:04:26] Speaker A: Well, thank you for that color and having been to your office and seen your company, it's actually quite impressive and it's been a great success story. So looking forward to learning more about private credit and why don't we get into it? So in my world, many of our, in fact all of our private equity clients are financing their deals in some form or fashion. Traditionally that was with bank financing. And that's ebbed and flowed over the years. Last couple years, actually going back even more than a couple years, the private credit world has become quite popular and really almost has stepped into the shoes in many situations of traditional bank financing.
In light of that and its popularity, can you give us your take on why many investors are going to private credit? What makes it so attractive, and why has it grown into such a mainstay over the last few years?
[00:05:24] Speaker B: So I'll break up the investor audience, right, because we work with larger institutions, interval funds, publicly traded assets, RIAs, wealth management firms, large family offices and individuals. So we get a very large perspective of different types of investors. And they all are kind of looking at something slightly different for the larger firms. I think think they're looking at stepping into just a big market gap where as you said, a lot of the banks have stepped out. They don't want to take the risk on the balance sheet. And pretty much since Dodd Frank in 2010, the risk on has been the opposite for banks but really great for the private markets. That's just continuously expanded in our asset class, which is non prime consumer banks just disappear.
We'll work at the bottom of credit cards. We don't work with deep subprime products, we don't work with payday title pawn lenders. But when you're right in that middle, there's these big gaps that have been created. We've seen it in our asset class. But if you look at it across the board, there's a big disconnect. The processes are taking a lot longer. With banks, if you look at some of the disruption in the marketplace, that may not be a bad thing. Sometimes it's better to take a little bit longer due diligence. But even the banks have gotten in trouble lately. So I think for the institutional guys, especially insurance, I've seen a lot of insurance come into private credit because it's coupon clipping.
I think across from the bottom to the top the rates have been so high.
There's this large demand for that free cash flow, that income production, high yield and they're not getting it in the banking market.
And on the flip side, the private sector needing a lot of capital and the debt markets being pretty liquid with private credit, the demand side is really hot. I'll give you one quick case study.
I can't tell the name of the company, but they're a tech company, did a bunch of roll ups and they did roll ups using private credit funds that capitalize them. They had at the time they were doing about 100 million EBITDA good cash flow been built up over 10 years.
Problem was like many people in commercial real estate, their five year notes were all coming due and they were all coming due at the exact wrong time. Cause they had structured all the debt coming into 2019 so they had really nice low rates.
So coming into last year, not a fun conversation. So talking to the owner entrepreneur and he said coming in having a panic attack, rates are really high.
In fact if the rates are the same with the amount of debt they would have on board, they would be underwater, they would have negative cash flow.
He went out to the markets and not only did he get one, he got like 20 different offers offers overnight where they are almost like mortgage arm where they didn't want him to pay the full amount of interest.
Sounds familiar.
And he's getting all these rates and he's like, nobody cares about the economics. And like I said, I can't say the name of the company.
That is a sign of a little bit of frothiness because there's so much dry powder. But it's not just private credit, Right. There's so much dry powder in venture capital, in private equity and in private credit, and there's not that many good quality deals that you're going to be able to put all that capital.
It almost reminds me of the hedge fund markets. Hedge fund markets in the late 90s were pretty small. And there's this explosion in the 2000s into trillion, 2 trillion, now 3 trillion marketplace. I see a very similar curve for private credit. There's the yield component, there's the demand component, there's the dry powder component. We got to put this to work.
And everybody's scratching because they don't know what the volatility is going to do in the market. Yes, the equity markets are up whatever percent, but 75% of it is a dozen companies.
What really, where is the actual evidence of the earnings following the price per P E ratios? It's not there. So they're thinking that the credit markets might be a safer bet. Now I'm not Mark Rowan, I'm not a genius. I don't have 100 billion under management or a trillion under management.
But I do think that there aren't that many great companies.
And if we're all going after the exact same set of companies, there's got to be either a rate compression issue or too much capital chasing bad deals. And you're just starting to see, I think, some of the cracks of it with a couple of these implosions in the auto sector.
[00:10:25] Speaker A: Sure. Well that's a great segue. And it sounds like ease of use from the, from the borrower's point of view for private credit. But maybe looking at the opposite side of it, maybe ease of use and access to more capital. But if you're dealing with private credit versus a traditional bank, what are some of the. Or have you seen some structural changes on how parties deal with one versus the other over your experience?
[00:10:57] Speaker B: It depends. In my marketplace in the non prime consumer lending, most of the capital was mom and pops.
You had family offices, ultra high net worths and syndicates that were funding the deals.
We were a good fit because working with one institutional party to provide a good quality line of credit but also support the lenders with their Underlying assets was a Double value add 1. I'm going to work with a good institutional partner that's an expert within the space and we get additional value add with technology, analytics, all this other stuff.
So I do think there are very specific sectors where you're having more institutional consolidation of capital. And so the sophistication in those spaces makes a lot more sense rather than getting mom and pop promissory notes in smaller debt in the illiquid markets. Now, as you go further upstream, the speed at which a lot of these deals need to get done is it's here today, it's gone tomorrow.
God forbid, everybody's here is investing in OpenAI and every single AI company in the world and hoping that things are going to be different than 2001 crash.
But if you're going to come in the debt markets, you see it with Elon and what they did with Twitter, it was a pretty quick process. And I saw some of those text messages being texted between institutions to be able to structure the debt was I think about 40 some billion, 45 billion or so.
And most of it being debt and most of it coming from private markets and non traditional institutional banks and moving very quickly on a very speculative deal.
That is a. I don't know if it's a good use case, but it is the use case that I've seen a lot of deals that are a little hairy. Reminds me of the good old junk bond days. Actually, Michael Milliken was speaking at a global business summit that I was at this week in la.
It really got that feeling of, hey, maybe we're not in the public markets, but doing those kind of deals in the modern era. It's just that it's not as visible as being run by a lot of the PE firms that have built these very large private credit arms.
[00:13:21] Speaker A: Interesting. So in many cases it sounds like some of these larger, more well known publicized deals, for lack of a better term, special situation moving fast, maybe no one else will touch it. Higher risk tolerance. And those are some of the advantages and things that firms would do with a private credit versus a traditional bank. That is a lot more deliberate, if you will, and perhaps more risk averse than many of the private credit funds out there. Why don't we get into our next question? So, in light of all the abundance of private credit and the access and money that's out there, would you agree with the statement that private credit is almost mainstream now?
[00:14:09] Speaker B: Mainstream with institutional larger players? Yes, mainstream. I wouldn't say it's Main Street.
I think that it's creeping there right now. I think some of the moves of the current administration sec to allow the retail markets both on 401s and being able to access private traditionally closed reg D type investments are actually going to become Main Street.
So I look at it on both sides. I think that at this point with I think it's 1.7 trillion, don't quote me on the exact number of private credit markets. That's a good size and it's going to keep on growing. I don't think even if there is volatility in defaults very similar to a hedge fund market, I don't think it's going to disappear. It's going to keep on growing.
I think there's a good place for it. But when you're dealing with hypergrowth of any marketplace, you're going to have the winners and the losers. And it really reminds me of the hedge fund space.
I remember when a lot of the big guys became incredibly large. JP Morgan had a platform and I think there was right around the 2008 crash before, after it was like 300 billion in allocation.
If you're a new fund you get zero.
But if you just been around and you had like a billion to 2 billion, they could give you whatever amount you wanted in one week. So if you said hey, I want a billion additional, there's some ratios and stuff like that and I want it in one week. Done. These platforms, so that's where I think like the institutions like JP Morgan, the big Morgan Stanley's and those guys are building platforms to very quickly allocate to the private credit market. So they the beauty of obviously of the United States is the speed at which this capital can move once it's been institutionalized. Downside though, I remember even the hedge fund days, the hedge funds you actually want to invest are not the biggest hedge funds.
They can't. If you look at Ray Dalio and Bridgewater, you can't move $200 billion in a very large amount of alpha. You just can't now. Funny actually, Bridgewater had a fantastic last quarter. I looked at their numbers. But when you're moving that kind of capital around, the speed, efficiency and the ability to create arbitrage gets less and less. I think I'm starting to see that in the private credit markets the efficiency is there, the institutions are coming in, they've created the platforms so any firm or major allocator can quickly deploy that capital into the private credit markets.
But it's going more and more to these hyper concentrated Very large institutions like Apollo, like Blackrock, et cetera, et cetera, which to some degree makes sense because they've got institutional controls. But when it comes to Alpha, that's not really where it is. And so you kind of have to look at more. I'm not going to say it's specifically us, although we fit in that asset class. But you're going to see very sophisticated direct deals in the lower markets as opposed to the larger markets.
I'm a big fan of Barbarians at the Gate and reading loving that story because my dad was helping manage Nabisco operations in the Northeast back then. And whenever they ripped apart our Jared Nabisco and went through that whole process, the amount of debt that came on there, I'm seeing Sartre of, or not even the start, kind of the middle phase of that process where you're getting some of these deals that aren't making sense. It's almost like cap rates in commercial real estate or cap rates in real estate markets where it starts getting thinner and thinner. You're like, I don't know how you guys are going to make money on this deal.
And the other component I think is the Apollo's are going to do the private equity and the Apollo is going to do the private debt.
And I've given this example, I've seen many use cases of larger institutions, publicly traded, even private, where Apollo's the debt on one, Blackstone's the equity on that same deal and then it swaps and then you have, you don't have that many firms. So if you look at the trillion, not quite 2 trillion in assets, it's not like 1,000 firms are holding those assets. So it's a very limited number.
And they have the private equity and the private credit and they're taking alternate sides of each of these deals. So when they say they're diversified, I think it's a question mark. Now they're a lot smarter than me. They've been able to raise a lot more capital than me from that standpoint. But what I definitely know is they are not controlling the risk at the underlying asset level.
They are simply saying, here's this line of credit or this structured finance. We've got good ltv, good ratios, good metrics, and honestly, yes, you've got covenants.
But here's the thing, when covenants is trip, that's not really a good thing. You're screwed in the process. And I was just talking to a big apartment investor, several million units, and he's seen across the board pullbacks in Pricing weakness in the market.
Now all of those, he said a very significant percentage is private credit backed.
Okay, they did the underwriting when it was really good.
They produced the lines of credit.
There is some flexibility that private credit has if things blow up, that they can unwind a little bit more efficiently. But what I've also seen is there's a disconnect in liquidity where I can buy B cred or I can buy BlackRock or Blackstone's Liquid ETF products with daily liquidity with underlying assets that have lines of credit for years. How does that work? My friends are at J.P. morgan, my friends are at Blackrock. If they see this, I apologize for pulling them down a little bit on this. But I think there is a disconnect between the liquidity for the investor and the underlying asset liquidity. And I think if there's a run on the bank, you're going to have an implosion. And I don't know where that excess liquidity is going to come in to fill in if there's going to write down. And I'm not saying the market's going to collapse, but at some point there's going to be a recession. And when that happens and all these assets are locked up, I think it's all one big pile that's going to implode.
[00:20:59] Speaker A: That's interesting point of view and it sounds like very similar to some of the issues that came out of 2008 or what caused 2008. It was all intertwined and once one fell, everything was related.
It's syndication.
Your point about being on both sides of the deal with various products and hopefully that doesn't happen, but it sounds like there's a lot of similarities.
Would you say, and you just outlined a bunch of different risks that I think are certainly real.
Would you say that's the biggest risk, almost the fact that these things are intertwined or is it the misalignment of liquidity needs between investors and the underlying asset or something else?
[00:21:47] Speaker B: I think those are all things that are risks to the market.
But I actually think there's something else that is fundamentally concerning with not just private credit, but the whole marketplace right now.
And you can look at the case study of these few implosions of the automotive lenders that blew up. I think there's like three different ones.
When you're doing the underwriting process again, there is a front end process and you get other institutions, you get the rating agencies, whatever it is, to stamp it.
At that point, these firms close their eyes, they're done.
All they care about is how fast and how much capital can I allocate to get that same yield. And I really don't care about anything else. I can go to my shareholders and say, I checked all the boxes and walk away.
I think the risk is that the institutions, as they get bigger and bigger, they have no understanding of the actual underlying assets when they actually now have the opportunity to do that. What does that mean?
I would say 10 years.
Even in the 90s, there's almost no way to get enough data fast enough to see the underlying asset risk, whatever it was. In the case of these automotive implosions, in a couple of the cases, there's, you know, it's not all out in the open, and we don't know exactly the court cases will come up. But some of these vehicles were being collateralized multiple times.
Loan on the asset, loan on the asset, loan on the asset. Nobody knows that there's like three loans on assets. So we'll just give an example. It's $1,000 car. It's a cheap car. Was a $10,000 car.
Give a loan for $5,000. Great, 50% LTV. We're going to do one more loan. We're not going to tell that the other person. I'm going to put one more loan. We got 15,000 in debt on a $10,000 asset.
Even that is fine. As long as all of the cash flow comes in and there's no defaults, everything is fine. Like I said, statistics is perfectly fine until it doesn't work and then everything implodes.
I think that's what you're going to start to see where.
It's one of those when all the tides go out, you see what the truth of the situation is.
The data, though, is available right now. Nobody's. I have not heard a single company is like, I don't know what a database is. We don't know what the underlying assets are, and there's no way for us to manage the risk.
But traditional institutions are using the old techniques to just push the capital through as efficiently as possible when they actually now have the ability to look at the underlying asset, see exactly what the risk is of the underlying asset, and then make the decision of how much capital should be coming in and out.
That sophistication is not there yet in Wall Street.
It's going to come. That's what we've been doing since the very beginning. That was our original thesis, which is I could just get in the business of raise capital and lend it out and have private credit structure and make money on the spread. So the big firms are designed around efficiency and just placing the capital, make sure they have the confidences and ratios. We have the ability now, with a lot of these standardized databases to look at the underlying asset. So no longer do you have to be like, I just need to figure out the ratios, look at the loan tape and see that everything is good to go.
We now have the ability to go into the underlying asset and see exactly what the performance of that asset class is at the individual level, whether it's an individual car, individual loan, individual customer end customers. On the other hand, a lot of this private credit is going as balance sheet financing for very large corporations.
And it would be easy to say somebody at Apollo or blackrock or Blackstone would say, there's no way. We're not in the business of actually knowing the business. We're just in the business of allocating capital.
Not everybody's saying that. I'm not pointing the finger at everybody, but honestly, that's complete BS if you are an expert and you are going to be allocating debt to a deal, I would hope that if you're the investor, that you're expecting that the firm knows how the underlying asset is going to perform, not just the corporate asset.
So I think that the disconnect right now is that there's a lot of information that is not getting through from the risk management side to be able to truly know the picture. So to prevent another 2008, and that is exactly what is happening to some degree.
They're collateralizing these assets. They don't know actually what's there. But guess what? This is not 2008. You can know exactly what is there, even if you are a large institution. And that lack of transparency, because this is just not how we're built, is an excuse in my opinion. So I think the firms that are going to do really, really well when the recession comes, whenever it is, are the ones who are able to understand and manage that underlying asset risk and really that becomes a partner. So if you've got a firm and they're doing really well and they need more capital, you're not blindly just keep to your ratios and provide capital from the commercial markets. You're actually looking at, okay, you're doing better here. We've got expertise and intelligence almost like what venture capital does. Good venture capitalists are not just writing a check. They're there to make the company successful. Great private equity does the same thing. They're there because they understand how to operate the business and, and unlock just shareholder value, not by breaking it apart, but actually figuring out how to create value for the company. Private credit needs to get there. It's not there.
[00:27:45] Speaker A: That's a great perspective.
Do you think looking forward, the ability to utilize technology and really understand the underlying asset will be the biggest evolution in the private credit industry?
Or is there something even beyond that that's even more important over the next five to ten years?
[00:28:06] Speaker B: Wow, five to ten years. Anthony, I would say in 1990 I could predict five to ten years.
In 2025. Five to ten years. When you say technology is almost like 50 years from now. And the reason why is most people have no clue about this function of law of accelerating returns with technology. It is a compounding function that Moore's law used to be. 18 months, we're going to double processor speed or millions of instructions per second every 18 months.
When it comes to artificial intelligence, when it comes to what will be quantum computing from a commercial standpoint, I know still plenty of people are like, okay, that's some nice pipe dream. We're going to create fusion. I saw the movie with Keanu Reeves back in the 90s with whatever, they're going to magically create it overnight.
[00:29:02] Speaker A: The Matrix.
[00:29:04] Speaker B: The speed though of this innovation is so fast, we're seeing a bifurcation in the markets for the sophistication.
There are going to be private credit firms and just companies in general that have a mindset from the top down where it's technology, AI and innovation and how to monetize it from the top down.
I was just speaking to a very good friend of mine, former IBMer and I won't hold that against him. That's a whole nother conversation.
He does digital transformation for companies.
He works with Fortune 100 companies.
The amount of BS that is coming out of CEOs mouths in earnings calls and using the A word AI every five seconds and none of them know at all what they're talking about because they don't want to be left behind on the valuation of the company if they're publicly traded is so ridiculous at this point.
Yes, everybody says they use AI and there's this also this other nonsense. That AI is the reason why we're terminating all these employees. I can tell you literally this is not what I should be doing as the chairman of the company. I Write code using AI tools like Replit Agent 3, using automation tools. You know why? Because if you have a technology mindset first and you're doing risk management, it can go from the way you think to the implementation in less than two to three weeks.
But if I said to, I could call Larry Fink right now.
He's an amazing person, he's an inspiration. Done. Incredible.
But the gap between him coming up with an idea and it being implemented as a risk management function, I know they built, they did that major acquisition in the infrastructure space. There's an incredible amount of debt. I think it's over a trillion dollar asset acquisition that they have in underlying assets.
The ability to take the technology and innovation and the insights from risk manager for private credit to go from idea to implementation is still years.
And if it's going to take years to do that, a lot of these firms are going to get displaced. Because if you say five to 10 years out, quantum computing is okay, I'm going to say it right now, Anthony. Quantum computing is going to become commercial for the retail markets definitely before 2000 and 40s, no doubt in my mind.
And I think it's going to really start to come to actual implementation in 2032. Coming into the back half of the 2000-30s. Why should you care at all about that? When you're doing private credit, your line of credit is not six months long.
These are five to ten year debt investments.
They can't look at these ratios and just even get the data. They have to know how these technologies are going to affect these industries and if they're going to be wiped out. One of the things that even Marc Benioff, the founder and CEO of Salesforce has said, the future. This is a company that invented SaaS effectively.
SaaS companies, they print money, they are so bankable.
Oracle, right. They're not a SaaS company, but they're a major beneficiary and they're raising tens of billions in debt. A lot of these companies are raising tens of billions debt and guess what? Private credit is willing to close their eyes and write a check on data centers, anything nuclear, anything AI, anything as quickly as possible. There's so much cash coming in, but the disruption in the process is very similar to dot com, but on a whole nother scale. So I think the innovation curve, private credit being able to understand not only the underlying assets using these technologies to be able to understand the risk from that standpoint, but then you've got the tech and how it's shifting and how that's going to displace a lot of these assets. So it may be a fantastic quality asset that you're underwriting today, but doing five year, 10 year terms on anything that's going to get affected by AI and soon to be qualified quantum after that. I am very concerned with how long these assets are going to be out there in the middle of one of the biggest transformations that we'll see. I think dramatically bigger than the Industrial Revolution and in a timeframe that is going to be in a matter of years. And I do not think that private credit is going to be able to adapt to it because the outstanding debt that's going to be out there is going to be. If it's 2025, it's already 2035 for a lot of these assets. It's going to be 2040 for a lot of these assets.
[00:33:53] Speaker A: Yeah.
Well, that's a great insight and I happen to agree with you on the technology front.
I see it in our business. I see it with our clients and where they're looking and it's both exciting and concerning at the same time.
I will say, though, and maybe to wrap it up here, it sounds like the years ahead are going to be filled with disruption.
And for people like me and you, that's somewhat exciting. My firm thrives when there's disruption and that's where we really succeed. And same with you and your underlying product and your client base. So for guys like us, that's a good thing. But hopefully that disruption is contained and doesn't do more harm than good. But time will tell.
So jp, I appreciate the insights. It's extremely fascinating and interesting listening, particularly from an insider who has a private credit fund and utilizing that technology and your expertise around technology. So I appreciate the time. Thank you very much and we'll talk to you soon. Take care.
[00:35:08] Speaker B: Thanks, Anthony.
