Join host Jim Jockle on "Trading Tomorrow - Navigating Trends in Capital Markets," as he dives into the transformative impact of technology on the finance sector with Prath Reddy, president at Percent. In this episode, they explore the burgeoning realm of private credit, how technology is redefining accessibility and efficiency, and the pivotal role of data in shaping investment strategies. Discover how these advancements are changing transactions and capital markets.
Join host Jim Jockle on "Trading Tomorrow - Navigating Trends in Capital Markets," as he dives into the transformative impact of technology on the finance sector with Prath Reddy, president at Percent. In this episode, they explore the burgeoning realm of private credit, how technology is redefining accessibility and efficiency, and the pivotal role of data in shaping investment strategies. Discover how these advancements are changing transactions and capital markets.
Welcome to Trading Tomorrow Navigating Trends in Capital Markets, the podcast where we deep dive into the technologies reshaping the world of capital markets. I'm your host, jim Jockle, a veteran of the finance industry with a passion for the complexities of financial technologies and market trends. Because this is Trading Tomorrow navigating trends in capital markets, where the future of capital markets unfolds. The landscape of the finance sector is undergoing a shift. We are firsthand witnessing an era where traditional banking and finance standards are being reshaped by technological advancements. This transformation is bigger than just transitioning from paper-based systems to digital platforms. It encompasses the integration of cutting-edge technologies such as blockchain, artificial intelligence, mobile banking and more, which are fundamentally altering the way we engage with monetary assets and financial services. Innovations that are not only making financial transactions more efficient, but are also revolutionizing capital markets by accelerating traditional processes. And while change in most industries can be difficult, in the highly regulated financial world it can be downright impossible, but sometimes getting ahead of the technology curve can mean big business.
Jim:Joining us to discuss further is Prath Reddy. He's the president of Percent, which gives accredited investors access to private credit, alternative asset classes and privately negotiated loans and debt financing from non-bank lenders. Prath himself has over 12 years experience in financial services, mostly within investment banking. Before Percent, he was a director at UBS Investment Bank with their Debt Capital Markets Group. He has originated, structured and executed numerous fixed income securities for both public and private corporations across various sectors and markets during his career. Welcome, prth, welcome to the podcast.
Prath:Yeah, it's great to be here, James. Thanks so much for having me.
Jim:Yeah, so you know what. Let's start with the basics. Can you explain to our listeners what is private credit and why is it so enticing?
Prath:Sure, let's start off with a nicely loaded question. So I think private credit, to me at least, is kind of most accurately described as any lending that's taking place outside of the banking system. I think, traditionally speaking, most folks have gotten loans from banks, whether you're an individual or an enterprise in the business, and really, since the 2008 financial crisis, a lot of this lending has shifted into the non-bank lending space, meaning that these are effectively private lenders that are organized typically as credit funds or other types of vehicles that extend loans and credit to businesses and individuals that are really taking a larger share of the overall lending market, and so private credit can take the form of many different types of loans and you know different bells and whistles, but you know at its core it's really anything that's being done outside of the banking system.
Jim:In my view, and you know, I think private credit obviously has been top of mind for so many people. It's popping up, as you up, as a significant growth area for financial institutions as well as for investors. How would you say technology has transformed the landscape of private credit in terms of accessibility and efficiency.
Prath:I think it's helping to bring a couple of the deficiencies that I think a lot of the current players have been able or rather the current players have identified as being impediments for growth.
Prath:You know, I think traditionally speaking, lending as it has been done traditionally with banks, you know there is a long kind of process to extend loans and that typically has taken, you know, let's say, weeks, if not months in many cases, whether it's a mortgage or a commercial loan, and so that's kind of the speed at which, you know, the banking lending activity had taken place historically. Now, because a lot of this has shifted to private lenders, speed is a competitive factor for a lot of these firms to, you know, be able to take more market share away from their competitors as well as away from the banking industry in general. So I think a lot of the technology has focused on how to execute loans more efficiently, how to speed up the process to make credit decisions, to evaluate credit worthiness from borrowers, being able to extend terms as well as extend actual capital to the end borrower very quickly, and then, on the flip side, once that money is outstanding, then the conversation, from a technology standpoint, shifts to portfolio management. You know, how well are we actually tracking all the risks associated with the loan portfolio that we have? Are we getting as much data as we possibly can from the underlying borrowers to make active portfolio decisions, whether it's tracking loan covenants and a variety of factors that are embedded in these loan agreements, or potentially looking at extending terms or providing more in terms of the actual amount of debt extended to the underlying borrowers?
Prath:So all of that is becoming more data driven, and we've seen that take place primarily over the last five or six years, as a lot more capital has flown into you know, kind of call it the fintech lending space, fintech lending space, but even broadly, just a lot more investment into technology and tech platforms to help solve for a lot of this initial sourcing and speed and execution, as well as kind of on the back end with managing debt that's outstanding.
Jim:I think one of the biggest unknowns is the credit quality and the risks associated, as you raised. I mean, perhaps you can provide a little bit more insight, you know, for individual homeowners. You know FICO has been, you know, kind of the backbone if you will, but you know, even in previous credit crunches we've seen challenges around that. So you know what kind of data you know is being consumed to shed the light for the private credit industry.
Prath:Yeah, and the answer is anything that lenders can get their hands on. So you know there's a fair bit of information that is available in the public domain, of course. So you know, whether that's FICO scores or anything that you can get from effectively, like a background check or a credit check on the individual or, more broadly, as a corporation, is still certainly I think the core of the credit analysis.
Prath:However, depending on the credit product that's being extended, I think that there's probably more relevant attributes to take a look at to determine, you know, the ability for the borrower to repay. So, as an example, you know we take a look at a lot of different types of interesting lending platforms. You know, on the percent platform that we run here, and a lot of these strategies are niche in nature. You know they're looking at different ways to kind of extend credit to either consumers or small businesses, um, that are not your typical, uh, personal loan or mortgage or car loan, um, or commercial loan, for that matter. So you know, as, as kind of one of many examples, you know there's, there's a couple of lenders on our, on our platform, uh, non-bank lenders that are extending, you know, small, you know effectively business loans, but to gig economy workers, right.
Prath:So think about you know people who are actively engaged in Uber or Lyft or Grubhub, or you know any of these services where you know they are effectively relying on these income streams as their primary source of income, and so these personal loans are being extended to these individuals based on their activity on these platforms, how consistent they are in terms of generating income across all these different platforms.
Prath:So aggregating all that data across all these underlying kind of gig economy platforms is their primary method to determine whether or not any individual borrower can repay, how consistent they are, as well as integrating directly into, perhaps, the bank accounts into which all of these payments are being received, so that you know, as the lender, they're getting kind of repaid first and they have visibility as to what else you know they're, you know, spending money on, to kind of capture the behavior of the consumer as well, in addition to their sources of income. So being able to kind of really integrate where the money is moving is, you know, I think, a theme that we've seen across a lot of different interesting lending strategies that are out there. But again, it's kind of meeting consumers and businesses where they want you to provide them the best possible terms, and the world keeps changing in terms of how individuals and companies make money and how they spend it.
Jim:And just out of curiosity are you aware of any data specifically around default rates around?
Prath:default rates. You know, is private credit inherently more risky than traditional vehicles? Yeah, you know, going back several years of data and you know I think the rating agencies have done a decent job of kind of documenting what's been going on in private credit relative to what's been going on in public debt markets. But the overall consensus is that private credit is not inherently riskier than public debt markets or kind of other asset classes, for a couple of different reasons I think. Number one lenders have a lot of flexibility in terms of negotiating the best possible terms for themselves. In terms of negotiating the best possible terms for themselves, you know whether that's very restrictive covenants or, you know, to my earlier point, you know very intrusive monitoring, if you will, to capture data points to make them feel more comfortable. So the downside risk I think with private credit has largely been mitigated by, you know, these terms that are going into these lending agreements that give lenders a lot more visibility and comfort in an adverse scenario, but also their ability to renegotiate terms if things go bad.
Prath:And you know, being able to work directly with companies as an example is something that I think every you know credit fund out there expects to do in a default scenario. You don't want to just demand repayment, you're kind of working directly with the company to figure out well, what is the new repayment going to look like? How do we restructure this so that it makes sense for all of us? So the ability to navigate uncertainties as they arise, I think is a cornerstone of private credit. But even looking at some of the benchmark data that's out there, we regularly point to the ProScour Private Credit Default Index, which ProScour is a law firm that puts out and going back several years, whether it's lower middle market, middle market or upper middle market, whether it's lower middle market, middle market or upper middle market, defined by EBITDA of underlying companies, the default rates have hovered right around call it, 2% give or take across all those different categories and when you compare that with public markets and kind of high yield in particular, it's not that far off.
Jim:It's probably right along the same kind of curve if you go back several years or even decades. Yeah, I'd jokingly say, private credit seems about a little bit more safer than grocery store bonds.
Prath:Exactly. Well, maybe not safer than Kroger bonds, but maybe lesser than grocery stores, safer than Kroger bonds, but maybe lesser in grocery stores.
Jim:So let's talk about Percent a little bit. Obviously, this is about technology powering the markets. What is the core technology that powers Percent's platform and how does it differentiate from traditional financial tools?
Prath:Yeah. So we've taken the approach that transactions create data points and transactions bring all the different counterparties to the table to really put their best foot forward, whether it's the information that each counterparty would need or the capital that one or more counterparties need. So we really focus on syndication. The cornerstone of the Percent platform is private debt syndication. So if we get approached by an existing credit fund or a placement agent that's looking to syndicate a loan or a portion of a loan that they may have on their balance sheet, that's when they use the Percent platform to effectively securitize that individual loan and offer it up to the investors that are sitting on the other side of our platform. And so you know, bringing all these parties together at the point of a transaction, bringing all these parties together at the point of a transaction, leverages a lot of the information that is otherwise left unseen for most of the market. So, just to put that into context, a private credit fund is going to underwrite an underlying loan using all the information at their disposal at the point in which they originate that loan. So they're getting all that info from the borrower and they're probably memorializing it internally through a credit memo and debating it back and forth amongst their investment committee and so forth, and then eventually the loan exists. Now that information that they collected originally is just sitting with that fund for zealably forever.
Prath:No one else has access to that data.
Prath:It's a private loan transaction. However, if that credit fund wants to sell a piece of that loan to somebody else for any number of reasons whether it's they want to decrease their concentration on it or they just want to raise some liquidity, whatever the case may be they all of a sudden need to expose that loan file to a prospective buyer, and so when that happens, you're able to capture a lot of interesting underlying data as it relates to that borrower, and you have to present that in a manner that makes sense for investors. And so being at that point of transaction and execution for that sale of that loan positions the percent platform in a unique way by capturing all those data points, seeing all that memorialized in the actual note that's being offered to investors and being able to benchmark that data and those individual notes against the overall market. So we're really looking at aggregating all of this kind of private lending activity that's taking place by being the nexus as to where these loans change hands effectively, because otherwise you never see the data.
Jim:What about alternative investments? Have you seen a rise in that, and when did that start? How does Percent's platform accommodate the growing demand for assets like private credit? Love to learn a little bit more about that.
Prath:Yeah, I mean in terms of alternatives. We've seen alternatives become a larger portion of investor portfolios over the know, over the last, you know, call it 10 to 20 years. I think it kind of started with real estate and hedge funds being kind of the primary way for investors to diversify away from, you know, public equity and debt markets. And then, I'd say, over the last you know, five or 10 years, I think there's been a boom in, you know, online platforms, more accessible fund vehicles and managers that are focused on alternative strategies. And you know, I think, really post the financial crisis again, with the prevalence of private lenders out there that are looking to raise capital for their own funds to then extend loans, obviously to individuals and consumers like that has been a huge driver of raising capital from investors that are looking for alternative ways to invest. I think there's a lot of dry powder, I think. According to Frequent, which seems to be the premium data aggregator of sorts for private credit, I think the dry powder is in the hundreds of billions still and it continues to grow year over year, despite there being a lot more private credit being extended and that dry powder being used. There's just a lot more capital flowing in.
Prath:So, in my view, alternatives is really anything outside of public equities and public debt, but I'd say private credit is taking an increasing share of what that alternative slice of investor portfolios looks like. I think if you talk to RIAs across the space and financial advisors, the ones that are a bit further up the curve in terms of wanting to provide their investors and their clients with something that's a bit unique, are really looking at alternatives as being that differentiator. I think anybody can put you into the S&P 500, but if you're an advisor or part of an RIA platform that has access to alternatives and access to ways to diversify, you know you into uncorrelated investments against public equity and public bonds. You know that's a unique value prop. So you know, and there's a large swath of wealth, you know, in the United States that is effectively under the management of all of these RIAs across the board, and so they're also driving towards this trend of bringing more capital into alternative investments as well.
Jim:So, you know, let's talk a little bit about barriers though. Right, you know, in terms of, you know you mentioned R, mentioned ras and um you know certain investments, uh, kind of post-financial crisis, you know, 10, 12 years ago, at this point, you know, uh, only quibs or qualified investment buyers would be able to have access, uh to, to certain products from an institution. Um, institutional buyers have, you know, like uh for funds, have investment guidelines that are governing where they can allocate money.
Prath:What are some of the barriers and to what extent are to the wayside as it relates to, you know, retail and accredited retail investors being able to access these types of investments that were traditionally reserved for qualified institutional buyers and kind of institutional investors more broadly. Front, in terms of expanding the accredited investor definition, in terms of blessing a variety of retail-oriented structures that a lot of these funds and asset managers out there can now create an additional sleeve of distribution for the assets that they have under management. So, for example, apollo, blackstone, all the major funds out there, they use some combination of business development companies, bdcs, that are publicly traded. They'll use interval fund vehicles. They may have other kind of retail-oriented structures that just have lower minimums and that are, you know, funds that are 3C1 instead of 3C7. So you can still attract accredited investors from that kind of designation.
Prath:And so there's any number of levers to pull these days to expand the universe and distribution of an asset manager's strategy to get into the hands of a retail and accredited retail investors across the country. It's just a matter of which strategy do you want to choose. They all have their pros and cons, but as the end retail and accredited retail customer or user of these different vehicles to build your own portfolio or use it to be an advisor. I think there's more options than ever these days, versus 10 years ago. In addition to all those vehicles that I just mentioned, there's plenty of online investment platforms as well, of course, percent included. That kind of brings a lot of this deal flow to everyone's fingertips in a very convenient way.
Jim:So, in terms of all this dry powder and barriers being removed, that means there's a potential influx of very large volumes of capitals into the asset class. How would you say your technology is positioned to scale and handle significant interest.
Prath:Yeah, it's a great question. You know we've been building percent over the last several years with scale. You know, front of mind, we don't. You know the system and the platform that we created doesn't care if the loan is a million dollars or a billion dollars, or, you know, if a trillion dollars flows through it or a million dollars flows through it. Right, it's all kind of set up in a way where it is disclosing information to the different counterparties involved in a transaction in what we believe is kind of the cleanest and, you know, most accurate and most efficient way.
Prath:But it's, you know, to my earlier point, it's serving as kind of this, effectively like a clearinghouse of sorts for, you know, different types of lenders out there that are looking to sell exposure, to find buyers of that exposure on the other side, to create some level of liquidity in this market and, you know, provide access to investors that otherwise wouldn't have access, provide access to investors that otherwise wouldn't have access.
Prath:So for us, you know we wanted to position Percent, as you know, this counterparty that everybody can trust, that everyone can kind of lean on to be able to discover new opportunities to, you know, kind of deploy capital into private credit and build that allocation in a full service brokerage capacity. We are a registered broker dealer and so, as a percent investor, you're kind of creating a new brokerage account that is specifically dedicated to private credit, of course, but it should be an analogous experience to anybody logging into their Fidelity or Schwab or wherever you're kind of trading stocks and bonds to simply be able to log into your percent account and have a similar experience. That's kind of been our goal from day one, and I think, with the rise of all of the retail brokerage platforms that have come up over the last 20, 25 years since the dot-com era, we're simply kind of following similar playbooks, if you will, and using all those existing platforms as inspiration, just simply applying it to a different asset class.
Jim:So I'd like to talk to you a little bit about your blended notes. Can you explain what it is and tell us a little bit about the technology you utilize to make it a reality?
Prath:Yeah, blended notes are kind of our version of a managed vehicle, akin to, but not directly like, an ETF that you would be able to pick up in the public equity markets. It's meant to be an ability for investors to buy a portfolio of assets, a cut of a bunch of different types of deals, all according to a specific theme or strategy. So, for example, if you log in your percent account and you really just want exposure to US borrowers that have at least let's call it 12% coupons that pay monthly, then you can buy the latest blended note that specifically has those types of investments within it, so that you don't have to curate and build your own portfolio of those types of deals. So we offer different versions of this and on our end it's simply an allocation of capital into those underlying deals that meet that criteria. So it's not kind of discretionary on our side.
Prath:You're not investing in a manager in a traditional sense.
Prath:You're simply investing in a strategy that we execute in a black and white fashion and it's a low cost option to be able to get diversified exposure. You know it's effectively a very low management fee of 1%, a 10% kind of servicing fee or carry. So that compares favorably to the typical 2 and 20 that you would see from most managers out there. But you're getting a diversified deal flow that's going into those portfolios not just in terms of the borrower, but also whoever the manager is as well, but also whoever the manager is as well. You know, and to my earlier point, a lot of the deal flow that is flowing through the Percent platform is coming from underlying credit funds, underlying private credit lenders and non-bank lenders that are looking to sell exposure. So you're kind of getting diversification not just at the underlying borrower or obligor level, but also you know who's servicing those deals, those underlying loans, who's managing them, who's sourcing new ones and so forth. So you're getting kind of a broader kind of cut of the private credit landscape with each one of these deals.
Jim:So we've made it to the final question of the podcast and we call it the trend drop. It's like a desert island question. So if you could only track one trend in speeding up capital markets, what would that trend be?
Prath:Yeah, I think it's a good question.
Prath:I think there's a lot of different trends that are taking place right now across capital markets.
Prath:I do think that the trend that seems to resonate with most people, that everyone can kind of relate to because they see it active in public markets, is kind of liquidity, and I think a lot of people gravitated towards crypto and those types of assets because of the kind of perceived liquidity that was available across all the exchanges that were out there, being able to get in and out very quickly at whatever price.
Prath:And I do think that in private credit, as well as every other kind of alternative capital markets that are out there, driving liquidity into the space seems to be the holy grail and you know, kind of that trend seems to be picking up in private credit, although it's been a little bit slow. You know, if the public bond markets are inspiration, that market is still relatively illiquid in many ways, especially the corporate bond market, and so even on the public side, you know it's been a laggard relative to equities. So it's not too surprising that private credit has been kind of a laggard in the alternative space when it comes to liquidity, in the alternative space when it comes to liquidity.
Prath:But I do think you know an active, robust secondary market is something that will speed up. You know the pace of primary offerings, the pace at which you know deals obviously change hands, the pace at which data is aggregated and disseminated by all the different, you know counterparties involved in the market and, you know, make it look more and more like the public equity markets, which I would argue are still not extremely efficient, but more efficient certainly than private markets.
Jim:Well Parath. I want to thank you so much for sharing your experience in arguably one of the most exciting asset classes and newest and best of luck to you. In percent.
Prath:Yeah, appreciate it so much, james, really great being on and thank you. Thank you so much.