TRANSCRIPT
Talk to me about the risk mitigation strategies we’re employing at the asset level.
The biggest feature is we’re investing in assets, not issuers. We’re doing our best to cleave off issuer risk. That’s especially important in niche when you have emerging originators. We’re looking for a segregated bankruptcy remote vehicle where the credit risk is attached to the assets, not the issuer. Next, we’re looking to maximize risk controls. This is a result of limited competition from other capital sources. Finally, one of the key features of credit risk that we underwrite is controlled principal exposure. We search out in our credit box rapidly self-amortizing structures that are fully self-liquidating and that are short term in nature. This just means that we kind of naturally cleave off certain market risks, such as interest rate sensitivities, duration sensitivities, and capital markets risk, otherwise known as refinancing risk. So if you package all three of those features together, you get a really durable credit profile.
Now, what strategies are we employing to mitigate risk at the portfolio level?
Our whole objective is to construct a portfolio full of unrelated assets. While a lot of folks will quote idiosyncratic assets or diverse collateral, what we think differentiates us is the source of repayment. Our investment returns are a) driven by events such as a lawsuit comes to fruition, or somebody gets a medical MRI scan or b) they’re tied to a contract that’s based on a bilateral counterparty. We’re not making a bet on someone buying or selling a security in the public markets. The diversity of the source repayments is what drives the uncorrelation of the asset pools both to the markets and amongst each other.
Second, we’re looking to mitigate the fund wrapper-level risks for an evergreen interval fund. So we have a unique tool to enhance our asset-liability mismatch risk mitigation strategy, and that’s just given the amortizing nature of our short-term book. We have this flow of cash flow coming back to us on a monthly basis and we’re more tightly controlling the reinvestment decision, or we can use that capital to meet investor liquidity demands if they need it.
Finally, how do we think about mitigating risk at the relationship or partnership level?
One of the key features of this strategy is we’re often one of the few capital providers to these emerging originators. That creates a tighter relationship that ultimately reduces investment risk in our strategy. For instance, we always put the originator in the first-loss position, so any underlying credit losses will accrue first to the originator and then hit any excess return and then principal loss. So there’s several layers of loss protection that we build into our facilities, and we can enforce that in our lending strategy and at a higher quantum due to limited capital competition. This also naturally aligns the underwriting and alignment with the originators. They’re making a bet on themselves because they’re the first line of losses.
In addition, we generally require a high quantum of overcollateralization and we look to cure that overcollateralization with any losses that occur. So we’ll do a static underwrite of the assets with an overcollateralization and a first-loss, and if asset performance dips down, we’ll actually force the originator to add cash or collateral to the pool to cure it, often on a weekly or monthly basis. That’s a very tight relationship that we feel differentiates us and adds a lot of value.
The final thing I’ll say is this lending strategy enables us to enact a performance-based allocation system. With our high surveillance and with a lot of covenants, the assets really need to perform to get more capital. So only our best performing assets and credit facilities to emerging originators will get more capital. We tend to lend it out on a layered basis, and if there are issues or problems, we’ll rapidly self-amortize that issuer out of the book. We feel that that’s a nice way to control risk, especially in an evergreen interval fund format.