Private Credit Turmoil? Keep Calm and Kiwi On.

There has been turmoil and much media attention in the private credit space lately as some very large private credit managers in the United States have had challenges with liquidity, portfolio concentration, and write-downs. Investors are understandably nervous.  We have previously written about why this has come about (here), and also how investors can evaluate private credit alternatives so that they don’t find themselves caught up in this turmoil (here). 

At Kilgour Williams Capital, we’re not experiencing the challenges being faced by the largest managers as our approach to private credit (“the Kiwi approach”) is very different from theirs.  Broadly speaking, the large firms have portfolios where the average loan size exceeds $100 million.  Kiwi specializes in funding small loans to small businesses where the average loan size is about $125,000.   Beyond this fundamental high-level difference in strategy, there are 5 main areas where the Kiwi approach differs markedly from the players who are in the news these days: leverage, independence, liquidity, diversification, and valuation.  Let’s unpack those.

Leverage

In order to generate the target yield for investors, the big firms need to add at least one full turn of leverage to their strategies.  This is because borrowers who are creditworthy for a $100+ million loan often have other options for borrowing, either the syndicated loan market or high yield bond issuance, both of which are typically lower cost options.  This drives down the return available to the large funds. 

To compensate, they add leverage.  In good times, adding leverage increases returns, but when times change leverage magnifies losses.  At Kiwi, our loans generate significant yield because we don’t have to compete with cheaper sources of capital.  Accordingly, we don’t require significant leverage in order to generate return for investors.

Independence

Many of the large US-based private credit managers that you’ve been reading about lately also happen to manage large private equity managers.  This is not a coincidence.  In recent years it has been very trendy to speak about ‘sponsor-backed’ private credit loans where the borrower is owned by a private equity fund and the manager of that fund also manages the private credit fund that provided the loan. 

This can lead to significant conflicts of interest in that equity and debt holders have different interests and certainly different tolerances for risk.  At the extreme, we’ve heard of private credit loans where the use of proceeds from the loan was to pay a large dividend to the private equity investor.   At Kilgour Williams, we want our borrowers to succeed, but we don’t take equity positions in them as that would compromise our independence.

Liquidity

Most people understand that private credit assets are illiquid relative to publicly traded securities. That said, it remains important for fund managers to align the liquidity terms promised to investors with the liquidity profile of the assets in the fund.

At Kiwi, we offer liquidity to investors who provide 2-3 months advance notice. That notice period is sufficient for us to ensure that we have cash available to meet investor requests. We accomplish this by having short term loans (6 – 24 months) where all loans are fully amortizing and make frequent, often daily payments of principal and income. And we don’t advance loans that offer payment in kind (“PIK”) interest where interest is accrued but not paid until a loan matures.

In contrast, the large funds typically make longer term loans that do not require regular payments of principal and increasingly they offer PIK interest options in order to win deals. This significantly limits the day-to-day cash flow that is available to provide liquidity to investors.

Diversification

Diversification is the only free lunch in investing.  This is particularly true in private credit.  It reduces down-side risk without surrendering any upside potential.  Unfortunately, we’ve seen a trend to more concentrated portfolios within the larger funds as they trend toward doing larger deals.  The motivation for this is that it’s easier to deploy the large amount of capital in these large funds by doing fewer, larger transactions rather than many smaller deals.  However, when a loan defaults – as some inevitably do – the impact on the portfolio is more significant and can result in losses to the investor. 

At Kiwi, we are committed to massive diversification and since we have lending partners who originate significant loan volume which is available to us, we are not tempted to fund larger loans.  With over 1,000 loans in our portfolio at any time, rigid policy restrictions around maximum loan size, and geographical and industry concentration limits, we have significantly mitigated our portfolio’s risk.

Valuation

Similar to the liquidity issue, most people understand there is no market quotation for private loans.  The lack of a market quotation doesn’t relieve us of the obligation to provide timely and transparent valuations.  Rather, it makes it even more important for private credit managers to do everything possible to provide independent, frequent and transparent valuations of their portfolios.  

At Kiwi, we take this very seriously.  Since launching our strategy in 2017, we have engaged an external independent valuation agent to value every loan in our portfolio every month. The valuation is conducted analytically and objectively, using a statistical model based on comparable historical results.  This valuation feeds directly into our fund results which we publish monthly.   Our valuation methodology is reviewed annually by the fund’s auditors and is available to investors who want to better understand it. When you see our results each month, they reflect the current performance of the portfolio, inclusive of any delinquency or defaults.  

We understand that not all managers take a similar approach as we do.  Valuations at the larger firms can be more subjective in nature and also less frequent than monthly.  And the methodology is certainly not transparent.  We see the impact of this when investors get blindsided as they have recently by large write-downs.

Keep Calm and Kiwi On

In sum, the Kiwi approach to private credit investing is very different from that of the large US managers we’re reading about in the news.  The type of credit we invest in is very different and our approach differs greatly from theirs on these 5 key dimensions. Accordingly, we’re not seeing the stresses in our portfolio that they’re experiencing and frankly we don’t expect to.

If you are affected by one or more of these large funds, we encourage you to reach out to the manager to get as much information as you can about your holdings.  If you are a current investor in one of our funds you’re always welcome to reach out to us, but in the meantime, keep calm and Kiwi on.