Private Credit: Riches in the Niches

Boom, people, welcome back. We're going to talk all about private credit, anything you're doing with debt and markets. So welcome to this section. We're going to dive in, talk all things private credit, how to build a private credit firm, a private credit fund. Now, I ran 2 private credit funds prior, and I've helped a lot of people in Black Card do this. And now, mine were— I'm going to talk about mine a little bit— very niche. And I will tell you that personally, people that I'm talking to probably in our Black Card community, the riches are made in the niches. In private credit because there is a lot of private credit players. There's a huge landscape of huge all the way down to micro. And if you can find a specific niche that derives alpha, I believe you can do very, very well. For example, my fund, we were doing short-term loans. I worked at a business in college. This is my first fund I ever started. We were— I was at this business. They had clients coming through this business that needed financing. And these clients, what they would do, we'd come in and they were— we would only work with the clients that were maxed out on their credit cards. We'd come in, we'd give them a debt consolidation loan. We consolidate down their credit card debt. Let's call this person, let's say they had $10,000 of credit card debt. We consolidate it down into one loan from us. We'd pay off their credit cards. It would make their credit look really good. It would update on the reporting balances. They could then go out and get business credit for $50,000, $60,000, $70,000, $100,000. Then once they got the $70,000 of business credit, they would come back to us and then they would— pay us back our loan plus interest rate. We did extremely well over the years. We did over 300+ loans. We had less than a 1.5% default rate. Our returns to our investors— we'll talk about returns and numbers all the time— we had a 64% net rate of return to investors year 1, 47% net rate of return year 2, and then year 3 was 36% cash-on-cash return to investors or net rate of return to investors. Year 3, we paid a distribution every month. We paid a distribution to investors, and people loved it. We then had a competitor come and buy us out. Actually, at the end of this, we're going to talk about exiting and selling portfolios or pools of loans, how you can exit a private credit fund. Now I'll say this: we just went to the Greenwich Economic Forum. Private credit was like the hot topic where interest rates are at right now. People loved the idea of private credit. A lot of money is flowing to private credit or debt funds because banks have tightened their balance sheets. Some lenders won't lend to certain asset classes where private credit can come in and fill those gaps where a bank says. says, we don't touch this area anymore. A private credit person can come in and say, hey, we'll touch it and we'll charge a little bit of a premium. And you can do very, very well. Private credit funds, at least last year when we went, were raising billions and billions of dollars were flowing into private credit. It's a hot asset class. You're in, you're in a good space. Like I said before, the riches are made in the niches. So in this section, in this section of the course, we're going to talk about the risks, exiting, how to play a private credit fund, how you should think about risk, reward, return, all that kind of stuff. And maybe a few things you should think about with that. So with that, let's dive in. All right. So let's dive into private credit. Private credit at a basic level is all about a few things. The biggest one is this, playing the spread. So we're going to go on the iPad here, playing the spread. Now, what do we mean by that? How— what's the spread on what you're borrowing or getting capital at and what are you lending it out at? And we'll look at a few other things of, you know, what's your default rate? How's risk mitigation when, you know, when deals go south? What's your collateral? All that kind of stuff. But at a basic sense, Here, playing the spread. So for example, you know if you can borrow at four percent and make loans at six percent, you have a spread, right? You have a difference there. It's then this example. It's a two percent spread. I'm going to show you in just a second with some math here how you can make loans at six percent and give your investors a twenty four percent rate of return. Okay, I'm going to do a little math here for you to show you where how are they making all these money? You know they're only doing loans at six percent. How are their invest getting a 24% rate of return? Well, this is how they are doing it. I'm going to give you some simple math here. And we'll use the same analogy here. So let's say you've got a $100 million fund. Okay? $100 million. And this is how it's broken up. You have borrowed $90 million from another lender at 4%. And you've raised $10 million from investors of equity for a total of $100 million. Okay? I'm just giving an example here. You can talk about the pros and cons of that later of how that would work, but this is a highly leveraged fund here. 10 to 1, or 9 times the amount of equity you have is in debt. Okay? For a total of $100 million. So then you are going to go make a loan. Let's say you just do simple, a $100 million loan for 1 year at 6%. Okay? So pretty simple math. You would make $6 million. So let's do the actual math down here. So let me break it down. This is how it would work. So you do the loan. This person, you do the loan at the end of the year, they're coming to pay you back. Okay. So they pay back. It all went well. They pay back the $100 million of principal. They then pay $6 million of interest. Right. It was a 6% loan for 1 year. Okay. And you, because we borrowed, remember, we borrowed $90 million at 4%. So we pay $3.6 million. Right. Because we borrowed this amount here. Following along so far on this simple example? We're borrowing at 4, making loans at 6. Leaves us a total of this transaction. We made $2.4 million. Okay, so not bad. I guess we made some money. It went well. We made $2.4 million. So what's our return to investors? Well, guess what? We've already paid back our debt. Right? So we made— we got $10 million of equity. Let me, let me do this. I'll put this up here a little bit. We got $10 million of equity and made $2.4 million on that money. So we produced, if you take $10 million right here over $2.4 million, that is a 24% rate of return. Not bad. See how that— you see how that math works? Because to our investors, right, we paid our debt services, all of our fees and everything. We raised $10 million and we produced $2.4 million off of $10 million raised. Now we borrowed $90 million, but we already paid the debt service back. So we produced a 24% rate of return to investors. Not bad. OK? Again, because we played the spread. So we lent money. See how that works? We lent money at 6%. We borrowed at 4%. We lent at 6%. A 2% spread turned into A 24% rate of return to investors. This is what everyone is doing. So when you're in the world of private credit, we talk about the landscape of private credit. The cheapest lender of all, the best lender is the Federal Reserve. Okay. So and I'm going to use just an example here. You guys can go get all the actual math because things change all the time. And I don't know when you're going to see this video, but let's just say if you can, by the way, if you can borrow from the Fed, Borrow from the Fed. Okay. They are the cheapest money by far. So let's say interest rates are 3.75% from the Fed. As of this recording, it's a little bit higher, but hopefully they're coming down here soon. Okay. 3.75% interest rate. Typically, that'll go to kind of some intermediate lenders. They borrow it, you know, these big banks. So Chase, Wells Fargo, they can borrow from the Fed at 3.75%. It's called the Fed funds rate. Okay. Another one they use is LIBOR. So LIBOR or the Fed funds rate. These London International Banking overnight rate. This is the rate that banks lend to each other every day or every night. Banks have to shore up their balance sheets and they lend at a certain rate. And, you know, if they're— if they get deposits or withdrawals every night, they have to strike and actually have enough cash. So they borrow money from each other. and sometimes from the Fed to balance all their books. And that's the Fed funds rate. The rate that they do that, let's just say for right now, is 3.75%. Okay. If the Fed funds rate or the LIBOR is around 3.75%, typically they're lending the money out. So let's just say like Chase Bank. Okay. Chase is going to lend that money out at— I'm using round numbers here for, you know, I don't know, let's, let's call it 4%. 4.75%, another percentage point on top of that. Okay? Chase will lend that out, but not to everybody, only to a certain group of people. And then from there, you know, you go down like, so your mortgage rate, if you're looking for mortgages, is going to be maybe closer. So a mortgage company and a mortgage company, it's going to be a direct line. They have Fannie Mae and Freddie Mac and there's a lot of intricacies there. I'm just giving you an example. Okay? But your mortgage price would be maybe 6.25%. And you go, well, wait, the Fed funds rate is 3.75%. Well, guess what? There's a bunch of intermediaries here all making money on you, just like we talked about, borrowing at 4% and they're playing a spread, okay? They are borrowing from the Federal Reserve at a cheaper price and giving you a mortgage on a house at 6.25% or a car loan or whatever. They're playing that rate. So, and there's a lot of times there's a bunch of different credit unions and in-betweens That are all taking a little bit of a spread. You know, they're taking 0.25%, they're taking 0.5%, and your end rate comes down to 6.25% for your mortgage. Okay? And that's where that, you know, if you look at the Fed funds rate and the gap, that's the mortgage spread. Now, I'm going to pause and just mention this. There are plenty of you that are smarter than me at this. I do not know the intricacies of all the banking universe. I'm just giving you an example here again of how, again, big banks play a spread. On private credit. Now, what I do know a lot about, though, is how you should play a spread. So hopefully as you grow bigger and I'll— and my— actually, my dad has a video on the back end about this. So he ran a private credit fund. So this is back in 2000, what, '03, '04, and '05. They ran a private credit fund. They were doing hard money loans and they looked at a number of things. We'll talk about this more. But at the beginning, they couldn't do this. There was no bank that would lend them $90 million at 4%. But over time, as they built a relationship with banks, as they built a fund, when you get bigger, banks give you better terms because you're a volume player. One of the biggest reasons funds are so great, especially for private credit, as you get bigger, you move up the food chain. Okay? When you're just a small little shop down, you're way down the food chain. No one cares about you. But when you're borrowing $3 billion a year from U.S. Bank or Wells Fargo, you move up the ladder and you get much better terms. You get closer to the Fed's funds rate. And if you're a trillion-dollar asset manager like Chase, you get to go directly to the Fed, Federal Reserve. And it takes years to move it, but it's, it's a worthwhile process to be on this. Now, on that same note, I mentioned earlier There are riches in the niches. Because when you're playing this game, oftentimes there's already a lot of big players in this space and they are up the— they're up the food ladder from you. OK? They are getting debt cheaper than you are. You know, you're borrowing at— let's go back to our example. You're borrowing at 4% and they're borrowing at 3.75%. Hence, they can beat you on deals. On big deals. So if you're, you know, someone's going to build a new stadium for, I don't know, the Raiders or the Mets or whoever the team is, there's already guys that are up this food ladder that are going to beat you out on that deal. However, if you're going to do like I was doing, small short-term loans for a, you know, business lines of credit that people are coming through, there's a lot of players. It's either too small, too niche for them. They're not going to touch those deals. And I can find a lot of riches in the niches. So, for example, my dad's group, they were doing, because some banks won't touch these, they were doing, and a very simple one is like hard money lending. Many of you might be doing this. Hard money or private money lending on real estate. Very simple business model. You are— I'm giving a loan for someone to go flip a house, whatever, on just real estate, whatever they want to do. I'm giving— I don't even care what they're doing, actually. Let me back up. I do not care what they're doing. All I care is about the collateral. And this is kind of the next piece we're going to talk about in the next videos. But the risks and the downsides and mitigating risk, we'll talk about this later. But I don't care about the real estate, the strategy, whatever. I mean, I kind of do, but all I care is about my collateral. I'm going to put a first deed of trust. So let's say the real estate is $100,000. I'm going to give a loan for $70,000. Because if this person goes to the Bahamas, they leave, they take off, guess what? I don't care. I have a first position lien on the real estate. So if they leave, guess what? I just bought essentially this real estate property for a 30% discount. Great. And guess what? If they pay me back, awesome. I earned some points and some fees. We'll talk about that in a minute. But pretty simple business model there. Looking at downside risk of hard money lending, I'm just going to— it's loan to own. Now you got to really ensure that your collateral is good and you're moving there. But that's a simple concept, right? Okay. I'm going to lend $70,000 on a $100,000 real estate piece, collateral. And if they default, well, guess what? I just take the collateral. And I make money either way. It mitigates my risk heavily. That sounds very simple. This is a very similar model all the way up the food ladder. Now it gets a little more complex on what the collateral is, but that's kind of it. You know, when you're doing huge multibillion-dollar leveraged buyouts, they will look, you know, Jersey Mike's, you know, sold recently to Blackstone, right? It was a leveraged buyout trade. So it was $2.5 billion, something like that. They're going to use a lot of debt on that deal. The debt position, and then they have equity that comes in as well from the fund. The fund goes and borrows debt from a bank. This is Blackstone. So they look at, OK, well, can Black— is Blackstone going to default on their debt? They seem like a pretty good borrower. They have a lot of— they have, you know, I don't know how much they have, like $500 billion in management. They're probably good for it. Number one. Number two, let's look at the assets of this business, Jersey Mike's. How many stores, location, brand value, all this kind of stuff. If we needed to and we had to foreclose and let's say we're doing debt of $1 point— I don't know, I'm just throwing terms out here, $1.75 billion. So even if the market drops, we lose $750 million of market value, could we still come into recoup? Is the collateral good enough for this investment? Yes or no? Now, there's a lot of spreadsheets, a lot of models. I'm very oversimplifying here, but that's generally what they're doing. Okay, what's the chances that Blackstone defaults? What's the chances if they default that we could grab the assets here and collateralize this loan? Just as simple as your $100,000 to $70,000. They're doing a very similar thing here with that. Now, certain debt players will come and stack this up as well. So, of the $1.75 billion, hey, we don't want to do the whole thing. We'll do, you know, the first billion. And then someone else does $200 million. And then someone else does $100 million. And you can have sometimes a debt stack all the way up to reach $1.75 billion. For example, when Elon bought Twitter, they— he had a huge— I can't remember the total numbers. It was over $20 billion. And I can't remember how many players. There was like a dozen or so debt firms that all stacked together in a capital stack. And they all got paid different interest payments because And let's say this guy's in first position, he'll earn 4% and this person will earn 4.5% and this person will earn 5% on that debt. And they have revenue generated from the business to pay that debt. And anyways, I go on and on. I won't. But these are the players, right? Again, riches are made in the niches. So if you can find a good niche that has relatively few players in it, and there's some industries that people, they're either too small or too whatever, they won't touch. You know, we, We help do buyouts of small laundromat businesses. That's it. We only do real estate on collateralized debt in, you know, Texas. Great. I would niche down. You can find a lot more riches in the niches.