Private Credit Markets Offer Investors Double-Digit Returns

One direct lending fund returned 12.7% last year;
seen as alternative to measly returns on bonds.

As traditional bond funds scramble to navigate around the threat of rising interest rates, a growing number of investors and financial advisers are tapping into private credit markets, thanks to an expanding network of entry points.

“It’s a great concept, but it’s definitely a matter doing enough due diligence to make sure you like the company you’re doing business with,” said David Reyes, founder of Financial Architecture, a financial advisory firm that has been allocating client assets to the private credit markets for nearly a year.

When stacked against traditional bond funds that carry both inflation and interest rate risks, Mr. Reyes described the private credit markets as a “no-brainer, because it’s a natural to take money out of bond funds and replace that allocation with this kind of investment.”

What investors and advisers like Mr. Reyes are tapping into is a growing niche of the so-called peer-to-peer lending market, which is expanding by filling gaps ignored by traditional banking systems.

“We are targeting a market that was underserved by banks and was being overcharged by other alternative lending options,” said Ethan Senturia, chief executive of Dealstruck Inc., one of the growing list of no-balance-sheet lending companies that rely on outside investors to capitalize and hold the loan portfolios.

That’s where the investment opportunity comes in.

Companies like Dealstruck are handLing the upfront and operational lending issues for loans of between $50,000 and $250,000 — taken mostly by small businesses — which are capitalized by outside investors for minimums starting at $5,000.

Even though the minimums are sometimes low, this is still considered a private investment arena, and investors must meet the same net-worth standards required of hedge fund investors.

Mr. Senturia, whose firm recently made its 100th loan after less than a year of actively lending, said firms like his are taking market share from the $10 billion cash advance industry, and from the $125 billion factoring market, in which companies finance the sale of their own products.

The loans, which typically have durations of less than two years, come with interest rates of between 15% and 36%.

“Our rates are higher than those charged by banks, but they are much, much lower than the alternatives, which can sometimes mean rates in the triple digits,” Mr. Senturia said.

Brendan Ross, president and portfolio manager at Direct Lending Investments, launched a hedge fund in November 2012 for the specific purpose of investing in this category of small private loans.

The $55 million Direct Lending Income Fund, which has a $100,000 investment minimum and currently holds 1,700 loans, generated a 12.7% return after fees and expenses last year. And the fund is currently up 6.7% through July.

That compares to a 2% decline by the Barclays U.S. Aggregate Bond Index last year, and a 3.7% gain this year through July.

“All I do is buy and hold loans of between six and 18 months in duration that are amortizing daily,” Mr. Ross said. “The whole idea is to focus on the part of the credit market where borrowers are paying the most interest.”

While the loan rates, which represent income to investors, sound high, the reality is less sensational because the loans are often paid off early, and they are structured like a home mortgage where the interest is constantly being applied to a shrinking principal.

For example, a $100,000 one-year loan at a 20% interest rate will cost the borrower $10,000, or 10%, if all payments are made on schedule.

Eric Thurber, one of the founders of Three Bridge Wealth Advisors, uses Mr. Ross’ hedge fund for his clientele, which is made up of wealthy families.

“It’s a relatively new investment for us,” he said. “But we are allocating to less traditional fixed income than we have in the past, and about half of our client portfolios are allocated to alternative and illiquid investments.”

While liquidity is usually an issue with private investments, the short duration of the loans and the fact the portfolio is turning over at a 20% monthly rate makes liquidity less of an issue, according to Mr. Ross, who provides his 85 investors with liquidity on 35 days’ notice.

The default risks are similar to those faced by any lending institution. But because the loans are set to fixed rates and are held to maturity, the portfolio is uniquely shielded from interest rate and inflation-related risks.

Mr. Ross said the category has a 7% annualized default rate, and that his portfolio’s break-even point would kick in if the default rate got above 22%.

“Our average borrower has been in business for 12 years, at an average age of 51, and has an average credit score of 680, with business revenues of between half a million and $55 million,” he said. “That’s the sweet spot we’re dealing with — the same group of businesses that was once being served by community banks.”

Julie Reyes

Chief Financial Officer, Chief Compliance Officer

Julie Reyes is Chief Financial Officer and Chief Compliance Officer with Reyes Financial Architecture, Inc., a Registered Investment Advisory Firm specializing in portfolio risk management strategies, retirement income distribution and generational wealth planning. Julie is a Certified Public Accountant (Inactive) and a California Real Estate Broker. She also holds multiple licenses in the insurance and financial services fields. Julie graduated from Pennsylvania State University, with distinguished honors in 1997 and began her career with Price Waterhouse, LLP that year specializing in tax and audit. She became a California Real Estate Broker in 2002. Julie has worked with David and Reyes Financial Architecture since the company’s inception, and uses her financial background and expertise to help a wide range of clients protect their assets, minimize their tax liabilities and maximize their cash flow.

David Reyes

David Reyes is the Founder of Reyes Financial Architecture, Inc., a Registered Investment Advisory Firm specializing in portfolio risk managed strategies, retirement income distribution planning and social security planning. David works in collaboration with CPA’s, attorneys and other money managers to ensure that all planning is not only implemented but also integrated. This collaborative team approach seeks to ensure the highest probability of success.

David has been an advisor for over 20 years and holds multiple licenses and registrations in the financial, real estate, and insurance fields. David is featured in many magazines such as “Kiplinger Personal Finance Magazine,” “Boomer Market Advisor,” and is co-author of four books on estate and retirement planning. David’s latest book “The Little Red Book of Retirement” has recently been released. Currently David is working on a new book entitled, “Momma’s Secret Recipe to a Successful Retirement” with Jack Canfield. David advises many professional and public groups including CPA’s and Attorneys on retirement, taxes, estate planning, and asset protection. David is also the host of “The Retirement Architect Radio” heard every Saturday on 1210 AM KPRZ.

David is a distinguished graduate from UCLA’s Personal Financial Planning program and is a graduate of e Wharton Business School in their Retirement Income Planning Certification program. David has also been named 2015 Advisor of the Year by the National Social Security Association (NSSA) for his advocacy to educate retirees on maximizing their retirement income.

David and Julie have been blessed with three wonderful children, Morgan, Taylor and young David Reyes, III. David’s hobbies include Tennis, Church fellowship and spending time with his family.