A Comparative Guide to Asset-Based Deals and Corporate Loans on Percent

Understanding the Risk-Reward Tradeoffs

In the complex world of private credit investing, understanding risk is paramount to achieving your long-term goals. At Percent, we’re committed to providing accredited investors with access to diverse investment opportunities, each with its own risk profile and potential rewards. 

Different Investments, Different Risks

On Percent’s private credit marketplace, we offer access to various investment types, each with its own unique risk profile and credit protections: 

• Asset-Based Securities (ABS)
• Corporate Loans
• LP Participations
• Blended Notes 

While each of these presents interesting opportunities, let’s focus on the two primary asset classes we work with: ABS and Corporate Loans.

Beyond Returns: Risk-Adjusted Decision Making

Successful investing isn’t just about chasing the highest Annual Percentage Yield (APY). While APY is important, it’s crucial to consider the associated risks and make decisions on a risk-adjusted basis. In essence, if all else is equal, a higher APY is desirable. However, the reality is that risk levels vary significantly across deals and asset classes, making a simple APY comparison insufficient. 

So, how do we compare ABS and Corporate Loans on Percent? Let’s dive in. 

Understanding Credit Protections

Both ABS and Corporate Loans offer distinct credit protections, acting as safeguards against underperformance or providing resources in the event of such an occurrence. These protections can be preventative, restricting borrower actions that could jeopardize your investment, or reactive, outlining recovery mechanisms in case of default. 

Asset-Based Securities

Asset-Based Securities on Percent are deals supported by a portfolio of underlying assets, such as consumer loans, small business loans, or other cash-generating assets. Here’s what you need to know about their risk profile:

Potential Sources of Repayment: The primary source of repayment for ABS investments comes from the cash flows generated by the underlying portfolio. For instance, if you invest in a note backed by Buy Now, Pay Later medical loans, your returns depend on the timely repayment of those loans by consumers. 

Credit Enhancements and Reporting: ABS deals on Percent come with several built-in protections: 

• Overcollateralization: Many ABS notes are structured with overcollateralization, meaning the value of the underlying portfolio exceeds the note’s value, providing a cushion against potential defaults. 
• Cash-Control Mechanisms: Percent might have control over collections from the underlying assets. 
• Collateral Verification: Third-party providers assess the existence and accuracy of collateral, mitigating fraud risk. 
• Surveillance: Regular performance reports offer detailed insights into the underlying portfolio’s health. 
• Due Diligence and Compliance: Ongoing checks ensure borrowers remain in good standing.

Corporate Loans

Corporate Loans on Percent are typically extended to more established businesses with a track record of operations. Here’s how they differ in terms of risk: 

Potential Sources of Repayment: The primary repayment source for Corporate Loans is the borrower’s ability to generate sufficient  cash flow to pay interest and repay principal on a timely basis. These loans are often provided to companies with a proven track record or those on a clear path to profitability. In some cases, the company’s assets may be pledged as collateral or the owners may provide personal performance guarantees, offering additional sources of recovery value in the event of a default.

Credit Enhancements and Reporting: Corporate loans on Percent may include: 

• Covenants: These can include maintenance covenants, restricted payments, minimum liquidity requirements, and limits on asset sales or additional indebtedness. 
• Surveillance: Investors typically receive monthly performance reports with financial information updates. 
• Due Diligence and Compliance: Regular checks to ensure borrower compliance. 

Comparing Risk Profiles

As of August 1, 2024, ABS transactions on Percent boasted a 17.74% weighted average APY with a 1.11% loss balance, while Corporate Loans had a 18.56% WA APY and a 6.60% loss balance. Historically, ABS deals have offered a compelling combination of high returns and lower risk, while Corporate Loans have presented higher potential returns but with increased risk.

Other Considerations

While this article focuses on ABS vs Corporate Loans, remember that other factors also play a crucial role in assessing risk: 

• Ranking: Senior or Subordinated notes have different risk-reward profiles.
• Geography: Consider the economic and political stability of the region.
• Industry/Sector: Understand industry-specific risks. 
• Term/Tenor of Note vs. Liquidity Needs: Match investment duration to your liquidity needs. 
• Credit Enhancements: Evaluate additional protections offered in specific deals. 

Risk Management Strategies

Effective risk management is key to achieving your financial goals. Here are some strategies to consider on Percent: 

1. Diversification: Spread your investments across different asset classes, sectors, and regions. 
2. Asset Allocation: Tailor your portfolio’s asset mix to your risk tolerance and goals. 
3. Risk-Adjusted Return: Assess investments based on their return relative to the risk taken. 
4. Regular Portfolio Review: Rebalance your portfolio periodically to maintain alignment with your goals. 

Remember, every deal is unique. APY is not a direct reflection of risk; it’s influenced by investor demand and the borrower’s target cost of capital. Always review individual deal pages for a comprehensive understanding of the specific risks involved. 

Investing isn’t just about maximizing returns; it’s about protecting your capital from potential losses. By understanding the different types of risks and employing effective risk management strategies, you can build a resilient and diversified portfolio that aligns with your financial goals. 

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Prath Reddy, CFA, is the President of Percent, bringing over a decade of experience in financial services and investment banking to his role. With extensive expertise in originating, structuring, and executing fixed-income securities for both public and private corporations, Prath offers valuable insights into the nuances of private credit investing and risk assessment.