E366: Keri Findley: The Credit Investor Peter Thiel Chose to Back

0:00Keri, you were introduced to me as the trader that Dan Loeb called the best adjusted by age trader he's ever met. What does that even mean? So I think that it was 2009, 2008, and Dan Loeb was trying to find structured credit talent to run a structured credit business for him. And he met people between the ages of 25 and 40. And, you know, I think that I probably wasn't the best person he met for the job, but age adjusted I was. And I think from his perspective, his view at the time was that by the time I grew into their age, I would be better than them. Obviously, as you age, you get better at a trader.

0:35But there must be some advantages of being a younger trader. What are they? At that time in that market of structured credit and mortgage-backed securities, being young was a huge advancement for me. I didn't have the scars of the financial crisis. I didn't have the scars of losing money and losing my job. I was able to think rationally and not emotionally. You know, it was one of these things where if you think about like every hedge fund had taken huge losses related to mortgage-backed securities or every hedge fund in the space and every trader was scared. How bad can it get? How bad can it get?

1:06You know, people at Bear Stearns created this like group called the Mod Squad. The Mod Squad was there to modify every mortgage loan that was outstanding. And they did that to protect their position. And I didn't have any of those battle scars. And so looking at mortgage-backed securities at that time, I was able to take a very rational, not emotional kind of look at, okay, how bad could it really be? How bad can losses be? How bad can housing be? In a way that wasn't colored by how bad it had been. And you started out this pressure cooker that was third point with one of the top credit teams.

1:38You've now developed yourself, your own firm as a top trader. When it comes to credit, where on the risk spectrum are the best credit investors? I don't think they're on the risk spectrum. And I look at it just differently. I think we're on the illiquidity spectrum. I always liked assets that were perceived to be risky, but I never thought they were as risky. I just thought they were very illiquid. And what that means is they don't fit nicely in a box. Usually a mutual fund can't buy them. Sometimes banks can't own them. They don't have ratings that would be associated with being able to be owned by an insurance company or someone like that.

2:14And so there's just a smaller buyer base. And so these assets are less liquid. What's upstream of that? Is that being able to find these type of opportunities? Is it access? What is it that makes a great credit muster? You'll find, create, and analyze. Back in 2009, there were all these mortgage bonds that were out there. They had all been downgraded from AAA to D. And so I realized, and many other people realized, that you took these bonds and they were rated D because they were going to take at least$1 of loss. Well,$1 of loss isn't that bad if the bond is trading at$0.60 on the dollar. It could take$40 of losses.

2:50And so I looked at it and I was like, okay, how do we create an asset that a mutual fund wants to buy at a really low rate? And then what else can I create from that? So we started taking these AAA, now downgraded to D or default bonds, selling them into trusts, getting S &P or Moody's or Fitch to put a rating on a percentage of it. And so they'd come back to us and say, I'll rate 60 % of this bond single A. Well, now I have a bond that traded at 60. I have a mutual fund out there buying this new single A bond. And I was able to create these unrated, defaulted Mez bonds off of it, which was the bottom 40%.

3:28They wouldn't rate at the beginning at like two times the coupon. So I was able to buy them at about 10 cents. And they were very illiquid. Nobody wanted them, but they paid me interest every month. And the downside was they'd pay me interest every month for a really long time. The upside was maybe I'd get some principal back. And I looked at these as the best risk-adjusted return assets I had ever seen. And for the most part, these assets paid interest for five, six, seven years. And in many cases, we got 50 % to 70 % of our principal back. And so it really is finding, creating, and analyzing risk that other people probably just didn't want to take, maybe because they can't, or maybe because the buyer base is so small because of limitations they may have.

4:12It reminds me of the story of the two economists walking on the side of the street and they see a$100 bill on the ground. Neither of them goes to pick it up and they keep on walking and a passerbier comes by and says, why didn't you pick it up? And they said, it shouldn't exist. That's correct. It shouldn't exist. Maybe you could double click on why that trade did exist and how that relates to being a good credit investor. The trade existed because insurance companies had to have ratings. Mutual funds had to have ratings. The hedge funds had just all lost a lot of money on mortgage-backed securities during the financial crisis.

4:43Banks had to have ratings or trade them quickly. And so the buyer bases just went away. And so the trade of, OK, there was a forced seller of the bond. And so if this bond previously lived in a bank portfolio, a mutual fund portfolio, it got downgraded to D or default, and they now had to sell it. And there just weren't a lot of buyers. and the kind of buy-sell lack of equilibrium created this opportunity where people like me could buy this bond at 60 cents on the dollar and then restructure it into this trust where I was able to get 60 % of it rated single A, sell that at about 95 cents. And then my 40%, I was able to buy at about 10.

5:23And being able to do that, it just, it existed because of what I would call a ratings arbitrage. Preparing for this interview, I read everything about Dan Lowe, obviously multi-billionaire, extremely successful. What was his superpower? I think he is the best in the world at hearing three, five stories and understanding which one Mr. Market is going to receive well. I remember back in the day, he would hear a story, you know, it's public, what about Yahoo? And the story of like, okay, the sum of the parts of Yahoo was worth more than it was trading at. I mean, he just - And that's because of Alibaba?

5:56In that case, it was Alibaba and I believe Yahoo Japan. And then you were creating the core Yahoo business for free or something like that. But the high level was that he really understood some of the parts analysis. And again, if the market, when given the analysis, if the market would understand it in a way that it wasn't today, and then it would go up. Tell me about the CXHE bond trade in 2005. CXHE was a mortgage originator pre-crisis called Centex. And Centex was originating actually very good performing, clean subprime, but good performing subprime mortgage bonds. And in 2010, a trader from a bank called Jeffries calls me up and says, I have this bond you should look at.

6:41The name of it is CXHE 2005 DM4. And I'm looking at this bond and I said, well, so why do you like it? And he said, if you run 1 ,990, you still get a 9 % yield. Well, what that meant was if you run 1 % expected prepayments, which is people prepaying their mortgage loan, 9 % expected defaults annually. That's 9 % of the pool defaulting annually. And 90 % severity, which means that every house that defaults sells for a 90 % loss on a loan, so 10 % of its money back. And I said to him, well, so you're thinking that 90 % of these loans are going to default? And he's like, well, I like knowing if they do, that I still get a 9 % yield.

7:20And I'm like, OK, this doesn't make any sense. And then like looking at every chart, trying to get data. And I found some chart that showed at the time in 2010 that 97 % of mortgage loans that actually end up defaulting default by month 60. So I'm looking at this bond. We're at like month 59. And it's only like 20 or 25 % delinquent. And so I'm like, OK, so if the data shows that 97 % of defaults occur by month 60, and you're saying that this is 25 % delinquent and 90 % are going to default, that's like saying that only like 25 % of the defaults-ish have happened. That doesn't make any sense. So I started running like, okay, what if 85 % of the loans default?

8:00Okay, what if it's 80? What if it's 70? And all of a sudden, this bond went from a 9 % yield to like a 25 % yield. And so I started buying bonds that were about 60 months seasoned that were what I would call the fulcrum security, where if losses weren't what the street was expecting, they had huge pops in value. And it just changed my way of thinking about it. It's like, yes, you have a base case, but let's look a little bit below that base case and see, okay, if 90 % is a 9 % yield, what if defaults are 85 %? Well, what if they're 75 %? Well, what if they're 65 %? And I think defaults on that pool, if I remember correctly, ended up being 40 something percent.

8:37And so this bond ended up getting 100 cents on the dollar back. And I believe I bought it at the time somewhere between 12 and 14 cents on the dollar. This is another variation of this Warren Buffett, where in the short term, the market is a voting machine and in the long term, it's a weighing machine. At some point, no matter how contrarian the trade is, the market will catch up to the thesis. So yes, but it didn't mean there was a lot of pain in the meantime. So I bought this bond in 2010. In 2011, this bond probably went down 30 or 40%. And, you know, you're thinking, oh my God, am I going to get stopped out?

9:10Am I going to have to sell these things? And like down 30 or 40%, like I don't think there were any buyers down 30 or 40%. I think there were just sellers. And so it was a really bad time where there was no liquidity in the market. People had this perception that loans weren't going to be advanced against. And what that means is that if the borrower stopped paying his interest, that the servicer who's supposed to advance it won't. And they thought that was going to make these bonds a lot less valuable. I actually thought it was going to make them more valuable because if you're not making my interest payment for me, if you're the servicer, when I sell the house, there's going to be more value left.

9:45And so there's all these complications as to why I thought it was worth more and everyone else thought it was worth less. And then your calendar year of 2011 ended. Calendar year of 2012 opened. And at that point, this group called NAIC, which is the National Association of Insurance, maybe commissioner, started rating these bonds. And they started saying, OK, Moody's, Fitch, S &P, your typical rating agencies, you guys aren't rating these properly. We're going to put ratings on them. And so they actually started putting prices on them. And so if you're an insurance company, now this bond that you couldn't own at all, as long as you bought it, if the NAIC price was 70, as long as you bought it below 70, you got tier one capital treatment on it.

10:21And it changed the market. And then over time, it became a weighing machine. And these bonds went from trading at 10 to 15 cents to 20 to 30 cents to 30 to 40 cents to 40 to 50 cents. And then at some point they started trading, you know, kind of north of 65, 70, which is where I started selling them. Because at that point, the market was perceiving that they were going to get 100 cents on the dollar back. It was just a long bond with a long duration. And it was just pulled apart at that point. And so I was like, OK, my credit trade on this is done. I'm not here to bet on the duration of this.

10:53I'm not here to bet on how many years it'll take to get your 100 cents back, just that you're going to get it back. I'll let the next buyer own them. this is one of those things that almost every great investor especially in the public market struggles with which is yes you might be right but what is the catalyst that's going to change the perception of the market and in many ways a lot of these things are unknowable what does that mean sometimes there's a famous activist investor that comes in and writes a letter to the board sometimes today there's somebody that makes an x post and you know does this whole dossier on the company, whether positively or negatively.

11:27It's very difficult, if not impossible, to predict the catalyst for something that's undervalued. In this case, I knew the catalyst was going to be time, and then I was wrong, and it was the NAIC pricing. So over time - You didn't need there to be a catalyst for you to make money. I didn't because bonds have fixed maturity, loans have fixed maturity. These were six or seven year duration bonds. Over six or seven years, I would have earned, if all I did was sit on those bonds, I would have earned a 20 plus percent yield as it pulled to par naturally. It just would have been a very long time. Instead, I was able to monetize these bonds in between two and four years as the market changed.

12:04But the catalyst would have been people making interest in principal payments, bonds paying down, the subprime mortgage structures, delevering. It would have happened. It just would have happened much slower. You had an implicit backstop there. Yes, of time. And then you saw a similar opportunity in SoFi. In 2013, I met SoFi through Goldman Sachs. And it was just shocking to me that SoFi had this whole idea that every student in the United States is lent to at the time at a 7.5 % rate by the federal government. In theory, 50 % of the borrowers are better, 50 % of the borrowers are worse. And SoFi's original idea was we're going to lend to the borrowers who are much better at a slightly better rate.

12:46So we're going to take the students who came out of Harvard, Yale, Princeton, Stanford, and a bunch of other schools with top names, and we're going to give them loans at 6%. Even though, just in theory, the government lent to them at 7%, there were probably 2 % to 3 % losses. And 7.5 minus 2 to 3 is, let's say, about 5%. Well, these top students they were lending to, they lent to them at 6 % and there was like 0.1 % losses. But over time, they had to prove it out. And so when they originally went out to get debt, nobody would give it to them. Eventually, you were able to get debt from funds and then from banks.

13:22And once they did that, I helped them finance their consumer loan portfolio, which was the same thesis. We're going to lend to the best borrowers in the country, and we're going to lend to them at a little bit of a better rate than Lending Club or a little bit of a better rate than they can get on their consumer unsecured loan at a bank. And so all of a sudden, you're looking at a pool that probably won't have many, if any, losses, and banks won't finance it. And so we did. And then very quickly, banks move in. And so once they can prove something out, again, this was a time exercise, right? if they're able to prove that losses are low in the student loan portfolio and the consumer portfolio for one year, for two years, all of a sudden, every bank in America wants to be part of that program.

14:02They just won't do it until it's proven out. I want to get back to how you structure these products in a bit. But first, with Tacora Capital today, a friend of mine said that it's Peter Thiel's biggest investment in any fund outside of Founders Fund. A, is that true? And B, how did you accomplish that? I don't think Peter's ever said that to me directly, but I've heard that as well. It's, I mean, it was really incredibly cool and really humbling and amazing. You know, I got to know him over a long period of time. I think that, you know, over time he grew to trust me. We'd talk about ideas, we'd talk about lending.

14:34It wasn't something he really knew or had interest in. And then one day I was, you know, trying to figure out how to start a fund. It's really hard, even with a track record from Third Point, even with a track record like I had, it's just really hard to get yourself in business. Maybe some people are better at it than me. Maybe Maybe they know who to talk to, but I just didn't. And I was at his house and he said, I want to be the biggest investor in your fund. And I was like, look, raising money is really hard for this. And he said, well, if I'm the only investor, if it's just you and me, that's just fine.

15:02And that's how we started. And why in the world would Peter Thiel want to invest in a lending fund? Peter cares more about like the person and trusting the person and knowing the person being ambitious, but also like being a good steward of capital than he cared about whether it was a lending fund or an equity fund. We create relatively interesting risks and securities. And I think he liked that. I think he knew that I had been around the venture ecosystem. You know, one of the reasons and one of the ways I got to know him was actually through SoFi. He was an investor in SoFi. His family office was in the same building as SoFi in the Presidio.

15:34And so that was, you know, that was very early on in getting to know him and getting to know, you know, kind of what he thinks about and his values. But I never pitched him. We just talked about ideas. And then one day at dinner, he offered to invest and I was shocked and it's been incredible. Expert calls have always been one of the most powerful ways to build conviction. But today, investors are asked to cover more companies, move faster, and do it with leaner teams. With AlphaSense AI-led expert calls, their TGIS call service team sources experts based on your research criteria and lets the AI interviewer get to work.

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17:26Take advantage of AlphaSense AI-led expert calls now. the first to see wins the rest follow learn more at alpha-sense.com slash how I invest it's maybe the most remarkable example of if you ask for money you get advice if you ask for advice you get money maybe I don't even know how much advice I asked for but he's always been very generous with it so I want to get back to we we talked about earlier about SoFi and the product creation that you did there is that one of your operating principles and that you're solving problems or are you looking for the most undervalued assets, existing assets in the market?

18:02I think we're looking for more illiquidity than we are looking for undervalued, but maybe those two things are more similar than I'm giving you credit for. But we are looking to solve problems. If you're a venture-backed business and you have a marketplace between ranchers and farmers and food distributors, you might get those ranchers and farmers a lot more money for their food. And This is a real deal that we looked at. And all of a sudden, the ranchers and farmers are so happy. They can sell their food for 30, 40 % more than they were six weeks ago. That changes their life. Well, then they realize that the guy they were selling it to, 40 % less, paid them within seven days.

18:39And this new national food distributor probably doesn't pay them for 90 to 180 days. Well, that's one to two seasons of their annual revenue. They can't put the money back into the next product, the next crop, the next herd. and all of a sudden they can't sell their food at 40 % more because they don't get the money quick enough. And so that company goes out there and they're like, okay, we just created a problem we didn't expect to create, but now we have to solve it. We have a customer that trusts us, the rancher or the farmer. Let's do an invoice purchasing product. A small cattle ranch in Montana, a national food kind of buyer slash market, does a transaction, and now the company is buying the invoice.

19:18We would lend the company the money to finance that purchase. It's anything from that to insurance products that we know have really low loss ratios because they're small and niche and proven out. And they need statutory or regulatory capital to get in business, to put money at the state insurance fund, and then also the surplus note in the actual insurance company itself. We'll do anything kind of that spans that gamut of anywhere from invoice finance, lending products, receivables finance, statutory capital, loans, leases, kind of anything in the financial services world. And how much of your book is adjacent to startups or around the startup ecosystem?

19:5580-ish. The other 20, though, are, you know, just not venture backed. They're still startup-y. You know, it's still a guy who started a business who, you know, financed it himself, bootstrapped it and has a financial service product. He just isn't in the VC startup ecosystem. Is this essentially a strategy that does really well, but it's very difficult to scale because as you scale, you're competing against those banks? You can't scale. Like the scaling just doesn't work. You're not just competing against banks. You're competing against Aries and Apollo and Blue Owl and Blackstone. And it's really funny because people often ask about the competition in the market and it's actually less now than it was two years ago.

20:37And people ask why. Well, the reason is because, you know, Blue Owl used to have maybe a two, three billion dollar fund in asset based lending. Now it's probably like 10 to 20. And they're obviously not 10 times the staff they were two to three years ago. And so they just have to make their deal size bigger. I mean, we can't process. It's going to be hard. We raised Fund 2 as a 700 million dollar fund. It is going to be hard to put that all to work. And we stay disciplined and we don't want to do bad deals and bad deals are fund killers. So you don't. And so you have to be pacing and just looking for all the same issues you look for.

21:10And you can't overlook them just because you have more money to put to work. It just doesn't work. And so, you know, we're kind of in a position where we might put the whole fund to work. We might be 80 percent. We don't know yet. We're working on it. But we see less competition because the big guys deal with that same problem and they have to put now billions and billions to work. And so our average deal size stays around 30 something million and theirs is probably closer to 150. I'm sure your LPs are totally fine with being in a capacity constrained, you know, good returning fund. But you yourself, how do you look at not being able to grow, not constantly increasing your fund size and your fund strategy?

21:46I like what I do enough that like... Why? Why do you like what you do? Oh, I find it fascinating. I mean, we get to deal with like some of the most interesting entrepreneurs, some of the most interesting problems. We meet people who are also really passionate about what they do, and we get to help them and work with them. We get to help them try to solve their problems. We get to help them work on, work through their problems. It's an unbelievably interesting and fascinating set of people we deal with. And the ones who are ethical are amazing and we love them. And then obviously you get the other half, or not half, the other 10 % who aren't.

22:16And that's like the part of the job that I dislike, I don't enjoy. But the 90 % that work hard, whether it's a good outcome or a bad outcome, like they tried, you tried, and you gave it a go. I recently relearned something that I just believe dogmatically since I made my first startup investment in 2008, which is the size of a market, the size of a company is directly proportional to the problem that's solving. And in the startup ecosystem, this was kind of obvious. I've come to learn, lo and behold, shocking, the same is true in the capital markets. It's the funds that actually solve problems are the funds that have embedded alpha in it.

22:51And I don't know why it was so surprising to me, but I just see it now everywhere. and before I even ask somebody about their strategy or their investment mandate or anything, I like to ask a fundamental question. What problem are you solving? And the problem we're solving is that a lot of these companies come to us with an idea. Hey, we have this customer and we want to finance their invoices. Hey, we have this purchase order and we want to finance it. Like they haven't even done any yet. And so they ask us for a term sheet before they've financed their first invoice. Sometimes they've done three to 500 grand and we give them a term sheet and we spend hundreds of thousands of dollars on legal documenting this.

23:24These are relatively complex legal documents. Hopefully AI helps us with the cost some days, but not yet. And we're in a situation where we might have spent all this time, all this effort, and it might turn out that nobody wants to sell their invoices. Or the first three to five hundred thousand did, but the rest don't care. The rest are bankable. And you just don't know. And so we take the scaling risk, which is like investors will often say, well, why'd you do a one million dollar deal? And it's like, I never intended to do a one million dollar deal. I did a ten million dollar deal and they couldn't find their customer.