MakerDAO Focus On, 23 Mar 2022

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From YouTube: Focus On #07 | RWF Lending Principles

Description

For the 7th episode of Focus On, we will host Eric Rapp from the RWF Core Unit.

Eric will lead a deep dive into more of the nuanced lending principles in play for RWAs, including:
• Crypto Lending Comparison
• RWA Risk Assessment
• Investment Grade Standard
• Structuring an Investment Grade Senior Loan
• Arm’s Length Transaction Standard
• Case Study

We will conclude with a Q&A to answer any follow up questions from the discussion.

A

It's thinking about it there we go well hello, everyone, and thank you for joining the seventh episode of focus on uh my name is retro, I'm a contributor at the sustainable ecosystem, skill and core unit, and I'm joined by juan our facilitator, and today, we're hosting eric rapp from the real world finance core unit.

A

Eric is going to be presenting the real world asset lending principles that he and his team uses to evaluate real world asset details and uh touch on the monitos risk profile a little bit at the end of the conversation using it as a case study to facilitate our conversation here. As you have questions, please feel free to drop them in the chat or the qa function and we'll address them during a pause in the action or at the end. So with that eric the floor is yours. Let me get your screen share here and take.

B

It away is it: are we shared okay, all right, good hi? My name is eric rapp, I'm in the rwa group. uh You know in terms of background I've been in traditional finance in various shapes and forms by about 20 plus years. You know, lately I've been more in fintech and then now in d5, and I just want to share with folks. You know in the rwa group. How do we think about um looking at you know: potential transactions, you know at the end of the day maker is basically a senior lender.

B

Hopefully senior secured you know, and how do you look at this? You know what are kind of the principles. What are some of the key processes you know? Hopefully this will help folks get a better idea of how we look at things. You know we're certainly open to innovation and criticism. You know we're not saying we have the only way. On the other hand, I will say yes a lot of what we're using has been developed in the real world for hundreds of years. People have lost a lot of money over the centuries.

B

You know not doing things certain ways and there's a rough way of doing things. It's not perfect, but I think there's some key principles that that, if you want to innovate, you should learn the key principles in the real world first and then figure out where you best think you can break them and not because you don't want to innovate and how to find ways to lose money, okie doke.

B

So in terms of the outline here, I want to first talk a bit about how it is crypto lending kind of the maker core product compared to uh real real world lending. There's some similar similarities and there's some definite differences. Then I want to talk a bit about the investment grade standard. You know it's what we're roughly trying to hit, um then I want to talk. You know more about how do we actually assess risk a bit more sense of the process?

B

Then, let's talk a bit about you know: how can you take a a pool of non-investment grade loans and create an investment grade senior part of it? You know it's kind of this remarkable transformation, structure, finance or maybe the full 100 million dollars.

B

You know say: there's a 100 loans of a million dollars each and they're not investment grade, but if you put them all together can maybe the top 70 or 80 percent b investment grade. You know, assuming the other part of it. You know, takes all the losses and absorbs the risk. First, that's part of the magic.

B

Then you know I want to talk a bit about the monetalist facility in terms of risks. You know returns and how does it compare in in terms of how we look at it? I I know there's been a lot of publicity in the forum about it, so I I think it's very fair to trying to give folks a sense, our perspective. It's not the only perspective. You know we're not the a or nay, but using these different tools, we will have gone through we're going to apply into monetalis.

B

Then I want to talk a bit about an arm's length. Transaction standard, which I think is is a key thing and I'll explain why down the road then? Finally, let's talk a bit about die stability risk. I think some of these topics are quite in depth and can have their own discussion site. I.E, die stability risk, but it's it's a concept. We really need to use when thinking about um making loans to different counterparties.

B

So with that in mind, I will take it away all right. So when we think about makers, crypto lending business, you know what's our basic strategy, you know how does maker get comfort that it's gonna get paid back almost all the time, because you know at the end of the day, what are our vaults maybe yield two or three percent, so if you're only getting two or three percent a year for the risk you're taking that kind of tells you you know, you're you're only going to make money.

B

If you get your money back almost all the time, you know if you're losing money, 10 percent of the time you're probably coming out um underwater. Needless to say, I think we're doing a good job because we're consistently making money, but keep that in mind if you're only earning a small amount. You know per year on your assets, you know your loans like two or three percent, that pretty much tells you how much risk you can take.

B

You know I.e not much. If you were earning 20 or 30 of your. You know on your assets, you could take a different type of risk all right. So how do we loan? uh How do we make crypto loans? You know if you want to open a vault with your bitcoin or eth one, it's gonna be supported by uh a crypto asset. That's locked in our vault, so it's secured is what we would say. You know maker controls that collateral maker controls that specific crypto assets.

B

So if there's any, you know issues about getting repaid, we were the first person to hold it. That's a big big deal in the lending world. You know you could probably say: 90 of uh of of the law is who possesses the assets and since we have it locked in our crypto vault, we possess it. Big deal two another big deal is senior in a sense, we're the only creditor supported by that asset, or at least we're the only creditor who's allowed to get paid back from that asset in our vault.

B

Until we're all you know, until we're made whole you know, maybe they have someone else who they owe money to, but the other creditor has no rights or has no ability to get to that collateral. Until we're happy that we've been paid off senior and secured big big deals um and over collateralized, you know again say: if we had a million dollar, we loaned a million dollars to someone on eath. You know each is pretty pretty risky. You know you've seen days when it could be down five or ten percent.

B

So we, if we loan someone a million dollars in each you know we probably want to have what a at least a million three a million for you know you've got this extra collateralization, so you know things go a little sideways. You know prices of the east decline. You still have enough to get out of there timely and get all your money back again.

B

These are, I think, defining principles of crypto lending and also, I think these you're gonna see these are defining principles in most lending um and now these next three are defining principles in crypto, but less so in our real world assets. One, it's fungible, you know like a bitcoin is a bitcoin. You know each is so the secure assets are, you know, they're, all homogenous, at least in their group. This is all bitcoin. This is all leave. We know exactly what it is. You know, there's nothing really idiosyncratic too transparent.

B

The prices of these you know be a bitcoin or eth are observable and frequently updated. You know these things tend to trade 24 7 worldwide. So you, you know, we know as a lender what the price is at any given time, and you know we can see if the the debt ceilings are starting to come under pressure. You know, is it time you know to have a liquidation, you know, does it hit the trigger level again? This is a very big deal because you know what your collateral is.

B

You know what it's worth and you know you can get out quickly and you're over collateralized and finally, when I said you know you can get out quickly. That implies the last point: liquidity, the uh the working assumption, which is, I think, roughly, has been proven, is the asset can be sold near near the market price pretty easily. You know, at least in a reasonable scale. You know if I wanted to move 10 billion. No, but you know when we want to move several. You know tens of millions out of a big vault.

B

It can be done so from my perspective, I'm gonna I'm claiming and I'd love to hear people's views to the contrary that this is really what makes crypto lending you know. Very. You know we are a good, safe strategy and why we're making money? You know. I think these are very important principles, and I I imagine if you asked our risk folks or even our growth folks, um do you want to start? You know uh lessening some of these key principles around lending into crypto. I think they would be concerned. They'd say eric.

B

You know these are important. This is how we make sure we get our money back, because there's a saying in lending like lending money is easy getting paid back the hard part. So these are all principles to make sure we get paid back all right if we flip to the next slide. Let's talk a bit about the crypto which we just discussed versus real world lending strategy in the real world.

B

You see I've lined up the same basic items on the left and then, where do they overlap and where they don't real world is senior we want to be. You know the first lender to get paid back, it's typically secured. You know we want to take collateral um it's over collateralized. You know we want more collateral than what the loan is. So if there's some losses, you know someone else eats those before we ever get hurt.

B

On the other hand, it's not fungible. You know. If I have a pool of auto loans, not all pool of auto loans are identical. You know there. Could you know if there's 400 different pools of auto loans out there they're all going to be somewhat different?

B

um So you know everything is a bit of a snowflake next transparency around pricing. Typically, um you know most loans aren't actively sold. You know at least a consumer loans. You know five thousand dollar credit card or something or even small business loans. Maybe fifty hundred 100 000, you could get a bid for them, but there's not really an active, clear market. You know to get it priced. You know. Typically, that's why you get these financing structures.

B

If you have, um you know 100 million dollars of small business loans, you put them all together in a pool, and you know then you issue bonds against them, so, instead of selling them one by one you're, creating this more complicated structure, we'll talk more about, you know how we need to create that structure. So the market, you know likes it. But again you don't really have active pricing in near the same way. That's a big difference and then related to that is liquidity.

B

You know, if it's not priced and not necessarily well understood, it's not easy to sell. You know if you have your 400 auto loans and you're like all right. I'm done with this. I want out your eventually go, find a bid, but you know it could take weeks or months. You know, and maybe it's 90 cents on the dollar. You know there's no idea that boom you're out the door and gone so these are all you know very important principles.

B

uh Let's keep going here all right. So then what does rwa do given that we don't have the fungibility the transparency on pricing or liquidity to sell kind of at will that crypto does here, here's you know from my perspective and actually my team roughly. What do we layer on as risk bit against, given that we don't have these other key things that the crypto folks who are making loans? Do we want quality cash flowing assets?

B

You know. So if you have a pool of um credit cards, you know you have a pretty good sense of how good the borrowers are. You know and how much money you should get paid back. You know you don't want assets where you don't understand the performance. You know that's probably like the worst thing, because if you step back a bit a lot of what we're doing in um rwa is we're not lending against a price. You know market observable for the crypto collateral and we know we get out at the market price.

B

What we're basically saying is look we're putting a pool of cash flowing assets together and the principal and interest generated by them over time is more than enough to safely pay off our loan. So if it's a two-year loan, you know we'd want to have you know a comfortable margin from this pool of credit cards. You know that even if you know there's some economic distress that we're still going to get paid off, you know timely, you know so that's a big deal and then it's not just quality cash flowing.

B

You know, in terms of like the deal structure. You know you typically want a diversified pool uh with stable. You know so in terms of diversified. You wouldn't want everyone. You know to necessarily live in california in the same zip code. You know it's going to depend by deal, but you're typically you'll. Think about a few key risks then diversify across it, be it geography or something like that. So I think I I wrote this same thing twice, but so we want a diversified pool which you, you know you don't have in crypto.

B

um We want a pool that generates stable, predictable cash flows. I'm sorry, we don't have that in crypto. I've been updating. This apologies, that's it say. No, you know the asset pool generating stable, predictable cash flows is not is no in crypto. You know there are no cash flows unless you sell it um all right. So that's a big deal, as I said we want to be able to have our pool of assets generate enough cash flow to pay our loan off safely. Over time.

B

um Also, you know there's in the deal structure, you're going to have credit enhancement which, which is in some ways it's very similar, same thing as over collateralization, but yeah there's other some. You know kind of more fancy, ways to slice and dice risk. You know we'll come back to it. uh You know, but there's a lot of different ways to try to mitigate risk using structural things and then, finally, again I'll say this is within deal structure. You want to align the borrower as best you can with maker the lender. You know.

B

Typically, the borrowing lender you're not really well aligned. You know every extra percent of interest rate I charge you know is money out of his net income, you're, suddenly kind of you're fighting over the same economic pie, but as a lender.

B

You know that the borrower knows a lot more about his business and has a lot of decisions to make that you can't tell him what to do so as much as you can. You want to create a scenario where he's aligned to make decisions that are in your interest and we'll talk about things. But alignment is a big one. You know there's a classic joke in like chicago. You know where chicago has the trading pits, they call it an o'hare trade where the the joke is look go to like the board of trade.

B

Take the biggest naked like option position. You can. You know on the most volatile commodity, like oil or crypto. If they would let you if you could put like 10 000 down and you'll they'll, give you 100 to 1 leverage. So you take a 10 million position. You take the biggest position you can. Then you drive to the airport. O'hare is the international airport. You know you call and see. If the position is, if it's moved big time in your favor you're rich, you come back, you retire.

B

If it's moved against you and now you owe a lot of extra money. Yeah you fly to bolivia. You know you're like to heck with it. So that's a classic example of kind of how the equity guy is not always well aligned with the lender.

B

You know, as the lender, you don't want people taking these kind of big existential risks, because if, if it goes well, you know you get your three percent interest back. If it goes poorly, you could lose everything.

B

Let's keep going here. We do have a lot of slides. So all right. What is investment grade risk? You know this? Is you know our?

B

We have a preference for investment grade, it doesn't have to be, but what does it mean? Historically speaking, you know you look at the data, it means the chance of a debt instrument or a loan. You know defaults, you know comfortably under one percent a year. You know there's specific grades within that, but just think something needs to default less than one percent a year. You know the other way. You'll see like rating agencies say that is it's highly likely to repay the loan as contractually specified I.e.

B

It makes all of its payments and doesn't default. You know the rating agencies and credit investors. You know all kind of use this similar view of things. They might have little differences, you know, but they all tend to think about. You know what is investment grade and and kind of have an idea of what an investment grade deal looks like across a number of key dimensions. You know people aren't perfectly agree, but it is a rough language. You know that will be.

B

You know talked about and argued about all right, so that's roughly investment grade risk just think. It's very likely to get paid back. You know it probably defaults less than one percent a year in terms of the rwa risk assessment. You know, how do we do this? um Well, so we look at an asset manager or a borrower. Go across some first, some key operating areas. What operating areas are most important?

B

How do they source the collateral or the assets? You know if it's going to be unsecured personal loans like sofi, you know: where do they find them all right? You really want to understand how they're getting them, and is it consistent because at the end of the day we're going to keep coming back to? We want stable cash flows from the pool of these loans, so you want to have a stable process. You don't want them to source everything one month from one channel and then the next month they go somewhere.

B

That's completely different and source it all there. So the performance you know between the two pools is very different. You don't like that. How do they underwrite it? You know because they're ultimately going to be saying yes or no. You know I I want to extend a loan or I don't that's a big deal. So how do they understand and manage their risk?

B

Then? Next, how do they manage and service the collateral? You know once they've invested in something you know: how do they manage the ongoing loan and if there's trouble, you know what do they do and then also we want to look at you know at their investment platform. You know uh what how what size of business can it comfortably um service and and if they you know, their loan is three times bigger than what they're currently doing. How are they going to get there?

B

You know, because at the end of the day is a lender, you're you're only going to add best cases, you get your principal and your interest back. You know if their business gets 10 times bigger. The equity guys have made a home run. You know you, maybe you've got a bigger loan, but you you get nowhere near the same upside as the equity guy.

B

So it's something to keep in mind and then also a big deal here is, as we look at you know the collateral, the underwriting, the managing and servicing you you like to look at their historical performance with the same or some similar collateral. You know what is the best predictor of their future returns. It's typically going to be based on what have they done for the last number of years.

B

You know it's almost like, like in sports. You know when someone has shown an ability to do something for several years. Usually that's a pretty good indicator of how it'll go in the future and then in terms of the principles that this is really looking at. You know, as we went through the key rwa principles, you know on the right again: it's quality cash flowing assets, that's what we want them to be originating.

B

um We want a nice, stable pool with predictable cash flows, and then we also want them to be aligned with maker, we'll come back more on alignment, but they have lots of little decisions around sourcing underwriting and so forth, and we can't micromanage those decisions as a lender. Even as a trad deploy lender, you don't want to, uh but particularly you know, even more so is a decentralized lender, so we need to construct a structure that makes them want to do things. That's in our interest, all right risk assessment.

B

um So then we look at them also in a number of non-operational areas. You know we just talked about the operations, so we also look at management and ownership. You know management, you know a big one. Is you know, what's their experience and track record in this area, you know you like to work with guys who've done this before and done it well and and then also teams that have worked together before you know, there's always some risk in putting a new team together. That's never worked.

B

You know together before because they might just not get along. um You want to know the financial strength of their business. Do they have enough capital so that they can? You know, focus on originating and servicing good collateral for you. Are they going to be running out to have to raise new equity in six months and might take the eye off the ball? You know and not make good investment decisions for you um also. You know, as I mentioned, what's their alignment with you, it's a big deal and are there any potential?

B

You know conflicts of interest. You know why might management or ownership um not really be thinking in your best interest? They could have other goals. You know that need at least be disclosed and understood, and again on these non-operational things again we're trying to make sure that they're focused on generating quality cash flowing assets. You know stable, predictable cash flows and they're aligned uh reasonably with the lender being maker here, okay and then there's so essentially, there's three sets here of the risk assessment I did um operational.

B

Then I did um kind of non-operational things just more looking at their business and now we also look at the financial structure and the legal structure of the specific deal. You know this is where you know everything comes together, they're making a proposal and you look at how it all works together. You know, and typically when you're looking at this we're going to want to see that is it creating a diversified asset pool uh with stable, predictable cash flows.

B

uh Is there good credit enhancement and other risk mitigants, and is it aligning the borrower with maker? You know at least to a reasonable degree. You know these are key key points and I hope I sound repetitive. That's my intent. You know lending good lending practices, it's not rocket science. You know, there's just a number of key things that, like around alignment and diversification, you just you, you consistently want it done. Well, you know.

B

Through the centuries we've seen lots of people kind of skip on these principles and it generally comes back to haunt you all right. Let's talk a bit about how do you make an investment grade loan here from a non-investment grade pool? So the idea is, let's just give an example. So there's a sponsor or an arranger who wants to buy a pool of loans, say there's 10 loans.

B

Each one is 10 of the pool. Let's make this real simple and then each loan has a 5 chance of defaulting. So I would I I want to note that to be investment grade, you know you, you want to have less than a 1 chance of defaulting, so each individual loan is clearly not investment grade, but is there a way to put this sucker together in a structure that we can make part of it investment grade? That's what a lot of structured finance is about.

B

So, let's take the first one, let's say: make your lens 100 to the sponsor to buy the loan pool. So the sponsor you know, tells us he's gonna, do a good job, but he's not putting his own money. In I mean he's got his own business but we're all of the all of the money. So if you come and look you know total collateral, let's just call it 100 these 10 loans and then the maker loan down here below is a hundred percent and the sponsor puts in no equity right.

B

So it's essentially it's all our capital and then can we trans or what will the um the risk of this group of 10 uh equal size loans be to us? You know, as the lander will, the annual default rate be under one percent. You know I think people are probably going to guess. No, but let's, let's take a look, so here's some basic statistics on this group of 10 loans, uh equal sized five percent probability of defaulting each.

B

What's the chance, no deals default, none of the loans default. It's basically you see here 60, so 60 of the time the loan performs. You overhear, why means it alone performs and it doesn't default and there's equity sponsor, essentially they've put nothing in, but you know in theory, should they be covering some loss, so there's zero default and everything goes good in the first scenario, right with no losses, that's 60 of the time.

B

What about? If there's one of the 10. you know this is just your basic um probabilities here. If one defaults, that is going to happen almost 32 percent of the time so and if that happens, we're we have no first loss capital under us, so the sponsor equity. In a sense there is no equity, but it's underwater and does the loan perform? No, it doesn't perform right. So one of the 10 is defaulted and we absorb that loss. That's not great! For maker.

B

You know this is uh needless to say, this is not investment grade, because we need to have no more than about one percent chance of defaulting. How many loans would this have to be able to absorb? If we come down to cumulative probability, I sum the individuals so the first chance of zero default.

B

No more than zero defaults is 60., then, what's the chance of no more than one default. That's just the sum of zero defaults, plus one default, so I sum fifty nine, nine and thirty one five. So ninety one point four percent of the time um we get no more than one default, so that's still not investment grade. You know we need to be like 99 uh percent no defaults. So if we come down to two defaults, um then we sum you know the 599 plus the 31.5, plus the 7.5.

B

We get 98.8 so we're almost at 99.. So in essence you know to be investment grade. This is telling us you'd have to be able to absorb two defaults or less you know, and so it's kind of the ideas I'm trying to plan in people's heads here is you somehow need to put in enough capital? First lost capital? That's not the maker loan that will absorb this first 20 default. You know to create something quasi investment grade. You need to do a little better than that. The sponsor puts no money in so then.

B

The next question is- and I hope this is kind of a leading is- is let's look at this and structuring it differently. Maker now lends 80 to the sponsor to buy the loan pool.

B

So again, it's 100 of the assets same asset side of the balance sheet maker now only puts an 80 and the sponsor puts in 20 20. This is a big difference and then it's not put in in in a pro rata, we don't share um losses and and um income equally with uh the uh sponsor equity, the sponsor absorbs the first losses and maker will only take a loss after the uh the sponsor's capital is all gone.

B

This is essentially what senior means with a senior loan we're senior to uh their capital, so they eat the losses. This is a typical lending, um a lending uh approach, and then so the question becomes, you know, is this investment in grade I.e? You know, is not this whole thing, but is the maker loan investment grade? Does it have less than a one percent probability of default? Let's take a look.

B

ah Sorry, let me move this. I somehow uh all right here we go so here again, you can see where I use the red. The red is where uh the loan stops performing.

B

So you can see uh with this new structure again remember the sponsor has 20 equity, so the first 20 percent of losses to the pool are on them again: zero default, the loan of course. Of course it performs there's no losses. The sponsor equity is untouched.

B

If there's one loss that we're assuming you know, there's no recovery, so the 10 percent of the capital disappears, but the sponsor absorbs the loss right. So then their sponsor equity, after the loss is 10 percent. It still performs. Why does it perform because the sponsor is taking the first loss, we're not taking it? Even if there's two losses that means 20 of the assets disappear without us getting paid back.

B

We don't like it, but the sponsor absorbs all 20, so we just get out kind of by the skin of our teeth, so the aluminum performs so in essence, for the first three scenarios. uh When there's no more than two defaults, we are okay. If there's three defaults, what happens?

B

Thirty percent of the pool is gone, the sponsor only put in twenty percent. So now the sponsor is gone, but that additional 10 percent comes to us and we take a loss. It doesn't perform right. I I hope this is clear. This is kind of the break right here, but you can see how much more resilient this is. How often do you get? Three losses um are three three defaults or more in the pool. Essentially it's a little. You know a little over one percent.

B

It's like one point, two percent of the time, so it's not quite investment grade, but it's very close. So if we flip back, we can see when there's no capital under us zero defaults is the only time our senior our senior loan performs when there's 20 percent first loss under us. You know we make it all the way up to two defaults, which is a big deal right. You know this is one of the key things in structured finance.

B

You know having a nice pool, that's predictable and then some nice first loss capital under you to absorb these potential losses.

B

So let's talk a bit about monetalis, you know, as we've gone through the um kind of the the machinery of how we look at lending in these principles in the real world, our rwa.

B

How would we think about montalis? And I don't mean to pick on them, but it is a well-known one in in the uh in the community and it's you know, there's I think, there's a vote coming and we believe you know in terms of radical, defy transparency. We want to be transparent, fully transparent on how we look at things you know and have a discussion. You know maybe we're missing something. So what is montales?

B

They aim to do wholesale wholesale lending in the uk to small medium enterprises and with a green focus, which we like it's good to be a green focus. Initially they asked for 400 million. They come back since and said now, they're asking for 40 million, you know so it's it's not a huge amount, but it's real money. 40 million is over half of our capital surplus, their uh their request.

B

Their proposal is to pay a two percent stability fee to us um and then also this look we'll see this later, but they would get a one percent management fee to run their business and they get 20 of the uh profits. You know the one in 20 is, you know ballpark and how these you know how some of these deals can be done. So when rwa rwf same thing thinks about this, how do we assess monica's proposal? What are the glasses we wear? Hopefully this is sounding. This is gonna sound repetitive.

B

um Is it investment grade? You know we talked about that. Is it a good risk-adjusted return for maker? You know when we think of what else is out there. um You know it's not that it has to be like on market.

B

You know the best deal out there, but if it's a big deviation from what else is out there, I think it's worth having the discussion because then in our, if you give a really, I want to put this, if you lend money to someone where it's not a very good deal for you, you're subsidizing their business in a sense, if you could do a lot better elsewhere.

B

So then I think you want to think about why you're doing it- and it very well could be a good reason to do it like the green focus um and then the next question is because is this transaction a good standard for other transactions? You know once we approve, at least from the risk guys that we don't approve once we bless it and say we like it, we know we're going to get lots of other folks coming and wanting you know same basic standard.

B

You know so once you set a standard as a you know, as a lender, you'll have a lot of folks expecting to come with a very similar standard. So you know you you want to be waving in you know all that kind of business and then finally, and I'll talk about this more towards the end. Would it be viewed as arm's length? You know we'll talk about it, but arm's length is basically.

B

Is it viewed as kind of like a uh a reasonable market transaction where both sides, the lender and the borrower, are acting independently in their own interest? You know this is uh something I think we want to be careful with, at least from our perspective. You know. Risk in the rwa group is, you know in traditional finance, you've seen a lot of times. People get in trouble when, when a company's, you know making a loan to some subsidiary, and it's not really doing it at market terms.

B

You know and there's there can be a question of. Is there some insider dealing and you know who's kind of getting the better deal and why I mean I think the optics. Do this really matter and we'll come back to it, but it's certainly it's something to keep in mind all right. Oh sorry, and then yeah, I I've kind of. I I've messed up my slide order, but I I do want to make just to review how we're gonna look at monitalis, so we talked about structuring investment grade loan.

B

You know we talked about these key steps here: um good quality assets and create cash, diversified asset pool, um uh good alignment, good stable cash flows.

B

These are all important and I just want to note and kind of a shout out to christian and the legal side. We don't just say: hey here's, a quick term sheet. You know all of this is done. Making sure all of these steps are done, takes a lot of legal structure and analysis. It's it's. You know, unlike crypto, where you can just take their crypto collateral in a vault and then liquidate. If you need this, all you know has to have these agreements and the collateral.

B

You know we need to have legal agreements that we can actually take the collateral if needed and enforce our rights and remedies. um It's it's a pain in the neck, but you to be a good lender. You really need to have all these rights and remedies, and if you don't it, it's troubling and that's a good way to lose money.

B

Okay. So when we think about monetalis what are the key risks? Let's first structure, you know how we're going to think about this one. The facility risk the money. You know we call a loan a facility. If monetaris and its investments underperform, you know we could lose capital, that's clearly a obvious risk. I think, there's a more subtle one, that's ultimately probably more important longer term for a maker when we think about how we're lending is.

B

What's the stability risk to the die, you know at the end of the day, the market, you know folks holding die, you know, look at it and say this is uh convertible one for one into dollars, but that's only true if there's really good collateral backing it, you know right now we have a lot of usdc, that's good stuff. What, if we all put it into say, uh bitcoin could be worth a whole lot more in a few months could be worth a whole lot less.

B

You know that would put it stability risk, so the market really wants to see that we've got solid collateral with a good structure and and a good manager. Your good managers who know what they're doing and you know if you, if you ever pay attention to kind of the history of bank, runs you'll, see uh banks getting into trouble when uh people don't think their assets are good and then people trying to get their money out quickly, because if there's a perception, there's not enough good collateral to back. You know your deposits.

B

You want to be the first one to get paid back, because maybe the last guy isn't going to get paid back at all, and so there's clearly a parallel. You know in kind of our world where someone thinks to die, isn't worth 100 on average. You want to be the first guys to get 100 cents back and then maybe the last guys get much less and we do not want. um We do not want to create that perception or risk, and a lot of it has to do with perception all right.

B

So we think about the facility risk of monetalis were looking really at three areas. One is the manager themselves. Two is the asset. You know they're, making loans against a green, small business collateral and three it's the structure. It's the deal itself, you know and and we'll go through these three and then typically, if there's a major deficiency in any you know kind of these areas, it's usually not investment grade investment grade has a numerical element but there's also kind of a qualitative element where you'd say: okay, let's look at this manager.

B

This manager, you know, has never managed this kind of asset. Before you know it's hard to put an investment grade number on it because you'd say well, what's you know? What's the chance, the collateral is going to perform really well, and you say well, what's his track record and they say well, he doesn't have a track record. You know in this or a similar type of collateral, so it gets hard to make. You know a very confident statement. You know about the consistency of the cash flows, to pay you back, okay, but yeah.

B

At the end of the day, we're going to think about manager, risk asset risk and structural risk. So let's go through them, one by one, all right manager. How do we look at uh monitalis in their manager? One? I think you know alessio and alan are very talented guys. You know alan has a lot of private equity experience.

B

This is all good, very, very respectable, but neither one has ever really been the guy running, a private credit fund asset finance manager, so they don't really have a track record and you know you can't say wow over the last four years. You know here's what they did across their deals, so it gets very hard to predict their performance given they've. Never really done this specific thing before that's definitely a concern.

B

Next is they're a startup asset manager. It's a business model that you think probably makes sense, but they don't have the last several years to show you um that they've made money at it and they also are going to need to scale up pretty quickly. You know it's kind of going from zero to 60 very quickly from an equity risk that could be a great risk, but to a lender. You know you typically like to have a business already going a bit.

B

You know, because at the end of the day, as a lender, we want to be taking risk on the assets. We don't want them, managers to be using our capital to essentially subsidize their equity. If you will, you know, because traditionally you know, um borrowers always want to get more capital from the lender, and you know in less equity. You know, so they don't have to dilute themselves. But as the lender you want to be careful. Is some of our debt capital implicitly being used in kind of equity-like functions in startup situations?

B

There's definitely a risk of that. um Monitalis is also you know it's relatively thinly. Capitalized, you know not profitable. You know it's just starting so well. They need more equity funding, given they're not making money out of the door. Well, they need to raise more money from investors than say six or eight months you know and if they are they're going to be really busy raising equity, as opposed to you know, thinking about arranging or origin uh making good loans and managing our collateral. Well, you know, there's that's an alignment issue.

B

You know it's not clear that you always be focused on what we wanted them to be focused on also um the way they're. They propose this they're, not putting in any first loss position. You know maker is 100 of the investment. You know. If there's any little oops, we made a loss, it very well could hit us, um you know, so it certainly raises our last our chances of losses, and it's also again kind of a question of um alignment. You know I mean how committed are they to the business and then?

B

Finally, it's an interesting thing where the way they propose this maker has been doing this some, but it's traditionally not done in the real world, and I think it's really worth thinking about. Let me explain: they proposed that this loan this facility can be liquidated at will based on the votes. You know, if the token holders vote, we could get rid of it at first glance. You're like all right. This is a good way to mitigate risk.

B

I got it okay, but on the flip side, if we can pull their capital at will what's their incentive to really invest, you know good equity dollars to really build a solid business. You know, if you're a businessman, you know you're building a lender. You know you don't want to put like 10 million of your own money in it. Knowing your 100 million dollar lender could disappear tomorrow. If they don't like, if they change their mind, you know. Traditionally, you know as a lender. You need capital stability.

B

You need good equity to you know just fund your operations, then you need good debt capital to help make your loans and if either one of those pillars is shaky. It really makes it hard to stay focused on your business, and you know, honestly, it reduces your incentive to really invest and build.

B

You know a really good quality business yeah, something I think maker needs to keep this in mind when you're dealing, you know with real world assets, if you can pull a facility at a debt facility at will you're really reducing uh the incentives and alignment of a lender to make a really good a good business, because he can't count on you and if he can't count on you, you know how can you put more of his own equity in it, knowing it might disappear or if your loan disappears? It's going to really damage his equity.

B

So there's clearly some big issues from the manager perspective, and then we also just wanted to benchmark the manager. We said they don't have a lot of credit, investing experience, not that alan has a lot of experience in equity, investing private equity, very good experience, much better than mine, but we wanted to look and he gave us a list of his competitors and there's a few other here and we kind of you know, looked at the guy running these different groups. You know running the equivalent of of like the head of the credit person.

B

You know similar to who would be, you know, same role, allen and alessio would have, and you look at these guys and they typically have what 18 years of prior credit experience before they get into that. You know kind of leading role.

B

You know so again, guys have you know serious private credit experience before they, you know or ever able, to really kind of run a big private asset finance business in the uk. You know so to us. This is a real concern. You know these guys, you know all have lots of experience in track records.

B

Let's talk a bit about the asset, let me try to go a little quicker here. um We've had a number of conversations with uk asset managers and the green asset financing is very competitive. You know, not, surprisingly, you know all the institutions want to do it and it tends to uh the demand to finance the green business is greater than the supply you know. So how does this play itself out? Typically, it's a pretty relationship driven business.

B

You know the brokers in the middle, you know, will work with uh financing sources that they already know and have been there consistently and then the guys who want to do the green stuff typically are going to also have to do the non-green kind of middle, the fairway stuff. You know, because if the broker's like look, you only want the green stuff, I'm going to go down to bill down the street. Who does everything you know he's more reliable for me, so it's going to make it harder for you to get in.

B

If you want to be very green, focused um two montalis is a new entrant. You know it might have trouble sourcing quality transactions- it's just you know it's hard to break into this market. And third, our general observation is not that it's it has to be true, but to break into these markets you, you, probably there's a good chance. You're gonna have to pay too much. You know so you get less yield and or taking on more risk than other folks.

B

Were you know you got to fight your way to get your foot in the door. You know- and none of these are really great things for the lender. You know if they had a big um first loss piece under us, it's a little easier to say: hey, okay, if they overpay or take a little too much risk. That's okay, because you know like the first 20 percent of the losses is on them. You know here the first 100 of the losses are on us, so we have no cushion on that risk structure.

B

Let's go on to structure here, so this is how the deal's actually done. You know I'm kind of beating the dead horse here, but there's no facility-wide credit enhancement right, there's, no first loss under us. First loss comes to us. You know that clearly raises the risk. We don't like that and then, even if there is a facility wide first loss which we do like, we would get a lot higher credit risk just during the ramp up, because you know maybe in the first three months they make one investment.

B

And then you know we don't have that group of 10 investments. You know where you have diversification everything's on that one investment. You know. Maybe they have two investments in three, but it takes months and months before you get a well-diversified pool. So let's go, you know, give us, you know more lumpy, early credit risk. Also their proposal does not pay current interest. You know this. This is rarely done in the traditional lending world. You know you. This is a lending relationship and part of this is to back to die.

B

You know die stability, you know we want the assets, you know to generate cash that can be used. You know, if the diet you know needs it. You know it's just very off market to want to not pay current interest. You know, and it doesn't really show a good alignment. You know really managing your business to generate stable, consistent cash flow for us if we need it.

B

So that's the first group of uh structural risks. I have one more sub, more structural risk. um They have no performance covenants on how the assets have to perform or corporate uh perform performance like financial health. Well, what? If they're running out of money and can't pay their employees, for instance, you know they would say well, we can shut the whole business down at will.

B

Okay, but again we don't like the idea. If we can shut the business down a will that doesn't give them incentives. You know to invest a lot in building a business and in a sense we want to know you know how them to commit to how the assets and then the in the uh in their corporate business should should perform. You know we want the business to be financially healthy. We want the assets to perform.

B

Well, you know traditional lender, you want them to commit, you know to levels and if they don't hit the levels, you know you, you have a discussion with them and what needs to be done also. This is a uk pound-based investment which it's a fine thing, but the die is in dollars. It's dollar denominated, so it needs to be uh hedged currency wise. You know if they don't hedge it, a 10 loss in in the dollar to the pound would mean we'd be down 10.

B

They haven't proposed the solid currency, hedging strategy and we think that that is essential. Otherwise you know we're kind of taking foreign currency trading risk. So I think that needs to be there, at least for us to say it's an appropriate facility and then also their guidelines. Allow like a lot of real estate up to sixty percent and up to a hundred percent loans that don't amortize is I've kind of gone on how we want good cash flowing low loans that pay down um our loan through principal and interest real estate itself.

B

Doesn't, you know, tend um cash flow or at least not fully? If you have a five year real estate loan, typically it'll pay off, maybe ten percent of the principal. Then you have to refinance it because it's just too big an asset. So if you get all of these loans that have refinancing risk, there will not be enough p. I generated to pay off our loan, we're winding up betting more and more that the real estate markets will be able to refinance the loans. You know four or five years down the road.

B

Again, people do real estate lending, but it it kind of changes the risk profile. You know and it's concerning and then let's just think uh we're gonna be out of time soon I'll try to clip it up. Monitalis. We just took a quick look at. What's the expected return to maker, you know, the asset yield is what they would earn on their loans. You know they'd pay us two percent.

B

uh They would get one percent uh to manage it. There's probably some other admin fees at one percent, so the net profit is 50 basis points not a lot, but they propose we get 80 of that. So, if you take our 2 stability fee and 80 of the 50 basis, point profit we get about 2.4, you know expected yield if everything goes well on this facility. How does that compare to other things is really the question.

B

So we look, you know, like experience uk, you know asset focused credit funds doing similar stuff. You know they're getting senior leverage, uh typically at sony, plus 100 or one percent, which is all in they're, paying about 1.25 and an 85 advanced rate, and they also you know. No single exposure can be more than 15.

B

So we'll compare this, you know. So it's definitely it's a lower uh interest rate. You know it's always almost like half the interest rate of a month. Alice would offer, but there's significantly different protections, and then we're also negotiating now with the big uh us-based credit fund that hopefully wanted to deal with. If we can reach terms they're offering about two percent yield an 80 advance rate and then a diversified portfolio again we're like no more than single exposure than 15 percent, again, not as much yield as monetalis, but a lot more protections.

B

Let's skim through this with a couple of matrices quickly. um If we think about you know how does monetalist look versus um you know? Who else is out there? So we have monitalis, then we have an experience fund and then we're going to go through manager, asset and uh structure just like before, and let's see how they line up, because this is really a very useful way to think about.

B

You know how what else is out there in the market and what's their proposal versus what else we could do, not that it has to be the same, but how much are we giving up to do business with them? So if we think experienced credit managers monetalists? No, it's a big one. Experience funds. Yes, that's their core skill.

B

Are they is that a startup manager with lots of scaling risk monitors? Yes, experience fun? No, I mean they've got a big existing business, that's already scaled a thin capital base monetalist! Yes, you know it's not clear, you know. Do they have to raise more equity? The experience funds you know we're looking at are all making money. You know they don't need to raise more equity, they're, profitable and consistently profitable first loss position. This is a huge one.

B

um If you know that 10 percent of the pool just the collateral disappeared overnight in montalis, would they absorb that loss and we'd? Be fine? No there's, no protection. The experience funds you know are offering 15 to 20. That's a huge one. You know if they stub their toe, they suffer the consequences. We don't and then also the lender can liquidate a will again. This is a bit of a complex one, but we don't want the monetary.

B

I mean sorry as maker we'd like to be able to pull someone's facility at will on one hand, you know things get scary other hand. We should have good covenants in the lending agreement where, if they are performing, we can pull it. We don't want to just say we don't like you. Here's a vote go away because then, like experienced quality um uh businesses aren't gonna want to do business with you. You know you could destroy their equity investment by pulling their line. You know so again. Monitalis has this risk.

B

The experienced guys aren't going to give you this, but they are going to give you. You know lots of other kind of covenants and protections. um So then, let's think about the asset risk comparison. It's very competitive, green deals for both experience fun. Clearly existing relationships, montalis doesn't have them. You know at least experience funds will um aggressive growth targets you know, does monitalis have to buy a lot of new deals to get into business? Yes, you know the experience fund is more kind of doing what they're currently doing with some growth.

B

um Might they need to risk up to get into the market? You know to build their business monetalis. We would think there's a good risk there. The experience fund, I mean, if there's a risk up, they've already been doing it right, so you've already seen it in their historical performance. You kind of know what they're doing so again on asset risk comparison, there's definitely a difference and finally, on structural risk, there's once again a lot a lot of difference.

B

Facility. Credit wide I'd mention this in both because here you know it's again, no first loss. I beat that to death. There's a lumpy exposure in the ramp up four montalis, yes, experience fun, no paying current interest. Monetalist no experience fund definitely would expect to pay current interest. You know it helps us back to die um asset performance and corporate covenants. You know to make sure the loans and the corporate health is good. Monetalist, there's nothing experience, fun, there's definitely going to be some good stuff there, currency hedging.

B

If it's a uk fund experience fund they'll both have it you know, but on the other hand, maybe they're already experienced doing it and then lose credit guidelines. You know monetalist guidelines can be tightened, but at this point they're pretty loose, you know we're an experienced fund, they tend to be tighter and then they've also got performance history with the existing guidelines. So you know how they've done you know with those credit guidelines.

B

So again, all these things make a big difference. Let me do one last thing and then I'll try. To sum up, I know we've covered a lot. What's an armed links, transaction standard, this will be relevant, so each party agrees to do business when they're acting independently in their own self-interest. You know so there's no insider deal everyone's doing their best. You know we typically look at transactions and ask: would it be funded in the real world and if so, would it be at the proposed terms? Or might it be very different?

B

um You know if it's substantially different from the proposed terms. It's we're probably going to start saying it's probably not arm's length transaction. You know you couldn't get this done so then the question becomes. Why would maker do this on worse terms?

B

They could typically get elsewhere, and I- and you know, I think that this is something to keep in mind. Let me flip the last slide. I think I'll give you a sense why um monitalis is also equity, funded by several significant uh token holders and maker token holders, which is a good thing, it's good. They like the business and they believe in it. You know, there's no problem with that and they've disclosed it. It's not like they're trying to hide it.

B

Let me be clear: this is not something they're trying to hire to get over on us, but the challenge here, sorry, is that these token holders and their delegates can vote on the monitor's funding decision, and the challenge is, if you know say, you've got three million in in monetalis as an equity investor. If uh and you can also vote as a make your token holder, if if they approve it, you know that equity position of monetalist will be worth a lot more with that.

B

If we give it a nice funding line so which book are you or which investment? Are you really voting? It's just it's not a great place to be. You know I mean from from the kind of our language in d5, we'd, say it's an entanglement. You know they have a serious financial entanglement in the real world. They say it's a conflict of interest, you know and both of those and they could be. You know I mean very well-meaning people with very good standards, but there's also a perception question.

B

You know if this was on the front if monitors get funded, and this was on the front page of the financial times in the wall street journal. How is this going to look? You know, I mean I've seen this movie many times and it is generally not a very pretty ending. You know when insiders are perceived to be funding, something that benefits them in another way and so in the in the uh trad fire world. The entangled voters would be typically required to recuse themselves from all votes where they're entangled.

B

You know it's not our decision to say what it should be, but we certainly think this is. This is something to think about. You know I mean we just don't kind of want this entanglement old school tradify conflict of interest. Entanglement. I don't think we want that here. That's my own opinion.

B

You know people need to decide, and so, if I had to you know summarize, what's our view on monetalis, what's the risk assessment summary- and I think it's pretty clear, hopefully that I'm just summarizing what I've been saying over and hopefully I've demonstrated clearly, if not please, let me know it's not investment grade. You know across a whole number of reasons.

B

It's not a great risk-readjusted return. We look, you know what else is out there even with deals we're currently in discussions with it's pretty, arguably not arm's length transaction, because the terms uh are so so much weaker to maker than what else we could do out there. So it's going to look like you know, it's an insider deal in some shape or form, and then the question becomes why and then. If we do this deal, other arrangers are going to expect the same basic standard.

B

So it's not that we just have monetalist at 40 million in arguably off market risk. We had. You know, lots of other guys lining up for something similar. You know, which I don't think is a great standard. You know and all all these different pieces together, I I would argue, create substantial facility risk and not just me, I mean other people in rwa and luca.

B

You know I mean we're aligned on this view, so there's substantial risk to the facility taking a capital hit, but even I think more meaningfully to creating a perception around die stability. You know what are we investing in? Are these good quality assets with good managers done? You know with really clean um governance standards. You know and transparency. I think, there's real risk there. You know not everyone would agree with me, but that's clearly. You know our view having been in this business a long time.

B

So in conclusion, we would suggest monitors, retire, its request or significantly restructure it. You know to be more in line with kind of how the market does things and more aligned with maker. I mean I, I hope it's pretty clear, some of the key ways we would suggest to be restructured and we also think makers should prioritize.

B

You know good investment grade collateral that could be perceived as arms linked. You know, good governance, you know and uh and just good investments where people go say wow I can hold the die because I know that's money, good wow, I I pulled it off in an hour, I'm surprised. uh Do we have some time to chat guys, I'd love to take questions. I know I've gone through a lot.

A

We do have a couple of questions eric and if anyone else has additional questions feel free to type them may stop sharing the screen. So I don't see my okay, I think I just oh. We got this oops okay,.

B

Where's the question.

A

And so before we jump into the general um into the general questions, I had a question more related to the to the monetary steel. So would it be possible, for I can't remember who said this so I'm stealing someone's credit, but someone suggested that maybe the investors should form a fund to cover the junior trench of this deal. Would that be something possible or would that make the deal look better.

B

It definitely would help yeah, I mean there's a fundamental question of. Why should we be a senior secured lender to a montalis when there's no money under you know, there's no first loss, that's not a senior lender! Yeah I mean I'm putting in a meaningful slice. It's not every! It wouldn't solve everything, but it. But it's a big first step yeah.

B

You know, because we we don't want a little hiccups and stuff to be giving us a loss. You know that that should be. You know. The originators should be absorbing the first losses. You know up to a pretty robust number.

A

Right and the other question- I don't know if you have a review about this, but again this is not my my original thought, I'm stealing it again, but uh how? How do you see this, this governance, um so governance trying to push something as monetaries or or or the community within the forums without uh without pointing fingers uh that potentially uh like cuts? Your ability to focus on other deals that you were working and then you need to jump onto this one and other deals might get delayed.

A

Is that the case or or or not, and how.

B

Do you put a lot of effort into this? Let me just say that yeah, you know every time you put a lot of effort into a everything else gets less attention. On the other hand, that monetalists I mean get get carefully reviewed and the community have a full, robust discussion and full transparency on its relative strength weaknesses. So I think it deserves the time you know, and um we want everyone to know exactly what we're doing and how we're viewing it and they can fully disagree.

A

Yeah absolutely and the other question I think, was coming from makerman, but is there a way of prioritizing these deals? How should we approach this and how should it be done? I don't know if you have any opinion about that as well. That's a.

B

Good question: I think in fact that's a great question. We should probably have a bigger discussion. I I don't I mean I want to get will on it and I don't feel I could give it justice in in one minute. It's just too important.

A

Sounds good um assad type, the question on the on the chat and it's how do makers real world assets? Borrowing rates compared to market rates.

B

A

B

um I think the first thing I want to say is you got a line, try to line up apples and apples. You know not apples and oranges. So if are we looking at lending say against eth and then what's the um uh collateralization, you know number or are we looking against bitcoin and what's the collateralization and then also then what so? What's the specific risk, product and structure we're doing in crypto and then what's the specific product and risk structure you're going to compare that into the real world, I'm not trying to be difficult.

B

It's just in crypto, there's a lot less things, but there's still variation and we have to line it up, um and so I it's like at the end of the day you kind of want to say well, can we benchmark and say these two products real world crypto are roughly the same risk. You know in roughly the same, you know basic terms and then what's the then you can compare the yield, but if one is much riskier than the other, it's not so meaningful and I think it's a great question.

B

I think we need to spend more time on. I feel like oh boy it I I don't think I can. I haven't given it enough thought, but it's a great question I feel like. We need to spend a lot more time and give more thought to it. It's a great question.

A

Sounds good! Thank you for that. Thanks for the question I said, and our own frank cruz is asking well he's saying these are great principles for sure. But what are some of the steps that are taken in tradify to monitor loans, in other words, who's on the ground, visiting sites.

B

Okay, um it's a good question. So if we are making a loan to an originator, say, there's um an auto lender and we're making a loan to them, then in essence we're the direct lender and it's going to be on us in some shape or form to have people visiting. You know management and you know making sure they're originating and servicing is all being done and there's auditing that being a traditional lender in private credit is a lot of work. You know it's not.

B

You know two guys in a bloomberg, there's a lot to be done. So one of the reasons um rwa has been focusing more on lending to folks like monitalis their asset managers. They are the lender. You know alan could be the lender to the automaker or to the auto lender. So then he's doing all of that work, and so in essence, what we're doing is we're underwriting his ability to underwrite so he's doing, 90 5 of the heavy lifting and we're just financing his overall book and we're not financing the whole book.

B

You know we're financing, maybe the top 80 percent and he's got that. You know first loss piece, so we're outsourcing most of the of the nitty gritty blocking tackling and stuff to the asset manager um and we're still gonna have some work, but it's much more getting comfortable with how they underwrite their their existing deals, manage their whole book yeah. So that's certainly why we've been focusing more on that, as opposed to us doing individual deals. You know with with uh the primary lender like the auto lender.

B

It would be a whole lot more work for us and much harder to scale.

A

Nice yeah thanks for for that, uh I don't see any more questions so uh eric. uh Where can people find you if they want to discuss these things or if they want to reach out privately? What's the best way to contact you.

B

um It's probably on uh discord, wait! What's my uh where's, my discord! Number! Sorry! I don't have it in front of me. uh Do you see it? I apologize so.

A

B

Or I'm I'm on the um on the forum at umani's.

B

So you know that's definitely one way to reach out to me. uh I apologize. I I need to look up my my discord. I oh here we go. Thank you. 7330 eric rapids 7330.

A

Nice all right so yeah thanks everyone for coming and participating thanks again eric for joining us. We'll definitely keep the discussion going uh at forum.makedown.com and we'll upload this video soon tm to the youtube channel, so everyone can watch it later. Thanks again, thank you folks,.

B

I really appreciate your time.