Funds: The Path to a Lasting Private Lending Business

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Private Lending has come a very long way in the past 15 years. In 2007, the industry was primarily funded through multi-lender direct investments from high-net-worth investments and debt funds. In today’s “institutionalized” and “commoditized” industry environment, many view these strategies as archaic. However, I would argue otherwise. Private lenders who have retained a strong capital base sourced from independent, committed capital have seen significant, long-term success over the past 15 years. Many have achieved significant origination milestones in the billions. Others have sold to financial institutions, institutional investors, and investment banks.

The industry was stress tested in 2020. In 2022, we are seeing rising rates, inflation, and negative GDP growth, which all indicate a recession is on its way or already here. This means the private lending industry will face its first long-term meaningful challenge.

This article will discuss the virtues of capital strategies like debt funds and new business opportunities private lenders should prepare for. Debt funds have remained the cornerstone of a successful, lasting private lending business. They are typically funded by high-net-worth investors, family offices, endowments, charities, and pension funds. The greatest merit to this strategy is that is allows private lenders to maintain and continue operations even if the secondary market dries up. Unlike our colleagues in the conventional industry, institutional capital in this industry is not as dependable because of no government agencies. Since the most recent Federal Reserve rate increase, the private lending industry has suffered significant volatility, primarily caused by the secondary market’s need to adjust. They are doing the right thing for themselves and their investors, and private lenders must adapt.

Just like in 2020, many private lenders realized the merits of having a balance sheet strategy sourced from investors they can control. While there may not be as much capital, this allows the lender to continue operations and avoid the worst thing a private lender can face, loss of credibility and trust with their borrowers.

In addition, these strategies typically grant more flexibility to the private lender to ensure they stay competitive in an ever-changing environment. They can work with their borrowers instead of forcing them to fit in a certain box. Lenders who had such flexibility in 2020 grew by leaps and bounds, with several reaching the big billion in origination. Ultimately, it allows for stability and for the private lender to operate on their own terms.

Private lenders who have stood up debt funds have also taken advantage of market opportunities during a correction. Default rates and foreclosures will inevitably rise as rates begin to climb. Private lenders with funds and other discretionary capital structures will let lenders take advantage of such opportunities, creating new prospects for rescue loans, property acquisition, or refinance/reposition. In fact, many private lenders created specific Scratch and Dent Funds, NPL Funds, and Opportunity Funds in preparation for such an increase in defaults.

Private lending is driven by diverse sources of capital. Volatility proves the thesis that private lenders must establish consistent, discretionary, and reliable sources of capital. This is not achieved exclusively from institutional capital sources. The reason is that volatility in capital markets will never be able to keep up with the consistent need of borrowers in this industry, which requires a retail and direct lending component. To achieve this, balance sheet lending with committed and discretionary capital in the form of funds or other similar capital strategies. This is the best means for a long successful private lending business.

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