The private lending industry is facing its first extended inflection point since the 2008 Global Financial Crisis. Rising default rates, decreasing home values, lack of new housing inventory, low unemployment, volatility on Wall Street, and regional bank failures are all adding to the significant stress and disruption in the industry. Not to mention that we are in the midst of our first real recession in years. To say the future of private lending is uncertain is an understatement.
One of the best pieces of advice I received as a young attorney was from Anthony Geraci. He told me, “When in doubt, go conservative.” I think that rings true in business as well. Now, conservative is a relative and subjective concept. What do I mean when I say this? There are two big areas that cause significant stress to a private lending business: Capital Management and Business Plan Risk.
Capital Sourcing
When it comes to capital, the conservative approach in private lending would be to develop a discretionary source of capital. This includes your own personal wealth, raised capital that you control (e.g. debt funds, note offerings, etc.), note investors that are reliable and consistent (usually HNWIs), and other sources that are controlled by you. Lines of credit generally do not fit into the conservative capital sourcing playbook unless they are a bit more discretionary in their uses and are with a bank that is not facing significant stress.
Know Your Loan Portfolio
This is not the time to start chasing shiny objects where your loan portfolio is concerned. It’s time to double down on what you’re best at. I strongly recommend following your core lending business and avoid unnecessary risk that does not fall within that business model. For example, if you are not fully equipped to make ground up construction loans, junior loans, or shared appreciation loans, now is not the time to jump into these types of strategies.
One area that is discussed at great length is Non-Performing Loans. This is an area of private lending that is capital intensive, requires asset management skills and risk mitigation skills. If you have never managed assets, foreclosures and defaults, this may not be the time to jump into this arena. For those clients that have such skills, I strongly encourage it! Nonperforming Loans can be an area of immense opportunity, but it’s fundamentally a business of managing risk.
In uncertain times, it is also important to mitigate risk. Increasing collateral monitoring, eliminating risky loans from the portfolio, and increasing loss mitigation strategies are paramount as things continue to be change. This applies to loans that have been sold as well. Buy-back provisions can be exercised, so lenders should keep an eye on which loans were sold and what buy-back provisions may apply to them, so they don’t come back to bite you.
Conclusion
In summary, the private lending industry is again in flux. We are facing a significant amount of stress and disruption and navigating this uncertainty requires a conservative approach. Zero in your focus on capital sourcing and lending guidelines, developing a discretionary source of capital, stick to your core lending business, and avoid areas of risk you can not manage. With a conservative approach and an eye on the changing market, private lenders can weather this storm and emerge stronger on the other side.
