Recruiting for Resilience: How to Build a Middle-Market Direct Lending Team for a Downturn Economy

In the intricate world of finance, the direct lending landscape has always thrived on resilience. As we find ourselves navigating an economic downturn, resilience has taken center stage like never before, particularly in the realm of middle-market direct lending. Our current economic climate may be challenging, but it also presents a unique opportunity – the opportunity to build a team that is not just equipped to weather the storm but to find growth within it.

The key to this growth lies in strategic recruitment. In this blog post, we will discuss the significance of durability in today’s challenging economic climate, particularly in the middle market direct lending sector. Following that, we’ll dive into the blueprint of assembling a resilient team and the crucial roles that contribute to its success.

Subsequently, we’ll guide you through the talent market, offering insights on spotting the direct lending all-stars. We’ll then focus on the role of resilience as a critical skill in potential candidates, and how to recognize it.

Beyond recruitment, we’ll discuss how to cultivate and encourage strength within your team. Finally, we’ll explore how to leverage economic downturns into growth opportunities with an adaptable team at your helm.

Regardless of the size of your private credit strategy, this post aims to empower you to build a direct lending team that can thrive amidst a downturn economy. Stay with us as we delve deeper into these crucial areas.

Resilience matters in economic downturns for middle-market direct lending.

The financial industry has always been a dynamic landscape, characterized by the ceaseless ebb and flow of economic cycles. Amidst this, resilience emerges as a crucial attribute that not only determines survival but also defines success. In the context of middle-market direct lending, this characteristic takes on an even more nuanced role, navigating the intricacies of private debt in times of economic downturns.

Middle-Market Direct Lending: The Resilient Navigator

Direct lending to the middle-market is an area where resilience is put to the test, especially during economic downturns. This sector involves extending loans to mid-sized businesses, which are often more vulnerable to economic headwinds than larger corporations. Despite these challenges, middle-market direct lending offers a range of opportunities, with options that cater to various risk appetites and provide portfolio diversification.

Interestingly, market conditions that may seem unfavorable on the surface can yield better returns in middle-market direct lending. This is because the strategy entails strict underwriting and deal terms, ensuring careful risk management. Amid economic uncertainty, institutional investors still find private debt attractive due to its ability to generate contractual returns, produce higher yield premiums in a rising-rate environment, and offer diversified strategies that function under varied market conditions.

Current Landscape: A Test of Resilience

The year 2023 presents the industry with a series of challenges, including persistent inflation, higher interest rates, and the prospect of slower economic growth. Around 76% of private credit executives anticipate higher default rates, signaling a potential increase in risk.

In response to these anticipated challenges, private credit funds and business development companies (BDCs) are shifting to more defensive investment strategies. These strategies include moving to less risky lower-yielding assets and leveraging at the fund level to generate higher returns. For instance, Goldman Sachs BDC and New Mountain Finance increased their first-lien assets while reducing their second-lien assets, a move that shows a strategic tilt toward safer investments.

Simultaneously, these funds are diversifying their portfolios by recruiting co-investors, reducing their costs, and expanding their reach into the market. There has been a rise in co-investment strategies to lower interest rate risk, achieve higher returns, and access a broader range of deals. However, the use of leverage, while beneficial in boosting returns, can also increase the risk, especially during a downturn. Therefore, it’s crucial for investors to understand the credit risk of the underlying investments.

To build a resilient direct lending team, key roles are essential for creating your dream team.

As the market conditions become more uncertain with the prospect of higher interest rates, inflation, and slower economic growth, a competent team can navigate these challenges and ensure steady returns for their investors.

Key Roles in a Direct Lending Team

●     Deal Origination Specialists: This role is primarily responsible for identifying and sourcing potential investment opportunities. They maintain relationships with intermediaries, industry contacts, and potential borrowers, and are skilled at assessing the market for viable investment prospects.

●     Credit Analysts: Credit analysts are the backbone of a direct lending team. They meticulously analyze the creditworthiness of potential borrowers, scrutinizing their financial health, business model, industry position, and more. Their goal is to mitigate risk and ensure the firm’s capital is deployed securely.

●     Portfolio Managers: Portfolio managers are the strategists of the team. They are responsible for managing the existing portfolio of loans, making decisions about loan approvals, pricing, and terms, based on the assessments from the credit analysts and the overall strategy of the firm.

●     Restructuring Specialists: As we prepare for a potential increase in defaults, restructuring specialists are becoming even more critical to a direct lending team. These professionals manage investments during a downturn, providing the necessary expertise to navigate challenging economic conditions.

●     Risk Management Professionals: These individuals identify, monitor, and manage various risks associated with direct lending. They work closely with credit analysts and portfolio managers to ensure risk is minimized across all investments.

Crucial Skills for a Direct Lending Team

●     Analytical Skills: From identifying potential investments to assessing credit risk, analytical skills are paramount in a direct lending team. The ability to scrutinize financial statements, market trends, and economic indicators is crucial for making informed lending decisions.

●     Relationship Management: Deal origination specialists and portfolio managers need strong relationship management skills to foster connections with potential borrowers and maintain healthy relationships with existing clients.

●     Negotiation Skills: Strong negotiation skills are necessary across several roles in a direct lending team. Whether it’s negotiating the terms of a loan or managing a restructuring process, the ability to drive a hard bargain while maintaining positive relationships is crucial.

●     Adaptability: In an industry that’s constantly evolving and facing new challenges, the ability to adapt to changes quickly is key. This is particularly relevant in the current economic climate, where firms are bracing for a potential uptick in defaults and a shift in market dynamics.

●     Risk Assessment: An inherent understanding of risk and the ability to assess it accurately is fundamental, particularly for credit analysts and risk management professionals.

As previously stated, this shift in the private debt landscape has prompted firms like Goldman Sachs BDC and New Mountain Finance to adjust towards less risky, lower-yielding assets in anticipation of a downturn. Moreover, there has been a trend of private credit funds recruiting co-investors to increase deal diversity, lower interest rate risk, and achieve higher rates of return.

Building a resilient direct lending team requires a careful selection of professionals with the right mix of skills and expertise. As the industry navigates through these uncertain times, a well-rounded team will be the bedrock of success, ensuring the firm can adapt and thrive no matter what the economic climate.

Experience the power of a resilient team as they turn downturns into remarkable opportunities.

Economic downturns and market volatility are natural aspects of the business cycle. While these situations pose challenges, they also present unique opportunities for those equipped with the right strategies and expertise.

As the industry prepares for an uptick in defaults and a potential economic downturn, private lenders are shoring up their restructuring teams and adopting more defensive strategies. Firms are rebalancing their portfolios to prioritize first-lien assets and are utilizing leverage at the fund level to generate higher returns, albeit with an increased level of risk.

In response to these trends, private credit funds are employing novel strategies such as co-investment to increase deal diversity and lower interest rate risk, while also maximizing returns. However, while leverage can boost returns, it also carries the potential to amplify losses during a downturn, underlining the importance of a thorough understanding of the credit risk of the underlying investments.

This complex environment requires a resilient team that can navigate economic downturns and seize the opportunities they present. With 20 years of experience in the private equity and debt market, The Locke Group is uniquely positioned to guide you through these challenging times. Our team’s expertise and deep understanding of market dynamics enable us to identify talent that can capitalize on opportunities that others may miss during periods of economic uncertainty.

In conclusion, while the current economic climate poses challenges, it also presents opportunities for those who are prepared. By partnering with The Locke Group, you are choosing a resilient team with the experience, expertise, and strategic insight needed to help you navigate these turbulent times successfully. Together, we can turn these challenges into opportunities, by making sure that you have the right team in place that is primed for long-term success.