The value of diversified capital sources—and why the biggest opportunity may still lie ahead.

No one saw this coming. At least not like this.

We have been talking about the next recession since we got out of the last one. Now that it’s here, some lenders seem to be affected more than others. Many lenders ground to a halt and others plowed ahead.

There’s a simple reason for that: capital. Not just having it, or having a lot of it, but access to various types of it. If you’re wondering what is differentiating lenders right now, what’s powering one over another, what’s driving their decision-making process, you can stop. It’s capital.

Not All Capital Is Equal
If we look at the private lending landscape through the lens of COVID, one thing is clear: Not all capital is created equal. Private lenders have historically used three types of capital sources: direct (or syndicated) lending, lending through a fund and secondary markets. All three of these sources can work together (and often do), but if we break them down, we see different strengths and weaknesses.

Over the past several years, we have seen the rise of Wall Street capital in private lending. It’s efficient (quick decision making). It’s hungry (lower cost). And it’s plentiful (virtually unlimited). At least it was until COVID-19. All it took was an existential crisis and Wall Street made for the exit door faster than you can say securitization.

While this capital may be fickle during a time of crisis, it will return (and has) with new rules, new loan guidelines and a renewed appetite. Why? Wall Street continues to struggle when it comes to generating reliable yield for investors.

But it wasn’t so long ago that private lenders played matchmaker. We matched, or syndicated, private loans between affluent investors and savvy flippers. We charged points, created a spread between the note rate and what the lender was paid, and serviced the loan. It was good old-fashioned private lending. It was also inefficient, limited and often frustrating when it came to managing the personalities of our lending pool.

It’s the middle ground that deserves another look. Yes, a fund. The only thing better than having a large pool of private lenders to rely upon is having one where the capital is captive and under your direct control. Naturally, creating a lending fund requires more time (and money). But they are efficient vehicles, if structured and managed properly. They give you control over your lending capital, ensuring you can continue to lend through a crisis, while giving your investors diversification across all your assets. While it may not be the cheapest capital, it’s yours to manage.

Opportunities in Diversity
Which one is best for you and your lending company? All of them. Yes, all of them. While having too many capital sources are likely to present problems, diversified capital means you have flexibility. You have several tools in your toolbox, and your capital toolbox is no different. If you want to solve the myriad challenges that being a private lending presents, and you want to survive this (and the next, and the next, etc.) challenge, you need to have diversified capital sources. Possessing lending capital is necessary to continue your core business operations, but managing abundant capital allows you to capture market share at the expense of your competitors.

When lenders stop being lenders, they are quickly forgotten. That’s because this business is unforgiving. The market moves forward, regardless of your level of preparedness. Lenders that have continued to market and lend during the COVID-19 pandemic will quickly gobble up market share. Those lenders will grow, and they will own the stage during the recovery. Just remember, hubris is the platform for greed. If you find yourself in this position, be wise. Make certain you maintain quality underwriting, process-driven servicing and always have a backstop for loans that fail.

For those of you with a more entrepreneurial spirit, there’s something new out there for you. And it’s coming in all shapes and sizes. It’s not just more loans or market share won from your competitor. No, it’s discounted loans. Nonperforming loans. Foreclosures. Loan tapes. REOs. Software platforms. Employees. Entire businesses are for sale. All of these will take capital if you plan to take advantage. More than that, it will require know-how, grit and focus. But remember what brought you to the dance. And if you do decide to take on additional lines of business, do so in a methodical and well-prepared manner. Rome wasn’t built in a day.

Whether your present situation is focused on surviving or thriving, you’re thinking about capital: types, cost, access, diversification. It doesn’t matter whether you’re doubling down on your lending or buying up new opportunities, you’re doing it with capital. And just like an experienced mechanic, you need various tools for the job.