Direct Lending’s Evolution: Mitigating risk through a commitment to the middle market

TED

To bring all these forces together, you must set out an investment strategy. And you've alluded to some of it, mid-market, sponsor backed. Where did you come out and say, okay, this is a strategy that we're going to pursue here?

RON

Yeah. So, when I joined Invesco, I put a lot of thought behind this because when I joined, we were in a benign interest rate environment, skies were blue, that nothing was going wrong. Lenders were being fairly aggressive in terms of how they were approaching opportunities.

And, and we sort of we looked at the investor base at Invesco, we looked at what Invesco had done across the private credit platform. For me, I wasn't predicting what would happen. But, you know, again, nothing good lasts forever. We decided out of the blocks to skew very much towards the conservative end of direct lending.

And so, what did that mean? Structure, it starts with structure. We said everything we do is going to be senior secured. First line uni-tranche.  We're not doing second line, and we're not doing mezzanine, we're going to be top of the cap stack. We're going to have our money attached to dollar point one.

We're going to full collateral and all the hard assets, all the IP of the businesses we lend to. So structurally, that's how we thought about it. The second piece of it was, we said everything we can do, we can do with private equity for the reasons we talked about earlier. We want partners, folks. We know folks are putting significant risk capital in these businesses in front of us.

That's a way to mitigate risk. And then we thought about from a sector perspective, you know, myself, my partners, we've spent our careers in the middle market. It didn't even occur to us to sort of think about going up market. This is the market. We knew this is where we knew we could generate compelling returns.

And so, we focused on the middle market. The last piece of this was really all about asset selection. For us, there are these two words we use over and over again, to define the right, the perfect business for us to, to lend to those two words are stable and boring.

For us, we look for businesses that have long historic track records. When you think about modeling out what the business is expected to do over the next five years, there's no hockey stick projections. You know, slow, stable businesses do two things really well; pay your interest, amortize your debt. The thing we talk about all the time as a senior lender, the best you could ever hope for is to get your money back, right.

You're not supposed to lose principal when you're lending senior debt. And so, everything about our philosophy was oriented around conservative structures. Everything had to have covenants associated with it. It wasn't an accident that that's the model we built, but it worked for us, as we went through these challenging, rising interest rate environments over the last handful of years where you had lots of businesses out there that were over-leveled and poorly structured and maybe didn't have covenants.

We didn't have any of that. This conservative model served us really well. We've come through this cycle much like we've done prior cycles. And look, no style drift. This is how we've set out to build this business and how we've done it for the last seven years. And touch with us how we do for the next seven years.