PE Hub’s Outlook 2022 Q&A series with high-profile private equity professionals continues today with insights from Monroe Capital‘s Zia Uddin. A long-time executive at Monroe since joining the firm in 2007, Uddin was promoted to president  in October 2021, reporting to chairman and CEO Ted Koenig. Monroe Capital specializes in private credit markets across various strategies, including direct lending, asset-based lending, specialty finance, opportunistic and structured credit, and equity.

Will the dealmaking momentum continue in 2022?

We expect 2022 will continue to be very active on the M&A front, although it will be difficult to see if we will meet the record levels seen in 2021. While many of the key drivers of the record pace of activity in 2021 – underlying macroeconomic growth, significant PE and direct lending dry powder, and attractive valuations for those seeking exits – continue into 2022, 2021 benefited from pent-up demand coming out of the 2020 covid-induced slowdown and 2022 deals that were pulled forward into 2021 as sellers were looking to crystalize capital gains in 2021 ahead of the expected increase in capital gains rates. Furthermore, I’m not sure the broader financial community (e.g. PE teams, lenders, bankers, lawyers, etc.) could survive another year like 2021. Work at home, human capital management, employee satisfaction and retaining top talent will get a lot more focus in 2022.

Which sectors and types of companies will be especially promising in 2022?

While we see attractive opportunities throughout the economy, our focus will be on software and technology and healthcare. The dust is yet to settle on the new normal coming out of covid, but it is indisputable that technology was the shining star of the pandemic as virtually every company and industry was forced to accelerate their digitization efforts. We believe we’re still in the early innings of the digital revolution, and in fact, we believe a more inflationary environment will drive further acceleration in demand as software is one of the only options available to companies looking for operational efficiencies. We’re obviously not alone in that view, as you’ve seen tremendous growth in private equity dry powder for software and tech-specific funds, leading us to believe you will see even more software and tech M&A in 2022 and beyond. The same holds true for the opportunities in healthcare.

What keeps you up at night? Inflation? Interest rates? Covid variants? Regulatory issues?

As investors we worry about all those risks, unfortunately, as well as many others. However, by and large, we see those risks as risks we can analyze, mitigate and get paid for. The key is to avoid risks you do not get paid for. Our job as stewards of limited partner capital is to generate an excess risk adjusted return for them. Risk is part of the equation and if you take away all risk you might as well be putting money in a mattress. Being smart about the risks is where we focus.

Supply chain issues, as well as the general labor shortage at certain wage levels is typically the most common discussion points for us. Wage inflation is, in some ways, the least impactful ramification of the labor shortage. A scarcity of talent, which has of course been exacerbated by COVID, inflation, and burnout after a stressful time for almost everyone personally and professionally, could drive an inability to meet customer demand (whether it’s a widget manufacturer or a law firm advising a private equity firm).

How will the hybrid work model affect deal origination and deal closings?

The hybrid work model is the new norm, whether some companies want to see that or not. The labor market is too efficient and fluid. It is very likely it will be a net positive for more deal closings in 2022. While there may be perceived negatives to the WFH trend from a mentorship and company culture perspective, it is hard to argue that it has increased productivity and job satisfaction for a large number of our employees if done properly.

It allows valuable employees more choices and that is a good thing. 2020 and 2021 showed that a mix of virtual meetings and in-person meetings can still drive more deal activity.

How will PE’s increasing focus on ESG affect dealmaking?

You’ll see continued advancements and deeper diligence on ESG issues, and more investments in “double impact” investments, but we’re still a bit away from major fund flows into sustainability funds, but it’s coming.

From the lender’s perspective, what role do you expect leverage to play in PE-backed transactions in 2022?

PE firms will be increasingly strategic in picking the right lenders who can bring something beyond the most leverage at the lowest price. Whether that’s unique industry expertise, an ability to speak for more of a deal, to move quickly, or to grow significantly post-close in support of the sponsor’s growth strategy, leverage providers will continue to find ways to add more value in PE-backed transactions. Further, the more experience a lender has in doing deals, especially through difficult times, allows PE firms to see if their financing partner truly understands their business.

How will interest rates affect PE-backed loans?

For the last few years, LIBOR has been well below the typical LIBOR floor on PE-backed loans. That is likely to change sometime in 2022 or 2023 as the Fed begins to increase rates in the face of the highest inflation we’ve seen in several decades. In a rising interest rate environment, there will be greater focus from borrowers and lenders alike on cash flow sensitivity from interest rate increases, which could mean that leverage levels may begin to plateau or even decline after consistent increases in leverage throughout the course of 2021. There are some creative solutions we are providing to our PE clients that we think will allow us to differentiate ourselves in the market.

What are you most looking forward to in 2022?

LIBOR getting back above 1.0 percent! I look forward to new products for our platform and expanding our reach in areas that have a “perceived” risk where we can create an edge for investors. Private Credit still has a lot of growth, and we are just getting started.

Editor’s Note: For more Outlook 2022 Q&As, see our interviews with Riverside vice chairman Pam Hendrickson and Grain Management founder David Grain. Check back later in the week for more.