Whipsaw trading shares of regional banks this week made it clear that the fallout from three federal bank foreclosures was far from over. Some investors are even betting against seemingly healthy banks like PacWest, and regulators are gearing up to crack down on new capital restrictions on small and medium-sized lenders.
Big banks, while raking in money, face their own limitations, saddled with loans that were issued before interest rates started to rise.
That means that businesses large and small may soon have to look elsewhere for loans. And a growing cohort of non-deposit-taking non-banks — including giant investment firms such as Apollo Global Management, Ares Management and Blackstone — are eager to step into the vacuum.
Over the past decade, these institutions and others like them have been aggressively borrowing and extending loans, increasing the private credit sector sixfold since 2013 to $850 billion, according to financial data provider Preqin.
With other lenders slowing down, the big investment firms see an opportunity.
“It’s actually good for players like us to step into the breach where, you know, everyone else has left the room,” Rishi Kapoor, a co-chief executive of Investcorp, said on stage at this week’s global conference. the Milken Institute. .
But the shift in lending from banks to non-banks carries risks. Private credit has exploded in part because its providers are not subject to the same financial rules that apply to banks after the financial crisis. What does it mean for US lending to move to less regulated entities as the country faces a potential recession?
The emergence of shadow banks
Institutions that provide loans but are not banks are known (much to their chagrin) as ‘shadow banks’. Think of pension funds, money market funds and asset managers.
Because shadow banks do not take deposits, they are not subject to the same rules as banks, allowing them to take greater risks. And so far, their riskier bets have paid off: Returns on private credit since 2000 have outperformed public-market loans by 300 basis points, according to Hamilton Lane, an investment management firm.
These high yields make private credit attractive to institutions that once focused primarily on private equity, especially when interest rates were low. For example, Apollo now has more than $392 billion in alternative loans. Its subsidiary, Atlas SP Partners, recently provided $1.4 billion in cash to beleaguered bank PacWest. Blackstone has $291 billion in credit and insurance assets under management.
Private equity firms are also some of the largest clients of shadow banks. Because regulations limit how many loans banks can keep on their books, banks have moved away from accepting leveraged buyouts as they struggle to sell debt they took on before interest rates rose.
“We have proven over time to be a reliable form of capital that has really come to the fore as banks, at least in this environment, have cut back,” Mark Jenkins, head of Global Credit at Carlyle, told DealBook .
Direct lending could gain new momentum as regional banks pull back, particularly in commercial real estate like office buildings, where landlords may be looking to refinance at least $1.5 trillion in mortgage contracts over the next two years, Morgan analysts estimate. Stanley. US regional banks account for about three-quarters of these types of loans, according to Morgan Stanley’s research.
“Real estate is going to have to find a new home and I think private lending institutions are a pretty big place for that,” Michael Patterson, board partner at HPS Investment Partners, told DealBook. More broadly, he said, “Reduced credit availability for businesses large and small is one thing, and I think private credit is a big part of the solution.”
Untested area
Direct lending on this scale has never been tested: almost all of its decade-long growth has taken place amid cheap money and outside the pressures of a recession. The opacity of the industry makes it almost impossible to know which fault lines exist before they break.
At the same time, shadow borrowers are providing more and more credit companies that traditional banks do not want to touch, such as small and medium-sized enterprises. “These are not necessarily credit-rated companies,” Cameron Joyce, deputy chief of research insights at Preqin, told DealBook.
And while private lending firms market themselves as able to offer more creative credit, and act more quickly in the process, that flexibility comes at a price. These firms often charge higher rates and stricter conditions than their more traditional counterparts.
“Many of the new ‘shadow bank’ market makers are fair-weather friends,” JPMorgan Chase CEO Jamie Dimon wrote in his recent annual letter. this could mean faster bankruptcies for the companies that tap their loans.
On regulators’ radar
In Washington, shadow banks have been a concern, if not quite alarming, for years. As credit conditions tighten, they are scrutinized even more closely.
The IMF has called for tighter regulatory oversight, and US Treasury Secretary Janet Yellen said last month she wanted to make it easier to designate non-banks as systemically important, which would allow regulators to tighten scrutiny.
But given the urgency of the regional banking crisis, there may be little incentive to further disrupt the increasingly fragile financial system.
“I don’t know if they carry the same kind of risk as the major destruction of many regional banks,” Ron Klain, the former White House chief of staff, said in an April interview about shadow banks. “I think it’s something people will look at.”
Industry insiders claim that many private lending firms are as friendly to borrowers and target repeat customers as banks are. These companies have no depositors, so only their own investors would be harmed by a bad bet, they say. Because they don’t borrow against customer cash — a form of leverage — they aren’t vulnerable to a run in the bank.
“Our clients and counterparties have learned that it is inherently safe to deal with us,” Blackstone CEO Steve Schwarzman told analysts in March. “We don’t work with the risk profile of financial companies that have gotten into trouble, almost always because of the combination of a highly leveraged balance sheet and a mismatch of assets and liabilities.”
But problems in private funds have also caused pain outside the company in the past, such as when Long Term Capital Management collapsed in 1998, causing markets around the world to collapse. The more shadow banks lend to each other, the more they become intertwined, increasing the risk of a cascading effect that could spill over to the broader economy.
“They’ll say, ‘we have good control over our risk,’ but somehow you’re generating this return — this higher return,” said Andrew Park, a senior policy analyst with the advocacy group Americans for Financial Reform. “There’s no free lunch on that.”
Bernard Warner reporting contributed.
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