Whipsaw trading in regional bank shares this week made it clear that the fallout from three federal bank seizures was far from over. Some investors are even betting against seemingly healthy banks like PacWest, and regulators are preparing to place new capital restrictions on small and midsize lenders.
The big banks, while hoarding cash, face their own limitations, saddled with loans issued before interest rates began to rise.
That means businesses large and small will soon have to look elsewhere for loans. And a growing cohort of deposit-free nonbanks, including giant investment firms like Apollo Global Management, Ares Management and Blackstone, are eager to fill the void.
Over the past decade, these institutions and others like them have aggressively borrowed and made loans, helping the private lending industry grow six-fold since 2013, to $850 billion, according to financial data provider Preqin.
Now, as other lenders slow down, big investment firms see an opportunity.
“It’s actually good for players like us to get into the gap where, you know, everyone else has vacated the space,” Rishi Kapoor, co-CEO of Investcorp, said onstage at the Milken Institute’s global conference this week. . .
But shifting lending from banks to nonbanks carries risks. Private credit has skyrocketed in part because its providers are not subject to the same financial regulations imposed on banks after the financial crisis. What does it mean that US loans are moving to less regulated entities at the same time that the country is facing a possible recession?
The rise of shadow banks
Institutions that make loans but are not banks are known (much to your chagrin) as “shadow banks.” They include pension funds, money market funds, and asset managers.
Because shadow banks do not accept deposits, they are not subject to the same regulations as banks, which allows them to take on higher risks. And so far, its riskiest bets have paid off: Private credit returns since 2000 have beaten the public benchmark by 300 basis points, according to Hamilton Lane, an investment management firm.
These large returns make private lending an attractive business for institutions that once focused primarily on private equity, especially when interest rates were low. Apollo, for example, now has more than $392 billion in its alternative lending business. Its affiliate, Atlas SP Partners, recently delivered $1.4 billion in cash to beleaguered PacWest bank. Blackstone has $291 billion in credit and insurance assets under management.
Private equity firms are also some of the biggest clients of shadow banks. Because regulations limit the amount of loans banks can keep on their books, banks have moved away from leveraged buyout subscription as they struggle to sell the debt they pledged before interest rates went up.
“We’ve proven over time that we’re a trusted form of capital that’s really come to the forefront as banks, at least in this environment, have shrunk,” Mark Jenkins, Carlyle’s global head of credit, told DealBook.
Direct lending may get another boost as regional banks backtrack, particularly in commercial real estate like office buildings, where homeowners may be looking to refinance at least $1.5 trillion in mortgage contracts over the next two years, analysts estimate. Morgan Stanley. Regional banks in the United States have accounted for about three-quarters of these types of loans, Morgan Stanley research shows.
“Real estate is going to have to find a new home and I think private lending firms are a pretty big place for that,” Michael Patterson, managing partner at HPS Investment Partners, told DealBook. More generally, he said: “The reduced availability of credit for businesses, large and small, is a problem, and I think private credit is a big part of the solution.”
untested territory
Direct lending on this scale has never been tested: Nearly all of its decade-long growth has come amid cheap money and outside of the pressures of a recession. The opacity of the industry means that it is almost impossible to know what fault lines exist before they break.
At the same time, shadow lenders are extending more and more credit to signatures that traditional banks won’t touch, such as small and medium businesses. “These are not necessarily companies with credit ratings,” Cameron Joyce, Preqin’s deputy head of data analytics, told DealBook.
And while private lending firms tout themselves as being able to offer more creative credit and move faster when doing so, that agility comes at a cost. These companies often demand a higher rate and stricter terms than their more traditional peers.
“Many of the new ‘shadow bank’ market makers are friends in good times,” Jamie Dimon, chief executive of JPMorgan Chase. wrote in his recent annual letter. “They don’t step in to help customers in difficult times.” Some fear that could mean faster foreclosures on businesses that tap into their loans.
On the regulators’ radar
In Washington, shadow banks have been a focal point, if not outright alarming, for years. As credit conditions tighten, they are being scrutinized even more closely.
The IMF has called for stricter regulatory oversightand US Treasury Secretary Janet Yellen said last month that she wanted to make it easier designated 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 interest in further disrupting what could be an increasingly fragile financial system.
“I don’t know if they pose the same kinds of risks that the big liquidation of many regional banks would pose,” Ron Klain, a former White House chief of staff, said of shadow banks in an interview in April. “I think it’s something that people will keep their eyes on.”
Industry insiders argue that many private lending firms are just as borrower-friendly and customer-focused as banks are. These companies have no depositors, so only their own investors would be hurt by a bad bet, they say. Because they are not lending against customer cash, a form of leverage, they are not vulnerable to a run on the bank.
“Our clients and counterparties have learned that there is inherent security in dealing with us,” Blackstone Chief Executive Steve Schwarzman told analysts in March. “We do not operate with the risk profile of financial firms that have had problems, almost always due to the combination of a highly leveraged balance sheet and a mismatch of assets and liabilities.”
But troubles in private funds in the past have caused pain beyond the company, such as when Long Term Capital Management collapsed in 1998, sending markets crashing around the world. The more shadow banks lend to each other, the more interconnected they become, raising the risk of a cascading effect that could hit the broader economy.
“They’ll say, ‘We have good control over our risk,’ but somehow you generate these returns, these higher returns,” said Andrew Park, senior policy analyst at advocacy group Americans for Financial Reform. “There’s no free lunch in that.”
bernard warner contributed reporting.
Thank you for reading! See you on Monday.
We would like your opinion. Email your ideas and suggestions to dealbook@nytimes.com.