Bank Turmoil Is Paving the Way for Even Bigger ‘Shadow Banks’

This week’s Whipsaw trading of local bank stocks made it clear that the fallout from the seizures of three federal banks is far from over.Some investors are betting even on seemingly sound banks like pack westand regulators are preparing to tackle new capital limits for small and medium-sized lenders.

big bank, even if you scrape the cashhaving loans written before interest rates start to rise, faces its own constraints.

That means businesses big and small may soon need to look elsewhere for loans. And a growing group of deposit-free non-banks, including investment giants like Apollo Global Management, Ares Management and Blackstone, are desperate to step into that vacuum.

Over the past decade, these and similar institutions have been aggressive in attracting and expanding loans, supporting a private credit industry that has grown six-fold since 2013 to $850 billion.

Now, as other lenders slow down, big investment firms see an opportunity.

Investcorp co-CEO Rishi Kapoor said on stage at the Milken Institute global conference, “Players like us step into a space where everyone else has spaced out. is actually a good thing,” he said. .

However, the shift in lending from banks to non-banks is fraught with risks. One of the reasons private credit has proliferated is that its providers are not subject to the same financial regulations imposed on banks after the financial crisis. What does it mean that US lending is shifting to less regulated entities at the same time that the US is facing a potential recession?

Rise of shadow banks

Institutions that offer loans but are not banks are known (to their chagrin) as ‘shadow banks’. This includes pension funds, money market funds and asset managers.

Shadow banks do not take deposits, so they are not subject to the same regulations as banks and can take greater risks. Since 2000, his private credit has outperformed public benchmarks by 300 basis points, according to investment management firm Hamilton Lane.

These large returns make private credit an attractive business, especially for institutions that have focused on private equity in times of low interest rates. Apollo, for example, currently holds more than $392 billion in his alternative lending business. Its affiliate, Atlas SP Partners, recently provided $1.4 billion in cash To bank PacWest in distress.Blackstone is $291 billion Credit and insurance assets under management.

Private equity firms are also some of the largest shadow bank customers. Banks are pulling back because regulations limit the number of loans they can keep on their books. Underwriting leveraged buyouts That’s because they’re struggling to sell their committed debt before interest rates rise.

Carlyle’s head of global credit, Mark Jenkins, told DealBook:

Morgan Stanley analysts say local banks are pulling out, especially in commercial real estate such as office buildings, where landlords may be looking to refinance at least $1.5 trillion of mortgage commitments over the next two years. We anticipate that direct lending could be further boosted as Morgan Stanley research shows that US regional banks account for about three-quarters of this type of lending.

Michael Patterson, managing partner at HPS Investment Partners, told Dealbook: More broadly, he states:

unknown territory

Direct lending on this scale has never been tested before. Nearly all of his decade-long growth has taken place outside the pressures of a recession, in cheap currencies. Industry opacity means it’s nearly impossible to know which fault line is there before it breaks.

At the same time, shadow lenders are increasingly extending credit Companies that traditional banks can’t touch Small and medium-sized enterprises. Cameron Joyce, his deputy head of research at Preqin and his insights, told DealBook:

Private credit companies also pride themselves on being able to offer more creative credit and be more responsive, but that agility comes at a price. These companies often demand higher rates and tougher terms than their traditional peers.

“Many of the new ‘shadow bank’ market makers are friends of the fair weather,” said Jamie Dimon, CEO of JPMorgan Chase & Co. I have written in his recent annual letter. “They don’t step in to help their clients in tough times.”

About Regulatory Radar

In Washington, shadow banking has been a hot topic for years. They are getting more attention as credit conditions tighten.

The IMF is called for stricter regulatory oversightand U.S. Treasury Secretary Janet Yellen said last month that she wants to make it easier specify Non-banks are systemically important, which allows regulators to increase scrutiny.

But given the urgency of the local bank crisis, there may be little incentive to further disrupt an increasingly fragile financial system.

Former White House Chief of Staff Ron Klein said of shadow banks in an April interview, “I don’t know if they pose the same kind of risks that the large-scale wipeout of many local banks poses. “I think that’s what people keep paying attention to.”

Industry insiders argue that many private credit firms are as borrower-friendly as banks and are focused on repeat customers. Since these companies have no depositors, the only people who lose money on bad bets are their own investors, they say. They are not vulnerable to bank runs because they do not lend against their customers’ cash (a form of leverage).

“Our customers and counterparties have learned that doing business with us is inherently safe,” Blackstone Chief Executive Steve Schwartzman told analysts in March. Told. “We do not operate at the risk profile of a troubled financial firm, mostly due to its highly leveraged balance sheet and asset-liability mismatch.”

But private fund issues have caused pain beyond the company in the past. Long-Term Capital Management collapsed in 1998, bringing down markets around the world. The more shadow banks lend to each other, the more interconnected they are, and the greater the risk of cascading effects that can spill over into the broader economy.

“They’ll say, ‘We’re managing the risks well,’ but you’re creating these returns in some way. These higher returns,” said a senior executive at the advocacy group Americans for Financial Reform. policy analyst Andrew Park said. “There is no free lunch on top of that.”