By Tim Courtney, Chief Investment Officer
Just a few years ago, the U.S. was in financial party mode. Interest rates were at historic lows1, the markets were thriving, assets were being bid up with cheap financing and investors were using more leverage.2 Fast-forward nearly two years, and we’ve found ourselves in a very different scenario as the Federal Reserve has raised interest rates at a historically rapid pace1. In response to this, markets are changing, and an area where we’re seeing a notable shift is corporate lending.
Most banks have had a challenging year. After Silicon Valley Bank, Signature Bank and First Republic Bank failed this year, customers rushed to withdraw their funds from smaller banks and transfer them to larger institutions.4 In addition, default rates on loans, including consumer loans, car loans and credit cards, have started to rise, adding to banks' fears.5 This has caused many banks to begin tightening their lending standards and hold onto deposits.
But borrowers still need financing, and they are finding it more frequently outside of the traditional banking systems as private lending and private credit markets have grown and become more mature.6 Traditionally, individuals and businesses sought loans from banks, which sometimes bundled and sold these loans in the open market as bank loans, mortgage backed debt, etc. However, increased regulations stemming from the 2008-2009 financial crisis, like the Dodd-Frank Act, led some banks to retreat from lending in certain markets.7
Over the last decade or so, alternative lending sources have gained more prominence, becoming crucial sources of liquidity for small and midsize businesses. While this alternative path to capital may come at a slightly higher cost, a lot of these companies are unable to meet the requirements of bank lenders.6 They are often too small to attract larger banks’ interest. So the opportunity to borrow capital through private market lending can be a viable, if also more expensive, option.
Private market lending can be funded through investors like our clients and other capital providers. Investors may provide lending through structures such as interval funds, limited partnerships and other private funds. These funds pool investor capital and channel it towards lending opportunities for students, households and small-to-mid-sized businesses.8 These loans generally do have higher default risks than investment-grade debt and subsequently also carry higher interest rates. As the private lending market grows, more funds, limited partnerships and other avenues are becoming available to investors.6 Many fintech-related companies and more efficient technology are being utilized in this space to reduce the costs of underwriting and make this lending more broadly available.
The bottom line is that as interest rates rise and challenges to banks remain, borrowing has become more costly and difficult. Some of this difficulty is necessary to eliminate the bad incentives and excesses of 2020-2021. But the market is also evolving to provide borrowers who are viable and provide value as an additional option. If you have any questions, please contact your Exencial advisor.
- NBC News (9/20/23) — Federal Reserve pauses rate hikes as inflation slows down
- Federal Reserve Bank of Richmond (2/21) — Bank lending in the time of COVID
- NPR (1/24/23) — A recession might be coming. Here's what it could look like
- The New York Times (5/1/23) — 3 failed banks this year were bigger than 25 that crumbled in 2008
- Washington Post (8/30/23) — Delinquencies rise for credit cards and auto loans, and it could get worse
- The Wall Street Journal (10/8/23) — The New Kings of Wall Street Aren’t Banks. Private Funds Fuel Corporate America.
- TheStreet (4/4/23) — What Is the Dodd-Frank Act? Why Is It Important?
- Investor.gov — Private equity funds
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