The great reshuffling: inside the decoupling of lending and deposits
In the traditional theory of banking, banks sit between savers and borrowers. They take deposits from savers, and they lend that money out to borrowers. (Even the name of, say, the "savings and loan association" reflects this simple dichotomy.) We show this dynamic in the diagram below.
And yet, as we covered in a previous post, much of the consumer and business lending in the United States now comes from non-bank lenders. In fact, the bank share of U.S. business debt stands at less than 20% today.
Private credit funds have stepped into fill the lending gap. For small to middle-market companies, or companies with between $3 million to $100 million in EBITDA, private credit funds / non-bank lenders are the primary source of debt capital.
So where does that leave banks? It's tempting to look at the shifting of lending from banks to private credit firms and to conclude that banks are doomed to follow the path of PacWest Bancorp, which announced this week that it was selling a $3.5 billion portfolio of loans to alternative asset manager Ares Management.
Selling assets has been one way for regional banks to shore up their liquidity in the wake of this year's banking crisis, and yet the transfer of "high-quality, asset-backed loans" from a regional bank to an alternative asset manager is in line with the longer-term trend of banks leaving lending. In that narrative, banks are outliving their usefulness in traditional lending (and may be replaced be neobanks or larger competitors).
And yet, as Matt Levine points out, the recent purchase of Pacific Western's loans, by Ares, was funded in part by Barclays, a large multinational bank. So it isn't the case that all banks are out of lending. It's just that small banks, or the borrower-facing "front-end" of lending, find their role diminishing, while large banks prefer to lend behind the scenes (and to "lend to lenders").
Why do alternative asset managers and private credit funds need loans from large, multinational banks? It comes down to leverage.
In reality, the capital stack of alternative asset managers and/or private credit funds often includes funding from both investors and multinational banks. So banks (large banks, in particular) still have a lending arm; that lending arm is just more likely to lend to asset managers and funds (who lend to small- and medium-sized businesses), rather than the businesses themselves.
Look around and you'll see similar developments in Blackstone's attempt to partner with regional banks to help them extend car loans and home improvement financing and in Apollo's acquisition of Credit Suisse's securitized assets.
There is a reshuffling of assets and lending between banks and asset managers of different sizes, and it's not clear how the game of musical chairs will shake out.
For now, the PacWest Bancorp deal signals a bifurcation in bank fortunes: small, regional banks are ceding their lending market share to alternative asset managers, while large, multinational banks are happy to step up lending to those same investment firms, behind the scenes.
What does this mean for lending standards and technology?
Market observers may have a sense of déjà vu as they observe the recent decoupling of business savings and lending: we saw the same story play out in the 1980s, just with mortgages.
As the Federal Reserve Bank of New York points out, mortgages used to be originated and held by regional banks and savings and loan associations, much like middle-market loans were almost exclusively originated and held by banks. The emergence of securitization in the 1980s allowed mortgages to be "held and traded by investors all over the world," leading to emergence of one of the largest fixed-income markets. Today, there are over $12 trillion in mortgage-backed securities outstanding, and the daily trading volume of these securities is at around $300 billion. A highly illiquid market became a highly liquid market.
What does the technological backbone for mortgage-backed securities look like, and how might the developments in that space be recreated in business lending?
Today, the largest issuing agent and administrator of mortgage-backed securities is Common Securitizations Solutions, which has over 300 employees and holds 75% of the market share (trillions of dollars annually) in processing mortgage-backed securities.
Common Securitization Solutions was formed by Fannie Mae and Freddie Mac in 2013 to modernize and standardize the "data validations, transmissions and reconciliations" associated with securitization, and developed its securitization platform for roughly six years, launching in 2019.
Will the same tendency toward efficiency in data standardization play out in the corporate lending world, or will the cost of developing structured finance technology be too high for vendors to bear?
It depends on whether you believe that liquidity and standardization go hand in hand. For most highly traded assets, there emerge a set of data standards and technologies that facilitate price transparency, ease of transaction, and visibility of reporting, all of which are missing from loan portfolio transactions today.
As market participants like large banks reconsider their role in lending, as well as "lending to lenders," the ad hoc nature of asset-backed and corporate loan portfolio transactions may end up evolving into something closer to the world of mortgage-backed securities, and new standards for transactions may emerge.
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