Regulations Lead to Rise in Risky Loans

With financial oversight focused on legitimate banks, some less-than-kosher loan providers are reaping the benefits.

Stemming from the recent release of the Financial Stability Oversight Council’s (FSOC) 2015 report, Bloomberg expands on the finding that the market for nonstandard — and therefore less supervised — lending companies is growing as restrictions increase for more established funds. What’s ironic is that some of these depositor-free lending outlets get their money from legitimate Wall Street banks, meaning that viable financial institutions are directly in harm’s way of the risk associated with high-yield credit disbursements.

The Bloomberg story relays findings showing that last year, direct-lending funds (which source capital from institutional investors like pension funds and insurance companies) reached a record $29.9 billion. Meanwhile, in the 4-year span between 2010 and 2014, loans from business development companies — which, the report notes, often have credit lines with banks — increased from $17 billion to $55 billion in the U.S.

“Right now we are, and will be over the next foreseeable future, the banks for middle-market credit,” Keith Read, a senior managing director at Cerberus Capital Management LP, said on an April 21 panel at IMN’s Investors’ Conference on CLOs & Leveraged Loans, according to Bloomberg. “The capital is flowing into this space and it’s alternative lenders like ourselves and others that are really providing capital, and we’re filling that vacuum as the banks go up-market.”

Alternative financing outlets, the story notes, continue to for the most part evade the watchful eye of regulators because they simply are not operating at the same volume as traditional banks. But that comparatively smaller market continues to grow — and with it, the financial risk associated with unmonitored lending.

“The migration in credit origination outside of the banking system could result in a further decline in underwriting standards for those particular loans,” the FSOC report states, “which could result in larger losses in stressed conditions.”