In its latest market commentary, investment adviser Old Hill Partners said large banks continue to eschew lower middle-market loans because of heightened regulatory scrutiny and unattractive risk-adjusted spreads as they concentrate on larger, more fertile customers.
The result is large banks and large companies have benefitted most from the post-crisis recovery, while small banks and small companies have not.
“Banks have become much larger and less prevalent, while lending assets have become highly concentrated and regulatory requirements much more complex”
Old Hill said this trend is borne out by hard data. According to the FDIC, 42% of all active loans held by U.S. banks originated from the five largest banks. Moreover, these loans are heavily concentrated: the six largest banks held 67% of loan assets, or some $9 trillion, while the remaining 6,775 U.S. banks held the remainder.
As such, alternative capital providers, including asset-backed lenders, are filling an important void for smaller companies, especially those whose business or credit history makes it difficult to secure traditional loans with reasonable conditions. Old Hill Partners’ asset strategy focused on lending to smaller companies has continued to perform well as a result.
“Banks have become much larger and less prevalent, while lending assets have become highly concentrated and regulatory requirements much more complex,” said John Howe, CEO of Old Hill Partners. “The result is that it is now simply too inefficient and uneconomical for these gigantic banks to lend to, and service, small, middle-market companies. That’s where Old Hill’s lending platform is positioned so that it can take advantage of this market inefficiency.”
Howe also notes that ironically, the macro environment for credit formation has rarely been more attractive. Low interest rates, ample liquidity, decent economic growth and low default rates mean the risk-reward profile for lenders and investors is generally positive. The outlook for asset-backed lending, in particular, should remain healthy for the foreseeable future because the advantages enjoyed by this niche are unlikely to dissipate quickly.
Darien, CT-based Old Hill Partners is an SEC-registered investment adviser with significant experience in all facets of asset-backed lending and alternative investment management.