What becomes of banks, as private credit eats specialty lending?

Rosa O'Hara

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The near-collapse of Silicon Valley Bank earlier this year prompted other bank runs and greater regulatory scrutiny. But for private credit firms — which were already gobbling so-called specialty finance assets like residential solar financing and subprime auto loans — it was an opportunity.

These firms are expanding their reach into specialty lending, filling the vacuum as banks retreat. As they pull back from holding such assets, banks are doing their best to maintain a presence in these markets by partnering with their non-bank peers.

Credit funds and fast-moving fintech lenders may be more inclined than banks to hold these speciality lending assets for the long term, but there are still things they need from their friendly neighborhood regional bank.

Helping hand

Cross River Bank, for example, helps fintech lenders comply with a complex web of state-by-state banking laws.

Providing safe passage through this complexity is a safe haven for banks, said Noah Cooper, chief investment officer at the bank, at DealCatalyst’s Specialty Lender Finance conference earlier this week, during a panel discussion moderated by 9fin.

“We've built a nice mousetrap,” said Cooper. “But that said, there is always quite a bit of competition from both new entrants and incumbents.”

Cross River offers its fintech clients interoperability between the FedNow program and RTP, both real-time payment systems that can be extremely complex. By figuring out the plumbing for fintech lenders to fund and administer the loans they originate, Cross River can make itself valuable and maintain some exposure to clients it won’t lend to directly.

“We’re trying to solve what are solutions we can provide, both end-to-end lifecycle [of deals], but also up and down the capital stack, where we are both solving the operational burden and the headache of issuing an ABS deal, but also being flexible,” said Cooper.

Other regional banks are doing their best to carve out a niche in an area of finance that is being gradually eaten up by private credit firms, said Joseph Weingarten, a managing director at East West Bank.

“We’re looking for new ways to try to add value [for clients],” said Weingarten during the panel discussion. “Whether we could start with a positive relationship that we didn't already have, and provide some other type of treasury service, or to be maybe a co-manager on their next transaction.”

Essentially, banks now find themselves on the back foot. SVB itself is a great example: before it nearly fell over in March, it generally required the VC-backed fintech firms that banked with it to keep 100% of their deposits at the bank. That’s clearly not feasible anymore, after the events of earlier this year.

“We can't ask for 100% deposits anymore,” said Brian Foley, a market manager at SVB focusing on fintech warehouse and relationship management. “Boards, treasurers and CFOs have all mandated that they want to diversify their deposits.”

SVB now offers multiple options for what clients can do with their cash, including cash sweeps into money market funds and broker networks for insured deposits, he said.

“That’s probably one of the biggest game-changers now, [the fact that] that market has grown pretty dramatically,” he said (our leveraged finance colleagues have covered some broker-dealers in this space, such as Osaic, Focus Financial and Cetera).

Symbiosis

As banks look to remain relevant in this rapidly shifting environment, there are plenty of opportunities to build symbiotic relationships with credit funds.

“I'm particularly fascinated by a potential strategy for collaboration between banks and credit funds,” said Gary Miller, director at specialty lender Revere Capital. “Banks are really good at originating assets, they're not so good at funding them, just because of the liability structure.”

Credit funds can also step in to provide riskier forms of capital that banks aren’t willing to hold, and thus help to complete capital structures, said Howard Schickler, a partner at Katten Muchin Rosenman.

“It's some combination of entities,” he said. “Whether it's a bank doing the financing and credit fund taking a piece of the bottom [of the capital structure].”

Banks may always have an advantage in certain areas, for instance very safe investments with low returns, which are of no use to yield-hungry credit markets, the panelists noted; these types of assets and markets are a clear-cut safe haven for banks. As risk gets higher, this is where more symbiotic relationships might form between credit funds and banks.

“I don't think, as this market develops, it is a zero sum game that either the credit funds will win that credit or banks will win that credit,” said Felix Zhang, a managing director at Ares. “Credit funds have always been taking risk off banks […] It’s just the same theme just being expressed potentially in a different structure.”

Another positive point for the banks is smaller deals are less attractive to private credit firms. The direct lenders doing mega-sized unitranches just aren’t interested in amassing pocket money by taking deposits.

“A lot of the larger money-center banks are not going to get out of bed for less than a $100m-plus transaction,” said Weingarten of East West.

Banks can also remain relevant by offering leverage to private credit firms, which is becoming as commonplace in the specialty lending space as it is in the leveraged finance markets. See, for example, the NAV loan that Goldman Sachs provided to enable Vista’s equity injection into Finastra.

One caveat, however, is that banks’ clients are significantly more focused on banks’ financial stability since the crisis earlier this year.

“A much larger percentage of my conversations now are the financial strength of my employing institution,” said Foley at SVB. “And those are not unfair questions.”