Staying Disciplined in an Era of Alternative Lending

By Kevin P. Lavender | Head of Corporate Banking, Joshua Landau | Corporate Banking Group Head, Lydia Altman | Corporate Banking Director

It’s no secret that non-traditional lending has grown exponentially in the wake of the financial crisis.

In fact, what was once a small niche in the market has become a key source of liquidity for corporations, institutions, and individuals. At the same time, investors seeking higher yields have also embraced these alternatives, further bolstering this trend.

Of course, new avenues for lending also pave the way for potential new risks. Which is to say, it’s one thing to adapt to an evolving market and quite another to grow complacent.

While this is true at any stage of the credit cycle, growing debt burdens and the prospect of slower economic growth are all the more reason for asset managers, private equity investors, and non-bank lenders to stay vigilant and disciplined.

The following primer is designed to help you successfully navigate this rapidly evolving arena of finance.

A Wave of Alternatives

The tighter lending standards and greater regulation that followed the financial crisis opened the door for a wide range of non-banking entities—from established asset managers to fintech startups—to enter the business of lending.

Private equity and other alternative asset managers have amassed an estimated $1 trillion in “dry powder” and they are looking to put this capital to work—not just via private equity, but also, increasingly, through private credit deals.

Although many non-bank lenders are building high-quality loan portfolios, a growing number of institutions are delving into the riskier parts of the market. Consider this statistic published in Institutional Investor: In 1994, 71% of participants in the U.S. leveraged loan market were global banks with the remainder made up of non-banks and funds. By 2017, it was just the opposite. Non-bank lenders represented 91% of leveraged loan market participants.

Borrowers, meanwhile, now possess more leverage than ever, prompting many lenders to offer more favorable structures, cut corners on documentation, and remove other barriers. According to a report by JPMorgan Chase & Co.'s asset management unit, by the end of 2018 80% of leveraged loans were covenant-lite.

Further, direct lending has grown from a sliver of the market before the financial crisis to one of the largest segments of credit and debit investment strategies. Prequin, a company which tracks data on alternative assets, reports that that global private credit assets under management tripled over the past decade to $667 billion.

Balancing Risk and Reward

From better access to credit to more efficient lending practices, an evolving credit market has plenty to offer. Yet, as the financial crisis demonstrated, it’s important to balance enthusiasm for changes in the marketplace with caution and due diligence. Issues such as covenant-lite loans—in which borrowers effectively name their terms—and weak documentation create vulnerabilities not just for lenders, but for their other clients and the broader market.

In the event of widespread defaults, banks that fund alternative lenders could also be forced into a corner: Traditional banks provide liquidity to alternative lenders via senior secured debt, shifting the risk to less regulated areas. Less disciplined banks, it follows, will be vulnerable—with potential implications for other clients.

Alternative lenders in search of a financing partner should look beyond the transaction at hand and consider the potential longevity of the relationship. Sponsors that have moved into the alternative lending space in a thoughtful way are likely to be better positioned in a more challenging credit environment.

The Value of a Holistic Approach

As lenders to lenders, Fifth Third understands how to balance the risks and rewards of financing at every stage of the market cycle. Our approach isn't to sell products, but to help identify opportunities, spot potential problems, and provide relevant solutions in a complex and evolving market.

Fifth Third is large enough to offer asset managers and other non-bank lenders access to the capital and resources needed while simultaneously facilitating connectivity throughout the bank—services that go well beyond being a financing partner and can provide value throughout the lifecycle of a deal.

More than simply a stable funding source, Fifth Third takes a holistic, tailored approach to clients’ businesses and balance sheets. Our goal is to empower our non-bank clients with the information and expertise necessary to make better, more effective decisions on the road to success.