Shadow banking is getting competitive
“Shadow Banking”: It sounds vaguely nefarious, or maybe a term from virtual snooker.
But it’s simply a post-meltdown term that describes any kind of private lending, as opposed to financing provided by federally insured financial institutions, which include commercial banks, thrifts (S&Ls) and credit unions.
To most bankers, shadow banking doesn’t exist. They manage to ignore it, sort of like your brother-in-law that keeps showing up in Cop Shop. But, unlike the brother-in-law who, if you’re lucky, might get sent away for a five- to 10-year sentence, SB is here to stay; at least for the foreseeable future.
Private lending is the oldest segment of the financial business, and it was probably around even before our ancestors started moving out of Africa to take over the prime hunting grounds from those Neanderthals, who didn’t appreciate the potential (in fact, for all we know, modern humans may have acquired the real estate through foreclosure). Actually, it may be tied for antiquity with the better-publicized Oldest Profession.
When the concept of banking as we know it was in its infancy, lending criteria for institutional (bank) and private lending began to polarize. Banks took what was perceived to be the best borrowers, private sources took the rest.
Banks had the best borrowing rates, with those of private sources being much higher because of the assumption of greater risk. The demarcation between the two became dramatically more pronounced as banks, worldwide, came under government supervision.
Bankers by nature tend to look at SB, if they look at all, as something that sort of takes place on a street corner at around 11:59 p.m. Of course, the impression is off the mark. There are national and multinational noninstitutional lenders that are every bit as sophisticated as J.P. Morgan/Chase.
This state of denial may change, because the private sources are taking business from the banks. Or, rather, taking business that banks would like to do but can’t because of new regulatory restrictions, mandated by the Dodd-Frank act in the wake of the financial crisis.
Private money gets a much higher return on loans than banks quote: often almost three times as much. But there’s an intriguing wind blowing in the lending landscape. Nonbank lenders are seeing an opportunity (sort of like the first humans walking into Europe) and they’re moving to take advantage of it. They’re actually starting to get competitive.
Typically, a borrower’s conversation with many private lenders might began like this: “The rate is 12 percent (or 14, or 18, depending on where the Wall Street Prime Rate might be) and the points will be five. Take it or leave it.”
But the hard line might be cracking just a bit. Recently, I know of a $2,000,000 construction loan to build some luxury resort townhouses that was just south of being bankable. Private lenders, of course, were all over it. At 12 percent and three to four points. Enter another nonbank lender, noted for very high rates, that quoted 11 percent and one on the deal. That would have been a shock a few years ago.
In another instance, a 50 percent loan to value primary home loan found a 7.75 percent rate from a nonbank source. (Although most private lenders won’t touch a primary home loan because of new, punitive regulations, there are still a few that do.) Of course, in both instances, these loans would have bee made by an institutional lender in, say, 2005.
It could be that the lending dynamic could be moving from the 20th century categories of hard and soft money, to a third classification:
Jello money, halfway between hard and soft.
Pat Dalrymple is a western Colorado native and has spent almost 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His e-mail is firstname.lastname@example.org.
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