NEW YORK–The business of making risky loans has returned a decade after the financial crisis, but this time there are new players involved as well as new risks, according to one new analysis.
That same analysis also found another familiar term in the runup to the housing crisis has made a comeback: CLOs.
So called “shadow banking,” a reference to lenders outside the traditional regulated banking system, now represent approximately $15 trillion in assets in the U.S., which is roughly the same size as the entire banking system of Britain, the world’s fifth-largest economy, reported the New York Times.
“In certain areas — including mortgages, auto lending and some business loans — shadow banks have eclipsed traditional banks, which have spent much of the last decade pulling back on lending in the face of stricter regulatory standards aimed at keeping them out of trouble,” the Times reported. “But new problems arise when the industry depends on lenders that compete aggressively, operate with less of a cushion against losses and have fewer regulations to keep them from taking on too much risk. Recently, a chorus of industry officials and policymakers — including the Federal Reserve chair, Jerome H. Powell, last month — have started to signal that they’re watching the growth of riskier lending by these non-banks.”
Amit Seru, a professor of finance at Stanford Graduate School of Business, told the Times, “We decided to regulate the banks, hoping for a more stable financial system, which doesn’t take as many risks. Where the banks retreated, shadow banks stepped in.”
The Primary Players
Among the big players to emerge in mortgage lending, for instance, are companies like loanDepot, Quicken Loans and Caliber Home Loans. Between 2009 and 2018, the share of mortgage loans made by these businesses and others like them soared from 9% to more than 52%, the Times noted, citing figures provided by Inside Mortgage Finance.
These non-bank lenders offer response times to consumers many credit unions would love to be able to replicate. One 24-year-old mortgage borrower told the Times he plugged his information into LendingTree.com and Quicken Loans, and said he received phone calls from the companies within 15 seconds. The borrower, who was approved, said he didn’t reach out to any banks during his search.
While that’s great for some consumers, the Times noted the potential downside is “because these entities aren’t regulated like banks, it’s unclear how much capital…they have. If they don’t have enough, it makes them less able to survive a significant slide in the economy and the housing market.”
Non-Banks Push Back
The non-bank lenders pushed back at the suggestion they are not regulated, telling the Times they are overseen by the CFPB and state regulators, and must also follow guidelines from Fannie Mae and Freddie Mac.
The Times noted in its analysis another practice common in the runup to the housing crisis has made its return: the packaging of loans into collateralized loan obligations, or CLOs. “Wall Street has revived and revamped the pre-crisis financial assembly line that packaged together risky loans and turned those bundles into seemingly safe investments,” the Times reported.
“If investors have any concerns about a replay in the CLO market, they’re hiding it fairly well. Money has poured in over the last few years as the Federal Reserve lifted interest rates,” the Times added.
But, again, there are risks. “For one thing, those loans are increasingly made without the kinds of protections that restrict activities like paying out dividends to owners, or taking out additional borrowing, without a lender’s approval,” the Times stated. “Roughly 80 of the leveraged loan market lacks such protections, up from less than 10% more than a decade ago. That means lenders will be less protected if defaults pick up steam.”