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Private equity wants to be your banker

Ares Management (ARES) bought a $3.5 billion loan portfolio from a weakened lender in the aftermath of the spring banking crisis. Now it wants more.

The private equity giant announced last week it amassed another $6.6 billion for a new fund to buy assets — and made it clear that consumer loans could be snapped up as traditional lenders continue to shrink their balance sheets.

"We're still pretty optimistic that the opportunity to partner with banks is still in the early innings," Ares CEO Michael Arougheti told analysts during his company’s quarterly earnings call last week.

The hottest names in lending are no longer banks. They’re Wall Street money managers.

Private equity firms, hedge funds, and other giant asset-management firms are either snapping up big bundles of loans from beleaguered banks or originating new lending to businesses and consumers as they try to fund everything from the building of a factory to the purchase of a car.

These funds now collectively control $1.6 trillion in private credit assets under management, according to data provider Preqin, a figure that has doubled five times over the last two decades.

Much of this "private credit" is controlled by giants like Apollo Global Management (APO), Ares, Blackstone (BX) and KKR (KKR). (Disclosure: Apollo Global Management is the parent company of Yahoo Finance.)

'Dancing in the streets'

The rise of the private credit industry is not without controversy.

Some supporters view the funding as a needed source of support for borrowers at a time when banks are pulling back. Bank lending officers tightened their standards in the third quarter, according to a new Federal Reserve survey released Monday.

But critics who refer to these lightly regulated funds as "shadow banks" worry they could be introducing new, unseen risks into the financial system.

The danger, according to Steven Kelly, associate director of research at Yale’s Program for Financial Stability, "is that as non-bank lenders begin picking up more credit, regulators lose sight of risks."

Some bankers argue that money managers have an unfair advantage because they don’t have to operate under the same capital requirements as banks do. US commercial banks held $12.3 trillion in loans and leases as of October 25, according to the Federal Reserve.

When regulators proposed making those bank capital requirements even tougher in the wake of three sizable bank failures this year, JPMorgan Chase (JPM) CEO Jamie Dimon quipped that private equity lenders were surely "dancing in the streets."

JP Morgan CEO Jamie Dimon delivers a speech during the inauguration the new French headquarters of JP Morgan bank in Paris, France June 29, 2021.  Michel Euler/Pool via REUTERS
JPMorgan CEO Jamie Dimon. Michel Euler/Pool via REUTERS (POOL New / reuters)

There are some signs that Washington could be preparing to intensify its scrutiny of these funds. The latest signal came last Friday when the Financial Stability Oversight Council voted to approve a new framework for labeling firms as "systemically important," a tag that triggers new oversight from the Fed.

The new framework creates an opening for firms other than banks to get that label. Funds argue they don’t present the same systematic risks as banks, and therefore the label is not appropriate for them.

'Banks should be more boring'

Private credit was around long before the 2008 financial crisis, but it was that seismic event that created the conditions for the industry to flourish.

In the aftermath of 2008, regulators began penalizing banks for holding riskier loans on their balance sheets, and banks began shedding some of their assets to meet these new requirements.

The private credit industry got another boost as the Fed began raising interest rates in late 2022 and 2023, a campaign that created challenging conditions for mid-sized banks saddled with loans and investments that were suddenly worth much less.

The failures of Silicon Valley Bank, Signature Bank, and First Republic triggered panic about the strength of many of these banks.

Customers line up outside of the Silicon Valley Bank headquarters, prior to it opening, in Santa Clara, California, U.S., March 13, 2023. REUTERS/Brittany Hosea-Small
Customers line up outside of the Silicon Valley Bank headquarters on March 13. REUTERS/Brittany Hosea-Small (Brittany Hosea-Small / reuters)

As that chaos stabilized, banks again looked to sell investments and loans as a way of preserving capital and getting ahead of tougher regulations from Washington.

One big buyer was Ares, a giant of the private equity world that had been around since 1997 and had been pushing into private credit since 2004.

In June it emerged as the buyer of $3.5 billion in loans from Beverly Hills, Calif.-based PacWest (PACW), which had lost a lot of deposits following Silicon Valley Bank’s seizure in March.

A Pacific Western Bank branch, as seen on Thursday, May 4, 2023, in Whittier, Calif. Shares of small regional lender PacWest Bank plunged nearly 50% Thursday after the company confirmed reports that it was considering “strategic options” that may include the possible sale of the company. (AP Photo/Ashley Landis)
A PacWest branch. (AP Photo/Ashley Landis) (ASSOCIATED PRESS)

Its private credit division has also purchased more than $5 billion of super prime auto loans from a regional bank, Ares said.

Out of a total of $395 billion in assets of all types held by the firm, Ares holds $269 billion in credit assets.

Banks “are becoming simpler, and honestly, banks should be more boring,” Joel Holsinger, Ares partner and alternative credit co-head, told Yahoo Finance.

The relationship between traditional banks and private asset lenders is far from black and white, Holsinger said.

They aren't always rivals, for one. Banks, Holsinger said, are still lenders to asset managers such as Ares, which has $765 million in revolving credit lines with 17 different banks. Ares also frequently taps investment bankers to facilitate loan portfolio purchases.

“We're here to partner with banks, not compete with them,” Holsinger said. “In reality, it's a symbiotic relationship.”

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