It has been a busy March for banking as well as private lending. There have been millions of words written about this, so I’ll mention again briefly in case you’ve been stuck on a ship in the middle of the ocean and just got back. Silicon Valley Bank was shut down by the FDIC in March, as well as Signature Bank. We’re seeing signs of pressure across quite a few regional banks, including First Republic Bank, PacWest Bank and others.
This caused the Federal Reserve Board to backstep its expected 50 basis point increase (bps) and only increase 25 basis points. Quite a few made the argument that there should have not been any increase in March. However, based solely on the metrics the Federal Reserve looks at (don’t shoot the messenger – me, here in this case), they had to raise it. Jobs data came in higher than expected in February and so did the CPI index. Add that to the FDIC backstopping all deposits in SVB as well as Signature Bank, and you had a relatively stable (volatile but stable) economy with the two key drivers both overheated in the eyes of the Federal Reserve. This made for the 25 bps increase. We can question the wisdom of this, but objectively speaking, the Federal Reserve intends to move us into a recession to stop inflation from going out of control. This should happen by Q1 2024 by the latest, and Q4 likely.
Federal Reserve’s Impact on Private Lending
With WSJ’s prime rate now at 8%, what was once considered good private lending rates of 9% look absolutely astounding right now. What the heck is going on?
Interest Rate Penetration will take an Entire Year to Take Effect
Still seeing mortgages in the 5-6% range? You should. This is because even though the Prime Rate is 8%, it takes time to cycle through the entire lending market (wholesalers, warehouse providers, banks, etc). Remember, banks are also playing catch-up with their depositors, and only paying them 4.25% on their deposits (and this is exactly how T-bills become toxic assets and shut down SVB).
Trickle Down Economics – The Private Lending Way
With capital aggregators still able to price around 6-7%, private lending is giving banking a run for their money. We should see an uptick in deals closed between Q2 and Q3 of 2023 because of this. Capital aggregators are also able to predict with some certainty where interest rates will land. Since everything the Feds look at are lagging indicators, and all indications are showing jobs as well as CPI going down, no one is predicting huge increases to the interest rate. 6 of the 9 Fed Chairs surveyed expect the Fed Funds rate to be between 5.5 and 6%. That means the prime rate will become 8.5-9%. If we are currently at 5% Fed Funds Rate, the delta is at maximum 1%. This should give banks confidence that even if they price slightly wrong, the products should be profitable enough that it won’t affect their reserves and balance sheets too much.
Return of the Balance Sheet Lender
The real winners of this recessionary piece? Balance sheet lenders. If you have control over funds that you can lend out, you are going to be well positioned to set any terms you want. While capital aggregators are still lending, there are still others on the fence. Further, the regional banks who have been servicing the private lending space are pulling back or outright cancelling their deals, causing further headaches with those who are predominately reliant on such capital.
What Should You Prepare for in Q3, Q4 and Q1 of 2024?
Things will get worse before they get better. The Feds’ unprecedented raising of the interest rates so swiftly have caused a shockwave through the banking industry as well as the private lending sector. There are two strategies that make sense right now to prepare for Q3, Q4, and Q1 of 2024.
Origination Strategy: Diversification of Capital
If you are going to continue to originate, the supply of capital is going to continue to be interrupted for the next 3, 6, and 9 months. Regionals themselves are under threat due to their reliance on treasury bills as a safe space, but they failed to match duration with need, causing unrealized losses on their balance sheets. If you plan on sticking to origination, and you want to attract capital aggregators, you’re going to need several to ensure your capital is stable and you’re able to rely on them.
Scratch & Dent: Time to Start Those Funds
Alternatively, now is the perfect time to prepare for scratch and dent. There are already several aggregators sitting on piles of cash for the downturn, and if you plan on doing the same, you’re going to need to start a fund now to start accepting funds in escrow to have them ready to deploy when the inevitable bargains start showing up.
Need Advice? Call Us and Let’s Talk.
If you want to discuss your options, give us a call. We’re always happy to have a call to discuss your needs and strategy to give you a unique look on where private lending is today and where it’s going tomorrow. We were here yesterday. We’re here today. We will be here tomorrow for you.