EZ Credit Gets Creative.

New players are increasingly emerging to fund loans that do not meet banks’ strict criteria. An article in the WSJ cites nonbank commercial loan growth of 7.5% in the first quarter compared to 3.6% for bank loans. The increase in the number of funds over the prior five year period is impressive:

“Overall, firms completed fundraising on 322 funds dedicated to this type of lending between 2013 and 2017, with 71 raised by firms that had never raised one before, according to data-provider Preqin. That compares with 85 funds, including 19 first-timers, in the previous five-year period.”

The article cites that Ares just raised a record $10 billion dollar fund for middle-market lending, and that KKR is creating the largest business development company. Other titans expanding in this space include Apollo, Blackstone and Carlyle.

Direct loans are generally made as floating rate notes to companies with less than $50 million in EBITDA. For borrowers that have grown accustomed to falling interest rates, a reversal may come as a painful surprise.

New lenders are popping up with claims that new data can be used to make loans to customers lacking enough borrowing history to secure credit from firms taking the traditional approach. What I find comical is that this is taking place within customer bases where the incumbent lender has realized increasing losses related to defaults. An article in the WSJ point out that Synchrony Financial, one of the largest providers of credit to WMT customers, has seen shares fall “amid concern that rising defaults could hit profits” and simultaneously a new lender [Affirm Inc.] has emerged to target “people who don’t have enough of a borrowing history to get a credit card.”

An article in the WSJ reports that stocks are supported by record levels of borrowing (known as margin debt). Per the author, margin lending growth has proven to be a decent indicator of overvalued markets.

“Rising margin lending from Swiss and U.S. wealth managers can make a downturn far more painful. … In the U.S., margin debt is more than three-times the level ahead of the 2008 crisis and is greater even than its peak in 2000 before the dot-com crash, according to the B.I.S.”

Home builders are testing new tactics to lure young buyers. Per an article in the WSJ, one such firm will pay down a portion (3% was cited) of a first-time-buyer’s outstanding student loans:

“A subsidiary called Eagle Home Mortgage plans to introduce on Tuesday a program under which Miami-based Lennar will pay off a significant chunk of the student loan of a borrower who purchases a home from them. … Such programs come with the risk, however, that the incentive drives up the price of new homes.”

It will be interesting to see if this becomes a trend that catches on with other home builders.

Highlighting a perfect example of lending that only works so long as the bull market thrives, large private equity firms are now financing home flippers. Per an article in the Wall Street Journal:

KKR is the latest example of Wall Street’s growing interest in the area. The private-equity house is boosting its commitment to Toorak Capital Partners LLC, a New Jersey concern that buys up loans made to home flippers and other residential-rehabilitation specialists from originators throughout the U.S. and the U.K. Toorak has been able to so far buy more than $1 billion of this debt.

KKR had previously invested $75 million in equity in Toorak. Now, the firm says it is increasing that to $250 million.

For so long as home prices keep rising, as they have for the last 7 years, this could prove to be a lucrative practice. But this carries real risk, and the downside will be exposed if the market turns.