What is Specialty Lending?
Specialty Lending is filling the lending void left by banks. The tightening of banking regulations has prompted banks to reassess their business models, regulatory capital and liquidity requirements, and the risk profile of the loans made by them. This has resulted in a significant reduction in the amount of debt that banks are making available to both business and consumer borrowers. Regulations such as Dodd-Frank and Basel III have also increased the minimum capital requirements applicable to a bank’s balance sheet. Another factor in the decline of bank lending is the decades-long trend of consolidation of community banks. Community banks have been shown to be more likely to make small business loans than the larger institutional banks, but the number of community banks continues to fall with less than 7,000 today in the United States, down from over 14,000 in the mid-1980s.
To the extent that traditional banks are lending, their lending model includes certain inefficiencies that make the cost of borrowing greater. A decision to extend credit to an individual or business is often not a binary decision made solely on the creditworthiness of the counterparty. Banks typically make decisions to extend credit based on a variety of exogenous factors, which often results in a lack of credit risk-based pricing for the borrower. As well as having to be cognizant of their capital adequacy and liquidity requirements, banks typically operate on a large fixed cost basis, including personnel, branch infrastructure and administration. These costs can also be a factor in the interest rates offered to their customers. All of these factors combine to result in the lending rates being offered by banks as opposed to analyzing the true creditworthiness of borrowers.
In light of all of the above and the continuing demand for credit in a challenging global economy, we believe that the opportunities for alternative lending sources, including Specialty Lending Platforms, to increase their share of the overall lending market, will continue to become available. Further, Specialty Lending Platforms are optimally positioned to take advantage of these opportunities, not least due to their significant access to online credit data. Additionally, the process of disintermediation of lending away from the traditional banking model remains in its early stages resulting, we believe, in significant opportunities for investors going forward.