Friday letter: Untested

We won’t know the resilience of the private credit space until the next financial crisis hits. When it comes, the reputation of the entire industry will be at stake.

Earlier this month, Jamie Dimon, the chief executive of US universal bank JPMorgan, said that non-bank lenders could withdraw credit support from existing borrowers during the next financial crisis. As part of a thought experiment penned for his annual letter to shareholders, Dimon also predicted that those alternative lenders that will be willing to roll over exposures during a crisis would likely charge their clients over the odds.

Having grown their market share in mid-market syndicated lending, from 3 percent a few years ago to 5 percent in the US, non-bank competitors will be a much more significant part of the marketplace in the next crisis, noted Dimon. This also means their behaviour at that moment will impact a lot more businesses and people than it would have done when they first arrived on the scene.

Dimon, for one, is sceptical: “It is my belief that in a crisis environment, non-bank lenders will not continue rolling over loans or extending new credit except at exorbitant prices that take advantage of the crisis situation,” he said.

This, he went on to say, contrasted with bank behaviour during the global financial crisis that hit in 2008, when lenders continued to support their clients.

It’s not surprising that the leader of one of the world’s largest conventional lending operations takes this kind of self-serving view. What his letter didn’t do is answer the question as to whether the credit crunch would have been called a credit crunch if banks, as per Dimon’s claim, really had continued to lend. Readers of PDI won’t have much trouble recounting stories about borrowers left high and dry by the banks during the last crisis.

Still, where Dimon is unquestionably right is that the possibility of another financial Armageddon is something every type of lender, bank or non-bank, must think through and be ready for. Regulation may have made the financial world safer, but that doesn’t mean alternative credit providers can do without careful planning for a new crunch or periods of extreme market volatility.

It’s easy to poke holes in Dimon’s theory that alternative providers won’t refinance when the going gets tough. The capital they deploy is long-term committed equity, and unlike banks, private lenders match assets to liabilities: if they do stop lending it likely will be due to careful credit work and to avoid some of the dangerous ‘amend and pretend’ actions that banks became notorious for in the wake of 2008.

But for non-bank lending to become a serious alternative to the banks – one that cannot be dismissed pejoratively as ‘shadow banking’ – the market must demonstrate that it has thought about these issues at a fundamental level, and run thorough stress tests well in advance.

Another financial crisis is sure to claim some victims from within the private debt sphere. Those who endure will need to demonstrate that they can, and will, continue to provide support for their clients when it is needed the most. If they don’t, debt funds may suffer a reputational blow that will be difficult to recover from. Just ask the banks that survived the Lehman disaster.