No. of Recommendations: 29
Last night I was at a gathering and spoke with a neighbor who is a commercial loan officer of a small local bank with five (5) branches. I asked him how business was and he said relatively good. He then went on to say his bank is now using an "efficiency" methodology for pricing loans and this is having the overall effect of greater cherry-picking and higher interest rate spreads for the new loans. I asked if private equity credit was being seen in his space. He said yes and then went on to give the following information:
a. Loans his bank had originated and were holding are being closed as commercial business customers (note: we are talking about customers who are modest sized local business entities) later get loans from private equity and repay his bank.
b. His bank will not make a loan unless there is recourse: someone has agreed to make it good either personally or pledging their company assets should they (the customer) be unable to make loan payments.
c. The private equity loans are non-recourse. Non-recourse means the respective company can say, sorry, I can no longer make loan payments, and there is no string to the owner's assets for the private equity firm to pull on to bring back their investment.
d. The private equity loans are issued at competitive rates to the bank.
Years ago I loaded up on BAC three (3) days before Buffett did (he got a much better deal from BAC management than I did). Over the years we have lightened our BAC position somewhat, cut the remainder in half last year and fully exited a week ago on May 19. In my view, banks are in an untenable space going forward as the various bank controls tie their hands, private equity takes a greater share of their commercial business and innovators chip away at other parts of their space. In the past fifteen years large banks have increased profits primarily through reducing head counts and offices. While there are undoubtedly more costs banks can reduce, methinks most of the low hanging fruit has already been harvested.
I do not know where this is all leading. Like Jamie Dimon said earlier this year, the rise of private equity lending may lead to "potential heck to pay" during a business recession for those retail investors who put their 401K money into the new private equity load vehicles and for those companies who find themselves being strong-armed by desperate PE managers looking to find a find a way to pull on strings despite the non-recourse nature of the loans they made earlier.
My concern is how there still may be loans on large bank books made to individuals or companies that, in turn, have positions in private equity firms. In the event of a business and credit downturn, those zombie loans would pull on the big banks despite all of the Federal Reserve audits and ratings we have been using to evaluate banks.
Again, I am pretty much trying to make sense of "shadows on the cave wall". Because I cannot make sense of the shadows, exiting BAC was my choice for the place to raise cash in our portfolio. I'd love to hear any opinions or information about the above topics from my fellow BRK board members.
Uwharrie
