Is shadow banking set to take off globally?
Shadow banking may get tagged as a big risk in China, but it's actually on the rise globally as low interest rates spur yield chasing and tougher regulations constrain lending by traditional banks.
"Banks have had to pull back from a lot of traditional areas they've been active in," such as corporate lending, said Jonathan Liang, senior portfolio manager for fixed income at AllianceBernstein (NYSE:AB - News), which has around $466 billion under management. "As banks withdraw, these companies are still going to need financing and that is giving us as an investor, an opportunity to step in."
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AllianceBernstein is currently expanding its team, aiming to target middle-market lending as well as infrastructure and real-estate financing, he said.
The liquidity premium, or extra yield, for extending loans that are less liquid than bonds is around 150-200 basis points over bond yields, he said. Compared with the 10-year U.S. Treasury (U.S.:US10Y) yielding around 2.65 percent, it gooses returns nicely.
"It was stimulated by a lack of lending on the part of banks themselves," said Paul Adkins, managing director at alternative credit manager Highland Capital. "It's a direct result of the search for yield."
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Within hedge funds, it's usually done in credit multi-strategy funds, rather than a "stand-alone" strategy, Hedge Fund Research said, but it noted those funds are up over 7 percent so far this year and their assets have grown to more than $425 billion. The segment saw around $9.7 billion in net fresh inflows in the first quarter, compared with $14.8 billion in inflows for all of 2013, HFR said.
Investors are calling it "credit disintermediation," but it's broadly similar to the high-yield lending that takes place off banks' balance sheets in China. Widely publicized defaults of some of China's trusts and wealth management products, which made loans to risky borrowers and promised investors returns higher than the around 3 percent bank deposit rate, have spurred fears of a credit crisis.
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But while authorities in China are pulling in the reins on the sector, it's growing in other areas of the globe.
Federal Reserve Chair Janet Yellen noted last week that the central bank has increased its monitoring of the segment, but that regulation would be "a huge challenge."
While 30 years ago banks provided more than 50 percent of the credit extended to U.S. non-financial and real estate companies -- which make up around 70 percent of total private-sector credit -- that number has fallen to around 23 percent currently, according to AllianceBernstein data.
It expects the trend will continue as banks face tougher regulation and capital requirements, citing the Basel global banking framework and the U.S. Dodd-Frank changes.
Societe Generale (Euronext Paris: GLE-FR) also expects disintermediation to increase, citing Standard & Poor's data estimating global business borrowing needs at $73 trillion through 2018, while banks' lending capacity is only around half that level.
But while disintermediation is strong in the U.S., bank financing has been making a comeback since 2011, it said in a note last week.
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Instead, it sees a "huge potential" for disintermediation in Europe, citing problems with the transmission of low central bank interest rates to bank loans, where margins generally remain high.
With Europe's banks facing an asset quality review later this year and stringent regulatory capital positions, it noted.
"In the slow repair process, euro area non-financial institutions have had to look for new sources of funding," it said. At the same time, "the ECB's commitment to supporting the economy will likely push investors towards higher yielding assets."
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Within Asia, however, interest in the strategy may be limited.
"Traditionally, Asia has been funded by bank loans," Clifford Lee, head of fixed income at DBS (Singapore Exchange: DBSM-SG), said.
"Banks continue to be well-funded in the region. The loan markets have their ups and downs, but they're still quite healthy," he said, noting this is a factor hampering the development of bond markets in the region.
While the strategy was more common before the global financial crisis, "the 2008 crisis saw that end in tears for hedge funds and those still have recent memories so we don't see the return of high-yield private debt coming back in a big way," Lee said.
Others are also skeptical that disintermediation will catch on as a trend.
"Because the bond markets are so alive and kicking, the need for companies to go to the private space is also lower," Harsh Agarwal, head of Asia credit research at Deutsche Bank (XETRA:DBK-DE), said, noting that Asia's bond issuance so far this year is around $105 billion, compared with around $125 billion for all of 2013. "If you get a rating, you could easily come to the bond market and raise money, so why go to the private market? I would guess the pie is smaller now than it was 4-5 years back," during the credit crisis.
- By CNBC.com's Leslie Shaffer. Follow her on Twitter @LeslieShaffer1
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