Minding the Gap
Private debt moves into areas where banks have been shut out.
BY Caroline Cakebread | August 23, 2017
Banks have been under huge pressure to rein in their lending practices post-2008. It’s a regulatory push that has seen financial institutions clean house, shed debt portfolios and boost capital levels, explains Russell Gannaway, executive vice-president and portfolio manager with PIMCO. He did so at the Global Investment Conference this past March.
In the years since the crisis, evolving monetary policy has pushed further the focus to “safe yields,” a move that’s proven to be a boon for assets like core commercial real estate. Increased regulatory complexity has been hard on other parts of the market, however. It has created supply and demand imbalances in some markets and a liquidity crunch in others.
“The impact of regulations on bank business models, including the Consumer Financial Protection Bureau, has touched every aspect of banking — mortgages, student loans,” Gannaway says.
As bank deleveraging yields to recovery in the U.S. real estate sector, however, a new set of uncertainties has risen — and investors must now assess how they will deal with them. With the election of President Donald Trump, there are a new set of disruptive policy options on the table, which, if they end up becoming reality, will further impact the real estate space going forward.
One of the biggest promises made by Trump is to dismantle Dodd-Frank. Investors need to understand how this could affect the market — if it ever comes to pass, that is. Could it, for example, cut through the regulatory complexity and add some much-needed liquidity to the investment environment?
Gannaway says that repealing Dodd-Frank could certainly create some “right tails” — market events stemming from the relaxation of regulations and corporate tax cuts that drive up U.S. GDP.
On the other end of the spectrum, major policy moves by Trump could also lead to fat tails and left tails, both of which bring a lot more risk and volatility — not to mention a trade war.
“It’s early days but not a given that some of these policy aspirations can be realized,” Gannaway says, adding that “nothing is off the table in terms of heightened risk relative to six months ago.”
So how can investors position themselves? Gannaway says it’s a good time to revisit your exposure to loans — and possibly add some. “If you want to position yourself for repeal of the Dodd-Frank Act, you could start buying loans,” he asserts. Investors could look at growing dislocations in the U.S. commercial real estate space where banks have pulled back and virtually stunted the commercial mortgagebacked securities market.
“It’s been reduced by over 75 percent since 2011,” Gannaway explains. Another place to move.
There are many gaps in the lending market that private capital could fill, especially as banks continue to cede market share in the residential space — another big postcrisis shift that has left demand untapped.
“There are still potential buyers underserved by the mortgage market and private capital has stepped in.” Gannaway says it’s time for investors to make their moves amidst all the uncertainty and pick up the slack as banks pull back.