A Moody's report indicates that U.S. regional banks have increased their exposure to nonbank financial companies, and some have no plans to stop.
The report included a recap of regional bank exposure to nonbanks, such as hedge funds or private equity firms, as well as a survey of 25 rated U.S. regional banks. The report showed regional bank exposure to nonbank financial institutions totaled 5.9% in the second quarter, up from 1.6% at year-end 2010. In the survey, 56% of bank respondents said they expect a moderate increase in their exposure to nonbank financial companies. Just 8% of respondents expect a decrease and the remainder expect no change.
Megan Fox, assistant vice president for Moody's, said signs of a global slowdown in economic activity suggest banks should be cautious about excessive growth in their exposure to nonbank financial companies.
"We typically say that loan growth above nominal [gross domestic product growth] is a red flag," Fox said in an interview. "Generally, given the slowing economic growth and the length of the credit cycle, an elevated pace of loan growth would be a concern."
At the same time, Fox said the pace of loan growth and total exposure levels were only parts of a credit analysis. Banks can have exposure well below a level of concern but still face a negative rating action if the sector enters a downturn. Conversely, banks can have high levels of exposure but have strong credit ratings due to appropriate due diligence practices.
"Our starting point is the problem loan ratio, which is at a very low level right now," said Andrea Usai, an associate managing director for Moody's.
Texas Capital Bancshares Inc. and SVB Financial Group had the highest nonbank exposure levels in the report at 317% and 264%, respectively, of tangible common equity. The report noted that both banks have track records that support the significant exposures. Texas Capital's nonbank lending comes from its mortgage warehouse business, which has an "adequate risk framework and strong operational and monitoring processes," the report stated. SVB Financial's exposure derives from its lending to venture capital and private equity companies, and analysts wrote that the bank "has a very strong asset quality track record in this type of lending."
The survey of regional banks asked respondents which nonbank sector was most concerning. Lending to private equity and venture capital firms topped the list, followed by loans to business development companies. When asked about the greatest threats to nonbank companies, survey respondents tabbed an economic downturn as the top concern, followed by excess corporate leverage. Fox said that while banks with a long track record of private equity lending appear to have strong risk mitigation practices, newcomers might be less prudent.
"We do know that other banks are moving into this sector," Fox said. "The concern is really around weakening structure."
