Wall Street’s big shift raises case for a new regulatory stance

The writer is a former investment banker and author of Power Failure: The Rise and Fall of an American Icon

While the spotlight in the financial world has lately been focused — understandably — on the shocking meltdowns of big financial institutions such as Credit Suisse and Silicon Valley Bank, a quiet but big shift has been taking shape on Wall Street.

Powerful, lightly regulated alternative asset-management behemoths are starting to elbow aside the traditional Wall Street lenders to provide financing for big buyouts.

Take, for example, Carlyle Group’s proposed acquisition of a 50 per cent equity stake in Cotiviti, a healthcare technology company, from another buyout firm, Veritas Capital. Carlyle is seeking to finance the acquisition with a $5.5bn loan.

In the old days, such financing would be the coveted preserve of syndicated loan powerhouses such as JPMorgan, Bank of America or Citigroup. Even Goldman Sachs and Morgan Stanley would have competed for a sizeable role in the Carlyle deal. And they still might.

But these days, the big Wall Street banks are increasingly groaning under the weight of close regulatory scrutiny and facing more restraints on how far they can stretch their balance sheets after a rough 2022. In a market they had previously dominated, they must now compete with rivals with funds swollen from an era of cheap money.

The likes of Blackstone, Apollo and KKR — firms that we used to associate only with private equity — are increasingly becoming big players in the world of credit. Apollo, for instance, now manages more than $500bn of assets, of which $400bn, or 80 per cent, is invested in credit. Most of this represents assets held by the funds it manages for clients. But Apollo, like its peers, retains some investments directly.

Although JPMorgan and Goldman Sachs are still fighting hard for a role in the Cotiviti deal, it’s Blackstone and Apollo that appear to have the pole position in the $5.5bn financing, along with smaller alternative asset managers such as Ares and HPS Investment Partners.

Should we care that Apollo and Blackstone are now buying and holding a variety of credit investments — some riskier than others — on their balance sheets and for their clients, as opposed to them being underwritten and then syndicated to investors by the traditional Wall Street banks? After all, the Praetorian guard is always changing on Wall Street and has been for generations. Fifteen years ago, firms such as Lehman Brothers and Bear Stearns were household names; now they are gone.

What’s different now is that following the 2007-8 financial crisis, the big Wall Street banks — those with more than $250bn in assets, including both Goldman and Morgan Stanley — are heavily regulated in ways that they weren’t before. Their balance sheets are regularly scrutinised by the Federal Reserve, among others, and their risk profiles are closely monitored. To put it mildly, the Fed doesn’t want Wall Street causing another financial crisis, like it did in 2008, and so its every move is being continuously and seriously examined.

Blackstone, Apollo and KKR are not regulated to nearly the same degree as the big Wall Street banks. They are not considered systemically important financial institutions, or Sifis. They are not as much under the thumb of the Fed. They have more freedom than the big banks to take risks and do all sorts of clever financial gymnastics.

But the Blackstones and Apollos of the world are increasingly becoming systemically important, if not exactly Sifis. Blackstone is quickly closing in on having $1tn in assets under management. Apollo’s stated goal is to reach $1tn in assets, and soon. With a market value of more than $105bn, Blackstone is valued about the same as Goldman Sachs.

And here’s the thing about financial risk: it doesn’t just disappear because it’s increasingly no longer on the balance sheets of the highly regulated Wall Street banks. It’s still out there, often invisible, and with the potential to wreak havoc, as we have just seen in spades.

One of the lessons of the collapse of Silicon Valley Bank, with its roughly $212bn of assets, is that having a powerful regulator on the beat can go far in preventing a financial panic. Silicon Valley Bank lobbied hard, and successfully, to avoid the Sifi label and thus the Fed’s deeper scrutiny.

We now know the consequences of that decision. Isn’t it high time the regulators increased oversight on Blackstone and Apollo, et al, as this relatively new and powerful group of financial titans continue their march to the top of the heap on Wall Street?