Besides severity, one key difference between the 2008 meltdown and earlier downturns was the proliferation of hedge funds, business development corporations (BDC), private equity funds and other alternative lenders as a source of cash. “This time, those private pools of capital are out there,” Berk said. He pointed out that the major investment banks, which previously had been conservative private partnerships investing their own money, have since gone public, raised significant capital and are competing with hedge funds, BDCs and banks to make direct loans. The private lenders tend to tolerate more risk than traditional lenders, and often are formed to take advantage of distress. “Their investors mandate that they pursue and return high yields. They’re managed differently. They’re essentially unregulated and they’re a big force in today’s ABL market.” In fact, 2013 marked the first time in history that nonbank lenders held more than 50 percent of the debt in the leveraged loan market.

“As long as the rules of the game stay the same,” Berk said, referring to the relatively unregulated landscape that private funds enjoy, “the trend will probably increase gradually. Nonbanks will have bigger and bigger pieces of the lending market.” He acknowledges, however, that precise trend lines are hard to forecast because added regulation of private funds would alter the playing field. “Private capital will still win deals because they are faster and more flexible,” he said. “But banks have weapons too—size, distribution capacity and other products—that they offer which private funds do not and will not, such as foreign exchange capability. If you’re not a loan customer of a bank, the bank may be less interested in providing you with the other products.”

Hedge funds and other private lenders can also have an edge over traditional banks, Berk says, because of their radically different cost structure and cost of capital. Heavily regulated banks must reserve for possible losses, with the size of the reserve varying directly with the risk of the loan. “Anything that the bank has to reserve cannot be deployed otherwise, and there’s a cost to money doing absolutely nothing but sitting there as a reserve,” Berk says. “That cost gets figured into how banks price their loans, and that can give the private pools of capital an edge on pricing.” (The cost of reserves can even motivate banks to sell performing loans at discounts, he says: “They sell the loan, which frees up the reserve and that, in turn, cleans up the balance sheet.”)

The likeliest challenge to private funds’ prominence in ABL will be when interest rates rise, according to Berk, who says: “That’s the big open question. If short-term rates increase to 3 or 4 percent, are all those loan funds still going to be in the game or gone? If rates go to 4 or 5 percent and I can invest in T-bills at that level essentially without risk, do I want to invest in a fund at 7 or 8 percent? That’s a harder call than it is today, when it’s zero for T-bills and 4 or 5 percent with the funds. If it’s Apollo or Cerberus, with gold standard management, investors have probably decided to stay with them unless they mess something up. Joe’s Loan Store, which got started with a few million dollars, will go away because it won’t be able to raise more capital. Nobody knows where those lines will be drawn or how many will go away. These are important issues because they will determine the competitiveness of the lending environment, and that will have a significant effect on ABL.”