Everyone remembers the 2008 Recession. Economic collapse and market turmoil paralyzed the capital markets. Washington’s response to all of this was, perhaps not unsurprisingly, heightened regulation. Dodd-Frank is probably the most notable, the most memorable piece of legislation that came out of this era.
It’s a massive, extremely complex law that, from a high level, adds additional reporting for big banks, while at the same time, reducing risky trading activity that contributed to the downturn.
Now, most market observers would argue that Dodd-Frank has had some positive impacts in helping reduce risk in the marketplace, but it has, at the same, had some very negative, unintended consequences. Most notably, it has created a void in how small and medium sized businesses obtain the capital to grow their businesses.
Now, think about the banking system since the downturn. The big banks have only gotten bigger from crises era consolidation. These massive institutions have tilted away from lending to small and medium sized businesses with increased regulatory cost.
At the other end of the continuum are small and community banks. These are businesses that frankly lack the capital, and they lack the resources to fill in that void, hence the lending gap.
Fortunately, we live in a dynamic economy. There have been a number of new channels that have grown in recent years to help both meet the needs of capital for small and medium sized businesses, while at the same time, creating new investment opportunities for individual retail investors.
Things such as BDCs, or business development companies, the proliferation of CLOs (collateralized loan obligations), and private credit funds that have launched in recent years. All of these have helped fit the need of small and medium sized businesses, and today, the middle market is thriving.
Ultimately, we take the view that a total repeal of Dodd-Frank is highly unlikely in a politically polarized Washington. However, international banking standards such as Basel III, which require banks to keep capital on their balance sheet in reserve against loans, are going to keep the big banks from reentering the middle market.
That’s why we think that this is an exciting investment opportunity for individual investors for years to come.