How private equity firms use smaller, less regulated players on Wall Street to keep the party going

The biggest banks on Wall Street have been forced out of some private equity deals by regulators.

But private equity firms aren’t missing out on that money.

Smaller and less-regulated lenders have cornered a tiny portion of the leveraged lending market. Right now, the least-regulated lenders for private equity transactions control just $US30 billion of a market valued at more than $US850 billion.

Bloomberg reported earlier today that PE is “paying up” for leveraged loans that are being issued by banks that face less government oversight.

However, the reality is that the price of loans isn’t going up, according to private equity sources. It’s the volume of them that’s actually increasing.

For as long as the Federal Reserve keeps rates low and regulators keep locking big banks out of riskier private equity transactions, dealmakers think the trend will continue for smaller lenders.

“Private equity is not paying up more for incremental debt simply because they don’t have to,” said Mounir Gad, vice president with SVB Financial Group. “It’s a function of the increasing abundance of liquidity out there for good deals.”

Another private equity lawyer who asked to not be quoted, supported this. He said there is virtually no difference in what it costs for a middle market loan compared to a large-cap transaction. This is true even when that loan comes from a less-regulated lender.

Wall Street’s biggest banks are forbidden by the Fed and by the Treasury Department from lending too much cash to private equity firms to support M&A. It means that instead of Wall Street’s top banks claiming all the loans, other lenders like Golub Capital and even the lending arm of KKR are financing more deals.

Thursday morning when Goldman Sachs reported its results, the bank said net revenues in underwriting were $US1.2 billion. The bank said this is 6% lower than record results in the second quarter of 2014, “reflecting lower leveraged finance activity” but on a quarterly basis debt underwriting revenue increased. JPMorgan also reported lower revenue year-over-year from middle-market banking in its earnings Tuesday.

The availability of cheap debt to do deals has long been coveted by little LBO shops. And the surge in debt issued to support middle-market deals coincides with a rise in M&A activity.

But until ancillary lenders can claim more of big banks’ business, it won’t matter much to regulators or to the banks themselves.

NOW WATCH: Scientists are astonished by these Goby fish that can climb 300-foot waterfalls

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.