Blackstone, Inflection Points and the Z.1
Doug Nolan
I’ve been eagerly anticipating the Fed’s Q3 Z.1 report.
As expected, Credit growth slowed somewhat.
At a seasonally-adjusted and annualized (SAAR) $3.284 TN pace, Non-Financial Debt (NFD) growth slowed from Q2’s SAAR $4.318 TN and Q1’s SAAR $5.438 TN.
NFD ended September at a record $68.463 TN, or 266% of GDP.
Unless Q4 Credit growth surprises to the downside, 2022 debt growth will be second only to 2020’s onslaught.
For perspective, annual NFD growth averaged $1.816 TN during the two-decade period 2000 through 2019.
This year’s growth in NFD will likely double this average, ongoing Credit excess that is creating ample inflationary fuel.
While there was slowing in mortgage Credit growth, powerful lending booms continued.
And as the Fed’s balance sheet contracts, the GSEs (government-sponsored enterprises) continue their substantial expansion.
Importantly, exceptionally strong lending growth ran unabated – bank and non-bank.
Despite the Fed’s tightening cycle and a year of weak securities market performance, the Great Credit Bubble inflation was ongoing.
It has been an extraordinary dynamic.
The Fed commenced an aggressive tightening cycle.
As one would expect, financial conditions tightened meaningfully – in the markets.
Unexpectedly, general Credit and financial conditions away from the securities markets loosened.
Indeed, market instability actually worked to bolster key Credit structures financing the economy, including bank lending and “private Credit.”
A brief jaunt down memory lane.
Recall that two Bear Stearns Credit funds blew up in June 2007, marking the beginning to the end of the mortgage finance Bubble.
As buyers of the riskier tranches of high-risk mortgage derivatives, their demise knocked out the marginal source of demand for riskier mortgage Credit.
Yet the subprime eruption was not immediately contractionary.
Instead, sinking Treasury and bond yields spurred a big rally in conventional mortgage securities prices.
This extended the mortgage lending cycle.
The $500 billion of second-half 2007 mortgage Credit growth bolstered the Bubble economy, while holding crisis dynamics at bay.
It all came home to roost in late 2008.
Fast-forward to 2022.
The Fed’s tightening cycle and resulting market instability worked to stoke the boom in non-market-based lending.
Resulting strong system Credit growth underpinned economic resilience and tight labor markets.
Loose finance and low unemployment supported strong household and business Credit fundamentals (i.e. low delinquencies/charge-offs), which further emboldened enterprising bank and non-bank lenders.
The role of so-called “private Credit” is huge and unappreciated.
December 8 – Bloomberg (Lisa Lee, Silas Brown and John Gittelsohn):
“Blackstone Inc.’s $50 billion private credit fund fueled its rise into the biggest powerhouse in direct leveraged lending.
But with some wealthy investors now pulling capital, nerves are on edge about what’s next for funds targeting affluent retail investors in the $1.4 trillion dollar market.
BCRED, a non-traded fund that’s been instrumental in transforming the leveraged finance markets, has had an incredible run since it was set up nearly two years ago, attracting billions of dollars each month.”
December 7 – Financial Times (Antoine Gara):
“The head of Blackstone has spoken out for the first time since the investment group restricted withdrawals from a $69bn property fund, tying a spate of redemptions to investors facing stress in Asia.
The outlook for the Blackstone Real Estate Income Trust, or Breit, has riveted Wall Street after the group limited withdrawals last week.
Blackstone’s stock has slid more than 10% since the announcement.
Blackstone chief executive Stephen Schwarzman… disputed the idea that the restrictions reflected problems at the fund, which has $125bn of assets mostly invested in warehouses and apartments in the US when accounting for leverage.”
Blackstone’s BCRED and BREIT have been at the leading edge of the non-bank “private Credit” boom.
I’m thinking Bear Stearns Credit funds 2007, though today’s funds are so much bigger.
There are other notable differences.
BCRED, BREIT and their ilk are structured specifically to avoid the mark-to-market nightmare that quickly decimated the Bear Stearns funds.
As leveraged buyers of non-securities (i.e. commercial and residential real estate, corporate and business loans), they don’t adjust portfolio prices daily.
They also avoid daily investor redemptions.
These funds have enjoyed the perfect structure for this period of market instability.
As equities and corporate bonds faltered and market financial conditions tightened, money flooded into these types of structures.
Investors were thrilled to bypass market instability and big drawdowns, while earning strong returns.
Growth has been nothing short of stunning – especially considering the market and macro backdrops.
BREIT assets surged $38.6 billion, or 36%, over nine months (ended 9/30) to $144.9 billion.
The fund is leveraged, with Total Liabilities jumping 39% in nine months to $92.292 billion.
BCRED assets surged $19.9 billion, or 62%, over nine months to $52.3 billion.
Over this period, debt jumped 48% to $27.0 billion.
Money flowed freely into these types of structures, providing fund managers bountiful buying power.
In the case of BREIT and other similar real estate funds, inflows supported both Credit demand and asset prices.
In the case of BCRED and Credit funds, companies enjoyed abundant Credit availability and loose lending conditions.
Booming “private Credit” became a key marginal source of finance for asset markets and the economy more generally.
The Bear Stearns funds blowup marked an inflection point for the mortgage finance Bubbles, a reversal of speculative finance that presaged tightening financial conditions, declining asset prices, acute Credit problems and eventually crisis.
I believe the move to redeem investments from the Blackstone funds and similar structures marks an inflection point in “private credit.”
And while Blackstone can limit quarterly withdrawals to 5% of assets, the prospect of these funds turning sellers instead of aggressive buyers/lenders has major ramifications for real estate markets and corporate lending.
I would expect this reversal of speculative finance over time to correspond to tighter financial conditions and declining asset prices.
Furthermore, deteriorating prospects will have investors lining up to redeem before sinking asset prices force downward adjustments to fund NAVs (net asset values).
Many will be shocked by the illiquidity of their investments.
I wanted to share this perspective prior to delving into the Q3 2022 Z.1 report.
While the powerful lending boom continued during Q3, I suspect this might prove the high-water mark for “private Credit.”
Going forward, I would expect slowdowns in Bank Loan and Mortgage growth, two powerful pillars in this year’s system Credit resilience in the face of tightened market financial conditions.
And slowing Credit growth only exacerbates vulnerability to the next round of market “risk off” deleveraging – even as emboldened market participants underscore system resilience.
Perhaps the Fed now sees the writing on the wall.
Bank Loans expanded a (nominal) $362 billion during Q3, or 10.8% annualized – down from Q2’s $549 billion, but up from Q3 2021’s $118 billion.
Over four quarters, Bank Loans surged an unprecedented $1.504 TN, or 12.3%.
For perspective, Bank Loans expanded $519 billion during 2021, below 2005’s record $685 billion.
Over the two decades ended 2019, annual Bank Loan growth averaged $363 billion.
By loan category, Loans (“not elsewhere categorized”) expanded $102 billion, or 8.8% annualized, to a record $4.774 billion.
Mortgages expanded $187 billion, or 12.1% annualized, to a record $6.349 billion.
Consumer Credit increased $73 billion, or 11.6% annualized, to a record $2.571 TN.
Strong quarterly growth, but the annual numbers highlight the historic nature of the lending boom.
Loans NEC surged $698 billion, or 17.1%; Mortgages $503 billion, or 8.6%; and Consumer Credit $307 billion, or 13.6%.
In contrast, Corporate Bonds contracted $149 billion during the quarter to $14.688 TN, with a one-year contraction of $309 billion, or 2.1%.
Lending more than made up the slack, providing system resilience, but also boosting the prospect for systemic fragilities once the lending Bubble succumbs.
Total Mortgage Credit expanded $322 billion, down from Q2’s $416 billion and Q3 2021’s $345 billion.
Home Mortgage borrowings expanded at a 6.61% rate, down from Q2’s 8.62%.
One-year Home Mortgage growth of $922 billion is the strongest growth since 2006’s $1.082 TN.
Commercial Mortgage growth slowed to $52 billion from Q2’s $92 billion.
Over one year, Commercial Mortgages grew $303 billion, or 9.4%, surpassing 2007’s annual record $265 billion.
At $170 billion, or 9.3%, one-year Multi-housing Mortgage growth surpassed 2019’s annual record $134 billion.
Huge deficit spending continued to bolster both system Credit and economic resilience.
Federal borrowings expanded SAAR $1.101 TN during the quarter.
In nominal dollars, Treasury Securities expanded $418 billion to a record $26.469 TN.
This put one-year growth at $2.219 TN, or 9.1%.
Over 11 pandemic quarters, Treasuries surged an incredible $7.450 TN, or 39.2%.
Since the end of 2007, outstanding Treasury Securities have inflated $20.418 TN, or 337%.
On the subject of “resilience,” the system functioned reasonably well in the face of the $537 billion contraction in Federal Reserve Assets - to $7.663 TN.
Fed holdings of Treasury securities declined $377 billion, with Agencies down $159 billion.
The Fed’s Reverse Repo Liability increased another $96 billion to a record $2.426 TN, having surged $821 billion, or 51%, over the past year.
Meanwhile, the GSEs continued their rapid expansion, reminiscent of their quasi-central bank role during past crises.
The GSEs came into their own as market liquidity backstops with their (at the time) unprecedented $150 billion expansion during the 1994 bond market crisis.
GSE growth then ballooned to $305 billion for crisis year 1998 (Russia/LTCM), then added another $317 billion during 1999; $345 billion during 2001; and then $301 billion for 2007.
GSE Assets expanded $217 billion, or 9.9% annualized, during Q3 to a record $8.983 TN – lagging only Q1 2020 ($325bn) and Q2 2022 ($248bn).
This boosted one-year growth to an outrageous $828 billion, or 10.2%.
Not shabby for such highly levered, thinly (being generous) capitalized and vulnerable financial institutions.
GSE assets inflated $1.853 TN, or 26%, over the past 11 pandemic quarters.
Why?
The Fed is now raising rates and attempting to tighten financial conditions, as it fights the worst inflation in decades.
Meanwhile, their Beltway neighbors partake in Credit inflation like never before.
Household Assets were little changed for the quarter at $162.513 TN.
Household Liabilities, meanwhile, jumped $320 billion, or 6.8% annualized, to a record $19.234 TN.
Liabilities expanded $1.266 TN, or 7.0%, over the past year, near 2006’s annual record (and cycle peak) $1.302 TN.
Household Net Worth (Assets less Liabilities) declined $392 billion during the quarter to $143.278 TN, with a one-year drop of $2.028 TN (1.4%).
After peaking at 617% (Q4 2021), Household Net Worth-to-GDP has declined to 558%.
This compares to previous cycle peaks of 491% (Q2 2007) and 445% (Q1 2000).
Net Worth-to-GDP dropped to 416% during Q1 2009.
Rest of World (ROW) analysis points to persistent weakened demand for U.S. financial assets.
ROW holdings fell $1.028 TN during Q3 to a two-year low $39.964 TN.
Holdings of Treasuries declined $134 billion to a two-year low $7.297 TN.
Agency holdings dipped $41 billion to $1.175 TN, and holdings of Corporate Bonds dropped $206 billion to a five-year low $3.572 TN.
Over the past year, Treasuries dropped $274 billion (3.6%), and Agencies declined $67 billion (5.4%).
Corporate Bonds sank a notable $834 billion, or 18.9%, over the past year.
Broker/Dealer Assets were little changed during the quarter at $4.424 TN.
The Asset “Loans” declined $14 billion for the quarter (and $10bn y-o-y) to $807 billion.
While down from Q2’s record high $855 billion, Loans remain about double pre-pandemic levels.
Total system “Repo” Assets jumped $230 billion, or 14.2% annualized, to a record $6.695 TN.
“Repo” was up $776 billion, or 13.1%, over four quarters.
Over 11 pandemic quarters, “Repos” surged $1.622 TN, or 42.6%.
Interestingly, Deposits posted declines.
Bank Time Deposits dropped $274 billion, or 7.8% annualized, during Q3 to $13.822 TN.
Money Market Fund Assets increased $52 billion during the quarter to $5.084 TN, with one-year growth of $65 billion, or 1.3%.
I see the redemption issue for Blackstone and similar funds as a serious issue.
The boom in “private Credit” – along with private equity and venture capital – is in jeopardy.
The Bank of International Settlements this week raised another serious issue.
December 5 – Bloomberg (Paul J. Davies):
“Sixty-five trillion dollars is a not big number: It’s a huge, barely comprehensible number.
It’s more than 2 1/2 times the size of the entire US Treasury market, the world’s biggest.
It’s 14% of the value of all financial assets globally…
It’s also the value of hidden dollar debt unrecorded on the balance sheets of non-US banks and shadow banks as of June this year, also according to the BIS…
It has been growing rapidly, having nearly doubled since 2008.
The fact that most of this hidden debt is owed to banks is another reminder of the ever-growing and opaque interconnections between the traditional financial system and the shadow banking sector.
A whole set of recent mini-crises has shown that these links are part of why central banks keep being forced to step in and stabilize government bond markets and other assets when stress levels rise.”
There are many reasons to fear the next serious global bout of de-risking/deleveraging.
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