There's a bear market hiding in the shadows of banking

The terrible, no-good very bad year for energy stocks is no secret to anyone, but there's a whole other batch of ugliness that you may have missed: the shadow banking system.

"Shadow bank" is a term coined by former Pimco economist Paul McCulley in 2007 to refer to nontraditional lenders, and it has been applied to a wide variety of firms that may not seem like they belong in the same boat otherwise, everything from online loan originators, mortgage-finance companies, money-market mutual funds and hedge funds to good old-fashioned pawn shops and loan sharks.

As for shadow banks that are publicly traded, the industry is in a bear market this year, with average declines of more than 20 percent when considering the firms that analysts at Keefe, Bruyette & Woods consider to be shadow banks. That's way worse than the rest of the financial stocks; the Russell 3000 Financial Services Index is down less than 3 percent year to date. Among those in the shadows sticking out like sore thumbs are OnDeck Capital and LendingClub, both of which went public with great promise not much more than a year ago but are down more than 50 percent in 2015.

So many different companies are considered to be part of the shadow banking system, all facing a plethora of issues, that it's hard to paint them with the same brush. Still, some common themes emerge for the slump, according to KBW's Fred Cannon and Allyson Boyd: the end of the Federal Reserve's asset purchases through quantitative easing, concern that weakness in energy credit may spread to other sectors and warnings from regulators.

Those are all big hurdles to jump. The rout in oil prices and the debt of energy companies will theoretically end one day. But who knows when? Conceivably, it could get even uglier from here, with contagion to other corners of the credit-market potentially worsening. Quantitative easing is unlikely to come back soon, and if it does, it'll presumably only be resurrected to clean up a mess in the financial system.

And when it comes to regulators, it's clear they've only just started poking around in the shadows. Like "dark pools" in the stock market, firms slapped with a "shadow banking" label may be at risk of heightened scrutiny because of the simple magic of rhetoric - prosecutors and politicians who investigate "shadow banks" and "dark pools" sound a whole lot braver than those who go after "nontraditional lenders" and "alternative electronic trading venues."

For example, California's Department of Business Oversight is looking at the practices of 14 so-called marketplace lenders. The Office of the Comptroller of the Currency notedthe explosion of growth in loans to financial firms that don't take deposits and warned banks to monitor the concentration risk, addingit will "be a focus of our supervision strategies going forward." The Basel Committee on Bank Supervision is examining "step-in" risks that could force regulated lenders to come to the rescue of shadow banking firms with which they do business. Even investigations into financing to terrorists may pose a risk, according to Compass Point analysts.

Online lenders like On Deck and LendingClub, especially, seem to be among the type of shadow banks that may face more scrutiny from regulators because they deal with consumers and small businesses. However, regulators won't be the only ones interested. Each firm has already struck a partnership with at least one big bank, so it's not too farfetched to think they could get a takeover bid one day.

After the plunge in their shares this year, these firms that exist somewhere in the shadows between the technology and financial sectors have price-to-tangible-book values that make them look cheap compared with technology firms but less cheap compared with financial firms. Which one is it? Well, the answer may be in the eye of the beholder. So if banks are the most likely bidders, they may wait to see if they get much cheaper. And with rising interest rates, increased regulatory scrutiny and fresh competition everywhere, there's a good chance some of the bargains that emerged in the shadows this year will be even greater next year.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.