Private credit is booming and banks, rather than fighting what would seem to a competitive threat, are fighting for a piece of the action.
As regulations on banks have tightened in the years since the financial crisis, many borrowers are turning to others for their cash needs. And right now, that means that means private-equity firms and the like, which have more money than they know what to do with. These borrowers tend to be small or midsize companies that may have banking relationships but are deemed a credit risk. As such, they’re willing to pay steeper interest rates to get financing. Unlike bank loans, which often get securitized, or bonds, which get traded, private credit is difficult to unload, so it’s generally restricted to institutional or accredited investors. That hasn’t limited its growth. The industry hovers around $1.5 trillion today, up from $200 billion in 2000, with much of the growth happening in the last three years, and could hit $2.8 trillion in five years, according to analysts at CFRA. Assets at banks appear to have flatlined, hovering around $20 trillion over the last three years.
Banks, though, aren’t simply watching as loans get siphoned away. Instead, many, including
Wells Fargo,
JPMorgan Chase,
and
Citizens Financial,
are increasingly acting as intermediaries, matching borrowers with lenders, all in exchange for a piece of the action. While that creates profits for banks, who desperately need them, it also takes money out of traditional banks and into the shadow banking system, where regulators have limited visibility into who is doing the borrowing and who is doing the lending, leading some to worry about systemic risks to the financial system—especially if banks simply get rewarded for making the connection, not the quality of the loan.
“You’re operating in a pure capitalist regime again,” says Dick Bove. “It raises risk in the financial system exponentially.”
Private credit is not a new phenomenon—but it is a growing one. Since the financial crisis, lending activity has been leaving banks as regulations have tightened, forcing banks out of some businesses, while accruing to the shadow banking industry, which accounted for nearly 47% of assets in the financial system in 2022, up from 43% in 2008, according to recent data from the Financial Stability Board. While that might seem like a modest increase, assets in the whole financial system have more than doubled in that time period.
That trend doesn’t look set to change soon. Upheaval in the sector this spring has ramped up regulatory pressure for banks to adhere to Basel III Endgame, a set of rules requiring banks to hold more capital against their risk-weighted assets. Implementation of the rules, which are set to begin next year, will constrain banks’ ability to lend—basically meaning that banks will favor only the more pristine credits, putting small businesses and borrowers with unconventional credit histories at risk of losing funding. Private creditors, while charging steeper interest rates, can guarantee funding—as long as they feel it’s worth the risk.
The new rules have faced criticism from Wall Street, with JPMorgan chief executive Jamie Dimon famously saying in July that firms like
Apollo Global Management
and
Blackstone
are “dancing in the streets” as more business is pushed their way. Banks, though, aren’t simply bystanders—they’re increasingly playing the part of the middleman. In September, Wells Fargo announced a partnership with Centerbridge Partners, a private investment firm, for the purpose of offering direct lending to borrowers sourced from the bank’s client base of midsize businesses through a $5 billion subsidiary called Overland Advisors. While the borrowers may have a banking relationship with Wells Fargo, the bank may be unable to extend credit to them because of the excess capital they would have to hold against the loans. Under the partnership, Wells Fargo can originate the loans, thereby supporting their clients, while the loans themselves live off the bank’s balance sheet in the fund.
Even JPMorgan is looking for a partner for its private credit effort. The bank has already set aside $10 billion of its own cash for the effort but needs money from another partner to be able to compete with the likes of Blackstone, Apollo Global Management, and
Ares Management,
according to a Bloomberg report. JPMorgan declined to comment further. Rather than a turf war brewing between traditional bank lenders and nonbank players, the two appear to be in a symbiotic relationship and are even looking for more ways to work together.
It’s also big business. Partnerships that allow banks to serve their client base without facing the same balance sheet risks were a focus of conversation in early December at an investor day for Blackstone’s Secured Lending Fund, a publicly traded business development company that allows individual investors to get a taste of the private credit world.
In an interview with Barron’s, Brad Marshall, global head of private credit strategies at Blackstone, characterized the notion that banks and private credit are opposing forces as “unfair.” Blackstone, for instance, often works with
Morgan Stanley’s
investment banking arm on deals. While Morgan Stanley’s business is to provide advice and underwriting, there are times that it doesn’t want loans to sit on its balance sheet or the added steps of syndicating the loan. Blackstone, with ample capital available, can fund such loans directly, creating fewer hiccups for the borrower and bank.
“That is this hybrid world that we live in and the partnership that you’re seeing between banks and private lenders,” Marshall said.
And it solves one of the biggest problems for banks—the mismatch in their short-term funding versus their longer term lending. Typically, this setup works, but when things unravel and depositors rush to redeem their money, the system fails, as was the case this spring, when Silicon Valley Bank, Signature Bank and First Republic Bank collapsed. By contrast, investors in private credit funds commit capital for the life of the loan, giving up liquidity for yields which recently have been in the low double digits. By joining with private capital, banks can get some of the profits, with few of the risks. “Growing bank partnerships mean alternative asset management (ALT) firms can help banks augment their existing businesses to improve risk weightings and reduce capital charges, while realizing attractive returns for ALT firms at the same time,” Kenneth Leon, research director at CFRA, recently wrote.
And private lenders also make good customers. Citizens Financial Group, the Providence, RI-based bank with $225 billion in assets, has been looking for partners to grow its private credit business, not only through the private lending but by lending to the firms themselves. But it is also important to remember that private credit managers have their own banking needs and they are often already clients of the types of banks they partner with. “We probably touch private credit in five or six different ways on a daily basis,” Ted Swimmer, head of corporate finance & capital markets at Citizens Financial, told Barron’s. “If we stopped dealing with direct lenders, they wouldn’t exist because 50% to 60% of their capital structure is bank debt.”
It’s this interconnection that worries some critics of private credit. The debt doesn’t live on the bank’s balance sheet but that doesn’t make the banks immune from risk.
“[Banks] probably bear greater reputational risk than the private credit guys do. If a…fund blows up, there’s not going to be a congressional hearing,” Chris Davis, of Davis Funds, told Barron’s. “The banks will be held to a higher standard if they in essence are involved in putting people into a fund, or associated with a fund that has a disastrous result.”
So far, such fears haven’t materialized but those risks could emerge as private capital lenders “jockey for greater capital clout and returns,” Christina Padgett, associate managing director at Moody’s, wrote in a recent note. Collecting new assets will mean reaching out to individual investors, which raises liquidity concerns as individual investors may be more likely to try to seek redemptions than institutional investors.
It remains to be seen whether private credit ultimately becomes a public risk.
Write to Carleton English at [email protected]
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