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The age-old activity of lending money, and getting it paid back with a bit of interest, feels pretty prosaic at a time of escalating wars and climate disasters on the one hand, and gung-ho hype about artificial intelligence on the other. But in one corner of corporate lending, where private capital groups are expanding aggressively into a space once dominated by banks, all of the above is coming together in an excitable cocktail of risk and opportunity.
Precise definitions and growth projections of the so-called private credit market differ. But whether you take the IMF’s view that this is a $2tn-a-year industry, or JPMorgan’s that it tops $3tn, experts seem to agree on one thing: the growth pattern of recent years is only going to accelerate. After expanding by 50 per cent over the past four years, Morgan Stanley believes the sector is set to balloon by 90 per cent over the next four. Private capital giant Apollo said last week that it aimed to double its assets under management to $1.5tn by 2029, powered by an annual $275bn of private credit.
To date, the principal narrative in this area has been a straightforward one of traditional private equity groups launching into corporate “direct lending” and stealing the lunch of banks that had been cowed by the 2008 financial crisis and the tougher regulation that followed.
But over the past few months a number of partnerships have been established between those rival factions. The most dramatic came last week with the announcement that Apollo and Citigroup would collaborate on $25bn of lending. Earlier deals involved Oaktree and Lloyds; Brookfield and Société Générale; AGL and Barclays; Centerbridge and Wells Fargo; the list goes on. All the deals are slightly different but all depend on effective collaboration.
So why the new cosiness? The short answer is that both sides see advantages, with private capital firms swimming in cash and banks well networked to bring in the deals.
As private capital firms seek to increase growth, many have realised that their own flow of deals — the vast majority related to private equity transactions done by buyout firms — will not be enough to sate the funding capacity they have available. But to expand into other kinds of corporate lending would be difficult without access to banks’ on-the-ground client networks.
The banks, for their part, are broadly happy to team up if it allows them to retain client relationships (and ancillary business), while at the same time facilitating riskier loans, getting assets off their books and conserving capital. The upcoming implementation of final-phase Basel III capital demands will provide an added incentive, particularly in Europe where mainstream corporate and asset-backed lending have traditionally been held on banks’ balance sheets.
Borrowers, meanwhile, get the option of quick, secure funding (albeit at a premium that might average 0.5 to 1 percentage point, according to market participants). And they do not have to rely on their bank to structure a syndicated loan agreement that might fall apart. The flightiness of syndication capacity — first during the height of the Covid pandemic, then when the Federal Reserve raised interest rates sharply — spooked borrowers.
From a systemic perspective, the positive view is that the shift of loans away from banks is exactly what regulators sought with their post-2008 rules to make banks safer. An inherent risk of bank finance — short-duration funding backing long-duration commitments — is also neutralised, given the pension assets and sovereign wealth money that typically back private credit.
And yet the combination of breakneck growth and limited visibility once credit risks move on to the books of private capital groups is concerning. The recent push by big asset managers, including BlackRock, State Street and Invesco, into the private capital space, making easy-access private credit exchange traded funds available to retail investors, adds another layer of systemic concern.
The stakes are made all the higher by the projected growth of credit demand. The climate change economy is forecast to require capital investment of $3tn-$5tn a year for 30 years. The buildout of AI and the increase of defence financing in a war-torn world could add trillions more. Private credit is likely to figure prominently in the supply.
Ever since regulators began chasing risk out of the banking system a decade and a half ago, they have acknowledged a need to monitor where it is going, without properly doing so. That need is now urgent.
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