Banks and private credit firms are the best of frenemies – competing aggressively in some areas but needing each other elsewhere.
Private credit managers may have been the big winners as banks have deleveraged since the global financial crisis but they now increasingly have the problem of too much money and too few opportunities.
Preqin estimates that dry powder for private credit firms is at an all-time high, having risen from US$250bn in the fourth quarter of 2019 to almost US$500bn by late 2023.
That’s a lot of money that needs to find a home so private credit firms are having to diversify. To do so, they need banks.
That’s less of an issue when it comes to leveraged finance. After all, private credit firms know all the sponsors and have relationships with them (indeed, they’re often owned by the same parent).
But looking at the thousands of mid-cap corporates that need debt financing there is huge value for private credit firms partnering with large banks that have massive networks and are already servicing these corporates by providing bread-and-butter payments, foreign exchange, interest rate hedging and lending.
Private credit firms are also under time pressure. Given how the valuation of private equity portfolios lags public market valuations – so-called “volatility washing” – and involves some subjective judgments, we are still seeing markdowns come through and the exit environment is extremely tough. This has made the need to expand into adjacent markets particularly time-sensitive for private credit players.
Ancillary services
For banks, if their corporate clients are looking at private credit anyway because of wanting to own optionality or speed when it comes to funding, it is much better for the former to keep their gatekeeper status to lock in ancillary services beyond lending, especially as such services are not capital intensive and are therefore more profitable.
Banks are also bringing capital to these partnerships by co-investing with private credit firms, finding others to co-invest with them or by providing leverage to private credit funds. JP Morgan, for instance, recently said it will allocate US$10bn of its huge balance sheet to lend in this space. The model involves retaining only a small part of any loan and is in line with its originate and distribute model in DCM.
Sovereign wealth funds are key clients of leading banks and both JP Morgan and Goldman Sachs have outlined plans to include them as co-investors. In February, Goldman’s asset management business said it and Abu Dhabi sovereign wealth fund Mubadala would invest US$1bn in Asian private credit. Goldman is able to leverage its expertise and relationships and Mubadala has been investing in direct lending to Europe and the US since 2009.
Limited penetration
A potentially even larger opportunity for partnerships is the very large US asset-backed lending market, which has seen limited penetration by private credit. Oliver Wyman estimates the US market is more than US$5.5trn with only US$200bn–$300bn of this sourced from private credit firms. It estimates that most of this market is still financed by bank balance sheets, particularly in credit cards and trade finance. Oaktree Capital Management recently also highlighted asset-backed markets as a big opportunity for private credit players.
At a time of increased concern about stresses in private credit loans, adding lending backed by collateral to the mix may be attractive for all stakeholders – investors and their clients – in the private credit space.
Even more than direct lending, banks have a natural advantage over private credit players given their unique origination networks, shorter lending horizons and much larger asset pools that makes these markets more complex to service for non-bank lenders.
The bottom line is that in most asset-backed markets, private credit can’t disintermediate banks and need them to be not just gatekeepers but to service loans given the complexity of data and operational challenges, as well as domain expertise.
Blackstone has struck two recent partnerships in asset-backed lending with Barclays and US regional lender KeyBank. The former focuses on US credit card receivables and the latter on lending across SMEs, transport, equipment, and other verticals. The banks continue to originate new business and service customers for a fee while private credit firms take on assets and associated coupons and risk of loss. A win-win for both sides.
Acceleration
The upshot of all this is that the partnership between banks and private credit has accelerated.
Oliver Wyman estimates that at least 10 partnerships have been announced in the past year compared with only seven before 2023.
Ten partnerships focus on direct lending and five on asset-backed lending, where many of the recent notable tie-ups have been. Only two of the 17 partnerships are in the leveraged finance space.
So banks and private credit firms are reliant on each other, as much as competitors.
Far from being a stand-off, the two sides should see their relationships as mutually supporting, in which banks originate assets and parcel up the riskiest slices for private credit funds – reducing their balance sheet exposure in the process and retaining profitable ancillary business – while private credit shops, with their advantages in not having to mark to market, count all that lovely interest income.
Rupak Ghose is a former financials research analyst