The debate on Wall Street over the rise of private credit is intensifying.
On the one hand, the head of America’s largest bank, Jamie Dimon, says increased lending by private equity firms, money managers and hedge funds creates more opportunities to pass up risks external to the regulated banking system without supervision.
“I expect there will be some issues,” JPMorgan Chase said (JPM) the CEO said at an industry conference in Bernstein in late May, adding that “there could be hell to pay” if retail investors in these funds suffered heavy losses.
On the other side are senior executives at some of the world’s biggest money managers who are quick to push back on this argument.
“Every dollar coming out of the banking sector and into the investment market makes the system safer, more resilient and less indebted,” Marc Rowan, Apollo (APO) CEO, said at the same Bernstein conference attended by Dimon. (Note: Apollo is the parent company of Yahoo Finance).
Private credit funds, their supporters say, do not face deposit runs and do not rely on short-term funding – a model that has proven problematic for some regional banks that have struggled over the past year. last and had to be seized by regulators.
Instead, they lend the money collected from large institutional investors such as pension funds and insurance companies, who know they will not get their money back for several years.
Another top executive at giant private lender Blackstone (B.X.) used the same Bernstein lecture to cite the asset-liability mismatch that ultimately sank First Republic, the San Francisco regional bank that failed last May and was sold at auction to JPMorgan.
“He had 20-year assets and 20-second deposits,” said Jonathan Gray, Blackstone’s chief operating officer and general partner.
“And if we can put those loans directly onto a life insurance company’s balance sheets, that’s a better fit.”
The rise of private credit
There’s no doubt that private credit is on the rise as traditional banks shy away from making loans at a time of high interest rates from the Federal Reserve and concerns about a possible economic slowdown.
The global private credit market, which represents all debt that is not publicly issued or traded, grew from $41 billion in 2000 to $1.67 trillion through September, according to data provider Preqin. Of this amount, more than $1 trillion is held in North America.
The sum is still small compared to the total loans held by U.S. banks – more than $12 billion – but some in the banking world fear panic among borrowers could spread if things go wrong.
“I’m not sure that a billion-and-a-half-dollar private credit market is particularly systemic, but the fact is that these things can have a snowball effect,” the president of the UBS, Colm Kelleher, in an interview with Bloomberg. This year.
For the moment, the performance of private credit is solid despite the concerns.
In five of the last six quarters, private credit has generated higher returns for investors than on average over the past decade, according to a global private credit index created by Preqin.
It also outperformed a similar index measuring overall private equity returns over the same period.
“Everyone can look pretty good when everything is going to the right, but it gets harder when you go through cycles,” John Waldron, COO of Goldman Sachs, said at the same Bernstein conference.
“Dancing in the streets”
Private credit assets are varied. They can range from business loans to personal auto loans and some commercial mortgages. The loans are particularly useful to mid-sized or below investment grade borrowers in special situations such as distress.
Terms are generally more flexible than those required by banks, with adjustable interest rates, which is a potential benefit or dilemma for borrowers expecting lower interest rates.
Some bankers argue that fund managers have an unfair advantage because they are not subject to the same capital requirements as banks. And banking regulators are preparing new rules that could make those capital requirements even stricter.
When these strengthened standards were first proposed last year, Dimon joked that private equity lenders were surely “dancing in the streets.”
But there are signs that Washington may be preparing to step up its control over these funds. The Financial Stability Oversight Council voted in favor of a new framework for labeling companies as “systemically important,” a label that triggers new oversight from the Fed.
The new framework opens the possibility for companies other than banks to obtain this label. The funds claim that they do not present the same systematic risks as banks and that the label is therefore not suitable for them.
The relationship between traditional banks and private asset lenders is complicated. They compete with each other, but many banks also lend money to these same asset managers.
Dimon acknowledged as much, saying there are many “brilliant” private lenders. “I mean, I know them all. We have a lot of them. They’re our customers.”
“We’re just in a unique position to be in the middle of all of this and I think it’s going to continue to grow,” Troy Rohrbaugh, co-CEO of JPM’s commercial and investment bank, said last Wednesday during another conference.
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto and other areas of finance.
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