There’s a lot of discussion on Wall Street about the rise of private credit.
On one side is Jamie Dimon, the head of America’s largest bank, who argues that increased lending by private equity firms, asset managers and hedge funds creates more opportunity for risks outside the regulated banking system to go unchecked.
“We expect there will be problems,” JPMorgan Chase & Co.’s CEO said at the Bernstein industry conference in late May, adding that if individual investors in these funds suffered big losses, “that could be disastrous.”
Meanwhile, top executives at the world’s largest asset managers have been quick to refute the allegations.
“Every dollar that flows from the banking industry into the investment markets makes the system safer, more resilient and less leveraged,” Apollo (APO) CEO Marc Rowan said at the same Bernstein conference that Dimon attended. (Note: Apollo is the parent company of Yahoo Finance.)
Proponents of private credit funds argue they wouldn’t face runs on deposits and wouldn’t rely on short-term money, which proved a troublesome model for some regional banks that got into trouble last year and had to be seized by regulators.
Instead, they lend out the money they raise from large institutional investors such as pension funds and insurance companies, who know they won’t get their money back for several years.
At the same Bernstein conference, another top executive at private lender Blackstone (BX) also mentioned the asset-liability mismatch that ultimately led to the collapse of First Republic, the San Francisco regional bank that collapsed last May and was sold to JPMorgan.
“They had 20 years of assets and 20 seconds of savings,” said Jonathan Gray, Blackstone’s chief operating officer and general partner.
“And if you can put these loans directly on the balance sheet of a life insurance company, it’s a better match.”
The rise of private credit
There’s no doubt that private credit is on the rise as traditional banks pull back on lending due to rising interest rates from the Federal Reserve and concerns about a possible recession.
The global private credit market, which covers all debt not publicly issued or traded, grew to $1.67 trillion through September from $41 billion in 2000, according to data provider Preqin. More than $1 trillion of that is held in North America.
While the amount is still small compared with the total loans held by U.S. banks (more than $12 billion), some in the banking industry worry that if things get worse, it could spark panic among borrowers.
“I don’t know if the $1.5 trillion private credit market is particularly systemic, but the point is these things have the potential to snowball,” UBS Chairman Colm Kelleher said in an interview with Bloomberg earlier this year.
For now, private credit performance has been solid despite the concerns.
In five of the past six quarters, private credit delivered higher investor returns than the average over the past 10 years, according to the Preqin Composite Private Credit Index.
It also outperformed a similar index measuring total private equity returns over the same period.
“When everything is going up and up, everything looks pretty good, but when you go through an economic cycle, things get tough,” John Waldron, chief operating officer at Goldman Sachs, said at the same Bernstein conference.
“Dancing in the street”
Private credit assets are diverse. They range from corporate loans to consumer auto loans to some commercial mortgages. These loans are particularly useful to mid-sized or below-investment-grade borrowers in special situations, such as financial difficulties.
The terms are typically more flexible than what banks require and interest rates are adjustable, presenting a potential benefit — or dilemma — for borrowers hoping that rates will eventually fall.
Some bankers argue that asset managers have an unfair advantage because they don’t have to operate under the same capital requirements as banks, and banking regulators are preparing new rules that could make those requirements even tougher.
When such stricter standards were first proposed last year, Dimon quipped that private equity lenders would be “dancing in the streets.”
But there are some signs that Washington is preparing to step up its oversight of these funds. The Financial Stability Oversight Council voted to approve a new framework for classifying companies as “systemically important,” which would trigger new scrutiny by the Fed.
The new framework gives room for non-bank companies to be given the label, which funds argue is inappropriate because they don’t face the same systematic risks as banks.
The relationship between traditional banks and private asset lenders is complex: they compete with each other, but many banks also lend to the same asset managers.
Dimon acknowledged that, saying there are many “good” private lenders: “I know them all. We do business with many of them. They’re our clients.”
“We’re uniquely positioned to be at the center of it all and we think we’ll continue to grow,” Troy Loebaugh, co-chief executive officer of JPMorgan’s commercial and investment banking division, said at a separate conference last Wednesday.
David Hollerith is a senior reporter at Yahoo Finance covering banking, cryptocurrency and other areas of finance.
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