The debate on Wall Street over the rise of private credit is growing louder.
On one side is the boss of the largest US bank, Jamie Dimon, who argues that increased lending by private equity firms, money managers and hedge funds is creating more opportunities for risks outside the regulated banking system to go unchecked.
“I do expect there will be problems,” the CEO of JPMorgan Chase (JPM) said at an industry conference in Bernstein in late May, adding that “it could be hell” if retail investors in such funds suffer big losses.
On the other side are top executives from some of the biggest money managers in the world, who don’t hesitate to undermine that argument.
“Every dollar that moves from the banking sector into the investment market makes the system more secure, more resilient and less leveraged,” Apollo (APO) CEO Marc Rowan said at the same Bernstein conference Dimon attended. (Note: Apollo is the parent company of Yahoo Finance).
Private credit funds, their proponents argue, don’t face deposit runs and don’t rely on short-term funding — a model that proved difficult for some regional banks that ran into trouble last year and had to be seized by regulators.
Instead, they lend money from large institutional investors, such as pension funds and insurance companies, who know that they will not get their money back for several years.
Another top executive from giant private lender Blackstone (BX) used the same Bernstein conference to highlight the asset-liability mismatch that ultimately brought down First Republic, the San Francisco regional bank that collapsed last May and was auctioned off to JPMorgan.
“It had 20-year assets and 20-second deposits,” said Jonathan Gray, Blackstone’s chief operating officer and general partner.
“And if we can put these loans directly on a life insurer’s balance sheets, that’s a better fit.”
The rise of private credit
There is little doubt that private lending is on the rise as traditional banks scale back lending at a time of high Federal Reserve interest rates and concerns about a possible economic downturn.
The global private credit market, which represents all debt that is not publicly issued or traded, has grown from $41 billion in 2000 to $1.67 trillion in September, according to data provider Preqin. More than $1 trillion of that amount is in North America.
The amount is still small compared to the total loans held by U.S. banks — more than $12 billion — but the concern among some in the banking community is that any panic among borrowers could spread if things get ugly.
“I’m not sure that a $1.5 trillion private credit market is particularly systemic, but the point is that these things can have a snowball effect,” UBS Chairman Colm Kelleher previously said in a Bloomberg interview. this year.
For now, private lending performance is solid, despite concerns.
For five of the past six quarters, private credit has delivered higher returns for investors than the average over the past decade, according to a private credit index compiled by Preqin.
It has also outperformed a comparable index measuring total private equity returns over the same period.
“Anyone can look pretty good when it’s all going to the right, but it gets harder as you go through cycles,” John Waldron, chief operating officer of Goldman Sachs, said at the same conference in Bernstein.
‘Dancing through the streets’
Private credit assets are varied. They can range from business loans to consumer auto loans and some commercial mortgages. The loans are especially useful for mid-market borrowers or borrowers with a rating below investment grade in special situations such as distress.
Terms are typically more flexible than what banks require, with adjustable interest rates, a potential benefit or dilemma for borrowers who expect interest rates to eventually fall.
Some bankers argue that money managers have an unfair advantage because they don’t have to operate under the same capital requirements as banks. And bank regulators are preparing new rules that could make these capital requirements even stricter.
When these increased standards were first proposed last year, Dimon joked that private equity lenders were certainly “dancing in the streets.”
But there are some signs that Washington may be preparing to step up its oversight of these funds. The Financial Stability Oversight Council has voted to adopt a new framework for labeling companies as “systemically important,” a label that is prompting new Fed oversight.
The new framework creates an opening for companies other than banks to receive that label. Funds argue that they do not pose the same systematic risks as banks, and therefore the label is 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 the same asset managers.
Dimon acknowledged that, saying there are many “brilliant” private lenders. “I mean, I know them all. We benched a lot of them. They are our clients.’
“We’re uniquely positioned to be in the thick of it and I think it’s going to continue to grow,” Troy Rohrbaugh, co-CEO of JPM’s commercial and investment bank, said at another conference on Wednesday.
David Hollerith is a senior reporter for Yahoo Finance, covering banking, cryptocurrency and other areas of finance.
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