The debate on Wall Street about the rise of private credit is getting 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 creates more opportunities to let risks outside the regulated banking system go unmonitored.
“I do expect there to be problems,” the JPMorgan Chase (JPM) CEO said at a Bernstein industry conference at the end of May, adding that “there could be hell to pay” if retail investors in such funds experience deep losses.
On the other side are top executives from some of the world’s biggest money managers who aren’t hesitating to push back on that argument.
“Every dollar that moves out of the banking industry and into the investment marketplace makes the system safer and more resilient and less leveraged,” 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 proponents argue, don’t face deposit runs and they don’t rely on short-term funding — a model that proved troublesome for some regional banks that ran into problems last year and had to be seized by regulators.
Instead, they lend money raised from large institutional investors such as pension funds and insurance companies that know they won’t get their money back for several years.
Another top executive with giant private lender Blackstone (BX) used the same Bernstein conference to cite the asset-liability mismatch that ultimately sank First Republic, the San Francisco regional bank that failed last May and was auctioned to JPMorgan.
“It had 20-year assets and 20-second deposits,” Blackstone COO and general partner Jonathan Gray said.
“And if we can place these loans directly on the balance sheets of a life insurance company, that’s better matching.”
The rise of private credit
There is little doubt that private credit is on the rise as traditional banks pull back on lending during a time of elevated interest rates from the Federal Reserve and worries about a possible economic downturn.
The global private credit market, which accounts for all debt that is not issued or traded publicly, has grown from $41 billion in 2000 to $1.67 trillion through September, according to data provider Preqin. More than $1 trillion of that amount is held in North America.
The sum is still small compared to total loans held by US banks — over $12 billion — but the concern by some in the banking world is that any panic among borrowers could spread if things were to get ugly.
“I’m not sure that a one-and-a-half-trillion-dollar private credit market is particularly systemic, but the point is that these things can have a snowball effect,” UBS chairman Colm Kelleher said in a Bloomberg interview earlier this year.
For now, private credit performance is solid despite the concerns.
For five of the past six quarters, private credit has brought higher investor returns than it has on average over the past decade, according to an aggregate private credit index created by Preqin.
It has also outperformed a similar index measuring aggregate returns in private equity for the same period.
“Everybody can look quite good when it’s all going up to the right, but it gets tougher when you go through cycles,” John Waldron, Goldman Sachs’ COO, said at the same Bernstein conference.
‘Dancing in the streets’
Private credit assets are varied. They can range from corporate loans to consumer car loans and some commercial mortgages. The loans are especially useful to midsize or below investment-grade borrowers in special situations like distress.
The terms are usually more flexible than what banks require, with adjustable interest rates, a potential advantage or dilemma for borrowers expecting interest rates to eventually drop.
Some bankers argue that money managers have an unfair advantage because they don’t have to operate under the same capital requirements as banks do. And bank regulators are preparing new rules that could make those capital requirements even stricter.
When those heightened standards were first proposed last year, Dimon quipped that private equity lenders were surely “dancing in the streets.”
But there are some signs that Washington could be preparing to intensify its scrutiny of these funds. The Financial Stability Oversight Council has voted to approve a new framework for labeling firms as “systemically important,” a tag that triggers new oversight from the Fed.
The new framework creates an opening for firms other than banks to get that label. Funds argue they don’t present the same systematic risks as banks, and therefore the label is not appropriate 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 those same asset managers.
Dimon acknowledged that, saying there are many “brilliant” private lenders. “I mean, I know them all. We bank a lot of them. They’re clients of ours.”
“We’re just uniquely positioned to be in the middle of all of it and I think it’s going to continue to grow,” Troy Rohrbaugh, co-CEO of JPM’s commercial and investment bank, said this past Wednesday at another conference.
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto, and other areas in finance.
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