If You Can’t Beat Them, Join Them: Banks Profit From Private Credit Boom
Rising interest rates and a darkening economic outlook have created a challenging backdrop for banks’ credit trading divisions this year, with desks handling everything from investment grade bonds to distressed and structured credits, all reporting a decline in income.
One notable area bucks the trend: private credit.
Revenues at major investment banks have risen about 35% in private credit over the past two years, according to data firm Coalition Greenwich. This has helped to cushion the decline of more traditional banking activities such as corporate bond trading, with ‘flow’ credit trading revenue falling by around 50% over this period.
“We have seen a significant expansion in private credit markets over the past two years as banks have become much better able to provide funding and meet these needs,” said Michael Turner, head of competitor analysis. at Coalition Greenwich.
“Banks want to grow revenue on a steady, accrual basis, in a rising rate environment, but they also need to be wary of credit deterioration and ensure they have enough margins to protect against a downturn,” he added.
There is more than a shred of irony in the banks’ expansion into private credit, a part of capital markets that has grown rapidly in recent years in response to a reduction in bank lending. Private debt fund assets roughly doubled to $1.25 billion at the end of 2021 from four years earlier, according to data provider Preqin, with the largest investors now able to deploy enough capital to compete with banks’ syndicated loan offices on many transactions.
Private credit funds have been able to flex their muscles even more this year, deploying some of their $400 billion in dry powder. Volatile credit markets saw banks stuck on exposure to leveraged buyouts, leaving underwriting desks with a hangover of deals to move – as well as heavy losses – and private credit stores showed up willing to take on that exposure, albeit only in aggregate (and potentially lucrative discounts).
If you can’t beat them
Despite the tale of private credit funds eating their lunch, many of the major investment banks have steadily increased their presence in these markets in recent years, often providing bridge funding or leverage to private credit funds. from funding offices housed in their fixed offices. – business units of income.
Take Goldman Sachs. Its Fixed Income, Currency and Commodity Funding revenues (which encompass a range of funding activities, including those related to Mortgages and Repurchase Agreements as well as Private Credit) amounted to 1 .5 billion in the first half of the year, an increase of more than four years. times at the same time in 2019.
“The emergence of the private credit market presents both a fascinating challenge and an opportunity for banks. The question is how individual banks respond,” said Chris Skinner, head of debt and capital advisory in the UK at Deloitte, noting the range of approaches banks have tried, including setting up loan partnerships, in-house funds and providing leverage to investors.
The attraction of such an activity is obvious for bank managers. Although it can be prone to occasional bursts, this funding generally provides a more stable source of income than volatile business ventures.
“We like to have a wide range of companies within credit to have a portfolio effect, so that when some are underperforming, others are performing better,” said a senior credit trader in a large bank. “Growth within the credit complex has shifted towards private credit as alternative finance has opened up. Capital markets have had a significant hangover to deal with, which has benefited the growth of this space. .
This year’s turmoil has helped foster a more collaborative attitude between bank underwriting desks and private credit funds, as bankers have sought help to offload some of their excess dealings. But this friendlier dynamic won’t stop many banks from forming their own in-house direct lending groups, whether within their asset management divisions or investment banks.
Mitsubishi Financial Group was the latest to join the fray when it announced earlier in August that it had formed a direct lending group. Barclays and Deutsche Bank are also considering an expansion of direct lending, while JP Morgan recently said it would dedicate more resources to this space.
In short, banks and investors are betting on the swelling of these markets in the years to come – and will continue to scramble for position.
“The direction of travel continues to be growth in the private credit market,” said Paul Simcock, partner at law firm Alston & Bird in London. “Private credit is much more mature in the US, but the European market is strengthening and we expect assets under management to continue to grow.”
Additional reporting by Eleanor Duncan