Investment banks vs private credit

Good morning. Ethan here; Rob’s off this week. The next few days are stuffed with Fedspeak, including the open market committee’s January meeting minutes on Wednesday. This week will test how many different ways monetary policymakers can say “we’re waiting on the data”. Raphael Bostic of the Atlanta Fed had a nicely universal formulation back in 2022: “Every option is on the table for every meeting.” Email me: ethan.wu@ft.com.

Banks strike back against private credit

The past year and a half has not been kind to investment banks’ syndicated loan departments. Their job is to originate loans, often for leveraged buyouts, to creditworthy-ish companies and sell them on to investors, in exchange for a fee. It was lucrative business, until rates started rising. Suddenly, banks were nursing losses from “hung loans”, stillborn debt stuck on the banks’ balance sheets. As uncertainty about rates and recession stalked the banks, their loan syndication departments pulled back.

Into the breach rushed private credit. So-called direct lenders had been around, but their domain had been relegated to the middle market — that is, smaller companies with complex financial situations. Over the past decade, capital has steadily flowed into private credit, with a marked pick-up after the pandemic began. Now, the direct lenders could muster formidable pools of capital to arrange bigger, multibillion-dollar deals. They touted certainty of execution, speed and tailoring to each borrower’s needs, in contrast to the discombobulated banks.

These were the makings of private credit’s “golden moment” in 2023. But the pendulum was eventually bound to swing back towards the banks. That appears to be happening now. But gauging the state of competition between private credit and syndicated lenders is hard. There is no live ticker to call up; a gestalt picture has to be pieced together from scraps of data and what market participants are seeing.

Start with the soft-landing-plus-rate-cuts market narrative, a very benign macro backdrop for credit markets. Just as that narrative has enabled a roaring market for high-yield bonds, so too has it boosted demand for syndicated loans. At the end of January, the average newly issued US loan traded at the tightest spreads since the pandemic began, according to PitchBook LCD. Here is what the past year in leveraged-loan spreads has looked like:

Syndicated loan demand has been fuelled by collateralised loan obligations, tranched vehicles which buy the bulk of leveraged loans. CLOs are seeing a big pop in demand for their highest-quality debt. Spreads on triple-A CLO tranches are near 20-month lows. Greater CLO demand, somewhat circularly, has come in part from US banks. Since banking is a spread business, the lure of triple-A CLO tranches is getting a roughly 150bp yield bump over Treasuries, without much increase in default risk. Citi, JPMorgan and Bank of America have all gotten in. Serhan Secmen, head of Napier Park Global Capital’s US CLOs, says bank demand for CLO debt is likely coming in anticipation of inflows from money market funds once rates begin to fall.

Heavier demand for syndicated loans helps investment banks compete with direct lenders on price. Last week, several banks signed on to loan KKR $5bn to buy a stake in Cotiviti, a much-watched health-tech company. Banks’ aggressive pricing was reportedly crucial; at a 350bp spread, they undercut the 525-550bp spread on offer from private credit. That trend holds more broadly, reports Bloomberg:

Blackstone Inc. recently sought a $250 million loan at a rate of around 4.75 percentage points over the US benchmark to finance its planned purchase of Rover Group, in what would be one of the cheapest private credit loans on record…

In response [to banks offering cheaper loans] private credit firms including Blackstone, KKR & Co., and HPS, among others, are proactively repricing existing loans to keep them on the books, according to separate people with knowledge of the matter. Private equity sponsors are often demanding between 50 and 100 basis points of discount to keep the loans with the direct lenders, the people said.

But even though banks are ramping up competition, they remain somewhat cautious. In our Friday interview last week, Armen Panossian of Oaktree noted that banks are mostly focused on higher-quality segments of the loan market:

Frankly, [banks are] back a bit faster than we thought, but I don’t want to overstate how “back” they are. They’re willing to do deals for high-quality credits. You can get a deal done for a double-B senior loan at a 300-350bp spread all day long. That market’s wide open. But as you go down the credit quality spectrum, such as in single-B’s, deals are going to price higher, maybe at a 450-500bp spread. When you’re in that range, the syndicated loan market is improving, but it’s not fully open yet. 

Ramki Muthukrishnan and Ruth Yang, who cover leveraged finance for S&P, agree this is best understood as the gradual restoration of competition, rather than banks surging into the lead. Private equity has come to rather like having financing options. Over time, they expect the market will settle into a natural equilibrium: straightforward deals opting for cheaper syndicated loans, with smaller or more complex deals ending up in private credit’s hands. Yang adds that while deal size matters less than it used to, it still matters:

There’s no doubt private credit has gained sophistication and can club up to do big deals. But if you’re going to do an $8bn jumbo transaction, I’m hard-pressed to see that going anywhere but [the broadly syndicated loan market]. We’ve yet to see those jumbo deals come back.

In the [syndicated loan market], you have 45-50 managers who can take on a little piece of a deal. In [private credit], you have only a handful of players who operate at the upper-middle-market level. So there’s a natural cap on the number of large deals per year that can be absorbed by the private credit managers.

It’s worth remembering that at its current scale, we haven’t yet seen private credit operate in any kind of steady state. Dealmaking remains depressed. Much of the recent activity in leveraged loans has been in refinancing old deals, not generating fresh credit. “There is a thirst for new paper, and you’re not getting that through new M&A,” says Muthukrishnan. How syndicated lenders and private credit divide the dealmaking pie will depend on how much there is to go around.

One good read

Gary Gensler vs Wall Street.

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