The first section of this report appeared in the Financial Times on April 23 under the headline “Is the boom in private credit losing steam?” by Huw van Steenis.
Private credit is looking to catch the next wave of growth — in asset-based lending. In part, that is to sustain the sector’s extraordinary growth and to satisfy the sea change in allocations to credit. But firms are also jumping in because leveraged lending has become more crowded. How large is the addressable market? Our new estimates suggest specialty finance is a $5.5 trillion asset opportunity in the United States alone, where private credit today has less than a 5% share.
The need to secure access to these new asset classes is prompting private credit players to change tack, looking to partner up with banks rather than be their adversaries. We explore what private credit 2.0 might look like — for banks and investors.
Private credit’s golden moment and the resurgence of banks
Private credit firms have enjoyed a “golden moment,” as Blackstone president Jonathan Gray put it last year, while banks have been on the back foot from the sharpest increase in interest rates in 45 years. In 2023, these non-bank lenders funded a whopping 86% of leveraged loans, up from 61% in 2019, according to PitchBook LCD. But one year on from the failures of Silicon Valley Bank and Credit Suisse, the strongest banks are ramping up their lending into the broadly syndicated bank loan markets — a key way to finance leveraged buyouts.
In the first quarter, 28 companies arranged bank loans to refinance $11.8 billion of debt that was previously provided by private credit firms, according to PitchBook data. Put another way, banks have been able to claw back just over half of the $20 billion that shifted in favor of private credit firms in 2023.
The shift from banks to private credit
So, have we reached peak private credit? The annals of banking suggest that, on the contrary, another wave of bank disintermediation is likely. The shift of lending away from banks has a long history. Astonishingly, bank lending as a share of total borrowing has been falling for 50 years. The 1973-74 inflation and interest rate shock created more profound disintermediation from banks than the rise of private credit today, as investment grade companies switched to borrowing from the market via commercial paper and bonds.
The rise of high-yield bonds in the 1980s was another large wave, as were the various advances in securitization, each enabling more borrowers to bypass banks. And since 2008, mid-market corporates and mortgage borrowing have increasingly moved away from banks. In all, banks’ share of private lending in the US economy has fallen from 60% in 1970 to 35% last year, according to a new National Bureau of Economic Research paper.
What can we learn from the history of bank disintermediation? First, it typically takes at least two to three years for weakened banks to get over large interest rate shocks. While major banks are back on their skis, regional banks will take longer to get the rates of interest on their assets and liabilities back in balance. Lending by US regional banks remains anemic, providing opportunities for private credit to fill the gap.
Second, outdated financial regulations often exacerbate such shocks. In the 1970s and 1980s, Regulation Q, which imposed ceilings on interest rates offered to depositors in the US, exacerbated deposit flight to money market funds. Similarly, the Fed’s overnight reverse repo facility triggered deposit flight as the Fed raised rates. Old rules are revised slowly — Reg Q was introduced in 1933 — disadvantaging banks.
Third, financial product innovation is a vital enabler. Money market mutual funds, introduced in the US in 1971, facilitated disintermediation by letting savers invest in a diverse range of instruments. Today, new private credit structures are giving investors access to assets previously confined to banks’ balance sheets such as equipment finance.
Fourth, new regulation aimed at addressing banks’ vulnerabilities can inadvertently push even more lending elsewhere. While new Fed proposals to increase bank capital (dubbed the “Basel endgame”) are being recalibrated, further adjustments to liquidity, capital rules and risk management practices are nonetheless likely.
The future of specialty finance lending
Specialty finance lending looks like a promising new seam for private credit companies to mine. One attraction of what we estimate to be a roughly $5.5 trillion category in the United States alone — which includes equipment leases, trade finance and royalty agreements — is greater diversification and the specialist skills required. Private credit has less than 5% of these types of loans, mostly packaged for insurers. Furthermore, infrastructure loans, commercial real estate, and mortgages each offer potential rich pickings, expanding the potential market to $26 trillion in the United States. All in, this could boost the 15% annual growth expected in the private credit market over the next five years — though much of course depends on bank regulators’ next moves.
But the need to secure access to these new asset classes explains why private credit players are changing tack, looking to partner with banks rather than be their adversaries. This year at least six partnerships with major banks have been signed, most recently Barclays with Blackstone. Half of these have focused on opportunities in asset-backed financing.
What we are seeing is the re-tranching of the banking system where banks parcel the riskiest slice to private credit, providing less risky lending themselves. Private credit could be the Ozempic to help banks on yet another diet.
Read the original op-ed here, or download our full report on "Private Credit's Next Act" below.