On the surface, it was your run-of-the-mill private credit deal. A bunch of heavy hitters in the industry — Oak Hill Advisors, Antares Capital and Golub Capital — were providing half-a-billion dollars to fund the buyout of an engineering firm. But at the end of the list of lenders was a name that caught the eye — a small, upstart player in the world of direct lending: JPMorgan Chase.
The bank, like almost all its rivals, has spent years watching its leveraged finance desk lose ground to private credit in the business of providing debt to risky companies. Awash with cash, these alternative lenders have been able to offer favorable terms for buyouts and line up larger deals, cutting into what has long been a profit-minting machine for Wall Street's biggest banks.
Now, the banks are trying a new tack to stanch the bleeding: building out direct lending operations of their own. Citigroup, Barclays and Morgan Stanley are just a few of the firms joining JPMorgan in what suddenly feels like a rush into the business.
What exactly this entails varies firm to firm. But in many ways, the model they're using, when stripped down to its most fundamental elements, looks strikingly similar to their vaunted leveraged lending outfits. Hamstrung by regulatory constraints that limit how much of their own capital they can put on the line for long periods of time, they're leaning on their extensive network of corporate clients to drum up deals, pairing with deep-pocketed investors for financing, and looking to reap juicy fees from acting as go-betweens.
The biggest difference: the order of business is flipped. Typically banks make debt commitments first and then find clients who want to buy chunks in the form of junk bonds or leveraged loans. That leaves them on the hook if borrowing costs spike or investors back out. Now banks are hitting up money managers to seed the private credit ventures they're creating, effectively lining up buyers in advance.
"Banks will try to find a way in which they can earn fees without having to lend their own money," said Ranesh Ramanathan, co-leader of Akin Gump Strauss Hauer & Feld's special situations and private credit practice. "Leveraged finance is such a core part of their business model that if they don't succeed and don't recapture that market, it will be a big hit to their profitability."
That this push comes at a time when concerns are mounting about the dangers lurking in private credit underscores just how strongly banks feel about the need to defend their turf. Success will secure them a role in the biggest debt financings for years to come. Failure means not only missing out on billions more in potential fees, but also the lending relationships that grease the wheels of their entire investment banking efforts.
In conversations with a dozen bank executives, many acknowledged that Wall Street was caught off guard in recent years by how quickly direct lenders were able to seize market share and that the shift is here to stay. Companies have flocked to private credit for the speed in which firms can provide cash, the convenience of dealing with just a handful of lenders, and the flexibility offered on deal terms. With total assets now surpassing $1.6 trillion globally — and some expecting that to roughly double in the coming years — banks are racing to get in on the action.
Their push into private credit runs the gamut of lending strategies, from traditional buyout finance, to providing debt to midsize companies, to infrastructure and sustainable investing.
The loan JPMorgan participated in to help finance Lindsay Goldberg & Bessemer's acquisition of engineering firm Kleinfelder Group is one of a handful the bank has done since ramping up its direct lending initiative in recent years.
Its approach is among the boldest in the industry, market watchers say. JPMorgan has dedicated more than $10 billion of its own balance sheet to help it win deals, a number that's likely to grow. Still, compared to firms like Apollo and Blackstone, which collectively manage hundreds of billions in private credit strategies, it's a drop in the bucket.
That's partly why the bank is seeking out third-party funds that will allow it to participate in more deals and make larger commitments. It's held talks with private credit firms about creating what would amount to a syndication group where members would help fund loans it originates, with JPMorgan collecting fees for its services, Bloomberg reported earlier this month. In addition to alternative asset managers, it's pursuing discussions with sovereign wealth funds, pension funds and endowments.
A spokesperson for JPMorgan declined to comment.
"Everything old is new again," said Lee Shaiman, the executive director of the LSTA, the industry group for syndicated corporate loans. "Banks got out of the storage business and into the moving business, and now they're looking at both."
Most firms are looking to commit a much smaller chunk of their own capital — or none at all — as they ramp up their private credit efforts.
That's because post-financial crisis rules made it more expensive for banks to hold risky debt on their balance sheets by forcing them to set aside additional money in case the loans don't pan out. Looming Basel III regulations are expected to up the required capital buffers. Leveraged lending guidelines have also curbed how much debt banks can provide to companies relative to earnings.
On the flip side, as more investors divert capital to private assets, many direct lenders find themselves sitting on mountains of cash with insufficient buyout activity to meet their needs. Bank partnerships give them access to exclusive deal flow, especially from corporate clients that it would otherwise take them years to cultivate relationships with.
Barclays recently earmarked balance sheet cash to make direct loans for a strategy it plans to grow into the billions, while also pursuing a partnership with AGL Credit Management to raise outside funding, including from the Abu Dhabi Investment Authority.
Citigroup is in exploratory discussions to start a new direct lending strategy. It could include teaming up with one or more outside partners that would provide capital for loans, which the bank would source. Nomura Holdings Inc. is looking to put down roughly $1 billion of its own over the next 18 months for private credit.
Representatives for Barclays, Citigroup and Nomura declined to comment.
Morgan Stanley, for its part, is discussing allocating a portion of its balance sheet into a new private credit fund that would include capital from external investors and originate large loans to closely-held borrowers, Bloomberg reported on Wednesday.
The bank has already been playing the role of debt adviser in private credit transactions. That's particularly true for corporations not backed by private equity, or businesses being acquired by smaller buyout firms that don't have their own capital markets strategy, said Dan Toscano, the bank's global head of leveraged finance. (Morgan Stanley's asset management arm has invested in direct lending for midsize firms since 2009.)
John Gally, who co-heads private capital markets, says helping deals get done, regardless of the lender, bolsters the bank's mergers and acquisitions franchise.
"Leveraged finance has never had more depth," he said. Morgan Stanley also occasionally uses the investment bank's balance sheet in some direct lending situations, he added.
Added Risk
Yet even if these partnerships work out, the fees banks can expect to get for their role in sourcing borrowers is likely to be much lower than what they used to earn for underwriting, distributing and trading syndicated deals, industry insiders say.
What's more, there's no guarantee that in its exuberance to embrace private credit, Wall Street won't make the same mistakes it did two years ago, when leveraged-lending excess at the height of the cheap-money era led to significant losses. A group of banks led by Morgan Stanley is still stuck with billions of Twitter buyout debt.
While direct lenders say that their loan portfolios have remained resilient in the face of higher interest rates, some signs of stress in the market are starting to emerge.
In the third quarter, S&P Global Ratings lowered credit estimates (a less rigorous version of its credit ratings) on 91 companies that issued debt through private markets while raising just 19 of them, a ratio of almost 5 to 1. That far outstripped the roughly 1.4 to 1 ratio of downgrades to upgrades on loans to companies via the broadly-syndicated market, according to a recent report.
Moody's Investors Service recently warned of a "race to the bottom" between banks and direct lenders in the coming years as they seek to put capital to work, which will likely cause pricing, terms and credit quality to erode.
That sentiment was echoed by UBS Chairman Colm Kelleher last month when he called private credit an "asset bubble" and warned against the risk of a "fiduciary crisis."
"What will be really interesting is how the partnerships play out if you get into a higher default environment," said Jennifer Daly, the head of the private credit and special situations group at King & Spalding. "When people's backs are up against the wall, and it's the first time you're figuring out how to book a default, that's where the rubber is going to hit the road."
One of the reasons bank executives are pushing so hard to gain a foothold in the market is the fact that leveraged lending serves as an entry point to so many other business lines, from cash management and hedging to M&A advisory.
Many executives expressed concern that without a private credit strategy, their broader investment-banking operations could eventually lose customers. For them, that makes sitting on the sidelines an even riskier proposition.
"One of the things the private equity firms are realizing is that there are a lot of other traditional commercial- and investment-banking services that their portfolio companies need that banks provide and direct lenders don't," said Kevin Sherlock, head of leveraged finance and private credit at Bank of Montreal. BMO and Oak Hill started a private credit partnership in 2021, and have deployed more than $12 billion.
Still, not all strategies are about preserving a bank's broadly-syndicated leveraged finance operations. With big private credit shops claiming a larger share of the buyout financing business, some firms are looking further afield for growth opportunities.
Wells Fargo and Centerbridge Partners earlier this year teamed up to start Overland, which focuses on lending to midsize companies not owned by private equity firms. The bank will source the loans while Centerbridge will provide the capital.
The tie-up provides Centerbridge a way to expand its direct lending business via Wells Fargo's relationships with thousands of companies. It also gives the bank's clients access to another source of funding as their debt requirements grow, said David Marks, executive vice president of Wells Fargo Commercial Banking.
"Having the capital that's been raised and the infrastructure with Centerbridge allows us to scale this in a way where doing it by ourselves would have taken a lot more time," he said.
Elsewhere, French bank Societe Generale is teaming with Brookfield Asset Management to raise as much as €10 billion ($10.9 billion) for private credit investments focused on infrastructure assets and fund finance, while Rabobank, a Dutch lender, recently created a new private credit platform for sustainable investing.
Even firms with longer track records in private credit are rushing to expand their operations.
Goldman Sachs, which launched a mezzanine lending strategy in the 1990s and houses its private credit unit within its asset management arm, is reshuffling senior executives within the $110 billion business as it looks to double assets over the medium term, Bloomberg reported last week.
And Jefferies, which has teamed up with Massachusetts Mutual Life Insurance since 2004 to lend to midsize borrowers, this year went a step further by launching a business development company (a type of investment vehicle for making private loans) to raise funds and participate in larger deals. Including the new BDC, Jefferies has raised over $6 billion in the last 18 months for private credit.
"Banks aren't going to sit down and just let their entire leveraged finance business evaporate into nothing," said John Liguori, chief investment officer of Jefferies Credit Partners' middle-market direct lending strategy. "As more money flowed in, as private credit returns were great, and managers were able to raise more money, it became the natural evolution of our market."
