Has the Growth of Private Lending Lost Momentum?

Private equity funds have experienced their ‘golden moment’, as Blackstone’s president Jonathan Gray stated last year, when banks faltered after the largest interest rate hike in the last 45 years. In 2023, non-bank lenders financed an astonishing 86 percent of loans with financial leverage, a significant increase from 61 percent in 2019, according to PitchBook LCD.

However, a year after the collapse of Silicon Valley Bank and Credit Suisse, the strongest banks are ramping up their loans in broadly syndicated bank loan markets, which is a key way to finance loan buyouts.

In the first quarter, 28 companies arranged bank loans to refinance $11.8 billion of debt previously secured by private credit firms, according to PitchBook data. In other words, banks managed to recover just over half of the $20 billion that was transferred in favor of private funds in 2023.

Escape from Banks

So, have we reached the peak of private equity? Banking history suggests that, on the contrary, another wave of ‘bank disintermediation’ is likely. The shift of lending away from banks has a long history. Remarkably, bank loans as a share of total borrowing have been declining for 50 years. The inflation and interest rate shock of 1973-74 created a deeper disintermediation of banks than the rise of private credit today, as investment-grade companies shifted to borrowing from the market through commercial paper and bonds.

The rise of high-yield bonds in the 1980s was another major wave, as were various advances in so-called securitization, each of which allowed a greater number of borrowers to bypass banks. Since 2008, middle-market companies and mortgage borrowing have increasingly distanced themselves from banks. Overall, the share of banks in private lending to the U.S. economy has fallen from 60 percent in 1970 to 35 percent last year, according to a new paper from the National Bureau of Economic Research.

What can we learn from the history of bank disintermediation? First, it typically takes at least two to three years for weakened banks to recover from major interest rate shocks. While major banks are back on their feet, regional banks will need more time to rebalance interest rates on their assets and liabilities. Borrowing from U.S. regional banks remains weak, providing opportunities for private credit to fill that gap.

Second, outdated financial regulations often exacerbate such shocks. In the 1970s and 1980s, Regulation Q, which imposed upper limits on interest rates offered to savers in the U.S., worsened the flight of deposits to money market funds. Similarly, the Fed’s overnight reverse repo mechanism triggered a flight of deposits as the Fed raised rates.

Expected Growth of Private Lending

Third, innovation in financial products is a key driver. Money market mutual funds, introduced in the U.S. in 1971, facilitated disintermediation by allowing savers to invest in a diverse range of instruments. Today, new private lending structures give investors access to assets that were previously limited to bank balance sheets, such as equipment financing.

Fourth, new regulations aimed at addressing bank vulnerabilities may inadvertently push even more lending elsewhere. As new Fed proposals for increasing bank capital (dubbed ‘Basel endgame‘) are recalibrated, further adjustments to liquidity, capital rules, and risk management practices are still to be expected.

Specialized loan financing appears to be a promising new solution for private credit firms. One of the attractions of this market – valued at $5.5 trillion just in the U.S. according to estimates from Oliver Wyman and which includes equipment leasing, trade financing, and royalty agreements – is greater diversification and the necessary specialized skills.

Private credit accounts for less than five percent of these types of loans, mostly ‘packaged’ for insurers. Furthermore, loans for infrastructure, commercial real estate, and mortgages offer a potentially rich selection, expanding the potential market to $26 trillion in the U.S. Overall, this could drive the expected annual growth of 15 percent in the private lending market over the next five years, although much will, of course, depend on the next moves of bank regulators.

The need to secure access to these new asset classes explains why private credit players are changing their approach, seeking partnerships with banks rather than being their adversaries. This year, at least six partnerships have been signed with major banks, the latest being between Barclays and Blackstone. Half of them focused on opportunities for asset-backed financing.

What we are witnessing is a re-tranching of the banking system where banks pass the riskiest part of the business to private equity funds, leaving themselves with lending money with as little risk as possible.