Why are banks both increasingly cooperating and competing with PE firms in providing private credit?
As banks have pulled back from lending to less creditworthy companies in recent decades, a trend that accelerated after the 2008 financial crisis, they have seen private equity firms step in through closed-end funds and other vehicles dedicated to financing corporate credits, usually for middle-market firms and often those in their equity portfolios.
Yet rather than sit passively by, a growing number of banks have responded by cooperating with or competing with PE firms in issuing private credit, either directly to companies through their own funds or through the PE firms themselves.
Bank lending to the private credit industry was estimated by the Federal Reserve in May 2023 to be $200 billion, although the Fed acknowledged that its estimate may have understated the actual amount.
Meanwhile, a report by global consultancy Deloitte analyzing US Federal Reserve data shows that bank lending decreased from 44% of all US corporate borrowing in 2020 to 35% in 2023.
The trends reflect both supply and demand forces. Bank consolidation is one factor depressing lending from the sector to corporates. Another is the tighter regulations imposed after the financial crisis, which have caused banks to lend less through the broadly syndicated loan market. Meanwhile, many middle-market companies prefer the flexibility, speed, confidentiality, and lower disclosure requirements of borrowing through private credit funds and publicly traded business development companies over what banks offer. These features are becoming increasingly attractive to larger companies as well.
Meanwhile, the global consultancy Deloitte points out in a recent study of the 50 largest banks by assets in the U.S., including foreign banking organizations and intermediate holding companies, that banks may prefer financing middle-market companies through private credit because they retain less credit risk while maintaining an advisory relationship with borrowers.
As a result, some banks, including Goldman Sachs, Morgan Stanley, and Standard Chartered, are establishing their own private credit units or funds, while others like Bank of America, Citizens Financial, PNC Financial, and Wells Fargo are partnering with PE firms by providing loans to their funds.
According to Fitch Ratings, Wells is the largest lender to private credit funds, with more than $57 billion in loans to the sector as of the quarter ended June 30. It is followed by PNC with $28.9 billion and Bank of America with $24.2 billion.
Deloitte finds that some regional banks participate in private credit through fund servicing arrangements and risk transfer, while foreign banking operations lend to private credit by financing funds or leveraging their home country capabilities through building their own funds.
Overall, Fitch found that bank loan balances to private credit increased 23% in the June quarter compared to the previous one.
While the interconnectedness of regulated banks with lightly regulated financial intermediaries like private credit funds has raised concerns among regulators, including the Bank of England, the Bank for International Settlements, the European Central Bank, and US Federal Reserve, an August 18 report from Fitch states it “continues to view financial stability risks from lending to private credit intermediaries as limited for now.”
