Banks are navigating a tricky dynamic amid a boom in the industry’s lending to the private credit sector. By embracing the trend, banks risk aiding new competitors. But by staying on the sidelines, they could miss out on partnerships that may be mutually beneficial.
The private credit market has
“They’ve come to the realization that private credit is here to stay,” said Brian Foran, an analyst at Truist Securities. “So you might as well work with them, not necessarily against them…Banks as an industry would rather private credit not be there, so they wouldn’t have a competitor. But any individual bank working with private credit often has incentives to do that.”
The interconnectedness between banks and nonbanks is famously murky — private credit firms and similar lenders have long been called “shadow banks.” Limited visibility into the arrangements makes it difficult to assess whether the added opportunities for banks outweigh
Loans to nonbanks have driven about half of bank loan growth this year, and now make up about 10% of all loans in the U.S. banking system, according to Truist Securities.
Most of the exposure to nonbanks is concentrated among the largest players — just 13 of the biggest banks in the country accounted for nearly 80% of the loan balances in the sector, according to an analysis from Fitch Ratings.
Fitch found that by the end of the first quarter, loans to nonbank entities had increased 20% from the previous year, to $1.2 trillion, compared with a commercial loan growth rate of 1.5% over the same period.
Regulators, as part of their role in
The Truist report found that banks with higher concentrations of loans to nonbanks have tended to see stronger loan growth in the last year.
While nonbank lending isn’t new, its entanglement with traditional banks has accelerated since the pandemic. Credit lines committed by the largest U.S. banks to private credit vehicles have increased by 145%, or an annualized growth rate of about 19.5%, in the past five years, according to a Federal Reserve report from May.
“The underlying drumbeat of private credit — how do banks work with them, work against them — has been going on for years, really,” Foran said. “But it definitely feels like it’s reached a new level over the past 12 months.”
Many private funds that were started after the 2008-2009 financial crisis — to take a piece of the leveraged buyout market — have evolved into entities that are “increasingly replicating the lending division of a bank,” Foran said.
Matthew Bisanz, a bank lawyer at Mayer Brown, said that private credit firms are sitting on a heap of dry powder, which gives them more opportunities. Meanwhile, banks have been extra-cautious with their capital in recent years. Making loans on their balance sheets — especially to companies in certain sectors — comes at a cost to that cushion.
Banks can use loans to private credit funds as a way to gain exposure to borrowers that were previously inaccessible, due to factors like credit risk, geography or size. But banks could inadvertently eat into their existing lending businesses if they finance funds that end up taking some of their current business.
Julie Solar, group credit officer for North America Financial Institutions at Fitch Ratings, said there is mutual benefit to be had.
What historically could have been a bank loan can now be done through private credit, according to Solar. As banks continually look to cross-sell a broader set of services to clients, this can be another product their customers want, she said.
“The banks are increasingly trying to offer those sort of complementary solutions and bring the whole product suite to the customer, lest they start to lose out more market share to the large alternative investment managers,” she said.
Webster Financial in Connecticut reported about $5.4 billion in loans to nonbanks, or around 10% of its book, as of the first quarter. The $80 billion-asset company operates a sponsor and specialty line of business that includes national lender finance and fund banking verticals.
“Private credit is here to stay,” Webster CEO John Ciulla said at an industry conference in March. He described the companies as “unlimited pools of capital, unregulated, and continuing to, I think, compete formidably with banks across more asset classes than people probably think.”
Last July, Webster announced a joint venture with Marathon Asset Management to provide direct lending to sponsor-backed middle-market companies. The joint venture helps Webster compete “at a higher level” to meet clients’ demands for more flexibility and larger transactions, while the bank also manages its credit exposure, Ciulla said.
JPMorgan Chase announced in February that it would expand its private credit capabilities, allocating $50 billion from its own balance sheet, along with $15 billion from several co-lenders. The strategy is about meeting customers’ needs, as opposed to gathering assets, JPMorgan Chief Operating Officer Jennifer Piepszak said at a conference in February.
“We probably don’t go through a week, sometimes not a day, without talking about private credit,” Piepszak said. “We can offer a client-focused, product-agnostic solution, in the sense that we can … .be very focused on what is the right client solution, while at the same time, financing private credit portfolios or partnering with direct lenders in our co-lending structure.”
Nonbank loans make up 13% of the New York megabank’s total book, per Truist Securities.
But some of the factors that have been a boon to private credit’s rise may be subsiding.
Loans to nonbanks gives banks some wiggle room on their balance sheets, since those transactions don’t trigger the same capital requirements as direct commercial loans. When previously proposed regulatory rules threatened to jack up required levels of capital, banks looked for creative ways to shore up their reserves.
Now, such regulatory mandates seem unlikely to come to fruition, which Bisanz said could slow the pace of growth in the sector.
“It will even out as if banks get some regulatory release from the Trump administration,” Bisanz said. “And it will even out as the competitive edge that some private credit firms have wears off.”
Despite the boost that some banks have gotten by lending to private credit firms, only a small portion of the banking industry has hitched its horse to the wagon.
The private credit business wouldn’t be as beneficial to banks that are more focused on consumer lending, including credit cards, Bisanz said. And some banks are staying on the sidelines for other reasons, deciding that private credit doesn’t align with their business strategies.
Regulators have been trying to gauge how much risk the private credit sector poses to financial stability. A recent report from the Federal Reserve Bank of Boston found that traditional lenders could be upended if defaults spike among private credit borrowers.
While banks typically hold senior positions relative to the underlying loans that private funds make, the report said a major financial shock could still be a threat.
Solar said she doesn’t think the financial system is in danger from private credit at this point, based on Fitch’s assessment.
It will take an entire credit cycle to see how well these deals will perform, Foran said. But he noted that during a credit crunch, private funds have more flexibility than banks to make financial maneuvers — like injecting equity into the companies that owe them money, or even taking ownership of those firms — which could dampen the shock to the financial system.
“There’s some argument that if you put the riskiest corporate credits into the hands of someone who’s more flexible, it might actually dampen the economic cycle,” Foran said. “You don’t get the credit crunch all at once.”
