It is 18 months since the Federal Reserve began hiking interest rates. There have been a couple of squawks from distressed canaries in certain consumer credit coalmines, such as sub-prime auto loans, but corporate default rates have barely stirred from their lows.
However, the pain is coming soon, as higher rates slow economies to the point of stagnation or recession and companies must scale a maturity wall looming in 2024 with refinancing rates at wider spreads off far higher base rates.
Many banks are reducing capital available to borrowers. Defaults will increase.
This is a perfect time to be lending money.
Margins are way up. Risks are way down. Lenders can charge far higher rates of interest at much lower leverage multiples than prevailed just one year ago.
Companies must scale a maturity wall looming in 2024 with refinancing rates at wider spreads off far higher base rates
Direct lenders will benefit handsomely. While new fundraising has slowed, private credit funds can still deploy previously committed institutional capital, free from the fear of deposit flight and from the high expense of regulatory capital now crimping competing supply from banks.
Some banks are quietly lobbying for the same capital rules to be applied to a private credit market that has grown since the global financial crisis from next to nothing to a $1.5 trillion asset class.
But it is rather simplistic to think of regulated banks and private credit investors as competitors. Banks may be good at originating and underwriting loans. That doesn’t make them the best holders. Those are two businesses, not one. Their separation has been playing out in fits and starts for two decades.
Next steps
Many dramas will be played out in US leveraged loans, with direct lenders replacing traditional bank loan arrangers and providers and presenting new terms to private equity sponsors for refinancing.
But the bigger stories may be in investment grade credit and in Europe, where companies have traditionally relied far more heavily on banks for credit than on the capital markets, and where the banks know that must change, especially to finance the vast capital investment in a green transition.
On September 11, Societe Generale announced a strategic partnership with Brookfield Asset Management on a private investment grade credit fund, launched with initial seed capital of €2.5 billion and an aim to hit €10 billion in the next four years.
Private credit has traditionally focused on unrated and below investment grade borrowers, but that is changing fast. The new fund is designed to provide insurance companies with investment grade products tailored to their ratings and duration requirements. The seed fund will focus on two strategies: one for real assets credit across the power, renewables, data, midstream and transportation sectors, and another one for fund finance.
European banks have sought to maintain origination fees but pass credit on to insurance companies since the arrival of the single currency.
Formalizing such arrangements into strategic partnerships is an intriguing next step.
Societe Generale has a good DCM business but not one that even its own bankers would place in the global bulge bracket. Tying up with a global alternatives manager that has $850 billion of assets under management won’t change that overnight. But it can only increase the bank’s importance in financing the global economy.