Credit Suisse, JPMorgan Take Cue From Goldman In Battle With Private Credit
Source: Bloomberg, Lisa Lee and Silas Brown
Photo: An office worker enters the JPMorgan Chase & Co. headquarters in New York. (Michael Nagle/Bloomberg)
Banks are setting up direct lending funds, imitating Goldman
Wall Street has lost ground in lucrative leveraged business
Wall Street banks, getting trounced by money managers in the battle for the high-fee business of financing risky companies, are setting up direct lending operations to fight back.
Credit Suisse Group AG, JPMorgan Chase & Co. and Morgan Stanley are among the banks creating units to lend money directly to junk-rated companies for areas like leveraged buyouts and acquisitions, or building up their businesses. They’re following a path that Goldman Sachs Group Inc. has successfully taken since the 2008 financial crisis.
The banks are struggling to regain ground they’ve lost to direct lending powerhouses like Blackstone Group Inc., Apollo Global Management, and Ares Management Corp. Those money managers started out making small loans to riskier companies backed by private equity firms, taking scraps that big banks cast aside.
The scraps ended up feeding direct lenders until they became big enough to eat Wall Street’s lunch. Private credit firms can now make multi-billion-dollar loans, the kinds of transactions banks would normally have financed. Losing that business is painful for banks: a third of investment-banking fees have historically come from underwriting bonds, arranging loans and selling them to investors.
Raining Cash
Investors have poured money into direct lending funds
Now Wall Street is trying to catch up with the upstarts, and it won’t be easy. They have to raise funds and hire staff, at a time when investors broadly seem less eager to pour money into the asset class.
“Will banks do it as well?,” said Kristopher Ring, a lawyer who works with private credit firms at Goodwin Procter. “Not at first. As they hire people with experience they will. But they will have years to go before they can compete with the established big direct lenders.”
The biggest asset managers have built enormous operations already. Blackstone has amassed $46 billion of direct lending in one US fund alone. Ares raised an $11 billion fund for Europe last year and is targeting another that will be larger than $11 billion in its next round in the region.
Meanwhile, Morgan Stanley is entering the European direct lending market, after having set up its US effort five years ago, and aims to raise between $2 billion and $3 billion. Credit Suisse has already raised a fund that’s $1.7 billion before leverage.
JPMorgan has begun lending to private equity-backed companies using its massive balance sheet, rather than outside investors’ funds. Mitsubishi UFJ Financial Group has set up a dedicated unit for direct lending.
Deutsche Bank AG has had a small-scale direct lending operation for years, but is now looking at growing it with third-party capital, according to a person with knowledge of the matter who wasn’t authorized to speak publicly on it. The bank’s asset management arm is also looking at raising a fund. Barclays Plc and HSBC Holdings are also in various stages of eying the business.
They can follow Goldman Sachs’s playbook. In 2008, the bank decided to raise a senior loan fund through what was then its merchant bank to lend to riskier companies, building on a junior debt business created in 1996. Fast forward 14 years and the $10.5 billion it got then has morphed into a $90 billion business today. Their funds control enough money to put them in the same league as the biggest of direct lending firms, leading and participating in the mega-billion dollar deals that would otherwise fund in the public markets.
When Goldman started ramping up its direct lending business, regulators were broadly pressuring banks to cut back on risk taking. Rulemakers raised capital requirements to make it much more painful for banks to hang onto leveraged loans on their balance sheets.
Most banks responded to that pressure by pulling back from lending directly to risky companies and to private equity firms’ leveraged buyouts. They instead focused on investment banking, operating mainly as middlemen and raising capital from institutional investors. Amid their efforts, the high yield and leveraged loan markets grew to $2.8 trillion in the US. The fee income from these deals has been enormous for banks.
That gave money managers an opening to lend directly to companies and hold the risk themselves. The returns for investors were steady and often around 7%, a relatively high figure when baseline lending rates were around zero and junk bond yields averaged around 5% or 6%. Money came flooding in, and the business mushroomed to over $1 trillion of assets, allowing funds to make ever-bigger loans.
Fire Power
Direct lending dry powder balloons to $210 billion
With rates having jumped this year, Wall Street banks are often not even trying to win deals now. Those firms are still looking to sell bonds and loans that they committed to finance for buyouts earlier this year, and that have spurred losses for them. That’s left direct lending as practically the only financing game in town.
Not every bank is approaching direct lending the same way. JPMorgan Chase’s decision to use money from its balance sheet will ensure the business can get big faster. But it’s also a difficult path to take, said Chris Kotowski, an analyst at Oppenheimer.
“I generally wouldn’t expect banks to put much of these loans in their balance sheet because they get a very punitive capital charge,” Kotowski said, referring to the relatively large amount of capital required to hold these assets. “Some regulator at the Fed will take a very skeptical and dim view of it.”
Apollo and Blackstone Are Stealing Wall Street Loan Business
Most banks are raising money for outside funds that they manage through their asset management arms. That route can be difficult as well. Existing funds have track records, and it can be harder to attract money to a fund that doesn’t have any history. Institutional investors often want to be sure that banks are truly treating their funds as independent investors that can decide to reject deals that don’t look good enough, instead of a captive fund designed to foist bad loans onto outsiders. On top of that, the portion of investors who intend to allocate to direct lending has dipped from 56% from 68% a year ago, according to data provider Preqin.
Goldman Sachs said it’s been successful in part because so many parts of the bank are committed to making it work.
“The growth of our asset management division has been laid out by David and John as a strategic priority,” said Julian Salisbury, global co-head of Goldman Sachs Asset Management, referring to Chief Executive Officer David Solomon and Chief Operating Officer John Waldron. “The only way banks will be successful launching direct lending funds is if it is a top strategic priority for the firm.”