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Apollo Global and Citigoup have set up a $25bn direct lending program.

Citi’s role – bring in the clients. Citi has clients who will be able to use this capital.

Apollo’s role – bring the capital. Apollo has raised large private credit funds and has a strong investor brand in this space.

Mubadala Investment Company will participate at Apollo’s strategic partner. Apollo’s retirement products subsidiary, Athene, will act aas an affiliate. Both may invest in direct loans originated through the partnership.

The program is initially for North America. There are plans to grow this to other geographies and beyond $25bn if things go well.

Citi launched a similar $2bn direct lending partnership with private credit manager LuminArx Capital Management earlier in the year.

Why

This type of partnership between private credit managers and banks is becomming more common.

For both banks and private credit managers, the partnerships are partly opportunistic and partly defensive.

For banks:

• Opportunistic: They can earn fees on the loans they originate through these partnerships.
• Defensive: They avoid losing clients to other banks and advisors. There will be many deals for which the bank will not be able to provide the loan themselves – this might be because of regulatory capital reasons, risk management reasons or other reasons. This could result in the client going elsewhere. Through this kind of partnership, the bank is able to keep the client and also keep business associated to the loan – for example if the loan is to finance an acqusition, the bank can keep the associated M&A business.

For private credit managers:

• Opportunistic: They are able to deploy funds.
• Defensive: By entering into partnerhsips, they prevent their competitors for entering these partnerships. This makes a difference to their ability to deploy raised capital, and to market themselves to their own investors when raising new funds.

Other bank – private credit manager partnerships

Other bank – private credit manager partnerships include: Goldman Sachs and Ares Management, JPMorgan Chase and Apollo, Credit Suisse and KKR, and Deutsche Bank and Blackstone.

Verena Ross, the Chair of the EU financial markets regulator, backed calls for deregulating securitization in the European union.

She said in a conference that the current regulatory framework has not produced the expected results, that regulatory incentives need to be improved to encourage securitization. She said that EU issuance volumes were €600bn in 2008 and were €200bn in 2003.

Changes would likely affect regulatory capital requirements, retention rules, due dilligence requirements and reporting requirements that were added since 2008.

Verena Ross is the Chair of the European Securities and Markets Authority (EMSA).

This follows a report released earlier this month for the European Commission by Mario Draghi that proposes securitization deregulation.

Change may happen quickly – Ross said that the EU Commission is working on a public consultation on securitization regulation, which is expected to be opened “in the coming weeks or months”.

Former ECB president Mario Draghi published a report for the European Commission – in which he proposes securitization deregulation.

Specifically he says:

• Capital requirements for securitised assets should be reduced.
• Current capital charges do not reflect actual risks for some asset classes.
• Transparency and due diligence requirements should be reviewed.
• The EU should set up a standardized securitization platform.
• The EU should consider public support – for example first-loss tranche guarantees.

The reasoning is that the European securitization market is broken following high levels of regulation following the 2008 financial crisis. This is leading to less capital being available for European investment and development.

Draghi points to annual European securitization being about 0.3% of GDP – whereas annual US securitization is 4% of GDP.

The report is titled “The future of European competitiveness”.

Private credit is private lending to companies by non-bank investors. It is one of the fastest growing areas of the global capital markets.

The “private” part of this means that the transactions are not publicly offered to investors and not listed on a stock exchange.

It is easiest to understand by considering the analogy to private equity deals – which are investments in companies by one or a small number of private investors. These investments are not publicly offered and are not listed.

Different to bank loans, syndicated loans and bonds

Private debt deals are different to traditional corporate loans – in that the lender (investor) is not a bank in that market. So for example a $50m loan from a local bank to a real estate company would not be a private credit deal – but the same loan from a pension fund would be a private credit deal.

Private debt deals are different from syndicated loan deals in that they are not documented in the same way as syndicated loan deals and not bought by syndicated loan desks at banks.

Private debt deals are different from public bonds in that they are not listed on a public stock exchange and are not publicly offered to a wide range of investors.

Private credit transaction sizes

Public credit transactions have typically historically ranged from around $30m to $300m. This has changed in recent years – as capital enters the market and now we see firms doing much smaller deals (to wrap up into a portfolio) and larger deals of up to $5bn.

Formats

Private credit deals are structured in a number of formats. These include:

• Loans
• Notes
• Bonds
• Facilities

Categories of Private Credit

The types of private credit are:

• Direct Lending, Investment Grade – private credit investors lend to investment grade (BBB- or higher rated) companies.
• Direct Lending, High Yield – private credit investors lend to sub-investment grade (BB+ or lower rated) companies.
• Mezzanine Debt/Junior Debt – lending to companies where you are only repaid after other senior lenders are repaid. This means that you receive a higher interest rate than senior lenders – but your losses if things go wrong can be higher.
• Asset Backed Private Finance – lending to companies where the loan is secured by assets – for example aircraft that the company owns.
• Distressed Debt – lending to companies that are unable to pay back their current debts.
• Special Situations – lending to companies that want to use the money for mergers/acquisitions or other special situations.

Market Size

The private credit market is growing fast. It is estimated to be around $1.5tn. That is up from $1tn four years ago. In four more years, it is estimated to be around $3tn.

The Largest Investors

The most active investors in private credit markets include Apollo Global Management, Ares Management, Oaktree Capital Management, Blackstone, Goldman Sachs Asset Management, Carlyle Group, Kohlberg Kravis Roberts (KKR), and Brookfield Asset Management.

The Future

The private credit markets have grown rapidly. The amount of capital in the private credit markets has grown rapidly, as has the number of asset managers. With this we are seeing greater competition for traditional private credit deals and the expansion of private credit into new asset classes – especially in asset-backed finance, investment grade lending and project finance.

We are also seeing private credit firms look to build their own origination capabilities – where, for example, they can lend directly to many smaller borrowers and then build up asset pools in that way rather than having to compete for already originated asset pools from third party originators. We expect this vertical integration to continue and it could become a major differentiating factor for private credit asset managers pitching for capital from their investors.

Connected with this is a race for scale – where the top private credit managers are raising larger and larger funds – with the view that this will let them invest in deals that are too large for competitors, and it will allow them to build origination and operational capabilities that would not be economical for smaller competitors. With higher interest rates and the risk of an upcoming recession, some existing private credit assets will default and there will be new opportunities for investors running distressed opportunity strategies. These might also limit private credit supply – and force greater competition and potentially ultimately consolidation in the sector.

The market (measured by deployed capital) is expected to continue to grow rapidly for the coming 5 years. Competition is expected to increase – which is leading to a race to scale as quickly as possible among managers, and is also creating a race to build capabilities to expand the types of credit that private credit managers extend. Looking at private credit as a competitor to the banking sector, there is a lot of room for growth.

JPMorgan is increasing its cap on banker bonuses in the UK from 2 times their base salary to 10 times.

This dramatically increases the amount that the best DCM bankers in London can earn at the bank – increasing the attractiveness of being based in London for these rainmakers.

If this is where the best DCM banker talent can be found, the centre of mass in London will increase for investment banks.

This decision by JPMorgan follows a similar decision by Goldman Sachs – which increased its bankers’ bonuses to 25 times their base salaries.

JPMorgan has not reduced bankers base salaries – but Goldman Sachs did reduce salaries for their bankers.

It is expected that all other top tier investment banks will follow.

With large discretionary bonuses back on the table, the incentives for bankers to outperform and innovate increases by perhaps an order of magnitude. With a low bonus cap, the risk-return for taking chances on new initiatives was poor in many cases – where if things went wrong you risk your high base salary, but if things go well, your upside is limited. With large bonuses available again, this changes.

Overall we expect this to be highly positive for the city of London as a hub, and positive for the UK and Europe economies through improving their capital markets.

With increased incentives for financial performance, the UK regulators and other standard-keepers like rating agencies should prepare to up their capabilities. With greater financial innovation comes the chance of new systemic risks – which the regulators need to have the capacity to monitor, understand and mitigate. This is especially the case with structured debt capital markets products – which can create tremendous value to global growth, but can also create crises if risks are not mitigated at a system-wide level as we saw in 2008.

We would suggest that governments take this opportunity to invest in its regulatory bodies – allowing them to hire greater numbers of high-expertise people – who will be able to implement the right regulation that protects from risks without damaging capital markets improvement. Many of the best people would be expensive (and increasingly expensive with higher pay now available at banks). But this is a tiny cost relative to the new income economies can expect with more effective capital markets.

June 20, 2024

FinanceIt is a Canadian fintech that provides point-of-sale financing for now over 10,000 home improvement, recreational vehicle and retail businesses in Canada.

They have grown their business through asset-backed warehouse financing.

FinanceIt has announced that they have grown their asset-backed warehouse facility size by C$500m to C$2bn.

The increase is from a facility upsize from CIBC and a facility with Concentra Bank.

FinanceIt set up its asset-backed warehouse facility with CIBC in September 2023 – through which it can issue loans to customers, and those loans are in turn funded through this warehouse facility. The loans are available as collateral to CIBC and Concentra.

Through this arrangement, FinanceIt is able to issue large numbers of loans, at a very low interest rate.

Their plan is to grow this facility and then issue asset-backed bonds once they have large enough total outstanding loan balances.

The benefit of refinancing the facility with asset-backed bonds is that they access capital at a lower cost, and free up the capacity of their warehouse facilities to be able to keep issuing more loans to their customers.

This warehouse facility -> securitisation process is a proven way for fintech companies around the world to compete with large bank lenders – in terms of the number of loans they can issue and the interest rate they can offer to customers.

Vista Equity Partners bought technology training platform company Pluralsight for $3.5bn in 2020.

Pluralsight has $1.7bn of debt – including from Ares, Benefit Street, Blackrock, Blue Own, Golub, GSAM, Golub and Oaktree.

The company is now distressed – with Vista marking its position to zero.

Vista has now reportedly used a drop-down structure to move intellectual property from Pluralsight to a foreign subsidiary – and Vista has invested $50m in that subsidiary. The $50m has been used to pay interest on Pluralsight’s existing debt. This new financing from Vista is secured on the intellectual property assets moved to the subsidiary – so effectively ranks senior to Pluralsight’s existing debt.

This move may help Vista to achieve a better outcome in a bankruptcy process. It pushes out when bankruptcy occurs – by continuing to service interest on the loan. Having a secured claim over the intellectual property assets in a foreign jurisdiction, may also complicate and delay the bankruptcy process. All this could allow Vista to negotiate a better outcome for itself with creditors to Pluralsight.

Stronger covenants can protect private credit lenders from this type of situation. Negotiating stronger covenants will still be difficult while we have a lot of capital chasing relatively few deals.

The International Monetary Fund (IMF) is encouraging regulators around the world to more intrusively regulate private credit funds, the institutions that invest in these funds and the institutions that provide leverage to these funds.

The IMF notes that private credit is now a $2 trillion+ market, and it has the potential to create systemic risks for the global financial system.

In particular, the IMF is sounding an early alarm on the risk of issues for the economy if the private credit markets seize up because of a crisis. Private credit is approaching the market size of the syndicated loan and high yield bond markets in the US – making it a significant part of the country’s financial infrastructure. The worry is that if the market stopped lending, there would not be enough other infrastructure in place to quickly take its place and extend credit to companies. This would then have follow-on economic and employment consequences.

The IMF works through this in detail in their 2024 Global Financial Stability Report. They look at potential systemic risks in the private credit markets – including the interconnectedness of investors, the multi-level layers of leverage in the market, and stale valuations because of a lack of market prices. In light of these risks, the IMF is particularly concerned about the opacity of the market – meaning that regulators have “severe data gaps” (within and across borders). This could in turn prevent them from pre-empting a crisis.

The IMF also talks in the report to the value that the Private Credit markets bring to the economy and the financial system. So their recommendations are for greater data gathering and regulation, rather than trying to dissolve the market. The IMF recommends that regulators take a more intrusive approach. Covering credit funds themselves, their investors and their leverage providers. This includes better data gathering, watching for investor concentrations, monitoring liquidity and conduct risks, and increasing cross-border cooperation with other regulators.

Goldman Sachs Asset Management’s (GSAM’s) Petershill Partners is reported to have bought 40% of private credit manager Kennedy Lewis.

Global investment banks and investment managers are investing to grow their private credit markets exposure.

Kennedy Lewis is an alternative credit manager founded in 2017 by David K. Chene (formerly CarVal) and Darren L. Richman (formerly Blackstone). It has $14 billion of assets under management – across funds, a business development company (Kennedy Lewis Capital Company) and collateralized loan obligations (Generate Advisors).

Through these vehicles, the firm invests in senior secured loans to mid-market companies in the US and Western Europe. Their strategies are: opportunistic credit, homebuilder finance, core lending and broadly syndicated loans.

Kennedy Lewis is headquartered in New York with offices in Miami and Geneva.

Petershill Partners was set up by Goldman Sachs in 2007 to invest in private equity firms, hedge funds and other alternative asset managers. Petershill is publicly listed and has stakes in over 20 asset managers. It is operated by GSAM and GSAM owns 77% of the firm.

We expect to see more deals like this as higher rates make the markets tougher for private credit managers.

AGL Credit Management (AGL), Barclays and the Abu Dhabi Investment Authority (ADIA) have teamed up to invest in private credit. AGL has launched a new vehicle, AGL Private Credit Platform.

The AGL Private Credit Platform will get exclusive access to private credit deals originated by Barclays’ leveraged finance and investment banking businesses.

ADIA is reported to have committed $1bn as an anchor investor. With leverage, this could provide the AGL Private Credit Platform with over $2bn of investment capital.

The platform will invest in directly originated senior secured loans to large corporates.

AGL is a New-York-headquartered investment manager focused on corporate loans. AGL manages CLOs and funds. The firm has have over $14bn in assets under management. AGL was founded in 2019 by former loan market-maker Peter Glesyteen and private equity veteran Thomas H. Lee. It has been supported by ADIA since its founding. The firm has 11 dedicated investment professionals.

This cooperation arrangement gives Barclays additional capabilities to offer its investment banking clients – reducing the risk of them going to other banks who have private credit capabilities.

We expect to see more investment banks to find ways to provide their clients with a private credit offering. Other banks including JP Morgan and Goldman Sachs have also set up their own arrangements to provide their clients with private credit financing.