Credit Deals Are Going Private, Leaving Wall Street in the Cold

Private credit is made up of firms and funds, including business-development companies, that directly lend money to companies, and the loans aren’t designed to be traded. These kinds of shifts in activity would typically be sparked by specific moments of volatility, such as the start of the pandemic in early 2020. But the fourth quarter was a crystallization of accumulated challenges Wall Street bankers have faced all year trying to syndicate, via the market, loans for buyouts such as those of Twitter and Citrix Systems. 

It is a reminder for investors that banks’ Wall Street capital-market businesses aren’t just facing a slow period, but also competing with alternatives. While nonbanks’ funding costs may be rising faster than banks’ deposit rates, Wall Street banks still have their own funding impediments that may make it tough for them to grab back lost market share.

Private-credit deals aren’t done exclusively at the expense of bankers. Banks can participate in this style of financing either with their own balance sheets or with clients’ money. But even more broadly defined, there has been a shift away from deals being funded by a market of investors and toward either private credit or commercial bankers making loans. So-called relationship lending was up 19% in the third quarter from a year prior, while capital-markets lending was up just 1%, according to figures compiled by analysts at Autonomous Research.

For banks, there are costs associated with the shift. The syndicated lending market is a capital efficient, high-return business that Wall Street investment bankers and trading desks will need to come back to fuel another upswing. Meanwhile, loans can carry a high risk weighting and consume a lot of capital—and for now, those capital resources are increasingly tight for banks.

Perhaps the market has been wise to avoid more corporate credit risk. Whether private credit is stepping up to grab good deals the market can’t absorb, or reaching for troubled deals to justify their own fundraising and fees, is one thing to watch closely. “We need the next credit cycle to find out whether lenders stepped in and supported clients amid market dislocations, or whether they underpriced risk and will live to regret it,” says Autonomous analyst

Brian Foran.

Private credit did show signs of caution as the year went on, such as by splitting up more deals between lenders, according to PitchBook LCD. The service’s data shows that 28% of private credit-financed deals tracked in the fourth quarter were funded by three or more lenders, up from just 5% in the same quarter a year prior. Splitting up deals allows lenders to take more of a portfolio approach, rather than putting all their eggs in one basket.

That doesn’t eliminate risk and just spreads it around a bit more. But the bottom line for investors is that they shouldn’t take it for granted that investment banks can just sit around waiting for others to blow up and for the deals to roll in. A shift away from syndicated loans could do lasting damage to their businesses.

Write to Telis Demos at Telis.Demos@wsj.com