JPMorgan Chase & Co. is making the titans of private credit markets very anxious.
The biggest US bank’s foray into trading private credit loans — an as yet largely untapped corner of the $1.7 trillion market — threatens to lift the veil on a world where a key selling point has been privacy of information about the debt.
Some of private credit’s biggest lenders argue such trading would undermine this advantage by forcing them to constantly value the assets on a marked-to-market basis, rather than at their discretion, inviting volatility. On the other side are smaller fund managers and investors in these loans who want more access to the debt and the ability to swiftly exit the assets trading would bring.
That existential debate may be a moot point. If, as some market participants expect, interest rates don’t fall as quickly as predicted — crushing borrowers in the process — private loan valuations could tumble. That will unleash a wave of distressed debt bargains, making trading the assets on a secondary market like bonds a near certainty. And JPMorgan plans to be ready.
“As the market grows, it becomes inevitable,” Troy Rohrbaugh, the freshly promoted co-head of JPMorgan’s commercial and investment bank, said in an interview. “If you believe private credit will continue to grow and compete side-by-side with public debt markets, it can’t continue forever as-is. Transparency will increase over time.”
Billions Traded
JPMorgan has already facilitated a couple of billion dollars worth of private trades after singling-out market making as one prong in its private credit strategy. While that’s a drop in the ocean for the lender — the volume it has traded is less than the direct loans it holds on its own balance sheet — it’s planning to expand as it steadily builds up an inventory of the loans.
Like its rivals, JPMorgan is fighting to stay competitive as private lending titans like Ares Management Corp., Apollo Global Management Inc. and Oaktree Capital Management increasingly swallow up ever larger deals. The business of trading, which locks in lucrative fees while swiftly shifting the risk off the banks’ books, has so far been a largely untapped portion of the market.
In a bid to stake their claim in an industry that threatens to upend their core lending businesses, major banks have been racing into other parts of the ballooning private credit complex. JPMorgan has earmarked at least $10 billion of its own balance sheet for direct lending, and is also working on forming a partnership. Barclays Plc has also allocated its own cash, while Societe Generale SA and Wells Fargo & Co. have launched partnerships.
JPMorgan appointed Jake Pollack, a 20-year veteran of the firm, to oversee its private credit efforts alongside debt capital markets boss Kevin Foley. It cuts across multiple divisions of the bank and includes financing, securitization and also any trading, which is ultimately done through the bank’s broader loan-trading desk. Longtime Chief Executive Officer Jamie Dimon and markets co-head Jason Sippel have also been involved in the overall strategy.
Price Discovery
Fund managers have capitalized on private strategies they say shield them from the volatility of mark-to-market losses in public markets, because portfolios are often marked quarterly. Live price discovery could force firms to mark down values during periods of financial stress, increasing volatility.
Unlike the public bond markets though, traders are not expected to blast pricing into the market widely, at least at the beginning, according to industry participants. Traders like those at JPMorgan have in some cases kept pricing off the screens to appease clients’ concerns about volatility that live pricing could create for the same or similar assets, according to people familiar with the matter.
This may change, if previous examples in leveraged finance markets are anything to go by. In 2022, banks were unable to sell billions of buyout debt they underwrote for clients during more favorable market conditions, so they eventually sold the deals directly at large discounts to a handful of funds in private transactions.
The funds that bought some of those loans, including those backing the buyouts of UK supermarket Morrisons and payment processor Worldline SA, have since started to offload their positions, and some of that debt is now actively traded by banks with price runs regularly being sent out to the market, according to market participants and price runs seen by Bloomberg.
‘White Lists’
Trading these loans freely has some obstacles. Fund managers, much like in leveraged loan markets, can often restrict who can own the debt, primarily to prevent it from falling into hands of aggressive distressed-debt funds who may try to take over the companies. They do this through so-called “white lists” where managers draw up lists of who can buy the debt, and who’s restricted from doing so.
But as the number of direct lenders in each deal grows, so too do the white lists, paving the way for debt to change hands — even if just within the original group of lenders. In December, for example, 19 funds participated in a record €4.5 billion loan ($4.9 billion) to back the buyout of Adevinta ASA, mimicking traditional leveraged loan and bond deals that are distributed to a larger and wider range of investors.
In Europe and the UK, white lists are included in approximately 90% of deals, according to Jim MacHale, a partner in Clifford Chance’s banking and finance practice. It’s also becoming common to exclude competitors and loan-to-own or distressed investors, he said.
However, restrictions on transfers to distressed investors are often lifted when the loan has defaulted, or in acceleration scenarios where investors demand a full repayment, MacHale said. That leaves an opening for trading activity should the market start to see an uptick in defaults.
“Generally, bets are off once there are certain covenant breaches,” said Gianluca Lorenzon, head of fund finance advisory at Validus Risk Management. “Debt can then be sold on to most funds. We’ve actually seen some trading happen very quietly for a while now.”
Souring Loans
Some credit hedge funds as well as the $1.86 trillion asset manager Pacific Investment Management Co. are already poised to pounce on souring loan prices as soon as signs of distress begin to grow.
Mark Attanasio, co-founder of Crescent Capital Group, called trading “good for the market” in a December interview — rare praise from direct lenders. The rush into the space boosts liquidity, allowing existing players the option to sell assets, he added.
Market participants got a glimpse into what a world with more private-credit trading might look like in late 2022 — so far, the high water mark for trading demand, according to JPMorgan’s Pollack. At that time, nearly a year into the Federal Reserve’s rate-hiking campaign, capital had dried up and a recession was widely expected.
“Fundraising was tougher and there was a desire to do so via selling existing assets,” Pollack said. Since then, more asset managers have entered the space, and they’re sitting on enough dry powder that trading demand is muted. In the meantime, JPMorgan is laying the groundwork.
“We want to build up enough internal inventory where we like it when it doesn’t trade but have inventory when it does,” Pollack said. “It’s building the market and being ready to trade.”
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