(Bloomberg) -- Banks are upping their exposure to private credit by funding the $1.7 trillion sector’s largest lenders, according to a report from Moody’s Ratings.
Across 32 banks, Moody’s found average annual lending grew 18% between 2021 and 2023, in lock-step with the 19% increase in capital raising from private credit funds over the same period, according to the report, which was released Tuesday.
Loans tied to private credit still makes up a small portion of banks’ total lending — about $525 billion in 2023 made up less than 4% of all commitments, according to the report. Still, this exposure has become a source of concern for regulators, including the European Central Bank.
“Private credit has grown a lot, and there’s a critical point to be made about how much leverage it takes and where it comes from,” Ana Arsov, a global head of private credit for Moody’s, said in an interview.
While private credit lenders and bank underwriters have been duking it out for deals in the market, fund managers still rely on banks for leverage in order to swell their bets.
Banks are mostly focused on lending to the few large players that dominate the market. On average, the surveyed banks lend to about 20 private credit clients.
“The largest funds are the biggest customers of the banks, which is why we see the concentration,” Arsov said in the interview.
Banks are funding private credit through a number of paths. About 37% of commitments from the surveyed banks was dedicated to structured finance vehicles, while banks are also lending directly to private credit funds and business development companies through warehouse lines.
“Banks’ lending facilities to private credit funds are often part of their overall strategy of servicing financial sponsors in their quest to gain market share in M&A advisory, IPOs and other capital markets structuring arrangements,” Moody’s said in its report.
But smaller banks are growing their exposure to the market fastest. Those with between $100 billion and $500 billion in total assets increased private credit-related lending by 26% between 2021 and 2023, according to the report.
Smaller banks that are expanding private credit capabilities aggressively could raise risk, since they have less sophisticated risk management controls, according to the report.
Most lending is secured by well-structured collateral with prudent underwriting, the report said, decreasing risk. About 58% of loans from the surveyed banks are secured by first-lien loans to middle-market borrowers or large corporates.
“Every institution is going to be interested in lending to a growing market, we just hope that the risk management capabilities are also growing,” Arsov also said.
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