Overview
The deal between UBS and Credit Suisse may have fended off the immediate threat of a banking crisis, but after the merger of two of the biggest European banks and the collapse of Silicon Valley Bank and two other smaller US institutions, it is clear that the sector is under pressure and that the challenges facing banks could drag on.
We do not believe a fundamental collapse of the entire banking system is imminent: banks are in a stronger position now than they ever were before the Global Financial Crisis, with better capital levels and stronger liquidity coverage ratios. But the shakiness in certain parts of the banking market is likely to accelerate their retreat from corporate lending – especially to non-investment grade and middle-market firms – as their own financing costs rise and regulatory requirements tighten. This may create further opportunities for private lenders to step into their wake.
A seismic shift
Even before the run of liquidity events over the last couple of weeks, the outlook for banks had been changing. The ECB’s bank lending survey had already flagged a significant tightening in credit standards in Europe in the rising rate environment, and this trend is only likely to accelerate after the events of recent weeks.
But the growing constraints on bank lending go far further back than the recent rate changes. One of the reasons that the banking sector is far more robust than in 2008 is due to the restrictive regulatory environment that has developed around it. Since the GFC much of the banking regulation has focused on banks’ lending requirements, with Basel III in particular increasing banks’ minimum capital requirements and limiting leverage levels. In the wake of the latest collapses in California and Switzerland, the regulatory backdrop is likely to tighten even further.
This is not necessarily going to be negative for larger, systemically important banks that are already under heavy regulatory scrutiny, but the collapse of the smaller SVB could focus regulators’ attention onto regional and local banks – traditionally lenders to mid-market firms – and here we may see the sharpest pullback in lending. Of all the unitranche financings agreed in Europe in 2022, banks still provided some 45 per cent of deals in Germany, 52 per cent of those in France, and 77 per cent of those in Austria/Switzerland. [1]
A private option
In the decade and a half since the GFC, private lenders have stepped up to provide corporates with an alternative source of funding. We believe that now - with banks’ books set to become even more restricted and their costs of funds rising – the role to be played by the private debt markets could become even more important.
Demand for private credit has expanded over recent years as lenders capitalised on banks' retrenchment, with the volume of European direct lending assets alone reaching $216 billion by mid-2022. The recent struggles of Credit Suisse and in particular of SVB have not only seen sizeable lending competitors exit the market, but could also mean that new private investment opportunities emerge in the secondary market as their lending books are reassessed.
But our positive outlook for private markets does not just stem from their chance to snap up assets from struggling banks. In general, we expect tremendous opportunities to emerge across the private credit markets, and expect the coming vintage of deals to be particularly attractive.
As the supply/demand imbalance swings in lenders’ favour, we are likely to see transactions with lower leverage levels, more attractive documentation, and better protections. With both base rates and margins rising, the risk adjusted returns available to private lenders make for a compelling offering, and as banks become more risk averse and step back even further from lending, this trend is only likely to expand.
The current crisis is not likely to bring about the end of the banking system as we know it. But it could be the start of an exciting new chapter for private credit, allowing investors to explore potentially the most interesting risk-adjusted return dynamic the market has seen in a very long time.
[1] Houlihan Lokey MidCapMonitor, Q4 2022.
