The private credit industry was already growing like gangbusters — then came 2023, Axios' Kate Marino writes.

What happened: The banking crisis in March along with the pending regulatory changes to bank capital requirements are adding even more rocket fuel to an asset class that's more than tripled in size since 2015.

Why it matters: The growth of the private credit industry is changing the lending landscape in the U.S., disintermediating banks from the process, and even taking the rough edge off the Fed's monetary tightening efforts.

• But a private credit market of this size is untested in a downturn, and regulators have little visibility into the risks it could pose to the markets.

The heavy hitters of the industry aren't hiding their excitement: On his firm's Q2 earnings call, Apollo Management's Marc Rowan hailed this era as a "great time" for private credit; Jon Gray of Blackstone called it a "golden moment."

• Meanwhile: Jamie Dimon, scion of legacy banking, seems less pleased. He accused these upstarts of "dancing in the streets" in response to the more onerous capital requirements that banks are set to face.
• Those rules are "great news for hedge funds, private equity, private credit, Apollo, Blackstone," the JPMorgan CEO said on the bank's Q2 earnings call.

Catch up fast: Private credit funds, sometimes known as "direct lenders," are arms of asset managers that lend directly to companies, often without using investment banks as a go-between. They hold the debt and collect interest, rather than sell it off in pieces to other investors like a bank would.

• Even before the pandemic, private credit funds were muscling in on an increasing share of the corporate lending deals typically arranged by investment banks — and spreading into other areas like specialized asset-backed lending.
• Then, last year, guess who stepped in to keep the leveraged buyout machine running when the banks froze up? Yup, private credit.

State of play: Now, with the balance sheets of small and midsize banks in disarray, private credit funds are popping up anywhere a bank needs to monetize some assets. They'll take the assets off your hands — at a discount of course.

• They've purchased tens of billions of dollars worth of auto loans and personal loans, Bloomberg reported. They've scooped up portfolios of mortgages, commercial real estate loans, student loans, and even receivables on timeshares.

What's next: Banking supervisors at the Fed are pushing forward with new rules requiring banks to hold more capital on their balance sheets — a rule change that's designed to constrain their markets activity, in the name of systemic safety.

• That may translate into more opportunities for private credit funds, Danielle Poli, managing director of Oaktree's global credit strategy, tells Axios.
• After all, "greater capital requirements for banks spells less deal activity by banks," says Gary Creem, partner at Proskauer and co-head of the firm's private credit group.

By filling in gaps in the flow of credit and providing liquidity to lenders who need it, private credit funds are helping the market avoid some of the extreme dislocations that many expected in the wake of the Federal Open Market Committee's rapid rate hikes.

Why it matters: Fallout from rapidly rising rates and the crisis that took down Silicon Valley Bank and First Republic could have been much worse.

• "Banks have impaired balance sheets and private credit lenders are jumping in to fill that void — and have probably lessened the overall impact to the economy compared to what would have happened if they weren't there," Proskauer's Creem tells Axios.

As Lazard CEO Ken Jacobs said in a recent interview with Bloomberg:

• The "explosion of private debt" has "supercharged the ability of companies to get financing," and that's especially true for companies that previously relied on smaller banks, Jacobs said.

💭 Our thought bubble: That's quite a comment, considering it came on the heels of the Fed's most aggressive campaign to tighten credit in nearly a half-century.

Fundraising by private credit funds re-accelerated in Q2.

• Globally, the private credit industry had about $1.5 trillion in assets at the end of 2022, according to Preqin.

Surging private credit has caught the attention of regulators and lawmakers, many of whom have zeroed in on the lack of visibility into the funds' activities and risk-taking.

• "Private credit funds have become direct competitors to banks, but are not subject to the same oversight and supervision," Sen. Elizabeth Warren wrote in a letter to SEC chair Gary Gensler earlier this year.

State of play: It's been a talking point for years, in both the U.S. and Europe.

• In the U.K., regulators in June launched their first financial sector stress tests that included non-bank institutions.
• Stateside, the SEC is ramping up its oversight of all sorts of private funds, and the Treasury Department is assessing the options for supervision of non-banks.

Zoom out: As for hidden risks in the system, the Fed's Board of Governors said in May that, although the private credit sector remains opaque, the risks it poses to financial stability "are likely limited."

• "The funds typically use little leverage, and investor redemption risks appear low," the regulators wrote.

Between the lines: Generally, shifting risk from banks — which are systemically important, and dependent on flighty sources of capital — into the private markets may be a net positive for financial stability.

• Investors in private credit funds are risk-tolerant wealthy individuals and institutions who agree to lock up their funds for a period of years.
• "The theory of the regulators back in 2008-09 has kind of played out. They wanted to remove risk from banks and put it with private credit managers. So the risk went where it should go," Creem says.

Reality check: In an economic downturn, or even just a higher-for-longer rate environment, some of the companies that credit funds lend to will inevitably run into cash flow problems, and defaults will climb.

• In that way, the risks facing the private credit space are similar to those facing their public counterparts, Oaktree's Poli says.

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