With US banks facing a fresh wave of capital restrictions, some are searching for ways to trade out of risky loan portfolios and free up their balance sheets. The solution may very well lie with capital-rich lenders in the booming $1.5 trillion private credit market.
These firms are seeing an uptick in demand for niche capital relief trades, according to David Snyderman, Managing Partner and Global Head of Alternative Credit and Fixed Income at alternative investment manager Magnetar Capital. Evanston, Illinois-based Magnetar is known for its profitable trades before the US housing bubble burst, betting that subprime mortgages would tumble.
Snyderman spoke with Bloomberg over a series of interviews that ended on Oct. 5. Here are some highlights of the conversation, which have been condensed and edited for clarity.
We've observed a shift across asset-based finance. What are some of the changes you've seen?
You are right, the asset-based finance markets have been trending higher since 2008, but it's accelerating now. Prior to the '08 financial crisis, banks largely directed the value chain of asset-based markets. They controlled origination so when they had a pool of assets, they'd structure them and distribute them as asset-backed securities.
It was very profitable for banks at the time as they earned fees across the entire value chain and they retained some of the investments they found attractive. It was scalable across all these different asset types.
But the bank model had this fatal flaw: the asset-liability mismatch. Banks used short-term financing on longer term assets and the global financial crisis stressed and ultimately broke that asset-liability mismatch. After 2008, banks were forced to reduce their balance sheet at the same time that private credit funds like us raised capital with the specific purpose of owning corporate, consumer and asset-backed credit.
You fast forward to today and the theme is partnerships between the banks and private credit providers. The way we think about it is, there's three major roles in the marketplace: origination, capital and underwriting. Banks have the customer relationships, so they are well placed to originate, whereas private credit funds have raised dedicated pools of capital. And both can underwrite through these newly formed or to be formed partnerships.
We are a big believer that it'll be a very good value proposition for us, a credit fund, to partner with banks both large and small. Private funds would invest in the higher risk, higher return part of the capital structure and large banks and insurers would round it out. I think the shared analytics between the banks and the private credit providers will really allow for credit to be priced more efficiently.
The pullback by banks trying to conserve capital has impacted both auto-backed loans and other types of asset-based lending. What do you expect banks to do to manage this?
The regional bank crisis has definitely been a catalyst to what's happening today in asset-backed lending. Regional banks and credit unions have a distinct advantage in origination. They know the borrower, which makes them the optimal partner for someone that has risk capital ready to invest in the asset class.
So, if they need capital, their first move is to sell off their current portfolio, which we've already seen. We believe the next step will be to partner with alternative credit providers.
Banks don't have many tools to manage their capital. They can either raise equity – but most are trading below book value so that's very expensive — or they can raise preferreds, which may be hard after the events involving Credit Suisse. Or, they can pursue regulatory relief or structured solutions risk transfer types of investments. We've been very active there.
Large European banks have been pursuing these types of transactions for a while, as a normal course of business for the last decade. Now, it's really expanding. Canada has seen a tick up. And it's coming to the US. We expect to see more of these opportunities in the future, although it's in the hands of the regulators – they need to decide whether there's been a risk transfer.
Going forward, we believe banks will keep pulling back from lending – they'll retain less risk and provide more services — and we think consolidation is likely to continue.
You've also overseen asset-based loans, including one for CoreWeave. Do you expect to see more of these?
We've been a partner to CoreWeave since mid-2021, and for the market, the transaction we did this year was large and somewhat novel, as it was a GPU [graphics processing unit]-secured financing.
For us, we seek to focus on underwriting high quality, predictable cash flows. When it came to CoreWeave, our research really centered on their cash flow generation, which was dependent on their GPUs and related customer contracts. To provide protection to the investors, aside from a CoreWeave guarantee, the financing vehicle holds the ownership of the GPUs and their related lease contracts.
The interesting thing is, that this is the type of transaction where it's much more difficult to get ratings from rating agencies upfront. So, there's a void of capital in that particular part of the market as insurers, for instance, favor rated investments. It's mainly private funds that fill it.
Talking about insurers, they're becoming a driving force in the private credit market. Where else is the new capital coming from?
The majority of our capital has come from pension funds. Traditionally, private asset-based finance has been a very good pension investment, as it's diversifying and stabilizing. But we are seeing significant interest now from insurance companies and high-net-worth platforms. These entities want more asset-based finance in their portfolio mix.
There's certainly a theme of investors moving slightly away from direct lending towards asset-backed lending. Certain assets can be more recession proof, but you need to think about extension risk – when will people and companies repay these loans.
