Bailed out commercial banks are now holding the sword of Damocles over their venture borrowers.
Below is a discussion of the pending migration of venture lending from commercial banks to private credit funds.
Of course, now with deposits completely guaranteed, those banks are holding their “compensating balances” term (as part of the original loan agreement) over the heads of their borrowers: “Return your deposits to us or we’ll call your loan!!”
Which is understandable but will also result in those same borrowers looking for opportunities to refi in order to give them custody optionality for their cash. “Compensating balances” are a feature of bank lending — but is not a thing for private fund lender terms.
(though perhaps the private credit fund would give you a free toaster or sleeveless fleece with their logo)
The link below is a very good summary by Greg Kyle on what happened at this trio of lenders — but is not necessarily a road map to all that may happen next, which can be hard to predict. So, read on…
If you look back to the post Dodd-Frank world, banks retreated from middle market lending and the slack was picked up by private fund sponsors.
Ares, for example, now has $200bn of their approx $350bn in private credit. And that makes that part of their business a loose comp to SVB (at least in size). Ares AUM has grown 3x in the past 5 years and there are plenty of other players who have already amassed some serious assets in Direct Lending — and other sophisticated players are on deck to do the same.
Less common, however, are those who have engaged in Direct Lending to venture stage companies and there are myriad reasons for this. That is a speciality line of business and those who are used to lending against hard collateral such as real estate, corporate assets, etc will find much more esoteric “assets” here such as the venture firm’s IP.
But there is precedent; recently, there have been some high profile moves of middle market direct lending firms moving into the venture/tech space in scale:
As bank balance sheets continue to contract and origination talent continues to flee with their borrower relationships, it would be very reasonable to expect that private funds will again take up the slack.
And unlike their banking counterparts, the private funds do not typically have the same ALM-type issues that the bank’s have with hot money wholesale funding and other funding mis-matches. The terms of the LPAs will typically fit the strategy regarding liquidity and other terms, though you will still find open-end funds with illiquid strategies even at some private fund sponsors.
Lastly, absent fraud or insider trading allegations (FrontPoint Partners anyone?) which in and of themselves can cause full redemptions, the regulators can’t simply shut private credit funds down for anything short of a criminal indictment (Allianz, DBL, are but 2 examples).
Investment banks have also taken it on the chin this past year in originating and syndicating leveraged loans (or trying to syndicate them). There were some high profile busts like Twitter etc where an origination flip turned into a longer-term hold for the banks who were hoping for an exit that would minimize their losses. And guess who’s moving into that space now?!
In sum, commercial and investment banks both continue to lose out on a variety of types of lending opportunities to scaled, sophisticated credit funds and this time is expected to be no different.
Originally published March 18, 2023
James A. Hartmann has over 30 years of experience in compliance, including implementation and ongoing support of compliance programs as well as general operational experience within the financial services industry.