Bloomberg Audio Studios, Podcasts, radio News. Hello and welcome to another episode of the All Thoughts Podcast.
I'm Tracy Alloway and I'm Joe Wisenthal.
Joe, I feel like I start every private credit episode with the same point, but I mean, private credit it's everywhere right now. I think I counted like dozens and dozens of stories on private credit that came out just on the Bloomberg in the past week.
There's two funny things that are going on. Which is one private credit. So these non bank entities providing loans, et cetera wanting to get into credit, and there's more and more about that every day. And then there's banks wanting to get more and more into private credit, which is his own thing of Okay, you're still at the bank, but you're doing it in some sort of bald and she'd structure that resembles private credit, and what's up with that?
What's up with that? Indeed, this is the what's up with that? Episode? I'm so glad you asked that question.
But we're going to be talking about the relationship between banks and private credit because the other thing that's been happening is every time we talk to a bank or a private credit entity on this show and we ask about the relationship between regulated banks and non banks, you get this really diplomatic, kind of awkward answer, like while we view our bank partners as opportunities and no one will really explain how they actually feel about each other totally.
You know.
The one other thing before we get into it that I think about it a lot is I look at the rise of private credit and there is a big part of me that says, this is what regulatory success looks like. This is what post DoD Frank's success looks like. That there is more of this risk taking, right, this was the intent, Yeah, happening outside of the deposit taking
banking institution. On the other hand, if a lot of the leverage for private credit and a lot of these relationships is being plied by banks and so forth, then it makes me wonder, did we actually extricate the risk.
Or in the air we just put a wrapper on it, we.
Put a rapper on it. In the end, does all financial risk readown back to the banking system?
That's exactly it. And I got to say, you know, there is a lot of discourse from which we can pull from a lot of historical analogies, because of course, bank disintermediation is not a new thing. It's basically been happening for as long as we've had banks. And if I think back to like two big moments in the process of bank disintermediation, it has to be the invention of the junk bond market in the nineteen eighties, securitization. Also in the nineteen eighties and nineteen nineties, peer to
peer lending. That was a fun one, remember that.
Well the other thing too, you know, it just occurred to me. And bear Stearns was not a retail deposit taking institution. But part of why they blew up is like they had these in house hedge funds, right, and so even this idea of hedge funds and non bank entities sort of existing within more larger, traditional regulated financial institutions is not that new. That was a story of the Great Financial Crisis.
That's exactly right. So I'm very happy to say this is our banks and private credit basically Frenemies episode. We're going to be speaking with really the perfect guest. It's someone that I've known for a long time and we've actually had him on the podcast before. But I don't think you were there. I promise you are really going to love this. We're going to be speaking with Hugh van Steinis. He is the vice chair at Oliver Wyman and also the former global head of Banking Research over
at Morgan Stantley. That's where I got to know his during the depths of the euro Zone financial crisis when I was on FT Alpha bel He's also formerly an advisor to Mark Karney at the BOE. I think he won like a series of research awards at various points in his career, but really one of the smartest guys I know when it comes to banks and financial So, Hugh, thank you so much for coming on.
All thoughts. Tracy, thanks so much for having me on.
We are very excited. First of all, maybe let's just start with the basic question, because everyone seems to have different opinions, different numbers around this, But how big is private credit at the moment compared to the traditional banking system.
Oh, I mean, honestly, it's pretty tiny. So the official stats are about one point seven trillion, and that's by Prequeen, the company that Black Croc bought recently. That number, though doesn't include insurers giving direct mandates to the private credit firms. So I think it's probably closer to two and a half to three trillion, which is a drop in the ocean to what investment grade bond markets nine trillion banking
assets in Europe at thirty two trillion. These are really relatively small numbers, and so I think that's why many of these firms think they've got a long run way still to grow.
So why do we care. If not because they're so big, it's just because it's growing.
Fairst Well, it's also because they're eating away at bank earnings, and I think that's where, you know, if I think about our conversations with bank CEOs and CFOs, and I literally just had one before coming on your show, they're worried about how much of their juice is being gobbled up. And I think that that's you know, that's why in way, Tracy's Right has gone from sort of counterparts to frenemies. And one way to think about it is that we
had a very unusual macro period. As you've spoken about many times, during twenty twenty three, private credit players wrote about ninety percent of all leverage loans, and they're also doing really well in direct lending. And so they're looking for the next avenue of growth. And one theme that we come up across a lot is about asset back lending, so in other words, financing i'd know, aviation, or auto loans or even royalties. That's a five and a half
trillion dollar market in the States. Private credit probably has less than five percent share, and they're really looking to mine this seam. And so if you're a banker, thinking, these guys are now after durre investment grade assets, not just are the high old assets.
So talk to us about how we got to this point because Joe correctly, I think, attributed this to a lot of the post two thousand and eight redesign of the financial system regulation. And I mean, this is what we wanted, right, We wanted the riskiest stuff, the riskiest activity to be pushed away from regulated banks and into I know they have the nefarious name of shadow banks, but you know, mostly we're talking about like a business development company or a direct lender or someone like that.
No, look, I think that's right. So looks if you take it since the financial crisis, where we changed the rigs for the banking system, a lot more capital, a lot less shortened the asset liability duration, a mismatch that went beyond an elastic limit into the financial crisis. So these private credit firms have created just over a trillion dollar parallel system to lend to corporate America and parts
of corporate Europe. And it's around leverage lending its areas which were either too risky or in some cases where the FED put in limits on how many leverage loans or what was the maximum you know, multiple of level that a bank loan could take on. And so these loans are being pushed outside of the banks. The other area, though, where private credit has been very active to is mid market. So let's say a loan between let's say thirty million
dollars to seventy five million dollars. That's a narrow where for the top six banks, this is just too small fry for them to get excited. And therefore so there was us kind of a missing piece, which you know, the private credit firms picked up the crumbs which are left on the table by the bank. So you're right, I think the regulators push this. I think where we're
going now is probably to the next level. And so what I the way I think about it is that we are now retranching the banking system where the banks are laying off the junior risk to private credit, and that's allowing them to optimize their capital, but quite frankly also lend more. And so what's really interesting for me is there's, like everything in life, people see things as
an opportunity or a threat. The top banks and CEOs that I talk to are now saying, actually, private credit allows me to recycle risk more quickly, I can lend more. And then there's a whole bunch of banks who are just sitting licking their wounds, going I'm not sure how I can do this. So I think there is a little bit symbiosis now between the banks and private credit.
SORR explain that a little bit further, at least on the opportunity side, when they can recycle their capital first, just sort of walk us through.
The Yeah, so Joe, let's take one of the top top us banks or your banks. So there are three ways they can lay off risk. The first would be to say I will seed the loans that I don't really want to write to give to a third party. So in a way, what you've seen with Apollo and City Group is the is the leverage lending or Brookfield with Lloyd's in Europe. Again, it was around leverage lending. So it's stuff that they didn't really want to do,
but they can arrange. They can get all sorts of origination fees, and then they can also keep the relationship. The second is if they let's say, originate a loan, they then pass that up, maybe get one hundred loans on hundred twenty loans, and then do a synthetic risk transfer around this, in other words, start to basically which I think you talked about two months ago on your show.
So in that case, think about a bell curve, you're going to ensure the bottom ten percent, you're going to take off the tail, and from a bank capital point of view, that dramatically optimizes your capital at risk. So the FED only permission this is about nine months ago. You've already seen Morman, Sandy, Golden Sacks a number of firms start to do these synthetic risk transfers. That space, I think is going to grow really strongly because for the largest firms it allows them to lend and then
do them. And then the third is then the more you know, there's some more complexities as well around you know, how else you can sort of lay off the risk.
So one thing I'm always asking on the show is how these conversations begin, because you know, I honestly have no idea. Like, clearly there's a lot of partnering that's happening between banks and private credit at the moment, but when did that start? In your mind, what was the first kind of big, notable instance of a bank teaming up with some sort of private credit entity.
Oh, that's a good question.
So, as you were sort of hinted earlier on Tracy, often in life a history of these things is far longer than we like to believe. So just like actually nineteen seventy three was the peak of bank lending as a percentage of lending to corporates. I mean, it's what, it's fifty years since that peak. So you're right, some of these partnerships are actually about fifteen years old. One
or two of them predate the financial crisis. But if you think about today, in the twelve months to September fourteen, banks tied up deals with private credit, and in the twelve months prior it was only two So it's basically about a year ago. Suddenly it snapped. Now why is that. I think it's because the private credit firms, particularly the top ten, felt that started to max out of you know, leverage lending or direct lending. But I think the subplot
is much more Shakespeare. I think there's a really interesting subplot, which which is more of the top ten private credit firms and now getting the assets from insurers. So take yesterday we had the Blackstone results. Half their assets now now come from insurance companies. Insurers can only invest investment grade.
So if you think about it from the point of view the private credit player, they are structurally lowering their cost of capital, which means that they can then go after investment grade assets on the bank's balance sheets.
And so that's subplot.
I mean, I think now of the top ten firms on my numbers, about forty percent of the assets come from insurers. They become much more relevant to compete for the investment grade pieces on the banks. And I think that's what you know, whether it's the Barclays deal with Blackstone, whether it's oak Tree with the SoC Gen, whether it's City with Apollo. In a way, the private credit is able to nibble away at more assets than they could in the past.
I'm going to back up and ask the dumb question. I'm like, oh, I think maybe listeners are a lot of clarification, but it's actually just me. What's the difference between leverage lending and direct lending?
Again?
Oh, look, the this is one of these where the MAENDC clature is pretty poor. Okay, I mean it's really poor, and it's pretty blurry. I think the way they think most of them would think about its direct lending is I'm lending to a mid market company, you know, thirty million dollars to one hundred million dollars, the kind of a mid market finance, whereas lever lending is going to be acquisition related finance.
But okay, got it? Yeah, yeah, Joe, it's a it's a it's a blurry fandomic.
No, the acquisition related finance. That makes a lot of sense to me.
So I'm going to go back to that conversation point and ask, Okay, so you know, a bank approaches a private credit lender, or a private credit lender approaches a bank and says, hey, we need to do something in this environment. You know, there's a lot of demand. I've got a bunch of insurance companies that are interested whatever, how do they go about identifying what exactly they're going to do and which particular assets are loans might be realistic for this kind of partnership.
Oh, it's a that's a great question, Tracy. So and it cuts look some of these relations These firms are being counterparts of the banks for many years, so there's a degree of relationship, even if maybe historically being a little bit antagonistic, and certainly one of the leaving product credit firms you know, has a swear box for every time they talk about a counterpart rather than a partner these days, how.
Much do you have to put in? Is it like five thousand bucks or five dollars?
Well, it probably should be five thousand, but I think it's actually got it's the charity. It's a charity pot. And so if we think about those deals, half have been around asset back lending and half around the you know, the overflow, the leverage finance or the more levered stuff. So I think that what the private credit companies are doing is very shrewdly going through that. They're almost doing
like my old job being a banks on list. They're looking at a bank and saying where is capital constrained at the end of the day, particularly in Europe, but even in the state and even particularly think about US regional banks or some of the European banks. They've become optimizers. They're optimizing for a cost efficiency, capital efficiency and revenues. And in that mindset of optimization, they're always looking to
try and lay off risk. And so the private credit company often says, well, look, I see your capital constrained.
You need to grow.
An example would be let's say Blackstone with Barclays, they want to grow their credit card business, but you know, but equally want to keep lots of money in there in their vestment bank. By partnering up, they can now fuel the growth of the credit card business in a way they couldn't do before, or did at least didn't believe they could before. So I think this is, you know,
in a very constrained world. In fact, I was an event last week with a bunch of investors and private credit firms, and one of the investors said, well, look, there is not enough capital for any bank to put capital behind an acronym. You know that that's just space is gone. You need to find partners and so I
think they're forensic. They're hiring people to do bank's analysts for them, and then I look in to try and create a solution because I said, the top ten firms feel their origination constraint and so they need the access to more assets.
So in a situation like a credit card deal, what the bank wants and the bank still has, and the bank will probably still have, is that brand, that relationship, that retail distribution network and so forth, and then the private credit entity just allows them to keep growing these lines and that they're presumably other lines without impairing their balance sheet.
Exactly.
It's about optimizing the castle as well, because you know it's at the end of the day, if you take off the riskiest piece, will take off the entire slice. Then you can just grow much faster.
That's very helpful. Can you go further in talking about the role of insurance and all this, because one of the things that I still find actually completely strange is that we have these gigantic financial entities called insurance companies their bad meth and they're important all kinds of areas, and no one ever talks about insurance companies Either's like that you don't really see them in the media the same way you see banks.
It's very stress that and accounting. Yea, like the two missing like major ingredients of financial.
Financial of the financial ecosystem that seemed to like punch and maybe they like it and punch it like you know, ten percent of their weight in terms of our understanding of their role. But talk a little bit more about their role of insurance capital on a.
This Oh, this is a great plot. And actually it's very different in Europe versus the US. But let's say, if you go back to Tracy point, the railways were funded mostly by insurance companies. I mean large, large capital projects were mostly funded by the insurers. So because they had long dated funding and you still had wildcat you know runs in the States as you as you may
not remember, but I was there. So so thet you know, everyone's looked at Apollo and their arrangement with a theme and seeing that they've created a very they've got a very stable source of funding through their annuity business, much like you know you might have seen through the last actually before even before the financial crisis, hedge funds wanted permanent capital vehicles, right, everyone wants ee wants to be aligned to long data capital, and so I think, you know,
most of the top ten now have an insurance business. So I mean I was just you know, I listened to the Blackstone call yesterday, two one hundred and twenty one billion other assets and now from insurers out of four hundred and thirty two, so over half of their credit assets come from insurers. Now, obviously that's great because these are investors with long duration liabilities who need long
dated assets. So they're the right kind of people to fund data centers, infrastructure assets, you know, the long dated and stuff we need to fund our growth. But the interesting thing for private credit is, rather than having to go for i know, ten to thirteen percent return, if they can just simply get one hundred to two hundred basis points more than the insurer could have got through
the public markets, there actually quits in. And so certainly the expectation for the CIOs of insurers I speak to is if they can get one hundred and fifty one hundred and seventy five basis points pick up on a single a bond by buying a private bond rather the public bond, if you compound that over ten years, that's huge for the insurance sector. And so as I said, I think about forty percent of the ass sets now
of the majors come from insurance. I think for the industry as always between near thirty and so that's fueling the growth and it's changing the nature of where private credit can invest.
By the way, Tracy, I didn't know that insurance companies funded the railways, but I will say early on in my career I do remember, and I sort of pat myself on the back for this, I do remember having the realization that sort of like clicked how similar banks and insurance companies are. Because with the bank, you know, you make a deposit of one thousand dollars and over the lifetime the bank will probably give you back your one thousand dollars in the form of you take it out.
Insurance companies basically the same. You buy a collect premium and you get the you know on no but like on average right for the industry, they pay out roughly what they get in and they hope to like make it on the float kind of. And so in the end, like the models, in the ideal sense, it's just a matter of timing of when the cash goat comes back.
Out but in aggregate, right, aggregate, but not my individual experience.
Some people get screwed and some people get way more than they put in and then on average anyway, Yeah, sort it sort of clicked to me one time in my own.
There's there's a lot of overlap here, for sure. Okay, So I want to go back to the financial risk slash regulation points. So we've established a number of times that to some extent, this is exactly what regulators wanted to see happen. But I think there's always a concern that maybe this will come back to bite them and the overall financial system in some unexpected way, and that maybe there are avenues that some of this risk is still entangled with the banking system, especially as we see
these new partnerships develop. What are the avenues for private credit risk to I guess, re enter the banking system and potentially cause problems.
Look, I think it's a great question. I think I've had almost every regulator post this question. This is this is one of the very hot buttons for the issue for them. So look, my take is that for sector which is very low on leverage, doesn't have the big asset liability mismatches is not systemically interconnected, and to be honest, is still relatively small, less than three trillion. It's on
the whole, not a source of systemic risk. But the question you gather therefore, well, are there pockets of leverage that we can't see? So, for instance, the Bank of England's got an investigation to think about where is the hidden leverage because obviously having had the LDI problems under trust,
they're worried about hidden leverage. So nav finance is an area which the regulators are pouring over and are getting trying to get the data from firms just to see as their leverage on leverage and the system that may be you know, may trip them up. I think second would be on the whole. If you've got ten plus two, if the funds are ten year in duration, or even even if they're six years and you're lending to five year loans, there isn't a big asset liberty in mismatch.
But to the extent that private credit may potentially be put into retail vehicles or even or even to ETFs, is there going to be an asset liability mismatch. And certainly the more that private credit looks to raise money from retail, the more there's going to be a questions around the structure. And we can come out to that because there's a Cambrian explosion of interest of traditional asset managers and private credit players teaming up to create commingle vehicles.
And then the third though, but tracy to your point, is how do the tentacles overlap. So there is a good piece by liberty streets. So like the Fed in New York that twenty seven percent of bank loans are now too non bank financial institutions, so hedge funds, private credit, you know, a private equity and the like, and it's been growing like a weed. And so they're war and doing you know, you know, at one level they're very happy that firms are laying off.
Risk to private credit.
But they but the question in fact, one of the big central banks is asking the banks to try and tos up every loan to private credit firm, every loan to private credit firm, be in reality they're not making the loan to the firm. They're doing it to the underlying asset. But they won't have a consolidated tape because you know what you don't know, you scares you, And so they're trying to get a much better transparency on this space.
This kind of reminds me of the conversation we had with Mickey Shemy about synthetic risk transfers, where you know, it's sort of the same idea. The bank is like selling off part of the risk of a lone portfolio totally to another entity. And that sounds fine, except sometimes those other entities who tend to be hedge funds or someone like that, are borrowing from banks in order to apply leverage to boost the yield.
You say more about the twenty seven percent, I have to go read the Liberty Street Economics report. But what is from the bank's perspective that specific type of lending? What are the risk characteristics?
What are the.
Capital impairment the capital cost characteristics of this kind of activity?
Well, look, so by the way, I'll send you THEA. I think it's about where do banks end and let and private markets begin? All banks begin is the title, So I think, look, it's very heterogeneous at the moment. So it's hedge funds, and I know that my good friend Tosin Slocke said that's to a new high it's to private equity firms.
So it's all over the place. But so I'm just like what, Sorry.
Jake, my question wasn't particularly sorry. I know, my particular question wasn't particularly cogent.
Here, it was worse.
It's like, no, no, no, it's fine, it's fine. I'm just trying to understand, Like, right, Okay, So banks are optimization vehicles, they're capital optimization vehicles and so forth, and they want to like, they want to do the lending that creates the fewest constraints on the size for regulators and all that stuff. So where does lending to financial institutions fit into this sort of like madetrix of costs and benefits?
Okay, So the way bank REGs work these days is to encourage the banks to do senior or high quality lending and to try and limit the amount of riskier lending, either to try and originate and distribute it very quickly or to lay it off through you know, derivatives of some sort. Yeah, and so let's say it's it's lending to hedge funds. Now, you know, because you've you've spoken out before with archaegos, they got that wrong. But the idea was up until then hedge fund lending. I mean very low risk.
For el So this is kind of what hedge fund lending is considered to be low risk.
Absolutely, although but I think that is changing, like there's more scrutiny of the prime brokerage business.
Yeah, exactly, Well, because they had a fifteen e run with almost no credit losses, and obviously they had good collateral with haircuts and if and this was the big question with the firms who got the wrong way around to our chaegoss was if they got the right haircuts, then there was secured lending. So on the whole, they you know, they could seize the assets and sell them off. What they got wrong was this was such a concentrated
pool and they were all stampeding. So so I think actually the risk here is not so much the belly, it's actually the tail.
So is there a scenario where there's.
A major credit event and that many companies go bust and then that works its way through and that's where the regulators are trying to piece it through. But my take is on the whole, the banks are trying to retranch keep the senior risk and I cheekily put in and the zen pick of the system because this was a wave for them to lay off risk local.
Directory very hard. Well, because in my mind, just sort of very naively, I don't necessarily think of lending to hedge funds is really safe lending, because aren't they taking all kinds of crazy risks and doing all kinds of stuff that may go wrong. But to your point, obviously beyond just the run, the fact that there it's backed by actual assets typically or typically the bank knows what the assets are, I can understand more conceptually why lending
to financial institutions is more frequently perceived as safe. So thank you for that, Joe.
I think we should do a prime brokerage episode of All Lots where all we do is a dramatic reading of the report on credit Swiss and our ke ghost.
Yeah, let's do it.
We just do that, because that was amazing and actually, well actually a really good insight into how it all works, or you know, a bad example of how it should not work. Anyway, Hugh, I'm going to ask a really basic question, but I find, you know, the changing answers to this one always really interesting. But how are banks making money?
Now? Oh? It's that Look, that's that's a really good question. So after fifteen years of zero or negative rates, We've had a wonderful couple of years where spread income, so the spread between the assets liability once again became profitable, and that really hurt the banks. But you know, if the majority of my conversations, both Stateside and Europe and even in Asia, as the banks want to make more fee income, so that could be asset management, could be
private banking, could be originate to distribute. They want to continue to shift more and more of their earnings towards fees and less from just common and garden banking. And that's partly cyclical. As interest rates are being cut now, the anticipation is the kind of the spread is going to be under a little bit of pressure, but you know, as we've seen actually it's continued to be very good.
But it's more and more fees that's where that's really where the banks are focused, and then within the loan income. My sort of take is that the kind of winner takes. Most dynamics we've seen in tech are starting to come to banking. The more of a bank cost base, which is the systems, the cloud data, you know, it's more and more the cost space is tech well quite frankly, it's very scalable, and so what you're starting to see
if you look at the roe. I actually did a piece the other day where I looked at the ros for the banks in every country by the number one player, number two, number three, umber five. The top three players in each market are doing so much better than the tails than they wear a decade ago. And I think it's that winner takes most win, it takes more behavior.
That's really interesting. Actually, let's talk a little bit more about this, because I have also from time to time pull up the chart of JP Morgan and compare it to other banks, and it is it looks kind of like a tech dog. I mean, it's not really quiet as good because it's not a techt Doug, but it sort of seems to exhibit And I wondered about this, this sort of winner take on this of the market
and whether there is a similar dynamic. And I hadn't thought about it quite so literally in terms of the actual tech stack of the bank, and I was wondering if it was more sort of like a network effects. And of course in finance work effects are important just like they are in software. But talk to us a little bit about the dynamics that you think are contributing to this. Winner take on this in any country banking system.
So look, I think obviously there's part of it is the is the tech stack. Of course, you know, if they're trading assets, there's always going to be some network effects. If you can take you know, thirteen fourteen, fifteen percent for market, you just see more, you can price better, you've got better source of flow. So I think in investment banking markets and in sort of wealth markets, there's definitely some network effects, but also just there's scale in origination.
I mean, you just need loan officers, loan processors. I mean it's very typically, it's very manual, and in fact, one of the not for me, but some of our colleagues are doing a lot of work actually using AI to automate loan procedures for banks because that's an area which is very physical, historically been very labor intensive. And actually one of the reasons why private credit is trying to team up with the banks is because they don't have enough people to originate, so they're trying to lean
on someone else's origination STAF. Now, look, but just there's one nuance here for every power, there's an equal and opposite power. So in the States, let's say for regional back for the smallest banks, they're all basically sitting on one of three players like five serv So they're enjoying scale,
but they're just outsourcing it. And then the other thing is, of course, you know the Google's alphabets and as you're within Microsoft are getting a winning handover fist because if you're a MidCap bank, the way you try to capture scale is by outsourcing to one of the superscalers.
I think you anticipated my next question perhaps when you brought up AI. But one thing I often think about the financial sector, so banks and insurance companies, is if AI is Obviously it's about the technology, but it's about the data too. Who has the most data? It's got to be insurers and banks, right, they just have noodles and oodles of it. How excited are banks in particular getting about, you know, the actual data component of their business here?
Well, hopefully Bloomberg's got one of the best data staffs. Well us too.
Oh no, this is so there's a huge amount of automation going on. I mean, look, let's take one step back. The banks need to make sure that their data is organized in a lake or in a way it can be used effectively. And then number two, you need to train. So actually one of the largest banks now has every new graduate doing AI prompt training as part of their core curriculum as they join. So one of my son's flatmates just done eight weeks of AI training. It's extraordinary.
So the way, of course, if the more data you've got, the better. But Tracy, there's some really subtle things in here, because the regulators want to know how you made the decisions right, and is the a optimizing just on past experience or is it right?
This is the black box alg point, right, where like if you have all this data going into a black box and algorithm and it's spitting out an answer, you actually have to know whether that answer is valid, like whether it might violate regulations on biased lending based on like racial or age characteristics or gender or something like that.
Absolutely, and so there's all sorts of bites. So at the moment, most of it is for co piloting, but you know, some of the use cases, Tracy, are fascinating. It's like one of the big banks I was talking with, they're actually using AI now in the right sharp departments to just basically automate and a thing. If they want to fask someone, they just they click a big thing less and then try and work it out.
Oh wow, dystopia is here.
Yeah, it really is. There's some great articles, by the way, done by Bloomberg, not related to banks or anything, but like on the sort of like Amazon auto hiring and firing, and just this idea of all that being the assumption of liquid labor markets and the you know, it's okay to make mistakes if there's just an endless supply of people who want to work at your company. Anyway, that's its own digression, you know, just on this point. So obviously, okay,
the big banks have their gigantic text ex. I had a conversation recently with someone who worked for a very small bank. Actually it was just like someone over coffee and I'm curious and so it's like kind of like doing an odd lots except over coffee with no microphone, like how it all works and how a region or
a small local bank actually has a business. And it was really striking in the conversation how many of the specific things that came up were literally about third party modeling or software packages and stuff like that, and how much the sort of all kinds of risk management, et cetera. It was really a job of plugging their numbers in
to various packages that they buy. And I have to imagine that the companies that sell these modeling services or software services or data services to any of the banks that aren't like JP Morgan and a few others must be making a mint.
Oh absolutely, Look, I mean that's not my area. No, But just in the same way, the MSCI has made an absolute fortune by being the day you know, the premier data company for markets.
See.
One way to frame it is in this of fifteen years post financial crisis, the banks you know, in many at least certainly for the first seven or eight, which is focused on capital repair, improving process, improving risk management, that the amount of discretionary that they had to invest in new textacs was really quite low, and so a lot of the innovation was happening outside banks and being
sold back in. Now, as you say, look from maybe twenty sixteen onwards, the US banks got back on the front foot, and the leading ones are investing disproportionately in tech and their own solutions but there's an enormous amount which is brought in and again that's sort of that's why if you go back to private credit, one of the areas they hope is is that they certainly the leading firms are also investing in tech stacks because they
want to make sure they have an information edge. And so also you're starting to see, i want to say, hollowing out of the middle in private credit. But definitely the larger firms are investing very significantly in treasury management data and underlike.
By the way, Tracy, check out look over a chart of five five serves duck, which does a bunch of various payment things for smaller and credit union banks and stuff like that, and check out the Oh geez, yeah, check out their stuck I just pulled it up.
I have to compare it to in video.
Yeah right, I know it looks like it hasn't it. It's probably well anyway.
Yeah, that's amazing. Why don't we get back to private credit. We're in danger of just making this an AI episode. But Hugh, you know, we've seen growth in private credit, although to your point, it's still relatively small, so you know, it's coming up from a low base. We've seen more partnerships between banks and private credit entities. What's next in terms of this dynamic? What are you watching out for as the next big thing?
So for me, private credit's next act is around asset back lending and secondly commercial real estate, and I think they're the two big asset classes which the private credit firms are really trying to either gain origination or do partnerships or get into and just go back to it. So, if specialty finances are five and a half trillion market,
private credit has about a five point share. If you then include consumer mortgages and commercial real estate, it gets to about twenty five trillion in the States, of which private credit has probably about a two percent share. So this is an area where they are really trying to say, with insurance led assets, with also some of the assets for the wealthy. This is where they're really gunning for
it now. At the moment, commercial real estate is probably less picked over because the areas where the banks are shedding is more the distressed or stressed, particularly if it's a US regional bank. But the asset back lending piece is they're going absolutely gung ho, and that's the area which I think is probably one of the most interesting areas to spend time on. And then the second bit trace is that's obviously on origination on the where they're
getting the assets from. As we've spoken about many times before, Let's be honest, the endowments and pension funds are still a lot of bit of have got a bit of indigestion to private equity and venture capital. Now that indigestion's passing, but most endowments I speak to still say they're abroout five points over allocated to VC. Would love to put that to private credit, but they just don't want to do more I liquid assets today. So the private credit
firms are doing three things. Going international, so going to the Middle East in particular, where there is just a ton of new money, and actually that those clients really like fixed income. They're going to insurers, and I still think there's a good runway to raise money from insurers we could discuss. And third and finally, it's the wealthy. And I think at the moment there's a little bit of misnomer. When they say wealthy, they mean seriously wealthy.
I mean they talk about you know, family offices, people with fifty million dollars plus there's about a nine trillion
dollar market of family offices globally. That's their sweet spot, but they're going to look increasingly towards the decently wealthy, and I think their product innovation around, you know, whether it's Capital International with KKR, where it's Black Crop with Partners Group, whether it's Apollo with State Street Global, there's some really interesting innovation about how you slice up private credit to some of like affluent clients, and that's something again, you could do a whole episode.
On Tracy we've never done. I don't think a family office episode. No, we should.
Yeah, we should go to Singapore, Yeah and do it from there. Yes, because I want to go back to Asia. Okay, Well, Hugh, thank you so much for coming back on this show. It was lovely to catch up with you as always, and you walked us through that perfectly. So thank you so much.
Thanks for having me.
Thanks you. That was fantastic.
Joe, that was great. I love catching up with you again. Like I've known him for a long time and he's always had really interesting thoughts on the financial sector and a great way of kind of explaining them. I do think his idea of retranching of risk in the financial system is definitely like the way to think about what's happening.
It seems like, in some respects seeing more and more specialization in the system where maybe it used to be, you know, back in nineteen seventy when bank lending was at its height, the bank would do all sorts of things right, But now it kind of breaks up all those different businesses into different pieces and has different partners for each one of those.
No, I think that makes a lot of sense. Look, I would still say, and you know famous last words that someone will make fun of me, but I would still say that by and large, I am of the view that the post grade financial crisis evolution of the financial system has probably been a net good in terms of overall financial stability risk. That to your point about the tranching, that the financial system has gotten better about putting the right form of risk in the right hands.
There's never total delinkage or anything. But even hearing them explain why financial lending to financial institutions is a safer form of lending that is really helpful, and so why that's grown like why you know, this emergence of his specific mid market type lending and the right entities for that.
I don't know.
I'm still of the view that probably things are better.
It's one of those things where there could always be something that we're missing, yeah, of course, right, and that regulators are missing. I do think at the moment we seem to be in a sweet spot where a lot of this is happening. So risk is getting divided up and you know, distributed differently in the financial system to where it was in two thousand and eight. But it's still relatively small, like he was saying, despite all those headlines about private credit, like, we're still talking about a
relatively small market. It could be that as it gets bigger and bigger, it becomes more problematic in various ways.
But the other thing that I think is interesting about private credit, and I think we've talked about it a couple of times at this point, is the idea that it kind of has acted as an additional cushion of financing during the past couple of years where we had really high rates and banks were still relatively capital constrained, so you could still get a lot of you know, middle market businesses have this addition layer of financing or funding that they could still tap even if the banks
weren't necessarily doing it.
The winner take all in this of banks.
Oh yeah, really interesting.
I think it's one of those things that you can see and you can look at the comparison of large caps for small caps or whatever, or JP Morgan versus literally everyone else in you guys. But it is like still sort of a little bit under discussed and underdiscussed why And I get the point about the tech stack, and I get the point about you know, capital markets. There's a natural network effects, but it's still interesting. We live in this network effects world and in almost any
industry this seems to be a phenomenon. And why that is across so many different areas where you have a number of companies in any industry that look like tech stocks is an interesting under discussed phenomenon.
Joe's theory of network effect.
You know what I said, all companies are banks except banks. Banks are media company.
That's perfect. Yeah, I love that. Okay, let's leave it there on a high note. Yeah, all right, this has been another episode the Authoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway, and.
I'm Joe Wisenthal. You can follow me at the Stalwart, follow our guest Hugh von steinas He's at Hugh Steinas, Follow our producers Carmen Rodriguez at Carman Ermann Dashel Bennett at dashbod In Kelbrooks at Keilbrooks. And thank you to our producer Moses Ondam and from our Oddlots content. Go to Bloomberg dot com slash odd lots, where you have transcripts, a blog and a daily newsletter and you can chat about all of these topics twenty four to seven in our discord Discord dot gg slash od loots.
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