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Markets


JPMORGAN’S TRADES THREATEN TO TAKE PRIVACY OUT OF PRIVATE CREDIT

 * Biggest US bank made a couple of billion in secondary trades
 * Market divided over trading of debt; some see distress ahead

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The JPMorgan Chase & Co. headquarters in New York.

Photographer: Michael Nagle/Bloomberg
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By Hannah Levitt and Laura Benitez
February 2, 2024 at 12:30 PM GMT+1
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JPMorgan Chase & Co. is making the titans of private credit markets very
anxious.

The biggest US bank’s foray into trading private credit loans — an as yet
largely untapped corner of the $1.7 trillion market — threatens to lift the veil
on a world where a key selling point has been privacy of information about the
debt.

Some of private credit’s biggest lenders argue such trading would undermine this
advantage by forcing them to constantly value the assets on a marked-to-market
basis, rather than at their discretion, inviting volatility. On the other side
are smaller fund managers and investors in these loans who want more access to
the debt and the ability to swiftly exit the assets trading would bring.

That existential debate may be a moot point. If, as some market participants
expect, interest rates don’t fall as quickly as predicted — crushing borrowers
in the process — private loan valuations could tumble. That will unleash a wave
of distressed debt bargains, making trading the assets on a secondary market
like bonds a near certainty. And JPMorgan plans to be ready.



“As the market grows, it becomes inevitable,” Troy Rohrbaugh, the freshly
promoted co-head of JPMorgan’s commercial and investment bank, said in an
interview. “If you believe private credit will continue to grow and compete
side-by-side with public debt markets, it can’t continue forever as-is.
Transparency will increase over time.”

Read More: JPMorgan, Goldman Plan to Start Trading Private Credit Loans


BILLIONS TRADED

JPMorgan has already facilitated a couple of billion dollars worth of private
trades after singling-out market making as one prong in its private credit
strategy. While that’s a drop in the ocean for the lender — the volume it has
traded is less than the direct loans it holds on its own balance sheet — it’s
planning to expand as it steadily builds up an inventory of the loans.

Like its rivals, JPMorgan is fighting to stay competitive as private lending
titans like Ares Management Corp., Apollo Global Management Inc. and Oaktree
Capital Management increasingly swallow up ever larger deals. The business of
trading, which locks in lucrative fees while swiftly shifting the risk off the
banks’ books, has so far been a largely untapped portion of the market.

Read More: JPMorgan Is Said to Seek Out Partner for Private Credit Push

In a bid to stake their claim in an industry that threatens to upend their core
lending businesses, major banks have been racing into other parts of the
ballooning private credit complex. JPMorgan has earmarked at least $10 billion
of its own balance sheet for direct lending, and is also working on forming a
partnership. Barclays Plc has also allocated its own cash, while Societe
Generale SA and Wells Fargo & Co. have launched partnerships.

JPMorgan appointed Jake Pollack, a 20-year veteran of the firm, to oversee its
private credit efforts alongside debt capital markets boss Kevin Foley. It cuts
across multiple divisions of the bank and includes financing, securitization and
also any trading, which is ultimately done through the bank’s broader
loan-trading desk. Longtime Chief Executive Officer Jamie Dimon and markets
co-head Jason Sippel have also been involved in the overall strategy.


PRICE DISCOVERY

Fund managers have capitalized on private strategies they say shield them from
the volatility of mark-to-market losses in public markets, because portfolios
are often marked quarterly. Live price discovery could force firms to mark down
values during periods of financial stress, increasing volatility.



Read More: How Private Credit Gives Banks a Run for Their Money



Unlike the public bond markets though, traders are not expected to blast pricing
into the market widely, at least at the beginning, according to industry
participants. Traders like those at JPMorgan have in some cases kept pricing off
the screens to appease clients’ concerns about volatility that live pricing
could create for the same or similar assets, according to people familiar with
the matter.

This may change, if previous examples in leveraged finance markets are anything
to go by. In 2022, banks were unable to sell billions of buyout debt they
underwrote for clients during more favorable market conditions, so they
eventually sold the deals directly at large discounts to a handful of funds in
private transactions.

The funds that bought some of those loans, including those backing the buyouts
of UK supermarket Morrisons and payment processor Worldline SA, have since
started to offload their positions, and some of that debt is now actively traded
by banks with price runs regularly being sent out to the market, according to
market participants and price runs seen by Bloomberg.


‘WHITE LISTS’

Trading these loans freely has some obstacles. Fund managers, much like in
leveraged loan markets, can often restrict who can own the debt, primarily to
prevent it from falling into hands of aggressive distressed-debt funds who may
try to take over the companies. They do this through so-called “white lists”
where managers draw up lists of who can buy the debt, and who’s restricted from
doing so.

But as the number of direct lenders in each deal grows, so too do the white
lists, paving the way for debt to change hands — even if just within the
original group of lenders. In December, for example, 19 funds participated in a
record €4.5 billion loan ($4.9 billion) to back the buyout of Adevinta ASA,
mimicking traditional leveraged loan and bond deals that are distributed to a
larger and wider range of investors.



In Europe and the UK, white lists are included in approximately 90% of deals,
according to Jim MacHale, a partner in Clifford Chance’s banking and finance
practice. It’s also becoming common to exclude competitors and loan-to-own or
distressed investors, he said.

However, restrictions on transfers to distressed investors are often lifted when
the loan has defaulted, or in acceleration scenarios where investors demand a
full repayment, MacHale said. That leaves an opening for trading activity should
the market start to see an uptick in defaults.

“Generally, bets are off once there are certain covenant breaches,” said
Gianluca Lorenzon, head of fund finance advisory at Validus Risk Management.
“Debt can then be sold on to most funds. We’ve actually seen some trading happen
very quietly for a while now.”


SOURING LOANS

Some credit hedge funds as well as the $1.86 trillion asset manager Pacific
Investment Management Co. are already poised to pounce on souring loan prices as
soon as signs of distress begin to grow.

Read More: Pimco Squares Up for a Bareknuckle Fight in Private Credit

Mark Attanasio, co-founder of Crescent Capital Group, called trading “good for
the market” in a December interview — rare praise from direct lenders. The rush
into the space boosts liquidity, allowing existing players the option to sell
assets, he added.

Market participants got a glimpse into what a world with more private-credit
trading might look like in late 2022 — so far, the high water mark for trading
demand, according to JPMorgan’s Pollack. At that time, nearly a year into the
Federal Reserve’s rate-hiking campaign, capital had dried up and a recession was
widely expected.

“Fundraising was tougher and there was a desire to do so via selling existing
assets,” Pollack said. Since then, more asset managers have entered the space,
and they’re sitting on enough dry powder that trading demand is muted. In the
meantime, JPMorgan is laying the groundwork.



“We want to build up enough internal inventory where we like it when it doesn’t
trade but have inventory when it does,” Pollack said. “It’s building the market
and being ready to trade.”


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