Twice a year, Oliver Wyman vice chair Huw van Steenis produces a presentation for clients exploring major strategic and investor trends in finance. This particular installment, based on a speech he gave at a recent investor conference, delves into private credit’s next act — and the implications for banks and traditional asset managers. Here, some highlights from the presentation (you can download the full presentation below):

A new era of growth — private credit 2.0

The private credit sector is set for significant growth, especially in asset-based lending, as it adapts to shifting investment allocations.

Speciality finance lending looks to be a promising new seam for private credit companies to mine. The market, worth $5.5 trillion in the United States alone based on our estimates, includes equipment leases, trade finance, and royalty agreements. The attraction: greater diversification, as well as the specialist skills required to understand these money flows. Private credit currently has less than 5% of these types of loans.

Bank-private credit partnerships are a new source of growth

Already 14 major banks have formed partnerships with private credit firms to distribute their loans in the past year — up from two the year before, according to our estimates. Banks around the world are under pressure from a range of new regulations such as new capital requirements, driving another wave of disintermediation. 

Now they are slicing up risk in the banking system and re-distributing it: They parcel out the riskiest portions of debt to private credit funds, retaining less risky parts themselves. As new bank rules become clearer, teams will adjust. The flurry of partnerships and risk-transfer deals in recent months is likely to accelerate.

The next wave of disintermediation of banks by markets is afoot

The shift of lending away from banks has a long history. Astonishingly, bank lending as a share of total borrowing has been falling for 50 years. The 1973-74 inflation and interest rate shock created more profound disintermediation from banks than the rise of private credit today, as investment-grade companies switched to borrowing from the market via commercial paper and bonds. 

The rise of high-yield bonds in the 1980s was another large wave, as were the various advances in securitization, each enabling more borrowers to bypass banks. And since 2008, mid-market corporates and mortgage borrowing have increasingly moved away from banks. In all, banks’ share of private lending in the US economy has fallen from 60% in 1970 to 35% last year, according to a new National Bureau of Economic Research paper. 

The barbell effect is coming to bond markets

The “barbell” long associated with equity investing is now playing out in the bond markets in earnest. This shift underscores just how much the market structure of finance is changing. Investor flows are polarizing between low-cost passive funds and specialized alternative asset managers. Investors have poured nearly $190 billion into US fixed-income exchange-traded funds this year to August, according to Morningstar, 50% more than this time last year. Last month Ares raised the largest private credit fund in history, at $34 billion.

The top six listed alternative players experienced a whopping 21% net new flows into their credit strategies in the year to June 2024, compared with just 1% for all traditional firms, according to Oliver Wyman estimates.

The barbell that has already tolled for equities is now coming in earnest for fixed income: Two-thirds of the market capitalization of listed asset managers are now represented by the value of alternative firms, up from 4% in 2010.

Cambrian explosion in new hybrid fixed-income funds

The pressure is also prompting a Cambrian explosion of innovation in new fixed-income products. The tie up between KKR and Capital Group to create one of the first public-private fixed-income funds, and the partnership between BlackRock and Partners Group to create blended private markets portfolios, are critical to watch. Another is the intriguing agreement between Apollo and State Street Global Investors to create a hybrid ETF fund to invest in both public and private credit. These mark significant bets on the mainstreaming of private credit.