Asset management giant BlackRock has revised its investment strategy in the face of mounting recessionary fears and continued tumult in the US banking sector.
The firm has revealed it would increase its exposure to private credit as the outlook for public credit shifts amid expectations of a looming credit crunch.
“The banking tumult has reshaped opportunities for income — we now favour private over public credit on a strategic horizon of five years and longer,” BlackRock noted.
“We think private credit could help fill a void left by banks pulling back on some lending and offer potentially attractive yields to investors.”
The global investment giant pointed to an increase in yields across direct lending, which could “compensate investors” for market risks in the near to medium term.
“US high yield and investment grade (IG) credit yields have faded from highs, but we think they will rise eventually,” BlackRock added.
“We go overweight private credit as a result and move to neutral on global IG. Private markets overall are complex, with high risk and volatility, and aren’t suitable for all investors.”
According to BlackRock, volatility in the banking sector could pave the way for a “boom” in the private lending space as non-banks look to capture orphaned borrowers.
“We think the rising interest rate environment and increased competition for deposits will put pressure on banks — and cause them to pull back some lending,” the firm noted.
“We see this making room for non-bank lending and private credit to play a greater role.”
But underpinning BlackRock’s pivot to private credit would be a careful examination of deal terms to ensure prospective investments support “quality borrowers”.
“We have had a conservative view on our assumptions about private credit default losses in our strategic views for some time because private credit is not immune to the credit risk from an economic downturn,” BlackRock observed.
“Yet even after allowing for these more prudent assumptions that would be a drag on returns, the wider set of opportunities for private lenders in the wake of the banking fallout, coupled with the divergence between private and public credit yields is enough to spur an upgrade.”
BlackRock’s repositioning comes just days after Federal Reserve chair Jerome Powell hinted at a pause to the monetary policy tightening cycle in lieu of tighter credit conditions.
On Friday, he told an audience at a conference in Washington that the Fed may need more time to assess the “lagged effects” of 500 bps in tightening in just over a year.
“…Our guidance is limited to identifying the factors we’ll be monitoring as we assess the extent to which additional policy firming may be appropriate to return inflation to 2 per cent.
“The risks of doing too much or doing too little are becoming more balanced and our policy adjusted to reflect that.”
Tighter credit conditions have merged off the back of three banking collapses in the United States, with Silicon Valley Bank, Signature Bank, and most recently, First Republic Bank caving under the pressure of aggressive interest rate rises.
Higher interest rates exposed vulnerabilities in the regional banks’ liquidity management, which undermined confidence among depositors and investors.
First Republic Bank — the latest to fall — was seized by US regulators, with the Federal Deposit Insurance Corporation (FDIC) ultimately accepting a takeover offer from banking juggernaut JPMorgan Chase.
JPMorgan is set to assume full ownership of First Republic’s deposits, assets, and bank branches (84 branches located in eight US states).
This includes:
- approximately US$173 billion (AU$260.5 billion) of loans;
- approximately US$30 billion (AU$45 billion) of securities;
- approximately US$92 billion (AU$138.5 billion) of deposits, including US$30 billion (AU$45 billion) of large bank deposits, which will be repaid post-close or eliminated in consolidation.
In a recent presentation to investors, JPMorgan revealed the acquisition would increase the bank’s expenses by approximately US$3.5 billion (AU$5.2 billion).
