May 2024

2024 Credit
Market Outlook
̒Never Let Me Go’: Competition
and Opportunity in the Era ofBank Disintermediation

EXECUTIVE SUMMARY

Markets rebounded sharply following the November and December 2023 Fed meetings, as therisk of recession receded and rate cuts came into view. Loan and bond issuance set records
through the first two months of the year, with credit spreads at their tightest levels since theonset of the pandemic.
Much of this activity involved bank-arranged refinancing of loans originated during the period
when private credit’s market share increased substantially relative to broadly syndicatedloans. Bank disintermediation continues to gather pace, but new competitive fault lines haveemerged. It is one thing to disintermediate loans from bank balance sheets. It’s quite another todisintermediate the banks themselves from their most prized clients and customers.
As bank balance sheets become more constrained due to regulation and other factors, theirlending decisions will become even more sensitized to relationship considerations, especiallyfor large banks who derive a disproportionate share of their operating earnings fromnoninterest income. While this may constrain the growth (or expected returns) of direct lenders
competing directly with banks for larger borrowers, it should create more opportunities virtually
everywhere else, as private funds partner with banks to assume more of their assets in someareas and displace them entirely in many others.

2Market narratives can be fickle things. A year ago, as theThis has, in turn, led to a reconsideration of credit market

Fed was taking base rates to levels that were unimaginable

narratives. A year ago, we warned of the “triumphalism”

just two years’ prior (Figure 1), market participants preparedthat characterized discussions of private credit’s

for the recession most analysts thought was necessary todisplacement of more traditional forms of finance. Banks

extirpate price pressures from the system. It was further

have not only returned to the market in force in 2024, but

assumed that once inflation returned to target, the Fedmuch of their activity has been concentrated on refinancing

would swiftly take base rates back down to more “normal”

borrowers out of the more expensive loans originatedlevels, leaving longer-term discount rates largely unaffected.

during the period when private credit was “the only game

These broadly shared expectations produced a plunge inin town.” A recalibration of expectations seems in order.

M&A activity and defensive market positioning, as investors
awaited signs of the inevitable downturn and aggressive

Bank disintermediation continues to gather pace, but new

rate cuts that would soon follow.

competitive fault lines have emerged. It is one thing todisintermediate loans from bank balance sheets. It’s quite

The economy proved more resilient than expected. U.S. GDP

another to disintermediate the banks themselves from their

growth accelerated in the period following the Fed’s last rate

most prized clients and customers. As more credit market

hike, even as inflation waned. The new narrative, born in theassets inevitably gravitate from banks to private portfolios,

wake of the November 2023 FOMC meeting, was that the risk

expect banks to mount a more vigorous defense of theof recession had dropped materially but the expected rate

smaller, but more lucrative, remaining territories; willing to

cuts would arrive just the same (Figure 2, page 4). This set

cede assets but not the relationships responsible for their

the stage for a remarkable rally in asset prices and market

most important income streams.

liquidity conditions.

Figure 1.
Markets Priced 5.3% Base Rates as a 1-in-1 Million Event

Figure 1. Source: Carlyle Analysis of Federal Reserve Data, Bloomberg, November 2023. There is no guarantee any trends will continue.

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Figure 2.
Simultaneous Drop in Recession Probabilities & Forward Interest Rates

A MARKET LOOKING MORE LIKE 2021
THAN 2022-23

large-cap tech stocks. Bitcoin has nearly doubled. Memecoins are back in vogue. And credit markets have been red
hot, with spreads at the tightest levels since the onset of

The proximate spark for the recent rally in asset prices was

the pandemic and bond and loan issuance at record levels

the strongly hinted conclusion to the Fed’s tightening cycle

through the first two months of the year (Figure 4, page 5).

in November 2023, followed by the promise of rate cuts thefollowing month. These announcements were premised on

Refinancing has been the main driver of 2024 issuance,

a rate of disinflation (at that time) that would have returned

accounting for more than 64% of leveraged loans and 88% ofcore inflation to the Fed’s target by June 2024. Since then,high-yield bonds (M&A accounted for a trivial share of year-

the monthly rate of disinflation has more than halved, whichto-date issuance, though one suspects that’s likely to change

would push the return of “price stability” out to the middle

meaningfully in the months ahead; Figure 5, page 6). Andof next year. Futures markets have dialed back rate cut

a non-trivial share of that refinancing involves borrowers

expectations, from nearly seven at the start of the year toopportunistically swapping out private credit in favor ofjust three now (Figure 3, page 5).

cheaper syndicated loans. On average, private lenders
charged 650 basis points over SOFR for loans extended

This retracement has done little to dent investor enthusiasm.

in 2022 and 2023 (Figure 6, page 6). With markets wide

The stock market is up by more than 25% since the Fed

open and spreads on bank-arranged first lien term loans

signaled base rates had peaked. And, unlike prior rallies,

averaging less 400bps, it’s no surprise to see borrowers takeparticipation has been broad-based, with the 25% gain in

advantage, even in cases that involve a 1% or 2% prepayment

the small cap Russell 2000 nearly matching the 30% rise infee (“call protection”).1

Figure 2. Source: Carlyle Analysis; FRBP Survey of Professional Forecasters, March 2024; ICE BAML Indices, Bloomberg, March 2024. There is no guarantee any trends will continue.
1. Pitchbook, Weekly Market Wrap, March 2024.

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Figure 3.
Stickier Inflation Delays Return to Fed Target

Figure 4.
Declining Risk Premia, Booming Issuance

Figure 3. Source: Carlyle Analysis; Bloomberg, March 2024. There is no guarantee any trends will continue.
Figure 4. Source: Carlyle Analysis; Federal Reserve Board of Governors; Bloomberg, March 2024. There is no guarantee any trends will continue.

5Figure 5.
Refinancing Main Driver of Issuance

Figure 6.
Differences in Credit Spreads & Lending Activity

Figure 5. Source: Carlyle Analysis; BAML Credit Market Chartbook, March 2024. There is no guarantee any trends will continue.
Figure 6. Source: Carlyle Analysis; “The U.S. Syndicated Term Loan Market: Who holds what and when?” Fed Notes, November 2019; Pitchbook, LCD Database, March 2024. There is no guarantee
any trends will continue.

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DOES THIS MEAN BANK DISINTERMEDIATIONWAS OVERHYPED?

atrophy.3 Over the years, pressures have mounted on bothsides of banks’ balance sheet. Funds have become harder toattain – the share of household savings channeled into bank

We warned a year ago that banks had “willingly ceded

deposits has dropped by half – and more difficult to deploy,ground,” understandably uneasy about the economy,

as new instruments and lenders emerged to offer credit oninterest rates, warehousing risk, and increased regulatory

terms more tailored to borrowers’ needs. At the end of 2023,

scrutiny.2 Prodigious as private credit’s growth has been, itbanks accounted for roughly one-third of the credit owed bystill amounts to just one-third of the credit market (Figure 7),

the U.S. corporate sector, and that share will almost certainly

insufficient in itself to meet M&A finance needs or broader

shrink in the years ahead (Figure 8, page 8).

corporate loan demand. Banks were always coming backat some point because of their central role as conduits to

The fissure cast in greater relief by private credit’s dominancebroader capital markets, and their return has certainly been

in 2022-23 was not between banks and loans, but between

welcomed by borrowers.

banks and their customers. Direct lenders disintermediatebanks to an extent not observed in the case of investment

The recent shift in market realities serves more as

funds that merely purchase loans or come into newa clarification rather than refutation of the “bankcommitments alongside banks; they not only deprive banks

disintermediation” thesis. The traditional banking businessof assets and the associated yields, but also the underwriting– taking deposits from savers to extend loans to households

fees and client relationships that allow banks to cross-selland businesses – peaked in the mid-1970s and continues toother services for which much of their income depends.

Figure 7.
Credit Market Size by Instrument

Figure 7. Source: Carlyle Analysis; BAML Credit Market Chartbook, March 2024; “Private Credit: Characteristics and Risks,” Fed Notes, February 2024. There is no guarantee any trends will continue.
2. Thomas, J and M. Jenkins (2023), “New Landscapes, New Eyes,” Carlyle, April 2023. https://www.carlyle.com/sites/default/files/2023-04/Carlyle-JT-2023-Credit-Whitepaper.pdf
3. FDIC (2019), Quarterly Banking Profile, Q3-2019. Pgs 31-50.

7Figure 8.
Banks’ Declining Role in Credit Intermediation

LEVERAGED LENDING AS “METERED”
DISINTERMEDIATION

Collateralized Loan Obligations (CLOs), which today serveas the ultimate home for about 70% of leveraged loans. The
ability to distribute loans is key to their origination; CLO

Leverage lending perhaps best clarifies this asset-clientissuance explains over 80% of the variation in leveraged loan

distinction. Originally conceived to allow one bank toorigination volumes over the past six years (Figure 9, page 9).

offload credit risk onto others, syndicated lending becamea mechanism for the banking sector as a whole to offload

In other words, leveraged lending still represents

credit risk onto nonbanks. In 2000, banks accounted fordisintermediation – the term loans end up on nonbank

about 20% of the primary purchases of leveraged term

balance sheets – but it’s of a sort that allows banks toloans. By the onset of the pandemic, that figure hadgarner underwriting fees, receipts from loan sales, anddropped to 3%.

strengthen relationships with borrowers in ways that can

4lead to other value-added services, like interest rate andOn average, the agent bank responsible for arranging

foreign exchange hedging, fiduciary and deposit services,committed credit for its client sells down its share of the termtransaction fees, loan sales, and other sources of noninterest

loan balance from 28% at the time of origination to just 1%

income that waned markedly during the time of private

three months later. Most of the loan ends up in the hands ofcredit’s ascendence (Figure 10, page 9).

Figure 8. Source: Carlyle Analysis; Federal Reserve Board of Governors. There is no guarantee any trends will continue.
4. FDIC (2019). P. 35.

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Figure 9.
Banks Serve as Market Conduits

Figure 10.
Recent Trends in Banks’ Operating Income

Figure 9. Source: Carlyle Analysis; “The U.S. Syndicated Term Loan Market: Who holds what and when?” Fed Notes, November 2019; Pitchbook, LCD Database, March 2024. There is no guarantee
any trends will continue.
Figure 10. Source: Carlyle Analysis; Federal Deposit Insurance Corporation, March 2024. There is no guarantee any trends will continue.

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RELATIONSHIPS DETERMINE WHAT ENDS UP
ON BANK BALANCE SHEETSin March 2020, leveraged loan issuance dropped by 65%
relative to its trailing 12-month average. But the only reason
issuance didn’t drop 100% was because all of the leveraged

Banks do hold a pro-rata tranche of leveraged loans on

loan originations that month came in the form of bank-retainedbalance sheet, which typically consists of a revolving credit

revolving credit facilities.5 And these loans were extended at

facility with tighter spreads and covenants. But this balancean especially steep discount: the average spread on revolvers

sheet capacity tends to be allocated strategically in service

issued in March 2020 was 157bps, which was 220bps below theof high-value clients. This is evident when examining bankaverage spread on the same facilities from the prior month.6

behavior during periods of market stress. When spreads
widen (loan prices drop) and leveraged loans cannot be

Such behavior may appear uneconomic to credit investors

easily distributed to CLOs or other buyers, origination

focused solely on extending credit at terms that deliver highvolumes tend to drop, often precipitously, but the pro-returns net of any default losses. But it merely reflects therata share of loan facilities intentionally retained by banks

extent to which the economics of banking strays from pureconsistently rises at the same time (Figure 11).

credit intermediation. The implied value of a client relationshipto a bank is equal 11.6% of loan principal, on average.7 And one

These revolving credit facilities are obviously extended tosuspects banks’ credit allocation decisions will become evenbolster relationships. For further proof, consider the inverse

sensitized to the needs of high-value clients in the future, as

relationship between spreads on newly-issued pro-rata

regulation (Basel III Endgame), further constrains bank risk-

tranches and spreads on secondary market credits (Figure

taking and the share of balance sheets that can be allocated to11). When credit markets froze at the onset of the pandemic

capital-intensive loans (Figure 12, page 11).

Figure 11.
Pro-Rata Share of Loans Rises & Spreads Compress During Market Stress

Figure 11. Source: Carlyle Analysis; Pitchbook, LCD Database, March 2024; Bloomberg, March 2024. There is no guarantee any trends will continue.
5. Pitchbook, LCD Database, Accessed March 2024.
6. While some of this inverse relationship could be explained by higher borrower quality during stressed periods (BB rather than B-rated
credits, for instance), most of the gap looks like concessionary terms.
7. Ruchti, T. et al. (2024), “The Value of Lending Relationships,” Office of Financial Research, U.S. Treasury.

10Figure 12.
Change in Bank Balance Sheets Over Time

SIZE MATTERS

be most sensitized to broader strategic calculation. And
when looking solely at the largest bank holding companies,

For private credit funds, with focused business models that

dependence on noninterest income appears bimodally

do not take deposits or derive ancillary fees to the same

distributed, with noninterest income accounting for between

extent as banks, recent developments represent both a

35% and 50% of operating income for a quarter andwarning and opportunity. Direct lenders whose scale pushes

between 75% and 90% for another fifth (Figure 13, page 12).

them to compete directly for banks’ most prized clients may
find themselves in a position akin to U.S. steelmakers in theThis suggests that the clients of a relatively small subset

1960s and 70s: forced to sell their product at market prices

of especially large banks may be able to access credit on(spreads, in this case) that seem to make no sense. But

more favorable terms because of the fees they generate

outside of this corner of the market, circumstances are likely

from potential IPOs, advisory work, acquisitions, and otherto improve materially, as banks disgorge assets and more

related needs, including deposit and transaction services.

borrowers seek out alternative sources of credit.

It’s impossible to know, analytically, which borrowers fit
precisely into this bucket. One suspects that companies

Size matters, both in terms of the banks against which

above an annual EBITDA threshold between $200 million

private lenders compete and the borrowers themselves.

to $400 million would be prime candidates for precisely

While all bank holding companies experienced a dip in

the sorts of value-added services for which banks derivenoninterest income over the past two years, it is the largest

so much of their operating income, as would companies

banks that derive the greatest share of their operating

affiliated with large financial sponsors with deep andincome from fees and whose lending decisions are likely tomultifaceted banking relationships.

Figure 12. Source: Carlyle Analysis; Federal Deposit Insurance Corporation, March 2024; Federal Reserve Bank of New York, March 2024. There is no guarantee any trends will continue.

11Ultimately, spreads on bank-arranged term loans aremain relationship-based motivation is retaining deposits –determined by conditions in the market in which they’re

which private lenders do not threaten.

distributed. And when added to base rates, the associatedcash interest expense limits the leverage (debt/EBITDA)

The aforementioned trends in balance sheet composition

that a first lien loan can accommodate in the current(Figure 12, page 11) should weaken banks’ competitive position inenvironment. For many capital structures, an increase inthis portion of the market. Bank holdings of duration-sensitivebank-intermediated lending necessitates corresponding

Treasuries and mortgage-backed securities (MBS) skyrocketed

growth in junior capital. In these cases, private capital willin the period preceding the rise in interest rates – partly due

still be central to the transaction, but instead of “unitranche”

to regulation – leading to catastrophic fair value losses thatloans from direct lenders, such participation will come in thehave not been recognized for regulatory purposes but reduce

form of higher-yielding second liens and preferred securities.

earnings capacity and economic capital just the same (Figure 14,

This dynamic is a return of sorts to the symbiotic relationshippage 13). And while the bank share of most types of loans has

between broadly syndicated and private markets thatdropped meaningfully over the years, their share of mortgages

existed just prior to the pandemic.

collateralized by commercial real estate has remained roughly
constant, equal to more than half the market.8 Given the

Below the $200 million to $400 million annual EBITDA

potential fall-out in the office sector, where the “structural”

threshold, competition for private lenders is likely to involve

vacancy rate is nearly 50% due to work-from-home trends,9more commercially-oriented large banks and regional banks

many banks may need to jealously guard capital that they mightwith less fee income to cross-subsidize lending and whose

otherwise have been able to commit to new loans.

Figure 13.
Dispersion in Noninterest Share of Bank Operating Income

Figure 13. Source: Carlyle Analysis; Federal Reserve Bank of New York, March 2024; S&P Global, June 2022. There is no guarantee any trends will continue.
8. FDIC (2019). P. 33.
9. Doolittle, T. and A. Fliegelman (2023), “Work-from-Home and the Future Consolidation of the U.S. Commercial Real Estate Office Sector: The Decline of Regional Malls May Provide Insight,”
Office of Financial Research, U.S. Treasury.

12Figure 14.
Bank Capital Hit by Bond Losses, Office Exposure

CONCLUSION

share of their operating earnings from M&A and IPO
underwriting, advisory work, transaction services,

Narratives surrounding the disintermediation of banks

and other fees. While direct lenders aspiring to enter

have not flipped but become more nuanced. The share

this territory may find themselves at a competitiveof total credit market assets on bank balance sheets

disadvantage, the actionable opportunity set is likely

has dropped materially over the past 50 years and thisto expand for private lenders in virtually every other

trend seems certain to continue. As bank balance sheets

direction. Appreciation for the asset-client distinction

become more constrained, their lending decisions will

and broader competitive dynamics may be the key to

become more sensitized to relationship considerations,assembling the best-performing credit portfolios in theespecially for large banks who derive a disproportionate

years ahead.

Figure 14. Source: Carlyle Analysis; Federal Deposit Insurance Corporation, March 2024; Federal Reserve Board of Governors, March 2024. There is no guarantee any trends will continue.

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Jason Thomas
HEAD OF GLOBAL RE SEARCH & INVE STME NT STRATEGY

jason.thomas@carlyle.com / (202) 729-5420

Jason Thomas is the Head of Global Research & Investment

Mr. Thomas received a BA from Claremont McKenna College

Strategy at Carlyle, focusing on economic and statisticaland an MS and PhD in finance from George Washington

analysis of Carlyle portfolio data, asset prices, and broader

University, where he studied as a Bank of America

trends in the global economy.

Foundation, Leo and Lillian Goodwin Foundation, andSchool of Business Fellow.

Prior to joining Carlyle, Mr. Thomas served on the WhiteHouse staff as Special Assistant to the President and Director

Mr. Thomas has earned the chartered financial analyst

for Policy Development at the National Economic Council.

designation and is a Financial Risk Manager certified by

In this capacity, Mr. Thomas acted as the primary adviser tothe Global Association of Risk Professionals.

the President for public finance.

Mark Jenkins
HEAD OF GLOBAL CRE DITMark Jenkins is Head of Carlyle Global Credit. He is also aacquisition and oversight of Antares Capital and themember of Carlyle's Leadership Committee. He is based insubsequent expansion in middle market lending. Prior to

New York.

CPPIB, he was Managing Director, Co-Head of Leveraged
Finance Origination and Execution for Barclays Capital in

Prior to joining Carlyle, Mr. Jenkins was a Senior Managing

New York. Before Barclays, Mr. Jenkins worked for 11 years

Director at CPPIB and responsible for leading CPPIB’s

at Goldman Sachs & Co. in senior positions within the Fixed

Global Private Investment group. He was Chair of the Credit

Income and Financing groups in New York.

Investment Committee, Chair of the Private Investments
Committee and also managed the portfolio value creation

Mr. Jenkins earned a B.Comm degree from Queen’s

group. While at CPPIB, Mr. Jenkins founded CPPIB Credit

University. He served on the boards of Wilton Re, Teine

Investments, which is a multi-strategy platform making

Energy, Antares Capital and Merchant Capital Solutions.

direct principal credit investments. He also led CPPIB’s

Economic and market views and forecasts reflect our judgment as of the date of this presentation and are subject to change without notice. In particular, forecasts are estimated, based onassumptions, and may change materially as economic and market conditions change. The Carlyle Group has no obligation to provide updates or changes to these forecasts. Certain information
contained herein has been obtained from sources prepared by other parties, which in certain cases have not been updated through the date hereof. While such information is believed to be reliable
for the purpose used herein, The Carlyle Group and its affiliates assume no responsibility for the accuracy, completeness or fairness of such information. References to particular portfolio companies
are not intended as, and should not be construed as, recommendations for any particular company, investment, or security. The investments described herein were not made by a single investment
fund or other product and do not represent all of the investments purchased or sold by any fund or product. This material should not be construed as an offer to sell or the solicitation of an offer tobuy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not soliciting any action based on this material. It is for the general information of clients of The Carlyle
Group. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors.

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