It Could Be Good That JPMorgan Is Late to Direct Lending

JPMorgan’s asset management arm has been aggressive in raising money for private credit.

Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

JPMorgan Chase & Co.’s asset management group is late to middle-market direct lending, which was among the fastest growing areas in alternatives for years leading up to the global pandemic. But the delay may ultimately help the asset manager sidestep a lot of problems in the sector that are arising since the pandemic hit earlier this year.

J.P. Morgan Asset Management has been aggressive in raising money for private credit investments in recent months. In May, the asset manager launched a real estate credit opportunity fund seeking $3 billion to profit from dislocations in public and private markets, according to a Bloomberg report, and it has plenty of dry powder from the closing of a special situations fund in the fourth quarter.

Megan McClellan, head of private credit within the bank’s global alternatives group, explained that lenders to midmarket companies will need to take a distressed approach to individual situations going forward. McClellan added that the direct lending sector will continue to grow post-pandemic as companies try to get back on their feet. Among other things, private loans can be structured more creatively than broadly syndicated bank loans. “If you think about it from the borrower’s perspective, the great thing in private markets is that you know your counterparties,” she said.

As more and more lenders entered the sector since 2008, valuations on deals rose and the terms of loans got much more attractive for borrowers, leaving few protections for many lenders.

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J.P. Morgan Asset Management estimates that 75 percent of private-debt portfolio companies could need fresh money to stay afloat. Many of the deals that have been struck in recent years are high risk and laced with debt.

Citing an estimate from Moody’s Investors Service last year, J.P. Morgan Asset Management says that the recovery rates on first-lien loans may decline to 61 percent, down from the historical average of 77 percent. Recovery rates over the 12 months through May were 45 percent for first-lien loans and 15 percent for high-yield bonds.

McClellan said many of these loans have little cushion to help in a recovery. “We’re at the tip of the iceberg right now. It takes a while to flow through. In public markets, prices adjust quickly. In private markets, there’s a lag in reporting. But it feels like there is more to come,” she said.

As a result, the asset manager wants to be set up with direct lending capabilities over the next six to 18 months.

“Money is going to be poured into companies that just won’t make it,” McClellan said, adding that “pre-pandemic, direct lending looked saturated.”

“Now, the risk-reward profile is compelling, and more money will shift from public to private, whether real estate or corporate,” she said. “Investors just can’t find income.”