We stopped competing with private credit for the term loan

I think regional banks that try to win back sponsor-backed middle-market term loans from private credit funds are fighting for the wrong part of the relationship. My position is that a bank of our size should leave the term loan to the direct lender whenever the structure demands more debt or looser terms than its credit policy allows, and compete instead for the revolving credit, the treasury management and the deposits of the same company, while lending to the funds themselves within firm limits. It is a smaller business than the one we had, and I believe a sounder one.

I want to be precise about scope. I mean companies owned by private equity sponsors with annual earnings of roughly US$10 million to US$75 million, which were a meaningful part of our commercial book a decade ago. I do not mean family-owned businesses, commercial property or the smaller companies we serve through business banking, where a bank remains the natural lender.

What we were losing, and what we were not

Between 2019 and 2023 Varrowfield's sponsor-backed term loans fell from US$3.4 billion to US$1.9 billion. In our loss reviews bankers gave the same reasons again and again. A direct lender would provide debt at six or seven times earnings where our policy stopped well short of that. It would commit within two weeks. It would accept a single maintenance covenant or none. And it would hold the whole loan, so the sponsor dealt with one counterparty rather than a syndicate.

Our first response, in 2022, was to compete. We relaxed some structures and shortened approval times. Our chief credit officer objected, and the loans we won on those terms were the ones that performed worst over the following two years. Of the eleven sponsor-backed loans we made on relaxed structures that year, four had been downgraded to criticised status within eighteen months, against one of the twenty-three we made on our standard terms. That told me we were losing the contest on terms we should not match.

When we looked more closely at the relationships we had lost, the picture was not uniform. In about two-thirds of the cases where a fund took the term loan, the company still needed a revolving facility for working capital, which many direct lenders prefer not to provide, and it still needed somewhere to run payroll, collections and cash management. In many of those cases we had lost the treasury relationship as well, not because the fund required it but because our bankers stopped calling once the term loan had gone.

The revolver, the treasury account and the first call

From the start of 2024 we organised our sponsor-finance team around the operating relationship rather than the term loan. Where a fund provides the term debt, we offer the revolver under an intercreditor agreement that gives us the first claim on receivables and inventory, together with treasury management and deposit services. We have built working arrangements with several direct lenders that prefer a bank partner for those pieces, and our bankers are now measured on operating accounts and revolver usage as well as loan balances.

The results so far are modest and real. Revolving commitments to sponsor-backed companies rose from US$0.8 billion at the end of 2023 to US$1.3 billion by September 2025, and those companies' deposits rose from US$1.1 billion to US$1.6 billion, most of it in operating accounts. Treasury fees from the segment have risen by about 70%. Total loans in the segment remain below their 2019 level, and sponsor-finance revenue has not returned to its peak. I would not describe this as a growth strategy. It is a decision about which part of a relationship a bank of our size can hold on sound terms.

The first call matters most. When a sponsor-backed company runs into difficulty, the bank that holds its operating accounts and its revolver sees the strain weeks before the quarterly accounts show it. Twice in the past year we have used that position to agree changes with a direct lender before a covenant breach, which was better for the company and for both lenders.

Lending to the lenders, with a ceiling

The other half of the strategy is lending to funds: subscription facilities secured by investors' commitments, and loans to credit funds secured by their portfolios. These have performed well historically and bring deposits and fund-administration business with them. They also carry a risk that is easy to miss. A bank that lends to a direct lender is exposed, at one remove, to the very middle-market companies it chose not to lend to directly, often at higher debt multiples and with less information about each borrower.

We therefore set a ceiling. Loans to non-bank lenders, fund finance included, are capped at a share of capital that our board approves each year, with sub-limits by manager and by strategy, and our credit team reviews the underlying portfolios instead of relying on each fund's own valuations. At September 2025 those loans stood at US$1.6 billion, a little under two-thirds of the ceiling, and during the year we declined two fund facilities because the managers would not share borrower-level data. Supervisors and investors have been asking banks to explain their lending to non-bank financial companies more fully, and I think the questions are fair. A bank that has stepped back from risky term loans should not quietly take the same risk back through a fund.

I hold this position with some uncertainty. If credit conditions deteriorate sharply, direct lenders may retreat, and banks with capital and deposits may find the term-loan market open to them again on better terms. We have kept a small team able to do that work. The argument I would put to a regional bank's board is narrower than a forecast. Decide which parts of a sponsor-backed company's banking you can provide on terms your credit policy supports, compete hard for those, and measure your bankers on them. Matching a fund's structure to keep a term loan rarely keeps the client for long.