Just as private credit is becoming an asset class of its own and private equity houses are finding a new revenue stream away from their bread-and-butter buyout businesses, this burgeoning part of leveraged finance is losing steam.

Direct lending has been its crowning achievement. Credit was not only extended to smaller companies that had limited access to public markets, but to back big buyout deals that in the past relied on banks to arrange syndicated loans or junk bond issues. Firms such as HPS Investment Partners Llc, a spinoff from JPMorgan Asset Management in 2016, were among private lenders that single-handedly underwrote billion-dollar loans. Last year, direct lending funds managed more than $550 billion, up from $95 billion a decade earlier, according to PitchBook. Investors in these funds, in turn, were able to earn 12% returns.

But the conditions that led to such huge success are unwinding. After two years of ceding turf to direct lenders, investment banks, which are the public credit markets’ gatekeepers, are striking back.

So far this year, 21 companies managed to refinance $8.3 billion of debt that was previously provided by private lenders via broadly syndicated loans, data from PitchBook show. Among those was Caliber Collision Inc., a B-rated auto-repair chain owned by private equity firm Hellman & Friedman Llc. The company retired expensive second-lien debt in January, using part of the $4 billion proceeds from bond and loan sales.

Banks are reclaiming their market share in leveraged buyout, too. Last month, JPMorgan Chase & Co. arranged a $5 billion debt deal for KKR & Co.’s purchase of healthcare tech company Cotiviti Inc., upstaging private lenders.

With confidence growing that the next Federal Reserve move will be an interest-rate cut, the premium that private credit funds charge will have to come down if they want to stay in the business. This year, both broadly syndicated loans and high-yield bonds are seeing a revival. For B or B+ rated loan issuers, the total spread — including upfront fees — dropped to 385 basis points in January, the lowest in three years. As a result, the final pricing that JPMorgan did for Cotiviti’s debt was tightened to 3.25% over the Secured Overnight Financing Rate, a 2 percentage-point cost saving compared to what direct lenders had offered in December.

One wonders how private equity giants, which have been pushing aggressively into credit, feel about a golden goose losing its shine. They compete with banks, nipping away at their business, but also rely on the lenders’ extensive client lists to raise cheap capital.

For now, these alternative asset managers seem Zen in the face of a retreat. Asset-backed finance, or lending that is supported by cash flows from, say, credit card receivables or aircraft leasing is talked up as the next act. It’s the perfect narrative: The three kings of private equity — Apollo Global Management Inc., Blackstone Inc. and KKR — have all bought insurance companies or taken minority stakes in them in exchange for managing their assets. Insurers, in turn, may be tempted to dip their toes in private credit. But in doing so, they demand higher-quality assets. Such pivots are already happening: In February, Barclays Plc sold about $1.1 billion worth of credit card debt to Blackstone’s credit and insurance division.

After all, the end of the direct lending boom is not necessarily a curse for buyout firms. Sure, they are losing momentum in a new business, but this trend also coincides with a rebound in public credit markets. As private equity sits on a “towering backlog” of unsold investments, unable to offload their portfolio companies because initial public offerings remain anemic, they need to get paid somehow. Quite a few, including Caliber Collision’s controlling shareholder Hellman & Friedman, have been doing so-called dividend recapitalization deals. They are raising cheap public debt and using the cash to give themselves special payouts.

With the strong tide of private credit receding, investment bankers are heaving a big sigh of relief. But the private equity firms may not be displeased either. 

This article was provided by Bloomberg News.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron’s. She is a CFA charterholder.