Apollo Global Management ranks among the largest investment firms on Wall Street. Most recently, Apollo Global Management reported $631 billion in assets under management as of Sept. 30, a 21% increase from $523 billion the end of the third quarter 2022. Apollo and other private credit firms are talking with institutional investors about supplementing fixed income with private credit — in theory, producing higher returns than plain vanilla bonds. Pensions & Investments Editor-in-Chief Jennifer Ablan sat down with Apollo's deputy CIO of credit, John Zito, to learn more about the boom, what qualifies as private credit and what he sees as risks for the credit cycle. Questions and answers have been edited for conciseness, clarity and style.

Apollo's John Zito

Q: Private credit is all the rage these days, but what exactly is private credit? I've heard Apollo's views that this is an addressable market as a $40 trillion opportunity. Walk us through that.


A: Private credit is going through a big change in terms of what it is, what it is to certain people. Obviously for a long time post the financial crisis, it was really providing capital to small and medium-sized businesses in the middle-market direct lending space. So effectively servicing sponsors that generated EBITDA somewhere between $10 million and $50 million.

What's happened in the last 15 years, for us, we're trying to get everybody to agree on what private credit is. For us, it's everything that doesn't have a CUSIP that sits on a bank balance sheet, that sits on an insurance company balance sheet. (A CUSIP number identifies most financial instruments, such as stocks, commercial paper and government bonds as well as the issuer.)


Historically, it's majority of which is investment-grade. And that marketplace is much larger than the traditional, what people would call the direct lending space for sponsors, which is subinvestment-grade.So I think our first step is just really trying to educate and just get some consensus around the market, around what private credit is, and then we can talk about the risk associated or potential risk associated with it. But we view it as majority investment-grade, and that's where we've been spending almost all of our time.


Q: What contributed to its growth in the last several years?


A: It's always been very big. It's providing capital to the entire economy. So it's mortgages, financing cars, financing any sort of real estate. Receivables finance, solar finance. You name it, it touches the economy, we're probably providing capital. The banks have historically provided that capital, and insurance companies have provided that capital.

And so historically, it's set within those balance sheets. Our retirement service business is growing really quickly. And so today we're $450 billion, $300 billion of which is our own balance sheet. And of that $450 billion, about a third is asset-backed, which is what I'm describing. And the other two-thirds, the other $300 billion, is our corporate business.


Q: Apollo seems particularly well-placed to take more share of this market. Given your cost of capital and origination capabilities, can you explain your model and how it differs from other private credit players?


A: We've we've spent a lot of time growing our business assuming rates would be zero forever.

Q: I think everybody felt that way.


A: Yeah, so I think we really missed the growth. We missed the parts of the real estate business. We were going all in on our retirement service business, and really generating assets for our own balance sheet and for other retirement service balance sheets. Really rated capital. To do that at scale, we had to go and build or buy our own origination capabilities. So whether that's a mortgage originator, or fleet finance business, or any sort of direct-associated loan.


We've built 16 different origination platforms, which, the largest and most recent was acquiring Credit Suisse's warehouse finance business (Atlas), which we acquired about a year ago. We've spent just under $10 billion of our own capital to acquire or build our own capabilities. So you look at our employment numbers, today we have about 2,500 people who sit at Apollo, another couple thousand who sit at Athene. People don't realize we have 4,000 originators that sit out there outside of affiliated companies that are actually just originating assets on behalf of Apollo.We really touch almost all parts of the economy, and we built direct source to service our own balance sheets.


Q: Let's talk about Atlas. Where do you see the private asset-backed security market over the next five years?


A: Yeah, so I think we'll look back at the Atlas transaction as one of the most innovative transactions that we've probably done as a firm. I'm most excited about the ability to grow that balance sheet. We touch over 200 originators, where we provide warehouse financing. So when they originate a loan, we'll provide a short-dated one- to two-year financing, and then we'll securitize that pool of loans.


Three hundred employees, over 200 origination relationships, just under a $40 billion balance sheet, which I think could double over the next five years. Super excited about just being able to scale that business. And I think from everything I can tell, having now owned it for nine months, it's vastly exceeded what we think we could have built on our own, so we're pretty excited about it.


Q: You talked about how this is a game changer. Explain that there's a lot of M&A activity going on within the private credit markets. Why is Atlas so instrumental here?


A: Yeah, so when you own an operating company that originates loans, typically you're owning the business and you own a series of access points to loans. With Atlas, you have been a historical 10-, 15-, 20-year relationship with hundreds of originators, where you've been their financing partner, where you built trust with those originators.


So by having all those relationships, and having executed several transactions — last year alone we did 100 transactions, I just think that that's going to really change the shape of the path of our growth. And can really be an accelerant for a lot of the things that we're doing in the asset-backed space.


If I take a huge step back, right now we're about, as I mentioned earlier, we're about a third in the asset-backed space. I could easily see us being 50-50 in five years. I think our asset-backed business will be the largest grower in the whole, in our entire, if you look at our four core verticals in credit, the asset-backed business will be the largest grower. Both on our balance sheet, but also if you look at investors, I think they're going to be looking for diversified private credit, diversified types of yield.


And it's really never been institutionalized. It's been predominantly a bank product.And so I think you're going to see lots of access points similar to the way direct lending was, but for asset-backed. And the shape of that investment is very similar. It's secured, it's senior, it's contracted cash flow. It's not so much sponsor, so it's somewhat of a diversifier from traditional sponsor lending. But it has all the characteristics for why investors have historically loved parts of the direct-lending business.


Q: So investors are just as bullish as Apollo?


A: I think it's early days of the education on what asset-backed is, and why we're trying to walk through all of the positives around not only being a direct loan against the hard asset typically, whether it's an airplane, car, or house, but also the diversification elements. That you're not only going to be contingent on the IPO market, or on the sponsor-to- sponsor business, you want to get yield from different sources.


And it's still the early days of that diversification happening. They've historically only had one access point, and we're trying to educate the market on why we love it, and we're doing it with our own balance sheet. And why we think our partners and other investors should do it alongside us.


Q: I'm just going to segue into the enthusiasm with market risk. Higher base rates that make deployment attractive can also stress current borrowers and credit portfolios. What's been the impact of higher rates on the portfolio to date, and what kind of cycle lies ahead?


A: There's no doubt that, historically, higher rates should slow down the economy. We've seen it slow in certain pockets, but by and large, the economy's held up thus far. There's been a couple episodic forced refinancings, where you've seen amend and extends, or things like that happen in the marketplace. But by and large, that refinancing wave is coming in the next two years.

If you raised debt in 2018, '19 or '20, when interest rates were zero, it's highly likely that when you have to roll that debt, you're either need to put new equity, you'll have to put new pref, (preferred return, or the first to get paid) or you'll have to get some sort of PIK (payment in kind) element to the debt. So we'll see what that looks like over the next 18 months or 24 months.


Q: What is it going to look like? Are you worried?


A: Look, I suspect you're going to see lots of lenders participate or assist sponsors to help them extend their option to see if the interest rate environment changes, or access to capital changes, or the IPO market changes. In many situations, it's not so much that the debt would be impaired, it's just there's too much debt. And it's more of an equity problem than it is a debt problem.


And so, how lenders partner with sponsors to work with them in this higher rate environment. Clearly the rate environment, if you look at the forward market, they're saying rates will go down significantly in the next 12, 18 months. So clearly, many sponsors and many corporates are going to try to wait and see if that actually plays out. Because it'll make their capital structures much more serviceable.But if you raise trillions and trillions of debt when interest rates are zero, then you raise rates by 500 basis points in 12 months, it's likely you're going to see stress points. We've seen that with the failure of many banks. We've seen that with the failure of some pretty aggressive companies in the crypto arena. You've seen that in all the weak points that sit with any sort of asset liability mismatch.


Q: Such as Silicon Valley Bank?


A: Yeah, you've seen how it's played out. It's played out slower than I would've expected, but it shows itself. And I think you'll see it in certain corporates, where either the business took on way too much leverage and potentially is a bit more cyclical, and you'll have your episodic defaults for sure.


I'm very bullish on recent and new direct lending, where you're doing it in this environment. Any sort of direct lending that happens, that's happened now in the last 12 months, you've assumed that the economy probably slows, and you've assumed that interest rates are at 5% forever. So you're building those capital structures with more equity, and in businesses that are less cyclical. We're pretty excited about that.


Q: Part and parcel to the default cycle, are you concerned by recoveries? Historically, that's been about 70% for all loans, 60% for leveraged loans?


A: Look, there's no doubt that in the traditional performing market, the documentation has gotten extremely weak. And their sponsors have the ability to be pretty aggressive with traditional loans. And so in certain cases, recoveries are going lower when there's a default, because there are some pretty aggressive tactics around the capital structure. And I suspect you'll see more of that as people, again, try to extend their runway and extend their options on their capital structure.


In the direct space, the thing we love about it is that the documents are much tighter than the traditional BSL (broadly syndicated loans, a form of leveraged bank loans) market. And I suspect that since most of the market now is first lien, it's a bit deeper in terms of first lien, but the second lien market has really slowed down. I suspect a lot of the weakness and a lot of the losses will end up happening in the mezzanine and subordinated tranches. Which we have ... really, really pulled back.


When I took on the CIO role coming up on four years, we had about $6 billion of second liens. We have less than $1 billion now.We've really taken down our balance sheet. People don't realize our balance sheet today is close to 60% investment grade. On our retirement service balance sheet, it's 95% investment grade. So we've really gone senior and gone with less-levered companies. And really in our credit business, really gotten out of the mezzanine and subordinated tranche business.


Q: When are you going to see that below investment-grade level as an opportunity?


A: When everybody wants to be doing it, we usually aren't big buyers. We're usually going senior. And when everybody doesn't like the market, we typically are probably pretty much more aggressive than most.


In COVID-19, this is well-documented. In COVID, we drew 100% of all of our capital. The three weeks after COVID in March, we deployed $40 billion in less than four weeks, mostly in the secondary market. So we were the largest buyer and market participant in that environment. And we came into that environment, again, being really senior and having the capability to do that.


So I think you'll see us, if you look at our (business development company), you look at our retirement, our own balance sheet, almost all of our business is less levered than our peers, more first lien, more senior. And when there's dislocation and when there's time to provide capital, we've really set up our business to be the provider of capital when people really need it.

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