Private credit managers supersizing their loans

The heftiest alternative investment managers have amassed enough capital in their credit businesses to make big loans for some of the largest corporations.

In 2020, the largest credit managers accounted for a big swath of the capital raised worldwide, according to a February Preqin report. The 10 largest private credit funds accounted for 39% of the total capital raised in 2020, up from 31% in 2019. And mega loans have been accounting for a greater percentage of total transaction volume over the past few years.

According to Preqin, 43.4% of the $82.4 billion in aggregate transactions in 2020 were loans of $1 billion or more, compared with 32.2% of the $102.2 billion in combined deal value in 2017.

Executives at the biggest alternative investment firms view making mega loans that only a year ago would have been provided by banks as an outsized investment opportunity. These executives expect these loan originations will not only propel further growth, but will serve as a source of excess return.

A number of alternative investment firms raised billions for their credit strategies in the last 12 months, including Clearlake Capital Group's $7 billion Clearlake Capital Partners VI; Blackstone Group Inc.'s direct lending fund, the $6.1 billion GSO European Senior Debt Fund II; Ares Management Corp.'s $3.5 billion Ares Special Opportunities Fund; and KKR & Co. Inc.'s $2.8 billion KKR Dislocation Fund.

Apollo Global Management Inc. in February closed its $2.34 billion Apollo Accord Fund IV, which invests in dislocated credit, just nine months after it held a final close for the $1.75 billion Apollo Accord Fund III B, an earlier dislocated credit offering.

During Apollo Global Management Inc.'s Feb 3 earnings call, Marc Rowan, co-founder and senior managing director, attributed a portion of the $88 billion the firm invested in 2020 to the growth of Apollo's private credit origination business as it expanded into making mega loans for large-cap corporations. Apollo has by far the largest credit business among the publicly traded alternative investment managers, with $328.6 billion as of Dec. 31 — 126% more than the next manager on the credit business list, Ares Management, with $145.5 billion as of Dec. 31.

"If we had sat here a year ago and we described for you the litany of transactions from (Abu Dhabi National Oil Co.) to Expedia to Albertsons ... you would have said those were going to come out of the auspices of the banks, that was their regime, that's their opportunity," said James Zelter, co-president and CIO of Apollo's credit business. "So the theme that we've talked about for several years, the evolution of intellectual capital from 'The Street' to the buy side, the search for yield, the regulatory environment, our footprint ... we just see those accelerating."

In the fourth quarter, Apollo provided $9.3 billion in financing to investment-grade companies. These transactions, some of which had institutional co-investors, included a $5 billion deal with ADNOC, leveraging the rental income streams of some of the oil company's properties that are under a 24-year master lease agreement, and a $4 billion financing for Hertz Global Holdings Inc. by Apollo insurance company affiliate Athene USA Corp., to allow the car rental company to refresh its fleet.

Apollo executives expect most of its growth to come from its credit business, not private equity, Mr. Rowan said.

"In the private equity business, we are large (but) that will not be a source of massive growth. The credit business is large ... but in the context of the markets that we participate in, we're just beginning. We have an amazing opportunity in credit, particularly with respect to origination," he said.

Apollo sometimes syndicates its loans, meaning it takes co-investments from institutional limited partners to make even larger loans, noted Scott Kleinman, Apollo co-president, during the same call.

Apollo is focusing on building its loan origination capability and hired about 300 people in 2020, many of them to originate loans, Mr. Zelter said.

In July, Apollo formed a partnership to originate loans of about $1 billion each for corporations, amounting to about $12 billion in financing over the three years, noted Apollo spokeswoman Joanna Rose. The new partnership, Apollo Strategic Origination Partners, is anchored by the $232 billion Abu Dhabi wealth fund, Mubadala Investment Co., and permanent capital vehicles managed by Apollo.

Blackstone Group also is aiming to make larger loans. During its Jan. 27 earnings call, Jonathan Gray, president and chief operating officer, noted that Blackstone's credit business had grown to $618.6 billion as of Dec. 31, up 8% from a year earlier, making it one of the largest in the world.

"Our scale allows us to provide bigger and more comprehensive capital solutions to borrowers," Mr. Gray said. "And the opportunity is enormous with subinvestment-grade financing markets in the U.S. alone totaling nearly $3 trillion."

For their part, institutional investors plan to continue investing in private credit. Some 47% of investors surveyed by Preqin at the end of 2020 expect to commit more capital to private debt over the next 12 months, with another 40% maintaining current investment levels.

About 14% of investors plan to reduce their private debt allocations in the next 12 months, indicating they were most concerned by asset valuations and competition for transactions, Preqin reported.

None of the investors mentioned the growing size of transactions as a concern.

At least one of Apollo's investors, Florida State Board of Administration, which oversees a total of $216.9 billion, is likewise unfazed by the increased deal size or expansion of Apollo's limited partner base.

Florida SBA has a total of $204.1 million invested with Apollo as of Dec. 31, with the last commitment of $200 million to Apollo Accord Fund IV, a private debt fund managed by Apollo Global Management, made less than six months ago.

"We do not see a change in our relationship with Apollo, and will give consideration to the products they offer in the future," said John Kuczwanski, manager of external affairs for the Florida board.

The low-interest-rate environment is pushing investors and their investment consultants to search for asset classes that will help them achieve their 7% expected rates of return, said Stephen Nesbitt, Marina del Rey, Calif.-based CEO of alternative investment consultant Cliffwater LLC.

Private credit is expected to produce returns greater than fixed income, he said. Long-term returns for private credit have been 9% net. Mr. Nesbitt estimates that when all the numbers are in for 2020, net returns will be 5% to 6.5%.

Aside from returns, capital committed to private credit can be invested quicker than private equity, which is attractive to some investors, Mr. Nesbitt said.

Private debt managers are not lacking in capital. Between 2010 and 2020, private credit funds raised at least $100 billion annually, Preqin data shows. In 2020, private credit managers raised a combined $117.7 billion in 200 funds, down from the record $132.1 billion raised by 223 funds in 2019.

Christopher G. Wright, managing director and head of private markets at private credit manager Crescent Capital Group, said the pandemic pushed more capital into private credit. "COVID caused institutional investors to face two simultaneous and profound phenomena," he said.

Investors like private credit because of the potential for earning returns over bonds in a low-interest-rate environment as well as to take advantage of accelerated demand by companies for private loans from managers, he said.

At Ares Management, business for private credit was brisk in 2020. Executives reviewed more than 2,400 transactions for direct lending transactions in the U.S. and Europe, Michael Arougheti, Ares CEO and president, said in an email. During the year, Ares committed more than $20 billion to nearly 200 companies, he said.

"Part of this activity was a result of the growing trend of larger, often public companies turning to private market providers like Ares for more flexible financing solutions," Mr. Arougheti said.

For example, Ares led the largest-ever unitranche financing transaction, a £1.9 billion ($2.6 billion) loan for insurance broker and underwriter Ardonagh Group Ltd.