In Part 2 of Pensions & Investments latest Face to Face interview, Editor-in-Chief Jennifer Ablan sat down with John Zito, Apollo Global Management's deputy CIO of credit, to talk more about the economy, working with banks and why investment-grade companies are turning to Apollo. Questions and answers have been edited for clarity, conciseness and style.
John Zito says Apollo's focus on investment-grade private credit puts it in sweet spot
A: Yeah. Construction lending has effectively gone to a halt with respect to commercial real estate, new CRE development lending, and there's typically some sort of correlation to anything that goes into building, such as asphalt and crane businesses. You've had mixed factors where you have construction lending collapsing, but you have big infrastructure projects that are going on in the states, which are really bolstering and stabilizing what otherwise would be a real cycle.
The backlog from COVID-19 — you've never seen an environment where you shut off the economy for a year. And so the backlog's been much higher. So even though you were raising rates by 500 basis points, lots of these companies ... still had demand from '20 and '21 on delayed projects. I think this year and into '25, you'll really see how the rate hikes start to flow through the overall economy. Bank lending should slow. CRE lending should slow.
Home Depot grew at 2.5%, GDP plus or minus a little bit, for 30 years. In COVID, it grew at 30% to 40% a year for two years. Did that pull forward demand for 10 years? Because everyone was at home, wanted to fix their bathroom, fix their porch, fix whatever they were doing at home a lot. Add an office.
Is that going to cause a significant slowdown or are we going to go back to growing at 2.5% a year? I think that there's lots of reasons to believe that you're going to see some big revenue gaps because you pulled forward lots of demand during COVID. You already fixed everything at your house you were going to fix. You don't need to go and spend anymore.
So we've yet to see it. But things like hotel prices, which doubled, anyone who's gone to a hotel in a major city, New York, London, any big city, saw double to triple prices in certain cases. Aviation doubled and is back to 2019 levels. So most ticketed prices, most travel, most leisure, is back or above 2019 levels. Which, given all the rate hikes, has surprised us a little bit.But it's good for the economy, good to see that we're actually functioning with the amount of rate hikes. So, we'll see. The market is effectively pricing in a near certainty of a soft landing at this point.
A: Again, over the next two years, we're close to $1 trillion of refinancings. It's $500 billion this year. Another, I think, $350 billion to $400 billion the following year.
Now we're a year forward from that interview. It's nice to see the CLO market is back on, because without that, you really need the private market for everything.
Anybody who's over-levered and has baskets, you can do super senior, senior tranches that'll give companies runway. I think you're going to see lots of capital solutions-type things that will get on to, just, again, all about sponsor solutions, extending runways.
We've done close to $15 billion of (net asset value) lending last year. So against great collateral, super low loan to value, 8% to 12% types of return.
So we're really trying to allow sponsors to extend their runway in safe credit, and let them play through this difficult time where there hasn't been a lot of sponsor-to-sponsor business. There hasn't been an IPO market to really bridge the gap. But with the refinancings due, you're going to have to pay a higher cost of capital.
If cash is paying you 5% to 6%, and how you service that, how much debt you have, I think there's probably a several hundred billion dollar hybrid preferred opportunity. Because many of these companies can't just take on debt for debt, they need a little bit of equity capital. And you've seen some companies go out and raise preferred, and then the existing lenders will roll their debt.So it's about putting all the pieces together between financing at the fund level, getting a little bit of equity capital either from the sponsor or some strategic, and then also rolling your debt and giving the company an extra two or three years. And maybe you add some level of PIK interest as, effectively, a bridge to get the lenders more return, but not tighten the cash flow statement from the company.
A: It was five to seven, now it's less than one.
A: Again, our business growth has really been about two big things going on in the world. There's a retirement crisis going on and people need access. And for the first time, you can get access to your cost of capital in credit.
And if you can make an 8%, 9% return in an investment-grade security, do you really need to go down and take 11%, 12%, 13% return for a subordinated security? We don't think so. So we've been trying to build fixed-income replacement product that looks like, and we think is similar risk. All you're taking is more illiquidity risk, in a much broader swath of assets, that's senior, that are collateralized, that we control the documentation directly.
That's the future of our business, and so that's where we've been spending all our time. Again, lots of press about the risks in private credit.I think they're talking about the sub-IG space. And so again, getting on the same page with everybody about what private credit is, I think, will be helpful.
A: If you're running that business, do you want to have a single source of financing, or do you want to have a little bit of diversification of financing? And what you're seeing is, if you have a $100 billion of debt doing a $5 billion tranche of private IG, to have a diversified funding source that may be able to fund a project differently, or do it on a non-recourse basis against specific collateral, or in times of dislocation, maybe they have a forward flow agreement with that lender; there's value there.
We also bring lots of expertise around capital structure, and ideas around capital structure or strategic view from the entirety of our firm. So I think what you're seeing is those companies are actually valuing us being in the capital structure as a different source.Again, the narrative of the banks vs. Apollo, I don't see that at all. I think that a majority of their funding, these companies, AT&T, they're still going to access the traditional CUSIP market, but it doesn't mean they're going to do 100% of it. It's just they have a lot of debt. So when we do a $2 billion, $3 billion deal, you see ...
A: It's more structured, typically a little bit more illiquid, and it matches with our capital. The vast majority of our capital is permanent capital, long-duration capital.
A: It's the early innings of seeing the transition from the traditional fixed income into fixed-income replacement, as defined as the broad swath of private credit. And almost all of that capital sits in, a lot of it, sits in daily liquid funds that doesn't need daily liquidity.
And so we're trying to figure out exactly, and educate people on, that the risk is very similar. That you are taking a little bit illiquidity risk, but you don't need the liquidity in a long-duration retirement account.So if you can earn 100, 150, 200 basis points of excess yield with the same exact rating, with really similar type counterparty risk, having a portion of that being less liquid fixed income vs. daily liquid fixed income, we think that's going to be a big market and people are going to realize that it's worth going into some of those more illiquid structures.
A: For us, we view the banks as one of our biggest, most strategic partners. We don't want the client, we want the asset. We can help the banks win where they have had relationships with many of these counterparties for a long time. On a lot of the deals that you just mentioned, there was a bank advising a company, and the bank took almost the same fee, if not more of a fee, than they would've done in a traditional syndicated deal.
So it doesn't get documented a lot as that. On those companies you just named, there was a bank on every one of those deals where they paid, they got paid a fee for advising the board on what the right capital solution was. But it's much better for the news to say that it was Apollo winning vs. the banks. We actually worked with the banks on a lot of those deals.And there's certain situations that we can help the banks win in certain ways, where maybe if they didn't have our capital, they might not win or not have exactly the right balance sheet for it. The regulatory regime is obviously changing.
A: First, let's define what private credit is. Two is, the more that we can get the capital and the loans next to the investors that want to own the loans, I think the better it is for the system. So deleveraging of when we go into a BDC, or into a regular way fund, those are unlevered funds.
Every time we can take an asset and it's deleveraging to the system, that should be better for the overall economy and the stability of the economy. So again, I think the regulatory environment is what it is. It seems to continue and get a focus. In the back half of last year, it got a big focus.
A: So again, there is regulation across the entire insurance industry. And private credit, I think, when people say it's in a bubble, they're really defining the traditional non-investment-grade sponsor-lending market. They're not talking about mortgages, and they're not talking about all types of other lending, fleet finance, aviation lending. Because that activity is stuff that everybody does and is regulated.
So where it sits is different, it's a different conversation. But I'm pretty certain that all that activity I just listed in the investment-grade space that sits on banks is pretty regulated. So I feel pretty good about the risk that sits on our balance sheet today.
A: When I take a huge step back, we had effectively a 14-year run where we printed $11 trillion. We kept rates at zero. And then we decided to raise rates in the fastest period that we ever have, at the fastest pace and the largest quantum we ever have. And we sit here today, 18 months into it, 20 months into it, and everybody's saying it's a 100% certainty of a soft landing, and that we can cut rates, and we'll land the plane.
And it's hard to imagine that there's not going to be more pain from a 14-year printing press, and then raising rates really quickly, and stressing the economy and stressing the consumers. So we'll see.
So far I've been surprised how resilient the economy's been. I think part of it is, I think the biggest, probably the most bullish thing this cycle around is that the home prices and structural home prices, and there's close to $20 trillion of home equity, which is very different than '08, where you have effectively negative equity in people's homes.This is a ton of positive equity. And I think that's what's kept the wealth effect, and kept people more willing to spend, and willing to go out and do traditional spending, despite maybe feeling a bit more uncertain around their month to month payments. So we'll see.
A: Yeah, yeah. I know in New York, I mean, everything's busy here. And I grew up in Miami, and everything's really busy in Miami. It's unique. This cycle's unique with the migration patterns. Where you kind of look at the overall economy data, and it kind of bundles everything together. But Miami is vastly different than Chicago or Midwest, vs. San Francisco or Los Angeles or New York or Austin, Texas. You have these certain cities where millions of families went, and you have home prices up triple, you have rents up triple. Versus other parts of the economy where everyone was leaving, you have rents flatten down.
But it all gets put into one dataset when you look at the aggregate data for the whole United States. So it's almost like you have to be running different monetary policy for different states at this point, given how different the economies are operating right now.
A: Again, I think it's in the process of being told. Which is, we kind of built our credit business 15, 17 years ago by really going after origination and excess spread, safe assets. Rates went up a lot, regulatory environment got a little tighter, and we were positioned for what's going on today.
In a way that, we built our entire business with tons of headwinds. And now we have tons of tailwinds. And it feels a little weird, actually. It feels a little weird around here sometimes.
A: Oh, goodness gracious. I don't know about that one. I'm not going to take that bait. I'm just, again, I feel so lucky actually at this place. So I am extremely fortunate, and I don't know if there's not really an untold story. I've been given a pretty good platform, and I feel pretty lucky.