Business Breakdowns
· Hunter Hopcroft, Matt Reustle
[00:00:00] S1: Apollo is not involved in this deal. But if you want to see how creative things are getting, think about the CoreWeave deal, which is basically a $12 billion private credit deal secured by NVIDIA chips. So, things are getting very creative on the debt side. And Rowan is very explicit about the demand for credit and their ability to scale up, with credit origination being the biggest constraint. In fact, he said at a conference in September, "The biggest single constraint on growth is not capital formation. It's not how many people you have. It's really about whether you can originate enough attractive assets to meet your need." And that's why they are so focused—and some might say maniacally focused—on making sure they are building the right type of origination in volumes, in the right places, because that's our whole business is about, "delivering excess return per unit of risk," which is a phrase that Rowan evokes time and time again. [00:00:00] S0: Just going back to the shift, the transition to bring something like Athene in house. Again, a very high-level view would be that you took something that is, in some ways, very asset-light, with other people's money, and transitioned this into something that is way more asset-heavy, with an operating business—something that has to manage an insurance book that's going to transform this business model quite a bit. What is the perspective from a business analyst's perspective, and also from an investor's perspective, on how that changes the dynamics of Apollo?
· Hunter Hopcroft
[00:00:00] S1: If you go back to that 2021 investor day with that massive deck and those six hours of presentation, one of the last presentations is Apollo's CFO, and he basically says, "Here's how to think about the business now." In Apollo's supplements, they break out their earnings—now in fee-related earnings. So, this includes things like asset management fees. This is your traditional alt-manager business, spread-related earnings. This is the difference between their liabilities and what their assets are earning on this retirement services and insurance sleeve. And then there's principal investing, which basically houses the carry that they're earning. And despite that initial skepticism, spread-related earnings are now larger than fee-related earnings for Apollo. And last year, Apollo originated something like $200 billion of credit—$222 billion of credit. And that's credit that they are originating, not going out and buying. That's $220 billion of credit that Apollo is originating in-house to feed that spread-related earnings business. To talk about where the firm is today in terms of this business plan, Apollo now either owns or has a role in 16 different origination platforms. And there's something like 4,000 employees spread across those various origination platforms. And they're all relatively niche, with aircraft leasing and music royalties. It's these very niche subsectors that Apollo feels like they can stand up or acquire teams that have a real specialty in those areas to originate this credit.
· Matt Reustle
[00:00:00] S0: Honestly, when I think about those categories, there are some obvious ones in private credit that have really transitioned away from the banks—they are high-quality, asset-backed, and have some type of cash-generating business underneath them all. It'll be interesting to see that $220 billion, if it can continue to grow at the same pace, sticking to those traditional asset classes or if they get continuously creative. Would you say there's any bucket that makes up a significant percentage of that spread portfolio? Is that something that they disclose?
· Hunter Hopcroft
[00:00:00] S1: The issue that credit origination has today—and it speaks to John Zito's comments and the desire to move up market—is that, up into, let's say, 2022, the private credit market was supported by private equity–sponsored lending to pursue LBOs. And that market, for a variety of reasons, has been effectively closed or at least is a lot less active. And so a lot of the demand that was coming on the private credit side has tapered off. And so they've had to get more creative and they've had to go farther afield to look for lending opportunities. And I think a big open question for the industry is: if private equity and sponsor-backed lending do not make a hard rebound, what fills that gap? Because what Rowan's created here—and I do think it's unique to Apollo—is that he's created a bit of a financial perpetual motion machine: you sell an annuity, which creates equity. You use that equity to set up an origination platform that originates debt that goes back into the top of the balance sheet and creates a new dollar of equity to do it again. The more annuities you sell and the bigger your insurance balance sheet grows, the more demand for credit is created. That's why Rowan is so explicit that the single biggest constraint on their growth is now not the ability to form capital—which was how most of these companies were judged. That's where their multiple comes from, being at least in large part based on people's perception of Blackstone's ability to go out and raise another 30 billion fund. Rowan is saying we're off that treadmill now, and our constraint is: can we find and originate the credit we need to meet the demand that we're generating?
· Matt Reustle, Hunter Hopcroft
[00:00:00] S0: I think you gave a very good distinction between the growth of private credit and there is so much focus on the sponsor-backed market, which in reality was fairly straightforward. I don't want to say easy, but that was something where you were part of a growing TAM. It is more difficult to find the higher-quality deals that are not sponsor-backed and that require a relationship with the businesses. And when you describe that perpetual motion machine, I think you hear about several forms of dollars creating leverage in the system. What that can often lead to, through financial complexity, is inherent risk in the system. Whether it's leverage or something that, once there is a break in the dam, creates a ripple effect through the organization that's not felt only once, but is felt multiple times and can bring things down. I think that is probably not the right way to categorize this. But just thinking about risks with the leveraged portfolio, or what is inherent from a standard company perspective in terms of how much traditional debt they have, and also the liabilities that exist within the system. Are there hidden things here that are worth paying attention to when you run something that has that complexity? [00:00:00] S1: I'll perhaps editorialize a little bit here. [00:00:00] S0: Please do.
· Hunter Hopcroft
[00:00:00] S1: Which is what you're asking me to do: I think that, especially because of the muscle memory of 2008, there is a tendency to believe in a building systemic risk—that there will be a Minsky moment, as they say, where all those credit dominoes start falling. And I actually disagree with that. I think the regulatory response following the Great Financial Crisis has, in fairness, made risk far more diffuse than it was before, when it was housed in a somewhat concentrated banking system. And now it's spread across these many asset managers in these many structures with many underlying investors in them. I think the bigger risk here is not fallout; it's that this truly self-perpetuating demand for debt leads to a degradation of returns over time, where there's a clear definition of financialization: it's the demand for debt securities and the absence of productive uses for that debt. And we have this structure here. In fairness, annuities are still a very small slice of the global markets pie. But I do think they speak to something where we are heading for an era where fewer and fewer people want to take equity risk. They want to feel higher up the capital stack. They want to feel they're in some sort of secured position. And that creates a tremendous demand for assets that can check the credit box. And there are only so many lending opportunities out there that meet those requirements. The bigger risk here is not some fallout, not some Minsky moment, not some dam breaking event. It's just a slow degradation of returns as debt eats more and more of the benefits of asset ownership or the activities of these businesses.