As Private Credit Surges, Banks and Alternative Asset Managers Turn Frenemies Rather Than Foes


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Wall Street settles for less underwriting in return for lucrative advisory fees.

Always good for a memorable complaint, Jamie Dimon asserted over the summer that the prospect of tougher banking regulations had the biggest purveyors of private credit “dancing in the streets.”

A few years before, Dimon — the statesman-like chief executive of JPMorgan Chase & Co. — similarly warned that regulators were creating an uneven playing field to the benefit of fintechs. These upstarts, he argued, could target profitable segments of banking without having to deal with the costs and regulatory burdens of traditional lenders.

As it turned out, deep-pocketed Wall Street banks easily overcame the fintechs’ threat. JPMorgan alone bought or invested in scores of them.

But private credit poses an altogether different challenge. Led by alternative-asset behemoths like Apollo Global Management and Blackstone, private credit has arguably become the most powerful transformational force in the financial world since the 2008 economic crisis.

These alternatives firms have increasingly stepped into lending voids left by risk-averse banks. They have also created new vehicles to issue and put money to work in investment-grade credit — such as loan origination firms and business development companies (BDCs) — that traditional lenders cannot match.

Banks have been reacting by treating private credit purveyors more as frenemies than foes. Wall Street lenders, including JPMorgan, are building up their private credit units, either on their own or by partnering with alternative lenders and hedge funds. And banks both large and small are inviting alternatives firms to acquire assets from their balance sheets to boost their capital reserves.

But make no mistake: The banks had little choice but to cede ground to large alternatives managers and are understandably uncomfortable at a long-term retreat to advisory roles even in debt deals they originate. As the financial crisis becomes a distant memory, banks are working on new ways to enter the private credit business.

It’s also true that alternatives firms look and sound like the new alpha dogs of finance, placating Wall Street banks with profitable proposals for more collaboration and offering to help lenders derisk their balance sheets.

Alts firms have taken on mortgages and car loans from regional banks. More recently, JPMorgan and other money-center banks have turned to hedge funds and private equity firms to reduce risk on some of their consumer and corporate loan portfolios to build up regulatory capital through debt instruments known as synthetic risk transfers.

“Banks get to keep their relationships with their clients, and we let them free up some of their capital,” says Blackstone president and chief operating officer Jonathan Gray.

Jabbing back at Dimon by pointing out that money-center lenders are enjoying a year of bumper profits, Apollo CEO Marc Rowan told analysts: “There’s actually been dancing on both the bank and private credit sides.”

Following the global financial crisis, government regulators acted to make the banking system safer. Banks were forced to reduce their lending, and their business clients had to look elsewhere for capital — mainly to alternative asset managers offering private credit.

From the standpoint of the alts firms, private credit was an expected outgrowth of the post-GFC regulations. Excess liquid credit has moved out of the banking system, reducing concentration and risk in the banks, just as the regulations intended. Meanwhile, alternative asset managers are attracting a wide range of investors and spreading risk among them.

Among alts managers, Apollo and Blackstone have emerged as private credit leaders, albeit with very different business models. And among banks, the Goldman Sachs Group has vaulted ahead of its Wall Street peers in developing an in-house private credit operation.

But while alts hail the current economic juncture as a golden age for private credit, there are plenty of potential pitfalls and risks ahead as lenders and debtors struggle under mounting burdens linked to rising interest rates and other uncertainties.

Apollo runs a unique private credit model that is asset-heavy and operates off its own balance sheet rather than relying solely on fundraising. At the heart of the model is an interdependence between Apollo, acting as the asset manager, and its huge insurance arm, Athene, which provides the parent firm with a waterfall of money to invest.

While Apollo pioneered the use of annuities as a massive source of funds for private credit more than a decade ago, its rivals have followed suit in recent years. In fact, alternative managers’ investments in insurance have grown so large and so quickly that they have raised regulatory concerns about transparency and potential risk.

With Athene accounting for about half of Apollo’s $631 billion in assets under management, two-thirds of its credit AUM, and most of its income, Apollo easily qualifies as more an insurer than an alternative asset manager.

It’s an identity with which Apollo executives aren’t entirely comfortable. Like its peers, the firm wants to remain a one-stop shop for institutional investors eager for exposure to every major alternative-asset class. So Rowan has tried out different ways to describe Apollo, saying it’s in two primary businesses — asset management and retirement services — and referring to its focus on investment grade credit as a “a fixed-income replacement.”

Athene is almost exclusively devoted to providing fixed annuities for future and current retirees — a business in which it leads all U.S. insurers. This year alone, Athene expects to write up more than $60 billion in annuities, driven by higher interest rates that make the product more attractive to retirees.

Retirees buy annuities from Athene, which turns over a portion of the premiums to Apollo to invest and collect management fees. Almost all this money is deployed into investment-grade credit, much of which Apollo originates either in-house or through one of its 16 so-called origination platforms.

Apollo has spent more than $8 billion buying or building these independently run firms. These entities provide asset-backed loans to companies in industries where they have longstanding experience. Thus, an Apollo originator might specialize in debt financing to midmarket companies or airlines or car-leasing firms that are willing to pay the originator slightly higher interest rates to cover the illiquidity of these loans that banks often won’t provide.

Athene uses these investment to generate returns owed to policyholders. The insurer keeps the spread left over after subtracting the money it must pay to cover future annuity payments plus its own operating expenses and an asset management fee to Apollo.

These spread-related earnings for Athene accounted for $873 million in the third quarter of this year. That’s far more than the $474 million that Apollo collected from asset management fees.

The strategy also allows Apollo to syndicate a portion of investment-grade loans to other insurers and investors.

Athene has experienced spectacular growth, with annual inflows multiplying 16 times over the last eight years.

Growth is expected to continue at a torrid pace as the U.S. population ages and the number of future retirees swells. And because of penalties for redemptions, Athene and Apollo can count on virtually permanent capital for their private credit business.

Apollo points out that its private credit deals require alliances with banks that are lucrative for both sides. “The banks are strong on origination and short on long-duration capital,” says John Zito, deputy CIO of credit at Apollo. “That makes for a natural symbiotic relationship.”

Zito cites last December’s deal with Concord Music Publishing, a global leader in the music industry, as an example of the growing cooperation.

Concord secured a five-year, $1.8 billion bond backed by more than 1 million copyrighted songs and sound recordings. Concord, owner of music ranging from Rodgers and Hammerstein to Kiss, will use the proceeds to expand its own labels and acquire more music catalogues.

The deal was co-structured by Apollo and JPMorgan. In the past, the bank would have provided the financing largely on its own or in concert with other lenders.

What helped make the deal attractive for both Concord and JPMorgan was Apollo’s ability to use its own balance sheet to commit to the entire securitization rather than having it split among multiple parties. Apollo then turned over the majority of the bond to Athene and allocated the rest to several Apollo-managed funds and third-party insurance companies.

Big alts firms like Apollo can provide the kind of bespoke private credit deals that banks cannot handle on their own. In two transactions over the last year, Apollo injected a total of €1 billion ($1.1 billion) into Air France-KLM to help it finance engines and spare parts. Deutsche Bank collected the advisory fees.

Under the deals, Apollo bought perpetual bonds issued by Air France-KLM, which for accounting purposes were treated as equity purchases under the International Financial Reporting Standards. The airliner will also use the proceeds from the transactions to help redeem bonds issued by the French government that kept Air France-KLM aloft during the Covid-19 crisis.

For internal expertise on the airline business, Apollo relies on two of its origination platforms: PK AirFinance, a specialist in aviation finance focusing on aircraft engine leasing, which Apollo acquired from General Electric; and Merx Aviation, a commercial aircraft leasing unit created by Apollo.

In October, Apollo signed yet another bespoke deal with Air France-KLM — for a €1.5 billion financing to strengthen the firm’s Flying Blue loyalty program. Deutsche Bank and Barclays will collect the advisory fees.

“Again, billion-dollar commitment, one-stop shop, and bank advisors,” Zito says.

Blackstone arrives at the same private credit formula, but with a very different business model.

For years, Blackstone’s private credit consisted almost entirely of distressed debt. Then in 2017, by shifting to direct lending, its growth accelerated sharply. Today, direct lending is the biggest driver of private credit operations.

Though still largely linked to middle-market debtors, direct lending by alternative asset managers has taken bigger business clients that used to be serviced by banks. At Blackstone Secured Lending Fund (BXSL), the current average EBITDA of its 180 portfolio companies is $183 million. And nowadays, direct lending is also increasingly a key source of debt funding for leveraged buyouts.

Blackstone already has $1 trillion in total AUM and predicts that within a decade, private credit alone will account for another $1 trillion in AUM.

While insurance provides an important source of capital and investment-grade credit for Blackstone, it has a lesser weight than at Apollo. Opting for an asset-light approach, Blackstone doesn’t own insurance firms, preferring instead to take less than 20 percent stakes.

“We like to have a fortress balance sheet so that we can take advantage of market situations,” says Dwight Scott, global head of Blackstone Credit. “And we don’t want to assume all the liabilities that come with being an insurance company.”

Another key part of the Blackstone private credit model is that it relies on wealthy individual investors to a far greater extent than Apollo and other rivals do. The retail component accounts for half of Blackstone’s private credit business.

To handle retail investments, Blackstone created two of the largest BDCs — privately held Blackstone Private Credit Fund (BCRED) and publicly listed BXSL. Both BDCs have consistently delivered more than 12 percent annual returns to investors.

Here again, direct lending plays a major role. Retail investors are attracted to direct lending deals because they involve floating interest rate debt, senior liens, and a big brand name.

“So we can tell a simple story for retail investors and deliver,” says Scott.

In most cases, that story is told through giant distribution partners like Morgan Stanley, Merrill Lynch, and UBS, who agree to promote Blackstone private credit products to wealthy individuals through their financial advisors and brokers.

Direct lending has the biggest potential for conflict between private credit purveyors and money-center banks. Nowhere is this more apparent than in leveraged buyouts, once the almost exclusive domain of Wall Street banks. The role of direct lenders in LBOs has accelerated dramatically during the recent period of high interest rates.

Blackstone estimates that this year private credit has accounted for 80 percent of LBOs, but it says that banks have been amply compensated for a loss of underwriting fees by rising advisory fees.

“It’s not just a zero-sum game,” insists Blackstone COO Gray.

As an example, Blackstone points to its funding in September of one of this year’s largest LBOs — the $3 billion merger of HealthComp Holding Co. and Virgin Pulse. The deal will provide health care plans for more than 20 million members of over 1,000 self-insured employers.

Blackstone originated the deal and split it between BCRED and BXSL. While Blackstone collected the bulk of the underwriting fees, JPMorgan Securities acted as financial advisor to HealthComp, and Evercore, an investment bank, advised Virgin Pulse.

Even when banks don’t participate in a private-credit-led deal, they can expect to benefit further on. One such case involves Westland Insurance Group, a property and casualty insurance broker that aspires to break out of its regional stronghold in British Columbia and become Canada’s leading independent insurance firm while remaining under family control.

Westland was unable to secure bank lending for its expansion plans. So, beginning in 2021, it turned to Blackstone, which over the next two years supplied $1.4 billion in loans and equity investment from Blackstone Credit, including a credit facility dedicated to funding the insurer’s acquisition strategy.

In April, Westland announced that Blackstone would exit its investment. In its place, the Ontario Teachers’ Pension Plan — through its financial partnership with BroadStreet Partners — invested $1.38 billion for an undisclosed stake in Westland.

Meanwhile, thanks to its rapid growth, Westland plans to expand borrowing for its operational expenses from its traditional Canadian and American banks.

No one doubts that stricter regulatory requirements have reduced the underwriting role of banks. And the crisis this year created by the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank ensures that further increases in regulatory capital requirements are on the way.

But a growing chorus of analysts and financial advisors faults Wall Street lenders for failing to adapt fast enough to the rise of private credit and settling instead for risk-free advisory fees.

“Banks haven’t been responsive enough to new trends in their industry,” says Richard Bove, a longtime banking analyst now at investment bank Odeon Capital Group. “They just didn’t demonstrate imagination.”

Only recently is this changing, as money-center banks press ahead with development of their own private credit operations or seek out nonbanking partners. Recent such tie-ups include Wells Fargo with Centerbridge Partners; Société Générale with Brookfield Asset Management; and Barclays with AGL Credit Management.

Even JPMorgan, despite Dimon’s remonstrations, has recently beefed up its own private credit fund at JPMorgan Asset Management to more than $10 billion, and, according to Bloomberg, it is seeking an outside partner.

“They realize they’ve got to get in front of this evolution,” says Augusto Sasso, global head of capital markets at investment bank Moelis & Co. “At the rate at which funds are being raised, private credit will probably double within a year.”

Among Wall Street banks, Goldman Sachs, through its asset management arm, has surged ahead of rivals in private credit operations.

Goldman has been in the news lately for the wrong reasons. The legendary Wall Street investment bank has run up multibillion-dollar losses in a failed attempt to become a Main Street bank as well. And CEO David Solomon has faced swelling employee discontent after a headcount reduction of several thousand this year.

But there is little to fault Goldman for in its private credit dealings. It began private credit operations almost three decades ago and uses its investment bank to originate deals.

“We work together with our M&A team, our leveraged finance team, and hundreds of bankers around the world covering the private equity industry,” says James Reynolds, global co-head of private credit at Goldman Sachs Asset Management. “And that’s what other banks are trying to emulate.”

In a sluggish year for mergers and acquisitions, Goldman participated in its biggest private credit deal in the U.S. to date. In July, KKR & Co. sold its portfolio company, RBmedia, the largest audiobook publisher in the world, to H.I.G. Capital, a private equity company and alternative asset manager.

Goldman advised RBmedia and provided half of the $940 million financing for H.I.G., with KKR covering the other half.

Despite an uncertain economic outlook and what looks like a prolonged period of expensive capital, managers of private credit find it hard to stifle their enthusiasm.

Reviewing Apollo’s strong third-quarter financial results, CEO Rowan told analysts: “Almost everything in our business works better with higher rates.”

But there are plenty of risks ahead for both lenders and borrowers. To begin with, private credit will have to compete with risk-free, long-term Treasury bonds with yields of 5 percent or higher.

No doubt, the higher rates have given alts managers an ascendant role over banks in financing mergers and acquisitions. But they also make it increasingly difficult for alts firms and their private equity clients to dispose of previously acquired assets and pay back investors.

“Overall, we’ve been highly selective in terms of realizations, and activity is likely to remain muted in the near term given the environment,” Blackstone chief financial officer Michael Chae recently told analysts.

Commercial real estate assets are especially vulnerable. In the aftermath of the Covid pandemic, office vacancy rates are at their highest levels in decades, with little prospect that they will soon come down. Since much of this real estate was acquired with floating-rate loans, landlords are squeezed between falling revenues and rising interest payments.

Even alts managers that invested only in the most upscale, desirable office buildings and shopping malls face difficulties in refinancing loans that are maturing. One example is Brookfield Property Partners — the real estate subsidiary of Canadian alts giant Brookfield Asset Management. BPP has already defaulted this year on office building loans in Los Angeles, New York, and Washington, D.C. And S&P Global Ratings has warned that it may reduce BPP’s credit rating to junk status.

Alts’ portfolio companies also face concerns. Their private credit borrowings — almost all of them at floating rates — are registering interest payments that are gobbling up revenue and diminishing profits. Still, the non-accrual rate — the percentage of companies that missed loan repayments — is low.

But the bankruptcy of private-equity-backed radiology provider Envision Healthcare Corp. in May was a shock. It was one of the worst losses ever for KKR, which acquired Envision for $9.4 billion just five years ago. In October, a U.S. bankruptcy court approved a reorganization plan that will allow Envision to cancel most of its $5.6 billion debt.

Moody’s baseline scenario calls for speculative-grade loan defaults to increase to about 6 percent in 2024. UBS predicts a 10 percent default rate in private credit next year.

These glum forecasts are sparking calls for more regulatory supervision over private credit — something alternative-asset managers claim is unnecessary.

“We have permanent capital that comes from retirement services products and sophisticated investors who sign up for illiquidity and duration,” says Apollo’s Zito.

Other alts managers worry at what they see as a growing tendency by critics to lump banks and private creditors together simply because they both engage in lending.

“Removing bank deposits just takes a click of the phone, while our liabilities are match-funded to our assets,” says Blackstone’s Gray. “So we really shouldn’t be regulated the same way.”