Joshua Easterly, Co-Chief Investment Officer and Co-president, Sixth Street, Carey Lathrop, Partner, Chief Operating Officer, Credit, Apollo Moderator: Shawn Tully, Senior Editor-at-Large, FORTUNE


Future of Finance 2024: Future Areas of Growth in Private Credit

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We're going to put up briefly, that should be helpful in understanding the immense scope of private credit. And you see all of these categories. Uh They're endless practically rail car infrastructure, agricultural lending, movie lending, uh inventory financing goes on and on. We don't have to get into all the categories, but just to give you an impression of how big this is. So the question I have for you guys is uh we'll start with, with uh with Josh, how did this enormous, not a pond? It's an ocean, be mistaken for a pond and fly below the radar for so long. Well, first of all, thank you for having me here and uh I can be more excited to have uh sure stage with Apollo. Um look, this was the intended consequence, not the unintended consequence of the regulation that came out of the global financial crisis, which was um policymakers woke up one day and there was a $700 billion put that they wrote for the global financial system or us banks and they wanted to figure out how to diffuse risk away from the taxpayer and away from the FDIC. Um And so you couldn't crush the economy by reducing credit. And so the private credit industry grew. Um the private credit industry actually has a I think a better model, more, more robust model holds more capital uh for the loans that they have on their balance sheet. Um has better funding, match funding. So, so more robust model with less risk without a taxpayer put uh so I think this was the intended consequence. Yeah, and but it's been mistaken for the high yield market, leverage loans. Could we go through that? Uh Sure. And first I wanna thank you. It's been a while since I was referred to me as young. So thank you. But um I think what Josh said was correct. I think there's a supply and a demand element, you know, and you know, we maybe we'll get into the demand for um you know, some of the uh the assets that you had up on the screen. Um But as the screen showed a number of people think about private credit as uh financing, maybe middle market uh loans and that is a, a portion of the market. But as that slide showed, it's a very small portion of the market and in Apollo, a large portion of what we do, which I think surprised a lot of people is actually investment grade risk. So when you looked at a lot of those categories, those assets generate um in investment grade um funding for um uh for us or that we provide to those uh to those originators and very attractive assets for our insurance balance sheet as well as our funds. So I think there's just a misnomer that private credit is a high yield or leverage finance market, which a portion of it is. But the large majority of what you had up on the screen actually is investment grade risk. And a lot of that, as Josh was saying, drives economic growth and prosperity. So we're lending to not just small companies but large companies as well. Yeah, and how did the the problems with the regional banks and the smaller banks that we've seen since the SVP collapse? How has that affected your growth or the the migration of assets to the alternative managers which had, of course, this trend started way before that the great financial crisis was it accelerated with these issues that the banks have had with capital essentially fleeing. Uh My, my view of it is is that it, it really showed the robustness of the business model, which was banks, business models are the lim long and borrow short and what kills financial institutions tend not to be an asset quality issue but tends to be a liability quality issue. And so banks have weak liabilities in the sense that you can go and take out your dollars anytime you want. And so it, it, I think it showed the value of our business model both from a, you know what we do for the economy, but what we do for investors because we don't have that asset liability mismatch. Uh and allows us to be a really good stable counter party for the issuer on the other side, which is we get to keep on supporting that company or supporting that asset class or supporting that originator. Uh uh And uh our capital is more durable. So I I think that was a watershed moment for the value of the asset class, both for the investor and for the, the end user of capital. And the one thing I would add again, think about like the assets that created some of the problems last year. They were, you know, HQ L A, they were treasuries and you know, mortgages, they just had long duration and to Josh's point, you just have this mismatch where you long gated assets or liquid assets with short term liabilities. We don't run a business that way we're much more, much more match funded. But I think the other misnomer about, you know, again, leverage, finance versus investment grade assets is we're not looking to disintermediate the bank. In fact, if anything, it's the opposite, like Mark Rowan will say we don't want the bank's client, we want the asset and I think the the banks or the uh entities that are smart and forward thinking realize our balance sheets are virtual extension of their balance sheet. They can use our balance sheet, which those assets have a more natural home and still kind of do all the other things of cross selling that they wanna do, uh, and own the client, but let us own the asset on our balance sheets. Right. So, are the banks working more? Did you? I think you guys would put it in the, uh, in the moving business, not the storage business. They're getting fees, they're doing originations, but then you're parking the, the assets with you. Is that pretty much what's happening? I, I think that's part of it. I think the banks, the regulatory regime of banks is the regulators want banks to not have the, the risk waiting asset system wants them to be wholesale financing sources for the private credit industry. That is the, that is actually what they want them to do. And so the, you know, the they already have hundreds of billions of dollars out to the private credit industry in wholesale financing. And I think what they really want to do is provide other services to that are capital, light services to the clients. So if it's, you know, liquidity management, checking 401k, all those types of services that we're not in the business of servicing, but they really want the assets to be in a different place. I wanted to go back also because you asked, you know, I think this is still the early innings of this game playing out because again, if you think about it, if you're a bank and you're kind of looking at your asset liability match you probably if you went back five or 10 years, you're like, ok, I have this deposit and it's going to be here for a long time, so I'm comfortable buying this long dated or a liquid asset. I think what we've all realized with just the speed of what happened last year is all of us can literally before this panel is over, withdraw our money from the bank and it just forces the banks to kind of get out of the business of holding either very long dated or illiquid assets because they don't have the liability structure that our firms have. Right? Um It's always amazed me too that you're, you're competing with the uh with the, the bond market too, the publicly traded bonds because the definition of private credit is it not publicly traded even though it's a gigantic asset class. Um But what I've always found amazing is you're able to get higher yields on the same duration. In other words, the length of maturity and the same credit quality for the rating agencies, the same ratings on these bonds as uh the public markets, but you get an extra 100 or 200 basis points in yield. Can you explain how that, how you're able to, to derive those, that those premiums? It, it's, I think it's perceive its value, it's not only perceived value but its value to the issuer which is banks are in the moving business, which when they talk to an issuer, they say, hey, we don't know where your bonds are gonna price. We'll underwrite them. We'll either do it on a best efforts basis or we'll do it with caps. And so your range of outcomes is X plus Y. Uh The private accredited industry basically says we will own that risk at X, That X is going to be wider than the tights, but probably inside the caps. And so that extra economics plus the origination fee gets economically picked up to the to to to the uh investor or the private credit provider. But there's real value of certainty being provided to the issuer. There's also less friction, there's, you know, you know who it's not going to be held in the markets, you know who your lender is, you are dealing with one counter party, you don't have to go through a ratings process. And so it's, it's all about value to the end user. And that value is just not captured in a single number of of spread number. It's captured through the process. It's captured through certainty, it's captured through ease of use. You know, I I think I would just echo the size speed and certainty there like we're not private credit is not going to eliminate like public markets. It's actually a compliment to them. And there are, you know, some assets So uh a triple B or a single A company needs to borrow money. They're just going to go to the investment grade market and blow that, you know, issue through the, you know, through the pipe. There are times that markets, you know, start to seize up a little bit as we saw in 22 and 23. And you may see some activity that maybe in a more benign environment would end up in uh public markets, end up in private markets. But I view it as a compliment to public what public markets. And again, even if you went back in time, like you think about the evolution of the investment grade market, high yield market, the tradable loan market, I think the private credit market is just that next, you know, evolution of assets and activity migrating out of the banking system into the, you know, pub the public if you will hands. Yeah. Also I know that both of you have specialized teams that many of which came out of the banks that specialize in rail car financing, airplane financing, leverage loans, numerous categories. And you got these teams on the ground, finding the best deals and the banks have lost those teams g credit. Many, many other organizations can you go through? Um Josh, the advantage that you have or the edge that you have with these specialized teams that uh uh that, that you have in house. Well, I think the, the the bigger I look for us, our competitive advantages are people and culture. And you know, hopefully we've tried to build a culture and we, we've had the opportunity to build a firm of firms only 15 years old to kind of build it in a new world where collaboration really matters. And so we've been able to, we have that 3.0 version of the alternative asset management firm. But the real issue is not only is capital changing in the regulatory framework for for banks, but that's led to, I think a little bit of a brain drain from DNA from banks. I started my career or middle part of my career was at Goldman Sachs. Before that I was at Wells Fargo Carry was at city for a long time. And there's a flow of talent, not only senior talent but junior talent away from banks and into our system. And that's ultimately what makes a difference that in culture and I would add in addition to people and culture, you know, we think one or two of the things that differentiate us is one, the Athene insurance balance sheet which has structural liquidity. It's raising seven and 10 year liabilities which allows us to take illiquidity or structure risk because we don't need daily liquidity, maybe like a mutual fund does and we capture that incremental 100 or 200 basis points. The other would be our origination platforms that we're actually we can create the alpha ourselves and you know whether it's then you know, those assets end up on the insurance balance sheet in the funds, some of those assets end up in the in the market. But being able to leverage off of the 16 origination platforms we think is, is differentiating alongside having uh a the balance sheet and the structural liquidity that comes with it. Yeah, it seems to me you guys both left major jobs and major banks. How did you see this thing coming so early? Because you immediately went into this business with you. You're coming, going to a policy. I thought of necessity. To be honest. I mean, I like I was sitting inside a business that ultimately survived in Goldman Sachs, but there was a vocal rule and it was, I remember I was sitting with my boss, there's a guy named Harvey Schwartz who now runs Carlisle and he says to me, hey, Josh, do you think the Feds gonna want Goldman in your business in, in 2000? This was in 2009 and I'm like, huh, I think I need to go find another job. So that, that mine was out of, you know, a little bit of a necessity. And I kind of joke around. I said Sixth Street wouldn't have been born if it wasn't for I was 32 years old and too dumb to think it was gonna be hard and the global financial crisis. Um look, I, I like to, we were joking with uh before this, like Josh was the founder, like I jumped on the band with, I'm a slow learner but, you know, I obviously knew Apollo and similar firms because they were, you know, great partners and clients of the firm. But, you know, it was clear how hard it was to get things done that made economic sense in, in the, in the bank environment versus, you know, I think both of our firms are probably more commercial and how we make decisions and how we price risk. Ok, guys. Thank you so much. A great job.