What is Apollo, anyway?

0:09Eric and Sujit, I have a question for you. What's the difference between a bank and an asset manager? Or for that matter, a bank and an insurance company? I know it's a good question because I got a couple of seconds of silence there. Okay, so we can jump in. We're going, man. So the first, hi, it's Sajid. The way to think about that question is to define what is a bank. and as a bank we think of a place where customers make deposits and put in cash and importantly they can get that cash whenever they want and that creates a little bit of an instability right because the bank takes deposits and makes loans which are due in one year or five years or 30 years, but their customers can get their money whenever they want.

1:02And that mismatch is the age-old puzzle of classical banking. What about an insurer, Eric? So an insurer has a very different model, right? While they are taking kind of cash in from policy holders, the claims that they're going to be paying out are for years, right? It could be 10, 20, 30 years for many of these policies. And so in that case, they actually have a very stable base of capital to use from. But traditionally, an insurer isn't in the actual asset management business. They've been writing these policies, and they've been often outsourcing the investment acumen to asset managers. It's an important question, and not just for philosophical reasons, because the big asset manager slash insurance companies, most notably Apollo, may be becoming more like banks all the time.

1:56This is Unhedged, the markets and finance podcast from the Financial Times in Pushkin. I am Rob Armstrong coming to you from the glorious Unhedged World headquarters in New York City. And I am joined by Sujit Indap, who is, remind me of your title, Sujit? Wall Street editor. Wall Street editor. Doesn't that sound powerful at the Financial Times? And down the phone from his apartment in the bucolic Upper West Side, Eric Platt, who is our, is it deals editor? Senior corporate finance correspondent. Senior corporate finance correspondent. These are the guys who make it happen at the FT. Welcome, guys.

2:39Thanks for having us. So you wrote an article today about how Apollo, one of the biggest private asset managers in the world, is going into an area of lending it hasn't been before, meaning lending to the very biggest U.S. companies. Why are they doing this and why weren't they doing it before? Trevor Burrus, Apollo, most listeners will probably know better as a private equity firm doing leveraged buyouts. But say over the last 15 years, its business has shifted pretty remarkably where it has both become an important life insurer and specifically a provider of annuities. Annuities aren't classic life insurance.

3:24It's just for regulatory reasons. Trevor Burrus, It's a retirement product. Trevor Burrus, Yeah, it's a retirement product. Trevor Burrus, You give me a pile of money. I give you a certain income stream for the rest of your life. That's right. And so first by accident and then by purpose, they are a massive annuities seller through a business called Athene. And as that business grew, they realized they could, on the other side of the balance sheet, become a much different kind of insurance or annuities investor. That business historically had been in dull investment grade bonds. And so in response to these trends, it became just a much more exotic but what it thinks is a safe lender.

4:08And that business, as we mentioned in our article now, has migrated to now being able to finance the biggest companies in the world. So again, just to make it crystal clear for our listeners, you run an annuities business. That means these nice retirees give you their savings. You take the savings and you invest it somewhere so you have enough return to pay for their retirement in little bits and to make yourself some money. You're a spread. Right? Am I getting the picture basically correct? That's exactly right. Why would a big American company, I don't know, an Intel, I guess was one of the examples that you used in your article, why would they come to an Apollo rather than just go into the good old American bond market and just issue bonds like big companies can and do at quite reasonable rates?

5:04So treasurers and chief financial officers are constantly looking at, you know, how to optimize their cost of capital. And so for many of these companies that are turning to Apollo or to its rivals who are pushing into this space, while they're high quality, the capital intensity or the needs that they have would start to test their ratings if they were to do this in just, you know, straight vanilla bond offerings. Slowing you down. If they borrowed enough money in the bond market, the credit rating agencies would downgrade them. Exactly. Hmm. And also, if you continue to raise so much debt in the bond market, your borrowing costs there, if your business wasn't, you know, scaling the same way, your borrowing costs would start to rise there.

5:46And so for many treasurers, they see this as a way to, you know, keep their traditional bonds, you know, trading at certain levels and price at a certain yield, then they can raise several billion more. But they're still borrowing. I don't quite get that. You go to this other place, you're still, the company's still more indebted. Yeah. So in the instance of Intel or Anheuser-Busch, which is another example we have in the story, Apollo is entering into a joint venture where they're essentially a 50 % partner in a specific project. In the case of Intel, it's a semiconductor plant in Ireland. In Anheuser-Busch, it's an aluminum can plant.

6:26And so they own half of this particular business in each of these instances. And so from From the Intel perspective, this investment isn't quite debt. And from the Apollo perspective, they essentially get a contract for specific cash flows. Those cash flows then are put into - Linked to a specific asset. Yeah. But those cash flows are turned into or put into like a machine. And what comes out of it essentially is a bond or a loan or an obligation, which is then put onto an insurance balance sheet. So there's a bunch of kind of financial engineering and gymnastics going on where the company gets something that looks like equity and not debt.

7:08And then Athene and Apollo, the insurers, get something that looks like a high-grade bond. Okay, I can imagine, Sujit, that our listeners, having listened to that explanation, which is probably as clear an explanation as one can give, are thinking this looks like financial chicanery. I don't even know if that's how you pronounce that word. I think I've only read it. Chicanery? In any case, that it looks like a bit like sleight of hand. And I think there is a general worry here, going back to the philosophical questions we began with, that the banking system we kind of understood. And it was making loans to people and they were quite straightforward.

7:52And then you get these Wall Street smoothies in there who put different names on things. And maybe there are risks here that we don't appreciate. I'm not asserting this. I'm just saying it would be a natural question to ask. I think that's an entirely fair question to ask. But ultimately, right, this is actually at its core going back to the kind of lending banks used to do to companies, right? These are contracts ultimately that get written up. And so the real question is, you know, how tight is the contract? How strong is it? Are the ratings that it's winning from rating agencies actually as pristine as they imply?

8:32Is it like asset-backed lending? Like, but this is what my mother was a local banker and as you do, like construction company has a huge crane. They need some money. They go to the bank where my mom works and they said, give us money. And if we don't pay you back, you get the crane. Is that, is this, is that what we're looking at here? Exactly that. Yes. Yes. And so that whole idea of senior secured safe lending is the entire basis of these insurance backed asset managers. Their assertion, and I think it's reasonably valid, we'll see how it lasts through like a real credit cycle, is that in fact, as Eric just said, this is secured, senior, equipment-based or asset-based lending.

9:18It's very similar to what GE Capital was doing 20 or 30 years ago. GE Capital obviously imploded for other reasons, but it was a very respected and important capital provider. Asset-backed lender, basically. And so even if there's a bunch of arrows being drawn and complexity, the ultimate underlying business here is ostensibly safe or safer. I would make the point, right, as Intel is having, in that example, having its own issues, right, trying to, you know, they're going through layoffs, their credit ratings have been on watch or have been threatened with downgrades. The Apollo project is tied to one specific project.

10:02So it's not being impacted by the wider issues of the company. And so to them, compared to the unsecured creditors, they have a claim on, you know, a factory that when it starts producing chips will have pretty contracted cash flows if all things go well and, you know, I don't know what happens if there's an earthquake in Ireland and the factory is hit. Let me circle back then to the question I began with. Are Apollo and its peers, the KKRs and the Blackstones of the world, are they becoming banks or not? They are resembling banks in two ways. One, they are taking customer savings. And two, they're transforming those savings.

10:48The term is maturity transformation, and that just means lending. So they are doing a banking - So borrowing short term or borrowing. Maybe we've hit the point. They're borrowing and lending. Yeah. And the idea is, though, with a bank deposit, again, And you and I can go to the ATM and take our money out. And sometimes there are bank runs. See Silicon Valley Bank. An annuity agreement is much more complicated. You can get your money out, but not at an ATM. And so it's supposedly stickier capital that is more aligned with the longer-term horizon of these investments. And so this conceptual question is really interesting.

11:26And we'll see how it plays out. And maybe just a question of which regulator should be overseeing Apollo. Well, you hit on the next question I was going to ask there, Sujit. One of the salient features of a bank is that it has regulators crawling all over it. We have three major bank regulators in the United States. If Apollo was a bank, it would have all three of those regulators crawling all over it all the time. given that Apollo is taking savings from mom and dad and turning them into risky loans and taking a spread. That sounds a lot like a bank to me. Is there a case that these things should be regulated more like a bank?

12:13Well, we should talk about the regulation that they do face. And so as an insurer, There's something called the NAIC, which is the National Association of Insurance Commissioners, I think, which sets the capital requirements and is kind of a broad market force. And then Athene is domiciled in Iowa as well as Bermuda. You and I, Rob, once did an insurance conference in Bermuda several years ago. And so those regimes oversee insurers. They worry about capital. They worry about the kinds of investments insurers are making. There is a real effort now amongst these regulators to understand the private equity or private capital model and how that's different and what risks it may or may not introduce.

13:05So it exists. It is different. And it has not been tested. But to suggest these firms are unregulated is not totally accurate. How new is what Apollo is doing now, really? Is this something that needs a proper rethink in terms of how investors think about it or in terms of how regulators think about it? Or is this, you know, the old wine in a new wineskin? Yeah. So insurance is not a new product. Obviously, there's been insurance for a long time, life insurance for a long time. There's always been the question is where do you invest the premiums? And in life insurance, it's an interesting product.

13:46It's different than property and casualty insurance in that you know from actuarial science when people are going to die or going to retire. And so with that knowledge, you can invest with some confidence. And so insurance companies typically, though, were relatively conservative investors sticking to like investment grade bonds. And that was OK for a long time. But then we had the financial crisis and interest rates went to zero for several years. And that crushed traditional insurers because they were owing money at like 5 % or 6 % roughly. And now they were investing in investment grade bronze at like 1 % or 2%.

14:25And that was a problem. And then that is how Apollo and its ilk came onto the scene. They had their legacy historically in leveraged buyouts. But they had the inkling that they were sophisticated investors just generally. and the fixed income markets were just much more massive. $40 trillion is like investment grade, the investment grade market now, which is probably as big as anything there is. Far bigger than like equity investing, certainly leveraged by investing. And they thought if we were just a little bit more creative and maybe slightly more aggressive in how we invested, we could actually generate the returns that policyholders needed and make a nice return for ourselves.

15:08And that insight is what has created a theme and a series of copycats that we know exotic investing structures, which are not riskier, but they're more liquid. They're a little bit more complicated. And that's going to be way better than investing in IBM corporate bonds. There's a counterpoint I think that might be helpful for listeners that I think about a lot and why it's important, kind of why they're focused on annuities. Is that, like take Berkshire Hathaway, right, which is really dominant in auto insurance and property and casualty. The issue with those claims is a natural disaster is much harder to predict than someone's life expectancy.

15:51And so the investment strategy makes it much harder to be invested in long-term securities. Berkshire runs hundreds of billions of dollars of short-term treasury position for this very reason. That's something that these private equity-backed or private capital-backed insurance groups don't have to contend with. They've got relatively predictable outflows eventually of when they'll have to make payments on these annuities or other structures. And so because of that, they have a lot more leeway in terms of where they think they can deploy this cash. Eric, let me put the final question to you. when you listen to a big shot at one of these asset managers talk, Mark Rowan, say the CEO and co-founder of Apollo, they say when a loan is done with them, is done by them instead of by a bank, that actually makes the financial system safer for two reasons.

16:54One, we don't have as much leverage as a bank, and two, we don't have demand deposits as a bank. So it's a bonanza for the American financial system that this business is growing because as it grows, the system gets safer. Do you think that's true? It is a great question, and I don't mean to waffle on it, but I think broadly it's true, but I think there are real questions about what if we see policy holders actually, there's a mechanism for them to get paid out early and to redeem their policies. We've seen that tested a bit, I believe during the pandemic and redemption rates didn't spike, which meant this is permanent capital in some sense.

17:37And so yes, to that point, it does make the financial system safer. You've moved this risk to retirees, which is perhaps a better outcome. So you don't need the government to step in if a bank gets hit with, you know, non-performing loans. But then again, a retiree now will be taking that risk. Sujit, I don't like the sound of moving risk to retirees. Sujit, do you have thoughts? Yeah, I mean, I think the other thing we have to see is that the investments in these private capital-backed either asset managers or insurers are in things like structured finance, CLOs. Yes. And those are, again, senior secured financings, but they are structured and they are a little bit more exotic.

18:25And we just don't know through a true credit cycle how they will perform. And so that part also remains to be seen. But again, there is something to be said for getting away from the traditional banking model where deposits can be withdrawn at a moment's notice and on the asset side, you're in illiquid mortgages or something you can't get out of quickly. And that is, again, the age-old question of banking. On that note, we'll be back with Long and Short.

19:11Welcome back. This is long and short. That portion of the show where we go long things we like, financially or otherwise, and short things that we do not like. Sujit, do you have a long or a short for us? I'll go with what I wrote for Lex yesterday, which was Boeing. And I'm kind of a long here at the Mo. No, only because the stock has been battered so much and they've got these planes they can't deliver and now there's this strike. And they actually are going to need to raise capital, most likely equity, because they have no more debt capacity at an investment grade rating. But you think they can pull it off.

19:49Well, the thing is, the problem for most companies or businesses is that people don't want their products. So there's not enough demand for them. The question with Boeing is they've got a$450 billion backlog. There's like real orders. They just can't make the planes. And theoretically, that's like fixable. It's a solvable problem. They just have to relearn how to make planes and they'll be fine. Yeah, just get some more people out of trade school who know how to bolt something down. And if they figure that out, the planes are going to get delivered. So maybe at this low point, it's a time to get in.

20:24I love it. Eric, after that hilariously stupid long call, what do you have to say for yourself? You know, so I am long the Murdoch drama that's going on in Nevada right now. Love the Murdoch drama. Give us like a 15 second recap of the drama. Yeah, so the drama is, right, the trust that will ultimately determine, you know, who takes control of News Corp might be rewritten. And so it might actually go to one child as opposed to being equally split. And when you look at the numbers, actually, this is a very profitable media company at a time when most people are down on traditional printer digital media news.

21:07So I'm long. You like News Corp. You like the drama? I like the drama, and I'm excited to see this get turned into the next television show. Well, if you come for contrarian ideas, you just got two of them. Listeners, thanks for listening. We'll be back in your feed later this week. Unhedged is produced by Jake Harper and edited by Bryant Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free.

21:52A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Rob Armstrong. Thanks for listening.

22:13Thank you.