At its investor presentation back in November, John Zito, Apollo’s deputy chief investment officer of credit, predicted that as much as 10 percent of the $2.5 trillion high-yield loan and bond market would go private over the following five years.
With its $12 billion direct lending partnership with Abu Dhabi’s sovereign wealth fund Mubadala announced in July, the mega-manager appears to be moving in earnest to capture a bigger share of that growing market. And by bulking up its corporate credit team, it is wagering that it can make the right bets originating big billion-dollar loans and holding them until the syndication market rights itself.
In the meantime, the platform, called Apollo Strategic Origination Partners, gets to collect hefty fees for underwriting all the risk. Assuming it does not get stuck with any loans that go sour before the coronavirus-induced disruption in the collateralised loan obligation market abates, Apollo can win big.
“We’re going to be the only lender,” Zito told Private Debt Investor when the deal was announced, with the partnership planning to hold the loans to maturity. But that won’t preclude Apollo from eventually spreading the risk around while it maintains a majority share of the loans.
“For most of my career, there have been a lot of situations where we’re the largest lender,” Zito says, noting that the firm often contributes one-third or more to a $1 billion loan. But he adds: “There’s been a natural progression, where we can pivot to providing the company the entire amount.” With the potential to make loans of as much as $2 billion, Zito says the partnership expects to add 15 people to its 70-person corporate credit team by the middle of 2021.
Apollo’s existing direct lending platform to mid-market companies constitutes a fraction of the asset manager’s $210 billion credit portfolio, and of the overall $400 billion direct lending market. Zito indicates that although Apollo had been eyeing this market before the pandemic, the difficulties CLOs were having in doing new financings as a result of the virus increased its allure.
In the past few years, there have been “more entrants with more prominent platforms with scale to start to disintermediate the broadly syndicated loan market,” says Jeff Topor, a director at Cliffwater who leads the research and investment due diligence firm’s coverage of private debt.
During times of dislocation and volatility, having this kind of heft can be a “good value proposition”, he says. He adds that the biggest driving force for sponsors is perhaps to pay up for such loans “to get a deal done fast and provide certainty”.
But Zito indicates that the operation will be extending credit to companies “as they need liquidity”, not necessarily for the traditional sponsored buyouts that constitute so much of the direct lending market: “It’s the evolution of direct lending.”
Suhail Shaikh, head of US direct lending at fund manager Alcentra, views the move as “seemingly a continuation” of Apollo’s current strategy. “The size is notable,” he says. “It will take some market share away from the banks. Direct lending is definitely displacing some portions of the traditional broadly-syndicated loan market.”
But with the uncertain economic backdrop, Richard Wheelahan III, co-founder of Fund Finance Partners, an advisor to asset managers, speculates that the risk to Apollo’s strategy is in “concentrating the portfolio among a small number of borrowers, if the partnership is ultimately unable to sell down portions of the loans to other investors.” Assuming the CLO market comes back, “this vehicle could be a valuable source of new loan supply to various CLOs that are hungry for new collateral”.