In The Ring With Rob: Exploring the Golden Age of Private Credit | Howard Widra & Jurgen van Vuuren

I'm in Bethesda, Maryland, right outside DC.

I am, yes. Very much. Pretty safe bet.

Well, definitely the bigger rivalry now is Ohio State. When I went there, whatever centuries ago, it was probably pretty equal because we were playing Notre Dame every year and it's regionally a rivalry and also I think people view it academically as a rivalry as well. But for anybody under 40, I think it's all the Buckeyes. And unfortunately, the Buckeyes wrote some big checks this year, so they have a pretty good team. We'll see. I mean, Michigan did everything on the up and up honestly, without paying anybody and stealing any signs, and so we won our championship. I think the Buckeyes, although from what I understand in the new college football playoff, Notre Dame almost gets in automatically. So it'll be a good time for both of them. I sure hope so. Well, go Blue. Until then, we'll hope that Notre Dame turns it around. It's been too many years of pain for me, to be honest.

Sure. MidCap is a broad-based commercial finance company providing senior debt across a range of products in the broadly defined middle market. So we do leverage lending to sponsor-backed companies, we do asset-based lending, receivables and inventory to healthcare companies and general corporate companies, we do life sciences lending, lender finance, franchise finance. What you would think of as a commercial finance supermarket, like CIT or GE Capital or Heller used to be 30 or 40 years ago. There's not that many companies out there like that anymore who do it that way, but that's what the MidCap business is. But MidCap is also managed by Apollo. I started MidCap 15 years ago with five partners, and then we were purchased by an Apollo affiliate five years after, 10 years ago, and we became effectively the senior debt offering for Apollo. So Apollo does most of its middle market senior lending through MidCap. And because private credit has grown so much during that time period, my role in overseeing MidCap has also expanded generally to direct origination of private credit at Apollo. So I oversee MidCap, which is the core direct lending business of Apollo, but there's also a lot of other direct lending private credit businesses as well.

Yeah. So Apollo had a public BDC which was previously called Apollo Investment Corp, its symbol was AINV, which did a lot of opportunistic lending as BDCs tended to do from 2004 when it was formed. It was actually the first public BDC until like 2016 when I became responsible for it and the strategy changed to really become a public vehicle that takes some of MidCap's origination, mostly for its sponsor business. So we renamed it at some point during the last few years to MidCap Financial Investment Corp, which describes more of its asset class. And now it is a public vehicle that owns senior loans only. It still has some older investments that are still working off that MidCap also originates as well. So it's a way for retail investors to get access to some parts of what MidCap does.

Well, when we were out raising capital, we actually closed on our equity investment the day Lehman failed. So obviously it was a challenging environment at the time for finance. But it's actually the best time to start a finance company, which is at the bottom of the cycle, if you can get someone to support the company. We had a real advantage in building our business because we actually started the first day we started business with 27 people. 24 of them we had all worked together at our previous two places, Merrill Lynch where you had bought a business, Heller, prior to that. And so people viewed us as a restart as opposed to a startup. It didn't feel like there was a lot of execution risk if we could get the capital side of the business right. I think to investors and really to us as well, we were comfortable with each other and knew our roles, and that was really helpful. But then upon raising the equity, it was a real challenge to get debt capital, which is rarely the problem for finance companies, for the first 18 months. And we were just fortunate in that Wells Fargo had given us a soft commitment, not a legal commitment, to support the business as we were raising the money. And even as the market got worse, they lived up to that. So we were able to have some debt capital and build the core of the business. And the market started to recover in late 2009. So the biggest challenge to our business was getting enough debt capital to be able to do the type of lending we wanted, which was not high yield and risky but stable and senior, maybe just outside what banks were doing. But our senior team, which is still all together now 15 years later from starting, was our biggest strength and still is our biggest strength. Lots of continuity in our group.

A couple things. First, it's been a great time for private credit. It's been a lot of growth. There hasn't really been a credit cycle in the last 10 or 15 years, so lots of people have been successful. But with that said, obviously we've grown a lot. I think we have a couple nice advantages. One is that we have a lot of products. There aren't that many multi-product vehicles. A lot of people raise money through their funds or even at BDCs, they do one thing. And because we do a lot of things, we've diversified away a bunch of the risk of our performance. We have a lot of levers in terms of how we grow. We can accentuate certain products depending on where the markets are. In some markets, leverage lending; in other markets, it also gives us a lot of leverage to our performance. It allows us to diversify our liability structure because we're borrowing against a lot of different types of assets. And that is a real strength from an equity investor's perspective, a real strength of our business, and adds more stability. The other thing I would say, and I think because the credit cycle hasn't occurred, the strength of this hasn't proven out, but we're very disciplined on our portfolio makeup, diversified by product and by hold size and by geography and by asset class. And I think because private credit has become so popular, so many people have entered the space and I don't think have as much discipline of building the business. You mentioned before, a lot of these predecessor places having spun off a bunch of places. So a lot of the big lenders come from Heller initially, and you see a similar way of doing business to what I just described. And then you'll see a whole other set of private lenders that have launched in the last five or seven years that come out of leveraged loan desks of Wall Street, which have a different approach. They were agents before, they're more comfortable with different sets of risks, they didn't grow up with the same thoughts on portfolio discipline. I think that's a real advantage to our platform, and it may be underappreciated until there's a credit cycle. But we believe that stability is the calling card of our whole platform, and we try to build our whole business around that.

First and foremost, driving the growth is the performance of the asset class over the last 10 years. It's outperformed most everything from a return perspective without any mark-to-market volatility. Because private credit doesn't have liquid marks, it doesn't move so widely, so you get your steady return. And in fact, it's been an upward return because credit's been good and interest rates are going up. It provides a lot of stability. So there's been a lot of demand for the asset class. At the same time, it's a growing market. It's sort of interrelated, chicken and egg thing. So both ends of its market. Because banks are not lending as aggressively coming out of the Great Financial Crisis, they were regulated more heavily, and now with the Silicon Valley Bank issues a year ago, the amount of the market taken up by banks on pure lending has shrunk. And at the same token, private credit has grown and taken significant amount of market from the capital markets for broadly syndicated loans. So there is a significantly growing pie. So demand and supply are both increasing. That is creating a real secular change which is sustainable, it seems. That said, it may be that more capital is being raised than even can be absorbed by those changes, certainly at given periods of time, and so it is a competitive market. One thing I would point out is that when people talk about private credit, and certainly when you read articles in the financial press, it generally focuses on leverage lending, loans to sponsor buyouts. And that has gone in private credit from over the last 10 years from roughly a $100 billion market to a $1.5 trillion market. But we define, at Apollo, the private credit market as $40 trillion. So what's the difference? The difference is not leverage lending. Asset-based lending, royalties, railcar, anything. And capital is being raised in all of those markets, but in a less linear, obvious way because it's harder to enter those markets. And so the private credit opportunity, I think, will continue to expand and capital be raised. And as you see people raise capital, you start to see some of these more robust platforms diversify their asset classes as well. And it's probably the thing that Apollo has done most aggressively, just a lot of different tentacles into markets that are less penetrated.

Well, in the US, effectively any deal that has more than four times leverage, debt to EBITDA, is a classified asset. And sponsors want to leverage their deals almost always more than that, so it's almost definitional in many cases. There are some banks that have created some capability to do more of that, are willing to take the capital charges in certain cases, but by and large not. So that's one. And then the other reason, which is more recent, the last four or five years, is that these private lenders are now much bigger. So sponsors, if they want more certainty, they can come to someone like Apollo or Blackstone or Ares and say, 'I want to borrow $500 million. Will you lend to me between you and all your affiliates?' And we will be able to do that. Whereas there's pretty much no bank that can do that. So it's both scale and then the other traditional thing that non-banks say, which is true, is more fast, will decide quicker, easier to deal with, less regimented. But if you're a private equity firm and you want to borrow less than four times and you have a stable business, you will borrow from a bank. But that's generally not what private equity firms do.

I don't know. The market does not feel that concentrated. It feels very competitive because although those numbers are right, the biggest firms are raising the most money because the overall pool is increasing so much. A lot of smaller firms are raising a lot more money than they used to raise before as well. So if we see a deal that is a company has $25 million of EBITDA and is borrowing $125 million, we will have 40 competitors. If there's a deal that's $500 million, four times that size, we will have 10 competitors. So in some ways it's a more stable market, it's better for us, right? But there's plenty of competition at the lower end of the markets even though those are smaller companies. The anomaly is behavior starts to become irresponsible in terms of what people are willing to do. So if you ask me, outside looking in, not as a lender, what's the sweet spot of stability where people are lending responsibly and not looking? I think there's plenty of competition. If there were three, I'd tell you there's lots of market power, but there's not, and there's a lot pushing up every day. So I think the markets, there are plenty of competitors on the biggest side of the market. And look, there's lots of regulatory cost to raising these big pools of capital, raising retail, so there are some barriers. There's only so many people who are going to be able to do it. So there's an inherent concentration that is going to occur because of the cost related to doing this the right way. So I don't think it's inherently a bad thing of where it is right now. I think there's plenty of groups with enough scale to keep competition in the market.

I would agree with that. I used to joke, when we were a private lender, we were the lowest people on the financial totem pole. If you were at a cocktail party, and now we just wait long enough and now everybody wants to be in private credit. And you can feel that honestly, even in anecdotal ways in terms of what you do. And you also see it in the ways that people are redefining what they say they did in their careers to say they now do private credit. So from that perspective, it is a golden age in that way, that people want to be in it. And it's also there because of the reasons I said before. The growth in the market is huge. And if you compare it to other areas of finance, whether it's distressed investing, it's private equity for sure, there's just not a lot of headwinds to its overall growth. And it's because the challenge in the banking system and the advantages of private credit over the capital markets, it's more predictable, more available, less regimented. It's not as cheap as either of those two options, but that's it. And people are unlocking capital pools that allow you to continue to grow. So there's more retail money being raised, mostly in non-traded BDCs. There's insurance capital that is flowing into these asset classes either through securitizations or through other arrangements. And so that demand for the assets combined with the competitive alternatives being separated out, it is really a golden age. And I don't think you can draw a very conclusive case that it won't continue to grow quite a bit.

Activity has been slower in the private debt markets over the last six or nine months than it was prior, because there's less activity. And combined with the money being raised, there's more competition in every deal and actually pricing is coming in and activity is a little lower. For us, having diversified asset classes, yes, there's more value to be driven off some of the other asset classes, asset-based lending in particular. So we do try to make sure that we're as aggressive as possible in the areas where there's a little bit more greenfield to go. But the sponsor lending business is driven by M&A activity. That said, it was a very slow year of investing in private equity last year, and at some point there needs to be value unlock. So for example, now because the debt markets are becoming more competitive, there are more deals being done. And so there is some more activity even if there's less M&A, because there's companies looking, sponsors looking to generate some returns that way. So the money finds a way to get invested, and that's happening a little bit. But our market does move with the M&A volume, and our market is down a little bit. You would hear that from public calls for public BDC vehicles, everybody saying that the flow is a little slower.

Well, the flavor of the year that a lot of the big asset managers are marketing, including Apollo, is what they're calling asset-based finance. In our business at MidCap, asset-based lending is lending against current assets, receivables and inventory. That's always been a good business, takes a lot of people and systems to do. So mostly what people are referring to as asset-based finance are more hard collateral, either equipment or lending against pools of loans that other people have. So someone will have, for example, a pool of aircraft loans and lending against some tranche, so you're covered by assets as opposed to covered by cash flow. And those deals are private in that they're not CLOs that people can go buy out there. So that is the biggest asset class that not only you'll see big firms raising large pools of money, but also see being offered retail soon, if not yet, for a lot of people to be able to get access to. Very broadly defined, it really means lending at some level in the capital structure against something that if it's worth what you think it's worth, you would get paid out even if things go wrong. At Apollo, there are some big asset classes that we are focused on growing. Something we call securitized products, which is the senior lender to people who are gathering assets, whether they're consumer or real estate or commercial, where the bank market has stepped away from. So there's a really big business called Atlas that Apollo bought out of Credit Suisse which is growing a lot. So that's a really big business. And we have an aircraft business, an equipment business, and a trade finance business. So all of these asset classes that have traditionally been banked well but maybe are bank-less, we're expanding into and have good size to them.

Well, mezzanine debt is either equity risk with debt returns or it's debt risk with equity returns, depending on if you raise the money or not. I'm a senior debt person, so I tend to be debt focused. But mezzanine debt has not really had a renaissance yet from when it sort of dipped down a while ago, if only because there's a lot of unitranche lending by the senior lenders. So there's lots of options from the senior lenders to go all the way through the capital structure, and so the opportunities are less. It's not as large and robust a market. But certainly you definitely see it from time to time on transactions where a sponsor decides to take less debt and take on some mezzanine instead, and they get two lenders in the capital structure. So no, it is not a huge booming market because of that senior debt component where the senior debt is sort of sucking up a bunch of the opportunities. Leverage is lower now because rates are higher, so you can attach at lower points from a mezzanine perspective. Interest coverage is worse, but if interest rates go down, you're going to end up in a good spot. So from an investment standpoint, this isn't a terrible vintage to be a mezzanine lender, but I still think it's an anecdotal market.

I do think it'll grow a lot. So if you think about it, the whole ecosystem prior to this, private credit accessing retail, the way people got fixed income exposure outside government bonds is through mutual funds. So there's huge dollars invested in this category, it's just all through mutual funds. So if you just take a small percentage of those dollars and they move into these assets, it's not even close to percentage points penetrated. There would be a lot of money move over there. And in fact, one of the trends that you'll see which I think underscores what I'm saying is that all the big mutual fund companies, Fidelity, Vanguard, BlackRock, are launching significant private credit businesses because they have to offer that to their retail clients to keep them. So it is, I think, very early in the building of this pool of capital.

I think first, I'll get more attention at cocktail parties.

For a little while. And then, I guess my prediction would be, and this is unusual for me because I've said I felt like maybe I've been wrong for the last decade, which was that we've been preparing for a credit cycle for a long time and expecting some of that shakeout to occur. And I'm not so sure it's coming in the immediate future. It feels like the Fed will prevent it as much as it could prevent it and remain accommodative such that a recession doesn't occur and people don't feel it. So my prediction would be probably a little bit more benign than it looks like it should be based on the length of the lack of pain as well as some crosswinds in the economy. So I think we've got some runway in the medium term right now for it to remain normal. And this is coming from someone who would be fine with the credit cycle because I think we've teed our business up as best as we possibly can to absorb it.

Thank you.