Leon Black had hardly chosen the easiest moment in American history to try to start a bank. It was 2010, the year when more financial institutions failed than at any time since the US savings and loans crisis of the 1990s. Yet amid the upheaval, it dawned on the billionaire founder of Apollo Global Management that he had a chance to transform his private equity firm into a pervasive financial force.
No longer would Apollo confine itself to buying companies and loading them with debt. The firm could instead become part of the basic plumbing of the financial system, lending money in its own right and allowing borrowers to bypass the battered banks that had just received a $500bn bailout.
A decade after Mr Black’s epiphany, he still has not set up a bank — but what he did not create, he has instead transcended. Hiring former top executives from Countrywide Financial, American International Group and other perceived corporate culprits of the financial crisis, Apollo built a credit division that has taken over the role that traditional financial institutions once played as lenders to millions of ordinary American households and businesses.
Emulated by peers including Blackstone and KKR, Apollo’s $200bn credit portfolio is among the slickest operators in America’s “shadow banking” industry, churning out everything from residential mortgages to aircraft leases and commercial real estate loans. It has become a vital source of funding for heartland businesses that many banks now consider too difficult, or too risky, to touch.
The new lending operation prospered mightily until the coronavirus pandemic sent American credit markets into a tailspin in March, with even the US Treasury bond market — the linchpin of the global financial system — creaking under the strain. As the coronavirus crisis closed in, the firm’s co-founder Marc Rowan sought a hearing with the Trump administration for his ideas about how the US authorities should respond.
With jobs evaporating and businesses forced to close their doors, the US Federal Reserve intervened decisively in early April, backstopping corporate and municipal bonds as well as various asset-backed securities.
The Fed’s actions have stabilised financial markets after brutal sell-offs and disruptions last month, offering some breathing room to the battered American economy. But one of the consequences of the flood of freshly minted dollars has been to buoy prices of credit-related securities similar to those held or managed by Apollo and its peers.
That has left Apollo and its $200bn credit portfolio exposed to a potentially divisive debate about the implications of the Fed’s approach.
Many in finance believe that Mr Black’s credit operation is a vital part of the economy, supporting jobs, reducing mortgage costs and freeing large banks to focus on utility-like activities such as running the payments system and lending to Fortune 500 companies.
But the decision to set up credit facilities overseen by the Fed was also swiftly denounced by Democratic Senator Elizabeth Warren, who said it had “failed to even put in place basic protections” to make sure the money reached workers rather than wealthy executives. Ms Warren had already put forward a bill to stop Wall Street “looting” and fundamentally reform private equity, ideas that may gain momentum once the immediate crisis has passed.
Meanwhile, the Fed’s intervention has even unnerved some of those who might expect to benefit from it. “Who’ll do the buying for the government and make sure the purchase prices aren’t too high and defaulting issuers are avoided?” asked Howard Marks, the billionaire co-founder of Oaktree Capital, in a letter to clients this month. “Or doesn’t anyone care?”
Whether it resuscitates the Main Street economy or merely stanches losses at some of Wall Street’s biggest institutions, the Fed’s move demonstrates that private capital managers have transformed American finance in more profound ways than many of them care to admit.
More than 10 years after a banking bailout that angered taxpayers and curtailed lending, the “alternative” investment industry is no longer a niche outgrowth of the mergers and acquisitions business. Lightly regulated and operating largely outside public view, firms like Apollo have become a central part of the US credit system — one whose complexity and financial health has policymakers worried about a new form of contagion.
For Mr Black, launching a bank in the middle of a financial crisis was not a fanciful ambition. Since starting out at Drexel Burnham Lambert under “junk bond king” Michael Milken, the former investment banker had become one of Wall Street’s inveterate winners. When Drexel collapsed, Mr Black had somehow come out on top, buying beaten-down junk bonds from the bank’s former clients and turning huge profits as the market recovered.
As the leveraged buyout game became crowded, Mr Black wanted to play a different game. So he set about hiring talented individuals who knew how to raise money at low interest rates and deftly lend it out for more, even if the companies they had helped run were not always entirely unblemished.
One early find was James Furash, a veteran of Countrywide Financial. While his former boss, chief executive Angelo Mozilo, chased new loans that ultimately killed the company he had founded, Mr Furash had run Countrywide’s banking arm. This was a “separate, independently regulated entity from the mortgage origination business at Countrywide,” he says, “and never purchased subprime loans of any kind”.
Another recruit was James Belardi, a former swimming champion who had made his first fortune as an investment wizard at SunAmerica before it was acquired by AIG, only to end up losing a chunk of his personal wealth when America’s biggest insurer fell victim to the mortgage crisis. Others came from struggling or defunct investment banks such as Merrill Lynch or Bear Stearns.
“Historically, your career options were to work for a European bank, a Japanese bank or US bank, and that was it,” explained Mr Rowan, the key architect of the shadow banking expansion, at an investor day last year. “All of a sudden, you and your 20-person team can come to Apollo . . . Being in a business that is focused on taking these things out of banks, I believe, to be a very, very good strategy.”
Apollo’s team ran into opposition. No sooner had their life insurance venture, Athene Holding, got off the ground than Mr Belardi began confronting questions from New York regulators about whether he and his team were taking too much risk. Still, at least they were in business — unlike the plan to launch a bank, which was dead before it started.
One reason may have lain in Washington, where officials were stung by popular discontent over financial industry bailouts. “For two years, we tried to create a bank,” says one person who was closely involved with the effort. “We gave up. The regulations were so onerous that if [Apollo] controlled the bank, the whole private equity fund could be on the hook.” (Apollo says a fund it managed once considered buying a bank, but abandoned the idea for economic reasons.)
With Athene raking in billions of dollars of annuity premiums, however, Apollo realised it did not need savings and checking accounts to fund its ambitions in the credit markets.
Stripped back to its essentials, the banking sector exists to borrow money and to lend it, two functions that sustain more or less the entire system of economic exchange.
The bank’s borrowings, or “liabilities”, take the form of deposits, which offer savers a minuscule interest rate but guarantee that their money will be available when they want it. Its assets, meanwhile, are generated by lending money to people or businesses, for periods ranging from weeks or months to an entire adult lifetime, against security that could be a house, a jet plane or nothing at all.
Apollo’s shadow banking operation serves the same basic functions but it performs them selectively, in a manner calculated to generate the highest possible returns. Its lending businesses focus on specialist forms of financing that command higher interest rates because they do not trade on liquid markets and require expertise to underwrite.
“Our strategy is to be the GE Capital of the future,” Mr Rowan told investors last year, referring to the industrial conglomerate’s once-envied position as senior lender to salt-of-the earth businesses. “If you think about what [GE] lent against, they lent against planes, trains, automobiles, medical equipment, dealer floor plan [used car inventories], franchises, and so on.”
To generate those assets, Apollo executives ventured far from their offices on the high floors of a skyscraper overlooking Manhattan’s Central Park. Decamping to drab office parks in American suburbia, they built banal-sounding companies and recruited an army of low-ranking loan officers and risk managers, who spent the past decade quietly inserting themselves into the finances of thousands of families and businesses.
In the Washington DC suburb of Bethesda is the headquarters of Midcap Financial, which takes money from Apollo clients and lends it to nursing homes, grocery stores and other midsized businesses. In Thousand Oaks — a neighbourhood that looks practically the same, though it is thousands of miles away, in California — is Amerihome, a company started by Mr Furash, which has used Apollo’s firepower to become the sixth-largest provider of mortgages to American homeowners. Other affiliates specialise in jet leases, franchise loans and other attractive niches.
And if Apollo is picky about the assets it accumulates, it has been positively inventive about how to pay for them, eschewing deposit funding in favour of the annuity premiums raked in by Athene. Like savings accounts, these typically pay 2 or 3 per cent a year on the amount invested, but they have one big advantage: customers typically cannot demand quick access to their money.
Apollo’s life insurance affiliate was drawing in a long-lasting pool of capital to lend out at interest rates that would cover payments to policyholders, and perhaps an additional 3 or 4 per cent return for itself. It was the financial innovation of the century. Between Athene and two other listed affiliates, as well as its institutional funds, Apollo has built up a lending operation that manages $200bn of assets and is still growing fast.
Until coronavirus struck, nothing could dim the fortunes of Apollo’s financial dynamo.
On the eve of the financial crisis in 2008, Apollo managed less than $20bn in its credit funds — too small to register on the Apollo partners’ paycheques, let alone the agendas of the Fed officials charged with keeping credit flowing.
Today, the $200bn figure is a substantial share of the $2tn of lending that analysts estimate has moved outside the banking sector over the past decade, much of it to companies such as Apollo, which are now widely identified as shadow banks, even if Mr Black has objected that he “hate[s] the term”.
Apollo, which is overseen by numerous regulators and makes regular stock market disclosures, says its credit businesses “are visible, transparent and distinctly not in the shadows.” Still, the firm would face even tighter regulation if regulators deemed it “systemically important”, a badge that larger asset manager BlackRock, fought hard to avoid.
Mr Black’s firm has told investors that such a designation is “unlikely”, but that if it happened, it would lead to heightened standards relating to capital, leverage and “risk management and “being subject to annual stress tests by the Federal Reserve”.
For now, however, Apollo hopes that far from submitting to such oversight, it will be able to wield influence of its own.
For a firm that has built its credit business on a bedrock of more complex and illiquid debt securities, the stakes are high. In an unscheduled conference call in late March, Mr Belardi, the Athene chief executive, sought to reassure investors by emphasising his company’s strong credit rating and pointing to Apollo’s record of making sound investment judgments. Still, Athene estimated its markdowns this year could total between $1bn and $2bn compared with the $1.3bn in profits it tallied in 2019.
In a presentation circulated among investors late last month, and in private correspondence with President Donald Trump’s son-in-law, Jared Kushner, Mr Rowan urged an expansion of the Fed’s purchases of securitised debt in order to unfreeze the capital markets, according to people familiar with the discussions.
In early April, with unemployment soaring to levels not seen since the 1930s, the US authorities announced interventions that were even bolder, in some ways, than what Mr Rowan was suggesting. With equity from the Treasury as a backstop to cover any losses, the Fed would buy securities linked to some junk-rated corporate bonds, leaving few taboos unbroken in Washington’s effort to resuscitate the economy.
There is no suggestion that the Fed was responding to pressure from Wall Street firms. Yet memories of the last crisis are still raw, as is resentment at the ensuing bailouts. As policymakers push the boundaries of even those dramatic rescues, it is a sensitive time for the asset management industry, some of whose members have resisted tighter regulation, to be seen receiving even an indirect benefit.
Apollo says the Fed has not taken the action it advocates, which would involve buying securities across the investment-grade market. “The various Apollo credit funds,” it adds, “have in fact received minimal — if any — benefit from any of the announced Fed programmes.”
However, in the days surrounding the announcement of the Fed’s intervention, shares in Apollo and its affiliates soared.
Athene, which lost two-thirds of its value in five frenzied weeks in February and March, has since traded as much as 90 per cent above its March 23 low, although it has fallen back a little recently. Apollo shares, which at one point had halved, now change hands for about 80 per cent of their January high.
Compared with businesses that cultivated banking relationships before the last crisis, only to be abruptly cut off when access to credit mattered most, clients of Apollo’s shadow banking operation have been relieved to find that money is still flowing. Midcap has honoured its commitments to dozens of borrowers, allowing them to draw down on life-saving credit lines, while Athene in mid-March provided a $133m mortgage to fund a developer’s purchase of a tower on Wall Street, and Apollo has delivered rescue financing to the likes of Expedia and United Airlines.
It is a performance that will be closely watched by regulators, who must decide whether a new breed of lenders are becoming as indispensable as the systemically important institutions they supplanted. For the titans of finance who prospered in the shadow of the global financial collapse, this even more destructive pandemic is a genuine crisis — but some of them sense that it is also a time to shine.
