The Solution to the Bank Lending Pull-Back May Be in the Mirror

This article was originally published in the Chanticleer column in Australian Financial Review on April 22, 2024.

Worried about bank loans turning into luxury items? The solution may be in your hands – or at least your superannuation savings.

That was the underlying message that Apollo Global Management’s co-president Jim Zelter pitched in Melbourne last week, telling the good and great of Australia’s $3.5 trillion super industry they are perfectly placed to help fill the gap left by banks that have been forced to limit their lending by regulation and, in some cases, poor returns.

Jim Zelter, co-president of Apollo Global Management, made a stealth visit Down Under earlier this month.

“You all are the banks of tomorrow,” he told a finance summit. “Your pools of capital, the long duration, and your ability to manage that – that’s the real secular trend that, as an investor in 2024, you need to be aware of.”

But what’s really remarkable is the breadth of ambition at Apollo, which has $US650 billion ($1 trillion) under management. This is not private credit as you might know it – the $US1.5 trillion global market in direct loans to companies that have become the default definition of the booming sector.

Instead, Zelter sees a market worth as much as $US40 trillion that encompasses “every asset on the bank balance sheet”.

“That $US40 trillion is what makes the economy work,” he tells this column. “It’s how you finance your planes, trains, automobiles, the franchise finance for the quick service restaurant – it touches everybody.

“And I think the real surprise to many people is that a vast majority of that private credit activity is investment-grade rated.”

This is a crucial point; Apollo is not looking to go out the risk curve by expanding the traditional remit of private credit, but will stay firmly in the realm of institutional-grade credit.

“Just because something is liquid doesn’t mean it’s safe. And just because something is illiquid doesn’t mean it’s risky,”

Zelter says.

While he carefully avoids any comments on the Australian banks, his visit coincided with growing concerns about the commoditisation of the banks, and retreat from risk, which has been called out by analysts and chief executives.

Barrenjoey analyst Jon Mott says the derisking of the banks is not just a concern for bank investors, but the broader economy.

“Banks are there to take risk via allocating capital to businesses and households and generate an economic return for shareholders,” he says. “If banks are forced to continue minimising risk, returns will continue to be competed away and capital will not be efficiently allocated to the economy.”

The Australian banking industry may have some unique features, such as the hangover from the Hayne royal commission and the extreme reliance on mortgage brokers, but Zelter provides context on a secular, global shift.

“It all comes down to return on equity and shareholder value. Banks have narrowed their businesses because they want to have a higher ROE and trade at a higher multiple. It doesn’t behoove the banks to be massively levered. They need to be much more efficient with the capital they have.”

To be clear, Apollo does not expect private credit will take all of that $US40 trillion market, and Zelter emphasises that Apollo has a symbiotic relationship with the banking industry.

“There’s this theme out there that we are in this dire fight with the banks – we’re actually in a much more co-operative relationship,” he says.

“If a company needs $100, it may be that the bank will give them $70 and we’ll give them $30. Now, that’s not like the bottom $30 – it’s still investment-grade risk.

“But where the bank may want 150 basis points over the funds rate, we’re lending at maybe 200, 250 basis points over the funds rate, and in exchange, providing the company with something they value that’s not offered in the traditional market – maybe something more structured, certainty of pricing, speed of execution.”

Zelter makes no secret of the solid returns from private credit. “I’m 61 years old. The S&P has returned 10 per cent a year since I was born. Today, If I can make what the S&P has made in senior secured credit, that’s probably a pretty wise move for the next few years.”

But it’s important to understand that Apollo’s push into this market began long before rates moved higher in response to post-pandemic inflation.

Fifteen years ago, Apollo started an annuities business called Athene (known as a retirement insurer in American parlance) and this “really forced us to think about how we were going to create safe yield at scale”.

One key feature of this business is that it’s long-dated nature of annuities means it could forgo some liquidity if it would generate better returns. That is, Athene’s clients don’t necessarily need all their money tomorrow, giving Apollo the opportunity to seek out higher-returning credit opportunities.

In theory, sovereign wealth funds are in a similar position. So are pension funds, college endowments and, of course, superannuation funds.

Or, as Zelter told the room of super fund bigwigs last week: “Thinking about that risk reward, do you really need that liquidity? Many of you [are] in the super fund industry, you’ve got folks that have money with you for 10, 20, 30 years. Does 100 per cent of it need to be liquid, every single day? I would argue that’s not a wise decision.”

The Australian super sector has put capital to work in the private credit market, and will undoubtedly continue to do so. But sitting on a panel with Zelter at last week’s symposium, UniSuper’s chief investment officer John Pearce said the sector did have to manage liquidity issues.

Fund members are getting older, fund choice means members can switch funds at any moment, and the COVID-19 pandemic showed governments are prepared to allow members to dip into super funds in some circumstances.

The debate about accessing super for housing could provide another example, Pearce says. “We have the capacity to take on long-term illiquid assets, but that capacity is not unlimited.”

While countless private capital giants have declared we are in the midst of a golden age of private credits, sceptics remain. In his letter to shareholders this month, JPMorgan chief executive Jamie Dimon warned that regulators would eventually force more transparency into private credit markets, and warned the sector was yet to face a real downturn.

“When credit spreads gap out, when interest rates go up and when some leveraged companies suffer in the recession, we will find out how those loans survive stress testing,” he wrote.

Zelter takes the point, but says the focus for regulators should be whether the right type of capital is matched with the right risks – and logic says long-term capital should sit with long-term risks.

“Look at any bank [earning report]; how much transparency is there on its corporate loan book? Almost none. I think there will probably be a greater degree of regulation, but I think it all gets down to what’s the genesis of your capital, and are you having asset/liability mismatches?

“In the post-Silicon Valley Bank era, with the ability to call your deposits from your phone, I think there are a lot of questions about what are the right types of capital regimes to own long-term risks.”

As for perceived risks associated with private credit, Zelter has heard it all before.

“Remember, a bank is levered 10 to one,” he says. “Every loan that comes out of a bank and goes into a sovereign fund or a pension fund or a managed account, basically has zero leverage. So, arguably, you’ve taken down the risk. This idea that private credit investors increase the risk in the system, we don’t see the logic in that.

“When people say there’s a looming disaster in private credit, we scratch our heads. Is there a looming disaster on bank balance sheets? We don’t buy that.”

Fair enough. But will regulators see it that way? Some, such as the Bank of England, have called for more data to help better understand potential systemic risks, particularly around valuations, which are obviously much harder to track than in public markets.

If private credit is to fill the gaps that the banks have left – and indeed have been incentivised to leave – then a regulatory rethink will be required.

James Thomson is senior Chanticleer columnist based in Melbourne. He was the Companies editor and editor of BRW Magazine. Connect with James on Twitter.