A MESSAGE FROM BREGUET

We’re currently living through a colorful era of mixed metaphors in the credit markets, which, depending on whom you listen to, is either rollicking along after years of unprecedented growth or careening toward a correction. In his latest memo, Oaktree co-chairman Howard Marks referred to “cockroaches in the coal mine”—combining the idiomatic canary with JPMorgan Chase C.E.O. Jamie Dimon’s recent observation about the bankruptcies of First Brands Group and Tricolor Holdings. “I probably shouldn’t say this,” Dimon said, “but when you see one cockroach, there are probably more.”

Marks, whose distressed-investing firm will soon be 100 percent owned by Brookfield Asset Management, an alternative-asset behemoth that competes with the likes of Blackstone and Apollo, offered a little clarity about his metaphor. “Both the cockroach and the canary can be precursors of problems ahead,” he said. “We’ve heard both sayings in use in the last month, and we’re likely to hear them more.”

Marks was his usual pithy self throughout his latest missive, wondering whether a new credit crunch is upon us, citing the old Wall Street adage that the worst of loans are made in the best of times. He acknowledged a growing litany of worrisome data points—the bankruptcies of First Brands and Tricolor; the recent filings of two small telecom firms under common ownership, Broadband Telecom and Bridgevoice; and revelations by a regional bank, Zions Bancorp, that it would take a $50 million writedown because two of its corporate borrowers had misrepresented material information and were unresponsive to subsequent inquiries—noting that while two high-ish–profile credit problems could be a coincidence, six high-ish–profile credit problems might constitute a trend.

In a potential allusion to Hemingway’s famous line about a bankruptcy occurring “gradually, then suddenly,” Marks offered a new insight: “In real life, things fluctuate between pretty good and not so hot. But in investors’ minds they go from flawless to hopeless.” In effect, Marks suggested that it was worth hitting the pause button on all the hand-wringing about the private credit markets. “The truth is that there are always defaults and not infrequently defalcations (how’s that for a good old-fashioned word?),” he wrote.

A MESSAGE FROM BREGUET

Marks waxed on with historical context. “Over my 47 years in the high yield bond market, more than 2 percent of all bonds by value have defaulted in a typical year, and many more during crises,” he wrote. “If you apply that percentage to the number of sub-investment grade issuers, which runs in the thousands, it shouldn’t come as a surprise if there are a few dozen defaults in a normal year. So no, I don’t think this is necessarily the beginning of a trend. It’s not an indictment of the whole sub-investment grade debt market, or the whole private credit market. Rather, it’s just a reminder that the yield spreads people care about so much are there for a reason: because sub-investment grade debt entails credit risk. And thus a reminder that credit skills are always a necessity for debt investors… even if the need for those skills isn’t apparent in good times.”

In his note, Marks also reminded the industry that “good times lead to complacency, risk tolerance, and carelessness, as people bid aggressively for assets and compete to make loans.” I think Apollo C.E.O. Marc Rowan would agree. Indeed, this seemed to be the very message that he wanted to convey on the firm’s recent third-quarter earnings call. Rowan acknowledged the concerns about the credit markets following the bankruptcies of First Brands and Tricolor (by the way, Apollo made a killing by shorting the First Brands debt) but essentially said things couldn’t be much better at Apollo, noting that the firm’s assets under management at the end of the third quarter were closing in on $1 trillion—$908 billion, to be precise—up 24 percent year over year. “In short,” he told research analysts, “the growth flywheel is spinning.”

Apollo, he said, was “fortunate” to be in an industry “experiencing very strong demand” for its products, chiefly private credit these days, with a twist of $150 billion or so in private equity. “Companies like ours and others in our industry do not get to be big unless we are attached to fundamentals in the economy and essentially are a source of secular growth for our country and for the world,” he observed, arguing that demand for capital has never been stronger thanks to what he called the Global Industrial Renaissance, “whether it’s infrastructure, energy, energy transition, data centers, defense, new manufacturing, or robotics.”

Apollo is also benefitting from other trends, according to Rowan, including a so-called retirement crisis, which he described as a “gap” in retirement income “almost everywhere in the Western world.” His firm provides a way to close that “gap,” he said, through the annuities issued by its insurance subsidiary, Athene. Apollo also claims to be able to provide other investors with “excess return per unit of risk,” one of Marc’s favorite sayings. “We provide an alternative to increasingly concentrated, correlated, and indexed public markets,” he said. “If you want to escape the Mag 7, but still want to be invested, it is very difficult to do efficiently in public markets.”

During Rowan’s reign, Apollo has gone from mostly providing private equity offerings to institutional investors, to satisfying the exploding demand from institutional investors, insurance companies, and traditional asset managers for both private equity and private credit. (Individual investors will soon be allowed to invest in alternative assets via their 401(k)s, too. Caveat emptor!) “For an industry that has grown pretty large over the years, we are now anchored by three really powerful secular trends that serve a fundamental good, not just in our economy, but in the world,” Marc said. “Private assets are becoming more and more acceptable and more and more in demand.”

Not that Rowan doesn’t worry. “I believe our industry will find that it is limited in its growth by its capacity to find good investments rather than by its capacity to raise capital,” he said. “It is incumbent on us to focus on origination—to make sure that we grow origination quarter over quarter, and that we really do respect the fundamental principle of our industry, which is excess return per unit of risk.” (There’s that phrase again!)

In the end, he also subscribed to the Dimon-Marks theory that, though there may be a few cockroaches, this is still a damn great business. “Credit is credit,” he argued, “whether it’s originated by a bank or an asset manager, it makes almost no difference to me. There are fundamentally good underwriters of credit, and there are less-good underwriters of credit. The observed outcome of a number of articles and the focus on a couple of isolated incidents in the marketplace is nil. Ten basis points of spread widening is essentially nothing.” As he noted later in his remarks, “If you look at the recent blow-ups—and we all know the various names—almost all of those blow-ups have taken place in credit underwritten by the banking system. It is not that we have public credit and private credit. We have credit. The difference between public credit and private credit and bank credit is literally whether it is syndicated or not. There are good banks; there are bad banks. There are good asset managers; there are bad asset managers. There are good insurance companies; there are bad insurance companies. I don’t think we’re talking about systemic risk.”

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