From Equity Research to Financial Crises: Examining the Growth of Private Credit | 8min snip from Alt Goes Mainstream: The Latest on Alternative Investments, WealthTech, & Private Markets

Speaker 2
Thank you, Brett Zabaya. Likewise, it's a pleasure to have you. You have an incredible background and I think something that's laid the foundation for a lot of the things that you write about these in services. So I'd love to cover from the start, how you got into the world of finance, starting your career as equity
Speaker 1
research analyst, and how did this lay the foundation for the path that you'd go down? To be honest with you, it's a fairly well -drawn path. I left college, went into investment banking, founded myself in equity research, and was allocated European banking sector to cover. It was actually an interesting time. This was mid -1990s. Europe was not as equitised as the US. Banks had been through a crisis in the early 90s in some regions of Europe, there was a spate of privateizations that I was able to cover in the late 1990s, which provides a really interesting grounding. It provided a very interesting introduction to how banks work and where they sit in the context of the broader economy.
Speaker 2
From your background covering banks then, how do you think about banks today, particularly as the alternative asset management world encroaches
Speaker 1
on traditional banks territory? It's a really interesting point. It's something I'm very focused on. There have always been shadow banks. There have always been players that have entered financial services from outside the financial system. Retailers, for example, a lot of the innovations around consumer credit, credit cards in particular, came out of department stores, retailers. The auto industry, they say even today makes more money doing car financing than it does selling cars. I looked recently at the airline industry to understand how air miles work, big part of an airline profitability. Ultimately, they are minting a currency the same way that a bank might be perceived to, and they are able to monetize that as well. There have always been shadow banks in some form or other, and the latest combination of that is alternative asset managers. Where do you think this goes? So as I say, it's always been there. There are periods where regulators in particular are fearful. Often it comes from a place of caution. Often it comes as a result of the experience that we all suffered in 2008 -2009 where shadow banking was in a different format. And policymakers write once or twice a year, financial stability reports. And they're great reads, by the way, they're great reads to understand where policymakers think the risks are that the Fed files one, the IMF files one, Bank of England, the ECB, the Bank of Japan. In combination, they're really interesting reads. They all highlight private credit as being something they think they should be looking at more carefully, but they all struggle to really identify what the risk actually is. Because ultimately, you've got a funded structure where long -term money is funding long -term assets. We learned in the collapse of Silicon Valley Bank in March, 2023, you've got one of the kind of common features of all banking crises is they stem from areas that people think of as being risk -free that turn out not to be risk -free. In 2007, 2008, it was AAA subprime. The fact that it was subprime is not relevant in this context. It had the imprimatur AAA. Eurozone crisis a few years later, again, sovereign risk, seen as being bulletproof. And similarly, the notion that retail deposit has kind of got a long duration was pulled into question at Silicon Valley Bank and First Republic in March 2023. Ultimately, what a bank is doing is it's funding long term lending with short term liabilities. The most kind of mechanisms to obviate that, but that's really what it is. The flip side with private credit is actually its long -term liabilities that are funding long -term assets. The mismatch is there, and the risk is therefore muted. Will Barron So then you
Speaker 2
don't think this is a systemic risk? I've got a number of rules of thumb. One
Speaker 1
of my rules of thumb is wherever you see excessive growth, financial services, anything grown like a weed in financial services, it's normally too good to be true. And in fact, every systemic crisis, every company crisis in financial services through history has come from excessive Most obviously, excessive credit growth, for example, 2007 -2008, what was interesting about 2023 was excessive deposit growth, which doesn't exist in a vacuum. Those deposits have to be invested somewhere. And so you see that also, whenever source of growth, it's a source of risk. That tells me where to look. So I will look at private credit, because it has been growing very rapidly, as the policymakers also look at private credit. But it tells me the vulnerability, it doesn't tell me the outcome. I will look at private credit as a source of risk, but a slightly deeper analysis, I think, ticks off some of the areas of concern.
Speaker 2
What would get the hairs on the back of your neck to stand up in terms of things you'd look for to say, okay, this is not just excessive growth, but there might be a real issue here? If
Speaker 1
we peel the onion, why is growth in and itself, such a red flag. I think about financial services businesses as platform businesses, two -sided marketplaces, whether it's a bank that is matching deposit funding up with investment opportunities, be they loans, be they government bonds, whether it's a private credit enterprise that's similarly matching up a demand for end investors, asset owners to invest in private credit, maybe for some kind of yield pickup, with the opportunity to place that. And typically, what the issue with growth is, is that it's very difficult to maintain an equilibrium on those two things. So to answer your question, it's not one thing, it's the combination, is there an equilibrium? Can we match up that appetite for credit? And it feels like that can actually go a lot higher because allocations to private credit are still relatively low compared to the overall assets are under the control of end investors. Apollo will say that both of those markets are enormous. If you think about what's available on banks' balance sheets to extract, that's a huge market on the one side of the platform and on the other side of the platform, what asset owners have available to allocate to net liquid fixed income alternatives is also very high as well. So there's plenty of upside in that equilibrium.

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