If you follow Apollo casually or closely, you’ve no doubt heard the banging of the “origination engine” drum. Well, I believe Apollo’s latest deal to acquire some of the assets and team associated with Credit Suisse’s Securitized Products Group (SPG) may be a bigger deal than current information lets on.
Why? A few points to make on SPG:
- It is really good at what it does.
- It’s likely to be really big.
Platform Quality
Apollo signed a definitive agreement to pick up a portion of CS’ notable Securitized Products Group this week. While all I have to add is speculation, since it likely won’t be reported on by Apollo until the GS financial services conference in December, or potentially Q1 earnings given the moving pieces, I figured it might be helpful to put some thoughts down on paper.
First, what is known: The SPG group is, or was at least, a marquee group at Credit Suisse. It was ranked #1 in all US securitizations, including RMBS, pass-throughs, and agency CMBS in 2018. It participates in the consumer, commercial, residential, commercial RE, transportation, renewables, and “other” alternatives buckets. Basically, the full gamut of the ABS landscape.
Within SPG, it is important to know that the business is made up of:
- Origination
- Distribution
- Market making
Obviously, Market Making does not qualify as a piece of the business that Apollo will pick up, as it is in the business of longer-duration fee streams that have lower volatility than a trading business (which is inherently deeply episodic). So it is likely that Apollo is picking up the entirety of the Origination business and perhaps some or all of the distribution business (which it can fold into ACS).
But more notably, Market Making made up roughly 1/3 (or perhaps more) of the revenue stream. There has also been a whisper that SPG printed north of $1B in profits during bumper years. One can presume these bumper years were driven by the Market Making group capturing outsized spreads during volatile times. Alas, the fee-based (and balance sheet) origination business was likely less volatile, though a growing portion of SPG’s focus.
There are numerous mentions of how the group was a star in the portfolio. Its actions are emblematic in many ways of Apollo’s culture of distress investing. Here are views of SPG’s participation in the liquidation of AIG and Fannie’s toxic asset pools:
Credit Suisse often commented on SPG specifically on earnings calls:
“I think it’s fair to say, and I actually said this on the Newswire call this morning, that the trading environment, which we had in the first quarter a year ago, was extremely favorable for the mix of businesses we have, particularly around securitized products…”
“Securitized products continue to outperform, especially in our #1 ranked asset finance franchise and non-agency trading businesses.”
“Jay Kim, who runs the team, is spending more and more of his time in Asia. And there is a huge upside there. If you think about what [securitized products] has done for us in the U.S., you can imagine in Asia.”CS Transcripts
Alas, I personally believe that the trail of evidence indicates that this was a good business. However, notable leads have left over the past years, and while Jay Kim (the current leader) has been part of the group since 2012, it is to be seen how solid the group is in its current form.
Might be a Beast…
For the sake of argument, let’s use MidCap’s rough figures to guide our calculations. MidCap does roughly a 13% ROE (normal times) and is leveraged 4:1. If SPG made ~$1B in good years, let’s say that the origination engine pumped out ~$500M of that (50% market making share to be safe). And let’s say the business generates a 15% ROE, though I have a feeling it may be higher. That would mean an equity base of $3.34B. And that would mean a gross loan base of roughly $17B if one presumes similar leverage to MidCap (not uncommon to see consumer ABS lenders leveraged 4:1 as well).
And given ABS’s relatively short time horizons on the loans, let’s say 24 to 36 months, one needs to turn over nearly half the asset base in new origination to stay flat each year. So perhaps SPG originates ~$8B to stay flat. However, for context, MidCap appears to originate ~$4B / quarter (~$16B / yr) on an asset base of $11B, or ~50% more than its gross asset base, given substantial syndication via structured securities, 3rd party investors, BDCs, etc. In this vein, SPG origination may be dramatically higher, perhaps up to $25B, if its syndication engine is of similar or better strength versus MidCap (which seems entirely possible, if not highly probable).
To put the scale in perspective, the three-party Wheels, Donelen, and Fleet Lease transactions now total $7 billion in assets and $4 billion in annual originations, and Apollo was thrilled with this. If SPG is at the low end of my semi-truck-sized range of origination numbers ($8B), it would be a large addition to the portfolio. But if it is at the high end of my comical range, it is an absolute monster and would be the largest platform in its quiver.
Disclaimer: We own shares of Apollo. Do your own work, this is not investment advice.