Apollo Global Management Analysis – February 2024

Private equity firms have relied on institutional investors to raise money to (usually) buy distressed companies, turn them around and sell them for a profit. This old way of fundraising is slowly dying. Several PE firms have acquired or bought stakes in insurance companies. Using premiums, they funnel money into leveraged, risky and illiquid assets. It is reminiscent of the banking industry before the financial crisis of 2007-2009. The logic is simple, since insurance companies don’t have deposits, its harder for there to a be a ‘run on the bank’, therefore it can prove to be a good vehicle to invest in long-term, higher-yield products. And because the insurance industry is mainly regulated by states, there are no consistent rules on capital standards, risk assessments or stress-tests. Some asset managers even create private debt by lending to their affiliated-insurer. Insurers also buy up ‘securitized’ products like collateralized loan obligations (CLO) and asset-backed-securities (ABS), which can be bought in investment-grade tranches but are backed by risky loans. Today I will look at Apollo Global Management and Athene, an insurer it merged with in 2022.

“Originating private credit assets to sell to its Athene annuities business, other insurance companies and individual investors is crucial for the firm’s growth”

“Apollo generated more net income in 2023 than it did over the previous decade as investors poured money into private credit amid higher interest rates and volatile public markets, including slower leveraged-loan and high-yield markets. More than 80% of the firm’s assets under management are in credit.”

Fixed income and other net investment income (FY2023): $8,739m
Fixed income and other net investment income (FY2022): $5,706m
Cost of funds (FY2023): $5,650m
Cost of funds (FY2022): $3,755m
“20% or $43 billion of Athene’s portfolio is invested in floating rate assets, 12% or $25 billion net of floating rate liabilities”
““Cost of Funds” includes liability costs related to cost of crediting on both deferred annuities and institutional products as well as other liability costs, but does not include the proportionate share of the ACRA cost of funds associated with the non-controlling interests.”
“”ACRA” refers to Athene Co-Invest Reinsurance Affiliate Holding Ltd, together with its subsidiaries”
Non-controlling interest: $11,189m

“Spread Related Earnings grew 26% in 2023 driven by higher floating rate income, robust organic growth trends and strong new business profitability, partially offset by lower alternative net investment income.” Floating rate assets will stall or decline in value with federal reserve policy decisions over the next year. If rates remain flat, it could affect market conditions and company valuations. Ratings downgrades could force companies to pay more interest. A default would cause a surge of surrender/withdrawal policies. A cut in rates would reduce income from floating rate assets. Cost of funds might turn out higher than income.

FY2022: “Losses during the year were driven primarily by unrealized losses on reinsurance assets within the Retirement Services segment, resulting from rising interest rates”

Level 1 accounting: “Quoted prices are available in active markets for identical financial instruments as of the reporting date.”
Level 2 accounting: “Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies.”
Level 3 accounting: employed for assets without clear value
Total Assets – Retirement Services FY2022:
Level 1: $11,588m
Level 2: $102,927m
Level 3: $45,582m

The share of total assets with a level 3 designation among ten insurers owned by investment firms is 19%, almost 4 times the insurance industry average.

“Spread Related Earnings, Excluding Notable Items in 2023 included a 7.2% return on Athene’s alternative investment portfolio; considering management’s longterm expected annual return of 11% would have resulted in $451 million of additional alternative net investment income”

Structured securities make up 29% of bonds on the balance-sheets of private-equity-owned insurers, compared with an insurance industry average of 11%.

“Approximately 58% of Apollo’s total AUM is comprised of perpetual capital, which is highly scalable and does not rely on cyclical fundraising dynamics”
Athene makes up $278bn out of $378bn of perpetual capital assets under management.

Average net invested assets Q42023: $207,312m
Average net invested assets – fixed income: $195,448m
Average net invested assets – alternatives: $11,864m

Credit quality of available-for-sale securities:
97% of fixed income portfolio in investment grade assets.
48.8 % of total in AAA/AA/A
38.6 % of total in BBB

“’BBB’ ratings denote good prospects for ongoing viability. The financial institution’s fundamentals are adequate, such that there is a low risk that it would have to rely on extraordinary support to avoid default. However, adverse business or economic conditions are more likely to impair this capacity.”

“For investment-grade corporate bonds, demand from annuities and other investors catering to retirees are helping to keep valuations high. The average risk premium, or spread, on a company note rated BBB- or higher is 0.95 percentage point”
“Over the last two decades, spreads have averaged closer to 1.49 percentage point, according to Bloomberg index data.”

Annuities are the main driver of income at Athene. People seeking higher returns are buying annuities while interest rates are high to lock in a better rate. But what would happen when interest rates go down? Demand for annuities will dampen but the nominal amount paid out won’t drop. Athene’s bond portfolio will increase in price while interest rates fall (price and yield are inversely correlated) but after that buffer is gone, they might have to continue paying out those higher-rates on policies agreed to over the last 2-3 years. And that might be difficult to sustain if Athene’s fixed income portfolio can’t replicate yields achieved during a high interest rate environment. “If the sector of the market that an annuity is linked to suffers in a recession, the annuity can perform poorly and even lose money.”

One last concern is that private equity firms generally deal with highly-indebted or distressed companies. A large portion of investment grade debt is going to mature this year and next, if bonds mature and are renewed, these companies could be facing hefty interest rates.

I do not own any shares or options of any company mentioned in this article.

Sources: Yahoo Finance, Globe and Mail, the Economist, company annual/quarterly reports

———————April 2025 Update——————-
Apollo has borrowed $15b from the Federal Home Loan Bank of Des Moines. Historically FHLBs have been used to increase homeownership by lending against housing assets. FHLBs dole out loans to banks and insurers that own them. In practice it acts as a subsidy to loans, providing cheap loans (with a similar yield to America’s treasury) to entities that were never meant to be beneficiaries like Apollo’s Athene insurance business. As I understand, Apollo uses assets as collateral to receive cheap funding that can be funnelled into private credit funds turning short-term borrowing into long-term illiquid buyout funds.