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Friday interview: Gilles Dellaert
Gilles Dellaert, who runs Blackstone’s credit operations, joined that firm in 2020, having been co-president and chief investment officer at Global Atlantic. He began his career at Goldman Sachs and JPMorgan. He sat down with Unhedged recently to discuss the forces pulling loans off bank balance sheets, how private credit earns premium spreads, and why Blackstone (unlike some peers) has not bought an insurance company.
This interview has been edited for length and clarity.
Unhedged: Describe the business that you run.
Gilles Dellaert: Blackstone brought together nearly all of our credit and lending activities into one centralised business unit earlier this year, which we refer to as Blackstone Credit and Insurance. Including our real estate debt business, it’s about $420bn of assets under management. It includes anything we do across credit and lending, from investment grade to high yield in public markets — leveraged loans, CLOs, anything like that — to private investment grade and private non-investment grade, that is, direct lending. It’s now a one-stop shop for borrowers, regardless of the type of financing they need. Short duration, long duration, liquid, illiquid, public or private. And so we do that across all sectors, all asset verticals.
Unhedged: Which is the biggest bit?
Dellaert: If you break down the business by asset profile, our private corporate credit, direct-lending business and opportunistic business, is in excess of $100bn. Our leveraged loan and CLO business, what we refer to as liquid corporate, is about $100bn, and real estate lending is around $85bn. The balance is in what I call structured finance, that is, asset-based finance. That’s what we call the private investment grade. Infrastructure, consumer and all of that.
Unhedged: It’s very evenly split.
Dellaert: It’s very well diversified and balanced. And I think people don’t necessarily always see that or appreciate the breadth of it, because they still think sometimes about, oh, Blackstone in credit was high-octane distressed lending. We’ve come a long way. As clients have asked for access to a broader set of strategies we’ve built that out. Similarly, it’s relatively evenly split across our three main client channels. Pension funds and sovereign wealth funds are around 40 per cent of the business. Insurance companies used to be small, but are now about 30 per cent of our business. And then the balance, around 30 per cent in individual investors.
Unhedged: I’m interested in the part of the business that is illiquid/speculative grade on the one side and insurance companies on the other side. It feels that we are witnessing a migration of what used to be a core asset of commercial banking over to asset management, and funding going from bank deposits to insurance premiums. Why is that happening at this particular moment?
Dellaert: We definitely agree that we’re seeing a structural shift across financing markets towards private financing. You saw it early in non-investment grade, where private equity sponsors started to borrow from private solutions providers as opposed to just taking a leveraged loan or turning to the public markets. That’s been under way for a few years now. What you’re seeing right now is the same trend is occurring in private investment grade. That’s where most of the inflows for us have been occurring. That’s really asset-based finance. Areas like infrastructure, consumer equipment finance, massive markets where you’re seeing the same trend play out. And so when people say “the rise of private credit”, sometimes they refer to it as just direct lending. We look at it as a much bigger picture.
Unhedged: It’s harder to understand, on the investment-grade end, what the advantage of a private provider is over a liquid bond market, or even a bank. The traditional story about the provision of private equity or private credit was that it’s a way of dealing with complexity. A lot of underwriting needed a lot of special contracting. What drives it with stuff as stable as an infrastructure loan?
Dellaert: With the evolving capital rules for banks, a lot of these activities that I referred to as investment-grade lending are increasingly going to be more punitive for banks to finance, given that they’ll attract higher capital charges. If you look at what we have been doing with banks, you saw this announced partnership with Barclays on credit cards, KeyBank on fund finance. You’re going to see us do more of that with banks, because they’re coming to us and saying, “Look, activity X is attracting more capital, I want to stay in that business, I want to continue to serve my customer, but I’d like to have access to you as a capital provider [to] effectively deal with the capital challenges.” In private equity-led finance, that was more about certainly of execution, complexity of deals. This is simpler business that needs to move to a place that ultimately is unlevered in nature. And that’s a good thing for the banks because they’re now stronger, they free up capital. And it’s a good thing for us, because our end customers [investors] get closer to the asset and pick up a better spread.
Unhedged: It’s surprising that something that’s investment grade would be punitive for a bank to lend to. If a bank can’t lend to a toll road, what on earth can it lend to?
Dellaert: I don’t think it’s as binary as to say they can’t. I think when they look at their capital regime, let’s say a bank is 13 times levered on average, clearly Basel III endgame is putting pressure on certain lines of business. It could be consumer, it could be infrastructure, equipment finance. All these lines of business are attracting slightly higher capital charges. So they have to de-lever and/or free up capital. That’s why you’ve seen them do things like SRTs [synthetic risk transfers] with people like us. That’s why you’ve seen them sell assets. They’re managing their balance sheet and they’re deciding, where do I want to grow? Where do I want to shrink? Where can I free up capital to bolster my strengths as a lender?
Unhedged: So they’re not being forced out of these businesses per se, they’re being more selective?
Dellaert: I think that’s right. And the banks all have different priorities; we want to do more of this, less of that; others will have a slightly different mix in mind. And then you have the regional banks which aren’t seeing growth, and on the back of what happened last year with Silicon Valley Bank and others, are under a bit more pressure to sell loan pools, and that’s a whole other dynamic.
Unhedged: It’s funny you mention Basel III. I was in Basel last week. I asked Agustín Carstens, head of the Bank for International Settlements, whether the Basel Committee was concerned about the rapid rise of private credit. And his answer was, we know that there are a lot of points of connection between the banking system and private credit provision. We just don’t really understand what they are. We haven’t seen them go through a full cycle. And we’re trying to figure that out. So I’d be keen to hear more from you about how you structure your relationships with banks.
Dellaert: Start with basic principles: making loans to healthy borrowers is not risky. Lending is not risky in and of itself. It is probably the least risky thing we do at Blackstone. What’s really happening is that banks are moving certain loans that they either used to own on their balance sheet, or that they’d own for some period of time and then they’d syndicate. And the loans are moving from the bank balance sheet, which has a certain amount of regulatory purview, is levered, and has short-duration deposits and long-term assets. They’re moving them to the end accounts — pension funds, sovereign wealth funds, insurance companies, depending on their risk profile — that want to own these assets for life, against their long- duration liabilities. We effectively underwrite these loans for our clients. We’re in the storage business because we underwrite them with a view to own them for those clients, for life. And the clients get a good deal because they get closer to the asset and there’s less intermediation occurring.
Our view is that that is holistically a good thing for the financial system. Our end investors get good loans on good economic terms. We help underwrite them. And oftentimes the vast majority of what we do for our clients is unlevered. So there’s no back leverage or whatever in there. Some of it might be slightly levered, but less than one times [one dollar of debt per dollar of equity]. That’s risk reductive. I think what you hear from regulators is they want more transparency. They want more visibility into what these things are.
Unhedged: But banks also provide leverage to these deals, even if they’ve moved some of the exposure elsewhere?
Dellaert: They may retain some of those loan exposures on their books, a portion of what they sell to us. And what they sell to us in our private investment-grade business, the vast majority of what we do is unlevered because the pension fund or the sovereign wealth or the insurance company just wants to own the asset unleveraged. Because they allocate those assets out of their public liquid market box. This is not a private equity strategy where they need to lever up to generate high returns. Some of our vehicles for institutional LPs historically would have one turn of leverage. And that oftentimes applies to our direct-lending business or private credit business. But the leverage is less than one times. So it’s a lot less than what it is on bank balance sheets.
Unhedged: Some of your competitors, rather than working on behalf of insurance companies, own insurance companies, or have insurance subsidiaries. I wonder why Blackstone hasn’t done that.
Dellaert: If you think about what we do as a firm, we’re an asset manager. That’s what we’ve always done. We happen to be an asset-light or capital light-asset manager. We don’t really deploy our balance sheet into deals. We’re unlevered as a firm. And we felt that we’d be best served if we did the same thing here in insurance.
We probably could have grown a little bit faster had we bought an insurance company. But buying a company and owning the risk associated with it, was not really something that fit our DNA. We want to be an asset manager. We want to be open architecture so that we can serve 10, 20, 30 different big insurance companies around the world. Because if we develop good lending strategies that are in high demand by that client base, odds are we’re going to grow with that client base. And that’s what’s happened. So it’s taken us a while to get there, but what you’re seeing in terms of growth of that business is coming from delivering strong performance for our insurance clients. And then they trust us with more of their capital over time. There’s no right or wrong model here. I think all of our peers and competitors do a terrific job with the companies they’ve owned.
Unhedged: The appeal of the asset-heavy model, where you own your insurance company — as Warren Buffett proved — is the opportunity to compound your capital. I understand in a bad year it doesn’t feel that way, but I just wonder if you ever sit there and think, man, there’s a lot of money to be made on that.
Dellaert: I came from one of the firms that happened to be owned by KKR. They’ve built a great business. But I think our model is a good model. It’s more akin to what we’ve done as a firm in our entire history. And what’s interesting is what’s happening in private investment grade today started with insurance companies, and it’s now going to pension funds and sovereign wealth funds that are saying the same thing: “How can I get access to private investment grade to enhance returns on my public bond portfolio?”
Unhedged: I’m curious about the different risk-adjusted return profiles of private and public credit markets. A lot of people in the private credit industry, broadly construed, have made a lot of money relative to, say, the high-yield bond market. And people are wondering where those extra percentage points come from. What’s the right way to think about that?
Dellaert: I think that in private financing deals where we negotiate directly with the borrower, we’re always going to charge a premium for security of execution, less liquidity, sometimes more complexity. There’s a spectrum on that as you go from non-investment grade direct lending to investment grade. So the quantum of that premium changes. But our view is investors that have long-duration liabilities don’t need as much liquidity on the assets under their balance sheet as they maybe once thought. Second point I would make is the things they think of as liquid. Like long-duration corporate bonds, investment grade or high yield, they may be liquid on a good day. But on a day where you want the liquidity, they’re not nearly as liquid as you thought they might be.
So I think there is a realisation, when we talk to chief investment officers and our clients in insurance, pensions and other account bases, that the notion of liquidity and how people look at it is changing. People are allocating more to private credit, whether or not it’s investment grade or non investment grade. And they want to capture that excess spread.
Unhedged: That gets at my question. If public markets are actually less liquid than they appear, the premium you get for giving up public market liquidity should be smaller, not bigger.
Dellaert: Markets aren’t always super efficient in every line of business. And that’s kind of what you’re seeing a little bit over time as more demand comes in. Could those premiums adjust or narrow slightly? In direct lending you’ve kind of seen this play out. The premium was wider last year because public markets weren’t available. So borrowers increasingly tap private financing providers. The premium was higher. Today it’s compressed because public markets are back and more open and are there for people to tap into. They have more choices.
Unhedged: Does that mean you have to adapt in terms of when you allocate capital — taking a countercyclical attitude?
Dellaert: The beauty of having a very broad based business that does everything in credit and lending is that you have the flexibility to be nimble and to adapt to where the opportunity set is. Blackstone is definitely one where if times are tougher we tend to do our best work because that’s where we’ve run towards opportunities, been a liquidity provider and delivered good returns for our investors. And that’s no different in our credit business than it is in our real estate business or our private equity business.
Unhedged: So, the premium you are harvesting, there’s two aspects to it. The stuff you do takes a little bit of work, so you get paid for that work, when there’s complexity. And then there is an illiquidity premium that you and your clients earn because the money is locked up. And those will vary over time.
Dellaert: That’s fair.
Unhedged: There has been a bit of a gold rush in the private credit industry. Times have been good. Are there some bubble dynamics in terms of the amount of capital flowing into this industry, to relatively new players who haven’t been through a credit cycle?
Dellaert: That’s not the way we see it. A bubble is something I typically associate with either access leverage or access valuations, or both. And that’s not what we see in the market. I think that the overall leverage level today in the market is a lot lower than it was before the great financial crisis. I look at our non-investment-grade corporate credit business, what we do in direct lending. We make loans to really large companies with over $200mn of Ebitda at 40 per cent loan to value, or 45 per cent. Pre-GFC, those would have been smaller companies and 65, 70, 75 per cent loan to value. So I think overall there’s less leverage in the system, there’s less leverage in lending activity itself, and I think you see that in default rates across the board.
I think our default rates in our non-investment-grade book are 0.4 per cent, which is a lot lower than the public market, and is a testament to how we underwrite. So I don’t think you see it now. We’ve been doing this for 20 years at Blackstone, a variety of cycles and a variety of interest rate environments. Whenever people allocate capital into a space, you always see newer entrants trying to catch up. But we don’t really see irrational risk-taking behaviour that worries us. It makes things a little bit more competitive, especially in the lower end of the middle market. But we don’t really play there.
Unhedged: If we are in a higher-rates-for-longer world, does that change the dynamics of your business in any meaningful way, or is it just the same spread over a different base rate, as it were?
Dellaert: I think it’s the latter. We’ve invested in high- and low-rate environments and seen demand from our borrowers and our investing clients persistently grow throughout. This is not a rate strategy. I think the path of rates is less important than the structural shifts that are occurring in the financing markets. What you’re likely going to see is inflation coming down. But the pace of disinflation is slowing, and that will result in a slowdown in growth. A slowdown in growth might result in more opportunities arising, or spreads even widening. It’s hard to get into the multivariable predicting game. But our business has grown throughout, despite the path of rates.
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