Earnings Call Transcript - APO Q2 2020

Operator, Operator

Good morning. And welcome to Apollo Global Management's Second Quarter 2020 Earnings Conference Call. During today's presentation, all callers will be placed in a listen-only mode, and following management's prepared remarks, the conference call will be open for questions. This conference call is being recorded. This call may include forward-looking statements and projections, which do not guarantee future events or performance. Please refer to Apollo's most recent SEC filings, including the 8-K Apollo filed this morning for risk factors related to these statements. Apollo will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in Apollo's earnings presentation, which is available on the Company's website. Also, note that nothing on this call constitutes an offer to sell or solicitation of an offer to purchase any interest in Apollo fund. I would now like to turn the call over to Gary Stein, Head of Investor Relations.

Gary Stein, Head of Investor Relations

Welcome to our second quarter 2020 earnings call. We hope you and your families are doing well in these challenging times. Joining me this morning are Leon Black, Founder, Chairman and Chief Executive Officer; Josh Harris, Co-Founder; and Martin Kelly, Chief Financial Officer and Co-Chief Operating Officer. Gary Parr, Senior Managing Director is also on the line and will be available during the Q&A session. Earlier this morning, we reported distributable earnings of $0.46 per common share, pretax fee-related earnings or FRE of $0.59 per share and a cash dividend of $0.49 per share for the second quarter. With that, I will turn the call over to Leon Black.

Leon Black, Founder, Chairman and CEO

Thanks, Gary, and thank you all for joining us. I'd like to express my wishes to everyone listening that this finds you and your families healthy and safe. To our employees who have continued to work tirelessly on behalf of our clients and our shareholders, I'd like to convey my appreciation and gratitude. We are not working under typical circumstances, to say the least. You have all continued to go above and beyond to drive the strong results that we're reporting today. This speaks to the tenacity and spirit of our employees, as well as the collaborative and innovative culture we have at Apollo. Globally, companies continue to operate in incredibly challenging circumstances as we face what started as a health crisis, but has progressed into an economic crisis as well. Across the firm, we have responded quickly to this changing landscape with a focus on engagement and operations across our investment professionals, client and product solutions teams, and enterprise solutions group, which has helped us smoothly transition into a work-from-home environment. This quarter marked the achievement of a significant milestone as Apollo’s AUM grew by approximately $100 billion to surpass $400 billion for the first time in our history. This growth was driven by Athene, Athora, and strong inflows during the quarter and represents 33% growth year-over-year. With $414 billion of AUM as of June 30th, we are well on our way toward the $600 billion goal that we provided at Investor Day this past November. We continue to see robust demand for Apollo products and a strong pipeline for insurance transactions over the next few years. As a further indication of the breadth of our platform and our activity level through the pandemic, gross purchases were $45 billion across the platform in the second quarter, with some of this related to the repositioning of insurance company balance sheets. We continue to dynamically navigate through this challenging environment on behalf of all our investors. Now, I would like to spend some time talking about the remarkable depth of leadership that resides at Apollo and continues to evolve. Since our founding, we have intensely focused on the strategic growth and evolution of Apollo as a leading world-class alternative investment manager. In recent years, we’ve broadened the firm's executive team, most notably by naming Scott Kleinman and Jim Zelter as co-presidents. Scott and Jim have shown strong corporate leadership, taking on responsibility for Apollo's revenue-generating and investment businesses. Additionally, we continue to elevate and hire exemplary individuals to run the day-to-day operations across all lines of our business, including credit, private equity, real assets, and our insurance platforms. Our recent hires and the evolution of our leadership structure demonstrate our commitment to growth, progression, and the ongoing modernization of our firm. Today, we are announcing that on the back of an almost unprecedented quarter, adding $80 billion of insurance assets and liabilities to the portfolios that we manage, Marc Rowan, co-founder, who oversees this area, has decided to take a step back from his day-to-day oversight of the business and enjoy a semi-sabbatical. Marc will continue to work with Josh and me, driving the strategic direction of the firm, especially for our financial institutions and insurance-related businesses. Marc will remain a member of the Apollo Board and Executive Committee, will continue to serve on the Board and Executive Committee of Athene, and will remain on the Board of Athora. Scott Kleinman will assume day-to-day operational responsibility for leading our financial institutions and insurance activities. Jim Zelter will continue to focus on asset management and credit investment activities across our insurance clients. Together with Gary Parr, Gernot Lohr, Matt Michelini, and Jasjit Singh, they will lead a broad team of over 100 professionals who are dedicated to our insurance clients. Josh, Marc, and I maintain the utmost confidence in this team to lead us into the next phase of growth and development for these platforms and for the firm more broadly. We are excited for what the future holds. We are also actively engaging on the topics of citizenship, diversity, and inclusion. We recently completed our latest annual social responsibility report, which highlights that since the inception of our ESG program in 2008, the combined efforts have resulted in more than 10 million tons of waste recycled by portfolio companies, over 1 million volunteer hours by employees of portfolio companies, and approximately $1 billion of charitable donations just to name a few achievements. We have brought on some exceptional talent to assist with our citizenship efforts, including Lauren Coape-Arnold, who joined late last year as Global Head of Citizenship. This year, we introduced a formal charitable matching program for employees, which included special initiatives for COVID, with $50 million in relief effort contributions globally from Apollo, its founders, and portfolio companies, and also initiatives for racial injustice reform. These initiatives were well-supported by our employee base. More recently, as tragic events have further brought the issue of systemic racial injustice in this country to the forefront, we've been spending a great deal of time listening and thinking about how we can engage to a greater degree on this issue. As leaders in the industry, we need to be honest in acknowledging that we can do more to help combat these inequities. We are committed to enhancing our diversity and inclusion strategy in all aspects of our business. We are very excited to welcome our new Head of Leadership Development and Diversity, Jonathan Simon, who joins us next month. In addition, we have expanded our existing partnerships with organizations that work with students of color and communities in need. Finally, before turning this over to Josh, who will speak more extensively on the subject, you should know that I am particularly proud of the strong performance delivered by the Apollo team in the second quarter. During challenging times, Apollo has generated dramatic growth in both AUM and FRE, in fundraising, and in deployments, while also raising the bar on social consciousness. This has truly been a prime example of grace under pressure or of the whole Apollo enterprise rising to the occasion when the going was getting tougher. With that, I'd like to turn it over to Josh to provide an overview of our business operations for the first quarter.

Josh Harris, Co-Founder

Thanks, Leon. We are really pleased to further evolve our leadership team, and I look forward to continuing to drive growth for Apollo alongside you and Marc. Apollo has responded, as Leon mentioned, to the challenges of working through the global pandemic exceptionally well. Our utmost priority during this time has been to focus on the health and safety of our people and their families, which include our 15 offices around the world. We have challenged ourselves to innovate and adapt to new technology and to make this remote work environment as efficient as possible. Looking forward, we are approaching the return to office with an emphasis on ensuring the ongoing well-being and productivity of our employees. Now, turning to our results. Our business has done exceptionally well over the last six months. For many years, we've been making four key points about how our business would perform during a period of severe market dislocation or recession. Number one, our FRE growth and margins would be durable and stable; two, our fundraising would be resilient and potentially accelerate, driving AUM growth; three, we would find attractive risk-reward investment opportunities for our investors; and four, the majority of our markdowns in our funds' portfolios would be transient. All of these are proving out during this period of time, reflecting the strength of our platform. I'd like to briefly highlight the two notable transactions that reflect our continued market leadership in serving our insurance clients. These transactions closed during the second quarter, despite a backdrop of continued market volatility and uncertainty. At the beginning of the second quarter, Athora closed on its acquisition of VIVAT. Athora’s assets now stand at $60 billion. This transaction is transformative for Athora, as it creates significant scale, diversifies Athora’s business further geographically, and adds significant operational talent and distribution capability to the Athora platform in the Netherlands. In addition, in June, Athene announced and closed its reinsurance transaction with Jackson National, which is the largest reinsurance transaction in recent history. Through these transactions, Athene and Athora have added $73 billion of assets. We believe that substantial consolidation opportunities remain across the insurance industry. Following these two transactions, our insurance clients continue to have a strong capital position with over $85 billion of buying power in aggregate. This capital serves as a key strategic differentiator for our clients as they have unique asset management, transaction, and origination capabilities of more than 150 employees at Apollo focused on serving them. Apollo’s permanent capital vehicles now represent 60% or approximately $250 billion of our AUM. Over 90% of our AUM is either derived from permanent capital vehicles or has a contractual life of five years or more from inception. The stable base of AUM continues to underpin our durable and growing fee-related earnings, which we have successfully grown through all market environments and expect to continue to do so. For the first half of 2020, our FRE grew at 9% compared to the first half of 2019. Despite multiple periods of market dislocation and the impact of an ongoing global health and economic crisis, we continue to remain highly committed to growing FRE at a robust pace over the long run and remain very confident in our ability to achieve the goals we set for our long-term FRE growth at our Investor Day last November. Our FRE margin was 55% for the first half of 2020, in line with our 2019 FRE margin. Turning to fundraising. Total inflows during the second quarter were a robust $89 billion, inclusive of Athene and Athora growth. Over the last 12 months, total inflows have been $119 billion, a record for Apollo. This includes $73 billion of growth from insurance clients, mergers and acquisitions, $35 billion of capital raising and other inflows from our fund investors, and $11 billion from organic growth at our insurance clients. In the second quarter, the breadth of our platform’s investment capabilities and strength of our global relationships with investors drove fundraising that was significantly above our average quarterly level. Notably, this momentum was achieved during a time of nearly all virtual interactions. During the quarter, we announced and closed on $17.4 billion in fund commitments. Key initiatives include the launch of the Apollo Strategic Origination Partners platform, which will target an emerging opportunity in the direct origination solutions for high-quality businesses, a market currently underserved by private credit. The origination partnership will leverage Apollo's incumbency with borrowers, utilizing our credit platform's relationships with approximately 3,300 issuers of both corporate and sponsor-backed companies. Also contributing to inflows was a $1.75 billion close for our Accord III B. This is our dislocation strategy that we were able to launch and close within approximately eight weeks, and we are now in the market for the next series of Accord strategies. Looking forward, we remain confident that we will be able to meet or exceed the $20 billion fundraising goal we discussed on our last earnings call, which consisted of increasing the target size for certain funds, accelerating the timeline for other fundraisers, and launching new strategies to address opportunities driven by market dislocation. We appreciate the trust and support from both existing and new investors as they commit to a range of strategies currently available on our platform, including our origination strategy, Accord, Hybrid Value, infrastructure, U.S. and Asia real estate, managed accounts, and various evergreen strategies. During the second quarter, turning to deployment, we deployed $7.2 billion of capital across our drawdown fund. Through a shifting market landscape, we remain active, looking for attractive asymmetric risk-reward and investing in high-quality opportunities at the top of the capital structure. As public markets have recovered, driven by significant but unnecessary federal stimulus, instead of fundamentals, it's been more challenging to find these attractive risk-reward opportunities. However, we have been able to successfully navigate these markets to date and are increasingly focused on providing bespoke capital solutions for brand-name franchises facing liquidity constraints or looking to capitalize on growth opportunities. Capital deployments for the quarter included originations led by our Hybrid Value and credit businesses for companies such as Expedia, Albertsons, Airbnb, MFA, Cimpress, NGL Energy, and Delta. As of the second quarter, Hybrid Value stood at 71% committed or invested. We were back in the market for this strategy. These transactions highlight the benefits of our globally integrated platform and the deep pools of capital across our clients, which allow us to structure bespoke financing solutions quickly and with certainty of execution. Going forward, we believe these factors will continue to make Apollo a premier financing partner for companies, and we see a strong pipeline ahead for Hybrid Value, our various credit vehicles, and our new strategic origination partnership. In addition, our private equity fund, Fund IX, recently closed on the $6 billion take-private transaction for Tech Data, representing the largest public-to-private transaction completed this year. Tech Data is a global leader in information technology distribution, which we believe is well-positioned to continue to benefit from the secular IT spending tailwinds. We created this investment in an attractive creation multiple of approximately 7 times EBITDA prior to cost savings. As of the end of the second quarter, Fund IX has reached 40% committed or invested. Looking ahead, we remain of the view that technicals are well ahead of fundamentals, and therefore we are prepared for continued volatility and a wide range of outcomes over the coming quarters. Apollo’s leading investment returns through cycles are reflective of both our focus on preserving capital for our investors and our ability to pivot quickly and opportunistically to invest during leading market dislocations. Our private equity and credit pipelines are robust, and we believe there will be many opportunities for us to identify and capture misplaced risk on behalf of our investors in the months and quarters to come. Finally, as we have discussed in recent quarters, we remain focused on increasing the accessibility and liquidity profile of our stock. As a result of the changes made to date, we are now included in the CRISP, S&P Total Market, MSCI, and Russell indices. To our existing shareholders, we are grateful that you have been along for the ride; and to our prospective new shareholders, we look forward to engaging with you. To conclude my comments, our strong results for the second quarter and first half of this year are a testament to the strength of Apollo's global integrated platform and the resiliency of our team. Against a very challenging market backdrop, we have demonstrated the durability of our growing FRE and the stability of our margins. Through severe market dislocations, our funds invested meaningfully during a short window of very attractive risk-reward opportunities, creating what we believe will be substantial value for our investors. We also demonstrated our ability to pivot quickly in reaction to shifting market landscapes and are now increasingly focused on providing capital solutions for franchise businesses. We see a growing pipeline of private equity opportunities. We've grown our AUM at a substantial pace over the last year and continue to see strong demand for our products, putting us on pace to achieve or exceed communicated goals of raising over $20 billion of new capital over the next year and being well on our way to surpassing $600 billion of AUM.

Operator, Operator

It looks like the line has dropped off.

Martin Kelly, CFO and Co-COO

I'll finish his comments and then go into mine. We are well on track to exceed $600 billion in assets under management over a five-year period while achieving a mid-teens average annual growth rate in our fee-related earnings, as we detailed during last November's Investor Day. To support these objectives, we continue to invest significantly across our platform, enhancing our investment talent and infrastructure. I’d like to echo appreciation for all our employees whose hard work has enabled a smooth transition to our current remote work environment. Regarding dividends, we announced a dividend of $0.49 per share for the second quarter, which is backed by our after-tax fee-related earnings. Our reliable earnings stream sustains the dividend above our minimum of $0.40 per quarter, with potential for higher dividends in quarters with substantial transaction fees, even without performance fees. We generated fee-related earnings of $0.59 per share on a pretax basis for the quarter, propelled by growth in management fees and increased transaction fees. Transaction and advisory fees totaled $62 million this quarter, driven by deals such as Tech Data and Albertsons, along with other capital solutions transactions. The rise in compensation costs reflects our ongoing investments in growth areas, as highlighted by Josh, which include infrastructure, our hybrid capital business, and our fee-related earnings platform, along with technology and various support functions throughout the firm. Regarding incentive earnings, we experienced very low gross realized performance fees this quarter, leading to negative pretax incentive earnings after accounting for profit-sharing interests in realized carry and financing costs linked to our debt and preferred securities. Consequently, our dividend of $0.49 per share was fully supported by our after-tax fee-related earnings. As previously mentioned, we achieved growth of $98 billion in assets under management, driven by strategic growth at Athene and Athora, strong fundraising, organic growth at Athene, and favorable mark-to-market adjustments. Our fee-generating assets under management grew by 36%, or $88 billion, reaching $330 billion, supported by these same factors and robust capital deployment. Gross redemptions in the first half of the year were just $1.2 billion, representing less than 1% of our assets under management during a period of significant volatility, demonstrating the long-dated nature of our funds' capital. Turning to investment performance for the second quarter, our private equity funds portfolio increased by 12%, mainly due to strong performance from our fund’s public holdings. Overall, the portfolio is in good shape despite the challenging economic landscape. Fund VIII is now out of holdback, having appreciated by 17% in the quarter. We focused Fund VIII on durable business models and strong free cash flow with a keen eye on purchase price. Portfolio companies in Fund VIII were acquired at an average enterprise value to EBITDA multiple of 6.5 times, excluding cost savings, with leverage averaging only 3.6 times, considerably lower than industry standards. Due to our value-oriented approach and the high quality of our portfolio companies, we remain confident in our ability to generate significant realized returns over time. We recorded impairment charges of about $1 billion in the second quarter across a few investments previously identified on our watch list, primarily in energy or those severely affected by COVID. We must recoup patient payments before future performance fees can be distributed. We anticipate that gross realized performance fees will be modest throughout 2020 as portfolio companies navigate the impacts of COVID on their operations and as we prioritize returning LP capital due to the impairments. In credit, our funds' aggregate portfolio gained 7.4% during the quarter, supported by a rebound in public credit markets. Year-to-date, our credit fund’s aggregate portfolio is down 2.5%, outperforming both the S&P Leveraged Loan Index and the Bank of America Merrill Lynch High Yield Index by approximately 2%. Our credit strategies fund has increased by 68% year-to-date. In real assets, our overall return for the quarter was positive 1.4%. Energy has had a minimal impact on our portfolio performance in both private equity and credit this quarter. At the end of the second quarter, our net economic balance sheet value, after accounting for debt and preferred equity financing obligations, was about $2 per share, representing meaningful growth from the prior quarter. Our net performance fee receivable rose by approximately $0.40 per share, partially reflecting the full reversal of holdback in Fund VIII. Apollo maintains a strong liquidity position with around $1.75 billion available on our balance sheet. In June, we raised $500 million through a debt offering to further strengthen our capital in the context of attractively priced markets. Our available capital for investments across our fund complex was $47 billion at the quarter's end, an increase of $6 billion driven by fundraising during the quarter. We will now turn the call back to the operator and open the line for any of your questions.

Operator, Operator

And Josh Harris has returned to the conference. Our first question will come from Alex Blostein with Goldman Sachs.

Alex Blostein, Analyst

Thank you. Good morning, everybody. So first, maybe just to touch on Marc's decision to step away from the business on a sabbatical, Leon, as you described. Is this a bigger picture succession plan effort, or is this more of a temporary change and Marc will be looking to reengage? And are there any implications on the pace of deal-making within the insurance space we should anticipate on the back of that?

Leon Black, Founder, Chairman and CEO

I think it's really that we've been in COVID lockdown now for five months. Marc has just quarter-backed two transactions in the second quarter, which we've talked to you about. He wants to take a little time off from day-to-day operations, especially with the confidence that there is a team there now of over 100 who are totally focused on insurance, and Scott Kleinman has been very involved in day-to-day operations. The reason we call it a semi-sabbatical is Marc is still very engaged in the firm and on the strategic planning with Josh and myself. He remains on the Executive Committee; he remains on the Apollo Board, as well as the Athene Board and Executive Committee and on Athora. I would really just take it at the face of what we've said and not read more into it. I think he has a well-deserved desire to not be involved in so much day-to-day, given the great team that's been built up and how much that's already been accomplished. I think he would tell you that he thinks we're still in the early innings in terms of what he has really masterminded over the last 12 years in building the insurance operations to over $200 billion, and I think he believes that there's no reason that can't double over the next three, four years, and I think he plans to be a major part of that.

Operator, Operator

Our next question will come from the line of Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler, Analyst

Good morning, everyone, and congratulations on completing two very sizable transactions this quarter. Just on the two transactions, as we look forward, can you remind us on the level of deal capacity at both Athene in the U.S. and Athora Europe? And also, can you update us on the current M&A and reinsurance backdrop in both markets as we try to estimate the potential for future transactions?

Leon Black, Founder, Chairman and CEO

Gary, do you want to take that?

Gary Parr, Senior Managing Director

Yes, I'd be happy to. And, I need to address the second one first. The activity level available is several ways to look at it. One is the market opportunity, and the second is how Apollo is positioned to address the issue. The market opportunity today is as robust as it has been over the last four years. The low interest rates continue to put a lot of pressure on traditional companies. Notably, the tight spreads on public securities make it very difficult in the spread business for other companies. We, of course, invest so much in originating good investments and creating extra spread. The capital rules continue to create pressure. Particularly in Europe, Solvency II is problematic for some back books. A lot of companies continue to focus more on lines where they can win business or just be winners. That means they're exiting lines of business or entire geographies, and we're seeing that level of flow. Sitting today, comparing to any point in time in the last four years, we are in as many substantive conversations. We have no idea exactly what the timing of transactions will be, but as an overall backdrop, the opportunity today is as attractive as it has been at any point in time in the last four years. In that four years, we've announced five material transactions, three in the U.S., two in Europe. You asked about the capacity; it’s over $85 billion of buying power, which relates to the excess capital at Athene plus borrowing capacity. ADIP, of course, still has quite a lot of capacity, and Athora also has about $0.5 billion of capacity of equity. As we said in Investor Day, we're very appreciative that our investors believe in us. We've raised over $12 billion in the last three and a half years of equity capital to do transactions. We think we can continue to do this.

Leon Black, Founder, Chairman and CEO

Just to add to that, it's very simple: The low interest rate environment means much of the industry is going to be challenged and will revert to shedding assets. We not only have the reference capital to do sizeable transactions, but we've also shown with both VOYA and with the recent Jackson that we can do highly complex deals that provide holistic solutions to sellers. So, I think one, it’s in our favor that there should be real supply as long as interest rates are low, which I think we all agree on in the near to medium term outlook; and two, that there's no one out there that has both the combination of capital and the ability to deal with complexity and come up with holistic solutions, along with the 100 to 150 people that we have with incredible depth of management in this specific area. All of this bodes very positively for us in the years to come.

Operator, Operator

Our next question will come from the line of Bill Katz with Citigroup.

Bill Katz, Analyst

Okay. Thank you very much for taking the questions. And Marc, best of luck in your short stay over. Question for maybe Martin just on the $1 billion. I wonder if you could just maybe fill that back a little bit and help us understand which portfolios are affected by that. And then, just relatively, I apologize for igniting this question. In your supplements, you mentioned that only 18 of the $47 billion of dry powder has a potential for management fees. I wondered if you could just expand on that a little bit.

Martin Kelly, CFO and Co-COO

Yes, the $1 billion is specific to Fund VIII, and we noted last quarter that about 5% of Fund VIII was on a watch list. These impairments are exclusively related to that. It also includes an impairment we mentioned two quarters ago on our Q4 call. Overall, the effect of all the impairments and the delay in carry distributions is approximately $0.25 a share. As mentioned earlier, it is partly due to energy and partly due to one or two other names that have been significantly impacted by the pandemic. We need to recover patient payments before we can distribute future performance fees. Regarding your second question, when we raise capital, we either manage fees as the capital is committed, which is standard for most drawdown funds including Fund VIII and Fund IX, or we earn management fees as we invest the capital. The $18 billion you referred to is the capital committed to us that earns management fees until it is invested, particularly relevant to the credit business. The rest of the dry powder has been committed and is earning management fees, which is typical in drawdown funds, with fund line being the most notable example.

Operator, Operator

The next question will come from the line of Glenn Schorr with Evercore.

Glenn Schorr, Analyst

Hi. Thanks very much. One quick follow-up after all your comments on fee and insurances. Just curious, in your view, rates have been low for a while, spreads have been tight for a while. What gets insurance companies to pull the trigger? I know there's a lot of conversations out there. And then, how important are your proprietary origination platforms for them to choose Apollo over the others in the space?

Leon Black, Founder, Chairman and CEO

Ultimately, each insurance company's transaction is highly customized, and so there's not really a one-size-fits-all answer to the factors driving their decisions. I think our ability to create customized bespoke deal situations and transactions that are highly engineered, as well as our asset management capability, makes a difference. We continue to target and earn 50 basis points extra on the asset management side, which provides a unique advantage that allows us to advise. So, it's both our ability to originate very idiosyncratic deals and our asset management capability that we have.

Operator, Operator

The next question will come from the line of Ken Worthington with JPMorgan.

Ken Worthington, Analyst

Hi. Good morning. First, I'm pretty impressed. You guys know each other so well that Martin can finish Josh's sentences and presentations without pausing.

Josh Harris, Co-Founder

Technology doesn't always work. I apologize.

Ken Worthington, Analyst

So, maybe just on the outlook for the pace of deployment. First, maybe what kind of economic recovery do you see? Are we in a U or an L, or maybe pick the letter that best describes what you think? And then, on the last call, you guys described three phases of deployment with bespoke capital solutions being sort of in the second phase. Do you see it being sort of early days or later days with regard to bespoke solution opportunities? And ultimately, do you see the outlook for deployment as we look forward relative to 2Q levels? Is it going to pick up, slow down, or generally stay the same?

Leon Black, Founder, Chairman and CEO

Let's break the business into private equity and opportunistic and credit. The fundamentals of the economy are behind the technicals of the economy. The big run-up in the market is driven by very significant fiscal and monetary stimulus. The S&P 500 earnings outlook continues to be surprisingly that ‘21 earnings are going to be ahead of ‘19 earnings. When we look at the underlying economy and compare it to the forecast of S&P earnings, we don't see it. We think there's going to be volatility as the market absorbs earnings that come in a little softer than expected, along with significant volatility around COVID, the political environment here in the U.S., and the U.S.-China relationship. Those factors will lead to volatility. We expect to have opportunities across our platform. The private equity pipeline is actually picking up. The bottom 25% of the S&P trades as 10, the top 25% trades above 30. There continue to be value-oriented opportunities. Even though the markets seem priced at a premium, we are seeing the pipeline change. In credit, we're seeing a robust flow of opportunities in bespoke capital solutions where companies are uniquely impacted by COVID and need capital. The public markets continue to be hospitable for some of the larger companies; but in many cases, the private capital sector that we operate in is continuing to step in and execute transactions. We see our pipeline across everything as being very robust.

Operator, Operator

The next question will come from the line of Patrick Davitt with Autonomous Research.

Patrick Davitt, Analyst

Good morning. Thank you. I just want to follow up on Bill's question to ensure we have the right understanding. The $0.25 needed for the netting holding would primarily be realized cash carry, and anything beyond that would flow through DE?

Martin Kelly, CFO and Co-COO

Yes. That's right, Patrick. It's a timing impact. The next set of realizations required to fill or cover that impairment are devoted exclusively to the LPs, and thereafter, it would then flow back into DE and the distribution. Everything else being unchanged pays down LP capital more quickly and creates more carry afterwards to the fund.

Operator, Operator

The next question will come from the line of Robert Lee with KBW.

Robert Lee, Analyst

Hey. Good morning. Thanks for taking my questions. I guess, maybe sticking with the insurance theme, just curious with Athora specifically. What is the opportunity there for redeployment of VIVAT assets? If I think historically, Leon has represented this way with Athene on a new block business, roughly about 20% of the investments were made their way to various Apollo managed funds. Is the same opportunity there for Athora, or given the different regulatory rules, is there not as much potential to shift the portfolio around?

Leon Black, Founder, Chairman and CEO

Gary, why don’t you take this one?

Gary Parr, Senior Managing Director

I can do a part of it and then hand off to Martin. As you know, our arrangement with Athora is that we have a standard fee, our base fee, where we provide various services to Athora and all the parts of Athora authority for asset liability management and risk management. So, that base fee is in place. As it relates to the rest of Athora and the various parts of Athora, we sub-advise on various asset classes where we have expertise. A big headline is that in Europe, about 50% of an insurer’s balance sheet is going to be sovereigns or governments. That's just a part of managing asset liability and Solvency II. We can provide our expertise on the segments of assets we do manage. Over the next 12 to 24 months, we would expect that Athora will be looking to us to redeploy VIVAT’s assets into higher yielding assets, and Apollo will be sub-advising more of those assets.

Operator, Operator

The next question will come from the line of Devin Ryan with JMP Securities.

Devin Ryan, Analyst

Good morning. Just a question here on the outlook for realizations. Appreciating that the capital markets have reopened, which has been a positive, but really trying to get a sense of whether you feel there's going to be an ability to sell assets through M&A. I'm curious if virtual processes are starting, if there's an ability to do that, and whether there are efficiencies being learned today that may last beyond the pandemic. Obviously, everyone's using technology quite a bit more. So, I'm curious how that connects as well. Anything more you can say about the realization outlook would be appreciated.

Leon Black, Founder, Chairman and CEO

The realization outlook is just difficult to predict. I would say that it's more difficult now. Things are changing on a daily basis. I think people are getting used to doing diligence by Zoom, virtual data rooms, and virtual management meetings. I actually experienced one myself. Ultimately, the face-to-face interaction needed when partnering with the team becomes limited, but it has to be done carefully. The M&A markets will work around the pandemic. It's not going to be easy, but it's manageable. We haven't predicted any realizations. We're focused now on growing and continuing to deliver very significant and durable FRE, and high margins, which is much more predictable. We think, in a cycle, our realizations would be there. We're building value on our portfolio.

Operator, Operator

The next question will come from the line of Gerry O'Hara with Jefferies.

Gerry O'Hara, Analyst

Great. Thanks for taking my question this morning, perhaps one on the strategic origination business. If you could maybe add some context or color on the opportunity set, what Apollo’s competitive advantage is there and perhaps even how you see that platform scaling going forward?

Leon Black, Founder, Chairman and CEO

Our Company’s advantage has been that we have the largest alternative credit business in the world. We have hundreds of investors and originators, as well as a significant capital base. This allows us to commit $1 billion to up to $2 billion of capital to larger companies that need capital solutions very quickly - in a bespoke way. The size of our platform and our capital base puts us in a unique position in today's market where the need for capital is substantial. Very few can match these advantages. It's a highly desirable capability that not many in the industry have.

Operator, Operator

Our next question will come from the line of Chris Harris with Wells Fargo.

Chris Harris, Analyst

Great. Can you give us an update on trends you're seeing in your underlying portfolio? I know, in the past, you talked about 5% of the portfolio being on watch. Has that changed at all since last quarter?

Leon Black, Founder, Chairman and CEO

Yes, at this point, it’s about 3%. We've taken a hit in energy, and we've had one or two other situations in COVID-affected industries, particularly restaurants. Those have all been marked down or marked to zero. Going forward, we don't see a lot of issues. We expect the portfolio to improve from here, subject to an economic downturn that goes in the opposite direction, which we don't really forecast right now. We believe that many of our issues are behind us, and we're building value from here.

Operator, Operator

Next question comes from the line of Michael Cyprys with Morgan Stanley.

Michael Cyprys, Analyst

Hey. Good morning, thanks for taking the question. I just wanted to follow up a little bit on the strategic origination platform. I was hoping you could elaborate a bit more on your aspirations there longer term and talk about how you're planning to originate in this larger part of the marketplace. What are you building out in terms of headcount? I know a lot of the private credit space has been more sponsor-financed. It sounds like this is maybe a little less so. Talk about any hurdles in terms of moving beyond sponsor finance and how you're approaching that.

Leon Black, Founder, Chairman and CEO

We're building out our significant origination efforts in the lower middle market. We're making hires in the middle and upper market. This relates to the banks pulling back from significant underwriting and capital commitment. We have a setup where we have client balance sheets capable of holding as well as a vehicle that allows us to underwrite and then sell. We're staffing up a whole team for this. We've made a series of hires and expect this team to exceed 20. We're out calling on companies and sponsors. This is straightforward. We have hundreds of professionals across our platform now with greater tools. Our private equity and credit teams have become increasingly integrated, providing us with a broader capability and skill set. We're making significant hires for both capital markets and origination, and we expect significant action in this area. This is our approach.

Operator, Operator

The next question will come from the line of Jeremy Campbell with Barclays.

Jeremy Campbell, Analyst

Just maybe one on the insurance landscape. Given that all your peers have jumped into the market relatively recently over the past year or so, and your relationship with Athene, the capital structure is a little bit differentiated. Does this competitive market kind of relegate you and the partners to more big game hunting in the insurance world as the smaller deals may get a little aggressively bid? What hurdles do you see to executives doing a big deal like that?

Leon Black, Founder, Chairman and CEO

It is both big deals and our ability to navigate complexity and structure bespoke solutions to tackle large insurance portfolios that might not just be fixed annuity or variable annuity, but broadly based. Our broad capabilities and our asset management capability set us apart. Gary, do you want to add anything?

Gary Parr, Senior Managing Director

Our breadth of expertise and size as a competitive advantage allows us to address multiple needs. We have segments of expertise: U.S. spread business, European spread, variable capability, life settlements, structured settlements in fund FCI, and property casualty. These skills allow us to go into larger companies and discuss solutions that are win-win-win. In the three U.S. transactions, one common theme was that these companies were looking for solutions rather than selling off their business portfolios. In those discussions, we've shown our capacity to create value for all parties involved, and this gives us an advantage in competitive situations.

Leon Black, Founder, Chairman and CEO

We have more permanent capital than anyone other than Berkshire Hathaway. Our reputation and relationships in the insurance space, along with our regulatory standing, create a franchise for us that is second to none. We expect to continue building on those capabilities.

Operator, Operator

Kotowski with Oppenheimer & Co.

Chris Kotowski, Analyst

Yes. Good morning. Thanks. Josh, you were talking about the disconnect between the real economy and the market. The statistics show leveraged loan default rates around 3.9% with most in energy resources and retail. If you had to guess six to nine months from now, where would that be? What is both the risk to existing investments and the opportunities to deploy against that?

Josh Harris, Co-Founder

The answer to that depends on the liquidity provided by the Federal Reserve and the economy's recovery. We expect the rate to go up from here, which will open several opportunities for us. We could approach double digits for a period. In that scenario, we expect to have a strong portfolio with a conservative stance toward investments. Our focus on first lien and top capital structure minimizes risk. It serves us well in a risk-off environment. Our portfolio should remain resilient, and we think it will provide many opportunities.

Operator, Operator

The next question will come from the line of Adam Beatty with UBS.

Adam Beatty, Analyst

Hi. Good morning. Thanks for taking the question. I wanted to follow up on the existing portfolio companies, mainly from the deployment angle. How much of the deployment this year has been with companies already owned by you? What is the mix and outlook on offense versus defense for these specific company circumstances?

Martin Kelly, CFO and Co-COO

Very little has been deployed into the existing portfolio; nearly 100% has been offense. The percentage mentioned before of 3% is accurate. We haven’t had to deploy into existing situations across the company.

Operator, Operator

With that, I will hand the conference back over to Gary Stein for closing remarks.

Gary Stein, Head of Investor Relations

Great. Thanks, operator. Thanks everyone for joining us. If you have any questions, please feel free to follow up with us. The team looks forward to catching up with you again next quarter.

Operator, Operator

This does conclude today’s conference call. We thank you for your participation and ask that you please disconnect your lines.