Is There a Problem with Alternative Asset Managers? What is the Net Effect of Tokenization and Stablecoins on the Big Banks. – Investment Moats

I find this interview that Steve Eisman did with Evercore ISI’s Glenn Schorr to be illuminating. The Private Credit Panic.

The most personally illuminating thing was the ROE difference between a traditional deposit-lending institution [10-20% ROE] and when you have a wealth management component [25% ROE].

I appreciate how Glenn share about stablecoin as well.

Do We Have a Private Credit Problem: Apollo, KKR, Blackstone.

Steve starts the interview with a discussion on private credit, which is a sub-sector that is a secular growth money, they are raising more and more money yet the stocks are down.

Glenn names KKR as his pick here. He doesn’t believe that the credit cycle has turned (you can see my description below). Private managers will outperform public markets.

But I do agree with Glenn’s point in that perhaps private credit manage to solve the problem of how do we:

1. Finance projects that are pretty long term.
2. Yet volatile in their shorter term outcome.
3. Where the end people need to see the returns over time.

You finance them with insurance money, which are longer duration money.

They do discuss the potential short term disaster which we are currently seeing: Difficult to exit underlying at good prices (because bought too expensive among other reasons) and hence the insurance companies who were expecting payouts don’t have payouts!

1. Stock Underperformance and the Credit Cycle Question

A credit cycle in private credit refers to the recurring pattern of how lending conditions tighten and loosen over time. In good periods, investors are eager to lend, so interest rates fall, leverage increases, and underwriting standards loosen—making it easy for companies to borrow. Over time, this often leads to weaker loans and rising risks. When the economy slows or defaults start to appear, lenders pull back: credit becomes scarce, underwriting gets stricter, interest rates rise, and weaker borrowers struggle to refinance or repay. This shift forces private credit funds to absorb losses, marks private loans down, and reduces new deal activity until conditions stabilize and the cycle slowly resets.

• Stock Drop and Anomaly: The stocks of leading alternative asset managers (AAMs) were down significantly (e.g., Apollo -25%, KKR -21%, Blackstone -15%) [01:51], which is unusual for secular growth stories in a bull market reaching all-time highs [02:18].
• The Fear of a Credit Cycle: The primary reason for the stock decline is the concern that this is the beginning of a new credit cycle, which would be problematic for companies that lend heavily [03:10].
• Contradictory Markets: This fear contradicts the public high-yield market, where spreads are tightening, indicating that bond investors feel good about credit [03:50]. The market action suggests public markets are taking reasonable risks, but private markets might be taking too much risk [04:08].
• Credit Conditions: While a run-of-the-mill credit cycle would naturally cause problems for highly levered, sub-investment grade companies that receive direct loans from AAMs [05:20], most major banks, asset managers, and credit experts (like Moody’s) report they do not see a turn in the credit cycle; they believe the economy and consumer are resilient [06:02].
• Loss Levels: Losses may simply rise from the “really low loss levels” of the past 17 years (e.g., 1% to 2%), which is viewed by some as an inevitable normalization rather than a disaster [06:22]. In a way, people didn’t realize that the loss levels in the past was really low and even if we double the loss levels here, that might just be a normalization.

2. The Superpower of Private Credit: Long-Duration Liabilities

• Apollo’s Leadership: Apollo is highlighted as the “king of private credit” [13:33] and has helped the world recognize that the superpower of asset management is long-duration liabilities [14:42].
• The Insurance Model: Insurance companies collect premiums and have the use of that capital for a long time (sometimes decades) before they must pay it back [15:08].
• Systemic Benefit: This long-dated capital allows AAMs to finance long-term, interesting projects—such as data centers, digital infrastructure, and wind/solar farms [15:29]—on a lot less leverage. This structure is seen as “better for the system” than banks using overnight funds for long-term loans on 10 times leverage [16:10].

3. Apollo’s Short-Term Headwinds

• Earnings Disappointment: In the short term, Apollo experienced disappointing earnings from its insurance and private credit businesses due to interest rates coming down from their highs and tight credit spreads [14:00].
• Balance Sheet Exposure: Apollo’s stock is more prone to credit loss concerns because a significant portion of its assets (via the insurance business) is on its balance sheet [17:11].

4. Outlook on Private Markets

• Private Credit Outperformance: The private credit sector has been able to consistently outperform the public credit markets despite the current headlines [12:46].
• Alpha and Diversification: Private markets remain a strong option for large institutional investors (LPs) to build “good durable diversified portfolios” and create “real Alpha” [17:22].
• The Growth of Private: The growth of private markets is enabling 86% of U.S. companies with over $250 million in revenue to remain private and finance themselves, giving investors exposure to growth companies like Open AI or Uber before they go public [18:04].

Goldman Sachs Stumble and how they Regain their Footing.

Glenn explains that Goldman has to get into the consumer business because the regulators were breathing down their neck as an investment banking firm and they have to balance their “story”.

But that got them into trouble:

The negative sentiment largely stemmed from the firm’s costly and ultimately failed venture into consumer banking.

• The Consumer Business Flop: Solomon and his predecessors decided to enter the consumer business (Marcus, Apple Card, installment loans). This was intended to provide a stable, “steady Eddie” source of revenue, appealing to regulators who disliked their cyclical, high-risk business mix.
• Venture into Subprime: They grew a lending business that included near-prime and sub-prime installment loans, which the firm had never done in its history on the consumer side.
• Perceived Arrogance: The firm’s attitude was critiqued as believing “We’re Goldman Sachs, we’re really smart and we know what we’re doing,” ignoring the history of other companies that failed in that high-risk space.
• Failed Outcome: After several years, the initiative “sunk a bunch of money in” and failed to work, resulting in a decision to wind it down, costing the company capital and credibility.

The CEO eventually pivoted back to the bank’s traditional strengths while building durable business lines:

• Cutting Losses: He made the gutsy decision to “pull the plug and move on” from the failing consumer business, demonstrating that the firm was willing to abandon a bad strategy, which earned respect.
• Building Wealth & Asset Management (AWM): The key to solving the cyclicality problem is aggressively expanding Asset and Wealth Management. This creates a more durable, fee-based revenue stream to increase the firm’s floor on Return on Equity (ROE).
• Reducing Capital Intensity: They are working to reduce the firm’s capital intensity by selling off internal private equity holdings and raising more third-party funds, effectively transitioning the balance sheet into a fee-generating engine (a strategy compared to Morgan Stanley’s successful pivot).

Bank of America’s Duration Problem and Current Opportunity.

Bank of America made a bad bet on what they do with the cash they had on their balance sheet. They can invest in short term safe fixed income (which pay low interest at that time), or longer duration one (higher interest).

• Massive Deposit Inflow: As a leading retail bank, BofA took in “tremendous amounts of deposits” during the pandemic because consumers were scared and flocked to the largest, safest institutions.
• The Deployment Error: With rates near zero, BofA had to decide what to do with the excess deposits it couldn’t turn into loans. Unlike competitors like JP Morgan, who sat on the money in very short-term securities, BofA “plowed a ton of money into treasuries and agency securities with literally sub 2% interest rates”.
• Scale of the Bet: This long-duration, low-yield investment was massive, totaling about $600 billion.
• The Consequence of Rate Hikes: When interest rates rapidly rose from near 0% to 5%, the value of those existing, low-yielding bonds dropped (negative mark-to-market), and they created a “negative spread” against the higher costs of funding.
• Profitability Lag: This decision has caused BofA’s Return on Equity (ROE) to be several hundred basis points lower than that of JP Morgan (e.g., 15% vs. 20%). The bank is “stuck” with these low-yielding, long-duration assets, resulting in a “slow grind” that will take years to work through.

Despite the historical mistake, the speakers see a potential investment opportunity because the problem is temporary and scheduled to resolve itself.

• The Roll-Off Advantage: Because the stock has underperformed due to this known issue, BofA now has a clear path to growth. As the low-yielding $600 billion of securities “rolls off” (matures), BofA can reinvest that capital into new securities at today’s much higher prevailing interest rates.
• Future Net Interest Income Growth: This reinvestment means BofA has “a better shot at growing their net interest income than just about any other” bank going forward.
• Underlying Strength: It’s stressed that BofA is “still a really good bank” and the issue was one “bad bet” rather than a fundamental flaw in the business, making it a compelling long-term play as the duration problem resolves.

Stablecoins, Tokenization and Banking.

Steven say that Glenn is the rare people that can explain these digital topics and most would still understand him. They discuss tokenization primarily through the lens of the digital ledger world, highlighting how this technology represents both an enormous threat to fee income and a massive opportunity for banks to evolve into essential intermediaries.

1. Positive/Opportunity for Banks

Tokenization, particularly of private assets, offers a new avenue for banks to serve clients and leverage their existing trust and capital.

• Trusted Counterparty: Glenn argues that in the new digital world, big, trusted financial institutions (like Goldman Sachs) are necessary to serve as the “trusted counterparty” for executing tokenized deals.
• Infrastructure Builders: Banks are viewed as the entities building the digital ledger infrastructure needed for fast, cheap, and safe settlement of these new assets.
• Market Expansion (Fractionalization): Tokenization of private assets (like private credit, private equity, or real estate) allows them to be fractionalized and offered to a broader market of clients, creating a new, expanded business line for banks to facilitate.

2. Negative/Threat to Current Banking Model

The core threat of digital ledger technology is its potential to eliminate the need for costly intermediaries, directly hitting bank profits.

• Erosion of Fee Income: The digital ledger world is a competitive threat to banks’ ability to earn large, profitable fees from payments, processing, and traditional settlement.
• The “Zero-Cost World”: Steve emphasizes that if the underlying technology is the digital ledger, it creates a “zero-cost world” for transactions. This drastically reduces the spread and profit margins banks currently extract from transaction services.
• Disintermediation: The technology has the potential to bypass the traditional financial architecture where banks act as middlemen, potentially making their current processing services obsolete.

3. Glenn’s View on How the Banks Would Do.

Glenn acknowledges the threat but is optimistic that the major, well-capitalized banks will adapt and win in the end.

• Trust as an Asset: His central belief is that trust will remain the most valuable asset. Banks with scale and regulatory approval will be the only firms that clients trust to build and maintain the necessary infrastructure for this new era.
• Adaptation is Key: The successful banks will be those that embrace the digital ledger to perform functions “better, faster, and cheaper” than they do today, transitioning from being expensive middlemen to being the essential, low-cost, trusted operators of the new infrastructure.

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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

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