June 17 (Bloomberg) -- GSO Capital Partners LP, a unit of the Blackstone Group LP, and Monarch Alternative Capital LP are raising money to invest in distressed companies in anticipation that more borrowers will default as the U.S. economy weakens.

GSO, which Blackstone acquired in March, is seeking $1.5 billion for a mezzanine fund that may invest in troubled companies including those taken private in leveraged buyouts, said two people with knowledge of the matter. Monarch is targeting as much as $600 million, according to an investor letter obtained by Bloomberg News.

Defaults on corporate debt may more than triple within a year to 6.3 percent as companies are squeezed by a slowing economy and reduced access to capital, according to Moody's Investors Service, the New York-based ratings company. Firms including Washington based-Carlyle Group and Oaktree Capital Management LP have opened funds this year that can invest in bankrupt or troubled companies.

``The opportunity will be U.S. and European buyouts gone bad,'' said Howard Marks, chairman of Los Angeles-based Oaktree, which raised the $10.9 billion OCM Opportunities Fund VIIB L.P. in May. ``This is a market where supply can swell very quickly under the right circumstances.''

Last month, the Commerce Department reported the economy grew 0.9 percent in the first quarter, the second three-month period of annualized growth below 1 percent. Apollo Management LP's Linens n' Things Inc., a Clifton, New Jersey-based retailer that filed for bankruptcy in May, contributed to a sixth consecutive monthly rise in companies with high-yield, high-risk debt that have failed to make interest payments, according to Kenneth Emery, an analyst at Moody's.

New Jersey's Commitment

GSO Capital Opportunities Fund L.P. fund has received a proposed $100 million commitment from New Jersey's pension fund, according to a memorandum from the State Investment Council available on the state's Web site. Mezzanine funds typically make loans to companies at higher rates than banks and buy their preferred stock.

In December, Blackstone raised $1.3 billion to invest in distressed debt securities through a separate fund.

New York-based Monarch, a spinoff of Steve Rattner's Quadrangle Group LLC, got $300 million from an unidentified European pension fund, according to the June investor letter. Monarch has purchased debt of companies including Linens n' Things and Interstate Bakeries Inc., the Kansas City, Missouri- based maker of Wonder Bread and Twinkies that filed for bankruptcy in 2004. New York-based Apollo paid $1.3 billion for Linens in 2006.

High-yield, or junk, bonds and loans are those rated below BBB- by Standard & Poor's and Baa3 by Moody's. Distressed debt yields 10 percentage points more than government bonds. The percentage of companies with bonds or loans trading at distressed levels has grown to 17.5 percent in May from 1.3 percent in June 2007, according to Moody's.

Companies borrowed $450 billion in high-risk loans between 2004 and 2007, according to New York-based Fitch Ratings.

To contact the reporters on this story: Jonathan Keehner in New York jkeehner@bloomberg.net; Pierre Paulden in New York at ppaulden@bloomberg.net

Last Updated: June 17, 2008 15:47 EDT