Bennett Goodman, who got his start almost 30 years ago helping Michael Milken use junk bonds to fund companies others thought too risky, says he is now the biggest investor in high-yield corporate loans in Europe as local banks back away.
His GSO Capital Partners LP, a unit of Blackstone Group LP, the world’s largest private-equity firm, is going after the $270 billion in speculative-grade loans and bonds coming due on the continent over the next three years. European banks are pulling back after the region’s three-year-old sovereign debt crisis, arranging $130 billion of the high-yield loans in the region last year, down 27 percent from $178 billion in 2011, according to data compiled by Bloomberg.
Goodman’s move into Europe underscores the growing role of asset managers as lenders, while regulators force the banking industry to take fewer risks. As the value of leveraged buyouts declined 22 percent last year, private-equity firms are expanding their credit units. Along with Blackstone, Carlyle Group LP and KKR & Co. are also increasing their loan businesses.
“Europe is the big event,” Goodman, 55, GSO’s chief executive officer, said during an interview at the office on the 31st floor of Blackstone’s headquarters in Manhattan that he’s occupied since January 2012.
Firms such as Carlyle Group and KKR have expanded beyond leveraged buyouts amid falling returns and a tougher time raising money. The $104 billion of such deals completed globally last year is down from $134 billion in 2011 and $832 billion at the peak in 2007, according to data compiled by Bloomberg.
David Rubenstein, co-CEO of Carlyle, said in a Bloomberg television interview in November that private-equity returns will decline from historic averages as a sluggish economy forces firms to put more money into deals and hold their investments longer. Raising capital for buyout funds has also become more difficult, he said.
Carlyle in December raised its fourth collateralized loan obligation fund in less than a year, and in November announced a $1.38 billion energy credit investment fund. KKR bought Prisma Capital Partners LP, a fund-of-hedge-funds manager with $8.1 billion of assets, in October.
GSO’s assets under management have swelled more than five-fold to $55 billion from $10 billion since it was acquired by Blackstone in 2008 for about $1 billion in cash and stock. Assets at the end of third quarter grew 62 percent from $34 billion a year earlier, including the acquisition of Dublin-based manager Harbourmaster Capital Management Ltd. in January 2012.
The unit has about $5 billion of cash on hand. Its deals last year include investments in Spanish cement maker Cementos Portland Valderrivas SA, U.K. homebuilder Miller Group Ltd., Hovnanian Enterprises Inc., New Jersey’s biggest homebuilder, and Oklahoma City-based natural-gas producer Chesapeake Energy Corp.
Its flagship hedge funds produced average gross returns of 17 percent in the year ended Sept. 30, while its mezzanine and rescue lending funds gained 24 percent and 17 percent, respectively, in the first nine months of 2012, according to a regulatory filing.
GSO is the fastest growing unit of Blackstone, whose shares are 46 percent below the 2007 initial public offering price. GSO managed about $46 billion, or 27 percent, of Blackstone’s $169 billion fee-earning assets at the end of September, the most of any of its businesses, third quarter earnings report filed with the Securities and Exchange Commission shows.
With Standard & Poor’s estimating that about $270 billion of junk-category loans and bonds are set to mature in Europe over the next three years, GSO co-founder Tripp Smith relocated to London last January, while Craig Snyder, a senior trader for GSO’s hedge funds, moved there in June. Thirty-five of its 105 investment professionals are in London and Dublin.
Europe’s loan market is split evenly between banks and investors such as CLOs, which pool high-yield loans and slice them into securities of varying risk and return. The region’s high-yield bond and loan markets aren’t broad or deep enough to absorb all the corporate debt coming due two years from now, according to Goodman.
“There will be ever increasing pressure on these banks to improve their capital ratios,” said Goodman, who worked with Milken at Drexel Burnham Lambert Inc. from 1984 to 1988. “We’re trying to insert ourselves” as they retreat from lending.
PricewaterhouseCoopers LLP estimates that European banks may sell about 60 billion euros ($78.7 billion) of non-core loans this year as they shrink their balance sheets to comply with stiffer regulation aimed at avoiding a repeat of the 2008 financial crisis. The sales may shift from a focus on real-estate-backed lending to corporate loans, and would be a rise from 45 billion euros of disposals last year, the consulting firm said in a study released this month.
GSO’s dealings with about 250 European companies is helping it identify those that may not be able to refinance maturing debt, as Smith holds discussions with banks and boards to avert bankruptcies.
In early August, GSO provided a $430 million dollar-denominated rescue loan to Spanish cement maker Cementos Portland Valderrivas. The company was in default and the banks wanted to reduce their lending, according to Smith, who said it took about four months to put a deal together.
The agreement convinced the bank group to amend and extend its debt, while allowing the parent to keep its Spanish and U.S. subsidiaries including Giant Cement Holding Inc., based in Summerville, South Carolina. The loan is secured by Cementos’s U.S. assets, which are governed under the U.S. bankruptcy code, so that GSO may seize them if the company runs into trouble.
The loan pays interest at 10 percent, or as much as 12 percent if the cement maker chooses to take on additional debt in lieu of cash payments. GSO will also receive 20 percent of Cementos’s annual earnings before interest, taxes, depreciation and amortization for six years.
“If we can solve a problem, we create value and get paid,” said Goodman in an interview in September. “Now, we don’t have 15 deals like that today. Maybe we have the potential of 5 deals like that over the next 12 months.”
In February, GSO led a group that invested 160 million pounds ($258 million) of debt and equity in Edinburgh-based homebuilder Miller.
GSO made a bet on a recovery in the U.S. residential real-estate market when in July it agreed to buy a group of housing development sites from Hovnanian with plans to sell them back under a $125 million deal. In November, the Red Bank, N.J.-based homebuilder said it was increasing the so-called land banking arrangement with GSO to $250 million.
At the time of the initial agreement, the company was running out of cash and its stock was trading at about $2.80, compared with $6.26 now. “We had a different opinion,” according to GSO’s third co-founder, Doug Ostrover, who helped negotiate the deal. By purchasing Hovnanian’s land and giving the homebuilder the option to buy it back, “we freed up liquidity for them,” he said.
In March, GSO provided preferred equity to Chesapeake for a second time to help the energy company keep investing in oil and gas development while completing asset sales, according to Goodman. Chesapeake said in May it was facing a potential cash-flow shortfall this year.
Not every deal has gone as planned. GSO provided a portion of the mezzanine financing for Ripplewood Holdings LLC’s leveraged buyout of Reader’s Digest Association Inc., the publisher of the pocket-sized magazine, in 2007. The company, based in New York, ran out of cash and filed for bankruptcy protection in 2009.
After graduating from Harvard Business School in 1984, Goodman joined Drexel Burnham as Milken was pioneering the use of junk bonds in buyouts. Goodman continued in speculative-grade securities after moving to Donaldson Lufkin & Jenrette in 1988 and later became global head of leveraged finance under Tony James, now president of Blackstone.
After DLJ was acquired by Credit Suisse First Boston in 2000, Goodman established the bank’s alternative capital division, overseeing $33 billion of assets.
Goodman, Smith and Ostrover co-founded GSO in 2005. In the spring of 2007, they attended a pre-initial public offering roadshow for Blackstone, which had about $92 billion of assets under management while two-year-old GSO had one hedge fund, two CLOs and had just held a first closing of a mezzanine fund it was raising. Its assets under management were in the range of $5 billion to $7 billion, according to Goodman.
“We were like secret ninjas of the night, darting around coves in a cigarette boat, and here you have the U.S.S. Blackstone, and we’re getting like capsized from their wake,” Goodman said.
They plowed the cash from their deal with Blackstone into their credit and distressed loan funds in March 2008, near the worst of the financial crisis, according to Goodman, who is also a Blackstone senior managing director.
After moving into Blackstone’s headquarters last January, Goodman didn’t replicate the wood and green marble Federal Style office he had decorated to resemble the one he occupied at DLJ, whose headquarters waiting room featured a Gilbert Stuart portrait of George Washington. His personal collection of antique furniture, mirrors and vases don’t match the contemporary look of his new employer, he said.
In September, GSO raised an $835 million closed-end fund targeting junk-rated corporate debt, increasing the offering to $960 million after the underwriters exercised an option to buy additional shares in the publicly-traded pool. It also offered two new CLOs totaling more than $1 billion during the third quarter, according to a presentation filed with the SEC in October.
As returns in the private-equity industry decline, investing in credit is more attractive, according to Goodman.
“We’ve got the sun, the moon, the stars all aligned,” he said. “We’re trying to take advantage of all that because we know it won’t last forever.”