Bennett Goodman Builds $95 Billion Credit MachineBy , , and
Direct lending is ‘natural extension’ of Drexel legacy: Milken
Debt deal terms are becoming indefensible, Ares’s deVeer says
Back in the Dark Ages of Wall Street, when Dow 1,000 was heady stuff, a small company from Texas did something extraordinary.
It sold new junk bonds.
That was 40 years ago, and few could have predicted what would follow: the junk-finance revolution, the ’80s merger mania, the Michael Milken saga, on and on.
Bennett Goodman saw it all up close, which is why what he’s doing today is worth knowing.
Goodman, who worked with Milken at Drexel Burnham Lambert, is now one of the world’s leading practitioners of private credit, a fast-growing area where exuberance is running hot. Some look across the markets and see shades of 2007, right before the bottom fell out.
“We’re very focused on what can go wrong,” says Goodman, one of the founders of GSO Capital Partners, a $95 billion powerhouse tucked inside Blackstone Group LP.
Operations like GSO bypass banks and capital markets and lend money directly to companies, often risky ones others might avoid. To Milken, private credit -- part of the vast, amorphous business some call shadow banking -- is part of the Drexel legacy.
“I think direct lending is a natural extension to what we did 30 to 40 years ago,” Milken said in an interview.
In the past year alone, GSO and similar firms collectively have raised a staggering $100 billion from investors boxed in by years of low interest rates. GSO and its ilk now have about $595 billion at their disposal, according to research firm Preqin.
As the money comes flooding in, the risks are intensifying. William Brady, who heads the alternative lender and private credit practice at law firm Paul Hastings LLP, says yields are shrinking and protections loosening for investors amid unprecedented competition for deals. The number of lenders has more than doubled in just a couple of years to 400.
“Lending standards are not where they should be,” warns Kipp deVeer, chief executive officer of Ares Capital Corp., which has about 5 percent of the direct lending market. “Having been through several market cycles, we are seeing a number of deals at prices or terms that we think are indefensible.”
The cash pouring into private debt, combined with demand for income worldwide, has created “a hazardous situation,” adds Dan Zwirn, CEO of Arena Investors, which specializes in lending to midsize businesses, real estate and structured finance assets unable to get bank loans or other conventional sources of funding.
“I don’t mathematically see how this ends in any way that isn’t bad,” Zwirn says.
At GSO, Goodman is prepared to own a business through bankruptcy and sell later if need be. In his corner office high above Park Avenue, in Midtown Manhattan, Goodman, 60, folds his lanky frame into a chair and says his group is constantly thinking about “what happens in the downturn.” That means weighing up a company’s sources of liquidity, the value of its assets, who might buy them and at what price.
As traditional banks pull back from leveraged lending, Goodman is uniquely positioned to capitalize in a highly fragmented market where private equity firms are going to need about $1 trillion in loans to buy companies and refinance existing debt over the next five years. Blackstone is the largest alternative-asset manager in the world, putting GSO at the center of a network of companies and connections any traditional Wall Street bank would be proud of. As the incumbent lender to about 2,000 companies, GSO has an advantage over many of its peers.
For a business looking to borrow money -- maybe one in a beaten-down industry or with a complicated history, or one that doesn’t have audited financial reports -- these guys are the saviors.
Take oil driller Sanchez Energy Corp. When it was looking to buy some land in Texas’s Eagle Ford shale basin from Anadarko Petroleum Corp. in January, oil was trading at levels that would’ve made drilling there unprofitable. And banks, burned by the oil crash a couple of years ago, were still trying to trim their holdings of energy debt.
Wall Street banks had previously arranged financing for Sanchez, but this time it was GSO that made it happen. It not only promised $500 million in debt for the $2.3 billion deal, but Blackstone tipped in equity as well, going halves with Sanchez to buy the assets.
For the borrowers, it’s much easier to deal with a direct lender than go through a banker who then has to seek permission from risk-management executives before agreeing to lend money. Banks, which have to put aside capital for potentially risky loans, also have to worry about regulations that stipulate just how much debt they can pile onto a company relative to its earnings.
Banks Pushed Out
Increasingly, these private credit providers are effectively cutting out old-school banks. Indeed, the banks have basically spent two decades backing out of the business of lending to risky companies. It was in the late 1990s that bankers realized they couldn’t really generate the returns their public market shareholders demanded if they simply lent their own money.
So instead of making a loan and holding onto the risk, banks started selling it on to investors like mutual funds and pension funds, which could then trade the debt among themselves.
The business model changed dramatically as banks effectively leased out their balance sheets again and again, thereby multiplying returns. They shied away from making loans for mid-size and smaller companies because they were harder to sell and trade, opening the door to a slew of private lenders concentrating on just that part of the market.
Then strict regulations after the financial crisis turned the screws on underwriting even the big transactions for the riskiest of companies. Banks were reined in even as breathless investors dived into the sketchiest of deals in search of income.
It was the perfect moment for the likes of GSO, Apollo Global Management LLC, KKR & Co., Oaktree Capital Group LLC and Ares to come in and claim the mantle. Not only does every private equity firm worth its fees suddenly have a credit arm, but sovereign wealth and pension funds are in on it, too. Even public employees, including prison officers, firefighters and policemen from New Jersey, Ohio and Texas have, in recent months, plowed chunks of their $100 billion in retirement funds into the sector.
Bill Sacher, a former co-head of leveraged finance at JPMorgan Chase & Co., says the balance of power in this field seems to have tipped -- permanently. He now runs the private debt operations at Chicago-based Adams Street Partners.
“It is exceedingly unlikely that the banks are coming back into the sector,” Sacher said.
— With assistance by Sally Bakewell