Blackstone Targets $10 Billion for Direct-Lending Comeback

(Bloomberg) -- Blackstone Group LP wants to crash the direct-lending party.

In the seven months since dissolving a partnership with FS Investment Corp., Blackstone’s GSO Capital Partners unit has rebuilt its business making nonbank loans to small and mid-size companies. GSO has extended some credit already and plans to amass $10 billion of equity and debt capital for the effort in the next several months and into 2019, according to people familiar with the matter.

That may be enough to reestablish GSO as a major competitor in one of the hottest corners of the credit market. Direct-lending funds raised $54.4 billion in 2017, by far the most of any debt strategy, according to research firm Preqin.

“GSO clearly has the capability to raise capital and do it in scale,” said Ken Kencel, chief executive officer of Churchill Asset Management, a $4.4 billion private credit manager. “They will be an active player.”

If the 2000s were the golden age of private equity, the 2010s ushered in the era of private credit. Regulation and cost-cutting that followed the financial crisis led banks to abandon the so-called middle market for corporate loans, opening a void that has since been filled mainly by alternative-asset managers such as Apollo Global Management LLC and Ares Management LP.

Ares, one of the largest among this new breed of credit provider, estimated in April that the total amount of direct loans outstanding in the U.S. middle market had swelled to at least $910 billion and said pension plans, endowments, sovereign wealth funds and insurers wanted to invest in even more.

‘Own Destiny’

Blackstone, the alternative investment giant headed by Stephen Schwarzman, used to originate such loans through its partnership with FS Investments. Then in December, that agreement between the two firms ended and KKR & Co. swooped in to replace GSO. At the time, GSO co-founder Bennett Goodman vowed to “control our own destiny” by returning with a new direct-lending business in house.

That plan entails forming a business development company, or BDC, and raising money in separately managed accounts from institutional investors, the people familiar with the matter said, asking not to be identified because the firm hasn’t yet discussed the details of its plan publicly.

Paula Chirhart, a spokeswoman for New York-based Blackstone, declined to comment.

It could be a precarious time to be plowing back into the middle market. While investors still hunger for the yields on direct loans made to mid-size companies because they are typically greater than those on comparable high-yield bonds, there’s a growing sense that rising interest rates could derail the U.S. economic expansion and trigger a surge in corporate defaults.

Once dominated by banks, the middle market is more and more the preserve of specialty lenders and private equity firms, including Antares Capital, Oaktree Capital Group LLC, Golub Capital, HPS Investment Partners and Owl Rock Capital Partners.

The influx of capital has increased competition for middle-market credits and compressed returns. Ares estimates that effective yields are now 6.5 percent to 7.25 percent on such senior secured loans in the U.S. As of Tuesday, the average yield on U.S. junk bonds was 6.4 percent, according to Bloomberg Barclays indices.

In the search for higher yields, some firms in the middle-market industry lend to riskier companies or participate lower down in the capital structure where payback is less assured. Blackstone will instead stick to higher-quality credits and use borrowed money to boost returns, the people said.

With about $140 billion in assets, Blackstone’s GSO is the largest of the firm’s multiple business lines and ranks second to Apollo in alternative credit. Blackstone oversaw $450 billion altogether as of March 31.

GSO believes it needs at least $10 billion in direct-lending assets to achieve three objectives, according to the people: absorb the fixed costs of running a private-credit platform; make large enough commitments to compete for the most attractive deals; and get favorable terms on leverage.

“There’s a tremendous amount of institutional interest in private credit, and the regulated lenders are still nowhere to be found,” Kencel said. “For a player with the scale and relationships GSO has, it’s a perfectly reasonable time to re-enter the market.”

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