Goldman Sachs Group Inc (GS.N) has cemented its dominance of a risky corner of the U.S. debt market, as traditional bank rivals retrench, by using a fund that it markets to investors to finance leveraged buyouts.
In the past two years, banks have gradually scaled back their supply of the riskiest junk-rated loans used to purchase companies because of tougher U.S. regulations. And the conditions worsened dramatically in December when a selloff in junk bonds roiled the entire leveraged loan market, frightening away some lenders and squeezing the availability of such financing.
Goldman’s GS Mezzanine Partners VI fund has taken advantage of the vacuum to be one of the most aggressive financiers of leveraged buyouts.
The fund is the biggest of its kind after raising some $8 billion earlier last year, according to market research firm Preqin. It is unclear how much of that came from outside investors, such as pension funds and insurers, and how much was funded through Goldman’s own balance sheet, though Goldman contributed about 35 percent to its previous mezzanine fund, raised in 2007.
Goldman declined to answer questions about the current fund or its strategy.
The fund has helped finance some of the largest leveraged buyouts of the last few weeks, including lending $750 million for the $4.6 billion acquisition of Petco Animal Supplies Inc by a consortium led by private equity CVC Capital Partners Ltd, and $580 million as part of the $4.5 billion sale of business software maker SolarWinds Inc (SWI.N) to buyout firms Silver Lake Partners LP and Thoma Bravo LLC. It also provided $210 million of the $1.3 billion cost of the acquisition of contact lenses retailer 1-800 Contacts Inc by AEA Investors LP.
The emergence of new funds like Goldman’s “is one of the most important developments recently in the area of leverage finance because they’re stepping into the void” that has been created by the retrenchment in traditional bank lending, said Kathie Brandt, a partner at law firm Thompson Hine LLP.
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The growth of the fund is a reflection of how Goldman has shifted risk – and any returns – from one side of its business to another. Instead of financing the deals through its leveraged lending business, Goldman is using an operation called investing and lending, where the mezzanine fund is housed.
The fund benefits from Goldman’s No. 1 position in the world as advisor on mergers and acquisitions. One of the reason for the scale of Goldman’s mezzanine business is the deal flow that comes its way through Goldman’s investment banking business network.
Because the fund is not part of Goldman’s traditional lending operations, which rely solely on the firm’s balance sheet, it is exempt from rules that cap how much debt it can provide to companies.
It is known as a mezzanine fund because it invests in usually higher risk but higher-yield debt that lies in the capital structure somewhere between less risky debt that is often secured against assets and equity capital, which can easily be wiped out in a bankruptcy. Mezzanine financing can be converted to equity under some conditions.
If one of the companies concerned were to default or go bankrupt, then the Goldman fund would likely face heavier losses than some other debt investors with less risky secured debt.
U.S. banks have cut back their lending of the riskier leveraged loans, traditionally used by private equity firms to buy companies. That was a result of guidance issued by financial regulators in 2013 cautioning banks against lending when a company going through a leveraged buyout is seeking to raise debt that is more than six times its annual earnings before interest, taxes, depreciation and amortization. As energy prices have sunk – crude oil prices reached their lowest levels for 12 years on Thursday – the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have stepped up their scrutiny of banks’ exposure to junk-rated companies, particularly those in the oil and gas sector. In recent months, investors have also been increasingly wary of such debt due to concerns about whether an already weak global economy could worsen further, and the timing of future U.S. interest rate hikes after the Fed increased rates for the first time for nine years last month. Wall Street banks have seen their fees from underwriting leveraged loans sink to a three-year low in 2015, according to Freeman Consulting Services.
Goldman’s mezzanine funds have raised $26.3 billion in the past ten years, more than any other institution, according to Preqin. Intermediate Capital Group and Crescent Capital Group trail Goldman with $11.5 billion and $8 billion in mezzanine funds respectively in that period. Some of Goldman’s bank rivals also offer such funds but on a much smaller scale – for example, Morgan Stanley’s (MS.N) latest mezzanine fund raised $1 billion.
Goldman aims for returns of more than 15 percent for investors in its funds, according to industry sources. Goldman does not publicly disclose the size of the fees it receives from investors in the funds, though industry sources say that typically a mezzanine fund will charge 3-5 percent of the money invested.
(Reporting by Olivia Oran, Greg Roumeliotis and Kristen Haunss. Editing by Carmel Crimmins and Martin Howell)
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