Goldman Raising $10 Billion Fund to Invest in LBOs

I must be missing something here.

Not too long ago, Goldman was wiling to act as a principal in LBO financings for deals the firm did and would then syndicate the deal. Now admittedly that was the sign of a bull market peak, that an investment bank would take that sort of risk, but bear with me.

The last cycle, when banks quit doing bridge loans, things reverted to the old model of deals going slower (not being done at all in the LBO workout phase) and reverting to a more-or-less a traditional loan syndication model. One of the implications is that possible syndicate members look at each deal and decide whether they want in or not.

According to the Financial Times, Goldman has raised $10 billion for a fund to invest in LBO debt. That means on a blind basis. This vehicle could be a decent opportunity, except the FT article indicates that the fund will invest in Goldman’s deals. The motivation for this risky lending originally was to get a leg up in winning lucrative M&A mandates with private equity firms and other financial buyers.

That is a patently foolish idea from an investor perspective. This arrangement has conflict of interest and adverse selection written all over it. Yet Goldman is apparently close to closing on a pretty sizable fund.

Another data point that the credit market is a long way from bottom. Too many people are eagerly bottom fishing. We have not hit the repudiation phase.

From the Financial Times:

Goldman Sachs has raised a $10bn fund to invest in loans backing leveraged buy-outs, taking advantage of a gap in the financing markets created by the credit crisis.

The fund will buy senior loans, so-called because they are paid off before other debts. It comes in addition to an existing $20bn Goldman fund that invests in “mezzanine” debts, which are paid after the senior debt.

Between the two funds, Goldman can now commit to financing sizeable deals itself without having to go through the long and sometimes painful process of recruiting outside investors for the debt.

During the buy-out boom that ended last year, loans for leveraged deals were often pooled and used to back complex securities, called collateralised loan obligations, that were sold to investors. The CLO business has collapsed during the credit turmoil of the past year.

Recent private equity deals have offered lenders better terms than were the norm in the boom years – when powerful private equity firms benefited from such Wall Street innovations as “covenant-lite” and “payment-in-kind” loans, the latter enabling borrowers to pay interest with paper instead of cash.

Goldman’s latest fund is an example of the accelerating convergence between private equity and debt investing. Goldman’s new loan fund will operate under its private equity arm, with money from Goldman’s clients as well as the bank and its partners.

While other private equity firms and investment banks have debt funds, none approach the scale of Goldman’s funds.

Blackstone has bought debt house GSO to give itself enhanced capability to finance purchases of companies such as Weather Channel. Other buy-out firms, such as Kohlberg Kravis Roberts and TPG, are developing the capability to invest both in debt generally and finance their own deals.

While Goldman’s new fund has not officially completed its fundraising, its head, Tom Connolly, is already involved in deals.

He is looking at providing the senior debt for the sale of a manufacturing company with an enterprise value of $2bn, according to people familiar with the transaction.

Mr Connolly has been in charge of Goldman’s leveraged financing in the US and brings relations with the leading buy-out firms to his new assignment.