The scrappy world of distressed-debt investing has become even more adversarial in the pandemic era, with borrowers battling creditors and creditors battling one another. It’s no place for Goldman Sachs.
The bank spells this out clearly in marketing materials for its new opportunistic credit fund under the heading, “What We Do/What We Do Not Do.” While determined to capitalize on the distortions created by COVID-19 with a war chest of $5 billion to $10 billion, Goldman says it won’t “act as vulture investors.”
The presentation, a copy of which was obtained by Bloomberg, also stipulates that Goldman won’t “intentionally execute a ‘loan-to-own’ strategy” or “seek to derail a process/pursue holdup value” or “actively trade in open market securities.”
Those no-nos, normally standard ploys in the opportunistic-credit playbook, are the price Goldman pays for running an investing business inside an investment bank. By limiting its options and staying out of confrontational situations, the firm is ceding ground to feistier players such as Apollo Global Management, Elliott Management and Aurelius Capital Management.
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Don’t expect significant changes anytime soon to longstanding complaints about conflicts of interest in the “issuer pay” model of the ratings business.
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Dubbed Disco III, the fund will target leveraged loans, high-yield bonds and collateralized loan obligations.
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Principal Investing
“Having flexibility in your mandate is essential to investing across a cycle,” said Mudrick Capital Management’s Jason Mudrick, who oversees $2.5 billion and is among the best-performing hedge fund managers in credit. “What’s attractive today may not be two years from now.”
CEO David Solomon wants to rebuild Goldman’s principal investing business into a machine that can raise billions of dollars for private equity and credit bets, generating a steady stream of high-margin revenue. But if the Wall Street firm hopes to keep winning merger mandates and underwriting stock and bond offerings, it can’t deploy capital in ways companies might perceive as self-interested and hostile.
The Goldman approach, as explained in the slide deck for West Street Strategic Solutions I, will be that of a “trusted, sought-after partner” to the managements of cash-starved companies. The firm aims to deploy its capital mainly as a lender in North America and Europe in “complex situations beyond the scope of traditional providers.” It’s targeting gross returns before fees of 15% to 20%.
Contrast that with Apollo, the largest manager of alternative credit. As cofounder Josh Harris said in a recent interview, Apollo is repositioning its $23.5 billion private-equity fund expressly to take control positions in distressed borrowers. It plans to buy up discounted debt and convert it to equity through a balance-sheet restructuring. Harris said he expects returns “well over” 20%.
There’s room for both. In a report this week, UBS estimated that $500 billion of debt globally is distressed or in need of fresh liquidity and said default rates are likely to accelerate. Many companies and households haven’t benefited from government aid programs and remain desperate for cash.
“There’s a huge need across our corporate client base,” Julian Salisbury, Goldman’s head of principal investing, said in an April interview. “Everyone is drinking from the same fire hose.”
The rules of the game in this latest cycle of distress are being rewritten daily, and they’re anything but genteel. One increasingly common move involves shifting collateral out from underneath a loan. In another, creditors cut side deals to gain seniority in the capital structure, even if it means recovering less money.
"It's now June and if you’ve been on a deserted island for the last five months you couldn’t have fathomed the movements we’ve seen," an expert says.
Faced with the prospect of losing out in a loan-to-own scenario, some companies may choose to work with Goldman because it professes to be a friendlier source of capital. As the pitch book for its fund states, Goldman is offering to “work constructively with management to resolve critical issues.” It’s planning to make 25 to 40 investments, each between $75 million and $500 million, over the eight-year life of the fund.
To participate, clients have to commit a minimum of $5 million and pay fees of 1.5% plus one-fifth of profits. Goldman pledges in the presentation to provide some capital from its own balance sheet, subject to regulatory restrictions, and says employees of the firm will supply about $250 million.
The inherent conflicts between investing and investment banking are one reason many of Goldman’s rivals on Wall Street have either withdrawn from private equity, like JPMorgan Chase, or exited asset management altogether, like Citigroup.
Since 2009, Goldman has invested $15.7 billion in situations similar to those it’s pursuing with the new fund, generating a 21% return before fees, according to the slide deck. Of the 60 positions it took, only two ended in default.
