How the biggest private equity firms became the new banks
Gibson Brands is the legendary guitar maker based in Tennessee that has made instruments for Jimi Hendrix and Keith Richards. Now, a legal brawl between two of America’s biggest investment firms means the faltering rock’n’roll emblem has also become a symbol of the shifting hierarchy in global finance.
Bankruptcy proceedings in Delaware have brought a crashing end to Gibson’s plan to reinvent itself by selling smart speakers and guitars that tune themselves. They have also set up a courtroom battle between Blackstone and KKR, two of America’s most powerful financial firms, which are among the biggest lenders to the company.
Which firm wins this skirmish matters less than a bigger victory that belongs to them both. Founded by former bankers, they are part of a group of private equity firms which has spent the years since the financial crisis quietly supplanting their former colleagues in the banking world. By setting up huge lending arms, they have been transformed from heavyweight deal makers that took stakes in companies into the principal bankers for a large tract of corporate America.
Until the financial crisis, private equity investors hewed closely to the “buyout” playbook pioneered by Henry Kravis and George Roberts when they founded KKR in the 1970s. Acquiring companies whole, they would cut costs and load them up with huge amounts of debt while paying the bank back at a low interest rate.
Now the biggest firms have all but pivoted from private equity to private debt, joining a new breed of lightly regulated asset managers that have filled the void as banks are forced to retreat from risky deals.
Unlike banks, which are dependent on deposits and other shortterm funding, these funds raise money from long-term investors such as insurance companies and pension funds. Many of the companies they lend to are owned by other private equity investors. The funds provide a crucial source of credit for companies that cannot tap the bond markets, their advocates contend.
“Banks have had to recapitalize and build larger capital cushions, and combined with recessions and weak recoveries, they really weren’t extending a lot of credit,” says Susan Lund, a partner at the consultancy McKinsey.
Ten years after the crisis, the rapid expansion in private credit raises the question of whether risks have simply been transferred to a different, less regulated part of the market. “It’s true that this is opaque,” says Ms. Lund. “But it does not have systemic risk. If the company doesn’t repay the investors will lose, and that’s where it ends.”
Howard Marks, the founder of Oaktree Capital Management who has made billions of dollars investing in distressed debt and profiting from the fallout of credit busts, agrees — up to a point.
“The raw material of this lending boom is not as fallacious as subprime [mortgages],” he says, comparing the borrowerfriendly terms of today’s corporate loans with the fraudulent loans obtained by tens of thousands of homeowners whose defaults later brought the banking system close to collapse.
But he adds that such judgments must always be uncertain. The pre-crisis mortgages were “something nobody caught,” he recalls. “You say: ‘What idiots. It’s obvious that
was all fallacious. Why didn’t anybody catch it at the time?’ Because we don’t see the flaws until the things are tested.”
As the US enters a 10th year of economic expansion with interest rates still near historic lows, some believe the harshest test is about to start.
Michael Patterson has more reason than most to worry about the potential fallout when that growth streak ends. From his position in charge of senior lending funds at one of America’s biggest private credit firms he has watched rivals make bullish calls, relying on economic expansion, he says, to cover their mistakes.
“[People think that] things usually grow and therefore if I’m overly aggressive lending today it’ll kind of catch up over time,” he says. “That has worked for a decade. We are acutely aware of it.”
Mr. Patterson is a partner in a firm that was once known as Highbridge Principal Strategies. That changed in 2016 when the former owner, JPMorgan Chase, sold the business to its senior staff. Regulators insisted on a change of name, fretting that investors might assume America’s biggest bank still stood behind the newly independent firm, according to a person briefed on the deal.
The rebranded HPS has raised debt funds worth $20 billion in the past decade, according to data from Preqin, putting it alongside private equity firms Blackstone, Apollo and Ares among the 10 biggest providers of private credit.
Private credit funds are still small in comparison with the $12 trillion global non-financial corporate bond market which now accounts for one-fifth of borrowing by companies other than banks. There, too, credit quality has been deteriorating; most of the growth in bond issuance has involved companies that are either on the lowest rung of investment grade ratings or else firmly in junk territory.
Still, private credit funds have carved out a niche by charging more for their money while promising borrowers greater certainty and less hassle.
“If you’re a company that is purchasing a competitor and believe you’re doing so at a really attractive