Via Financial Times

Dressed in a Hawaiian shirt and clutching a tropical cocktail, Bennett Goodman counts the days left before he leaves GSO, Blackstone’s powerful credit division, which the 62-year-old executive founded nearly 15 years ago. “Fourteen days, six hours, 32 minutes to go. I can handle this,” he said, taking a long sip.

The scene, from a jocular Christmas video the private equity company sent to staff last week, reflects the brave face its leaders are putting on the imminent departure of GSO’s last remaining founder. Announcing his retirement in August, Mr Goodman delivered a message of continuity, heaping praise on his successor Dwight Scott and vowing to stay on as chairman.

But behind the scenes, new leadership has found reasons for urgent change, as well as continuity.

Mr Scott has been distancing the company from aggressive trading manoeuvres that were recently seen as GSO’s calling card, particularly in distressed debt. He has been battling to contain the fallout from an exodus of top executives that threatened to freeze one of its most important funds. And, to make matters worse, the energy business that Mr Scott used to run has incurred losses on several big investments.

“The business is in extraordinarily positive shape,” said Jon Gray, Blackstone’s chief operating officer and heir apparent to its founder Steven Schwarzman. “The one area where we’re not satisfied with the performance has been in this distressed area.”

Dissected on late-night TV

Named from the initials of its three founders — Mr Goodman and fellow ex-bankers Tripp Smith and Doug Ostrover — GSO has shifted the balance of power on Wall Street since it was acquired by Blackstone for $1bn in 2008. 

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Today, the $142bn specialist debt fund manager is corporate America’s first call for a swath of activities that investment banks once regarded as their core business, offering expensive but flexible loans to companies that are too small to tap the financial markets and too risky for heavily regulated banks.

Grab of Bennett Goodman in a Hawaiian shirt, in a Blackstone video
GSO co-founder Bennett Goodman, in a Hawaiian shirt in a Blackstone Christmas video, is full of praise for his successor Dwight Scott © Youtube

Overshadowing all of that, however, is a trade that achieved notoriety for GSO. In 2017, the company offered financial inducements for US homebuilder Hovnanian to default on some of its debt so its funds could cash in on a derivatives side-bet — a trade that Blackstone had to unwind after regulatory scrutiny. This kind of aggressive manoeuvre, known as a manufactured default, was invented in 2013 by another GSO trader, London-based Akshay Shah, and it remained in Blackstone’s playbook even after it was dissected on late-night US television by comedian Jon Stewart. 

“We learnt a very hard lesson [and] we underestimated the public nature of that transaction,” said Mr Scott of the Hovnanian trade, echoing those at Blackstone who increasingly see themselves as custodians of an enduring financial institution whose reputation is paramount.

Mr Gray was especially wary of the potential damage to the company’s image. He began attending GSO investment committee meetings after he replaced Mr Goodman’s longtime colleague Tony James as Blackstone chief operating officer last year.

One by one, the champions of the Hovnanian trade began to leave. Ryan Mollett resigned to join rival credit group Angelo Gordon. Jason New announced in the summer that he would quit his role as distressed debt chief by the end of the year. 

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But the departures spelt trouble for a large GSO fund.

Persuading investors to keep the faith

The $7bn Capital Solutions III fund was raised in 2018 to offer expensive rescue financing for companies on the verge of bankruptcy.

When Mr Goodman, too, announced his departure over the summer, it started the clock ticking on a “key man” clause, which allows investors to pull their money out if enough named executives leave.

Blackstone set about trying to persuade investors to keep faith with its $7bn distressed debt fund, but matters were complicated by heavy losses on distressed debt investments linked to GSO’s energy franchise, which Mr Scott used to run. One of the troubled energy companies, Oklahoma-based Tapstone Energy, whose board Mr Scott previously sat on, this month missed an interest payment on its debt.

The setbacks wiped out most of the gains made by investors in Capital Solutions II, a previous fund that investors viewed as similar.

Column chart of Capital Solutions II (started June 2013) showing Performance has deteriorated at GSO's prior distressed debt fund

Between June 2013 and the end of 2017, the predecessor fund had notched up annual gains of 14 per cent, securities filings show. By the end of September 2019, however, Blackstone’s portfolio valuation indicated that those profits had all but disappeared, leaving investors with net internal rate of return of just 1 per cent.

Executives trying to win investor support for Capital Solutions III first held discussions with a powerful committee of top clients, before taking their case to the entire body of investors. 

That painstaking process of persuasion ultimately yielded consent for GSO to appoint a new group of managers, but only after the company offered a range of concessions — including reductions in fees.

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“We were asking our investors to do something that is different from what we asked when they made the initial investment,” said Mr Scott. “It never crossed my mind that there wouldn’t be something that we would do to reflect that change.”

‘The nature of being inside Blackstone’

Blackstone executives point to the investor approval as a vote of confidence for its new team, but some outsiders view the incident as a narrowly averted crisis. One gleeful hedge fund manager at a London-based rival called GSO’s relative quiet in distressed debt trading after Hovnanian “astonishing”.

Other GSO teams are making up for the lull in activity. All told, the company put $10bn to work last year, more than ever before. It more than replenished that financial firepower, raising $30bn in new funds, including one that is dedicated to energy investments. Most of the $142bn that GSO manages is committed to vehicles that lend to companies not facing big difficulties.

“I don’t think [it] changes our culture,” said Mr Scott, reflecting on a tamer approach to distressed investing. Colleagues say GSO is likely to shun elaborate derivatives contracts in favour of more traditional gambits, such as buying the debt of over-extended companies and trying to seize control in a bankruptcy.

“It has something to do with the nature of being inside of this big asset management business called Blackstone,” Mr Scott said of the shift. “It also has something to do with where we saw we made money and didn’t make money.”