BlackRock tried private credit once before. Will this time be better?

Seven years after BlackRock’s last big foray into private credit, last week Larry Fink finally turned the world’s largest asset manager into a player.

With the completion of the $12bn takeover of HPS Investment Partners on Tuesday, the $11.6tn investment group has closed a trio of takeovers that shift it from a position of dominance in public markets to one where it straddles both public and private assets.

BlackRock folded in infrastructure investment firm Global Infrastructure Partners last October and private market data provider Preqin in March.

The deals are crucial to BlackRock’s success in the private investment space, widely regarded as the future of global capital markets — and the key to higher fees in an industry where they are continuously being squeezed.

How it integrates HPS, the final piece of last year’s almost $30bn deal spree, has the potential to determine what role BlackRock gets to play.

“We had lost our way as an investor” in private markets before the acquisitions, one recent employee said.

But they were blunt about BlackRock’s previous effort to break into private credit, with its 2018 acquisition of Tennenbaum Capital Partners. “It was a disaster.”

BlackRock and HPS declined to comment for this article.

HPS is known for making big and often risky investments that have paid off handsomely: the firm has grown from $34bn in assets in 2016 to $157bn this year.

HPS’s leadership team will now oversee BlackRock’s entire private credit portfolio, as well as BlackRock’s collateralised loan obligation business — a structured credit offering that is a massive business on Wall Street. In total, HPS chief executive Scott Kapnick estimated at BlackRock’s recent investor day that he would run close to $280bn in his new role.

BlackRock founder and chief executive Fink has a history of making wagers that have delivered for his shareholders, chief among them the purchase of the Barclays Global Investors business in 2009 that made it the largest asset manager in the world with the iShares exchange-traded fund platform.

“Different firms are talking about what they can do differently, we’re doing them all,” Fink told investors last month. “We’re transforming like no other firm.”

With HPS, the stakes are all the higher because some of BlackRock’s previous efforts in private credit have not played out as planned.

Current and former executives said that Tennenbaum fell far short of expectations. Part of the work of the 800 HPS employees who now work for BlackRock will be cleaning up the issues in that pre-existing private credit portfolio, which continues to set off fireworks.

BlackRock’s bet on Tennenbaum gave it a toehold in the burgeoning direct lending market — where asset managers bypass banks to underwrite loans directly to companies — and an investment team to buy riskier bonds and loans.

But almost from the start things went sideways. Tennenbaum focused heavily on so-called opportunistic credit, generally riskier deals. Its direct lending funds were also smaller than larger rivals and it did not have a vast fundraising team. That meant it often took a small slice of deals its competitors were leading. But if a deal went south, Tennenbaum was not in a position of control.

The unit suffered poor fund performance, high staff turnover and a handful of credit deals that ultimately soured.

“They sort of injected, and I think in an unplanned way from BlackRock’s perspective, a higher risk tolerance than BlackRock thought they . . . were buying,” one former employee said. “That oversight was because it was an acquisition done in the blind pursuit of scale and growth.”

The loans Tennenbaum did underwrite were often more speculative than traditional senior debts, which BlackRock executives had wanted the team to focus on.

The portfolio has been riddled with problems and the publicly traded fund, BlackRock TCP Capital, has returned minus 15.6 per cent over the past year — ranking among the worst performing of its peers. The fund warned at the end of last year that 14.4 per cent of the loans it had provided were on non-accrual, meaning those borrowers were facing such financial strain that they were unable to make their interest payments or would struggle to pay off their debts.

It is or was involved in many of the thorniest restructurings that hit the private credit industry, including for educational video maker Pluralsight, cyber security group McAfee, Amazon aggregators Thras.io, Razor Group and SellerX and software companies Khoros and InMoment. The non-accrual rate has fallen as some of the original loans have been restructured.

Rating agency Moody’s downgraded the fund’s debts to junk earlier this year as a result of the losses.

“Did they hit it out of the park? No,” one current employee said. They added there were “cultural and leadership issues”, pointing to executive departures. A former executive involved in the business added that it had been hard to sell existing BlackRock clients on Tennenbaum funds.

Tennenbaum’s funds for sophisticated investors have also underperformed. A report from the San Joaquin County Employees’ Retirement Association showed BlackRock’s existing direct lending fund returned 5.5 per cent last year, 3.6 percentage points below its benchmark.

HPS’s so-called workout team is expected to assist in a number of the restructurings, but BlackRock does not plan to combine the existing $1.8bn publicly listed fund — known by the ticker TCPC — with a $20bn fund operated by HPS, known as HLEND.

HLEND is seen as a flagship retail product that competes with offerings from the likes of Ares Management and Blackstone, and a prime vehicle for BlackRock to use to target individual investors with its 13 per cent return last year. Executives are also considering ways to leverage the fund’s strategy in the model portfolios that BlackRock offers.

Had BlackRock sought to merge HLEND with TCPC, one person cautioned it would dent returns. “Some shocking amount of [TCPC’s] book is on non-accrual, which tells you why BlackRock felt the need to buy HPS,” one of the former employees added.

Even if Tennenbaum had grown faster or generated higher returns, it is possible BlackRock would have still pursued a takeover of HPS. Private credit has exploded in size over the past five years as the market has matured to a $1.7tn asset class, according to Preqin.

Much of that growth has come from loans that funds like HPS are now making to ever-larger companies as they take on traditional banks head-on. Tennenbaum, by contrast, primarily lent to smaller businesses.

BlackRock was already shaking things up within its private credit business as conversations with HPS got under way. Last September, head of private credit Jim Keenan announced he would leave. The asset manager inked the HPS deal less than three months later.

The firm had also been investing in private credit outside of Tennenbaum, growing its business in asset-backed and investment grade private debt. In 2023 it acquired a lender to venture capital-backed companies called Kreos.

But the integration will nonetheless involve meshing an independently minded HPS with much larger BlackRock.

In the months leading up to the deal’s closing some HPS executives had complained about having to move to BlackRock’s headquarters while others were adamant they retain their existing email domain, like Oaktree had after the credit manager sold to Brookfield.

So far, HPS has been able to keep some of its distinct identity. Existing employees will retain current email addresses even as they get new BlackRock ones. HPS will also keep its own brand, adding the tagline “a part of BlackRock” to its name. Top executives based in New York also plan to stay in their current offices, floors away from Elliott Management and across the street from Apollo. Eventually, though, HPS is expected to move in with its new owner.

Fink says he is confident HPS will take to BlackRock. “Strategic acquisitions have strengthened our firm,” Fink said last month. “With GIP, HPS and Preqin, we were again looking for the right partners.”

BlackRock’s chief financial officer, Martin Small, underlined that point last month, telling investors the GIP integration was already showing momentum and delivering on the company’s plans.

“In the nine months since closing the GIP combination, we’ve made major progress across the capital raise and return life cycle,” he said.

Fink has put top HPS and GIP executives on committees that shape strategy. Kapnick will be an observer on BlackRock’s board. The asset manager has set aside more than $1bn to compensate HPS and GIP employees in a bid to entice them to stay.

Fink also gave Kapnick a spotlight at BlackRock’s investor day earlier this year, weeks before the takeover completed. The HPS chief acknowledged that BlackRock had “entrusted us really to run a large business”.

The challenge for Kapnick and his team will be to keep returns elevated as money pours into the private credit industry, a phenomenon that has amplified competition among top lenders and reduced the yields on new loans direct lenders offer.

As he looks to grow the division, Kapnick is expected to push deeper into private investment-grade debt, providing bespoke financings to blue-chip companies — many of which count BlackRock as a large investor or turn to the firm to help manage their own finances.

“We’re ready to hit the ground running,” Kapnick said. “The combination of BlackRock and HPS creates an asset manager with breadth and scale to compete with anyone.”