Inside Goldman Sachs' expanding but risky financing engine
Concerns grows about these loans, especially those secured by a private equity fund’s value
A GOLDMAN Sachs bet put in place in 2021 on lending to private funds has helped drive record revenues in fixed-income financing.
Now, the Wall Street bank is pushing even deeper into the growing but risky market.
The fund finance unit, housed in the bank’s global banking and markets division, lends money secured by different types of assets to private equity and other funds.
However, such assets can be hard to value and trade. Some loan products have not been tested in a downturn. This makes lending against them risky.
Goldman has revealed few details about the business, but interviews with bank executives and industry experts provide a window into the unit and its operations.
The fund finance unit is part of the bank’s efforts to put the Wall Street bank back on a sustainable growth path after an ill-fated foray into consumer businesses, where the bank lost billions of dollars.
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The business has grown rapidly in three years, with one source familiar with the matter saying it has gone from contributing very little to becoming “a very meaningful part of the firm’s profitability”.
The source did not want to be identified because the details of the business are not public.
Lending identified as major part of Goldman’s strategy
In the first quarter, for example, the fund finance unit was a significant contributor to a 31 per cent increase in the bank’s fixed income, currencies and commodities (FICC) financing revenues, the source said.
The bank has said the increase was driven by mortgages and structured lending.
Goldman reported a record US$852 million in FICC financing revenues in the first quarter. This is almost double the amount it reported three years ago, when the unit took shape.
Reuters was not able to determine exactly how much of the growth was due to fund finance.
“It’s a marketplace that has grown a lot, and we’ve participated in that growth,” said Ashok Varadhan, Goldman’s co-head of global banking and markets.
Varadhan said Goldman had “featured more prominently” in areas from where regional banks withdrew after the banking failures of March last year.
When asked about risks – especially in loans made against the value of private equity funds that are considered the riskiest – he said the bank is “fairly conservative”.
“The amount of leverage that’s being put on these loans is fairly low,” he said.
Goldman reports second quarter results on Monday (Jul 15).
It has identified lending as a major part of its strategy, setting targets to also significantly increase the financing it provides to other clients. This includes private credit and loans to wealthy clients.
Economic downturn ‘biggest risk’ to NAV loans
The unit offers loans against different kinds of assets, ranging from the net asset value (NAV) of a private equity fund and cash commitments from fund investors to real estate and private credit loans.
Concern has been growing in the industry about some of these loans, especially the ones secured by private equity fund’s value – called NAV loans. The higher-for-longer interest rate environment increases stress in these private markets.
Bankers and analysts said the biggest risk is a potential economic downturn that could lead to defaults, in particular of assets that carry a lot of debt.
Shana Ramirez, a partner at law firm Katten Muchin Rosenman, who is an expert in fund finance and private credit, said many banks do not offer NAV loans because of these risks.
The lawyer said that a bank can try to structure the loans “in a way that makes you comfortable, get whatever collateral you can, recognizing that some of these are unsecured. Beyond that, it’s really a matter of trusting your sponsor”.
‘All roads’ lead to Goldman
For NAV loans, Goldman has been writing large checks, mostly in the US$500 million to US$1 billion range, the source familiar with the business said.
But the source added that the bank provides low loan-to-value NAV loans, typically 5 to 15 per cent.
That gives the bank a cushion, as the value of the asset would have to drop down to those levels for Goldman to take any losses.
It also demands other protections during negotiations over terms of the loan. The source said that if valuations drop, Goldman has an ability to force the borrowers to remedy it by putting in more equity.
In addition, the company is examining whether it can package these loans to sell to investors – such as insurance companies – which reduces the risk on its balance sheet.
Two years ago, Goldman got a call from a private equity firm that wanted a US$1.5 billion NAV line against its US$20 billion fund to finance the acquisition of a company, the source said.
The private equity firm lost the deal to another sponsor, which raised financing from four private credit providers.
But in the end all roads led back to the Wall Street firm.
Goldman’s client took out the NAV loan anyway, using it to return cash to its limited partners. The private credit funds that had given the loan to the other sponsor were also Goldman’s clients – and the bank ended up providing them leverage as well, the source noted.
“The goal was not to downshift in trading, but really amplify what we’re doing on the lending side,” said Mahesh Saireddy, head of Goldman’s mortgage and structured products, who oversees financing activity to private funds. REUTERS
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