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. Such assets, however, can be hard to value and trade, and some loan products are yet to be tested in a downturn, making 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.
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.
In the first quarter, for example, the fund finance unit was a significant contributor to a 31% 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 $852 million in FICC financing revenues in the first quarter, 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.
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. I see it as a fairly early cycle activity," he said.
Goldman reports second quarter results on Monday.
Goldman has identified lending as a major part of its strategy, setting targets to also significantly increase financing it provides to other clients, including private credit and loans to wealthy clients.
Amplify lending
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 a private equity fund's value, called NAV loans, as the higher-for-longer interest rate environment increases stress in private markets. Bankers and analysts said the biggest risk is a potential economic downturn 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 don't offer NAV loans because of these risks.
Ramirez said 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."
"The majority of clients we provide fund financing to are sponsors we have longstanding relationships with," a Goldman spokesperson said.
The spokesperson said the bank has "robust" due diligence processes in place for the underlying assets, enabling it to mitigate risk and meet growing client demand for these products.
Large checks
For NAV loans, Goldman has been writing large checks, mostly in the $500 million to $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%. That gives the bank a cushion, as the asset's value 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. If valuations drop, for example, Goldman has an ability to force the borrowers to remedy it by putting in more equity, the source said. In addition, Goldman is examining whether it can package such loans to sell to investors, such as insurance companies, reducing the risk on its balance sheet, the source said.
Two years ago, Goldman got a call from a private equity firm that wanted a $1.5 billion NAV line against its $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 said.
"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.
