Synopsis: 'Goldman Sachs' fund finance unit, part of the global banking and markets division, lends money secured by various assets to private equity and other funds. While this strategy has driven record revenues in fixed-income financing, it carries significant risks due to the difficulty in valuing and trading these assets.
The fund finance unit, part of Goldman Sachs' global banking and markets division, lends money secured by various assets to private equity and other funds.
However, these assets can be difficult to value and trade, and some loan products remain untested in a downturn, making this lending risky.
A strategic move in 2021 to lend to private funds has driven record revenues in fixed-income financing for Goldman Sachs.
Now, the bank is venturing further into this growing yet risky market.
Despite limited details from Goldman about the business, interviews with bank executives and industry experts shed light on the unit's operations.
This expansion is part of Goldman's efforts to return to sustainable growth after significant losses in consumer businesses.
The business has grown rapidly over three years, becoming a significant contributor to the firm's profitability.
In the first quarter, the fund finance unit played a major role in a 31% increase in the bank's Fixed Income, Currencies, and Commodities (FICC) financing revenues, contributing to a record $852 million in FICC financing revenues, nearly double the amount from three years ago.
Ashok Varadhan, Goldman's co-head of global banking and markets, noted that the bank has become more prominent in areas where regional banks withdrew after banking failures last year.
Regarding risks, especially loans against private equity funds, he emphasized the bank's conservative approach, with low leverage on these loans.
Goldman Sachs reports its second-quarter results on Monday, identifying lending as a key strategy and setting targets to increase financing for other clients, including private credit and loans to wealthy clients.
Amplifying Lending:
The unit offers loans against a variety of assets, from the net asset value (NAV) of private equity funds and cash commitments from fund investors to real estate and private credit loans.
Concerns are rising in the industry about these loans, especially NAV loans, as higher interest rates stress private markets.
Bankers and analysts warn that an economic downturn could lead to defaults, particularly for heavily indebted assets.
Shana Ramirez, a fund finance and private credit expert at Katten Muchin Rosenman, noted that many banks avoid NAV loans due to these risks, emphasizing the importance of structuring loans to mitigate risks and trusting the sponsor.
Large Checks:
Goldman has been writing large NAV loans, typically in the $500 million to $1 billion range, but with low loan-to-value ratios, typically 5% to 15%.
This cushion means the asset's value would need to drop significantly for Goldman to incur losses.
The bank also includes protections in loan terms, allowing it to require borrowers to add equity if valuations drop.
Goldman is exploring ways to package these loans for sale to investors, such as insurance companies, to reduce risk on its balance sheet.
For example, two years ago, Goldman was approached by a private equity firm seeking a $1.5 billion NAV line against its $20 billion fund for an acquisition.
Although the firm lost the deal to another sponsor, it still took out the NAV loan from Goldman to return cash to its limited partners.
The private credit funds that financed the winning sponsor were also Goldman clients, and the bank ended up providing leverage to them as well.
"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, overseeing financing activity to private funds.
In conclusion, 'Goldman Sachs' fund finance unit has emerged as a significant growth driver, despite the inherent risks associated with lending against difficult-to-value assets.
The bank's conservative approach and strategic initiatives have helped navigate this complex market, contributing to record revenues in fixed-income financing.
As Goldman continues to expand its lending operations, including exploring ways to mitigate risks by packaging loans for investors, the unit exemplifies the bank's efforts to achieve sustainable growth and adapt to changing market dynamics.
With a focus on amplifying lending activities, Goldman Sachs is poised to remain a key player in the evolving financial landscape.
