Wall Street titan Goldman Sachs is venturing into a new form of financing that poses both threats as well as possibilities. Beginning in 2021, this Wall Street titan has cranked up lending to private funds in ways that have powered record fixed-income financing sales. While entering this new but somewhat un-tested business is one thing for the bank, it is equally important to consider what opportunities and threats are likely to come with it.
Peeking into the Early Operations of Goldman’s Fund Finance Team
In operation as part of the global banking and markets division of the firm, the Goldman Sachs fund finance unit lends money to private equity and various other funds with assets acting as collateral. These assets may as well be highly profitable, however, these may be difficult to appraise and sell. The unit has grown significantly in size to now be a major source of the firm’s profits, a change from consumer businesses that were once unprofitable for Goldman.
Its fund finance unit participated in a rise of the bank’s FICC financing revenues by 31 percent in the first quarter of this year. Goldman’s recent FICC financing brought a record of $852 million as compared to the $450 million three years back when the division was still in its building stage. Such growth speaks volumes of the position of this unit in Goldman’s strategic direction.
Managing Risks during Adverse Market Condition
However, it is important to note that like any other high-returning market there exists a lot of risk involved in this market. NAV loans are more dangerous because the underlying asset is rather volatile, or, in other words, the loans are floated on the account of private equity funds. These risks are magnified in a higher-for-longer interest rate environment because stress in private markets is prolonged.
Goldman Sachs keeps these risks in check to minimize them while ensuring that it operates within a conservative outlook. The type of loan financing available from the bank is low LTV NAV loans with financing rates ranging from 5% to 15%. This conservative leverage helps Goldman since the asset is relatively protected; their losses would only occur in the event of a very low stock price. Also, to protect itself, the bank will indulge certain provisions in loan contracts, to enable it to demand additional equity from borrowers in case of a decline in valuations.
Building and Managing Business Relationships and Due Diligence
Here, Goldman has established a long-term relationship with its clients as one of the ways of addressing these risks. PRO itself is funded by clients, and its fund financing is provided to the sponsors with whom Goldman Sachs has been in business for quite a long time, a Goldman representative mentioned. These robust due diligence procedures on the underlying assets also help the bank to achieve enhanced risk management hence responding to increasing client demand in these products.
Amplifying Lending Efforts
Goldman Sachs’s fund finance division provides cash advances against various types of collateral, namely the net asset value of private equity funds, fund investor pledges, and real estate and private credit loans. It also helps in diversification to avoid putting all your eggs in one basket and also getting a piece of the action where possible.
For instance, Goldman recently contemplated securitizing NAV loans to be offered to investors including insurance firms thus dealing with risk on the NAV balance sheet. This is not only helps Goldman reduce risk but also creates new generated revenues for the firm.
The Path Forward
While building up its lending operations, Goldman Sachs is aware of the possible dangers and challenges associated with it. The firm’s approach is to write such gigantic cheques, anywhere between $500m to $1bn but with a small loan to value so that the oil price weakness would not threaten its existence.
At the same time, it is obvious that there can be an extremely large number of contracts and, thus, large profits. The fund finance unit is already a large earner for Goldman, and the bank is in a good place to advantage of the increasing trend of private fund financing.
Conclusion
It is overall to credit Goldman Sachs to have been capable of formulating new ways of financing in this fairly unconstructive environment for the banking business. Thus, Goldman is trying to overcome the potential problems of this market by using its large number of contacts, strict checks on the credits, and cautious lending strategies.
As the bank keeps extending its operation in the private fund financing industry, the free cash flow investors and stakeholders will be eager to know the way Goldman is going to maintain sustainable growth and avoid high risk. Such a daring new plan, as much as it can bring various problems, can turn into a major factor in increasing the company’s profitability and consolidating its positions in the sphere of the financial business.