By Saeed Azhar and Paritosh Bansal

NEW YORK (Reuters) – A Goldman Sachs bet launched in 2021 on private equity lending has helped drive record revenue growth in fixed-income financing. Now, the Wall Street bank is pushing even deeper into the growing but risky market.

Housed in the bank’s global banking and markets division, the mutual fund financing unit lends money secured by different types of assets to private equity and other mutual funds. Such assets, however, can be difficult to value and trade, and some loan products have yet to be recession-tested, making lending against them risky.

Goldman has disclosed few details about the business, but interviews with bank executives and industry experts provide a window into the unit and its operations.

The mutual fund 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 a source familiar with the matter saying it has gone from a very small contribution to “a very important part of the company’s profitability”. The source did not want to be named because the business details are not public.

In the first quarter, for example, the mutual fund financing unit contributed significantly to a 31 percent increase in the bank’s fixed income, currency and commodity (FICC) financing revenue, the source said. The bank said the increase was driven by mortgages and structured lending.

Goldman reported a record $852 million in FICC financing revenue in the first quarter, nearly double the amount it reported three years ago when the unit was formed. Reuters was unable to determine exactly how much of the growth was due to capital funding.

“It’s a market that’s grown a lot and we’ve been a part of that growth,” said Ashok Varadhan, Goldman’s co-head of global banking and markets.

Varadhan said Goldman had been “more exposed” in areas where regional banks had pulled out after last March’s banking failures.

Asked about the risks, especially in loans made against the value of private equity funds which are considered the riskiest, he said the bank is “pretty conservative”.

“The amount of leverage that goes into these loans is pretty low. I see it as a pretty early-cycle business,” he said.

Goldman reported second-quarter results on Monday.

Goldman has identified lending as an important part of its strategy, aiming to also significantly increase the financing it provides to other clients, including private credit and loans to wealthy clients.

LOAN ENHANCEMENT The unit offers loans against different types of assets, ranging from the net asset value (NAV) of a private equity fund and cash commitments from equity investors to real estate and private credit loans.

Concern has grown in the industry about some of these loans, especially those secured by the value of a private equity capital, called NAV loans, as the longer-term higher interest rate environment increases pressure on private markets. Bankers and analysts said the biggest risk is that a potential economic downturn could lead to defaults, particularly of heavily indebted assets.

Shana Ramirez, a partner at the law firm Katten Muchin Rosenman who specializes in equity financing and private credit, said many banks do not offer NAV loans because of these risks.

Ramirez said a bank can try to structure loans “in a way that makes you feel comfortable, getting whatever collateral you can, recognizing that some of it is unsecured. From there, it’s really a matter of trusting your sponsor.”

“The majority of clients to whom we provide funding are sponsors with whom we have long-standing relationships,” a Goldman spokesman said.

The spokesman said the bank has “robust” due diligence processes in place for the underlying assets, enabling it to mitigate risk and meet growing customer demand for these products.

BIG CHECKS

For NAV loans, Goldman has written large checks, mostly in the $500 million to $1 billion range, the source familiar with the business said.

However, the source added that the bank provides low loan-to-value NAV loans, typically 5% to 15%. This gives the bank a cushion, as the value of the asset would have to fall to those levels for Goldman to absorb any losses.

It also requires other protections when negotiating loan terms. If valuations fall, for example, Goldman has the ability to force borrowers to correct it by putting up more equity, the source said. In addition, Goldman is looking at 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 a company buyout, the source said. The private equity firm lost the deal with another sponsor, which raised funding from four private lenders. But in the end all roads led back to the Wall Street firm. Goldman’s client took the NAV loan anyway, using it to return cash to its limited partners. The private equity funds that had given the loan to the other sponsor were also clients of Goldman – and the bank ended up providing them with leverage as well, the source said.

“The goal was not to pull back on trading, but to really strengthen what we do on the lending side,” said Mahesh Saireddy, Goldman’s head of mortgage and structured products, who oversees the private equity financing business.