In the process, fund financing is becoming one of the largest revenue engines within investment bank securitization units, and a core strategic focus for Goldman's fixed income business, operating through its ‘private markets investing and lending’ group.

The firm's 2023 investor day (February 2023) took the opportunity to underline the importance of ‘FICC financing’ to the franchise, both in terms of absolute revenues, but also as a way to stabilise the historically volatile earnings from fixed income trading businesses.

“We were at $2.6bn of financing revenues 10 years ago. We're now in 2022 over $7bn with an intent to be higher this year and higher in the years ahead,” said Dan Dees, head of global banking and markets.

He noted high growth in equities financing (essentially prime brokerage) but added: “The growth has come in the FICC financing business, mostly through the growth of asset secured lending, where we've seen real growth in that marketplace and an expansion of the products we offer in our portfolio.”

FICC financing covers a lot of activities within credit; warehousing for non-bank lenders or CLO managers, or repo financing for credit funds might come under this umbrella and form the core revenue engine for a traditional securitized products business.

Goldman’s annual report notes that it includes “(i) secured lending to our clients through structured credit and asset-backed lending, including warehouse loans backed by mortgages (including residential and commercial mortgage loans), corporate loans and consumer loans (including auto loans and private student loans), (ii) financing through securities purchased under agreements to resell (resale agreements) and (iii) commodity financing to clients through structured transactions”.

But lending to funds has been a major pivot for Goldman. Dees said at the 2023 investor day that the firm had a fund finance business earning $300m, where previously it had zero.

He didn’t specify a timeline, but the overall FICC financing revenue has been growing, with the strong performance last quarter attributed to mortgages and structured lending. As the chart below shows, revenues are tracking at more than $850m per quarter, up from $450m-$500m in 2021. The market volatility from Covid, the Russian invasion of Ukraine and the rates tightening cycle makes the figure noisy, with some stand-out quarters in 2022 driven by mortgage trading, but the trend is clear.

Source: Goldman Sachs investor reporting

“We’re able to create new and innovative ways for [funds] to access capital, across their GPs and across their portfolios, across a variety of markets,” said Dees. “By solving this problem, we created wallet. We didn't take wallet share from another bank. We created wallet.”

One of the attractive elements of deploying capital in lending to funds in this way is its sheer scale. Banks can lend the billion-plus tickets you might see in an marquee LBO, rather than the $100m-400m you might see for a typical mortgage or CLO warehouse.

It's a better use of time for a bank's structuring team to lever a giant fund from an Ares or Blackstone and put $2bn to work, instead of negotiating 10 mortgage and leasing deals at $200m each. Underwrite a billion dollar levered sleeve for a private credit fund instead of competing to provide $50-$100m corporate loans at a time.

Putting the fun in fund finance

Despite the large size of the bank tickets, the appetite for fund leverage is larger still, and that's keeping spreads attractive. Traditional securitization business (mortgage warehousing, for example) has had much of the juice competed away.

“Given the enormous growth in alternative investing, the appetite for this product far outstrips the capacity of large bank balance sheets to provide it, and that's keeping spreads attractive,” said Mahesh Saireddy, head of mortgages and structured products at Goldman Sachs. “Five years ago, spreads were in a 150-200bps context, now we're looking at 225-275bps, and it's a very capital-efficient product for us, most of the risk is IG with a premium to IG spreads.”

Although the balance sheet is coming from the ‘markets’ part of the bank, this is mostly buy-and-hold financing. It has more in common with traditional banking than with bond repos.

“We want to stick down the middle of the fairway; most of what we're doing is IG lending,” said Saireddy. “We're not in the business of leveraging up more concentrated portfolios. The core of the business is senior lending against senior corporate loans.”

You can think of these trades as heading further up the capital structure, as the non-banks have crowded in to much of the corporate lending market. Instead of a bank lending to companies directly, it’s now taking a senior slice of senior risk.

“Let's start the story with middle-market private credit, which has grown hugely in the last decade,” said Saireddy. ”Banks have evolved into more of a loan-on-loan position than doing the loan itself given the risk profile. The banks are still lending, but they're doing less risky lending than they used to, at a higher attachment point.”

Saireddy didn’t discuss regulation, but fund finance is also subject to far less direct or indirect scrutiny than other parts of a securitized products business.

There’s no rating requirement (though some banks opt for public or private ratings to improve capital treatment), no 15G notification (an SEC filing for traditional ABS deals), no risk retention, and no P-factor (a capital add-on for securitization positions).

Various structures can be used, with different levels of security over assets and cashflows, but diversification across a fund’s positions is generally important.

Saireddy said: “Our whole philosophy is about diversified portfolio lending, with the ability to call margin. We have done single assets here and there, but that's not a core strategy, and usually we do it with a fund guarantee from a much more diversified asset pool.”

Recycling risk

Unlike other activities in the securitization group, this asset class is for now, mostly buy-and-hold — Saireddy said that Goldman syndicates perhaps 5-10% of a typical deal, more on large transactions where it has a defined credit hold.

The demand for fund leverage, though, points the way towards building a more active distribution model, potentially with securitisation-style takeouts to come.

Levering funds through NAV-style facilities or private CLO structures is distinct from capital call or subscription line finance, which essentially bridges the short term gap from a fund investing in an asset to it drawing down on its LP commitments.

It’s generally reckoned low-risk business, since the credit risk is essentially that an LP will not come up with the cash, rather than being credit risk to the assets or the fund itself.

Goldman has also been active lending, structuring and purchasing these assets — last year, it bought a $15bn bundle of private equity capital call facilities, of which around $9bn was drawn, from the FDIC’s auction of Signature Bank’s portfolio. By year-end 2023, this had paid down to around $6bn, according to Goldman’s results.

Last week, Goldman launched a first-of-kind capital call securitization in cash format, Capital Street Master Trust 2024-1. This adapts the revolving master trust structure often used in credit card securitizations to private equity capital calls, which are also relatively short-term revolving exposures.

As in a credit card trust, there are defined eligibility criteria, concentration limits and quality grading, aimed at ensuring the pool quality remains high — and the advance rate is exceptionally attractive, with 90% of the structure rated triple-A and a further 5% double A, according to DBRS.

Subscription lines have also been a popular subject for significant risk transfer or SRT transactions, though spreads have become extremely tight, with some deals (essentially an equity position in a capital call portfolio) said to be priced in the 400bps-500bps range over SOFR.

Big banks like Goldman have capacity for this risk, but it’s not infinite — so expect more capital markets management, in cash or synthetic markets.

Trading through it

Goldman’s securitization business has historically been strong as a principal trading outfit — and that’s still a big part of the GS mortgage business in the US, with a regular flow of mortgage-repackaging deals collecting loans from a variety of originators.

Major European deals from Goldman include taking down a portfolio of legacy Barclays second-lien mortgages, buying and securitising loans excluded from the back book sale of Kensington, and buying Irish mortgage portfolios from KBC Bank and Danske Bank as part of these firms’ exit from the country.

“In the US, housing loans especially are done through the non-banks, and our securitization business at GS still plays a fairly large role in buying these from originators, packaging and securitizing,” said Saireddy. “But in Europe that activity is more episodic, and driven by particular situations where a large bank needs to sell something and we'll buy it and securitize/sell it. But it's not a flow business like in the US, and even in the US, where the trading business is pretty active, it's really been financing that's grown for us over the last five to seven years.”

Goldman has historically been less active in vanilla securitized products financing activity such as mortgage or consumer loan warehousing — where it chooses to lend in this way, it might fund more esoteric positions such as instant home-buying operations, or electric scooters.

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