Goldman Wants to Replace Your Bank

Goldman Sachs filed for an initial public offering of its new business development company, an investment firm that lends to middle market companies.
Vincent RyanApril 2, 2013

To benefit from the increased regulation of commercial banks, investment banking giant Goldman Sachs is jumping into middle-market lending. Goldman filed a preliminary registration statement on Friday to list shares in Liberty Harbor Capital, a type of lending vehicle called a business development company (BDC). BDCs are publicly held firms that by law must distribute 90% of their profits to shareholders.

Borrowers may benefit too. Business loans originated by BDCs typically carry higher interest rates than are charged by banks, but the lending agreements are less covenant-driven, Manuel Henriquez, CEO of Hercules Technology Growth Capital, told CFO last November. “Because we are not regulated like a bank and have permanent capital on our balance sheet, we can work with a company through difficult times,” he said.

Goldman’s filing lays out why it’s attracted to this niche lending sector. For one, loans to middle-market companies are illiquid and unrated, making them increasingly unattractive to commercial banks–and hence ripe for other players. “Stakeholders in banks, including their shareholders, lenders, and regulators, continue to exert pressure to contain the amount of illiquid, unrated assets held on bank balance sheets,” the filing says. “Examples of this include moves to codify the Basel III accords in the U.S., which increase the regulatory capital charge for lower rated and unrated assets in most instances, and continued investor focus on the amount of illiquid assets whose fair value cannot be determined by using observable measures.”

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Second, Goldman says, since the financial crisis, the amount of capital available to middle-market borrowers through the shadow-banking sector – which includes hedge and mezzanine funds, private equity firms, and structured vehicles – has shrunk significantly, thus diminishing competition in this sector. Shadow bankers “have struggled to attract investor interest in long-term capital commitments of the nature required to allow the managers of these vehicles to purchase illiquid assets such as middle-market loans,” the filing says.

Goldman defines middle-market as companies with EBITDA (earnings before interest, taxes, depreciation, and amortization) of between $5 million and $75 million annually. Loans and other investments from Liberty Harbor will have maturities between three years and 10 years and range in size from $5 million to $50 million, says the filing. While Liberty Harbor will originate loans, it will also pursue open-market secondary purchases.

Liberty Harbor Capital started operating in November 2012 with seed capital from Goldman Sachs Group. As of February 28, it had invested $73 million in eight companies. The portfolio has a mix of fixed- and floating-rate investments, the largest a $21.5 million senior secured loan to Affordable Care, a dental services company with 200 affiliated practices. It also holds $15 million of senior secured bonds of Dispensing Dynamics, a maker of paper towel and soap dispensers.

In a majority of the loans on Liberty Capital’s books, borrowers pay more than 10% interest, and all but 9% of the dollars are in secured debt. The weighted average term of the instruments is 5.6 years.

By becoming a BDC, Liberty Harbor not only gets to tap the public market but can also issue debt to lower its cost of capital. Under BDC rules, however, total debt outstanding cannot exceed the firm’s total equity.

Another financing avenue for the Goldman unit could be credit from the federal government. Goldman said it will consider forming a Small Business Investment Company (SBIC) subsidiary of Liberty Capital. SBICs are privately held investment firms licensed by the Small Business Administration to provide venture capital to small businesses. They can borrow from the federal government at low rates. Goldman says it has not yet applied to the SBA for approval.

Goldman could also expand on its balance sheet by securitizing certain investments through a collateralized loan obligation (CLO). “This would involve contributing a pool of assets to a special-purpose entity, and selling debt interests in such entity on a non-recourse or limited-recourse basis to purchasers,” says the filing.

Up to 30% of Liberty Harbor’s capital can be invested outside middle-market company debt. Investment targets could include large U.S. companies, foreign companies, stressed or distressed debt, structured products, or private equity, the firm says in the filing.

The Goldman filing does not specify how much equity capital the Liberty Harbor unit is trying to raise from public investors. According to the Financial Times, BDCs raised $4 billion in equity in 2012, most of it in secondary offerings.

Large asset management firms KKR, THL, and TPG Capital have all launched BDCs the last three years. The Securities and Exchange Commission lists 136 business development companies, some of which have yet to sell shares to the public and some that have ceased operations.

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