For more than three years, Goldman Sachs Group has been attempting to clean up the mess at its publicly traded private-lending subsidiary, yet investors remain unconvinced.

Goldman's business development company (BDC) is an entity focused on lending to mid-sized companies. Like all BDCs, it raises capital by issuing shares or taking on its own debt, then lends the money out through customized private credit deals, distributing the profits to shareholders as dividends. This dividend-paying feature has made BDCs a popular investment choice for individual investors.

Affected by deteriorating loan assets, the per-share value of the assets held by Goldman's BDC has declined for seven consecutive quarters, with its stock price falling even more sharply. One analyst ranked the company's credit performance 25th out of 26 publicly traded BDCs—a position that represents an unprecedented predicament for the Wall Street giant.

To turn the situation around, the company has replaced its management team and restructured existing loans through measures such as deferring interest payments and extending loan maturities. The company has stated that the quality of newly issued loans has improved, with several metrics showing positive trends over the past year, and it is now awaiting the clearance of risks from older loans. However, analysts note that legacy loans still constitute a significant portion of its investment portfolio.

David Miller, Co-CEO of Goldman's BDC, said on an earnings call last month: "The asset write-downs are primarily concentrated in a subset of our legacy portfolio, where the underlying performance of these companies has not improved. Outside of these legacy positions, we have a high degree of confidence in the overall portfolio's performance."

This multi-year cleanup process, coupled with the persistent performance decline, may signal that the rapidly expanded private credit industry could expose investors to the risk of asset depreciation. Loan restructurings often take years to complete, tying up significant capital, depressing asset values, and continuing to exert pressure on stock prices. Since the start of the year, share prices of several BDCs have fallen.

This autumn, as numerous banks and lenders suffered losses due to alleged corporate fraud, market concerns grew that the private credit sector might harbor more hidden risks. The challenges faced by Goldman's BDC vividly illustrate the ripple effects that even relatively moderate problems can trigger.

Fintan O'Shea, a BDC analyst at Wells Fargo, who ranked Goldman's BDC 25th based on loss data, stated: "The core issue is credit losses, the severity of which has exceeded expectations over the past few years. While performance has improved under the new management team, their tenure at this BDC is still relatively short."

Goldman's private credit business manages approximately $162 billion in assets, while its BDC accounts for only about $3.4 billion of that total.

For years, Goldman's BDC operated almost as an "island," completely separate from the rest of the firm's private credit asset management operations. According to former employees of Goldman's private credit division, the BDC initially focused on purchasing loans originated by other banks that were tied to private equity deals, before shifting its focus to direct lending to mid-sized companies, many of which were backed by private equity firms and spanned sectors like fitness and senior care search engines. Some employees jokingly remarked that this BDC wasn't truly a Goldman subsidiary—it merely rented office space from the firm.

This situation changed following reforms implemented by Goldman CEO David Solomon. He consolidated all the firm's asset management teams under a unified structure and placed the BDC within the private credit division. Former private credit division employees recall that after management conducted a deep dive into the BDC's investment portfolio, they pointed out to colleagues that its lending operations had underwriting deficiencies, with some loans having been made to companies in poor financial health that should never have been approved.

Subsequently, Goldman appointed seasoned executives from within the firm's private credit business as the BDC's new management. The firm also allowed the BDC to participate in and receive support for private equity deals handled by Goldman's investment bank, enabling it to collaborate with the firm's other private credit operations on loans to larger companies.

Despite these changes, they are still dealing with legacy loans issued before the reforms.

Over the years, the BDC's management had publicly highlighted several investment projects, all of which later underperformed expectations. In the third quarter of this year, 2.6% of the company's portfolio assets were essentially in default and posed a risk of causing "significant losses" to the company.

During the pandemic, the BDC participated in a syndicated loan to Thrasio, a digital consumer goods company that acquires third-party sellers on Amazon. Thrasio's sales surged during the 2020 pandemic, allowing it to raise substantial funds from creditors and equity investors at a multi-billion dollar valuation.

For over three years, the BDC has been writing down the value of its Thrasio-related loan assets. By the end of 2023, Goldman's BDC reported moving at least a portion of these loans into non-accrual status. In early 2024, Thrasio filed for bankruptcy protection as online consumer spending declined. That summer, the BDC stated it had reached a restructuring agreement with Thrasio regarding one debt exposure, but the related loans remained on non-accrual status.

A similar collapse occurred with Pluralsight. This technology skills learning platform received a loan from the BDC in 2021, which the company at the time called an "extremely attractive opportunity." However, by 2024, the BDC had classified the Pluralsight-related loan as non-accrual and was negotiating a restructuring with other lenders.

When an analyst asked if the BDC would learn from these failures and apply the lessons to future loan underwriting, company executives responded that Pluralsight was already in a "negative margin" state when the loan was made. Goldman executives stated that the BDC has now ceased issuing new loans to companies without cash flow.

Loan losses have severely impacted the BDC's net asset value (NAV)—the value of the underlying portfolio minus liabilities. In the third quarter, its NAV per share fell to $12.75, down approximately 20% from $15.92 in 2021. Several special dividends paid to investors this year also contributed to the decline in NAV.

To prevent more loans from being classified as non-accrual, the BDC has employed various loan modification strategies, but these measures have still been insufficient to bring some troubled loans back on track.

Simultaneously, the proportion of payment-in-kind (PIK) loans has been increasing. PIK loans typically allow borrowers to defer interest payments, instead adding the accrued interest to the loan's principal balance. While this eases the immediate repayment burden for borrowers, it defers potential risks and disrupts the BDC's expected interest income stream.

Five years ago, PIK interest accounted for about 4% of Goldman's BDC's total investment income. Last year, this proportion climbed to 12%, though it fell back to 8% in the third quarter of this year.

Earlier this year, the BDC announced a dividend cut, citing market expectations for Federal Reserve interest rate cuts and increased industry competition. Loan losses were also a significant factor in this decision.