Add $5 billion: How Goldman hopes to be better at (nearly) everything


Mark Baker
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Goldman Sachs has laid out a three year revenue growth plan that is nothing short of extraordinary

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The intro music was saxophone classic Take Five, but Goldman Sachs’ presentation at the Barclays Global Financial Services Conference in New York on Tuesday was all about Add Five – the $5 billion of incremental annual revenues it thinks it can rustle up by 2020.

The big story heading into the presentation by co-COO Harvey Schwartz was what Goldman was planning to do to fix its underperforming FICC business, but Goldman didn’t see it like that at all.

Yes, there was plenty to be done there – and lots of exciting developments to unveil – but it was wrong to see it in isolation. And all the natty things it was announcing today were things it was already working on. This was just a view “under the hood” to give us a glimpse of what was going on.

FICC might be only part of the story, but it’s the bit that investors are interested in this year, as Schwartz conceded. And here’s why. Goldman’s FICC revenues were down 21% in the first half, including a 40% decline in the second quarter alone, which was also its worst-ever quarter for commodities. Revenues at the other big four were up 9% in the first half.

The third quarter is not likely to be great – Schwartz said conditions were still tough in FICC, and Citi CFO John Gerspach said yesterday that he was expecting Citi’s third quarter FICC revenues to be down 15% year on year.

Goldman has blamed low volatility and low client conviction, as well as its business and client mix. It’s more heavily skewed than peers are towards hedge funds and asset managers, as well as derivatives and commodities. And at Goldman the franchise has been much less about financing than at peers.

Data from Coalition show that some 61% of average peer FICC revenues in 2016 came from liquidity provision or market-making. At Goldman that was nearly 90%.

That kind of mix hurts in current conditions, or in Schwartz-speak, it means “our opportunity set was more challenged”.

In the first half of the year, FICC sales credits were down by double-digit percentages in the first half of the year in all client groups except corporates, which were up 6%. Compare that with the 2012-2016 period, when asset manager sales credits leapt by 32% – reflecting the opportunity that Goldman had identified.

Industry-wide FICC wallet is probably about half what it was in the heady immediate post-crisis times of 2009. Unsurprisingly, Goldman has restructured its business pretty heavily. Since mid-2013, it has slashed FICC market and credit risk-weighted assets in half, and its FICC headcount has dropped 20% since 2012. Compensation is down 30%.

The priority was protecting FICC margins through a more efficient use of capital – all of which has contributed to what has been a significant return of capital to shareholders – some $35 billion since 2011.

And it’s worth remembering that even though Goldman has had a shoddy first half in FICC when looking at performance relative to the previous year, and a worse performance on that basis relative to peers, it’s actually in a better place versus peers than it was in 2005.

Back then, the bank reckons it had a 7% share of a $77 billion wallet. That peaked at 19% of a $121 billion wallet in 2009, but it’s now standing at 10% of a $66 billion wallet on a trailing 12-month basis. So it has a bigger slice of a smaller pie, but that slice is still bigger in absolute terms than it used to be, at $6.6 billion instead of $5.4 billion.

Closing gaps

So what now? Closing FICC market-share gaps is the first move. That 32% jump in asset manager sales credits that Goldman notched up from 2012-2016 was achieved against an industry-wide drop that Oliver Wyman puts at about 12%.

But Goldman thinks the opportunity there is far from exhausted. It got most of its growth from derivatives: now it reckons it can do something similar from a focus on cash.

There’s also plenty of ground to make up in terms of penetration with those clients, too. According to Coalition, Goldman ranked in the top three of FICC liquidity providers in 2016.

Goldman tableBut while it ranked top three with more than half of its hedge fund clients, this fell to just 30% with its bank and asset management clients. That meant, as Schwartz noted, that there were roughly 600 clients where the firm did not rank in the top three. Fixing that was a $600 million revenue opportunity by 2020, he reckoned.

Next up, corporates. The firm has a terrific corporate advisory franchise when it comes to M&A, and has been ramping up its financing offering, too. But corporates account for just 16% of its FICC clients. Schwartz said that a greater focus on this – and in particular in FX and commodities – could net it an additional $250 million of revenue.

FICC client inventory financing is another leg. In 2016 the firm allocated just $5 billion of its $900 billion balance sheet to this, but reckons it can double that by 2020, and clock up an incremental $100 million of revenue. It will be relying on GS Bank, its deposit-taking institution, to provide liquidity here.

Lastly, people. So far this year it has doubled the number of lateral hires into FICC, with those going into sales rising from 19% to 43% – a quadrupling of hires to that function. There will be more to come to support the new efforts.

Cautious assumptions

The FICC effort adds up to almost $1 billion – just one fifth of what the firm thinks it can add in total. The rest is spread across the other parts of the firm, but shares two key aspects of the moves on FICC.

First, it is built around broadening the client base. Second, it is based on an assumption that market conditions do not improve. The latter was something that Schwartz took pains to emphasise, reiterating it four or five times.

In lending, the firm has already been growing its footprint, but is still much lower than peers. It said it would commit some $28 billion of incremental balance sheet to its Marcus loan and deposit platform, institutional lending and financing, private wealth management and GS Select, its private bank digital lending platform for financial advisers and clients. The revenues to come from that could amount to $2 billion.

Investment banking sees the firm targeting new clients or ones where its penetration is low, as well as increasing its presence in cities such as Atlanta, Dallas, Seattle and Toronto. That is an important recognition of the investment banking opportunity to be had from the US domestic market – one that has already borne rich fruit for Bank of America Merrill Lynch, for example. It reckons the revenue opportunity there is $500 million.

Continuing to build the GSAM platform in investment management, increasing the private wealth management client base and getting more traction in the mass affluent segment is predicted to add another billion.

In equities the emphasis is on technology, where Goldman has traditionally shied away from expanding quickly into the low-latency area because of concerns over risks. Tech improvements there have given it more confidence, and might allow it to add $500 million of revenue by 2020.

Blinding ambition

That’s a lot of initiatives, and it’s worth putting them into some perspective. That $5 billion total is about 16% of Goldman’s revenues in 2016, and is expected to produce $2.5 billion of profits, a 50% marginal margin.

For the other divisions, the equivalent revenue numbers are 13% for FICC, 7% for equities, 8% for investment banking, 17% for investment management and 49% for the investing and lending division.

Those are astounding figures, particularly in lending, an area that even Goldman would concede is not exactly its home turf. And they are predicated on no improvement in market conditions. Consider also that Goldman’s revenues are down 10% over the last three full years. The fact that the $950 million opportunity in FICC is only a little more than the $750 million drop in Goldman’s first half FICC revenues is also sobering, to say the least.

Breaking into more US cities? Relying a bit more on deposit-taking? A shift into low-latency? An awful lot of this looks to be fighting on competitors’ ground. Getting new clients means shifting them from peers that are already servicing them. That holds too for those existing clients where Goldman is looking to deepen penetration – particularly if the stated emphasis is on securing top three rankings.

There is a caveat, however. Goldman has not explicitly said that its revenues will be 16% higher in 2020 than they were in 2016. The $5 billion has been presented as an incremental revenue opportunity – it is not part of a formal revenue target for three years’ time. The firm would also argue that it already operates in a highly competitive market – and has done so successfully for some time.

Tackling the FICC issue by putting it in the context of a firm-wide effort made it look more coherent than if Goldman had just been seen to be reacting to recent critics of one business line. And the stock was up 2.4% a couple of hours after Schwartz finished his presentation.

But that doesn’t change the fact that this is all coming against severe headwinds in some businesses, and that revenues have been falling even while Goldman was doing what Goldman was best at. It might be done, but it looks like a mighty challenge.