Goldman Sachs spent much of 2017 with its fixed income, currencies and commodities (FICC) under the same level of scrutiny that Morgan Stanley CEO James Gorman used to hate a few years ago.
Goldman has underperformed peers throughout the year, with much of the blame lying at the door of its commodities business. And so CFO Marty Chavez had to spend much of his full-year results call in January tackling the issue again, even after COO Harvey Schwartz had outlined a big strategic update in September.
Chavez talked of the industry-wide headwinds facing the fixed income sales and trading business, but while the glimpse of a chink in the formidable Goldman armour seemed curious in the second quarter of 2017, it is starting to have the ring of familiarity.
Chavez trotted out the same talk of industry-wide headings facing fixed income sales and trading – how could he not? – but he will be sorely hoping that the “investments in future revenue opportunities” that Schwartz outlined in the autumn start to bear fruit soon.
Back then Schwartz spoke of a target for an additional $5 billion of annual revenues by 2020, with much of the work targeting the firm’s FICC business, including broadening its corporate client base.
However, although he was at pains to emphasize that such moves were merely the kind of thing that Goldman was always working on, the unusual disclosure – giving outsiders a glimpse “under the hood”, as Schwartz said – was widely interpreted as a recognition that the firm needed to seize back the initiative, and be seen to be doing so.
For all the plans for the future, it was 2017 numbers that Chavez was considering on his call, and those didn’t look good in FICC. The fourth quarter revenues of $1 billion were just half the same period in the previous year – although Morgan Stanley’s percentage fall was almost as bad, and JPMorgan was not far behind.
The underperformance at Goldman showed up most starkly in the full-year result, where it saw a 30% fall in FICC revenues. JPMorgan was the next worst, with 16%.
As he has done in the past few results calls, Chavez reminded his audience that it had been a particularly challenging backdrop for the commodities franchise, which at Goldman is outsized in comparison to peers. In 2017 it was the single biggest driver for the year-on-year decline in revenues, accounting for more than one third of the fall.
Chavez grew up in commodities: when he joined Goldman in 1993 it was in the old J Aron commodities brokerage business that Goldman had bought in the early 1980s. His experience makes him pretty sanguine about the business, noting that it rarely has trends that last decades.
In typical CFO mode, he can have a fairly dry demeanour when presenting results, but he gets anecdotal when discussing things close to his heart. People used to ask him the outlook for oil prices, he recalled. “I would say accurately, but perhaps not all that helpfully, 50% chance they go up and 50% chance they go down.”
And he doesn’t think much has changed in other ways either. Exchange volumes are an important part of the business but not all of it, and unlike some observers he sees no opposition between that business and off-exchange activity.
In fact, he sees exchange activity as “potentiating” the ability to provide liquidity and hedging to clients over the counter, in a virtuous circle.
He thinks Goldman’s business is in a better place than it was, too. He said it had now reduced risk in its commodities business – risk that it had acquired on the back of doing things for clients, he noted – and that inventory headwinds had subsided “meaningfully” in the fourth quarter.
However, an underwhelming performance from the currencies business – in particular G10 – didn’t help the overall picture in FICC. Results in credit were also down, with particular declines in US high yield and distressed. Mortgages were up, so that was a rare bright spot.
Good in parts
Goldman’s recent weakness in fixed income sales and trading has come in spite of another strong year for its primary debt capital markets franchise. It is one of the areas where the bank has put a focus over the past few years, and to good effect.
A bigger share of leveraged finance business in particular helped take DCM to a $3 billion business at Goldman in 2017 – that’s more than double the kind of results it was seeing seven or eight years ago. The last few years have been especially striking, with revenues rising from $2 billion in 2015 and $2.5 billion in 2016.
It’s a contrast that can seem puzzling – a strong pick-up in DCM just doesn’t appear to feed through to the FICC business. Chavez argues that there are plenty of reasons for that: the success of the firm’s debt underwriting business is closely aligned with acquisition finance, including sponsor activity, and a lot of the focus on building the firm’s DCM franchise was done with that in mind rather than leveraging a big balance sheet as others have done.
However, feeding some of that performance through to FICC relies on a lot of other things to fall the right way, such as volatility, client activity and central-bank actions.
More fundamental even than that apparent conundrum is the continuing need for the firm to broaden its connection with corporate clients in businesses such as FICC. Goldman-watchers have long said that the firm needs to broaden its presence with corporates to give the kind of revenue stability that comes with more diversification, and Chavez again acknowledged that the firm was looking to increase its client and product footprint.
However, if Goldman is so good at the strategic dialogue needed to achieve what it does in M&A and ECM, how come it can’t bring that to bear elsewhere in the franchise? In the words of analyst Mike Mayo at Wells Fargo: “You have great relationships with the CEOs, the boards of directors, the people on top of the house. So why can’t you do more business trading with those so much further down from the top of the house?”
For a firm such as Goldman, which prides itself on exactly those kinds of relationships, this is a key question – as Chavez conceded, but his defence is along similar lines to the debate around DCM versus FICC, which is that there isn’t a smooth path running from one to the other.
"You have great relationships with the CEOs, the boards of directors, the people on top of the house. Why can't you do do more business trading with those much further down?"- Mike Mayo, Wells Fargo
Areas such as hedging strategy can have much more varied lines of responsibility than a decision around buying a competitor: it might be the CFO, it might be someone in procurement. Also the mandate timeframe on primary and strategic business is very long, months or quarters. And most fundamental of all, if those clients simply don’t want to do much activity, then there is nothing to flow through to revenues.
Chavez sounds like he is obliged to mount a defence, but ultimately accepts that the point is fair: that the firm needs to step up its corporate coverage in such a way that it does not only see the fruits of it at the very “top of the house”.
And proof of that acceptance is that the firm is doing a lot to fix it: it is hiring, it is investing in tech and it is broadening its regional corporate coverage model, adding senior bankers in a host of US cities to cover mid-sized corporate clients.
As Schwartz noted last year, Goldman thinks it has identified a $250 million additional revenue opportunity in expanding its corporate franchise in FX and commodities.
The tech investment also includes leveraging better solutions that have been developed elsewhere. Chavez noted that tightening of the bid-offer spread has been one of the pressures on fee revenues, but he said it was difficult to assess whether that was ephemeral, cyclical or secular.
However, that didn’t mean Goldman couldn’t respond, and one way in which it is doing so is to apply some of the engineering it has developed on the equity side to its fixed income business.
He said that equity commissions were now just a small percentage of what they were in 2000, but that the business still thrived. One of the reasons was the automated platform that Goldman had built for systematic market-making. “Why confine that activity, which is something that is a historical strength of ours, to equities?”
One obvious move was to bring that to FICC, and FX in particular. Last year the firm created a new group with that in mind – securities systemic solutions, which sits inside its markets business and aims to extend what has worked in equities to other businesses.
“If the bid-offer compression turns out to be ephemeral, then having done all this will make it even better,” said Chavez. “And if it turns out to be more persistent, we’ll have a plan in place.”