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Inside the belly of the curve
When David Solomon took over as chief executive at Goldman Sachs in October 2018 the headline strategic plan for the bank was to achieve $5 billion in annual revenue from new businesses by the end of 2020.
One year later it has become evident just how expensive achieving this may turn out to be.
When Goldman announced its third-quarter results in mid October, it was not a set of figures that would usually be associated with the storied firm: profit was down 26% year on year, revenue was down 6% and investment banking fees were down 15% – something that would have been unbelievable just a few years ago.
This is a reflection of the investment that is going into building Goldman’s consumer platforms, the businesses that the bank hopes will plug the revenue gaps left by the retreat in DCM and other parts of its investment banking franchise, the bank says.
The results clearly demonstrate that Goldman needs to grow its new businesses – and fast. The focus is on three initiatives: the consumer platform Marcus; the credit card with Apple; and transaction banking. The firm seems to be finding things rather tougher than expected.
Marcus has now raised more than $55 billion in retail deposits in the US and UK and written $5 billion of unsecured consumer loans. But things seem to have been somewhat rushed: loan default rates initially tracked higher than expected, perhaps as the firm did not have special servicing in place at the time of launch.
According to public filings, Goldman wrote off $156 million in 2018 and a further $155 million in the first six months of 2019, with loan losses amounting to 5.5% of the total loan book in the year to June 30. And in early December Marcus still didn’t have a mobile app.
Speaking at a Bank of America conference on November 5, CFO Stephen Scherr observed, however, that the loans were “now playing and performing in line with what our expectations were”. But he seemed very alive to the challenges the new consumer businesses face.
“You will almost never find the perfect moment to launch a new initiative to grow a business,” he mused. “The consumer growth initiative is seemingly late-cycle but being built for the longer term. We have slowed the pace of growth in the unsecured loan book in Marcus, but it is still growing – we intend it to still grow, but we are watching what the data is suggesting, mindful of the consumer debt that we are taking on through Apple Card. We are only now coming to on-premise data with a greater level of comfort as to our ability to manage that risk.”
As the markets eagerly anticipate Goldman’s first ever investor day on January 29, the firm will likely urge patience to allow the new businesses to bed down and bear fruit.
“This is not meant to be a big reveal,” Scherr said in November. “You shouldn’t expect a big pivot. It will be about shedding incremental light on how we have been evolving over the last year.”
A common feature of all the new initiatives at Goldman is that they are in markets where there are big pools of revenue and the firm does not need to capture commanding market share to grow a profitable business quickly.
In transaction banking, it had taken roughly $500 billion of its own operational flows and brought them onto its own platform by the end of 2019. The expectation is to have third-party customers and clients of the firm on the platform in 2020. This is all part of a drive to attract operating deposits for the bank’s own cost of funds.
“I aspire to achieve some of the efficiency ratios that some of the larger banks have, and will spend quite a bit of time at the investor day talking about this,” said Scherr in November. “We have been controlling our base operating expenses in the firm in order to subsidize some of the spend that is being made on the new initiatives.
“My team and I are extraordinarily focused on our cost of funds. We need to bring it down. Part of the initiative around Marcus and the growth of retail deposits and equally a view forward towards the operational deposits we can take from transaction banking is to meaningfully lower the funding costs of the firm.”
Doing that is, however, proving expensive. Scherr emphasized that 2019 will be “the belly of the curve” in terms of investment in the new growth businesses, and Goldman will continue to aggressively harvest deposits and get the new initiatives to scale.
It will need to do so before dissent in the ranks over how much the consumer arm is dragging on the rest of the firm gets any more vocal.