We've done it before: Goldman tells investors why they should trust its ambitions

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By:
Mark Baker
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The bank says it remains committed to excellence, but its biggest pitch seems to be that it doesn’t feel the need to be the leader in everything it does any more. That may give it the flexibility it needs as it develops into new areas, but will it be enough to satisfy shareholders?

When Goldman Sachs chief executive David Solomon stood in front of analysts to lay out three-year financial targets at the bank's first ever investor day on January 29, he knew the questions he had to answer: How was he going to change the firm? How would that make things better for investors? And why should anyone believe him?

David Solomon 160x186

David Solomon

Solomon had plenty of answers. Goldman remained a proud advocate of capitalism – that had not changed. But it would broaden the scope of its business and of its clients. And it would get better at presenting every part of itself to those clients: with no great imagination, the bank is calling that effort ‘One Goldman Sachs’.

It would improve existing businesses, start new ones, raise revenues and cut expenses. And as an overlay to all this, it would be more transparent and accessible about its operations, engaging more with the outside world about its plans and progress.

That last commitment was perhaps the most telling.

In the past, no one really cared to ask questions about Goldman's strategy. That it was successful was sufficient. This was useful because in any case Goldman didn't really care to answer questions about its strategy, for the same reason.

GOLDMAN SACHS
INVESTOR DAY
1. We've done it before: Goldman tells investors why they should trust its ambitions
2. Goldman and IB: where do you go from number one?
3. Goldman hunts better returns from challenged markets business
4. Opinion: Goldman reveals it's no longer special
5. Goldman's Lemkau: The cat who got the cream
6. Goldman held an investor day and there were jokes

Now something has changed. Whether because of regulatory burdens, a tough point in the cycle, the inexorable press forward of automation, or a challenging search for growth from a leading position in a mature industry, Goldman finds investors have more questions. Sensible to those doubts, it has decided it must respond.

But even after the investor day's wealth of disclosure and parade of executives, those answers haven't exactly resonated with shareholders yet. The bank's stock closed down 1% on the investor day itself. One week on, and the stock had risen nearly 1%, while the S&P500 was up nearly 2% over the same period.

At first glance it looks odd that the firm finds itself on the defensive. It has just posted annual revenues of $36.5 billion, after a fourth quarter that was its second best ever. Investment banking fees for the year were also the second best in the firm's history.

But pre-tax profits were below those booked in 2018 and 2017 as expenses grew faster than revenues. Rivals have fared better: profits were up at Citi, JPMorgan and Morgan Stanley. They fell at Bank of America, but not by much.

Imagine a Goldman Sachs in which one or more of these opportunities really blossoms
- David Solomon

The irony is that some of the reason for those rising expenses is the investment the firm is putting into precisely those ventures that it hopes will diversify, smooth and increase its earnings.

But many of these new initiatives are not things that look like Goldman. They are the processing of payments for corporates, more credit cards and savings accounts for individuals, more wealth management services for the merely very well-off rather than the fabulously rich.

Some of these things may be very successful: "Imagine a Goldman Sachs in which one or more of these opportunities really blossoms," said Solomon, with enough wistfulness in his voice to remind everyone that this was no certainty.

In the meantime, Solomon has to hope that investors keep the faith – a faith that has been long-standing and justified. He needs them to be as energised as Goldman is with growth plans that he argues need only modest success to create higher returns.

Whether it all comes to anything or nothing remains to be seen. But most startling of all was the sight of a Goldman that is happy not to be a leader in everything it does.

'Super-excited'

Solomon, who was "super-excited" to be presenting the bank's first investor day in its two decades as a public company, told analysts that Goldman would seek a return on equity of at least 13% within three years, and a return on tangible equity of at least 14%. In 2019, the bank's ROE was 10%. At JPMorgan it was 15%, at Morgan Stanley 11.7%.

CFO Stephen Scherr walked analysts through the path of that increased ROE target. Lower litigation and tax expense would add 75 basis points, business activity would add another 50bp, funding optimization 75bp and expense efficiencies a final 125bp.

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Stephen Scherr

The bank also now has an efficiency ratio target for the same period of 60%, compared with 2019's 68%, with the improvement to be driven by both sides of the revenue-expense equation.

Annual expenses will be cut by $1.3 billion within three years. Incremental revenues of $2 billion to $3 billion should come in the medium term from its incumbent businesses, with a further $1 billion or $2 billion from new initiatives. And tweaks to its funding mix should generate another $1 billion, through lower interest expense.

The plan is intended to provide higher sustainable returns via a transition to more fee-based revenues. And throughout the day the message was rammed home that the targets the firm was setting across its businesses were just the beginning, not the final destination. For ROE, it hopes that mid-teens can be achievable.

Since September 2017, when Goldman first outlined its plan to break into new businesses as a way of diversifying and increasing revenues, there has been plenty of scrutiny of its expectation that it can’t only build productive consumer and corporate banking operations but also cut expenses in its established franchises without harming revenues.

Back then the bank unveiled hopes to gather an extra $5 billion of revenues by the end of 2020. At the start of 2020, the focus has shifted a little. While revenue increases were an important part of what the bank's management team said at the investor day, the emphasis is now firmly on returns rather than the top line.

Investor relations head Heather Miner said that the plans being outlined were "a clear message that we are focused on driving shareholder value".

And in a nod to those sceptical of Goldman's plans, the other priority of the day was to communicate why the bank was confident that it could deliver. The growth opportunities were clear, even in legacy businesses, and the bank had done it all before.

All about the clients

For all the presentation of Goldman's strategy as something dynamic and new, there was much that was familiar from the last 20 years or more in financial services. Solomon and his colleagues almost all referenced One Goldman Sachs, or OneGS. There are few big banks that have not embarked on something similar before.

In the same vein, Goldman will now apparently be ‘client-centric’, shifting its organizational structure to better reflect how clients want to interact with it. A multi-year financial planning process, commonplace elsewhere, was another feature.

But while Goldman might be late to a number of parties in what it is now attempting, there is no question that it is changing.

Solomon wants to increase transparency: the firm is already disclosing more in earnings calls than it traditionally did. And an acknowledgement that it must do more to track and improve its firm-wide engagement with clients reflects the need for all banks to do more with less.

As Solomon was able to point out, Goldman has good examples of where it has got this engagement right. Apple, the current obsession, was one, and he wanted the bank to replicate the way in which it had been instrumental in Apple's development (despite having not been on its IPO in 1980 – a missed deal that sounded like it still hurt) with many more clients than it does now.

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John Waldron

The new strategy has three parts: growing the bank's portfolio of existing businesses, diversifying its services, and operating more efficiently.

In doing all this, Solomon stressed, the firm must adopt a longer-term mindset, tolerating J-curves where break-even might be several years away, as is the case with the transaction banking business that it is rolling out this year.

It might not be revolutionary, but what does Goldman think OneGS means? There was no shortage of suggestions.

For Solomon it was a firm-wide effort to revitalise the way that the bank engages with clients. Goldman has historically delivered its most diverse set of products to a number of big and complex clients, but now was the time to take that same approach across the whole organization.

For COO John Waldron, the initiative was nothing short of foundational. Having grown up covering clients, he declared himself passionate about the philosophy. The fact that the firm's new transaction banking business was being embedded between investment banking and global markets was one way in which it was being put into practice, but he had more immediate examples.

As proof of concept, Waldron said that Goldman had launched a new client coverage programme to put OneGS into operation with 31 firm-wide clients, accounting for $2 billion of revenues, who would be served by a cross-divisional team of more than 200 bankers.

Key to the effort had been a change in the way that bankers were incentivized to prioritise relationship progress rather than pure revenues.

That provided the foundation for the next phase, which will see Matt Gibson from investment banking and Sam Morgan from global markets tasked with extending the OneGS approach to 100 more clients in 2020. They will also have the responsibility of making the knowledge generated by the firm more accessible to those clients and engaging the bank's digital teams to improve the experience for those clients.

Making what's good better

When it comes to growing existing businesses, none are outside scope. In investment banking there was more that could be done in spite of the firm's already strong positions in areas such as equity underwriting and financial advisory, said Solomon.

In markets, the watchwords were automation and efficiency, as well as working to shift the balance more in favour of financing, with a smaller reliance on the intermediation revenues that have typically dominated Goldman's revenue line and that are much more volatile and longer-dated.

In 2019, a mere 19% of Goldman's fixed income revenues came from financing, compared with a US peer average of 32%.

In asset management, the firm will be seeking much closer partnerships with asset allocators, whether pension funds, insurers, sovereign wealth funds, endowments or corporates. Again, from the perspective of OneGS, the explicit emphasis will be on delivering everything that Goldman can offer to these counterparties.

And in wealth, there was scope to leverage the firm's US ultra-high net-worth business to penetrate European and Asian markets.

On new initiatives, the most eye-catching has been Goldman's long touted development of a transaction bank – something that is has been trialling on its own transactions but is now set to roll out to clients in the first half of this year. The medium-term revenue target here, from capturing just a 1% share of the addressable US market, is some $1 billion, Goldman thinks.

In consumer banking the plan is to scale up from its first steps with the Marcus deposit and lending operation, as well as the Apple Card business that it launched last year. It will also be building an integrated digital banking and wealth platform.

It also plans more partnerships with external parties. At the time of writing, rumours were just emerging of plans by Goldman to launch a lending platform to small and medium-sized businesses through Amazon.

Last year Goldman overhauled the structure of its alternatives business, bringing together five different investing platforms into one operation, the alternative capital markets and strategy group.

According to Waldron, there was a five-year opportunity for Goldman for $100 billion of alternative net inflows. With some $320 billion of alternative assets already, the firm was among the largest in the field.

And better structuring of its more capital intensive investments into fund format would result in a capital reduction of about $4 billion over that time.

The alternatives business is one obvious area where Goldman has rejigged its structure to create more opportunity. But it is not the only one.

Goldman executives like to talk about engineers, and a recasting of the way the firm is organised is putting them much closer to the heart of its businesses. It was a long way from the manic "Developers! Developers! Developers!" chant of former Microsoft chief executive Steve Ballmer back in 2000, but Waldron couldn't stress enough the role of engineers at Goldman.

"You cannot be a leading global financial services firm without also being a world-class engineering organization," he said.

And with that in mind, some 7,500 engineers have been moved out of a central division and into the businesses that they support.

Why believe the hype?

Why should anyone share Goldman's confidence? Solomon thinks he has the answer. Goldman's people are the best; they know it, and clients like Bob Iger, chief executive of Disney, know it. Iger has told him that while the bank had provided many productive transactions for the company over the last 20 years, it was its people that had given the most value.

They were indeed "truly exceptional", said Solomon, adding that when Goldman's co-CIO Marco Argenti joined in September 2019 from Amazon Web Services, what had impressed Argenti most too was the talent.

In a section of his slideshow entitled ‘Why we will be successful’, Solomon had a chart entitled ‘Our people are our greatest asset’. It's hardly a new boast. Back in 1981, John Whitehead, Goldman's co-chairman at the time, was telling Euromoney: "People are our most important asset. If we have the best people we have the best investment banking firm."

In 1993, chairman Stephen Friedman was telling a Securities Industry Association conference that what mattered to Goldman long-term was "people and culture, culture and people, people and culture".

And people are certainly still clamouring to join the firm, with 85,000 campus applications for 2,600 positions last year. According to Gregg Lemkau, co-head of investment banking, there were 28,000 applications for 500 positions in his division.

That intake is becoming more diverse. Solomon conceded that senior management had yet to reflect that diversity and that there was work to be done there, but half the 2019 analyst class was women, up from 40% in 2017.

The firm was building from a position of strength as the number one investment banking franchise and a proven risk manager, Solomon argued. And it had a proven track record of building businesses. It had identified gaps in its capabilities in the past, like in debt capital markets, and filled them to good effect.

Debt underwriting revenues climbed from $1.2 billion in 2011 to $2.1 billion in 2019. Within asset and wealth management, assets under supervision soared from $285 billion at the end of 1999 to $1.9 trillion at the end of 2019. The firm's overall international revenues are up 22-fold since 1990, now accounting for 40% of the total.

A new focus on the purpose of the firm is intended to provide context for the changes under way. Solomon might have been an external hire to Goldman in 1999, but he has learned the history well enough to be able to reference the 14 business principles drawn up by Whitehead 20 years earlier.

Today every company needed a "north star" to guide its strategy, said Solomon. With that in mind, the firm had distilled Whitehead's principles into four core values: partnership, client service, integrity and excellence – the mention of integrity enabling him to draw an early reference to the 1MDB scandal in Malaysia.

A big part of the new strategy is a belief that Goldman has scope to build in even those businesses where it already appears to be a leading player, the most obvious of which is investment banking.

Lemkau took obvious delight in enumerating the firm's strengths in this area, although his claim to be number one in IB fees flattered the firm through its 2015 to 2019 timeframe (JPMorgan outstripped Goldman by 11% in 2019).

Lemkau also noted that the firm had been analysing its leading positions in broad product and sector areas to find gaps in coverage or lower sub-rankings that it could improve. There were plenty of those.

But as important when it comes to the new initiatives is the large size of the addressable market in each case and the relatively small success that Goldman needs to have to see a meaningful effect. A case in point are the targets in transaction services.

Change, but not too much

An efficiency drive in operations and funding, a plan to fill gaps in its legacy franchises, a track record of patient delivery of new businesses, and only modest market share requirements in its new initiatives: these are the cornerstones of Goldman's transformation.

And within that, as Scherr's analysis showed, it is in fact the funding optimization and expense-cutting parts that are set to be a much bigger driver of improved returns than anything the firm can do at this stage on the revenue front – at least until the new businesses really start to bear fruit.

After all, expense efficiencies and funding optimization add up to 200bp of Scherr's predicted 300bp ROE uplift from 10% to 13%.

A combination of greater reliance on deposits (in 2019 the bank refinanced about $20 billion of maturing vanilla debt with just $5 billion of issuance) and better asset-liability management will drive that.

If the entire scope of the strategy seems in many places to be underwhelming, it is perhaps deliberately so. Solomon is facing that tricky balancing act of changing the firm without looking as if he is changing too much.

In fact, he deploys this consciously conservative approach as a virtue, evidence of the sticking power of the firm when it decides to commit to a venture.

How long did it take for Goldman to make money in Europe, he asked Goldman Sachs International chief Richard Gnodde during the analyst Q&A session. Twenty-five years was the answer, to laughter around the room.

"To be clear, that isn't going to happen here," said Solomon, referring to the new initiatives, but the point was made: Goldman has a track record of long-term investments that come good.

It is of course one thing to take existing franchises into new markets and quite another to build entirely new businesses. But the firm's growth from its earliest days as an underwriter and market-maker testify to its ability to do that too. After all, there was a time when Goldman didn't do financial advisory.

The question Solomon can't answer at the moment is whether or not investors will be as patient as Goldman while they wait for results in the form of returns, and as "super-excited" when they see them.

To cement his legacy as custodian of the firm in the wake of former chief executive Lloyd Blankfein, he will be hoping for both.