The problem at Goldman Sachs isn’t what you think

Goldman Sachs’ consumer business isn’t a crucial factor in overall performance in return on equity.
Goldman Sachs’ consumer business isn’t a crucial factor in overall performance in return on equity.

Summary

Bank’s transformation in asset management needs to pick up pace.

For Goldman Sachs, identifying the right problem is the first step.

Much of the conversation lately around Goldman Sachs has focused on its foray into consumer banking and lending, with its newly created platform-solutions unit reporting billions in cumulative pretax losses since 2020. Yet the reality is that the consumer business isn’t a huge factor in Goldman’s overall performance in metrics such as return on equity. The unit remains relatively small in that equation, and as of the fourth quarter consumed less than 4% of the common equity allocated to its three business units.

The firm’s still-evolving business in asset management is a much bigger stumbling block. Goldman has been aiming to shift from on-balance sheet investing that consumes a lot of capital to raising funds from third parties, which consumes far less capital and generates steady fees. Asset and wealth management accounted for roughly a third of the firm’s allocated common equity in the fourth quarter—and the return on that equity was slightly negative in the quarter. The firm had significantly lower revenue in its equity and debt investments from a year prior, reflecting tough market conditions.

Chief Executive David Solomon notably listed growth of management fees in the asset and wealth unit as the first of three crucial priorities. “One thing I just want to make sure people are focused on is, we have to do better in asset management," he said, adding that the firm’s balance sheet is still “larger than we’d like to have." The firm reduced its on-balance sheet alternative investments by $9 billion over 2022. But it is a difficult time to be shedding assets given the disruptions in markets. There is progress, as Goldman’s management and other fees were $8.8 billion last year. But the firm is still aiming for $10 billion, which it says it is on track to hit in 2024.

Not having a better ballast of steady fees ultimately magnifies the swings inherent in Goldman’s core Wall Street business. In 2022, the firm’s investment-banking fee revenue dropped by almost half.

Against that backdrop, Goldman still did relatively well overall in its global banking and markets unit, increasing fixed income, currency and commodities revenue by 38% in 2022 over 2021. But the net result was still that Goldman’s firmwide return on-average tangible common shareholders’ equity fell to 11% in 2022 from 24% in 2021. Over the course of two years, that puts Goldman well on track for its midteens targets. Yet it is a big swing.

Meanwhile, Morgan Stanley‘s huge wealth management unit, which consumed about a third of its common equity resources in the fourth quarter, produced a 31% return on average tangible common equity in 2022. Overall, Morgan Stanley generated a 15.3% return on average tangible common equity in full-year 2022, compared with 19.8% in full-year 2021.

Investors often prize steadiness as much or more than through-cycle performance—and that is usually reflected in price-to-earnings ratios. Morgan Stanley’s stock is barely down over the past 12 months, especially after a nearly 6% gain on Tuesday. It is also now trading well above its average forward price-to-earnings ratio over the past decade, now at a bit under 13.5 times versus a roughly 11 times average, according to FactSet. Goldman’s forward ratio is now around 9.5 times, below its 10-year 10 times average.

Despite the gloomy mood for deal-making and waves of job cuts across banking, both Morgan and Goldman right now might be better bets than their commercial-banking Main Street peers—who will be more directly feeling the effects of rising consumer credit risk and higher deposit rates in the year to come. Perhaps for different reasons, both Wall Street banks could see their shares do well: Goldman Sachs because of its potential to execute on its strategy in asset management, Morgan Stanley owing to a growth story in its later stage of transformation. Both would also hugely benefit from any bounceback in capital markets, where there are green shoots in early 2023 and relatively more capital flexibility than peers.

Knowing the problem is key to figuring out how, and when, things might turn around.

 

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