What's wrong with Goldman Sachs (vs. BAML and the rest)?
Goldman Sachs likes to win. When the firm had a terrible first quarter in fixed income trading, co-head of securities Pablo Salame told staff he was fed up with losing and that they should please clients with little added extras ("Just add butter!") to keep the clients happy. Unfortunately, today's Goldman results suggest it might need to add cheese too, or else go and find some new clients - particularly in fixed income sales and trading and maybe also in the investment banking division.
"It was a difficult quarter on all fronts," said Goldman CFO Marty Chavez in today's call, speaking of Goldman's fixed income trading division. "The market backdrop was challenged. Client activity remained light. We didn’t navigate the market as well as we aspired to or as well as we had in the past."
Bank of America also reported today. It's results are somewhat overshadowed by the tribulations at Goldman Sachs, but together with Citi and J.P. Morgan's results last week, they help throw Goldman's quarter into relief. The upshot is that it's not all bad at Goldman, but where it is bad, it's pretty awful.
Yes, Goldman's fixed income currencies and commodities (FICC) trading business is doing very badly, but the client execution part of its equities business is doing rather well
Goldman's FICC business had a terrible second quarter (revenues down 40% vs. the second quarter of 2016) and a terrible second half as a whole (revenues down 21%). As the chart below shows, Goldman's FICC business is losing market share as rival banks have either increased revenues or seen their businesses shrink by a lot less. At Bank of America, for example, fixed income sales and trading revenues were up 6% in the first half, even though they fell 14% in the second quarter.
While Goldman's FICC business shrivels, however, its equities sales and trading business is doing ok. As the chart below also shows, equities sales and trading revenues at GS were up 0.9% in the first half of this year vs. 2016. At Bank of America equities revenues were up 5%. At Citi, they fell.
Needless to say, the performance of Goldman's equities business hasn't gone unnoticed internally. Chavez said Goldman has been gaining equities market share and that this is, "the positive result of investing [in equities] over multiple quarters in both execution and capital commitment." More importantly, Chavez added that Goldman is already rolling out its new and successful approach to equities execution to its fixed income business - the equities approach has already been applied to U.S. corporate credit and is now being "extended" to Europe.
This is a big change to the past: Goldman's equities traders are on top; Goldman's fixed income traders are way below.
Blame Goldman's fixed income fragility on its product and client mix
What's up with Goldman's fixed income sales and trading business? Everything.
Firstly, it's Goldman's focus on commodities. This year, Chavez said Goldman experienced its worst quarter in commodities since becoming a public company 73 quarters ago. Other banks have pulled out of commodities trading. Goldman hasn't (but is reportedly thinking of it ). "Commodities is a story of challenges on all fronts," said Chavez. "- Lower client activity and a difficult market making environment." He declined to say whether the commodities business actually made a massive loss in the past two quarters, but this seems a possibility.
Secondly, it's Goldman's focus on complex derivatives over cash and cash-like products. In rates, for example, Chavez acknowledged there's been more activity in treasury bills and futures and vanilla products than in the more complex products Goldman's strongest in. This might be why Goldman's rates revenues were down "significantly" in the second quarter, while Citi said G10 rates revenues were stable.
Thirdly, it's Goldman's strength in macro product (fixed income and rates) trading over credit trading. Goldman's a top tier player in macro products, but isn't so hot in credit. By comparison, Bank of America said today that 64% of its fixed income revenues came from credit trading and that only 36% came from macro.
Fourthly, Goldman's just got the wrong kind of clients. Banks like Citi and J.P. Morgan and Bank of America are popular with corporate clients. There are plenty of these and they use their trading businesses to hedge against things like exchange rate changes in all markets. Goldman Sachs, on the other hand, is popular with hedge funds and asset managers. There are fewer of these (or at least fewer large successful ones which it's worth dealing with) and they like to trade against volatility (of which there hasn't been much lately). Goldman was already alert to this issue before today's miserable results - co-president (and D.J.) David Solomon said in June that Goldman needed to adjust its client base away from hedge funds and towards long only asset managers and corporates. Chavez said today that Goldman wants to have a great corporate client franchise and a great asset manager/hedge fund franchise and is setting about creating this. He omitted to say that wooing corporates might tough in the absence of a strong corporate lending arm...
Chavez also said that Goldman's feeble fixed income performance wasn't down to restrained risk taking. - Yes, Value at Risk fell at GS relative to peers, but this was just because Goldman's clients traded less ("We don't have VaR targets... there was less client demand for the VaR capacity.") Nor can Goldman's weakness really be attributed to calm markets - other banks operated in similar markets and performed far better.
Despite Chavez' ultra-chill delivery, the state of Goldman's fixed income trading business seems to be a source of anxiety internally. "I can tell you that everyone in our FICC business is focused on this topic and is working on it at a granular level," said Chavez. "We are looking to see where there are potentially gaps in our client coverage and [whether we can] onboard new clients and serve them."
Bank of America is killing Goldman in investment banking. So is Citi
While everyone focuses on Goldman's fixed income misery, it's easy to overlook the equally mediocre performance of the investment banking division. As the chart below shows, Goldman has lost market share to its U.S. rivals this year.
What's going wrong? Chavez said the bank had been "conflicted out" in equity capital markets deals and blamed fewer "follow-on" offerings and lower issuance of convertible bonds.
Either way, M&A at Bank of America looks like a far happier place than M&A at Goldman Sachs.
But Goldman increased profits plenty more than Bank of America, so who cares about revenues anyway?
As Goldman's top line shrinks, its bottom line has been growing. Chavez said in April that the bank wasn't really focusing on revenue share and was more about returns and, "strong RoE across the cycle." So, perhaps this year's shrinking fixed income and M&A revenues aren't a big deal.
Maybe so. Except, as the chart below shows, most banks (BofA's global markets division excepted) increased profits substantially in their investment banking divisions in the first half of this year. Goldman's strong profit performance was therefore nothing special.
More importantly, if Goldman's targeting its return on equity (RoE) over revenues, it's not exactly doing great. Yes, Goldman achieved a Return on Equity of 10.1% in the first half of this year. Yes, this was better than last year, but Goldman's RoE was 11.5% in the first half of 2013. - It's hard to make an argument for consistent improvement.
And Goldman still says it's done with headcount cuts and has hiked pay
Lastly, despite its trials, Goldman didn't cut headcount in the second quarter. Instead, employees were weirdly flat at 34,100 - exactly the same as the end of March 2017. Chavez reiterated that the firm has finished making its $900m of cost savings, implying that there aren't any more layoffs to come.
Best of all, it looks like GS is paying more per head. In the first half of 2017, it set aside $191k to pay each employee - up 11% on last year.
No other U.S. bank breaks out compensation in a meaningful way, so it's hard to say what's happening to pay at rivals. - But whatever's wrong with Goldman right now, getting paid doesn't seem to be part of the issue.