Goldman Sachs Group Inc. (NYSE:GS)
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Barclays Global Financial Service Conference
September 12, 2017 7:30 AM ET
Harvey Schwartz - President and Co-Chief Operating Officer
Martin Chavez - Executive Vice President and Chief Financial Officer
Jason Goldberg - Barclays
Good morning, and welcome to day two of our 15th Annual Global Financial Services Conference. We have 50, that’s right, 50 companies presenting today alone. I am told this is a world record for a sell-side financial services conference, we’ll see. But very pleased to have Goldman Sachs who has historically participated in this event, but this is first we’re actually doing a formal presentation, which if you saw the slides that are posted, extremely timing and we think a lot of new information.© Provided by Seeking Alpha Earnings Call Transcripts
From the company, we welcome President and COO, Harvey Schwartz. Harvey is a member of Goldman’s management committee and serves as Co-Chair of the Firmwide Enterprise Risk Committee. A lot of you know him as CFO, prior to that and in other roles throughout the company before that. We also have onstage Marty Chavez, who took over the CFO when Harvey has moved up. Prior to that Mary was CIO in addition to other roles at Goldman.
Before we kick it off to the presentation, we thought we do some polling questions real quick just to get those out of the way. But consistent with what we did yesterday, the first two questions will be the same. And if could have those pulled up. Do you own the stock, overweight, market weight, underweight or no? One of the takeaways yesterday we are surprised how under owned some of these stocks were despite the fact that attendance is actually up.
Interesting. So, and then the next question would be just, what line item influences the most – and same choices as yesterday. Profitability, at these specs we are going to touch on yesterday followed by fee income AKA deck and trading.
And then last question, Goldman’s FICC revenues declined 20% in the first half of the year, what are your expectations for the second half. We should get Harvey a clicker.
Down 10% to 20%, interesting, maybe we’ll get a response to that. With that, let me turn it over to Harvey.
All right. Good morning everyone. Great to be here with all of you and before starting today’s presentation, I just want to take a moment to acknowledge that our hearts and minds are with the people doing with the restructuring caused by the two recent hurricanes. Our thoughts and our prayers are with all of you.
Regarding today’s presentation, we want to discuss the two main questions that have come up in our conversations with investors. First, our strategy around FICC and second, our future growth plans. Today, I’ll talk about both.
Across our global businesses, we have a series of growth initiatives that are designed to drive $5 billion of incremental annual revenues. To be clear, the initiatives we are outlining today, they aren’t hypothetical. They are already underway. We estimate the full impact when we realize in three years.
Importantly, these opportunities don’t require any improvement in the broader operating environment. However the environment does improve from here. Obviously, we could see additional revenue upside. An important component of our future growth plan is our Fixed Income Currencies Commodities franchise. We are not satisfied with our recent performance in FICC. We are intensely focused on it, we know you are, as well.
In today’s discussion, I’ll spend a reasonable amount of time on our FICC business. For each of our five key businesses, we are focused on the future and we are looking to capture the significant opportunities that lay ahead. We have a long-term plan. We are in execution mode. And we know that by effectively delivering on these opportunities, we will create greater value for our clients and by extension, our shareholders.
With that as a background, let’s do a brief review of where we currently stand before outlining the growth initiatives. If you look at the first half of 2017, there are a number of important takeaways. First on the slide, if you look to the left, you can see our revenue mix through June. Quite a balanced picture. Each of our five main businesses contributed between 18% and 22% of revenues.
Over the years, our diversified business mix has been a key component of our track record of superior financial performance. Despite the challenges in FICC, the firm’s first half revenues are actually up 12% or $1.6 billion versus the first half of 2016. You see on the right, four key performance metrics. Year-to-date, they’ve all improved driven by a combination of stronger revenues, and our constant focus on expenses.
Pretax margin up 340 basis points to nearly 32%. Diluted earnings per share increased by 42% to $9.10. Book value per share grew by $10.70 finishing at $187.32 and last, but certainly not least, return on equity expanded by 260 basis points to 10.1%.
In summary, at a firmwide level, our first half performance has been solid. A key driver of our performance has been a multi-year focus on efficiency. As you know, we’ve executed a series of initiatives. A $1.9 billion effort completed in 2012, last year, we also completed a $900 million initiative.
Our efficiency efforts have focused on two key areas, adjusting our employee mix, and optimizing our operating footprint. On mix, since 2012, we’ve seen a 13% decrease in partners and managing directors and a 13% increase in associates and analysts. Also, nearly 30% of our global headcount is located in strategic locations.
This strategy has contributed to a significant decline in our compensation ratio. The average ratio over the past five years was 470 basis points lower than the prior five years. We are also able to post our lowest first half compensation accrual in our history, 41%. Our efforts weren’t limited to the expense line, we have also been incredibly focused on capital utilization.
Now we’ve always viewed strong risk-based capital as critical to meeting our significant responsibilities to our clients and the financial system. Robust capital levels position us to be a source of support during the periods of both strength and market weakness.
As you can see on the left, our common equity Tier-1 capital ratio has improved by 430 basis points. We also show that standardized RWAs have declined by $100 billion since 2013 and capital has increased by $8.2 billion. This is the literal definition of deleveraging and de-risking.
We have achieved this meaningful improvement in capital ratios while returning significant capital to our shareholders. We’ve returned $35 billion since the end of 2011. That’s roughly 40% of our current market cap. Very importantly, looking at our share count on the right, a historic low, roughly 403 million shares.
In addition, we grew book value per share by 44% since 2011, a critical indicator of shareholder value creation.
Our focus on expenses and capital has been a primary contributor to our track record of long-term outperformance. When you look at key metrics relative to our peer group, the story is pretty clear. Here we show ROE, book value per share, and share count versus both U.S. and European peers since 2012.
I swallowed some ice, sorry about that. Over that period, our ROE, same slide, our ROE is 330 basis points higher than the U.S. average. It’s 850 basis points higher than the European average. Book value per share again up 44%, 15 points higher than U.S. peers, 69 points higher than European peers. Our share count, we declined by 22%, that’s 16 points better than the U.S. peer group, 89 points better than the Europe peer group.
We are able to achieve these results because we understood that we needed to rethink our resource allocation, resize our financial footprints, and pivot. We devised a plan, then we focused on execution, and in the process, we created significant operating leverage. While executing that plan, we never lost sight of our clients. That steady focus on our clients resulted in a diversified set of market-leading global businesses.
In investment banking, we are a partner of choice for corporate clients as evidenced by our leading M&A franchise. Investment management has grown assets under supervision to over $1.4 trillion and has further runway from here. Our equities franchise is world-class. We are one of the few global players at scale and we continue to benefit from our continued investment in technology.
The reason that I want to talk about our historical efforts around resource reallocation before talking about the future is simple. Our past efforts serve as the foundation for the future. We believe we are uniquely positioned today for growth. Our client franchise, very balanced. We have robust liquidity and capital to support both long-term investment and near-term opportunities.
Our cost structure has been significantly revamped. Our share count at a historic low and our brand and technology expertise has positioned us to consider a whole range of Greenfield opportunities, particularly with consumers. All this means that both our ability to grow and the potential impact of that growth is significant.
With that as a background, let’s talk a bit about FICC. Before talking about our future plans for FICC, we want to spend a few moments giving you our perspective on the broader market and our positioning. As you know, FICC has seen a number of industry-wide challenges over the last several years. Industry-wide revenue trends, they tell the story. Industry wallet totaled $77 billion in 2005. Back then, we had 7% of the revenues.
The industry wallet peaked in 2009. We significantly expanded our share to 19% in 2009. This disproportionate share was due to two key factors. First, our relative financial strength and second, being a dependable liquidity provider to our clients during a period of extreme stress. Of course, we all knew of what’s unsustainable.
Since 2009, we’ve seen a pretty steady decline in the industry wallet. We certainly weren’t immune to that. In the last 12 months, industry wallet was roughly half of the peak. It’s fell to $66 billion. Our share roughly 10% understandably below the 2009 peak, but nevertheless above our 2005 share.
As you are aware, the mix of FICC businesses differs across our peers. Most of our U.S. bank peers have sizable lending books, not surprising given their roots as commercial lenders and of course, the size of their balance sheets. Goldman Sachs’ FICC business is more heavily focused on providing liquidity to clients.
In addition as you know, we consolidated our lending activities into a separate reporting segment called investing and lending. Some of the difference in lending footprint is attributable to our historical roots. But it also reflects our view that some aspects of the lending market are mispriced from a risk return perspective.
So, while lending can appear less volatile, we know that in stress it can become extremely volatile and also as liquid. Of course, we all saw that clearly displayed in 2008.
On this slide, we show coalition data. It breaks the industry wallet down by activity. Liquidity provision, financing and other. On the left of this slide, you see that our U.S. banking peers average $12.7 million of revenue in 2016. 61% are close to $8 billion from liquidity provision, 23% or $3 billion from financing, and the remaining $2 billion from captive activities associated with servicing other divisions within their corporate families.
Now let’s take a look at Goldman Sachs. The chart on the right shows our mix is dominated by marketing making or providing liquidity for clients. This represented nearly 90% of net revenues in 2016. With greater focus on liquidity provision, and less reliance on lending income, our addressable market in FICC is fundamentally different than many of our peers.
If we isolate liquidity provision, we were at $6.7 billion in 2016 versus a peer average of $7.7 billion. That’s a $1 billion gap to the average. Again, not surprising, given that our commercial bank peers have balance sheets that are generally twice our size and dominated by lending.
Another difference relative to peers is client mix. One of the challenges facing our FICC franchise in the first half of 2017 was a decline in client activity, in part, resulting from a decrease in market volatility and lower client conviction.
On this slide, we show activity levels across various types of FICC clients. So that pie chart shows our client mix. Asset managers and hedge funds were the largest client segments in the first half of 2017. This is based on internal sales credits which is one way of measuring client activity. Our strength with these clients is well understood given our historical leadership in providing liquidity and derivative solutions.
The right-hand table shows activity trends. In the first column, you can see sales credits decline between 2012 and 2016 in three of the five client segments, hedge funds, banks brokers and other, which includes pension funds, insurance companies and central banks.
As we’ve discussed in the past, we’ve dedicated significant resources to providing greater value to our asset manager and corporate clients. We believe this is reflected in the growth – in those segments since 2012. But across every segment, there is always more work to do.
I want to highlight an important take away from this data. In the far right column, you see the changes in FICC sales credits for the first half of 2017 versus the first half of 2016. Activity declined in four of the five client segments with corporates being the only segment that showed growth. As the pie chart shows, that is a smaller client segment for us today.
Given our client mix and lower activity levels, our opportunity set has been more challenged during the first half of the year. However, that in no way removes our responsibility to do much better and we are completely committed to improving our performance.
As the environment evolves, we responded by adjusting our resources. We cut risk-weighted assets almost in half. The ICS balance sheet down by more than 15%. FICC headcount declined by nearly 20% and FICC compensation benefits expense is down roughly 30%.
By taking these steps, we achieved a series of objectives. We protected our FICC margins. We became a more efficient user of capital which supported significant capital return to shareholders. We generated strong risk-adjusted returns and we maintained world-class client service.
Now that we’ve discussed the steps we’ve taken around efficiency and resource allocation, let’s talk about growth. Growing the business is key to driving better performance and returns. Our strategy for FICC is based on several key initiatives. At the core of everything we do in FICC is the focus on delivering value to clients and servicing their needs.
The first initiative is to close existing market share gaps anywhere they exist, particularly with asset managers and banks. Second, we are focused on strengthening our corporate offering. Next, we are increasing our lending footprints. Finally, everything we do is dependent on our ability to attract, retain, and develop the best people.
Let’s dig into each of these initiatives. As part of our processes, we comprehensively assessed client revenue gaps. Although we made pretty significant strides of asset managers and currently rank number three, significant opportunities still exists. On the left of the slide, you can see our sales credits with asset managers increased by 32% between 2012 and 2016.
According to data compiled by Oliver Wyman, industry-wide activity levels with asset managers actually declined over that period by 12%. Therefore, we believe we’ve gained significant share. However, our improvements to-date have largely been in providing derivative solutions. We see further opportunities to improve our share, specifically in cash products.
Let’s take a look at the graph on the right. It captures the top 1000 clients and shows our percentage of top three rankings by client segment. We have a top three ranking with more than half of the hedge funds. However, we rank in the top three with only about 30% of the asset managers and banks.
Bottom-line, we are not satisfied that there are roughly 600 clients where we don’t rank top three. Not only unacceptable, it’s also a great opportunity to provide incremental value to clients. Improving our coverage with these clients represents a significant revenue opportunity up to $600 million annually.
Another initiative is the focus on our corporate clients. As you know, we have the leading investment banking franchise. We also have a significant global financing franchise. However, our corporate client base is underweighed versus peers and we are committed to expanding it. We see incremental opportunity to leverage our expertise in foreign exchange and commodities to provide hedging and risk management solutions to these clients.
Shifting to the right-side of the slide, we highlighted an initiative to expand our client inventory financing efforts. This is an opportunity to provide financing solutions for clients with bespoke pools of collateral. And by bespoke pools of collateral, just to be clear, I mean, our clients’ financing needs that are not being serviced by traditional capital markets activities.
In 2016, we had approximately $5 billion of balance sheet allocated to client inventory financing. Clearly, a small component of our $900 billion balance sheet. There is a potential to allocate an additional $5 billion of balance sheet to this activity. We believe that executing this strategy represents up to a $100 million of incremental annual revenues and provides significant value to our clients.
As you would imagine, all of these initiatives require the hard work and commitment of our people. Our ability to attract, retain and develop the best people has been and continues to be critical to our success. We are always focused on bringing new talent to the firm. In FICC we doubled our level of hiring year-to-date versus last year. We have particular focus on broadening our sales talent and European coverage. All in, we’ve been a net attractor of talent.
To summarize again, FICC industry wallet has declined for a number of years. As stewards of your capital, we responded. We resized our financial footprint and we reallocated resources. Simply, we created operating leverage. Of course, at the same time, we remain focused on our clients and are now in a position to grow.
We have identified an incremental $1 billion revenue opportunity within FICC. Importantly, we believe this is attainable, even if the markets remains challenged like it is today. If we see modest or perhaps more significant improvement in the operating environment, we expect FICC could deliver significantly more upside.
I’d like to switch gears away from FICC to highlight various lending initiatives. You’ve already seen us grow our lending footprint. Total loans have tripled since the end of 2012. Despite this, we are still quite small relative to peers. There are three areas of focus as it relates to lending. Our digital lending platform Marcus, where we lend to consumers, private wealth, where we provide collateralized loans to high net worth clients and the mass-affluent and corporate lending.
In aggregate, this is a two plus billion dollar annual revenue opportunity. Across our lending initiatives, we look for opportunities to provide significant value to clients and at the same time generate attractive returns. Again, because of our current lending footprint is smaller than virtually all peers, we can be targeted and deliberate about how we grow. You’ve seen us do this with Marcus, being disciplined and patient.
Also, it’s certainly not lost on us where we maybe in the credit cycle. We remain committed to the intense credit risk management that has served us well across prior cycles. We recently disclosed that we crossed the $1 billion mark for loans originated by Marcus. We expect to reach $2 billion by year end. If we take a step back to reflect, we recruited Harit Talwar to the firm just two years ago and launched Marcus just under a year ago.
Today our platform has reached these milestones faster than anyone else despite our disciplined approach to growth. As you know, we have acquired the online deposit platform from GE where we’ve had $5 million of growth in retail deposits despite limited marketing. This supports our thesis of growth opportunities focused on providing customers great value, simple transparent products and excellent customer experience.
From a revenue perspective, we believe there is a $1 billion opportunity for existing and adjacent Marcus businesses in the next three years. Of course, we are exploring additional products and services to broaden our consumer footprint beyond the $1 billion of opportunity we are pursuing today.
Similar to our efforts with Marcus, these opportunities are all about leveraging technology and our expertise to provide consumers with highly valuable solutions to meet their financial needs.
Given we start with a white sheet of paper, we are well positioned to adapt to a changing marketplace for consumer finance. Capturing this opportunity is a unique and meaningful opportunity for the firm. We’ve also identified revenue opportunities within investment banking, investment management and our equities business. Let me briefly touch on each.
Despite our leading position in investment banking, we see further opportunities for growth. We are expanding our client coverage to provide deeper and more frequent contact with companies where we have lower market share. By broadening our client franchise, we expect to generate up to $500 million of incremental annual revenues.
We also have a highly successful investment management franchise. We’ve both grown organically and through acquisition. At $1.4 trillion, assets under supervision are at a record level. We are continuing to make investments across the private wealth platform including AYCO which provides financial planning resources for corporate executives.
Across the investment management business, we see a $1 billion revenue opportunity in the next three years. Finally, we will continue to invest in our leading equities franchise for both existing and new clients.
A number of years ago, we delayed expansion into certain low latency opportunities due to a number of risks mostly operational in nature. Since then, we’ve seen significant improvements in technology and important changes to market structure. As a result, we are now expanding our client coverage in a controlled and methodical way.
We believe that our successful execution of these efforts translates into approximately $500 million of annual revenues.
Before taking your questions, a few comments. We approach these growth initiatives from a position of strength. In today’s discussion, we outlined revenue opportunities of $5 billion. These opportunities don’t require any improvement in the broader market environments. They simply require our collective focus and strong execution.
Given the work that we’ve done on costs, we believe these opportunities provide attractive margins and returns with marginal returns in excess of 30%. We estimate that $5 billion of incremental revenues could expand pretax earnings by $2.5 billion and our ROE by approximately $150 basis points.
Obviously, as we execute these initiatives, we aspire to do even better. We also know that the environment could get better. For example, both interest rate and volatility could increase from near record levels. The yield curve could steepen. Our investing clients could post better performance and have more conviction.
There could be more clarity on economic policy and the global economy could grow at a higher rate. Any or all of these factors could drive greater client activity and a better opportunity set for the firm. That would provide even more potential revenue upside to both our initiatives and the firm more broadly.
In closing, we are focused on the future. We will rely on the strength of our client franchise and the caliber of our people to not only capture these opportunities, but also to capture new ones. We can grow our existing franchise and expand into the consumer market, which is white space for Goldman Sachs.
We’ll wake up every day on executing into these initiatives and others, we are confident these efforts will benefit both our clients and our shareholders.
Now, before taking your questions, I want to take a few moments to thank Dane. I think everyone knows Dane. Dane is actually not standing up. As our Global Head of Investor Relations, he has made a significant contribution to the firm providing invaluable counsels to me and the rest of the senior management and Dane, thank you for helping make my transition as easy as it could be back in 2012.
As you may be aware Dane will become the firm’s new Global Head of Human Capital Management with responsibility for all the functions related to our people. Dane brings a longstanding involvement of number of key people priorities and a deep understanding of the firm and his strategy to his new role. We are all excited about the positive impact that he will have on the firm’s people, culture and our continued success.
We also want to welcome Heather Miner back to the executive office as the new Head of Investor Relations. Heather, raise your hand. Heather is actually seated, but you can’t see her because she is next to Dane. Many of you already know Heather well from her previous time in IR and I am sure, she will be reaching out to many of you in the days and weeks ahead.
With that, thanks again. It’s great to be here. Marty and I are happy to take your questions.
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