Goldman Sachs: retrofit bank must deal with pay and capital costs ahead

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Meet the new Goldman Sachs. It should look like the old Goldman Sachs. Some notable differences will exist. But investors should ask how profitable the retro Goldman can be.

On Tuesday, Goldman reported its third-quarter results. These were muddied by extra charges due to its exit from consumer lending along with those from a continuing purge of certain capital-heavy investments. Goldman’s stated annualised return on equity for the quarter was just 7.1 per cent. 

But exclude these one-time expenses, said the bank, and its RoE would have hit 10 per cent. Moreover, its two core businesses, institutional securities and money management, should eventually generate mid-teens RoEs “through the cycle”.

The credibility of that promise will be tested within this new, streamlined Goldman model. One analyst rightly asked chief executive David Solomon why the firm’s pay (to income) ratio had ticked up when overall revenues had jumped. The firm is targeting an efficiency ratio — with all operating expenses — of 60 per cent, which looks ambitious.

Solomon intriguingly noted that Goldman remains an “aspirational” career brand. Each junior analyst must get past hundreds of other applicants. But he conceded that the labour market for top talent remains tight, intimating that Goldman must fight hard to keep its stars. 

That sounds odd given that Goldman has shed thousands of jobs this year. Moreover, several star executives and rainmakers in its core businesses have departed for greener pastures. 

Goldman’s proprietary trading and investment banking businesses in the 1990s and 2000s could routinely churn out returns of equity above 30 per cent. Modest regulatory capital requirements enabled a big part of that profitability.

All changed post financial crisis. The trend for enhanced regulation should culminate with the stricter Basel III rules. Big banks warn they may have to boost their equity capital by 25 per cent, which has led to a furious opposition campaign.

Goldman’s rivals including JPMorgan and Bank of America continue to benefit from their interest-rate dependent consumer lending businesses. Goldman can only hope to position itself for a rebound in IPOs and merger activity. Shareholders will hope to avoid a squeeze from rising banker pay and added regulatory capital when business does finally pick up again.