Goldman's Trading Turnaround Plan Takes Back Seat to Lending

(Bloomberg) -- Investors have been waiting for Goldman Sachs Group Inc.’s strategy to turn around its fixed-income trading operation. What overshadowed that Tuesday was a plan to expand in a business that’s been mostly a sideline.

Lending to wealthy clients and consumers through an online bank, as well as other loans, could bring in $2 billion of new revenue over the next three years, twice as much as a revamp of the firm’s storied bond-trading business, Co-President Harvey Schwartz said in a presentation.

The strategy for growth, which follows years of cutting senior staff, compensation and risk-weighted assets, could boost return on equity 1.5 percentage points over three years, the company said. Schwartz, one of Chief Executive Officer Lloyd Blankfein’s top lieutenants, addressed investors demanding answers after trading suffered the worst first half of the CEO’s 11-year tenure.

“We are somewhat skeptical,” Keefe, Bruyette and Woods analysts wrote in a note. The strategy “is focused on penetrating new markets or client segments outside of the company’s traditional strengths.”

Fixed-income trading can bring in $1 billion more in revenue over the next three years through a mix of adding talent, financing client trades and doing more with asset managers, banks and corporations, New York-based Goldman Sachs said. Enhancements across investment banking, investment management and equities trading could add $2 billion in revenue.

Credit Cycle

The emphasis on lending dominated the revenue projections, and JMP Securities analyst Devin Ryan called it “the best detail yet” on the strategy. Schwartz, 53, touted the opportunity even as he acknowledged that it’s late in the credit cycle and the market is mispricing some types of loans. Wells Fargo & Co. said Tuesday it’s making fewer auto loans and avoiding some types of commercial and real estate lending because the environment is becoming overheated. “It’s certainly not lost on us, where we may be in the credit cycle,” Schwartz said.

“We are a bank now and we can provide value opportunities across the private wealth platform, corporate clients and now the consumer,” Schwartz said in a Bloomberg Television interview after the presentation. “We will not take our eye off the risk side of this.”

Among the areas Schwartz highlighted for the next three years was an estimated $12 billion in growth from the firm’s Marcus lending platform, which will originate about $2 billion in loans by the end of 2017. The bank said it will make $5 billion in loans in sectors such as middle market, real estate, alternative energy and structured credit. And lending to wealthy individuals would mean an additional $11 billion in loan growth.

In August, Goldman Sachs said it plans to start a digital-only deposit-taking business next year in the U.K.

Revenue Assumptions

The new revenue figures shouldn’t be viewed as targets, and don’t assume any improvement in the market, economic or policy-making environment, Schwartz said during the presentation. If conditions worsen, the bank will adjust, he said.

“If operating conditions improve, I have no doubt we can exceed the revenue potential presented today,” Blankfein, 62, said in a voicemail message to employees Tuesday.

Shares of the company advanced 2.6 percent to $226.90 at 11:46 a.m. in New York, the third-best performance in the 67-company S&P 500 Financials Index.

Schwartz expressed optimism that the trading environment would eventually improve, though he said that’s unlikely in the third quarter. The fixed-income business remains “pretty challenging,” with this quarter’s activity much the same as during the first half of the year, he said.

Goldman Sachs has already taken steps to enact some of the changes, doubling lateral hires in its fixed-income, currencies and commodities business in the first six months of 2017. Salespeople make up 43 percent of the new additions, with market-making roles accounting for 30 percent. More than half of the people have been added in the Europe, Middle East and Africa region.

The firm said it sees opportunities in providing corporate customers more commodities and currencies products, as well as making inroads with the roughly 600 clients at hedge funds, insurance companies, asset managers and banks for which Goldman Sachs isn’t among the top three trading partners. That’s “not only unacceptable, it’s also a great opportunity,” he said.

The bank has lost ground to rivals including JPMorgan Chase & Co. and Citigroup Inc., which have larger lending footprints. In prior presentations and interviews over recent months, executives have preached improving cooperation among trading desks, relieving clients from some fees and reducing a reliance on hedge funds as keys to boosting performance.

Pablo Salame, the firm’s co-head of trading, has implored traders this year to look for ways to reward favorite customers with free add-ons, coining the slogan “Just Add Butter” in a nod to restaurant-industry practice. Too often, top clients are confronted with a tangle of fees from disparate desks that don’t work together, or they’re snubbed by a misguided trader who may think a transaction is too small, he told employees in April.

“Our relative performance, in the long run, is totally within our control,” Blankfein said in the voicemail message to employees Tuesday. “We have the people, the client franchise and the drive and I’m excited to show our shareholders and our clients what we’re capable of.”