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Goldman Sachs (NYSE: GS) is a U.S. bank holding company which is particularly know for its investment bank arm. Goldman Sachs advises corporations on mergers and acquisitions, offers trading services, and manages the assets of large institutions, governments, and wealthy individuals. Goldman Sachs also uses its own capital to engage in long-term (private equity) and short-term investments (propriety trading).
Goldman had the distinction of being the oldest and most reputed pure play investment bank in the world, but became a bank holding company on September 21, 2008. Even though Goldman Sachs was not directly hurt by the subprime crisis, the banks stock price per share fell and the company incurred losses due to a drop in the overall market. The new holding bank status allows the company to run commercial banking operations and gives its depositors insurance through Federal Deposit Insurance Corporation (FDIC). Deposits, in turn, allows Goldman Sachs to reduce its leverage ratio and hence reduce the risk of bankruptcy.[1] Goldman Sachs also accepted $10B under the Troubled Assets Relief Program (TARP). In an attempt to protect itself from increased government regulation, Goldman Sachs applied and received permission to repay the $10B TARP loan.[2][3] Goldman Sachs had accomplished its high returns in the past by taking greater risk in terms of capital risk. However, as a holding bank, it is not allowed to take on such risk and so its future performance may be impacted.[4]
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[edit] History and Business Overview
Goldman Sachs is a holding bank with a strong global investment bank. Although the company was originally a stand alone investment bank, it added a holding bank in order to become less leveraged during the 2008 financial crisis. Goldman Sachs offers services to a variety of customers including government agencies, high net work individuals (HNI), financial institutions, and corporations.[5]
GS has frequently performed above the market, but it reported a loss in the fourth quarter 2008. This was its first quarterly loss in in its history since going public in 1999.[6] Because of these losses and the overall market condition, Goldman Sachs accepted $10B in capital injection under the Troubled Assets Relief Program (TARP). On September 23, 2008 the company received $5 billion in equity investment from Berkshire Hathaway (BRK) and announced that it plans to raise another $10 billion from other investors. The company expects that these capital infusions will ease concerns about bankruptcy. In April 2009, GS also sold $5.75B in stock and $2B in 5 year debt.[7] This most recent sale of stock has been in hopes of raising enough money to pay off the TARP loans and free itself of excess regulation.
| Net Revenues Data, in millions | FY2005 | FY2006 | FY2007 | FY2008[8] | Q12009[9] | |
|---|---|---|---|---|---|---|
| Investment Banking | $3,671 | $5,629 | $7,555 | $5,185 | $823 | |
| Trading and Principal Investments | $16,818 | $25,562 | $31,226 | $9,063 | $7,15 | |
| Asset Management & Securities Services | $4,749 | $6,474 | $7,206 | $7,974 | $1,45 | |
| Total Net Revenue | $25,238 | $37,665 | $45,987 | $22,222 | $9,425 | |
| Operating Expenses | $16,965 | $23,105 | $28,383 | $19,886 | $6,796 | |
| Pre-Tax Earnings | $8,273 | $14,560 | $17,604 | $2,336 | $2,629 | |
The company's operations can be broken down into three main segments - Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.
[edit] Investment Banking (23.3% of 2008 revenue; 87.4% of 2008 earnings)[10]
The Investment Banking Division (IBD) advises large institutions on mergers and acquisitions in addition to assisting them in raising money through debt and equity issuance. The company also underwrites IPOs. Clients include financial institutions, institutional investors, large corporations, and governments.[11]
Within the Investment Banking Division, the Financial Advisory component is in charge or mergers and acquisitions and financial restructuring advising. In 2009, Goldman was replaced by J P Morgan Chase (JPM) as the number one ranked global adviser on mergers and acquisitions in terms of transaction volumes. Although Goldman has lost its number one spot, the entire market activity for mergers has greatly dropped by 53% from 2007 to 2008.[12]
The underwriting component in Investment Banking is incharge of equity and debt underwriting. Although it is not as highly ranked, as the financial advisory component, underwriting still has a substantial reputation. Underwriting decisions are typically made by CFOs, and Goldman's relationships in this area are not quite as extensive as with CEOs.
Although only 23% of Goldman's revenue comes from investment banking, the impact of this segment reaches far beyond its measurable revenue contribution. Goldman is the most effective of the major investment banks when it comes to leveraging its relationships to cross-sell additional services to its clients. It is estimated that investment banking is indirectly responsible for an additional 10% of Goldman's revenues.
[edit] Trading & Principal Investments (40.8% of 2008 revenue; -117.5% of 2008 earnings)[10]
This division generates over 40% of Goldman's revenues. This division both facilitates trades on behalf of clients and invests Goldman's own capital using various debt and equity instruments. The segment experienced severe losses due mainly to a $3.1B loss in corporate debt and private equity and a $3.1B loss in residential and commercial mortgages. There are three subdivisions in the Trading & Principal Investments segment:
Equities As its name implies, this division specializes in facilitating equity trades. This segment is also heavily involved in proprietary trading and derivatives. Goldman, along with its competitor Morgan Stanley, is a leader in electronic equities trading. Over the last decade, there has been a move toward electronic trading. Electronic trading eliminates the need for specialists, or people physically executing trades on stock exchange floors, and carries significantly smaller commissions than traditional trading. Goldman is unique in that it has embraced this trend, investing in making its operations as efficient as possible. In addition, the equities subdivision sells insurance and reinsurance from a variety of activities.[13]
Principal Investments Area (PIA) PIA engages in merchant banking activities and private equity ventures. PIA makes investments in other corporations, as well as in real estate. As of 2008, the segment had investments in corporate and real estate valuing $15.13B.[14] In addition to managing the firm's own investments, PIA is partially owned by limited partners, institutions, and high-net-worth clients, who earn a portion of the group's returns. Goldman Sachs is one of the few investment banks to maintain a separate private equity division. GS PEG, the so called private equity group, competes with KKR, the Carlyle Group and TPG, among others, in private equity.
[edit] Asset Management & Securities Services (35.9% of 2008 revenue; 129.9% of 2008 earnings)[10]
Goldman's asset management division manages assets for large institutional investors such as pension plans, endowments, and trusts. Unlike most full-service investment banks, Goldman Sachs also provides loans to hedge funds through its Prime Brokerage business.
Goldman's asset management business is distinct in that alternative assets compose a relatively high percentage of its assets under management relative to its peers. Investors wishing to gain exposure to alternative assets, which include investment vehicles such as hedge funds and private equity, can do so through Goldman's asset management services. Goldman is also second in prime brokerage, having entered the market earlier than most of its competitors.
[edit] International Exposure and Emerging Markets
Goldman first entered China in 1992, well ahead of most of its competitors. Over the last 17 years, it has cultivated strong relationships with the Chinese government and various regulatory agencies. As a result, Goldman is one of only two foreign banks licensed to underwrite domestic deals in China and trade in the Chinese markets. UBS AG (UBS) has similar rights, but the Chinese government didn't grant UBS these rights until 2006, two years after it allowed Goldman to begin operating in China. Since 2004, Goldman has participated in underwriting both equities and IPOs for Chinese companies such as China Mobile (Hong Kong) (CHL). It also had the opportunity to invest in the Industrial and Commercial Bank of China prior to its IPO, resulting in gains of nearly $1 billion between Q4 2006 and Q1 2007. Although other banks have gained access to the Chinese markets in a variety of segments, Goldman Sachs has remained a leader. In a 2008 survey run by PriceWaterhouseCoopers on foreign banks in China, Goldman Sachs ranked number one in performance, presences, and momentum in Investment Banking, Corporate Finance, Mergers and Acquistions, and Equity and Capital Markets.[15]
Goldman Sachs is the most geographically diverse of its non-commercial banking peers, such as Morgan Stanley, Merrill Lynch, and Lehman Brothers. As seen in the graph to the right, Goldman derived 46% of its 2006 revenues from the outside the US. In 2007, 56% of Goldman's pre-tax income came from non-U.S. sources. As of 2008, 17% of its deposits were from non-US offices.[16]In addition to Goldman's long history in China, the firm is firmly entrenched in several other countries, including key emerging markets. In India, Goldman participated in a joint venture for several years and is now significantly expanding its local presence. The firm is also well established in Japan and various European countries.
[edit] Trends & Forces
[edit] Exposure to US economic fluctuations
Investment banks are highly dependent on both global and U.S. economic cycles. When the economy is growing rapidly, companies typically borrow more money and engage in larger numbers of IPOs, leading to greater demand for Goldman's investment banking services. Also, the stock markets often move in the same direction as the overall economy. If the market is up, then demand for trading and other capital markets services increases. Conversely if the economy is depressed, demand for banking services decreases substantially. In addition to fluctuations in demand for services caused by economic cycles, Goldman itself derives a large portion of its revenue from trading and other investments. As such, poor conditions in the larger economy are likely to have a negative impact on both Goldman's portfolio and demand for its services.
[edit] Benefit from low interest rates
Interest rates can be thought of as the cost of borrowing money. Though the impact of interest rates spans across the economy, businesses and lenders are particularly sensitive to fluctuations in interest rates. As the Federal Reserve cuts the interest rate at which it lends out money, banks are able to gain access to "cheaper" money. In an attempt to spur the economy back into growth, the Federal Reserve cut the fed fund rate 10 times since June 2006. With an intended rate of 0%-.25%, the rate is at the lowest in over 50 years.[17] These extremely low rates can allow Goldman Sachs to borrow money with low interest and increase its profit margins.
[edit] Subprime lending: large losses
Subprime lending refers to the practice of extending credit or loans to borrowers to who fail qualify for prime or market rates due to their less than optimal credit scores. For the past decade, the interest rates associated with subprime mortgages have been about 2% higher than those associated with prime loans; the rationale is that borrowers with lower credit scores carry a higher risk of default and must therefore pay a considerable risk premium. Subprime borrowers can be extremely sensitive to interest rates. As rates rise, these borrowers, many of whom have adjustable-rate mortgages, find themselves unable to meet their debt obligations.
Investment banks like Goldman Sachs generate profit by bundling subprime mortgages and reselling them to other investors in the form of mortgage-backed securities (MBSs). As an increasing number of subprime originators have been faced with bankruptcy (three more in June 2007 alone), both the value of existing MBSs and demand for additional MBSs have fallen significantly. This, in turn, has led to a fall in revenues for Goldman, who both securitizes mortgages and has some holdings of MBSs. Goldman reported a $2.12B loss in earnings for Q4 2008 - its first quarterly loss in its history. Although Goldman stayed relatively out the subprime mortgage market compared to some of its competitors, the almost 30% drop in the global equity market drastically hurt the company's returns. GS's chief financial officer argued that the losses were a result of a market wide trend and that the firm would reverse the losses as the market turned around.[18] In April 2009, Goldman sold 6.1 million shares to raise $5.75B and sold $2B in five-year debt. The company hopes to raise capital to pay off theTroubled Assets Relief Program (TARP) loans and to maintain liquidity despite its past losses.[19]
[edit] High litigation risk
As a premier investment bank, Goldman is both blessed and cursed with a very high degree of visibility. The firm's tenure in the industry and its reputation are integral to its ability to win clients. Additionally, access to confidential information is inherent in the nature of the firm's work. Given these factors, any perceived violation of ethical standards on Goldman's part can have negative repercussions on the firm's bottom line. In an organization that contains tens of thousands of people, a single negative act by an individual can have disproportionately severe consequences for the entire firm. Recently, two Goldman employees were charged with insider trading. Their actions tarnished both their reputations and the reputation of Goldman Sachs as a whole.
[edit] Private equity bubble burst
After the tech bubble of the 1990s, private equity firms have been increasingly engaging in leveraged buyouts, borrowing substantial amounts of debt to finance their acquisitions of target firms. There are some worries that there are too many private equity firms chasing potential deals, leading to overvalued purchases; this trend is sometimes likened to a private equity "bubble". With more than $500B in private equity debt that will have to be renegotiated by 2010, some experts predicts up to 30% of buyouts could default. In addition, the weakened economic state makes finding big deals more difficult and so harder to pay off losses from past deals.[20] If this so-called bubble were to burst, investment banks that serve private equity firms would be among the biggest losers. Goldman is involved in the PE process at several different points, including sourcing deals, representing the company being purchased, and facilitating IPOs or any subsequent equity or debt offering. Additionally, Goldman itself has significant investments in private equity, exposing it to conditions in the PE market. In August 2008, as many in the industry became cautious on PE investments, Goldman actually bought a portfolio of private equity investments for $1.5 billion.[21]
[edit] Competitive Landscape
Although Goldman has been the number one investment bank in terms of merger & acquisition in the past, it recently was surpassed by its rival J P Morgan Chase (JPM). In addition, Goldman competes most fiercely with other pure play investment banks such as Citigroup (C) and Lazard (LAZ). It also competes with J P Morgan Chase (JPM) and UBS AG (UBS) on the trading and asset management side. Goldman, unlike many of its peers, has not maintained an extensive retail brokerage sales force, opting instead to focus on higher-margin businesses such as investment banking and private equity. Goldman also derives a large portion of its revenue from sales and trading, both proprietary and on behalf of clients. Trading, particularly proprietary trading, has allowed Goldman Sachs to stay insulated from the subprime crisis.
| 2008 metrics | Goldman Sachs | Morgan Stanley[22] |
|---|---|---|
| Gross Earnings ($B) | 22,222 | 24,739 |
| Pre-tax income ($M) | 2,336 | 1,707 |
| 1-yr revenue growth (%) | -51.7 | -11.6 |
| Equity origination revenue ($B) | 1,353 | 1,045 |
| M&A advisory revenue ($B) | 2,656 | 1,740 |
| Debt underwriting revenue ($B) | 1,176 | 845 |
[edit] Transformation into Bank Holding Company
Goldman Sachs was largely insulated from the subprime crisis due to bets placed by the banks propriety trading desks. Propriety trading is the practice of risking the banks own capital on a certain position. However, the banks stock price per share fell from $169 on Sept. 8, 2008 to $86 on September 18, 2008. This was caused by concerns about the company's ability to stay solvent in the wake of the collapse of Lehman Brothers (LEH) and the fire-sale of Merrill Lynch (MER) to Bank of America (BAC) on September 15, 2008.
In order to prevent the bank's market capitalization from plummeting, Goldman Sachs, which had the distinction of being the oldest and most reputed pure play investment bank in the world, became a bank holding company on September 21, 2008. The new status allows the company to run commercial banking operations and gives its depositors insurance through Federal Deposit Insurance Corporation (FDIC). Most importantly, the new status allows Goldman to use deposits to support its leverage. On September 21 2008, Goldman had a leverage of 26, meaning that for every dollar in equity, the bank had $26 in assets, the rest of the aseets were supported by borrowed money.[23] This decreases the chances that Goldman Sachs will face bankruptcy since its investments are increasingly backed by deposits and not loans.
The new status comes with the burden of more regulation than the company had faced previously. Even though the effects of this oversight is unclear, industry observers believe that this will hurt the bank's profitability.[24] Goldman Sachs had accomplished its high returns in part by taking greater risk in terms of capital risk. Historically, the amount of Goldman's money invested in the equity and bond markets is far greater than its peers. However, being a bank holding company places limits on risky positions that the bank is allowed to take.[25]
On September 23, 2008 the company received $5 billion in equity investment from Berkshire Hathaway (BRK) and the company announced that it plans to raise another $10 billion from other investors. The company expects that these investments will ease concerns about bankruptcy. The new capital should reduce the leverage ratio to 19.[26]
[edit] References
- ↑ Bloomberg.com, Retrieved September 23, 2008
- ↑ Blogging Stocks "Goldman Sachs wants to give back TARP money, but can it?" 6 Feb 2009
- ↑ Street Insider "Goldman Sachs (GS) Receives Permission to Repay TARP Funds" 9 June 2009</ref< In addition, as a holding bank, Goldman faces more regulation than it previously faced. <ref>[http://online.wsj.com/article/SB122202739111460721.html?mg=com-wsj&mg=com-wsj Wall Street Journal, retrieved September 22, 2008]</li> <li id="_note-3">[[#_ref-3|↑]] [http://online.wsj.com/article/SB122202739111460721.html?mg=com-wsj&mg=com-wsj Wall Street Journal, retrieved September 22, 2008]</li> <li id="_note-4">[[#_ref-4|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 2008 10-K Part 1 "Business" p.1]</li> <li id="_note-5">[[#_ref-5|↑]] [http://online.wsj.com/article/SB122818833059071519.html The Wall Street Journal "Goldman Faces Loss of $2 Billion for Quarter" 2 Dec 2008]</li> <li id="_note-6">[[#_ref-6|↑]] [http://www.bloomberg.com/apps/news?pid=20601087&sid=asmg3o2dr0y8&refer=home Bloomberg "Goldman Sachs Boosts Stock Sale to $5.75 Billion as Shares Gain" 29 April 2009]</li> <li id="_note-7">[[#_ref-7|↑]] [http://www2.goldmansachs.com/our-firm/press/press-releases/current/pdfs/2008-q3-earnings.pdf Goldman Sachs 3Q2008 earnings release]</li> <li id="_note-8">[[#_ref-8|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309006460/y76096e8vk.htm GS 8-K Current Report "Net Revenues" 13 April 2009]</li> <li id="_note-seg">↑ <sup>[[#_ref-seg_0|10.0]]</sup> <sup>[[#_ref-seg_1|10.1]]</sup> <sup>[[#_ref-seg_2|10.2]]</sup> [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 2008 10-K Part 1 "Segment Operating Results" p.3]</li> <li id="_note-9">[[#_ref-9|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 2008 10-K Part 1 "Investment Banking" p.6]</li> <li id="_note-10">[[#_ref-10|↑]] [http://online.wsj.com/article/SB123076066898846511.html The Wall Street Journal "M&A Went MIA and May Stay That Way" 2 Jan 2009]</li> <li id="_note-11">[[#_ref-11|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 10-K 2008 Item 1 "Equities" p.10]</li> <li id="_note-12">[[#_ref-12|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 10-K 2008 Item 1 "Principal Investments" p.10]</li> <li id="_note-13">[[#_ref-13|↑]] [http://www.pwchk.com/home/eng/fs_foreign_banks_china_jun2008.html PriceWaterhouseCoopers "Foreign Banks in China" 3rd Survey Jun 2008]</li> <li id="_note-14">[[#_ref-14|↑]] [http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 10-K 2008 "Notes to Consolidated Financial Statements" p168]</li> <li id="_note-15">[[#_ref-15|↑]] [http://www.federalreserve.gov/fomc/fundsrate.htm The Federal Reserve Board "Open Market Operations" 16 Dec 2008]</li> <li id="_note-16">[[#_ref-16|↑]] [http://www.nytimes.com/2008/12/17/business/17goldman.html?partner=rssnyt&emc=rss The Wall Street Journal "Goldman Sachs Reports $2.1 Billion Quarterly Loss" 16 Dec 2008]</li> <li id="_note-17">[[#_ref-17|↑]] [http://www.bloomberg.com/apps/news?pid=20601087&sid=asmg3o2dr0y8&refer=home Bloomberg "Goldman Sachs Boosts Stock Sale to $5.75 Billion as Shares Gain" 29 April 2009]</li> <li id="_note-18">[[#_ref-18|↑]] [http://www.guardian.co.uk/business/2009/feb/03/private-equity-bubble-to-burst The Guardian: Business "Private equity 'next bubble to burst,' unions warn" 3 Feb 2009]</li> <li id="_note-19">[[#_ref-19|↑]] [http://online.wsj.com/article/SB121854728125033325.html?mod=rss_whats_news_us Goldman Goes All In on 'Secondary' Bet - WSJ.com]</li> <li id="_note-20">[[#_ref-20|↑]] [http://www.sec.gov/Archives/edgar/data/895421/000119312509013429/d10k.htm MS 10-K 2008 Item 6. "Selected Financial Data" p.34]</li> <li id="_note-21">[[#_ref-21|↑]] [http://www.nytimes.com/2007/12/20/business/20wall.html The Wall Street Journal, Retrieved September 23, 2008]</li> <li id="_note-22">[[#_ref-22|↑]] [http://online.wsj.com/article/SB122202739111460721.html?mg=com-wsj&mg=com-wsj Wall Street Journal, retrieved September 22, 2008]</li> <li id="_note-23">[[#_ref-23|↑]] [http://online.wsj.com/article/SB122202739111460721.html?mg=com-wsj&mg=com-wsj Wall Street Journal, retrieved September 22, 2008]</li> <li id="_note-24">[[#_ref-24|↑]] [http://www.bloomberg.com/apps/news?pid=conewsstory&refer=conews&tkr=BRK%2FA%3AUS&sid=ahbWMTyWKc_8 Bloomberg "Goldman Sachs Plans to Raise $5 Billion to Repay U.S. (Update2)" 14 April 2009]</li></ol></ref>
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