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Can Goldman’s merchant bank help group regain old edge?

You used to know where you were with Goldman Sachs. The cockiest firm on Wall Street was also the smartest, edgiest rent seeker of them all, with supposedly unrivalled risk management to match. At its peak in mid-2007, it was bringing in a return on equity above 30 per cent.

Today, under newish boss David Solomon, the self-assurance is as shaky as the share price. Goldman’s profitability is a third of that pre-crisis high, and the stock has stagnated since Mr Soloman started in the job 14 months ago. The likes of Morgan Stanley and JPMorgan have seen their shares bounce 10-20 per cent over the same period.

So expectations are running high ahead of Goldman’s first ever investor day in January, when Mr Solomon will seek to clarify the group’s strategic priorities and revive investor faith that it can regain its pre-crisis chutzpah.

It is a tough challenge. Many of the bank’s old areas of excellence, notably the trading revenues it generated from investing its own balance-sheet (“proprietary trading” in the argot of investment banking) have been undermined by tough post-crisis regulation and a lower risk appetite. Others have been undone by accusations of improper behaviour (the 1MDB scandal relating to the bank’s alleged involvement in a vast fraud in Malaysia drags on).

Over the past decade, as Goldman has cast around for new sources of revenue, it has strayed from its high-end origins — with limited success. The build-up of the Marcus consumer finance unit, and the deposits it has attracted, have secured cheap funding for the bank. But the unit’s profitability is weak and its move into lending — originally a draw because of the vast margins enjoyed by consumer lending rivals — has coincided with the top of the credit cycle.

Critics, both internal and external, query the wisdom of deigning to service the hoi polloi. Mr Solomon’s plan to build a cash management franchise has attracted sniffiness, too.

But when investors and analysts gather to hear Mr Solomon’s new year vision for the group, a bit of old-style Goldman — with a twist — looks set to take centre stage.

The retooling of the group’s merchant banking division — expanded through its amalgamation with the bulk of Goldman’s proprietary investment businesses into a $135bn unit — will be significant both practically and symbolically.

This is the guts of the business that used to make a vast contribution to Goldman’s revenues and profits. It is impossible to compare current disclosures with those from a decade ago, because the group has changed its divisional structure. But broad trends are clear.

At its peak in 2007, the then reporting segment of “Trading & Principal Investments” generated $30bn, or two-thirds of the group’s total revenue.

The 2015 Volcker rule, part of the Dodd-Frank package of reforms, has begun limiting much of Goldman’s principal investing, though full introduction was delayed by several years as regulators granted forbearance to banks if investments were judged illiquid.

That pragmatism has helped buoy Goldman’s “Investing & Lending” segment, which includes investments in private equity, infrastructure, real estate and credit. The unit generated $8bn, nearly a quarter of total revenues, in 2018.

But as the Volcker rule bites, the new merchant banking division is set to launch a radical expansion, with a string of new funds designed to bring in external cash, in part replacing Goldman’s own money.

Over recent months senior executives have spent much of their time on the road selling the concept and the new funds to a fresh tier of investors. Goldman will also tap the assets of its wealth management clients, another business line prioritised for expansion.

The group’s seven main existing funds are likely to be supplemented with half a dozen new ones spanning venture capital, real estate, SME credit and distressed debt as well as private equity and infrastructure.

Goldman executives talk of ambitions to become another Blackstone. In size terms, that is quite a goal: Steve Schwarzman’s firm has four times the assets under management. But unlike the misfit flirtations with consumer finance and cash management, at least this is a business that aligns with the group’s genetic heritage — and one that could even help the bank, and its investors, regain a little of that old Goldman edge.

patrick.jenkins@ft.com


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