The Business Of
Banking | Goldman Sachs | What Do They Do With Their Profits?
Morning All!
Yesterday we put together Goldman’s costs with their revenues. And we’ve covered a fair amount this week. So, let’s have a quick recap…
Big And Bumpy: Goldman’s revenues have grown from $16bn in 2000 to $40bn in 2022. But over those 22 years, revenue growth has been negative in 9 years!
Big Paychecks, Little Sleep: The average 1st year analyst at Goldman makes a handsome $110k/year… but only gets ~5 hours of sleep/night!
EBT Margin: Despite the combination of cyclical revenues and fairly fixed costs, Goldman’s EBT margin has never fallen below 11% since 2000!
And speaking of margin - it is a Thursday morning. Which means it’s time to take a look at our famous TBO EBIT Margin ranking! Below, we can see our ranking updated to include Goldman Sachs - and the investment banking giant slots in at a very impressive 4th place! It’s interesting to note that the two financial companies we’ve looked at so far on TBO (Ninety One and Goldman) are both in the top 5…
And that observation about Ninety One and Goldman is a helpful one. Because in general, companies that are (i) asset-light, (ii) who sell services (e.g. financial advice), and (iii) have people as their main cost, tend to have high margins! We’ll see more of this when we look at The Business Of Consulting soon!
Anyway, let’s move on. Today, we’re going to look at Goldman’s cash profile, and we’ll be introduced to a completely new concept. Let’s dive in!
Hello Deposits, Welcome To TBO!
So, to kick us off as always, let’s look at the waterfall chart below. Which shows us how Goldman Sachs have spent their cash from operations (CFO) since 2012. And we see something we’ve not yet seen on TBO... deposits!
Now, the reason why we’re seeing deposits for the first time today is because Goldman is the first bank we’ve looked at on TBO! And because it is the first time – and I imagine a lot of readers will be unfamiliar with how deposits really work – I’m going to spend the rest of today doing a rundown on deposits. What they are, why they’re important, and how it plays into The Business Of Goldman Sachs!
To Give Out Loans, You First Need Deposits…
Okay, so first question - what are deposits? Well, deposits are basically money that’s held in a bank account. For example, when your employer pays your salary into your bank account, that’s a deposit. Now, these deposits are absolutely crucial for a bank’s operations. Why? Well, for banks with retail operations (e.g. Barclays), a big part of what they do is provide loans. Loans for mortgages, loans to buy a car, etc. But question - where do banks get the money to hand out loans in the first place?
Well, they get it from deposits! Millions of people have deposited their money at Barclays in current accounts, savings accounts, etc! As we can see from the graphic below, Barclays sits between these two groups of people. Those that need a bank to deposit their money in. And those that need a bank to give them a loan.
Okay, so I hope that’s clear. Banks like Barclays can only give loans to people because of the deposits that millions of people have given them in the first place!
But hold on, Goldman Sachs until very recently didn’t work with retail customers. And didn’t give people like me and you loans. So, why does an investment bank like Goldman Sachs need funding?
To Give Out Tesla Shares, You First Need Tesla Shares!
Well, the reason investment banks need funding is because market making and underwriting requires money! Let’s look at market making first. Going back to our example from yesterday, let’s say Ninety One wants to buy Tesla shares. But when Ninety One comes to Goldman looking for the shares, what does Goldman need? Well, Goldman needs to have the Tesla shares ready to sell!
So, what does Goldman do? Goldman purchases a load of shares (plus bonds, currencies, etc) that they think clients will want to buy at some point. And they let those assets sit in their inventory, ready to be sold for when clients want them. Now, what does this all require? Money! Goldman needs funding in order to purchase all these assets that clients want!
Okay, so that’s market making. What about underwriting? Well, like we said on Tuesday, underwriting an IPO means buying all the shares of the listing company. And then selling those shares to investors on behalf of the IPOing company. But in order to buy all the shares, Goldman needs to have a fair amount of money! So, again, this is where an investment bank like Goldman needs funding!
Okay, so we know why it’s not only banks with retail operations (like Barclays) that need funding. Investment banks also need funding. But here’s a question. Our chart above shows that Goldman didn’t really have any deposits back in 2003. So, where did Goldman get all their funding from in order to do all their market making and underwriting?
Why Borrow From Others When I Can Borrow From My Friends?!
Well, deposits aren’t the only way banks can raise funding! In fact, the major way a bank like Goldman used to fund its operations was through wholesale funding options. But question - what on Earth is wholesale funding?
Well, wholesale funding is when banks like Goldman Sachs borrow funds from other banks! One way to do this is via the interbank market. This market is where banks lend to each other for very short-term needs - often as short as overnight loans!
The second main form of wholesale funding is when a bank like Goldman issues their own debt to raise short-term funds. For instance, Goldman may say ‘Hey Friends, we’re looking for $200m. We’re going to issue a bond for this amount. We’ll pay you all back after 3 months. And with a bit of interest on top!’ To read more about wholesale funding options, this article here is a real cracker.
So, what used to happen was that Goldman and their other investment banking chums including Morgan Stanley, Lehman Brothers, etc. used wholesale funding for the majority of their existence because it suited them well! I mean, why take out long term (>1 year) loans with higher interest rates, when you can just keep taking out short term loans with lower interest rates from your pals?
However, as we saw earlier in the chart of Goldman’s deposits over time, it appears Goldman did change strategy! From about 2005 onwards, Goldman started to take on more and more deposits. And in 2022, the company actually had $387 billion in deposits. So the question is - why? If wholesale funding was so cheap and convenient, why change your funding strategy?
Well, much of this change had to do with the Global Financial Crisis in 2007-08. All of a sudden, banks weren’t that reliable! They were collapsing, being bailed out, and going through all sorts of strife. And what did that mean for Goldman Sachs? Well, it meant that borrowing from their fellow banking pals had become MUCH more risky and expensive! Banks didn’t want to lend to each other in fear they might not get their money back, as so interest rates rose dramatically. As a result of this, Goldman switched strategy and decided to up their deposit game!
Goldman Sachs + Apple = The Dream Team
So, from the 2008-2015 period, Goldman started talking more and more deposits. Now, these deposits weren’t the ones we saw earlier with Barclays. ‘Normal’ individuals couldn’t create a current or savings account and deposit their money at Goldman. However, high net-worth individuals (the Kardashians of the world) and big institutions who wanted to keep their cash with Goldman could finally do so!
And remember, the reason for Goldman taking on deposits was because these deposits gave the bank an extra source of funding. They could use the funds deposited in their bank by super wealthy individuals and fund their operations - e.g. underwrite IPOs and make market!
But then in 2016, new CEO David Solomon took the reins, Goldman did the unthinkable. They entered retail banking! For the first time, ‘normal’ individuals could set up current accounts and savings accounts with Goldman Sachs. And Goldman called this retail bank, Marcus.
At the time, this was truly extraordinary. For years, Goldman Sachs was the pillar of investment banking and the furthest thing from a consumer/retail bank. So, why did this investment banking behemoth completely change strategy to work with retail customers? Did they suddenly want to become the bank of the people?
Ha, not exactly! The reason Goldman let individuals create bank accounts and deposit their money at Goldman, was because Goldman wanted to use all these retail deposits to fund even bigger investment banking deals and even more market making activities! One of their biggest competitors, Morgan Stanley, had already been doing this for years!
However, as we mentioned on Monday, Marcus and Goldman’s venture into retail banking has been an unmitigated disaster. And one of the main reasons for this has been the partnership with Apple. Which may surprise a lot of us because a partnership between two heavyweights like Goldman Sachs and Apple sounds like it should have been a match made in heaven! The headline below would suggest not…
Alrighty, let’s wrap up. Tomorrow, I’m excited to share that we’ve got another TBO special. Where we’ll dive into The Business Of Credit Cards. We’ll dive into how credit card companies really make money. And why Goldman’s venture with Apple Card was such a disaster!
26th Oct 2023
And that’s a wrap! Lots to look forward to tomorrow. Credit cards, Apple, and a real look at the British Airways/American Express credit card!
Have a fabulous day!
The Business Of Team