 | ||
After the fall: Rebuilding in the post-crisis world Financial industry scans horizon for next crisis, 10 years after Lehman's fall A decade after Lehman, EU still far from solution to too-big-to-fail Even post-Popular, EU postcrisis bank resolution rules await first real test Europe's 'bad banks' did their job but a cross-border version faces problems
Yield-seeking Japanese banks exposed to Chinese risk End of QE set to shift global capital and expose indebted US corporates Risk-averse banking sector could facilitate a snapback in debt markets |
Goldman Sachs Group Inc. and Morgan Stanley were able to survive the credit crisis, but since, they have gradually morphed into companies that more closely resemble traditional banks.
Now, a decade after the depths of the crisis, the success of that transformation — driven by a greater emphasis on deposit gathering and lending — is leading management and analysts to consider just how far into bankland Goldman Sachs and Morgan Stanley should travel.
Sooner or later, the companies might find themselves considering more dramatic changes, said Vining Sparks analyst Marty Mosby.
"Will Goldman and Morgan Stanley want to eventually buy a big superregional bank?" Mosby said in an interview.
Leaders from Goldman Sachs and Morgan Stanley have not publicly said they are interested in buying a large bank, nor have they suggested that such a deal is part of their long-term strategic plans. But given the companies' forays into traditional banking activities, the question of whether to enter the space fully is a logical one, Mosby believes.
An acquisition of a regional bank would give Goldman Sachs and Morgan Stanley a banking branch network for the first time and greater exposure to consumers. But perhaps more importantly, it would also create a more comprehensive offering for the corporate clients they have spent years cultivating as investment banks.
JPMorgan Chase & Co. attempts to build relationships with corporate clients by offering them a wide range of banking products. Other large competitors Citigroup Inc. and Bank of America Corp. can do the same.
"Will Goldman Sachs and Morgan Stanley want to compete on that basis with the full suite of products?" Mosby said.
Then and now
Before the credit crisis and the failure of Lehman Brothers Holdings Inc. on Sept. 15, 2008, the idea of a bulge bracket firm buying a bank might have seemed counterproductive. Large investment banks avoided any such deal because owning a bank would bring higher capital requirements and greater business restrictions.
But now, thanks to post-crisis rules, regulators would deem broker/dealers of Goldman Sachs' or Morgan Stanley's size systemically important, and the companies would face greater scrutiny whether they were banks or not. Goldman Sachs and Morgan Stanley chose to become bank holding companies in the aftermath of the Lehman failure.
"That was a big turning point in terms of how they thought of themselves and how they have to think of themselves going forward," Sandler O'Neill & Partners LP analyst Jeffery Harte said.
Becoming bank holding companies meant Goldman Sachs and Morgan Stanley would subject themselves to Federal Reserve regulation, but it also assured the market that they could borrow directly from the Fed at a time when access to funding was a top concern for broker/dealers. During the crisis, counterparties stopped lending to broker/dealers that faced speculation about their inability to fund themselves.
"Typically, you don't see brokers fail from leverage and things like that," Harte said. "It tends to come down to cash flow."
The failure of Lehman Brothers and the sale of Bear Stearns Cos. LLC were the results of a "classic" funding and liability mismatch: "investing long and borrowing short," Harte said.
In the midst of the Lehman Brothers failure, Merrill Lynch & Co. Inc. rushed into a sale agreement with BofA rather than run the risk of watching its funding outlets dry up. The liquidity concerns at Goldman Sachs and Morgan Stanley were not as dire as their fallen peers, and the move to become banks increased the likelihood of them surviving as independent companies.
Deposit strategy
Having bank holding company status does allow financial institutions to attract FDIC-insured deposits, which can provide a low-cost and stable funding source. Goldman Sachs and Morgan Stanley have done just that, and they each executed acquisitions to jump-start their deposit levels.
Morgan Stanley boosted its deposits with the deal for Citi's Smith Barney, while Goldman Sachs purchased General Electric Co.'s deposit platform. But bank holding companies are only allowed to use the funding for certain businesses. For example, deposits cannot fund trading, a traditional investment banking activity that is still a key part of Goldman Sachs and Morgan Stanley.
The companies can use the deposits for loans, and corporate lending has become a bigger area of focus for Morgan Stanley and Goldman Sachs. Previously, the business was less financially attractive when the companies did not have low-cost deposits to draw on.
Morgan Stanley has targeted loans for its retail brokerage clients, and the effort has boosted wealth management net interest income to $4.11 billion in 2017, up substantially from $1.48 billion in 2011. The increase has helped Morgan Stanley achieve return on equity goals in the wealth management division.
Goldman Sachs has been trying to build a consumer lending business through its online platform Marcus. The company had not previously offered a consumer-lending product, and Goldman Sachs has been taking a slow approach with the expansion in part because investors have concerns about the company's ability to manage credit risk in the new business, Harte said.
Still, some signs of progress are evident. In 2017, higher net interest income led to Goldman Sachs' investing and lending business reporting $2.00 billion in net revenues from debt securities and loans, a 33% increase from 2016.
Goldman Sachs could make a further push into the consumer business by offering products such as credit cards and more wealth management services, JMP Securities LLC analyst Devin Ryan said.
"I'm actually pretty upbeat about what that could look like over the next five years," he said in an interview.
But while the lending businesses have growth potential, Ryan noted that the main revenue drivers at Morgan Stanley and Goldman Sachs are still their traditional investment banking operations.
"There has definitely been an evolution now that they are banks," Ryan said. "But they are still most dependent on businesses that are more levered to the capital markets."
New rules, new ROE
Just as before the crisis, investment banking and trading are the biggest revenue drivers for Goldman Sachs, and Morgan Stanley is most reliant on those businesses along with wealth management. What has changed is the amount of equity regulators require the companies to hold.
At year-end 2017, Morgan Stanley reported common shareholders' equity of $68.87 billion, more than double the $30.17 billion in common equity the company reported having at the end of November 2007. During the same time, Goldman Sachs' common shareholders' equity also more than doubled to $74.72 billion from $34.86 billion.
The higher capital levels make it more challenging to produce high returns on equity. Morgan Stanley generated an ROE of more than 20% in fiscal year 2006 but is now aiming for the range of 10% to 13%. Goldman Sachs' ROE topped 30% in fiscal years 2006 and 2007, but it produced an annualized ROE of 14.1% through the first half of 2018.
Higher capital levels have also hurt returns at other large U.S. financial institutions such as JPMorgan, BofA and Citi. However, those institutions were bank holding companies before the credit crisis, and the regulation — while more stringent now — has not forced them to venture onto a new strategic course, Vining Sparks' Mosby said.
Goldman Sachs and Morgan Stanley, on the other hand, were subjected to bank regulations for the first time. Playing by a different set of rules has forced them to find new ways to grow, Mosby said.
"The regulatory constraint and environment that they live under is so different that it will begin to dictate the strategic decisions," Mosby said.