Friday, November 18, 2016

That Coveted Goldman Partnership

Goldman recently announced its 2016 class of "partners." Is the title still one of the most coveted goals on Wall Street?
Every other year in even years, mid-autumn becomes hush-hush time around the corridors at Goldman Sachs.  That's when the big bank announces its new slate of partners.

A partnership at Goldman has long been a treasured milestone, the culm
ination of a decade or two of hard work and internal accomplishments--at hours of commitment that most workers can't fathom.

Is it still coveted reward? Do prestige, power, and mounds of wealth accompany the promotion in the way it often did through much of the firm's history?

The New York Times reported the recent announcement and elected to focus on the percentage of women in this year's class and assess in any trends.  Of the 84 named, 19 (or 23 percent) were women. Trends show improvement in the numbers, although the increases trickle upward; they don't surge upward. No information was disclosed about under-represented minorities.

Like most banks (commercial, corporate and investment banks), senior bankers are granted the title managing director. At Goldman, a subset of managing directors have partnership privileges.  They are not partners in the company, because Goldman is not a partnership (although it was decades ago).  Managing director-partner is a privileged title.  Those who hold the title are granted, however, a large percentage of shares.

For this new partnership roster, is Goldman the same firm as it was when partners numbered less than a couple of hundred (not the 500-plus today) and when it focused much of its activity on mergers, acquisitions, underwriting and a modest amount of trading?  Is a partnership there still a stepping stone toward the top of Goldman's hierarchy or (as has been in the past) a pathway to a senior, powerful government post?

What is the true Goldman today?

It's now formally classified as a bank holding company, subject to the same supervision and oversight that its new group of peers (like JPMorgan Chase and Citi) must adapt to everyday. It still maintains predictable leads in the league tables that investment bankers care much about (mergers, acquisitions, IPO's, bond underwriting, etc.). And it appears to have a side-table seat and the ears of board members involved in the merger transactions that keep getting bigger and bigger as years go by.

Yet because it's a big bank (a "systemically important" one, in fact) and because it chooses to remain aggressively at the frontlines of sales and trading, it has to confront issues and challenges that JPMorgan and Citi do, issues and challenges its IB boutique peers (Evercore, Moellis, Greenhill, Lazard, e.g.) aren't bothered with.

Addressing many of those issues and challenges often means boosting capital, reducing leverage, stockpiling liquidity, and worrying excessively about stable funding--all while sending its armies of M&A and advisory bankers around the world to advise on the biggest companies on what they should do and how they should finance what they should do.

Peek at recent numbers.

Investment banking is for which Goldman is best known--the merger deal valued in the tens of billions, the advice its teams present to CEO's and board members to buy out another company or defend itself from unwanted suitor, the financing packages they assemble to permit Company A to acquire Company B with debt levels that might cause the unacquainted to faint, and the timetables they lay out to shepherd a Silicon Valley unicorn through its IPO.

The numbers, however, show Goldman--despite restraints from regulators--is still a trading powerhouse.  Trading has been slowed down, even hand-cuffed. Yet Goldman continues to push in that direction, seizing roles and market share where other banks have stepped back. Trading activity (from trading and commissions revenues) contributes about half of all net revenues at the bank. Investment-banking fees, by comparison, comprise less than a quarter.

Still, some would argue the IB tail wags the trading dog. IB polishes the Goldman name and brand.

Critics have lately cited the bank's lagging returns on equity, especially compared to some of its peers. Check the best measurement of ongoing performance:  returns on (book) equity (ROE), the returns the bank generates on behalf of its owners, including the hundreds of partners who run the firm.  ROE for the past two years hovers about 7-8% (including 2016 results)--returns that lag some banks (JPMorgan Chase and Wells Fargo, e.g.) and returns that shove it into a pack of mediocrity.
All big banks struggle to generate decent returns nowadays. Regulators insist on greater and greater levels of capital and also limit leverage and the size of balance sheets.  Furthermore, the Volcker Rule (which prohibits proprietary trading) puts constraints on what Goldman can do well: trade all classes of securities, derivatives and options in most venues and in many countries and manage related risks.

In 2016, the bank is on a pace to generate about $13 billion in trading revenues.  Imagine how much more it could generate if it weren't hampered by the Volcker Rule or didn't have to adhere too closely to capital requirements and leverage limits.

Critics would argue, of course, that restrictions keep Goldman from taking on extraordinary risks that lead to billions in losses. By comparison, Goldman takes on about the same level of trading and derivatives risks (measured by the common market-risk metric "value at risk") as JPMorgan Chase and Citi, but has about a third the amount of capital.  (Goldman could rebut and show it doesn't have the same level of loan and credit risks as JPMorgan and Citi.)

Investment-banking fees (the fees it generates from the Wall Street Journal headline-splashing deals) comprises only 21% of 2016 net revenues for the firm. For decades, the firm has been an elite institution in corporate finance and advisory, and it will continue to attract the talent (and pay the talent) to ensure that it will also be. The brand alone will help keep Goldman in the top 5 in most league tables (barring any embarrassing scandal). But IB fees fluctuate. They rise, fall, come and go, based in part on corporate balance sheets, company shareholders' desperation to grow, and confidence in the economy.

Since the crisis, Goldman is supervised by the Federal Reserve. It is no longer a pure investment bank and broker/dealer. The bank holding company presides over bank, broker/dealer, and asset-management operations.  It can choose to take deposits and make corporate and consumer loans in the way Wells Fargo does.  But it hardly emphasizes loan-making. The loan books of Bank of America, Citi, and JPMorgan Chase are about 20-times greater. (The lending it does is focused almost entirely on corporates, real estate and wealthy individuals and is likely done to accommodate treasured clients on a special-needs basis.)

No need to be sympathetic toward the firm.  Despite less-than-stellar results (or results that might pale in comparison to some of the glory days before the Federal Reserve imposed the new set of rules), the firm will still press on. 

ROE's will touch and occasionally exceed 10%. Risks will be measured and managed.  It will get the first call from corporate clients when they set out to do the biggest deals. It will attract its share of the best talent from top business schools.  Partners will be selected and be compensated at jaw-dropping levels. 

Let's make sure it doesn't forget to include a fair number of women and under-represented minorities at that table.

Tracy Williams

See also:

CFN: How Does Goldman Do It? 2010
CFN: Did Goldman Overpay for its Facebook Stake? 2011
CFN:  Volckerized, 2010
CFN:  Goldman and Work-Life Balance, 2013
CFN:  Goldman and the Greg Smith Letter, 2012

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