We recently saw first-quarter results from investment banking giants Goldman Sachs (GS +1.15%) and Morgan Stanley (MS +1.53%). Not only did both banks beat expectations on the top and bottom lines, but there are several other reasons for investors to smile.
A full transcript follows the video.
This video was recorded on April 23, 2018.
Michael Douglass: Let's go ahead and turn to our second story. Rounding out the remainder of big bank earnings, Morgan Stanley and Goldman Sachs, the investment banks. Frankly, both had pretty strong results.
Matt Frankel: Yeah. In last week's episode, we said how the Big Four banks all beat on earnings and revenue, the first time in a while I've seen all of them. Now it's a six-for-six, because Goldman and Morgan Stanley also both beat on the top and bottom lines, and by a pretty significant margin. The big headline that we saw was trading revenue. If you read anything about their earnings, you probably heard about trading revenue, because it's just been so terrible the past few quarters. And now, especially in these two cases, it's gone up a whole lot.
Douglass: And what's interesting about that to me -- and, of course, first off, that it's a major headline, not surprising. These are investment banks. Trading revenue is a big portion of things for them, so of course it's going to get brought up, just like the iPhone is going to get brought up whenever you're talking about Apple. OK, it's not quite as big for them as the iPhone is for Apple, but you get the idea. But, what was interesting to me is, their fixed income and the commodities and currency revenue was up really quite a lot. Morgan Stanley's was up 12%. Goldman Sachs' was up 23%. It's interesting, because when you look at the other large banks, they didn't perform nearly as well on the fixed income side of their trading revenue.
Frankel: No, not at all, they were actually pretty flat in most cases.
Douglass: That's one of the interesting things that you always want to look at when you're looking at the big banks -- why are a couple of them doing much better than the others in a particular area?
Frankel: Goldman and Morgan Stanley both had terrible performance, even relative to the other banks with trading desks, for the past year or so. I think Goldman's last quarter was down 50% while everyone else's was down in the 20-30% range. So, it could just mean more of a rebound from terrible numbers. Goldman and Morgan Stanley both said that it was commodities and foreign currency trading that really fueled their results, so, it could have something to do with those two being more levered to that.
It could also be that, as Michael said, Goldman and Morgan Stanley are investment banks, so they depend a whole lot more on trading revenue than, say, a Bank of America does, so are willing to drive more of their resources in that direction to try to right the ship. So, there are a few different things it could be, but the gain in Goldman and Morgan's trading revenue is definitely much more impressive than the rest of the pack.
Douglass: Yeah. So, certainly an important thing to watch going forward, again, probably in part because of a weak comp. But, we'll see how that plays out over the next few quarters, especially as volatility has been up. Anyone invested in the stock market right now has probably noticed that.
Let's talk about the rest of their businesses as well. Both, really across the board, doing quite well. Asset management, wealth management portfolios looking strong. You've got good, strong inflows, so it's not just a matter of being up 20% because stocks were up 20%. It's more like, up 20% while stocks were up a lower percentage because adding new clients and getting clients to commit more resources to their current accounts.
Frankel: Yeah, definitely. Tax reform was also a big, big driver of the good performance. Goldman's effective tax rate was down to about 17%. Morgan Stanley was right around 21%. Generally, banks run in the upper 20s to 30% range. So, as a result, both of them had much higher profitability than they normally do. They both had returns on equity of close to 15%. Goldman's was actually a little bit over. And tax reform or no tax reform, if a bank is generating a 15% return on equity, they're doing something right. That's a pretty impressive number.
Douglass: Yes, absolutely. Just, across the board, things looking impressive. One of the other things that you'll often see with the banks is, they'll juice profitability by cutting expenses. You can think about expense cutting in two ways, and it really does depend on exactly what expenses they're cutting, which they're never very clear about. But, expense cutting can either be, "OK, cool, we're cutting out bloat," or it's, "We're trimming muscle and heading down toward the bone because we're trying to hit," perhaps, an arbitrary number. So, cuts can be a good thing or a bad thing, depending on those nuances.
But, in both cases, a lot of reinvestment in the business. So, a lot of potentially good news there, particularly, I would say, in Goldman with their Marcus platform. Longtime listeners, or, well, listeners who have been listening for more than a couple of months, have heard us talk about Marcus before, but it's basically Goldman's consumer lending platform. So, just the sort of thing that's marketed online and they'll source loans through it. And they're up to $3 billion in loans originated now, which is just enormous growth. So, a lot of good news for Goldman there.
Frankel: I've followed Marcus a lot, especially in the beginning. They have a real leg up on their competition, because they're devoting a whole lot of resources to it, and Goldman has a lot more resources to throw at it than, say, a LendingClub or one of those. And they're not really worried about making money on it yet. They offer a savings account through the Marcus platform that pays higher interest. I just saw this morning 1.6%, which is pretty much unmatched anywhere else, so they're stealing some market share with that. And they got to the $1 billion mark quicker than anyone else, and I'd be willing to bet that the $3 billion origination mark is also quicker than anyone else got there.
They also just acquired Clarity Money, an app designed to help people manage their money. That should help fuel their growth even more. Goldman looks more and more serious about getting into consumer banking, is the takeaway I get from this Marcus news.
Douglass: It's interesting, because, when we talked about disruptors to the big banks -- and thanks, by the way, to the folks who wrote in to get that transcript and head back to that episode. We're certainly happy to provide that for anyone who is looking for more background and a thoughtful commentary on what's going on in banking writ large. But, the fact is, I think one of the best opportunities for these big banks to really be competitive long-term is to create the one-stop-shop, an easy, as-frictionless-as-possible experience that's primarily online, where people can put all of their stuff, all their different accounts, all the different ways that they are making money and are trying to save money, preferably juiced with some good ideas from the bank, into one app, one place, one shop to rule them all, if you will.
And it looks increasingly like Goldman is trying to get into that game, because that's really what Clarity Money does. I think the problem that a lot of folks have seen when they've worked with a Mint or a Clarity or some of these apps online is that they get most of the way there, but there are just some things that don't quite compute well. So, this is a really good opportunity for Goldman, if they can be patient, keep it free for a long time, and really build the perfect product.
Of course, that requires a long-term mindset, which, frankly, publicly traded companies often struggle with. And this, to my mind, is a real test of whether management can execute something well here, because if they can, then Goldman is really very well-positioned to compete online for a long time hence.
Frankel: Yeah. If I were one of the smaller peer-to-peer lenders, I would be very worried about where Goldman's taking this.
Douglass: Yes, absolutely.
