Goldman Sachs (NYSE:GS) recently reported its second-quarter earnings, and to put it mildly, the results were impressive. In addition to strong investment banking and wealth management performance, Goldman's young consumer banking unit is turning into a significant revenue source.
A full transcript follows the video.
This video was recorded on July 23, 2018.
Michael Douglass: Goldman Sachs. What a bumper earnings report. Profits up 40% year over year, revenue growth of 19%. 19% year over year! That's not something you would expect for any company the size of a Goldman Sachs.
Matt Frankel: No. Actually, 19% revenue growth was the best out of the Big Four and the two we're covering today, by a significant margin, too. That's really impressive. That means, unlike most of the big banks, the bulk of the profit growth wasn't just from tax reform. I mean, that definitely helped, it pushed Goldman's return on equity up to over 14%, which was the bank's highest in over nine years. I think that's the highest since the middle of the financial crisis, when Goldman was producing a ton of trading revenue.
Goldman's results were pretty great all around. Investment banking revenue was up 18%. Really strong underwriting results. They said, "significantly higher backlog compared to the first quarter," so you can expect the revenue growth to carry into the third quarter and beyond. They achieved the top market share for M&A activity, equity underwriting, IPO underwriting. Investment management revenue looked great. It was up 20% year over year. Their assets under supervision actually grew by $15 billion, despite a slight market value decline, which means money is flowing in despite so-so market performance, which is always a great sign for an investment bank.
My favorite reason to like Goldman is their Investing and Lending segment, which includes their Marcus consumer banking platform. Revenue soared by 23% year over year, a 67% increase in revenue related directly to the interest income they're receiving from Marcus. That's a big deal.
The only thing that wasn't great was, trading revenue was just OK. Trading revenue is a big deal for investment banks, as we'll get into in the second half of the show. But while other banks with big investment banking presences like JPMorgan Chase and Morgan Stanley blew expectations away on trading revenue, Goldman just did what was expected. That was one weak point.
But, all in all, Goldman Sachs had a really strong quarter.
Douglass: Yeah, they did. Let's actually jump into Marcus a little bit more. A couple of things I want to highlight here. First off, Goldman's CFO on the call reported that they've originated over $4 billion in consumer loans at Marcus at this point, and they're holding $3.1 billion of those loans on their balance sheet, as of June 30. They're lending, it's scaling pretty rapidly, and these are loans that they're pretty comfortable holding on their balance sheet. Additionally, their retail deposits, I'm quoting here, grew to over $23 billion. That's an enormous amount of deposit activity for a bank that historically hasn't been that involved in deposits. That's a real sign that this digital banking initiative is working well for Goldman.
Of course, the flip side of that is, now a lot of other folks are looking to get involved. Citigroup has started making noise about it, JPM as well. There's a lot of interest, and other folks building increasingly strong digital presences to try to combat Marcus' success.
Goldman's stance on this is essentially, "Listen, even with a relatively small market share long-term," not that they're predicting that, but it's certainly possible. Competitive, online, we all get it, it may in fact be that they aren't a massive winner long-term. But even with a relatively small market share across, it can still meaningfully move their business forward. They believe that they can maintain some differentiation with all they're doing to develop the tech back end, and because they aren't as tethered to some of the older ways of doing things that the universal banks largely are. So, that can be a long-term benefit to Marcus.
Frankel: It's also interesting to point out that Goldman is not stopping with just personal loans and savings accounts. They did a presentation about a month ago where they mentioned areas like mortgages, credit cards, auto loans, checking accounts, things that traditionally have not been in their wheelhouse that they're planning on jumping into. We recently learned that they're going to be Apple's co-branding credit card partner. I don't know of a bigger way to make an instant impact in the credit card space than to partner with a company like Apple.
So, when Goldman is getting into this consumer banking business, they're jumping in really strong. They're not just tiptoeing in the water. They're jumping into this full-force. If they actually do add mortgages, auto loans, and other things like that -- they also mentioned insurance, for example, for consumers -- they could really produce some serious revenue if they're successful.
Douglass: Insurance is a huge opportunity. It's interesting, one of the things they're trying to do is test doing some lending to folks with somewhat lower FICO scores. Think your 630-660 range. They call this "deliberate testing." It represents less than 5% of originations. But they're trying to go a little further down on the credit ladder to see what things look like down there.
To be clear, overall portfolio quality through Marcus is very strong. Average FICO score is over 700, so I think we can feel pretty good that this is intentional, thoughtful risk that they're taking on.
But I will say, it does make me a little bit nervous. This consumer lending historically has been something that the banks haven't been that involved in. Particularly given that Goldman doesn't have that much experience in this particular area, I'm a little bit nervous that this might be chasing yield, and that when the credit cycle turns -- as it inevitably will one day -- that could become a real problem for them.
Frankel: I agree with that. That makes me nervous. On one hand, I don't want to question Goldman's ability to manage risk, because they've done that very, very well for a very long time. But as Michael just said, this is a new area for the bank. Traditionally, their clients, institutional investors and high-net-worth investors, are not low FICO score risk. This is definitely a new area for them that is worth watching.
Douglass: Yeah. Just to sum up their quarter and where things stand, it's very clear that they're investing very heavily in the digital bank. Certainly, their acquisition of the Clarity Money app is also part of that move to make this as robust an online offering as possible. I think it puts them in place, long-term, to compete with your Mints and the online financial hacking softwares and apps that have really seized a lot of people's interest and have done a lot to democratize banking.
Then, of course, the quarter itself, pretty darn good. Sure, trading was a little bit disappointing, but consumer banking looks pretty darn huge. Of course, valuation, Matt, you and I have talked about this before, is pretty attractive.
Frankel: Absolutely. Goldman is trading for right around 1.2X book, which is less than all of the Big Four banks except Citigroup. And, Goldman has significantly underperformed the banking sector in 2018. So, Goldman is trading like a pretty cheap bank right now. If you think that consumer banking especially is going to be a big future catalyst, then Goldman looks like a pretty compelling value right now.
Douglass: Yeah, and that's not something I say lightly with one of the big banks.
Matthew Frankel owns shares of AAPL. Michael Douglass owns shares of AAPL. The Motley Fool owns shares of and recommends AAPL. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.