In 2016, the investment banking powerhouse Goldman Sachs (GS +1.72%) launched a consumer banking business that would gather deposits, provide online investing capabilities, and issue personal and credit card loans.
The goal was to diversify Goldman's earnings and make them more durable. While Goldman has a great investment banking business, the earnings can be volatile from year to year, which is why the market doesn't assign the business a high valuation. Consumer banking earnings tend to be more consistent and draw higher multiples from the market.
But about six years after the launch of its consumer business, Goldman is pivoting and taking a big step back from its consumer banking ambitions, which have turned into a bit of a disaster. Here's what went wrong.
Poor financial results
Goldman's consumer banking efforts consist of its various credit card partnerships with Apple and General Motors, point-of-sale financing through its acquisition of GreenSky, and its digital platform, Marcus, which accepts deposits and provides online investing capabilities.
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For many years the business looked promising, significantly building up deposits and growing loans quickly. In September 2021, when tech valuations were near an all-time high, Goldman purchased GreenSky for $2.24 billion, which represented more than a 50% premium over the company's share price.
Between 2020 and 2022, revenue in the consumer business was on pace to triple, but expenses were also piling up from $630 million in 2020 to nearly $1.26 billion through the first nine months of 2022. Additionally, loan losses rose steadily and Goldman had to significantly build its provision for credit losses. In 2022 as credit began to normalize, Goldman's credit card losses underperformed the broader industry and came in higher than its peers.
Between 2020 and the first nine months of 2022, Goldman's consumer banking business reported more than $3 billion in losses. Some of Goldman's bigger investors had never really liked the idea of the consumer business and in the third quarter of 2022, Goldman CEO David Solomon announced the bank would significantly scale back the business and focus on existing customers.
What went wrong
On Goldman's fourth-quarter earnings call, an analyst asked Solomon specifically what went wrong with the consumer banking push. "We tried to do too much too quickly," Solomon answered.
This is a common mistake in banking, especially consumer lending. When banks grow too fast it may mean they're not paying enough attention to underwriting. The fast growth is then followed by fast-growing loan losses as well. In fact, The Wall Street Journal recently reported that the Federal Reserve is investigating Goldman to see if it had the proper controls in place as it grew its consumer business, another hint that the bank was likely growing too quickly.
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Key Data Points
But Solomon also chalked up the disappointing consumer results to a much harsher regulatory environment in recent years that prevented the bank from scaling like it wanted to.
One of those is the current expected credit loss (CECL) accounting methodology that got implemented at the start of 2020 and requires banks to book lifetime losses on loans as soon as they hit the balance sheet. This tends to result in elevated credit provisioning up front, particularly on the consumer lending side.
"I think it became clear to us early in 2022 that we were doing too much, [which] was affecting our execution. I think we probably, in some places, haven't had all the talent that we have needed to execute the way we have wanted," Solomon added.
Regaining credibility
I think banks should be given some leeway to try new things that will improve their earnings and get a higher valuation from the market. I also think it's a good thing that Solomon is looking at the results, listening to investors, and making the decision to pivot instead of trying to keep pushing a strategy that clearly wasn't working.
But I also think that this is going to cost the bank. Not only have significant resources been put into consumer banking efforts over the last roughly six years, but now there could be regulatory matters and management has likely lost credibility.
Goldman Sachs is still Goldman Sachs and has one of the world's premier investment banks and sales and trading businesses, but now management has a much higher bar going forward. It will need to once again win investors over and deliver a new strategy to achieve a higher valuation.
