Goldman 10% Return Tied to CEO Pay Too Low for InvestorsMichael J. Moore
Goldman Sachs Group Inc. investors want a target for annual returns -- as long as it’s higher than the one that pays a bonus to Chief Executive Officer Lloyd C. Blankfein and his top deputies.
With the New York-based firm set to report a fourth straight year of lower profitability than it had in the decade before the financial crisis, shareholders are waiting for Goldman Sachs to end its status as the only major investment bank that won’t declare a public profitability target. The company’s board of directors set a 10 percent return-on-equity target for top executives to earn their long-term bonuses, a level that even Blankfein has called “hardly aspirational.”
While the lack of a target hasn’t prevented Goldman Sachs’s stock from almost doubling in the past two years, executives have been asked for a goal by analysts and investors during six of the last seven earnings calls and conference presentations. The most recent request came after third-quarter trading revenue dropped the most among the nine largest global investment banks.
“It does come up a lot with investors, how long do they have?” said Roger Freeman, a Barclays Plc analyst in New York. “It’s a question of time -- whether the environment for dealers gets better fast enough to avoid being in a difficult position of having to put a target out there that’s meaningfully higher than where they’re at.”
After posting a return on equity of more than 30 percent before the financial crisis, Goldman Sachs has struggled to reach 10 percent in the past three years. Still, investors want the firm to aim higher than that, said Keith Davis, an analyst at Farr, Miller & Washington LLC in Washington, which manages more than $1 billion, including shares of Goldman Sachs.
“I don’t think that is a target that management would want to put forth for investors,” Davis said. “It would almost certainly be received negatively.”
From its initial public offering in 1999 through 2007, Goldman Sachs had a public long-term goal of a 20 percent return on tangible equity, a subset of equity that excludes assets such as goodwill. That was equivalent to a return on equity in 2007 of about 17 percent. The bank met or topped that target in seven of the nine years. Profitability peaked in 2006, when return on tangible equity was 40 percent and return on equity 33 percent.
Returns at the fifth-largest U.S. bank have fallen since then as revenue across the industry dipped and regulators required banks to fund more of their business with equity capital generated from selling stock or retaining earnings. That prompted Goldman Sachs to double its equity from 2006 levels.
The bank reported a return on equity of 10.4 percent in the first nine months of last year, after earning 10.7 percent in 2012 and 3.7 percent in 2011. That compares with 8 percent for JPMorgan Chase & Co. in the first three quarters of 2013, 7.8 percent for Citigroup Inc. and 6 percent for Morgan Stanley.
Goldman Sachs’s superior returns helped drive its shares to the highest premium over book value of the five largest Wall Street banks. The firm’s shares fell 1 percent to $176.58 at 2:23 p.m. in New York, after climbing 39 percent in 2013.
The full-year return on equity probably will be 10.4 percent, according to the average of estimates by 15 analysts surveyed by Bloomberg. The company reports fourth-quarter and full-year earnings on Jan. 16. Michael DuVally, a spokesman for Goldman Sachs, declined to comment.
Analysts aren’t optimistic about the bank’s profitability. Keith Horowitz at Citigroup in New York estimates that return on equity will remain below 12 percent through 2016, and Brad Hintz at Sanford C. Bernstein & Co. predicts that new rules will probably keep it from surpassing 15 percent again.
Blankfein and then-Chief Financial Officer David Viniar said in 2009 and 2010 that it was too soon after the financial crisis to say whether they would change the 20 percent target. In June 2011, President Gary Cohn said the firm couldn’t forecast return on equity in the current environment and would provide a goal when management had greater clarity on new regulations including international capital requirements and the Volcker Rule, which curbs proprietary trading.
Blankfein and CFO Harvey Schwartz said last year that the regulatory environment was still too uncertain to set a target. Regulators didn’t adopt a final version of the Volcker Rule until last month, more than three years after it was included in the Dodd-Frank Act.
“Most investors prefer clarity over uncertainty,” said Christopher Lee, a money manager focused on financial firms at Boston-based Fidelity Investments, the second-biggest mutual-fund company. “In the absence of having explicit targets, whether you believe them or not, it can in general be an overhang.”
Lee said he understands why Goldman Sachs isn’t quick to set a target amid the uncertainty over new regulations and reshaped trading businesses. While investors aren’t discounting current returns, they also aren’t giving the firm credit for any expected future improvement, he said.
“It seems investors in some ways are in a similar type of wait-and-see mode,” he said.
The one place investors can find a stated target is in the bank’s annual proxy filing, where it lays out what executives must achieve to earn long-term performance bonuses. Half of those awards, which have been set at a total of $15 million for Blankfein over the past three years, are based on the firm’s return on equity in a three-year period. The other half is based on increasing book value per share.
The board set targets that award the full amount if the firm earns a 10 percent return, company filings show. The award rises as returns climb above 10 percent and tops out at 1.5 times the stated value if they reach 15 percent. The first awards were set to pay out based on performance ending in 2013 until the board decided in December 2012 to extend the period another five years, according to a regulatory filing.
While 10 percent is a fine short-term target, the market reaction would be “very negative” if Goldman Sachs made that its long-term goal, said Charles Peabody, an analyst at Portales Partners LLC in New York. Investors expect a minimum of 15 percent as the firm’s long-term aspiration, he said.
“I’d be shocked if they publicly accepted” 10 percent, Peabody said. “I can understand them saying that for bonus purposes, because everyone sets their hurdles at rates that ensure compensation of some magnitude, but I can’t imagine shareholders would accept that as a reasonable return.”
Goldman Sachs’s minimum of 10 percent return on equity to pay executives the full amount of their bonuses puts the firm in line with Morgan Stanley, which has made that its target both for shareholders and bonus calculations. Morgan Stanley pays 1.5 times the bonus with any return on equity of 12 percent or more, a lower threshold than at Goldman Sachs.
Other banks set thresholds for executive bonuses at lower levels than their public targets. Bank of America Corp. and Citigroup calculate bonuses based on return-on-asset targets. The equivalent returns on tangible equity, based on the firms’ latest asset-to-equity ratios, were about 11.8 percent and 9.8 percent, respectively, according to data compiled by Bloomberg.
Bank of America posted a return on tangible equity of 6.4 percent in the first nine months of 2013, less than half the 14 percent goal set by the Charlotte, North Carolina-based bank. JPMorgan targets a 16 percent return on tangible equity for the firm, while Citigroup maintains a 10 percent goal.
Goldman Sachs executives are wary of setting a target that can be derailed by circumstances outside their control after watching competitors post returns well short of their goals, said a person familiar with their thinking.
Morgan Stanley has improved from 5 percent return on equity in 2012 to 6 percent in the first nine months of 2012, excluding some accounting charges. CEO James Gorman, 55, said achieving the firm’s 10 percent goal this year will depend on regulators allowing the New York-based bank to return a “reasonable” amount of capital to shareholders.
Barclays, which posted a return on equity of 3.1 percent for the first nine months of 2013, pushed back by one year to 2016 its goal of topping its cost of equity as the London-based bank raised capital to comply with new leverage ratios.
UBS AG, Switzerland’s largest lender, said in October that its goal of reaching 15 percent by 2015 would be delayed a year because of higher capital requirements imposed by Swiss regulators. The Zurich-based firm reported a 6.4 percent return on equity for the first three quarters of last year.
Deutsche Bank AG, Germany’s biggest lender, plans to reach 12 percent by 2015, up from 4.8 percent in the first nine months of 2013. Credit Suisse Group AG, based in Zurich, said it would boost its 11 percent return on equity to 15 percent, without providing a time frame.
Goldman Sachs’s top managers probably want to be within a few percentage points of whatever target they lay out before they make it public, Freeman, the Barclays analyst, said. Still, if 2014 threatens to be a fifth straight year below 12 percent, investors may demand some goal, he said.
“They probably get the benefit of the doubt because of their long-term track record of strong relative performance,” Freeman said. “But more quarters where they’re perceived to not be doing as well as either they’re expected or versus peers, the pressure builds.”
Fewer than 30 percent of analysts covering Goldman Sachs recommended buying the stock in each of the past two months, the lowest figure in a decade, according to data compiled by Bloomberg. Shares climbed more than 38 percent in each of the past two years, rising to the highest level since 2010.
“They’ve trained their investor base pretty well to expect outperformance, but in trade you’re not going to get the stability and the transparency like from other banks,” said Davis of Farr, Miller & Washington.
Blankfein, 59, said in November that the firm is focused on earning 10 percent, which satisfies the goals in his long-term award. That’s also the estimate many investors have used as the bank’s cost of equity, or the minimum return shareholders are willing to accept given the risk.
“People throw out that number, 10 percent, I happen to think that’s a pretty high number given that the risk-free rate of return is zero,” Blankfein said at a conference in New York in November. “But the market seems to have focused on that, so we’ve kind of focused on that number. Not for the long-term, but for this part of the cycle, I think that looks OK.”
At an investor conference hosted by Bank of America in November, Michael Carrier, a Bank of America analyst, polled the audience on what Goldman Sachs’s return on equity would be from 2014 to 2016. More than 80 percent of the people predicted it would be between 10 percent and 14 percent.
“We’re doing this by survey?” Blankfein asked, as the investors punched in their answers.
“Yeah,” Carrier answered, “unless you know.”