Update: GS, MS, SCHW, RJF & SF

June 21, 2023 | Premium Service | The segment of the banking world that we refer to as “asset gatherers" is predominantly involved in the investment advisory world, either facilitating investment or acting as advisor and dealer in the global capital markets. The group starts at the top with UBS Group AG (UBS), then goes to Morgan Stanley (MS), Goldman Sachs (GS) and Charles Schwab (SCHW), and ends with Raymond James Financial (RJF) and Stifel Financial (SF).

Most of the group is up over the past year with the notable exception of SCHW, which we profiled earlier in the year (“Update: Charles Schwab (SCHW); Sagent Presentation”). The chart below shows the huge decline on SCHW in March, which has since moved sideways. If you agree with our view that the short-selling of the stock was mistaken, then the discount for SCHW is unwarranted.

Source: Google

Readers of The IRA are aware of the auction of a non-agency servicer owned by Credit Suisse, SPS, a sale process that apparently failed for a second time last month. It will take years for UBS to work through the issues it has acquired in CS, including a portfolio of money losing mortgage businesses in the US that nobody seems to want. CS/UBS was just sued by a group of bond holders in the Eastern District of New York. The case is Star Colbert v. Dougan, 23-cv-04582, US District Court, Eastern District of New York (Brooklyn).

The first test for our group is net credit losses and as you’d expect, SF and SCHW have loss rates around zero because the banks take little principal risk. Next is Morgan Stanley and RJF and then the average of the 140 banks in Peer Group 1. Well about the rest is GS, which reported over 40bp in net losses in Q1 2023 or a “BBB” bond equivalent. Citigroup (C), by comparison, reported 77bp of net credit losses in the first quarter. GS is really in the wrong neighborhood of credit compared with MS and SCHW. But this is nothing new.

Source: FFIEC

The volatility visible in the GS credit performance is just the beginning of a story that features striking volatility in assets and income. For example, in Q1 2023 GS reported a gross spread on loans and leases of 9.6% – 500bp above the level reported at year-end 2022. Of note, the income and revenue figures for Q1 do not show nearly this degree of volatility, but the payoff for Goldman may lie ahead in Q2. We’ll see.

Source: FFIEC

The sheer movement illustrated by the GS spread data is remarkable, but the public market valuation for GS not compelling. Back in Q1 2023, a lot of people were hyperventilating about Charles Schwab, but we said no big deal. SCHW has continued to shrink its bank unit, now down to just $535 billion in balance sheet assets or the 10th largest bank in the US. At the end of Q1 2023, SCHW still had among the lowest cost of funds in the industry at 0.88% vs average assets compared with 1.52% for Peer Group 1 and over 3.5% for GS and MS.

Source: FFIEC

Notice that the cost of funds for MS and GS rose by hundreds of percent year-over-year, but we think that funding costs could double again in Q2 2023. Recalling that there were only a couple of weeks in March following the collapse of Silicon Valley Bank, the impact on funding was relatively muted. The increase in deposit rates during the full period of Q2 2023 could see some of the largest increases in bank funding costs in recent memory.

When we look at the bottom line, the two smallest members of the group, Raymond James and Stifel, turn out to be the best performers looking at income vs average assets. Going back five years, the returns from the broker dealer have driven earnings for both of these banks.

Source: FFIEC

Notice that the asset returns for GS are the worst in the group, but the smaller players lead the pack. RJF, for example, did $9 billion in non-interest income in 2022 vs $1.6 billion in net interest income. Stifel was more than 2:1 fee income vs interest earnings. SCHW, on the other hand, still made more money on interest than fees, but not by much.

The announcement last month by James Gorman that he will step down as CEO of Morgan Stanley sets a well-earned victory lap. MS generates 4x the fee revenue vs income from the group's two banks. All of the key performance metrics place MS dead center of Peer Group 1 in terms of financial performance. The major criticism is the relatively higher overhead expenses, as shown in the table below. Notice that JPMorgan (JPM) has the best efficiency in the group.

Source: FFIEC

You could argue that SCHW is the most undervalued name in the group given the strong funding and profits. It is down small for the past year, yet still trades at a much higher multiple to book value than the rest of the group. We expect that SCHW will continue to run down the size of the bank and that the investment business will predominate in the future.

Source: Bloomberg (06/20/2023)

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