Merchant banking: Goldman Sachs's $2.7bn question

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But if Congress does act, Goldman Sachs has the most to lose among big banks, according to one high-profile analyst.

Evercore ISI’s Glenn Schorr says the revenue at risk for Goldman runs between $ 115 million and $ 2.7 billion. The wide range contemplates everything from a narrow ban on physical commodities activities to a blanket ban on balance-sheet investments. Goldman has remained a bigger player in both areas than rivals, many of which have retreated from such capital-intensive businesses since the financial crisis.

About one-quarter of Goldman’s roughly $ 100 billion investment book is equity, according to a November 2015 presentation, and much of that could land in the crosshairs. Most of it is in private companies, which carry higher risks than publicly traded stocks. Goldman has been an active investor in early-stage technology companies including Uber Technologies, Pinterest and Dropbox.

Goldman’s investing and lending segment, which includes its merchant banking equity stakes and a much larger loan book, has earned $ 1.2 billion this year through the second quarter.

Schorr doesn’t expect anything near-term, and many industry experts said the Fed’s report seemed more a political message than a deeply held policy position.

But finance seems to have few friends in Washington. Both presidential candidates have criticised the industry, and a return to Glass-Steagall’s separation of commercial and investment banking activities appears on both party platforms.

“The anti-Wall Street rhetoric feels like it is at all-time highs so it wouldn’t be out of the question this would be on the to-do list of Congress,” Schorr writes.

Should Congress act, two key questions determine how big a hit Goldman and others, to a lesser extent, take.

One is how broadly regulators or lawmakers define non-financial companies. Upstart financial-technology firms often straddle the line, selling software and services to a broad array of customers. Uber facilitates electronic payments to taxi drivers, but is it a financial company? Probably not. The intersection of finance and big data, also an area in which Goldman has invested, is murky, too.

The second question is whether Congress would also simultaneously tackle a provision in a separate piece of bank legislation, the Bank Holding Company Act, that allows regulated banks to own stakes of less than 5% in non-financial companies. The Fed hasn’t recommended any change here, so status quo may prevail. If so, many of Goldman’s smaller merchant banking bets might be allowed to continue.

Expect the industry to fight if rule changes to this business approach reality. Merchant banking has been hugely profitable. It’s also an important source of business generation and intelligence gathering, helping investment bankers keep abreast of the market and get their hooks early into a future unicorn. And bankers say it’s a key source of capital for companies that don’t want to, or can’t, take on debt.

What’s more, banks can argue that merchant investments, even bad ones, rarely do much damage. Goldman, for example, owned a stake in Energy Future Holdings, the Texas utility that went bankrupt, yet the fund in which the investment sat is expected to be profitable, WSJ has reported.

This article was published by The Wall Street Journal’s MoneyBeat blog

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