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Goldman Sachs (NYSE: GS) Beats Expectations

Shaky Banking Sector

Written by Brian Hicks
Posted April 17, 2013

The ghosts of the pre-financial crisis period have returned to haunt Wall Street, it seems.

Goldman Sachs (NYSE: GS) recently reported a profit increase of 7 percent over Q1, up to $2.26 billion ($4.29/share). Revenue was posted at $10.1 billion.

Despite the fact that these figures exceeded Wall Street’s expectations, Goldman’s shares dropped. According to Goldman, there was ample action going on in the leveraged finance and commercial mortgage areas.

greedy bankerLeveraged finances, or high-risk/high-yield debt finances, are precisely what played a major role in the financial crisis that decimated Wall Street just a few years ago.

The bank’s investing and lending revenue of $2.1 billion is 8 percent higher than figures of a year ago. However, Q1 returns on equity dropped to 12.4 percent despite these increases in overall profits and earnings.

Return on equity is usually seen as a metric of how successful a banking institution is in giving capital back to its shareholders. For comparison’s sake, Goldman Sachs typically posted returns on equity in excess of 20 percent annually before the financial crisis.

Moreover, CNN reports that CEO Harvey Schwartz refused to answer some fairly standard questions (such as the bank’s target for its next return on equity) during the conference call for Goldman’s earnings report. No doubt, that has increased investors' trepidation regarding the company.

As far as next quarter is concerned, Goldman Sachs’ investment banking revenues may decline somewhat due to the fact that its transaction backlog is lower than in the quarter just past. While expenses have dropped overall by about 1 percent, they're still 36 percent higher than levels in the past quarter.

Meanwhile, the bank’s level of $4.34 billion for compensations remains fixed despite an institution-wide staffing decrease of 1 percent.

Equities Problem Spreads

In general, Wall Street has seen revenue from equities trading decline over recent years. Mostly, the expansion of online trading platforms has been a key factor here.

However, that problem is now spreading to fixed-income, currency, and commodities businesses. Goldman’s revenue from trading bonds with clients saw a decline of almost 7 percent—something that caused plenty of questions at the conference call regarding the institution’s vision for ramping up future trading revenue.

Primarily, it appears Goldman Sachs would be looking to snatch market share from other banks that may be turning increasingly skittish when it comes to bond trading (per Reuters).

What’s worrying investors the most appears to be the strange mixture of anemic customer trading revenue and institutional bravado when it comes to Goldman’s own money. Such high-risk/high-reward behavior was rather typical of institutions like Goldman Sachs (and indeed Goldman Sachs itself) prior to the crash, and it was largely seen as having created a toxic financial atmosphere.

Meanwhile, more and more trades continue to be cleared centrally or occur via an exchange (instead of the previous convention between a bank and a client). As a result, banks are being gradually pushed out of their middleman position between clients, Reuters reports. Witness Goldman’s drops in revenue from fixed-income, currency, and commodities: down to $3.22 billion from 2012’s $3.46 billion.

Despite a 15 percent drop in equities trading, it’s this decline in fixed-income trading that is far more worrisome due to its larger size.

In fact, the problem is so acute that some banks (UBS, for example) have withdrawn from the fixed-income, currencies, and commodities trading businesses. That could actually work in Goldman Sachs’ favor, since it means less competition on the market (though that still really isn’t an ideal situation).

Shares for Goldman Sachs dropped to $144.10 as of 4:15PM in New York on Tuesday (a drop of 1.6 percent). That’s also the second-largest such drop among all the companies listed on the S&P 500 Index, Bloomberg reports.

Interestingly, CEO Schwartz blamed the Cyprus chaos in part, suggesting that trading and banking activity overall had paled in light of the troubles taking place over there. Certainly those issues did create uncertainties in the market, but Citigroup (NYSE: C) in its own results report stated that fixed-income trading had actually risen 69 percent from Q4 (healthily beating expectations). Meanwhile, JPMorgan (NYSE: JPM) reported trading revenue drops of 5 percent.

At any rate, at least Warren Buffett sees Goldman Sachs favorably. Last month, Berkshire Hathaway (NYSE: BRK.A) completed an agreement with the institution under which it can buy 43.5 million Goldman Sachs common shares for $115 each until October 1.

This deal relates to settling warrants that were granted during the 2008 financial crisis

 

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