The Goldman Sachs Group Inc.’s (GS) third quarter 2010 earnings per share of $2.98 were significantly ahead of the Zacks Consensus Estimate of $2.29. Goldman’s impressive results reflected strong performance in Investment Banking and lowered operating expenses. Though economic conditions were challenging, the company gained from a solid balance sheet.
Net income in the quarter was $1.9 billion, compared with $613 million in the prior quarter and $3.2 billion in the prior-year quarter.
Behind the Headlines
Total revenue of Goldman increased 1% from the prior quarter, but decreased 28% year over year to $8.9 billion. Revenue reported was below the Zacks Consensus Estimate of $9.2 billion, primarily due to lower equity trading. Revenue by business segment is as follows:
Investment Banking generated revenues of $1.12 billion, up 22% from the prior quarter and 24% year over year. Results reflected higher-than-expected revenues from financial advisory business as a result of an increase in client activity and higher revenues from debt underwriting reflecting noteworthy increase in leveraged finance activity. However, these increases were partially offset by lower revenues from equity underwriting due to lower levels of activity.
Trading and Principal Investments generated revenues of $6.38 billion, down 3% from prior quarter and significantly down 36% year over year. Results deteriorated due to a decrease in revenues in equity trading (down 33% year over year) and a decline in Fixed Income, Currency and Commodities (FICC), signifying challenging environment during the reported quarter. Concurrently, Principal investments also declined 20% sequentially and 40% year over year to $754 million, accelerating the shrinkage in revenue.
Asset Management and Securities Services generated revenues of $1.40 billion, up 2% from the prior quarter, but down 3% year over year. While revenues from Asset Management improved, Securities Services slumped 19% due to rigid securities lending spreads.
Operating expenses decreased 18% from $7.39 billion in the prior quarter and 20% from $7.58 billion in the prior-year quarter to $6.09 billion. Expenses declined as a result of lower non-compensation expenses and other expenses during the quarter.
Non-compensation expenses were $2.26 billion, down 24% from the prior quarter, but up 2%. Expenses declined sequentially as a result of lower brokerage, clearing, exchange and distribution fees and lower depreciation and amortization, partially offset by higher professional fees.
Evaluation of Capital
As of September 30, 2010, Goldman’s Tier 1 capital ratio under Basel I was 15.7%, up from 15.2% as of June 30, 2010. Tier 1 common ratio under Basel I was 13.0% as of September 30, 2010, compared with 12.5% as of June 30, 2010. During the reported quarter, ROE on an annualized basis increased to 10.3% from 7.9% reported in the prior quarter.
Goldman’s book value per share improved 3% to $127.08 compared with $123.73 as of June 30, 2010. Tangible book value per share increased 3% to $116.23 from $112.82 as of June 30, 2010.
Assets under management increased by $21 billion to $823 billion in the quarter, due to $34 billion of net appreciation, partially offset by $13 billion of net outflows.
Dividend Update
Goldman declared a dividend of 35 cents per share payable on December 30, 2010 to common shareholders of record as of December 2, 2010.
Performance by Peers
In Goldman’s peer group, JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) reported positive results surpassing the Zacks Consensus Estimates. The impressive results were primarily bolstered by a slowdown in provision for credit losses for both the banks.
Other competitors Morgan Stanley (MS) and Wells Fargo (WFC) will be releasing their third quarter earnings on October 20, 2010.
Our Take
Though most of the major banks had to absorb extraordinary shocks from the recession, Goldman maintained consistent profitability throughout the downturn in the economy. Despite the impact on earnings power from the recent financial reform law and continuing pressure on trading revenues, Goldman is expected to deliver, based on its prudent business model and strong fundamentals.
Fundamentally, we expect the company to benefit from its well managed global franchise, strong capital base and leading position in investment banking, capital markets, trading, and asset management business. Though the new financial regulatory reform will remain a challenge for Goldman’s top line, we believe its proactive measures to strengthen its business model while complying with such regulatory changes is encouraging.
Additionally, following the SEC settlement, we believe that much of the overhang on the stock is removed and along with expectations for an improved operating environment in the upcoming quarters, Goldman is poised to grow in the long term.
Goldman currently retains its Zacks #4 rank, which translates to a short-term Sell rating. However, considering the fundamentals, we are maintaining our Neutral recommendation on the stock.
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