Goldman Reports First Loss since IPO
Posted on: December 22, 2008 - Email Article - Printable Version
Last week, investors anxiously awaited earnings announcements from both banking giants Goldman Sachs [GS: 176.19, +2.66 (+1.53%)] and Morgan Stanley [MS: 30.31, +0.67 (+2.26%)]. These reports gave Wall Street a good look at the progress of both companies in their transformation from investment banks to commercial banks. Goldman Sachs and Morgan Stanley gained 19.18% and 11.55% on the week as the financial sector rallied a mere 2.72%. One thing is certain from both of their announcements, it will take a long time for both companies to successfully transform their businesses to deposit taking, de-leveraged and well-capitalized banks.
First, let’s start with Goldman Sachs. Goldman reported there first loss since going public in 1999. They proved themselves to be the most profitable Wall Street Firm, and climbed to the top of many of the industry’s league tables… beating out behemoths such as Bank of America [BAC: 17.03, +0.18 (+1.07%)], J.P. Morgan [JPM: 43.24, +0.17 (+0.39%)] and Citigroup [C: 4.05, +0.16 (+4.11%)]. 
Although they were arguably the best firm on Wall Street, Goldman showed that after a year of the financial crisis, their earnings were not completely immune. They reported a loss of $4.97 a share with negative net revenues of $1.6 billion in their fiscal 4th quarter, which ended on November 28th. This compares to a profit of $7.01 a share, or $3.22 billion, just a year earlier. For their 2008 fiscal year, they were still able to record a gain of $4.47 a share, or $2.32 billion, and a return on equity (ROE) of 4.9%. This is much better than their peers, who are struggling to return to profitability… or even survive.
A majority of Goldman’s losses can be attributed to their FICC and Principal Investments divisions as they were hit with severe market declines in both equity and credit assets. The FICC trading division, which used to generate about 60% of Goldman’s earnings, fell hard this quarter as they took $1.7 billion in marks on an undisclosed investment portfolio. This would represent about a 10% write-down on the group’s roughly $20 billion in assets. The principal investment division recorded a $3.86 billion net loss for 2008. These losses in the group were $2.53 billion from corporate principal investment, approximately $1 billion from real estate principal investments and approximately $0.5 billion from Goldman’s investment in the Industrial and Commercial Bank of China.
Although results were worse than the consensus loss of $3.14 according to FactSet, they still provided crucial information that eased investor’s concerns, at least for now. Their leverage has been reduced to about 14x from a high of over 23x. This balance sheet reduction is a huge success for Goldman’s management as they have worked hard to transition the bank away from risk.
In Goldman’s 4th quarter earnings press release, Lloyd Blankfein stated:
“Our results for the fourth quarter reflect extraordinarily difficult operating conditions, including a sharp decline in values across virtually every asset class. While our quarterly performance obviously didn’t meet our expectations, Goldman Sachs remained profitable during one of the most challenging years in our industry’s history. Our deep and global client franchise, experienced and talented people and strong balance sheet position our firm well for the year ahead.”
Negative news surrounds Goldman Sachs, as Moody’s chose to downgrade their long-term senior debt to A1 from Aa3. This rating downgrade excludes FDIC guaranteed debt. Moody’s downgraded their debt because of increased vulnerabilities of the firm due to the credit crisis, likelihood of increased structural subordination for Goldman’s creditors, and a difficult operating environment. S&P also lowered Goldman’s credit rating, along with other banks such as UBS [UBS: 15.74, +0.29 (+1.88%)], Deutsche Bank [DB: 74.60, +2.42 (+3.35%)] and Morgan Stanley [MS: 30.31, +0.67 (+2.26%)], to A from AA-… but kept a negative outlook on the rating. 
These rating downgrades won’t affect Goldman in the near term though, as the FDIC has pledged to guarantee newly issued bank debt. Issues surrounding the downgrade include the potential liquidity of Goldman. S&P and Moody’s re-affirmed that Goldman is adequately capitalized now, but with further deterioration in the markets, no one is safe. Goldman has been quick to raise capital when necessary. In an article I wrote back in December, “Goldman Sachs, A Great Deal for Buffet”, I outlined the terms of the deal where Warren Buffet’s Berkshire Hathaway [[BRK.A]] investment in the praised Wall Street Firm.
Investors have been keeping a close eye on Goldman to see how they will gain deposits under their new “bank holding” status. There are three ways for a bank to gain new capital: issue new equity, raise debt, or gain deposits. The cheapest of these options is to gain deposits. Deposits are a cheap way for banks to fund their business because they pay virtually nothing to their customers, only have to keep a fraction of the deposits in cash like securities as reserve requirements, and can lend or trade against the excess reserves that they have on their books. Goldman’s management has stated many times that even though they have over $30 billion in cash and cash equivalents, they are not looking for a large acquisition or merger to gain deposits. Rather they will target their high net worth clients through depository assets like certificate of deposits, or CD’s. They haven’t ruled out picking up smaller regional banks to “kick-start” their deposit conquest, but I think you will see them targeting their own clients first.
Goldman is still “best of breed” in the industry due to their top talent retention and network of Goldman alumni. I think that this turmoil in the financial markets will allow them to make their businesses leaner and their financial strength has given them tremendous market share from their competitors and failed institutions, in many businesses. Although short-term volatility may affect Goldman in the short-term, they will remain one of the industry’s top firms for years to come.
-Steve Murray
Disclosure: The mutual fund the author is associated with is long JPM and GS.
The Following Stocks Were Mentioned In This Article: BAC, BRK.A, C, DB, GS, JPM, MS, UBS
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