Stock of the week - Goldman Sachs (19.01.2023)

Bucket of cold water for Wall Street bulls

On Tuesday, two large US banks posted their quarterly results. While Morgan Stanley (MS.US) surprised on the upside, Goldman Sachs (GS.US) reported the biggest profits decline in a decade, which pushed its stock 6.44% lower. What negatively impacted the bank's recent quarterly results, and are they a sign of an incoming recession?

Worse than bad

Goldman Sachs reported its biggest drop in profits in a decade on Tuesday, driven by dwindling revenues and rising costs, provisions for credit losses that turned out to be higher than expected. Quarterly profit fell by 66% y/y to $1.33 billion, equivalent to earnings per share (EPS) of $3.32 per share, which is approximately 39% below the market consensus of $5.48. It was the biggest EPS drop since October 2011, according to Refinitiv data. Revenues amounted to $ 10.59 billion (-16% y/y) also below analysts estimates of $10.83 billion.

The devil is in the costs

"Goldman Sachs' results were widely expected to be disastrous, but they turned out to be even worse than expected," said Octavio Marenzi, president of a consultancy firm Opimas. "Revenue was largely in line with forecasts, but net profit declined significantly. The real problem is that operating costs increased by 11%, while revenues decreased."

The bank announced that operating costs increased by 11% to $8.09 billion YoY due to higher salaries, benefits and transaction fees. Cost figures came in about $800 million above the market consensus. Analysts signaled concerns that wage inflation could hit banks' earnings in the fourth quarter. However no one expected that the scale would be so significant.

The Fed's monetary policy supports the banks... up to a certain point

Goldman Sachs booked credit loss provisions of $972 million, up from $344 million last year, which was not welcomed by the markets. The bank set aside 50% more funds for potential credit losses than analysts' expected.

The bank sees "early signs of deterioration in the quality of consumer loans". With a slowing economy, more borrowers are at risk of defaulting, CFO Denis Coleman said Tuesday during a call with analysts.

Asset & Wealth management and Global Banking & Markets divisions under pressure

Goldman said that revenues decline was mainly associated with poor performance of two main divisions, namely Asset & Wealth management and Global Banking & Markets. Investment banking revenue fall 48% to $1.87 billion due to weak issuance activity in the equity and debt markets and lower advisory fees. It is also worrying that the company's transaction portfolio has decreased compared to Q3'22.

Asset & Wealth Management revenues plunged 27% y/y to $3.56 billion due to significantly lower gains from private equity holdings and margins on debt instruments.

A wave of layoffs in the background

After a difficult quarter, analysts peppered the bank's CEO with questions regarding workforce and costs after the bank laid off 3,200 employees last week. Analysts were also curious about Goldman's plans regarding its consumer operations as the bank scales down its activity in this area.

The 3,200 employees who were cut last week cost Goldman a total of about $475 million in expenses annually. However the impact of the recent layoffs was not factored into fourth-quarter results: Goldman had 48,500 employees at year-end, which is only 1.2% less compared to the previous year. quarter. According to Octavio Marenci from Opimas, investors should expect another wave of cost cuts and layoffs in the near future.

Summary of Goldman Sachs quarterly results

Conclusions

Recent quarterly results of major US banks, especially Goldman Sachs, show the impact of the deteriorating economic conditions on the sector. The management board's warnings regarding the constantly deteriorating quality of the loan portfolio, the growing risk of defaults and creation of higher provisions for potential credit losses should be taken into consideration by investors. Despite the fundamental indications of an imminent economic slowdown or even recession, sentiment on Wall Street is still relatively good, which leaves  room for a negative surprise. In this scenario, banking stocks could potentially erase most of the gains generated from October 2022. On the other hand, this would create an investment opportunity for investors who are currently “sitting on cash”.