Goldman's Earnings Were Great… Until You Look At The Details

Lloyd Blankfein

Goldman Sachs may have just crushed earnings estimates, but that’s in no way the whole story here. To get the bigger picture of how the bank (and thus The Street) is fairing you need to look at debt and equity underwriting, sales and trading, and the bank’s return on equity (ROE)  all together.

That’s when things get a little more complicated. Even though things are looking great year over year, a slight rise in interest rates and additional volatility in the market held Goldman down in Q2.

Yes, that was expected across the Street, but it still contributes the bank’s less than stellar ROE and shows that the banking business is still struggling toward boom times.

This isn’t to take away from Goldman’s earnings beat. Q2 is a traditionally tougher quarter all around as companies tend to issue more debt (generating more business for banks) at the beginning of the year. Wall Street’s army of analysts estimated that Goldman would post an adjusted EPS of $2.88 and a revenue of $7.972 billion. The bank posted an adjusted EPS of $3.70 and a revenue of $8.61 billion.

Goldman continued its leadership in one of the hottest businesses in investment banking right now, debt and equity underwriting. The bank earned $1.06 billion in that business, and like a lot of what you’ll see in Goldman earnings, this figure is down slightly from Q1 2013, but up 45% from this time last year.

Goldman also leads Wall Street in sales and trading revenue, so you have to check that out. Wall Street was concerned that rising interest rates would take everyone to the cleaners, but that wasn’t necessarily the case here.

Goldman’s net revenue in fixed income, currencies, and commodities client execution fell 23% from Q1, but rose 12% from Q2 2012.

From Goldman’s earnings release:

Net revenues in Fixed Income, Currency and Commodities Client Execution were $2.46 billion, 12% higher than the second quarter of 2012, reflecting significantly higher net revenues in currencies, credit products and commodities. These increases were partially offset by significantly lower net revenues in mortgages and lower net revenues in interest rate products. Although Fixed Income, Currencies and Commodities Client Execution operated in a generally favourable environment during the first half of the quarter, market conditions across products became more challenging during the latter part of the quarter, as interest rates and market volatility increased.

About a month ago, Bloomberg reported that Wall Street was headed toward the smallest percentage drop in trading revenue between Q1 and Q2 since 2009. The main reason for that, though, was the fact that there was no end-the-world-disaster news coming from Europe (or anywhere else really).

And that’s just it — Wall Street has become accustomed to it’s annual beating in Q2. Since the paddle didn’t come down, it looks like the time for optimism, but you still have to remember that last quarter everyone knew sales and trading was still on life support.

Goldman’s sales and trading team was down 7% y/o/y last quarter — this year they’re up 12% y/o/y, but without the face melting European crisis to contend with. Additionally, rising interest rates didn’t cause the destruction analysts expected. 

So Goldman’s numbers are better than a dip, but not every quarter should be considered in contrast to the post-apocalyptic disaster The Street’s been living in since 2008. At some point, we have to start trying to figure out when Wall Street will be healthy, not just surviving.

When you look at the big picture, as Bloomberg TV’s Erik Schatzker pointed out, Goldman has a ROE of 10.5%, which is essentially the cost of capital for a bank of its size. If shareholders are going to really, really love the bank’s stock, ROE has to rise to the mid teens.

For now, we’ll take it, but just remember we’re not out of the woods yet.

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