SEC Charge Casts Shadow on Goldman's Strong 1Q

Until there is greater clarity on the SEC charge, investors may discount Goldman Sachs' strong performance

Michael Wong, CPA 20 April, 2010 | 5:59PM
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Goldman Sachs reported first-quarter net earnings to common shareholders of $3.3 billion, or $5.59 per diluted share, on $12.8 billion of net revenue. Once again, FICC--fixed-income, currency, and commodities--trading revenue was the standout performer. FICC revenue increased 86% sequentially and was even higher than the second quarter of 2009, which we had previously thought would stand out as the highest quarterly FICC revenue for years to come. Goldman Sachs attributes the strong FICC revenue to particularly strong credit products, mortgages, and currencies and decent performance in rates and commodities. We were expecting a meaningful rebound in fixed-income trading revenue from the abnormally seasonally slow fourth quarter of 2009, but are inclined to believe that it was currency trading that put results over the top. Investment banking revenue declined as a result of weak equity underwriting and financial advisory. A bit surprisingly, asset-management revenue declined despite a rally across asset classes because of large outflows from the company's money market funds that were not reinvested in other Goldman Sachs-managed products. As early as next quarter, we wouldn't be surprised if the revenue line growth profiles flip, with trading revenue decreasing and investment banking and asset-management revenue increasing. At the moment, we don't anticipate any material change to our fair value estimate.

A primary concern recently for Goldman Sachs is a fraud charge by the Securities and Exchange Commission. (For our initial take on this, please see our April 16 note.) Goldman Sachs' general counsel elaborated on four key points about the case: The investors were experts who should have known that to make a synthetic collateralised debt obligation there must be a short; ACA selected the securities and had an economic interest to select a portfolio of securities that would perform well; there was no representation that Paulson & Co. would be long; and Goldman Sachs had no economic interest for the CDO to fail and actually lost more than $100 million on the transaction. We believe that until there is greater clarity on the SEC charge, investors may discount Goldman Sachs' strong performance.

Besides the SEC charge, compensation has been a persistent issue with Goldman Sachs. The company accrued compensation at 43% of net revenue for the quarter, less then its historical average of more than 46%, but above the approximately 36% ratio that it had in 2009. We believe that 43% is a decent compromise in the balancing act among its employee, Main Street, and government stakeholders. That said, we must point out that the 43% compensation accrual is merely an accounting entry and that it's the full-year compensation rate determined in the fourth quarter that counts.

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Michael Wong, CPA  Michael Wong is a stock analyst at Morningstar.