Lower Employee Costs Help Goldman Salvage Lukewarm Q4 Results

Goldman Sachs (NYSE:GS) reported its performance figures for last quarter and full-year 2014 on Friday, January 16, and the investment bank fared slightly better-than-expected for the period despite weak debt trading revenues thanks to a notable reduction in total compensation expenses. ^[1] Goldman’s debt trading desk was hit by the sudden increase in debt market volatility over the month of December even as activity levels for Q4 2014 remained depressed – a trend that has dragged down fixed income, currency and commodities (FICC) trading revenues for the industry as a whole. As a result, total revenues fell from around $8.8 billion in Q4 2013 and $8.4 billion in Q3 2014 to under $7.7 billion for Q4 2014. In response, Goldman trimmed employee compensation and benefits to $1.96 billion – the lowest since the $1.58 billion figure seen for the particularly weak Q3 2011. This represents an 11% reduction in these costs year-on-year and a significant 30% cut quarter-on-quarter.

Goldman’s figures for the quarter do have some notable positives, though – especially the strong performance of its equities trading and M&A advisory units. While the equities trading desk churned out its best quarterly performance in two years, Goldman’s advisory revenues of $692 million for the period were the highest since the economic downturn of 2008. Also, steady growth in the size of the bank’s assets under supervision (AUS) to a record $1.18 billion at the end of Q4 2014 also helped Goldman generate strong revenues from its investment management operations.

We maintain a $189 price estimate for Goldman’s stock – about 10% ahead of the current market price.

See the full Trefis analysis for Goldman Sachs

Goldman’s FICC Trading Desk Ends Forgettable Year

Unlike many of its peers who have shrunk their fixed-income, currencies and commodities (FICC) trading business considerably over recent years in response to stricter regulatory requirements and changing economic conditions, Goldman Sachs has chosen to retain a full-fledged FICC trading desk. Global investment banking giants such as Morgan Stanley and UBS, who were once major players in the industry, now maintain bare-minimum FICC trading desks. This has allowed incumbents such as Goldman and Citigroup to target a larger share of the industry – something that is necessary to ensure profitability and long-term sustainability in what was once a money-minting enterprise.

But Goldman’s FICC trading desk has had a poor run over 2014, with the third quarter being the only period in which the bank saw a year-on-year improvement in revenues. While performance over the first half of the year was hit by weak debt trading activity due to uncertainty about interest rates, an unexpected increase in volatility over December had a negative impact on the numbers for the last quarter. In fact, the $1.2 billion in FICC trading revenues that Goldman announced for the last quarter were the lowest in at least 10 years except for the $3.4 billion loss in Q4 2008 (adjusted for any accounting gains/losses from a revaluation of its own debt). Also, the $8.4 billion in FICC trading revenues for full-year 2014 was the worst performance by the desk for any year since the economic downturn of 2008.

Lower Compensation Expenses Comes To The Rescue, Again

In the third quarter of 2014, Goldman incurred total employee-related costs of $2.8 billion – 33% of its total revenues for the period. The figure stood out, as it was one of the few quarters over recent years when the ratio of the bank’s compensation expenses to total revenues fell below 40%. But this figure fell further to 25% for Q4 2014, as Goldman set aside the lowest amount of cash for compensating employees in 14 quarters. A better idea of the trend seen in Goldman’s compensation expenses, as well as total operating expenses for each quarter over the last four years, can be obtained from the chart below.

As demonstrated by the chart, Goldman has capped compensation expenses at 44% of total revenues for a quarter, with the ratio remaining above 40% for 11 of the last 16 quarters. Notably, the ratio tends to be lowest for the fourth quarter – something that gave Goldman’s Q4 2014 results a leg-up this time around. While performance-linked bonuses would definitely be lower for the period, we believe that Goldman has also deferred some its bonus payouts over the last two quarters – hoping to hike bonus payouts again in the first quarter, when revenues are usually the highest for a year.

The chart below captures the operating margin for Goldman’s FICC business. You can see how changes to this figure affects the bank’s share value by making changes here.

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1. 2014 Annual and Fourth Quarter Results, Goldman Sachs Press Releases, Jan 16 2015 [↩]