Goldman Sachs Earnings Preview: Improved Security Valuation, Strong Investment Banking Fees To Drive Q3 Profits

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Goldman Sachs

Goldman Sachs (NYSE:GS) will detail its earnings figure for the third quarter on Tuesday, October 18, and we expect the premier investment bank to report strong operating figures for the period on the back of improved securities trading conditions and increased global M&A and capital raising activity. While exceptionally weak activity levels in the first quarter and the unexpected Brexit vote in June contributed to a sharp increase in trading revenues for the second quarter, elevated currency and debt trading activity are expected to help these revenues for the third quarter. Also, the bank should have benefited from an improvement in the volume of M&A advisory and debt origination deals for the period – helping fees nudge ahead of the already high figures seen in the previous quarter. Additionally, we expect Goldman’s top line to benefit from higher net interest revenues, as strong growth in its deposit base over recent quarters helps reduce its overall funding costs.

Goldman’s share price has fallen considerably over recent months as investors express concern about the negative impact of stricter regulation on its extremely profitable (and volatile) proprietary investments unit, even as the bank sticks to its policy of focusing on the capital-intensive FICC (fixed income, currencies and commodities) trading business. But we believe that Goldman’s efforts in exploring additional avenues of growth – including products and services targeted towards retail banking customers – will add sizable value in the long run. This is why we stick to our $200 price estimate for Goldman’s stock, which is about 20% ahead of the current market price.

See the full Trefis analysis for Goldman Sachs

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Goldman’s FICC Trading Focus Will Work In Its Favor For Q3

The FICC trading business has lost a lot of its sheen since the economic downturn of 2008, with stricter capital requirement norms and an overall reduction in activity levels globally from the pre-2008 era hurting returns for the industry. As a result, nearly every global investment bank has cut down on its FICC trading operations – especially Morgan Stanley and UBS, who have shifted their focus almost completely to  equity trading. Goldman, however, continues to believe that the debt trading industry will soon witness a turnaround and has retained a full-service FICC trading desk. If conditions in the industry actually improve, Goldman is in a position to pocket much bigger gains than any of its rivals, due to its notably larger presence.

Goldman’s strategy was questioned earlier this year, when its FICC trading desk generated less than $1.7 billion in revenues for Q1 2016 – in sharp contrast to the seasonally-boosts average figure of $3.4 billion over the first quarters of 2011-2015. In fact, this was the bank’s worst first quarter FICC trading performance since 2005. Although debt trading activity levels were subdued over a bulk of Q2, things picked up late in the quarter before and immediately after the Brexit vote, and helped Goldman’s FICC trading revenues improve to over $1.9 billion. The uncertainty surrounding Brexit led to an increase in debt and rates trading activity over Q3, and this coupled with mark-to-market gains from a recovery in asset valuation should help these revenues cross $2 billion for the quarter.

Advisory & Underwriting Revenues Should Also Nudge Higher

Goldman’s advisory and underwriting operations are also expected to report a notable gain compared to Q2. As we pointed out in a series of recent articles based on Thomson Reuters’ quarterly investment banking league tables, there was an improvement in deal volumes for the global M&A advisory, equity underwriting as well as debt origination industries quarter-on-quarter.

Goldman’s market share in its core M&A advisory business fell slightly from 41% in Q2 to 37% in Q3, but its role in the largest deals that closed over the period should have helped related fees improve marginally. On the other hand, despite Goldman’s improved market share in the equity underwriting industry, fees from equity issuances are expected to shrink 10% quarter-on-quarter. This should be more than compensated for by Goldman’s continuing strength in the debt origination industry, though, as fees from debt capital market deals are estimated to grow 11% sequentially. Taken together, we estimate a total increase of roughly 4% in Goldman’s advisory and underwriting fee revenues compared to the previous quarter. This points to revenues of ~$1.86 billion for Q3 2016 compared to $1.79 billion in Q2 2016 and the much lower $1.56 billion in Q3 2015.

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