Goldman’s Q1 FICC Trading Stumble Is Best Treated As A One-Off Event For Now

Investors were not happy when Goldman Sachs (NYSE:GS) reported lower-than-expected revenue and earnings figures for the first quarter of the year earlier this week, and they expressed their displeasure by sending the bank’s shares tumbling 5% over trading on Tuesday, April 18. ^[1] The sell-off was primarily triggered by an underwhelming performance by Goldman’s FICC (fixed income, currencies and commodities) trading desk – something that stood in sharp contrast to the extremely strong quarter by competitors JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C) and Bank of America (NYSE:BAC). The fact that operating expenses climbed to $5.5 billion from under $4.8 billion in Q1 2016 and Q4 2016 only made things worse, as it resulted in pre-tax profits shrinking 25% sequentially.

But there are several factors that lead us to believe that these sub-par results from Goldman were likely an anomaly in the bank’s otherwise strong earnings track record. Firstly, a key reason for the reduction in Goldman’s FICC trading revenues were “significantly lower net revenues in commodities and currencies.” The bank does not seem to have lost out on the uptick in debt trading activity towards the end of the quarter, but it appears to have given up a chunk of its debt trading gains to poor commodity and forex trading bets. This is not a particularly common occurrence for the bank, so one poor showing isn’t reason enough to call into question the strength of the bank’s FICC trading operations. Also, operating expenses (including compensation expenses) are seasonally elevated in the first quarter, and taken together with the fact that the bank’s overall performance was otherwise rather strong, the bank would also have had to set aside more cash for bonuses – eating into its profits further.

That said, the outlook for the debt trading industry remains strong in light of the Fed’s rate hike plan, and the Trump administration is expected to reduce the regulatory burden for U.S. banking giants in the near future – something that will benefit Goldman more than most of its peers given that the bank’s business model generates more than 60% of its profits from volatile sources (its trading desks, and its investment portfolio). Because of this, we maintain our $225 price estimate for Goldman’s stock, which is slightly ahead of the current market price.

See the full Trefis analysis for Goldman Sachs

The table above summarizes the factors that aided Goldman’s pre-tax profit figure for Q1 2017 compared to the figures in Q1 2016 and Q4 2016. The fact that sales and trading revenues fell compared to both quarters stands out in particular because the securities trading business is highly seasonal, with the first quarter of the year being the strongest period, and also because trading activity had recovered considerably in Q1 2017 compared to Q1 2016. Investment banking fees for the period benefited from seasonally elevated debt and equity underwriting levels for the quarter, while M&A advisory fees nudged lower. As for Goldman’s investment management business, the increasing popularity of the bank’s ETF offerings mitigated the impact of strong outflows from its liquidity funds over the quarter. Investing & Lending revenues (shown in the chart below) were directly aided by the rally in share prices across sectors for the period, as the bank booked sizable mark-to-market profits on its investment portfolio.

As we pointed out earlier, the increase in compensation costs was justified given its seasonal nature. Also, Goldman’s compensation expenses increased 24% y-o-y which is comparable to the 27% jump in revenues from a year ago – indicating a proportional increase in performance-related payments. Non-compensation expenses remained largely level compared to prior periods.

FICC Trading Mishap Sticks Out In An Otherwise Strong Investment Banking Performance

After remaining subdued for most of 2012-15, the global FICC trading industry saw a revival in its fortunes over 2016 as an improved outlook for U.S. interest rates, coupled with the unexpected Brexit vote, drove debt as well as currency trading volumes. Although debt trading volumes were subdued over the first two months of Q1, things picked up in early March after the Fed’s rate hike. U.S. investment banks made the most of this reversal in trend, as is evident from the fact that JPMorgan, Bank of America and Citigroup reported a 20% jump in FICC trading revenues on an average compared to a year ago. Except for Goldman, that is.

Although Goldman stated that it benefited from “significantly higher net revenues in mortgages and higher net revenues in interest rate products” it witnessed a sharp reduction in revenues from trading currencies, commodities as well as credit products – resulting in revenues falling from over $2 billion in the previous quarter to below $1.7 billion in Q1 2017.

The table below details the changes in Goldman’s investment banking revenues for Q1 2017 compared to Q1 2016 and Q4 2016.

The first quarter was a great quarter for underwriting activity, though, and Goldman did well to report sizable improvements in debt as well as equity underwriting fees for the period. On the other hand. M&A activity remaining subdued for a second consecutive quarter, because of which M&A advisory fees fell compared to the figure a year ago.

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1. 2017 First Quarter Results, Goldman Sachs Press Releases, Jan 18 2017 [↩]