It May Be Time For Goldman To Consider Streamlining Its FICC Trading Business

by Trefis Team
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The securities trading business is generally volatile when it comes to generating revenues, which is why investors usually do not give too much thought to wild changes in banks’ securities trading revenues from one quarter to the next. But over the years, investors have certainly come to recognize Goldman Sachs’ (NYSE:GS) prowess in this business – evidenced by the investment bank avoiding quarterly losses even at the peak of the economic downturn of 2008, despite having a business model that is centered on securities trading. Taking into account industry-wide fluctuations in trading activity for any quarter, Goldman has historically emerged as one of the best performers in the industry. In light of this stellar track record, what exactly should one infer from Goldman’s disappointing trading revenues over the last two quarters?

One clear takeaway from Goldman’s under-performance over the first half of 2017 is that the bank’s commodities trading unit is losing a lot of money. While Goldman attributed its poor FICC trading revenues for the first quarter to “significantly lower net revenues in commodities and currencies,” the problem this time around was commodities again, with the period being the “worst quarter on record” for the commodities unit. It should be noted that Goldman is the only major investment bank that still retains a sizable commodities trading business, as pressure from the government as well as financial regulators led its peers to almost completely exit this business over 2014-2015. And it looks like may have been the best path for Goldman too, as the commodities trading business has been depressed over recent years due to stricter regulatory requirements and an overall reduction in commodity trading volumes from the peak levels seen in 2009-2010.

That said, Goldman is reportedly reviewing its commodities business. However, while commodities trading may have weighed the most on Goldman’s trading revenues over recent quarter, we believe that there are other aspects of its FICC trading desk that also need to be streamlined – especially since most investment banks are generating comparable FICC trading revenues with a much smaller employee base. A stricter regulatory regime since the downturn makes it unlikely that Goldman’s FICC trading revenues will scale the heights it reached in 2006-2007, and it may be in the bank’s best interest to readjust these operations to make the most of the current environment. We maintain a $230 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 Q2 2017 compared to the figures in Q2 2016 and Q1 2017. Investors’ disappointment from the results was primarily due to the steep y-o-y decline in trading revenues. The bank’s advisory and underwriting fees were largely similar to those for the other quarters. Goldman’s investment management business continues to report steady revenue improvements from the increasing popularity of its ETF offerings. Notably, Investing & Lending revenues helped mitigate the impact of poor trading revenues on the top line to a good extent, as the bank booked sizable mark-to-market profits on its investment portfolio from improved securities valuation.

After remaining subdued for most of 2012-2015, 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 and currency trading volumes. The first quarter of 2017 was also an overall good period for debt trading, as volumes picked up after the Fed’s March rate hike before slowing down again in Q2. While all of Goldman’s competitors successfully gained from the Q1 trading boom to report a roughly 20% jump in FICC trading revenues y-o-y, Goldman’s Q1 revenues slipped by about 15%. And things only got worse in Q2, as Goldman’s FICC trading revenues shrunk a whopping 40% compared to Q2 2016. This compares with an 18% decline in these revenues for JPMorgan, 14% for Bank of America and just 6% for Citigroup.

Goldman admitted that its Q2 FICC revenues were bad across the board, with interest rate products, commodities, credit products and currencies all generating lesser revenues compared to the previous year. Mortgage securities offered some respite, but it was hardly enough to reverse the poor showing by other products. While commodities fared the worst, the fact that the other banks did not see such steep declines leads us to believe that several of Goldman’s big bets likely went bad this quarter. At the very least, this would warrant a more detailed review of the FICC trading operations to determine the reason for these declines. How Goldman puts its money-minting division back into order will remain at the top of investors’ minds over the coming months.

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