DBRS: Goldman Sachs Ratings Unchanged After 2Q12 Earnings – Sr. at A (high), Trend Stable

DBRS, Inc. (DBRS) has today commented on the 2Q12 results of The Goldman Sachs Group, Inc. (Goldman or the Company). The Issuer & Senior Debt rating of A (high) and Short-Term Instruments rating of R-1 (middle) remain unchanged with a Stable trend. Goldman reported net earnings of $927 million for the quarter, as compared to net earnings of $2.1 billion in 1Q12 and $1.1 billion in 2Q11.

The first half of 2012 proved to be similar in tone to the first half of 2011, as the general improvement in market sentiment and stronger capital markets of the first quarter were replaced by a more challenging environment characterized by macroeconomic concerns and political uncertainty in 2Q12. Despite the difficult market conditions, Goldman disclosed generally solid results. While net revenues of $6.6 billion in 2Q12 were down by 33% quarter-over-quarter (QoQ) and down 9% year-over-year (YoY), the Company continued to generate solid results across many of its business lines. DBRS sees these declines as reflective of the more challenging market conditions rather than any Company-specific weakness.

Institutional Client Services (ICS) net revenues of $3.9 billion declined from a strong 1Q12 ($5.7 billion). Included within the ICS segment, Fixed Income, Currency and Commodities Client Execution (FICC) net revenues of $2.2 billion in 2Q12 (1Q12: $3.5 billion) were negatively affected by macro concerns and weaker market sentiment. Equities client execution net revenues of $510 million were approximately halved from the prior quarter reflecting increased volatility levels and lower global equity prices. Commissions and fees declined less severely to $776 million, from $834 million in the prior quarter, impacted by lower volumes. Also included within Total Equities, Securities Services net revenues contributed to some revenue stability, generating $409 million in 2Q12 as compared to $367 million in 1Q12 and $432 million in 2Q11.

Goldman’s Investment Banking (IB) franchise continues to show signs of strength in a weak market environment with net revenues of $1.2 billion in 2Q12, a 4% improvement QoQ but a 17% decline YoY. Goldman continues to maintain a leading position in worldwide announced and completed M&A, having participated in a number of important transactions in the quarter. Reflecting weaker issuance activity, Equity Underwriting revenues declined; Debt Underwriting improved despite lower industry-wide issuance volumes as Goldman participated in several significant transactions. Goldman reported that its IB backlog increased QoQ.

The Company’s Investing & Lending (I&L) segment reported net revenues of just $203 million, down significantly from net revenues of $1.9 billion in 1Q12, impacted by a net loss on its investment in ICBC (-$194 million) and a net loss on other equity securities (-$112 million). Helping to offset these net losses were net revenues of $222 million in debt securities and loans and $287 million in other I&L, which includes Goldman’s consolidated investment entities. While these are generally longer-term investments that have generated significant positive MTM revenues for the Company over time, DBRS views the revenue volatility in this business as having the potential to increase headline risk given the importance of quarterly profitability.

Goldman’s Investment Management (IM) segment produced stable revenues again in the quarter, generating net revenues of $1.3 billion, slightly above the typical quarterly run rate for the business due to the boost in incentive fees related to the sale of Goldman’s clients’ remaining investment in ICBC. DBRS views positively that the Company sees IM as a growth segment, highlighting the importance of this business as a stable revenue generator.

In light of the lower revenue environment and a focus on expense reductions, the Company maintained a relatively low compensation accrual of 44% of net revenues in 2Q12, in line with the prior quarter. Non-compensation expenses were $2.3 billion in 2Q12, down 4% sequentially. Last year, the Company announced $1.4 billion in run rate expense savings going forward; this run rate cost savings was further increased by $500 million, expected to be achieved by year end 2012. The Company has inferred that the additional expense savings will largely come from a reduction in compensation and benefits expense, which DBRS views as appropriate given the current environment.

Goldman’s sound funding and liquidity profile and solid capital levels afford it greater flexibility, relative to many banks, to cope with the challenging market conditions and manage through the evolving regulatory environment. The Company’s substantial liquidity buffer, termed its Global Core Excess, averaged $174 billion in 2Q12, or 18% of total assets. Goldman’s regulatory capital ratios remain solid. At quarter end, the Company’s estimated Basel I Tier 1 Common ratio was 13.1%. Goldman’s estimated Basel III Tier 1 Common ratio would be just below 8% as of 2Q12, but would improve to just under 10% by the end of 2013, based on consensus estimates and assuming mainly passive mitigation.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: October 12, 2000
Most Recent Rating Update: November 11, 2011

For additional information on this rating, please see the linking document under Related Research.