DBRS: Goldman Sachs Ratings Unchanged After 4Q12 Earnings – Sr. at A (high), Trend Stable

DBRS, Inc. (DBRS) has today commented on the 4Q12 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 $2.9 billion for the quarter, up from $1.5 billion in 3Q12 and $1.0 billion in 4Q11. For the full year, the Company reported net earnings of $7.5 billion, up significantly from $4.4 billion in 2011 but down slightly from $8.4 billion in 2010.

The strong linked quarter earnings growth came against the backdrop of slowly improving market conditions that generally supported client activity. Risk appetite, however, remains relatively low for both the Company and its clients in the sluggish, uncertain environment. Due primarily to lower market volatility, Goldman’s average daily trading VaR was $76 million in the fourth quarter, down $5 million quarter-over-quarter (QoQ), and at its lowest since 4Q05. That said, more constructive market conditions relative to 3Q12 were the primary driver of the QoQ improvement, helping to drive up valuations in Investing & Lending (I&L) and contributing to better Investment Banking (IB) results. Importantly, the Company continues to generate solid results across its key business lines and Goldman’s advisory and equities (underwriting and trading) franchises remain market leading.

Fourth quarter and full-year results affirm the strength of Goldman’s IB franchise, in DBRS’s view. Illustrating Goldman’s leading position, the Company ranked #1 in global announced and completed M&A in 2012 and had its second best debt underwriting year. As a result, IB net revenues rose 21% QoQ to $1.4 billion. Relative to 3Q12, advisory revenues were flat at $508 million, while underwriting revenues increased 37% to $897 million driven by higher levels of industry-wide activity. For 2012, IB generated $4.9 billion, up 13 % from $4.4 billion in 2011.

The Institutional Client Services (ICS) segment contributed net revenues of $4.47 billion (ex-DVA), or approximately 48% of total 4Q12 net revenues (ex-DVA). Fixed Income, Currency and Commodities Client Execution (FICC) net revenues of $2.12 billion (ex-DVA) in 4Q12 reflected strength in credit products with better results in currencies and commodities, while rates and mortgages were down, but remained large contributors. Benefitting from a $500 million gain on the sale of the Company’s hedge fund administration business, total Equities net revenues rose 12% QoQ to $2.35 billion (ex-DVA) . Excluding this gain, net revenues declined 12% QoQ to $1.85 billion (ex-DVA) due primarily to lower net revenues in cash equities.

DBRS views positively Goldman’s success in building out its Investment Management (IM). In the quarter, IM delivered net revenues of $1.52 billion, up 26% QoQ and 20% YoY, driven by higher incentive fees. Although assets under management declined by $2 billion QoQ to $854 billion, due to net outflows in long-term assets that were only partially offset by market appreciation and money market inflows, DBRS notes that assets under supervision in IM increased by $14 billion in the quarter to $965 billion. For the year, IM generated net revenues of $5.2 billion, up 4% from $5.0 billion in 2011.

The Company’s I&L segment reported net revenues of $1.97 billion, up from $1.80 billion in 3Q12. The increase reflected a net gain of $334 million on its investment in ICBC shares in the quarter, which was up from $99 million in 3Q12 Net gains from equity securities, including realized and unrealized gains, amounted to $789 million (down 4% QoQ), while net gains and net interest income from debt securities were $485 million for 4Q12 (down 13% QoQ). For 2012, I&L generated $5.9 billion, up 175% from $2.1 billion in 2011. While the investments in I&L are generally longer-term and have generated significant positive mark-to-market revenues for the Company over time, DBRS views the potential revenue volatility in this business as having the potential to increase headline risk given the importance of quarterly profitability.

DBRS views Goldman as being able to successfully adapt to the evolving operating environment characterized by the changing regulatory requirements and still sluggish financial market activity. One indicator is the Company’s ability to adjust its compensation to reflect the new circumstances. In 2012, Goldman increased compensation by only 6%, even though net revenues were up 19%. After accruing just 21.4% of net revenues for compensation in 4Q12, Goldman reported a full year compensation ratio of 37.9%, down from 42.4% in 2011. Non-compensation expenses rose 24% QoQ to $3.0 billion in 4Q12, due largely to elevated net provisions for litigation and regulatory proceedings, including the settlement with the Federal Reserve regarding the independent foreclosure review and a one-time charitable contribution. Despite the quarterly increase, non-compensation expenses of $10.0 billion in 2012 were actually 4% lower than in 2011, highlighting continued progress with the Company’s costs savings initiatives.

In the current environment, management reiterated its approach to regulatory uncertainty that balances Goldman’s focus on meeting its clients’ needs, while preserving its ability to adapt as the final form of regulatory changes becomes clearer. One example of this adaptation was indicated in the announcement that the Company is exploring options for the sale of a majority stake in its reinsurance business. Nevertheless, management continues to build its regulatory capitalization given the known longer run rules. At quarter end, the Company’s estimated Basel I Tier 1 Common ratio stood at 14.5%, and its estimated Basel III Tier 1 Common ratio was approximately 9%, up from 8% at the end of 2011. Given continued uncertainty in global financial markets and its objective of demonstrating a strong liquidity profile, the Company continues to maintain a very sizeable liquidity buffer, termed its Global Core Excess, which averaged $173 billion in 4Q12, or a substantial 18% of total assets. Consequently, DBRS perceives that Goldman retains the financial flexibility necessary to meet evolving regulatory requirements.

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

[Amended on June 25, 2014 to remove unnecessary disclosures.]