Goldman Sachs (NYSE:GS) reported its third-quarter earnings on Thursday, and the numbers don't look too promising on first glance. However, there's more to the bank's quarter than just the numbers. Here are five points from Goldman's recent conference call that investors need to hear.
1. Investment-banking revenue was down, but the outlook is good
During the third quarter, Goldman's investment-banking division produced revenue that was 23% less than the second quarter, including a sharp 38% drop in underwriting revenue. And it makes sense: When markets drop and volatility rises, companies are hesitant to issue new shares and debt offerings. Even with the revenue drop, there were a few reasons for investors to smile.
First of all, Goldman Sachs is No. 1 year to date in terms of announced and completed M&A. The bank has served as an advisor on $900 billion of completed transactions -- $350 billion more than its closest competitor, including such high-profile deals as AT&T's $67.1 billion acquisition of DirecTV and the $46.8 billion spin-off of PayPal from eBay. Goldman also has the top ranking for global-equity offerings YTD, impressive considering the sharp quarterly decline. In other words, although economic conditions are challenging, Goldman's position remains strong.
Second, while revenue was down, the investment-banking backlog actually grew during the quarter. And the company believes that things will get even better -- especially in regards to M&A activity. As Executive Vice President and CFO Harvey Schwartz said, "...the most significant information component for us is the level of dialogue that boards' CEOs are having, and the dialogue feels quite good."
2. Goldman will proactively adapt to any challenges
In most of its conference calls, Goldman likes to emphasize its ability to adapt to any environment -- and why not? The company has proven its ability to do just that time and again.
For example, Goldman's revenue in its fixed income, currency, and commodities (FICC) trading business was down 33% year over year, so it was obviously a cause for concern among investors. However, Schwartz made sure to note that Goldman isn't being complacent.
"Within FICC, we are proactively responding to industrywide challenges, including asset sales, expense initiatives, and balance sheet reduction," said Schwartz. "We will always (emphasis added) look for additional opportunities to improve our FICC operations."
3. Don't worry too much about commodities
Many bank investors are worried about the plunge in commodities prices, and for good reason. After all, banks loan money to energy and commodities businesses, and when things turn sour, these companies could have trouble paying the money back.
However, Goldman wants to assure its shareholders that this needn't be a big concern. As Schwartz said, "In terms of the exposure, we're not a big lender to the energy sector."
Schwartz went on to say that, if the drop is sustained, it could actually be a good thing for Goldman's business, as the world adjusts to the lower prices. "Ultimately, that will be a catalyst for activity, as clients consider hedging strategies, as they think about financing alternatives, and as clients and companies struggle for refinancing."
4. Investment management continues to be a strong point
Goldman's investment-management (IM) business posted a third-quarter revenue drop, just like most of its business segments, but it is still growing in the way that matters in the long term. Specifically, new money is flowing in to the business, and at a relatively constant rate.
During the third quarter, a total of $41 billion in net inflows came into the IM business, $23 billion of which was organic, and the other $18 billion came from the Pacific Global Advisors acquisition. And since the beginning of 2012, a net total of $195 flowed in.
The significance of more money coming in than going out is that it sets the bank up to prosper over the long term. Sure, investment-management revenue will suffer when the market declines the way it did during the second quarter. However, an increase in client assets means more ability to generate commissions and fee revenue in the future.
5. Lower revenue isn't surprising, but the future is bright
Perhaps most significantly, Schwartz emphasized the reasons for the mediocre quarter, as well as why Goldman's future is still on track.
The Chinese currency devaluation, and anticipation of a Federal Reserve rate increase, created uncertainty and doubt among investors. The decrease in commodity prices drove an increase in credit spreads across the energy sector, leading to a lower level of client activity. Finally, stock markets were down all over the world, which led to lower asset values and poor investment returns.
However, Schwartz made it clear that Goldman's strategy remains intact, and that the long-term growth catalysts are solid. I already mentioned that the investment-banking backlog is strong, and that the investment-management business is doing well. Furthermore, he said that Goldman is experiencing increased pricing power as other companies are exiting certain aspects of the business -- particularly in regards to equity derivatives.
Finally, Schwartz said that one of the most important takeaways of the quarter was not the economic challenges, but the higher activity levels in investment banking, which translates to client confidence. And confident clients are profitable clients for institutions like Goldman Sachs.