Goldman Sachs: Is a recovery underway?

Of all the US banks that have been negatively affected by the economic crisis, Goldman Sachs (NYSE:GS) arguably dealt with this better and more effectively than any other within the industry. The banking industry was the major victim of the 2008 global financial crisis, and Goldman Sachs was able to weather the storm whilst other financial giants like WaMU, Bear Stearns and Lehman Brothers could not, albeit with a little help from the Us Government under the Troubled Assets Relief Program (TARP).

As anticipated, the 2011 full year results of Goldman Sachs were not particularly pleasing to investors. All the financials were in the red, with total equity, revenue, operating income and net income all dropping substantially. Return on equity, which was previously at 27% prior before the global financial crisis, is now at a mere 9.9%.

These figures, along with the lack of sympathy for poor risk management and banking frailties, has put tremendous pressure on the management of the bank, with shareholders, employee unions, religious institutions and union pension funds all pressing for sweeping changes to the way the bank is run. The unfortunate recent comments included in the resignation letter of the former head of Goldman Sachs Equity Derivatives business, alleged that executives of the bank commonly referred to clients as “muppets” and that colleagues commonly made comments about “ripping their clients off”, did nothing to help the fortunes and public image of the bank. At a time when attracting clients to use its services was critical this was particularly damaging and has added to the negative sentiment held by investors towards all banking stock.

The result of this negative sentiment has been a consistent drop in the share price of Goldman Sachs stock, from a 52-week high of just under $157 to just above $115 per share. The first quarter earnings reports on the 17^th of April announced a 23% fall in profits as the bank lagged behind JPMorgan Chase and Citibank in their trading departments. Whilst the underlying figures are not looking good for the bank, they did beat analysts expectations on the earnings per share at $3.92 and surprised investors with a 46 cent dividend; the first since 2006.

Looking at the actions taken prior to the report announcement, it is clear to see that there are several issues going behind the scenes:

Firstly, the damage control mechanism of the bank is in full gear with the slashing of the pay to Chairman/CEO Lloyd Blankfein, who now earns a conservative $11m which is a far cry from the $50m he was earning just before the global financial crisis. Other top bank executives have also had their pay packages slashed, in what the bank says is in pursuance of its “say for pay” policy where performance was the indicator to justify the level of financial compensation to bank executives.

Secondly, the bank had succeeded in striking out three of six major shareholder demands in the proxy statement, heading into the earnings call. The management of the bank is advising shareholders to defeat the proposals when they come up for voting. Shareholders are asking for a slash in the lobbying expenditure of the bank, splitting of the Chairman/CEO portfolio of Blankfein, and forcing bank executives to hold on to their stock holdings until 3 years after they have left office (recall that former CEO Henry Paulson sold off all his holdings after leaving the position, and effectively lost nothing when share prices tumbled in late 2008). This will, the bank hopes, enforce a more responsible attitude from its employees and reflect a more accountable ethos to potential investors.

Thirdly, the bank has made moves in cutting costs by laying off 2,400 workers in 2011, as well as reducing operating costs by close to 14%. Although controversial in terms of the social costs of such mass unemployment, the bank is displaying, to its shareholders, that it is serious about austerity within the company.

However, despite Goldman Sachs beating analyst expectations the relative performance of the bank shows that there are currently several better options available within the industry. Both Citigroup and JP Morgan currently represent more profitable, and perhaps more solid options for investors. Goldman Sachs still has to prove that its austerity measures and company ethos have improved the profitability of the bank. Having said this, the bank lost 46% of its stock value in 2011 and so far it has gained around 30% this year. On this basis it would appear that a slow, but steady, recovery may be underway not only for the individual bank but the entire sector itself.