A Tale of Two Banks: Goldman Sachs & Bank America
This week provides an interesting comparison between two “financials,” Bank of America (NYSE: BAC) and Goldman Sachs (NYSE:GS). The former is the best performing large bank stock in the US over the past six months, while the latter just disappointed on both revenue and earnings.
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Now let’s consider GS, one of Wall Street’s leading investment houses and also one of the most political banks in the world. There are two kind of Goldman partners – deal guys and politicos. The latter category include the likes of Robert Rubin, Hank Paulson, Jon Corzine and now Gary Cohn. Quite a list, yes?
In fact, there are about a dozen or so former Goldman Sachs bankers working in the Trump Administration. This either means that the financial world is headed for a crisis or the Mother Ship on Broad Street is in some serious kimchi. Looking at the latest financial results, our informed guess is the latter.
As Goldman’s CFO Martin Chavez put it: “We did underperform.” Jim Cramer at CNBC put it better: “Talk about not executing.”
GS fell to a five month low yesterday after missing on both earnings and revenue. Normally the Street analysts set the bar on forward estimates pretty low, so a miss is pretty bad – especially when you are Goldman Sachs.
The other issue is that the chief financial officers of large cap financials usually have a couple of cents worth of earnings in their pockets to help meet or beat, so when you miss large that is even more disturbing to investors.
So what happened? Investment banking was actually up 15%, but the other business lines missed and by a wide margin. Most notable was the 22% drop in fixed income and commodities trading in institutional client services. Investment management results also fell, driven down by a 46% decline in incentive fees.
Q: Was there a loss that caused the big move in results in fixed income and commodities trading in institutional client services? GS says no. Awfully big move for a failure in execution.
But with all that said, the net revenue line was down just 2% sequentially and actually up 27% year-over-year, but the GS stock got hammered anyway. Remember that Q1 2016 was awful for the Street, so the YOY comparisons require a lot of seasoning. The sizable increase in operating expenses then put the kibosh on a happy ending, leaving GS with flat net income sequentially but up 80% YOY.
Indeed, leaving aside the sharp rise in expenses, the YOY comparisons for all of the GS business lines were not bad, yet investors turned their backs on Goldman. Maybe more than the numbers, the damage to the aura of invincibility of the House of Goldman may be the real story in this quarter’s financial results.
Meanwhile, BAC managed a significant beat in terms of both earnings and revenue. Keep in mind that going into this week, BAC had Street estimates for earnings and revenue growth that are normally associated with tech companies. In particular, BAC has taken operating expenses down more than 30% over the past five years. Operating income has stayed remarkably steady in the low $80 billion range, leading to an 1,110% improvement in net income over the past five years.
What is remarkable is that CEO Brian Moynihan did not get much credit for his expense reductions until the election of Donald Trump last November. BAC then sprinted, leading the large cap financials higher, outdoing JPMorgan (NYSE:JPM) by a 2:1 margin.
Total income for BAC was up 10% YOY to $22 billion, but expenses rose as well and yet were flat YOY. All of this cost cutting led to earnings up small vs Q4 2016 and $1.3 billion YOY. Fully diluted earnings were 41 cents vs 28 cents a year earlier. Hoo Rah!
All of the progress made by BAC is of course splendid, but Wall Street has a notoriously short memory. Just ask the folks at Goldman Sachs. So if BAC is really going to hit the 16% earnings growth estimate for 2017 and the 21% estimate for next year, Brian Moynihan is going to need to pull multiple bunnies out of the proverbial top hat.
To be specific, that means getting quarterly net income up to $5 billion by the end of 2017 and $6 billion by the end of 2018. This implies a significant increase in the assets and revenue of BAC that we simply cannot see happening in this environment. We give kudos to BAC for the great performance over the past five years, but fade the forward Street estimates on earnings and revenue growth please.
Of course, nothing is impossible, as proven by the remarkable job of cost cutting and expense containment achieved by BAC so far. But if BAC can get run rate quarterly net income up to $5 billion plus by year end, then maybe this long neglected stock will manage to stay above book value. Then JPM will need to start running faster.