Goldman Sachs (GS) spooked the market with surprisingly high litigation costs in its second quarter, and you can bet the uncertainty surrounding additional legal costs will be an overhang for GS stock — at least until the next report.
The money center banks like Citigroup (C) and Bank of America (BAC) delivered big doses of optimism after Q2 results reassured investors that the crushing costs of legal and regulatory woes are largely behind them. Other expense reductions are also boosting the banks’ bottom lines.
Investment bank Goldman Sachs, however, went in a different direction in the most recent quarter. A massive charge for litigation related to mortgage bonds took attention away from what was an otherwise pretty good quarter.
Indeed, after stripping out the legal charge, earnings per share came to $4.75. That crushed Wall Street’s consensus of $3.89, according to a survey by Thomson Reuters.
Revenue, likewise, came in ahead of analysts’ average estimate by a decent amount: The top line hit $9.07 billion vs. a forecast for $8.78 billion.
Admittedly, the top line slipped nearly 1%, but every bank is having a rough time with revenue growth these days. What’s important is that the Street thought the top line would come in even worse than it did.
And yet, the market was still disappointed with the news.
As noted, a big part of that was due to investors being surprised by a massive jump in costs for legal and regulatory issues. Goldman Sachs set aside $1.45 billion in Q2 vs. about $300 million a year ago. Even the mighty Goldman Sachs gets hurt when it springs that kind of a nasty surprise on the market. It’s not even so much the sheer size of the charge. Rather, it’s the uncertainty the unexpected cost creates.
Things like this make investors worry that there are other problems lurking in the shadows. In beloved Wall Street cliché, the market is scared of the other shoe dropping.
Goldman Sachs Is Also a Victim of Its Own Success
Goldman Sachs also has to deal with lofty expectations. After all, Goldman Sachs is the most important investment bank in the world and the biggest brand in high finance. The market expects Goldman Sachs earnings to blow it away.
That goes double during this period of frenzied mergers and acquisitions activity. Goldman Sachs is practically synonymous with such deals. The dizzying pace of M&A was good for Goldman Sachs in the quarter — revenue from investment banking rose 13% — but the market wanted even more.
And although investors knew that revenue from trading in fixed income, currencies and commodities was going to decline, Goldman Sachs suffered a steeper drop than Citigroup, Bank of America and JPMorgan Chase (JPM). We’ll see how Morgan Stanley (MS) fares when it reports Q2 earnings on July 20.
The market is accustomed to getting upside surprises from Goldman Sachs, not a bucket of charges that cause net income to plunge 50%. One analyst told CNBC that Goldman Sachs earnings ruined his morning.
Goldman Sachs stock fell as much as 1.7% in the first hour of trading. That’s not an insignificant move against a market capitalization of $90 billion, but it wasn’t really a disproportionate reaction.
GS stock shouldn’t have much trouble overcoming such a mixed report, but the market hates uncertainty and that’s going to take something away from its performance.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
