One Wall Street analyst, Glenn Schorr at UBS, predicted a loss for the bank on Friday. The potential for a quarterly loss, combined with the generally weaker environment for financial institutions, has some investors wondering if Goldman Sachs really deserves to trade at a higher valuation than Morgan Stanley, (MS.N: Quote, Profile, Research, Stock Buzz) the other major independent investment bank that is now a commercial bank.
Goldman's shares trade at about 1.1 times their tangible book value, while Morgan Stanley's shares trade at less than half their tangible book value. A spokesman for Goldman declined to comment.
Goldman Sachs is legendary for its risk management expertise. In early 2007, it saw the storm clouds gathering above the subprime mortgage market and positioned itself to profit from the expected home loan downturn.
The company posted record net income in the fourth quarter of 2007, even as less nimble competitors like Merrill Lynch & Co Inc (MER.N: Quote, Profile, Research, Stock Buzz) were already recording massive losses.
But the duration and intensity of this credit crunch has surprised many of the savviest investors. After having already fallen 21 percent in the first nine months of the year, the Standard & Poor's 500's .SPX fell 17 percent in October.
Many bond sectors have weakened in recent weeks, the dollar has unexpectedly surged against the euro and other currencies, and the price of oil has plummeted.
Meanwhile merger activity has ground to a halt globally, and hedge funds, some of Goldman's best trading customers, are cratering.
"The business conditions are horrendous for these guys now," said Anton Schutz, chief investment officer at Mendon Capital Advisors in Rochester, New York.
The conditions will likely pressure Goldman's net revenue, which was typically at least $10 billion a quarter in 2007 and dropped to about $6 billion last quarter. With so many business lines looking weaker, Goldman's revenue in the fourth quarter could be closer to about $5 billion, although the average estimate among Wall Street analysts is $6.3 billion, according to Reuters Estimates.
Meanwhile, Goldman faces significant potential writedowns.
The bank's investment in Industrial and Commercial Bank of China Ltd (601398.SS: Quote, Profile, Research, Stock Buzz) (1398.HK: Quote, Profile, Research, Stock Buzz), worth $2.6 billion in its fiscal third quarter ended August 29, is worth about $900 million less after a broad rout in Chinese stocks. The bank's principal investments, including private assets, public assets and real estate, worth about $17.1 billion at the end of last quarter, could now be worth $3.4 billion less.
Goldman's $14.6 billion of commercial real estate could be worth $700 million less, assuming the firm was able to hedge all but 5 percent of the potential declines. The same assumption for Goldman's $7.6 billion of residential mortgage exposure yields another $380 million of write downs.
Add up those numbers, and the writedowns could total $5 billion. Throw in another $2 billion of non-personnel related expenses, which is about what Goldman averages every quarter, and the fourth quarter could be ugly.
"We think the firm's principal investments could suffer meaningful mark downs in the quarter and lead to a loss," wrote UBS analyst Glenn Schorr on Friday. Schorr is the first Wall Street sellside analyst to forecast a quarterly loss for Goldman Sachs -- he cut his estimate to a loss of 40 cents a share from his prior estimate of earnings of $1.40 a share. The Wall Street average estimate is for earnings of $2.40 a share before items.
To be sure, a fourth-quarter loss is not a sure thing for Goldman Sachs. The company still has another month left in its fiscal fourth quarter, and markets may recover then, particularly as credit markets show signs of thawing, said Mendon's Schutz.
And Goldman can set aside much less money for compensation in the fourth quarter than it has in prior quarters, which would reduce its costs.
But amid all the difficulties facing the investment banking business, some investors wonder if Goldman Sachs deserves to trade at a higher valuation than Morgan Stanley.
Morgan Stanley is facing problems of its own, some analysts note. It has lost hedge fund customers in its prime brokerage business to other banks. Its efforts to collect deposits could end up being quite costly.
But even with these challenges for Morgan Stanley, some investors wonder if Goldman deserves such a large premium valuation over its competitor.
"Is Goldman that much of a better business than Morgan Stanley now?" one hedge fund manager asked.
(Editing by Leslie Gevirtz)