Goldman Sachs Group, Inc. (NYSE:GS) recently announced its third quarter earnings. Lloyd C. Blankfein, the Chairman and Chief Executive Officer, said, "The third quarter's results reflected a period of slow client activity." The company's performance was not up to the mark in the third quarter of the current fiscal year as compared to the same period last year. I am aiming to analyze the financial health of Goldman Sachs and figure out an investment opportunity.
A peek into its financial health
The most important liquidity policy of Goldman Sachs is to pre-fund what the company estimates to be its cash and collateral needs during a liquidity crisis. The Global Core Excess (GCE) liquidity is comprised of cash and highly liquid securities that would be easily converted into cash in a matter of days. The company's GCE was $175 billion as of 30 September 2013. Average GCE was $187 billion in the quarter ended 30 September 2013, which is higher as compared to the average global core excess of $180 billion in the second quarter of 2013.
Level 3 assets are typically quite illiquid. In addition, it is very difficult to determine their fair values. Therefore, it is better for the company to have lesser level 3 assets as a percentage of the total assets. Level 3 assets of the company were $42 billion as of 30 September 2013 relative to $43 billion as of 30 June 2013. These assets represented 4.5% of the total assets as of 30 September 2013. Level 3 assets as a percentage of the total assets declined to 4.50% in 3Q13 as compared to the 4.58% in 2Q13.
As of 30 September 2013, the company's Tier 1 capital ratio and Tier 1 common ratio were 16.3% and 14.2%, respectively, up from a respective level of 15.6% and 13.5% in 2Q13. The current Tier 1 capital ratio of the company is well above the legal requirement of 4%.
Moreover, price-to-book (P/B) ratio is the key price multiple in order to compare the performance of the financial services companies. The company's P/B is 1, which is lower than the industry average of 1.3. A lower P/B ratio is a healthy sign for the company.
As shown in the above table, the outlook for Goldman Sachs is negative according to S&P, while Moody's (NYSE:MCO) is still reviewing it for a downgrade. A downgrade may cause many investors to withdraw their deposits. This could have a materially adverse impact on the performance of the company.
What is coming ahead
As the U.S. budget issues are resolved, I believe that Goldman Sachs's performance will be better in the near term because of an improvement in the corporate and investor sentiment. With the recovery of the US economy, I believe Goldman Sachs will be able to post a decent result in the future.
In the US, jobs recovery takes a long time after each recession. The unemployment rate is expected to decline to 6.5% from 7.2% by 2015. Moreover, the deficit is expected to be 2% until 2015, which is down from 10% today. Therefore, I believe that the improving US economy will eventually boost the earnings of the companies operating in the financial services sector.
Underwriting volumes were healthy in the third quarter of FY13. Mergers and acquisition volume has also increased. However, a bulk of the fees may not be materialized until the beginning of the fiscal year 2014, when the deals will actually close. Moreover, the rise of the equity markets will also give a boost to the earnings of the investment banks.
Most of the Fed officials predicted that the benchmark lending rate would remain at 2% or lower by the end of 2016 in order to support growth and create jobs. A slow recovery in the housing sector and tight credit would cause the lower benchmark lending rates. Thus, I believe that there will be no more fixed-income inventory markdown for the banks in the coming years. Therefore, I believe that the lower interest rates will give a boost to fixed-income trading volumes.
I believe that Goldman Sachs is a healthy company because of its improving liquidity ratios and Tier ratios. The company's Tier 1 capital ratio and Tier 1 common capital ratio improved in the third quarter of the current fiscal as compared to the second quarter of the fiscal year 2012. Moreover, its average Global Core Excess also increased in the most recent quarter.
The US economy is on its path of recovery. The unemployment rate is expected to decline in the future. Therefore, I believe that, with the recovery of US economy, the stock's performance and the company's profit margins will improve in the future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.