(GS) The Goldman Sachs Group Analyst Maintains Shares at Neutral

We maintain our Neutral recommendation on The Goldman Sachs Group Inc. (GS) as with the improving economic conditions, the company is gaining from a solid balance sheet and growth of its global clients.

In April, Goldman reported first-quarter 2011 earnings of $1.56 per share, significantly outpacing the Zacks Consensus Estimate of 79 cents per share. Results included a preferred dividend of $1.64 billion related to the redemption of Goldman’s Series G Preferred Stock. During the first quarter of 2011, Goldman repurchased 9 million shares of its common stock at an average cost per share of $163.22, for a total cost of $1.47 billion.

Despite the broad macro concerns, Goldman experienced increased client activity across many of its businesses within Institutional Client Services during the first quarter of 2011, although volumes were still restrained. Reflecting seasonal upswing, the company recorded improved client activity in each of its major businesses within Fixed Income, Currency and Commodities (FICC) client execution, in addition to higher volumes across equities as reflected in equities client execution and commissions and fees. The increased activity reflects the company’s continual investments in the global client franchise, which is expected to prevail in the upcoming quarters.

Further, in the volatile macro environment, Goldman foresees new market expansion. In March 2011, the asset-management unit of Goldman agreed to acquire India’s Benchmark Asset Management Co. (BAM), which is the largest provider of exchange-traded funds (ETFs). The acquisition is meant for expansion in Asia’s third-largest economy. This commitment will enable the company to continue its legacy of providing superior services to clients, returning to shareholders, and attracting and retaining competitive position in the global marketplace.

Moreover, in May 2011, Goldman received approval from a sufficient number of shareholders of its Australian and New Zealand joint venture to acquire the remaining 55%. Previously, in 2003, the company had acquired a 45% stake in the joint venture for operating its business in Australia and New Zealand. Goldman’s primary intention was to strengthen its business in Australian investment banking market.

On the flip side, the profitability of several of Goldman’s segments, including Asset Management and Securities Services, remains challenging. However, Asset management division continued to improve in the first quarter of 2011 on a year-over-year basis, primarily due to higher incentive fees. However, given the tighter securities lending spreads, resulting from the changes in the composition of securities lending customer balances, the Securities Services segment deteriorated significantly in the prior years, while remaining stable in the reported quarter. The growth in such segments remains uncertain in the upcoming quarters due to the vague economic environment.

Goldman is currently meeting the requirements of the Basel II regulations. Though Basel 2.5 and Basel III capital guidelines have been finalized, their implementation is expected to take place over an extended transition period, starting from the end of 2011 for Basel 2.5 and end of 2012 for Basel III. The proposed changes will add further uncertainty regarding the company’s future capital requirements.

Earlier this week, Goldman announced the sale of its mortgage-servicing subsidiary, Litton Loan Servicing to Ocwen Financial Corp. (OCN) for about $263.7 million. Litton was acquired in 2007 for $428 million from Credit-Based Asset Servicing and Securitization LLC, known as C-BASS, a subprime mortgage investment firm. Besides, Goldman also agreed to repay more than $916 million of Litton’s debt.

The acquisition was a part of the strategy to acquire troubled mortgages at attractive prices and restructure the debts. Unfortunately, the strategy failed for Goldman as some distressed loans came up for sale than expected and prices were still higher. Further, the financial crisis hit the servicing businesses due to the rapid growth of foreclosures while boosting costs. Goldman is selling the unit as it failed to find opportunities of buying distressed mortgage loans.

After selling off Litton, Goldman will be able to reduce costs related to foreclosures and will be subsidized from mortgage mess to a certain extent. Further, Litton’s sale will bring an end to business, which involved dealing customers on a daily basis. Besides, Goldman will be able to prioritize high-valued investors that make up most of the bank’s business.

Fundamentally, we expect Goldman to benefit from its well-managed global franchise, strong capital base, and industry leading position in trading and asset management. However, on a year-over-year basis, the company recorded lower equity trading and the overall revenue decline in the quarter, coupled with persisting regulatory issues. However, we expect its prudent business model, market expansions and strong fundamentals to deliver better earnings in the upcoming quarters.

Goldman currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.

GOLDMAN SACHS (GS): Free Stock Analysis Report

OCWEN FINL CORP (OCN): Free Stock Analysis Report

Zacks Investment Research

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