NEW YORK ( TheStreet) --With Goldman Sachs ( GS) widely expected to make a loss in the third quarter, the investment bank may have to make deeper cuts to convince shareholders that it can deliver higher returns amid difficult market conditions. More than 20 analysts have downgraded estimates for Goldman Sachs in the past month, on expectations that its "investing and lending" segment will post a huge loss amid a declining equity market. The difficult operating environment is also likely to have affected trading revenues and investment banking fees. Citigroup's Keith Horowitz became the latest to downgrade the earnings estimate for the company on Tuesday. The analyst now expects Goldman to post a loss of 65 cents per share, compared to an earlier estimate of a profit of 10 cents per share. Analysts on an average expect the investment bank to post a loss of 9 cents per share, adjusting for one-off items, according to consensus estimates from Bloomberg. More troubling is the fact that the market uncertainty and volatility is now expected to last for several quarters, as there is no quick resolution to Europe in sight and the global economic outlook has weakened. The weak revenue outlook might increase the pressure on traditional investment banks to get more aggressive with their expense reduction programs. Compensation accounts for the bulk of the expenses for investment banks and, therefore, is the greatest lever management has to boost profitability. According to a New York State Comptroller report released on Tuesday, the securities industry in New York City has lost 4,100 jobs since April 2011. The Office of State Comptroller expects that the city could lose nearly 10,000 additional jobs by the end of 2012, which would bring total job losses in the securities industry to 32,000 since January 2008. Still, firms always have to walk a delicate balance between cutting the fat and cutting the bone. Banks need to have the talent in place to bring in the money when the cycle turns. Goldman has, so far, refrained from making big cuts to headcount. Last quarter, it said it will lay off 1,000 employees as part of a $1.2 billion cost-reduction initiative.
Still, management indicated during the conference call that they were more focused on dollar savings rather than "number of heads", meaning they were more likely to drop expensive employees rather than take to mass layoffs. However, it remains to be seen how the company can make dramatic cuts to expenses without laying off more workers. Reducing headcount does ultimately help in driving savings in non-compensation expenses such as travel and telephone expenses. It might boil down to how Goldman sees its business model evolving. Part of the reason why the stock is trading at a discount to tangible book is because markets remain uncertain of the business model of pure-play investment banks post- Dodd Frank regulations that seeks to curb risk-taking. According to Morgan Stanley analyst Betsy Graseck, Goldman Sachs' management is currently viewing the difficult environment as merely "cyclical". CFO David Viniar apparently indicated in a meeting in September that the investment bank will only start using headcount as a lever if the environment lasts for a longer period, say two years. But the market might not be that patient. --Written by Shanthi Bharatwaj in New York >To contact the writer of this article, click here: Shanthi Bharatwaj.
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