Sept. 16 (Bloomberg) -- Goldman Sachs Group Inc., the largest of the remaining independent U.S. securities firms, said third-quarter profit fell a record 70 percent as revenue from advising corporations and trading stocks declined.

Net income was $845 million, or $1.81 a share, in the three months ended Aug. 29, compared with $2.85 billion, or $6.13, a year earlier. Goldman dropped 3.3 percent in New York as credit- rating downgrades of American International Group Inc. raised concern strains on the financial system are spreading.

After setting Wall Street profit records in 2006 and 2007, Chief Executive Officer Lloyd Blankfein, 53, is grappling with market convulsions that drove Merrill Lynch & Co. and Bear Stearns Cos. into emergency sales and Lehman Brothers Holdings Inc. into bankruptcy. Goldman shares slumped 12 percent yesterday and its senior notes dropped to a record low on concern no investment bank, even the most profitable, was safe.

``The business is just not happening and therefore Goldman can't take advantage of what doesn't exist,'' Ladenburg Thalmann & Co. analyst Richard Bove said in a Bloomberg Television interview. ``This is still 50 percent to 60 percent below what the company had been earning a couple years ago. The quarter is really terrible in many respects.''

Goldman's profit drop was the steepest in its nine years as a public company.

The shares declined $4.56 to $130.94 in composite trading on the New York Stock Exchange at 1:12 p.m. Morgan Stanley, the second-biggest U.S. securities firm, fell 12 percent. Both companies are based in New York.

Bank Deal

While Goldman has suffered a fraction of the writedowns on fixed-income assets that New York-based competitors Citigroup Inc. and Merrill have taken, its shares have dropped 40 percent this year as markets tumbled and fees from securities underwriting and providing merger advice dried up.

Analysts including David Trone at Fox-Pitt Kelton Cochran Caronia Waller have said the credit crisis shows independent securities firms such as Goldman should consider merging with a bank, to provide a more stable source of funding.

Chief Financial Officer David Viniar said today the company isn't interested in doing a deal with a bank. He also said he'd never rule out the possibility entirely.

``Right now we think our business model works because our business works,'' Viniar, 53, said in a telephone interview. ``Our performance speaks for itself and will continue to speak for itself.''

Tax Advantage

Analysts surveyed by Bloomberg estimated earnings of $1.71 a share. Goldman has beaten analysts' estimates for 13 straight quarters.

The firm would have fallen short of estimates in the third quarter if it hadn't been for a lower-than-usual tax rate, according to Jeff Harte, an analyst at Sandler O'Neill & Partners in Chicago.

``The effective tax rate came in at 12 percent, versus our 29 percent expectation,'' Harte in a note today. ``If the tax rate had come in at our 29 percent estimate, EPS would have been reduced by $0.37 to $1.44.''

Return on equity, a measure of how effectively the firm reinvests earnings, fell to 7.7 percent from 20.4 percent in the second quarter.

Revenue dropped 51 percent from a year ago to $6.04 billion. Fixed-income, currencies and commodities, the company's biggest source of revenue, generated $1.6 billion, down 67 percent. The firm took $275 million in writedowns on leveraged loans and related hedges, $500 million on residential mortgages and securities and $325 million on commercial mortgages and securities.

`Robust' Liquidity

Goldman held $1.7 billion of subprime mortgage assets, $3.6 billion of so-called Alt-A mortgages, and a bit more than $7 billion of prime mortgages at the end of the quarter, Viniar said in a conference call with analysts. The firm held the Alt-A mortgages at about 50 percent of face value at the end of the quarter, he said.

The firm cut its holdings of commercial real estate loans to $12.4 billion at the end of the quarter from $15.2 billion three months earlier, mostly through sales, he said.

Viniar said on a conference call with reporters that the firm had reduced its leveraged loan positions to about $8 billion. He said access to market liquidity remains ``robust.''

Equities trading revenue fell 50 percent to $1.56 billion and revenue from investment banking, which includes providing merger advice and underwriting stock and bond sales, dropped 40 percent to $1.29 billion.

ICBC Gain

The equities division was affected by a drop in stock prices, less trading by clients and ``very weak results'' from the firm's proprietary traders, Goldman said. Derivative revenue from equities was also lower.

The principal investments group, which includes the company's stake in Industrial & Commercial Bank of China Ltd., produced a $453 million loss, compared with a gain of $211 million a year earlier. ICBC dropped 17 percent in Hong Kong trading during Goldman's fiscal third quarter. Goldman owns about 5 percent of the company, although about two-thirds of its holding is on behalf of clients.

Goldman recorded a $106 million gain on the investment, as a quarterly accounting adjustment to the value of the stake on the firm's books outweighed ICBC's stock decline.

Asset-management revenue fell 6 percent from a year ago to $1.13 billion, partly because the third quarter in 2008 had one fewer week than in 2007, the company said. Assets under management declined $32 billion, of which $25 billion was because the market fell and $7 billion was because clients pulled their money out of Goldman's funds.

Tier 1, Level 3

Goldman's Tier 1 ratio was 11.6 percent, up from 10.8 percent in the second quarter. So-called Level 3 assets, including those to which the firm says it has no economic exposure, totaled $68 billion, or 6 percent of total assets. Level 3 assets are the ones that are hardest to value.

Lehman last week reported the biggest loss in its 158-year history, and its share price plunged 74 percent as management led by CEO Richard Fuld raced to find a buyer. Negotiations over the weekend at the New York Federal Reserve's downtown Manhattan headquarters failed to assuage the concerns of potential buyers and the company filed for bankruptcy protection yesterday.

Viniar said the market has mostly factored in the likelihood that Lehman will sell many of its real estate and loan holdings, so the bankruptcy shouldn't weigh on prices. A steep drop in asset values yesterday was more a ``shock reaction'' than an accurate reflection of the prices the investments will fetch, he said.

Lehman, AIG

Lehman's predicament made it clear to Merrill CEO John Thain that his firm's survival could be in jeopardy if he didn't find a buyer soon. Merrill, expected to post its fifth-straight quarterly deficit next month, agreed to be acquired by Charlotte, North Carolina-based Bank of America Corp. in an all- stock deal valued at about $50 billion.

Merrill considered selling a minority stake to Goldman before agreeing to the Bank of America deal, the Wall Street Journal reported today, citing people familiar with the matter.

AIG, the biggest U.S. insurer by assets, had its ratings cut yesterday, raising speculation the company needs to find more cash to post collateral. The insurer is trying to arrange loans from Goldman and JPMorgan Chase & Co., according to two people familiar with the situation.

``Our exposure to AIG is not material,'' Lucas van Praag, a Goldman spokesman, said today in an interview. ``We have always managed our exposure to single names extremely conservatively. That was the case with Bear and Lehman.''

Viniar, the CFO, declined to comment on possible financial transactions between Goldman and AIG.

`Adequate Caution'

Morgan Stanley is scheduled to report third-quarter earnings tomorrow. The firm may post a 44 percent drop in net income to $866 million, according to the average estimate of 10 analysts surveyed by Bloomberg.

Goldman and Morgan Stanley need to show investors that they've learned from the errors made by Merrill, Lehman and Bear Stearns by selling off some of their holdings of complex, hard- to-trade assets.

``I would hope they have taken the last few months as an adequate caution to clarify their positions and reduce some of their exposures,'' said John Gutfreund, president of Gutfreund & Co. and the former CEO of Salomon Brothers, in a Bloomberg Television interview yesterday.

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.

Last Updated: September 16, 2008 13:19 EDT