Goldman Sachs Profit Falls 82%, Misses Estimates on Trading-Revenue Drop
July 20 (Bloomberg) -- Matthew McCormick, a portfolio manager at Cincinnati-based Bahl & Gaynor Inc., talks with Bloomberg's Lori Rothman and Dominic Chu about Goldman Sachs Group Inc.'s second-quarter profit and the outlook for the U.S. banking industry. Goldman Sachs said profit dropped 82 percent, missing analysts’ estimates on a slide in trading revenue, five days after settling U.S. regulators’ fraud allegations. (Source: Bloomberg)
Goldman Sachs Group Inc. said second-quarter profit plunged 82 percent to the lowest level since the end of 2008 as trading revenue declined more than analysts estimated.
Net income fell to $613 million, or 78 cents a share, from $3.44 billion, or $4.93, a year earlier, New York-based Goldman Sachs said in a statement today. The average estimate of 21 analysts surveyed by Bloomberg was for earnings of $1.99 per share, with estimates ranging from 77 cents to $4.34.
The earnings, released five days after the firm agreed to pay $550 million to settle a U.S. Securities and Exchange Commission fraud lawsuit, followed similar drops at larger competitors including JPMorgan Chase & Co. Concern about economic growth and financial reform legislation reduced clients’ willingness to take risk and do deals, crimping profits at finance companies and weighing on stocks.
“They still had a good and profitable quarter, but it was lackluster based on expectations,” said Douglas Ciocca, a managing director at Renaissance Financial Corp. in Leawood, Kansas, which oversees about $2 billion. Still, “without question, the SEC settlement was bigger news than the earnings.”
Goldman Sachs rose $3.23, or 2.2 percent to $148.91 in New York Stock Exchange composite trading at 4 p.m., reducing the stock’s year-to-date decline to 12 percent. The S&P 500 Financials Index, which tracks the performance of 80 financial company shares, is down 0.8 percent this year.
Equities Trading
Goldman Sachs’s 36 percent drop in revenue exceeded analysts’ estimates, with equities trading revenue plunging because market volatility surged when the firm was positioned to profit from a decline.
David Viniar, Goldman Sachs’s chief financial officer, said on a call with analysts that the firm’s equity derivatives division didn’t hedge its short position on volatility fast enough.
“This is a rare admission by GS that their traders are mere mortals like the rest of us,” Brad Hintz, an analyst at Sanford C. Bernstein & Co., wrote in an e-mail that referred to Goldman Sachs by its stock market ticker symbol.
Overall revenue dropped to $8.84 billion, 31 percent below the first quarter and down 36 percent from the second quarter of last year. The biggest component, revenue from trading fixed- income, currencies and commodities, fell to $4.4 billion from $7.39 billion in the first quarter and $6.8 billion a year earlier.
‘More Difficult’
“The market environment became more difficult during the second quarter and, as a result, client activity across our businesses declined,” Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, said in the statement.
Viniar said he couldn’t estimate when markets would revive, although the company isn’t worried enough yet to scale back hiring or expansion plans.
“I’m worried, as you know I worry about everything,” he said. “We don’t know and it doesn’t feel great but not enough that we think we should stop our plans for the future.”
Costs during the quarter included a $600 million charge for a tax levied by the U.K. government on bonuses paid to bank employees last year as well as a $550 million cost from the SEC settlement. Excluding those two items, earnings per share would have been $2.75 per share. That’s still the lowest since the fourth quarter of 2008.
Total operating expenses dropped to $7.39 billion from $8.73 billion in the same period a year earlier as the company reduced compensation costs to $3.8 billion from $6.65 billion.
Employee Pay
Goldman Sachs set aside $9.3 billion to pay each of its 34,100 employees in the first half of the year, or an average of $272,580 per person. That compares with $11.4 billion in the first half of 2009, which equated to $364,134 for each of the firm’s 31,200 employees at the time.
The ratio of compensation to net revenue fell to 43 percent in the first half from 49 percent in the first half of 2009.
Goldman Sachs’s shares rebounded last week after the firm settled with the SEC over its 2007 sale of a collateralized debt obligation. The cost was lower than the $1 billion some analysts had estimated and the settlement didn’t require any management changes. Viniar said in an interview that he’s “not aware of any discussions” about changing the CEO or chief operating officer following the accord.
Analysts slashed earnings estimates in recent weeks on concern market declines would hurt trading revenue as well as on costs related to the settlement and the U.K.’s bonus tax.
Bank of America
Shares of some of Goldman Sachs’s biggest rivals fell last week after they reported revenue that was lower than investors predicted. JPMorgan Chase’s second-quarter net revenue dropped 9 percent from the first quarter as sales at the investment-bank unit slid 24 percent. Bank of America Corp.’s revenue fell 9 percent as global banking and markets results tumbled 38 percent. Citigroup Inc.’s revenue also fell.
“When you heard from JPMorgan, Bank of America and Citi, you had a pretty good idea of where some of the trading trends were lining up, and Goldman followed suit,” Ciocca said.
Morgan Stanley, which was the second-biggest securities firm after Goldman Sachs before both converted to banks in 2008, is due to report earnings tomorrow.
Goldman Sachs’s second-quarter annualized return on common equity, or ROE, a measure of how well the firm reinvests earnings, declined to 7.9 percent in the quarter from 20.1 percent in the first quarter and 23 percent in the same quarter a year earlier. Book value per share climbed to $123.73 from $122.52 at the end of the first quarter.
Better Returns
“We certainly hope to have better returns than this in the future,” Viniar told reporters on a conference call today. “We expect our ROE over the cycle will be significantly higher than this.”
Principal investments, which includes gains and losses from Goldman Sachs’s stake in Industrial & Commercial Bank of China Ltd. as well as stakes in other companies and real estate, provided a $943 million gain in the quarter. The figure included a $905 million accounting gain on the company’s stake in ICBC, even though ICBC stock fell during the quarter, because transfer restrictions on the shares expired.
Investment-banking revenue dropped 23 percent to $917 million from the first quarter as advisory fees gained 2 percent, debt underwriting revenue declined 36 percent and equity underwriting revenue decreased 40 percent. The company said the so-called backlog of pending deals increased during the quarter.
Proprietary Trading
Investors and analysts said before the earnings that they’re keen for news on how the settlement, which imposes changes to the way Goldman Sachs sells mortgage-related securities, and the wider financial regulatory reform bill passed by the U.S. Senate last week will affect earnings.
In calls with reporters and analysts, Viniar provided little insight into how the financial legislation might affect the firm’s revenue or earnings. He said the two areas of the firm’s business that are likely to be most affected are derivatives and proprietary trading and investment, both of which will be subject to new restrictions under the bill.
New rules won’t be adopted “for probably 15 months, then the transition period, as you know, for many of the businesses are quite long, in some cases up to five years beyond that,” Viniar said. “To quantify that now, I would just be making up numbers.”
Viniar said most of the changes in the legislation will either increase the firm’s available capital or have no effect.
“I think most of the provisions are either capital- enhancing in a way or capital-neutral,” he said.
Revenue from asset management rose 3 percent to $976 million from $946 million in the first quarter as assets under management fell 5 percent to $802 billion from $840 billion in the first quarter. Securities services, the division that includes fees charged for providing services to hedge funds, reported $397 million in revenue, up from $395 million in the first quarter.
To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net
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