Goldman Sachs Results May Show Whether Debt Dominance at Risk

Lloyd Blankfein, CEO of Goldman Sachs Group Inc.
Lloyd Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc., testifies before the Financial Crisis Inquiry Commission (FCIC) in Washington, on Jan. 13, 2010. Photographer: Brendan Hoffman/Bloomberg

Goldman Sachs Group Inc., accused by regulators last week of fraud in its mortgage-securities business, may show investors tomorrow whether its dominance of Wall Street’s debt trading is being eroded by competitors.

Analysts including Howard Chen at Credit Suisse Group AG expect New York-based Goldman Sachs, which reports first-quarter earnings tomorrow, to say revenue from fixed-income trading dropped from $6.56 billion in last year’s first quarter. Earnings last week from Bank of America Corp. and JPMorgan Chase & Co., the two biggest U.S. banks by assets, surged on record first-quarter revenue from the business.

Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, relied on fixed-income trading for more than half of revenue last year, helping the firm post record profit. Competitors that lagged behind Goldman Sachs a year ago are trying to catch up. Morgan Stanley, which reports earnings on April 21, hired more than 350 people last year to rebuild its sales and trading business.

“Competition appears to be returning, but it’s not necessarily a zero-sum game as the overall market is growing,” said New York-based Chen, who has an “outperform” rating on both Goldman Sachs and Morgan Stanley. “Global GDP is positive, fixed-income issuance levels have been robust and client liquidity levels seem healthy.”

Goldman Sachs’s competitors may see the Securities and Exchange Commission’s suit against the firm as an opportunity to grab market share. The SEC sued the firm for fraud on April 16, saying Goldman Sachs misled investors in its marketing of collateralized debt obligations tied to subprime mortgages. Goldman Sachs said the allegations were “completely unfounded in law and fact.”

Dimon’s Outlook

JPMorgan CEO Jamie Dimon told analysts last week that he didn’t expect his bank to be alone in reporting gains in trading revenue because overall demand from clients has picked up.

“It is a lot of client flow, so we’re not the only ones who saw that,” Dimon said. “I think you’re going to see other people report similarly good numbers driven by client flow.”

Of the six-biggest U.S. banks by assets, only Goldman Sachs and San Francisco-based Wells Fargo & Co. are expected by analysts to show a decline in profit in 2010 compared with last year, when they both generated record earnings.

First-quarter adjusted earnings at Goldman Sachs will probably rise 54 percent from a year earlier to $2.55 billion, or $4.14 per share, according to the average estimate of 23 analysts surveyed by Bloomberg.

Gorman’s Goal

James Gorman, Morgan Stanley’s new CEO, is expected to report $1.1 billion in adjusted first-quarter earnings, or 57 cents a share, compared with a loss a year earlier, a Bloomberg survey shows. Credit Suisse’s Chen expects Morgan Stanley’s fixed-income trading revenue to rise to $1.95 billion from last year’s $1.29 billion, which was damped by writedowns and accounting adjustments related to the firm’s credit costs.

“You listen to James Gorman on the call last quarter and he’s very clear that we want to be top three in all of our businesses,” Chen said. “That would mean closing the gap in fixed-income and equities trading.”

Morgan Stanley spokesman Mark Lake declined to comment about trading revenue. Goldman Sachs spokesman Lucas van Praag also declined to comment.

Goldman Sachs gained 4.7 percentage points of market share in fixed-income trading since the first half of 2007, more than double the next-biggest climb of any of the top 14 banks, Keith Horowitz, an analyst at Citigroup Inc., said in an April 6 note to investors. Morgan Stanley’s market share in fixed-income trading fell 2.4 percentage points in that time, Horowitz said.

“Ability to regain trading market share is the key to the stock,” Horowitz wrote of Morgan Stanley.

Analysts’ Estimates

Goldman Sachs will probably report $6.09 billion in fixed-income trading revenue in the first quarter, down 7 percent from a year earlier, Barclays Capital analyst Roger Freeman said in a March 30 note. Morgan Stanley may report $1.94 billion in fixed-income trading revenue, up 50 percent, Freeman said.

JPMorgan’s first-quarter earnings surpassed estimates last week in part because of $5.5 billion in fixed-income revenue that set a record for the New York-based bank. Bank of America said April 16 that revenue from fixed-income, currency and commodity trading climbed 16 percent to $5.52 billion in the first quarter, the most since the largest U.S. bank acquired Merrill Lynch last year.

UBS AG generated about $2.3 billion of revenue at its fixed-income division in the first quarter, people with knowledge of the situation said last month. The bank said that figure was “slightly higher” than its forecast. Writedowns in the first quarter of 2009 forced the Zurich-based company to report negative revenue of 1.97 billion Swiss francs ($1.86 billion) for the period.

‘Normal Level’

“Revenues you’re seeing now are probably more broadly based,” said Richard Staite, a London-based analyst at Atlantic Equities LLP. “Bid-offer spreads have come down to a more normal level, but you’ve seen a pickup in client activity across a number of different sectors, so I think we’re getting more toward a normal environment.”

Goldman Sachs generated $23.3 billion in revenue from sales and trading in fixed-income, currencies and commodities, more than half of the firm’s total revenue last year. That performance helped drive the firm to the largest profit in Wall Street history just one year after reporting its first quarterly loss as a public company.

Morgan Stanley generated $5.02 billion of fixed-income sales and trading revenue as it ramped up risk at a slower pace than Goldman. The firm replaced its sales and trading chief, Mitch Petrick, and its head of interest-rate trading, Roberto Hoornweg, and has been hiring to revive the business.

Debt Spreads

Charges related to the firm’s debt spreads that reduced fixed-income trading revenue by $3.3 billion in 2009 “are largely behind” it, Gorman said this month in a letter to shareholders.

Still, 12 analysts have cut their estimate for Morgan Stanley’s first-quarter earnings in the past four weeks, according to data compiled by Bloomberg. The average adjusted earnings per-share estimate fell 13.8 cents in that period, the data show.

“Morgan Stanley is trying to become more diversified by expanding its retail brokerage, but trading revenues remain the key factor driving their results,” Staite said.

Goldman Sachs shares have dropped 4.8 percent this year, including a 13 percent decline on April 16 when the fraud allegations were announced. Morgan Stanley has dropped 1.5 percent in 2010, after gaining gained 85 percent last year.

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