Blankfein's Decade Ending With a Thud on a Humbled Wall Street

Can Goldman Sachs Cost Cut Its Way to Profitability?
  • Goldman posts worst first-quarter revenue of CEO's tenure
  • Firm's 6.4% return on equity falls below cost of capital

To see how Wall Street has changed over the past decade, look to Goldman Sachs Group Inc. under Lloyd C. Blankfein.

The company, once the most profitable securities firm, reported the lowest first-quarter revenue of Blankfein’s tenure as chief executive officer, which began June 2006. Return-on-equity, a closely watched measure of profitability, fell to 6.4 percent, well below where it needs to be to show investors the firm can create value.

The results on Tuesday stem from sweeping structural changes buffeting Wall Street and renewed questions about whether firms including Goldman Sachs are doing enough to adapt to the altered landscape. The bank has been trying to wait out a years-long slump in fixed-income trading to win market share and boost profits once conditions improve. But will the industry ever rebound -- and if so, will it be soon enough?

It was an “un-Goldmanlike quarter with revenue pressures on just about every business,” Glenn Schorr, an analyst at Evercore ISI, wrote in a note. While market tumult at the start of the year eventually subsided, “Goldman (and everyone else) really needs capital markets to open further,” he said.

Goldman Sachs shares rose 2.3 percent Tuesday to $162.65, leading the 30-company Dow Jones Industrial Average higher and paring the bank’s 2016 decline to 9.8 percent. Markets stabilized in March and April after a rough start to the year, which suggests revenue may improve in the remaining months, Sandler O’Neill & Partners analysts Jeffrey Harte and Sumeet Mody wrote in a note on Tuesday.

Still, the first-quarter results at Goldman Sachs show how hard it is for global investment banks to navigate increasingly difficult terrain. Blankfein, 61, led his firm through the 2008 financial crisis in better shape than many rivals and posted record profit in 2009. In subsequent years, he shepherded the company through assaults on its reputation, including a congressional inquiry into pre-crisis sale of mortgage-linked investments.

Now the firm is trying to weather a storm of a different sort, as new rules cut leverage used to amplify returns, make bond inventory more expensive and prohibit the proprietary trading that was once one of Wall Street’s biggest sources of profit. In this year’s U.S. presidential election, the bank has become a target for candidates including Senator Bernie Sanders, who has repeatedly criticized it in debates, stump speeches and campaign ads.

Goldman Sachs’s revenue was 10 percent lower last year than in 2006, when Blankfein took the helm. At the start of this year’s first quarter, typically Wall Street’s busiest, market volatility and falling asset values drove clients to the sidelines, curbed dealmaking and further cut into trading across the industry. Goldman Sachs’s investment-banking revenue fell 23 percent to $1.46 billion amid a dearth of initial stock offerings. Trading revenue tumbled 37 percent from a year earlier to $3.44 billion.

The same forces eroded earnings across Wall Street at the start of the year. In the past week, JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Morgan Stanley all reported lower net revenue. Morgan Stanley, which has been shrinking its fixed-income operations, posted the biggest drop in sales and trading of that group -- about 32 percent less than a year earlier. Investment-banking revenue tumbled 27 percent at Citigroup. All of the companies cut expenses to cushion the blow. JPMorgan and Bank of America also were able to generate more income from their consumer businesses.

Blankfein has taken some steps in that direction, building up the firm’s Main Street operations and departing from its customary focus on institutional clients by operating a deposit-taking bank and planning an online lender. The asset management group purchased a retirement-plan startup this year that serves small businesses and freelance workers.

He has invested in technology, too, both to drive innovation and reduce the cost of having humans do tasks better served by machines. Blankfein has touted the programmers and other support staff he’s added in recent years. The firm’s workforce has grown to 36,500, including consultants and temporary staff, up from the 24,000 it employed at the end of May 2006, when its figures didn’t include those people.

The Wall Street slump has led the CEO to cut pay and other costs, with the $2.1 billion of non-compensation expenses in the first quarter the lowest in almost seven years. People familiar with his efforts have said he’s also embarked on the largest cost-cutting push in years, dismissing support staff, rejecting bankers’ spending on airfare, hotels and entertainment unless it directly serves clients, choosing not to fill open positions, and spending less on printing pitch books or brochures.

In the meantime, he and President Gary Cohn, 55, have defended the firm’s focus on trading, writing in their annual letter to shareholders they will continue to wait out the downturn in fixed-income markets. The bet is that Goldman Sachs can withstand structural changes to the industry and ultimately thrive as competitors, especially in Europe, pull back.

At the core, “he kept a pure investment bank,” and it’s already better adapted for the new market than most other firms, said Paul Gulberg, an analyst at Portales Partners LLC. “You have to judge it in the context of the environment and relative to peers.”

The firm has created value, Chief Financial Officer Harvey Schwartz said Tuesday, citing an increase in book value and $25 billion returned to shareholders over the past four years. The dividend is about double what it was when Blankfein took over.

Indeed, Goldman Sachs’s investors have fared better under Blankfein than at many other financial firms. The stock returned 17 percent from mid-2006 through the end of March, including reinvested dividends, while the 90-company Standard & Poor’s 500 Financials Index lost 14 percent.

When Hank Paulson handed Blankfein the CEO’s title in 2006, Wall Street’s mortgage machine was humming. The firm reported almost $38 billion of revenue that year and $46 billion in 2007 before seeing it cut in half to $22 billion following the collapse of Lehman Brothers Holdings Inc. Revenue climbed back to about $34 billion by 2012, and has hovered around that level for four straight years.

Many analysts have used the firm’s quarterly conference calls to ask for more clarity on when, and how, it can increase. On Tuesday, Schwartz attempted once more to defend the firm’s strategy from those demanding more widespread changes.

“We can’t control what happens in terms of the environment,” he said. “You really have to look at this over long periods of time.”

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