Goldman Sachs Group Inc's profits fell 72 percent and one of the few businesses that performed well for the bank -- investments and trading with its own funds -- faces regulatory restrictions in the future.
The bank's investing and trading for its own account generated 37 percent more revenue in the first quarter, representing the most growth of any of Goldman's businesses. But the main U.S. financial reform law features a rule limiting the bank's ability to bet for its own account.
Goldman has long been viewed as an earnings machine, consistently posting some of the highest returns on Wall Street. The results reflect a $1.64 billion charge for Goldman buying back preferred shares, but even ignoring that, profit fell.
Investors wonder if U.S. financial reform will cut into trading revenue and force the bank to focus on investment banking businesses that have historically been less profitable, such as underwriting stock and advising on mergers.
There's a paradigm shift toward the core banking side as opposed to buying and selling junk to make money over the short term, said Jason Ware, an analyst with fund manager Albion Financial Group.
I look at Goldman and I see an eroding brand, he added.
Revenue from trading with customers fell 22 percent from an unusually strong first quarter last year. Officials at the bank said customer trading volume in fixed income and currencies has been weaker than it had been historically, and if volume does not pick up, it might make sense to lay off traders.
The bank's clients are cautious because of macroeconomic doubt and uncertainty about how financial markets will be regulated, Chief Financial Officer David Viniar said.
We're taking advantage of opportunities where we see them with our clients, but there aren't that many, Viniar said in response to a question about why the bank does not borrow more to boost its returns.
In January, the bank posted a 53 percent decline in fourth-quarter profit and talked about how client trading volume in December was dead.
Customer trading volumes have risen since then. On Tuesday, Goldman said first-quarter customer trading revenue was 83 percent higher than the fourth quarter.
Trading profit across Wall Street has fallen from the unusually strong first quarter of 2010, but some banks have fared better than others. Trading revenue from clients at Goldman's fixed income, currency and commodity unit fell 28 percent, while JPMorgan Chase & Co posted a drop of just 4 percent. JPMorgan's results include any trading the bank may have done for its own account.
Profit from trading with customers may fall even further as financial regulators globally push for derivatives trading to move to exchanges. Currently, investors looking to trade many kinds of derivatives deal with banks rather than exchanges.
One bright spot in customer trading during the quarter was commodities, where revenue was higher during the first quarter than in the same quarter last year.
For the bank's investing and lending unit, profit growth came mainly from gains in its investment in Industrial and Commercial Bank of China Ltd and other equity securities.
Overall, Goldman's revenue fell 7 percent in the first quarter. The investments and lending business were responsible for about a fifth of overall revenue.
The bank posted a profit to common shareholders of $908 million, or $1.56 a share. Analysts' average forecast was 82 cents a share, according to Thomson Reuters I/B/E/S.
A year earlier, it posted earnings of $3.3 billion, or $5.59 a share.
Goldman's shares fell $1.89 to $151.89.
The bank bought back $5 billion of preferred shares from Warren Buffett's Berkshire Hathaway Inc in the quarter, resulting in a one-time charge of $1.64 billion.
Excluding that charge, the bank would have earned $4.38 a share.
Goldman set aside $5.23 billion for employee compensation in the quarter, a 5 percent decline from a year earlier.
The bank's return on average common shareholders' equity was 12.2 percent in the quarter, but excluding the preferred redemption it was 14.5 percent, annualized. By one rule of thumb, a 14.5 percent return on equity should correspond to shares trading at about 1.45 times their book value, or net accounting value.
With Goldman's shares trading at about 1.2 times their book value based on Tuesday's closing price, some investors see the stock as cheap.
Unfortunately, they've got an incredible amount of regulatory scrutiny on them right now and litigation risk. I think that's what holding back the stock, said Keith Davis of Farr, Miller & Washington, who holds Goldman shares.
Even if a 14.5 percent return on equity is sustainable, it is far below the levels in the years leading up to the financial crisis, when Goldman often posted returns on equity greater than 30 percent.
(Reporting by Lauren Tara LaCapra and Dan Wilchins; additional reporting by Angela Moon; editing by John Wallace and Andre Grenon)