Goldman Sachs Group Inc rattled investors with earnings that fell far short of expectations because of sharp declines in bond trading revenue, long a key source of profits for the investment bank.
Goldman, once Wall Street's largest bond trading house, reported its sixth consecutive quarterly decline in that business, where Chief Executive Lloyd Blankfein earned his spurs.
Equities trading, which typically produces lower margins, produced stronger revenue for the company during the quarter.
Goldman's fixed income, currency and commodities trading revenue fell 53 percent to $1.6 billion, far worse than analysts had expected.
On a conference call, Chief Financial Officer David Viniar said the bank is likely to lay off about 1,000 employees by the end of the year, or about 3 percent of its staff.
Analysts questioned whether Goldman and its Wall Street rival Morgan Stanley are losing ground to larger commercial banks, which are traditionally less nimble in trading than the investment banks.
What happened? Did they lose market share? asked Chris Whalen, an analyst who covers bank stocks at Institutional Risk Metrics, based in Los Angeles. It seems like Goldman and Morgan Stanley cannot compete with the big commercial banks.
Goldman attributed the trading weakness to insipid client activity and a lack of clear market direction. Unlike JPMorgan Chase & Co and Citigroup Inc, which posted better-than-expected trading results last week, Goldman does not have a commercial banking operation to bulk up revenue or the flexibility to boost its earnings by drawing money from huge loan loss reserves.
Goldman can't release reserves, and JPMorgan, Wells and Citi can. That's the difference, said Keith Davis, bank analyst and principal at money manager Farr, Miller & Washington in Washington.
Viniar said trading feels a little better so far in the third quarter, but he cautioned that the business will be slower for the foreseeable future.
Overall, Goldman earned $1.05 billion, or $1.85 per share, in the second quarter, far below the $2.27 per share analysts had forecast. Adjusted for special charges, Goldman earned $2.75 per share a year earlier.
During the second quarter, the operating environment was more difficult given global macro-economic concerns, Blankfein said in a statement.
In addition, certain of our businesses had disappointing results as we reduced our market risk, he added.
Goldman shares fell 2.7 percent at the market open but later recouped a bit. They were down 1.4 percent at $127.50 near midday.
The shares are down by about a quarter so far this year, underperforming the broader market. Investors have been holding off buying the stock because of the weak trading environment and worries over financial regulation, which is set to cut further into Goldman's revenues.
The markets haven't been that great, and I just think a lot of financial institutions, because of regulatory concerns, they've held back a little bit on proprietary trading and other aspects of their business, said Mark Bronzo, portfolio manager for Security Global Investors, who does not hold Goldman stock. All of that is going to put a damper on trading results.
Indeed, Goldman's value-at-risk, a key measure of how much risky trading activity it took on during the quarter, dropped nearly 26 percent from a year earlier and 11 percent from the first quarter. Value-at-risk is now at its lowest level since the third quarter of 2006.
On the bright side, Goldman's performance in investment banking, where it advises clients on mergers or debt and equity issuance, was strong, although not strong enough to make up for the trading declines. Investment banking revenues overall rose 54 percent to $1.45 billion.
Net revenues in the bank's investment and lending business, where it trades and holds equity stakes for its own account, were hurt by weak equity markets and fell 42 percent to $1.04 billion. The bank took a loss of $176 million from its investment in Industrial and Commercial Bank of China Ltd.
Goldman has been on a cost-cutting campaign, but the reductions so far haven't been enough to stem its profit decline. Second-quarter operating expenses fell 23 percent from a year ago to $5.67 billion. Goldman aims to cut $1 billion in non-compensation costs by the middle of next year, and has recently started to lay off some staff.
The firm is in the process of implementing expense reduction initiatives, Goldman said in a statement, without elaborating.
Goldman accrued $3.2 billion for compensation, bonuses and benefits in the second quarter, down 16 percent from a year ago. Its compensation ratio was unchanged from the previous quarter at 44 percent.
The bank's return on equity, a key metric of shareholder return, fell to 6.1 percent in the latest quarter, half of the level just three months ago and far below its returns of more than 30 percent during the boom years of 2006 and 2007. (Reporting by Lauren Tara LaCapra; additional reporting by Jonathan Spicer; editing by Knut Engelmann and John Wallace)