Goldman Sachs' anemic second-quarter results on Tuesday rattled investors and cast a pall on its reputation as Wall Street's trading powerhouse.
The biggest U.S. investment bank reported earnings and revenue far below analysts' already-reduced expectations and year-ago levels once adjusted for a special charge.
The culprit of the sharp decline was a big drop in income from fixed income, currency and commodities (FICC) trading, due to weak client activity and a sharp pullback in risk taking.
That business has historically been a highly profitable one for Goldman, representing 35 to 48 percent of revenue in recent years. This quarter, it comprised just 22 percent.
Without sugarcoating it, we did underperform during the quarter, Chief Financial Officer David Viniar told analysts on a conference call. We are disappointed in the results.
A source familiar with the bank's results said Goldman had left millions of dollars of potential revenue on the table by being overly conservative in its trading approach and by hedging certain trades more aggressively than it should have.
Maybe we made a bad decision in taking too little risk, Viniar said.
Viniar said the trading environment had improved somewhat in early July. But he cautioned investors the overall situation was unlikely to get much better soon, citing tremendous uncertainty in markets created by sovereign debt woes in Europe and other macroeconomic worries around the globe.
In response, Goldman plans to cut about 1,000 jobs across the firm by the end of this year, part of a plan to reduce costs by $1.2 billion. The cutbacks would represent almost 3 percent of Goldman's 35,500 employees.
Once Wall Street's largest bond trading house, Goldman reported its sixth consecutive quarterly decline in its FICC business. Revenue there fell 53 percent to $1.6 billion, far worse than analysts had expected.
Equities trading, which typically produces lower margins, produced stronger revenue for the company during the quarter.
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.
The weak results sent Goldman's stock down more than 3 percent early in the day to a new two-year low of $125.50, before they recovered to close down 0.65 percent at $128.49.
'Disappointing' is a good way to describe it, said Oliver Pursche, president of Gary Goldberg Financial Services, which manages $550 million in assets and holds a small Goldman position in its GMG Defensive Beta Fund.
These results and other events have certainly chipped away at the armor of Goldman Sachs and may be lessening the absolute dominance that it had for so many years, Pursche added. Still, he said the stock might be a buy if it falls further.
Goldman's shares have lost a quarter of their value so far this year, underperforming the broader stock market and other bank stocks. Investors have shunned Goldman stock, worried about profitability and the impact of new regulations as well as government investigations.
Trying to get ahead of new rules prohibiting banks from trading for their own accounts, Goldman already dismantled two large proprietary trading desks. Viniar said the bank does not see a need to sell or significantly change any more units.
Some will have to be smaller. Some will have to be different, Viniar said.
Some analysts believe that Goldman's heavy reliance on proprietary trading in the past has made it more difficult for the bank to reinvent itself as an investment bank focused on making markets for its customers rather than itself.
Goldman was not the only Wall Street bank to report big declines in fixed income trading, as many clients kept to the sidelines because of economic and political uncertainty in Europe and beyond. But most rivals fared better than Goldman.
Citigroup Inc reported a fixed-income, currency and commodities trading decline of 18 percent from the year-ago quarter, while JPMorgan Chase & Co and Bank of America Corp said FICC trading revenues climbed 20 percent.
Chris Whalen, an analyst who covers bank stocks at Los Angeles-based Institutional Risk Metrics, believes that Goldman and its chief rival, Morgan Stanley, might be losing business to big competitors that can offer an array of financing options and other services to lure in otherwise reluctant clients.
It seems like Goldman and Morgan Stanley cannot compete with the big commercial banks, said Whalen.
TRADING IS KEY
Goldman's value-at-risk dropped nearly 26 percent from a year earlier and 11 percent from the first quarter. The closely watched number -- the lower it is, the less risk the bank took in its day-to-day trading operations -- 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 revenue overall rose 54 percent to $1.45 billion.
Net revenue in the bank's investment and lending business, where it trades and holds equity stakes for its own account, was 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 accrued $3.2 billion for compensation, bonuses and benefits in the quarter, 16 percent less than a year ago.
The bank kept its compensation ratio, or what it pays to employees in salaries, bonuses and benefits relative to revenue, steady at 44 percent. Still, its return on equity - a crucial measure of what investors earn on their capital - fell to a paltry 6.1 percent.
That's just half of the level it returned in the first quarter and what competitors such as JPMorgan earned in the second quarter. It is also a far cry off Goldman's returns of more than 30 percent during the boom years of 2006 and 2007.
Jack Kaplan, a portfolio manager for Carret Asset Management, which has $1.4 billion under management and recently bought a small position in Goldman shares, said he was holding off on making additional purchases until Goldman can prove its strength once the regulatory storm has blown over.
Right now, it all comes down to trading, and who knows where that's going to go? said Kaplan. I'm not going to make Goldman a full position until after I see some kind of confirmation of its earnings ability.
(Reporting by Lauren Tara LaCapra and by Knut Engelmann; editing by John Wallace and Matthew Lewis)