Goldman Sachs Group Inc (GS.N) said revenue from trading bonds with clients fell 7 percent in the first quarter, raising questions about the health of the bank's biggest money maker and the prospects for fixed-income trading profits on Wall Street.
Equities trading revenue has been squeezed for years across Wall Street by the growth of online trading platforms, but the fixed-income, currency, and commodities business has only recently begun facing similar pressures.
On a conference call, analysts peppered Harvey Schwartz, Goldman's chief financial officer, with questions about how the bank plans to boost trading revenue in the future.
Schwartz said Goldman hopes to win market share from banks that are pulling back from bond trading and other businesses. Even if the near term is a little uncertain, Goldman has enough strength in areas ranging from commodities to prime brokerage to maintain a full range of trading businesses, he said.
Goldman's trading results overshadowed its overall profit, which rose 5.5 percent as other businesses made up for trading declines. The bank's own investments grew more valuable, and its investment banking revenue climbed. Yet each of those businesses is a fraction of the size of the equity and fixed income trading franchise.
Overall, Goldman reported just a 1 percent increase in revenue, which David Trone, an analyst with JMP Securities, said indicated a "lack of momentum."
For the first quarter, Goldman reported $2.07 billion of revenue from its Investing and Lending segment, where it bets its own capital. The results were up 8 percent from a year earlier and the second-highest total since the bank began separating out that earnings category in 2011. Most of the increase came from gains in private-equity holdings, Goldman said.
The weakness in customer trading revenue, combined with the strength in the bank's bets with its own money, gave many investors a sense of deja vu. Before the crisis, Goldman Sachs was famous for making big wagers that often paid off. After the financial crisis, new laws and regulations are meant to discourage banks from putting themselves and the financial system at risk with big trades.
"Goldman hasn't really changed its stripes that much, except that it shut down a few of its prop trading desks," said Bernie Williams, vice president of discretionary money management at USAA Investments, which oversees $55 billion in assets. "Goldman is still a classic investment-banking and trading firm. Some people still call them a giant hedge fund which probably isn't too far off the mark."
Goldman says it does not make short-term bets, but instead makes longer-term investments and loans. Still, Williams said he does not invest in Goldman shares because he cannot forecast how well the bank's investments will perform in the future. Instead, he invests in Goldman's chief rival, Morgan Stanley (MS.N), which has a steadier earnings stream from wealth management.
Overall, Goldman's first-quarter profit rose thanks to both the Investing and Lending gains and sharp increases in stock and bond underwriting fees. Net income applicable to common shareholders rose to $2.19 billion, or $4.29 per share, from $2.07 billion, or $3.92 per share, a year earlier.
Analysts on average had expected earnings of $3.88 per share before unusual items, according to Thomson Reuters I/B/E/S.
Michael Wong, an analyst with Morningstar, said Goldman's results were "pretty decent" considering weak client trading volumes across Wall Street. He said Morgan Stanley might have a tough time matching Goldman's performance because it has less exposure to principal investing and because he expects it to report weaker wealth-management profits compared with the prior period.
PRESSURE ON BOND TRADING
Even aside from weak trading volumes, fixed income, currency and commodities trading faces profit pressure in coming years as the market changes. More trades are being cleared centrally or taking place on an exchange, rather than taking place bilaterally between a bank and a client, meaning banks are making less money from serving as a middlemen between clients.
Goldman's first-quarter revenue from fixed income, currency and commodities trading fell to $3.22 billion from $3.46 billion a year earlier. Equities trading revenue fell 15 percent, to $1.92 billion from $2.25 billion, but the decline in fixed income trading was the bigger concern for many analysts because of its relative size.
In 2011, the bank's CFO at the time, David Viniar, acknowledged these pressures. "It's pretty clear that some of the technological advances that happen in equities are going to happen in some of the FICC businesses," he said.
With these challenges, many of Goldman's competitors are retreating. UBS UBSN.VX, for example, is pulling back from the fixed income, currencies and commodities trading business.
Less competition may help Goldman Sachs, CFO Schwartz said.
"It feels like there is reasonable market share opportunity, given the environment," he said on an earnings conference call. For competitors, "unless you're a leader in some of these businesses, I think it is a difficult time to build," he added.
GAINS FROM EQUITIES
Goldman's first-quarter revenue totaled $10.09 billion. Investment banking revenue jumped 36 percent to $1.57 billion.
Operating expenses were little changed at $6.72 billion.
Goldman's annualized return-on-equity, a closely watched measure of profitability, rose to 12.4 percent from 12.2 percent a year earlier but was still far below pre-crisis levels above 30 percent.
Goldman's Investing and Lending earnings come mostly from mark-to-market gains on stocks, bonds, loans and other assets. It also included interest income from loans.
The unit continues to befuddle investors and analysts since it invests in a wide array of assets and there is little disclosure.