UPDATE 5-Goldman profit falls, but beats forecasts

(Adds detail on risk, tax savings)

By Joseph A. Giannone

NEW YORK, June 17 (Reuters) - Goldman Sachs Group Inc (GS.N) said on Tuesday quarterly earnings fell 11 percent as market turmoil hit trading and slowed investment banking, yet the firm again exceeded expectations by avoiding major losses on assets slammed by the credit crisis.

For more than a year, banks have been grappling with the challenges of a new world where profit engines such as mortgages, buyout finance and commercial real estate seized up. Goldman anticipated the changes earlier its rivals and was more aggressive in reducing exposure to hard-hit assets.

As a result, Goldman earnings fell for a second straight quarter, but not as much as its rivals.

"They have an uncanny ability to stay out of trouble," said Thomas Russo, portfolio manager at Gardner Russo & Gardner in Lancaster, Pennsylvania.

In the second quarter ended May 30, net income at the largest U.S. investment bank fell to $2.09 billion, or $4.58 a share, from $2.33 billion, or $4.93, a year earlier. The results beat the average analyst forecast of $3.42 by a third.

Net revenue fell 7 percent to $9.42 billion in a period that included the March panic that drove Bear Stearns into the ground and handed Lehman Brothers LEH.N a $2.8 billion loss.

Growth in equity underwriting, mergers and prime brokerage let Goldman beat forecasts, despite $775 million in write-downs and hedging losses. Goldman generated a surprisingly high 20 percent return on equity even as Merrill Lynch MER.N and Lehman executives forecast years of muted profit.

"They benefited from the disruption at the other investment banks," said Rose Grant, who helps manage $2 billion for Boston's Eastern Investment Advisors. "In tough times, people tend to gravitate toward the stronger financial firms."

Goldman shares, which had rallied 12 percent during the past week, were little changed in early afternoon trading.

TOUGH SLEDDING

Since credit and mortgage markets broke down last year, the world's banks and brokers have been forced to write down assets by more than $400 billion. The bursting of the credit bubble so far has led to 60,000 job losses and the ouster of senior executives at six of the world's largest banks.

The lack of easy credit also has slowed the pace of leveraged buyouts, mergers and public stock offerings. For stronger firms like Goldman, the environment led to new business helping companies raise capital and restructure.

Reflecting on the recent market environment, Goldman Chief Financial Officer David Viniar said markets remained treacherous. He estimated the credit crisis had probably moved past the halfway mark, yielding an environment that right now is "less stressed" than previous months.

"Clearly, the first weeks of March were the bottom, at least up to now," Viniar told reporters in a briefing. "Now there is less concern about systemic liquidity risk. People are focused on individual investments and credit."

Viniar also observed that Goldman has reduced its exposure to hard-hit assets, such as leveraged loans, at the same time it is scouring the market snapping up bad loans and other distressed assets at discounts. Goldman in the quarter reduced its balance sheet by 8 percent to just under $1.1 trillion.

"Our performance through the last several quarters leaves us well positioned to take advantage of market opportunities as they arise," he told analysts in a later conference call.

While rivals are busy pulling in their horns, Goldman has increased risk-taking. Value at risk, a measure for what it could lose in one day, rose 17 percent to $184 million from the first quarter, fueled by interest-rate derivatives and commodities.

Still, Goldman proved it is not immune from the problems caused by a market breakdown now in its second year. The firm absorbed $775 million of losses from credit products, including $500 million of losses on ineffective hedges.

Second-quarter revenue from fixed-income trading, normally Goldman's largest business, fell 29 percent to $2.38 billion. Revenue from trading interest rates, currencies and mortgages helped offset a steep drop in credit products.

Morgan Stanley (MS.N), which reports its quarterly results on Wednesday, saw its shares fall 4 percent in afternoon trading amid worries the No. 2 U.S. investment bank will suffer bigger losses than Goldman.

GROWTH AREAS

Other Goldman businesses fared better. Equity trading revenue was little changed, but was the quarter's biggest contributor at $2.49 billion. Robust client buying and selling offset a weak quarter in the firm's internal hedge fund.

Investment banking revenue fell 2 percent to $1.69 billion, reflecting the sharp downturn in bond and loan underwriting, but stock issuance fees were the highest in eight years.

Merger and acquisition fees rose 13 percent, as Goldman remained the top advisor worldwide so far this year, yet the backlog of pending investment banking fees fell during the quarter amid a slowdown of announced deals.

Asset management revenue rose 10 percent to $1.16 billion as funds under management swelled by $22 billion to $895 billion, including $6 billion of new client money.

Revenue from securities services, which includes prime brokerage services for hedge funds, soared 29 percent to a record $985 million, in part as disruptions at rival banks such as Bear Stearns attracted new accounts.

Principal investments revenue fell 7 percent to $725 million of revenue, including a $214 million gain on its Industrial and Commercial Bank of China (601398.SS) stake.

Goldman's compensation and other expenses also fell more than expected, as the firm reduced headcount by 1 percent to 31,495. It paid a lower income tax rate as more profit came from outside the United States, savings that accounted for about a third of the margin by which Goldman beat its estimates this quarter.

The bank reaffirmed it expects to increase employees this year by low single-digit percentage rates at a time Wall Street is slashing jobs. Goldman is aggressively expanding in Asia and other fast-growing regions.

The company's shares were down 21 cents at $181.88 in afternoon trading. The stock has fallen about 15 percent this year, outperforming a 20 percent drop in the Amex Securities Broker Dealer index .XBD. (Additional reporting by Dan Wilchins; Editing by Andre Grenon, Phil Berlowitz)