Credit crunch catches up with Goldman

By Joseph A. Giannone

NEW YORK (Reuters) - It soared above the mortgage crisis with record earnings last year, yet Goldman Sachs cannot escape the pull of the widening credit crunch.

The world's largest investment bank traded and hedged its way through the subprime mess last year, posting record profit and when other U.S. and European banks suffered more than $120 billion of losses. Relative to Goldman's enormous trading and investment operations, mortgages are a bit player.

But the credit storm has intensified this year, striking businesses where Goldman does have scale: financing and advising buyouts, corporate real estate, underwriting and equity investments.

Analysts, used to watching Goldman exceed expectations with surprise trading gains, only in recent weeks slashed forecasts. The average estimate for 2008 earnings, down modestly during the second half last year, plunged 13 percent since February 1 as analysts focused on Goldman's exposure to hard-hit markets.

Goldman is expected to report first-quarter earnings of $3.24 a share on March 18, according to Reuters Estimates. That's about half what it earned last year, buoyed by an LBO boom, frothy financial markets and investment gains.

Forecasts have come down sharply for all the big banks, as the credit crunch spreads across almost every market -- the contagion effect that Wall Street executives last year assured analysts was not happening.

The most important yardstick, though, is the stock market. Goldman, for years a leader among financial stocks, is down more than 26 percent this year. Only Lehman fared worse among the big broker-dealers, with a 30 percent decline.

Lehman Brothers LEH.N, Bear Stearns BSC.N and Morgan Stanley (MS.N), which have larger mortgage exposures and which suffered losses last year, also report results in two weeks.

"Investment banking revenues are down, retail investors are pulling money out of mutual funds, a softening economy is spreading the subprime infections to new areas of the credit markets," Bernstein analyst Brad Hintz said in a recent note. "It is not a happy period on Wall Street."

With roughly $200 billion of risky corporate loans and few willing buyers, bank lenders have scrambled to sell loans at steep discounts in recent weeks. Oppenheimer analyst Meredith Whitney forecast the biggest U.S. brokers could post up to $14 billion of first-quarter write-downs on these loans.

Goldman had about $42 billion of leveraged loan commitments on its books at the end of its fiscal year in November, according to regulatory filings. Analysts predict nearly $2 billion in write-offs at the bank.

Another potential source of trouble is Goldman's variable interest entities, vehicles that keep assets off the books by issuing short-term debt. Goldman had $62.1 billion in VIEs holding mortgage securities, real estate and other assets, at the end of November, excluding hedges.

Goldman also is the most aggressive bank investing its own capital in private and public companies, including $6.8 billion in Industrial and Commercial Bank of China (601398.SS) and $4.1 billion in Japan's Sumitomo Mitsui Financial Group (8316.T). Shares of both banks fell about 20 percent during the quarter.

Even without these stakes, Goldman carried $11.9 billion of corporate and real estate investments on its books at the end of November. These values are expected to come down in a period when markets around the world slumped.

Investment banking, which plays a small role in overall results, likewise suffered as market woes stalled deal activity. In the first two months of this year, industry-wide announced M&A activity fell 27 percent from last year. Goldman's market share also slipped, according to Dealogic.