Goldman Sachs Group Inc took less risk and earned less money from customers' trading last quarter, even as the Wall Street bank reaped big gains from the rising values of its stock and bond investments.
The bank's executives struck a cautious tone on a conference call with analysts, saying that events such as the U.S. presidential election and the European debt crisis will continue to weigh on earnings in the coming quarters.
"There is still so much political uncertainty out there that is driving markets, both for our clients and for us," said outgoing Chief Financial Officer David Viniar. "And in that environment, it is very hard to have conviction and very hard to take risk, both for our clients and for us."
Goldman's average daily value at risk - which represents how much money the investment bank could potentially lose in a day - dropped to $81 million, the lowest level in roughly six years.
Its return-on-equity, a key measure of how much profit a company can wring from its balance sheet, also remained low at 8.6 percent. That's below the 15 percent level that shareholders generally expect investment banks to earn in better times and far below the 30 percent or more Goldman posted just before the financial crisis.
"ROE's kind of skimpy, but that goes along with high capital and some softness in the business," said Regency Wealth Management portfolio manager Andrew Aran, who owns Goldman shares for clients. "It's going to be impossible to go back to 15 percent in this environment."
All told, Goldman earned $1.5 billion, or $2.85 per share, in the third quarter, compared with a year-earlier loss of $428 million, or 84 cents per share.
Last quarter included a charge to reflect the rising value of Goldman's own debt, which reduced earnings by $370 million. The third quarter of 2011 included the cost of buying back preferred stock from Warren Buffett, as well as losses on Goldman's stock and bond holdings.
Analysts on average had expected the bank to earn $2.12 per share, according to Thomson Reuters I/B/E/S.
Goldman's biggest business, trading, reported a 3 percent increase in revenue.
A sizeable portion of that trading gain was at the expense of Knight Capital Group, which nearly went bankrupt in August after losing $440 million because of trading glitch. Goldman bought a lot of the stocks that Knight had inadvertently acquired, at a steep discount.
Revenue from commissions and fees dropped 29 percent. What little client-driven trading took place was mostly lower fee products like stock and bond indexes.
Investment banking revenue jumped 49 percent from a very weak period a year ago, but the backlog of deals dropped slightly from the previous period.
An uncertain economic outlook "has weighed on the psychology of corporate leaders and investors," making them more hesitant to pull the trigger on deals, Viniar said.
The one bright spot of Goldman's earnings was its investing and lending division, which consists of stocks and bonds that Goldman holds as investments. The value of those assets rose during the quarter after the U.S. Federal Reserve unveiled a new program to boost liquidity.
That business generated $1.8 billion in revenue; a year earlier, it reduced overall revenue by $2.5 billion.
The sustainability of those earnings are in question, due to a regulation that limits large U.S. banks' ability to invest their own money and new capital requirements that punish banks for holding illiquid assets, like private equity and corporate debt.
Goldman is aiming to reduce its risk-weighted assets by $88 billion through 2015, some of which will come from the investing and lending division.
"The big takeaway from this quarter is that Goldman needs a stronger economic environment to have adequate returns on capital, rather than just the asset price rally," said Michael Wong, an equity analyst at Morningstar who covers the bank. "People are just kind of waiting for Goldman Sachs and other investment banks to start being positive."
Goldman shares rose 0.3 percent to $124.89 in afternoon trading.
The company also said it would lift its dividend for the second time in a year, which is unusual because Goldman has historically preferred to use capital to invest in businesses, or buy back shares.
Goldman will now pay shareholders 50 cents per share in dividends each quarter, up from 46 cents. Viniar did not rule out further dividend hikes in the future. He said much more of the bank's capital planning will revolve around share repurchases going forward. Goldman spent $1.25 billion buying back stock during the quarter.
Viniar also said that the bank has already finished most of a cost-saving program that aims to reduce annual expenses by $1.9 billion, by cutting staff and other non-compensation expenses. In fact, Goldman added 300 employees last quarter and paid out 44 percent of revenue in compensation, consistent with its payout ratio in the previous two quarters.
Goldman has set aside $10.97 billion for compensation so far this year, a 10 percent increase from a year ago. That equates to $336,442 per employee, up 15 percent from $292,836 per worker during the first nine months of 2011.
(Editing by John Wallace, Lisa Von Ahn, Matthew Goldstein and Andrew Hay)