Goldman Sachs Group Inc (GS.N) posted its second quarterly loss as a public company on Tuesday as its investment portfolio lost billions of dollars in value.
Goldman is suffering as market turmoil and new regulations squeeze trading profits. The bank set aside 59 percent less money for compensation, in the latest sign of how weaker revenue is cutting into pay on Wall Street.
The biggest headwinds for the bank came from its investment and lending business, which lost $2.48 billion during the quarter. Even as regulators clamp down on short-term risk-taking through new laws, investment banks can get hit by their longer-term holdings.
"The one glaring problem area was their investment account, and particularly their stake in the Chinese bank," said Stanley J. G. Crouch, chief investment officer of Aegis Capital Corp. "That's what really kind of imploded them."
Goldman recorded a $1.05 billion paper loss on its stake in Industrial and Commercial Bank of China Ltd (1398.HK).
The European debt crisis triggered market turmoil in the quarter, and Chief Financial Officer David Viniar was reluctant to say that markets have settled down in recent weeks.
"There is still a lot of uncertainty (in markets), and a lot of it is based on who says what on what day," Viniar said on a conference call with investors and analysts.
Investors seemed to take Goldman's quarterly performance, which executives labeled a disappointment, in stride. The bank's shares rose 5.5 percent to $102.25.
Charlie Smith, chief investment officer of Fort Pitt Capital Group, which owns Goldman shares, said the stock likely rose because Viniar said it was undervalued and Goldman might buy back more shares. The bank spent $2.16 billion on stock repurchases in the third quarter.
"Goldman is the best house in a bad neighborhood," said Smith. "You heard the CFO say he'd love to buy back more of the stock because it's so cheap."
Shares of financial companies broadly rose after a report said the euro zone's rescue fund could increase in size.
Goldman's quarterly loss was its second since going public in 1999. Its only other quarter in the red came at the end of 2008 after the demise of Lehman Brothers.
Goldman Sachs posted a shareholder loss of $428 million, or 84 cents per share, far worse than analysts' average forecast for a loss of 16 cents per share, according to Thomson Reuters I/B/E/S. In last year's third quarter, Goldman earned 1.74 billion, or $2.98 per share.
Because the bank repurchased its shares during the quarter at a discount to their tangible value, the bank's tangible book value per share was essentially unchanged from the second quarter at $120.41. Goldman ended the quarter with $164 billion of unencumbered cash and liquid securities.
In a sign of how difficult the market environment is for Goldman, the bank's return on equity was just 6 percent for the first three quarters of 2011, even ignoring a special charge, compared with pre-crisis levels of more than 30 percent.
The bank is responding to weaker revenue with cost-cutting.
Compensation as a percentage of revenue was around 44 percent, in line with prior quarters this year but up slightly from a year earlier.
The investment & lending division generated losses, but revenue also declined in some of Goldman's main banking and trading businesses.
Big declines in Goldman's bond-trading and underwriting revenue weighed on results, more than offsetting gains from equity sales and trading and its advisory business.
Goldman's fixed income, currency and commodities client trading business -- once a key profit driver for the bank -- reported $1.73 billion in revenue, a 36 percent decline from a year earlier.
Equities sales and trading is now a larger slice of Goldman's revenue pie, as higher trading volumes led to bigger commissions. That business reported $2.3 billion in revenue, up 18 percent.
The bank's underwriting business suffered as clients held back on issuing new securities into volatile markets. Underwriting revenue dropped 61 percent to $258 million, while advisory revenue rose 5 percent to $523 million.
The U.S. financial reform law known as Dodd-Frank features a provision called the Volcker Rule, which is meant to limit banks' betting with their own money.
Regulators last week released a draft of the rule. which focuses on short-term trading.
Goldman is still talking to regulators about how the rule will work out, Viniar said.
With credit and equity markets broadly weakening in the third quarter, the cost of protecting Goldman's debt against default rose. Because of the bank's hedging, those changes tend to have a minimal impact on its results, unlike its competitors.
(Reporting by Lauren Tara LaCapra in New York; editing by Dan Wilchins, John Wallace and Ted Kerr)