Low Trading Revenues Hit Goldman Sachs in the Knees, Again


After a difficult and disappointing third-quarter, in which revenue fell 20 percent, Goldman Sachs (NYSE:GS) shareholders were waiting to see whether the investment bank’s powerful trading machine could pick up steam. But on Thursday, Goldman Sachs reported a 21 percent drop in quarterly profit, thanks to a steep drop in revenue from fixed-income trading that was proof the trading boom that reshaped Wall Street’s largest investment banks over the past ten years is stumbling. That suggests that one of the largest profit engines on Wall Street is in trouble, and Goldman’s reliance on trading fixed-income, currencies and commodities, or FICC, may become a liability in the future.

Other investment banks, like Morgan Stanley (NYSE:MS), have dialed back their FICC businesses. Yet, despite the increasing pressure from the Volcker Rule — which restricts United States banks from making certain types of speculative investments that do not benefit their customers — and despite the fact investors have eschewed higher-risk trading in favor of low-risk government bonds, Goldman is still very dependent on trading. The bank’s dependence was clear in its fourth-quarter and full-year results.

Fourth-quarter net revenue at Goldman’s fixed income, currency, and commodities unit continued the fall it began earlier in the year, dropping 15 percent to $1.72 billion from $2 billion in the year-ago quarter. Throughout all of 2013, revenue generated by the historically important FICC trading unit decreased 13 percent to $8.65 billion from 2012’s $9.91 billion. FICC trading now accounts for 25.3 percent of the bank’s total revenue, down from a peak of 48 percent in 2009.

However, several of Goldman’s competitors in FICC trading posted much strong results last quarter; Bank of America (NYSE:BAC) reported that revenue from fixed-income trading rose 16 percent from a year earlier, and JPMorgan Chase’s (NYSE:JPM) fixed-income trading revenue increased 1 percent. The bond market, which has also historically been a source of strong profits, weakened in the fourth-quarter as investors readied themselves for higher interest rates.

Even with difficulties in the trading unit, Goldman did beat Wall Street expectations; the bank reported net income of $2.21 billion for the fourth-quarter, and earnings of $4.60 share, significantly higher than the $4.22 per share forecast by analysts. Overall, revenue fell 5 percent from the fourth quarter of 2012 to $8.78 billion. While investors bid shares of Goldman Sachs marginally higher in pre-market trading on Thursday, after the markets opened, the stock was pushed below its opening price of $178.75. As the quarter’s results make clear, Goldman Sachs remains a very profitable institution, and investors have confidence in that fact — bidding shares up more than 40 percent in 2013. But it also remains true that a significant portion of recent increases in earnings are the result of cutting back on costs of employee compensation and repurchasing shares.

Goldman’s return-on-equity — a key measure of how much profit it squeezed out of its balance sheet — came in at 11 percent for the year, above the 10 percent minimum that analysts say is necessary for banks to produce in order to meet their cost of capital. Yet, that level was far below the 30 percent returns that Goldman averaged during its prime years. In more specific terms, the equity businesses produced mixed results; revenue from client stock trading dropped 22 percent to $598 million, even though the stock market hit new highs last year, while the bank’s equity investments recorded a 25 percent increase in revenue, hitting $1.40 billion.

For the full year, Goldman earned $8.04 billion, or $15.46 per share, beating the $14.13 per share recorded in 2012. However, net revenue remained basically flat with 2012; the bank generated $34.21 billion in 2013, which compared to $34.16 billion in 2012

The FICC unit may have been hit hard during 2013, particularly during the summer, but Goldman Sachs Chief Executive Officer Lloyd Blankfein has made a risky gamble on strategy; he believes the bank’s trading profits can grow once again in 2014. “Our work in advancing our client franchise and in ensuring continued cost discipline has allowed us to provide solid returns even in a somewhat challenging environment,” he said in the earnings press release. “We believe that we are well positioned to generate solid returns as the economy continues to heal and provide considerable upside for our shareholders as conditions materially improve.”

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