Goldman Misses Big on Trading, Trails Rivals Badly -- 7th Update

A rare trading stumble from Goldman Sachs Group Inc. ended a streak of strong earnings for big U.S. banks and set the Wall Street powerhouse, fresh off a leadership transition, on its heels early in the year.

Goldman reported first-quarter net income of $2.26 billion, or $5.15 a share, on revenue of $8.03 billion. All three figures were better than a year ago, but fell below what Wall Street analysts had ballparked.

The reason: a 2.4% decline from a year earlier in all-important trading revenue, which was well behind results reported by rivals.

The lackluster result shows that for all its postcrisis changes--dialing down risk, adding consumer-facing businesses and embracing lending--Goldman still lives and dies by the unpredictable and unforgiving business of swapping stocks, bonds and commodities.

The rare misstep comes amid a transition atop the firm. Gary Cohn, the former No. 2 to Chief Executive Lloyd Blankfein, departed for a job in the White House in December and was replaced by a new pair of top lieutenants.

R. Martin Chavez, who takes over as chief financial officer later this month, spent his first analyst-earnings call explaining the misstep. "We didn't navigate the market well," Mr. Chavez said. "There are always things we can do better... but no one quarter defines the franchise."

Goldman shares fell 5%. The biggest contributor to the Dow Jones' Industrial Average's post-election run, Goldman shares have been the index's biggest laggard this year as investors' exuberance about the Trump administration's agenda has worn off.

Goldman's results were in contrast to big-bank rivals. J.P. Morgan Chase & Co. and Citigroup Inc. beat estimates last week, powered by huge trading gains, and Bank of America Corp. followed suit Tuesday. Morgan Stanley reports Wednesday.

Goldman's return on equity, a closely watched measure of profitability, was 11.4% in the first quarter, though it would have been 8.9% without a tax adjustment. That's below the bank's theoretical cost of capital of around 10%, a threshold Goldman rarely falls below.

Investors were expecting a better performance, in part, because the Federal Reserve in recent months has twice raised interest rates. That bodes well for trading businesses as investors buy products to protect themselves from future increases and bet on diverging rates.

But Goldman didn't get the boost seen elsewhere. Its fixed-income revenue was essentially flat versus a year earlier, while J.P. Morgan posted a 17% gain, Citigroup was up 19% and Bank of America led with a 29% increase.

Mr. Chavez blamed calm markets, which present clients with fewer opportunities to make wagers on price moves. For example, the price of U.S. crude oil hasn't been this stable in more than two years, by one measure. That stings Goldman, which is bigger in commodities trading than rivals.

In other areas, Goldman tripped while rivals shone. Bank of America singled out corporate-bond trading as a bright spot, while Goldman said that dragged on its results. The Charlotte-based bank also generated $1 billion more in overall fixed-income trading revenue than Goldman, the largest-ever gap between the two firms.

"Hard to put lipstick on these results," UBS Group AG analysts wrote in a note to clients.

Goldman's trading desk hasn't been Wall Street's biggest by revenue in years, eclipsed after the financial crisis by J.P. Morgan and others. But it has long been seen as its fiercest and most profitable, relying on its brains rather than brawn.

Making matters worse, the first quarter is typically the strongest for trading desks as investors reposition portfolios for the new year. The slow start is also likely to raise questions about whether the firm has the right mix of trading clients.

Goldman's traditional strength in peddling complex trading products to hedge funds, a high-margin business, once powered its results. But that focus became a liability in recent years as these clients struggled with poor returns and investor preference shifted to simpler widgets that, for example, protect against currency or interest-rate swings.

Goldman has pushed over the past year or so to emphasize those plain-vanilla products and do more trading business with corporations and asset managers. Mr. Chavez said Tuesday that the firm's efforts in that area were still under way.

The bank also reshuffled leadership in its fixed-income trading business last fall and has been heavily courting so-called quantitative funds. These use algorithms, rather than human hands, to trade heavy volumes of securities.

Revenue in Goldman's investment-banking division, which advises on mergers and acquisitions and corporate fundraisings, rose 16% on a surge in stock offerings. The firm held off a late-quarter challenge from Morgan Stanley to retain its M&A crown.

But there are warning signs there, too. Merger fees fell 1.9% from last year and the bank's pipeline of future deals has shrunk.

Even Goldman's faster-growing businesses aren't yet big enough to make up for a blunder in core trading activities. Since the crisis, the firm has tiptoed into areas such as consumer lending and asset management, which have more stable revenue.

For example, revenue at Goldman's investment-management division, which handles money for pension funds, wealthy families and others, rose 12% from a year earlier. And Marcus, the firm's new online personal-lending business, is nearing $1 billion in loans outstanding after launching just six months ago, according to people familiar with the matter.

Write to Liz Hoffman at liz.hoffman@wsj.com

Goldman reported first-quarter net income of $2.26 billion, or $5.15 a share, on revenue of $8.03 billion. All three figures were better than a year earlier but fell below what Wall Street analysts had forecast.

The reason: a 2.4% decline from a year earlier in all-important trading revenue, which was well behind results reported by rivals.

The lackluster result shows that for all of its postcrisis changes -- dialing down risk, adding consumer-facing businesses and embracing lending -- the unpredictable and unforgiving business of swapping stocks, bonds and commodities remains critical to Goldman's fortunes.

Of course, one quarter of weakness is far from a trend, and investors still view Goldman as having one of the strongest trading franchises on Wall Street. The firm had a dismal first quarter in 2016 as well, only for results to bounce back later in the year.

But the rare misstep comes amid a transition atop the firm. Gary Cohn, the former No. 2 to Chief Executive Lloyd Blankfein, departed for a job in the White House in December and was succeeded by a new pair of top lieutenants.

R. Martin Chavez, who takes over as chief financial officer later this month, spent his first analyst earnings call explaining the misstep. "We didn't navigate the market well," Mr. Chavez said. "There are always things we can do better...but no one quarter defines the franchise."

Goldman shares fell 4.7% Tuesday. The biggest contributor to the Dow Jones Industrial Average's postelection run, Goldman shares have been the index's biggest laggard this year as investors' skepticism about enactment of the Trump administration's agenda has increased.

Goldman's results contrast with those of big-bank rivals. J.P. Morgan Chase & Co. and Citigroup Inc. beat estimates last week, powered by huge trading gains, and Bank of America Corp. followed suit Tuesday. Morgan Stanley is scheduled to report Wednesday.

Goldman's return on equity, a closely watched measure of profitability, was 11.4% in the first quarter, though it would have been 8.9% without a tax adjustment. That is below the bank's theoretical cost of capital of around 10%, a threshold Goldman rarely falls below.

Investors expected a better performance, in part because the Federal Reserve in recent months has twice raised interest rates. That bodes well for trading businesses as investors buy products to protect themselves from future increases and bet on interest rates moving in different directions.

But Goldman didn't get the boost seen elsewhere. Its fixed-income revenue was essentially flat compared with a year earlier, while J.P. Morgan posted a 17% gain, Citigroup was up 19% and Bank of America led with a 29% increase.

In other areas, Goldman tripped while rivals shone. Bank of America singled out corporate-bond trading as a bright spot, while Goldman said that dragged on its results. The Charlotte, N.C.-based bank also generated $1 billion more in overall fixed-income trading revenue than Goldman, the largest-ever gap between the two firms.

"Hard to put lipstick on these results," UBS Group AG analysts wrote in a note to clients. Goldman's trading desk hasn't been Wall Street's biggest by revenue in years, eclipsed by J.P. Morgan and others. But it has long been seen as its fiercest and most profitable, relying on its brains rather than size.

The bank also shuffled leadership in its fixed-income trading business last fall and has been heavily courting quantitative funds. These use algorithms, rather than human hands, to trade heavy volumes of securities.

There are warning signs there, too. Merger fees fell 1.9% from last year and the bank's pipeline of future deals has shrunk.

Even Goldman's faster-growing businesses aren't yet big enough to make up for a blunder in core trading activities. Since the crisis, the firm has invested in areas such as consumer lending and asset management, which have more stable revenue.

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

April 18, 2017 21:06 ET (01:06 GMT)