Bond Trading Thrashes Goldman -- WSJ

Fixed-income business drops 40%, leaving storied bank at back of Wall Street's pack

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (July 19, 2017).

Goldman Sachs Group Inc.'s once-vaunted bond-trading unit posted a poor performance for the second straight quarter, fueling a selloff in the firm's shares and deepening questions about the bank's strategy.

Goldman, once the fiercest trading shop on Wall Street, reported a 40% decline in its fixed-income trading business that lands it at the back of the pack among big U.S. banks to report quarterly results.

The results will likely amplify criticism that Goldman hasn't responded quickly enough to dramatic changes in trading trends and market conditions. A rejiggering of the division's leadership last fall failed to jolt the desk from its malaise, which culminated in having its revenue surpassed in the first quarter by Morgan Stanley, Goldman's rival historically weaker in debt trading. Morgan Stanley reports its earnings Wednesday.

The poor showing drowned out a surprise earnings beat, which Goldman owed to gains in its portfolio of private-equity stakes. Shares fell 2% as investors looked through to shakiness at Goldman's core, tumbling as Chief Financial Officer R. Martin Chavez addressed concerns on a conference call.

"We didn't navigate the market as well as we want to," he said, echoing nearly verbatim comments he made three months ago. "Everyone in our business is intently focused on this topic and at a granular, molecular level are working on it, as are all of us in the leadership team."

The firm, run by Chief Executive Lloyd Blankfein, reported earnings of $3.95 a share on revenue of $7.89 billion, both better than analysts had forecast.

Still, Goldman's traders have struggled to find their footing as markets churn quietly higher and trillions of dollars shift from human portfolio managers to algorithms and index funds that don't try to beat the market, but simply match it. Meanwhile, many among Goldman's stable of hedge-fund clients are grappling with poor performance and outflows.

That has led to less demand for Goldman's specialty: exotic trading products that allow investors to make one-of-a-kind bets on asset prices. Overall, the firm's trading revenue fell 17% from a year ago, capping a six-month run that is the worst start of a year in Mr. Blankfein's 11-year tenure.

"The demand side of the equation has dried up for" Goldman, said James Mitchell of Buckingham Research Group. "The market has moved to plain-vanilla."

Goldman cited weakness in nearly every major fixed-income product it sells, from interest-rate derivatives to credit instruments.

Goldman's trading business is more reliant on swashbuckling stock pickers than peers, a strategy that paid off in years past but now puts the bank on the wrong side of shifts in the money-management industry. As more assets move from actively managed funds to passive ones, trillion-dollar pools trade less frequently and generally need fewer services.

Goldman has pushed over the past year or so to win more business from corporate treasurers and passive managers, and worked to better track where top clients are spending their trading commissions and fees.

So far, it hasn't worked. Goldman's six-month trading revenue fell 10% from last year. Commodities trading, a business Mr. Blankfein once ran, had its worst quarter in Goldman's 17 years as a public company as the firm struggled to adequately hedge its inventory.

Goldman has also seen a stream of departures among rank-and-file fixed-income salespeople and traders in recent months. Continued woes in the division are likely to ramp up pressure for another shake-up.

"Goldman was the unbeatable firm, the smartest guys on the block," Octavio Marenzi, CEO of capital markets consultancy Opimas, said of the business's results. "They've lost that luster."

The story was better in stock-trading, which posted its best quarter in two years. Goldman lost the equities crown in 2014 to Morgan Stanley, a jolt that spurred it to revamp its trading technology through investments that are now beginning to pay off.

Rescuing the quarter was its portfolio of private company stakes, which rose 88%. Goldman has held on more tightly to merchant banking than rivals, and rising markets push up the prices for the shares it holds in everything from a publicly traded credit bureau to private technology startups.

But investors tend to discount the lumpy revenues in the unit. Charles Peabody of research firm Compass Point called Goldman's results a "low quality beat...aided by gains that the marketplaces won't pay up for."

Investment-banking reported a 3% decline in revenue from a year ago, with merger fees down 6% and stock and debt underwriting basically flat.

Goldman has leaned hard on investment banking in recent years, though there are signs that it also may be slowing. A record deal boom in 2015 and 2016 is cooling, and some companies have been postponing deals as they wait to see if the Trump administration can achieve promised tax and regulatory changes.

Goldman's investment-management division reported a 13% rise in revenue and net inflows of $25 billion, though nearly all of that came from the acquisition of a business that courts big pension funds.

Goldman's return on equity, a key measure of profitability, stood at 8.7% in the quarter. Goldman is one of few banks that has reliably exceeded 10% -- a level typically demanded by investors -- since the crisis. But in recent quarters, Goldman's ROE has slipped and in the second quarter, stalled in the same place it was year ago.

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

(END) Dow Jones Newswires

July 19, 2017 02:48 ET (06:48 GMT)