Goldman revenue drop signals weakness in banking

Goldman Sachs posted a 20 percent decline in third quarter revenues, signaling that the economic recovery may still have a ways to go and that banking still has some hurdles to overcome. But, of course, the more entertaining part of the stories were about banker pay.

First, here’s the Wall Street Journal with the basic earnings story:

Goldman Sachs Group Inc. posted a 20% decline in quarterly revenue, raising doubts that the securities industry will pull out of its trading slump—and putting a damper on expectations for Wall Street bonuses.

Goldman shares fell 2.4% Thursday, after the New York-based firm delivered disappointing third-quarter results. Per-share earnings exceeded analysts’ estimates, but revenue came in $1 billion short of expectations.

Goldman’s steepest drop came from one of its most-reliable profit engines—its fixed-income, currencies and commodities trading arm. Revenue for the business tumbled 44% from a year ago, to $1.25 billion, a worse performance than rivals.

“Just not a great quarter,” Harvey Schwartz, Goldman’s finance chief, said Thursday during a conference call with analysts.

The results were a surprise to Wall Street, where Goldman’s bond-trading dominance has become something of a staple. Now, the onetime king of fixed-income is suffering disproportionately, as larger banks thought to be more plodding and bureaucratic surpass it.

The firm’s fixed-income revenue fell 49% from the second quarter— at least double the drop of rivals including J.P. Morgan Chase & Co. and Citigroup Inc.  The overall revenue in Goldman’s fixed income, currency and commodity trading division was more than $1 billion short of the comparable number at Citigroup and about $470 million shy of the result at Bank of America Corp.

The New York Times took a different approach, saying bankers were disappointed that 2013 bonuses likely wouldn’t return to previous highs:

Among Goldman Sachs employees, the chatter started months ago that 2013 was going to be a good bonus year. The Wall Street bank began the year strong, and despite concerns about the economy, its profit doubled over year-ago levels in the second quarter.

These hopes were all but dashed Thursday when the firm announced that revenue in its fixed-income, currency and commodities division, a powerful unit inside the bank that in better years has produced more than 35 percent of Goldman’s entire revenue, dropped 44 percent from year-ago levels. It was the worst quarterly result in fixed income since the fourth quarter of 2008, when the financial crisis was raging.

Analysts apparently had many questions for the firm, the Times said:

Analysts pushed, without much success, for more details on the reasons behind the drop in revenue for the unit. They also pressed executives about their expectations for the firm’s return on equity, which effectively measures the profit a bank is able to generate on its capital. That return is hovering around 8 percent on an annualized basis, significantly lower than it has been in previous years, and well below the company’s previously stated goal of 20 percent over time.

“It is a quarter,” Mr. Schwartz reiterated several times on the call.

By slashing what it sets aside for compensation, Goldman was able to post a decent third-quarter profit, despite the revenue weakness. Quarterly earnings came in at $1.52 billion on Thursday, largely flat compared with the period a year earlier.

Reuters also led with the cut in compensation:

Goldman Sachs Group Inc (GS.N) slashed employee compensation costs by 35 percent in the third quarter as bond-trading revenue plunged, an unusual step that signals the investment bank’s concern about performance for the rest of the year.

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Goldman responded to the weaker revenue by setting aside less money to pay employees during the quarter – $2.38 billion, compared with $3.68 billion in the same quarter last year. The 35 percent decline is high compared with competitors. JPMorgan Chase & Co (JPM.N) cut its third quarter compensation expense by 15 percent.

Goldman’s compensation costs amounted to 35 percent of its revenue in the quarter. The bank’s target is usually closer to 43 percent.

The bank sometimes cuts the money it sets aside for pay in a quarter, but it usually does so in the fourth quarter, when there is no hope of earning extra revenue for the year. Doing so in the third quarter signals that it does not expect a big rebound in the fourth quarter, a point Schwartz conceded on the conference call.

One bright spot– Goldman set aside a fair amount for pay in the first half of the year, when net income was up about 35 percent over the year-earlier period. Even with the third quarter drop, total compensation costs for the first three quarters are only down 5 percent from the same period last year.

While the bank may always change the amount of money it sets aside later in the year, the third-quarter reduction will likely translate to lower bonuses for employees.

Pay consultant Alan Johnson estimates that across Wall Street, fixed-income, currency, and commodities trading bonuses could fall 10 to 15 percent this year, with many employees getting $0 bonus checks.

Bloomberg added comments that Goldman wasn’t shifting its policy, just the amount it plans to pay this year:

The bank hasn’t changed its principles on compensation, Chief Financial Officer Harvey M. Schwartz said on a conference call with analysts. It reduced the year-to-date compensation ratio based on current revenue and “better visibility” into year-end pay, he said.

Roger Freeman, an analyst at Barclays Plc, predicts the ratio for the full year will be 39 percent. While a lower figure than that “would likely be welcome news for investors,” he wrote in a note to clients today that “we suspect that the third-quarter represents more of a true-up than anything else.”

The interesting point in many of these stories is that the compensation cut signals the firm isn’t expecting the fourth quarter to be any better. That’s a sign that Goldman is losing clients and trading business to rivals, or that the state of the global economy continues to rattle markets – either way, not good news.