July 10 (Bloomberg) -- Goldman Sachs Group Inc. is poised to report the largest profit since it set earnings records in 2007, marking the return of a business model that was the envy of Wall Street before the financial crisis devastated competitors and spurred a government bailout.
Chief Executive Officer Lloyd Blankfein, who helped make Goldman Sachs the highest-paying securities firm by wagering capital and fueling the bets with borrowed money, may report the most second-quarter profit per share among the 15 biggest U.S. banks, analysts estimate. While rivals have pared risks, New York-based Goldman Sachs has ratcheted up trading gains and reaped more fees from stock and bond sales, according to Barclays Capital analyst Roger Freeman.
The results come on the heels of a rescue effort that funneled about $200 billion from taxpayers to U.S. financial firms, including $10 billion to Goldman Sachs, after the bankruptcy of Lehman Brothers Holdings Inc. and near-failure of American International Group Inc. ignited concern that the credit contraction might cripple the world economy.
“Once all the government support mechanisms were in place, they were able to basically go about business as usual,” Freeman, who’s based in New York, said in a phone interview.
Goldman Sachs, which shed government-imposed restrictions on employee compensation by repaying the $10 billion from the U.S. Treasury, will kick off U.S. bank earnings season on July 14. The company will probably say it earned $2.2 billion, or $3.57 per share, in the three months through June, according to the average estimate of 25 analysts surveyed by Bloomberg.
Investors will receive earnings reports later in the week from JPMorgan Chase & Co., Citigroup Inc., and Bank of America Corp. Morgan Stanley, which was the second-biggest U.S. securities firm behind Goldman Sachs when both firms converted to banks last year, may report the following week.
Goldman’s trading revenue in 2009 will top its 2007 record as the firm profits from reduced competition after the collapse of rivals, including Lehman Brothers and Bear Stearns Cos., according to Bank of America analyst Guy Moszkowski in New York.
The firm has “unmatched risk-taking/risk-management skills in a market that strongly rewards these because of a decline in competitor risk appetite,” Moszkowski wrote in a note to investors yesterday in which he changed his recommendation on the stock to “buy” from “neutral.”
Goldman Sachs’s results may raise a “fundamental question,” about Wall Street, according to Arthur Wilmarth, a professor at George Washington University law school who specializes in issues related to banking. “Do we think it would be good or desirable to go back to the status quo again?”
Michael DuVally, a spokesman at Goldman Sachs, declined to comment. “The vast majority of all our risk-taking is on behalf of clients,” Lucas van Praag, another company spokesman, said in April after the first-quarter results.
Freeman, the Barclays Capital analyst in New York, expects Goldman to make $5.93 billion from fixed-income, currencies and commodities trading, down from a record $6.56 billion in the first quarter, and $2.3 billion from trading equities, up from $2 billion.
“It’s going to be a really good quarter in fixed income trading and equity trading,” said Keith Davis, an analyst at Farr, Miller & Washington LLC in Washington, which manages about $500 million, including Goldman shares. “But I do not think this environment’s sustainable for the long term.”
Investment banking, which includes fees from providing takeover advice as well as managing stock and bond sales, will probably jump to $1.06 billion from $823 million, Freeman estimates.
The Goldman Way
Goldman managed $27.9 billion of global equity and equity- linked offerings in the quarter, up from $1.5 billion in the first quarter, and $3.98 billion of high-yield debt sales, compared with $798 million in the first quarter, according to data compiled by Bloomberg.
Before the crisis, Goldman’s success in generating revenue by taking trading risks and making investments with its own money led other firms like Merrill Lynch & Co. and Citigroup to try to ape its model, with disastrous results, Wilmarth said. He said he’s concerned firms may be tempted to try to follow Goldman’s example again.
“Regulators ought to be concerned and say ‘Is Goldman making this money with any kind of reasonable prudence?’” Wilmarth asked. “Do we want other people sort of trying to emulate what they’re doing, perhaps not with the same skill or resources?”
Compensation at Goldman Sachs may rise 64 percent to $17.9 billion this year from $10.9 billion last year based on projected revenue gains, Moszkowski estimated. The firm set a record for Wall Street pay in 2007 when it doled out a total of $20.2 billion, including $68.5 million for Blankfein, 54.
Executives at companies such as AIG, Bank of America and Citigroup reaped bonuses when the risks they took paid off. Then, when the banks’ bets went awry and they began amassing losses on subprime mortgages and other devalued assets, taxpayers wound up footing the bill through bailout programs, Wilmarth noted.
One of the lessons of the crisis was that the biggest banks, including Goldman Sachs, are now seen by the U.S. government as “too big to fail,” ensuring that they’ll be rescued if their strategies backfire, Wilmarth said.
“It’s really quite rational for somebody like Goldman, who of course made a lot of money on the backbone of risk coming into the crisis, after being bailed out, to increase risk as a natural extension of that strategy,” said Joseph Mason, a banking professor at Louisiana State University in Baton Rouge who previously worked at the U.S. Treasury’s Office of the Comptroller of the Currency. “The government has created those incentives.”
Freeman at Barclays Capital said Goldman Sachs’s executives wouldn’t be tempted to take risks they weren’t sure they could manage.
“Given this political climate, I think that if they were viewed to take undue risks that there would be repercussions,” he said. “Just because a firm is deemed too big to fail that does not mean the equity won’t be wiped out and these partners all have a lot of stock in the company.”
The company illustrated its ability to rebound in the first quarter when it reported a record $6.56 billion in revenue from trading fixed-income, currencies and commodities, 34 percent more than its previous high. Morgan Stanley, which had promised to scale back risks in areas like proprietary trading, was left behind with $1.3 billion of fixed-income revenue.
The profit banks make buying and selling fixed-income securities and derivatives remains elevated 10 months after Lehman Brothers collapsed, sending the so-called bid-ask spread to record levels.
The bid-ask spread on credit-default swaps in the Markit CDX North American Investment-Grade Index widened to 9.73 basis points yesterday, about 60 percent higher than the week before Lehman filed for bankruptcy and about 169 percent more than two years ago, according to CMA DataVision. The spread soared to a high of 22 basis points on Oct. 13.
The index is a benchmark for the cost of protecting bonds against default linked to 125 companies in the U.S. and Canada. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
Goldman Sachs’s value-at-risk, a statistical measure of its potential losses from trading, soared to an average of $240 million in the first quarter from $197 million in the previous quarter. Morgan Stanley’s, by contrast, rose to $115 million from $98 million.
The amount that Goldman Sachs set aside for compensation in the quarter jumped to $4.7 billion from $4 billion a year earlier, even as the number of employees fell 12 percent. Morgan Stanley, which reported a first-quarter loss, set aside $2.1 billion in the quarter, down 46 percent from a year earlier.
“Goldman was one of the big beneficiaries of taking market share,” Jason Tyler, a senior vice president at Ariel Investments LLC in Chicago, said in an interview this week. “They are going to prove to the world that they’re a leader in their space and their compensation is going to be justified by being able to generate good returns for shareholders.”
Goldman Sachs sold $5.75 billion of stock during the second quarter to help gain approval to repay the U.S. government, a move that will also incur a $425 million charge for dividend payments, Freeman estimates. The move frees Goldman from limits on year-end bonuses that Congress mandated for firms that have more than $500 million of government money.
Goldman’s cost of capital was also helped by government guarantees provided on about $30 billion of debt the firm issued between November and March. A lower cost of capital makes it easier to profit from investments. Other banks, including JPMorgan Chase and Morgan Stanley, also benefited from the debt guarantees from the Federal Deposit Insurance Corp.
“It would be disingenuous to ignore the government assistance in helping to generate those earnings,” Mason said. “Those institutions, especially Goldman, played their cards really beautifully obtaining that assistance and using that to help them weather the crisis.”
Morgan Stanley, Goldman Sachs Plan To Rebrand Failure As Success
I have wonderful news to report to everyone! Apparently I have woken up today in a parallel universe, where the sun is shining and the birds are singing and my coffee tastes like malted orgasm. There's something called a "Dylan Ratigan" on my teevee, asking shouty sports pundit Stephen A. Smith about auto bailouts, so it's not like EVERYTHING makes perfect sense, but here's the real good news! Apparently, the financial collapse in the derivatives market never happened! EVERYTHING OLD IS NEW AGAIN AND WILL SUCK AGAIN, YAY!
From this bizarro universe's Bloomberg:
Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.
Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody's Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.
Ahh, apparently this parallel universe's version of Choire Sicha is just as critical of these geniuses as he is in the real one. This is blockquoted for maximum sarcasm:
HOW COULD THIS IDEA FAIL? How could anyone not want to put their money in this? This is so dizzying, it's like it is 2003 outside, and everything is new and shiny again.
You know what is going to be neat? Seeing which ratings agency bites first at giving this turd sandwich a AAA rating! All of us in this parallel universe plan on running around the streets with our pants off that day, because there are no consequences for failure, ever, apparently.
UPDATE, from my exasperated father, who writes:
It will be interesting to see who buys this shit but we may never know. Some people never learn. BUT! If you offer it at a price and a rate, somebody can be found to speculate on anything, and if you sell it to somebody connected or to someone who is "too big to fail"...well we have already proven that we can handle the "moral hazard" argument. Here we go again. Look at the names associated with all this. And the one you have to wonder about the most is the rating's agency, Moody's. They must feel like they are invisible and bullet-proof because they certainly have escaped real scrutiny in all of this that has just passed. And! They are paid by the issuers to give them a rating on this shit. Not much independence there!