July 20, 2010

Goldman Sachs Q2 Earnings Plummet on SEC Settlement, U.K. Bank Tax, and Market Volatility

Bank reports $613 million in net earnings, at 78 cents per share, an 82% drop from Q2 2009

The Goldman Sachs Group Inc. on Tuesday, July 20, reported net earnings of $613 million for second-quarter 2010, an 82% drop from quarterly earnings a year ago, at $3.44 billion. Earnings per common share were posted at 78 cents versus $4.93, 84% lower.

In explaining the largest decline in earnings since the deep recession days of 2008, company officials cited the impact of a $550 million settlement with the Securities and Exchange Commission, a $600 million U.K. bank payroll tax on bonuses paid to employees, and lower revenues in investment banking and trading.

Goldman's total net revenues for the quarter posted at $8.84 billion versus $13.76 billion in the year-ago quarter, according to the second-quarter 2010 earnings release.

"The market environment became more difficult during the second quarter and, as a result, client activity across our businesses declined," said Goldman Chairman and CEO Lloyd Blankfein in the release. "Looking ahead, we remain focused on helping our clients to raise capital, manage risk, and invest for the future, which are all important to economic growth."

Analysts' consensus was for net earnings of $1.23 billion, or $2.03 a share, on net revenues of $8.98 billion, according to Thomson Reuters.

Goldman shares (GS) traded upward on Tuesday, ranging from a low of $141.55 per share in the morning to a high of $149.74 by mid-afternoon.

Asset management net revenues were $976 million, 6% higher than the second quarter of 2009, "primarily due to changes in the composition of assets managed," according to the release. During the second quarter of 2010, assets under management decreased $38 billion to $802 billion due to $24 billion of net outflows primarily reflecting outflows in money market and equity assets, and $14 billion of net market depreciation, primarily reflecting depreciation in equity assets.

A Goldman spokesperson said the bank's asset management unit comprises mutual funds, institutional investing, private wealth management, and private equity. The bank does not break out the revenue figures in those individual areas when publicly reporting quarterly earnings, the spokesperson said.

Bonnie Baha, chief portfolio manager for corporate credit at fixed-income investment management firm DoubleLine Capital LP, said the increase in asset management revenue came as no surprise.

"The asset management area of Goldman, like at most other financial concerns, is meant to smooth over earnings and provide some source of consistency," Baha said. "You would anticipate that revenues from trading would be volatile, so investment banks usually like to have an asset management group in-house because the income is much more steady and predictable. And in fact, that ended up being the case here."

Baha said Goldman's $6.55 billion in trading revenues, which were 39% lower than second-quarter 2009 and 36% lower than first-quarter 2010, added to the bank's headaches along with the SEC fine and British tax levy. Investment banking net revenues were $917 million, 36% lower than second-quarter 2009 and 23% lower than first-quarter 2010.

"Whether the drop in trading revenue was due primarily to an overall slowdown in the economy or due to investor nervousness about Goldman and the SEC investigation is difficult to tell," Baha said. "Probably a little bit of both. But the SEC came after Goldman, and they just wrote out a check and moved forward. The startling speed with which that was resolved was astounding. We're talking about a company that after all these charges still made $600 million. Net income fell to $613 million, to be exact, in the quarter just reported. It's not like they posted anything close to a loss. They just didn't make as much as they're used to making."

Goldman agreed to its $550 million settlement with the SEC on July 15 to resolve the pending case against the firm relating to disclosures in the ABACUS 2007-AC1 CDO offering. The firm entered into the settlement without admitting or denying the SEC's allegations.

"As part of the settlement, however, we acknowledged that the marketing materials for the ABACUS 2007-ACI transaction contained incomplete information," Goldman said in a July 15 release. "In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure."

Read a Kate McBride Viewpoint Blog comment about Goldman, the SEC, and the fiduciary standard from the archives of InvestmentAdvisor.com.
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