Amidst some of the most tumultuous markets in over the year, one of the market's behemoths, Goldman Sachs, reported its earnings for the third quarter Thursday morning. Although the $2.24 billion it earned in profit and $8.39 billion of revenue it generated were from July through September, volatility in the market started to return towards the end of the quarter, helping drive $2.17 worth of revenue in fixed income, commodities, and currenencies trading, up 74% from last year, which the firm described as "challenging."
When volatility was hitting historical lows over the summer, Goldman executives expressed confidence that it would return. They were right. On Wednesday, when the market, especially in the morning plunged downward with normally staid U.S. treasuries leading the charge, Goldman's trading desks set a record for trading volume, a Goldman executive familiar with the matter said.
Analysts surveyed by Bloomberg expected revenue of $7.83 billion, net income of $1.5 billion, and earnings per share of $3.21. With such sizable outperformance, Goldman was able to boost its quarterly dividend from $.55 to $.60.
The better-than-expected performance and higher dividend wasn't enough to cheer investors, the bank's stock is down $3.31 or 1.87% in early trading. Steven Chubak, an analyst at Nomura, attributed investors tepid reaction to revenue being driven by segments of the business whose earnings investors value less like fixed income trading and investing and lending, the portion of Goldman's business that makes direct equity and debt investments in comapnies and funds. "We do not anticipate meaningful share outperformance/positive estimate revisions on the back of today's result," Chubak wrote in a note.
Banks with large trading operations — Goldman Sachs first among them — had been suffering in the last year thanks to an industry-wide trading slump driven by record low volatility. When volatility is low and prices of assets like stocks and bonds don't move around very much, banks's clients like large asset managers and hedge funds don't trade and one of the industry's most profitable businessess gets starved. For Goldman, fixed income revenue has declined year-over-year in the last four quarters, a trend reversed in the third quarter of this year.
"The combination of improving economic conditions in the U.S. and a strong global franchise continued to drive client activity across our diverse set of businesses," said Lloyd Blankfein, the investment bank's chairman and chief executive officer, in a statement.
Markets have gotten increasinly volatile this month but have also been driven down, with sizable declines in America and European stocks recently. Banks have not been able to avoid those declines. This week, banks across the board slid in value, especially Wednesday, when Goldman's stock fell .82%, or $1.46, and was down just over 3.5% in the month leading up to Thursday's earnings report. Many hedge funds saw dire losses as popular trades in oil and betting on mergers fell precipitously. One of Goldman's own strategists told clients to close out a trade on rising U.S. government bond yields, which fell substantially yesterday.
A Goldman executive said that the violent moves in the market, particularly in ten-year treasury yields, which at one point dropped more than 30 basis points, were at least partially caused by traders who had large short positions being forced to buy to unwind their losing trees.
"A couple of months ago, people were saying volatility will never return to the marketplace. Now people feel like we have too much volatility," Goldman's chief financial officer Harvey Schwartz said on a call with analysts Thursday morning.
"While conditions and sentiment can shift quickly, the strength of our transaction backlog indicates our clients' desire to pursue and execute their strategic plans for growth," Blankfein said in a statement.
Speaking about the broader market, Schwartz said on a call with analysts that the market's gyration in the last two days was "clearly a market the where investors were, quite frankly, shooting first and asking questions later," but that such bevhaior was "a normal part of how markets function."
Schwartz said that the firm's economists think that "nothing has fundamentally changed in the past few weeks or certainly the last 24 hours regarding the long-term outlook for the global economy."
Goldman also saw massive revenues from the return of big mergers and acquisitions, with advisory revenues of $594 million, up from 40% a year ago, "reflecting an increase in industry-wide completed mergers and acquisitions," the company said.
The bank also profited from a surge in initial public offerings, many of which it lead or co-lead. It had $426 million in revenues from equity underwriting, up 54% from a year ago, while its debt underwriting business generated $444 million, a 5% decline in a year ago.
Up until the last few months, low-interest rates had encouraged large corporations, especially those with less-than-great bond ratings, to binge on debt, leading to massive fees for big underwriters like Goldman. In the second quarter of this year, Goldman had $195 million more revenue in debt underwriting revenue than equity underwriting, tha gap narrowed to $18 million in the third quarter.
Some analysts have wondered if Goldman's business model and heavy reliance on high-profit trading businesses has been permanently hampered by regulations designed to discourage risky trading by banks. Unlike Citigroup, JPMorgan, or Bank of America, Goldman does not have a consumer bank with credit card and mortgage banking businesses that could provide stable earnings despite a stricter regulatory environment. Also, Goldman, unlike Morgan Stanley, does not have an army of financial advisors serving a large customer base.
Morgan Stanley has almost twice as many assets under management and is trying to get more of its profit mix from that more stable business. Goldman's investment management business had $1.46 in revenue, about 17% of its total revenue in the third quarter, while for Morgan Stanley last quarter, 51% of its revenue come from wealth and investment management. The bank's total assets under supervision rose $8 billion to $1.15 trillion in the quarter.
While Goldman's revenue and profits have been able to beat expectations and even rise, some analysts have worried that the bank is increasingly dependent on its investing and lending division, which makes long term debt and equity investments in companies, hedge funds, private equity funds, and real estate, to drive revenue and profits. Because of new regulations, Goldman has to exit some of these investments over time. Revenue of $1.69 billion in that division this quarter was 20% of its total revenue. Nomura analyst Steven Chubak said on the earnings call that investors have shown a "continued reluctance to ascribe as much value" to investing and lending revenues "given the lack of earnings visibility tied to the portfolio gains."
In the second quarter of this year investing and lending was 23% of its revenue and 38% of its profit, making it the most proftiable segment. Its typically in the mid-teens for revenue, although it can jump around depending on how the assets in the division gain value or are sold off.