Goldman Sachs Reaps Big Profits from Fixed Income

Goldman Sachs reaped huge profits from fixed income for the second straight quarter, apparently benefiting above all from reduced competition.
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(Update includes new analyst comments; updates share prices throughout.)

Goldman Sachs

(GS) - Get Report

reaped huge profits from its giant, opaque fixed income, currencies and commodities division for the second straight quarter, apparently benefitting above all from reduced competition.

On a conference call discussing the earnings Tuesday morning, Goldman CFO David Viniar gave the impression that the strong revenues in that division, as well as in equities trading, came above all from acting as an agent between two parties, or providing services such as hedging, rather than by making risky investments.

Goldman's overall profit of $3.44 billion, or $4.93 per share, is more than 6% higher than the highest estimate of 16 analysts polled by Thomson Reuters. The consensus analyst estimate was a profit of $3.54 a shares, according to Thomson Reuters.

The ability to take advantage of the turbulent markets impressed several analysts.

"Goldman Sachs is the only company within our entire coverage universe that is actually benefiting from the continued dislocation in credit markets globally," wrote analysts at William Blair & Co.

Credit Suisse analyst Howard Chen increased his price target to $180, citing Goldman's "best-in-class franchise with solid market positioning across myriad businesses and strong balance sheet." He sees an opportunity for continued success both in its ability to act as a middleman and to take risk on its own balance sheet.

That Goldman could make so much money without taking on significant risk is an indication of just how skittish and damaged other large financial institutions are compared with Goldman. Net revenues in its FICC division for the last six months were $13.36 billion, shattering the $5.52 billion in net revenues Goldman posted in the first six months of 2008. Value at Risk, the measure of how much money Goldman could lose in a single trading day, has gone up -- to $245 million for the quarter, compared to $184 million in the second quarter of 2008. But this seems like peanuts alongside the giant revenue figure.

Goldman's compensation costs were lower than some analysts predicted. Sandler O'Neill analyst Jeff Harte wrote that lower compensation accounted for 30 cents a share more than he had accounted for in his earnings model.

If Goldman is really making so much money so easily, competition is bound to be coming. However, Viniar said he believes when that happens, it will likely be accompanied by a rise in merger activity, allowing Goldman's investment banking division to pick up some of the slack.

Several analysts asked Viniar about Goldman's very large capital cushion, wondering whether the company may begin to buy back some of its shares. Tangible common equity levels are 50% higher than they were 18 months ago, according to analyst Chris Kotowski of Oppenheimer & Co.

In response, Viniar repeatedly stressed that the firm wants to hold onto this capital until management becomes more confident that risks to the economy have lessened and until they have more clarity about new capital requirements currently being debated by regulators.

Investment banking revenues were $1.44 billion, down 15% from a year ago but up 75% from the first quarter. Goldman posted net revenues of $811 million in principal investments, including $948 million in its investment in Industrial and Commercial Bank of China Limited. Goldman lost $499 million on real estate investments, and another $700 million on commercial mortgage loans.

Despite the blowout results, Goldman shares were down fractionally to $148.97 in recent trading.

Morgan Stanley

(MS) - Get Report

, Goldman's historic rival, will report earnings next week.

JPMorgan Chase

(JPM) - Get Report

, which during the crisis has perhaps taken over from Morgan Stanley as Goldman's most formidable competitor, will disclose its second quarter results on Thursday.