Sept. 20 (Bloomberg) --
Goldman Sachs Group Inc. reported the third-best profit in its 138-year history after betting against the mortgage bonds that roiled credit markets and left
Bear Stearns Cos. with its biggest earnings decline in more than a decade.
The world's largest securities firm said net income rose 79 percent in the third quarter to $2.85 billion, or $6.13 a share, beating the highest analyst estimate by more than 20 percent. Earnings at Bear Stearns fell 61 percent to $171 million, or $1.16 a share.
Goldman said mortgage profits rose ``significantly,'' after wagering correctly that prices of securities tied to home loans would decline. While Chief Executive Officer Lloyd Blankfein also doubled revenue from equities and reaped record investment- banking fees, his counterpart at Bear Stearns, James ``Jimmy'' Cayne, floundered in the market turmoil as bad mortgage bets saddled the firm with $200 million of hedge fund losses.
``They're apples and oranges,'' said William Fitzpatrick, who helps oversee more than $1 billion at Johnson Asset Management in Racine, Wisconsin. ``If there was ever a time that's going to show up, it's going to be here, when the U.S. fixed-income market is deteriorating. Goldman has other businesses to offset that, and Bear definitely doesn't.''
Revenue rose 63 percent to $12.3 billion, Goldman said in a statement today. Return on equity, a measure of how effectively the firm reinvests earnings, was 31.6 percent. Bear Stearns's return on equity was 5.3 percent.
Blankfein Premium
Samuel Molinaro, Bear Stearns's chief financial officer, said on a conference call that ``the worst is definitely behind us.'' Investors remain skeptical. The firm's shares have dropped 29 percent this year and trade at only 1.3 times book value, down from more than 2 as recently as February.
Goldman's price-to-book ratio is about 2.5, illustrating the premium shareholders are willing to pay for its assets and the leadership of Blankfein, who turns 53 today.
``They dominate the business in so many different ways,'' said Michael Vogelzang, who helps manage $2.3 billion, including Goldman shares, as president and chief investment officer at Boston Advisors LLC. ``Goldman will tell us what the state of the industry is because they have their hands in most of this stuff.''
Morgan Stanley, Goldman's largest rival, and Lehman also reported profit declines this week. Goldman got an added boost from an extra-long reporting period. The firm, which closes its books on the last Friday of the month, ended the third quarter on Aug. 31, compared with Aug. 25 last year.
Fed Relief
Investors are betting that pressure on the securities industry will ease in future quarters now that the Federal Reserve has lowered its benchmark interest rate by half a percentage point. When overnight interest rates decline, banks can make money by borrowing cheap and investing in longer-term assets with higher yields.
Shares of the five largest Wall Street firms have advanced since the Fed's Sept. 18 cut. They fell today, with Bear Stearns dropping 18 cents to $115.46 as of 4:02 p.m. on the New York Stock Exchange. Goldman fell $1.97 cents, or less than 1 percent, to $203.53.
``We think that the outlook for our businesses is pretty good,'' Goldman CFO David Viniar said in an interview today. Goldman has no plans to slow hiring, he said.
Revenue in Goldman's fixed income, currency and commodities division, the firm's largest, rose 71 percent to a record $4.89 billion -- even after $1.48 billion of losses for marking to market the value of non-investment grade credits.
Beating Estimates
Analysts had expected Goldman to earn $4.35 a share, the average estimate of 18 surveyed by Bloomberg. The high estimate was $5.08. In the year-earlier period, Goldman's profit was $1.59 billion, or $3.26 a share.
``The numbers are great,'' Glenn Schorr, an analyst at UBS AG in New York, wrote in a note to investors today. The earnings demonstrate Goldman's ``ability to not only navigate choppy waters, but make a ton of money doing so,'' he said.
Viniar said hedging and fee income reduced the markdowns from $2.4 billion and ``substantially all'' of the losses were for loans to finance leveraged buyouts. Goldman ended the quarter with $42 billion of unfunded LBO commitments, down from $51 billion on June 1.
Lehman and Bear Stearns each recorded $700 million of losses on similar markdowns and Morgan Stanley's totaled $877 million.
Mortgage Magic
Under Dan Sparks, Goldman's New York-based head of mortgages, the firm profited from short positions that anticipated declining loan values. Goldman made money in part by entering into contracts tied to ABX indexes, which reflect the perceived risk of mortgage defaults. The gains more than offset losses from writedowns on Goldman's inventory of non-prime home loans and related securities.
``There are going to be opportunities in the mortgage business,'' Viniar said on a call with analysts and investors. ``There are certainly going to be opportunities to buy distressed assets. It's something we're certainly looking at.''
Blankfein warned at a June conference that ``a very big crisis in the credit markets'' was the ``biggest risk we face.'' He also said Goldman was ``organizing ourselves like the market is undervaluing risk and so we are in a high state of nervousness.''
Hedge Fund Collapse
Cayne, 73, failed to anticipate the collapse in demand for mortgage-related securities after default rates on subprime loans surged earlier this year. Two Bear Stearns hedge funds that invested in mortgage debt collapsed in June and ultimately went bankrupt, leaving the firm with the $200 million of losses and expenses.
Goldman also benefited from a strategy of buying and selling companies like it does stocks and bonds. Fixed-income revenue included a $900 million gain on Goldman's $2.15 billion sale of Horizon Wind Energy LLC to EDP-Energias de Portugal SA in July.
The firm had similar gains in previous quarters, on a New Jersey power plant and Japan's Accordia Golf Co. Yesterday, Goldman's Cogentrix subsidiary sold 80 percent of its share in 14 power plants. Viniar declined to say how much Goldman may gain on that transaction.
Investment-banking revenue at Goldman rose 67 percent to $2.15 billion. The firm arranged $255 billion of takeovers completed during the third quarter, 78 percent more than a year earlier, according to data compiled by Bloomberg. Goldman also managed $11.5 billion of equity offerings during the quarter, more than twice as much as a year earlier, Bloomberg data show.
Equity Trading
Equity-trading revenue more than doubled to $3.13 billion on higher commissions, gains on proprietary bets and increased demand for derivatives. Goldman's principal-investments unit, which holds stakes in companies including Japan's Sumitomo Mitsui Financial Group and Industrial and Commercial Bank of China, had $211 million of revenue, down 51 percent from a year earlier.
Revenue in the asset management and securities services unit rose 35 percent to $1.96 billion, even after two of Goldman's largest hedge funds declined by more than 20 percent in August. The firm said a 40 percent increase in management fees more than made up for a drop in its share of fund profits.
The Global Equity Opportunities fund fell 23 percent in August, its steepest monthly decline ever. Global Alpha, Goldman's biggest hedge fund, dropped 22.5 percent for the month and is down 34.9 percent this year. Viniar said investors have notified Goldman that they plan to withdraw $1.6 billion from Global Alpha, redemptions that will leave the fund with about $4.5 billion to $5 billion in assets.
Goldman injected $2 billion into Global Equity Opportunities on Aug. 13 and raised $1 billion more from outside investors to keep the fund solvent. The fund rose 16 percent from the day of the investment and the end of the quarter, Viniar said. Goldman has no plans to add cash to Global Alpha, he added.
