Goldman's Golden Quarter

While rival investment banks struggled, Goldman used its global reach and subprime savvy to increase profits sharply

by Steve Rosenbush

Goldman Sachs (GS) reminded Wall Street on Thursday why it's the undisputed leader of the investment banking sector. While rivals such as Morgan Stanley (MS), Lehman Brothers (LEH), and Bear Stearns (BSC) have reported declining profits (BusinessWeek, 9/7/07) for the third quarter, Goldman's performance was stellar during a period marked by crisis in the U.S. and European credit markets.

Citing a global revenue base and savvy bets on subprime mortgages, Goldman said earnings for the period that ended August 31 soared compared with the same period in 2006. The firm reported a profit of $2.85 billion, or $6.13 a share, up 79% from $1.59 billion, or $3.26 in the third period of 2006. The results exceeded the consensus estimate of $4.36 a share, according to the financial research firm Thomson Financial. Goldman reported third quarter revenue of $12.33 billion, up more than 20% from the $10.18 billion in the comparable period of last year. The revenue figure was the second-highest in the firm's history.

Goldman shares rose on the news. The stock price increased by more than 2% in midday trading, before closing down slightly as the stock market overall dropped on concerns about the broader economy. "This is standout performance by Goldman, which, based on these results, reinforces its leadership among U.S. investment banking players in terms of its ability to adapt [to] and profit from changing environments," analyst Mike Mayo of Deutsche Bank (DB) said in a note to clients.

Sailing Through the Summer

Goldman had a few unusual factors working in its favor. For one, the third quarter of 2007 was five days longer than the third quarter of 2006. The latest quarter's results also included $900 million from the sale of Horizon Wind Energy, in New Jersey. But the quarter also included $1.5 billion in losses stemming from the reduced value of assets such as leveraged buyout loans (BusinessWeek, 9/12/07).

The company all but sailed through one of the most painful and abrupt financial crises in memory. Some analysts and economists believe the summer of 2007 (BusinessWeek, 8/20/07) was worse than the stock market crash of 1987 or the credit crisis of 1998, when Russia defaulted on some of its debt. Goldman reported record revenue in investment banking, equities, and even fixed-income investments.

Goldman managed to adjust on the fly as conditions in the market worsened. When its Global Equity Opportunities Fund took a hit, it assembled a group of investors to put $3 billion into the fund. That allowed the fund to buy assets at a discount. It's up 16% since the capital infusion, according to Goldman Chief Financial Officer David Viniar. And even though Goldman made some bad bets on the subprime mortgage market, they were offset by others wagering that the subprime mortgage market would fall. Its net position was a bet on falling asset prices, Viniar said during a call with investors.