Goldman Sachs Boosts Risk-Taking at Fastest Pace on Wall Street 


By Christine Harper

April 27 (Bloomberg) — Goldman Sachs Group Inc., unbowed by the securities industry’s worst year since the Great Depression, increased its trading bets at the fastest rate on Wall Street.

Goldman Sachs’s so-called value-at-risk, the amount the New York-based bank estimates it could lose from trading in a day, jumped 22 percent to $240 million in the first quarter, twice what Morgan Stanley stands to lose, company reports show. VaR climbed 2.8 percent in the same period at JPMorgan Chase & Co. and dropped 14 percent at Credit Suisse Group AG.

Offense beat defense in the first three months of 2009 as Goldman Sachs reported record revenue of $9.4 billion, dwarfing Morgan Stanley’s $3.04 billion. Since Goldman Sachs and Morgan Stanley, the two biggest U.S. securities firms, converted into banks in September, Morgan Stanley Chief Executive Officer John J. Mack has reduced proprietary trading and principal investing to focus on the firm’s role as a financial adviser and broker.

“What stands out to me isn’t so much that Goldman had a blow-out quarter, it’s that Morgan Stanley had a disappointing quarter,” said Jeffery Harte, an analyst at Sandler O’Neill & Partners LP in Chicago, who has a “hold” rating on both firms.

Morgan Stanley posted a $177 million loss in the first quarter and slashed its dividend by 81 percent after real estate and debt-related writedowns. By contrast, Goldman Sachs, led by Chief Executive Officer Lloyd C. Blankfein, reported better- than-estimated earnings of $1.81 billion in the same period.

Seeing Opportunity

“Morgan may have it right for 2010, but for the first quarter of 2009 that wasn’t the right answer,” said Peter Sorrentino, a senior fund manager at Cincinnati-based Huntington Asset Advisors Inc., which oversees about $13.3 billion and owns Goldman Sachs shares. “Goldman saw the moment completely differently. They saw the opportunity, saw the pricing and realized this isn’t going to last forever.”

Goldman Sachs wasn’t alone. New York-based JPMorgan generated a record $4.9 billion of fixed-income revenue, and profits at Citigroup Inc. and Credit Suisse, based in Zurich, were helped by trading revenue that exceeded analysts’ estimates. Deutsche Bank AG, Germany’s biggest bank, may report record trading when it discloses first-quarter earnings tomorrow, people with knowledge of the situation said last week.

VaR is just one measure banks use to try to gauge losses. It isn’t designed to capture the risk of rare and extreme losses. For that reason, some critics such as Nassim Taleb, author of the “The Black Swan,” say the metric is inadequate.

Market Spreads

Wall Street made money in the first quarter from traditionally unprofitable corporate loans and trades for their customers, as the gap between what banks pay to buy fixed-income securities and what they sell them for, the so-called bid-ask spread, almost doubled.

“Spreads are way up,” JPMorgan CEO Jamie Dimon told analysts April 16 after the biggest U.S. bank by market value reported a 10 percent drop in first-quarter net income. The past three months represent “a historically high quarter, and if you were looking at it, it’s not reasonable to expect it to continue at that level,” said the 53-year-old Dimon.

Credit Suisse Chief Executive Officer Brady W. Dougan, 49, said last week that taking fewer chances to lose money “remains a key area of focus” for the biggest Swiss bank by market value. Barclays Plc President Robert Diamond, who runs the London-based bank’s securities unit, said in an April 15 interview that he’s “reasonably optimistic” as he looks ahead.

“It has been quite a while since we’ve seen analysts talk about revenue as opposed to writedowns and balance-sheet risks,” said Diamond, 57.

Repaying TARP

Goldman Sachs sold $5 billion of stock on April 14, and Blankfein, 54, pledged to use the proceeds to help repay the $10 billion that the firm received last year under the Troubled Asset Relief Program. Morgan Stanley also got $10 billion.

Mack, 64, told employees on March 30 that 2009 would be a “difficult” year and said “it’s the wrong time” to return the money. New York-based Morgan Stanley then said last week it would “consider” repayment.

The firms can’t make refunds until after they learn the results of stress tests conducted by banking regulators to determine which of the 19 largest U.S. banks needs more capital to help weather adverse economic conditions. The assessments may be made public as soon as May 4. Goldman Sachs and Morgan Stanley are the fifth- and sixth-largest banks by assets.

“Both companies would like to find a way to give back the TARP capital, but I think Goldman has been a little more vocal about that, a little more aggressive in going to the market and raising capital,” said Nick Sheumack, an investment banker at Keefe Bruyette & Woods Inc. in New York who advises securities firms and asset-management companies.

‘Risk Appetite’

Morgan Stanley Chief Financial Officer Colm Kelleher, 51, said on a conference call with analysts and investors last week that weaker-than-expected fixed-income trading revenue of $1.3 billion, or $2.3 billion excluding writedowns related to the firm’s improved creditworthiness, was “about risk appetite.”

“We will take risk when we think the risk-adjusted return appetite warrants that,” Kelleher said.

Goldman Sachs CFO David Viniar, 53, told analysts on April 14 that his firm took advantage of a reduced number of competitors to charge more for executing trades, even in some of the most liquid securities. The bank booked $6.56 billion of fixed-income trading revenue, 34 percent more than its previous record and five times Morgan Stanley’s.

“The vast majority of all our risk-taking is on behalf of clients,” said Goldman Sachs spokesman Lucas van Praag.

Balance-Sheet Constraints

Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, said Morgan Stanley hampered its traders from participating as so-called counterparties in even safer, liquid markets because of efforts to reduce balance-sheet assets. That limited the financing that the firm could provide to customers, he said.

“Fixed-income traders without the ability to provide customer financing and with limited use of balance sheet are unable to take advantage of even favorable market conditions,” Hintz wrote in an April 23 report.

Total assets climbed 5 percent at Goldman Sachs to $925 billion in the four months ended March 31, while Morgan Stanley’s assets dropped 5 percent to $626 billion.

Morgan Stanley’s conservative stance may stem from its need to win over investors. The firm’s stocks and bonds are priced at a discount to Goldman Sachs’s. Morgan Stanley shares dropped below $10 in October and still trade at less than the firm’s $27.32 book value. Goldman Sachs’s stock never fell below $50 and trades above the company’s $98.82 book value.

Lehman’s Collapse

“If you think back to last fall, Morgan was in a much more precarious situation than Goldman Sachs,” said Roger Freeman, an analyst at Barclays Capital in New York who worked for Lehman Brothers Holdings Inc. when it went bankrupt last year. “It’s perfectly understandable that there’s shock there.”

Lehman’s collapse led investors to lose confidence in Wall Street. Goldman Sachs’s $4 billion of senior unsecured bonds maturing in April 2018 traded as low as 77 percent of face value on Sept. 16, the day after the bankruptcy. Morgan Stanley’s $4.5 billion of senior unsecured bonds maturing in April 2018 plunged to 61 percent of face value on Oct. 10, according to trades of more than $1 million on NASD’s Trace system.

The two companies responded by converting to bank holding companies to win government financing support. Both qualified for $10 billion injections from the U.S. Treasury in October.

Default Insurance

Goldman Sachs and Morgan Stanley bonds have since recovered. Goldman Sachs’s April 2018 senior unsecured notes traded at 93 cents on the dollar last week, and Morgan Stanley’s were 95 cents on the dollar, according to Trace.

The cost of insuring against a default on Morgan Stanley’s bonds is still higher than for Goldman Sachs. Morgan Stanley’s credit-default swaps traded on April 24 at 3.65 percent, compared with 2.38 percent for Goldman Sachs. The difference means it costs $127,000 more each year to protect $10 million of Morgan Stanley debt than to insure the debt of Goldman Sachs.

While both companies are able to issue debt with a guarantee from the government, Goldman Sachs sold $2 billion of 10-year notes in January without a guarantee to test market confidence. Morgan Stanley hasn’t tried to do that yet, and CFO Kelleher said the firm is waiting until the market is receptive.

The 24-member KBW Bank Index has declined 22 percent this year, compared with Goldman Sachs’s 44 percent advance in New York Stock Exchange composite trading and Morgan Stanley’s 37 percent increase. New York-based Citigroup slumped 52 percent in the same period, and JPMorgan climbed 5.9 percent.

Sticking to Model

Goldman Sachs and Morgan Stanley said last year that they intended to build their base of deposits. Morgan Stanley’s deposits rose 67 percent to $60 billion at the end of March. Goldman Sachs, which had deposits of $27.6 billion at the end of November, didn’t disclose a figure for the end of March.

Blankfein has shown no inclination to change the business model that helped Goldman Sachs set industry records for earnings and pay in 2006 and 2007.

“Nothing that happened this year altered the core of what Goldman Sachs is,” Blankfein told investors at a Nov. 11 conference in New York. “We won’t stop doing the things that made us a leading investment bank.”

Trading is such an integral part of Goldman Sachs’s culture that Blankfein has no choice, Huntington’s Sorrentino said.

“Goldman is Goldman because they’ve done that,” he said. “If they can get paid to take a risk, they’ll take it. You don’t get paid for doing safe stuff.”

Revenue Per Employee

First-quarter revenue-per-employee and compensation figures bear that out. At Goldman Sachs, each of the firm’s 27,898 employees brought in, on average, $338,017 in revenue, compared with $68,760 apiece for Morgan Stanley’s 44,241 employees, according to data compiled by Bloomberg.

Compensation and benefits at Goldman Sachs totaled $4.71 billion in the quarter, an average of $168,829 per employee, compared with $2.08 billion at Morgan Stanley, or $47,060 for each person.

Mack began pulling out of businesses that used a lot of the company’s capital in November, reducing proprietary trading, principal investments, mortgage origination and the prime brokerage division that caters to hedge funds.

“They’re just trying to get to where the puck is going to be, whereas Goldman just said, ‘No, we’re still playing the game we’ve always played,’” Sorrentino said.

To contact the reporter on this story: Christine Harper in New York atcharper@bloomberg.net.

Last Updated: April 26, 2009 19:01 EDT 

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