Goldman's bad equities bet
A failed gamble on derivatives hurt the company in the second quarter.
By Dan Freed, TheStreet
Goldman Sachs' (GS) second-quarter results provided a reminder that the bank doesn't exactly walk on water.
Goldman suggested the mediocre performance was driven by one-time items, including its $550 million settlement of fraud charges with the Securities and Exchange Commission and a $600 million U.K. bank payroll tax. CFO David Viniar also referred repeatedly to low levels of customer activity on a conference call with the media today.
The poor fixed-income trading results were to be expected, as underwriters like Goldman have an unspoken obligation to buy back inventory from clients in the face of declining markets, says Bernstein Research analyst Brad Hintz.
But the disappointing numbers from Goldman's equities trading business caught Hintz off guard. The bank earned just $235 million from this business in the second quarter, compared with $1.47 billion in the first quarter and $2.16 billion in the second quarter of 2009.
Goldman's Viniar told reporters the poor equities performance was driven partly by the fact Goldman was short certain indices that track volatility, the best known of which is the VIX.
"We had that position going into the quarter and volatility just spiked," Viniar said, adding that the trade was in response to client demand.
But the fact that Goldman's clients wanted it to do this trade is no excuse, as Goldman could have hedged against the position, a point made by Barclays Capital analyst Roger Freeman on a call with analysts Tuesday morning.
"We didn't hedge it fast enough," Viniar said, adding "clearly we were reducing position size and hedging things, but things spiked really dramatically really fast."
Bernstein's Hintz nonetheless expressed surprise that Goldman chose to be short volatility. He says that though it costs money to bet on volatility, most equities derivatives desks tend to prefer that position as it protects them when volatility spikes.
"This explains to investors why Goldman has a high beta," or measure of volatility. "It's a volatile stock that goes up and down with market conditions," Hintz says.
Goldman shares were up 1.3% to $147.62 in early afternoon trading.
Copyright © 2014 Microsoft. All rights reserved.
Excitement is growing about the company's new iPhone, expected this fall.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.