Goldman's bad equities bet

A failed gamble on derivatives hurt the company in the second quarter.

By TheStreet Staff Jul 20, 2010 1:29PM

thestreet.comBy 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.

 

 

Other big debt underwriters, including Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup (C), showed similar weakness in their fixed-income trading results.

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.

 

Related Articles

0Comments

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

126
126 rated 1
286
286 rated 2
474
474 rated 3
680
680 rated 4
626
626 rated 5
609
609 rated 6
620
620 rated 7
462
462 rated 8
304
304 rated 9
132
132 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
AAPLAPPLE Inc10
BIDUBAIDU Inc10
BXTHE BLACKSTONE GROUP L.P10
CELGCELGENE CORP10
FOXATWENTY-FIRST CENTURY FOX Inc CLASS A10
More

VIDEO ON MSN MONEY

ABOUT

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.