Bank of Goldman

July 14, 2009

Lloyd Blankfein, chief executive officer of Goldman Sachs and banker-in-chief of the US/world, didn’t disappoint as his investment firm once again proved that it’s second to none on Wall Street when it comes to printing money and profits.

By now you know the headline news that Goldman generated blowout second-quarter earnings on record net revenues of $13.8 billion. Net revenues from trading and principal investments were $10.78 billion, up 93% from the year ago period.

Remember that trading code theft case with Sergey Aleynikov? No worries here.

The firm exceeded even the most widely optimistic analyst forecasts and demonstrated that the financial crisis, which pushed Goldman’s stock down to $51 last November is a distant memory–for Goldman at least. BTW, Goldman’s stock is now trading around $150. Talk about stock appreciation.

And it looks like maybe Goldman will be able to pay those fat year-end bonuses afterall. In the quarter, compensation and benefits expenses were $6.65 billion. That amount is higher than the second-quarter of 2008 because of higher net revenues. Fatter Goldman bonsues will make all those luxury real estate brokers in Manhattan happy.

But while everyone is singing Goldman’s praises, let me point out a few blemishes–albeit small ones.

First, Goldman continues to do investors no favor by failing to publish a detailed financial supplement along with its earnings release (something every other big bank does) to help decipher its quarterly numbers.

Second, Level 3 assets–assets that the firm can’t value and trade–remain stubbornly high at $54 billion. Sure, the dollar value of Level 3 assets is down by $5 billion from the first quarter. But these impossible-to-value assets (some of them toxic) represent 6.1% of Goldman’s total assets.

Third, the risk Goldman is taking in its trading operation continues to edge up. The average daily VaR, or value at risk, was $245 million as of June 26.  That’s up from $240 million in the first quarter and up from $184 million as of May 2008. Goldman keeps piling on risk to drive its trading gains.

Fourth, the firm says a good chunk of its 28% year-over-year gain in net revenues from stock trading came from “significantly higher net revenues in derivatives.” Goldman, since its conversion to a bank holding company last year, now ranks second among US banks in total notional value of derivatives contracts. More and more, counterparty risk is getting concentrated in Goldman–now that Lehman and Bear Stearns are gone.

Fifth, as I argued last week, Goldman needs to start providing a more detailed account of just where all those trading dollars come from. The following explanation for the $6.8 billion in trading revenue it churned out in fixed income, currencies and commodities doesn’t cut it:

“These results refelected particularly strong performances in credit products, interest rate products and currencies, reflecting strength in the client franchise.” Well, duh.

Sixth, the news that the firm posted strong FICC trading numbers, even after taking a $700 million loss on commercial mortgage loans is not necessarily troubling for Goldman. But it is a troubling sign for other banks that don’t Goldman’s secret sauce for generating outsized trading gains. 

Stay tuned for more updates on Goldman’s earnings and watch out for our live blogging of the Goldman conference call at 11 a.m. (ET).

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