Profit at Goldman Less Easy to Find

Even when Goldman Sachs’s public reputation was taking a beating, the bank’s business acumen and profit remained the envy of Wall Street.

Now the company is facing questions about whether it will be able to maintain its place atop the financial industry in a new era of regulations that hit hardest the very businesses in which Goldman makes the most money.

Among Wall Street analysts, the company has been losing its favored position. Only a quarter of the analysts that follow the company have a buy recommendation on the shares of Goldman Sachs — the lowest proportion in years — while roughly half are still positive on its fiercest rival, Morgan Stanley, and even more recommend buying JPMorgan Chase stock.

Further signs will come next week, when Goldman and the other big banks report third-quarter results. Goldman is expected to report higher profit than it did a year ago, but much of the bank’s recent success has come from divisions that are expected to shrink as new regulations are phased in.

Analysts and some investors say they are concerned that lawmakers may continue to come down harder on the company than on its competitors, most of which are not as reliant on Wall Street activities as Goldman. In September, for instance, an influential Federal Reserve official, Daniel K. Tarullo, announced plans to rein in a type of financing that Goldman particularly depends on.

“They are concentrated in the hardest part of the business,” said Roy C. Smith, a former partner at Goldman who is now a historian of the financial industry at New York University. “In terms of the modern life of the place, this is the most difficult ordeal to manage its way through that the firm has ever faced.”

Goldman Sachs’s Annual Earnings

	2014 Y.TD.	2013 Y.T.D.	2013	2012	2011	2010	2009
Y.T.D. = year to date as of second quarter results; E.P.S. = earnings per common share; R.O.E. = return on average common shareholders’ equity. Sources: Goldman Sachs; Bloomberg
Profit	$4.0 billion	$4.2 billion	$8.0 billion	$7.5 billion	$4.4 billion	$8.4 billion	$13.4 billion
Institutional Client Services	$8.2 billion	$9.5 billion	$15.7 billion	$18.1 billion	$17.3 billion	$21.8 billion	$32.7 billion
E.P.S.	$4.06	$4.00	$15.46	$14.13	$4.51	$13.18	$22.13
R.O.E.	11%	11.5%	11.0%	10.7%	3.7%	11.5%	22.5%

The concerns have not stopped the bank from churning out profit. It is one of the few banks in the industry that have been earning more than their cost of capital — its return on equity is now 10.7 percent, compared with Morgan Stanley’s 6.7 percent.

Those figures reflect, in part, steady cost-cutting at Goldman. But they are also a result of businesses that have been successful even as they shrink because of regulatory pressures.

Since analysts began downgrading Goldman’s stock, the share price has continued to outperform many of its peers’. The stock is up 3.7 percent so far this year. Still, given the variety of outstanding questions, it will be some time before Goldman will be able to quiet its critics.

“We just don’t know how their business mix is going to evolve,” said Steven Chubak, a bank analyst with Nomura Securities.

The company’s executives have not ignored the changing business conditions. They have curtailed some of the business lines that are hit the hardest by the new rules, such as lending to hedge fund clients.

This summer, the chief executive, Lloyd C. Blankfein, named a new chief strategy officer, Stephen M. Scherr, who has been tasked with finding new business lines where the company can expand. He is looking into ways the bank can offer more asset management to wealthy clients and expand its technology business — neither of which requires the bank to maintain expensive capital buffers.

The company’s executives are dismissive of the notion that it needs to be fundamentally reshaped — as many other banks have been — to be as successful as it was in the past.

Goldman executives say they believe that the company’s position as essentially the last independent Wall Street bank will give it an ability to capture future profit. But they acknowledge they will have to continue to stay nimble.

“Adaptability has always been important for our industry,” Goldman’s chief financial officer, Harvey M. Schwartz, said in the company’s last earnings call. “However, it may be even more valuable in the current environment, given the numerous regulatory and economic changes underfoot.”

Dealing with the evolving landscape is likely to be a central challenge for whoever takes over as chief executive for Mr. Blankfein, who is 60, whenever the recurring rounds of speculation about him stepping down come true.

Goldman’s current trials are a result, in no small part, of its success over the last decade. It thrived during the financial crisis in troubled corners of the financial markets that knocked out some of Goldman’s competitors, like Bear Stearns and Lehman Brothers.

The pullback by other companies left Goldman strong in markets that have attracted the heaviest regulatory scrutiny. The accusations that Goldman capitalized on the crisis did not help its standing in Washington.

The bank continues to serve as a lightning rod for controversy. In late September, secret recordings of regulators and bankers surfaced, suggesting that the bank had come under scrutiny from regulators, even after the crisis, for pushing regulatory limits.

Morgan Stanley was the other free-standing Wall Street bank to survive the crisis. But in recent years, Morgan Stanley has moved away from risky trading and emphasized the Smith Barney asset management business it bought from Citigroup. The Smith Barney business now accounts for almost half of Morgan Stanley’s revenue.

Goldman has continued to turn in significantly higher profit than Morgan Stanley, but the analysts who give Morgan Stanley a higher rating have argued that its business mix provides it with greater opportunities for profit growth, while Goldman’s businesses are in danger of further shrinkage.

JPMorgan, Bank of America and Citigroup also compete with Goldman, but they also have large consumer and commercial banks that make them less dependent on their trading and investment banking operations. What is more, their big commercial banks provide a steady flow of reliable business from big corporate customers that Goldman does not have.

The biggest limitation on Goldman’s business comes from new capital rules, which require all banks that hold risky assets to maintain a buffer of shareholder funding that cannot be withdrawn in a crisis.

Because banks have to maintain capital for every trade they make, the new rules have curtailed the amount of trading going on across Wall Street. This has hurt revenue at several banks, but it is a particular issue at Goldman because trading has accounted for a majority of Goldman’s revenue and profit in recent years.

The new regulations hit hardest on the buying and selling of bonds and derivatives — the fixed-income operations — which were a big profit driver at many banks. This sort of trading is facing other challenges caused by the Federal Reserve’s bond-buying stimulus programs, which have calmed the market and led to less overall trading.

While competitors have responded to this situation by shutting down parts of their fixed-income operations, Goldman has largely stayed the course and is betting that when trading activity returns to normal, the bank will have an opportunity to capture even more of the market.

So far, though, Goldman has not shown any sign of gaining market share from big competitors in either stock or fixed-income trading.

The stagnant businesses have been compensated for, in the last few years, by gains on Goldman’s investing portfolio. Last year, the investing division was the largest single generator of profit at the company. But the Volcker Rule is forcing Goldman to unload some of the most profitable parts of that portfolio.

The company’s executives say they can probably find other ways to put that money to work — and the current investments will continue to be profitable for the next year or two — but the capital rules will eventually make that much more expensive than it has been.

“Remaining the leaders that they are as the regulatory and capital landscapes evolve is their No. 1 challenge,” said Glenn Schorr, a bank analyst with the International Strategy and Investment Group.