Brendan McDermid/ReutersThe Goldman Sachs post on Wednesday at the New York Stock Exchange. The bank’s stock rose 6.8 percent.8:47 p.m. | Updated
Goldman Sachs’s chief financial officer told analysts on Wednesday that his firm could not cut its way to prosperity.
That may be, but Goldman has been busy slashing costs from compensation to car services to deliver a profit to its shareholders.
Its tight reins on expenses helped the firm on Wednesday report a fourth-quarter profit of $978 million, or $1.84 a share, exceeding analysts’ expectations of $1.24 a share, according to Thomson Reuters. Shares of Goldman surged 6.8 percent, to $104.31.
Yet its results also revealed some ugly truths about how hard Goldman is struggling with weak economies and nervous markets. The bank’s profit was well below the $2.2 billion it posted in the year-ago period. And its 2011 return on equity — a crucial measure of profitability — fell to 5.9 percent, roughly where it was 2008, when the financial crisis was in full swing. It is the second-lowest return on equity the firm has posted since going public in 1999. In contrast, in the boom year of 2006, its return on equity was 41.5 percent.
In the face of falling revenue across most of its main business lines, Goldman has turned to the only lever it has to increase profitability: expenses. The chief financial officer, David A. Viniar, said the firm planned to cut an additional $200 million from noncompensation expenses, bringing the latest round of cost-cutting to $1.4 billion, or almost 5 percent of 2011 net revenue.
And Goldman, a bank known for paying out multimillion-dollar bonuses, has also been forced to cut compensation. In 2011 it set aside $12.22 billion, or 42.4 percent, of its 2011 net revenue to pay compensation and benefits for its 33,300 employees.
This is enough to pay each employee about $367,000. In 2010, when it had 2,400 more employees, it set aside $15.38 billion or an average of $431,000 for each employee.
“What and where to cut is the toughest challenge these banks face as they wait out the slowdown in the economy,” said Glenn Schorr, an analyst who follows Goldman Sachs for Nomura. “It’s just a very slow environment, and these companies are built for a higher-octane environment.”
Goldman is not the only bank vexed by current conditions. Rivals like JPMorgan Chase and Citigroup have already reported results, and they too are struggling to churn out big trading profits.
But for Goldman, the problem is more pronounced. It is considered the savviest trader on Wall Street, a reputation that comes with the expectation that it should be able to better navigate difficult markets. And, unlike most of its rivals, it does not have a retail banking arm, a division that tends to produce steady profits, to fall back on in hard times.
On a conference call with analysts, Mr. Viniar shied away from saying whether he felt this downturn in business — which is also caused by new regulations that have required banks to shut down certain operations and put up more capital against others — is permanent.
“So is it cyclical, is it secular? It is a very difficult question to answer,” he said.
Over all, Goldman produced net revenue — or revenue minus interest expense — of $6.05 billion in the fourth quarter, down 30 percent from the period a year earlier. Its 5.9 percent return on equity falls to just 3.7 percent when the one-time cost of buying back shares from Warren E. Buffett is included.
Net revenue in Goldman’s division that trades bonds, currencies and commodities was $1.36 billion, down 17 percent from levels a year ago. The firm attributed the drop to lower results in mortgages and credit products “as continued global economic uncertainty contributed to difficult market-making conditions.” This division accounted for roughly 22 percent of the firm’s total revenue in the fourth quarter. In contrast, the division accounted for 33 percent of Goldman’s revenue in 2006.
The firm’s investment management division posted net revenue of $1.26 billion, down 16 percent from a year ago in part because incentive fees, a fee it charges it clients, dropped.
Goldman also logged a $450 million paper loss on what it calls relationship lending, an item it does not often disclose. Goldman sometimes lends money to its clients in the course of doing underwriting business with them. These loans are typically made at favorable, below-market rates. As a result, Goldman is forced to book a loss on them.