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Goldman's profit doubles, but questions loom

In this Wednesday, Feb. 13, 2013, photo, Paul Cosentino, left, of Goldman Sachs and Patrick Armstrong of Prime Executions work on the floor of the New York Stock Exchange, in New York. Goldman Sachs reports quarterly earnings on Tuesday, July 16, 2013.
In this Wednesday, Feb. 13, 2013, photo, Paul Cosentino, left, of Goldman Sachs and Patrick Armstrong of Prime Executions work on the floor of the New York Stock Exchange, in New York. Goldman Sachs reports quarterly earnings on Tuesday, July 16, 2013.

NEW YORK – Goldman Sachs said Tuesday that its second-quarter profit doubled and revenue jumped 30 percent, helped by gains in stock and bond underwriting and the bank's own investments. But the hot topic for analysts who follow the bank was a set of impending capital rules and how they might affect the powerful New York investment bank.

Goldman's stock rose in pre-market trading after the bank released its earnings results with rosy headline numbers. But the stock dipped by the time the market opened, just as Chief Financial Officer Harvey Schwartz faced a barrage of questions about the capital rules and other hard-to-predict factors that could affect the bank's future earnings, including how clients might react to rising interest rates.

Capital requirements have been the topic du jour as big financial companies have reported second-quarter earnings over the past few days. The consternation started last week, when U.S. regulators said they were considering requiring U.S. banks to hold greater amounts of capital. Regulators in the U.S. and around the world have been raising capital requirements since the financial crisis, saying it will give banks a cushion in troubled times; the banking industry has protested, saying it will put them at a disadvantage to international peers, and constrain them from lending.

The talk around capital requirements also underscores a shift in thinking in the banking industry, where even profitable banks are focused on cutting costs, partly to deal with an uncertain economy and partly from the effect of stricter government regulations. Goldman's total assets were down about 2 percent over the year and it also cut about 2 percent of its staff, or 600 jobs. It sold the majority of its reinsurance business in May as a way to deal with capital requirements, which are making it more expensive for banks to hold risky assets.

Unlike JPMorgan Chase on Friday and Citigroup on Monday, Goldman did not release estimates of how close its current capital levels would come to meeting the proposed rules on the so-called leverage ratio. Schwartz said the bank was comfortable with its position and knew how to adapt to changing environments. But he also said it was too early to release specifics. He noted that the rules were far from final and that the bank hadn't had the time to go through the proposal with "the kind of diligence we would normally want."

That didn't stop analysts from asking, though.

"On the leverage ratio, when you say you're comfortable, what is your definition of comfortable?" asked Morgan Stanley analyst Betsy Graseck.

"Comfortable," Schwartz replied.

A few moments later, when UBS analyst Brennan Hawken also asked about the leverage ratio, Schwartz told him: "I like the persistence."

To be sure, Goldman posted plenty of gains. Revenue from underwriting stocks and bonds soared 45 percent compared with a year ago. The bank's own investments in stocks turned a profit, bouncing back from a loss a year ago. Revenue from trading bonds for clients was up 12 percent.

Compared to the first quarter, however, the bank's performance was less impressive. That's because investors homed in on the Federal Reserve in late May and early June, trying to guess when the central bank might ease back on its programs meant to help the economy. While that uncertainty wasn't near the level of the fitful quarter a year ago, when worries about debt-riddled Europe were acute and the U.S. budget battle was still looming, the guessing-game over the Fed was enough to send stocks fluctuating and bond prices drooping.

Schwartz said that the drop in bond prices — and the accompanying rise in interest rates — had forced many investors to recalibrate their strategies and had made them less eager for mortgage-related investments. Though he was asked many times, Schwartz said he couldn't predict how investors would react as interest rates continue to rise, saying only that clients were on high alert to the changes.

"Clients," he said, "are basically sitting on the edge of their seats for every communique out of the Federal Reserve."

BY THE NUMBERS: Profit was $1.9 billion after payments to preferred shareholders, compared with $927 million a year ago.

Per share, those profits were $3.70. Analysts polled by FactSet had expected $2.83.

Revenue was $8.6 billion, up 30 percent from $6.6 billion a year ago. That also beat the expectations of analysts, who had forecast $8 billion.

ANALYST REACTION: Even though the headline numbers blew away analysts' expectations, some were unimpressed. Citigroup analyst Keith Horowitz and Evercore analyst Chris Allen noted that the earnings were helped by one-time items like a break on the bank's tax rate, and the sale of the reinsurance business and Goldman's stake in a Chinese bank.

Horowitz said he had expected a bigger increase in revenue from trading bonds for clients. Allen said that the bond trading revenue was below levels seen at JPMorgan Chase and Citigroup.

Credit Suisse analyst Howard Chen was more positive. He said that Goldman's core businesses still turned in a good performance. He raised his estimates for annual earnings and the bank's stock price.

LITIGATION: The bank said it set aside more money, $149 million, for potential lawsuits and regulatory proceedings, but didn't give details on the reasons. In the most recent three quarters, Goldman has set aside a combined $519 million for legal and regulatory proceedings. In the three quarters before that, it set aside $176 million.

A former Goldman Sachs trader, Fabrice Tourre, went to trial Monday in New York, accused of selling mortgage-backed securities that he knew were going to fail. Goldman already settled related charged with the Securities and Exchange Commission in 2010, though it still faces private lawsuits.

STOCK ACTION: Goldman's stock fell $2.30, or 1.4 percent, to $160.70. It's still up 26 percent this year.

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