Goldman Sachs and Investment Banking’s Swan Song
Karen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Goldman Sachs’ (NYSE: GS) dismal second quarter earnings report confirms that the investment bank bubble has finally burst. The firm lost $194 million on its investment in the Industrial and Commercial Bank of China on top of the $112 million lost on their other stock investments.
This past quarter Goldman Sachs’ corporate investment bank profit dropped by 81%, and its net revenue fell 9%. The firm earned $962 million, or $1.78 a share, as opposed to $1.09 billion, or $1.85 a share, a 12% decline from second quarter 2011 to the same quarter this year. Revenue likewise fell from $7.28 billion second quarter 2011 to $6.63 billion second quarter 2012. The firm beat the Street's EPS estimate of $1.16 per share primarily from spending approximately $1.5 billion in a 14.3 million share buyback. As a final kick, Goldman was downgraded from A- to BBB+ by Egan-Jones based on their decrease in net income and investment banking revenue and the overall weak economic climate.
Investment banking produces sky high profits in a bull market but carries the risk of astronomical losses when the bears take over. In a weak economy or in choppy markets, investment banking becomes very unattractive to clients because profits tend to be low while risks remain high.
JPMorgan Chase’s (NYSE: JPM) fortress balance sheet wasn’t enough to prevent their investment banking unit from reporting a 7% fall in their second quarter 2012 profit of $1.91 billion from the same quarter a year earlier. The bank's annual profit is $4.96 billion, down from $5.43 billion reported the same time last year. The stock has dropped 21% in the past three months, and the London Whale trading loss was reported as $4.4 billion.
CEO Jamie Dimon has acknowledged material weakness in the bank’s internal controls and that changes were being made to address these problems. But Jamie’s assurances haven’t been enough to keep federal regulators from launching a full-scale investigation into the investment bank’s loss.
Seeking to curtail the inherent risks, the Volcker Rule took effect last month to restrict investment banks’ ability to trade for the banks' own benefit. As a result, profits have fallen enough to make investment banks look favorably at more traditional banking profit centers.
Both Morgan Stanley (NYSE: MS) and Citibank (NYSE: C) are looking to retail banking and at expanding Smith Barney’s brokerage firm for new sources of revenue. Morgan Stanley’s second quarter 2012 revenue of $7 billion represents a 24% drop from the $9.2 billion reported the same period 2011, and investment banking revenue is down by 37%.
Citibank likewise saw their second quarter revenue decline to $18.6 billion, a 9.7% drop from last year’s figure. The companies’ stock price dropped 25% and investment banking revenue fell 21% during second quarter 2012.
Europe is also seeing their investment banks struggling. UBS (NYSE: UBS), Switzerland’s largest bank, saw their first quarter 2012 $746.9 million profit turn into an ugly $133 million loss in second quarter 2012. In response, CEO Sergio Ermotti is shrinking the investment bank unit by more than 50% to focus more on client wealth management.
Although investment banks will always be around, their heyday of earning record profits quarter after quarter is over. Recently enacted and upcoming regulations which continue to limit investment banking’s risks and earnings will put retail banking’s smaller profits and lower risk in a favorable new light.
kprogers has no positions in the stocks mentioned above. The Motley Fool owns shares of Citigroup Inc and JPMorgan Chase & Co. Motley Fool newsletter services recommend Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.