DealBook: Goldman’s Sluggish Growth Raises Concern on Wall Street

Pankaj Nangia/Bloomberg News Goldman Sachs paid off a lifeline from Warren E. Buffett’s company, Berkshire Hathaway.

Goldman Sachs gave investors a peek at the new normal on Wall Street — and many are worried.

In some ways, Goldman’s latest results looked good.

On Tuesday, the bank reported first-quarter earnings of $1.56 a share, nearly double analysts’ expectations. Some divisions like investment banking and investment management showed improvement. And Goldman repaid the pricey lifeline from Warren E. Buffett’s holding company, Berkshire Hathaway, the bank’s last major shackle from the financial crisis.

But investors instead focused on Goldman’s sluggish growth, which offered a stark reminder of the difficulties for an investment bank in this postcrisis world.

In trading and the rest of institutional client services, once the hallmark of the firm’s operations, revenue dropped by 22 percent, to $6.7 billion. Over all, first-quarter earnings slumped 21 percent, to $2.74 billion from $3.5 billion, including the one-time hit from the Berkshire repayment. Revenue fell to $11.9 billion from $12.8 billion. And its return on equity, an important measure of profitability, is down sharply from just a few years ago.

“Everyone is saying this sector is dead money,” said Roger Freeman, an analyst with Barclays Capital. “I hear it over and over, and Goldman is part of that.”

Investors took notice. Shares of Goldman fell sharply on Tuesday, dropping by as much as 3 percent before settling at $151.86, down 1.3 percent. The stock is off almost 10 percent for the year.

At issue is how Goldman Sachs and the rest of Wall Street will reverse the profit situation, given the new mandate to temper leverage and hang on to more capital. The looming threat of new financial regulation only makes the outlook more uncertain. Investment banks, and their shareholders, do not have a clear sense how the rules will affect business at a time when economic growth is already slow.

Goldman, which emerged from the crisis stronger than most companies, is not saddled with many of the same problems as its rivals. Bank of America continues to struggle under the weight of bad loans and mounting legal liabilities. Morgan Stanley is paying for a 2008 investment from the Japanese bank Mitsubishi UFJ Financial Group, a deal that costs the company roughly $900 million a year.

The firm also struck a note of optimism about the quarter despite lackluster results. On a conference call with analysts, executives said that client activity had increased, even amid continued economic concerns.

“We are pleased with our first-quarter results,” Lloyd C. Blankfein, chief executive, said in a statement. “Generally improving market and economic conditions, coupled with our strong client franchise, produced solid results. Looking ahead, we continue to see encouraging indications for economic activity globally.”

Even so, investors are nervous about Goldman’s prospects. Many big names have been actively reducing their exposure, including Wellington Management, based in Boston. It sold more than one million shares in Goldman in late 2010, according to regulatory filings. Wellington declined to comment.

One concern is Goldman’s deteriorating return on equity. In the first quarter, Goldman’s return on equity was 12.2 percent. It was 20.1 percent a year ago and 38 percent at the beginning of 2009.

“Most investors have just one question: ‘How is the return on equity going to go up?’ ” said Mr. Freeman of Barclays. “The answer isn’t clear, given the uncertain regulatory environment.”

The current return on equity is also well below Goldman’s stated goal of 20 percent — a level that tracks closely to the firm’s average since its initial public offering in 1999. But the company is unwilling to revise its objective downward until there are fewer “unknown variables” surrounding its operating model, according to a person close to the company who was not authorized to speak publicly on the matter.

Although analysts are confident that Goldman will eventually be able to raise returns over time, it will be a tough slog in the near term.

Return on equity is the amount of money that a company delivers on each share. So if the total investor base grows, Goldman must produce even higher earnings to keep returns the same. Currently, Goldman is sitting on $64 billion of shareholder equity, up from $46.6 billion at the end of 2008, meaning that it has to work harder to generate the same return on equity.

To help increase returns, the company could issue a series of one-time dividends or share repurchases to reduce its capital. But that would be a tricky move right now. Regulators have been loath to let companies like Goldman buy back significant amounts of stock because they want them to have ample capital in the event of another economic shock. Also, Goldman is reluctant to let go of capital until it knows what regulatory changes are coming.

Meanwhile, the firm does not have the same ways to increase profits. Before, Goldman could ratchet up its leverage, relying on borrowed money to help amplify gains. With pressure from regulators to damp risk, the company’s gross leverage ratio fell to 12.9 percent at the end of the quarter, from 27.9 percent at the beginning of 2008.

“Until now, they were operating with two hands tied behind their back,” said Mr. Freeman. “Now they have just one hand, and it is still isn’t easy.”

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