Goldman cautious on near-term outlook

Goldman Sachs Group Inc said on Tuesday fourth-quarter earnings rose 2 percent, beating expectations and capping a record year, but its shares fell after the investment bank cautioned that markets will remain challenging in the near future.

The world's largest securities firm by market value said net income rose to $3.22 billion, or $7.01 a share, in the quarter ended November 30, from $3.15 billion, or $6.59, a year earlier.

Net revenue rose 14 percent to $10.74 billion as higher merger advisory fees and surprisingly strong debt trading results helped it sidestep the credit crunch that has hammered the rest of Wall Street in the second half.

The results exceeded analyst expectations for earnings of$6.68 a share. Yet shares of Goldman fell 2.3 percent to $203.80 in morning trade, as the bank indicated that trading and investment banking markets would make earnings growth challenging.

We're cautious about the near-term outlook for our businesses as we see dislocation in some of the world's capital markets has continued, said Goldman Chief Financial Officer David Viniar in a conference call with reporters,

Goldman's muted outlook, combined with Lehman Brothers Holdings Corp last week reporting a 12 percent decline in earnings, cast a pall on other financial stocks. Morgan Stanley, which reports its results Wednesday, saw its shares fall 3 percent in morning trade.

RECORD YEAR

The Goldman results capped a record year for the bank, which generated a 33 percent return on equity despite the turmoil in credit markets and a slump in leveraged buyout activity. And while the rest of Wall Street recorded billions in mortgage and credit write-downs, Goldman's losses were modest.

Goldman Chief Executive Lloyd Blankfein does it again, as he has for several cycles. He avoided the land mines that exploded the competition and made a profit in a challenging environment because clients stayed with him, said Michael Holland of money management firm Holland & Co.

Employees of Goldman certainly profited, as salaries, bonuses and benefits surged 23 percent to $20.2 billion for the year. With headcount growing 15 percent to 30,500 people, that's average compensation of $661,181.

Once again, it was the firm's traders and principal investment desks that set the pace, generating nearly two-thirds of revenue.

Fixed-income, currency and commodities (FICC) trading revenue rose 6 percent to $3.3 billion, reflecting in part $800 million from Goldman's sale of its Cogentrix Energy power plant interests during the quarter and higher revenue from mortgages and interest rate products.

Viniar declined to comment on Goldman's current mortgage trading position -- he disclosed a large gain made from betting against subprime mortgages during the third quarter -- but he indicated the subprime crisis is not yet over.

We're getting closer to the bottom. I don't know if we reached there yet, Viniar said.

GAINS AND BUMPS

Goldman's quarter was also helped by a $500 million net gain from leveraged finance commitments, an area that had prompted $1.7 billion in third-quarter write-offs. Viniar told reporters that leverage loan markets opened briefly in October, allowing the bank to sell some positions and reduce its overall exposure.

Principal investments booked revenue of $1.04 billion from a variety of corporate and real estate investments as well as a $163 million gain on its stake in Industrial and Commercial Bank of China (601398.SS: Quote, Profile, Research).

Fox-Pitt Kelton analyst David Trone observed that some bearish investors will take issue with the factors behind the Goldman earnings. Roughly 75 cents a share came from unexpected investment gains, not including the Cogentrix gains, which some argued helped Goldman beat expectations.

The absence of mortgage woes was fully expected. More importantly, the problems in corporate credit markets are having a bigger negative impact than we expected, Trone said in a research note.

Goldman officials stress that its other, client facing businesses helped carry the day.

Investment banking net revenue rose 47 percent to $1.97 billion, as a surge of completed deals helped to double merger advisory fees. Underwriting fees were little changed, as increases in IPOs were offset by a decline in debt issuance.

Equities trading revenue rose 22 percent to $2.59 billion in a volatile period.

One area of concern could be that the investment banking backlog decreased during the quarter. The outlook for M&A, Viniar said, depends on whether the economy holds up well.

I think there will be LBOs in 2008. There will be plenty of them. I don't think we'll see the mega public-to-private that we saw in 2007 for a while, Viniar said, citing the challenge of selling buyout debt to investors.