Goldman Sachs Group Inc. barely managed to show a rise in quarterly profit as a sharp drop in fixed income trading revenue offset record investment banking fees and strong equities income.

The world's largest investment bank by profit and market value on Thursday said net earnings rose 1 percent to $2.33 billion, or $4.93 a share, in the second quarter ended on May 25, from $2.29 billion, or $4.78 a share, a year earlier.

While earnings were about 4 percent higher than the analysts' average estimate of $4.76 a share, the results paled in comparison with the double-digit growth of previous periods.

Net revenue slipped 1 percent to $10.2 billion, just beating the average estimate, while Goldman routinely trounces expectations. Some analysts said earnings growth would have been even lower if not for reduced compensation and tax rates, and Goldman shares fell more than 3 percent.

Goldman has historically beaten by so much, so people are bound to have high expectations, said Jim Huguet, president and co-chief executive at Great Companies Inc. in Tampa.

The mixed results come two days after Lehman Brothers reported a 27 percent jump in profit, surprising investors and sparking a rebound in broker stocks as the one-time bond shop benefited from expansion in new businesses.

Goldman has been doing spectacularly for several quarters and this was only OK, and that's not OK with investors, said Ken Crawford, who helps run $850 million in separate accounts for Argent Capital Management in St. Louis.

MIXED TRENDS

Trading and principal investment revenue fell 6 percent to $6.65 billion, paced by a 24 percent drop in debt and commodities trading revenue, the bank's largest business. Goldman said rising defaults on risky home loans had hurt the mortgage business.

Business trends during the quarter were mixed, Goldman Chief Financial Officer David Viniar said on a conference call. Where equities recovered after a weak start, several businesses saw reduced volatility and risk appetite from our clients, compared with a very robust first quarter. At the same time, corporate and financial sponsor activity did accelerate to record levels.

Trading results last year included a $700 million gain from a power plant sale.

Goldman's traders took on even more risk in bonds and stocks, with average daily value at risk reaching $133 million.

Analyst Michael Hecht of Bank of America said he was disappointed that Goldman, which is bigger and broader than Lehman, was hurt more by subprime mortgage weakness. Bear Stearns Cos. on Thursday said earnings fell by a third due to mortgages and the write-down of a trading venture.

Revenue from principal investments more than doubled to $784 million from last year, fueled by a range of company and real estate stakes.

Yet the quarter also demonstrated the risk of making big direct bets with house money, as Goldman's stakes in Industrial & Commercial Bank of China and Japan's Sumitomo Mitsui Financial Group fell in value and trimmed overall earnings by 14 cents a share.

RECORD BACKLOG IN INVESTMENT BANKING

Investment banking income rose 18 percent to a record $1.72 billion for the quarter, as advisory fees from mergers and acquisitions rose 17 percent. Debt underwriting revenue rose by 50 percent, powered by loans for leveraged buyouts. These gains helped overcome a 26 percent drop in stock underwriting.

Goldman this year is the top adviser for M&A and public stock offerings worldwide. Looking ahead, Viniar said the backlog of investment banking business set a record, surpassing its previous high in the second quarter of 2000, when the 1990s technology stock bull market peaked.

Revenue from the bank's asset management arm increased 11 percent to $1.06 billion, as managed assets rose 28 percent to $758 billion. Noncompensation costs rose 16 percent to $1.86 billion, with headcount soaring 17 percent to 28,012 people from last year.

Looking ahead, Viniar predicted that problems in subprime would get worse before they get better. Goldman previously expressed interest in acquiring subprime businesses, but Viniar said the company would be very cautious.

I think there is pain yet to be felt in some structured vehicles and potential default rates, Viniar said. I don't think we're through.

The company's shares were down $7.36, or 3.2 percent, at $226.28 in afternoon New York Stock Exchange trade.

The stock, which hit an all-time high of $233.94 at the end of May, rose 4 percent during the fiscal quarter, outperforming the 1.3 percent gain in the AMEX Securities Broker-Dealer Index, but lagged the S&P 500.

(Additional reporting by Dan Wilchins)

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