Proprietary trading has been a significant area of income growth for the large investment banks. But in a recent Barron's article (see Eli Hoffmann's summary and comment), Jacqueline Doherty argued that investment banks' profits from proprietary trading may not continue to grow, and the stocks may be a "sell". Sure enough, when Goldman reported quarterly results Wednesday morning, its trading business did decline from the first quarter. (Its in-house hedge fund also took a serious whack.) But the stock traded up on the results, presumably because they were better than the Street's (by then pessimistic) expectations.
Here are the key details about its trading business, excerpted from the prepared comments by Goldman Sachs' CFO David Viniar on the conference call:
Let me turn to trading and principal investments. This comprises fixed income currency and commodities, or FICC, equities and principal investments. Net revenues were $4.7 billion in the third quarter, down 32% from the record second quarter and 7% from the third quarter of 2005. Our trading businesses were affected by investor uncertainty and the slowdown in customer activity across most of the capital markets.
Despite the more challenging environment, FICC had its third best quarter with net revenues of $2.7 billion, down 37% from the record second quarter but up 4% from the year-ago third quarter. These results reflect a decreased customer flow and fewer opportunities to transact as FICC products traded within relatively tight bands and volumes declined during the quarter.
Revenues in all major areas of FICC -- credit, rates, commodities, currencies, and mortgages -- were down versus record or near-record performances in the second quarter. Currencies, rates, and commodities had the largest sequential declines, although the decline in commodities was largely due to the inclusion of a $700 million one-time gain in the second quarter from the sale of the Linden power plant.
Nonetheless the overall environment for FICC remains constructive as interest rates are low by historic standards, credit spreads remain relatively tight, and much of the uncertainty around interest rate policy in the U.S. seems to have eased for the moment. Commodities also remain very active, given strong fundamental demand for key commodities and continued investor interest in the sector.
Equities net revenues for the third quarter were $1.6 billion, down 34% from the second quarter and 3% from the third quarter of 2005. Equities trading revenues were $707 million, down 50% sequentially, principally in our customer-driven businesses while equities commissions decreased 10% to $844 million.
The third quarter was challenging for equities. Following the correction that began in mid-May and continued into early June, equity markets fluctuated within tight ranges as investors struggled to understand where the market and broader global economy might be going next. This market uncertainty led to fewer opportunities and lower level of customer activity over the summer months. The difficult equity market also affected our principal strategies business, which produced results that were significantly lower than the second quarter.
Average daily value at risk in the third quarter was $92 million, compared to $112 million for the second quarter, reflecting fewer opportunities across most of our trading businesses during the quarter. Principal investments net revenues were $430 million in the third quarter compared to $293 million in the second quarter. This increase was driven by the mark-to-market on our investment in Sumitomo Mitsui Financial Group, where we recognized a gain of $261 million or $0.20 per share. We also generated $169 million in gains and overrides from other principal investments, as we continue to benefit from strong investment performance.
The full Goldman Sachs conference call transcript is here. You can also view other recent conference call transcripts, and sign up to receive them by email as soon as they are published. And here's Erik Dellith's detailed analysis of Goldman's results.