By Steve Eder
NEW YORK (Reuters) - Goldman Sachs Group Inc managed to do a better than expected job in weathering a weak trading environment, suggesting that the much-maligned firm still has plenty to teach its rivals.
Analysts had feared a trading drought would mute the Wall Street firm's profits, but the results were not as ugly as expected. Goldman reported that net trading revenues fell by more than a third in the quarter, but the firm's profits still beat analysts' estimates, sending its shares up 2.4 percent.
"We underestimated Goldman," said Brad Hintz, an analyst with Sanford C Bernstein. "They are still the best traders on the Street."
Trading volumes sank in the third quarter as nervous investors stayed on the sidelines after the "flash crash" and amid volatile markets. Weak volume spurred analysts to slash their estimates for Goldman earnings.
Third-quarter shareholder net income fell to $1.9 billion, or $2.98 a share, from $3.19 billion, or $5.25 a share, a year earlier, hurt by the decline in trading revenues.
Analysts' average forecast was $2.32 a share, according to Thomson Reuters I/B/E/S.
The drop-off in earnings might hit Goldman bankers and traders when bonus season comes. The firm has set aside $3.83 billion for compensation in the third quarter, bringing its total pool to $13.12 billion for the year, down 21 percent from a year ago.
That comes out to $370,706 per employee through three quarters, down from $527,192 at this time a year ago.
Goldman's bottom line in the third quarter got a boost from its principal investments unit, which reported net revenues of $754 million. The revenues reflected gains of $635 million in corporate principal investments, largely in private equity stakes.
Goldman's public and private principal investments portfolio, which includes real estate and corporate investments, grew by $1.3 billion in the quarter to $15.3 billion.
It was not clear whether the private equity assets grew because of higher valuations or if the firm added capital. Goldman declined to comment.
While Goldman's earnings were down from a year before, the firm still looked strong compared with some banking rivals, which have been rattled by the foreclosure crisis.
"Even though expectations were lower and even though the EPS numbers were reduced dramatically in the past couple of weeks, it's still a much more positive release than many of their competitors," said Matt McCormick, portfolio manager at Bahl & Gaynor Investment Counsel Inc.
Goldman has limited direct exposure to the foreclosure crisis through its Litton Loan Servicing unit.
Goldman Chief Financial Officer David Viniar said on a call with reporters that Litton, which has about 23,000 mortgages in foreclosure and has initiated a review of its foreclosure procedures, "believes the underlying foreclosure decisions were warranted."
Investors last week saw signs that trading results might not be as bad as expected when JPMorgan Chase & Co <JPM.N> reported trading revenues that beat Wall Street estimates.
A hedge fund manager said Goldman frequently hints to analysts that trading revenues will be very weak, only to surprise investors with results.
Goldman's Viniar indicated that there are signs that some improvements in client activity could be on the way, which would be a boon to the firm's businesses.
"While we have seen some modestly positive signs in recent weeks, it is difficult to predict the catalyst for improved client activity, especially since human psychology remains such an important driver," Viniar said.
For now, the results remain weak compared with a year ago.
Goldman reported net revenues in fixed income, currency and commodities of $3.77 billion, down 37 percent from a year before. The firm cited a challenging environment in which activity levels dropped significantly.
Fixed income trading revenues were the driver behind Goldman's historic recovery from the financial crisis, helping the firm to report record profits in 2009.
Equities trading net revenues were $1.05 billion in the third quarter, down 43 percent.
Goldman, by at least one measure, scaled back risk in the quarter. Its average daily value-at-risk -- a measure of the maximum possible losses the bank will face on 95 percent of its trading days -- was $121 million, down 41 percent from the year-ago quarter.
Goldman's chief rival, Morgan Stanley <MS.N>, is due to report earnings on Wednesday.
A bright spot in the earnings report was Goldman's investment banking division, which reported net revenues of $1.12 billion, up 24 percent.
During the third quarter, Goldman found itself bracing for new rules under the U.S. financial reform that will affect its business.
Goldman is winding down its Principal Strategies Group, a division of proprietary traders that bets with the firm's own cash. The change is a result of the so-called "Volcker rule," which limits the extent to which banks can bet with their own capital.
Goldman has also been trying to restore its brand after it was hit with fraud charge by the U.S. Securities and Exchange Commission in April. Goldman paid $550 million to settle the charges.
The firm recently launched a public relations campaign to burnish its image.
It did not host its usual conference call with analysts on Tuesday to discuss its results.
Goldman shares were up $3.71 to $157.41 in afternoon trading.
(Reporting by Steve Eder; Editing by John Wallace and Gerald E. McCormick)