Visions of bonus heaven in Goldman Sachs profit
By Jenny Anderson

Wednesday, December 13, 2006, International Herald Tribune


Money is not supposed to grow on trees. Unless you happen to work at Goldman Sachs.

The investment bank reported earnings Tuesday that left jaws agape on Wall Street. Quarterly profits soared 93 percent. The bank earned nearly as much per share in 2006 as it had in the last two years combined, both of which were also record years. Immediately after the results were released, they were labeled the best ever by an American investment bank.

The figures were certainly good news to the scores of Goldman bankers and traders who will find out, starting Wednesday, what their bonuses will be. Chances are good they will be impressive: the bank is paying $16.5 billion in compensation this year, or roughly $623,418 for every employee.

Wealth on Wall Street is not distributed evenly, of course. Rainmakers in investment banking can expect to see $20 million to $25 million each while traders who booked big profits will take home a chunk of those profits, up to $50 million apiece, according to senior executives at leading Wall Street banks.

"Anyone at the bonus line at Goldman Sachs died and went to bonus heaven," said Michael Holland, chairman of Holland & Company, a New York-based investment firm. "It doesn't get any better than this."

The bonuses at Goldman, the leading merger adviser in the industry, and elsewhere on Wall Street ( Lehman Brothers and Bear Stearns report earnings later this week, and their earnings are expected to be robust as well) are expected to give the New York area's economy a substantial boost, particularly in sales of high-end residential real estate, luxury cars and other pricey goods.

"When these guys learn what their bonuses are, we are among the first people they call," said Pamela Liebman, the chief executive of the Corcoran Group, a residential brokerage. "They call their mothers, and then their real estate brokers."

Investment banking earnings are often proxies for the health of the American and global economy. And conditions have been ripe for Goldman and its competitors to mint money.

Stock markets have been on a tear for months, while credit markets — far bigger than the equity markets — have continued to be robust. Credit derivatives continue to grow at a geometric pace, with $27 trillion outstanding. Opportunities abound to invest in companies, trade securities or advise clients in markets around the world, including China, Russia and the Middle East.

Private equity firms continue to buy increasingly large companies — witness the Blackstone Group's $36 billion acquisition of Equity Office Properties Trust, the nation's largest office-building owner and manager, a deal Goldman advised on. And hedge funds, which account for 40 to 80 percent of trading in certain markets, represent significant profit-making potential for Wall Street — and, of course, for Wall Street's persistent leader.

For the year, Goldman produced record revenue of $37.7 billion and a record profit of $9.5 billion, or $19.69 a share.

In the fourth quarter, the bank earned $3.15 billion, or $6.59 a share, on revenue of $9.41 billion. Investment banking revenue climbed 42 percent, to $1.3 billion, and trading and principal investments rose 57 percent, to $6.6 billion.

Even David Viniar, Goldman Sach's cautious chief financial officer, sounded vaguely optimistic.

"Our economists' view is that we will continue to have good economic growth, somewhat slower in the U.S., somewhat better in Europe and very good in Asia," Viniar said. And "our business tends to be tied to economic growth more than anything else."

Fueling Viniar's optimism is the breadth of Goldman's business as well as the number of deals the bank has in the pipeline, the so-called backlog. That pipeline is more robust than it has been at any point since 2000, Viniar said.

Like many universal and investment banks, Goldman Sachs has transformed its business to capitalize on sea changes in the capital markets, particularly new opportunities in far-flung markets and a shift from issuing and trading plain-vanilla stocks and bonds to building and trading complex derivative products. That shift is apparent in the makeup of Goldman's revenue.

In 1997, investment banking and trading and principal investments produced roughly the same revenue ($2.6 billion and $2.9 billion, respectively), for total net revenue of $7.4 billion.

In 2006, investment banking earned $5.6 billion while trading and principal investments produced $25.6 billion — almost 70 percent of the total $37.7 billion in net revenue.

Goldman derives significant profits from acting as an investor, deploying the firm's capital to buy and sell companies. In the second quarter, the bank spent $2.6 billion for a 5 percent stake in the Industrial and Commercial Bank of China, China's largest state-owned bank ($1.6 billion came from Goldman Sachs's private equity funds and the remainder was financed off Goldman's balance sheet). When the giant Chinese bank went public in October in the largest initial public offering ever, Goldman's stake soared in value. For the fourth quarter, Goldman earned $949 million in profits from the investment.

It made another half a billion dollars on the sale of the Accordia Golf Company, a portfolio of Japanese golf courses that Goldman began to acquire in 2001.

Investors seemed to question whether the good times could continue. Goldman's stock traded down $2.52, or 1.2 percent, to $200. "The stock being down almost shows they are victims of their own success," said Jeffrey Harte, a securities industry analyst at Sandler O'Neill. "Ninety-seven percent year-on-year earnings growth is spectacular," referring to earnings per share.

Goldman's returns do not come without significant risk. Banks use "value at risk" to calibrate how much money they could potentially lose in particular trading strategies over a set period of time. Goldman's average value at risk soared 33 percent in the fourth quarter, to $106 million this year from $80 million at the end of November 2005. For the year, value at risk totaled $101 million, compared with $70 million in 2005.

And yet Goldman's size seems to insulate it from downturns in some of its businesses. For example, the firm has aggressively developed internal hedge funds for wealthy investors, which generate high fees for Goldman. The bank's flagship hedge fund, Global Alpha, is down more than 11 percent from a year, a drastic change from 2005 when the fund returned more than 40 percent after fees. The impact of the fund's poor performance will be booked in January, but fees from smaller accounts that match the strategies of Global Alpha were down 78 percent in the fourth quarter, to $23 million.

Viniar acknowledged that the fund's returns would adversely impact first quarter earnings but expressed optimism about the growth of the hedge fund industry.

"The hedge fund asset class is a growing asset class," he said. "It is one that is sensible. It is one that a lot of people with money to invest are interested in. It will continue to grow at a reasonable pace moving forward."

His unusual optimism did not completely outweigh his characteristic caution, however. Asked about the quality of deals in the backlog, Viniar was quick to point out, "Conditions in the capital markets can change quickly and no backlog is ever guaranteed."