Goldman Said to Get Burned by Coal, Retail in Trading Miss
(Bloomberg) -- Goldman Sachs Group Inc.’s fixed-income revenue was so unexpectedly weak in the first quarter that last week’s earnings report left the stock tumbling and Wall Street buzzing over what happened. Part of the answer is now emerging.
Traders got burned by a constellation of souring debts tied to a coal-mining giant and struggling mall retailers, as well as wagers linked to the U.S. dollar, according to people familiar with the matter. The bank incurred tens of millions of dollars in losses on companies including Peabody Energy Corp. and Energy Future Holdings Corp. Borrowings from retailers including Rue 21 Inc., Gymboree Corp. and Claire’s Stores Inc. also stung, the people said.
The behind-the-scenes losses contributed to a disappointing profit, announced April 18, that left analysts and shareholders puzzling about what went wrong. The firm’s fixed-income desks handling bonds, currencies and commodities generated $1.69 billion in revenue, about $340 million below estimates and barely higher than a year earlier, which was the worst first quarter in at least a decade. Chief Executive Officer Lloyd Blankfein blamed the “operating environment,” but it was the same one that had helped every major U.S. rival post double-digit increases.
“I’m still confused,” Brennan Hawken, an analyst at UBS Group AG, told Goldman Sachs executives on a conference call to discuss results. Beating last year’s numbers should’ve been relatively easy, and solid profits flowed in from “everybody else,” he said.
Deputy Chief Financial Officer Marty Chavez told analysts that clients were less active in trading commodities, currencies and credits amid low volatility in some markets. Goldman also has a different mix of clients, he said, with competitors boasting larger lending books and more corporate customers.
But for some investors, the comments on credit became a point of confusion as rivals including Bank of America Corp. and Morgan Stanley cited it as an area of strength.
Under partner Adam Savarese, who heads Goldman Sachs’s distressed-debt desk, the bank loaded up on borrowings from energy companies and other beaten-down names, the people said, asking not to be named discussing the bank’s trading. Some positions ended up incurring losses, hurting the unit’s revenue growth.
“We specifically cited other areas and factors as the primary reasons” for the fixed-income division’s underperformance, said Michael DuVally, a spokesman for the New York-based company. “In fact, the distressed desk had a stronger performance this past quarter than during the same period last year.”
For years, Goldman Sachs resisted the banking industry’s broad retreat from fixed-income trading as firms struggled to maintain profits in the face of stiffer rules and muted client activity. The idea was that by preserving its franchise, Goldman would build market share once markets revived. That’s what analysts predicted would happen in the first quarter.
Expectations were heightened after the company built up a reputation last year for its ability to profit under the Volcker Rule. The regulation, passed after the financial crisis, broadly limits banks’ traders to handling client orders, rather than betting their own firm’s money on future market prices. However, those lines can be blurry.
By the end of September, star junk bond trader Thomas Malafronte had generated about $250 million for Goldman over nine months. Internally, the bank’s executives examined his transactions and deemed them as comporting with the new rule.
But the flip side of such risk-taking can be the occasional flub.
After enjoying several quarters of rising tides, distressed-debt investors -- and the banks handling their trades -- are starting to have a tougher time. Some securities that were profitable in 2016 have whipsawed, moving against Wall Street firms this year. Prices have slid on bonds from strained energy companies and retailers, as well as other ventures struggling with large debt burdens, such as radio broadcaster iHeartMedia Inc.
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Goldman Sachs held roughly $200 million in Peabody bonds, about 10 times more than other major dealers, as the coal miner prepared earlier this year to exit bankruptcy protection, according to data from Securities and Exchange Commission filings and a person with knowledge of the restructuring’s terms. Those bonds would have lost about $40 million this year as their value slumped.
The bank also got hurt by Energy Future after Texas regulators blocked the sale of a key unit that was designed to pay off some debts. The debacle prompted about $1 billion in losses for a roster of creditors including hedge funds Elliott Management and York Capital Management.
In retail, debts owed by teen and children’s clothing chains Rue21 and Gymboree have traded lower this year as their private-equity owners prepared the companies for potential bankruptcy filings. Neither of their bonds trade for more than 13 cents on the dollar. Bonds from tween jewelry retailer Claire’s have been trading below 45 cents on the dollar as it tries to keep up with more than $2 billion in debt.
The bank also was caught wrong-footed on some positions tied to the U.S. dollar, according to one of the people with knowledge of the situation. Chavez singled out a specific “headwind” in currency trading as he spoke to analysts: Volatility in dollar-euro exchange was about the lowest in two years.
Goldman’s results sent shares tumbling 4.7 percent for the biggest daily drop in almost 10 months. Much of that loss reversed on Monday after French election results buoyed global markets. But as of 2:15 p.m. in New York, the stock was still down 6.3 percent this year.
“We could have done a better job navigating the market,” Chavez told analysts. “It’s a cyclic market, and that’s really all I would say.”