Over a year ago we attempted to deconstruct Goldman's prop trading activity using scraps of data from the tax returns of the Goldman Sachs Foundation. The reason we did that, is that up until today, the firm had never disclosed the non-client aspect of its trading, instead dumping all related revenues and profits in the umbrella "Trading and Principal Investments." That is no longer the case, as starting today the firm will break down its client facing and prop ("Investing and Lending") revenue and profit streams. The reason for our long-term fascination with Goldman prop trading, which is nothing less than a glorified hedge fund, and has no client flow focus whatsoever (presuambly), is that we had always claimed it accounts for a substantial portion of the firm's if not top, then certainly bottom line. After all it was Lucan van Praag who told us directly, that prop trading contributions to Goldman were really de minimis, a response which we took extremely skeptically as the margins associated with a modest revenue amount may well be huge and thus result in a substantial pre tax net income benefit to the firm. Today Goldman also published an 8-K that did a pro forma breakdown of its earnings. To our great surprise, we were correct in assuming that Goldman prop has been the dynamo behind the firm's profitability in 2010.
As a reminder, here is how our exchange with Goldman proceeded back in late 2009:
4) “Does the firm's FICC revenue line have absolutely no prop trading embedded within it? Goldman made $20 billion in FICC year to date: is none of this $20 billion due to capital at risk, or is it all due to wide bid//ask spreads? ”
We’ve said publicly that prop trading represents approximately 10% of this year’s reported net revenue. Some of that revenue is reflected in the FICC line.
We generate the vast majority of our revenue in FICC by facilitating trading activity for our clients and nearly all our revenues in FICC are “due to capital at risk” (your phrase). In periods when capital withdraws from the market, bid-offer spreads tend to widen and we benefit to the extent that we are willing to commit capital and do so successfully. These activities necessarily involve risk taking.
Here are the facts: below we present the breakdown, per Goldman, of its now 4 key divisions, with the "Investing and Lending" group singled out.
Two things should be immediately obvious:
1) while revenues for the prop group were indeed not material compared to the other groups in the company, its pre tax net income margin was astounding, and seems to gravitate around 50%. Compare this to the Flow group, whose margins fluctuate with order flow and market conditions anywhere between 43% and 16% in the past three quarters. Additionally, margins for the other two traditional groups: Investment Banking and Investment Management are so low, that the contribution from these groups to the bottom line combined is less than Prop alone!
2) The net income contribution from Prop to Goldman is massive: in Q1 it was 20.4% of total, in Q2 it was a whopping 41.2% and in Q3 it was 29.6%. Does Mr. van Praag still contend that Prop is a minimum contributor to Goldman's net income? In fact, YTD Prop has accounted for 27.2% of all pre tax earnings, and the group with the most stable top line and margin. Does anyone see now why Goldman was so modest in disclosing the details behind Prop?
Of course, what this means is that Goldman will never end prop trading as such. It will merely rebrand it as it has now done to "Investing and Lending." And with Volcket now out of the picture, and all the crappy prop traders fired with the excuse that Goldman was ending its prop business, the firm can continue to generate massive top line revenue and bottom line profits in a group which is basically Prop trading in sheep's clothing. Which is as we had always expected.
The only good thing to come out of this, is that Goldman will now be forced to break down its VaR for both the Flow and the Prop groups. And we can't wait to see just what the risk differential that the glorified and backstopped hedge fund takes, when it is trading on behalf of clients and on behalf of itself, knowing full well that it can never possibly blow up courtesy of the Bernanke Put.
We are also looking forward to JP Morgan disclosing precisely the same detail, and we also hope that Jamie Dimon can find the time to disclose the alleged massive losses the firm has suffered in its commodity prop trading division in the past two quarters courtesy of the XY-sigma move in precious metals which the Fed's favorite bank was unfortunately not axed all that well in...