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Goldman Sachs May Cash In on UBS’ Retreat

The big margin on Wall Street in is bonds -- and a major player just bowed out


Swiss banking giant UBS (NYSE:UBS) is essentially getting out of the investment banking business — a move that could open up a huge opportunity for Goldman Sachs (NYSE:GS) in the critically profitable bond business.

UBS is slashing 10,000 jobs, shuttering riskier activities like fixed-income trading to focus on its more profitable and predictable wealth management business. The European sovereign debt crisis, heavier capital requirements and stricter regulations (as well as self-inflicted wounds like the Libor scandal and a rogue trader) have simply made it too tough for UBS to thrive as currently constructed.

Even better for rivals, the Swiss bank may not be alone. UBS Chairman Axel Weber told the media that some of the firm’s European competitors — like Credit Suisse (NYSE:CS) and Deutsche Bank (NYSE:DB) — might need to dramatically downsize, too.

Ceding lucrative investment banking territory to competitors couldn’t come at a better time for Goldman Sachs. Bond trading, as well as currencies and commodities, has always been a core area of expertise and excellence for Wall Street’s most powerful investment bank. The bank is a perennial top performer in the ruthless global market for fixed income, currencies and commodities (FICC) and — more important — it’s been a huge driver of results.

Goldman Sachs derives maximum value from the division, which contributes greatly to the firm’s net revenues, write analysts at Trefis. Sure, stocks and derivatives might get all the headlines, but the big money and margins are in bonds.

“Goldman Sachs’ trading assets (capital) for bond, currency and commodity trading are almost 50% greater than the company’s equity and derivatives trading assets,” Trefis analysts note. “Additionally, Goldman’s yield on bonds, currencies and commodities is nearly 3x greater than that of equities & derivatives.”

Those factors make bonds, as well as currencies and commodities, far more valuable than equities and derivatives.

And yet the financial crisis, waves of new regulations and tougher capital requirements have damped this extraordinarily lucrative field. Trading assets in the firm’s bonds, currencies and commodities division ballooned to $293 billion in 2007 from $205 billion in 2005 — and then cratered, hitting $246 billion in 2008 as the global economy and financial system imploded, Trefis notes.

True, FICC trading assets have since rebounded to $281 billion last year, but that’s still well off the all-time peak — and at a time when Goldman Sachs (and the entire industry) needs all the revenue it can get.

As we’ve written before, Goldman Sachs’ money-minting days are over. Net income peaked at $13.39 billion in fiscal 2009. Through the trailing 12 months ended Sept. 30, net income came to $5.6 billion. Goldman is forecast to hit $6.11 billion for the current fiscal year — or 54% below its 2009 peak.

It’s been hard to get overly bullish on the stock, at least based on its current valuation. But the latest seismic change in the competitive landscape shakes things up. If Goldman Sachs can pounce on the opportunity afforded by UBS’ big retreat, the stock suddenly looks a lot more compelling.

As of this writing, Dan Burrows didn’t hold positions in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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