Goldman Sachs (NYSE:GS) is rightfully acknowledged as one of the best investment banking firms on Wall Street. Its ability to transform relationships into profits has opened the path for non-investment banking revenue to balance out losses from credit related products. A closer look at Goldman's revenue composition, and specifically its interest income, will help investors identify how tough economic times can still generate business line profits for diversified investment banks.
Revenue Road Map
For the first six months of the year in 2005, Goldman Sachs investment banking segment represented nearly 9% of revenue while trading and principal investments represented just over 35%. Interest income led the way representing more than 47% of total revenue with $9 billion. Fast forward to 2008 and the numbers reveal that investment banking made up less than 8% of revenue for the first six months of the year, followed by trading revenue at just under 28% and interest income at more than 57% of revenue at $20 billion.
What makes up Interest Income?
While individual investors must shop around for high paying interest savings accounts like those offered by ING Group (NYSE:ING), investment banking firms have come up with multiple ways to generate healthy revenue from lending activities.
For example, short selling is often mentioned as a method of hedging equity or futures positions in order to either protect against a downside pullback or to profit from the falling value of an underlying security. This strategy is often used by hedge funds who are seeking to outpace their predetermined benchmarks. When investors borrow securities for the purpose of short-selling, Goldman receives cash plus accrued interest on the securities loaned. The SEC has been debating about whether to institute long standing rules to limit short selling which could effect this revenue stream. (For more on this strategy to profit, read Short Sales For Market Downturns.)
Other Banks Focus On Credit Cards
JPMorgan Chase (NYSE:JPM) reported a 7% decrease in total revenue for the first six months ending June 30, but its net interest income increased 30% to nearly $16 billion over the same time period a year ago. JPMorgan's interest income was driven in part by higher trade related interest income and better spreads credit card balances of consumers. In contrast, Morgan Stanley (NYSE:MS) reported a nearly 28% drop in total revenue for the first six month, but its net interest income decreased nearly 19% to $24 billion. Morgan's exposure to the credit-markets that have been dragged down by subprime-related debt weighed too heavily on the firm's ability to generate higher year-over-year profits from interest income related activities.
All investment banks are not the same. Goldman found a way to profit from short selling and JPMorgan has found another way to profit from consumer credit card balances. The idea is to align your investments to reflect the multiple paths to profits that can carry a firm through good and bad economic times.
To learn more about the credit crisis, and how it has affected the profitability of many banks, be sure to read How Will The Subprime Mess Impact You?