Classy Goldman Shows How It's Done

No financial institution has been left unscathed in the past few months. But for Goldman Sachs (NYSE: GS  ) , Wall Street's largest investment bank, its stellar reputation has been its saving grace, keeping it humming in what is now an infamously brutal industry.

New York-based Goldman reported first-quarter net income of $1.5 billion, or $3.23 per share, a notable decline from last year's $3.2 billion, or $6.67 per share. Revenue for the quarter came in at $8.3 billion, down 35% from a year ago. While the 52% decline in earnings per share represents quite a battering, Goldman still managed to surpass analysts' expectations.

Let's be honest. In the wake of the unprecedented pain banks have endured lately, performance expectations aren't exactly lofty. Reacting to the news, Goldman shares climbed 16% yesterday.

Part of what helped Goldman exceed expectations was a big jump in commodities trading, where exposure to hot markets such as oil, gold, and corn soared 46%. In contrast, revenue for Goldman's principal stock trading unit, which usually brings in bundles of cash, fell by almost half.

During the quarter, Goldman took a loss of about $1 billion on investments linked to residential mortgage products, and another $1 billion hit from leveraged loan products, even though fixed-income trading as a whole dipped only slightly.

Goldman was the sole major Wall Street bank to actually profit from the credit crunch, reporting a $4 billion windfall after correctly betting mortgage-backed securities would fall starting in late 2006.

Winning by not losing
Investors breathed a huge sigh of relief after CFO David Viniar came through with the nine words they had been aching to hear: "Our liquidity position is stronger than it's ever been."

Bear Stearns' (NYSE: BSC  ) fall from grace happened in what seemed a matter of hours, and now the investment banking industry's future relies on one factor: confidence. By keeping investors and clients calm, and by reassuring markets that its liquidity will enable it to continue business as usual, Goldman set itself up to capitalize on the market's sour mood.

As Bear Stearns learned last week, it is counterparty risk -- scared clients pulling their money out -- that can determine a bank's ultimate fate. After Bear Stearns' blowup, counterparties have to ask themselves a serious question: Should they continue working with firms such as Lehman Brothers (NYSE: LEH  ) and UBS (NYSE: UBS  ) , firms that are mentioned in liquidity rumors, or should they jump ship to Goldman where there are no doubts about the quality of operations?

This reputation will pay huge dividends to Goldman Sachs. While rival firms scramble to keep panicky investors and clients at bay, Goldman has remained the go-to firm that has largely avoided both the subprime crisis as well as the serious drop in confidence from the financial world. If the reputations of other companies continue to deteriorate, Goldman could become the new home for a surge of investing refugees who are unwilling to take more chances.

What lies ahead for Goldman? Investors should pay close attention to the final chapter of the Bear Stearns saga. What JPMorgan (NYSE: JPM  ) will do with Bear's assets will play a key role in how competitive the banking market becomes after the smoke clears.

If JPMorgan chooses to scrap Bear's investment banking division, for example, a major Goldman competitor is removed from the market. The investment banking world is fiercely competitive, but it's controlled by only a handful of major banks. Remove one from the mix, and suddenly the remaining players have a far different environment to work in.

Foolish final thoughts
Over the past decade, investment banks enjoyed phenomenal growth and unprecedented profitability. By most accounts, those glory days are over. Every firm will need to take a step back and reevaluate the amount of risk it's willing to take to maximize profits. Nonetheless, by maintaining its rock-solid reputation, Goldman Sachs is in place to keep its spot as Wall Street's most formidable player.

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