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Goldman Sachs’ earnings plunge, as looming mortgage settlement dents

Goldman Sachs headquarters Sao Paulo BrazilGoldman Sachs headquarters Sao Paulo Brazil

Goldman Sachs’ second quarter earnings made it clear that the shadow of the financial crisis still hangs over the investment bank.

What you need to know: Net income for Goldman Sachs (GS) tumbled 49% to to a little over $1 billion for the second quarter. That translated to earnings per share of $1.98. Analysts had been expecting $3.96. The bank earned $4.10 per share in the same quarter a year ago. Despite the earning drop, Goldman’s revenue was better than expected. The investment bank had sales of just over $9 billion in the quarter, which was slightly lower than a year ago. The biggest part of the plunge came from legal expenses, which Goldman says cut earnings in the quarter by $2.77 a share. Without the legal expense, Goldman’s earnings would have been $4.75 a share, well above expectations.

Goldman is reportedly nearing a settlement with the government related to mortgage bonds it sold in the run up to the financial crisis. Other banks have settled claims that they misled investors about the quality of those bonds, and that is likely to be the claim against Goldman as well. Goldman said it set aside $1.45 billion for mortgage-related litigation and legal maters.

The big number: Despite changes on Wall Street, and new regulations, Goldman still takes in more money from its trading division than any of its other business units. The second quarter was a rocky one from Goldman’s trading desk, which the firm says makes the bulk of its money executing trades for clients. Revenue from Goldman’s Institutional Client Services division fell 6% in the quarter to $3.6 billion. The biggest drag on Goldman’s trading profits was from its bond, commodities, and currency trading businesses. Revenue from that business dropped 28%. Goldman CEO Lloyd Blankfein said in a statement that he was pleased with the quarter’s results, but that uncertainty about what would happen in Europe with the euro put a damper on client activity. Although not in stock markets, where Goldman’s revenue was up 24%.

What you may have missed: Goldman’s earnings from its proprietary investments fell as well. The firm said revenue from its private equity investments was down, but it didn’t say by how much. And it said that the drop was offset by an increase in revenue from its public equity investments. Overall, its revenue from equity investments was down 13% from a year ago.

Later this month, the Volcker Rule—which makes it much harder for banks to risk their own money on proprietary investments, especially in private equity funds—goes into affect, though Goldman does have a window to wind those investments down. So it’s not such a bad thing that Goldman’s revenue would be shrinking from equity investments, as it will need to be less reliant on that business.

Not as good, though, is the fact that Goldman’s revenue from lending and debt securities fell 12%. Those activities are more traditionally what a bank does, and what Goldman will have to rely on as it becomes more bank-like. Goldman’s return on equity, too, a key measure of profitability for Wall Street, which used to be routinely above 20%, was still only 11.5% for the quarter, even excluding the legal expenses. Goldman’s post-financial crisis transition is still in the works.