One part of Goldman Sachs' business blew it -- and everyone wants to figure out why

Photo: Ross Land/ Getty.

Goldman Sachs reported Q3 earnings on Thursday that were pretty rough across the board.

The bank missed on both the top and bottom lines.

Lloyd BlankfeinGoldman SachsGoldman Sachs CEO Lloyd Blankfein.

But the most striking part of the announcement was a 60% revenue drop in the investing and lending division.

That division, also known as I&L, is all anyone has been talking about on Thursday. On a call with CFO Harvey Schwartz following the earnings announcement, I&L dominated the Q&A period with analysts.

So if you’re wondering why Goldman struggled this quarter, it’s important to understand what I&L is.

What is investing and lending?

According to Goldman’s website, the investing and lending division brings “investors together with projects and organisations in need of capital.”

It’s not a business of its own, but a reporting segment for the bank that encompasses the businesses that lend to and make investments in companies. It includes the bank’s merchant banking business and its “special situations group.”

Harvey SchwartzImage courtesy of Goldman SachsGoldman Sachs CFO Harvey Schwartz

In I&L, Goldman invests its own money in addition to client money. Investments are mostly long-term, and made across debt securities and loans, public and private equity securities, and real estate.

Businesses like the merchant bank and special situations group used to report earnings as part of the investment bank and the institutional client services, or trading, divisions. About four years ago, Goldman changed the way it reports earnings, and created the I&L category.

No other major Wall Street bank has an I&L division, which makes it a bit of a black box when trying to compare it to the rest of the Street.

So what happened?

Things didn’t go well for Goldman’s I&L businesses last quarter. Revenues of $US670 million were down 60% from the $US1.69 billion reported in the year-ago quarter. They were also down 63% from Q2.

The firm chalked this up to a “significant decrease” in revenues from equities investments, “as net revenues in public equities were negatively impacted by a significant decrease in global equity prices.”

A company statement also noted that “significantly lower” revenues in debt securities and loans reflected “lower net gains from certain investments.”

On Thursday’s call, one analyst asked Schwartz how the bank can manage I&L risk quarter to quarter.

He said that 75% of the bank’s I&L portfolio is made up of debt, compared to 2011 when debt made up less than 50% of the portfolio. And of that debt portfolio, he said, 60% comes from Goldman’s “good old fashioned bank.”

All this, he said, should mean the division is less subject to volatility than it used to be.

Apparently that didn’t pan out this time around.

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