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Did Obama Just Kill Bank Of America; Is Prop Responsible For 45% Of Goldman's Bottom Line?
After today's ban on prop trading, the bulk of the attention has been focused on Goldman Sachs and for good reason: without the ability to commingle trading information from the biggest flow operation in the world, with its own principal risk exposure, Goldman becomes just another B-grade bank, which has a solid balance sheet, a massive inventory of products in its flow business it must offload regularly (and unable to capitalize on, by taking the opposite side of the trade), and is eagerly anticipating the "boom" in M&A and underwriting advisory deals that is "just around the corner." While we wish Goldman well, having to compete on a fair basis with the remaining banks should make for a novel departure from its traditional, monopoly-facilitated business model. Is the current stock price fair? Absolutely not, and if indeed Goldman finds no way to prevent the prop ban, it is very much overvalued here. Yet speaking of overvalued companies, and the prop trading ban impact, one company that may have well slipped under the radar today is none other than Bank of America. Ironically, after fooling around with the most recent BAC model by none other than Goldman's Richard Ramsden, we have uncovered just what a huge impact on the bottom line BAC's "trading account profits" aka prop trading has. If we zero out the revenue contribution from this line item, 2011P EPS goes from $2.25 to... $1.25. This may be relevant information for all those massive hedge funds who believe that Bank of America is a slam dunk double from here. It will be poetic justice if the stock price is indeed mispriced by 50%...in the wrong direction.
Below we present a snapshot from Ramsden's model, as it stands right now, which projects revenue for Trading Account Profits of $14.3 billion and $14.8 billion in 2010 and 2011. This translates to an EPS of $1.30 and $2.25 for the next two years.
So we play around with the assumptions and we zero out the revenue contribution from prop, as the president seems inclined to suggest. We get a stunner:
With revenues dropping simply by the amount pointed out above, the impact on EPS is a whopping $1.00/share! As a result of zeroing out trading account profits, EPS drops to $0.30 and $1.25 for 2010 and 2011, respectively. And while we acknowledge that there is a cost component associated with the prop revenue, due to the very high margin nature of this business, we are confident that nearly all the revenue from prop falls to the bottom line. Which brings us to the point of why Mr. van Praag keeps pointing out what prop is in terms of Goldman's revenue - we would be much more interested in learning what prop is in terms of the bottom line. For BAC prop trading is less than 10% of total revenue, yet account for a whopping 45% of after tax income. If this is indeed the case for Goldman as well, look for Goldman's stock price to crash and burn shortly as analysts digest the full impact of this most recent presidential ban. And we somehow doubt that Goldman's employees will be happy with negative compensation expense in future quarters.
Readers can pull up and play with the Goldman BAC model here. Assuming that the full $1.00 impact to the bottom line from a prop ban is even partially mitigated, the future EPS will still be hobbled, and the result would be a stock crash, as analysts scramble to find alternative ways to justify their stock price targets, and come up very short in the credibility department.
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Hey, if they get bonuses during profitable periods, they should be obligated to pay the co. for any losses incurred. It is, after all, a fair way to keep talent paid what it deserves.
What? No way man, losses are socialized, remember?
First let's get them to figure out counterfeiting is wrong. Be it money, stocks, stolen art, etc etc. Then we'll work on the more subtle lessons.
Bonuses are paid as a percentage of net revenues (50% +/- historically) so profitability is irrelevant. PROFITS???? We don't need no stinkin' profits!!! Think ML in 2008.
That's why you want to be an employee of an investment bank, but not an outside shareholder. Heads I win, tails you lose....
well spoted and interesting.
Only that the prop ban will never become reality. As usual, Obama and his super crew (I'm speaking of his criminal accolites Timmy,Larry, fat cat Romer and senile Volker) are once again barking but not biting.
NOT CHANGE WE CAN !
President Obama first enabled and then sat and watched the banks as they systematically looted America. He then comes out two days after losing a major election with some tough talk and all of a sudden throughout the blogosphere people have GS, BAC etc down for the count.
Do you honestly think that the president has suddenly had a conversion experience? This is all politics and to appease the populist sentiment the president will stir things up but when the dust settles the banksters will have their bonuses, Bernanke will be reappointed and whatever regulations are implemented will be diluted. Oh and Volcker will be put back into the storage locker with the other stage props that he uses from time to time.
The interesting part of this story is that Obama and Volcker went to work on this in December (about the same time as Volcker came off the reservation and started making more frequent speeches).
The bankers were kept in the dark about these new proposals. This story started to leak on Tuesday afternoon and when the bankers started calling the WH yesterday for an explanation, they did not get a warm reception. In fact when Jamie Dimon (Obama's go too banker) was discussing the new banking tax on the JPM conference call (Friday) he stated he learned about at the same time the public did.
That said i am always extremely cynical when is comes to the motives of politicians and bankers. However, Obama knows he is a one term president if he doesn't do something (a la jimmy carter). And the masses are not currently being placated by American Idol and Keeping up with with the Kardashians .
Andy, you are so cynical, client facilitation dictates that the desk(s) need to be set up like that.
ps. logic (don't get long regionals vs. short big banks) is so 2000;s,1990's ? (when was it again that fundamentals actual mattered?).
GS is down a punishing 2.6% since the beginning of the week
A.D. I don't disagree but I don't buy the notion that they did not get a call.
I believe fuck over the people that you're able to fuck over is the proper definition of legitiMATE when it's involved in world affairs.
Lizzy...very interesting insight and well composed on your part.
The first para made a light bulb go off in this rather thick head of mine i.e. maybe, just maybe, Obama really did start listening to Volcker, not only for the obvious political (perhaps populist is a better word) reasons, but maybe for the reasons that it finally came home what the fed, wall st, and banks are doing. i have to think about it more....
para 3 is spot on.
now I know we are f'd - this is like Invasion of the Body Snatchers and Donald Sutherland aka Deadhead is now one of them
http://www.youtube.com/watch?v=na2W38tLp_Q
Remember when Blankfein and others "called into" a meeting with Obama in December instead of showing up in person? I think this may have been a turning point in Obama's attitude towards the banks. A coincidence perhaps, but I remember thinking at the time that if I were Obama, I'd nail these bastards.
Lizzy,
Not for nothing, I prefer "Keeping up with the Kashkaris"
"Did Obama Just Kill Bank Of America;" Hilarity Ensues.
Goldman stated in there conference call this morning that theres no way they would willigly give up their bank holding company status - all that free gravy courtesy of taxpayers...
Thank you for this piece! I had no idea of these numbers and they are certainly remarkable.
I suspect FASB 157 has a lot more to do with BAC's "earnings" but that is a whole different kettle of fish known as the "legitimization of fraudulent accounting".
Plus BankAmerica owns 34% of BlackRock which poses a whole bunch more questions.
good point and thank you for the reminder.
Well the crocodile starts to eat it's own young, i c a revolution around the corner
not to defend the rakcet but the prop line whether in house or out has a PV to someone. iPerhaops this is the geneis of rumors that a group of investors is back looking to buy ML. Regardless, the PV may be much smaller due to the elimination of flow synergy but it is not a zero. Whatever the value would innure to the EV thus making it perhaps overvalued but maybe not 50%. Then again there is that thorny issue of the loan book.
Tyler...question.
I know that GS has BAC on their conviction buy list and that GS has reiterated this at least twice that I have read.
is BAC still on the conviction buy list? (snicker....)
"is BAC still on the conviction buy list? (snicker....)"
To quote Jethro Bodine, Heck Yeah! As Goldman is on the opposite side of the trade for every entity on that list. GS will come out way ahead on the prop ruling (if it actually comes to pass) by making much more off shorting the other firms that get hammered by it than GS loses itself. Then the GS accounting team swings into action and their earnings reports show them losing dramatically even as their profitability soars (ala 4Q2008) so that Lloyd Blankfein can don his homeless outfit (complete with white cane and scruffy dog) and then sit on Wall Street and watch as Uncle Sam drops copious amounts of bailout cash into his donation can. All the while, Lloyd's chauffer waits patiently around the corner in the solid gold Rolls.
> If we zero out the revenue contribution from this line item, 2011P EPS goes from $2.25 to... $1.25
That is a silly analysis.
Are you going to zero out the costs as well? What about the potential sales value of the prop trading units?
Just because a bank may or may not at some undetermined point in the future be able to trade prop under the same corporate umbrella does not mean that any investments in prop trading that a bank has made will become worthless.
While I know it is common practice in this echo chamber blog to say that GS makes its prop trading money by front running their own clients, I beg to differ. The GS REDI clients are not the dumbest group of professional traders out there (i.e. they are more likely than not to check their order execution carefully and they are less likely to provide sound bites to CNBC). GS like it or not (as well as all of the other major banks that are successful in prop trading) makes their money by exploiting mis-priced assets, mis-priced risk, and by market making activities. Those prop trading strategies, hardware and personnel do not become worthless just because they be unable to operate within the same corporate entity.
There would certainly be more overhead, but conceptually - nothing stops GS (or BofA, C etc...) from spinning out to shareholders a new entity - call it GS-PROP. Yes, the legal, HR, accounting, telecom, server, various registration fees etc... are all added overhead that would need to be duplicated across the 2 entities, but to think that there is no value to current shareholders from the existing intellectual property, hardware and personnel currently dedicated to prop trading is grossly mistaken.
Costs of capital would clearly be higher for a spun-out entity, but given the relatively low capital requirements that the most productive strategies require (i.e. most HF strategies turn over their capital base multiple times per day - sometimes hundreds of times per day), and the relatively low interest rates, this too will not be a death blow.
I do not follow bank equities and have no opinion as to their current valuation against future cash flows, but anyone building a model that says current shareholders are going to lose all of the value of prop trading currently embedded into share prices is not thinking the issue through.
Stop making sense.
We zero revenue! Costs are going UP! Onward to the land of gold, spam, and shotguns!
Barney Frank tipped his hand today talking to his buddy Jim Cramer on tv saying he wanted to phase this in over 3-5 years. hehe. Unfortunately for Cramer, Frank, and Goldman, this isn't Volker's first time at the rodeo.
this isn't Volker's first time at the rodeo
Well said!
It will be interesting to see if Volcker is really being taken seriously by Obama or not....
I keep hoping that maybe, just maybe, Volcker would return to his old chair at the Fed......
I thought it was interesting who was not there today. Where IS the head of the Treasury and the Grand Pooba of the Federal Reserve?
Geitner was in the photo that was published, standing next to Christina Romer, who makes me want to puke.
I believe protocol is that the Fed chair is never at these events....part of that whole "independence" culture.
If memory serves me, Martin Armstrong pointed out that Volker's inflation-killing rate hikes resulted in a doubling of the national debt in just 5 years.
As long as the banks and their auditors are allowed encouraged to publish fictional balance sheets, they will all find a way to be profitable.
Asset write-ups are the new black.
Looks like single-digit PEs are the new black. (GS... 7.13x trailing, 8.70x fwd)
Well, there's one thing GS can do. Pay off all the FDIC insured debt, drop the fiction that it is a "bank," and revert to a privately-held, NTBTF hedge fund. Fellows, have at it! Just don't expect any rescue helicopters when you get in trouble. Glass-Steagall created a wall - they just have to go back to the other side where they belong.
Considering GS just paid $32/shr in bonuses and earned $22/shr in 2009... I wish they consider reverting to private. Its a good idea.
I wonder if recent talk has GS wavering on performing their PPT duties since the DJ is down 4% recently....
Well, I did note that the bank's main regulator (supposedly), Zimbabwe Ben, wasn't at the press conference, at least not that I saw. Maybe he was protesting along with the TBTF.
Andy...today's action on regionals is a repeat of what has happened a few times this year....i think it is all mo mo monkeys and probably some heavy duty ghost trading.
Props for this one. One sure sign that all was not going to end well was their desperate plea for bailouts. A dying business' last request. Too bad Obama did their bidding then....and now they self destruct. Brilliant business model!
The Volcker rule will pass. The Community Bankers want it and they are the ones that are showing up to shake hands with their representatives at SEC football games on Saturday.
Every local small banker I know hates GS, BAC, JPM, etc...
This is an excellent point 201444 and many are not aware or forget that there is a 2 tier banking system in this country. And those bankers do carry some weight in their local communites and have influence over congress critters.
great point and thank you for raising it!
While we wish Goldman well...
Speak for yourself.
What will be interesting is watching the crap fly as the banks try to narrowly define "prop trading". They will say it's only dedicated prop desks. But, years ago, these desks were cut back and the big risk taking was put in the flow businesses. That makes sense - better to have traders who see all the flows make the big bets then some desk operating in a vacuum.
The right distintion will be principal vs agency (i.e. crosses) trades. Banks will argue that all client trades are not prop. Of course, where do their prop positions come from - client trades. So only crosses are truly not prop.
There will be a lot of mis-leading garbage flying as this gets sorted out.
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I thought what was more interesting than the prop trading ban was the ban on private equity. Wasn't that part of the proposal as well? Every major bank I know of has private equity arms.
These should definitely be banned. This was one of the main reasons for Glass Steagal (prop trading wasn't so big in 1930), and one of the major criticisms of Japan - the ability of banks to hold large chunks of corporations.
After all, if Walmart can't own a small bank, why should a bank be allowed to own a small Walmart?
Its always been insane to me that banks could gamble with the money from depositors that was guaranteed by the taxpayer.
This is the most sensible proposal Obama has yet issued.
Since we view the banking system as systemically important and a vital piece of infrastructure we can't allow anyone to gamble with it.
I see it as if the core banking system, deposits and loans, is like a utility, necessary for the economy to function and for everyone to live their lives. We wouldn't let the owner of an electricity grid gamble it away on the turn of a card and then when we go to turn on the lights and it stays dark say, "Ah ha, free market capitalism at work." No we recognise that its a utility and it can't be gambled with.
Now prop desks are like home generators. If you want to gamble it away, that's up to you as it'll only be you that gets cold in the winter.
Bank of America is like a utility that has already gambled and lost its power stations and electric grids and they're in the process of being shipped to the winner's house, but because the government has put a delay on the shipping BAC is acting as if everything is still working normally. Its essentially using all its little generators to keep the lights on and pretend that its power stations arent gone.
Even if it sells the little generators, once they're gone it'll be obvious that the big power stations aren't there any more and the company is a hollow shell.
Phew, this metaphor is getting labored! Anyway BAC is busted and has only kept the lights on through insane gambling using money guaranteed by the taxpayer. Take that away and the scale of losses on its mortgage, CRE, commercial, credit card and autoloan portfolios will completely overwhelm its ability to earn money from fresh loans from those kinds of products.
Am I the only one who finds the model completely useless? I mean, sure, it's a fine recreation of BAC's P&L, but there are no assumptions underpinning anything except constant growth. Trading account profits should tie with comp, period. And the bank's NIM is hardcoded, which is pretty meaningless considering the IR sensitivity of several business units. And obvious run-off portfolios (like discontinued loans) are held flat through 2010.
Sure, I shouldn't be too hard on them for not rebuilding the bank, but I just don't see what exact purpose this model serves.
I don't think any tweaking of the model will get us any closer to reality. My own personal view is that the big banks have been generating even more profit from trading than they've declared and they've used some of it to hide the loss of cashflow that would otherwise be apparent from their loan portfolios.
I did an analysis of the banks in 2007 trying to figure out what their losses would be based on various falls in asset prices. The interesting thing is that the price declines on homes, CRE and the loss rate on credit card loans have been much higher but the declared losses have been less than I anticipated.
Its likely my model was completely wrong, and we know they're marking to fantasy, but non-performing loans don't generate cash and that's harder to hide.
So my conspiracy theory for the day is that the banks have been diverting profits from trading to make their loan portfolios look better than they are
Goldman will just opt out as a bank holding company...which they can easily do now that they are out of the alphabet soup musical chairs. BAC on the other hand is not that flexible. Thanks for the heads up - I have to say I totally missed this.
http://www.c-spanarchives.org/program/291517-1
Watch him closely -- he's actually talking (and not just reading) at certain points, which is refreshing to see.
I like the tough talk, so let's hope it's followed up with actual beneficial change.
Hope...springs...eternal...sort of...
Nice try Lloyd "I am the real Jesus" Blankfein. Next time you announce your earnings, make sure you bring plenty of lube for everyone who is willing to bend over and believe what you have to say. I know that at least Steve Liesman is buyin' it.
Goldman's earnings were ushered in with great fanfare on Bubblevision TV (CNBC and Bloomberg). And of course this is based solely on looking at the net income number, which blew away estimates and expectations. Of course, as per usual, there is a much different story to tell if you examine the bowels of a financial statement, especially bank financial statements. So I took out my "Greg House" marker pen and board and took a look at Goldman's 8-K SEC filing, which contains an expanded version of the press release that the monkeys on CNBC regurgitate.
The bottom line is that a substantial portion of Goldman's net income for Q4 '09 appears to have been derived from marking up illiquid positions sitting in its Fixed Income operations and is not attributable to the interest rate and currencies segment of FICC, which means the numbers came from fixed income products like mortgage and asset-backed securities.
http://truthingold.blogspot.com/2010/01/goldmans-earnings-market-to-mark...
thanks...i checked your blog quickly and will read the GS article tomorrow...looks interesting.
The Tim Geithner, Larry Summers picture after drafting the Obama bank reform is fucking hilarious! Great sense of humor on your part, I laughed my stones off.
BAC has another problem: DEPOSITS
Part of the Volcker Rules is that the "law" dictating a maximum of 10% of the country's bank deposits will finally be enforced (we'll see). BAC now stands at just over 11% of total US bank deposits, so they lose a good percent of their funding advantage if the rule is finally applied.
Also, any spin-off of BAC's Prop Trading would have to be valued based on NOT having access to 0% checking accounts and 0% Fed Window money. Undoubtedly this would impact the bttom line of this "trading desk", maybe even making its profit negative.
peterpeter: fair enough in response to your comment about spinning off the prop trading. In that case then what would be your preferred ratio of holdings between the two new companies?
You have got to be kidding. This is what GS calls a sophisticated financial model?
Note to self; add GS.com to the spam filter
I don't know how this article's arguments hold water.
BofA has 10 bn shares counting those issued as equity equivalents to repay TARP. This author assumes $1/share contribution by MER, that'd be $10bn a year in 2011.
Did MER make $10 billion in profit before it was acquired?
You better think twice if you short based on this article. I worked for BofA/ML capital markets for 17 years and true prop trading is minimal. In fact, BofA has a history of being risk averse and prefers transaction flow business instead of prop. Their prop desks are a revolving door for traders who want to move up to bigger/better houses and are not a significant profit generator. Their prop desks come and go with the wind there and don't really add value. In fact, they often contribute to losses. I think BofA fits more closely with a WFC with the added benefit of a significant asset management business in ML.
Obvious short post, how bout the employee costs associated from the zeroed trading profits. And only roughly 5-10% is associated with prop trading. The rest can be interpreted as customer trades.
Further, this is likely to be done tomorrow and more like over a 3-5 yr period like Barney Frank stated, and that would be after a year of legislation even if it goes through.
How about normalized earnings beyond 2011?
I took into account the removal of the prop, adjusted for employee expenses, assumed lower loan and deposit growth to 2% from 5% (due to the obama caps). Notably, this is more bearish than in the model as it drags net interest income. And I associated a 15 bps fee on non FDIC insured liabilities.
Also, adjustments must be made to salary increases as it is not likely to be as high as the model suggests.
Further, there is wiggleroom to increase net interest margin as a result of removing the repurchase reserves and reducing the cash balances associated to the TARP fee.
Assuming 2007 losses to be normalized losses, you get still get an EPS of around $2.11-$2.15 per share. That would take into account all of the ills Obama is trying to pass, so that would be a bear case. Obama may have hurt the certainty of what is normalized earnings, but this is still a cheap stock.