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.