Goldman Sachs Analysts Say Bank Slowdown Isn’t Temporary

Goldman Sachs
Goldman Sachs has stopped offering two-year contracts to its most junior investment bankers. Photographer: Scott Eells/Bloomberg

New bank regulations and capital requirements are “structural” changes to the industry that are more to blame for declining profits than the U.S. economic slump, Goldman Sachs Group Inc. analysts said.

“The operating environment is unlikely to change any time soon, and we see shareholders of challenged banks becoming more demanding in asking management teams to lay out a path to unlocking value in the near term,” analysts led by Richard Ramsden in New York wrote in a report published today.

Their view contrasts with Goldman Sachs Chief Executive Officer Lloyd C. Blankfein, who said in November, “I don’t think we can conclude that the slowdown is secular rather than cyclical change.” Goldman Sachs, based in New York, is the fifth-biggest U.S. bank by assets.

More than half of the top 25 U.S. banks aren’t earning enough to cover their cost of capital, leading to stock prices that are “significantly lagging previous global recoveries,” according to the note. “The vast majority of the reduction relative to pre-crisis levels is attributable to structural issues like deleveraging and regulatory reform.”

Morgan Stanley, the sixth-biggest U.S. bank, and similar firms could improve returns by shrinking businesses like fixed-income trading and distressed-mortgage investing that require high levels of capital, according to the note. Using that capital to buy back shares instead “could be meaningfully accretive to shareholders,” the analysts wrote.

Bank Conversions

Goldman Sachs and Morgan Stanley were the biggest U.S. securities firms before converting to banks in September 2008.

Citigroup Inc., the third-biggest U.S. lender, could spin off about $100 billion of U.S. mortgages into a new company to boost profit and improve its share price, the analysts wrote.

Shareholders could choose to own stock in the new firm, which would be funded by a loan from the New York-based lender, the analysts wrote. The move could help to increase the bank’s “theoretical valuation” to $50 a share from about $30 a share today, said the analysts, who reaffirmed their buy rating on the company.

The loans, which are almost equal to the total assets of Cincinnati-based Fifth Third Bancorp, are now in the Citi Holdings division, which CEO Vikram Pandit created for unwanted assets in 2009. The part of the division that contains the loans lost $1.5 billion for the first half of 2012, compared with $2.2 billion for the same period last year.

‘Eliminate Assets’

“The most efficient way to boost returns -- and create value for shareholders -- is to eliminate assets with both the largest losses and largest capital requirements,” according to the note. “While we recognize the challenges for Citigroup given the size and complexity of the portfolio, the North America mortgage book within Citi Holdings fits the bill for both.”

John Gerspach, Citigroup’s chief financial officer, said today that the lender had sold about $14 billion of mortgages since 2010. Roughly 60 percent of those were delinquent, he said at a conference in New York.

Pandit, 55, speaking at the same conference, said that his bank was ready for regulatory changes after “reshaping our businesses.” Some of the problems facing the industry, including a slump in trading revenue, are likely to be temporary, he said.

Low Volume

“Some of what you’re seeing in the capital markets activities today are likely to be more cyclical than secular,” Pandit said. “You cannot make a case to say that low volumes can continue for a long period of time.”

The Goldman Sachs note also raised the firm’s recommendation on Regions Financial Corp., the 10th biggest U.S. bank by deposits, to conviction buy from buy because the analysts estimate the Birmingham, Alabama-based lender’s shares could increase 35 percent if it cuts branches or sells businesses.

Goldman Sachs lowered San Francisco-based Wells Fargo & Co., the U.S. bank with the biggest market value, to buy from conviction buy because the stock has outperformed rivals recently, according to the note.


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