Description

I like big banks.  I've liked big banks for a while and have paid the price.  If you believe US rates are following an inevitable path to zero then banks won't do well and this idea is not for you.  In that world (MMT in all but name) we could have a serious existential crisis on our hands with this whole fiat currency thing.  I guess you buy Gold and Bitcoin in that world or any growth stock at any multiple given capital is free.

Thesis:  I like the risk/reward buying a leading investment bank below tangible book.  An investment bank with a new leadership team that is growing/investing in less capital intensive businesses.  An investment bank that has been shrinking its share count by ~5% +/- per year for the last several years that is also committed to returning additional capital to shareholders via increased dividends.  Using street estimates and reasonable capital return assumptions tangible book value per share could be $300+ by year-end 2023 with a mid-teens ROE.  What is the appropriate multiple?  Maybe 1.5x?  Assuming 1x, you have a 50% return.

Business:  Leading investment bank, top five alternative asset manager, growing direct-to-consumer retail banking, Apple Card, United Capital and Ayco for mass affluent segment.  Not standing still.  Current valuation suggests no franchise value.  Actually less than $0 franchise value.

The company is obviously widely followed and I have no better insight into their future results than anyone else.  Short to medium term it will likely trade with financials, which will likely continue to trade with the gyrations in the yield curve.  So I'll take a slightly different angle with my analysis.

Analysis:  Large financial institutions are a math problem with binding constraints; risk-weighted assets (RWAs), total assets, off balance sheet exposure, regulatory capital ratios and required capital to run the businesses.

BIG PICTURE: increasing RWAs require more capital, more off balance sheet exposure requires more capital.  Prior to the financial crisis the name of the game was to increase leverage; i.e., grow balance sheet without increasing capital.  Banks were allowed to do this which resulted in higher ROEs, higher multiples, etc.  We experienced the downside to this, to say the least.

So new environment is how to optimize results/returns while adhering to the capital constraints?  The key ratios are: 1) Supplemental Leverage Ratio (SLR), 2) CET1, 3) Tier1, and Total Capital.  [ASIDE: I am not going to get into the weeds with these formulas.  I suppose we can if you'd like but it really isn't terribly interesting.]  [ASIDE: the Fed is looking to simplify the process and is working on a stress capital buffer (SCB).  Apparently it will be similar to SLR, but rumor has it slightly less restrictive.]  The Fed provides mimimum levels for each.  Currently the binding constraint for Goldman is the SLR; by "binding" I mean it has the least buffer/amount of excess capital when you compare their actual statistics with the required minimums.  As of 2Q2019, excess capital by ratio:

CET1                    $22 bn
Tier1                    $24 bn
Total Capital         $27 bn
SLR                     $18 bn

Goldman cannot run any of these ratios at the minimum, but at the very least we can say that they have more than enough capital.  [ASIDE: the SLR calculation treats Preferred Stock and Common Stock equally so, in theory, Goldman could issue Preferred and buy back common at no cost to the SLR ratio.  Not required for this analysis but an option.]  Goldman passed the CCAR in June and announced a quarterly dividend increase from $0.85 to $1.25 and a $7 bn 12 month share repurchase program for a total payout of ~$9.0 bn, roughly equal to net income to common they are projected to generate over the next 12 months.

So what if the current amount of capital is at least enough for Goldman to pursue their current growth/new business initiatives as they also continue to optimize their more capital intensive businesses?  One outcome could be Goldman continuing to return 100% of their net income to shareholders.  In the following table I used conensus estimates from Bloomberg for the forecast period and made a few assumptions:

I accept that this is wrong.  However, it could be in the corrrect direction.  Management has made it clear that capital return is a focus including increasing dividends.  So, I increase dividends.  Easy to play around with net income, dividends, buyback price, etc.  Ultimate outcome is higher tangible book value per share and increased returns on capital.  Tough to see Goldman continuing to trade at or below tangible book value if this is directionally correct.  I like the risk/reward.

If of interest, we can also talk about their business initiatives; streamling alternative asset platform and pursuing third-party capital, Marcus retail platform, Apple Card, United Capital acquisition, hiring 100 coders in equities division, etc.  You know, a more traditional analysis.  Fundamentally I believe in the future and using math the future points to a much higher tangible book value per share.

Catalyst

Continued growth in tangible book value per share.

Berkshire taking out at $300 per share.  Kidding, kidding.