Tags: bernstein

Bernstein: Goldman, Morgan Move Will be Costly

Tuesday, 23 Sep 2008 01:39 PM

Sanford C. Bernstein said the move by Goldman Sachs and Morgan Stanley to convert into banks may be costly, and that regulatory changes will hurt their returns on equity (ROE) and limit non-financial business commitments.

On Sunday, the Federal Reserve approved a move by Morgan Stanley and Goldman Sachs — the only remaining big investment banks — to become bank holding companies.

"What led Morgan Stanley and Goldman Sachs to make this change may have been declining counterparty support and increasing funding concerns," Analyst Brad Hintz said in a note to clients.

Both companies will face tighter regulatory oversight by the Federal Reserve compared with that of the U.S. Securities and Exchange Commission, Hintz said.

"Establishing the commercial bank infrastructure to report to the Fed will be costly."

Hintz expects the average ROE for a broker converting into a bank to decline from about 19 percent to 15.5 percent, and firms with a capital-intensive revenue mix to see greater declines. Goldman's ROE will fall 420 basis points, and Morgan's ROE will drop 320 basis points, he said.

The Federal Reserve will direct the two new banks to employ less leverage and maintain more liquidity, limit the leverage provided to hedge funds and constrain participation in private equity, commercial real estate, venture capital, and commodities trading, the analyst noted.

The move will increase Goldman's and Morgan Stanley's ability to avail direct loans from the Fed against a wide pool of collateral, Hintz said.

In a separate research report, J.P. Morgan said it expects high 20 percent ROE for Goldman Sachs, against a high 30 percent in the past cycle, given potentially suppressed ability to take on leverage.

Shares of Goldman were trading down about 4.5 percent at $115.44 on the New York Stock Exchange, while those of Morgan Stanley were trading down about 3 percent at $26.37.

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