Lloyd Blankfein sounds optimistic about 2011 returns in an interview with Nomura’s Glenn Schorr, but the Japanese bank disagrees (via FT Alphaville).
First, check the data. Goldman’s return on equity this year was only 14.4%, less than half the total level the financial crisis.
Negative factors for the future include the forced spin-off of the prop trading unit under the Volcker Rule; high capital requirements under Basel 3; along with a slowing economic recovery around the world.
Normura expects future returns in the mid-teens, good enough for a “Buy” rating, but not as good as it used to be.
When talking about the prospects for future returns, Lloyd noted a series of streams that are moving in opposite directions (some positive, some negative) that will impact ROEs. On the positive side, limits on investing in private equity will likely lead to an improved ROE in that business (with less capital deployed), though the total P&L hit might be a drag. On the negative side, higher capital requirements will likely weigh on returns, but management noted that the firm has been operating at or above Basel III minimum levels for the past 18 months or so, and returns have been pretty good despite a sluggish operating backdrop. (Goldman’s 2010 YTD ROTE is 14%.) At the same time, while the Volcker Rule will also curb prop trading, Goldman has already shut down its equity prop trading business and it has not had a material impact on 2010 results (at this point management does not see any issue with its SSG business within FICC, as they view it as more of a middle-market lender). In addition, a lot will depend on what competitors choose to do with their business mixes.
In our view, future returns are likely going to be lower than Goldman’s past peak results, but we still think the firm can generate mid- to high-teens ROEs. For example, so far this year Goldman has generated a 90bps ROA, despite a less-than-stellar operating environment. If the ROA can lift just a drop to 100bps-plus as the backdrop improves (we’ve been there many times), we think mid-teens ROEs are very achievable, with leverage on common equity in the 14-17x range. In addition, investors may be willing to pay a higher multiple for these returns if the business mix is viewed as less volatile post implementation of the Volcker Rule.
The key reason for optimism at Goldman as always is ‘being Goldman in more places’, namely the emerging markets.
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