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Goldman, Morgan Stanley Buy Time for Deals by Becoming Banks

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09/23/2008 11:46 AM
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Goldman, Morgan Stanley Buy Time for Deals by Becoming Banks
[link to www.bloomberg.com]

Goldman, Morgan Stanley Buy Time for Deals as Banks (Update1)

By Christine Harper

Sept. 23 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley have won a respite from investor panic by transforming themselves into bank holding companies.

The change in status allows the last two major independent investment banks on Wall Street to take advantage of different accounting rules, gives them more access to federal funds and buys them time to stabilize their funding base by acquiring deposits, analysts said.

``The move appears aimed at improving market confidence but does not, in our view, signal a major change in the business model,'' Richard Staite, an analyst at Atlantic Equities in London, wrote in a note to investors yesterday. ``The move provides Goldman with time to continue the process of de-risking itself to a level deemed suitable by the market.''

Instead of carrying all of their loans, bonds, stocks and other assets at market value, as investment banks are required to do, the two New York-based firms can now avoid further writedowns by moving some assets into their banking units. They will also gain the ability to borrow from the Federal Reserve indefinitely, an improvement over the primary-dealer credit facility that is scheduled to expire in January.

Deposit Bases

Now it's up to the banks to raise enough capital and attract enough stable, low-cost deposits to reassure investors that market gyrations won't drive them out of business. Morgan Stanley said yesterday that it plans to sell as much as 20 percent of the firm to Tokyo-based Mitsubishi UFJ Financial Group Inc. for $8.4 billion. Goldman has no immediate plans to raise capital, although it may decide to if it finds attractive investment opportunities, spokesman Lucas van Praag said yesterday.

The S&P 500 Financials Index dropped 8.5 percent yesterday as investors lost confidence that a proposed U.S. $700 billion government bailout would solve the industry's bad-debt problem. After dropping 27 percent last week, Morgan Stanley's stock was little changed yesterday and fell $1.14, or 4.2 percent, to $25.95 at 10:11 a.m. in New York Stock Exchange composite trading today. Goldman's shares, which fell 16 percent last week and dropped 7 percent yesterday, rose 47 cents to $121.25.

The deposit bases of Goldman and Morgan Stanley, at $20 billion and $36 billion respectively, are much smaller than those of their largest bank competitors, according to David Hendler, an analyst at CreditSights Inc. in New York.

Citigroup, JPMorgan

Morgan Stanley's deposits amounted to about 4 percent of the firm's liabilities at the end of August, while Goldman's amounted to 2 percent of liabilities, Hendler wrote in a note to investors yesterday. At larger banks, deposits typically account for between 40 percent and 60 percent of liabilities, he wrote.

``We cannot rule out that these companies could pursue bank acquisitions in order to increase their deposit funding more in- line with a typical bank,'' Hendler wrote. Yet their depressed stock prices may make Goldman and Morgan Stanley reluctant to enter deals ``until some premium has been restored.''

Deposits are the largest funding source for Citigroup Inc., accounting for about 42 percent on average, and for JPMorgan Chase & Co., contributing about 51 percent, wrote David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York in a note to investors today. Those banks' weighted average cost of funds is about 1.5 percentage point to 2 percentage points lower than that of Goldman and Morgan Stanley, he wrote.

`Safety and Soundness'

Both Goldman and Morgan Stanley issued statements after the Fed approved their applications that stressed how the change would improve their image with investors. ``We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness,'' Goldman said in a statement on Sept. 21. John Mack, Morgan Stanley's chairman and chief executive officer, said the change ``offers the marketplace certainty about the strength of our financial position and our access to funding.''

Morgan Stanley, which already has more than 3 million retail brokerage clients, said it plans to ``pursue initiatives to expand the retail banking services it offers its retail clients and build a stable base of core deposits.''

Goldman Sachs, now the fourth-largest U.S. bank by market value, is more interested in buying deposits than in buying entire banks, according to a person familiar with the firm's thinking. The firm sees opportunities to buy deposits in the wholesale market and also to buy deposits of failed institutions, such as IndyMac Bancorp Inc., that are under the control of the Federal Deposit Insurance Corp., the person said.

Money-Market Funds

Goldman doesn't have a retail brokerage like Morgan Stanley's, and is more likely to try to get deposits from institutional clients that have money-market funds at Goldman, Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, wrote in a note to investors today. Goldman managed $262 billion in money market funds for institutional clients at the end of August.

Goldman ``will rely more heavily on collecting wholesale deposits than Morgan Stanley,'' Hintz wrote. ``This shift should be operationally painless to GS because the firm has a large and powerful money market business that will be tasked with gathering deposits from institutional clients.''

In return for the advantages accorded by their new status, Goldman and Morgan Stanley won't have to change much about the way they operate, at least not immediately. Neither firm is being required to dispose of non-financial assets, such as commodities or stakes in companies, that banks normally are prohibited from owning, for at least two years, according to the Federal Reserve orders.


Efforts by the companies to reduce their so-called leverage, or ratio of assets to shareholder equity, are more about trying to reassure markets than to meet any requirements imposed by the Fed. Instead of monitoring gross leverage, the Fed looks at firms' Tier 1 capital ratios, which measure capital requirements based on the riskiness of assets. Both firms exceed the 6 percent Tier 1 capital requirement to be deemed ``well capitalized.''

Fox-Pitt's Trone expects the Fed will impose new limits on leverage, capping assets at 20 times shareholder equity, ``to avoid the conditions that fuelled the current credit debacle in the future."
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