Dreams of Goldman doing big takeover meet stress test's reality
Almost 10 years after the financial crisis, Wall Street was starting to wonder aloud: Might Goldman Sachs or Morgan Stanley make a big acquisition?
At Goldman, the question arose on a conference call in April, as analysts examined the firm's ambitious plan to expand banking services for consumers. Chief Financial Officer Marty Chavez was measured: Usually the company leans toward smaller "bolt-on" acquisitions, he said, but it's also "open-minded."
At Morgan Stanley, most of the chatter was behind the scenes. Speaking on condition they not be named, dealmakers around Wall Street — including some inside the firm — batted around names of asset managers the bank could acquire to build out its business. "We can do a number of fill-ins," Chief Executive Officer James Gorman said at a conference when asked about the possibility in May.
Much of that speculation got a reality check on June 28 when both firms scraped through the Federal Reserve's annual stress tests. The pair got special permission to continue paying out capital to shareholders at past levels — even though the regulator projected such distributions could leave them with too little capital in a severe economic shock.
The results show how difficult it would be for Goldman Sachs and Morgan Stanley to make a major takeover, said Mike Mayo, the analyst who had raised the question with Chavez just months ago. Back then it made sense to wonder, because Goldman was looking to expand in so many areas, the Wells Fargo analyst said in an interview last week. "But now, with less dry powder, that possibility seems to be incrementally less."
In interviews, several analysts predicted both firms will limit themselves to small deals. Representatives of the banks declined to comment.
Caveats abound. If either firm spots a golden opportunity, it could temporarily reduce shareholder payouts to free up capital and seek a blessing from regulators. Authorities might embrace a plan that encourages more lending, said Jeff Harte, an analyst at Sandler O'Neill & Partners.
"To the extent that they can make acquisitions it would help them grow their loan balance — essentially put the deposits they already have to use through loan origination — that could be interesting," he said.
On the other hand, there are all sorts of impediments.
For one, the investment banks' relatively low valuations aren't helpful, KBW analyst Brian Kleinhanzl said. Their price-to-book ratios are hovering below that of regional banks, and significantly less than that of asset managers, making an acquisition in either space that much harder.
There's also little political appetite to let global banks grow even further, said Karen Petrou, co-founder of Federal Financial Analytics, a research and advisory firm in Washington. And depending on the deal, it could become all the harder for them to clear future tests.
"A bigger bank would have a harder time passing," Petrou said in an interview. "Goldman and Morgan Stanley scraped by this time, but with a bigger balance sheet boosted by deposits, from a bank they buy let's say, the test would punish them even harsher."
Shares of the two firms each jumped more than 2 percent as of 12:45 p.m. in New York as the broader market rallied Monday. Morgan Stanley has dropped 8.5 percent this year, while Goldman Sachs has fallen 11 percent.
Goldman Sachs and Morgan Stanley both fell short in the Fed's projections by two key measures, including their Tier 1 leverage ratio. Many other banks, in contrast, were estimated to have billions of dollars of excess capital — even after they finish their proposed payouts to shareholders. Firms with those buffers would be freer to make acquisitions, if they see opportunities.
Investors are recalibrating their expectations for takeovers as the 2008 financial crisis fades and President Donald Trump's administration eases regulation.
Earlier this year, a KBW research report set some tongues wagging about takeovers. The authors highlighted persistent questions they've received from investors on potential deals, and mentioned the possibility that Goldman Sachs could accelerate its expansion beyond past bolt-ons.
The stress test results underscore just how unlikely that is, KBW's Kleinhanzl said in an interview. If they were to pull one off, investors might have to wait many years to see a return.
"Capital constrained banks can do all-stock deals, but then the new shares they issue to make the purchase will dilute their existing shareholders," he said. "That's also a very hard sell."