Goldman should buy back Buffett’s preferred stock
What should Goldman Sachs do with its excess capital? According to David Viniar, the finance chief, the Wall Street firm already appears to have more than enough to surpass the minimum 7 percent Tier 1 common equity ratio that will be required under Basel III, and may have as much as 11 percent by the end of 2011.
That is stoking speculation that Goldman could increase its common stock dividend, buy back shares or go on a spending spree. But the first thing executives should do is retire the $5 billion of cumulative perpetual preferred stock that Warren Buffett bought two years ago.
It was much-needed capital at the time. Lehman Brothers had just collapsed, and Morgan Stanley and Goldman were dangerously close to being next in line. The Sage of Omaha’s vote of confidence bolstered the firm and helped convince other investors to buy $5 billion in new shares the following day. It was a good deal all round.
Now, though, it’s a pricey chunk of capital: Goldman is paying Buffett 10 percent a year. What’s more, under new capital rules being phased in from 2013, such preferred stock will no longer count toward core Tier 1 capital—and thus this slug of funding was excluded from Viniar’s projections about beating Basel III requirements.
So Goldman wouldn’t even need to refinance the prefs with common stock. And with $173 billion of excess liquidity—the bank’s surplus of cash and liquid assets over the amount needed to safely fund the firm—it doesn’t need to add any cover elsewhere in the capital structure, either. If it chose to fund a repurchase with long-term debt anyway, it would probably only pay a 4 percent coupon, according to Bank of America analysts.
True, Goldman would pay a penalty of a year’s dividends, or $500 million, if it chose to buy Buffett out. But against alternative funding at 4 percent, that would pay for itself in less than two years. After that, it would free up more cash to be either invested or returned to shareholders. As for Buffett, he’d miss the certainty of those juicy dividends, but would still have warrants over Goldman stock granted when he made the investment. He paid nothing for those. Today, he could cash them in for almost $2 billion.