Goldman should buy back Buffett’s preferred stock

October 20, 2010

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.

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hsdhhhhhhhhhhhhhhh“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.” 

Correct, but the opportunity cost to the Goldman franchise from such redemption may exceed the short term gain on the bottom line many times over. The position of Goldman’s uniqueness and unparallel ingenuity is gone and in its absence this vacuum hurts… staff moral and pride as well as the slashed attraction to Goldman within public authorities and country-leaderships world-wide.    

In unruly times where form is the preferred political tool over substance any fall-from-grace management team would need all support available for the near term. The Buffett-Munger team is a perfect instrument….… while shareholders in both camps prosper.  

Just think of the valuable support in April/May when legendary Buffett ethics were hitting the air waves well aware of the potential short-term cost to his own reputation as the media went on a one-sided attack on Goldman as the conduit for all things bad Wall Street.  

This triggered even doubt within the community of faithful die-hard Buffett shareholders whether his stance was reasonable and acceptable all in the wake of the SEC’s carefully selected targeting of a frontrunner in the political agenda of financial reform and reigning in excesses developed over the previous two decades.  

The targeted transaction?  A zero sum wager between punters with money in the kitty and financial support but miles away from diligent investment procedures and usual hedging when choosing a synthetic MBS instrument as the object for their multi-million gaming. 

The value of the Buffett-Munger support for Goldman? Priceless! 

When the Buffett era of financial skills combined with a visionary, yet hands-on approach to managing and developing a conglomerate soon comes to an end, America will lose more than it bargained for. And the form over substance approach by politicians would be less likely opposed by giant-killers with integrity and substance… while mediocre management at Wall Street would rule the seas.     

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