Shareholders at Goldman Sachs paid dearly for being shored up by Warren Buffett during the crisis. They may find another cost in bidding him adieu.
While bank investors salivate over the prospect that the Federal Reserve soon will give firms a green light to increase dividends or share buybacks, Goldman shareholders may have to wait longer than others. That is because it makes sense to redeem Mr. Buffett's $5 billion in preferred stock first, given its eye-watering 10% dividend.
Although Goldman can argue its capital is strong, it is questionable if regulators would let the firm simultaneously buy out Mr. Buffett and repurchase stock much above that needed to offset employee share issuance. A Buffett deal would mean Goldman paying a 10% premium, or $500 million, on top of the headline $5 billion. It also would likely include a move to buy back warrants covering 43.5 million shares issued to Mr. Buffett as part of his crisis investment. This would result in a $1.1 billion charge.
Fed deliberations will look at current capital, but also how the firm holds up under the latest "stress tests" and how it will be affected by new Basel capital rules. The latter are particularly important since Goldman, like rival Morgan Stanley, has a big trading book and could see a sharp increase in risk-weighted assets, used to calculate measures like Tier 1 common capital.
Last fall, Goldman estimated its Tier 1 common ratio would be about 8% under the new rules. That is above a 7% minimum threshold, but using cash to buy out Mr. Buffett would bring the ratio closer to the minimum.
A wild card is Goldman's ability to take actions to lessen the blow of the new rules, such as unloading or hedging assets that would require high capital charges. Credit Suisse has forecast those could halve the swelling of the firm's risk-weighted assets. Also, since the new rules will take years to kick in, Goldman will add to capital through profits—analysts estimate it will earn more than $10 billion in 2011, according to FactSet.
The Fed likely will want firms to tread gingerly, given that moves to return capital will be seen in the context of recent bailouts and continued economic uncertainty.
But even if the Fed is conservative on payouts, Goldman will benefit. Getting rid of Mr. Buffett would remove a slug of seriously expensive capital, whose 10% payout cuts into profit attributable to common shareholders and damps returns on average common equity. Excluding the dividend payment to Mr. Buffett, the return would have been about 12.2% in 2010, instead of 11.5%.
Given postcrisis fears over Wall Street's ability to generate strong returns, Goldman investors should be happy to give Mr Buffett first dibs.