Goldman Sachs as an Internet Bank? Pleeease!

Includes: GS, ING, MS
by: Christopher Whalen

Doubtless SA readers who follow financials saw the announcement by the princes of volatility at Goldman Sachs (NYSE:GS) that they were thinking of establishing an internet bank as part of their new business strategy of being a commercial bank. Oh, Nelly.

Hearing the news, we thought for a moment of that day a few months ago when Lehman Brothers publicly advanced the idea of Korea Development Bank as a potential savior. We thought at the time: KDB? Not impressed. And now GS wants us to think positively about their prospects as a going concern because of internet banking. Please. This does not bode well for the investment thesis behind GS.

We were trying to fight off feelings of dizziness, but then another name came into focus, out of the fog and ether of good intentions and top line growth at any price, namely ING Direct, the US bank unit of ING Group (NYSE:ING). The biggest of the pure play online banks. And nice people at ING too. They want you to have babies and mortgages, shop at IKEA, and be home for dinner on time. Now some $81 billion in assets, ING Direct FSB has a triple digit RAROC on the IRA Bank Monitor's Economic Capital Model cause they take no risk with a whole, are you ready, 18bp in defaults in Q3 2008.

You see, online banking has never been profitable - especially on a total economic or return on capital basis. You simply substitute advertising for the cost of brick and mortar. Indeed, even when you have one of the largest, most polite financial conglomerates in the world behind you, the online banking model still does not work. It is wonderful advertising, but it is also very costly. ING Direct somehow managed to push its efficiency ratio from 50% in 2007 to 33% at the end of Q3 2008, but asset and equity returns are likewise falling. And you no longer see those ING Direct ads on TV constantly, do you?

As of the end of Q3 2008, ING Bank FSB was one of the most stable banks in the US, albeit with performance that would make a utility proud. The overall Bank Stress Rating for ING Bank is below the index benchmark (1995=1). How about 12% tier one leverage and 30% total capital? But with an ROA of 0.3% and ROE in single digits and falling. Even though the folks at ING Bank have given new meaning to the term minimal when it comes to customer service, there may not be much cost left to cut.

By the way, if you comp ING Bank FSB vs. its mortgage lending peers using the screens in The IRA Bank Monitor, it ranks 11th based on ROA at the end of Q3 2008.

And this is the business GS finds attractive? Just imagine how exciting GS will look when it is an internet bank! No, we don't need to imagine. Both GS and Morgan Stanley (NYSE:MS) are now visible in The IRA Bank Monitor via their filings with the FDIC.

You will also eventually see consolidated profiles of these entities generated by the FFIEC using the links in the Bank Monitor profile as and when they start filing financials with the Fed. Of note, neither GS nor MS have yet filed a Y-9 with the Fed -- at least not one that is publicly available.

In this first ever quarterly filing, GS and its $21 billion Goldman Sachs Bank USA unit are reflected. In Q4 2008, the bank will reportedly merge with a newly minted NY State chartered bank unit. The GS profile on the IRA Bank Monitor does not yet reflect Goldman Sachs Trust Company, National Association or the parent assets.

GS earns a score of 20 on The IRA Bank Stress Index vs. the industry average of 1.5, that is more than one order of magnitude above the industry average. But remember this is the first GS call report, so there may be some transient issues driving the maxed-out 100 score for the ROE degradation.

MS's first call reports with the FDIC as a bank holding company show a far low risk profile, with an overall score of 0.8 vs. the industry average of 1.5 for The IRA Bank Stress Index. The $31 billion in assets shown in Q3 are for Morgan Stanley Bank, National Association, based in Salt Lake City.

Like GS, MS owns two other banks that have still not been tagged as part of the MS group within the FDIC data. We have raised the issue with the FDIC and will do as well with the Fed.

By the end of Q4, the other two small FDIC insured banks owned by MS should be coded by the Fed's Board of Governors to point to the parent company ID, then we will be able to show you a complete "bank only" roll up of both GS and MS. But at the moment, the largest regulated bank unit of MS looks a lot better than its counterpart at GS. Stay tuned.

Disclosure: no positions