Goldman Sachs Raids the Cookie Jar

Includes: BAC, CMA, FITB, KEY, RF, STI
by: Saul Sterman

There was an interesting note put out by Goldman Sachs (NYSE:GS) on Thursday evening (6/12/08) wherein GS claimed that Keycorp (NYSE:KEY) was in good company and that several other banks would follow suit. As we all know, Keycorp cut its dividend by 50% to $0.75 and issued stock (dilution) in order to raise $1.65B (gross) in fresh capital. 

Goldman Sachs targeted the following banks: Bank of America (NYSE:BAC), Comerica (NYSE:CMA), Fifth Third Bancorp (NASDAQ:FITB), Regions Financial Corp (NYSE:RF) and one of Goldman's favorites, SunTrust (NYSE:STI). 

My daughter likes to bake cookies. My granddaughters and I love to eat them. This reminded me of a deal that I had with my sister when I was a kid. All the whole cookies belonged to her. All the broken cookies were mine. So we made the same deal with my daughter. As my daughter took the trays out of the oven we got very busy inspecting all the cookies. Lo and behold we had all the broken cookies to fill our tummies to our hearts content. It's amazing how fragile hot cookies are when you handle them! 

The banking and financial sectors are extremely fragile these days. It doesn't take much handling from Goldman Sachs to chip away at a bank's shares. Full disclosures by GS analysts are superfluous because in theory there is no connection between the various GS departments and their clients. 

The Keycorp Cutter 

Keycorp gave a very detailed press release concerning both the dividend cut and the new equity, yet GS reaps the reward by disseminating half baked information. It is self explanatory so here's an excerpt:

CLEVELAND, June 12 /PRNewswire-FirstCall/ -- KeyCorp today announced a series of steps to preserve and enhance its capital strength in response to a previously announced ruling by a federal court in a dispute over tax treatment of a segment of its leveraged lease portfolio. Although the announced steps are being taken primarily to offset the accounting effects of the adverse court ruling, they will also help maintain the company's strong capital ratios and position it to better address both current economic conditions and future growth opportunities… 

Finally, it is the Board's current intention to reduce the dividend on KeyCorp's common shares by 50 percent commencing with the third quarter 2008 dividend, to an annualized dividend of $0.75 per common share. The dividend reduction will result in Key retaining approximately $200 million of capital annually (pro forma, after giving effect to the anticipated capital raise).

You would think that the Goldman boys could figure out that Keycorp just lost a very big tax related lawsuit. Nope, the boys applied a cookie-cutter (lack of originality or distinction) analogy and didn't seem to realize that this has nothing to do with sub-prime, the economy or whatever else is plaguing the financial sector these days. The court case specifically pertained to Keycorp's leveraged lease portfolio tax practice. 

Arguably you might conclude that the dividend cut is related to the bank's 'dire condition' being that the fresh equity covers the entire legal bill. Well, not really. If you think about it, due to the same judgment, earnings will be less in the future as well. If Keycorp has to pay higher taxes on its leases, this means lower earnings. If you add up the numbers, the only way it paid out higher dividends until now was by stiffing Uncle Sam. That's how I see it. I'm not referring to the actual court case; I don't have a legal opinion, just opining on the outcome. 

If They Are Whole, Break Them 

I looked up our research to see if BAC, CMA, FITB, RF and STI were in court with the State or IRS over the same issue and found nothing. I'm not calling the $14.7M BAC settlement with the IRS regarding City of Oakland bond rigging a trivial issue, it's just a different recipe. Regions Financial Corp just won its lawsuit against the IRS but that has no dough. What a shame; those cookies are whole so I guess we will have to do a closer inspection. 

Yup, they're broken. With the upcoming interest rate hikes, this will lead to lower demand which in turn will lead to lower commercial real estate prices which in turn will lead to higher commercial defaults which in turn spell hard times ahead for the aforementioned banks. After all, we didn't 'break' them on the first round of sub-prime inspection so we will take a closer look at their commercial texture. For instance, STI prides itself for having stayed out of the sub-prime mess for the most part and instead relied heavily on commercial real estate. Ah-ha, now we know where STI crumbles. 

As an aside, BAC refuted Goldman's assertions just this week; the Goldman boys just weren't paying attention…probably because they were busy counting the chocolate chips in their cookie collection or something along those circles. 

Cookie Press 

My granddaughters aren't old enough to read press releases so I can't run the above (FirstCall) quote through a kids' comprehension test. Apparently Keycorp is familiar with the crumby (crummy) attention span of others so CEO Meyer handedly kneaded the press release summary into two short paragraphs:

"We are taking these actions to preserve and enhance our balance sheet strength," said KeyCorp CEO Henry Meyer. 

"If it had not been for the adverse court ruling on our tax treatment of a leveraged lease transaction, we probably would not have considered the capital raising actions", Meyer continued. "But the ruling forced our hand and prompted the decision to build on our strength with a capital raise, one that we think not only is prudent in light of the economic climate, but also is an appropriate move as we look to the future of the enterprise."

"The ruling forced our hand" is the key. I wonder who is forcing Goldman's hand into the cookie jar! 

Disclosure: Associates long various BAC instruments and common stock.