One thing is clear. You can push Goldman Sachs (NYSE:GS) to a wall by restricting its activities, but the investment bank will always find some way to do what it does best – make money. Quite recently, the bank revealed its intention to raise $600 million for a publicly traded credit fund, which will be structured as a business development company.  This is because business development companies lie outside the purview of the Volcker Rule, Goldman will be well within the law to trade credit products through this vehicle, which will be funded nearly 25% by the bank itself. Last month, we detailed another one of Goldman’s other responses to the Volcker Rule in our article Goldman Finds A Way Around Volcker Rule To Continue Proprietary Trades.
Goldman’s eagerness to make money under tightening regulations would seem to be a good thing from an investor’s point of view, provided the bank doesn’t rub regulators the wrong way. Goldman seems to be succeeding in maintaining a balancing act while walking the regulatory tightrope, by also giving in to rules on quite a few instances. The bank has already closed down most of its proprietary trading units over the years.  It is also shrinking its private-equity (PE) business to comply with the Volcker Rule’s 3% limit on investment in such funds. 
We maintain a $146 price estimate for Goldman’s stock, which is about 5% below current market prices.
One look at Goldman’s main sources of value depicted in the chart above and you can see why Goldman is not very happy about the Volcker Rule. The rule lays restrictions on Goldman’s top businesses – trading (fixed-income & equities) and other investments – which together contribute to over 70% of the investment bank’s value. More specifically, the most sticking inclusions in the Volcker Rule is the complete ban on proprietary trading.
Goldman seems to be exploring various solutions to the Volcker problem. One of the approach is to structure an upcoming credit fund as a business development company, to take advantage of the exception granted to such companies in the Volcker Rule. The $600 million fund will have up to $150 million of Goldman’s own money, which will then be used to extend credit to middle-market companies. As of now, the fund already has $50 million worth of assets, which yield an average return of 11% to investors.  So if Goldman actually goes in for the entire proposed $150 million investment, then it will generate about $16.5 million in gross revenues from the fund each year. It’s not a bad deal considering the fact that without this approach there can be no such revenues at all from credit products, once the Volcker Rule is in place.
The model is quite easy to replicate, allowing Goldman to multiply its revenue streams. Also, other investment banks will come up with similar ‘business development’ companies of their own soon.
We represent the revenues from such investments as part of ’securities services & other investment revenue’ in our analysis of the bank. You can make changes to the chart below to understand how a change in these revenues would affect Goldman’s total share value.Notes:
- Goldman finds a way past Volcker with new credit fund, Reuters, Jan 25 2013 [↩] [↩]
- Goldman Sachs Said to Close Fixed-Income Prop Group, Bloomberg, Feb 15 2011 [↩]
- Goldman Readies Fund Business for ‘Volcker’, The Wall Street Journal, Feb 13 2013 [↩]