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The Goldman Sachs Group, Inc.

US Banks: Regulation

May 2010
Large Cap: Attractive
Regionals: Neutral
Trust Banks: Neutral
Consumer Finance: Neutral

Richard Ramsden Goldman Sachs & Co. 212-357-9981 richard.ramsden@gs.com


Alec Phillips Goldman Sachs & Co. 202-637-3746 alec.phillips@gs.com
Brian Foran Goldman Sachs & Co. 212-855-9908 brian.foran@gs.com
Daniel Harris Goldman Sachs & Co. 212-855-7512 daniel.harris@gs.com

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that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.
For Reg AC certification, see the end of the text. Other important disclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html.
Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.
Regulation

1. Stepping back – what’s really on the table


– First tenant: limitations of scope, which would restrict the activities of banks (ie the Volcker
rule, the Blanche Lincoln proposal)
– Second tenant: alterations to existing practices and market structures (ie the derivatives
proposals, the consumer protection agency)

2. An off-setting force – credit and liquidity


– Must be weighed against credit availability and liquidity in secondary markets
– This may moderate some of the worst case scenarios (eg momentum seems to be building
to remove an outright prohibition on swaps dealing by banks )

Where we would position


– We believe big banks have lagged enough to justify the legislative risk
– Continue to favor JPM and BAC
– Exchanges (CME, ICE, NDAQ and NYX) should benefit from the move to central clearing

Goldman Sachs Global Investment Research 2


Overview of regulatory reform
The Senate’s proposal on one page

Derivatives Reform Resolution Authority


• Bank Prohibition: No institution that receives federal support may • Process: Modeled on FDIC resolution process; FDIC may take
be a (1) swap dealer or (2) “major swap participant”. control of institution, sell assets or transfer to bridge firm.
• Clearing and Execution: Central clearing of standardized contracts • Creditor Protections: (1) panel of 3 bankruptcy judges must agree
and execution on exchange or alternative execution facility. with Treasury that company is in “default or danger of default.” (2)
Creditors receive at least what they would in Chap. 7 bankruptcy.
• Capital and Margin: Prudential requirements for large market
participants; higher capital for non-standardized contracts. Initial and • Emergency Lending: Federal Reserve lending under Sec. 13 (3)
variation margin required for all non-cleared contracts. limited to broadly available programs; FDIC may guarantee
bank/BHC obligations, but requires 2/3 support of council + Fed.
• End-user exemption: Smaller users that hedge “commercial risk” –
not financial risk—exempt from clearing, execution, and margin reqs.
• Reporting: Real-time price reporting for centrally cleared contracts Bank Tax
(even if end user is exempt); aggregated delayed reporting for non-
cleared swaps. Block trades subject to delayed reporting.
• $50bn Fund: Financed through assessments on BHCs $50bn+ in
assets, and systemic non-bank firms. Raised over 5-10 yr period.
• Position Limits: CFTC may impose position limits. Add’l industry assessments if fund incurs losses.
• Coverage: Covers commodity, rates, securities, and FX swaps. • Other tax proposals not included: President Obama’s “Financial
Crisis Responsibility Fee” (15bps non-deposit liability tax); Boxer-
Webb 50% bonus tax.
Systemic Risk Regulation
• Scope: Banks with $50bn+ assets; systemic important non-banks. Consumer Financial Protection
• Prudential Requirements: Capital, leverage, liquidity requirements. • Bureau of Consumer Financial Protection: Housed within
Federal Reserve, but director appointed by President, and Fed is
• “Hotel California” Provision: BHCs $50bn+ assets that took TARP
prohibited from intervening in Consumer Bureau actions.
capital deemed systemically important if it drops BHC status.
• Volcker Rule: BHCs may not engage in proprietary trading, may not
• Scope: Takes primary jurisdiction over consumer financial products
for institutions with $10bn+ in total assets, and non-banks that deal
sponsor or invest in hedge or private equity funds; systemically
in mortgages or are a large participant in other consumer markets.
important non-banks may still operate in these areas, but with
Does not regulate activities regulated by the SEC/CFTC.
increased prudential requirements.
• Concentration limits: No financial company may exceed 10% of
• No State Preemption: Federal rules would set floor for regulation,
but state laws could supersede federal if stronger.
national financial liabilities through M&A.
Goldman Sachs Global Investment Research 4
Summary of key proposals and potential
impact to financial sub sectors

Potential Sector Risk


Big Regional Credit Smid Mkt Asset
Area of reform What seems likely Points of greatest debate from here Banks Banks Cards Brokers Structure Mgrs

1. Section 106 - can banks own swaps dealers


Derivatives Greater use of central clearing 2. Margin requirements ─ +
3. Central clearing vs. exchange trading

1. Sponsorship of hedge funds and private equity --


Volcker rule Less proprietary trading i.e. can banks put HF and PE into asset mgmt ─ +
divisions

1. Rule making authority: CFPA vs. Fed


New Consumer Financial
Consumer Protection
Protection Agency (CFPA) 2. National pre-emption vs. state by state lending
─ ─ ─
laws

1. Pre-funded money for any future crisis


Some form of tax to fund any
Bank tax & size limitations
losses from TARP

2. Legislative restrictions on size of banks

Ability to wind down systemically 1. Impact on credit markets including potential


Resolution Authority
important firms ratings agency actions

MOST POTENTIAL
OVERALL RISK --> NEGATIV LESS AT RISK MODEST
E RISK POSITIVES

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 5
The reform debate from here

House Senate

Passes Financial Services


Committee (Nov. 2009)
Banking Committee Markup
(March 2010)
Passes House Floor 223-202
Ag. Committee Markup
(Dec. 2009)
(April 2010)

Senate Floor
(April/May 2010)
Option 1: Conference Committee

House-Senate Conference
Committee
(May/June 2010)
House Passage of Conf. Senate Passage of Conf.
Report (June 2010) Report (June 2010)

Option 2: House Passage of Senate Bill

House Passage of Senate


Bill (May/June 2010)

Goldman Sachs Global Investment Research 6


Derivatives and prop trading
RAFSA has two important proposals that
impact market structure companies

 The Volcker Rule (Section 619 or Title VII)


 Would prohibit certain types of high risk activity
 Proposal could reduce overall trading activity, potentially lower market liquidity, and
impact fees generated by exchanges in the transaction parts of their business
 Creating a safer derivatives market: there are three tenets to this proposal:
 Central clearing of OTC derivatives: all OTC products would be required to be centrally
cleared with requisite initial margin requirements for all products
 Exchange trading as a price transparency mechanism would be required
• Can be exchange traded or traded on an alternative swap execution facility
(ASEF)
 Allow for some customized bilateral contracts. Exceptions are fairly well defined:
• One counterparty is not a swap/security dealer or MSP (major swap participant),
the product does not meet the eligibility requirements of a clearing house
• Margin may be waived in certain circumstances if one party is not a swap/security
dealer or MSP, is using the swap to hedge under GAAP, and is not predominantly
engaged in financial activities

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 8
Market Structure & Exchange stocks
appear well positioned to benefit

 Difficult to see how exchange and clearing stocks are not incremental beneficiaries
 CME: currently trades and clears 99% of U.S. futures products on interest rates
 NDAQ: acquired the International Derivatives Clearing Group (IDCG) in 2009, which is
the only market participant to have announced it has an interest rate swap clearing
platform ready for clients to test
 Dealers/Brokers have less directional authority to drive clearing strategy than they have had
in the past few years
 ICE Trust is the dominant provider of clearing services in CDS clearing in the U.S.
 Dealers were able to secure 49% of net profits from ICE Trust to support that platform
 NYSE – sold 49% stake in its U.S. options business to attract flow
 Beyond clearing, there could be positive impacts on transactions and associated exchange
traded product
 Clearing tends to have a higher profit stickiness given underlying liquidity pool
 Other market structure names may benefit: GFIG, BGCP, MKTX, NITE

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 9
Sizing the OTC markets: $604 tn notional
and multiple the size of exchange markets
$800 Interest rate contracts Unallocated Credit default swaps
Foreign exchange contracts Commodity contracts Equity-linked contracts

• OTC markets have grown at a 24% CAGR


OTC notional amount outstanding ($, trillions)

$700 684

596 604
$600
516
592
since 1998
$500

$400 370
414
• Interest Rate swaps have grown the
297
$300
220
257
281
fastest at 26% and represent 72% of total
$200 197
169

$100 72 80 81 88 94 95 99 111
127 141
• CDS swaps are now $25 tn
• But exchange traded products turn over
$0
1H98

2H98

1H99

2H99

1H00

2H00

1H01

2H01

1H02

2H02

1H03

2H03

1H04

2H04

1H05

2H05

1H06

2H06

1H07

2H07

1H08

2H08

1H09
much more rapidly
100 93.0x 92.0x
90
80
500
Interest rate and F/X OTC markets are multiple of exchange peers 70
450 437.2
60
6.5x 50 45.0x
400
40
350
30 21.2x
300 20 11.9x
10 4.5x 2.8x
0.6x 1.2x 1.1x 1.0x
250
0
200 Total FX FX Swaps FX Total FRAs IRS IR F/X Rate Equity
Forward Options Options Futures Futures Futures
150 F/X OTC Interest Rate OTC Exchange Traded

100
67.1
48.8 157x
50 1.2x
6.6 5.8 0.3
-
Interest Rate Equity Index F/X

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 10
CDS markets: $25 tn gross notional, but
netting reduces risk roughly 90%

$30 Index Single Name


• The CDS markets remain quite robust, with
$25.0 tn
$25 90% Com pression over $25 tn in gross exposure
from Gross to Net
$20 CDS exposure • With compression and tear-ups, the amount
of net exposure is $2.4 tn
$15
• 77% of CDS is dealer to dealer and is likely to
$10
move into the ICE Trust Clearing House
$5 $2.4 tn • The average length of time to termination is
$0
2.7 years
Gross Net

Dealer to $16 Cumulative Single Name Notional Outstanding ($ tn) Cumulative Notional % Outstanding 120%

Client $14
100%
23%
$12
80%
$10 Average Years to Sw ap
Term ination: 2.7 years
$8 60%

$6
40%
$4
20%
$2
Dealer to
$0 0%
Dealer
2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020
77%

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 11
We estimate $75 bn in CDS initial margin
requirements for U.S. companies
CDS Market Summary ($ in bn)
• We estimate 40% of
Dealer to Dealer Dealer to Client Client to Client Total outstanding CDS
Single Name 12,167 2,735 24 14,927 contracts are in the U.S.
Index 4,455 2,929 3 7,386
Tranched 2,568 130 0 2,698 • Initial margin
Gross Exposure Outstanding 19,190 5,794 27 25,011
requirements are likely
% of Total
Single Name 49% 11% 0% 60%
to be 5%-10% of net
Index 18% 12% 0% 30% notional
Tranched 10% 1% 0% 11%
% of Total 77% 23% 0% 100% • We estimate dealers will
Compression estimate need to contribute close
Single Name 95% 75% 75% 91%
Index 95% 75% 75% 87% to $20 bn, and clients
Tranched 95% 75% 75% 94% $55 bn when all
Estimated Compression 95% 75% 75% 90%
contracts are loaded
Net Exposure
Single Name 602 670 6 1,279 into ICE Trust
Index 221 718 1 939
Tranched 127 32 0 159 • Today, there is $635 bn
Net Exposure Outstanding 950 1,420 7 2,377
in net notional CDS in
U.S. estimated Exposure 40% 40% 40% 40% ICE Trust U.S. ($367 bn)
Net U.S. exposure (estimate) 380 568 3 951
Initial Margin required for U.S. firms (% of net, est) 5% 10% 10% 8%
and EU ($268 bn)
Initial Margin required for U.S. firms ($ bn, est) $19 $56 $0 $75
• There is likely an
• ICE has indicated it expects $80-$100 mn in CDS clearing revenue in additional $45 bn in
2010, we estimate it will at least double over the next 1-2 years initial margin required
among U.S. firms
• This revenue is split with participating dealers
Source: Goldman Sachs Research estimates.
Goldman Sachs Global Investment Research 12
Interest Rate Swaps: the upcoming $437 tn
opportunity
Interest Rate Swaps by Currency: Total $437 tn • 35% of global interest rate swap products are U.S.
CAD Other
Swedish krona
1% 1% 4%
based
Swiss franc
1% • More than three-quarters are interest rate swaps,
Sterling Euro plain vanilla and somewhat easy to standardize
7% 38%
Yen
13%
• Roughly 60% of product is dealer-to-dealer, with the
remaining 40% up for client central clearing and thus
impacted by U.S. regulatory changes

US dollar
35%

Interest Rate Swap Clearing Opportunity


More bespoke structures
Exotics
Interest Rate Swaps by Derivative Type: Total: $437 tn w hose eligibility w ill Currently cleared
10%
require further product Basis and X- 25%
expansion currency
6%
FRAs 30 yr + Options
Options eligibility via 9%
11%
product set
expansion
Interest rate sw aps 3%
78% Eligible to clear by
Customer trades -
focus on customer cpty and type
clearing 27%
Eligible w / smaller
Forw ard rate 12% Backloading
dealers - focus on
agreements
11% increased program to
Sw apclear 8% address

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 13
Client Clearing U.S. denominated swaps is
the targeted Interest Rate product

Total Global Interest Rate Swap • The interest rate swap market is the focus of
Market: the next leg of clearing. It represents 72% of
$437 tn the global OTC market

• Dealer to Dealer transactions (52%) are cleared


Dealer to Client at LCH SwapClear
(25%):
$109 tn • The clearing opportunity lies in plain vanilla
client transactions

USD • The initial opportunity to clear will be in USD


Swaps:
(35%):
denominated swaps
$39 tn • However, their could emerge global solutions
following a successful U.S. Launch

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 14
Could be up to $570 bn in IRS initial margin
requirements needed for USD swaps
Interest Rate Margin Estimates for U.S. Clients ($ bn) • We estimate USD swaps
Less than 1 Between 1-5
Duration Year Years Over 5 Years Total
account for 35% of total
Total Interest Rate OTC Global Market ($ bn) 159,143 128,301 149,754 437,198
global swaps.
% of total 36% 29% 34% 100%
• Initial margin
U.S. denominated swaps, % of total 35%
U.S. denominated swaps, in $ bn 56,118 45,242 52,807 154,167
requirements are likely to
% of original interest rate swap notional value 35% 35% 35% 35% be 1%-5% of notional
Transaction Type based on duration
Dealer-to-Dealer 60%
Dealer-to-Client 25% • We estimate clients may
Non-Clearable (bespoke, option, basis) 15%
need to post up to $570
Dealer-to-Client summary of notional exposure ($ bn) 14,029 11,311 13,202 38,542 bn in initial margin on
% of original interest rate swap notional value 9% 9% 9% 9%
swap positions for USD
Estimated Compression (netting, tear-ups) 25%
Net Exposure 10,522 8,483 9,901 28,906
swaps
% of original interest rate swap notional value 7% 7% 7% 7%
• The size of the client swap
Initial Margin required for U.S. denominated Swaps (est)
Initial Margin required for U.S. firms ($ bn, est)
1.0%
$105
2.0%
$170
3.0%
$297
2.0%
$572
market may decline
meaningfully with higher
costs/margin
• NDAQ and CME have announced they would offer an interest rate swap
product for clients; LCH SwapClear has also launched a client product • Today, there is a de
minimis amount of margin
• NDAQ’s IDCG indicated it would charge $1/$100K of notional value
collected on client swaps
cleared per contract
outside hedge fund
• Average duration is 5-7 years for most plain vanilla swaps clients

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 15
How we think about the interest rate swap
clearing opportunity: up to $400 mn annually
Interest Rate Swap Clearing opportunity
Summary Notes

Total Global Interest Rate Swap Notional Outstanding $437,198,000,000,000 $437 tn

U.S. Percentage of total 35%


U.S. Dollar denominated IRS $154,167,000,000,000

Swap participant break-down


Dealer to Dealer - plain vanilla 60% $92,500,200,000,000 Already within LCH SwapClear Clearing mechanism
Dealer to Client - plain vanilla 25% $38,541,750,000,000 Target market opportunity
Other (bespoke, option, basis, etc) 15% $23,125,050,000,000 Will require initial margin, not likely to be cleared

Dealer to Client Notional $38,541,750,000,000 This is the sector CME, NDAQ are pursuing

Number of 'one $ mn units' 38,541,750 Assumes full backloading, probably takes 4-7 years to reach this level

Potential Clearing Revenues Cost per million Potential revenue


$2 $77,083,500
$5 $192,708,750
$10 $385,417,500 This is IDCG's target pricing

• The only part of the market up for competition is the dealer-to-client


IRS market, about 25% of the total IRS market, or about $39 tn in
notional
• There is limited netting given client positions are bespoke
• Potential revenue opportunity from clearing of $100-$400 mn over time,
though this could take 4-7 years to achieve

Source: Goldman Sachs Research


Goldman Sachs Global Investment Research 16
Consumer protection
The CFPA is arguably the biggest concern but most
has been accomplished via overdraft protection
(Reg E) and credit card legislation (CARD Act)

Reg E Impact CARD Act Impact

Reg E Impact CARD Act Impact


Pre-tax 2009 EPS Norm
$BN Guidance % $BN Guidance %
Impact DSC Impact EPS

PNC $115MM after-tax impact in 2010 (half year impact) 0.35 1.0 37% COF Margin to decline to 15% from 17% currently $0.93 $5.00 19%

USB $200MM-$300MM impact in 2010 0.25 1.0 26% DFS Margin to decline by 25-50 bps from 2009YE $0.30 $2.00 15%

BAC about $2.0BN / quarter run rate vs $2.57BN currently 2.00 11.0 18% AXP Margin to decline to 9% from 10% currently $0.34 $3.15 11%

KEY $50MM on an annualized basis 0.05 0.3 15% BAC $900MM after-tax annual impact $0.09 $2.40 4%

STI reduction of 10-20% during the 2H of the year 0.13 0.8 15% JPM $500-$750MM net income reduction $0.15 $6.50 2%

JPM $500MM +/- annualized after-tax impact 0.77 5.6 14% C $400-600MM pre-tax annual net impact $0.01 $0.45 2%

WFC $500MM after-tax annualized impact 0.77 5.7 13% PNC $40MM after-tax annual impact $0.08 $6.50 1%

FITB $20MM / quarter by 4Q09 0.08 0.6 13% USB $100MM pre-tax impact in 2010 $0.03 $2.85 1%

BBT $70-$80MM pre-tax annual impact 0.08 0.7 11% WFC $235MM after-tax gross impact $0.05 $4.35 1%

FNFG $5-6MM on annualized basis 0.01 0.05 10%


Average 6%
RF $70MM pre-tax annual net impact 0.07 1.2 6% *: EPS impact for COF, DFS, AXP are based on GS estimates.

Average 16%

Source: Company reports, Goldman Sachs Research


Goldman Sachs Global Investment Research 18
Resolution Authority
Capital levels are back to pre-crisis levels

Capital ratios back to pre-crisis levels 50% of banks have >8% Tier 1 common

13.0%
TCE / TA Tier 1 Common
Tier 1 Common STT 15.9%
12.0% Tier 1 Ratio NTRS 12.8%
BK 11.6%
11.0% ~11.0% COF 10.7%
50% above FHN 9.9%
8% CMA 9.6%
10.0% CYN 9.4%
C 9.1%
US Banks Capital Ratios

JPM 9.1%
9.0% BBT 8.7%
WAL 8.2%
~8.3%
8.0% MS 8.2%
8.0%
STI 7.7%
7.0% BAC 7.6%
PNC 7.6%
KEY 7.5%
6.0% MI 7.5%
~5.8% 100%
FNFG 7.5%
above 6%
RF 7.1%
5.0%
USB 7.1%
WFC 7.1%
4.0% ZION 7.0%
FITB 7.0%
HBAN 6.5%
3.0% 6.0%
Simple Avg 8.8%
1Q91
2Q92
3Q93
4Q94
1Q96
2Q97
3Q98
4Q99
1Q01
2Q02
3Q03
4Q04
1Q06
2Q07
3Q08
4Q09

Weighted Avg 8.3%

Source: Company reports, Goldman Sachs Research


Goldman Sachs Global Investment Research 20
We are about ¾ of the way through losses
and capital markets remain accommodative

$1.8 tn through $2.1-2.6 tn of losses Capital markets remain open

Low High 160

US Banks Common and Converts Issuance ($bn)


Out- 140
Cumulative Cumulative
standing 140
$ trillions Losses Loss Rate Losses Loss Rate

Subprime 0.9 0.3 32% 0.3 38%


120
Option ARM 0.5 0.1 27% 0.2 33%

Home Equity 1.1 0.1 13% 0.2 16% 100


Other (FHA, GNMA) 0.9 0.1 11% 0.1 14%

Alt-A 2.2 0.2 11% 0.3 14% 80


64
Prime 5.7 0.3 5% 0.4 6%
60 52
Resi Mortgage 11.3 1.2 11% 1.5 13%
45

Commercial Real Estate 3.3 0.3 8% 0.3 10% 40


26
Cards 1.0 0.2 20% 0.2 23%
20
Auto 1.1 0.1 9% 0.2 14% 9

Commercial 6.8 0.4 5% 0.5 7%


0
Total 23.5 2.1 9% 2.6 11% 2H07 1H08 2H08 1H09 2H09 1H10 TD

Losses Recognized as of 1Q10 $1.8TN Average Deal


-49% -8% 5% 62% 34% 29%
Performance

Source: Company reports, Goldman Sachs Research


Goldman Sachs Global Investment Research 21
Bank tax and size caps
Size caps would be a big deal but we’re
not sure there is support to enact them

Liabilities would increase through a boom,


2% GDP cap implies $2.7TN of shrinkage then need to fall in a bust

310

Non- Implied Implied


$BN Assets Liabilities Deposits 2% of GDP 290
Deposits Decline shrinkage

BAC 2330 2,103 976 1,127 285 842 36%


270
JPM 2130 1,971 925 1,046 285 761 36%

2% of Nominal GDP ($bn)


C 2000 1,848 828 1,021 285 735 37% 250

MS 820 765 64 701 285 416 51%


230
WFC 1220 1,105 805 301 285 15 1%

Total 8500 7794 3598 4,196 1,426 2,770 33%


210

190

170

150
1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009
Source: Company data, SNL, Goldman Sachs Research estimates.
Goldman Sachs Global Investment Research 23
Credit availability and liquidity
Less interest rate hedging = more volatile
mortgage rates relative to 10yr UST

Less hedging = more volatility

500bps Conforming Mortgage spread to 10yr Treasury

450bps Average
+1SD
400bps -1SD
Standard Deviation
350bps 1970 - 1989 70
1990 - Now 32
300bps

250bps
224bps
200bps
170bps
150bps
134bps
116bps
100bps

50bps

0bps
Jan-72
Jan-73
Jan-74
Jan-75
Jan-76
Jan-77
Jan-78
Jan-79
Jan-80
Jan-81
Jan-82
Jan-83
Jan-84
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Source: Federal Reserves, Freddie Mac, Goldman Sachs Research estimates.
Goldman Sachs Global Investment Research 25
As private sector credit shrinks, loans are
shifted to the government balance sheet

Transfer of credit to government balance sheet most pronounced in resi mortgages


% of US YoY % YoY $bn
Credit Market Change Change
Non-banks and securitization account for biggest piece of
Non-banks + securitization 40% -12% -607
credit outstanding and credit shrinkage

Bank loans 31% -7% -552


Private credit is being transferred to Government balance
Government incl GSEs 29% +8% +495
sheet

Total 100% -3% -664

500 100%
US Resi Real Estate Credit - YoY Change, $bn

Mortgage origination share - Fannie, Freddie, FHA


400 90%

300 80%

200 70%

100 60%

0 50%

-100 40%

-200 30%

-300 20%

-400 10%

0%
-500

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
1Q09
2Q09
3Q09
Gov't incl GSEs Bank Loans Non-banks + securitization

Note: Loan shrinkage data cited here differs from similar data points cited on p14 and p24 as this data point is sourced from Federal Reserve- Flow of Funds data while p12 and
p28 data points are derived from the Federal Reserve- H-8 data
Source: Industry sources, Goldman Sachs Research.
Goldman Sachs Global Investment Research 26
Banks – possible risks to normalized EPS
Significant range of EPS outcomes depending
on legislation

EPS risk: from small plus to -20% Estimate risk vs valuation gap to history

20%
Potential Earnings
Potential % Factored in to
Estimate
Earning Impact Estimates
Upside/Downside
10%

Asset Managers
Exchanges 7% 0% 7%

0%
Asset Managers 5% 0% 5%

Current Multiple vs. LT Average


Small Brokers 3% 0% 3%
Small Brokers
-10%
Regionals -6% 70% -2% Negative, but
seems factored
Credit Cards -17% 80% -3% into valuation
-20% Regionals
Large Banks -26% 20% -20%
Large Banks Credit Cards
-30%
Exchanges

-40%
A positive that may
not be fully
factored in
-50%
-25% -20% -15% -10% -5% 0% 5% 10%
Potential Earnings Estim ate Upside/Dow nside from Reg Reform

Source: FactSet, Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 28
Market appears to be discounting some
element of reg reform

We estimate the market discounts about an 80% chance of worst case scenario

100.0%

77%
80.0%
Financial Regulatory Reform *
Market Implied Probability of

60.0%

40.0%

20.0%

0.0%

-20.0%

-40.0%
01/01/10

01/08/10

01/15/10

01/22/10

01/29/10

02/05/10

02/12/10

02/19/10

02/26/10

03/05/10

03/12/10

03/19/10

03/26/10

04/02/10

04/09/10

04/16/10

04/23/10

04/30/10
*: defined as underperformance of big banks relative regionals, credit cards and small brokers divided by the incremental earnings from
regulatory reforms to big banks relative to the other sectors

Source: FactSet, Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 29
Assessing impact of legislation by item

Everything proposed so far could haircut normalized EPS about 18%

Hit to Industry Accounted for by


Large Banks * Regionals All
Normalized EPS Street?

CARD Act 2% Mostly Total risk 25.7% 5.5% 17.6%

Overdraft Fees 3% Mostly Already modeled ** 5.3% 3.7% 5.2%

Incremental risk to
TARP Tax 4% No 20.4% 1.8% 12.4%
normalzed EPS

Prop Restriction 3% No
*: BAC, C, JPM and MS.

Liability Caps 2% No **: assuming CARD Act and Reg E are mostly modeled in.

Derivatives Legislation 4% No

Total 18% Partly

Large Banks * 26% Partly


Regionals 5% Mostly

Source: Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 30
Our estimates of regulatory impact to
normalized earnings by bank

Regulatory actions could negatively impact normalized earnings

Large Banks Trust Banks Cards Regionals


$bn BAC C JPM MS WFC PNC USB BK NTRS STT AXP COF DFS BBT CYN CMA FITB FHN FNFG HCBK HBAN KEY MI PBCT RF STI WAL ZION Wtd Avg
Regulatory Impact (pre-tax)
OD / NSF Fees (1) 2.0 0.1 0.8 0.0 0.8 0.4 0.3 0.0 0.0 0.0 0.0 0.1 0.0 0.1 0.0 0.0 0.1 0.0 0.0 0.0 0.1 0.1 0.0 0.0 0.1 0.1 0.0 0.0
CARD Act (2) 1.4 0.5 0.9 -- 0.4 0.1 0.1 -- -- -- 0.6 0.7 0.3 -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Financial Crisis Responsibility Fee (3) 1.4 1.9 1.6 0.8 0.6 0.1 0.1 0.2 0.1 0.2 0.1 0.1 0.0 0.1 -- 0.0 0.0 -- -- 0.0 0.0 0.0 0.0 -- 0.1 0.1 -- 0.0
Restrictions on "Liabilities" (4) 1.8 1.5 1.6 -- -- -- -- 0.2 0.1 0.1 -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Restrictions on "Prop" (5) 0.5 1.3 1.0 0.6 0.0 -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Derivatives Legislation (6) 2.2 2.1 2.5 1.5 -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Total Regulatory Impact 9.3 7.5 8.4 2.9 1.7 0.5 0.5 0.4 0.1 0.3 0.7 0.8 0.3 0.1 0.0 0.1 0.1 0.0 0.0 0.0 0.1 0.1 0.0 0.0 0.1 0.2 0.0 0.0

After-tax Impact 6.0 4.9 5.5 1.9 1.1 0.3 0.3 0.3 0.1 0.2 0.5 0.5 0.2 0.1 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.0
S/O (bn) 9.9 29.9 4.0 1.4 5.2 0.5 1.9 1.2 0.2 0.5 1.2 0.5 0.5 0.7 0.1 0.2 0.8 0.2 0.2 0.5 0.7 0.9 0.5 0.4 1.2 0.5 0.1 0.16
"Gross" EPS hit $0.61 $0.16 $1.38 $1.34 $0.21 $0.62 $0.17 $0.21 $0.38 $0.38 $0.41 $1.14 $0.32 $0.13 $0.13 $0.24 $0.09 $0.09 $0.02 $0.04 $0.05 $0.05 $0.05 $0.00 $0.07 $0.24 $0.01 $0.20
% of Normalized EPS 25% 33% 21% 30% 5% 10% 6% 8% 11% 12% 11% 23% 16% 4% 3% 5% 6% 7% 1% 3% 9% 5% 8% 0% 9% 7% 3% 9% 18%

Impact by Regulatory Action


OD / NSF Fees (1) 5% 1% 2% 0% 2% 7% 3% 1% 0% 0% 0% 2% 0% 2% 3% 4% 4% 7% 1% 0% 7% 4% 5% 0% 5% 5% 3% 8% 3%
CARD Act (2) 4% 2% 2% 0% 1% 1% 1% 0% 0% 0% 9% 19% 15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 2%
Financial Crisis Responsibility Fee (3) 4% 8% 4% 8% 2% 2% 2% 4% 6% 7% 2% 2% 1% 2% 0% 2% 2% 0% 0% 3% 1% 2% 3% 0% 4% 2% 0% 1% 4%
Restrictions on "Liabilities" (4) 5% 7% 4% 0% 0% 0% 0% 3% 5% 5% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 3%
Restrictions on "Prop" (5) 1% 6% 3% 6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 2%
Derivatives Legislation (6) 6% 9% 6% 15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 4%
Total 25% 33% 21% 30% 5% 10% 6% 8% 11% 12% 11% 23% 16% 4% 3% 5% 6% 7% 1% 3% 9% 5% 8% 0% 9% 7% 3% 9% 18%

(1): estimated using 15% of annual deposit servicing charges (5% for trust banks), similar to banks that provide guidance.
(2): estimated where not provided.
(3): estimated using 15bps of Total Assets - Tier 1 Capital - FDIC-assessed deposits - UST Repos. Assuming USB reports make up 80% of total repo outstanding.
(4) assuming 10% decline in b/s size for big 3 banks. Also assuming 10% for trust banks as they reduce the repo books.
(5): using disclosed % of revenue by bank where applicable.
(6): for JPM using guidance of $2.0-$3.0bn pre-tax; others estimated as % of gross derivatives.

Source: Industry sources, Goldman Sachs Research.


Goldman Sachs Global Investment Research 31
Break-up values for BAC and JPM are
higher than the current stock prices

BANK OF AMERICA JP MORGAN

Commercial Global Card Investment Commercial Global Card Investment


3Q09 Total 3Q09 AM & Trust Total
Bank Services Bank Bank Services Bank
Net interest income 5.2 2.7 3.8 11.8 Net interest income 7.2 2.3 2.3 1.1 12.8
Noninterest income 7.7 1.3 7.8 14.6 Noninterest income 4.9 1.1 5.4 2.8 14.3
Total revenue 12.9 4.0 11.7 26.4 Total revenue 12.1 3.5 7.7 3.9 27.1

Provision expense 7.0 3.7 1.1 11.7 Provision expense 4.4 3.3 0.4 0.1 8.1
Noninterest expense 8.0 2.0 6.4 16.3 Noninterest expense 5.2 1.3 4.3 2.6 13.5

Pre-tax income -2.1 -1.6 4.3 -1.6 Pre-tax income 2.5 -1.1 3.0 1.2 5.5
Taxes -0.8 -0.6 1.6 -0.6 Taxes 1.1 -0.4 0.9 0.4 2.0
Tax rate 40% 36% 36% 39% Tax rate 43% 37% 31% 37% 36%
Net income -1.3 -1.0 2.7 -1.0 Net income 1.4 -0.7 2.1 0.7 3.5

Total assets 1,237 224 885 2,345 Total assets 1,161 192 679 93 2,125
Total loans 702 208 99 1,009 Total loans 450 169 66 52 738

Adjustment Adjustment
Revenue run rate 12.9 4.0 11.7 28.6 Revenue run rate 11.3 3.5 7.7 3.9 26.3
Normalized provision rate 0.50% 3.00% 0.10% 0.98% Normalized provision rate 0.50% 3.00% 0.10% 0.00% 1.00%
Normalized provision ($) 3.5 6.2 0.1 9.8 Normalized provision ($) 2.3 5.1 0.1 0.0 7.4
Normal efficiency 50% 40% 70% 57% Normal efficiency 50% 40% 70% 70% 14.8
Assumed efficiency * 55% 44% 77% 62% Assumed efficiency * 55% 44% 77% 77% 63%

Annual Pre-tax 19.6 2.8 10.7 33.1 Annual Pre-tax 18.1 2.7 7.0 3.6 31.3
Tax rate 35% 35% 35% 35% Tax rate 35% 35% 35% 35% 35%
Preferred dividend 2.6 0.0 0.0 2.6 Preferred dividend 0.0 0.0 0.0 0.0 0.0
Net income 10.2 1.8 6.9 18.9 Net income 11.8 1.7 4.5 2.3 20.4
ROA 0.8% 0.8% 0.8% 0.8% ROA 1.0% 0.9% 0.7% 2.5% 1.0%

Multiple 10.0x 10.0x 10.0x 10.0x Multiple 10.0x 10.0x 10.0x 15.0x 10.6x
Value 102 18 69 189 Value 118 17 45 35 215
Value per share $11.8 $2.1 $8.0 $21.8 Value per share $29.8 $4.4 $11.6 $8.8 $54.6

*: assuming expenses are 10% higher due to the cost of running businesses separately.

Note: Note:
Commercial Bank includes Deposits, Home Loans & Insurance and Global Commercial Banking. Commercial Bank includes Retail Financial Services and Commercial Banking.
Investment Bank includes Global Corporate & IB, Global Markets and GWIM. AM & Trust includes Asset Management and Treasury & Securities Services.
Corporate segment is allocated to each segment. Excluding $2.2bn of MER CVA. Corporate segment is allocated to each segment.

Source: Company data, Goldman Sachs Research estimates.


Goldman Sachs Global Investment Research 32
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We, Richard Ramsden, Brian Foran and Daniel Harris, hereby certify that all
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about the subject company or companies and its or their securities. We also
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this report.

Goldman Sachs Global Investment Research 33


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Goldman Sachs Global Investment Research 35


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