Nearly one year ago I made clear to all, for absolutely free, that Goldman
Sachs was akin to an overpriced hedge fund. The bulk of their profits come
from proprietary trading, as do the bulk of the their economic risk added.
I first started going bearish on Goldman in July with a flurry of puts with
the share price at about $180. Everybody and their mother told me how shorting
Goldman would be disastrous. Well, I need a few more disasters like that for
my account this year. Take a looksee:
I have recent research on Goldman, marking assets to what I believe to be
realistic marks to be expected from the PPIP program, for my subscribers:
In June of last year I made it clear that Goldman was trading on name brand
premium only, and a premium that was quite undeserved. This premium was paid
by those who don't like to run numbers and observe correlations, two activities
which happen to be my specialty. See "Goldman
Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street", from which
I have excerpted the justifications for my bearish moves:
We have looked at company's recent quarterly filings and 10K to have a closer
view of Goldman Sachs' (GS) exposure. Following are some of our observations:
Value at Risk (VAR) and Risk Adjusted Return on Risk Adjusted Capital
(RARORAC)
Goldman has the highest VAR among its peer group of $184 mn, followed
by Lehman at distant $123 mn (we all know how well LEH is currently faring).
Notably, GS also the highest range (difference of highest and lowest
daily VAR during a quarter) of daily trading VAR of $92 million, reflecting significant
(read risky) volatility in its trading portfolio. This is higher than
$61 mn and $67 mn (for 1Q2008) for Lehman and JPM, respectively. This is
also being reflected in the lowest risk adjusted return on risk adjusted
capital (RARORAC - a much more grounded measure of risk adjusted return)
of 14.8% for GS among its peer group. Just so this doesn't escape anybody,
GS has the lowest risk adjusted return on the Street. Simply analyzing
earnings (or looking at CNBC) would lead one to believe that Goldman has
the highest return on investment, but unfortunately, the world is a bit
more complex than an earnings statement or a cable news channel.
Average Daily Trading VAR
(in million dollars) |
Q208 |
Q108 |
Q407 |
Q307 |
| Goldman Sachs |
184 |
157 |
138 |
139 |
| Morgan Stanley |
99 |
97 |
89 |
87 |
| Merrill Lynch |
NA |
65 |
65 |
76 |
| Lehman Brothers |
123 |
130 |
124 |
96 |
| JPM |
NA |
122 |
107 |
112 |
| |
| Range of Daily Trading VAR (Difference between
highs and lows) (in million dollars) |
Q208 |
Q108 |
Q407 |
Q307 |
| Goldman Sachs |
NA |
92 |
77 |
68 |
| Morgan Stanley |
NA |
34 |
46 |
36 |
| Merrill Lynch |
NA |
39 |
51 |
32 |
| Lehman Brothers |
37 |
61 |
107 |
66 |
| JPM |
NA |
67 |
138 |
64 |
Risk Adjusted return on risk
adjusted capital (RARORAC) |
Q208 |
Q108 |
Q407 |
Q307 |
| Goldman Sachs |
12.9% |
14.8% |
16.1% |
15.3% |
| Morgan Stanley |
19.7% |
19.1% |
21.5% |
23.3% |
| Merrill Lynch |
NA |
31.6% |
32.5% |
30.5% |
| Lehman Brothers |
14.0% |
12.3% |
12.0% |
15.3% |
| JPM |
NA |
54.1% |
60.2% |
56.8% |
Goldman also has the highest adjusted leverage ratio (adjusted asset
divided by adjusted equity) of 18.6x (for 1Q2008) among its peer group, reflecting
lower equity cushion against any valuation write-down or loss. This highest
leverage portends much greater volatility in economic earnigns. In other
words, when the win chooses not to blow in their direction, the sh1t will
hit the fan that much harder than the rest of the Street
| Adjusted leverage ratio |
Q208 |
Q108 |
Q407 |
Q307 |
| Goldman Sachs |
NA |
18.6x |
17.5x |
18.0x |
| Morgan Stanley |
14.1x |
16.0x |
17.6x |
18.8x |
| Merrill Lynch |
NA |
18.2x |
20.3x |
17.9x |
| Lehman Brothers |
12.0x |
15.4x |
16.1x |
16.1x |
| JPM |
NA |
13.1x |
12.7x |
12.3x |
Click here for a worksheet that illustrates the VaR exposure for all ofthe
big US brokers in detail:
Broker
VaR Worksheet (634.49 kB 2008-07-05 09:25:24).
Goldman Sachs' exposure
- GS' level 3 assets as percentage of its equity at 258% is close to highest
figure of 274% among its peer group. Its level 3 assets proportion to total
asset has increased consistently from 5.7% in 2Q2007 to 8.1% in 1Q2008.
- It is also worth noting that approximately 25% of its OTC derivative
credit exposure (comprised in level 3 assets) is rated BBB and lower.
| OTC Derivative Credit Exposure ($ mn) |
| |
Feb-08 |
% of total |
Nov-07 |
% of total |
| AAA/Aaa |
$15,387 |
15.6% |
$14,596 |
20.7% |
| AA/Aa2 |
$33,820 |
34.2% |
$24,419 |
34.7% |
| A/A2 |
$25,291 |
25.6% |
$16,189 |
23.0% |
| BBB/Baa2 |
$9,724 |
9.8% |
$6,558 |
9.3% |
| BB/Ba2 or lower |
$13,354 |
13.5% |
$7,478 |
10.6% |
| Unrated |
$1,236 |
1.3% |
$1,169 |
1.7% |
| Total |
$98,812 |
100.0% |
$70,409 |
100.0% |
- In March 2008, Standard & Poor's affirmed Group Inc.'s credit ratings
but revised its outlook from "stable" to "negative.
On a positive side, the investment banks' has been able to withstand the
current turmoil in the credit market and has been the best performing banks
when looked at mark-to-market writedown of its asset portfolio. I must note
that it is my belief that this immunity to the markdown mania was achieved
by the very risky trading in hedges and opposing positions. This is most
likely what drove up the risk comonent in their economic capital. In 2Q2008,
the writedown in cash instruments and other assets was more than offset by
gains in derivative contracts. It also seems to have one of the lowest exposure
exposure into Alt-A and subprime asset categories.
However, recent change in some of the variables (level 3 assets, VAR, adjusted
leverage ratio) indicate that the bank may be susceptible to slowing capital
market activities and further deterioration in the credit and financial markets.
Needless to say, Goldman has earned itself a full forensic analysis. I will
report back when I have the results.
Well, now its time to revisit Goldman, for they are still significantly overpriced
given the amount of risk they take. Remember, risk is the price for reward
and many investors simply overpay. Those investors who will be paying $120something
per share for the third or fourth equity offerring in 12 months from a company
that is loaded with overleveraged, rapidly devaluing assets in an awful macro
operating environment, that has just been saddled with a significant amount
of new operating restrictions due to their new status as a commercial bank
holding company and the acceptance of TARP, not to mention the fact that this
company is now just essentially a big hedge fund are case in point - paying
$1.50 worth of risk for a $1's worth of reward. It seems cheap when the risk
doesn't come up with snake eyes, but keep rolling those dice...
Goldman Sachs
Group Inc., the sixth-biggest U.S. bank by assets, plans
to raise $5 billion to repay (code words for DILUTE currently beat up shareholders,
many of whom are nursing 50% losses already) U.S. government
rescue funds (Hmmm! Why did you need or even
accept "rescue" funds, not to mention 10% preferred money in a 5% environment
from Buffet! Sounds to me like you needed to be rescued!) after
posting profit that exceeded the most optimistic Wall Street estimates.
The New York-based bank said today it will use proceeds from the common
stock offering plus "additional resources" to redeem the $10 billion it got
from the U.S. Treasury's Troubled Asset Relief Program. [They
are robbing Peter to pay Paul! They cannot afford to pay back the TARP now,
but they are doing it to avoid pay restricitions. Why should the government
even allow it??!!! If you are going to pay back money, pay back Warren Buffet's
money. It is costing Goldman nearly twice what the TARP money is costing,
and the TARP is insisting on cutting compensation costs, which is effectively
making the money even cheaper. I am not a lawyer, but I sense a shareholder
law suit building merit here. It is obvious to me that management is acting
in management's best interest and not the best interest of the shareholder
by failing to adhere to the prudent man rule. I don't want to hear the argument
that they need to retain XYZ talent either. That is the same talent that
had them running, hat in hand to Buffet @ 10% in a 6% environemtn, taking
TARP with the inevitable strings attached, and becoming a commerical bank
on Wall Street at risk of offereing free toasters to open up savings accounts.
Mayhap they may be better off finding a new pool of talent under a new compensation
structure. The old one didn't seem to work out that well. The company hasn't
been public that long, yet would have been driven out of business save the
government's expedition of the bank charter and the TARP funds. Just think
about it!] The company said it earned $1.81 billion, or $3.39 a share,
in the first quarter as a surge in trading revenue [code
worded: our hedge fund operations are practically taking over the entire
company since hedge fund style trading is the only thing that is making money.
I hope nobody looks at the risk/reward metrics that Reggie Middleton is posting
on his Blog. I also hope nobody looks at the valuation given publicly traded
hedge funds, private equity funds and asset managers these days, either]
outweighed asset writedowns, beating the $1.64 estimate of 16 analysts surveyed
by Bloomberg.
Chief Executive Officer Lloyd
Blankfein, 54, is raising capital to shore up finances [really,
'cause when I add up the numbers, it looks like you are raising just barely
enough to pay back the government] and repay government money the
bank got in October after the bankruptcy of Lehman Brothers Holdings Inc.
Goldman Sachs was the most-profitable Wall Street firm before converting
to a bank last year and posting its first quarterly loss since the
company went public in 1999.
"The only toxic thing on their balance sheet is the TARP and they want to
get rid of that as soon as they can," said Gary
Townsend, president of Hill-Townsend Capital LLC. in Chevy Chase, Maryland.
The earnings show "they're taking enormous market share away from virtually
everyone else." [I'll tend to disagree with you
here buddy. The TARP is worth just as much now as when it was issued, actually
probably more with cash dividends. Can you say that about all of the private
equity, MBS, ABS, CDO, leveraged loans, equity, commodity and fixed income
derivatives that GS has on its balance sheet? You should have some salt and
pepper handy for when you are forced to eat those words, buddy! Let's see
if GS will get away with offering the Treasury 50 to 80 cents on the dollar
to pay back the TARP 
]
The company, which changed its fiscal year to end in December instead of
November, also reported results for the month of December today. They showed
the bank lost $780 million, or $2.15 per share, as losses in fixed-income
trading and principal investments overwhelmed revenue from other units. [Uh
huh! Just as I warned above. You keep rolling those dice and you will come
up with snake eyes eventually. This company is just big hedge fund, plain
and simple. See my VAR and RAROC notes above. To think, the multiple that
people are about to pay for this company's stock given the risk that they
are taking to achieve rapidly decreasing and highly unstable profits.
In addition, don't we have a littel earnings arbitrage here, with this spare
month of reporting dangling (with losses big enough to ruin the taste of
desert), it appears that GS has managed to sneak the less than stellar news
past most pundits in the fiscal year switch. How about adding the December
results into the first quarter. Wouldn't that make sense? But then again
the result wouldn't have that accounting shenanigan kick to it, would it?]
Book Value
Book value per share rose to $98.82 at the end of March from $98.68 in November
[well, there's economic (or real) book value then
there's accounting book value, which is just about as real as your local
lobbyist's get well wishes - see my stress test results with FASB fantasy
attachments below or you can see
my FASB Fantasy Instruction Manual], and return on equity, a gauge of
how effectively the firm invests earnings, was 14.3 percent in the first
quarter, the company said.
First-quarter revenue was
$9.43 billion. Fixed-income trading revenue was a record $6.56 billion, 34
percent higher than its previous mark, as client-driven income outweighed
an $800 million loss on commercial mortgage loans, excluding hedges.
Goldman Sachs benefited as the gap between what banks pay to buy fixed-income
securities and the price at which they sell, the so-called bid-ask spread,
almost doubled to 19 basis points in six months, according to data compiled
by Bloomberg. [and what will happen to these earings
if these spreads collapse back to mean levels??? This is not sustainable!]
Equity Trading
Every other business unit had lower revenue compared with the first quarter
of 2008, or reported a loss. [Let me repeat this
line so it sinks in for everybody: "Every other business unit had lower
revenue compared with the first quarter of 2008, or reported a loss." HMMM!
So, spreads blowout in the last six months of trading (out of 10 years of
being a public company) which results in what is apparently a one time (maybe
two or three at the most) gain in profits which is probably backed by some
of the highest VAR and lowest RAROC and any other risk weighted reward metric
available's measure while the rest of the entire company did worse, much
worse or took a loss. Just as I told you in the beginning, Goldman Sachs
is a big, overvalued HEDGE FUND with a big private equity arm. Why don't
you guys look at what valuations similar funds are trading at. Here's some
hints: Man Group, Plc (hey, go ask the Brits), Blackstone (just ask the Chinese),
and Fortress. Now, compare that with what you are about to pay Goldman so
they can pay back their "Rescue" money in order for upper management to recieve
larger bonuses. If investors thought more, or read BoomBustBlog more, I think
they would be a lot wealthier!]
Equity trading revenue was $2.0 billion as slower activity outside the U.S.
meant the firm generated fewer trading commissions than a year ago.
Investment banking revenue of $823 million compared with $1.17 billion in
the first quarter of 2008, reflecting a decline in leveraged finance activity
and fewer mergers and share offerings. [With investment
banking fees being only 13% of trading revenue, no wonder why GS is not calling
itself an investment bank anymore. It is not. It is a trading company with
a small investment banking arm, as is evident from its revenue breakdown.
In other words, its a HEDGE FUND! Yeah, that's righ! I said it again. I wouldn't
bet anything of value that you see it again before you finsih reading this
missive, either!]
Asset management fees slumped 28 percent to $949 million as assets under
management fell 3.3 percent. Securities services, which include the firm's
prime brokerage unit, made $503 million, 30 percent less than the first quarter
of 2008.
Goldman Sachs had a $1.41 billion net loss from principal investments, including
a $151 million loss from the firm's investment in Industrial and Commercial
Bank of China Ltd. [and this was with significantly
added freedom granted by the Fantasy Accounting Standards Boards, aka FASB]
The bank set aside $4.71 billion to pay compensation and benefits, 18 percent
more than the first quarter a year earlier. The expense totaled 50 percent
of revenue, up from 48 percent in the first quarter last year. The number
of employees, which fell 7 percent during the quarter to 27,989, is 12 percent
lower than the first quarter of last year. [Let's
put this into perspective for all of the small business men and womand and
fellow entrepneurs out their who can't understand this pay for no reward
fee structure talk. Goldman has reduced revenues, reduced profits and losses
in every business segment except for the highly risky and highly unpredictable
fixed income trading (that's right, I'm saying it again - HEDGE FUND - business,
and they are paying a Moby (my) Dick, Whopping Whale style, 260% of
thier (only one profitable business unit, that is probably not sustainable)
profit to employees this quarter, after taking a flat out loss last quarter,
and apparently smoothing over the fact that they would have taken a loss
this quarter if they didn't shift the fiscal year by a month and benefit
from the Fantasy Accounting Standards Boards, aka FASB new rules. And on
top of all that, they are issuing $5 billion of common equity to dilute existing
shareholders to pay back the TARP so they can pay out even more in executive
compensation, all the while leaving the much, much more financing in place.
Listen boys and girls - I won't even pay myself 260% of my profit, and I
don't have public shareholders to answer to. Then again, I guess neither
does Goldman since no one is bitching besides me. You guys can talk about
my man Obama all you want, but it appears that his idea of reigning in Wall
Street executive compensation has a whole lot more merit than it is given
credit for. See Obama
Actually Did Wall Street a Favor, The
Wall Street Pay Dilemma Really Shouldn't Be Much of a Dilemma at all! and I
Went to a Fight and a Compensation Committee Meeting Broke Out! - Class,
Compensation & the Street]
Assets Rose
Total assets on Goldman Sachs's balance sheet
rose 5 percent from the end of November to $925 billion as of March 27. Of
that, about $59 billion qualified as "Level 3" assets, which are the hardest
to value, down from $66 billion at the end of November. [Assets
rose, despite the fact that more than 2.6x the retained earnings were paid
out as compensation and nearly all business units declined or took a loss.
I think it's safe to say that leverage increased here fellas. I doubt if
equity cash bougth these assets. Think about it boys and girls, increased
trading activity leads to higher short term profits in an illiquid, spread
blown highly volatile market. This bank grows its balance sheet to take advantage
of it in a leveraged fashion. Can anyone see the risk of a blow up here,
or is it just me?]
Goldman Sachs raised $5.75 billion by selling shares at
$123 apiece in September in an offering that started after the company announced
that Warren
Buffett's Berkshire Hathaway Inc. bought $5 billion in preferred stock.
A month later, Goldman Sachs was among nine financial institutions that
shared $125 billion in the first payments from the Treasury's $700 billion
bailout program.
"A stock sale would be a good thing for the government; it would be a good
thing for Goldman Sachs or any other bank which was able to do it, especially
if they were also able to repay the TARP," said Roy
Smith, a finance professor at New York University's Stern School of Business
and a former partner at Goldman Sachs. [Now there's
an unbiased opinion if I ever heard one!] "They would be free of the
high cost of the dividend paid in after-tax dollars and the other restrictions,
which everybody realizes they would like to get out of." [But
wouldn't they be freer, if they paid off the higher cost Buffet dividends?
As I said, about as unbiased as it can get.]
Rivals Pressure
If Goldman Sachs returns the TARP money, it may pressure other banks to
follow suit or risk appearing dependent on the government, Brad
Hintz, an analyst at Sanford C. Bernstein Co. in New York, said before
today's announcement. [Or they may risk looking
like they are putting the shareholder's interests before management's, but
why mince words?]
"The right thing for government officials to do will be to delay the GS
repayment until a significant group of banks are able to repay simultaneously
under some organized plan," Hintz said. [Actually,
the right thing to do would be to delay all repayments until they can be
made prudently and in the best interests of the shareholders, and not the
interests of management.]
Blankfein said last week at a conference in Washington sponsored by the
Council of Institutional Investors that the U.S. funds Wall
Street firms received wasn't intended to be "permanent capital."
'That Minute'
"The minute that an institution is allowed to return the money and is capable
of returning the money, while still carrying out its obligations and its
role in the capital markets effectively, then it should do it that minute," Blankfein
said. [Hey, you're about as unbiased as that other
Goldman guy, aren't you?]
Goldman Sachs has gained 55
percent this year to close at $130.15 today in New York Stock Exchange composite
trading. The price is more than double the stock's closing low of $52 on
Nov. 20.
Since I ramble a bit in this post, I will put the stress test results in a
follow up post to make the articels a little shorter.
Who am I?