Using Veritas to Construct the "Per…

29-04-2017 Hits:86460 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

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The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:80573 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

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What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:80397 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

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Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:84881 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

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This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:81415 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

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What is the Value Proposition For Verita…

01-04-2017 Hits:83607 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

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This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:54648 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

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Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:82798 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

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Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:82596 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

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The Country's First Newly Elected Lame D…

27-03-2017 Hits:82476 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

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Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:88627 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

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The Transformation of Television in Amer…

21-03-2017 Hits:86419 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

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This is your daily dose of the Goldman Sachs Stress Test Scenario Analysis, Professional edition. I will be releasing the Stress Tests for Wells Fargo, PNC, Sun Trust, Morgan Stanley and the top secret asset managers, insurers, and banks whose identity are for subscribers eyes only over the next day or two (or three - or as fast as I can get them out). Since the subscriber content pipeline is so rich, I have decided to let out excerpts from the Goldman report in dribs and drabs. I will do so until the mainstream media catches the hint: Goldman's Doo Doo smells no sweeter than anyone else's on the Street. As a matter of fact, I find it to have a particularly more intense, pungent odor.

What you don't know can collapse you! A primer on what lurks off the balance sheet...

Goldman Sachs is a very large, very diverse financial operation (although it appears that the vast majority of revenues and profits are emanating primarily from trading operations, hence it is essentially an overpriced public traded hedge fund). A very significant amount of Goldman's assets and operations are not privvy to the average investor or the capricious analysts. How significant an amount, you ask? How about to the tune of US$16 to US$58+ billion. I am getting ahead of myself though. In order to increase implied leverage and minimize collateral and reserve requirements, many entities carry much of their risk off of their balance sheet through vehicles called Variable Interest Entities (VIEs). Why are they doing this? Well, because they can. How are they doing this? Well, let's reference my favorite (okay second favorite - BoomBustBlog carries a bias) open source info hub, Wikipedia: A Variable Interest Entity (VIE) is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity (the investee) in which the investor holds a controlling interest which is not based on the majority of voting rights. It is closely related to the concept Special Purpose Entity. The importance of identifying a VIE is that companies need to consolidate such entities if it is the primary beneficiary of the VIE.

Criteria

A VIE is an entity meeting one of the following three criteria as elaborated in paragraph 5 of FIN46:

  1. The equity-at-risk is not sufficient to support the entity's activities (e.g.: the entity is thinly capitalized, the group of equity holders possess no substantive voting rights, etc.);
  2. As a group, the equity-at-risk holders cannot control the entity; or
  3. The economics do not coincide with the voting interests (commonly known as the "anti-abuse rule").
  4. External links

But "Wait", you may proclaim! "I never see these off balance sheet entities consolidated, measured, quantified, or even mentioned in my brokerage reports, SEC reports, or by may investment advisor or asset manager." Don't worry, don't fret, your brother from another mother has come to your rescue. 

Goldman Sachs Unconsolidated Varaible Interest Entities  ($ mn)30-Nov-08 (last quarter)
  VIE Assets Maximum Exposure to Loss in Nonconsolidated VIEs
    Purchased and retained interests Commitments and Guarantees Derivatives Loans and investments Total  
Mortgage CDOs 13,061 242 0 5,616 0 5,858  
Corporate CDOs and CLOs 8,584 161 0 918 0 1,079  
Real estate, credit-related and other investing 26,898 0 143 0 3,223 3,366  
Municipal bond securitizations 111 0 111 0 0 111  
Other mortgage-backed 0 0 0 0 0 0  
Other asset-backed 4,355 0 0 1,084 0 1,084  
Power-related 844 0 37 0 213 250  
Principal-protected notes 4,516 0 0 4,353 0 4,353  
 Total 58,369 403 291 11,971 3,436 16,101  
               
Base case            27.6%  
           
 

Remember in my last article (Who is the new Riskiest Bank on the Street?) I made clear that leverage can come in more forms than mere plain vanilla loans, hence we include derivatives, commitments and guarantees as well as loans and investments in the mix of exposure. This means that although these assets are held off of Goldman's balance sheet, they are still on the hook as a derivative counterparty, lender (direct or contingent), or a provider of a commitment or a guarantee. These risks are direct and real and rightfully should be reflected in the balance sheet and not the footnotes of a 60 page document.

How real are these risks, you ask (Yeah, I heard you ask that right through your screen)? Well, let's attempt to run through them... 

Unconsolidated VIE's  ($ mn) VIE assets Maximum loss exposure Maximum loss as % of assets Default assumptions Recovery rates Net losses (in  $ mn)  
Mortgage CDOs 13,061 5,858 45% 13% 70.0% 527 <-Recoveries stated here are very optimistic
Corporate CDOs and CLOs 8,584 1,079 13% 4% 90.0% 32  Losses and recoveries here may surprise to the downside, but I'll be conservative
Real estate, credit-related and other investing 26,898 3,366 13% 4% 50.0% 505  <- Manna from heaven if they get this!
Municipal bond securitizations 111 111 100% 30% 100.0% 0  
Other mortgage-backed 0 0 0% 0% 0.0% 0  
Other asset-backed 4,355 1,084 25% 7% 50.0% 163  
Power-related 844 250 30% 9% 70.0% 23  
Principal-protected notes 4,516 4,353 96% 29% 80.0% 261  
Total 58,369 16,101 27.6%                  1,511  
Total VIE loss (after tax)                        1,058  
               
% Loss on total VIE exposure 2.6%  Be aware that this is off of a US$58 billion base.
   

Now, keep in mind the reason for GS to hold all of this stuff off  

gs_stress_test_cover.jpg
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balance sheet. They pull revenues and profits from these assets while denouncing ownership and attempting to trivialize liability. It's almost as if it were financial engineering magic! Nothing goes in, and just profit pops back out (well, if you read my last report, this would be viewed very differently from a risk adjusted reward perspective, but for now, feeble investors are sated with simple, manipulable accounting earnings).

What's that? Speak up. Yes, you in the background! You know I can read your thoughts through my keyboard. It was a good question. That smart guy inquired, "If Goldman is allowed to carry on operations off balance sheet and the corporate entity collateral and reserve requirements are based off of what was on the balance sheet, then doesn't this allow Goldman to cheat the system? Doesn't this mean that we really don't know what Goldman's real leverage ratio is since there are no leverage numbers for the VIE's?"

Ya' Damn skippy my intellectual blog pundit! 

As a matter of fact, the use of off balance vehicles make literally impossible to accurately determine the leverage used by entities such as Goldman Sachs. One thing we can be relatively sure of, though. The actual leverage is greater than the leverage stated by Goldman. 

The vast majority of the assets held in VIEs are most likely level 3 assets, and it is a very safe bet to assume excessive leverage was used in financing these assets. Once you adjust for the bullsh1t normally identified as equity in an effort to placate investors and regulators, you will find that you get an adjusted leverage ratio that is much higher than most would consider prudent.

Let's walk though this process in the table below then look at some pretty graphs to bring the point home.

 

Bank

Level 3 Assets

Total Assets

Shareholders Equity

Adjusted Shareholder Equity

Adjusted Leverage

Level 3 Assets-to-Total Assets

Level 3 Assets to Equity

Level 3 Assets-to-Adjusted Equity

 

Goldman Sachs

$78

$1,088

$45

$40

27.4

7.2%

174%

198%

Lehman Brothers

$41

$639

$26

$22

28.7

6.5%

157%

186%

  As you can see, Goldman Sachs has a higher Level 3 assets to adjusted equity ratio than Lehman Brothers, and Lehman Brothers was bad enough to drive them out of business. 

level_3_assets.png

 When comparing the top investment banks, Goldman has - by far - the greatest gross and net exposure to off balance sheet risk. As a matter of fact, it is so great that I will have to dedicate a whole other article to it and Goldman's level 3 exposure. 

vie_exposure.png

  We will go over Goldman's level 3 exposure in detail tomorrow. For now, I need to work on getting the updated PNC stress test out.

Must read, related content:

  1. The Official Reggie Middleton Bank Stress Tests
  2. GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months
  3. For those that attempt to argue that short sellers are bad for the market, I bring you GGP! 
  4. More on the Goldmans Sachs - GGP Connection
  5. Who is the Newest Riskiest Bank on the Street?