Wednesday, 27 October 2010 04:18

A Few Questions on Goldman Sachs 3rd Quarter 2010 Results That No One Thought to Ask

"Goldman, unlike the rest of the street and practically the rest of the I banking world, is ratcheting up off balance sheet risk!!! Is BoomBustBlog the only one inquiring as to WHY??? We have a few reasons in mind... And to think, many thought the Enronesque days of off balance sheet "hide the sausage" games have come to an end..." Go through your sell side analyst's quarterly update and if you don't find these tidbits of information thoroughly explained, but instead see a Goldman fan boy(girl) cheering section, come back and subscribe to BoomBustblog. At the very least, we tell it like it is!

My opinion and updated valuation for Goldman and its 3rd quarter performance is available for download to all paying subscribers: File Icon GS 3rd Quarter 2010 Update. While I can't spill the beans on the entire contents of the subscription document, there  are a few issues (as usual) and observations that I would like to make public.

To begin with, I must commend Goldman's management. They do a helluva job massaging numbers and attempting to right their ship, particularly in relation to some other banks. Anecdotally, I'm aware of their losing some talent on the equities side but I am sure they have no problem replacing it. There is also the issue of their subprime servicing unit, Litton Loans, which I am sure will bring them nothing but heartache in the near to medium term, but at least that aspect of the business has been recognized by the sell side, if not under appreciated in terms of potential risk. Despite its small size in relation to Goldman's aggregate operations, it carries with it material reputation risk as well as the prospects for significant litigation and more.

Now, on to the aspects which the sell side decided not to cover - or somehow overlooked. Goldman was applauded for having strong accounting earnings. In Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!, I warned of the danger at looking at accounting earnings as if they were actually a legitimate barometer of a companies actual economic value. If that were the case, wouldn't accountants be the best investors in the world? I will delve into the folly of relying strictly on accounting earnings later on this missive as well, particularly in regards to a company with management as crafty and capable as Goldman - but before I do let's realize that even those accounting earnings were down significantly from previous periods...

Trading revenues under pressure

Goldman Sachs posted Q3 net revenues of $8.9bn, a y-o-y decline of 28%. This is despite strong growth recorded at its investment banking and the asset management division which grew at 24.5% and 7.0%, respectively. The decline was principally led by dismal performance of the trading and principal transaction segment which declined 36% y-o-y as a result of weak market conditions. The decline in overall revenues despite strong growth recorded elsewhere underscores the importance of trading revenues in Goldman Sachs overall performance. Historically, trading and principal transaction segment contributed c60-65% of total revenues underpinning inherent risk in Goldman’s business model which is nothing short of a corporate hedge fund. We have expended considerable ink in demonstrating the overvaluation of Goldman Sachs and the volatility inherent in its revenues, particularly as they have been so dependent on trading - as many hedge funds are. As a matter of fact, I have been issuing this GS warning since 2009 when Goldman had perfect trading quarter and record trading profits. Reference last quarter's quarterly update: The BoomBustBlog Review of Goldman Sach’s 2nd Quarter, 2010 Performance: I Told You So!

About three months ago, Boombustblog forewarned that GS will stand out to be the worst hit in the event of trend reversal in the financial markets and the company will have little means to escape the implications of the same on its profitability and solvency. The company generates 60-70% of the revenues from trading activities which is largely dictated by the unpredictable turn of financial events. While the financial markets were celebrating the US officially coming out of recession in the 1Q10, the subsequent Eurozone crisis (see the Pan-European Sovereign Debt Crisis series) and the slowdown of expectations in 2Q10 has beaten down the irrational exuberance and the markets experienced spurt in volatility and drop in prices. The consequent softening of trading revenues in 2Q10 vis-à-vis 1Q10 drove 31% drop in revenues and 82% drop in net income.

The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!

Given the regulatory pressures pertaining to banks’ prop trading as a result of Dodd-Frank regulation and the Volker rule, Goldman Sachs is shrinking its propriety trading business. Recently, Goldman Sachs closed its proprietary trading desk in New York with Kohlberg Kravis Roberts (KKR) hiring nine traders from Goldman Sachs. With the egression of prop trading, GS would definitely lose some of its charm (premium multiples) and more fundamentally speaking the impact of bottom-line would be material considering the dependence of prop trading on the bank’s aggregate results. According to Bloomberg, it is estimated that nearly 10% of total revenues are derived from proprietary trading.

Goldman, unlike the rest of the street and practically the rest of the I banking world, is ratcheting up off balance sheet risk!!! Why is BoomBustBlog the only one inquiring as to WHY??? We have a few reasons in mind... And to think, many thought the Enronesque days of off balance sheet "hide the sausage" games have come to an end...

Although, Goldman Sachs capital ratios have improved it has nothing to do with reduction in risks weighted assets. Risk weighted assets to the corollary have increased to $444bn as at end Sep 2010 from $409bn and $380bn as at end Sep 2009 and end Sep 2008. One of the key reasons for the increase in capital ratios have been dilutions. To give a perspective, Goldman Sachs diluted shares outstanding have increased by c25% since beginning of 2008.

Click to expand...

 

 

VIE loss exposure still increased compared to pre-crisis levels

Maximum loss exposure from unconsolidated VIE has increased compared to pre-crisis levels. Although loss exposure as proportion of VIE assets have declined due to dramatic increase in off-balance sheet assets, absolute loss exposure has actually increased. In addition, we are also concerned about dramatic increase in GS’ VIE assets during a time when companies globally are talking about de-leveraging. Goldman Sach’s VIE assets have increased to $110 billion as of June 30, 2010 from $67bn as of December 31, 2009 while maximum loss exposure from unconsolidated VIE have increased to $18.5bn as of June 30, 2010 from $18.1bn as of December 31, 2009. Maximum loss exposure from unconsolidated VIE as proportion of tangible equity was 30% as of June 30, 2010, a marginal decline over Dec 2009 due to an increase in shareholders’ equity.

Is Goldman Ratcheting Up Its Risk Profile In and Attempt To Recoup the Nearly Guaranteed Loss of  Bonus Earning Power of FICC and the Prop Desk??? If So, the Equity Owners Will Be the Bag Holders (Again) If the Shit Hits the Fan (Again)...

As excerpted from Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!"

...accountants have not been – and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit. Hence we hear much about easily manipulable and manageable accounting earnings, revenues, operating margins, earnings per share, etc. These measures are highly flawed in a variety of ways, with the primary flaw being that they do not account for the efforts both required and undertaken to achieve them. Basically, they measure JUST HALF (and coincidentally, the positive half may I add) of the risk/reward equation that should be at the root of every investors move. Long story short, they do not account for, nor do they EVEN RESPECT, the cost of capital. This concept ties in closely with Chairman Bernanke’s current course of action as well as the ZIRP discussion later on this missive demonstrates (capital offered at zero cost causes reckless abandonment of risk management principles which eventually causes crashes – yes, more crashes). Acknowledgment of the cost of capital enforces a certain discipline on both corporate management and investors/traders. Without respect for such, it is much too easy to create and portray a scenario that is all too rosy, since we are only looking at rewards but never bother to glance at the risks taken to achieve said rewards. I reviewed this concept in detail as it relates to bonuses and compensation on Wall Street in The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma.

Net revenues, net profits, and earnings per share are totally oblivious to what took to generate them. As a result, anyone who adheres solely to these metrics is probably oblivious as well to what it takes to generate these measures. It’s really simple, put more money into the machine to get more money out – damn the risks taken, or the cost of the monies used. This has been the bane of Wall Street for well over a decade, is the direct and sole reason for this current crisis, and is the reason why bonuses based upon revenue generation alone engender systemic risk. Just sell more, do more, to get a bigger bonus. It doesn’t matter what you sell or who you sell it to, as long as it blows up AFTER the bonus is paid. This short term-ism is now so deeply ingrained within the investor psyche as to allow companies’ to rampantly destroy economic shareholder value with the abject blessing of the shareholders, with cheer leading by the analysts – as long as those accounting earnings per share keep rolling in higher and higher!

Ignoring the cost of capital inflates returns by default, because those returns were never costed in the first place. The problem is, ignoring something does not make it go away. Capital does have a cost whether you acknowledge it or not, and if you ignore that cost you may skate for awhile but eventually it will come back to reassert itself, and often with a vengeance towards the wayward investor.

This material tilting of the risk/reward equation would be obvious to most and many, if they would look at the true economic numbers and stop following accounting numbers!

In What Do Goldman Sachs and B.B. King Have in Common? The Thrill is Gone…,, I made the following note:

GS’s considerable leverage provides a means (the lever) of high returns to shareholders when asset prices are appreciating but the same becomes a very material economic concern when the asset prices lose value. With low trading revenues, GS has little cushion to absorb write-downs on these assets, leading to erosion of equity. As of March, 2010, the GS’s investments portfolio amounted to $339 billion (nearly 566% of the tangible equity). Referencing my previous posts, “Can You Believe There Are Still Analysts Arguing How Undervalued Goldman Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a Look” and “When the Patina Fades… The Rise and Fall of Goldman Sachs???“, we can reminisce over the fact that Goldman BARELY earns its cost of capital on an economic basis, and that’s before considering the potential horrors which may (and probably do) lay on the balance sheet (for more on BS horror, referenceReggie Middleton vs Goldman Sachs, Round 2) .


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Recommended recent reading from Reggie Middleton's BoomBustBlog in the investment banking space...

  1. Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?
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  3. JP Morgan’s 3rd Quarter Earnigns Analysis and a Chronological Reminder of Just How Wrong Brand Name Banks, Analysts, CEOs & Pundits Can Be When They Say XYZ Bank Can Never Go Out of Business!!!
  4. Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!
  5. We’ve Been Bamboozled by the Banking Industry, but the Chickens Are Coming Home to Roost
  6. The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!
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  8. As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves
  9. The Truth Goes Viral, Part 2: Italian Towns Damaged by Derivatives, Downtown Brooklyn Real Estate, Goldman Sachs, JP Morgan, Europe’s Overbanked Status, Reggie Middleton, Matt Taibbi, and Simon Johnson – All in One Video
  10. Re: Morgan Stanley’s Q2 2010 Results – The Mainstream Media May Be Hazadous to Your Wealth!

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Posts Tagged ‘Investment Banks’

Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

Friday, October 15th, 2010 by Reggie Middleton

Summary: Bloomberg features what they consider to be the most successful and accurate financial analysts since 2008. Of course, the firm that “Does God’s work” is the one that won! Reggie Middleton disagrees, and thinks a blog beat them all! I urge the mainstream media to look beyond the traditional banking centers of influence for analysis. Not only is it soooo old school in a new digital age, but they just might find comparable (of not superior) talent in the blogosphere.

I urge the mainstream media to take a look at more than just the traditional sources when they make these all star rankings…

Bloomberg Regports: Goldman No. 1 at Rating Financial Companies With 38% Right

Daniel Harris, a financial services analyst at Goldman Sachs

Daniel Harris, a financial services analyst at Goldman Sachs Group Inc. [Clean cut, meticulous, ivy league, cookie cutter Goldmanite, Hamptoms in the summer, straight out of the Wall Street handbook - I get it]

… Goldman Sachs and KBW did better than most at figuring out where markets were headed. Goldman is No. 1 and KBW No. 2 in the Bloomberg Markets ranking of the world’s best financial sector research firms. Goldman’s Harris is one of the top three analysts of financial service firms, according to data compiled by Bloomberg.

2,500 Analysts [but no bloggers, which is exactly where this story went awry, IMHO :-) ]

The ranking is based on stock recommendations made by more than 2,500 analysts worldwide at 77 research firms and investment banks from January 2008 to July 2010. It looks at the analysts’ “buy,” “hold” and “sell” calls on shares of 90 of the largest banks, diversified financial service companies and insurers in the U.S., Europe and Asia with at least 20 analysts covering them.

Even the best of the firms and individual stock pickers failed to accurately predict the fall and rise of most big financial stocks. Goldman Sachs’s analysts won their No. 1 rank by making 30 accurate calls on the 79 financial stocks they follow, or 38 percent, while KBW’s No. 2 post was based on 27 prescient calls on 78 stocks.

… “It was a very difficult climate to make stock recommendations in,” says S.P. Kothari, a professor of management and deputy dean at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge. “First, you had to predict the downfall of the financial sector in 2008, which only very few people did. Then, you had to change your outlook to catch the recovery — all within a relatively short period of time.” [So true, at least sort of. The problem was not about changing your outlook, it was about going against the fundamentals to catch manipulated stock price action to capture bank stocks as they shot to the upside in an environment where they were doomed to simply crash back down. Of course, I don't really expect to hear a lot of that in the MSM, but it does peek its nose out every now and then]

Looking for Ideas… Jason Brady, a managing director at Santa Fe, New Mexico- based Thornburg Investment Management, which oversees about $56 billion, says he doesn’t read analyst reports for picks on individual stocks. “It’s unusual to see original thinking in these reports, even though that’s what’s most valuable to me,” he says. “The ones who are different aren’t always right, but they’re frequently the most interesting and thoughtful.” [May I suggest you subscribe to BoomBustBlog, I am the antithesis of the sell side, and have nothing but crazy ideas - that is until a year  has gone past, and people say "hmmmm..."]

Yeah, I bet these guys get paid an awful lot of money for that as well. I hope Bloomberg’s editors dont’ forget us poor bloggers in the future comparisons. Uhh…. Not that I’m hating or anything (I definitely want to give these Goldman dudes credit where their due), but I think I may have just BLOWN THESE GUYS OUT OF WATER with damn near zero recognition. Come on mainstream media, it’s a new day and age and you should know by now there are other places to look for analysis other than the big banks that “Do God’s work”! Give the little man some luv! You know times are hard when you get featured as the best of the best with only a 38% success rate! Then again, and admittedly, these last few years were very hard – all jokes aside. Let me recast this Bloomberg article in BoomBust fashion.

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The Truth Goes Viral, Part 2: Italian Towns Damaged by Derivatives, Downtown Brooklyn Real Estate, Goldman Sachs, JP Morgan, Europe’s Overbanked Status, Reggie Middleton, Matt Taibbi, and Simon Johnson – All in One Video

Tuesday, October 5th, 2010 by Reggie Middleton

I present to you a very well made 45 minute documentary on big banks, derivatives, US real estate and the root causes of the Pan-European Sovereign Debt Crisis! Yes, it covers a lot, and it also has a list of colorful and insightful characters sharing their insights.

This is a viral video that hasn’t made a lot of leeway in the states yet (it was just released yesterday), but is going viral in (of all places) Amsterdam and the Netherlands – the birth place of irrational exuberance with $30,000 Dutch Tulips selling at a bargain…  Because it was different that time! Click here for the video: The Attack on Europe: Debt and Redemption, produced by VPRO Backlight and aired on BBC2. For those who aren’t fluent in Italian and Dutch, I have provided breakpoints that are in English for you to skip to:

  • 7:22 Matt Taibbi on IR swaps, big banks and small Italian towns (for those of you who don’t know, Matt Taibbi wrote that scathing piece in Rolling Stone on Goldman Sachs – The Great American Bubble Machine | Rolling Stone Politics
  • 10:32 More Matt Taibbi on derivative products
  • 27:10 to hear Matt Taibbi, Goldmans Sachs’ biggest fan (what would you guys think of a Matt Taibbi/Reggie Middleton collaboration?)
  • 28:40 Simon Johnson, former  Economic Counsellor and Director of the Research Department at the IMF, called for European boycott of Goldman Sachs (Simon Johnson — Biographical Information – IMF
  • 30:30 Matt Taibbi
  • 31:29 Simon and Matt
  • 31:46  to 37:43 Yours truly, Reggie Middleton in Downtown Brooklyn on the banks and the truly distressed sovereigns. It resumes at 38:15, but you should watch it through to get the feel for the subject matter at hand. By the, the discussion on derivatives here gets quite interesting, be sure to view the whole piece.
  • 46:35 resumes in English with some basic, common sense advice

I have made available below a lot of background info on Goldmans Sachs, JP Morgan, and the sovereigns in question. I will do a walk through of a European soverign nation’s practically guaranteed default in a few days, publicly on the blog, in full detail – complete with facts and numbers, the stuff you don’t see very often in the mainstream media. I will also attempt to update my big bank research and findings with data from the ground and independent sources in time for earnings. The banks have no more than one quarter left before the truth catches up with them… Then, we are back to 2008.

Read the rest of this entry »

JP Morgan Aids in the (Fraudulent???) Sale of Restricted Stock and Insider Stock Sales

Tuesday, July 27th, 2010 by Reggie Middleton

I’ve been harping on banks a lot lately, so why give up a good thing. Next up, we have a “how to” manual for JP Morgan private bank salespersons to assist wealthy executives in insider trading and the liquidation and/or monetization of restricted stock. You see, this gets sticky because it very well may be against the law to put a hedging position on your restricted stock portfolio based upon non-public information. As a matter of fact, I’m pretty sure it is against the law. This is how JP Morgan presents it…

Read the rest of this entry »

Re: Morgan Stanley’s Q2 2010 Results – The Mainstream Media May Be Hazadous to Your Wealth!

Thursday, July 22nd, 2010 by Reggie Middleton

The mainstream media has gone Ga Ga over Morgan Stanley’s latest results. Just take a look…

The Wall Street Journal Blog: Morgan Stanley Earnings: Sticking It to Goldman Sachs

Morgan Stanley, which beat earnings analyst expectations by posting better trading revenue than its rivals. While Goldman Sachs Group and J.P. Morgan Chase took hits to their trading books, Morgan Stanley’s trading revenue doubled to $3.1 billion from a year ago. What was the secret?

Well, apparently the secret was to get your ass handed to you in the previous comparable period while simultaneously under performing your peers, then turn in a simply below mediocre performance the next reporting period and you will receive accolades from the mainstream media. After all, who cares about those [BoomBust]Blogs who actually bother to read into the results.

The International Business Journal: Morgan Stanley earnings surge, credits trading revenues to DVA

On the revenues side, results in its three divisions were much improved from last year but slightly worse than last quarter. Net revenues in Global Wealth Management were impressive, coming in at $3.07 billion, compared to $1.92 billion last year and $3.1 billion last quarter.

Like rival Goldman Sachs (NYSE:GS), Morgan Stanley saw lower underwriting revenues from last quarter and last year, reflecting the difficult environment for investment banking. However, unlike Goldman, Morgan Stanley’s trading revenues were strong, coming in at $3.3 billion, up 93 percent from last year and down 11 percent from last quarter.

I don’t even think these guys bothered to read the results at all. They are comparing revenues pre-multi billion dollar acquisition with the post acquisition entity. Hey, I can double my revenues if I purchased a company that had 3x my revenues too! This is just sloppy! Yet, these euphoric headlines were all over the place as MS stock climbs nearly 10%. Yes, MS did relatively better than GS, but GS is a federally insured hedge fund (that’s right, I said it), and we all know how most hedge funds do in times of volatility and declining prices. Well, I hate to rain on the positive earnings parade, but a couple of my subscribers have requested the truth be told!

Reggie’s Take:

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The BoomBustBlog Review of Goldman Sach’s 2nd Quarter, 2010 Performance: I Told You So!

Thursday, July 22nd, 2010 by Reggie Middleton

About three months ago, Boombustblog forewarned that GS will stand out to be the worst hit in the event of trend reversal in the financial markets and the company will have little means to escape the implications of the same on its profitability and solvency. The company generates 60-70% of the revenues from trading activities which is largely dictated by the unpredictable turn of financial events. While the financial markets were celebrating the US officially coming out of recession in the 1Q10, the subsequent Eurozone crisis (see the Pan-European Sovereign Debt Crisis series) and the slowdown of expectations in 2Q10 has beaten down the irrational exuberance and the markets experienced spurt in volatility and drop in prices. The consequent softening of trading revenues in 2Q10 vis-à-vis 1Q10 drove 31% drop in revenues and 82% drop in net income.

The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!

Last modified on Friday, 12 August 2011 07:20

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