Wednesday, 17 September 2008 01:07

Reggie Middleton on Goldman Sachs Q3 2008

As in Morgan Stanley (The Riskiest Bank on the Street and Reggie Middleton on the Street's Riskiest Bank - Update), Lehman Brothers (Is Lehman a Lying Lemming?), and Bear Stearns (Bear Fight - A most bearish view on Bear Stearns in a bear market and Is this the Breaking of the Bear's Back?), I am
bearish on Goldman as well (
Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street and Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis). They have carried a very high, and in my
opinion, unjustified valuation premium at a time when their business
cycle has passed its nadir and the macro environment is crumbling
around them as they carry a boatload of bad assets.

In 3Q2008
Goldman Sachs net revenues declined 51% to $6,043 mn compared with
$12,334 mn in 3Q2007 as all the segments witnessed steep decline in
their revenues.

Investment banking revenues declined 40%
y-o-y to $1,294 mn from $2,145 mn in 3Q2007. Trading and principal
investments revenues and asset management segment revenues declined 68%
and 8% y-o-y to $2,440 mn and $1,174 mn, respectively in 3Q2008.
Interest income and interest expense reported a decline of 32% and 34%,
respectively to $8,717 mn and $7,562 mn, respectively.

In
line with drop in revenues, compensation expenses declined 51% to
$2,901 mn. As a result the ratio of compensation expenses-to-net revenues
stood flat at 48% in 3Q2008. Non-compensation expenses increased
marginally by 1% to $2,182 mn off higher deprecation and amortization
expenses with ratio of non-compensation expenses-to-net revenues
increasing steeply to 36.1% from 17.5% in 3Q2007
(excpect to see painful cost cutting). Goldman Sachs pre-tax
earnings declined 53% to $5,935 mn form $12,549 mn in 3Q2007.

Overall
Goldman Sachs net income available to common shareholders' declined 47%
to $4,328 mn (or $9.62 per share) from $8,241 mn (or $17.75 per share)
in 3Q2007.

Due to increased volatility Goldman Sachs average
daily VaR increased 30% to $181 mn over previous year
.
I saw this coming last quarter, and it is a strong chance that it will
blow up in thier face. Reference my post about their previous quarter
concerning risk adjusted performance. As it turns out, it was rather
prescient:

Risk vs. Reward is what the successful investor looks at when
gauging an oppurtunity. The Street and the media are just looking at
reward in regards to Goldman Sachs!

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

image002.gif

  • 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: icon Broker VaR Worksheet (634.49 kB 2008-07-05 09:25:24).

Goldman Sachs
level 3 assets to total assets declined marginally to 6.7% of total
assets as of August 2008 as against 6.9% and 7.2% 2Q2008 and 3Q2007,
respectively.

Last modified on Wednesday, 17 September 2008 01:07

5 comments

  • Comment Link Reggie Middleton Wednesday, 17 September 2008 22:30 posted by Reggie Middleton

    I can't give individual answers to questions such as that. It may be perceived as giving advice. I can say that the assumptions in the original analysis from last year were not only extremely conservative, but are now in need of updating considering the recent slate of events.

    Report
  • Comment Link neal thompson Wednesday, 17 September 2008 22:27 posted by neal thompson

    Reggie:

    Regarding GGP. I remember in one of your earlier replies that you said there would be GGP management margin calls when the stock gets to $22.
    Now that the stock is around 20, do you have a suggested valuation so I can decide when to close my puts. Good call on GS. Was sick that I got cold feet around 145 (your suggested valuation though dated) and bailed.

    aloha, neal.

    Report
  • Comment Link J. Bishop Wednesday, 17 September 2008 19:42 posted by J. Bishop

    Reggie,

    Do you think GS is a short to zero, or do you think there's someone out there with the balance sheet to buy them out?

    Report
  • Comment Link Reggie Middleton Wednesday, 17 September 2008 19:36 posted by Reggie Middleton

    I need to move to a stronger server. Should have it up by next week.

    Report
  • Comment Link Johnny Lay Wednesday, 17 September 2008 19:16 posted by Johnny Lay

    reggie i dont know if its jus me or not but i get some kind of error 'overlay' in the menu. cant copy and email bounced....

    message says somethin about '....menu is crashed'
    cheers

    Report
Login to post comments