Financial, Real Estate, Stock Markets Trends and Current Affairs

There has been a lot of chatter in the comment sections regarding how I have been wrong regarding my research for the last 6 weeks or so. These comments seem to be totally disregarding the last two years of outperformance! These comments also are short sighted and apparently unaware if how bear market rallies work.

This is not to say that I am not necessarily wrong, or could not be wrong, it is just that it is absolutely impossible to condemn or vindicate a medium or long term opinion in a 6 week period! I don't trade stocks, I invest in corporate and global macro opportunities, often through the stock and derivatives market. There is a very big difference! I also don't offer investment advice or trading recommendations. I do offer insight into my own investment style and research. I can't control or predict stock markets, prices or short term movements. Trying to predict such will simply cause me (and most likely anyone else who tries to do so) to underperform. I invite all to learn more about my proprietary investment style, see "The Great Global Macro Experiment, Revisited". In reading this, you will see that one cannot take advantage of the longer term fluctuations therein and predict short term price movements (at least consistently), simultaneously. I also invite readers to remain cognizant that the since inception modeled return of this blog's research should still be above 70%, and probably approaching 100% (I haven't crunched the numbers recently so can't give you an exact number) - see BoomBustBlog Performance, year to date. Granted this was done in March at the market lows, thus should be somewhere around 30% off, but hopefully you get the point.

The historical perspective

The following is a retail subscriber summary of the stress test that I planned to release, unedited. I will wait until after I incorporate the most recent data before I release the full pro version. There are no real surprises, though.

MS Stess Test Model Assumptions and Stress Test Valuation 2009-04-22 07:55:17 339.99 Kb

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

• http://www.vinodkothari.com/fin46vk.htm
• http://www.bloomberg.com/apps/news?pid=20601103&sid=aFTh5VXP9m0U&refer=news
• http://www.ft.com/cms/s/0/b7e7876a-e564-11dc-9334-0000779fd2ac.html

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.

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...

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

gs_stress_test_cover.jpg

Subscribe Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages

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.

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?

I urge all subscribers to download the appropriate document, read it thoroughly and participate in the private discussion forums below:

Retail Subscriber Forum

Professional Subscriber Forum

Institutional Subscriber Forum

pnc_stress_test_cover.jpg

Download the reports here below. The update reflects a summary which explains, in detail, the assumptions behind the modeling and an updated book valuation engine.

PNC Stress Test update - Retail 2009-04-21 15:53:52 777.50 Kb - 9 pages
PNC Stress Test update - Professional 2009-04-21 15:55:56 3.00 Kb - 59 pages

Contents of the professional edition:

Summary 2
Key assumptions 2
Valuation 4
PNC Financial Core valuation 4
Valuation of PNC’s interest in Blackrock 5
Computation of moving average multiple 5
The Scenario Analysis 7
Relative Value: Sum of the Parts 11
Blackrock Multiple Summary 12
PNC Multiple Summary 13
Securities Available for Sale 14
Net Interest Income 15
Interest Bearing Liabilities 17
Non-interest Income 19
Off Balance Sheet Items 25
Business Segments 25
Retail Banking 27
Corporate and Institutional 32
PFPC 34
The BlackRock Investment 36
Loan Portfolio 45
Securities Available for Sale 48
Regulatory Ratios 49
Charge-offs and Delinquencies 50
FDIC Supporting Data, Tables, Charts and Graphs 56

Okay, this is going to be a quick and dirty review of Goldman's derivative real estate and off balance sheet real estate exposure as is probably reflected through their credit exposure as well.

Now, why would Goldman's OTC Credit Exposure be increasing and deteriorating even as it has taken expensive emergency money from Warren Buffet and strings attached TARP funds it is trying to pass on like a itchy veneral disease? You would think they would be trying to get rid of this stuff versus stuffing the balance sheet with it.

Hmmm! 16% of Goldman's equity is in Alt-A and subprime assets. Alt-a doesn't look to good. Read this article thoroughly (The banking backdrop for 2009 ), then let's move on - or we can just glance at this chart.

Click image to enlarge

recast.jpg

The problem ahead: According to Fitch, of the nearly $200 bn of option ARMs outstanding, roughly $29 bn of loans are expected to recast by 2009. Of this $6.6 bn constitute 2004 vintage (that would be recast as a result of completion of the end of five-year term in 2009) and $23 bn constitute 2005 and 2006 vintage loans that would recast early due to the 110% balance cap limit.

Further an additional $67 bn is expected to recast in 2010 of which $37 bn belong to 2005 vintage (that would be recast as a result of completion of the end of five-year term in 2010) and the balance $30 bn consist of 2006 and 2007 vintage loans that would be recast early due to the 110% balance limit cap.

The potential average payment increase on the loans recast is 63%, representing an additional $1,053 due each month on top of the current average payment of $1,672. These large payment increases could cause delinquencies to increase, and increase dramatically, after the recast. The fact that only 65% of borrowers have elected (or are able) to make only minimum payments underscores the magnitude of the potential problem. The potential payment shock combined with the continuous deteriorating outlook for home prices and lack of refinancing opportunities could be a negative cause of concern for investors in Option ARM securities. Even more ominous, is pall cast upon the banks that hold these assets and are additionally exposed to other forms of consumer credit, ie. HELOCs, credit card debt and other unsecured loans (remember the links from the Asset Securitization Crisis above).

Well, let's take a look at the composition of their other exposures...

This is the "other exposure" not included in VaR table. Notice which category has the largest change...

Hmmmm! Their biggest non-VaR risk is real estate, primarily commercial real estate, but they have plenty of other juicy stuff as well. Let's bring back those two graphs from the previous article:

gscre.png

Reference the CMBS exposure that Goldman has above (at no less than 14x leverage), then reference this chart directly below.

image004.png

Damn, that really looks like its going to hurt! Now, let's move on to the Off Balance Sheet Assets for the last quarter of 2008.

Q4-08

Hmmmm! $40 billion dollars in real estate related assets and nearly $9 billion in loss exposure, and that's JUST THE OFF BALANCE SHEET EDITION!This begs the question. If they have this much exposure off balance sheet, how much do they have on balance sheet? Well, let's take a look-see...

Now, if any of you are paying attention, you should be agasp in your chair. Why in the hell does Goldman carry more real estate assets exposure off balance sheet than on. Well, just take a look at those pretty graphs above. The answer is self-evident! Then there is also the spate of current events that are bound to make those commercial real estate credits worth a mint... Such as the nation's second largest Commercial property owner filing bankruptcy last week (as I made clear that they would fold in some form or fashion in 2007 - GGP and the type of investigative analysis you will not get from your brokerage house).

Long story short, if you are bullish on commercial real estate and CLOs, then you may want to be bullish on Goldman. However, if you foresee any real estate problems, then this heavily laden, heavily valued, publicly traded fixed income and real estate hedge fund may not be seeing the best of days in the near to medium term!

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?
6. Warning: "What you don't report in your balance sheet can screw the average investor"!

Below are the results of my updated, proprietary GS model loosely based on the US government stress tests gs_stress_test_cover.jpg(albeit adjusted for reality via assumptions). The professional version is 132 pages of facts, figures and calculations. There is very little wording, so it is primarily for those who need to dig into the figures and don't have the manpower or expertise to go through the thousands of pages of reporting, particularly as it is now couched in accounting shenanigans.

Similar to the regional bank, asset manager and reinsurer stress tests soon to be released (in the next day or two, seriously), we have created 3 scenarios with RGE Monitor's estimates as the base case, The Fed's base line assumption as optimistic case and a distressed scenario. The Fed's baseline assumptions are on an average higher than RGE's estimates by a factor of 1.33x while under the adverse case the macroeconomic assumptions are lower by a factor of 0.80x.

In addition to these three scenarios we have segregated accounting losses and economic losses since the new FASB guidelines gives more leeway to management regarding valuation of securities. This is a very big deal. I doubt there is such a report available anywhere on te net, and one has to wonder if even the government has access to such a high level of analysis. One tends to doubt that they do, considering the level of predictive ability demonstrated thus far.

Please take note of the new method of calculating the book value which should take some of the confusion out of fluctuating results that stem from the unprecedented market volatility over the last few quarters.

Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages

Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages

The completed table of contents:

Goldman Sachs 1Q09 results. 2

Summary. 4

Key assumptions. 4

GS' core business, Investment banking division, is
expected to continue with its dismay performance in 2009. 5

Higher revenues from FICC is not expected to sustain
going forward. 5

Plunging asset values and decline in AUM fee to impact
asset management revenues 6

Investment write-downs. 6

Valuation.. 7

The Stress Test Results. 10

VAR and Risk Data. 10

Comparative Var Analysis. 12

CMBS Pressure Points and Other Risk Factors Not
Reflect in VaR.. 16

Economic Writedowns. 20

Future Value of Assets (economic) 23

Future Value of Liabilities (economic) 32

Financial liabilities at fair value. 38

Movement in Level 3 Financial Assets and Financial
Liabilities ($ mn) 44

Writedowns (accounting) 48

Future Value of Assets (accounting) 50

Financial Liabilities at Fair Value (accounting) 60

Movement in Level 3 Financial Assets and Financial
Liabilities ($ mn) (accounting) 69

SFAS 157 and SFAS 159. 74

Debt Maturity. 76

Level Three Comparison.. 76

Level 2, Level 3, CDOs and Related Assets. 81

Revenue, Expense and Off Balance Sheet Loss
Assumptions. 84

Relative Book Valuation.. 85

Financial Projections. 88

Income Drivers. 92

Key Ratios. 97

Unconsolidated Variable Interest Entity (VIE) Exposure. 99

Scenario Analysis. 103

Disclaimer 115

I encourage subscribers to discuss these documents and their own independent findings in detail in the private subscriber forums. I have had a rash of hedge fund managers sign up recently. This is a good time to put the brain trust to work!

• Retail Subscriber Forum
• Professional Subscriber Forum
• Institutional Subscriber Forum

Next on tap is the recast of the PNC Stress Test (with the new book value calculations and assumptions), Wells Fargo Stress test with the bifurcation of accounting and economic earnings (I will create two separate sets of books, just like WFC did!), and Morgan Stanley's Stress Test, as well as all of the other relevant research subjects I have covered that can benefit from the stress test, time and resources permitting.

Early in 2008 I named Morgan Stanley the "The Riskiest Bank on the Street" (see historical links at the bottom of this article). Well, now its time to update my opinion. Who deserves the title "The Riskiest Bank on the Street" now? Well, let's see what the market says...

As defined by Wikipedia: Cost of Captial - Capital (money) used for funding a business should earn returns for the capital providers who risk their capital. For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. In other words, the risk-adjusted return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital.

This means that one should not simply glance at accounting earnings and declare all is clear on the western front. Whatever return your company generates has to exceed the cost of investing in said company. Well, of the bulge bracket, who has the highest cost of capital? Who has the highest bar? Who does the Street see as the Riskiest Bank on the Street?

cost_of_capital.png

Well it seems as if the company that had the highest cost of capital apparently had enough risk to actually implode. Is there a pattern here? If so, I must be the only one that recognizes it because the current number one spot (the graphed number one spot already collapsed) traded over $130 per share last week.

For those that don't believe in Cost of Capital in measuring risk, I bring you to another metric. As defined by Wikipedia: Leverage (or gearing due to its analogy with a gearbox) is borrowing money to supplement existing funds for investment in such a way that the potential positive or negative outcome is magnified and/or enhanced.^[1] It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity. Deleveraging is the action of reducing borrowings.^[1]

Financial leverage

Financial leverage (FL) takes the form of a loan or other borrowings (debt), the proceeds of which are (re)invested with the intent to earn a greater rate of return than the cost of interest. If the firm's rate of return on assets (ROA) is higher than the rate of interest on the loan, then its return on equity (ROE) will be higher than if it did not borrow because assets = equity + debt (see accounting equation). On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will be lower than if it did not borrow. Leverage allows greater potential returns to the investor that otherwise would have been unavailable but the potential for loss is also greater because if the investment becomes worthless, the loan principal and all accrued interest on the loan still need to be repaid.

Margin buying is a common way of utilizing the concept of leverage in investing. An unleveraged firm can be seen as an all-equity firm, whereas a leveraged firm is made up of ownership equity and debt. A firm's debt to equity ratio is therefore an indication of its leverage. This debt to equity ratio's influence on the value of a firm is described in the Modigliani-Miller theorem. As is true of operating leverage, the degree of financial leverage measures the effect of a change in one variable on another variable. Degree of financial leverage (DFL) may be defined as the percentage change in earnings (earnings per share) that occurs as a result of a percentage change in earnings before interest and taxes.

gs_stress_test_cover.jpg

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Derivatives

Derivatives allow leverage without borrowing explicitly, though the "effect" of borrowing is implicit in the cost of the derivative.

• Buying a futures contract magnifies your exposure with little money down.
• Options do the same. The purchase of a call option on a security gives the buyer the right to purchase the underlying security at a given price in the future. If the price of the underlying security rises, the value of the call option will rise at a rate much greater than the value of the underlying security. However if the rate of the call option falls or does not rise, the call option may be worthless, involving a much greater loss than if the same money had been invested in the underlying instrument. Generally speaking, a put option allows the holder (owner), the investor, to achieve inverted-leverage and/or inverted enhancement--- sometimes called inverse enhancement and/or inverse leverage.
• Structured products that exist as either closed-ended funds, or public companies, or income trusts are responding to the public's demand for yield by leveraging. That's a good idea. Let's refer to Goldman Sachs as a Structured Product!

Risk and overleverage

Employing leverage amplifies the potential gain from an investment or project, but also increases the potential loss. Interest and principal payments (usually certain ex-ante) may be higher than the investment returns (which are uncertain ex-ante).

This increased risk may still lead to the optimal outcome for the entity or person making the investment. In fact, precisely managing risk utilizing strategies including leverage and security purchases, is the subject of a discipline known as financial engineering.

There are economic periods when optimism incites to a widespread and excessive use of leverage, what is called overleverage. One of its forms, associated to the subprime crisis, was the practice of financing homes with no or little down payment, playing on the hope that the price of the assets (the property in this case) will rise. Another form involved the five largest U.S. investment banks, which borrowed funds to invest in mortgage-backed securities, increasing their leverage between 2003-2007 (see diagram). During September 2008, the five largest firms either went bankrupt (Lehman Brothers), were bought out by other banks (Merrill Lynch and Bear Stearns) or changed to commercial bank holding companies, subjecting themselves to leverage restrictions (Morgan Stanley and Goldman Sachs).

Well, on the topic of leverage, who do you think is the most leveraged bank? Notice that these leverage ratios below are unadjusted. That means that they will go up significantly if I took the time to extract the accounting shenanigan trash that is used to give the impression of lower leverage (this adjustment is explictly done in the 131 page Goldman Sachs Professional Stress Test).

newestriskiestbank.gif

Notice that although Goldman Sachs is the leveraged risk winner as of now, but they would have probably been beaten by Merrill Lynch. Hey, where is Merrill Lynch by the way? You know, it can get pretty painful for guys to play hide the "leveraged" sausage. If you know what I mean...

Okay, for you real stubborn guys and gals who don't think the cost of capital or leverage are legitmate determinants of risk, let's take a look at other popular risk metrics. Surely they will vindicate the riskiest bank on the Street, right? Below, please find the Goldman Sachs VaR and Risk Adjusted Return on Risk Adjusted Capital Chart.

varrarorc.gif

Now, as we can plainly see, Goldman Sachs has steadily trended down in its RARORAC and steadily trended higher in VaR. In other words, risk has steadily increased as risk adjusted return has steadily decreased.

For those who feel I am simply blogging in sanscrit, let's pull up the Wikipedia definitions for VaR and RARORAC:

Value at Risk (VaR):

In financial mathematics and financial risk management, Value at Risk (VaR) is a widely used measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability and time horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value (assuming normal markets and no trading in the portfolio) is the given probability level.^[1]

For example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 5% probability that the portfolio will fall in value by more than $1 million over a one day period, assuming markets are normal and there is no trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day in 20. A loss which exceeds the VaR threshold is termed a “VaR break.”^[2]

The 10% Value at Risk of a normally distributed portfolio

VaR has five main uses in finance: risk management, risk measurement, financial control, financial reporting and computing regulatory capital. VaR is sometimes used in non-financial applications as well.^[3]

Risk adjusted return on capital (RAROC) is a risk-based profitability measurement framework for analysing risk-adjusted financial performance and providing a consistent view of profitability across businesses. The concept was developed by Bankers Trust in the late 1970s. Note, however, that more and more Risk Adjusted Return on Risk Adjusted Capital (RARORAC) is used as a measure, whereby the risk adjustment of Capital is based on the capital adequacy guidelines as outlined by the Basel Committee, currently Basel II.

...

Broadly speaking, in business enterprises, risk is traded off against benefit. RAROC is defined as the ratio of risk adjusted return to economic capital. The economic capital is the amount of money which is needed to secure the survival in a worst case scenario, that is it is a buffer against heavy shocks. Economic capital is a function of market risk, credit risk, and operational risk, and is often calculated by VaR. This use of capital based on risk improves the capital allocation across different functional areas of banks, insurance companies, or any business in which capital is placed at risk for an expected return above the risk-free rate.

RAROC system allocates capital for 2 basic reasons:

1. Risk management
2. Performance evaluation

For risk management purposes, the main goal of allocating capital to individual business units is to determine the bank's optimal capital structure—that is economic capital allocation is closely correlated with individual business risk. As a performance evaluation tool, it allows banks to assign capital to business units based on the economic value added of each unit.

Now that we're all up to speed, let's take this one step farther. Below you may find the One-Day Trading VaR of GS with a 95% confidence level.

dailytradingvar.gif

Here we find proof that Goldman Sachs has indeed usurped Morgan Stanley for the title of "Riskiest Bank on the Street".

daysexceedingvar.png

Hey, notice how Goldman Sachs has trended DOWNWARD regularly and steadily over the one year period. As a matter of fact, the only company that had a lower risk adjusted capital return was Lehman. So let's compare what is happening now... Oh yeah, we can't because Lehman has already collapsed. What does that portend for Goldman who appears to operate quite similarly?

raroc.png

I know many of you new readers are wondering, "Who the hell is this guy?". Well, this guy is someone who has been pretty good at ferreting out weak companies on the verge of collapse:

There is the call of the fall of REITs and commercial real estate in 2007 - "GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months". I also called Bear Stearns (Is this the Breaking of the Bear? [Sunday, 27 January 2008]), Lehman Brothers CRE implosion connection (Is Lehman really a lemming in disguise? [Thursday, 21 February 2008]), Countrywide and Washington Mutual (Yeah, Countrywide is pretty bad, but it ain’t the only one at the subprime party… Comparing Countrywide with its peer), nearly all of the failed or failing regional banks of significant size (As I see it, these 32 banks and thrifts are in deep doo-doo!), MBIA (A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton) and Ambac (Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap and Follow up to the Ambac Analysis), among others - well in advance.

More Goldman Sach's Research:

gs_stress_test_cover.jpg

Subscribe Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages

Free research and opinion

• Reggie Middleton on Goldman Sachs' fourth quarter, 2008 results
• Goldman and Morgan losses in the news, about 11 months late
• Blog vs. Broker, whom do you trust!
• Monkey business on Goldman Superheroes
• Reggie Middleton asks, "Do you guys know who you're messin' with?"
• Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis
• Reggie Middleton on Goldman Sachs Q3 2008

§ As Reality hits, the Masters of the Universe are starting to look like regular bank employees

Premium Stuff!

Goldman Sachs - strategic investment and public offering 2008-09-26 02:29:15 895.36 Kb

Goldman Sachs Report June 21, 2008 2008-10-20 16:48:01 361.18 Kb

Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Professional 2008-12-18 10:12:37 267.49 Kb

Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Retail 2008-10-20 15:45:05 348.99 Kb

GS ABS Inventory 2008-02-25 06:48:56 1.22 Mb

Historical context for the "Riskiest Bank on the Street" moniker.

Banks, Brokers, & Bullsh1+ part 1

Wednesday, 19 December 2007 | Reggie Middleton

A thorough forensic analysis of Goldman Sachs, Bear Stearns, Citigroup, Morgan Stanley, and Lehman Brothers has uncovered... Last week, Morgan Stanley called Citibank the “short play of...

The Riskiest Bank on the Street
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

A closer look at the exposure of the other brokers
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

I have been receiving a decent amount of unsolicited interest in my work on GGP ( GGP and the type of investigative analysis you will not get from your brokerage house). This interest is ranging from law firms to banks to media. It is a text book case of how investigative analysis can uncover a significant mispricing of value, despite management's and the markets short term proclamations of said value. For those pundits and know-it-alls who feel that short sellers are bad for the US markets, I suggest you bring your argument to the small business men and women, pensioners, retail investors and taxpayers who were shafted by GGP as its share price collapsed from over $70 to near zero and into bankruptcy. I made it quite clear this was a probable, no actually an unavoidable scenario (firesale or foreclosure).

I went short short GGP at $60 in November of 2007 and released research shortly thereafter. I want to state again for those that follow me, this is a process that takes time to unfold and the markets are now as volatile and probably as manipulated as they have ever been. Since I cannot predict the markets or short term share price movements, you should anticipate (if not actually expect) prices to move against you (and sometime violently) in the short term. Look at the GGP chart above and you can see where I suffered several drawdowns that would have given cause to pop out of the position.

As I stated in my previous posting, "GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months", this was not a one off event either. I also called Bear Stearns (Is this the Breaking of the Bear? [Sunday, 27 January 2008]), Lehman Brothers CRE implosion connection (Is Lehman really a lemming in disguise? [Thursday, 21 February 2008]), Countrywide and Washington Mutual (Yeah, Countrywide is pretty bad, but it ain’t the only one at the subprime party… Comparing Countrywide with its peer), nearly all of the failed or failing regional banks of significant size (As I see it, these 32 banks and thrifts are in deep doo-doo!), MBIA (A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton) and Ambac (Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap and Follow up to the Ambac Analysis), among others - well in advance.

Why am I bringing all of this up again? Well its definitely not to boast or brag. After all we are all wrong sometimes, and even I doubt my findings on occasion. Recently many of my research subjects have skyrocketed in price giving short term bulls the fuzzy warm feeling in the mid section while giving those that are bearish diarrhea. I want to make clear, again, that short term movements do not condemn nor vindicate my research. It is just short term movement, often accurately considered noise. Positions must be taken carefully though, with hedges, stops or small sizes. Every home run that I hit above (nearly all of the companies above are either close to or in bankruptcy/insolvency or are no longer going concerns) has been far from a smooth ride down. As a matter of fact, Bill Ackman, who provided the orginal idea for the monolines, was short MBIA for 5 years before it finally collapsed from near $100 to about $7. Patience and steady hands must accompany strong research or market volatility will always shake you out before you have a chance to profit.

I have recently found what could be the most horrendous cover up(s) and accounting shenanigans that have come across my desk in some time. There are some big, brand name banks that are pushing numbers and false concepts around their earnings statements in a fashion that seems to make GGP 's management look like choir boys. Despite this, their share prices are doubling. Either I am wrong and will lose a lot of money shorting these guys, or I am right (like I was in the 39 examples above) and will make a killing. I will bring the issues to light for subscribers shortly if they bear out by the end of my analysis. Either way though, I think it is obvious how important it is for short sellers to have their say in the markets. A lot of pain could have been avoided by creditors and investors if they would have heeded my warnings back in 2007 and early 2008 regarding GGP - or any of the other 38 other companies mentioned above.

From the LAS VEGAS REVIEW-JOURNAL:

Mall operator files for bankruptcy protection

Teetering retail real estate giant General Growth Properties finally collapsed under nearly $27.3 billion in debt, much of it heaped on during a Las Vegas buying spree.

The Chicago-based real estate investment trust, or REIT, Thursday filed for Chapter 11 bankruptcy protection in federal court in New York, leaving judges, lawyers and creditors to unravel holdings in about 200 complex properties in 44 states. The malls will continue to operate during bankruptcy proceedings, which experts said could drag on for years.

The federal bankruptcy filing in the Southern District of New York included pending cases for 360 separate entities, including at least 16 with connections to Las Vegas.

It listed nearly $29.6 billion dollars in assets nationally, although the bulk of the assets are retail real estate holdings which face significant downward pressure on their value thanks to the recession that’s finally caught up with General Growth management’s buy-now, pay-later strategy.

In Las Vegas, General Growth and its subsidiaries own three high-profile malls on the Strip, retail, residential and office real estate in Summerlin and two regional malls for locals, Meadows and Boulevard malls.

“It is a doozy,” Nancy Rappaport, a bankruptcy expert at the University of Nevada, Las Vegas, abou the filing.

The Strip properties include Fashion Show Mall, Grand Canal Shoppes and Shoppes at Palazzo. Its Summerlin holdings include The Hughes Corp., which owns the stalled-in-construction Summerlin Centre retail, office and residential development.

One local representative of the company referred questions to General Growth’s home office in Chicago. A spokesman there did not return calls for comment.

Tom Warden, spokesman for The Hughes Corp., did not return calls for comment.

The company was a joint venture partner with Boyd Gaming in the gaming company’s stalled Echelon resort. But Boyd bought out General Growth’s stake in October for $9.7 million.

Among the top 100 creditors listed in the filing, several have Las Vegas connections.

Mandalay Bay is the largest local creditor listed with General Growth owing the resort $1.1 million. It owes The Venetian, home to Grand Canal Shoppes, $531,444.

Southern Nevada Paving is listed as being owed $178,296 and LVI Environmental is listed as being owed $99,533, although an LVI official says General Growth paid its tab to the company.

“They paid us last Friday. We just made it right under the wire,” said LVI President Joe Catania.

General Growth’s extensive holdings and massive debt load mean the list of local creditors will likely grow as lawyers for the renown mega-bankruptcy firm Weil, Gotshal & Manges of New York sort through the paperwork and file cases for every entity that falls under the General Growth umbrella, Rappaport said.

“They are going to try and unwind some of that in bankruptcy,” she said. “It is really going to depend on each individual business and whether the business plan for each company makes sense.”

Companies that have a business-to-business trade relationship with General Growth or a subsidiary are likely to be unsecured creditors, meaning their bills aren’t secured by a piece of General Growth’s property the way a mortgage is secured by a house.

The largest unsecured creditors will organize an unsecured creditors committee, which will itemize all of General Growth’s unsecured debt.

Smaller creditors, however, won’t be overlooked in court, Rappaport says.

That’s because in bankruptcy the lawyers working on behalf of the unsecured creditors committee have a legal and fiduciary responsibility to act in the best interest of all unsecured creditors.

That said, there’s no way yet for creditors to know just how much debt they’ll recoup from the hobbled titan.

“It is too early to say whether they are going to get screwed,” Rappaport said.

Founded in 1954, the company was primarily a regional player that in recent years used aggressive leverage to become the nation’s second-largest REIT after Simon Property Group.

The buying binge peaked in 2004 with the leveraged purchase of The Rouse Co., in a $14 billion deal that included Fashion Show and the Summerlin holdings.

It also included marquee properties such as Boston’s Faneuil Hall Marketplace, South Street Seaport in lower Manhattan and Baltimore’s Inner Harbor.

It committed more than $1 billion in separate transactions to buy Grand Canal Shoppes in 2004 and the Shoppes at Palazzo in 2008.

Management maintained complex fiscal arrangements by continually rolling debt over into new debt, a strategy that unraveled when the credit markets went sour last year.

“Their problem is they paid too much for it and they used too much debt to get it,” said investor Reggie Middleton who in January 2008 was among the first people to publicly state the company was in danger on his Web site, www.boombustblog.com.

Middleton, who was indirectly ridiculed for his skepticism by General Growth management, published an in-depth analysis of the company’s complicated finances that included a property-by-property look at the firm’s holdings.

He says the Las Vegas properties are moneymakers under the right conditions.

“Most of (General Growth’s) Las Vegas stuff looks good anecdotally, it is just a matter of what price it looks good at,” Middleton said.

Had General Growth not overpaid for holdings in Las Vegas or elsewhere or if had bought the properties with cash instead of debt it could have ridden out the recession, Middleton said.

With both the Las Vegas economy and nation’s retail sector in doubt, it is tough to say how General Growth’s Las Vegas properties will be valued.

Their Strip properties are well located and do well compared to other retail properties. But they are one-trick ponies compared to the resorts, which get money from gambling, room rentals, retail and food.

“The retail malls have one source of revenue, that is rent,” Middleton said.

Although the value of General Growth’s Las Vegas holdings is murky, Middleton says lessons for investors from the company’s downfall are clear.

“When everyone wants to buy you should be selling,” he said. “When everyone wants to sell you should be buying.”

Contact reporter Benjamin Spillman at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or 702-477-3861.

In finishing up the GS Stress Test, I decided to throw in this chart to the free part of the blog as well. The Goldman Stress test is a Tour de Force, and I seriously doubt if the government has put as much into uncovering the truth as I have.

gscre.png

Reference the CMBS exposure that Goldman has above (at no less than 14x leverage), then reference this chart directly below.

image004.png

We are talking a 6x increase in CMBS spreads that GS is rife with at a minimum of 14x leverage over a comparable time period (and a 30x increase all in all). This will just get worse as we get more of this: For those that attempt to argue that short sellers are bad for the market, I bring you GGP! and GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months. With this GGP bankruptcy, spreads will blow out even wider as asset values drop farther. Then there are all of the other REITs who share similar problems, just on a lower scale (at least thus far).

With the advent of the new FASB Fantasy Accounting Rules, it is possible that Goldman can hide these stresses and losses from average institutional and retail investors as well as the government. Well, they can't hide it from BoomBustBlog subscribers. Bear Stearns and Lehman Brothers had very, very similar real estate exposure. Look at where they are now! As a matter of fact, there are charts comparing the exposure of Goldman, Lehman, Merrill Lynch and Morgan Stanley in the Stress Test that I am about to release. It is revealing and interesting indeed. Goldman is trading at nearly $130...

As I have stated, I believe the Goldman Research to be above and beyond anything available to the typical instituional or retail investor, and I am sure I have covered (or uncovered) bases that the government has failed to. Here is an (unfinished) table of contents (the Pro report is over 100 pages long, consiting primarily of numbers, tables and stats) as I wrap up the report to release some time today for Professional Level users (along with a summary for Retail subscibers):

Contents
Goldman Sachs 1Q09 results 2
Reggie Middleton’s Goldman Sachs Stress Test 4
Summary 4
Stress Test Macro Assumptions 5
VAR and Risk Data 6
Comparative Var Analysis 8
CMBS Pressure Points and Other Risk Factors Not Reflect in VaR 12
Economic Writedowns 16
Future Value of Assets (economic) 19
Future Value of Liabilities (economic) 28
Financial liabilities at fair value 34
Movement in Level 3 Financial Assets and Financial Liabilities ($ mn) 40
Writedowns (accounting) 44
Future Value of Assets (accounting) 46
Financial Liabilities at Fair Value (accounting) 56
Movement in Level 3 Financial Assets and Financial Liabilities ($ mn) (accounting) 65
SFAS 157 and SFAS 159 70
Debt Maturity 72
Level Three Comparison 72
Level 2, Level 3, CDOs and Related Assets 77
Revenue, Expense and Off Balance Sheet Loss Assumptions 80
Relative Book Valuation 81
Financial Projections 84
Income Drivers 88
Key Ratios 93
Unconsolidated Variable Interest Entity (VIE) Exposure 95
Scenario Analysis 99
Disclaimer 111