Displaying items by tag: Asset Securitization Crisis

Monday, 20 April 2009 05:00

Reggie Middleton's Goldman Sachs Stress Test

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.

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

pdf 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

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)

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)

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
. 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!

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.

Published in BoomBustBlog

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?


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.


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

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


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).


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.


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.


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


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?


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:


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

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

Free research and opinion

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

Goldman Sachs Report June 21, 2008 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 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 Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Retail 2008-10-20 15:45:05 348.99 Kb

GS ABS Inventory 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)

Key highlights of my research on the "Riskiest Investment Bank on the Street": The Riskiest Bank on Wall Street – Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its eq
Monday, 11 February 2008

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

...- Who has the most of their assets tied up in illiquid Level 3 as a proportion to tangible equity? You guessed it, The Riskiest Bank on the Street. Now, they do have a decent amount of liquidity the ...
Sunday, 16 March 2008

19. On the insolvencies of non-bank financial institutions
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...Bullsh1+ part 1 Banks, Brokers, & Bullsh1+ part 2 Money Panic Bear Fight The Breaking of the Bear The Riskiest Bank on the Street Here comes the CRE Bust (Quip on Lehman Brothers)...
Tuesday, 18 March 2008

20. Quick Morgan Stanley update from my lab
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is a refresher to the The Riskiest Bank on the Street piece that I posted a few months ago on Morgan Stanley. Let me get straight to the salient points. High exposure to lev
Thursday, 20 March 2008

21. Early morning scan of events
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
For those that haven't noticed, I've begun sharing my early morning news and data routine with the blog. Here goes Monday moring EST. Is the Fed running out of ammo? Reserve
Monday, 31 March 2008

22. Reggie Middleton on the Street's Riskiest Bank - Update
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is the update to my forensic deep dive analysis of Morgan Stanley. It is still, in my opinion, the "riskiest bank on the street". A few things to make note of as you browse through my opinion a
Sunday, 06 April 2008

23. Banks, Brokers & Bullsh1t 3.0: Shenanigans at Morgan and Lehman
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
I've been promising to give an illustration of the shenanigans being played by the commercial and investment bank's for some time now, but I've been quite busy working on my entrepeneurial pursuits
Wednesday, 16 April 2008

24. I warned you about the risk of those I Banks
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...ive counterparty and credit risk to imperfect hedges to dead and depreciating assets held off balance sheet: The Riskiest Bank on the Street Is this the Breaking of the Bear? Banks, Broke...
Wednesday, 21 May 2008
Published in BoomBustBlog
Friday, 17 April 2009 05:00

More on the Goldmans Sachs - GGP Connection

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.


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


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):

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

Published in BoomBustBlog

I am still in the process of preparing the Goldman Sachs stress tests for publication, but came across this headline in Bloomberg: General Growth Files for Protection in Biggest U.S. Real Estate Bankruptcy.

This prompted me to excerpt a portion of the Pro level Stress Test Analysis to publish on the public blog. Remember that Goldman has some of the highest VaR numbers of the bulge bracket save the collapsed Lehman Brothers, who collapsed in large part due to their commercial real estate exposure (as well as Bear Stearns). I also want to point out the investment horizon that I use when implementing my research. With the recent bear market rally forcing shorts into drawdown, keep in mind that my research looks 3 months to 1 year out. I personally bought puts on GGP at $60 and suffered through many a drawdown before the position reached fruition. That means that if I say XYZ company has poor prospects and that company doubles in price within 3 months, it really has no bearing on whether said analysis was right or wrong. I have absolutely no control or special insights into the markets. I can tell you if a company is in trouble though. The issue is, this trouble takes time to manifest, and this time period is often more than just a few months. Be prepared to hold on to your positions for a year or more. Trust me, it is worth it and I am right more often than not. Shorting a company from $60 to $1 yields a very strong IRR of return on an annual basis. Patience is both justified and highly rewarded. A lack of patience and weak hands easily turns a big profit into a big loss.

Goldman Sach's CMBS Pressure Points and Other Risk Factors Not Reflect in VaR

I have been banging the table about the unappreciated risk the commercial real estate market poses since September of 2007 - way before the crowd of investors, pundits, analysts and media. See:

Well, the nations second largest property owner and REIT has just filed chapter 11, after I warned readers over a year and a half ago of this very distinct possibility. See General Growth Files for Protection in Biggest U.S. Real Estate Bankruptcy then go on to read the 80 or so pages of research that I have generated to support riding the share price down from $60 to near zero: GGP and the type of investigative analysis you will not get from your brokerage house.

This underappreciated risk will reverberate through investment banks, insurers, money center and regional banks alike for these are the sourced of the large nonrecourse loans and CMBS that funded these vehicles. In addition, the retail mall REITs will see significant hits to asset prices and consequently rents (more so than they have already seen, which has been significant already) which will put additional stress on debt service. Keep in mind that the GGP issue is not confined to GGP. Debt that had financed assets during a property bubble cannot be rolled over due to a dearth in financing - causing bankruptcy. Chances are that this will be seen several more times in the next 8 quarters or so. Long story short - expect valuations, rents, credit quality and cashflows to drop as vacancies and delinquencies rise.


Break up of mortgage backed securities

Q4 07

Q1 08

Q2 08

Total mortgage backed securities




Commercial real estate
















Sub prime




Loan portfolio




As the CRE market starts to deteriorate and the CMBS market collapses, the entities that are holding these securities through high leverage (Goldman currently has a roughly 22x leverage ratio) will be very sensitive to any changes in valuation. Goldman holds nearly $17 billion in CMBS, an at 22x leverage will be hurt if the GGPs of the world force realistic marks to be made through real world transaction, ex. Bankruptcy.

As a percentage of total mortgage backed securities

Q4 07

Q1 08

Q2 08

Commercial real estate
















Sub prime




Loan portfolio




The commercial real estate risk that Goldman Sachs is woefully underappreciated by the market and apparently unknown to the sell side analytical community. Take it from the guy that clearly anticipated the fall of Bear Stearns (Is this the Breaking of the Bear? [Sunday, 27 January 2008]) and (with the help of his readers) pointed out the Lehman Brothers CRE implosion connection (Is Lehman really a lemming in disguise? [Thursday, 21 February 2008]), as well as the GGP debacle in full detail (GGP and the type of investigative analysis you will not get from your brokerage house). Goldman has risk here, among other places that aren't even visible in its rapidly increasing VaR numbers....


Other risk exposure not included in VaR

Q1 07

Q2 07

Q3 07

Q4 07

Q1 08

Q2 08

Trading Risk















Non-trading Risk















Other Equity














Real Estate














See also: The Official Reggie Middleton Bank Stress Tests

Published in BoomBustBlog
Wednesday, 08 April 2009 05:00

And another "I told 'ya so"

From Marketwatch:

SANTA CLARA, Calif., April 7, 2009 /PRNewswire-FirstCall via COMTEX/ -- SVB Financial Group (SIVB 16.65, -4.24, -20.3%) , parent company of Silicon Valley Bank, announced selected unaudited preliminary financial results expected for the first quarter of 2009 and an update to the company's outlook on credit quality for 2009.
Based on preliminary first quarter financial information, the company is expecting to report a consolidated net loss applicable to common stockholders for the first quarter of 2009 in the range of approximately $9.0 million to $12.0 million and a diluted loss per common share in the range of $0.28 to $0.36. As discussed below, the expected loss is generally attributable to the impact of: (i) credit quality of certain specific loans, (ii) valuation declines of venture capital/private equity investments, (iii) a lower than expected net interest margin primarily due to deposit growth and low returns on excess cash levels, and (iv) other items as discussed below.
This earnings release loss exolanation is literally right out of the subcriber forensic reports below, damn near verbatim. Subscribers have had 4 months notice on this company. Hat tip to Shaunsnoll for alerting me to it, and hat tip to my analyst who put the report together!

Published in BoomBustBlog
Tuesday, 07 April 2009 05:00

More on Reggie Middleton's Bank Stress Testing

The FDIC has released a document describing the stress test and the parameters used to assess the banks health under assumed base case and adverse case scenarios. Unfortunately, their adverse case scenarios are actually the base case scenarios. Look at the appendix of this document from the FDIC (I will save it if I were you to ensure that it doesn't disappear when word gets out), and you will see an unemployment "adverse case" of 8.9% and a average baseline case of 8.4%. Well, the baseline case is already too optimistic. This is a fact, since I just pulled the government's own numbers (see below) and unemployment for the month of March is currently 8.5%! Thus, you can see where the baseline assumptions are already too optimistic, without a doubt. If one were to look at the rate of increase of unemployment, it would not take much imagination to see the actual rate easily pierce the "adverse" case before the end of 2009 (we are near the adverse case alreay, and this is just the beginning of the 4th month of the year). If this were to be true, it would be safe to assume the stress tests to be a total farce, with realistic numbers showing banks to be in far worse conditions. Be aware that I am not using shadow stats, or numbers derived by basement bloggers, but the actual numbers released by our fair government.

My stress test numbers will use the governments (already antiquated and inaccurate numbers) only as a point of reference, but will include more realistic projections in order to determine a more accurate outcome. I will start with the members of the Doo Doo 32 that have forensic analysis on this site - for subscribers only.

Taken from the Bureau of Labor Statistics:

Data extracted on: April 8, 2009 (12:18:52 AM)

Labor Force Statistics from the Current Population Survey

																					Series Id:  LNS14000000
Seasonal Adjusted
Series title: (Seas) Unemployment Rate
Labor force status: Unemployment rate
Type of data: Percent
Age: 16 years and over

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
1999 4.3 4.4 4.2 4.3 4.2 4.3 4.3 4.2 4.2 4.1 4.1 4.0
2000 4.0 4.1 4.0 3.8 4.0 4.0 4.0 4.1 3.9 3.9 3.9 3.9
2001 4.2 4.2 4.3 4.4 4.3 4.5 4.6 4.9 5.0 5.3 5.5 5.7
2002 5.7 5.7 5.7 5.9 5.8 5.8 5.8 5.7 5.7 5.7 5.9 6.0
2003 5.8 5.9 5.9 6.0 6.1 6.3 6.2 6.1 6.1 6.0 5.8 5.7
2004 5.7 5.6 5.8 5.6 5.6 5.6 5.5 5.4 5.4 5.5 5.4 5.4
2005 5.2 5.4 5.2 5.2 5.1 5.1 5.0 4.9 5.0 5.0 5.0 4.8
2006 4.7 4.8 4.7 4.7 4.7 4.6 4.7 4.7 4.5 4.4 4.5 4.4
2007 4.6 4.5 4.4 4.5 4.5 4.6 4.7 4.7 4.7 4.8 4.7 4.9
2008 4.9 4.8 5.1 5.0 5.5 5.6 5.8 6.2 6.2 6.6 6.8 7.2
2009 7.6 8.1 8.5

From Bloomberg:

April 8 (Bloomberg) -- A congressional panel overseeing the
U.S. financial rescue suggested that getting rid of top
executives and liquidating problem banks may be a better way to
solve the economic crisis.

The Congressional Oversight Panel, in a report released
yesterday, also said the Treasury may be relying on too rosy an
economic scenario to guide its $700 billion bailout (Ya' think???), and
declared that the success of the program after six months is
“mixed.” Three of the group’s members disagreed with at least
some of the findings.

“All successful efforts to address bank crises have
involved the combination of moving aside failed management and
getting control of the process of valuing bank balance sheets,”
the panel, headed by Harvard Law School Professor Elizabeth
, said in its report.

Depth of Downturn

In the report, Warren’s panel said “it is possible that
Treasury’s approach fails to acknowledge the depth of the
current downturn and the degree to which the low valuation of
troubled assets accurately reflects their worth.” That would be my bet! Like I tell my son's, "When there are no transactions, the bid IS the market!"

The group said it was offering an examination of
“potential policy alternatives” for the Treasury and not
endorsing any shift at this time.

Still, it said a bank liquidation would be “least likely
to sap the patience of taxpayers” and “provides clarity
relatively quickly” to the markets.

“Allowing institutions to fail in a structured manner
supervised by appropriate regulators offers a clearer exit
strategy than allowing those institutions to drift into
government control piecemeal,” the report said.

The report also said that past successful financial rescues
were accompanied by governments’ “willingness to hold
management accountable by replacing -- and, in cases of criminal
conduct, prosecuting -- failed managers.”

Separate Findings

Two of the panel members, New York State Superintendent of
Banks Richard Neiman and former New Hampshire Senator John
, issued separate findings.

“We are concerned that the prominence of alternate
approaches presented in the report, particularly reorganization
through nationalization, could incorrectly imply both that the
banking system is insolvent and that the new administration does
not have a workable plan,” the two wrote.

Sununu and the five-member panel’s other Republican
appointee, Representative Jeb Hensarling of Texas, dissented
from the entire report.

The oversight panel was set up under the rescue law passed
in October. It has three members appointed by Democrats and two
by Republicans. The group’s reports are required by the

Published in BoomBustBlog

I am really proud of our president, but I am truly suspect, no... disappointed in some of his economic team appointments and the holes in their recent ideas. This may really come back to bite him in the ass. Granted, this may be a bit unfair since I may have considerably more financial knowledge and acumen than even the most accomplished politicians, but a mistake is a mistake.

Heavily excerpted from TPMMuckraker:

Harvard Derivatives Whiz Fired For Emailing Larry Summers About "Frightening" Trades?


A former quantitative analyst at Harvard Management Company, the university's once-vaunted endowment manager, tells the Harvard Crimson she was fired for voicing concern to then-university president Larry Summers' chief of staff about the money manager's risky use of derivatives the traders didn't understand.

The episode dates back to 2002, when analyst Iris Mack, whose website identifies her as the second African American woman to earn a Harvard PhD. in applied math (and someone who likes primary colors) joined the much-venerated Harvard Management Company, which invests the university's then $18 billion endowment, to find what she termed a "frightening" state of affairs.

"The group I was working for had no background whatsoever to be working on [derivatives]," Mack says, adding that, to her knowledge, several of her colleagues were not licensed securities traders. "Sometimes the ways they handled even basic Black-Scholes models [widely used to price stock options] were puzzling."

So Mack took inventory of the abuses -- high employee turnover, lax risk management practices and a "low level of productivity in the workplace" were among others, and detailed them in an email to Marne Levine, Summers' chief of staff and a Treasury staffer on the Obama Transition Team. (Summers was the only person to whom Meyers reported, and according to a recent Forbes story he personally ordered the university's biggest derivatives trade, a purchase of interest rate swaps that cost the university billions this year.)

A month after sending her email, Mack was fired after a meeting in which the endowment fund's then-chief furnished her the emails and castigated her for making "baseless accusations." She later sued for wrongful termination and settled out-of-court with the university. But she claims the practices "shocked" her, and -- the punchline is -- she had joined the company from Enron.

Which is also to say, lest you dismiss Mack as an opportunistic snitch capitalizing on Summers fateful opposition to regulating the derivatives that wreaked havoc on the financial system, she had a pretty valid reason to believe in the importance of whistleblowing.

"I'm not trying to pretend I'm omniscient or anything, but a lot of people who were quantitative traders, in the back of our minds, we knew a lot of these models were just that: guestimates," Mack says. "I have mixed feelings, on the one hand, I wasn't crazy, I knew what I was talking about. But maybe if more and more people had spoken up, the economy wouldn't be the way it is now."

If Mack's allegations are true Harvard certainly paid the price for its recklessness: Summers' swaps sowed the seeds for a financial disaster at HMC:

It doesn't feel good to be borrowing at 6% while holding assets with negative returns. Harvard has oversize positions in emerging market stocks and private equity partnerships, both disaster areas in the past eight months. The one category that has done well since last June is conventional Treasury bonds, and Harvard appears to have owned little of these. As of its last public disclosure on this score, it had a modest 16% allocation to fixed income, consisting of 7% in inflation-indexed bonds, 4% in corporates and the rest in high-yield and foreign debt.


But risk brings pain in a market crash. Although the full extent of the damage won't be known until Harvard releases the endowment numbers for June 30, 2009, the university is already working on the assumption that the portfolio will be down 30%, or $11 billion.

Mack's boss at HMC, Jack Meyer, parted ways with the university in 2005. His bets were still paying off but his relationship with Summers had reportedly cooled -- among other things, over alumni outcry led by the university's Class of 1969 over the hedge fund-sized bonuses being awarded to employees of a supposed nonprofit. But if there's anything we've learned from the past year, gratuitous compensation and gratuitous risk go hand-in-hand.

"The events of the last year show that the whole procedure of rewarding people so handsomely based on increases on paper value of the endowment was deeply flawed," says a spokesman for the [Class of 1969], which recently sent a letter to the Harvard president suggesting HMC staffers return $21 million of their latest bonuses. "Even now we don't really know how well it has done in the last ten years."

Reggie's Comment:
Published in BoomBustBlog

A lot of people have been asking my about my opinion of the latest M2M rule changes. Well, I find it to be a travesty that political pressure and corporate lobbying can actually change the way accounting is done. Note, I say it is a travesty, but not a surprise. I should be grateful, though. This actually means that I should be making more money as people will undoubtedly have significantly more problems evaluating companies due to the ADDED LACK of TRANSPARENCY! Hey, more people for me to sell puts to buy puts from (this was a typo that came from posting at 3 am).

In an earlier posting, I made clear that the lack of transparency should bring down the valuation of the entire sector, for when in doubt, devalue - hiding market values and permanent impairment losses does nothing if casts significant doubt. Yes, there will be a momentum trading pop, but I am a longer term investor, and I see these companies being devalued as guys like me start to punch holes in them. Even more profound is that I will not be able to make macro calls on 32 stocks to drop as accurately as before (see the Doo Doo 32), but when I do hit my target, it will be the motherload. The reason, well before the FASB political travesty that just happened, institutions had to move "other than temporary" impairments from the balance sheet to the income statement and take a loss for it. Now, they no longer have to. It was bad enough before, since the impairments that they did take weren't very accurately marked down to market. Now, there's no telling what kind of fairy tale numbers will be thrown at us. There is one thing for sure, though. Many (outside of my blog's paying subscribers, of course) will not see a company's collapse coming until they actually feel the impact of the debris slam against their cranium! FASB has effectively removed the warning signs for everyone who does not have a team of forensic CPAs and CFAs who have no conflicts of interests. In other words, just about 95% of the investment population!

Mark to Market will do nothing to aid the economic values of banks and financial institutions. Cash flows are cash flows, and losses are losses. Calling a loan a performing asset (in lieu of a non-performing assets) does not make the borrower pay his bills! As a matter, it very well may damage economic value of the companies in question due to the warped compensation system therein. For instance, many companies will not act in the best interests of the company and raise capital due to its dilutive effects when share prices are low and costs of capital are high. The alternative is that they risk running undercapitalized, which they now have considerably more freedom to do thanks to the punks pundits at the FASB. Management will receive higher bonuses due to higher per share performance metrics when compared to what they would have received had they went the safer route and diluted, but they run much, much higher risk. If, or more accurately when, the stinky brown mushy stuff hits the impeller blades, splat!!! Corporate implosion, ala Bear Stearns, Countrywide, IndyMac, Lehman Brothers, WaMu, etc. style. Let it be known that I warned on all of these companies months ahead of their implosions (save IndyMac).

Hey, if you catch HIV, and then call all of your political friends, and coerce, threaten or make love to the members of the Medical Boards to change the nomenclature of virus to that of a dermal rash, it does absolutely nothing to extend your lifespan or alter your medical condition. The most it will do is allow you to fool yourself or make it easier for you to pass the disease along to others as you tell them it's just a rash (while still remaining within the confines of technical veracity) as you infect them and put their lives in danger. Just keep that in mind when evaluating the financials under the M2M rules.

Published in BoomBustBlog
Friday, 03 April 2009 05:00

Financial Engineering at its Finest

An interesting bit I found on the Safehaven listserv that I took the liberty of editing:

Financial Engineering at its Finest ....

Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi's drink-now pay-later marketing strategy and as a result, increasing numbers of customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS - all rated AAA by Snooty's Investor Services, Snitch and Standard and Get Poor's - for a fee, of course. These securities are then traded on security markets worldwide. Naive investors don't really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation's leading brokerage houses.

One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. Heidi demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 70 %. The decreased bond asset value destroys the banks liquidity since the banks borrowed up to 32x their initial capital to buy the bonds (even more in their off balance sheet bar companies) and a mere 20% drop in these bonds would wipe them clean, save government intervention. The events effectively prevent it from issuing new loans since the market won't give them more than 30 cents on the dollar for the best of them. The suppliers of Heidi's bar, having granted her generous payment extensions and having invested in the securities are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers. The Detroit stock market drops, then rallies vociferously as the Fantasy Accounting Standards Boards states, under duress and a sleeper choke hold from honest politicians that causes them to tap out (UFC style), that the bank may now use their discretion in valuing these bonds due to the fact that no on in the entire world wants to buy them really has no bearing on their true value!

The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.

Finally an explanation that alI can understand .....

I will be posting significant subscriber content over the next 48 to 96 hours. I have been updating the financial services and banking models to reflect the potential effects of PPIP and have a reinsurer to distribute, not to mention notes on the education industry.

Published in BoomBustBlog
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