Thursday, December 27, 2007

With Friends Like Goldman Sachs, Who Needs Enemies?

Went out and saw the new Will Smith film "I am Legend". I was not sure what to expect. It was a pretty good film overall. The isolation and routine coping mechanisms that the lead character had developed were very interesting. Not a top 10 film, but a solid film. Then there was a small ice storm up here in Massachusetts. Always fun.

Sallie Mae Doubling Down on a Losing Bet
I had to read, reread, and then reread this piece a few times because I just could not believe how funny it was. Sallie Mae, while not a mortgage paper player, is of interest to Me because it is a loan company. All companies that are in the business of lending (auto, school, credit cards, etc) are on watch to gauge how rough the credit crunch is. A few posts back the conference call with SLM CEO Albert Lord was covered in all its hilarity. Today we get some more great material, from Yahoo Finance (by Forbes.com):
Sallie Mae's Sophomoric Deal
Andrew Farrell, 12.27.07, 4:05 PM ET
College students could learn a lesson on the evils of gambling from student lender SLM, which bet its stock would rise and undertook a complicated financing deal with Citigroup based on that premise. As any follower of financial markets knows, SLM, better known as Sallie Mae, has been diving since a planned acquisition of the company fell apart earlier this year, and now it will have to sell new shares cheaply so it can buy the old ones back expensively.
Sallie said late Wednesday it will sell about 70 million shares of common stock for $1.5 billion. It will also sell 1 million shares of preferred stock for $1.0 billion. The preferred stock will convert into an unspecified number of common shares in 2010.
Sallie Mae will use about $2.0 billion of the proceeds from the selling of its shares to buy back other of its own shares from Citigroup division Citibank. Sallie Mae sold Citigroup its shares previously under a forward contract.
In an equity forward contract, an issuer, like Sallie Mae, sells securities to a buyer like Citigroup for the current stock price. The issuer agrees to repurchase the shares for a greater amount in the future. In essence, it’s a cheap way to borrow money as long as the company's share price goes up. If the share price falls, however, it means the issuer must overpay to buy back the shares.
Unfortunately for Sallie Mae, its stock has dropped sharply this year Shares of SLM have plummeted 57.8% during 2007.
Sallie Mae will need to purchase the shares back from Citigroup for more than twice the current market price, an average of $45.25. (Close 12/27 at $19.65)
During a contentious conference call earlier this month, SLM Chief Executive Albert Lord raised the possibility the company will sell more shares.

Sorry for the long article insert, but it was worth the read! So Sallie has to buy back shares from Citi for $45, while they are currently priced at around $20! Those equity forward contracts are great ways to get financing huh?
I wonder who in their right mind is going to step up to the plate and buy a bunch of new shares of SLM after learning about this calamity. After losing their bet with the forward contract, Sallie is now going to double down their position by issuing large amounts of stock at whatever price it may fetch. It may be interesting to note that the CEO Mr. Lord, while executing the forward contract that implied he thought the share price would go up, was voting with his feet and selling massive amounts of options up and until the most recent news. Too funny. You almost cannot make any of this up anymore.

With Friends Like Goldman Sachs, Who Needs Enemies?
The firm Goldman Sachs has been an interesting player during the current debacle. While most firms were taking massive writedowns and doing the walk of subprime shame, GS was immune. News came out that GS had even been shorting a bunch of mortgage paper positions held by various banks while their values crumbled. I am all for that by the way, and I had covered that exact idea a while back on this blog.
So from the SLM news above you may think Citi was in a good spot. They were going to get paid by SLM and they also received a cash infusion form some country. Plenty of analysts and commentators were praising Citi for their moves to shore up their position. Along comes Goldman Sachs today and they unleash this whopper:
AP
Citi May Write Down $18.7B, Analysts Say
Thursday December 27, 4:39 pm ET
By Madlen Read, AP Business Writer
Citi May Write Down $18.7B, Goldman Analysts Say, Which Could Force Bank to Slash Dividend
NEW YORK (AP) -- When Citigroup warned in early November that it was likely to write down its portfolio by $8 billion to $11 billion in the fourth quarter because of exposure to bad loans, investors recoiled at the size of the losses. Some now say those early estimates appear drastically understated.
Citigroup Inc. could write off as much as $18.7 billion in the fourth quarter, wrote Goldman analysts William F. Tanona, Betsy Miller and Neil C. Sanyal in a note to investors late Wednesday. If it does, they say, the bank may be forced to lower its dividend by 40 percent.
Citi has about $55 billion in exposure to subprime mortgages, about $43 billion of which are collateralized debt obligations, or CDOs, that have mortgages underlying them.
"We still believe it will be a couple of quarters before the current credit crisis is fully digested by the markets," the Goldman analysts wrote.
Already, Citi has been propped up by a $7.5 billion investment from the Abu Dhabi Investment Authority, a sovereign wealth fund that in late November bought a 4.9 percent stake in the bank.
But if Citi must write down the value of its portfolio by more than it estimated back in early November -- a distinct possibility, given the lack of improvement in the tight credit markets -- Goldman analysts said the bank may need to raise an extra $5 billion to $10 billion in cash.

HAHAHAHA! Goldman lowers the boom on Citi. I have to give credit here. While the ratings agencies like Moody's, Fitch, and S&P play the game of "we won't lower your rating if you are still open, we will wait till the doors are locked to drop ratings" Goldman is coming out swinging in regards to the bank prospects.

This brings up a key point. Why is GS so hot to put out these kinds of reports? I mean, if they are right obviously they are in a great spot. I mean something more along the lines of burning bridges and fostering bad blood. The banks are all linked and constantly do each other's business. While certainly each bank is it's own entity with it's own interests, they all depend on each other for all kinds of deals. For Goldman to continue to make waves among the banks, they must be pretty sure of two things:
  1. They are correct in their reading of the situation
  2. They will not require, in the near term, any special treatment from sister banks

If they are sure about points 1 & 2 the relative performance of GS will be very interesting to see going forward.

Still Not getting IT

I know, I should not watch CNBC! They trotted out a bunch of people all day long that are sure home demand will pick right up in 2008, maybe late in the year, and all will be fine. It is very annoying to listen to these fools and the have the hosts ask not even one question about how that occurrence will happen. Here is what any "rebound in 2008" type person must answer before their opinion can even be taken seriously:

  • With major lenders like CFC and IndyMac now requiring FULL DOCUMENTATION, as well as 5% DOWN by how much does that kill off potential demand?
  • Lending standards are going to keep getting more restrictive, so what pool of buyers can replace the loads of subprime borrowers from the last 4 years?
  • Lawsuits over restructuring, hidden losses, REO's through the roof, foreclosures still rising, and possible capital problems at banks will cause home loans to go a) UP b) DOWN?

Until one of these clowns can answer at least one of the above without invoking Unicorns and magic wands, they should just shut up. Seriously, it's fine to be wrong but at least try and pretend you have any idea what the deal is.

New poll up tonight about the Goldman playbook, please vote!

Have a good night.

4 comments:

Anonymous said...

My guess on Goldman is they are shorting the hell out of anything that looks wounded, may as well give your competition a push down the stairs if they are off balance and already heading that way and maybe pick up some assets on the cheap later.

I would like nothing better then to see some dirt uncovered on Goldman though these guy's have way to many inside government connections as far as I can tell.

Kevin

getyourselfconnected said...

Kevin,
Your point about the GS government connections was one I forgot to cover. It does seem strange that GS may be shorting the banks while at the same time Paulson (former GS CEO) is the secretary of the treasury and the treasury and FED are trying to bail the banks out. Working is opposition it would seem. This is a very ineresting story to me and I will try to keep an eye out for more information.

Anonymous said...

It's not just Paulson the current Treasury secretary having been the head of Goldman, Canada's new head central banker is from Goldman, and about 17 ex-Goldman Sachs people in the current administration there is no doubt in my mind that the game is rigged. The fall in oil prices that started within days after Hank Paulson was sworn in and started the o6 advance in the stock market were a result of Goldman reconfiguring their commodity index which caused oil to be given a smaller weighting and caused firm who tracked that index to sell oil and re-balance their funds which also drove the price of oil down and resulted in a hedge fund blow up. I follow this group as closely as I can also but there are a lot of smoke and mirrors. I lost a lot of money on that little scam so this is personal to me.

Kevin

TexasRadio said...

GS, whatever their flaws, does have some semblance of fiduciary responsibility. If they discover some data about Citi, they are duty-bound to report it.

Also, GS is not short the banks. I do not know this for a fact, but the backlash of such a position would destroy the basis for the firm's existence. Since GS doubtless employs many top economists, they know what is coming.

GS will undoubtedly benefit from bank failures as they pick up valuable assets for pennies on the dollar. That is not to say that their own stock will not decline: it is a certainty. But they can't stop that and likely know it.

From GS to Bernanke to Hillary and everyone in between, they can do nothing other than what they are already doing. That is the hell of a deflationary asset spiral.