While celebrating our new Totalitarian Woke reality, we noticed something about the Vampire Squid (aka Goldman Sachs) financials.
[ Standard disclosure: Not investment advice, not investment advice, not investment advice, Cancel Manchester City from Premier league ]
As depicted in the chart above, the Provision for Credit losses at its Investment Banking division has exponentially increased from $34 million in 2017 to $1.6 billion in 2020!
It must be noted that when we quote a figure, you can be absolutely certain that we are accurate as we argue with facts and figures and not with narrative.
Now it used to be that Investment Banking was a relatively low credit risk business, as it relies on the networking and deal-making ability of the bank to land merger and acquisition deals, i.e. how close the bankers were with members of The Cabal. It was primarily fee paying and you do the deal, you get paid, sell-off the junk and you take little balance sheet risk.
(Note : You get credit losses when you have to warehouse loans on your balance sheet. The idea of investment banking has always been to sell the crappiest stuff off your book to unsuspecting Muppets )
(Note: Per Disney, the Muppets includes negative depictions and/or mistreatment of people or cultures )
However, that all changed when the Fed continued the policy of destroying super savers by crushing the real interest rates. This opened up the market for many corporates which were semi-functioning to enter into the corporate debt market and with that they brought some of the zombies around to the debt markets.
The idea is this: If cost of equity is less say 10% and cost of debt is 3% and you don’t care if your company goes down, then why raise money through equity?
The worst of the zombies are the private equity funded leveraged buyout (“LBO”) deals. These LBO deals rely on the business generating sufficient cash-flow to pay down debt by slashing costs. If the deal works out, essentially the owners of the business unit make spectacular gains because their initial investment is only a small fraction of the total cost required to purchase the business, with the remaining coming from your friendly banker or vampire.
Conversely, if things don’t work out, the company most exposed to the risk of the deal is not the fund which bought out the business but the bankers who financed the business. In return for taking this risk, the bankers demand high fees and high interest rates, in the hope that they can offload the junk as soon as possible to any unsuspecting funds out there.
That could help us answer the question behind the sudden increase.
To answer that question, lets look at the Asset profile of the Investment Banking Division of the Vampire Squid. (Note: This is a segment level of $116 billion, not the consolidated entity!)
So over the last year, the Vampire Squid has about $26 billion in loans, which was not too different from the rest of the years.
A further digging into the FT revealed this interesting article over here.
Basically, the article talked about how Bankers eager for deals underwrote some extremely risky sub-investment grade loans, mainly used to finance Private equity buyouts such as Advent International and Cinven’s €17bn buyout of Thyssenkrupp’s elevator business. According to the FT, Goldman Sachs retained a €1.5 billion portion of the loan used to finance the buyout.
With Commercial Real Estate sector now in big trouble due to Covid , only time will tell whether this loan will enter the deeper reaches of Stage 3 Death and Doom, in the CECL Loan Stage of Doom. (Stage 1 ok, Stage 3 – You die).
The lessons of this are 2 fold:
- Blame Covid
2. Don’t go chasing waterfalls, stick to the rivers and lakes you’re used to
A Primer on Loan Accounting Framework
So a question some folk who look through the financials of a bank may ask is , hey Jazzman, there are so many types of loans out there such as
- Loans – held – for investment
- Loans held for sale
- Loans at fair value
When we talk about provisioning , like above, what do we actually mean? Is it for all 3 categories or just one!
Generally American (“Cabal”) banks only record provision for Loans-held-for-investment.
This is because “Loans held for sale” or “Loans at fair value” are valued at either lower of cost or fair value, or at fair value. The idea is that these banks employ risk pricing models which should give a “fit and proper” (ahem., cough, bad cough, at-choo, wobobob, aargh) valuation of the loan based on appropriate inputs. One key input is the Credit Spread on a loan – which tracks the probability of default (tracks! not equivalent). But you can mathematically derive the estimated probability of default from the credit spread. Using this input you get a new fair value for the loan which should give you the price of the loan as if all the bad information had been incorporated.
If the loan price goes down, banks may hide the figure under the category “Noninterest revenue”, which will go down as the fair value goes down, or goes up if the fair value goes up. Now the above is only true for American banks who are the protection of the ,Cabal-to-end-all-Cabals, called the Federal Reserve.
For non-Cabal affiliated banks, they are subject to this even scarier ghost, even scarier than hantu raya, called Hantu IFRS 9. Under IFRS 9, Credit Impairment losses are recognized for debt securities if it is held under the “Fair value through other comprehensive income” method.
So it pays to be in a cabal.
That is all I want to say today.