Lots of interesting things to report regarding Goldman Sachs (GS) today.
- In this post: accounting gimmickry, higher leverage (tangible assets/tangible common equity calculated below), and silence regarding AIG payments.
- In the next post: Goldman raises $5 billion in a sale of stock, which is good news.
Accounting Gimmicks and Tangible Common Equity
With respect to their Q1 earnings announcement, it appears Goldman may have one-upped Wells Fargo (WFC) in the accounting shenanigans department. As Floyd Norris blogged this morning, they ditched an entire month…
Where’s December?: Goldman Sachs reported a profit of $1.8 billion in the first quarter, and plans to sell $5 billion in stock and get out of the government’s clutches, if it can.
How did it do that? One way was to hide a lot of losses in not-so-plain sight.
Goldman’s 2008 fiscal year ended Nov. 30. This year the company is switching to a calendar year. That leaves December as an orphan month, one that will be largely ignored. In Goldman’s earnings statement, and in most of the news reports, the quarter ended March 31 is compared to the quarter last year that ended in February.
The orphan month featured — surprise — lots of write-offs. The pretax loss was $1.3 billion, and the after-tax loss was $780 million.
Would the firm have had a profit if it had stuck to its old calendar, and had to include December and exclude March?
For its part, S&P said it’s not buying the hype that Goldman’s earnings indicate a turnaround:
'Coupled with persisting weak economic conditions and capital markets turmoil, we believe it would be premature to conclude that a sustained turnaround’ in Goldman Sachs’s financial performance is under way, S&P wrote.
It’s important to put this particular accounting shenanigan into context. Yeah, it’s underhanded to play games like this in order to enhance reported earnings; investors hate this kind of thing. [An analyst at my old firm once yelled at a CEO on a conference call when he noticed an extra day was added to a quarter in order to boost profits. We were long-term holders of the stock. In such cases, management credibility is more valuable than an extra penny of "earnings." But I digress.]
Smart investors, however, pay less attention to accounting profits, since these can be manipulated so easily by management. Instead, they focus on the balance sheet and the cash flow statement. Whether Goldman chose to write down a particular asset in the “missing month” of December or during Q1 makes little difference for balance sheet purposes.
So for instance, take OA’s favorite metric: tangible assets/tangible common equity. Writedowns are problematic because they hit the numerator and denominator by equal amounts, more or less. And when you’re talking about a grossly over-leveraged institution like a bank, a 5% writedown of assets can wipe out 100% of TCE. [Remember: a million-dollar house with a $950k mortgage need only fall 5% in value to wipe out 100% of the homeowner's equity.]
The timing of writedowns is clearly important. Banks are delaying hundreds of billions worth via all manner of accounting gimmickry. But the strange timing of these particular writeoffs from Goldman, i.e. the ones that were taken EARLY so as to avoid impacting Q1 earnings, are not as pernicious as those that are being delayed. Whether Goldman took ‘em in December or in March wouldn’t matter for purposes of calculating the bank’s end of March leverage ratio, for instance. And in fact, an argument can be made that it’s better to take the writeoffs sooner rather than later so as to avoid adding too many assets to an already bloated balance sheet.
While Goldman didn’t publish their full balance sheet, it appears you can back into the TA/TCE ratio based on what they did disclose (see pages 4 & 11).
Total Assets were $925 billion at the end of Q1. Intangibles were $5 billion. Backing that out, GS has $920 billion of tangible assets at quarter end. Shareholder equity ended the quarter at $64 billion. Subtract preferred stock of $17 billion and intangibles of $5 billion and you have tangible common equity of $42 billion. In other words, GS’ tangible leverage ratio was 22x at the end of Q1. (920 / 42 = 22)
That marks a slight deterioration from last quarter, when the ratio was 21x.
Besides a full balance sheet, there are other important disclosures we’ll have to wait for. For example, while they noted that mark to myth Level 3 assets fell a bit to $59 billion from $66 billion, they made no mention of changes in mark to model Level 2 assets, which are substantially larger. Level 2 and 3 assets overwhelm tangible common equity, which is a big reason few investors trust that big banks are solvent.
Many are also wondering about the impact of payments Goldman received for CDS positions with AIG Financial Products. AIG’s bailout, readers will recall, wasn’t so much for AIG. It was for AIG’s counterparties, other banks that made margin calls on CDS positions when AIG’s debt rating was downgraded.
Goldman was the largest recipient of payments from AIG. It received $12.9 billion. Losses due to counterparty risk that should have been absorbed by shareholders and creditors were instead funded by taxpayers. Naturally, Goldman isn’t much interested in discussing the issue. Back to Norris:
Analyst Guy Moszkowski of Merrill Lynch wants to know if they made money from the now-famous government-financed American International Group transactions.
The answer is cautious. Most of the impact was in December. For the first quarter, the total A.I.G. effect on earnings was, in round numbers, zero.
So what was the A.I.G. effect in December? They did not say.