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I am still in the process of preparing the Goldman Sachs (NYSE:GS) stress tests for publication, but just 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. Remember that Goldman has some of the highest VaR numbers of the bulge bracket save the collapsed Lehman Brothers (LEH), which collapsed in large part due to its commercial real estate exposure (much as Bear Stearns).

I also want to reiterate 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 that position reached fruition.

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

Well, the nation's 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 source 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 General Growth Properties (NYSE: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

54073

51852

37523

Commercial real estate

19,020

19440

16572

Residential

22837

19070

15238

Prime

14,370

12290

8597

Alt-A

6,358

4940

4704

Sub prime

2,109

1840

1937

Loan portfolio

12216

13342

5713

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, and at 22x leverage, it 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

35.17%

37.49%

44.16%

Residential

42.23%

36.78%

40.61%

Prime

26.58%

23.70%

22.91%

Alt-A

11.76%

9.53%

12.54%

Sub prime

3.90%

3.55%

5.16%

Loan portfolio

22.59%

25.73%

15.23%

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

Equity

512

709

1,183

1,325

1,094

1,102

Debt

782

1,045

934

1,020

1,112

1,147

Non-trading Risk

SMFG

133

130

99

41

0

0

ICBC

217

205

231

250

239

262

Other Equity

462

591

1,059

1,054

1,083

1,224

Debt

222

277

403

500

550

637

Real Estate

455

497

708

1108

1241

1369

Total

2,783

3454

4617

5,298

5,319

5,741

See also: The Official Reggie Middleton Bank Stress Tests

Disclamer and explanation as to what I do for a living: I am a pure investor, plain and simple. I am not a journalist, analyst or professional pundit. As such, I am short GS since June of 2008, and was heavily short GGP from 11/07 to the latter part of 2008. So there is no confusion, I am nearly always short a company that I am bearish enough on to generate and publish bearish research - just as I will always be long a company that I take the time to publish bullish research on. This is a constant, and I don't have the time and bandwidth to do otherwise, unless otherwise stated - which is quite rare.

Source: GGP Bankruptcy: Implications for Financials