Goldman Believes Two-Thirds Of Financial Losses Realized, Completely Ignores Derivatives And FAS 166/167
"Bad loans = big losses" Golaman's most recent quantification of bank losses begins objectively enough, yet promptly devolves into yet another cheer fest for the financial system. GS promptly rehashes its estimate of "only" $2.1-2.6 trillion in bank losses, slighty adjusting the composition of loans it believes will go bad, while completely ignoring the onboarding of off-balance sheet liabilities (FAS 166-167) as well as any and all potential losses in the derivative realm, where Goldman itself is on the hook for tens of trillions in gross notional. The only thing missing from this fluff piece is a Conviction Buy rating on Goldman itself (but the Conviction Buy on toxic credit card and real estate debt laden BAC, JPM and COF is certainly present).
The highlights from the report:
We are entering the final third of loss recognition with $1.6 tn of losses realized to date. Key points:
(1) Stable estimate, changing composition: We have estimated $2.1-$2.6 tn of total losses from US credit since March of 2009. We still believe this is the right range but update the composition with more for prime mortgage and commercial real estate and less for consumer and C&I.
(2) Two-thirds through recognition: $1.6 tn of losses have been recognized, putting us about 2/3 through the cycle. Bank NPA and reserve levels are also about 2/3 of the way to the peak in prior regional home price depressions, which have exhibited similar cumulative loss rates.
(3) Remember the cause- bad lending: The core cause of the crisis – bad lending, particularly in real estate. 98% of losses can be traced to bad loans in general, and 70% of losses can be traced back to bad real estate loans. Regulators will likely re-focus on this. Consider that almost every bank that has failed cycle to date has either been overweight Option ARMs or construction loans.
(4) Prime problems: Prime mortgage credit trends continue to disappoint while commercial
real estate will be increasingly evident as well. Conversely, consumer and C&I losses seem likely to come in below our original expectations given recent improvement in the data and outlook.
(5) Q: Was the stress test enough? A: Yes: With unemployment at 10.2% vs. a 10.3% stress test peak, it is reasonable to ask if the stress test was enough. 2009 loan losses, trading results, and pre-provision earnings have all tracked better than the stress test forecast. Moreover, banks raised $10 bn more capital than the stress test required.
Continue to favor consumer credit.
A lower consumer cumulative loss outlook simply formalizes what we have been saying for some time – rate of change of unemployment matters more than the level. If unemployment flattens out at a high level, consumer credit will improve. Thus we remain positive on big banks and credit card stocks with JPMorgan Chase, Bank of America and Capital One rated CL-Buy.
If the last sentence is not enough to force you to projectile vomit all over your monitor, here are some of the pretty charts that accompany what is in the narrowest definition of the term, a fluff piece, which as we pointed out completely ignores any discussion on critical derivative reform (shhh, keep quiet - any problems will just go away... and those trillions in IR swaps GS is on the hook for will behave very nicely once (when, not if) the US can not sell its tens of billions in 0% yielding bonds at any one given time in the near or more distant future).
Estimates of total expected losses and current losses versus prior cycles:
Cumulative estimates by loan category:
Recognized losses to date and future estimates:
Here are the main culprits:
Any mention of derivative is strictly verboten. So the underlying has caused trillions of losses yet derivatives thereto are all hunky-dory? Tell that to Barney Frank. Instead, here is what GS does tell: "Despite the current attention being paid to derivatives and other trading activities, such activities accounted for less than 2% of total losses to date. 98% of losses to date began with loan decisions and consequently, we believe that regulators will likely re-focus on the topic of lending standards." We, on the other hand, believe Goldman is very wrong.
And somehow Goldman wants us to believe lending standards are sound... With the FHA giving virtually no money down loans to any semi-self aware bundle of protoplasm that can sign above the dotted line, we would have to feverishly agree.
And here is why banks have been selling every last MBS exposure on their books to the Federal Reserve. Ever wonder why that dollar in your pocket has lost so much value since Goldman started planning its bonus parties? Wonder no more.
If in need of more emetic content, full report attached.