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11 December 2023

Goldman Sachs hedges mortgage exposure to tower over rivals

By Nitin Nambiar



Hedging its exposure to the sub-prime mortgage market helped Goldman Sachs Group cut losses this year, a spokesperson for the Wall Street investment bank said.

In a year when most rival banks have reported quarters saddled with billions of dollars in credit losses, Goldman turned out a near-record profit in the third quarter, despite having to write down $1.7 billion (Dh6.2bn) of leveraged loan commitments. Shares of the other three major investment banks that report quarterly results this month – Morgan Stanley, Bear Stearns and Lehman Brothers Holdings – are down more than 20 per cent from the start of this year. Goldman stock is up 6.4 per cent so far.

“During the course of the year, we had become increasingly concerned about the US housing market and began to hedge our mortgage exposure,” said Lucas van Praag, global spokesperson for Goldman. “In spite of the strength of our financial performance, we wrote down $1.7 billion of leveraged loan commitments and continued to suffer losses in our mortgage business,” Van Praag told Business 24|7 in an e-mailed statement.

Goldman has been attracting more attention than the firm desires, including scrutiny from regulators and conspiracy theorists. Some market-watchers have criticised the bank for placing massive “short bets” on the direction of the mortgage market.

Being “mortgage short” implies the bank is in a position to profit when mortgages perform badly. The bank has denied this. “At the end of the third quarter, we had a net short position in our mortgage book. Some people have incorrectly described this as placing a massive ‘short bet’… Hedging is the definitional opposite of betting. It involves buying protection, or insurance, against adverse movements and is generally considered to be a good example of prudent risk management,” Van Praag said.

Goldman seems to have made the correct bet on the mortgage market by positioning itself as net short. Analysts expect Goldman’s final quarter to be the strongest of the four banks reporting this month.

Although the bank refused to divulge detailed performance information for its Middle East operations, Van Praag said it intends to expand its business from the region.

With mortgage credit quality decaying and demand draining for risky investments, a host of investment banking mainstays from junk bonds to corporate takeovers has slowed or in some cases shut down this year.

The fallout from this upheaval has hurt some major banks worse than others. Bear Stearns expects to book credit costs of $1.2bn (Dh4.4bn) for the fourth quarter. Two hedge funds managed by the bank have gone bankrupt, and the company’s stock is down more than 40 per cent this year.

By contrast, Goldman Sachs shares currently trade at 2.33 times the net value of the company’s assets. Of the major Wall Street banks, the second-highest price-to-book ratio is roughly 1.6. Goldman’s stock climbed 29 per cent during the fourth quarter to close November at $226.64 (Dh831).

Earlier this month, economist and writer Ben Stein accused a Goldman economist of issuing bearish reports on the housing and mortgage market to support the firm’s traders betting on the market’s decline. In a New York Times column, Stein compared Goldman’s “sub-prime short-selling of securities” with the tech research scandals five years ago. Stein also questioned whether former Goldman Sachs Chief Executive Henry Paulson should be Treasury Secretary.

Accused of understating its exposure to the mortgage market, Van Praag said: “We rigorously mark our positions to market everyday. The numbers we report are correct.”

Still, the questions are drawing attention from regulators and politicians. Senator Chris Dodd of Connecticut, a Democratic presidential candidate, has called for an investigation. The Securities and Exchange Commission is “taking a closer look” at how Goldman and other banks value assets, Reuters reported, particularly illiquid securities that have fuelled losses at hedge funds and rival banks.

Profits and payouts are both higher

Goldman Sachs Group, the world’s largest investment bank, yesterday beat Wall Street expectations for the fiscal fourth quarter, driven by gains in its investment banking and financial advisory segments.

Profit after paying preferred dividends for the three months ended November 30 rose to $3.17 billion (Dh11.6bn) from $3.10bn (Dh11.3bn) in the year-ago period. Revenue rose to $10.74bn (Dh39.4bn) from $9.41bn (Dh34.5bn) a year earlier.

Goldman’s stock climbed 29 per cent during the fourth quarter to close November at $226.64 (Dh831). While most of Wall Street is expected to hand out bonuses that are flat or lower this year, Goldman’s payouts will be generously higher.

Morgan Stanley and Merrill Lynch have dismissed top executives and are expected to cap the year with money-losing quarters. In contrast, Goldman’s payouts will rise to roughly $18bn (Dh66bn) for the year. On average, that is about $600,000 (Dh2.2 million) per employee, or double the average paid at other firms. CEO Lloyd Blankfein will lead the way with as much as $70m (Dh256m) in salary and bonus, according to Bloomberg.

The Wall Street Journal reported last week that Goldman generated $4bn (Dh14.6bn) in gains from the sub-prime trades. A news report on Monday said Goldman’s shares were trading at 2.33 times the net value of the company’s assets. Of the major Wall Street banks, the next highest price-to-book ratio is roughly 1.6.

Bloomberg reported on Monday that Goldman Sachs may commence its newest hedge fund with about $10bn (Dh36.7bn). The fund, to be known as Goldman Sachs Investment Partners, is set to open on January 1 and will be led by two traders who previously worked on the firm’s proprietary equity desk. The new fund is reportedly part of Blankfein’s plan to expand the company’s wealth-management business.