Wednesday, April 9, 2008

Goldman Sachs Level III assets balloon

Goldman's latest 10Q reports $82.3 billion of Level 3 assets for the quarter ending February of 2008, versus $54.7 in November of 2007.

Goldman had this to say:

The increase in level 3 assets during the first quarter of 2008 primarily reflected reduced levels of liquidity, and therefore reduced price transparency, related to loans and securities backed by commercial real estate, loans and securities backed by residential real estate, and corporate debt securities and other debt obligations, as well as the funding of certain bank loans. (pages 65&66)

In the opaquest instruments of all, level 3 derivative pricing, Goldman threw in $9.3 billion more derivatives for the quarter to $25 billion. GS says this on pricing and risk:

"Valuation models are calibrated to initial trade price. Subsequent valuations are based on observable inputs to the valuation model (e.g., interest rates, credit spreads, volatilities, etc.). Model inputs are changed only when corroborated by market data..."Derivative transactions may also involve legal risks including the risk that they are not authorized or appropriate for a counterparty, that documentation has not been properly executed or that executed agreements may not be enforceable against the counterparty. We attempt to minimize these risks by obtaining advice of counsel on the enforceability of agreements as well as on the authority of a counterparty to effect the derivative transaction. In addition, certain derivative transactions (e.g., credit derivative contracts) involve the risk that we may have difficulty obtaining, or be unable to obtain, the underlying security or obligation in order to satisfy any physical settlement requirement."

On page 98, Goldman has a table of their OTC derivative credit exposure. Last quarter, November of 2007, they had net derivative credit exposure, to those parties rated BBB or below of $15.2 billion. In this quarter, ending February 2008 they had exposure to $24.3 of OTC derivative credit exposure rated BBB or below.

So we know where Goldman's increase in level 3 derivative exposure came from.

And since no-one knows for sure what constitutes level 3 pricing, or the inputs on derivatives, this will probably get some play by the bears, who want to offset Citigroup's good news: The off loading of $12.5 billion of leveraged loans from Citigroup's balance sheet at .90 cents on the dollar:

Citigroup is nearing a deal to sell $12bn in leveraged loans at a discount to a group of leading private equity firms, marking another step in new chief executive Vikram Pandit’s efforts to shrink the beleaguered bank’s balance sheet.

Although details of the deal were still being worked out, people familiar with the matter said Apollo Management, the Blackstone Group and TPG would buy the loan portfolio at a discount that could come in at about 90 cents on the dollar

The Citi portfolio includes loans used to finance acquisitions by Apollo, Blackstone and TPG, as well as debt in their rivals’ deals. Apollo would buy about half the portfolio, with Blackstone and TPG taking the rest. Citi declined comment.

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