Goldman’s misleading statement on ACA

By Felix Salmon
April 19, 2010
last two. But since Goldman is making such a big deal of it, let's take a closer look at ACA's "investment" in the Abacus deal.

Here's Goldman, which doesn't seem to have put this latest statement up on its website:

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Goldman Sachs has yet another statement out on the subject of the SEC charges against it, which adds little to the last two. But since Goldman is making such a big deal of it, let’s take a closer look at ACA’s “investment” in the Abacus deal.

Here’s Goldman, which doesn’t seem to have put this latest statement up on its website:

ACA Capital Management was both the portfolio selection agent and the overwhelmingly largest investor in the transaction ($951 million, with the other professional investor’s exposure being $150 million)…

ACA, the Largest Investor, Selected and Approved the Portfolio.

And here’s the facts, as laid out in the SEC complaint, none of which have been disputed by Goldman:

ABACUS 2007-AC1 closed on or about April 26, 2007…

On or about May 31, 2007, ACA Capital sold protection or “wrapped” the $909 million super senior tranche of ABACUS 2007-AC1…

The super senior transaction with ACA Capital was intermediated by ABN AMRO Bank N.V. (“ABN”), which was one of the largest banks in Europe during the relevant period. This meant that, through a series of CDS between ABN and Goldman and between ABN and ACA that netted ABN premium payments of approximately 17 basis points per year, ABN assumed the credit risk associated with the super senior portion of ABACUS 2007- AC1’s capital structure in the event ACA Capital was unable to pay.

In English, it seems that Goldman Sachs held on to the super-senior tranche of the Abacus deal for a good five weeks while it was negotiating to lay off that risk to ACA and ABN Amro.

What that says to me is that ACA was not really an investor in the Abacus transaction in the way that IKB was; it certainly never bought any of the Abacus securities. Instead, it insured the super-senior tranche. (I’m unclear on how to account for the difference between Goldman’s $951 million and the SEC’s $909 million.)

If ACA Management had been working on this deal since January, and ACA Capital was always going to insure the super-senior tranche, why did Goldman wait so long after closing to close the wrap? It’s pretty clear that ACA Management, the entity which “Selected and Approved the Portfolio”, was in no sense the “Largest Investor” that Goldman is referring to.

There’s a real difference of fact here between Goldman and the SEC: While Goldman refers to a single entity called “ACA Capital Management”, the SEC talks about three different entities: ACA Management LLC, the CDO manager; its parent, ACA Capital Holdings; and the guarantor, ACA Financial Guaranty Corporation.

It’s also worth noting that when Goldman wrapped the super-senior tranche of the Abacus deal, it did so with ABN Amro, a too-big-to-fail bank, and not with ACA. ABN Amro then laid off that risk onto ACA, but was on the hook for all of it if ACA went bust. As, of course, it did.

Why didn’t Goldman simply wrap the super-senior tranche with ACA at the time the deal closed, and then go ahead and manage its ACA counterparty risk in much the same way as it claims to have managed its AIG counterparty risk? Probably because it sniffed out the cost of buying $1 billion of credit protection on ACA, and it was a lot more than the 17 basis points that it managed to get from ABN Amro by getting ABN to intermediate the wrap.

Goldman, then, seems to be conflating the concepts of insurance and investment — a point made well by Brad DeLong this weekend. And it’s conflating, too, the various different subsidiaries of ACA Capital Holdings. And it’s glossing over its own significant efforts to go through ABN Amro when wrapping the super-senior tranche, precisely because, it seems, it had worries about the creditworthiness of ACA. Once again, Goldman seems to be giving us much less than the whole truth. But that no longer comes as a surprise.

Update: As Sandrew points out in the comments, now that we’ve seen Goldman’s response to the SEC, we can see that ACA did buy $42m of the Abacus deal in security form. Probably because the investor, IKB, required that they have some skin in the game.

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