Comments on: Goldman’s CELF-interest A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Danny_Black Wed, 01 Dec 2010 11:00:59 +0000 foodist, it actually is not that complicated…

Basically what happens is that GS has a load of loans. Either loans it made or loans it bought. It doesn’t want to keep them on its balance sheet so it forms a new company. This company issues bonds with the promise to go out and buy these loans – it does not appear to be a static portfolio but the general characteristics are defined.

Thinking of the cash flow as water, there is a certain expected flow from the loans in terms of interest payments and then principal repayments. This is one bucket. There is typically some extra cash added in, this is the “over collaterisation” bucket, it is used to make up any shortfall in the loan bucket. These two then poor water into the third bucket. Imagine this bucket has holes in it. The first hole at the bottom of the bucket is the A1a note, water comes out if it first and the amount depends on the amount of water the loan bucket and O/C bucket are pouring in up to a limited amount. Above that hole is A2a and water comes out of there as soon as the A1a hole is flowing freely. Then A2b after. This is the AAA tranche. Any water left over is flows through the sub note hole. In principle, this structure should stay in place until 2020. It has to stay in place until Sept 2010 and then if people holding 50% or more of the sub notes vote so then the entire thing can be unwound – so the underlying loans are sold to someone else and the bonds are bought back with the money earnt from the sale plus the excess cash. The AAA tranche gets paid off in full – this is a requirement – and then what is left over goes to the sub note owners.

What GS did was buy back the AAA tranche and some of the equity and then use the right to unwind. Mr Salmon is suggesting that if GS was serving the client then they would have done it the other way round ie sold **their** equity to the client and left it to the client to unwind.

What makes this stuff complicated – and by the way gives it a major reason to exist – is tax and regulatory treatment. If the sub notes paid no interest and GS and others bought at 72.5 and sold at 80 then that is a capital gain whereas interest would be income and the tax treatment is usually different. The other issue can be regulation. The client might be the same but there might be different funds run by that client that invested, so maybe the ABC high-grade fund bought the AAA tranche and the ABC high-yield fund bought the sub notes. The high-grade fund won’t be allowed to buy the sub notes and the high-yield might have limits on their exposure to it. Also ABC might be the same company but the two funds might have different managers and will be separate legal entities.

Equity=subordinate bond, note=bond( normally a medium tenor bond ) in above.

By: Danny_Black Wed, 01 Dec 2010 08:28:53 +0000 Well lets do the sums shall we?

A1a notes got 6 month EURIBOR + 165bips, A2a got plus 150 and A2b got + 300. You imply that they took a 400 bips hit on the principal. In 2008 6m EURIBOR was averaged above 3% but lets assume 3 to make sums easy, so they will have earnt very roughly 37m on A1a note, 13m on A2a and 2m on A2b. In 2009, again lowball average is around 1.5% so they earn 25m, 8m and 1.5. 2010 again very roughly EURIBOR is 1%, so 21.5m, 7m and 1.3m and the haircut means a loss of 45m, total gain to fund is 71.3. Lets assume GS buys sub notes at par and sells at 80 plus gets that gain on the AAA tranche, GS makes 73m. So the difference to the client is around 2 million between your suggestion and what actually happened. In return for losing out on that extra 2m GS takes on a billion plus onto their balance sheet for just over a month whilst the underlying get sold/redeemed in the midst of a EUR crisis.

I can think of lots and lots of other reasons. Tax reasons for taking the loss on one bit and gains on the other. Regulatory restrictions of the amount of sub debt the client can buy vs AAA rated stuff. Not wanting to a billion plus risk in the middle of a EUR crisis. Certainly isn’t straight forward. Here is a crazy insane idea… why don’t you ASK the client?

PS here is the prospectus: Final-Prospectus

careful arithmetic was never my strong point so it is more than possible I made a horrible error, especially given the smug tone of the post…

By: crocodilechuck Tue, 30 Nov 2010 05:57:04 +0000 Felix, TED: good work, thanks

By: OnTheTimes Tue, 30 Nov 2010 05:28:47 +0000 “I’ve since learned a few more interesting facts about this transaction, none of which make Goldman look particularly client-centric.”

It should have been obvious to everyone that when Goldman got the government to take over AIG and then use AIG to bail out Goldman that Goldman is not very client-centric. By any measure, AIG was a huge client of Goldman, and for the short term gains of Goldman management, they threw AIG under the steam roller.

Goldman is not client-centric nor shareholder-centric. They are Goldman executive-centric.

And, by the way, they do not put their capital at risk. They risk the government’s capital.

By: hsvkitty Tue, 30 Nov 2010 03:52:22 +0000 @foodist

Warn me so I can take a gravol! (sorry Felix, couldn’t help the little dig!)

By: FreddieJJ Tue, 30 Nov 2010 03:16:05 +0000 Is it possible that the Dutch pension fund wasn’t actually allowed to take the loans on their books? I know lots of funds have very strict rules about the amount of capital they can allocate to lower rated securities. If that were the case it would explain Goldman’s insistence that the process was client driven. It might also explain why the fund had some of the equity. They wanted to make sure that the deal couldn’t be unwound on them putting them in an untenable position. Don’t know if that makes any sense or not, but it is an alternate explanation.

By: foodist Tue, 30 Nov 2010 02:13:17 +0000 Felix, you usually do a follow-up post/video in plain English for those of us who aren’t up to par with the finance lingo. Would it be too much to ask for you to do one for this particular story?

By: ErnieD Tue, 30 Nov 2010 02:06:51 +0000 You folks really don’t get it.

Goldman Sachs IS the client now, as is JPM and the other TBTF firms. The entities Formerly Known as Clients, as well as the taxpayer, now exist to serve the TBTF firms.

The entire global financial system is now structured to maximize the returns of the TBTF firms around the world, whether they be US, German or Japanese companies and to ensure that they are not injured even through their own monumental greed and stupidity. There is no other priority that takes precedence.

By: EpicureanDeal Mon, 29 Nov 2010 23:04:43 +0000 Yes.

Interesting new facts, which support my gloss on the story. Goldman did not treat its counterparty as a client in any respect. Saying so is indeed vintage ordure de cheval.