Why the Fed thinks Goldman is America’s riskiest bank

Goldman Sachs has a new title that it may have to live with: America’s riskiest big bank, according to the Federal Reserve.

This week, the Fed slapped Goldman with a higher total capital requirement than any other US bank, thanks to a large “stress capital buffer” that the regulator wants all banks to maintain to see them through the most severe shocks. . The resulting requirement for Level 1 common stocks – generated largely from retained earnings and share sales – represents at least 13.7% of Goldman’s risk-weighted assets.

React at the verdict, the Wall Street bank said it could Carry on with plans to invest in new business and would maintain current dividend payouts, even though the level 1 target he is due by October is a little above his current position.

The Fed arrived at this number based on its stress test, which models the performance of Goldman and 32 other banks in a garden variety recession and a severe one. A second “sensitivity analysisA rougher exercise that examined how banks might cope with the added strain of the pandemic, informed the Fed’s thinking about how banks should approach issues such as dividends, but failed affected the stress capital cushion.

But for Goldman, the numbers that really jump off the page are the Fed’s assessment of its worst loan losses in the nine quarters from the start of this year to March 2022.

Goldman’s numbers include astonishing outliers, like a 25.9% loss rate on its mortgage portfolio: nearly 10 times higher than the next worst result.

Meanwhile, the 14.9% supposed loss on Goldman’s commercial and industrial loan portfolio is more than double the 7.2% average of the rest of the participating banks.

Faced with a less mind-boggling set of figures and a demand for capital that it is already meeting, US retail bank Citizens has publicly targeted “inaccuracies” in the Fed’s calculations.

Goldman is holding his tongue so far. Marty Mosby, analyst at Vining Sparks, said the bank suffered higher losses on consumer loans largely because its business – which started offering online lending less than four years ago and credit cards in 2019 – had not been tested by a recession, so regulators might be inclined to be conservative.

Mr Mosby also said that the higher mortgage losses reflected the fact that the loans “don’t match” the Fed’s models since they were intended for high net worth individuals at Goldman’s private bank, rather than the “loans to the bank”. butter and butter ”generally reviewed by the central bank.

Some analysts are less circumspect. “These are bananas,” says Chris Kotowski, banking analyst at Oppenheimer.

Bananas or not, the damage done to Goldman by these murderous assumptions is manageable because the bank loan book is relatively small, at $ 128 billion, roughly an eight the size of JPMorgan Chase.

This means that the Fed’s loan loss forecast took only $ 9.8 billion of Goldman’s bottom line during the period, far less than the $ 47 billion in losses expected for Citi, BofA or Wells Fargo.

The real damage is the $ 18.4 billion in trading and counterparty losses on Goldman’s trading assets that the Fed envisioned, which pushed Goldman to a net loss of $ 27.5 billion over the course of the testing period.

Mr Kotowski argues that these assumptions have already been proven wrong for Goldman, since the Fed’s worst-case swings were similar to those banks actually endured in March. Rather than losing billions, Goldman’s trading operations made money: $ 2.25 billion in pre-tax profits in the first quarter, up 75% from the previous year.

There are legitimate reasons for the divergence between the Fed’s projections and Goldman’s actual performance. The Fed did not assume any political support – let alone the dramatic interventions by the central bank itself, which stabilized the market. The Fed’s assessment was also based on historical snapshots of end-2019 balance sheets, which moved rapidly in March and April.

Yet Mike Mayo, an analyst at Wells Fargo, said the Fed’s models were so at odds with reality that Goldman had a duty to shareholders to challenge them.

“You have a fantastic record [on managing risk] and now you’re going to leave the Fed. . . do you have the highest capital requirements due to some assumptions which are not even clear to them or to us? Mr. Mayo said. “Why do you go to bed and take this?”

Citizens will ask the Fed to “reconsider” its stress capital cushion as part of a consultation process that will continue until August, a person familiar with the bank’s situation told the FT.

So far, Goldman has shown no signs of going with the flow.

A person from another major bank said it was difficult to argue with confidence against an exercise that was a “black box”.

Even Mr. Mayo admits that challenging the Fed is risky. After all, regulators oversee the day-to-day operations of a bank and can veto strategic plans like mergers.

“You can fight that and make headway, but then you’re screwed for the next century,” he said.

  • this article was amended on July 6 to correct the lines on the Fed’s “sensitivity analysis”. The original version indicated that this additional analysis had contributed to banks’ stress capital cushion requests. In fact, these claims are based purely on regular stress testing.

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