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The Goldman Earnings Call, Part 2 (It?s Not Our Fault Other People Are Stupid, And By The Way, We Lost A Bunch of Money Too)

By Kim Krawiec

 In my last two posts, I went through the SEC?s complaint against Goldman Sachs and assessed the strength of the allegations, and began an analysis of the information shared by Goldman Sachs yesterday in its first quarter 2010 earnings call.  (Reminder: you can access the full transcript here).

I believe that four major points emerge from that call.  I discussed the first two in my post earlier this morning: (1) ACA Chose and Had Every Reason To Choose Well and (2) Who Chose ? And Even The Contents ? Are Not Material.  In this post, I?ll discuss the second two points.

1.       3.  We Did Not Mislead ACA

The SEC complaint alleges that Goldman led ACA to believe that Paulson would be buying an equity position, as opposed to taking a short position.  According to the SEC, if ACA had been aware of Paulson?s true position, it would not have allowed him to take such an active role in selecting the reference portfolio.  In his prepared statement, however, Palm insists that the evidence cited by the SEC does not establish that ?ACA was misled into believing Paulson was going to be buying an equity position and the term sheets and offering circular did not reflect an equity trench.? 

Now, this apparently missing equity tranche has been much-discussed, because (as I?ll come back to in a minute) it appears that Goldman did not hold the equity tranche either.  The flipbook does reference a ?first loss? tranche. Says Felix Salmon on this point:

Goldman said that they did not hold on to the equity tranche of the deal, which raises the obvious question: who owned ABACUS 2007-AC1, and whatever happened to the famous 0-9% equity tranche? If the bonds in the deal had all performed perfectly, where would the excess profits have gone?

Also recall this portion of the SEC complaint:

47. On January 10, 2007, Tourre emailed ACA a ?Transaction Summary? that included a description of Paulson as the ?Transaction Sponsor? and referenced a ?Contemplated Capital Structure? with a ?[0]% - [9]%: pre-committed first loss? as part of the Paulson deal structure. The description of this [0]% - [9]% tranche at the bottom of the capital structure was consistent with the description of an equity tranche and ACA reasonably believed it to be a reference to the equity tranche.  In fact, GS&Co never intended to market to anyone a ?[0]% - [9]%? first loss equity tranche in this transaction.   

48. On January 12, 2007, Tourre spoke by telephone with ACA about the proposed transaction. Following that conversation, on January 14, 2007, ACA sent an email to the GS&Co sales representative raising questions about the proposed transaction and referring to Paulson?s equity interest. The email, which had the subject line ?Call with Fabrice [Tourre] on Friday,? read in pertinent part:

?I certainly hope I didn?t come across too antagonistic on the call with Fabrice [Tourre] last week but the structure looks difficult from a debt investor perspective. I can understand Paulson?s equity perspective but for us to put our name on something, we have to be sure it enhances our reputation.?

Goldman was pressed on this point in the Q&A.  For example, David Trone, of Macquarie Securities said:

It strikes me that if there is a synthetic and if ACA was as experienced as you say they must have known there was a short so it comes to the question of when Paulson was making recommendations did they; A. Solely think they were long. B. Did they think they were the short side of the trade? C. Did they think they were going to be the short and maybe hedge it with the equity trench? I guess that is really the crux of the matter.

Palm responded that he had no idea what ACA might or might not have thought or why, but that Goldman did not mislead them. UBS?s Glenn Schorr asked similar questions, with largely similar results:

If there was no misrepresentation about Paulson being a long, how were they introduced into the process? In other words they were obviously making suggestions into what securities ACA should include but under what capacity were they introduced if it wasn?t a long or a short? What were they doing?

Now, at this point, Palm seems to me to dance around the idea that ACA did know Paulson was a short, but without really saying so, noting that ?in this market there has to be a long and a short,? and that the reference portfolio has to be acceptable to both sides.  Consistent with that, both the WSJ and CNBC are reporting that Paolo Pellegrini, a former top Paulson executive, told ACA that Paulson intended to short the Abacus portfolio (HT: WSJ Law Blog).

2.        4.. We Lost Money, Stupid!

Lastly, Goldman emphasizes that it lost money ? nearly $100 million ? on the deal, meaning that it was exposed to portfolio losses as well and had no reason to structure a deal designed to lose money.  Says Palm:

Finally, a significant point missing from the SEC?s complaint was the fact that Goldman Sachs retained a significant residual long position in the transaction. Our overall losses in connection with the transaction exceeded $100 million including $83 million with respect to the retained long position. We certainly had no incentive to structure a transaction that was designed to lose money. 

That claim was called into question by the New York Times today, which reports that Goldman desperately tried to off-load its Abacus investment, but found no takers.  The article also reports that several Goldman employees claim the firm bought insurance against losses in the Abacus portfolio, and thus did not suffer net losses. 

This latter claim seems contrary to Goldman?s statements on the conference call, though I suppose the definition of "net" in this context is open to some interpretation. In response to a question from David Trone of Macquarie Securities, Palm says that the reported loss is net loss, rather than gross.  Palm also clarifies that Goldman?s equity position was the super senior tranche, rather than the equity tranche, but does not respond to questions from Trone about why the firm held it, saying instead that the reasons are irrelevant ? ?we had skin in the game.? 

In my next post, I plan to end with a wrap up of what we know about the Abacus deal, would still like to know, and what it all means for the strength of the SEC?s complaint. 

Related Posts:
The Goldman Earnings Call, Part 1: ACA Chose and It Doesn?t Matter Anyway
The Goldman Complaint

Full post as published by The Faculty Lounge on April 21, 2010 (boomark / email).