Ducking The Subprime Hit

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Ducking The Subprime Hit

 

 

The mortgage maelstrom that has been swirling around Wall Street has left few bright spots and a number of casualties. But a handful of firms have managed to stand out.

 

Goldman Sachs Group Inc. remains an investment star. Deutsche Bank AG has lowered its exposure to risky bets that have hit its rivals. And Lehman Brothers Holdings Inc. appears to be in relatively safe territory.

 

As firms like Citigroup Inc. and Merrill Lynch & Co. grapple with multibillion-dollar write-downs from failed mortgage-security investments and vacant executive suites, Goldman Chief Executive Lloyd Blankfein saw his company's stock price rise 9% after he made upbeat comments at an investor conference yesterday. With fewer than three weeks to go in its fiscal fourth quarter, the firm is expected to deliver its best annual performance ever.

 

For Goldman fans, standout results are nothing new. But the firm's continued dominance in investment banking is particularly noteworthy at a time when some of its closest competitors are flailing. During the past month, Citigroup Chief Executive Charles Prince and Merrill CEO Stan O'Neal left their jobs after owning up to potential multibillion-dollar write-downs from failed investments in mortgage-backed securities. Last week, Morgan Stanley also announced pretax paper losses of $3.7 billion. And at yesterday's investor conference in New York hosted by research analysts at Merrill, Bank of America Corp. announced an unexpected write-down, of $3 billion.

 

Goldman, however, has emerged relatively unscathed. Asked yesterday if the firm would take the sort of significant write-down facing many of its peers, Mr. Blankfein answered with a succinct 'No.' Given the continued, challenging conditions in the trading of complex mortgage products, 'we continue to be net shorting these markets,' he told the crowd.

 

In fact, the firm is expected to earn $6.60 a share for the current quarter, a penny more than during the same period last year, according to Thomson Financial, when the firm delivered record full-year net income of $9.5 billion, or $19.69 a share.

 

So these days, the popular parlor game on Wall Street poses the following question: How did Goldman pull it off?

 

The answers lie both in serendipity and some savvy moves. Following a record third quarter for the firm's fixed-income, currencies and commodities department that was buoyed by lucrative trades in its mortgage division, Goldman used its own capital to make some winning bets, according to people familiar with the matter. One of those: going short, or making a bearish bet on, various mortgage-related instruments. Another: maintaining relatively small holdings of collateralized debt obligations, or CDOs, the complex mortgage-related securities whose rapid devaluation prompted the massive write-downs at other firms.

 

Securities analysts, who have long loved Goldman's strong returns, credit its team culture and risk management with successfully averting such big losses. 'Goldman Sachs isn't No. 13 in many things in the world, but they were No. 13 in CDO underwriting' according to figures issued by Thomson late last month, says UBS AG analyst Glenn Schorr. 'And that's no accident.' Mr. Schorr has a 'buy' rating on Goldman stock, and recently raised his price target to $270.

 

To be sure, CDO underwriting isn't a direct indicator of CDO holdings. But both Merrill and Citigroup were top producers and sellers of CDOs as well as large investors. And while Goldman held some CDOs, people familiar with the matter say the firm sold off the majority of its CDO portfolio at a loss in April and May -- taking some short-term pain but avoiding the far steeper price declines that followed. For the quarter ended Aug. 31, Goldman had $1.8 billion in retained interests in CDOs and collateralized loan obligations, according to regulatory filings.

 

Goldman isn't the only firm whose star is rising these days.

 

Deutsche Bank was a top underwriter of certain CDOs. But people close to the firm say Deutsche largely limited or hedged its exposure to subprime securities, including the top tiers of CDOs that led to losses for other banks, mostly because it tends to shy away from stockpiling assets. The bank also hedged its exposure to subprime securities by betting against the ABX index, which acts as a proxy for the value of underlying mortgage bonds.

 

For now, Deutsche doesn't plan any major write-offs, these people said. The bank plans to meet with analysts and investors today to explain its trading positions.

 

Lehman Brothers also appears to have curtailed its own investment in CDOs, and to have relied heavily on its robust risk-management structure to head off bad bets, analysts say. Investors and analysts will look for further guidance today, as Lehman addresses the Merrill conference.

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