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Why the Fed thinks Goldman is America’s riskiest bank

Annual capital review finds that New York bank would struggle in a deep recession

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

This week the Fed slapped Goldman with a total capital requirement higher than any other US bank, thanks to a large “stress capital buffer” the regulator wants all banks to maintain to see them through the severest of shocks. The resulting requirement for tier 1 common equity — largely generated from retained profits and share sales — is at least 13.7 per cent of Goldman’s risk-weighted assets. 

Reacting to the verdict, the Wall Street bank said it could continue with plans to invest in new business and would maintain current dividend payments, even though the tier 1 target it must hit by October is a touch above its current position. 

The Fed arrived at that number based on two assessments. 

The first is the regular annual stress test, which models how Goldman and 32 other banks would perform in a garden-variety recession and a severe one. The second is a new “sensitivity analysis,” a rougher exercise that looked at how the banks could fare under the additional strain of the pandemic. Results of that exercise were released only on an aggregate basis.

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

Goldman’s numbers include some stunning outliers, like a loss rate of 25.9 per cent on its mortgage book: almost 10 times higher than the next worst result.

Meanwhile, the 14.9 per cent assumed losses on Goldman’s commercial and industrial lending portfolio are more than twice the 7.2 per cent average of the rest of the participating banks.

Faced with a less jaw-dropping set of numbers and a capital demand it is already meeting, US retail bank Citizens publicly took aim at “inaccuracies” in the Fed’s calculations.

Goldman is so far holding its tongue. Marty Mosby, analyst at Vining Sparks, said the bank faced higher losses for consumer loans largely because its business — which began offering online loans 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 the higher mortgage losses reflected the fact the loans “don’t fit” the Fed’s models since they were for wealthy individuals in Goldman’s private bank, rather than the “bread-and-butter lending” the central bank typically reviewed.

Some analysts are less circumspect. “It’s bananas,” says Chris Kotowski, banks analyst at Oppenheimer.

Bananas or not, the damage to Goldman from those bruising assumptions is manageable because the bank’s loan book is relatively small, at $128bn, about one-eighth the size of JPMorgan Chase’s.

That means the Fed’s loan-loss predictions took just $9.8bn from Goldman’s bottom line over the period, far less than the $47bn of losses pencilled in for Citi, BofA or Wells Fargo.

The real damage is the $18.4bn of trading and counterparty losses to Goldman’s trading assets that the Fed envisaged, which pushed Goldman to a net $27.5bn loss over the test period.

Mr Kotowski argues that these assumptions have already proven wrong for Goldman, since the swings of the Fed’s worst-case scenario were similar to what banks actually endured in March. Rather than losing billions, Goldman’s trading operations made money: $2.25bn in first-quarter pre-tax profits, up 75 per cent from a year earlier.

There are legitimate reasons for discrepancies between the Fed’s projections and Goldman’s actual performance. The Fed assumed no policy support — least of all the dramatic interventions from the central bank itself, which steadied the market. The Fed’s assessment was also based on historic snapshots of end-2019 balance sheets, which shifted rapidly during March and April.

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

“You have a fantastic record [on managing risk] and now you’re going to let the Fed . . . make you have the highest capital requirements because of some assumptions that aren’t even clear to them or to us?” Mr Mayo said. “Why are you lying down and taking this?”

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

So far, Goldman has shown no sign of following suit.

A person at another large bank said it was difficult to confidently argue against an exercise that was a “black box”.

Even Mr Mayo admits that challenging the Fed is risky. After all, regulators oversee a bank’s day-to-day activities and can veto strategic plans such as mergers. 

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

Looming fight over which authority will have control over review of £31bn tie-up

The UK competition watchdog is to ask Brussels for full control over the review of the proposed £31bn merger between Virgin Media and telecoms operator O2, kicking off what is expected to be a fierce battle over which authority gets the ultimate say on the transaction.

Brussels will receive a request from the UK’s Competition and Markets Authority, which will argue that the merger solely affects UK consumers.

“This important merger will only impact consumers in the UK and since any review will likely conclude after the transition period, it is only right for the CMA to request it back now,” the CMA told the Financial Times, referring to the December 31 deadline.

A person familiar with the discussions added: “This is a no-brainer.”

As part of the transition withdrawal agreement there are specific mechanisms for the CMA to take over mergers that affect solely the UK. But British regulators will argue that it would be strange for the EU to examine a deal that is only a UK matter after the transition period.

Ultimately, it is for Brussels to decide whether it wants to claim jurisdiction or not. 

However, European officials are expected to want to retain jurisdiction over the mooted tie-up on the grounds that they have historically examined telecoms deals and that the UK is technically still part of the EU during the transition period, according to people familiar with the European Commission’s thinking.

The commission said: “This transaction has not been formally notified to the commission. If a transaction has an EU dimension, it is always up to the companies to notify it to the commission.”

The CMA tried to gain control of the approval process for Three's proposed £10.25bn takeover of O2 in 2015 on the basis that the combination of the two mobile phone networks would only affect UK consumers. 

That request was unsuccessful but the British watchdog put pressure on its EU counterpart by publicly calling on it to block the Three-O2 deal, arguing it would harm consumer interests. The deal was ultimately blocked by Brussels on competition grounds in 2016 — a decision that was annulled this year by the General Court.

The CMA is not the only local regulator to try to wrest control of a takeover decision from Brussels. German antitrust watchdog, the Bundeskartellamt, tried to take control of Vodafone’s acquisition of Unitymedia, a German cable network owned by Liberty Media, in 2018 but was unsuccessful.

Broadly speaking, Brussels has allowed the combination of mobile and cable assets in recent years but has taken a firmer line on mobile-to-mobile tie-ups. Deals in Spain, the Netherlands, Sweden, Germany and eastern Europe have been permitted although often with remedies that have strengthened the hand of smaller challengers. 

In the UK, the CMA oversaw BT’s takeover of EE, the mobile phone network that was then owned by Deutsche Telekom and Orange, and approved the deal with no remedies in early 2016.

Executives from Liberty Global and Telefónica, the respective owners of Virgin Media and O2, have expressed confidence in recent weeks that the deal will be cleared by regulators as it does not reduce competition and is in line with previous European convergence tie-ups in telecoms. A person with direct knowledge of the talks said there is hope that clearance would be received by the end of the year if it is handled by Brussels.

Can BNP Paribas become Europe’s JPMorgan?

French lender thinks it can avoid pitfalls associated with opportunist approach during a crisis

BNP Paribas takes on Wall Street heavyweights 

They say fortune favours the bold and BNP Paribas is hoping that will certainly be the case.

The French lender stepped up in recent months when several US banks balked at lending money to European businesses that were reeling from the impact of the coronavirus pandemic. 

In the six weeks to the end of May, BNP Paribas worked on more than half of the investment-grade corporate bond issuances across Europe. 

The bank underwrote more than €83bn of syndicated loans in Europe between mid-March and the end of May, leading the region with a 16.8 per cent market share. That was up from 7.9 per cent for 2019.

Meanwhile, Wall Street stalwarts like JPMorgan Chase and Goldman Sachs focused their energy on their home market and took a more cautious approach in Europe. 

This is all part of a grand plan for BNP Paribas to dominate European investment banking, a brave yet fraught endeavour that has often led to abject failure for many of the bank’s rivals. 

Deutsche Bank, Royal Bank of Scotland and Nomura are just a few of the names that have been forced to make a quick retreat. The legacy of those failed efforts continue to haunt their organisations. 

So how does BNP Paribas plan to avoid the same fate? Last year it took over Deutsche’s $200bn prime brokerage business, giving the bank a hand-up in the potentially lucrative but risky business of servicing hedge funds. 

Then in the first quarter of 2020, the French lender added half a trillion euros of additional loans to its balance sheet.

But history tells us that opportunism during a crisis can backfire — notably at Deutsche and RBS during the financial crisis more than a decade ago. BNP Paribas was one of the groups that emerged stronger than most until transatlantic ambitions were halted in 2014 after it pleaded guilty to violating US sanctions.

This time, BNP Paribas thinks it has done enough to earn the loyalty of its European clients.

Go deeper here.

Firm that audited Wirecard goes live with audit committee webcast

EY

Wirecard and webinars

EY, the totally trusting auditor of fibbing fintech Wirecard, has been trying to improve clients’ financial reporting for years. It now operates a “Global Center for Board Matters”, with a UK Centre in London, offering events, workshops, webinars and videos — not to mention a must-listen podcast called (wait for it) “Board Matters”. And it has not let coronavirus make any of this matter less. Its latest webcasts cover: “The role of corporates post COVID-19” and “How can non-executive directors help their companies prepare for recovery?”. But shareholders in the now collapsed Wirecard — and consumers reliant on its payment technology — may wish EY had begun the programme a little earlier. Last week, it emerged that EY auditors failed to check whether Wirecard really did have up to $1bn in cash in a Singapore bank for more than three years. It was not until Wednesday this week, however, that EY went live with its latest webcast on “Considerations for audit committees”. Helpfully, a slide in the presentation reminds all those involved in audits of “Five current questions investors seek information on”. Question number one is . . . “How much cash does the company have?” When EY’s Wirecard blunder was revealed, a rival beancounter expressed incredulity, noting “cash is easy to audit”. Evidently, at EY it remains difficult until you’ve sat through the right webinar.