Goldman Declares the Distressed Debt Market Dark

Goldman Sachs
Goldman Sachs

Something extraordinary happened at Goldman Sachs in the first quarter of this year: it moved over 10 times the usual amount of distressed debt into a category reserved for assets whose prices are "not observable."

Goldman transferred $144 million of its distressed debt loan portfolio from "Level 2" to "Level 3." In the fourth quarter 2010, only $12 million of the portfolio was transferred in this way. A year ago, the transfer was also $12 million.

Assets are categorized as Level 2 when their valuations can be verified by quoted prices, recent trading activity, or other sources of reasonably clear pricing. When the pricing becomes difficult to determine, the assets get moved to Level 3. They are then valued, initially, at their transaction price. The valuations are later adjusted according to internal models and market evidence, including sales of other Level 3 assets.

Goldman says that its distressed debt portfolio is doing well, despite the plunge into darkness. It sold distressed debt assets for a gain of $22 million and marked up the assets it holds by another $23 million.

That $23 million gain on Level 3 distressed debt assets is also many multiples of the usual quarterly gain on Level 3 assets. In the fourth quarter of 2010, Goldman said its Level 3 distressed debt portfolio gained $3 million. For the first quarter of last year, it recorded a gain of $3 million.

What seems to have happened is that Goldman moved a huge portion of its distressed debt portfolio to Level 3 because prices are "not observable"—but then went ahead an marked them up anyway.

Goldman now holds just $2 million of distressed debt that it considers to be Level 2 assets.

Goldman hasn't publicly discussed this move to declare the entirety of its distressed debt portfolio into Level 3. Goldman did not immediately respond to requests for comments this morning.


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