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| GS > SEC Filings for GS > Form 10-Q on 9-Aug-2012 | All Recent SEC Filings |
9-Aug-2012
Quarterly Report
INDEX
Page No. Introduction 113 Executive Overview 113 Business Environment 116 Critical Accounting Policies 117 Use of Estimates 121 Results of Operations 122 Balance Sheet and Funding Sources 136 Equity Capital 143 Off-Balance-Sheet Arrangements and Contractual Obligations 148 Overview and Structure of Risk Management 151 Liquidity Risk Management 156 Market Risk Management 163 Credit Risk Management 168 Operational Risk Management 175 Recent Accounting Developments 176 Certain Risk Factors That May Affect Our Businesses 177 Cautionary Statement Pursuant to the U.S. Private Securities 178 Litigation Reform Act of 1995
112 Goldman Sachs June 2012 Form 10-Q
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Introduction
The Goldman Sachs Group, Inc. (Group Inc.) is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.
We report our activities in four business segments: Investment Banking, Institutional Client Services, Investing & Lending and Investment Management. See "Results of Operations" below for further information about our business segments.
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2011. References to "our Annual Report on Form 10-K" are to our Annual Report on Form 10-K for the year ended December 31, 2011.
When we use the terms "Goldman Sachs," "the firm," "we," "us" and "our," we mean Group Inc., a Delaware corporation, and its consolidated subsidiaries.
References to "this Form 10-Q" are to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012. All references to June 2012 and June 2011 refer to our periods ended, or the dates, as the context requires, June 30, 2012 and June 30, 2011, respectively. All references to March 2012 and December 2011 refer to the dates March 31, 2012 and December 31, 2011, respectively. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
Executive Overview
Three Months Ended June 2012 versus June 2011. The firm generated net earnings of $962 million for the second quarter of 2012, compared with $1.09 billion for the second quarter of 2011. Our diluted earnings per common share were $1.78 for the second quarter of 2012, compared with $1.85 for the second quarter of 2011. Annualized return on average common shareholders' equity (ROE) 1 was 5.4% for the second quarter of 2012, compared with 6.1% for the second quarter of 2011.
Book value per common share was $137.00 and tangible book value per common share 2 was $126.12 as of June 2012, both approximately 2% higher compared with the end of the first quarter of 2012. Our Tier 1 capital ratio under Basel 1 was 15.0% and our Tier 1 common ratio under Basel 1 3 was 13.1% as of June 2012, both up slightly from the end of the first quarter of 2012. During the quarter, the firm repurchased 14.3 million shares of its common stock for a total cost of $1.50 billion.
The firm generated net revenues of $6.63 billion for the second quarter of 2012, compared with $7.28 billion for the second quarter of 2011. These results reflected significantly lower net revenues in Investing & Lending, as well as lower net revenues in Investment Banking compared with the second quarter of 2011. These decreases were partially offset by higher net revenues in Institutional Client Services and Investment Management compared with the second quarter of 2011.
In the context of difficult economic and financial conditions, the firm continues to focus on improving operating efficiencies and reducing operating expenses. We are currently targeting approximately $500 million in additional annual run rate compensation and non-compensation reductions that we expect to complete by year-end.
An overview of net revenues for each of our business segments is provided below.
1. See "Results of Operations - Financial Overview" below for further information about our calculation of annualized ROE.
2. Tangible book value per common share is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies. See "Equity Capital - Other Capital Metrics" below for further information about our calculation of tangible book value per common share.
3. Tier 1 common ratio is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies. See "Equity Capital - Consolidated Regulatory Capital Ratios" below for further information about our Tier 1 common ratio.
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Investment Banking
Net revenues in Investment Banking decreased compared with the second quarter of 2011, reflecting significantly lower net revenues in Financial Advisory, as well as lower net revenues in our Underwriting business. The decrease in Financial Advisory reflected a decline in industry-wide completed mergers and acquisitions. Net revenues in equity underwriting were significantly lower compared with the second quarter of 2011, principally due to a decline in industry-wide activity. Net revenues in debt underwriting were higher compared with the second quarter of 2011, reflecting higher net revenues from investment-grade and commercial mortgage-related activity, partially offset by lower net revenues from leveraged finance activity.
Institutional Client Services
Net revenues in Institutional Client Services increased compared with the second quarter of 2011, reflecting significantly higher net revenues in Fixed Income, Currency and Commodities Client Execution, partially offset by lower net revenues in Equities.
The increase in Fixed Income, Currency and Commodities Client Execution compared with the second quarter of 2011 reflected higher net revenues in mortgages and commodities compared with difficult market-making conditions during the second quarter of 2011. During the second quarter of 2012, Fixed Income, Currency and Commodities Client Execution operated in a challenging environment reflecting broad market concerns and uncertainty, which resulted in generally wider credit spreads and lower activity levels compared with the first quarter of 2012.
The decrease in Equities compared with the second quarter of 2011 was primarily due to lower net revenues in equities client execution, reflecting significantly lower net revenues in derivatives. In addition, commissions and fees were lower compared with the second quarter of 2011, generally consistent with broader market activity. Securities services net revenues were lower compared with the second quarter of 2011, reflecting the impact of slightly lower average customer balances. During the second quarter of 2012, Equities operated in an environment characterized by a decrease in global equity prices and higher volatility levels compared with the first quarter of 2012.
Investing & Lending
Net revenues in Investing & Lending were $203 million for the second quarter of 2012, compared with $1.04 billion for the second quarter of 2011. During the second quarter of 2012, Investing & Lending net revenues were negatively impacted by a decrease in global equity prices and generally wider credit spreads. Results for the second quarter of 2012 included a loss of $194 million from our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC) and net losses of $112 million from other investments in equities, reflecting losses in public equities, largely offset by gains in private equities. In addition, Investing & Lending included net interest income and net gains of $222 million from debt securities and loans, and other net revenues of $287 million, principally related to our consolidated investment entities.
Investment Management
Net revenues in Investment Management increased compared with the second quarter of 2011 due to significantly higher incentive fees, primarily related to the sale of our funds' remaining investment in the ordinary shares of ICBC, partially offset by lower management and other fees, and lower transaction revenues. During the quarter, assets under management increased $12 billion to $836 billion. The increase in assets under management included net inflows of $16 billion 1, primarily in fixed income and money market assets, partially offset by net market depreciation of $4 billion, primarily in equity assets.
Six Months Ended June 2012 versus June 2011. The firm generated net earnings of $3.07 billion for the first half of 2012, compared with $3.82 billion for the first half of 2011. Our diluted earnings per common share were $5.72 for the first half of 2012, compared with $3.40 2 for the first half of 2011. Annualized ROE 3 was 8.8% for the first half of 2012, compared with 8.0% 2 for the first half of 2011.
The firm generated net revenues of $16.58 billion for the first half of 2012, compared with $19.18 billion for the first half of 2011. These results reflected significantly lower net revenues in Investing & Lending, as well as lower net revenues in each of our other business segments compared with the first half of 2011. An overview of net revenues for each of our business segments is provided below.
1. Includes $17 billion of fixed income asset inflows in connection with our acquisition of Dwight Asset Management Company LLC (Dwight Asset Management).
2. Excluding the impact of the preferred dividend of $1.64 billion in the first quarter of 2011 related to the redemption of our Series G Preferred Stock (calculated as the difference between the carrying value and the redemption value of the preferred stock), diluted earnings per common share were $6.25 and annualized ROE was 10.2% for the first half of 2011. We believe that presenting our results for the first half of 2011 excluding this dividend is meaningful, as it increases the comparability of period-to-period results. Diluted earnings per common share and annualized ROE excluding this dividend are non-GAAP measures and may not be comparable to similar non-GAAP measures used by other companies. See "Results of Operations - Financial Overview" below for further information about our calculation of diluted earnings per common share and annualized ROE excluding the impact of this dividend.
3. See "Results of Operations - Financial Overview" below for further information about our calculation of annualized ROE.
114 Goldman Sachs June 2012 Form 10-Q
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Investment Banking
Net revenues in Investment Banking decreased compared with the first half of 2011, primarily reflecting lower net revenues in our Underwriting business. Net revenues in equity underwriting were significantly lower compared with the first half of 2011, primarily reflecting a decline in industry-wide activity. Net revenues in debt underwriting were essentially unchanged compared with the first half of 2011. In addition, net revenues in Financial Advisory were slightly lower compared with the first half of 2011.
Institutional Client Services
Net revenues in Institutional Client Services decreased compared with the first half of 2011, reflecting lower net revenues in both Fixed Income, Currency and Commodities Client Execution, and Equities.
The decrease in Fixed Income, Currency and Commodities Client Execution compared with the first half of 2011 reflected lower net revenues in credit products, currencies and commodities, partially offset by higher net revenues in interest rate products and mortgages. Although the first quarter of 2012 was generally characterized by tighter credit spreads and improved activity levels, the environment became more challenging during the second quarter of 2012, as broad market concerns and uncertainties resurfaced, which led to generally wider credit spreads and lower activity levels compared with the first quarter of 2012.
The decrease in Equities compared with the first half of 2011 was primarily due to lower commissions and fees, generally consistent with broader market activity. Equities client execution net revenues were slightly lower compared with the first half of 2011, reflecting lower net revenues in derivatives. In addition, securities services net revenues decreased slightly compared with the first half of 2011. During the first half of 2012, Equities operated in an environment generally characterized by higher volatility levels towards the end of the period and an increase in global equity prices, although equity prices decreased during the second quarter.
Investing & Lending
Net revenues in Investing & Lending were $2.11 billion for the first half of 2012, compared with $3.75 billion for the first half of 2011. Results for the first half of 2012 included a loss of $25 million from our investment in the ordinary shares of ICBC and net gains of $779 million from other investments in equities, reflecting gains in private equities. In addition, Investing & Lending included net gains and net interest income of $807 million from debt securities and loans, primarily reflecting the impact of generally tighter credit spreads, particularly during the first quarter of 2012, and other net revenues of $553 million, principally related to our consolidated investment entities.
Investment Management
Net revenues in Investment Management decreased slightly compared with the first half of 2011 due to lower management and other fees, and lower transaction revenues, partially offset by significantly higher incentive fees, primarily related to the sale of our funds' remaining investment in the ordinary shares of ICBC. During the first half of 2012, assets under management increased $8 billion to $836 billion. The increase in assets under management included net market appreciation of $18 billion in fixed income and equity assets, partially offset by net outflows of $10 billion 1. Net outflows included outflows in money market, equity and alternative investment assets, partially offset by inflows in fixed income assets.
Our business, by its nature, does not produce predictable earnings. Our results in any given period can be materially affected by conditions in global financial markets, economic conditions generally and other factors. For a further discussion of the factors that may affect our future operating results, see "Certain Risk Factors That May Affect Our Businesses" below, as well as "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K.
1. Includes $17 billion of fixed income asset inflows in connection with our acquisition of Dwight Asset Management.
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Business Environment
Global
During the second quarter of 2012, global economic conditions weakened, as real gross domestic product (GDP) appeared to decline in Europe, and real GDP in the United States and Japan appeared to grow at a slower pace. In addition, the global economy was further impacted by slowing economic conditions in China. After positive developments during the first quarter of 2012, concerns regarding European sovereign debt risk heightened as a result of political uncertainty in Greece and concerns about the fiscal outlook in Spain and Italy. These conditions contributed to generally wider credit spreads, lower global equity prices and higher volatility levels, which weighed on investment banking activity, particularly in equity and equity-related underwriting activity levels. In addition, the price of crude oil declined during the quarter. In response to these weakened macroeconomic conditions, some major central banks moved to further ease monetary policy.
United States
In the United States, real GDP growth decelerated during the quarter. Growth in fixed investment, industrial production and consumer spending slowed and net exports declined. Measures of business and consumer confidence deteriorated. Unemployment levels declined slightly, although the rate of unemployment remained elevated. Measures of inflation declined, reflecting the impact of lower energy prices. Housing market activity continued to improve, although the level of activity remained low. The U.S. Federal Reserve maintained its federal funds rate at a target of zero to 0.25% and extended through the end of the year its program to lengthen the maturity of the U.S. Treasury debt it holds. The 10-year Treasury note yield ended the quarter at 1.67%, 56 basis points lower than the end of the first quarter of 2012. In equity markets, the NASDAQ Composite Index decreased by 5%, and the S&P 500 Index and the Dow Jones Industrial Average each decreased by 3%.
Europe
In the Euro area, real GDP growth appeared to decline during the quarter, reflecting the impact that the ongoing sovereign debt crisis has had on the region's economic growth. Measures of business confidence deteriorated and measures of inflation declined. The European Central Bank maintained its main refinancing operations rate at 1.00% and continued supporting liquidity in the Eurosystem. The Euro depreciated by 5% against the U.S. dollar. In the United Kingdom, real GDP declined during the quarter, for the third consecutive quarter. The Bank of England maintained its official bank rate at 0.50% and the British pound depreciated by 2% against the U.S. dollar. Long-term government bond yields in the U.K. and the Euro area generally declined during the quarter, although long-term government bond yields in Greece, Spain and Italy increased. The Euro Stoxx 50 Index, the DAX Index, the CAC 40 Index, and the FTSE 100 Index decreased by 9%, 8%, 7%, and 3%, respectively.
Asia
In Japan, real GDP appeared to increase during the quarter, although at a slower pace than in the first quarter of 2012, as growth in domestic demand moderated. The Bank of Japan left its target overnight call rate unchanged at a range of zero to 0.10% and continued to expand its asset purchase program. The yield on 10-year Japanese government bonds decreased, while the Japanese yen appreciated against the U.S. dollar by 4%. The Nikkei 225 Index ended the quarter 11% lower. In China, real GDP growth increased modestly during the quarter, but remained lower compared with the solid pace of growth in previous years. Measures of inflation continued to decline. The People's Bank of China reduced the reserve requirement ratio by 50 basis points and lowered the benchmark lending and deposit rates. The Chinese yuan depreciated slightly against the U.S. dollar, while the Shanghai Composite Index decreased by 2%. In addition, equity markets in Hong Kong and South Korea decreased during the quarter. In India, real GDP growth appeared to decelerate during the quarter, as domestic demand continued to moderate. In addition, measures of wholesale inflation remained at an elevated level. The Indian rupee depreciated against the U.S. dollar and equity markets ended the second quarter essentially unchanged.
116 Goldman Sachs June 2012 Form 10-Q
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Critical Accounting Policies
Fair Value
Fair Value Hierarchy. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value (i.e., inventory), as well as certain other financial assets and financial liabilities, are reflected in our condensed consolidated statements of financial condition at fair value (i.e., marked-to-market), with related gains or losses generally recognized in our condensed consolidated statements of earnings. The use of fair value to measure financial instruments is fundamental to our risk management practices and is our most critical accounting policy.
The fair value of a financial instrument is the amount that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. In determining fair value, the
hierarchy under U.S. generally accepted accounting principles (U.S. GAAP) gives
(i) the highest priority to unadjusted quoted prices in active markets for
identical, unrestricted assets or liabilities (level 1 inputs), (ii) the next
priority to inputs other than level 1 inputs that are observable, either
directly or indirectly (level 2 inputs), and (iii) the lowest priority to inputs
that cannot be observed in market activity (level 3 inputs). Assets and
liabilities are classified in their entirety based on the lowest level of input
that is significant to their fair value measurement.
The fair values for substantially all of our financial assets and financial liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the hierarchy. Certain level 2 and level 3 financial assets and financial liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors such as counterparty and the firm's credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Valuation adjustments are generally based on market evidence.
Instruments categorized within level 3 of the fair value hierarchy, which represent approximately 5% of the firm's total assets, require one or more significant inputs that are not observable. Absent evidence to the contrary, instruments classified within level 3 of the fair value hierarchy are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the transaction date, we use other methodologies to determine fair value, which vary based on the type of instrument. Estimating the fair value of level 3 financial instruments requires judgments to be made. These judgments include:
Ÿ determining the appropriate valuation methodology and/or model for each type of level 3 financial instrument;
Ÿ determining model inputs based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations; and
Ÿ determining appropriate valuation adjustments related to illiquidity or counterparty credit quality.
Regardless of the methodology, valuation inputs and assumptions are only changed when corroborated by substantive evidence.
Controls Over Valuation of Financial Instruments. Market makers and investment professionals in our revenue-producing units are responsible for pricing our financial instruments. Our control infrastructure is independent of the revenue-producing units and is fundamental to ensuring that all of our financial instruments are appropriately valued at market-clearing levels. In the event that there is a difference of opinion in situations where estimating the fair value of financial instruments requires judgment (e.g., calibration to market comparables or trade comparison, as described below), the final valuation decision is made by senior managers in control and support functions that are independent of the revenue-producing units (independent control and support functions). This independent price verification is critical to ensuring that our financial instruments are properly valued.
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Price Verification. The objective of price verification is to have an informed and independent opinion with regard to the valuation of financial instruments under review. Instruments that have one or more significant inputs which cannot be corroborated by external market data are classified within level 3 of the fair value hierarchy. Price verification strategies utilized by our independent control and support functions include:
Ÿ Trade Comparison. Analysis of trade data (both internal and external where available) is used to determine the most relevant pricing inputs and valuations.
Ÿ External Price Comparison. Valuations and prices are compared to pricing data obtained from third parties (e.g., broker or dealers, MarkIt, Bloomberg, IDC, TRACE). Data obtained from various sources is compared to ensure consistency and validity. When broker or dealer quotations or third-party pricing vendors are used for valuation or price verification, greater priority is generally given to executable quotations.
Ÿ Calibration to Market Comparables. Market-based transactions are used to corroborate the valuation of positions with similar characteristics, risks and components.
Ÿ Relative Value Analyses. Market-based transactions are analyzed to determine the similarity, measured in terms of risk, liquidity and return, of one instrument relative to another or, for a given instrument, of one maturity relative to another.
Ÿ Collateral Analyses. Margin disputes on derivatives are examined and investigated to determine the impact, if any, on our valuations.
Ÿ Execution of Trades. Where appropriate, trading desks are instructed to execute trades in order to provide evidence of market-clearing levels.
Ÿ Backtesting.Valuations are corroborated by comparison to values realized upon sales.
See Notes 5 through 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about fair value measurements.
Review of Net Revenues. Independent control and support functions ensure adherence to our pricing policy through a combination of daily procedures, including the explanation and attribution of net revenues based on the underlying factors. Through this process we independently validate net revenues, . . .
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