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GS > SEC Filings for GS > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for GOLDMAN SACHS GROUP INC

Form 10-Q for GOLDMAN SACHS GROUP INC


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

INDEX

Page No. Introduction 114 Executive Overview 114 Business Environment 118 Critical Accounting Policies 119 Use of Estimates 123 Results of Operations 124 Balance Sheet and Funding Sources 139 Equity Capital 146 Off-Balance-Sheet Arrangements and Contractual Obligations 151 Overview and Structure of Risk Management 154 Liquidity Risk Management 159 Market Risk Management 166 Credit Risk Management 171 Operational Risk Management 178 Recent Accounting Developments 180 Certain Risk Factors That May Affect Our Businesses 181 Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995 182

Goldman Sachs September 2012 Form 10-Q 113


Table of Contents

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 September 30, 2012. All references to September 2012 and September 2011 refer to our periods ended, or the dates, as the context requires, September 30, 2012 and September 30, 2011, respectively. All references to June 2012 and December 2011 refer to the dates June 30, 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 September 2012 versus September 2011. The firm generated net earnings of $1.51 billion for the third quarter of 2012, compared with a net loss of $393 million for the third quarter of 2011. Our diluted earnings per common share were $2.85 for the third quarter of 2012, compared with a diluted loss per common share of $0.84 for the third quarter of 2011. Annualized return on average common shareholders' equity (ROE) 1 was 8.6% for the third quarter of 2012.

Book value per common share was $140.58 and tangible book value per common share 2 was $129.69 as of September 2012, both approximately 3% higher compared with the end of the second 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 September 2012, both unchanged from the end of the second quarter of 2012. During the quarter, the firm repurchased 11.8 million shares of its common stock for a total cost of $1.25 billion.

The firm generated net revenues of $8.35 billion for the third quarter of 2012, compared with $3.59 billion for the third quarter of 2011. These results reflected significantly improved results in Investing & Lending and, to a lesser extent, significantly higher net revenues in Investment Banking and slightly higher net revenues in Institutional Client Services compared with the third quarter of 2011. These increases were partially offset by slightly lower net revenues in Investment Management compared with the third quarter of 2011.

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.

114 Goldman Sachs September 2012 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management's Discussion and Analysis

Investment Banking

Net revenues in Investment Banking increased significantly compared with the third quarter of 2011, as net revenues in our Underwriting business were more than double the amount in the third quarter of 2011, which had particularly low volumes. This increase primarily reflected significantly higher net revenues in debt underwriting, principally due to higher net revenues from leveraged finance activity. Net revenues in equity underwriting were higher compared with the third quarter of 2011, primarily reflecting an increase in client activity. Net revenues in Financial Advisory were slightly lower compared with the third quarter of 2011.

Institutional Client Services

Net revenues in Institutional Client Services increased slightly compared with the third 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 third quarter of 2011 reflected significantly higher net revenues in mortgages and higher net revenues in credit products, currencies and interest rate products, partially offset by significantly lower net revenues in commodities. During the third quarter of 2012, Fixed Income, Currency and Commodities Client Execution operated in an environment generally characterized by tighter credit spreads, as certain central banks took steps to ease monetary policy; however, broad market concerns persisted and levels of activity generally remained low.

The decrease in Equities compared with the third quarter of 2011 was primarily due to significantly lower commissions and fees, reflecting lower market volumes, and lower net revenues in equities client execution. In addition, net revenues in securities services were slightly lower compared with the third quarter of 2011, primarily reflecting the impact of lower average customer balances. During the quarter, Equities operated in an environment generally characterized by an increase in global equity prices and lower volatility levels.

The net loss attributable to the impact of changes in our own credit spreads on borrowings for which the fair value option was elected was $370 million ($225 million and $145 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the third quarter of 2012, compared with a net gain of $450 million ($308 million and $142 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the third quarter of 2011.

Investing & Lending

Net revenues in Investing & Lending were $1.80 billion for the third quarter of 2012, compared with negative net revenues of $2.48 billion for the third quarter of 2011. During the third quarter of 2012, Investing & Lending net revenues were positively impacted by tighter credit spreads and an increase in global equity prices. Results for the third quarter of 2012 included a gain of $99 million from our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), net gains of $824 million from other investments in equities, primarily in private equities, net gains and net interest income of $558 million from debt securities and loans, and other net revenues of $323 million, principally related to our consolidated investment entities.

Goldman Sachs September 2012 Form 10-Q 115


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management's Discussion and Analysis

Investment Management

Net revenues in Investment Management decreased slightly compared with the third quarter of 2011, reflecting lower transaction revenues and slightly lower management and other fees, partially offset by higher incentive fees. During the quarter, assets under management increased $20 billion to $856 billion, reflecting net market appreciation.

Nine Months Ended September 2012 versus September 2011. The firm generated net earnings of $4.58 billion for the first nine months of 2012, compared with $3.43 billion for the first nine months of 2011. Our diluted earnings per common share were $8.57 for the first nine months of 2012, compared with $2.70 1 for the first nine months of 2011. Annualized ROE 2 was 8.8% for the first nine months of 2012, compared with 3.7% 1 for the first nine months of 2011.

The firm generated net revenues of $24.93 billion for the first nine months of 2012, compared with $22.76 billion for the first nine months of 2011. These results reflected significantly higher net revenues in Investing & Lending compared with the first nine months of 2011. This increase was partially offset by slightly lower net revenues in both Institutional Client Services and Investment Management compared with the first nine months of 2011. Net revenues in Investment Banking were essentially unchanged compared with the first nine months of 2011. An overview of net revenues for each of our business segments is provided below.

Investment Banking

Net revenues in Investment Banking were essentially unchanged compared with the first nine months of 2011. Net revenues in our Underwriting business were slightly higher than the first nine months of 2011. Net revenues in debt underwriting were significantly higher compared with the first nine months of 2011, reflecting higher net revenues across all types of underwriting offerings. Net revenues in equity underwriting were significantly lower compared with the first nine months of 2011, primarily reflecting a decline in industry-wide initial public offerings. Net revenues in Financial Advisory were slightly lower compared with the first nine months of 2011.

Institutional Client Services

Net revenues in Institutional Client Services decreased slightly compared with the first nine months of 2011, reflecting lower net revenues in Equities, partially offset by slightly higher net revenues in Fixed Income, Currency and Commodities Client Execution.

The increase in Fixed Income, Currency and Commodities Client Execution compared with the first nine months of 2011 reflected significantly higher net revenues in mortgages and higher net revenues in interest rate products, partially offset by significantly lower net revenues in commodities and lower net revenues in currencies. Net revenues in credit products were essentially unchanged compared with the first nine months of 2011. Although credit spreads generally tightened during the first nine months of 2012, broad market concerns and uncertainties contributed to generally low levels of activity, particularly during the second and third quarters of 2012.

The decrease in Equities compared with the first nine months of 2011 was primarily due to lower commissions and fees, reflecting lower market volumes, and slightly lower net revenues in equities client execution. In addition, net revenues in securities services were slightly lower compared with the first nine months of 2011, primarily reflecting the impact of lower average customer balances. During the first nine months of 2012, Equities operated in an environment generally characterized by an increase in global equity prices and lower volatility levels, as compared with the first nine months of 2011.

The net loss attributable to the impact of changes in our own credit spreads on borrowings for which the fair value option was elected was $588 million ($354 million and $234 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first nine months of 2012, compared with a net gain of $576 million ($399 million and $177 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first nine months of 2011.

1. 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 $5.60 and annualized ROE was 6.0% for the first nine months of 2011. We believe that presenting our results for the first nine months 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.

2. See "Results of Operations - Financial Overview" below for further information about our calculation of annualized ROE.

116 Goldman Sachs September 2012 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management's Discussion and Analysis

Investing & Lending

Net revenues in Investing & Lending were $3.92 billion for the first nine months of 2012, compared with $1.27 billion for the first nine months of 2011. During the first nine months of 2012, Investing & Lending net revenues were positively impacted by generally tighter credit spreads and an increase in global equity prices. Results for the first nine months of 2012 included a gain of $74 million from our investment in the ordinary shares of ICBC and net gains of $1.60 billion from other investments in equities, primarily in private equities. In addition, Investing & Lending included net gains and net interest income of $1.37 billion from debt securities and loans, and other net revenues of $876 million, principally related to our consolidated investment entities.

Investment Management

Net revenues in Investment Management decreased slightly compared with the first nine months of 2011 due to slightly 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 second quarter of 2012. During the first nine months of 2012, assets under management increased $28 billion to $856 billion. The increase in assets under management included net market appreciation of $39 billion, primarily in fixed income and equity assets, partially offset by net outflows of $11 billion. Net outflows included outflows in money market, equity and alternative investment assets, partially offset by inflows in fixed income assets (including $17 billion of fixed income asset inflows in connection with our acquisition of Dwight Asset Management Company LLC (Dwight Asset Management)).

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.

Goldman Sachs September 2012 Form 10-Q 117


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management's Discussion and Analysis

Business Environment

Global

Global economic conditions continued to weaken during the third quarter of 2012, as real gross domestic product (GDP) appeared to decline in Europe and Japan, while real GDP growth in the United States and China was modest. After concerns regarding European sovereign debt risk heightened in the second quarter of 2012 and continued into the beginning of the third quarter, some positive developments, including certain central bank actions to ease monetary policy, alleviated market pressure. These actions resulted in tighter credit spreads, higher global equity prices and lower volatility levels compared with the second quarter of 2012. In addition, the price of crude oil increased. However, concerns and uncertainties about the outlook of the global economy, particularly as it relates to Europe, persisted. These concerns continued to weigh on investment banking activity, particularly in mergers and acquisitions, and initial public offerings activity levels, although industry-wide debt underwriting activity improved compared with the second quarter of 2012.

United States

In the United States, real GDP growth accelerated modestly during the quarter, reflecting an increase in the growth of consumer spending and an upturn in government spending, although growth in fixed investment slowed and net exports declined. Measures of business and consumer confidence improved. Unemployment levels declined, although the rate of unemployment remained elevated. Measures of inflation on average were lower compared with the second quarter of 2012. Housing market activity continued to improve, particularly in housing starts. The U.S. Federal Reserve maintained its federal funds rate at a target of zero to 0.25% and announced further easing measures that included an open-ended program to purchase mortgage-backed securities, as well as an extension of its commitment to keep interest rates exceptionally low until at least mid-2015. After reaching yields close to 1.40% earlier in the quarter, the 10-year Treasury note yield ended the quarter at 1.65%, essentially unchanged compared with the end of the second quarter of 2012. In equity markets, the NASDAQ Composite Index and the S&P 500 Index each increased by 6%, while the Dow Jones Industrial Average increased by 4%.

Europe

In the Euro area, real GDP appeared to decline during the quarter for the fourth consecutive quarter, reflecting the impact that the ongoing sovereign debt crisis has had on the region's economic growth, particularly in Spain and Italy. Although measures of business confidence improved in some countries from low levels, they deteriorated in the aggregate. Measures of inflation on average were essentially unchanged

compared with the second quarter of 2012. The European Central Bank (ECB) decreased its main refinancing operations rate by 25 basis points to 0.75%. In addition, the ECB announced a new program to make outright purchases of sovereign bonds in the secondary markets, with the goal of having a single monetary policy in the Euro area, maintaining price stability and preserving the Euro. The Euro appreciated by 2% against the U.S. dollar. In the United Kingdom, real GDP strongly rebounded after declining for three consecutive quarters, reflecting increases in industrial production, consumption and exports, positively impacted in part by the Olympic Games. The Bank of England maintained its official bank rate at 0.50% and increased the size of its asset purchase program. The British pound appreciated by 3% against the U.S. dollar. Long-term government bond yields declined in most Euro area economies, while yields decreased slightly in the U.K. In equity markets, the DAX Index, the Euro Stoxx 50 Index, the CAC 40 Index, and the FTSE 100 Index increased by 12%, 8%, 5%, and 3%, respectively, during the quarter.

Asia

In Japan, real GDP appeared to decline during the quarter, primarily reflecting declines in consumer spending and fixed investment, as well as a sharp contraction in exports. The Bank of Japan left its target overnight call rate unchanged at a range of zero to 0.10%, and continued to ease monetary policy by further increasing the size of its asset purchase program and by facilitating outright purchases of government and corporate bonds. The yield on 10-year Japanese government bonds decreased, while the Japanese yen appreciated by 2% against the U.S. dollar. The Nikkei 225 Index ended the quarter 2% lower. In China, real GDP growth increased modestly during the quarter, reflecting growth in industrial production and retail spending, but remained lower compared with the solid pace of growth in previous years. Measures of inflation continued to decline during the quarter, reaching its lowest level since 2010. The People's Bank of China left the reserve requirement ratio unchanged during the quarter. The Chinese yuan appreciated slightly against the U.S. dollar, while the Shanghai Composite Index decreased by 6%. In contrast, equity markets in Hong Kong and South Korea increased during the quarter. In India, real GDP growth during the quarter appeared to remain weak, reflecting continued weakness in investment demand, negatively impacted in part by less than normal monsoon rainfall. In addition, measures of wholesale inflation remained at an elevated level. The Indian rupee appreciated against the U.S. dollar and equity markets in India ended the quarter higher.

118 Goldman Sachs September 2012 Form 10-Q


Table of Contents

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 fair value 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:

determining the appropriate valuation methodology and/or model for each type of level 3 financial instrument;

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

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.

Goldman Sachs September 2012 Form 10-Q 119

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