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
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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 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.
Goldman Sachs June 2012 Form 10-Q 113
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Table of Contents
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
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Table of Contents
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.
Goldman Sachs June 2012 Form 10-Q 115
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Table of Contents
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
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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 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.
Goldman Sachs June 2012 Form 10-Q 117
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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,
identify and resolve potential fair value or trade booking issues on a timely
basis and ensure that risks are being properly categorized and quantified.
Review of Valuation Models. Quantitative professionals within our Market Risk
Management department (Market Risk Management) perform an independent model
approval process. This process incorporates a review of a diverse set of model
and trade parameters across a broad range of values (including extreme and/or
improbable conditions) in order to critically evaluate:
Ÿ the model's suitability for valuation and risk management of a particular
instrument type;
Ÿ the model's accuracy in reflecting the characteristics of the related product
and its significant risks;
Ÿ the suitability and properties of the numerical algorithms incorporated in the
model;
Ÿ the model's consistency with models for similar products; and
Ÿ the model's sensitivity to input parameters and assumptions.
New or changed models are reviewed and approved. Models are evaluated and
re-approved annually to assess the impact of any changes in the product or
market and any market developments in pricing theories.
118 Goldman Sachs June 2012 Form 10-Q
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Table of Contents
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Level 3 Financial Assets at Fair Value. The table below presents financial
assets measured at fair value and the amount of such assets that are classified
within level 3 of the fair value hierarchy.
Total level 3 financial assets were $46.51 billion, $48.02 billion and
$47.94 billion as of June 2012, March 2012 and December 2011, respectively.
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 changes in level
3 financial assets and fair value measurements.
As of June 2012 As of March 2012 As of December 2011
Total at Level 3 Total at Level 3 Total at Level 3
in millions Fair Value Total Fair Value Total Fair Value Total
Commercial paper, certificates of
deposit, time deposits and other
money market instruments $ 10,011 $ 7 $ 10,553 $ 8 $ 13,440 $ -
U.S. government and federal agency
obligations 94,949 - 90,488 - 87,040 -
Non-U.S. government and agency
obligations 63,890 8 60,812 105 49,205 148
Mortgage and other asset-backed
loans and securities:
Loans and securities backed by
commercial real estate 7,199 3,166 6,724 3,156 6,699 3,346
Loans and securities backed by
residential real estate 8,467 1,632 8,815 1,610 7,592 1,709
Bank loans and bridge loans 20,770 10,461 18,988 11,051 19,745 11,285
Corporate debt securities 21,534 2,367 24,370 2,512 22,131 2,480
State and municipal obligations 3,493 547 3,407 612 3,089 599
Other debt obligations 4,639 1,757 4,702 1,549 4,362 1,451
Equities and convertible debentures 74,606 14,420 75,927 14,874 65,113 13,667
Commodities 6,330 - 9,462 - 5,762 -
Total cash instruments 315,888 34,365 314,248 35,477 284,178 34,685
Derivatives 71,308 10,501 71,258 11,151 80,028 11,900
Financial instruments owned, at
fair value 387,196 44,866 385,506 46,628 364,206 46,585
Securities segregated for
regulatory and other purposes 37,279 - 33,679 - 42,014 -
Securities purchased under
agreements to resell 167,344 1,023 181,050 956 187,789 557
Securities borrowed 51,897 - 57,062 - 47,621 -
Receivables from customers and
counterparties 7,444 616 8,328 431 9,682 795
Total $651,160 $46,505 $665,625 $48,015 $651,312 $47,937
Goldman Sachs June 2012 Form 10-Q 119
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Table of Contents
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Goodwill and Identifiable Intangible Assets
Goodwill. Goodwill is the cost of acquired companies in excess of the fair value
of net assets, including identifiable intangible assets, at the acquisition
date. Goodwill is assessed annually for impairment, or more frequently if events
occur or circumstances change that indicate an impairment may exist, by first
assessing qualitative factors to determine whether it is more likely than not
that the fair value of a reporting unit is less than its carrying amount. If the
results of the qualitative assessment are not conclusive, a quantitative
goodwill impairment test is performed by comparing the estimated fair value of
each reporting unit with its estimated net book value. We derive the fair value
based on valuation techniques we believe market participants would use (i.e.,
observable price-to-earnings multiples and price-to-book multiples). We derive
the net book value by estimating the amount of shareholders' equity required to
support the activities of each reporting unit. Estimating the fair value of our
reporting units requires management to make judgments. Critical inputs include
(i) projected earnings, (ii) estimated long-term growth rates and (iii) cost of
equity.
During the second half of 2011, consistent with the decline in stock prices in
the broader financial services sector, our stock price declined and throughout
most of this period, our market capitalization was below book value.
Accordingly, we performed a quantitative impairment test during the fourth
quarter of 2011 and determined that goodwill was not impaired. The estimated
fair value of our reporting units in which we hold substantially all of our
goodwill significantly exceeded the estimated carrying values. We believe that
it is appropriate to consider market capitalization, among other factors, as an
indicator of fair value over a reasonable period of time.
If the current economic market conditions persist, and there is a prolonged
period of weakness in the business environment and financial markets, our
earnings may be adversely affected, which could result in an impairment of
goodwill in the future. In addition, significant changes to other critical
inputs of the goodwill impairment test (e.g., cost of equity) could cause the
estimated fair value of our reporting units to decline, which could result in an
impairment of goodwill in the future.
See Note 13 to the condensed consolidated financial statements in Part I, Item 1
of this Form 10-Q for the carrying value of our goodwill.
Identifiable Intangible Assets. We amortize our identifiable intangible assets
(i) over their estimated lives, (ii) based on economic usage or (iii) in
proportion to estimated gross profits or premium revenues. Identifiable
intangible assets are tested for impairment whenever events or changes in
circumstances suggest that an asset's or asset group's carrying value may not be
fully recoverable.
An impairment loss, generally calculated as the difference between the estimated
fair value and the carrying value of an asset or asset group, is recognized if
the sum of the estimated undiscounted cash flows relating to the asset or asset
group is less than the corresponding carrying value. See Note 13 to the
condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q
for the carrying value and estimated remaining lives of our identifiable
intangible assets by major asset class and impairments of our identifiable
intangible assets.
A prolonged period of market weakness could adversely impact our businesses and
impair the value of our identifiable intangible assets. In addition, certain
events could indicate a potential impairment of our identifiable intangible
assets, including (i) decreases in revenues from commodity-related customer
contracts and relationships, (ii) decreases in cash receipts from television
broadcast royalties, (iii) an adverse action or assessment by a regulator or
(iv) adverse actual experience on the contracts in our variable annuity and life
insurance business. Management judgment is required to evaluate whether
indications of potential impairment have occurred, and to test intangibles for
impairment if required.
120 Goldman Sachs June 2012 Form 10-Q
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Table of Contents
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Use of Estimates
The use of generally accepted accounting principles requires management to make
certain estimates and assumptions. In addition to the estimates we make in
connection with fair value measurements, the accounting for goodwill and
identifiable intangible assets, and discretionary compensation accruals, the use
of estimates and assumptions is also important in determining provisions for
losses that may arise from litigation, regulatory proceedings and tax audits.
A substantial portion of our compensation and benefits represents discretionary
compensation, which is finalized at year-end. We believe the most appropriate
way to allocate estimated annual discretionary compensation among interim
periods is in proportion to the net revenues earned in such periods. In addition
to the level of net revenues, our overall compensation expense in any given year
is also influenced by, among other factors, prevailing labor markets, business
mix, the structure of our share-based compensation programs and the external
environment. See "Results of Operations - Financial Overview - Operating
Expenses" below for information regarding our ratio of compensation and benefits
to net revenues.
We estimate and provide for potential losses that may arise out of litigation
and regulatory proceedings to the extent that such losses are probable and can
be reasonably estimated. In accounting for income taxes, we estimate and provide
for potential liabilities that may arise out of tax audits to the extent that
uncertain tax positions fail to meet the recognition standard under FASB
Accounting Standards Codification 740. See Note 24 to the condensed consolidated
financial statements in Part I, Item 1 of this Form 10-Q for further information
about accounting for income taxes.
Significant judgment is required in making these estimates and our final
liabilities may ultimately be materially different. Our total estimated
liability in respect of litigation and regulatory proceedings is determined on a
case-by-case basis and represents an estimate of probable losses after
considering, among other factors, the progress of each case or proceeding, our
experience and the experience of others in similar cases or proceedings, and the
opinions and views of legal counsel. See Notes 18 and 27 to the condensed
consolidated financial statements in Part I, Item 1 of this Form 10-Q for
information on certain judicial, regulatory and legal proceedings.
Goldman Sachs June 2012 Form 10-Q 121
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Results of Operations
The composition of our net revenues has varied over time as financial markets
and the scope of our operations have changed. The composition of net revenues
can also vary over the shorter term due to fluctuations in U.S. and global
economic and market conditions. See "Certain Risk Factors That May Affect Our
Businesses" below and "Risk Factors" in Part I, Item 1A of our Annual Report on
Form 10-K for a further discussion of the impact of economic and market
conditions on our results of operations.
Financial Overview
The table below presents an overview of our financial results.
Three Months Six Months
Ended June Ended June
$ in millions, except per share amounts 2012 2011 2012 2011
Net revenues $6,627 $7,281 $16,576 $19,175
Pre-tax earnings 1,415 1,612 4,596 5,652
Net earnings 962 1,087 3,071 3,822
Net earnings applicable to common shareholders 927 1,052 3,001 1,960
Diluted earnings per common share 1.78 1.85 5.72 3.40 2
Annualized return on average common shareholders'
equity 1 5.4 % 6.1 % 8.8 % 8.0 % 2
1. Annualized ROE is computed by dividing annualized net earnings applicable to
common shareholders by average monthly common shareholders' equity. The impact
of the $1.64 billion Series G Preferred Stock dividend in the first quarter of
2011 was not annualized in the calculation of annualized net earnings
applicable to common shareholders for the six months ended June 2011 as this
amount had no impact on other quarters in the year. The table below presents
our average common shareholders' equity.
Average for the
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
Total shareholders' equity $71,637 $72,474 $71,170$74,519
Preferred stock (3,538 ) (3,100 )
(3,350 ) (4,753 )
Common shareholders' equity $68,099 $69,374
$67,820$69,766
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. The tables below present the calculation of net
earnings applicable to common shareholders, diluted earnings per common share
and average common shareholders' equity excluding the impact of this dividend.
Six Months Ended
in millions, except per share amount June 2011
Net earnings applicable to common shareholders $1,960
Impact of the Series G Preferred Stock dividend
1,643
Net earnings applicable to common shareholders, excluding
the impact of the Series G Preferred Stock dividend
3,603
Divided by: average diluted common shares outstanding
576.4
Diluted earnings per common share, excluding the impact of
the Series G Preferred Stock dividend
$ 6.25
Average for the
Six Months Ended
in millions June 2011
Total shareholders' equity $74,519
Preferred stock (4,753 )
Common shareholders' equity 69,766
Impact of the Series G Preferred Stock dividend
939
Common shareholders' equity, excluding the impact of the
Series G Preferred Stock dividend
$70,705
122 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Net Revenues
Three Months Ended June 2012 versus June 2011. Net revenues on the condensed
consolidated statements of earnings were $6.63 billion for the second quarter of
2012, 9% lower than the second quarter of 2011, reflecting significantly lower
other principal transactions revenues and net interest income, as well as lower
investment banking revenues and commissions and fees. These decreases were
partially offset by significantly higher market-making revenues, as well as
higher investment management revenues compared with the second quarter of 2011.
Six Months Ended June 2012 versus June 2011. Net revenues on the condensed
consolidated statements of earnings were $16.58 billion for the first half of
2012, 14% lower than the first half of 2011, reflecting significantly lower
other principal transactions revenues and net interest income, as well as lower
investment banking revenues, commissions and fees and market-making revenues.
Investment management revenues were essentially unchanged compared with the
first half of 2011.
Non-interest Revenues
Investment banking
During the second quarter of 2012, investment banking revenues reflected an
operating environment generally characterized by heightened macroeconomic
concerns, including concerns about European sovereign debt risk and the slowing
economic conditions in the United States and China. These concerns contributed
to a decline in global equity prices, an increase in volatility levels and
generally wider credit spreads compared with the first quarter of 2012. These
factors weighed on investment banking activity, particularly in equity and
equity-related underwriting activity levels. If macroeconomic concerns continue
and equity prices decline further, resulting in lower levels of client activity,
investment banking revenues would likely continue to be negatively impacted.
Three Months Ended June 2012 versus June 2011. Investment banking revenues on
the condensed consolidated statements of earnings were $1.21 billion for the
second quarter of 2012, 17% lower than the second quarter of 2011, reflecting
significantly lower revenues in financial advisory, as well as lower revenues in
our underwriting business. The decrease in financial advisory reflected a
decline in industry-wide completed mergers and acquisitions. Revenues in equity
underwriting were significantly lower compared with the second quarter of 2011,
principally due to a decline in industry-wide activity. Revenues in debt
underwriting were higher compared with the second quarter of 2011, reflecting
higher revenues from investment-grade and commercial mortgage-related activity,
partially offset by lower revenues from leveraged finance activity.
Six Months Ended June 2012 versus June 2011. Investment banking revenues on the
condensed consolidated statements of earnings were $2.37 billion for the first
half of 2012, 13% lower than the first half of 2011, primarily reflecting lower
revenues in our underwriting business. Revenues in equity underwriting were
significantly lower compared with the first half of 2011, primarily reflecting a
decline in industry-wide activity. Revenues in debt underwriting were
essentially unchanged compared with the first half of 2011. In addition,
revenues in financial advisory were slightly lower compared with the first half
of 2011.
Investment management
During the second quarter of 2012, investment management revenues reflected an
operating environment generally characterized by decreased asset prices,
particularly in equities, and a shift in investor assets away from asset classes
with potentially higher risk and returns to asset classes with potentially lower
risk and returns. If asset prices decline or investors continue to change their
mix of assets to lower risk asset classes or withdraw their assets, investment
management revenues would likely be negatively impacted. In addition, continued
uncertainty regarding the global economic outlook could result in downward
pressure on assets under management.
Three Months Ended June 2012 versus June 2011. Investment management revenues on
the condensed consolidated statements of earnings were $1.27 billion for the
second quarter of 2012, 7% higher than 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.
Six Months Ended June 2012 versus June 2011. Investment management revenues on
the condensed consolidated statements of earnings were $2.37 billion for the
first half of 2012, essentially unchanged compared with the first half of 2011,
as significantly higher incentive fees, primarily related to the sale of our
funds' remaining investment in the ordinary shares of ICBC, were offset by lower
management and other fees, and lower transaction revenues.
Goldman Sachs June 2012 Form 10-Q 123
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Commissions and fees
Broad market concerns and uncertainties, including concerns about European
sovereign debt risk and the slowing economic conditions in the United States and
China, heightened during the second quarter of 2012. These concerns and
uncertainties resulted in a decrease in global equity prices and higher
volatility levels compared with the first quarter of 2012. The macroeconomic
challenges during the quarter contributed to generally lower transaction volumes
and fees. If macroeconomic concerns continue and equity prices decline further,
resulting in lower market volumes, commissions and fees would likely continue to
be negatively impacted.
Three Months Ended June 2012 versus June 2011. Commissions and fees on the
condensed consolidated statements of earnings were $799 million for the second
quarter of 2012, 11% lower than the second quarter of 2011, generally consistent
with broader market activity.
Six Months Ended June 2012 versus June 2011. Commissions and fees on the
condensed consolidated statements of earnings were $1.66 billion for the first
half of 2012, 13% lower than the first half of 2011, generally consistent with
broader market activity.
Market making
During the second quarter of 2012, market-making revenues reflected a
challenging operating environment, as broad market concerns and uncertainties
resurfaced, with the sovereign debt situation in Europe remaining the primary
concern. The outlook for the global economy was further impacted by concerns
about slowing economic conditions in the United States and China as a result of
weak economic data during the quarter. These conditions resulted in generally
wider credit spreads, lower global equity prices, higher volatility levels and
lower activity levels in most businesses, compared with the first quarter of
2012, and negatively impacted revenues during the quarter. In addition, other
broad market concerns persisted, such as continued uncertainty over financial
regulatory reform. If these concerns and uncertainties continue over the long
term, market-making revenues would likely continue to be negatively impacted.
Three Months Ended June 2012 versus June 2011. Market-making revenues on the
condensed consolidated statement of earnings were $2.10 billion for the second
quarter of 2012, 21% higher than the second quarter of 2011, reflecting higher
revenues in mortgages and commodities compared with difficult market-making
conditions during the second quarter of 2011, partially offset by lower revenues
in most of our other major market-making activities, particularly in equity
derivatives. During the second quarter of 2012, market-making revenues reflected
a challenging operating environment characterized by broad market concerns and
uncertainty, which resulted in generally wider credit spreads, lower global
equity prices, higher volatility levels and lower activity levels compared with
the first quarter of 2012.
Six Months Ended June 2012 versus June 2011. Market-making revenues on the
condensed consolidated statement of earnings were $6.00 billion for the first
half of 2012, 3% lower than the first half of 2011, primarily reflecting lower
revenues in credit products, equity derivatives, currencies and commodities,
partially offset by higher revenues in interest rate products and mortgages.
Although the first quarter of 2012 was generally characterized by tighter credit
spreads, higher global equity prices, lower volatility levels 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, lower global equity prices, higher
volatility levels and lower activity levels compared with the first quarter of
2012.
124 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Other principal transactions
During the second quarter of 2012, other principal transactions revenues
reflected an operating environment characterized by a decrease in global equity
prices and generally wider credit spreads, as broad market concerns and
uncertainties resurfaced, with the sovereign debt situation in Europe remaining
the primary concern. The outlook for the global economy was further impacted by
concerns about slowing economic conditions in the United States and China as a
result of weak economic data during the quarter. In addition, other broad market
concerns persisted, such as continued uncertainty over financial regulatory
reform. If equity prices continue to decline and credit spreads continue to
widen, other principal transactions revenues would likely continue to be
negatively impacted.
Three Months Ended June 2012 versus June 2011. Other principal transactions
revenues on the condensed consolidated statements of earnings were $169 million
for the second quarter of 2012, compared with $602 million for the second
quarter of 2011. Results for the second quarter of 2012 included a loss from our
investment in the ordinary shares of ICBC and net losses from other investments
in equities, reflecting losses in public equities, largely offset by gains in
private equities. In addition, other principal transactions revenues included
net gains from debt securities and loans, and revenues related to our
consolidated investment entities. In the second quarter of 2011, other principal
transactions revenues primarily included net gains from private equities and
revenues from our consolidated investment entities, partially offset by net
losses from our investment in the ordinary shares of ICBC and other public
equities.
Six Months Ended June 2012 versus June 2011. Other principal transactions
revenues on the condensed consolidated statements of earnings were $2.11 billion
for the first half of 2012, compared with $3.21 billion for the first half of
2011. Results for the first half of 2012 included a loss from our investment in
the ordinary shares of ICBC and net gains from other investments in equities,
reflecting gains in private equities. In addition, other principal transactions
revenues included net gains from debt securities and loans, and revenues related
to our consolidated investment entities. In the first half of 2011, other
principal transactions revenues primarily included net gains from private
equities, net gains from debt securities and loans, and revenues from our
consolidated investment entities.
Net Interest Income
Three Months Ended June 2012 versus June 2011. Net interest income on the
condensed consolidated statements of earnings was $1.09 billion for the second
quarter of 2012, 23% lower than the second quarter of 2011. The decrease
compared with the second quarter of 2011 was primarily due to lower average
yields on financial instruments owned, at fair value and collateralized
agreements.
Six Months Ended June 2012 versus June 2011. Net interest income on the
condensed consolidated statements of earnings was $2.07 billion for the first
half of 2012, 25% lower than the first half of 2011. The decrease compared with
the first half of 2011 was primarily due to lower average yields on financial
instruments owned, at fair value and collateralized agreements, as well as
higher interest expense related to our long-term borrowings.
Operating Expenses
Our operating expenses are primarily influenced by compensation, headcount and
levels of business activity. Compensation and benefits includes salaries,
estimated year-end discretionary compensation, amortization of equity awards and
other items such as benefits. Discretionary compensation is significantly
impacted by, among other factors, the level of net revenues, prevailing labor
markets, business mix, the structure of our share-based compensation programs
and the external environment.
In the context of more difficult economic and financial conditions, the firm
launched an initiative during the second quarter of 2011 to identify areas where
we can operate more efficiently and reduce our operating expenses. We have met
our 2011 targeted annual run rate compensation and non-compensation reduction of
approximately $1.4 billion. 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.
Goldman Sachs June 2012 Form 10-Q 125
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The table below presents our operating expenses and total staff.
Three Months Six Months
Ended June Ended June
$ in millions 2012 2011 2012 2011
Compensation and benefits $ 2,915 $ 3,204 $ 7,293 $ 8,437
Brokerage, clearing, exchange and distribution fees 544 615 1,111 1,235
Market development 129 183 246 362
Communications and technology 202 210 398 408
Depreciation and amortization 409 372 842 962
Occupancy 214 252 426 519
Professional fees 213 263 447 496
Insurance reserves 1 121 117 278 205
Other expenses 465 453 939 899
Total non-compensation expenses 2,297 2,465 4,687 5,086
Total operating expenses $ 5,212 $ 5,669 $11,980 $13,523
Total staff at period-end 2 32,300 35,500
1. Revenues related to our insurance activities are included in "Market making"
on the condensed consolidated statements of earnings.
2. Includes employees, consultants and temporary staff.
Three Months Ended June 2012 versus June 2011. Operating expenses were $5.21
billion for the second quarter of 2012, 8% lower than the second quarter of
2011. The accrual for compensation and benefits expenses was $2.92 billion for
the second quarter of 2012, a 9% decline compared with the second quarter of
2011. Total staff remained essentially unchanged during the second quarter of
2012.
Non-compensation expenses were $2.30 billion, 7% lower than the second quarter
of 2011. The decrease compared with the second quarter of 2011 primarily
reflected decreased levels of business activity and the impact of expense
reduction initiatives, partially offset by higher impairment charges related to
consolidated investment entities during the second quarter of 2012. The second
quarter of 2012 included net provisions for litigation and regulatory
proceedings of $67 million.
Six Months Ended June 2012 versus June 2011. Operating expenses were $11.98
billion for the first half of 2012, 11% lower than the first half of 2011. The
accrual for compensation and benefits expenses was $7.29 billion for the first
half of 2012, a 14% decline compared with the first half of 2011. The ratio of
compensation and benefits to net revenues for the first half of 2012 was 44.0%,
consistent with the first half of 2011. Total staff decreased 3% during the
first half of 2012.
Non-compensation expenses were $4.69 billion, 8% lower than the first half of
2011. The decrease compared with the first half of 2011 primarily reflected
decreased levels of business activity, the impact of expense reduction
initiatives and lower impairment charges during the first half of 2012.
These decreases were partially offset by increased reserves related to our
insurance business. The first half of 2012 included net provisions for
litigation and regulatory proceedings of $126 million.
Provision for Taxes
The effective income tax rate for the first half of 2012 was 33.2%, down
slightly from 33.7% for the first quarter of 2012 and up from 28.0% for 2011.
The increase in the effective income tax rate from 28.0% to 33.2% was primarily
due to the earnings mix and a decrease in the impact of permanent benefits.
Effective January 1, 2012, the rules related to the deferral of U.S. tax on
certain non-repatriated active financing income expired. This change did not
have a material effect on our financial condition, results of operations or cash
flows as of or for the three and six months ended June 2012 and we do not expect
this change to have a material effect on our financial condition, results of
operations or cash flows for the remainder of 2012. This change may have a
material impact on our effective tax rate for 2013 if the expired provisions are
not re-enacted.
During March 2012, the United Kingdom government announced a budget proposal
that would reduce the corporate income tax rate effective April 1, 2012. This
budget proposal was enacted into law during the third quarter of 2012. We do not
expect this change to have a material impact on our financial condition, results
of operations or cash flows for the remainder of 2012.
126 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Segment Operating Results
The table below presents the net revenues, operating expenses and pre-tax
earnings of our segments.
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
Investment Banking Net revenues $1,203 $1,448 $ 2,357 $ 2,717
Operating expenses 869 981 1,735 1,904
Pre-tax earnings $ 334 $ 467 $ 622 $ 813
Institutional Client Services Net revenues $3,889 $3,515 $ 9,598 $10,162
Operating expenses 2,947 3,040 6,830 7,624
Pre-tax earnings $ 942 $ 475 $ 2,768 $ 2,538
Investing & Lending Net revenues $ 203 $1,044 $ 2,114 $ 3,749
Operating expenses 256 547 1,214 1,778
Pre-tax earnings/(loss) $ (53 ) $ 497 $ 900 $ 1,971
Investment Management Net revenues $1,332 $1,274 $ 2,507 $ 2,547
Operating expenses 1,070 1,056 2,060 2,123
Pre-tax earnings $ 262 $ 218 $ 447 $ 424
Total Net revenues $6,627 $7,281 $16,576 $19,175
Operating expenses 5,212 5,669 11,980 13,523
Pre-tax earnings $1,415 $1,612 $ 4,596 $ 5,652
Total operating expenses in the table above include the following expenses that
have not been allocated to our segments:
Ÿ net provisions for a number of litigation and regulatory proceedings of $67
million and $45 million for the three months ended June 2012 and June 2011,
respectively, and $126 million and $69 million for the six months ended June
2012 and June 2011, respectively;
Ÿ charitable contributions of $12 million and $25 million for the six months
ended June 2012 and June 2011, respectively; and
Ÿ real estate-related exit costs of $3 million for both the three and six months
ended June 2012.
Net revenues in our segments include allocations of interest income and interest
expense to specific securities, commodities and other positions in relation to
the cash generated by, or funding requirements of, such underlying positions.
See Note 25 to the condensed consolidated financial statements in Part I, Item 1
of this Form 10-Q for further information about our business segments.
The cost drivers of Goldman Sachs taken as a whole -compensation, headcount and
levels of business activity - are broadly similar in each of our business
segments. Compensation and benefits expenses within our segments reflect, among
other factors, the overall performance of Goldman Sachs as well as the
performance of individual businesses. Consequently, pre-tax margins in one
segment of our business may be significantly affected by the performance of our
other business segments. A discussion of segment operating results follows.
Goldman Sachs June 2012 Form 10-Q 127
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Investment Banking
Our Investment Banking segment is comprised of:
Financial Advisory.Includes advisory assignments with respect to mergers and
acquisitions, divestitures, corporate defense activities, risk management,
restructurings and spin-offs, and derivative transactions directly related to
these client advisory assignments.
Underwriting.Includes public offerings and private placements of a wide range of
securities, loans and other financial instruments, and derivative transactions
directly related to these client underwriting activities.
The table below presents the operating results of our Investment Banking
segment.
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
Financial Advisory $ 469 $ 637 $ 958 $ 994
Equity underwriting 239 378 494 804
Debt underwriting 495 433 905 919
Total Underwriting 734 811 1,399 1,723
Total net revenues 1,203 1,448 2,357 2,717
Operating expenses 869 981 1,735 1,904
Pre-tax earnings $ 334 $ 467 $ 622 $ 813
The table below presents our financial advisory and underwriting transaction
volumes.1
Three Months Six Months
Ended June Ended June
in billions 2012 2011 2012 2011 Announced mergers and acquisitions $178$183$305$354
Completed mergers and acquisitions 160 190
242 355
Equity and equity-related offerings 2 11 17
24 42
Debt offerings 3 41 60 109 133
1. Source: Thomson Reuters. Announced and completed mergers and acquisitions
volumes are based on full credit to each of the advisors in a transaction.
Equity and equity-related offerings and debt offerings are based on full
credit for single book managers and equal credit for joint book managers.
Transaction volumes may not be indicative of net revenues in a given period.
In addition, transaction volumes for prior periods may vary from amounts
previously reported due to the subsequent withdrawal or a change in the value
of a transaction.
2. Includes Rule 144A and public common stock offerings, convertible offerings
and rights offerings.
3. Includes non-convertible preferred stock, mortgage-backed securities,
asset-backed securities and taxable municipal debt. Includes publicly
registered and Rule 144A issues. Excludes leveraged loans.
Three Months Ended June 2012 versus June 2011. Net revenues in Investment
Banking were $1.20 billion, 17% lower than the second quarter of 2011.
Net revenues in Financial Advisory were $469 million, 26% lower than the second
quarter of 2011, reflecting a decline in industry-wide completed mergers and
acquisitions. Net revenues in our Underwriting business were $734 million, 9%
lower than the second quarter of 2011. 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.
During the second quarter of 2012, Investment Banking operated in an environment
generally characterized by heightened macroeconomic concerns, including concerns
about European sovereign debt risk and the slowing economic conditions in the
United States and China. These concerns contributed to a decline in global
equity prices, an increase in volatility levels and generally wider credit
spreads compared with the first quarter of 2012. These factors weighed on
investment banking activity, particularly in equity and equity-related
underwriting activity levels. If macroeconomic concerns continue and equity
prices decline further, resulting in lower levels of client activity, net
revenues in Investment Banking would likely continue to be negatively impacted.
Our investment banking transaction backlog increased compared with the end of
the first quarter of 2012. The increase compared with the end of the first
quarter of 2012 was due to an increase in potential debt underwriting
transactions, primarily reflecting an increase in client mandates to underwrite
leveraged finance transactions, as well as higher estimated net revenues from
potential advisory transactions. These increases were partially offset by a
decrease in potential equity underwriting transactions compared with the end of
the first quarter of 2012, reflecting a decrease in client mandates to
underwrite initial public offerings.
128 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Our investment banking transaction backlog represents an estimate of our future
net revenues from investment banking transactions where we believe that future
revenue realization is more likely than not. We believe changes in our
investment banking transaction backlog may be a useful indicator of client
activity levels which, over the long term, impact our net revenues. However, the
timeframe for completion and corresponding revenue recognition of transactions
in our backlog varies based on the nature of the assignment, as certain
transactions may remain in our backlog for longer periods of time and others may
enter and leave within the same reporting period. In addition, our transaction
backlog is subject to certain limitations, such as assumptions about the
likelihood that individual client transactions will occur in the future.
Transactions may be cancelled or modified, and transactions not included in the
estimate may also occur.
Operating expenses were $869 million for the second quarter of 2012, 11% lower
than the second quarter of 2011, primarily due to decreased compensation and
benefits expenses. Pre-tax earnings were $334 million in the second quarter of
2012, 28% lower than the second quarter of 2011.
Six Months Ended June 2012 versus June 2011. Net revenues in Investment Banking
were $2.36 billion, 13% lower than the first half of 2011.
Net revenues in Financial Advisory were $958 million, 4% lower than the first
half of 2011. Net revenues in our Underwriting business were $1.40 billion, 19%
lower than the first half of 2011. 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.
During the first half of 2012, Investment Banking operated in an environment
generally characterized by heightened macroeconomic concerns, including concerns
about European sovereign debt risk and the slowing economic conditions in the
United States and China, despite positive developments during the first quarter
of 2012. These concerns weighed on investment banking activity, particularly in
equity and equity-related underwriting activity levels. If macroeconomic
concerns continue and equity prices decline, resulting in lower levels of client
activity, net revenues in Investment Banking would likely continue to be
negatively impacted.
Our investment banking transaction backlog increased compared with the end of
2011. The increase compared with the end of 2011 was due to an increase in
potential debt underwriting transactions, primarily reflecting an increase in
client mandates to underwrite leveraged finance transactions, as well as an
increase in potential advisory transactions. These increases were partially
offset by a decrease in potential equity underwriting transactions compared with
the end of 2011, reflecting a decrease in client mandates to underwrite initial
public offerings.
Operating expenses were $1.74 billion for the first half of 2012, 9% lower than
the first half of 2011, primarily due to decreased compensation and benefits
expenses. Pre-tax earnings were $622 million in the first half of 2012, 23%
lower than the first half of 2011.
Institutional Client Services
Our Institutional Client Services segment is comprised of:
Fixed Income, Currency and Commodities Client Execution. Includes client
execution activities related to making markets in interest rate products, credit
products, mortgages, currencies and commodities.
We generate market-making revenues in these activities, in three ways:
Ÿ In large, highly liquid markets (such as markets for U.S. Treasury bills,
large capitalization S&P 500 stocks or certain mortgage pass-through
certificates), we execute a high volume of transactions for our clients for
modest spreads and fees.
Ÿ In less liquid markets (such as mid-cap corporate bonds, growth market
currencies and certain non-agency mortgage-backed securities), we execute
transactions for our clients for spreads and fees that are generally somewhat
larger.
Ÿ We also structure and execute transactions involving customized or tailor-made
products that address our clients' risk exposures, investment objectives or
other complex needs (such as a jet fuel hedge for an airline).
Goldman Sachs June 2012 Form 10-Q 129
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Given the focus on the mortgage market, our mortgage activities are further
described below.
Our activities in mortgages include commercial mortgage-related securities,
loans and derivatives, residential mortgage-related securities, loans and
derivatives (including U.S. government agency-issued collateralized mortgage
obligations, other prime, subprime and Alt-A securities and loans), and other
asset-backed securities, loans and derivatives.
We buy, hold and sell long and short mortgage positions, primarily for market
making for our clients. Our inventory therefore changes based on client demands
and is generally held for short-term periods.
See Notes 18 and 27 to the condensed consolidated financial statements in Part
I, Item 1 of this Form 10-Q for information about exposure to mortgage
repurchase requests, mortgage rescissions and mortgage-related litigation.
Equities. Includes client execution activities related to making markets in
equity products, as well as commissions and fees from executing and clearing
institutional client transactions on major stock, options and futures exchanges
worldwide. Equities also includes our securities services business, which
provides financing, securities lending and other prime brokerage services to
institutional clients, including hedge funds, mutual funds, pension funds and
foundations, and generates revenues primarily in the form of interest rate
spreads or fees, and revenues related to our insurance activities.
The table below presents the operating results of our Institutional Client
Services segment.
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
Fixed Income, Currency and
Commodities Client Execution $2,194 $1,599 $5,652 $ 5,924
Equities client execution 510 623 1,560 1,602
Commissions and fees 776 861 1,610 1,832
Securities services 409 432 776 804
Total Equities 1,695 1,916 3,946 4,238
Total net revenues 3,889 3,515 9,598 10,162
Operating expenses 2,947 3,040 6,830 7,624
Pre-tax earnings $ 942 $ 475 $2,768 $ 2,538
Three Months Ended June 2012 versus June 2011. Net revenues in Institutional
Client Services were $3.89 billion, 11% higher than the second quarter of 2011.
Net revenues in Fixed Income, Currency and Commodities Client Execution were
$2.19 billion, 37% higher than the second quarter of 2011, reflecting 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.
Net revenues in Equities were $1.70 billion, 12% lower than the second quarter
of 2011, 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.
The net gain attributable to the impact of changes in our own credit spreads on
borrowings for which the fair value option was elected was $6 million for the
second quarter of 2012 compared with $85 million for the second quarter of 2011.
130 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
During the second quarter of 2012, Institutional Client Services operated in a
challenging environment, as broad market concerns and uncertainties resurfaced,
with the sovereign debt situation in Europe remaining the primary concern. The
outlook for the global economy was further impacted by concerns about slowing
economic conditions in the United States and China as a result of weak economic
data during the quarter. These conditions resulted in generally wider credit
spreads, lower global equity prices, higher volatility levels and lower activity
levels in most businesses, compared with the first quarter of 2012, and
negatively impacted net revenues during the quarter. In addition, other broad
market concerns persisted, such as continued uncertainty over financial
regulatory reform. If these concerns and uncertainties continue over the long
term, net revenues in Fixed Income, Currency and Commodities Client Execution
and Equities would likely continue to be negatively impacted.
Operating expenses were $2.95 billion for the second quarter of 2012, 3% lower
than the second quarter of 2011, primarily due to decreased levels of business
activity. Pre-tax earnings were $942 million in the second quarter of 2012,
compared with $475 million in the second quarter of 2011.
Six Months Ended June 2012 versus June 2011. Net revenues in Institutional
Client Services were $9.60 billion, 6% lower than the first half of 2011.
Net revenues in Fixed Income, Currency and Commodities Client Execution were
$5.65 billion, 5% lower than the first half of 2011, reflecting 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.
Net revenues in Equities were $3.95 billion, 7% lower than the first half of
2011, 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.
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 $218 million for the
first half of 2012, compared with a net gain of $126 million for the first half
of 2011.
Institutional Client Services operated in an environment generally characterized
by broad market concerns and uncertainties. Positive developments during the
first quarter of 2012 helped to improve market conditions, including actions
undertaken by the European Central Bank and other central banks to address
funding risks for European financial institutions, the progress in resolving
Greece's debt situation, as well as encouraging U.S. economic data. However,
during the second quarter of 2012, concerns surrounding the stability of the
global economy and its future prospects resurfaced, with the sovereign debt
situation in Europe remaining the primary concern. The outlook for the global
economy was further impacted during the second quarter of 2012 by concerns about
slowing economic conditions in the United States and China as a result of weak
economic data, which led to generally wider credit spreads, lower global equity
prices, higher volatility levels and lower activity levels in most businesses.
In addition, other broad market concerns persisted, such as continued
uncertainty over financial regulatory reform. If these concerns and
uncertainties continue over the long term, net revenues in Fixed Income,
Currency and Commodities Client Execution and Equities would likely continue to
be negatively impacted.
Operating expenses were $6.83 billion for the first half of 2012, 10% lower than
the first half of 2011, primarily due to decreased compensation and benefits
expenses, the impact of impairment charges during the first half of 2011,
principally related to Litton Loan Servicing LP, and decreased levels of
business activity. These decreases were partially offset by increased reserves
related to our insurance business. Pre-tax earnings were $2.77 billion in the
first half of 2012, 9% higher than the first half of 2011.
Goldman Sachs June 2012 Form 10-Q 131
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Table of Contents
THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Investing & Lending
Investing & Lending includes our investing activities and the origination of
loans to provide financing to clients. These investments and loans are typically
longer-term in nature. We make investments, directly and indirectly through
funds that we manage, in debt securities, loans, public and private equity
securities, real estate, consolidated investment entities and power generation
facilities.
The table below presents the operating results of our Investing & Lending
segment.
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
ICBC $(194 ) $ (176 ) $ (25 ) $ 140
Equity securities (excluding ICBC) (112 ) 686 779 1,740
Debt securities and loans 222 200 807 1,224
Other 287 334 553 645
Total net revenues 203 1,044 2,114 3,749
Operating expenses 256 547 1,214 1,778
Pre-tax earnings/(loss) $ (53 ) $ 497 $ 900 $1,971
Three Months Ended June 2012 versus June 2011. 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 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.
Results for the second quarter of 2011 included a loss of $176 million from our
investment in the ordinary shares of ICBC, net gains of $686 million from other
investments in equities and net revenues of $200 million from debt securities
and loans, primarily reflecting net interest income on loans, primarily
mezzanine and senior corporate loans. The net gains from other investments in
equities were primarily driven by gains from private equities, partially
offset by losses from public equities. In addition, Investing & Lending included
other net revenues of $334 million, principally related to our consolidated
investment entities.
Operating expenses were $256 million for the second quarter of 2012, 53% lower
than the second quarter of 2011, primarily due to decreased compensation and
benefits expenses. Pre-tax loss was $53 million in the second quarter of 2012,
compared with pre-tax earnings of $497 million in the second quarter of 2011.
Six Months Ended June 2012 versus June 2011. 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.
Results for the first half of 2011 included a gain of $140 million from our
investment in the ordinary shares of ICBC, net gains of $1.74 billion from other
investments in equities and net gains and net interest of $1.22 billion from
debt securities and loans, primarily mezzanine and senior corporate loans. The
net gains from other investments in equities were primarily driven by gains from
private equities. Net revenues from debt securities and loans reflected the
impact of generally favorable credit markets, which provided favorable
conditions for borrowers to refinance, primarily during the first quarter of
2011. In addition, Investing & Lending included other net revenues of
$645 million, principally related to our consolidated investment entities.
Operating expenses were $1.21 billion for the first half of 2012, 32% lower than
the first half of 2011, primarily due to decreased compensation and benefits
expenses, partially offset by higher impairment charges related to our
consolidated investment entities. Pre-tax earnings were $900 million in the
first half of 2012, 54% lower than the first half of 2011.
132 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Investment Management
Investment Management provides investment management services and offers
investment products (primarily through separately managed accounts and
commingled vehicles, such as mutual funds and private investment funds) across
all major asset classes to a diverse set of institutional and individual
clients. Investment Management also offers wealth advisory services, including
portfolio management and financial counseling, and brokerage and other
transaction services to high-net-worth individuals and families.
Assets under management typically generate fees as a percentage of net asset
value, which vary by asset class and are affected by investment performance as
well as asset inflows and redemptions. In certain circumstances, we are also
entitled to receive incentive fees based on a percentage of a fund's return or
when the return exceeds a specified benchmark or other performance targets.
Incentive fees are recognized when all material contingencies are resolved.
The table below presents the operating results of our Investment Management
segment.
Three Months Six Months
Ended June Ended June
in millions 2012 2011 2012 2011
Management and other fees $1,019 $1,080 $2,022 $2,128
Incentive fees 217 63 275 137
Transaction revenues 96 131 210 282
Total net revenues 1,332 1,274 2,507 2,547
Operating expenses 1,070 1,056 2,060 2,123
Pre-tax earnings $ 262 $ 218 $ 447 $ 424
Assets under management include client assets where we earn a fee for managing
assets on a discretionary basis. This includes net assets in our mutual funds,
hedge funds and private equity funds (including real estate funds), and
separately managed accounts for institutional and individual investors. Assets
under management do not include the self-directed assets of our clients,
including brokerage accounts, or interest-bearing deposits held through our bank
depository institution subsidiaries.
The tables below present our assets under management by asset class and a
summary of the changes in our assets under management.
As of
June 30, December 31,
in billions 2012 2011 2011 2010
Alternative investments 1 $137 $148 $142 $148
Equity 127 148 126 144
Fixed income 363 352 340 340
Total non-money market assets 627 648 608 632
Money markets 209 196 220 208
Total assets under management $836 $844 $828 $840
1. Primarily includes hedge funds, private equity, real estate, currencies,
commodities and asset allocation strategies.
Three Months Six Months
Ended June 30, Ended June 30,
in billions 2012 2011 2012 2011
Balance, beginning of period $824 $840 $828 $840
Net inflows/(outflows)
Alternative investments (1 ) (3 ) (5 ) (3 )
Equity (2 ) (2 ) (7 ) (2 )
Fixed income 12 7 13 2
Total non-money market net inflows/(outflows) 9 2 1 (3 )
Money markets 7 (5 ) (11 ) (12 )
Total net inflows/(outflows) 16 1 (3 ) (10 ) 1 (15 )
Net market appreciation/(depreciation) (4 ) 7 18 19
Balance, end of period $836 $844 $836 $844
1. Includes $17 billion of fixed income asset inflows in connection with our
acquisition of Dwight Asset Management.
Three Months Ended June 2012 versus June 2011. Net revenues in Investment
Management were $1.33 billion, 5% higher than the second quarter of 2011. The
increase in net revenues compared with the second quarter of 2011 was 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 (including $17
billion of fixed income asset inflows in connection with our acquisition of
Dwight Asset Management), primarily in fixed income and money market assets,
partially offset by net market depreciation of $4 billion, primarily in equity
assets.
Goldman Sachs June 2012 Form 10-Q 133
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
During the second quarter of 2012, Investment Management operated in an
environment generally characterized by decreased asset prices, particularly in
equities, and a shift in investor assets away from asset classes with
potentially higher risk and returns to asset classes with potentially lower risk
and returns. If asset prices decline or investors continue to change their mix
of assets to lower risk asset classes or withdraw their assets, net revenues in
Investment Management would likely be negatively impacted. In addition,
continued uncertainty regarding the global economic outlook could result in
downward pressure on assets under management.
Operating expenses were $1.07 billion for the second quarter of 2012,
essentially unchanged compared with the second quarter of 2011. Pre-tax earnings
were $262 million in the second quarter of 2012, 20% higher than the second
quarter of 2011.
Six Months Ended June 2012 versus June 2011. Net revenues in Investment
Management were $2.51 billion, slightly lower than 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. Net outflows included outflows in money market, equity and
alternative investment assets, partially offset by inflows in fixed income
assets.
During the first quarter of 2012, Investment Management operated in an
environment generally characterized by improved asset prices, resulting in
appreciation in the value of client assets and a shift in investor assets away
from money markets, consistent with industry trends. However, during the second
quarter of 2012, heightened uncertainty regarding the global economic outlook
resulted in a decline in asset prices, particularly in equities. These
conditions contributed to investors shifting assets away from asset classes with
potentially higher risk and returns to asset classes with potentially lower risk
and returns. If asset prices decline or investors continue to change their mix
of assets to lower risk asset classes or withdraw their assets, net revenues in
Investment Management would likely be negatively impacted. In addition,
continued uncertainty regarding the global economic outlook could result in
downward pressure on assets under management.
Operating expenses were $2.06 billion for the first half of 2012, 3% lower than
the first half of 2011, due to decreased compensation and benefits expenses.
Pre-tax earnings were $447 million in the first half of 2012, 5% higher than the
first half of 2011.
Geographic Data
See Note 25 to the condensed consolidated financial statements in Part I, Item 1
of this Form 10-Q for a summary of our total net revenues and pre-tax earnings
by geographic region.
Regulatory Developments
The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act), enacted in July 2010, significantly altered the financial
regulatory regime within which we operate. The implications of the
Dodd-Frank Act for our businesses will depend to a large extent on the rules
that will be adopted by the Board of Governors of the Federal Reserve System
(Federal Reserve Board), the Federal Deposit Insurance Corporation (FDIC), the
SEC, the U.S. Commodity Futures Trading Commission (CFTC) and other agencies to
implement the legislation, as well as the development of market practices and
structures under the regime established by the legislation and the implementing
rules. Similar reforms are being considered by other regulators and policy
makers worldwide and these reforms may affect our businesses. We expect that the
principal areas of impact from regulatory reform for us will be:
Ÿ the Dodd-Frank prohibition on "proprietary trading" and the limitation on the
sponsorship of, and investment in, hedge funds and private equity funds by
banking entities, including bank holding companies, referred to as the
"Volcker Rule";
Ÿ increased regulation of and restrictions on over-the-counter (OTC) derivatives
markets and transactions; and
Ÿ increased regulatory capital requirements.
In October 2011, the proposed rules to implement the Volcker Rule were issued
and included an extensive request for comments on the proposal. The proposed
rules are highly complex and many aspects of the Volcker Rule remain unclear.
The full impact of the rule will depend upon the detailed scope of the
prohibitions, permitted activities, exceptions and exclusions, and the full
impact on the firm will not be known with certainty until the rules are
finalized.
While many aspects of the Volcker Rule remain unclear, we evaluated the
prohibition on "proprietary trading" and determined that businesses that engage
in "bright line" proprietary trading are most likely to be prohibited. In 2011
and 2010, we liquidated substantially all of our Principal Strategies and global
macro proprietary trading positions.
134 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
In addition, we evaluated the limitations on sponsorship of, and investments in,
hedge funds and private equity funds. The firm earns management fees and
incentive fees for investment management services from private equity and hedge
funds, which are included in our Investment Management segment. The firm also
makes investments in funds and the gains and losses from such investments are
included in our Investing & Lending segment; these gains and losses will be
impacted by the Volcker Rule. The Volcker Rule limitation on investments in
hedge funds and private equity funds requires the firm to reduce its investment
in each private equity and hedge fund to 3% or less of net asset value, and to
reduce the firm's aggregate investment in all such funds to 3% or less of the
firm's Tier 1 capital. Over the period from 1999 through the second quarter of
2012, the firm's aggregate net revenues from its investments in hedge funds and
private equity funds were not material to the firm's aggregate total net
revenues over the same period. We continue to manage our existing private equity
funds taking into account the transition periods under the Volcker Rule. With
respect to our hedge funds, we currently plan to comply with the Volcker Rule by
redeeming certain of our interests in the funds. We currently expect to redeem
up to approximately 10% of certain hedge funds' total redeemable units per
quarter over ten consecutive quarters, beginning March 2012 and ending
June 2014. We redeemed approximately $250 million and $500 million of these
interests in hedge funds during the three and six months ended June 2012,
respectively. In addition, we have limited the firm's initial investment to 3%
for certain new funds.
As required by the Dodd-Frank Act, the Federal Reserve Board and FDIC have
jointly issued a rule requiring each bank holding company with over $50 billion
in assets and each designated systemically important financial institution to
provide to regulators an annual plan for its rapid and orderly resolution in the
event of material financial distress or failure (resolution plan). Our
resolution plan must, among other things, ensure that Goldman Sachs Bank USA (GS
Bank USA) is adequately protected from risks arising from our other entities.
The regulators' joint rule sets specific standards for the resolution plans,
including requiring a detailed resolution strategy and analyses of the company's
material entities, organizational structure, interconnections and
interdependencies, and management information systems, among other elements. We
submitted our first resolution plan to the regulators on June 29, 2012. GS Bank
USA also submitted a plan for its rapid and orderly resolution in the event of
material financial distress or failure on June 29, 2012, as required by the
FDIC.
In September 2011, the SEC proposed rules to implement the Dodd-Frank Act's
prohibition against securitization participants' engaging in any transaction
that would involve or result in any material conflict of interest with an
investor in a securitization transaction. The proposed rules would except bona
fide market-making activities and risk-mitigating hedging activities in
connection with securitization activities from the general prohibition.
In December 2011, the Federal Reserve Board proposed regulations designed to
strengthen the regulation and supervision of large bank holding companies and
systemically important nonbank financial firms. These proposals address
risk-based capital and leverage requirements, liquidity requirements, stress
tests, single counterparty limits and early remediation requirements that are
designed to address financial weakness at an early stage. Although many of the
proposals mirror initiatives to which bank holding companies are already
subject, their full impact on the firm will not be known with certainty until
the rules are finalized.
The Dodd-Frank Act also contains provisions that include (i) requiring the
registration of all swap dealers, major swap participants, security-based swap
dealers, and/or major security-based swap participants, and the clearing and
execution of more liquid "swaps" through regulated facilities (subject to
limited exceptions) and both public and regulatory reporting of trade
information, (ii) placing new requirements on swap dealers and security-based
swap dealers to comply with new business conduct standards, covering their
relationships with counterparties and their internal management of risks and
information associated with swaps and securities based swaps, and
(iii) establishing mandatory margin requirements for trades that are not cleared
through a central counterparty. Although it has not yet finalized its capital
regulations, the CFTC has finalized many other rules and has laid out
implementation deadlines in the second half of 2012, while the SEC has not yet
finalized certain of its rules or the implementation deadlines for its rules.
The Dodd-Frank Act also establishes a Bureau of Consumer Financial Protection
having broad authority to regulate providers of credit, payment and other
consumer financial products and services, and this Bureau has oversight over
certain of our products and services.
See Note 20 to the condensed consolidated financial statements in Part I, Item I
of this Form 10-Q for additional information about regulatory developments as
they relate to our regulatory capital ratios.
See "Business - Regulation" in Part I, Item 1 of our Annual Report on Form 10-K
for more information.
Goldman Sachs June 2012 Form 10-Q 135
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Balance Sheet and Funding Sources
Balance Sheet Management
One of our most important risk management disciplines is our ability to manage
the size and composition of our balance sheet. While our asset base changes due
to client activity, market fluctuations and business opportunities, the size and
composition of our balance sheet reflect (i) our overall risk tolerance,
(ii) our ability to access stable funding sources and (iii) the amount of equity
capital we hold.
Although our balance sheet fluctuates on a day-to-day basis, our total assets
and adjusted assets at quarterly and year-end dates are generally not materially
different from those occurring within our reporting periods.
In order to ensure appropriate risk management, we seek to maintain a liquid
balance sheet and have processes in place to dynamically manage our assets and
liabilities which include:
Ÿ quarterly planning;
Ÿ business-specific limits;
Ÿ monitoring of key metrics; and
Ÿ scenario analyses.
Quarterly Planning. We prepare a quarterly balance sheet plan that combines our
projected total assets and composition of assets with our expected funding
sources and capital levels for the upcoming quarter. The objectives of this
quarterly planning process are:
Ÿ to develop our near-term balance sheet projections, taking into account the
general state of the financial markets and expected client-driven and
firm-driven activity levels;
Ÿ to ensure that our projected assets are supported by an adequate amount and
tenor of funding and that our projected capital and liquidity metrics are
within management guidelines; and
Ÿ to allow business risk managers and managers from our independent control and
support functions to objectively evaluate balance sheet limit requests from
business managers in the context of the firm's overall balance sheet
constraints. These constraints include the firm's liability profile and equity
capital levels, maturities and plans for new debt and equity issuances, share
repurchases, deposit trends and secured funding transactions.
To prepare our quarterly balance sheet plan, business risk managers and managers
from our independent control and support functions meet with business managers
to review current and prior period metrics and discuss expectations for the
upcoming quarter. The specific metrics reviewed include asset and liability size
and composition, aged inventory, limit utilization, risk and performance
measures, and capital usage.
Our consolidated quarterly plan, including our balance sheet plans by business,
funding and capital projections, and projected capital and liquidity metrics, is
reviewed by the Firmwide Finance Committee. See "Overview and Structure of Risk
Management."
136 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Business-Specific Limits. The Firmwide Finance Committee sets asset and
liability limits for each business and aged inventory limits for certain
financial instruments as a disincentive to hold inventory over longer periods of
time. These limits are set at levels which are close to actual operating levels
in order to ensure prompt escalation and discussion among business managers and
managers in our independent control and support functions on a routine basis.
The Firmwide Finance Committee reviews and approves balance sheet limits on a
quarterly basis and may also approve changes in limits on an ad hoc basis in
response to changing business needs or market conditions.
Monitoring of Key Metrics. We monitor key balance sheet metrics daily both by
business and on a consolidated basis, including asset and liability size and
composition, aged inventory, limit utilization, risk measures and capital usage.
We allocate assets to businesses and review and analyze movements resulting from
new business activity as well as market fluctuations.
Scenario Analyses. We conduct scenario analyses to determine how we would manage
the size and composition of our balance sheet and maintain appropriate funding,
liquidity and capital positions in a variety of situations:
Ÿ These scenarios cover short-term and long-term time horizons using various
macro-economic and firm-specific assumptions. We use these analyses to assist
us in developing longer-term funding plans, including the level of unsecured
debt issuances, the size of our secured funding program and the amount and
composition of our equity capital. We also consider any potential future
constraints, such as limits on our ability to grow our asset base in the
absence of appropriate funding.
Ÿ Through our Internal Capital Adequacy Assessment Process (ICAAP) and our
resolution and recovery planning, we further analyze how we would manage our
balance sheet and risks through the duration of a severe crisis and we develop
plans to access funding, generate liquidity, and/or redeploy or issue equity
capital, as appropriate.
Balance Sheet Allocation
In addition to preparing our condensed consolidated statements of financial
condition in accordance with U.S. GAAP, we prepare a balance sheet that
generally allocates assets to our businesses, which is a non-GAAP presentation
and may not be comparable to similar non-GAAP presentations used by other
companies. We believe that presenting our assets on this basis is meaningful
because it is consistent with the way management views and manages risks
associated with the firm's assets and better enables investors to assess the
liquidity of the firm's assets. The table below presents a summary of this
balance sheet allocation.
As of
June December
in millions 2012 2011
Excess liquidity (Global Core Excess) $174,584 $171,581
Other cash 7,393 7,888
Excess liquidity and cash 181,977 179,469
Secured client financing 255,528 283,707
Inventory 298,922 273,640
Secured financing agreements 94,977 71,103
Receivables 40,670 35,769
Institutional Client Services 434,569 380,512
ICBC 1,717 4,713
Equity (excluding ICBC) 21,023 23,041
Debt 23,154 23,311
Receivables and other 6,506 5,320
Investing & Lending 52,400 56,385
Total inventory and related assets 486,969 436,897
Other assets 24,164 23,152
Total assets $948,638 $923,225
Goldman Sachs June 2012 Form 10-Q 137
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The following is a description of the captions in the table above.
Excess Liquidity and Cash. We maintain substantial excess liquidity to meet a
broad range of potential cash outflows and collateral needs in the event of a
stressed environment. See "Liquidity Risk Management" below for details on the
composition and sizing of our excess liquidity pool or "Global Core Excess"
(GCE). In addition to our excess liquidity, we maintain other operating cash
balances, primarily for use in specific currencies, entities, or jurisdictions
where we do not have immediate access to parent company liquidity.
Secured Client Financing. We provide collateralized financing for client
positions, including margin loans secured by client collateral, securities
borrowed, and resale agreements primarily collateralized by government
obligations. As a result of client activities, we are required to segregate cash
and securities to satisfy regulatory requirements. Our secured client financing
arrangements, which are generally short-term, are accounted for at fair value or
at amounts that approximate fair value, and include daily margin requirements to
mitigate counterparty credit risk.
Institutional Client Services. In Institutional Client Services, we maintain
inventory positions to facilitate market-making in fixed income, equity,
currency and commodity products. Additionally, as part of client market-making
activities, we enter into resale or securities borrowing arrangements to obtain
securities which we can use to cover transactions in which we or our clients
have sold securities that have not yet been purchased. The receivables in
Institutional Client Services primarily relate to securities transactions.
Investing & Lending. In Investing & Lending, we make investments and originate
loans to provide financing to clients. These investments and loans are typically
longer-term in nature. We make investments, directly and indirectly through
funds that we manage, in debt securities, loans, public and private equity
securities, real estate and other investments.
Other Assets. Other assets are generally less liquid, non-financial assets,
including property, leasehold improvements and equipment, goodwill and
identifiable intangible assets, income tax-related receivables, equity-method
investments and miscellaneous receivables.
138 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The tables below present the reconciliation of this balance sheet allocation to
our U.S. GAAP balance sheet. In the tables below, total assets for Institutional
Client Services and Investing & Lending represent the inventory and related
assets. These amounts differ from total assets by
business segment disclosed in Note 25 to the condensed consolidated financial
statements in Part I, Item 1 of this Form 10-Q because total assets disclosed in
Note 25 include allocations of our excess liquidity and cash, secured client
financing and other assets.
As of June 2012
Excess Secured Institutional
Liquidity Client Client Investing & Other Total
in millions and Cash 1 Financing Services Lending Assets Assets
Cash and cash equivalents $ 58,913 $ - $ - $ - $ - $ 58,913
Cash and securities segregated for
regulatory and other purposes - 56,685 - - - 56,685
Securities purchased under agreements
to resell and federal funds sold 54,128 80,458 32,668 90 - 167,344
Securities borrowed 27,746 77,461 62,309 - - 167,516
Receivables from brokers, dealers and
clearing organizations - 4,557 14,455 134 - 19,146
Receivables from customers and
counterparties - 36,367 26,215 5,092 - 67,674
Financial instruments owned, at fair
value 41,190 - 298,922 47,084 - 387,196
Other assets - - - - 24,164 24,164
Total assets $181,977 $255,528 $434,569 $52,400 $24,164 $948,638
As of December 2011
Excess Secured Institutional
Liquidity Client Client Investing & Other Total
in millions and Cash 1 Financing Services Lending Assets Assets
Cash and cash equivalents $ 56,008 $ - $ - $ - $ - $ 56,008
Cash and securities segregated for
regulatory and other purposes - 64,264 - - - 64,264
Securities purchased under agreements
to resell and federal funds sold 70,220 98,445 18,671 453 - 187,789
Securities borrowed 14,919 85,990 52,432 - - 153,341
Receivables from brokers, dealers and
clearing organizations - 3,252 10,612 340 - 14,204
Receivables from customers and
counterparties - 31,756 25,157 3,348 - 60,261
Financial instruments owned, at fair
value 38,322 - 273,640 52,244 - 364,206
Other assets - - - - 23,152 23,152
Total assets $179,469 $283,707 $380,512 $56,385 $23,152 $923,225
1. Includes unencumbered cash, U.S. government and federal agency obligations
(including highly liquid U.S. federal agency mortgage-backed obligations), and
German, French, Japanese and United Kingdom government obligations.
Goldman Sachs June 2012 Form 10-Q 139
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Less Liquid Inventory Composition
We seek to maintain a liquid balance sheet comprised of assets that can be
readily sold or funded on a secured basis. However, we do hold certain financial
instruments that may be more difficult to sell, or fund on a secured basis,
especially during times of market stress. We focus on funding these assets with
liabilities that have longer-term contractual maturities to reduce the need to
refinance in periods of market stress. The table below presents our aggregate
holdings in these categories of financial instruments.
As of
June December
in millions 2012 2011
Bank loans and bridge loans 1 $20,770 $19,745
Private equity investments and restricted public
equity securities 2 16,275
15,463
Mortgage and other asset-backed loans and securities 15,666
14,291
High-yield and other debt obligations 12,004
11,118
Emerging market debt securities 5,770
4,624
Emerging market equity securities 4,351 3,922
Other investments in funds 3 3,034 3,394
ICBC ordinary shares 4 1,717 4,713
1. Includes funded commitments and inventory held in connection with our
origination, investing and market-making activities.
2. Includes interests in funds that we manage. Such amounts exclude assets for
which the firm does not bear economic exposure of $2.38 billion as of both
June 2012 and December 2011, including assets related to consolidated
investment funds and consolidated variable interest entities (VIEs).
3. Includes interests in other investment funds that we manage. We redeemed
approximately $250 million and $500 million of these interests in hedge funds
during the three and six months ended June 2012, respectively. See "Results of
Operations - Regulatory Developments" for more information about our plans to
redeem certain of our interests in hedge funds to comply with the Volcker
Rule.
4. Includes interests of $2.60 billion as of December 2011, held by investment
funds managed by Goldman Sachs. These investment funds no longer have an
interest in the ordinary shares of ICBC.
See Notes 4 through 6 to the condensed consolidated financial statements in
Part I, Item 1 of this Form 10-Q for further information about the financial
instruments we hold.
Balance Sheet Analysis and Metrics
As of June 2012, total assets on our condensed consolidated statements of
financial condition were $948.64 billion, an increase of $25.41 billion from
December 2011. This increase was primarily due to an increase in financial
instruments owned, at fair value of $22.99 billion, primarily due to increases
in U.S. government and federal agency obligations, non-U.S. government and
agency obligations and equities and convertible debentures, partially offset by
a decrease in derivatives.
As of June 2012, total liabilities on our condensed consolidated statements of
financial condition were $875.78 billion, an increase of $22.94 billion from
December 2011. This increase reflects (i) an increase in payables to customers
and counterparties of $14.89 billion, primarily due to client activity and
(ii) an increase in deposits of $11.21 billion, primarily due to increases in
client activity.
As of June 2012 and December 2011, our total securities sold under agreements to
repurchase, accounted for as collateralized financings, were $160.44 billion and
$164.50 billion, respectively, which were 5% lower and 7% higher, respectively,
than the daily average amount of repurchase agreements over the respective
quarters. As of June 2012, the decrease in our repurchase agreements relative to
the daily average during the quarter was due to a decrease in firm financing and
client activity at the end of the quarter. The level of our repurchase
agreements fluctuates between and within periods, primarily due to providing
clients with access to highly liquid collateral, such as U.S. government and
federal agency, and investment-grade sovereign obligations through
collateralized financing activities.
140 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The table below presents information on our assets, unsecured long-term
borrowings, shareholders' equity and leverage ratios.
As of
June December
$ in millions 2012 2011
Total assets $948,638 $923,225
Adjusted assets $654,799 $604,391
Unsecured long-term borrowings $166,993 $173,545
Total shareholders' equity $ 72,855 $ 70,379
Leverage ratio 13.0 x 13.1 x
Adjusted leverage ratio 9.0 x 8.6 x
Debt to equity ratio 2.3 x 2.5 x
Adjusted assets. Adjusted assets equals total assets less (i) low-risk
collateralized assets generally associated with our secured client financing
transactions, federal funds sold and excess liquidity (which includes financial
instruments sold, but not yet purchased, at fair value, less derivative
liabilities) and (ii) cash and securities we segregate for regulatory and other
purposes. Adjusted assets is a non-GAAP measure and may not be comparable to
similar non-GAAP measures used by other companies.
The table below presents the reconciliation of total assets to adjusted assets.
As of
June December
in millions 2012 2011
Total assets $ 948,638 $ 923,225
Deduct: Securities borrowed (167,516 ) (153,341 )
Securities purchased under agreements to
resell and federal funds sold (167,344 ) (187,789 )
Add: Financial instruments sold, but not yet
purchased, at fair value 149,948 145,013
Less derivative liabilities (52,242 ) (58,453 )
Subtotal (237,154 ) (254,570 )
Deduct: Cash and securities segregated for
regulatory and other purposes (56,685 ) (64,264 )
Adjusted assets $ 654,799 $ 604,391
Leverage ratio. The leverage ratio equals total assets divided by total
shareholders' equity and measures the proportion of equity and debt the firm is
using to finance assets. This ratio is different from the Tier 1 leverage ratio
included in "Equity Capital - Consolidated Regulatory Capital Ratios" below, and
further described in Note 20 to the condensed consolidated financial statements
in Part I, Item 1 of this Form 10-Q.
Adjusted leverage ratio. The adjusted leverage ratio equals adjusted assets
divided by total shareholders' equity. We believe that the adjusted leverage
ratio is a more meaningful measure of our capital adequacy than the leverage
ratio because it excludes certain low-risk collateralized assets that are
generally supported with little or no capital. The adjusted leverage ratio is a
non-GAAP measure and may not be comparable to similar non-GAAP measures used by
other companies.
Our adjusted leverage ratio increased to 9.0x as of June 2012 from 8.6x as of
December 2011 as our adjusted assets increased.
Debt to equity ratio. The debt to equity ratio equals unsecured long-term
borrowings divided by total shareholders' equity.
Funding Sources
Our primary sources of funding are secured financings, unsecured long-term and
short-term borrowings, and deposits. We seek to maintain broad and diversified
funding sources globally.
We raise funding through a number of different products, including:
Ÿ collateralized financings, such as repurchase agreements, securities loaned
and other secured financings;
Ÿ long-term unsecured debt (including structured notes) through syndicated U.S.
registered offerings, U.S. registered and 144A medium-term note programs,
offshore medium-term note offerings and other debt offerings;
Ÿ demand and savings deposits through deposit sweep programs and time deposits
through internal and third-party broker-dealers; and
Ÿ short-term unsecured debt through U.S. and non-U.S. commercial paper and
promissory note issuances and other methods.
We generally distribute our funding products through our own sales force and
third-party distributors, to a large, diverse creditor base in a variety of
markets in the Americas, Europe and Asia. We believe that our relationships with
our creditors are critical to our liquidity. Our creditors include banks,
governments, securities lenders, pension funds, insurance companies, mutual
funds and individuals. We have imposed various internal guidelines to monitor
creditor concentration across our funding programs.
Goldman Sachs June 2012 Form 10-Q 141
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Secured Funding. We fund a significant amount of our inventory on a secured
basis. Secured funding is less sensitive to changes in our credit quality than
unsecured funding due to the nature of the collateral we post to our lenders.
However, because the terms or availability of secured funding, particularly
short-dated funding, can deteriorate rapidly in a difficult environment, we
generally do not rely on short-dated secured funding unless it is collateralized
with highly liquid securities such as government obligations.
Substantially all of our other secured funding is executed for tenors of one
month or greater. Additionally, we monitor counterparty concentration and hold a
portion of our GCE for refinancing risk associated with our secured funding
transactions. We seek longer terms for secured funding collateralized by
lower-quality assets because these funding transactions may pose greater
refinancing risk. In addition, we maintain secured funding capacity that is in
excess of our existing requirements. This capacity is available to finance
additional eligible inventory or to replace other secured liabilities.
The weighted average maturity of our secured funding, excluding funding
collateralized by highly liquid securities eligible for inclusion in our GCE,
exceeded 100 days as of June 2012.
A majority of our secured funding for securities not eligible for inclusion in
the GCE is executed through term repurchase agreements and securities lending
contracts. We also raise financing through other types of collateralized
financings, such as secured loans and notes.
GS Bank USA has access to funding through the Federal Reserve Bank discount
window. While we do not rely on this funding in our liquidity planning and
stress testing, we maintain policies and procedures necessary to access this
funding and test discount window borrowing procedures.
Unsecured Long-Term Borrowings. We issue unsecured long-term borrowings as a
source of funding for inventory and other assets and to finance a portion of our
GCE. We issue in different tenors, currencies, and products to maximize the
diversification of our investor base. The table below presents our quarterly
unsecured long-term borrowings maturity profile through the second quarter of
2018 as of June 2012.
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The weighted average maturity of our unsecured long-term borrowings as of
June 2012 was approximately eight years. To mitigate refinancing risk, we seek
to limit the principal amount of debt maturing on any one day or during any week
or year. We enter into interest rate swaps to convert a substantial portion of
our long-term borrowings into floating-rate obligations in order to manage our
exposure to interest rates. See Note 16 to the condensed consolidated financial
statements in Part I, Item 1 of this Form 10-Q for further information about our
unsecured long-term borrowings.
Temporary Liquidity Guarantee Program (TLGP). The remaining portion of our
senior unsecured short-term debt guaranteed by the FDIC under the TLGP matured
during the second quarter of 2012. As of June 2012, no borrowings guaranteed by
the FDIC under the TLGP were outstanding and the program had expired for new
issuances.
Deposits. As of June 2012, our bank depository institution subsidiaries had
$57.32 billion in customer deposits, including $19.57 billion of certificates of
deposit and other time deposits with a weighted average maturity of three years,
and $37.75 billion of other deposits, substantially all of which were from
private bank deposits and deposit sweep programs sourced through our own sales
force and third-party distributors. We utilize deposits to finance activities in
our bank subsidiaries and to support potential outflows, such as draws on
unfunded commitments.
Unsecured Short-Term Borrowings. A significant portion of our short-term
borrowings were originally long-term debt that is scheduled to mature within one
year of the reporting date. We use short-term borrowings to finance liquid
assets and for other cash management purposes. We primarily issue commercial
paper, promissory notes, and other hybrid instruments.
As of June 2012, our unsecured short-term borrowings, including the current
portion of unsecured long-term borrowings, were $45.69 billion. See Note 15 to
the condensed consolidated financial statements in Part I, Item 1 of this
Form 10-Q for further information about our unsecured short-term borrowings.
Equity Capital
Capital adequacy is of critical importance to us. Our objective is to be
conservatively capitalized in terms of the amount and composition of our equity
base. Accordingly, we have in place a comprehensive capital management policy
that serves as a guide to determine the amount and composition of equity capital
we maintain.
The level and composition of our equity capital are determined by multiple
factors including our current and future consolidated regulatory capital
requirements, our ICAAP and results of stress tests, and may also be influenced
by other factors such as rating agency guidelines, subsidiary capital
requirements, the business environment, conditions in the financial markets and
assessments of potential future losses due to adverse changes in our business
and market environments. In addition, we maintain a capital plan which projects
sources and uses of capital given a range of business environments, and a
contingency capital plan which provides a framework for analyzing and responding
to an actual or perceived capital shortfall.
As part of the Federal Reserve Board's annual Comprehensive Capital Analysis and
Review, U.S. bank holding companies with total consolidated assets of
$50 billion or greater, are required to submit annual capital plans for review
by the Federal Reserve Board. The capital plans should demonstrate the ability
of a bank holding company to maintain its capital ratios above minimum
regulatory capital requirements and above a Tier 1 common ratio of 5% on a pro
forma basis inclusive of proposed capital actions under expected and stressed
scenarios. The purpose of the Federal Reserve Board's review is to ensure that
these institutions have robust, forward-looking capital planning processes that
account for their unique risks and that permit continued operations during times
of economic and financial stress. As part of the capital plan review, the
Federal Reserve Board evaluates an institution's plan to make capital
distributions, such as increasing dividend payments or repurchasing or redeeming
stock, across a range of macro-economic and firm-specific assumptions. The
Federal Reserve has informed us that it does not object to our proposed capital
actions through the first quarter of 2013, including the repurchase of
outstanding common stock and an increase in the quarterly common stock dividend.
Goldman Sachs June 2012 Form 10-Q 143
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Our consolidated regulatory capital requirements are determined by the Federal
Reserve Board, as described below. Our ICAAP incorporates an internal risk-based
capital assessment designed to identify and measure material risks associated
with our business activities, including market risk, credit risk and operational
risk, in a manner that is closely aligned with our risk management practices.
Our internal risk-based capital assessment is supplemented with the results of
stress tests.
As of June 2012, our total shareholders' equity was $72.86 billion (consisting
of common shareholders' equity of $68.01 billion and preferred stock of
$4.85 billion). As of December 2011, our total shareholders' equity was
$70.38 billion (consisting of common shareholders' equity of $67.28 billion and
preferred stock of $3.10 billion). In addition, $3.25 billion of our junior
subordinated debt issued to trusts qualifies as equity capital for regulatory
and certain rating agency purposes. See "- Consolidated Regulatory Capital
Ratios" below for information regarding the impact of regulatory developments.
Consolidated Regulatory Capital
The Federal Reserve Board is the primary regulator of Group Inc., a bank holding
company and a financial holding company under the U.S. Bank Holding Company Act
of 1956. As a bank holding company, we are subject to consolidated regulatory
capital requirements that are computed in accordance with the Federal Reserve
Board's generally applicable risk-based capital requirements (which are based on
the 'Basel 1' Capital Accord of the Basel Committee on Banking Supervision
(Basel Committee)). These capital requirements are expressed as capital ratios
that compare measures of capital to risk-weighted assets (RWAs). See Note 20 to
the condensed consolidated financial statements in Part I, Item 1 of this
Form 10-Q for additional information regarding the firm's RWAs. The firm's
capital levels are also subject to qualitative judgments by its regulators about
components, risk weightings and other factors.
Federal Reserve Board regulations require bank holding companies to maintain a
minimum Tier 1 capital ratio of 4% and a minimum total capital ratio of 8%. The
required minimum Tier 1 capital ratio and total capital ratio in order to be
considered a "well-capitalized" bank holding company under the Federal Reserve
Board guidelines are 6% and 10%, respectively. Bank holding companies may be
expected to maintain ratios well above the minimum levels, depending on their
particular condition, risk profile and growth plans. The minimum Tier 1 leverage
ratio is 3% for bank holding companies that have received the highest
supervisory rating under Federal Reserve Board guidelines or that have
implemented the Federal Reserve Board's risk-based capital measure for market
risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of
4%.
144 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Consolidated Regulatory Capital Ratios
The table below presents information about our regulatory capital ratios.
As of
June December
$ in millions 2012 2011
Common shareholders' equity $ 68,005 $ 67,279
Less: Goodwill (3,779 ) (3,802 )
Less: Disallowable intangible assets (1,621 ) (1,666 )
Less: Other deductions 1 (6,261 ) (6,649 )
Tier 1 Common Capital 56,344 55,162
Preferred stock 4,850
3,100
Junior subordinated debt issued to trusts 2 3,250 5,000
Tier 1 Capital 64,444 63,262
Qualifying subordinated debt 3 13,221 13,828
Other adjustments 83 53
Tier 2 Capital $ 13,304 $ 13,881
Total Capital $ 77,748 $ 77,143
Risk-Weighted Assets 4 $428,589 $457,027
Tier 1 Capital Ratio 15.0 %
13.8 %
Total Capital Ratio 18.1 %
16.9 %
Tier 1 Leverage Ratio 4 7.0 %
7.0 %
Tier 1 Common Ratio 5 13.1 %
12.1 %
1. Principally includes equity investments in non-financial companies and the
cumulative change in the fair value of our unsecured borrowings attributable
to the impact of changes in our own credit spreads, disallowed deferred tax
assets, and investments in certain nonconsolidated entities.
2. See Note 16 to the condensed consolidated financial statements in Part I,
Item 1 of this Form 10-Q for additional information about the junior
subordinated debt issued to trusts.
3. Substantially all of our subordinated debt qualifies as Tier 2 capital for
Basel 1 purposes.
4. See Note 20 to the condensed consolidated financial statements in Part I,
Item 1 of this Form 10-Q for additional information about the firm's RWAs and
Tier 1 leverage ratio.
5. The Tier 1 common ratio equals Tier 1 common capital divided by RWAs. We
believe that the Tier 1 common ratio is meaningful because it is one of the
measures that we and investors use to assess capital adequacy and, while not
currently a formal regulatory capital ratio, this measure is of increasing
importance to regulators. The Tier 1 common ratio is a non-GAAP measure and
may not be comparable to similar non-GAAP measures used by other companies.
Our Tier 1 capital ratio increased to 15.0% as of June 2012 from 13.8% as of
December 2011 primarily reflecting an increase in shareholders' equity and a
decrease in RWAs.
See Note 20 to the condensed consolidated financial statements in Part I, Item 1
of this Form 10-Q for additional information about our regulatory capital ratios
and the related regulatory requirements, including pending and proposed
regulatory changes.
Internal Capital Adequacy Assessment Process
We perform an ICAAP with the objective of ensuring that the firm is
appropriately capitalized relative to the risks in our business.
As part of our ICAAP, we perform an internal risk-based capital assessment. This
assessment incorporates market risk, credit risk and operational risk. Market
risk is calculated by using Value-at-Risk (VaR) calculations supplemented by
risk-based add-ons which include risks related to rare events (tail risks).
Credit risk utilizes assumptions about our counterparties' probability of
default, the size of our losses in the event of a default and the maturity of
our counterparties' contractual obligations to us. Operational risk is
calculated based on scenarios incorporating multiple types of operational
failures. Backtesting is used to gauge the effectiveness of models at capturing
and measuring relevant risks.
We evaluate capital adequacy based on the result of our internal risk-based
capital assessment, supplemented with the results of stress tests which measure
the firm's performance under various market conditions. Our goal is to hold
sufficient capital, under our internal risk-based capital framework, to ensure
we remain adequately capitalized after experiencing a severe stress event. Our
assessment of capital adequacy is viewed in tandem with our assessment of
liquidity adequacy and integrated into the overall risk management structure,
governance and policy framework of the firm.
We attribute capital usage to each of our businesses based upon our internal
risk-based capital and regulatory frameworks and manage the levels of usage
based upon the balance sheet and risk limits established.
Goldman Sachs June 2012 Form 10-Q 145
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Rating Agency Guidelines
The credit rating agencies assign credit ratings to the obligations of Group
Inc., which directly issues or guarantees substantially all of the firm's senior
unsecured obligations. Goldman, Sachs & Co. (GS&Co.) and Goldman Sachs
International (GSI) have been assigned long- and short-term issuer ratings by
certain credit rating agencies. GS Bank USA has also been assigned long-term
issuer ratings as well as ratings on its long-term and short-term bank deposits.
In addition, credit rating agencies have assigned ratings to debt obligations of
certain other subsidiaries of Group Inc.
The level and composition of our equity capital are among the many factors
considered in determining our credit ratings. Each agency has its own definition
of eligible capital and methodology for evaluating capital adequacy, and
assessments are generally based on a combination of factors rather than a single
calculation. See "Liquidity Risk Management - Credit Ratings" for further
information about credit ratings of Group Inc., GS&Co., GSI and GS Bank USA.
Subsidiary Capital Requirements
Many of our subsidiaries, including GS Bank USA and our broker-dealer
subsidiaries, are subject to separate regulation and capital requirements of the
jurisdictions in which they operate. For purposes of assessing the adequacy of
its capital, GS Bank USA has established an ICAAP which is similar to that used
by Group Inc.GS Bank USA's capital levels and prompt corrective action
classification are subject to qualitative judgments by its regulators about
components, risk weightings and other factors.
We expect that the capital requirements of several of our subsidiaries will be
impacted in the future by the various developments arising from the Basel
Committee, the Dodd-Frank Act, and other governmental entities and regulators.
See Note 20 to the condensed consolidated financial statements in Part I, Item 1
of this Form 10-Q for information about GS Bank USA's capital ratios under
Basel 1 as implemented by the Federal Reserve Board, and for further information
about the capital requirements of our other regulated subsidiaries and the
potential impact of regulatory reform.
Subsidiaries not subject to separate regulatory capital requirements may hold
capital to satisfy local tax and legal guidelines, rating agency requirements
(for entities with assigned credit ratings) or internal policies, including
policies concerning the minimum amount of capital a subsidiary should hold based
on its underlying level of risk. In certain instances, Group Inc. may be limited
in its ability to access capital held at certain subsidiaries as a result of
regulatory, tax or other constraints. As of June 2012 and December 2011, Group
Inc.'s equity investment in subsidiaries was $70.13 billion and $67.70 billion,
respectively, compared with its total shareholders' equity of $72.86 billion and
$70.38 billion, respectively.
Group Inc. has guaranteed the payment obligations of GS&Co., GS Bank USA,
Goldman Sachs Bank (Europe) plc and Goldman Sachs Execution & Clearing, L.P.
(GSEC) subject to certain exceptions. In November 2008, Group Inc. contributed
subsidiaries into GS Bank USA, and Group Inc. agreed to guarantee certain
losses, including credit-related losses, relating to assets held by the
contributed entities. In connection with this guarantee, Group Inc. also agreed
to pledge to GS Bank USA certain collateral, including interests in subsidiaries
and other illiquid assets.
Our capital invested in non-U.S. subsidiaries is generally exposed to foreign
exchange risk, substantially all of which is managed through a combination of
derivatives and non-U.S. denominated debt.
Contingency Capital Plan
Our contingency capital plan provides a framework for analyzing and responding
to a perceived or actual capital deficiency, including, but not limited to,
identification of drivers of a capital deficiency, as well as mitigants and
potential actions. It outlines the appropriate communication procedures to
follow during a crisis period, including internal dissemination of information
as well as ensuring timely communication with external stakeholders.
146 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Equity Capital Management
Our objective is to maintain a sufficient level and optimal composition of
equity capital. We principally manage our capital through issuances and
repurchases of our common stock. We may also, from time to time, issue or
repurchase our preferred stock, junior subordinated debt issued to trusts and
other subordinated debt or other forms of capital as business conditions warrant
and subject to any regulatory approvals. We manage our capital requirements
principally by setting limits on balance sheet assets and/or limits on risk, in
each case both at the consolidated and business levels. We attribute capital
usage to each of our businesses based upon our internal risk-based capital and
regulatory frameworks and manage the levels of usage based upon the balance
sheet and risk limits established.
Preferred Stock. In March 2011, we provided notice to Berkshire Hathaway that we
would redeem in full the 50,000 shares of our Series G Preferred Stock held by
Berkshire Hathaway for the stated redemption price of $5.50 billion ($110,000
per share), plus accrued and unpaid dividends. In connection with this notice,
we recognized a preferred dividend of $1.64 billion (calculated as the
difference between the carrying value and the redemption value of the preferred
stock), which was recorded as a reduction to earnings applicable to common
shareholders for the first quarter of 2011. The redemption also resulted in the
acceleration of $24 million of preferred dividends related to the period from
April 1, 2011 to the redemption date, which was included in our results during
the three months ended March 2011. The Series G Preferred Stock was redeemed on
April 18, 2011. Berkshire Hathaway continues to hold a five-year warrant, issued
in October 2008, to purchase up to 43.5 million shares of common stock at an
exercise price of $115.00 per share.
Share Repurchase Program. We seek to use our share repurchase program to help
maintain the appropriate level of common equity and to substantially offset
increases in share count over time resulting from employee share-based
compensation. The repurchase program is effected primarily through regular
open-market purchases, the amounts and timing of which are determined primarily
by our current and projected capital positions (i.e., comparisons of our desired
level and composition of capital to our actual level and composition of capital)
and the issuance of shares resulting from employee share-based compensation, but
which may also be influenced by general market conditions and the prevailing
price and trading volumes of our common stock.
As of June 2012, under the share repurchase program approved by the Board, we
can repurchase up to 46.0 million additional shares of common stock; however,
any such repurchases are subject to the approval of the Federal Reserve Board.
See "Unregistered Sales of Equity Securities and Use of Proceeds" in Part II,
Item 2 and Note 19 to the condensed consolidated financial statements in Part I,
Item 1 of this Form 10-Q for additional information on our repurchase program.
See Notes 16 and 19 to the condensed consolidated financial statements in
Part I, Item 1 of this Form 10-Q for further information about our preferred
stock, junior subordinated debt issued to trusts and other subordinated debt.
Goldman Sachs June 2012 Form 10-Q 147
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
Other Capital Metrics
The table below presents information on our shareholders' equity and book value
per common share.
As of
June December $ in millions, except per share amounts 2012 2011
Total shareholders' equity $72,855$70,379
Common shareholders' equity 68,005
67,279
Tangible common shareholders' equity 62,605 61,811
Book value per common share 137.00
130.31
Tangible book value per common share 126.12 119.72
Tangible common shareholders' equity. Tangible common shareholders' equity
equals total shareholders' equity less preferred stock, goodwill and
identifiable intangible assets. We believe that tangible common shareholders'
equity is meaningful because it is a measure that we and investors use to assess
capital adequacy. Tangible common shareholders' equity is a non-GAAP measure and
may not be comparable to similar non-GAAP measures used by other companies.
The table below presents the reconciliation of total shareholders' equity to
tangible common shareholders' equity.
As of
June December
in millions 2012 2011
Total shareholders' equity $72,855 $70,379
Deduct: Preferred stock (4,850 )
(3,100 )
Common shareholders' equity 68,005
67,279
Deduct: Goodwill and identifiable intangible assets (5,400 ) (5,468 )
Tangible common shareholders' equity $62,605
$61,811
Book value and tangible book value per common share. Book value and tangible
book value per common share are based on common shares outstanding, including
restricted stock units granted to employees with no future service requirements,
of 496.4 million and 516.3 million as of June 2012 and December 2011,
respectively. We believe that tangible book value per common share (tangible
common shareholders' equity divided by common shares outstanding) is meaningful
because it is a measure that we and investors use to assess capital adequacy.
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.
Off-Balance-Sheet Arrangements and Contractual Obligations
Off-Balance-Sheet Arrangements
We have various types of off-balance-sheet arrangements that we enter into in
the ordinary course of business. Our involvement in these arrangements can take
many different forms, including:
Ÿ purchasing or retaining residual and other interests in special purpose
entities such as mortgage-backed and other asset-backed securitization
vehicles;
Ÿ holding senior and subordinated debt, interests in limited and general
partnerships, and preferred and common stock in other nonconsolidated
vehicles;
Ÿ entering into interest rate, foreign currency, equity, commodity and credit
derivatives, including total return swaps;
Ÿ entering into operating leases; and
Ÿ providing guarantees, indemnifications, loan commitments, letters of credit
and representations and warranties.
We enter into these arrangements for a variety of business purposes, including
securitizations. The securitization vehicles that purchase mortgages, corporate
bonds, and other types of financial assets are critical to the functioning of
several significant investor markets, including the mortgage-backed and other
asset-backed securities markets, since they offer investors access to specific
cash flows and risks created through the securitization process.
We also enter into these arrangements to underwrite client securitization
transactions; provide secondary market liquidity; make investments in performing
and nonperforming debt, equity, real estate and other assets; provide investors
with credit-linked and asset-repackaged notes; and receive or provide letters of
credit to satisfy margin requirements and to facilitate the clearance and
settlement process.
Our financial interests in, and derivative transactions with, such
nonconsolidated entities are generally accounted for at fair value, in the same
manner as our other financial instruments, except in cases where we apply the
equity method of accounting.
148 Goldman Sachs June 2012 Form 10-Q
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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES
Management's Discussion and Analysis
The table below presents where a discussion of our various off-balance-sheet
arrangements may be found in Part I, Items 1 and 2 of this Form 10-Q. In
addition, see Note 3 to
the condensed consolidated financial statements in Part I, Item 1 of this
Form 10-Q for a discussion of our consolidation policies.
