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GOLDMAN SACHS GROUP INC – 10-Q – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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INDEX Page No. Introduction 106 Executive Overview 106 Business Environment 108 Critical Accounting Policies 109 Use of Estimates 113 Results of Operations 114 Balance Sheet and Funding Sources 125 Equity Capital 132 Off-Balance-Sheet Arrangements and Contractual Obligations 138 Overview and Structure of Risk Management 141 Liquidity Risk Management 146 Market Risk Management 153 Credit Risk Management 158 Operational Risk Management 165 Recent Accounting Developments 166 Certain Risk Factors That May Affect Our Businesses 167 Cautionary Statement Pursuant to theU.S. Private Securities 168 Litigation Reform Act of 1995 105
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Table of Contents
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 inNew 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 endedDecember 31, 2011 . References to "our Annual Report on Form 10-K" are to our Annual Report on Form 10-K for the year endedDecember 31, 2011 .
When we use the terms "Goldman Sachs," "the firm," "we," "us" and "our," we mean
References to "this Form 10-Q" are to our Quarterly Report on Form 10-Q for the quarterly period endedMarch 31, 2012 . All references toMarch 2012 andMarch 2011 refer to our periods ended, or the dates, as the context requires,March 31, 2012 andMarch 31, 2011 , respectively. All references toDecember 2011 refer to the dateDecember 31, 2011 . Any reference to a future year refers to a year ending onDecember 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
Executive Overview
The firm generated net earnings of$2.11 billion for the first quarter of 2012, compared with$2.74 billion for the first quarter of 2011. Our diluted earnings per common share were$3.92 for the first quarter of 2012, compared with$1.56 1 for the first quarter of 2011. Annualized return on average common shareholders' equity (ROE) 2 was 12.2% for the first quarter of 2012, compared with 12.2% 1 for the first quarter of 2011. Book value per common share was$134.48 and tangible book value per common share 3 was$123.94 as ofMarch 2012 , both approximately 3% higher compared with the end of 2011. Our Tier 1 capital ratio underBasel 1 was 14.7% and our Tier 1 common ratio underBasel 1 4 was 12.9% as ofMarch 2012 , up from 13.8% and 12.1%, respectively, as of the end of 2011. InApril 2012 , the Board of Directors ofGroup, Inc. (Board) increased the firm's quarterly dividend to$0.46 per common share from$0.35 per common share. The firm generated net revenues of$9.95 billion for the first quarter of 2012, compared with$11.89 billion for the first quarter of 2011. These results reflected lower net revenues in each of our business segments compared with the first quarter of 2011. An overview of net revenues for each of our business segments is provided below.
1. Excluding the impact of the preferred dividend of
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
the first quarter of 2011. We believe that presenting our results for the
first quarter of 2011 excluding this dividend is meaningful, as it increases
the comparability of period-to-period results. Diluted earnings per common
share and 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 ROE excluding the impact
of this dividend.
2. See "Results of Operations - Financial Overview" below for further information
about our calculation of ROE.
3. 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.
4. 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. 106
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Management's Discussion and Analysis
Investment Banking
Net revenues in Investment Banking decreased compared with the first quarter of 2011 as significantly higher net revenues in Financial Advisory were more than offset by significantly lower net revenues in our Underwriting business. Net revenues in equity underwriting were significantly lower than the first quarter of 2011, primarily reflecting a decline in industry-wide activity. Net revenues in debt underwriting were lower compared with a strong first quarter of 2011, primarily reflecting a decline in leveraged finance activity.
Institutional Client Services
Net revenues in Institutional Client Services decreased compared with the first quarter of 2011. The decrease primarily reflected significantly lower net revenues in Fixed Income, Currency and Commodities Client Execution compared with a solid first quarter of 2011, as higher net revenues in interest rate products were more than offset by lower net revenues in the other major businesses. During the first quarter of 2012, Fixed Income, Currency and Commodities Client Execution operated in an environment generally characterized by tighter credit spreads and improved activity levels compared with the fourth quarter of 2011. Net revenues in Equities decreased slightly compared with the first quarter of 2011, as higher net revenues in equities client execution, reflecting an increase in derivatives, were more than offset by lower commissions and fees, consistent with lower market volumes. Securities services net revenues were essentially unchanged compared with the first quarter of 2011. During the first quarter of 2012, Equities operated in an environment generally characterized by an increase in global equity prices and lower volatility levels compared with the fourth quarter of 2011. Investing & Lending Net revenues in Investing & Lending were$1.91 billion for the first quarter of 2012, compared with$2.71 billion for the first quarter of 2011. During the first quarter of 2012, an increase in global equity prices and tighter credit spreads contributed to positive results in Investing & Lending. These results included a gain of$169 million from our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), net gains of$891 million from other investments in equities (with public and private equities each contributing approximately one-half of the net gains), net gains and net interest of$585 million from debt securities and loans, and other net revenues of$266 million , principally related to our consolidated entities held for investment purposes.
Investment Management
Net revenues in Investment Management decreased compared with the first quarter of 2011, primarily due to lower management and other fees and lower transaction revenues. During the quarter, assets under management decreased$4 billion to$824 billion , reflecting net outflows of$26 billion , including net outflows in money market assets and, to a lesser extent, equity and alternative investment assets. This decrease was partially offset by net market appreciation of$22 billion , primarily in equity and 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. 107
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Management's Discussion and Analysis
Business Environment Global Global economic conditions improved gradually during the first quarter of 2012 as real gross domestic product (GDP) appeared to increase inthe United States andJapan , as well asChina and other emerging markets. However, real GDP inEurope appeared to decline due to continued concerns about European sovereign debt risk. Although macroeconomic challenges persist, positive developments during the first quarter of 2012, including actions undertaken by theEuropean Central Bank and other central banks to address funding risks for European financial institutions, as well as progress in resolvingGreece's debt situation, helped to improve global market conditions. Encouraging U.S. economic data also contributed to the improved market sentiment. In response to these events, credit markets improved, global equity markets increased and volatility levels declined during the quarter. The price of crude oil increased, but showed signs of stabilization by the end of the quarter. The U.S. dollar depreciated against the Euro and the British pound, but appreciated against the Japanese yen. Industry-wide debt offerings and equity and equity-related offerings both increased during the quarter, while announced and completed mergers and acquisitions volumes declined.
Inthe United States , real GDP increased during the quarter, although at a modestly slower pace than in the fourth quarter of 2011. The growth of fixed investment slowed during the quarter and government spending fell, while consumer spending and residential construction growth increased. Measures of business and consumer confidence improved. Unemployment levels declined during the quarter, although the rate of unemployment remained elevated. Measures of inflation remained subdued during the quarter. Housing market activity improved but continued to be impacted by uncertainty about economic growth. The U.S. Federal Reserve maintained its federal funds rate at a target range of zero to 0.25% and continued to extend the duration of the U.S. Treasury debt it holds. The 10-year U.S. Treasury note yield ended the quarter at 2.23%, 34 basis points higher than the end of 2011. In equity markets, the NASDAQ Composite Index, the S&P 500 Index, and the Dow Jones Industrial Average increased by 19%, 12% and 8%, respectively, during the quarter.
In the Euro area, real GDP appeared to decline during the quarter, broadly in line with the decline during the fourth quarter of 2011. Despite these contractions, measures of business confidence improved. Measures of core inflation declined during the first quarter.The European Central Bank maintained its main refinancing operations rate at 1.00% and continued injecting liquidity in the Eurosystem through its longer-term refinancing operations (LTROs) which were announced at the end of 2011. The Euro appreciated by 3% against the U.S. dollar. In theUnited Kingdom , real GDP also declined during the quarter, for the second consecutive quarter. The Bank ofEngland maintained its official bank rate at 0.50% and the British pound appreciated by 3% against the U.S. dollar. Long-term government bond yields generally declined in most Euro area economies, although yields increased in theU.K. The DAX Index, CAC 40 Index, the Euro Stoxx 50 Index, and theFTSE 100 Index increased by 18%, 8%, 7% and 4%, respectively, during the quarter.
InJapan , real GDP appeared to increase during the quarter, following a decline in the fourth quarter of 2011. Growth appeared to be supported by improved exports and an increase in industrial production and business confidence. During the quarter, the Bank of Japan left its target overnight call rate unchanged at a range of zero to 0.10% and expanded its asset purchase program. In addition, the Bank of Japan introduced a price stability goal in the medium to long term, currently set at an inflation level of 1%. The yield on 10-year Japanese government bonds was essentially unchanged compared with the end of 2011. The Japanese yen depreciated by 8% against the U.S. dollar and theNikkei 225 index ended the quarter 19% higher. InChina , real GDP growth moderated compared with the fourth quarter of 2011, reflecting a slowdown in the pace of growth in industrial production. Measures of inflation continued to decline during the quarter.The People's Bank of China reduced the reserve requirement ratio by 50 basis points during the quarter. The Chinese yuan slightly appreciated against the U.S. dollar and the Shanghai Composite Index increased by 3% during the quarter. In addition, equity markets inHong Kong andSouth Korea increased significantly during the quarter. InIndia , economic growth appeared to remain solid during the quarter. The rate of wholesale inflation declined significantly during the quarter. The Indian rupee appreciated against the U.S. dollar and equity markets inIndia increased significantly. 108
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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. 109
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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,
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.
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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
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 March 2012 As of December 2011 Total at Level 3 Total at Level 3 in millions Fair Value Total Fair Value Total Commercial paper, certificates of deposit, time deposits and other money market instruments $ 10,553 $ 8 $ 13,440 $ - U.S. government and federal agency obligations 90,488 - 87,040 - Non-U.S. government obligations 60,812 105 49,205 148 Mortgage and other asset-backed loans and securities: Loans and securities backed by commercial real estate 6,724 3,156 6,699 3,346 Loans and securities backed by residential real estate 8,815 1,610 7,592 1,709 Bank loans and bridge loans 18,988 11,051 19,745 11,285 Corporate debt securities 24,370 2,512 22,131 2,480 State and municipal obligations 3,407 612 3,089 599 Other debt obligations 4,702 1,549 4,362 1,451 Equities and convertible debentures 75,927 14,874 65,113 13,667 Commodities 9,462 - 5,762 - Total cash instruments 314,248 35,477 284,178 34,685 Derivatives 71,258 11,151 80,028 11,900 Financial instruments owned, at fair value 385,506 46,628 364,206 46,585 Securities segregated for regulatory and other purposes 33,679 - 42,014 - Securities purchased under agreements to resell 181,050 956 187,789 557 Securities borrowed 57,062 - 47,621 - Receivables from customers and counterparties 8,328 431 9,682 795 Total $665,625 $48,015 $651,312 $47,937 111
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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. Although economic market conditions have generally improved during the first quarter of 2012, if 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. 112
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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. 113
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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 Ended March $ in millions, except per share amounts 2012 2011 Net revenues $9,949 $11,894 Pre-tax earnings 3,181 4,040 Net earnings 2,109 2,735 Net earnings applicable to common shareholders 2,074
908
Diluted earnings per common share 3.92 1.56 2 Annualized return on average common shareholders' equity 1 12.2 % 12.2 % 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
2011 was not annualized in the calculation of annualized net earnings
applicable to common shareholders for the three months ended
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 Ended March in millions 2012 2011 Total shareholders' equity $70,824 $76,052 Preferred stock (3,100 ) (5,993 ) Common shareholders' equity $67,724 $70,059
2. Excluding the impact of the preferred dividend of
redemption of our Series G Preferred Stock (calculated as the difference
between the carrying value and the redemption value of the preferred stock),
diluted earnings per common share were
the first quarter of 2011. We believe that presenting our results for the
first quarter of 2011 excluding this dividend is meaningful, as it increases
the comparability of period-to-period results. Diluted earnings per common
share and ROE excluding this dividend are non-GAAP measures and may not be
comparable to similar non-GAAP measures used by other companies. The tables
below present the calculation of net earnings applicable to common shareholders, diluted earnings per common share and average common shareholders' equity excluding the impact of this dividend. Three Months Ended in millions, except per share amountMarch 2011 Net earnings applicable to common shareholders$ 908 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
2,551
Divided by: average diluted common shares outstanding
583.0
Diluted earnings per common share, excluding the impact of the Series G Preferred Stock dividend
$ 4.38 Average for the Three Months Ended in millionsMarch 2011 Total shareholders' equity$76,052 Preferred stock (5,993 ) Common shareholders' equity 70,059 Impact of the Series G Preferred Stock dividend
411
Common shareholders' equity, excluding the impact of the Series G Preferred Stock dividend
$70,470 114
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Management's Discussion and Analysis
Net Revenues
Three Months EndedMarch 2012 versusMarch 2011 . Net revenues on the condensed consolidated statements of earnings were$9.95 billion for the first quarter of 2012, 16% lower than the first quarter of 2011, reflecting lower net revenues in each of our business segments compared with the first quarter of 2011.
Non-interest Revenues
Investment banking
During the first quarter of 2012, investment banking revenues reflected an operating environment generally characterized by continued macroeconomic concerns that weighed on certain corporate activity, despite positive developments during the quarter. Although global equity markets increased and volatility levels declined, industry-wide equity and equity-related underwriting activity levels remained low. However, industry-wide debt underwriting activity significantly improved compared with the second half of 2011, as credit spreads tightened and interest rates remained low. If macroeconomic concerns continue and result in lower levels of client activity, investment banking revenues would likely continue to be negatively impacted. Three Months EndedMarch 2012 versusMarch 2011 . Investment banking revenues on the condensed consolidated statements of earnings were$1.16 billion for the first quarter of 2012, 9% lower than the first quarter of 2011, as significantly higher revenues from financial advisory were more than offset by significantly lower revenues in our underwriting business. Revenues in equity underwriting were significantly lower than the first quarter of 2011, primarily reflecting a decline in industry-wide activity. Revenues in debt underwriting were lower compared with a strong first quarter of 2011, primarily reflecting a decline in leveraged finance activity. Investment management During the first quarter of 2012, investment management revenues reflected an operating 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. If asset prices decline or investors change their mix of assets to favor lower risk asset classes or continue to withdraw their assets, investment management revenues would likely be negatively impacted. Three Months EndedMarch 2012 versusMarch 2011$1.11 billion for the first quarter of 2012, 6% lower than the first quarter of 2011, primarily due to lower management and other fees.
Commissions and fees
During the first quarter of 2012, commissions and fees reflected an operating environment generally characterized by an increase in global equity prices and lower volatility levels compared with the second half of 2011. Although there were positive developments during the quarter, macroeconomic concerns persist, which contributed to lower market volumes. If macroeconomic concerns continue and result in lower market volumes, commissions and fees would likely continue to be negatively impacted. Three Months EndedMarch 2012 versusMarch 2011 . Commissions and fees on the condensed consolidated statements of earnings were$860 million for the first quarter of 2012, 16% lower than the first quarter of 2011, consistent with lower market volumes. Market making During the first quarter of 2012, market-making revenues reflected an operating environment characterized by a general improvement in market conditions. Positive developments during the quarter helped to improve market conditions, including actions undertaken by theEuropean Central Bank and other central banks to address funding risks for European financial institutions, as well as progress in resolvingGreece's debt situation. Encouraging U.S. economic data also contributed to the improved market sentiment. These events resulted in tighter credit spreads, improved market liquidity and higher activity levels in certain products, compared with the fourth quarter of 2011. In addition, global equity prices increased and volatility levels decreased. Despite improvements in the operating environment, client sentiment remains fragile as macroeconomic concerns persist, including European sovereign debt risk, uncertainty surrounding the economic prospects in the U.S. and the potential slowdown in the growth of emerging market economies. In addition, other broad market concerns, such as uncertainty over financial regulatory reform persist. If these concerns continue over the long term, market-making revenues would likely continue to be negatively impacted. Three Months EndedMarch 2012 versusMarch 2011 . Market-making revenues on the condensed consolidated statements of earnings were$3.91 billion for the first quarter of 2012, 12% lower than the first quarter of 2011, as higher revenues in interest rate products and equity derivatives were more than offset by lower revenues in most of our other major market-making activities. 115
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Management's Discussion and Analysis
Other principal transactions
During the first quarter of 2012, other principal transactions results reflected an operating environment characterized by an increase in global equity markets and tighter credit spreads. Although these conditions contributed to positive revenues in other principal transactions, macroeconomic concerns persist, particularly regarding the state of global economies, including European sovereign debt risk and uncertainty surrounding the economic prospects in the U.S. In addition, other broad market concerns, such as uncertainty over financial regulatory reform persist. If equity markets decline and credit spreads widen, other principal transactions revenues would likely be negatively impacted. Three Months EndedMarch 2012 versusMarch 2011 . Other principal transactions revenues on the condensed consolidated statements of earnings were$1.94 billion for the first quarter of 2012, compared with$2.61 billion for the first quarter of 2011. Results for the first quarter of 2012 included a gain from our investment in the ordinary shares of ICBC, net gains from other investments in equities (with public and private equities each contributing approximately one-half of the net gains), net gains from debt securities and loans, and revenues related to our consolidated entities held for investment purposes. In the first quarter of 2011, revenues in other principal transactions included a gain from our investment in the ordinary shares of ICBC, net gains from other investments in equities, net gains from debt securities and loans, and revenues related to our consolidated entities held for investment purposes.
Net Interest Income
Three Months EndedMarch 2012 versusMarch 2011 . Net interest income on the condensed consolidated statements of earnings was$981 million for the first quarter of 2012, 28% lower than the first quarter of 2011. The decrease compared with the first quarter of 2011 was primarily due to higher interest expense related to our long-term borrowings and lower average yields on financial instruments owned, at fair value.
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 largely implemented our targeted annual run rate compensation and non-compensation reduction of approximately$1.4 billion and continue to identify savings opportunities.
The table below presents our operating expenses and total staff.
Three Months Ended March $ in millions 2012 2011 Compensation and benefits $ 4,378 $
5,233
Brokerage, clearing, exchange and distribution fees 567 620 Market development 117 179 Communications and technology 196 198 Depreciation and amortization 433 590 Occupancy 212 267 Professional fees 234 233 Insurance reserves 1 157 88 Other expenses 474 446 Total non-compensation expenses 2,390
2,621
Total operating expenses $ 6,768 $
7,854
Total staff at period-end 2 32,400 35,400
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.
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Three Months EndedMarch 2012 versusMarch 2011 . Operating expenses were$6.77 billion for the first quarter of 2012, 14% lower than the first quarter of 2011. The accrual for compensation and benefits expenses was$4.38 billion for the first quarter of 2012, a 16% decline compared with the first quarter of 2011. The ratio of compensation and benefits to net revenues for the first quarter of 2012 was 44.0%, consistent with the first quarter of 2011. Total staff decreased 3% during the first quarter of 2012. Non-compensation expenses were$2.39 billion , 9% lower than the first quarter of 2011. The decrease compared with the first quarter of 2011 reflected lower impairment charges, lower market development expenses, principally reflecting the impact of expense reduction initiatives, lower occupancy expenses and lower brokerage, clearing, exchange and distribution fees. These decreases were partially offset by increased reserves related to the firm's insurance business. The first quarter of 2012 included impairment charges related to consolidated investments of$116 million and net provisions for litigation and regulatory proceedings of$59 million .
Provision for Taxes
The effective income tax rate for the first quarter of 2012 was 33.7%, up from 28.0% for 2011. The increase in the effective income tax rate was primarily due to the earnings mix and a decrease in the impact of permanent benefits. EffectiveJanuary 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 for the three months endedMarch 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. 117
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Segment Operating Results
The table below presents the net revenues, operating expenses and pre-tax earnings of our segments. Three Months Ended March in millions 2012 2011 Investment Banking Net revenues $ 1,154 $ 1,269 Operating expenses 866 923 Pre-tax earnings $ 288 $ 346 Institutional Client Services Net revenues $ 5,709 $ 6,647 Operating expenses 3,883 4,584 Pre-tax earnings $ 1,826 $ 2,063 Investing & Lending Net revenues $ 1,911 $ 2,705 Operating expenses 958 1,231 Pre-tax earnings $ 953 $ 1,474 Investment Management Net revenues $ 1,175 $ 1,273 Operating expenses 990 1,067 Pre-tax earnings $ 185 $ 206 Total Net revenues $ 9,949 $ 11,894 Operating expenses 6,768 7,854 Pre-tax earnings $ 3,181 $ 4,040
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 $59
million and
respectively; and
Ÿ charitable contributions of
ended
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. 118
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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 Ended March in millions 2012 2011 Financial Advisory $ 489 $ 357 Equity underwriting 255 426 Debt underwriting 410 486 Total Underwriting 665 912 Total net revenues 1,154 1,269 Operating expenses 866 923 Pre-tax earnings $ 288 $ 346 The table below presents our financial advisory and underwriting transaction volumes.1 Three Months Ended March in billions 2012 2011 Announced mergers and acquisitions $117 $170 Completed mergers and acquisitions 79 165 Equity and equity-related offerings 2 14 26 Debt offerings 3 72 72
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
Net revenues in Financial Advisory were$489 million , 37% higher than the first quarter of 2011. Net revenues in our Underwriting business were$665 million , 27% lower than the first quarter of 2011. Net revenues in equity underwriting were significantly lower than the first quarter of 2011, primarily reflecting a decline in industry-wide activity. Net revenues in debt underwriting were lower compared with a strong first quarter of 2011, primarily reflecting a decline in leveraged finance activity. During the first quarter of 2012, Investment Banking operated in an environment generally characterized by continued macroeconomic concerns that weighed on certain corporate activity, despite positive developments during the quarter. Although global equity markets increased and volatility levels declined, industry-wide equity and equity-related underwriting activity levels remained low. However, industry-wide debt underwriting activity significantly improved compared with the second half of 2011, as credit spreads tightened and interest rates remained low. If macroeconomic concerns continue and result in lower levels of client activity, net revenues in Investment Banking would likely continue to be negatively impacted. Our investment banking transaction backlog was essentially unchanged compared with the end of 2011, reflecting higher estimated net revenues from potential underwriting transactions, offset by lower estimated net revenues from potential advisory transactions. Estimated net revenues from potential debt underwriting transactions were higher compared with the end of 2011, primarily reflecting an increase in client mandates to underwrite leveraged finance transactions. Estimated net revenues from potential equity underwriting transactions were also higher compared with the end of 2011, reflecting an increase in client mandates to underwrite initial public offerings. 119
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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$866 million for the first quarter of 2012, 6% lower than the first quarter of 2011, primarily due to decreased compensation and benefits expenses. Pre-tax earnings were$288 million in the first quarter of 2012, 17% lower than the first quarter 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).
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 Ended March in millions 2012 2011
Fixed Income, Currency and Commodities Client Execution
Equities client execution 1,050 979 Commissions and fees 834 971 Securities services 367 372 Total Equities 2,251 2,322 Total net revenues 5,709 6,647 Operating expenses 3,883 4,584 Pre-tax earnings $1,826 $2,063 120
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Three Months Ended
Net revenues in Fixed Income, Currency and Commodities Client Execution were$3.46 billion , 20% lower than a solid first quarter of 2011, as higher net revenues in interest rate products were more than offset by lower net revenues in the other major businesses. During the first quarter of 2012, Fixed Income, Currency and Commodities Client Execution operated in an environment generally characterized by tighter credit spreads and improved activity levels compared with the fourth quarter of 2011. Net revenues in Equities were$2.25 billion , 3% lower than the first quarter of 2011, as higher net revenues in equities client execution, reflecting an increase in derivatives, were more than offset by lower commissions and fees, consistent with lower market volumes. Securities services net revenues were essentially unchanged compared with the first quarter of 2011. During the first quarter of 2012, Equities operated in an environment generally characterized by an increase in global equity prices and lower volatility levels compared with the fourth quarter of 2011. The net loss attributable to the impact of changes in our own credit spreads on borrowings for which the fair value option was elected was$224 million for the first quarter of 2012, compared with a net gain of$41 million for the first quarter of 2011. During the first quarter of 2012, Institutional Client Services operated in an environment characterized by a general improvement in market conditions. Positive developments during the quarter helped to improve market conditions, including actions undertaken by theEuropean Central Bank and other central banks to address funding risks for European financial institutions, as well as progress in resolvingGreece's debt situation. Encouraging U.S. economic data also contributed to the improved market sentiment. These events resulted in tighter credit spreads, improved market liquidity and higher activity levels in certain businesses, compared with the fourth quarter of 2011. In addition, global equity prices increased and volatility levels decreased. Despite improvements in the operating environment, client sentiment remains fragile as macroeconomic concerns persist, including European sovereign debt risk, uncertainty surrounding the economic prospects in the U.S. and the potential slowdown in the growth of emerging market economies. In addition, other broad market concerns, such as uncertainty over financial regulatory reform persist. If these concerns 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$3.88 billion for the first quarter of 2012, 15% lower than the first quarter of 2011, primarily due to decreased compensation and benefits expenses and the impact of impairment charges related toLitton Loan Servicing LP during the first quarter of 2011. These decreases were partially offset by increased reserves related to our insurance business. Pre-tax earnings were$1.83 billion in the first quarter of 2012, 11% lower than the first quarter of 2011.
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 Ended March in millions 2012 2011 ICBC $ 169 $ 316 Equity securities (excluding ICBC) 891 1,054 Debt securities and loans 585 1,024 Other 1 266 311 Total net revenues 1,911 2,705 Operating expenses 958 1,231 Pre-tax earnings $ 953 $1,474
1. Primarily includes net revenues related to our consolidated entities held for
investment purposes.
Three Months EndedMarch 2012 versusMarch 2011 . Net revenues in Investing & Lending were$1.91 billion for the first quarter of 2012, compared with$2.71 billion for the first quarter of 2011. During the first quarter of 2012, an increase in global equity prices and tighter credit spreads contributed to positive results in Investing & Lending. These results included a gain of$169 million from our investment in the ordinary shares of ICBC, net gains of$891 million from other investments in equities (with public and private equities each contributing approximately one-half of the net gains), net gains and net interest of$585 million from debt securities and loans, and other net revenues of$266 million , principally related to our consolidated entities held for investment purposes. 121
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Results for the first quarter of 2011 included a gain of$316 million from our investment in the ordinary shares of ICBC, net gains of$1.05 billion from other investments in equities, net gains and net interest of$1.02 billion from debt securities and loans, and other net revenues of$311 million , principally related to our consolidated entities held for investment purposes. These results generally reflected an increase in global equity prices and favorable credit markets during the first quarter of 2011. Operating expenses were$958 million for the first quarter of 2012, 22% lower than the first quarter of 2011, primarily due to decreased compensation and benefits expenses, partially offset by higher impairment charges related to our consolidated investments. Pre-tax earnings were$953 million in the first quarter of 2012, 35% lower than the first quarter of 2011.
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 Ended March in millions 2012 2011 Management and other fees $1,003 $1,048 Incentive fees 58 74 Transaction revenues 114 151 Total net revenues 1,175 1,273 Operating expenses 990 1,067 Pre-tax earnings $ 185 $ 206 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 March 31, December 31, in billions 2012 2011 2011 2010 Alternative investments 1 $139 $151 $142 $148 Equity 136 150 126 144 Fixed income 347 338 340 340 Total non-money market assets 622 639 608 632 Money markets 202 201 220 208 Total assets under management $824 $840 $828 $840
1. Primarily includes hedge funds, private equity, real estate, currencies,
commodities and asset allocation strategies. Three Months Ended March 31, in billions 2012 2011 Balance, beginning of period $828 $840 Net inflows/(outflows) Alternative investments (4 ) - Equity (5 ) - Fixed income 1 (5 ) Total non-money market net inflows/(outflows) (8 ) (5 ) Money markets (18 ) (7 ) Total net inflows/(outflows) (26 ) (12 ) Net market appreciation/(depreciation) 22 12 Balance, end of period $824 $840 122
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Three Months EndedMarch 2012 versusMarch 2011 . Net revenues in Investment Management were$1.18 billion , 8% lower than the first quarter of 2011. The decrease in net revenues compared with the first quarter of 2011 was primarily due to lower management and other fees and lower transaction revenues. During the quarter, assets under management decreased$4 billion to$824 billion , reflecting net outflows of$26 billion , including net outflows in money market assets and, to a lesser extent, equity and alternative investment assets. This decrease was partially offset by net market appreciation of$22 billion , primarily in equity and 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. If asset prices decline or investors change their mix of assets to favor lower risk asset classes or continue to withdraw their assets, net revenues in Investment Management would likely be negatively impacted. Operating expenses were$990 million for the first quarter of 2012, 7% lower than the first quarter of 2011, primarily due to decreased compensation and benefits expenses. Pre-tax earnings were$185 million in the first quarter of 2012, 10% lower than the first quarter 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 inJuly 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 theBoard of Governors of theFederal Reserve System (Federal Reserve Board ), theFederal Deposit Insurance Corporation (FDIC), theSEC , theU.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.
InOctober 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. 123
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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 first 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, beginningMarch 2012 and endingJune 2014 . We redeemed approximately$250 million of these interests in hedge funds during the quarter endedMarch 2012 . In addition, we have limited the firm's initial investment to 3% for certain new funds. As required by the Dodd-Frank Act, theFederal Reserve Board andFDIC 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 have commenced work on our first resolution plan, which we must submit to the regulators byJuly 1, 2012 .GS Bank USA is also required by theFDIC to submit a plan for its rapid and orderly resolution in the event of material financial distress or failure byJuly 1, 2012 . InSeptember 2011 , theSEC 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. InDecember 2011 , theFederal 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. In addition, the U.S. federal bank regulatory agencies issued revised proposals to modify their market risk regulatory capital requirements for banking organizations inthe United States that have significant trading activities. The modifications are designed to address the adjustments to the market risk framework that were announced by the Basel Committee inJune 2010 (Basel 2.5), as well as the prohibition on the use of credit ratings, as required by the Dodd-Frank Act. We expect the federal banking agencies to propose further modifications to their capital adequacy regulations to address both the guidelines issued by the Basel Committee inDecember 2010 (Basel 3) and other aspects of the Dodd-Frank Act, including requirements for global systemically important banks. Once implemented, it is likely that these changes will result in increased capital requirements, although their full impact will not be known until the U.S. federal bank regulatory agencies publish their final rules. The Dodd-Frank Act also establishes aBureau 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 "Business - Regulation" in Part I, Item 1 of our Annual Report on Form 10-K for more information.
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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 theFinance Committee . See "Overview and Structure of Risk Management." 125
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Business-Specific Limits. TheFinance 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. TheFinance 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 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 March December in millions 2012 2011 Excess liquidity (Global Core Excess) $170,851 $171,581 Other cash 8,196 7,888 Excess liquidity and cash 179,047 179,469 Secured client financing 261,952 283,707 Inventory 297,297 273,640 Secured financing agreements 96,286 71,103 Receivables 36,478 35,769 Institutional Client Services 430,061 380,512 ICBC 5,126 4,713 Equity (excluding ICBC) 23,890 23,041 Debt 22,261 23,311 Receivables and other 5,645 5,320 Investing & Lending 56,922 56,385 Total inventory and related assets 486,983 436,897 Other assets 22,950 23,152 Total assets $950,932 $923,225 126
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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.
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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 March 2012 Excess Secured Institutional Liquidity Client Client Investing & Other Total in millions and Cash 1 Financing Services Lending Assets Assets Cash and cash equivalents $ 57,138 $ - $ - $ - $ - $ 57,138 Cash and securities segregated for regulatory and other purposes - 53,099 - - - 53,099 Securities purchased under agreements to resell and federal funds sold 56,996 80,440 43,327 287 - 181,050 Securities borrowed 28,975 87,158 52,959 - - 169,092 Receivables from brokers, dealers and clearing organizations - 4,067 12,598 221 - 16,886 Receivables from customers and counterparties - 37,188 23,880 4,143 - 65,211 Financial instruments owned, at fair value 35,938 - 297,297 52,271 - 385,506 Other assets - - - - 22,950 22,950 Total assets $179,047 $261,952 $430,061 $56,922 $22,950 $950,932 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 andUnited Kingdom government obligations. 128
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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 March December in millions 2012 2011 Bank loans and bridge loans 1 $ 18,988
Private equity investments and restricted public equity securities 2 16,529
15,463
Mortgage and other asset-backed loans and securities 15,539
14,291
High-yield and other debt obligations 13,276
11,118
ICBC ordinary shares 3 5,126
4,713
Emerging market debt securities 5,629
4,624
Emerging market equity securities 4,843 3,922 Other investments in funds 4 3,396 3,394
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
assets related to consolidated investment funds and consolidated variable
interest entities (VIEs).
3. Includes interests of
Sachs. As of the date of this filing, these investment funds no longer have an
interest in the ordinary shares of ICBC.
4. Includes interests in other investment funds that we manage. We redeemed
approximately
quarter ended
Developments" for more information about our plans to redeem certain of our
interests in hedge funds to comply with the Volcker Rule.
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 ofMarch 2012 , total assets on our condensed consolidated statements of financial condition were$950.93 billion , an increase of$27.71 billion fromDecember 2011 . This increase was due to (i) an increase in financial instruments owned, at fair value of$21.30 billion , primarily due to increases in non-U.S. government obligations and equities and convertible debentures, partially offset by a decrease in derivatives and (ii) an increase in securities borrowed of$15.75 billion , primarily due to increases in client and firm activity. These increases were partially offset by decreases in cash and securities segregated of$11.17 billion , primarily due to decreases in reserve balances held by broker-dealer subsidiaries related to client activity. As ofMarch 2012 , total liabilities on our condensed consolidated statements of financial condition were$879.28 billion , an increase of$26.43 billion fromDecember 2011 . This increase was due to (i) an increase in payables to customers and counterparties of$12.00 billion , primarily due to increases in client activity, (ii) an increase in securities sold under agreements to repurchase, at fair value of$8.59 billion , due to client activity, and (iii) an increase in financial instruments sold, but not yet purchased, at fair value of$6.24 billion , primarily due to increases in U.S. and non-U.S. government and federal agency obligations, partially offset by decreases in derivatives. As ofMarch 2012 andDecember 2011 , our total securities sold under agreements to repurchase, accounted for as collateralized financings, were$173.09 billion and$164.50 billion , respectively, which were 3% higher and 7% higher, respectively, than the daily average amount of repurchase agreements over the respective quarters. As ofMarch 2012 , the increase in our repurchase agreements relative to the daily average during the quarter was due to 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. 129
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The table below presents information on our assets, unsecured long-term borrowings, shareholders' equity and leverage ratios.
As of March December $ in millions 2012 2011 Total assets $950,932 $923,225 Adjusted assets $647,592 $604,391 Unsecured long-term borrowings $171,592 $173,545 Total shareholders' equity $ 71,656 $ 70,379 Leverage ratio 13.3 x 13.1 x Adjusted leverage ratio 9.0 x 8.6 x Debt to equity ratio 2.4 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 March December in millions 2012 2011 Total assets $ 950,932 $ 923,225 Deduct: Securities borrowed (169,092 )
(153,341 )
Securities purchased under agreements to resell and federal funds sold (181,050 ) (187,789 ) Add: Financial instruments sold, but not yet purchased, at fair value 151,251 145,013 Less derivative liabilities (51,350 ) (58,453 ) Subtotal (250,241 ) (254,570 ) Deduct: Cash and securities segregated for regulatory and other purposes (53,099 ) (64,264 ) Adjusted assets $ 647,592 $ 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
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 cash sweep programs and time deposits
through internal and third-party broker networks; 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 to a large, diverse creditor base in a variety of markets in theAmericas ,Europe andAsia . 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. 130
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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.
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
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.
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 first quarter of 2018 as ofMarch 2012 . [[Image Removed: LOGO]] 131
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The weighted average maturity of our unsecured long-term borrowings as ofMarch 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). As ofMarch 2012 , we had$5.51 billion of senior unsecured short-term debt outstanding guaranteed by theFDIC under the TLGP, all of which will mature on or prior toJune 15, 2012 . We have not issued long-term debt under the TLGP sinceMarch 2009 and the program has expired for new issuances. Deposits. As ofMarch 2012 , our bank depository institution subsidiaries had$50.87 billion in customer deposits, including$17.48 billion of certificates of deposit and other time deposits with a weighted average maturity of three years, and$33.39 billion of other deposits, substantially all of which were from cash sweep programs. We utilize deposits to finance lending 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 ofMarch 2012 , our unsecured short-term borrowings, including the current portion of unsecured long-term borrowings, were$48.72 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 principal 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 consolidated regulatory capital requirements and ICAAP, 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. EffectiveDecember 2011 , as part of theFederal 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 theFederal 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 theFederal 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, theFederal 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. OnMarch 13, 2012 , the Federal Reserve informed us that it did 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. 132
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Our consolidated regulatory capital requirements are determined by theFederal 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 ofMarch 2012 , our total shareholders' equity was$71.66 billion (consisting of common shareholders' equity of$68.56 billion and preferred stock of$3.10 billion ). As ofDecember 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 and$1.75 billion of preferred stock purchase contracts related toNormal Automatic Preferred Enhanced Capital Securities (APEX) issued byGoldman Sachs Capital II qualify as equity capital for regulatory and certain rating agency purposes. See "- Consolidated Regulatory Capital Ratios" below for information regarding the impact of regulatory developments.
TheFederal Reserve Board is the primary regulator ofGroup 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 theFederal Reserve Board's capital adequacy regulations currently applicable to bank holding companies (which are based on the 'Basel 1' Capital Accord of theBasel 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 theFederal 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 underFederal Reserve Board guidelines or that have implemented theFederal Reserve Board's risk-based capital measure for market risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of 4%. 133
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Consolidated Regulatory Capital Ratios
The table below presents information about our regulatory capital ratios.
As of March December $ in millions 2012 2011 Common shareholders' equity $ 68,556 $ 67,279 Less: Goodwill (3,782 ) (3,802 ) Less: Disallowable intangible assets (1,588 ) (1,666 ) Less: Other deductions 1 (6,752 ) (6,649 ) Tier 1 Common Capital 56,434 55,162 Preferred stock 3,100 3,100 Junior subordinated debt issued to trusts 2 3,250
5,000
Stock purchase contracts related to APEX securities 2 1,750
-
Tier 1 Capital 64,534
63,262
Qualifying subordinated debt 3 13,480 13,828 Other adjustments 79 53 Tier 2 Capital $ 13,559 $ 13,881 Total Capital $ 78,093 $ 77,143 Risk-Weighted Assets 4 $437,570 $457,027 Tier 1 Capital Ratio 14.7 % 13.8 % Total Capital Ratio 17.8 % 16.9 % Tier 1 Leverage Ratio 4 7.1 % 7.0 % Tier 1 Common Ratio 5 12.9 % 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 and the preferred stock purchase contracts
related to APEX securities issued byGoldman Sachs Capital II .
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 14.7% as ofMarch 2012 from 13.8% as ofDecember 2011 primarily reflecting an increase in shareholders' equity and a decrease in RWAs. Our Tier 1 leverage ratio increased to 7.1% as ofMarch 2012 from 7.0% as ofDecember 2011 reflecting an increase in our Tier 1 capital, primarily due to an increase in shareholders' equity. We are currently working to implement the requirements set out in theFederal Reserve Board's Risk-Based Capital Standards: Advanced Capital Adequacy Framework -Basel 2, as applicable to us as a bank holding company (Basel 2), which are based on the advanced approaches under the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee. U.S. banking regulators have incorporated theBasel 2 framework into the existing risk-based capital requirements by requiring that internationally active banking organizations, such as us, adoptBasel 2, once approved to do so by regulators. As required by the Dodd-Frank Act, U.S. banking regulators have adopted a rule that requires large banking organizations, upon adoption ofBasel 2, to continue to calculate risk-based capital ratios under bothBasel 1 andBasel 2. For each of the Tier 1 and Total capital ratios, the lower of theBasel 1 andBasel 2 ratios calculated will be used to determine whether the bank meets its minimum risk-based capital requirements. The U.S. federal bank regulatory agencies have issued revised proposals to modify their market risk regulatory capital requirements for banking organizations inthe United States that have significant trading activities. These modifications are designed to address the adjustments toBasel 2.5, as well as the prohibition on the use of credit ratings, as required by the Dodd-Frank Act. Once implemented, it is likely that these changes will result in increased capital requirements for market risk. 134
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Additionally,Basel 3 revises the definition of Tier 1 capital, introduces Tier 1 common equity as a regulatory metric, sets new minimum capital ratios (including a new "capital conservation buffer," which must be composed exclusively of Tier 1 common equity and will be in addition to the minimum capital ratios), introduces a Tier 1 leverage ratio within international guidelines for the first time, and makes substantial revisions to the computation of RWAs for credit exposures. Implementation of the new requirements is expected to take place over the next several years. Although the U.S. federal banking agencies have now issued proposed rules that are intended to implement certain aspects of theBasel 2.5 guidelines, they have not yet addressed all aspects of those guidelines or theBasel 3 changes. The Basel Committee has published its final provisions for assessing the global systemic importance of banking institutions and the range of additional Tier 1 common equity that should be maintained by banking institutions deemed to be globally systemically important. The additional capital for these institutions would initially range from 1% to 2.5% of Tier 1 common equity and could be as much as 3.5% for a bank that increases its systemic footprint (e.g., by increasing total assets). The firm was one of 29 institutions identified by the Financial Stability Board (established at the direction of the leaders of the Group of 20) as globally systemically important under the Basel Committee's methodology. Therefore, depending upon the manner and timing of the U.S. banking regulators' implementation of the Basel Committee's methodology, we expect that the minimum Tier 1 common ratio requirement applicable to us will include this additional capital assessment. The final determination of whether an institution is classified as globally systemically important and the calculation of the required additional capital amount is expected to be disclosed by theBasel Committee no later thanNovember 2014 based on data through the end of 2013. The Dodd-Frank Act will subject us at a firmwide level to the same leverage and risk-based capital requirements that apply to depository institutions and directs banking regulators to impose additional capital requirements as disclosed above. TheFederal Reserve Board is expected to adopt the new leverage and risk-based capital regulations in 2012. As a consequence of these changes, Tier 1 capital treatment for our junior subordinated debt issued to trusts will be phased out over a three-year period beginning onJanuary 1, 2013 . The interaction among the Dodd-Frank Act, the Basel Committee's proposed changes and other proposed or announced changes from other governmental entities and regulators adds further uncertainty to our future capital requirements. 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.
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.
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Rating Agency Guidelines
The credit rating agencies assign credit ratings to the obligations ofGroup Inc. , which directly issues or guarantees substantially all of the firm's senior unsecured obligations. Goldman, Sachs & Co. (GS&Co.) andGoldman 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 ofGroup 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 ofGroup Inc. , GS&Co.,GSI and GS Bank USA .
Subsidiary Capital Requirements
Many of our subsidiaries, includingGS Bank USA and our broker-dealer subsidiaries, are subject to separate regulation and capital requirements in jurisdictions throughout the world. For purposes of assessing the adequacy of its capital,GS Bank USA has established an ICAAP which is similar to that used byGroup 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 aboutGS Bank USA's capital ratios underBasel 1 as implemented by theFederal 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 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 ofMarch 2012 andDecember 2011 ,Group Inc.'s equity investment in subsidiaries was$68.60 billion and$67.70 billion , respectively, compared with its total shareholders' equity of$71.66 billion and$70.38 billion , respectively.Group Inc. has guaranteed the payment obligations of GS&Co.,GS Bank USA ,Goldman Sachs Bank (Europe) plc andGoldman Sachs Execution & Clearing, L.P. (GSEC) subject to certain exceptions. InNovember 2008 ,Group Inc. contributed subsidiaries intoGS Bank USA , andGroup 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 toGS 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. 136
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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. InMarch 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 fromApril 1, 2011 to the redemption date, which was included in our results during the three months endedMarch 2011 . The Series G Preferred Stock was redeemed onApril 18, 2011 . Berkshire Hathaway continues to hold a five-year warrant, issued inOctober 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 ofMarch 2012 , under the share repurchase program approved by the Board, we can repurchase up to 60.3 million additional shares of common stock; however, any such repurchases are subject to the approval of theFederal Reserve Board . See "Unregistered Sales ofEquity 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. 137
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Other Capital Metrics
The table below presents information on our shareholders' equity and book value per common share. As of March December $ in millions, except per share amounts 2012 2011 Total shareholders' equity $71,656 $70,379 Common shareholders' equity 68,556 67,279 Tangible common shareholders' equity 63,186 61,811 Book value per common share 134.48 130.31 Tangible book value per common share 123.94 119.72 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 March December in millions 2012 2011 Total shareholders' equity $71,656
Deduct: Preferred stock (3,100 )
(3,100 )
Common shareholders' equity 68,556
67,279
Deduct: Goodwill and identifiable intangible assets (5,370 ) (5,468 )
Tangible common shareholders' equity$63,186
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 509.8 million and 516.3 million as ofMarch 2012 andDecember 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 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.
138
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Table of Contents
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.
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