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(Registrant’s telephone
number, including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or
15(d) of the
Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.
x Yes o No
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
(§232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant
was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a
non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,”“accelerated
filer” and “smaller reporting company” in
Rule 12b-2
of the Exchange Act.
Large accelerated
filer x
Accelerated
filer o
Non-accelerated
filer o
(Do not check if a smaller reporting company) Smaller reporting
company o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange Act).
o Yes x No
APPLICABLE ONLY
TO CORPORATE ISSUERS
As of
July 29, 2011, there were 505,793,947 shares of the
registrant’s common stock outstanding.
C:
C:
THE GOLDMAN SACHS
GROUP, INC.
QUARTERLY REPORT ON
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2011
Cash and securities segregated for regulatory and other purposes
(includes $42,343 and $36,182 at fair value as of June 2011
and December 2010, respectively)
61,491
53,731
Collateralized agreements:
Securities purchased under agreements to resell and federal
funds sold (includes $162,285 and $188,355 at fair value as of
June 2011 and December 2010, respectively)
162,285
188,355
Securities borrowed (includes $61,865 and $48,822 at fair value
as of June 2011 and December 2010, respectively)
175,472
166,306
Receivables from brokers, dealers and clearing organizations
16,785
10,437
Receivables from customers and counterparties (includes $7,674
and $7,202 at fair value as of June 2011 and
December 2010, respectively)
77,367
67,703
Financial instruments owned, at fair value (includes $57,687 and
$51,010 pledged as collateral as of June 2011 and
December 2010, respectively)
370,605
356,953
Other assets
27,472
28,059
Total assets
$
936,910
$
911,332
Liabilities and shareholders’ equity
Deposits (includes $2,165 and $1,975 at fair value as of
June 2011 and December 2010, respectively)
$
39,004
$
38,569
Collateralized financings:
Securities sold under agreements to repurchase, at fair value
155,450
162,345
Securities loaned (includes $4,839 and $1,514 at fair value as
of June 2011 and December 2010, respectively)
14,474
11,212
Other secured financings (includes $26,448 and $31,794 at fair
value as of June 2011 and December 2010, respectively)
34,520
38,377
Payables to brokers, dealers and clearing organizations
6,412
3,234
Payables to customers and counterparties
203,382
187,270
Financial instruments sold, but not yet purchased, at fair value
149,639
140,717
Unsecured
short-term
borrowings, including the current portion of unsecured
long-term
borrowings (includes $22,334 and $22,116 at fair value as of
June 2011 and December 2010, respectively)
56,554
47,842
Unsecured
long-term
borrowings (includes $20,130 and $18,171 at fair value as of
June 2011 and December 2010, respectively)
175,210
174,399
Other liabilities and accrued expenses (includes $7,487 and
$2,972 at fair value as of June 2011 and
December 2010, respectively)
29,909
30,011
Total liabilities
864,554
833,976
Commitments, contingencies and guarantees
Shareholders’ equity
Preferred stock, par value $0.01 per share; aggregate
liquidation preference of $3,100 and $8,100 as of June 2011
and December 2010, respectively
3,100
6,957
Common stock, par value $0.01 per share;
4,000,000,000 shares authorized, 790,705,627 and
770,949,268 shares issued as of June 2011 and
December 2010, respectively, and 507,855,774 and
507,530,772 shares outstanding as of June 2011 and
December 2010, respectively
8
8
Restricted stock units and employee stock options
5,200
7,706
Nonvoting common stock, par value $0.01 per share;
200,000,000 shares authorized, no shares issued and
outstanding
—
—
Additional
paid-in
capital
44,955
42,103
Retained earnings
58,659
57,163
Accumulated other comprehensive loss
(347
)
(286
)
Stock held in treasury, at cost, par value $0.01 per share;
282,849,855 and 263,418,498 shares as of June 2011 and
December 2010, respectively
(39,219
)
(36,295
)
Total shareholders’ equity
72,356
77,356
Total liabilities and shareholders’ equity
$
936,910
$
911,332
The accompanying notes are an integral part of these condensed
consolidated financial statements.
Cash and securities segregated for regulatory and other purposes
(7,759
)
(19,748
)
Net receivables from brokers, dealers and clearing organizations
(3,170
)
(1,336
)
Net payables to customers and counterparties
3,884
3,263
Securities borrowed, net of securities loaned
(5,904
)
(4,296
)
Securities sold under agreements to repurchase, net of
securities purchased under agreements to resell and federal
funds sold
19,175
(3,452
)
Financial instruments owned, at fair value
(9,966
)
16,823
Financial instruments sold, but not yet purchased, at fair value
8,919
18,145
Other, net
703
(14,428
)
Net cash provided by operating activities
12,655
2,449
Cash flows from investing activities
Purchase of property, leasehold improvements and equipment
(520
)
(452
)
Proceeds from sales of property, leasehold improvements and
equipment
33
49
Business acquisitions, net of cash acquired
(247
)
(753
)
Proceeds from sales of investments
966
445
Purchase of
available-for-sale
securities
(1,122
)
(1,248
)
Proceeds from sales of
available-for-sale
securities
1,339
1,269
Net cash provided by/(used for) investing activities
449
(690
)
Cash flows from financing activities
Unsecured
short-term
borrowings, net
298
204
Other secured financings
(short-term),
net
(461
)
1,392
Proceeds from issuance of other secured financings
(long-term)
2,334
1,752
Repayment of other secured financings
(long-term),
including the current portion
(5,363
)
(2,528
)
Proceeds from issuance of unsecured
long-term
borrowings
17,470
9,518
Repayment of unsecured
long-term
borrowings, including the current portion
(13,686
)
(13,458
)
Derivative contracts with a financing element, net
244
536
Deposits, net
435
(2,394
)
Preferred stock repurchased
(3,857
)
—
Common stock repurchased
(2,980
)
(2,269
)
Dividends and dividend equivalents paid on common stock,
preferred stock and restricted stock units
(2,326
)
(722
)
Proceeds from issuance of common stock, including stock option
exercises
123
250
Excess tax benefit related to
share-based
compensation
346
271
Cash settlement of
share-based
compensation
(36
)
(1
)
Net cash used for financing activities
(7,459
)
(7,449
)
Net increase/(decrease) in cash and cash equivalents
5,645
(5,690
)
Cash and cash equivalents, beginning of year
39,788
38,291
Cash and cash equivalents, end of period
$
45,433
$
32,601
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest, net of capitalized interest, were
$4.02 billion and $3.75 billion during the six months
ended June 2011 and June 2010, respectively.
Cash payments for income taxes, net of refunds, were
$1.79 billion and $2.77 billion during the six months
ended June 2011 and June 2010, respectively.
Non-cash
activities:
The firm assumed $90 million of debt in connection with
business acquisitions during the six months ended
June 2010. In addition, in the first quarter of 2010, the
firm recorded an increase of approximately $3 billion in
both assets (primarily financial instruments owned, at fair
value) and liabilities (primarily unsecured
short-term
borrowings and other liabilities) upon adoption of Accounting
Standards Update (ASU)
No. 2009-17,
“Consolidations (Topic 810) — Improvements to
Financial Reporting by Enterprises Involved with Variable
Interest Entities.”
The accompanying notes are an integral part of these condensed
consolidated financial statements.
The Goldman Sachs Group, Inc. (Group Inc.), a Delaware
corporation, together with its consolidated subsidiaries
(collectively, the firm), is a leading global investment
banking, securities and investment management firm that provides
a wide range of financial services to a substantial and
diversified client base that includes corporations, financial
institutions, governments and
high-net-worth
individuals. Founded in 1869, the firm is headquartered in New
York and maintains offices in all major financial centers around
the world.
The firm reports its activities in the following four business
segments:
Investment
Banking
The firm provides a broad range of investment banking services
to a diverse group of corporations, financial institutions,
investment funds and governments. Services include advisory
assignments with respect to mergers and acquisitions,
divestitures, corporate defense activities, risk management,
restructurings and
spin-offs,
and debt and equity underwriting of public offerings and private
placements, as well as derivative transactions directly related
to these activities.
Institutional
Client Services
The firm facilitates client transactions and makes markets in
fixed income, equity, currency and commodity products, primarily
with institutional clients such as corporates, financial
institutions, investment funds and governments. The firm also
makes markets and clears client transactions on major stock,
options and futures exchanges worldwide and provides financing,
securities lending and prime brokerage services to institutional
clients.
Investing &
Lending
The firm invests in and originates loans to provide financing to
clients. These investments and loans are typically longer-term
in nature. The firm makes investments, directly and indirectly
through funds that the firm manages, in debt securities, loans,
public and private equity securities, real estate, consolidated
investment entities and power generation facilities.
Investment
Management
The firm 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. The firm
also offers wealth advisory services, including portfolio
management and financial counseling, and brokerage and other
transaction services to
high-net-worth
individuals and families.
These condensed consolidated financial statements are prepared
in accordance with accounting principles generally accepted in
the United States (U.S. GAAP) and include the accounts of
Group Inc. and all other entities in which the firm has a
controlling financial interest. Intercompany transactions and
balances have been eliminated.
These condensed consolidated financial statements are unaudited
and should be read in conjunction with the audited consolidated
financial statements included in the firm’s Annual Report
on
Form 10-K
for the year ended December 31, 2010. References to
“the firm’s Annual Report on
Form 10-K”
are to the firm’s Annual Report on
Form 10-K
for the year ended December 31, 2010. The condensed
consolidated financial information as of
December 31, 2010 has been derived from audited
consolidated financial statements not included herein.
These unaudited condensed consolidated financial statements
reflect all adjustments that are, in the opinion of management,
necessary for a fair statement of the results for the interim
periods presented. These adjustments are of a normal, recurring
nature. Interim period operating results may not be indicative
of the operating results for a full year.
All references to June 2011 and June 2010, unless
specifically stated otherwise, refer to the firm’s periods
ended, or the dates, as the context requires,
June 30, 2011 and June 30, 2010,
respectively. All references to March 2011 and
December 2010, unless specifically stated otherwise, refer
to the dates March 31, 2011 and
December 31, 2010, respectively. Certain
reclassifications have been made to previously reported amounts
to conform to the current presentation.
The firm’s significant accounting policies include when and
how to measure the fair value of assets and liabilities,
accounting for goodwill and identifiable intangible assets, and
when to consolidate an entity. See Notes 5 through 8 for
policies on fair value measurements, Note 13 for policies
on goodwill and identifiable intangible assets, and below and
Note 11 for policies on consolidation accounting. All other
significant accounting policies are either discussed below or
included in the following footnotes:
Financial Instruments Owned, at Fair Value and Financial
Instruments Sold, But Not Yet Purchased, at Fair Value
Note 4
Fair Value Measurements
Note 5
Cash Instruments
Note 6
Derivatives and Hedging Activities
Note 7
Fair Value Option
Note 8
Collateralized Agreements and Financings
Note 9
Securitization Activities
Note 10
Variable Interest Entities
Note 11
Other Assets
Note 12
Goodwill and Identifiable Intangible Assets
Note 13
Deposits
Note 14
Short-Term
Borrowings
Note 15
Long-Term
Borrowings
Note 16
Other Liabilities and Accrued Expenses
Note 17
Commitments, Contingencies and Guarantees
Note 18
Shareholders’ Equity
Note 19
Regulation and Capital Adequacy
Note 20
Earnings Per Common Share
Note 21
Transactions with Affiliated Funds
Note 22
Interest Income and Interest Expense
Note 23
Income Taxes
Note 24
Business Segments
Note 25
Credit Concentrations
Note 26
Legal Proceedings
Note 27
Consolidation
The firm consolidates entities in which the firm has a
controlling financial interest. The firm determines whether it
has a controlling financial interest in an entity by first
evaluating whether the entity is a voting interest entity or a
variable interest entity (VIE).
Voting Interest Entities. Voting interest
entities are entities in which (i) the total equity
investment at risk is sufficient to enable the entity to finance
its activities independently and (ii) the equity holders
have the power to direct the activities of the entity that most
significantly impact its economic performance, the obligation to
absorb the losses of the entity and the right to receive the
residual returns of the entity. The usual condition for a
controlling financial interest in a voting interest entity is
ownership of a majority voting interest. If the firm has a
majority voting interest in a voting interest entity, the entity
is consolidated.
C:
Variable Interest Entities. A VIE is an entity
that lacks one or more of the characteristics of a voting
interest entity. The firm has a controlling financial interest
in a VIE when the firm has a variable interest or interests that
provide it with (i) the power to direct the activities of
the VIE that most significantly impact the VIE’s economic
performance and (ii) the obligation to absorb losses of the
VIE or the right to receive benefits from the VIE that could
potentially be significant to the VIE. See Note 11 for
further information about VIEs.
C:
Equity-Method
Investments. When the firm does not have a
controlling financial interest in an entity but can exert
significant influence over the entity’s operating and
financial policies, the investment is accounted for either
(i) under the equity method of accounting or (ii) at
fair value by electing the fair value option available under
U.S. GAAP. Significant influence generally exists when the
firm owns 20% to 50% of the entity’s common stock or
in-substance
common stock.
In general, the firm accounts for investments acquired
subsequent to November 24, 2006, when the fair value
option became available, at fair value. In certain cases, the
firm applies the equity method of accounting to new investments
that are strategic in nature or closely related to the
firm’s principal business activities, when the firm has a
significant degree of involvement in the cash flows or
operations of the investee or when
cost-benefit
considerations are less significant. See Note 12 for
further information about
equity-method
investments.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Investment Funds. The firm has formed numerous
investment funds with
third-party
investors. These funds are typically organized as limited
partnerships or limited liability companies for which the firm
acts as general partner or manager. Generally, the firm does not
hold a majority of the economic interests in these funds. These
funds are usually voting interest entities and generally are not
consolidated because
third-party
investors typically have rights to terminate the funds or to
remove the firm as general partner or manager. Investments in
these funds are included in “Financial instruments owned,
at fair value.” See Notes 6, 18 and 22 for further
information about investments in funds.
C:
Use of
Estimates
Preparation of these condensed consolidated financial statements
requires management to make certain estimates and assumptions,
the most important of which relate to fair value measurements,
accounting for goodwill and identifiable intangible assets,
discretionary compensation accruals and the provision for losses
that may arise from litigation, regulatory proceedings and tax
audits. These estimates and assumptions are based on the best
available information but actual results could be materially
different.
C:
Revenue
Recognition
Financial Assets and Financial Liabilities at Fair
Value. Financial instruments owned, at fair value
and Financial instruments sold, but not yet purchased, at fair
value are recorded at fair value either under the fair value
option or in accordance with other U.S. GAAP. In addition,
the firm has elected to account for certain of its other
financial assets and financial liabilities at fair value by
electing the fair value option. 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. Financial
assets are marked to bid prices and financial liabilities are
marked to offer prices. Fair value measurements do not include
transaction costs. Fair value gains or losses are generally
included in “Market making” for positions in
Institutional Client Services and “Other principal
transactions” for positions in Investing &
Lending. See Notes 5 through 8 for further information
about fair value measurements.
Investment Banking. Fees from financial
advisory assignments and underwriting revenues are recognized in
earnings when the services related to the underlying transaction
are completed under the terms of the assignment. Expenses
associated with such transactions are deferred until the related
revenue is recognized or the assignment is otherwise concluded.
Expenses associated with financial advisory assignments are
recorded as
non-compensation
expenses, net of client reimbursements. Underwriting revenues
are presented net of related expenses.
Investment Management. The firm earns
management fees and incentive fees for investment management
services. Management fees are calculated as a percentage of net
asset value, invested capital or commitments, and are recognized
over the period that the related service is provided. Incentive
fees are calculated as a percentage of a fund’s or
separately managed account’s return, or excess return above
a specified benchmark or other performance target. Incentive
fees are generally based on investment performance over a
12-month
period or over the life of a fund. Fees that are based on
performance over a
12-month
period are subject to adjustment prior to the end of the
measurement period. For fees that are based on investment
performance over the life of the fund, future investment
underperformance may require fees previously distributed to the
firm to be returned to the fund. Incentive fees are recognized
only when all material contingencies have been resolved.
Management and incentive fee revenues are included in
“Investment management” revenues.
Commissions and Fees. The firm earns
“Commissions and fees” from executing and clearing
client transactions on stock, options and futures markets.
Commissions and fees are recognized on the day the trade is
executed.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Transfers of
Assets
Transfers of assets are accounted for as sales when the firm has
relinquished control over the assets transferred. For transfers
of assets accounted for as sales, any related gains or losses
are recognized in net revenues. Assets or liabilities that arise
from the firm’s continuing involvement with transferred
assets are measured at fair value. For transfers of assets that
are not accounted for as sales, the assets remain in
“Financial instruments owned, at fair value” and the
transfer is accounted for as a collateralized financing, with
the related interest expense recognized over the life of the
transaction. See Note 9 for further information about
transfers of assets accounted for as collateralized financings
and Note 10 for further information about transfers of
assets accounted for as sales.
C:
Receivables from
Customers and Counterparties
Receivables from customers and counterparties generally consist
of collateralized receivables, primarily customer margin loans,
related to client transactions. Certain of the firm’s
receivables from customers and counterparties are accounted for
at fair value under the fair value option, with changes in fair
value generally included in “Market making” revenues.
See Note 8 for further information about the fair values of
these receivables. Receivables from customers and counterparties
not accounted for at fair value are accounted for at amortized
cost net of estimated uncollectible amounts, which generally
approximates fair value. Interest on receivables from customers
and counterparties is recognized over the life of the
transaction and included in “Interest income.”
C:
Insurance
Activities
Certain of the firm’s insurance and reinsurance contracts
are accounted for at fair value under the fair value option,
with changes in fair value included in “Market making”
revenues. See Note 8 for further information about the fair
values of these insurance and reinsurance contracts.
Revenues from variable annuity and life insurance and
reinsurance contracts not accounted for at fair value generally
consist of fees assessed on contract holder account balances for
mortality charges, policy administration fees and surrender
charges. These revenues are recognized in earnings over the
period that services are provided and are included in
“Market making” revenues. Interest credited to
variable annuity and life insurance and reinsurance contract
account balances and changes in reserves are recognized in
“Other expenses.”
Premiums earned for underwriting property catastrophe
reinsurance are recognized in earnings over the coverage period,
net of premiums ceded for the cost of reinsurance, and are
included in “Market making” revenues. Expenses for
liabilities related to property catastrophe reinsurance claims,
including estimates of losses that have been incurred but not
reported, are included in “Other expenses.”
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Share-based
Compensation
The cost of employee services received in exchange for a
share-based
award is generally measured based on the grant-date fair value
of the award.
Share-based
awards that do not require future service (i.e., vested
awards, including awards granted to retirement-eligible
employees) are expensed immediately.
Share-based
employee awards that require future service are amortized over
the relevant service period. Expected forfeitures are included
in determining
share-based
employee compensation expense.
The firm pays cash dividend equivalents on outstanding
restricted stock units (RSUs). Dividend equivalents paid on RSUs
are generally charged to retained earnings. Dividend equivalents
paid on RSUs expected to be forfeited are included in
compensation expense.
The firm accounts for the tax benefit related to dividend
equivalents paid on RSUs as an increase to additional
paid-in
capital.
In certain cases, primarily related to the death of an employee
or conflicted employment (as outlined in the applicable award
agreements), the firm may cash settle
share-based
compensation awards. For awards accounted for as equity
instruments, additional
paid-in
capital is adjusted to the extent of the difference between the
current value of the award and the grant-date value of the award.
C:
Foreign Currency
Translation
Assets and liabilities denominated in
non-U.S. currencies
are translated at rates of exchange prevailing on the date of
the condensed consolidated statements of financial condition and
revenues and expenses are translated at average rates of
exchange for the period. Foreign currency remeasurement gains or
losses on transactions in nonfunctional currencies are
recognized in earnings. Gains or losses on translation of the
financial statements of a
non-U.S. operation,
when the functional currency is other than the U.S. dollar,
are included, net of hedges and taxes, in the condensed
consolidated statements of comprehensive income.
C:
Cash and Cash
Equivalents
The firm defines cash equivalents as highly liquid overnight
deposits held in the ordinary course of business. As of
June 2011 and December 2010, “Cash and cash
equivalents” included $5.02 billion and
$5.75 billion, respectively, of cash and due from banks,
and $40.41 billion and $34.04 billion, respectively,
of interest-bearing deposits with banks.
C:
Recent Accounting
Developments
Improving Disclosures about Fair Value
Measurements. In January 2010, the FASB
issued ASU
No. 2010-06,
“Fair Value Measurements and Disclosures (Topic
820) — Improving Disclosures about Fair Value
Measurements.” ASU
No. 2010-06
provides amended disclosure requirements related to fair value
measurements. Certain of these disclosure requirements became
effective for the firm beginning in the first quarter of 2010,
while others became effective for the firm beginning in the
first quarter of 2011. Since these amended principles require
only additional disclosures concerning fair value measurements,
adoption did not affect the firm’s financial condition,
results of operations or cash flows.
Reconsideration of Effective Control for Repurchase
Agreements. In April 2011, the FASB issued ASU
No. 2011-03,
“Transfers and Servicing (Topic 860) —
Reconsideration of Effective Control for Repurchase
Agreements.” ASU
No. 2011-03
changes the assessment of effective control by removing
(i) the criterion that requires the transferor to have the
ability to repurchase or redeem financial assets on
substantially the agreed terms, even in the event of default by
the transferee, and (ii) the collateral maintenance
implementation guidance related to that criterion. ASU
No. 2011-03
is effective for periods beginning after
December 15, 2011. The adoption of ASU
No. 2011-03
will not affect the firm’s financial condition, results of
operations or cash flows.
Amendments to Achieve Common Fair Value Measurement and
Disclosure Requirements in U.S. GAAP and IFRSs (FASB
Accounting Standards Codification (ASC) 820). In
May 2011, the FASB issued ASU
No. 2011-04,
“Fair Value Measurements and Disclosures (Topic
820) — Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and
IFRSs.” ASU
No. 2011-04
clarifies the application of existing fair value measurement and
disclosure requirements, changes certain principles related to
measuring fair value, and requires additional disclosures about
fair value measurements. ASU
No. 2011-04
is effective for periods beginning after
December 15, 2011. The firm is currently evaluating
the impact of adoption.
Financial instruments owned, at fair value and financial
instruments sold, but not yet purchased, at fair value are
accounted for at fair value either under the fair value option
or in accordance with other U.S. GAAP. See Note 8 for
further information about the fair value option. The table below
presents the firm’s financial instruments owned, at fair
value, including those
pledged as collateral, and financial instruments sold, but not
yet purchased, at fair value. Financial instruments owned, at
fair value included $3.48 billion and $3.67 billion as
of June 2011 and December 2010, respectively, of
securities accounted for as
available-for-sale,
substantially all of which are held in the firm’s insurance
subsidiaries.
C:
As of June 2011
As of December 2010
Financial
Financial
Instruments
Instruments
Financial
Sold, But
Financial
Sold, But
Instruments
Not Yet
Instruments
Not Yet
in millions
Owned
Purchased
Owned
Purchased
Commercial paper, certificates of deposit, time deposits and
other money market instruments
$
7,186
$
—
$
11,262
4
$
—
U.S. government and federal agency obligations
87,075
29,392
84,928
23,264
Non-U.S. government
obligations
55,023
28,622
40,675
29,009
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
6,693
—
6,200
5
Loans and securities backed by residential real estate
7,716
12
9,404
6
Loan
portfolios 1
1,238
—
1,438
—
Bank loans and bridge loans
18,927
1,823
3
18,039
1,487
3
Corporate debt securities
25,582
9,267
24,719
7,219
State and municipal obligations
3,328
—
2,792
—
Other debt obligations
2,554
4
3,232
—
Equities and convertible debentures
71,626
33,019
67,833
24,988
Commodities
10,133
8
13,138
9
Derivatives 2
73,524
47,492
73,293
54,730
Total
$
370,605
$
149,639
$
356,953
$
140,717
1.
Consists of acquired portfolios of distressed loans, primarily
backed by commercial and residential real estate.
2.
Net of cash collateral received or posted under credit support
agreements and reported on a
net-by-counterparty
basis when a legal right of setoff exists under an enforceable
netting agreement.
3.
Includes the fair value of unfunded commitments to extend
credit. The fair value of partially funded commitments is
primarily included in “Financial instruments owned, at fair
value.”
4.
Includes $4.06 billion as of December 2010 of money
market instruments held by William Street Funding Corporation
(Funding Corp.) to support the William Street credit extension
program. See Note 18 for further information about the
William Street credit extension program.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Gains and Losses
from Market Making and Other Principal Transactions
The table below presents, by major product type, the firm’s
“Market making” and “Other principal
transactions” revenues. These gains/(losses) are primarily
related to the firm’s financial instruments owned, at fair
value and financial instruments sold, but not yet purchased, at
fair value, including both derivative and
non-derivative
financial instruments. These gains/(losses) exclude related
interest income and interest expense. See Note 23 for
further information about interest income and interest expense.
The gains/(losses) in the table are not representative of the
manner in which the firm manages its business activities because
many of the firm’s market making, client facilitation, and
investing and lending strategies utilize financial instruments
across various product types. Accordingly, gains or losses in
one product type frequently offset gains or losses in other
product types.
For example, most of the firm’s longer-term derivatives are
sensitive to changes in interest rates and may be economically
hedged with interest rate swaps. Similarly, a significant
portion of the firm’s cash instruments and derivatives has
exposure to foreign currencies and may be economically hedged
with foreign currency contracts.
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. Financial assets are marked to bid
prices and financial liabilities are marked to offer prices.
Fair value measurements do not include transaction costs.
The best evidence of fair value is a quoted price in an active
market. If listed prices or quotations are not available, fair
value is determined by reference to prices for similar
instruments, quoted prices or recent transactions in less active
markets, or internally developed models that primarily use, as
inputs,
market-based
or independently sourced parameters, including but not limited
to interest rates, volatilities, equity or debt prices, foreign
exchange rates, commodities prices and credit curves.
U.S. GAAP has a three-level fair value hierarchy for
disclosure of fair value measurements. The fair value hierarchy
prioritizes inputs to the valuation techniques used to measure
fair value, giving the highest priority to level 1 inputs
and the lowest priority to level 3 inputs. A financial
instrument’s level in the fair value hierarchy is based on
the lowest level of any input that is significant to its fair
value measurement.
The fair value hierarchy is as follows:
Level 1. Inputs are unadjusted quoted
prices in active markets to which the firm had access at the
measurement date for identical, unrestricted assets or
liabilities.
Level 2. Inputs to valuation techniques
are observable, either directly or indirectly.
Level 3. One or more inputs to valuation
techniques are significant and unobservable.
See Notes 6 and 7 for further information about fair value
measurements of cash instruments and derivatives, respectively.
The fair value of certain level 2 and level 3
financial assets and financial liabilities may include valuation
adjustments for counterparty and the firm’s credit quality,
transfer restrictions, large
and/or
concentrated positions, illiquidity and bid/offer inputs. See
Notes 6 and 7 for further information about valuation
adjustments.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3 financial assets are summarized below.
C:
As of
June
March
December
in millions
2011
2011
2010
Total level 3 financial assets
$
47,007
$
45,843
$
45,377
Total assets
$
936,910
$
933,289
$
911,332
Total financial assets at fair value
$
644,772
$
641,556
$
637,514
Total level 3 financial assets as a percentage of Total
assets
5.0%
4.9%
5.0%
Total level 3 financial assets as a percentage of Total
financial assets at fair value
7.3%
7.1%
7.1%
The increase in level 3 assets during the three months
ended June 2011 primarily reflected an increase in private
equity investments, principally due to transfers from
level 2. The increase in level 3 assets during the six
months ended June 2011 primarily reflected an increase in
private equity investments, principally due to purchases and
transfers from level 2, partially offset by a decrease in
credit derivatives, primarily due to transfers to level 2
and settlements.
Financial Assets
and Financial Liabilities by Level
The tables below present, by level within the fair value
hierarchy, financial instruments owned, at fair value and
financial instruments sold, but not yet purchased, at fair
value, and other financial assets and financial liabilities
accounted for at fair value under the fair value option. See
Notes 6 and 7 for further information on the assets and
liabilities included in cash instruments and derivatives,
respectively, and their valuation methodologies and inputs. See
Note 8 for the valuation methodologies and inputs for other
financial assets and financial liabilities accounted for at fair
value under the fair value option.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Financial Assets at Fair Value as of June 2011
Netting and
in millions
Level 1
Level 2
Level 3
Collateral
Total
Total cash instruments
$
131,798
$
130,418
$
34,865
$
—
$
297,081
Total derivatives
157
166,689
11,522
(104,844
) 3
73,524
Financial instruments owned, at fair value
131,955
297,107
46,387
(104,844
)
370,605
Securities segregated for regulatory and other purposes
15,770
1
26,573
2
—
—
42,343
Securities purchased under agreements to resell
—
161,986
299
—
162,285
Securities borrowed
—
61,865
—
—
61,865
Receivables from customers and counterparties
—
7,353
321
—
7,674
Total
$
147,725
$
554,884
$
47,007
$
(104,844
)
$
644,772
Financial Liabilities at Fair Value as of June 2011
Netting and
in millions
Level 1
Level 2
Level 3
Collateral
Total
Total cash instruments
$
89,231
$
12,304
$
612
$
—
$
102,147
Total derivatives
60
59,738
5,291
(17,597
) 3
47,492
Financial instruments sold, but not yet purchased, at fair value
89,291
72,042
5,903
(17,597
)
149,639
Deposits
—
2,165
—
—
2,165
Securities sold under agreements to repurchase
—
153,374
2,076
—
155,450
Securities loaned
—
4,839
—
—
4,839
Other secured financings
—
21,151
5,297
—
26,448
Unsecured
short-term
borrowings
—
19,233
3,101
—
22,334
Unsecured
long-term
borrowings
—
17,576
2,554
—
20,130
Other liabilities and accrued expenses
—
543
6,944
—
7,487
Total
$
89,291
$
290,923
$
25,875
4
$
(17,597
)
$
388,492
1.
Principally consists of U.S. Department of the Treasury
(U.S. Treasury) securities and money market instruments, as
well as insurance separate account assets measured at fair value.
2.
Principally consists of securities borrowed and resale
agreements. The underlying securities have been segregated to
satisfy certain regulatory requirements.
3.
Represents cash collateral and the impact of netting across
levels of the fair value hierarchy. Netting among positions
classified in the same level is included in that level.
4.
Level 3 liabilities were 6.7% of total financial
liabilities at fair value.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Financial Assets at Fair Value as of December 2010
Netting and
in millions
Level 1
Level 2
Level 3
Collateral
Total
Total cash instruments
$
117,800
$
133,653
$
32,207
$
—
$
283,660
Total derivatives
93
172,513
12,772
(112,085
) 3
73,293
Financial instruments owned, at fair value
117,893
306,166
44,979
(112,085
)
356,953
Securities segregated for regulatory and other purposes
19,794
1
16,388
2
—
—
36,182
Securities purchased under agreements to resell
—
188,255
100
—
188,355
Securities borrowed
—
48,822
—
—
48,822
Receivables from customers and counterparties
—
6,904
298
—
7,202
Total
$
137,687
$
566,535
$
45,377
$
(112,085
)
$
637,514
Financial Liabilities at Fair Value as of December
2010
Netting and
in millions
Level 1
Level 2
Level 3
Collateral
Total
Total cash instruments
$
75,668
$
9,873
$
446
$
—
$
85,987
Total derivatives
45
66,963
5,210
(17,488
) 3
54,730
Financial instruments sold, but not yet purchased, at fair value
75,713
76,836
5,656
(17,488
)
140,717
Deposits
—
1,975
—
—
1,975
Securities sold under agreements to repurchase
—
160,285
2,060
—
162,345
Securities loaned
—
1,514
—
—
1,514
Other secured financings
—
23,445
8,349
—
31,794
Unsecured
short-term
borrowings
—
18,640
3,476
—
22,116
Unsecured
long-term
borrowings
—
16,067
2,104
—
18,171
Other liabilities and accrued expenses
—
563
2,409
—
2,972
Total
$
75,713
$
299,325
$
24,054
4
$
(17,488
)
$
381,604
1.
Principally consists of U.S. Treasury securities and money
market instruments, as well as insurance separate account assets
measured at fair value.
2.
Principally consists of securities borrowed and resale
agreements. The underlying securities have been segregated to
satisfy certain regulatory requirements.
3.
Represents cash collateral and the impact of netting across
levels of the fair value hierarchy. Netting among positions
classified in the same level is included in that level.
4.
Level 3 liabilities were 6.3% of total financial
liabilities at fair value.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3
Unrealized Gains/(Losses)
Cash Instruments. Level 3 cash
instruments are frequently economically hedged with level 1
and level 2 cash instruments
and/or
level 1, level 2 and level 3 derivatives.
Accordingly, gains or losses that are reported in level 3
can be partially offset by gains or losses attributable to
level 1 or level 2 cash instruments
and/or
level 1, level 2 and level 3 derivatives. As a
result, gains/(losses) included in the level 3 rollforward
below do not necessarily represent the overall impact on the
firm’s results of operations, liquidity or capital
resources.
Derivatives. Gains and losses on level 3
derivatives should be considered in the context of the following:
•
A derivative with level 1
and/or
level 2 inputs is classified in level 3 in its
entirety if it has at least one significant level 3 input.
•
If there is one significant level 3 input, the entire gain
or loss from adjusting only observable inputs
(i.e., level 1 and level 2 inputs) is classified
as level 3.
•
Gains or losses that have been reported in level 3
resulting from changes in level 1 or level 2 inputs
are frequently offset by gains or losses attributable to
level 1 or level 2 derivatives
and/or
level 1, level 2 and level 3 cash instruments. As
a result, gains/(losses) included in the level 3
rollforward below do not necessarily represent the overall
impact on the firm’s results of operations, liquidity or
capital resources.
The table below presents the unrealized gains/(losses) on
level 3 financial assets and financial liabilities at fair
value still held at the period-end. See Notes 6 and 7 for
further information about level 3 cash instruments and
derivatives, respectively. See Note 8 for further
information about other financial assets and financial
liabilities at fair value under the fair value option.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Gains and losses in the table above include:
Three Months Ended June 2011
•
A net unrealized gain on cash instruments of $651 million,
primarily consisting of unrealized gains on private equity
investments, and bank loans and bridge loans, where prices were
generally corroborated through market transactions for similar
assets during the period.
•
A net unrealized gain on derivatives of $456 million,
primarily reflecting an unrealized gain on credit derivatives
attributable to changes in interest rates (which are
level 2 inputs). This gain was partially offset by an
unrealized loss on commodity derivatives, primarily due to
changes in the volatility inputs (which are level 2 inputs)
used to value these derivatives.
Three Months Ended June 2010
•
A net unrealized gain on cash instruments of $82 million,
primarily consisting of unrealized gains across most asset
classes, partially offset by unrealized losses on bank loans and
bridge loans.
•
A net unrealized gain on derivatives of $1.39 billion,
primarily driven by wider credit spreads (which are level 2
inputs) on the underlying instruments, as well as decreases in
certain equity prices (which are either level 1 or
level 2 inputs). These unrealized gains were substantially
offset by unrealized losses on currency, interest rate and
credit derivatives, which are classified within level 2 and
are used to economically hedge derivatives classified within
level 3.
Six Months Ended June 2011
•
A net unrealized gain on cash instruments of $1.85 billion,
primarily consisting of unrealized gains on bank loans and
bridge loans, reflecting generally favorable credit markets,
primarily during the first quarter of 2011, and private equity
investments, where prices were generally corroborated through
market transactions for similar assets during the period.
•
A net unrealized gain on derivatives of $93 million,
reflecting an unrealized gain on credit derivatives, primarily
attributable to changes in interest rates (which are
level 2 inputs), partially offset by an unrealized loss on
currency derivatives, primarily due to changes in foreign
exchange rates (which are level 2 inputs).
Six Months Ended June 2010
•
A net unrealized gain on cash instruments of $795 million,
primarily consisting of unrealized gains on loans and securities
backed by commercial real estate, private equity investments and
real estate fund investments, loans and securities backed by
residential real estate, and other debt obligations, evidenced
by sales of similar assets in each of these asset classes during
the period.
•
A net unrealized gain on derivatives of $2.85 billion,
primarily attributable to changes in foreign exchange rates and
interest rates (which are level 2 inputs) underlying
certain credit derivatives. These unrealized gains were
substantially offset by unrealized losses on currency, interest
rate and credit derivatives, which are classified within
level 2 and are used to economically hedge derivatives
classified within level 3.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3
Rollforward
If a financial asset or financial liability was transferred to
level 3 during a reporting period, its entire gain or loss
for the period is included in level 3. Transfers between
levels are recognized at the beginning of the reporting period
in which they occur.
The tables below present a summary of changes in fair value for
all financial assets and financial liabilities categorized as
level 3 as of the end of the period.
See Notes 6 and 7 for further information about cash
instruments and derivatives, respectively, included in
level 3, including information about significant transfers
in or out of level 3 financial assets. See Note 8 for
other financial assets and financial liabilities at fair value
under the fair value option.
C:
Level 3 Financial Assets at Fair Value for the Three Months
Ended June 2011
Net unrealized
gains/(losses)
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
gains/
still held at
(out) of
end of
in millions
of period
(losses)
period-end
Purchases
Sales
Settlements
level 3
period
Total cash instruments — assets
$
33,526
$
509
1
$
746
1
$
2,856
$
(2,492
)
$
(1,378
)
$
1,098
$
34,865
Total derivatives — net
6,803
(160
) 2
456
2,
3
414
(575
)
59
(766
)
6,231
Securities purchased under agreements to resell
158
—
—
181
—
(40
)
—
299
Receivables from customers and counterparties
322
—
5
—
—
(6
)
—
321
1.
The aggregate amounts include approximately $277 million,
$606 million and $372 million reported in “Market
making,”“Other principal transactions” and
“Interest income,” respectively.
2.
The aggregate amounts include approximately $138 million
and $158 million reported in “Market making” and
“Other principal transactions,” respectively.
3.
Principally resulted from changes in level 2 inputs.
C:
Level 3 Financial Liabilities at Fair Value for the Three
Months Ended June 2011
Net unrealized
(gains)/losses
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
(gains)/
still held at
(out) of
end of
in millions
of period
losses
period-end
Purchases
Sales
Issuances
Settlements
level 3
period
Total cash instruments — liabilities
$
482
$
1
$
95
$
(130
)
$
201
$
—
$
(21
)
$
(16
)
$
612
Securities sold under agreements to repurchase, at fair value
1,946
—
—
—
—
130
—
—
2,076
Other secured financings
7,107
9
(5
)
—
—
261
(2,091
)
16
5,297
Unsecured
short-term
borrowings
3,209
(41
)
82
(23
)
—
179
(438
)
133
3,101
Unsecured
long-term
borrowings
2,404
6
117
(34
)
—
22
(2
)
41
2,554
Other liabilities and accrued expenses
6,852
—
150
—
—
—
(58
)
—
6,944
There were no significant transfers in or out of level 3
financial liabilities during the three months ended
June 2011.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3 Financial Assets at Fair Value for the Six Months
Ended June 2011
Net unrealized
gains/(losses)
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
gains/
still held at
(out) of
end of
in millions
of year
(losses)
period-end
Purchases
Sales
Settlements
level 3
period
Total cash instruments — assets
$32,207
$
912
1
$
1,913
1
$
7,452
$
(4,106
)
$
(2,956
)
$
(557
)
$
34,865
Total derivatives — net
7,562
(133
) 2
93
2,
3
776
(843
)
(414
)
(810
)
6,231
Securities purchased under agreements to resell
100
2
—
245
—
(48
)
—
299
Receivables from customers and counterparties
298
—
21
14
—
(12
)
—
321
1.
The aggregate amounts include approximately $688 million,
$1.38 billion and $758 million reported in
“Market making,”“Other principal
transactions” and “Interest income,” respectively.
2.
The aggregate amounts include approximately $(52) million
and $12 million reported in “Market making” and
“Other principal transactions,” respectively.
3.
Principally resulted from changes in level 2 inputs.
C:
Level 3 Financial Liabilities at Fair Value for the Six
Months Ended June 2011
Net unrealized
(gains)/losses
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
(gains)/
still held at
(out) of
end of
in millions
of year
losses
period-end
Purchases
Sales
Issuances
Settlements
level 3
period
Total cash instruments — liabilities
$
446
$
(15
)
$
67
$
(193
)
$
325
$
—
$
(15
)
$
(3
)
$
612
Securities sold under agreements to repurchase, at fair value
2,060
—
—
—
—
194
(178
)
—
2,076
Other secured financings
8,349
9
4
—
—
274
(3,356
)
17
5,297
Unsecured
short-term
borrowings
3,476
68
(174
)
(31
)
—
541
(666
)
(113
)
3,101
Unsecured
long-term
borrowings
2,104
10
162
(50
)
—
291
(73
)
110
2,554
Other liabilities and accrued expenses
2,409
—
303
4,337
—
—
(105
)
—
6,944
Significant transfers in or out of level 3 financial
liabilities during the six months ended June 2011 included:
•
Unsecured
short-term
borrowings and Unsecured
long-term
borrowings: net transfer out of level 3 of
$113 million and net transfer into level 3 of
$110 million, respectively, principally due to a transfer
of approximately $230 million from level 3 Unsecured
short-term
borrowings to level 3 Unsecured
long-term
borrowings related to an extension in the tenor of certain
borrowings.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Level 3 Financial Assets at Fair Value for the Three Months
Ended June 2010
Net unrealized
gains/(losses)
Net
relating to
Net
Net
Balance,
realized
instruments
purchases,
transfers in
Balance,
beginning
gains/
still held at
sales and
and/or
(out)
end of
in millions
of period
(losses)
period-end
settlements
of level 3
period
Total cash instruments — assets
$32,528
$
334
1
$
191
1
$
(667
)
$
(435
)
$
31,951
Total derivatives — net
6,336
(104
) 2
1,386
2, 3
(89
)
343
7,872
Securities purchased under agreements to resell
268
—
—
—
(268
)
—
Receivables from customers and counterparties
234
5
(21
)
—
—
218
1.
The aggregate amounts include approximately $28 million,
$145 million and $352 million reported in “Market
making,”“Other principal transactions” and
“Interest income,” respectively.
2.
The aggregate amounts include approximately $999 million
and $283 million reported in “Market making” and
“Other principal transactions,” respectively.
3.
Principally resulted from changes in level 2 inputs.
Level 3 Financial Liabilities at Fair Value for the Three
Months Ended June 2010
Net unrealized
Net
(gains)/losses
purchases,
Net
Net
relating to
sales,
transfers
Balance,
realized
instruments
issuances
in
and/or
Balance,
beginning
(gains)/
still held at
and
(out) of
end of
in millions
of period
losses
period-end
settlements
level 3
period
Total cash instruments — liabilities
$
483
$
(112
)
$
109
$
113
$
2
$
595
Securities sold under agreements to repurchase, at fair value
1,055
—
—
531
(167
)
1,419
Other secured financings
8,139
12
(50
)
38
(53
)
8,086
Unsecured
short-term
borrowings
2,994
47
(224
)
(224
)
175
2,768
Unsecured
long-term
borrowings
1,715
2
(124
)
(53
)
359
1,899
Other liabilities and accrued expenses
2,327
2
17
21
19
2,386
There were no significant transfers in or out of level 3
financial liabilities during the three months ended
June 2010.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3 Financial Assets at Fair Value for the Six Months
Ended June 2010
Net unrealized
gains/(losses)
Net
Net
relating to
Net
transfers
Balance,
realized
instruments
purchases,
in
and/or
Balance,
beginning
gains/
still held at
sales and
(out) of
end of
in millions
of year
(losses)
period-end
settlements
level 3
period
Total cash instruments — assets
$
34,879
$
735
1
$
855
1
$
(2,062
)
$
(2,456
)
$
31,951
Total derivatives — net
5,196
(401
) 2
2,852
2, 3
153
72
7,872
Receivables from customers and counterparties
—
10
(48
)
—
256
218
1.
The aggregate amounts include approximately $416 million,
$516 million and $658 million reported in “Market
making,”“Other principal transactions” and
“Interest income,” respectively.
2.
The aggregate amounts include approximately $2.19 billion
and $263 million reported in “Market making” and
“Other principal transactions,” respectively.
3.
Principally resulted from changes in level 2 inputs.
Level 3 Financial Liabilities at Fair Value for the Six
Months Ended June 2010
Net unrealized
Net
(gains)/losses
purchases,
Net
Net
relating to
sales,
transfers
Balance,
realized
instruments
issuances
in
and/or
Balance,
beginning
(gains)/
still held at
and
(out) of
end of
in millions
of year
losses
period-end
settlements
level 3
period
Total cash instruments — liabilities
$ 572
$
(132
)
$
60
$
169
$
(74
)
$
595
Securities sold under agreements to repurchase, at fair value
394
—
—
1,025
—
1,419
Other secured financings
6,756
21
(39
)
1,174
174
8,086
Unsecured
short-term
borrowings
2,310
67
(307
)
(267
)
965
2,768
Unsecured
long-term
borrowings
3,077
15
(137
)
(19
)
(1,037
)
1,899
Other liabilities and accrued expenses
1,913
5
(47
)
22
493
2,386
Significant transfers in or out of level 3 financial
liabilities during the six months ended June 2010, which
were principally due to the consolidation of certain VIEs upon
adoption of ASU
No. 2009-17
as of January 1, 2010, included:
•
Unsecured
long-term
borrowings: net transfer out of level 3 of
$1.04 billion, principally due to the consolidation of
certain VIEs, which caused the firm’s borrowings from these
VIEs to become intercompany borrowings which were eliminated in
consolidation. Substantially all of these borrowings were
level 3.
•
Unsecured
short-term
borrowings: net transfer into level 3 of $965 million,
principally due to the consolidation of certain VIEs.
•
Other liabilities and accrued expenses: net transfer into
level 3 of $493 million, principally due to an
increase in subordinated liabilities issued by certain
consolidated VIEs.
•
Other secured financings: net transfer into level 3 of
$174 million, principally due to the consolidation of
certain VIEs.
Cash instruments include U.S. government and federal agency
obligations,
non-U.S. government
obligations, bank loans and bridge loans, corporate debt
securities, equities and convertible debentures, and other
non-derivative
financial instruments owned and financial instruments sold, but
not yet purchased. See below for the types of cash instruments
included in each level of the fair value hierarchy and the
valuation techniques and significant inputs used to determine
their fair values. See Note 5 for an overview of the
firm’s fair value measurement policies and the fair value
hierarchy.
Level 1 Cash
Instruments
Level 1 cash instruments include U.S. government
obligations and most
non-U.S. government
obligations, actively traded listed equities and certain money
market instruments. These instruments are valued using quoted
prices for identical unrestricted instruments in active markets.
The firm defines active markets for equity instruments based on
the average daily trading volume both in absolute terms and
relative to the market capitalization for the instrument. The
firm defines active markets for debt instruments based on both
the average daily trading volume and the number of days with
trading activity.
The fair value of a level 1 instrument is calculated as
quantity held multiplied by quoted market price. U.S. GAAP
prohibits valuation adjustments being applied to level 1
instruments even in situations where the firm holds a large
position and a sale could impact the quoted price.
Level 2 Cash
Instruments
Level 2 cash instruments include commercial paper,
certificates of deposit, time deposits, most government agency
obligations, most corporate debt securities, commodities,
certain
mortgage-backed
loans and securities, certain bank loans and bridge loans, less
liquid publicly listed equities, certain state and municipal
obligations and certain money market instruments and lending
commitments.
Valuations of level 2 cash instruments can be verified to
quoted prices, recent trading activity for identical or similar
instruments, broker or dealer quotations or alternative pricing
sources with reasonable levels of price transparency.
Consideration is given to the nature of the quotations
(e.g., indicative or firm) and the relationship of recent
market activity to the prices provided from alternative pricing
sources.
Valuation adjustments are typically made to level 2 cash
instruments (i) if the cash instrument is subject to
transfer restrictions
and/or
(ii) for other premiums and discounts that a market
participant would require to arrive at fair value. Valuation
adjustments are generally based on market evidence.
Level 3 Cash
Instruments
Level 3 cash instruments have one or more significant
valuation inputs that are not observable. Absent evidence to the
contrary, level 3 cash instruments are initially valued at
transaction price, which is considered to be the best initial
estimate of fair value. Subsequently, the firm uses other
methodologies to determine fair value, which vary based on the
type of instrument. Valuation inputs and assumptions are changed
when corroborated by substantive observable evidence, including
values realized on sales of level 3 financial assets.
The table below presents the valuation techniques and the nature
of significant inputs generally used to determine the fair
values of each class of level 3 cash instrument.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3 Cash Instrument
Valuation Techniques and Significant Inputs
Loans and securities backed by commercial real estate
• Collateralized by a single commercial real estate property or a portfolio of properties
• May include tranches of varying levels of subordination
Valuation techniques vary by instrument, but are generally based
on discounted cash flow techniques.
Significant inputs for these valuations include:
• Transaction prices in both the
underlying collateral and instruments with the same or
similar underlying
collateral
• Current levels and changes in market
indices such as the CMBX (an index that tracks
the performance of
commercial mortgage bonds)
• Market yields implied by transactions of
similar or related assets
• Current performance of the underlying
collateral
• Capitalization rates and multiples
Loans and securities backed by residential real estate
• Collateralized by portfolios of residential real estate
• May include tranches of varying levels of subordination
Valuation techniques vary by instrument, but are generally based on relative value analyses, discounted cash flow techniques or a combination thereof.
Significant inputs are determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles, including relevant indices such as the ABX (an index that tracks the performance of subprime residential mortgage bonds). Significant inputs include:
• Home price projections, residential property liquidation timelines and related costs
• Underlying loan prepayment, default and cumulative loss expectations
• Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral
• Market yields implied by transactions of similar or related assets
Loan portfolios
• Acquired portfolios of distressed loans
• Primarily backed by commercial and residential real estate collateral
Valuations are based on discounted cash flow techniques.
Significant inputs are determined based on relative value
analyses, which incorporate comparisons to recent auction data
for other similar loan portfolios. Significant inputs
include:
• Amount and timing of expected future
cash flows
• Market yields implied by transactions of
similar or related assets
Bank loans and bridge loans
Corporate debt securities
State and municipal obligations
Other debt obligations
Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.
Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying credit risk and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:
• Amount and timing of expected future cash flows
• Current levels and trends of market indices such as CDX, LCDX and MCDX (indices that track the performance of corporate credit, loans and municipal obligations, respectively)
• Market yields implied by transactions of similar or related assets
• Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation
Equities and convertible debentures
• Private equity investments
Recent third-party investments or pending transactions are
considered to be the best evidence for any change in fair
value. When these are not available, the following valuation
methodologies are used, as appropriate and available:
• Transactions in similar instruments
• Discounted cash flow techniques
• Third-party appraisals
• Industry multiples and public
comparables
Evidence includes recent or pending reorganizations
(e.g., merger proposals, tender offers, debt
restructurings) and significant changes in financial metrics,
such as:
• Current financial performance as
compared to projected performance
• Capitalization rates and multiples
• Market yields implied by transactions of
similar or related assets
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Fair Value of
Cash Instruments by Level
The tables below present, by level within the fair value
hierarchy, cash instrument assets and liabilities, at fair
value. Cash instrument assets and liabilities are
included in “Financial instruments owned, at fair
value” and “Financial instruments sold, but not yet
purchased, at fair value,” respectively.
C:
Cash Instrument Assets at Fair Value as of June 2011
in millions
Level 1
Level 2
Level 3
Total
Commercial paper, certificates of deposit, time deposits and
other money market instruments
$
3,354
$
3,832
$
—
$
7,186
U.S. government and federal agency obligations
34,736
52,339
—
87,075
Non-U.S. government
obligations
49,036
5,987
—
55,023
Mortgage and other
asset-backed
loans and
securities 1:
Loans and securities backed by commercial real estate
—
4,298
2,395
6,693
Loans and securities backed by residential real estate
—
4,981
2,735
7,716
Loan portfolios
—
—
1,238
1,238
Bank loans and bridge loans
—
8,744
10,183
18,927
Corporate debt
securities 2
114
22,721
2,747
25,582
State and municipal obligations
—
2,685
643
3,328
Other debt
obligations 2
—
1,082
1,472
2,554
Equities and convertible debentures
44,558
3
13,616
4
13,452
5
71,626
Commodities
—
10,133
—
10,133
Total
$
131,798
$
130,418
$
34,865
$
297,081
Cash Instrument Liabilities at Fair Value as of June
2011
in millions
Level 1
Level 2
Level 3
Total
U.S. government and federal agency obligations
$
29,194
$
198
$
—
$
29,392
Non-U.S. government
obligations
27,763
859
—
28,622
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by residential real estate
—
8
4
12
Bank loans and bridge loans
—
1,240
583
1,823
Corporate debt
securities 6
78
9,168
21
9,267
Other debt obligations
—
4
—
4
Equities and convertible
debentures 7
32,196
819
4
33,019
Commodities
—
8
—
8
Total
$
89,231
$
12,304
$
612
$
102,147
1.
Includes $210 million and $684 million of
collateralized debt obligations (CDOs) backed by real estate in
level 2 and level 3, respectively.
2.
Includes $786 million and $1.45 billion of CDOs and
collateralized loan obligations (CLOs) backed by corporate
obligations in level 2 and level 3, respectively.
3.
Consists of publicly listed equity securities.
4.
Principally consists of restricted and less liquid publicly
listed securities.
5.
Includes $11.93 billion of private equity investments,
$1.17 billion of real estate investments and
$348 million of convertible debentures.
6.
Includes $14 million of CDOs and CLOs backed by corporate
obligations in level 3.
7.
Substantially all consists of publicly listed equity securities.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3
Rollforward
If a cash instrument was transferred to level 3 during a
reporting period, its entire gain or loss for the period is
included in level 3. Transfers between levels are reported
at the beginning of the reporting period in which they occur.
The tables below present changes in fair value for all cash
instrument assets and liabilities categorized as level 3 as
of the end of the period.
See Note 5 for further information about unrealized gains
and losses on level 3 cash instruments.
C:
Level 3 Cash Instrument Assets at Fair Value for the Three
Months Ended June 2011
Net unrealized
gains/(losses)
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
gains/
still held at
(out) of
end of
in millions
of period
(losses)
period-end
Purchases
1
Sales
Settlements
level 3
period
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
$2,521
$
41
$
31
$
302
$
(436
)
$
(225
)
$
161
$
2,395
Loans and securities backed by residential real estate
2,636
60
15
382
(183
)
(148
)
(27
)
2,735
Loan portfolios
1,312
(15
)
62
3
(44
)
(44
)
(36
)
1,238
Bank loans and bridge loans
9,929
189
220
1,249
(559
)
(524
)
(321
)
10,183
Corporate debt securities
3,138
93
14
404
(627
)
(127
)
(148
)
2,747
State and municipal obligations
742
1
4
26
(119
)
(2
)
(9
)
643
Other debt obligations
1,483
51
20
158
(316
)
(90
)
166
1,472
Equities and convertible debentures
11,765
89
380
332
(208
)
(218
)
1,312
13,452
Total
$33,526
$
509
$
746
$
2,856
$
(2,492
)
$
(1,378
)
$
1,098
$
34,865
Level 3 Cash Instrument Liabilities at Fair Value for the
Three Months Ended June 2011
Net unrealized
(gains)/losses
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
(gains)/
still held at
(out) of
end of
in millions
of period
losses
period-end
Purchases
Sales
Settlements
level 3
period
Total
$482
$
1
$
95
$
(130
)
$
201
$
(21
)
$
(16
)
$
612
1.
Includes both originations and secondary market purchases.
Significant transfers in or out of level 3 financial assets
during the three months ended June 2011 included:
•
Equities and convertible debentures: net transfer into
level 3 of $1.31 billion, principally due to transfers
into level 3 of certain private equity investments due to
reduced transparency of market prices, partially offset by
transfers to level 2 of certain private equity investments
due to improved transparency of market prices as a result of
market transactions in these financial instruments.
•
Bank loans and bridge loans: net transfer out of level 3 of
$321 million, principally due to transfers to level 2
of certain loans due to improved transparency of market prices
as a result of market transactions in these financial
instruments, partially offset by transfers to level 3 of
certain loans due to reduced transparency of market prices as a
result of less market activity in these financial instruments.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Level 3 Cash Instrument Assets at Fair Value for the Six
Months Ended June 2011
Net unrealized
gains/(losses)
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
gains/
still held at
(out) of
end of
in millions
of year
(losses)
period-end
Purchases
1
Sales
Settlements
level 3
period
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
$2,819
$
79
$
142
$
659
$
(803
)
$
(304
)
$
(197
)
$
2,395
Loans and securities backed by residential real estate
2,373
122
90
829
(394
)
(369
)
84
2,735
Loan portfolios
1,285
7
81
16
(77
)
(187
)
113
1,238
Bank loans and bridge loans
9,905
344
721
2,269
(802
)
(1,330
)
(924
)
10,183
Corporate debt securities
2,737
209
148
1,154
(889
)
(173
)
(439
)
2,747
State and municipal obligations
754
3
4
29
(135
)
(3
)
(9
)
643
Other debt obligations
1,274
87
48
441
(306
)
(153
)
81
1,472
Equities and convertible debentures
11,060
61
679
2,055
(700
)
(437
)
734
13,452
Total
$32,207
$
912
$
1,913
$
7,452
$
(4,106
)
$
(2,956
)
$
(557
)
$
34,865
Level 3 Cash Instrument Liabilities at Fair Value for the Six
Months Ended June 2011
Net unrealized
(gains)/losses
Net
Net
relating to
transfers
Balance,
realized
instruments
in
and/or
Balance,
beginning
(gains)/
still held at
(out) of
end of
in millions
of year
losses
period-end
Purchases
Sales
Settlements
level 3
period
Total
$446
$(15
)
$67
$(193
)
$325
$(15
)
$(3
)
$612
1.
Includes both originations and secondary market purchases.
Significant transfers in or out of level 3 financial assets
during the six months ended June 2011 included:
•
Bank loans and bridge loans: net transfer out of level 3 of
$924 million, principally due to transfers to level 2
of certain loans due to improved transparency of market prices
as a result of market transactions in these financial
instruments, partially offset by transfers to level 3 of
certain loans due to reduced transparency of market prices as a
result of less market activity in these financial instruments.
•
Equities and convertible debentures: net transfer into
level 3 of $734 million, principally due to transfers
to level 3 of certain private equity investments due to
reduced transparency of market prices, partially offset by
transfers to level 2 of certain private equity investments
due to improved transparency of market prices as a result of
market transactions in these financial instruments.
•
Corporate debt securities: net transfer out of level 3 of
$439 million, principally due to transfers to level 2
of certain corporate debt securities due to increased
transparency of market prices as a result of market transactions
in these financial instruments.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Level 3 Cash Instrument
Assets at Fair Value for the Three Months Ended June 2010
Net unrealized
gains/(losses)
Net
Net
relating to
Net
transfers
Balance,
realized
instruments
purchases,
in
and/or
Balance,
beginning
gains/
still held at
sales and
(out) of
end of
in millions
of period
(losses)
period-end
settlements
level 3
period
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
$
4,070
$
88
$
60
$
(327
)
$
(23
)
$
3,868
Loans and securities backed by residential real estate
2,131
57
61
37
(162
)
2,124
Loan portfolios
1,291
4
(16
)
(72
)
51
1,258
Bank loans and bridge loans
9,323
134
(205
)
(162
)
483
9,573
Corporate debt securities
2,703
36
49
(202
)
6
2,592
State and municipal obligations
870
(5
)
34
(73
)
(1
)
825
Other debt obligations
1,487
(1
)
78
(116
)
(72
)
1,376
Equities and convertible debentures
10,653
21
130
248
(717
)
10,335
Total
$
32,528
$
334
$
191
$
(667
)
$
(435
)
$
31,951
Level 3 Cash Instrument
Liabilities at Fair Value for the Three Months Ended June 2010
Net unrealized
(gains)/losses
Net
Net
relating to
Net
transfers
Balance,
realized
instruments
purchases,
in
and/or
Balance,
beginning
(gains)/
still held at
sales and
(out) of
end of
in millions
of period
losses
period-end
settlements
level 3
period
Total
$
483
$
(112
)
$
109
$
113
$
2
$
595
Significant transfers in or out of level 3 financial assets
during the three months ended June 2010 included:
•
Bank loans and bridge loans: net transfer into level 3 of
$483 million, principally reflecting transfers from
level 2 of certain loans due to reduced transparency of
market prices as a result of less market activity in these loans.
•
Equities and convertible debentures: net transfer out of
level 3 of $717 million, principally due to transfers
to level 2 of certain private equity investments reflecting
improved transparency of market prices as a result of market
transactions.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Level 3 Cash Instrument Assets at Fair Value for the Six
Months Ended June 2010
Net unrealized
gains/(losses)
Net
relating to
Net
transfers
Balance,
Net
instruments
purchases,
in
and/or
Balance,
beginning
realized
still held at
sales and
(out) of
end of
in millions
of year
gains/(losses)
period-end
settlements
level 3
period
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
$
4,620
$
172
$
202
$
(1,002
)
$
(124
)
$
3,868
Loans and securities backed by residential real estate
1,880
66
143
52
(17
)
2,124
Loan portfolios
1,364
28
(6
)
(194
)
66
1,258
Bank loans and bridge loans
9,560
260
83
(404
)
74
9,573
Corporate debt securities
2,235
72
141
793
(649
)
2,592
State and municipal obligations
1,114
(3
)
26
(299
)
(13
)
825
Other debt obligations
2,235
(10
)
119
(105
)
(863
)
1,376
Equities and convertible debentures
11,871
150
147
(903
)
(930
)
10,335
Total
$
34,879
$
735
$
855
$
(2,062
)
$
(2,456
)
$
31,951
Level 3 Cash Instrument Liabilities at Fair Value for the Six
Months Ended June 2010
Net unrealized
(gains)/losses
Net
relating to
Net
transfers
Balance,
Net
instruments
purchases,
in
and/or
Balance,
beginning
realized
still held at
sales and
(out) of
end of
in millions
of year
(gains)/losses
period-end
settlements
level 3
period
Total
$
572
$
(132
)
$
60
$
169
$
(74
)
$
595
Significant transfers in or out of level 3 financial assets
during the six months ended June 2010 included:
•
Equities and convertible debentures: net transfer out of
level 3 of $930 million, principally due to transfers
into level 2 of certain private equity investments
reflecting improved transparency of market prices as a result of
market transactions.
•
Other debt obligations: net transfer out of level 3 of
$863 million, principally due to a reduction in financial
instruments as a result of the consolidation of a VIE, which
holds real estate assets. Such assets are included in
“Other assets” in the condensed consolidated
statements of financial condition.
•
Corporate debt securities: net transfer out of level 3 of
$649 million, principally due to a reduction in financial
instruments as a result of the consolidation of a VIE, which
holds identifiable intangible assets, as a result of the
adoption of ASU
No. 2009-17.
Such assets are included in “Other assets” in the
condensed consolidated statements of financial condition.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Investments in
Funds That Calculate Net Asset
Value Per Share
Cash instruments at fair value include investments in funds that
are valued based on the net asset value per share (NAV) of the
investment fund. The firm uses NAV as its measure of fair value
for fund investments when (i) the fund investment does not
have a readily determinable fair value and (ii) the NAV of
the investment fund is calculated in a manner consistent with
the measurement principles of investment company accounting,
including measurement of the underlying investments at fair
value.
The firm’s investments in funds that calculate NAV
primarily consist of investments in firm-sponsored funds where
the firm co-invests with
third-party
investors. The private equity, private debt and real
estate funds are primarily closed-end funds in which the
firm’s investments are not eligible for redemption.
Distributions will be received from these funds as the
underlying assets are liquidated and it is estimated that
substantially all of the underlying assets of existing funds
will be liquidated over the next 10 years. The firm’s
investments in hedge funds are generally redeemable on a
quarterly basis with 91 days’ notice, subject to a
maximum redemption level of 25% of the firm’s initial
investments at any quarter-end.
The table below presents the fair value of the firm’s
investments in, and unfunded commitments to, funds that
calculate NAV.
C:
As of June 2011
As of December 2010
Fair Value of
Unfunded
Fair Value of
Unfunded
in millions
Investments
Commitments
Investments
Commitments
Private equity
funds 1
$
8,507
$
4,326
$
7,911
$
4,816
Private debt
funds 2
3,884
3,406
4,267
3,721
Hedge
funds 3
3,213
—
3,169
—
Real estate and other
funds 4
1,292
1,809
1,246
1,884
Total
$
16,896
$
9,541
$
16,593
$
10,421
1.
These funds primarily invest in a broad range of industries
worldwide in a variety of situations, including leveraged
buyouts, recapitalizations and growth investments.
2.
These funds generally invest in loans and other fixed income
instruments and are focused on providing private
high-yield
capital for mid- to large-sized leveraged and management buyout
transactions, recapitalizations, financings, refinancings,
acquisitions and restructurings for private equity firms,
private family companies and corporate issuers.
3.
These funds are primarily multi-disciplinary hedge funds that
employ a fundamental
bottom-up
investment approach across various asset classes and strategies
including long/short equity, credit, convertibles, risk
arbitrage/special situations and capital structure arbitrage.
4.
These funds invest globally, primarily in real estate companies,
loan portfolios, debt recapitalizations and direct property.
Derivatives are instruments that derive their value from
underlying asset prices, indices, reference rates and other
inputs, or a combination of these factors. Derivatives may be
privately negotiated contracts, which are usually referred to as
over-the-counter
(OTC) derivatives, or they may be listed and traded on an
exchange
(exchange-traded).
Market-Making. As
a market maker, the firm enters into derivative transactions
with clients and other market participants to provide liquidity
and to facilitate the transfer and hedging of risk. In this
capacity, the firm typically acts as principal and is
consequently required to commit capital to provide execution. As
a market maker, it is essential to maintain an inventory of
financial instruments sufficient to meet expected client and
market demands.
Risk Management. The firm also enters into
derivatives to actively manage risk exposures that arise from
market-making
and investing and lending activities in derivative and cash
instruments. The firm’s holdings and exposures are hedged,
in many cases, on either a portfolio or
risk-specific
basis, as opposed to an
instrument-by-instrument
basis. The offsetting impact of this economic hedging is
reflected in the same business segment as the related revenues.
In addition, the firm may enter into derivatives designated as
hedges under U.S. GAAP. These derivatives are used to
manage foreign currency exposure on the net investment in
certain
non-U.S. operations
and to manage interest rate exposure in certain fixed-rate
unsecured
long-term
and
short-term
borrowings, and certificates of deposit.
The firm enters into various types of derivatives, including:
•
Futures and Forwards. Contracts that commit
counterparties to purchase or sell financial instruments,
commodities or currencies in the future.
•
Swaps. Contracts that require counterparties
to exchange cash flows such as currency or interest payment
streams. The amounts exchanged are based on the specific terms
of the contract with reference to specified rates, financial
instruments, commodities, currencies or indices.
•
Options. Contracts in which the option
purchaser has the right but not the obligation to purchase from
or sell to the option writer financial instruments, commodities
or currencies within a defined time period for a specified price.
Derivatives are accounted for at fair value, net of cash
collateral received or posted under credit support agreements.
Derivatives are reported on a
net-by-counterparty
basis (i.e., the net payable or receivable for derivative
assets and liabilities for a given counterparty) when a legal
right of setoff exists under an enforceable netting agreement.
Derivative assets and liabilities are included in
“Financial instruments owned, at fair value” and
“Financial instruments sold, but not yet purchased, at fair
value,” respectively.
Substantially all gains and losses on derivatives not designated
as hedges under ASC 815 are included in “Market
making” and “Other principal transactions.”
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The table below presents the fair value of
exchange-traded
and OTC derivatives on a
net-by-counterparty
basis.
C:
As of June 2011
As of December 2010
Derivative
Derivative
Derivative
Derivative
in millions
Assets
Liabilities
Assets
Liabilities
Exchange-traded
$
4,878
$
2,877
$
7,601
$
2,794
Over-the-counter
68,646
44,615
65,692
51,936
Total
$
73,524
$
47,492
$
73,293
$
54,730
The table below presents the fair value and the number of
derivative contracts by major product type on a gross basis.
Gross fair values in the table below exclude the effects of both
netting under enforceable netting
agreements and netting of cash collateral received or posted
under credit support agreements, and therefore are not
representative of the firm’s exposure.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Valuation
Techniques for Derivatives
See Note 5 for an overview of the firm’s fair value
measurement policies and the fair value hierarchy.
Level 1
Derivatives
Exchange-traded
derivatives fall within level 1 if they are actively traded
and are valued at their quoted market price.
Level 2
Derivatives
Level 2 derivatives include
exchange-traded
derivatives that are not actively traded and OTC derivatives for
which all significant valuation inputs are corroborated by
market evidence.
Level 2
exchange-traded
derivatives are valued using models that calibrate to
market-clearing
levels of OTC derivatives. Inputs to the valuations of
level 2 OTC derivatives can be verified to
market-clearing
transactions, broker or dealer quotations or other alternative
pricing sources with reasonable levels of price transparency.
Consideration is given to the nature of the quotations
(e.g., indicative or firm) and the relationship of recent
market activity to the prices provided from alternative pricing
sources.
Where models are used, the selection of a particular model to
value an OTC derivative depends on the contractual terms of and
specific risks inherent in the instrument, as well as the
availability of pricing information in the market. Valuation
models require a variety of inputs, including contractual terms,
market prices, yield curves, credit curves, measures of
volatility, prepayment rates, loss severity rates and
correlations of such inputs. For OTC derivatives that trade in
liquid markets, model selection does not involve significant
management judgment because outputs of models can be calibrated
to
market-clearing
levels.
Price transparency of OTC derivatives can generally be
characterized by product type.
Interest Rate. In general, the prices and
other inputs used to value interest rate derivatives are
transparent, even for
long-dated
contracts. Interest rate swaps and options denominated in the
currencies of leading industrialized nations are characterized
by high trading volumes and tight bid/offer spreads. Interest
rate derivatives that reference indices, such as an inflation
index, or the shape of the yield curve
(e.g., 10-year
swap rate vs.
2-year swap
rate), are more complex and are therefore less transparent, but
the prices and other inputs are generally observable.
Credit. Price transparency for credit default
swaps, including both single names and baskets of credits,
varies by market and underlying reference entity or obligation.
Credit default swaps that reference indices, large corporates
and major sovereigns generally exhibit the most price
transparency. For credit default swaps with other underliers,
price transparency varies based on credit rating, the cost of
borrowing the underlying reference obligations, and the
availability of the underlying reference obligations for
delivery upon the default of the issuer. Credit default swaps
that reference loans,
asset-backed
securities and emerging market debt instruments tend to be less
transparent than those that reference corporate bonds. In
addition, more complex credit derivatives, such as those
sensitive to the correlation between two or more underlying
reference obligations, generally have less price transparency.
Currency. Prices for currency derivatives
based on the exchange rates of leading industrialized nations,
including those with longer tenors, are generally transparent.
The primary difference between the transparency of developed and
emerging market currency derivatives is that emerging markets
tend to be observable for contracts with shorter tenors.
Commodity. Commodity derivatives include
transactions referenced to energy (e.g., oil and natural
gas), metals (e.g., precious and base) and soft commodities
(e.g., agricultural). Price transparency varies based on
the underlying commodity, delivery location, tenor and product
quality (e.g., diesel fuel compared to unleaded gasoline).
In general, price transparency for commodity derivatives is
greater for contracts with shorter tenors and contracts that are
more closely aligned with major
and/or
benchmark commodity indices.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Equity. Price transparency for equity
derivatives varies by market and underlier. Options on indices
and the common stock of corporates included in major equity
indices exhibit the most price transparency.
Exchange-traded
and OTC equity derivatives generally have observable market
prices, except for contracts with long tenors or reference
prices that differ significantly from current market prices.
More complex equity derivatives, such as those sensitive to the
correlation between two or more individual stocks, generally
have less price transparency.
Liquidity is essential to observability of all product types. If
transaction volumes decline, previously transparent prices and
other inputs may become unobservable. Conversely, even highly
structured products may at times have trading volumes large
enough to provide observability of prices and other inputs.
Level 3
Derivatives
Level 3 OTC derivatives are valued using models which
utilize observable level 1
and/or
level 2 inputs, as well as unobservable level 3 inputs.
•
For the majority of the firm’s interest rate and currency
derivatives classified within level 3, the significant
unobservable inputs are correlations of certain currencies and
interest rates (e.g., the correlation of Japanese yen
foreign exchange rates to U.S. dollar interest rates).
•
For credit derivatives classified within level 3,
significant level 3 inputs include
long-dated
credit and funding spreads, as well as certain correlation
inputs required to value credit and mortgage derivatives
(e.g., the likelihood of default of the underlying
reference obligations relative to one another).
•
For level 3 equity derivatives, significant level 3
inputs generally include equity volatility inputs for options
that are very
long-dated
and/or have
strike prices that differ significantly from current market
prices. In addition, the valuation of certain structured trades
requires the use of level 3 inputs for the correlation of
the price performance for two or more individual stocks.
•
For level 3 commodity derivatives, significant level 3
inputs include volatilities for options with strike prices that
differ significantly from current market prices and prices for
certain products for which the product quality is not aligned
with benchmark indices.
Subsequent to the initial valuation of a level 3 OTC
derivative, the firm updates the level 1 and level 2
inputs to reflect observable market changes and any resulting
gains and losses are recorded in level 3. Level 3
inputs are changed when corroborated by evidence such as similar
market transactions,
third-party
pricing services
and/or
broker or dealer quotations or other empirical market data. In
circumstances where the firm cannot verify the model value by
reference to market transactions, it is possible that a
different valuation model could produce a materially different
estimate of fair value.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Valuation
Adjustments
Valuation adjustments are integral to determining the fair value
of derivatives and are used to adjust the mid-market valuations,
produced by derivative pricing models, to the appropriate exit
price valuation. These adjustments incorporate bid/offer
spreads, the cost of liquidity on large or illiquid positions
and credit valuation adjustments (CVA) which account for the
credit risk inherent in derivative portfolios. Market-based
inputs are generally used when calibrating valuation adjustments
to
market-clearing
levels.
In addition, for derivatives that include significant
unobservable inputs, the firm makes model or exit
price adjustments to account for the valuation uncertainty
present in the transaction.
Fair Value of
Derivatives by Level
The tables below present the fair value of derivatives on a
gross basis by level and major product type. Gross fair values
in the tables below exclude the effects of both netting under
enforceable netting agreements and netting of cash received or
posted under credit support agreements both in and across levels
of the fair value hierarchy, and therefore are not
representative of the firm’s exposure.
C:
Derivative Assets at Fair Value as of June 2011
Cross-Level
in millions
Level 1
Level 2
Level 3
Netting
Total
Interest rates
$
90
$
451,134
$
81
$
—
$
451,305
Credit
—
109,832
10,211
—
120,043
Currencies
—
82,194
2,090
—
84,284
Commodities
—
33,592
1,756
—
35,348
Equities
67
66,235
1,673
—
67,975
Gross fair value of derivative assets
157
742,987
15,811
—
758,955
Counterparty
netting 1
—
(576,298
)
(4,289
)
(1,937
) 3
(582,524
)
Subtotal
$
157
$
166,689
$
11,522
$
(1,937
)
$
176,431
Cash collateral
netting 2
(102,907
)
Fair value included in financial instruments owned
$
73,524
Derivative Liabilities at Fair Value as of June 2011
Cross-Level
in millions
Level 1
Level 2
Level 3
Netting
Total
Interest rates
$
41
$
388,437
$
273
$
—
$
388,751
Credit
—
96,137
4,192
—
100,329
Currencies
—
66,354
967
—
67,321
Commodities
—
35,896
1,572
—
37,468
Equities
19
49,212
2,576
—
51,807
Gross fair value of derivative liabilities
60
636,036
9,580
—
645,676
Counterparty
netting 1
—
(576,298
)
(4,289
)
(1,937
) 3
(582,524
)
Subtotal
$
60
$
59,738
$
5,291
$
(1,937
)
$
63,152
Cash collateral
netting 2
(15,660
)
Fair value included in financial instruments sold, but not
yet purchased
$
47,492
1.
Represents the netting of receivable balances with payable
balances for the same counterparty under enforceable netting
agreements.
2.
Represents the netting of cash collateral received and posted on
a counterparty basis under credit support agreements.
3.
Represents the netting of receivable balances with payable
balances for the same counterparty across levels of the fair
value hierarchy under enforceable netting agreements.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Derivative Assets at Fair Value as of December 2010
Cross-Level
in millions
Level 1
Level 2
Level 3
Netting
Total
Interest rates
$
49
$
486,037
$
455
$
—
$
486,541
Credit
—
115,519
11,634
—
127,153
Currencies
—
86,158
1,807
—
87,965
Commodities
—
34,511
2,178
—
36,689
Equities
44
64,267
1,504
—
65,815
Gross fair value of derivative assets
93
786,492
17,578
—
804,163
Counterparty
netting 1
—
(613,979
)
(4,806
)
(1,768
) 3
(620,553
)
Subtotal
$
93
$
172,513
$
12,772
$
(1,768
)
$
183,610
Cash collateral
netting 2
(110,317
)
Fair value included in financial instruments owned
$
73,293
Derivative Liabilities at Fair Value as of December
2010
Cross-Level
in millions
Level 1
Level 2
Level 3
Netting
Total
Interest rates
$
18
$
422,267
$
262
$
—
$
422,547
Credit
—
99,813
4,594
—
104,407
Currencies
—
69,726
709
—
70,435
Commodities
—
39,709
1,957
—
41,666
Equities
27
49,427
2,494
—
51,948
Gross fair value of derivative liabilities
45
680,942
10,016
—
691,003
Counterparty
netting 1
—
(613,979
)
(4,806
)
(1,768
) 3
(620,553
)
Subtotal
$
45
$
66,963
$
5,210
$
(1,768
)
$
70,450
Cash collateral
netting 2
(15,720
)
Fair value included in financial instruments sold, but not
yet purchased
$
54,730
1.
Represents the netting of receivable balances with payable
balances for the same counterparty under enforceable netting
agreements.
2.
Represents the netting of cash collateral received and posted on
a counterparty basis under credit support agreements.
3.
Represents the netting of receivable balances with payable
balances for the same counterparty across levels of the fair
value hierarchy under enforceable netting agreements.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3
Rollforward
If a derivative was transferred to level 3 during a
reporting period, its entire gain or loss for the period is
included in level 3. Transfers between levels are reported
at the beginning of the reporting period in which they occur.
The tables below present changes in fair value for all
derivatives categorized as level 3 as of the end of the
period.
See Note 5 for further information about unrealized gains
and losses on level 3 derivatives.
C:
Level 3 Derivative Assets and Liabilities at Fair Value for
the Three Months Ended June 2011
Net unrealized
Asset/
gains/(losses)
Net
Asset/
(liability)
Net
relating to
transfers
(liability)
balance,
realized
instruments
in
and/or
balance,
beginning
gains/
still held at
(out) of
end of
in millions
of period
(losses)
period-end
Purchases
Sales
Settlements
level 3
period
Interest rates — net
$
(97
)
$
(18
)
$
(10
)
$
9
$
—
$
14
$
(90
)
$
(192
)
Credit — net
6,591
95
568
99
(262
)
(145
)
(927
)
6,019
Currencies — net
1,132
(22
)
(17
)
7
(8
)
2
29
1,123
Commodities — net
193
(131
)
(159
)
118
(91
)
143
111
184
Equities — net
(1,016
)
(84
)
74
181
(214
)
45
111
(903
)
Total derivatives — net
$
6,803
$
(160
)
$
456
$
414
$
(575
)
$
59
$
(766
)
$
6,231
Level 3 Derivative Assets and Liabilities at Fair Value for
the Six Months Ended June 2011
Net unrealized
Asset/
gains/(losses)
Net
Asset/
(liability)
Net
relating to
transfers
(liability)
balance,
realized
instruments
in
and/or
balance,
beginning
gains/
still held at
(out) of
end of
in millions
of period
(losses)
period-end
Purchases
Sales
Settlements
level 3
period
Interest rates — net
$
194
$
(36
)
$
(33
)
$
9
$
(2
)
$
20
$
(344
)
$
(192
)
Credit — net
7,040
136
388
140
(334
)
(465
)
(886
)
6,019
Currencies — net
1,098
(31
)
(180
)
35
(12
)
(51
)
264
1,123
Commodities — net
220
(223
)
(33
)
277
(122
)
78
(13
)
184
Equities — net
(990
)
21
(49
)
315
(373
)
4
169
(903
)
Total derivatives — net
$
7,562
$
(133
)
$
93
$
776
$
(843
)
$
(414
)
$
(810
)
$
6,231
Significant transfers in or out of level 3 during the three
months ended June 2011 included:
•
Credit — net: net transfer out of
level 3 of $927 million, principally due to increased
transparency of market prices for certain derivatives as a
result of market transactions in these financial instruments, as
well as unobservable inputs no longer being significant to the
valuation of certain derivatives.
Significant transfers in or out of level 3 during the six
months ended June 2011 included:
•
Credit — net: net transfer out of
level 3 of $886 million, principally due to increased
transparency of market prices for certain derivatives as a
result of market transactions in these financial instruments, as
well as unobservable inputs no longer being significant to the
valuation of certain derivatives.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Level 3 Derivative Assets and Liabilities at Fair Value for
the Three Months Ended June 2010
Net unrealized
Asset/
gains/(losses)
Net
Asset/
(liability)
Net
relating to
Net
transfers
(liability)
balance,
realized
instruments
purchases,
in
and/or
balance,
beginning
gains/
still held at
sales and
(out) of
end of
in millions
of period
(losses)
period-end
settlements
level 3
period
Interest rates — net
$
94
$
(6
)
$
43
$
(51
)
$
(195
)
$
(115
)
Credit — net
7,137
(1
)
949
83
358
8,526
Currencies — net
468
—
75
287
270
1,100
Commodities — net
(244
)
(92
)
(4
)
92
(23
)
(271
)
Equities — net
(1,119
)
(5
)
323
(500
)
(67
)
(1,368
)
Total derivatives — net
$
6,336
$
(104
)
$
1,386
$
(89
)
$
343
$
7,872
Level 3 Derivative Assets and Liabilities at Fair Value for
the Six Months Ended June 2010
Net unrealized
Asset/
gains/(losses)
Net
Asset/
(liability)
Net
relating to
Net
transfers
(liability)
balance,
realized
instruments
purchases,
in
and/or
balance,
beginning
gains/
still held at
sales and
(out) of
end of
in millions
of period
(losses)
period-end
settlements
level 3
period
Interest rates — net
$
(71
)
$
(14
)
$
7
$
21
$
(58
)
$
(115
)
Credit — net
6,366
(39
)
2,238
(19
)
(20
)
8,526
Currencies — net
215
(37
)
64
331
527
1,100
Commodities — net
(90
)
(259
)
105
259
(286
)
(271
)
Equities — net
(1,224
)
(52
)
438
(439
)
(91
)
(1,368
)
Total derivatives — net
$
5,196
$
(401
)
$
2,852
$
153
$
72
$
7,872
There were no significant transfers in or out of level 3
during the three months ended June 2010.
Significant transfers in or out of level 3 during the six
months ended June 2010 included:
•
Currencies — net: net transfer into
level 3 of $527 million, principally due to reduced
transparency of the correlation inputs used to value certain
currency derivatives.
Impact of Credit
Spreads on Derivatives
On an ongoing basis, the firm realizes gains or losses relating
to changes in credit risk on derivatives through changes in
credit mitigants or the sale or unwind of the contracts.
The net gain attributable to the impact of changes in credit
exposure and credit spreads on derivatives was $156 million
and $145 million for the three months ended June 2011
and June 2010, respectively, and $131 million and
$189 million for the six months ended June 2011 and
June 2010, respectively.
Bifurcated
Embedded Derivatives
The table below presents derivatives, primarily equity and
interest rate products, that have been bifurcated from their
related borrowings. These derivatives are recorded at fair value
and included in “Unsecured
short-term
borrowings” and “Unsecured
long-term
borrowings.” See Note 8 for further information.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
OTC
Derivatives
The tables below present the fair values of OTC derivative
assets and liabilities by tenor and by product type. Tenor is
based on expected duration for
mortgage-related
credit derivatives and generally on remaining contractual
maturity for other derivatives.
C:
in millions
OTC Derivatives as of June 2011
Assets
0-12
1-5
5 Years or
Product Type
Months
Years
Greater
Total
Interest rates
$
7,590
$
28,596
$
62,772
$
98,958
Credit
2,289
14,784
12,068
29,141
Currencies
9,400
12,381
14,266
36,047
Commodities
5,708
5,439
500
11,647
Equities
5,312
13,023
6,899
25,234
Netting across product
types 1
(2,496
)
(6,120
)
(4,715
)
(13,331
)
Subtotal
$
27,803
$
68,103
$
91,790
187,696
Cross maturity
netting 2
(16,143
)
Cash collateral
netting 3
(102,907
)
Total
$
68,646
Liabilities
0-12
1-5
5 Years or
Product Type
Months
Years
Greater
Total
Interest rates
$
3,790
$
14,317
$
18,302
$
36,409
Credit
1,220
5,056
3,152
9,428
Currencies
8,696
5,121
5,290
19,107
Commodities
5,087
6,565
1,847
13,499
Equities
3,350
4,644
3,312
11,306
Netting across product
types 1
(2,496
)
(6,120
)
(4,715
)
(13,331
)
Subtotal
$
19,647
$
29,583
$
27,188
76,418
Cross maturity
netting 2
(16,143
)
Cash collateral
netting 3
(15,660
)
Total
$
44,615
1.
Represents the netting of receivable balances with payable
balances for the same counterparty across product types within a
tenor category under enforceable netting agreements. Receivable
and payable balances with the same counterparty in the same
product type and tenor category are netted within such product
type and tenor category.
2.
Represents the netting of receivable balances with payable
balances for the same counterparty across tenor categories under
enforceable netting agreements.
3.
Represents the netting of cash collateral received and posted on
a counterparty basis under credit support agreements.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
in millions
OTC Derivatives as of December 2010
Assets
0-12
1-5
5 Years or
Product Type
Months
Years
Greater
Total
Interest rates
$
7,137
$
34,384
$
60,750
$
102,271
Credit
2,777
16,145
13,525
32,447
Currencies
9,968
10,696
14,868
35,532
Commodities
5,664
5,996
248
11,908
Equities
4,795
10,942
7,037
22,774
Netting across product
types 1
(2,937
)
(5,513
)
(5,077
)
(13,527
)
Subtotal
$
27,404
$
72,650
$
91,351
$
191,405
Cross maturity
netting 2
(15,396
)
Cash collateral
netting 3
(110,317
)
Total
$
65,692
Liabilities
0-12
1-5
5 Years or
Product Type
Months
Years
Greater
Total
Interest rates
$
4,470
$
14,072
$
19,760
$
38,302
Credit
1,024
4,862
3,816
9,702
Currencies
8,036
5,219
4,986
18,241
Commodities
7,279
7,838
2,528
17,645
Equities
3,962
4,977
3,750
12,689
Netting across product
types 1
(2,937
)
(5,513
)
(5,077
)
(13,527
)
Subtotal
$
21,834
$
31,455
$
29,763
$
83,052
Cross maturity
netting 2
(15,396
)
Cash collateral
netting 3
(15,720
)
Total
$
51,936
1.
Represents the netting of receivable balances with payable
balances for the same counterparty across product types within a
tenor category under enforceable netting agreements. Receivable
and payable balances with the same counterparty in the same
product type and tenor category are netted within such product
type and tenor category.
2.
Represents the netting of receivable balances with payable
balances for the same counterparty across tenor categories under
enforceable netting agreements.
3.
Represents the netting of cash collateral received and posted on
a counterparty basis under credit support agreements.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Derivatives with
Credit-Related
Contingent
Features
Certain of the firm’s derivatives have been transacted
under bilateral agreements with counterparties who may require
the firm to post collateral or terminate the transactions based
on changes in the firm’s credit ratings. The table below
presents the aggregate fair value of net derivative liabilities
under such agreements (excluding application of collateral
posted to reduce these liabilities), the related aggregate fair
value of the assets posted as collateral, and the additional
collateral or termination payments that could have been called
at the reporting date by counterparties in the event of a
one-notch
and
two-notch
downgrade in the firm’s credit ratings.
C:
As of
June
December
in millions
2011
2010
Net derivative liabilities under bilateral agreements
$
22,240
$
23,843
Collateral posted
16,743
16,640
Additional collateral or termination payments for a
one-notch
downgrade
662
1,353
Additional collateral or termination payments for a
two-notch
downgrade
1,842
2,781
Credit
Derivatives
The firm enters into a broad array of credit derivatives in
locations around the world to facilitate client transactions and
to manage the credit risk associated with
market-making
and investing and lending activities. Credit derivatives are
actively managed based on the firm’s net risk position.
Credit derivatives are individually negotiated contracts and can
have various settlement and payment conventions. Credit events
include failure to pay, bankruptcy, acceleration of
indebtedness, restructuring, repudiation and dissolution of the
reference entity.
Credit Default Swaps. Single-name credit
default swaps protect the buyer against the loss of principal on
one or more bonds, loans or mortgages (reference obligations) in
the event the issuer (reference entity) of the reference
obligations suffers a credit event. The buyer of protection pays
an initial or periodic premium to the seller and receives
protection for the period of the contract. If there is no credit
event, as defined in the contract, the seller of protection
makes no payments to the buyer of protection. However, if a
credit event occurs, the seller of protection is required to
make a payment, which is calculated in accordance with the terms
of the contract, to the buyer of protection.
Credit Indices, Baskets and Tranches. Credit
derivatives may reference a basket of single-name credit default
swaps or a
broad-based
index. If a credit event occurs in one of the underlying
reference obligations, the protection seller pays the protection
buyer. The payment is typically a
pro-rata
portion of the transaction’s total notional amount based on
the underlying defaulted reference obligation. In certain
transactions, the credit risk of a basket or index is separated
into various portions (tranches) each having different levels of
subordination. The most junior tranches cover initial defaults
and once losses exceed the notional amount of these junior
tranches, any excess loss is covered by the next most senior
tranche in the capital structure.
Total Return Swaps. A total return swap
transfers the risks relating to economic performance of a
reference obligation from the protection buyer to the protection
seller. Typically, the protection buyer receives from the
protection seller a floating rate of interest and protection
against any reduction in fair value of the reference obligation,
and in return the protection seller receives the cash flows
associated with the reference obligation, plus any increase in
the fair value of the reference obligation.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Credit Options. In a credit option, the option
writer assumes the obligation to purchase or sell a reference
obligation at a specified price or credit spread. The option
purchaser buys the right but not the obligation to sell the
reference obligation to, or purchase it from, the option writer.
The payments on credit options depend either on a particular
credit spread or the price of the reference obligation.
The firm economically hedges its exposure to written credit
derivatives primarily by entering into offsetting purchased
credit derivatives with identical underlyings. Substantially all
of the firm’s purchased credit derivative transactions are
with financial institutions and are subject to stringent
collateral thresholds. In addition, upon the occurrence of a
specified trigger event, the firm may take possession of the
reference obligations underlying a particular written credit
derivative, and consequently may, upon liquidation of the
reference obligations, recover amounts on the underlying
reference obligations in the event of default.
As of June 2011, written and purchased credit derivatives
had total gross notional amounts of $2.08 trillion and
$2.22 trillion, respectively, for total
net notional purchased protection of $140.51 billion. As of
December 2010, written and purchased credit derivatives had
total gross notional amounts of $2.05 trillion and
$2.19 trillion, respectively, for total net notional
purchased protection of $140.63 billion.
The table below presents certain information about credit
derivatives. In the table below:
•
fair values exclude the effects of both netting under
enforceable netting agreements and netting of cash received or
posted under credit support agreements, and therefore are not
representative of the firm’s exposure;
•
tenor is based on expected duration for
mortgage-related
credit derivatives and on remaining contractual maturity for
other credit derivatives; and
•
the credit spread on the underlying, together with the tenor of
the contract, are indicators of payment/performance risk. The
firm is less likely to pay or otherwise be required to perform
where the credit spread and the tenor are lower.
C:
Maximum Payout/Notional
Maximum Payout/Notional Amount
Amount of Purchased
Fair Value of
of Written Credit Derivatives by Tenor
Credit Derivatives
Written Credit Derivatives
Offsetting
Other
5 Years
Purchased
Purchased
Net
0 – 12
1 – 5
or
Credit
Credit
Asset/
$ in millions
Months
Years
Greater
Total
Derivatives 1
Derivatives 2
Asset
Liability
(Liability)
As of June 2011
Credit spread on
underlying
(basis points)
0-250
$
280,294
$
1,114,921
$
261,840
$
1,657,055
$
1,544,169
$
250,334
$
29,771
$
12,915
$
16,856
251-500
14,348
148,516
50,168
213,032
177,754
34,221
7,097
6,248
849
501-1,000
11,066
85,855
26,656
123,577
103,322
18,577
2,868
10,122
(7,254
)
Greater than 1,000
10,559
62,851
15,069
88,479
75,379
18,895
369
35,267
(34,898
)
Total
$
316,267
$
1,412,143
$
353,733
$
2,082,143
$
1,900,624
$
322,027
$
40,105
$
64,552
$
(24,447
)
1.
Offsetting purchased credit derivatives represent the notional
amount of purchased credit derivatives to the extent they
economically hedge written credit derivatives with identical
underlyings.
2.
This purchased protection represents the notional amount of
purchased credit derivatives in excess of the notional amount
included in “Offsetting Purchased Credit Derivatives.”
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Maximum Payout/Notional
Maximum Payout/Notional Amount
Amount of Purchased
Fair Value of
of Written Credit Derivatives by Tenor
Credit Derivatives
Written Credit Derivatives
Offsetting
Other
5 Years
Purchased
Purchased
Net
0 – 12
1 – 5
or
Credit
Credit
Asset/
$ in millions
Months
Years
Greater
Total
Derivatives 1
Derivatives 2
Asset
Liability
(Liability)
As of December 2010
Credit spread on
underlying
(basis points)
0-250
$
235,798
$
1,094,308
$
288,851
$
1,618,957
$
1,511,113
$
232,506
$
32,071
$
14,780
$
17,291
251-500
14,412
144,448
52,072
210,932
183,613
36,713
7,368
7,739
(371
)
501-1,000
6,384
89,212
33,553
129,149
110,019
18,686
2,571
11,256
(8,685
)
Greater than 1,000
11,721
63,982
12,022
87,725
70,945
23,795
483
33,670
(33,187
)
Total
$
268,315
$
1,391,950
$
386,498
$
2,046,763
$
1,875,690
$
311,700
$
42,493
$
67,445
$
(24,952
)
1.
Offsetting purchased credit derivatives represent the notional
amount of purchased credit derivatives to the extent they
economically hedge written credit derivatives with identical
underlyings.
2.
This purchased protection represents the notional amount of
purchased credit derivatives in excess of the notional amount
included in “Offsetting Purchased Credit Derivatives.”
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Hedge
Accounting
The firm applies hedge accounting for (i) certain interest
rate swaps used to manage the interest rate exposure of certain
fixed-rate unsecured
long-term
and
short-term
borrowings and certain fixed-rate certificates of deposit and
(ii) certain foreign currency forward contracts and foreign
currency-denominated
debt used to manage foreign currency exposures on the
firm’s net investment in certain
non-U.S. operations.
To qualify for hedge accounting, the derivative hedge must be
highly effective at reducing the risk from the exposure being
hedged. Additionally, the firm must formally document the
hedging relationship at inception and test the hedging
relationship at least on a quarterly basis to ensure the
derivative hedge continues to be highly effective over the life
of the hedging relationship.
Interest Rate
Hedges
The firm designates certain interest rate swaps as fair value
hedges. These interest rate swaps hedge changes in fair value
attributable to the relevant benchmark interest rate
(e.g., London Interbank Offered Rate (LIBOR)), effectively
converting a substantial portion of fixed-rate obligations into
floating-rate obligations.
The firm applies the
“long-haul
method” in assessing the effectiveness of its fair value
hedging relationships in achieving offsetting changes in the
fair values of the hedging instrument and the risk being hedged
(i.e., interest rate risk).
During the three months ended March 2010, the firm changed
its method of prospectively and retrospectively assessing the
effectiveness of all of its fair value hedging relationships
from a
dollar-offset
method, which is a
non-statistical
method, to regression analysis, which is a statistical method.
An interest rate swap is considered highly effective in
offsetting changes in fair value attributable to changes in the
hedged risk when the regression analysis results in a
coefficient of determination of 80% or greater and a slope
between 80% and 125%.
The
dollar-offset
method compared the change in the fair value of the hedging
instrument to the change in the fair value of the hedged item,
excluding the effect of the passage of time. The prospective
dollar-offset
assessment used scenario analyses to test hedge effectiveness
through simulations of numerous parallel and slope shifts of the
relevant yield curve. Parallel shifts changed the interest rate
of all maturities by identical amounts. Slope shifts changed the
curvature of the yield curve. For both the prospective
assessment, in response to each of the simulated yield curve
shifts, and the retrospective assessment, a hedging relationship
was considered effective if the fair value of the hedging
instrument and the hedged item changed inversely within a range
of 80% to 125%.
For qualifying fair value hedges, gains or losses on derivatives
are included in “Interest expense.” The change in fair
value of the hedged item attributable to the risk being hedged
is reported as an adjustment to its carrying value and is
subsequently amortized into interest expense over its remaining
life. Gains or losses resulting from hedge ineffectiveness are
included in “Interest expense.” See Note 23 for
further information about interest income and interest expense.
For the three months ended June 2011 and June 2010,
the gain recognized on interest rate derivatives accounted for
as hedges was $836 million and $4.95 billion,
respectively, and the related loss recognized on the hedged
borrowings and bank deposits was $1.25 billion and
$5.37 billion, respectively. For the six months ended
June 2011 and June 2010, the gain/(loss) recognized on
interest rate derivatives accounted for as hedges was
$(1.82) billion and $5.64 billion, respectively, and
the related gain/(loss) recognized on the hedged borrowings and
bank deposits was $913 million and $(6.47) billion,
respectively. The hedge ineffectiveness recognized on these
derivatives for the three months ended June 2011 and
June 2010 was a loss of $414 million and a loss of
$418 million, respectively. The hedge ineffectiveness
recognized on these derivatives for the six months ended
June 2011 and June 2010 was a loss of
$909 million and a loss of $831 million, respectively.
These losses consisted primarily of the amortization of prepaid
credit spreads. The gain/(loss) excluded from the assessment of
hedge effectiveness was not material for the three and six
months ended June 2011 and June 2010.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Net Investment
Hedges
The firm seeks to reduce the impact of fluctuations in foreign
exchange rates on its net investment in certain
non-U.S. operations
through the use of foreign currency forward contracts and
foreign
currency-denominated
debt. For foreign currency forward contracts designated as
hedges, the effectiveness of the hedge is assessed based on the
overall changes in the fair value of the forward contracts
(i.e., based on changes in forward rates). For foreign
currency-denominated
debt designated as a hedge, the effectiveness of the hedge is
assessed based on changes in spot rates.
For qualifying net investment hedges, the gains or losses on the
hedging instruments, to the extent effective, are included in
the condensed consolidated statements of comprehensive income.
The table below presents the gains/(losses) from net investment
hedging. The gains/(losses) below are included in “Currency
translation adjustment, net of tax.”
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Currency hedges
$
(178
)
$
196
$
(403
)
$
317
Foreign
currency-
denominated debt
(94
)
(190
)
(12
)
(178
)
The gain/(loss) related to ineffectiveness and the gain/(loss)
reclassified to earnings from accumulated other comprehensive
income was not material for the three and six months ended
June 2011 and June 2010.
As of June 2011 and December 2010, the firm had
designated $2.98 billion and $3.88 billion,
respectively, of foreign
currency-denominated
debt, included in “Unsecured
long-term
borrowings” and “Unsecured
short-term
borrowings,” as hedges of net investments in
non-U.S. subsidiaries.
Other Financial
Assets and Financial Liabilities at Fair Value
In addition to all cash and derivative instruments included in
“Financial instruments owned, at fair value” and
“Financial instruments sold, but not yet purchased, at fair
value,” the firm has elected to account for certain of its
other financial assets and financial liabilities at fair value
under the fair value option.
The primary reasons for electing the fair value option are to:
•
reflect economic events in earnings on a timely basis;
•
mitigate volatility in earnings from using different measurement
attributes (e.g., transfers of financial instruments owned
accounted for as financings are recorded at fair value whereas
the related secured financing would be recorded on an accrual
basis absent electing the fair value option); and
•
address simplification and
cost-benefit
considerations (e.g., accounting for hybrid financial
instruments at fair value in their entirety versus bifurcation
of embedded derivatives and hedge accounting for debt hosts).
Hybrid financial instruments are instruments that contain
bifurcatable embedded derivatives and do not require settlement
by physical delivery of
non-financial
assets (e.g., physical commodities). If the firm elects to
bifurcate the embedded derivative from the associated debt, the
derivative is accounted for at fair value and the host contract
is accounted for at amortized cost, adjusted for the effective
portion of any fair value hedges. If the firm does not elect to
bifurcate, the entire hybrid financial instrument is accounted
for at fair value under the fair value option.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Other financial assets and financial liabilities accounted for
at fair value under the fair value option include:
•
resale and repurchase agreements;
•
securities borrowed and loaned within Fixed Income, Currency and
Commodities Client Execution;
•
certain other secured financings, primarily transfers of assets
accounted for as financings rather than sales, and certain other
nonrecourse financings, including debt raised through the
firm’s William Street credit extension program outstanding
as of December 2010;
•
certain unsecured
short-term
borrowings, consisting of all promissory notes and commercial
paper and certain hybrid financial instruments;
•
certain unsecured
long-term
borrowings, including prepaid commodity transactions and certain
hybrid financial instruments;
•
certain receivables from customers and counterparties, including
certain margin loans, transfers of assets accounted for as
secured loans rather than purchases and prepaid variable share
forwards;
•
certain insurance and reinsurance contract assets and
liabilities and certain guarantees;
•
certain deposits issued by the firm’s bank subsidiaries, as
well as securities held by Goldman Sachs Bank USA (GS Bank
USA);
•
certain subordinated liabilities issued by consolidated VIEs; and
•
in general, investments acquired after
November 24, 2006, when the fair value option became
available, where the firm has significant influence over the
investee and would otherwise apply the equity method of
accounting.
C:
These financial assets and financial liabilities at fair value
are generally valued based on discounted cash flow techniques,
which incorporate inputs with reasonable levels of price
transparency, and are generally classified as level 2
because the inputs are observable. Valuation adjustments may be
made for counterparty and the firm’s credit quality.
Significant inputs for each category of other financial assets
and financial liabilities at fair value are as follows:
Resale and Repurchase Agreements and Securities Borrowed and
Loaned. The significant inputs to the valuation
of resale and repurchase agreements and
securities borrowed and loaned are the amount and timing of
expected future cash flows, interest rates and collateral
funding spreads. See Note 9 for further information.
Other Secured Financings. The significant
inputs to the valuation of other secured financings at fair
value are the amount and timing of expected future cash flows,
interest rates, the fair value of the collateral delivered by
the firm (which is determined using the amount and timing of
expected future cash flows, market yields and recovery
assumptions), the frequency of additional collateral calls and
the credit spreads of the firm. See Note 9 for further
information.
Unsecured
Short-term
and
Long-term
Borrowings. The significant inputs to the
valuation of unsecured
short-term
and
long-term
borrowings at fair value are the amount and timing of expected
future cash flows, interest rates, the credit spreads of the
firm, as well as commodity prices in the case of prepaid
commodity transactions and, for certain hybrid financial
instruments, equity prices, inflation rates and index levels.
See Notes 15 and 16 for further information.
Receivables from Customers and
Counterparties. The significant inputs to the
valuation of certain receivables from customers and
counterparties are commodity prices, interest rates and the
amount and timing of expected future cash flows.
Insurance and Reinsurance Contracts. Insurance
and reinsurance contracts at fair value are included in
“Receivables from customers and counterparties” and
“Other liabilities and accrued expenses.” The
insurance and reinsurance contracts for which the firm has
elected the fair value option are contracts that can be settled
only in cash and that qualify for the fair value option because
they are recognized financial instruments. These contracts are
valued using market transactions and other market evidence where
possible, including
market-based
inputs to models, calibration to
market-clearing
transactions or other alternative pricing sources with
reasonable levels of price transparency. Significant
level 2 inputs typically include interest rates and
inflation risk. Significant level 3 inputs typically
include mortality or funding benefit assumptions. When
unobservable inputs to a valuation model are significant to the
fair value measurement of an instrument, the instrument is
classified in level 3.
Deposits. The significant inputs to the
valuation of deposits are interest rates.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Gains and Losses
on Other Financial Assets and
Financial Liabilities at Fair Value
The “Fair Value Option” columns in the table below
present the gains and losses recognized as a result of the firm
electing to apply the fair value option to certain financial
assets and financial liabilities. These gains and losses are
included in “Market making” and “Other principal
transactions.”
The amounts in the table exclude contractual interest, which is
included in “Interest income” and “Interest
expense,” for all instruments other than hybrid financial
instruments. See Note 23 for further information about
interest income and interest expense. The table also excludes
gains and losses related to financial instruments owned, at fair
value and financial instruments sold, but not yet purchased, at
fair value.
Included in the “Other” columns in the table below are:
•
Gains and losses on the embedded derivative component of hybrid
financial instruments included in unsecured
short-term
borrowings and unsecured
long-term
borrowings. These gains and losses would have been recognized
under other U.S. GAAP even
if the firm had not elected to account for the entire hybrid
instrument at fair value.
•
Gains and losses on secured financings related to transfers of
assets accounted for as financings rather than sales. These
gains and losses are offset by gains and losses on the related
instruments included in “Financial instruments owned, at
fair value” and “Receivables from customers and
counterparties.”
•
Gains and losses on receivables from customers and
counterparties related to transfers of assets accounted for as
receivables rather than purchases. These gains and losses are
offset by gains and losses on the related financial instruments
included in “Other secured financings.”
•
Gains and losses on subordinated liabilities issued by
consolidated VIEs, which are included in “Other liabilities
and accrued expenses.” These gains and losses are offset by
gains and losses on the financial assets held by the
consolidated VIEs.
C:
Gains/(Losses) on Financial Assets and Financial Liabilities at Fair Value
Three Months Ended June
Six Months Ended June
2011
2010
2011
2010
Fair
Fair
Fair
Fair
Value
Value
Value
Value
in millions
Option
Other
Option
Other
Option
Other
Option
Other
Receivables from customers and
counterparties 1
$
(6
)
$
200
$
(55
)
$
—
$
(5
)
$
519
$
(93
)
$
—
Other secured financings
29
(510
)
58
—
33
(925
)
54
(5
)
Unsecured
short-term
borrowings
24
327
61
964
31
103
74
759
Unsecured
long-term
borrowings
68
432
286
(2,166
)
71
(839
)
370
(1,591
)
Other liabilities and accrued
expenses 2
(64
)
(20
)
(142
)
44
(253
)
67
(73
)
151
Other 3
10
—
20
—
45
—
17
—
Total
$
61
$
429
$
228
$
(1,158
)
$
(78
)
$
(1,075
)
$
349
$
(686
)
1.
Primarily consists of gains/(losses) on certain transfers
accounted for as receivables rather than purchases and certain
reinsurance contracts.
2.
Primarily consists of gains/(losses) on certain insurance and
reinsurance contracts.
3.
Primarily consists of gains/(losses) on resale and repurchase
agreements, securities borrowed and loaned and deposits.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Excluding the gains and losses on the instruments accounted for
under the fair value option described above, “Market
making” and “Other principal transactions”
primarily represents gains and losses on “Financial
instruments owned, at fair value” and “Financial
instruments sold, but not yet purchased, at fair value.”
Loans and Lending
Commitments
The table below presents the difference between the aggregate
fair value and the aggregate contractual principal amount for
loans and
long-term
receivables for which the fair value option was elected.
C:
As of
June
December
in millions
2011
2010
Aggregate contractual principal amount of performing loans and
long-term
receivables in excess of the related fair value
$
2,923
$
3,090
Aggregate contractual principal amount of loans on nonaccrual
status
and/or more
than 90 days past due in excess of the related fair value
24,433
26,653
Total
1
$
27,356
$
29,743
Aggregate fair value of loans on nonaccrual status
and/or more
than 90 days past due
$
3,392
$
3,994
1.
The aggregate contractual principal exceeds the related fair
value primarily because the firm regularly purchases loans, such
as distressed loans, at values significantly below contractual
principal amounts.
As of June 2011 and December 2010, the fair value of
unfunded lending commitments for which the fair value option was
elected was a liability of $1.70 billion and
$1.26 billion, respectively, and the related total
contractual amount of these lending commitments was
$63.27 billion and $51.20 billion, respectively.
Long-term
Debt Instruments
The aggregate contractual principal amount of
long-term
debt instruments (principal and
non-principal
protected) for which the fair value option was elected exceeded
the related fair value by $832 million and
$701 million as of June 2011 and December 2010,
respectively. Of these amounts, $538 million and
$349 million as of June 2011 and December 2010,
respectively, related to unsecured
long-term
borrowings and the remainder related to
long-term
other secured financings.
Impact of Credit
Spreads on Loans and Lending Commitments
The net gains/(losses) attributable to changes in
instrument-specific credit spreads on loans and lending
commitments for which the fair value option was elected were
$53 million and $(118) million for the three months ended
June 2011 and June 2010, respectively, and
$809 million and $952 million for the six months ended
June 2011 and June 2010, respectively. Changes in the
fair value of floating-rate loans and lending commitments are
attributable to changes in instrument-specific credit spreads.
For fixed-rate loans and lending commitments the firm allocates
changes in fair value between interest rate-related changes and
credit spread-related changes based on changes in interest rates.
Impact of Credit
Spreads on Borrowings
The table below presents the net gains attributable to the
impact of changes in the firm’s own credit spreads on
borrowings for which the fair value option was elected. The firm
calculates the fair value of borrowings by discounting future
cash flows at a rate which incorporates the firm’s credit
spreads.
Collateralized agreements are securities purchased under
agreements to resell (resale agreements or reverse repurchase
agreements) and securities borrowed. Collateralized financings
are securities sold under agreements to repurchase (repurchase
agreements), securities loaned and other secured financings. The
firm enters into these transactions in order to, among other
things, facilitate client activities, invest excess cash,
acquire securities to cover short positions and finance certain
firm activities.
C:
Collateralized agreements and financings are presented on a
net-by-counterparty
basis when a legal right of setoff exists. Interest on
collateralized agreements and collateralized financings is
recognized over the life of the transaction and included in
“Interest income” and “Interest expense,”
respectively. See Note 23 for further information about
interest income and interest expense.
The table below presents the carrying value of resale and
repurchase agreements and securities borrowed and loaned
transactions.
C:
As of
June
December
in millions
2011
2010
Securities purchased under agreements to
resell 1
$
162,285
$
188,355
Securities
borrowed 2
175,472
166,306
Securities sold under agreements to
repurchase 1
155,450
162,345
Securities
loaned 2
14,474
11,212
1.
Resale and repurchase agreements are carried at fair value under
the fair value option. See Note 8 for further information
about the valuation techniques and significant inputs used to
determine fair value.
2.
As of June 2011 and December 2010, $61.87 billion
and $48.82 billion of securities borrowed and
$4.84 billion and $1.51 billion of securities loaned
were at fair value, respectively.
Resale and
Repurchase Agreements
A resale agreement is a transaction in which the firm purchases
financial instruments from a seller, typically in exchange for
cash, and simultaneously enters into an agreement to resell the
same or substantially the same financial instruments to the
seller at a stated price plus accrued interest at a future date.
A repurchase agreement is a transaction in which the firm sells
financial instruments to a buyer, typically in exchange for
cash, and simultaneously enters into an agreement to repurchase
the same or substantially the same financial instruments from
the buyer at a stated price plus accrued interest at a future
date.
The financial instruments purchased or sold in resale and
repurchase agreements typically include U.S. government and
federal agency, and
investment-grade
sovereign obligations.
The firm receives financial instruments purchased under resale
agreements, makes delivery of financial instruments sold under
repurchase agreements, monitors the market value of these
financial instruments on a daily basis, and delivers or obtains
additional collateral due to changes in the market value of the
financial instruments, as appropriate. For resale agreements,
the firm typically requires delivery of collateral with a fair
value approximately equal to the carrying value of the relevant
assets in the condensed consolidated statements of financial
condition.
C:
Even though repurchase and resale agreements involve the legal
transfer of ownership of financial instruments, they are
accounted for as financing arrangements because they require the
financial instruments to be repurchased or resold at the
maturity of the agreement. However, “repos to
maturity” are accounted for as sales. A repo to maturity is
a transaction in which the firm transfers a security that has
very little, if any, default risk under an agreement to
repurchase the security where the maturity date of the
repurchase agreement matches the maturity date of the underlying
security. Therefore, the firm effectively no longer has a
repurchase obligation and has relinquished control over the
underlying security and, accordingly, accounts for the
transaction as a sale. The firm had no such transactions
outstanding as of June 2011 or December 2010.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Securities
Borrowed and Loaned Transactions
In a securities borrowed transaction, the firm borrows
securities from a counterparty in exchange for cash. When the
firm returns the securities, the counterparty returns the cash.
Interest is generally paid periodically over the life of the
transaction.
In a securities loaned transaction, the firm lends securities to
a counterparty typically in exchange for cash or securities, or
a letter of credit. When the counterparty returns the
securities, the firm returns the cash or securities posted as
collateral. Interest is generally paid periodically over the
life of the transaction.
The firm receives securities borrowed, makes delivery of
securities loaned, monitors the market value of these securities
on a daily basis, and delivers or obtains additional collateral
due to changes in the market value of the securities, as
appropriate. For securities borrowed transactions, the firm
typically requires delivery of collateral with a fair value
approximately equal to the carrying value of the securities
borrowed transaction.
C:
Securities borrowed and loaned within Fixed Income, Currency and
Commodities Client Execution, are recorded at fair value under
the fair value option.
Securities borrowed and loaned within Securities Services are
recorded based on the amount of cash collateral advanced or
received plus accrued interest. As these arrangements generally
can be terminated on demand, they exhibit little, if any,
sensitivity to changes in interest rates.
As of June 2011 and December 2010, the firm had
$24.02 billion and $12.86 billion, respectively, of
securities received under resale agreements and securities
borrowed transactions that were segregated to satisfy certain
regulatory requirements. These securities are included in
“Cash and securities segregated for regulatory and other
purposes.”
C:
Other Secured
Financings
In addition to repurchase agreements and securities lending
transactions, the firm funds certain assets through the use of
other secured financings and pledges financial instruments and
other assets as collateral in these transactions. These other
secured financings consist of:
•
liabilities of consolidated VIEs;
•
transfers of assets accounted for as financings rather than
sales (primarily collateralized central bank financings, pledged
commodities, bank loans and mortgage whole loans);
•
other structured financing arrangements; and
•
debt raised through the firm’s William Street credit
extension program outstanding as of December 2010.
Other secured financings include arrangements that are
nonrecourse. As of June 2011 and December 2010,
nonrecourse other secured financings were $4.54 billion and
$8.42 billion, respectively.
The firm has elected to apply the fair value option to the
following other secured financings because the use of fair value
eliminates
non-economic
volatility in earnings that would arise from using different
measurement attributes:
•
transfers of assets accounted for as financings rather than
sales;
•
certain other nonrecourse financings; and
•
debt raised through the firm’s William Street credit
extension program outstanding as of December 2010.
See Note 8 for further information about other secured
financings that are accounted for at fair value. Other secured
financings that are not recorded at fair value are recorded
based on the amount of cash received plus accrued interest,
which generally approximates fair value.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The table below presents information about other secured
financings. In the table below:
•
short-term
secured financings include financings maturing within one year
of the financial statement date and financings that are
redeemable within one year of the financial statement date at
the option of the holder;
•
long-term
secured financings that are repayable prior to maturity at the
option of the firm are reflected at their contractual maturity
dates; and
•
long-term
secured financings that are redeemable prior to maturity at the
option of the holders are reflected at the dates such options
become exercisable.
C:
As of June 2011
As of December 2010
U.S.
Non-U.S.
U.S.
Non-U.S.
$ in millions
Dollar
Dollar
Total
Dollar
Dollar
Total
Other secured financings
(short-term):
At fair value
$
16,216
$
4,061
$
20,277
$
16,404
$
3,684
$
20,088
At amortized cost
135
6,097
6,232
99
4,342
4,441
Interest rates1
3.29%
0.26%
2.96%
0.71%
Other secured financings
(long-term):
At fair value
3,309
2,862
6,171
9,594
2,112
11,706
At amortized cost
1,376
464
1,840
1,565
577
2,142
Interest rates1
1.95%
2.23%
2.14%
1.94%
Total2
$
21,036
$
13,484
$
34,520
$
27,662
$
10,715
$
38,377
Amount of other secured financings collateralized by:
Financial
instruments 3
$
20,614
$
11,872
$
32,486
$
27,014
$
8,760
$
35,774
Other
assets 4
422
1,612
2,034
648
1,955
2,603
1.
The weighted average interest rates exclude secured financings
at fair value and include the effect of hedging activities. See
Note 7 for further information about hedging activities.
2.
Includes $9.90 billion and $8.32 billion related to
transfers of financial assets accounted for as financings rather
than sales as of June 2011 and December 2010,
respectively. Such financings were collateralized by financial
assets included in “Financial instruments owned, at fair
value” of $10.15 billion and $8.53 billion as of
June 2011 and December 2010, respectively.
3.
Includes $19.70 billion and $25.63 billion of other
secured financings collateralized by financial instruments
owned, at fair value and $12.78 billion and
$10.14 billion of other secured financings collateralized
by financial instruments received as collateral and repledged as
of June 2011 and December 2010, respectively.
4.
Primarily real estate and cash.
The table below presents other secured financings by maturity.
C:
As of
in millions
June 2011
Other secured financings
(short-term)
$
26,509
Other secured financings
(long-term):
2012
2,470
2013
1,596
2014
921
2015
578
2016
257
2017-thereafter
2,189
Total other secured financings
(long-term)
8,011
Total other secured financings
$
34,520
The aggregate contractual principal amount of other secured
financings
(long-term)
for which the fair value option was elected exceeded the related
fair value by $294 million and $352 million as of
June 2011 and December 2010, respectively.
Collateral
Received and Pledged
The firm receives financial instruments
(e.g., U.S. government and federal agency, other
sovereign and corporate obligations, as well as equities and
convertible debentures) as collateral, primarily in connection
with resale agreements, securities borrowed, derivative
transactions and customer margin loans.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
In many cases, the firm is permitted to deliver or repledge
these financial instruments when entering into repurchase
agreements, securities lending agreements and other secured
financings, collateralizing derivative transactions and meeting
firm or customer settlement requirements.
The table below presents financial instruments at fair value
received as collateral that were available to be delivered or
repledged and were delivered or repledged by the firm.
C:
As of
June
December
in millions
2011
2010
Collateral available to be delivered or repledged
$
639,691
$
618,423
Collateral that was delivered or repledged
476,343
447,882
The firm also pledges certain financial instruments owned, at
fair value in connection with repurchase agreements, securities
lending agreements and other secured financings, and other
assets (primarily real estate and cash) in connection with other
secured financings to counterparties who may or may not have the
right to deliver or repledge them. The table below presents
information about assets pledged by the firm.
C:
As of
June
December
in millions
2011
2010
Financial instruments owned, at fair value pledged to
counterparties that:
The firm securitizes residential and commercial mortgages,
corporate bonds, loans and other types of financial assets by
selling these assets to securitization vehicles
(e.g., trusts, corporate entities, and limited liability
companies) and acts as underwriter of the beneficial interests
that are sold to investors. The firm’s residential mortgage
securitizations are substantially all in connection with
government agency securitizations.
Beneficial interests issued by securitization entities are debt
or equity securities that give the investors rights to receive
all or portions of specified cash inflows to a securitization
vehicle and include senior and subordinated shares of principal,
interest
and/or other
cash inflows. The proceeds from the sale of beneficial interests
are used to pay the transferor for the financial assets sold to
the securitization vehicle or to purchase securities which serve
as collateral.
C:
The firm accounts for a securitization as a sale when it has
relinquished control over the transferred assets. Prior to
securitization, the firm accounts for assets pending transfer at
fair value and therefore does not typically recognize gains or
losses upon the transfer of assets. Net revenues from
underwriting activities are recognized in connection with the
sales of the underlying beneficial interests to investors.
For transfers of assets that are not accounted for as sales, the
assets remain in “Financial instruments owned, at fair
value” and the transfer is accounted for as a
collateralized financing, with the related interest expense
recognized over the life of the transaction. See Notes 9
and 23 for further information about collateralized financings
and interest expense, respectively.
The firm generally receives cash in exchange for the transferred
assets but may also have continuing involvement with transferred
assets, including ownership of beneficial interests in
securitized financial assets, primarily in the form of senior or
subordinated securities, and servicing rights that the firm
retains at the time of securitization. The firm may also
purchase senior or subordinated securities issued by
securitization vehicles (which are typically VIEs) in connection
with secondary
market-making
activities.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The primary risks included in beneficial interests and other
interests from the firm’s continuing involvement with
securitization vehicles are the performance of the underlying
collateral, the position of the firm’s investment in the
capital structure of the securitization vehicle and the market
yield for the security. These interests are accounted for at
fair value and are included in “Financial instruments
owned, at fair value” and are generally classified in
level 2 of the fair value hierarchy. See Notes 5
through 8 for further information about fair value measurements.
The table below presents the amount of financial assets
securitized and the cash flows received on retained interests in
securitization entities in which the firm had continuing
involvement.
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Residential mortgages
$
14,602
$
13,461
$
22,305
$
23,420
Commercial mortgages
—
—
325
—
Other financial assets
49
—
81
14
Total
$
14,651
$
13,461
$
22,711
$
23,434
Cash flows on retained interests
$
148
$
218
$
367
$
417
The table below presents the firm’s continuing involvement
in nonconsolidated securitization entities to which the firm
sold assets, as well as the total outstanding principal amount
of transferred assets in which the firm has continuing
involvement. In this table:
•
the outstanding principal amount is presented for the purpose of
providing information about the size of the securitization
entities in which the firm has continuing involvement and is not
representative of the firm’s risk of loss;
•
for retained or purchased interests, the firm’s risk of
loss is limited to the fair value of these interests; and
•
purchased interests represent senior and subordinated interests,
purchased in connection with secondary
market-making
activities, in securitization entities in which the firm also
holds retained interests.
C:
As of June 2011
As of December 2010
Outstanding
Fair Value of
Fair Value of
Outstanding
Fair Value of
Fair Value of
Principal
Retained
Purchased
Principal
Retained
Purchased
in millions
Amount
Interests
Interests
Amount
Interests
Interests
U.S. government
agency-issued
collateralized mortgage
obligations
1
$
64,929
$
4,739
$
—
$
60,352
$
5,929
$
—
Other residential
mortgage-backed 2
11,166
129
5
13,318
125
5
Commercial
mortgage-backed 3
4,642
753
272
5,040
849
82
CDOs, CLOs and
other 4
12,131
61
201
12,872
62
229
Total
5
$
92,868
$
5,682
$
478
$
91,582
$
6,965
$
316
1.
Outstanding principal amount and fair value of retained
interests primarily relate to securitizations during 2011 and
2010 as of June 2011, and securitizations during 2010 and
2009 as of December 2010.
2.
Outstanding principal amount and fair value of retained
interests as of both June 2011 and December 2010
primarily relate to prime and
Alt-A
securitizations during 2007 and 2006.
3.
Outstanding principal amount as of both June 2011 and
December 2010 primarily relate to securitizations during
2010, 2007 and 2006. Fair value of retained interests as of both
June 2011 and December 2010 primarily relate to
securitizations during 2010.
4.
Outstanding principal amount and fair value of retained
interests as of both June 2011 and December 2010
primarily relate to CDO and CLO securitizations during 2007 and
2006.
5.
Outstanding principal amount and fair value of retained
interests include $6.86 billion and $16 million,
respectively, as of June 2011, and $7.64 billion and
$16 million, respectively, as of December 2010,
related to securitization entities in which the firm’s only
continuing involvement is retained servicing which is not a
variable interest.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
In addition to the interests in the table above, the firm had
other continuing involvement in the form of derivative
transactions and guarantees with certain nonconsolidated VIEs.
The carrying value of these derivatives and guarantees was a net
liability of $85 million and $98 million as of
June 2011 and December 2010, respectively. The
notional amounts of these derivatives and guarantees are
included in maximum exposure to loss in the nonconsolidated VIE
tables in Note 11.
The table below presents the weighted average key economic
assumptions used in measuring the fair value of retained
interests and the sensitivity of this fair value to immediate
adverse changes of 10% and 20% in those assumptions.
C:
As of June 2011
As of December 2010
Type of Retained Interests
Type of Retained Interests
$ in millions
Mortgage-Backed
Other
1
Mortgage-Backed
Other
1
Fair value of retained interests
$
5,621
$
61
$
6,903
$
62
Weighted average life (years)
6.3
3.8
7.4
4.2
Constant prepayment
rate 2
9.1%
N.M.
11.6%
N.M.
Impact of 10% adverse
change 2
$
(36
)
N.M.
$
(62
)
N.M.
Impact of 20% adverse
change 2
(69
)
N.M.
(128
)
N.M.
Discount
rate 3
4.6%
N.M.
5.3%
N.M.
Impact of 10% adverse change
$
(114
)
N.M.
$
(175
)
N.M.
Impact of 20% adverse change
(223
)
N.M.
(341
)
N.M.
1.
Due to the nature and current fair value of certain of these
retained interests, the weighted average assumptions for
constant prepayment and discount rates and the related
sensitivity to adverse changes are not meaningful as of
June 2011 and December 2010. The firm’s maximum
exposure to adverse changes in the value of these interests is
the carrying value of $61 million and $62 million as
of June 2011 and December 2010, respectively.
2.
Constant prepayment rate is included only for positions for
which constant prepayment rate is a key assumption in the
determination of fair value.
3.
The majority of
mortgage-backed
retained interests are U.S. government
agency-issued
collateralized mortgage obligations, for which there is no
anticipated credit loss. For the remainder of retained
interests, the expected credit loss assumptions are reflected in
the discount rate.
The preceding table does not give effect to the offsetting
benefit of other financial instruments that are held to mitigate
risks inherent in these retained interests. Changes in fair
value based on an adverse variation in assumptions generally
cannot be extrapolated because the relationship of the change in
assumptions to the change in fair value is not usually linear.
In addition, the impact of a change in a particular assumption
in the preceding table is calculated independently of changes in
any other assumption. In practice, simultaneous changes in
assumptions might magnify or counteract the sensitivities
disclosed above.
VIEs generally finance the purchase of assets by issuing debt
and equity securities that are either collateralized by or
indexed to the assets held by the VIE. The debt and equity
securities issued by a VIE may include tranches of varying
levels of subordination. The firm’s involvement with VIEs
includes securitization of financial assets, as described in
Note 10, and investments in and loans to other types of
VIEs, as described below. See Note 10 for additional
information about securitization activities, including the
definition of beneficial interests. See Note 3 for the
firm’s consolidation policies, including the definition of
a VIE.
The firm is principally involved with VIEs through the following
business activities:
Mortgage-Backed
VIEs and Corporate CDO and CLO VIEs. The firm
sells residential and commercial mortgage loans and securities
to
mortgage-backed
VIEs and corporate bonds and loans to corporate CDO and CLO VIEs
and may retain beneficial interests in the assets sold to these
VIEs. The firm purchases and sells beneficial interests issued
by
mortgage-backed
and corporate CDO and CLO VIEs in connection with
market-making
activities. In addition, the firm may enter into derivatives
with certain of these VIEs, primarily interest rate swaps, which
are typically not variable interests. The firm generally enters
into derivatives with other counterparties to mitigate its risk
from derivatives with these VIEs.
Certain
mortgage-backed
and corporate CDO and CLO VIEs, usually referred to as synthetic
CDOs or
credit-linked
note VIEs, synthetically create the exposure for the
beneficial interests they issue by entering into credit
derivatives, rather than purchasing the underlying assets. These
credit derivatives may reference a single asset, an index, or a
portfolio/basket of assets or indices. See Note 7 for
further information on credit derivatives. These VIEs use the
funds from the sale of beneficial interests and the premiums
received from credit derivative counterparties to purchase
securities which serve to collateralize the beneficial interest
holders
and/or the
credit derivative counterparty. These VIEs may enter into other
derivatives, primarily interest rate swaps, which are typically
not variable interests. The firm may be a counterparty to
derivatives with these VIEs and generally enters into
derivatives with other counterparties to mitigate its risk.
Real Estate,
Credit-Related
and Other Investing VIEs. The firm purchases
equity and debt securities issued by and makes loans to VIEs
that hold real estate, performing and nonperforming debt,
distressed loans and equity securities.
Other
Asset-Backed
VIEs. The firm structures VIEs that issue notes
to clients and purchases and sells beneficial interests issued
by other
asset-backed
VIEs in connection with
market-making
activities. In addition, the firm may enter into derivatives
with certain other
asset-backed
VIEs, primarily total return swaps on the collateral assets held
by these VIEs under which the firm pays the VIE the return due
to the note holders and receives the return on the collateral
assets owned by the VIE. The firm generally can be removed as
the total return swap counterparty. The firm generally enters
into derivatives with other counterparties to mitigate its risk
from derivatives with these VIEs. The firm typically does not
sell assets to the other
asset-backed
VIEs it structures.
Power-Related VIEs. The firm purchases debt
and equity securities issued by and may provide guarantees to
VIEs that hold power-related assets. The firm typically does not
sell assets to or enter into derivatives with these VIEs.
Investment Funds. The firm purchases equity
securities issued by and may provide guarantees to certain of
the investment funds it manages. The firm typically does not
sell assets to or enter into derivatives with these VIEs.
Principal-Protected Note VIEs. The firm
structures VIEs that issue principal-protected notes to clients.
These VIEs own portfolios of assets, principally with exposure
to hedge funds. Substantially all of the principal protection on
the notes issued by these VIEs is provided by the asset
portfolio rebalancing that is required under the terms of the
notes. The firm enters into total return swaps with these VIEs
under which the firm pays the VIE the return due to the
principal-protected note holders and receives the return on the
assets owned by the VIE. The firm may enter into derivatives
with other counterparties to mitigate the risk it has from the
derivatives it enters into with these VIEs. The firm also
obtains funding through these VIEs. These VIEs were consolidated
by the firm upon adoption of changes to U.S. GAAP on
January 1, 2010.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Municipal Bond Securitizations. The firm sells
municipal securities to VIEs that issue
short-term
qualifying
tax-exempt
securities. The firm consolidates these VIEs because it owns the
residual interests, which allows the firm to make decisions that
significantly impact the economic performance of these VIEs.
VIE Consolidation
Analysis
A variable interest in a VIE is an investment (e.g., debt
or equity securities) or other interest (e.g., derivatives
or loans and lending commitments) in a VIE that will absorb
portions of the VIE’s expected losses or receive portions
of the VIE’s expected residual returns.
The firm’s variable interests in VIEs include senior and
subordinated debt in residential and commercial
mortgage-backed
and other
asset-backed
securitization entities, CDOs and CLOs; loans and lending
commitments; limited and general partnership interests;
preferred and common equity; derivatives that may include
foreign currency, equity
and/or
credit risk; guarantees; and certain of the fees the firm
receives from investment funds. Certain interest rate, foreign
currency and credit derivatives the firm enters into with VIEs
are not variable interests because they create rather than
absorb risk.
C:
The enterprise with a controlling financial interest in a VIE is
known as the primary beneficiary and consolidates the VIE. The
firm determines whether it is the primary beneficiary of a VIE
by performing an analysis that principally considers:
•
which variable interest holder has the power to direct the
activities of the VIE that most significantly impact the
VIE’s economic performance;
•
which variable interest holder has the obligation to absorb
losses or the right to receive benefits from the VIE that could
potentially be significant to the VIE;
•
the VIE’s purpose and design, including the risks the VIE
was designed to create and pass through to its variable interest
holders;
•
the VIE’s capital structure;
•
the terms between the VIE and its variable interest holders and
other parties involved with the VIE; and
•
related party relationships.
The firm reassesses its initial evaluation of whether an entity
is a VIE when certain reconsideration events occur. The firm
reassesses its determination of whether it is the primary
beneficiary of a VIE on an ongoing basis based on current facts
and circumstances.
Nonconsolidated
VIEs
The firm’s exposure to the obligations of VIEs is generally
limited to its interests in these entities. In certain
instances, the firm provides guarantees, including derivative
guarantees, to VIEs or holders of variable interests in VIEs.
The tables below present information about nonconsolidated VIEs
in which the firm holds variable interests. Nonconsolidated VIEs
are aggregated based on principal business activity. The nature
of the firm’s variable interests can take different forms,
as described in the rows under maximum exposure to loss. In the
tables below:
•
The maximum exposure to loss excludes the benefit of offsetting
financial instruments that are held to mitigate the risks
associated with these variable interests.
•
For retained and purchased interests and loans and investments,
the maximum exposure to loss is the carrying value of these
interests.
•
For commitments and guarantees, and derivatives, the maximum
exposure to loss is the notional amount, which does not
represent anticipated losses and also has not been reduced by
unrealized losses already recorded. As a result, the maximum
exposure to loss exceeds liabilities recorded for commitments
and guarantees, and derivatives provided to VIEs.
The carrying values of the firm’s variable interests in
nonconsolidated VIEs are included in the condensed consolidated
statement of financial condition as follows:
•
Substantially all assets held by the firm related to
mortgage-backed,
corporate CDO and CLO and other
asset-backed
VIEs and investment funds are included in “Financial
instruments owned, at fair value.” Substantially all
liabilities held by the firm related to
mortgage-backed,
corporate CDO and CLO and other
asset-backed
VIEs are included in “Financial instruments sold, but not
yet purchased, at fair value.”
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
•
Assets and liabilities held by the firm related to real estate,
credit-related
and other investing VIEs are primarily included in
“Financial instruments owned, at fair value” and
“Payables to customers and counterparties” and
“Other liabilities and accrued expenses,” respectively.
•
Assets and liabilities held by the firm related to power-related
VIEs are primarily included in “Other assets” and
“Other liabilities and accrued expenses,” respectively.
C:
Nonconsolidated VIEs
As of June 2011
Corporate
Real estate, credit-
Other
Mortgage-
CDOs and
related and
asset-
Power-
Investment
in millions
backed
CLOs
other investing
backed
related
funds
Total
Assets in VIE
$
94,287
2
$
25,377
$
8,813
$
4,267
$
529
$
2,557
$
135,830
Carrying Value of the Firm’s Variable Interests
Assets
6,835
1,383
1,421
220
271
4
10,134
Liabilities
—
87
1
25
5
—
118
Maximum Exposure to Loss in Nonconsolidated VIEs
Retained interests
5,605
43
—
18
—
—
5,666
Purchased interests
905
701
—
190
—
—
1,796
Commitments and
guarantees 1
—
1
324
—
50
—
375
Derivatives 1
2,673
8,207
—
1,152
—
—
12,032
Loans and investments
110
—
1,421
—
271
4
1,806
Total
$
9,293
2
$
8,952
$
1,745
$
1,360
$
321
$
4
$
21,675
Nonconsolidated VIEs
As of December 2010
Corporate
Real estate, credit-
Other
Mortgage-
CDOs and
related and
asset-
Power-
Investment
in millions
backed
CLOs
other investing
backed
related
funds
Total
Assets in VIE
$
88,755
2
$
21,644
$
12,568
$
5,513
$
552
$
2,330
$
131,362
Carrying Value of the Firm’s Variable Interests
Assets
8,076
909
1,063
266
239
5
10,558
Liabilities
—
114
1
19
14
—
148
Maximum Exposure to Loss in Nonconsolidated VIEs
Retained interests
6,887
50
—
12
—
—
6,949
Purchased interests
839
353
—
247
—
—
1,439
Commitments and
guarantees 1
—
1
125
—
69
—
195
Derivatives 1
3,128
7,593
—
1,105
—
—
11,826
Loans and investments
104
—
1,063
—
239
5
1,411
Total
$
10,958
2
$
7,997
$
1,188
$
1,364
$
308
$
5
$
21,820
1.
The aggregate amounts include $4.10 billion and
$4.52 billion as of June 2011 and December 2010,
respectively, related to guarantees and derivative transactions
with VIEs to which the firm transferred assets.
2.
Assets in VIE and maximum exposure to loss include
$5.55 billion and $2.78 billion, respectively, as of
June 2011, and $6.14 billion and $3.25 billion,
respectively, as of December 2010, related to CDOs backed
by mortgage obligations.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Consolidated
VIEs
The tables below present the carrying amount and classification
of assets and liabilities in consolidated VIEs, excluding the
benefit of offsetting financial instruments that are held to
mitigate the risks associated with the firm’s variable
interests. Consolidated VIEs are aggregated based on principal
business activity and their assets and liabilities are presented
net of intercompany eliminations. The majority of the assets in
principal-protected notes VIEs are intercompany and are
eliminated in consolidation.
Substantially all the assets in consolidated VIEs can only be
used to settle obligations of the VIE.
The tables below exclude VIEs in which the firm holds a majority
voting interest if (i) the VIE meets the definition of a
business and (ii) the VIE’s assets can be used for
purposes other than the settlement of its obligations.
The liabilities of real estate,
credit-related
and other investing VIEs and CDOs,
mortgage-backed
and other
asset-backed
VIEs do not have recourse to the general credit of the firm.
C:
Consolidated VIEs
As of June 2011
CDOs,
Real estate,
mortgage-
credit-related
Municipal
backed and
Principal-
and other
bond
other asset-
protected
in millions
investing
securitizations
backed
notes
Total
Assets
Cash and cash equivalents
$
446
$
—
$
48
$
13
$
507
Cash and securities segregated for regulatory and other purposes
169
—
—
—
169
Receivables from brokers, dealers and clearing organizations
3
—
—
—
3
Receivables from customers and counterparties
—
—
17
—
17
Financial instruments owned, at fair value
2,277
191
580
699
3,747
Other assets
2,546
—
468
—
3,014
Total
$
5,441
$
191
$
1,113
$
712
$
7,457
Liabilities
Other secured financings
$
2,037
$
200
$
473
$
3,234
$
5,944
Payables to customers and counterparties
—
—
24
36
60
Financial instruments sold, but not yet purchased, at fair value
—
—
58
—
58
Unsecured
short-term
borrowings, including the current portion of unsecured
long-term
borrowings
Other assets are generally less liquid,
non-financial
assets. The table below presents other assets by type.
C:
As of
June
December
in millions
2011
2010
Property, leasehold improvements and
equipment 1
$
9,743
$
11,106
Goodwill and identifiable intangible
assets 2
5,187
5,522
Income tax-related
assets 3
4,917
6,239
Equity-method
investments 4
1,140
1,445
Miscellaneous receivables and
other 5
6,485
3,747
Total
$
27,472
$
28,059
1.
Net of accumulated depreciation and amortization of
$8.06 billion and $7.87 billion as of June 2011
and December 2010, respectively.
2.
See Note 13 for further information about goodwill and
identifiable intangible assets.
3.
See Note 24 for further information about income taxes.
4.
Excludes investments of $3.82 billion and
$3.77 billion accounted for at fair value under the fair
value option as of June 2011 and December 2010,
respectively, which are included in “Financial instruments
owned, at fair value.” See Note 8 for further
information.
5.
Includes $2.93 billion of assets held for sale as of
June 2011, primarily consisting of servicing advances.
Property,
Leasehold Improvements and Equipment
Property, leasehold improvements and equipment included
$6.61 billion and $6.44 billion as of June 2011
and December 2010, respectively, related to property,
leasehold improvements and equipment that the firm uses in
connection with its operations. The remainder is held by
investment entities, including VIEs, consolidated by the firm.
C:
Substantially all property and equipment are depreciated on a
straight-line basis over the useful life of the asset.
Leasehold improvements are amortized on a straight-line basis
over the useful life of the improvement or the term of the
lease, whichever is shorter.
Certain costs of software developed or obtained for internal use
are capitalized and amortized on a straight-line basis over the
useful life of the software.
Property, leasehold improvements and equipment 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. The firm’s policy for impairment
testing of property, leasehold improvements and equipment is the
same as is used for identifiable intangible assets with finite
lives. See Note 13 for further information.
Assets Held for
Sale
In the first quarter of 2011, the firm classified certain assets
as held for sale, primarily related to Litton Loan Servicing LP
(Litton), the firm’s residential mortgage servicing
subsidiary, and recognized impairment losses of approximately
$220 million, principally in the firm’s Institutional
Client Services segment. These impairment losses, which were
included in “Depreciation and amortization,” represent
the excess of (i) the carrying value of the assets held for
sale over (ii) their estimated fair value less estimated
cost to sell. The firm has since entered into agreements to sell
these assets. The transactions are expected to close in 2011.
The sale of Litton is subject to regulatory approvals and other
closing conditions. In connection with the pending sale of
Litton, the firm agreed to provide certain representations and
warranties, specific indemnities related to Litton’s
servicing and foreclosure practices prior to closing, and a
secured advance facility to the purchaser. The firm expects to
receive total consideration that approximates the firm’s
adjusted carrying value for Litton.
The tables below present, by operating segment, the carrying
values of goodwill and identifiable intangible assets, which are
included in “Other assets.”
C:
Goodwill
As of
June
December
in millions
2011
2010
Investment Banking:
Underwriting
$
125
$
125
Institutional Client Services:
Fixed Income, Currency and Commodities Client
Execution 1
5
159
Equities Client Execution
2,361
2,361
Securities Services
117
117
Investing & Lending
154
172
Investment Management
561
561
Total
$
3,323
$
3,495
C:
Identifiable
Intangible Assets
As of
June
December
in millions
2011
2010
Institutional Client Services:
Fixed Income, Currency and Commodities Client Execution
$
525
$
608
Equities Client Execution
687
718
Investing & Lending
538
579
Investment Management
114
122
Total
$
1,864
$
2,027
1.
The decrease from December 2010 to June 2011 is
related to the classification of Litton as held for sale. See
Note 12 for further information.
C:
Goodwill
Goodwill is the cost of acquired companies in excess of the fair
value of identifiable net assets at acquisition date.
Goodwill is tested annually for impairment or more frequently if
events occur or circumstances change that indicate an impairment
may exist.
The goodwill impairment test consists of two steps.
•
The first step compares the fair value of each reporting unit
with its estimated net book value (including goodwill and
identified intangible assets). If the reporting unit’s fair
value exceeds its estimated net book value, goodwill is not
impaired.
•
If the estimated fair value of a reporting unit is less than its
estimated net book value, the second step of the goodwill
impairment test is performed to measure the amount of impairment
loss, if any. An impairment loss is equal to the excess of the
carrying amount of goodwill over its fair value.
Goodwill was tested for impairment during the fourth quarter of
2010 and no impairment was identified.
To estimate the fair value of each reporting unit, both relative
value and residual income valuation techniques are used because
the firm believes market participants would use these techniques
to value the firm’s reporting units.
Relative value techniques apply average observable
price-to-earnings
multiples of comparable competitors to certain reporting
units’ net earnings. For other reporting units, fair value
is estimated using
price-to-book
multiples based on residual income techniques, which compare
excess reporting unit returns on equity to the firm’s cost
of equity capital over a
long-term
stable growth period. The net book value of each reporting unit
reflects the estimated amount of shareholders’ equity
required to support the activities of the reporting unit.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
C:
Substantially all of the firm’s identifiable intangible
assets are considered to have finite lives and are amortized
over their estimated lives or, in the case of insurance
contracts, in proportion to estimated gross profits or premium
revenues. Amortization expense for identifiable intangible
assets is included in “Depreciation and amortization.”
The tables below present amortization expense for identifiable
intangible assets for the three and six months ended
June 2011 and June 2010, and the estimated future
amortization expense through 2016 for identifiable intangible
assets as of June 2011.
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Amortization expense
$
66
$
82
$
123
$
126
As of
in millions
June 2011
Estimated future amortization expense:
Remainder of 2011
$
134
2012
249
2013
232
2014
202
2015
170
2016
167
C:
Identifiable intangible assets are tested for recoverability
whenever events or changes in circumstances indicate that an
asset’s or asset group’s carrying value may not be
recoverable.
If a recoverability test is necessary, the carrying value of an
asset or asset group is compared to the total of the
undiscounted cash flows expected to be received over the
remaining useful life and from the disposition of the asset or
asset group.
•
If the total of the undiscounted cash flows exceeds the carrying
value, the asset or asset group is not impaired.
•
If the total of the undiscounted cash flows is less than the
carrying value, the asset or asset group is not fully
recoverable and an impairment loss is recognized as the
difference between the carrying amount of the asset or asset
group and its estimated fair value.
The tables below present deposits held in U.S. and
non-U.S. offices
and the maturities of time deposits. Substantially all
U.S. deposits were held at GS Bank USA and were
interest-bearing and substantially all
non-U.S. deposits
were held at Goldman Sachs Bank (Europe) PLC (GS Bank
Europe) and were interest-bearing.
C:
As of
June
December
in millions
2011
2010
U.S. offices
$
31,851
$
32,353
Non-U.S. offices
7,153
6,216
Total
$
39,004
$
38,569
C:
As of June 2011
in millions
U.S.
Non-U.S.
Total
Remainder of 2011
$
989
$
815
$
1,804
2012
1,015
652
1,667
2013
1,982
—
1,982
2014
499
—
499
2015
801
—
801
2016
83
—
83
2017 − thereafter
1,372
—
1,372
Total
$
6,741
1
$
1,467
2
$
8,208
1.
Includes $106 million greater than $100,000, of which
$17 million matures within three months, $21 million
matures within three to six months, $6 million matures
within six to twelve months, and $62 million matures after
twelve months.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Unsecured
short-term
borrowings include the portion of unsecured
long-term
borrowings maturing within one year of the financial statement
date and unsecured
long-term
borrowings that are redeemable within one year of the financial
statement date at the option of the holder.
The firm accounts for promissory notes, commercial paper and
certain hybrid financial instruments at fair value under the
fair value option. See Note 8 for further information about
unsecured
short-term
borrowings that are accounted for at fair value.
Short-term
borrowings that are not recorded at fair value are recorded
based on the amount of cash received plus accrued interest, and
such amounts approximate fair value due to the
short-term
nature of the obligations.
The table below presents unsecured
short-term
borrowings.
C:
As of
June
December
in millions
2011
2010
Current portion of unsecured
long-term
borrowings 1
$
33,236
$
25,396
Hybrid financial instruments
14,456
13,223
Promissory notes
3,252
3,265
Commercial paper
925
1,306
Other
short-term
borrowings
4,685
4,652
Total
$
56,554
$
47,842
Weighted average interest
rate 2
1.74
%
1.77
%
1.
Includes $17.14 billion and $10.43 billion as of
June 2011 and December 2010, respectively, guaranteed
by the Federal Deposit Insurance Corporation (FDIC) under the
Temporary Liquidity Guarantee Program (TLGP).
2.
The weighted average interest rates for these borrowings include
the effect of hedging activities and exclude financial
instruments accounted for at fair value under the fair value
option. See Note 7 for further information about hedging
activities.
Long-term
borrowings were comprised of the following:
C:
As of
June
December
in millions
2011
2010
Other secured financings
(long-term)
$
8,011
$
13,848
Unsecured
long-term
borrowings
175,210
174,399
Total
$
183,221
$
188,247
See Note 9 for further information about other secured
financings. The table below presents unsecured
long-term
borrowings extending through 2060 and consisting principally of
senior borrowings.
C:
As of June 2011
As of December 2010
U.S.
Non-U.S.
U.S.
Non-U.S.
in millions
Dollar
Dollar
Total
Dollar
Dollar
Total
Fixed-rate
obligations 1
$
77,837
$
40,387
$
118,224
$
82,814
$
35,885
$
118,699
Floating-rate
obligations 2
26,927
30,059
56,986
27,316
28,384
55,700
Total3
$
104,764
$
70,446
$
175,210
$
110,130
$
64,269
$
174,399
1.
Interest rates on
U.S. dollar-denominated
debt ranged from 0.10% to 10.04% (with a weighted average rate
of 5.61%) and 0.20% to 10.04% (with a weighted average rate of
5.52%) as of June 2011 and December 2010,
respectively. Interest rates on
non-U.S. dollar-denominated
debt ranged from 0.85% to 14.85% (with a weighted average rate
of 4.75%) and 0.85% to 14.85% (with a weighted average rate of
4.65%) as of June 2011 and December 2010, respectively.
2.
Floating interest rates generally are based on LIBOR or the
federal funds target rate.
Equity-linked
and indexed instruments are included in floating-rate
obligations.
3.
Includes $0 and $8.58 billion as of June 2011 and
December 2010, respectively, guaranteed by the FDIC under
the TLGP.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The table below presents unsecured
long-term
borrowings by maturity date. In the table below:
•
unsecured
long-term
borrowings maturing within one year of the financial statement
date and unsecured
long-term
borrowings that are redeemable within one year of the financial
statement date at the option of the holder are included as
unsecured
short-term
borrowings;
•
unsecured
long-term
borrowings that are repayable prior to maturity at the option of
the firm are reflected at their contractual maturity dates; and
•
unsecured
long-term
borrowings that are redeemable prior to maturity at the option
of the holders are reflected at the dates such options become
exercisable.
C:
As of
in millions
June 2011
2012
$
11,460
2013
23,195
2014
20,474
2015
17,685
2016
27,514
2017 − thereafter
74,882
Total1
$
175,210
1.
Amount includes an increase of $6.23 billion to the
carrying amount of certain unsecured
long-term
borrowings related to hedge accounting. The amounts related to
the carrying value of unsecured
long-term
borrowings associated with the effect of hedge accounting by
year of maturity are as follows: $206 million in 2012,
$563 million in 2013, $696 million in 2014,
$374 million in 2015, $698 million in 2016 and
$3.69 billion in 2017 and thereafter.
The aggregate contractual principal amount of unsecured
long-term
borrowings (principal and
non-principal
protected) for which the fair value option was elected exceeded
the related fair value by $538 million and
$349 million as of June 2011 and December 2010,
respectively.
The firm designates certain derivatives as fair value hedges to
effectively convert a substantial portion of its fixed-rate
unsecured
long-term
borrowings which are not accounted for at fair value into
floating-rate obligations. Accordingly, excluding the cumulative
impact of changes in the firm’s credit spreads, the
carrying value of unsecured
long-term
borrowings approximated fair value as of June 2011 and
December 2010. For unsecured
long-term
borrowings for which the firm did not elect the fair value
option, the cumulative impact due to changes in the firm’s
own credit spreads would be a reduction in the carrying value of
total unsecured
long-term
borrowings of less than 1% as of both June 2011 and
December 2010. See Note 7 for further information
about hedging activities.
The table below presents unsecured
long-term
borrowings, after giving effect to hedging activities that
converted a substantial portion of fixed-rate obligations to
floating-rate obligations.
C:
As of
June
December
in millions
2011
2010
Fixed-rate obligations
At fair value
$
516
$
22
At amortized
cost 1
12,685
5,877
Floating-rate obligations
At fair value
19,615
18,148
At amortized
cost 1
142,394
150,352
Total
$
175,210
$
174,399
1.
The weighted average interest rates on the aggregate amounts
were 2.31% (6.25% related to fixed-rate obligations and 1.99%
related to floating-rate obligations) and 1.90% (5.69% related
to fixed-rate obligations and 1.74% related to floating-rate
obligations) as of June 2011 and December 2010,
respectively. These rates exclude financial instruments
accounted for at fair value under the fair value option.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Subordinated
Borrowings
Unsecured
long-term
borrowings include subordinated debt and junior subordinated
debt. Junior subordinated debt is junior in right of payment to
other subordinated borrowings, which are junior to senior
borrowings. As of
June 2011 and December 2010, subordinated debt had
maturities ranging from 2014 to 2038 and 2012 to 2038,
respectively. The table below presents subordinated borrowings.
C:
As of June 2011
As of December 2010
Par
Carrying
Par
Carrying
in millions
Amount
Amount
Rate 1
Amount
Amount
Rate 1
Subordinated debt
$14,490
$
16,874
4.08
%
$14,345
$
16,977
1.19
%
Junior subordinated debt
5,085
5,613
2.44
%
5,082
5,716
2.50
%
Total subordinated borrowings
$19,575
$
22,487
3.65
%
$19,427
$
22,693
1.54
%
1.
Weighted average interest rate after giving effect to fair value
hedges used to convert these fixed-rate obligations into
floating-rate obligations. See Note 7 for further
information about hedging activities. See below for information
about interest rates on junior subordinated debt.
Junior
Subordinated Debt
Junior Subordinated Debt Issued to APEX
Trusts. In 2007, Group Inc. issued a total
of $2.25 billion of remarketable junior subordinated debt
to Goldman Sachs Capital II and Goldman Sachs Capital III (APEX
Trusts), Delaware statutory trusts. The APEX Trusts issued
$2.25 billion of guaranteed perpetual Normal Automatic
Preferred Enhanced Capital Securities (APEX) to third parties
and a de minimis amount of common securities to Group Inc.
Group Inc. also entered into contracts with the APEX Trusts
to sell $2.25 billion of Group Inc. perpetual
non-cumulative
preferred stock (the stock purchase contracts).
The APEX Trusts are wholly-owned finance subsidiaries of the
firm for regulatory and legal purposes but are not consolidated
for accounting purposes.
The firm accounted for the stock purchase contracts as equity
instruments and, accordingly, recorded the cost of the stock
purchase contracts as a reduction to additional
paid-in
capital. See Note 19 for information on the preferred stock
that Group Inc. will issue in connection with the stock
purchase contracts.
The firm pays interest
semi-annually
on $1.75 billion of junior subordinated debt issued to
Goldman Sachs Capital II at a fixed annual rate of 5.59% and the
debt matures on June 1, 2043. The firm pays interest
quarterly on $500 million of junior subordinated debt
issued to Goldman Sachs Capital III at a rate per annum equal to
three-month
LIBOR plus 0.57% and the debt
matures on September 1, 2043. In addition, the firm
makes contract payments at a rate of 0.20% per annum on the
stock purchase contracts held by the APEX Trusts.
The firm has the right to defer payments on the junior
subordinated debt and the stock purchase contracts, subject to
limitations, and therefore cause payment on the APEX to be
deferred. During any such extension period, the firm will not be
permitted to, among other things, pay dividends on or make
certain repurchases of its common or preferred stock.
In connection with the APEX issuance, the firm covenanted in
favor of certain of its debtholders, who were initially and are
currently the holders of Group Inc.’s 6.345% Junior
Subordinated Debentures due February 15, 2034, that,
subject to certain exceptions, the firm would not redeem or
purchase (i) Group Inc.’s junior subordinated
debt issued to the APEX Trusts prior to the applicable stock
purchase date or (ii) APEX or shares of
Group Inc.’s perpetual
Non-Cumulative
Preferred Stock, Series E (Series E Preferred Stock)
or perpetual
Non-Cumulative
Preferred Stock, Series F (Series F Preferred Stock)
prior to the date that is ten years after the applicable stock
purchase date, unless the applicable redemption or purchase
price does not exceed a maximum amount determined by reference
to the aggregate amount of net cash proceeds that the firm has
received from the sale of qualifying equity securities during
the 180-day
period preceding the redemption or purchase.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Junior Subordinated Debt Issued in Connection with
Trust Preferred Securities. Group Inc.
issued $2.84 billion of junior subordinated debentures in
2004 to Goldman Sachs Capital I (Trust), a Delaware statutory
trust. The Trust issued $2.75 billion of guaranteed
preferred beneficial interests to third parties and
$85 million of common beneficial interests to
Group Inc. and used the proceeds from the issuances to
purchase the junior subordinated debentures from Group Inc.
The Trust is a wholly-owned finance subsidiary of the firm for
regulatory and legal purposes but is not consolidated for
accounting purposes.
The firm pays interest
semi-annually
on the debentures at an annual rate of 6.345% and the debentures
mature on February 15, 2034. The coupon rate and the
payment dates applicable to the beneficial interests are the
same as the interest rate and payment dates for the debentures.
The firm has the right, from time to time, to defer payment of
interest on the debentures, and therefore cause payment on the
Trust’s preferred beneficial interests to be deferred, in
each case up to ten consecutive
semi-annual
periods. During any such extension period, the firm will not be
permitted to, among other things, pay dividends on or make
certain repurchases of its common stock. The Trust is not
permitted to pay any distributions on the common beneficial
interests held by Group Inc. unless all dividends payable
on the preferred beneficial interests have been paid in full.
Reserves for guaranteed minimum death and income benefits
225
248
Total
$
15,754
$
11,381
1.
Includes increased liabilities related to the acquisition of
Paternoster U.K. Limited, a U.K. life insurance company, in the
first quarter of 2011. In connection with this acquisition, the
firm acquired $4.75 billion of assets (primarily financial
instruments owned, at fair value, principally consisting of
corporate debt securities) and assumed $4.35 billion of
liabilities.
Separate account liabilities are supported by separate account
assets, representing segregated contract holder funds under
variable annuity and life insurance contracts. Separate account
assets are included in “Cash and securities segregated for
regulatory and other purposes.”
Liabilities for future benefits and unpaid claims include
liabilities arising from reinsurance provided by the firm to
other insurers. The firm had a receivable of $1.35 billion
and $1.26 billion as of June 2011 and
December 2010, respectively, related to such reinsurance
contracts, which is reported in “Receivables from customers
and counterparties.” In addition, the firm has ceded risks
to reinsurers related to certain of its liabilities for future
benefits and unpaid claims and had a receivable of
$722 million and $839 million as of June 2011 and
December 2010, respectively, related to such reinsurance
contracts, which is reported in “Receivables from customers
and counterparties.”Contracts to cede risks to reinsurers
do not relieve the firm of its obligations to contract holders.
Liabilities for future benefits and unpaid claims include
$6.64 billion and $2.05 billion carried at fair value
under the fair value option as of June 2011 and
December 2010, respectively.
Reserves for guaranteed minimum death and income benefits
represent a liability for the expected value of guaranteed
benefits in excess of projected annuity account balances. These
reserves are based on total payments expected to be made less
total fees expected to be assessed over the life of the contract.
Contingent and forward starting resale and securities borrowing
agreements 2
71,177
—
—
—
71,177
46,886
Forward starting repurchase and securities lending
agreements 2
19,180
—
—
—
19,180
12,509
Underwriting commitments
188
—
—
—
188
835
Letters of
credit 3
1,010
515
142
1
1,668
2,210
Investment commitments
2,339
6,698
326
923
10,286
11,093
Other
375
124
60
25
584
389
Total commitments
$99,988
$
33,908
$
17,314
$
16,159
$167,369
$125,819
1.
Commitments to extend credit are presented net of amounts
syndicated to third parties.
2.
These agreements generally settle within three business days.
3.
Consists of commitments under letters of credit issued by
various banks which the firm provides to counterparties in lieu
of securities or cash to satisfy various collateral and margin
deposit requirements.
Commitments to
Extend Credit
The firm’s commitments to extend credit are agreements to
lend with fixed termination dates and depend on the satisfaction
of all contractual conditions to borrowing. The total commitment
amount does not necessarily reflect actual future cash flows
because the firm may syndicate all or substantial portions of
these commitments and commitments can expire unused or be
reduced or cancelled at the counterparty’s request.
C:
The firm generally accounts for commitments to extend credit at
fair value. Losses, if any, are generally recorded, net of any
fees in “Other principal transactions.”
Commercial Lending. The firm’s commercial
lending commitments are generally extended in connection with
contingent acquisition financing and other types of corporate
lending as well as commercial real estate financing. Commitments
that are extended for contingent acquisition financing are often
intended to be
short-term
in nature, as borrowers often seek to replace them with other
funding sources.
William Street Credit Extension Program. Substantially all of the commitments provided under the
William Street credit extension program are to
investment-grade
corporate borrowers. Commitments under the program are
principally extended by William Street Commitment Corporation
(Commitment Corp.), a consolidated wholly-owned subsidiary of
GS Bank USA, GS Bank USA, and other subsidiaries of
GS Bank USA. Historically, commitments extended by
Commitment Corp. were supported, in part, by funding raised by
Funding Corp., another consolidated wholly-owned subsidiary of
GS Bank USA. As of April 26, 2011, the funding
raised by Funding Corp. had been repaid in its entirety. The
commitments extended by Commitment Corp. that had been supported
by this funding are now supported by funding from GS Bank
USA.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The assets and liabilities of Commitment Corp. are
legally separated from other assets and liabilities of the firm.
The assets of Commitment Corp. will not be available to its
shareholders until the claims of its creditors have been paid.
In addition, no affiliate of Commitment Corp., except in limited
cases as expressly agreed in writing, is responsible for any
obligation of Commitment Corp.
Sumitomo Mitsui Financial Group, Inc. (SMFG) provides the firm
with credit loss protection that is generally limited to 95% of
the first loss the firm realizes on approved loan commitments,
up to a maximum of approximately $950 million, with respect
to most of the William Street commitments. In addition, subject
to the satisfaction of certain conditions, upon the firm’s
request, SMFG will provide protection for 70% of additional
losses on such commitments, up to a maximum of
$1.13 billion, of which $300 million and
$375 million of protection had been provided as of
June 2011 and December 2010, respectively. The firm
also uses other financial instruments to mitigate credit risks
related to certain William Street commitments not covered by
SMFG.
Warehouse Financing. The firm provides
financing to clients who warehouse financial assets. These
arrangements are secured by the warehoused assets, primarily
consisting of residential and commercial mortgages.
Contingent and Forward Starting Resale and Securities
Borrowing Agreements/Forward Starting Repurchase and Securities
Lending Agreements
The firm enters into resale and securities borrowing agreements
and repurchase and securities lending agreements that settle at
a future date. The firm also enters into commitments to provide
contingent financing to its clients through resale agreements.
The firm’s funding of these commitments depends on the
satisfaction of all contractual conditions to the resale
agreement and these commitments can expire unused.
Investment
Commitments
The firm’s investment commitments consist of commitments to
invest in private equity, real estate and other assets directly
and through funds that the firm raises and manages. These
commitments include $1.86 billion and $1.97 billion as
of June 2011 and December 2010, respectively, related
to real estate private investments and $8.43 billion and
$9.12 billion as of June 2011 and December 2010,
respectively, related to corporate and other private
investments. Of these amounts, $9.48 billion and
$10.10 billion as of June 2011 and December 2010,
respectively, relate to commitments to invest in funds managed
by the firm, which will be funded at market value on the date of
investment.
Leases
The firm has contractual obligations under
long-term
noncancelable lease agreements, principally for office space,
expiring on various dates through 2069. Certain agreements are
subject to periodic escalation provisions for increases in real
estate taxes and other charges. The table below presents future
minimum rental payments, net of minimum sublease rentals.
C:
As of
in millions
June 2011
Remainder of 2011
$
251
2012
493
2013
428
2014
399
2015
366
2016
333
2017-thereafter
1,437
Total
$
3,707
C:
Operating leases include office space held in excess of current
requirements. Rent expense relating to space held for growth is
included in “Occupancy.” The firm records a liability,
based on the fair value of the remaining lease rentals reduced
by any potential or existing sublease rentals, for leases where
the firm has ceased using the space and management has concluded
that the firm will not derive any future economic benefits.
Costs to terminate a lease before the end of its term are
recognized and measured at fair value on termination.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Contingencies
Legal Proceedings. See Note 27 for
information on legal proceedings, including certain
mortgage-related
matters.
Certain
Mortgage-Related
Contingencies. There are multiple areas of focus
by regulators, governmental agencies and others within the
mortgage market that may impact originators, issuers, servicers
and investors. There remains significant uncertainty surrounding
the nature and extent of any potential exposure for participants
in this market.
•
Representations and Warranties. The firm was
not a significant originator of residential mortgage loans. The
firm did purchase loans originated by others and generally
received loan-level representations of the type described below
from the originators. During the period 2005 through 2008, the
firm sold approximately $10 billion of loans to
government-sponsored enterprises and approximately
$11 billion of loans to other third parties. In addition,
the firm transferred loans to trusts and other mortgage
securitization vehicles. As of June 2011, the outstanding
balance of the loans transferred to trusts and other mortgage
securitization vehicles during the period 2005 through 2008 was
approximately $45 billion. This amount reflects paydowns
and cumulative losses of approximately $80 billion
($16 billion of which are cumulative losses). A small
number of these Goldman Sachs-issued securitizations with an
outstanding principal balance of $683 million and total
paydowns and cumulative losses of $1.38 billion
($440 million of which are cumulative losses) were
structured with credit protection obtained from monoline
insurers. In connection with both sales of loans and
securitizations, the firm provided loan level representations of
the type described below
and/or
assigned the loan level representations from the party from whom
the firm purchased the loans.
The loan level representations made in connection with the sale
or securitization of mortgage loans varied among transactions
but were generally detailed representations applicable to each
loan in the portfolio and addressed matters relating to the
property, the borrower and the note. These representations
generally included, but were not limited to, the following:
(i) certain attributes of the borrower’s financial
status;
(ii) loan-to-value
ratios, owner occupancy status and certain other characteristics
of the property; (iii) the lien position; (iv) the
fact that the loan was originated in compliance with law; and
(v) completeness of the loan documentation.
To date, repurchase claims and actual repurchases of residential
mortgage loans based upon alleged breaches of representations
have not been significant and have mainly involved
government-sponsored enterprises. During both the three and six
months ended June 2011, the firm incurred an immaterial
loss on the repurchase of less than $10 million of loans.
As of June 2011, outstanding repurchase claims were not
material.
Ultimately, the firm’s exposure to claims for repurchase of
residential mortgage loans based on alleged breaches of
representations will depend on a number of factors including the
following: (i) the extent to which these claims are
actually made; (ii) the extent to which there are
underlying breaches of representations that give rise to valid
claims for repurchase; (iii) in the case of loans
originated by others, the extent to which the firm could be held
liable and, if it is, the firm’s ability to pursue and
collect on any claims against the parties who made
representations to the firm; (iv) macro-economic factors,
including developments in the residential real estate market;
and (v) legal and regulatory developments.
Based upon the large number of defaults in residential
mortgages, including those sold or securitized by the firm,
there is a potential for increasing claims for repurchases.
However, the firm is not in a position to make a meaningful
estimate of that exposure at this time.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
•
Foreclosure and Other Mortgage Loan Servicing Practices and
Procedures. The firm has received a number of requests for
information from regulators and other agencies, including state
attorneys general and banking regulators, as part of an
industry-wide
focus on the practices of lenders and servicers in connection
with foreclosure proceedings and other aspects of mortgage loan
servicing practices and procedures. The requests seek
information about the foreclosure and servicing protocols and
activities of Litton, the firm’s residential mortgage
servicing subsidiary, and any deviations therefrom. The firm is
cooperating with the requests and is reviewing Litton’s
practices in this area. These inquiries may result in the
imposition of fines or other regulatory action. Litton
temporarily suspended evictions and foreclosure and real estate
owned sales in a number of states, including those with judicial
foreclosure procedures in the third quarter of 2010. Litton
resumed these activities beginning in the fourth quarter of
2010. As of June 2011, the firm is not aware of
foreclosures where the underlying foreclosure decision was not
warranted. As of June 2011, the value of the firm’s
mortgage servicing rights was not material and any impact on
their value would not be material to the firm. In connection
with the pending sale of Litton, the firm agreed to provide
certain representations and warranties, and specific indemnities
related to Litton’s servicing and foreclosure practices
prior to the close of the sale.
Guaranteed Minimum Death and Income
Benefits. In connection with its insurance
business, the firm is contingently liable to provide guaranteed
minimum death and income benefits to certain contract holders
and has established a reserve related to $6.19 billion and
$6.11 billion of contract holder account balances as of
June 2011 and December 2010, respectively, for such
benefits. The weighted average attained age of these contract
holders was 69 years for both June 2011 and
December 2010.
The net amount at risk, representing guaranteed minimum death
and income benefits in excess of contract holder account
balances, was $1.29 billion and $1.60 billion as of
June 2011 and December 2010, respectively. See
Note 17 for further information about insurance liabilities.
Guarantees
The firm enters into various derivatives that meet the
definition of a guarantee under U.S. GAAP, including
written equity and commodity put options, written currency
contracts and interest rate caps, floors and swaptions.
Disclosures about derivatives are not required if they may be
cash settled and the firm has no basis to conclude it is
probable that the counterparties held the underlying instruments
at inception of the contract. The firm has concluded that these
conditions have been met for certain large, internationally
active commercial and investment bank counterparties and certain
other counterparties. Accordingly, the firm has not included
such contracts in the table below.
The firm, in its capacity as an agency lender, indemnifies most
of its securities lending customers against losses incurred in
the event that borrowers do not return securities and the
collateral held is insufficient to cover the market value of the
securities borrowed.
In the ordinary course of business, the firm provides other
financial guarantees of the obligations of third parties
(e.g., standby letters of credit and other guarantees to
enable clients to complete transactions and fund-related
guarantees). These guarantees represent obligations to make
payments to beneficiaries if the guaranteed party fails to
fulfill its obligation under a contractual arrangement with that
beneficiary.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The table below presents certain information about derivatives
that meet the definition of a guarantee and certain other
guarantees. The maximum payout in the table below is based on
the notional amount of the contract and therefore does not
represent anticipated losses. See Note 7 for further
information about credit derivatives that meet the definition of
a guarantee which are not included below.
Because derivatives are accounted for at fair value, carrying
value is considered the best indication of payment/performance
risk for individual contracts. However, the carrying values
below exclude the effect of a legal right of setoff that may
exist under an enforceable netting agreement and the effect of
netting of cash collateral posted under credit support
agreements.
C:
As of June 2011
Carrying
Maximum Payout/Notional Amount by Period of Expiration
Value of
Remainder
2012-
2014-
2016-
in millions
Net Liability
of 2011
2013
2015
Thereafter
Total
Derivatives 1
$
8,941
$282,572
$
397,688
$
72,796
$75,698
$
828,754
Securities lending
indemnifications 2
—
32,604
—
—
—
32,604
Other financial
guarantees
3
30
249
1,251
490
1,188
3,178
1.
These derivatives are risk managed together with derivatives
that do not meet the definition of a guarantee, and therefore
these amounts do not reflect the firm’s overall risk
related to its derivative activities.
2.
Collateral held by the lenders in connection with securities
lending indemnifications was $33.58 billion as of
June 2011. Because the contractual nature of these
arrangements requires the firm to obtain collateral with a
market value that exceeds the value of the securities lent to
the borrower, there is minimal performance risk associated with
these guarantees.
3.
Other financial guarantees excludes certain commitments to issue
standby letters of credit that are included in “Commitments
to extend credit.” See table in “Commitments”
above for a summary of the firm’s commitments.
As of December 2010, the carrying value of the net
liability related to derivative guarantees and other financial
guarantees was $8.26 billion and $28 million,
respectively.
Guarantees of Securities Issued by Trusts. The
firm has established trusts, including Goldman Sachs Capital I,
II and III, and other entities for the limited purpose of
issuing securities to third parties, lending the proceeds to the
firm and entering into contractual arrangements with the firm
and third parties related to this purpose. The firm does not
consolidate these entities. See Note 16 for further
information about the transactions involving Goldman Sachs
Capital I, II and III.
The firm effectively provides for the full and unconditional
guarantee of the securities issued by these entities. Timely
payment by the firm of amounts due to these entities under the
borrowing, preferred stock and related contractual arrangements
will be sufficient to cover payments due on the securities
issued by these entities.
Management believes that it is unlikely that any circumstances
will occur, such as nonperformance on the part of paying agents
or other service providers, that would make it necessary for the
firm to make payments related to these entities other than those
required under the terms of the borrowing, preferred stock and
related contractual arrangements and in connection with certain
expenses incurred by these entities.
Indemnities and Guarantees of Service
Providers. In the ordinary course of business,
the firm indemnifies and guarantees certain service providers,
such as clearing and custody agents, trustees and
administrators, against specified potential losses in connection
with their acting as an agent of, or providing services to, the
firm or its affiliates.
The firm also indemnifies some clients against potential losses
incurred in the event specified
third-party
service providers, including
sub-custodians
and
third-party
brokers, improperly execute transactions. In addition, the firm
is a member of payment, clearing and settlement networks as well
as securities exchanges around the world that may require the
firm to meet the obligations of such networks and exchanges in
the event of member defaults.
In connection with its prime brokerage and clearing businesses,
the firm agrees to clear and settle on behalf of its clients the
transactions entered into by them with other brokerage firms.
The firm’s obligations in respect of such transactions are
secured by the assets in the client’s account as well as
any proceeds received from the transactions cleared and settled
by the firm on behalf of the client. In connection with joint
venture investments, the firm may issue loan guarantees under
which it may be liable in the event of fraud, misappropriation,
environmental liabilities and certain other matters involving
the borrower.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The firm is unable to develop an estimate of the maximum payout
under these guarantees and indemnifications. However, management
believes that it is unlikely the firm will have to make any
material payments under these arrangements, and no material
liabilities related to these guarantees and indemnifications
have been recognized in the condensed consolidated statements of
financial condition as of June 2011 and December 2010.
Other Representations, Warranties and
Indemnifications. The firm provides
representations and warranties to counterparties in connection
with a variety of commercial transactions and occasionally
indemnifies them against potential losses caused by the breach
of those representations and warranties. The firm may also
provide indemnifications protecting against changes in or
adverse application of certain U.S. tax laws in connection
with ordinary-course transactions such as securities issuances,
borrowings or derivatives.
In addition, the firm may provide indemnifications to some
counterparties to protect them in the event additional taxes are
owed or payments are withheld, due either to a change in or an
adverse application of certain
non-U.S. tax
laws.
These indemnifications generally are standard contractual terms
and are entered into in the ordinary course of business.
Generally, there are no stated or notional amounts included in
these indemnifications, and the contingencies triggering the
obligation to indemnify are not expected to occur. The firm is
unable to develop an estimate of the maximum payout under these
guarantees and indemnifications. However, management believes
that it is unlikely the firm will have to make any material
payments under these arrangements, and no material liabilities
related to these arrangements have been recognized in the
condensed consolidated statements of financial condition as of
June 2011 and December 2010.
Guarantees of Subsidiaries. Group Inc.
fully and unconditionally guarantees the securities issued by GS
Finance Corp., a wholly-owned finance subsidiary of the firm.
Group Inc. has guaranteed the payment obligations of
Goldman, Sachs & Co. (GS&Co.), GS Bank USA,
GS Bank Europe and Goldman Sachs Execution &
Clearing, L.P. (GSEC), subject to certain exceptions.
In November 2008, the firm contributed subsidiaries into
GS Bank USA, and Group Inc. agreed to guarantee
certain losses, including
credit-related
losses, relating to assets held by the contributed entities. In
connection with this guarantee, Group Inc. also agreed to
pledge to GS Bank USA certain collateral, including
interests in subsidiaries and other illiquid assets.
In addition, Group Inc. guarantees many of the obligations
of its other consolidated subsidiaries on a
transaction-by-transaction
basis, as negotiated with counterparties. Group Inc. is
unable to develop an estimate of the maximum payout under its
subsidiary guarantees; however, because these guaranteed
obligations are also obligations of consolidated subsidiaries
included in the table above, Group Inc.’s liabilities
as guarantor are not separately disclosed.
The firm’s share repurchase program is intended 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 the firm’s current and projected capital
positions (i.e., comparisons of the firm’s desired
level and composition of capital to its 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 the
firm’s common stock. Any repurchase of the firm’s
common stock requires approval by the Board of Governors of the
Federal Reserve System (Federal Reserve Board).
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
During the three and six months ended June 2011, the firm
repurchased 10.8 million and 19.8 million shares of
its common stock at an average cost per share of $139.20 and
$150.14, for a total cost of $1.50 billion and
$2.97 billion, respectively, under the share repurchase
program. In addition, pursuant to the terms of certain
share-based
compensation plans, employees may remit shares to the firm or
the firm may cancel RSUs to satisfy minimum statutory
employee tax withholding requirements. Under these plans, during
the six months ended June 2011, employees remitted
75,378 shares with a total value of $12 million and
the firm cancelled 11.0 million of RSUs with a total value
of $1.78 billion.
Preferred
Equity
The table below presents perpetual preferred stock issued and
outstanding.
C:
Redemption
Shares
Shares
Shares
Earliest
Value
Series
Authorized
Issued
Outstanding
Dividend Rate
Redemption Date
(in millions)
A
50,000
30,000
29,999
3 month LIBOR + 0.75%,
with floor of 3.75% per annum
Each share of
non-cumulative
Series A Preferred Stock, Series B Preferred Stock,
Series C Preferred Stock and Series D Preferred Stock
issued and outstanding has a par value of $0.01, has a
liquidation preference of $25,000, is represented by 1,000
depositary shares and is redeemable at the firm’s option,
subject to the approval of the Federal Reserve Board, at a
redemption price equal to $25,000 plus declared and unpaid
dividends.
All series of preferred stock are pari passu and have a
preference over the firm’s common stock on liquidation.
Dividends on each series of preferred stock, if declared, are
payable quarterly in arrears. The firm’s ability to declare
or pay dividends on, or purchase, redeem or otherwise acquire,
its common stock is subject to certain restrictions in the event
that the firm fails to pay or set aside full dividends on the
preferred stock for the latest completed dividend period.
In 2007, the Board of Directors of Group Inc. (Board)
authorized 17,500.1 shares of Series E Preferred
Stock, and 5,000.1 shares of Series F Preferred Stock,
in connection with the APEX Trusts. See Note 16 for further
information.
Under the stock purchase contracts with the APEX Trusts,
Group Inc. will issue on the relevant stock purchase dates
(on or before June 1, 2013 and
September 1, 2013 for Series E and Series F
Preferred Stock, respectively) one share of Series E and
Series F Preferred Stock to Goldman Sachs Capital II and
III, respectively, for each $100,000 principal amount of
subordinated debt held by these trusts. When issued, each share
of Series E and Series F Preferred Stock will have a
par value of $0.01 and a liquidation preference of $100,000 per
share.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Dividends on Series E Preferred Stock, if declared, will be
payable
semi-annually
at a fixed annual rate of 5.79% if the stock is issued prior to
June 1, 2012 and quarterly thereafter, at a rate per
annum equal to the greater of
(i) three-month
LIBOR plus 0.77% and (ii) 4.00%.
Dividends on Series F Preferred Stock, if declared, will be
payable quarterly at a rate per annum equal to
three-month
LIBOR plus 0.77% if the stock is issued prior to
September 1, 2012 and quarterly thereafter, at a rate
per annum equal to the greater of
(i) three-month
LIBOR plus 0.77% and (ii) 4.00%.
The preferred stock may be redeemed at the option of the firm on
the stock purchase dates or any day thereafter, subject to
approval from the Federal Reserve Board and certain covenant
restrictions governing the firm’s ability to redeem or
purchase the preferred stock without issuing common stock or
other instruments with
equity-like
characteristics.
In March 2011, the firm provided notice to Berkshire
Hathaway Inc. and certain of its subsidiaries (collectively,
Berkshire Hathaway) that it would redeem in full the
50,000 shares of the firm’s 10% Cumulative Perpetual
Preferred Stock, Series G (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, the firm recognized a
preferred dividend of $1.64 billion (calculated as the
difference between the carrying value and redemption value of
the preferred stock), which was recorded as a reduction to the
firm’s first quarter earnings applicable to common
shareholders and common shareholders’ equity. The
redemption also resulted in the acceleration of $24 million
of preferred dividends related to the period from
April 1, 2011 to the redemption date, which was
included in the firm’s results during the three months
ended March 2011. The Series G Preferred Stock was
redeemed on April 18, 2011. Berkshire Hathaway
continues to hold a five-year warrant, issued in
October 2008, to purchase up to 43.5 million shares of
common stock at an exercise price of $115.00 per share.
The table below presents preferred dividends declared on
preferred stock.
C:
Three Months
Six Months
Ended June
Ended June
2011
2010
2011
2010
per share
in millions
per share
in millions
per share
in millions
per share
in millions
Series A
$
231.77
$
7
$
231.77
$
7
$
471.35
$
14
$
471.35
$
14
Series B
387.50
13
387.50
13
775.00
25
775.00
25
Series C
247.22
2
247.22
2
502.78
4
502.78
4
Series D
247.22
13
247.22
13
502.78
27
502.78
27
Series G
—
—
2,500.00
125
2,500.00
125
1
5,000.00
250
Total
$
35
$
160
$
195
$
320
1.
Excludes preferred dividends related to the redemption of the
firm’s Series G Preferred Stock.
Accumulated Other Comprehensive Income/(Loss)
The table below presents accumulated other comprehensive
income/(loss) by type.
C:
As of
June
December
in millions
2011
2010
Currency translation adjustment, net of tax
$
(205
)
$
(170
)
Pension and postretirement liability adjustments, net of tax
(226
)
(229
)
Net unrealized gains on
available-for-sale
securities, net of
tax 1
84
113
Total accumulated other comprehensive loss, net of tax
$
(347
)
$
(286
)
1.
Substantially all consists of net unrealized gains on
available-for-sale
securities held by the firm’s insurance subsidiaries as of
both June 2011 and December 2010.
The Federal Reserve Board is the primary regulator of
Group Inc., a bank holding company and a financial holding
company under the U.S. Bank Holding Company Act of 1956. As
a bank holding company, the firm is subject to consolidated
regulatory capital requirements that are computed in accordance
with the Federal Reserve Board’s capital adequacy
regulations currently applicable to bank holding companies
(Basel 1). These capital requirements, which are based on the
Capital Accord of the Basel Committee on Banking Supervision
(Basel Committee), are expressed as capital ratios that compare
measures of capital to
risk-weighted
assets (RWAs). The firm’s bank depository institution
subsidiaries, including GS Bank USA, are subject to similar
capital requirements.
Under the Federal Reserve Board’s capital adequacy
requirements and the regulatory framework for prompt corrective
action that is applicable to GS Bank USA, the firm and its
bank depository institution subsidiaries must meet specific
capital requirements that involve quantitative measures of
assets, liabilities and certain
off-balance-sheet
items as calculated under regulatory reporting practices. The
firm and its bank depository institution subsidiaries’
capital amounts, as well as GS Bank USA’s prompt
corrective action classification, are also subject to
qualitative judgments by the regulators about components, risk
weightings and other factors.
Many of the firm’s subsidiaries, including GS&Co. and
the firm’s other
broker-dealer
subsidiaries, are subject to separate regulation and capital
requirements as described below.
Group Inc.
Federal Reserve Board regulations require bank holding companies
to maintain a minimum Tier 1 capital ratio of 4% and a
minimum total capital ratio of 8%. The required minimum
Tier 1 capital ratio and total capital ratio in order to be
considered a “well-capitalized” bank holding company
under the Federal Reserve Board guidelines are 6% and 10%,
respectively. Bank holding companies may be expected to maintain
ratios well above the minimum
levels, depending on their particular condition, risk profile
and growth plans. The minimum Tier 1 leverage ratio is 3%
for bank holding companies that have received the highest
supervisory rating under Federal Reserve Board guidelines or
that have implemented the Federal Reserve Board’s
risk-based
capital measure for market risk. Other bank holding companies
must have a minimum Tier 1 leverage ratio of 4%.
The table below presents information regarding
Group Inc.’s regulatory capital ratios.
As of
June
December
$ in millions
2011
2010
Tier 1 capital
$
66,365
$
71,233
Tier 2 capital
13,811
13,660
Total capital
80,176
84,893
Risk-weighted assets
451,010
444,290
Tier 1 capital ratio
14.7%
16.0%
Total capital ratio
17.8%
19.1%
Tier 1 leverage ratio
7.3%
8.0%
RWAs under the Federal Reserve Board’s
risk-based
capital guidelines are calculated based on the amount of market
risk and credit risk. RWAs for market risk are determined by
reference to the firm’s
Value-at-Risk
(VaR) models, supplemented by other measures to capture risks
not reflected in VaR models. Credit risk for on-balance sheet
assets is based on the balance sheet value. For off-balance
sheet exposures, including OTC derivatives and commitments, a
credit equivalent amount is calculated based on the notional
amount of each trade. All such assets and amounts are then
assigned a risk weight depending on, among other things, whether
the counterparty is a sovereign, bank or qualifying securities
firm or other entity (or if collateral is held, depending on the
nature of the collateral).
Tier 1 leverage ratio is defined as Tier 1 capital
under Basel 1 divided by average adjusted total assets (which
includes adjustments for disallowed goodwill and intangible
assets, and the carrying value of equity investments in
non-financial
companies that are subject to deductions from Tier 1
capital).
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Regulatory
Reform
The firm is currently working to implement the requirements set
out in the Federal Reserve Board’s Capital Adequacy
Guidelines for Bank Holding Companies: Internal-Ratings-Based
and Advanced Measurement Approaches, 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 as applicable to
Group Inc. as a bank holding company (Basel 2).
U.S. banking regulators have incorporated the Basel 2
framework into the existing
risk-based
capital requirements by requiring that internationally active
banking organizations, such as Group Inc., adopt Basel 2
following the successful completion of a parallel run. As
required by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act), U.S. banking regulators
have adopted a rule which requires large banking organizations,
upon adoption of Basel 2, to continue to calculate
risk-based
capital ratios under both Basel 1 and Basel 2. For each of the
Tier 1 and Total capital ratios, the lower of the ratios
calculated will be used to determine whether the bank meets its
minimum
risk-based
capital requirements.
In addition, the Basel Committee has undertaken a program of
substantial revisions to its capital guidelines. In particular,
the changes in the “Basel 2.5” guidelines will result
in increased capital requirements for market risk; additionally,
the Basel 3 guidelines issued by the Basel Committee in
December 2010 revise the definition of Tier 1 capital,
introduce Tier 1 common equity as a regulatory metric, set
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 other
capital ratios), introduce a Tier 1 leverage ratio within
international guidelines for the first time, and make
substantial revisions to the computation of
risk-weighted
assets 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 the Basel 2.5 guidelines, they have not yet addressed
all aspects of those guidelines or the Basel 3 changes. In
addition, both the Basel Committee and U.S. banking
regulators implementing the Dodd-Frank
Act have indicated that they will impose more stringent capital
standards on systemically important financial institutions. The
Basel Committee has proposed a methodology to assess the global
systemic importance of a bank and the range of loss absorbing
capital that a bank that is deemed systemically important should
maintain. Because this proposal has not yet been adopted by the
Basel Committee, the assessment criteria have not yet been
finalized; nevertheless, it is probable that they will apply to
the firm. Therefore, the regulations ultimately applicable to
the firm may be substantially different from those that have
been published to date.
The Dodd-Frank Act will subject the firm 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. The Federal Reserve Board will
be required to begin implementing the new leverage and
risk-based
capital regulation by January 2012. As a consequence of
these changes, Tier 1 capital treatment for the firm’s
junior subordinated debt issued to trusts will be phased out
over a three-year period beginning on January 1, 2013.
The interaction between the Dodd-Frank Act and the Basel
Committee’s proposed changes adds further uncertainty to
the firm’s future capital requirements.
A number of other governmental entities and regulators,
including the U.S. Treasury, the European Union (EU) and
the U.K.’s Financial Services Authority (FSA), have also
proposed or announced changes which will result in increased
capital requirements for financial institutions.
As a consequence of these developments, the firm expects minimum
capital ratios required to be maintained under Federal Reserve
Board regulations will be increased and changes in the
prescribed calculation methodology are expected to result in
higher RWAs and lower capital ratios than those currently
computed.
The capital requirements of several of the firm’s
subsidiaries will also be impacted in the future by the various
proposals from the Basel Committee, the Dodd-Frank Act, and
other governmental entities and regulators.
GS Bank USA, an FDIC-insured, New York State-chartered bank
and a member of the Federal Reserve System and the FDIC, is
regulated by the Federal Reserve Board and the New York State
Banking Department and is subject to minimum capital
requirements (described further below) that are calculated in a
manner similar to those applicable to bank holding companies.
GS Bank USA computes its capital ratios in accordance with
the regulatory capital guidelines currently applicable to state
member banks, which are based on Basel 1 as implemented by the
Federal Reserve Board, for purposes of assessing the adequacy of
its capital. In order to be considered a
“well-capitalized” depository institution under the
Federal Reserve Board guidelines, GS Bank USA must maintain
a Tier 1 capital ratio of at least 6%, a total capital
ratio of at least 10% and a Tier 1 leverage ratio of at
least 5%. In November 2008, the firm contributed
subsidiaries into GS Bank USA. In connection with this
contribution, GS Bank USA agreed with the Federal Reserve
Board to minimum capital ratios in excess of these
“well-capitalized” levels. Accordingly, for a period
of time, GS Bank USA is expected to maintain a Tier 1
capital ratio of at least 8%, a total capital ratio of at least
11% and a Tier 1 leverage ratio of at least 6%.
The table below presents information regarding GS Bank
USA’s regulatory capital ratios under Basel 1 as
implemented by the Federal Reserve Board.
C:
As of
June
December
2011
2010
Tier 1 capital ratio
19.1%
18.8%
Total capital ratio
20.1%
1
23.9%
Tier 1 leverage ratio
21.5%
19.5%
1.
The decrease from December 2010 to June 2011 is
primarily related to GS Bank USA’s repayment of
$4.00 billion of subordinated debt to Group Inc. and
$1.00 billion dividend to Group Inc. in the first
quarter of 2011.
GS Bank USA is currently working to implement the Basel 2
framework. Similar to the firm’s requirement as a bank
holding company, GS Bank USA is required to adopt Basel 2
following the successful completion of a parallel run. In
addition, the capital requirements for GS Bank USA are
expected to be impacted by changes to the Basel Committee’s
capital guidelines and by the Dodd-Frank Act, as outlined above.
The deposits of GS Bank USA are insured by the FDIC to the
extent provided by law. The Federal Reserve Board requires
depository institutions to maintain cash reserves with a Federal
Reserve Bank. The amount deposited by the firm’s depository
institution subsidiaries held at the Federal Reserve Bank was
approximately $31.77 billion and $28.12 billion as of
June 2011 and December 2010, respectively, which
exceeded required reserve amounts by $31.19 billion and
$27.45 billion as of June 2011 and December 2010,
respectively. GS Bank Europe, a wholly-owned credit
institution, is regulated by the Central Bank of Ireland and is
subject to minimum capital requirements. As of June 2011
and December 2010, GS Bank USA and GS Bank Europe
were both in compliance with all regulatory capital requirements.
Transactions between GS Bank USA and its subsidiaries and
Group Inc. and its subsidiaries and affiliates (other than,
generally, subsidiaries of GS Bank USA) are regulated by
the Federal Reserve Board. These regulations generally limit the
types and amounts of transactions (including loans to and
borrowings from GS Bank USA) that may take place and
generally require those transactions to be on an
arm’s-length basis.
The firm’s U.S. regulated
broker-dealer
subsidiaries include GS&Co. and GSEC. GS&Co. and GSEC
are registered
U.S. broker-dealers
and futures commission merchants, and are subject to regulatory
capital requirements, including those imposed by the SEC, the
U.S. Commodity Futures Trading Commission (CFTC), Chicago
Mercantile Exchange, the Financial Industry Regulatory
Authority, Inc. (FINRA) and the National Futures Association.
Rule 15c3-1
of the SEC and Rule 1.17 of the CFTC specify uniform
minimum net capital requirements, as defined, for their
registrants, and also effectively require that a significant
part of the registrants’ assets be kept in relatively
liquid form. GS&Co. and GSEC have elected to compute their
minimum capital requirements in accordance with the
“Alternative Net Capital Requirement” as permitted by
Rule 15c3-1.
As of June 2011, GS&Co. had regulatory net capital, as
defined by
Rule 15c3-1,
of $11.51 billion, which exceeded the amount required by
$9.61 billion. As of June 2011, GSEC had regulatory
net capital, as defined by
Rule 15c3-1,
of $1.68 billion, which exceeded the amount required by
$1.55 billion.
In addition to its alternative minimum net capital requirements,
GS&Co. is also required to hold tentative net capital in
excess of $1 billion and net capital in excess of
$500 million in accordance with the market and credit risk
standards of Appendix E of
Rule 15c3-1.
GS&Co. is also required to notify the SEC in the event that
its tentative net capital is less than $5 billion. As of
June 2011 and December 2010, GS&Co. had tentative
net capital and net capital in excess of both the minimum and
the notification requirements.
The firm has U.S. insurance subsidiaries that are subject
to state insurance regulation and oversight in the states in
which they are domiciled and in the other states in which they
are licensed. In addition, certain of
the firm’s insurance subsidiaries outside of the
U.S. are regulated by the FSA and certain are regulated by
the Bermuda Monetary Authority. The firm’s insurance
subsidiaries were in compliance with all regulatory capital
requirements as of June 2011 and December 2010.
The firm’s principal
non-U.S. regulated
subsidiaries include Goldman Sachs International (GSI) and
Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, the firm’s
regulated U.K.
broker-dealer,
is subject to the capital requirements of the FSA. GSJCL, the
firm’s regulated Japanese
broker-dealer,
is subject to the capital requirements imposed by Japan’s
Financial Services Agency. As of June 2011 and
December 2010, GSI and GSJCL were in compliance with their
local capital adequacy requirements. Certain other
non-U.S. subsidiaries
of the firm are also subject to capital adequacy requirements
promulgated by authorities of the countries in which they
operate. As of June 2011 and December 2010, these
subsidiaries were in compliance with their local capital
adequacy requirements.
Restrictions on
Payments
The regulatory requirements referred to above restrict
Group Inc.’s ability to withdraw capital from its
regulated subsidiaries. As of June 2011 and
December 2010, approximately $24.85 billion and
$24.70 billion, respectively, of net assets of regulated
subsidiaries were restricted as to the payment of dividends to
Group Inc. In addition to limitations on the payment of
dividends imposed by federal and state laws, the Federal Reserve
Board, the FDIC and the New York State Banking Department have
authority to prohibit or to limit the payment of dividends by
the banking organizations they supervise (including GS Bank
USA) if, in the relevant regulator’s opinion, payment of a
dividend would constitute an unsafe or unsound practice in the
light of the financial condition of the banking organization.
Basic earnings per common share (EPS) is calculated by dividing
net earnings applicable to common shareholders by the weighted
average number of common shares outstanding. Common shares
outstanding includes common stock and RSUs for which no future
service is required as a condition to the delivery of the
underlying common stock. Diluted EPS includes the determinants
of basic EPS and, in addition reflects the dilutive effect of
the common stock deliverable for stock warrants and options and
for RSUs
for which future service is required as a condition to the
delivery of the underlying common stock. The firm treats
unvested
share-based
payment awards that have
non-forfeitable
rights to dividends or dividend equivalents as a separate class
of securities in calculating EPS.
The table below presents the computations of basic and diluted
EPS.
C:
Three Months
Six Months
Ended June
Ended June
in millions, except per share amounts
2011
2010
2011
2010
Numerator for basic and diluted EPS — net earnings
applicable to common shareholders
$
1,052
$
453
$
1,960
$
3,749
Denominator for basic EPS — weighted average number of
common shares
531.9
539.8
536.2
542.9
Effect of dilutive securities:
RSUs
14.3
14.2
13.4
13.2
Stock options and warrants
23.3
26.4
26.8
29.1
Dilutive potential common shares
37.6
40.6
40.2
42.3
Denominator for diluted EPS — weighted average
number of common shares and dilutive potential common shares
569.5
580.4
576.4
585.2
Basic EPS
$
1.96
$
0.82
$
3.62
$
6.87
Diluted EPS
1.85
0.78
3.40
6.41
In the table above, unvested
share-based
payment awards that have
non-forfeitable
rights to dividends or dividend equivalents are treated as a
separate class of securities in calculating EPS. The impact of
applying this methodology was a reduction to basic EPS of $0.02
for both the three months ended June 2011 and
June 2010, and $0.04 for both the six months ended
June 2011 and June 2010.
The diluted EPS computations in the table above do not include
the antidilutive effect as follows:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Number of antidilutive RSUs and common shares underlying
antidilutive stock options and warrants
The firm has formed numerous nonconsolidated investment funds
with
third-party
investors. The firm generally acts as the investment manager for
these funds and, as such, is entitled to receive management fees
and, in certain cases, advisory fees or incentive fees from
these funds. Additionally, the firm invests alongside the
third-party
investors in certain funds.
The tables below present fees earned from affiliated funds, fees
receivable from affiliated funds and the aggregate carrying
value of the firm’s interests in affiliated funds.
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Fees earned from affiliated funds
$
664
$
597
$
1,516
$
1,150
C:
As of
June
December
in millions
2011
2010
Fees receivable from funds
$
698
$
886
Aggregate carrying value of interests in funds
15,071
14,773
The firm has provided voluntary financial support to certain of
its funds that have experienced significant reductions in
capital and liquidity or had limited access to the debt markets
during the financial crisis. As of June 2011 and
December 2010, the firm had exposure to these funds in the
form of loans and guarantees of $297 million and
$253 million, respectively, primarily related to certain
real estate funds. In addition, as of December 2010, the
firm had outstanding commitments to extend credit to these funds
of $160 million. No such commitments were outstanding as of
June 2011.
The firm may provide additional voluntary financial support to
these funds if they were to experience significant financial
distress; however, such amounts are not expected to be material
to the firm. In the ordinary course of business, the firm may
also engage in other activities with these funds, including,
among others, securities lending, trade execution, market
making, custody, and acquisition and bridge financing. See
Note 18 for the firm’s investment commitments related
to these funds.
Income taxes are provided for using the asset and liability
method under which deferred tax assets and liabilities are
recognized for temporary differences between the financial
reporting and tax bases of assets and liabilities. The firm
reports interest expense related to income tax matters in
“Provision for taxes” and income tax penalties in
“Other expenses.”
Deferred Income
Taxes
Deferred income taxes reflect the net tax effects of temporary
differences between the financial reporting and tax bases of
assets and liabilities. These temporary differences result in
taxable or deductible amounts in future years and are measured
using the tax rates and laws that will be in effect when such
differences are expected to reverse. Valuation allowances are
established to reduce deferred tax assets to the amount that
more likely than not will be realized. Tax assets and
liabilities are presented as a component of “Other
assets” and “Other liabilities and accrued
expenses,” respectively.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Unrecognized Tax
Benefits
The firm recognizes tax positions in the financial statements
only when it is more likely than not that the position will be
sustained on examination by the relevant taxing authority based
on the technical merits of the position. A position that meets
this standard is measured at the largest amount of benefit that
will more likely than not be realized on settlement. A liability
is established for differences between positions taken in a tax
return and amounts recognized in the financial statements.
Regulatory Tax
Examinations
The firm is subject to examination by the U.S. Internal
Revenue Service (IRS) and other taxing authorities in
jurisdictions where the firm has significant business
operations, such as the United Kingdom, Japan, Hong Kong, Korea
and various states, such as New York. The tax years under
examination vary by jurisdiction. The firm believes that during
2011, certain audits have a reasonable possibility of being
completed. The firm does not expect completion of these audits
to have a material impact on the firm’s financial condition
but it may be material to operating results for a particular
period, depending, in part, on the operating results for that
period.
The table below presents the earliest tax years that remain
subject to examination by major jurisdiction.
C:
As of
Jurisdiction
June 2011
U.S. Federal 1
2005
New York State and
City 2
2004
United Kingdom
2007
Japan 3
2005
Hong Kong
2005
Korea
2008
1.
IRS examination of fiscal 2008 through calendar 2010 will begin
during 2011. IRS examination of fiscal 2005, 2006 and 2007 began
during 2008. IRS examination of fiscal 2003 and 2004 has been
completed but the liabilities for those years are not yet final.
2.
New York State and City examination of fiscal 2004, 2005 and
2006 began in 2008.
3.
Japan National Tax Agency examination of fiscal 2005 through
2009 began during the first quarter of 2010.
All years subsequent to the above remain open to examination by
the taxing authorities. The firm believes that the liability for
unrecognized tax benefits it has established is adequate in
relation to the potential for additional assessments.
In the fourth quarter of 2010, the firm reorganized its three
previous reportable business segments into four new reportable
business segments: Investment Banking, Institutional Client
Services, Investing & Lending and Investment
Management. Prior periods are presented on a comparable basis.
Basis of
Presentation
In reporting segments, certain of the firm’s business lines
have been aggregated where they have similar economic
characteristics and are similar in each of the following areas:
(i) the nature of the services they provide,
(ii) their methods of distribution, (iii) the types of
clients they serve and (iv) the regulatory environments in
which they operate.
The cost drivers of the firm taken as a whole —
compensation, headcount and levels of business
activity — are broadly similar in each of the
firm’s business segments. Compensation and benefits
expenses in the firm’s segments reflect, among other
factors, the overall performance of the firm as well as the
performance of individual businesses. Consequently,
pre-tax
margins in one segment of the firm’s business may be
significantly affected by the performance of the firm’s
other business segments.
The firm allocates revenues and expenses among the four
reportable business segments. Due to the integrated nature of
these segments, estimates and judgments are made in allocating
certain revenue and expense items. Transactions between segments
are based on specific criteria or approximate
third-party
rates. Total operating expenses include corporate items that
have not been allocated to individual business segments. The
allocation process is based on the manner in which management
views the business of the firm.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Management believes that the following information provides a
reasonable representation of each
segment’s contribution to consolidated
pre-tax
earnings and total assets.
C:
For the Three
For the Six
Months Ended
Months Ended
or as of June
or as of June
in millions
2011
2010
2011
2010
Investment Banking
Net revenues
$
1,448
$
941
$
2,717
$
2,144
Operating expenses
981
713
1,904
1,593
Pre-tax earnings
$
467
$
228
$
813
$
551
Segment assets
$
1,670
$
1,345
$
1,670
$
1,345
Institutional Client Services
Net
revenues 1
$
3,515
$
4,981
$
10,162
$
13,488
Operating expenses
3,040
4,173
7,624
9,004
Pre-tax earnings
$
475
$
808
$
2,538
$
4,484
Segment assets
$
844,569
$
787,148
$
844,569
$
787,148
Investing & Lending
Net revenues
$
1,044
$
1,786
$
3,749
$
3,756
Operating expenses
547
934
1,778
1,842
Pre-tax earnings
$
497
$
852
$
1,971
$
1,914
Segment assets
$
79,058
$
83,727
$
79,058
$
83,727
Investment Management
Net revenues
$
1,274
$
1,133
$
2,547
$
2,228
Operating expenses
1,056
954
2,123
1,903
Pre-tax earnings
$
218
$
179
$
424
$
325
Segment assets
$
11,613
$
10,968
$
11,613
$
10,968
Total
Net revenues
$
7,281
$
8,841
$
19,175
$
21,616
Operating expenses
5,669
7,393
13,523
15,009
Pre-tax earnings
$
1,612
$
1,448
$
5,652
$
6,607
Total assets
$
936,910
$
883,188
$
936,910
$
883,188
1.
Includes $21 million and $37 million for the three
months ended June 2011 and June 2010, respectively,
and $50 million and $63 million for the six months
ended June 2011 and June 2010, respectively, of
realized gains on securities held in the firm’s insurance
subsidiaries which are accounted for as
available-for-sale.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Operating expenses in the table above include the following
expenses that have not been allocated to the firm’s
segments:
•
net provisions for a number of litigation and regulatory
proceedings of $45 million and $615 million for the
three months ended June 2011 and June 2010,
respectively, and $69 million and $636 million for the
six months ended June 2011 and June 2010, respectively;
•
charitable contributions of $25 million for both the six
months ended June 2011 and June 2010; and
•
real estate-related exit costs of $4 million and
$6 million for the three and six months ended
June 2010, respectively.
The tables below present the amounts of net interest income
included in net revenues, and the amounts of depreciation and
amortization expense included in
pre-tax
earnings.
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Investment Banking
$
—
$
—
$
—
$
—
Institutional Client Services
918
1,190
2,132
2,468
Investing & Lending
442
379
535
468
Investment Management
53
50
104
101
Total net interest
$
1,413
$
1,619
$
2,771
$
3,037
C:
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Investment Banking
$ 38
$ 40
$ 89
$ 84
Institutional Client Services
192
225
523
448
Investing & Lending
94
130
262
191
Investment Management
48
45
92
92
Total depreciation and amortization
$372
$440
$966
$815
Geographic
Information
Due to the highly integrated nature of international financial
markets, the firm manages its businesses based on the
profitability of the enterprise as a whole. The methodology for
allocating profitability to geographic regions is dependent on
estimates and management judgment because a significant portion
of the firm’s activities require cross-border coordination
in order to facilitate the needs of the firm’s clients.
Specifically, in interim periods, the firm generally allocates
compensation and benefits to geographic regions based upon the
firmwide compensation to net revenues ratio. In the fourth
quarter when compensation by employee is finalized, compensation
and benefits are allocated to the geographic regions based upon
total actual compensation during the year.
Geographic results are generally allocated as follows:
•
Investment Banking: location of the client and investment
banking team.
•
Institutional Client Services: Fixed Income, Currency and
Commodities Client Execution, and Equities (excluding Securities
Services): location of the
market-making
desk; Securities Services: location of the primary market for
the underlying security.
•
Investing & Lending: Investing: location of the
investment; Lending: location of the client.
•
Investment Management: location of the sales team.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The table below presents the total net revenues and
pre-tax
earnings of the firm by geographic region allocated based on the
methodology referred to
above, as well as the percentage of total net revenues and
pre-tax
earnings (excluding Corporate) for each geographic region.
C:
Three Months Ended June
Six Months Ended June
$ in millions
2011
2010
2011
2010
Net revenues
Americas 1
$
4,825
66
%
$
4,575
52
%
$
11,664
61
%
$
11,706
54
%
EMEA 2
1,751
24
2,146
24
4,625
24
6,051
28
Asia
705
10
2,120
24
2,886
15
3,859
18
Total net revenues
$
7,281
100
%
$
8,841
100
%
$
19,175
100
%
$
21,616
100
%
Pre-tax
earnings
Americas 1
$
1,202
73
%
$
1,202
58
%
$
3,475
61
%
$
3,991
55
%
EMEA 2
483
29
117
6
1,571
27
1,917
26
Asia
(28
)
(2
)
748
36
700
12
1,366
19
Subtotal
1,657
100
%
2,067
100
%
5,746
100
%
7,274
100
%
Corporate 3
(45
)
(619
)
(94
)
(667
)
Total
pre-tax
earnings
$
1,612
$
1,448
$
5,652
$
6,607
1.
Substantially all relates to the U.S.
2.
EMEA (Europe, Middle East and Africa).
3.
Consists of net provisions for a number of litigation and
regulatory proceedings of $45 million and $615 million
for the three months ended June 2011 and June 2010,
respectively, and $69 million and $636 million for the
six months ended June 2011 and June 2010,
respectively; charitable contributions of $25 million for
both the six months ended June 2011 and June 2010; and
real estate-related exit costs of $4 million and
$6 million for the three and six months ended
June 2010, respectively.
Credit concentrations may arise from market making, client
facilitation, investing, underwriting, lending and
collateralized transactions and may be impacted by changes in
economic, industry or political factors. The firm seeks to
mitigate credit risk by actively monitoring exposures and
obtaining collateral from counterparties as deemed appropriate.
While the firm’s activities expose it to many different
industries and counterparties, the firm routinely executes a
high volume of transactions with asset managers, investment
funds, commercial banks, brokers and dealers, clearing houses
and exchanges, which results in significant credit
concentrations.
In the ordinary course of business, the firm may also be subject
to a concentration of credit risk to a particular counterparty,
borrower or issuer, including sovereign issuers, or to a
particular clearing house or exchange.
The table below presents the credit concentrations in assets
held by the firm. As of June 2011 and December 2010,
the firm did not have credit exposure to any other counterparty
that exceeded 2% of total assets.
C:
As of
June
December
$ in millions
2011
2010
U.S. government and federal agency
obligations 1
$
94,283
$
96,350
% of total assets
10.1%
10.6%
Other sovereign
obligations 1,2
$
54,740
$
40,379
% of total assets
5.8%
4.4%
1.
Included in “Financial instruments owned, at fair
value” and “Cash and securities segregated for
regulatory and other purposes.”
2.
Principally consisting of securities issued by the governments
of the United Kingdom, Japan and Germany as of June 2011,
and the United Kingdom, Japan and France as of
December 2010.
To reduce credit exposures, the firm may enter into agreements
with counterparties that permit the firm to offset receivables
and payables with such counterparties
and/or
enable the firm to obtain collateral on an upfront or contingent
basis. Collateral obtained by the firm related to derivative
assets is principally cash and is held by the firm or a
third-party
custodian. Collateral obtained by the firm related to resale
agreements and securities borrowed transactions is primarily
U.S. government and federal agency obligations and other
sovereign obligations. See Note 9 for further information
about collateralized agreements and financings.
The table below presents U.S. government and federal agency
obligations, and other sovereign obligations that collateralize
resale agreements and securities borrowed transactions
(including those in “Cash and securities segregated for
regulatory and other purposes”). Because the firm’s
primary credit exposure on such transactions is to the
counterparty to the transaction, the firm would be exposed to
the collateral issuer only in the event of counterparty default.
C:
As of
June
December
in millions
2011
2010
U.S. government and federal agency obligations
$
106,982
$
121,366
Other sovereign
obligations 1
97,628
73,357
1.
Principally consisting of securities issued by the governments
of France and Germany.
The firm is involved in a number of judicial, regulatory and
arbitration proceedings (including those described below)
concerning matters arising in connection with the conduct of the
firm’s businesses. Many of these proceedings are at
preliminary stages, and many of these cases seek an
indeterminate amount of damages.
With respect to matters described below, management has
estimated the upper end of the range of reasonably possible loss
as being equal to (i) the amount of money damages claimed,
where applicable, (ii) the amount of securities that the
firm sold in cases involving underwritings where the firm is
being sued by purchasers and is not being indemnified by a party
that the firm believes will pay any judgment, or (iii) in
cases where the purchasers are demanding that the firm
repurchase securities, the price that purchasers paid for the
securities less the estimated value, if any, as of
June 2011 of the relevant securities. As of June 2011,
the firm has estimated the aggregate amount of reasonably
possible losses for these matters to be approximately
$2.0 billion.
Under ASC 450 an event is “reasonably possible” if
“the chance of the future event or events occurring is more
than remote but less than likely” and an event is
“remote” if “the chance of the future event or
events occurring is slight.” Thus, references to the upper
end of the range of reasonably possible loss for cases in which
the firm is able to estimate a range of reasonably possible loss
mean the upper end of the range of loss for cases for which the
firm believes the risk of loss is more than slight. The amounts
reserved against such matters are not significant as compared to
the upper end of the range of reasonably possible loss.
Management is unable to estimate a range of reasonably possible
loss for cases described below in which damages have not been
specified and (i) the proceedings are in early stages,
(ii) there is uncertainty as to the likelihood of a class
being certified or the ultimate size of the class,
(iii) there is uncertainty as to the outcome of pending
appeals or motions, (iv) there are significant factual
issues to be resolved,
and/or
(v) there are novel legal issues presented. However, for
these cases, management does not believe, based on currently
available
information, that the outcomes of these proceedings will have a
material adverse effect on the firm’s financial condition,
though the outcomes could be material to the firm’s
operating results for any particular period, depending, in part,
upon the operating results for such period.
IPO Process Matters. Group Inc. and
GS&Co. are among the numerous financial services companies
that have been named as defendants in a variety of lawsuits
alleging improprieties in the process by which those companies
participated in the underwriting of public offerings in recent
years.
GS&Co. has, together with other underwriters in certain
offerings as well as the issuers and certain of their officers
and directors, been named as a defendant in a number of related
lawsuits filed in the U.S. District Court for the Southern
District of New York alleging, among other things, that the
prospectuses for the offerings violated the federal securities
laws by failing to disclose the existence of alleged
arrangements tying allocations in certain offerings to higher
customer brokerage commission rates as well as purchase orders
in the aftermarket, and that the alleged arrangements resulted
in market manipulation. On October 5, 2009, the
district court approved a settlement agreement entered into by
the parties. The firm has paid into a settlement fund the full
amount that GS&Co. would contribute in the proposed
settlement. On October 23, 2009, certain objectors
filed a petition in the U.S. Court of Appeals for the
Second Circuit seeking review of the district court’s
certification of a class for purposes of the settlement, and
various objectors appealed certain aspects of the
settlement’s approval. All but two of the appeals have been
withdrawn, and on December 8, 2010,
January 14, 2011 and February 3, 2011,
plaintiffs moved to dismiss the remaining appeals. On
May 17, 2011, the appellate court dismissed one of the
appeals and remanded the other, and further proceedings are in
progress in the district court regarding the objectors’
membership in the class. On July 19, 2011, the
objectors whose appeal had been dismissed filed a motion to
recall the mandate dismissing the appeal and for reconsideration.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
GS&Co. is among numerous underwriting firms named as
defendants in a number of complaints filed commencing
October 3, 2007, in the U.S. District Court for
the Western District of Washington alleging violations of
Section 16 of the Exchange Act in connection with offerings
of securities for 15 issuers during 1999 and 2000. The
complaints generally assert that the underwriters, together with
each issuer’s directors, officers and principal
shareholders, entered into purported agreements to tie
allocations in the offerings to increased brokerage commissions
and aftermarket purchase orders. The complaints further allege
that, based upon these and other purported agreements, the
underwriters violated the reporting provisions of, and are
subject to
short-swing
profit recovery under, Section 16 of the Exchange Act. The
district court granted defendants’ motions to dismiss by a
decision dated March 12, 2009 on the grounds that the
plaintiff’s demands were inadequate with respect to certain
actions and that the remainder of the actions were time-barred.
On December 2, 2010, the appellate court affirmed in
part and reversed in part, upholding the dismissal of seven of
the actions in which GS&Co. is a defendant that were
dismissed based on the deficient demands but remanding the
remaining eight actions in which GS&Co. is a defendant that
were dismissed as time-barred for consideration of other bases
for dismissal. On December 16, 2010, the underwriters
and the plaintiff filed petitions for rehearing
and/or
rehearing en banc, which were denied on
January 18, 2011. On June 27, 2011, the
U.S. Supreme Court granted the defendants’ petition
for review of whether the actions that were remanded are
time-barred and denied the plaintiff’s petition.
GS&Co. has been named as a defendant in an action commenced
on May 15, 2002 in New York Supreme Court, New York
County, by an official committee of unsecured creditors on
behalf of eToys, Inc., alleging that the firm intentionally
underpriced eToys, Inc.’s initial public offering. The
action seeks, among other things, unspecified compensatory
damages resulting from the alleged lower amount of offering
proceeds. On appeal from rulings on GS&Co.’s motion to
dismiss, the New York Court of Appeals dismissed claims for
breach of contract, professional malpractice and unjust
enrichment, but permitted claims for breach of fiduciary duty
and fraud to continue. On remand to the lower court, GS&Co.
moved to dismiss the surviving claims or, in the alternative,
for summary
judgment, but the motion was denied by a decision dated
March 21, 2006, and the court subsequently permitted
plaintiff to amend the complaint again. On
November 8, 2010, GS&Co.’s motion for
summary judgment was granted by the lower court; plaintiff has
appealed.
Group Inc. and certain of its affiliates have, together
with various underwriters in certain offerings, received
subpoenas and requests for documents and information from
various governmental agencies and self-regulatory organizations
in connection with investigations relating to the public
offering process. Goldman Sachs has cooperated with these
investigations.
World Online Litigation. In March 2001, a
Dutch shareholders’ association initiated legal proceedings
for an unspecified amount of damages against GSI and others in
Amsterdam District Court in connection with the initial public
offering of World Online in March 2000, alleging
misstatements and omissions in the offering materials and that
the market was artificially inflated by improper public
statements and stabilization activities. Goldman Sachs and ABN
AMRO Rothschild served as joint global coordinators of the
approximately €2.9 billion offering. GSI underwrote
20,268,846 shares and GS&Co. underwrote
6,756,282 shares for a total offering price of
approximately €1.16 billion.
The district court rejected the claims against GSI and ABN AMRO,
but found World Online liable in an amount to be determined. On
appeal, the Netherlands Court of Appeals affirmed in part and
reversed in part the decision of the district court, holding
that certain of the alleged disclosure deficiencies were
actionable as to GSI and ABN AMRO. On further appeal, the
Netherlands Supreme Court on November 27, 2009
affirmed the rulings of the Court of Appeals, except that it
found certain additional aspects of the offering materials
actionable and held that individual investors could potentially
hold GSI and ABN AMRO responsible for certain public statements
and press releases by World Online and its former CEO. The
parties entered into a definitive settlement agreement, dated
July 15, 2011, pursuant to which GSI will contribute
up to €48 million to a settlement fund. The firm has
reserved the full amount of GSI’s proposed contribution to
the settlement. Smaller shareholders’ associations have
made demands for compensation of damages.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Research Matters. Group Inc. and certain
of its affiliates are subject to a number of investigations and
reviews by various governmental and regulatory bodies and
self-regulatory organizations relating to research practices,
including communications among research analysts, sales and
trading personnel and clients. On June 9, 2011,
pursuant to a settlement, a consent order was entered by the
Massachusetts Securities Division pursuant to which GS&Co.
paid a $10 million civil penalty and agreed to certain
undertakings regarding its research practices. Other regulators,
including the SEC and FINRA, have been investigating similar
matters, and Goldman Sachs is in discussions with the SEC staff
and the FINRA staff concerning resolutions of their proposed
charges.
Adelphia Communications Fraudulent Conveyance
Litigation. GS&Co. is named a defendant in
two adversary proceedings commenced in the U.S. Bankruptcy
Court for the Southern District of New York, one on
July 6, 2003 by a creditors committee, and the second
on or about July 31, 2003 by an equity committee of
Adelphia Communications, Inc. Those proceedings were
consolidated in a single amended complaint filed by the Adelphia
Recovery Trust on October 31, 2007. The complaint
seeks, among other things, to recover, as fraudulent
conveyances, approximately $62.9 million allegedly paid to
GS&Co. by Adelphia Communications, Inc. and its affiliates
in respect of margin calls made in the ordinary course of
business on accounts owned by members of the family that
formerly controlled Adelphia Communications, Inc. The district
court assumed jurisdiction over the action and on
April 8, 2011 granted GS&Co.’s motion for
summary judgment. On May 6, 2011, the plaintiff filed
a notice of appeal.
Specialist Matters. Spear, Leeds &
Kellogg Specialists LLC (SLKS) and certain affiliates have
received requests for information from various governmental
agencies and self-regulatory organizations as part of an
industry-wide
investigation relating to activities of floor specialists in
recent years. Goldman Sachs has cooperated with the requests.
On March 30, 2004, certain specialist firms on the
NYSE, including SLKS, without admitting or denying the
allegations, entered into a final global settlement with the SEC
and the NYSE covering certain activities during the years 1999
through 2003. The SLKS settlement involves, among other things,
(i) findings by the SEC and the NYSE that SLKS violated
certain federal securities laws and NYSE rules, and in some
cases failed to supervise certain individual specialists, in
connection with trades that allegedly disadvantaged customer
orders, (ii) a cease and desist order against SLKS,
(iii) a censure of SLKS, (iv) SLKS’ agreement to
pay an aggregate of $45.3 million in disgorgement and a
penalty to be used to compensate customers, (v) certain
undertakings with respect to SLKS’ systems and procedures,
and (vi) SLKS’ retention of an independent consultant
to review and evaluate certain of SLKS’ compliance systems,
policies and procedures. Comparable findings were made and
sanctions imposed in the settlements with other specialist
firms. The settlement did not resolve the related private civil
actions against SLKS and other firms or regulatory
investigations involving individuals or conduct on other
exchanges. On May 26, 2011, the SEC issued an order
directing the undistributed settlement funds to be transferred
to the U.S. Treasury; the funds will accordingly not be
allocated to any settlement fund for the civil actions described
below.
SLKS, Spear, Leeds & Kellogg, L.P. and Group Inc.
are among numerous defendants named in purported class actions
brought beginning in October 2003 on behalf of investors in
the U.S. District Court for the Southern District of New
York alleging violations of the federal securities laws and
state common law in connection with NYSE floor specialist
activities. The actions, which have been consolidated, seek
unspecified compensatory damages, restitution and disgorgement
on behalf of purchasers and sellers of unspecified securities
between October 17, 1998 and
October 15, 2003. By a decision dated
March 14, 2009, the district court granted
plaintiffs’ motion for class certification. The
defendants’ petition with the U.S. Court of Appeals
for the Second Circuit seeking review of the certification
ruling was denied by an order dated October 1, 2009.
The specialist defendants’ petition for a rehearing
and/or
rehearing en banc was denied on February 24, 2010.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Treasury Matters. GS&Co. was named as a
defendant in a purported class action filed on
March 10, 2004 in the U.S. District Court for the
Northern District of Illinois on behalf of holders of short
positions in
30-year
U.S. Treasury futures and options on the morning of
October 31, 2001. The complaint alleged that the firm
purchased
30-year
bonds and futures prior to a forthcoming U.S. Treasury
refunding announcement that morning based on
non-public
information about that announcement, and that such purchases
increased the costs of covering such short positions. The
complaint also named as defendants the Washington, D.C.-based
political consultant who allegedly was the source of the
information, a former GS&Co. economist who allegedly
received the information, and another company and one of its
employees who also allegedly received and traded on the
information prior to its public announcement. The complaint
alleged violations of the federal commodities and antitrust
laws, as well as Illinois statutory and common law, and seeks,
among other things, unspecified damages including treble damages
under the antitrust laws. The district court dismissed the
antitrust and Illinois state law claims but permitted the
federal commodities law claims to proceed. Plaintiff’s
motion for class certification was denied by a decision dated
August 22, 2008. GS&Co. moved for summary
judgment, and the district court granted the motion but only
insofar as the claim relates to the trading of treasury bonds.
On October 13, 2009, the parties filed an offer of
judgment and notice of acceptance with respect to
plaintiff’s individual claim. The plaintiff attempted to
pursue an appeal of the denial of class certification, as did
another individual trader who had previously litigated and lost
an individual claim and unsuccessfully sought to intervene in
the purported class action. On August 5, 2011, the
U.S. Court of Appeals for the Seventh Circuit affirmed the
lower court’s rulings denying both the plaintiff’s and
the proposed intervenor’s ability to pursue class claims,
but remanded for further consideration as to the amount of
pre-judgment interest on the plaintiff’s individual claim.
Fannie Mae Litigation. GS&Co. was added
as a defendant in an amended complaint filed on
August 14, 2006 in a purported class action pending in
the U.S. District Court for the District of Columbia. The
complaint asserts violations of the federal securities laws
generally arising from allegations concerning Fannie Mae’s
accounting practices in connection with certain Fannie
Mae-sponsored REMIC transactions that were allegedly arranged by
GS&Co. The complaint does not specify a dollar amount of
damages. The other defendants include Fannie Mae, certain of its
past and present officers and directors, and accountants. By a
decision dated May 8, 2007, the district court granted
GS&Co.’s motion to dismiss the claim against it. The
time for an appeal will not begin to run until disposition of
the claims against other defendants.
Beginning in September 2006, Group Inc.
and/or
GS&Co. were named as defendants in four Fannie Mae
shareholder derivative actions in the U.S. District Court
for the District of Columbia. The complaints generally allege
that the Goldman Sachs defendants aided and abetted a breach of
fiduciary duty by Fannie Mae’s directors and officers in
connection with certain Fannie Mae-sponsored REMIC transactions,
and one of the complaints also asserts a breach of contract
claim. The complaints also name as defendants certain former
officers and directors of Fannie Mae as well as an outside
accounting firm. The complaints seek, inter alia,
unspecified damages. The Goldman Sachs defendants were dismissed
without prejudice from the first filed of these actions, and the
remaining claims in that action were dismissed for failure to
make a demand on Fannie Mae’s board of directors. That
dismissal has been affirmed on appeal. The district court
dismissed the remaining three actions on
July 28, 2010. The plaintiffs filed motions for
reconsideration, which were denied on
October 22, 2010, and have revised their notices of
appeal in these actions. On January 20, 2011, the
appellate court consolidated all actions on appeal.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Compensation-Related Litigation. On
January 17, 2008, Group Inc., its Board, executive
officers and members of its management committee were named as
defendants in a purported shareholder derivative action in the
U.S. District Court for the Eastern District of New York
predicting that the firm’s 2008 Proxy Statement would
violate the federal securities laws by undervaluing certain
stock option awards and alleging that senior management received
excessive compensation for 2007. The complaint seeks, among
other things, an equitable accounting for the allegedly
excessive compensation. Plaintiff’s motion for a
preliminary injunction to prevent the 2008 Proxy Statement from
using options valuations that the plaintiff alleges are
incorrect and to require the amendment of SEC Form 4s filed
by certain of the executive officers named in the complaint to
reflect the stock option valuations alleged by the plaintiff was
denied, and plaintiff’s appeal from this denial was
dismissed. On February 13, 2009, the plaintiff filed
an amended complaint, which added purported direct
(i.e., non-derivative)
claims based on substantially the same theory. The plaintiff
filed a further amended complaint on March 24, 2010,
and the defendants’ motion to dismiss this further amended
complaint was granted on September 30, 2010. On
October 22, 2010, the plaintiff filed a notice of
appeal from the dismissal of his complaint.
On March 24, 2009, the same plaintiff filed an action
in New York Supreme Court, New York County against
Group Inc., its directors and certain senior executives
alleging violation of Delaware statutory and common law in
connection with substantively similar allegations regarding
stock option awards. On January 7, 2011, the plaintiff
filed an amended complaint. Defendants moved to dismiss the
amended complaint on March 4, 2011, and the parties
subsequently agreed to stay the state court action pending the
final resolution of the appeal from the dismissal of the federal
court action in respect of the firm’s 2008 Proxy Statement,
as well as any remanded proceedings further adjudicating
defendants’ motion to dismiss.
Purported shareholder derivative actions have been commenced in
New York Supreme Court, New York County and the Delaware Court
of Chancery beginning on December 14, 2009, alleging
that the Board breached its fiduciary duties in connection with
setting compensation levels for the year 2009 and that such
levels are excessive. The complaints name as defendants
Group Inc., the Board and certain senior executives. The
complaints seek, inter alia, unspecified damages,
restitution of certain compensation paid, and an order requiring
the firm to adopt corporate reforms. In the actions in New York
state court, on April 8, 2010, the plaintiffs filed a
motion indicating that they no longer intend to pursue their
claims but are seeking an award of attorneys’ fees in
connection with bringing the suit, which the defendants have
opposed. In the actions brought in the Delaware Court of
Chancery, the defendants moved to dismiss on
March 9, 2010, and the plaintiffs amended their
complaint on April 28, 2010 to include, among other
things, the allegations included in the SEC’s action
described in the
“Mortgage-Related
Matters” section below. The defendants moved to dismiss
this amended complaint on May 12, 2010. In lieu of
responding to defendants’ motion, plaintiffs moved on
December 8, 2010 for permission to file a further
amended complaint, which the defendants had opposed. The court
granted plaintiffs’ motion to amend on
January 19, 2011, and the defendants moved to dismiss
the second amended complaint on February 4, 2011.
Group Inc. and certain of its affiliates are subject to a
number of investigations and reviews from various governmental
agencies and self-regulatory organizations regarding the
firm’s compensation processes. The firm is cooperating with
the investigations and reviews.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Mortgage-Related
Matters. On April 16, 2010, the SEC
brought an action (SEC Action) under the U.S. federal
securities laws in the U.S. District Court for the Southern
District of New York against GS&Co. and Fabrice Tourre, one
of its employees, in connection with a CDO offering made in
early 2007 (ABACUS
2007-AC1
transaction), alleging that the defendants made materially false
and misleading statements to investors and seeking, among other
things, unspecified monetary penalties. Investigations of
GS&Co. by FINRA and of GSI by the FSA were subsequently
initiated, and Group Inc. and certain of its affiliates
have received subpoenas and requests for information from other
regulators, regarding CDO offerings, including the ABACUS
2007-AC1
transaction, and related matters.
On July 14, 2010, GS&Co. entered into a consent
agreement with the SEC, settling all claims made against
GS&Co. in the SEC Action (SEC Settlement), pursuant to
which, GS&Co. paid $550 million of disgorgement and
civil penalties, and which was approved by the
U.S. District Court for the Southern District of New York
on July 20, 2010.
On September 9, 2010, the FSA announced a settlement
with GSI pursuant to which the FSA found that GSI violated
certain FSA principles by failing to (i) provide
notification about the SEC Wells Notice issued to
Mr. Tourre (who worked on the ABACUS
2007-AC1
transaction but subsequently transferred to GSI and became
registered with the FSA) and (ii) have procedures and
controls to ensure that GSI’s Compliance Department would
be alerted to various aspects of the SEC investigation so as to
be in a position to determine whether any aspects were
reportable to the FSA. The FSA assessed a fine of
£17.5 million.
On November 9, 2010, FINRA announced a settlement with
GS&Co. relating to GS&Co.’s failure to file
Form U4 updates within 30 days of learning of the
receipt of Wells Notices by Mr. Tourre and another employee
as well as deficiencies in the firm’s systems and controls
for such filings. FINRA assessed a fine of $650,000 and
GS&Co. agreed to undertake a review and remediation of the
applicable systems and controls.
On January 6, 2011, ACA Financial Guaranty Corp. filed
an action against GS&Co. in respect of the ABACUS
2007-AC1
transaction in New York Supreme Court, New York County. The
complaint includes allegations of fraudulent inducement,
fraudulent concealment and unjust enrichment and seeks at least
$30 million in compensatory damages, at least
$90 million in punitive damages and unspecified
disgorgement. On March 8, 2011, GS&Co. filed a
motion to compel arbitration
and/or to
dismiss the complaint. On April 25, 2011, the
plaintiff filed an amended complaint, and on
June 3, 2011, GS&Co. moved to dismiss the amended
complaint.
Since April 22, 2010, a number of putative shareholder
derivative actions have been filed in New York Supreme Court,
New York County, and the U.S. District Court for the
Southern District of New York against Group Inc., the Board
and certain officers and employees of Group Inc. and its
affiliates in connection with
mortgage-related
matters between 2004 and 2007, including the ABACUS
2007-AC1
transaction and other CDO offerings. These derivative complaints
generally include allegations of breach of fiduciary duty,
corporate waste, abuse of control, mismanagement, unjust
enrichment, misappropriation of information, securities fraud
and insider trading, and challenge the accuracy and adequacy of
Group Inc.’s disclosure. These derivative complaints
seek, among other things, declaratory relief, unspecified
compensatory damages, restitution and certain corporate
governance reforms. The New York Supreme Court has consolidated
the two actions pending in that court. The federal court cases
have also been consolidated, and plaintiffs filed a consolidated
amended complaint on August 1, 2011. In addition, as
described in the “Compensation-Related Litigation”
section above, the plaintiffs in the compensation-related
Delaware Court of Chancery actions have amended their complaint
to assert, among other things, allegations similar to those in
the derivative claims referred to above, the defendants moved to
dismiss this amended complaint, the plaintiffs amended the
complaint further and the defendants moved to dismiss the second
amended complaint on February 4, 2011. On
May 18, 2011, the defendants moved to stay or dismiss
the New York state court action in favor of the federal court
action
and/or the
Delaware Chancery Court action.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Since April 23, 2010, the Board has received letters
from shareholders demanding that the Board take action to
address alleged misconduct by GS&Co., the Board and certain
officers and employees of Group Inc. and its affiliates.
The demands generally allege misconduct in connection with the
firm’s securitization practices, including the ABACUS
2007-AC1
transaction, the alleged failure by Group Inc. to
adequately disclose the SEC investigation that led to the SEC
Action, and Group Inc.’s 2009 compensation practices.
The demands include a letter from a Group Inc. shareholder,
which previously made a demand that the Board investigate and
take action in connection with auction products matters, and
expanded its demand to address the foregoing matters. The Board
previously rejected the demand relating to auction products
matters.
In addition, beginning April 26, 2010, a number of
purported securities law class actions have been filed in the
U.S. District Court for the Southern District of New York
challenging the adequacy of Group Inc.’s public
disclosure of, among other things, the firm’s activities in
the CDO market and the SEC investigation that led to the SEC
Action. The purported class action complaints, which name as
defendants Group Inc. and certain officers and employees of
Group Inc. and its affiliates, have been consolidated,
generally allege violations of Sections 10(b) and 20(a) of
the Exchange Act and seek unspecified damages. Plaintiffs filed
a consolidated amended complaint on July 25, 2011.
GS&Co., Goldman Sachs Mortgage Company and GS Mortgage
Securities Corp. and three current or former Goldman Sachs
employees are defendants in a putative class action commenced on
December 11, 2008 in the U.S. District Court for
the Southern District of New York brought on behalf of
purchasers of various mortgage pass-through certificates and
asset-backed
certificates issued by various securitization trusts established
by the firm and underwritten by GS&Co. in 2007. The
complaint generally alleges that the registration statement and
prospectus supplements for the certificates violated the federal
securities laws, and seeks unspecified compensatory damages and
rescission or recessionary damages. On
January 28, 2010, the defendants’ motion to
dismiss the second amended complaint was granted with leave to
replead certain claims. On March 31, 2010, the
plaintiff filed a third amended complaint relating to two
offerings, which the defendants moved to dismiss on
June 22, 2010. This motion to dismiss was denied as to
the plaintiff’s Section 12(a)(2) claims and granted as
to the plaintiff’s
Section 11 claims, and the plaintiff’s motion for
reconsideration was denied on November 17, 2010. The
plaintiff filed a motion for entry of final judgment or
certification of an interlocutory appeal as to plaintiff’s
Section 11 claims, which was denied on
January 11, 2011. The plaintiff then filed a motion
for leave to amend to reinstate the damages claims based on
allegations that it had now sold its securities, which was
denied on March 3, 2011. On May 5, 2011, the
court granted plaintiff’s motion for entry of a final
judgment dismissing all its claims. On July 5, 2011,
plaintiff filed a notice of appeal. On June 3, 2010,
another investor (who had unsuccessfully sought to intervene in
the action) filed a separate putative class action asserting
substantively similar allegations relating to an additional
offering pursuant to the 2007 registration statement. The
defendants moved to dismiss this separate action on
November 1, 2010. These trusts issued, and GS&Co.
underwrote, approximately $785 million principal amount of
certificates to all purchasers in the offerings at issue in the
complaint (excluding those offerings for which the claims have
been dismissed).
Group Inc., GS&Co., Goldman Sachs Mortgage Company and
GS Mortgage Securities Corp. are among the defendants in a
separate putative class action commenced on
February 6, 2009 in the U.S. District Court for
the Southern District of New York brought on behalf of
purchasers of various mortgage pass-through certificates and
asset-backed
certificates issued by various securitization trusts established
by the firm and underwritten by GS&Co. in 2006. The other
defendants include three current or former Goldman Sachs
employees and various rating agencies. The second amended
complaint generally alleges that the registration statement and
prospectus supplements for the certificates violated the federal
securities laws, and seeks unspecified compensatory and
rescissionary damages. Defendants moved to dismiss the second
amended complaint. On January 12, 2011, the district
court granted the motion to dismiss with respect to offerings in
which plaintiff had not purchased securities, but denied the
motion to dismiss with respect to a single offering in which the
plaintiff allegedly purchased securities. These trusts issued,
and GS&Co. underwrote, approximately $698 million
principal amount of certificates to all purchasers in the
offerings at issue in the complaint (excluding those offerings
for which the claims have been dismissed). On
March 18, 2011, the district court bifurcated class
and merits discovery.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
On September 30, 2010, a putative class action was
filed in the U.S. District Court for the Southern District
of New York against GS&Co., Group Inc. and two former
GS&Co. employees on behalf of investors in notes issued in
2006 and 2007 by two synthetic CDOs (Hudson Mezzanine
2006-1 and
2006-2). The
complaint, which was amended on February 4, 2011,
asserts federal securities law and common law claims, and seeks
unspecified compensatory, punitive and other damages. The
defendants moved to dismiss on April 5, 2011.
Various alleged purchasers of, and counterparties involved in
transactions relating to, mortgage pass-through certificates,
CDOs and other
mortgage-related
products (including the Federal Home Loan Banks of Seattle,
Chicago, Indianapolis and Boston, the Charles Schwab
Corporation, Cambridge Place Investment Management Inc.,
Heungkuk Life Insurance Co. Limited (Heungkuk), Basis Yield
Alpha Fund (Master) (Basis Yield), Landesbank
Baden-Württemberg, The Union Central Life Insurance
Company, Ameritas Life Insurance Corp., Acacia Life Insurance
Company and Massachusetts Mutual Life Insurance Company, among
others) have filed complaints in state and federal court against
firm affiliates, generally alleging that the offering documents
for the securities that they purchased contained untrue
statements of material facts and material omissions and
generally seeking rescission and damages. Certain of these
complaints also name other firms as defendants. A number of
other entities (including the National Credit Union
Administration, the Federal Housing Finance Agency, Fannie Mae,
Freddie Mac, Allstate Insurance Company, John Hancock and
related parties and American International Group, Inc. (AIG))
have threatened to assert claims against the firm in connection
with various
mortgage-related
offerings, and the firm has entered into agreements with a
number of these entities to toll the relevant statute of
limitations. The firm estimates, based on currently available
information, that the aggregate cumulative losses experienced by
the plaintiffs with respect to the securities at issue in active
cases brought against the firm where purchasers are seeking
rescission of
mortgage-related
securities was approximately $485 million as of
June 2011. This amount was calculated as the aggregate
amount by
which the initial purchase price for the securities allegedly
purchased by the plaintiffs exceeds the estimated June 2011
value of those securities. This estimate does not include the
threatened claims noted above or potential claims by other
purchasers in the same or other
mortgage-related
offerings that have not actually brought claims against the firm
or the claim by Basis Yield, which has been dismissed with leave
to amend.
Heungkuk has also filed a criminal complaint against certain
past and present employees of the firm in South Korea relating
to its purchase of a CDO securitization from Goldman Sachs. The
filing does not represent any judgment by a governmental entity,
but starts a process whereby the prosecutor investigates the
complaint and determines whether to take action.
On July 1, 2011, a putative shareholder derivative
action was filed in the U.S. District Court for the
Southern District of New York against Group Inc., the Board
and certain officers and employees of Group Inc. and its
affiliates in connection with the servicing of residential
mortgage loans and other
mortgage-related
activities, since January 2009. The complaint alleges
breach of fiduciary duty, and seeks, among other things,
declaratory relief, unspecified damages and certain governance
reforms.
The firm has also received requests for information
and/or
subpoenas from federal, state and local regulators and law
enforcement authorities, relating to the
mortgage-related
securitization process, subprime mortgages, CDOs, synthetic
mortgage-related
products, particular transactions involving these products, and
servicing and foreclosure activities, and is cooperating with
these regulators and other authorities. See also “Financial
Crisis-Related Matters” below.
The firm expects to be the subject of additional putative
shareholder derivative actions, purported class actions,
rescission and “put back” claims and other litigation,
additional investor and shareholder demands, and additional
regulatory and other investigations and actions with respect to
mortgage-related
offerings, loan sales, CDOs, and servicing and foreclosure
activities. See Note 18 for further information regarding
mortgage-related
contingencies.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Auction Products Matters. On
August 21, 2008, GS&Co. entered into a settlement
in principle with the Office of the Attorney General of the
State of New York and the Illinois Securities Department (on
behalf of the North American Securities Administrators
Association) regarding auction rate securities. Under the
agreement, Goldman Sachs agreed, among other things, (i) to
offer to repurchase at par the outstanding auction rate
securities that its private wealth management clients purchased
through the firm prior to February 11, 2008, with the
exception of those auction rate securities where auctions are
clearing, (ii) to continue to work with issuers and other
interested parties, including regulatory and governmental
entities, to expeditiously provide liquidity solutions for
institutional investors, and (iii) to pay a
$22.5 million fine. The settlement is subject to definitive
documentation and approval by the various states. On
June 2, 2009, GS&Co. entered into an Assurance of
Discontinuance with the New York State Attorney General. On
March 19, 2010, GS&Co. entered into an
Administrative Consent Order with the Illinois Secretary of
State, Securities Department, which had conducted an
investigation on behalf of states other than New York.
GS&Co. has entered into similar consent orders with most
states and is in the process of doing so with the remaining
states.
On September 4, 2008, Group Inc. was named as a
defendant, together with numerous other financial services
firms, in two complaints filed in the U.S. District Court
for the Southern District of New York alleging that the
defendants engaged in a conspiracy to manipulate the auction
securities market in violation of federal antitrust laws. The
actions were filed, respectively, on behalf of putative classes
of issuers of and investors in auction rate securities and seek,
among other things, treble damages in an unspecified amount.
Defendants’ motion to dismiss was granted on
January 26, 2010. On March 1, 2010, the
plaintiffs filed a notice of appeal from the dismissal of their
complaints.
Private
Equity-Sponsored
Acquisitions Litigation. Group Inc. and
“GS Capital Partners” are among numerous private
equity firms and investment banks named as defendants in a
federal antitrust action filed in the U.S. District Court
for the District of Massachusetts in December 2007. As
amended, the complaint generally alleges that the defendants
have colluded to limit competition in bidding for private
equity-sponsored
acquisitions of public companies, thereby resulting in lower
prevailing bids and, by extension, less consideration for
shareholders of those companies in violation of Section 1
of the U.S. Sherman Antitrust Act and common law. The
complaint seeks, among other things, treble damages in an
unspecified amount. Defendants moved to dismiss on
August 27, 2008. The district court dismissed claims
relating to certain transactions that were the subject of
releases as part of the settlement of shareholder actions
challenging such transactions, and by an order dated
December 15, 2008 otherwise denied the motion to
dismiss. On April 26, 2010, the plaintiffs moved for
leave to proceed with a second phase of discovery encompassing
additional transactions. On August 18, 2010, the court
permitted discovery on eight additional transactions, and the
plaintiffs filed a fourth amended complaint on
October 7, 2010. The defendants filed a motion to
dismiss certain aspects of the fourth amended complaint on
October 21, 2010, and the court granted that motion on
January 13, 2011. On January 21, 2011,
certain defendants, including Group Inc., filed a motion to
dismiss another claim of the fourth amended complaint on the
grounds that the transaction was the subject of a release as
part of the settlement of a shareholder action challenging the
transaction. The court granted that motion on
March 1, 2011. On July 11, 2011, the
plaintiffs moved for leave to file a fifth amended complaint
encompassing additional transactions.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Washington Mutual Securities
Litigation. GS&Co. is among numerous
underwriters named as defendants in a putative securities class
action amended complaint filed on August 5, 2008 in
the U.S. District Court for the Western District of
Washington. As to the underwriters, plaintiffs allege that the
offering documents in connection with various securities
offerings by Washington Mutual, Inc. failed to describe
accurately the company’s exposure to
mortgage-related
activities in violation of the disclosure requirements of the
federal securities laws. The defendants include past and present
directors and officers of Washington Mutual, the company’s
former outside auditors, and numerous underwriters. By a
decision dated October 27, 2009, the federal district
court granted and denied in part the underwriters’ motion
to dismiss the plaintiffs’ amended complaint. On
October 12, 2010, the court granted class
certification (except as to one transaction). On
December 1, 2010, the defendants moved for partial
judgment on the pleadings as to two of the offerings. By a
decision dated January 28, 2011, the district court
denied the defendants’ motion for partial judgment on the
pleadings. On June 30, 2011, the underwriter defendants and
plaintiffs entered into a definitive settlement agreement,
pursuant to which GS&Co. would contribute to a settlement
fund. On July 21, 2011 the court preliminarily
approved the settlement and scheduled a final hearing for
November 4, 2011. The firm has paid the full amount of
GS&Co.’s proposed contribution to the settlement.
GS&Co. underwrote approximately $520 million principal
amount of securities to all purchasers in the offerings at issue
in the complaint (excluding those offerings for which the claims
have been dismissed).
On September 25, 2008, the FDIC took over the primary
banking operations of Washington Mutual, Inc. and then sold
them. On September 27, 2008, Washington Mutual, Inc.
filed for Chapter 11 bankruptcy in the U.S. bankruptcy
court in Delaware.
IndyMac Pass-Through Certificates Litigation. GS&Co. is among numerous underwriters named as
defendants in a putative securities class action filed on
May 14, 2009 in the U.S. District Court for the
Southern District of New York. As to the underwriters,
plaintiffs allege that the offering documents in connection with
various securitizations of
mortgage-related
assets violated the disclosure requirements of the federal
securities laws. The defendants include IndyMac-related entities
formed in connection with the securitizations, the underwriters
of the offerings, certain ratings agencies which evaluated the
credit quality of the securities, and certain former officers
and directors of IndyMac affiliates. On
November 2, 2009, the underwriters moved to dismiss
the complaint. The motion was granted in part on
February 17, 2010 to the extent of dismissing claims
based on offerings in which no plaintiff purchased, and the
court reserved judgment as to the other aspects of the motion.
By a decision dated June 21, 2010, the district court
formally dismissed all claims relating to offerings in which no
named plaintiff purchased certificates (including all offerings
underwritten by GS&Co.), and both granted and denied the
defendants’ motions to dismiss in various other respects.
On May 17, 2010, four additional investors filed a
motion seeking to intervene in order to assert claims based on
additional offerings (including two underwritten by
GS&Co.). On July 6, 2010 and
August 19, 2010, two additional investors filed
motions to intervene in order to assert claims based on
additional offerings (none of which were underwritten by
GS&Co.). The defendants opposed the motions on the ground
that the putative intervenors’ claims were time-barred and,
on June 21, 2011, the court denied the motions to
intervene with respect to, among others, the claims based on the
offerings underwritten by GS&Co. Certain of the putative
intervenors (including those seeking to assert claims based on
two offerings underwritten by GS&Co.) have filed notices of
appeal.
GS&Co. underwrote approximately $751 million principal
amount of securities to all purchasers in the offerings at issue
in the May 2010 motion to intervene. On
July 11, 2008, IndyMac Bank was placed under an FDIC
receivership, and on July 31, 2008, IndyMac Bancorp,
Inc. filed for Chapter 7 bankruptcy in the
U.S. Bankruptcy Court in Los Angeles, California.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Employment-Related Matters. On
May 27, 2010, a putative class action was filed in the
U.S. District Court for the Southern District of New York
by several contingent technology workers who were employees of
third-party
vendors. The plaintiffs are seeking overtime pay for alleged
hours worked in excess of 40 per work week. The complaint
alleges that the plaintiffs were de facto employees of
GS&Co. and that GS&Co. is responsible for the overtime
pay under federal and state overtime laws. The complaint seeks
class action status and unspecified damages. On
March 21, 2011, the parties agreed to the terms of a
settlement in principle. The parties are in the process of
seeking court approval of the settlement. The firm has reserved
the full amount of the proposed settlement.
On September 15, 2010, a putative class action was
filed in the U.S. District for the Southern District of New
York by three former female employees alleging that
Group Inc. and GS&Co. have systematically
discriminated against female employees in respect of
compensation, promotion, assignments, mentoring and performance
evaluations. The complaint alleges a class consisting of all
female employees employed at specified levels by Group Inc.
and GS&Co. since July 2002, and asserts claims under
federal and New York City discrimination laws. The complaint
seeks class action status, injunctive relief and unspecified
amounts of compensatory, punitive and other damages. On
November 22, 2010, Group Inc. and GS&Co.
filed a motion to stay the claims of one of the named plaintiffs
and to compel individual arbitration with that individual, based
on an arbitration provision contained in an employment agreement
between Group Inc. and the individual. On
April 28, 2011, the magistrate judge to whom the
district judge assigned the motion denied the motion. On
July 7, 2011, the magistrate judge denied
Group Inc.’s and GS&Co.’s motion for
reconsideration of the magistrate judge’s decision, and on
July 21, 2011 Group Inc. and GS&Co. appealed
the magistrate judge’s decision to the district court. On
June 13, 2011, Group, Inc. and GS&Co. moved to
strike the class allegations of one of the three named
plaintiffs based on her failure to exhaust administrative
remedies. On July 22, 2011, Group Inc. and
GS&Co. moved to strike all of the plaintiffs’ class
allegations, and for partial summary judgment as to
plaintiffs’ disparate impact claims.
Transactions with the Hellenic Republic (Greece).
Group Inc. and certain of its affiliates are subject to a
number of investigations and reviews by various governmental and
regulatory bodies and self-regulatory organizations in
connection with the firm’s transactions with the Hellenic
Republic (Greece), including financing and swap transactions.
Goldman Sachs is cooperating with the investigations and reviews.
Sales, Trading and Clearance Practices. Group Inc.
and certain of its affiliates are subject to a number of
investigations and reviews, certain of which are
industry-wide,
by various governmental and regulatory bodies and
self-regulatory organizations relating to the sales, trading and
clearance of corporate and government securities and other
financial products, including compliance with the SEC’s
short sale rule, algorithmic and quantitative trading, futures
trading, securities lending practices, trading and clearance of
credit derivative instruments, commodities trading, private
placement practices, compliance with the U.S. Foreign
Corrupt Practices Act and the effectiveness of insider trading
controls and internal information barriers.
The European Commission announced in April 2011 that it is
initiating proceedings to investigate further numerous financial
services companies, including Group Inc., in connection
with the supply of data related to credit default swaps and in
connection with profit sharing and fee arrangements for clearing
of credit default swaps, including potential anti-competitive
practices. The U.S. Department of Justice (DOJ) has been
investigating similar matters as regards the supply of data.
The CFTC has been investigating the role of GSEC as the clearing
broker for an SEC-registered
broker-dealer
client. The CFTC staff has orally advised GSEC that it intends
to recommend that the CFTC bring aiding and abetting, civil
fraud and supervision-related charges against GSEC arising from
its provision of clearing services to this
broker-dealer
client based on allegations that GSEC knew or should have known
that the client’s subaccounts maintained at GSEC were
actually accounts belonging to customers of the
broker-dealer
client and not the client’s proprietary accounts.
Goldman Sachs is cooperating with the investigations and reviews.
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
EU
Price-Fixing
Matter. On July 5, 2011, the European
Commission issued a Statement of Objections to Group Inc.
raising allegations of an
industry-wide
conspiracy to fix prices for power cables including by an
Italian cable company in which certain Goldman Sachs-affiliated
investment funds held ownership interests from 2005 to 2009. The
Statement of Objections proposes to hold Group Inc. jointly
and severally liable for some or all of any fine levied against
the cable company under the concept of parental liability under
EU competition law.
Municipal Securities Matters. Group Inc.
and certain of its affiliates are subject to a number of
investigations and reviews by various governmental and
regulatory bodies and self-regulatory organizations relating to
transactions involving municipal securities, including
wall-cross procedures and conflict of interest disclosure with
respect to state and municipal clients, the trading and
structuring of municipal derivative instruments in connection
with municipal offerings, political contribution rules,
underwriting of Build America Bonds and the possible impact of
credit default swap transactions on municipal issuers. Goldman
Sachs is cooperating with the investigations and reviews.
Group Inc., Goldman Sachs Mitsui Marine Derivative
Products, L.P. (GSMMDP) and GS Bank USA are among numerous
financial services firms that have been named as defendants in
numerous substantially identical individual antitrust actions
filed beginning on November 12, 2009 that have been
coordinated with related antitrust class action litigation and
individual actions, in which no Goldman Sachs affiliate is
named, for
pre-trial
proceedings in the U.S. District Court for the Southern
District of New York. The plaintiffs include individual
California municipal entities and three New York
non-profit
entities.
On April 26, 2010, the Goldman Sachs defendants’
motion to dismiss complaints filed by several individual
California municipal plaintiffs was denied. All of these
complaints against Group Inc., GSMMDP and GS Bank USA
generally allege that the Goldman Sachs defendants participated
in a conspiracy to arrange bids, fix prices and divide up the
market for derivatives used by municipalities in refinancing and
hedging transactions from 1992 to 2008. The complaints assert
claims under the federal antitrust laws and either
California’s Cartwright Act or New York’s Donnelly
Act, and seek, among other things, treble damages under the
antitrust laws in an unspecified amount and injunctive relief.
Financial Crisis-Related
Matters. Group Inc. and certain of its
affiliates are subject to a number of investigations and reviews
by various governmental and regulatory bodies and
self-regulatory organizations and litigation relating to the
2008 financial crisis, including the establishment and unwind of
credit default swaps between Goldman Sachs and American
International Group, Inc. (AIG) and other transactions with, and
in the securities of, AIG, The Bear Stearns Companies Inc.,
Lehman Brothers Holdings Inc. and other firms. Goldman Sachs is
cooperating with the investigations and reviews.
In the second quarter of 2011, a Staff Report of the Senate
Permanent Subcommittee on Investigations concerning the key
causes of the financial crisis was issued. Goldman Sachs and
another financial institution were used as case studies with
respect to the role of investment banks. The report was referred
to the DOJ and the SEC for review. The firm is cooperating with
the investigations arising from this referral, which are ongoing.
We have reviewed the accompanying condensed consolidated
statement of financial condition of The Goldman Sachs Group,
Inc. and its subsidiaries (the Company) as of
June 30, 2011, the related condensed consolidated
statements of earnings for the three and six months ended
June 30, 2011 and 2010, the condensed consolidated
statement of changes in shareholders’ equity for the six
months ended June 30, 2011, the condensed consolidated
statements of cash flows for the six months ended
June 30, 2011 and 2010, and the condensed consolidated
statements of comprehensive income for the three and six months
ended June 30, 2011 and 2010. These condensed
consolidated interim financial statements are the responsibility
of the Company’s management.
We conducted our review in accordance with the standards of the
Public Company Accounting Oversight Board (United States). A
review of interim financial information consists principally of
applying analytical procedures and making inquiries of persons
responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in
accordance with the standards of the Public Company Accounting
Oversight Board (United States), the objective of which is the
expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the accompanying condensed
consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the
United States of America.
We previously audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated statement of financial condition as of
December 31, 2010, and the related consolidated
statements of earnings, changes in shareholders’ equity,
cash flows and comprehensive income for the year then ended (not
presented herein), and in our report dated
February 28, 2011, we expressed an unqualified opinion
on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated
statement of financial condition as of
December 31, 2010 and the condensed consolidated
statement of changes in shareholders’ equity for the year
ended December 31, 2010, is fairly stated in all
material respects in relation to the consolidated financial
statements from which it has been derived.
Consists of cash financial instruments, including equity
securities and convertible debentures.
2.
Derivative instruments and commodities are included in other
non-interest-earning
assets and other
non-interest-bearing
liabilities.
3.
Primarily consists of cash and securities segregated for
regulatory and other purposes and certain receivables from
customers and counterparties.
4.
Consists of
short-term
other secured financings and unsecured
short-term
borrowings, excluding commercial paper.
5.
Interest rates include the effects of interest rate swaps
accounted for as hedges.
6.
Consists of
long-term
other secured financings and unsecured
long-term
borrowings.
7.
Primarily consists of certain payables to customers and
counterparties.
8.
Assets, liabilities and interest are attributed to U.S. and
non-U.S. based
on the location of the legal entity in which the assets and
liabilities are held.
The table below presents selected financial ratios.
Three Months
Six Months
Ended June
Ended June
2011
2010
2011
2010
Annualized net earnings to average assets
0.5
%
0.7
%
0.8
%
1.1
%
Annualized return on average common shareholders’
equity 1
6.1
4
7.9
8.0
4
13.1
Annualized return on average total shareholders’
equity 2
6.0
8.0
10.3
12.7
Total average equity to average assets
7.6
8.3
8.0
8.3
Dividend payout
ratio 3
18.9
44.9
20.6
10.9
1.
Based on net earnings applicable to common shareholders divided
by average monthly common shareholders’ equity.
2.
Based on net earnings divided by average monthly total
shareholders’ equity.
3.
Dividends declared per common share as a percentage of diluted
earnings per common share.
4.
The $1.64 billion Series G Preferred Stock dividend
was not annualized in the calculation of annualized net earnings
applicable to common shareholders since it has no impact on
other quarters in the year.
Cross-border
Outstandings
Cross-border outstandings are based upon the Federal Financial
Institutions Examination Council’s (FFIEC) regulatory
guidelines for reporting cross-border risk. Claims include cash,
receivables, securities purchased under agreements to resell,
securities borrowed and cash financial instruments, but exclude
derivative instruments and commitments. Securities purchased
under agreements to resell and securities
borrowed are presented based on the domicile of the
counterparty, without reduction for related securities
collateral held.
The tables below present cross-border outstandings for each
country in which cross-border outstandings exceed 0.75% of
consolidated assets in accordance with the FFIEC guidelines.
As of June 2011
in millions
Banks
Governments
Other
Total
Country
France
$
38,462
$
4,665
$
4,215
$
47,342
United Kingdom
5,425
5,787
32,405
43,617
Cayman Islands
1
81
41,716
41,798
Japan
23,764
147
4,107
28,018
Germany
9,679
13,001
3,643
26,323
China
11,178
166
3,683
15,027
Switzerland
2,796
13
5,746
8,555
Ireland
739
229
6,996
1
7,964
As of December 2010
in millions
Banks
Governments
Other
Total
Country
France
$
29,380
$
7,369
$
4,326
$
41,075
United Kingdom
5,630
4,833
26,516
36,979
Cayman Islands
7
—
35,949
35,956
Japan
28,579
49
4,936
33,564
Germany
3,897
15,791
2,186
21,874
China
10,724
700
2,705
14,129
Switzerland
2,464
150
6,875
9,489
1.
Primarily comprised of interests in mutual funds domiciled in
Ireland, but whose underlying investments are primarily located
outside of Ireland.
The Goldman Sachs Group, Inc. (Group Inc.) is a leading
global investment banking, securities and investment management
firm that provides a wide range of financial services to a
substantial and diversified client base that includes
corporations, financial institutions, governments and
high-net-worth
individuals. Founded in 1869, the firm is headquartered in New
York and maintains offices in all major financial centers around
the world.
We report our activities in the following four business
segments: Investment Banking, Institutional Client Services,
Investing & Lending and Investment Management. See
“Results of Operations” below for further information
about our business segments.
This Management’s Discussion and Analysis of Financial
Condition and Results of Operations should be read in
conjunction with our Annual Report on
Form 10-K
for the year ended December 31, 2010. References to
“our Annual Report on
Form 10-K”
are to our Annual Report on
Form 10-K
for the year ended December 31, 2010.
When we use the terms “Goldman Sachs,”“the
firm,”“we,”“us” and “our,”
we mean Group Inc., a Delaware corporation, and its
consolidated subsidiaries.
References to “this
Form 10-Q”
are to our Quarterly Report on
Form 10-Q
for the quarterly period ended June 30, 2011. All
references to June 2011 and June 2010, unless
specifically stated otherwise, refer to our periods ended, or
the dates, as the context requires, June 30, 2011 and
June 30, 2010, respectively. All references to
March 2011 and December 2010, unless specifically
stated otherwise, refer to the dates March 31, 2011
and December 31, 2010, respectively. Certain
reclassifications have been made to previously reported amounts
to conform to the current presentation.
Three Months Ended June 2011 versus
June 2010. Our diluted earnings per common
share were $1.85 for the second quarter of 2011 compared with
$0.78 1
for the second quarter of 2010. Annualized return on average
common shareholders’ equity
(ROE) 2
was 6.1% for the second quarter of 2011.
During the quarter, the firm repurchased 10.8 million
shares of its common stock for a total cost of
$1.50 billion. Including the impact of these repurchases,
book value per common share and tangible book value per common
share 3
each increased 1.6% during the quarter to $131.44 and $121.60,
respectively. Our Tier 1 capital ratio under Basel
1 4
was 14.7% and our Tier 1 common ratio under Basel
1 4
was 12.9% as of June 2011, both essentially unchanged
compared with the end of the first quarter of 2011.
The firm generated net revenues of $7.28 billion and net
earnings of $1.09 billion for the second quarter of 2011.
These results reflected significantly lower net revenues in
Institutional Client Services and Investing & Lending
compared with the second quarter of 2010. This decrease was
partially offset by significantly higher net revenues in
Investment Banking, as well as higher net revenues in Investment
Management compared with the second quarter of 2010.
In the context of more difficult economic and financial
conditions, the firm launched an initiative to identify areas
where we can operate more efficiently and reduce our operating
expenses. We have targeted approximately $1.2 billion in
annual run rate compensation and
non-compensation
reductions. This initiative will be achieved through a
combination of a reduction in total staff and planned
expenditures, and we expect to complete it before year-end.
C:
1. Excluding the impact of the $600 million related to
the U.K. bank payroll tax and the $550 million related to
the SEC settlement in the second quarter of 2010, diluted
earnings per common share were $2.75 and $8.36 for the three and
six months ended June 2010, respectively. We believe that
presenting our results excluding the impact of these items is
meaningful because it increases the comparability of
period-to-period
results. Diluted earnings per common share excluding these items
is a
non-GAAP
measure 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 excluding the impact of these items.
2. See “Results of Operations — Financial
Overview” below for further information about our
calculation of ROE.
3. We believe that tangible common shareholders’
equity and tangible book value per common share are meaningful
because they are measures that we and investors use to assess
capital adequacy. Tangible common shareholders’ equity and
tangible book value per common share are
non-GAAP
measures 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 common
shareholders’ equity and 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 capital
ratio and Tier 1 common ratio.
An overview of the results for each of our business segments are
discussed below.
Institutional
Client Services
The decrease in Institutional Client Services compared with the
second quarter of 2010 reflected significantly lower net
revenues in Fixed Income, Currency and Commodities Client
Execution, partially offset by higher net revenues in Equities.
The decline in Fixed Income, Currency and Commodities Client
Execution reflected significantly lower results in mortgages,
commodities and interest rate products. High levels of
uncertainty and decreased levels of liquidity during the quarter
contributed to difficult
market-making
conditions, particularly in mortgages and commodities, and
prompted us to operate at generally lower levels of risk. In
addition, net revenues in currencies decreased slightly and net
revenues in credit products were essentially unchanged compared
with the second quarter of 2010. During the quarter, Fixed
Income, Currency and Commodities Client Execution operated in a
challenging environment reflecting broad market concerns and
uncertainty, which led to slightly lower levels of activity. The
effect of these macro concerns was more pronounced within our
Asian and European franchises.
The increase in Equities compared with the second quarter of
2010 primarily reflected higher net revenues in equities client
execution. This increase reflected improved results in
derivatives compared with a difficult second quarter of 2010.
However, results in the second quarter of 2011 for equities
client execution more broadly reflected a challenging
environment generally characterized by lower levels of activity
and low volatility levels. In addition, commissions and fees
were lower compared with the second quarter of 2010, reflecting
lower client activity. Securities services net revenues were
higher compared with the second quarter of 2010, reflecting the
impact of higher average customer balances.
Investing &
Lending
Results in Investing & Lending for the second quarter
of 2011 included a loss of $176 million from our investment
in the ordinary shares of Industrial and Commercial Bank of
China Limited (ICBC), net gains of $686 million from other
investments in equities and net revenues of $200 million
from debt securities and loans, primarily reflecting net
interest income.
Investment
Banking
The increase in Investment Banking reflected significantly
higher net revenues in our Underwriting business, as well as in
Financial Advisory. Net revenues in debt underwriting were
significantly higher than the second quarter of 2010, primarily
reflecting an increase in leveraged finance activity. Net
revenues in equity underwriting were also significantly higher
than the second quarter of 2010, reflecting an increase in
industry-wide
equity and
equity-related
offerings. The increase in Financial Advisory reflected an
increase in
industry-wide
completed mergers and acquisitions.
Investment
Management
The increase in Investment Management was primarily due to an
increase in management and other fees, reflecting both favorable
changes in the mix of assets under management and higher average
assets under management, as well as higher incentive fees.
During the quarter, assets under management increased
$4 billion to $844 billion reflecting market
appreciation and inflows in fixed income assets, partially
offset by outflows in money market, alternative investment and
equity assets.
Six Months Ended June 2011 versus
June 2010. Our diluted earnings per common
share were $3.40 for the first half of 2011 compared with $6.41
1 for the
first half of 2010. Annualized ROE
2 was
8.0% for the first half of 2011. Excluding the impact of the
$1.64 billion preferred dividend related to the redemption
of our 10% Cumulative Perpetual Preferred Stock, Series G
(Series G Preferred Stock) in the first quarter of 2011,
diluted earnings per common share were
$6.25 3
and annualized ROE was
10.2% 3 for
the first half of 2011.
1. Excluding the impact of the $600 million related to
the U.K. bank payroll tax and the $550 million related to
the SEC settlement in the second quarter of 2010, diluted
earnings per common share were $2.75 and $8.36 for the three and
six months ended June 2010, respectively. We believe that
presenting our results excluding the impact of these items is
meaningful because it increases the comparability of
period-to-period
results. Diluted earnings per common share excluding these items
is a
non-GAAP
measure 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 excluding the impact of these items.
2. See “Results of Operations — Financial
Overview” below for further information about our
calculation of ROE.
3. We believe that presenting our results excluding the
impact of the $1.64 billion preferred dividend related to
the redemption of our Series G Preferred Stock (calculated
as the difference between the carrying value and the redemption
value of the preferred stock) is meaningful because it increases
the comparability of
period-to-period
results. Diluted earnings per common share and ROE excluding the
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.
The firm generated net revenues of $19.18 billion and net
earnings of $3.82 billion for the first half of 2011. These
results reflected significantly lower net revenues in
Institutional Client Services, partially offset by significantly
higher net revenues in Investment Banking and higher net
revenues in Investment Management. Net revenues in
Investing & Lending were essentially unchanged
compared with the first half of 2010.
An overview of the results for each of our business segments are
discussed below.
Institutional
Client Services
The decrease in Institutional Client Services compared with the
first half of 2010 reflected significantly lower net revenues in
Fixed Income, Currency and Commodities Client Execution.
Although client activity levels improved during the first
quarter of 2011, the environment became more challenging during
the second quarter of 2011 reflecting broad market concerns and
uncertainty, which led to slightly lower levels of activity. In
addition, high levels of uncertainty and decreased levels of
liquidity during the second quarter of 2011 contributed to
difficult
market-making
conditions and prompted us to operate at generally lower levels
of risk. As a result of these conditions, net revenues across
the franchise were lower during the first half of 2011 compared
with the first half of 2010.
Net revenues in Equities increased slightly compared with the
first half of 2010, primarily reflecting higher net revenues in
securities services. The increase in securities services
compared with the first half of 2010 reflected the impact of
higher average customer balances. Equities client execution net
revenues were essentially unchanged and reflected improved
results in derivatives compared with the first half of 2010,
although results more broadly in equities client execution for
the first half of 2011 reflected a challenging environment
characterized by low levels of activity and low volatility
levels. Commissions and fees increased slightly compared with
the first half of 2010.
Investing &
Lending
Net revenues in Investing & Lending for the first half
of 2011 included a gain of $140 million from our investment
in the ordinary shares of ICBC, net gains of $1.74 billion
from other investments in equities and net gains and net
interest of $1.22 billion from debt securities and loans.
Investment
Banking
The increase in Investment Banking primarily reflected
significantly higher net revenues in our Underwriting business.
Net revenues in debt underwriting were significantly higher than
the first half of 2010, reflecting an increase in leveraged
finance and
investment-grade
activity. Net revenues in equity underwriting were also
significantly higher than the first half of 2010, reflecting
higher net revenues from initial public offerings. Net revenues
in Financial Advisory also increased compared with the first
half of 2010.
Investment
Management
The increase in Investment Management was primarily due to an
increase in management and other fees, reflecting favorable
changes in the mix of assets under management and higher average
assets under management, as well as higher incentive fees.
During the first half of 2011, assets under management increased
$4 billion to $844 billion reflecting net market
appreciation, primarily in fixed income and equity assets,
partially offset by net outflows, primarily in money market
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.
Real gross domestic product (GDP) appears to have increased in
most economies in the second quarter of 2011, although at a
slower pace than in the first quarter. However, concerns about
European sovereign debt risk, the supply-chain disruptions
resulting from the earthquake and tsunami in Japan and inflation
in emerging markets intensified during the second quarter of
2011, while concerns emerged towards the end of the quarter
about the uncertainty of a resolution on the U.S. federal
debt ceiling. In addition, other broad market concerns that
emerged during 2010 and the first quarter of 2011, such as
political unrest in the Middle East and uncertainty over
financial regulatory reform, continued during the quarter.
Global equity markets were negatively impacted by these concerns
and uncertainties during the second quarter. Measures of
inflation in most major and emerging economies increased during
the quarter primarily due to earlier commodity price increases,
although the price of crude oil decreased during the quarter.
The U.S. dollar depreciated against the Euro and the
Japanese yen, but remained essentially unchanged against the
British pound.
Industry-wide
announced mergers and acquisitions volumes decreased during the
quarter, while completed mergers and acquisitions volumes were
essentially unchanged. In addition, debt offerings volumes
decreased during the quarter, while equity and
equity-related
offerings volumes increased, particularly in initial public
offerings.
United
States
In the United States, real GDP increased modestly during the
second quarter, although growth in consumer spending slowed.
Industrial production remained broadly unchanged, reflecting the
impact of supply-chain disruptions associated with Japan, and
unemployment levels increased during the quarter. In addition,
measures of core inflation increased during the second quarter.
The U.S. Federal Reserve maintained its federal funds rate
at a target range of zero to 0.25% and concluded its
quantitative easing measures, which included the purchase of
significant amounts of U.S. Treasury debt. The
10-year
U.S. Treasury note yield ended the second quarter
29 basis points lower at 3.18%. In equity markets, the
Dow Jones Industrial Average increased 1%, while the
S&P 500 Index and the NASDAQ Composite Index ended the
quarter essentially unchanged.
Europe
In the Eurozone economies, real GDP growth appeared to moderate
during the second quarter. Concerns about fiscal challenges in
several Eurozone economies intensified during the quarter,
weighing on economic growth in these economies and risk appetite
more broadly. Surveys of business confidence deteriorated and
measures of core inflation increased during the second quarter.
The European Central Bank increased its main refinancing
operations rate by 25 basis points to 1.25% during the
quarter. The Euro appreciated by 2% against the
U.S. dollar. In the United Kingdom, real GDP growth
moderated during the second quarter. The Bank of England
maintained its official bank rate at 0.50% and the British pound
was essentially unchanged against the U.S. dollar.
Long-term
government bond yields in the U.K. and the Eurozone generally
declined during the quarter, although spreads between German
bond yields and those of certain Eurozone economies widened
during the quarter. Equity markets in continental Europe
generally decreased during the quarter, while equity markets in
the U.K. were essentially unchanged.
Asia
In Japan, real GDP appeared to decline further in the second
quarter due to the economic impact of the earthquake and
tsunami. Measures of core inflation turned positive during the
quarter for the first time since early 2009. The Bank of Japan
left its target overnight call rate unchanged at a range of zero
to 0.10%. The yield on
10-year
Japanese government bonds decreased during the quarter. The
Japanese yen appreciated by 3% against the U.S. dollar and
the Nikkei 225 Index ended the quarter 1% higher. In China, real
GDP growth remained strong during the second quarter, although
the pace of growth moderated compared with the first quarter of
2011. Measures of inflation remained elevated during the
quarter. The People’s Bank of China increased the reserve
requirement ratio by 150 basis points during the quarter. The
Chinese yuan appreciated slightly against the U.S. dollar
and the Shanghai Composite Index decreased by 6% during the
quarter. Equity markets in Hong Kong and South Korea also
decreased during the quarter. In India, economic growth appeared
to remain solid, supported by continued strength in domestic
demand. In addition, measures of inflation remained elevated.
The Indian rupee was essentially unchanged against the
U.S. dollar and equity markets in India declined.
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
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, including derivatives, are based on
observable prices and inputs and are classified in levels 1
and 2 of the hierarchy. Certain level 2 financial
instruments may require appropriate discounts
(i.e., valuation adjustments) for factors such as:
•
transfer restrictions;
•
the credit quality of a counterparty or the firm; and
•
other premiums and discounts that a market participant would
require to arrive at fair value.
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 may require
judgments to be made. These judgments include:
•
determining the appropriate valuation methodology
and/or model
for each type of level 3 financial instrument;
•
determining model inputs based on an evaluation of all relevant
empirical market data, including prices evidenced by market
transactions, interest rates, credit spreads, volatilities and
correlations; and
•
determining appropriate valuation adjustments related to
illiquidity or counterparty credit quality.
Regardless of the methodology, valuation inputs and assumptions
are only changed when corroborated by substantive evidence.
Controls Over Valuation of Financial
Instruments. Market makers and investment
professionals in our revenue-producing units are responsible for
pricing our financial instruments. Our control infrastructure is
independent of the revenue-producing units and is fundamental to
ensuring that all of our financial instruments are appropriately
valued at
market-clearing
levels. In the event that there is a difference of opinion in
situations where estimating the fair value of financial
instruments requires judgment (e.g., calibration to market
comparables or trade comparison, as described below), the final
valuation decision is made by senior managers in control and
support functions that are independent of the revenue-producing
units (independent control and support functions). This
independent price verification is critical to ensuring that our
financial instruments are properly valued.
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:
•
Trade Comparison.Analysis of trade
data (both internal and external where available) is used to
determine the most relevant pricing inputs and valuations.
•
External Price Comparison.Valuations
and prices are compared to pricing data obtained from third
parties (e.g., broker or dealers, MarkIt, Bloomberg, IDC,
TRACE). Data obtained from various sources is compared to ensure
consistency and validity. When broker or dealer quotations or
third-party
pricing vendors are used for valuation or price verification,
greater priority is generally given to executable quotations.
•
Calibration to Market
Comparables.
Market-based
transactions are used to corroborate the valuation of positions
with similar characteristics, risks and components.
•
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.
•
Collateral Analyses.Margin disputes on
derivatives are examined and investigated to determine the
impact, if any, on our valuations.
•
Execution of Trades.Where appropriate,
trading desks are instructed to execute trades in order to
provide evidence of
market-clearing
levels.
•
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, one of which is the
process of validating and understanding results by attributing
and explaining net revenues by 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:
•
the model’s suitability for valuation and risk management
of a particular instrument type;
•
the model’s accuracy in reflecting the characteristics of
the related product and its significant risks;
•
the suitability and properties of the numerical algorithms
incorporated in the model;
•
the model’s consistency with models for similar products;
and
•
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.
See “Market Risk Management” and “Credit Risk
Management” for a further discussion of how we manage the
risks inherent in our businesses.
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 assets were $47.01 billion,
$45.84 billion and $45.38 billion as of
June 2011, March 2011 and December 2010,
respectively. The increase in level 3 assets during the
three months ended June 2011 primarily reflected an
increase in private equity investments, principally due to
transfers from level 2.
The increase in level 3 assets during the six months ended
June 2011 primarily reflected an increase in private equity
investments, principally due to purchases and transfers from
level 2, partially offset by a decrease in credit
derivatives, primarily due to transfers to level 2 and
settlements.
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.
As of June 2011
As of March 2011
As of December 2010
Total at
Level 3
Total at
Level 3
Total at
Level 3
in millions
Fair Value
Total
Fair Value
Total
Fair Value
Total
Commercial paper, certificates of deposit, time deposits and
other money market instruments
$
7,186
$
—
$
13,100
$
—
$
11,262
$
—
U.S. government and federal agency obligations
87,075
—
100,222
—
84,928
—
Non-U.S. government
obligations
55,023
—
44,540
—
40,675
—
Mortgage and other
asset-backed
loans and securities:
Loans and securities backed by commercial real estate
6,693
2,395
5,912
2,521
6,200
2,819
Loans and securities backed by residential real estate
7,716
2,735
8,426
2,636
9,404
2,373
Loan
portfolios 1
1,238
1,238
1,314
1,312
1,438
1,285
Bank loans and bridge loans
18,927
10,183
2
18,063
9,929
2
18,039
9,905
2
Corporate debt securities
25,582
2,747
26,515
3,138
24,719
2,737
State and municipal obligations
3,328
643
2,718
742
2,792
754
Other debt obligations
2,554
1,472
3,599
1,483
3,232
1,274
Equities and convertible debentures
71,626
13,452
75,343
11,765
67,833
11,060
Commodities
10,133
—
5,911
—
13,138
—
Total cash instruments
297,081
34,865
305,663
33,526
283,660
32,207
Derivatives
73,524
11,522
69,143
11,837
73,293
12,772
Financial instruments owned, at fair value
370,605
46,387
374,806
45,363
356,953
44,979
Securities segregated for regulatory and other purposes
42,343
—
34,325
—
36,182
—
Securities purchased under agreements to resell
162,285
299
162,094
158
188,355
100
Securities borrowed
61,865
—
62,236
—
48,822
—
Receivables from customers and counterparties
7,674
321
8,095
322
7,202
298
Total
$
644,772
$
47,007
$
641,556
$
45,843
$
637,514
$
45,377
1.
Consists of acquired portfolios of distressed loans, primarily
backed by commercial and residential real estate.
2.
Includes certain mezzanine financing, leveraged loans arising
from capital market transactions and other corporate bank debt.
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. We test
the goodwill in each of our reporting units for impairment at
least annually, 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. Our last annual
impairment test was performed during our 2010 fourth quarter and
no impairment was identified. 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 by operating segment.
Identifiable Intangible Assets. We amortize
our identifiable intangible assets over their estimated lives
or, in the case of insurance contracts, 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 the
carrying value of our identifiable intangible assets by
operating segment.
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.
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 potential 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.
The composition of our net revenues has varied over time as
financial markets and the scope of our operations have changed.
The composition of net revenues can also vary over the shorter
term due to fluctuations in U.S. and global economic and
market
conditions. See “Certain Risk Factors That May Affect Our
Businesses” below and “Risk Factors” in
Part I, Item 1A of our Annual Report on
Form 10-K
for a further discussion of the impact of economic and market
conditions on our results of operations.
Financial
Overview
The table below presents an overview of our financial results.
Three Months
Six Months
Ended June
Ended June
$ in millions, except per share amounts
2011
2010
2011
2010
Net revenues
$
7,281
$
8,841
$
19,175
$
21,616
Pre-tax
earnings
1,612
1,448
5,652
6,607
Net earnings
1,087
613
3,822
4,069
Net earnings applicable to common shareholders
1,052
453
1,960
3,749
Diluted earnings per common share
1.85
0.78
3.40
6.41
Annualized return on average common shareholders’
equity 1
6.1
%
7.9
%
8.0
%
13.1
%
Diluted earnings per common share, excluding the impact of the
Series G Preferred Stock
dividend 2
N/A
N/A
$
6.25
N/A
Annualized return on average common shareholders’ equity,
excluding the impact of the Series G Preferred Stock
dividend 2
N/A
N/A
10.2
%
N/A
Diluted earnings per common share, excluding the impact of U.K.
bank payroll tax and SEC
settlement 3
N/A
$
2.75
N/A
$
8.36
Annualized return on average common shareholders’ equity,
excluding the impact of U.K. bank payroll tax and SEC
settlement 3
N/A
9.5
%
N/A
14.8
%
1.
Annualized ROE is computed by dividing annualized net earnings
applicable to common shareholders by average monthly common
shareholders’ equity. The impact of the $1.64 billion
Series G Preferred Stock dividend in the first quarter of
2011 was not annualized in the calculation of annualized net
earnings applicable to common shareholders for the six months
ended June 2011 as this amount has no impact on other
quarters in the year. In addition, the impact of the
$600 million U.K. bank payroll tax and the
$550 million SEC settlement in the second quarter of 2010
were not annualized in the calculation of annualized net
earnings applicable to common shareholders for the three and six
months ended June 2010 as these are
one-time
events and therefore these amounts have no impact on other
quarters in the year. The table below presents our average
common shareholders’ equity.
Average for the
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Total shareholders’ equity
$
72,474
$
73,529
$
74,519
$
72,986
Preferred stock
(3,100
)
(6,957
)
(4,753
)
(6,957
)
Common shareholders’ equity
$
69,374
$
66,572
$
69,766
$
66,029
2.
We believe that presenting our results excluding the impact of
the $1.64 billion Series G Preferred Stock dividend in
the first quarter of 2011 is meaningful because 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.
Six Months Ended
in millions, except per share amount
June 2011
Net earnings applicable to common shareholders
$
1,960
Impact of the Series G Preferred Stock dividend
1,643
Net earnings applicable to common shareholders, excluding the
impact of the Series G Preferred Stock dividend
3,603
Divided by: average diluted common shares outstanding
576.4
Diluted earnings per common share, excluding the impact of
the Series G Preferred Stock dividend
Common shareholders’ equity, excluding the impact of the
Series G Preferred Stock dividend
$
70,705
3.
We believe that presenting our results excluding the impact of
the $600 million U.K. bank payroll tax and the
$550 million SEC settlement in the second quarter of 2010
is meaningful as these were
one-time
events and excluding them increases the comparability of
period-to-period
results. Diluted earnings per common share and ROE excluding
these items 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 these items.
Three Months
Six Months
Ended June
Ended June
in millions, except per share amounts
2010
2010
Net earnings applicable to common shareholders
$
453
$
3,749
Impact of U.K. bank payroll tax
600
600
Pre-tax
impact of SEC settlement
550
550
Tax impact of SEC settlement
(6
)
(6
)
Net earnings applicable to common shareholders, excluding the
impact of U.K. bank payroll tax and SEC settlement
1,597
4,893
Divided by: average diluted common shares outstanding
580.4
585.2
Diluted earnings per common share, excluding the impact of
U.K. bank payroll tax and SEC settlement
$
2.75
$
8.36
Average for the
Three Months
Six Months
Ended June
Ended June
in millions
2010
2010
Total shareholders’ equity
$
73,529
$
72,986
Preferred stock
(6,957
)
(6,957
)
Common shareholders’ equity
66,572
66,029
Impact of U.K. bank payroll tax
300
171
Impact of SEC settlement
136
78
Common shareholders’ equity, excluding the impact of
U.K. bank payroll tax and SEC settlement
Three Months Ended June 2011 versus
June 2010. Net revenues were
$7.28 billion for the second quarter of 2011, 18% lower
than the second quarter of 2010, reflecting significantly lower
net revenues in Institutional Client Services and
Investing & Lending. This decrease was partially
offset by significantly higher net revenues in Investment
Banking, as well as higher net revenues in Investment Management.
Six Months Ended June 2011 versus
June 2010. Net revenues were
$19.18 billion for the first half of 2011, 11% lower than
the first half of 2010, reflecting significantly lower net
revenues in Institutional Client Services, partially offset by
significantly higher net revenues in Investment Banking and
higher net revenues in Investment Management. Net revenues in
Investing & Lending were essentially unchanged
compared with the first half of 2010.
Net Interest
Income
Three Months Ended June 2011 versus
June 2010. Net interest income for the
second quarter of 2011 was $1.41 billion, 13% lower than
the second quarter of 2010. The decrease compared with the
second quarter of 2010 was primarily due to higher interest
expense related to our
long-term
borrowings and a decrease in net dividend income.
Six Months Ended June 2011 versus
June 2010. Net interest income for the first
half of 2011 was $2.77 billion, 9% lower than the first
half of 2010. The decrease compared with the first half of 2010
was primarily due to higher interest expense related to our
long-term
borrowings and a decrease in net dividend income.
Non-interest
Revenues
Investment
banking
During the second quarter of 2011, investment banking revenues
continued to reflect an operating environment generally
characterized by higher levels of industry-wide mergers and
acquisitions activity as compared with 2010. Underwriting
activity levels were higher compared with the second quarter of
2010, reflecting generally higher equity prices, continued low
interest rates and increased refinancing activity. However,
heightened uncertainty regarding the global economic outlook and
concerns about European sovereign debt risk and the
U.S. debt ceiling negatively impacted global equity markets
during the second quarter of 2011, and continued to weigh on
corporate activity. If these concerns and uncertainties were to
continue, or if equity prices decline or interest rates
increase,
resulting in lower levels of client activity, investment banking
revenues would likely be negatively impacted.
Three Months Ended June 2011 versus June
2010. Investment banking revenues on the
condensed consolidated statement of earnings were
$1.45 billion, 54% higher than the second quarter of 2010,
reflecting significantly higher underwriting and financial
advisory revenues. The increase in underwriting revenues
primarily reflected an increase in leveraged finance activity
and an increase in industry-wide equity and equity-related
offerings. The increase in financial advisory revenues reflected
an increase in industry-wide completed mergers and acquisitions.
Six Months Ended June 2011 versus June
2010. Investment banking revenues on the
condensed consolidated statement of earnings were
$2.72 billion, 27% higher than the first half of 2010,
primarily reflecting significantly higher underwriting revenues.
The increase in underwriting revenues primarily reflected an
increase in leveraged finance and investment-grade activity, as
well as higher revenues from initial public offerings. Financial
advisory revenues were also higher compared with the first half
of 2010.
Investment
management
During the second quarter of 2011, investment management
revenues reflected an operating environment generally
characterized by a continuation of industry trends, including
improved asset prices and a shift in investor assets away from
money markets in favor of asset classes with potentially higher
risk and returns. These trends have resulted in favorable
changes in the mix of assets under management, as well as
appreciation in the value of client assets. If asset prices
decline or investors change their mix of assets to lower risk
asset classes or withdraw their assets, investment management
revenues would likely be negatively impacted. In addition,
continued uncertainty regarding the global economic outlook
could result in downward pressure on assets under management.
Three Months Ended June 2011 versus June
2010. Investment management revenues on the
condensed consolidated statement of earnings were
$1.19 billion, 14% higher than the second quarter of 2010.
The increase in revenues compared with the second quarter of
2010 was primarily due to an increase in management fees,
reflecting both favorable changes in the mix of assets under
management and higher average assets under management, as well
as higher incentive fees.
Six Months Ended June 2011 versus June
2010. Investment management revenues on the
condensed consolidated statement of earnings were
$2.36 billion, 15% higher than the first half of 2010. The
increase in revenues compared with the first half of 2010 was
primarily due to an increase in management fees, reflecting
favorable changes in the mix of assets under management and
higher average assets under management, as well as higher
incentive fees.
Commissions and
fees
Broad market concerns and uncertainties that emerged during
2010, including concerns about European sovereign debt risk,
continued to have a negative impact on client activity during
the second quarter of 2011. Client activity was also negatively
impacted by concerns regarding the state of the global economy,
including a further deterioration in economic data, increased
sovereign risk in a number of smaller European member states
along with the potential negative economic impact on financial
institutions with credit exposure to those sovereigns, and the
U.S. debt ceiling. If these concerns and uncertainties were
to continue, commissions and fees would likely be negatively
impacted.
Three Months Ended June 2011 versus June
2010. Commissions and fees on the condensed
consolidated statement of earnings were $894 million, 9%
lower than the second quarter of 2010, reflecting lower client
activity.
Six Months Ended June 2011 versus June
2010. Commissions and fees on the condensed
consolidated statement of earnings were $1.91 billion, 3%
higher than the first half of 2010.
Market
making
Broad market concerns and uncertainties that emerged during
2010, including concerns about European sovereign debt risk and
uncertainty over financial regulatory reform, continued to have
a negative impact on our market-making revenues during the
second quarter of 2011. Market-making revenues during the
quarter were also negatively impacted by concerns regarding the
state of the global economy, including a further deterioration
in economic data, increased sovereign risk in a number of
smaller European member states along with the potential negative
economic impact on financial institutions with credit exposure
to those sovereigns, and the U.S. debt ceiling. In
addition, volatility in market prices, price divergence between
our cash positions and corresponding hedges, and decreased
liquidity
levels contributed to lower revenues from managing
client-originated market-making inventory. In this environment,
we reduced our market risk levels, and many of our clients
reduced their risk appetite, resulting in slightly lower
activity levels during the quarter. If these concerns and
uncertainties were to continue, and conditions were to remain
challenging, market-making revenues would likely be negatively
impacted.
Three Months Ended June 2011 versus June
2010. Market-making revenues on the condensed
consolidated statement of earnings were $1.74 billion, 39%
lower than the second quarter of 2010, reflecting significantly
lower revenues in mortgages, commodities and interest rate
products. High levels of uncertainty and decreased levels of
liquidity during the quarter contributed to difficult
market-making conditions, particularly in mortgages and
commodities, and prompted us to operate at generally lower
levels of risk. During the quarter, revenues in these products
were impacted by a challenging environment reflecting broad
market concerns and uncertainty, which led to slightly lower
levels of activity. These decreases were partially offset by
higher revenues in equities, reflecting improved results in
derivatives compared with a difficult second quarter of 2010.
However, in the second quarter of 2011, revenues in equities
more broadly reflected a challenging environment generally
characterized by lower levels of activity and low volatility
levels.
Six Months Ended June 2011 versus June
2010. Market-making revenues on the condensed
consolidated statement of earnings were $6.20 billion, 33%
lower than the first half of 2010. Although client activity
levels improved during the first quarter of 2011, the
environment became more challenging during the second quarter of
2011 reflecting broad market concerns and uncertainty, which led
to slightly lower levels of activity. In addition, high levels
of uncertainty and decreased levels of liquidity during the
second quarter of 2011 contributed to difficult market-making
conditions and prompted us to operate at generally lower levels
of risk. As a result of these conditions, revenues were lower in
most of our major market-making products during the first half
of 2011 compared with the first half of 2010. Equities revenues
were essentially unchanged compared with the first half of 2010,
as results in derivatives improved compared with the first half
of 2010, although revenues more broadly in equities for the
first half of 2011 reflected a challenging environment
characterized by low levels of activity and low volatility
levels.
During the second quarter of 2011, other principal transactions
revenues reflected an operating environment characterized by
generally widening credit spreads and global equity markets that
were negatively impacted by broad market concerns and
uncertainty. If equity markets decline and credit spreads widen,
other principal transactions revenues would likely be negatively
impacted.
Three Months Ended June 2011 versus June
2010. Other principal transactions revenues on
the condensed consolidated statement of earnings were
$602 million for the second quarter of 2011. Results for
the second quarter of 2011 primarily included net gains from
private equity investments and revenues from our consolidated
entities held for investment purposes, partially offset by net
losses from our investment in the ordinary shares of ICBC and
other public equity investments. In the second quarter of 2010,
revenues in other principal transactions primarily included a
gain from our investment in the ordinary shares of ICBC,
revenues from our consolidated entities held for investment
purposes and net gains from debt securities and loans.
Six Months Ended June 2011 versus June
2010. Other principal transactions revenues on
the condensed consolidated statement of earnings were
$3.21 billion for the first half of 2011. Results for the
first half of 2011 primarily included net gains from private
equity investments, net gains from debt securities and loans,
and revenues from our consolidated entities held for investment
purposes. In the first half of 2010, revenues in other principal
transactions primarily included net gains from debt securities
and loans, net gains from both private and public equity
securities, including a gain from our investment in the ordinary
shares of ICBC, as well as revenues from our consolidated
entities held for investment purposes.
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.
On July 19, 2011, the United Kingdom enacted
legislation that imposes an annual
non-deductible
tax on relevant liabilities, as defined in the legislation, for
periods ending on or after January 1, 2011 for certain
financial services activities of large banks, including their
subsidiaries, that operate in the U.K. Our current estimate of
the tax for 2011 is approximately $130 million, of which
three-fourths will be recognized in
non-compensation
expenses in the third quarter of 2011, with the remainder
recognized in
non-compensation
expenses in the fourth quarter of 2011. The final amount may
vary from this estimate because the tax will be based on the
relevant liabilities as of December 31, 2011.
In the context of more difficult economic and financial
conditions, the firm launched an initiative to identify areas
where we can operate more efficiently and reduce our operating
expenses. We have targeted approximately $1.2 billion in
annual run rate compensation and
non-compensation
reductions. This initiative will be achieved through a
combination of a reduction in total staff and planned
expenditures, and we expect to complete it before year-end.
The table below presents our operating expenses and total staff.
Three Months
Six Months
Ended June
Ended June
$ in millions
2011
2010
2011
2010
Compensation and benefits
$
3,204
$
3,802
$
8,437
$
9,295
U.K. bank payroll tax
—
600
—
600
Brokerage, clearing, exchange and distribution fees
615
622
1,235
1,184
Market development
183
116
362
226
Communications and technology
210
186
408
362
Depreciation and amortization
372
437
962
809
Occupancy
252
274
519
530
Professional fees
263
227
496
409
Other expenses
570
1,129
1,104
1,594
Total
non-compensation
expenses
2,465
2,991
5,086
5,114
Total operating expenses
$
5,669
$
7,393
$
13,523
$
15,009
Total staff at
period-end 1
35,500
34,100
Total staff at period-end including consolidated entities held
for investment
purposes 2
38,300
38,900
1.
Includes employees, consultants and temporary staff.
2.
Compensation and benefits and
non-compensation
expenses related to consolidated entities held for investment
purposes are included in their respective line items in the
condensed consolidated statements of earnings. Consolidated
entities held for investment purposes are entities that are held
strictly for capital appreciation, have a defined exit strategy
and are engaged in activities that are not closely related to
our principal businesses.
Three Months Ended June 2011 versus
June 2010. Operating expenses were
$5.67 billion for the second quarter of 2011, 23% lower
than the second quarter of 2010. The accrual for compensation
and benefits expenses was $3.20 billion for the second
quarter of 2011, a 16% decline compared with the second quarter
of 2010. Operating expenses for the second quarter of 2010
included an estimate of $600 million related to the U.K.
bank payroll tax. Total staff and total staff including
consolidated entities held for investment purposes were
essentially unchanged during the second quarter of 2011.
Non-compensation
expenses were $2.47 billion, 18% lower than the second
quarter of 2010. The decrease compared with the second quarter
of 2010 was primarily attributable to the impact of net
provisions for litigation and regulatory proceedings of
$615 million during the second quarter of 2010 (including
$550 million related to the SEC settlement). The second
quarter of 2011 included net provisions for litigation and
regulatory proceedings of $45 million.
Six Months Ended June 2011 versus
June 2010. Operating expenses were
$13.52 billion for the first half of 2011, 10% lower than
the first half of 2010. The accrual for compensation and
benefits expenses was $8.44 billion for the first half of
2011, a 9% decline compared with the first half of 2010. The
ratio of compensation and benefits to net revenues for the first
half of 2011 was 44.0%, compared with
43.0% 1
(which excludes the impact of the U.K. bank payroll tax) for the
first half of 2010. Operating expenses for the first half of
2010 included an estimate of $600 million related to the
U.K. bank payroll tax. Total staff and total staff including
consolidated entities held for investment purposes decreased
slightly during the first half of 2011.
Non-compensation
expenses were $5.09 billion, essentially unchanged compared
with the first half of 2010. The first half of 2011 included net
provisions for litigation and regulatory proceedings of
$69 million compared with $636 million during the
first half of 2010 (including $550 million related to the
SEC settlement). This decrease was offset by the impact of
impairment charges of approximately $220 million related to
assets classified as held for sale during the first half of
2011, primarily related to Litton Loan
Servicing LP, our residential mortgage servicing subsidiary, and
increased levels of business activity, including higher market
development expenses and increased operating expenses related to
our consolidated entities held for investment purposes.
Provision for
Taxes
The effective income tax rate for the first half of 2011 was
32.4%, essentially unchanged from 32.3% for the first quarter of
2011 and down slightly from 32.7%
2 for
2010, which excluded the impact of the $465 million U.K.
bank payroll tax for the full year and the $550 million SEC
settlement, substantially all of which was
non-deductible.
Including the impact of these items, the effective income tax
rate was 35.2% for 2010.
In December 2010, the rules related to the deferral of
U.S. tax on certain
non-repatriated
active financing income were extended retroactively to
January 1, 2010 through December 31, 2011.
If these rules are not extended beyond
December 31, 2011, the expiration may materially
increase our effective income tax rate beginning in 2013.
1.
Our total compensation and benefits expenses including the
$600 million U.K. bank payroll tax were $4.40 billion
and $9.90 billion for the three and six months ended
June 2010, respectively. We believe that presenting our
ratio of compensation and benefits to net revenues excluding the
impact of the $600 million U.K. bank payroll tax is
meaningful as this is a
one-time
event and excluding it increases the comparability of
period-to-period
results. The ratio of compensation and benefits to net revenues
excluding the impact of this item is a
non-GAAP
measure and may not be comparable to similar
non-GAAP
measures used by other companies. The table below presents the
calculation of the ratio of compensation and benefits to net
revenues including and excluding the impact of this item.
Six Months Ended
$ in millions
June 2010
Compensation and benefits (which excludes the impact of the
$600 million U.K. bank payroll tax)
$
9,295
Ratio of compensation and benefits to net revenues
43.0
%
Compensation and benefits, including the impact of the
$600 million U.K. bank payroll tax
$
9,895
Ratio of compensation and benefits to net revenues, including
the impact of the $600 million U.K. bank payroll tax
45.8
%
2.
We believe that presenting our effective income tax rate for
2010 excluding the impact of the U.K. bank payroll tax for the
full year and the SEC settlement, substantially all of which was
non-deductible,
is meaningful as excluding these items increases the
comparability of
period-to-period
results. Effective income tax rate excluding the impact of these
items is a
non-GAAP
measure and may not be comparable to similar
non-GAAP
measures used by other companies. The table below presents the
calculation of the effective income tax rate excluding the
impact of these amounts.
The table below presents the net revenues, operating expenses
and pre-tax
earnings of our segments.
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Investment Banking
Net revenues
$
1,448
$
941
$
2,717
$
2,144
Operating expenses
981
713
1,904
1,593
Pre-tax earnings
$
467
$
228
$
813
$
551
Institutional Client Services
Net revenues
$
3,515
$
4,981
$
10,162
$
13,488
Operating expenses
3,040
4,173
7,624
9,004
Pre-tax earnings
$
475
$
808
$
2,538
$
4,484
Investing & Lending
Net revenues
$
1,044
$
1,786
$
3,749
$
3,756
Operating expenses
547
934
1,778
1,842
Pre-tax earnings
$
497
$
852
$
1,971
$
1,914
Investment Management
Net revenues
$
1,274
$
1,133
$
2,547
$
2,228
Operating expenses
1,056
954
2,123
1,903
Pre-tax earnings
$
218
$
179
$
424
$
325
Total
Net revenues
$
7,281
$
8,841
$
19,175
$
21,616
Operating expenses
5,669
7,393
13,523
15,009
Pre-tax earnings
$
1,612
$
1,448
$
5,652
$
6,607
Operating expenses in the table above include the following
expenses that have not been allocated to our segments:
•
net provisions for a number of litigation and regulatory
proceedings of $45 million and $615 million for the
three months ended June 2011 and June 2010,
respectively, and $69 million and $636 million for the
six months ended June 2011 and June 2010, respectively;
•
charitable contributions of $25 million for both the six
months ended June 2011 and June 2010; and
•
real estate-related exit costs of $4 million and
$6 million for the three and six months ended
June 2010, respectively.
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.
Financial Advisory. Includes advisory
assignments with respect to mergers and acquisitions,
divestitures, corporate defense activities, risk management,
restructurings and
spin-offs,
and derivative transactions directly related to these client
advisory assignments.
Underwriting. Includes public offerings and
private placements of a wide range of securities, loans and
other financial instruments, and derivative transactions
directly related to these client underwriting activities.
The table below presents the operating results of our Investment
Banking segment.
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Financial Advisory
$
637
$
471
$
994
$
935
Equity underwriting
378
225
804
597
Debt underwriting
433
245
919
612
Total Underwriting
811
470
1,723
1,209
Total net revenues
1,448
941
2,717
2,144
Operating expenses
981
713
1,904
1,593
Pre-tax
earnings
$
467
$
228
$
813
$
551
The table below presents our financial advisory and underwriting
transaction
volumes.1
Three Months
Six Months
Ended June
Ended June
in billions
2011
2010
2011
2010
Announced mergers and acquisitions
$
184
$
86
$
358
$
211
Completed mergers and acquisitions
175
98
339
195
Equity and
equity-related
offerings 2
17
9
42
23
Debt
offerings 3
59
54
132
117
1.
Source: Thomson Reuters. Announced and completed mergers and
acquisitions volumes are based on full credit to each of the
advisors in a transaction. Equity and
equity-related
offerings and debt offerings are based on full credit for single
book managers and equal credit for joint book managers.
Transaction volumes may not be indicative of net revenues in a
given period. In addition, transaction volumes for prior periods
may vary from amounts previously reported due to the subsequent
withdrawal or a change in the value of a transaction.
2.
Includes Rule 144A and public common stock offerings,
convertible offerings and rights offerings.
3.
Includes
non-convertible
preferred stock,
mortgage-backed
securities,
asset-backed
securities and taxable municipal debt. Includes publicly
registered and Rule 144A issues. Excludes leveraged loans.
Three Months Ended June 2011 versus
June 2010. Net revenues in Investment
Banking were $1.45 billion, 54% higher than the second
quarter of 2010.
Net revenues in Financial Advisory were $637 million, 35%
higher than the second quarter of 2010, reflecting an increase
in
industry-wide
completed mergers and acquisitions. Net revenues in our
Underwriting business were $811 million, 73% higher than
the second quarter of 2010. Net revenues in debt underwriting
were significantly higher than the second quarter of 2010,
primarily reflecting an increase in leveraged finance activity.
Net revenues in equity underwriting were also significantly
higher than the second quarter of 2010, reflecting an increase
in
industry-wide
equity and
equity-related
offerings.
During the second quarter of 2011, Investment Banking continued
to operate in an environment generally characterized by higher
levels of
industry-wide
mergers and acquisitions activity as compared with 2010.
Underwriting activity levels were higher compared with the
second quarter of 2010, reflecting generally higher equity
prices, continued low interest rates and increased refinancing
activity. However, heightened uncertainty regarding the global
economic outlook and concerns about European sovereign debt risk
and the U.S. debt ceiling negatively impacted global equity
markets during the second quarter of 2011, and continued to
weigh on corporate activity. If these concerns and uncertainties
were to continue, or if equity prices decline or interest rates
increase, resulting in lower levels of client activity, net
revenues in Investment Banking would likely be negatively
impacted.
Our investment banking transaction backlog was unchanged
compared with the end of the first quarter of 2011. Estimated
net revenues from potential advisory transactions were higher
compared with the end of the first quarter of 2011, reflecting
an increase in client activity. This increase was offset by a
decline in potential debt underwriting transactions, reflecting
a decrease in client mandates to underwrite leveraged finance
transactions, as well as lower estimated net revenues from
potential equity underwriting transactions.
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 $981 million for the second quarter
of 2011, 38% higher than the second quarter of 2010, due to
increased compensation and benefits expenses, primarily
resulting from higher net revenues, partially offset by the
impact of the U.K. bank payroll tax during the second quarter of
2010.
Pre-tax
earnings were $467 million in the second quarter of 2011,
compared with $228 million in the second quarter of 2010.
Six Months Ended June 2011 versus
June 2010. Net revenues in Investment
Banking were $2.72 billion, 27% higher than the first half
of 2010.
Net revenues in Financial Advisory were $994 million, 6%
higher than the first half of 2010. Net revenues in our
Underwriting business were $1.72 billion, 43% higher than
the first half of 2010. Net revenues in debt underwriting were
significantly higher than the first half of 2010, reflecting an
increase in leveraged finance and
investment-grade
activity. Net revenues in equity underwriting were also
significantly higher than the first half of 2010, reflecting
higher net revenues from initial public offerings.
During the first half of 2011, Investment Banking operated in an
environment generally characterized by higher levels of
industry-wide
mergers and acquisitions activity as compared with 2010.
Underwriting activity levels were higher compared with the first
half of 2010, reflecting generally higher equity prices,
continued low interest rates, increased refinancing activity and
a slight recovery in the commercial
mortgage-backed
securities market. However, heightened uncertainty regarding the
global economic outlook and concerns about European sovereign
debt risk and the U.S. debt ceiling
negatively impacted global equity markets, particularly in the
second quarter of 2011, and continued to weigh on corporate
activity. If these concerns and uncertainties were to continue,
or if equity prices decline or interest rates increase,
resulting in lower levels of client activity, net revenues in
Investment Banking would likely be negatively impacted.
Our investment banking transaction backlog increased compared
with the end of 2010. The increase compared with the end of 2010
was primarily due to an increase in estimated net revenues from
potential advisory transactions, as well as an increase in
potential equity underwriting transactions, which reflected an
increase in client mandates to underwrite initial public
offerings. Estimated net revenues from potential debt
underwriting transactions also increased during the first half
of 2011, reflecting an increase in client mandates to underwrite
commercial
mortgage-backed
securities.
Operating expenses were $1.90 billion for the first half of
2011, 20% higher than the first half of 2010, due to increased
compensation and benefits expenses, primarily resulting from
higher net revenues, partially offset by the impact of the U.K.
bank payroll tax during the first half of 2010.
Pre-tax
earnings were $813 million for the first half of 2011, 48%
higher than the first half of 2010.
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:
•
In large, highly liquid markets (such as markets for
U.S. Treasury bills, large capitalization S&P 500
stocks, or mortgage pass-through certificates), we execute a
high volume of transactions for our clients for modest spreads
and fees.
•
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.
•
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.
The table below presents the operating results of our
Institutional Client Services segment.
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Fixed Income, Currency and Commodities Client Execution
$
1,599
$
3,367
$
5,924
$
9,384
Equities client execution
623
312
1,602
1,599
Commissions and fees
861
940
1,832
1,784
Securities services
432
362
804
721
Total Equities
1,916
1,614
4,238
4,104
Total net revenues
3,515
4,981
10,162
13,488
Operating expenses
3,040
4,173
7,624
9,004
Pre-tax
earnings
$
475
$
808
$
2,538
$
4,484
Three Months Ended June 2011 versus
June 2010. Net revenues in Institutional
Client Services were $3.52 billion, 29% lower than the
second quarter of 2010.
Net revenues in Fixed Income, Currency and Commodities Client
Execution were $1.60 billion, 53% lower than the second
quarter of 2010, reflecting significantly lower results in
mortgages, commodities and interest rate products. High levels
of uncertainty and decreased levels of liquidity during the
quarter contributed to difficult
market-making
conditions, particularly in mortgages and commodities, and
prompted us to operate at generally lower levels of risk. In
addition, net revenues in currencies decreased slightly and net
revenues in credit products were essentially unchanged compared
with the second quarter of 2010. During the quarter, Fixed
Income, Currency and Commodities Client Execution operated in a
challenging environment reflecting broad market concerns and
uncertainty, which led to slightly lower levels of activity. The
effect of these macro concerns was more pronounced within our
Asian and European franchises.
Net revenues in Equities were $1.92 billion, 19% higher
than the second quarter of 2010, primarily reflecting higher net
revenues in equities client execution. This increase reflected
improved results in derivatives compared with a difficult second
quarter of 2010. However, results in the second quarter of 2011
for equities client execution more broadly reflected a
challenging environment generally characterized by lower levels
of activity and low volatility levels. In addition, commissions
and fees were lower compared with the second quarter of 2010,
reflecting lower client activity. Securities services net
revenues were higher compared with the second quarter of 2010,
reflecting the impact of higher average customer balances.
Institutional Client Services operated in an environment
generally characterized by broad market concerns and
uncertainties that emerged during 2010, including concerns about
European sovereign debt risk and uncertainty over financial
regulatory reform, that continued to have a negative impact on
our net revenues during the second quarter of 2011. Our results
during the quarter were also negatively impacted by concerns
regarding the state of the global economy, including a further
deterioration in economic data, increased sovereign risk in a
number of smaller European member states along with the
potential negative economic impact on financial institutions
with credit exposure to those sovereigns, and the U.S. debt
ceiling. In addition, volatility in market prices, price
divergence between our cash positions and corresponding hedges,
and decreased liquidity levels contributed to lower net revenues
from managing client-originated
market-making
inventory in Fixed Income, Currency and Commodities Client
Execution. In this environment, we reduced our market risk
levels, and many of our clients reduced their risk appetite,
resulting in slightly lower activity levels during the quarter.
If these concerns and uncertainties were to continue, and
market-making
conditions were to remain challenging, net revenues in Fixed
Income, Currency and Commodities Client Execution and Equities
would likely be negatively impacted.
Operating expenses were $3.04 billion for the second
quarter of 2011, 27% lower than the second quarter of 2010, due
to decreased compensation and benefits expenses and the impact
of the U.K. bank payroll tax during the second quarter of 2010.
Pre-tax
earnings were $475 million in the second quarter of 2011,
41% lower than the second quarter of 2010.
Six Months Ended June 2011 versus
June 2010. Net revenues in Institutional
Client Services were $10.16 billion, 25% lower than the
first half of 2010.
Net revenues in Fixed Income, Currency and Commodities Client
Execution were $5.92 billion, 37% lower than the first half
of 2010. Although client activity levels improved during the
first quarter of 2011, the environment became more challenging
during the second quarter of 2011 reflecting broad market
concerns and uncertainty, which led to slightly lower levels of
activity. In addition, high levels of uncertainty and decreased
levels of liquidity during the second quarter of 2011
contributed to difficult
market-making
conditions and prompted us to operate at generally lower levels
of risk. As a result of these conditions, net revenues across
the franchise were lower during the first half of 2011 compared
with the first half of 2010.
Net revenues in Equities were $4.24 billion, 3% higher
compared with the first half of 2010, primarily reflecting
higher net revenues in securities services. The increase in
securities services compared with the first half of 2010
reflected the impact of higher average customer balances.
Equities client execution net revenues were essentially
unchanged and reflected improved results in derivatives compared
with the first half of 2010, although results more broadly in
equities client execution for the first half of 2011 reflected a
challenging environment characterized by low levels of activity
and low volatility levels. Commissions and fees increased
slightly compared with the first half of 2010.
Institutional Client Services operated in an environment
generally characterized by broad market concerns and
uncertainties that emerged during 2010, including concerns about
European sovereign debt risk and uncertainty over financial
regulatory reform, along with additional concerns and
uncertainties that emerged during the first quarter of 2011,
including political unrest in the Middle East, the earthquake
and tsunami in Japan and inflation in emerging markets. In
addition, during the second quarter of 2011, a further
deterioration in economic data, increased sovereign risk in a
number of smaller European member states along with the
potential negative economic impact on financial institutions
with credit exposure to those sovereigns, and concerns regarding
the U.S. debt ceiling negatively impacted our net revenues.
If these concerns and uncertainties were to continue, and
market-making
conditions were to remain challenging, net revenues in Fixed
Income, Currency and Commodities Client Execution and Equities
would likely be negatively impacted.
Operating expenses were $7.62 billion for the first half of
2011, 15% lower than the first half of 2010, due to decreased
compensation and benefits expenses and the impact of the U.K.
bank payroll tax during the first half of 2010.
Pre-tax
earnings were $2.54 billion in the first half of 2011, 43%
lower than the first half of 2010.
Investing &
Lending
Investing & Lending includes our investing activities
and the origination of loans to provide financing to clients.
These investments and loans are typically longer-term in nature.
We make investments, directly and indirectly through funds that
we manage, in debt securities, loans, public and private equity
securities, real estate, consolidated investment entities and
power generation facilities.
The table below presents the operating results of our
Investing & Lending segment.
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
ICBC
$
(176
)
$
905
$
140
$
683
Equity securities (excluding ICBC)
686
(44
)
1,740
803
Debt securities and loans
200
422
1,224
1,552
Other 1
334
503
645
718
Total net revenues
1,044
1,786
3,749
3,756
Operating expenses
547
934
1,778
1,842
Pre-tax
earnings
$
497
$
852
$
1,971
$
1,914
1.
Primarily includes net revenues related to our consolidated
entities held for investment purposes.
Three Months Ended June 2011 versus
June 2010. Net revenues in
Investing & Lending were $1.04 billion for the
second quarter of 2011. Results for the second quarter of 2011
included a loss of $176 million from our investment in the
ordinary shares of ICBC, net gains of $686 million from
other investments in equities and net revenues of
$200 million from debt securities and loans, primarily
reflecting net interest income on loans, primarily mezzanine and
senior corporate loans. The net gains from other investments in
equities were primarily driven by private equity positions,
partially offset by losses from public equity positions. In the
second quarter of 2010, net revenues in Investing &
Lending primarily reflected a net gain of $905 million from
our investment in the ordinary shares of ICBC, net losses of
$44 million from other investments in equities and net
gains and net interest of $422 million from debt securities
and loans. If equity markets decline and credit spreads widen,
net revenues in Investing & Lending would likely be
negatively impacted.
Operating expenses were $547 million for the second quarter
of 2011, 41% lower than the second quarter of 2010, primarily
due to decreased compensation and benefits expenses.
Pre-tax
earnings were $497 million in the second quarter of 2011,
42% lower than the second quarter of 2010.
Six Months Ended June 2011 versus
June 2010. Net revenues in
Investing & Lending were $3.75 billion for the
first half of 2011. Net revenues in Investing &
Lending included a gain of $140 million from our investment
in the ordinary shares of ICBC, net gains of $1.74 billion
from other investments in equities and net gains and net
interest of $1.22 billion from debt securities and loans,
primarily mezzanine and senior corporate loans. The net gains
from other investments in equities were primarily driven by
gains from private equity positions. Net revenues from debt
securities and loans reflected the impact of generally favorable
credit markets, which provided favorable conditions for
borrowers to refinance, primarily during the first quarter of
2011. In the first half of 2010, net revenues in
Investing & Lending included a gain of
$683 million from our investment in the ordinary shares of
ICBC, net gains of $803 million from other investments in
equities and net gains and net interest of $1.55 billion
from debt securities and loans. If equity markets decline and
credit spreads widen, net revenues in Investing &
Lending would likely be negatively impacted.
Operating expenses were $1.78 billion for the first half of
2011, 3% lower than the first half of 2010, due to decreased
compensation and benefits expenses, partially offset by higher
expenses related to our consolidated entities held for
investment purposes.
Pre-tax
earnings were $1.97 billion in the first half of 2011, 3%
higher than the first half of 2010.
Investment
Management
Investment Management provides investment management services
and offers investment products (primarily through separately
managed accounts and commingled vehicles, such as mutual funds
and private investment funds) across all major asset classes to
a diverse set of institutional and individual clients.
Investment Management also offers wealth advisory services,
including portfolio management and financial counseling, and
brokerage and other transaction services to
high-net-worth
individuals and families.
Assets under management typically generate fees as a percentage
of net asset value, which vary by asset class and are affected
by investment performance as well as asset inflows and
redemptions. In certain circumstances, we are also entitled to
receive incentive fees based on a percentage of a fund’s
return or when the return exceeds a specified benchmark or other
performance targets. Incentive fees are recognized when all
material contingencies are resolved.
The table below presents the operating results of our Investment
Management segment.
Three Months
Six Months
Ended June
Ended June
in millions
2011
2010
2011
2010
Management and other fees
$
1,080
$
966
$
2,128
$
1,898
Incentive fees
63
33
137
59
Transaction revenues
131
134
282
271
Total net revenues
1,274
1,133
2,547
2,228
Operating expenses
1,056
954
2,123
1,903
Pre-tax
earnings
$
218
$
179
$
424
$
325
Assets under management include only client assets where we earn
a fee for managing assets on a discretionary basis. This
includes assets in our mutual funds, hedge funds, private equity
funds and separately managed accounts for institutional and
individual investors. Assets under management do not include the
self-directed assets of our clients, including brokerage
accounts, or interest-bearing deposits held through our bank
depository institution subsidiaries.
The tables below present our assets under management by asset
class and a summary of the changes in our assets under
management.
As of
June 30,
December 31,
in billions
2011
2010
2010
2009
Alternative
investments 1
$
148
$
146
$
148
$
146
Equity
148
125
144
146
Fixed income
352
326
340
315
Total
non-money
market assets
648
597
632
607
Money markets
196
205
208
264
Total assets under management
$
844
$
802
$
840
$
871
1.
Primarily includes hedge funds, private equity, real estate,
currencies, commodities and asset allocation strategies.
Three Months
Six Months
Ended June 30,
Ended June 30,
in billions
2011
2010
2011
2010
Balance, beginning of period
$
840
$
840
$
840
$
871
Net inflows/(outflows)
Alternative investments
(3
)
1
(3
)
2
Equity
(2
)
(9
)
(2
)
(11
)
Fixed income
7
(2
)
2
5
Total
non-money
market net inflows/(outflows)
2
(10
)
(3
)
(4
)
Money markets
(5
)
(14
)
(12
)
(59
)
Total net inflows/(outflows)
(3
)
(24
)
(15
)
(63
)
Net market appreciation/(depreciation)
7
(14
)
19
(6
)
Balance, end of period
$
844
$
802
$
844
$
802
Three Months Ended June 2011 versus
June 2010. Net revenues in Investment
Management were $1.27 billion, 12% higher than the second
quarter of 2010. The increase in net revenues compared with the
second quarter of 2010 was primarily due to an increase in
management and other fees, reflecting both favorable changes in
the mix of assets under management and higher average assets
under management, as well as higher incentive fees. During the
quarter, assets under management increased $4 billion to
$844 billion reflecting market appreciation and inflows in
fixed income assets, partially offset by outflows in money
market, alternative investment and equity assets.
During the second quarter of 2011, Investment Management
operated in an environment generally characterized by a
continuation of industry trends, including improved asset prices
and a shift in investor assets away from money markets in favor
of asset classes with potentially higher risk and returns. These
trends have resulted in favorable changes in the mix of assets
under management, as well as appreciation in the value of client
assets. If asset prices decline or
investors change their mix of assets to lower risk asset classes
or withdraw their assets, net revenues in Investment Management
would likely be negatively impacted. In addition, continued
uncertainty regarding the global economic outlook could result
in downward pressure on assets under management.
Operating expenses were $1.06 billion for the second
quarter of 2011, 11% higher than the second quarter of 2010, due
to increased compensation and benefits expenses, partially
offset by the impact of the U.K. bank payroll tax during
the second quarter of 2010.
Pre-tax
earnings were $218 million in the second quarter of 2011,
22% higher than the second quarter of 2010.
Six Months Ended June 2011 versus
June 2010. Net revenues in Investment
Management were $2.55 billion, 14% higher than the first
half of 2010. The increase in net revenues compared with the
first half of 2010 was primarily due to an increase in
management and other fees, reflecting favorable changes in the
mix of assets under management and higher average assets under
management, as well as higher incentive fees. During the first
half of 2011, assets under management increased $4 billion
to $844 billion reflecting net market appreciation of
$19 billion, primarily in fixed income and equity assets,
partially offset by net outflows of $15 billion, primarily
in money market assets.
The trends during the entire first half of 2011 were similar to
those in the second quarter of 2011 noted above. In the future,
if asset prices decline or investors change their mix of assets
to lower risk asset classes or withdraw their assets, net
revenues in Investment Management would likely be negatively
impacted. In addition, continued uncertainty regarding the
global economic outlook could result in downward pressure on
assets under management.
Operating expenses were $2.12 billion for the first half of
2011, 12% higher than the first half of 2010, due to increased
compensation and benefits expenses, primarily resulting from
higher net revenues, partially offset by the impact of the U.K.
bank payroll tax during the first half of 2010.
Pre-tax
earnings were $424 million for the first half of 2011, 30%
higher than the first half of 2010.
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.
The
U.S. Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act),
enacted in July 2010, significantly restructures the
financial regulatory regime under which we operate. The
implications of the Dodd-Frank Act for our businesses will
depend to a large extent on the provisions of required future
rulemaking by the Board of Governors of the Federal Reserve
System (Federal Reserve Board), the Federal Deposit Insurance
Corporation (FDIC), the SEC, the U.S. Commodity Futures
Trading Commission (CFTC) and other agencies, as well as the
development of market practices and structures under the regime
established by the legislation and the rules adopted pursuant to
it. Additionally, we expect that major European and Asian
authorities will adopt regulatory reforms consistent with some
aspects of the Dodd-Frank Act. These reforms may also affect our
businesses. However, we expect that the principal areas of
impact for us will be:
•
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;
•
increased regulation of and restrictions on
over-the-counter
(OTC) derivatives markets and transactions; and
•
increased regulatory capital requirements.
In addition, the legislation creates a new systemic risk
oversight body to oversee and coordinate the efforts of the
primary U.S. financial regulatory agencies in establishing
regulations to address financial stability concerns, including
more stringent supervisory requirements and prudential standards
applicable to systemically important financial institutions.
Legal and regulatory changes under consideration in other
jurisdictions could also have an impact on our activities. See
“Business — Regulation” in Part I,
Item 1 of our Annual Report on
Form 10-K
for more information.
We evaluated the prohibition on “proprietary trading”
and determined that businesses that engage in “bright
line” proprietary trading, as discussed in the Financial
Stability Oversight Council’s study on the Volcker Rule of
the Dodd-Frank Act, are most likely to be prohibited under the
legislation. As such, in 2010, we liquidated substantially all
of the positions that had been held within Principal Strategies
in our former Equities operating segment. In addition, during
the first quarter of 2011, we commenced the liquidation of the
positions that had been held by the global macro proprietary
trading business in our former Fixed Income, Currency and
Commodities operating segment. We believed the activities of
these businesses were likely to be considered “bright
line” proprietary trading and therefore not permissible
under the Dodd-Frank Act. The full impact of the Dodd-Frank Act
and other regulatory reforms on our businesses, our clients and
the markets in which we operate will depend on the manner in
which the relevant authorities develop and implement the
required rules and the reaction of market participants to these
regulatory developments over the next several years. We will
continue to assess our business, risk management, and compliance
practices to conform to developments in the regulatory
environment. However, the remaining businesses within our
Institutional Client Services segment perform
market-making
and securities services related activities, and we currently
expect that their activities will be permissible under the
Dodd-Frank Act.
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:
•
quarterly planning;
•
business-specific limits;
•
monitoring of key metrics; and
•
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:
•
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;
•
to ensure that our projected assets are supported by an adequate
level and tenor of funding and that our projected capital and
liquidity metrics are within management guidelines; and
•
to allow business risk managers and managers from our
independent control and support functions to objectively
evaluate balance sheet limit requests from business managers in
the context of the firm’s overall balance sheet
constraints. These constraints include the firm’s liability
profile and equity capital levels, maturities and plans for new
debt and equity issuances, share repurchases, deposit trends and
secured funding transactions.
To prepare our quarterly balance sheet plan, business risk
managers and managers from our independent control and support
functions meet with business managers to review current and
prior period metrics and discuss expectations for the upcoming
quarter. The specific metrics reviewed include asset and
liability size and composition, aged inventory, limit
utilization, risk and performance measures, and capital usage.
Our consolidated quarterly plan, including our balance sheet
plans by business, funding and capital projections, and
projected capital and liquidity metrics, is reviewed by the
Finance Committee. See “Overview and Structure of Risk
Management.”
Business-Specific Limits. The Finance
Committee sets asset and liability limits for each business and
aged inventory limits for certain financial instruments as a
disincentive to hold inventory over longer periods of time.
These limits are set at levels which are close to actual
operating levels in order to ensure prompt escalation and
discussion among business managers and managers in our
independent control and support functions on a routine basis.
The Finance Committee reviews and approves balance sheet limits
on a quarterly basis and may also approve changes in limits on
an ad hoc basis in response to changing business needs or market
conditions.
Monitoring of Key Metrics. We monitor key
balance sheet metrics daily both by business and on a
consolidated basis, including asset and liability size and
composition, aged inventory, limit utilization, risk measures
and capital usage. In our consolidated balance sheet, 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:
•
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.
•
Through our Internal Capital Adequacy Assessment Process (ICAAP)
and our resolution and recovery planning, we further analyze how
we would manage our balance sheet through the duration of a
severe crisis and we develop plans for mitigating actions to
access funding, generate liquidity,
and/or
redeploy equity capital, as appropriate.
Balance Sheet
Allocation
In addition to preparing our condensed consolidated statement of
financial condition in accordance with U.S. GAAP, we
prepare a balance sheet that generally allocates assets to our
businesses, which is a
non-GAAP
presentation and may not be comparable to similar
non-GAAP
presentations used by other companies. We believe that
presenting our assets on this basis is meaningful because it is
consistent with the way management views and manages risks
associated with the firm’s assets and better enables
investors to assess the liquidity of the firm’s assets. The
table below presents a summary of this balance sheet allocation.
As of
June
December
in millions
2011
2010
Excess liquidity (Global Core Excess)
$
165,843
$
174,776
Other cash
9,086
7,565
Excess liquidity and cash
174,929
182,341
Secured client financing
269,336
279,291
Inventory
270,853
260,406
Secured financing agreements
91,252
70,921
Receivables
43,992
32,396
Institutional Client Services
406,097
363,723
ICBC
8,001
7,589
Equity (excluding ICBC)
24,990
22,972
Debt
22,006
24,066
Receivables and other
4,079
3,291
Investing & Lending
59,076
57,918
Total inventory and related assets
465,173
421,641
Other assets
27,472
28,059
Total assets
$
936,910
$
911,332
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.
The tables below present the reconciliation of this balance
sheet allocation to our U.S. GAAP balance sheet. In the
tables below, total assets for Institutional Client Services and
Investing & Lending represent the inventory and
related assets. These amounts differ from total assets by
business segment disclosed in Note 25
to the condensed consolidated financial statements in
Part I, Item 1 of this
Form 10-Q
because total assets disclosed in Note 25 include
allocations of our excess liquidity and cash, secured client
financing and other assets.
As of June 2011
Excess
Secured
Institutional
Liquidity
Client
Client
Investing &
Other
Total
in millions
and Cash
1
Financing
Services
Lending
Assets
Assets
Cash and cash equivalents
$
45,433
$
—
$
—
$
—
$
—
$
45,433
Cash and securities segregated for regulatory and other purposes
—
61,491
—
—
—
61,491
Securities purchased under agreements to resell and federal
funds sold
64,395
73,984
23,607
299
—
162,285
Securities borrowed
21,087
86,740
67,645
—
—
175,472
Receivables from brokers, dealers and clearing organizations
—
3,028
13,755
2
—
16,785
Receivables from customers and counterparties
—
44,093
30,237
3,037
—
77,367
Financial instruments owned, at fair value
44,014
—
270,853
55,738
—
370,605
Other assets
—
—
—
—
27,472
27,472
Total assets
$
174,929
$
269,336
$
406,097
$
59,076
$
27,472
$
936,910
As of December 2010
Excess
Secured
Institutional
Liquidity
Client
Client
Investing &
Other
Total
in millions
and Cash
1
Financing
Services
Lending
Assets
Assets
Cash and cash equivalents
$
39,788
$
—
$
—
$
—
$
—
$
39,788
Cash and securities segregated for regulatory and other purposes
—
53,731
—
—
—
53,731
Securities purchased under agreements to resell and federal
funds sold
62,854
102,537
22,866
98
—
188,355
Securities borrowed
37,938
80,313
48,055
—
—
166,306
Receivables from brokers, dealers and clearing organizations
—
3,702
6,698
37
—
10,437
Receivables from customers and counterparties
—
39,008
25,698
2,997
—
67,703
Financial instruments owned, at fair value
41,761
—
260,406
54,786
—
356,953
Other assets
—
—
—
—
28,059
28,059
Total assets
$
182,341
$
279,291
$
363,723
$
57,918
$
28,059
$
911,332
1.
Includes unencumbered cash, U.S. government and federal
agency obligations (including highly liquid U.S. federal
agency
mortgage-backed
obligations), and French, German, United Kingdom and Japanese
government obligations.
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, and
generally hold higher levels of total capital for these assets
than for more liquid types of financial instruments. The table
below presents our aggregate holdings in these categories of
financial instruments.
As of
June
December
in millions
2011
2010
Mortgage and other
asset-backed
loans and securities
$
15,647
$
17,042
Bank loans and bridge
loans 1
18,927
18,039
Emerging market debt securities
4,961
3,931
High-yield
and other debt obligations
12,146
11,553
Private equity investments and real estate fund
investments 2
15,669
14,807
Emerging market equity securities
5,515
5,784
ICBC ordinary
shares 3
8,001
7,589
Other restricted public equity securities
82
116
Other investments in
funds 4
3,259
3,212
1.
Includes funded commitments and inventory held in connection
with our origination, investing and
market-making
activities.
2.
Includes interests in funds that we manage. Such amounts exclude
assets for which the firm does not bear economic exposure of
$2.43 billion and $1.68 billion as of June 2011
and December 2010, respectively, including assets related
to consolidated investment funds and consolidated VIEs.
3.
Includes interests of $4.98 billion and $4.73 billion
as of June 2011 and December 2010, respectively, held
by investment funds managed by Goldman Sachs.
4.
Includes interests in other investment funds that we manage.
See Notes 4 through 6 to the condensed consolidated
financial statements in Part I, Item 1 of this
Form 10-Q
for further information about the financial instruments we hold.
Balance Sheet
Analysis and Metrics
As of June 2011, total assets on our condensed consolidated
statement of financial condition were $936.91 billion, an
increase of $25.58 billion from December 2010. This
increase is primarily due to (i) an increase in financial
instruments owned, at fair value of $13.65 billion,
primarily due to increases in
non-U.S. government
obligations, and equities and convertible debentures, partially
offset by a decrease in physical commodities, within
Institutional Client Services and (ii) an increase in
receivables from customers and counterparties of
$9.66 billion, primarily due to client-driven activity in
Secured Client Financing and Institutional Client Services.
These increases were partially offset by a decrease in
collateralized agreements of $16.90 billion, primarily due
to a decrease in client-driven activity.
As of June 2011, total liabilities on our condensed
consolidated statement of financial condition were
$864.55 billion, an increase of $30.58 billion from
December 2010. This increase is primarily due to
(i) an increase in payables to customers and counterparties
of $16.11 billion primarily due to client-driven activity,
(ii) an increase in unsecured borrowings of
$9.52 billion, primarily due to new issuances, partially
offset by maturities, and (iii) an increase in financial
instruments sold, but not yet purchased, at fair value of
$8.92 billion, primarily due to increases in
U.S. government and federal agency obligations and equities
and convertible debentures.
As of June 2011 and December 2010, our total
securities sold under agreements to repurchase, accounted for as
collateralized financings, were $155.45 billion and
$162.35 billion, respectively, which were 5% lower and 2%
higher, respectively, than the daily average amount of
repurchase agreements over the respective quarters. As of
June 2011, the decrease in our repurchase agreements
relative to the daily average during the quarter was due to a
decrease in client-driven and a decrease in firm financing
activities 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, federal agency and
investment-grade
sovereign obligations through collateralized financing
activities.
The table below presents information on our assets,
shareholders’ equity and leverage ratios.
As of
June
December
$ in millions
2011
2010
Total assets
$
936,910
$
911,332
Adjusted assets
639,809
588,927
Total shareholders’ equity
72,356
77,356
Leverage ratio
12.9x
11.8x
Adjusted leverage ratio
8.8x
7.6x
Debt to equity ratio
2.4x
2.3x
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 and (ii) cash and securities we segregate for
regulatory and other purposes. Adjusted assets is a
non-GAAP
measure and may not be comparable to similar
non-GAAP
measures used by other companies.
The table below presents the reconciliation of total assets to
adjusted assets.
As of
June
December
in millions
2011
2010
Total assets
$
936,910
$
911,332
Deduct:
Securities borrowed
(175,472
)
(166,306
)
Securities purchased under agreements to resell and federal
funds sold
(162,285
)
(188,355
)
Add:
Financial instruments sold, but not yet purchased, at fair value
149,639
140,717
Less derivative liabilities
(47,492
)
(54,730
)
Subtotal
102,147
85,987
Deduct:
Cash and securities segregated for regulatory and other purposes
(61,491
)
(53,731
)
Adjusted assets
$
639,809
$
588,927
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 8.8x as of
June 2011 from 7.6x as of December 2010 as our
adjusted assets increased and our total shareholders’
equity decreased, primarily reflecting the redemption of the
firm’s Series G Preferred Stock.
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:
•
collateralized financings, such as repurchase agreements,
securities loaned and other secured financings;
•
long-term
unsecured debt through syndicated U.S. registered
offerings, U.S. registered and 144A
medium-term
note programs, offshore
medium-term
note offerings and other debt offerings;
•
short-term
unsecured debt through U.S. and
non-U.S. commercial
paper and promissory note issuances and other methods; and
•
demand and savings deposits through cash sweep programs and time
deposits through internal and
third-party
broker networks.
We generally distribute our funding sources through our own
sales force to a large, diverse creditor base in a variety of
markets in the Americas, Europe and Asia. We believe that our
relationships with our creditors are critical to our liquidity.
Our creditors include banks, governments, securities lenders,
pension funds, insurance companies, mutual funds and
individuals. We have imposed various internal guidelines to
monitor creditor concentration across our funding programs.
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
June 2011.
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 to meet our
long-term
financing requirements and to finance a portion of our GCE. We
issue in different tenors, currencies, and products to maximize
the diversification of our investor base. The table below
presents our quarterly unsecured
long-term
borrowings maturity profile through the second quarter of 2017
as of June 2011.
The weighted average maturity of our unsecured
long-term
borrowings as of June 2011 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 minimize
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 of June 2011, we had
$17.14 billion of senior unsecured
short-term
debt outstanding guaranteed by the FDIC under the TLGP, all of
which will mature on or prior to June 15, 2012. We
have not issued
long-term
debt under the TLGP since March 2009 and the program has
expired for new issuances.
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. We prefer
issuing promissory notes, in which we do not make a market, over
commercial paper, which we may repurchase prior to maturity
through the ordinary course of business as a market maker.
As of June 2011, our unsecured
short-term
borrowings, including the current portion of unsecured
long-term
borrowings, were $56.55 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.
Deposits. As of June 2011, our bank
depository institution subsidiaries had $39.00 billion in
customer deposits, including $8.21 billion of certificates
of deposit and other time deposits with a weighted average
maturity of three years, and $30.79 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
lending commitments.
Goldman Sachs Bank USA (GS Bank USA) has access to funding
through the Federal Reserve Bank discount window. While we do
not rely on this funding in our liquidity planning and stress
testing, we maintain policies and procedures necessary to access
this funding and test discount window borrowing procedures.
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 contingency capital plan which
provides a framework for analyzing and responding to an actual
or perceived capital shortfall.
Our consolidated regulatory capital requirements are determined
by the Federal Reserve Board, as described below. Our ICAAP
incorporates an internal
risk-based
capital assessment designed to identify and measure material
risks associated with our business activities, including market
risk, credit risk and operational risk, in a manner that is
closely aligned with our risk management practices. Our internal
risk-based
capital assessment is supplemented with the results of stress
tests.
As of June 2011, our total shareholders’ equity was
$72.36 billion (consisting of common shareholders’
equity of $69.26 billion and preferred stock of
$3.10 billion). As of December 2010, our total
shareholders’ equity was $77.36 billion (consisting of
common shareholders’ equity of $70.40 billion and
preferred stock of $6.96 billion). In addition, our
$5.00 billion of junior subordinated debt issued to trusts
qualifies as equity capital for regulatory and certain rating
agency purposes. See
“— Consolidated
Regulatory Capital Ratios” below for information regarding
the impact of regulatory developments.
The Federal Reserve Board is the primary regulator of
Group Inc., a bank holding company and a financial holding
company under the U.S. Bank Holding Company Act of 1956. As
a bank holding company, we are subject to consolidated
regulatory capital requirements that are computed in accordance
with the Federal Reserve Board’s capital adequacy
regulations currently applicable to bank holding companies
(Basel 1). These capital requirements, which are based on the
Capital Accord of the Basel Committee on Banking Supervision
(Basel Committee), are expressed as capital ratios that compare
measures of capital to
risk-weighted
assets (RWAs). See Note 20 to the condensed consolidated
financial statements in Part I, Item 1 of this
Form 10-Q
for additional information regarding the firm’s RWAs. The
firm’s capital levels are also subject to qualitative
judgments by its regulators about components, risk weightings
and other factors.
Federal Reserve Board regulations require bank holding companies
to maintain a minimum Tier 1 capital ratio of 4% and a
minimum total capital ratio of 8%. The required minimum
Tier 1 capital ratio and total capital ratio in order to be
considered a “well-capitalized” bank holding company
under the Federal Reserve Board guidelines are 6% and 10%,
respectively. Bank holding companies may be expected to maintain
ratios well above the minimum levels, depending on their
particular condition, risk profile and growth plans. The minimum
Tier 1 leverage ratio is 3% for bank holding companies that
have received the highest supervisory rating under Federal
Reserve Board guidelines or that have implemented the Federal
Reserve Board’s
risk-based
capital measure for market risk. Other bank holding companies
must have a minimum Tier 1 leverage ratio of 4%.
Consolidated
Regulatory Capital Ratios
The table below presents information about our regulatory
capital ratios.
As of
June
December
$ in millions
2011
2010
Common shareholders’ equity
$
69,256
$
70,399
Less: Goodwill
(3,323
)
(3,495
)
Less: Disallowable intangible assets
(1,864
)
(2,027
)
Less: Other
deductions 1
(5,804
)
(5,601
)
Tier 1 Common Capital
58,265
59,276
Preferred stock
3,100
6,957
Junior subordinated debt issued to trusts
5,000
5,000
Tier 1 Capital
66,365
71,233
Qualifying subordinated
debt 2
14,046
13,880
Less: Other
deductions 1
(235
)
(220
)
Tier 2 Capital
13,811
13,660
Total Capital
$
80,176
$
84,893
Risk-Weighted
Assets3
$
451,010
$
444,290
Tier 1 Capital Ratio
14.7
%
16.0
%
Total Capital Ratio
17.8
%
19.1
%
Tier 1 Leverage Ratio3
7.3
%
8.0
%
Tier 1 Common Ratio4
12.9
%
13.3
%
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.
Substantially all of our subordinated debt qualifies as
Tier 2 capital for Basel 1 purposes.
3.
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.
4.
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 decreased to 14.7% as of
June 2011 from 16.0% as of December 2010. Our
Tier 1 leverage ratio decreased to 7.3% as of
June 2011 from 8.0% as of December 2010. Substantially
all of the decrease in our Tier 1 capital ratio and
Tier 1 leverage ratio reflected the impact of the
redemption of the firm’s Series G Preferred Stock.
We are currently working to implement the requirements set out
in the Federal Reserve Board’s Capital Adequacy Guidelines
for Bank Holding Companies: Internal Ratings-Based and Advanced
Measurement Approaches, 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 as applicable to us as a bank holding
company (Basel 2). U.S. banking regulators have
incorporated the Basel 2 framework into the existing
risk-based
capital requirements by requiring that internationally active
banking organizations, such as us, adopt Basel 2 following the
successful completion of a parallel run. As required by the
Dodd-Frank Act, U.S. banking regulators have adopted a rule
which requires large banking organizations, upon adoption of
Basel 2, to continue to calculate
risk-based
capital ratios under both Basel 1 and Basel 2. For each of the
Tier 1 and Total capital ratios, the lower of the ratios
calculated will be used to determine whether the bank meets its
minimum
risk-based
capital requirements.
In addition, the Basel Committee has undertaken a program of
substantial revisions to its capital guidelines. In particular,
the changes in the “Basel 2.5” guidelines will
result in increased capital requirements for market risk;
additionally, the Basel 3 guidelines issued by the Basel
Committee in December 2010 revise the definition of
Tier 1 capital, introduce Tier 1 common equity as a
regulatory metric, set 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 other capital ratios), introduce a Tier 1
leverage ratio within international guidelines for the first
time, and make 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 the
Basel 2.5 guidelines, they have not yet addressed all
aspects of those guidelines or the Basel 3 changes. In addition,
both the Basel Committee and U.S. banking regulators
implementing the Dodd-Frank Act have indicated that they will
impose more stringent capital standards on systemically
important financial institutions. The Basel Committee has
proposed a methodology to assess the global systemic importance
of a bank and the range of loss absorbing capital that a bank
that is deemed systemically important should maintain. Because
this proposal has not yet been adopted by the Basel Committee,
the assessment criteria have not yet been finalized;
nevertheless, it is probable that they will apply to us.
Therefore, the regulations ultimately applicable to us may be
substantially different from those that have been published to
date.
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. The Federal Reserve Board will
be required to begin implementing the new leverage and
risk-based
capital regulation by January 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 on January 1, 2013. The
interaction between the Dodd-Frank Act and the Basel
Committee’s proposed changes adds further uncertainty to
our future capital requirements.
A number of other governmental entities and regulators,
including the U.S. Treasury, the European Union and the
Financial Services Authority in the United Kingdom, have also
proposed or announced changes which will result in increased
capital requirements for financial institutions.
As a consequence of these developments, we expect minimum
capital ratios required to be maintained under Federal Reserve
Board regulations will be increased and changes in the
prescribed calculation methodology are expected to result in
higher RWAs and lower capital ratios than those currently
computed.
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.
Rating Agency
Guidelines
The credit rating agencies assign credit ratings to the
obligations of Group Inc., which directly issues or
guarantees substantially all of the firm’s senior unsecured
obligations. GS Bank USA has also been assigned
long-term
issuer ratings as well as ratings on its
long-term
and
short-term
bank deposits. In addition, credit rating agencies have assigned
ratings to debt obligations of certain other subsidiaries of
Group Inc.
The level and composition of our equity capital are among the
many factors considered in determining our credit ratings. Each
agency has its own definition of eligible capital and
methodology for evaluating capital adequacy, and assessments are
generally based on a combination of factors rather than a single
calculation. See “Liquidity Risk Management —
Credit Ratings” for further information about our credit
ratings.
Subsidiary
Capital Requirements
Many of our subsidiaries, including GS 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 by
Group Inc. GS Bank USA’s capital levels and
prompt corrective action classification are subject to
qualitative judgments by its regulators about components, risk
weightings and other factors.
We expect that the capital requirements of several of our
subsidiaries will be impacted in the future by the various
developments arising from the Basel Committee, the Dodd-Frank
Act, and other governmental entities and regulators.
See Note 20 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q
for information about GS Bank USA’s capital ratios
under Basel 1 as implemented by the Federal Reserve Board, and
for further information about the capital requirements of our
other regulated subsidiaries and the potential impact of
regulatory reform.
Subsidiaries not subject to separate regulatory capital
requirements may hold capital to satisfy local tax guidelines,
rating agency requirements (for entities with assigned credit
ratings) or internal policies, including policies concerning the
minimum amount of capital a subsidiary should hold based on its
underlying level of risk. In certain instances, Group Inc.
may be limited in its ability to access capital held at certain
subsidiaries as a result of regulatory, tax or other
constraints. As of June 2011 and December 2010,
Group Inc.’s equity investment in subsidiaries was
$70.96 billion and $71.30 billion, respectively,
compared with its total shareholders’ equity of
$72.36 billion and $77.36 billion, respectively.
Group Inc. has guaranteed the payment obligations of
GS&Co., GS Bank USA, Goldman Sachs Bank (Europe) PLC
and GSEC subject to certain exceptions. In November 2008,
we contributed subsidiaries into GS Bank USA, and
Group Inc. agreed to guarantee certain losses, including
credit-related
losses, relating to assets held by the contributed entities. In
connection with this guarantee, Group Inc. also agreed to
pledge to GS Bank USA certain collateral, including
interests in subsidiaries and other illiquid assets.
Our capital invested in
non-U.S. subsidiaries
is generally exposed to foreign exchange risk, substantially all
of which is managed through a combination of derivatives and
non-U.S. denominated
debt.
Contingency
Capital Plan
Our contingency capital plan provides a framework for analyzing
and responding to a perceived or actual capital deficiency,
including, but not limited to, identification of drivers of a
capital deficiency, as well as mitigants and potential actions.
It outlines the appropriate communication procedures to follow
during a crisis period, including internal dissemination of
information as well as ensuring timely communication with
external stakeholders.
Our objective is to maintain a sufficient level and optimal
composition of equity capital. We principally manage our capital
through issuances and repurchases of our common stock. We may
also, from time to time, issue or repurchase our preferred
stock, junior subordinated debt issued to trusts and other
subordinated debt or other forms of capital as business
conditions warrant and subject to any regulatory approvals. We
manage our capital requirements principally by setting limits on
balance sheet assets
and/or
limits on risk, in each case both at the consolidated and
business levels. We attribute capital usage to each of our
businesses based upon our internal
risk-based
capital and regulatory frameworks and manage the levels of usage
based upon the balance sheet and risk limits established.
Preferred Stock. In March 2011, we
provided notice to Berkshire Hathaway that we would redeem in
full the 50,000 shares of our Series G Preferred Stock
held by Berkshire Hathaway for the stated redemption price of
$5.50 billion ($110,000 per share), plus accrued and unpaid
dividends. In connection with this notice, we recognized a
preferred dividend of $1.64 billion (calculated as the
difference between the carrying value and redemption value of
the preferred stock), which was recorded as a reduction to our
first quarter earnings applicable to common shareholders and
common shareholders’ equity, and reduced our earnings per
common share and book value per common share by $2.82 and $3.06,
respectively, in the first quarter of 2011. The redemption also
resulted in the acceleration of $24 million of preferred
dividends related to the period from April 1, 2011 to
the redemption date, which was included in our results during
the three months ended March 2011. The Series G
Preferred Stock was redeemed on April 18, 2011.
Berkshire Hathaway continues to hold a five-year warrant, issued
in October 2008, to purchase up to 43.5 million shares
of common stock at an exercise price of $115.00 per share.
Share Repurchase Program. We seek to use our
share repurchase program to help maintain the appropriate level
of common equity and to substantially offset increases in share
count over time resulting from employee
share-based
compensation. The repurchase program is effected primarily
through regular
open-market
purchases, the amounts and timing of which are determined
primarily by our current and projected capital positions
(i.e., comparisons of our desired level and composition of
capital to our actual level and composition of capital) and the
issuance of shares resulting from employee
share-based
compensation, but which may also be influenced by general market
conditions and the prevailing price and trading volumes of our
common stock.
On July 18, 2011, the Board of Directors of
Group Inc. (Board) authorized the repurchase of an
additional 75.0 million shares of common stock pursuant to
the firm’s existing share repurchase program. As of
July 18, 2011, under the share repurchase program
approved by the Board, we can repurchase up to 90.8 million
additional shares of common stock, including the newly
authorized amount; however, any such repurchases are subject to
the approval of the Federal Reserve Board. See
“Unregistered Sales of Equity Securities and Use of
Proceeds” in Part II, Item 2 and Note 19 to
the condensed consolidated financial statements in Part I,
Item 1 of this
Form 10-Q
for additional information on our repurchase program.
See Notes 16 and 19 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q
for further information about our preferred stock, junior
subordinated debt issued to trusts and other subordinated debt.
Other Capital
Metrics
The table below presents information on our shareholders’
equity and book value per common share.
Tangible common shareholders’
equity. Tangible common shareholders’ equity
equals total shareholders’ equity less preferred stock,
goodwill and identifiable intangible assets. Tangible book value
per common share is computed by dividing tangible common
shareholders’ equity by the number of common shares
outstanding, including RSUs granted to employees with no future
service requirements. We believe that tangible common
shareholders’ equity and tangible book value per common
share are meaningful because they are measures that we and
investors use to assess capital adequacy. Tangible common
shareholders’ equity and tangible book value per common
share are
non-GAAP
measures and may not be comparable to similar
non-GAAP
measures used by other companies.
The table below presents the reconciliation of total
shareholders’ equity to tangible common shareholders’
equity.
As of
June
December
in millions
2011
2010
Total shareholders’ equity
$
72,356
$
77,356
Deduct: Preferred stock
(3,100
)
(6,957
)
Common shareholders’ equity
69,256
70,399
Deduct: Goodwill and identifiable intangible assets
(5,187
)
(5,522
)
Tangible common shareholders’ equity
$
64,069
$
64,877
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
RSUs granted to employees with no future service requirements,
of 526.9 million and 546.9 million as of
June 2011 and December 2010, respectively.
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:
•
purchasing or retaining residual and other interests in special
purpose entities such as
mortgage-backed
and other
asset-backed
securitization vehicles;
•
holding senior and subordinated debt, interests in limited and
general partnerships, and preferred and common stock in other
nonconsolidated vehicles;
•
entering into interest rate, foreign currency, equity, commodity
and credit derivatives, including total return swaps;
•
entering into operating leases; and
•
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.
When we transfer a security that has very little, if any,
default risk under an agreement to repurchase the security where
the maturity date of the repurchase agreement matches the
maturity date of the underlying security (such that we
effectively no longer have a repurchase obligation) and we have
relinquished
control over the underlying security, we record such
transactions as sales. These transactions are referred to as
“repos to maturity.” We had no such transactions
outstanding as of June 2011 or December 2010.
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.
Type of Off-Balance-Sheet Arrangement
Disclosure in
Form 10-Q
Variable interests and other obligations, including contingent
obligations, arising from variable interests in nonconsolidated
VIEs
See Note 11 to the condensed consolidated financial statements
in Part I, Item 1 of this
Form 10-Q.
Leases, letters of credit, and lending and other commitments
See below and Note 18 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q.
Guarantees
See below and Note 18 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q.
Derivatives
See Notes 4, 5, 7 and 18 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q.
We have certain contractual obligations which require us to make
future cash payments. These contractual obligations include our
unsecured
long-term
borrowings, secured
long-term
financings, time deposits, contractual interest payments and
insurance agreements, all of which are included in our condensed
consolidated statement of financial condition. Our obligations
to make future cash payments also
include certain
off-balance-sheet
contractual obligations such as purchase obligations, minimum
rental payments under noncancelable leases and commitments and
guarantees.
The table below presents our contractual obligations,
commitments and guarantees as of June 2011.
Remainder
2016-
in millions
of 2011
2012-2013
2014-2015
Thereafter
Total
Amounts related to on-balance-sheet obligations
Time
deposits 1
$
—
$
2,316
$
1,300
$
1,455
$
5,071
Secured
long-term
financings 2
—
4,066
1,499
2,446
8,011
Unsecured
long-term
borrowings 3
—
34,655
38,159
102,396
175,210
Contractual interest
payments 4
3,233
13,509
10,456
35,251
62,449
Insurance
liabilities 5
461
1,653
1,539
16,518
20,171
Subordinated liabilities issued by consolidated VIEs
—
49
117
1,210
1,376
Amounts related to
off-balance-sheet
arrangements
Commitments to extend credit
5,719
26,571
16,786
15,210
64,286
Contingent and forward starting resale and securities borrowing
agreements
71,177
—
—
—
71,177
Forward starting repurchase and securities lending agreements
19,180
—
—
—
19,180
Underwriting commitments
188
—
—
—
188
Letters of credit
1,010
515
142
1
1,668
Investment commitments
2,339
6,698
326
923
10,286
Minimum rental payments
251
921
765
1,770
3,707
Purchase obligations
375
124
60
25
584
Derivative guarantees
282,572
397,688
72,796
75,698
828,754
Securities lending indemnifications
32,604
—
—
—
32,604
Other financial guarantees
249
1,251
490
1,188
3,178
1.
Excludes $3.14 billion of time deposits maturing within one
year.
2.
The aggregate contractual principal amount of secured
long-term
financings for which the fair value option was elected,
primarily consisting of transfers of financial assets accounted
for as financings rather than sales and certain other
nonrecourse financings, exceeded their related fair value by
$294 million.
3.
Includes an increase of $6.23 billion to the carrying
amount of certain of our unsecured
long-term
borrowings related to fair value hedges. In addition, the
aggregate contractual principal amount of unsecured
long-term
borrowings (principal and
non-principal
protected) for which the fair value option was elected exceeded
the related fair value by $538 million.
4.
Represents estimated future interest payments related to
unsecured
long-term
borrowings, secured
long-term
financings and time deposits based on applicable interest rates
as of June 2011. Includes stated coupons, if any, on
structured notes.
5.
Represents estimated undiscounted payments related to future
benefits and unpaid claims arising from policies associated with
our insurance activities, excluding separate accounts and
estimated recoveries under reinsurance contracts.
Obligations maturing within one year of our financial statement
date or redeemable within one year of our financial statement
date at the option of the holder are excluded and are treated as
short-term
obligations.
•
Obligations that are repayable prior to maturity at the option
of Goldman Sachs are reflected at their contractual maturity
dates and obligations that are redeemable prior to maturity at
the option of the holders are reflected at the dates such
options become exercisable.
•
Amounts included in the table do not necessarily reflect the
actual future cash flow requirements for these arrangements
because commitments and guarantees represent notional amounts
and may expire unused or be reduced or cancelled at the
counterparty’s request.
•
Due to the uncertainty of the timing and amounts that will
ultimately be paid, our liability for unrecognized tax benefits
has been excluded. See Note 24 to the condensed
consolidated financial statements in Part I, Item 1 of
this
Form 10-Q
for further information about our unrecognized tax benefits.
See Notes 15 and 18 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q
for further information about our
short-term
borrowings, and commitments and guarantees.
As of June 2011, our unsecured
long-term
borrowings were $175.21 billion, with maturities extending
to 2060, and consisted principally of senior borrowings. 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.
As of June 2011, our future minimum rental payments net of
minimum sublease rentals under noncancelable leases were
$3.71 billion. These lease commitments, principally for
office space, expire on various dates through 2069. Certain
agreements are subject to periodic escalation provisions for
increases in real estate taxes and other charges. See
Note 18 to the condensed consolidated financial statements
in Part I, Item 1 of this
Form 10-Q
for further information about our leases.
Our occupancy expenses include costs associated with office
space held in excess of our current requirements. This excess
space, the cost of which is charged to earnings as incurred, is
being held for potential growth or to replace currently occupied
space that we may exit in the future. We regularly evaluate our
current and future space capacity in relation to current and
projected staffing levels. During the three and six months ended
June 2011, total occupancy expenses for space held in
excess of our current requirements were $29 million and
$58 million, respectively, which includes costs related to
the transition to our new headquarters in New York City. In
addition, during the six months ended June 2011, we did not
incur any exit costs related to our office space. We may incur
exit costs in the future to the extent we (i) reduce our
space capacity or (ii) commit to, or occupy, new properties
in the locations in which we operate and, consequently, dispose
of existing space that had been held for potential growth. These
exit costs may be material to our results of operations in a
given period.
We believe that effective risk management is of primary
importance to the success of the firm. Accordingly, we have
comprehensive risk management processes through which we
monitor, evaluate and manage the risks we assume in conducting
our activities. These include market, credit, liquidity,
operational, legal, regulatory and reputational risk exposures.
Our risk management framework is built around three core
components: governance, processes and people.
Governance. Risk management governance starts
with our Board, which plays an important role in reviewing and
approving risk management policies and practices, both directly
and through its Risk Committee, which consists of all of our
independent directors. The Board also receives periodic updates
on firmwide risks from our independent control and support
functions. Next, at the most senior levels of the firm, our
leaders are experienced risk managers, with a sophisticated and
detailed understanding of the risks we take. Our senior managers
lead and participate in
risk-oriented
committees, as do the leaders of our independent control and
support functions — including those in internal audit,
compliance, controllers, credit risk management, human capital
management, legal, market risk management, operations,
operational risk management, tax, technology and treasury.
The firm’s governance structure provides the protocol and
responsibility for decision-making on risk management issues and
ensures implementation of those decisions. We make extensive use
of
risk-related
committees that meet regularly and serve as an important means
to facilitate and foster ongoing discussions to identify, manage
and mitigate risks.
We maintain strong communication about risk and we have a
culture of collaboration in decision-making among the
revenue-producing units, independent control and support
functions, committees and senior management. While we believe
that the first line of defense in managing risk rests with the
managers in our revenue-producing units, we dedicate extensive
resources to independent control and support functions in order
to ensure a strong oversight structure and an appropriate
segregation of duties.
Processes. We maintain various processes and
procedures that are critical components of our risk management.
First and foremost is our daily discipline of marking
substantially all of the firm’s inventory to current market
levels. Goldman Sachs carries its inventory at fair value, with
changes in valuation reflected immediately in our risk
management systems and in net revenues. We do so because we
believe this discipline is one of the most effective tools for
assessing and managing risk and that it provides transparent and
realistic insight into our financial exposures.
We also apply a rigorous framework of limits to control risk
across multiple transactions, products, businesses and markets.
This includes setting credit and market risk limits at a variety
of levels and monitoring these limits on a daily basis. Limits
are typically set at levels that will be periodically exceeded,
rather than at levels which reflect our maximum risk appetite.
This fosters an ongoing dialogue on risk among revenue-producing
units, independent control and support functions, committees and
senior management, as well as rapid escalation of
risk-related
matters. See “Market Risk Management” and “Credit
Risk Management” for further information on our risk limits.
Active management of our positions is another important process.
Proactive mitigation of our market and credit exposures
minimizes the risk that we will be required to take outsized
actions during periods of stress.
We also focus on the rigor and effectiveness of the firm’s
risk systems. The goal of our risk management technology is to
get the right information to the right people at the right time,
which requires systems that are comprehensive, reliable and
timely. We devote significant time and resources to our risk
management technology to ensure that it consistently provides us
with complete, accurate and timely information.
People. Even the best technology serves only
as a tool for helping to make informed decisions in real time
about the risks we are taking. Ultimately, effective risk
management requires our people to interpret our risk data on an
ongoing and timely basis and adjust risk positions accordingly.
In both our revenue-producing units and our independent control
and support functions, the experience of our professionals, and
their understanding of the nuances and limitations of each risk
measure, guide the firm in assessing exposures and maintaining
them within prudent levels.
Structure
Ultimate oversight of risk is the responsibility of the
firm’s Board. The Board oversees risk both directly and
through its Risk Committee. Within the firm, a series of
committees with specific risk management mandates have oversight
or decision-making responsibilities for risk management
activities. Committee membership generally consists of senior
managers from both our revenue-producing units and our
independent control and support functions. We have established
procedures for these committees to ensure that appropriate
information barriers are in place. Our primary risk committees,
most of which also have additional
sub-committees
or working groups, are described below. In addition to these
committees, we have other
risk-oriented
committees which provide oversight for different businesses,
activities, products, regions and legal entities.
Membership of the firm’s risk committees is reviewed
regularly and updated to reflect changes in the responsibilities
of the committee members. Accordingly, the length of time that
members serve on the respective committees varies as determined
by the relevant committee charter or the committee chairs, and
based on the responsibilities of the members within the firm.
In addition, independent control and support functions, which
report to the chief financial officer, general counsel, chief
administrative officer, or in the case of Internal Audit, to the
Audit Committee of the Board, are responsible for
day-to-day
oversight of risk, as discussed in greater detail in the
following sections.
The chart below presents an overview of our risk management
governance structure, highlighting the oversight of our Board,
our key
risk-related
committees and the independence of our control and support
functions.
Management Committee. The Management Committee
oversees the global activities of the firm, including all of the
firm’s independent control and support functions. It
provides this oversight directly and through authority delegated
to committees it has established. This committee is comprised of
the most senior leaders of the firm, and is chaired by the
firm’s chief executive officer. The Management Committee
has established various committees with delegated authority and
appoints the chairpersons of these committees (the chairpersons
then appoint the other members of the committees). All of these
committees (and other committees established by such committees)
report, directly or indirectly, to the Management Committee.
Most members of the Management Committee are also members of
other firmwide, divisional and regional committees. The
following are the committees established by the Management
Committee that are principally involved in firmwide risk
management.
Firmwide Client and Business Standards
Committee. The Firmwide Client and Business
Standards Committee assesses and makes determinations regarding
business standards and practices, reputational risk management,
client relationships and client service, and is chaired by the
firm’s president and chief operating officer. This
committee also has responsibility for overseeing the
implementation of the recommendations of the Business Standards
Committee. This committee has established the following two
committees that report to it and is responsible for appointing
the chairpersons of these committees and other committee members:
Firmwide New Activity Committee. The Firmwide
New Activity Committee is responsible for reviewing new
activities and establishing a process to identify and review
previously approved activities that are significant and that
have changed in complexity
and/or
structure or present different reputational and suitability
concerns over time to consider whether these activities remain
appropriate. This committee is co-chaired by the firm’s
head of operations/chief operating officer for Europe, Middle
East and Africa and the chief administrative officer of our
Investment Management Division.
•
Firmwide Suitability Committee. The Firmwide
Suitability Committee is responsible for setting standards and
policies for product, transaction and client suitability and
providing a forum for consistency across divisions, regions and
products on suitability assessments. This committee also reviews
suitability matters escalated from other firm committees. This
committee is co-chaired by the firm’s international general
counsel and the chief operating officer of our Investment
Management Division.
Firmwide Risk Committee. The Firmwide Risk
Committee is responsible for the ongoing monitoring and control
of the firm’s global financial risks. Through both direct
and delegated authority, the Firmwide Risk Committee approves
firmwide, product, divisional and business-level limits for both
market and credit risks, approves sovereign credit risk limits
and reviews results of stress tests and scenario analyses. This
committee is co-chaired by the firm’s chief financial
officer and a senior managing director from the firm’s
executive office. The following four committees report to the
Firmwide Risk Committee, which is responsible for appointing the
chairperson of each of these committees, who then appoints the
other committee members:
•
Securities Division Risk Committee. The
Securities Division Risk Committee sets market risk limits,
subject to overall firmwide risk limits, for our Fixed Income,
Currency and Commodities Client Execution and Equities Client
Execution businesses based on a number of risk measures,
including VaR, stress tests, scenario analyses, and inventory
levels. This committee is chaired by the chief risk officer of
our Securities Division.
•
Credit Policy Committee. The Credit Policy
Committee establishes and reviews broad credit policies and
parameters that are implemented by our Credit Risk Management
department (Credit
Risk Management). This committee is chaired by the firm’s
chief credit officer.
•
Operational Risk Committee. The Operational
Risk Committee provides oversight of the ongoing development and
implementation of our operational risk policies, framework and
methodologies, and monitors the effectiveness of operational
risk management. This committee is chaired by the chief risk
officer of GS Bank USA.
•
Finance Committee. The Finance Committee has
oversight of firmwide liquidity, the size and composition of our
balance sheet and capital base, and our credit ratings. This
committee regularly reviews our liquidity, balance sheet,
funding position and capitalization, and makes adjustments in
light of current events, risks and exposures, and regulatory
requirements. This committee is also responsible for reviewing
and approving balance sheet limits and the size of our GCE. This
committee is co-chaired by the firm’s chief financial
officer and the firm’s global treasurer.
The following committees report jointly to the Firmwide Risk
Committee and the Firmwide Client and Business Standards
Committee, which also appoint the chairpersons of these
committees (who then appoint the members of the committees).
•
Firmwide Capital Committee. The Firmwide
Capital Committee provides approval and oversight of
debt-related underwriting transactions, including related
commitments of the firm’s capital. This committee aims to
ensure that business and reputational standards for
underwritings and capital commitments are maintained on a global
basis. This committee is co-chaired by the firm’s global
treasurer and the head of credit finance for Europe, Middle East
and Africa.
•
Firmwide Commitments Committee. The Firmwide
Commitments Committee reviews the firm’s underwriting and
distribution activities with respect to equity and
equity-related
product offerings, and sets and maintains policies and
procedures designed to ensure that legal, reputational,
regulatory and business standards are maintained on a global
basis. In addition to reviewing specific transactions, this
committee periodically conducts general strategic reviews of
sectors and products and establishes policies in connection with
transaction practices. This committee is co-chaired by the head
of our Latin America Group and the global co-head of the
firm’s technology, media and telecom group for Investment
Banking.
Investment Management Division Risk
Committee. The Investment Management Division
Risk Committee is responsible for the ongoing monitoring and
control of global market, counterparty credit and liquidity
risks associated with the activities of our investment
management businesses. The head of Investment Management
Division risk management is the chair of this committee and
appoints the other members.
Liquidity is of critical importance to financial institutions.
Most of the recent failures of financial institutions have
occurred in large part due to insufficient liquidity.
Accordingly, the firm has in place a comprehensive and
conservative set of liquidity and funding policies to address
both firm-specific and broader industry or market liquidity
events. Our principal objective is to be able to fund the firm
and to enable our core businesses to continue to generate
revenues, even under adverse circumstances.
We manage liquidity risk according to the following principles:
Excess Liquidity. We maintain substantial
excess liquidity to meet a broad range of potential cash
outflows and collateral needs in a stressed environment.
Asset-Liability
Management. We assess anticipated holding periods
for our assets and their potential illiquidity in a stressed
environment. We manage the maturities and diversity of our
funding across markets, products and counterparties; and seek to
maintain liabilities of appropriate tenor relative to our asset
base.
Contingency Funding Plan. We maintain a
contingency funding plan to provide a framework for analyzing
and responding to a liquidity crisis situation or periods of
market stress. This framework sets forth the plan of action to
fund normal business activity in emergency and stress
situations. These principles are discussed in more detail below.
Excess
Liquidity
Our most important liquidity policy is to
pre-fund our
estimated potential cash needs during a liquidity crisis and
hold this excess liquidity in the form of unencumbered, highly
liquid securities and cash. We believe that this global core
excess would be readily convertible to cash in a matter of days,
through liquidation, by entering into repurchase agreements or
from maturities of reverse repurchase agreements, and that this
cash would allow us to meet immediate obligations without
needing to sell other assets or depend on additional funding
from
credit-sensitive
markets.
As of June 2011 and December 2010, the fair value of
the securities and certain overnight cash deposits included in
our GCE totaled $165.84 billion and $174.78 billion,
respectively. Based on the results of our internal liquidity
risk model, discussed below, as well as our consideration of
other factors including but not limited to a qualitative
assessment of the condition of the financial markets and the
firm, we believe our liquidity position as of June 2011 was
appropriate.
The table below presents the fair value of the securities and
certain overnight cash deposits that are included in our GCE.
Average for the
Three Months
Year
Ended
Ended
June
December
in millions
2011
2010
U.S. dollar-denominated
$123,087
$130,072
Non-U.S. dollar-denominated
41,191
37,942
Total
$164,278
$168,014
The
U.S. dollar-denominated
excess is composed of unencumbered U.S. government and
federal agency obligations (including highly liquid
U.S. federal agency
mortgage-backed
obligations), all of which are eligible as collateral in Federal
Reserve open market operations and certain overnight
U.S. dollar cash deposits. The
non-U.S. dollar-denominated
excess is composed of only unencumbered French, German, United
Kingdom and Japanese government obligations and certain
overnight cash deposits in highly liquid currencies. We strictly
limit our excess liquidity to this narrowly defined list of
securities and cash because they are highly liquid, even in a
difficult funding environment. We do not include other potential
sources of excess liquidity, such as lower-quality unencumbered
securities or committed credit facilities, in our GCE.
The first days or weeks of a liquidity crisis are the most
critical to a company’s survival.
•
Focus must be maintained on all potential cash and collateral
outflows, not just disruptions to financing flows. Our
businesses are diverse, and our liquidity needs are determined
by many factors, including market movements, collateral
requirements and client commitments, all of which can change
dramatically in a difficult funding environment.
•
During a liquidity crisis,
credit-sensitive
funding, including unsecured debt and some types of secured
financing agreements, may be unavailable, and the terms
(e.g., interest rates, collateral provisions and tenor) or
availability of other types of secured financing may change.
•
As a result of our policy to
pre-fund
liquidity that we estimate may be needed in a crisis, we hold
more unencumbered securities and have larger debt balances than
our businesses would otherwise require. We believe that our
liquidity is stronger with greater balances of highly liquid
unencumbered securities, even though it increases our total
assets and our funding costs.
We believe that our GCE provides us with a resilient source of
funds that would be available in advance of potential cash and
collateral outflows and gives us significant flexibility in
managing through a difficult funding environment.
In order to determine the appropriate size of our GCE, we use an
internal liquidity model, referred to as the Modeled Liquidity
Outflow, which captures and quantifies the firm’s liquidity
risks. We also consider other factors including but not limited
to a qualitative assessment of the condition of the financial
markets and the firm.
We distribute our GCE across subsidiaries, asset types, and
clearing agents to provide us with sufficient operating
liquidity to ensure timely settlement in all major markets, even
in a difficult funding environment.
We maintain our GCE to enable us to meet current and potential
liquidity requirements of our parent company, Group Inc.,
and our major
broker-dealer
and bank subsidiaries. The Modeled Liquidity Outflow
incorporates a consolidated requirement as well as a standalone
requirement for each of our major
broker-dealer
and bank subsidiaries. Liquidity held directly in each of these
subsidiaries is intended for use only by that subsidiary to meet
its liquidity requirements and is assumed not to be available to
Group Inc. unless (i) legally provided for and
(ii) there are no additional regulatory, tax or other
restrictions. We hold a portion of our GCE directly at
Group Inc. to support consolidated requirements not
accounted for in the major subsidiaries. In addition to the GCE
held at our major
broker-dealer
and bank subsidiaries, we maintain operating cash balances in
several of our other operating entities, primarily for use in
specific currencies, entities, or jurisdictions where we do not
have immediate access to parent company liquidity.
In addition to our GCE, we have a significant amount of other
unencumbered cash and financial instruments, including other
government obligations,
high-grade
money market securities, corporate obligations, marginable
equities, loans and cash deposits not included in our GCE. The
fair value of these assets averaged $86.84 billion and
$72.98 billion for the three months ended June 2011
and year ended December 2010, respectively. We do not
consider these assets liquid enough to be eligible for our GCE
liquidity pool and therefore conservatively do not assume we
will generate liquidity from these assets in a
short-term
stress scenario.
Modeled Liquidity Outflow. Our Modeled
Liquidity Outflow is based on a scenario that includes both a
market-wide
stress and a firm-specific stress, characterized by some or all
of the following qualitative elements:
•
Global recession, default by a
medium-sized
sovereign, low consumer and corporate confidence, and general
financial instability.
•
Severely challenged market environment with material declines in
equity markets and widening of credit spreads.
•
Damaging follow-on impacts to financial institutions leading to
the failure of a large bank.
•
A firm-specific crisis potentially triggered by material losses,
reputational damage, litigation, executive departure,
and/or a
ratings downgrade.
The following are the critical modeling parameters of the
Modeled Liquidity Outflow:
•
Liquidity needs over a
30-day
scenario.
•
A two-notch
downgrade of the firm’s
long-term
senior unsecured credit ratings.
•
A combination of contractual outflows, such as upcoming
maturities of unsecured debt, and contingent outflows
(e.g., actions though not contractually required, we may
deem necessary in a crisis). We assume that most contingent
outflows will occur within the initial days and weeks of a
crisis.
•
No issuance of equity or unsecured debt.
•
No support from government funding
facilities. Although we have access to various
central bank funding programs, we do not assume reliance on them
as a source of funding in a liquidity crisis.
•
No diversification benefit across liquidity risks. We assume
that liquidity risks are additive.
•
Maintenance of our normal business levels. We do not assume
asset liquidation, other than the GCE.
The Modeled Liquidity Outflow is calculated and reported to
senior management on a daily basis. We regularly refine our
model to reflect changes in market or economic conditions and
the firm’s business mix.
The potential contractual and contingent cash and collateral
outflows covered in our Modeled Liquidity Outflow include:
Unsecured
Funding
•
Contractual: All upcoming maturities of unsecured
long-term
debt, commercial paper, promissory notes and other unsecured
funding products. We assume that we will be unable to issue new
unsecured debt or rollover any maturing debt.
•
Contingent: Repurchases of our outstanding
long-term
debt, commercial paper and hybrid financial instruments in the
ordinary course of business as a market maker.
Deposits
•
Contractual: All upcoming maturities of term
deposits. We assume that we will be unable to raise new term
deposits or rollover any maturing term deposits.
•
Contingent: Withdrawals of bank deposits that have no
contractual maturity. The withdrawal assumptions reflect, among
other factors, the type of deposit, whether the deposit is
insured or uninsured, and the firm’s relationship with the
depositor.
Secured
Funding
•
Contractual: A portion of upcoming contractual
maturities of secured funding trades due to either the inability
to refinance or the ability to refinance only at wider haircuts
(i.e., on terms which require us to post additional
collateral). Our assumptions reflect, among other factors, the
quality of the underlying collateral and counterparty
concentration.
•
Contingent: A decline in value of financial assets
pledged as collateral for financing transactions, which would
necessitate additional collateral postings under those
transactions.
OTC
Derivatives
•
Contingent: Collateral postings to counterparties due
to adverse changes in the value of our OTC derivatives.
•
Contingent: Other outflows of cash or collateral
related to OTC derivatives, including the impact of trade
terminations, collateral substitutions, collateral disputes,
collateral calls or termination payments required by a
two-notch
downgrade in our credit ratings, and collateral that has not
been called by counterparties, but is available to them.
Contingent: Variation margin postings required due to
adverse changes in the value of our outstanding
exchange-traded
derivatives.
•
Contingent: An increase in initial margin and
guaranty fund requirements by derivative clearing houses.
Customer Cash
and Securities
•
Contingent: Liquidity outflows associated with our
prime brokerage business, including withdrawals of customer
credit balances, and a reduction in customer short positions,
which serve as a funding source for long positions.
Unfunded
Commitments
•
Contingent: Draws on our unfunded commitments. Draw
assumptions reflect, among other things, the type of commitment
and counterparty.
Other
•
Other upcoming large cash outflows, such as tax payments.
Asset-Liability
Management
Our liquidity risk management policies are designed to ensure we
have a sufficient amount of financing, even when funding markets
experience persistent stress. We seek to maintain a
long-dated
and diversified funding profile, taking into consideration the
characteristics and liquidity profile of our assets.
Our approach to
asset-liability
management includes:
•
Conservatively managing the overall characteristics of our
funding book, with a focus on maintaining
long-term,
diversified sources of funding in excess of our current
requirements. See “Balance Sheet and Funding
Sources — Funding Sources” for additional details.
•
Actively managing and monitoring our asset base, with particular
focus on the liquidity, holding period and our ability to fund
assets on a secured basis. This enables us to determine the most
appropriate funding products and tenors. Less liquid assets are
more difficult to fund and therefore require funding that has
longer tenors with a greater proportion of unsecured debt. See
“Balance Sheet and Funding Sources — Balance
Sheet Management” for more detail on our balance sheet
management process.
•
Raising secured and unsecured financing that has a sufficiently
longer term than the anticipated holding period of our assets.
This reduces the risk that our liabilities will come due in
advance of our ability to generate liquidity from the sale of
our assets. Because we maintain a highly liquid balance sheet,
the holding period of certain of our assets may be materially
shorter than their contractual maturity dates.
Our goal is to have sufficient total capital (unsecured
long-term
borrowings plus total shareholders’ equity) so that we can
avoid reliance on asset sales (other than our GCE). However, we
recognize that orderly asset sales may be prudent or necessary
in a severe or persistent liquidity crisis. The target amount of
our total capital is based on an internal funding model which
incorporates the following
long-term
financing requirements:
•
The portion of financial instruments owned, at fair value that
we believe could not be funded on a secured basis in periods of
market stress, assuming stressed fair values.
•
Goodwill and identifiable intangible assets, property, leasehold
improvements and equipment, and other illiquid assets.
•
Derivative and other margin and collateral requirements.
•
Anticipated draws on our unfunded loan commitments.
•
Regulatory requirements to hold capital or other forms of
financing in excess of what we would otherwise hold in regulated
subsidiaries.
Subsidiary Funding Policies. The majority of
our unsecured funding is raised by Group Inc. which lends
the necessary funds to its subsidiaries, some of which are
regulated, to meet their asset financing, liquidity and capital
requirements. In addition, Group Inc. provides its
regulated subsidiaries with the necessary capital to meet their
regulatory requirements. The benefits of this approach to
subsidiary funding are enhanced control and greater flexibility
to meet the funding requirements of our subsidiaries. Funding is
also raised at the subsidiary level through a variety of
products, including secured funding, unsecured borrowings and
deposits.
Our intercompany funding policies assume that, unless legally
provided for, a subsidiary’s funds or securities are not
freely available to its parent company or other subsidiaries. In
particular, many of our subsidiaries are subject to laws that
authorize regulatory bodies to block or reduce the flow of funds
from those subsidiaries to Group Inc. Regulatory action of
that kind could impede access to funds that Group Inc.
needs to make payments on its obligations. Accordingly, we
assume that the capital provided to our regulated subsidiaries
is not available to Group Inc. or other subsidiaries and
any other financing provided to our regulated subsidiaries is
not available until the maturity of such financing.
Group Inc. has provided substantial amounts of equity and
subordinated indebtedness, directly or indirectly, to its
regulated subsidiaries. For example, as of June 2011,
Group Inc. had $29.73 billion of equity and
subordinated indebtedness invested in GS&Co., its principal
U.S. registered
broker-dealer;
$43.81 billion invested in GSI, a regulated U.K.
broker-dealer;
$2.71 billion invested in Goldman Sachs
Execution & Clearing, L.P., a U.S. registered
broker-dealer;
$3.22 billion invested in Goldman Sachs Japan Co., Ltd., a
regulated Japanese
broker-dealer;
and $19.44 billion invested in GS Bank USA, a
regulated New York State-chartered bank. Group Inc. also
had $67.52 billion of unsubordinated loans and
$11.38 billion of collateral provided to these entities as
of June 2011 and significant amounts of capital invested in
and loans to its other regulated subsidiaries.
Contingency
Funding Plan
The Goldman Sachs contingency funding plan sets out the plan of
action we would use to fund business activity in crisis
situations and periods of market stress. The contingency funding
plan outlines a list of potential risk factors, key reports and
metrics that are reviewed on an ongoing basis to assist in
assessing the severity of, and managing through, a liquidity
crisis
and/or
market dislocation. The contingency funding plan also describes
in detail the firm’s potential responses if our assessments
indicate that the firm has entered a liquidity crisis, which
include
pre-funding
for what we estimate will be our potential cash and collateral
needs as well as utilizing secondary sources of liquidity.
Mitigants and action items to address specific risks which may
arise are also described and assigned to individuals responsible
for execution.
The contingency funding plan identifies key groups of
individuals to foster effective coordination, control and
distribution of information, all of which are critical in the
management of a crisis or period of market stress. The
contingency funding plan also details the responsibilities of
these groups and individuals, which include making and
disseminating key decisions, coordinating all contingency
activities throughout the duration of the crisis or period of
market stress, implementing liquidity maintenance activities and
managing internal and external communication.
Credit
Ratings
The table below presents our unsecured credit ratings (excluding
debt guaranteed by the FDIC under the TLGP) and outlook.
As of June 2011
Short-Term
Long-Term
Subordinated
Trust
Preferred
Rating
Debt
Debt
Debt
Preferred 1
Stock
2
Outlook
DBRS, Inc.
R-1 (middle
)
A (high
)
A
A
BBB
Stable 5
Fitch,
Inc. 3
F1+
A+
A
A-
A-
Stable 6
Moody’s Investors
Service 4
P-1
A1
A2
A3
Baa2
Negative 7
Standard & Poor’s Ratings Services
A-1
A
A-
BBB-
BBB-
Negative 7
Rating and Investment Information, Inc.
a-1+
AA-
A+
N/A
N/A
Negative 8
1.
Trust preferred securities issued by Goldman Sachs Capital I.
2.
Includes Group Inc.’s
non-cumulative
preferred stock and the Normal Automatic Preferred Enhanced
Capital Securities (APEX) issued by Goldman Sachs Capital II and
Goldman Sachs Capital III.
3.
GS Bank USA has been assigned a rating of AA- for
long-term
bank deposits, F1+ for
short-term
bank deposits and A+ for
long-term
issuer.
4.
GS Bank USA has been assigned a rating of Aa3 for
long-term
bank deposits,
P-1 for
short-term
bank deposits and Aa3 for
long-term
issuer.
We rely on the
short-term
and
long-term
debt capital markets to fund a significant portion of our
day-to-day
operations and the cost and availability of debt financing is
influenced by our credit ratings. Credit ratings are also
important when we are competing in certain markets, such as OTC
derivatives, and when we seek to engage in longer-term
transactions. 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 discussion of the risks associated with a reduction in our
credit ratings.
We believe our credit ratings are primarily based on the credit
rating agencies’ assessment of:
•
our liquidity, market, credit and operational risk management
practices;
•
the level and variability of our earnings;
•
our capital base;
•
our franchise, reputation and management;
•
our corporate governance; and
•
the external operating environment, including the assumed level
of government support.
We allocate a portion of our GCE to ensure we would be able to
make the additional collateral or termination payments that may
be required in the event of a
two-notch
reduction in our
long-term
credit ratings, as well as collateral that has not been called
by counterparties, but is available to them. The table below
presents the additional collateral or termination payments that
could have been called at the reporting date by counterparties
in the event of a
one-notch
and
two-notch
downgrade in our credit ratings.
As of
June
December
in millions
2011
2010
Additional collateral or termination payments for a
one-notch
downgrade
$
662
$
1,353
Additional collateral or termination payments for a
two-notch
downgrade
1,842
2,781
The Basel Committee on Banking Supervision’s international
framework for liquidity risk measurement, standards and
monitoring calls for imposition of a liquidity coverage ratio,
designed to ensure that the banking entity maintains an adequate
level of unencumbered
high-quality
liquid assets based on expected cash outflows under an acute
liquidity stress scenario, and a net stable funding ratio,
designed to promote more medium- and
long-term
funding of the assets and activities of banking entities over a
one-year
time horizon. The liquidity coverage ratio would be implemented
subject to an observation period beginning in 2011, but would
not be introduced as a requirement until
January 1, 2015, and the net stable funding ratio
would not be introduced as a requirement until
January 1, 2018. While the principles behind the new
framework are broadly consistent with our current liquidity
management framework, it is possible that the implementation of
these standards could impact our liquidity and funding
requirements and practices.
Cash
Flows
As a global financial institution, our cash flows are complex
and bear little relation to our net earnings and net assets.
Consequently, we believe that traditional cash flow analysis is
less meaningful in evaluating our liquidity position than the
excess liquidity and
asset-liability
management policies described above. Cash flow analysis may,
however, be helpful in highlighting certain macro trends and
strategic initiatives in our businesses.
Six Months Ended June 2011. Our cash and
cash equivalents increased by $5.65 billion to
$45.43 billion at the end of the second quarter of 2011. We
generated $13.10 billion in net cash from operating and
investing activities. We used net cash of $7.45 billion for
financing activities, primarily for the repurchases of our
Series G Preferred Stock and common stock, and the payment
of dividends, partially offset by net issuances of unsecured and
secured borrowings.
Six Months Ended June 2010. Our cash and
cash equivalents decreased by $5.69 billion to
$32.60 billion at the end of the second quarter of 2010. We
generated net cash of $2.45 billion in our operating
activities. We used net cash in investing and financing
activities of $8.14 billion, primarily due to net
repayments in unsecured
long-term
borrowings, a decrease in bank deposits and repurchases of
common stock.
Market risk is the risk of loss in the value of our inventory
due to changes in market prices. We hold inventory primarily for
market making for our clients and for our investing and lending
activities. Our inventory therefore changes based on client
demands and our investment opportunities. Our inventory is
accounted for at fair value and therefore fluctuates on a daily
basis. Categories of market risk include the following:
•
Interest rate risk: primarily results from exposures to changes
in the level, slope and curvature of yield curves, the
volatilities of interest rates, mortgage prepayment speeds and
credit spreads.
•
Equity price risk: results from exposures to changes in prices
and volatilities of individual equities, baskets of equities and
equity indices.
•
Currency rate risk: results from exposures to changes in spot
prices, forward prices and volatilities of currency rates.
•
Commodity price risk: results from exposures to changes in spot
prices, forward prices and volatilities of commodities, such as
electricity, natural gas, crude oil, petroleum products, and
precious and base metals.
Market Risk
Management Process
We manage our market risk by diversifying exposures, controlling
position sizes and establishing economic hedges in related
securities or derivatives. This includes:
•
accurate and timely exposure information incorporating multiple
risk metrics;
•
a dynamic limit setting framework; and
•
constant communication among revenue-producing units, risk
managers and senior management.
Market Risk Management, which is independent of the
revenue-producing units and reports to the firm’s chief
risk officer, has primary responsibility for assessing,
monitoring and managing market risk at the firm. We monitor and
control risks through strong firmwide oversight and independent
control and support functions across the firm’s global
businesses.
Managers in revenue-producing units are accountable for managing
risk within prescribed limits. These managers have
in-depth
knowledge of their positions, of markets and the instruments
available to hedge their exposures.
Managers in revenue-producing units and Market Risk Management
discuss market information, positions and estimated risk and
loss scenarios on an ongoing basis.
Risk
Measures
Market Risk Management produces risk measures and monitors them
against market risk limits set by our firm’s risk
committees. These measures reflect an extensive range of
scenarios and the results are aggregated at trading desk,
business and firmwide levels.
We use a variety of risk measures to estimate the size of
potential losses for both moderate and more extreme market moves
over both
short-term
and
long-term
time horizons. Risk measures used for shorter-term periods
include VaR and sensitivity metrics. For longer-term horizons,
our primary risk measures are stress tests. Our risk reports
detail key risks, drivers and changes for each desk and
business, and are distributed daily to senior management of both
our revenue-producing units and our independent control and
support functions.
Systems
We have made a significant investment in technology to monitor
market risk including:
•
an independent calculation of VaR and stress measures;
•
risk measures calculated at individual position levels;
•
attribution of risk measures to individual risk factors of each
position;
•
the ability to report many different views of the risk measures
(e.g., by desk, business, product type or legal entity); and
•
the ability to produce ad hoc analyses in a timely manner.
VaR is the potential loss in value of inventory positions due to
adverse market movements over a defined time horizon with a
specified confidence level. We typically employ a
one-day time
horizon with a 95% confidence level. The VaR model captures
risks including interest rates, equity prices, currency rates
and commodity prices. As such, VaR facilitates comparison across
portfolios of different risk characteristics. VaR also captures
the diversification of aggregated risk at the firmwide level.
We are aware of the inherent limitations to VaR and therefore
use a variety of risk measures in our market risk management
process. Inherent limitations to VaR include:
•
VaR does not estimate potential losses over longer time horizons
where moves may be extreme.
•
VaR does not take account of the relative liquidity of different
risk positions.
•
Previous moves in market risk factors may not produce accurate
predictions of all future market moves.
When calculating VaR, we use historical simulations with full
valuation of approximately 70,000 market factors. The historical
data used in our VaR calculation is weighted to give greater
importance to more recent observations and reflect current asset
volatilities. This improves the accuracy of our estimates of
potential loss. As a result, even if our inventory positions
were unchanged, our VaR would increase with increasing market
volatility and vice versa.
Given its reliance on historical data, VaR is most effective in
estimating risk exposures in markets in which there are no
sudden fundamental changes or shifts in market conditions.
We evaluate the accuracy of our VaR model through daily
backtesting (i.e., comparing daily trading net revenues to
the VaR measure calculated as of the prior business day) at the
firmwide level and for each of our businesses and major
regulated subsidiaries.
Our VaR measure does not include:
•
positions that are best measured and monitored using sensitivity
measures; and
•
the impact of changes in counterparty and our own credit spreads
on derivatives as well as changes in our own credit spreads on
unsecured borrowings for which the fair value option was elected.
Stress
Testing
We use stress testing to examine risks of specific portfolios as
well as the potential impact of significant risk exposures
across the firm. We use a variety of scenarios to calculate the
potential loss from a wide range of market moves on the
firm’s portfolios. These scenarios include the default of
single corporate or sovereign entities, the impact of a move in
a single risk factor across all positions (e.g., equity
prices or credit spreads) or a combination of two or more risk
factors.
Unlike VaR measures, which have an implied probability because
they are calculated at a specified confidence level, there is
generally no implied probability that our stress test scenarios
will occur. Instead, stress tests are used to model both
moderate and more extreme moves in underlying market factors.
When estimating potential loss, we generally assume that our
positions cannot be reduced or hedged (although experience
demonstrates that we are generally able to do so).
Stress test scenarios are conducted on a regular basis as part
of the firm’s routine risk management process and on an ad
hoc basis in response to market events or concerns. Stress
testing is an important part of the firm’s risk management
process because it allows us to highlight potential loss
concentrations, undertake risk/reward analysis, and assess and
mitigate our risk positions.
Limits
We use risk limits at various levels in the firm (including
firmwide, product and business) to govern risk appetite by
controlling the size of our exposures to market risk. Limits are
reviewed frequently and amended on a permanent or temporary
basis to reflect changing market conditions, business conditions
or tolerance for risk.
The Firmwide Risk Committee sets market risk limits at firmwide
and product levels and our Securities Division Risk
Committee sets
sub-limits
for
market-making
and investing activities at a business level. The purpose of the
firmwide limits is to assist senior management in controlling
the firm’s overall risk profile.
Sub-limits
set the desired maximum amount of exposure that may be managed
by any particular business on a
day-to-day
basis without additional levels of senior management approval,
effectively leaving
day-to-day
trading decisions to individual desk managers and traders.
Accordingly,
sub-limits
are a management tool designed to ensure appropriate escalation
rather than to establish maximum risk tolerance.
Sub-limits
also distribute risk among various businesses in a manner that
is consistent with their level of activity and client demand,
taking into account the relative performance of each area.
Our market risk limits are monitored daily by Market Risk
Management, which is responsible for identifying and escalating,
on a timely basis, instances where limits have been exceeded.
The business-level limits that are set by the Securities
Division Risk Committee are subject to the same scrutiny
and limit escalation policy as the firmwide limits.
When a risk limit has been exceeded (e.g., due to changes
in market conditions, such as increased volatilities or changes
in correlations), it is reported to the appropriate risk
committee and a discussion takes place with the relevant desk
managers, after which either the risk position is reduced or the
risk limit is temporarily or permanently increased.
Metrics
We analyze VaR at the firmwide level and a variety of more
detailed levels, including by risk category, business, and
region. The tables below present average daily VaR and
quarter-end VaR by risk category.
Average Daily
VaR
Three Months
Six Months
in millions
Ended June
Ended June
Risk Categories
2011
2010
2011
2010
Interest rates
$
76
$
87
$
81
$
98
Equity prices
35
61
42
74
Currency rates
21
36
23
36
Commodity prices
39
32
38
40
Diversification
effect 1
(70
)
(80
)
(77
)
(100
)
Total
$
101
$
136
$
107
$
148
1.
Equals the difference between total VaR and the sum of the VaRs
for the four risk categories. This effect arises because the
four market risk categories are not perfectly correlated.
Our average daily VaR decreased to $101 million for the
second quarter of 2011 from $136 million for the second
quarter of 2010, reflecting decreases across most risk
categories, primarily due to reduced exposures and lower levels
of volatility.
Quarter-End VaR
and High and Low VaR
Three Months
As of
Ended
in millions
June
March
June 2011
Risk Categories
2011
2011
High
Low
Interest rates
$
78
$
82
$
87
$
71
Equity prices
33
42
67
21
Currency rates
15
26
28
13
Commodity prices
22
49
53
20
Diversification
effect 1
(63
)
(87
)
Total
$
85
$
112
$
114
$
82
1.
Equals the difference between total VaR and the sum of the VaRs
for the four risk categories. This effect arises because the
four market risk categories are not perfectly correlated.
Our daily VaR decreased to $85 million as of June 2011
from $112 million as of March 2011, due to decreases
across all risk categories, primarily due to reduced exposures.
These decreases were partially offset by a decrease in the
diversification benefit across risk categories.
During the second quarter of 2011, the firmwide VaR risk limit
was not exceeded. Separately, the firmwide VaR risk limit was
reduced on one occasion during the quarter, reflecting lower
risk utilization and the market environment.
The chart below reflects the VaR over the last four quarters.
The chart below presents the frequency distribution of our daily
trading net revenues for substantially all
inventory positions included in VaR for the quarter ended
June 2011.
Daily trading net revenues are compared with VaR calculated as
of the end of the prior business day. The firm incurred trading
losses on a single day in excess of our 95%
one-day VaR
(i.e., a VaR exception) on one occasion during the second
quarter of 2011.
During periods in which the firm has significantly more positive
net revenue days than net revenue loss days,
we expect to have fewer VaR exceptions because, under normal
conditions, our business model generally produces positive net
revenues. In more adverse markets, we generally produce lower
net revenues and more loss days, resulting in more VaR
exceptions. In addition, VaR backtesting is performed against
total daily
market-making
revenues, including bid/offer net revenues which are more likely
than not to be positive by their nature.
Certain portfolios and individual positions are not included in
VaR because VaR is not the most appropriate risk measure. The
market risk of these positions is determined by estimating the
potential reduction in net revenues of a 10% decline in the
underlying asset value. The market risk related to our
investment in the ordinary shares of ICBC excludes interests
held by investment funds managed by Goldman Sachs.
The table below presents market risk for positions that are not
included in VaR. These measures do not reflect diversification
benefits across asset categories and therefore have not been
aggregated.
Asset Categories
10% Sensitivity
Amount as of
June
March
in millions
2011
2011
ICBC
$
292
$
319
Equity (excluding
ICBC) 1
2,549
2,596
Debt 2
1,486
1,483
1.
Relates to private and restricted public equity securities,
including interests in firm-sponsored funds that invest in
corporate equities and real estate and interests in
firm-sponsored hedge funds.
2.
Relates to corporate bank debt, loans backed by commercial and
residential real estate, and other corporate debt, including
acquired portfolios of distressed loans and interests in our
firm-sponsored funds that invest in corporate mezzanine and
senior debt instruments.
VaR excludes the impact of changes in counterparty and our own
credit spreads on derivatives as well as changes in our own
credit spreads on unsecured borrowings for which the fair value
option was elected. The estimated sensitivity of our net
revenues to a one basis point increase in credit spreads
(counterparty and our own) on derivatives was a $4 million
gain as of June 2011. In addition, the estimated
sensitivity of our net revenues to a one basis point increase in
our own credit spreads on unsecured borrowings for which the
fair value option was elected was an $8 million gain
(including hedges) as of June 2011.
In addition to the positions included in VaR and the sensitivity
measures described above, as of June 2011, we held
$3.48 billion of securities accounted for as
available-for-sale
primarily consisting of $1.27 billion of corporate debt
securities, the majority of which will mature after five years,
with an average yield of 6%, $865 million of mortgage and
other
asset-backed
loans and securities, the majority of which will mature after
ten years, with an average yield of 11%, and $563 million
of U.S. government and federal agency obligations, the
majority of which will mature after five years, with an average
yield of 3%. As of December 2010, we held
$3.67 billion of securities accounted for as
available-for-sale
primarily consisting of $1.69 billion of corporate debt
securities, the majority of which will mature after five years,
with an average yield of 6%, $670 million of mortgage and
other
asset-backed
loans and securities, which will mature after ten years, with an
average yield of 11%, and $637 million of
U.S. government and federal agency obligations, the
majority of which will mature after ten years, with an average
yield of 4%.
In addition, as of June 2011 and December 2010, we had
commitments and held loans under the William Street credit
extension program. As of December 2010, we also held money
market instruments under this program. See Note 18 to the
condensed consolidated financial statements in Part I,
Item 1 of this
Form 10-Q
for further information about our William Street credit
extension program.
Additionally, we make investments accounted for under the equity
method and we also make direct investments in real estate, both
of which are included in “Other assets” in the
condensed consolidated statements of financial condition. Direct
investments in real estate are accounted for at cost less
accumulated depreciation. See Note 12 to the condensed
consolidated financial statements in Part I, Item 1 of
this
Form 10-Q
for information on “Other assets.”
Credit risk represents the potential for loss due to the default
or deterioration in credit quality of a counterparty
(e.g., an OTC derivatives counterparty or a borrower) or an
issuer of securities or other instruments we hold. Our exposure
to credit risk comes mostly from client transactions in OTC
derivatives and loans and lending commitments. Credit risk also
comes from cash placed with banks, securities financing
transactions (i.e., resale and repurchase agreements and
securities borrowing and lending activities) and receivables
from brokers, dealers, clearing organizations, customers and
counterparties.
Credit Risk Management, which is independent of the
revenue-producing units and reports to the firm’s chief
risk officer, has primary responsibility for assessing,
monitoring and managing credit risk at the firm. The Credit
Policy Committee and the Firmwide Risk Committee establish and
review credit policies and parameters. In addition, we hold
other positions that give rise to credit risk (e.g., bonds
held in our inventory and secondary bank loans). These credit
risks are captured as a component of market risk measures, which
are monitored and managed by Market Risk Management, consistent
with other inventory positions.
Policies authorized by the Firmwide Risk Committee and the
Credit Policy Committee prescribe the level of formal approval
required for the firm to assume credit exposure to a
counterparty across all product areas, taking into account any
enforceable netting provisions, collateral or other credit risk
mitigants.
Credit Risk
Management Process
Effective management of credit risk requires accurate and timely
information, a high level of communication and knowledge of
customers, countries, industries and products. Our process for
managing credit risk includes:
•
approving transactions and setting and communicating credit
exposure limits;
•
monitoring compliance with established credit exposure limits;
•
assessing the likelihood that a counterparty will default on its
payment obligations;
•
measuring the firm’s current and potential credit exposure
and losses resulting from counterparty default;
•
reporting of credit exposures to senior management, the Board
and regulators;
•
use of credit risk mitigants, including collateral and hedging;
and
•
communication and collaboration with other independent control
and support functions such as operations, legal and compliance.
As part of the risk assessment process, Credit Risk Management
performs credit reviews which include initial and ongoing
analyses of our counterparties. A credit review is an
independent judgment about the capacity and willingness of a
counterparty to meet its financial obligations. For
substantially all of our credit exposures, the core of our
process is an annual counterparty review. A counterparty review
is a written analysis of a counterparty’s business profile
and financial strength resulting in an internal credit rating
which represents the probability of default on financial
obligations to the firm. The determination of internal credit
ratings incorporates assumptions with respect to the
counterparty’s future business performance, the nature and
outlook for the counterparty’s industry, and the economic
environment. Senior personnel within Credit Risk Management,
with expertise in specific industries, inspect and approve
credit reviews and internal credit ratings.
Our global credit risk management systems capture credit
exposure to individual counterparties and on an aggregate basis
to counterparties and their subsidiaries (economic groups).
These systems also provide management with comprehensive
information on our aggregate credit risk by product, internal
credit rating, industry, country and region.
Risk Measures and
Limits
We measure our credit risk based on the potential loss in an
event of
non-payment
by a counterparty. For derivatives and securities financing
transactions, the primary measure is potential exposure, which
is our estimate of the future exposure that could arise over the
life of a transaction based on market movements within a
specified confidence level. Potential exposure takes into
account netting and collateral arrangements. For loans and
lending commitments, the primary measure is a function of the
notional amount of the position. We also monitor credit risk in
terms of current exposure, which is the amount presently owed to
the firm after taking into account applicable netting and
collateral.
We use credit limits at various levels (counterparty, economic
group, industry, country) to control the size of our credit
exposures. Limits for counterparties and economic groups are
reviewed regularly and revised to reflect changing appetites for
a given counterparty or group of counterparties. Limits for
industries and countries are based on the firm’s risk
tolerance and are designed to allow for regular monitoring,
review, escalation and management of credit risk concentrations.
Stress
Tests/Scenario Analysis
We use regular stress tests to calculate the credit exposures,
including potential concentrations that would result from
applying shocks to counterparty credit ratings or credit risk
factors (e.g., currency rates, interest rates, equity
prices). These shocks include a wide range of moderate and more
extreme market movements. Some of our stress tests include
shocks to multiple risk factors, consistent with the occurrence
of a severe market or economic event. Unlike potential exposure,
which is calculated within a specified confidence level, with a
stress test there is generally no assumed probability of these
events occurring.
We run stress tests on a regular basis as part of our routine
risk management processes and conduct tailored stress tests on
an ad hoc basis in response to market developments. Stress tests
are regularly conducted jointly with the firm’s market and
liquidity risk functions.
Risk
Mitigants
To reduce our credit exposures on derivatives and securities
financing transactions, we may enter into netting agreements
with counterparties that permit us to offset receivables and
payables with such counterparties. We may also reduce credit
risk with counterparties by entering into agreements that enable
us to obtain collateral from them on an upfront or contingent
basis and/or
to terminate transactions if the counterparty’s credit
rating falls below a specified level.
For loans and lending commitments, we typically employ a variety
of potential risk mitigants, depending on the credit quality of
the borrower and other characteristics of the transaction. Risk
mitigants include: collateral provisions, guarantees, covenants,
structural seniority of the bank loan claims and, for certain
lending commitments, provisions in the legal documentation that
allow the firm to adjust loan amounts, pricing, structure and
other terms as market conditions change. The type and structure
of risk mitigants employed can significantly influence the
degree of credit risk involved in a loan.
When we do not have sufficient visibility into a
counterparty’s financial strength or when we believe a
counterparty requires support from its parent company, we may
obtain
third-party
guarantees of the counterparty’s obligations. We may also
mitigate our credit risk using credit derivatives or
participation agreements.
Credit
Exposures
The firm’s credit exposures are described further below.
Cash and Cash Equivalents. Cash and cash
equivalents include both interest-bearing and
non-interest
bearing deposits. To mitigate the risk of credit loss, we place
substantially all of our deposits with highly rated banks and
central banks.
OTC Derivatives. Derivatives are reported on a
net-by-counterparty
basis (i.e., the net payable or receivable for derivative
assets and liabilities for a given counterparty) when a legal
right of setoff exists under an enforceable netting agreement.
Derivatives are accounted for at fair value net of cash
collateral received or posted under credit support agreements.
As credit risk is an essential component of fair value, the firm
includes a credit valuation adjustment (CVA) in the fair value
of derivatives to reflect counterparty credit risk, as described
in Note 7 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q.
CVA is a function of the present value of expected exposure, the
probability of counterparty default and the assumed recovery
upon default.
The tables below present the distribution of our exposure to OTC
derivatives by tenor, based on expected duration for
mortgage-related
credit derivatives and generally on remaining contractual
maturity for other derivatives, both before and after the effect
of collateral and netting agreements. The categories shown
reflect our internally determined public rating agency
equivalents.
in millions
As of June 2011
5 Years
Exposure
0 - 12
1 - 5
or
Net of
Credit Rating Equivalent
Months
Years
Greater
Total
Netting
1
Exposure
Collateral
AAA/Aaa
$
720
$
1,038
$
2,395
$
4,153
$
(611
)
$
3,542
$
3,252
AA/Aa2
3,628
9,069
20,342
33,039
(17,278
)
15,761
10,140
A/A2
14,683
34,831
47,186
96,700
(71,464
)
25,236
14,267
BBB/Baa2
3,831
16,607
16,207
36,645
(24,062
)
12,583
7,624
BB/Ba2 or lower
4,068
5,327
5,376
14,771
(5,628
)
9,143
6,447
Unrated
873
1,231
284
2,388
(7
)
2,381
2,054
Total
$
27,803
$
68,103
$
91,790
$
187,696
$
(119,050
)
$
68,646
$
43,784
in millions
As of December 2010
5 Years
Exposure
0 - 12
1 - 5
or
Net of
Credit Rating Equivalent
Months
Years
Greater
Total
Netting
1
Exposure
Collateral
AAA/Aaa
$
504
$
728
$
2,597
$
3,829
$
(491
)
$
3,338
$
3,088
AA/Aa2
5,234
8,875
15,579
29,688
(18,167
)
11,521
6,935
A/A2
13,556
38,522
49,568
101,646
(74,650
)
26,996
16,839
BBB/Baa2
3,818
18,062
19,625
41,505
(27,832
)
13,673
8,182
BB/Ba2 or lower
3,583
5,382
3,650
12,615
(4,553
)
8,062
5,439
Unrated
709
1,081
332
2,122
(20
)
2,102
1,539
Total
$
27,404
$
72,650
$
91,351
$
191,405
$
(125,713
)
$
65,692
$
42,022
1.
Represents the netting of receivable balances with payable
balances for the same counterparty across tenor categories under
enforceable netting agreements, and the netting of cash
collateral received under credit support agreements. Receivable
and payable balances with the same counterparty in the same
tenor category are netted within such tenor category.
Lending Activities. We manage the firm’s
traditional credit origination activities, including funded
loans, lending commitments and the William Street credit
extension program, using the credit risk process, measures and
limits described above. Other lending positions, including
secondary trading positions, are
risk-managed
as a component of market risk.
Resale Agreements and Securities Borrowed. The
firm bears credit risk related to resale agreements and
securities borrowed only to the extent that cash advanced to the
counterparty exceeds the value of the collateral received.
Therefore, the firm’s credit exposure on these transactions
is significantly lower than the amounts recorded on the
condensed consolidated statement of financial condition (which
represent fair value or contractual value before consideration
of collateral received). The firm also has credit exposure on
repurchase agreements and securities loaned, which are
liabilities on our condensed consolidated statement of financial
condition, to the extent that the value of collateral pledged to
the counterparty for these transactions exceeds the amount of
cash received.
Other Credit Exposures. The firm is exposed to
credit risk from its receivables from brokers, dealers and
clearing organizations and customers and counterparties.
Receivables from brokers, dealers and clearing organizations are
primarily comprised of initial margin placed with clearing
organizations and receivables related to sales of securities
which have traded, but not yet settled. These receivables have
minimal credit risk due to the low probability of clearing
organization default and the
short-term
nature of receivables related to securities settlements.
Receivables from customers and counterparties are generally
comprised of collateralized receivables related to customer
securities transactions and have minimal credit risk due to both
the value of the collateral received and the
short-term
nature of these receivables.
Credit
Exposures
The tables below present the firm’s credit exposures
related to cash, OTC derivatives, loans and lending commitments
associated with traditional credit origination activities, and
securities financing transactions, broken down by industry,
region and internal credit rating.
During the six months ended June 2011, total credit
exposures increased by $27.70 billion primarily reflecting
growth in loans and lending commitments as well as an increase
in exposure from securities financing transactions. Counterparty
defaults and the associated credit losses remained at low levels
during the six months ended June 2011. The credit quality
of the overall portfolio as of June 2011 was relatively
unchanged from December 2010.
During the second quarter of 2011 a number of European member
states, including Portugal, Ireland, Italy, Greece and Spain,
experienced credit deterioration. As of June 2011, our
combined current credit exposure, net of collateral and economic
hedges, to these countries, including sovereign and corporate
counterparties or borrowers, was approximately
$1.89 billion, with no one country representing a majority
of the exposure. The combined current credit exposure to these
countries excluding economic hedges was approximately
$3.13 billion as of June 2011. In addition to current
exposure, we held unfunded lending commitments to borrowers in
these countries of approximately $700 million as of
June 2011.
Includes approximately $5 billion and $4 billion of
loans as of June 2011 and December 2010, respectively,
and approximately $60 billion and $49 billion of
lending commitments as of June 2011 and December 2010,
respectively. Excludes approximately $14 billion of loans
as of both June 2011 and December 2010, and lending
commitments with a total notional value of approximately
$4 billion and $3 billion as of June 2011 and
December 2010, respectively, that are risk managed as part
of market risk using VaR and sensitivity measures.
2.
Represents credit exposure, net of securities collateral
received on resale agreements and securities borrowed and net of
cash received on repurchase agreements and securities loaned.
These amounts are significantly lower than the amounts recorded
on the condensed consolidated statements of financial condition,
which represent fair value or contractual value before
consideration of collateral received.
Operational risk is the risk of loss resulting from inadequate
or failed internal processes, people and systems or from
external events. Our exposure to operational risk arises from
routine processing errors as well as extraordinary incidents,
such as major systems failures. Potential types of loss events
related to internal and external operational risk include:
•
clients, products and business practices;
•
execution, delivery and process management;
•
business disruption and system failures;
•
employment practices and workplace safety;
•
damage to physical assets;
•
internal fraud; and
•
external fraud.
The firm maintains a comprehensive control framework designed to
provide a well-controlled environment to minimize operational
risks. The Firmwide Operational Risk Committee provides
oversight of the ongoing development and implementation of our
operational risk policies and framework. Our Operational Risk
Management department (Operational Risk Management) is a risk
management function independent of our revenue-producing units
and is responsible for developing and implementing policies,
methodologies and a formalized framework for operational risk
management with the goal of minimizing our exposure to
operational risk.
Operational Risk
Management Process
Managing operational risk requires timely and accurate
information as well as a strong control culture. We seek to
manage our operational risk through:
•
the training, supervision and development of our people;
•
the active participation of senior management in identifying and
mitigating key operational risks across the firm;
•
independent control and support functions that monitor
operational risk on a daily basis and have instituted extensive
policies and procedures and implemented controls designed to
prevent the occurrence of operational risk events;
•
proactive communication between our revenue-producing units and
our independent control and support functions; and
•
a network of systems throughout the firm to facilitate the
collection of data used to analyze and assess our operational
risk exposure.
We combine top-down and
bottom-up
approaches to manage and measure operational risk. From a
top-down perspective, the firm’s senior management assesses
firmwide and business level operational risk profiles. From a
bottom-up
perspective, revenue-producing units and independent control and
support functions are responsible for risk management on a
day-to-day
basis, including identifying, mitigating, and escalating
operational risks to senior management.
Our operational risk framework is in part designed to comply
with the operational risk measurement rules under Basel 2 and
has evolved based on the changing needs of our businesses and
regulatory guidance. Our framework includes the following
practices:
•
Risk identification and reporting;
•
Risk measurement; and
•
Risk monitoring.
Internal Audit performs a review of our operational risk
framework, including our key controls, processes and
applications, on an annual basis to ensure the effectiveness of
our framework.
Risk
Identification and Reporting
The core of our operational risk management framework is risk
identification and reporting. We have a comprehensive data
collection process, including firmwide policies and procedures,
for operational risk events.
We have established policies that require managers in our
revenue-producing units and our independent control and support
functions to escalate operational risk events. When operational
risk events are identified, our policies require that the events
be documented and analyzed to determine whether changes are
required in the firm’s systems
and/or
processes to further mitigate the risk of future events.
In addition, our firmwide systems capture internal operational
risk event data, key metrics such as transaction volumes, and
statistical information such as performance trends. We use an
internally-developed operational risk management application to
aggregate and organize this information. Managers from both
revenue-producing units and independent control and support
functions analyze the information to evaluate operational risk
exposures and identify businesses, activities or products with
heightened levels of operational risk. We also provide
operational risk reports to senior management, risk committees
and the Board periodically.
We measure the firm’s operational risk exposure over a
twelve-month time horizon using scenario analyses, together with
qualitative assessments of the potential frequency and extent of
potential operational risk losses, for each of the firm’s
businesses. Operational risk measurement incorporates
qualitative and quantitative assessments of factors including:
•
internal and external operational risk event data;
•
assessments of the firm’s internal controls;
•
evaluations of the complexity of the firm’s business
activities;
•
the degree of and potential for automation in the firm’s
processes;
•
new product information;
•
the legal and regulatory environment;
•
changes in the markets for the firm’s products and
services, including the diversity and sophistication of the
firm’s customers and counterparties; and
•
the liquidity of the capital markets and the reliability of the
infrastructure that supports the capital markets.
The results from these scenario analyses are used to monitor
changes in operational risk and to determine business lines that
may have heightened exposure to operational risk. These analyses
ultimately are used to determine the appropriate level of
operational risk capital to hold.
Risk
Monitoring
We evaluate changes in the operational risk profile of the firm
and its businesses, including changes in business mix or
jurisdictions in which the firm operates, by monitoring these
factors at a firmwide, entity and business level. The firm has
both detective and preventive internal controls, which are
designed to reduce the frequency and severity of operational
risk losses and the probability of operational risk events. We
monitor the results of assessments and independent internal
audits of these internal controls.
See Note 3 to the condensed consolidated financial
statements in Part I, Item 1 of this
Form 10-Q
for information about Recent Accounting Developments.
We face a variety of risks that are substantial and inherent in
our businesses, including market, liquidity, credit,
operational, legal, regulatory and reputational risks. For a
discussion of how management seeks to manage some of these
risks, see “Overview and Structure of Risk
Management.” A summary of the more important factors that
could affect our businesses follows. For a further discussion of
these and other important factors that could affect our
businesses, financial condition, results of operations, cash
flows and liquidity, see “Risk Factors” in
Part I, Item 1A of our Annual Report on
Form 10-K.
•
Our businesses have been and may continue to be adversely
affected by conditions in the global financial markets and
economic conditions generally.
•
Our businesses have been and may be adversely affected by
declining asset values. This is particularly true for those
businesses in which we have net “long” positions,
receive fees based on the value of assets managed, or receive or
post collateral.
•
Our businesses have been and may be adversely affected by
disruptions in the credit markets, including reduced access to
credit and higher costs of obtaining credit.
•
Our
market-making
activities have been and may be affected by changes in the
levels of market volatility.
•
Our investment banking, client execution and investment
management businesses have been adversely affected and may
continue to be adversely affected by market uncertainty or lack
of confidence among investors and CEOs due to general declines
in economic activity and other unfavorable economic,
geopolitical or market conditions.
•
Our investment management business may be affected by the poor
investment performance of our investment products.
•
We may incur losses as a result of ineffective risk management
processes and strategies.
•
Our liquidity, profitability and businesses may be adversely
affected by an inability to access the debt capital markets or
to sell assets or by a reduction in our credit ratings or by an
increase in our credit spreads.
•
Conflicts of interest are increasing and a failure to
appropriately identify and address conflicts of interest could
adversely affect our businesses.
Group Inc. is a holding company and is dependent for
liquidity on payments from its subsidiaries, many of which are
subject to restrictions.
•
Our businesses, profitability and liquidity may be adversely
affected by deterioration in the credit quality of, or defaults
by, third parties who owe us money, securities or other assets
or whose securities or obligations we hold.
•
Concentration of risk increases the potential for significant
losses in our
market-making,
underwriting, investing and lending activities.
•
The financial services industry is highly competitive.
•
We face enhanced risks as new business initiatives lead us to
transact with a broader array of clients and counterparties and
expose us to new asset classes and new markets.
•
Derivative transactions and delayed settlements may expose us to
unexpected risk and potential losses.
•
Our businesses may be adversely affected if we are unable to
hire and retain qualified employees.
•
Our businesses and those of our clients are subject to extensive
and pervasive regulation around the world.
•
We may be adversely affected by increased governmental and
regulatory scrutiny or negative publicity.
•
A failure in our operational systems or infrastructure, or those
of third parties, could impair our liquidity, disrupt our
businesses, result in the disclosure of confidential
information, damage our reputation and cause losses.
•
Substantial legal liability or significant regulatory action
against us could have material adverse financial effects or
cause us significant reputational harm, which in turn could
seriously harm our business prospects.
•
The growth of electronic trading and the introduction of new
trading technology may adversely affect our business and may
increase competition.
•
Our commodities activities, particularly our power generation
interests and our physical commodities activities, subject us to
extensive regulation, potential catastrophic events and
environmental, reputational and other risks that may expose us
to significant liabilities and costs.
•
In conducting our businesses around the world, we are subject to
political, economic, legal, operational and other risks that are
inherent in operating in many countries.
•
We may incur losses as a result of unforeseen or catastrophic
events, including the emergence of a pandemic, terrorist attacks
or natural disasters.
On August 5, 2011, Standard & Poor’s lowered
the long-term sovereign credit rating of U.S. Government
debt obligations from AAA to AA+. On August 8, 2011,
S&P also downgraded the long-term credit ratings of
U.S. government-sponsored enterprises. These actions
initially have had an adverse effect on financial markets and
although we are unable to predict the longer-term impact on such
markets and the participants therein, it might be material and
adverse.
We have included or incorporated by reference in this
Form 10-Q,
and from time to time our management may make, statements that
may constitute “forward-looking statements” within the
meaning of the safe harbor provisions of the U.S. Private
Securities Litigation Reform Act of 1995. Forward-looking
statements are not historical facts, but instead represent only
our beliefs regarding future events, many of which, by their
nature, are inherently uncertain and outside our control. It is
possible that our actual results and financial condition may
differ, possibly materially, from the anticipated results and
financial condition indicated in these forward-looking
statements. For a discussion of some of the risks and important
factors that could affect our future results and financial
condition, see “Certain Risk Factors That May Affect Our
Businesses” above, as well as “Risk Factors” in
Part I, Item 1A of our Annual Report on
Form 10-K.
Statements about our investment banking transaction backlog also
may constitute forward-looking statements. Such statements are
subject to the risk that the terms of these transactions may be
modified or that they may not be completed at all; therefore,
the net revenues, if any, that we actually earn from these
transactions may differ, possibly materially, from those
currently expected. Important factors that could result in a
modification of the terms of a transaction or a transaction not
being completed include, in the case of underwriting
transactions, a decline or continued weakness in general
economic conditions, outbreak of hostilities, volatility in the
securities markets generally or an adverse development with
respect to the issuer of the securities and, in the case of
financial advisory transactions, a decline in the securities
markets, an inability to obtain adequate financing, an adverse
development with respect to a party to the transaction or a
failure to obtain a required regulatory approval. For a
discussion of other important factors that could adversely
affect our investment banking transactions, see “Certain
Risk Factors That May Affect Our Businesses” above, as well
as “Risk Factors” in Part I, Item 1A of our
Annual Report on
Form 10-K.
Quantitative and qualitative disclosures about market risk are
set forth under “Management’s Discussion and Analysis
of Financial Condition and Results of Operations —
Market Risk Management” in Part I, Item 2 above.
As of the end of the period covered by this report, an
evaluation was carried out by Goldman Sachs’ management,
with the participation of our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our disclosure
controls and procedures (as defined in
Rule 13a-15(e)
under the Securities Exchange Act of 1934 (Exchange Act)). Based
upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and
procedures were effective as of the end of the period covered by
this report. In addition, no change in our internal control over
financial reporting (as defined in
Rule 13a-15(f)
under the Exchange Act) occurred during our most recent quarter
that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
We are involved in a number of judicial, regulatory and
arbitration proceedings concerning matters arising in connection
with the conduct of our businesses. Many of these proceedings
are at preliminary stages, and many of these cases seek an
indeterminate amount of damages. However, we believe, based on
currently available information, that the results of such
proceedings, in the aggregate, will not have a material adverse
effect on our financial condition, but may be material to our
operating results for any particular period, depending, in part,
upon the operating results for such period. Given the range of
litigation and investigations presently under way, our
litigation expenses can be expected to remain high. See
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Use of
Estimates” in Part I, Item 2 of this
Form 10-Q.
See Note 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.
The table below sets forth the information with respect to
purchases made by or on behalf of The Goldman Sachs Group, Inc.
or any “affiliated purchaser” (as
defined in
Rule 10b-18(a)(3)
under the Securities Exchange Act of 1934) of our common
stock during the three months ended June 30, 2011.
On March 21, 2000, we announced that the Board of
Directors of Group Inc. (Board) had approved a repurchase
program, pursuant to which up to 15 million shares of our
common stock may be repurchased. This repurchase program was
increased by an aggregate of 355 million shares by
resolutions of our Board adopted on June 18, 2001,
March 18, 2002, November 20, 2002,
January 30, 2004, January 25, 2005,
September 16, 2005, September 11, 2006,
December 17, 2007 and July 18, 2011. 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.
The total remaining authorization under the firm’s
repurchase program was 90,791,110 shares as of
July 18, 2011; the repurchase program has no set
expiration or termination date. Any repurchase of our common
stock requires approval by the Board of Governors of the Federal
Reserve System.
Statement re:
Computation of Ratios of Earnings to Fixed Charges and Ratios of
Earnings to Combined Fixed Charges and Preferred Stock
Dividends.
15
.1
Letter re: Unaudited Interim Financial Information.
31
.1
Rule 13a-14(a) Certifications.*
32
.1
Section 1350 Certifications.*
101
Interactive data
files pursuant to Rule 405 of Regulation S-T: (i) the Condensed
Consolidated Statements of Earnings for the three and six months
ended June 30, 2011 and June 30, 2010, (ii) the
Condensed Consolidated Statements of Financial Condition as of
June 30, 2011 and December 31, 2010, (iii) the Condensed
Consolidated Statements of Changes in Shareholders’ Equity
for the six months ended June 30, 2011 and year ended
December 31, 2010, (iv) the Condensed Consolidated
Statements of Cash Flows for the six months ended June 30,2011 and June 30, 2010, (v) the Condensed Consolidated
Statements of Comprehensive Income for the three and six months
ended June 30, 2011 and June 30, 2010, and
(vi) the notes to the Condensed Consolidated Financial
Statements.*
*
This information is furnished and not filed for purposes of
Sections 11 and 12 of the Securities Act of 1933 and Section 18
of the Securities Exchange Act of 1934.
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.