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2: EX-10.1 Ex-10.1: Gs&Co. Executive Life Insurance Policy HTML 195K
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3: EX-10.2 Ex-10.2: Form of Gs&Co. Executive Life Insurance HTML 168K
Policy - Pacific Life
4: EX-12.1 Ex-12.1: Statement Re: Computation of Ratios of HTML 20K
Earnings to Fixed Charges and Ratios of
Earnings to Combined Fixed Charges and
Preferred Stock Dividends
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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 is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See
definition of “accelerated filer and large accelerated
filer” in
Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated
filer x Accelerated
filer o Non-accelerated
filer 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
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
As of
August
November
2006
2005
(in millions, except share
and per share amounts)
Assets
Cash and cash equivalents
$
10,063
$
10,261
Cash and securities segregated for
regulatory and other purposes
76,309
51,405
Receivables from brokers, dealers
and clearing organizations
13,200
15,150
Receivables from customers and
counterparties
76,112
60,231
Securities borrowed
210,190
191,800
Financial instruments purchased
under agreements to resell
82,958
83,619
Financial instruments owned, at
fair value
269,238
238,043
Financial instruments owned and
pledged as collateral, at fair value
39,936
38,983
Total financial instruments owned,
at fair value
309,174
277,026
Other assets
20,303
17,312
Total assets
$
798,309
$
706,804
Liabilities and
shareholders’ equity
Secured
short-term
borrowings
$
18,850
$
7,972
Unsecured
short-term
borrowings
53,814
47,247
Total
short-term borrowings,
including the current portion of
long-term
borrowings
72,664
55,219
Payables to brokers, dealers and
clearing organizations
5,056
10,014
Payables to customers and
counterparties
215,396
178,304
Securities loaned
26,409
23,331
Financial instruments sold under
agreements to repurchase
128,132
149,026
Financial instruments sold, but not
yet purchased, at fair value
156,557
149,071
Other liabilities and accrued
expenses
31,271
13,830
Secured
long-term
borrowings
19,553
15,669
Unsecured
long-term
borrowings
109,778
84,338
Total
long-term
borrowings
129,331
100,007
Total liabilities
764,816
678,802
Commitments, contingencies and
guarantees
Shareholders’
equity
Preferred stock, par value
$0.01 per share; 150,000,000 shares authorized,
124,000 and 70,000 shares issued and outstanding as of
August 2006 and November 2005, respectively, with liquidation
preference of $25,000 per share
3,100
1,750
Common stock, par value
$0.01 per share; 4,000,000,000 shares authorized,
595,168,224 and 573,970,935 shares issued as of August 2006
and November 2005, respectively, and 428,909,579 and
437,170,695 shares outstanding as of August 2006 and
November 2005, respectively
6
6
Restricted stock units and employee
stock options
3,812
3,415
Nonvoting common stock, par value
$0.01 per share; 200,000,000 shares authorized, no
shares issued and outstanding
—
—
Additional
paid-in capital
19,213
17,159
Retained earnings
24,927
19,085
Accumulated other comprehensive
income
13
—
Common stock held in treasury, at
cost, par value $0.01 per share; 166,258,645 and
136,800,240 shares as of August 2006 and November 2005,
respectively
(17,578
)
(13,413
)
Total shareholders’ equity
33,493
28,002
Total liabilities and
shareholders’ equity
$
798,309
$
706,804
The accompanying notes are an integral part of these condensed
consolidated financial statements.
Cash and securities segregated for
regulatory and other purposes
(16,364
)
1,687
Net receivables from brokers,
dealers and clearing organizations
(3,009
)
(1,321
)
Net payables to customers and
counterparties
22,009
419
Securities borrowed, net of
securities loaned
(15,312
)
(34,851
)
Financial instruments sold under
agreements to repurchase, net of financial instruments purchased
under agreements to resell
(20,233
)
36,472
Financial instruments owned, at
fair value
(31,535
)
(40,673
)
Financial instruments sold, but not
yet purchased, at fair value
7,136
17,241
Other, net
7,779
2,787
Net cash used for operating
activities
(41,567
)
(12,964
)
Cash flows from investing
activities
Purchase of property, leasehold
improvements and equipment
(1,785
)
(1,025
)
Proceeds from sales of property,
leasehold improvements and equipment
175
621
Business acquisitions, net of cash
acquired
(780
)
(523
)
Proceeds from sales of investments
1,197
—
Purchase of available-for-sale
securities
(6,363
)
—
Proceeds from sales of
available-for-sale securities
4,193
—
Net cash used for investing
activities
(3,363
)
(927
)
Cash flows from financing
activities
Short-term borrowings, net
11,477
172
Issuance of
long-term
borrowings
47,602
35,669
Repayment of
long-term borrowings,
including the current portion of
long-term
borrowings
(15,732
)
(16,806
)
Derivative contracts with a
financing element, net
3,195
823
Common stock repurchased
(4,165
)
(4,646
)
Dividends paid on common and
preferred stock
(543
)
(385
)
Proceeds from issuance of common
stock
1,200
738
Proceeds from issuance of preferred
stock, net of issuance costs
1,349
856
Excess tax benefit related to
share-based
compensation
349
—
Net cash provided by financing
activities
44,732
16,421
Net (decrease)/increase in cash and
cash equivalents
(198
)
2,530
Cash and cash equivalents,
beginning of year
10,261
4,365
Cash and cash equivalents, end of
period
$
10,063
$
6,895
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest, net of capitalized interest, were
$22.56 billion and $12.48 billion during the nine
months ended August 2006 and August 2005, respectively.
Cash payments for income taxes, net of refunds, were
$2.85 billion and $1.69 billion during the nine months
ended August 2006 and August 2005, respectively.
Non-cash activities:
The firm assumed $352 million and $1.15 billion of
debt in connection with business acquisitions during the nine
months ended August 2006 and August 2005, respectively.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1.
Description of Business
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 services worldwide to a substantial and
diversified client base that includes corporations, financial
institutions, governments and
high-net-worth
individuals.
The firm’s activities are divided into three segments:
•
Investment Banking. The firm provides a broad range of
investment banking services to a diverse group of corporations,
financial institutions, governments and individuals.
•
Trading and Principal Investments. The firm facilitates
client transactions with a diverse group of corporations,
financial institutions, governments and individuals and takes
proprietary positions through market making in, trading of and
investing in fixed income and equity products, currencies,
commodities and derivatives on such products. In addition, the
firm engages in specialist and market-making activities on
equities and options exchanges and clears client transactions on
major stock, options and futures exchanges worldwide. In
connection with the firm’s merchant banking and other
investing activities, the firm makes principal investments
directly and through funds that the firm raises and manages.
•
Asset Management and Securities Services. The firm
provides investment advisory and financial planning services and
offers investment products across all major asset classes to a
diverse group of institutions and individuals worldwide, and
provides prime brokerage services, financing services and
securities lending services to mutual funds, pension funds,
hedge funds, foundations and high-net-worth individuals
worldwide.
Note 2.
Significant Accounting Policies
Basis of Presentation
These condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting
principles that require management to make certain estimates and
assumptions. The most important of these estimates and
assumptions relate to fair value measurements, the accounting
for goodwill and identifiable intangible assets, the
determination of compensation and benefits expenses for interim
periods, and the provision for potential losses that may arise
from litigation and regulatory proceedings and tax audits.
Although these and other estimates and assumptions are based on
the best available information, actual results could be
materially different from these estimates.
These condensed consolidated financial statements include the
accounts of Group Inc. and all other entities in which the firm
has a controlling financial interest. All material intercompany
transactions and balances have been eliminated.
The firm determines whether it has a controlling financial
interest in an entity by first evaluating whether the entity is
a voting interest entity, a variable interest entity
(VIE) or a qualifying
special-purpose entity
(QSPE) under generally accepted accounting principles.
•
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
obligation to absorb losses, the right to receive residual
returns and the right to make decisions about the entity’s
activities. Voting interest entities
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
are consolidated in accordance with Accounting Research Bulletin
(ARB) No. 51, “Consolidated Financial
Statements,” as amended. ARB No. 51 states that
the usual condition for a controlling financial interest in an
entity is ownership of a majority voting interest. Accordingly,
the firm consolidates voting interest entities in which it has a
majority voting interest.
•
Variable Interest Entities. VIEs are entities that lack
one or more of the characteristics of a voting interest entity.
A controlling financial interest in a VIE is present when an
enterprise has a variable interest, or a combination of variable
interests, that will absorb a majority of the VIE’s
expected losses, receive a majority of the VIE’s expected
residual returns, or both. The enterprise with a controlling
financial interest, known as the primary beneficiary,
consolidates the VIE. In accordance with Financial Accounting
Standards Board (FASB) Interpretation (FIN) No. 46-R,
“Consolidation of Variable Interest Entities,” the
firm consolidates VIEs of which it is the primary beneficiary.
The firm determines whether it is the primary beneficiary of a
VIE by first performing a qualitative analysis of the VIE that
includes a review of, among other factors, its capital
structure, contractual terms, which interests create or absorb
variability, related party relationships and the design of the
VIE. Where qualitative analysis is not conclusive, the firm
performs a quantitative analysis. For purposes of allocating a
VIE’s expected losses and expected residual returns to its
variable interest holders, the firm utilizes the “top
down” method. Under that method, the firm calculates its
share of the VIE’s expected losses and expected residual
returns using the specific cash flows that would be allocated to
it, based on contractual arrangements and/or the firm’s
position in the capital structure of the VIE, under various
probability-weighted scenarios.
•
QSPEs. QSPEs are passive entities that are commonly used
in mortgage and other securitization transactions. Statement of
Financial Accounting Standards (SFAS) No. 140,
“Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities,” sets forth the
criteria an entity must satisfy to be a QSPE. These criteria
include the types of assets a QSPE may hold, limits on asset
sales, the use of derivatives and financial guarantees, and the
level of discretion a servicer may exercise in attempting to
collect receivables. These criteria may require management to
make judgments about complex matters, including whether a
derivative is considered passive and the degree of discretion a
servicer may exercise. In accordance with SFAS No. 140
and FIN No. 46-R, the firm does not consolidate QSPEs.
•
Equity-Method Investments. When the firm does not have a
controlling financial interest in an entity but exerts
significant influence over the entity’s operating and
financial policies (generally defined as owning a voting
interest of 20% to 50%) and has an investment in common stock or
in-substance common stock, the firm accounts for its investment
in accordance with the equity method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 18,
“The Equity Method of Accounting for Investments in Common
Stock.”
•
Other. If the firm does not consolidate an entity or
apply the equity method of accounting, the firm accounts for its
investment at fair value. The firm also has formed numerous
nonconsolidated investment funds with third-party investors that
are typically organized as limited partnerships. The firm acts
as general partner for these funds and does not hold a majority
of the economic interests in any fund. For funds established on
or before June 29, 2005 in which the firm holds more
than a minor interest and for funds established or modified
after June 29, 2005, the firm has provided the third-party
investors with rights to remove the
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
firm as the general partner or to terminate the funds (see
“— Recent Accounting Developments” below for
a discussion of the impact of Emerging Issues Task Force
(EITF) Issue No. 04-5). These fund investments are
included in “Financial instruments owned, at fair
value” in the condensed consolidated statements of
financial condition.
These condensed consolidated financial statements are unaudited
and should be read in conjunction with the audited consolidated
financial statements incorporated by reference in the
firm’s Annual Report on
Form 10-K for the
fiscal year ended November 25, 2005. The condensed
consolidated financial information as of
November 25, 2005 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.
Unless specifically stated otherwise, all references to
August 2006 and August 2005 refer to the firm’s
fiscal periods ended, or the dates, as the context requires,
August 25, 2006 and August 26, 2005,
respectively. All references to November 2005, unless
specifically stated otherwise, refer to the firm’s fiscal
year ended, or the date, as the context requires,
November 25, 2005. All references to 2006, unless
specifically stated otherwise, refer to the firm’s fiscal
year ending, or the date, as the context requires,
November 24, 2006. Certain reclassifications have been
made to previously reported amounts to conform to the current
presentation.
Revenue Recognition
Investment Banking. Underwriting revenues and fees from
mergers and acquisitions and other financial advisory
assignments are recognized in the condensed consolidated
statements of earnings when the services related to the
underlying transaction are completed under the terms of the
engagement. Expenses associated with such transactions are
deferred until the related revenue is recognized or the
engagement is otherwise concluded. Underwriting revenues are
presented net of related expenses. Expenses associated with
financial advisory transactions are recorded as
non-compensation
expenses, net of client reimbursements.
Financial Instruments.“Total financial instruments
owned, at fair value” and “Financial instruments sold,
but not yet purchased, at fair value” are reflected in the
condensed consolidated statements of financial condition on a
trade-date basis and consist of financial instruments carried at
fair value or amounts that approximate fair value, with related
unrealized gains or losses generally recognized in the condensed
consolidated statements of earnings. The fair value of a
financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale.
In determining fair value, the firm separates its financial
instruments into three categories — cash (i.e.,
nonderivative) trading instruments, derivative contracts and
principal investments.
•
Cash Trading Instruments. Fair values of the firm’s
cash trading instruments are generally obtained from quoted
market prices in active markets, broker or dealer price
quotations, or alternative pricing sources with reasonable
levels of price transparency. The types of instruments valued in
this manner include U.S. government and agency securities,
other sovereign government obligations, liquid mortgage
products, investment-grade and high-yield
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
corporate bonds, listed equities, money market securities,
state, municipal and provincial obligations, and physical
commodities.
Certain cash trading instruments trade infrequently and have
little or no price transparency. Such instruments may include
certain corporate bank loans, mortgage whole loans and
distressed debt. The firm values these instruments initially at
cost and generally does not adjust valuations unless there is
substantive evidence supporting a change in the value of the
underlying instrument or valuation assumptions (such as similar
market transactions, changes in financial ratios or changes in
the credit ratings of the underlying companies). Where there is
evidence supporting a change in the value, the firm uses
valuation methodologies such as the present value of known or
estimated cash flows.
Cash trading instruments owned by the firm (long positions) are
marked to bid prices, and instruments sold but not yet purchased
(short positions) are marked to offer prices. If liquidating a
position is expected to affect its prevailing market price, the
valuation is adjusted generally based on market evidence or
predetermined policies. In certain circumstances, such as for
highly illiquid positions, management’s estimates are used
to determine this adjustment.
•
Derivative Contracts. Fair values of the firm’s
derivative contracts consist of
exchange-traded and
over-the-counter (OTC)
derivatives and are reflected net of cash that the firm has paid
and received (for example, option premiums or cash paid or
received pursuant to credit support agreements). Fair values of
the firm’s exchange-traded derivatives are generally
determined from quoted market prices. OTC derivatives are valued
using valuation models. The firm uses a variety of valuation
models including the present value of known or estimated cash
flows and option-pricing models. The valuation models used to
derive the fair values of the firm’s OTC derivatives
require inputs including contractual terms, market prices, yield
curves, credit curves, measures of volatility, prepayment rates
and correlations of such inputs. The selection of a model to
value an OTC derivative depends upon the contractual terms of,
and specific risks inherent in, the instrument as well as the
availability of pricing information in the market. The firm
generally uses similar models to value similar instruments.
Where possible, the firm verifies the values produced by its
pricing models to market transactions. For OTC derivatives that
trade in liquid markets, such as generic forwards, swaps and
options, model selection does not involve significant judgment
because market prices are readily available. For OTC derivatives
that trade in less liquid markets, model selection requires more
judgment because such instruments tend to be more complex and
pricing information is less available in these markets. Price
transparency is inherently more limited for more complex
structures because they often combine one or more product types,
requiring additional inputs such as correlations and
volatilities. As markets continue to develop and more pricing
information becomes available, the firm continues to review and
refine the models it uses.
At the inception of an OTC derivative contract (day one), the
firm values the contract at the model value if the firm can
verify all of the significant model inputs to observable market
data and verify the model to market transactions. When
appropriate, valuations are adjusted to reflect various factors
such as liquidity, bid/offer spreads and credit considerations.
These adjustments are generally based on market evidence or
predetermined policies. In certain circumstances, such as for
highly illiquid positions, management’s estimates are used
to determine these adjustments.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Where the firm cannot verify all of the significant model inputs
to observable market data and verify the model to market
transactions, the firm values the contract at the transaction
price at inception and, consequently, records no day one gain or
loss in accordance with EITF Issue
No. 02-3,
“Issues Involved in Accounting for Derivative Contracts
Held for Trading Purposes and Contracts Involved in Energy
Trading and Risk Management Activities” (see
“— Recent Accounting Developments” below for
a discussion of the impact of SFAS No. 157 on EITF
Issue No. 02-3).
Following day one, the firm adjusts the inputs to its valuation
models only to the extent that changes in these inputs can be
verified by similar market transactions, third-party pricing
services and/or broker quotes, or can be derived from other
substantive evidence such as empirical market data. In
circumstances where the firm cannot verify the model to market
transactions, it is possible that a different valuation model
could produce a materially different estimate of fair value.
•
Principal Investments. In valuing corporate and real
estate principal investments, the firm’s portfolio is
separated into investments in private companies (including the
firm’s investment in the ordinary shares of Industrial and
Commercial Bank of China Limited (ICBC)), investments in public
companies (excluding the firm’s investment in the
convertible preferred stock of Sumitomo Mitsui Financial Group,
Inc. (SMFG)) and the firm’s investment in SMFG.
The firm’s private principal investments, by their nature,
have little or no price transparency. Such investments
(including the firm’s investment in ICBC) are initially
carried at cost as an approximation of fair value. Adjustments
to carrying value are made if there are third-party transactions
evidencing a change in value. Downward adjustments are also
made, in the absence of third-party transactions, if it is
determined that the expected realizable value of the investment
is less than the carrying value. In reaching that determination,
many factors are considered including, but not limited to, the
operating cash flows and financial performance of the companies
or properties relative to budgets or projections, trends within
sectors and/or regions, underlying business models, expected
exit timing and strategy, and any specific rights or terms
associated with the investment, such as conversion features and
liquidation preferences.
The firm’s public principal investments, which tend to be
large, concentrated holdings that result from initial public
offerings or other corporate transactions, are valued using
quoted market prices discounted based on predetermined written
policies for nontransferability and illiquidity.
The firm’s investment in the convertible preferred stock of
SMFG is carried at fair value, which is derived from a model
that incorporates SMFG’s common stock price and credit
spreads, the impact of nontransferability and illiquidity, and
the downside protection on the conversion strike price. The
firm’s investment in the convertible preferred stock of
SMFG is generally nontransferable, but is freely convertible
into SMFG common stock. Restrictions on the firm’s ability
to hedge or sell two-thirds of the common stock underlying its
investment in SMFG lapsed in equal installments on
February 7, 2005 and March 9, 2006. As of the date of
this filing, the firm has fully hedged the first one-third
installment of the unrestricted shares and has hedged a majority
of the second one-third installment of the unrestricted shares.
Restrictions on the firm’s ability to hedge or sell the
remaining one-third installment lapse on February 7, 2007.
As of the date of this filing, the conversion price of the
firm’s SMFG preferred stock into shares of SMFG common
stock was ¥319,700. This price is subject to
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
downward adjustment if the price of SMFG common stock at the
time of conversion is less than the conversion price (subject to
a floor of ¥105,400).
In general, transfers of financial assets are accounted for as
sales under SFAS No. 140 when the firm has
relinquished control over the transferred assets. For transfers
accounted for as sales, any related gains or losses are
recognized in net revenues. Transfers that are not accounted for
as sales are accounted for as collateralized financing
arrangements and secured borrowings, with the related interest
expense recognized in net revenues over the lives of the
transactions.
Collateralized Financing Arrangements. Collateralized
financing arrangements consist of resale and repurchase
agreements, securities borrowed and loaned, and secured short
and long-term
borrowings. Interest income or expense on collateralized
financing arrangements is recognized in net revenues over the
life of the transaction.
•
Resale and Repurchase Agreements. Financial instruments
purchased under agreements to resell and financial instruments
sold under agreements to repurchase, principally
U.S. government, federal agency and investment-grade
foreign sovereign obligations, represent short-term
collateralized financing transactions and are carried in the
condensed consolidated statements of financial condition at
their contractual amounts plus accrued interest. These amounts
are presented on a net-by-counterparty basis when the
requirements of FIN No. 41, “Offsetting of
Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements,” or FIN No. 39, “Offsetting of
Amounts Related to Certain Contracts,” are satisfied. The
firm receives financial instruments purchased under agreements
to resell, makes delivery of financial instruments sold under
agreements to repurchase, monitors the market value of these
financial instruments on a daily basis and delivers or obtains
additional collateral as appropriate.
•
Securities Borrowed and Loaned. Securities borrowed and
loaned are recorded based on the amount of cash collateral
advanced or received. These transactions are generally
collateralized by cash, securities or letters of credit. The
firm receives securities borrowed, makes delivery of securities
loaned, monitors the market value of securities borrowed and
loaned, and delivers or obtains additional collateral as
appropriate.
•
Secured Short and Long-Term Borrowings. The firm also
obtains financing through the use of secured short and long-term
borrowings. The firm pledges financial instruments and other
assets as collateral for such borrowings. See Notes 3, 4
and 5 for further information regarding the firm’s secured
short and long-term borrowings.
Power Generation. Power generation revenues associated
with the firm’s consolidated power generation facilities
are included in “Trading and principal investments” in
the condensed consolidated statements of earnings when power is
delivered. “Cost of power generation” in the condensed
consolidated statements of earnings includes all of the direct
costs of these facilities (e.g., fuel, operations and
maintenance), as well as the depreciation and amortization
associated with the facilities and related contractual assets.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
The following table sets forth the power generation revenues and
costs directly associated with the firm’s consolidated
power generation facilities:
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
Revenues
(1)
$146
$132
$436
$377
Cost of power generation
121
108
363
339
(1)
Excludes revenues from nonconsolidated power generation
facilities, accounted for in accordance with the equity method
of accounting, as well as revenues associated with the
firm’s power trading activities.
Commissions. Commission revenues from executing and
clearing client transactions on stock, options and futures
markets worldwide are recognized in “Trading and principal
investments” in the condensed consolidated statements of
earnings on a trade-date basis.
Insurance Contracts. Revenues from variable annuity and
variable life insurance contracts, and from providing
reinsurance of such contracts, generally consist of fees
assessed on contract holder account balances for mortality
charges, policy administration and surrender charges. These fees
are recognized in the condensed consolidated statements of
earnings in the period that services are provided. Premiums
earned for providing catastrophe reinsurance are recognized in
revenues over the coverage period, net of premiums ceded for the
cost of reinsurance. Insurance revenues are included in
“Trading and principal investments” in the condensed
consolidated statements of earnings.
Merchant Banking Overrides. The firm is entitled to
receive merchant banking overrides (i.e., an increased share of
a fund’s income and gains) when the return on the
funds’ investments exceeds certain threshold returns.
Overrides are based on investment performance over the life of
each merchant banking fund, and future investment
underperformance may require amounts of override previously
distributed to the firm to be returned to the funds.
Accordingly, overrides are recognized in the condensed
consolidated statements of earnings only when all material
contingencies have been resolved. Overrides are included in
“Trading and principal investments” in the condensed
consolidated statements of earnings.
Asset Management. Management fees are recognized over the
period that the related service is provided based upon average
net asset values. In certain circumstances, the firm is also
entitled to receive asset management incentive fees based on a
percentage of a fund’s return or when the return on assets
under management exceeds specified benchmark returns or other
performance targets. Incentive fees are generally based on
investment performance over a
12-month period and are
subject to adjustment prior to the end of the measurement
period. Accordingly, incentive fees are recognized in the
condensed consolidated statements of earnings when the
measurement period ends. Asset management fees and incentive
fees are included in “Asset management and securities
services” in the condensed consolidated statements of
earnings.
Share-Based Compensation
In the first quarter of fiscal 2006, the firm adopted
SFAS No. 123-R,
“Share-Based
Payment,” which is a revision to SFAS No. 123,
“Accounting for
Stock-Based
Compensation.”
SFAS No. 123-R
focuses primarily on accounting for transactions in which an
entity obtains employee services in exchange for
share-based payments.
Under
SFAS No. 123-R,
share-based awards that
do not require future service (i.e., vested awards) are expensed
immediately.
Share-based employee
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
awards that require future service are amortized over the
relevant service period. The firm adopted
SFAS No. 123-R
under the modified prospective adoption method. Under that
method of adoption, the provisions of
SFAS No. 123-R
are generally applied only to
share-based awards
granted subsequent to adoption. The accounting treatment of
share-based awards
granted to
retirement-eligible
employees prior to the firm’s adoption of
SFAS No. 123-R
has not changed and financial statements for periods prior to
adoption are not restated for the effects of adopting
SFAS No. 123-R.
Two key differences between
SFAS No. 123-R
and SFAS No. 123 are:
First,
SFAS No. 123-R
requires expected forfeitures to be included in determining
share-based employee
compensation expense. Prior to the adoption of
SFAS No. 123-R,
forfeiture benefits were recorded as a reduction to compensation
expense when an employee left the firm and forfeited the award.
In the first quarter of fiscal 2006, the firm recorded a benefit
for expected forfeitures on all outstanding
share-based awards. The
transition impact of adopting
SFAS No. 123-R
as of the first day of the firm’s 2006 fiscal year,
including the effect of accruing for expected forfeitures on
outstanding share-based
awards, was not material to the firm’s results of
operations for that quarter.
Second,
SFAS No. 123-R
requires the immediate expensing of
share-based awards
granted to
retirement-eligible
employees, including awards subject to
non-compete agreements.
Share-based awards
granted to
retirement-eligible
employees prior to the adoption of
SFAS No. 123-R
must continue to be amortized over the stated service period of
the award (and accelerated if the employee actually retires).
Consequently, the firm’s compensation and benefits expenses
in fiscal 2006 (and, to a lesser extent, in fiscal 2007 and
fiscal 2008) will include both the amortization (and
acceleration) of awards granted to
retirement-eligible
employees prior to the adoption of
SFAS No. 123-R
as well as the full
grant-date fair value
of new awards granted to such employees under
SFAS No. 123-R.
The estimated annual
non-cash expense in
fiscal 2006 associated with the continued amortization of
share-based awards
granted to
retirement-eligible
employees prior to the adoption of
SFAS No. 123-R
is approximately $650 million, of which $133 million
and $508 million were recognized in the three and nine
months ended August 2006, respectively.
The firm began to account for
share-based awards in
accordance with the fair value method prescribed by
SFAS No. 123, “Accounting for
Stock-Based
Compensation,” as amended by SFAS No. 148,
“Accounting for
Stock-Based
Compensation — Transition and Disclosure,”
in 2003. Share-based
employee awards granted for the year ended
November 29, 2002 and prior years were accounted for
under the
intrinsic-value-based
method prescribed by APB Opinion No. 25, “Accounting
for Stock Issued to Employees,” as permitted by
SFAS No. 123. Therefore, no compensation expense was
recognized for unmodified stock options issued for years prior
to fiscal 2003 that had no intrinsic value on the date of grant.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
If the firm were to recognize compensation expense over the
relevant service period, generally three years, under the fair
value method per SFAS No. 123 with respect to stock
options granted for the year ended November 29, 2002
and prior years, net earnings would have decreased for the three
and nine months ended August 2005, resulting in pro forma
net earnings and earnings per common share (EPS) as set
forth below:
Three Months Ended
Nine Months Ended
August 2005
August 2005
(in millions, except per share amounts)
Net earnings applicable to common
shareholders, as reported
$
1,608
$
3,985
Add: Share-based
compensation expense, net of related
tax effects,
included in reported net earnings
144
415
Deduct: Share-based
compensation expense, net of related
tax effects,
determined under the fair value method for
all awards
(156
)
(451
)
Pro forma net earnings applicable
to common shareholders
$
1,596
$
3,949
Earnings per common share, as
reported
Basic
$
3.40
$
8.23
Diluted
3.25
7.89
Pro forma earnings per common share
Basic
$
3.37
$
8.15
Diluted
3.23
7.82
The firm pays cash dividend equivalents on outstanding
restricted stock units. Dividend equivalents paid on restricted
stock units accounted for under SFAS No. 123 and
SFAS No. 123-R
are charged to retained earnings when paid.
SFAS No. 123-R
requires dividend equivalents paid on restricted stock units
expected to be forfeited to be included in compensation expense.
Prior to the adoption of
SFAS No. 123-R,
dividend equivalents paid on restricted stock units that were
later forfeited by employees were reclassified to compensation
expense from retained earnings. Dividend equivalents paid on
restricted stock units granted prior to 2003 were accounted for
under APB Opinion No. 25 and charged to compensation
expense.
Prior to the adoption of
SFAS No. 123-R,
the firm presented all tax benefits resulting from
share-based
compensation as cash flows from operating activities in the
condensed consolidated statements of cash flows.
SFAS No. 123-R
requires cash flows resulting from tax deductions in excess of
the grant-date fair
value of share-based
awards to be included in cash flows from financing activities.
Goodwill
Goodwill is the cost of acquired companies in excess of the fair
value of identifiable net assets at acquisition date. In
accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets,” goodwill is tested at least annually
for impairment. An impairment loss is triggered if the estimated
fair value of an operating segment is less than its estimated
net book value. Such loss is calculated as the difference
between the estimated fair value of goodwill and its carrying
value.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Identifiable Intangible Assets
Identifiable intangible assets, which consist primarily of
customer lists,
above-market power
contracts, specialist rights and the value of business acquired
(VOBA) and deferred acquisition costs (DAC) in the
firm’s insurance subsidiaries, are amortized over their
estimated useful lives. Identifiable intangible assets are
tested for potential impairment whenever events or changes in
circumstances suggest that an asset’s or asset group’s
carrying value may not be fully recoverable in accordance with
SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived
Assets.” An impairment loss, 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.
Property, Leasehold Improvements and Equipment
Property, leasehold improvements and equipment, net of
accumulated depreciation and amortization, are included in
“Other assets” in the condensed consolidated
statements of financial condition.
Property and equipment placed in service prior to
December 1, 2001 are depreciated under the accelerated
cost recovery method. Property and equipment placed in service
on or after December 1, 2001 are depreciated on a
straight-line basis
over the useful life of the asset. Leasehold improvements for
which the useful life of the improvement is shorter than the
term of the lease are amortized under the accelerated cost
recovery method if placed in service prior to December 1,2001. All other 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
potential impairment whenever events or changes in circumstances
suggest that an asset’s or asset group’s carrying
value may not be fully recoverable in accordance with
SFAS No. 144. An impairment loss, 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 expected undiscounted cash flows relating to the asset or
asset group is less than the corresponding carrying value.
The firm’s operating leases include space held in excess of
current requirements. Rent expense relating to space held for
growth is included in “Occupancy” in the condensed
consolidated statements of earnings. In accordance with
SFAS No. 146, “Accounting for Costs Associated
with Exit or Disposal Activities,” the firm records a
liability, based on 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 upon termination.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
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 statement of financial condition, and
revenues and expenses are translated at average rates of
exchange for the fiscal period. 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, on the condensed
consolidated statements of comprehensive income. The firm seeks
to reduce its net investment exposure to fluctuations in foreign
exchange rates through the use of foreign currency forward
contracts and foreign
currency-denominated
debt. For foreign currency forward contracts, hedge
effectiveness is assessed based on changes in forward exchange
rates; accordingly, forward points are reflected as a component
of the currency translation adjustment in the condensed
consolidated statements of comprehensive income. For foreign
currency-denominated
debt, hedge effectiveness is assessed based on changes in spot
rates. Foreign currency remeasurement gains or losses on
transactions in nonfunctional currencies are included in the
condensed consolidated statements of earnings.
Income Taxes
Deferred tax assets and liabilities are recognized for temporary
differences between the financial reporting and tax bases of the
firm’s assets and liabilities. Valuation allowances are
established to reduce deferred tax assets to the amount that
more likely than not will be realized. The firm’s tax
assets and liabilities are presented as a component of
“Other assets” and “Other liabilities and accrued
expenses,” respectively, in the condensed consolidated
statements of financial condition. Tax provisions are computed
in accordance with SFAS No. 109, “Accounting for
Income Taxes.” Contingent liabilities related to income
taxes are recorded when the criteria for loss recognition under
SFAS No. 5, “Accounting for Contingencies,”
as amended, have been met (see “— Recent
Accounting Developments” below for a discussion of the
impact of FIN No. 48 on SFAS No. 109).
Earnings Per Common Share
Basic 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 restricted stock units 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 pursuant to stock options and to restricted stock
units for which future service is required as a condition to the
delivery of the underlying common stock.
Cash and Cash Equivalents
The firm defines cash equivalents as highly liquid overnight
deposits held in the ordinary course of business.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Recent Accounting Developments
In June 2005, the EITF reached consensus on Issue
No. 04-5,
“Determining Whether a General Partner, or the General
Partners as a Group, Controls a Limited Partnership or Similar
Entity When the Limited Partners Have Certain Rights,”
which requires general partners (or managing members in the case
of limited liability companies) to consolidate their
partnerships or to provide limited partners with rights to
remove the general partner or to terminate the partnership. The
firm, as the general partner of numerous merchant banking and
asset management partnerships, is required to adopt the
provisions of EITF Issue
No. 04-5
(i) immediately for partnerships formed or modified after
June 29, 2005 and (ii) in the first quarter of
fiscal 2007 for partnerships formed on or before
June 29, 2005 that have not been modified. The firm
generally expects to provide limited partners in these funds
with rights to remove the firm as the general partner or to
terminate the partnerships and, therefore, does not expect that
EITF Issue
No. 04-5 will have
a material effect on the firm’s financial condition,
results of operations or cash flows.
In February 2006, the FASB issued SFAS No. 155,
“Accounting for Certain Hybrid Financial
Instruments — an amendment of FASB Statements
No. 133 and 140.” SFAS No. 155 permits an
entity to measure at fair value any financial instrument that
contains an embedded derivative that otherwise would require
bifurcation. As permitted, the firm early adopted
SFAS No. 155 in the first quarter of fiscal 2006.
Adoption did not have a material effect on the firm’s
financial condition, results of operations or cash flows.
Effective for the first quarter of fiscal 2006, the firm adopted
SFAS No. 156, “Accounting for Servicing of
Financial Assets — an amendment of FASB Statement
No. 140,” which permits entities to elect to measure
servicing assets and servicing liabilities at fair value and
report changes in fair value in earnings. The firm acquires
residential mortgage servicing rights in connection with its
mortgage securitization activities and has elected under
SFAS No. 156 to account for these servicing rights at
fair value. Adoption did not have a material effect on the
firm’s financial condition, results of operations or cash
flows.
In April 2006, the FASB issued FASB Staff Position
(FSP) FIN No. 46-R-6,
“Determining the Variability to Be Considered in Applying
FASB Interpretation
No. 46-R.”
This FSP addresses how a reporting enterprise should determine
the variability to be considered in applying
FIN No. 46-R
by requiring an analysis of the purpose for which an entity was
created and the variability that the entity was designed to
create. This FSP must be applied prospectively to all entities
with which a reporting enterprise first becomes involved and to
all entities previously required to be analyzed under
FIN No. 46-R
when a reconsideration event has occurred. As permitted, the
firm early adopted
FSP FIN No. 46-R-6
in the third quarter of fiscal 2006. Adoption did not have a
material effect on the firm’s financial condition, results
of operations or cash flows.
In June 2006, the FASB issued FIN No. 48,
“Accounting for Uncertainty in Income
Taxes — an Interpretation of FASB Statement
No. 109.” FIN No. 48 requires that the firm
determine whether a tax position is more likely than not to be
sustained upon examination, including resolution of any related
appeals or litigation processes, based on the technical merits
of the position. Once it is determined that a position meets
this recognition threshold, the position is measured to
determine the amount of benefit to be recognized in the
financial statements. The firm expects to adopt the provisions
of FIN No. 48 beginning in the first quarter of fiscal
2008. The firm is currently evaluating the impact of adopting
FIN No. 48 on its financial condition, results of
operations and cash flows.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements.” SFAS No. 157
clarifies that fair value is the amount that would be exchanged
to sell an asset or transfer a liability, in an orderly
transaction between market participants. SFAS No. 157
nullifies the consensus reached in EITF Issue
No. 02-3
prohibiting the recognition of day one gain or loss on
derivative contracts (and hybrid instruments measured at fair
value under SFAS No. 133 as modified by SFAS No. 155)
where the firm cannot verify all of the significant model inputs
to observable market data and verify the model to market
transactions. However, SFAS No. 157 requires that a
fair value measurement technique include an adjustment for risks
inherent in a particular valuation technique (such as a pricing
model) and/or the risks inherent in the inputs to the model, if
market participants would also include such an adjustment. In
addition, SFAS No. 157 prohibits the recognition of
“block discounts” for large holdings of unrestricted
financial instruments where quoted prices are readily and
regularly available in an active market. The provisions of
SFAS No. 157 are to be applied prospectively, except
for changes in fair value measurements that result from the
initial application of SFAS No. 157 to existing
derivative financial instruments measured under EITF Issue
No. 02-3, existing
hybrid instruments measured at fair value, and block discounts,
which are to be recorded as an adjustment to opening retained
earnings in the year of adoption. SFAS No. 157 is
effective for fiscal years beginning after
November 15, 2007. The firm is evaluating whether it
will early adopt SFAS No. 157 as of the first quarter
of fiscal 2007 as permitted, and is currently evaluating the
impact adoption may have on its financial condition, results of
operations and cash flows.
In September 2006, the FASB issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106 and
132-R.” SFAS
No. 158 requires an entity to recognize in its statement of
financial condition the funded status of its defined benefit
postretirement plans, measured as the difference between the
fair value of the plan assets and the benefit obligation. SFAS
No. 158 also requires an entity to recognize changes in the
funded status of a defined benefit postretirement plan within
accumulated other comprehensive income, net of tax, to the
extent such changes are not recognized in earnings as components
of periodic net benefit cost. SFAS No. 158 is effective as
of the end of the fiscal year ending after December 15,2006. The firm will adopt SFAS No. 158 as of the end of
fiscal 2007. The firm does not expect that the adoption of SFAS
No. 158 will have a material effect on the firm’s
financial condition, results of operations or cash flows.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Note 3.
Financial Instruments
Fair Value of Financial Instruments
The following table sets forth 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:
As of
August 2006
November 2005
Assets
Liabilities
Assets
Liabilities
(in millions)
Commercial paper, certificates of
deposit, time deposits and other money market instruments
$
10,641
(1)
$
—
$
14,609
(1)
$
—
U.S. government, federal
agency and sovereign obligations
67,436
57,720
68,688
51,458
Corporate and other debt obligations
Mortgage whole loans and
collateralized debt obligations
Includes $7.28 billion and $6.12 billion, as of
August 2006 and November 2005, respectively, of money
market instruments held by William Street Funding Corporation to
support the William Street credit extension program.
(2)
Net of cash received pursuant to credit support agreements of
$22.24 billion and $22.61 billion as of
August 2006 and November 2005, respectively.
(3)
Net of cash paid pursuant to credit support agreements of
$17.27 billion and $16.10 billion as of
August 2006 and November 2005, respectively.
(4)
Includes securities held by the firm’s bank and insurance
subsidiaries, which are accounted for as
“available-for-sale”
(AFS) under SFAS No. 115, “Accounting for
Certain Investments in Debt and Equity Securities.” The
following table sets forth the types of AFS securities and their
maturity profile:
Under
Over
One Year
1-5 Years
6-10 Years
10 Years
Total
(in millions)
Mortgage-backed and other federal
agency securities
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Derivative Activities
Derivative contracts are instruments, such as futures, forwards,
swaps or option contracts that derive their value from
underlying assets, indices, reference rates or a combination of
these factors. Derivative instruments may be privately
negotiated contracts, which are often referred to as OTC
derivatives, or they may be listed and traded on an exchange.
Derivatives may involve future commitments to purchase or sell
financial instruments or commodities, or to exchange currency or
interest payment streams. The amounts exchanged are based on the
specific terms of the contract with reference to specified
rates, securities, commodities, currencies or indices.
Certain cash instruments, such as mortgage-backed securities,
interest-only and principal-only obligations, and indexed debt
instruments, are not considered derivatives even though their
values or contractually required cash flows are derived from the
price of some other security or index. However, certain
commodity-related contracts are included in the firm’s
derivatives disclosure, as these contracts may be settled in
cash or are readily convertible into cash.
The firm enters into derivative transactions to facilitate
client transactions, to take proprietary positions and as a
means of risk management. Risk exposures are managed through
diversification, by controlling position sizes and by entering
into offsetting positions. For example, the firm may manage the
risk related to a portfolio of common stock by entering into an
offsetting position in a related equity-index futures contract.
The firm applies hedge accounting under SFAS No. 133,
“Accounting for Derivative Instruments and Hedging
Activities,” to certain derivative contracts. The firm uses
these derivatives to manage certain interest rate and currency
exposures, including the firm’s net investment in
non-U.S. operations.
The firm designates certain interest rate swap contracts as fair
value hedges. These interest rate swap contracts hedge changes
in the relevant benchmark interest rate (e.g., London Interbank
Offered Rate (LIBOR)), effectively converting a substantial
portion of the firm’s long-term and certain short-term
borrowings into floating rate obligations. In addition, the firm
applies cash flow hedge accounting to a limited number of
foreign currency forward contracts that hedge currency exposure
on certain forecasted transactions in its consolidated power
generation facilities. See Note 2 for information regarding
the firm’s policy on foreign currency forward contracts
used to hedge its net investment in
non-U.S. operations.
The firm applies a long-haul method to substantially all of its
hedge accounting relationships to perform an ongoing assessment
of the effectiveness of these relationships in achieving
offsetting changes in fair value or offsetting cash flows
attributable to the risk being hedged. The firm utilizes a
dollar-offset method, which compares 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,
to prospectively and retrospectively assess hedge effectiveness.
The firm’s prospective dollar-offset assessment utilizes
scenario analyses to test hedge effectiveness via simulations of
numerous parallel and slope shifts of the relevant yield curve.
Parallel shifts change the interest rate of all maturities by
identical amounts. Slope shifts change the curvature of the
yield curve. A hedging relationship is deemed to be effective if
the fair values of the hedging instrument and the hedged item
change inversely within a range of 80 to 125% in response to
each of the simulated yield curve shifts.
For fair value hedges, gains or losses on derivative
transactions as well as the hedged item are recognized in
“Interest expense” in the condensed consolidated
statements of earnings. For cash flow hedges, the effective
portion of gains or losses on derivative transactions is
reported as a component of “Other comprehensive
income.” Gains or losses related to hedge ineffectiveness
for
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
all hedges are generally included in “Interest
expense.” These gains or losses and the component of gains
or losses on derivative transactions excluded from the
assessment of hedge effectiveness (e.g., the effect of the
passage of time on fair value hedges of the firm’s
borrowings) were not material to the firm’s results of
operations for the three and nine months ended August 2006.
Gains and losses on derivatives used for trading purposes are
generally included in “Trading and principal
investments” in the condensed consolidated statements of
earnings.
Fair values of the firm’s derivative contracts are
reflected net of cash paid or received pursuant to credit
support agreements and are reported on a net-by-counterparty
basis in the firm’s condensed consolidated statements of
financial condition when management believes a legal right of
setoff exists under an enforceable netting agreement. The fair
value of derivative financial instruments, computed in
accordance with the firm’s netting policy, is set forth
below:
The fair values of derivatives accounted for as qualifying
hedges under SFAS No. 133 consisted of
$1.69 billion and $2.10 billion in assets as of
August 2006 and November 2005, respectively, and
$991 million and $443 million in liabilities as of
August 2006 and November 2005, respectively.
The firm also has embedded derivatives that have been bifurcated
from related borrowings under SFAS No. 133. Such
derivatives, which are classified in short-term and long-term
borrowings, had a carrying value of $1.18 billion and
$607 million (excluding the debt host contract) as of
August 2006 and November 2005, respectively. See
Notes 4 and 5 for further information regarding the
firm’s borrowings.
Securitization Activities
The firm securitizes commercial and residential mortgages, home
equity and auto loans, government and corporate bonds and other
types of financial assets. The firm acts as underwriter of the
beneficial interests that are sold to investors. The firm
derecognizes financial assets transferred in securitizations
provided it has relinquished control over such assets.
Transferred assets are accounted for at fair value prior to
securitization. Net revenues related to these underwriting
activities are recognized in connection with the sales of the
underlying beneficial interests to investors.
The firm may retain interests in securitized financial assets,
primarily in the form of senior or subordinated securities,
including residual interests. Retained interests are accounted
for at fair value and included in “Total financial
instruments owned, at fair value” in the condensed
consolidated statements of financial condition.
During the nine months ended August 2006 and August 2005, the
firm securitized $78.77 billion and $65.10 billion,
respectively, of financial assets, including $55.20 billion
and $45.39 billion, respectively, of residential mortgage
loans and securities. Cash flows received on
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
retained interests were approximately $613 million and
$655 million for the nine months ended August 2006 and
August 2005, respectively.
As of August 2006 and November 2005, the firm held
$8.28 billion and $6.07 billion of retained interests,
respectively, including $6.26 billion and
$5.62 billion, respectively, held in QSPEs. The fair value
of retained interests valued using quoted market prices in
active markets was $1.27 billion and $1.34 billion as
of August 2006 and November 2005, respectively.
The following table sets forth the weighted average key economic
assumptions used in measuring retained interests for which fair
value is based on alternative pricing sources with reasonable,
little or no price transparency and the sensitivity of those
fair values to immediate adverse changes of 10% and 20% in those
assumptions:
As of August 2006
As of November 2005
Type of Retained Interests
Type of Retained Interests
Mortgage-
Corporate
Mortgage-
Corporate
Backed
CDOs
Debt (3)
Backed
CDOs
Debt (3)
($ in millions)
Fair value of retained interests
$
3,841
$
2,101
$
1,071
$
2,928
$
516
$
1,283
Weighted average life (years)
6.6
5.2
2.4
5.7
4.9
2.2
Constant prepayment rate
19.1
%
24.7
%
N/A
%
18.6
%
21.5
%
N/A
%
Impact of 10% adverse change
$
(90
)
$
(4
)
$
—
$
(44
)
$
(2
)
$
—
Impact of 20% adverse change
(162
)
(7
)
—
(73
)
(4
)
—
Anticipated credit losses
(1)
3.7
%
2.1
%
N/A
%
5.0
%
2.5
%
N/A
%
Impact of 10% adverse change
(2)
$
(92
)
$
(3
)
$
—
$
(25
)
$
(4
)
$
—
Impact of 20% adverse change
(2)
(172
)
(5
)
—
(48
)
(9
)
—
Discount rate
8.8
%
5.8
%
2.3
%
7.4
%
6.1
%
3.7
%
Impact of 10% adverse change
$
(137
)
$
(40
)
$
(9
)
$
(70
)
$
(3
)
$
(10
)
Impact of 20% adverse change
(263
)
(80
)
(18
)
(136
)
(8
)
(21
)
(1)
Anticipated credit losses are computed only on positions in
which expected credit loss is a key assumption in the
determination of fair values.
(2)
The impacts of adverse change take into account credit mitigants
incorporated in the retained interests, including over-
collateralization and subordination provisions.
(3)
Includes retained interests in bonds and other types of
financial assets that are not subject to prepayment risk.
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
is calculated independently of changes in any other assumption.
In practice, simultaneous changes in assumptions might magnify
or counteract the sensitivities disclosed above.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
In addition to the retained interests described above, the firm
also held interests in residential mortgage QSPEs purchased in
connection with secondary market-making activities. These
purchased interests approximated $7 billion and
$5 billion as of August 2006 and November 2005,
respectively.
Variable Interest Entities (VIEs)
The firm, in the ordinary course of business, retains interests
in VIEs in connection with its securitization activities. The
firm also purchases and sells variable interests in VIEs, which
primarily issue mortgage-backed and other asset-backed
securities and collateralized debt obligations (CDOs), in
connection with its market-making activities and makes
investments in and loans to VIEs that hold performing and
nonperforming debt, equity, real estate, power-related and other
assets. In addition, the firm utilizes VIEs to provide investors
with credit-linked and asset-repackaged notes designed to meet
their objectives.
VIEs generally purchase assets by issuing debt and equity
instruments. In certain instances, the firm provides guarantees
to VIEs or holders of variable interests in VIEs. In such cases,
the maximum exposure to loss included in the tables set forth
below is the notional amount of such guarantees. Such amounts do
not represent anticipated losses in connection with these
guarantees.
The firm’s variable interests in VIEs include senior and
subordinated debt; limited and general partnership interests;
preferred and common stock; interest rate, foreign currency,
equity, commodity and credit derivatives; guarantees; and
residual interests in mortgage-backed and asset-backed
securitization vehicles and CDOs. The firm’s exposure to
the obligations of VIEs is generally limited to its interests in
these entities.
The following table sets forth the firm’s total assets and
maximum exposure to loss associated with its significant
variable interests in consolidated VIEs where the firm does not
hold a majority voting interest. The firm has aggregated
consolidated VIEs based on principal business activity, as
reflected in the first column.
As of August 2006
As of November 2005
Maximum
Maximum
VIE
Exposure
VIE
Exposure
Assets (1)
to Loss
Assets (1)
to Loss
(in millions)
Investments in loans and real estate
$
1,788
$
637
$
2,081
$
717
Municipal bonds
2,568
2,568
1,587
1,587
Mortgage-backed and other
asset-backed
457
117
522
55
Asset repackagings and
credit-linked notes
1,246
929
1,266
880
Investments in preferred stock
425
244
416
221
Foreign exchange and commodities
554
412
600
205
Other
150
286
152
279
Total
$
7,188
$
5,193
$
6,624
$
3,944
(1)
Consolidated VIE assets include assets financed by nonrecourse
short-term and long-term debt. Nonrecourse debt is debt that
only the issuing subsidiary or, if applicable, a subsidiary
guaranteeing the debt is obligated to repay.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
The following tables set forth total assets in nonconsolidated
VIEs in which the firm holds significant variable interests and
the firm’s maximum exposure to loss associated with these
interests. The firm has aggregated nonconsolidated VIEs based on
principal business activity, as reflected in the first column.
The nature of the firm’s variable interests can take
different forms, as described in the columns under maximum
exposure to loss.
As of August 2006
Maximum Exposure to Loss in Nonconsolidated VIEs
Purchased
Commitments
VIE
and Retained
and
Loans and
Assets
Interests
Guarantees
Derivatives (1)
Investments
Total
(in millions)
Collateralized debt obligations
$
40,916
$
2,170
$
—
$
9,439
$
—
$
11,609
Asset repackagings and
credit-linked notes
4,778
—
—
3,237
—
3,237
Power-related
3,398
2
73
—
618
693
Investments in loans and real estate
14,086
—
34
15
1,658
1,707
Mortgage-backed and other
asset-backed
4,714
62
1,256
63
260
1,641
Total
$
67,892
$
2,234
$
1,363
$
12,754
$
2,536
$
18,887
As of November 2005
Maximum Exposure to Loss in Nonconsolidated VIEs
Purchased
Commitments
VIE
and Retained
and
Loans and
Assets
Interests
Guarantees
Derivatives (1)
Investments
Total
(in millions)
Collateralized debt obligations
$
24,295
$
780
$
—
$
4,536
$
—
$
5,316
Asset repackagings and
credit-linked notes
2,568
—
—
1,527
—
1,527
Power-related
6,667
2
95
—
1,070
1,167
Investments in loans and real estate
14,232
—
11
—
1,082
1,093
Mortgage-backed and other
asset-backed
6,378
208
248
52
426
934
Total
$
54,140
$
990
$
354
$
6,115
$
2,578
$
10,037
(1)
Derivatives related to CDOs consist of total return swaps on
investment-grade securities issued by VIEs as well as
out-of-the-money
written put options that provide protection on investment-grade
collateral held by VIEs. Derivatives related to asset
repackagings and credit-linked notes consist of
out-of-the-money
written put options that provide principal protection on notes
issued by VIEs. Neither the total return swaps nor the written
put options expose the firm to a majority of the VIE’s
expected losses or expected residual returns.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Secured Borrowing and Lending Activities
The firm obtains secured short-term financing principally
through the use of repurchase agreements, securities lending
agreements and other financings. In these transactions, the firm
receives cash or financial instruments in exchange for other
financial instruments, including U.S. government, federal
agency and sovereign obligations, corporate debt and other debt
obligations, equities and convertibles, letters of credit and
other assets.
The firm obtains financial instruments as collateral principally
through the use of resale agreements, securities borrowing
agreements, derivative transactions, customer margin loans and
other secured borrowing activities to finance inventory
positions, to meet customer needs and to satisfy settlement
requirements. In many cases, the firm is permitted to sell or
repledge financial instruments held as collateral. These
financial instruments may be used to secure repurchase
agreements, to enter into securities lending or derivative
transactions, or to cover short positions. As of August 2006 and
November 2005, the fair value of financial instruments received
as collateral by the firm that it was permitted to sell or
repledge was $691.85 billion and $629.94 billion,
respectively, of which the firm sold or repledged
$585.06 billion and $550.33 billion, respectively.
The firm also pledges financial instruments it owns.
Counterparties may or may not have the right to sell or repledge
the financial instruments. Financial instruments owned and
pledged to counterparties that have the right to sell or
repledge are reported as “Financial instruments owned and
pledged as collateral, at fair value” in the condensed
consolidated statements of financial condition and were
$39.94 billion and $38.98 billion as of August 2006
and November 2005, respectively. Financial instruments owned and
pledged in connection with repurchase and securities lending
agreements to counterparties that did not have the right to sell
or repledge are included in “Financial instruments owned,
at fair value” in the condensed consolidated statements of
financial condition and were $83.71 billion and
$93.90 billion as of August 2006 and November 2005,
respectively.
In addition to repurchase and securities lending agreements, the
firm also pledges financial instruments and other assets it owns
to counterparties that do not have the right to sell or
repledge, in order to collateralize secured short-term and
long-term borrowings. In connection with these transactions, the
firm pledged assets of $45.08 billion and
$27.84 billion as collateral as of August 2006 and
November 2005, respectively. See Note 4 and Note 5 for
further information regarding the firm’s secured short-term
and long-term borrowings.
Note 4.
Short-Term Borrowings
The firm obtains short-term borrowings primarily through the use
of promissory notes, commercial paper, secured debt and bank
loans. As of August 2006 and November 2005, secured short-term
borrowings were $18.85 billion and $7.97 billion,
respectively. Unsecured short-term borrowings were
$53.81 billion and $47.25 billion as of August 2006
and November 2005, respectively. Short-term borrowings also
include the portion of long-term borrowings maturing within one
year of the financial statement date and certain long-term
borrowings that are redeemable within one year of the financial
statement date at the option of the holder. The carrying value
of these short-term obligations approximates fair value due to
their short-term nature.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Short-term borrowings are set forth below:
As of
August
November
2006
2005
(in millions)
Promissory notes
$
18,277
$
17,339
Commercial paper
2,437
5,154
Secured debt, bank loans and other
35,586
15,975
Current portion of secured and
unsecured long-term borrowings
16,364
16,751
Total
(1)
(2)
$
72,664
$
55,219
(1)
As of August 2006 and November 2005, the weighted average
interest rates for
short-term borrowings,
including commercial paper, were 5.04% and 3.98%, respectively.
The weighted average interest rates, after giving effect to
hedging activities, were 4.97% and 3.86% as of August 2006 and
November 2005, respectively.
(2)
Short-term borrowings as of August 2006 include
$8.38 billion of hybrid financial instruments accounted for
at fair value under SFAS No. 155.
Note 5.
Long-Term Borrowings
The firm obtains secured and unsecured long-term borrowings,
which consist principally of senior borrowings with maturities
extending to 2036. As of August 2006 and November 2005, secured
long-term borrowings were $19.55 billion and
$15.67 billion, respectively. Unsecured
long-term borrowings
were $109.78 billion and $84.34 billion as of August
2006 and November 2005, respectively.
Long-term borrowings are set forth below:
As of
August
November
2006
2005
(in millions)
Fixed rate obligations
(1)
U.S. dollar
$
38,866
$
35,530
Non-U.S. dollar
20,427
16,224
Floating rate obligations
(2)
U.S. dollar
44,473
31,952
Non-U.S. dollar
25,565
16,301
Total
(3)
$
129,331
$
100,007
(1)
As of August 2006 and November 2005, interest rates on
U.S. dollar fixed rate obligations ranged from 3.88% to
12.00% and from 3.72% to 12.00%, respectively. As of August 2006
and November 2005, interest rates on
non-U.S. dollar
fixed rate obligations ranged from 0.31% to 10.00% and from
0.65% to 8.88%, respectively.
(2)
Floating interest rates generally are based on LIBOR or the
federal funds rate. Certain equity-linked and indexed
instruments are included in floating rate obligations.
(3)
Long-term borrowings as of August 2006 include
$5.51 billion of hybrid financial instruments accounted for
at fair value under SFAS No. 155.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Long-term borrowings include nonrecourse debt issued by the
following subsidiaries, as set forth in the table below.
Nonrecourse debt is debt that only the issuing subsidiary or, if
applicable, a subsidiary guaranteeing the debt is obligated to
repay.
Includes $1.10 billion and $1.33 billion of
nonrecourse debt related to the firm’s consolidated power
generation facilities as of August 2006 and November 2005,
respectively.
Long-term borrowings by fiscal maturity date are set forth below:
As of
August 2006 (1) (2)
November 2005 (1) (2)
U.S.
Non-U.S.
U.S.
Non-U.S.
Dollar
Dollar
Total
Dollar
Dollar
Total
(in millions)
2007
$
7,058
$
72
$
7,130
$
13,662
$
861
$
14,523
2008
10,310
2,778
13,088
6,218
2,872
9,090
2009
12,031
3,446
15,477
9,241
3,094
12,335
2010
6,200
6,163
12,363
6,411
7,698
14,109
2011
7,071
5,894
12,965
4,840
1,430
6,270
2012-thereafter
40,669
27,639
68,308
27,110
16,570
43,680
Total
$
83,339
$
45,992
$
129,331
$
67,482
$
32,525
$
100,007
(1)
Long-term borrowings maturing within one year of the financial
statement date and certain long-term borrowings that are
redeemable within one year of the financial statement date at
the option of the holder are included as short-term borrowings
in the condensed consolidated statements of financial condition.
(2)
Long-term borrowings that are repayable prior to maturity at the
option of the firm are reflected at their contractual maturity
dates. Long-term borrowings that are redeemable prior to
maturity at the option of the holder are reflected at the dates
such options become exercisable.
The firm enters into derivative contracts, such as interest rate
futures contracts, interest rate swap agreements, currency swap
agreements, equity-linked and indexed contracts, to effectively
convert a substantial portion of its long-term borrowings into
U.S. dollar-based floating rate obligations. Accordingly,
the aggregate carrying value of these long-term borrowings and
related derivatives approximates fair value.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
The effective weighted average interest rates for long-term
borrowings are set forth below:
As of
August 2006
November 2005
Amount
Rate
Amount
Rate
($ in millions)
Fixed rate obligations
$
2,671
5.94
%
$
3,468
5.48
%
Floating rate obligations
(1)
126,660
5.56
96,539
4.31
Total
$
129,331
5.57
$
100,007
4.35
(1)
Includes fixed rate obligations that have been converted into
floating rate obligations through derivative contracts.
Subordinated Borrowings
Long-term borrowings include $1.50 billion of subordinated
notes as of August 2006 and $2.84 billion of junior
subordinated debentures as of August 2006 and November 2005.
Subordinated Notes. The firm issued $1.50 billion of
subordinated notes in its second quarter of fiscal 2006. The
firm pays interest semiannually on these notes at an annual rate
of 6.45% and the notes mature on May 1, 2036. These notes
are junior in right of payment to all of the firm’s senior
indebtedness.
Junior Subordinated Debentures. The firm issued
$2.84 billion of junior subordinated debentures in its
first quarter of fiscal 2004 to Goldman Sachs Capital
Trust I (the Trust), a Delaware statutory trust created for
the exclusive purposes of (i) issuing $2.75 billion of
guaranteed preferred beneficial interests and $85 million
of common beneficial interests in the Trust, (ii) investing
the proceeds from the sale to purchase junior subordinated
debentures issued by the firm and (iii) engaging in only
those other activities necessary or incidental to these
purposes. The preferred beneficial interests were purchased by
third parties, and, as of August 2006 and November 2005, the
firm held all the common beneficial interests. 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 semiannually on these 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 applicable to 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 semiannual 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 the
firm unless all dividends payable on the preferred beneficial
interests have been paid in full. These notes are junior in
right of payment to all of the firm’s senior indebtedness
and all of the firm’s subordinated notes (described above).
See Note 6 for information regarding the firm’s
guarantee of the preferred beneficial interests issued by the
Trust.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Note 6.
Commitments, Contingencies and Guarantees
Commitments
Forward Secured Financings. The firm had commitments to
enter into forward secured financing transactions, including
certain repurchase and resale agreements and secured borrowing
and lending arrangements, of $53.31 billion and
$49.93 billion as of August 2006 and November 2005,
respectively.
Commitments to Extend Credit. In connection with its
lending activities, the firm had outstanding commitments to
extend credit of $70.20 billion and $61.12 billion as
of August 2006 and November 2005, respectively. The firm’s
commitments to extend credit are agreements to lend to
counterparties that have fixed termination dates and are
contingent on the satisfaction of all conditions to borrowing
set forth in the contract. Since these commitments may expire
unused, the total commitment amount does not necessarily reflect
the actual future cash flow requirements. The firm accounts for
these commitments at fair value.
The following table summarizes the firm’s commitments to
extend credit at August 2006 and November 2005:
Commitments to Extend Credit
As of
August
November
2006
2005
(in millions)
William Street program
$
17,958
$
14,505
Other commercial lending commitments
Investment-grade
11,901
17,592
Non-investment-grade
24,978
18,536
Warehouse financing
15,364
10,489
Total commitments to extend credit
$
70,201
$
61,122
•
William Street program. Substantially all of the
commitments provided under the William Street credit extension
program are to investment-grade corporate borrowers. Commitments
under the William Street credit extension program are issued by
William Street Commitment Corporation (Commitment Corp.), a
consolidated wholly owned subsidiary of Group Inc. whose assets
and liabilities are legally separated from other assets and
liabilities of the firm, and also by other subsidiaries of Group
Inc. William Street Funding Corporation (Funding Corp.), another
consolidated wholly owned subsidiary of Group Inc. whose assets
and liabilities are legally separated from other assets and
liabilities of the firm, was formed to raise funding to support
the William Street credit extension program. The assets of
Commitment Corp. and of Funding Corp. will not be available to
their respective shareholders until the claims of their
respective creditors have been paid. In addition, no affiliate
of either Commitment Corp. or Funding Corp., except in limited
cases as expressly agreed in writing, is responsible for any
obligation of either entity. With respect to these commitments,
the firm has credit loss protection provided to it by SMFG,
which is generally limited to 95% of the first loss the firm
realizes on approved loan commitments, subject to a maximum of
$1.00 billion. In addition, subject to the satisfaction of
certain conditions, upon the firm’s request, SMFG will
provide protection for 70% of the second loss on such
commitments,
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
subject to a maximum of $1.13 billion. The firm also uses
other financial instruments to mitigate credit risks related to
certain William Street commitments not covered by SMFG.
•
Other commercial lending commitments. In addition to the
commitments issued under the William Street credit extension
program, the firm extends other credit commitments, primarily in
connection with contingent acquisition financing and other types
of corporate lending. As part of its ongoing credit origination
activities, the firm may reduce its credit risk on commitments
by syndicating all or substantial portions of commitments to
other investors. In addition, commitments that are extended for
contingent acquisition financing are often short-term in nature,
as borrowers often replace them with other funding sources.
•
Warehouse financing. The firm provides financing for the
warehousing of financial assets to be securitized, primarily in
connection with CDOs and mortgage securitizations. These
financings are expected to be repaid from the proceeds of the
related securitizations for which the firm may or may not act as
underwriter. These arrangements are secured by the warehoused
assets, primarily consisting of mortgage-backed and other
asset-backed securities, residential and commercial mortgages
and corporate debt instruments.
Letters of Credit. The firm provides letters of credit
issued by various banks to counterparties in lieu of securities
or cash to satisfy various collateral and margin deposit
requirements. Letters of credit outstanding were
$6.40 billion and $9.23 billion as of August 2006 and
November 2005, respectively.
Merchant Banking Commitments. The firm acts as an
investor in merchant banking transactions, which includes making
long-term investments in equity and debt instruments in
privately negotiated transactions, corporate acquisitions and
real estate transactions. In connection with these activities,
the firm had commitments to invest up to $4.56 billion and
$3.54 billion in corporate and real estate investment funds
as of August 2006 and November 2005, respectively.
Construction-Related Commitments. As of August 2006 and
November 2005, the firm had construction-related commitments of
$1.62 billion and $579 million, respectively,
including commitments of $1.26 billion and
$481 million, respectively, related to the development of
wind energy projects. Construction-related commitments also
include outstanding commitments of $306 million and
$47 million as of August 2006 and November 2005,
respectively, related to the firm’s new world headquarters
in New York City, which is expected to cost between
$2.3 billion and $2.5 billion.
Underwriting Commitments. As of August 2006, the firm had
commitments to purchase $85 million of securities in
connection with its underwriting activities. As of November
2005, the firm had no such commitments.
Other. The firm had other purchase commitments of
$828 million and $644 million as of August 2006 and
November 2005, respectively.
Leases. The firm has contractual obligations under
long-term noncancelable lease agreements, principally for office
space, expiring on various dates through 2069. Certain agreements
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
are subject to periodic escalation provisions for increases in
real estate taxes and other charges. Future minimum rental
payments, net of minimum sublease rentals, are set forth below:
(in millions)
Minimum rental payments
Remainder of 2006
$
104
2007
575
2008
394
2009
373
2010
285
2011-thereafter
2,359
Total
$
4,090
Contingencies
The firm is involved in a number of judicial, regulatory and
arbitration proceedings concerning matters arising in connection
with the conduct of its businesses. Management believes, based
on currently available information, that the results of such
proceedings, in the aggregate, will not have a material adverse
effect on the firm’s financial condition, but may be
material to the firm’s operating results for any particular
period, depending, in part, upon the operating results for such
period. Given the inherent difficulty of predicting the outcome
of the firm’s litigation and regulatory matters,
particularly in cases or proceedings in which substantial or
indeterminate damages or fines are sought, the firm cannot
estimate losses or ranges of losses for cases or proceedings
where there is only a reasonable possibility that a loss may be
incurred.
The firm is contingently liable to provide guaranteed mortality
benefits in connection with its insurance business. The net
amount at risk, representing guaranteed mortality benefits in
force under annuity contracts in excess of contract holder
account balances, was $1.55 billion as of August 2006. The
average attained age of contract holders was 70 years as of
August 2006.
Guarantees
The firm enters into various derivative contracts that meet the
definition of a guarantee under FIN No. 45,
“Guarantor’s Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others.” Such derivative contracts include credit default
and total return swaps, written equity and commodity put
options, written currency contracts and interest rate caps,
floors and swaptions. FIN No. 45 does not require
disclosures about derivative contracts if such contracts may be
cash settled and the firm has no basis to conclude it is
probable that the counterparties held, at inception, the
underlying instruments related to the derivative contracts. The
firm has concluded that these conditions have been met for
certain large, internationally active commercial and investment
bank end users and certain other users. Accordingly, the firm
has not included such contracts in the tables 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 connection with the firm’s establishment of the Trust,
Group Inc. effectively provided for the full and unconditional
guarantee of the beneficial interests in the Trust held by third
parties. Timely payment by Group Inc. of interest on the junior
subordinated debentures and other amounts due and performance of
its other obligations under the transaction documents will be
sufficient to cover
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
payments due by the Trust on its beneficial interests. As a
result, management believes that it is unlikely the firm will
have to make payments related to the Trust other than those
required under the junior subordinated debentures and in
connection with certain expenses incurred by the Trust.
In the ordinary course of business, the firm provides other
financial guarantees of the obligations of third parties (e.g.,
letters of credit and other guarantees to enable clients to
complete transactions and merchant banking 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.
The following tables set forth certain information about the
firm’s derivative contracts that meet the definition of a
guarantee and certain other guarantees as of August 2006 and
November 2005:
As of August 2006
Maximum Payout/ Notional Amount by Period of Expiration (5)
Carrying
Remainder
2007-
2009-
2011-
Value
of 2006
2008
2010
Thereafter
Total
(in millions)
Derivatives (1)
(2)
$
1,100
$
218,807
$
438,715
$
329,366
$
606,804
$
1,593,692
Securities lending
indemnifications (3)
—
16,050
—
—
—
16,050
Guarantees of trust preferred
beneficial
interest (4)
—
—
349
349
6,850
7,548
Other financial guarantees
36
459
497
161
170
1,287
As of November 2005
Maximum Payout/ Notional Amount by Period of Expiration (5)
Carrying
2007-
2009-
2011-
Value
2006
2008
2010
Thereafter
Total
(in millions)
Derivatives
(1)
(2)
$
8,217
$
356,131
$
244,163
$
259,332
$
289,459
$
1,149,085
Securities lending indemnifications
(3)
—
16,324
—
—
—
16,324
Guarantees of trust preferred
beneficial interest
(4)
—
174
349
349
6,851
7,723
Other financial guarantees
4
516
144
230
177
1,067
(1)
The carrying value excludes the effect of a legal right of
setoff that may exist under an enforceable netting agreement.
(2)
The carrying value consists of $8.03 billion of assets and
$9.13 billion of liabilities as of August 2006 and
$1.91 billion of assets and $10.13 billion of
liabilities as of November 2005.
(3)
Collateral held by the lenders in connection with securities
lending indemnifications was $16.62 billion and
$16.89 billion as of August 2006 and November 2005,
respectively.
(4)
Includes the guarantee of all payments scheduled to be made over
the life of the Trust, which could be shortened in the event the
firm redeemed the junior subordinated debentures issued to fund
the Trust. See Note 5 for further information regarding the
Trust.
(5)
Such amounts do not represent the anticipated losses in
connection with these contracts.
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
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
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. 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 liabilities related to these
guarantees and indemnifications have been recognized in the
condensed consolidated statements of financial condition as of
August 2006 and November 2005.
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 liabilities related to
these arrangements have been recognized in the condensed
consolidated statements of financial condition as of August 2006
and November 2005.
Note 7.
Shareholders’ Equity
On September 11, 2006, the Board of Directors of Group Inc.
(the Board) declared a dividend of $0.35 per common share
with respect to the firm’s third quarter of fiscal 2006 to
be paid on November 20, 2006, to common shareholders of
record on October 23, 2006.
During the third quarter of fiscal 2006, the firm repurchased
3.8 million shares of its common stock at a total cost of
$573 million. In the first nine months of fiscal 2006, the
firm repurchased a total of 29.5 million shares of its
common stock at a total cost of $4.17 billion. The average
price paid per share for repurchased shares was $148.90 and
$141.40 for the three and nine months ended August 2006,
respectively. In addition, to satisfy minimum statutory employee
tax withholding requirements related to the delivery of shares
underlying restricted stock units, the firm cancelled
3.0 million restricted stock units with a total value of
$375 million during the first nine months of fiscal 2006.
On July 24, 2006, the firm issued an additional
20,000 shares of perpetual Floating Rate
Non-Cumulative
Preferred Stock, Series D.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
As of August 2006, the firm had 124,000 shares of perpetual
non-cumulative preferred stock outstanding in four series as set
forth in the following table:
Preferred Stock by Series
Shares
Shares
Earliest
Redemption Value
Series
Issued
Authorized
Dividend Rate
Redemption Date
(in millions)
A
30,000
50,000
3 month LIBOR + 0.75%,
with floor of 3.75% per annum
Each share of preferred stock 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 at
a redemption price equal to $25,000 plus declared and unpaid
dividends. 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. All preferred stock also has a
preference over the firm’s common stock upon liquidation.
On September 11, 2006, the Board declared a dividend per
preferred share of $395.85, $387.50, $395.85 and $390.74 for
Series A, Series B, Series C and Series D
preferred stock, respectively, to be paid on November 10,2006 to preferred shareholders of record on
October 26, 2006.
The following table sets forth the firm’s accumulated other
comprehensive income by type:
As of
August
November
2006
2005
(in millions)
Currency translation adjustment,
net of tax
$
14
$
(16
)
Minimum pension liability
adjustment, net of tax
(11
)
(11
)
Net gains/(losses) on cash flow
hedges, net of tax
(3
)
9
Net unrealized gains on
available-for-sale
securities, net of tax
13
(1)
18
Total accumulated other
comprehensive income, net of tax
$
13
$
—
(1)
Consists of net unrealized losses of $4 million on
available-for-sale securities held by the firm’s bank and
insurance subsidiaries and net unrealized gains of
$17 million on available-for-sale securities held by
investees accounted for under the equity method.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Note 9.
Goodwill and Identifiable Intangible Assets
Goodwill
The following table sets forth the carrying value of the
firm’s goodwill by operating segment, which is included in
“Other assets” in the condensed consolidated
statements of financial condition:
As of
August
November
2006
2005
(in millions)
Investment Banking
Financial Advisory
$
—
$
—
Underwriting
125
125
Trading and Principal Investments
FICC
155
91
Equities (1)
2,387
2,390
Principal Investments
22
1
Asset Management and Securities
Services
Asset
Management (2)
421
424
Securities Services
117
117
Total
$
3,227
$
3,148
(1)
Primarily related to SLK LLC (SLK).
(2)
Primarily related to The Ayco Company, L.P. (Ayco).
Primarily includes the firm’s clearance and execution and
NASDAQ customer lists related to SLK and financial counseling
customer lists related to Ayco.
(2)
Primarily relates to above-market power contracts of
consolidated power generation facilities related to Cogentrix
Energy, Inc. and National Energy & Gas Transmission,
Inc. (NEGT). Substantially all of these power contracts have
been pledged as collateral to counterparties in connection with
certain of the firm’s secured short-term and
long-term borrowings.
The weighted average remaining life of these power contracts is
approximately 11 years.
(3)
Consists of VOBA and DAC. VOBA represents the present value of
estimated future gross profits of the variable annuity and
variable life insurance business acquired in fiscal 2006. DAC
represents commissions paid by the firm in connection with
providing reinsurance. VOBA and DAC are amortized over the
estimated life of the underlying contracts based on estimated
gross profits, and amortization is adjusted based on actual
experience. The weighted average remaining amortization period
for VOBA and DAC is six years as of the end of the third quarter.
(4)
Primarily includes technology-related and other assets related
to SLK.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Substantially all of the firm’s identifiable intangible
assets are considered to have finite lives and are amortized
over their estimated useful lives. The weighted average
remaining life of the firm’s identifiable intangibles is
approximately 12 years.
Amortization expense associated with identifiable intangible
assets was $69 million and $34 million for the three
months ended August 2006 and August 2005, respectively, and
$182 million and $127 million for the nine months
ended August 2006 and August 2005, respectively, including
amortization associated with the firm’s consolidated power
generation facilities reported within “Cost of power
generation” in the condensed consolidated statements of
earnings.
The estimated future amortization for existing identifiable
intangible assets through 2011 is set forth below:
(in millions)
Remainder of 2006
$
67
2007
234
2008
212
2009
200
2010
192
2011
184
Note 10.
Other Assets and Other Liabilities
Other Assets
Other assets are generally less liquid, nonfinancial assets. The
following table sets forth the firm’s other assets by type:
As of
August
November
2006
2005
(in millions)
Goodwill and identifiable
intangible
assets (1)
$
5,821
$
5,203
Property, leasehold improvements
and
equipment (2)
6,916
5,097
Equity-method investments and joint
ventures
2,633
2,965
Income tax-related assets
1,811
1,304
Miscellaneous receivables and other
3,122
2,743
Total
$
20,303
$
17,312
(1)
See Note 9 for further information regarding the
firm’s goodwill and identifiable intangible assets.
(2)
Net of accumulated depreciation and amortization of
$5.04 billion and $4.62 billion for August 2006 and
November 2005, respectively.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Other Liabilities
Other liabilities and accrued expenses primarily includes
insurance-related liabilities, compensation and benefits,
minority interest in consolidated entities, litigation
liabilities, tax-related payables, deferred revenue and other
payables. The following table sets forth the firm’s other
liabilities and accrued expenses by type:
As of
August
November
2006
2005
(in millions)
Insurance-related
liabilities (1)
$
11,398
$
—
Compensation and benefits
10,401
6,598
Minority interest
4,321
3,164
Income tax-related liabilities
1,339
868
Accrued expenses and other payables
3,812
3,200
Total
$
31,271
$
13,830
(1)
Insurance-related liabilities are set forth in the table below:
Reserves for guaranteed minimum
death and income benefits
274
—
Total insurance-related liabilities
$
11,398
$
—
Separate account liabilities are offset by separate account
assets, representing segregated contract holder funds under
variable annuity and variable life insurance contracts. Separate
account assets are included in “Cash and securities
segregated for regulatory and other purposes” in the
condensed consolidated statements of financial condition.
Liabilities for future benefits and unpaid claims include
liabilities arising from reinsurance provided by the firm to
other insurers. The firm has a receivable for $1.36 billion
related to such reinsurance contracts, which is reported in
“Receivables from customers and counterparties” in the
condensed consolidated statements of financial condition. In
addition, the firm has ceded risks to reinsurers related to
certain of its liabilities for future benefits and unpaid claims
and has a receivable of $799 million related to such
reinsurance contracts, which is reported in “Receivables
from customers and counterparties” in the condensed
consolidated statements of financial condition. Contracts to
cede risks to reinsurers do not relieve the firm from its
obligations to contract holders.
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 computed in accordance with AICPA Statement of
Position 03-1, “Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts
and for Separate Accounts,” and are based on total payments
expected to be made less total fees expected to be assessed over
the life of the contract.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Note 11.
Employee Benefit Plans
The firm sponsors various pension plans and certain other
postretirement benefit plans, primarily healthcare and life
insurance. The firm also provides certain benefits to former or
inactive employees prior to retirement.
Defined Benefit Pension Plans and Postretirement
Plans
The firm maintains a defined benefit pension plan for
substantially all U.S. employees hired prior to
November 1, 2003. As of November 2004, this plan has been
closed to new participants and no further benefits will be
accrued to existing participants. Employees of certain
subsidiaries participate in various defined benefit pension
plans. These plans generally provide benefits based on years of
credited service and a percentage of the employee’s
eligible compensation. In addition, the firm has unfunded
postretirement benefit plans that provide medical and life
insurance for eligible retirees and their dependents covered
under the U.S. benefits program.
The components of pension expense/(income) and postretirement
expense are set forth below:
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
U.S. pension
Service cost
$
—
$
—
$
—
$
—
Interest cost
5
5
15
15
Expected return on plan assets
(7
)
(7
)
(20
)
(20
)
Net amortization
2
1
5
4
Total
$
—
$
(1
)
$
—
$
(1
)
Non-U.S. pension
Service cost
$
14
$
11
$
42
$
34
Interest cost
6
5
18
15
Expected return on plan assets
(7
)
(5
)
(21
)
(17
)
Net amortization
3
3
8
9
Other (1)
—
—
—
(17
)
Total
$
16
$
14
$
47
$
24
Postretirement
Service cost
$
4
$
3
$
12
$
10
Interest cost
4
3
13
9
Net amortization
5
1
15
3
Total
$
13
$
7
$
40
$
22
(1)
Represents a benefit as a result of the termination of a
Japanese pension plan.
The firm expects to contribute a minimum of $23 million to
its pension plans and $9 million to its postretirement
plans in fiscal 2006.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Note 12.
Employee Incentive Plans
Stock Incentive Plan
The firm sponsors a stock incentive plan, The Goldman Sachs
Amended and Restated Stock Incentive Plan (the Amended SIP),
which provides for grants of incentive stock options,
nonqualified stock options, stock appreciation rights, dividend
equivalent rights, restricted stock, restricted stock units and
other share-based awards. In the second quarter of fiscal 2003,
the Amended SIP was approved by the firm’s shareholders,
effective for grants after April 1, 2003, and no further
awards were or will be made under the original plan after that
date, although awards granted under the original plan prior to
that date remain outstanding.
The total number of shares of common stock that may be issued
under the Amended SIP through fiscal 2008 may not exceed
250 million shares and, in each fiscal year thereafter, may
not exceed 5% of the issued and outstanding shares of common
stock, determined as of the last day of the immediately
preceding fiscal year, increased by the number of shares
available for awards in previous fiscal years but not covered by
awards granted in such years. As of August 2006 and November
2005, 196.3 million and 196.6 million shares,
respectively, were available for grant under the Amended SIP.
Restricted Stock Units
The firm issued restricted stock units to employees under the
Amended SIP, primarily in connection with year-end compensation
and acquisitions. Of the total restricted stock units
outstanding as of August 2006 and November 2005,
(i) 28.3 million units and 30.1 million units,
respectively, required future service as a condition to the
delivery of the underlying shares of common stock and
(ii) 18.9 million units and 25.0 million units,
respectively, did not require future service. In all cases,
delivery of the underlying shares of common stock is conditioned
on the grantees satisfying certain other requirements outlined
in the award agreements. When delivering the underlying shares
to employees, the firm generally issues new shares of common
stock, as opposed to reissuing treasury shares.
The activity related to these restricted stock units is set
forth below:
Weighted Average
Grant-Date Fair Value
Restricted Stock
of Restricted Stock
Units Outstanding
Units Outstanding
Future
No Future
Future
No Future
Service
Service
Service
Service
Required
Required
Required
Required
Outstanding, November
2005 (1)
30,117,820
24,993,866
$
112.01
$
107.18
Granted (2) (3)
1,015,239
145,270
143.64
138.09
Forfeited
(649,649
)
(209,085
)
110.83
100.08
Delivered
—
(8,229,059
)
—
91.72
Vested (3)
(2,210,062
)
2,210,062
106.67
106.67
Outstanding, August 2006
28,273,348
18,911,054
$
113.59
$
114.16
(1)
Includes restricted stock units granted to employees during the
nine-month period ended August 2006 as part of compensation for
fiscal 2005.
(2)
The weighted average grant-date fair value of restricted stock
units granted during the nine-month period ended August 2006 was
$142.95 per unit, compared with $108.89 per unit for
the same prior year period.
(3)
The aggregate fair value of awards vested during the nine-month
period ended August 2006 was $333 million.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Stock Options
As of November 2004, all stock options granted to employees in
May 1999 in connection with the firm’s initial public
offering became fully vested and exercisable. Stock options
granted to employees subsequent to the firm’s initial
public offering generally vest as outlined in the applicable
stock option agreement and first become exercisable on the third
anniversary of the grant date.
Year-end stock options
for 2005 become exercisable in January 2009 and expire on
November 27, 2015. Shares received on exercise prior
to January 2010 will not be transferable until January
2010. All employee stock option agreements provide that vesting
is accelerated in certain circumstances, such as upon
retirement, death and extended absence. In general, all stock
options expire on the tenth anniversary of the grant date,
although they may be subject to earlier termination or
cancellation in certain circumstances in accordance with the
terms of the Amended SIP and the applicable stock option
agreement. The dilutive effect of the firm’s outstanding
stock options is included in “Average common shares
outstanding — Diluted” on the condensed
consolidated statements of earnings.
The activity related to these stock options is set forth below:
Weighted
Weighted
Aggregate
Average
Options
Average
Intrinsic Value
Remaining Life
Outstanding
Exercise Price
(in millions)
(in years)
Outstanding, November
2005 (1)
64,237,687
$
83.24
Granted
—
—
Exercised
(16,753,885
)
77.67
Forfeited
(203,751
)
98.57
Outstanding, August 2006
47,280,051
$
85.15
$
3,069
5.2
Exercisable, August 2006
43,329,313
81.59
2,967
4.9
(1)
Includes stock options granted to employees in the nine months
ended August 2006 as part of compensation for fiscal 2005.
The total intrinsic value of options exercised during the nine
months ended August 2006 and August 2005 was $1.09 billion
and $566 million, respectively.
The following table sets forth share-based compensation and the
related tax benefit:
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
Share-based compensation
$
239
$
223
$
851
$
643
Cash settled share-based
compensation
110
—
127
—
Total share-based compensation
349
223
978
643
Excess tax benefit related to
options exercised
50
41
387
201
Excess tax benefit related to
share-based
compensation (1)
$
60
$
40
$
495
$
205
(1)
Represents the tax benefit, recognized in additional paid-in
capital, on stock options exercised and the delivery of shares
underlying vested restricted stock units.
As of August 2006, there was $1.61 billion of total
unrecognized compensation cost related to nonvested share-based
compensation arrangements. This cost is expected to be
recognized over a weighted average period of 1.95 years.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
The firm’s stock repurchase program is intended to maintain
its total shareholders’ equity at appropriate levels and to
substantially offset increases in share count over time
resulting from employee share-based compensation. The repurchase
program has been effected primarily through regular open-market
purchases and is influenced by, among other factors, the level
of the firm’s common shareholders’ equity, its overall
capital position, share-based awards and exercises of employee
stock options, the prevailing market price of its common stock
and general market conditions.
Note 13.
Affiliated Funds
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,
incentive fees or overrides from these funds. These fees
amounted to $2.56 billion and $1.62 billion for the
nine months ended August 2006 and August 2005,
respectively. As of August 2006 and November 2005, the
fees receivable from these funds were $383 million and
$388 million, respectively. Additionally, the firm may
invest alongside the third-party investors in certain funds. The
aggregate carrying value of the firm’s interests in these
funds was $3.48 billion and $2.17 billion as of
August 2006 and November 2005, respectively. In the
ordinary course of business, the firm may also engage in other
activities with these funds, including, among others, securities
lending, trade execution, trading and custody. See Note 6
for the firm’s commitments related to these funds.
Note 14.
Regulation
The firm is regulated by the U.S. Securities and Exchange
Commission (SEC) as a Consolidated Supervised Entity (CSE).
As such, it is subject to group-wide supervision and examination
by the SEC and to minimum capital requirements on a consolidated
basis. As of August 2006 and November 2005, the firm
was in compliance with the CSE capital requirements.
The firm’s principal U.S. regulated subsidiaries
include Goldman, Sachs & Co. (GS&Co.) and Goldman
Sachs Execution & Clearing, L.P. (GSEC). GS&Co. and
GSEC are registered
U.S. broker-dealers
and futures commission merchants subject to
Rule 15c3-1 of the
SEC and Rule 1.17 of the Commodity Futures Trading
Commission, which specify uniform minimum net capital
requirements, as defined, for their registrants. 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
August 2006 and November 2005, GS&Co. and GSEC had net
capital in excess of their minimum capital requirements. 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
August 2006 and November 2005, GS&Co. had tentative net
capital and net capital in excess of both the minimum and the
notification requirements.
Goldman Sachs Bank USA (GS Bank), a wholly owned industrial loan
corporation, is regulated by the Federal Deposit Insurance
Corporation and the State of Utah Department of Financial
Institutions and is subject to minimum capital requirements. As
of August 2006, GS Bank was in compliance with all federal and
state regulatory capital requirements. GS Bank had approximately
$8 billion of interest-bearing deposits as of August 2006,
which are included in “Payables to customers and
counterparties” in the condensed consolidated statements of
financial condition.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
The firm’s principal
non-U.S. regulated
subsidiaries include Goldman Sachs International (GSI) and
Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, a regulated U.K.
broker-dealer, is subject to the capital requirements of the
U.K.’s Financial Services Authority. GSJCL, a Japanese
regulated broker-dealer, is subject to the capital requirements
of Japan’s Financial Services Agency. Prior to
October 1, 2006, Goldman Sachs (Japan) Ltd. (GSJL) was the
primary regulated subsidiary based in Japan. As of August 2006
and November 2005, GSI, GSJCL and GSJL 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 August 2006 and November 2005, these subsidiaries
were in compliance with their local capital adequacy
requirements.
Note 15.
Business Segments
In reporting to management, the firm’s operating results
are categorized into the following three segments: Investment
Banking, Trading and Principal Investments, and Asset Management
and Securities Services.
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 expenses within the
firm’s segments reflect, among other factors, the overall
performance of the firm as well as the performance of individual
business units. 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
timing and magnitude of changes in the firm’s bonus
accruals can have a significant effect on segment results in a
given period.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(UNAUDITED)
Segment Operating Results
Management believes that the following information provides a
reasonable representation of each segment’s contribution to
consolidated pre-tax earnings and total assets:
As of or for the
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
Investment
Net revenues
$
1,288
$
1,015
$
4,285
$
2,723
Banking
Operating expenses
940
887
3,223
2,392
Pre-tax earnings
$
348
$
128
$
1,062
$
331
Segment assets
$
3,060
$
3,048
$
3,060
$
3,048
Trading and Principal
Net revenues
$
4,720
$
5,062
$
18,565
$
12,258
Investments
Operating expenses
3,199
3,231
11,900
8,025
Pre-tax earnings
$
1,521
$
1,831
$
6,665
$
4,233
Segment assets
$
547,662
$
482,905
$
547,662
$
482,905
Asset Management and
Net revenues
$
1,455
$
1,208
$
5,045
$
3,515
Securities Services
Operating expenses
970
754
3,157
2,254
Pre-tax earnings
$
485
$
454
$
1,888
$
1,261
Segment assets
$
247,587
$
183,565
$
247,587
$
183,565
Total
Net revenues
(1)
$
7,463
$
7,285
$
27,895
$
18,496
Operating expenses
(2)
5,101
4,880
18,320
12,702
Pre-tax earnings
(3)
$
2,362
$
2,405
$
9,575
$
5,794
Total assets
$
798,309
$
669,518
$
798,309
$
669,518
(1)
Net revenues include net interest and cost of power generation
as set forth in the table below:
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
Investment Banking
$
3
$
17
$
9
$
56
Trading and Principal Investments
352
220
589
713
Asset Management and Securities
Services
480
436
1,500
1,245
Total net interest and cost of
power generation
$
835
$
673
$
2,098
$
2,014
(2)
Includes net provisions for a number of litigation and
regulatory proceedings of $(8) million and $8 million
for the three months ended August 2006 and August 2005,
respectively, and $40 million and $31 million for the
nine months ended August 2006 and August 2005, respectively,
that have not been allocated to the firm’s segments.
(3)
Pre-tax earnings include total depreciation and amortization as
set forth in the table below:
Report of Independent Registered Public Accounting Firm
To the Directors and Shareholders of
The Goldman Sachs Group, Inc.:
We have reviewed the accompanying condensed consolidated
statement of financial condition of The Goldman Sachs Group,
Inc. and its subsidiaries (the Company) as of August 25,2006, the related condensed consolidated statements of earnings
for the three and nine months ended August 25, 2006 and
August 26, 2005, the condensed consolidated statement of
changes in shareholders’ equity for the nine months ended
August 25, 2006, the condensed consolidated statements of
cash flows for the nine months ended August 25, 2006 and
August 26, 2005, and the condensed consolidated statements
of comprehensive income for the three and nine months ended
August 25, 2006 and August 26, 2005. 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 have previously audited, in accordance with the standards of
the Public Company Accounting Oversight Board (United States),
the consolidated statement of financial condition
as of November 25, 2005 and the related
consolidated statements of earnings, changes in
shareholders’ equity, cash flows and comprehensive income
for the year then ended, management’s assessment of the
effectiveness of the Company’s internal control over
financial reporting as of November 25, 2005 and the
effectiveness of the Company’s internal control over
financial reporting as of November 25, 2005; and in
our report dated February 3, 2006, we expressed unqualified
opinions thereon. The consolidated financial statements and
management’s assessment of the effectiveness of internal
control over financial reporting referred to above are not
presented herein. In our opinion, the information set forth in
the accompanying condensed consolidated statement of financial
condition as of November 25, 2005, and the condensed
consolidated statement of changes in shareholders’ equity
for the year ended November 25, 2005, is fairly stated in
all material respects in relation to the consolidated financial
statements from which it has been derived.
Goldman Sachs is a leading global investment banking, securities
and investment management firm that provides a wide range of
services worldwide to a substantial and diversified client base
that includes corporations, financial institutions, governments
and high-net-worth individuals.
Our activities are divided into three segments:
•
Investment Banking. We provide a broad range of
investment banking services to a diverse group of corporations,
financial institutions, governments and individuals.
•
Trading and Principal Investments. We facilitate client
transactions with a diverse group of corporations, financial
institutions, governments and individuals and take proprietary
positions through market making in, trading of and investing in
fixed income and equity products, currencies, commodities and
derivatives on such products. In addition, we engage in
specialist and market-making activities on equities and options
exchanges and we clear client transactions on major stock,
options and futures exchanges worldwide. In connection with our
merchant banking and other investing activities, we make
principal investments directly and through funds that we raise
and manage.
•
Asset Management and Securities Services. We provide
investment advisory and financial planning services and offer
investment products across all major asset classes to a diverse
group of institutions and individuals worldwide, and provide
prime brokerage services, financing services and securities
lending services to mutual funds, pension funds, hedge funds,
foundations and high-net-worth individuals worldwide.
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
fiscal year ended November 25, 2005. References herein to
the Annual Report on
Form 10-K are to
our Annual Report on
Form 10-K for the
fiscal year ended November 25, 2005.
Unless specifically stated otherwise, all references to August
2006 and August 2005 refer to our fiscal periods ended, or the
dates, as the context requires, August 25, 2006 and
August 26, 2005, respectively. All references to November
2005, unless specifically stated otherwise, refer to our fiscal
year ended, or the date, as the context requires,
November 25, 2005. All references to 2006, unless
specifically stated otherwise, refer to our fiscal year ending,
or the date, as the context requires, November 24, 2006.
When we use the terms “Goldman Sachs,”“we,”“us” and “our,” we mean The Goldman Sachs
Group, Inc. (Group Inc.), a Delaware corporation, and its
consolidated subsidiaries.
Our diluted earnings per common share were $3.26, annualized
return on average tangible common shareholders’ equity
(1) was
24.9% and annualized return on average common shareholders’
equity was 20.9% for the third quarter of 2006. Excluding
incremental non-cash expenses of $133 million related to
the accounting for certain share-based awards under
SFAS No. 123-R
(2),
diluted earnings per common share were $3.45
(2),
annualized return on average tangible common shareholders’
equity
(1) was
26.5%
(2) and
annualized return on average common shareholders’ equity
was 22.2%
(2) for
the third quarter of 2006. Diluted earnings per common share for
the third quarter of 2005 were $3.25.
Our third quarter results reflected solid performances in each
of our three segments. Net revenues in Investment Banking
increased compared with the third quarter of 2005, reflecting
significantly higher net revenues in Underwriting, as both debt
and equity underwriting results improved, as well as higher net
revenues in Financial Advisory, reflecting increased client
activity. Our investment banking backlog was essentially
unchanged during the
quarter (3).
Strong net revenue growth in our Asset Management and Securities
Services businesses primarily reflected significantly higher
management and other fees as well as continued strength in our
prime brokerage business. Assets under management increased
significantly from a year ago, including net asset inflows of
$30 billion during the quarter. Net revenues in Trading and
Principal Investments were lower than a particularly strong
third quarter of 2005. Net revenues in Principal Investments
decreased reflecting a smaller gain related to our investment in
the convertible preferred stock of Sumitomo Mitsui Financial
Group, Inc. (SMFG) as well as lower net revenues from our
other principal investments. In addition, net revenues in
Equities were lower than the same prior year period, while net
revenues in Fixed Income, Currency and Commodities
(FICC) were higher than a strong third quarter of 2005.
During the quarter, Equities operated in a less favorable
environment as equity prices lacked direction and
customer-driven activity declined from the first half of the
year. In addition, although FICC performed well, the business
operated in a less favorable environment, as customer-driven
activity declined from the first half of the year and volatility
levels were generally low.
Our diluted earnings per common share were $13.12 for the nine
months ended August 2006 compared with $7.89 for the same period
last year. Annualized return on average tangible common
shareholders’ equity
(1) was
35.6% and annualized return on average common shareholders’
equity was 29.6%. Excluding incremental non-cash expenses of
$508 million related to the accounting for certain
share-based awards under SFAS No. 123-R
(2),
diluted earnings per common share were $13.83
(2),
annualized return on average tangible common shareholders’
equity
(1) was
37.6% (2) and
annualized return on average common shareholders’ equity
was 31.4%
(2) for
the nine months ended August 2006. Our results for the first
nine months of 2006 reflected strong net revenue growth in each
of our three segments as compared with the same period last year.
During the first nine months of 2006, each of our segments
achieved record results reflecting generally favorable market
conditions and strong customer activity. Trading and Principal
Investments results reflected significantly higher net revenues
in FICC and Equities and a strong performance in Principal
Investments. Net revenues in FICC reflected particularly strong
results across all major businesses, and net revenues in
Equities reflected significant growth in our customer franchise
business, while results in principal strategies, although
strong, were lower than the same prior year period. In our
trading businesses, we saw generally favorable trading and
investing opportunities for our clients and ourselves, and
consequently increased our market risk in the first half of the
year. However, as the environment became more challenging during
the third quarter of 2006, our market risk declined, reflecting
fewer opportunities in the markets. In Investment Banking, net
revenues reflected strong growth in Underwriting and Financial
Advisory as industry-wide volumes across equity underwriting and
mergers and acquisitions were significantly ahead of the same
prior year period and debt underwriting volumes remained at high
levels. In Asset Management and Securities
Services, revenue growth was driven by record assets under
management and significantly higher incentive fees, as well as
significantly higher global customer balances in Securities
Services.
We continued to focus on managing our capital base, with the
goal of optimizing our returns while, at the same time, growing
our businesses. During the third quarter of 2006, we repurchased
3.8 million shares of our common stock at a total cost of
$573 million. In the first nine months of 2006, we
repurchased 29.5 million shares of our common stock at a
total cost of $4.17 billion. On September 11, 2006,
the Board of Directors of Goldman Sachs authorized the
repurchase of an additional 60.0 million shares of common
stock pursuant to the existing repurchase program. With respect
to the regulatory environment, financial services firms
continued to be under intense scrutiny, with the volume and
amount of claims against financial institutions and other
related costs remaining significant. Given the range of
litigation and investigations presently under way, our
litigation expenses can be expected to remain high.
Though our operating results were very strong in the first nine
months of 2006, 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
and economic conditions generally. For a further discussion of
the factors that may affect our future operating results, see
“Risk Factors” in Part I, Item 1A of our
Annual Report on
Form 10-K.
(1)
Annualized return on average tangible common shareholders’
equity is computed by dividing annualized net earnings
applicable to common shareholders by average monthly tangible
common shareholders’ equity. See “— Results
of Operations — Financial Overview” below for
further information regarding our calculation of annualized
return on average tangible common shareholders’ equity.
(2)
Statement of Financial Accounting Standards
(SFAS) No. 123-R,
“Share-Based Payment,” focuses primarily on accounting
for transactions in which an entity obtains employee services in
exchange for share-based payments. In the first quarter of 2006,
we adopted
SFAS No. 123-R,
which requires that share-based awards granted to
retirement-eligible employees, including those subject to
non-compete agreements, be expensed in the year of grant. In
addition to expensing current year awards, prior year awards
must continue to be amortized over the relevant service period.
Therefore, our compensation and benefits expenses in fiscal 2006
(and, to a lesser extent, in fiscal 2007 and fiscal 2008) will
include both amortization of prior year awards and new awards
granted to retirement-eligible employees for services rendered
in fiscal 2006. We believe that presenting our results excluding
the impact of the continued amortization of prior year
share-based awards granted to retirement-eligible employees
increases the comparability of
period-to-period
operating results and allows for a more meaningful
representation of the relationship of current period
compensation to net revenues.
The following tables set forth a
reconciliation of diluted earnings per common share, common
shareholders’ equity and net earnings applicable to common
shareholders as reported, to these items excluding the impact of
the continued amortization of prior year share-based awards
granted to retirement-eligible employees:
Three Months
Nine Months
Ended
Ended
August 2006
August 2006
Diluted earnings per common share
$
3.26
$
13.12
Impact of the continued
amortization of prior year share-based awards,
net of tax
0.19
0.71
Diluted earnings per common share,
excluding the impact of the continued amortization of prior year
share-based awards
Impact of the continued
amortization of prior year share-based awards, net of tax
(147
)
(98
)
Common shareholders’ equity,
excluding the impact of the continued amortization of prior year
share-based awards
29,621
28,210
Goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets (see footnote 1 above)
(4,745
)
(4,709
)
Tangible common shareholders’
equity (see footnote 1 above), excluding the impact of the
continued amortization of prior year share-based awards
$
24,876
$
23,501
Three Months
Nine Months
Ended
Ended
August 2006
August 2006
(in millions)
Net earnings applicable to common
shareholders
$
1,555
$
6,294
Impact of the continued
amortization of prior year share-based awards, net of tax
90
340
Net earnings applicable to common
shareholders, excluding the impact of the continued amortization
of prior year share-based awards
$
1,645
$
6,634
(3)
Our investment banking 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.
Global economic conditions remained generally favorable during
our third quarter of fiscal 2006, although economic growth in
the U.S. and, to a lesser extent, in Europe, slowed from the
first half of the year. Business and consumer confidence
remained generally high across the major economies, although
consumer confidence appeared to decline toward the end of our
third fiscal quarter, particularly in the U.S. Concerns
over inflationary pressures in the U.S. early in the fiscal
quarter subsided toward the end of the quarter. In the equity
markets, global equity prices lacked direction and generally
ended only slightly above or below levels at the beginning of
our fiscal quarter. In the fixed income markets, yield curves in
both the U.S. and Europe flattened and corporate credit spreads
remained narrow. Investment banking activity levels decreased
during the fiscal quarter, as evidenced by lower industry-wide
announced and completed mergers and acquisitions and equity
underwritings.
In the U.S., economic growth continued to slow from stronger
levels seen in the beginning of the fiscal year, as consumer
spending continued to decline, reflecting the effects of higher
interest rates, high energy prices and the decline in the
housing market. Unemployment remained at low levels, although it
increased slightly during the fiscal quarter. While concerns
over inflationary pressures near the end of our second fiscal
quarter continued into June, growth in measures of core
inflation subsided in July and August. The U.S. Federal
Reserve raised its federal funds target rate by 25 basis
points to 5.25% in June, its
17th consecutive
increase, but held the target rate steady during its August
meeting. Long-term bond yields fell, with the
10-year
U.S. Treasury note yield ending the quarter down
27 basis points at 4.78%. In the equity markets, the
S&P 500 Index and the Dow Jones Industrial Average ended the
quarter essentially unchanged, while the NASDAQ Composite Index
fell by 3%.
In Europe, economic growth moderated slightly during our third
fiscal quarter, but remained solid, with increasing industrial
and construction activity, particularly in Germany. The modest
decrease in economic growth was evident in surveys of business
activity, which declined slightly during the quarter, but
remained at high levels. In addition, consumer confidence
remained at high levels, as private consumption and employment
both increased during the quarter. The European Central Bank
increased its main refinancing operations rate by 50 basis
points during the fiscal quarter to 3.0%, its highest level in
nearly five years. In the U.K., although financial conditions
became less accommodative, the economy showed continued modest
growth. The Bank of England raised its official bank rate by
25 basis points to 4.75%, its first change since August
2005. European equity markets ended the quarter modestly higher,
while long-term yields remained essentially unchanged.
In Japan, real gross domestic product growth softened during our
third fiscal quarter, reflecting a slowdown in domestic demand,
although growth in exports remained solid. Unemployment levels
remained low and wages increased moderately. During the quarter,
the Bank of Japan ended its five year zero interest rate policy
and set the target overnight call rate at 0.25%. Despite a sharp
decline early in the fiscal quarter, the Nikkei 225 Index ended
the fiscal quarter essentially unchanged. In China, economic
growth remained solid, driven by strength in both exports and
domestic demand. The People’s Bank of China increased the
one-year benchmark lending rate by 27 basis points to
6.12%. Elsewhere in Asia, growth in exports and domestic demand
softened, but remained steady. Equity markets ended our fiscal
quarter higher in Hong Kong, essentially unchanged in South
Korea and China, and lower in Taiwan.
The use of fair value to measure our financial instruments, with
related unrealized gains or losses generally recognized
immediately in our results of operations, is fundamental to our
financial statements and is our most critical accounting policy.
The fair value of a financial instrument is the amount at which
the instrument could be exchanged in a current transaction
between willing parties, other than in a forced or liquidation
sale.
In determining fair value, we separate our financial instruments
into three categories — cash (i.e., nonderivative)
trading instruments, derivative contracts and principal
investments, as set forth in the following table:
Includes securities held by our bank and insurance subsidiaries
which are accounted for as “available-for-sale”
(AFS) under SFAS No. 115, “Accounting for
Certain Investments in Debt and Equity Securities.” The
following table sets forth the types of AFS securities and their
maturity profile:
Under
Over
One Year
1-5 Years
6-10 Years
10 Years
Total
(in millions)
Mortgage-backed and other federal
agency securities
$
826
$
794
$
146
$
7
$
1,773
Investment-grade corporate bonds
50
564
66
52
732
Collateralized debt obligations
7
645
20
—
672
Other investment-grade debt
securities
42
8
58
111
219
Total
$
925
$
2,011
$
290
$
170
$
3,396
(2)
Excludes assets for which Goldman Sachs is not at risk (e.g.,
assets related to consolidated merchant banking funds) of
$3.64 billion and $1.93 billion as of August 2006 and
November 2005, respectively.
(3)
Represents an economic hedge on the unrestricted shares of
common stock underlying our investment in the convertible
preferred stock of SMFG. For a further discussion of our
investment in SMFG, see “— Principal
Investments” below.
Cash Trading Instruments. The following table sets forth
the valuation of our cash trading instruments by level of price
transparency:
Cash Trading Instruments by Price Transparency
(in millions)
As of August 2006
As of November 2005
Financial
Financial
Financial
Instruments Sold,
Financial
Instruments Sold,
Instruments
But Not Yet
Instruments
But Not Yet
Owned, At
Purchased, At
Owned, At
Purchased, At
Fair Value
Fair Value
Fair Value
Fair Value
Quoted prices or alternative
pricing sources with reasonable price transparency
$
219,785
$
96,176
$
198,233
$
89,565
Little or no price transparency
14,200
115
11,809
170
Total
$
233,985
$
96,291
$
210,042
$
89,735
Fair values of our cash trading instruments are generally
obtained from quoted market prices in active markets, broker or
dealer price quotations, or alternative pricing sources with
reasonable levels of price transparency. The types of
instruments valued in this manner include U.S. government
and agency securities, other sovereign government obligations,
liquid mortgage products, investment-grade and high-yield
corporate bonds, listed equities, money market securities,
state, municipal and provincial obligations, and physical
commodities.
Certain cash trading instruments trade infrequently and have
little or no price transparency. Such instruments may include
certain corporate bank loans, mortgage whole loans and
distressed debt. We value these instruments initially at cost
and generally do not adjust valuations unless there is
substantive evidence supporting a change in the value of the
underlying instrument or valuation assumptions (such as similar
market transactions, changes in financial ratios or changes in
the credit ratings of the underlying companies). Where there is
evidence supporting a change in the value, we use valuation
methodologies such as the present value of known or estimated
cash flows.
Cash trading instruments we own (long positions) are marked to
bid prices, and instruments we have sold but not yet purchased
(short positions) are marked to offer prices. If liquidating a
position is expected to affect its prevailing market price, our
valuation is adjusted generally based on market evidence or
predetermined policies. In certain circumstances, such as for
highly illiquid positions, management’s estimates are used
to determine this adjustment.
Derivative Contracts. Derivative contracts consist of
exchange-traded and
over-the-counter
(OTC) derivatives. The following table sets forth the fair
value of our exchange-traded and OTC derivative assets and
liabilities:
Derivative Assets and Liabilities
(in millions)
As of August 2006
As of November 2005
Assets
Liabilities
Assets
Liabilities
Exchange-traded derivatives
$
11,735
$
10,681
$
10,869
$
9,083
OTC derivatives
48,446
46,515
47,663
48,746
Total
$
60,181
(1)
$
57,196
(2)
$
58,532
(1)
$
57,829
(2)
(1)
Net of cash received pursuant to credit support agreements of
$22.24 billion and $22.61 billion as of August 2006
and November 2005, respectively.
(2)
Net of cash paid pursuant to credit support agreements of
$17.27 billion and $16.10 billion as of August 2006
and November 2005, respectively.
Fair values of our exchange-traded derivatives are generally
determined from quoted market prices. OTC derivatives are valued
using valuation models. We use a variety of valuation models
including the present value of known or estimated cash flows and
option-pricing models. The valuation models that we use to
derive the fair values of our OTC derivatives require inputs
including contractual terms, market prices, yield curves, credit
curves, measures of volatility, prepayment rates and
correlations of such inputs. The selection of a model to value
an OTC derivative depends upon the contractual terms of, and
specific risks inherent in, the instrument as well as the
availability of pricing information in the market. We generally
use similar models to value similar instruments. Where possible,
we verify the values produced by our pricing models to market
transactions. For OTC derivatives that trade in liquid markets,
such as generic forwards, swaps and options, model selection
does not involve significant judgment because market prices are
readily available. For OTC derivatives that trade in less liquid
markets, model selection requires more judgment because such
instruments tend to be more complex and pricing information is
less available in these markets. Price transparency is
inherently more limited for more complex structures because they
often combine one or more product types, requiring additional
inputs such as correlations and volatilities. As markets
continue to develop and more pricing information becomes
available, we continue to review and refine the models that we
use.
At the inception of an OTC derivative contract (day one), we
value the contract at the model value if we can verify all of
the significant model inputs to observable market data and
verify the model to market transactions. When appropriate,
valuations are adjusted to reflect various factors such as
liquidity, bid/offer spreads and credit considerations. These
adjustments are generally based on market evidence or
predetermined policies. In certain circumstances, such as for
highly illiquid positions, management’s estimates are used
to determine these adjustments.
Where we cannot verify all of the significant model inputs to
observable market data and verify the model to market
transactions, we value the contract at the transaction price at
inception and, consequently, record no day one gain or loss in
accordance with Emerging Issues Task Force (EITF) Issue
No. 02-3, “Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts
Involved in Energy Trading and Risk Management Activities.”
Following day one, we adjust the inputs to our valuation models
only to the extent that changes in these inputs can be verified
by similar market transactions, third-party pricing services
and/or broker quotes, or can be derived from other substantive
evidence such as empirical market data. In circumstances where
we cannot verify the model to market transactions, it is
possible that a different valuation model
could produce a materially different estimate of fair value. See
“— Recent Accounting Developments” below for
a discussion of the impact of SFAS No. 157 on EITF
Issue No. 02-3.
The following tables set forth the fair values of our OTC
derivative assets and liabilities by product and by remaining
contractual maturity:
We enter into certain OTC option transactions that provide us or
our counterparties with the right to extend the maturity of the
underlying contract. The fair value of these option contracts is
not material to the aggregate fair value of our OTC derivative
portfolio. In the tables above, for option contracts that
require settlement by delivery of an underlying derivative
instrument, the remaining contractual maturity is generally
classified based upon the maturity date of the underlying
derivative
instrument. In those instances where the underlying instrument
does not have a maturity date or either counterparty has the
right to settle in cash, the remaining contractual maturity is
generally based upon the option expiration date.
Principal Investments. The following table sets forth the
carrying value of our corporate and real estate principal
investments in private companies (excluding our investment in
the ordinary shares of Industrial and Commercial Bank of China
Limited (ICBC)), in public companies (excluding our investment
in the convertible preferred stock of SMFG) and our investments
in SMFG and ICBC:
Principal Investments
(in millions)
As of August 2006
As of November 2005
Corporate
Real Estate
Total
Corporate
Real Estate
Total
Private
$
2,359
$
616
$
2,975
$
1,538
$
716
$
2,254
Public
848
5
853
185
29
214
Subtotal (1)
3,207
621
3,828
1,723
745
2,468
SMFG convertible preferred
stock (2) (3)
4,938
—
4,938
4,058
—
4,058
ICBC ordinary
shares (4)
2,605
—
2,605
—
—
—
Total
$
10,750
$
621
$
11,371
$
5,781
$
745
$
6,526
(1)
Excludes assets for which Goldman Sachs is not at risk (e.g.,
assets related to consolidated merchant banking funds) of
$3.64 billion and $1.93 billion as of August 2006 and
November 2005, respectively.
(2)
The fair value of our Japanese yen-denominated investment in the
convertible preferred stock of SMFG includes the effect of
foreign exchange revaluation. We mitigate our economic exposure
to exchange rate movements on our investment in SMFG by
borrowing Japanese yen. Foreign exchange revaluation on the
investment and the related borrowing are generally equal and
offsetting. For example, if the Japanese yen appreciates against
the U.S. dollar, the U.S. dollar carrying value of our
SMFG investment will increase and the U.S. dollar carrying
value of the related borrowing will also increase by an amount
that is generally equal and offsetting.
(3)
Excludes an economic hedge on the unrestricted shares of common
stock underlying our investment in the convertible preferred
stock of SMFG. The fair value of this hedge was
$3.07 billion and $1.51 billion as of August 2006
and November 2005, respectively, and is reflected in
“Financial instruments sold, but not yet purchased, at fair
value” in the condensed consolidated statements of
financial condition. For a further discussion of the
restrictions on our ability to hedge or sell the common stock
underlying our investment in SMFG, see below.
(4)
Includes economic interests of $1.65 billion as of August
2006 assumed by investment funds managed by Goldman Sachs. The
fair value of our Chinese renminbi-denominated investment in the
ordinary shares of ICBC includes the effect of foreign exchange
revaluation.
Our private principal investments, by their nature, have little
or no price transparency. Such investments (including our
investment in ICBC) are initially carried at cost as an
approximation of fair value. Adjustments to carrying value are
made if there are third-party transactions evidencing a change
in value. Downward adjustments are also made, in the absence of
third-party transactions, if we determine that the expected
realizable value of the investment is less than the carrying
value. In reaching that determination, we consider many factors
including, but not limited to, the operating cash flows and
financial performance of the companies or properties relative to
budgets or projections, trends within sectors and/or regions,
underlying business models, expected exit timing and strategy,
and any specific rights or terms associated with the investment,
such as conversion features and liquidation preferences.
Our public principal investments, which tend to be large,
concentrated holdings that result from initial public offerings
or other corporate transactions, are valued using quoted market
prices discounted based on predetermined written policies for
nontransferability and illiquidity.
Our investment in the convertible preferred stock of SMFG is
carried at fair value, which is derived from a model that
incorporates SMFG’s common stock price and credit spreads,
the impact of nontransferability and illiquidity, and the
downside protection on the conversion strike price. The fair
value of our investment is particularly sensitive to movements
in the SMFG common stock price. As a result of transfer
restrictions and the downside protection on the conversion
strike price, the relationship between changes in the fair value
of our investment and changes in SMFG’s common stock price
is nonlinear. During the third quarter, the fair value of our
investment (excluding the economic hedge on the unrestricted
shares of common stock) increased 11% (expressed in Japanese
yen), primarily reflecting an increase in the SMFG common stock
price and, to a lesser extent, the impact of passage of time in
respect of the transfer restrictions on the underlying common
stock.
Our investment in the convertible preferred stock of SMFG is
generally nontransferable, but is freely convertible into SMFG
common stock. Restrictions on our ability to hedge or sell
two-thirds of the
common stock underlying our investment in SMFG lapsed in equal
installments on February 7, 2005 and
March 9, 2006. As of the date of this filing, we have
fully hedged the first
one-third installment
of the unrestricted shares and have hedged a majority of the
second one-third
installment of the unrestricted shares. Restrictions on our
ability to hedge or sell the remaining
one-third installment
lapse on February 7, 2007. As of the date of this
filing, the conversion price of our SMFG preferred stock into
shares of SMFG common stock was ¥319,700. This price is
subject to downward adjustment if the price of SMFG common stock
at the time of conversion is less than the conversion price
(subject to a floor of ¥105,400).
Controls Over Valuation of Financial Instruments. A
control infrastructure, independent of the trading and investing
functions, is fundamental to ensuring that our financial
instruments are appropriately valued and that fair value
measurements are reliable. This is particularly important in
valuing instruments with lower levels of price transparency.
We employ an oversight structure that includes appropriate
segregation of duties. Senior management, independent of the
trading functions, is responsible for the oversight of control
and valuation policies and for reporting the results of these
policies to our Audit Committee. We seek to maintain the
necessary resources to ensure that control functions are
performed to the highest standards. We employ procedures for the
approval of new transaction types and markets, price
verification, review of daily profit and loss, and review of
valuation models by personnel with appropriate technical
knowledge of relevant products and markets. These procedures are
performed by personnel independent of the
revenue-producing
units. For trading and principal investments with little or no
price transparency, we employ, where possible, procedures that
include comparisons with similar observable positions, analysis
of actual to projected cash flows, comparisons with subsequent
sales and discussions with senior business leaders. See
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Risk
Management” in Part II, Item 7 of the Annual
Report on
Form 10-K for a
further discussion on how we manage the risks inherent in our
trading and principal investing businesses.
Goodwill and Identifiable Intangible Assets
As a result of our acquisitions, principally SLK LLC
(SLK) in fiscal 2000, The Ayco Company, L.P. (Ayco) in
fiscal 2003, Cogentrix Energy, Inc. (Cogentrix) in fiscal 2004,
National Energy & Gas Transmission, Inc. (NEGT) in
fiscal 2005 and the acquisition of the variable annuity and
variable life insurance business of The Hanover Insurance Group,
Inc. (formerly Allmerica Financial Corporation) in fiscal 2006,
we have acquired goodwill and identifiable intangible assets.
Goodwill is the cost of acquired companies in excess of the fair
value of net assets, including identifiable intangible assets,
at the acquisition date.
Goodwill. We test the goodwill in each of our operating
segments for impairment at least annually in accordance with
Statement of Financial Accounting Standards
(SFAS) No. 142, “Goodwill and Other Intangible
Assets,” by comparing the estimated fair value of each
operating segment with its estimated net book value. We derive
the fair value of each of our operating segments primarily based
on price-earnings multiples. We derive the net book value of our
operating segments by estimating the amount of
shareholders’ equity required to support the assets of each
operating segment. Our last annual impairment test was performed
during our fiscal 2005 fourth quarter and no impairment was
identified.
The following table sets forth the carrying value of our
goodwill by operating segment:
Goodwill by Operating Segment
(in millions)
As of
August
November
2006
2005
Investment Banking
Financial Advisory
$
—
$
—
Underwriting
125
125
Trading and Principal Investments
FICC
155
91
Equities (1)
2,387
2,390
Principal Investments
22
1
Asset Management and Securities
Services
Asset
Management (2)
421
424
Securities Services
117
117
Total
$
3,227
$
3,148
(1)
Primarily related to SLK.
(2)
Primarily related to Ayco.
Identifiable Intangible Assets. We amortize our
identifiable intangible assets over their estimated useful lives
in accordance with SFAS No. 142, and test for
potential impairment whenever events or changes in circumstances
suggest that an asset’s or asset group’s carrying
value may not be fully recoverable in accordance with
SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” An impairment loss,
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.
Primarily includes our clearance and execution and NASDAQ
customer lists related to SLK and financial counseling customer
lists related to Ayco.
(2)
Primarily relates to above-market power contracts of
consolidated power generation facilities related to Cogentrix
and NEGT. Substantially all of these power contracts have been
pledged as collateral to counterparties in connection with
certain of our secured short-term and long-term borrowings.
(3)
Consists of the value of business acquired (VOBA) and
deferred acquisition costs (DAC). VOBA represents the present
value of estimated future gross profits of the variable annuity
and variable life insurance business acquired in fiscal 2006.
DAC represents commissions paid in connection with providing
reinsurance. VOBA and DAC are amortized over the estimated life
of the underlying contracts based on estimated gross profits,
and amortization is adjusted based on actual experience. The six
year useful life represents the weighted average remaining
amortization period of the underlying contracts (certain of
which extend approximately 30 years).
(4)
Primarily includes technology-related and other assets related
to SLK.
(5)
During the first quarter of 2006, we reduced the estimated
useful lives of our NYSE specialist rights from
22-24 years to
16 years. This change was due to higher than expected
attrition in acquired NYSE specialist rights, primarily from
mergers and delistings.
A prolonged period of weakness in global equity markets and the
trading of securities in multiple markets and on multiple
exchanges could adversely impact our businesses and impair the
value of our goodwill and/or identifiable intangible assets. In
addition, certain events could indicate a potential impairment
of our identifiable intangible assets, including
(i) changes in market structure that could adversely affect
our specialist businesses, (ii) an adverse action or
assessment by a regulator, (iii) a default event under a
power contract or physical damage or other adverse events
impacting the underlying power generation facilities, or
(iv) adverse actual experience on the contracts in our
variable annuity and variable life insurance business.
The use of generally accepted accounting principles requires
management to make certain estimates. In addition to the
estimates we make in connection with fair value measurements and
the accounting for goodwill and identifiable intangible assets,
the use of estimates is also important in determining
compensation and benefits expenses for interim periods and in
determining provisions for potential losses that may arise from
litigation and regulatory proceedings and tax audits.
A substantial portion of our compensation and benefits
represents discretionary bonuses, which are determined at year
end. We believe the most appropriate way to allocate estimated
annual discretionary bonuses 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 and the
structure of our share-based compensation programs. We generally
target compensation and benefits at 50% (plus or minus a few
percentage points) of consolidated net revenues. During the
first nine months of 2006, our ratio of compensation and
benefits to net revenues was 49.8%. Excluding the
$508 million impact of the continued amortization of prior
year share-based awards under SFAS No. 123-R, our
ratio of compensation and benefits to net revenues was
48.0% (1).
We estimate and provide for potential losses that may arise out
of litigation and regulatory proceedings and tax audits to the
extent that such losses are probable and can be estimated, in
accordance with SFAS No. 5, “Accounting for
Contingencies.” Significant judgment is required in making
these estimates and our final liabilities may ultimately be
materially different. Our total 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. Given the inherent difficulty of predicting the
outcome of our litigation and regulatory matters, particularly
in cases or proceedings in which substantial or indeterminate
damages or fines are sought, we cannot estimate losses or ranges
of losses for cases or proceedings where there is only a
reasonable possibility that a loss may be incurred. See
“Legal Proceedings” in Part I, Item 3 of the
Annual Report on
Form 10-K, and in
Part II, Item 1 of our Quarterly Report on
Form 10-Q for the
quarters ended May 26, 2006 and February 24, 2006 and
in Part II, Item 1 of this Quarterly Report on
Form 10-Q for
information on our judicial, regulatory and arbitration
proceedings.
(1)
Our ratio of compensation and benefits to net revenues,
excluding the impact of the continued amortization of prior year
share-based awards, is computed by dividing compensation and
benefits, excluding the impact of the continued amortization of
prior year share-based awards, by net revenues. We believe that
presenting the ratio of compensation and benefits to net
revenues excluding the impact of the continued amortization of
prior year share-based awards granted to retirement-eligible
employees increases the comparability of
period-to-period
operating results and allows for a more meaningful
representation of the relationship of current period
compensation to net revenues. The following table sets forth the
reconciliation of the ratio of compensation and benefits to net
revenues, as reported, to the ratio of compensation and benefits
to net revenues excluding the impact of the continued
amortization of prior year share-based awards:
Three Months
Nine Months
Six Months
Ended
Ended
Ended
August 2006
August 2006
May 2006
($ in millions)
Compensation and benefits
$
3,510
$
13,897
$
10,387
Impact of the continued
amortization of prior year share-based awards
(133
)
(508
)
(375
)
Compensation and benefits,
excluding the impact of the continued amortization of prior year
share-based awards
$
3,377
$
13,389
$
10,012
Net revenues
$
7,463
$
27,895
$
20,432
Ratio of compensation and benefits
to net revenues, excluding the impact of the continued
amortization of prior year share-based awards
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. For a further discussion of the impact of economic
and market conditions on our results of operations, see
“Risk Factors” in Part I, Item 1A of the
Annual Report on
Form 10-K.
Financial Overview
The following table sets forth an overview of our financial
results:
Financial Overview
($ in millions, except per share amounts)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Net revenues
$
7,463
$
7,285
$
27,895
$
18,496
Pre-tax earnings
2,362
2,405
9,575
5,794
Net earnings
1,594
1,617
6,385
3,994
Net earnings applicable to common
shareholders
1,555
1,608
6,294
3,985
Diluted earnings per common share
3.26
3.25
13.12
7.89
Annualized return on average common
shareholders’
equity (1)
20.9
%
25.1
%
29.6
%
20.7
%
Annualized return on average
tangible common shareholders’
equity (2)
24.9
%
30.7
%
35.6
%
25.3
%
(1)
Annualized return on average common shareholders’ equity is
computed by dividing annualized net earnings applicable to
common shareholders by average monthly common shareholders’
equity.
(2)
Tangible common shareholders’ equity equals total
shareholders’ equity less preferred stock, goodwill and
identifiable intangible assets, excluding power contracts and
insurance-related intangible assets. Insurance-related
intangible assets consist of the value of business acquired
(VOBA) and deferred acquisition costs (DAC). VOBA
represents the present value of estimated future gross profits
of the variable annuity and variable life insurance business
acquired in fiscal 2006. DAC represents commissions paid in
connection with providing reinsurance. In fiscal 2006, we
amended our calculation of tangible common shareholders’
equity. We no longer deduct identifiable intangible assets
associated with power contracts and insurance-related assets
from common shareholders’ equity, in each case because,
unlike other intangible assets, we do not hold material amounts
of common shareholders’ equity to support these assets.
Prior periods have been restated to conform to the current
period presentation.
We believe that annualized return on average tangible common
shareholders’ equity is meaningful because it measures the
performance of businesses consistently, whether they were
acquired or developed internally. Annualized return on average
tangible common shareholders’ equity is computed by
dividing annualized net earnings applicable to common
shareholders by average monthly tangible common
shareholders’ equity.
The following table sets forth a reconciliation of average
total shareholders’ equity to average tangible common
shareholders’ equity:
Average for the
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
(in millions)
Total shareholders’ equity
$
32,618
$
26,405
$
30,498
$
26,100
Preferred stock
(2,850
)
(750
)
(2,190
)
(375
)
Common shareholders’ equity
29,768
$
25,655
28,308
$
25,725
Goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets
Three Months Ended August 2006 versus August 2005. Our
net revenues were $7.46 billion for the third quarter of
2006, an increase of 2% compared with the third quarter of 2005,
reflecting significantly higher net revenues in Investment
Banking and Asset Management and Securities Services, partially
offset by lower net revenues in Trading and Principal
Investments. The increase in Investment Banking reflected
significantly higher net revenues in Underwriting, as both debt
and equity underwriting results improved, as well as higher net
revenues in Financial Advisory, reflecting increased client
activity. Strong net revenue growth in our Asset Management and
Securities Services businesses primarily reflected significantly
higher management and other fees as well as continued strength
in our prime brokerage business. Assets under management
increased significantly from a year ago, including net asset
inflows of $30 billion during the quarter. Net revenues in
Trading and Principal Investments were lower than a particularly
strong third quarter of 2005. Net revenues in Principal
Investments decreased reflecting a smaller gain related to our
investment in the convertible preferred stock of SMFG as well as
lower net revenues from our other principal investments. In
addition, net revenues in Equities were lower than the same
prior year period, while net revenues in FICC were higher than a
strong third quarter of 2005. During the quarter, Equities
operated in a less favorable environment as equity prices lacked
direction and customer-driven activity declined from the first
half of the year. In addition, although FICC performed well, the
business operated in a less favorable environment, as
customer-driven activity declined from the first half of the
year and volatility levels were generally low.
Nine Months Ended August 2006 versus August 2005. Our net
revenues were $27.90 billion for the first nine months of
2006, an increase of 51% compared with the same period last
year, reflecting strong net revenue growth in each of our three
segments. Trading and Principal Investments results reflected
significantly higher net revenues in FICC and Equities and a
strong performance in Principal Investments. Net revenues in
FICC reflected particularly strong results across all major
businesses, and net revenues in Equities reflected significant
growth in our customer franchise business, while results in
principal strategies, although strong, were lower than the same
prior year period. In our trading businesses, we saw generally
favorable trading and investing opportunities for our clients
and ourselves, and consequently increased our market risk in the
first half of the year. However, as the environment became more
challenging during the third quarter of 2006, our market risk
declined, reflecting fewer opportunities in the markets. In
Investment Banking, net revenues reflected strong growth in
Underwriting and Financial Advisory as industry-wide volumes
across equity underwriting and mergers and acquisitions were
significantly ahead of the same prior year period and debt
underwriting volumes remained at high levels. In Asset
Management and Securities Services, revenue growth was driven by
record assets under management and significantly higher
incentive fees, as well as significantly higher global customer
balances in Securities Services.
Our operating expenses are primarily influenced by compensation,
headcount and levels of business activity. A substantial portion
of our compensation expense represents discretionary bonuses,
with our overall compensation and benefits expenses generally
targeted at 50% (plus or minus a few percentage points) of
consolidated net revenues. In addition to the level of net
revenues, our compensation expense in any given year is
influenced by, among other factors, prevailing labor markets,
business mix and the structure of our share-based compensation
programs. During the first nine months of 2006, our ratio of
compensation and benefits to net revenues was 49.8%. Excluding
the $508 million impact of the continued amortization under
SFAS No. 123-R
of prior year
share-based awards
granted to retirement-eligible employees, for the first nine
months of 2006, our ratio of compensation and benefits to net
revenues was 48.0%, down from 49.0% for the first six months of
2006. This lower compensation ratio reflects our strong net
revenues in 2006 as well as greater visibility into expected
compensation levels as year end approaches. See
“— Use of Estimates” above for more
information on our ratio of compensation and benefits to net
revenues.
The following table sets forth our operating expenses and number
of employees:
Operating Expenses and Employees
($ in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Compensation and
benefits (1)
$3,510
$3,642
$13,897
$9,248
Brokerage, clearing and exchange
fees
454
271
1,208
797
Market development
117
92
338
268
Communications and technology
141
124
396
365
Depreciation and amortization
126
125
378
371
Amortization of identifiable
intangible assets
50
31
128
93
Occupancy
221
200
613
534
Professional fees
135
117
367
322
Other expenses
347
278
995
704
Total non-compensation expenses
1,591
1,238
4,423
3,454
Total operating expenses
$5,101
$4,880
$18,320
$12,702
Employees at period
end (1) (2)
25,647
23,195
(1)
Excludes 9,901 and 7,308 employees as of August 2006 and August
2005, respectively, of consolidated entities held for investment
purposes. Compensation and benefits includes $83 million
and $52 million for the three months ended August 2006 and
August 2005, respectively, and $196 million and
$77 million for the nine months ended August 2006 and
August 2005, respectively, attributable to these consolidated
entities. Consolidated entities held for investment purposes
includes 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.
(2)
Includes 1,281 employees as of August 2006 of Goldman
Sachs’ consolidated property management and loan servicing
subsidiaries. August 2005 has been restated to conform to the
current presentation and includes 1,163 employees.
The following table sets forth non-compensation expenses of
consolidated entities held for investment purposes and our
remaining non-compensation expenses by line item:
Non-Compensation Expenses
(in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Non-compensation expenses of
consolidated
investments (1)
Consolidated entities held for investment purposes includes
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. For example, these
investments include consolidated entities that hold real estate
assets, such as golf courses and hotels in Asia, but exclude
investments in entities that primarily hold financial assets. We
believe that it is meaningful to review non-compensation
expenses excluding expenses related to these consolidated
entities in order to evaluate trends in non-compensation
expenses related to our principal business activities. Revenues
related to such entities are included in “Trading and
principal investments” in the condensed consolidated
statements of earnings.
Three Months Ended August 2006 versus August 2005.
Operating expenses of $5.10 billion increased 5% compared
with the third quarter of 2005. Compensation and benefits
expenses of $3.51 billion decreased 4% compared with the
third quarter of 2005. The ratio of compensation and benefits to
net revenues for the third quarter of 2006 was 47.0% compared
with 50.0% for the third quarter of 2005. Excluding the
$133 million impact of the continued amortization of prior
year share-based awards under
SFAS No. 123-R,
the ratio of compensation and benefits to net revenues was 45.2%
for the third quarter of 2006 compared with 50.0% for the third
quarter of 2005. Employment levels increased 7% during the third
quarter of 2006. See “— Use of Estimates”
above for more information on our ratio of compensation and
benefits to net revenues.
In the first quarter of 2006, we adopted
SFAS No. 123-R, which requires that share-based awards
granted to
retirement-eligible
employees, including those subject to non-compete agreements, be
expensed in the year of grant. In addition to expensing current
year awards, prior year awards must continue to be amortized
over the relevant service period. Therefore, our compensation
and benefits expenses in fiscal 2006 (and, to a lesser extent,
in fiscal 2007 and fiscal 2008) will include both amortization
of prior year awards and new awards granted to
retirement-eligible
employees for services rendered in fiscal 2006. The majority of
the expense related to the continued amortization of prior year
awards will be recognized in fiscal 2006. The estimated annual
expense for fiscal 2006 is approximately $650 million of
which $133 million was recognized in the third quarter of
2006.
Non-compensation expenses were $1.59 billion, 29% higher
than the third quarter of 2005. Excluding consolidated entities
held for investment purposes, non-compensation expenses were 26%
higher than the third quarter of 2005. More than one-half of
this increase was attributable to higher brokerage, clearing and
exchange fees, primarily in Equities. Other expenses were higher
primarily due to costs related to our insurance business, which
was acquired in fiscal 2006.
Nine Months Ended August 2006 versus August 2005.
Operating expenses of $18.32 billion for the first nine
months of 2006 increased 44% compared with the first nine months
of 2005. Compensation and benefits expenses of
$13.90 billion increased 50% compared with the first nine
months of 2005, reflecting higher net revenues. The ratio of
compensation and benefits to net revenues for the first nine
months of 2006 was 49.8% compared with 50.0% for the same period
last year. Excluding the $508 million impact of the
continued amortization of prior year share-based awards under
SFAS No. 123-R, the ratio of compensation and benefits
to net revenues was 48.0% for the first nine months of 2006
compared with 50.0% for the first nine months of 2005.
Employment levels increased 9% during the first nine months of
2006. See “— Use of Estimates” above for
more information on our ratio of compensation and benefits to
net revenues.
Non-compensation expenses were $4.42 billion, 28% higher
than the first nine months of 2005. Excluding consolidated
entities held for investment purposes, non-compensation expenses
were 23% higher than the first nine months of 2005. More than
one-half of this increase was attributable to higher brokerage,
clearing and exchange fees, primarily in Equities. Other
expenses were higher primarily due to costs related to our
insurance business, which was acquired in fiscal 2006.
Provision for Taxes
The provision for taxes for the three and nine months ended
August 2006 was $768 million and $3.19 billion,
respectively. The effective income tax rate was 33.3% for the
first nine months of 2006, down from 33.6% for the first six
months of 2006 and up from 32.0% for fiscal year 2005. The
increase in the effective tax rate for the first nine months of
2006 compared with fiscal year 2005 was primarily due to the
impact of audit settlements in 2005 and lower estimated tax
credits in 2006.
The following table sets forth the net revenues, operating
expenses and pre-tax earnings of our segments:
Segment Operating Results
(in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Investment
Net revenues
$
1,288
$
1,015
$
4,285
$
2,723
Banking
Operating expenses
940
887
3,223
2,392
Pre-tax earnings
$
348
$
128
$
1,062
$
331
Trading and Principal
Net revenues
$
4,720
$
5,062
$
18,565
$
12,258
Investments
Operating expenses
3,199
3,231
11,900
8,025
Pre-tax earnings
$
1,521
$
1,831
$
6,665
$
4,233
Asset Management and
Net revenues
$
1,455
$
1,208
$
5,045
$
3,515
Securities Services
Operating expenses
970
754
3,157
2,254
Pre-tax earnings
$
485
$
454
$
1,888
$
1,261
Total
Net revenues
$
7,463
$
7,285
$
27,895
$
18,496
Operating expenses (1)
5,101
4,880
18,320
12,702
Pre-tax earnings
$
2,362
$
2,405
$
9,575
$
5,794
(1)
Includes net provisions for a number of litigation and
regulatory proceedings of $(8) million and $8 million
for the three months ended August 2006 and August 2005,
respectively, and $40 million and $31 million for the
nine months ended August 2006 and August 2005, respectively,
that have not been allocated to our segments.
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.
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 expenses within our segments reflect,
among other factors, the overall performance of Goldman Sachs as
well as the performance of individual business units.
Consequently, pre-tax margins in one segment of our business may
be significantly affected by the performance of our other
business segments. The timing and magnitude of changes in our
bonus accruals can have a significant effect on segment results
in a given period. A discussion of segment operating results
follows.
Investment Banking
Our Investment Banking segment is divided into two components:
•
Financial Advisory. Financial Advisory includes advisory
assignments with respect to mergers and acquisitions,
divestitures, corporate defense activities, restructurings and
spin-offs.
•
Underwriting. Underwriting includes public offerings and
private placements of equity, equity-related and debt
instruments.
The following table sets forth the operating results of our
Investment Banking segment:
Investment Banking Operating Results
(in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Financial Advisory
$
609
$
559
$
1,953
$
1,359
Equity underwriting
270
199
1,035
499
Debt underwriting
409
257
1,297
865
Total Underwriting
679
456
2,332
1,364
Total net revenues
1,288
1,015
4,285
2,723
Operating expenses
940
887
3,223
2,392
Pre-tax earnings
$
348
$
128
$
1,062
$
331
The following table sets forth our financial advisory and
underwriting transaction volumes:
Goldman Sachs Global Investment Banking
Volumes (1)
(in billions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Announced mergers and acquisitions
$
184
$
142
$
883
$
522
Completed mergers and acquisitions
151
192
633
416
Equity and equity-related
offerings (2)
8
14
51
34
Debt
offerings (3)
68
67
225
206
(1)
Source: Thomson Financial. 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.
(2)
Includes public common stock offerings and convertible offerings.
(3)
Includes non-convertible preferred stock, mortgage-backed
securities, asset-backed securities and taxable municipal debt.
Includes publicly registered and Rule 144A issues.
Three Months Ended August 2006 versus August 2005. Net
revenues in Investment Banking of $1.29 billion for the
third quarter of 2006 increased 27% compared with the third
quarter of 2005. Net revenues in Financial Advisory of
$609 million increased 9% compared with the third quarter
of 2005, reflecting increased client activity. Net revenues in
our Underwriting business of $679 million increased 49%
compared with the third quarter of 2005. Net revenues were
significantly higher in debt underwriting, primarily due to an
increase in leveraged finance activity, and in equity
underwriting. Our investment banking backlog was essentially
unchanged during the
quarter (1).
Operating expenses of $940 million for the third quarter of
2006 increased 6% compared with the third quarter of 2005,
primarily due to increased compensation and benefits expenses
resulting from a higher accrual of discretionary compensation.
Pre-tax earnings were $348 million compared with
$128 million in the third quarter of 2005.
(1)
Our investment banking 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.
Nine Months Ended August 2006 versus August 2005. Net
revenues in Investment Banking of $4.29 billion for the
first nine months of 2006 increased 57% compared with the same
period last year, reflecting growth across all regions. Net
revenues in Financial Advisory of $1.95 billion increased
44% compared with the same period last year, primarily
reflecting an increase in industry-wide completed mergers and
acquisitions. Net revenues in our Underwriting business of
$2.33 billion increased 71% compared with the first nine
months of 2005. Net revenues were significantly higher in equity
underwriting, primarily reflecting an increase in industry-wide
equity and equity-related offerings, and in debt underwriting,
primarily due to an increase in leveraged finance activity.
Operating expenses of $3.22 billion for the nine months
ended August 2006 increased 35% compared with the same period
last year, primarily due to increased compensation and benefits
expenses resulting from a higher accrual of discretionary
compensation. Pre-tax earnings were $1.06 billion compared
with $331 million in the same period last year.
Trading and Principal Investments
Our Trading and Principal Investments segment is divided into
three components:
•
FICC. We make markets in and trade interest rate and
credit products, mortgage-backed securities and loans,
currencies and commodities, structure and enter into a wide
variety of derivative transactions and engage in proprietary
trading and investing.
•
Equities. We make markets in, trade and act as a
specialist for equities and equity-related products, structure
and enter into equity derivative transactions, engage in
proprietary trading and enter into insurance transactions. We
also execute and clear client transactions on major stock,
options and futures exchanges worldwide.
•
Principal Investments. We generate net revenues from our
corporate and real estate merchant banking investments,
including the increased share of the income and gains derived
from our merchant banking funds when the return on a fund’s
investments exceeds certain threshold returns (merchant banking
overrides), as well as gains or losses related to our investment
in the convertible preferred stock of SMFG.
Substantially all of our inventory is
marked-to-market daily
and, therefore, its value and our net revenues are subject to
fluctuations based on market movements. In addition, net
revenues derived from our principal investments in privately
held concerns and in real estate may fluctuate significantly
depending on the revaluation or sale of these investments in any
given period. We also regularly enter into large transactions as
part of our trading businesses. The number and size of such
transactions may affect our results of operations in a given
period.
Net revenues from Principal Investments do not include
management fees generated from our merchant banking funds. These
management fees are included in the net revenues of the Asset
Management and Securities Services segment.
The following table sets forth the operating results of our
Trading and Principal Investments segment:
Trading and Principal Investments Operating Results
(in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
FICC
$
2,739
$
2,626
$
10,795
$
6,634
Equities trading
707
872
3,730
2,073
Equities commissions
844
721
2,622
2,175
Total Equities
1,551
1,593
6,352
4,248
SMFG
261
498
605
752
Gross gains
269
249
1,003
583
Gross losses
(135
)
(44
)
(389
)
(123
)
Net other corporate and real estate
investments
134
205
614
460
Overrides
35
140
199
164
Total Principal Investments
430
843
1,418
1,376
Total net revenues
4,720
5,062
18,565
12,258
Operating expenses
3,199
3,231
11,900
8,025
Pre-tax earnings
$
1,521
$
1,831
$
6,665
$
4,233
Three Months Ended August 2006 versus August 2005. Net
revenues in Trading and Principal Investments of
$4.72 billion for the third quarter of 2006 decreased 7%
compared with the third quarter of 2005. Net revenues in FICC of
$2.74 billion increased 4% compared with a strong third
quarter of 2005, reflecting higher net revenues in commodities
and mortgages, partially offset by lower net revenues in
currencies. In addition, net revenues in credit products were
strong, but lower compared with the third quarter of 2005, while
net revenues in interest rate products were essentially
unchanged. Although FICC performed well, the business operated
in a less favorable environment, as customer-driven activity
declined from the first half of the year and volatility levels
were generally low. Net revenues in Equities of
$1.55 billion decreased 3% compared with the third quarter
of 2005, primarily reflecting significantly lower net revenues
in principal strategies and, to a lesser extent, shares. These
declines were partially offset by higher net revenues in
derivatives and the contribution from our insurance business,
which was acquired in fiscal 2006. During the quarter, Equities
operated in an environment in which equity prices lacked
direction, and customer-driven activity declined from the first
half of the year. Principal Investments recorded net revenues of
$430 million, reflecting a $261 million gain related
to our investment in the convertible preferred stock of SMFG and
$169 million in gains and overrides from other principal
investments.
Operating expenses of $3.20 billion for the third quarter
of 2006 decreased slightly compared with the third quarter of
2005, primarily due to decreased compensation and benefits
expenses resulting from a lower accrual of discretionary
compensation. This decrease was partially offset by an increase
in non-compensation expenses. Excluding consolidated entities
held for investment purposes, the increase in non-compensation
expenses was primarily due to higher brokerage, clearing and
exchange fees, principally in Equities. Other expenses were also
higher, primarily due to costs
related to the insurance business, which was acquired in fiscal
2006. Pre-tax earnings of $1.52 billion decreased 17%
compared with the third quarter of 2005.
Nine Months Ended August 2006 versus August 2005. Net
revenues in Trading and Principal Investments of
$18.57 billion for the first nine months of 2006 increased
51% compared with the same period last year. Net revenues in
FICC of $10.80 billion increased 63% compared with the
first nine months of 2005, reflecting strong performances across
all major businesses. During the first nine months of 2006, FICC
operated in a generally favorable environment, although
conditions became more challenging in the third quarter as
customer-driven activity declined and volatility levels were
low. Net revenues in Equities of $6.35 billion increased
50% compared with the same period last year, primarily
reflecting significantly higher net revenues in derivatives and
shares and the contribution from our insurance business, which
was acquired in fiscal 2006, partially offset by lower net
revenues in principal strategies. Although Equities operated in
an environment characterized by strong customer-driven activity
and generally higher equity prices during the first half of
2006, following more challenging conditions in May, equity
markets generally lacked direction and customer-driven activity
declined during our third quarter. Principal Investments
recorded net revenues of $1.42 billion, reflecting a
$605 million gain related to our investment in the
convertible preferred stock of SMFG and $813 million in
gains and overrides from other principal investments.
Operating expenses of $11.90 billion for the nine months
ended August 2006 increased 48% compared with the nine months
ended August 2005, primarily due to increased compensation and
benefits expenses resulting from a higher accrual of
discretionary compensation. Excluding consolidated entities held
for investment purposes, non-compensation expenses increased
primarily due to higher brokerage, clearing and exchange fees,
principally in Equities. In addition, other expenses increased
primarily due to costs related to the insurance business, which
was acquired in fiscal 2006. Pre-tax earnings of
$6.67 billion increased 57% compared with the same period
last year.
Asset Management and Securities Services
Our Asset Management and Securities Services segment is divided
into two components:
•
Asset Management. Asset Management provides investment
advisory and financial planning services and offers investment
products across all major asset classes to a diverse group of
institutions and individuals worldwide and primarily generates
revenues in the form of management and incentive fees.
•
Securities Services. Securities Services provides prime
brokerage services, financing services and securities lending
services to mutual funds, pension funds, hedge funds,
foundations and high-net-worth individuals worldwide, and
generates revenues primarily in the form of interest rate
spreads or fees.
Assets under management typically generate fees as a percentage
of asset value. In certain circumstances, we are also entitled
to receive asset management incentive fees based on a percentage
of a fund’s return or when the return on assets under
management exceeds specified benchmark returns or other
performance targets. Incentive fees are recognized when the
performance period ends and they are no longer subject to
adjustment. We have numerous incentive fee arrangements, many of
which have annual performance periods that end on
December 31. For that reason, incentive fees are seasonally
weighted each year to our first fiscal quarter.
The following table sets forth the operating results of our
Asset Management and Securities Services segment:
Asset Management and Securities Services Operating Results
(in millions)
Three Months
Nine Months
Ended August
Ended August
2006
2005
2006
2005
Management and other fees
$
822
$
672
$
2,422
$
1,947
Incentive fees
96
59
939
222
Total Asset Management
918
731
3,361
2,169
Securities Services
537
477
1,684
1,346
Total net revenues
1,455
1,208
5,045
3,515
Operating expenses
970
754
3,157
2,254
Pre-tax earnings
$
485
$
454
$
1,888
$
1,261
Assets under management include our mutual funds, alternative
investment funds and separately managed accounts for
institutional and individual investors. Substantially all assets
under management are valued as of calendar month end.
The following table sets forth our assets under management by
asset class:
In the first quarter of fiscal 2006, the methodology for
classifying certain non-money market assets was changed. The
changes were primarily to reclassify certain assets allocated to
external investment managers out of alternative investment
assets and to reclassify currency funds into alternative
investment assets. The changes did not impact total assets under
management and prior periods have been restated to conform to
the current period presentation.
(2)
Primarily includes private equity funds, hedge funds, real
estate funds, currency funds and asset allocation strategies.
Total non-money market net asset
inflows/(outflows)
27
18
60
47
Money markets
3
(1)
—
10
(1)
8
Total net asset inflows/(outflows)
30
18
70
(2)
55
Net market
appreciation/(depreciation)
6
12
27
13
Balance, end of period
$
629
$
520
$
629
$
520
(1)
Includes the transfer of $8 billion of money market assets
under management to interest-bearing deposits at Goldman Sachs
Bank USA, a wholly owned subsidiary of Goldman Sachs. These
deposits are not included in assets under management.
(2)
Includes $3 billion of net asset inflows in connection with
the December 30, 2005 acquisition of the variable annuity
and variable life insurance business of The Hanover Insurance
Group, Inc.
Three Months Ended August 2006 versus August 2005. Net
revenues in Asset Management and Securities Services of
$1.46 billion for the third quarter of 2006 increased 20%
compared with the third quarter of 2005. Asset Management net
revenues of $918 million increased 26% compared with the
third quarter of 2005. The increase was primarily driven by
significantly higher management and other fees, principally due
to growth in assets under management. During the quarter, assets
under management increased 6% to a record $629 billion,
reflecting non-money market net asset inflows of
$27 billion, principally in alternative investment and
fixed income assets, money market net asset inflows of
$3 billion (1)
and market appreciation of $6 billion, primarily in equity
and fixed income assets. Securities Services net revenues of
$537 million increased 13% compared with the third quarter
of 2005, as our prime brokerage business continued to generate
strong results, primarily reflecting significantly higher global
customer balances in securities lending and margin lending.
Operating expenses of $970 million for the third quarter of
2006 increased 29% compared with the third quarter of 2005,
primarily due to increased compensation and benefits expenses
resulting from a higher accrual of discretionary compensation.
Pre-tax earnings of $485 million increased 7% compared with
the third quarter of 2005.
Nine Months Ended August 2006 versus August 2005. Net
revenues in Asset Management and Securities Services of
$5.05 billion for the first nine months of 2006 increased
44% compared with the same period last year. Asset Management
net revenues of $3.36 billion increased 55% compared with
the first nine months of 2005, reflecting significantly higher
incentive fees and a 24% increase in management and other fees.
Incentive fees were $939 million for the first nine months
of 2006 compared with $222 million for the same period last
year. During the first nine months of 2006, assets under
management increased 18% to $629 billion, reflecting
non-money market net asset inflows of $60 billion,
primarily in alternative investment and fixed income assets,
money market net
asset inflows of
$10 billion (1)
and market appreciation of $27 billion, primarily in equity
and fixed income assets. Securities Services net revenues of
$1.68 billion increased 25% compared with the same period
last year, as our prime brokerage business generated strong
results, primarily reflecting significantly higher global
customer balances in securities lending and margin lending.
Operating expenses of $3.16 billion for the nine months
ended 2006 increased 40% compared with the nine months ended
August 2005, primarily due to increased compensation and
benefits expenses resulting from a higher accrual of
discretionary compensation. Pre-tax earnings of
$1.89 billion increased 50% compared with the same period
last year.
Capital and Funding
Capital
The amount of capital we hold is principally determined by
regulatory capital requirements, rating agency guidelines,
subsidiary capital requirements and our overall risk profile,
which is largely driven by the size and composition of our
trading and investing positions. Goldman Sachs’ total
capital (total shareholders’ equity and long-term
borrowings) increased 27% to $162.82 billion as of August
2006 compared with $128.01 billion as of November 2005. See
“— Liquidity Risk — Cash Flows”
below for a discussion of how we deployed capital raised as part
of our financing activities.
The increase in total capital resulted primarily from an
increase in long-term borrowings to $129.33 billion as of
August 2006 from $100.01 billion as of November 2005. The
weighted average maturity of our long-term borrowings as of
August 2006 was approximately seven years. We swap a substantial
portion of our long-term borrowings into U.S. dollar
obligations with short-term floating interest rates in order to
minimize our exposure to interest rates and foreign exchange
movements. See Note 5 to the condensed consolidated
financial statements included in this Quarterly Report on
Form 10-Q for
further information regarding our long-term borrowings.
Over the past several years, our ratio of long-term borrowings
to total shareholders’ equity has been increasing. The
growth in our long-term borrowings has been driven primarily by
(i) our ability to replace a portion of our short-term
borrowings with long-term borrowings and pre-fund near-term
refinancing requirements, in light of the favorable debt
financing environment, and (ii) the need to increase total
capital in response to growth in our trading and investing
businesses.
(1)
Includes the transfer of $8 billion of money market assets
under management to interest-bearing deposits at Goldman Sachs
Bank USA, a wholly owned subsidiary of Goldman Sachs. These
deposits are not included in assets under management.
Total shareholders’ equity increased by 20% to
$33.49 billion (common equity of $30.39 billion and
preferred stock of $3.10 billion) as of August 2006 from
$28.00 billion as of November 2005. On July 24, 2006,
Goldman Sachs issued an additional 20,000 shares of
perpetual Floating Rate
Non-Cumulative
Preferred Stock, Series D. As of August 2006, Goldman Sachs
had 124,000 shares of perpetual non-cumulative preferred
stock outstanding in four series as set forth in the following
table:
Each share of preferred stock 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 our option at a
redemption price equal to $25,000 plus declared and unpaid
dividends. Dividends on each series of preferred stock, if
declared, are payable quarterly in arrears. Our ability to
declare or pay dividends on, or purchase, redeem or otherwise
acquire, our common stock is subject to certain restrictions in
the event that we fail to pay or set aside full dividends on our
preferred stock for the latest completed dividend period. All
preferred stock also has a preference over our common stock upon
liquidation.
Our common stock repurchase program is intended to maintain our
total shareholders’ equity at appropriate levels and to
substantially offset increases in share count over time
resulting from employee share-based compensation. The repurchase
program has been effected primarily through regular open-market
purchases and is influenced by, among other factors, the level
of our common shareholders’ equity, our overall capital
position, share-based awards and exercises of employee stock
options, the prevailing market price of our common stock and
general market conditions.
During the third quarter of fiscal 2006, we repurchased
3.8 million shares of our common stock at a total cost of
$573 million. In the first nine months of fiscal 2006, we
repurchased a total of 29.5 million shares of our common
stock at a total cost of $4.17 billion. The average price
paid per share for repurchased shares was $148.90 and $141.40
for the three and nine months ended August 2006, respectively.
In addition, to satisfy minimum statutory employee tax
withholding requirements related to the delivery of shares
underlying restricted stock units, we cancelled 3.0 million
restricted stock units with a total value of $375 million
during the first nine months of fiscal 2006. As of August 2006,
we were authorized to repurchase up to 13.3 million
additional shares of common stock pursuant to our repurchase
program. On September 11, 2006, the Board of Directors of
Goldman Sachs authorized the repurchase of an additional
60.0 million shares of common stock pursuant to the
existing common stock repurchase program. As of
September 11, 2006, the remaining share authorization
under our existing common stock repurchase program, including
the newly authorized amount, was 73.3 million shares. For
additional information on our repurchase program, see
“Unregistered Sales of Equity Securities and Use of
Proceeds” included in Part II, Item 2 of this
Quarterly Report on
Form 10-Q.
The following table sets forth information on our assets,
shareholders’ equity, leverage ratios and book value per
common share:
As of
August
November
2006
2005
($ in millions, except per
share amounts)
Total assets
$
798,309
$
706,804
Adjusted assets
(1)
523,465
466,500
Total shareholders’ equity
33,493
28,002
Tangible equity capital
(2)
31,495
26,030
Leverage ratio
(3)
23.8
x
25.2
x
Adjusted leverage ratio
(4)
16.6
x
17.9
x
Debt to equity ratio
(5)
3.9
x
3.6
x
Common shareholders’ equity
30,393
26,252
Tangible common shareholders’
equity
(6)
25,645
21,530
Book value per common share
(7)
$
67.87
$
57.02
Tangible book value per common
share
(8)
57.27
46.76
(1)
Adjusted assets excludes (i) low-risk collateralized assets
generally associated with our matched book and securities
lending businesses (which we calculate by adding our securities
borrowed and financial instruments purchased under agreements to
resell, and then subtracting our nonderivative short positions),
(ii) cash and securities we segregate for regulatory and
other purposes and (iii) goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets. In fiscal 2006, we amended
our calculation of adjusted assets. We no longer deduct
identifiable intangible assets associated with power contracts
and insurance-related assets. We do not deduct these assets in
order to be consistent with the calculation of tangible equity
capital and the adjusted leverage ratio. Prior periods have been
restated to conform to the current period presentation.
The following
table sets forth a reconciliation of total assets to adjusted
assets:
As of
August
November
2006
2005
(in millions)
Total assets
$
798,309
$
706,804
Deduct:
Securities borrowed
(210,190
)
(191,800
)
Financial instruments purchased
under agreements to resell
(82,958
)
(83,619
)
Add:
Financial instruments sold, but not
yet purchased, at fair value
156,557
149,071
Less derivative liabilities
(57,196
)
(57,829
)
Subtotal
99,361
91,242
Deduct:
Cash and securities segregated for
regulatory and other purposes
(76,309
)
(51,405
)
Goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets
(4,748
)
(4,722
)
Adjusted assets
$
523,465
$
466,500
(2)
Tangible equity capital equals total shareholders’ equity
and junior subordinated debt issued to a trust less goodwill and
identifiable intangible assets, excluding power contracts and
insurance-related intangible assets. We consider junior
subordinated debt issued to a trust to be a component of our
tangible equity capital base due to the inherent characteristics
of these securities, including the long-term nature of the
securities, our ability to defer coupon interest for up to ten
consecutive semiannual periods and the subordinated nature of
the obligations in our capital structure. In fiscal 2006, we
amended our calculation of tangible equity capital. We no longer
deduct identifiable intangible assets associated with power
contracts and insurance-related assets from total
shareholders’ equity, in each case because, unlike other
intangible assets, we do not hold material amounts of common
shareholders’ equity to support these assets. Prior periods
have been restated to conform to the current period presentation.
The following table sets forth the reconciliation of total
shareholders’ equity to tangible equity capital:
As of
August
November
2006
2005
(in millions)
Total shareholders’ equity
$
33,493
$
28,002
Add:
Junior subordinated debt issued to
a trust
2,750
2,750
Deduct:
Goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets
(4,748
)
(4,722
)
Tangible equity capital
$
31,495
$
26,030
(3)
Leverage ratio equals total assets divided by total
shareholders’ equity.
(4)
Adjusted leverage ratio equals adjusted assets divided by
tangible equity capital. 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 and reflects the tangible equity capital deployed
in our businesses.
(5)
Debt to equity ratio equals long-term borrowings divided by
total shareholders’ equity.
(6)
Tangible common shareholders’ equity equals total
shareholders’ equity less preferred stock, goodwill and
identifiable intangible assets, excluding power contracts and
insurance-related intangible assets. In fiscal 2006, we amended
our calculation of tangible common shareholders’ equity. We
no longer deduct identifiable intangible assets associated with
power contracts and insurance-related assets from common
shareholders’ equity, in each case because, unlike other
intangible assets, we do not hold material amounts of common
shareholders’ equity to support these assets. Prior periods
have been restated to conform to the current period presentation.
The following table sets forth a reconciliation of total
shareholders’ equity to tangible common shareholders’
equity:
As of
August
November
2006
2005
(in millions)
Total shareholders’ equity
$
33,493
$
28,002
Deduct:
Preferred stock
(3,100
)
(1,750
)
Common shareholders’ equity
30,393
26,252
Deduct:
Goodwill and identifiable
intangible assets, excluding power contracts and
insurance-related intangible assets
(4,748
)
(4,722
)
Tangible common shareholders’
equity
$
25,645
$
21,530
(7)
Book value per common share is based on common shares
outstanding, including restricted stock units granted to
employees with no future service requirements, of
447.8 million as of August 2006 and 460.4 million as
of November 2005.
(8)
Tangible book value per common share is computed by dividing
tangible common shareholders’ equity by the number of
common shares outstanding, including restricted stock units
granted to employees with no future service requirements.
Consolidated Supervised Entity
Goldman Sachs is regulated by the U.S. Securities and
Exchange Commission (SEC) as a Consolidated Supervised Entity
(CSE). As such, it is subject to group-wide supervision and
examination by the SEC and to minimum capital requirements on a
consolidated basis. As of August 2006 and November 2005,
Goldman Sachs was in compliance with the CSE capital
requirements. See Note 14 to the condensed consolidated
financial statements included in this Quarterly Report on
Form 10-Q for
further information regarding our regulated subsidiaries.
Goldman Sachs obtains short-term borrowings primarily through
the use of promissory notes, commercial paper, secured debt and
bank loans. Short-term
borrowings also include the portion of
long-term borrowings
maturing within one year of our financial statement date and
certain long-term
borrowings that are redeemable within one year of our financial
statement date at the option of the holder.
The following table sets forth our short-term borrowings:
Short-Term Borrowings
(in millions)
As of
August
November
2006
2005
Promissory notes
$
18,277
$
17,339
Commercial paper
2,437
5,154
Secured debt, bank loans and other
35,586
15,975
Current portion of secured and
unsecured long-term borrowings
16,364
16,751
Total
(1)
$
72,664
$
55,219
(1)
Short-term borrowings as of August 2006 include
$8.38 billion of hybrid financial instruments accounted for
at fair value under SFAS No. 155, “Accounting for
Certain Hybrid Financial Instruments, an amendment of FASB
Statements No. 133 and 140.”
Our liquidity depends to an important degree on our ability to
refinance these borrowings on a continuous basis. Investors who
hold our outstanding promissory notes
(short-term unsecured
debt that is nontransferable and in which Goldman Sachs does not
make a market) and commercial paper have no obligation to
purchase new instruments when the outstanding instruments mature.
The following table sets forth our secured and unsecured
short-term borrowings:
A large portion of our secured
short-term borrowings
are similar in nature to our other collateralized financing
sources such as financial instruments sold under agreements to
repurchase. These secured
short-term borrowings
provide Goldman Sachs with a more stable source of liquidity
than unsecured
short-term borrowings,
as they are less sensitive to changes in our credit ratings due
to underlying collateral. Our unsecured
short-term borrowings
include extendible debt if the earliest maturity occurs within
one year of our financial statement date. Extendible debt is
debt that allows the holder the right to extend the maturity
date at predetermined periods during the contractual life of the
instrument. These borrowings can be, and in the past generally
have been, extended. See “— Liquidity Risk”
below for a discussion of the principal liquidity policies we
have in place to manage the liquidity risk associated with our
short-term borrowings.
For a discussion of factors that could impair our ability to
access the capital markets, see “Risk Factors” in
Part I, Item 1A of the Annual Report on
Form 10-K. See
Note 4 to the condensed consolidated financial statements
included in this Quarterly Report on
Form 10-Q for
further information regarding our
short-term borrowings.
Credit Ratings
We rely upon the
short-term and
long-term debt capital
markets to fund a significant portion of our
day-to-day operations.
The cost and availability of debt financing is influenced by our
credit ratings. Credit ratings are important when we are
competing in certain markets and when we seek to engage in
longer term transactions, including OTC derivatives. 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. See “Risk Factors” in Part I,
Item 1A of the Annual Report on
Form 10-K for a
discussion of the risks associated with a reduction in our
credit ratings.
The following table sets forth our unsecured credit ratings as
of August 2006:
Short-Term Debt
Long-Term Debt
Subordinated Debt (1)
Preferred Stock
Dominion Bond Rating Service Limited
R-1 (middle)
AA (low)
Not applicable
Not applicable
Fitch, Inc.
F1+
AA-
A+
A+
Moody’s Investors Service
P-1
Aa3
A1
A2
Standard & Poor’s
A-1
A+
A
A-
(1)
During the second quarter of 2006, we issued $1.50 billion
of subordinated notes. See Note 5 to the condensed
consolidated financial statements included in this Quarterly
Report on
Form 10-Q for
further information regarding our subordinated debt.
As of August 2006, collateral or termination payments pursuant
to bilateral agreements with certain counterparties of
approximately $531 million would have been required in the
event of a one-notch
reduction in our
long-term credit
ratings. In evaluating our liquidity requirements, we consider
additional collateral or termination payments that would be
required in the event of further reductions in our
long-term credit
ratings, as well as collateral that has not been called by
counterparties, but is available to them. For a further
discussion of our excess liquidity policies, see
“— Liquidity Risk — Excess
Liquidity — Maintenance of a Pool of Highly
Liquid Securities” below.
Goldman Sachs has contractual obligations to make future
payments under
long-term debt,
long-term noncancelable
lease agreements and purchase obligations and has commitments
under a variety of commercial arrangements.
The following table sets forth our contractual obligations by
fiscal maturity date as of August 2006:
Contractual Obligations
(in millions)
Remainder
2007-
2009-
2011-
of 2006
2008
2010
Thereafter
Total
Long-term borrowings
(1) (2) (3)
$
—
$
20,218
$
27,840
$
81,273
$
129,331
Minimum rental payments
104
969
658
2,359
4,090
Purchase obligations
(4)
998
1,380
47
22
2,447
(1)
Long-term borrowings maturing within one year of our financial
statement date and certain
long-term borrowings
that are redeemable within one year of our financial statement
date at the option of the holder are included as short-term
borrowings in the condensed consolidated statements of financial
condition.
(2)
Long-term borrowings that are repayable prior to maturity at the
option of Goldman Sachs are reflected at their contractual
maturity dates.
Long-term borrowings
that are redeemable prior to maturity at the option of the
holder are reflected at the dates such options become
exercisable.
(3)
Long-term borrowings as of August 2006 include
$5.51 billion of hybrid financial instruments accounted for
at fair value under SFAS No. 155.
(4)
Primarily includes construction-related obligations.
As of August 2006, our long-term borrowings were
$129.33 billion and consisted principally of senior
borrowings with maturities extending to 2036. These
long-term borrowings
consisted of $19.55 billion in secured
long-term borrowings
and $109.78 billion in unsecured
long-term borrowings.
As of August 2006,
long-term borrowings
included nonrecourse debt of $16.41 billion, consisting of
$6.23 billion issued by William Street Funding Corporation
(a wholly owned subsidiary of Group Inc. formed to raise funding
to support loan commitments to
investment-grade
clients made by another wholly owned William Street entity), and
$10.18 billion issued by other consolidated entities, of
which $1.10 billion was related to our power generation
facilities. Nonrecourse debt is debt that only the issuing
subsidiary or, if applicable, a subsidiary guaranteeing the debt
is obligated to repay. See Note 5 to the condensed
consolidated financial statements included in this Quarterly
Report on
Form 10-Q for
further information regarding our long-term borrowings.
The following table sets forth our quarterly long-term
borrowings maturity profile through the third fiscal quarter of
2012:
Long-Term Borrowings
Maturity Profile
($ in millions)
(1)
Our long-term borrowings include extendible debt if the earliest
maturity is one year or greater from our financial statement
date. Extendible debt is categorized in the maturity profile at
the earliest possible maturity even though the debt can be, and
in the past generally has been, extended.
As of August 2006, our future minimum rental payments, net of
minimum sublease rentals, under noncancelable leases were
$4.09 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 6 to the condensed consolidated financial statements
included in this Quarterly Report on
Form 10-Q for
further information regarding 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. We may incur exit costs in fiscal
2006 and thereafter 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.
As of August 2006 and November 2005, we had
construction-related
obligations of $1.62 billion and $579 million,
respectively, including purchase obligations of
$1.26 billion and $481 million, respectively, related
to the development of wind energy projects.
Construction-related
obligations
also include outstanding purchase obligations of
$306 million and $47 million as of August 2006 and
November 2005, respectively, related to our new world
headquarters in New York City, which is expected to cost between
$2.3 billion and $2.5 billion.
As of August 2006, we had commitments to enter into forward
secured financing transactions, including certain repurchase and
resale agreements and secured borrowing and lending
arrangements, of $53.31 billion.
The following table sets forth our commitments as of August 2006:
Commitments
(in millions)
Commitment Amount by Fiscal Period of Expiration
Remainder
2007-
2009-
2011-
of 2006
2008
2010
Thereafter
Total
Commitments to extend credit
William Street program
$
383
$
2,378
$
6,551
$
8,646
$
17,958
Other commercial lending:
Investment-grade
974
3,948
2,030
4,949
11,901
Non-investment-grade
524
4,049
1,916
18,489
24,978
Warehouse financing
4,886
10,302
176
—
15,364
Total commitments to extend credit
6,767
20,677
10,673
32,084
70,201
Commitments under letters of credit
issued by banks to counterparties
2,592
3,779
2
31
6,404
Merchant banking commitments
4
38
3,719
796
4,557
Underwriting commitments
49
36
—
—
85
Total
$
9,412
$
24,530
$
14,394
$
32,911
$
81,247
Our commitments to extend credit are agreements to lend to
counterparties that have fixed termination dates and are
contingent on the satisfaction of all conditions to borrowing
set forth in the contract. In connection with our lending
activities, we had outstanding commitments to extend credit of
$70.20 billion as of August 2006 compared with
$61.12 billion as of November 2005. Since these
commitments may expire unused, the total commitment amount does
not necessarily reflect the actual future cash flow
requirements. Our commercial lending commitments outside the
William Street credit extension program are generally extended
in connection with contingent acquisition financing and other
types of corporate lending. We may reduce our credit risk on
these commitments by syndicating all or substantial portions of
commitments to other investors. In addition, commitments that
are extended for contingent acquisition financing are often
short-term in nature,
as borrowers often replace them with other funding sources.
With respect to the William Street credit extension program,
substantially all of the commitments extended are to
investment-grade
corporate borrowers. With respect to these commitments, we have
credit loss protection provided to us by SMFG, which is
generally limited to 95% of the first loss we realize on
approved loan commitments, subject to a maximum of
$1.00 billion. In addition, subject to the satisfaction of
certain conditions, upon our request, SMFG will provide
protection for 70% of the second loss on such commitments,
subject to a maximum of $1.13 billion. We also use other
financial instruments to mitigate credit risks related to
certain William Street commitments not covered by SMFG.
Our commitments to extend credit also include financing for the
warehousing of financial assets to be securitized, primarily in
connection with collateralized debt obligations (CDOs) and
mortgage securitizations, which are expected to be repaid from
the proceeds of the related securitizations for which we may or
may not act as underwriter. These arrangements are secured by
the warehoused
assets, primarily consisting of mortgage-backed and other
asset-backed securities, residential and commercial mortgages
and corporate debt instruments.
See Note 6 to the condensed consolidated financial
statements included in this Quarterly Report on
Form 10-Q for
further information regarding our commitments, contingencies and
guarantees.
Liquidity Risk
Liquidity is of critical importance to companies in the
financial services sector. Most failures of financial
institutions have occurred in large part due to insufficient
liquidity resulting from adverse circumstances. Accordingly,
Goldman Sachs has in place a comprehensive set of liquidity and
funding policies that are intended to maintain significant
flexibility to address both
firm-specific and
broader industry or market liquidity events. Our principal
objective is to be able to fund Goldman Sachs and to enable our
core businesses to continue to generate revenue even under
adverse circumstances.
Management has implemented a number of policies according to the
following liquidity risk management framework:
•
Excess Liquidity — maintain substantial excess
liquidity to meet a broad range of potential cash outflows in a
stressed environment including financing obligations.
•
Asset-Liability
Management — ensure we fund our assets with
appropriate financing.
•
Intercompany Funding — maintain parent company
liquidity and manage the distribution of liquidity across the
group structure.
•
Crisis Planning — ensure all funding and
liquidity management is based on
stress-scenario
planning and feeds into our liquidity crisis plan.
Excess Liquidity
Maintenance of a Pool of Highly Liquid Securities. Our
most important liquidity policy is to
pre-fund what we
estimate will be our likely cash needs during a liquidity crisis
and hold such excess liquidity in the form of unencumbered,
highly liquid securities that may be sold or pledged to provide
same-day liquidity.
This “Global Core Excess” liquidity is intended to
allow us to meet immediate obligations without needing to sell
other assets or depend on additional funding from
credit-sensitive
markets. We believe that this pool of excess liquidity provides
us with a resilient source of funds and gives us significant
flexibility in managing through a difficult funding environment.
Our Global Core Excess reflects the following principles:
•
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. Goldman
Sachs’ businesses are diverse, and its cash needs are
driven 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 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 larger unsecured 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 unsecured
liabilities.
The following table sets forth the average loan value (the
estimated amount of cash that would be advanced by
counterparties against these securities) of our Global Core
Excess:
Three Months
Fiscal Year
Ended
Ended
August 2006
November 2005
(in millions)
U.S. dollar-denominated
$
47,196
$
35,310
Non-U.S. dollar-denominated
10,504
11,029
Total Global Core Excess
$
57,700
$
46,339
The U.S. dollar-denominated excess is comprised of only
unencumbered U.S. government and agency securities and
highly liquid mortgage securities, all of which are Federal
Reserve repo-eligible,
as well as overnight cash deposits. Our
non-U.S. dollar-denominated
excess is comprised of only unencumbered French, German, United
Kingdom and Japanese government bonds and euro, British pound
and Japanese yen overnight cash deposits. We strictly limit our
Global Core Excess to this narrowly defined list of securities
and cash that we believe are highly liquid, even in a difficult
funding environment.
The majority of our Global Core Excess is structured such that
it is available to meet the liquidity requirements of our parent
company, Group Inc., and all of its subsidiaries. The remainder
is held in our principal
non-U.S. operating
entities, primarily to better match the currency and timing
requirements for those entities’ potential liquidity
obligations.
The size of our Global Core Excess is determined by an internal
liquidity model together with a qualitative assessment of the
condition of the financial markets and of Goldman Sachs. Our
liquidity model identifies and estimates cash and collateral
outflows over a short-term horizon in a liquidity crisis,
including, but not limited to:
•
upcoming maturities of unsecured debt and letters of credit;
•
potential buybacks of a portion of our outstanding negotiable
unsecured debt;
•
adverse changes in the terms or availability of secured funding;
•
derivatives and other margin and collateral outflows, including
those due to market moves or increased requirements;
•
additional collateral that could be called in the event of a
downgrade in our credit ratings;
•
draws on our unfunded commitments not supported by William
Street Funding
Corporation (1);
and
•
upcoming cash outflows, such as tax and other large payments.
Other Unencumbered Assets. In addition to our Global Core
Excess described above, we have a significant amount of other
unencumbered securities as a result of our business activities.
These assets, which are located in the United States, Europe and
Asia, include other government bonds, high-grade money market
securities, corporate bonds and marginable equities. We do not
include these securities in our Global Core Excess.
We maintain Global Core Excess and other unencumbered assets in
an amount that, if pledged or sold, would provide the funds
necessary to replace at least 110% of our unsecured obligations
that are scheduled to mature (or where holders have the option
to redeem) within the next 12 months. This implies that we
could fund our positions on a secured basis for one year in the
event we were unable to issue new unsecured debt or liquidate
assets. We assume conservative
(1)
The Global Core Excess excludes liquid assets held separately to
support the William Street credit extension program.
loan values that are based on stress-scenario borrowing capacity
and we regularly review these assumptions asset-by-asset. The
estimated aggregate loan value of our Global Core Excess and our
other unencumbered assets averaged $141.11 billion,
$124.56 billion and $125.36 billion in the third
quarter of 2006, second quarter of 2006 and in the fiscal year
2005, respectively.
Asset-Liability Management
Asset Quality and Balance Sheet Composition. We seek to
maintain a highly liquid balance sheet and substantially all of
our inventory is
marked-to-market daily.
We utilize aged inventory limits for certain financial
instruments as a disincentive to our businesses to hold
inventory over longer periods of time. We believe that these
limits provide a complementary mechanism for ensuring
appropriate balance sheet liquidity in addition to our standard
position limits. In addition, we periodically reduce the size of
certain parts of our balance sheet to comply with period end
limits set by management. Because of these periodic reductions
and certain other factors including seasonal activity, market
conventions and periodic market opportunities in certain of our
businesses that result in larger positions during the middle of
our reporting periods, our balance sheet fluctuates between
financial statement dates and is lower at fiscal period end than
would be observed on an average basis. Over the last six
quarters, our total assets and adjusted assets at quarter end
each would have been, on average, 5% lower than amounts that
would have been observed based on a weekly average over that
period. These differences, however, have not resulted in
material changes to our credit risk, market risk or liquidity
position because they are generally in highly liquid assets that
are typically financed on a secured basis.
Certain financial instruments may be more difficult to fund on a
secured basis during times of market stress and, accordingly, we
generally hold higher levels of capital for these assets than
more liquid types of financial instruments. The table below sets
forth our aggregate holdings in these categories of financial
instruments:
As of
August
November
2006
2005
(in millions)
Mortgage whole loans and
collateralized debt
obligations (1)
$
36,507
$
31,459
Bank
loans (2)
27,254
13,843
High-yield securities
8,318
8,822
Emerging market debt securities
2,285
1,789
SMFG convertible preferred stock
4,938
4,058
ICBC ordinary
shares (3)
2,605
—
Other corporate principal
investments (4)
3,207
1,723
Real estate principal
investments (4)
621
745
(1)
Includes certain mortgage-backed interests held in QSPEs. See
Note 3 to the condensed consolidated financial statements
included in this Quarterly Report on
Form 10-Q for
further information regarding our securitization activities.
(2)
Includes funded commitments and inventory held in connection
with our origination and secondary trading activities.
(3)
Includes economic interests of $1.65 billion as of August
2006 assumed by investment funds managed by Goldman Sachs.
(4)
Excludes assets for which Goldman Sachs is not at risk (e.g.,
assets related to consolidated merchant banking funds) of
$3.64 billion and $1.93 billion as of August 2006 and
November 2005, respectively.
A large portion of these assets are funded on a secured basis
through secured funding markets or nonrecourse financing. We
focus on demonstrating a consistent ability to fund these assets
on a secured basis for extended periods of time to reduce
refinancing risk and to help ensure that these assets have an
established amount of loan value in order that they can be
funded in periods of market stress.
See Note 3 to the condensed consolidated financial
statements included in this Quarterly Report on the
Form 10-Q for
further information regarding the financial instruments we hold.
Appropriate Financing of Asset Base. We seek to manage
the maturity profile of our funding base such that we should be
able to liquidate our assets prior to our liabilities coming
due, even in times of prolonged or severe liquidity stress. We
generally do not rely on immediate sales of assets (other than
our Global Core Excess) to maintain liquidity in a distressed
environment. However, we recognize that orderly asset sales may
be prudent and necessary in a persistent liquidity crisis.
In order to avoid reliance on asset sales, our goal is to ensure
that we have sufficient total capital (long-term borrowings plus
total shareholders’ equity) to fund our balance sheet for
at least one year. We seek to maintain total capital in excess
of the aggregate of the following long-term financing
requirements:
•
the portion of financial instruments owned that we believe could
not be funded on a secured basis in periods of market stress,
assuming conservative loan 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; and
•
capital or other forms of financing in our regulated
subsidiaries that is in excess of their long-term financing
requirements. See “— Intercompany Funding”
below for a further discussion of how we fund our subsidiaries.
Our total capital of $162.82 billion and
$128.01 billion as of August 2006 and November 2005,
respectively, exceeded the aggregate of these requirements.
Conservative Liability Structure. We structure our
liabilities conservatively to reduce refinancing risk as well as
the risk that we may redeem or repurchase certain of our
borrowings prior to their contractual maturity. For example, we
may repurchase Goldman Sachs’ commercial paper through the
ordinary course of business as a market maker. As such, we
emphasize the use of promissory notes (in which Goldman Sachs
does not make a market) over commercial paper in order to
improve the stability of our short-term unsecured financing
base. We have also created internal guidelines regarding the
principal amount of debt maturing on any one day or during any
single week or year and have average maturity targets for our
unsecured debt programs.
We seek to maintain broad and diversified funding sources
globally for both secured and unsecured funding. We have imposed
various internal guidelines, including the amount of our
commercial paper that can be owned and letters of credit that
can be issued by any single investor or group of investors. We
benefit from distributing our debt issuances through our own
sales force to a large, diverse global creditor base and we
believe that our relationships with our creditors are critical
to our liquidity.
We access funding in a variety of markets in the United States,
Europe and Asia. We issue debt through syndicated
U.S. registered offerings, U.S. registered and 144A
medium-term note programs, offshore medium-term note offerings
and other bond offerings, U.S. and
non-U.S. commercial
paper and promissory note issuances, and other methods. We make
extensive use of the repurchase agreement and securities lending
markets and arrange for letters of credit to be issued on our
behalf.
Substantially all of our unsecured debt is issued without
provisions that would, based solely upon an adverse change in
our credit ratings, financial ratios, earnings, cash flows or
stock price, trigger a requirement for an early payment,
collateral support, change in terms, acceleration of maturity or
the creation of an additional financial obligation.
Subsidiary Funding Policies. Substantially all of our
unsecured funding is raised by our parent company, Group Inc.
The parent company then lends the necessary funds to its
subsidiaries, some of which are regulated, to meet their asset
financing and capital requirements. In addition, the parent
company provides its regulated subsidiaries with the necessary
capital to meet their regulatory requirements. The benefits of
this approach to subsidiary funding include enhanced control and
greater flexibility to meet the funding requirements of our
subsidiaries.
Our intercompany funding policies are predicated on an
assumption that, unless legally provided for, funds or
securities are not freely available from a subsidiary to its
parent company or other subsidiaries. In particular, many of our
subsidiaries are subject to laws that authorize regulatory
bodies to block or limit 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
obligations, including debt obligations. As such, we assume that
capital or other financing provided to our regulated
subsidiaries is not available to our parent company or other
subsidiaries. In addition, we assume that the Global Core Excess
held in our principal
non-U.S. operating
entities will not be available to our parent company or other
subsidiaries and therefore is available only to meet the
potential liquidity requirements of those entities.
We also manage our intercompany exposure by requiring senior and
subordinated intercompany loans to have maturities equal to or
shorter than the maturities of the aggregate borrowings of the
parent company. This policy ensures that the subsidiaries’
obligations to the parent company will generally mature in
advance of the parent company’s third-party borrowings. In
addition, many of our subsidiaries and affiliates pledge
collateral at loan value to the parent company to cover their
intercompany borrowings (other than subordinated debt) in order
to mitigate parent company liquidity risk.
Equity investments in subsidiaries are generally funded with
parent company equity capital. As of August 2006, Group
Inc.’s equity investment in subsidiaries was
$29.99 billion compared with its total shareholders’
equity of $33.49 billion.
Group Inc. has provided substantial amounts of equity and
subordinated indebtedness, directly or indirectly, to its
regulated subsidiaries; for example, as of August 2006, Group
Inc. had $17.48 billion of such equity and subordinated
indebtedness invested in Goldman, Sachs & Co., its
principal U.S. registered broker-dealer;
$22.08 billion invested in Goldman Sachs International, a
regulated U.K. broker-dealer; $2.44 billion invested in
Goldman Sachs Execution & Clearing, L.P., a
U.S. registered
broker-dealer; and
$2.61 billion invested in Goldman Sachs (Japan) Ltd., a
regulated broker-dealer based in Tokyo. Group Inc. also had
$52.84 billion of unsubordinated loans to these entities as
of August 2006, as well as significant amounts of capital
invested in and loans to its other regulated subsidiaries.
Subsidiary Foreign Exchange Policies. Our capital
invested in
non-U.S. subsidiaries
is generally exposed to foreign exchange risk, substantially all
of which is hedged. In addition, we generally hedge the
non-trading exposure to foreign exchange risk that arises from
transactions denominated in currencies other than the
transacting entity’s functional currency.
In order to be prepared for a liquidity event, or a period of
market stress, we base our liquidity risk management framework
and our resulting funding and liquidity policies on conservative
stress-scenario
planning.
In addition, we maintain a liquidity crisis plan that specifies
an approach for analyzing and responding to a
liquidity-threatening event. The plan provides the framework to
estimate the likely impact of a liquidity event on Goldman Sachs
based on some of the risks identified above and outlines which
and to what extent liquidity maintenance activities should be
implemented based on the severity of the event. It also lists
the crisis management team and internal and external parties to
be contacted to ensure effective distribution of information.
Cash Flows
As a global financial institution, our cash flows are complex
and interrelated and bear little relation to our net earnings
and net assets and, 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 business.
Nine Months Ended August 2006. Our cash and cash
equivalents decreased by $198 million to
$10.06 billion as of August 2006. We raised
$44.73 billion in net cash from financing activities,
primarily in long-term debt, in light of the favorable debt
financing environment, partially offset by common stock
repurchases. We used net cash of $44.93 billion in our
operating and investing activities, primarily to capitalize on
trading and investing opportunities for ourselves and our
clients.
Nine Months Ended August 2005. Our cash and cash
equivalents increased by $2.53 billion to
$6.90 billion as of August 2005. We raised
$16.42 billion in net cash from financing activities,
primarily in long-term debt, in light of the favorable debt
financing environment, partially offset by common stock
repurchases. We used net cash of $13.89 billion in our
operating and investing activities, primarily to capitalize on
trading and investing opportunities for ourselves and our
clients.
In December 2004, the Financial Accounting Standards Board
(FASB) issued
SFAS No. 123-R,
“Share-Based Payment,” which is a revision to
SFAS No. 123, “Accounting for Stock-Based
Compensation.”
SFAS No. 123-R
focuses primarily on accounting for transactions in which an
entity obtains employee services in exchange for share-based
payments. Under SFAS No. 123-R, the cost of employee
services received in exchange for an award of equity instruments
is generally measured based on the grant-date fair value of the
award. Effective for the first quarter of 2006, we adopted
SFAS No. 123-R, under the modified prospective
adoption method. Under that method of adoption, the provisions
of
SFAS No. 123-R
are generally applied only to share-based awards granted
subsequent to adoption. The accounting treatment of share-based
awards granted to
retirement-eligible
employees prior to our adoption of SFAS No. 123-R has
not changed and financial statements for periods prior to
adoption are not restated for the effects of adopting
SFAS No. 123-R.
SFAS No. 123-R requires expected forfeitures to be
included in determining share-based employee compensation
expense. Prior to the adoption of SFAS No. 123-R,
forfeiture benefits were recorded as a reduction to compensation
expense when an employee left the firm and forfeited the award.
In the first quarter of fiscal 2006, we recorded a benefit for
expected forfeitures on all outstanding share-based awards. The
transition impact of adopting SFAS No. 123-R as of the
first day of our 2006 fiscal year, including the effect of
accruing for expected forfeitures on outstanding share-based
awards, was not material to our results of operations for that
quarter.
SFAS No. 123-R requires the immediate expensing of
share-based awards granted to retirement-eligible employees,
including awards subject to non-compete agreements. Share-based
awards granted to retirement-eligible employees prior to the
adoption of SFAS No. 123-R must continue to be
amortized over the stated service period of the award (and
accelerated if the employee actually retires). Consequently, our
compensation and benefits expenses in fiscal 2006 (and, to a
lesser extent, in fiscal 2007 and fiscal 2008) will include both
the amortization (and acceleration) of awards granted to
retirement-eligible employees prior to the adoption of
SFAS No. 123-R as well as the full grant-date fair
value of new awards granted to such employees under
SFAS No. 123-R. The estimated annual non-cash expense
in fiscal 2006 associated with the continued amortization of
share-based awards granted to retirement-eligible employees
prior to the adoption of SFAS No. 123-R is
approximately $650 million, of which $133 million and
$508 million were recognized in the three and nine months
ended August 2006, respectively.
In June 2005, the EITF reached consensus on Issue No. 04-5,
“Determining Whether a General Partner, or the General
Partners as a Group, Controls a Limited Partnership or Similar
Entity When the Limited Partners Have Certain Rights,”
which requires general partners (or managing members in the case
of limited liability companies) to consolidate their
partnerships or to provide limited partners with rights to
remove the general partner or to terminate the partnership.
Goldman Sachs, as the general partner of numerous merchant
banking and asset management partnerships, is required to adopt
the provisions of EITF Issue
No. 04-5
(i) immediately for partnerships formed or modified after
June 29, 2005 and (ii) in the first quarter of fiscal
2007 for partnerships formed on or before June 29, 2005
that have not been modified. We generally expect to provide
limited partners in these funds with rights to remove Goldman
Sachs as the general partner or to terminate the partnerships
and, therefore, do not expect that EITF Issue
No. 04-5 will have
a material effect on our financial condition, results of
operations or cash flows.
In February 2006, the FASB issued SFAS No. 155,
“Accounting for Certain Hybrid Financial
Instruments — an amendment of FASB Statements
No. 133 and 140.” SFAS No. 155 permits an
entity to measure at fair value any financial instrument that
contains an embedded derivative that otherwise would require
bifurcation. As permitted, we early adopted
SFAS No. 155 in the first quarter of fiscal 2006.
Adoption did not have a material effect on our financial
condition, results of operations or cash flows.
Effective for the first quarter of fiscal 2006, we adopted
SFAS No. 156, “Accounting for Servicing of
Financial Assets — an amendment of FASB Statement
No. 140,” which permits entities
to elect to measure servicing assets and servicing liabilities
at fair value and report changes in fair value in earnings.
Goldman Sachs acquires residential mortgage servicing rights in
connection with its mortgage securitization activities and has
elected under SFAS No. 156 to account for these
servicing rights at fair value. Adoption did not have a material
effect on our financial condition, results of operations or cash
flows.
In April 2006, the FASB issued FASB Staff Position
(FSP) FIN No. 46-R-6, “Determining the
Variability to Be Considered in Applying FASB Interpretation
No. 46-R.” This FSP addresses how a reporting
enterprise should determine the variability to be considered in
applying FIN No. 46-R by requiring an analysis of the
purpose for which an entity was created and the variability that
the entity was designed to create. This FSP must be applied
prospectively to all entities with which a reporting enterprise
first becomes involved and to all entities previously required
to be analyzed under FIN No. 46-R when a
reconsideration event has occurred. As permitted, we early
adopted FSP FIN No. 46-R-6 in the third quarter of
fiscal 2006. Adoption did not have a material effect on our
financial condition, results of operations or cash flows.
In June 2006, the FASB issued FIN No. 48,
“Accounting for Uncertainty in Income Taxes — an
Interpretation of FASB Statement No. 109.”
FIN No. 48 requires that management determine whether
a tax position is more likely than not to be sustained upon
examination, including resolution of any related appeals or
litigation processes, based on the technical merits of the
position. Once it is determined that a position meets this
recognition threshold, the position is measured to determine the
amount of benefit to be recognized in the financial statements.
We expect to adopt the provisions of FIN No. 48
beginning in the first quarter of fiscal 2008. We are currently
evaluating the impact of adopting FIN No. 48 on our
financial condition, results of operations and cash flows.
In September 2006, the FASB issued SFAS No. 157,
“Fair Value Measurements.” SFAS No. 157
clarifies that fair value is the amount that would be exchanged
to sell an asset or transfer a liability, in an orderly
transaction between market participants. SFAS No. 157
nullifies the consensus reached in EITF Issue
No. 02-3
prohibiting the recognition of day one gain or loss on
derivative contracts (and hybrid instruments measured at fair
value under SFAS No. 133 as modified by SFAS No. 155)
where we cannot verify all of the significant model inputs to
observable market data and verify the model to market
transactions. However, SFAS No. 157 requires that a
fair value measurement technique include an adjustment for risks
inherent in a particular valuation technique (such as a pricing
model) and/or the risks inherent in the inputs to the model, if
market participants would also include such an adjustment. In
addition, SFAS No. 157 prohibits the recognition of
“block discounts” for large holdings of unrestricted
financial instruments where quoted prices are readily and
regularly available in an active market. The provisions of
SFAS No. 157 are to be applied prospectively, except
for changes in fair value measurements that result from the
initial application of SFAS No. 157 to existing
derivative financial instruments measured under EITF Issue
No. 02-3, existing
hybrid instruments measured at fair value, and block discounts,
which are to be recorded as an adjustment to opening retained
earnings in the year of adoption. SFAS No. 157 is
effective for fiscal years beginning after November 15,2007. We are evaluating whether we will early adopt
SFAS No. 157 as of the first quarter of fiscal 2007 as
permitted, and are currently evaluating the impact adoption may
have on our financial condition, results of operations and cash
flows.
In September 2006, the FASB issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106 and
132-R.” SFAS
No. 158 requires an entity to recognize in its statement of
financial condition the funded status of its defined benefit
postretirement plans, measured as the difference between the
fair value of the plan assets and the benefit obligation. SFAS
No. 158 also requires an entity to recognize changes in the
funded status of a defined benefit postretirement plan within
accumulated other comprehensive income, net of tax, to the
extent such changes are not recognized in earnings as components
of periodic net benefit cost. SFAS No. 158 is effective as
of the end of the fiscal year ending after
December 15, 2006. We will adopt SFAS No. 158 as
of the end of fiscal 2007. We do not expect that the adoption of
SFAS No. 158 will have a material effect on our financial
condition, results of operations or cash flows.
Cautionary Statement Pursuant to the Private Securities
Litigation Reform Act of 1995
We have included in Parts I and II of this Quarterly Report on
Form 10-Q, and
from time to time our management may make, statements which may
constitute “forward-looking statements” within the
meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements
are not historical facts but instead represent only our belief
regarding future events, many of which, by their nature, are
inherently uncertain and outside our control. It is possible
that our actual results may differ, possibly materially, from
the anticipated results indicated in these forward-looking
statements. Important factors that could cause actual results to
differ from those in our specific forward-looking statements
include, but are not limited to, those discussed under
“Risk Factors” in Part I, Item 1A of the
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 that we expect
to 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 in general economic
conditions, 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 adverse development with respect
to a party to the transaction or a failure to obtain a required
regulatory approval. Other important factors that could
adversely affect our investment banking transactions are
described under “Risk Factors” in Part I,
Item 1A of the Annual Report on
Form 10-K.
Item 3: Quantitative and Qualitative Disclosures About
Market Risk
In addition to applying business judgment, senior management
uses a number of quantitative tools to manage our exposure to
market risk for “Financial instruments owned, at fair
value” and “Financial instruments sold, but not yet
purchased, at fair value” in the condensed consolidated
statements of financial condition. These tools include:
•
risk limits based on a summary measure of market risk exposure
referred to as Value-at-Risk (VaR);
•
scenario analyses, stress tests and other analytical tools that
measure the potential effects on our trading net revenues of
various market events, including, but not limited to, a large
widening of credit spreads, a substantial decline in equity
markets and significant moves in selected emerging
markets; and
•
inventory position limits for selected business units.
See “Quantitative and Qualitative Disclosures About Market
Risk” in Part II, Item 7A of the Annual Report on
Form 10-K for a
description of our risk management policies and procedures.
VaR
VaR is the potential loss in value of Goldman Sachs’
trading positions due to adverse market movements over a defined
time horizon with a specified confidence level.
For the VaR numbers reported below, a one-day time horizon and a
95% confidence level were used. This means that there is a 1 in
20 chance that daily trading net revenues will fall below the
expected daily trading net revenues by an amount at least as
large as the reported VaR. Thus, shortfalls from expected
trading net revenues on a single trading day greater than the
reported VaR would be anticipated to occur, on average, about
once a month. Shortfalls on a single day can exceed reported VaR
by significant amounts. Shortfalls can also accumulate over a
longer time horizon such as a number of consecutive trading days.
The modeling of the risk characteristics of our trading
positions involves a number of assumptions and approximations.
While management believes that these assumptions and
approximations are reasonable, there is no standard methodology
for estimating VaR, and different assumptions and/or
approximations could produce materially different VaR estimates.
We use historical data to estimate our VaR and, to better
reflect current asset volatilities, we generally weight
historical data to give greater importance to more recent
observations. 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. An inherent limitation of VaR is that the
distribution of past changes in market risk factors may not
produce accurate predictions of future market risk. Different
VaR methodologies and distributional assumptions could produce a
materially different VaR. Moreover, VaR calculated for a one-day
time horizon does not fully capture the market risk of positions
that cannot be liquidated or offset with hedges within one day.
Changes in VaR between reporting periods are generally due to
changes in levels of exposure, volatilities and/or correlations
among asset classes.
Beginning in the first quarter of 2006, we excluded from our
calculation certain equity positions generally due to their
transfer restrictions or illiquidity. The effect of excluding
these positions was not material to prior periods and,
accordingly, such periods have not been adjusted. For a further
discussion of the market risk associated with these positions,
see “— Other Market Risk Measures” below.
(2)
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.
The following chart presents our daily VaR during the last four
quarters:
Substantially all of our inventory positions are
marked-to-market on a
daily basis and changes are recorded in net revenues. The
following chart sets forth the frequency distribution of our
daily trading net revenues for substantially all inventory
positions included in VaR for the quarter ended August 2006:
Daily Trading Net Revenues
($ in millions)
As part of our overall risk control process, daily trading net
revenues are compared with VaR calculated as of the end of the
prior business day. Trading losses incurred on a single day did
not exceed our 95% one-day VaR during the quarter ended August
2006.
Other Market Risk Measures
Certain portfolios and individual positions are not included in
VaR, where VaR is not the most appropriate measure of risk
(e.g., due to transfer restrictions and/or illiquidity). The
market risk related to our investment in the convertible
preferred stock of SMFG is measured by estimating the potential
reduction in net revenues associated with a 10% decline in the
SMFG common stock price. The market risk related to the
remaining positions is measured by estimating the potential
reduction in net revenues associated with a 10% decline in asset
values.
The sensitivity analyses for equity and debt positions in our
trading portfolio and equity, debt (primarily mezzanine
instruments) and real estate positions in our non-trading
portfolio are measured by the impact of a decline in the asset
values (including the impact of leverage in the underlying
investments for real estate positions in our non-trading
portfolio) of such positions. The fair values of the underlying
positions may be sensitive to changes in a number of factors,
including, but not limited to, the financial performance of the
companies or properties relative to budgets or projections, the
projected timing and amount of future cash flows, discount
rates, trends within sectors and/or regions, underlying business
models and equity prices.
The sensitivity analysis of our investment in the convertible
preferred stock of SMFG, net of the economic hedge on the
unrestricted shares of common stock underlying a portion of our
investment, is measured by the impact of a decline in the SMFG
common stock price. This sensitivity should not be extrapolated
to other movements in the SMFG common stock price, as the
relationship between the fair value of our investment and the
SMFG common stock price is nonlinear.
The following table sets forth market risk for positions not
included in VaR. These measures do not reflect diversification
benefits across asset categories and, given the differing
likelihood of such events occurring, these measures have not
been aggregated:
Amount
Amount
As of
As of
Asset Categories
10% Sensitivity Measure
August 2006
May 2006
(in millions)
Trading Risk
Equity
Underlying asset value
$
307
$
224
Debt
Underlying asset value
718
705
Non-trading Risk
SMFG
SMFG common stock price
193
231
Other Equity
Underlying asset value
403
373
Debt
Underlying asset value
142
96
Real Estate
Underlying asset value
243
201
The increase in market risk in the third quarter of 2006 for
equity positions in our trading portfolio was due to an increase
in the fair value of the portfolio as well as new investments.
The increase in market risk in the third quarter of 2006 for
debt positions in our trading portfolio and equity, debt and
real estate positions in our non-trading portfolio was primarily
due to new investments.
The decrease in market risk in the third quarter of 2006 for
SMFG was primarily due to the impact of additional hedging with
respect to the second one-third installment of unrestricted
shares underlying our investment, partially offset by the impact
of an increase in the SMFG common stock price and the passage of
time in respect of the transfer restrictions on the underlying
common stock.
Derivatives
Derivative contracts are instruments, such as futures, forwards,
swaps or option contracts, that derive their value from
underlying assets, indices, reference rates or a combination of
these factors. Derivative instruments may be privately
negotiated contracts, which are often referred to as OTC
derivatives, or they may be listed and traded on an exchange.
Substantially all of our derivative transactions are entered
into for trading purposes, to facilitate client transactions, to
take proprietary positions or as a means of risk management. In
addition to derivative transactions entered into for trading
purposes, we enter into derivative contracts to hedge our net
investment in
non-U.S. operations,
to hedge certain forecasted transactions and to manage the
interest rate and currency exposure on a substantial portion of
our long-term borrowings and certain short-term borrowings.
Derivatives are used in many of our businesses, and we believe
that the associated market risk can only be understood relative
to all of the underlying assets or risks being hedged, or as
part of a broader trading strategy. Accordingly, the market risk
of derivative positions is managed together with our
nonderivative positions.
Fair values of our derivative contracts are reflected net of
cash paid or received pursuant to credit support agreements and
are reported on a net-by-counterparty basis in our condensed
consolidated statements of financial condition when management
believes a legal right of setoff exists under an enforceable
netting agreement. For an OTC derivative, our credit exposure is
directly with our counterparty and continues until the maturity
or termination of such contract.
The following table sets forth the distribution, by credit
rating, of substantially all of our exposure with respect to OTC
derivatives as of August 2006, after taking into consideration
the effect of netting agreements. The categories shown reflect
our internally determined public rating agency equivalents.
Over-the-Counter
Derivative Credit Exposure
($ in millions)
Exposure
Percentage of
Collateral
Net of
Total Exposure
Credit Rating Equivalent
Exposure (1)
Held
Collateral
Net of Collateral
AAA/ Aaa
$
5,108
$
430
$
4,678
13
%
AA/ Aa2
10,009
2,006
8,003
23
A/ A2
13,167
3,720
9,447
27
BBB/ Baa2
9,494
3,167
6,327
18
BB/ Ba2 or lower
8,989
3,286
5,703
16
Unrated
1,679
539
1,140
3
Total
$
48,446
$
13,148
$
35,298
100
%
(1)
Net of cash received pursuant to credit support agreements of
$22.24 billion.
The following tables set forth our OTC derivative credit
exposure, net of collateral, by remaining contractual maturity:
Where we have obtained collateral from a counterparty under a
master trading agreement that covers multiple products and
transactions, we have allocated the collateral ratably based on
exposure before giving effect to such collateral.
Derivative transactions may also involve legal risks including
the risk that they are not authorized or appropriate for a
counterparty, that documentation has not been properly executed
or that executed agreements may not be enforceable against the
counterparty. We attempt to minimize these risks by obtaining
advice of counsel on the enforceability of agreements as well as
on the
authority of a counterparty to effect the derivative
transaction. In addition, certain derivative transactions
involve the risk that we may have difficulty obtaining, or be
unable to obtain, the underlying security or obligation in order
to satisfy any physical settlement requirement or that the
derivative may have been assigned to a different counterparty
without our knowledge or consent.
Item 4: Controls and Procedures
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). 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 Securities Exchange Act of 1934) occurred during our
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control
over financial reporting.
The following supplements and amends our discussion set forth
under “Legal Proceedings” in Part I, Item 3
of our Annual Report on
Form 10-K for the
fiscal year ended November 25, 2005, as updated by our
Quarterly Reports on
Form 10-Q for the
quarters ended February 24, 2006 and May 26, 2006.
Iridium Securities Litigation
By a decision dated September 15, 2006, the federal
district court denied the underwriter defendants’ motion
for summary judgment as to claims under Section 11 of the
Securities Act of 1933, but granted summary judgment dismissing
claims under Section 12(2) of the Securities Act against
Goldman, Sachs & Co. and all but one of the other
underwriter defendants.
Research Independence Matters
On July 7, 2006, defendants moved to dismiss the second
amended complaint in the action relating to research coverage of
Exodus Communications, Inc.
In the lawsuit alleging that The Goldman Sachs Group, Inc.,
Goldman, Sachs & Co. and Henry M. Paulson, Jr. violated
the federal securities laws in connection with the firm’s
research activities, the district court, in a decision dated
September 29, 2006, granted Mr. Paulson’s motion
to dismiss with leave to replead but otherwise denied the motion.
Exodus Securities Litigation
In the class action relating to certain securities offerings by
Exodus Communications, Inc., by a decision dated August 14,2006 the district court denied the motion to intervene by two
proposed new plaintiffs and entered judgment dismissing the
action. On August 30, 2006, the proposed new plaintiffs
moved to vacate the judgment.
Refco Securities Litigation
In the action brought on behalf of customers that held
securities custodied with certain Refco Inc. affiliates,
Goldman, Sachs & Co. and other underwriters of
Refco’s initial public offering were not included as
defendants in the amended complaint filed on September 5,2006.
Fannie Mae Litigation
Goldman, Sachs & Co. has been added as a defendant in
amended complaints filed on August 14, 2006 and
September 1, 2006, respectively, in a purported class
action and a separate shareholder derivative action pending in
the U.S. District Court for the District of Columbia, which
generally arise from allegations concerning Fannie Mae’s
accounting practices. The complaints’ allegations relating
to Goldman, Sachs & Co. assert violations of the
federal securities laws and common law in connection with
certain Fannie Mae-sponsored REMIC transactions that were
allegedly arranged by Goldman, Sachs & Co. The other
defendants include Fannie Mae, certain of its past and present
officers and directors, accountants and other financial services
firms.
Unregistered Sales of Equity Securities and Use of
Proceeds
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 August 25, 2006.
Goldman Sachs generally does not repurchase shares of its common
stock as part of the repurchase program during
self-imposed
“black-out”
periods, which run from the last two weeks of a fiscal quarter
through the date of the earnings release for such quarter.
(2)
On March 21, 2000, we announced that our Board of Directors
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
220 million shares by resolutions of our Board of Directors
adopted on June 18, 2001, March 18, 2002,
November 20, 2002, January 30, 2004,
January 25, 2005, September 16, 2005 and
September 11, 2006. The repurchase program is intended
to maintain our total shareholders’ equity at appropriate
levels and to substantially offset increases in share count over
time resulting from employee
share-based
compensation. The repurchase program has been effected primarily
through regular
open-market purchases
and is influenced by, among other factors, the level of our
common shareholders’ equity, our overall capital position,
share-based awards and
exercises of employee stock options, the prevailing market price
of our common stock and general market conditions. The total
remaining authorization under the repurchase program was
68,960,284 shares as of September 22, 2006; the
repurchase program has no set expiration or termination date.
Goldman, Sachs & Co.
Executive Life Insurance Policy and Certificate with
Metropolitan Life Insurance Company for Participating Managing
Directors.
10.2
Form of Goldman, Sachs &
Co. Executive Life Insurance Policy with Pacific Life &
Annuity Company for Participating Managing Directors, including
policy specifications and form of restriction on Policy
Owner’s Rights.
12.1
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.
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.