10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

or

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                             to

  

Commission File Number: 001-14965

The Goldman Sachs Group, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware
  13-4019460

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

200 West Street, New York, N.Y.   10282
(Address of principal executive offices)   (Zip Code)

(212) 902-1000

(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 ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer  x                    Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)        Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes x No

APPLICABLE ONLY TO CORPORATE ISSUERS

As of April 26, 2013, there were 458,505,280 shares of the registrant’s common stock outstanding.

 


Table of Contents

THE GOLDMAN SACHS GROUP, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2013

 

INDEX

 

Form 10-Q Item Number

  Page No.
 

PART I

 

FINANCIAL INFORMATION

  2
 

Item 1

 

Financial Statements (Unaudited)

  2
 

Condensed Consolidated Statements of Earnings for the three months ended March 31,  2013 and March 31, 2012

  2
 
 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31,  2013 and March 31, 2012

  3
 
 

Condensed Consolidated Statements of Financial Condition as of March 31,  2013 and December 31, 2012

  4
 
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2013 and year ended December 31, 2012

  5
 
 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31,  2013 and March 31, 2012

  6
 
 

Notes to Condensed Consolidated Financial Statements

  7
 
 

Note 1.        Description of Business

  7
 
 

Note 2.        Basis of Presentation

  7
 
 

Note 3.        Significant Accounting Policies

  8
 
 

Note 4.         Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

  13
 
 

Note 5.        Fair Value Measurements

  14
 
 

Note 6.        Cash Instruments

  16
 
 

Note 7.        Derivatives and Hedging Activities

  25
 
 

Note 8.        Fair Value Option

  41
 
 

Note 9.        Collateralized Agreements and Financings

  50
 
 

Note 10.      Securitization Activities

  56
 
 

Note 11.      Variable Interest Entities

  59
 
 

Note 12.      Other Assets

  64
 
 

Note 13.      Goodwill and Identifiable Intangible Assets

  65
 
 

Note 14.      Deposits

  67
 
 

Note 15.      Short-Term Borrowings

  68
 
 

Note 16.      Long-Term Borrowings

 

69

 
 

Note 17.      Other Liabilities and Accrued Expenses

  72
 
 

Note 18.      Commitments, Contingencies and Guarantees

  73
 
 

Note 19.      Shareholders’ Equity

 

79

 
 

Note 20.      Regulation and Capital Adequacy

  82
 
 

Note 21.      Earnings Per Common Share

  87
 
 

Note 22.      Transactions with Affiliated Funds

 

88

 
 

Note 23.      Interest Income and Interest Expense

 

89

 
 

Note 24.      Income Taxes

 

89

 
 

Note 25.      Business Segments

  90
 
 

Note 26.      Credit Concentrations

  94
 
 

Note 27.      Legal Proceedings

  95
 
 

Report of Independent Registered Public Accounting Firm

  108
 
 

Statistical Disclosures

  109
 

Item 2

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  111
 

Item 3

 

Quantitative and Qualitative Disclosures About Market Risk

  179
 

Item 4

 

Controls and Procedures

  179
 

PART II

 

OTHER INFORMATION

  179
 

Item 1

 

Legal Proceedings

  179
 

Item 2

 

Unregistered Sales of Equity Securities and Use of Proceeds

  180
 

Item 6

 

Exhibits

  181
 

SIGNATURES

  182

 

    Goldman Sachs March 2013 Form 10-Q   1


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements (Unaudited)

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)

 

   

Three Months

Ended March

 
in millions, except per share amounts     2013         2012   

Revenues

    

Investment banking

    $  1,568         $1,160   
   

Investment management

    1,250         1,105   
   

Commissions and fees

    829         860   
   

Market making

    3,437         3,905   
   

Other principal transactions

    2,081         1,938   

Total non-interest revenues

    9,165         8,968   
   

 

Interest income

    2,608         2,833   
   

Interest expense

    1,683         1,852   

Net interest income

    925         981   

Net revenues, including net interest income

    10,090         9,949   

 

Operating expenses

    

Compensation and benefits

    4,339         4,378   
   

 

Brokerage, clearing, exchange and distribution fees

    561         567   
   

Market development

    141         117   
   

Communications and technology

    188         196   
   

Depreciation and amortization

    302         433   
   

Occupancy

    218         212   
   

Professional fees

    246         234   
   

Insurance reserves

    127         157   
   

Other expenses

    595         474   

Total non-compensation expenses

    2,378         2,390   

Total operating expenses

    6,717         6,768   

 

Pre-tax earnings

    3,373         3,181   
   

Provision for taxes

    1,113         1,072   

Net earnings

    2,260         2,109   
   

Preferred stock dividends

    72         35   

Net earnings applicable to common shareholders

    $  2,188         $2,074   

 

Earnings per common share

    

Basic

    $    4.53         $  4.05   
   

Diluted

    4.29         3.92   
   

 

Dividends declared per common share

    $    0.50         $  0.35   
   

 

Average common shares outstanding

    

Basic

    482.1         510.8   
   

Diluted

    509.8         529.2   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

   

Three Months

Ended March

 
in millions     2013         2012   

Net earnings

    $2,260         $2,109   
   

Other comprehensive income/(loss), net of tax:

    

Currency translation adjustment, net of tax

    (26      (28
   

Pension and postretirement liability adjustments, net of tax

    (4      7   
   

Net unrealized gains on available-for-sale securities, net of tax

    15         30   

Other comprehensive income/(loss)

    (15      9   

Comprehensive income

    $2,245         $2,118   

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

    Goldman Sachs March 2013 Form 10-Q   3


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

    As of  
in millions, except share and per share amounts    

 

March

2013

  

  

    

 

December

2012

  

  

Assets

    

Cash and cash equivalents

    $  63,333         $  72,669   
   

Cash and securities segregated for regulatory and other purposes (includes $22,676 and $30,484 at fair value as of March 2013 and December 2012, respectively)

    41,044         49,671   
   

Collateralized agreements:

    

Securities purchased under agreements to resell and federal funds sold (includes $158,283 and $141,331 at fair value as of March 2013 and December 2012, respectively)

    158,506         141,334   
   

Securities borrowed (includes $54,879 and $38,395 at fair value as of March 2013 and December 2012, respectively)

    172,041         136,893   
   

Receivables from brokers, dealers and clearing organizations

    20,501         18,480   
   

Receivables from customers and counterparties (includes $7,154 and $7,866 at fair value as of March 2013 and December 2012, respectively)

    77,917         72,874   
   

Financial instruments owned, at fair value (includes $67,891 and $67,177 pledged as collateral as of March 2013 and December 2012, respectively)

    387,393         407,011   
   

Other assets (includes $13,448 and $13,426 at fair value as of March 2013 and December 2012, respectively)

    38,488         39,623   

Total assets

    $959,223         $938,555   

 

Liabilities and shareholders’ equity

    

Deposits (includes $7,070 and $5,100 at fair value as of March 2013 and December 2012, respectively)

    $  72,685         $  70,124   
   

Collateralized financings:

    

Securities sold under agreements to repurchase, at fair value

    155,356         171,807   
   

Securities loaned (includes $2,423 and $1,558 at fair value as of March 2013 and December 2012, respectively)

    20,669         13,765   
   

Other secured financings (includes $28,482 and $30,337 at fair value as of March 2013 and
December 2012, respectively)

    29,468         32,010   
   

Payables to brokers, dealers and clearing organizations

    6,949         5,283   
   

Payables to customers and counterparties

    196,578         189,202   
   

Financial instruments sold, but not yet purchased, at fair value

    153,749         126,644   
   

Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $18,298 and $17,595 at fair value as of March 2013 and December 2012, respectively)

    40,980         44,304   
   

Unsecured long-term borrowings (includes $12,248 and $12,593 at fair value as of March 2013 and December 2012, respectively)

    167,008         167,305   
   

Other liabilities and accrued expenses (includes $11,842 and $12,043 at fair value as of March 2013 and December 2012, respectively)

    38,553         42,395   

Total liabilities

    881,995         862,839   
   

 

Commitments, contingencies and guarantees

    

 

Shareholders’ equity

    

Preferred stock, par value $0.01 per share; aggregate liquidation preference of $6,200 as of both March 2013 and December 2012

    6,200         6,200   
   

Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 822,358,425 and 816,807,400 shares issued as of March 2013 and December 2012, respectively, and 460,782,218 and 465,148,387 shares outstanding as of March 2013 and December 2012, respectively

    8         8   
   

Restricted stock units and employee stock options

    3,679         3,298   
   

Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding

              
   

Additional paid-in capital

    48,732         48,030   
   

Retained earnings

    67,164         65,223   
   

Accumulated other comprehensive loss

    (208      (193
   

Stock held in treasury, at cost, par value $0.01 per share; 361,576,209 and 351,659,015 shares as of March 2013 and December 2012, respectively

    (48,347      (46,850

Total shareholders’ equity

    77,228         75,716   

Total liabilities and shareholders’ equity

    $959,223         $938,555   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

        Three Months Ended         Year Ended  
in millions        

 

March

2013

  

  

       

 

December

2012

  

  

Preferred stock

       

Balance, beginning of year

      $   6,200          $   3,100   
   

Issued

                   3,100   

Balance, end of period

      6,200          6,200   
   

Common stock

       

Balance, beginning of year

      8          8   
   

Issued

                     

Balance, end of period

      8          8   
   

Restricted stock units and employee stock options

       

Balance, beginning of year

      3,298          5,681   
   

Issuance and amortization of restricted stock units and employee stock options

      1,502          1,368   
   

Delivery of common stock underlying restricted stock units

      (1,099       (3,659
   

Forfeiture of restricted stock units and employee stock options

      (18       (90
   

Exercise of employee stock options

        (4         (2

Balance, end of period

      3,679          3,298   
   

Additional paid-in capital

       

Balance, beginning of year

      48,030          45,553   
   

Delivery of common stock underlying share-based awards

      1,102          3,939   
   

Cancellation of restricted stock units in satisfaction of withholding tax requirements

      (458       (1,437
   

Preferred stock issuance costs

               (13
   

Excess net tax benefit/(provision) related to share-based awards

      58          (11
   

Cash settlement of share-based compensation

                   (1

Balance, end of period

      48,732          48,030   
   

Retained earnings

       

Balance, beginning of year

      65,223          58,834   
   

Net earnings

      2,260          7,475   
   

Dividends and dividend equivalents declared on common stock and restricted stock units

      (247       (903
   

Dividends declared on preferred stock

        (72         (183

Balance, end of period

      67,164          65,223   
   

Accumulated other comprehensive loss

       

Balance, beginning of year

      (193       (516
   

Other comprehensive income/(loss)

        (15         323   

Balance, end of period

      (208       (193
   

Stock held in treasury, at cost

       

Balance, beginning of year

      (46,850       (42,281
   

Repurchased

      (1,525       (4,637
   

Reissued

      38          77   
   

Other

        (10         (9

Balance, end of period

        (48,347         (46,850

Total shareholders’ equity

        $ 77,228            $ 75,716   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

    Goldman Sachs March 2013 Form 10-Q   5


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   

Three Months

Ended March

 
in millions     2013         2012   

Cash flows from operating activities

    

Net earnings

    $   2,260         $   2,109   
   

Adjustments to reconcile net earnings to net cash provided by/(used for) operating activities

    

Depreciation and amortization

    302         433   
   

Share-based compensation

    1,509         643   
   

Changes in operating assets and liabilities

    

Cash and securities segregated for regulatory and other purposes

    8,527         11,165   
   

Net receivables from brokers, dealers and clearing organizations

    (339      (2,671
   

Net payables to customers and counterparties

    3,356         7,290   
   

Securities borrowed, net of securities loaned

    (28,245      (14,813
   

Securities sold under agreements to repurchase, net of securities purchased under agreements to resell and federal funds sold

    (33,576      15,328   
   

Financial instruments owned, at fair value

    20,028         (22,023
   

Financial instruments sold, but not yet purchased, at fair value

    27,227         6,304   
   

Other, net

    (6,747      11   

Net cash provided by/(used for) operating activities

    (5,698      3,776   
   

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (171      (390
   

Proceeds from sales of property, leasehold improvements and equipment

    17         13   
   

Business acquisitions, net of cash acquired

    (160      (39
   

Proceeds from sales of investments

    526         130   
   

Purchase of available-for-sale securities

    (501      (653
   

Proceeds from sales of available-for-sale securities

    709         699   
   

Loans held for investment, net

    (1,373      (238

Net cash used for investing activities

    (953      (478
   

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    (435      (869
   

Other secured financings (short-term), net

    (4,824      (483
   

Proceeds from issuance of other secured financings (long-term)

    1,829         798   
   

Repayment of other secured financings (long-term), including the current portion

    (969      (4,334
   

Proceeds from issuance of unsecured long-term borrowings

    13,069         9,358   
   

Repayment of unsecured long-term borrowings, including the current portion

    (12,530      (11,134
   

Derivative contracts with a financing element, net

    380         208   
   

Deposits, net

    2,562         4,765   
   

Common stock repurchased

    (1,525      (365
   

Dividends and dividend equivalents paid on common stock, preferred stock and restricted stock units

    (319      (220
   

Proceeds from issuance of common stock, including stock option exercises

    14         39   
   

Excess tax benefit related to share-based compensation

    63         70   
   

Cash settlement of share-based compensation

            (1

Net cash used for financing activities

    (2,685      (2,168

Net increase/(decrease) in cash and cash equivalents

    (9,336      1,130   
   

Cash and cash equivalents, beginning of year

    72,669         56,008   

Cash and cash equivalents, end of period

    $ 63,333         $ 57,138   

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $1.96 billion and $4.04 billion during the three months ended March 2013 and March 2012, respectively.

Cash payments for income taxes, net of refunds were $464 million during the three months ended March 2013. Income tax refunds, net of cash payments were $29 million during the three months ended March 2012.

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 1. Description of Business

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 financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

The firm reports its activities in the following four business segments:

Investment Banking

The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds and governments. Services include strategic advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, risk management, restructurings and spin-offs, and debt and equity underwriting of public offerings and private placements, including domestic and cross-border transactions, as well as derivative transactions directly related to these activities.

Institutional Client Services

The firm facilitates client transactions and makes markets in fixed income, equity, currency and commodity products, primarily with institutional clients such as corporations, financial institutions, investment funds and governments. The firm also makes markets in and clears client transactions on major stock, options and futures exchanges worldwide and provides financing, securities lending and other prime brokerage services to institutional clients.

Investing & Lending

The firm invests in and originates loans to provide financing to clients. These investments and loans are typically longer-term in nature. The firm makes investments, directly and indirectly through funds that the firm manages, in debt securities and loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities.

Investment Management

The firm provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. The firm also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.

 

 

Note 2. Basis of Presentation

Note 2.

Basis of Presentation

These condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. Intercompany transactions and balances have been eliminated.

These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the firm’s Annual Report on Form 10-K for the year ended December 31, 2012. References to “the firm’s Annual Report on Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2012. The condensed consolidated financial information as of December 31, 2012 has been derived from audited consolidated financial statements not included herein.

These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.

All references to March 2013 and March 2012 refer to the firm’s periods ended, or the dates, as the context requires, March 31, 2013 and March 31, 2012, respectively. All references to December 2012 refer to the date December 31, 2012. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

 

 

    Goldman Sachs March 2013 Form 10-Q   7


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 3. Significant Accounting Policies

Note 3.

Significant Accounting Policies

 

The firm’s significant accounting policies include when and how to measure the fair value of assets and liabilities, accounting for goodwill and identifiable intangible assets, and when to consolidate an entity. See Notes 5 through 8 for policies on fair value measurements, Note 13 for policies on goodwill and identifiable intangible assets, and below and Note 11 for policies on consolidation accounting. All other significant accounting policies are either discussed below or included in the following footnotes:

 

Financial Instruments Owned, at Fair Value

and Financial Instruments Sold, But Not Yet

Purchased, at Fair Value

    Note 4   

Fair Value Measurements

    Note 5   

Cash Instruments

    Note 6   

Derivatives and Hedging Activities

    Note 7   

Fair Value Option

    Note 8   

Collateralized Agreements and Financings

    Note 9   

Securitization Activities

    Note 10   

Variable Interest Entities

    Note 11   

Other Assets

    Note 12   

Goodwill and Identifiable Intangible Assets

    Note 13   

Deposits

    Note 14   

Short-Term Borrowings

    Note 15   

Long-Term Borrowings

    Note 16   

Other Liabilities and Accrued Expenses

    Note 17   

Commitments, Contingencies and Guarantees

    Note 18   

Shareholders’ Equity

    Note 19   

Regulation and Capital Adequacy

    Note 20   

Earnings Per Common Share

    Note 21   

Transactions with Affiliated Funds

    Note 22   

Interest Income and Interest Expense

    Note 23   

Income Taxes

    Note 24   

Business Segments

    Note 25   

Credit Concentrations

    Note 26   

Legal Proceedings

    Note 27   

Consolidation

The firm consolidates entities in which the firm has a controlling financial interest. The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE).

Voting Interest Entities. Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The usual condition for a controlling financial interest in a voting interest entity is ownership of a majority voting interest. If the firm has a majority voting interest in a voting interest entity, the entity is consolidated.

Variable Interest Entities. A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. The firm has a controlling financial interest in a VIE when the firm has a variable interest or interests that provide it with (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 11 for further information about VIEs.

 

 

8   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Equity-Method Investments. When the firm does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for either (i) under the equity method of accounting or (ii) at fair value by electing the fair value option available under U.S. GAAP. Significant influence generally exists when the firm owns 20% to 50% of the entity’s common stock or in-substance common stock.

In general, the firm accounts for investments acquired after the fair value option became available, at fair value. In certain cases, the firm applies the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, when the firm has a significant degree of involvement in the cash flows or operations of the investee or when cost-benefit considerations are less significant. See Note 12 for further information about equity-method investments.

Investment Funds. The firm has formed numerous investment funds with third-party investors. These funds are typically organized as limited partnerships or limited liability companies for which the firm acts as general partner or manager. Generally, the firm does not hold a majority of the economic interests in these funds. These funds are usually voting interest entities and generally are not consolidated because third-party investors typically have rights to terminate the funds or to remove the firm as general partner or manager. Investments in these funds are included in “Financial instruments owned, at fair value.” See Notes 6, 18 and 22 for further information about investments in funds.

Use of Estimates

Preparation of these condensed consolidated financial statements requires management to make certain estimates and assumptions, the most important of which relate to fair value measurements, accounting for goodwill and identifiable intangible assets, discretionary compensation accruals and the provision for losses that may arise from litigation, regulatory proceedings and tax audits. These estimates and assumptions are based on the best available information but actual results could be materially different.

Revenue Recognition

Financial Assets and Financial Liabilities at Fair Value. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value are recorded at fair value either under the fair value option or in accordance with other U.S. GAAP. In addition, the firm has elected to account for certain of its other financial assets and financial liabilities at fair value by electing the fair value option. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Fair value gains or losses are generally included in “Market making” for positions in Institutional Client Services and “Other principal transactions” for positions in Investing & Lending. See Notes 5 through 8 for further information about fair value measurements.

Investment Banking. Fees from financial advisory assignments and underwriting revenues are recognized in earnings when the services related to the underlying transaction are completed under the terms of the assignment. Expenses associated with such transactions are deferred until the related revenue is recognized or the assignment is otherwise concluded. Expenses associated with financial advisory assignments are recorded as non-compensation expenses, net of client reimbursements. Underwriting revenues are presented net of related expenses.

 

 

    Goldman Sachs March 2013 Form 10-Q   9


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investment Management. The firm earns management fees and incentive fees for investment management services. Management fees are calculated as a percentage of net asset value, invested capital or commitments, and are recognized over the period that the related service is provided. Incentive fees are calculated as a percentage of a fund’s or separately managed account’s return, or excess return above a specified benchmark or other performance target. Incentive fees are generally based on investment performance over a 12-month period or over the life of a fund. Fees that are based on performance over a 12-month period are subject to adjustment prior to the end of the measurement period. For fees that are based on investment performance over the life of the fund, future investment underperformance may require fees previously distributed to the firm to be returned to the fund. Incentive fees are recognized only when all material contingencies have been resolved. Management and incentive fee revenues are included in “Investment management” revenues.

Commissions and Fees. The firm earns “Commissions and fees” from executing and clearing client transactions on stock, options and futures markets. Commissions and fees are recognized on the day the trade is executed.

Transfers of Assets

Transfers of assets are accounted for as sales when the firm has relinquished control over the assets transferred. For transfers of assets accounted for as sales, any related gains or losses are recognized in net revenues. Assets or liabilities that arise from the firm’s continuing involvement with transferred assets are measured at fair value. For transfers of assets that are not accounted for as sales, the assets remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Note 9 for further information about transfers of assets accounted for as collateralized financings and Note 10 for further information about transfers of assets accounted for as sales.

Receivables from Customers and Counterparties

Receivables from customers and counterparties generally relate to collateralized transactions. Such receivables are primarily comprised of customer margin loans, certain transfers of assets accounted for as secured loans rather than purchases at fair value, collateral posted in connection with certain derivative transactions, and loans held for investment. Certain of the firm’s receivables from customers and counterparties are accounted for at fair value under the fair value option, with changes in fair value generally included in “Market making” revenues. Receivables from customers and counterparties not accounted for at fair value are accounted for at amortized cost net of estimated uncollectible amounts. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in “Interest income.” See Note 8 for further information about receivables from customers and counterparties.

Payables to Customers and Counterparties

Payables to customers and counterparties primarily consist of customer credit balances related to the firm’s prime brokerage activities. Payables to customers and counterparties are accounted for at cost plus accrued interest, which generally approximates fair value. While these payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

Receivables from and Payables to Brokers, Dealers and Clearing Organizations

Receivables from and payables to brokers, dealers and clearing organizations are accounted for at cost plus accrued interest, which generally approximates fair value. While these receivables and payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these receivables and payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

 

 

10   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Offsetting Assets and Liabilities

To reduce credit exposures on derivatives and securities financing transactions, the firm may enter into netting agreements with counterparties that permit it to offset receivables and payables with such counterparties. Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) in the condensed consolidated statements of financial condition when a legal right of setoff exists under an enforceable netting arrangement or similar agreement. Resale and repurchase agreements and securities borrowed and loaned transactions with the same term and currency may be presented on a net-by-counterparty basis in the condensed consolidated statements of financial condition when such transactions meet certain settlement criteria and are subject to agreements that provide for rights of setoff upon a termination event.

The firm receives and posts cash and securities collateral with respect to its derivatives, resale and repurchase agreements, and securities borrowed and loaned transactions. Such collateral is subject to the terms of the related credit support agreements. In the condensed consolidated statements of financial condition, derivatives are reported net of cash collateral received and posted under enforceable credit support agreements, when transacted under an enforceable netting agreement. In the condensed consolidated statements of financial condition, resale and repurchase agreements, and securities borrowed and loaned are not reported net of the related cash and securities received or posted as collateral. See Note 9 for further information about collateral received and pledged, including rights to deliver or repledge collateral.

In order to assess enforceability of the firm’s right of setoff under netting and credit support agreements, the firm evaluates various factors including applicable bankruptcy laws, local statutes and regulatory provisions in the jurisdiction of the parties to the agreement. See Notes 7 and 9 for further information about offsetting.

Insurance Activities

Certain of the firm’s insurance and reinsurance contracts are accounted for at fair value under the fair value option, with changes in fair value included in “Market making” revenues. See Note 8 for further information about the fair values of these insurance and reinsurance contracts. See Note 12 for further information about the firm’s reinsurance business classified as held for sale as of March 2013 and December 2012.

Revenues from variable annuity and life insurance and reinsurance contracts not accounted for at fair value generally consist of fees assessed on contract holder account balances for mortality charges, policy administration fees and surrender charges. These revenues are recognized in earnings over the period that services are provided and are included in “Market making” revenues. Changes in reserves, including interest credited to policyholder account balances, are recognized in “Insurance reserves.”

Premiums earned for underwriting property catastrophe reinsurance are recognized in earnings over the coverage period, net of premiums ceded for the cost of reinsurance, and are included in “Market making” revenues. Expenses for liabilities related to property catastrophe reinsurance claims, including estimates of losses that have been incurred but not reported, are included in “Insurance reserves.”

Share-based Compensation

The cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based awards that require future service are amortized over the relevant service period. Expected forfeitures are included in determining share-based employee compensation expense.

The firm pays cash dividend equivalents on outstanding restricted stock units (RSUs). Dividend equivalents paid on RSUs are generally charged to retained earnings. Dividend equivalents paid on RSUs expected to be forfeited are included in compensation expense. The firm accounts for the tax benefit related to dividend equivalents paid on RSUs as an increase to additional paid-in capital.

In certain cases, primarily related to conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards accounted for as equity instruments. For these awards, whose terms allow for cash settlement, additional paid-in capital is adjusted to the extent of the difference between the value of the award at the time of cash settlement and the grant-date value of the award.

 

 

    Goldman Sachs March 2013 Form 10-Q   11


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(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 statements of financial condition and revenues and expenses are translated at average rates of exchange for the period. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are recognized in earnings. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, in the condensed consolidated statements of comprehensive income.

Cash and Cash Equivalents

The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business. As of March 2013 and December 2012, “Cash and cash equivalents” included $5.95 billion and $6.75 billion, respectively, of cash and due from banks, and $57.38 billion and $65.92 billion, respectively, of interest-bearing deposits with banks.

Recent Accounting Developments

Derecognition of in Substance Real Estate (ASC 360). In December 2011, the FASB issued ASU No. 2011-10, “Property, Plant, and Equipment (Topic 360) — Derecognition of in Substance Real Estate — a Scope Clarification.” ASU No. 2011-10 clarifies that in order to deconsolidate a subsidiary (that is in substance real estate) as a result of a parent no longer controlling the subsidiary due to a default on the subsidiary’s nonrecourse debt, the parent also must satisfy the sale criteria in ASC 360-20, “Property, Plant, and Equipment — Real Estate Sales.” The ASU was effective for fiscal years beginning on or after June 15, 2012. The firm applied the provisions of the ASU to such events occurring on or after January 1, 2013. Adoption of ASU No. 2011-10 did not materially affect the firm’s financial condition, results of operations or cash flows.

Disclosures about Offsetting Assets and Liabilities (ASC 210). In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210) — Disclosures about Offsetting Assets and Liabilities.” ASU No. 2011-11, as amended by ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities,” requires disclosure of the effect or potential effect of offsetting arrangements on the firm’s financial position as well as enhanced disclosure of the rights of setoff associated with the firm’s recognized derivative instruments, resale and repurchase agreements, and securities borrowing and lending transactions. ASU No. 2011-11 was effective for periods beginning on or after January 1, 2013. Since these amended principles require only additional disclosures concerning offsetting and related arrangements, adoption did not affect the firm’s financial condition, results of operations or cash flows. See Notes 7 and 9 for further information about the firm’s offsetting and related arrangements.

 

 

12   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 4. Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

Note 4.

 

Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

    

 

Financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value are accounted for at fair value either under the fair value option or in accordance with other U.S. GAAP. See Note 8 for further information about the fair value option. The table below presents the firm’s financial instruments owned, at fair value, including those pledged as collateral, and financial instruments sold, but not yet purchased, at fair

value. The firm held $8.90 billion and $9.07 billion as of March 2013 and December 2012, respectively, of securities accounted for as available-for-sale related to the firm’s reinsurance business. As of March 2013 and December 2012, such assets were classified as held for sale and were included in “Other assets.” See Note 12 for further information about assets held for sale.

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
 
Financial
Instruments
Owned
  
  
  
    
 
 
 
 
Financial
Instruments
Sold, But
Not Yet
Purchased
  
  
  
  
  
       
 
 
Financial
Instruments
Owned
  
  
  
    
 
 
 
 
Financial
Instruments
Sold, But
Not Yet
Purchased
  
  
  
  
  

Commercial paper, certificates of deposit, time deposits and other
money market instruments

    $    5,705         $          —          $    6,057         $          —   
   

U.S. government and federal agency obligations

    96,930         25,894          93,241         15,905   
   

Non-U.S. government and agency obligations

    57,657         42,754          62,250         32,361   
   

Mortgage and other asset-backed loans and securities:

           

Loans and securities backed by commercial real estate

    6,909         11          9,805           
   

Loans and securities backed by residential real estate

    7,570         2          8,216         4   
   

Bank loans and bridge loans

    22,467         1,479  3        22,407         1,779  3 
   

Corporate debt securities

    20,442         6,874          20,981         5,761   
   

State and municipal obligations

    2,219         7          2,477         1   
   

Other debt obligations

    2,481                  2,251           
   

Equities and convertible debentures

    89,278         24,381          96,454         20,406   
   

Commodities 1

    7,695                  11,696           
   

Derivatives 2

    68,040         52,347            71,176         50,427   

Total

    $387,393         $153,749            $407,011         $126,644   

 

1.

Includes commodities that have been transferred to third parties, which were accounted for as collateralized financings rather than sales, of $2.77 billion and $4.29 billion as of March 2013 and December 2012, respectively.

 

2.

Reported on a net-by-counterparty basis when a legal right of setoff exists under an enforceable netting agreement and reported net of cash collateral received or posted under enforceable credit support agreements.

 

3.

Primarily relates to the fair value of unfunded lending commitments for which the fair value option was elected.

 

    Goldman Sachs March 2013 Form 10-Q   13


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Gains and Losses from Market Making and Other Principal Transactions

The table below presents, by major product type, the firm’s “Market making” and “Other principal transactions” revenues. These gains/(losses) are primarily related to the firm’s financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, including both derivative and non-derivative financial instruments. These gains/(losses) exclude related interest income and interest expense. See Note 23 for further information about interest income and interest expense.

The gains/(losses) in the table are not representative of the manner in which the firm manages its business activities because many of the firm’s market-making, client facilitation, and investing and lending strategies utilize financial instruments across various product types. Accordingly, gains or losses in one product type frequently offset gains or losses in other product types. For example, most of the firm’s longer-term derivatives are sensitive to changes in interest rates and may be economically hedged with interest rate swaps. Similarly, a significant portion of the firm’s cash instruments and derivatives has exposure to foreign currencies and may be economically hedged with foreign currency contracts.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Interest rates

    $(1,141 )       $1,889   
   

Credit

    1,828         1,710   
   

Currencies

    2,460         (724
   

Equities

    1,908         1,973   
   

Commodities

    493         471   
   

Other

    (30 )       524   

Total

    $ 5,518         $5,843   

 

Note 5. Fair Value Measurements

Note 5.

Fair Value Measurements

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. The firm measures certain financial assets and financial liabilities as a portfolio (i.e., based on its net exposure to market and/or credit risks).

The best evidence of fair value is a quoted price in an active market. If quoted prices in active markets are not available, fair value is determined by reference to prices for similar instruments, quoted prices or recent transactions in less active markets, or internally developed models that primarily use market-based or independently sourced parameters as inputs including, but not limited to, interest rates, volatilities, equity or debt prices, foreign exchange rates, commodity prices, credit spreads and funding spreads (i.e., the spread, or difference, between the interest rate at which a borrower could finance a given financial instrument relative to a benchmark interest rate).

U.S. GAAP has a three-level fair value hierarchy for disclosure of fair value measurements. The fair value hierarchy prioritizes inputs to the valuation techniques used to measure fair value, giving the highest priority to level 1 inputs and the lowest priority to level 3 inputs. A financial instrument’s level in the fair value hierarchy is based on the lowest level of input that is significant to its fair value measurement.

The fair value hierarchy is as follows:

Level 1. Inputs are unadjusted quoted prices in active markets to which the firm had access at the measurement date for identical, unrestricted assets or liabilities.

Level 2. Inputs to valuation techniques are observable, either directly or indirectly.

Level 3. One or more inputs to valuation techniques are significant and unobservable.

 

 

14   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The fair values for substantially all of the firm’s financial assets and financial liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the fair value hierarchy. Certain level 2 and level 3 financial assets and financial liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors such as counterparty and the firm’s credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Valuation adjustments are generally based on market evidence.

See Notes 6 and 7 for further information about fair value measurements of cash instruments and derivatives, respectively, included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” and Note 8 for further information about fair value measurements of other financial assets and financial liabilities accounted for at fair value under the fair value option.

Financial assets and financial liabilities accounted for at fair value under the fair value option or in accordance with other U.S. GAAP are summarized below.

 

 

 

    As of  
$ in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Total level 1 financial assets

    $175,729         $ 190,737   
   

Total level 2 financial assets

    512,909         502,293   
   

Total level 3 financial assets

    46,023         47,095   
   

Cash collateral and counterparty netting 1

    (90,828 )       (101,612

Total financial assets at fair value

    $643,833         $ 638,513   
   

Total assets

    $959,223         $ 938,555   
   

Total level 3 financial assets as a percentage of Total assets

    4.8 %       5.0
   

Total level 3 financial assets as a percentage of Total financial assets at fair value

    7.1 %       7.4
   

 

Total level 1 financial liabilities

    $  90,186         $   65,994   
   

Total level 2 financial liabilities

    304,217         318,764   
   

Total level 3 financial liabilities

    24,759         25,679   
   

Cash collateral and counterparty netting 1

    (29,694 )       (32,760

Total financial liabilities at fair value

    $389,468         $ 377,677   
   

Total level 3 financial liabilities as a percentage of Total financial liabilities at fair value

    6.4 %       6.8

 

1.

Represents the impact on derivatives of cash collateral, and counterparty netting across levels of the fair value hierarchy. Netting among positions classified in the same level is included in that level.

 

Level 3 financial assets as of March 2013 decreased compared with December 2012, primarily reflecting a decrease in level 3 derivative assets, principally due to unrealized losses on currency derivative assets and settlements of credit derivative assets.

See Notes 6, 7 and 8 for further information about level 3 cash instruments, derivatives and other financial assets and financial liabilities accounted for at fair value under the fair value option, respectively, including information about significant unrealized gains and losses, and transfers in and out of level 3.

 

 

    Goldman Sachs March 2013 Form 10-Q   15


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 6. Cash Instruments

Note 6.

Cash Instruments

 

Cash instruments include U.S. government and federal agency obligations, non-U.S. government and agency obligations, bank loans and bridge loans, corporate debt securities, equities and convertible debentures, and other non-derivative financial instruments owned and financial instruments sold, but not yet purchased. See below for the types of cash instruments included in each level of the fair value hierarchy and the valuation techniques and significant inputs used to determine their fair values. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Cash Instruments

Level 1 cash instruments include U.S. government obligations and most non-U.S. government obligations, actively traded listed equities, certain government agency obligations and money market instruments. These instruments are valued using quoted prices for identical unrestricted instruments in active markets.

The firm defines active markets for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalization for the instrument. The firm defines active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity.

Level 2 Cash Instruments

Level 2 cash instruments include commercial paper, certificates of deposit, time deposits, most government agency obligations, certain non-U.S. government obligations, most corporate debt securities, commodities, certain mortgage-backed loans and securities, certain bank loans and bridge loans, restricted or less liquid listed equities, most state and municipal obligations and certain lending commitments.

Valuations of level 2 cash instruments can be verified to quoted prices, recent trading activity for identical or similar instruments, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Valuation adjustments are typically made to level 2 cash instruments (i) if the cash instrument is subject to transfer restrictions and/or (ii) for other premiums and liquidity discounts that a market participant would require to arrive at fair value. Valuation adjustments are generally based on market evidence.

Level 3 Cash Instruments

Level 3 cash instruments have one or more significant valuation inputs that are not observable. Absent evidence to the contrary, level 3 cash instruments are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequently, the firm uses other methodologies to determine fair value, which vary based on the type of instrument. Valuation inputs and assumptions are changed when corroborated by substantive observable evidence, including values realized on sales of financial assets.

 

 

16   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques and Significant Inputs

The table below presents the valuation techniques and the nature of significant inputs generally used to determine the

fair values of each type of level 3 cash instrument.

 

 

Level 3 Cash Instruments         Valuation Techniques and Significant Inputs

 

Loans and securities backed by commercial real estate

 

Ÿ     Collateralized by a single commercial real estate property or a portfolio of properties

 

Ÿ     May include tranches of varying levels of subordination

      

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

    

 

Significant inputs are generally determined based on relative value analyses and include:

    

 

Ÿ     Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral and the basis, or price difference, to such prices

    

 

Ÿ     Market yields implied by transactions of similar or related assets and/or current levels and changes in market indices such as the CMBX (an index that tracks the performance of commercial mortgage bonds)

    

 

Ÿ     Recovery rates implied by the value of the underlying collateral, which is mainly driven by current performance of the underlying collateral, capitalization rates and multiples

    

 

Ÿ     Timing of expected future cash flows (duration)

 

 

Loans and securities backed by residential real estate

 

Ÿ     Collateralized by portfolios of residential real estate

 

Ÿ     May include tranches of varying levels of subordination

      

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

    

 

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles, including relevant indices such as the ABX (an index that tracks the performance of subprime residential mortgage bonds). Significant inputs include:

    

 

Ÿ     Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral

    

 

Ÿ     Market yields implied by transactions of similar or related assets

    

 

Ÿ     Cumulative loss expectations, driven by default rates, home price projections, residential property liquidation timelines and related costs

    

 

Ÿ     Duration, driven by underlying loan prepayment speeds and residential property liquidation timelines

 

 

Bank loans and bridge loans

      

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

    

 

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

    

 

Ÿ     Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX and LCDX (indices that track the performance of corporate credit and loans, respectively)

    

 

Ÿ     Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation

    

 

Ÿ     Duration

 

 

Non-U.S. government and

agency obligations

 

Corporate debt securities

 

State and municipal obligations

 

Other debt obligations

      

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

    

 

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

    

 

Ÿ     Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX, LCDX and MCDX (an index that tracks the performance of municipal obligations)

    

 

Ÿ     Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation

    

 

Ÿ     Duration

 

 

Equities and convertible debentures (including private equity investments and investments in real estate entities)

      

 

Recent third-party completed or pending transactions (e.g., merger proposals, tender offers, debt restructurings) are considered to be the best evidence for any change in fair value. When these are not available, the following valuation methodologies are used, as appropriate:

    

 

Ÿ     Industry multiples (primarily EBITDA multiples) and public comparables

    

 

Ÿ     Transactions in similar instruments

    

 

Ÿ     Discounted cash flow techniques

    

 

Ÿ     Third-party appraisals

    

 

The firm also considers changes in the outlook for the relevant industry and financial performance of the issuer as compared to projected performance. Significant inputs include:

    

 

Ÿ     Market and transaction multiples

    

 

Ÿ     Discount rates, long-term growth rates, earnings compound annual growth rates and capitalization rates

    

 

Ÿ     For equity instruments with debt-like features: market yields implied by transactions of similar or related assets, current performance and recovery assumptions, and duration

 

 

    Goldman Sachs March 2013 Form 10-Q   17


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The tables below present the ranges of significant unobservable inputs used to value the firm’s level 3 cash instruments. These ranges represent the significant unobservable inputs that were used in the valuation of each type of cash instrument. The ranges and weighted averages of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one cash instrument.

For example, the highest multiple presented in the tables below for private equity investments is appropriate for valuing a specific private equity investment but may not be appropriate for valuing any other private equity investment. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 cash instruments.

 

 

 

Level 3 Cash Instruments

 

  

Level 3 Assets as of   
March 2013   

(in millions)   

 

  

Significant Unobservable Inputs   

by Valuation Technique

 

  

Range of Significant Unobservable
Inputs (Weighted Average 1)

as of March 2013

 

 

Loans and securities backed by commercial real estate

 

Ÿ   Collateralized by a single commercial real estate property or a portfolio of properties

 

Ÿ   May include tranches of varying levels of subordination

 

  

 

$3,164

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

3.6% to 27.9% (8.6%)

     

 

Ÿ   Recovery rate 3

  

 

36.0% to 98.3% (71.4%)

     

 

Ÿ   Duration (years) 4

  

 

0.6 to 7.0 (2.9)

       

 

Ÿ   Basis

 

  

 

(19) points to 16 points (3 points)

 

Loans and securities backed by residential real estate

 

Ÿ   Collateralized by portfolios of residential real estate

 

Ÿ   May include tranches of varying levels of subordination

  

 

$1,683

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

3.6% to 16.9% (9.1%)

     

 

Ÿ   Cumulative loss rate

  

 

0.0% to 61.8% (29.6%)

       

 

Ÿ   Duration (years) 4

 

  

 

1.4 to 8.7 (3.5)

 

Bank loans and bridge loans

  

 

$11,688

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

0.4% to 36.5% (8.6%)

     

 

Ÿ   Recovery rate 3

  

 

28.1% to 85.0% (59.5%)

       

 

Ÿ   Duration (years) 4

 

  

 

0.4 to 4.6 (2.2)

 

Non-U.S. government and agency obligations

 

Corporate debt securities

 

State and municipal obligations

 

Other debt obligations

  

 

$3,678

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

0.5% to 35.3% (7.8%)

     

 

Ÿ   Recovery rate 3

  

 

0.0% to 70.0% (64.9%)

       

 

Ÿ   Duration (years) 4

 

  

 

0.4 to 14.6 (4.0)

 

Equities and convertible debentures (including private equity investments and investments in real estate entities)

  

 

$15,224 2

  

 

 

Comparable multiples:

    
     

 

Ÿ   Multiples

  

 

0.7x to 25.7x (7.0x)

     

 

Discounted cash flows:

    
     

 

Ÿ   Discount rate

  

 

10.0% to 25.0% (13.9%)

     

 

Ÿ   Long-term growth rate/compound annual growth rate

  

 

0.7% to 25.0% (9.0%)

       

 

Ÿ   Capitalization rate

 

 

  

 

3.3% to 11.4% (6.9%)

 

1.

Weighted averages are calculated by weighting each input by the relative fair value of the respective financial instruments.

 

2.

The fair value of any one instrument may be determined using multiple valuation techniques. For example, market comparables and discounted cash flows may be used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

 

3.

Recovery rate is a measure of expected future cash flows in a default scenario, expressed as a percentage of notional or face value of the instrument, and reflects the benefit of credit enhancement on certain instruments.

 

4.

Duration is an estimate of the timing of future cash flows and, in certain cases, may incorporate the impact of other unobservable inputs (e.g., prepayment speeds).

 

18   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Cash Instruments

 

  

Level 3 Assets as of      December 2012

(in millions)

 

  

Significant Unobservable Inputs   

by Valuation Technique

 

  

Range of Significant Unobservable Inputs (Weighted Average 1)

as of December 2012

 

 

Loans and securities backed by commercial real estate

 

Ÿ    Collateralized by a single commercial real estate property or a portfolio of properties

 

Ÿ    May include tranches of varying levels of subordination

  

 

$3,389

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

4.0% to 43.3% (9.8%)

     

Ÿ    Recovery rate 3

 

  

37.0% to 96.2% (81.7%)

     

Ÿ    Duration (years) 4

 

  

0.1 to 7.0 (2.6)

       

Ÿ    Basis

 

  

(13) points to 18 points (2 points)

 

Loans and securities backed by residential real estate

 

Ÿ    Collateralized by portfolios of residential real estate

 

Ÿ    May include tranches of varying levels of subordination

  

 

$1,619

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

3.1% to 17.0% (9.7%)

     

Ÿ    Cumulative loss rate

 

  

0.0% to 61.6% (31.6%)

       

Ÿ    Duration (years) 4

 

  

1.3 to 5.9 (3.7)

 

Bank loans and bridge loans

  

 

$11,235

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

0.3% to 34.5% (8.3%)

     

Ÿ    Recovery rate 3

 

  

16.5% to 85.0% (56.0%)

       

Ÿ    Duration (years) 4

 

  

0.2 to 4.4 (1.9)

 

Non-U.S. government and agency obligations

 

Corporate debt securities

 

State and municipal obligations

 

Other debt obligations

  

 

$4,651

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

0.6% to 33.7% (8.6%)

     

Ÿ    Recovery rate 3

 

  

0.0% to 70.0% (53.4%)

       

Ÿ    Duration (years) 4

 

  

0.5 to 15.5 (4.0)

 

Equities and convertible debentures (including private equity investments and investments in real estate entities)

  

 

$14,855 2

  

 

Comparable multiples:

 

    
     

Ÿ    Multiples

 

  

0.7x to 21.0x (7.2x)

     

Discounted cash flows:

 

    
     

Ÿ    Discount rate

 

  

10.0% to 25.0% (14.3%)

     

Ÿ    Long-term growth rate/ compound annual growth rate

 

  

0.7% to 25.0% (9.3%)

 

       

Ÿ    Capitalization rate

 

  

3.9% to 11.4% (7.3%)

 

1.

Weighted averages are calculated by weighting each input by the relative fair value of the respective financial instruments.

 

2.

The fair value of any one instrument may be determined using multiple valuation techniques. For example, market comparables and discounted cash flows may be used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

 

3.

Recovery rate is a measure of expected future cash flows in a default scenario, expressed as a percentage of notional or face value of the instrument, and reflects the benefit of credit enhancement on certain instruments.

 

4.

Duration is an estimate of the timing of future cash flows and, in certain cases, may incorporate the impact of other unobservable inputs (e.g., prepayment speeds).

 

Increases in yield, discount rate, capitalization rate, duration or cumulative loss rate used in the valuation of the firm’s level 3 cash instruments would result in a lower fair value measurement, while increases in recovery rate, basis, multiples, long-term growth rate or compound annual

growth rate would result in a higher fair value measurement. Due to the distinctive nature of each of the firm’s level 3 cash instruments, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

    Goldman Sachs March 2013 Form 10-Q   19


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Cash Instruments by Level

The tables below present, by level within the fair value hierarchy, cash instrument assets and liabilities, at fair value. Cash instrument assets and liabilities are included in

“Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.

 

 

 

    Cash Instrument Assets at Fair Value as of March  2013  
in millions     Level 1           Level 2           Level 3           Total   

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $    1,294           $    4,411           $       —           $    5,705   
   

U.S. government and federal agency obligations

    46,973           49,957                     96,930   
   

Non-U.S. government and agency obligations

    40,379           17,231           47           57,657   
   

Mortgage and other asset-backed loans and securities 1:

                

Loans and securities backed by commercial real estate

              3,745           3,164           6,909   
   

Loans and securities backed by residential real estate

              5,887           1,683           7,570   
   

Bank loans and bridge loans

              10,779           11,688           22,467   
   

Corporate debt securities 2

    132           17,868           2,442           20,442   
   

State and municipal obligations

              1,885           334           2,219   
   

Other debt obligations 2

              1,626           855           2,481   
   

Equities and convertible debentures

    64,850           9,204           15,224  3         89,278   
   

Commodities

              7,695                     7,695   

Total

    $153,628           $130,288           $35,437           $319,353   
    Cash Instrument Liabilities at Fair Value as of March  2013  
in millions     Level 1           Level 2           Level 3           Total   

U.S. government and federal agency obligations

    $  25,665           $        229           $        —           $  25,894   
   

Non-U.S. government and agency obligations

    41,389           1,365                     42,754   
   

Mortgage and other asset-backed loans and securities:

                

Loans and securities backed by commercial real estate

              11                     11   
   

Loans and securities backed by residential real estate

              2                     2   
   

Bank loans and bridge loans

              1,044           435           1,479   
   

Corporate debt securities

    10           6,862           2           6,874   
   

State and municipal obligations

              7                     7   
   

Equities and convertible debentures

    22,974           1,403           4           24,381   

Total

    $  90,038           $  10,923           $     441           $101,402   

 

1.

Includes $609 million and $452 million of collateralized debt obligations (CDOs) backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $583 million and $1.46 billion of CDOs and collateralized loan obligations (CLOs) backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Includes $13.27 billion of private equity investments, $1.45 billion of investments in real estate entities and $508 million of convertible debentures.

 

20   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Cash Instrument Assets at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3           Total   

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $    2,155           $    3,902           $        —           $     6,057   
   

U.S. government and federal agency obligations

    42,856           50,385                     93,241   
   

Non-U.S. government and agency obligations

    46,715           15,509           26           62,250   
   

Mortgage and other asset-backed loans and securities 1:

                

Loans and securities backed by commercial real estate

              6,416           3,389           9,805   
   

Loans and securities backed by residential real estate

              6,597           1,619           8,216   
   

Bank loans and bridge loans

              11,172           11,235           22,407   
   

Corporate debt securities 2

    111           18,049           2,821           20,981   
   

State and municipal obligations

              1,858           619           2,477   
   

Other debt obligations 2

              1,066           1,185           2,251   
   

Equities and convertible debentures

    72,875           8,724           14,855  3         96,454   
   

Commodities

              11,696                     11,696   

Total

    $164,712           $135,374           $35,749           $335,835   
    Cash Instrument Liabilities at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3           Total   

U.S. government and federal agency obligations

    $  15,475           $       430           $        —           $  15,905   
   

Non-U.S. government and agency obligations

    31,011           1,350                     32,361   
   

Mortgage and other asset-backed loans and securities:

                

Loans and securities backed by residential real estate

              4                     4   
   

Bank loans and bridge loans

              1,143           636           1,779   
   

Corporate debt securities

    28           5,731           2           5,761   
   

State and municipal obligations

              1                     1   
   

Equities and convertible debentures

    19,416           986           4           20,406   

Total

    $  65,930           $    9,645           $     642           $  76,217   

 

1.

Includes $489 million and $446 million of CDOs backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $284 million and $1.76 billion of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Includes $12.67 billion of private equity investments, $1.58 billion of investments in real estate entities and $600 million of convertible debentures.

Transfers Between Levels of the Fair Value Hierarchy

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. During the three months ended March 2013, transfers into level 2 from level 1 of cash instruments were $43 million, reflecting transfers of public equity securities due to less market activity in these securities.

During the three months ended March 2012, transfers into level 2 from level 1 of cash instruments were $728 million, consisting of transfers of public equity investments, primarily reflecting the impact of transfer restrictions. See level 3 rollforwards below for further information about transfers between level 2 and level 3.

 

 

    Goldman Sachs March 2013 Form 10-Q   21


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

If a cash instrument asset or liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3.

Level 3 cash instruments are frequently economically hedged with level 1 and level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. Accordingly, gains or losses that are reported in level 3 can be partially offset by gains or losses attributable to level 1 or level 2 cash

instruments and/or level 1, level 2 or level 3 derivatives. As a result, gains or losses included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

The tables below present changes in fair value for all cash instrument assets and liabilities categorized as level 3 as of the end of the period.

 

 

 

    Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended March 2013  
in millions    
 
 
Balance,
beginning
of period
  
  
  
    
 
 
 
Net
realized
gains/
(losses)
  
  
  
  
   
 
 
 
 

 

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

  
  
  
  
  

  

    Purchases  1      Sales        Settlements       
 
 
Transfers
into
level 3
  
  
  
    
 
 
Transfers
out of
level 3
  
  
  
   
 

 

Balance,
end of

period

  
  

  

Non-U.S. government and agency obligations

    $        26         $    3        $    2        $      28        $        (9     $        (1     $        1         $        (3     $        47   
   

Mortgage and other asset-backed loans and securities:

                   

Loans and securities backed by commercial real estate

    3,389         36        91        50        (249     (277     318         (194     3,164   
   

Loans and securities backed by residential real estate

    1,619         38        25        268        (172     (56     104         (143     1,683   
   

Bank loans and bridge loans

    11,235         153        97        1,460        (543     (1,361     1,688         (1,041     11,688   
   

Corporate debt securities

    2,821         116        157        301        (728     (141     116         (200     2,442   
   

State and municipal obligations

    619         2        1        19        (269     (1             (37     334   
   

Other debt obligations

    1,185         19        21        192        (210     (201     61         (212     855   
   

Equities and convertible debentures

    14,855         70        481        185        (378     (543     1,000         (446     15,224   

Total

    $35,749         $437  2      $875  2      $2,503        $(2,558     $(2,581     $3,288         $(2,276     $35,437   
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 2013  
in millions    
 
 
Balance,
beginning
of period
  
  
  
    
 
 
 
Net
realized
(gains)/
losses
  
  
  
  
   
 
 
 
 
 
Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases  1      Sales        Settlements       
 
 
Transfers
into
level 3
  
  
  
    
 
 
Transfers
out of
level 3
  
  
  
   
 

 

Balance,
end of

period

  
  

  

Total

    $     642         $   (4     $ (11     $  (147     $       97        $         3        $     22         $    (161     $     441   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $317 million, $687 million and $308 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain on level 3 cash instruments of $886 million (reflecting $875 million on cash instrument assets and $11 million on cash instrument liabilities) for the three months ended March 2013 primarily consisted of gains on private equity investments, corporate debt securities and mortgage and other asset-backed loans and securities. Unrealized gains during the three months ended March 2013 primarily reflected the impact of an increase in equity prices and generally tighter credit spreads.

Transfers into level 3 during the three months ended March 2013 primarily reflected transfers of certain bank loans and bridge loans and private equity investments from level 2, principally due to a lack of market transactions in these instruments.

Transfers out of level 3 during the three months ended March 2013 primarily reflected transfers of certain bank loans and bridge loans and private equity investments to level 2. Transfers of bank loans and bridge loans to level 2 were principally due to market transactions in certain loans and unobservable inputs no longer being significant to the valuation of other loans. Transfers of private equity investments to level 2 were principally due to market transactions in these instruments.

 

 

22   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

     Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended March 2012  
in millions     
 
 
Balance,
beginning
of period
  
  
  
    
 
 
 
Net
realized
gains/
(losses)
  
  
  
  
   
 
 
 
 

 

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

  
  
  
  
  

  

    Purchases  1      Sales        Settlements       
 
 
Transfers
into
level 3
  
  
  
    
 
 
Transfers
out of
level 3
  
  
  
   
 

 

Balance,
end of

period

  
  

  

Commercial paper, certificates of deposit, time deposits and other money market instruments

     $        —         $  —        $   —        $        8        $       —        $        —        $      —         $        —        $          8   
   

Non-U.S. government and agency obligations

     148         (1     (59     7        (8            20         (2     105   
   

Mortgage and other asset-backed
loans and securities:

                    

Loans and securities backed by commercial real estate

     3,346         39        96        295        (276     (289     486         (541     3,156   
   

Loans and securities backed by residential real estate

     1,709         43        23        254        (181     (101     14         (151     1,610   
   

Bank loans and bridge loans

     11,285         150        206        1,188        (1,246     (792     960         (700     11,051   
   

Corporate debt securities

     2,480         92        158        295        (422     (128     260         (223     2,512   
   

State and municipal obligations

     599         2        8        20        (39     (2     25         (1     612   
   

Other debt obligations

     1,451         44        24        99        (120     (56     123         (16     1,549   
   

Equities and convertible debentures

     13,667         39        332        558        (150     (194     779         (157     14,874   

Total

     $34,685         $408  2      $788  2      $2,724        $(2,442     $(1,562     $2,667         $(1,791     $35,477   
     Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 2012  
in millions     
 
 
Balance,
beginning
of period
  
  
  
    
 
 
 
Net
realized
(gains)/
losses
  
  
  
  
   
 
 
 
 
 
Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases  1      Sales        Settlements       
 
 
Transfers
into
level 3
  
  
  
    
 
 
Transfers
out of
level 3
  
  
  
   
 

 

Balance,
end of

period

  
  

  

Total

     $      905         $ (34     $ (68     $  (326     $       87        $     195        $    102         $    (114     $      747   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $167 million, $654 million and $375 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain on level 3 cash instruments of $856 million (reflecting $788 million on cash instrument assets and $68 million on cash instrument liabilities) for the three months ended March 2012 primarily consisted of gains on private equity investments, bank loans and bridge loans, and corporate debt securities, primarily reflecting an increase in global equity prices and tighter credit spreads.

Transfers into level 3 during the three months ended March 2012 primarily reflected transfers from level 2 of certain bank loans and bridge loans, private equity investments, and loans and securities backed by commercial real estate, principally due to reduced transparency of market prices as a result of less market activity in these instruments.

Transfers out of level 3 during the three months ended March 2012 primarily reflected transfers to level 2 of certain bank and bridge loans, and loans and securities backed by commercial real estate, principally due to improved transparency of market prices as a result of market activity in these instruments.

 

 

    Goldman Sachs March 2013 Form 10-Q   23


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investments in Funds That Calculate Net Asset Value Per Share

    

Cash instruments at fair value include investments in funds that are valued based on the net asset value per share (NAV) of the investment fund. The firm uses NAV as its measure of fair value for fund investments when (i) the fund investment does not have a readily determinable fair value and (ii) the NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the underlying investments at fair value.

The firm’s investments in funds that calculate NAV primarily consist of investments in firm-sponsored funds where the firm co-invests with third-party investors. The private equity, credit and real estate funds are primarily closed-end funds in which the firm’s investments are not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated and it is estimated that substantially all of the underlying assets of existing funds will be liquidated over the next seven years. The firm continues to manage its existing funds taking into

account the transition periods under the Volcker Rule of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), although the rules have not yet been finalized.

The firm’s investments in hedge funds are generally redeemable on a quarterly basis with 91 days’ notice, subject to a maximum redemption level of 25% of the firm’s initial investments at any quarter-end. The firm currently plans to comply with the Volcker Rule by redeeming certain of its interests in hedge funds. Since March 2012, the firm has redeemed approximately $1.32 billion of these interests in hedge funds, including approximately $260 million during the three months ended March 2013.

The table below presents the fair value of the firm’s investments in, and unfunded commitments to, funds that calculate NAV.

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
Fair Value of
Investments
  
  
    
 
Unfunded
Commitments
  
  
       
 
Fair Value of
Investments
  
  
    
 
Unfunded
Commitments
  
  

Private equity funds 1

    $  7,183         $2,453          $  7,680         $2,778   
   

Credit funds 2

    3,976         2,884          3,927         2,843   
   

Hedge funds 3

    2,339                  2,167           
   

Real estate funds 4

    2,058         868            2,006         870   

Total

    $15,556         $6,205            $15,780         $6,491   

 

1.

These funds primarily invest in a broad range of industries worldwide in a variety of situations, including leveraged buyouts, recapitalizations, growth investments and distressed investments.

 

2.

These funds generally invest in loans and other fixed income instruments and are focused on providing private high-yield capital for mid- to large-sized leveraged and management buyout transactions, recapitalizations, financings, refinancings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers.

 

3.

These funds are primarily multi-disciplinary hedge funds that employ a fundamental bottom-up investment approach across various asset classes and strategies including long/short equity, credit, convertibles, risk arbitrage, special situations and capital structure arbitrage.

 

4.

These funds invest globally, primarily in real estate companies, loan portfolios, debt recapitalizations and direct property.

 

24   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 7. Derivatives and Hedging Activities

Note 7.

Derivatives and Hedging Activities

Derivative Activities

Derivatives are instruments that derive their value from underlying asset prices, indices, reference rates and other inputs, or a combination of these factors. Derivatives may be traded on an exchange (exchange-traded) or they may be privately negotiated contracts, which are usually referred to as over-the-counter (OTC) derivatives. Certain of the firm’s OTC derivatives are cleared and settled through central clearing counterparties (OTC-cleared), while others are bilateral contracts between two counterparties (bilateral OTC).

Market-Making. As a market maker, the firm enters into derivative transactions to provide liquidity and to facilitate the transfer and hedging of risk. In this capacity, the firm typically acts as principal and is consequently required to commit capital to provide execution. As a market maker, it is essential to maintain an inventory of financial instruments sufficient to meet expected client and market demands.

Risk Management. The firm also enters into derivatives to actively manage risk exposures that arise from market-making and investing and lending activities in derivative and cash instruments. The firm’s holdings and exposures are hedged, in many cases, on either a portfolio or risk-specific basis, as opposed to an instrument-by-instrument basis. The offsetting impact of this economic hedging is reflected in the same business segment as the related revenues. In addition, the firm may enter into derivatives designated as hedges under U.S. GAAP. These derivatives are used to manage foreign currency exposure on the net investment in certain non-U.S. operations and to manage interest rate exposure in certain fixed-rate unsecured long-term and short-term borrowings, and deposits.

The firm enters into various types of derivatives, including:

 

Ÿ  

Futures and Forwards. Contracts that commit counterparties to purchase or sell financial instruments, commodities or currencies in the future.

 

Ÿ  

Swaps. Contracts that require counterparties to exchange cash flows such as currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, financial instruments, commodities, currencies or indices.

 

Ÿ  

Options. Contracts in which the option purchaser has the right, but not the obligation, to purchase from or sell to the option writer financial instruments, commodities or currencies within a defined time period for a specified price.

Derivatives are accounted for at fair value, net of cash collateral received or posted under enforceable credit support agreements. Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement. Derivative assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively. Substantially all gains and losses on derivatives not designated as hedges under ASC 815 are included in “Market making” and “Other principal transactions.”

The table below presents the fair value of derivatives on a net-by-counterparty basis.

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
Derivative
Assets
  
  
      
 
Derivative
Liabilities
  
  
       
 
Derivative
Assets
  
  
      
 
Derivative
Liabilities
  
  

Exchange-traded

    $  4,455           $  3,581          $  3,772           $  2,937   
   

OTC

    63,585           48,766            67,404           47,490   

Total

    $68,040           $52,347            $71,176           $50,427   

 

    Goldman Sachs March 2013 Form 10-Q   25


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the fair value and the notional amount of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting and collateral, and therefore are not representative of the firm’s exposure. OTC derivatives that are cleared with certain clearing organizations are reflected as settled each day. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the condensed consolidated statements of financial condition, as well as cash and securities collateral

posted and received under enforceable credit support agreements that do not meet the criteria for netting under U.S. GAAP. Where the firm has received or posted collateral under credit support agreements, but has not yet determined such agreements are enforceable, the related collateral has not been netted in the table below. Notional amounts, which represent the sum of gross long and short derivative contracts, provide an indication of the volume of the firm’s derivative activity, and do not represent anticipated losses.

 

 

 

    As of March 2013         As of December 2012  
in millions    

 

Derivative

Assets

  

  

   

 

Derivative

Liabilities

  

  

   

 

Notional

Amount

  

  

       

 

Derivative

Assets

  

  

   

 

Derivative

Liabilities

  

  

   

 

Notional

Amount

  

  

Derivatives not accounted for as hedges

             

Interest rates

    $ 518,022        $ 482,433        $36,083,019          $ 584,584        $ 545,605        $34,891,763   
   

Exchange-traded

    86        70        2,621,038          47        26        2,502,867   
   

OTC-cleared

    14,700        15,837        16,298,152          8,847        11,011        14,678,349   
   

Bilateral OTC

    503,236        466,526        17,163,829          575,690        534,568        17,710,547   
   

Credit

    81,669        72,495        3,632,242          85,816        74,927        3,615,757   
   

OTC-cleared

    3,595        3,348        323,457          3,359        2,638        304,100   
   

Bilateral OTC

    78,074        69,147        3,308,785          82,457        72,289        3,311,657   
   

Currencies

    69,534        62,197        4,053,493          72,128        60,808        3,833,114   
   

Exchange-traded

    45        68        13,815          31        82        12,341   
   

OTC-cleared

    31        20        8,723          14        14        5,487   
   

Bilateral OTC

    69,458        62,109        4,030,955          72,083        60,712        3,815,286   
   

Commodities

    22,246        21,752        819,726          23,320        24,350        774,115   
   

Exchange-traded

    5,491        4,640        396,230          5,360        5,040        344,823   
   

OTC-cleared

    31        40        874          26        23        327   
   

Bilateral OTC

    16,724        17,072        422,622          17,934        19,287        428,965   
   

Equities

    51,672        48,082        1,339,285          49,483        43,681        1,202,181   
   

Exchange-traded

    9,636        9,606        495,994          9,409        8,864        441,494   
   

Bilateral OTC

    42,036        38,476        843,291            40,074        34,817        760,687   

Subtotal

    743,143        686,959        45,927,765            815,331        749,371        44,316,930   

Derivatives accounted for as hedges

             

Interest rates

    20,825        180        132,886          23,772        66        128,302   
   

OTC-cleared

    9               66                          
   

Bilateral OTC

    20,816        180        132,820          23,772        66        128,302   
   

Currencies

    37        39        8,427          21        86        8,452   
   

OTC-cleared

                  84                        3   
   

Bilateral OTC

    37        39        8,343            21        86        8,449   

Subtotal

    20,862        219        141,313            23,793        152        136,754   

Gross fair value/notional amount of derivatives

    $ 764,005  1      $ 687,178  1      $46,069,078            $ 839,124  1      $ 749,523  1      $44,453,684   

Amounts that have been offset in the condensed consolidated statements of financial condition

             

Counterparty netting

    (607,096     (607,096         (668,460     (668,460  
   

Exchange-traded

    (10,803     (10,803         (11,075     (11,075  
   

OTC-cleared

    (17,146     (17,146         (11,507     (11,507  
   

Bilateral OTC

    (579,147     (579,147         (645,878     (645,878  
   

Cash collateral

    (88,869     (27,735         (99,488     (30,636  
   

OTC-cleared

    (335     (2,028         (468     (2,160  
   

Bilateral OTC

    (88,534     (25,707                 (99,020     (28,476        

Fair value included in financial instruments owned/financial instruments sold, but not yet purchased

    $   68,040        $   52,347                    $   71,176        $   50,427           

Amounts that have not been offset in the condensed consolidated statements of financial condition

             

Cash collateral received/posted

    (937     (3,706         (812     (2,994  
   

Securities collateral received/posted

    (16,172     (14,384                 (17,225     (14,262        

Total

    $   50,931        $   34,257                    $   53,139        $   33,171           

 

1.

Includes derivative assets and derivative liabilities of $25.43 billion and $27.30 billion, respectively, as of March 2013, and derivative assets and derivative liabilities of $24.62 billion and $25.73 billion, respectively, as of December 2012, which are not subject to an enforceable netting agreement or are subject to a netting agreement that the firm has not yet determined to be enforceable.

 

26   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques for Derivatives

The firm’s level 2 and level 3 derivatives are valued using derivative pricing models (e.g., models that incorporate option pricing methodologies, Monte Carlo simulations and discounted cash flows). Price transparency of derivatives can generally be characterized by product type.

Interest Rate. In general, the prices and other inputs used to value interest rate derivatives are transparent, even for long-dated contracts. Interest rate swaps and options denominated in the currencies of leading industrialized nations are characterized by high trading volumes and tight bid/offer spreads. Interest rate derivatives that reference indices, such as an inflation index, or the shape of the yield curve (e.g., 10-year swap rate vs. 2-year swap rate) are more complex, but the prices and other inputs are generally observable.

Credit. Price transparency for credit default swaps, including both single names and baskets of credits, varies by market and underlying reference entity or obligation. Credit default swaps that reference indices, large corporates and major sovereigns generally exhibit the most price transparency. For credit default swaps with other underliers, price transparency varies based on credit rating, the cost of borrowing the underlying reference obligations, and the availability of the underlying reference obligations for delivery upon the default of the issuer. Credit default swaps that reference loans, asset-backed securities and emerging market debt instruments tend to have less price transparency than those that reference corporate bonds. In addition, more complex credit derivatives, such as those sensitive to the correlation between two or more underlying reference obligations, generally have less price transparency.

Currency. Prices for currency derivatives based on the exchange rates of leading industrialized nations, including those with longer tenors, are generally transparent. The primary difference between the price transparency of developed and emerging market currency derivatives is that emerging markets tend to be observable for contracts with shorter tenors.

Commodity. Commodity derivatives include transactions referenced to energy (e.g., oil and natural gas), metals (e.g., precious and base) and soft commodities (e.g., agricultural). Price transparency varies based on the underlying commodity, delivery location, tenor and product quality (e.g., diesel fuel compared to unleaded gasoline). In general, price transparency for commodity derivatives is greater for contracts with shorter tenors and contracts that are more closely aligned with major and/or benchmark commodity indices.

Equity. Price transparency for equity derivatives varies by market and underlier. Options on indices and the common stock of corporates included in major equity indices exhibit the most price transparency. Equity derivatives generally have observable market prices, except for contracts with long tenors or reference prices that differ significantly from current market prices. More complex equity derivatives, such as those sensitive to the correlation between two or more individual stocks, generally have less price transparency.

Liquidity is essential to observability of all product types. If transaction volumes decline, previously transparent prices and other inputs may become unobservable. Conversely, even highly structured products may at times have trading volumes large enough to provide observability of prices and other inputs. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Derivatives

Level 1 derivatives include short-term contracts for future delivery of securities when the underlying security is a level 1 instrument, and exchange-traded derivatives if they are actively traded and are valued at their quoted market price.

Level 2 Derivatives

Level 2 derivatives include OTC derivatives for which all significant valuation inputs are corroborated by market evidence and exchange-traded derivatives that are not actively traded and/or that are valued using models that calibrate to market-clearing levels of OTC derivatives.

The selection of a particular model to value a derivative depends on the contractual terms of and specific risks inherent in the instrument, as well as the availability of pricing information in the market. For derivatives that trade in liquid markets, model selection does not involve significant management judgment because outputs of models can be calibrated to market-clearing levels.

 

 

    Goldman Sachs March 2013 Form 10-Q   27


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation models require a variety of inputs, such as contractual terms, market prices, yield curves, discount rates (including those derived from interest rates on collateral received and posted as specified in credit support agreements for collateralized derivatives), credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. Inputs to the valuations of level 2 derivatives can be verified to market transactions, broker or dealer quotations or other alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Level 3 Derivatives

Level 3 derivatives are valued using models which utilize observable level 1 and/or level 2 inputs, as well as unobservable level 3 inputs.

 

Ÿ  

For the majority of the firm’s interest rate and currency derivatives classified within level 3, significant unobservable inputs include correlations of certain currencies and interest rates (e.g., the correlation between Euro inflation and Euro interest rates) and specific interest rate volatilities.

 

Ÿ  

For level 3 credit derivatives, significant unobservable inputs include illiquid credit spreads, which are unique to specific reference obligations and reference entities, recovery rates and certain correlations required to value credit and mortgage derivatives (e.g., the likelihood of default of the underlying reference obligation relative to one another).

 

Ÿ  

For level 3 equity derivatives, significant unobservable inputs generally include equity volatility inputs for options that are very long-dated and/or have strike prices that differ significantly from current market prices. In addition, the valuation of certain structured trades requires the use of level 3 correlation inputs, such as the correlation of the price performance of two or more individual stocks or the correlation of the price performance for a basket of stocks to another asset class such as commodities.

Ÿ  

For level 3 commodity derivatives, significant unobservable inputs include volatilities for options with strike prices that differ significantly from current market prices and prices or spreads for certain products for which the product quality or physical location of the commodity is not aligned with benchmark indices.

Subsequent to the initial valuation of a level 3 derivative, the firm updates the level 1 and level 2 inputs to reflect observable market changes and any resulting gains and losses are recorded in level 3. Level 3 inputs are changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data. In circumstances where the firm cannot verify the model value by reference to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. See below for further information about significant unobservable inputs used in the valuation of level 3 derivatives.

Valuation Adjustments

Valuation adjustments are integral to determining the fair value of derivative portfolios and are used to adjust the mid-market valuations produced by derivative pricing models to the appropriate exit price valuation. These adjustments incorporate bid/offer spreads, the cost of liquidity, credit valuation adjustments (CVA) and funding valuation adjustments, which account for the credit and funding risk inherent in the uncollateralized portion of derivative portfolios. Market-based inputs are generally used when calibrating valuation adjustments to market-clearing levels.

In addition, for derivatives that include significant unobservable inputs, the firm makes model or exit price adjustments to account for the valuation uncertainty present in the transaction.

 

 

28   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The tables below present the ranges of significant unobservable inputs used to value the firm’s level 3 derivatives. These ranges represent the significant unobservable inputs that were used in the valuation of each type of derivative. The ranges, averages and medians of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one derivative.

For example, the highest correlation presented in the tables below for interest rate derivatives is appropriate for valuing a specific interest rate derivative but may not be appropriate for valuing any other interest rate derivative. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 derivatives.

 

 

 

Level 3 Derivative
Product Type
 

Net Level 3 Assets/(Liabilities)     

as of March 2013     

(in millions)     

  Significant Unobservable Inputs
of Derivative Pricing Models
 

Range of Significant Unobservable

Inputs (Average / Median) 1

as of March 2013

 

Interest rates

 

 

$(305)

 

 

Correlation 2

 

Volatility

 

 

22% to 84% (64% / 65%)

 

37 basis points per annum (bpa) to 59 bpa (48 bpa / 47 bpa)

 

 

 

 

Credit

 

 

$5,882

 

 

Correlation 2

 

Credit spreads

 

Recovery rates

 

 

5% to 96% (52% / 50%)

 

3 bps to 6,149 bps

(319 bps / 136 bps) 3

 

20% to 88% (53% / 50%)

 

 

Currencies

 

 

$(289)

 

 

Correlation 2

 

 

 

 

65% to 84% (75% / 77%)

 

Commodities

 

 

$(27)

 

 

Volatility

 

Spread per million British Thermal units (MMBTU) of natural gas

 

Price per megawatt hour of power

 

Price per barrel of oil

 

 

 

9% to 56% (23% / 23%)

 

$(0.71) to $3.80 ($(0.02) / $(0.01))

 

 

$17.26 to $60.18 ($36.21 / $35.82)

 

$88.68 to $103.73 ($94.06 / $94.31)

 

Equities

 

 

$(1,135)

 

 

Correlation 2

 

Volatility

 

 

 

29% to 98% (55% / 53%)

 

9% to 67% (27% / 25%)

 

1.

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average.

 

2.

The range of unobservable inputs for correlation across derivative product types (i.e., cross-asset correlation) was (58)% to 82% (Average: 24% / Median: 33%) as of March 2013.

 

3.

The difference between the average and the median for the credit spreads input indicates that the majority of the inputs fall in the lower end of the range.

 

    Goldman Sachs March 2013 Form 10-Q   29


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Derivative
Product Type
 

Net Level 3 Assets/(Liabilities)     

as of December 2012     

(in millions)     

  Significant Unobservable Inputs of
Derivative Pricing Models
 

Range of Significant Unobservable

Inputs (Average / Median) 1

as of December 2012

 

Interest rates

 

 

$(355)

 

 

Correlation 2

 

Volatility

 

 

 

 

 

22% to 97% (67% / 68%)

 

37 bpa to 59 bpa (48 bpa / 47 bpa)

 

Credit

 

 

$6,228

 

 

Correlation 2

 

Credit spreads

 

 

Recovery rates

 

 

 

5% to 95% (50% / 50%)

 

9 bps to 2,341 bps

(225 bps / 140 bps) 3

 

15% to 85% (54% / 53%)

 

Currencies

 

 

$35

 

 

Correlation 2

 

 

 

 

65% to 87% (76% / 79%)

 

Commodities

 

 

$(304)

 

 

Volatility

 

Spread per MMBTU of natural gas

 

Price per megawatt hour of power

 

Price per barrel of oil

 

 

 

13% to 53% (30% / 29%)

 

$(0.61) to $6.07 ($0.02 / $0.00)

 

$17.30 to $57.39 ($33.17 / $32.80)

 

$86.64 to $98.43 ($92.76 / $93.62)

 

Equities

 

 

$(1,248)

 

 

Correlation 2

 

Volatility

 

 

 

48% to 98% (68% / 67%)

 

15% to 73% (31% / 30%)

 

1.

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average.

 

2.

The range of unobservable inputs for correlation across derivative product types (i.e., cross-asset correlation) was (51)% to 66% (Average: 30% / Median: 35%) as of December 2012.

 

3.

The difference between the average and the median for the credit spreads input indicates that the majority of the inputs fall in the lower end of the range.

 

30   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Range of Significant Unobservable Inputs

The following provides further information about the ranges of significant unobservable inputs used to value the firm’s level 3 derivative instruments.

 

Ÿ  

Correlation: Ranges for correlation cover a variety of underliers both within one market (e.g., equity index and equity single stock names) and across markets (e.g., correlation of a commodity price and a foreign exchange rate), as well as across regions. Generally, cross-asset correlation inputs are used to value more complex instruments and are lower than correlation inputs on assets within the same derivative product type.

 

Ÿ  

Volatility: Ranges for volatility cover numerous underliers across a variety of markets, maturities and strike prices. For example, volatility of equity indices is generally lower than volatility of single stocks.

 

Ÿ  

Credit spreads and recovery rates: The ranges for credit spreads and recovery rates cover a variety of underliers (index and single names), regions, sectors, maturities and credit qualities (high-yield and investment-grade). The broad range of this population gives rise to the width of the ranges of significant unobservable inputs.

 

Ÿ  

Commodity prices and spreads: The ranges for commodity prices and spreads cover variability in products, maturities and locations, as well as peak and off-peak prices.

Sensitivity of Fair Value Measurement to Changes in Significant Unobservable Inputs

The following provides a description of the directional sensitivity of the firm’s level 3 fair value measurements to changes in significant unobservable inputs, in isolation. Due to the distinctive nature of each of the firm’s level 3 derivatives, the interrelationship of inputs is not necessarily uniform within each product type.

 

Ÿ  

Correlation: In general, for contracts where the holder benefits from the convergence of the underlying asset or index prices (e.g., interest rates, credit spreads, foreign exchange rates, inflation rates and equity prices), an increase in correlation results in a higher fair value measurement.

 

Ÿ  

Volatility: In general, for purchased options an increase in volatility results in a higher fair value measurement.

 

Ÿ  

Credit spreads and recovery rates: In general, the fair value of purchased credit protection increases as credit spreads increase or recovery rates decrease. Credit spreads and recovery rates are strongly related to distinctive risk factors of the underlying reference obligations, which include reference entity-specific factors such as leverage, volatility and industry, market-based risk factors, such as borrowing costs or liquidity of the underlying reference obligation, and macro-economic conditions.

 

Ÿ  

Commodity prices and spreads: In general, for contracts where the holder is receiving a commodity, an increase in the spread (price difference from a benchmark index due to differences in quality or delivery location) or price results in a higher fair value measurement.

 

 

    Goldman Sachs March 2013 Form 10-Q   31


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Derivatives by Level

The tables below present the fair value of derivatives on a gross basis by level and major product type. Gross fair values exclude the effects of both counterparty

netting and collateral, and therefore are not representative of the firm’s exposure.

 

 

 

    Derivative Assets at Fair Value as of March 2013  
in millions     Level 1           Level 2           Level 3          
 
Cross-Level
Netting
  
  
       Total   

Interest rates

    $  26           $ 538,655           $     166           $       —           $  538,847   
   

Credit

              71,039           10,630                     81,669   
   

Currencies

              68,953           618                     69,571   
   

Commodities

              21,765           481                     22,246   
   

Equities

    28           51,062           582                     51,672   

Gross fair value of derivative assets

    54           751,474           12,477                     764,005   
   

Counterparty netting 1

              (601,944        (3,193        (1,959 ) 3         (607,096

Subtotal

    $  54           $ 149,530           $  9,284           $(1,959        $  156,909   
   

Cash collateral 2

                                                (88,869

Fair value included in financial instruments owned

                                                $    68,040   
    Derivative Liabilities at Fair Value as of March 2013  
in millions     Level 1           Level 2           Level 3          

 

Cross-Level

Netting

  

  

       Total   

Interest rates

    $  29           $ 482,113           $     471           $       —           $  482,613   
   

Credit

              67,747           4,748                     72,495   
   

Currencies

              61,329           907                     62,236   
   

Commodities

              21,244           508                     21,752   
   

Equities

    119           46,246           1,717                     48,082   

Gross fair value of derivative liabilities

    148           678,679           8,351                     687,178   
   

Counterparty netting 1

              (601,944        (3,193        (1,959 ) 3         (607,096

Subtotal

    $148           $   76,735           $  5,158           $(1,959        $    80,082   
   

Cash collateral 2

                                                (27,735

Fair value included in financial instruments sold,
but not yet purchased

                                                $    52,347   

 

1.

Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.

 

2.

Represents the netting of cash collateral received and posted on a counterparty basis under enforceable credit support agreements.

 

3.

Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.

 

32   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Derivative Assets at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3          
 
Cross-Level
Netting
  
  
       Total   

Interest rates

    $13           $ 608,151           $     192           $       —           $ 608,356   
   

Credit

              74,907           10,909                     85,816   
   

Currencies

              71,157           992                     72,149   
   

Commodities

              22,697           623                     23,320   
   

Equities

    43           48,698           742                     49,483   

Gross fair value of derivative assets

    56           825,610           13,458                     839,124   
   

Counterparty netting 1

              (662,798        (3,538        (2,124 ) 3         (668,460

Subtotal

    $56           $ 162,812           $ 9,920           $(2,124        $ 170,664   
   

Cash collateral 2

                                                (99,488

Fair value included in financial instruments owned

                                                $   71,176   
    Derivative Liabilities at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3          

 

Cross-Level

Netting

  

  

       Total   

Interest rates

    $14           $ 545,110           $     547           $       —           $ 545,671   
   

Credit

              70,246           4,681                     74,927   
   

Currencies

              59,937           957                     60,894   
   

Commodities

              23,423           927                     24,350   
   

Equities

    50           41,641           1,990                     43,681   

Gross fair value of derivative liabilities

    64           740,357           9,102                     749,523   
   

Counterparty netting 1

              (662,798        (3,538        (2,124 ) 3         (668,460

Subtotal

    $64           $   77,559           $ 5,564           $(2,124        $   81,063   
   

Cash collateral 2

                                                (30,636

Fair value included in financial instruments sold,
but not yet purchased

                                                $   50,427   

 

1.

Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.

 

2.

Represents the netting of cash collateral received and posted on a counterparty basis under enforceable credit support agreements.

 

3.

Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.

 

    Goldman Sachs March 2013 Form 10-Q   33


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

If a derivative was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3. Transfers between levels are reported at the beginning of the reporting period in which they occur. In the tables below, negative amounts for transfers into level 3 and positive amounts for transfers out of level 3 represent net transfers of derivative liabilities.

Gains and losses on level 3 derivatives should be considered in the context of the following:

 

Ÿ  

A derivative with level 1 and/or level 2 inputs is classified in level 3 in its entirety if it has at least one significant level 3 input.

 

Ÿ  

If there is one significant level 3 input, the entire gain or loss from adjusting only observable inputs (i.e., level 1 and level 2 inputs) is classified as level 3.

Ÿ  

Gains or losses that have been reported in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to level 1 or level 2 derivatives and/or level 1, level 2 and level 3 cash instruments. As a result, gains/(losses) included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

The tables below present changes in fair value for all derivatives categorized as level 3 as of the end of the period.

 

 

 

    Level 3 Derivative Assets and Liabilities at Fair Value for the Three Months Ended March 2013  
in millions    

 
 
 
 

Asset/

(liability)
balance,
beginning
of period

  

  
  
  
  

   

 
 
 

Net

realized
gains/
(losses)

  

  
  
  

   
 
 
 
 
 
Net unrealized
gains/(losses)
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases         Sales        Settlements       
 

 

Transfers
into

level 3

  
  

  

   

 

 

Transfers

out of

level 3

  

  

  

   

 

 
 

 

Asset/

(liability)

balance,
end of

period

  

  

  
  

  

Interest rates — net

    $   (355     $  (6     $   30        $    5         $    —        $   51        $ (14 )      $ (16     $   (305
   

Credit — net

    6,228        (3     18        75         (46     (527     230        (93     5,882   
   

Currencies — net

    35        (8     (329     2         (3     26        40        (52     (289
   

Commodities — net

    (304     22        167        38         (21     (22     19        74        (27
   

Equities — net

    (1,248     (32     (170     39         (488     141        (51 )      674        (1,135

Total derivatives — net

    $ 4,356        $(27 ) 1      $(284 ) 1, 2      $159         $(558     $(331     $224        $587        $ 4,126   

 

1.

The aggregate amounts include approximately $(193) million and $(118) million reported in “Market making” and “Other principal transactions,” respectively.

 

2.

Principally resulted from changes in level 2 inputs.

 

The net unrealized loss on level 3 derivatives of $284 million for the three months ended March 2013 was primarily attributable to changes in foreign exchange rates on certain currency derivatives and increases in equity prices on certain equity derivatives, partially offset by the impact of a decline in volatility on certain commodity derivatives.

Transfers into level 3 derivatives during the three months ended March 2013 primarily reflected transfers of certain credit derivative assets from level 2, principally due to reduced transparency of credit spread inputs used to value these derivatives.

Transfers out of level 3 derivatives during the three months ended March 2013 primarily reflected transfers of certain equity derivative liabilities to level 2, principally due to unobservable inputs no longer being significant to the valuation of these derivatives.

 

 

34   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

    Level 3 Derivative Assets and Liabilities at Fair Value for the Three Months Ended March 2012  
in millions    

 
 
 
 

Asset/

(liability)
balance,
beginning
of period

  

  
  
  
  

    

 
 
 

Net

realized
gains/
(losses)

  

  
  
  

   
 
 
 
 
 
Net unrealized
gains/(losses)
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases         Sales         Settlements        
 

 

Transfers
into

level 3

  
  

  

    

 

 

Transfers

out of

level 3

  

  

  

    

 

 
 

 

Asset/

(liability)

balance,
end of

period

  

  

  
  

  

Interest rates — net

    $  (371      $(63     $   32        $    3         $    (1      $ 164         $       8         $  (12      $  (240
   

Credit — net

    6,300         10        (308     75         (73      (553      1,332         (281      6,502   
   

Currencies — net

    842         (6     (266     1         (7      (234      2         58         390   
   

Commodities — net

    (605      40        206        99         (99      41         100         119         (99
   

Equities — net

    (432      (25     (277     73         (100      306         15         (80      (520

Total derivatives — net

    $5,734         $(44 ) 1      $(613 ) 1, 2      $251         $(280      $(276      $1,457         $(196      $6,033   

 

1.

The aggregate amounts include approximately $(444) million and $(213) million reported in “Market making” and “Other principal transactions,” respectively.

 

2.

Principally resulted from changes in level 2 inputs.

 

The net unrealized loss on level 3 derivatives of $613 million for the three months ended March 2012 was primarily attributable to the impact of tighter credit spreads, increases in equity prices and changes in foreign exchange rates on the underlying derivatives, partially offset by the impact of changes in commodity prices.

Transfers into level 3 derivatives during the three months ended March 2012 primarily reflected transfers of certain credit derivative assets from level 2, primarily due to unobservable inputs becoming significant to the valuation of these derivatives.

Transfers out of level 3 derivatives during the three months ended March 2012 primarily reflected transfers to level 2 of certain credit derivative assets, principally due to unobservable inputs no longer being significant to the valuation of these derivatives.

Impact of Credit Spreads on Derivatives

On an ongoing basis, the firm realizes gains or losses relating to changes in credit risk through the unwind of derivative contracts and changes in credit mitigants.

The net loss, including hedges, attributable to the impact of changes in credit exposure and credit spreads (counterparty and the firm’s) on derivatives was $83 million and $179 million for the three months ended March 2013 and March 2012, respectively.

Bifurcated Embedded Derivatives

The table below presents the fair value and the notional amount of derivatives that have been bifurcated from their related borrowings. These derivatives, which are recorded at fair value, primarily consist of interest rate, equity and commodity products and are included in “Unsecured short-term borrowings” and “Unsecured long-term borrowings” with the related borrowings. See Note 8 for further information.

 

 

    As of  
in millions    

 

March

2013

 

  

    

 

December

2012

  

  

Fair value of assets

    $     275         $     320   
   

Fair value of liabilities

    367         398   

Net asset/(liability)

    $      (92      $      (78

Notional amount

    $10,188         $10,567   
 

 

    Goldman Sachs March 2013 Form 10-Q   35


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

OTC Derivatives

The tables below present the fair values of OTC derivative assets and liabilities by tenor and by product type. Tenor is based on expected duration for mortgage-related credit

derivatives and generally on remaining contractual maturity for other derivatives.

 

 

 

in millions     OTC Derivatives as of March 2013   

Assets

Product Type

   

 

0 - 12

Months

  

  

      

 

1 - 5

Years

  

  

      

 

5 Years or

Greater

  

  

       Total   

Interest rates

    $  8,817           $27,020           $72,111           $107,948   
   

Credit

    2,025           11,105           7,804           20,934   
   

Currencies

    11,086           7,780           8,561           27,427   
   

Commodities

    4,037           3,666           398           8,101   
   

Equities

    5,326           7,626           6,235           19,187   
   

Netting across product types 1

    (2,279        (5,857        (4,380        (12,516

Subtotal

    $29,012           $51,340           $90,729           $171,081   
   

Cross maturity netting 2

                   (18,627
   

Cash collateral 3

                                     (88,869

Total

                                     $  63,585   

Liabilities

Product Type

   

 

0 - 12

Months

  

  

      

 

1 - 5

Years

  

  

      

 

5 Years or

Greater

  

  

       Total   

Interest rates

    $  4,126           $17,437           $30,165           $  51,728   
   

Credit

    764           7,645           3,352           11,761   
   

Currencies

    9,732           5,161           5,176           20,069   
   

Commodities

    3,815           2,597           2,046           8,458   
   

Equities

    6,189           5,487           3,952           15,628   
   

Netting across product types 1

    (2,279        (5,857        (4,380        (12,516

Subtotal

    $22,347           $32,470           $40,311           $  95,128   
   

Cross maturity netting 2

                   (18,627
   

Cash collateral 3

                                     (27,735

Total

                                     $  48,766   

 

1.

Represents the netting of receivable balances with payable balances for the same counterparty across product types within a tenor category under enforceable netting agreements. Receivable and payable balances with the same counterparty in the same product type and tenor category are netted within such product type and tenor category.

 

2.

Represents the netting of receivable balances with payable balances for the same counterparty across tenor categories under enforceable netting agreements.

 

3.

Represents the netting of cash collateral received and posted on a counterparty basis under enforceable credit support agreements.

 

36   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

in millions     OTC Derivatives as of December 2012   

Assets

Product Type

   

 

0 - 12

Months

  

  

      

 

1 - 5

Years

  

  

      

 

5 Years or

Greater

  

  

       Total   

Interest rates

    $10,318           $28,445           $  80,449           $119,212   
   

Credit

    2,190           12,244           7,970           22,404   
   

Currencies

    11,100           8,379           11,044           30,523   
   

Commodities

    3,840           3,862           304           8,006   
   

Equities

    3,757           7,730           6,957           18,444   
   

Netting across product types 1

    (2,811        (5,831        (5,082        (13,724

Subtotal

    $28,394           $54,829           $101,642           $184,865   
   

Cross maturity netting 2

                   (17,973
   

Cash collateral 3

                                     (99,488

Total

                                     $  67,404   

Liabilities

Product Type

   

 

0 - 12

Months

  

  

      

 

1 - 5

Years

  

  

      

 

5 Years or

Greater

  

  

       Total   

Interest rates

    $  6,266           $17,860           $  32,422           $  56,548   
   

Credit

    809           7,537           3,168           11,514   
   

Currencies

    8,586           4,849           5,782           19,217   
   

Commodities

    3,970           3,119           2,267           9,356   
   

Equities

    3,775           5,476           3,937           13,188   
   

Netting across product types 1

    (2,811        (5,831        (5,082        (13,724

Subtotal

    $20,595           $33,010           $  42,494           $  96,099   
   

Cross maturity netting 2

                   (17,973
   

Cash collateral 3

                                     (30,636

Total

                                     $  47,490   

 

1.

Represents the netting of receivable balances with payable balances for the same counterparty across product types within a tenor category under enforceable netting agreements. Receivable and payable balances with the same counterparty in the same product type and tenor category are netted within such product type and tenor category.

 

2.

Represents the netting of receivable balances with payable balances for the same counterparty across tenor categories under enforceable netting agreements.

 

3.

Represents the netting of cash collateral received and posted on a counterparty basis under enforceable credit support agreements.

 

    Goldman Sachs March 2013 Form 10-Q   37


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Derivatives with Credit-Related Contingent Features

Certain of the firm’s derivatives have been transacted under bilateral agreements with counterparties who may require the firm to post collateral or terminate the transactions based on changes in the firm’s credit ratings. The firm assesses the impact of these bilateral agreements by determining the collateral or termination payments that would occur assuming a downgrade by all rating agencies. A downgrade by any one rating agency, depending on the agency’s relative ratings of the firm at the time of the downgrade, may have an impact which is comparable to the impact of a downgrade by all rating agencies. The table below presents the aggregate fair value of net derivative liabilities under such agreements (excluding application of collateral posted to reduce these liabilities), the related aggregate fair value of the assets posted as collateral, and the additional collateral or termination payments that could have been called at the reporting date by counterparties in the event of a one-notch and two-notch downgrade in the firm’s credit ratings.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Net derivative liabilities under bilateral agreements

    $27,925         $27,885   
   

Collateral posted

    24,378         24,296   
   

Additional collateral or termination payments for a one-notch downgrade

    1,597         1,534   
   

Additional collateral or termination payments for a two-notch downgrade

    2,476         2,500   

Credit Derivatives

The firm enters into a broad array of credit derivatives in locations around the world to facilitate client transactions and to manage the credit risk associated with market-making and investing and lending activities. Credit derivatives are actively managed based on the firm’s net risk position.

Credit derivatives are individually negotiated contracts and can have various settlement and payment conventions. Credit events include failure to pay, bankruptcy, acceleration of indebtedness, restructuring, repudiation and dissolution of the reference entity.

Credit Default Swaps. Single-name credit default swaps protect the buyer against the loss of principal on one or more bonds, loans or mortgages (reference obligations) in the event the issuer (reference entity) of the reference obligations suffers a credit event. The buyer of protection pays an initial or periodic premium to the seller and receives

protection for the period of the contract. If there is no credit event, as defined in the contract, the seller of protection makes no payments to the buyer of protection. However, if a credit event occurs, the seller of protection is required to make a payment to the buyer of protection, which is calculated in accordance with the terms of the contract.

Credit Indices, Baskets and Tranches. Credit derivatives may reference a basket of single-name credit default swaps or a broad-based index. If a credit event occurs in one of the underlying reference obligations, the protection seller pays the protection buyer. The payment is typically a pro-rata portion of the transaction’s total notional amount based on the underlying defaulted reference obligation. In certain transactions, the credit risk of a basket or index is separated into various portions (tranches), each having different levels of subordination. The most junior tranches cover initial defaults and once losses exceed the notional amount of these junior tranches, any excess loss is covered by the next most senior tranche in the capital structure.

Total Return Swaps. A total return swap transfers the risks relating to economic performance of a reference obligation from the protection buyer to the protection seller. Typically, the protection buyer receives from the protection seller a floating rate of interest and protection against any reduction in fair value of the reference obligation, and in return the protection seller receives the cash flows associated with the reference obligation, plus any increase in the fair value of the reference obligation.

Credit Options. In a credit option, the option writer assumes the obligation to purchase or sell a reference obligation at a specified price or credit spread. The option purchaser buys the right, but does not assume the obligation, to sell the reference obligation to, or purchase it from, the option writer. The payments on credit options depend either on a particular credit spread or the price of the reference obligation.

The firm economically hedges its exposure to written credit derivatives primarily by entering into offsetting purchased credit derivatives with identical underlyings. Substantially all of the firm’s purchased credit derivative transactions are with financial institutions and are subject to stringent collateral thresholds. In addition, upon the occurrence of a specified trigger event, the firm may take possession of the reference obligations underlying a particular written credit derivative, and consequently may, upon liquidation of the reference obligations, recover amounts on the underlying reference obligations in the event of default.

 

 

38   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

As of March 2013, written and purchased credit derivatives had total gross notional amounts of $1.77 trillion and $1.86 trillion, respectively, for total net notional purchased protection of $88.75 billion. As of December 2012, written and purchased credit derivatives had total gross notional amounts of $1.76 trillion and $1.86 trillion, respectively, for total net notional purchased protection of $98.33 billion.

The table below presents certain information about credit derivatives. In the table below:

 

Ÿ  

fair values exclude the effects of both netting of receivable balances with payable balances under enforceable netting agreements, and netting of cash received or posted under enforceable credit support agreements, and therefore are not representative of the firm’s credit exposure;

Ÿ  

tenor is based on expected duration for mortgage-related credit derivatives and on remaining contractual maturity for other credit derivatives; and

 

Ÿ  

the credit spread on the underlying, together with the tenor of the contract, are indicators of payment/performance risk. The firm is less likely to pay or otherwise be required to perform where the credit spread and the tenor are lower.

 

 

 

   

Maximum Payout/Notional Amount

of Written Credit Derivatives by Tenor

        Maximum Payout/Notional
Amount of Purchased
Credit Derivatives
       

Fair Value of

Written Credit Derivatives

 
$ in millions    

 

0 - 12

Months

 

  

    

 

1 - 5

Years

  

  

    

 

5 Years

or Greater

  

  

     Total           
 
 
 
Offsetting
Purchased
Credit
Derivatives
  
  
  
 1 
   
 
 
 
Other
Purchased
Credit
Derivatives
  
  
  
 2 
        Asset         Liability        

 

 

Net

Asset/

(Liability)

  

  

  

As of March 2013

                          

Credit spread on underlying

(basis points)

                          

0-250

    $364,116         $   990,658         $118,650         $1,473,424          $1,353,367        $203,517          $29,211         $  7,923         $21,288   
   

251-500

    12,780         143,576         37,314         193,670          174,983        19,548          4,290         8,350         (4,060
   

501-1,000

    5,061         42,215         5,520         52,796          50,663        5,137          440         3,326         (2,886
   

Greater than 1,000

    10,214         40,936         2,936         54,086            47,216        8,291            520         20,588         (20,068

Total

    $392,171         $1,217,385         $164,420         $1,773,976            $1,626,229        $236,493            $34,461         $40,187         $ (5,726

As of December 2012

                          

Credit spread on underlying

(basis points)

                          

0-250

    $360,289         $   989,941         $103,481         $1,453,711          $1,343,561        $201,459          $28,817         $  8,249         $20,568   
   

251-500

    13,876         126,659         35,086         175,621          157,371        19,063          4,284         7,848         (3,564
   

501-1,000

    9,209         52,012         5,619         66,840          60,456        8,799          769         4,499         (3,730
   

Greater than 1,000

    11,453         49,721         3,622         64,796            57,774        10,812            568         21,970         (21,402

Total

    $394,827         $1,218,333         $147,808         $1,760,968            $1,619,162        $240,133            $34,438         $42,566         $ (8,128

 

1.

Offsetting purchased credit derivatives represent the notional amount of purchased credit derivatives to the extent they economically hedge written credit derivatives with identical underlyings.

 

2.

This purchased protection represents the notional amount of purchased credit derivatives in excess of the notional amount included in “Offsetting Purchased Credit Derivatives.”

Hedge Accounting

The firm applies hedge accounting for (i) certain interest rate swaps used to manage the interest rate exposure of certain fixed-rate unsecured long-term and short-term borrowings and certain fixed-rate certificates of deposit and (ii) certain foreign currency forward contracts and foreign currency-denominated debt used to manage foreign currency exposures on the firm’s net investment in certain non-U.S. operations.

To qualify for hedge accounting, the derivative hedge must be highly effective at reducing the risk from the exposure being hedged. Additionally, the firm must formally document the hedging relationship at inception and test the hedging relationship at least on a quarterly basis to ensure the derivative hedge continues to be highly effective over the life of the hedging relationship.

 

 

    Goldman Sachs March 2013 Form 10-Q   39


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Interest Rate Hedges

The firm designates certain interest rate swaps as fair value hedges. These interest rate swaps hedge changes in fair value attributable to the relevant benchmark interest rate (e.g., London Interbank Offered Rate (LIBOR)), effectively converting a substantial portion of fixed-rate obligations into floating-rate obligations.

The firm applies a statistical method that utilizes regression analysis when assessing the effectiveness of its fair value hedging relationships in achieving offsetting changes in the fair values of the hedging instrument and the risk being hedged (i.e., interest rate risk). An interest rate swap is considered highly effective in offsetting changes in fair value attributable to changes in the hedged risk when the regression analysis results in a coefficient of determination of 80% or greater and a slope between 80% and 125%.

For qualifying fair value hedges, gains or losses on derivatives are included in “Interest expense.” The change in fair value of the hedged item attributable to the risk being hedged is reported as an adjustment to its carrying value and is subsequently amortized into interest expense over its remaining life. Gains or losses resulting from hedge ineffectiveness are included in “Interest expense.” When a derivative is no longer designated as a hedge, any remaining difference between the carrying value and par value of the hedged item is amortized to interest expense over the remaining life of the hedged item using the effective interest method. See Note 23 for further information about interest income and interest expense.

The table below presents the gains/(losses) from interest rate derivatives accounted for as hedges, the related hedged borrowings and bank deposits, and the hedge ineffectiveness on these derivatives.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Interest rate hedges

    $(1,843 )       $(2,238
   

Hedged borrowings and bank deposits

    1,393         1,778   

Hedge ineffectiveness 1

    $   (450 )       $   (460

 

1.

Primarily consisted of amortization of prepaid credit spreads resulting from the passage of time.

Net Investment Hedges

The firm seeks to reduce the impact of fluctuations in foreign exchange rates on its net investment in certain non-U.S. operations through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts designated as hedges, the effectiveness of the hedge is assessed based on the overall changes in the fair value of the forward contracts (i.e., based on changes in forward rates). For foreign currency-denominated debt designated as a hedge, the effectiveness of the hedge is assessed based on changes in spot rates.

For qualifying net investment hedges, the gains or losses on the hedging instruments, to the extent effective, are included in “Currency translation adjustment, net of tax” within the condensed consolidated statements of comprehensive income.

The table below presents the gains/(losses) from net investment hedging.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Currency hedges

    $220         $(212
   

Foreign currency-denominated debt hedges

    220         221   

The gain/(loss) related to ineffectiveness and the gain/(loss) reclassified to earnings from accumulated other comprehensive income were not material for the three months ended March 2013 and March 2012.

As of March 2013 and December 2012, the firm had designated $2.55 billion and $2.77 billion, respectively, of foreign currency-denominated debt, included in “Unsecured long-term borrowings” and “Unsecured short-term borrowings,” as hedges of net investments in non-U.S. subsidiaries.

 

 

40   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 8. Fair Value Option

Note 8.

Fair Value Option

 

Other Financial Assets and Financial Liabilities at Fair Value

    

In addition to all cash and derivative instruments included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” the firm has elected to account for certain of its other financial assets and financial liabilities at fair value under the fair value option.

The primary reasons for electing the fair value option are to:

 

Ÿ  

reflect economic events in earnings on a timely basis;

 

Ÿ  

mitigate volatility in earnings from using different measurement attributes (e.g., transfers of financial instruments owned accounted for as financings are recorded at fair value whereas the related secured financing would be recorded on an accrual basis absent electing the fair value option); and

 

Ÿ  

address simplification and cost-benefit considerations (e.g., accounting for hybrid financial instruments at fair value in their entirety versus bifurcation of embedded derivatives and hedge accounting for debt hosts).

Hybrid financial instruments are instruments that contain bifurcatable embedded derivatives and do not require settlement by physical delivery of non-financial assets (e.g., physical commodities). If the firm elects to bifurcate the embedded derivative from the associated debt, the derivative is accounted for at fair value and the host contract is accounted for at amortized cost, adjusted for the effective portion of any fair value hedges. If the firm does not elect to bifurcate, the entire hybrid financial instrument is accounted for at fair value under the fair value option.

Other financial assets and financial liabilities accounted for at fair value under the fair value option include:

 

Ÿ  

repurchase agreements and substantially all resale agreements;

 

Ÿ  

securities borrowed and loaned within Fixed Income, Currency and Commodities Client Execution;

 

Ÿ  

substantially all other secured financings, including transfers of assets accounted for as financings rather than sales;

Ÿ  

certain unsecured short-term borrowings, consisting of all promissory notes and commercial paper and certain hybrid financial instruments;

 

Ÿ  

certain unsecured long-term borrowings, including certain prepaid commodity transactions and certain hybrid financial instruments;

 

Ÿ  

certain insurance and reinsurance contract assets and liabilities and certain guarantees;

 

Ÿ  

certain receivables from customers and counterparties, including transfers of assets accounted for as secured loans rather than purchases and certain margin loans;

 

Ÿ  

certain time deposits issued by the firm’s bank subsidiaries (deposits with no stated maturity are not eligible for a fair value option election), including structured certificates of deposit, which are hybrid financial instruments; and

 

Ÿ  

certain subordinated liabilities issued by consolidated VIEs.

These financial assets and financial liabilities at fair value are generally valued based on discounted cash flow techniques, which incorporate inputs with reasonable levels of price transparency, and are generally classified as level 2 because the inputs are observable. Valuation adjustments may be made for liquidity and for counterparty and the firm’s credit quality.

See below for information about the significant inputs used to value other financial assets and financial liabilities at fair value, including the ranges of significant unobservable inputs used to value the level 3 instruments within these categories. These ranges represent the significant unobservable inputs that were used in the valuation of each type of other financial assets and financial liabilities at fair value. The ranges and weighted averages of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one instrument. For example, the highest yield presented below for resale and repurchase agreements is appropriate for valuing a specific agreement in that category but may not be appropriate for valuing any other agreements in that category. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 other financial assets and financial liabilities.

 

 

    Goldman Sachs March 2013 Form 10-Q   41


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Resale and Repurchase Agreements and Securities Borrowed and Loaned. The significant inputs to the valuation of resale and repurchase agreements and securities borrowed and loaned are collateral funding spreads, the amount and timing of expected future cash flows and interest rates. The ranges of significant unobservable inputs used to value level 3 resale and repurchase agreements are as follows:

As of March 2013:

 

Ÿ  

Yield: 1.8% to 5.2% (weighted average: 1.9%)

 

Ÿ  

Duration: 1.1 to 4.4 years (weighted average: 4.2 years)

As of December 2012:

 

Ÿ  

Yield: 1.7% to 5.4% (weighted average: 1.9%)

 

Ÿ  

Duration: 0.4 to 4.5 years (weighted average: 4.1 years)

Generally, increases in yield or duration, in isolation, would result in a lower fair value measurement. Due to the distinctive nature of each of the firm’s level 3 resale and repurchase agreements, the interrelationship of inputs is not necessarily uniform across such agreements.

See Note 9 for further information about collateralized agreements.

Other Secured Financings. The significant inputs to the valuation of other secured financings at fair value are the amount and timing of expected future cash flows, interest rates, collateral funding spreads, the fair value of the collateral delivered by the firm (which is determined using the amount and timing of expected future cash flows, market prices, market yields and recovery assumptions) and the frequency of additional collateral calls. The ranges of significant unobservable inputs used to value level 3 other secured financings are as follows:

As of March 2013:

 

Ÿ  

Funding spreads: 42 bps to 210 bps (weighted average: 111 bps)

 

Ÿ  

Yield: 2.7% to 15.9% (weighted average: 10.0%)

 

Ÿ  

Duration: 0.6 to 10.5 years (weighted average: 3.8 years)

As of December 2012:

 

Ÿ  

Yield: 0.3% to 20.0% (weighted average: 4.2%)

 

Ÿ  

Duration: 0.3 to 10.8 years (weighted average: 2.4 years)

Generally, increases in funding spreads, yield or duration, in isolation, would result in a lower fair value measurement. Due to the distinctive nature of each of the

firm’s level 3 other secured financings, the interrelationship of inputs is not necessarily uniform across such financings.

See Note 9 for further information about collateralized financings.

Unsecured Short-term and Long-term Borrowings. The significant inputs to the valuation of unsecured short-term and long-term borrowings at fair value are the amount and timing of expected future cash flows, interest rates, the credit spreads of the firm, as well as commodity prices in the case of prepaid commodity transactions. The inputs used to value the embedded derivative component of hybrid financial instruments are consistent with the inputs used to value the firm’s other derivative instruments. See Note 7 for further information about derivatives. See Notes 15 and 16 for further information about unsecured short-term and long-term borrowings, respectively.

Certain of the firm’s unsecured short-term and long-term instruments are included in level 3, substantially all of which are hybrid financial instruments. As the significant unobservable inputs used to value hybrid financial instruments primarily relate to the embedded derivative component of these borrowings, these inputs are incorporated in the firm’s derivative disclosures related to unobservable inputs in Note 7.

Insurance and Reinsurance Contracts. Insurance and reinsurance contracts at fair value are primarily included in “Receivables from customers and counterparties” and “Other liabilities and accrued expenses.” In addition, assets related to the firm’s reinsurance business that were classified as held for sale as of March 2013 and December 2012 are included in “Other assets.” The insurance and reinsurance contracts for which the firm has elected the fair value option are contracts that can be settled only in cash and that qualify for the fair value option because they are recognized financial instruments. These contracts are valued using market transactions and other market evidence where possible, including market-based inputs to models, calibration to market-clearing transactions or other alternative pricing sources with reasonable levels of price transparency. Significant inputs are interest rates, inflation rates, volatilities, funding spreads, yield and duration, which incorporates policy lapse and projected mortality assumptions. When unobservable inputs to a valuation model are significant to the fair value measurement of an instrument, the instrument is classified in level 3. The ranges of significant unobservable inputs used to value level 3 insurance and reinsurance contracts are as follows:

 

 

42   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

As of March 2013:

 

Ÿ  

Funding spreads: 33 bps to 49 bps (weighted average: 40 bps)

 

Ÿ  

Yield: 3.6% to 11.3% (weighted average: 6.2%)

 

Ÿ  

Duration: 7.6 to 10.5 years (weighted average: 9.1 years)

As of December 2012:

 

Ÿ  

Funding spreads: 39 bps to 61 bps (weighted average: 49 bps)

 

Ÿ  

Yield: 4.4% to 15.1% (weighted average: 6.2%)

 

Ÿ  

Duration: 5.3 to 8.8 years (weighted average: 7.6 years)

Generally, increases in funding spreads, yield or duration, in isolation, would result in a lower fair value measurement. Due to the distinctive nature of each of the firm’s level 3 insurance and reinsurance contracts, the interrelationship of inputs is not necessarily uniform across such contracts.

Receivables from Customers and Counterparties. Receivables from customers and counterparties at fair value, excluding insurance and reinsurance contracts, are primarily comprised of transfers of assets accounted for as secured loans rather than purchases. The significant inputs to the valuation of such receivables are commodity prices, interest rates, the amount and timing of expected future cash flows and funding spreads. The ranges of significant unobservable inputs used to value level 3 receivables from customers and counterparties are as follows:

As of March 2013:

 

Ÿ  

Funding spreads: 74 bps to 84 bps (weighted average: 81 bps)

As of December 2012:

 

Ÿ  

Funding spreads: 85 bps to 99 bps (weighted average: 99 bps)

Generally, an increase in funding spreads would result in a lower fair value measurement.

Receivables from customers and counterparties not accounted for at fair value are accounted for at amortized cost net of estimated uncollectible amounts, which generally approximates fair value. Such receivables are primarily comprised of customer margin loans and collateral posted in connection with certain derivative transactions. While these items are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these items been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013. Receivables from customers and counterparties not accounted for at fair value also includes loans held for investment, which are primarily comprised of collateralized loans to private wealth management clients and corporate loans. As of March 2013 and December 2012, the carrying value of such loans was $7.88 billion and $6.50 billion, respectively, which generally approximated fair value. As of March 2013, had these loans been carried at fair value and included in the fair value hierarchy, $2.77 billion and $5.09 billion would have been classified in level 2 and level 3, respectively. As of December 2012, had these loans been carried at fair value and included in the fair value hierarchy, $2.41 billion and $4.06 billion would have been classified in level 2 and level 3, respectively.

Deposits. The significant inputs to the valuation of time deposits are interest rates and the amount and timing of future cash flows. The inputs used to value the embedded derivative component of hybrid financial instruments are consistent with the inputs used to value the firm’s other derivative instruments. See Note 7 for further information about derivatives. See Note 14 for further information about deposits.

The firm’s deposits that are included in level 3 are hybrid financial instruments. As the significant unobservable inputs used to value hybrid financial instruments primarily relate to the embedded derivative component of these deposits, these inputs are incorporated in the firm’s derivative disclosures related to unobservable inputs in Note 7.

 

 

    Goldman Sachs March 2013 Form 10-Q   43


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Other Financial Assets and Financial Liabilities by Level

    

The tables below present, by level within the fair value hierarchy, other financial assets and financial liabilities

accounted for at fair value primarily under the fair value option.

 

 

 

    Other Financial Assets at Fair Value as of March  2013  
in millions     Level 1           Level 2           Level 3           Total   

Securities segregated for regulatory and other purposes 1

    $17,670           $    5,006           $       —           $  22,676   
   

Securities purchased under agreements to resell

              158,179           104           158,283   
   

Securities borrowed

              54,879                     54,879   
   

Receivables from customers and counterparties

              6,521           633           7,154   
   

Other assets 2

    4,377           8,506           565  3         13,448   

Total

    $22,047           $233,091           $  1,302           $256,440   
    Other Financial Liabilities at Fair Value as of March 2013  
in millions     Level 1           Level 2           Level 3           Total   

Deposits

    $       —           $    6,672           $     398           $    7,070   
   

Securities sold under agreements to repurchase

              153,579           1,777           155,356   
   

Securities loaned

              2,423                     2,423   
   

Other secured financings

              27,317           1,165           28,482   
   

Unsecured short-term borrowings

              15,563           2,735           18,298   
   

Unsecured long-term borrowings

              10,440           1,808           12,248   
   

Other liabilities and accrued expenses

              565           11,277  4         11,842   

Total

    $       —           $216,559           $19,160           $235,719   

 

1.

Includes securities segregated for regulatory and other purposes accounted for at fair value under the fair value option, which consists of securities borrowed and resale agreements. The table above includes $17.67 billion of level 1 securities segregated for regulatory and other purposes accounted for at fair value under other U.S. GAAP, consisting of U.S. Treasury securities and money market instruments.

 

2.

Consists of assets classified as held for sale related to the firm’s reinsurance business, primarily consisting of securities accounted for as available-for-sale and insurance separate account assets which are accounted for at fair value under other U.S. GAAP.

 

3.

Substantially all of the balance consists of insurance contracts and derivatives classified as held for sale. See “Insurance and Reinsurance Contracts” above and Note 7 for further information about valuation techniques and inputs related to insurance contracts and derivatives, respectively.

 

4.

Includes $873 million of liabilities classified as held for sale related to the firm’s reinsurance business accounted for at fair value under the fair value option.

 

44   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Other Financial Assets at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3           Total   

Securities segregated for regulatory and other purposes 1

    $21,549           $    8,935           $        —           $  30,484   
   

Securities purchased under agreements to resell

              141,053           278           141,331   
   

Securities borrowed

              38,395                     38,395   
   

Receivables from customers and counterparties

              7,225           641           7,866   
   

Other assets 2

    4,420           8,499           507  3         13,426   

Total

    $25,969           $204,107           $  1,426           $231,502   
    Other Financial Liabilities at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3           Total   

Deposits

    $        —           $    4,741           $     359           $    5,100   
   

Securities sold under agreements to repurchase

              169,880           1,927           171,807   
   

Securities loaned

              1,558                     1,558   
   

Other secured financings

              28,925           1,412           30,337   
   

Unsecured short-term borrowings

              15,011           2,584           17,595   
   

Unsecured long-term borrowings

              10,676           1,917           12,593   
   

Other liabilities and accrued expenses

              769           11,274  4         12,043   

Total

    $        —           $231,560           $19,473           $251,033   

 

1.

Includes securities segregated for regulatory and other purposes accounted for at fair value under the fair value option, which consists of securities borrowed and resale agreements. The table above includes $21.55 billion of level 1 securities segregated for regulatory and other purposes accounted for at fair value under other U.S. GAAP, consisting of U.S. Treasury securities and money market instruments.

 

2.

Consists of assets classified as held for sale related to the firm’s reinsurance business, primarily consisting of securities accounted for as available-for-sale and insurance separate account assets which are accounted for at fair value under other U.S. GAAP.

 

3.

Consists of insurance contracts and derivatives classified as held for sale. See “Insurance and Reinsurance Contracts” above and Note 7 for further information about valuation techniques and inputs related to insurance contracts and derivatives, respectively.

 

4.

Includes $692 million of liabilities classified as held for sale related to the firm’s reinsurance business accounted for at fair value under the fair value option.

 

    Goldman Sachs March 2013 Form 10-Q   45


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Transfers Between Levels of the Fair Value Hierarchy

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. There were no transfers of other financial assets and financial liabilities between level 1 and level 2 during the three months ended March 2013 and March 2012. The tables below present information about transfers between level 2 and level 3.

Level 3 Rollforward

If a financial asset or financial liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3.

 

The tables below present changes in fair value for other financial assets and financial liabilities accounted for at fair value categorized as level 3 as of the end of the period. Level 3 other financial assets and liabilities are frequently economically hedged with cash instruments and derivatives. Accordingly, gains or losses that are reported in level 3 can be partially offset by gains or losses attributable to level 1, 2 or 3 cash instruments or derivatives. As a result, gains or losses included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

 

 

 

    Level 3 Other Financial Assets at Fair Value for the Three Months Ended March 2013  
in millions    
 
 
Balance,
beginning
of period
  
  
  
   
 
 

 

Net
realized
gains/

(losses)

  
  
  

  

   
 
 
 
 
 
Net unrealized
gains/(losses)
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases        Sales        Issuances        Settlements       

 
 

Transfers

into
level 3

  

  
  

   
 
 
Transfers
out of
level 3
  
  
  
   
 
 
Balance,
end of
period
  
  
  

Securities purchased under agreements to resell

    $     278        $   1        $   —        $  —        $  —        $      —        $     (16     $  —        $(159     $     104   
   

Receivables from customers and counterparties

    641               (8                                               633   
   

Other assets

    507               4        7                             47               565   

Total

    $  1,426        $   1  1      $    (4 ) 1      $    7        $  —        $      —        $     (16     $  47        $(159     $  1,302   

 

1. The aggregate amounts include gains/(losses) of approximately $(4) million and $1 million reported in “Market making” and “Interest income,” respectively.

    

    Level 3 Other Financial Liabilities at Fair Value for the Three Months Ended March 2013  
in millions    
 
 
Balance,
beginning
of period
  
  
  
   
 
 

 

Net
realized
(gains)/

losses

  
  
  

  

   
 
 
 
 

 

Net unrealized
(gains)/losses
relating to
instruments
still held at

period-end

  
  
  
  
  

  

    Purchases        Sales        Issuances        Settlements       

 
 

Transfers

into
level 3

  

  
  

   
 
 
Transfers
out of
level 3
  
  
  
   
 
 
Balance,
end of
period
  
  
  

Deposits

    $     359        $  —        $     4        $  —        $  —        $    36        $       (1     $  —        $    —        $     398   
   

Securities sold under agreements to repurchase, at fair value

    1,927                                           (150                   1,777   
   

Other secured financings

    1,412        1        (19                   394        (750     127               1,165   
   

Unsecured short-term borrowings

    2,584        3        (11                   453        (491     290        (93     2,735   
   

Unsecured long-term borrowings

    1,917        9        (42     (3            175        (214     59        (93     1,808   
   

Other liabilities and accrued expenses

    11,274        (13     (191     304                      (97                   11,277   

Total

    $19,473        $  —  1      $(259 ) 1      $301        $  —        $1,058        $(1,703     $476        $(186     $19,160   

 

1.

The aggregate amounts include gains/(losses) of approximately $337 million, $(77) million and $(1) million reported in “Market making,” “Other principal transactions” and “Interest expense,” respectively.

 

The net unrealized gain on level 3 other financial liabilities of $259 million for the three months ended March 2013 primarily reflected a net gain on certain insurance liabilities, principally due to changes in foreign exchange rates, partially offset by the impact of changes in inflation and tighter funding spreads.

Transfers out of level 3 of other financial assets during the three months ended March 2013 reflected transfers of certain resale agreements to level 2, principally due to increased price transparency as a result of market transactions in similar instruments.

 

 

46   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Transfers into level 3 of other financial liabilities during the three months ended March 2013 primarily reflected transfers of certain hybrid financial instruments from level 2, principally due to reduced transparency of certain correlation and volatility inputs used to value these instruments.

Transfers out of level 3 of other financial liabilities during the three months ended March 2013 primarily reflected transfers of certain hybrid financial instruments to level 2, principally due to increased transparency of certain correlation and volatility inputs used to value certain instruments, and unobservable inputs no longer being significant to the valuation of other instruments.

 

 

 

    Level 3 Other Financial Assets at Fair Value for the Three Months Ended March 2012  
in millions    
 
 
Balance,
beginning
of period
  
  
  
   
 
 

 

Net
realized
gains/

(losses)

  
  
  

  

   
 
 
 
 
 
Net unrealized
gains/(losses)
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases        Sales        Issuances        Settlements       

 
 

Transfers

into
level 3

  

  
  

   
 
 
Transfers
out of
level 3
  
  
  
   
 
 
Balance,
end of
period
  
  
  

Securities purchased under
agreements to resell

    $     557        $   1        $  30        $535        $—        $  —        $(167     $   —        $    —        $     956   
   

Receivables from customers and counterparties

    795               9                                           (373     431   

Total

    $  1,352        $   1  1      $  39  1      $535        $—        $  —        $(167     $   —        $(373     $  1,387   

 

1. The aggregate amounts include gains of approximately $37 million and $3 million reported in “Market making” and “Interest income,” respectively.

    

    Level 3 Other Financial Liabilities at Fair Value for the Three Months Ended March 2012  
in millions    
 
 
Balance,
beginning
of period
  
  
  
   
 
 

 

Net
realized
(gains)/

losses

  
  
  

  

   
 
 
 
 

 

Net unrealized
(gains)/losses
relating to
instruments
still held at

period-end

  
  
  
  
  

  

    Purchases        Sales        Issuances        Settlements       

 
 

Transfers

into
level 3

  

  
  

   
 
 
Transfers
out of
level 3
  
  
  
   
 
 
Balance,
end of
period
  
  
  

Deposits

    $       13        $  —        $   (6     $   —        $—        $  89        $    —        $   —        $    —        $       96   
   

Securities sold under agreements to repurchase, at fair value

    2,181                                           (133                   2,048   
   

Other secured financings

    1,752        1        (1                   24        (465     14        (43     1,282   
   

Unsecured short-term borrowings

    3,294        (16     152        (13            129        (118     167        (220     3,375   
   

Unsecured long-term borrowings

    2,191        11        176                      155        (116     134        (241     2,310   
   

Other liabilities and accrued expenses

    8,996        4        50                             (85                   8,965   

Total

    $18,427        $  —  1      $371  1      $ (13     $—        $397        $(917     $315        $(504     $18,076   

 

1.

The aggregate amounts include losses of approximately $355 million, $15 million and $1 million reported in “Market making,” “Other principal transactions” and “Interest expense,” respectively.

 

The net unrealized gain/(loss) on level 3 other financial assets and liabilities at fair value of $(332) million (reflecting $39 million on other financial assets and $(371) million on other financial liabilities) for the three months ended March 2012 primarily consisted of losses on unsecured short-term and long-term borrowings. These losses primarily reflected losses on certain equity-linked notes, principally due to an increase in global equity prices, which are level 2 inputs.

Transfers out of level 3 related to other financial assets during the three months ended March 2012 reflected transfers to level 2 of certain insurance receivables, primarily due to increased transparency of the mortality inputs used to value these receivables.

Transfers into level 3 related to other financial liabilities during the three months ended March 2012 primarily reflected transfers from level 2 of certain unsecured short-term and long-term borrowings, principally due to reduced transparency of the correlation and volatility inputs used to value certain hybrid financial instruments.

Transfers out of level 3 related to other financial liabilities during the three months ended March 2012 primarily reflected transfers to level 2 of certain unsecured short-term and long-term borrowings, principally due to increased transparency of the correlation and volatility inputs used to value certain hybrid financial instruments.

 

 

    Goldman Sachs March 2013 Form 10-Q   47


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Gains and Losses on Financial Assets and Financial Liabilities Accounted for at Fair Value Under the Fair Value Option

    

The table below presents the gains and losses recognized as a result of the firm electing to apply the fair value option to certain financial assets and financial liabilities. These gains and losses are included in “Market making” and “Other principal transactions.” The table below also includes gains and losses on the embedded derivative component of hybrid financial instruments included in unsecured short-term borrowings, unsecured long-term borrowings and deposits. These gains and losses would have been recognized under

other U.S. GAAP even if the firm had not elected to account for the entire hybrid instrument at fair value.

The amounts in the table exclude contractual interest, which is included in “Interest income” and “Interest expense,” for all instruments other than hybrid financial instruments. See Note 23 for further information about interest income and interest expense.

 

 

 

   

Gains/(Losses) on Financial Assets
and Financial Liabilities at Fair Value

Under the Fair Value Option

 
    Three Months Ended March  
in millions     2013           2012   

Receivables from customers and counterparties 1

    $  (12        $       44   
   

Other secured financings

    (110        (148
   

Unsecured short-term borrowings 2

    (148        (895
   

Unsecured long-term borrowings 3

    198           (599
   

Other liabilities and accrued expenses 4

    192           (61
   

Other 5

    (15        (12

Total

    $ 105           $(1,671

 

1.

Primarily consists of gains/(losses) on certain reinsurance contracts and certain transfers accounted for as receivables rather than purchases.

 

2.

Includes losses on the embedded derivative component of hybrid financial instruments of $130 million and $853 million for the three months ended March 2013 and March 2012, respectively.

 

3.

Includes gains/(losses) on the embedded derivative component of hybrid financial instruments of $284 million and $(368) million for the three months ended March 2013 and March 2012, respectively.

 

4.

Primarily consists of gains/(losses) on certain insurance contracts.

 

5.

Primarily consists of gains/(losses) on resale and repurchase agreements, securities borrowed and loaned and deposits.

 

Excluding the gains and losses on the instruments accounted for under the fair value option described above, “Market making” and “Other principal transactions”

primarily represent gains and losses on “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value.”

 

 

48   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Loans and Lending Commitments

The table below presents the difference between the aggregate fair value and the aggregate contractual principal amount for loans and long-term receivables for which the fair value option was elected.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Aggregate contractual principal amount of performing loans and long-term receivables in excess of the related fair value

    $  2,105         $  2,742   
   

Aggregate contractual principal amount of loans on nonaccrual status and/or more than 90 days past due in excess of the related fair value

    21,830         22,610   

Total 1

    $23,935         $25,352   

Aggregate fair value of loans on nonaccrual status and/or more than 90 days past due

    $  2,232         $  1,832   

 

1.

The aggregate contractual principal exceeds the related fair value primarily because the firm regularly purchases loans, such as distressed loans, at values significantly below contractual principal amounts.

As of March 2013 and December 2012, the fair value of unfunded lending commitments for which the fair value option was elected was a liability of $1.43 billion and $1.99 billion, respectively, and the related total contractual amount of these lending commitments was $55.92 billion and $59.29 billion, respectively. See Note 18 for further information about lending commitments.

Long-term Debt Instruments

The aggregate contractual principal amount of long-term other secured financings for which the fair value option was elected exceeded the related fair value by $134 million and $115 million as of March 2013 and December 2012, respectively. The fair value of unsecured long-term borrowings for which the fair value option was elected exceeded the related aggregate contractual principal amount by $140 million and $379 million as of March 2013 and December 2012, respectively. The amounts above include both principal and non-principal-protected long-term borrowings.

Impact of Credit Spreads on Loans and Lending Commitments

The estimated net gain attributable to changes in instrument-specific credit spreads on loans and lending commitments for which the fair value option was elected was $794 million and $973 million for the three months ended March 2013 and March 2012, respectively. Changes in the fair value of loans and lending commitments are primarily attributable to changes in instrument-specific credit spreads. Substantially all of the firm’s performing loans and lending commitments are floating-rate.

Impact of Credit Spreads on Borrowings

The table below presents the net gains/(losses) attributable to the impact of changes in the firm’s own credit spreads on borrowings for which the fair value option was elected. The firm calculates the fair value of borrowings by discounting future cash flows at a rate which incorporates the firm’s credit spreads.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Net gains/(losses) including hedges

    $  (77      $(224
   

Net gains/(losses) excluding hedges

    (109      (289
 

 

    Goldman Sachs March 2013 Form 10-Q   49


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 9. Collateralized Agreements and Financings

Note 9.

 

Collateralized Agreements and Financings

    

 

Collateralized agreements are securities purchased under agreements to resell (resale agreements) and securities borrowed. Collateralized financings are securities sold under agreements to repurchase (repurchase agreements), securities loaned and other secured financings. The firm enters into these transactions in order to, among other things, facilitate client activities, invest excess cash, acquire securities to cover short positions and finance certain firm activities.

Collateralized agreements and financings are presented on a net-by-counterparty basis when a legal right of setoff exists. Interest on collateralized agreements and collateralized financings is recognized over the life of the transaction and included in “Interest income” and “Interest expense,” respectively. See Note 23 for further information about interest income and interest expense.

The table below presents the carrying value of resale and repurchase agreements and securities borrowed and loaned transactions.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Securities purchased under agreements to resell 1

    $158,506         $141,334   
   

Securities borrowed 2

    172,041         136,893   
   

Securities sold under agreements to repurchase 1

    155,356         171,807   
   

Securities loaned 2

    20,669         13,765   

 

1.

Substantially all resale and repurchase agreements are carried at fair value under the fair value option. See Note 8 for further information about the valuation techniques and significant inputs used to determine fair value.

 

2.

As of March 2013 and December 2012, $54.88 billion and $38.40 billion of securities borrowed, and $2.42 billion and $1.56 billion of securities loaned were at fair value, respectively.

Resale and Repurchase Agreements

A resale agreement is a transaction in which the firm purchases financial instruments from a seller, typically in exchange for cash, and simultaneously enters into an agreement to resell the same or substantially the same financial instruments to the seller at a stated price plus accrued interest at a future date.

A repurchase agreement is a transaction in which the firm sells financial instruments to a buyer, typically in exchange for cash, and simultaneously enters into an agreement to repurchase the same or substantially the same financial instruments from the buyer at a stated price plus accrued interest at a future date.

The financial instruments purchased or sold in resale and repurchase agreements typically include U.S. government and federal agency, and investment-grade sovereign obligations.

The firm receives financial instruments purchased under resale agreements, makes delivery of financial instruments sold under repurchase agreements, monitors the market value of these financial instruments on a daily basis, and delivers or obtains additional collateral due to changes in the market value of the financial instruments, as appropriate. For resale agreements, the firm typically requires delivery of collateral with a fair value approximately equal to the carrying value of the relevant assets in the condensed consolidated statements of financial condition.

Even though repurchase and resale agreements involve the legal transfer of ownership of financial instruments, they are accounted for as financing arrangements because they require the financial instruments to be repurchased or resold at the maturity of the agreement. However, “repos to maturity” are accounted for as sales. A repo to maturity is a transaction in which the firm transfers a security under an agreement to repurchase the security where the maturity date of the repurchase agreement matches the maturity date of the underlying security. Therefore, the firm effectively no longer has a repurchase obligation and has relinquished control over the underlying security and, accordingly, accounts for the transaction as a sale. The firm had no repos to maturity outstanding as of March 2013 or December 2012.

 

 

50   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Securities Borrowed and Loaned Transactions

In a securities borrowed transaction, the firm borrows securities from a counterparty in exchange for cash. When the firm returns the securities, the counterparty returns the cash. Interest is generally paid periodically over the life of the transaction.

In a securities loaned transaction, the firm lends securities to a counterparty typically in exchange for cash or securities, or a letter of credit. When the counterparty returns the securities, the firm returns the cash or securities posted as collateral. Interest is generally paid periodically over the life of the transaction.

The firm receives securities borrowed, makes delivery of securities loaned, monitors the market value of these securities on a daily basis, and delivers or obtains additional collateral due to changes in the market value of the securities, as appropriate. For securities borrowed transactions, the firm typically requires collateral with a fair value approximately equal to the carrying value of the securities borrowed transaction.

Securities borrowed and loaned within Fixed Income, Currency and Commodities Client Execution are recorded at fair value under the fair value option. See Note 8 for further information about securities borrowed and loaned accounted for at fair value.

Securities borrowed and loaned within Securities Services are recorded based on the amount of cash collateral advanced or received plus accrued interest. As these arrangements generally can be terminated on demand, they exhibit little, if any, sensitivity to changes in interest rates. Therefore, the carrying value of such arrangements approximates fair value. While these arrangements are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these arrangements been included in the firm’s fair value hierarchy, they would have been classified in level 2 as of March 2013 and December 2012.

 

 

    Goldman Sachs March 2013 Form 10-Q   51


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Offsetting Arrangements

The tables below present the gross and net resale and repurchase agreements and securities borrowed and loaned transactions, and the related amount of netting with the same counterparty under enforceable netting agreements (“counterparty netting”) included in the condensed consolidated statements of financial condition. Substantially all of the gross carrying values of these arrangements are subject to enforceable netting agreements. The tables below also present the amounts not offset in the

condensed consolidated statements of financial condition including counterparty netting that does not meet the criteria for netting under U.S. GAAP and the fair value of cash or securities collateral received or posted subject to enforceable credit support agreements. Where the firm has received or posted collateral under credit support agreements, but has not yet determined such agreements are enforceable, the related collateral has not been netted in the table below.

 

 

 

    As of March 2013  
    Assets         Liabilities  
in millions    
 

 

Securities purchased
under agreements

to resell

  
  

  

   
 
Securities
borrowed
  
  
       

 

 

Securities sold

under agreements

to repurchase

  

  

  

   
 
Securities
loaned
  
  

Amounts included in the condensed consolidated statements of financial condition

         

Gross carrying value

    $ 202,217        $ 182,905          $ 194,714        $ 30,894   
   

Counterparty netting

    (39,162     (10,225         (39,162     (10,225

Total

    163,055  1, 2      172,680  1          155,552  2      20,669   

Amounts that have not been offset in the condensed consolidated statements of financial condition

         

Counterparty netting

    (15,014     (4,797       (15,014     (4,797
   

Collateral

    (134,711     (143,812         (105,163     (14,077

Total

    $   13,330        $   24,071            $   35,375        $   1,795   
    As of December 2012  
    Assets         Liabilities  
in millions    
 

 

Securities purchased
under agreements

to resell

  
  

  

   
 
Securities
borrowed
  
  
       

 

 

Securities sold

under agreements

to repurchase

  

  

  

   
 
Securities
loaned
  
  

Amounts included in the condensed consolidated statements of financial condition

         

Gross carrying value

    $ 175,656        $ 151,162          $ 201,688        $ 23,509   
   

Counterparty netting

    (29,766     (9,744         (29,766     (9,744

Total

    145,890  1, 2      141,418  1          171,922  2      13,765   

Amounts that have not been offset in the condensed consolidated statements of financial condition

         

Counterparty netting

    (27,512     (2,583       (27,512     (2,583
   

Collateral

    (104,344     (117,552         (106,638     (10,990

Total

    $   14,034        $   21,283            $   37,772        $      192   

 

1.

As of March 2013 and December 2012, the firm had $4.37 billion and $4.41 billion, respectively, of securities received under resale agreements and $639 million and $4.53 billion, respectively, of securities borrowed transactions that were segregated to satisfy certain regulatory requirements. These securities are included in “Cash and securities segregated for regulatory and other purposes.”

 

2.

As of March 2013 and December 2012, the firm classified $183 million and $148 million, respectively, of resale agreements and $196 million and $115 million, respectively, of repurchase agreements as held for sale. See Note 12 for further information.

 

52   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Other Secured Financings

In addition to repurchase agreements and securities lending transactions, the firm funds certain assets through the use of other secured financings and pledges financial instruments and other assets as collateral in these transactions. These other secured financings consist of:

 

Ÿ  

liabilities of consolidated VIEs;

 

Ÿ  

transfers of assets accounted for as financings rather than sales (primarily collateralized central bank financings, pledged commodities, bank loans and mortgage whole loans); and

 

Ÿ  

other structured financing arrangements.

Other secured financings include arrangements that are nonrecourse. As of March 2013 and December 2012, nonrecourse other secured financings were $1.51 billion and $1.76 billion, respectively.

The firm has elected to apply the fair value option to substantially all other secured financings because the use of fair value eliminates non-economic volatility in earnings that would arise from using different measurement attributes. See Note 8 for further information about other secured financings that are accounted for at fair value.

Other secured financings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest, which generally approximates fair value. While these financings are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these financings been included in the firm’s fair value hierarchy, they would have primarily been classified in level 3 as of March 2013 and December 2012.

 

 

    Goldman Sachs March 2013 Form 10-Q   53


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents information about other secured financings. In the table below:

 

Ÿ  

short-term secured financings include financings maturing within one year of the financial statement date and financings that are redeemable within one year of the financial statement date at the option of the holder;

Ÿ  

long-term secured financings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates; and

 

Ÿ  

long-term secured financings that are redeemable prior to maturity at the option of the holders are reflected at the dates such options become exercisable.

 

 

 

    As of March 2013          As of December 2012  
$ in millions    
 
U.S.
Dollar
  
  
   
 
Non-U.S.
Dollar
  
  
    Total            
 
U.S.
Dollar
  
  
   
 
Non-U.S.
Dollar
  
  
    Total   

Other secured financings (short-term):

              

At fair value

    $15,109        $5,362        $20,471           $16,504        $6,181        $22,685   
           

At amortized cost

    26               26           34        326        360   
           

Interest rates 1

    6.37              6.18     0.10  
           

Other secured financings (long-term):

              

At fair value

    6,134        1,877        8,011           6,134        1,518        7,652   
           

At amortized cost

    247        713        960           577        736        1,313   
           

Interest rates 1

    4.67     2.54                  3.38     2.55        

Total 2

    $21,516        $7,952        $29,468             $23,249        $8,761        $32,010   

Amount of other secured financings collateralized by:

              

Financial instruments 3

    $21,307        $7,517        $28,824           $22,323        $8,442        $30,765   
           

Other assets 4

    209        435        644             926        319        1,245   

 

1.

The weighted average interest rates exclude secured financings at fair value and include the effect of hedging activities. See Note 7 for further information about hedging activities.

 

2.

Includes $9.23 billion and $8.68 billion related to transfers of financial assets accounted for as financings rather than sales as of March 2013 and December 2012, respectively. Such financings were collateralized by financial assets included in “Financial instruments owned, at fair value” of $9.74 billion and $8.92 billion as of March 2013 and December 2012, respectively.

 

3.

Includes $15.32 billion and $17.24 billion of other secured financings collateralized by financial instruments owned, at fair value as of March 2013 and December 2012, respectively, and includes $13.50 billion and $13.53 billion of other secured financings collateralized by financial instruments received as collateral and repledged as of March 2013 and December 2012, respectively.

 

4.

Primarily real estate and cash.

 

The table below presents other secured financings by maturity.

 

 

in millions    

 

As of

March 2013

  

  

Other secured financings (short-term)

    $20,497   
   

Other secured financings (long-term):

 

2014

    4,766   
   

2015

    1,663   
   

2016

    954   
   

2017

    243   
   

2018

    652   
   

2019-thereafter

    693   

Total other secured financings (long-term)

    8,971   

Total other secured financings

    $29,468   
 

 

54   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Collateral Received and Pledged

The firm receives cash and securities (e.g., U.S. government and federal agency, other sovereign and corporate obligations, as well as equities and convertible debentures) as collateral, primarily in connection with resale agreements, securities borrowed, derivative transactions and customer margin loans. The firm obtains cash and securities as collateral on an upfront or contingent basis for derivative instruments and collateralized agreements to reduce its credit exposure to individual counterparties.

In many cases, the firm is permitted to deliver or repledge financial instruments received as collateral when entering into repurchase agreements and securities lending agreements, primarily in connection with secured client financing activities. The firm is also permitted to deliver or repledge these financial instruments in connection with other secured financings, collateralizing derivative transactions and meeting firm or customer settlement requirements.

The firm also pledges certain financial instruments owned, at fair value in connection with repurchase agreements, securities lending agreements and other secured financings, and other assets (primarily real estate and cash) in connection with other secured financings to counterparties who may or may not have the right to deliver or repledge them.

The table below presents financial instruments at fair value received as collateral that were available to be delivered or repledged and were delivered or repledged by the firm.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Collateral available to be delivered or repledged

    $614,337         $540,949   
   

Collateral that was delivered or repledged

    459,267         397,652   

The table below presents information about assets pledged by the firm.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Financial instruments owned, at fair value pledged to counterparties that:

    

Had the right to deliver or repledge

    $  67,891         $  67,177   
   

Did not have the right to deliver
or repledge

    114,701         120,980   
   

Other assets pledged to counterparties that:

    

Did not have the right to deliver
or repledge

    1,148         2,031   
 

 

    Goldman Sachs March 2013 Form 10-Q   55


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 10. Securitization Activities

Note 10.

Securitization Activities

 

The firm securitizes residential and commercial mortgages, corporate bonds, loans and other types of financial assets by selling these assets to securitization vehicles (e.g., trusts, corporate entities and limited liability companies) and acts as underwriter of the beneficial interests that are sold to investors. The firm’s residential mortgage securitizations are substantially all in connection with government agency securitizations.

Beneficial interests issued by securitization entities are debt or equity securities that give the investors rights to receive all or portions of specified cash inflows to a securitization vehicle and include senior and subordinated shares of principal, interest and/or other cash inflows. The proceeds from the sale of beneficial interests are used to pay the transferor for the financial assets sold to the securitization vehicle or to purchase securities which serve as collateral.

The firm accounts for a securitization as a sale when it has relinquished control over the transferred assets. Prior to securitization, the firm accounts for assets pending transfer at fair value and therefore does not typically recognize significant gains or losses upon the transfer of assets. Net revenues from underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.

For transfers of assets that are not accounted for as sales, the assets remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Notes 9 and 23 for further information about collateralized financings and interest expense, respectively.

The firm generally receives cash in exchange for the transferred assets but may also have continuing involvement with transferred assets, including ownership of beneficial interests in securitized financial assets, primarily in the form of senior or subordinated securities. The firm may also purchase senior or subordinated securities issued by securitization vehicles (which are typically VIEs) in connection with secondary market-making activities.

The primary risks included in beneficial interests and other interests from the firm’s continuing involvement with securitization vehicles are the performance of the underlying collateral, the position of the firm’s investment in the capital structure of the securitization vehicle and the market yield for the security. These interests are accounted for at fair value and are included in “Financial instruments owned, at fair value” and are generally classified in level 2 of the fair value hierarchy. See Notes 5 through 8 for further information about fair value measurements.

 

 

56   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the amount of financial assets securitized and the cash flows received on retained interests in securitization entities in which the firm had continuing involvement.

 

 

   

Three Months

Ended March

 
in millions     2013           2012   

Residential mortgages

    $7,387           $10,989   
   

Commercial mortgages

    2,352             

Total

    $9,739           $10,989   

Cash flows on retained interests

    $   165           $     147   

The table below presents the firm’s continuing involvement in nonconsolidated securitization entities to which the firm sold assets, as well as the total outstanding principal amount of transferred assets in which the firm has continuing involvement. In this table:

 

Ÿ  

the outstanding principal amount is presented for the purpose of providing information about the size of the securitization entities in which the firm has continuing involvement and is not representative of the firm’s risk of loss;

 

Ÿ  

for retained or purchased interests, the firm’s risk of loss is limited to the fair value of these interests; and

 

Ÿ  

purchased interests represent senior and subordinated interests, purchased in connection with secondary market-making activities, in securitization entities in which the firm also holds retained interests.

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
 
Outstanding
Principal
Amount
  
  
  
    
 
 
Fair Value of
Retained
Interests
  
  
  
    
 
 
Fair Value of
Purchased
Interests
  
  
  
       
 
 
Outstanding
Principal
Amount
  
  
  
    
 
 
Fair Value of
Retained
Interests
  
  
  
    

 
 

Fair Value of

Purchased
Interests

  

  
  

U.S. government agency-issued collateralized mortgage obligations 1

    $58,541         $4,761         $   —          $57,685         $4,654         $   —   
   

Other residential mortgage-backed 2

    3,465         104                  3,656         106           
   

Other commercial mortgage-backed 3

    2,874         214         82          1,253         1         56   
   

CDOs, CLOs and other 4

    8,592         72         331            8,866         51         331   

Total 5

    $73,472         $5,151         $413            $71,460         $4,812         $387   

 

1.

Outstanding principal amount and fair value of retained interests primarily relate to securitizations during 2013, 2012 and 2011 as of March 2013, and securitizations during 2012 and 2011 as of December 2012.

 

2.

Outstanding principal amount and fair value of retained interests as of both March 2013 and December 2012 primarily relate to prime and Alt-A securitizations during 2007 and 2006.

 

3.

Outstanding principal amount as of both March 2013 and December 2012 primarily relate to securitizations during 2012 and 2007. Fair value of retained interests as of both March 2013 and December 2012 primarily relate to securitizations during 2012.

 

4.

Outstanding principal amount and fair value of retained interests as of both March 2013 and December 2012 primarily relate to CDO and CLO securitizations during 2007 and 2006.

 

5.

Outstanding principal amount includes $631 million and $835 million as of March 2013 and December 2012, respectively, related to securitization entities in which the firm’s only continuing involvement is retained servicing which is not a variable interest.

 

    Goldman Sachs March 2013 Form 10-Q   57


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In addition to the interests in the table above, the firm had other continuing involvement in the form of derivative transactions and guarantees with certain nonconsolidated VIEs. The carrying value of these derivatives and guarantees was a net asset of $39 million and $45 million as of March 2013 and December 2012, respectively. The notional amounts of these derivatives and guarantees are included in maximum exposure to loss in the nonconsolidated VIE tables in Note 11.

The table below presents the weighted average key economic assumptions used in measuring the fair value of retained interests and the sensitivity of this fair value to immediate adverse changes of 10% and 20% in those assumptions.

 

 

 

    As of March 2013         As of December 2012  
    Type of Retained Interests         Type of Retained Interests  
$ in millions     Mortgage-Backed        Other  1          Mortgage-Backed        Other  1 

Fair value of retained interests

    $5,079        $     72          $4,761        $     51   
   

Weighted average life (years)

    8.3        1.9          8.2        2.0   
   

 

Constant prepayment rate 2

    8.6     N.M.          10.9     N.M.   
   

Impact of 10% adverse change 2

    $    (39     N.M.          $    (57     N.M.   
   

Impact of 20% adverse change 2

    (81     N.M.          (110     N.M.   
   

 

Discount rate 3

    3.8     N.M.          4.6     N.M.   
   

Impact of 10% adverse change

    $    (86     N.M.          $    (96     N.M.   
   

Impact of 20% adverse change

    (168     N.M.            (180     N.M.   

 

1.

Due to the nature and current fair value of certain of these retained interests, the weighted average assumptions for constant prepayment and discount rates and the related sensitivity to adverse changes are not meaningful as of March 2013 and December 2012. The firm’s maximum exposure to adverse changes in the value of these interests is the carrying value of $72 million and $51 million as of March 2013 and December 2012, respectively.

 

2.

Constant prepayment rate is included only for positions for which constant prepayment rate is a key assumption in the determination of fair value.

 

3.

The majority of mortgage-backed retained interests are U.S. government agency-issued collateralized mortgage obligations, for which there is no anticipated credit loss. For the remainder of retained interests, the expected credit loss assumptions are reflected in the discount rate.

 

The preceding table does not give effect to the offsetting benefit of other financial instruments that are held to mitigate risks inherent in these retained interests. Changes in fair value based on an adverse variation in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value is

not usually linear. In addition, the impact of a change in a particular assumption in the preceding table is calculated independently of changes in any other assumption. In practice, simultaneous changes in assumptions might magnify or counteract the sensitivities disclosed above.

 

 

58   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 11. Variable Interest Entities

Note 11.

Variable Interest Entities

 

VIEs generally finance the purchase of assets by issuing debt and equity securities that are either collateralized by or indexed to the assets held by the VIE. The debt and equity securities issued by a VIE may include tranches of varying levels of subordination. The firm’s involvement with VIEs includes securitization of financial assets, as described in Note 10, and investments in and loans to other types of VIEs, as described below. See Note 10 for additional information about securitization activities, including the definition of beneficial interests. See Note 3 for the firm’s consolidation policies, including the definition of a VIE.

The firm is principally involved with VIEs through the following business activities:

Mortgage-Backed VIEs and Corporate CDO and CLO VIEs. The firm sells residential and commercial mortgage loans and securities to mortgage-backed VIEs and corporate bonds and loans to corporate CDO and CLO VIEs and may retain beneficial interests in the assets sold to these VIEs. The firm purchases and sells beneficial interests issued by mortgage-backed and corporate CDO and CLO VIEs in connection with market-making activities. In addition, the firm may enter into derivatives with certain of these VIEs, primarily interest rate swaps, which are typically not variable interests. The firm generally enters into derivatives with other counterparties to mitigate its risk from derivatives with these VIEs.

Certain mortgage-backed and corporate CDO and CLO VIEs, usually referred to as synthetic CDOs or credit-linked note VIEs, synthetically create the exposure for the beneficial interests they issue by entering into credit derivatives, rather than purchasing the underlying assets. These credit derivatives may reference a single asset, an index, or a portfolio/basket of assets or indices. See Note 7 for further information about credit derivatives. These VIEs use the funds from the sale of beneficial interests and the premiums received from credit derivative counterparties to purchase securities which serve to collateralize the beneficial interest holders and/or the credit derivative counterparty. These VIEs may enter into other derivatives, primarily interest rate swaps, which are typically not variable interests. The firm may be a counterparty to derivatives with these VIEs and generally enters into derivatives with other counterparties to mitigate its risk.

Real Estate, Credit-Related and Other Investing VIEs. The firm purchases equity and debt securities issued by and makes loans to VIEs that hold real estate, performing and nonperforming debt, distressed loans and equity securities. The firm typically does not sell assets to, or enter into derivatives with, these VIEs.

Other Asset-Backed VIEs. The firm structures VIEs that issue notes to clients and purchases and sells beneficial interests issued by other asset-backed VIEs in connection with market-making activities. In addition, the firm may enter into derivatives with certain other asset-backed VIEs, primarily total return swaps on the collateral assets held by these VIEs under which the firm pays the VIE the return due to the note holders and receives the return on the collateral assets owned by the VIE. The firm generally can be removed as the total return swap counterparty. The firm generally enters into derivatives with other counterparties to mitigate its risk from derivatives with these VIEs. The firm typically does not sell assets to the other asset-backed VIEs it structures.

Power-Related VIEs. The firm purchases debt and equity securities issued by, and may provide guarantees to, VIEs that hold power-related assets. The firm typically does not sell assets to, or enter into derivatives with, these VIEs.

Investment Funds. The firm purchases equity securities issued by and may provide guarantees to certain of the investment funds it manages. The firm typically does not sell assets to, or enter into derivatives with, these VIEs.

Principal-Protected Note VIEs. The firm structures VIEs that issue principal-protected notes to clients. These VIEs own portfolios of assets, principally with exposure to hedge funds. Substantially all of the principal protection on the notes issued by these VIEs is provided by the asset portfolio rebalancing that is required under the terms of the notes. The firm enters into total return swaps with these VIEs under which the firm pays the VIE the return due to the principal-protected note holders and receives the return on the assets owned by the VIE. The firm may enter into derivatives with other counterparties to mitigate the risk it has from the derivatives it enters into with these VIEs. The firm also obtains funding through these VIEs.

 

 

    Goldman Sachs March 2013 Form 10-Q   59


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

VIE Consolidation Analysis

A variable interest in a VIE is an investment (e.g., debt or equity securities) or other interest (e.g., derivatives or loans and lending commitments) in a VIE that will absorb portions of the VIE’s expected losses and/or receive portions of the VIE’s expected residual returns.

The firm’s variable interests in VIEs include senior and subordinated debt in residential and commercial mortgage-backed and other asset-backed securitization entities, CDOs and CLOs; loans and lending commitments; limited and general partnership interests; preferred and common equity; derivatives that may include foreign currency, equity and/or credit risk; guarantees; and certain of the fees the firm receives from investment funds. Certain interest rate, foreign currency and credit derivatives the firm enters into with VIEs are not variable interests because they create rather than absorb risk.

The enterprise with a controlling financial interest in a VIE is known as the primary beneficiary and consolidates the VIE. The firm determines whether it is the primary beneficiary of a VIE by performing an analysis that principally considers:

 

Ÿ  

which variable interest holder has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance;

 

Ÿ  

which variable interest holder has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE;

 

Ÿ  

the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders;

 

Ÿ  

the VIE’s capital structure;

 

Ÿ  

the terms between the VIE and its variable interest holders and other parties involved with the VIE; and

 

Ÿ  

related-party relationships.

The firm reassesses its initial evaluation of whether an entity is a VIE when certain reconsideration events occur. The firm reassesses its determination of whether it is the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances.

Nonconsolidated VIEs

The firm’s exposure to the obligations of VIEs is generally limited to its interests in these entities. In certain instances, the firm provides guarantees, including derivative guarantees, to VIEs or holders of variable interests in VIEs.

The tables below present information about nonconsolidated VIEs in which the firm holds variable interests. Nonconsolidated VIEs are aggregated based on principal business activity. The nature of the firm’s variable interests can take different forms, as described in the rows under maximum exposure to loss. In the tables below:

 

Ÿ  

The maximum exposure to loss excludes the benefit of offsetting financial instruments that are held to mitigate the risks associated with these variable interests.

 

Ÿ  

For retained and purchased interests and loans and investments, the maximum exposure to loss is the carrying value of these interests.

 

Ÿ  

For commitments and guarantees, and derivatives, the maximum exposure to loss is the notional amount, which does not represent anticipated losses and also has not been reduced by unrealized losses already recorded. As a result, the maximum exposure to loss exceeds liabilities recorded for commitments and guarantees, and derivatives provided to VIEs.

The carrying values of the firm’s variable interests in nonconsolidated VIEs are included in the condensed consolidated statement of financial condition as follows:

 

Ÿ  

Substantially all assets held by the firm related to mortgage-backed, corporate CDO and CLO, real estate, credit-related and other investing, and other asset-backed VIEs and investment funds are included in “Financial instruments owned, at fair value.” Substantially all liabilities held by the firm related to corporate CDO and CLO, real estate, credit-related and other investing, and other asset-backed VIEs are included in “Financial instruments sold, but not yet purchased, at fair value.”

 

Ÿ  

Assets held by the firm related to power-related VIEs are primarily included in “Financial instruments owned, at fair value” and “Other assets.”

 

 

60   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

    Nonconsolidated VIEs  
    As of March 2013  
in millions    

 

Mortgage-

backed

  

  

   
 
 
Corporate
CDOs and
CLOs
  
  
  
    
 
 
 
Real estate,
credit-related
and other
investing
  
  
  
  
    
 

 

Other
asset-

backed

  
  

  

    

 

Power-

related

  

  

    
 
Investment
funds
  
  
     Total   

Assets in VIE

    $86,199  2      $21,037         $6,900         $3,373         $110         $1,840         $119,459   
   

Carrying Value of the Firm’s Variable Interests

                  

Assets

    7,027        1,107         1,695         280         49         4         10,162   
   

Liabilities

           9         1         37                         47   
   

Maximum Exposure to Loss in Nonconsolidated VIEs

                  

Retained interests

    5,079        71                 1                         5,151   
   

Purchased interests

    1,596        576                 263                         2,435   
   

Commitments and guarantees 1

           1         414                 111         1         527   
   

Derivatives 1

    1,487        5,666                 854                         8,007   
   

Loans and investments

    38                1,695                 49         4         1,786   

Total

    $  8,200  2      $  6,314         $2,109         $1,118         $160         $       5         $  17,906   
    Nonconsolidated VIEs  
    As of December 2012  
in millions    

 

Mortgage-

backed

  

  

   
 
 
Corporate
CDOs and
CLOs
  
  
  
    
 
 
 
Real estate,
credit-related
and other
investing
  
  
  
  
    
 

 

Other
asset-

backed

  
  

  

    

 

Power-

related

  

  

    
 
Investment
funds
  
  
     Total   

Assets in VIE

    $79,171  2      $23,842         $9,244         $3,510         $147         $1,898         $117,812   
   

Carrying Value of the Firm’s Variable Interests

                  

Assets

    6,269        1,193         1,801         220         32         4         9,519   
   

Liabilities

           12                 30                         42   
   

Maximum Exposure to Loss in Nonconsolidated VIEs

                  

Retained interests

    4,761        51                                         4,812   
   

Purchased interests

    1,162        659                 204                         2,025   
   

Commitments and guarantees 1

           1         438                         1         440   
   

Derivatives 1

    1,574        6,761                 952                         9,287   
   

Loans and investments

    39                1,801                 32         4         1,876   

Total

    $  7,536  2      $  7,472         $2,239         $1,156         $  32         $       5         $  18,440   

 

1.

The aggregate amounts include $3.08 billion and $3.25 billion as of March 2013 and December 2012, respectively, related to guarantees and derivative transactions with VIEs to which the firm transferred assets.

 

2.

Assets in VIE and maximum exposure to loss include $4.48 billion and $1.80 billion, respectively, as of March 2013, and $3.57 billion and $1.72 billion, respectively, as of December 2012, related to CDOs backed by mortgage obligations.

 

    Goldman Sachs March 2013 Form 10-Q   61


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Consolidated VIEs

The tables below present the carrying amount and classification of assets and liabilities in consolidated VIEs, excluding the benefit of offsetting financial instruments that are held to mitigate the risks associated with the firm’s variable interests. Consolidated VIEs are aggregated based on principal business activity and their assets and liabilities are presented net of intercompany eliminations. The majority of the assets in principal-protected notes VIEs are intercompany and are eliminated in consolidation.

Substantially all the assets in consolidated VIEs can only be used to settle obligations of the VIE.

The tables below exclude VIEs in which the firm holds a majority voting interest if (i) the VIE meets the definition of a business and (ii) the VIE’s assets can be used for purposes other than the settlement of its obligations.

The liabilities of real estate, credit-related and other investing VIEs and CDOs, mortgage-backed and other asset-backed VIEs do not have recourse to the general credit of the firm.

 

 

 

    Consolidated VIEs  
    As of March 2013  
in millions    
 
 
 
Real estate,
credit-related
and other
investing
  
  
  
  
    

 
 

 
 

CDOs,

mortgage-
backed and

other asset-
backed

  

 
  

 
  

    
 

 

Principal-
protected

notes

 
  

  

     Total   

Assets

          

Cash and cash equivalents

    $   336         $245         $       1         $   582   
   

Cash and securities segregated for regulatory and other purposes

    62                 92         154   
   

Receivables from brokers, dealers and clearing organizations

    49                         49   
   

Financial instruments owned, at fair value

    2,188         494         348         3,030   
   

Other assets

    903                         903   

Total

    $3,538         $739         $   441         $4,718   

 

Liabilities

          

Other secured financings

    $   484         $578         $   301         $1,363   
   

Financial instruments sold, but not yet purchased, at fair value

            87                 87   
   

Unsecured short-term borrowings, including the current portion of
unsecured long-term borrowings

                    1,466         1,466   
   

Unsecured long-term borrowings

    4                 310         314   
   

Other liabilities and accrued expenses

    1,096                         1,096   

Total

    $1,584         $665         $2,077         $4,326   

 

62   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Consolidated VIEs  
    As of December 2012  
in millions    
 
 
 
Real estate,
credit-related
and other
investing
  
  
  
  
    

 

 

 

CDOs,

mortgage-backed

and other

asset-backed

  

  

  

  

    
 

 

Principal-
protected

notes

 
  

  

     Total   

Assets

          

Cash and cash equivalents

    $   236         $107         $      —         $   343   
   

Cash and securities segregated for regulatory and other purposes

    134                 92         226   
   

Receivables from brokers, dealers and clearing organizations

    5                         5   
   

Financial instruments owned, at fair value

    2,958         763         124         3,845   
   

Other assets

    1,080                         1,080   

Total

    $4,413         $870         $   216         $5,499   

Liabilities

          

Other secured financings

    $   594         $699         $   301         $1,594   
   

Financial instruments sold, but not yet purchased, at fair value

            107                 107   
   

Unsecured short-term borrowings, including the current portion of
unsecured long-term borrowings

                    1,584         1,584   
   

Unsecured long-term borrowings

    4                 334         338   
   

Other liabilities and accrued expenses

    1,478                         1,478   

Total

    $2,076         $806         $2,219         $5,101   

 

    Goldman Sachs March 2013 Form 10-Q   63


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 12. Other Assets

Note 12.

Other Assets

 

Other assets are generally less liquid, non-financial assets. The table below presents other assets by type.

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Property, leasehold improvements and equipment 1

    $  7,960         $  8,217   
   

Goodwill and identifiable intangible assets 2

    4,683         5,099   
   

Income tax-related assets 3

    5,345         5,620   
   

Equity-method investments 4

    455         453   
   

Miscellaneous receivables and other 5

    20,045         20,234   

Total

    $38,488         $39,623   

 

1.

Net of accumulated depreciation and amortization of $8.66 billion and $9.05 billion as of March 2013 and December 2012, respectively.

 

2.

Includes $152 million and $149 million of intangible assets classified as held for sale as of March 2013 and December 2012, respectively. See Note 13 for further information about goodwill and identifiable intangible assets.

 

3.

See Note 24 for further information about income taxes.

 

4.

Excludes investments accounted for at fair value under the fair value option where the firm would otherwise apply the equity method of accounting of $5.08 billion and $5.54 billion as of March 2013 and December 2012, respectively, which are included in “Financial instruments owned, at fair value.” The firm has generally elected the fair value option for such investments acquired after the fair value option became available.

 

5.

Includes $16.65 billion and $16.77 billion of assets related to the firm’s reinsurance business which were classified as held for sale as of March 2013 and December 2012, respectively.

Assets Held for Sale

In the fourth quarter of 2012, the firm classified its reinsurance business within its Institutional Client Services segment as held for sale. Assets related to this business of $16.80 billion and $16.92 billion, as of March 2013 and December 2012, respectively, consisting primarily of available-for-sale securities and separate account assets at fair value, are included in “Other assets.” Liabilities related to this business of $14.52 billion and $14.62 billion, as of March 2013 and December 2012, respectively, are included in “Other liabilities and accrued expenses.” See Note 8 for further information about insurance-related assets and liabilities held for sale at fair value.

The firm completed the sale of a majority stake in its reinsurance business in April 2013 and, as a result, the firm will no longer consolidate this business.

Property, Leasehold Improvements and Equipment

Property, leasehold improvements and equipment included $6.07 billion and $6.20 billion as of March 2013 and December 2012, respectively, related to property, leasehold improvements and equipment that the firm uses in

connection with its operations. The remainder is held by investment entities, including VIEs, consolidated by the firm.

Substantially all property and equipment are depreciated on a straight-line basis over the useful life of the asset. Leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter. Certain costs of software developed or obtained for internal use are capitalized and amortized on a straight-line basis over the useful life of the software.

Property, leasehold improvements and equipment are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable. The firm’s policy for impairment testing of property, leasehold improvements and equipment is the same as is used for identifiable intangible assets with finite lives. See Note 13 for further information.

Impairments

The firm tests property, leasehold improvements and equipment, intangible assets and other assets for impairment in accordance with ASC 360. To the extent the carrying value of an asset exceeds the projected undiscounted cash flows over the estimated remaining useful life of the asset, the firm determines the asset is impaired and records an impairment loss. In addition, the firm will recognize an impairment loss prior to the sale of an asset if the carrying value of the asset exceeds its estimated fair value.

During the first quarter of 2012, as a result of a decline in the market conditions in which certain of the firm’s consolidated investments operated, the firm determined certain assets were impaired and recorded an impairment loss of $116 million ($90 million related to property, leasehold improvements and equipment, $20 million related to commodity-related intangible assets and $6 million related to other assets), substantially all of which was included in “Depreciation and amortization.” These impairment losses were included in the firm’s Investing & Lending segment and represented the excess of the carrying values of these assets over their estimated fair values, which are level 3 measurements, using a combination of discounted cash flow analyses and relative value analyses, including the estimated cash flows expected to be received from the disposition of certain of these assets.

 

 

64   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 13. Goodwill and Identifiable Intangible Assets

Note 13.

 

Goodwill and Identifiable Intangible Assets

    

 

The tables below present the carrying values of goodwill and identifiable intangible assets, which are included in “Other assets.”

 

 

    Goodwill  
    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Investment Banking:

    

Financial Advisory

    $     98         $     98   
   

Underwriting

    183         183   
   

Institutional Client Services:

    

Fixed Income, Currency and Commodities Client Execution

    269         269   
   

Equities Client Execution

    2,402         2,402   
   

Securities Services

    105         105   
   

Investing & Lending

    59         59   
   

Investment Management

    586         586   

Total

    $3,702         $3,702   
    Identifiable Intangible Assets  
    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Investment Banking:

    

Financial Advisory

    $     —         $       1   
   

Institutional Client Services:

    

Fixed Income, Currency and Commodities Client Execution 1

    45         421   
   

Equities Client Execution

    556         565   
   

Investing & Lending

    260         281   
   

Investment Management

    120         129   

Total

    $   981         $1,397   

 

1.

The decrease from December 2012 to March 2013 is related to the sale of the firm’s television broadcast royalties in the first quarter of 2013.

Goodwill

Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date.

Goodwill is assessed annually in the fourth quarter for impairment or more frequently if events occur or circumstances change that indicate an impairment may exist. Qualitative factors are assessed to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If results of the qualitative assessment are not conclusive, a quantitative goodwill impairment test is performed.

The quantitative goodwill impairment test consists of two steps.

 

Ÿ  

The first step compares the estimated fair value of each reporting unit with its estimated net book value (including goodwill and identified intangible assets). If the reporting unit’s fair value exceeds its estimated net book value, goodwill is not impaired.

 

Ÿ  

If the estimated fair value of a reporting unit is less than its estimated net book value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. An impairment loss is equal to the excess of the carrying amount of goodwill over its fair value.

Goodwill was tested for impairment, using a quantitative test, during the fourth quarter of 2012 and goodwill was not impaired.

To estimate the fair value of each reporting unit, both relative value and residual income valuation techniques are used because the firm believes market participants would use these techniques to value the firm’s reporting units.

Relative value techniques apply average observable price-to-earnings multiples of comparable competitors to certain reporting units’ net earnings. For other reporting units, fair value is estimated using price-to-book multiples based on residual income techniques, which consider a reporting unit’s return on equity in excess of the firm’s cost of equity capital. The net book value of each reporting unit reflects an allocation of total shareholders’ equity and represents the estimated amount of shareholders’ equity required to support the activities of the reporting unit under guidelines issued by the Basel Committee on Banking Supervision (Basel Committee) in December 2010.

 

 

    Goldman Sachs March 2013 Form 10-Q   65


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Identifiable Intangible Assets

The table below presents the gross carrying amount, accumulated amortization and net carrying amount of

identifiable intangible assets and their weighted average remaining lives.

 

 

 

         As of  
$ in millions         

 

March

2013

  

  

   Weighted Average
Remaining Lives
(years)
   

 

December

2012

  

  

 

 

Customer lists

   Gross carrying amount     $ 1,099           $ 1,099   
   
     Accumulated amortization     (659          (643
   Net carrying amount     440       8     456   
   

 

 

Commodities-related intangibles 1

   Gross carrying amount     508           513   
   
     Accumulated amortization     (242          (226
   Net carrying amount     266       10     287   
   

 

 

Television broadcast royalties 2

   Gross carrying amount               560   
   
     Accumulated amortization                 (186
   Net carrying amount           N/A 2     374   
   

 

 

Insurance-related intangibles 3

   Gross carrying amount     380           380   
   
     Accumulated amortization     (228          (231
   Net carrying amount     152       N/A 3     149   
   

 

 

Other 4

   Gross carrying amount     941           950   
   
     Accumulated amortization     (818          (819
   Net carrying amount     123       12     131   
   

 

 

Total

   Gross carrying amount     2,928           3,502   
   
     Accumulated amortization     (1,947          (2,105
     Net carrying amount     $    981       9     $ 1,397   

 

1.

Primarily includes commodity-related customer contracts and relationships, permits and access rights.

 

2.

These assets were sold in the first quarter of 2013 and total proceeds received approximated carrying value.

 

3.

Related to the firm’s reinsurance business, which is classified as held for sale. See Note 12 for further information.

 

4.

Primarily includes the firm’s exchange-traded fund lead market maker rights.

 

Substantially all of the firm’s identifiable intangible assets are considered to have finite lives and are amortized (i) over their estimated lives, (ii) based on economic usage for certain commodity-related intangibles or (iii) in proportion

to estimated gross profits or premium revenues. Amortization expense for identifiable intangible assets is included in “Depreciation and amortization.”

 

 

66   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The tables below present amortization expense for identifiable intangible assets for the three months ended March 2013 and March 2012, and the estimated future amortization expense through 2018 for identifiable intangible assets as of March 2013.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Amortization expense

    $42         $70   

 

 

in millions    

 

As of

March 2013

  

  

Estimated future amortization expense:

 

Remainder of 2013

    $121   
   

2014

    128   
   

2015

    95   
   

2016

    93   
   

2017

    91   
   

2018

    82   

Identifiable intangible assets are tested for recoverability whenever events or changes in circumstances indicate that an asset’s or asset group’s carrying value may not be recoverable.

If a recoverability test is necessary, the carrying value of an asset or asset group is compared to the total of the undiscounted cash flows expected to be received over the remaining useful life and from the disposition of the asset or asset group.

 

Ÿ  

If the total of the undiscounted cash flows exceeds the carrying value, the asset or asset group is not impaired.

 

Ÿ  

If the total of the undiscounted cash flows is less than the carrying value, the asset or asset group is not fully recoverable and an impairment loss is recognized as the difference between the carrying amount of the asset or asset group and its estimated fair value.

See Note 12 for information about impairments of the firm’s identifiable intangible assets.

 

 

Note 14. Deposits

Note 14.

Deposits

The table below presents deposits held in U.S. and non-U.S. offices, substantially all of which were interest-bearing. Substantially all U.S. deposits were held at Goldman Sachs Bank USA (GS Bank USA) as of March 2013 and December 2012. Substantially all non-U.S. deposits were held at Goldman Sachs International Bank (GSIB) as of March 2013 and held at Goldman Sachs Bank (Europe) plc (GS Bank Europe) and GSIB as of December 2012. On

January 18, 2013, GS Bank Europe surrendered its banking license to the Central Bank of Ireland after transferring its deposits to GSIB and subsequently changed its name to Goldman Sachs Ireland Finance plc.

 

 

    As of  
in millions    

 

March

2013

  

  

   

 

December

2012

  

  

U.S. offices

    $63,424        $62,377   
   

Non-U.S. offices

    9,261        7,747   

Total

    $72,685  1      $70,124  1 

The table below presents maturities of time deposits held in U.S. and non-U.S. offices.

 

 

    As of March 2013  
in millions     U.S.        Non-U.S.        Total   

Remainder of 2013

    $  4,760        $4,025        $  8,785   
   

2014

    4,023        130        4,153   
   

2015

    4,054               4,054   
   

2016

    1,919               1,919   
   

2017

    2,502               2,502   
   

2018

    1,421               1,421   
   

2019 - thereafter

    4,096               4,096   

Total

    $22,775  2      $4,155  3      $26,930  1 

 

1.

Includes $7.07 billion and $5.10 billion as of March 2013 and December 2012, respectively, of time deposits accounted for at fair value under the fair value option. See Note 8 for further information about deposits accounted for at fair value.

 

2.

Includes $40 million greater than $100,000, of which $24 million matures within three months, $6 million matures within three to six months, $6 million matures within six to twelve months, and $4 million matures after twelve months.

 

3.

Substantially all were greater than $100,000.

As of March 2013 and December 2012, savings and demand deposits, which represent deposits with no stated maturity, were $45.76 billion and $46.51 billion, respectively, which were recorded based on the amount of cash received plus accrued interest, which approximates fair value. In addition, the firm designates certain derivatives as fair value hedges on substantially all of its time deposits for which it has not elected the fair value option. Accordingly, $19.86 billion and $18.52 billion as of March 2013 and December 2012, respectively, of time deposits were effectively converted from fixed-rate obligations to floating-rate obligations and were recorded at amounts that generally approximate fair value. While these savings and demand deposits and time deposits are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these deposits been included in the firm’s fair value hierarchy, they would have been classified in level 2.

 

 

    Goldman Sachs March 2013 Form 10-Q   67


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 15. Short-Term Borrowings

Note 15.

Short-Term Borrowings

 

Short-term borrowings were comprised of the following:

 

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Other secured financings (short-term)

    $20,497         $23,045   
   

Unsecured short-term borrowings

    40,980         44,304   

Total

    $61,477         $67,349   

See Note 9 for further information about other secured financings.

Unsecured short-term borrowings include the portion of unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder.

The firm accounts for promissory notes, commercial paper and certain hybrid financial instruments at fair value under the fair value option. See Note 8 for further information about unsecured short-term borrowings that are accounted for at fair value. The carrying value of unsecured short-term borrowings that are not recorded at fair value generally approximates fair value due to the short-term nature of the obligations. While these unsecured short-term borrowings are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these borrowings been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

The table below presents unsecured short-term borrowings.

 

 

    As of  
$ in millions    

 

March

2013

  

  

   

 

December

2012

  

  

Current portion of unsecured
long-term borrowings

    $23,053        $25,344   
   

Hybrid financial instruments

    12,531        12,295   
   

Promissory notes

    356        260   
   

Commercial paper

    999        884   
   

Other short-term borrowings

    4,041        5,521   

Total

    $40,980        $44,304   

 

Weighted average interest rate 1

    1.56     1.57

 

1.

The weighted average interest rates for these borrowings include the effect of hedging activities and exclude financial instruments accounted for at fair value under the fair value option. See Note 7 for further information about hedging activities.

 

 

68   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 16. Long-Term Borrowings

Note 16.

Long-Term Borrowings

Long-term borrowings were comprised of the following:

 

 

    As of  
in millions    

 

March

2013

  

  

      

 

December

2012

  

  

Other secured financings (long-term)

    $    8,971           $    8,965   
   

Unsecured long-term borrowings

    167,008           167,305   

Total

    $175,979           $176,270   

 

See Note 9 for further information about other secured financings. The table below presents unsecured long-term

borrowings extending through 2061 and consisting principally of senior borrowings.

 

 

 

    As of March 2013         As of December 2012  
in millions    

 

U.S.

Dollar

  

  

      

 

Non-U.S.

Dollar

  

  

       Total           

 

U.S.

Dollar

  

  

      

 

Non-U.S.

Dollar

  

  

       Total   

Fixed-rate obligations 1

    $  91,305           $34,911           $126,216          $  88,561           $36,869           $125,430   
   

Floating-rate obligations 2

    21,110           19,682           40,792            20,794           21,081           41,875   

Total

    $112,415           $54,593           $167,008            $109,355           $57,950           $167,305   

 

1.

Interest rates on U.S. dollar-denominated debt ranged from 0.20% to 10.04% (with a weighted average rate of 5.02%) and 0.20% to 10.04% (with a weighted average rate of 5.48%) as of March 2013 and December 2012, respectively. Interest rates on non-U.S. dollar-denominated debt ranged from 0.10% to 14.85% (with a weighted average rate of 4.47%) and 0.10% to 14.85% (with a weighted average rate of 4.66%) as of March 2013 and December 2012, respectively.

 

2.

Floating interest rates generally are based on LIBOR or the federal funds target rate. Equity-linked and indexed instruments are included in floating-rate obligations.

 

    Goldman Sachs March 2013 Form 10-Q   69


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents unsecured long-term borrowings by maturity date. In the table below:

 

Ÿ  

unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holders are included as unsecured short-term borrowings;

 

Ÿ  

unsecured long-term borrowings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates; and

 

Ÿ  

unsecured long-term borrowings that are redeemable prior to maturity at the option of the holders are reflected at the dates such options become exercisable.

 

 

in millions    
 
As of
March 2013
  
  

2014

    $  15,154   
   

2015

    21,967   
   

2016

    21,594   
   

2017

    20,675   
   

2018

    17,443   
   

2019 - thereafter

    70,175   

Total 1

    $167,008   

 

1.

Includes $9.84 billion related to interest rate hedges on certain unsecured long-term borrowings, by year of maturity as follows: $487 million in 2014, $443 million in 2015, $1.01 billion in 2016, $1.30 billion in 2017, $1.36 billion in 2018 and $5.24 billion in 2019 and thereafter.

The firm designates certain derivatives as fair value hedges to effectively convert a substantial portion of its fixed-rate unsecured long-term borrowings which are not accounted for at fair value into floating-rate obligations. Accordingly, excluding the cumulative impact of changes in the firm’s credit spreads, the carrying value of unsecured long-term borrowings approximated fair value as of March 2013 and December 2012. See Note 7 for further information about hedging activities. For unsecured long-term borrowings for which the firm did not elect the fair value option, the cumulative impact due to changes in the firm’s own credit spreads would be an increase of less than 2% in the carrying value of total unsecured long-term borrowings as of both March 2013 and December 2012. As these borrowings are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP, their fair value is not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these borrowings been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

The table below presents unsecured long-term borrowings, after giving effect to hedging activities that converted a substantial portion of fixed-rate obligations to floating-rate obligations.

 

 

    As of  
in millions    

 

March

2013

  

  

      

 

December

2012

  

  

Fixed-rate obligations

      

At fair value

    $       153           $       122   
   

At amortized cost 1

    20,225           24,547   
   

Floating-rate obligations

      

At fair value

    12,095           12,471   
   

At amortized cost 1

    134,535           130,165   

Total

    $167,008           $167,305   

 

1.

The weighted average interest rates on the aggregate amounts were 2.36% (5.25% related to fixed-rate obligations and 1.96% related to floating-rate obligations) and 2.47% (5.26% related to fixed-rate obligations and 1.98% related to floating-rate obligations) as of March 2013 and December 2012, respectively. These rates exclude financial instruments accounted for at fair value under the fair value option.

 

 

70   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Subordinated Borrowings

Unsecured long-term borrowings include subordinated debt and junior subordinated debt. Junior subordinated debt is junior in right of payment to other subordinated borrowings, which are junior to senior borrowings. As of

both March 2013 and December 2012, subordinated debt had maturities ranging from 2015 to 2038. The table below presents subordinated borrowings.

 

 

 

    As of March 2013         As of December 2012  
$ in millions    

 

Par

Amount

  

  

      

 

Carrying

Amount

  

  

       Rate  1         

 

Par

Amount

  

  

      

 

Carrying

Amount

  

  

       Rate  1 

Subordinated debt

    $14,270           $17,106           4.19       $14,409           $17,358           4.24
   

Junior subordinated debt

    2,835           4,135           3.01         2,835           4,228           3.16

Total subordinated borrowings

    $17,105           $21,241           3.99         $17,244           $21,586           4.06

 

1.

Weighted average interest rate after giving effect to fair value hedges used to convert these fixed-rate obligations into floating-rate obligations. See Note 7 for further information about hedging activities. See below for information about interest rates on junior subordinated debt.

Junior Subordinated Debt

Junior Subordinated Debt Held by 2012 Trusts. In 2012, the Vesey Street Investment Trust I (Vesey Street Trust) and the Murray Street Investment Trust I (Murray Street Trust) (together, the 2012 Trusts) issued an aggregate of $2.25 billion of senior guaranteed trust securities to third parties. The proceeds of that offering were used to fund purchases of $1.75 billion of junior subordinated debt securities issued by Group Inc. that pay interest semi-annually at a fixed annual rate of 4.647% and mature on March 9, 2017, and $500 million of junior subordinated debt securities issued by Group Inc. that pay interest semi-annually at a fixed annual rate of 4.404% and mature on September 1, 2016.

The 2012 Trusts purchased the junior subordinated debt from Goldman Sachs Capital II and Goldman Sachs Capital III (APEX Trusts). The APEX Trusts used the proceeds from such sales to purchase shares of Group Inc.’s Perpetual Non-Cumulative Preferred Stock, Series E (Series E Preferred Stock) and Perpetual Non-Cumulative Preferred Stock, Series F (Series F Preferred Stock). See Note 19 for more information about the Series E and Series F Preferred stock.

The 2012 Trusts are required to pay distributions on their senior guaranteed trust securities in the same amounts and on the same dates that they are scheduled to receive interest on the junior subordinated debt they hold, and are required to redeem their respective senior guaranteed trust securities upon the maturity or earlier redemption of the junior subordinated debt they hold.

The firm has the right to defer payments on the junior subordinated debt, subject to limitations. During any such deferral period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common or preferred stock. However, as Group Inc. fully and unconditionally guarantees the payment of the distribution and redemption amounts when due on a senior basis on the senior guaranteed trust securities issued by the 2012 Trusts, if the 2012 Trusts are unable to make scheduled distributions to the holders of the senior guaranteed trust securities, under the guarantee, Group Inc. would be obligated to make those payments. As such, the $2.25 billion of junior subordinated debt held by the 2012 Trusts for the benefit of investors is not classified as junior subordinated debt.

The APEX Trusts and the 2012 Trusts are Delaware statutory trusts sponsored by the firm and wholly-owned finance subsidiaries of the firm for regulatory and legal purposes but are not consolidated for accounting purposes.

The firm has covenanted in favor of the holders of Group Inc.’s 6.345% Junior Subordinated Debentures due February 15, 2034, that, subject to certain exceptions, the firm will not redeem or purchase the capital securities issued by the APEX Trusts or shares of Group Inc’s Series E or Series F Preferred Stock prior to specified dates in 2022 for a price that exceeds a maximum amount determined by reference to the net cash proceeds that the firm has received from the sale of qualifying securities.

 

 

    Goldman Sachs March 2013 Form 10-Q   71


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Junior Subordinated Debt Issued in Connection with Trust Preferred Securities. Group Inc. issued $2.84 billion of junior subordinated debentures in 2004 to Goldman Sachs Capital I (Trust), a Delaware statutory trust. The Trust issued $2.75 billion of guaranteed preferred beneficial interests to third parties and $85 million of common beneficial interests to Group Inc. and used the proceeds from the issuances to purchase the junior subordinated debentures from Group Inc. The Trust is a wholly-owned finance subsidiary of the firm for regulatory and legal purposes but is not consolidated for accounting purposes.

The firm pays interest semi-annually on the debentures at an annual rate of 6.345% and the debentures mature on February 15, 2034. The coupon rate and the payment dates applicable to the beneficial interests are the same as the interest rate and payment dates for the debentures. The firm has the right, from time to time, to defer payment of interest on the debentures, and therefore cause payment on the Trust’s preferred beneficial interests to be deferred, in each case up to ten consecutive semi-annual periods. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common stock. The Trust is not permitted to pay any distributions on the common beneficial interests held by Group Inc. unless all dividends payable on the preferred beneficial interests have been paid in full.

 

Note 17. Other Liabilities and Accrued Expenses

Note 17.

Other Liabilities and Accrued Expenses

The table below presents other liabilities and accrued expenses by type.

 

 

    As of  
in millions    

 

March

2013

  

  

      

 

December

2012

  

  

Compensation and benefits

    $  4,898           $  8,292   
   

Insurance-related liabilities 1

    10,178           10,274   
   

Noncontrolling interests 2

    432           508   
   

Income tax-related liabilities 3

    3,086           2,724   
   

Employee interests in consolidated funds

    245           246   
   

Subordinated liabilities issued by consolidated VIEs

    993           1,360   
   

Accrued expenses and other 4

    18,721           18,991   

Total

    $38,553           $42,395   

 

1.

Represents liabilities for future benefits and unpaid claims carried at fair value under the fair value option as of March 2013 and December 2012, respectively.

 

2.

Includes $367 million and $419 million related to consolidated investment funds as of March 2013 and December 2012, respectively.

 

3.

See Note 24 for further information about income taxes.

 

4.

Includes $14.52 billion and $14.62 billion of liabilities related to the firm’s reinsurance business which were classified as held for sale as of March 2013 and December 2012, respectively. See Note 12 for further information.

 

 

72   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 18. Commitments, Contingencies and Guarantees

Note 18.

Commitments, Contingencies and Guarantees

Commitments

The table below presents the firm’s commitments.

 

 

   

Commitment Amount by Period

of Expiration as of March 2013

       

Total Commitments

as of

 
in millions    
 
Remainder
of 2013
  
  
    

 

2014-

2015

  

  

    

 

2016-

2017

  

  

    

 

2018-

Thereafter

  

  

       

 

March

2013

  

  

    

 

December

2012

  

  

Commitments to extend credit 1

                 

Commercial lending:

                 

Investment-grade

    $  6,301         $11,203         $30,997         $  5,702          $  54,203         $  53,736   
   

Non-investment-grade

    1,603         5,086         8,976         3,450          19,115         21,102   
   

Warehouse financing

    259         524                            783         784   

Total commitments to extend credit

    8,163         16,813         39,973         9,152          74,101         75,622   
   

Contingent and forward starting resale and securities borrowing agreements 2

    72,068                                  72,068         47,599   
   

Forward starting repurchase and secured lending agreements 2

    13,268                                  13,268         6,144   
   

Letters of credit 3

    533         179                 15          727         789   
   

Investment commitments

    1,627         1,908         239         3,608          7,382         7,339   
   

Other

    3,483         80         27         69            3,659         4,624   

Total commitments

    $99,142         $18,980         $40,239         $12,844            $171,205         $142,117   

 

1.

Commitments to extend credit are presented net of amounts syndicated to third parties.

 

2.

These agreements generally settle within three business days.

 

3.

Consists of commitments under letters of credit issued by various banks which the firm provides to counterparties in lieu of securities or cash to satisfy various collateral and margin deposit requirements.

Commitments to Extend Credit

The firm’s commitments to extend credit are agreements to lend with fixed termination dates and depend on the satisfaction of all contractual conditions to borrowing. The total commitment amount does not necessarily reflect actual future cash flows because the firm may syndicate all or substantial portions of these commitments and commitments can expire unused or be reduced or cancelled at the counterparty’s request.

The firm generally accounts for commitments to extend credit at fair value. Losses, if any, are generally recorded, net of any fees in “Other principal transactions.”

As of March 2013 and December 2012, approximately $18.55 billion and $16.09 billion, respectively, of the firm’s lending commitments were held for investment and were accounted for on an accrual basis. The carrying value and the estimated fair value of such lending commitments were liabilities of $78 million and $624 million, respectively, as of March 2013, and $63 million and $523 million, respectively, as of December 2012. As these lending

commitments are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP, their fair value is not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these commitments been included in the firm’s fair value hierarchy, they would have primarily been classified in level 3 as of March 2013 and December 2012.

Commercial Lending. The firm’s commercial lending commitments are extended to investment-grade and non-investment-grade corporate borrowers. Commitments to investment-grade corporate borrowers are principally used for operating liquidity and general corporate purposes. The firm also extends lending commitments in connection with contingent acquisition financing and other types of corporate lending as well as commercial real estate financing. Commitments that are extended for contingent acquisition financing are often intended to be short-term in nature, as borrowers often seek to replace them with other funding sources.

 

 

    Goldman Sachs March 2013 Form 10-Q   73


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Sumitomo Mitsui Financial Group, Inc. (SMFG) provides the firm with credit loss protection on certain approved loan commitments (primarily investment-grade commercial lending commitments). The notional amount of such loan commitments was $30.95 billion and $32.41 billion as of March 2013 and December 2012, respectively. The credit loss protection on loan commitments provided by SMFG is generally limited to 95% of the first loss the firm realizes on such commitments, up to a maximum of approximately $950 million. In addition, subject to the satisfaction of certain conditions, upon the firm’s request, SMFG will provide protection for 70% of additional losses on such commitments, up to a maximum of $1.13 billion, of which $300 million of protection had been provided as of both March 2013 and December 2012. The firm also uses other financial instruments to mitigate credit risks related to certain commitments not covered by SMFG. These instruments primarily include credit default swaps that reference the same or similar underlying instrument or entity or credit default swaps that reference a market index.

Warehouse Financing. The firm provides financing to clients who warehouse financial assets. These arrangements are secured by the warehoused assets, primarily consisting of commercial mortgage loans.

Contingent and Forward Starting Resale and Securities Borrowing Agreements/Forward Starting Repurchase and Secured Lending Agreements

The firm enters into resale and securities borrowing agreements and repurchase and secured lending agreements that settle at a future date. The firm also enters into commitments to provide contingent financing to its clients and counterparties through resale agreements. The firm’s funding of these commitments depends on the satisfaction of all contractual conditions to the resale agreement and these commitments can expire unused.

Investment Commitments

The firm’s investment commitments consist of commitments to invest in private equity, real estate and other assets directly and through funds that the firm raises and manages. These commitments include $1.04 billion and $872 million as of March 2013 and December 2012, respectively, related to real estate private investments and $6.34 billion and $6.47 billion as of March 2013 and December 2012, respectively, related to corporate and other private investments. Of these amounts, $5.96 billion and $6.21 billion as of March 2013 and December 2012, respectively, relate to commitments to invest in funds managed by the firm, which will be funded at market value on the date of investment.

Leases

The firm has contractual obligations under long-term noncancelable lease agreements, principally for office space, expiring on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. The table below presents future minimum rental payments, net of minimum sublease rentals.

 

 

in millions    
 
As of
March 2013
  
  

Remainder of 2013

    $   304   
   

2014

    393   
   

2015

    337   
   

2016

    288   
   

2017

    270   
   

2018

    219   
   

2019 - thereafter

    1,144   

Total

    $2,955   

Operating leases include office space held in excess of current requirements. Rent expense relating to space held for growth is included in “Occupancy.” The firm records a liability, based on the fair value of the remaining lease rentals reduced by any potential or existing sublease rentals, for leases where the firm has ceased using the space and management has concluded that the firm will not derive any future economic benefits. Costs to terminate a lease before the end of its term are recognized and measured at fair value on termination.

 

 

74   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Contingencies

Legal Proceedings. See Note 27 for information about legal proceedings, including certain mortgage-related matters.

Certain Mortgage-Related Contingencies. There are multiple areas of focus by regulators, governmental agencies and others within the mortgage market that may impact originators, issuers, servicers and investors. There remains significant uncertainty surrounding the nature and extent of any potential exposure for participants in this market.

 

Ÿ  

Representations and Warranties. The firm has not been a significant originator of residential mortgage loans. The firm did purchase loans originated by others and generally received loan-level representations of the type described below from the originators. During the period 2005 through 2008, the firm sold approximately $10 billion of loans to government-sponsored enterprises and approximately $11 billion of loans to other third parties. In addition, the firm transferred loans to trusts and other mortgage securitization vehicles. As of March 2013 and December 2012, the outstanding balance of the loans transferred to trusts and other mortgage securitization vehicles during the period 2005 through 2008 was approximately $33 billion and $35 billion, respectively. This amount reflects paydowns and cumulative losses of approximately $92 billion ($21 billion of which are cumulative losses) as of March 2013 and approximately $90 billion ($20 billion of which are cumulative losses) as of December 2012. A small number of these Goldman Sachs-issued securitizations with an outstanding principal balance of $520 million and total paydowns and cumulative losses of $1.54 billion ($516 million of which are cumulative losses) as of March 2013, and an outstanding principal balance of $540 million and total paydowns and cumulative losses of $1.52 billion ($508 million of which are cumulative losses) as of December 2012, were structured with credit protection obtained from monoline insurers. In connection with both sales of loans and securitizations, the firm provided loan level representations of the type described below and/or assigned the loan level representations from the party from whom the firm purchased the loans.

   

The loan level representations made in connection with the sale or securitization of mortgage loans varied among transactions but were generally detailed representations applicable to each loan in the portfolio and addressed matters relating to the property, the borrower and the note. These representations generally included, but were not limited to, the following: (i) certain attributes of the borrower’s financial status; (ii) loan-to-value ratios, owner occupancy status and certain other characteristics of the property; (iii) the lien position; (iv) the fact that the loan was originated in compliance with law; and (v) completeness of the loan documentation.

 

 

The firm has received repurchase claims for residential mortgage loans based on alleged breaches of representations, from government-sponsored enterprises, other third parties, trusts and other mortgage securitization vehicles, which have not been significant. During the three months ended March 2013 and March 2012, the firm repurchased loans with an unpaid principal balance of less than $10 million. The loss related to the repurchase of these loans was not material for both the three months ended March 2013 and March 2012.

 

 

Ultimately, the firm’s exposure to claims for repurchase of residential mortgage loans based on alleged breaches of representations will depend on a number of factors including the following: (i) the extent to which these claims are actually made; (ii) the extent to which there are underlying breaches of representations that give rise to valid claims for repurchase; (iii) in the case of loans originated by others, the extent to which the firm could be held liable and, if it is, the firm’s ability to pursue and collect on any claims against the parties who made representations to the firm; (iv) macro-economic factors, including developments in the residential real estate market; and (v) legal and regulatory developments.

 

 

Based upon the large number of defaults in residential mortgages, including those sold or securitized by the firm, there is a potential for increasing claims for repurchases. However, the firm is not in a position to make a meaningful estimate of that exposure at this time.

 

 

    Goldman Sachs March 2013 Form 10-Q   75


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Ÿ  

Foreclosure and Other Mortgage Loan Servicing Practices and Procedures. The firm had received a number of requests for information from regulators and other agencies, including state attorneys general and banking regulators, as part of an industry-wide focus on the practices of lenders and servicers in connection with foreclosure proceedings and other aspects of mortgage loan servicing practices and procedures. The requests sought information about the foreclosure and servicing protocols and activities of Litton, a residential mortgage servicing subsidiary sold by the firm to Ocwen Financial Corporation (Ocwen) in the third quarter of 2011. The firm is cooperating with the requests and these inquiries may result in the imposition of fines or other regulatory action. In the third quarter of 2010, prior to the firm’s sale of Litton, Litton had temporarily suspended evictions and foreclosure and real estate owned sales in a number of states, including those with judicial foreclosure procedures. Litton resumed these activities beginning in the fourth quarter of 2010.

 

 

In connection with the sale of Litton, the firm provided customary representations and warranties, and indemnities for breaches of these representations and warranties, to Ocwen. These indemnities are subject to various limitations, and are capped at approximately $50 million. The firm has not yet received any claims under these indemnities. The firm also agreed to provide specific indemnities to Ocwen related to claims made by third parties with respect to servicing activities during the period that Litton was owned by the firm and which are in excess of the related reserves accrued for such matters by Litton at the time of the sale. These indemnities are capped at approximately $125 million. The firm has recorded a reserve for the portion of these potential losses that it believes is probable and can be reasonably estimated. As of March 2013, claims under these indemnities, and payments made in connection with these claims, were not material to the firm.

 

 

The firm further agreed to provide indemnities to Ocwen not subject to a cap, which primarily relate to potential liabilities constituting fines or civil monetary penalties which could be imposed in settlements with certain terms with U.S. states’ attorneys general or in consent orders with certain terms with the Federal Reserve, the Office of Thrift Supervision, the Office of the Comptroller of the Currency, the FDIC or the New York State Department of Financial Services, in each case relating to Litton’s

   

foreclosure and servicing practices while it was owned by the firm. The firm has entered into a settlement with the Board of Governors of the Federal Reserve System (Federal Reserve Board) relating to foreclosure and servicing matters as described below.

 

 

Under the Litton sale agreement the firm also retained liabilities associated with claims related to Litton’s failure to maintain lender-placed mortgage insurance, obligations to repurchase certain loans from government-sponsored enterprises, subpoenas from one of Litton’s regulators, and fines or civil penalties imposed by the Federal Reserve or the New York State Department of Financial Services in connection with certain compliance matters. Management is unable to develop an estimate of the maximum potential amount of future payments under these indemnities because the firm has received no claims under these indemnities other than an immaterial amount with respect to government-sponsored enterprises. However, management does not believe, based on currently available information, that any payments under these indemnities will have a material adverse effect on the firm’s financial condition.

 

 

On September 1, 2011, Group Inc. and GS Bank USA entered into a Consent Order (the Order) with the Federal Reserve Board relating to the servicing of residential mortgage loans. The terms of the Order were substantially similar and, in many respects, identical to the orders entered into with the Federal Reserve Board by other large U.S. financial institutions. The Order set forth various allegations of improper conduct in servicing by Litton, requires that Group Inc. and GS Bank USA cease and desist such conduct, and required that Group Inc. and GS Bank USA, and their boards of directors, take various affirmative steps. The Order required (i) Group Inc. and GS Bank USA to engage a third-party consultant to conduct a review of certain foreclosure actions or proceedings that occurred or were pending between January 1, 2009 and December 31, 2010; (ii) the adoption of policies and procedures related to management of third parties used to outsource residential mortgage servicing, loss mitigation or foreclosure; (iii) a “validation report” from an independent third-party consultant regarding compliance with the Order for the first year; and (iv) submission of quarterly progress reports as to compliance with the Order by the boards of directors (or committees thereof) of Group Inc. and GS Bank USA.

 

 

76   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

On January 16, 2013, Group Inc. and GS Bank USA entered into a settlement in principle with the Federal Reserve Board relating to the servicing of residential mortgage loans and foreclosure processing. This settlement in principle amends the Order which is described above, provides for the termination of the independent foreclosure review under the Order and calls for Group Inc. and GS Bank USA collectively to: (i) make cash payments into a settlement fund for distribution to eligible borrowers; and (ii) provide other assistance for foreclosure prevention and loss mitigation over the next two years. The other provisions of the Order will remain in effect. On February 28, 2013, Group Inc. and GS Bank USA entered into final documentation with the Federal Reserve Board relating to the settlement.

Guarantees

The firm enters into various derivatives that meet the definition of a guarantee under U.S. GAAP, including written equity and commodity put options, written currency contracts and interest rate caps, floors and swaptions. Disclosures about derivatives are not required if they may be cash settled and the firm has no basis to conclude it is probable that the counterparties held the underlying instruments at inception of the contract. The firm has concluded that these conditions have been met for certain large, internationally active commercial and investment bank counterparties, central clearing counterparties and certain other counterparties. Accordingly, the firm has not included such contracts in the table below.

The firm, in its capacity as an agency lender, indemnifies most of its securities lending customers against losses incurred in the event that borrowers do not return securities and the collateral held is insufficient to cover the market value of the securities borrowed.

In the ordinary course of business, the firm provides other financial guarantees of the obligations of third parties (e.g., standby letters of credit and other guarantees to enable clients to complete transactions and fund-related guarantees). These guarantees represent obligations to make payments to beneficiaries if the guaranteed party fails to fulfill its obligation under a contractual arrangement with that beneficiary.

The table below presents certain information about derivatives that meet the definition of a guarantee and certain other guarantees. The maximum payout in the table below is based on the notional amount of the contract and therefore does not represent anticipated losses. See Note 7 for further information about credit derivatives that meet the definition of a guarantee which are not included below.

Because derivatives are accounted for at fair value, the carrying value is considered the best indication of payment/performance risk for individual contracts. However, the carrying values below exclude the effect of a legal right of setoff that may exist under an enforceable netting agreement and the effect of netting of cash collateral posted under enforceable credit support agreements.

 

 

 

    As of March 2013  
              Maximum Payout/Notional Amount by Period of Expiration  
in millions    
 

 

Carrying
Value of

Net Liability

  
  

  

       
 
Remainder
of 2013
  
  
    
 
2014-
2015
  
  
    
 
2016-
2017
  
  
    
 
2018-
Thereafter
  
  
     Total   

Derivatives 1

    $8,083          $318,426         $275,467         $53,158         $58,370         $705,421   
   

Securities lending indemnifications 2

             30,360                                 30,360   
   

Other financial guarantees 3

    142            751         455         1,268         1,028         3,502   

 

1.

These derivatives are risk managed together with derivatives that do not meet the definition of a guarantee, and therefore these amounts do not reflect the firm’s overall risk related to its derivative activities. As of December 2012, the carrying value of the net liability and the notional amount related to derivative guarantees were $8.58 billion and $663.15 billion, respectively.

 

2.

Collateral held by the lenders in connection with securities lending indemnifications was $31.24 billion as of March 2013. Because the contractual nature of these arrangements requires the firm to obtain collateral with a market value that exceeds the value of the securities lent to the borrower, there is minimal performance risk associated with these guarantees. As of December 2012, the maximum payout and collateral held related to securities lending indemnifications were $27.12 billion and $27.89 billion, respectively.

 

3.

Other financial guarantees excludes certain commitments to issue standby letters of credit that are included in “Commitments to extend credit.” See table in “Commitments” above for a summary of the firm’s commitments. As of December 2012, the carrying value of the net liability and the maximum payout related to other financial guarantees were $152 million and $3.48 billion, respectively.

 

    Goldman Sachs March 2013 Form 10-Q   77


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Guarantees of Securities Issued by Trusts. The firm has established trusts, including Goldman Sachs Capital I, the APEX Trusts, the 2012 Trusts, and other entities for the limited purpose of issuing securities to third parties, lending the proceeds to the firm and entering into contractual arrangements with the firm and third parties related to this purpose. The firm does not consolidate these entities. See Note 16 for further information about the transactions involving Goldman Sachs Capital I, the APEX Trusts, and the 2012 Trusts.

The firm effectively provides for the full and unconditional guarantee of the securities issued by these entities. Timely payment by the firm of amounts due to these entities under the guarantee, borrowing, preferred stock and related contractual arrangements will be sufficient to cover payments due on the securities issued by these entities.

Management believes that it is unlikely that any circumstances will occur, such as nonperformance on the part of paying agents or other service providers, that would make it necessary for the firm to make payments related to these entities other than those required under the terms of the guarantee, borrowing, preferred stock and related contractual arrangements and in connection with certain expenses incurred by these entities.

Indemnities and Guarantees of Service Providers. In the ordinary course of business, the firm indemnifies and guarantees certain service providers, such as clearing and custody agents, trustees and administrators, against specified potential losses in connection with their acting as an agent of, or providing services to, the firm or its affiliates.

The firm may also be liable to some clients for losses caused by acts or omissions of third-party service providers, including sub-custodians and third-party brokers. 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 material liabilities related to these guarantees and indemnifications have been recognized in the condensed consolidated statements of financial condition as of March 2013 or December 2012.

Other Representations, Warranties and Indemnifications. The firm provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. The firm may also provide indemnifications protecting against changes in or adverse application of certain U.S. tax laws in connection with ordinary-course transactions such as securities issuances, borrowings or derivatives.

In addition, the firm may provide indemnifications to some counterparties to protect them in the event additional taxes are owed or payments are withheld, due either to a change in or an adverse application of certain non-U.S. tax laws.

These indemnifications generally are standard contractual terms and are entered into in the ordinary course of business. Generally, there are no stated or notional amounts included in these indemnifications, and the contingencies triggering the obligation to indemnify are not expected to occur. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no material liabilities related to these arrangements have been recognized in the condensed consolidated statements of financial condition as of March 2013 or December 2012.

 

 

78   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Guarantees of Subsidiaries. Group Inc. fully and unconditionally guarantees the securities issued by GS Finance Corp., a wholly-owned finance subsidiary of the firm.

Group Inc. has guaranteed the payment obligations of Goldman, Sachs & Co. (GS&Co.), GS Bank USA and Goldman Sachs Execution & Clearing, L.P. (GSEC), subject to certain exceptions.

In November 2008, the firm contributed subsidiaries into GS Bank USA, and Group Inc. agreed to guarantee the reimbursement of certain losses, including credit-related losses, relating to assets held by the contributed entities. In connection with this guarantee, Group Inc. also agreed to pledge to GS Bank USA certain collateral, including interests in subsidiaries and other illiquid assets.

In addition, Group Inc. guarantees many of the obligations of its other consolidated subsidiaries on a transaction-by-transaction basis, as negotiated with counterparties. Group Inc. is unable to develop an estimate of the maximum payout under its subsidiary guarantees; however, because these guaranteed obligations are also obligations of consolidated subsidiaries, Group Inc.’s liabilities as guarantor are not separately disclosed.

 

Note 19. Shareholders' Equity

Note 19.

Shareholders’ Equity

Common Equity

On April 15, 2013, Group Inc. declared a dividend of $0.50 per common share to be paid on June 27, 2013 to common shareholders of record on May 30, 2013.

The firm’s share repurchase program is intended to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by the firm’s current and projected capital positions (i.e., comparisons of the firm’s desired level and composition of capital to its actual level and composition of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of the firm’s common stock. Any repurchase of the firm’s common stock requires approval by the Federal Reserve Board.

During the three months ended March 2013, the firm repurchased 10.1 million shares of its common stock at an average cost per share of $150.53, for a total cost of $1.52 billion, under the share repurchase program. In addition, pursuant to the terms of certain share-based compensation plans, employees may remit shares to the firm or the firm may cancel RSUs to satisfy minimum statutory employee tax withholding requirements. Under these plans, during the three months ended March 2013, employees remitted 70,754 shares with a total value of $10 million and the firm cancelled 3.2 million of RSUs with a total value of $458 million.

On March 25, 2013, the firm amended its warrant agreement with Berkshire Hathaway Inc. and certain of its subsidiaries (collectively, Berkshire Hathaway) to require net share settlement and to specify the exercise date as October 1, 2013. Under the amended agreement, the firm will deliver to Berkshire Hathaway the number of shares of common stock equal in value to the difference between the average closing price of the firm’s common stock over the 10 trading days preceding October 1, 2013 and the exercise price of $115.00 multiplied by the number of shares of common stock (43.5 million) covered by the warrant.

 

 

    Goldman Sachs March 2013 Form 10-Q   79


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Preferred Equity

The table below presents perpetual preferred stock issued and outstanding as of March 2013.

 

 

Series   Shares
Authorized
       Shares
Issued
       Shares
Outstanding
       Dividend Rate      Redemption
Value
(in millions)
 

A

    50,000           30,000           29,999        

3 month LIBOR + 0.75%,

with floor of 3.75% per annum

       $   750   
   

B

    50,000           32,000           32,000         6.20% per annum        800   
   

C

    25,000           8,000           8,000        

3 month LIBOR + 0.75%,

with floor of 4.00% per annum

       200   
   

D

    60,000           54,000           53,999        

3 month LIBOR + 0.67%,

with floor of 4.00% per annum

       1,350   
   

E

    17,500           17,500           17,500        

3 month LIBOR + 0.77%,

with floor of 4.00% per annum

       1,750   
   

F

    5,000           5,000           5,000        

3 month LIBOR + 0.77%,

with floor of 4.00% per annum

       500   
   

I

    34,500           34,000           34,000         5.95% per annum        850   
      242,000           180,500           180,498                  $6,200   

 

Each share of non-cumulative Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock issued and outstanding has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option, at a redemption price equal to $25,000 plus declared and unpaid dividends.

Each share of non-cumulative Series E and Series F Preferred Stock issued and outstanding has a par value of $0.01, has a liquidation preference of $100,000 and is redeemable at the option of the firm at any time subject to certain covenant restrictions governing the firm’s ability to redeem or purchase the preferred stock without issuing common stock or other instruments with equity-like characteristics, at a redemption price equal to $100,000 plus declared and unpaid dividends. See Note 16 for further information about the replacement capital covenants applicable to the Series E and Series F Preferred Stock.

Each share of non-cumulative Series I Preferred Stock issued and outstanding has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option beginning November 10, 2017 at a redemption price equal to $25,000 plus accrued and unpaid dividends.

Any redemption of preferred stock by the firm requires the approval of the Federal Reserve Board. All series of preferred stock are pari passu and have a preference over the firm’s common stock on liquidation. Dividends on each series of preferred stock, if declared, are payable quarterly in arrears. The firm’s ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, its common stock is subject to certain restrictions in the event that the firm fails to pay or set aside full dividends on the preferred stock for the latest completed dividend period.

On April 25, 2013, Group Inc. issued 40,000 shares of perpetual 5.50% Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series J, par value $0.01 per share (Series J Preferred Stock), out of a total of 46,000 shares of Series J Preferred Stock authorized for issuance. Each share of Series J Preferred Stock issued and outstanding has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option beginning May 10, 2023, at a redemption price equal to $25,000 plus accrued and unpaid dividends. Dividends on Series J Preferred Stock, if declared, will be payable quarterly at a fixed rate per annum of 5.50% from the issuance date to, but excluding, May 10, 2023, and thereafter at a rate per annum equal to three-month LIBOR plus 3.64%.

 

 

80   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents preferred dividends declared on preferred stock.

 

 

    Three Months Ended March  
    2013          2012  
      per share           in millions             per share           in millions   

Series A

    $234.38           $  7           $239.58           $  7   
   

Series B

    387.50           12           387.50           12   
   

Series C

    250.00           2           255.56           2   
   

Series D

    250.00           14           255.56           14   
   

Series E

    977.78           17                       
   

Series F

    977.78           5                       
   

Series I

    437.99           15                         

Total

               $72                        $35   

Accumulated Other Comprehensive Income/(Loss)

The tables below present accumulated other comprehensive income/(loss) by type.

 

 

    As of March 2013  
in millions    
 
 
 
Currency
translation
adjustment,
net of tax
  
  
  
  
      
 

 
 

Pension and
postretirement

liability adjustments,
net of tax

  
  

  
  

      
 
 
 
Net unrealized
gains/(losses) on
available-for-sale
securities, net of tax
  
  
  
  
      
 
 

 

Accumulated other
comprehensive
income/(loss),

net of tax

  
  
  

  

Balance, beginning of year

    $(314        $(206        $327           $(193
   

Other comprehensive income/(loss)

    (26        (4        15           (15

Balance, end of period

    $(340        $(210        $342  1         $(208
    As of December 2012  
in millions    
 
 
 
Currency
translation
adjustment,
net of tax
  
  
  
  
      
 

 
 

Pension and
postretirement

liability adjustments,
net of tax

  
  

  
  

      
 
 
 
Net unrealized
gains/(losses) on
available-for-sale
securities, net of tax
  
  
  
  
      
 
 

 

Accumulated other
comprehensive
income/(loss),

net of tax

  
  
  

  

Balance, beginning of year

    $(225        $(374        $  83           $(516
   

Other comprehensive income/(loss)

    (89        168           244           323   

Balance, end of year

    $(314        $(206        $327  1         $(193

 

1.

Substantially all consists of net unrealized gains on securities held by the firm’s insurance subsidiaries as of both March 2013 and December 2012.

 

    Goldman Sachs March 2013 Form 10-Q   81


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 20. Regulation and Capital Adequacy

Note 20.

Regulation and Capital Adequacy

 

The Federal Reserve Board is the primary regulator of Group Inc., a bank holding company under the Bank Holding Company Act of 1956 (BHC Act) and a financial holding company under amendments to the BHC Act effected by the U.S. Gramm-Leach-Bliley Act of 1999. As a bank holding company, the firm is subject to consolidated regulatory capital requirements that are computed in accordance with the Federal Reserve Board’s risk-based capital regulations (which are based on the ‘Basel 1’ Capital Accord of the Basel Committee) reflecting the Federal Reserve Board’s revised market risk regulatory capital requirements which became effective on January 1, 2013. These capital requirements are expressed as capital ratios that compare measures of capital to risk-weighted assets (RWAs). The firm’s U.S. bank depository institution subsidiaries, including GS Bank USA, are subject to similar capital requirements.

Under the Federal Reserve Board’s capital adequacy requirements and the regulatory framework for prompt corrective action that is applicable to GS Bank USA, the firm and its U.S. bank depository institution subsidiaries must meet specific capital requirements that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory reporting practices. The firm and its U.S. bank depository institution subsidiaries’ capital amounts, as well as GS Bank USA’s prompt corrective action classification, are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Many of the firm’s subsidiaries, including GS&Co. and the firm’s other broker-dealer subsidiaries, are subject to separate regulation and capital requirements as described below.

Group Inc.

Federal Reserve Board regulations require bank holding companies to maintain a minimum Tier 1 capital ratio of 4% and a minimum total capital ratio of 8%. The required minimum Tier 1 capital ratio and total capital ratio in order to be considered a “well-capitalized” bank holding company under the Federal Reserve Board guidelines are 6% and 10%, respectively. Bank holding companies may be expected to maintain ratios well above the minimum levels, depending on their particular condition, risk profile and growth plans. The minimum Tier 1 leverage ratio is 3% for bank holding companies that have received the highest supervisory rating under Federal Reserve Board guidelines

or that have implemented the Federal Reserve Board’s risk-based capital measure for market risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of 4%.

The table below presents information regarding Group Inc.’s regulatory capital ratios under Basel 1, as implemented by the Federal Reserve Board. The information as of March 2013 reflects the revised market risk regulatory capital requirements, which became effective on January 1, 2013. The information as of December 2012 is prior to the implementation of these revised market risk regulatory capital requirements.

 

 

    As of  
$ in millions    
 
March
2013
  
  
      

 

December

2012

  

  

Tier 1 capital

    $  69,371           $  66,977   
   

Tier 2 capital

    $  13,445           $  13,429   
   

Total capital

    $  82,816           $  80,406   
   

Risk-weighted assets

    $480,080           $399,928   
   

Tier 1 capital ratio

    14.4        16.7
   

Total capital ratio

    17.3        20.1
   

Tier 1 leverage ratio

    7.5        7.3

Changes to the market risk regulatory capital requirements referenced above introduced a new methodology for determining RWAs for market risk and are designed to implement the new market risk framework of the Basel Committee, as well as the prohibition on the use of external credit ratings, as required by the Dodd-Frank Act. These revised market risk regulatory capital requirements are a significant part of the regulatory capital changes that will ultimately be reflected in the firm’s capital ratios under the guidelines issued by the Basel Committee in December 2010 (Basel 3).

RWAs under the Federal Reserve Board’s risk-based capital requirements are calculated based on measures of credit risk and market risk. Credit risk for on-balance sheet assets is based on the balance sheet value. For off-balance sheet exposures, including OTC derivatives and commitments, a credit equivalent amount is calculated based on the notional amount of each trade. All such assets and exposures are then assigned a risk weight depending on, among other things, whether the counterparty is a sovereign, bank or a qualifying securities firm or other entity (or if collateral is held, depending on the nature of the collateral).

 

 

82   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Under Basel 1, prior to the implementation of the revised market risk regulatory capital requirements outlined above, RWAs for market risk were determined by reference to the firm’s Value-at-Risk (VaR) model, supplemented by the standardized measurement method used to determine RWAs for specific risk for certain positions. Under the Federal Reserve Board’s revised market risk regulatory capital requirements, which became effective on January 1, 2013, the methodology for calculating the RWAs for market risk was changed. RWAs for market risk are now determined using VaR, stressed VaR, incremental risk, comprehensive risk and a standardized measurement method for specific risk.

Tier 1 leverage ratio is defined as Tier 1 capital divided by average adjusted total assets (which includes adjustments for disallowed goodwill and intangible assets, and the carrying value of equity investments in non-financial companies that are subject to deductions from Tier 1 capital).

Regulatory Reform

The firm is currently working to implement the requirements set out in the Federal Reserve Board’s “Risk-Based Capital Standards: Advanced Capital Adequacy Framework — Basel 2” (Basel 2), as applicable to Group Inc. as a bank holding company and as an advanced approach banking organization. These requirements are based on the advanced approaches under the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee. Basel 2, among other things, revises the regulatory capital framework for credit risk and equity investments, and introduces a new operational risk capital requirement. The firm will implement Basel 2 once approved to do so by regulators following the completion of a parallel run period. Based on the parallel run calculations, the firm currently meets the minimum capital requirements calculated in accordance with Basel 2, including the revised market risk regulatory capital requirements. The firm’s capital adequacy ratio will also be impacted by the further changes outlined below under Basel 3 and provisions of the Dodd-Frank Act.

The “Collins Amendment” of the Dodd-Frank Act requires advanced approach banking organizations to continue, upon adoption of Basel 2, to calculate risk-based capital ratios under both Basel 2 and Basel 1 (in each case reflecting the Federal Reserve Board’s revised market risk regulatory

capital requirements). For each of the Tier 1 and Total capital ratios, the lower of the Basel 1 and Basel 2 ratios calculated will be used to determine whether such advanced approach banking organizations meet their minimum risk-based capital requirements. Furthermore, the June 2012 proposals described below include provisions which, if enacted as proposed, would modify these minimum risk-based capital requirements.

In June 2012, the U.S. federal bank regulatory agencies (Agencies) proposed further modifications to their capital adequacy regulations to address aspects of both the Dodd-Frank Act and Basel 3. If enacted as proposed, the most significant changes that would impact the firm include (i) revisions to the definition of Tier 1 capital, including new deductions from Tier 1 capital, (ii) higher minimum capital and leverage ratios, (iii) a new minimum ratio of Tier 1 common equity to RWAs, (iv) new capital conservation and counter-cyclical capital buffers, (v) an additional leverage ratio that includes measures of off-balance sheet exposures, (vi) revisions to the methodology for calculating RWAs, particularly for credit risk capital requirements for derivatives and (vii) a new “standardized approach” to the calculation of RWAs that would replace the Federal Reserve Board’s current Basel 1 risk-based capital framework in 2015, including for purposes of calculating the requisite capital floor under the Collins Amendment. In November 2012, the Agencies announced that the proposed effective date of January 1, 2013 for these modifications would be deferred, but have not indicated a revised effective date. These proposals incorporate the phase-out of Tier 1 capital treatment for the firm’s junior subordinated debt issued to trusts; such capital would instead be eligible as Tier 2 capital under the proposals. Under the Collins Amendment, this phase-out was scheduled to begin on January 1, 2013. Due to the aforementioned deferral of the effective date of the proposed capital rules, the required application of this phase-out remains uncertain at this time. However, beginning on January 1, 2013, the firm has begun the phase-out of the firm’s Tier 1 capital treatment of its junior subordinated debt issued to trusts. The firm has assumed a phase-out period allowing for only 75% of the capital instrument to be included in additional Tier 1 capital in calendar year 2013 reflecting the Federal Reserve Board’s proposed capital rules. Phased-out amounts that are no longer eligible as Tier 1 capital treatment are eligible for Tier 2 capital treatment.

 

 

    Goldman Sachs March 2013 Form 10-Q   83


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In November 2011, the Basel Committee published its final provisions for assessing the global systemic importance of banking institutions and the range of additional Tier 1 common equity that should be maintained by banking institutions deemed to be globally systemically important. The additional capital for these institutions would initially range from 1% to 2.5% of Tier 1 common equity and could be as much as 3.5% for a banking institution that increases its systemic footprint (e.g., by increasing total assets). In November 2012, the Financial Stability Board (established at the direction of the leaders of the Group of 20) indicated that the firm, based on its 2011 financial data, would be required to hold an additional 1.5% of Tier 1 common equity as a globally systemically important banking institution under the Basel Committee’s methodology. The final determination of the amount of additional Tier 1 common equity that the firm will be required to hold will be based on the firm’s 2013 financial data and the manner and timing of the U.S. banking regulators’ implementation of the Basel Committee’s methodology. The Basel Committee indicated that globally systemically important banking institutions will be required to meet the capital surcharges on a phased-in basis from 2016 through 2019.

In October 2012, the Basel Committee published its final provisions for calculating incremental capital requirements for domestic systemically important banking institutions. The provisions are complementary to the framework outlined above for global systemically important banking institutions, but are more principles-based in order to provide an appropriate degree of national discretion. The impact of these provisions on the regulatory capital requirements of GS Bank USA and the firm’s other subsidiaries, including Goldman Sachs International (GSI), will depend on how they are implemented by the banking and non-banking regulators in the United States and other jurisdictions.

The Basel Committee has released other consultation papers that may result in further changes to the regulatory capital requirements, including a “Fundamental review of the trading book” and “Revisions to the Basel Securitization Framework.” In addition, the Basel Committee has issued other proposals on regulatory changes including a “Supervisory framework for measuring and controlling large exposures.” The full impact of these developments on the firm will not be known with certainty until after any resulting rules are finalized.

The Dodd-Frank Act contains provisions that require the registration of all swap dealers, major swap participants, security-based swap dealers and major security-based swap participants. The firm has registered certain subsidiaries as “swap dealers” under the U.S. Commodity Futures Trading Commission (CFTC) rules, including GS&Co., GS Bank USA, GSI and J. Aron & Company. These entities and other entities that would require registration under the CFTC or SEC rules will be subject to regulatory capital requirements, which have not yet been finalized by the CFTC and SEC.

The interaction among the Dodd-Frank Act, other reform initiatives contemplated by the Agencies, the Basel Committee’s proposed and announced changes and other proposed or announced changes from other governmental entities and regulators (including the European Union (EU) and the U.K.’s Financial Services Authority (FSA)) adds further uncertainty to the firm’s future capital and liquidity requirements and those of the firm’s subsidiaries. The EU has recently finalized legislation which implements Basel 3 and it is expected to be in force for the European Union on January 1, 2014. As of April 1, 2013, GSI is regulated by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) which replaced the FSA.

 

 

84   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Bank Subsidiaries

GS Bank USA, an FDIC-insured, New York State-chartered bank and a member of the Federal Reserve System, is supervised and regulated by the Federal Reserve Board, the FDIC, the New York State Department of Financial Services and the Consumer Financial Protection Bureau, and is subject to minimum capital requirements (described below) that are calculated in a manner similar to those applicable to bank holding companies. GS Bank USA computes its capital ratios in accordance with the regulatory capital requirements currently applicable to state member banks, which are based on Basel 1 reflecting the revised market risk regulatory capital requirements as implemented by the Federal Reserve Board, for purposes of assessing the adequacy of its capital. Under the regulatory framework for prompt corrective action that is applicable to GS Bank USA, in order to be considered a “well-capitalized” depository institution, GS Bank USA must maintain a Tier 1 capital ratio of at least 6%, a total capital ratio of at least 10% and a Tier 1 leverage ratio of at least 5%. GS Bank USA has agreed with the Federal Reserve Board to maintain minimum capital ratios in excess of these “well-capitalized” levels. Accordingly, for a period of time, GS Bank USA is expected to maintain a Tier 1 capital ratio of at least 8%, a total capital ratio of at least 11% and a Tier 1 leverage ratio of at least 6%. As noted in the table below, GS Bank USA was in compliance with these minimum capital requirements as of March 2013 and December 2012.

The table below presents information regarding GS Bank USA’s regulatory capital ratios under Basel 1, as implemented by the Federal Reserve Board. The information as of March 2013 reflects the revised market risk regulatory capital requirements, which became effective on January 1, 2013. These changes resulted in increased regulatory capital requirements for market risk. The information as of December 2012 is prior to the implementation of these revised market risk regulatory capital requirements.

 

 

    As of  
$ in millions    
 
March
2013
  
  
      

 

December

2012

  

  

Tier 1 capital 1

    $  19,089           $  20,704   
   

Tier 2 capital

    $         56           $         39   
   

Total capital

    $  19,145           $  20,743   
   

Risk-weighted assets

    $120,010           $109,669   
   

Tier 1 capital ratio

    15.9        18.9
   

Total capital ratio

    16.0        18.9
   

Tier 1 leverage ratio

    16.1        17.6

 

1.

The decrease from December 2012 to March 2013 is related to GS Bank USA’s $2.00 billion dividend to Group Inc. in the first quarter of 2013.

GS Bank USA is also currently working to implement the Basel 2 framework, as implemented by the Federal Reserve Board. GS Bank USA will implement Basel 2 once approved to do so by regulators following the completion of a parallel run period. Based on the parallel run calculations, GS Bank USA currently meets the minimum capital requirements calculated in accordance with Basel 2, including the revised market risk regulatory requirements.

In addition, the capital requirements for GS Bank USA are expected to be impacted by the June 2012 proposed modifications to the Agencies’ capital adequacy regulations outlined above, including the requirements of a floor to the advanced risk-based capital ratios. If enacted as proposed, these proposals would also change the regulatory framework for prompt corrective action that is applicable to GS Bank USA by, among other things, introducing a common equity Tier 1 ratio requirement, increasing the minimum Tier 1 capital ratio requirement and introducing a supplementary leverage ratio as a component of the prompt corrective action analysis. GS Bank USA will also be impacted by aspects of the Dodd-Frank Act, including new stress tests.

The deposits of GS Bank USA are insured by the FDIC to the extent provided by law. The Federal Reserve Board requires depository institutions to maintain cash reserves with a Federal Reserve Bank. The amount deposited by the firm’s depository institution held at the Federal Reserve Bank was approximately $49.64 billion and $58.67 billion as of March 2013 and December 2012, respectively, which exceeded required reserve amounts by $49.54 billion and $58.59 billion as of March 2013 and December 2012, respectively.

Transactions between GS Bank USA and its subsidiaries and Group Inc. and its subsidiaries and affiliates (other than, generally, subsidiaries of GS Bank USA) are regulated by the Federal Reserve Board. These regulations generally limit the types and amounts of transactions (including credit extensions from GS Bank USA) that may take place and generally require those transactions to be on market terms or better to GS Bank USA.

The firm’s principal non-U.S. bank subsidiary, GSIB, is a wholly-owned credit institution, which was regulated by the FSA through March 2013, and is subject to minimum capital requirements. As of April 1, 2013, GSIB is regulated by the PRA and the FCA, which replaced the FSA. As of March 2013 and December 2012, GSIB was in compliance with all regulatory capital requirements.

 

 

    Goldman Sachs March 2013 Form 10-Q   85


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Broker-Dealer Subsidiaries

The firm’s U.S. regulated broker-dealer subsidiaries include GS&Co. and GSEC. GS&Co. and GSEC are registered U.S. broker-dealers and futures commission merchants, and are subject to regulatory capital requirements, including those imposed by the SEC, the CFTC, Chicago Mercantile Exchange, the Financial Industry Regulatory Authority, Inc. (FINRA) and the National Futures Association. Rule 15c3-1 of the SEC and Rule 1.17 of the CFTC specify uniform minimum net capital requirements, as defined, for their registrants, and also effectively require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1.

As of March 2013 and December 2012, GS&Co. had regulatory net capital, as defined by Rule 15c3-1, of $14.80 billion and $14.12 billion, respectively, which exceeded the amount required by $12.85 billion and $12.42 billion, respectively. As of March 2013 and December 2012, GSEC had regulatory net capital, as defined by Rule 15c3-1, of $2.05 billion and $2.02 billion, respectively, which exceeded the amount required by $1.94 billion and $1.92 billion, respectively.

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 March 2013 and December 2012, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements.

Insurance Subsidiaries

The firm has U.S. insurance subsidiaries that are subject to state insurance regulation and oversight in the states in which they are domiciled and in the other states in which they are licensed. In addition, certain of the firm’s insurance subsidiaries outside of the U.S. were regulated by the FSA through March 2013. As of April 1, 2013, such entities are regulated by the PRA and the FCA, which replaced the FSA. Additionally, certain other non-U.S. insurance subsidiaries are regulated by the Bermuda Monetary Authority. The firm’s insurance subsidiaries were in compliance with all regulatory capital requirements as of March 2013 and December 2012.

Other Non-U.S. Regulated Subsidiaries

The firm’s principal non-U.S. regulated subsidiaries include GSI and Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, the firm’s regulated U.K. broker-dealer, was subject to the capital requirements imposed by the FSA through March 2013. As of April 1, 2013, GSI is regulated by the PRA and the FCA, which replaced the FSA. GSJCL, the firm’s regulated Japanese broker-dealer, is subject to the capital requirements imposed by Japan’s Financial Services Agency. As of March 2013 and December 2012, GSI and GSJCL were in compliance with their local capital adequacy requirements. Certain other non-U.S. subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of March 2013 and December 2012, these subsidiaries were in compliance with their local capital adequacy requirements.

Restrictions on Payments

The regulatory requirements referred to above restrict Group Inc.’s ability to withdraw capital from its regulated subsidiaries. As of March 2013 and December 2012, Group Inc. was required to maintain approximately $30.48 billion and $31.01 billion, respectively, of minimum equity capital in these regulated subsidiaries. This minimum equity capital requirement includes certain restrictions imposed by federal and state laws as to the payment of dividends to Group Inc. by its regulated subsidiaries. In addition to limitations on the payment of dividends imposed by federal and state laws, the Federal Reserve Board, the FDIC and the New York State Department of Financial Services have authority to prohibit or to limit the payment of dividends by the banking organizations they supervise (including GS Bank USA) if, in the relevant regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in the light of the financial condition of the banking organization.

 

 

86   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 21. Earnings Per Common Share

Note 21.

Earnings Per Common Share

 

Basic earnings per common share (EPS) is calculated by dividing net earnings applicable to common shareholders by the weighted average number of common shares outstanding. Common shares outstanding includes common stock and RSUs for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of

basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable for stock warrants and options and for RSUs for which future service is required as a condition to the delivery of the underlying common stock.

The table below presents the computations of basic and diluted EPS.

 

 

 

   

Three Months

Ended March

 
in millions, except per share amounts     2013           2012   

Numerator for basic and diluted EPS — net earnings applicable to common shareholders

    $2,188           $2,074   

 

Denominator for basic EPS — weighted average number of common shares

    482.1           510.8   
   

Effect of dilutive securities:

      

RSUs

    6.1           9.2   
   

Stock options and warrants

    21.6           9.2   

Dilutive potential common shares

    27.7           18.4   

Denominator for diluted EPS — weighted average number of common shares and dilutive
potential common shares

    509.8           529.2   

 

Basic EPS

    $  4.53           $  4.05   
   

Diluted EPS

    4.29           3.92   

 

In the table above, unvested share-based payment awards that have non-forfeitable rights to dividends or dividend equivalents are treated as a separate class of securities in calculating EPS. The impact of applying this methodology

was a reduction in basic EPS of $0.01 for both the three months ended March 2013 and March 2012.

The diluted EPS computations in the table above do not include the following:

 

 

 

   

Three Months

Ended March

 
in millions     2013           2012   

Number of antidilutive RSUs and common shares underlying antidilutive stock options and warrants

    6.1           52.5   

 

    Goldman Sachs March 2013 Form 10-Q   87


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 22. Transactions with Affiliated Funds

Note 22.

Transactions with Affiliated Funds

 

The firm has formed numerous nonconsolidated investment funds with third-party investors. As the firm generally acts as the investment manager for these funds, it is entitled to receive management fees and, in certain cases, advisory fees or incentive fees from these funds. Additionally, the firm invests alongside the third-party investors in certain funds.

The tables below present fees earned from affiliated funds, fees receivable from affiliated funds and the aggregate carrying value of the firm’s interests in affiliated funds.

 

 

   

Three Months

Ended March

 
in millions     2013           2012   

Fees earned from affiliated funds

    $     700           $     594   
   

As of

 
in millions    

 

March

2013

  

  

      

 

December

2012

  

  

Fees receivable from funds

    $     569           $     704   
   

Aggregate carrying value of
interests in funds

    14,114           14,725   

As of March 2013 and December 2012, the firm had outstanding loans and guarantees to certain of its funds of $89 million and $582 million, respectively, which are collateralized by certain fund assets. These amounts relate primarily to certain real estate funds for which the firm voluntarily provided financial support to alleviate liquidity constraints during the financial crisis and, more recently, to enable them to fund investment opportunities. As of March 2013 and December 2012, the firm had no outstanding commitments to extend credit to these funds.

The Volcker Rule, as currently drafted, would restrict the firm from providing additional voluntary financial support to these funds after July 2014 (subject to extension by the Federal Reserve Board). As a general matter, in the ordinary course of business, the firm does not expect to provide additional voluntary financial support to these funds; however, in the event that such support is provided, the amount of any such support is not expected to be material. In addition, in the ordinary course of business, the firm may also engage in other activities with these funds including, among others, securities lending, trade execution, market making, custody, and acquisition and bridge financing. See Note 18 for the firm’s investment commitments related to these funds.

 

 

88   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 23. Interest Income and Interest Expense

Note 23.

Interest Income and Interest Expense

 

Interest income is recorded on an accrual basis based on contractual interest rates. The table below presents the

sources of interest income and interest expense.

 

 

 

   

Three Months

Ended March

 
in millions     2013           2012   

Interest income

      

Deposits with banks

    $     48           $     38   
   

Securities borrowed, securities purchased under agreements to resell and federal funds sold 1

    (24        (14
   

Financial instruments owned, at fair value

    2,238           2,442   
   

Other interest 2

    346           367   

Total interest income

    2,608           2,833   

Interest expense

      

Deposits

    93           91   
   

Securities loaned and securities sold under agreements to repurchase

    164           211   
   

Financial instruments sold, but not yet purchased, at fair value

    511           525   
   

Short-term borrowings 3

    106           168   
   

Long-term borrowings 3

    910           1,009   
   

Other interest 4

    (101        (152

Total interest expense

    1,683           1,852   

Net interest income

    $   925           $   981   

 

1.

Includes rebates paid and interest income on securities borrowed.

 

2.

Includes interest income on customer debit balances and other interest-earning assets.

 

3.

Includes interest on unsecured borrowings and other secured financings.

 

4.

Includes rebates received on other interest-bearing liabilities and interest expense on customer credit balances.

 

 

Note 24. Income Taxes

Note 24.

Income Taxes

 

Provision for Income Taxes

Income taxes are provided for using the asset and liability method under which deferred tax assets and liabilities are recognized for temporary differences between the financial reporting and tax bases of assets and liabilities. The firm reports interest expense related to income tax matters in “Provision for taxes” and income tax penalties in “Other expenses.”

Deferred Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities. These temporary differences result in taxable or deductible amounts in future years and are measured using the tax rates and laws that will be in effect when such differences are expected to

reverse. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. Tax assets and liabilities are presented as a component of “Other assets” and “Other liabilities and accrued expenses,” respectively.

Unrecognized Tax Benefits

The firm recognizes tax positions in the financial statements only when it is more likely than not that the position will be sustained on examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized on settlement. A liability is established for differences between positions taken in a tax return and amounts recognized in the financial statements.

 

 

    Goldman Sachs March 2013 Form 10-Q   89


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Regulatory Tax Examinations

The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. The firm believes that during 2013, certain audits have a reasonable possibility of being completed. The firm does not expect completion of these audits to have a material impact on the firm’s financial condition but it may be material to operating results for a particular period, depending, in part, on the operating results for that period.

The table below presents the earliest tax years that remain subject to examination by major jurisdiction.

 

 

Jurisdiction    

 

As of

March 2013

  

  

U.S. Federal 1

    2005   
   

New York State and City 2

    2004   
   

United Kingdom

    2007   
   

Japan 3

    2008   
   

Hong Kong

    2005   
   

Korea

    2008   

 

1.

IRS examination of fiscal 2008 through calendar 2010 began in 2011. IRS examination of fiscal 2005, 2006 and 2007 began in 2008. IRS examination of fiscal 2003 and 2004 has been completed, but the liabilities for those years are not yet final. The firm anticipates that the audits of fiscal 2005 through calendar 2010 should be completed in 2013. The audit of 2011 began in 2013 and the audit of 2012 is expected to begin in 2013.

 

2.

New York State and City examination of fiscal 2004, 2005 and 2006 began in 2008. The examination of fiscal 2007 through 2010 began in 2013.

 

3.

Japan National Tax Agency examination of fiscal 2005 through 2009 began in 2010. The examinations have been completed, but the liabilities for 2008 and 2009 are not yet final.

All years subsequent to the above remain open to examination by the taxing authorities. The firm believes that the liability for unrecognized tax benefits it has established is adequate in relation to the potential for additional assessments.

In January 2013, the firm was accepted into the Compliance Assurance Process program by the IRS. This program will allow the firm to work with the IRS to identify and resolve potential U.S. federal tax issues before the filing of tax returns. The 2013 tax year will be the first year examined under the program.

 

Note 25. Business Segments

Note 25.

Business Segments

The firm reports its activities in the following four business segments: Investment Banking, Institutional Client Services, Investing & Lending and Investment Management.

Basis of Presentation

In reporting segments, certain of the firm’s business lines have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate.

The cost drivers of the firm taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of the firm’s business segments. Compensation and benefits expenses in the firm’s segments reflect, among other factors, the overall performance of the firm as well as the performance of individual businesses. Consequently, pre-tax margins in one segment of the firm’s business may be significantly affected by the performance of the firm’s other business segments.

The firm allocates assets (including allocations of excess liquidity and cash, secured client financing and other assets), revenues and expenses among the four reportable business segments. Due to the integrated nature of these segments, estimates and judgments are made in allocating certain assets, revenues and expenses. The allocation process is based on the manner in which management currently views the performance of the segments. Transactions between segments are based on specific criteria or approximate third-party rates. Total operating expenses include corporate items that have not been allocated to individual business segments.

 

 

90   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The segment information presented in the table below is prepared according to the following methodologies:

 

Ÿ  

Revenues and expenses directly associated with each segment are included in determining pre-tax earnings.

 

Ÿ  

Net revenues in the firm’s 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. Net interest is included in segment

   

net revenues as it is consistent with the way in which management assesses segment performance.

 

Ÿ  

Overhead expenses not directly allocable to specific segments are allocated ratably based on direct segment expenses.

Management believes that the following information provides a reasonable representation of each segment’s contribution to consolidated pre-tax earnings and total assets.

 

 

 

          

For the Three Months Ended

or as of March

 
in millions            2013           2012   

Investment Banking

    

Net revenues

    $    1,568           $    1,154   
   
      

Operating expenses

    1,064           871   
      

Pre-tax earnings

    $       504           $       283   
      

Segment assets

    $    1,873           $    1,944   

 

Institutional Client Services

    

Net revenues 1

    $    5,139           $    5,709   
   
      

Operating expenses

    3,566           3,938   
      

Pre-tax earnings

    $    1,573           $    1,771   
      

Segment assets

    $848,375           $842,587   

 

Investing & Lending

    

Net revenues

    $    2,068           $    1,911   
   
      

Operating expenses

    996           958   
      

Pre-tax earnings

    $    1,072           $       953   
      

Segment assets

    $  97,303           $  94,457   

 

Investment Management

    

Net revenues

    $    1,315           $    1,175   
   
      

Operating expenses

    1,090           989   
      

Pre-tax earnings

    $       225           $       186   
      

Segment assets

    $  11,672           $  11,944   

 

Total

    

Net revenues

    $  10,090           $    9,949   
   
      

Operating expenses

    6,717           6,768   
      

Pre-tax earnings

    $    3,373           $    3,181   
      

Total assets

    $959,223           $950,932   

 

1.

Includes $40 million and $29 million for the three months ended March 2013 and March 2012, respectively, of realized gains on available-for-sale securities held in the firm’s reinsurance subsidiaries.

 

Total operating expenses in the table above include the following expenses that have not been allocated to the firm’s segments:

 

Ÿ  

charitable contributions of $12 million for the three months ended March 2012; and

 

Ÿ  

real estate-related exit costs of $1 million for the three months ended March 2013. Real estate-related exit costs are included in “Depreciation and amortization” in the condensed consolidated statements of earnings.

Operating expenses related to net provisions for litigation and regulatory proceedings, previously not allocated to the firm’s segments, have now been allocated. This allocation is consistent with the manner in which management currently views the performance of the firm’s segments. Reclassifications have been made to previously reported segment amounts to conform to the current presentation.

 

 

    Goldman Sachs March 2013 Form 10-Q   91


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The tables below present the amounts of net interest income or interest expense included in net revenues, and the amounts of depreciation and amortization expense included in pre-tax earnings.

 

 

   

Three Months

Ended March

 
in millions     2013         2012   

Investment Banking

    $  —         $   (6
   

Institutional Client Services

    909         971   
   

Investing & Lending

    (13      (27
   

Investment Management

    29         43   

Total net interest income

    $925         $981   
   

Three Months

Ended March

 
in millions     2013         2012   

Investment Banking

    $  33         $  42   
   

Institutional Client Services

    152         166   
   

Investing & Lending

    75         183   
   

Investment Management

    41         42   

Total depreciation and amortization 1

    $302         $433   

 

1.

Includes real estate-related exit costs of $1 million for the three months ended March 2013 that have not been allocated to the firm’s segments.

Geographic Information

Due to the highly integrated nature of international financial markets, the firm manages its businesses based on the profitability of the enterprise as a whole. The methodology for allocating profitability to geographic regions is dependent on estimates and management judgment because a significant portion of the firm’s activities require cross-border coordination in order to facilitate the needs of the firm’s clients.

Geographic results are generally allocated as follows:

 

Ÿ  

Investment Banking: location of the client and investment banking team.

 

Ÿ  

Institutional Client Services: Fixed Income, Currency and Commodities Client Execution, and Equities (excluding Securities Services): location of the market-making desk; Securities Services: location of the primary market for the underlying security.

 

Ÿ  

Investing & Lending: Investing: location of the investment; Lending: location of the client.

 

Ÿ  

Investment Management: location of the sales team.

 

 

92   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the total net revenues and pre-tax earnings of the firm by geographic region allocated based on the methodology referred to above, as well as the

percentage of total net revenues and pre-tax earnings (excluding Corporate) for each geographic region.

 

 

 

    Three Months Ended March  
$ in millions           2013               2012   

Net revenues

          

Americas 1

    $  6,005         60      $5,787         58
   

EMEA 2

    2,421         24         2,708         27   
   

Asia 3

    1,664         16         1,454         15   

Total net revenues

    $10,090         100      $9,949         100

Pre-tax earnings

          

Americas 1

    $  1,851         55      $1,668         52
   

EMEA 2

    907         27         1,062         33   
   

Asia 3

    616         18         463         15   

Subtotal

    3,374         100      3,193         100
   

Corporate 4

    (1               (12         

Total pre-tax earnings

    $  3,373                  $3,181            

 

1.

Substantially all relates to the U.S.

 

2.

EMEA (Europe, Middle East and Africa).

 

3.

Asia also includes Australia and New Zealand.

 

4.

Consists of real estate-related exit costs of $1 million for the three months ended March 2013, and charitable contributions of $12 million for the three months ended March 2012. Net provisions for litigation and regulatory proceedings, previously included in Corporate, have now been allocated to the geographic regions. Reclassifications have been made to previously reported geographic region amounts to conform to the current presentation.

 

    Goldman Sachs March 2013 Form 10-Q   93


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 26. Credit Concentrations

Note 26.

Credit Concentrations

 

Credit concentrations may arise from market making, client facilitation, investing, underwriting, lending and collateralized transactions and may be impacted by changes in economic, industry or political factors. The firm seeks to mitigate credit risk by actively monitoring exposures and obtaining collateral from counterparties as deemed appropriate.

While the firm’s activities expose it to many different industries and counterparties, the firm routinely executes a high volume of transactions with asset managers, investment funds, commercial banks, brokers and dealers, clearing houses and exchanges, which results in significant credit concentrations.

In the ordinary course of business, the firm may also be subject to a concentration of credit risk to a particular counterparty, borrower or issuer, including sovereign issuers, or to a particular clearing house or exchange.

The table below presents the credit concentrations in cash instruments held by the firm. As of March 2013 and December 2012, the firm did not have credit exposure to any other counterparty that exceeded 2% of total assets.

 

 

    As of  
$ in millions    

 

March

2013

  

  

    

 

December

2012

  

  

U.S. government and federal agency obligations 1

    $114,268         $114,418   
   

% of total assets

    11.9      12.2
   

Non-U.S. government and agency obligations 1

    $  57,666         $  62,252   
   

% of total assets

    6.0      6.6

 

1.

Substantially all included in “Financial instruments owned, at fair value” and “Cash and securities segregated for regulatory and other purposes.”

To reduce credit exposures, the firm may enter into agreements with counterparties that permit the firm to offset receivables and payables with such counterparties and/or enable the firm to obtain collateral on an upfront or contingent basis. Collateral obtained by the firm related to derivative assets is principally cash and is held by the firm or a third-party custodian. Collateral obtained by the firm related to resale agreements and securities borrowed transactions is primarily U.S. government and federal agency obligations and non-U.S. government and agency obligations. See Note 9 for further information about collateralized agreements and financings.

The table below presents U.S. government and federal agency obligations, and non-U.S. government and agency obligations, that collateralize resale agreements and securities borrowed transactions (including those in “Cash and securities segregated for regulatory and other purposes”). Because the firm’s primary credit exposure on such transactions is to the counterparty to the transaction, the firm would be exposed to the collateral issuer only in the event of counterparty default.

 

 

    As of  
in millions    

 

March

2013

  

  

      

 

December

2012

  

  

U.S. government and federal
agency obligations

    $75,935           $73,477   
   

Non-U.S. government and
agency obligations 1

    98,908           64,724   

 

1.

Principally consisting of securities issued by the governments of Germany and France.

 

 

94   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

 

Note 27. Legal Proceedings

Note 27.

Legal Proceedings

 

The firm is involved in a number of judicial, regulatory and arbitration proceedings (including those described below) concerning matters arising in connection with the conduct of the firm’s businesses. Many of these proceedings are in early stages, and many of these cases seek an indeterminate amount of damages.

Under ASC 450, an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote” if “the chance of the future event or events occurring is slight.” Thus, references to the upper end of the range of reasonably possible loss for cases in which the firm is able to estimate a range of reasonably possible loss mean the upper end of the range of loss for cases for which the firm believes the risk of loss is more than slight.

With respect to proceedings described below for which management has been able to estimate a range of reasonably possible loss where (i) plaintiffs have claimed an amount of money damages, (ii) the firm is being sued by purchasers in an underwriting and is not being indemnified by a party that the firm believes will pay any judgment, or (iii) the purchasers are demanding that the firm repurchase securities, management has estimated the upper end of the range of reasonably possible loss as being equal to (a) in the case of (i), the amount of money damages claimed, (b) in the case of (ii), the amount of securities that the firm sold in the underwritings and (c) in the case of (iii), the price that purchasers paid for the securities less the estimated value, if any, as of March 2013 of the relevant securities, in each of cases (i), (ii) and (iii), taking into account any factors believed to be relevant to the particular proceeding or proceedings of that type. As of the date hereof, the firm has estimated the upper end of the range of reasonably possible aggregate loss for such proceedings and for any other proceedings described below where management has been able to estimate a range of reasonably possible aggregate loss to be approximately $3.5 billion in excess of the aggregate reserves for such proceedings.

Management is generally unable to estimate a range of reasonably possible loss for proceedings other than those included in the estimate above, including where (i) plaintiffs have not claimed an amount of money damages, unless management can otherwise determine an appropriate

amount, (ii) the proceedings are in early stages, (iii) there is uncertainty as to the likelihood of a class being certified or the ultimate size of the class, (iv) there is uncertainty as to the outcome of pending appeals or motions, (v) there are significant factual issues to be resolved, and/or (vi) there are novel legal issues presented. However, for these cases, management does not believe, based on currently available information, that the outcomes of such proceedings will have a material adverse effect on the firm’s financial condition, though the outcomes could be material to the firm’s operating results for any particular period, depending, in part, upon the operating results for such period.

IPO Process Matters. Group Inc. and GS&Co. are among the numerous financial services companies that have been named as defendants in a variety of lawsuits alleging improprieties in the process by which those companies participated in the underwriting of public offerings.

GS&Co. has been named as a defendant in an action commenced on May 15, 2002 in New York Supreme Court, New York County, by an official committee of unsecured creditors on behalf of eToys, Inc., alleging that the firm intentionally underpriced eToys, Inc.’s initial public offering. The action seeks, among other things, unspecified compensatory damages resulting from the alleged lower amount of offering proceeds. On appeal from rulings on GS&Co.’s motion to dismiss, the New York Court of Appeals dismissed claims for breach of contract, professional malpractice and unjust enrichment, but permitted claims for breach of fiduciary duty and fraud to continue. On remand, the lower court granted GS&Co.’s motion for summary judgment and, on December 8, 2011, the appellate court affirmed the lower court’s decision. On September 6, 2012, the New York Court of Appeals granted the creditors’ motion for leave to appeal.

Group Inc. and certain of its affiliates have, together with various underwriters in certain offerings, received subpoenas and requests for documents and information from various governmental agencies and self-regulatory organizations in connection with investigations relating to the public offering process. Goldman Sachs has cooperated with these investigations.

 

 

    Goldman Sachs March 2013 Form 10-Q   95


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World Online Litigation. In March 2001, a Dutch shareholders’ association initiated legal proceedings for an unspecified amount of damages against GSI and others in Amsterdam District Court in connection with the initial public offering of World Online in March 2000, alleging misstatements and omissions in the offering materials and that the market was artificially inflated by improper public statements and stabilization activities. Goldman Sachs and ABN AMRO Rothschild served as joint global coordinators of the approximately €2.9 billion offering. GSI underwrote 20,268,846 shares and GS&Co. underwrote 6,756,282 shares for a total offering price of approximately €1.16 billion.

The district court rejected the claims against GSI and ABN AMRO, but found World Online liable in an amount to be determined. On appeal, the Netherlands Court of Appeals affirmed in part and reversed in part the decision of the district court, holding that certain of the alleged disclosure deficiencies were actionable as to GSI and ABN AMRO. On further appeal, the Netherlands Supreme Court affirmed the rulings of the Court of Appeals, except that it found certain additional aspects of the offering materials actionable and held that individual investors could potentially hold GSI and ABN AMRO responsible for certain public statements and press releases by World Online and its former CEO. The parties entered into a definitive settlement agreement, dated July 15, 2011, and GSI has paid the full amount of its contribution. In the first quarter of 2012, GSI and ABN AMRO, on behalf of the underwriting syndicate, entered into a settlement agreement with respect to a claim filed by another shareholders’ association, and has paid the settlement amount in full. Other shareholders have made demands for compensation of alleged damages, and GSI and other syndicate members are discussing the possibility of settlement with certain of these shareholders.

Adelphia Communications Fraudulent Conveyance Litigation. GS&Co. is named as a defendant in two proceedings commenced in the U.S. Bankruptcy Court for the Southern District of New York, one on July 6, 2003 by a creditors committee, and the second on or about July 31, 2003 by an equity committee of Adelphia Communications, Inc. Those proceedings were consolidated in a single amended complaint filed by the Adelphia Recovery Trust on October 31, 2007. The complaint seeks, among other things, to recover, as fraudulent conveyances, approximately $62.9 million allegedly paid to GS&Co. by Adelphia Communications, Inc. and its affiliates in respect of margin calls made in the ordinary course of business on accounts owned by members of the family that formerly controlled Adelphia Communications, Inc. The district court assumed jurisdiction over the action and, on April 8, 2011, granted GS&Co.’s motion for summary judgment. The plaintiff appealed on May 6, 2011.

Specialist Matters. Spear, Leeds & Kellogg Specialists LLC, Spear, Leeds & Kellogg, L.P. and Group Inc. are among numerous defendants named in purported class actions brought beginning in October 2003 on behalf of investors in the U.S. District Court for the Southern District of New York alleging violations of the federal securities laws and state common law in connection with NYSE floor specialist activities. On October 24, 2012, the parties entered into a definitive settlement agreement, subject to court approval. The firm has reserved the full amount of its proposed contribution to the settlement.

 

 

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Fannie Mae Litigation. GS&Co. was added as a defendant in an amended complaint filed on August 14, 2006 in a purported class action pending in the U.S. District Court for the District of Columbia. The complaint asserts violations of the federal securities laws generally arising from allegations concerning Fannie Mae’s accounting practices in connection with certain Fannie Mae-sponsored REMIC transactions that were allegedly arranged by GS&Co. The complaint does not specify a dollar amount of damages. The other defendants include Fannie Mae, certain of its past and present officers and directors, and accountants. By a decision dated May 8, 2007, the district court granted GS&Co.’s motion to dismiss the claim against it. The time for an appeal will not begin to run until disposition of the claims against other defendants. A motion to stay the action filed by the Federal Housing Finance Agency (FHFA), which took control of the foregoing action following Fannie Mae’s conservatorship, was denied on November 14, 2011.

Compensation-Related Litigation. On January 17, 2008, Group Inc., its Board, executive officers and members of its management committee were named as defendants in a purported shareholder derivative action in the U.S. District Court for the Eastern District of New York predicting that the firm’s 2008 Proxy Statement would violate the federal securities laws by undervaluing certain stock option awards and alleging that senior management received excessive compensation for 2007. The complaint seeks, among other things, an equitable accounting for the allegedly excessive compensation. Plaintiff’s motion for a preliminary injunction to prevent the 2008 Proxy Statement from using options valuations that the plaintiff alleges are incorrect and to require the amendment of SEC Forms 4 filed by certain of the executive officers named in the complaint to reflect the stock option valuations alleged by the plaintiff was denied, and plaintiff’s appeal from this denial was dismissed. On February 13, 2009, the plaintiff filed an amended complaint, which added purported direct (i.e., non-derivative) claims based on substantially the same theory. The plaintiff filed a further amended complaint on March 24, 2010, and the defendants’ motion to dismiss this further amended complaint was granted on the ground that dismissal of the shareholder plaintiff’s prior action relating to the firm’s 2007 Proxy Statement based on the failure to make a demand to

the Board precluded relitigation of demand futility. On December 19, 2011, the appellate court vacated the order of dismissal, holding only that preclusion principles did not mandate dismissal and remanding for consideration of the alternative grounds for dismissal. On April 18, 2012, plaintiff disclosed that he no longer is a Group Inc. shareholder and thus lacks standing to continue to prosecute the action. On January 7, 2013, the district court dismissed the claim due to the plaintiff’s lack of standing and the lack of any intervening shareholder.

On March 24, 2009, the same plaintiff filed an action in New York Supreme Court, New York County, against Group Inc., its directors and certain senior executives alleging violation of Delaware statutory and common law in connection with substantively similar allegations regarding stock option awards. On January 4, 2013, another purported shareholder moved to intervene as plaintiff, which defendants have opposed. On January 15, 2013, the court dismissed the action only as to the original plaintiff with prejudice due to his lack of standing.

Mortgage-Related Matters. On April 16, 2010, the SEC brought an action (SEC Action) under the U.S. federal securities laws in the U.S. District Court for the Southern District of New York against GS&Co. and Fabrice Tourre, a former employee, in connection with a CDO offering made in early 2007 (ABACUS 2007-AC1 transaction), alleging that the defendants made materially false and misleading statements to investors and seeking, among other things, unspecified monetary penalties. Investigations of GS&Co. by FINRA and of GSI by the FSA were subsequently initiated and resolved, and Group Inc. and certain of its affiliates have received subpoenas and requests for information from other regulators, regarding CDO offerings, including the ABACUS 2007-AC1 transaction, and related matters. On July 14, 2010, GS&Co. entered into a consent agreement with the SEC, settling all claims made against GS&Co. in the SEC Action, pursuant to which GS&Co. paid $550 million of disgorgement and civil penalties, and which was approved by the U.S. District Court for the Southern District of New York on July 20, 2010.

 

 

    Goldman Sachs March 2013 Form 10-Q   97


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On January 6, 2011, ACA Financial Guaranty Corp. filed an action against GS&Co. in respect of the ABACUS 2007-AC1 transaction in New York Supreme Court, New York County. The complaint includes allegations of fraudulent inducement, fraudulent concealment and unjust enrichment and seeks at least $30 million in compensatory damages, at least $90 million in punitive damages and unspecified disgorgement. On April 25, 2011, the plaintiff filed an amended complaint and, on June 3, 2011, GS&Co. moved to dismiss the amended complaint. By a decision dated April 23, 2012, the court granted the motion to dismiss as to the unjust enrichment claim and denied the motion as to the other claims, and on May 29, 2012, GS&Co. appealed the decision to the extent that its motion was denied and filed counterclaims for breach of contract and fraudulent inducement, and third-party claims against ACA Management, LLC for breach of contract, unjust enrichment and indemnification. ACA Financial Guaranty Corp. and ACA Management, LLC moved to dismiss GS&Co.’s counterclaims and third-party claims on August 31, 2012. On January 31, 2013, ACA filed an amended complaint naming a third party to the ABACUS 2007-AC1 transaction as an additional defendant.

Beginning April 26, 2010, a number of purported securities law class actions have been filed in the U.S. District Court for the Southern District of New York challenging the adequacy of Group Inc.’s public disclosure of, among other things, the firm’s activities in the CDO market and the SEC investigation that led to the SEC Action. The purported class action complaints, which name as defendants Group Inc. and certain officers and employees of Group Inc. and its affiliates, have been consolidated, generally allege violations of Sections 10(b) and 20(a) of the Exchange Act and seek unspecified damages. Plaintiffs filed a consolidated amended complaint on July 25, 2011. On October 6, 2011, the defendants moved to dismiss, and by a decision dated June 21, 2012, the district court dismissed the claims based on Group Inc.’s not disclosing that it had received a “Wells” notice from the staff of the SEC related to the ABACUS 2007-AC1 transaction, but permitted the plaintiffs’ other claims to proceed.

On February 1, 2013, a putative shareholder derivative action was filed in the U.S. District Court for the Southern District of New York against Group Inc. and certain of its officers and directors in connection with mortgage-related activities during 2006 and 2007, including three CDO offerings. The derivative complaint, which is based on similar allegations to those at issue in the consolidated class action discussed above and purported shareholder derivative actions that were previously dismissed, includes allegations of breach of fiduciary duty, challenges the accuracy and adequacy of Group Inc.’s disclosure and seeks, among other things, declaratory relief, unspecified compensatory and punitive damages and restitution from the individual defendants and certain corporate governance reforms.

In June 2012, the Board received a demand from a shareholder that the Board investigate and take action relating to the firm’s mortgage-related activities and to stock sales by certain directors and executives of the firm. On February 15, 2013, this shareholder filed a putative shareholder derivative action in New York Supreme Court, New York County, against Group Inc. and certain current or former directors and employees, based on these activities and stock sales. The derivative complaint includes allegations of breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement and corporate waste, and seeks, among other things, unspecified monetary damages, disgorgement of profits and certain corporate governance and disclosure reforms.

 

 

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Since April 23, 2010, the Board has received other letters from shareholders demanding that the Board take action to address alleged misconduct by GS&Co., the Board and certain officers and employees of Group Inc. and its affiliates. These demands, which the Board has rejected, generally alleged misconduct in connection with the firm’s securitization practices, including the ABACUS 2007-AC1 transaction, the alleged failure by Group Inc. to adequately disclose the SEC investigation that led to the SEC Action, and Group Inc.’s 2009 compensation practices.

In addition, the Board has received books and records demands from several shareholders for materials relating to, among other subjects, the firm’s mortgage servicing and foreclosure activities, participation in federal programs providing assistance to financial institutions and homeowners, loan sales to Fannie Mae and Freddie Mac, mortgage-related activities and conflicts management.

GS&Co., Goldman Sachs Mortgage Company (GSMC) and GS Mortgage Securities Corp. (GSMSC) and three current or former Goldman Sachs employees are defendants in a putative class action commenced on December 11, 2008 in the U.S. District Court for the Southern District of New York brought on behalf of purchasers of various mortgage pass-through certificates and asset-backed certificates issued by various securitization trusts established by the firm and underwritten by GS&Co. in 2007. The complaint generally alleges that the registration statement and prospectus supplements for the certificates violated the federal securities laws, and seeks unspecified compensatory damages and rescission or rescissionary damages. Following dismissals of certain of the plaintiff’s claims under the initial and three amended complaints, on May 5, 2011, the court granted plaintiff’s motion for entry of a final judgment dismissing all its claims, thereby allowing plaintiff to appeal. The plaintiff appealed from the dismissal with respect to all 17 of the offerings included in its original complaint. By a decision dated September 6, 2012, the U.S. Court of Appeals for the Second Circuit affirmed the district court’s dismissal of plaintiff’s claims with respect to 10 of the offerings included

in plaintiff’s original complaint but vacated the dismissal and remanded the case to the district court with instructions to reinstate the plaintiff’s claims with respect to the other seven offerings. On March 18, 2013, the U.S. Supreme Court denied the defendants’ petition for certiorari from the Second Circuit decision. On October 31, 2012, the plaintiff served a fourth amended complaint relating to those seven offerings, plus seven additional offerings. On June 3, 2010, another investor (who had unsuccessfully sought to intervene in the action) filed a separate putative class action asserting substantively similar allegations relating to one of the offerings included in the initial plaintiff’s complaint. The district court twice granted defendants’ motions to dismiss this separate action, both times with leave to replead. On July 9, 2012, that separate plaintiff filed a second amended complaint, and the defendants moved to dismiss on September 21, 2012. On December 26, 2012, that separate plaintiff filed a motion to amend the second amended complaint to add claims with respect to two additional offerings included in the initial plaintiff’s complaint, which defendants have opposed. The securitization trusts issued, and GS&Co. underwrote, approximately $11 billion principal amount of certificates to all purchasers in the fourteen offerings at issue in the complaints.

On September 30, 2010, a putative class action was filed in the U.S. District Court for the Southern District of New York against GS&Co., Group Inc. and two former GS&Co. employees on behalf of investors in $821 million of notes issued in 2006 and 2007 by two synthetic CDOs (Hudson Mezzanine 2006-1 and 2006-2). The complaint, which was amended on February 4, 2011, asserts federal securities law and common law claims, and seeks unspecified compensatory, punitive and other damages. The defendants moved to dismiss on April 5, 2011, and the motion was granted as to plaintiff’s claim of market manipulation and denied as to the remainder of plaintiff’s claims by a decision dated March 21, 2012. On May 21, 2012, the defendants counterclaimed for breach of contract and fraud. On December 17, 2012, the plaintiff moved for class certification.

 

 

    Goldman Sachs March 2013 Form 10-Q   99


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GS&Co., GSMC and GSMSC are among the defendants in a lawsuit filed in August 2011 by CIFG Assurance of North America, Inc. (CIFG) in New York Supreme Court, New York County. The complaint alleges that CIFG was fraudulently induced to provide credit enhancement for a 2007 securitization sponsored by GSMC, and seeks, among other things, the repurchase of $24.7 million in aggregate principal amount of mortgages that CIFG had previously stated to be non-conforming, an accounting for any proceeds associated with mortgages discharged from the securitization and unspecified compensatory damages. On October 17, 2011, the Goldman Sachs defendants moved to dismiss. By a decision dated May 1, 2012, the court dismissed the fraud and accounting claims but denied the motion as to certain breach of contract claims that were also alleged. On June 6, 2012, the Goldman Sachs defendants filed counterclaims for breach of contract. In addition, the parties have each appealed the court’s May 1, 2012 decision to the extent adverse. By an order dated May 7, 2013, the appellate court reversed the dismissal of the fraud claim but otherwise affirmed the trial court’s May 1, 2012 decision.

In addition, on January 15, 2013, CIFG filed a complaint against GS&Co. in New York Supreme Court, New York County, alleging that GS&Co. falsely represented that a third party would independently select the collateral for a 2006 CDO. CIFG seeks unspecified compensatory and punitive damages, including claims for approximately $10 million in connection with its purchase of notes, which CIFG has agreed to refer to arbitration with FINRA, and claims for over $30 million for payments to discharge alleged liabilities arising from its issuance of a financial guaranty insurance policy guaranteeing payment on a credit default swap referencing the CDO, which CIFG has agreed to stay until the arbitration of the notes-related claims has concluded.

Various alleged purchasers of, and counterparties involved in transactions relating to, mortgage pass-through certificates, CDOs and other mortgage-related products (including certain Allstate affiliates, Aozora Bank, Ltd., Bank Hapoalim B.M., Basis Yield Alpha Fund (Master), Bayerische Landesbank, the Charles Schwab Corporation, Deutsche Zentral-Genossenschaftbank, the FDIC (as receiver for Guaranty Bank), the Federal Home Loan Banks of Boston, Chicago, Indianapolis and Seattle, the FHFA (as conservator for Fannie Mae and Freddie Mac), HSH Nordbank, IKB Deutsche Industriebank AG, Landesbank Baden-Württemberg, Joel I. Sher (Chapter 11 Trustee) on

behalf of TMST, Inc. (TMST), f/k/a Thornburg Mortgage, Inc. and certain TMST affiliates, John Hancock and related parties, Massachusetts Mutual Life Insurance Company, MoneyGram Payment Systems, Inc., National Australia Bank, the National Credit Union Administration, Phoenix Light SF Limited and related parties, Prudential Insurance Company of America and related parties, Royal Park Investments SA/NV, Sealink Funding Limited, The Union Central Life Insurance Company, Ameritas Life Insurance Corp., Acacia Life Insurance Company, Watertown Savings Bank, and The Western and Southern Life Insurance Co.) have filed complaints or summonses with notice in state and federal court or initiated arbitration proceedings against firm affiliates, generally alleging that the offering documents for the securities that they purchased contained untrue statements of material fact and material omissions and generally seeking rescission and/or damages. Certain of these complaints allege fraud and seek punitive damages. Certain of these complaints also name other firms as defendants.

A number of other entities (including American International Group, Inc. (AIG), Deutsche Bank National Trust Company, John Hancock and related parties, M&T Bank, Norges Bank Investment Management, Selective Insurance Company and U.S. Bank) have threatened to assert claims of various types against the firm in connection with various mortgage-related transactions, and the firm has entered into agreements with a number of these entities to toll the relevant statute of limitations.

As of the date hereof, the aggregate notional amount of mortgage-related securities sold to plaintiffs in active cases brought against the firm where those plaintiffs are seeking rescission of such securities was approximately $19.7 billion (which does not reflect adjustment for any subsequent paydowns or distributions or any residual value of such securities, statutory interest or any other adjustments that may be claimed). This amount does not include the threatened claims noted above, potential claims by these or other purchasers in the same or other mortgage-related offerings that have not actually been brought against the firm, or claims that have been dismissed.

Group Inc. and GS Bank USA have entered into a Consent Order and a settlement with the Federal Reserve Board relating to the servicing of residential mortgage loans and foreclosure practices. See Note 18 for information about this settlement.

 

 

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Group Inc., GS&Co. and GSMC are among the numerous financial services firms named as defendants in a qui tam action originally filed by a relator on April 7, 2010 purportedly on behalf of the City of Chicago and State of Illinois in Cook County, Illinois Circuit Court asserting claims under the Illinois Whistleblower Reward and Protection Act and Chicago False Claims Act, based on allegations that defendants had falsely certified compliance with various Illinois laws, which were purportedly violated in connection with mortgage origination and servicing activities. The complaint, which was originally filed under seal, seeks treble damages and civil penalties. Plaintiff filed an amended complaint on December 28, 2011, naming GS&Co. and GSMC, among others, as additional defendants and a second amended complaint on February 8, 2012. On March 12, 2012, the action was removed to the U.S. District Court for the Northern District of Illinois, and on September 17, 2012 the district court granted the plaintiff’s motion to remand the action to state court. On November 16, 2012, the defendants moved to dismiss, and discovery has been stayed pending a ruling on the motion to dismiss.

Group Inc., Litton and Ocwen are defendants in a putative class action filed on January 23, 2013 in the U.S. District Court for the Southern District of New York generally challenging the procurement manner and scope of “force-placed” hazard insurance arranged by Litton when homeowners failed to arrange for insurance as required by their mortgages. The complaint asserts claims for breach of contract, breach of fiduciary duty, misappropriation, conversion, unjust enrichment and violation of Florida unfair practices law, and seeks unspecified compensatory and punitive damages as well as declaratory and injunctive relief.

On February 25, 2013, Group Inc. was added as a defendant through an amended complaint in a putative class action, originally filed on April 6, 2012 in the U.S. District Court for the Southern District of New York, against Litton, Ocwen and Ocwen Loan Servicing, LLC (Ocwen Servicing). The amended complaint generally alleges that Litton and Ocwen Servicing systematically breached agreements and violated various federal and state consumer protection laws by failing to modify the mortgage loans of homeowners participating in the federal Home Affordable Modification Program, and names Group Inc. based on its prior ownership of Litton. The plaintiffs seek unspecified compensatory, statutory and punitive damages as well as declaratory and injunctive relief. On April 29, 2013, Group Inc. moved to dismiss.

The firm has also received, and continues to receive, requests for information and/or subpoenas from federal, state and local regulators and law enforcement authorities, relating to the mortgage-related securitization process, subprime mortgages, CDOs, synthetic mortgage-related products, particular transactions involving these products, and servicing and foreclosure activities, and is cooperating with these regulators and other authorities, including in some cases agreeing to the tolling of the relevant statute of limitations. See also “Financial Crisis-Related Matters” below.

The firm expects to be the subject of additional putative shareholder derivative actions, purported class actions, rescission and “put back” claims and other litigation, additional investor and shareholder demands, and additional regulatory and other investigations and actions with respect to mortgage-related offerings, loan sales, CDOs, and servicing and foreclosure activities. See Note 18 for further information regarding mortgage-related contingencies.

 

 

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Private Equity-Sponsored Acquisitions Litigation. Group Inc. and “GS Capital Partners” are among numerous private equity firms and investment banks named as defendants in a federal antitrust action filed in the U.S. District Court for the District of Massachusetts in December 2007. As amended, the complaint generally alleges that the defendants have colluded to limit competition in bidding for private equity-sponsored acquisitions of public companies, thereby resulting in lower prevailing bids and, by extension, less consideration for shareholders of those companies in violation of Section 1 of the U.S. Sherman Antitrust Act and common law. The complaint seeks, among other things, treble damages in an unspecified amount. Defendants moved to dismiss on August 27, 2008. The district court dismissed claims relating to certain transactions that were the subject of releases as part of the settlement of shareholder actions challenging such transactions, and by an order dated December 15, 2008 otherwise denied the motion to dismiss. On April 26, 2010, the plaintiffs moved for leave to proceed with a second phase of discovery encompassing additional transactions. On August 18, 2010, the court permitted discovery on eight additional transactions, and the plaintiffs filed a fourth amended complaint on October 7, 2010. On January 13, 2011, the court granted defendants’ motion to dismiss certain aspects of the fourth amended complaint. On March 1, 2011, the court granted the motion filed by certain defendants, including Group Inc., to dismiss another claim of the fourth amended complaint on the grounds that the transaction was the subject of a release as part of the settlement of a shareholder action challenging the transaction. On June 14, 2012, the plaintiffs filed a fifth amended complaint encompassing additional transactions. On July 18, 2012, the court granted defendants’ motion to dismiss certain newly asserted claims on the grounds that certain transactions are subject to releases as part of settlements of shareholder actions challenging those transactions, and denied defendants’ motion to dismiss certain additional claims as time-barred. On July 23, 2012, the defendants filed motions for summary judgment. On March 13, 2013, the court granted defendants’ motions in part and denied them in part, rejecting plaintiffs’ theory of overarching collusion, but permitting plaintiffs’ claims to proceed based on narrower theories. On April 16, 2013, the defendants filed renewed motions for summary judgment as to the certain claims and, on April 22, 2013, certain defendants, including Group Inc., filed a motion for reconsideration of the court’s summary judgment denial as to an additional claim.

IndyMac Pass-Through Certificates Litigation. GS&Co. is among numerous underwriters named as defendants in a putative securities class action filed on May 14, 2009 in the U.S. District Court for the Southern District of New York. As to the underwriters, plaintiffs allege that the offering documents in connection with various securitizations of mortgage-related assets violated the disclosure requirements of the federal securities laws. The defendants include IndyMac-related entities formed in connection with the securitizations, the underwriters of the offerings, certain ratings agencies which evaluated the credit quality of the securities, and certain former officers and directors of IndyMac affiliates. On November 2, 2009, the underwriters moved to dismiss the complaint. The motion was granted in part on February 17, 2010 to the extent of dismissing claims based on offerings in which no plaintiff purchased, and the court reserved judgment as to the other aspects of the motion. By a decision dated June 21, 2010, the district court formally dismissed all claims relating to offerings in which no named plaintiff purchased certificates (including all offerings underwritten by GS&Co.), and both granted and denied the defendants’ motions to dismiss in various other respects. On November 16, 2012, the district court denied the plaintiffs’ motion seeking reinstatement of claims relating to 42 offerings previously dismissed for lack of standing (one of which was co-underwritten by GS&Co.) without prejudice to renewal depending on the outcome of the now-denied petition for a writ of certiorari to the U.S. Supreme Court with respect to the Second Circuit’s decision described under “Mortgage-Related Matters” above. By an order dated March 26, 2013, the district court stayed the action for 60 days and directed the parties to mediate. On May 17, 2010, four additional investors filed a motion seeking to intervene in order to assert claims based on additional offerings (including two underwritten by GS&Co.). The defendants opposed the motion on the ground that the putative intervenors’ claims were time-barred and, on June 21, 2011, the court denied the motion to intervene with respect to, among others, the claims based on the offerings underwritten by GS&Co. Certain of the putative intervenors (including those seeking to assert claims based on two offerings underwritten by GS&Co.) have appealed. GS&Co. underwrote approximately $751 million principal amount of securities to all purchasers in the offerings at issue in the May 2010 motion to intervene.

On July 11, 2008, IndyMac Bank was placed under an FDIC receivership, and on July 31, 2008, IndyMac Bancorp, Inc. filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court in Los Angeles, California.

 

 

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

RALI Pass-Through Certificates Litigation. GS&Co. is among numerous underwriters named as defendants in a putative securities class action initially filed in September 2008 in New York Supreme Court, and subsequently removed to the U.S. District Court for the Southern District of New York. As to the underwriters, plaintiffs allege that the offering documents in connection with various offerings of mortgage-backed pass-through certificates violated the disclosure requirements of the federal securities laws. In addition to the underwriters, the defendants include Residential Capital, LLC (ResCap), Residential Accredit Loans, Inc. (RALI), Residential Funding Corporation (RFC), Residential Funding Securities Corporation (RFSC), and certain of their officers and directors. On March 31, 2010, the defendants’ motion to dismiss was granted in part and denied in part by the district court, resulting in dismissal on the basis of standing of all claims relating to offerings in which no plaintiff purchased securities. In June and July 2010, the lead plaintiff and five additional investors moved to intervene in order to assert claims based on additional offerings (including two underwritten by GS&Co.). On April 28, 2011, the court granted defendants’ motion to dismiss as to certain of these claims (including those relating to one offering underwritten by GS&Co. based on a release in an unrelated settlement), but otherwise permitted the intervenor case to proceed. By an order dated January 3, 2013, the district court denied the defendants’ motions to dismiss certain of the intervenors’ remaining claims as time barred. Class certification of the claims based on the pre-intervention offerings was initially denied by the district court, and that denial was upheld on appeal; however, following remand, on October 15, 2012, the district court certified a class in connection with the pre-intervention offerings. By an order dated January 3, 2013, the district court granted plaintiffs’ application to modify the class definition to include only initial purchasers who bought the securities directly from the underwriters or their agents no later than ten trading days after the offering date (rather than just on the offering date). On March 26, 2013, the U.S. Court of Appeals for the Second Circuit denied the defendants’ petition seeking leave to appeal the district court’s class certification orders. On April 30, 2013, the district court granted, in part, plaintiffs’ request to reinstate a number of the claims, including claims related to seven offerings underwritten by GS&Co., that were previously dismissed on March 31, 2010.

GS&Co. underwrote approximately $5.51 billion principal amount of securities to all purchasers in the offerings for which claims have not been dismissed or which have been reinstated. On May 14, 2012, ResCap, RALI and RFC filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the Southern District of New York and the action has been stayed with respect to them, RFSC and certain of their officers and directors.

MF Global Securities Litigation. GS&Co. is among numerous underwriters named as defendants in class action complaints filed in the U.S. District Court for the Southern District of New York commencing November 18, 2011. These complaints generally allege that the offering materials for two offerings of MF Global Holdings Ltd. convertible notes (aggregating approximately $575 million in principal amount) in February 2011 and July 2011, among other things, failed to describe adequately the nature, scope and risks of MF Global’s exposure to European sovereign debt, in violation of the disclosure requirements of the federal securities laws. On August 20, 2012, the plaintiffs filed a consolidated amended complaint and on October 19, 2012, the defendants filed motions to dismiss the amended complaint. Numerous parties, including GS&Co., have commenced a mediation relating to various MF Global-related proceedings. GS&Co. underwrote an aggregate principal amount of approximately $214 million of the notes. On October 31, 2011, MF Global Holdings Ltd. filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court in Manhattan, New York.

GS&Co. has also received inquiries from various governmental and regulatory bodies and self-regulatory organizations concerning certain transactions with MF Global prior to its bankruptcy filing. Goldman Sachs is cooperating with all such inquiries.

 

 

    Goldman Sachs March 2013 Form 10-Q   103


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Employment-Related Matters. On September 15, 2010, a putative class action was filed in the U.S. District for the Southern District of New York by three former female employees alleging that Group Inc. and GS&Co. have systematically discriminated against female employees in respect of compensation, promotion, assignments, mentoring and performance evaluations. The complaint alleges a class consisting of all female employees employed at specified levels by Group Inc. and GS&Co. since July 2002, and asserts claims under federal and New York City discrimination laws. The complaint seeks class action status, injunctive relief and unspecified amounts of compensatory, punitive and other damages. Group Inc. and GS&Co. filed a motion to stay the claims of one of the named plaintiffs and to compel individual arbitration with that individual, based on an arbitration provision contained in an employment agreement between Group Inc. and the individual. On April 28, 2011, the magistrate judge to whom the district judge assigned the motion denied the motion, and the district court affirmed the magistrate judge’s decision on November 15, 2011. On March 21, 2013, the U.S. Court of Appeals for the Second Circuit reversed the district court’s decision, holding that arbitration should be compelled. On June 13, 2011, Group Inc. and GS&Co. moved to strike the class allegations of one of the three named plaintiffs based on her failure to exhaust administrative remedies. On September 29, 2011, the magistrate judge recommended denial of the motion to strike and, on January 10, 2012, the district court denied the motion to strike. On July 22, 2011, Group Inc. and GS&Co. moved to strike all of the plaintiffs’ class allegations, and for partial summary judgment as to plaintiffs’ disparate impact claims. By a decision dated January 19, 2012, the magistrate judge recommended that defendants’ motion be denied as premature. The defendants filed objections to that recommendation with the district judge and on July 17, 2012, the district court issued a decision granting in part Group Inc.’s and GS&Co.’s motion to strike plaintiffs’ class allegations on the ground that plaintiffs lacked standing to pursue certain equitable remedies and denying in part Group Inc.’s and GS&Co.’s motion to strike plaintiffs’ class allegations in their entirety as premature.

Investment Management Services. Group Inc. and certain of its affiliates are parties to various civil litigation and arbitration proceedings and other disputes with clients relating to losses allegedly sustained as a result of the firm’s investment management services. These claims generally seek, among other things, restitution or other compensatory damages and, in some cases, punitive damages. In addition, Group Inc. and its affiliates are subject from time to time to investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations in connection with the firm’s investment management services. Goldman Sachs is cooperating with all such investigations and reviews.

Goldman Sachs Asset Management International (GSAMI) is the defendant in an action filed on July 9, 2012 with the High Court of Justice in London by certain entities representing Vervoer, a Dutch pension fund, alleging that GSAMI was negligent in performing its duties as investment manager in connection with the allocation of the plaintiffs’ funds among asset managers in accordance with asset allocations provided by plaintiffs and that GSAMI breached its contractual and common law duties to the plaintiffs. Specifically, plaintiffs allege that GSAMI caused their assets to be invested in unsuitable products for an extended period, thereby causing in excess of €67 million in losses, and caused them to be under-exposed for a period of time to certain other investments that performed well, thereby resulting in foregone potential gains. The plaintiffs are seeking unspecified monetary damages. On November 2, 2012, GSAMI served its defense to the allegations and on December 21, 2012, the plaintiffs served their reply to the defense.

 

 

104   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Financial Advisory Services. Group Inc. and certain of its affiliates are parties to various civil litigation and arbitration proceedings and other disputes with clients and third parties relating to the firm’s financial advisory activities. These claims generally seek, among other things, compensatory damages and, in some cases, punitive damages, and in certain cases allege that the firm did not appropriately disclose or deal with conflicts of interest. In addition, Group Inc. and its affiliates are subject from time to time to investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations in connection with conflicts of interest. Goldman Sachs is cooperating with all such investigations and reviews.

Group Inc., GS&Co. and The Goldman, Sachs & Co. L.L.C. are defendants in an action brought by the founders and former majority shareholders of Dragon Systems, Inc. (Dragon) on November 18, 2008, alleging that the plaintiffs incurred losses due to GS&Co.’s financial advisory services provided in connection with the plaintiffs’ exchange of their purported $300 million interest in Dragon for stock of Lernout & Hauspie Speech Products, N.V. (L&H) in 2000. L&H filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court in Wilmington, Delaware on November 29, 2000. The action is pending in the United States District Court for the District of Massachusetts. The complaint sought unspecified compensatory, punitive and other damages, and alleged breach of fiduciary duty, violation of Massachusetts unfair trade practices laws, negligence, negligent and intentional misrepresentation, gross negligence, willful misconduct and bad faith. Former minority shareholders of Dragon brought a similar action against GS&Co. with respect to their purported $49 million interest in Dragon, and this action was consolidated with the action described above. By an order dated October 31, 2012, the court granted summary judgment with respect to certain counterclaims and an indemnification claim brought by the Goldman Sachs defendants against one of the shareholders, but denied summary judgment with respect to all other claims. On January 23, 2013, a jury found in favor of the Goldman Sachs defendants on the plaintiffs’ claims for negligence, negligent and intentional misrepresentation, gross negligence, and breach of fiduciary duty. The plaintiffs’ claims for violation of Massachusetts unfair trade practices laws will be addressed by the district court and have not yet been decided.

Sales, Trading and Clearance Practices. Group Inc. and certain of its affiliates are subject to a number of investigations and reviews, certain of which are industry-wide, by various governmental and regulatory bodies and self-regulatory organizations relating to the sales, trading and clearance of corporate and government securities and other financial products, including compliance with the SEC’s short sale rule, algorithmic and quantitative trading, futures trading, transaction reporting, securities lending practices, trading and clearance of credit derivative instruments, commodities trading, private placement practices and compliance with the U.S. Foreign Corrupt Practices Act.

The European Commission announced in April 2011 that it was initiating proceedings to investigate further numerous financial services companies, including Group Inc., in connection with the supply of data related to credit default swaps and in connection with profit sharing and fee arrangements for clearing of credit default swaps, including potential anti-competitive practices. The proceedings in connection with the supply of data related to credit default swaps are ongoing. Group Inc.’s current understanding is that the proceedings related to profit sharing and fee arrangements for clearing of credit default swaps have been suspended indefinitely. The firm has received civil investigative demands from the U.S. Department of Justice (DOJ) for information on similar matters. Goldman Sachs is cooperating with the investigations and reviews.

GS&Co. is among the numerous defendants in a putative antitrust class action filed on May 3, 2013 in the U.S. District Court for the Northern District of Illinois. The complaint generally alleges that defendants violated federal antitrust laws by conspiring to inflate bid-ask spreads for credit derivatives. The complaint seeks declaratory and injunctive relief as well as treble damages in an unspecified amount.

Insider Trading Investigations. From time to time, the firm and its employees are the subject of or otherwise involved in regulatory investigations relating to insider trading, the potential misuse of material nonpublic information and the effectiveness of the firm’s insider trading controls and information barriers. It is the firm’s practice to cooperate fully with any such investigations.

 

 

    Goldman Sachs March 2013 Form 10-Q   105


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Research Investigations. From time to time, the firm is the subject of or otherwise involved in regulatory investigations relating to research practices, including research independence and interactions between research analysts and other firm personnel, including investment banking personnel. It is the firm’s practice to cooperate fully with any such investigations.

EU Price-Fixing Matter. On July 5, 2011, the European Commission issued a Statement of Objections to Group Inc. raising allegations of an industry-wide conspiracy to fix prices for power cables, including by an Italian cable company in which certain Goldman Sachs-affiliated investment funds held ownership interests from 2005 to 2009. The Statement of Objections proposes to hold Group Inc. jointly and severally liable for some or all of any fine levied against the cable company under the concept of parental liability under EU competition law.

Municipal Securities Matters. Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations relating to transactions involving municipal securities, including wall-cross procedures and conflict of interest disclosure with respect to state and municipal clients, the trading and structuring of municipal derivative instruments in connection with municipal offerings, political contribution rules, underwriting of Build America Bonds, municipal advisory services and the possible impact of credit default swap transactions on municipal issuers. Goldman Sachs is cooperating with the investigations and reviews.

Group Inc., Goldman Sachs Mitsui Marine Derivative Products, L.P. (GSMMDP) and GS Bank USA are among numerous financial services firms that have been named as defendants in numerous substantially identical individual antitrust actions filed beginning on November 12, 2009 that have been coordinated with related antitrust class action litigation and individual actions, in which no Goldman Sachs affiliate is named, for pre-trial proceedings in the U.S. District Court for the Southern District of New York. The plaintiffs include individual California municipal entities and three New York non-profit entities. All of these complaints against Group Inc., GSMMDP and GS Bank USA generally allege that the Goldman Sachs defendants participated in a conspiracy to arrange bids, fix prices and

divide up the market for derivatives used by municipalities in refinancing and hedging transactions from 1992 to 2008. The complaints assert claims under the federal antitrust laws and either California’s Cartwright Act or New York’s Donnelly Act, and seek, among other things, treble damages under the antitrust laws in an unspecified amount and injunctive relief. On April 26, 2010, the Goldman Sachs defendants’ motion to dismiss complaints filed by several individual California municipal plaintiffs was denied. On August 19, 2011, Group Inc., GSMMDP and GS Bank USA were voluntarily dismissed without prejudice from all actions except one brought by a California municipal entity.

On August 21, 2008, GS&Co. entered into a settlement in principle with the Office of the Attorney General of the State of New York and the Illinois Securities Department (on behalf of the North American Securities Administrators Association) regarding auction rate securities. Under the agreement, Goldman Sachs agreed, among other things, (i) to offer to repurchase at par the outstanding auction rate securities that its private wealth management clients purchased through the firm prior to February 11, 2008, with the exception of those auction rate securities where auctions were clearing, (ii) to continue to work with issuers and other interested parties, including regulatory and governmental entities, to expeditiously provide liquidity solutions for institutional investors, and (iii) to pay a $22.5 million fine. The settlement is subject to approval by the various states. GS&Co. has entered into consent orders with New York, Illinois and most other states and is in the process of doing so with the remaining states.

On September 4, 2008, Group Inc. was named as a defendant, together with numerous other financial services firms, in two complaints filed in the U.S. District Court for the Southern District of New York alleging that the defendants engaged in a conspiracy to manipulate the auction securities market in violation of federal antitrust laws. The actions were filed, respectively, on behalf of putative classes of issuers of and investors in auction rate securities and seek, among other things, treble damages in an unspecified amount. Defendants’ motion to dismiss was granted on January 26, 2010 and, by an order dated March 5, 2013, the U.S. Court of Appeals for the Second Circuit upheld the dismissal. Plaintiffs have agreed not to seek further review of that decision.

 

 

106   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Beginning in February 2012, GS&Co. was named as respondent in four FINRA arbitrations filed, respectively, by the cities of Houston, Texas and Reno, Nevada, a California school district and a North Carolina municipal power authority, based on GS&Co.’s role as underwriter and broker-dealer of the claimants’ issuances of an aggregate of over $1.8 billion of auction rate securities from 2003 through 2007 (in the Houston arbitration, two other financial services firms were named as respondents, and in the North Carolina arbitration, one other financial services firm was named). Each claimant alleges that GS&Co. failed to disclose that it had a practice of placing cover bids on auctions, and failed to offer the claimant the option of a formulaic maximum rate (rather than a fixed maximum rate), and that, as a result, the claimant was forced to engage in a series of expensive refinancing and conversion transactions after the failure of the auction market (at an estimated cost, in the case of Houston, of approximately $90 million). Houston and Reno also allege that GS&Co. advised them to enter into interest rate swaps in connection with their auction rate securities issuances, causing them to incur additional losses (including, in the case of Reno, a swap termination obligation of over $8 million). The claimants assert claims for breach of fiduciary duty, fraudulent concealment, negligent misrepresentation, breach of contract, violations of the Exchange Act and state securities laws, and breach of duties under the rules of the Municipal Securities Rulemaking Board and the NASD, and seek unspecified damages. In federal court, GS&Co. has filed complaints and motions seeking to enjoin the Reno, California school district and North Carolina arbitrations pursuant to the exclusive forum selection clauses in the transaction documents. On November 26, 2012, GS&Co.’s motion to enjoin was denied with regard to the Reno arbitration, and GS&Co. appealed on March 11, 2013. On February 8, 2013, GS&Co.’s motion to enjoin was granted with regard to the California school district arbitration, and the California school district appealed on March 5, 2013. On April 26, 2013, GS&Co. filed its formal motion to enjoin the North Carolina arbitration, and the North Carolina municipal power authority filed a motion to dismiss GS&Co.’s complaint for lack of venue.

Financial Crisis-Related Matters. Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations and litigation relating to the 2008 financial crisis. Goldman Sachs is cooperating with the investigations and reviews.

 

 

    Goldman Sachs March 2013 Form 10-Q   107


Table of Contents

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and the 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 March 31, 2013, the related condensed consolidated statements of earnings for the three months ended March 31, 2013 and 2012, the condensed consolidated statements of comprehensive income for the three months ended March 31, 2013 and 2012, the condensed consolidated statement of changes in shareholders’ equity for the three months ended March 31, 2013, and the condensed consolidated statements of cash flows for the three months ended March 31, 2013 and 2012. These condensed consolidated interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition as of December 31, 2012, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for the year then ended (not presented herein), and in our report dated February 28, 2013, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of December 31, 2012, and the condensed consolidated statement of changes in shareholders’ equity for the year ended December 31, 2012, is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived.

/s/ PRICEWATERHOUSECOOPERS LLP

New York, New York

May 8, 2013

 

 

108   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Statistical Disclosures

Distribution of Assets, Liabilities and Shareholders’ Equity

The table below presents a summary of consolidated average balances and interest rates.

 

    Three Months Ended March  
    2013         2012  
in millions, except rates    

 

Average

balance

  

  

     Interest        

 

 

Average

Rate

(annualized)

  

  

  

       

 

Average

balance

  

  

     Interest        

 

 

Average

rate

(annualized)

  

  

  

Assets

                 

Deposits with banks

    $  64,007         $     48         0.30       $  48,029         $     38         0.32
   

U.S.

    60,919         43         0.29          43,939         29         0.27   
   

Non-U.S.

    3,088         5         0.66          4,090         9         0.89   
   

Securities borrowed, securities purchased under agreements to resell and
federal funds sold

    316,390         (24      (0.03       348,873         (14      (0.02
   

U.S.

    180,008         (85      (0.19       200,486         (112      (0.22
   

Non-U.S.

    136,382         61         0.18          148,387         98         0.27   
   

Financial instruments owned, at fair value 1, 2

    316,072         2,238         2.87          294,257         2,442         3.34   
   

U.S.

    193,652         1,510         3.16          181,376         1,590         3.53   
   

Non-U.S.

    122,420         728         2.41          112,881         852         3.04   
   

Other interest-earning assets 3

    134,889         346         1.04          133,707         367         1.10   
   

U.S.

    82,295         239         1.18          87,609         236         1.08   
   

Non-U.S.

    52,594         107         0.83            46,098         131         1.14   

Total interest-earning assets

    831,358         2,608         1.27          824,866         2,833         1.38   
   

Cash and due from banks

    6,074                6,770         
   

Other non-interest-earning assets 2

    124,476                              110,222                     

Total assets

    $961,908                              $941,858                     

Liabilities

                 

Interest-bearing deposits

    $  69,118         $     93         0.55       $  48,096         $     91         0.76
   

U.S.

    61,704         88         0.58          40,571         81         0.80   
   

Non-U.S.

    7,414         5         0.27          7,525         10         0.53   
   

Securities loaned and securities sold under agreements to repurchase

    187,101         164         0.36          176,115         211         0.48   
   

U.S.

    122,299         80         0.27          121,092         84         0.28   
   

Non-U.S.

    64,802         84         0.53          55,023         127         0.93   
   

Financial instruments sold, but not yet purchased, at fair value 1, 2

    95,490         511         2.17          91,587         525         2.31   
   

U.S.

    37,028         167         1.83          40,292         162         1.62   
   

Non-U.S.

    58,462         344         2.39          51,295         363         2.85   
   

Short-term borrowings 4

    62,993         106         0.68          75,367         168         0.90   
   

U.S.

    43,053         97         0.91          49,891         136         1.10   
   

Non-U.S.

    19,940         9         0.18          25,476         32         0.51   
   

Long-term borrowings 4

    177,257         910         2.08          182,239         1,009         2.23   
   

U.S.

    170,652         881         2.09          175,006         947         2.18   
   

Non-U.S.

    6,605         29         1.78          7,233         62         3.45   
   

Other interest-bearing liabilities 5

    197,393         (101      (0.21       204,166         (152      (0.30
   

U.S.

    141,253         (221      (0.63       150,736         (251      (0.67
   

Non-U.S.

    56,140         120         0.87            53,430         99         0.75   

Total interest-bearing liabilities

    789,352         1,683         0.86          777,570         1,852         0.96   
   

Non-interest-bearing deposits

    750                184         
   

Other non-interest-bearing liabilities 2

    95,104                              93,280                     

Total liabilities

    885,206                871,034         
   

Shareholders’ equity

                 

Preferred stock

    6,200                3,100         
   

Common stock

    70,502                              67,724                     

Total shareholders’ equity

    76,702                70,824         
   

Total liabilities and shareholders’ equity

    $961,908                              $941,858                     

Interest rate spread

          0.41             0.42
   

Net interest income and net yield on interest-earning assets

       $   925         0.45             $   981         0.48   
   

U.S.

       615         0.48             584         0.46   
   

Non-U.S.

       310         0.40             397         0.51   
   

Percentage of interest-earning assets and interest-bearing liabilities attributable to non-U.S. operations 6

                 

Assets

          37.83             37.76
   

Liabilities

                      27.03                              25.72   

 

1.

Consists of cash financial instruments, including equity securities and convertible debentures.

 

2.

Derivative instruments and commodities are included in other non-interest-earning assets and other non-interest-bearing liabilities.

 

3.

Primarily consists of cash and securities segregated for regulatory and other purposes and certain receivables from customers and counterparties.

 

4.

Interest rates include the effects of interest rate swaps accounted for as hedges.

 

5.

Primarily consists of certain payables to customers and counterparties.

 

6.

Assets, liabilities and interest are attributed to U.S. and non-U.S. based on the location of the legal entity in which the assets and liabilities are held.

 

    Goldman Sachs March 2013 Form 10-Q   109


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Statistical Disclosures

 

Ratios

The table below presents selected financial ratios.

 

   

Three Months

Ended March

 
      2013           2012   

Annualized net earnings to average assets

    0.9        0.9
   

Annualized return on average common shareholders’ equity 1

    12.4           12.2   
   

Annualized return on average total shareholders’ equity 2

    11.8           11.9   
   

Total average equity to average assets

    8.0           7.5   
   

Dividend payout ratio 3

    11.7           8.9   

 

1.

Based on annualized net earnings applicable to common shareholders divided by average monthly common shareholders’ equity.

 

2.

Based on annualized net earnings divided by average monthly total shareholders’ equity.

 

3.

Dividends declared per common share as a percentage of diluted earnings per common share.

 

110   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

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

INDEX

 

     Page No.  
   

Introduction

    112   
   

Executive Overview

    112   
   

Business Environment

    114   
   

Critical Accounting Policies

    115   
   

Use of Estimates

    119   
   

Results of Operations

    120   
   

Regulatory Developments

    130   
   

Balance Sheet and Funding Sources

    133   
   

Equity Capital

    140   
   

Off-Balance-Sheet Arrangements and Contractual Obligations

    147   
   

Overview and Structure of Risk Management

    149   
   

Liquidity Risk Management

    154   
   

Market Risk Management

    161   
   

Credit Risk Management

    167   
   

Operational Risk Management

    174   
   

Recent Accounting Developments

    176   
   

Certain Risk Factors That May Affect Our Businesses

    177   
   

Available Information

    178   
   

Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995

    178   

 

    Goldman Sachs March 2013 Form 10-Q   111


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Introduction

The Goldman Sachs Group, Inc. (Group Inc.) is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

We report our activities in four business segments: Investment Banking, Institutional Client Services, Investing & Lending and Investment Management. See “Results of Operations” below for further information about our business segments.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2012. References to “our Annual Report on Form 10-K” are to our Annual Report on Form 10-K for the year ended December 31, 2012.

When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” and “our,” we mean Group Inc., a Delaware corporation, and its consolidated subsidiaries.

References to “this Form 10-Q” are to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2013. All references to March 2013 and March 2012 refer to our periods ended, or the dates, as the context requires, March 31, 2013 and March 31, 2012, respectively. All references to December 2012 refer to the date December 31, 2012. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

Executive Overview

The firm generated net earnings of $2.26 billion and diluted earnings per common share of $4.29 for the first quarter of 2013, compared with $2.11 billion and $3.92 per common share, respectively, for the first quarter of 2012. Annualized return on average common shareholders’ equity (ROE) 1 was 12.4% for the first quarter of 2013, compared with 12.2% for the first quarter of 2012.

Book value per common share was $148.41 and tangible book value per common share 2 was $138.62 as of March 2013, both approximately 3% higher compared with the end of 2012. During the quarter, the firm repurchased 10.1 million shares of its common stock for a total cost of $1.52 billion. Our Tier 1 capital ratio was 14.4% and our Tier 1 common ratio 3 was 12.7% as of March 2013, in each case under Basel 1 and reflecting the revised market risk regulatory capital requirements which became effective on January 1, 2013. As of December 2012, our Tier 1 capital ratio under Basel 1 was 16.7% and our Tier 1 common ratio under Basel 1 was 14.5% (prior to the implementation of the revised market risk regulatory capital requirements).

The firm generated net revenues of $10.09 billion for the first quarter of 2013, compared with $9.95 billion for the first quarter of 2012. These results reflected significantly higher net revenues in Investment Banking, as well as higher net revenues in both Investing & Lending and Investment Management compared with the first quarter of 2012. These increases were largely offset by lower net revenues in Institutional Client Services compared with the first quarter of 2012.

An overview of net revenues for each of our business segments is provided below.

 
1.

See “Results of Operations — Financial Overview” below for further information about our calculation of annualized ROE.

 

2.

Tangible book value per common share is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies. See “Equity Capital — Other Capital Metrics” below for further information about our calculation of tangible book value per common share.

 

3.

Tier 1 common ratio is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies. See “Equity Capital — Consolidated Regulatory Capital Ratios” below for further information about our Tier 1 common ratio.

 

112   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Investment Banking

Net revenues in Investment Banking increased significantly compared with the first quarter of 2012 due to significantly higher net revenues in our Underwriting business. This increase primarily reflected significantly higher net revenues in debt underwriting, due to leveraged finance and commercial mortgage-related activity. Net revenues in equity underwriting were also significantly higher compared with the first quarter of 2012, reflecting an increase in client activity. Net revenues in Financial Advisory were essentially unchanged compared with the first quarter of 2012.

Institutional Client Services

Net revenues in Institutional Client Services decreased compared with the first quarter of 2012, reflecting lower net revenues in both Equities and Fixed Income, Currency and Commodities Client Execution.

The decrease in Fixed Income, Currency and Commodities Client Execution compared with the first quarter of 2012 was due to lower net revenues across most businesses, primarily reflecting significantly lower net revenues in interest rate products compared with a strong first quarter of 2012. Net revenues in mortgages were higher compared with the first quarter of 2012. During the quarter, Fixed Income, Currency and Commodities Client Execution operated in an environment characterized by generally tighter credit spreads and improved client activity levels compared with the fourth quarter of 2012.

The decrease in Equities compared with the first quarter of 2012 primarily reflected lower net revenues in equities client execution. This decrease reflected significantly lower net revenues in derivatives compared with a strong first quarter of 2012, partially offset by higher net revenues in cash products. Commissions and fees were lower compared with the first quarter of 2012, reflecting lower market volumes. In addition, securities services net revenues were lower compared with the first quarter of 2012. During the quarter, Equities operated in an environment generally characterized by an increase in global equity prices, lower volatility levels and improved client activity levels compared with the fourth quarter of 2012.

The net loss attributable to the impact of changes in our own credit spreads on borrowings for which the fair value option was elected was $77 million ($42 million and $35 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first quarter of 2013, compared with a net loss of $224 million ($117 million and $107 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first quarter of 2012.

Investing & Lending

Net revenues in Investing & Lending were $2.07 billion for the first quarter of 2013, compared with $1.91 billion for the first quarter of 2012. During the first quarter of 2013, Investing & Lending net revenues were positively impacted by an increase in equity prices and generally tighter credit spreads. Results for the first quarter of 2013 included a gain of $24 million from our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), net gains of $1.10 billion from other investments in equities, primarily in private equities, net gains and net interest income of $566 million from debt securities and loans, and other net revenues of $375 million related to our consolidated investments.

Investment Management

Net revenues in Investment Management increased compared with the first quarter of 2012, due to higher incentive fees and higher management and other fees. During the quarter, assets under supervision 1 increased $3 billion to $968 billion, reflecting net market appreciation of $12 billion, primarily in equity assets. Net outflows in assets under supervision were $9 billion, as outflows in money market assets and, to a lesser extent, alternative investment assets, were partially offset by inflows in fixed income and equity assets.

Our businesses, by their nature, do not produce predictable earnings. Our results in any given period can be materially affected by conditions in global financial markets, economic conditions generally and other factors. For a further discussion of the factors that may affect our future operating results, see “Certain Risk Factors That May Affect Our Businesses” below, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.

 
1.

Assets under supervision include assets under management and other client assets. Assets under management include client assets where we earn a fee for managing assets on a discretionary basis. Other client assets include client assets invested with third-party managers, private bank deposits and advisory relationships where we earn a fee for advisory and other services, but do not have investment discretion.

 

    Goldman Sachs March 2013 Form 10-Q   113


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Business Environment

 

Global

Global economic conditions improved during the first quarter of 2013, as real gross domestic product (GDP) appeared to increase in most major economies. However, real GDP in the Euro area appeared to decline due to continued concerns about European sovereign debt risk and ongoing fiscal retrenchment. Political developments in the Euro area temporarily increased market volatility, although the continued supportive stance of the European Central Bank (ECB) to address funding risks for European financial institutions and sovereigns helped to improve global market conditions. Positive U.S. economic data also contributed to the improvement in market sentiment. These developments contributed to generally tighter credit spreads, higher global equity prices and lower levels of volatility. In addition, the price of crude oil increased during the quarter. The U.S. dollar appreciated significantly against the Japanese yen, and appreciated against both the British pound and the Euro. In investment banking, activity levels were mixed during the quarter, as industry-wide debt underwriting activity continued at a robust pace, industry-wide equity underwriting activity improved, although initial public offerings activity remained low, and industry-wide announced and completed mergers and acquisitions activity declined compared with the fourth quarter of 2012.

United States

In the United States, real GDP growth accelerated during the quarter, reflecting an increase in the growth of consumer spending and a positive turn in the inventory cycle. The expiration of the payroll tax cuts and the increase in some income tax rates did not appear to have had a large impact on personal consumption during the quarter, but cuts in government spending continued to have a negative effect on growth. Measures of consumer and business confidence were mixed over the quarter. Housing market activity continued to improve as sales increased and housing starts were at their highest levels since mid-2008. Unemployment levels declined, although the rate of unemployment remained elevated. Measures of inflation remained subdued during the quarter. The U.S. Federal Reserve maintained its federal funds rate at a target range of zero to 0.25% and continued its program to purchase U.S. Treasury securities and mortgage-backed securities. The 10-year U.S. Treasury note yield ended the quarter at 1.87%, 9 basis points higher than at the end of 2012. In equity markets, the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite Index increased by 11%, 10% and 8%, respectively, compared with the end of 2012.

Europe

In the Euro area, real GDP appeared to decline for the sixth consecutive quarter, although at a lower rate than in the fourth quarter of 2012. This reflected a smaller decrease in consumer spending, which was partially offset by a downturn in government spending. Political uncertainty around the Italian elections and the debt crisis in Cyprus increased uncertainty in financial markets. Measures of inflation were slightly lower compared with the fourth quarter of 2012, and unemployment levels remained elevated. The ECB maintained its main refinancing operations rate at 0.75% and received payments on parts of the loans made through its longer-term refinancing operations program. The Euro depreciated by 3% against the U.S. dollar. In the United Kingdom, real GDP increased during the quarter, after having contracted during the fourth quarter of 2012. The Bank of England maintained its official bank rate at 0.50% and the British pound depreciated by 6% against the U.S. dollar. The movements in long-term government bond yields were mixed, as yields increased in Greece and Italy, declined in Spain, and only marginally changed in France, Germany and the United Kingdom. In equity markets, the FTSE 100 Index increased by 9%, the DAX Index and the CAC 40 Index both increased by 2%, and the Euro Stoxx 50 Index was essentially unchanged compared with the end of 2012.

Asia

In Japan, real GDP growth appeared to accelerate during the quarter, reflecting an upturn in private investment. In the midst of a leadership transition, the Bank of Japan introduced a 2% price stability target and made its asset purchase program open-ended. As a result of expectations for an aggressive monetary easing program, the yield on 10-year Japanese government bonds declined to near record lows, the Japanese yen depreciated against the U.S. dollar by 9% and the Nikkei 225 Index increased by 19% compared with the end of 2012. In China, real GDP growth moderated during the quarter, reflecting a slowdown in retail sales. Measures of inflation increased slightly compared with the fourth quarter of 2012. The People’s Bank of China left its reserve requirement ratio unchanged during the quarter. The Chinese yuan appreciated slightly against the U.S. dollar. In equity markets, the Hang Seng Index decreased 2%, while the Shanghai Composite Index and the KOSPI Composite Index were both essentially unchanged compared with the end of 2012. In India, economic growth appeared to increase during the quarter, although growth rates are still at the lower end of the historical range. The rate of wholesale inflation declined during the quarter, but remained elevated. The Indian rupee appreciated slightly against the U.S. dollar, and the BSE Sensex Index decreased by 3% compared with the end of 2012.

 

 

114   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Critical Accounting Policies

Fair Value

Fair Value Hierarchy. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value (i.e., inventory), as well as certain other financial assets and financial liabilities, are reflected in our condensed consolidated statements of financial condition at fair value (i.e., marked-to-market), with related gains or losses generally recognized in our condensed consolidated statements of earnings. The use of fair value to measure financial instruments is fundamental to our risk management practices and is our most critical accounting policy.

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the hierarchy under U.S. generally accepted accounting principles (U.S. GAAP) gives (i) the highest priority to unadjusted quoted prices in active markets for identical, unrestricted assets or liabilities (level 1 inputs), (ii) the next priority to inputs other than level 1 inputs that are observable, either directly or indirectly (level 2 inputs), and (iii) the lowest priority to inputs that cannot be observed in market activity (level 3 inputs). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement.

The fair values for substantially all of our financial assets and financial liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the fair value hierarchy. Certain level 2 and level 3 financial assets and financial liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors such as counterparty and the firm’s credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Valuation adjustments are generally based on market evidence.

Instruments categorized within level 3 of the fair value hierarchy are those which require one or more significant inputs that are not observable. As of March 2013 and December 2012, level 3 assets represented 4.8% and 5.0%, respectively, of the firm’s total assets. Absent evidence to the contrary, instruments classified within level 3 of the fair value hierarchy are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the transaction date, we use other methodologies to determine fair value, which vary based on the type of instrument. Estimating the fair value of level 3 financial instruments requires judgments to be made. These judgments include:

 

Ÿ  

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

 

Ÿ  

determining model inputs based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations; and

 

Ÿ  

determining appropriate valuation adjustments related to illiquidity or counterparty credit quality.

Regardless of the methodology, valuation inputs and assumptions are only changed when corroborated by substantive evidence.

 

 

    Goldman Sachs March 2013 Form 10-Q   115


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Controls Over Valuation of Financial Instruments. Market makers and investment professionals in our revenue-producing units are responsible for pricing our financial instruments. Our control infrastructure is independent of the revenue-producing units and is fundamental to ensuring that all of our financial instruments are appropriately valued at market-clearing levels. In the event that there is a difference of opinion in situations where estimating the fair value of financial instruments requires judgment (e.g., calibration to market comparables or trade comparison, as described below), the final valuation decision is made by senior managers in control and support functions that are independent of the revenue-producing units (independent control and support functions). This independent price verification is critical to ensuring that our financial instruments are properly valued.

Price Verification. All financial instruments at fair value in levels 1, 2 and 3 of the fair value hierarchy are subject to our independent price verification process. The objective of price verification is to have an informed and independent opinion with regard to the valuation of financial instruments under review. Instruments that have one or more significant inputs which cannot be corroborated by external market data are classified within level 3 of the fair value hierarchy. Price verification strategies utilized by our independent control and support functions include:

 

Ÿ  

Trade Comparison. Analysis of trade data (both internal and external where available) is used to determine the most relevant pricing inputs and valuations.

 

Ÿ  

External Price Comparison. Valuations and prices are compared to pricing data obtained from third parties (e.g., broker or dealers, MarkIt, Bloomberg, IDC, TRACE). Data obtained from various sources is compared to ensure consistency and validity. When broker or dealer quotations or third-party pricing vendors are used for valuation or price verification, greater priority is generally given to executable quotations.

 

Ÿ  

Calibration to Market Comparables. Market-based transactions are used to corroborate the valuation of positions with similar characteristics, risks and components.

 

Ÿ  

Relative Value Analyses. Market-based transactions are analyzed to determine the similarity, measured in terms of risk, liquidity and return, of one instrument relative to another or, for a given instrument, of one maturity relative to another.

Ÿ  

Collateral Analyses. Margin disputes on derivatives are examined and investigated to determine the impact, if any, on our valuations.

 

Ÿ  

Execution of Trades. Where appropriate, trading desks are instructed to execute trades in order to provide evidence of market-clearing levels.

 

Ÿ  

Backtesting. Valuations are corroborated by comparison to values realized upon sales.

See Notes 5 through 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about fair value measurements.

Review of Net Revenues. Independent control and support functions ensure adherence to our pricing policy through a combination of daily procedures, including the explanation and attribution of net revenues based on the underlying factors. Through this process we independently validate net revenues, identify and resolve potential fair value or trade booking issues on a timely basis and seek to ensure that risks are being properly categorized and quantified.

Review of Valuation Models. The firm’s independent model validation group, consisting of quantitative professionals who are separate from model developers, performs an independent model approval process. This process incorporates a review of a diverse set of model and trade parameters across a broad range of values (including extreme and/or improbable conditions) in order to critically evaluate:

 

Ÿ  

the model’s suitability for valuation and risk management of a particular instrument type;

 

Ÿ  

the model’s accuracy in reflecting the characteristics of the related product and its significant risks;

 

Ÿ  

the suitability of the calculation techniques incorporated in the model;

 

Ÿ  

the model’s consistency with models for similar products; and

 

Ÿ  

the model’s sensitivity to input parameters and assumptions.

New or changed models are reviewed and approved prior to being put into use. Models are evaluated and re-approved annually to assess the impact of any changes in the product or market and any market developments in pricing theories.

 

 

116   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Level 3 Financial Assets at Fair Value. The table below presents financial assets measured at fair value and the amount of such assets that are classified within level 3 of the fair value hierarchy.

Total level 3 financial assets were $46.02 billion and $47.10 billion as of March 2013 and December 2012, respectively.

See Notes 5 through 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about changes in level 3 financial assets and fair value measurements.

 

 

    As of March 2013         As of December 2012  
in millions    

 

Total at

Fair Value

  

  

      

 

Level 3

Total

  

  

       

 

Total at

Fair Value

  

  

      

 

Level 3

Total

  

  

Commercial paper, certificates of deposit, time deposits
and other money market instruments

    $    5,705           $       —          $    6,057           $        —   
   

U.S. government and federal agency obligations

    96,930                    93,241             
   

Non-U.S. government and agency obligations

    57,657           47          62,250           26   
   

Mortgage and other asset-backed loans and securities:

               

Loans and securities backed by commercial real estate

    6,909           3,164          9,805           3,389   
   

Loans and securities backed by residential real estate

    7,570           1,683          8,216           1,619   
   

Bank loans and bridge loans

    22,467           11,688          22,407           11,235   
   

Corporate debt securities

    20,442           2,442          20,981           2,821   
   

State and municipal obligations

    2,219           334          2,477           619   
   

Other debt obligations

    2,481           855          2,251           1,185   
   

Equities and convertible debentures

    89,278           15,224          96,454           14,855   
   

Commodities

    7,695                      11,696             

Total cash instruments

    319,353           35,437          335,835           35,749   
   

Derivatives

    68,040           9,284            71,176           9,920   

Financial instruments owned, at fair value

    387,393           44,721          407,011           45,669   
   

Securities segregated for regulatory and other purposes

    22,676                    30,484             
   

Securities purchased under agreements to resell

    158,283           104          141,331           278   
   

Securities borrowed

    54,879                    38,395             
   

Receivables from customers and counterparties

    7,154           633          7,866           641   
   

Other assets 1

    13,448           565            13,426           507   

Total

    $643,833           $46,023            $638,513           $47,095   

 

1.

Consists of assets classified as held for sale related to our reinsurance business, primarily consisting of securities accounted for as available-for-sale and insurance separate account assets. See Note 12 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about assets held for sale.

 

    Goldman Sachs March 2013 Form 10-Q   117


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Goodwill and Identifiable Intangible Assets

Goodwill. Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date. Goodwill is assessed annually for impairment, or more frequently if events occur or circumstances change that indicate an impairment may exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the results of the qualitative assessment are not conclusive, a quantitative goodwill impairment test is performed by comparing the estimated fair value of each reporting unit with its estimated net book value.

Estimating the fair value of our reporting units requires management to make judgments. Critical inputs to the fair value estimates include (i) projected earnings, (ii) estimated long-term growth rates and (iii) cost of equity. The net book value of each reporting unit reflects an allocation of total shareholders’ equity and represents the estimated amount of shareholders’ equity required to support the activities of the reporting unit under guidelines issued by the Basel Committee on Banking Supervision (Basel Committee) in December 2010.

Our market capitalization was below book value during 2012. Accordingly, we performed a quantitative impairment test during the fourth quarter of 2012 and determined that goodwill was not impaired. The estimated fair value of our reporting units in which we hold substantially all of our goodwill significantly exceeded the estimated carrying values. We believe that it is appropriate to consider market capitalization, among other factors, as an indicator of fair value over a reasonable period of time.

If we return to a prolonged period of weakness in the business environment or financial markets, our goodwill could be impaired in the future. In addition, significant changes to critical inputs of the goodwill impairment test (e.g., cost of equity) could cause the estimated fair value of our reporting units to decline, which could result in an impairment of goodwill in the future.

See Note 13 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our goodwill.

Identifiable Intangible Assets. We amortize our identifiable intangible assets (i) over their estimated lives, (ii) based on economic usage or (iii) in proportion to estimated gross profits or premium revenues. Identifiable intangible assets are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable.

An impairment loss, generally calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value. See Note 13 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for the carrying value and estimated remaining lives of our identifiable intangible assets by major asset class and impairments of our identifiable intangible assets.

A prolonged period of market weakness could adversely impact our businesses and impair the value of our identifiable intangible assets. In addition, certain events could indicate a potential impairment of our identifiable intangible assets, including (i) decreases in revenues from commodity-related customer contracts and relationships, (ii) an adverse action or assessment by a regulator or (iii) adverse actual experience on the contracts in our variable annuity and life insurance business. Management judgment is required to evaluate whether indications of potential impairment have occurred, and to test intangibles for impairment if required.

 

 

118   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Use of Estimates

 

The use of generally accepted accounting principles requires management to make certain estimates and assumptions. In addition to the estimates we make in connection with fair value measurements, the accounting for goodwill and identifiable intangible assets, and discretionary compensation accruals, the use of estimates and assumptions is also important in determining provisions for losses that may arise from litigation, regulatory proceedings and tax audits.

A substantial portion of our compensation and benefits represents discretionary compensation, which is finalized at year-end. We believe the most appropriate way to allocate estimated annual discretionary compensation among interim periods is in proportion to the net revenues earned in such periods. In addition to the level of net revenues, our overall compensation expense in any given year is also influenced by, among other factors, overall financial performance, prevailing labor markets, business mix, the structure of our share-based compensation programs and the external environment. See “Results of Operations — Financial Overview — Operating Expenses” below for information regarding our ratio of compensation and benefits to net revenues.

We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. In accounting for income taxes, we estimate and provide for potential liabilities that may arise out of tax audits to the extent that uncertain tax positions fail to meet the recognition standard under FASB Accounting Standards Codification 740. See Note 24 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about accounting for income taxes.

Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. See Notes 18 and 27 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on certain judicial, regulatory and legal proceedings.

 

 

    Goldman Sachs March 2013 Form 10-Q   119


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Results of Operations

 

The composition of our net revenues has varied over time as financial markets and the scope of our operations have changed. The composition of net revenues can also vary over the shorter term due to fluctuations in U.S. and global economic and market conditions. See “Certain Risk Factors That May Affect Our Businesses” below and “Risk Factors”

in Part I, Item 1A of our Annual Report on Form 10-K for a further discussion of the impact of economic and market conditions on our results of operations.

Financial Overview

The table below presents an overview of our financial results.

 

 

   

Three Months

Ended March

 
$ in millions, except per share amounts     2013         2012   

Net revenues

    $10,090         $9,949   
   

Pre-tax earnings

    3,373         3,181   
   

Net earnings

    2,260         2,109   
   

Net earnings applicable to common shareholders

    2,188         2,074   
   

Diluted earnings per common share

    4.29         3.92   
   

Annualized return on average common shareholders’ equity 1

    12.4      12.2

 

1.

Annualized ROE is computed by dividing annualized net earnings applicable to common shareholders by average monthly common shareholders’ equity. The table below presents our average common shareholders’ equity.

 

   

Average for the

Three Months

Ended March

 
in millions     2013         2012   

Total shareholders’ equity

    $76,702         $70,824   
   

Preferred stock

    (6,200      (3,100

Common shareholders’ equity

    $70,502         $67,724   

 

120   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Net Revenues

Three Months Ended March 2013 versus March 2012. Net revenues on the condensed consolidated statements of earnings were $10.09 billion for the first quarter of 2013, essentially unchanged compared with the first quarter of 2012. Net revenues in the first quarter of 2013 included significantly higher investment banking revenues, as well as higher investment management revenues and higher other principal transactions revenues compared with the first quarter of 2012. These increases were largely offset by lower market-making revenues and, to a lesser extent, lower net interest income and lower commissions and fees compared with the first quarter of 2012.

Non-interest Revenues

Investment banking

During the first quarter of 2013, investment banking revenues reflected an operating environment generally characterized by mixed activity levels as a result of continued macroeconomic concerns. Industry-wide debt underwriting activity continued at a robust pace, as interest rates remained low and credit spreads generally tightened. In addition, industry-wide equity underwriting activity improved, although initial public offerings activity remained low. Industry-wide announced and completed mergers and acquisitions activity declined compared with the fourth quarter of 2012. If macroeconomic concerns continue and result in lower levels of client activity, investment banking revenues would likely be negatively impacted.

Three Months Ended March 2013 versus March 2012. Investment banking revenues on the condensed consolidated statements of earnings were $1.57 billion for the first quarter of 2013, 35% higher than the first quarter of 2012, due to significantly higher revenues in our underwriting business. This increase primarily reflected significantly higher revenues in debt underwriting, due to leveraged finance and commercial mortgage-related activity. Revenues in equity underwriting were also significantly higher compared with the first quarter of 2012, reflecting an increase in client activity. Revenues in financial advisory were essentially unchanged compared with the first quarter of 2012.

Investment management

During the first quarter of 2013, investment management revenues reflected an operating environment generally characterized by improved asset prices, resulting in appreciation in the value of client assets. In addition, the mix of assets under supervision has shifted slightly compared with the fourth quarter of 2012 from asset classes that typically generate lower fees to asset classes that typically generate higher fees. In the future, if asset prices were to decline, or investors favor asset classes that typically generate lower fees or investors continue to withdraw their assets, investment management revenues would likely be negatively impacted. In addition, continued concerns about the global economic outlook could result in downward pressure on assets under supervision.

Three Months Ended March 2013 versus March 2012. Investment management revenues on the condensed consolidated statements of earnings were $1.25 billion for the first quarter of 2013, 13% higher than the first quarter of 2012, due to higher incentive fees and higher management and other fees.

Commissions and fees

During the first quarter of 2013, commissions and fees reflected an operating environment generally characterized by an increase in global equity prices and lower volatility levels. Although macroeconomic concerns persisted, positive developments during the quarter contributed to higher market volumes compared with the fourth quarter of 2012. If macroeconomic concerns continue and result in lower market volumes, commissions and fees would likely be negatively impacted.

Three Months Ended March 2013 versus March 2012. Commissions and fees on the condensed consolidated statements of earnings were $829 million for the first quarter of 2013, 4% lower than the first quarter of 2012, reflecting lower market volumes.

 

 

    Goldman Sachs March 2013 Form 10-Q   121


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Market making

During the first quarter of 2013, market-making revenues reflected an operating environment generally characterized by positive developments in the U.S. economy early in the quarter, specifically in housing and unemployment. These improvements contributed to improved client activity levels, generally tighter credit spreads, higher global equity prices and lower levels of volatility. However, later in the quarter, market sentiment was mixed, as political uncertainty in Europe and the United States began to resurface, contributing to client risk aversion and lower client activity levels. Also, uncertainty over financial regulatory reform persisted. If these concerns and uncertainties continue over the long term, market-making revenues would likely continue to be negatively impacted.

Three Months Ended March 2013 versus March 2012. Market-making revenues on the condensed consolidated statements of earnings were $3.44 billion for the first quarter of 2013, 12% lower than the first quarter of 2012. Revenues were lower across most products, primarily reflecting significantly lower revenues in interest rate products and equity derivatives both compared with a strong first quarter of 2012. Revenues in mortgages were higher compared with the first quarter of 2012.

Other principal transactions

During the first quarter of 2013, other principal transactions revenues reflected an operating environment characterized by an increase in equity prices and generally tighter credit spreads. However, concerns about the outlook for the global economy and uncertainty over financial regulatory reform continues to be a meaningful consideration for the global marketplace. If equity markets decline or credit spreads widen, other principal transactions revenues would likely be negatively impacted.

Three Months Ended March 2013 versus March 2012. Other principal transactions revenues on the condensed consolidated statements of earnings were $2.08 billion for the first quarter of 2013, compared with $1.94 billion for the first quarter of 2012. Results for the first quarter of 2013 included a gain from our investment in the ordinary shares of ICBC, net gains from other investments in equities, primarily in private equities, net gains from debt securities and loans, and revenues related to our consolidated investments. In the first quarter of 2012, other principal transactions revenues included a gain from our investment in the ordinary shares of ICBC, net gains from other investments in equities (with public and private equities each contributing approximately one-half of the net gains), net gains from debt securities and loans, and revenues related to our consolidated investments.

Net Interest Income

Three Months Ended March 2013 versus March 2012. Net interest income on the condensed consolidated statements of earnings was $925 million for the first quarter of 2013, 6% lower than the first quarter of 2012. The decrease compared with the first quarter of 2012 was primarily due to lower average yields on financial instruments owned, at fair value, partially offset by lower interest expense related to our short- and long-term borrowings.

 

 

122   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Operating Expenses

Our operating expenses are primarily influenced by compensation, headcount and levels of business activity. Compensation and benefits includes salaries, estimated year-end discretionary compensation, amortization of equity awards and other items such as benefits. Discretionary compensation is significantly impacted by, among other factors, the level of net revenues, overall financial performance, prevailing labor markets, business mix, the structure of our share-based compensation programs and the external environment.

The table below presents our operating expenses and total staff.

 

   

Three Months

Ended March

 
$ in millions     2013           2012   

Compensation and benefits

    $  4,339           $  4,378   
   

 

Brokerage, clearing, exchange and distribution fees

    561           567   
   

Market development

    141           117   
   

Communications and technology

    188           196   
   

Depreciation and amortization

    302           433   
   

Occupancy

    218           212   
   

Professional fees

    246           234   
   

Insurance reserves 1

    127           157   
   

Other expenses

    595           474   

Total non-compensation expenses

    2,378           2,390   

Total operating expenses

    $  6,717           $  6,768   

Total staff at period-end 2

    32,000           32,400   

 

1.

Related revenues are included in “Market making” on the condensed consolidated statements of earnings.

 

2.

Includes employees, consultants and temporary staff.

Three Months Ended March 2013 versus March 2012. Operating expenses on the condensed consolidated statements of earnings were $6.72 billion for the first quarter of 2013, essentially unchanged compared with the first quarter of 2012. The accrual for compensation and benefits expenses on the condensed consolidated statements of earnings was $4.34 billion for the first quarter of 2013, essentially unchanged compared with the first quarter of 2012. The ratio of compensation and benefits to net revenues for the first quarter of 2013 was 43.0%, compared with 44.0% for the first quarter of 2012. Total staff decreased 1% during the first quarter of 2013.

Non-compensation expenses on the condensed consolidated statements of earnings were $2.38 billion for the first quarter of 2013, essentially unchanged compared with the first quarter of 2012. Non-compensation expenses for the first quarter of 2013 included lower depreciation and amortization expenses, primarily reflecting lower impairment charges related to consolidated investments. This decrease was largely offset by higher other expenses, primarily reflecting increased net provisions for litigation and regulatory proceedings and higher expenses related to consolidated investments. The first quarter of 2013 included net provisions for litigation and regulatory proceedings of $110 million.

Provision for Taxes

The effective income tax rate for the first quarter of 2013 was 33.0%, essentially unchanged from the full year tax rate of 33.3% for 2012.

 

 

    Goldman Sachs March 2013 Form 10-Q   123


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Segment Operating Results

The table below presents the net revenues, operating expenses and pre-tax earnings of our segments.

 

       

Three Months

Ended March

 
in millions         2013           2012   

Investment Banking

  Net revenues     $  1,568           $1,154   
                        
    Operating expenses     1,064           871   
    Pre-tax earnings     $     504           $   283   

 

Institutional Client Services

  Net revenues     $  5,139           $5,709   
                        
    Operating expenses     3,566           3,938   
    Pre-tax earnings     $  1,573           $1,771   

 

Investing & Lending

  Net revenues     $  2,068           $1,911   
                        
    Operating expenses     996           958   
    Pre-tax earnings     $  1,072           $   953   

 

Investment Management

  Net revenues     $  1,315           $1,175   
                        
    Operating expenses     1,090           989   
    Pre-tax earnings     $     225           $   186   

 

Total

  Net revenues     $10,090           $9,949   
                        
    Operating expenses     6,717           6,768   
    Pre-tax earnings     $  3,373           $3,181   

 

Total operating expenses in the table above include the following expenses that have not been allocated to our segments:

 

Ÿ  

charitable contributions of $12 million for the three months ended March 2012; and

 

Ÿ  

real estate-related exit costs of $1 million for the three months ended March 2013. Real estate-related exit costs are included in “Depreciation and amortization” in the condensed consolidated statements of earnings.

Operating expenses related to net provisions for litigation and regulatory proceedings, previously not allocated to our segments, have now been allocated. This allocation is consistent with the manner in which management currently views the performance of our segments. Reclassifications have been made to previously reported segment amounts to conform to the current presentation.

Net revenues in our segments include allocations of interest income and interest expense to specific securities, commodities and other positions in relation to the cash generated by, or funding requirements of, such underlying positions. See Note 25 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our business segments.

The cost drivers of Goldman Sachs taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of our business segments. Compensation and benefits expenses within our segments reflect, among other factors, the overall performance of Goldman Sachs as well as the performance of individual businesses. Consequently, pre-tax margins in one segment of our business may be significantly affected by the performance of our other business segments. A discussion of segment operating results follows.

 

 

124   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Investment Banking

Our Investment Banking segment is comprised of:

Financial Advisory. Includes strategic advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, risk management, restructurings and spin-offs, and derivative transactions directly related to these client advisory assignments.

Underwriting. Includes public offerings and private placements, including domestic and cross-border transactions, of a wide range of securities, loans and other financial instruments, and derivative transactions directly related to these client underwriting activities.

The table below presents the operating results of our Investment Banking segment.

 

   

Three Months

Ended March

 
in millions     2013           2012   

Financial Advisory

    $   484           $   489   
   

Equity underwriting

    390           255   
   

Debt underwriting

    694           410   

Total Underwriting

    1,084           665   

Total net revenues

    1,568           1,154   
   

Operating expenses

    1,064           871   

Pre-tax earnings

    $   504           $   283   

The table below presents our financial advisory and underwriting transaction volumes. 1

 

   

Three Months

Ended March

 
in billions     2013           2012   

Announced mergers and acquisitions

    $   134           $   117   
   

Completed mergers and acquisitions

    214           81   
   

Equity and equity-related offerings 2

    24           13   
   

Debt offerings 3

    84           73   

 

1.

Source: Thomson Reuters. Announced and completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related offerings and debt offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or a change in the value of a transaction.

 

2.

Includes Rule 144A and public common stock offerings, convertible offerings and rights offerings.

 

3.

Includes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and taxable municipal debt. Includes publicly registered and Rule 144A issues. Excludes leveraged loans.

Three Months Ended March 2013 versus March 2012. Net revenues in Investment Banking were $1.57 billion for the first quarter of 2013, 36% higher than the first quarter of 2012.

Net revenues in Financial Advisory were $484 million, essentially unchanged compared with the first quarter of 2012. Net revenues in our Underwriting business were $1.08 billion, 63% higher than the first quarter of 2012. This increase primarily reflected significantly higher net revenues in debt underwriting, due to leveraged finance and commercial mortgage-related activity. Net revenues in equity underwriting were also significantly higher compared with the first quarter of 2012, reflecting an increase in client activity.

During the first quarter of 2013, Investment Banking operated in an environment generally characterized by mixed activity levels as a result of continued macroeconomic concerns. Industry-wide debt underwriting activity continued at a robust pace, as interest rates remained low and credit spreads generally tightened. In addition, industry-wide equity underwriting activity improved, although initial public offerings activity remained low. Industry-wide announced and completed mergers and acquisitions activity declined compared with the fourth quarter of 2012. If macroeconomic concerns continue and result in lower levels of client activity, net revenues in Investment Banking would likely be negatively impacted.

Our investment banking transaction backlog decreased compared with the end of 2012, reflecting lower estimated net revenues from potential advisory transactions and lower estimated net revenues from potential equity underwriting transactions, due to a decrease in potential initial public offerings transactions. Estimated net revenues from potential debt underwriting transactions were higher compared with the end of 2012, primarily reflecting an increase in potential transactions across a broad range of products.

 

 

    Goldman Sachs March 2013 Form 10-Q   125


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Our investment banking transaction backlog represents an estimate of our future net revenues from investment banking transactions where we believe that future revenue realization is more likely than not. We believe changes in our investment banking transaction backlog may be a useful indicator of client activity levels which, over the long term, impact our net revenues. However, the time frame for completion and corresponding revenue recognition of transactions in our backlog varies based on the nature of the assignment, as certain transactions may remain in our backlog for longer periods of time and others may enter and leave within the same reporting period. In addition, our transaction backlog is subject to certain limitations, such as assumptions about the likelihood that individual client transactions will occur in the future. Transactions may be cancelled or modified, and transactions not included in the estimate may also occur.

Operating expenses were $1.06 billion for the first quarter of 2013, 22% higher than the first quarter of 2012, due to increased compensation and benefits expenses, primarily resulting from higher net revenues. Pre-tax earnings were $504 million in the first quarter of 2013, 78% higher than the first quarter of 2012.

Institutional Client Services

Our Institutional Client Services segment is comprised of:

Fixed Income, Currency and Commodities Client Execution. Includes client execution activities related to making markets in interest rate products, credit products, mortgages, currencies and commodities.

We generate market-making revenues in these activities, in three ways:

 

Ÿ  

In large, highly liquid markets (such as markets for U.S. Treasury bills or certain mortgage pass-through certificates), we execute a high volume of transactions for our clients for modest spreads and fees.

 

Ÿ  

In less liquid markets (such as mid-cap corporate bonds, growth market currencies or certain non-agency mortgage-backed securities), we execute transactions for our clients for spreads and fees that are generally somewhat larger.

 

Ÿ  

We also structure and execute transactions involving customized or tailor-made products that address our clients’ risk exposures, investment objectives or other complex needs (such as a jet fuel hedge for an airline).

Given the focus on the mortgage market, our mortgage activities are further described below.

Our activities in mortgages include commercial mortgage-related securities, loans and derivatives, residential mortgage-related securities, loans and derivatives (including U.S. government agency-issued collateralized mortgage obligations, other prime, subprime and Alt-A securities and loans), and other asset-backed securities, loans and derivatives.

We buy, hold and sell long and short mortgage positions, primarily for market making for our clients. Our inventory therefore changes based on client demands and is generally held for short-term periods.

See Notes 18 and 27 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information about exposure to mortgage repurchase requests, mortgage rescissions and mortgage-related litigation.

Equities. Includes client execution activities related to making markets in equity products, as well as commissions and fees from executing and clearing institutional client transactions on major stock, options and futures exchanges worldwide. Equities also includes our securities services business, which provides financing, securities lending and other prime brokerage services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and generates revenues primarily in the form of interest rate spreads or fees, and revenues related to our reinsurance activities.

The table below presents the operating results of our Institutional Client Services segment.

 

   

Three Months

Ended March

 
in millions     2013           2012   

Fixed Income, Currency and Commodities Client Execution

    $3,217           $3,458   
   

Equities client execution 1

    809           1,050   
   

Commissions and fees

    793           834   
   

Securities services

    320           367   

Total Equities

    1,922           2,251   

Total net revenues

    5,139           5,709   
   

Operating expenses

    3,566           3,938   

Pre-tax earnings

    $1,573           $1,771   

 

1.

Includes net revenues related to reinsurance of $233 million and $211 million for the three months ended March 2013 and March 2012, respectively.

 

 

126   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Three Months Ended March 2013 versus March 2012. Net revenues in Institutional Client Services were $5.14 billion for the first quarter of 2013, 10% lower than the first quarter of 2012.

Net revenues in Fixed Income, Currency and Commodities Client Execution were $3.22 billion, 7% lower than the first quarter of 2012. Net revenues were lower across most businesses, primarily reflecting significantly lower net revenues in interest rate products compared with a strong first quarter of 2012. Net revenues in mortgages were higher compared with the first quarter of 2012. During the quarter, Fixed Income, Currency and Commodities Client Execution operated in an environment characterized by generally tighter credit spreads and improved client activity levels compared with the fourth quarter of 2012.

Net revenues in Equities were $1.92 billion, 15% lower than the first quarter of 2012, primarily reflecting lower net revenues in equities client execution. This decrease reflected significantly lower net revenues in derivatives compared with a strong first quarter of 2012, partially offset by higher net revenues in cash products. Commissions and fees were lower compared with the first quarter of 2012, reflecting lower market volumes. In addition, securities services net revenues were lower compared with the first quarter of 2012. During the quarter, Equities operated in an environment generally characterized by an increase in global equity prices, lower volatility levels and improved client activity levels compared with the fourth quarter of 2012.

The net loss attributable to the impact of changes in our own credit spreads on borrowings for which the fair value option was elected was $77 million ($42 million and $35 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first quarter of 2013, compared with a net loss of $224 million ($117 million and $107 million related to Fixed Income, Currency and Commodities Client Execution and equities client execution, respectively) for the first quarter of 2012.

During the first quarter of 2013, Institutional Client Services operated in an environment generally characterized by positive developments in the U.S. economy early in the quarter, specifically in housing and unemployment. These improvements contributed to improved client activity levels, generally tighter credit spreads, higher global equity prices and lower levels of volatility. However, later in the quarter, market sentiment was mixed, as political uncertainty in Europe and the United States began to resurface, contributing to client risk aversion and lower client activity levels. Also, uncertainty over financial regulatory reform persisted. If these concerns and uncertainties continue over the long term, net revenues in Fixed Income, Currency and Commodities Client Execution and Equities would likely continue to be negatively impacted.

Operating expenses were $3.57 billion for the first quarter of 2013, 9% lower than the first quarter of 2012, due to decreased compensation and benefits expenses, primarily resulting from lower net revenues, partially offset by higher net provisions for litigation and regulatory proceedings. Pre-tax earnings were $1.57 billion in the first quarter of 2013, 11% lower than the first quarter of 2012.

Investing & Lending

Investing & Lending includes our investing activities and the origination of loans to provide financing to clients. These investments and loans are typically longer-term in nature. We make investments, directly and indirectly through funds that we manage, in debt securities and loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities.

The table below presents the operating results of our Investing & Lending segment.

 

   

Three Months

Ended March

 
in millions     2013           2012   

ICBC

    $     24           $   169   
   

Equity securities (excluding ICBC)

    1,103           891   
   

Debt securities and loans

    566           585   
   

Other

    375           266   

Total net revenues

    2,068           1,911   
   

Operating expenses

    996           958   

Pre-tax earnings

    $1,072           $   953   
 

 

    Goldman Sachs March 2013 Form 10-Q   127


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Three Months Ended March 2013 versus March 2012. Net revenues in Investing & Lending were $2.07 billion for the first quarter of 2013, compared with $1.91 billion for the first quarter of 2012. During the first quarter of 2013, Investing & Lending net revenues were positively impacted by an increase in equity prices and generally tighter credit spreads. Results for the first quarter of 2013 included a gain of $24 million from our investment in the ordinary shares of ICBC, net gains of $1.10 billion from other investments in equities, primarily in private equities, net gains and net interest income of $566 million from debt securities and loans, and other net revenues of $375 million related to our consolidated investments.

During the first quarter of 2012, an increase in global equity prices and tighter credit spreads contributed to positive results in Investing & Lending. These results included a gain of $169 million from our investment in the ordinary shares of ICBC, net gains of $891 million from other investments in equities (with public and private equities each contributing approximately one-half of the net gains), net gains and net interest of $585 million from debt securities and loans, and other net revenues of $266 million related to our consolidated investments.

Operating expenses were $996 million for the first quarter of 2013, 4% higher than the first quarter of 2012, due to increased compensation and benefits expenses, primarily resulting from higher net revenues, partially offset by lower non-compensation expenses related to our consolidated investments. Pre-tax earnings were $1.07 billion in the first quarter of 2013, 12% higher than the first quarter of 2012.

Investment Management

Investment Management provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. Investment Management also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.

Assets under supervision include assets under management and other client assets. Assets under management include client assets where we earn a fee for managing assets on a discretionary basis. This includes net assets in our mutual funds, hedge funds, credit funds and private equity funds (including real estate funds), and separately managed accounts for institutional and individual investors. Other client assets include client assets invested with third-party managers, private bank deposits and advisory relationships where we earn a fee for advisory and other services, but do not have investment discretion. Assets under supervision do not include the self-directed brokerage assets of our clients.

Assets under management and other client assets typically generate fees as a percentage of net asset value, which vary by asset class and are affected by investment performance as well as asset inflows and redemptions.

In certain circumstances, we are also entitled to receive incentive fees based on a percentage of a fund’s return or when the return exceeds a specified benchmark or other performance targets. Incentive fees are recognized only when all material contingencies are resolved.

The table below presents the operating results of our Investment Management segment.

 

   

Three Months

Ended March

 
in millions     2013           2012   

Management and other fees

    $1,060           $1,003   
   

Incentive fees

    140           58   
   

Transaction revenues

    115           114   

Total net revenues

    1,315           1,175   
   

Operating expenses

    1,090           989   

Pre-tax earnings

    $   225           $   186   
 

 

128   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The tables below present our assets under supervision, including assets under management by asset class and other client assets, as well as a summary of the changes in our assets under supervision.

 

    As of  
    March 31,         December 31,  
in billions     2013         2012            2012         2011   

Alternative investments 1

    $130         $139          $133         $142   
   

Equity

    149         136          133         126   
   

Fixed income

    378         347            370         340   

Total non-money market assets

    657         622          636         608   
   

Money markets

    203         202            218         220   

Total assets under management (AUM)

    860         824          854         828   
   

Other client assets

    108         76            111         67   

Total assets under supervision (AUS)

    $968         $900            $965         $895   

 

1.

Primarily includes hedge funds, credit, funds, private equity, real estate, currencies, commodities and asset allocation strategies.

 

       

Three Months

Ended March 31,

 
in billions         2013         2012   

Balance, beginning of period

      $965         $895   
   

Net inflows/(outflows)

      

Alternative investments

      (3      (4
   

Equity

      4         (5
   

Fixed income

        10         1   

Total non-money market net
inflows/(outflows)

      11         (8
   

Money markets

        (15      (18

Total AUM net inflows/(outflows)

      (4      (26

Other client assets net inflows/(outflows)

        (5      5   

Total AUS net inflows/(outflows)

      (9 )       (21
   

Net market appreciation/(depreciation)

      

AUM

      10         22   
   

Other client assets

        2         4   

Total AUS net market
appreciation/(depreciation)

        12         26   

Balance, end of period

        $968         $900   

Three Months Ended March 2013 versus March 2012. Net revenues in Investment Management were $1.32 billion for the first quarter of 2013, 12% higher than the first quarter of 2012, due to higher incentive fees and higher management and other fees. During the quarter, assets under supervision increased $3 billion to $968 billion, reflecting net market appreciation of $12 billion, primarily in equity assets. Net outflows in assets under supervision were $9 billion, as outflows in money market assets and, to a lesser extent, alternative investment assets, were partially offset by inflows in fixed income and equity assets.

During the first quarter of 2013, Investment Management operated in an environment generally characterized by improved asset prices, resulting in appreciation in the value of client assets. In addition, the mix of assets under supervision has shifted slightly compared with the fourth quarter of 2012 from asset classes that typically generate lower fees to asset classes that typically generate higher fees. In the future, if asset prices were to decline, or investors favor asset classes that typically generate lower fees or investors continue to withdraw their assets, net revenues in Investment Management would likely be negatively impacted. In addition, continued concerns about the global economic outlook could result in downward pressure on assets under supervision.

Operating expenses were $1.09 billion for the first quarter of 2013, 10% higher than the first quarter of 2012, primarily due to increased compensation and benefits expenses, primarily resulting from higher net revenues. Pre-tax earnings were $225 million in the first quarter of 2013, 21% higher than the first quarter of 2012.

Geographic Data

See Note 25 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for a summary of our total net revenues and pre-tax earnings by geographic region.

 

 

    Goldman Sachs March 2013 Form 10-Q   129


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Regulatory Developments

 

The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), enacted in July 2010, significantly altered the financial regulatory regime within which we operate. The implications of the Dodd-Frank Act for our businesses will depend to a large extent on the rules that will be adopted by the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), the SEC, the U.S. Commodity Futures Trading Commission (CFTC) and other agencies to implement the legislation, as well as the development of market practices and structures under the regime established by the legislation and the implementing rules. Other reforms have been adopted or are being considered by other regulators and policy makers worldwide and these reforms may affect our businesses. We expect that the principal areas of impact from regulatory reform for us will be:

 

Ÿ  

the Dodd-Frank prohibition on “proprietary trading” and the limitation on the sponsorship of, and investment in, hedge funds and private equity funds by banking entities, including bank holding companies, referred to as the “Volcker Rule”;

 

Ÿ  

increased regulation of and restrictions on over-the-counter (OTC) derivatives markets and transactions; and

 

Ÿ  

increased regulatory capital requirements.

In October 2011, the proposed rules to implement the Volcker Rule were issued and included an extensive request for comments on the proposal. The proposed rules are highly complex, and many aspects of the Volcker Rule remain unclear. The full impact of the rule on us will depend upon the detailed scope of the prohibitions, permitted activities, exceptions and exclusions, and will not be known with certainty until the rules are finalized and market practices and structures develop under the final rules. Currently, companies are expected to be required to be in compliance by July 2014 (subject to possible extensions).

While many aspects of the Volcker Rule remain unclear, we evaluated the prohibition on “proprietary trading” and determined that businesses that engage in “bright line” proprietary trading are most likely to be prohibited. In 2011 and 2010, we liquidated substantially all of our Principal Strategies and Global Macro Proprietary trading positions.

In addition, we have evaluated the limitations on sponsorship of, and investments in, hedge funds and private equity funds. The firm earns management fees and incentive fees for investment management services from hedge funds and private equity funds, which are included in our Investment Management segment. The firm also makes

investments in funds, and the gains and losses from these investments are included in our Investing & Lending segment; these gains and losses will be impacted by the Volcker Rule. The Volcker Rule limitation on investments in hedge funds and private equity funds requires the firm to reduce its investment in each hedge fund and private equity fund to 3% or less of the fund’s net asset value, and to reduce the firm’s aggregate investment in all such funds to 3% or less of the firm’s Tier 1 capital. The firm’s aggregate net revenues from its investments in hedge funds and private equity funds were not material to the firm’s aggregate total net revenues over the period from 1999 through the first quarter of 2013. We continue to manage our existing private equity funds, taking into account the transition periods under the Volcker Rule. With respect to our hedge funds, we currently plan to comply with the Volcker Rule by redeeming certain of our interests in the funds. Since March 2012, we have been redeeming up to approximately 10% of certain hedge funds’ total redeemable units per quarter, and expect to continue to do so through June 2014. Since March 2012, we have redeemed approximately $1.32 billion of these interests in hedge funds, including approximately $260 million during the three months ended March 2013. In addition, we have limited the firm’s initial investment to 3% for certain new investments in hedge funds and private equity funds.

As required by the Dodd-Frank Act, the Federal Reserve Board and FDIC have jointly issued a rule requiring each bank holding company with over $50 billion in assets and each designated systemically important financial institution to provide to regulators an annual plan for its rapid and orderly resolution in the event of material financial distress or failure (resolution plan). Our resolution plan must, among other things, demonstrate that Goldman Sachs Bank USA (GS Bank USA) is adequately protected from risks arising from our other entities. The regulators’ joint rule sets specific standards for the resolution plans, including requiring a detailed resolution strategy and analyses of the company’s material entities, organizational structure, interconnections and interdependencies, and management information systems, among other elements. We submitted our first resolution plan to the regulators on June 29, 2012. GS Bank USA also submitted its first resolution plan on June 29, 2012, as required by the FDIC. In April 2013, the Federal Reserve Board and the FDIC provided additional guidance to the firm relating to its 2013 resolution plan. At the same time, they extended the deadline for submission of our 2013 resolution plan to October 1, 2013. The deadline for submission of GS Bank USA’s 2013 resolution plan was also extended by the FDIC to October 1, 2013.

 

 

130   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

In September 2011, the SEC proposed rules to implement the Dodd-Frank Act’s prohibition against securitization participants’ engaging in any transaction that would involve or result in any material conflict of interest with an investor in a securitization transaction. The proposed rules would except bona fide market-making activities and risk-mitigating hedging activities in connection with securitization activities from the general prohibition. We will also be affected by rules to be adopted by federal agencies pursuant to the Dodd-Frank Act that require any person who organizes or initiates an asset-backed security transaction to retain a portion (generally, at least five percent) of any credit risk that the person conveys to a third party.

In December 2011, the Federal Reserve Board proposed regulations designed to strengthen the regulation and supervision of large bank holding companies and systemically important nonbank financial institutions. These proposals address, among other things, risk-based capital and leverage requirements, liquidity requirements, overall risk management requirements, single counterparty limits and early remediation requirements that are designed to address financial weakness at an early stage. Although many of the proposals mirror initiatives to which bank holding companies are already subject, their full impact on the firm will not be known with certainty until the rules are finalized and market practices and structures develop under the final rules. In addition, in October 2012, the Federal Reserve Board issued final rules for stress testing requirements for certain bank holding companies, including the firm. See “Equity Capital” below for further information about our Comprehensive Capital Analysis and Review (CCAR).

The Dodd-Frank Act also contains provisions that include (i) requiring the registration of all swap dealers and major swap participants with the CFTC and of security-based swap dealers and major security-based swap participants with the SEC, the clearing and execution of certain swaps and security-based swaps through central counterparties, regulated exchanges or electronic facilities and real-time public and regulatory reporting of trade information,

(ii) placing new business conduct standards and other requirements on swap dealers, major swap participants, security-based swap dealers and major security-based swap participants, covering their relationships with counterparties, their internal oversight and compliance structures, conflict of interest rules, internal information barriers, general and trade-specific record-keeping and risk management, (iii) establishing mandatory margin requirements for trades that are not cleared through a central counterparty, (iv) position limits that cap exposure to derivatives on certain physical commodities and (v) entity-level capital requirements for swap dealers, major swap participants, security-based swap dealers and major security-based swap participants.

The CFTC is responsible for issuing rules relating to swaps, swap dealers and major swap participants, and the SEC is responsible for issuing rules relating to security-based swaps, security-based swap dealers and major security-based swap participants. Although the CFTC has not yet finalized its capital regulations, certain of the requirements, including registration of swap dealers and real-time public trade reporting, have taken effect already under CFTC rules, and the SEC and the CFTC have finalized the definitions of a number of key terms. The CFTC adopted final rules requiring the mandatory clearing of certain credit default swaps and interest rate swaps between dealers beginning in March 2013, which include a phase-in for covered transactions with non-dealer financial entities in June 2013 and end-users in September 2013. The CFTC has finalized a number of other implementing rules and laid out a series of implementation deadlines in 2013, covering rules for business conduct standards for swap dealers and clearing requirements.

The SEC has proposed rules to impose margin, capital and segregation requirements for security-based swap dealers and major security-based swap participants. The SEC has also proposed rules relating to registration of security-based swap dealers and major security-based swap participants, trade reporting and real-time reporting, and business conduct requirements for security-based swap dealers and major security-based swap participants.

 

 

    Goldman Sachs March 2013 Form 10-Q   131


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

We have registered certain subsidiaries as “swap dealers” under the CFTC rules, including Goldman, Sachs & Co. (GS&Co.), GS Bank USA, Goldman Sachs International (GSI) and J. Aron & Company. We expect that these entities, and our businesses more broadly, will be subject to significant and developing regulation and regulatory oversight in connection with swap-related activities. Similar regulations have been proposed or adopted in jurisdictions outside the United States and, in July 2012 and February 2013, the Basel Committee and the International Organization of Securities Commissions released consultative documents proposing margin requirements for non-centrally-cleared derivatives. The full impact of the various U.S. and non-U.S. regulatory developments in this area will not be known with certainty until the rules are implemented and market practices and structures develop under the final rules.

The Dodd-Frank Act also establishes the Consumer Financial Protection Bureau, which has broad authority to regulate providers of credit, payment and other consumer financial products and services, and has oversight over certain of our products and services.

In February 2013, the European Commission published a proposal for enhanced cooperation in the area of financial transactions tax in response to a request from certain member states of the European Union. The proposed financial transactions tax is broad in scope and would apply to transactions in a wide variety of financial instruments and derivatives. The proposed date for implementation of the tax is January 1, 2014. We are currently evaluating the impact of the draft legislation, which is still subject to further revisions. The full impact of these proposals will not be known with certainty until the legislation is finalized.

See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about regulatory developments as they relate to our regulatory capital ratios.

See “Business — Regulation” in Part I, Item 1 of our Annual Report on Form 10-K for more information on the laws, rules and regulations and proposed laws, rules and regulations that apply to us and our operations.

 

 

132   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Balance Sheet and Funding Sources

Balance Sheet Management

One of our most important risk management disciplines is our ability to manage the size and composition of our balance sheet. While our asset base changes due to client activity, market fluctuations and business opportunities, the size and composition of our balance sheet reflect (i) our overall risk tolerance, (ii) our ability to access stable funding sources and (iii) the amount of equity capital we hold.

Although our balance sheet fluctuates on a day-to-day basis, our total assets and adjusted assets at quarterly and year-end dates are generally not materially different from those occurring within our reporting periods.

In order to ensure appropriate risk management, we seek to maintain a liquid balance sheet and have processes in place to dynamically manage our assets and liabilities which include:

 

Ÿ  

quarterly planning;

 

Ÿ  

business-specific limits;

 

Ÿ  

monitoring of key metrics; and

 

Ÿ  

scenario analyses.

Quarterly Planning. We prepare a quarterly balance sheet plan that combines our projected total assets and composition of assets with our expected funding sources and capital levels for the upcoming quarter. The objectives of this quarterly planning process are:

 

Ÿ  

to develop our near-term balance sheet projections, taking into account the general state of the financial markets and expected business activity levels;

 

Ÿ  

to ensure that our projected assets are supported by an adequate amount and tenor of funding and that our projected capital and liquidity metrics are within management guidelines and regulatory requirements; and

 

Ÿ  

to allow business risk managers and managers from our independent control and support functions to objectively evaluate balance sheet limit requests from business managers in the context of the firm’s overall balance sheet constraints. These constraints include the firm’s liability profile and equity capital levels, maturities and plans for new debt and equity issuances, share repurchases, deposit trends and secured funding transactions.

To prepare our quarterly balance sheet plan, business risk managers and managers from our independent control and support functions meet with business managers to review current and prior period metrics and discuss expectations for the upcoming quarter. The specific metrics reviewed include asset and liability size and composition, aged inventory, limit utilization, risk and performance measures, and capital usage.

Our consolidated quarterly plan, including our balance sheet plans by business, funding and capital projections, and projected capital and liquidity metrics, is reviewed by the Firmwide Finance Committee. See “Overview and Structure of Risk Management” for an overview of our risk management structure.

 

 

    Goldman Sachs March 2013 Form 10-Q   133


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Business-Specific Limits. The Firmwide Finance Committee sets asset and liability limits for each business and aged inventory limits for certain financial instruments as a disincentive to hold inventory over longer periods of time. These limits are set at levels which are close to actual operating levels in order to ensure prompt escalation and discussion among business managers and managers in our independent control and support functions on a routine basis. The Firmwide Finance Committee reviews and approves balance sheet limits on a quarterly basis and may also approve changes in limits on an ad hoc basis in response to changing business needs or market conditions.

Monitoring of Key Metrics. We monitor key balance sheet metrics daily both by business and on a consolidated basis, including asset and liability size and composition, aged inventory, limit utilization, risk measures and capital usage. We allocate assets to businesses and review and analyze movements resulting from new business activity as well as market fluctuations.

Scenario Analyses. We conduct scenario analyses to determine how we would manage the size and composition of our balance sheet and maintain appropriate funding, liquidity and capital positions in a variety of situations:

 

Ÿ  

These scenarios cover short-term and long-term time horizons using various macro-economic and firm-specific assumptions. We use these analyses to assist us in developing longer-term funding plans, including the level of unsecured debt issuances, the size of our secured funding program and the amount and composition of our equity capital. We also consider any potential future constraints, such as limits on our ability to grow our asset base in the absence of appropriate funding.

 

Ÿ  

Through our Internal Capital Adequacy Assessment Process (ICAAP), CCAR, the Dodd-Frank Act Stress Tests (DFAST), and our resolution and recovery planning, we further analyze how we would manage our balance sheet and risks through the duration of a severe crisis and we develop plans to access funding, generate liquidity, and/or redeploy or issue equity capital, as appropriate.

Balance Sheet Allocation

In addition to preparing our condensed consolidated statements of financial condition in accordance with U.S. GAAP, we prepare a balance sheet that generally allocates assets to our businesses, which is a non-GAAP presentation and may not be comparable to similar non-GAAP presentations used by other companies. We believe that presenting our assets on this basis is meaningful because it is consistent with the way management views and manages risks associated with the firm’s assets and better enables investors to assess the liquidity of the firm’s assets. The table below presents a summary of this balance sheet allocation.

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Excess liquidity (Global Core Excess)

    $174,435         $174,622   
   

Other cash

    7,440         6,839   

Excess liquidity and cash

    181,875         181,461   
   

Secured client financing

    238,029         229,442   
   

Inventory

    297,813         318,323   
   

Secured financing agreements

    106,491         76,277   
   

Receivables

    41,897         36,273   

Institutional Client Services

    446,201         430,873   
   

ICBC 1

    1,110         2,082   
   

Public equity (excluding ICBC)

    2,931         3,866   
   

Private equity

    17,164         17,401   
   

Debt

    23,788         25,386   
   

Receivables and other

    9,637         8,421   

Investing & Lending

    54,630         57,156   

Total inventory and related assets

    500,831         488,029   
   

Other assets 2

    38,488         39,623   

Total assets

    $959,223         $938,555   

 

1.

In January 2013, we sold approximately 45% of the ordinary shares of ICBC.

 

2.

Includes assets related to our reinsurance business classified as held for sale as of March 2013 and December 2012, respectively. See Note 12 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information.

 

 

134   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The following is a description of the captions in the table above.

Excess Liquidity and Cash. We maintain substantial excess liquidity to meet a broad range of potential cash outflows and collateral needs in the event of a stressed environment. See “Liquidity Risk Management” below for details on the composition and sizing of our excess liquidity pool or “Global Core Excess” (GCE). In addition to our excess liquidity, we maintain other operating cash balances, primarily for use in specific currencies, entities, or jurisdictions where we do not have immediate access to parent company liquidity.

Secured Client Financing. We provide collateralized financing for client positions, including margin loans secured by client collateral, securities borrowed, and resale agreements primarily collateralized by government obligations. As a result of client activities, we are required to segregate cash and securities to satisfy regulatory requirements. Our secured client financing arrangements, which are generally short-term, are accounted for at fair value or at amounts that approximate fair value, and include daily margin requirements to mitigate counterparty credit risk.

Institutional Client Services. In Institutional Client Services, we maintain inventory positions to facilitate market-making in fixed income, equity, currency and commodity products. Additionally, as part of client market-making activities, we enter into resale or securities borrowing arrangements to obtain securities which we can use to cover transactions in which we or our clients have sold securities that have not yet been purchased. The receivables in Institutional Client Services primarily relate to securities transactions.

Investing & Lending. In Investing & Lending, we make investments and originate loans to provide financing to clients. These investments and loans are typically longer-term in nature. We make investments, directly and indirectly through funds that we manage, in debt securities, loans, public and private equity securities, real estate and other investments.

Other Assets. Other assets are generally less liquid, non-financial assets, including property, leasehold improvements and equipment, goodwill and identifiable intangible assets, income tax-related receivables, equity-method investments, assets classified as held for sale and miscellaneous receivables.

 

 

    Goldman Sachs March 2013 Form 10-Q   135


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The tables below present the reconciliation of this balance sheet allocation to our U.S. GAAP balance sheet. In the tables below, total assets for Institutional Client Services and Investing & Lending represent the inventory and related assets. These amounts differ from total assets by

business segment disclosed in Note 25 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q because total assets disclosed in Note 25 include allocations of our excess liquidity and cash, secured client financing and other assets.

 

 

    As of March 2013  
in millions    
 
 
Excess
Liquidity
and Cash
  
  
 1 
   
 
 
Secured
Client
Financing
  
  
  
    
 
 
Institutional
Client
Services
  
  
  
    

 

Investing &

Lending

  

  

    
 
Other
Assets
  
  
    

 

Total

Assets

  

  

Cash and cash equivalents

    $  63,333        $         —         $         —         $       —         $       —         $  63,333   
   

Cash and securities segregated for regulatory and other purposes

           41,044                                 41,044   
   

Securities purchased under agreements to resell and federal funds sold

    37,803        73,253         46,832         618                 158,506   
   

Securities borrowed

    36,913        75,469         59,659                         172,041   
   

Receivables from brokers, dealers and clearing organizations

           5,662         14,802         37                 20,501   
   

Receivables from customers and counterparties

           42,601         27,095         8,221                 77,917   
   

Financial instruments owned, at fair value

    43,826                297,813         45,754                 387,393   
   

Other assets

                                   38,488         38,488   

Total assets

    $181,875        $238,029         $446,201         $54,630         $38,488         $959,223   
    As of December 2012  
in millions    
 
 
Excess
Liquidity
and Cash
  
  
 1 
   
 
 
Secured
Client
Financing
  
  
  
    
 
 
Institutional
Client
Services
  
  
  
    

 

Investing &

Lending

  

  

    
 
Other
Assets
  
  
    

 

Total

Assets

  

  

Cash and cash equivalents

    $  72,669        $         —         $          —         $        —         $        —         $  72,669   
   

Cash and securities segregated for regulatory and other purposes

           49,671                                 49,671   
   

Securities purchased under agreements to resell and federal funds sold

    28,018        84,064         28,960         292                 141,334   
   

Securities borrowed

    41,699        47,877         47,317                         136,893   
   

Receivables from brokers, dealers and clearing organizations

           4,400         14,044         36                 18,480   
   

Receivables from customers and counterparties

           43,430         22,229         7,215                 72,874   
   

Financial instruments owned, at fair value

    39,075                318,323         49,613                 407,011   
   

Other assets

                                   39,623         39,623   

Total assets

    $181,461        $229,442         $430,873         $57,156         $39,623         $938,555   

 

1.

Includes unencumbered cash, U.S. government and federal agency obligations (including highly liquid U.S. federal agency mortgage-backed obligations), and German, French, Japanese and United Kingdom government obligations.

 

136   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Balance Sheet Analysis and Metrics

As of March 2013, total assets on our condensed consolidated statements of financial condition were $959.22 billion, an increase of $20.67 billion from December 2012. This increase was primarily due to an increase in collateralized agreements of $52.32 billion, primarily due to firm and client activities. This increase was partially offset by a decrease in financial instruments owned, at fair value of $19.62 billion, primarily due to decreases in equities and convertible debentures, non-U.S. government and agency obligations, commodities and derivatives.

As of March 2013, total liabilities on our condensed consolidated statements of financial condition were $882.00 billion, an increase of $19.16 billion from December 2012. This increase was primarily due to an increase in financial instruments sold, but not yet purchased, at fair value of $27.11 billion, primarily due to increases in non-U.S. government and agency obligations, U.S. government and federal agency obligations, and equities and convertible debentures. This increase was partially offset by a decrease in securities sold under agreements to repurchase, at fair value of $16.45 billion, primarily due to firm financing activities.

As of March 2013 and December 2012, our total securities sold under agreements to repurchase, at fair value, accounted for as collateralized financings, were $155.36 billion and $171.81 billion, respectively, which were 8% lower and essentially unchanged, respectively, compared with the daily average amount of repurchase agreements over the respective quarters. As of March 2013, the decrease in our repurchase agreements relative to the daily average during the quarter was primarily due to firm financing activities. The level of our repurchase agreements fluctuates between and within periods, primarily due to providing clients with access to highly liquid collateral, such as U.S. government and federal agency, and investment-grade sovereign obligations through collateralized financing activities.

The table below presents information on our assets, unsecured long-term borrowings, shareholders’ equity and leverage ratios.

 

$ in millions   As of  
 

March

2013

      

December

2012

 

Total assets

    $959,223           $938,555   
   

Adjusted assets

    $689,034           $686,874   
   

Unsecured long-term borrowings

    $167,008           $167,305   
   

Total shareholders’ equity

    $  77,228           $  75,716   
   

Leverage ratio

    12.4x           12.4x   
   

Adjusted leverage ratio

    8.9x           9.1x   
   

Debt to equity ratio

    2.2x           2.2x   

Adjusted assets. Adjusted assets equals total assets less (i) low-risk collateralized assets generally associated with our secured client financing transactions, federal funds sold and excess liquidity (which includes financial instruments sold, but not yet purchased, at fair value, less derivative liabilities) and (ii) cash and securities we segregate for regulatory and other purposes. Adjusted assets is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.

The table below presents the reconciliation of total assets to adjusted assets.

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Total assets

    $ 959,223         $ 938,555   
   

Deduct:

 

Securities borrowed

    (172,041      (136,893
   
 

Securities purchased under agreements to resell and federal funds sold

    (158,506      (141,334
   

Add:

 

Financial instruments sold, but not yet purchased, at fair value

    153,749         126,644   
   
   

Less derivative liabilities

    (52,347      (50,427
 

Subtotal

    (229,145      (202,010
   

Deduct:

 

Cash and securities segregated for regulatory and other purposes

    (41,044      (49,671

Adjusted assets

    $ 689,034         $ 686,874   

Leverage ratio. The leverage ratio equals total assets divided by total shareholders’ equity and measures the proportion of equity and debt the firm is using to finance assets. This ratio is different from the Tier 1 leverage ratio included in “Equity Capital — Consolidated Regulatory Capital Ratios” below, and further described in Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

 

    Goldman Sachs March 2013 Form 10-Q   137


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Adjusted leverage ratio. The adjusted leverage ratio equals adjusted assets divided by total shareholders’ equity. We believe that the adjusted leverage ratio is a more meaningful measure of our capital adequacy than the leverage ratio because it excludes certain low-risk collateralized assets that are generally supported with little or no capital. The adjusted leverage ratio is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.

Our adjusted leverage ratio decreased to 8.9x as of March 2013 from 9.1x as of December 2012 as our total shareholders’ equity increased.

Debt to equity ratio. The debt to equity ratio equals unsecured long-term borrowings divided by total shareholders’ equity.

Funding Sources

Our primary sources of funding are secured financings, unsecured long-term and short-term borrowings, and deposits. We seek to maintain broad and diversified funding sources globally.

We raise funding through a number of different products, including:

 

Ÿ  

collateralized financings, such as repurchase agreements, securities loaned and other secured financings;

 

Ÿ  

long-term unsecured debt (including structured notes) through syndicated U.S. registered offerings, U.S. registered and Rule 144A medium-term note programs, offshore medium-term note offerings and other debt offerings;

 

Ÿ  

savings and demand deposits through deposit sweep programs and time deposits through internal and third-party broker-dealers; and

 

Ÿ  

short-term unsecured debt through U.S. and non-U.S. commercial paper and promissory note issuances and other methods.

We generally distribute our funding products through our own sales force and third-party distributors, to a large, diverse creditor base in a variety of markets in the Americas, Europe and Asia. We believe that our relationships with our creditors are critical to our liquidity. Our creditors include banks, governments, securities lenders, pension funds, insurance companies, mutual funds and individuals. We have imposed various internal guidelines to monitor creditor concentration across our funding programs.

Secured Funding. We fund a significant amount of inventory on a secured basis. Secured funding is less sensitive to changes in our credit quality than unsecured funding, due to our posting of collateral to our lenders. Nonetheless, we continually analyze the refinancing risk of our secured funding activities, taking into account trade tenors, maturity profiles, counterparty concentrations, collateral eligibility and counterparty rollover probabilities. We seek to mitigate our refinancing risk by executing term trades with staggered maturities, diversifying counterparties, raising excess secured funding, and pre-funding residual risk through our GCE.

We seek to raise secured funding with a term appropriate for the liquidity of the assets that are being financed, and we seek longer maturities for secured funding collateralized by asset classes that may be harder to fund on a secured basis especially during times of market stress. Substantially all of our secured funding, excluding funding collateralized by liquid government obligations, is executed for tenors of one month or greater. Assets that may be harder to fund on a secured basis during times of market stress include certain financial instruments in the following categories: mortgage and other asset-backed loans and securities, non-investment grade corporate debt securities, equities and convertible debentures and emerging market securities. Assets that are classified as level 3 in the fair value hierarchy are generally funded on an unsecured basis. See Note 6 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about the classification of financial instruments in the fair value hierarchy and see “— Unsecured Long-Term Borrowings” below for further information about the use of unsecured long-term borrowings as a source of funding.

The weighted average maturity of our secured funding, excluding funding collateralized by highly liquid securities eligible for inclusion in our GCE, exceeded 100 days as of March 2013.

A majority of our secured funding for securities not eligible for inclusion in the GCE is executed through term repurchase agreements and securities lending contracts. We also raise financing through other types of collateralized financings, such as secured loans and notes.

GS Bank USA has access to funding through the Federal Reserve Bank discount window. While we do not rely on this funding in our liquidity planning and stress testing, we maintain policies and procedures necessary to access this funding and test discount window borrowing procedures.

 

 

138   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Unsecured Long-Term Borrowings. We issue unsecured long-term borrowings as a source of funding for inventory and other assets and to finance a portion of our GCE. We issue in different tenors, currencies, and products to

maximize the diversification of our investor base. The table below presents our quarterly unsecured long-term borrowings maturity profile through the first quarter of 2019 as of March 2013.

 

 

LOGO

 

The weighted average maturity of our unsecured long-term borrowings as of March 2013 was approximately eight years. To mitigate refinancing risk, we seek to limit the principal amount of debt maturing on any one day or during any week or year. We enter into interest rate swaps to convert a substantial portion of our long-term

borrowings into floating-rate obligations in order to manage our exposure to interest rates. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unsecured long-term borrowings.

 

 

    Goldman Sachs March 2013 Form 10-Q   139


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Deposits. As part of our efforts to diversify our funding base, deposits have become a more meaningful share of our funding activities. GS Bank USA has been actively growing its deposit base with an emphasis on issuance of long-term certificates of deposit and on expanding our deposit sweep program, which involves long-term contractual agreements with several U.S. broker-dealers who sweep client cash to FDIC-insured deposits. We utilize deposits to finance activities in our bank subsidiaries. The table below presents the sourcing of our deposits.

 

    As of March 2013  
    Type of Deposit  
in millions     Savings and Demand  1       Time  2 

Private bank deposits 3

    $30,022         $        —   
   

Certificates of deposit

            22,749   
   

Deposit sweep programs

    15,431           
   

Institutional

    302         4,181   

Total 4

    $45,755         $26,930   

 

1.

Represents deposits with no stated maturity.

 

2.

Weighted average maturity in excess of three years.

 

3.

Substantially all were from overnight deposit sweep programs related to private wealth management clients.

 

4.

Deposits insured by the FDIC as of March 2013 were approximately $43.98 billion.

Unsecured Short-Term Borrowings. A significant portion of our short-term borrowings was originally long-term debt that is scheduled to mature within one year of the reporting date. We use short-term borrowings to finance liquid assets and for other cash management purposes. We primarily issue commercial paper, promissory notes, and other hybrid instruments.

As of March 2013, our unsecured short-term borrowings, including the current portion of unsecured long-term borrowings, were $40.98 billion. See Note 15 to the condensed consolidated financial statements in Part I, Item 1 of this Form  10-Q for further information about our unsecured short-term borrowings.

Equity Capital

Capital adequacy is of critical importance to us. Our objective is to be conservatively capitalized in terms of the amount and composition of our equity base. Accordingly, we have in place a comprehensive capital management policy that serves as a guide to determine the amount and composition of equity capital we maintain.

The level and composition of our equity capital are determined by multiple factors including our current and future consolidated regulatory capital requirements, our ICAAP, CCAR and results of stress tests, and may also be influenced by other factors such as rating agency guidelines, subsidiary capital requirements, the business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments. In addition, we maintain a capital plan which projects sources and uses of capital given a range of business environments, and a contingency capital plan which provides a framework for analyzing and responding to an actual or perceived capital shortfall.

As part of the Federal Reserve Board’s annual CCAR, U.S. bank holding companies with total consolidated assets of $50 billion or greater are required to submit annual capital plans for review by the Federal Reserve Board. The purpose of the Federal Reserve Board’s review is to ensure that these institutions have robust, forward-looking capital planning processes that account for their unique risks and that permit continued operations during times of economic and financial stress. The Federal Reserve Board will evaluate a bank holding company based on whether it has the capital necessary to continue operating under the baseline and stressed scenarios provided by the Federal Reserve. As part of the capital plan review, the Federal Reserve Board evaluates an institution’s plan to make capital distributions, such as increasing dividend payments or repurchasing or redeeming stock, across a range of macro-economic and firm-specific assumptions. In addition, the DFAST rules require us to conduct stress tests on a semi-annual basis and publish a summary of certain results. The Federal Reserve Board also conducts its own annual stress tests and publishes a summary of certain results.

We submitted our 2013 CCAR to the Federal Reserve on January 7, 2013 and published a summary of our DFAST results under the Federal Reserve Board’s severely adverse scenario in March 2013. As part of our 2013 CCAR submission, the Federal Reserve informed us that it did not object to our proposed capital actions, including the repurchase of outstanding common stock, a potential increase in our quarterly common stock dividend and the possible issuance, redemption and modification of other capital securities through the first quarter of 2014. However, as required by the Federal Reserve, we will resubmit our capital plan by the end of the third quarter of 2013, incorporating certain enhancements to our stress test processes.

 

 

140   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Our consolidated regulatory capital requirements are determined by the Federal Reserve Board, as described below. Our ICAAP incorporates an internal risk-based capital assessment designed to identify and measure material risks associated with our business activities, including market risk, credit risk and operational risk, in a manner that is closely aligned with our risk management practices. Our internal risk-based capital assessment is supplemented with the results of stress tests.

As of March 2013, our total shareholders’ equity was $77.23 billion (consisting of common shareholders’ equity of $71.03 billion and preferred stock of $6.20 billion). As of December 2012, our total shareholders’ equity was $75.72 billion (consisting of common shareholders’ equity of $69.52 billion and preferred stock of $6.20 billion). In addition, as of both March 2013 and December 2012, $2.75 billion of our junior subordinated debt issued to trusts qualified as capital for regulatory and certain rating agency purposes. See “— Consolidated Regulatory Capital Ratios” below for information regarding the impact of regulatory developments.

Consolidated Regulatory Capital

The Federal Reserve Board is the primary regulator of Group Inc., a bank holding company under the Bank Holding Company Act of 1956 (BHC Act) and a financial holding company under amendments to the BHC Act effected by the U.S. Gramm-Leach-Bliley Act of 1999. As a bank holding company, we are subject to consolidated regulatory capital requirements that are computed in accordance with the Federal Reserve Board’s risk-based capital regulations (which are based on the ‘Basel 1’ Capital Accord of the Basel Committee) reflecting the Federal Reserve Board’s revised market risk regulatory capital requirements which became effective on January 1, 2013. These capital requirements are expressed as capital ratios that compare measures of capital to risk-weighted assets (RWAs). See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information regarding the firm’s RWAs. The firm’s capital levels are also subject to qualitative judgments by its regulators about components, risk weightings and other factors.

Federal Reserve Board regulations require bank holding companies to maintain a minimum Tier 1 capital ratio of 4% and a minimum total capital ratio of 8%. The required minimum Tier 1 capital ratio and total capital ratio in order to be considered a “well-capitalized” bank holding company under the Federal Reserve Board guidelines are 6% and 10%, respectively. Bank holding companies may be expected to maintain ratios well above the minimum levels, depending on their particular condition, risk profile and growth plans. The minimum Tier 1 leverage ratio is 3% for bank holding companies that have received the highest supervisory rating under Federal Reserve Board guidelines or that have implemented the Federal Reserve Board’s risk-based capital measure for market risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of 4%.

Consolidated Regulatory Capital Ratios

The table below presents information about our regulatory capital ratios, which are based on Basel 1, as implemented by the Federal Reserve Board. The information as of March 2013 reflects the revised market risk regulatory capital requirements, which became effective on January 1, 2013. The information as of December 2012 is prior to the implementation of these revised market risk regulatory capital requirements. In the table below:

 

Ÿ  

Equity investments in certain entities primarily represent a portion of our equity investments in non-financial companies.

 

Ÿ  

Debt valuation adjustment represents the cumulative change in the fair value of our unsecured borrowings attributable to the impact of changes in our own credit spreads (net of tax at the applicable tax rate).

 

Ÿ  

Other adjustments within our Tier 1 common capital include net unrealized gains/(losses) on available-for-sale securities (net of tax at the applicable tax rate), the cumulative change in our pension and postretirement liabilities (net of tax at the applicable tax rate) and investments in certain nonconsolidated entities.

 

Ÿ  

Qualifying subordinated debt represents subordinated debt issued by Group Inc. with an original term to maturity of five years or greater. The outstanding amount of subordinated debt qualifying for Tier 2 Capital is reduced, or discounted, upon reaching a remaining maturity of five years. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about the subordinated debt.

 

 

    Goldman Sachs March 2013 Form 10-Q   141


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

    As of  
$ in millions    
 
March
2013
  
  
   
 
December
2012
  
  

Common shareholders’ equity

    $  71,028        $  69,516   
   

Less: Goodwill

    (3,702     (3,702
   

Less: Intangible assets

    (981     (1,397
   

Less: Equity investments in certain entities

    (3,959     (4,805
   

Less: Disallowed deferred tax assets

    (1,002     (1,261
   

Less: Debt valuation adjustment

    (115     (180
   

Less: Other adjustments

    (134     (124

Tier 1 Common Capital

    61,135        58,047   
   

Perpetual non-cumulative preferred stock

    6,200        6,200   
   

Junior subordinated debt issued to trusts 1

    2,063        2,750   
   

Other adjustments

    (27     (20

Tier 1 Capital

    69,371        66,977   

Qualifying subordinated debt

    12,721        13,342   
   

Junior subordinated debt issued to trusts 1

    687          
   

Other adjustments

    37        87   

Tier 2 Capital

    13,445        13,429   

Total Capital

    $  82,816        $  80,406   

Risk-Weighted Assets

    $480,080        $399,928   
   

Tier 1 Capital Ratio

    14.4     16.7
   

Total Capital Ratio

    17.3     20.1
   

Tier 1 Leverage Ratio 2

    7.5     7.3
   

Tier 1 Common Ratio 3

    12.7     14.5

 

1.

Beginning on January 1, 2013, we began to incorporate the Dodd-Frank Act’s phase-out of Tier 1 capital treatment for junior subordinated debt issued to trusts. The firm has assumed a phase-out period allowing for only 75% of the capital instrument to be included in Tier 1 capital in calendar year 2013, reflecting the Federal Reserve Board’s proposed capital rules. Phased-out amounts that are no longer eligible as Tier 1 capital treatment are eligible for Tier 2 capital treatment. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about the junior subordinated debt issued to trusts.

 

2.

See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about the firm’s Tier 1 leverage ratio.

 

3.

The Tier 1 common ratio equals Tier 1 common capital divided by RWAs. We believe that the Tier 1 common ratio is meaningful because it is one of the measures that we and investors use to assess capital adequacy and is of increasing importance to regulators. The Tier 1 common ratio is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.

Our Tier 1 capital ratio decreased to 14.4% as of March 2013 from 16.7% as of December 2012 primarily reflecting an increase in RWAs. The increase in RWAs was primarily driven by the implementation of the revised market risk regulatory capital requirements which introduced a new methodology for determining RWAs for market risk and are designed to implement the new market risk framework of the Basel Committee, as well as the prohibition on the use of external credit ratings, as required by the Dodd-Frank Act. These revised market risk capital requirements are a significant part of the regulatory capital changes that will ultimately be reflected in our Basel 3 capital ratios.

The table below presents the changes in Tier 1 common capital, Tier 1 capital and Tier 2 capital for the three months ended March 2013.

 

in millions   Three Months Ended

March 2013

  

  

Tier 1 Common Capital

  

Balance, beginning of year

     $58,047   
   

Increase in common shareholders’ equity

     1,512   
   

Decrease in intangible assets

     416   
   

Decrease in equity investments in certain entities

     846   
   

Decrease in disallowed deferred tax assets

     259   
   

Decrease in debt valuation adjustment

     65   
   

Increase in other adjustments

     (10

Balance, end of period

     61,135   

Tier 1 Capital

    

Balance, beginning of year

     66,977   
   

Net increase in Tier 1 common capital

     3,088   
   

Redesignation of junior subordinated debt issued to trusts

     (687
   

Increase in other adjustments

     (7

Balance, end of period

     69,371   

Tier 2 Capital

    

Balance, beginning of year

     13,429   
   

Decrease in qualifying subordinated debt

     (621
   

Redesignation of junior subordinated debt issued to trusts

     687   
   

Decrease in other adjustments

     (50

Balance, end of period

     13,445   

Total Capital

     $82,816   

See “Business — Regulation” in Part I, Item 1 of our Annual Report on Form 10-K and Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about our regulatory capital ratios and the related regulatory requirements, including pending and proposed regulatory changes.

 

 

142   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Risk-Weighted Assets

RWAs under the Federal Reserve Board’s risk-based capital requirements are calculated based on measures of credit risk and market risk.

RWAs for credit risk reflect amounts for on-balance sheet and off–balance sheet exposures. Credit risk requirements for on-balance sheet assets, such as receivables and cash, are generally based on the balance sheet value. Credit risk requirements for securities financing transactions are determined based upon the positive net exposure for each trade, and include the effect of counterparty netting and collateral, as applicable. For off-balance sheet exposures, including commitments and guarantees, a credit equivalent amount is calculated based on the notional amount of each trade. Requirements for OTC derivatives are based on a combination of positive net exposure and a percentage of the notional amount of each trade, and include the effect of counterparty netting and collateral, as applicable. All such assets and exposures are then assigned a risk weight depending on, among other things, whether the counterparty is a sovereign, bank or a qualifying securities firm or other entity (or if collateral is held, depending on the nature of the collateral).

Under Basel 1, prior to the implementation of the revised market risk regulatory capital requirements, RWAs for market risk were determined by reference to the firm’s Value-at-Risk (VaR) model, supplemented by the standardized measurement method used to determine RWAs for specific risk for certain positions.

Under the Federal Reserve Board’s revised market risk regulatory capital requirements, which became effective on January 1, 2013, the methodology for calculating RWAs for market risk was changed. RWAs for market risk are now determined using VaR, stressed VaR, incremental risk, comprehensive risk and a standardized measurement method for specific risk.

VaR is the potential loss in value of inventory positions due to adverse market movements over a defined time horizon with a specified confidence level. For both risk management purposes and regulatory capital calculations we use a single VaR model which captures risks including interest rates, equity prices, currency rates and commodity prices. VaR used for regulatory capital requirements (Regulatory VaR) differs from risk management VaR due to different time horizons (10-day vs. 1-day), confidence levels (99% vs. 95%) and differences in the scope of positions on which VaR is calculated. Stressed VaR is the potential loss in value of inventory positions during a period of significant market

stress. Incremental risk is the potential loss in value of non-securitized inventory positions due to the default or credit migration of issuers of financial instruments over a one-year time horizon. Comprehensive risk is the potential loss in value, due to price risk and defaults, within the firm’s credit correlation positions. The standardized measurement method is used to determine RWAs for specific risk for certain positions by applying supervisory defined risk-weighting factors to such positions after applicable netting is performed.

We will provide additional information on Regulatory VaR, stressed VaR, incremental risk, comprehensive risk and the standardized measurement method for specific risk on our web site as described under “Available Information” below.

The table below presents information on the components of RWAs within our consolidated regulatory capital ratios.

 

    As of  
in millions    
 
March
2013
  
  
      
 
December
2012
  
  

Credit RWAs

      

OTC derivatives

    $  93,903           $107,269   
   

Commitments and guarantees 1

    41,067           46,007   
   

Securities financing transactions 2

    38,054           47,069   
   

Other 3

    99,791           87,181   

Total Credit RWAs

    $272,815           $287,526   

Total Market RWAs

    207,265           112,402   

Total RWAs 4

    $480,080           $399,928   

 

1.

Principally includes certain commitments to extend credit and letters of credit.

 

2.

Represents resale and repurchase agreements and securities borrowed and loaned transactions.

 

3.

Principally includes receivables from customers, other assets, cash and cash equivalents and available-for-sale securities.

 

4.

Under the current regulatory capital framework, there is no explicit requirement for Operational Risk.

The table below presents information on the components of market RWAs within our consolidated regulatory capital ratios as of March 2013.

 

in millions     As of March 2013   

Regulatory VaR

    $  12,600   
   

Stressed VaR

    43,875   
   

Incremental risk

    23,388   
   

Comprehensive risk

    22,700   
   

Specific risk

    104,702   

Total Market RWAs

    $207,265   
 

 

    Goldman Sachs March 2013 Form 10-Q   143


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Internal Capital Adequacy Assessment Process

We perform an ICAAP with the objective of ensuring that the firm is appropriately capitalized relative to the risks in our business.

As part of our ICAAP, we perform an internal risk-based capital assessment. This assessment incorporates market risk, credit risk and operational risk. Market risk is calculated by using VaR calculations supplemented by risk-based add-ons which include risks related to rare events (tail risks). Credit risk utilizes assumptions about our counterparties’ probability of default, the size of our losses in the event of a default and the maturity of our counterparties’ contractual obligations to us. Operational risk is calculated based on scenarios incorporating multiple types of operational failures. Backtesting is used to gauge the effectiveness of models at capturing and measuring relevant risks.

We evaluate capital adequacy based on the result of our internal risk-based capital assessment and regulatory capital ratios, supplemented with the results of stress tests which measure the firm’s estimated performance under various market conditions. Our goal is to hold sufficient capital to ensure we remain adequately capitalized after experiencing a severe stress event. Our assessment of capital adequacy is viewed in tandem with our assessment of liquidity adequacy and is integrated into the overall risk management structure, governance and policy framework of the firm.

We attribute capital usage to each of our businesses based upon our internal risk-based capital and regulatory frameworks and manage the levels of usage based upon the balance sheet and risk limits established.

Rating Agency Guidelines

The credit rating agencies assign credit ratings to the obligations of Group Inc., which directly issues or guarantees substantially all of the firm’s senior unsecured obligations. GS&Co. and GSI have been assigned long- and short-term issuer ratings by certain credit rating agencies. GS Bank USA has also been assigned long-term issuer ratings as well as ratings on its long-term and short-term bank deposits. In addition, credit rating agencies have assigned ratings to debt obligations of certain other subsidiaries of Group Inc.

The level and composition of our equity capital are among the many factors considered in determining our credit ratings. Each agency has its own definition of eligible capital and methodology for evaluating capital adequacy, and assessments are generally based on a combination of factors rather than a single calculation. See “Liquidity Risk Management — Credit Ratings” for further information about credit ratings of Group Inc., GS&Co., GSI and GS Bank USA.

Subsidiary Capital Requirements

Many of our subsidiaries, including GS Bank USA and our broker-dealer subsidiaries, are subject to separate regulation and capital requirements of the jurisdictions in which they operate.

GS Bank USA is subject to minimum capital requirements that are calculated in a manner similar to those applicable to bank holding companies and computes its capital ratios in accordance with the regulatory capital requirements currently applicable to state member banks, which are based on Basel 1, as implemented by the Federal Reserve Board. As of March 2013 and December 2012, GS Bank USA’s Tier 1 capital ratio under Basel 1 as implemented by the Federal Reserve Board was 15.9% and 18.9%, respectively. See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about GS Bank USA’s regulatory capital ratios under Basel 1, as implemented by the Federal Reserve Board. Effective January 1, 2013, GS Bank USA also implemented the revised market risk regulatory capital requirements outlined above. These revised market risk regulatory capital requirements are a significant part of the regulatory capital changes that will ultimately be reflected in GS Bank USA’s Basel 3 capital ratios.

 

 

144   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

For purposes of assessing the adequacy of its capital, GS Bank USA has established an ICAAP which is similar to that used by Group Inc. In addition, the rules adopted by the Federal Reserve Board under the Dodd-Frank Act require GS Bank USA to conduct stress tests on an annual basis and publish a summary of certain results. GS Bank USA submitted its annual stress results to the Federal Reserve on January 7, 2013 and published a summary of its results in March 2013. GS Bank USA’s capital levels and prompt corrective action classification are subject to qualitative judgments by its regulators about components, risk weightings and other factors.

We expect that the capital requirements of several of our subsidiaries are likely to increase in the future due to the various developments arising from the Basel Committee, the Dodd-Frank Act, and other governmental entities and regulators. See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information about the capital requirements of our other regulated subsidiaries and the potential impact of regulatory reform.

Subsidiaries not subject to separate regulatory capital requirements may hold capital to satisfy local tax and legal guidelines, rating agency requirements (for entities with assigned credit ratings) or internal policies, including policies concerning the minimum amount of capital a subsidiary should hold based on its underlying level of risk. In certain instances, Group Inc. may be limited in its ability to access capital held at certain subsidiaries as a result of regulatory, tax or other constraints. As of March 2013 and December 2012, Group Inc.’s equity investment in subsidiaries was $71.68 billion and $73.32 billion, respectively, compared with its total shareholders’ equity of $77.23 billion and $75.72 billion, respectively.

Group Inc. has guaranteed the payment obligations of GS&Co., GS Bank USA, and Goldman Sachs Execution & Clearing, L.P. (GSEC) subject to certain exceptions. In November 2008, Group Inc. contributed subsidiaries into GS Bank USA, and Group Inc. agreed to guarantee certain losses, including credit-related losses, relating to assets held by the contributed entities. In connection with this guarantee, Group Inc. also agreed to pledge to GS Bank USA certain collateral, including interests in subsidiaries and other illiquid assets.

Our capital invested in non-U.S. subsidiaries is generally exposed to foreign exchange risk, substantially all of which is managed through a combination of derivatives and non-U.S. denominated debt.

Contingency Capital Plan

Our contingency capital plan provides a framework for analyzing and responding to a perceived or actual capital deficiency, including, but not limited to, identification of drivers of a capital deficiency, as well as mitigants and potential actions. It outlines the appropriate communication procedures to follow during a crisis period, including internal dissemination of information as well as ensuring timely communication with external stakeholders.

Equity Capital Management

Our objective is to maintain a sufficient level and optimal composition of equity capital. We principally manage our capital through issuances and repurchases of our common stock. We may also, from time to time, issue or repurchase our preferred stock, junior subordinated debt issued to trusts and other subordinated debt or other forms of capital as business conditions warrant and subject to approval of the Federal Reserve Board. We manage our capital requirements principally by setting limits on balance sheet assets and/or limits on risk, in each case both at the consolidated and business levels. We attribute capital usage to each of our businesses based upon our internal risk-based capital and regulatory frameworks and manage the levels of usage based upon the balance sheet and risk limits established.

See Notes 16 and 19 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our preferred stock, junior subordinated debt issued to trusts and other subordinated debt.

Berkshire Hathaway Warrant. On March 25, 2013, the firm amended its warrant agreement with Berkshire Hathaway Inc. and certain of its subsidiaries (collectively, Berkshire Hathaway) to require net share settlement and to specify the exercise date as October 1, 2013. Under the amended agreement, the firm will deliver to Berkshire Hathaway the number of shares of common stock equal in value to the difference between the average closing price of the firm’s common stock over the 10 trading days preceding October 1, 2013 and the exercise price of $115.00 multiplied by the number of shares of common stock (43.5 million) covered by the warrant.

 

 

 

    Goldman Sachs March 2013 Form 10-Q   145


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Share Repurchase Program. We seek to use our share repurchase program to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by our current and projected capital positions (i.e., comparisons of our desired level and composition of capital to our actual level and composition of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of our common stock.

On April 15, 2013, the Board of Directors of Group Inc. (Board), authorized the repurchase of an additional 75.0 million shares of common stock pursuant to the firm’s existing share repurchase program. As of April 15, 2013, under the share repurchase program approved by the Board, we can repurchase up to 86.4 million additional shares of common stock, including the newly authorized amount; however, any such repurchases are subject to the approval of the Federal Reserve Board. See “Unregistered Sales of Equity Securities and Use of Proceeds” in Part II, Item 2 and Note 19 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information on our repurchase program and see above for information about the annual CCAR.

Other Capital Metrics

The table below presents information on our shareholders’ equity and book value per common share.

 

    As of  
in millions, except per share amounts    

 

March

2013

  

  

    

 

December

2012

  

  

Total shareholders’ equity

    $77,228         $75,716   
   

Common shareholders’ equity

    71,028         69,516   
   

Tangible common shareholders’ equity

    66,345         64,417   
   

Book value per common share

    148.41         144.67   
   

Tangible book value per common share

    138.62         134.06   

Tangible common shareholders’ equity. Tangible common shareholders’ equity equals total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets. We believe that tangible common shareholders’ equity is meaningful because it is a measure that we and investors use to assess capital adequacy. Tangible common shareholders’ equity is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.

The table below presents the reconciliation of total shareholders’ equity to tangible common shareholders’ equity.

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Total shareholders’ equity

    $77,228         $75,716   
   

Deduct: Preferred stock

    (6,200      (6,200

Common shareholders’ equity

    71,028         69,516   
   

Deduct: Goodwill and identifiable intangible assets

    (4,683      (5,099

Tangible common shareholders’ equity

    $66,345         $64,417   

Book value and tangible book value per common share. Book value and tangible book value per common share are based on common shares outstanding, including restricted stock units granted to employees with no future service requirements, of 478.6 million and 480.5 million as of March 2013 and December 2012, respectively. We believe that tangible book value per common share (tangible common shareholders’ equity divided by common shares outstanding) is meaningful because it is a measure that we and investors use to assess capital adequacy. Tangible book value per common share is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.

 

 

146   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Off-Balance-Sheet Arrangements

and Contractual Obligations

Off-Balance-Sheet Arrangements

We have various types of off-balance-sheet arrangements that we enter into in the ordinary course of business. Our involvement in these arrangements can take many different forms, including:

 

Ÿ  

purchasing or retaining residual and other interests in special purpose entities such as mortgage-backed and other asset-backed securitization vehicles;

 

Ÿ  

holding senior and subordinated debt, interests in limited and general partnerships, and preferred and common stock in other nonconsolidated vehicles;

 

Ÿ  

entering into interest rate, foreign currency, equity, commodity and credit derivatives, including total return swaps;

 

Ÿ  

entering into operating leases; and

 

Ÿ  

providing guarantees, indemnifications, loan commitments, letters of credit and representations and warranties.

We enter into these arrangements for a variety of business purposes, including securitizations. The securitization vehicles that purchase mortgages, corporate bonds, and other types of financial assets are critical to the functioning

of several significant investor markets, including the mortgage-backed and other asset-backed securities markets, since they offer investors access to specific cash flows and risks created through the securitization process.

We also enter into these arrangements to underwrite client securitization transactions; provide secondary market liquidity; make investments in performing and nonperforming debt, equity, real estate and other assets; provide investors with credit-linked and asset-repackaged notes; and receive or provide letters of credit to satisfy margin requirements and to facilitate the clearance and settlement process.

Our financial interests in, and derivative transactions with, such nonconsolidated entities are generally accounted for at fair value, in the same manner as our other financial instruments, except in cases where we apply the equity method of accounting.

The table below presents where a discussion of our various off-balance-sheet arrangements may be found in Part I, Items 1 and 2 of this Form 10-Q. In addition, see Note 3 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for a discussion of our consolidation policies.

 

 

Type of Off-Balance-Sheet Arrangement       Disclosure in Form 10-Q

Variable interests and other obligations, including contingent obligations, arising from variable interests in nonconsolidated VIEs

   

See Note 11 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

Leases, letters of credit, and lending and other commitments

   

See “Contractual Obligations” below and Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

Guarantees

   

See “Contractual Obligations” below and Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

Derivatives

     

See “Credit Risk Management — Credit Exposures — OTC Derivatives” below and Notes 4, 5, 7 and 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

    Goldman Sachs March 2013 Form 10-Q   147


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Contractual Obligations

We have certain contractual obligations which require us to make future cash payments. These contractual obligations include our unsecured long-term borrowings, secured long-term financings, time deposits, contractual interest payments and insurance agreements, all of which are included in our condensed consolidated statements of financial condition. Our obligations to make future cash

payments also include certain off-balance-sheet contractual obligations such as purchase obligations, minimum rental payments under noncancelable leases and commitments and guarantees.

The table below presents our contractual obligations, commitments and guarantees as of March 2013.

 

 

in millions    
 
Remainder
of 2013
  
  
    

 

2014-

2015

  

  

    

 

2016-

2017

  

  

    

 

2018-

Thereafter

  

  

     Total   

Amounts related to on-balance-sheet obligations

             

Time deposits 1

    $         —         $    6,781         $  4,421         $  5,517         $  16,719   
   

Secured long-term financings 2

            6,429         1,197         1,345         8,971   
   

Unsecured long-term borrowings 3

            37,121         42,269         87,618         167,008   
   

Contractual interest payments 4

    4,933         12,974         9,959         33,812         61,678   
   

Insurance liabilities 5

    355         923         905         13,731         15,914   
   

Subordinated liabilities issued by consolidated VIEs

    7         55         30         901         993   
   

Amounts related to off-balance-sheet arrangements

             

Commitments to extend credit

    8,163         16,813         39,973         9,152         74,101   
   

Contingent and forward starting resale and securities borrowing agreements

    72,068                                 72,068   
   

Forward starting repurchase and secured lending agreements

    13,268                                 13,268   
   

Letters of credit

    533         179                 15         727   
   

Investment commitments

    1,627         1,908         239         3,608         7,382   
   

Other commitments

    3,483         80         27         69         3,659   
   

Minimum rental payments

    304         730         558         1,363         2,955   
   

Derivative guarantees

    318,426         275,467         53,158         58,370         705,421   
   

Securities lending indemnifications

    30,360                                 30,360   
   

Other financial guarantees

    751         455         1,268         1,028         3,502   

 

1.

Excludes $10.21 billion of time deposits maturing within one year.

 

2.

The aggregate contractual principal amount of secured long-term financings for which the fair value option was elected, primarily consisting of transfers of financial assets accounted for as financings rather than sales and certain other nonrecourse financings, exceeded their related fair value by $134 million.

 

3.

Includes $9.84 billion related to interest rate hedges on certain unsecured long-term borrowings. In addition, the fair value of unsecured long-term borrowings (principal and non-principal-protected) for which the fair value option was elected exceeded the related aggregate contractual principal amount by $140 million. Excludes $82 million of unsecured long-term borrowings related to our reinsurance business classified as held for sale as of March 2013. See Note 17 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information.

 

4.

Represents estimated future interest payments related to unsecured long-term borrowings, secured long-term financings and time deposits based on applicable interest rates as of March 2013. Includes stated coupons, if any, on structured notes.

 

5.

Represents estimated undiscounted payments related to future benefits and unpaid claims arising from policies associated with our insurance activities, excluding separate accounts and estimated recoveries under reinsurance contracts. Excludes $13.02 billion of insurance liabilities related to our reinsurance business classified as held for sale as of March 2013. See Note 17 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information.

 

In the table above:

 

Ÿ  

Obligations maturing within one year of our financial statement date or redeemable within one year of our financial statement date at the option of the holder are excluded and are treated as short-term obligations.

 

Ÿ  

Obligations that are repayable prior to maturity at our option are reflected at their contractual maturity dates and obligations that are redeemable prior to maturity at the option of the holders are reflected at the dates such options become exercisable.

Ÿ  

Amounts included in the table do not necessarily reflect the actual future cash flow requirements for these arrangements because commitments and guarantees represent notional amounts and may expire unused or be reduced or cancelled at the counterparty’s request.

 

Ÿ  

Due to the uncertainty of the timing and amounts that will ultimately be paid, our liability for unrecognized tax benefits has been excluded. See Note 24 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unrecognized tax benefits.

 

 

148   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

See Notes 15 and 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our short-term borrowings and commitments and guarantees, respectively.

As of March 2013, our unsecured long-term borrowings were $167.01 billion, with maturities extending to 2061, and consisted principally of senior borrowings. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unsecured long-term borrowings.

As of March 2013, our future minimum rental payments net of minimum sublease rentals under noncancelable leases were $2.96 billion. These lease commitments, principally for office space, expire on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. See Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our leases.

Our occupancy expenses include costs associated with office space held in excess of our current requirements. This excess space, the cost of which is charged to earnings as incurred, is being held for potential growth or to replace currently occupied space that we may exit in the future. We regularly evaluate our current and future space capacity in relation to current and projected staffing levels. During the three months ended March 2013, total occupancy expenses for space held in excess of our current requirements were not material. In addition, during the three months ended March 2013, we incurred exit costs of $1 million related to our office space. We may incur exit costs in the future to the extent we (i) reduce our space capacity or (ii) commit to, or occupy, new properties in the locations in which we operate and, consequently, dispose of existing space that had been held for potential growth. These exit costs may be material to our results of operations in a given period.

Overview and Structure of Risk Management

Overview

We believe that effective risk management is of primary importance to the success of the firm. Accordingly, we have comprehensive risk management processes through which we monitor, evaluate and manage the risks we assume in conducting our activities. These include market, credit, liquidity, operational, legal, regulatory and reputational risk exposures. Our risk management framework is built around three core components: governance, processes and people.

Governance. Risk management governance starts with our Board, which plays an important role in reviewing and approving risk management policies and practices, both directly and through its Risk Committee, which consists of all of our independent directors. The Board also receives regular briefings on firmwide risks, including market risk, liquidity risk, credit risk and operational risk from our independent control and support functions, including the chief risk officer. The chief risk officer, as part of the review of the firmwide risk package, regularly advises the Risk Committee of the Board of relevant risk metrics and material exposures. Next, at the most senior levels of the firm, our leaders are experienced risk managers, with a sophisticated and detailed understanding of the risks we take. Our senior managers lead and participate in risk-oriented committees, as do the leaders of our independent control and support functions — including those in compliance, controllers, credit risk management, human capital management, legal, market risk management, operations, operational risk management, tax, technology and treasury.

The firm’s governance structure provides the protocol and responsibility for decision-making on risk management issues and ensures implementation of those decisions. We make extensive use of risk-related committees that meet regularly and serve as an important means to facilitate and foster ongoing discussions to identify, manage and mitigate risks.

 

 

    Goldman Sachs March 2013 Form 10-Q   149


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

We maintain strong communication about risk and we have a culture of collaboration in decision-making among the revenue-producing units, independent control and support functions, committees and senior management. While we believe that the first line of defense in managing risk rests with the managers in our revenue-producing units, we dedicate extensive resources to independent control and support functions in order to ensure a strong oversight structure and an appropriate segregation of duties. We regularly reinforce the firm’s strong culture of escalation and accountability across all divisions and functions.

Processes. We maintain various processes and procedures that are critical components of our risk management. First and foremost is our daily discipline of marking substantially all of the firm’s inventory to current market levels. Goldman Sachs carries its inventory at fair value, with changes in valuation reflected immediately in our risk management systems and in net revenues. We do so because we believe this discipline is one of the most effective tools for assessing and managing risk and that it provides transparent and realistic insight into our financial exposures.

We also apply a rigorous framework of limits to control risk across multiple transactions, products, businesses and markets. This includes setting credit and market risk limits at a variety of levels and monitoring these limits on a daily basis. Limits are typically set at levels that will be periodically exceeded, rather than at levels which reflect our maximum risk appetite. This fosters an ongoing dialogue on risk among revenue-producing units, independent control and support functions, committees and senior management, as well as rapid escalation of risk-related matters. See “Market Risk Management” and “Credit Risk Management” for further information on our risk limits.

Active management of our positions is another important process. Proactive mitigation of our market and credit exposures minimizes the risk that we will be required to take outsized actions during periods of stress.

We also focus on the rigor and effectiveness of the firm’s risk systems. The goal of our risk management technology is to get the right information to the right people at the right time, which requires systems that are comprehensive, reliable and timely. We devote significant time and resources to our risk management technology to ensure that it consistently provides us with complete, accurate and timely information.

People. Even the best technology serves only as a tool for helping to make informed decisions in real time about the risks we are taking. Ultimately, effective risk management requires our people to interpret our risk data on an ongoing and timely basis and adjust risk positions accordingly. In both our revenue-producing units and our independent control and support functions, the experience of our professionals, and their understanding of the nuances and limitations of each risk measure, guide the firm in assessing exposures and maintaining them within prudent levels.

Structure

Ultimate oversight of risk is the responsibility of the firm’s Board. The Board oversees risk both directly and through its Risk Committee. Within the firm, a series of committees with specific risk management mandates have oversight or decision-making responsibilities for risk management activities. Committee membership generally consists of senior managers from both our revenue-producing units and our independent control and support functions. We have established procedures for these committees to ensure that appropriate information barriers are in place. Our primary risk committees, most of which also have additional sub-committees or working groups, are described below. In addition to these committees, we have other risk-oriented committees which provide oversight for different businesses, activities, products, regions and legal entities.

Membership of the firm’s risk committees is reviewed regularly and updated to reflect changes in the responsibilities of the committee members. Accordingly, the length of time that members serve on the respective committees varies as determined by the committee chairs and based on the responsibilities of the members within the firm.

In addition, independent control and support functions, which report to the chief financial officer, the general counsel and the chief administrative officer, or in the case of Internal Audit, to the Audit Committee of the Board, are responsible for day-to-day oversight or monitoring of risk, as discussed in greater detail in the following sections. Internal Audit, which includes professionals with a broad range of audit and industry experience, including risk management expertise, is responsible for independently assessing and validating key controls within the risk management framework.

 

 

150   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The chart below presents an overview of our risk management governance structure, highlighting the

oversight of our Board, our key risk-related committees and the independence of our control and support functions.

 

 

LOGO

 

Management Committee. The Management Committee oversees the global activities of the firm, including all of the firm’s independent control and support functions. It provides this oversight directly and through authority delegated to committees it has established. This committee is comprised of the most senior leaders of the firm, and is chaired by the firm’s chief executive officer. The Management Committee has established various committees with delegated authority and the chairperson of the Management Committee appoints the chairpersons of these committees. Most members of the Management Committee are also members of other firmwide, divisional and regional committees. The following are the committees that are principally involved in firmwide risk management.

Firmwide Client and Business Standards Committee. The Firmwide Client and Business Standards Committee assesses and makes determinations regarding business standards and practices, reputational risk management, client relationships and client service, is chaired by the firm’s president and chief operating officer, and reports to the Management Committee. This committee also has responsibility for overseeing the implementation of the recommendations of the Business Standards Committee. This committee has established the following two risk-related committees that report to it:

 

 

    Goldman Sachs March 2013 Form 10-Q   151


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Ÿ  

Firmwide New Activity Committee. The Firmwide New Activity Committee is responsible for reviewing new activities and for establishing a process to identify and review previously approved activities that are significant and that have changed in complexity and/or structure or present different reputational and suitability concerns over time to consider whether these activities remain appropriate. This committee is co-chaired by the firm’s head of operations/chief operating officer for Europe, Middle East and Africa and the chief administrative officer of our Investment Management Division who are appointed by the Firmwide Client and Business Standards Committee chairperson.

 

Ÿ  

Firmwide Suitability Committee. The Firmwide Suitability Committee is responsible for setting standards and policies for product, transaction and client suitability and providing a forum for consistency across divisions, regions and products on suitability assessments. This committee also reviews suitability matters escalated from other firm committees. This committee is co-chaired by the firm’s international general counsel and the co-head of our Investment Management Division who are appointed by the Firmwide Client and Business Standards Committee chairperson.

Firmwide Risk Committee. The Firmwide Risk Committee is globally responsible for the ongoing monitoring and management of the firm’s financial risks. Through both direct and delegated authority, the Firmwide Risk Committee approves firmwide, product, divisional and business-level limits for both market and credit risks, approves sovereign credit risk limits and reviews results of stress tests and scenario analyses. This committee is co-chaired by the firm’s chief financial officer and a senior managing director from the firm’s executive office, and reports to the Management Committee. The following four committees report to the Firmwide Risk Committee. The chairperson of the Securities Division Risk Committee is appointed by the chairpersons of the Firmwide Risk Committee; the chairpersons of the Credit Policy and Firmwide Operational Risk Committees are appointed by the firm’s chief risk officer; and the chairpersons of the Firmwide Finance Committee are appointed by the Firmwide Risk Committee.

Ÿ  

Securities Division Risk Committee. The Securities Division Risk Committee sets market risk limits, subject to overall firmwide risk limits, for the Securities Division based on a number of risk measures, including but not limited to VaR, stress tests, scenario analyses and balance sheet levels. This committee is chaired by the chief risk officer of our Securities Division.

 

Ÿ  

Credit Policy Committee. The Credit Policy Committee establishes and reviews broad firmwide credit policies and parameters that are implemented by our Credit Risk Management department (Credit Risk Management). This committee is chaired by the firm’s chief credit officer.

 

Ÿ  

Firmwide Operational Risk Committee. The Firmwide Operational Risk Committee provides oversight of the ongoing development and implementation of our operational risk policies, framework and methodologies, and monitors the effectiveness of operational risk management. This committee is chaired by a managing director in Credit Risk Management.

 

Ÿ  

Firmwide Finance Committee. The Firmwide Finance Committee has oversight responsibility for liquidity risk, the size and composition of our balance sheet and capital base, and credit ratings. This committee regularly reviews our liquidity, balance sheet, funding position and capitalization, approves related policies, and makes recommendations as to any adjustments to be made in light of current events, risks, exposures and regulatory requirements. As a part of such oversight, this committee reviews and approves balance sheet limits and the size of our GCE. This committee is co-chaired by the firm’s chief financial officer and the firm’s global treasurer.

 

 

152   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The following committees report jointly to the Firmwide Risk Committee and the Firmwide Client and Business Standards Committee:

 

Ÿ  

Firmwide Commitments Committee. The Firmwide Commitments Committee reviews the firm’s underwriting and distribution activities with respect to equity and equity-related product offerings, and sets and maintains policies and procedures designed to ensure that legal, reputational, regulatory and business standards are maintained on a global basis. In addition to reviewing specific transactions, this committee periodically conducts general strategic reviews of sectors and products and establishes policies in connection with transaction practices. This committee is co-chaired by the firm’s senior strategy officer and the co-head of Global Mergers & Acquisitions who are appointed by the Firmwide Client and Business Standards Committee chairperson.

 

Ÿ  

Firmwide Capital Committee. The Firmwide Capital Committee provides approval and oversight of debt-related transactions, including principal commitments of the firm’s capital. This committee aims to ensure that business and reputational standards for underwritings and capital commitments are maintained on a global basis. This committee is co-chaired by the firm’s global treasurer and the head of credit finance for Europe, Middle East and Africa who are appointed by the Firmwide Risk Committee chairpersons.

Investment Management Division Risk Committee. The Investment Management Division Risk Committee is responsible for the ongoing monitoring and control of global market, counterparty credit and liquidity risks associated with the activities of our investment management businesses. The head of Investment Management Division risk management is the chair of this committee. The Investment Management Division Risk Committee reports to the firm’s chief risk officer.

Conflicts Management

Conflicts of interest and the firm’s approach to dealing with them are fundamental to our client relationships, our reputation and our long-term success. The term “conflict of interest” does not have a universally accepted meaning, and conflicts can arise in many forms within a business or between businesses. The responsibility for identifying potential conflicts, as well as complying with the firm’s policies and procedures, is shared by the entire firm.

We have a multilayered approach to resolving conflicts and addressing reputational risk. The firm’s senior management oversees policies related to conflicts resolution. The firm’s senior management, the Business Selection and Conflicts Resolution Group, the Legal Department and Compliance Division, the Firmwide Client and Business Standards Committee and other internal committees all play roles in the formulation of policies, standards and principles and assist in making judgments regarding the appropriate resolution of particular conflicts. Resolving potential conflicts necessarily depends on the facts and circumstances of a particular situation and the application of experienced and informed judgment.

At the transaction level, various people and groups have roles. As a general matter, the Business Selection and Conflicts Resolution Group reviews all financing and advisory assignments in Investment Banking and certain investing, lending and other activities of the firm. Various transaction oversight committees, such as the Firmwide Capital, Commitments and Suitability Committees and other committees across the firm, also review new underwritings, loans, investments and structured products. These committees work with internal and external lawyers and the Compliance Division to evaluate and address any actual or potential conflicts.

We regularly assess our policies and procedures that address conflicts of interest in an effort to conduct our business in accordance with the highest ethical standards and in compliance with all applicable laws, rules, and regulations.

 

 

    Goldman Sachs March 2013 Form 10-Q   153


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Liquidity Risk Management

 

Liquidity is of critical importance to financial institutions. Most of the recent failures of financial institutions have occurred in large part due to insufficient liquidity. Accordingly, the firm has in place a comprehensive and conservative set of liquidity and funding policies to address both firm-specific and broader industry or market liquidity events. Our principal objective is to be able to fund the firm and to enable our core businesses to continue to serve clients and generate revenues, even under adverse circumstances.

We manage liquidity risk according to the following principles:

Excess Liquidity. We maintain substantial excess liquidity to meet a broad range of potential cash outflows and collateral needs in a stressed environment.

Asset-Liability Management. We assess anticipated holding periods for our assets and their expected liquidity in a stressed environment. We manage the maturities and diversity of our funding across markets, products and counterparties, and seek to maintain liabilities of appropriate tenor relative to our asset base.

Contingency Funding Plan. We maintain a contingency funding plan to provide a framework for analyzing and responding to a liquidity crisis situation or periods of market stress. This framework sets forth the plan of action to fund normal business activity in emergency and stress situations. These principles are discussed in more detail below.

Excess Liquidity

Our most important liquidity policy is to pre-fund our estimated potential cash and collateral needs during a liquidity crisis and hold this excess liquidity in the form of unencumbered, highly liquid securities and cash. We believe that the securities held in our global core excess would be readily convertible to cash in a matter of days, through liquidation, by entering into repurchase agreements or from maturities of resale agreements, and that this cash would allow us to meet immediate obligations without needing to sell other assets or depend on additional funding from credit-sensitive markets.

As of March 2013 and December 2012, the fair value of the securities and certain overnight cash deposits included in our GCE totaled $174.44 billion and $174.62 billion, respectively. Based on the results of our internal liquidity risk model, discussed below, as well as our consideration of other factors including, but not limited to, an assessment of our potential intraday liquidity needs and a qualitative assessment of the condition of the financial markets and the firm, we believe our liquidity position as of March 2013 was appropriate.

The table below presents the fair value of the securities and certain overnight cash deposits that are included in our GCE.

 

    Average for the  
in millions    

 

Three Months Ended

March 2013

  

  

    

 

Year Ended

December 2012

  

  

U.S. dollar-denominated

    $136,228         $125,111   
   

Non-U.S. dollar-denominated

    44,278         46,984   

Total

    $180,506         $172,095   

The U.S. dollar-denominated excess is composed of (i) unencumbered U.S. government and federal agency obligations (including highly liquid U.S. federal agency mortgage-backed obligations), all of which are eligible as collateral in Federal Reserve open market operations and (ii) certain overnight U.S. dollar cash deposits. The non-U.S. dollar-denominated excess is composed of only unencumbered German, French, Japanese and United Kingdom government obligations and certain overnight cash deposits in highly liquid currencies. We strictly limit our excess liquidity to this narrowly defined list of securities and cash because they are highly liquid, even in a difficult funding environment. We do not include other potential sources of excess liquidity, such as less liquid unencumbered securities or committed credit facilities, in our GCE.

 

 

154   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The table below presents the fair value of our GCE by asset class.

 

    Average for the  
in millions    

 

Three Months Ended

March 2013

  

  

    

 

Year Ended

December 2012

  

  

Overnight cash deposits

    $  63,045         $  52,233   
   

U.S. government obligations

    73,106         72,379   
   

U.S. federal agency obligations, including highly liquid U.S. federal agency mortgage-backed obligations

    1,580         2,313   
   

German, French, Japanese and United Kingdom government obligations

    42,775         45,170   

Total

    $180,506         $172,095   

The GCE is held at Group Inc. and our major broker-dealer and bank subsidiaries, as presented in the table below.

 

    Average for the  
in millions    

 

Three Months Ended

March 2013

  

  

    

 

Year Ended

December 2012

  

  

Group Inc.

    $  25,656         $  37,405   
   

Major broker-dealer subsidiaries

    87,895         78,229   
   

Major bank subsidiaries

    66,955         56,461   

Total

    $180,506         $172,095   

Our GCE reflects the following principles:

 

Ÿ  

The first days or weeks of a liquidity crisis are the most critical to a company’s survival.

 

Ÿ  

Focus must be maintained on all potential cash and collateral outflows, not just disruptions to financing flows. Our businesses are diverse, and our liquidity needs are determined by many factors, including market movements, collateral requirements and client commitments, all of which can change dramatically in a difficult funding environment.

 

Ÿ  

During a liquidity crisis, credit-sensitive funding, including unsecured debt and some types of secured financing agreements, may be unavailable, and the terms (e.g., interest rates, collateral provisions and tenor) or availability of other types of secured financing may change.

 

Ÿ  

As a result of our policy to pre-fund liquidity that we estimate may be needed in a crisis, we hold more unencumbered securities and have larger debt balances than our businesses would otherwise require. We believe that our liquidity is stronger with greater balances of highly liquid unencumbered securities, even though it increases our total assets and our funding costs.

We believe that our GCE provides us with a resilient source of funds that would be available in advance of potential cash and collateral outflows and gives us significant flexibility in managing through a difficult funding environment.

In order to determine the appropriate size of our GCE, we use an internal liquidity model, referred to as the Modeled Liquidity Outflow, which captures and quantifies the firm’s liquidity risks. We also consider other factors including, but not limited to, an assessment of our potential intraday liquidity needs and a qualitative assessment of the condition of the financial markets and the firm.

We distribute our GCE across entities, asset types, and clearing agents to provide us with sufficient operating liquidity to ensure timely settlement in all major markets, even in a difficult funding environment.

We maintain our GCE to enable us to meet current and potential liquidity requirements of our parent company, Group Inc., and our major broker-dealer and bank subsidiaries. The Modeled Liquidity Outflow incorporates a consolidated requirement as well as a standalone requirement for each of our major broker-dealer and bank subsidiaries. Liquidity held directly in each of these subsidiaries is intended for use only by that subsidiary to meet its liquidity requirements and is assumed not to be available to Group Inc. unless (i) legally provided for and (ii) there are no additional regulatory, tax or other restrictions. We hold a portion of our GCE directly at Group Inc. to support consolidated requirements not accounted for in the major subsidiaries. In addition to the GCE, we maintain operating cash balances in several of our other operating entities, primarily for use in specific currencies, entities, or jurisdictions where we do not have immediate access to parent company liquidity.

In addition to our GCE, we have a significant amount of other unencumbered cash and financial instruments, including other government obligations, high-grade money market securities, corporate obligations, marginable equities, loans and cash deposits not included in our GCE. The fair value of these assets averaged $92.03 billion and $87.09 billion for the three months ended March 2013 and year ended December 2012, respectively. We do not consider these assets liquid enough to be eligible for our GCE liquidity pool and therefore conservatively do not assume we will generate liquidity from these assets in our Modeled Liquidity Outflow.

 

 

    Goldman Sachs March 2013 Form 10-Q   155


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Modeled Liquidity Outflow. Our Modeled Liquidity Outflow is based on a scenario that includes both a market-wide stress and a firm-specific stress, characterized by the following qualitative elements:

 

Ÿ  

Severely challenged market environments, including low consumer and corporate confidence, financial and political instability, adverse changes in market values, including potential declines in equity markets and widening of credit spreads.

 

Ÿ  

A firm-specific crisis potentially triggered by material losses, reputational damage, litigation, executive departure, and/or a ratings downgrade.

The following are the critical modeling parameters of the Modeled Liquidity Outflow:

 

Ÿ  

Liquidity needs over a 30-day scenario.

 

Ÿ  

A two-notch downgrade of the firm’s long-term senior unsecured credit ratings.

 

Ÿ  

A combination of contractual outflows, such as upcoming maturities of unsecured debt, and contingent outflows (e.g., actions though not contractually required, we may deem necessary in a crisis). We assume that most contingent outflows will occur within the initial days and weeks of a crisis.

 

Ÿ  

No issuance of equity or unsecured debt.

 

Ÿ  

No support from government funding facilities. Although we have access to various central bank funding programs, we do not assume reliance on them as a source of funding in a liquidity crisis.

 

Ÿ  

We do not assume asset liquidation, other than the GCE.

The Modeled Liquidity Outflow is calculated and reported to senior management on a daily basis. We regularly refine our model to reflect changes in market or economic conditions and the firm’s business mix.

The potential contractual and contingent cash and collateral outflows covered in our Modeled Liquidity Outflow include:

Unsecured Funding

Ÿ  

Contractual: All upcoming maturities of unsecured long-term debt, commercial paper, promissory notes and other unsecured funding products. We assume that we will be unable to issue new unsecured debt or rollover any maturing debt.

 

Ÿ  

Contingent: Repurchases of our outstanding long-term debt, commercial paper and hybrid financial instruments in the ordinary course of business as a market maker.

Deposits

Ÿ  

Contractual: All upcoming maturities of term deposits. We assume that we will be unable to raise new term deposits or rollover any maturing term deposits.

 

Ÿ  

Contingent: Withdrawals of bank deposits that have no contractual maturity. The withdrawal assumptions reflect, among other factors, the type of deposit, whether the deposit is insured or uninsured, and the firm’s relationship with the depositor.

Secured Funding

Ÿ  

Contractual: A portion of upcoming contractual maturities of secured funding due to either the inability to refinance or the ability to refinance only at wider haircuts (i.e., on terms which require us to post additional collateral). Our assumptions reflect, among other factors, the quality of the underlying collateral, counterparty roll probabilities (our assessment of the counterparty’s likelihood of continuing to provide funding on a secured basis at the maturity of the trade) and counterparty concentration.

 

Ÿ  

Contingent: Adverse changes in value of financial assets pledged as collateral for financing transactions, which would necessitate additional collateral postings under those transactions.

 

 

156   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

OTC Derivatives

Ÿ  

Contingent: Collateral postings to counterparties due to adverse changes in the value of our OTC derivatives, excluding those that are cleared and settled through central counterparties (OTC-cleared).

 

Ÿ  

Contingent: Other outflows of cash or collateral related to OTC derivatives, excluding OTC-cleared, including the impact of trade terminations, collateral substitutions, collateral disputes, collateral calls or termination payments required by a two-notch downgrade in our credit ratings, and collateral that has not been called by counterparties, but is available to them.

Exchange-Traded and OTC-cleared Derivatives

Ÿ  

Contingent: Variation margin postings required due to adverse changes in the value of our outstanding exchange-traded and OTC-cleared derivatives.

 

Ÿ  

Contingent: An increase in initial margin and guaranty fund requirements by derivative clearing houses.

Customer Cash and Securities

Ÿ  

Contingent: Liquidity outflows associated with our prime brokerage business, including withdrawals of customer credit balances, and a reduction in customer short positions, which serve as a funding source for long positions.

Unfunded Commitments

Ÿ  

Contingent: Draws on our unfunded commitments. Draw assumptions reflect, among other things, the type of commitment and counterparty.

Other

Ÿ  

Other upcoming large cash outflows, such as tax payments.

Asset-Liability Management

Our liquidity risk management policies are designed to ensure we have a sufficient amount of financing, even when funding markets experience persistent stress. We seek to maintain a long-dated and diversified funding profile, taking into consideration the characteristics and liquidity profile of our assets.

Our approach to asset-liability management includes:

 

Ÿ  

Conservatively managing the overall characteristics of our funding book, with a focus on maintaining long-term, diversified sources of funding in excess of our current requirements. See “Balance Sheet and Funding Sources — Funding Sources” for additional details.

 

Ÿ  

Actively managing and monitoring our asset base, with particular focus on the liquidity, holding period and our ability to fund assets on a secured basis. This enables us to determine the most appropriate funding products and tenors. See “Balance Sheet and Funding Sources — Balance Sheet Management” for more detail on our balance sheet management process and “— Funding Sources — Secured Funding” for more detail on asset classes that may be harder to fund on a secured basis.

 

Ÿ  

Raising secured and unsecured financing that has a long tenor relative to the liquidity profile of our assets. This reduces the risk that our liabilities will come due in advance of our ability to generate liquidity from the sale of our assets. Because we maintain a highly liquid balance sheet, the holding period of certain of our assets may be materially shorter than their contractual maturity dates.

Our goal is to ensure that the firm maintains sufficient liquidity to fund its assets and meet its contractual and contingent obligations in normal times as well as during periods of market stress. Through our dynamic balance sheet management process (see “Balance Sheet and Funding Sources — Balance Sheet Management”), we use actual and projected asset balances to determine secured and unsecured funding requirements. Funding plans are reviewed and approved by the Firmwide Finance Committee on a quarterly basis. In addition, senior managers in our independent control and support functions regularly analyze, and the Firmwide Finance Committee reviews, our consolidated total capital position (unsecured long-term borrowings plus total shareholders’ equity) so that we maintain a level of long-term funding that is sufficient to meet our long-term financing requirements. In a liquidity crisis, we would first use our GCE in order to avoid reliance on asset sales (other than our GCE). However, we recognize that orderly asset sales may be prudent or necessary in a severe or persistent liquidity crisis.

 

 

    Goldman Sachs March 2013 Form 10-Q   157


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Subsidiary Funding Policies. The majority of our unsecured funding is raised by Group Inc. which lends the necessary funds to its subsidiaries, some of which are regulated, to meet their asset financing, liquidity and capital requirements. In addition, Group Inc. provides its regulated subsidiaries with the necessary capital to meet their regulatory requirements. The benefits of this approach to subsidiary funding are enhanced control and greater flexibility to meet the funding requirements of our subsidiaries. Funding is also raised at the subsidiary level through a variety of products, including secured funding, unsecured borrowings and deposits.

Our intercompany funding policies assume that, unless legally provided for, a subsidiary’s funds or securities are not freely available to its parent company or other subsidiaries. In particular, many of our subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to Group Inc. Regulatory action of that kind could impede access to funds that Group Inc. needs to make payments on its obligations. Accordingly, we assume that the capital provided to our regulated subsidiaries is not available to Group Inc. or other subsidiaries and any other financing provided to our regulated subsidiaries is not available until the maturity of such financing.

Group Inc. has provided substantial amounts of equity and subordinated indebtedness, directly or indirectly, to its regulated subsidiaries. For example, as of March 2013, Group Inc. had $30.03 billion of equity and subordinated indebtedness invested in GS&Co., its principal U.S. registered broker-dealer; $29.77 billion invested in GSI, a regulated U.K. broker-dealer; $2.63 billion invested in GSEC, a U.S. registered broker-dealer; $3.50 billion invested in Goldman Sachs Japan Co., Ltd., a regulated Japanese broker-dealer; and $19.06 billion invested in GS Bank USA, a regulated New York State-chartered bank. Group Inc. also provided, directly or indirectly, $74.24 billion of unsubordinated loans and $10.28 billion of collateral to these entities, substantially all of which was to GS&Co., GSI and GS Bank USA, as of March 2013. In addition, as of March 2013, Group Inc. had significant amounts of capital invested in and loans to its other regulated subsidiaries.

Contingency Funding Plan

The Goldman Sachs contingency funding plan sets out the plan of action we would use to fund business activity in crisis situations and periods of market stress. The contingency funding plan outlines a list of potential risk factors, key reports and metrics that are reviewed on an ongoing basis to assist in assessing the severity of, and managing through, a liquidity crisis and/or market dislocation. The contingency funding plan also describes in detail the firm’s potential responses if our assessments indicate that the firm has entered a liquidity crisis, which include pre-funding for what we estimate will be our potential cash and collateral needs as well as utilizing secondary sources of liquidity. Mitigants and action items to address specific risks which may arise are also described and assigned to individuals responsible for execution.

The contingency funding plan identifies key groups of individuals to foster effective coordination, control and distribution of information, all of which are critical in the management of a crisis or period of market stress. The contingency funding plan also details the responsibilities of these groups and individuals, which include making and disseminating key decisions, coordinating all contingency activities throughout the duration of the crisis or period of market stress, implementing liquidity maintenance activities and managing internal and external communication.

Proposed Liquidity Framework

The Basel Committee on Banking Supervision’s international framework for liquidity risk measurement, standards and monitoring calls for imposition of a liquidity coverage ratio, designed to ensure that banks and bank holding companies maintain an adequate level of unencumbered high-quality liquid assets based on expected cash outflows under an acute liquidity stress scenario, and a net stable funding ratio, designed to promote more medium- and long-term funding of the assets and activities of these entities over a one-year time horizon. While the principles behind the new framework are broadly consistent with our current liquidity management framework, it is possible that the implementation of these standards could impact our liquidity and funding requirements and practices. Under the Basel Committee framework, the liquidity coverage ratio would be introduced on January 1, 2015; however, there would be a phase-in period whereby firms would have a 60% minimum in 2015 which would be raised 10% per year until it reaches 100% in 2019. The net stable funding ratio is not expected to be introduced as a requirement until January 1, 2018.

 

 

158   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Credit Ratings

The table below presents the unsecured credit ratings and outlook of Group Inc.

 

    As of March 2013  
     

 

Short-Term

Debt

  

  

      

 

Long-Term

Debt

  

  

    

 

Subordinated

Debt

  

  

      
 
Trust
Preferred
  
 1 
    

 

Preferred

Stock

  

  

    

 

Ratings

Outlook

  

  

DBRS, Inc.

    R-1 (middle        A (high      A           A         BBB  3       Stable   
   

Fitch, Inc.

    F1           A  2       A-           BBB-         BB+  3       Stable   
   

Moody’s Investors Service (Moody’s)

    P-2           A3  2       Baa1           Baa3         Ba2  3       Negative  4 
   

Standard & Poor’s Ratings Services (S&P)

    A-2           A-  2       BBB+           BB+         BB+  3       Negative   
   

Rating and Investment Information, Inc.

    a-1           A+         A           N/A         N/A         Negative   

 

1.

Trust preferred securities issued by Goldman Sachs Capital I.

 

2.

Includes the senior guaranteed trust securities issued by Murray Street Investment Trust I and Vesey Street Investment Trust I.

 

3.

Includes Group Inc.’s non-cumulative preferred stock and the APEX issued by Goldman Sachs Capital II and Goldman Sachs Capital III.

 

4.

The ratings outlook for trust preferred and preferred stock is stable.

The table below presents the unsecured credit ratings of GS Bank USA, GS&Co. and GSI.

 

    As of March 2013  
     

 

Short-Term

Debt

  

  

    
 
Long-Term
Debt
  
  
    

 

Short-Term

Bank Deposits

  

  

    

 

Long-Term

Bank Deposits

  

  

Fitch, Inc.

          

GS Bank USA

    F1         A         F1         A+   
   

GS&Co.

    F1         A         N/A         N/A   
   

GSI

    F1         A         N/A         N/A   
   

Moody’s

          

GS Bank USA

    P-1         A2         P-1         A2   
   

S&P

          

GS Bank USA

    A-1         A         N/A         N/A   
   

GS&Co.

    A-1         A         N/A         N/A   
   

GSI

    A-1         A         N/A         N/A   

 

We rely on the short-term and long-term debt capital markets to fund a significant portion of our day-to-day operations and the cost and availability of debt financing is influenced by our credit ratings. Credit ratings are also important when we are competing in certain markets, such as OTC derivatives, and when we seek to engage in

longer-term transactions. See “Certain Risk Factors That May Affect Our Businesses” below and “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for a discussion of the risks associated with a reduction in our credit ratings.

 

 

    Goldman Sachs March 2013 Form 10-Q   159


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

We believe our credit ratings are primarily based on the credit rating agencies’ assessment of:

 

Ÿ  

our liquidity, market, credit and operational risk management practices;

 

Ÿ  

the level and variability of our earnings;

 

Ÿ  

our capital base;

 

Ÿ  

our franchise, reputation and management;

 

Ÿ  

our corporate governance; and

 

Ÿ  

the external operating environment, including the assumed level of government support.

Certain of the firm’s derivatives have been transacted under bilateral agreements with counterparties who may require us to post collateral or terminate the transactions based on changes in our credit ratings. We assess the impact of these bilateral agreements by determining the collateral or termination payments that would occur assuming a downgrade by all rating agencies. A downgrade by any one rating agency, depending on the agency’s relative ratings of the firm at the time of the downgrade, may have an impact which is comparable to the impact of a downgrade by all rating agencies. We allocate a portion of our GCE to ensure we would be able to make the additional collateral or termination payments that may be required in the event of a two-notch reduction in our long-term credit ratings, as well as collateral that has not been called by counterparties, but is available to them. The table below presents the additional collateral or termination payments that could have been called at the reporting date by counterparties in the event of a one-notch and two-notch downgrade in our credit ratings.

 

    As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

Additional collateral or termination
payments for a one-notch downgrade

    $1,597         $1,534   
   

Additional collateral or termination
payments for a two-notch downgrade

    2,476         2,500   

Cash Flows

As a global financial institution, our cash flows are complex and bear little relation to our net earnings and net assets. Consequently, we believe that traditional cash flow analysis is less meaningful in evaluating our liquidity position than the excess liquidity and asset-liability management policies described above. Cash flow analysis may, however, be helpful in highlighting certain macro trends and strategic initiatives in our businesses.

Three Months Ended March 2013. Our cash and cash equivalents decreased by $9.34 billion to $63.33 billion at the end of the first quarter of 2013. We used net cash of $5.70 billion for operating activities. We used $3.64 billion in net cash for investing and financing activities for net repayments of unsecured and secured short-term borrowings and repurchases of common stock, partially offset by an increase in bank deposits.

Three Months Ended March 2012. Our cash and cash equivalents increased by $1.13 billion to $57.14 billion at the end of the first quarter of 2012. We generated $3.78 billion in net cash from operating activities. We used net cash of $2.65 billion in investing and financing activities, primarily from the net repayments of secured and unsecured borrowings, partially offset by a net increase in bank deposits.

 

 

160   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Market Risk Management

 

Overview

Market risk is the risk of loss in the value of our inventory due to changes in market prices. We hold inventory primarily for market making for our clients and for our investing and lending activities. Our inventory therefore changes based on client demands and our investment opportunities. Our inventory is accounted for at fair value and therefore fluctuates on a daily basis, with the related gains and losses included in “Market making,” and “Other principal transactions.” Categories of market risk include the following:

 

Ÿ  

Interest rate risk: results from exposures to changes in the level, slope and curvature of yield curves, the volatilities of interest rates, mortgage prepayment speeds and credit spreads.

 

Ÿ  

Equity price risk: results from exposures to changes in prices and volatilities of individual equities, baskets of equities and equity indices.

 

Ÿ  

Currency rate risk: results from exposures to changes in spot prices, forward prices and volatilities of currency rates.

 

Ÿ  

Commodity price risk: results from exposures to changes in spot prices, forward prices and volatilities of commodities, such as electricity, natural gas, crude oil, petroleum products, and precious and base metals.

Market Risk Management Process

We manage our market risk by diversifying exposures, controlling position sizes and establishing economic hedges in related securities or derivatives. This includes:

 

Ÿ  

accurate and timely exposure information incorporating multiple risk metrics;

 

Ÿ  

a dynamic limit setting framework; and

 

Ÿ  

constant communication among revenue-producing units, risk managers and senior management.

Market Risk Management, which is independent of the revenue-producing units and reports to the firm’s chief risk officer, has primary responsibility for assessing, monitoring and managing market risk at the firm. We monitor and control risks through strong firmwide oversight and independent control and support functions across the firm’s global businesses.

Managers in revenue-producing units are accountable for managing risk within prescribed limits. These managers have in-depth knowledge of their positions, markets and the instruments available to hedge their exposures.

Managers in revenue-producing units and Market Risk Management discuss market information, positions and estimated risk and loss scenarios on an ongoing basis.

Risk Measures

Market Risk Management produces risk measures and monitors them against market risk limits set by our firm’s risk committees. These measures reflect an extensive range of scenarios and the results are aggregated at trading desk, business and firmwide levels.

We use a variety of risk measures to estimate the size of potential losses for both moderate and more extreme market moves over both short-term and long-term time horizons. Our primary risk measures are VaR, which is used for shorter-term periods, and stress tests. Our risk reports detail key risks, drivers and changes for each desk and business, and are distributed daily to senior management of both our revenue-producing units and our independent control and support functions.

Value-at-Risk

VaR is the potential loss in value of inventory positions due to adverse market movements over a defined time horizon with a specified confidence level. We typically employ a one-day time horizon with a 95% confidence level. We use a single VaR model which captures risks including interest rates, equity prices, currency rates and commodity prices. As such, VaR facilitates comparison across portfolios of different risk characteristics. VaR also captures the diversification of aggregated risk at the firmwide level.

We are aware of the inherent limitations to VaR and therefore use a variety of risk measures in our market risk management process. Inherent limitations to VaR include:

 

Ÿ  

VaR does not estimate potential losses over longer time horizons where moves may be extreme.

 

Ÿ  

VaR does not take account of the relative liquidity of different risk positions.

 

Ÿ  

Previous moves in market risk factors may not produce accurate predictions of all future market moves.

 

 

    Goldman Sachs March 2013 Form 10-Q   161


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

When calculating VaR, we use historical simulations with full valuation of approximately 70,000 market factors. VaR is calculated at a position level based on simultaneously shocking the relevant market risk factors for that position. We sample from 5 years of historical data to generate the scenarios for our VaR calculation. The historical data is weighted so that the relative importance of the data reduces over time. This gives greater importance to more recent observations and reflects current asset volatilities, which improves the accuracy of our estimates of potential loss. As a result, even if our inventory positions were unchanged, our VaR would increase with increasing market volatility and vice versa.

Given its reliance on historical data, VaR is most effective in estimating risk exposures in markets in which there are no sudden fundamental changes or shifts in market conditions.

Our VaR measure does not include:

 

Ÿ  

positions that are best measured and monitored using stress testing; and

 

Ÿ  

the impact of changes in counterparty and our own credit spreads on derivatives, as well as changes in our own credit spreads on unsecured borrowings for which the fair value option was elected.

Stress Testing

Stress testing is a method of determining the effect on the firm of various hypothetical stress scenarios. We use stress testing to examine risks of specific portfolios as well as the potential impact of significant risk exposures across the firm. We use a variety of stress testing techniques to calculate the potential loss from a wide range of market moves on the firm’s portfolios, including sensitivity analysis, scenario analysis and firmwide stress tests. The results of our various stress tests are analyzed together for risk management purposes.

Sensitivity analysis is used to quantify the impact of a market move in a single risk factor across all positions (e.g., equity prices or credit spreads) using a variety of defined market shocks, ranging from those that could be expected over a one-day time horizon up to those that could take many months to occur. We also use sensitivity analysis to quantify the impact of the default of a single corporate entity, which captures the risk of large or concentrated exposures.

Scenario analysis is used to quantify the impact of a specified event, including how the event impacts multiple risk factors simultaneously. For example, for sovereign stress testing we calculate potential direct exposure associated with our sovereign inventory as well as the corresponding debt, equity and currency exposures associated with our non-sovereign inventory that may be impacted by the sovereign distress. When conducting scenario analysis, we typically consider a number of possible outcomes for each scenario, ranging from moderate to severely adverse market impacts. In addition, these stress tests are constructed using both historical events and forward-looking hypothetical scenarios.

Firmwide stress testing combines market, credit, operational and liquidity risks into a single combined scenario. Firmwide stress tests are primarily used to assess capital adequacy as part of the ICAAP process; however, we also ensure that firmwide stress testing is integrated into our risk governance framework. This includes selecting appropriate scenarios to use for the ICAAP process. See “Equity Capital — Internal Capital Adequacy Assessment Process” above for further information about our ICAAP process.

Unlike VaR measures, which have an implied probability because they are calculated at a specified confidence level, there is generally no implied probability that our stress test scenarios will occur. Instead, stress tests are used to model both moderate and more extreme moves in underlying market factors. When estimating potential loss, we generally assume that our positions cannot be reduced or hedged (although experience demonstrates that we are generally able to do so).

Stress test scenarios are conducted on a regular basis as part of the firm’s routine risk management process and on an ad hoc basis in response to market events or concerns. Stress testing is an important part of the firm’s risk management process because it allows us to quantify our exposure to tail risks, highlight potential loss concentrations, undertake risk/reward analysis, and assess and mitigate our risk positions.

 

 

162   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Limits

We use risk limits at various levels in the firm (including firmwide, product and business) to govern risk appetite by controlling the size of our exposures to market risk. Limits are set based on VaR and on a range of stress tests relevant to the firm’s exposures. Limits are reviewed frequently and amended on a permanent or temporary basis to reflect changing market conditions, business conditions or tolerance for risk.

The Firmwide Risk Committee sets market risk limits at firmwide and product levels and our Securities Division Risk Committee sets sub-limits for market-making and investing activities at a business level. The purpose of the firmwide limits is to assist senior management in controlling the firm’s overall risk profile. Sub-limits set the desired maximum amount of exposure that may be managed by any particular business on a day-to-day basis without additional levels of senior management approval, effectively leaving day-to-day trading decisions to individual desk managers and traders. Accordingly, sub-limits are a management tool designed to ensure appropriate escalation rather than to establish maximum risk tolerance. Sub-limits also distribute risk among various businesses in a manner that is consistent with their level of activity and client demand, taking into account the relative performance of each area.

Our market risk limits are monitored daily by Market Risk Management, which is responsible for identifying and escalating, on a timely basis, instances where limits have been exceeded. The business-level limits that are set by the Securities Division Risk Committee are subject to the same scrutiny and limit escalation policy as the firmwide limits.

When a risk limit has been exceeded (e.g., due to changes in market conditions, such as increased volatilities or changes in correlations), it is reported to the appropriate risk committee and a discussion takes place with the relevant desk managers, after which either the risk position is reduced or the risk limit is temporarily or permanently increased.

Model Review and Validation

Our VaR and stress testing models are subject to review and validation by our independent model validation group at least annually. This review includes:

 

Ÿ  

a critical evaluation of the model, its theoretical soundness and adequacy for intended use;

 

Ÿ  

verification of the testing strategy utilized by the model developers to ensure that the model functions as intended; and

 

Ÿ  

verification of the suitability of the calculation techniques incorporated in the model.

Our VaR and stress testing models are regularly reviewed and enhanced in order to incorporate changes in the composition of inventory positions, as well as variations in market conditions. Prior to implementing significant changes to our assumptions and/or models, we perform model validation and test runs. Significant changes to our VaR and stress testing models are reviewed with the firm’s chief risk officer and chief financial officer, and approved by the Firmwide Risk Committee.

We evaluate the accuracy of our VaR model through daily backtesting (i.e., comparing daily trading net revenues to the VaR measure calculated as of the prior business day) at the firmwide level and for each of our businesses and major regulated subsidiaries.

Systems

We have made a significant investment in technology to monitor market risk including:

 

Ÿ  

an independent calculation of VaR and stress measures;

 

Ÿ  

risk measures calculated at individual position levels;

 

Ÿ  

attribution of risk measures to individual risk factors of each position;

 

Ÿ  

the ability to report many different views of the risk measures (e.g., by desk, business, product type or legal entity); and

 

Ÿ  

the ability to produce ad hoc analyses in a timely manner.

 

 

    Goldman Sachs March 2013 Form 10-Q   163


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Metrics

We analyze VaR at the firmwide level and a variety of more detailed levels, including by risk category, business, and region. The tables below present, by risk category, average daily VaR and period-end VaR, as well as the high and low VaR for the period. Diversification effect in the tables below represents 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.

Average Daily VaR

 

in millions

 

Risk Categories

 

Three Months

Ended March

 
    2013           2012   

Interest rates

    $ 62           $ 90   
   

Equity prices

    30           29   
   

Currency rates

    14           15   
   

Commodity prices

    21           26   
   

Diversification effect

    (51        (65

Total

    $ 76           $ 95   

Our average daily VaR decreased to $76 million for the first quarter of 2013 from $95 million for the first quarter of 2012, primarily reflecting a decrease in the interest rates category due to lower levels of volatility, partially offset by a decrease in the diversification benefit across risk categories.

Quarter-End VaR and High and Low VaR

 

in millions

 

Risk Categories

  As of        

Three Months Ended

March 2013

 
  March     December        
    2013        2012            High        Low   

Interest rates

    $ 67        $ 64          $  70        $55   
   

Equity prices

    24        22          90  1      20   
   

Currency rates

    18        9          22        9   
   

Commodity prices

    17        18          25        16   
   

Diversification effect

    (43     (42      

Total

    $ 83        $ 71            $127        $64   

 

1.

Reflects the impact of temporarily increased exposures as a result of equity underwriting transactions.

Our daily VaR increased to $83 million as of March 2013 from $71 million as of December 2012, primarily reflecting an increase in the currency rates category, principally due to increased exposures.

During the first quarter of 2013, the firmwide VaR risk limit was not exceeded, raised or reduced.

 

 

164   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

The chart below reflects the VaR over the last four quarters.

 

LOGO

 

The chart below presents the frequency distribution of our daily trading net revenues for substantially all inventory

positions included in VaR for the quarter ended March 2013.

 

 

LOGO

 

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 first quarter of 2013 (i.e., a VaR exception).

During periods in which the firm has significantly more positive net revenue days than net revenue loss days, we expect to have fewer VaR exceptions because, under

normal conditions, our business model generally produces positive net revenues. In periods in which our franchise revenues are adversely affected, we generally have more loss days, resulting in more VaR exceptions. In addition, VaR backtesting is performed against total daily market-making revenues, including bid/offer net revenues, which are more likely than not to be positive by their nature.

 

 

    Goldman Sachs March 2013 Form 10-Q   165


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Sensitivity Measures

Certain portfolios and individual positions are not included in VaR because VaR is not the most appropriate risk measure. The market risk of these positions is determined by estimating the potential reduction in net revenues of a 10% decline in the underlying asset value.

The table below presents market risk for positions that are not included in VaR. These measures do not reflect diversification benefits across asset categories and therefore have not been aggregated.

 

Asset Categories   10% Sensitivity  
    Amount as of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

ICBC

    $   111         $   208   
   

Equity (excluding ICBC) 1

    2,235         2,263   
   

Debt 2

    1,568         1,676   

 

1.

Relates to private and restricted public equity securities, including interests in firm-sponsored funds that invest in corporate equities and real estate and interests in firm-sponsored hedge funds.

 

2.

Primarily relates to interests in our firm-sponsored funds that invest in corporate mezzanine and senior debt instruments. Also includes loans backed by commercial and residential real estate, corporate bank loans and other corporate debt, including acquired portfolios of distressed loans.

The decrease in our 10% sensitivity measure for ICBC as of March 2013 from December 2012 was due to the sale of approximately 45% of the ordinary shares in January 2013.

VaR excludes the impact of changes in counterparty and our own credit spreads on derivatives as well as changes in our own credit spreads on unsecured borrowings for which the fair value option was elected. The estimated sensitivity to a one basis point increase in credit spreads (counterparty and our own) on derivatives was a $3 million gain (including hedges) as of March 2013. In addition, the estimated sensitivity to a one basis point increase in our own credit spreads on unsecured borrowings for which the fair value option was elected was an $8 million gain (including hedges) as of March 2013. However, the actual net impact of a change in our own credit spreads is also affected by the liquidity, duration and convexity (as the sensitivity is not linear to changes in yields) of those unsecured borrowings for which the fair value option was elected, as well as the relative performance of any hedges undertaken.

The firm engages in insurance activities where we reinsure and purchase portfolios of insurance risk and pension liabilities. The risks associated with these activities include, but are not limited to: equity price, interest rate, reinvestment and mortality risk. The firm mitigates risks

associated with insurance activities through the use of reinsurance and hedging. Certain of the assets associated with the firm’s insurance activities are included in VaR. In addition to the positions included in VaR, we held $8.90 billion of securities accounted for as available-for-sale as of March 2013, which support the firm’s reinsurance business. As of March 2013, our available-for-sale securities primarily consisted of $3.38 billion of corporate debt securities with an average yield of 4%, the majority of which will mature after five years, $3.50 billion of mortgage and other asset-backed loans and securities with an average yield of 7%, the majority of which will mature after ten years, $682 million of state and municipal obligations with an average yield of 6%, the majority of which will mature after ten years, and $637 million of U.S. government and federal agency obligations with an average yield of 3%, the majority of which will mature after ten years. As of December 2012, we held $9.07 billion of securities accounted for as available-for-sale, primarily consisting of $3.63 billion of corporate debt securities with an average yield of 4%, the majority of which will mature after five years, $3.38 billion of mortgage and other asset-backed loans and securities with an average yield of 6%, the majority of which will mature after ten years, and $856 million of U.S. government and federal agency obligations with an average yield of 3%, the majority of which will mature after five years. As of March 2013 and December 2012, such assets were classified as held for sale and were included in “Other assets.” See Note 12 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about assets held for sale.

In addition, as of March 2013 and December 2012, we had commitments and held loans for which we have obtained credit loss protection from Sumitomo Mitsui Financial Group, Inc. See Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about such lending commitments. As of March 2013, the firm also had $7.88 billion of loans held for investment which were accounted for at amortized cost and included in “Receivables from customers and counterparties,” substantially all of which had floating interest rates. The estimated sensitivity to a 100 basis point increase in interest rates on such loans was $74 million of additional interest income over a 12-month period, which does not take into account the potential impact of an increase in costs to fund such loans. See Note 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about loans held for investment.

 

 

166   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Additionally, we make investments accounted for under the equity method and we also make direct investments in real estate, both of which are included in “Other assets” in the condensed consolidated statements of financial condition. Direct investments in real estate are accounted for at cost less accumulated depreciation. See Note 12 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on “Other assets.”

Credit Risk Management

Overview

Credit risk represents the potential for loss due to the default or deterioration in credit quality of a counterparty (e.g., an OTC derivatives counterparty or a borrower) or an issuer of securities or other instruments we hold. Our exposure to credit risk comes mostly from client transactions in OTC derivatives and loans and lending commitments. Credit risk also comes from cash placed with banks, securities financing transactions (i.e., resale and repurchase agreements and securities borrowing and lending activities) and receivables from brokers, dealers, clearing organizations, customers and counterparties.

Credit Risk Management, which is independent of the revenue-producing units and reports to the firm’s chief risk officer, has primary responsibility for assessing, monitoring and managing credit risk at the firm. The Credit Policy Committee and the Firmwide Risk Committee establish and review credit policies and parameters. In addition, we hold other positions that give rise to credit risk (e.g., bonds held in our inventory and secondary bank loans). These credit risks are captured as a component of market risk measures, which are monitored and managed by Market Risk Management, consistent with other inventory positions.

Policies authorized by the Firmwide Risk Committee and the Credit Policy Committee prescribe the level of formal approval required for the firm to assume credit exposure to a counterparty across all product areas, taking into account any applicable netting provisions, collateral or other credit risk mitigants.

Credit Risk Management Process

Effective management of credit risk requires accurate and timely information, a high level of communication and knowledge of customers, countries, industries and products. Our process for managing credit risk includes:

 

Ÿ  

approving transactions and setting and communicating credit exposure limits;

 

Ÿ  

monitoring compliance with established credit exposure limits;

 

Ÿ  

assessing the likelihood that a counterparty will default on its payment obligations;

 

Ÿ  

measuring the firm’s current and potential credit exposure and losses resulting from counterparty default;

 

Ÿ  

reporting of credit exposures to senior management, the Board and regulators;

 

Ÿ  

use of credit risk mitigants, including collateral and hedging; and

 

Ÿ  

communication and collaboration with other independent control and support functions such as operations, legal and compliance.

As part of the risk assessment process, Credit Risk Management performs credit reviews which include initial and ongoing analyses of our counterparties. A credit review is an independent judgment about the capacity and willingness of a counterparty to meet its financial obligations. For substantially all of our credit exposures, the core of our process is an annual counterparty review. A counterparty review is a written analysis of a counterparty’s business profile and financial strength resulting in an internal credit rating which represents the probability of default on financial obligations to the firm. The determination of internal credit ratings incorporates assumptions with respect to the counterparty’s future business performance, the nature and outlook for the counterparty’s industry, and the economic environment. Senior personnel within Credit Risk Management, with expertise in specific industries, inspect and approve credit reviews and internal credit ratings.

Our global credit risk management systems capture credit exposure to individual counterparties and on an aggregate basis to counterparties and their subsidiaries (economic groups). These systems also provide management with comprehensive information on our aggregate credit risk by product, internal credit rating, industry, country and region.

 

 

    Goldman Sachs March 2013 Form 10-Q   167


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Risk Measures and Limits

We measure our credit risk based on the potential loss in an event of non-payment by a counterparty. For derivatives and securities financing transactions, the primary measure is potential exposure, which is our estimate of the future exposure that could arise over the life of a transaction based on market movements within a specified confidence level. Potential exposure takes into account netting and collateral arrangements. For loans and lending commitments, the primary measure is a function of the notional amount of the position. We also monitor credit risk in terms of current exposure, which is the amount presently owed to the firm after taking into account applicable netting and collateral.

We use credit limits at various levels (counterparty, economic group, industry, country) to control the size of our credit exposures. Limits for counterparties and economic groups are reviewed regularly and revised to reflect changing appetites for a given counterparty or group of counterparties. Limits for industries and countries are based on the firm’s risk tolerance and are designed to allow for regular monitoring, review, escalation and management of credit risk concentrations.

Stress Tests/Scenario Analysis

We use regular stress tests to calculate the credit exposures, including potential concentrations that would result from applying shocks to counterparty credit ratings or credit risk factors (e.g., currency rates, interest rates, equity prices). These shocks include a wide range of moderate and more extreme market movements. Some of our stress tests include shocks to multiple risk factors, consistent with the occurrence of a severe market or economic event. In the case of sovereign default, we estimate the direct impact of the default on our sovereign credit exposures, changes to our credit exposures arising from potential market moves in response to the default, and the impact of credit market deterioration on corporate borrowers and counterparties that may result from the sovereign default. Unlike potential exposure, which is calculated within a specified confidence level, with a stress test there is generally no assumed probability of these events occurring.

We run stress tests on a regular basis as part of our routine risk management processes and conduct tailored stress tests on an ad hoc basis in response to market developments. Stress tests are regularly conducted jointly with the firm’s market and liquidity risk functions.

Risk Mitigants

To reduce our credit exposures on derivatives and securities financing transactions, we may enter into netting agreements with counterparties that permit us to offset receivables and payables with such counterparties. We may also reduce credit risk with counterparties by entering into agreements that enable us to obtain collateral from them on an upfront or contingent basis and/or to terminate transactions if the counterparty’s credit rating falls below a specified level.

For loans and lending commitments, depending on the credit quality of the borrower and other characteristics of the transaction, we employ a variety of potential risk mitigants. Risk mitigants include: collateral provisions, guarantees, covenants, structural seniority of the bank loan claims and, for certain lending commitments, provisions in the legal documentation that allow the firm to adjust loan amounts, pricing, structure and other terms as market conditions change. The type and structure of risk mitigants employed can significantly influence the degree of credit risk involved in a loan.

When we do not have sufficient visibility into a counterparty’s financial strength or when we believe a counterparty requires support from its parent company, we may obtain third-party guarantees of the counterparty’s obligations. We may also mitigate our credit risk using credit derivatives or participation agreements.

 

 

168   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Credit Exposures

The firm’s credit exposures are described further below.

Cash and Cash Equivalents. Cash and cash equivalents include both interest-bearing and non-interest-bearing deposits. To mitigate the risk of credit loss, we place substantially all of our deposits with highly rated banks and central banks.

OTC Derivatives. Derivatives are accounted for at fair value, net of cash collateral received or posted under enforceable credit support agreements. Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement.

As credit risk is an essential component of fair value, the firm includes a credit valuation adjustment (CVA) in the fair value of derivatives to reflect counterparty credit risk, as described in Note 7 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q. CVA is a function of the present value of expected exposure, the probability of counterparty default and the assumed recovery upon default.

The tables below present the distribution of our exposure to OTC derivatives by tenor, based on expected duration for mortgage-related credit derivatives and generally on remaining contractual maturity for other derivatives, both before and after the effect of collateral and netting agreements. Receivable and payable balances for the same counterparty across tenor categories are netted under enforceable netting agreements, and cash collateral received is netted under enforceable credit support agreements. Receivable and payable balances with the same counterparty in the same tenor category are netted within such tenor category. Net credit exposure in the tables below represents OTC derivative assets included in “Financial instruments owned, at fair value” less the fair value of securities collateral and cash collateral received under credit support agreements, which management considers when determining credit risk, but such collateral is not eligible for netting under U.S. GAAP. The categories shown reflect our internally determined public rating agency equivalents.

 

 

    As of March 2013  

in millions

 

Credit Rating Equivalent

   

 

0 - 12

Months

  

  

    

 

1 - 5

Years

  

  

    
 
5 Years
or Greater
  
  
     Total         Netting        
 
 
OTC
Derivative
Assets
  
  
  
    

 

Net Credit

Exposure

  

  

AAA/Aaa

    $     650         $  1,655         $    2,798         $    5,103         $    (1,505      $  3,598         $  3,243   
   

AA/Aa2

    4,990         6,706         21,383         33,079         (16,128      16,951         10,039   
   

A/A2

    12,439         25,669         37,078         75,186         (52,356      22,830         13,592   
   

BBB/Baa2

    7,316         11,174         24,935         43,425         (31,695      11,730         4,061   
   

BB/Ba2 or lower

    2,941         5,183         4,214         12,338         (5,782      6,556         4,830   
   

Unrated

    676         953         321         1,950         (30      1,920         1,509   

Total

    $29,012         $51,340         $  90,729         $171,081         $(107,496      $63,585         $37,274   
    As of December 2012  

in millions

 

Credit Rating Equivalent

   

 

0 - 12

Months

  

  

    

 

1 - 5

Years

  

  

    
 
5 Years
or Greater
  
  
     Total         Netting        
 
 
OTC
Derivative
Assets
  
  
  
    

 

Net Credit

Exposure

  

  

AAA/Aaa

    $     494         $  1,934         $    2,778         $    5,206         $    (1,476      $  3,730         $  3,443   
   

AA/Aa2

    4,631         7,483         20,357         32,471         (16,026      16,445         10,467   
   

A/A2

    13,422         26,550         42,797         82,769         (57,868      24,901         16,326   
   

BBB/Baa2

    7,032         12,173         27,676         46,881         (32,962      13,919         4,577   
   

BB/Ba2 or lower

    2,489         5,762         7,676         15,927         (9,116      6,811         4,544   
   

Unrated

    326         927         358         1,611         (13      1,598         1,259   

Total

    $28,394         $54,829         $101,642         $184,865         $(117,461      $67,404         $40,616   

 

    Goldman Sachs March 2013 Form 10-Q   169


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Lending Activities. We manage the firm’s traditional credit origination activities, including funded loans and lending commitments (both fair value and held for investment loans and lending commitments), using the credit risk process, measures and limits described above. Other lending positions, including secondary trading positions, are risk-managed as a component of market risk.

Other Credit Exposures. The firm is exposed to credit risk from its receivables from brokers, dealers and clearing organizations and customers and counterparties. Receivables from brokers, dealers and clearing organizations are primarily comprised of initial margin placed with clearing organizations and receivables related to sales of securities which have traded, but not yet settled. These receivables have minimal credit risk due to the low probability of clearing organization default and the short-term nature of receivables related to securities settlements. Receivables from customers and counterparties are generally comprised of collateralized receivables related to customer securities transactions and have minimal credit risk due to both the value of the collateral received and the short-term nature of these receivables.

Credit Exposures

As of March 2013, our credit exposures decreased as compared with December 2012, reflecting a decrease in cash and OTC derivative exposures, partially offset by an increase in loans and lending commitments. The percentage of our credit exposure arising from non-investment-grade counterparties (based on our internally determined public rating agency equivalents) increased from December 2012 reflecting an increase in loans and lending commitments. During the three months ended March 2013, counterparty defaults and the estimated losses associated with these counterparty defaults were lower as compared with the same prior year period.

The tables below present the firm’s credit exposures related to cash, OTC derivatives, and loans and lending commitments associated with traditional credit origination activities broken down by industry, region and internal credit rating.

 

 

170   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Credit Exposure by Industry

 

    Cash          OTC Derivatives          Loans and Lending
Commitments 1
 
    As of          As of          As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

Asset Managers & Funds

    $       —         $        —           $  9,836         $10,552           $  2,111         $  1,673   
   

Banks, Brokers & Other Financial Institutions

    10,398         10,507           17,397         21,310           8,474         6,192   
   

Consumer Products, Non-Durables & Retail

                      2,156         1,516           14,139         13,304   
   

Government & Central Banks

    52,935         62,162           15,178         14,729           1,695         1,782   
   

Healthcare & Education

                      3,952         3,764           8,220         7,717   
   

Insurance

                      3,628         4,214           3,224         3,199   
   

Natural Resources & Utilities

                      4,830         4,383           16,972         16,360   
   

Real Estate

                      330         381           4,332         3,796   
   

Technology, Media, Telecommunications & Services

                      1,744         2,016           16,403         17,674   
   

Transportation

                      904         1,207           6,415         6,557   
   

Other

                        3,630         3,332             5,373         4,650   

Total 2

    $63,333         $72,669             $63,585         $67,404             $87,358         $82,904   

Credit Exposure by Region

 

    Cash          OTC Derivatives          Loans and Lending
Commitments 1
 
    As of          As of          As of  
in millions    

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

Americas

    $55,124         $65,193           $28,793         $32,968           $60,433         $59,792   
   

EMEA 3

    2,486         1,683           27,858         26,739           24,485         21,104   
   

Asia

    5,723         5,793             6,934         7,697             2,440         2,008   

Total 2

    $63,333         $72,669             $63,585         $67,404             $87,358         $82,904   

Credit Exposure by Credit Quality

 

    Cash          OTC Derivatives          Loans and Lending
Commitments 1
 
    As of          As of          As of  

in millions

Credit Rating Equivalent

   

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

        

 

March

2013

  

  

    

 

December

2012

  

  

AAA/Aaa

    $50,679         $59,825           $  3,598         $  3,730           $  2,164         $  2,179   
   

AA/Aa2

    5,580         6,356           16,951         16,445           6,996         7,220   
   

A/A2

    5,850         5,068           22,830         24,901           21,887         21,901   
   

BBB/Baa2

    228         326           11,730         13,919           27,903         26,313   
   

BB/Ba2 or lower

    996         1,094           6,556         6,811           28,243         25,291   
   

Unrated

                        1,920         1,598             165           

Total 2

    $63,333         $72,669             $63,585         $67,404             $87,358         $82,904   

 

1.

Includes approximately $17 billion and $12 billion of loans as of March 2013 and December 2012, respectively, and approximately $70 billion and $71 billion of lending commitments as of March 2013 and December 2012, respectively. Excludes certain bank loans and bridge loans and certain lending commitments that are risk managed as part of market risk using VaR and sensitivity measures.

 

2.

The firm bears credit risk related to resale agreements and securities borrowed only to the extent that cash advanced or the value of securities pledged or delivered to the counterparty exceeds the value of the collateral received. The firm also has credit exposure on repurchase agreements and securities loaned to the extent that the value of securities pledged or delivered to the counterparty for these transactions exceeds the amount of cash or collateral received. We had approximately $40 billion and $37 billion as of March 2013 and December 2012, respectively, in credit exposure related to securities financing transactions reflecting both netting agreements and collateral that management considers when determining credit risk.

 

3.

EMEA (Europe, Middle East and Africa).

 

    Goldman Sachs March 2013 Form 10-Q   171


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Selected Country Exposures

There have been continuing concerns about European sovereign debt risk and its impact on the European banking system and a number of European member states have been experiencing significant credit deterioration. The most pronounced market concerns relate to Greece, Ireland, Italy, Portugal and Spain. The tables below present our credit exposure (both gross and net of hedges) to all sovereigns, financial institutions and corporate counterparties or borrowers in these countries. Credit exposure represents the potential for loss due to the default or deterioration in credit quality of a counterparty or borrower. In addition, the tables include the market

exposure of our long and short inventory for which the issuer or underlier is located in these countries. Market exposure represents the potential for loss in value of our inventory due to changes in market prices. There is no overlap between the credit and market exposures in the tables below.

The country of risk is determined by the location of the counterparty, issuer or underlier’s assets, where they generate revenue, the country in which they are headquartered, and/or the government whose policies affect their ability to repay their obligations.

 

 

    As of March 2013  
    Credit Exposure       Market Exposure  
in millions     Loans       
 
OTC
Derivatives
  
  
  Other   Gross   Funded     Hedges     

Total Net Funded Credit

Exposure

 

  Unfunded

Credit Exposure

  Total Credit   Exposure         Debt       
 
 
Equities
and
Other
  
  
  
   
 
Credit
Derivatives
  
  
   

 
 

Total

Market
Exposure

  

  
  

Greece

                         

Sovereign

    $      —        $     92      $  —   $     92     $       —      $     92   $      —   $     92       $     36        $  —        $       —        $     36   
   

Non-Sovereign

           18      6   24          24     24         60        32        (28     64   

Total Greece

           110      6   116          116     116       96        32        (28     100   
   

Ireland

                         

Sovereign

           1        1          1     1       (11            (240     (251
   

Non-Sovereign

    454        281      83   818     (13   805   28   833         210        60        149        419   

Total Ireland

    454        282      83   819     (13   806   28   834       199        60        (91     168   
   

Italy

                         

Sovereign

           1,809      64   1,873     (1,717   156     156       (566            (418     (984
   

Non-Sovereign

    100        611      114   825     (29   796   439   1,235         167        1        (1,492     (1,324

Total Italy

    100        2,420      178   2,698     (1,746   952   439   1,391       (399     1        (1,910     (2,308
   

Portugal

                         

Sovereign

           128      53   181          181     181       257               (188     69   
   

Non-Sovereign

           22      2   24          24     24         167        (8     (322     (163

Total Portugal

           150      55   205          205     205       424        (8     (510     (94
   

Spain

                         

Sovereign

           54        54          54     54       (23            6        (17
   

Non-Sovereign

    1,173        182      80   1,435     (65   1,370   735   2,105         1,465        61        (278     1,248   

Total Spain

    1,173        236      80   1,489     (65   1,424   735   2,159         1,442        61        (272     1,231   

Total

    $1,727  1      $3,198  2    $402   $5,327     $(1,824 ) 3    $3,503   $1,202   $4,705         $1,762        $146        $(2,811 3      $  (903

 

1.

Principally consists of collateralized loans.

 

2.

Includes the benefit of $6.6 billion of cash and U.S. Treasury securities collateral and excludes non-U.S. government and agency obligations and corporate securities collateral of $393 million.

 

3.

Includes written and purchased credit derivative notionals reduced by the fair values of such credit derivatives.

 

In addition, during the first quarter of 2013, Cyprus experienced significant credit deterioration and there are market concerns about its sovereign debt risk. Our total

credit and market exposure to Cyprus was not material as of March 2013.

 

 

172   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

    As of December 2012  
    Credit Exposure         Market Exposure  
in millions     Loans       
 
OTC
Derivatives
  
  
    Other       
 
Gross
Funded
  
  
    Hedges       
 
 

 

Total Net
Funded
Credit

Exposure

  
  
  

  

   

 
 

Unfunded

Credit
Exposure

  

  
  

   
 
 
Total
Credit
Exposure
  
  
  
        Debt       
 
 
Equities
and
Other
  
  
  
   
 
Credit
Derivatives
  
  
   

 
 

Total

Market
Exposure

  

  
  

Greece

                         

Sovereign

    $      —        $      —        $  —        $     —        $       —        $     —        $      —        $      —          $     30        $   —        $      —        $     30   
   

Non-Sovereign

           5        1        6               6               6            65        15        (5     75   

Total Greece

           5        1        6               6               6          95        15        (5     105   
   

Ireland

                         

Sovereign

           1        103        104               104               104          8               (150     (142
   

Non-Sovereign

           126        36        162               162               162            801        74        155        1,030   

Total Ireland

           127        139        266               266               266          809        74        5        888   
   

Italy

                         

Sovereign

           1,756        1        1,757        (1,714     43               43          (415            (603     (1,018
   

Non-Sovereign

    43        560        129        732        (33     699        587        1,286            434        65        (996     (497

Total Italy

    43        2,316        130        2,489        (1,747     742        587        1,329          19        65        (1,599     (1,515
   

Portugal

                         

Sovereign

           141        61        202               202               202          155               (226     (71
   

Non-Sovereign

           44        2        46               46               46            168        (6     (133     29   

Total Portugal

           185        63        248               248               248          323        (6     (359     (42
   

Spain

                         

Sovereign

           75               75               75               75          986               (268     718   
   

Non-Sovereign

    1,048        259        23        1,330        (95     1,235        733        1,968            1,268        83        (186     1,165   

Total Spain

    1,048        334        23        1,405        (95     1,310        733        2,043            2,254        83        (454     1,883   

Total

    $1,091  1      $2,967  2      $356        $4,414        $(1,842 3      $2,572        $1,320        $3,892            $3,500        $231        $(2,412 3      $1,319   

 

1.

Principally consists of collateralized loans.

 

2.

Includes the benefit of $6.6 billion of cash and U.S. Treasury securities collateral and excludes non-U.S. government and agency obligations and corporate securities collateral of $357 million.

 

3.

Includes written and purchased credit derivative notionals reduced by the fair values of such credit derivatives.

 

We economically hedge our exposure to written credit derivatives by entering into offsetting purchased credit derivatives with identical underlyings. Where possible, we endeavor to match the tenor and credit default terms of such hedges to that of our written credit derivatives. Substantially all purchased credit derivatives included above are bought from investment-grade counterparties domiciled outside of these countries and are collateralized with cash or U.S. Treasury securities. The gross purchased and written credit derivative notionals across the above countries for single-name and index credit default swaps (included in ‘Hedges’ and ‘Credit Derivatives’ in the tables above) were $178.1 billion and $167.6 billion, respectively, as of March 2013, and $179.4 billion and $168.6 billion, respectively, as of December 2012. Including netting under legally enforceable netting agreements, within each and across all of the countries above, the purchased and written credit derivative notionals for single-name and index credit default swaps were $25.8 billion and $15.1 billion,

respectively, as of March 2013, and $26.0 billion and $15.3 billion, respectively, as of December 2012. These notionals are not representative of our exposure because they exclude available netting under legally enforceable netting agreements on other derivatives outside of these countries and collateral received or posted under credit support agreements.

In credit exposure above, ‘Other’ principally consists of deposits, secured lending transactions and other secured receivables, net of applicable collateral. As of March 2013 and December 2012, $8.3 billion and $4.8 billion, respectively, of secured lending transactions and other secured receivables were fully collateralized.

For information about the nature of or payout under trigger events related to written and purchased credit protection contracts see Note 7 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

 

 

    Goldman Sachs March 2013 Form 10-Q   173


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

We conduct stress tests intended to estimate the direct and indirect impact that might result from a variety of possible events involving the above countries, including sovereign defaults and the exit of one or more countries from the Euro area. In the stress tests, described in “Market Risk Management — Stress Testing” and “Credit Risk Management — Stress Tests/Scenario Analysis,” we estimate the direct impact of the event on our credit and market exposures resulting from shocks to risk factors including, but not limited to, currency rates, interest rates, and equity prices. The parameters of these shocks vary based on the scenario reflected in each stress test. We also estimate the indirect impact on our exposures arising from potential market moves in response to the event, such as the impact of credit market deterioration on corporate borrowers and counterparties along with the shocks to the risk factors described above. We review estimated losses produced by the stress tests in order to understand their magnitude, highlight potential loss concentrations, and assess and mitigate our exposures where necessary.

Euro area exit scenarios include analysis of the impacts on exposure that might result from the redenomination of assets in the exiting country or countries. Constructing stress tests for these scenarios requires many assumptions about how exposures might be directly impacted and how resulting secondary market moves would indirectly impact such exposures. Given the multiple parameters involved in such scenarios, losses from such events are inherently difficult to quantify and may materially differ from our estimates. In order to prepare for any market disruption that might result from a Euro area exit, we test our operational and risk management readiness and capability to respond to a redenomination event.

See “Liquidity Risk Management — Modeled Liquidity Outflow,” “Market Risk Management — Stress Testing” and “Credit Risk Management — Stress Tests/Scenario Analysis” for further discussion.

Credit events which occurred subsequent to March 2013 related to these countries did not have a material effect on our financial condition, results of operations, liquidity or capital resources.

Operational Risk Management

Overview

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Our exposure to operational risk arises from routine processing errors as well as extraordinary incidents, such as major systems failures. Potential types of loss events related to internal and external operational risk include:

 

Ÿ  

clients, products and business practices;

 

Ÿ  

execution, delivery and process management;

 

Ÿ  

business disruption and system failures;

 

Ÿ  

employment practices and workplace safety;

 

Ÿ  

damage to physical assets;

 

Ÿ  

internal fraud; and

 

Ÿ  

external fraud.

The firm maintains a comprehensive control framework designed to provide a well-controlled environment to minimize operational risks. The Firmwide Operational Risk Committee, along with the support of regional or entity-specific working groups or committees, provides oversight of the ongoing development and implementation of our operational risk policies and framework. Our Operational Risk Management department (Operational Risk Management) is a risk management function independent of our revenue-producing units, reports to the firm’s chief risk officer, and is responsible for developing and implementing policies, methodologies and a formalized framework for operational risk management with the goal of minimizing our exposure to operational risk.

 

 

174   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Operational Risk Management Process

Managing operational risk requires timely and accurate information as well as a strong control culture. We seek to manage our operational risk through:

 

Ÿ  

the training, supervision and development of our people;

 

Ÿ  

the active participation of senior management in identifying and mitigating key operational risks across the firm;

 

Ÿ  

independent control and support functions that monitor operational risk on a daily basis and have instituted extensive policies and procedures and implemented controls designed to prevent the occurrence of operational risk events;

 

Ÿ  

proactive communication between our revenue-producing units and our independent control and support functions; and

 

Ÿ  

a network of systems throughout the firm to facilitate the collection of data used to analyze and assess our operational risk exposure.

We combine top-down and bottom-up approaches to manage and measure operational risk. From a top-down perspective, the firm’s senior management assesses firmwide and business level operational risk profiles. From a bottom-up perspective, revenue-producing units and independent control and support functions are responsible for risk management on a day-to-day basis, including identifying, mitigating, and escalating operational risks to senior management.

Our operational risk framework is in part designed to comply with the operational risk measurement rules under Basel 2 and has evolved based on the changing needs of our businesses and regulatory guidance. Our framework comprises the following practices:

 

Ÿ  

Risk identification and reporting;

 

Ÿ  

Risk measurement; and

 

Ÿ  

Risk monitoring.

Internal Audit performs an independent review of our operational risk framework, including our key controls, processes and applications, on an annual basis to assess the effectiveness of our framework.

Risk Identification and Reporting

The core of our operational risk management framework is risk identification and reporting. We have a comprehensive data collection process, including firmwide policies and procedures, for operational risk events.

We have established policies that require managers in our revenue-producing units and our independent control and support functions to escalate operational risk events. When operational risk events are identified, our policies require that the events be documented and analyzed to determine whether changes are required in the firm’s systems and/or processes to further mitigate the risk of future events.

In addition, our firmwide systems capture internal operational risk event data, key metrics such as transaction volumes, and statistical information such as performance trends. We use an internally-developed operational risk management application to aggregate and organize this information. Managers from both revenue-producing units and independent control and support functions analyze the information to evaluate operational risk exposures and identify businesses, activities or products with heightened levels of operational risk. We also provide periodic operational risk reports to senior management, risk committees and the Board.

 

 

    Goldman Sachs March 2013 Form 10-Q   175


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Risk Measurement

We measure the firm’s operational risk exposure over a twelve-month time horizon using both statistical modeling and scenario analyses, which involve qualitative assessments of the potential frequency and extent of potential operational risk losses, for each of the firm’s businesses. Operational risk measurement incorporates qualitative and quantitative assessments of factors including:

 

Ÿ  

internal and external operational risk event data;

 

Ÿ  

assessments of the firm’s internal controls;

 

Ÿ  

evaluations of the complexity of the firm’s business activities;

 

Ÿ  

the degree of and potential for automation in the firm’s processes;

 

Ÿ  

new product information;

 

Ÿ  

the legal and regulatory environment;

 

Ÿ  

changes in the markets for the firm’s products and services, including the diversity and sophistication of the firm’s customers and counterparties; and

 

Ÿ  

the liquidity of the capital markets and the reliability of the infrastructure that supports the capital markets.

The results from these scenario analyses are used to monitor changes in operational risk and to determine business lines that may have heightened exposure to operational risk. These analyses ultimately are used in the determination of the appropriate level of operational risk capital to hold.

Risk Monitoring

We evaluate changes in the operational risk profile of the firm and its businesses, including changes in business mix or jurisdictions in which the firm operates, by monitoring the factors noted above at a firmwide level. The firm has both detective and preventive internal controls, which are designed to reduce the frequency and severity of operational risk losses and the probability of operational risk events. We monitor the results of assessments and independent internal audits of these internal controls.

Recent Accounting Developments

See Note 3 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information about Recent Accounting Developments.

 

 

176   Goldman Sachs March 2013 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Certain Risk Factors That May Affect Our Businesses

    

 

We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal, regulatory and reputational risks. For a discussion of how management seeks to manage some of these risks, see “Overview and Structure of Risk Management.” A summary of the more important factors that could affect our businesses follows. For a further discussion of these and other important factors that could affect our businesses, financial condition, results of operations, cash flows and liquidity, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.

 

Ÿ  

Our businesses have been and may continue to be adversely affected by conditions in the global financial markets and economic conditions generally.

 

Ÿ  

Our businesses have been and may be adversely affected by declining asset values. This is particularly true for those businesses in which we have net “long” positions, receive fees based on the value of assets managed, or receive or post collateral.

 

Ÿ  

Our businesses have been and may be adversely affected by disruptions in the credit markets, including reduced access to credit and higher costs of obtaining credit.

 

Ÿ  

Our market-making activities have been and may be affected by changes in the levels of market volatility.

 

Ÿ  

Our investment banking, client execution and investment management businesses have been adversely affected and may continue to be adversely affected by market uncertainty or lack of confidence among investors and CEOs due to general declines in economic activity and other unfavorable economic, geopolitical or market conditions.

 

Ÿ  

Our investment management business may be affected by the poor investment performance of our investment products.

 

Ÿ  

We may incur losses as a result of ineffective risk management processes and strategies.

 

Ÿ  

Our liquidity, profitability and businesses may be adversely affected by an inability to access the debt capital markets or to sell assets or by a reduction in our credit ratings or by an increase in our credit spreads.

 

Ÿ  

Conflicts of interest are increasing and a failure to appropriately identify and address conflicts of interest could adversely affect our businesses.

 

Ÿ  

Group Inc. is a holding company and is dependent for liquidity on payments from its subsidiaries, many of which are subject to restrictions.

Ÿ  

Our businesses, profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money, securities or other assets or whose securities or obligations we hold.

 

Ÿ  

Concentration of risk increases the potential for significant losses in our market-making, underwriting, investing and lending activities.

 

Ÿ  

The financial services industry is highly competitive.

 

Ÿ  

We face enhanced risks as new business initiatives lead us to transact with a broader array of clients and counterparties and expose us to new asset classes and new markets.

 

Ÿ  

Derivative transactions and delayed settlements may expose us to unexpected risk and potential losses.

 

Ÿ  

Our businesses may be adversely affected if we are unable to hire and retain qualified employees.

 

Ÿ  

Our businesses and those of our clients are subject to extensive and pervasive regulation around the world.

 

Ÿ  

We may be adversely affected by increased governmental and regulatory scrutiny or negative publicity.

 

Ÿ  

A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our businesses, result in the disclosure of confidential information, damage our reputation and cause losses.

 

Ÿ  

Substantial legal liability or significant regulatory action against us could have material adverse financial effects or cause us significant reputational harm, which in turn could seriously harm our business prospects.

 

Ÿ  

The growth of electronic trading and the introduction of new trading technology may adversely affect our business and may increase competition.

 

Ÿ  

Our commodities activities, particularly our power generation interests and our physical commodities activities, subject us to extensive regulation, potential catastrophic events and environmental, reputational and other risks that may expose us to significant liabilities and costs.

 

Ÿ  

In conducting our businesses around the world, we are subject to political, economic, legal, operational and other risks that are inherent in operating in many countries.

 

Ÿ  

We may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks, extreme weather events or other natural disasters.

 

 

    Goldman Sachs March 2013 Form 10-Q   177


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Management’s Discussion and Analysis

 

Available Information

Our internet address is www.gs.com and the investor relations section of our web site is located at www.gs.com/shareholders. We make available free of charge through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934 (Exchange Act), as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Also posted on our web site, and available in print upon request of any shareholder to our Investor Relations Department, are our certificate of incorporation and by-laws, charters for our Audit Committee, Risk Committee, Compensation Committee, and Corporate Governance, Nominating and Public Responsibilities Committee, our Policy Regarding Director Independence Determinations, our Policy on Reporting of Concerns Regarding Accounting and Other Matters, our Corporate Governance Guidelines and our Code of Business Conduct and Ethics governing our directors, officers and employees. Within the time period required by the SEC, we will post on our web site any amendment to the Code of Business Conduct and Ethics and any waiver applicable to any executive officer, director or senior financial officer.

In addition, our web site includes information concerning purchases and sales of our equity securities by our executive officers and directors, as well as disclosure relating to certain non-GAAP financial measures (as defined in the SEC’s Regulation G) that we may make public orally, telephonically, by webcast, by broadcast or by similar means from time to time. In addition, we make available on the Investor Relations section of our web site information regarding DFAST results and intend to make available, on a quarterly basis, information on the firm’s risk management practices and regulatory capital ratios, as required under the disclosure-related provisions of the Federal Reserve Board’s market risk capital rules.

Our Investor Relations Department can be contacted at The Goldman Sachs Group, Inc., 200 West Street, 29th Floor, New York, New York 10282, Attn: Investor Relations, telephone: 212-902-0300, e-mail: gs-investor-relations@gs.com.

Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995

We have included or incorporated by reference in this Form 10-Q, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts, but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. It is possible that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. For a discussion of some of the risks and important factors that could affect our future results and financial condition, see “Certain Risk Factors That May Affect Our Businesses” above, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.

Statements about our investment banking transaction backlog also may constitute forward-looking statements. Such statements are subject to the risk that the terms of these transactions may be modified or that they may not be completed at all; therefore, the net revenues, if any, that we actually earn from these transactions may differ, possibly materially, from those currently expected. Important factors that could result in a modification of the terms of a transaction or a transaction not being completed include, in the case of underwriting transactions, a decline or continued weakness in general economic conditions, outbreak of hostilities, volatility in the securities markets generally or an adverse development with respect to the issuer of the securities and, in the case of financial advisory transactions, a decline in the securities markets, an inability to obtain adequate financing, an adverse development with respect to a party to the transaction or a failure to obtain a required regulatory approval. For a discussion of other important factors that could adversely affect our investment banking transactions, see “Certain Risk Factors That May Affect Our Businesses” above, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.

 

 

178   Goldman Sachs March 2013 Form 10-Q    


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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosures about market risk are set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk Management” in Part I, Item 2 above.

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 (Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

We are involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of our businesses. Many of these proceedings are in early stages, and many of these cases seek an indeterminate amount of damages. However, we believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition, but may be material to our operating results for any particular period, depending, in part, upon the operating results for such period. Given the range of litigation and investigations presently under way, our litigation expenses can be expected to remain high. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Use of Estimates” in Part I, Item 2 of this Form 10-Q. See Note 27 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on certain judicial, regulatory and legal proceedings.

 

 

    Goldman Sachs March 2013 Form 10-Q   179


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Item 2.    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. (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 March 31, 2013.

 

 

Period    

 
 

Total Number

of Shares
Purchased

  

  
  

   

 

Average Price

Paid per Share

  

  

    
 
 
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
 
 
 1 
   
 
 
 
Maximum Number of
Shares That May Yet Be
Purchased Under the
Plans or Programs
 
 
 
 1 

Month #1

(January 1, 2013 to January 31, 2013)

    2,701,284  2      $144.82         2,630,530        18,858,321   
   

Month #2

(February 1, 2013 to February 28, 2013)

    4,761,527        152.15         4,761,527        14,096,794   
   

Month #3

(March 1, 2013 to March 31, 2013)

    2,738,346        153.11         2,738,346        11,358,448  3 

Total

    10,201,157                 10,130,403           

 

1.

On March 21, 2000, we announced that the Board of Directors of Group Inc. (Board) had approved a repurchase program, pursuant to which up to 15 million shares of our common stock may be repurchased. This repurchase program was increased by an aggregate of 355 million shares by resolutions of our Board adopted from June 2001 through July 2011. We use our share repurchase program to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by the firm’s current and projected capital position (i.e., comparisons of our desired level and composition of capital to our actual level and composition of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of our common stock. The repurchase program has no set expiration or termination date. Any repurchase of our common stock requires approval by the Federal Reserve Board.

 

2.

Includes 70,754 shares remitted by employees to satisfy minimum statutory withholding taxes on equity-based awards that were delivered to employees during the period.

 

3.

On April 15, 2013, the Board authorized the repurchase of an additional 75.0 million shares of common stock pursuant to the firm’s existing share repurchase program. As of April 15, 2013, under the share repurchase program approved by the Board, we can repurchase up to 86.4 million additional shares of common stock, including the newly authorized amount; however, any such repurchases are subject to the approval of the Federal Reserve Board.

 

180   Goldman Sachs March 2013 Form 10-Q    


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Item 6.    Exhibits

Exhibits

 

    3.1

  

Restated Certificate of Incorporation of The Goldman Sachs Group, Inc., amended as of May 6, 2013.

    4.1

  

Form of Amendment to Warrant (originally issued on October 1, 2008), dated as of March 25, 2013, between The Goldman Sachs Group, Inc. and each Warrantholder named therein (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed March 26, 2013).

  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.

  31.1

   Rule 13a-14(a) Certifications.

  32.1

   Section 1350 Certifications.*

101

  

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Statements of Earnings for the three months ended March 31, 2013 and March 31, 2012, (ii) the Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and March 31, 2012, (iii) the Condensed Consolidated Statements of Financial Condition as of March 31, 2013 and December 31, 2012, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2013 and year ended December 31, 2012, (v) the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and March 31, 2012, and (vi) the notes to the Condensed Consolidated Financial Statements.

  

*     This information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

 

    Goldman Sachs March 2013 Form 10-Q   181


Table of Contents

SIGNATURES

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.

 

THE GOLDMAN SACHS GROUP, INC.

By:  

 

/s/          Harvey M. Schwartz

 

Name:  Harvey M. Schwartz

  Title:  Chief Financial Officer

By:  

 

/s/          Sarah E. Smith

  Name:  Sarah E. Smith
  Title:  Principal Accounting Officer

Date: May 8, 2013

 

182   Goldman Sachs March 2013 Form 10-Q