Goldman Sachs Group Inc. — Q3 2016 Form 10-Q Summary
Business context and reporting period
The filing covers the unaudited three and nine months ended September 30, 2016, with comparisons to the corresponding 2015 periods and balance-sheet comparisons to December 31, 2015. Goldman Sachs is a global investment banking, securities and investment management firm operating through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net revenues | $8.17 billion | $6.86 billion | $22.44 billion | $26.55 billion |
| Pre-tax earnings | $2.87 billion | $2.05 billion | $6.91 billion | $7.71 billion |
| Net earnings | $2.09 billion | $1.43 billion | $5.05 billion | $5.32 billion |
| Net earnings applicable to common shareholders | $2.10 billion | $1.33 billion | $4.93 billion | $4.99 billion |
| Diluted EPS | $4.88 | $2.90 | $11.24 | $10.84 |
| Operating expenses | $5.30 billion | $4.82 billion | $15.53 billion | $18.84 billion |
| Net interest income | $614 million | $842 million | $2.25 billion | $2.36 billion |
| Net cash from operating activities | Not separately presented | Not separately presented | $1.77 billion | $166 million |
Q3 net revenue increased 19%, pre-tax earnings increased 40%, and net earnings increased 47% year over year. The implied Q3 pre-tax margin was approximately 35.1% versus 29.8% in Q3 2015; the implied net margin was approximately 25.6% versus 20.8%. For the first nine months, net revenue declined 15%, pre-tax earnings declined 10%, and net earnings declined 5%. Annualized ROE was 11.2% in Q3 and 8.7% for the first nine months, compared with 7.0% and 8.8%, respectively, in the prior-year periods.
- Q3 market-making revenue rose 57% to $2.72 billion, and other principal transactions revenue more than doubled to $1.16 billion.
- Q3 Investment Banking revenue was essentially unchanged at $1.54 billion; Investment Management revenue increased 4% to $1.39 billion; commissions and fees declined 12% to $753 million.
- Q3 net interest income declined 27%, as interest expense increased faster than interest income.
- Q3 compensation and benefits expense increased 36% to $3.21 billion. Nine-month compensation expense declined 13% to $9.20 billion, while the compensation-to-net-revenue ratio increased to 41.0% from 40.0%.
- Nine-month net provisions for litigation and regulatory proceedings were $249 million, versus $2.06 billion in 2015, materially reducing non-compensation expenses.
Balance sheet, debt, liquidity and capital
| Balance-sheet item | September 30, 2016 | December 31, 2015 |
|---|---|---|
| Total assets | $879.99 billion | $861.40 billion |
| Cash and cash equivalents | $99.54 billion | $75.11 billion |
| Deposits | $124.55 billion | $97.52 billion |
| Unsecured short-term borrowings | $42.83 billion | $42.79 billion |
| Unsecured long-term borrowings | $190.59 billion | $175.42 billion |
| Total shareholders’ equity | $87.11 billion | $86.73 billion |
| Global core liquid assets | $214.27 billion | $199.12 billion |
Cash increased by $24.43 billion during the first nine months. Operating activities provided $1.77 billion, investing activities provided $11.30 billion, and financing activities provided $11.36 billion. Investing cash flow included $15.75 billion of net cash acquired in business acquisitions. Financing cash flow included $39.13 billion of unsecured long-term debt issuance, $29.20 billion of repayments, $10.51 billion of net deposit inflows, $4.59 billion of common-share repurchases and $1.24 billion of dividends and dividend equivalents paid.
Goldman Sachs reported a Basel III Advanced CET1 ratio of 12.4%, a Tier 1 capital ratio of 14.1%, a total capital ratio of 16.8%, and a Tier 1 leverage ratio of 9.3%. The applicable minimum ratios were 5.875%, 7.375%, 9.375% and 4.0%, respectively. The firm’s supplementary leverage ratio was 6.3%, compared with an estimated 5.0% minimum effective in 2018 for U.S. G-SIBs. GS Bank USA remained well-capitalized.
Material changes versus comparable periods
- Q3 performance benefited from improved equity markets, tighter credit spreads and stronger market-making conditions after a difficult first half.
- Institutional Client Services Q3 revenue increased 17% to $3.75 billion and pre-tax earnings increased 77% to $1.22 billion. For nine months, revenue declined 11%, reflecting first-half weakness.
- Investing & Lending Q3 revenue more than doubled to $1.40 billion and pre-tax earnings increased to $708 million, primarily from improved public-equity results. Nine-month revenue fell 37% and pre-tax earnings fell 60%, largely because of weak private-equity and loan-related results earlier in the year.
- Investment Management assets under supervision increased to $1.35 trillion from $1.19 trillion a year earlier, but nine-month revenue declined 10% because incentive fees were substantially lower.
- Deposits increased by $27.03 billion, primarily following the April 2016 acquisition of GE Capital Bank’s online deposit platform, which added approximately $16.52 billion of deposits.
- The firm adopted consolidation guidance that reduced assets and liabilities by approximately $200 million without affecting earnings. It also early adopted debt valuation adjustment presentation guidance, reclassifying a cumulative $305 million gain, net of tax, from retained earnings to accumulated other comprehensive loss.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide formal quantitative earnings guidance. Management described Q3 conditions as improved but cautioned that prolonged macroeconomic concerns, lower market-making or investment-banking activity, unfavorable asset mix or asset withdrawals could reduce future revenue.
- Investment banking backlog increased from Q2 but remained below Q3 2015 and is subject to cancellation, modification and timing risk.
- Brexit could affect the firm’s ability to provide services across the European Union, require operational restructuring and increase market volatility.
- Regulatory capital, TLAC, leverage, margin, commodity and physical-activity rules remain evolving and could increase capital or liquidity requirements. The firm expects margin requirements for uncleared swaps to increase as rules phase in.
- Most investments in funds measured at NAV, totaling $6.86 billion, may need to be reduced under the Volcker Rule conformance period. The firm warns that limited secondary markets could result in sales below carrying value.
- Legal proceedings remain significant. Management estimated the upper end of reasonably possible aggregate loss for certain matters at approximately $1.7 billion in excess of reserves, while noting that many investigations and mortgage-related claims cannot currently be estimated.
- Loans receivable totaled $49.06 billion, with a $491 million allowance for loan losses. Lending commitments totaled $116.09 billion, including $91.15 billion held for investment.
- Derivative and other guarantee disclosures include $741.80 billion of derivative guarantees, $38.39 billion of securities-lending indemnifications and $3.25 billion of other financial guarantees; these are not expected losses and generally represent notional or maximum payout amounts.
- Q3 included approximately $63 million of exit costs for excess office space. The APEX exchange for Series E and F preferred stock produced a $105 million benefit to common earnings in Q3 and $266 million for the nine months.
Investor verification priorities
- Verify the sustainability of Q3’s market-making and Investing & Lending gains versus the weaker nine-month trend.
- Review compensation accruals, the 41.0% year-to-date compensation ratio and the effect of lower litigation provisions on expense comparisons.
- Reconcile cash generation with debt issuance, deposit growth, acquisitions, share repurchases and collateralized financing activity.
- Monitor CET1, leverage and liquidity ratios as capital buffers and other regulatory requirements phase in.
- Assess exposure to litigation, mortgage repurchase claims, regulatory investigations and the disclosed $1.7 billion reasonably possible loss estimate above reserves.
- Evaluate fair-value sensitivity, including $24.29 billion of level 3 financial assets, $19.02 billion of level 3 liabilities and the assumptions used for private equity, credit, real-estate and derivative positions.
- Track Volcker Rule fund reductions, Brexit-related restructuring and the potential effect of new TLAC, margin, commodity and liquidity rules.