Business Context and Reporting Period
The Goldman Sachs Group, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The firm operates through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. Results were affected by weaker global equity markets, lower commodity prices, wider credit spreads, China-related concerns, and uncertainty regarding U.S. Federal Reserve policy.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenues | $6.861 billion | $8.387 billion | $26.547 billion | $26.840 billion |
| Pre-tax earnings | $2.046 billion | $3.305 billion | $7.706 billion | $9.147 billion |
| Net earnings | $1.426 billion | $2.241 billion | $5.318 billion | $6.311 billion |
| Net earnings applicable to common shareholders | $1.330 billion | $2.143 billion | $4.994 billion | $6.045 billion |
| Diluted EPS | $2.90 | $4.57 | $10.84 | $12.69 |
| Annualized ROE on average common equity | 7.0% | 11.8% | 8.8% | 11.2% |
- Q3 net revenue fell 18%, pre-tax earnings fell 38%, net earnings fell 36%, and diluted EPS fell 37% year over year. Nine-month net revenue was essentially flat, while pre-tax earnings declined 16%, net earnings declined 16%, and diluted EPS declined 15%.
- Approximate pre-tax margin was 29.8% in Q3 2015 versus 39.4% in Q3 2014; nine-month margin was 29.0% versus 34.1%. Approximate net margin was 20.8% versus 26.7% in Q3 and 20.0% versus 23.5% for the nine-month periods.
- Investment banking revenue increased 6% in Q3 and 9% for the nine-month period, driven primarily by financial advisory and mergers and acquisitions activity. Nine-month Investment Banking pre-tax earnings increased 16%.
- Institutional Client Services revenue declined 15% in Q3, although nine-month revenue increased 2%. Q3 pre-tax earnings declined 42% and nine-month pre-tax earnings declined 35%, principally reflecting litigation and regulatory provisions and weaker fixed-income, currency and commodities conditions.
- Investing & Lending revenue declined 60% in Q3 and 22% for the nine-month period. Q3 pre-tax earnings declined 72%; nine-month pre-tax earnings declined 22%. Public-equity investment results were pressured by falling global equity prices.
- Investment Management revenue declined 3% in Q3 but increased 4% for the nine-month period. Assets under supervision were $1.188 trillion at September 30, 2015, up from $1.178 trillion at December 31, 2014, despite $27 billion of nine-month market depreciation.
- Operating expenses were $4.815 billion in Q3 and $18.841 billion for nine months. Compensation and benefits declined 16% in Q3 and were essentially flat for nine months. Non-compensation expenses increased 8% in Q3 and 18% for nine months.
- Net provisions for litigation and regulatory proceedings were $416 million in Q3 and $2.06 billion for nine months, compared with $194 million and $593 million, respectively, in the prior-year periods.
- Cash and cash equivalents increased to $65.575 billion from $57.600 billion at December 31, 2014. Nine-month operating cash flow was $166 million, investing cash flow was negative $14.747 billion, and financing cash flow was $22.556 billion.
- Total assets were $880.559 billion, up from $855.842 billion. Total liabilities were $792.856 billion, and shareholders’ equity was $87.703 billion, up from $82.797 billion.
- Loans receivable increased to $42.189 billion from $28.938 billion. Unsecured short-term borrowings were $41.331 billion, unsecured long-term borrowings were $175.817 billion, and total deposits were $91.458 billion.
- Global Core Liquid Assets were $192.511 billion at September 30, 2015. The firm stated that its liquidity position was appropriate based on internal liquidity models and other considerations.
- Applicable Standardized capital ratios were 12.4% CET1, 14.1% Tier 1, and 16.6% total capital. The Basel III Advanced CET1, Tier 1, and total capital ratios were 12.7%, 14.4%, and 16.9%, respectively; the Standardized ratios were the binding ratios.
Material Changes Versus Prior Comparable Period
- The principal year-over-year deterioration was concentrated in Q3, when Investing & Lending and Fixed Income, Currency and Commodities Client Execution were adversely affected by market declines and reduced client activity.
- Market-making revenue decreased 17% in Q3 but increased 15% for the nine-month period. Other principal transactions revenue decreased 66% in Q3 and 25% for nine months.
- Net interest income decreased 20% in Q3 and 23% for nine months, primarily because of lower interest income from a smaller average financial-instrument inventory.
- Litigation and regulatory provisions increased materially, contributing to higher non-compensation expenses despite lower revenue and compensation expense.
- The firm’s balance sheet shifted toward higher lending and client receivables, while financial instruments owned at fair value declined by $21.761 billion from year-end.
- Shareholders’ equity increased partly because the firm issued $2.0 billion of preferred stock in 2015. The firm repurchased 13.3 million common shares for $2.545 billion during the first nine months.
Outlook, Risks, Contingencies, and Unusual Items
- No formal earnings or revenue guidance was provided. Management stated that continued macroeconomic concerns, declining market-making activity, weaker investment-banking activity, asset-price declines, or lower assets under supervision could reduce future revenue.
- Investment-banking backlog increased during the quarter, particularly for potential equity and leveraged-finance transactions, but management cautioned that transactions may be delayed, modified, or cancelled.
- The filing identifies substantial exposure to market, liquidity, credit, operational, legal, regulatory, and reputational risks. A two-notch credit-rating downgrade could have required approximately $2.787 billion of additional collateral or termination payments on bilateral derivatives.
- Management estimated the upper end of reasonably possible aggregate legal losses at approximately $5.3 billion in excess of recorded reserves for matters where a range could be estimated. Other matters, including mortgage-related claims and regulatory investigations, were not included in that estimate.
- Mortgage-related matters, foreign-exchange and commodities litigation, credit-derivatives antitrust matters, U.S. Treasury litigation, and regulatory investigations remain significant contingencies. The filing states that outcomes may be material to results for a particular period even if not expected to materially affect financial condition.
- The firm held $7.896 billion of investments in funds measured at NAV, including private-equity, credit, hedge, and real-estate funds, and expects to reduce most covered-fund interests to comply with the Volcker Rule. Related investments may be difficult to sell at carrying value.
- The firm recorded $78 million of asset impairments during the first nine months, primarily related to consolidated energy investments affected by low commodity prices.
- The firm early adopted accounting updates concerning debt issuance costs and NAV-based fair-value disclosures. The debt issuance cost adoption reduced both assets and liabilities by $444 million at September 30, 2015.
Investor Verification Priorities
- Verify the composition, reserve coverage, and credit quality of the increased loan portfolio and lending commitments, particularly oil and gas, corporate, real-estate, and non-investment-grade exposures.
- Review litigation and regulatory reserves against the disclosed approximately $5.3 billion excess reasonably possible loss estimate and monitor pending settlements and investigations.
- Assess whether market-making and Investing & Lending weakness persists if equity prices decline, credit spreads widen, or client activity remains subdued.
- Reconcile reported liquidity, including the $192.511 billion of Global Core Liquid Assets, with subsidiary-level restrictions and potential collateral calls following a ratings downgrade.
- Monitor the effect of Volcker Rule compliance on the $7.896 billion of fund investments and related unfunded commitments.
- Compare applicable and fully phased-in capital ratios, including the expected 2019 capital conservation buffer and G-SIB surcharge, with future regulatory requirements.