GOLDMAN SACHS GROUP INC quarterly report, Q2 FY2011

Goldman Sachs Group Inc. — Q2 2011 Form 10-Q Summary

Business context and reporting period

The Goldman Sachs Group, Inc. is a global investment banking, securities and investment management firm serving corporations, financial institutions, governments and high-net-worth individuals. The filing covers the unaudited quarter and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods. Reportable segments are Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management.

Key financial metrics

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Net revenues	$7.281 billion	$8.841 billion	$19.175 billion	$21.616 billion
Pre-tax earnings	$1.612 billion	$1.448 billion	$5.652 billion	$6.607 billion
Net earnings	$1.087 billion	$613 million	$3.822 billion	$4.069 billion
Net earnings applicable to common shareholders	$1.052 billion	$453 million	$1.960 billion	$3.749 billion
Diluted EPS	$1.85	$0.78	$3.40	$6.41
Net interest income	$1.413 billion	$1.619 billion	$2.771 billion	$3.037 billion
Total operating expenses	$5.669 billion	$7.393 billion	$13.523 billion	$15.009 billion

Q2 pre-tax margin was approximately 22.1% and net margin was approximately 14.9%. Six-month pre-tax margin was approximately 29.5% and net margin was approximately 19.9%. Annualized return on average common equity was 6.1% for Q2 and 8.0% for the first half.

Investment Banking revenue increased 54% year over year to $1.448 billion in Q2 and increased 27% to $2.717 billion for the first half.
Institutional Client Services revenue declined 29% in Q2 to $3.515 billion and 25% for the first half to $10.162 billion, primarily because of weaker fixed income, currency and commodities client execution.
Investing & Lending revenue declined 42% in Q2 to $1.044 billion but was broadly unchanged for the first half at $3.749 billion.
Investment Management revenue increased 12% in Q2 to $1.274 billion and 14% for the first half to $2.547 billion. Assets under management were $844 billion at June 30, 2011.
Q2 operating expenses declined 23%, including a 16% decline in compensation and benefits. The first half compensation-to-revenue ratio was 44.0%, compared with 43.0% in the comparable 2010 period excluding the prior-year U.K. bank payroll tax.
Net cash provided by operating activities was $12.655 billion for the first half, compared with $2.449 billion in 2010. Cash and cash equivalents increased to $45.433 billion from $39.788 billion at year-end 2010.
Total assets were $936.910 billion and total liabilities were $864.554 billion at June 30, 2011. Shareholders’ equity was $72.356 billion, down from $77.356 billion at year-end 2010.
Unsecured short-term borrowings were $56.554 billion and unsecured long-term borrowings were $175.210 billion. Total short-term borrowings, including other secured financings, were $83.063 billion.
Global Core Excess liquidity was $165.843 billion at June 30, 2011, compared with $174.776 billion at year-end 2010.
Basel 1 Tier 1 capital ratio was 14.7%, total capital ratio was 17.8%, Tier 1 leverage ratio was 7.3%, and Tier 1 common ratio was 12.9%.

Material changes versus the prior comparable period

Revenue mix shifted away from market-sensitive trading and toward investment banking and investment management. Market-making revenue declined 39% in Q2 and 33% for the first half, while investment banking revenue rose substantially.
Q2 net earnings improved despite lower revenue because expenses were lower and the second quarter of 2010 included a $600 million U.K. bank payroll tax and a $550 million SEC settlement.
Six-month earnings applicable to common shareholders and EPS were reduced by a $1.643 billion preferred dividend adjustment related to the redemption of Series G Preferred Stock. Excluding that item, six-month diluted EPS was $6.25 and annualized ROE was 10.2%; these are non-GAAP measures.
Series G Preferred Stock was redeemed on April 18, 2011 for $5.50 billion plus accrued dividends. Preferred stock outstanding declined to $3.1 billion from $6.957 billion at year-end.
The firm repurchased 19.8 million common shares for approximately $2.97 billion during the first half, including 10.8 million shares for $1.50 billion in Q2.
Management launched an efficiency initiative targeting approximately $1.2 billion of annual run-rate compensation and non-compensation reductions, expected to be completed before year-end.
Adjusted leverage increased to 8.8x from 7.6x at year-end, primarily reflecting lower equity following the Series G redemption and higher adjusted assets.
Average daily VaR declined to $101 million in Q2 from $136 million in Q2 2010; quarter-end VaR was $85 million, and the firm reported one trading loss exceeding its 95% one-day VaR during the quarter.

Guidance, outlook, commentary, risks and unusual items

Management stated that earnings are inherently unpredictable and depend materially on global market conditions, economic activity, volatility, liquidity, asset prices and client activity.
Management expected approximately $130 million of U.K. bank levy expense for 2011, with approximately three-fourths expected in the third quarter and the balance in the fourth quarter. The final amount may vary.
Management cited European sovereign debt concerns, the U.S. debt ceiling, weak or uncertain economic data, low volatility, reduced liquidity and lower client risk appetite as pressures on trading, commissions, investment banking and investment management results.
Future regulatory requirements under Dodd-Frank, Basel 2.5 and Basel 3 are expected to increase capital requirements, raise risk-weighted assets and potentially reduce reported capital ratios. The final requirements were not yet established.
Mortgage-related litigation, regulatory investigations, foreclosure and servicing inquiries remain significant. The estimated aggregate upper end of reasonably possible legal losses was approximately $2.0 billion, while reserves were not significant relative to that amount.
Mortgage repurchase claims were not material at June 30, 2011, but management could not meaningfully estimate potential future exposure because claims may increase with mortgage defaults and depend on legal and economic developments.
Commitments totaled $167.369 billion, including $64.286 billion of commitments to extend credit and $10.286 billion of investment commitments. These amounts may not represent actual future cash outflows.
Derivative guarantees had a maximum payout or notional amount of $828.754 billion, while the carrying value of the related net liability was $8.941 billion. Notional amounts are not expected losses.
A two-notch credit-rating downgrade could have required approximately $1.842 billion of additional collateral or termination payments at June 30, 2011.
Fair-value Level 3 assets were $47.007 billion, or 5.0% of total assets. These valuations involve significant unobservable inputs and management judgment.
The filing reports that disclosure controls and procedures were effective as of June 30, 2011 and that no material change occurred in internal control over financial reporting during the quarter.

Most important facts for investors to verify

Whether the $1.2 billion cost-reduction initiative produces the targeted run-rate savings without materially impairing revenue-generating capacity.
Whether trading revenue, particularly in fixed income, mortgages and commodities, recovers as liquidity, volatility and client activity change.
The effect of the U.K. bank levy, evolving Dodd-Frank and Basel requirements, and the phase-out of regulatory capital treatment for junior subordinated debt.
Changes in liquidity reserves, secured and unsecured funding maturities, credit ratings, and collateral requirements following any market stress or downgrade.
Movement in Level 3 assets, private equity valuations, distressed loans and other less-liquid inventory.
Developments in mortgage-related litigation, repurchase claims, foreclosure investigations, SEC and other regulatory matters, including potential losses beyond recorded reserves.
The effect of the Series G redemption, continued share repurchases and future dividend decisions on common equity, leverage and regulatory capital.