GOLDMAN SACHS GROUP INC quarterly report, Q2 FY2010

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. Its three segments are Investment Banking; Trading and Principal Investments; and Asset Management and Securities Services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010, with comparable periods ended June 26, 2009, and financial-condition comparisons to December 31, 2009.

Financial Performance and Position

Metric	Three months ended June 2010	Three months ended June 2009	Six months ended June 2010	Six months ended June 2009
Net revenues	$8.84 billion	$13.76 billion	$21.62 billion	$23.19 billion
Pre-tax earnings	$1.45 billion	$5.03 billion	$6.61 billion	$7.66 billion
Net earnings	$613 million	$3.44 billion	$4.07 billion	$5.25 billion
Net earnings applicable to common shareholders	$453 million	$2.72 billion	$3.75 billion	$4.38 billion
Diluted EPS	$0.78	$4.93	$6.41	$8.42
Net cash provided by operating activities	Not applicable	Not applicable	$2.45 billion	$16.02 billion

Second-quarter net revenues declined 36% year over year; first-half net revenues declined 7%.
Second-quarter pre-tax margin was approximately 16.4%, versus 36.5% in the prior-year quarter. First-half pre-tax margin was approximately 30.6%, versus 33.0%.
Second-quarter net margin was approximately 6.9%, versus 25.0% in the prior-year quarter. First-half net margin was approximately 18.8%, versus 22.6%.
Operating expenses were $7.39 billion in the quarter and $15.01 billion in the first half, including a $600 million U.K. bank payroll tax and $615 million of litigation and regulatory provisions in the quarter, of which $550 million related to the SEC settlement.
Excluding the U.K. payroll tax and SEC settlement, management reported second-quarter diluted EPS of $2.75 and annualized return on average common equity of 9.5%; reported figures were $0.78 and 7.9%, respectively.
At June 30, total assets were $883.19 billion, up from $848.94 billion at year-end 2009. Total liabilities were $809.37 billion and shareholders’ equity was $73.82 billion.
Cash and cash equivalents were $32.60 billion, down $5.69 billion from year-end. Management reported average Global Core Excess liquidity of $162.52 billion for the quarter and $168.10 billion at June 30.
Unsecured short-term borrowings were $39.12 billion; total short-term borrowings, including other secured financings, were $52.55 billion. Unsecured long-term borrowings were $178.58 billion, and total long-term borrowings were $190.98 billion.
Regulatory capital remained strong: Basel I Tier 1 capital ratio was 15.2%, total capital ratio 18.2%, Tier 1 leverage ratio 8.0% and Tier 1 common ratio 12.5% at June 30.

Material Changes Versus Prior Comparable Period

Trading and Principal Investments segment net revenues fell 39% in the quarter and 6% in the first half. Second-quarter FICC revenue fell 35% and Equities revenue fell 62%, reflecting lower activity, wider credit spreads, declining equity markets and higher volatility.
Investment Banking revenue declined 36% in the quarter and 7% in the first half. Financial Advisory revenue increased, but underwriting revenue fell sharply as industry-wide equity and debt issuance slowed.
Asset Management and Securities Services revenue declined 11% in the quarter and 9% in the first half. Asset Management revenue increased, while Securities Services revenue fell because of tighter securities-lending spreads.
Principal Investments produced $943 million of second-quarter revenue and $1.45 billion for the first half. Results included gains of $905 million and $683 million, respectively, related primarily to the expiration of transfer restrictions on ICBC shares.
Assets under management declined to $802 billion at June 30 from $840 billion at the beginning of the quarter, reflecting $24 billion of quarterly net outflows and $14 billion of market depreciation. First-half net outflows were $63 billion.
Cash flow from operations fell substantially from the prior-year period, while financing activities used $7.45 billion, primarily reflecting debt repayments, deposit reductions, common-stock repurchases and dividends.
The firm adopted new VIE and financial-asset transfer accounting standards on January 1, 2010. Adoption increased assets and liabilities by approximately $3 billion and did not materially affect earnings or cash flows.

Guidance, Outlook, Commentary, Risks and Unusual Items

The filing provides no specific earnings or revenue guidance. Management states that results are inherently unpredictable and may be materially affected by global financial markets, economic conditions and other factors.
Management described the second-quarter environment as challenging, citing European sovereign-debt concerns, slower Chinese growth, regulatory uncertainty, lower equity prices, higher volatility, wider corporate credit spreads and reduced investment-banking activity.
The Dodd-Frank Act was enacted on July 21, 2010. Expected areas of impact include restrictions on proprietary trading and investments in hedge funds and private equity funds, increased OTC-derivatives regulation, higher capital requirements and expanded regulatory oversight. The ultimate effect remained dependent on implementing rules.
The SEC settlement relating to the ABACUS 2007-AC1 CDO offering totaled $550 million, comprising $15 million of disgorgement and a $535 million civil penalty. Related FINRA and U.K. FSA investigations continued.
Management states that litigation and regulatory matters are not expected to have a material adverse effect on financial condition in the aggregate, but could materially affect results in a particular period. The firm cannot estimate losses for matters where a loss is only reasonably possible.
Credit-rating downgrades could increase collateral or termination requirements. At June 30, estimated additional requirements were approximately $1.33 billion for a one-notch downgrade and $2.68 billion for a two-notch downgrade.
Level 3 assets totaled $46.13 billion, or 5.2% of total assets; the firm bore economic exposure to $43.52 billion. Valuations depend in part on unobservable inputs and management judgment.
Nonconsolidated VIE maximum exposure to loss was $18.46 billion, excluding offsetting risk mitigants. Total commitments were $125.78 billion, including $51.68 billion of commitments to extend credit.
Market-risk measures excluded certain illiquid or restricted positions. A 10% adverse move in specified positions represented sensitivities of $359 million for ICBC, $1.01 billion for other principal-investment equity and $684 million for principal-investment real estate.
The filing identifies a potential future risk to the $400 million carrying value of NYSE designated market-maker rights if market-data, trading-volume or business-performance issues persist.

Investor Verification Priorities

Verify the sustainability of trading revenue after the sharp second-quarter decline, particularly FICC and Equities performance under continued volatility and wider credit spreads.
Assess the recurring earnings impact of the $600 million U.K. payroll tax, $550 million SEC settlement and other litigation provisions separately from reported results.
Review liquidity availability by legal entity, since liquidity held at regulated subsidiaries may not be freely transferable to the parent.
Reconcile gross borrowings, secured funding, collateral requirements and debt maturities with the reported Global Core Excess liquidity.
Monitor assets-under-management outflows, especially money-market and equity outflows, and their effect on recurring fee revenue.
Evaluate fair-value sensitivity, Level 3 exposures, real-estate and mortgage positions, VIE commitments and derivative counterparty exposures.
Track the implementation of Dodd-Frank and subsequent capital, proprietary-trading and derivatives rules, including the phase-out of certain preferred-stock and junior-subordinated-debt capital treatment beginning in 2013.
Confirm the status and ultimate cost of continuing litigation, regulatory investigations, tax examinations and contingent guarantees.