GOLDMAN SACHS GROUP INC quarterly report, Q2 FY2009

Goldman Sachs Group, Inc. 10-Q Summary

Business context and reporting period

Goldman Sachs is a global financial services firm operating through Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services. This unaudited report covers the three and six months ended June 26, 2009. Comparisons are against the previously reported periods ended May 30, 2008, rather than June 27, 2008. The firm changed its fiscal year-end in connection with becoming a bank holding company; fiscal 2009 ends December 31, 2009.

Key financial metrics

Metric	Three months ended June 2009	Six months ended June 2009
Net revenues	$13.761 billion	$23.186 billion
Pre-tax earnings	$5.029 billion	$7.658 billion
Net earnings	$3.435 billion	$5.249 billion
Net earnings applicable to common shareholders	$2.718 billion	$4.377 billion
Diluted EPS	$4.93	$8.42
Pre-tax margin	36.5%	33.0%
Net margin	25.0%	22.6%
Annualized ROE on common equity	23.0%	18.3%

Reported diluted EPS increased from $4.58 to $4.93 for the quarter and from $7.81 to $8.42 for the first half. Results included a $426 million one-time preferred dividend associated with repurchasing the U.S. Treasury’s TARP preferred stock. Excluding that item, diluted EPS was $5.71 for the quarter and $9.23 for the first half, with annualized common ROE of 23.8% and 19.2%, respectively.

Revenue and segment performance

• Trading and Principal Investments: Second-quarter net revenues rose 93% to $10.784 billion and first-half net revenues rose 67% to $17.934 billion. FICC revenue was $6.795 billion for the quarter and $13.352 billion for the first half, supported by strong client activity, credit products and interest-rate products. Equities revenue was $3.178 billion for the quarter and $5.179 billion for the first half.
• Principal Investments: Second-quarter revenue included a $948 million gain on ICBC shares, a $343 million gain from corporate investments and a $499 million real estate investment loss. First-half principal investments produced a $597 million net loss, including $1.14 billion of real estate losses and $278 million of corporate losses, partly offset by a $797 million ICBC gain.
• Investment Banking: Net revenues declined 15% to $1.440 billion in the quarter and 21% to $2.263 billion in the first half. Financial Advisory revenue fell sharply because of lower completed M&A activity, partly offset by stronger underwriting revenue. Management said the investment banking backlog decreased during the quarter.
• Asset Management and Securities Services: Net revenues declined 28% to $1.537 billion in the quarter and 29% to $2.989 billion in the first half. Assets under management increased to $819 billion at June 30, 2009, including $42 billion of quarterly market appreciation and $6 billion of net inflows; first-half net flows were negative $5 billion.

Expenses, cash flow, debt and liquidity

• Operating expenses were $8.732 billion for the quarter and $15.528 billion for the first half, up 33% and 21%, respectively. Compensation and benefits represented 48.3% of quarterly net revenues and 49.0% for the first half.
• Non-compensation expenses included approximately $170 million of real estate impairment charges in the quarter and approximately $470 million in the first half, primarily related to consolidated investment entities. The quarter also included approximately $50 million of special FDIC assessment expense and $25 million of litigation and regulatory provisions.
• Net cash provided by operating activities was $16.020 billion for the first half, compared with $14.092 billion of cash used in the comparable 2008 period. Cash and cash equivalents increased to $22.177 billion from $13.805 billion at the beginning of the period.
• Total assets were $889.544 billion at June 26, 2009, compared with $884.547 billion at November 28, 2008. Total shareholders’ equity was $62.813 billion, including $55.856 billion of common equity and $6.957 billion of preferred equity.
• Total borrowings included $35.173 billion of unsecured short-term borrowings, $191.242 billion of unsecured long-term borrowings and $30.297 billion of other secured financings. Total long-term borrowings were $207.30 billion, compared with $185.68 billion at November 2008.
• Average Global Core Excess liquidity was $170.948 billion during the quarter. Average Global Core Excess and other unencumbered assets totaled $220.77 billion, which management stated was sufficient to replace at least 110% of unsecured obligations maturing or redeemable within 12 months.

Capital, material changes and unusual items

• The firm issued 46.7 million common shares at $123 per share, generating $5.75 billion of proceeds.
• Goldman Sachs repurchased the TARP Series H preferred stock for $10.04 billion, including accrued dividends, reducing preferred stock liquidation preference by approximately $10 billion. The transaction generated the $426 million one-time preferred dividend.
• At June 2009, Basel I Tier 1 and total capital ratios were 13.8% and 17.2%, respectively, and the Tier 1 leverage ratio was 6.4%. Basel II-style Tier 1 and total capital ratios were 16.1% and 19.7%.
• Book value per common share increased to $106.41 from $98.68 at November 2008; tangible book value per common share increased to $96.94 from $88.27.
• Total level 3 assets declined to $54.444 billion from $66.190 billion at November 2008. Six-month level 3 unrealized losses were $5.981 billion, primarily from private equity and real estate investments and commercial real estate exposures.
• On July 22, 2009, after the reporting date, the firm repurchased the U.S. Treasury warrant for up to 12.2 million common shares for $1.1 billion, recorded as a reduction to shareholders’ equity.

Outlook, risks and contingencies

Management described global economic conditions as weak but showing signs of stabilization. Equity markets rose, volatility generally declined and corporate credit spreads tightened during the quarter, creating favorable trading conditions. However, management emphasized that earnings are not predictable and remain materially dependent on global financial markets and economic conditions.

• Key market risks include interest rates, equity prices, currencies, commodities, credit spreads, liquidity and counterparty performance. Average daily VaR increased to $245 million in the quarter from $184 million in the comparable 2008 period; quarter-end VaR was $221 million.
• Commercial real estate, private equity, distressed loans and other less-liquid level 3 assets remain exposed to valuation uncertainty. Valuations rely partly on management estimates and unobservable inputs.
• Gross derivative fair values were approximately $1.094 trillion of assets and $955 billion of liabilities before netting and collateral. A one-notch and two-notch downgrade could have triggered approximately $763 million and $1.93 billion, respectively, of additional collateral or termination payments.
• Nonconsolidated VIE maximum exposure to loss was $17.114 billion, excluding offsetting risk mitigants and not representing expected losses. Securitization entities with continuing involvement had $74.291 billion of outstanding principal, with $2.347 billion of retained interests and $199 million of purchased interests at fair value.
• Total commitments were $131.039 billion, including $39.944 billion of commitments to extend credit, $58.574 billion of forward-starting resale and securities-borrowing agreements, and $13.723 billion of investment commitments.
• The firm is involved in judicial, regulatory and arbitration proceedings. Management believes aggregate matters will not materially affect financial condition, but losses could be material to results for a particular period. The filing does not provide a clear aggregate maximum loss estimate for matters where loss is reasonably possible but not probable or estimable.
• SFAS 166 and 167, which change securitization and VIE consolidation requirements, were issued in June 2009. The firm was evaluating their effect and had not quantified the expected impact.

Investor verification priorities

• Verify the sustainability of unusually strong FICC and Equities results and the extent to which second-quarter trading revenue reflected favorable market conditions rather than recurring client activity.
• Reconcile reported earnings with the $426 million one-time TARP preferred dividend and separately assess the effect of the July 2009 $1.1 billion warrant repurchase.
• Review commercial real estate, private investment, level 3 and other illiquid exposures, including valuation assumptions and unrealized losses.
• Assess funding concentration, debt maturities, secured financing availability, downgrade-related collateral requirements and the accessibility of liquidity held in regulated subsidiaries.
• Monitor investment banking backlog, M&A activity, assets under management and net flows as indicators of future fee revenue.
• Review litigation, regulatory inquiries, mortgage-related claims, credit derivative matters and potential effects from future securitization and VIE accounting changes.