GOLDMAN SACHS GROUP INC quarterly report, Q3 FY2018

Goldman Sachs Group Inc. — 3Q18 Form 10-Q Summary

Business context and reporting period

The filing covers the unaudited quarter and nine months ended September 30, 2018, compared primarily with the corresponding 2017 periods. Goldman Sachs is a global investment banking, securities and investment management firm operating through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. The firm reported under U.S. GAAP and adopted ASC 606 revenue recognition in January 2018.

Financial performance and key metrics

Metric	3Q18	3Q17	9M18	9M17
Net revenues	$8.646B	$8.326B	$28.084B	$24.239B
Pre-tax earnings	$3.078B	$2.976B	$9.773B	$8.024B
Net earnings	$2.524B	$2.128B	$7.921B	$6.214B
Net earnings applicable to common	$2.453B	$2.035B	$7.538B	$5.828B
Diluted EPS	$6.28	$5.02	$19.21	$14.11
Annualized ROE	13.1%	10.9%	13.7%	10.3%
Annualized ROTE	13.8%	11.5%	14.6%	10.9%

Implied pre-tax margin was approximately 35.6% in 3Q18 and 34.8% for 9M18; implied net margin was approximately 29.2% and 28.2%, respectively. Compensation and benefits were $3.091B in 3Q18 and $10.672B in 9M18. Total operating expenses were $5.568B and $18.311B, respectively.

3Q18 revenue growth was driven by higher investment banking, investment management, market making and net interest income revenues, partly offset by lower other principal transactions.
9M18 revenue growth reflected higher results across all four segments, particularly market making, net interest income, investment management and Investing & Lending.
Net interest income increased to $856M in 3Q18 and $2.776B in 9M18, versus $730M and $2.034B in the comparable 2017 periods.
Investment banking revenue increased 10% in 3Q18 and 11% in 9M18. Investment management revenue increased 11% and 16%, respectively.
Market making revenue increased 8% in 3Q18 and 25% in 9M18. Other principal transactions declined 20% in 3Q18 but increased 4% for 9M18.
Assets under supervision increased to $1.550T at September 30, 2018, from $1.456T a year earlier, reflecting net inflows and market appreciation.

Cash flow, balance sheet, debt and liquidity

Cash and cash equivalents were $118.871B at September 30, 2018, up $8.820B from December 31, 2017. Nine-month cash flow from operating activities was $2.320B, investing activities used $16.835B, and financing activities provided $23.335B.
Total assets were $957.190B, up from $916.776B at year-end 2017. Financial instruments owned increased to $351.028B and loans receivable increased to $76.011B from $65.933B.
Total liabilities were $870.428B and shareholders’ equity was $86.762B, compared with $834.533B and $82.243B at December 31, 2017.
Deposits increased to $151.518B from $138.604B, driven principally by Marcus deposits and brokered certificates of deposit.
Unsecured short-term borrowings were $41.735B, while unsecured long-term borrowings were $229.387B. Total long-term borrowings, including secured financing, were $242.132B.
In September 2018, the firm repurchased $4.10B principal amount of unsecured borrowings for $4.37B and recognized a $160M gain.
Average GCLA was $237.831B in 3Q18. Average daily LCR was 128%, versus a 100% minimum. Other unencumbered assets averaged $179.810B.
Basel III Advanced CET1, Tier 1 and total capital ratios were 12.4%, 14.3% and 16.7%, respectively. The standardized CET1 ratio was 13.1%. The Tier 1 leverage ratio was 8.6% and the supplementary leverage ratio was 6.0%.
Book value per common share was $197.33 and tangible book value per common share was $186.62, compared with $181.00 and $170.61 at year-end 2017.

Material changes versus comparable periods

9M18 net revenues rose 16%, net earnings rose 27%, and diluted EPS rose 36% year over year. The effective tax rate was 19.0%, versus the unusually high 2017 rate caused by a $4.40B Tax Cuts and Jobs Act charge.
Operating expenses increased 13% in 9M18. Non-compensation expenses increased 17%, including higher technology, business growth, Marcus, consolidated investment and litigation-related costs. Litigation and regulatory provisions were $328M versus $179M in 9M17.
The firm adopted ASC 606 under a modified retrospective approach. The filing states that presentation changes increased both 3Q18 net revenues and non-compensation expenses by approximately $85M and 9M18 amounts by approximately $215M; 3Q18 net revenues were also approximately $35M lower than under the prior recognition timing.
Loans receivable grew 15% from year-end 2017, while the allowance for loan losses increased to $974M from $803M. Marcus loans increased to $3.959B from $1.912B.
Common stock repurchases totaled $2.044B in 9M18, versus $5.143B in 9M17, and common dividends declared increased to $2.35 per share from $2.15.

Guidance, outlook, risks and unusual items

Management did not provide conventional revenue or earnings guidance. The 2018 capital plan permits up to $6.30B of capital returns from 3Q18 through 2Q19, including up to $5.00B of common share repurchases and $1.30B of common dividends, subject to regulatory and board approval. The plan contemplated increasing the quarterly common dividend to $0.85 in 2Q19.
Management cautioned that continued low market volatility, weak fixed-income client activity, declining investment banking activity, lower asset prices or reduced assets under supervision could negatively affect revenue.
Business risks include trade tensions, emerging-market weakness, higher interest rates, credit and market volatility, funding and liquidity stress, counterparty defaults, valuation/model risk, operational and technology failures, regulatory changes and litigation.
Legal and regulatory matters remained significant. The estimated upper end of reasonably possible aggregate legal losses was approximately $1.8B in excess of recorded reserves, while management stated that aggregate outcomes were not expected to materially affect financial condition but could materially affect a particular period’s results.
The firm committed to provide $1.80B of consumer relief under a mortgage-related settlement by January 2021; approximately $1.12B had been provided by September 2018. Potential mortgage repurchase exposure could not be meaningfully estimated.
The filing describes investigations and litigation involving, among other matters, mortgage activities, securities and derivatives trading, employment practices, FCPA compliance and 1MDB-related transactions. It states that proceedings related to 1MDB could result in significant fines, penalties or other sanctions, but the outcome could not be predicted.
The firm expects an approximately $2B gross-up to the balance sheet upon adoption of the new lease standard in January 2019. The filing also identifies CECL adoption in January 2020 as potentially increasing allowances, with the ultimate impact dependent on economic conditions and asset composition.

Most important facts for an investor to verify

Whether market-making and investment banking activity recovered from the low-volatility and lower-client-activity environment described for 3Q18.
The sustainability of earnings driven by private-equity gains, incentive-fee harvesting, investment banking underwriting and higher interest rates.
Future litigation, regulatory and 1MDB-related settlements, reserves and cash payments, including the approximately $1.8B reasonably possible loss excess.
Loan growth, Marcus credit performance, allowance coverage and the effect of future CECL implementation.
Capital-return execution relative to the $6.30B approved plan and the effect of fully phased-in capital buffers and other regulatory changes.
Liquidity availability at the parent and regulated subsidiaries, including the transfer restrictions affecting subsidiary capital and the firm’s 128% average LCR.
The effects of ASC 606, the expected 2019 lease-accounting balance-sheet gross-up and other accounting estimates on comparability and reported profitability.