Business Context and Reporting Period
The Goldman Sachs Group, Inc. is a global investment banking, securities and investment management firm operating through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods, and the balance sheet is compared with December 31, 2013.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net revenues | $8.387 billion | $6.722 billion | $26.840 billion | $25.424 billion |
| Pre-tax earnings | $3.305 billion | $2.167 billion | $9.147 billion | $8.185 billion |
| Net earnings | $2.241 billion | $1.517 billion | $6.311 billion | $5.708 billion |
| Net earnings applicable to common shareholders | $2.143 billion | $1.429 billion | $6.045 billion | $5.478 billion |
| Diluted EPS | $4.57 | $2.88 | $12.69 | $10.89 |
| Net margin | 26.7% | 22.6% | 23.5% | 22.4% |
| Pre-tax margin | 39.4% | 32.2% | 34.1% | 32.2% |
- Net revenues increased 25% year over year in Q3 and 6% in the first nine months. Net earnings increased 48% in Q3 and 11% year to date.
- Annualized return on average common shareholders’ equity was 11.8% in Q3 and 11.2% for the first nine months, compared with 8.1% and 10.4%, respectively, in 2013.
- Operating expenses were $5.082 billion in Q3 and $17.693 billion year to date. Compensation and benefits were $2.801 billion in Q3 and $10.736 billion year to date; the nine-month compensation-to-net-revenue ratio was 40.0%, versus 41.0% in 2013.
- Net interest income rose 25% in Q3 to $1.049 billion and 19% year to date to $3.086 billion.
- Cash flow from operating activities was an outflow of $12.591 billion for the first nine months, compared with an inflow of $2.263 billion in 2013. Investing activities used $10.591 billion, while financing activities provided $16.199 billion. Cash and cash equivalents ended at $54.150 billion, down from $61.133 billion at year-end 2013.
- Total assets were $868.933 billion, down from $911.507 billion at December 31, 2013. Total shareholders’ equity was $82.275 billion, up from $78.467 billion.
- Unsecured short-term borrowings were $48.282 billion and unsecured long-term borrowings were $165.304 billion. Total long-term borrowings, including secured financings, were $172.357 billion. The leverage ratio was 10.6x, down from 11.6x, and debt to equity was 2.0x, down from 2.1x.
- Management reported Global Core Excess liquidity of $180.040 billion at September 30, 2014, compared with $184.070 billion at year-end 2013. The firm’s estimated Basel III Advanced CET1 ratio was 11.8%, Tier 1 capital ratio 13.2%, total capital ratio 15.4%, and Tier 1 leverage ratio 9.0%.
Material Changes Versus Comparable Periods
- Investment Banking: Q3 revenue rose 26% to $1.464 billion, driven by financial advisory and equity underwriting. Nine-month revenue rose 17% to $5.024 billion. Q3 pre-tax earnings increased 34% to $659 million.
- Institutional Client Services: Q3 revenue rose 32% to $3.772 billion, principally from stronger currencies, commodities, interest-rate products and mortgages. Nine-month revenue declined 2% to $12.048 billion, reflecting weaker equities and generally low volatility.
- Investing & Lending: Q3 revenue increased 15% to $1.692 billion, largely from gains on debt investment sales. Nine-month revenue increased 7% to $5.293 billion, but pre-tax earnings were essentially unchanged at $2.812 billion because expenses increased.
- Investment Management: Q3 revenue increased 20% to $1.459 billion and nine-month revenue increased 16% to $4.475 billion. Assets under supervision reached $1.150 trillion, up $108 billion from year-end 2013, supported by net inflows and acquisitions.
- Market-making revenue increased 53% in Q3 but declined 8% for the first nine months. The Q3 and year-to-date results included a $270 million gain from extinguishing junior subordinated debt.
- The firm repurchased 7.1 million common shares in Q3 for $1.250 billion and 25.2 million shares during the first nine months for $4.219 billion.
- The firm recorded $250 million of impairment losses during the first nine months, including $180 million related primarily to a Latin American consolidated investment and $70 million primarily related to exchange-traded fund market-maker rights.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- The filing provides no formal earnings or revenue guidance. Management states that results are inherently unpredictable and depend materially on global financial markets, economic conditions, volatility, asset values, client activity and funding conditions.
- Management described Q3 market-making conditions as generally more favorable late in the quarter, but activity and volatility remained low. Investment banking backlog increased during Q3, although transactions may be delayed, modified or cancelled.
- The Volcker Rule requires compliance by July 2015, with possible extensions for certain provisions. The firm holds $11.380 billion of investments valued using NAV and expects to reduce most covered-fund interests. Forced sales could occur in limited secondary markets at values below carrying amounts.
- Legal and regulatory matters remain significant. Management estimated the upper end of reasonably possible aggregate loss for certain matters at approximately $2.5 billion in excess of reserves, while noting that significant mortgage-related and regulatory exposures cannot presently be estimated. Litigation and regulatory provisions were $194 million in Q3 and $593 million for the first nine months.
- Mortgage-related claims, regulatory investigations, derivatives, credit concentrations, potential ratings downgrades, operational failures and evolving capital, liquidity and derivatives regulation remain material risks.
- A one-notch credit-rating downgrade could have required approximately $1.340 billion of additional collateral or termination payments; a two-notch downgrade could have required approximately $3.206 billion.
- Commitments totaled $157.023 billion, including $90.209 billion of commitments to extend credit. Maximum derivative guarantees were $799.156 billion, although these notional amounts do not represent expected losses.
Most Important Facts for Investors to Verify
- Whether the strong Q3 earnings improvement, particularly in currencies and fixed income, is sustainable in a low-volatility environment and excluding the $270 million debt-extinguishment gain.
- The quality and persistence of Investing & Lending gains, including private-equity valuation gains and investment-sale gains.
- Cash-flow volatility and the relationship between reported earnings and liquidity, given the $12.591 billion operating cash outflow for the first nine months.
- The effect of the Basel III transition, future capital buffers, the supplementary leverage ratio and regulatory changes on capital distributions and balance-sheet capacity.
- Potential losses from mortgage-related representations and warranties, RMBS litigation, regulatory investigations, benchmark-related matters and other legal proceedings beyond recorded reserves.
- Whether the firm can reduce covered-fund investments under the Volcker Rule without material valuation losses or disruption to Investment Management and Investing & Lending activities.
- The level, composition and encumbrance of liquidity, including the $180.040 billion Global Core Excess pool and restrictions on transferring capital from regulated subsidiaries.