GOLDMAN SACHS GROUP INC quarterly report, Q1 FY2016

Goldman Sachs Group, Inc. — First-Quarter 2016 Form 10-Q

Business context and reporting period

The filing covers the unaudited three months ended March 31, 2016, compared primarily with the three months ended March 31, 2015 and, for balance-sheet items, December 31, 2015. Goldman Sachs operates through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management.

Management characterized the quarter as challenging, citing economic uncertainty, higher volatility, significant price pressure across equity and fixed-income markets, weaker investor risk appetite, and reduced industry-wide investment-banking activity.

Financial performance and key metrics

Metric	Q1 2016	Q1 2015	Change
Net revenues	$6.338 billion	$10.617 billion	Down 40%
Pre-tax earnings	$1.576 billion	$3.934 billion	Down 60%
Net earnings	$1.135 billion	$2.844 billion	Down 60%
Net earnings applicable to common shareholders	$1.200 billion	$2.748 billion	Down 56%
Diluted EPS	$2.68	$5.94	Down 55%
Operating expenses	$4.762 billion	$6.683 billion	Down 29%
Net interest income	$883 million	$859 million	Up 3%
Annualized ROE on average common equity	6.4%	14.7%	Down 8.3 points
Compensation-to-net-revenue ratio	42.0%	42.0%	Unchanged

Approximate calculated margins were 24.9% pre-tax and 17.9% on net earnings for Q1 2016, compared with approximately 37.1% and 26.8%, respectively, in Q1 2015.

Investment banking revenue was $1.463 billion, down 23%; financial advisory revenue declined 20% and equity underwriting revenue declined materially, partly offset by higher debt underwriting revenue.
Institutional Client Services revenue was $3.443 billion, down 37%; Fixed Income, Currency and Commodities Client Execution declined 47%, while Equities declined 23%. Commissions and fees increased 8% to $917 million.
Investing & Lending revenue was $87 million versus $1.669 billion, producing a pre-tax loss of $356 million versus prior-year pre-tax earnings of $932 million. Lower equity valuations, weaker corporate performance, energy-sector pressure, and higher lending-loss provisions were significant factors.
Investment Management revenue was $1.345 billion, down 15%, primarily because incentive fees fell to $46 million from $254 million. Assets under supervision increased to $1.287 trillion from $1.252 trillion at year-end 2015.
Compensation and benefits expense declined 40% to $2.662 billion. Non-compensation expense declined 6% to $2.100 billion, including litigation and regulatory provisions of $77 million versus $190 million.
The effective tax rate was 28.0%; the filing does not provide a Q1 2015 effective tax rate for direct comparison.

Cash flow, balance sheet, debt and liquidity

Operating cash flow was negative $3.932 billion, compared with positive $6.736 billion in Q1 2015, largely reflecting collateralized transactions and changes in financial instruments.
Investing cash flow was negative $3.140 billion, including $2.537 billion of net lending activity and $562 million for acquisitions.
Financing cash flow was positive $11.136 billion, led by higher deposits, net issuance of unsecured long-term borrowings, and other financing activity.
Cash and cash equivalents increased to $79.169 billion from $75.105 billion at December 31, 2015.
Total assets increased to $878.036 billion from $861.395 billion; total liabilities increased to $791.199 billion from $774.667 billion; shareholders’ equity was $86.837 billion versus $86.728 billion.
Deposits increased to $104.866 billion from $97.519 billion. Unsecured short-term borrowings increased to $46.691 billion from $42.787 billion, and unsecured long-term borrowings increased to $180.159 billion from $175.422 billion.
Global Core Liquid Assets were $195.763 billion at quarter-end, compared with $199.120 billion at year-end. Management stated that liquidity was appropriate and that average first-quarter GCLA was $197.988 billion.
The leverage ratio was 10.1x and the debt-to-equity ratio was 2.1x, compared with 9.9x and 2.0x, respectively, at year-end.
The Basel III Advanced CET1 ratio was 12.2%, versus a 5.875% minimum requirement; the Standardized CET1 ratio was 13.4%. The supplementary leverage ratio was 6.0% on a fully phased-in basis.

Material changes versus prior comparable periods

The principal deterioration was in market-making, other principal transactions, investment banking, and incentive-fee revenue. Market-making revenue fell 53% to $1.862 billion, while other principal transactions moved to a $49 million loss from $1.572 billion of revenue.
All four segments reported lower pre-tax earnings; Investing & Lending moved from profitability to a loss, and Institutional Client Services remained the largest contributor but declined substantially.
Net interest income modestly improved because of higher average loans and collateralized-agreement income, despite higher interest expense.
Balance-sheet growth was driven primarily by collateralized agreements, cash, deposits, and financial instruments sold but not yet purchased; financial instruments owned at fair value declined.
Common share repurchases totaled approximately 10.0 million shares at an average cost of $154.44 per share, or $1.550 billion. The quarterly common dividend was $0.65 per share, up from $0.60 in Q1 2015.
The firm adopted ASU 2015-02, reducing assets and liabilities by approximately $200 million without affecting earnings. It also early adopted the debt valuation adjustment provisions of ASU 2016-01, reclassifying a $305 million cumulative after-tax DVA gain from retained earnings to accumulated other comprehensive loss.

Guidance, outlook, risks and unusual items

The filing does not provide formal quantitative earnings guidance. Management stated that continued macroeconomic concerns, lower market-making or investment-banking activity, declining asset prices, weaker equity markets, or prolonged energy-sector weakness could further pressure revenue.

Market and valuation risk remained significant: level 3 financial assets were $24.462 billion, or 2.8% of total assets. Level 3 cash-instrument losses reflected lower global equity prices and corporate performance.
Credit exposure included $152.431 billion of loans and lending commitments, $56.928 billion of net OTC derivative exposure, and $79.169 billion of cash exposure. Management reported that counterparty defaults remained low and related estimated losses were not material.
Oil and gas-related exposure included $10.7 billion of loans and lending commitments, $1.7 billion of derivative and receivables exposure, and negative $532 million of market exposure.
Total commitments were $186.767 billion, including $107.958 billion of commitments to extend credit. Derivative guarantees had a $1.038 trillion maximum notional payout; these notional amounts do not represent expected losses.
Management estimated the upper end of reasonably possible aggregate legal losses at approximately $1.9 billion above recorded reserves for matters where a range could be estimated. Mortgage-related repurchase exposure remained difficult to estimate.
Volcker Rule compliance may require the firm to reduce most interests in covered funds. Investments in funds measured at NAV were $7.177 billion, with $2.554 billion of unfunded commitments.
Subsequent to quarter-end, GS Bank USA acquired GE Capital Bank’s online deposit platform and assumed approximately $16 billion of deposits. The filing also disclosed subsequent mortgage-related and other litigation settlements for which the firm had reserved the required amounts.
Goodwill was not impaired, but management identified the Fixed Income, Currency and Commodities Client Execution reporting unit as more sensitive to prolonged weakness, market deterioration, or higher capital requirements.

Most important facts for investors to verify

Whether market-making, investment-banking, and Investing & Lending revenues recover from the unusually weak Q1 environment.
Whether the decline in incentive fees and the shift toward lower-fee liquidity products persist in Investment Management.
The trajectory of operating expenses, compensation accruals, litigation provisions, and the 42% compensation-to-revenue ratio.
Liquidity and funding resilience, including GCLA, deposit growth, unsecured debt maturities, and collateral requirements under rating downgrades.
Capital-ratio headroom as Basel III buffers, TLAC, leverage rules, and other regulatory requirements phase in.
Credit quality and loss reserves, particularly for corporate, energy, non-investment-grade, and criticized exposures.
Developments in mortgage-related claims, regulatory investigations, benchmark and trading litigation, and the approximately $1.9 billion excess reasonably possible legal-loss estimate.
The effect of the GE Capital deposit-platform acquisition and other post-quarter-end events on future funding and liquidity metrics.