Goldman Sachs Group Inc. — Q2 2014 Form 10-Q Summary
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. The filing presents unaudited U.S. GAAP results for the three and six months ended June 30, 2014, compared with the corresponding 2013 periods, and financial condition as of June 30, 2014, compared with December 31, 2013.
Reportable segments are Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. Management noted that quarterly results are highly dependent on global financial markets and are not necessarily indicative of full-year results.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | H1 2014 | H1 2013 |
|---|---|---|---|---|
| Net revenues | $9.125 billion | $8.612 billion | $18.453 billion | $18.702 billion |
| Pre-tax earnings | $2.821 billion | $2.645 billion | $5.842 billion | $6.018 billion |
| Net earnings | $2.037 billion | $1.931 billion | $4.070 billion | $4.191 billion |
| Net earnings applicable to common shareholders | $1.953 billion | $1.861 billion | $3.902 billion | $4.049 billion |
| Diluted EPS | $4.10 | $3.70 | $8.13 | $7.99 |
| Annualized ROE on average common equity | 10.9% | 10.5% | 10.9% | 11.5% |
Q2 net revenues increased 6%, pre-tax earnings increased 7%, net earnings increased 5% and diluted EPS increased 11% year over year. For the first half, net revenues declined 1%, pre-tax earnings declined 3% and net earnings declined 3%, while diluted EPS increased 2% because of the lower average share count.
Revenue mix and margins
- Investment Banking: Q2 revenue was $1.781 billion, up 15%; H1 revenue was $3.560 billion, up 14%. Equity underwriting was the primary driver, supported by stronger industry activity.
- Institutional Client Services: Q2 revenue was $3.830 billion, down 11%; H1 revenue was $8.276 billion, down 12%. Low volatility and subdued client activity weighed on currencies, equities and other market-making businesses.
- Investing & Lending: Q2 revenue was $2.072 billion, up 46%, primarily from private equity gains. H1 revenue was $3.601 billion, up 3%.
- Investment Management: Q2 revenue was $1.442 billion, up 8%; H1 revenue was $3.016 billion, up 14%. Growth reflected higher average assets under supervision and, for the first half, higher incentive fees.
| Profitability measure | Q2 2014 | Q2 2013 | H1 2014 | H1 2013 |
|---|---|---|---|---|
| Pre-tax margin | 30.9% | 30.7% | 31.7% | 32.2% |
| Net margin | 22.3% | 22.4% | 22.0% | 22.4% |
| Compensation and benefits as % of net revenues | 43.0% | 43.0% | 43.0% | 43.0% |
Operating expenses were $6.304 billion in Q2, up 6%, and $12.611 billion in H1, essentially unchanged. Q2 included $284 million of net provisions for litigation and regulatory proceedings versus $149 million in the prior-year quarter. H1 provisions were $399 million versus $259 million in H1 2013.
Balance sheet, liquidity, debt and capital
- Total assets were $859.9 billion, down $51.6 billion, or approximately 6%, from December 31, 2013. Management attributed the reduction primarily to lower-return secured client financing and a decline in matched-book activity.
- Cash and cash equivalents were $57.0 billion, down from $61.1 billion at year-end. H1 operating cash flow was negative $3.692 billion and investing cash flow was negative $6.813 billion; financing cash flow was positive $6.355 billion.
- Shareholders’ equity was $81.6 billion, up from $78.5 billion. Common shareholders’ equity was $72.4 billion; tangible common shareholders’ equity was $68.0 billion.
- Unsecured short-term borrowings were $45.8 billion and unsecured long-term borrowings were $167.0 billion. Total long-term borrowings, including long-term secured financings, were $173.5 billion. The leverage ratio was 10.5x and the unsecured long-term debt-to-equity ratio was 2.0x.
- Global Core Excess liquidity was $169.7 billion at June 30, 2014. Management stated that the firm’s liquidity position was appropriate under its internal stress framework.
- The Basel III Advanced CET1 ratio was 11.4%, Tier 1 capital ratio was 12.9%, total capital ratio was 15.1% and Tier 1 leverage ratio was 8.4%. June 2014 ratios are not directly comparable with December 2013 ratios because of the change in regulatory capital framework.
- Book value per common share was $158.21 and tangible book value per common share was $148.45. The firm repurchased 7.8 million common shares in Q2 for $1.25 billion and 18.1 million shares in H1 for $2.97 billion.
Material changes versus comparable periods
- Q2 performance benefited from stronger Investment Banking, Investing & Lending and Investment Management results, which more than offset weaker Institutional Client Services revenue.
- Market-making revenue declined 19% in Q2 and 21% in H1, reflecting low volatility and subdued client activity, particularly in currencies and equity derivatives.
- Other principal transactions increased 42% in Q2, driven by private equity gains and company-specific events; these gains are inherently volatile.
- Net interest income increased 21% in Q2 and 16% in H1, primarily because of lower interest expense.
- Assets under supervision increased to $1.142 trillion from $1.042 trillion at December 31, 2013, supported by $63 billion of H1 net inflows and $37 billion of market appreciation.
- The firm recorded $194 million of impairment losses in H1, substantially related to a consolidated Latin American investment, including $180 million on property and equipment and $14 million on identifiable intangible assets.
- Preferred stock increased by $2.0 billion during H1 through issuances of Series K and Series L preferred stock. The firm also purchased $1.36 billion of trust preferred securities and planned an exchange and extinguishment of related junior subordinated debt.
Guidance, outlook, risks and unusual items
The filing does not provide quantified earnings or revenue guidance. Management expects results to remain sensitive to global economic conditions, asset prices, market volatility, client activity, credit spreads and regulatory developments.
- Low volatility and subdued client risk appetite could continue to pressure market-making and commissions revenue.
- Investment Banking revenue depends on transaction activity and completion of transactions in the backlog; transactions may be delayed, modified or cancelled.
- Investment Management revenue is exposed to declines in asset prices, withdrawals, changes in asset mix and lower-fee products.
- Investing & Lending results may fluctuate materially because of private equity valuations, company-specific events, credit conditions and market movements.
- The Volcker Rule requires reductions in most covered-fund interests by the applicable compliance date. The firm reported approximately $13.7 billion of NAV-based fund investments and $4.4 billion of unfunded commitments; forced sales could occur at values below carrying value.
- Legal and regulatory matters remain significant. Management estimated the upper end of reasonably possible aggregate litigation losses at approximately $3.2 billion in excess of reserves for matters where a range could be estimated, excluding certain mortgage-related and other matters for which no meaningful estimate was available.
- Mortgage-related matters include potential repurchase claims, securities litigation, regulatory investigations and servicing-related indemnities. Management stated that outcomes are not expected to materially affect financial condition but could materially affect results for a particular period.
- A two-notch credit-rating downgrade could have required approximately $3.071 billion of additional collateral or termination payments under bilateral derivative agreements as of June 30, 2014.
- Adoption of new revenue recognition guidance was still under evaluation. The filing stated that adoption of the new repurchase-accounting standard was not expected to materially affect financial condition, results or cash flows.
Most important facts for investors to verify
- Whether low volatility and weak fixed-income, currency and equity client activity persist and continue to pressure Institutional Client Services.
- The sustainability and cash realization of private equity and other principal-investment gains, including the effect of the $194 million impairment charge.
- Changes in litigation reserves and the potential range of losses beyond the approximately $3.2 billion reasonably possible-loss estimate.
- Progress and valuation impact of required covered-fund reductions under the Volcker Rule.
- Changes in Basel III, standardized risk-weighted assets, leverage requirements and the firm’s ability to maintain capital distributions.
- Liquidity trends, including Global Core Excess, secured-financing rollovers, collateral requirements and the effect of any credit-rating changes.
- Assets under supervision flows, market appreciation, asset mix and incentive-fee contribution in Investment Management.