GOLDMAN SACHS GROUP INC quarterly report, Q3 FY2011

Goldman Sachs Group Inc. — 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 covers the unaudited quarter and nine months ended September 30, 2011, compared primarily with the corresponding 2010 periods and December 31, 2010 balance-sheet amounts. The firm reports four segments: Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management.

Key financial metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Net revenues	$3.59 billion	$8.90 billion	$22.76 billion	$30.52 billion
Pre-tax earnings/(loss)	$(730) million	$2.81 billion	$4.92 billion	$9.42 billion
Net earnings/(loss)	$(393) million	$1.90 billion	$3.43 billion	$5.97 billion
Net earnings/(loss) to common	$(428) million	$1.74 billion	$1.53 billion	$5.49 billion
Diluted EPS	$(0.84)	$2.98	$2.70	$9.39
Net interest income	$1.36 billion	$1.13 billion	$4.13 billion	$4.17 billion
Operating expenses	$4.32 billion	$6.09 billion	$17.84 billion	$21.10 billion

Q3 2011 net revenue fell 60% year over year, producing a negative pre-tax margin of approximately 20%. Nine-month net revenue declined 25%, and the reported annualized return on average common equity was 3.7%. Excluding the $1.64 billion preferred dividend associated with the Series G redemption, nine-month diluted EPS was $5.60 and annualized return on average common equity was 6.0%; these are non-GAAP measures.

Investment Banking revenue was $781 million in Q3, down 33%, but $3.50 billion for nine months, up 6%.
Institutional Client Services revenue was $4.06 billion in Q3, down 13%, and $14.22 billion for nine months, down 22%. Fixed Income, Currency and Commodities Client Execution declined sharply, while Equities revenue increased.
Investing & Lending generated $(2.48) billion of Q3 revenue and $(2.57) billion of pre-tax loss. Q3 losses included $1.05 billion from ICBC shares, $1.00 billion from other equity investments and $907 million from debt securities and loans.
Investment Management revenue was $1.22 billion in Q3, down 4%, and $3.77 billion for nine months, up 8%. Assets under management ended at $821 billion, down $23 billion in Q3 and $19 billion from year-end 2010.
Q3 compensation and benefits expense was $1.58 billion, down 59%; nine-month expense was $10.02 billion, down 24%. The nine-month compensation-to-net-revenue ratio was 44.0%.
Cash and cash equivalents were $44.20 billion at September 30, 2011, up $4.42 billion from year-end. Nine-month operating cash flow was $2.43 billion, compared with $3.13 billion in 2010.
Total assets were $948.91 billion and total liabilities were $878.82 billion, compared with $911.33 billion and $833.98 billion, respectively, at December 31, 2010.
Unsecured short-term borrowings were $54.63 billion; unsecured long-term borrowings were $175.65 billion. Total shareholders’ equity was $70.09 billion, down from $77.36 billion.
The firm maintained $163.96 billion of Global Core Excess liquidity. The adjusted leverage ratio increased to 8.9x from 7.6x at year-end.
Basel 1 Tier 1 capital was $63.13 billion, the Tier 1 capital ratio was 13.8%, the total capital ratio was 16.9%, and the Tier 1 leverage ratio was 6.7%.

Material changes versus comparable periods

Q3 performance deteriorated substantially because global equity markets declined, credit spreads widened and European sovereign-debt concerns intensified. These conditions impaired Investing & Lending and market-making results.
Other principal transactions swung to a $(2.54) billion Q3 loss from $1.76 billion of revenue in Q3 2010. Market-making revenue fell to $1.80 billion from $2.85 billion.
Net interest income increased 20% in Q3 despite only modest change for the nine-month period.
Operating expenses declined, primarily because of lower compensation accruals, but non-compensation expenses increased. Q3 included approximately $100 million of U.K. bank levy expense; the estimated full-year levy was approximately $130 million.
During the first quarter, the firm redeemed its Series G preferred stock for $5.50 billion and recorded a $1.64 billion preferred dividend reduction to common earnings and equity. The firm repurchased $5.14 billion of common stock during the first nine months, including $2.16 billion in Q3.
Regulatory capital ratios declined from year-end, principally due to the preferred-stock redemption and common-share repurchases. Future Basel 2.5, Basel 3 and Dodd-Frank requirements are expected to increase capital requirements and may reduce reported ratios.
The firm sold Litton Loan Servicing in Q3 after recognizing approximately $220 million of impairment charges earlier in 2011. It also acquired the remaining interest in Goldman Sachs & Partners Australia Group Holdings, issuing $103 million of common stock.

Outlook, risks, contingencies and unusual items

Management stated that earnings are inherently unpredictable and may be materially affected by global financial markets, economic conditions, volatility, credit spreads, client activity and regulatory developments. The firm expected difficult market conditions to continue affecting market making, investment banking, Investing & Lending and Investment Management if equity prices declined further, credit spreads widened or clients reduced activity.

The firm initiated expense-reduction efforts targeting approximately $1.4 billion of annual run-rate compensation and non-compensation reductions, expected to be substantially completed before year-end.
Management did not provide a clear numerical earnings or revenue forecast for future periods.
Investment banking backlog increased from year-end and from the end of Q2, but management cautioned that transactions may be delayed, modified or cancelled.
Level 3 financial assets were $46.91 billion, or approximately 4.9% of total assets. Q3 level 3 cash instruments recorded $1.54 billion of net unrealized losses, partly offset by $1.19 billion of net unrealized derivative gains.
Credit-related exposures included $35.26 billion of gross funded European exposure and $30.81 billion net of hedges. Net derivative liabilities under bilateral agreements were $35.21 billion; a two-notch ratings downgrade could have required approximately $2.03 billion of additional collateral or termination payments.
Total commitments were $173.64 billion, including $65.99 billion of commitments to extend credit, $79.37 billion of contingent or forward-starting resale and securities-borrowing agreements, and $9.81 billion of investment commitments.
Management estimated approximately $2.6 billion of aggregate reasonably possible losses for certain legal proceedings. Mortgage-related repurchase exposure could increase, but management stated that it could not meaningfully estimate the potential exposure.
The firm and subsidiaries entered into mortgage-servicing consent and related agreements requiring remediation, reviews and reporting. Certain Litton-related indemnities and regulatory investigations remain unresolved.
Moody’s and Standard & Poor’s ratings carried negative outlooks as of September 30, 2011. Fitch placed Group Inc.’s short- and long-term debt ratings under review for downgrade on October 13, 2011.

Most important facts for investors to verify

Whether market-making revenue, Investing & Lending valuations and private-equity and credit exposures stabilized after the third quarter.
The sustainability and implementation costs of the proposed $1.4 billion expense-reduction program.
The effect of Basel 2.5, Basel 3, Dodd-Frank and Volcker Rule implementation on capital, leverage, permissible activities and returns.
Changes in liquidity reserves, funding costs, credit ratings and downgrade-related collateral requirements.
Developments in mortgage-related litigation, repurchase claims, foreclosure-servicing matters and other regulatory investigations.
Valuation sensitivity and realized performance of Level 3 assets, ICBC shares, private equity, bank loans and other less-liquid inventory.
The impact of share repurchases and the Series G redemption on common equity, regulatory capital and book value.