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. Its four segments are Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, with comparisons to the corresponding 2011 periods and balance-sheet comparisons to December 31, 2011.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net revenues | $8.351 billion | $3.587 billion | $24.927 billion | $22.762 billion |
| Pre-tax earnings/(loss) | $2.298 billion | $(730) million | $6.894 billion | $4.922 billion |
| Net earnings/(loss) | $1.512 billion | $(393) million | $4.583 billion | $3.429 billion |
| Net earnings applicable to common | $1.458 billion | $(428) million | $4.459 billion | $1.532 billion |
| Diluted EPS | $2.85 | $(0.84) | $8.57 | $2.70 |
| Annualized ROE | 8.6% | Not meaningful | 8.8% | 3.7% |
| Pre-tax margin | 27.5% | Negative | 27.7% | 21.6% |
| Net margin | 18.1% | Negative | 18.4% | 15.1% |
All dollar amounts are in U.S. dollars. Margins are calculated from reported net revenues and earnings.
- Revenue mix: Q3 investment banking revenue was $1.168 billion, market making was $2.650 billion, other principal transactions were $1.802 billion, investment management was $1.147 billion, commissions and fees were $748 million, and net interest income was $836 million. For the first nine months, these amounts were $3.534 billion, $8.652 billion, $3.909 billion, $3.518 billion, $2.407 billion and $2.907 billion, respectively.
- Expenses: Operating expenses were $6.053 billion in Q3 and $18.033 billion for nine months. Compensation and benefits were $3.675 billion and $10.968 billion, respectively. Compensation represented 44.0% of nine-month net revenues.
- Cash flow: Nine-month operating cash flow was $9.918 billion, compared with $2.430 billion in 2011. Investing activities used $1.517 billion and financing activities used $770 million. Cash and cash equivalents increased to $63.639 billion from $56.008 billion at year-end 2011.
- Balance sheet and liquidity: Total assets were $949.207 billion, up from $923.225 billion. Shareholders’ equity was $73.687 billion, up from $70.379 billion. Management reported $170.210 billion of Global Core Excess liquidity and $176.538 billion of excess liquidity and cash.
- Debt and deposits: Unsecured short-term borrowings were $47.271 billion; total short-term borrowings, including other secured financings, were $68.321 billion. Unsecured long-term borrowings were $167.878 billion, and total long-term borrowings were $176.221 billion. Deposits increased to $61.526 billion from $46.109 billion.
- Capital: Basel 1 Tier 1 capital was $65.230 billion and the Tier 1 capital ratio was 15.0%, compared with 13.8% at year-end 2011. The total capital ratio was 18.1%, Tier 1 leverage ratio was 7.2%, and Tier 1 common ratio was 13.1%.
- Fair value exposure: Financial assets at fair value totaled $651.647 billion, including $47.810 billion of Level 3 assets, or approximately 5.0% of total assets. Financial instruments owned at fair value were $415.293 billion.
Material changes versus prior comparable periods
- Q3 net revenues increased 133%, and the firm moved from a $393 million net loss to $1.512 billion of net earnings. The improvement was driven principally by Investing & Lending, higher investment banking revenue and stronger market making.
- Investing & Lending generated $1.804 billion of Q3 revenue versus a $2.479 billion loss in Q3 2011. The 2012 quarter benefited from higher global equity prices, tighter credit spreads, gains on private equity and other equity investments, and gains on debt securities and loans.
- Investment Banking revenue increased 49% in Q3 to $1.164 billion, primarily because debt underwriting and leveraged finance activity improved from unusually low 2011 levels. Nine-month revenue was essentially unchanged at $3.521 billion.
- Institutional Client Services revenue increased 3% in Q3 but declined 3% for the first nine months. Fixed Income, Currency and Commodities Client Execution improved, while Equities and commissions and fees declined because of lower market volumes.
- Investment Management revenue declined 2% in Q3 and 2% for the first nine months. Assets under management rose to $856 billion, supported by $39 billion of market appreciation for the first nine months, but offset by $11 billion of net outflows.
- Net interest income declined 38% in Q3 and 30% for the first nine months, primarily because of lower average yields. The impact of the firm’s own credit spreads on fair-value borrowings was a $370 million loss in Q3 and a $588 million loss for nine months, compared with gains in the prior-year periods.
- Q3 operating expenses increased 40%, mainly from higher compensation tied to stronger revenues, although non-compensation expenses declined 13%. Nine-month operating expenses were essentially unchanged, as lower non-compensation costs offset higher compensation.
- The firm repurchased 11.8 million common shares for $1.25 billion in Q3 and 29.4 million shares for $3.11 billion during the first nine months. Book value per common share was $140.58 and tangible book value per common share was $129.69 at September 30, 2012.
Guidance, outlook, risks and unusual items
- Management did not provide formal earnings guidance. It stated that investment banking activity, commissions, market making, investment management revenue and Investing & Lending results remain sensitive to global economic conditions, market volumes, asset prices, volatility and credit spreads.
- Management described persistent uncertainty related to Europe and global growth, despite central-bank actions that supported tighter credit spreads, higher equity prices and lower volatility during the quarter. The investment banking backlog declined slightly from June 30, 2012, although it remained higher than at year-end 2011.
- The firm targeted approximately $500 million of additional annualized compensation and non-compensation expense reductions by year-end 2012, following approximately $1.4 billion of targeted annualized reductions achieved in 2011.
- Regulatory requirements remain a material uncertainty, including Basel 2.5, proposed Basel 3 rules, the Dodd-Frank Act, the Volcker Rule, OTC derivatives regulation and potential increases in capital and liquidity requirements. The firm expected increased market-risk capital requirements beginning in January 2013.
- Volcker Rule compliance included plans to reduce certain hedge-fund interests. The firm redeemed approximately $300 million during Q3 and $800 million during the first nine months of 2012. It also continued to manage private-equity funds within the applicable transition framework.
- The firm reported an upper-end estimate of approximately $3.6 billion for reasonably possible aggregate losses in certain legal proceedings where a range could be estimated. Management stated that many other proceedings could not be reasonably quantified and may still materially affect results for a particular period.
- Mortgage-related contingencies remain significant. The firm stated that it was unable to meaningfully estimate potential exposure to future repurchase claims. Active cases seeking rescission involved approximately $20.1 billion of mortgage-related securities sold to plaintiffs, excluding threatened and other potential claims.
- Other unusual items included $252 million of impairment losses during the first nine months, substantially in depreciation and amortization, and $188 million of litigation and regulatory provisions. After the quarter, the firm completed the sale of its hedge-fund administration business for approximately $515 million and expected a pre-tax gain of approximately $500 million in Q4 2012.
- After the reporting date, the quarterly common dividend was increased from $0.46 to $0.50 per share. The firm also issued $850 million liquidation preference of Series I preferred stock on October 24, 2012.
Most important facts for investors to verify
- Whether gains from Investing & Lending, private equity and fair-value marks are repeatable or primarily market-driven.
- The sustainability of revenue and earnings given lower market volumes, persistent European uncertainty and the decline in net interest income.
- The effect of Basel 2.5, Basel 3, Dodd-Frank and Volcker Rule implementation on capital requirements, business mix, fund investments and returns.
- Liquidity under stress, including the $170.210 billion Global Core Excess pool, funding maturities, deposit stability and potential collateral calls from ratings downgrades.
- The ultimate cost and timing of mortgage-related litigation, repurchase claims, regulatory investigations and other legal proceedings.
- The valuation sensitivity of Level 3 assets, including private equity, bank loans, mortgage-related assets and derivatives using significant unobservable inputs.
- The impact of the $500 million expected Q4 pre-tax gain from the hedge-fund administration sale and whether it should be excluded when assessing ongoing earnings power.