GOLDMAN SACHS GROUP INC annual report, FY2012

Goldman Sachs Group Inc. — FY2012 Form 10-K Summary

Business context and reporting period

The filing covers the fiscal year ended December 31, 2012, with quarterly information for the three months ended December 31, 2012. Goldman Sachs is a global investment banking, securities and investment management firm operating through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. The firm had 32,400 staff, offices in more than 30 countries, and generated 41% of net revenues outside the Americas.

Financial performance and key metrics

Metric	2012	2011	Change
Net revenues	$34.16 billion	$28.81 billion	19% increase
Pre-tax earnings	$11.21 billion	$6.17 billion	82% increase
Net earnings	$7.48 billion	$4.44 billion	68% increase
Net earnings applicable to common shareholders	$7.29 billion	$2.51 billion	191% increase
Diluted EPS	$14.13	$4.51	213% increase
Return on average common equity	10.7%	3.7%	Improved
Effective tax rate	33.3%	28.0%	Higher

Net earnings margin was approximately 21.9%, compared with approximately 15.4% in 2011. Operating expenses were $22.96 billion, essentially unchanged year over year. Compensation and benefits increased 6% to $12.94 billion, but compensation as a percentage of net revenues declined to 37.9% from 42.4%. Non-compensation expenses declined 4% to $10.01 billion.

Investment Banking: Net revenues of $4.93 billion, up 13%; pre-tax earnings of $1.60 billion, up 17%. Debt underwriting improved materially, while equity underwriting declined and financial advisory revenues were essentially unchanged.
Institutional Client Services: Net revenues of $18.12 billion, up 5%; pre-tax earnings of $5.64 billion, up 27%. Fixed Income, Currency and Commodities Client Execution benefited from stronger mortgage, credit and interest-rate activity. Equities revenues were broadly stable, including an approximately $500 million gain from the sale of the hedge fund administration business.
Investing & Lending: Net revenues of $5.89 billion versus $2.14 billion; pre-tax earnings of $3.23 billion versus a $531 million loss. Results benefited from tighter credit spreads, higher equity prices, a $408 million ICBC gain, $2.39 billion of equity gains and $1.85 billion from debt securities and loans.
Investment Management: Net revenues of $5.22 billion, up 4%; pre-tax earnings of $928 million, down 8% because expenses increased faster than revenues. Assets under supervision rose to $965 billion from $895 billion, while assets under management rose to $854 billion from $828 billion despite $18 billion of net AUM outflows.

Cash flow, balance sheet, debt and liquidity

Net cash provided by operating activities was $12.88 billion; investing activities used $3.73 billion; financing activities provided $7.52 billion. Cash and cash equivalents increased $16.66 billion to $72.67 billion.
Total assets were $938.56 billion, up from $923.23 billion. Total liabilities were $862.84 billion, up from $852.85 billion. Shareholders’ equity increased to $75.72 billion from $70.38 billion.
Unsecured long-term borrowings were $167.31 billion, down from $173.55 billion. Unsecured short-term borrowings were $44.30 billion, down from $49.04 billion. Total long-term borrowings, including secured financing, were $176.27 billion.
Deposits increased to $70.12 billion from $46.11 billion. The firm reported $174.62 billion of Global Core Excess liquidity at year-end and average Global Core Excess of $172.10 billion for 2012.
The leverage ratio improved to 12.4x from 13.1x, although adjusted leverage increased to 9.1x from 8.6x. The debt-to-equity ratio declined to 2.2x from 2.5x.
Basel 1 regulatory capital strengthened: Tier 1 capital ratio was 16.7% versus 13.8%, total capital ratio was 20.1% versus 16.9%, and Tier 1 leverage ratio was 7.3% versus 7.0%. The Tier 1 common ratio was 14.5% versus 12.1%.
Average daily VaR declined to $86 million from $113 million; year-end VaR declined to $71 million from $99 million. No daily trading loss exceeded one-day 95% VaR in 2012.

Material changes versus the prior comparable period

Performance improved substantially, driven primarily by Investing & Lending gains and better market-making conditions, while 2011 had been affected by European sovereign-debt concerns, wider credit spreads and significant investment losses.
Net interest income declined 25% to $3.88 billion because of lower average yields. Commissions and fees declined 16% to $3.16 billion due to lower market volumes.
The firm recognized a $714 million net loss from changes in its own credit spreads on fair-value borrowings, compared with a $596 million gain in 2011.
Staff declined 3% to 32,400, following aggregate targeted annual run-rate compensation and non-compensation reductions of approximately $1.9 billion announced during 2011 and 2012.
During 2012, the firm repurchased 42.0 million common shares for $4.64 billion and issued $3.10 billion of preferred stock. Common dividends declared increased to $1.77 per share from $1.40.
The reinsurance business was classified as held for sale in the fourth quarter. Related assets of $16.92 billion and liabilities of $14.62 billion were reclassified to other assets and other liabilities; management expected the 2013 sale of a majority stake to produce no material gain or loss.

Outlook, commentary, risks and contingencies

Management described the 2012 environment as improved but fragile: central-bank actions, tighter credit spreads and higher equity prices supported results, while weak global growth, fiscal-policy uncertainty, low volatility, regulatory uncertainty and client risk aversion constrained activity. The filing does not provide quantitative earnings guidance.

The Volcker Rule, Basel 2 and Basel 3, Dodd-Frank implementation, derivatives regulation, liquidity standards and systemic-bank capital surcharges were expected to increase compliance costs, capital requirements and constraints on business activities. The firm had liquidated substantially all proprietary trading positions in 2011 and 2010 and was redeeming certain hedge-fund interests to comply with anticipated Volcker Rule limits.
Management identified market, liquidity, credit, operational, legal, regulatory, reputational, cybersecurity, concentration and counterparty risks. A ratings downgrade could increase collateral or termination payments; a one-notch downgrade was estimated at $1.53 billion and a two-notch downgrade at $2.50 billion.
Legal and regulatory provisions were $448 million in 2012. The estimated upper end of reasonably possible aggregate loss for specified legal proceedings was approximately $3.5 billion, although management stated that the proceedings were not expected to have a material adverse effect on financial condition.
Mortgage-related matters remained significant. The firm disclosed active cases seeking rescission of approximately $20.7 billion of mortgage-related securities, while noting that potential repurchase exposure could not be meaningfully estimated.
On January 16, 2013, the firm entered into a settlement in principle with the Federal Reserve concerning mortgage servicing and foreclosure processing. The settlement called for cash payments and borrower assistance over two years; related reserves were included at December 31, 2012.
Contractual commitments included $75.62 billion of commitments to extend credit, $47.60 billion of contingent and forward-starting resale or securities-borrowing agreements, $663.15 billion of derivative guarantees, and $3.19 billion of future minimum rental payments. Notional amounts do not represent expected losses or cash payments.

Most important facts for an investor to verify

Whether 2012 earnings growth, particularly Investing & Lending gains, is repeatable or primarily market-driven and non-recurring.
The effect of the $500 million hedge-fund administration sale gain, the $408 million ICBC gain, credit-spread valuation effects and other principal transactions on underlying earnings quality.
The impact of finalized Basel 3, Volcker Rule, derivatives and liquidity requirements on capital ratios, leverage, business mix and returns.
The composition, availability and legal-entity location of the $174.62 billion Global Core Excess liquidity pool, given restrictions on transfers from regulated subsidiaries.
Potential future losses from mortgage-related litigation, foreclosure settlements, representations and warranties, regulatory investigations and the approximately $3.5 billion estimated upper range of reasonably possible legal losses.
Quarterly earnings volatility, including the fourth-quarter 2012 net revenues of $9.24 billion and net earnings applicable to common shareholders of $2.83 billion.
The sustainability of assets under supervision, considering $18 billion of net AUM outflows in 2012 and the reliance on market appreciation to increase AUM.