GOLDMAN SACHS GROUP INC quarterly report, Q3 FY2015

Business Context and Reporting Period

The Goldman Sachs Group, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The firm operates through Investment Banking, Institutional Client Services, Investing & Lending, and Investment Management. Results were affected by weaker global equity markets, lower commodity prices, wider credit spreads, China-related concerns, and uncertainty regarding U.S. Federal Reserve policy.

Key Financial Metrics

Metric	Q3 2015	Q3 2014	Nine months 2015	Nine months 2014
Net revenues	$6.861 billion	$8.387 billion	$26.547 billion	$26.840 billion
Pre-tax earnings	$2.046 billion	$3.305 billion	$7.706 billion	$9.147 billion
Net earnings	$1.426 billion	$2.241 billion	$5.318 billion	$6.311 billion
Net earnings applicable to common shareholders	$1.330 billion	$2.143 billion	$4.994 billion	$6.045 billion
Diluted EPS	$2.90	$4.57	$10.84	$12.69
Annualized ROE on average common equity	7.0%	11.8%	8.8%	11.2%

Q3 net revenue fell 18%, pre-tax earnings fell 38%, net earnings fell 36%, and diluted EPS fell 37% year over year. Nine-month net revenue was essentially flat, while pre-tax earnings declined 16%, net earnings declined 16%, and diluted EPS declined 15%.
Approximate pre-tax margin was 29.8% in Q3 2015 versus 39.4% in Q3 2014; nine-month margin was 29.0% versus 34.1%. Approximate net margin was 20.8% versus 26.7% in Q3 and 20.0% versus 23.5% for the nine-month periods.
Investment banking revenue increased 6% in Q3 and 9% for the nine-month period, driven primarily by financial advisory and mergers and acquisitions activity. Nine-month Investment Banking pre-tax earnings increased 16%.
Institutional Client Services revenue declined 15% in Q3, although nine-month revenue increased 2%. Q3 pre-tax earnings declined 42% and nine-month pre-tax earnings declined 35%, principally reflecting litigation and regulatory provisions and weaker fixed-income, currency and commodities conditions.
Investing & Lending revenue declined 60% in Q3 and 22% for the nine-month period. Q3 pre-tax earnings declined 72%; nine-month pre-tax earnings declined 22%. Public-equity investment results were pressured by falling global equity prices.
Investment Management revenue declined 3% in Q3 but increased 4% for the nine-month period. Assets under supervision were $1.188 trillion at September 30, 2015, up from $1.178 trillion at December 31, 2014, despite $27 billion of nine-month market depreciation.
Operating expenses were $4.815 billion in Q3 and $18.841 billion for nine months. Compensation and benefits declined 16% in Q3 and were essentially flat for nine months. Non-compensation expenses increased 8% in Q3 and 18% for nine months.
Net provisions for litigation and regulatory proceedings were $416 million in Q3 and $2.06 billion for nine months, compared with $194 million and $593 million, respectively, in the prior-year periods.
Cash and cash equivalents increased to $65.575 billion from $57.600 billion at December 31, 2014. Nine-month operating cash flow was $166 million, investing cash flow was negative $14.747 billion, and financing cash flow was $22.556 billion.
Total assets were $880.559 billion, up from $855.842 billion. Total liabilities were $792.856 billion, and shareholders’ equity was $87.703 billion, up from $82.797 billion.
Loans receivable increased to $42.189 billion from $28.938 billion. Unsecured short-term borrowings were $41.331 billion, unsecured long-term borrowings were $175.817 billion, and total deposits were $91.458 billion.
Global Core Liquid Assets were $192.511 billion at September 30, 2015. The firm stated that its liquidity position was appropriate based on internal liquidity models and other considerations.
Applicable Standardized capital ratios were 12.4% CET1, 14.1% Tier 1, and 16.6% total capital. The Basel III Advanced CET1, Tier 1, and total capital ratios were 12.7%, 14.4%, and 16.9%, respectively; the Standardized ratios were the binding ratios.

Material Changes Versus Prior Comparable Period

The principal year-over-year deterioration was concentrated in Q3, when Investing & Lending and Fixed Income, Currency and Commodities Client Execution were adversely affected by market declines and reduced client activity.
Market-making revenue decreased 17% in Q3 but increased 15% for the nine-month period. Other principal transactions revenue decreased 66% in Q3 and 25% for nine months.
Net interest income decreased 20% in Q3 and 23% for nine months, primarily because of lower interest income from a smaller average financial-instrument inventory.
Litigation and regulatory provisions increased materially, contributing to higher non-compensation expenses despite lower revenue and compensation expense.
The firm’s balance sheet shifted toward higher lending and client receivables, while financial instruments owned at fair value declined by $21.761 billion from year-end.
Shareholders’ equity increased partly because the firm issued $2.0 billion of preferred stock in 2015. The firm repurchased 13.3 million common shares for $2.545 billion during the first nine months.

Outlook, Risks, Contingencies, and Unusual Items

No formal earnings or revenue guidance was provided. Management stated that continued macroeconomic concerns, declining market-making activity, weaker investment-banking activity, asset-price declines, or lower assets under supervision could reduce future revenue.
Investment-banking backlog increased during the quarter, particularly for potential equity and leveraged-finance transactions, but management cautioned that transactions may be delayed, modified, or cancelled.
The filing identifies substantial exposure to market, liquidity, credit, operational, legal, regulatory, and reputational risks. A two-notch credit-rating downgrade could have required approximately $2.787 billion of additional collateral or termination payments on bilateral derivatives.
Management estimated the upper end of reasonably possible aggregate legal losses at approximately $5.3 billion in excess of recorded reserves for matters where a range could be estimated. Other matters, including mortgage-related claims and regulatory investigations, were not included in that estimate.
Mortgage-related matters, foreign-exchange and commodities litigation, credit-derivatives antitrust matters, U.S. Treasury litigation, and regulatory investigations remain significant contingencies. The filing states that outcomes may be material to results for a particular period even if not expected to materially affect financial condition.
The firm held $7.896 billion of investments in funds measured at NAV, including private-equity, credit, hedge, and real-estate funds, and expects to reduce most covered-fund interests to comply with the Volcker Rule. Related investments may be difficult to sell at carrying value.
The firm recorded $78 million of asset impairments during the first nine months, primarily related to consolidated energy investments affected by low commodity prices.
The firm early adopted accounting updates concerning debt issuance costs and NAV-based fair-value disclosures. The debt issuance cost adoption reduced both assets and liabilities by $444 million at September 30, 2015.

Investor Verification Priorities

Verify the composition, reserve coverage, and credit quality of the increased loan portfolio and lending commitments, particularly oil and gas, corporate, real-estate, and non-investment-grade exposures.
Review litigation and regulatory reserves against the disclosed approximately $5.3 billion excess reasonably possible loss estimate and monitor pending settlements and investigations.
Assess whether market-making and Investing & Lending weakness persists if equity prices decline, credit spreads widen, or client activity remains subdued.
Reconcile reported liquidity, including the $192.511 billion of Global Core Liquid Assets, with subsidiary-level restrictions and potential collateral calls following a ratings downgrade.
Monitor the effect of Volcker Rule compliance on the $7.896 billion of fund investments and related unfunded commitments.
Compare applicable and fully phased-in capital ratios, including the expected 2019 capital conservation buffer and G-SIB surcharge, with future regulatory requirements.