XNYS:GS Goldman Sachs Group Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

or

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                             to

  

Commission File Number: 001-14965

The Goldman Sachs Group, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   13-4019460

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

200 West Street, New York, N.Y.  

10282

(Address of principal executive offices)   (Zip Code)

(212) 902-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer  x                     Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)        Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes x No

APPLICABLE ONLY TO CORPORATE ISSUERS

As of July 27, 2012, there were 479,416,563 shares of the registrant’s common stock outstanding.


Table of Contents

THE GOLDMAN SACHS GROUP, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2012

 

INDEX

 

Form 10-Q Item Number   Page No.  
PART I  

FINANCIAL INFORMATION

    2   
Item 1  

Financial Statements (Unaudited)

    2   
   

Condensed Consolidated Statements of Earnings for the three and six months ended June 30, 2012 and June 30, 2011

    2   
   

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and June 30, 2011

    3   
   

Condensed Consolidated Statements of Financial Condition as of June 30, 2012 and December 31, 2011

    4   
   

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2012 and year ended December 31, 2011

    5   
   

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and June 30, 2011

    6   
 

Notes to Condensed Consolidated Financial Statements

    7   
   

Note 1.       Description of Business

    7   
   

Note 2.       Basis of Presentation

    7   
   

Note 3.       Significant Accounting Policies

    8   
   

Note 4.      Financial  Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

    12   
   

Note 5.       Fair Value Measurements

    13   
   

Note 6.      Cash Instruments

    15   
   

Note 7.       Derivatives and Hedging Activities

    25   
   

Note 8.      Fair Value Option

    40   
   

Note 9.       Collateralized Agreements and Financings

    50   
   

Note 10.    Securitization Activities

    53   
   

Note 11.    Variable Interest Entities

    56   
   

Note 12.    Other Assets

    61   
   

Note 13.     Goodwill and Identifiable Intangible Assets

    62   
   

Note 14.    Deposits

    64   
   

Note 15.    Short-Term Borrowings

    65   
   

Note 16.    Long-Term Borrowings

    66   
   

Note 17.     Other Liabilities and Accrued Expenses

    70   
   

Note 18.     Commitments, Contingencies and Guarantees

    71   
   

Note 19.    Shareholders’ Equity

    77   
   

Note 20.     Regulation and Capital Adequacy

    80   
   

Note 21.    Earnings Per Common Share

    85   
   

Note 22.     Transactions with Affiliated Funds

    86   
   

Note 23.     Interest Income and Interest Expense

    87   
   

Note 24.    Income Taxes

    87   
   

Note 25.    Business Segments

    88   
   

Note 26.    Credit Concentrations

    92   
   

Note 27.    Legal Proceedings

    93   
   

Report of Independent Registered Public Accounting Firm

    107   
   

Statistical Disclosures

    108   
Item 2  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

    112   
Item 3  

Quantitative and Qualitative Disclosures About Market Risk

    179   
Item 4  

Controls and Procedures

    179   
PART II  

OTHER INFORMATION

    179   
Item 1  

Legal Proceedings

    179   
Item 2  

Unregistered Sales of Equity Securities and Use of Proceeds

    180   
Item 6  

Exhibits

    181   
SIGNATURES     182   

 

Exhibit 10.1 - Description of Compensation Arrangements with Executive Officer.

Exhibit 12.1 - Statement re: Computation of Ratios of Earnings to Fixed Charges and Ratios of Earnings to Combined Fixed Charges and Preferred Stock Dividends.

Exhibit 15.1 - Letter re: Unaudited Interim Financial Information.

Exhibit 31.1 - Rule 13a-14(a) Certifications.

Exhibit 32.1 - Section 1350 Certifications.

Exhibit 101 - Interactive Data.

 

      

 

  Goldman Sachs June 2012 Form 10-Q   1


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements (Unaudited)

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)

 

    Three Months
Ended June
        Six Months
Ended June
 
in millions, except per share amounts     2012        2011            2012        2011   

Revenues

         

Investment banking

    $1,206        $1,448            $  2,366        $  2,717   

Investment management

    1,266        1,188            2,371        2,362   

Commissions and fees

    799        894            1,659        1,913   

Market making

    2,097        1,736            6,002        6,198   

Other principal transactions

    169        602            2,107        3,214   

Total non-interest revenues

    5,537        5,868            14,505        16,404   

Interest income

    3,055        3,681            5,888        6,788   

Interest expense

    1,965        2,268            3,817        4,017   

Net interest income

    1,090        1,413            2,071        2,771   

Net revenues, including net interest income

    6,627        7,281            16,576        19,175   

Operating expenses

         

Compensation and benefits

    2,915        3,204            7,293        8,437   

Brokerage, clearing, exchange and distribution fees

    544        615            1,111        1,235   

Market development

    129        183            246        362   

Communications and technology

    202        210            398        408   

Depreciation and amortization

    409        372            842        962   

Occupancy

    214        252            426        519   

Professional fees

    213        263            447        496   

Insurance reserves

    121        117            278        205   

Other expenses

    465        453            939        899   

Total non-compensation expenses

    2,297        2,465            4,687        5,086   

Total operating expenses

    5,212        5,669            11,980        13,523   

Pre-tax earnings

    1,415        1,612            4,596        5,652   

Provision for taxes

    453        525            1,525        1,830   

Net earnings

    962        1,087            3,071        3,822   

Preferred stock dividends

    35        35            70        1,862   

Net earnings applicable to common shareholders

    $   927        $1,052            $  3,001        $  1,960   

Earnings per common share

         

Basic

    $  1.83        $  1.96            $    5.90        $    3.62   

Diluted

    1.78        1.85            5.72        3.40   

Dividends declared per common share

    $  0.46        $  0.35            $    0.81        $    0.70   

Average common shares outstanding

         

Basic

    501.5        531.9            506.1        536.2   

Diluted

    520.3        569.5            524.7        576.4   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2   Goldman Sachs June 2012 Form 10-Q  

 


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

    Three Months
Ended June
        Six Months
Ended June
 
in millions     2012         2011             2012         2011    

Net earnings

    $962         $1,087             $3,071         $3,822    

Other comprehensive income/(loss), net of tax:

         

Currency translation adjustment, net of tax

    (24)        (13)            (52)        (35)   

Pension and postretirement liability adjustments, net of tax

    —                             

Net unrealized gains/(losses) on available-for-sale securities, net of tax

    25         (6)            55         (29)   

Other comprehensive income/(loss)

           (17)            10         (61)   

Comprehensive income

    $963         $1,070             $3,081         $3,761    

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

  Goldman Sachs June 2012 Form 10-Q   3

 


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

   

As of

in millions, except share and per share amounts  

June 

2012 

 

December 

2011 

Assets

   

Cash and cash equivalents

  $  58,913    $  56,008 

Cash and securities segregated for regulatory and other purposes (includes $37,279 and $42,014 at fair value as of
June 2012 and December 2011, respectively)

  56,685    64,264 

Collateralized agreements:

   

Securities purchased under agreements to resell and federal funds sold (includes $167,344 and $187,789 at fair value as of June 2012 and December 2011, respectively)

  167,344    187,789 

Securities borrowed (includes $51,897 and $47,621 at fair value as of June 2012 and December 2011, respectively)

  167,516    153,341 

Receivables from brokers, dealers and clearing organizations

  19,146    14,204 

Receivables from customers and counterparties (includes $7,444 and $9,682 at fair value as of June 2012 and December 2011, respectively)

  67,674    60,261 

Financial instruments owned, at fair value (includes $67,004 and $53,989 pledged as collateral as of June 2012 and December 2011, respectively)

  387,196    364,206 

Other assets

  24,164    23,152 

Total assets

  $948,638    $923,225 

Liabilities and shareholders’ equity

   

Deposits (includes $5,646 and $4,526 at fair value as of June 2012 and December 2011, respectively)

  $  57,320    $  46,109 

Collateralized financings:

   

Securities sold under agreements to repurchase, at fair value

  160,442    164,502 

Securities loaned (includes $24 and $107 at fair value as of June 2012 and December 2011, respectively)

  9,448    7,182 

Other secured financings (includes $25,039 and $30,019 at fair value as of June 2012 and December 2011, respectively)

  28,790    37,364 

Payables to brokers, dealers and clearing organizations

  12,167    3,667 

Payables to customers and counterparties

  209,517    194,625 

Financial instruments sold, but not yet purchased, at fair value

  149,948    145,013 

Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $16,928 and $17,854 at fair value as of June 2012 and December 2011, respectively)

  45,693    49,038 

Unsecured long-term borrowings (includes $12,644 and $17,162 at fair value as of June 2012 and December 2011, respectively)

  166,993    173,545 

Other liabilities and accrued expenses (includes $9,416 and $9,486 at fair value as of June 2012 and December 2011, respectively)

  35,465    31,801 

Total liabilities

  875,783    852,846 

Commitments, contingencies and guarantees

   

Shareholders’ equity

   

Preferred stock, par value $0.01 per share; aggregate liquidation preference of $4,850 and $3,100 as of June 2012 and December 2011, respectively

  4,850    3,100 

Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 808,306,923 and 795,555,310 shares issued as of June 2012 and December 2011, respectively, and 480,990,890 and 485,467,565 shares outstanding as of June 2012 and December 2011, respectively

   

Restricted stock units and employee stock options

  4,128    5,681 

Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding

  —    — 

Additional paid-in capital

  47,055    45,553 

Retained earnings

  61,412    58,834 

Accumulated other comprehensive loss

  (506)   (516)

Stock held in treasury, at cost, par value $0.01 per share; 327,316,035 and 310,087,747 shares as of June 2012 and
December 2011, respectively

  (44,092)   (42,281)

Total shareholders’ equity

  72,855    70,379 

Total liabilities and shareholders’ equity

  $948,638    $ 923,225 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

    Six Months Ended         Year Ended  
in millions  

June

2012

        

December

2011

 

Preferred stock

     

Balance, beginning of year

    $   3,100            $   6,957   

Issued

    1,750              

Repurchased

               (3,857

Balance, end of period

    4,850            3,100   

Common stock

     

Balance, beginning of year

    8            8   

Issued

                 

Balance, end of period

    8            8   

Restricted stock units and employee stock options

     

Balance, beginning of year

    5,681            7,706   

Issuance and amortization of restricted stock units and employee stock options

    899            2,863   

Delivery of common stock underlying restricted stock units

    (2,415         (4,791

Forfeiture of restricted stock units and employee stock options

    (36         (93

Exercise of employee stock options

    (1         (4

Balance, end of period

    4,128            5,681   

Additional paid-in capital

     

Balance, beginning of year

    45,553            42,103   

Issuance of common stock

               103   

Delivery of common stock underlying share-based awards

    2,432            5,160   

Cancellation of restricted stock units in satisfaction of withholding tax requirements

    (872         (1,911

Excess net tax benefit/(provision) related to share-based awards

    (57         138   

Cash settlement of share-based compensation

    (1         (40

Balance, end of period

    47,055            45,553   

Retained earnings

     

Balance, beginning of year

    58,834            57,163   

Net earnings

    3,071            4,442   

Dividends and dividend equivalents declared on common stock and restricted stock units

    (423         (769

Dividends on preferred stock

    (70         (2,002

Balance, end of period

    61,412            58,834   

Accumulated other comprehensive income/(loss)

     

Balance, beginning of year

    (516         (286

Other comprehensive income/(loss)

    10            (230

Balance, end of period

    (506         (516

Stock held in treasury, at cost

     

Balance, beginning of year

    (42,281         (36,295

Repurchased

    (1,869         (6,051

Reissued

    58            65   

Balance, end of period

    (44,092         (42,281

Total shareholders’ equity

    $ 72,855            $ 70,379   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

  Goldman Sachs June 2012 Form 10-Q   5


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

        Six Months
    Ended June
in millions   2012     2011 

Cash flows from operating activities

   

Net earnings

    $   3,071      $   3,822 

Non-cash items included in net earnings

   

Depreciation and amortization

    842      966 

Share-based compensation

    890      1,985 

Changes in operating assets and liabilities

   

Cash and securities segregated for regulatory and other purposes

    7,579      (7,759)

Net receivables from brokers, dealers and clearing organizations

    3,559      (3,170)

Net payables to customers and counterparties

    7,949      3,884

Securities borrowed, net of securities loaned

    (11,909   (5,904)

Securities sold under agreements to repurchase, net of securities purchased under agreements to resell
and federal funds sold

    16,385      19,175 

Financial instruments owned, at fair value

    (22,954   (9,966)

Financial instruments sold, but not yet purchased, at fair value

    4,996      8,919 

Other, net

    (1,503   703 

Net cash provided by operating activities

    8,905      12,655 

Cash flows from investing activities

   

Purchase of property, leasehold improvements and equipment

    (542   (520)

Proceeds from sales of property, leasehold improvements and equipment

    28      33 

Business acquisitions, net of cash acquired

    (355   (247)

Proceeds from sales of investments

    290      966 

Purchase of available-for-sale securities

    (1,988   (1,122)

Proceeds from sales of available-for-sale securities

    1,386      1,339 

Net cash provided by/(used for) investing activities

    (1,181   449 

Cash flows from financing activities

   

Unsecured short-term borrowings, net

    (1,300   298 

Other secured financings (short-term), net

    (5,232   (461)

Proceeds from issuance of other secured financings (long-term)

    1,907      2,334 

Repayment of other secured financings (long-term), including the current portion

    (5,496   (5,363)

Proceeds from issuance of unsecured long-term borrowings

    15,677      17,470 

Repayment of unsecured long-term borrowings, including the current portion

    (22,062   (13,686)

Derivative contracts with a financing element, net

    964      244 

Deposits, net

    11,211      435 

Preferred stock repurchased

         (3,857)

Common stock repurchased

    (1,866   (2,980)

Dividends and dividend equivalents paid on common stock, preferred stock and restricted stock units

    (493   (2,326)

Proceeds from issuance of preferred stock, net of issuance costs

    1,750      — 

Proceeds from issuance of common stock, including stock option exercises

    46      123 

Excess tax benefit related to share-based compensation

    76      346 

Cash settlement of share-based compensation

    (1   (36)

Net cash used for financing activities

    (4,819   (7,459)

Net increase in cash and cash equivalents

    2,905      5,645 

Cash and cash equivalents, beginning of year

    56,008      39,788 

Cash and cash equivalents, end of period

    $ 58,913      $ 45,433 

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $5.72 billion and $4.02 billion during the six months ended June 2012 and June 2011, respectively.

Cash payments for income taxes, net of refunds, were $671 million and $1.79 billion during the six months ended June 2012 and June 2011, respectively.

Non-cash activities:

The firm assumed $92 million of debt in connection with business acquisitions during the six months ended June 2012.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1. Description of Business

Note 1.

Description of Business

The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, together with its consolidated subsidiaries (collectively, the firm), is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

The firm reports its activities in the following four business segments:

Investment Banking

The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds and governments. Services include advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, risk management, restructurings and spin-offs, and debt and equity underwriting of public offerings and private placements, as well as derivative transactions directly related to these activities.

Institutional Client Services

The firm facilitates client transactions and makes markets in fixed income, equity, currency and commodity products, primarily with institutional clients such as corporations, financial institutions, investment funds and governments. The firm also makes markets and clears client transactions on major stock, options and futures exchanges worldwide and provides financing, securities lending and prime brokerage services to institutional clients.

Investing & Lending

The firm invests in and originates loans to provide financing to clients. These investments and loans are typically longer-term in nature. The firm makes investments, directly and indirectly through funds that the firm manages, in debt securities, loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities.

Investment Management

The firm provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. The firm also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.

 

Note 2. Basis of Presentation

Note 2.

Basis of Presentation

These condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. Intercompany transactions and balances have been eliminated.

These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the firm’s Annual Report on Form 10-K for the year ended December 31, 2011. References to “the firm’s Annual Report on Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2011. The condensed consolidated financial information as of December 31, 2011 has been derived from audited consolidated financial statements not included herein.

These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.

All references to June 2012 and June 2011 refer to the firm’s periods ended, or the dates, as the context requires, June 30, 2012 and June 30, 2011, respectively. All references to March 2012 and December 2011 refer to the dates March 31, 2012 and December 31, 2011, respectively. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

 

 

  Goldman Sachs June 2012 Form 10-Q   7


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 3. Significant Accounting Policies

Note 3.

Significant Accounting Policies

 

The firm’s significant accounting policies include when and how to measure the fair value of assets and liabilities, accounting for goodwill and identifiable intangible assets, and when to consolidate an entity. See Notes 5 through 8 for policies on fair value measurements, Note 13 for policies on goodwill and identifiable intangible assets, and below and Note 11 for policies on consolidation accounting. All other significant accounting policies are either discussed below or included in the following footnotes:

 

Financial Instruments Owned, at Fair Value

and Financial Instruments Sold, But Not Yet

Purchased, at Fair Value

     Note 4   

Fair Value Measurements

     Note 5   

Cash Instruments

     Note 6   

Derivatives and Hedging Activities

     Note 7   

Fair Value Option

     Note 8   

Collateralized Agreements and Financings

     Note 9   

Securitization Activities

     Note 10   

Variable Interest Entities

     Note 11   

Other Assets

     Note 12   

Goodwill and Identifiable Intangible Assets

     Note 13   

Deposits

     Note 14   

Short-Term Borrowings

     Note 15   

Long-Term Borrowings

     Note 16   

Other Liabilities and Accrued Expenses

     Note 17   

Commitments, Contingencies and Guarantees

     Note 18   

Shareholders’ Equity

     Note 19   

Regulation and Capital Adequacy

     Note 20   

Earnings Per Common Share

     Note 21   

Transactions with Affiliated Funds

     Note 22   

Interest Income and Interest Expense

     Note 23   

Income Taxes

     Note 24   

Business Segments

     Note 25   

Credit Concentrations

     Note 26   

Legal Proceedings

     Note 27   

Consolidation

The firm consolidates entities in which the firm has a controlling financial interest. The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE).

Voting Interest Entities. Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The usual condition for a controlling financial interest in a voting interest entity is ownership of a majority voting interest. If the firm has a majority voting interest in a voting interest entity, the entity is consolidated.

Variable Interest Entities. A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. The firm has a controlling financial interest in a VIE when the firm has a variable interest or interests that provide it with (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 11 for further information about VIEs.

Equity-Method Investments. When the firm does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for either (i) under the equity method of accounting or (ii) at fair value by electing the fair value option available under U.S. GAAP. Significant influence generally exists when the firm owns 20% to 50% of the entity’s common stock or in-substance common stock.

 

 

8   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In general, the firm accounts for investments acquired subsequent to November 24, 2006, when the fair value option became available, at fair value. In certain cases, the firm applies the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, when the firm has a significant degree of involvement in the cash flows or operations of the investee or when cost-benefit considerations are less significant. See Note 12 for further information about equity-method investments.

Investment Funds. The firm has formed numerous investment funds with third-party investors. These funds are typically organized as limited partnerships or limited liability companies for which the firm acts as general partner or manager. Generally, the firm does not hold a majority of the economic interests in these funds. These funds are usually voting interest entities and generally are not consolidated because third-party investors typically have rights to terminate the funds or to remove the firm as general partner or manager. Investments in these funds are included in “Financial instruments owned, at fair value.” See Notes 6, 18 and 22 for further information about investments in funds.

Use of Estimates

Preparation of these condensed consolidated financial statements requires management to make certain estimates and assumptions, the most important of which relate to fair value measurements, accounting for goodwill and identifiable intangible assets, discretionary compensation accruals and the provision for losses that may arise from litigation, regulatory proceedings and tax audits. These estimates and assumptions are based on the best available information but actual results could be materially different.

Revenue Recognition

Financial Assets and Financial Liabilities at Fair Value. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value are recorded at fair value either under the fair value option or in accordance with other U.S. GAAP. In addition, the firm has elected to account for certain of its other financial assets and financial liabilities at fair value by electing the fair value option. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to

transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Fair value gains or losses are generally included in “Market making” for positions in Institutional Client Services and “Other principal transactions” for positions in Investing & Lending. See Notes 5 through 8 for further information about fair value measurements.

Investment Banking. Fees from financial advisory assignments and underwriting revenues are recognized in earnings when the services related to the underlying transaction are completed under the terms of the assignment. Expenses associated with such transactions are deferred until the related revenue is recognized or the assignment is otherwise concluded. Expenses associated with financial advisory assignments are recorded as non-compensation expenses, net of client reimbursements. Underwriting revenues are presented net of related expenses.

Investment Management. The firm earns management fees and incentive fees for investment management services. Management fees are calculated as a percentage of net asset value, invested capital or commitments, and are recognized over the period that the related service is provided. Incentive fees are calculated as a percentage of a fund’s or separately managed account’s return, or excess return above a specified benchmark or other performance target. Incentive fees are generally based on investment performance over a 12-month period or over the life of a fund. Fees that are based on performance over a 12-month period are subject to adjustment prior to the end of the measurement period. For fees that are based on investment performance over the life of the fund, future investment underperformance may require fees previously distributed to the firm to be returned to the fund. Incentive fees are recognized only when all material contingencies have been resolved. Management and incentive fee revenues are included in “Investment management” revenues.

Commissions and Fees. The firm earns “Commissions and fees” from executing and clearing client transactions on stock, options and futures markets. Commissions and fees are recognized on the day the trade is executed.

 

 

  Goldman Sachs June 2012 Form 10-Q   9


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Transfers of Assets

Transfers of assets are accounted for as sales when the firm has relinquished control over the assets transferred. For transfers of assets accounted for as sales, any related gains or losses are recognized in net revenues. Assets or liabilities that arise from the firm’s continuing involvement with transferred assets are measured at fair value. For transfers of assets that are not accounted for as sales, the assets remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Note 9 for further information about transfers of assets accounted for as collateralized financings and Note 10 for further information about transfers of assets accounted for as sales.

Receivables from Customers and Counterparties

Receivables from customers and counterparties generally relate to collateralized transactions. Such receivables are primarily comprised of customer margin loans, transfers of assets accounted for as secured loans rather than purchases and collateral posted in connection with certain derivative transactions. Certain of the firm’s receivables from customers and counterparties are accounted for at fair value under the fair value option, with changes in fair value generally included in “Market making” revenues. See Note 8 for further information about the fair values of these receivables. Receivables from customers and counterparties not accounted for at fair value are accounted for at amortized cost net of estimated uncollectible amounts. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in “Interest income.”

Insurance Activities

Certain of the firm’s insurance and reinsurance contracts are accounted for at fair value under the fair value option, with changes in fair value included in “Market making” revenues. See Note 8 for further information about the fair values of these insurance and reinsurance contracts.

Revenues from variable annuity and life insurance and reinsurance contracts not accounted for at fair value generally consist of fees assessed on contract holder account balances for mortality charges, policy administration fees and surrender charges. These revenues are recognized in earnings over the period that services are provided and are included in “Market making” revenues. Changes in reserves, including interest credited to policyholder account balances, are recognized in “Insurance reserves.”

Premiums earned for underwriting property catastrophe reinsurance are recognized in earnings over the coverage period, net of premiums ceded for the cost of reinsurance, and are included in “Market making” revenues. Expenses for liabilities related to property catastrophe reinsurance claims, including estimates of losses that have been incurred but not reported, are included in “Insurance reserves.”

Share-based Compensation

The cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based awards that require future service are amortized over the relevant service period. Expected forfeitures are included in determining share-based employee compensation expense.

The firm pays cash dividend equivalents on outstanding restricted stock units (RSUs). Dividend equivalents paid on RSUs are generally charged to retained earnings. Dividend equivalents paid on RSUs expected to be forfeited are included in compensation expense. The firm accounts for the tax benefit related to dividend equivalents paid on RSUs as an increase to additional paid-in capital.

In certain cases, primarily related to conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards. For awards accounted for as equity instruments, additional paid-in capital is adjusted to the extent of the difference between the current value of the award and the grant-date value of the award.

 

 

10   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Foreign Currency Translation

Assets and liabilities denominated in non-U.S. currencies are translated at rates of exchange prevailing on the date of the condensed consolidated statements of financial condition and revenues and expenses are translated at average rates of exchange for the period. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are recognized in earnings. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, in the condensed consolidated statements of comprehensive income.

Cash and Cash Equivalents

The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business. As of June 2012 and December 2011, “Cash and cash equivalents” included $8.02 billion and $7.95 billion, respectively, of cash and due from banks, and $50.89 billion and $48.05 billion, respectively, of interest-bearing deposits with banks.

Recent Accounting Developments

Reconsideration of Effective Control for Repurchase Agreements (ASC 860). In April 2011, the FASB issued ASU No. 2011-03, “Transfers and Servicing (Topic 860) — Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 changes the assessment of effective control by removing (i) the criterion that requires the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance implementation guidance related to that criterion. ASU No. 2011-03 is effective for periods beginning after December 15, 2011. The firm adopted the standard on January 1, 2012. Adoption of ASU No. 2011-03 did not affect the firm’s financial condition, results of operations or cash flows.

Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASC 820). In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurements and Disclosures (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU No. 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes certain principles related to measuring fair value, and requires additional disclosures about fair value measurements. ASU No. 2011-04 is effective for periods beginning after December 15, 2011. The firm adopted the standard on January 1, 2012. Adoption of ASU No. 2011-04 did not materially affect the firm’s financial condition, results of operations or cash flows.

Derecognition of in Substance Real Estate (ASC 360). In December 2011, the FASB issued ASU No. 2011-10, “Property, Plant, and Equipment (Topic 360) — Derecognition of in Substance Real Estate — a Scope Clarification.” ASU No. 2011-10 clarifies that in order to deconsolidate a subsidiary (that is in substance real estate) as a result of a parent no longer controlling the subsidiary due to a default on the subsidiary’s nonrecourse debt, the parent also must satisfy the sale criteria in ASC 360-20, “Property, Plant, and Equipment — Real Estate Sales.” The ASU is effective for fiscal years beginning on or after June 15, 2012. The firm will apply the provisions of the ASU to such events occurring on or after January 1, 2013. Adoption is not expected to materially affect the firm’s financial condition, results of operations or cash flows.

Disclosures about Offsetting Assets and Liabilities (ASC 210). In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210) — Disclosures about Offsetting Assets and Liabilities.” ASU No. 2011-11 requires disclosure of the effect or potential effect of offsetting arrangements on the firm’s financial position as well as enhanced disclosure of the rights of setoff associated with the firm’s recognized assets and recognized liabilities. ASU No. 2011-11 is effective for periods beginning on or after January 1, 2013. Since these amended principles require only additional disclosures concerning offsetting and related arrangements, adoption will not affect the firm’s financial condition, results of operations or cash flows.

 

 

  Goldman Sachs June 2012 Form 10-Q   11


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 4. Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

Note 4.

Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value

 

 

 

Financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value are accounted for at fair value either under the fair value option or in accordance with other U.S. GAAP. See Note 8 for further information about the fair value option. The table below presents the firm’s financial instruments owned, at fair value, including those pledged as collateral, and

financial instruments sold, but not yet purchased, at fair value. Financial instruments owned, at fair value included $6.96 billion and $4.86 billion as of June 2012 and December 2011, respectively, of securities accounted for as available-for-sale, substantially all of which are held in the firm’s insurance subsidiaries.

 

 

    As of June 2012          As of December 2011  
in millions   Financial
Instruments
Owned
     Financial
Instruments
Sold, But
Not Yet
Purchased
          Financial
Instruments
Owned
    

Financial
Instruments
Sold, But

Not Yet
Purchased

 

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $  10,011         $          —             $  13,440         $          —   

U.S. government and federal agency obligations

    94,949         21,391             87,040         21,006   

Non-U.S. government and agency obligations

    63,890         37,736             49,205         34,886   

Mortgage and other asset-backed loans and securities:

            

Loans and securities backed by commercial real estate

    7,199         1             6,699         27   

Loans and securities backed by residential real estate

    8,467         4             7,592         3   

Bank loans and bridge loans

    20,770         2,412  2           19,745         2,756  2 

Corporate debt securities

    21,534         6,752             22,131         6,553   

State and municipal obligations

    3,493                     3,089         3   

Other debt obligations

    4,639                     4,362           

Equities and convertible debentures

    74,606         29,410             65,113         21,326   

Commodities

    6,330                     5,762           

Derivatives 1

    71,308         52,242             80,028         58,453   

Total

    $387,196         $149,948             $364,206         $145,013   

 

1.

Net of cash collateral received or posted under credit support agreements and reported on a net-by-counterparty basis when a legal right of setoff exists under an enforceable netting agreement.

 

2.

Includes the fair value of unfunded lending commitments for which the fair value option was elected.

 

12   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Gains and Losses from Market Making and Other Principal Transactions

The table below presents, by major product type, the firm’s “Market making” and “Other principal transactions” revenues. These gains/(losses) are primarily related to the firm’s financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, including both derivative and non-derivative financial instruments. These gains/(losses) exclude related interest income and interest expense. See Note 23 for further information about interest income and interest expense.

The gains/(losses) in the table are not representative of the manner in which the firm manages its business activities because many of the firm’s market-making, client facilitation, and investing and lending strategies utilize financial instruments across various product types. Accordingly, gains or losses in one product type frequently offset gains or losses in other product types. For example, most of the firm’s longer-term derivatives are sensitive to changes in interest rates and may be economically hedged with interest rate swaps. Similarly, a significant portion of the firm’s cash instruments and derivatives has exposure to foreign currencies and may be economically hedged with foreign currency contracts.

 

 

    Three Months
Ended June
        Six Months
Ended June
 
in millions   2012      2011          2012      2011  

Interest rates

    $  (565      $1,034            $1,324         $ 3,440   

Credit

    1,465         929            3,175         2,980   

Currencies

    776         (984         52         (2,590

Equities

    214         1,024            2,187         3,874   

Commodities

    105         (71         576         886   

Other

    271         406            795         822   

Total

    $2,266         $2,338            $8,109         $ 9,412   
Note 5. Fair Value Measurements

Note 5.

Fair Value Measurements

The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. The firm measures certain financial assets and financial liabilities as a portfolio (i.e., based on its net exposure to market and/or credit risks).

The best evidence of fair value is a quoted price in an active market. If quoted prices in active markets are not available, fair value is determined by reference to prices for similar instruments, quoted prices or recent transactions in less active markets, or internally developed models that primarily use market-based or independently sourced parameters as inputs including, but not limited to, interest rates, volatilities, equity or debt prices, foreign exchange rates, commodity prices, credit spreads and funding spreads.

U.S. GAAP has a three-level fair value hierarchy for disclosure of fair value measurements. The fair value hierarchy prioritizes inputs to the valuation techniques used to measure fair value, giving the highest priority to level 1 inputs and the lowest priority to level 3 inputs. A financial instrument’s level in the fair value hierarchy is based on the lowest level of input that is significant to its fair value measurement.

The fair value hierarchy is as follows:

Level 1. Inputs are unadjusted quoted prices in active markets to which the firm had access at the measurement date for identical, unrestricted assets or liabilities.

Level 2. Inputs to valuation techniques are observable, either directly or indirectly.

Level 3. One or more inputs to valuation techniques are significant and unobservable.

 

 

  Goldman Sachs June 2012 Form 10-Q   13


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The fair values for substantially all of the firm’s financial assets and financial liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the hierarchy. Certain level 2 and level 3 financial assets and financial liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors such as counterparty and the firm’s credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Valuation adjustments are generally based on market evidence.

See Notes 6 and 7 for further information about fair value measurements of cash instruments and derivatives, respectively, included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” and Note 8 for further information about fair value measurements of other financial assets and financial liabilities accounted for at fair value under the fair value option.

Financial assets and financial liabilities accounted for at fair value under the fair value option or in accordance with other U.S. GAAP are summarized below.

 

 

    As of  
$ in millions    

 

June

2012

  

  

    

 

March

2012

  

  

    

 

December

2011

  

  

Total level 1 financial assets

    $ 163,712         $ 159,906         $ 136,780   

Total level 2 financial assets

    552,082         566,165         587,416   

Total level 3 financial assets

    46,505         48,015         47,937   

Netting and collateral 1

    (111,139      (108,461      (120,821

Total financial assets at fair value

    $ 651,160         $ 665,625         $ 651,312   

Total assets

    $ 948,638         $ 950,932         $ 923,225   

Total level 3 financial assets as a percentage of Total assets

    4.9      5.0      5.2

Total level 3 financial assets as a percentage of Total financial assets at fair value

    7.1      7.2      7.4

Total level 3 financial liabilities at fair value
    $   23,127         $   23,941         $   25,498   

Total financial liabilities at fair value

    $ 380,087         $ 403,516         $ 388,669   

Total level 3 financial liabilities as a percentage of Total financial liabilities at fair value

    6.1      5.9      6.6

 

1.

Represents the impact on derivatives of cash collateral and counterparty netting across levels of the fair value hierarchy. Netting among positions classified in the same level is included in that level.

 

Level 3 financial assets as of June 2012 decreased compared with March 2012, primarily reflecting a decrease in derivative assets, bank loans and bridge loans and private equity investments. The decline in derivative assets primarily reflected transfers of certain credit derivatives to level 2 and unrealized losses on certain equity derivatives, partially offset by the impact of decreased counterparty netting. The decline in bank loans and bridge loans primarily reflected sales and settlements, partially offset by purchases. The decline in private equity investments primarily reflected transfers to level 2, partially offset by purchases.

Level 3 financial assets as of June 2012 also decreased compared with December 2011, reflecting a decrease in derivative assets, principally due to a decline in credit and currency derivative assets, partially offset by the impact of decreased counterparty netting. The decline in credit and currency derivative assets was principally due to transfers to level 2 and settlements, as well as unrealized losses on currency derivatives.

See Notes 6, 7 and 8 for further information about level 3 cash instruments, derivatives and other financial assets and financial liabilities accounted for at fair value under the fair value option, respectively, including information about significant unrealized gains or losses and transfers in or out of level 3.

 

 

14   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6. Cash Instrument

Note 6.

Cash Instruments

 

Cash instruments include U.S. government and federal agency obligations, non-U.S. government and agency obligations, bank loans and bridge loans, corporate debt securities, equities and convertible debentures, and other non-derivative financial instruments owned and financial instruments sold, but not yet purchased. See below for the types of cash instruments included in each level of the fair value hierarchy and the valuation techniques and significant inputs used to determine their fair values. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Cash Instruments

Level 1 cash instruments include U.S. government obligations and most non-U.S. government obligations, actively traded listed equities and certain government agency obligations and money market instruments. These instruments are valued using quoted prices for identical unrestricted instruments in active markets.

The firm defines active markets for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalization for the instrument. The firm defines active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity.

Level 2 Cash Instruments

Level 2 cash instruments include commercial paper, certificates of deposit, time deposits, most government agency obligations, certain non-U.S. government obligations, most corporate debt securities, commodities, certain mortgage-backed loans and securities, certain bank loans and bridge loans, restricted or less liquid listed equities, most state and municipal obligations and certain lending commitments.

Valuations of level 2 cash instruments can be verified to quoted prices, recent trading activity for identical or similar instruments, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Valuation adjustments are typically made to level 2 cash instruments (i) if the cash instrument is subject to transfer restrictions and/or (ii) for other premiums and liquidity discounts that a market participant would require to arrive at fair value. Valuation adjustments are generally based on market evidence.

Level 3 Cash Instruments

Level 3 cash instruments have one or more significant valuation inputs that are not observable. Absent evidence to the contrary, level 3 cash instruments are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequently, the firm uses other methodologies to determine fair value, which vary based on the type of instrument. Valuation inputs and assumptions are changed when corroborated by substantive observable evidence, including values realized on sales of financial assets.

 

 

  Goldman Sachs June 2012 Form 10-Q   15


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the valuation techniques and the nature of significant inputs generally used to determine

the fair values of each type of level 3 cash instrument.

 

 

Level 3 Cash Instrument    Valuation Techniques and Significant Inputs

 

Loans and securities backed by commercial real estate

 

Ÿ   Collateralized by a single commercial real estate property or a portfolio of properties

 

Ÿ   May include tranches of varying levels of subordination

  

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

 

Significant inputs for these valuations, which may be determined based on relative value analyses, include:

 

Ÿ   Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral

 

Ÿ   Market yields implied by transactions of similar or related assets and/or current levels and changes in market indices such as the CMBX (an index that tracks the performance of commercial mortgage bonds)

 

Ÿ   Recovery rates implied by the value of the underlying collateral, which is mainly driven by current performance of the underlying collateral, capitalization rates and multiples

 

Ÿ   Timing of expected future cash flows (duration)

 

 

Loans and securities backed by residential real estate

 

Ÿ   Collateralized by portfolios of residential real estate

 

Ÿ   May include tranches of varying levels of subordination

  

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

 

Significant inputs are determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles, including relevant indices such as the ABX (an index that tracks the performance of subprime residential mortgage bonds). Significant inputs include:

 

Ÿ   Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral

 

Ÿ   Market yields implied by transactions of similar or related assets

 

Ÿ   Cumulative loss expectations, driven by default rates, home price projections, residential property liquidation timelines and related costs

 

Ÿ   Duration, driven by underlying loan prepayment speeds and residential property liquidation timelines

 

 

 

Bank loans and bridge loans

  

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

 

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 

Ÿ   Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX and LCDX (indices that track the performance of corporate credit and loans, respectively)

 

Ÿ   Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation

 

Ÿ   Duration

 

 

Corporate debt securities

 

State and municipal obligations

 

Non-U.S. government and agency obligations

 

Other debt obligations

  

 

Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

 

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 

Ÿ   Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices such as CDX, LCDX and MCDX (an index that tracks the performance of municipal obligations)

 

Ÿ   Current performance and recovery assumptions and, where the firm uses credit default swaps to value the related cash instrument, the cost of borrowing the underlying reference obligation

 

Ÿ   Duration

 

 

Equities and convertible debentures (including private equity investments and investments in real estate entities)

  

 

Recent third-party completed or pending transactions (e.g., merger proposals, tender offers, debt restructurings) are considered to be the best evidence for any change in fair value. When these are not available, the following valuation methodologies are used, as appropriate:

 

Ÿ   Industry multiples and public comparables

 

Ÿ   Transactions in similar instruments

 

Ÿ   Discounted cash flow techniques

 

Ÿ   Third-party appraisals

 

The firm also considers changes in the outlook for the relevant industry and financial performance of the issuer as compared to projected performance. Significant inputs include:

 

Ÿ   Market and transaction multiples

 

Ÿ   Discount rates, long-term growth rates, earnings compound annual growth rates and capitalization rates

 

Ÿ   For equity instruments with debt-like features: market yields implied by transactions of similar or related assets, current performance and recovery assumptions, and duration

 

16   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The table below presents the ranges of significant unobservable inputs used to value the firm’s level 3 cash instruments. These ranges represent the significant unobservable inputs that were used in the valuation of each type of cash instrument. These inputs are not representative of the inputs that could have been used in the valuation of any one cash instrument. For example, the highest multiple

presented in the table for private equity investments is appropriate for valuing a specific private equity investment but may not be appropriate for valuing any other private equity investment. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 cash instruments.

 

 

Level 3 Cash Instrument   

Significant Unobservable Inputs

by Valuation Technique

   Range of Significant Unobservable
Inputs as of June 2012

 

Loans and securities backed by commercial real estate

 

•  Collateralized by a single commercial real estate property or a portfolio of properties

 

•  May include tranches of varying levels of subordination

 

  

 

Discounted cash flows:

 

•  Yield

 

•  Recovery rate 1

 

•  Duration (years) 2

  

 

 

4.4% to 35.8%

 

20.0% to 100.0%

 

0.3 to 7.3

 

Loans and securities backed by residential real estate

 

•  Collateralized by portfolios of residential real estate

 

•  May include tranches of varying levels of subordination

 

  

 

Discounted cash flows:

 

•  Yield

 

•  Cumulative loss rate

 

•  Duration (years) 2

 

  

 

 

2.8% to 29.2%

 

0.0% to 61.5%

 

0.3 to 10.3

 

Bank loans and bridge loans

  

 

Discounted cash flows:

 

•  Yield

 

•  Recovery rate 1

 

•  Duration (years) 2

 

  

 

 

0.8% to 32.7%

 

15.0% to 100.0%

 

0.4 to 7.6

 

Corporate debt securities

 

State and municipal obligations

 

Non-U.S. government and agency obligations

 

Other debt obligations

 

  

 

Discounted cash flows:

 

•  Yield

 

•  Recovery rate 1

 

•  Duration (years) 2

  

 

 

1.8% to 35.3%

 

0.0% to 100.0%

 

0.6 to 17.4

 

Equities and convertible debentures (including private equity investments and investments in real estate entities)

  

 

Comparable multiples:

 

•  Multiples

 

Discounted cash flows:

 

•  Yield/discount rate

 

•  Long-term growth rate/compound annual growth rate

 

•  Capitalization rate

 

•  Recovery rate 1

 

•  Duration (years) 2

 

  

 

 

0.7x to 24.1x

 

 

10.0% to 32.6%

 

 

(3.2)% to 26.0%

 

5.5% to 11.9%

 

45.0% to 100.0%

 

0.8 to 8.5

 

1.

A measure of expected future cash flows, expressed as a percentage of notional or face value of the instrument.

 

2.

Duration is an estimate of the timing of future cash flows and, in certain cases, may incorporate the impact of other unobservable inputs (e.g., prepayment speeds).

 

Increases in yield, discount rate, capitalization rate, duration or cumulative loss rate used in the valuation of the firm’s level 3 cash instruments would result in a lower fair value measurement; while increases in recovery rate, multiples, long-term growth rate or compound annual

growth rate would result in a higher fair value measurement. Due to the distinctive nature of each of the firm’s level 3 cash instruments, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

  Goldman Sachs June 2012 Form 10-Q   17


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Cash Instruments by Level

 

The tables below present, by level within the fair value hierarchy, cash instrument assets and liabilities, at fair value. Cash instrument assets and liabilities are included in

“Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.

 

 

    Cash Instrument Assets at Fair Value  as of June 2012  
in millions   Level 1          Level 2          Level 3          Total  

Commercial paper, certificates of deposit, time deposits
and other money market instruments

    $    1,463             $    8,541             $         7             $  10,011   

U.S. government and federal agency obligations

    40,737             54,212             —             94,949   

Non-U.S. government and agency obligations

    47,601             16,281             8             63,890   

Mortgage and other asset-backed loans and securities 1:

                

Loans and securities backed by commercial real estate

    —             4,033             3,166             7,199   

Loans and securities backed by residential real estate

    —             6,835             1,632             8,467   

Bank loans and bridge loans

    —             10,309             10,461             20,770   

Corporate debt securities 2

    183             18,984             2,367             21,534   

State and municipal obligations

    —             2,946             547             3,493   

Other debt obligations 2

    —             2,882             1,757             4,639   

Equities and convertible debentures

    50,909 3           9,277 4           14,420 5           74,606   

Commodities

    —             6,330             —             6,330   

Total

    $140,893             $140,630             $34,365             $315,888   
    Cash Instrument Liabilities at Fair  Value as of June 2012  
in millions   Level 1          Level 2          Level 3          Total  

U.S. government and federal agency obligations

    $  20,909             $       482             $       —             $  21,391   

Non-U.S. government and agency obligations

    36,657             1,079             —             37,736   

Mortgage and other asset-backed loans and securities:

                

Loans and securities backed by commercial real estate

    —             1             —             1   

Loans and securities backed by residential real estate

    —             4             —             4   

Bank loans and bridge loans

    —             1,702             710             2,412   

Corporate debt securities 6

    14             6,717             21             6,752   

Equities and convertible debentures

    28,799 3           603 4           8             29,410   

Total

    $  86,379             $  10,588             $     739             $  97,706   

 

1.

Includes $309 million and $689 million of collateralized debt obligations (CDOs) backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $954 million and $1.29 billion of CDOs and collateralized loan obligations (CLOs) backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Consists of listed equity securities.

 

4.

Principally consists of restricted or less liquid listed securities.

 

5.

Includes $12.66 billion of private equity investments, $1.29 billion of real estate investments and $469 million of convertible debentures.

 

6.

Includes $6 million and $11 million of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.

 

18   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Cash Instrument Assets at Fair Value as of December 2011  
in millions   Level 1        Level 2        Level 3        Total  

Commercial paper, certificates of deposit, time deposits
and other money market instruments

    $    3,255           $  10,185           $       —           $  13,440   

U.S. government and federal agency obligations

    29,263           57,777                     87,040   

Non-U.S. government and agency obligations

    42,854           6,203           148           49,205   

Mortgage and other asset-backed loans and securities 1:
Loans and securities backed by commercial real estate

              3,353           3,346           6,699   

Loans and securities backed by residential real estate

              5,883           1,709           7,592   

Bank loans and bridge loans

              8,460           11,285           19,745   

Corporate debt securities 2

    133           19,518           2,480           22,131   

State and municipal obligations

              2,490           599           3,089   

Other debt obligations 2

              2,911           1,451           4,362   

Equities and convertible debentures

    39,955  3         11,491  4         13,667  5         65,113   

Commodities

              5,762                     5,762   

Total

    $115,460           $134,033           $34,685           $284,178   
    Cash Instrument Liabilities at Fair Value as of December 2011  
in millions   Level 1        Level 2        Level 3        Total  

U.S. government and federal agency obligations

    $  20,940           $         66           $       —           $  21,006   

Non-U.S. government and agency obligations

    34,339           547                     34,886   

Mortgage and other asset-backed loans and securities:
Loans and securities backed by commercial real estate

              27                     27   

Loans and securities backed by residential real estate

              3                     3   

Bank loans and bridge loans

              1,891           865           2,756   

Corporate debt securities 6

              6,522           31           6,553   

State and municipal obligations

              3                     3   

Equities and convertible debentures

    20,069  3         1,248  4         9           21,326   

Total

    $  75,348           $  10,307           $     905           $  86,560   

 

1.

Includes $213 million and $595 million of CDOs backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $403 million and $1.19 billion of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Consists of listed equity securities.

 

4.

Principally consists of restricted or less liquid listed securities.

 

5.

Includes $12.07 billion of private equity investments, $1.10 billion of real estate investments and $497 million of convertible debentures.

 

6.

Includes $27 million of CDOs and CLOs backed by corporate obligations in level 3.

Transfers Between Levels of the Fair Value Hierarchy

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. Transfers of cash instruments between level 1 and level 2 during the three months ended June 2012 were $2.26 billion, primarily reflecting transfers to level 2 of certain non-U.S. government obligations due to the level of market activity in these instruments.

Transfers of cash instruments between level 1 and level 2 during the six months ended June 2012 were $2.55 billion, primarily reflecting transfers to level 2 of certain non-U.S. government obligations due to the level of market activity in these instruments, and transfers to level 2 of certain public equity investments principally due to the impact of transfer restrictions. See level 3 rollforwards below for further information about transfers between level 2 and level 3.

 

 

  Goldman Sachs June 2012 Form 10-Q   19


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

 

If a cash instrument asset or liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3.

Level 3 cash instruments are frequently economically hedged with level 1 and level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. Accordingly, gains or losses that are reported in level 3 can be partially offset by gains or losses attributable to level 1 or level 2 cash

instruments and/or level 1, level 2 or level 3 derivatives. As a result, gains or losses included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

The tables below present changes in fair value for all cash instrument assets and liabilities categorized as level 3 as of the end of the period.

 

 

    Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended June 2012  
in millions   Balance,
beginning
of period
    Net
realized
gains/
(losses)
   

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

    Purchases 1     Sales     Settlements     Transfers
into
level 3
    Transfers
out of
level 3
   

Balance,
end of

period

 

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $         8        $   —        $   —        $     —          $       (1     $      —        $      —        $       —        $         7   

Non-U.S. government and agency obligations

    105        (4     (1     —          (20     (70            (2     8   

Mortgage and other asset-backed loans and securities:

Loans and securities backed by commercial real estate

    3,156        70        46        502          (494     (274     233        (73     3,166   

Loans and securities backed by residential real estate

    1,610        79        28        301          (237     (254     119        (14     1,632   

Bank loans and bridge loans

    11,051        122        20        1,685          (1,113     (1,035     691        (960     10,461   

Corporate debt securities

    2,512        83        (28     453          (397     (177     135        (214     2,367   

State and municipal obligations

    612        4        5        13          (67     (3     5        (22     547   

Other debt obligations

    1,549        13        18        423          (214     (43     17        (6     1,757   

Equities and convertible debentures

    14,874        (4     357        792          (182     (408     272        (1,281     14,420   

Total

    $35,477        $363  2      $445  2      $4,169          $(2,725     $(2,264     $1,472        $(2,572     $34,365   
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended June 2012  
in millions   Balance,
beginning
of period
    Net
realized
(gains)/
losses
    Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
    Purchases 1     Sales     Settlements     Transfers
into
level 3
    Transfers
out of
level 3
   

Balance,
end of

period

 

Total

    $     747        $    5        $  37        $  (151)         $      51        $    103        $     46        $     (99     $     739   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $59 million, $409 million and $340 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain/(loss) on level 3 cash instruments of $408 million (reflecting $445 million on cash instrument assets and $(37) million on cash instrument liabilities) for the three months ended June 2012 primarily consisted of gains on private equity investments, where valuations were generally corroborated through market transactions in similar instruments during the quarter.

Transfers into level 3 during the three months ended June 2012 primarily reflected transfers from level 2 of certain bank loans and bridge loans, private equity investments and loans and securities backed by commercial real estate, principally due to less market activity in these instruments.

 

 

20   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Transfers out of level 3 during the three months ended June 2012 primarily reflected transfers to level 2 of certain private equity investments and bank loans and bridge loans. Transfers of private equity investments to level 2 were principally due to improved transparency of market

prices as a result of market transactions in these financial instruments. Transfers of bank loans and bridge loans to level 2 were principally due to market transactions in these instruments and unobservable inputs no longer being significant to the valuation of certain loans.

 

 

    Level 3 Cash Instrument Assets at Fair Value for the Six Months Ended June 2012  
in millions   Balance,
beginning
of period
    Net
realized
gains/
(losses)
   

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

    Purchases  1     Sales     Settlements     Transfers
into
level 3
    Transfers
out of
level 3
   

Balance,
end of

period

 

Commercial paper, certificates of deposit, time deposits and other money market instruments

    $       —        $   —        $      —        $       8          $       (1     $       —        $      —        $       —        $         7   

Non-U.S. government and agency obligations

    148        (56     1        —          (16     (70     5        (4     8   

Mortgage and other asset-backed loans and securities:

Loans and securities backed by commercial real estate

    3,346        121        116        829          (1,007     (517     359        (81     3,166   

Loans and securities backed by residential real estate

    1,709        109        63        514          (406     (390     59        (26     1,632   

Bank loans and bridge loans

    11,285        334        77        2,153          (2,235     (1,409     1,297        (1,041     10,461   

Corporate debt securities

    2,480        175        89        658          (662     (325     267        (315     2,367   

State and municipal obligations

    599        10        5        20          (65     (10     6        (18     547   

Other debt obligations

    1,451        69        30        445          (283     (78     127        (4     1,757   

Equities and convertible debentures

    13,667        27        644        1,410          (219     (587     842        (1,364     14,420   

Total

    $34,685        $789  2      $1,025  2      $6,037          $(4,894     $(3,386     $2,962        $(2,853     $34,365   
    Level 3 Cash Instrument Liabilities at Fair Value for the Six Months Ended June 2012  
in millions   Balance,
beginning
of period
    Net
realized
(gains)/
losses
    Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
    Purchases  1     Sales     Settlements     Transfers
into
level 3
    Transfers
out of
level 3
   

Balance,
end of

period

 

Total

    $     905        $  (22     $       (2     $   (311)         $    100        $    141        $    118        $    (190     $     739   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $187 million, $960 million and $667 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain on level 3 cash instruments of $1.03 billion (reflecting $1.03 billion on cash instrument assets and $2 million on cash instrument liabilities) for the six months ended June 2012 primarily consisted of gains on private equity investments, where valuations were generally corroborated by market transactions in similar instruments.

Transfers into level 3 during the six months ended June 2012 primarily reflected transfers from level 2 of certain bank loans and bridge loans and private equity investments, principally due to less market activity in these instruments.

Transfers out of level 3 during the six months ended June 2012 primarily reflected transfers to level 2 of certain private equity investments and bank loans and bridge loans. Transfers of private equity investments to level 2 were principally due to improved transparency of market prices as a result of market transactions in these financial instruments. Transfers of bank loans and bridge loans to level 2 were principally due to market transactions in these instruments and unobservable inputs no longer being significant to the valuation of certain loans.

 

 

  Goldman Sachs June 2012 Form 10-Q   21


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

    Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended June 2011  
in millions   Balance,
beginning
of period
     Net
realized
gains/
(losses)
   

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

    Purchases  1      Sales     Settlements     Net
transfers
in and/or
(out) of
level 3
   

Balance,
end of

period

 

Mortgage and other asset-backed loans
and securities:

Loans and securities backed by
commercial real estate

    $  3,713         $  27        $  88        $    305           $   (476     $    (246     $   128        $  3,539   

Loans and securities backed by
residential real estate

    2,756         59        20        382           (187     (171     (30     2,829   

Bank loans and bridge loans

    9,929         189        220        1,249           (559     (524     (321     10,183   

Corporate debt securities

    3,138         93        14        404           (627     (127     (148     2,747   

State and municipal obligations

    742         1        4        26           (119     (2     (9     643   

Other debt obligations

    1,483         51        20        158           (316     (90     166        1,472   

Equities and convertible debentures

    11,765         89        380        332           (208     (218     1,312        13,452   

Total

    $33,526         $509  2      $746  2      $2,856           $(2,492     $(1,378     $1,098        $34,865   
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended June 2011  
in millions   Balance,
beginning
of period
     Net
realized
(gains)/
losses
    Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
    Purchases  1      Sales     Settlements     Net
transfers
in and/or
(out) of
level 3
   

Balance,
end of

period

 

Total

    $     482         $    1        $  95        $   (130)          $    201        $     (21     $    (16     $     612   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $277 million, $606 million and $372 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain/(loss) on level 3 cash instruments of $651 million (reflecting $746 million on cash instrument assets and $(95) million on cash instrument liabilities) for the three months ended June 2011 primarily consisted of unrealized gains on private equity investments, and bank loans and bridge loans, where prices were generally corroborated through market transactions for similar assets during the period.

Significant transfers in or out of level 3 during the three months ended June 2011 included:

 

Ÿ  

Equities and convertible debentures: net transfer into level 3 of $1.31 billion, principally due to transfers into level 3 of certain private equity investments due to

   

reduced transparency of market prices, partially offset by transfers to level 2 of certain private equity investments due to improved transparency of market prices as a result of market transactions in these financial instruments.

 

Ÿ  

Bank loans and bridge loans: net transfer out of level 3 of $321 million, principally due to transfers to level 2 of certain loans due to improved transparency of market prices as a result of market transactions in these financial instruments, partially offset by transfers to level 3 of certain loans due to reduced transparency of market prices as a result of less market activity in these financial instruments.

 

 

22   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

    Level 3 Cash Instrument Assets at Fair Value for the Six Months Ended June 2011  
in millions   Balance,
beginning
of period
     Net
realized
gains/
(losses)
   

Net unrealized
gains/(losses)
relating to
instruments
still held at

period-end

    Purchases  1      Sales     Settlements     Net
transfers
in and/or
(out) of
level 3
   

Balance,
end of

period

 

Mortgage and other asset-backed loans
and securities:

Loans and securities backed by
commercial real estate

    $  3,976         $  83        $   189        $    668           $   (848     $   (398     $(131     $  3,539   

Loans and securities backed by
residential real estate

    2,501         125        124        836           (426     (462     131        2,829   

Bank loans and bridge loans

    9,905         344        721        2,269           (802     (1,330     (924     10,183   

Corporate debt securities

    2,737         209        148        1,154           (889     (173     (439     2,747   

State and municipal obligations

    754         3        4        29           (135     (3     (9     643   

Other debt obligations

    1,274         87        48        441           (306     (153     81        1,472   

Equities and convertible debentures

    11,060         61        679        2,055           (700     (437     734        13,452   

Total

    $32,207         $912  2      $1,913  2      $7,452           $(4,106     $(2,956     $(557     $34,865   
    Level 3 Cash Instrument Liabilities at Fair Value for the Six Months Ended June 2011  
in millions   Balance,
beginning
of period
     Net
realized
(gains)/
losses
    Net unrealized
(gains)/losses
relating to
instruments
still held at
period-end
    Purchases  1      Sales     Settlements     Net
transfers
in and/or
(out) of
level 3
   

Balance,
end of

period

 

Total

    $     446         $ (15     $     67        $  (193)          $    325        $     (15     $    (3     $     612   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $688 million, $1.38 billion and $758 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain/(loss) on level 3 cash instruments of $1.85 billion (reflecting $1.91 billion on cash instrument assets and $(67) million on cash instrument liabilities) for the six months ended June 2011 primarily consisted of unrealized gains on bank loans and bridge loans, reflecting generally favorable credit markets, primarily during the first quarter of 2011, and private equity investments, where prices were generally corroborated through market transactions for similar assets during the period.

Significant transfers in or out of level 3 during the six months ended June 2011 included:

 

Ÿ  

Bank loans and bridge loans: net transfer out of level 3 of $924 million, principally due to transfers to level 2 of certain loans due to improved transparency of market prices as a result of market transactions in these financial instruments, partially offset by transfers to

   

level 3 of certain loans due to reduced transparency of market prices as a result of less market activity in these financial instruments.

 

Ÿ  

Equities and convertible debentures: net transfer into level 3 of $734 million, principally due to transfers to level 3 of certain private equity investments due to reduced transparency of market prices, partially offset by transfers to level 2 of certain private equity investments due to improved transparency of market prices as a result of market transactions in these financial instruments.

 

Ÿ  

Corporate debt securities: net transfer out of level 3 of $439 million, principally due to transfers to level 2 of certain corporate debt securities due to increased transparency of market prices as a result of market transactions in these financial instruments.

 

 

  Goldman Sachs June 2012 Form 10-Q   23


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investments in Funds That Calculate Net Asset

Value Per Share

Cash instruments at fair value include investments in funds that are valued based on the net asset value per share (NAV) of the investment fund. The firm uses NAV as its measure of fair value for fund investments when (i) the fund investment does not have a readily determinable fair value and (ii) the NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the underlying investments at fair value.

The firm’s investments in funds that calculate NAV primarily consist of investments in firm-sponsored funds where the firm co-invests with third-party investors. The private equity, private debt and real estate funds are primarily closed-end funds in which the firm’s investments are not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated and it is estimated that substantially all of the underlying assets of existing funds will be liquidated over

the next 10 years. The firm continues to manage its existing funds taking into account the transition periods under the Volcker Rule of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), although the rules have not yet been finalized.

The firm’s investments in hedge funds are generally redeemable on a quarterly basis with 91 days’ notice, subject to a maximum redemption level of 25% of the firm’s initial investments at any quarter-end. The firm currently plans to comply with the Volcker Rule by redeeming certain of its interests in hedge funds. The firm redeemed approximately $250 million and $500 million of these interests in hedge funds during the three and six months ended June 2012, respectively.

The table below presents the fair value of the firm’s investments in, and unfunded commitments to, funds that calculate NAV.

 

 

    As of June 2012          As of December 2011  
in millions   Fair Value of
Investments
       Unfunded
Commitments
          Fair Value of
Investments
       Unfunded
Commitments
 

Private equity funds 1

    $  7,939           $2,970             $  8,074           $3,514   

Private debt funds 2

    3,540           3,066             3,596           3,568   

Hedge funds 3

    2,706                       3,165             

Real estate funds 4

    1,755           1,312             1,531           1,613   

Total

    $15,940           $7,348             $16,366           $8,695   

 

1.

These funds primarily invest in a broad range of industries worldwide in a variety of situations, including leveraged buyouts, recapitalizations and growth investments.

 

2.

These funds generally invest in loans and other fixed income instruments and are focused on providing private high-yield capital for mid- to large-sized leveraged and management buyout transactions, recapitalizations, financings, refinancings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers.

 

3.

These funds are primarily multi-disciplinary hedge funds that employ a fundamental bottom-up investment approach across various asset classes and strategies including long/short equity, credit, convertibles, risk arbitrage, special situations and capital structure arbitrage.

 

4.

These funds invest globally, primarily in real estate companies, loan portfolios, debt recapitalizations and direct property.

 

24   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 7. Derivatives and Hedging Activities

Note 7.

Derivatives and Hedging Activities

Derivative Activities

Derivatives are instruments that derive their value from underlying asset prices, indices, reference rates and other inputs, or a combination of these factors. Derivatives may be privately negotiated contracts, which are usually referred to as over-the-counter (OTC) derivatives, or they may be listed and traded on an exchange (exchange-traded).

Market-Making. As a market maker, the firm enters into derivative transactions to provide liquidity and to facilitate the transfer and hedging of risk. In this capacity, the firm typically acts as principal and is consequently required to commit capital to provide execution. As a market maker, it is essential to maintain an inventory of financial instruments sufficient to meet expected client and market demands.

Risk Management. The firm also enters into derivatives to actively manage risk exposures that arise from market-making and investing and lending activities in derivative and cash instruments. The firm’s holdings and exposures are hedged, in many cases, on either a portfolio or risk-specific basis, as opposed to an instrument-by-instrument basis. The offsetting impact of this economic hedging is reflected in the same business segment as the related revenues. In addition, the firm may enter into derivatives designated as hedges under U.S. GAAP. These derivatives are used to manage foreign currency exposure on the net investment in certain non-U.S. operations and to manage interest rate exposure in certain fixed-rate unsecured long-term and short-term borrowings, and certificates of deposit.

The firm enters into various types of derivatives, including:

 

Ÿ  

Futures and Forwards. Contracts that commit counterparties to purchase or sell financial instruments, commodities or currencies in the future.

 

Ÿ  

Swaps. Contracts that require counterparties to exchange cash flows such as currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, financial instruments, commodities, currencies or indices.

 

Ÿ  

Options. Contracts in which the option purchaser has the right, but not the obligation, to purchase from or sell to the option writer financial instruments, commodities or currencies within a defined time period for a specified price.

Derivatives are accounted for at fair value, net of cash collateral received or posted under credit support agreements. Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement. Derivative assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.

Substantially all gains and losses on derivatives not designated as hedges under ASC 815 are included in “Market making” and “Other principal transactions.”

 

 

  Goldman Sachs June 2012 Form 10-Q   25


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the fair value of derivatives on a net-by-counterparty basis.

 

    As of June 2012          As of December 2011  
in millions   Derivative
Assets
     Derivative
Liabilities
          Derivative
Assets
      

Derivative

Liabilities

 

Exchange-traded

  $  4,334        $  3,957             $  5,880           $  3,172   

Over-the-counter

  66,974        48,285             74,148           55,281   

Total

  $71,308        $52,242             $80,028           $58,453   

 

The table below presents the fair value and the number of derivative contracts by major product type on a gross basis. Gross fair values in the table below exclude the effects of both netting under enforceable netting agreements and

netting of cash collateral received or posted under credit support agreements, and therefore are not representative of the firm’s exposure.

 

 

    As of June 2012          As of December 2011  
in millions, except number of contracts  

Derivative

Assets

    

Derivative

Liabilities

     Number of
Contracts
         

Derivative

Assets

    

Derivative

Liabilities

    Number of
Contracts
 

Derivatives not accounted for as hedges

Interest rates

    $ 615,146         $ 573,246         298,856             $ 624,189         $ 582,608        287,351   

Credit

    114,777         98,762         361,895             150,816         130,659        362,407   

Currencies

    73,084         62,940         241,085             88,654         71,736        203,205   

Commodities

    31,640         33,663         84,926             35,966         38,050        93,755   

Equities

    58,406         50,084         303,491             64,135         51,928        332,273   

Subtotal

    893,053         818,695         1,290,253             963,760         874,981        1,278,991   

Derivatives accounted for as hedges

Interest rates

    23,346         73         1,451             21,981         13        1,125   

Currencies

    67         70         73             124         21        71   

Subtotal

    23,413         143         1,524             22,105         34        1,196   

Gross fair value of derivatives

    $ 916,466         $ 818,838         1,291,777             $ 985,865         $ 875,015        1,280,187   

Counterparty netting 1

    (736,148      (736,148                   (787,733      (787,733        

Cash collateral netting 2

    (109,010      (30,448                   (118,104      (28,829        

Fair value included in financial instruments owned

    $   71,308                               $   80,028                    

Fair value included in financial instruments sold,
but not yet purchased

             $   52,242                               $   58,453           

 

1.

Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.

 

2.

Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.

 

26   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques for Derivatives

Price transparency of derivatives can generally be characterized by product type.

Interest Rate. In general, the prices and other inputs used to value interest rate derivatives are transparent, even for long-dated contracts. Interest rate swaps and options denominated in the currencies of leading industrialized nations are characterized by high trading volumes and tight bid/offer spreads. Interest rate derivatives that reference indices, such as an inflation index, or the shape of the yield curve (e.g., 10-year swap rate vs. 2-year swap rate) are more complex, but the prices and other inputs are generally observable.

Credit. Price transparency for credit default swaps, including both single names and baskets of credits, varies by market and underlying reference entity or obligation. Credit default swaps that reference indices, large corporates and major sovereigns generally exhibit the most price transparency. For credit default swaps with other underliers, price transparency varies based on credit rating, the cost of borrowing the underlying reference obligations, and the availability of the underlying reference obligations for delivery upon the default of the issuer. Credit default swaps that reference loans, asset-backed securities and emerging market debt instruments tend to have less price transparency than those that reference corporate bonds. In addition, more complex credit derivatives, such as those sensitive to the correlation between two or more underlying reference obligations, generally have less price transparency.

Currency. Prices for currency derivatives based on the exchange rates of leading industrialized nations, including those with longer tenors, are generally transparent. The primary difference between the price transparency of developed and emerging market currency derivatives is that emerging markets tend to be observable for contracts with shorter tenors.

Commodity. Commodity derivatives include transactions referenced to energy (e.g., oil and natural gas), metals (e.g., precious and base) and soft commodities (e.g., agricultural). Price transparency varies based on the underlying commodity, delivery location, tenor and product quality (e.g., diesel fuel compared to unleaded gasoline). In general, price transparency for commodity derivatives is greater for contracts with shorter tenors and contracts that are more closely aligned with major and/or benchmark commodity indices.

Equity. Price transparency for equity derivatives varies by market and underlier. Options on indices and the common stock of corporates included in major equity indices exhibit the most price transparency. Equity derivatives generally have observable market prices, except for contracts with long tenors or reference prices that differ significantly from current market prices. More complex equity derivatives, such as those sensitive to the correlation between two or more individual stocks, generally have less price transparency.

Liquidity is essential to observability of all product types. If transaction volumes decline, previously transparent prices and other inputs may become unobservable. Conversely, even highly structured products may at times have trading volumes large enough to provide observability of prices and other inputs. See Note 5 for an overview of the firm’s fair value measurement policies.

Level 1 Derivatives

Level 1 derivatives include short-term contracts for future delivery of securities when the underlying security is a level 1 instrument, and exchange-traded derivatives if they are actively traded and are valued at their quoted market price.

Level 2 Derivatives

Level 2 derivatives include exchange-traded derivatives that are not actively traded and OTC derivatives for which all significant valuation inputs are corroborated by market evidence.

Level 2 exchange-traded derivatives are valued using models that calibrate to market-clearing levels of OTC derivatives. Inputs to the valuations of level 2 OTC derivatives can be verified to market transactions, broker or dealer quotations or other alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Where models are used, the selection of a particular model to value an OTC derivative depends on the contractual terms of and specific risks inherent in the instrument, as well as the availability of pricing information in the market. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, model selection does not involve significant management judgment because outputs of models can be calibrated to market-clearing levels.

 

 

  Goldman Sachs June 2012 Form 10-Q   27


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Derivatives

Level 3 OTC derivatives are valued using models which utilize observable level 1 and/or level 2 inputs, as well as unobservable level 3 inputs.

 

Ÿ  

For the majority of the firm’s interest rate and currency derivatives classified within level 3, significant unobservable inputs include correlations of certain currencies and interest rates (e.g., the correlation between Euro inflation and Euro interest rates) and specific interest rate volatilities.

 

Ÿ  

For level 3 credit derivatives, significant level 3 inputs include illiquid credit spreads, which are unique to specific reference obligations and reference entities, recovery rates, certain correlations required to value credit and mortgage derivatives (e.g., the likelihood of default of the underlying reference obligation relative to one another) and the basis, or price difference, of certain reference obligations to benchmark indices.

 

Ÿ  

For level 3 equity derivatives, significant level 3 inputs generally include equity volatility inputs for options that are very long-dated and/or have strike prices that differ significantly from current market prices. In addition, the valuation of certain structured trades requires the use of level 3 inputs for the correlation of the price performance of two or more individual stocks or the correlation of the price performance for a basket of stocks to another asset class such as commodities.

 

Ÿ  

For level 3 commodity derivatives, significant level 3 inputs include volatilities for options with strike prices that differ significantly from current market prices and prices or spreads for certain products for which the product quality or physical location of the commodity is not aligned with benchmark indices.

Subsequent to the initial valuation of a level 3 OTC derivative, the firm updates the level 1 and level 2 inputs to reflect observable market changes and any resulting gains and losses are recorded in level 3. Level 3 inputs are changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data. In circumstances where the firm cannot verify the model value by reference to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. See below for further information about unobservable inputs used in the valuation of level 3 derivatives.

Valuation Adjustments

Valuation adjustments are integral to determining the fair value of derivatives and are used to adjust the mid-market valuations, produced by derivative pricing models, to the appropriate exit price valuation. These adjustments incorporate bid/offer spreads, the cost of liquidity, credit valuation adjustments (CVA) and funding valuation adjustments, which account for the credit and funding risk inherent in derivative portfolios. Market-based inputs are generally used when calibrating valuation adjustments to market-clearing levels.

In addition, for derivatives that include significant unobservable inputs, the firm makes model or exit price adjustments to account for the valuation uncertainty present in the transaction.

 

 

28   Goldman Sachs June 2012 Form 10-Q  


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The table below presents the ranges of significant unobservable inputs used to value the firm’s level 3 derivatives. These ranges represent the significant unobservable inputs that were used in the valuation of each type of derivative. These inputs are not representative of the inputs that could have been used in the valuation of any one derivative. For example, the highest correlation presented

in the table for interest rate derivatives is appropriate for valuing a specific interest rate derivative but may not be appropriate for valuing any other interest rate derivative. Accordingly, the ranges of inputs presented below do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 derivatives.

 

 

Significant

Unobservable Inputs

 

Derivative

Product Type

 

Range of Significant

Unobservable Inputs

as of June 2012

 

Sensitivity of Fair Value Measurement to Changes in Significant

Unobservable Inputs 1

Correlation

 

Interest rates

 

Credit

 

Currencies

 

Equities

 

Various 2

 

14% to 70%

 

5% to 99%

 

65% to 87%

 

49% to 99%

 

(51)% to 66%

 

For contracts where the holder benefits from the convergence of the underlying asset or index prices (e.g., interest rates, credit spreads, foreign exchange rates, inflation rates and equity prices), an increase in correlation generally results in a higher fair value measurement.

Volatility

 

Interest rates

 

Commodities

 

Equities

 

32% to 88%

 

7% to 85%

 

7% to 98%

 

In general, for purchased options an increase in volatility results in a higher fair value measurement.

Credit spreads

 

 

 

Recovery rates

 

 

Basis

 

Credit

 

 

 

Credit

 

 

Credit

 

89 basis points (bps) to 1,975 bps

 

 

0% to 90%

 

 

1 point to 11 points

 

 

In general, the fair value of purchased credit protection increases as credit spreads increase, recovery rates decrease or basis widens.

 

Credit spreads, recovery rates and basis are strongly related to distinctive risk factors of the underlying reference obligations, which include reference entity-specific factors such as leverage, volatility and industry, market-based risk factors, such as borrowing costs or liquidity of the underlying reference obligation and macro-economic conditions.

Spread per million British Thermal units (MMBTU) of natural gas

  Commodities   $(0.83) to $3.52  

For contracts where the holder is receiving a commodity, an increase in the spread (price difference from a benchmark index due to differences in quality or delivery location) or price generally results in a higher fair value measurement.

       

Price per megawatt hour of power

 

  Commodities   $11.93 to $67.91    

 

1.

Represents the directional sensitivity of the firm’s level 3 fair value measurements to changes in significant unobservable inputs, in isolation. Due to the distinctive nature of each of the firm’s level 3 derivatives, the interrelationship of inputs is not necessarily uniform within each product type.

 

2.

Represents correlation across derivative product types.

 

  Goldman Sachs June 2012 Form 10-Q   29


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Derivatives by Level

The tables below present the fair value of derivatives on a gross basis by level and major product type. Gross fair values in the tables below exclude the effects of both netting under enforceable netting agreements and netting of cash

received or posted under credit support agreements both in and across levels of the fair value hierarchy, and therefore are not representative of the firm’s exposure.

 

 

    Derivative Assets at Fair Value as of June 2012  
in millions   Level 1     Level 2     Level 3    

Cross-Level

Netting

    Total  

Interest rates

    $  34        $ 638,196        $     262        $       —        $ 638,492   

Credit

           104,133        10,644               114,777   

Currencies

           71,893        1,258               73,151   

Commodities

           30,832        808               31,640   

Equities

    163        57,113        1,130               58,406