10-Q 1 d513857d10q.htm 10-Q 10-Q
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 March 31, 2013

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 April 26, 2013, there were 458,505,280 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 MARCH 31, 2013

 

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 months ended March 31,  2013 and March 31, 2012

  2
 
 

Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31,  2013 and March 31, 2012

  3
 
 

Condensed Consolidated Statements of Financial Condition as of March 31,  2013 and December 31, 2012

  4
 
 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2013 and year ended December 31, 2012

  5
 
 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31,  2013 and March 31, 2012

  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

  13
 
 

Note 5.        Fair Value Measurements

  14
 
 

Note 6.        Cash Instruments

  16
 
 

Note 7.        Derivatives and Hedging Activities

  25
 
 

Note 8.        Fair Value Option

  41
 
 

Note 9.        Collateralized Agreements and Financings

  50
 
 

Note 10.      Securitization Activities

  56
 
 

Note 11.      Variable Interest Entities

  59
 
 

Note 12.      Other Assets

  64
 
 

Note 13.      Goodwill and Identifiable Intangible Assets

  65
 
 

Note 14.      Deposits

  67
 
 

Note 15.      Short-Term Borrowings

  68
 
 

Note 16.      Long-Term Borrowings

 

69

 
 

Note 17.      Other Liabilities and Accrued Expenses

  72
 
 

Note 18.      Commitments, Contingencies and Guarantees

  73
 
 

Note 19.      Shareholders’ Equity

 

79

 
 

Note 20.      Regulation and Capital Adequacy

  82
 
 

Note 21.      Earnings Per Common Share

  87
 
 

Note 22.      Transactions with Affiliated Funds

 

88

 
 

Note 23.      Interest Income and Interest Expense

 

89

 
 

Note 24.      Income Taxes

 

89

 
 

Note 25.      Business Segments

  90
 
 

Note 26.      Credit Concentrations

  94
 
 

Note 27.      Legal Proceedings

  95
 
 

Report of Independent Registered Public Accounting Firm

  108
 
 

Statistical Disclosures

  109
 

Item 2

 

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

  111
 

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

 

    Goldman Sachs March 2013 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 March

 
in millions, except per share amounts     2013         2012   

Revenues

    

Investment banking

    $  1,568         $1,160   
   

Investment management

    1,250         1,105   
   

Commissions and fees

    829         860   
   

Market making

    3,437         3,905   
   

Other principal transactions

    2,081         1,938   

Total non-interest revenues

    9,165         8,968   
   

 

Interest income

    2,608         2,833   
   

Interest expense

    1,683         1,852   

Net interest income

    925         981   

Net revenues, including net interest income

    10,090         9,949   

 

Operating expenses

    

Compensation and benefits

    4,339         4,378   
   

 

Brokerage, clearing, exchange and distribution fees

    561         567   
   

Market development

    141         117   
   

Communications and technology

    188         196   
   

Depreciation and amortization

    302         433   
   

Occupancy

    218         212   
   

Professional fees

    246         234   
   

Insurance reserves

    127         157   
   

Other expenses

    595         474   

Total non-compensation expenses

    2,378         2,390   

Total operating expenses

    6,717         6,768   

 

Pre-tax earnings

    3,373         3,181   
   

Provision for taxes

    1,113         1,072   

Net earnings

    2,260         2,109   
   

Preferred stock dividends

    72         35   

Net earnings applicable to common shareholders

    $  2,188         $2,074   

 

Earnings per common share

    

Basic

    $    4.53         $  4.05   
   

Diluted

    4.29         3.92   
   

 

Dividends declared per common share

    $    0.50         $  0.35   
   

 

Average common shares outstanding

    

Basic

    482.1         510.8   
   

Diluted

    509.8         529.2   

 

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

 

2   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

   

Three Months

Ended March

 
in millions     2013         2012   

Net earnings

    $2,260         $2,109   
   

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

    

Currency translation adjustment, net of tax

    (26      (28
   

Pension and postretirement liability adjustments, net of tax

    (4      7   
   

Net unrealized gains on available-for-sale securities, net of tax

    15         30   

Other comprehensive income/(loss)

    (15      9   

Comprehensive income

    $2,245         $2,118   

 

 

 

 

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

 

    Goldman Sachs March 2013 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    

 

March

2013

  

  

    

 

December

2012

  

  

Assets

    

Cash and cash equivalents

    $  63,333         $  72,669   
   

Cash and securities segregated for regulatory and other purposes (includes $22,676 and $30,484 at fair value as of March 2013 and December 2012, respectively)

    41,044         49,671   
   

Collateralized agreements:

    

Securities purchased under agreements to resell and federal funds sold (includes $158,283 and $141,331 at fair value as of March 2013 and December 2012, respectively)

    158,506         141,334   
   

Securities borrowed (includes $54,879 and $38,395 at fair value as of March 2013 and December 2012, respectively)

    172,041         136,893   
   

Receivables from brokers, dealers and clearing organizations

    20,501         18,480   
   

Receivables from customers and counterparties (includes $7,154 and $7,866 at fair value as of March 2013 and December 2012, respectively)

    77,917         72,874   
   

Financial instruments owned, at fair value (includes $67,891 and $67,177 pledged as collateral as of March 2013 and December 2012, respectively)

    387,393         407,011   
   

Other assets (includes $13,448 and $13,426 at fair value as of March 2013 and December 2012, respectively)

    38,488         39,623   

Total assets

    $959,223         $938,555   

 

Liabilities and shareholders’ equity

    

Deposits (includes $7,070 and $5,100 at fair value as of March 2013 and December 2012, respectively)

    $  72,685         $  70,124   
   

Collateralized financings:

    

Securities sold under agreements to repurchase, at fair value

    155,356         171,807   
   

Securities loaned (includes $2,423 and $1,558 at fair value as of March 2013 and December 2012, respectively)

    20,669         13,765   
   

Other secured financings (includes $28,482 and $30,337 at fair value as of March 2013 and
December 2012, respectively)

    29,468         32,010   
   

Payables to brokers, dealers and clearing organizations

    6,949         5,283   
   

Payables to customers and counterparties

    196,578         189,202   
   

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

    153,749         126,644   
   

Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $18,298 and $17,595 at fair value as of March 2013 and December 2012, respectively)

    40,980         44,304   
   

Unsecured long-term borrowings (includes $12,248 and $12,593 at fair value as of March 2013 and December 2012, respectively)

    167,008         167,305   
   

Other liabilities and accrued expenses (includes $11,842 and $12,043 at fair value as of March 2013 and December 2012, respectively)

    38,553         42,395   

Total liabilities

    881,995         862,839   
   

 

Commitments, contingencies and guarantees

    

 

Shareholders’ equity

    

Preferred stock, par value $0.01 per share; aggregate liquidation preference of $6,200 as of both March 2013 and December 2012

    6,200         6,200   
   

Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 822,358,425 and 816,807,400 shares issued as of March 2013 and December 2012, respectively, and 460,782,218 and 465,148,387 shares outstanding as of March 2013 and December 2012, respectively

    8         8   
   

Restricted stock units and employee stock options

    3,679         3,298   
   

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

              
   

Additional paid-in capital

    48,732         48,030   
   

Retained earnings

    67,164         65,223   
   

Accumulated other comprehensive loss

    (208      (193
   

Stock held in treasury, at cost, par value $0.01 per share; 361,576,209 and 351,659,015 shares as of March 2013 and December 2012, respectively

    (48,347      (46,850

Total shareholders’ equity

    77,228         75,716   

Total liabilities and shareholders’ equity

    $959,223         $938,555   

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

 

4   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

        Three Months Ended         Year Ended  
in millions        

 

March

2013

  

  

       

 

December

2012

  

  

Preferred stock

       

Balance, beginning of year

      $   6,200          $   3,100   
   

Issued

                   3,100   

Balance, end of period

      6,200          6,200   
   

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

      3,298          5,681   
   

Issuance and amortization of restricted stock units and employee stock options

      1,502          1,368   
   

Delivery of common stock underlying restricted stock units

      (1,099       (3,659
   

Forfeiture of restricted stock units and employee stock options

      (18       (90
   

Exercise of employee stock options

        (4         (2

Balance, end of period

      3,679          3,298   
   

Additional paid-in capital

       

Balance, beginning of year

      48,030          45,553   
   

Delivery of common stock underlying share-based awards

      1,102          3,939   
   

Cancellation of restricted stock units in satisfaction of withholding tax requirements

      (458       (1,437
   

Preferred stock issuance costs

               (13
   

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

      58          (11
   

Cash settlement of share-based compensation

                   (1

Balance, end of period

      48,732          48,030   
   

Retained earnings

       

Balance, beginning of year

      65,223          58,834   
   

Net earnings

      2,260          7,475   
   

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

      (247       (903
   

Dividends declared on preferred stock

        (72         (183

Balance, end of period

      67,164          65,223   
   

Accumulated other comprehensive loss

       

Balance, beginning of year

      (193       (516
   

Other comprehensive income/(loss)

        (15         323   

Balance, end of period

      (208       (193
   

Stock held in treasury, at cost

       

Balance, beginning of year

      (46,850       (42,281
   

Repurchased

      (1,525       (4,637
   

Reissued

      38          77   
   

Other

        (10         (9

Balance, end of period

        (48,347         (46,850

Total shareholders’ equity

        $ 77,228            $ 75,716   

 

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

 

    Goldman Sachs March 2013 Form 10-Q   5


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   

Three Months

Ended March

 
in millions     2013         2012   

Cash flows from operating activities

    

Net earnings

    $   2,260         $   2,109   
   

Adjustments to reconcile net earnings to net cash provided by/(used for) operating activities

    

Depreciation and amortization

    302         433   
   

Share-based compensation

    1,509         643   
   

Changes in operating assets and liabilities

    

Cash and securities segregated for regulatory and other purposes

    8,527         11,165   
   

Net receivables from brokers, dealers and clearing organizations

    (339      (2,671
   

Net payables to customers and counterparties

    3,356         7,290   
   

Securities borrowed, net of securities loaned

    (28,245      (14,813
   

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

    (33,576      15,328   
   

Financial instruments owned, at fair value

    20,028         (22,023
   

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

    27,227         6,304   
   

Other, net

    (6,747      11   

Net cash provided by/(used for) operating activities

    (5,698      3,776   
   

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (171      (390
   

Proceeds from sales of property, leasehold improvements and equipment

    17         13   
   

Business acquisitions, net of cash acquired

    (160      (39
   

Proceeds from sales of investments

    526         130   
   

Purchase of available-for-sale securities

    (501      (653
   

Proceeds from sales of available-for-sale securities

    709         699   
   

Loans held for investment, net

    (1,373      (238

Net cash used for investing activities

    (953      (478
   

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    (435      (869
   

Other secured financings (short-term), net

    (4,824      (483
   

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

    1,829         798   
   

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

    (969      (4,334
   

Proceeds from issuance of unsecured long-term borrowings

    13,069         9,358   
   

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

    (12,530      (11,134
   

Derivative contracts with a financing element, net

    380         208   
   

Deposits, net

    2,562         4,765   
   

Common stock repurchased

    (1,525      (365
   

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

    (319      (220
   

Proceeds from issuance of common stock, including stock option exercises

    14         39   
   

Excess tax benefit related to share-based compensation

    63         70   
   

Cash settlement of share-based compensation

            (1

Net cash used for financing activities

    (2,685      (2,168

Net increase/(decrease) in cash and cash equivalents

    (9,336      1,130   
   

Cash and cash equivalents, beginning of year

    72,669         56,008   

Cash and cash equivalents, end of period

    $ 63,333         $ 57,138   

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $1.96 billion and $4.04 billion during the three months ended March 2013 and March 2012, respectively.

Cash payments for income taxes, net of refunds were $464 million during the three months ended March 2013. Income tax refunds, net of cash payments were $29 million during the three months ended March 2012.

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

 

6   Goldman Sachs March 2013 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 strategic 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, including domestic and cross-border transactions, 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 in and clears client transactions on major stock, options and futures exchanges worldwide and provides financing, securities lending and other 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 and 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, 2012. 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, 2012. The condensed consolidated financial information as of December 31, 2012 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 March 2013 and March 2012 refer to the firm’s periods ended, or the dates, as the context requires, March 31, 2013 and March 31, 2012, respectively. All references to December 2012 refer to the date December 31, 2012. 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 March 2013 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.

 

 

8   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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.

In general, the firm accounts for investments acquired after 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.

 

 

    Goldman Sachs March 2013 Form 10-Q   9


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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.

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, certain transfers of assets accounted for as secured loans rather than purchases at fair value, collateral posted in connection with certain derivative transactions, and loans held for investment. 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. 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.” See Note 8 for further information about receivables from customers and counterparties.

Payables to Customers and Counterparties

Payables to customers and counterparties primarily consist of customer credit balances related to the firm’s prime brokerage activities. Payables to customers and counterparties are accounted for at cost plus accrued interest, which generally approximates fair value. While these payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

Receivables from and Payables to Brokers, Dealers and Clearing Organizations

Receivables from and payables to brokers, dealers and clearing organizations are accounted for at cost plus accrued interest, which generally approximates fair value. While these receivables and payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6, 7 and 8. Had these receivables and payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2013 and December 2012.

 

 

10   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Offsetting Assets and Liabilities

To reduce credit exposures on derivatives and securities financing transactions, the firm may enter into netting agreements with counterparties that permit it to offset receivables and payables with such counterparties. 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) in the condensed consolidated statements of financial condition when a legal right of setoff exists under an enforceable netting arrangement or similar agreement. Resale and repurchase agreements and securities borrowed and loaned transactions with the same term and currency may be presented on a net-by-counterparty basis in the condensed consolidated statements of financial condition when such transactions meet certain settlement criteria and are subject to agreements that provide for rights of setoff upon a termination event.

The firm receives and posts cash and securities collateral with respect to its derivatives, resale and repurchase agreements, and securities borrowed and loaned transactions. Such collateral is subject to the terms of the related credit support agreements. In the condensed consolidated statements of financial condition, derivatives are reported net of cash collateral received and posted under enforceable credit support agreements, when transacted under an enforceable netting agreement. In the condensed consolidated statements of financial condition, resale and repurchase agreements, and securities borrowed and loaned are not reported net of the related cash and securities received or posted as collateral. See Note 9 for further information about collateral received and pledged, including rights to deliver or repledge collateral.

In order to assess enforceability of the firm’s right of setoff under netting and credit support agreements, the firm evaluates various factors including applicable bankruptcy laws, local statutes and regulatory provisions in the jurisdiction of the parties to the agreement. See Notes 7 and 9 for further information about offsetting.

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. See Note 12 for further information about the firm’s reinsurance business classified as held for sale as of March 2013 and December 2012.

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 accounted for as equity instruments. For these awards, whose terms allow for cash settlement, additional paid-in capital is adjusted to the extent of the difference between the value of the award at the time of cash settlement and the grant-date value of the award.

 

 

    Goldman Sachs March 2013 Form 10-Q   11


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 March 2013 and December 2012, “Cash and cash equivalents” included $5.95 billion and $6.75 billion, respectively, of cash and due from banks, and $57.38 billion and $65.92 billion, respectively, of interest-bearing deposits with banks.

Recent Accounting Developments

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 was effective for fiscal years beginning on or after June 15, 2012. The firm applied the provisions of the ASU to such events occurring on or after January 1, 2013. Adoption of ASU No. 2011-10 did not 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, as amended by ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities,” 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 derivative instruments, resale and repurchase agreements, and securities borrowing and lending transactions. ASU No. 2011-11 was effective for periods beginning on or after January 1, 2013. Since these amended principles require only additional disclosures concerning offsetting and related arrangements, adoption did not affect the firm’s financial condition, results of operations or cash flows. See Notes 7 and 9 for further information about the firm’s offsetting and related arrangements.

 

 

12   Goldman Sachs March 2013 Form 10-Q    


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. The firm held $8.90 billion and $9.07 billion as of March 2013 and December 2012, respectively, of securities accounted for as available-for-sale related to the firm’s reinsurance business. As of March 2013 and December 2012, such assets were classified as held for sale and were included in “Other assets.” See Note 12 for further information about assets held for sale.

 

 

 

    As of March 2013         As of December 2012  
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

    $    5,705         $          —          $    6,057         $          —   
   

U.S. government and federal agency obligations

    96,930         25,894          93,241         15,905   
   

Non-U.S. government and agency obligations

    57,657         42,754          62,250         32,361   
   

Mortgage and other asset-backed loans and securities:

           

Loans and securities backed by commercial real estate

    6,909         11          9,805           
   

Loans and securities backed by residential real estate

    7,570         2          8,216         4   
   

Bank loans and bridge loans

    22,467         1,479  3        22,407         1,779  3 
   

Corporate debt securities

    20,442         6,874          20,981         5,761   
   

State and municipal obligations

    2,219         7          2,477         1   
   

Other debt obligations

    2,481                  2,251           
   

Equities and convertible debentures

    89,278         24,381          96,454         20,406   
   

Commodities 1

    7,695                  11,696           
   

Derivatives 2

    68,040         52,347            71,176         50,427   

Total

    $387,393         $153,749            $407,011         $126,644   

 

1.

Includes commodities that have been transferred to third parties, which were accounted for as collateralized financings rather than sales, of $2.77 billion and $4.29 billion as of March 2013 and December 2012, respectively.

 

2.

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

 

3.

Primarily relates to the fair value of unfunded lending commitments for which the fair value option was elected.

 

    Goldman Sachs March 2013 Form 10-Q   13


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 March

 
in millions     2013         2012   

Interest rates

    $(1,141 )       $1,889   
   

Credit

    1,828         1,710   
   

Currencies

    2,460         (724
   

Equities

    1,908         1,973   
   

Commodities

    493         471   
   

Other

    (30 )       524   

Total

    $ 5,518         $5,843   

 

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 (i.e., the spread, or difference, between the interest rate at which a borrower could finance a given financial instrument relative to a benchmark interest rate).

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.

 

 

14   Goldman Sachs March 2013 Form 10-Q    


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 fair value 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    

 

March

2013

  

  

    

 

December

2012

  

  

Total level 1 financial assets

    $175,729         $ 190,737   
   

Total level 2 financial assets

    512,909         502,293   
   

Total level 3 financial assets

    46,023         47,095   
   

Cash collateral and counterparty netting 1

    (90,828 )       (101,612

Total financial assets at fair value

    $643,833         $ 638,513   
   

Total assets

    $959,223         $ 938,555   
   

Total level 3 financial assets as a percentage of Total assets

    4.8 %       5.0
   

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

    7.1 %       7.4
   

 

Total level 1 financial liabilities

    $  90,186         $   65,994   
   

Total level 2 financial liabilities

    304,217         318,764   
   

Total level 3 financial liabilities

    24,759         25,679   
   

Cash collateral and counterparty netting 1

    (29,694 )       (32,760

Total financial liabilities at fair value

    $389,468         $ 377,677   
   

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

    6.4 %       6.8

 

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 March 2013 decreased compared with December 2012, primarily reflecting a decrease in level 3 derivative assets, principally due to unrealized losses on currency derivative assets and settlements of credit derivative assets.

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 and losses, and transfers in and out of level 3.

 

 

    Goldman Sachs March 2013 Form 10-Q   15


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

Note 6. Cash Instruments

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, 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.

 

 

16   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques and Significant Inputs

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 Instruments         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 are generally determined based on relative value analyses and include:

    

 

Ÿ     Transaction prices in both the underlying collateral and instruments with the same or similar underlying collateral and the basis, or price difference, to such prices

    

 

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 generally 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

 

 

Non-U.S. government and

agency obligations

 

Corporate debt securities

 

State and municipal 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 (primarily EBITDA 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

 

 

    Goldman Sachs March 2013 Form 10-Q   17


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The tables below present 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. The ranges and weighted averages of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one cash instrument.

For example, the highest multiple presented in the tables below 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 Instruments

 

  

Level 3 Assets as of   
March 2013   

(in millions)   

 

  

Significant Unobservable Inputs   

by Valuation Technique

 

  

Range of Significant Unobservable
Inputs (Weighted Average 1)

as of March 2013

 

 

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

 

  

 

$3,164

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

3.6% to 27.9% (8.6%)

     

 

Ÿ   Recovery rate 3

  

 

36.0% to 98.3% (71.4%)

     

 

Ÿ   Duration (years) 4

  

 

0.6 to 7.0 (2.9)

       

 

Ÿ   Basis

 

  

 

(19) points to 16 points (3 points)

 

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

  

 

$1,683

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

3.6% to 16.9% (9.1%)

     

 

Ÿ   Cumulative loss rate

  

 

0.0% to 61.8% (29.6%)

       

 

Ÿ   Duration (years) 4

 

  

 

1.4 to 8.7 (3.5)

 

Bank loans and bridge loans

  

 

$11,688

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

0.4% to 36.5% (8.6%)

     

 

Ÿ   Recovery rate 3

  

 

28.1% to 85.0% (59.5%)

       

 

Ÿ   Duration (years) 4

 

  

 

0.4 to 4.6 (2.2)

 

Non-U.S. government and agency obligations

 

Corporate debt securities

 

State and municipal obligations

 

Other debt obligations

  

 

$3,678

  

 

Discounted cash flows:

    
     

 

Ÿ   Yield

  

 

0.5% to 35.3% (7.8%)

     

 

Ÿ   Recovery rate 3

  

 

0.0% to 70.0% (64.9%)

       

 

Ÿ   Duration (years) 4

 

  

 

0.4 to 14.6 (4.0)

 

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

  

 

$15,224 2

  

 

 

Comparable multiples:

    
     

 

Ÿ   Multiples

  

 

0.7x to 25.7x (7.0x)

     

 

Discounted cash flows:

    
     

 

Ÿ   Discount rate

  

 

10.0% to 25.0% (13.9%)

     

 

Ÿ   Long-term growth rate/compound annual growth rate

  

 

0.7% to 25.0% (9.0%)

       

 

Ÿ   Capitalization rate

 

 

  

 

3.3% to 11.4% (6.9%)

 

1.

Weighted averages are calculated by weighting each input by the relative fair value of the respective financial instruments.

 

2.

The fair value of any one instrument may be determined using multiple valuation techniques. For example, market comparables and discounted cash flows may be used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

 

3.

Recovery rate is a measure of expected future cash flows in a default scenario, expressed as a percentage of notional or face value of the instrument, and reflects the benefit of credit enhancement on certain instruments.

 

4.

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).

 

18   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Cash Instruments

 

  

Level 3 Assets as of      December 2012

(in millions)

 

  

Significant Unobservable Inputs   

by Valuation Technique

 

  

Range of Significant Unobservable Inputs (Weighted Average 1)

as of December 2012

 

 

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

  

 

$3,389

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

4.0% to 43.3% (9.8%)

     

Ÿ    Recovery rate 3

 

  

37.0% to 96.2% (81.7%)

     

Ÿ    Duration (years) 4

 

  

0.1 to 7.0 (2.6)

       

Ÿ    Basis

 

  

(13) points to 18 points (2 points)

 

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

  

 

$1,619

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

3.1% to 17.0% (9.7%)

     

Ÿ    Cumulative loss rate

 

  

0.0% to 61.6% (31.6%)

       

Ÿ    Duration (years) 4

 

  

1.3 to 5.9 (3.7)

 

Bank loans and bridge loans

  

 

$11,235

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

0.3% to 34.5% (8.3%)

     

Ÿ    Recovery rate 3

 

  

16.5% to 85.0% (56.0%)

       

Ÿ    Duration (years) 4

 

  

0.2 to 4.4 (1.9)

 

Non-U.S. government and agency obligations

 

Corporate debt securities

 

State and municipal obligations

 

Other debt obligations

  

 

$4,651

  

 

Discounted cash flows:

 

    
     

Ÿ    Yield

 

  

0.6% to 33.7% (8.6%)

     

Ÿ    Recovery rate 3

 

  

0.0% to 70.0% (53.4%)

       

Ÿ    Duration (years) 4

 

  

0.5 to 15.5 (4.0)

 

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

  

 

$14,855 2

  

 

Comparable multiples:

 

    
     

Ÿ    Multiples

 

  

0.7x to 21.0x (7.2x)

     

Discounted cash flows:

 

    
     

Ÿ    Discount rate

 

  

10.0% to 25.0% (14.3%)

     

Ÿ    Long-term growth rate/ compound annual growth rate

 

  

0.7% to 25.0% (9.3%)

 

       

Ÿ    Capitalization rate

 

  

3.9% to 11.4% (7.3%)

 

1.

Weighted averages are calculated by weighting each input by the relative fair value of the respective financial instruments.

 

2.

The fair value of any one instrument may be determined using multiple valuation techniques. For example, market comparables and discounted cash flows may be used together to determine fair value. Therefore, the level 3 balance encompasses both of these techniques.

 

3.

Recovery rate is a measure of expected future cash flows in a default scenario, expressed as a percentage of notional or face value of the instrument, and reflects the benefit of credit enhancement on certain instruments.

 

4.

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, basis, 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 March 2013 Form 10-Q   19


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 March  2013  
in millions     Level 1           Level 2           Level 3           Total   

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

    $    1,294           $    4,411           $       —           $    5,705   
   

U.S. government and federal agency obligations

    46,973           49,957                     96,930   
   

Non-U.S. government and agency obligations

    40,379           17,231           47           57,657   
   

Mortgage and other asset-backed loans and securities 1:

                

Loans and securities backed by commercial real estate

              3,745           3,164           6,909   
   

Loans and securities backed by residential real estate

              5,887           1,683           7,570   
   

Bank loans and bridge loans

              10,779           11,688           22,467   
   

Corporate debt securities 2

    132           17,868           2,442           20,442   
   

State and municipal obligations

              1,885           334           2,219   
   

Other debt obligations 2

              1,626           855           2,481   
   

Equities and convertible debentures

    64,850           9,204           15,224  3         89,278   
   

Commodities

              7,695                     7,695   

Total

    $153,628           $130,288           $35,437           $319,353   
    Cash Instrument Liabilities at Fair Value as of March  2013  
in millions     Level 1           Level 2           Level 3           Total   

U.S. government and federal agency obligations

    $  25,665           $        229           $        —           $  25,894   
   

Non-U.S. government and agency obligations

    41,389           1,365                     42,754   
   

Mortgage and other asset-backed loans and securities:

                

Loans and securities backed by commercial real estate

              11                     11   
   

Loans and securities backed by residential real estate

              2                     2   
   

Bank loans and bridge loans

              1,044           435           1,479   
   

Corporate debt securities

    10           6,862           2           6,874   
   

State and municipal obligations

              7                     7   
   

Equities and convertible debentures

    22,974           1,403           4           24,381   

Total

    $  90,038           $  10,923           $     441           $101,402   

 

1.

Includes $609 million and $452 million of collateralized debt obligations (CDOs) backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $583 million and $1.46 billion of CDOs and collateralized loan obligations (CLOs) backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Includes $13.27 billion of private equity investments, $1.45 billion of investments in real estate entities and $508 million of convertible debentures.

 

20   Goldman Sachs March 2013 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 2012  
in millions     Level 1           Level 2           Level 3           Total   

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

    $    2,155           $    3,902           $        —           $     6,057   
   

U.S. government and federal agency obligations

    42,856           50,385                     93,241   
   

Non-U.S. government and agency obligations

    46,715           15,509           26           62,250   
   

Mortgage and other asset-backed loans and securities 1:

                

Loans and securities backed by commercial real estate

              6,416           3,389           9,805   
   

Loans and securities backed by residential real estate

              6,597           1,619           8,216   
   

Bank loans and bridge loans

              11,172           11,235           22,407   
   

Corporate debt securities 2

    111           18,049           2,821           20,981   
   

State and municipal obligations

              1,858           619           2,477   
   

Other debt obligations 2

              1,066           1,185           2,251   
   

Equities and convertible debentures

    72,875           8,724           14,855  3         96,454   
   

Commodities

              11,696                     11,696   

Total

    $164,712           $135,374           $35,749           $335,835   
    Cash Instrument Liabilities at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3           Total   

U.S. government and federal agency obligations

    $  15,475           $       430           $        —           $  15,905   
   

Non-U.S. government and agency obligations

    31,011           1,350                     32,361   
   

Mortgage and other asset-backed loans and securities:

                

Loans and securities backed by residential real estate

              4                     4   
   

Bank loans and bridge loans

              1,143           636           1,779   
   

Corporate debt securities

    28           5,731           2           5,761   
   

State and municipal obligations

              1                     1   
   

Equities and convertible debentures

    19,416           986           4           20,406   

Total

    $  65,930           $    9,645           $     642           $  76,217   

 

1.

Includes $489 million and $446 million of CDOs backed by real estate in level 2 and level 3, respectively.

 

2.

Includes $284 million and $1.76 billion of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.

 

3.

Includes $12.67 billion of private equity investments, $1.58 billion of investments in real estate entities and $600 million of convertible debentures.

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. During the three months ended March 2013, transfers into level 2 from level 1 of cash instruments were $43 million, reflecting transfers of public equity securities due to less market activity in these securities.

During the three months ended March 2012, transfers into level 2 from level 1 of cash instruments were $728 million, consisting of transfers of public equity investments, primarily reflecting the impact of transfer restrictions. See level 3 rollforwards below for further information about transfers between level 2 and level 3.

 

 

    Goldman Sachs March 2013 Form 10-Q   21


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 March 2013  
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

  
  

  

Non-U.S. government and agency obligations

    $        26         $    3        $    2        $      28        $        (9     $        (1     $        1         $        (3     $        47   
   

Mortgage and other asset-backed loans and securities:

                   

Loans and securities backed by commercial real estate

    3,389         36        91        50        (249     (277     318         (194     3,164   
   

Loans and securities backed by residential real estate

    1,619         38        25        268        (172     (56     104         (143     1,683   
   

Bank loans and bridge loans

    11,235         153        97        1,460        (543     (1,361     1,688         (1,041     11,688   
   

Corporate debt securities

    2,821         116        157        301        (728     (141     116         (200     2,442   
   

State and municipal obligations

    619         2        1        19        (269     (1             (37     334   
   

Other debt obligations

    1,185         19        21        192        (210     (201     61         (212     855   
   

Equities and convertible debentures

    14,855         70        481        185        (378     (543     1,000         (446     15,224   

Total

    $35,749         $437  2      $875  2      $2,503        $(2,558     $(2,581     $3,288         $(2,276     $35,437   
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 2013  
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

    $     642         $   (4     $ (11     $  (147     $       97        $         3        $     22         $    (161     $     441   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $317 million, $687 million and $308 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain on level 3 cash instruments of $886 million (reflecting $875 million on cash instrument assets and $11 million on cash instrument liabilities) for the three months ended March 2013 primarily consisted of gains on private equity investments, corporate debt securities and mortgage and other asset-backed loans and securities. Unrealized gains during the three months ended March 2013 primarily reflected the impact of an increase in equity prices and generally tighter credit spreads.

Transfers into level 3 during the three months ended March 2013 primarily reflected transfers of certain bank loans and bridge loans and private equity investments from level 2, principally due to a lack of market transactions in these instruments.

Transfers out of level 3 during the three months ended March 2013 primarily reflected transfers of certain bank loans and bridge loans and private equity investments to level 2. Transfers of bank loans and bridge loans to level 2 were principally due to market transactions in certain loans and unobservable inputs no longer being significant to the valuation of other loans. Transfers of private equity investments to level 2 were principally due to market transactions in these instruments.

 

 

22   Goldman Sachs March 2013 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 Three Months Ended March 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        $       —        $        —        $      —         $        —        $          8   
   

Non-U.S. government and agency obligations

     148         (1     (59     7        (8            20         (2     105   
   

Mortgage and other asset-backed
loans and securities:

                    

Loans and securities backed by commercial real estate

     3,346         39        96        295        (276     (289     486         (541     3,156   
   

Loans and securities backed by residential real estate

     1,709         43        23        254        (181     (101     14         (151     1,610   
   

Bank loans and bridge loans

     11,285         150        206        1,188        (1,246     (792     960         (700     11,051   
   

Corporate debt securities

     2,480         92        158        295        (422     (128     260         (223     2,512   
   

State and municipal obligations

     599         2        8        20        (39     (2     25         (1     612   
   

Other debt obligations

     1,451         44        24        99        (120     (56     123         (16     1,549   
   

Equities and convertible debentures

     13,667         39        332        558        (150     (194     779         (157     14,874   

Total

     $34,685         $408  2      $788  2      $2,724        $(2,442     $(1,562     $2,667         $(1,791     $35,477   
     Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 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         $ (34     $ (68     $  (326     $       87        $     195        $    102         $    (114     $      747   

 

1.

Includes both originations and secondary market purchases.

 

2.

The aggregate amounts include approximately $167 million, $654 million and $375 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

 

The net unrealized gain on level 3 cash instruments of $856 million (reflecting $788 million on cash instrument assets and $68 million on cash instrument liabilities) for the three months ended March 2012 primarily consisted of gains on private equity investments, bank loans and bridge loans, and corporate debt securities, primarily reflecting an increase in global equity prices and tighter credit spreads.

Transfers into level 3 during the three months ended March 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 reduced transparency of market prices as a result of less market activity in these instruments.

Transfers out of level 3 during the three months ended March 2012 primarily reflected transfers to level 2 of certain bank and bridge loans, and loans and securities backed by commercial real estate, principally due to improved transparency of market prices as a result of market activity in these instruments.

 

 

    Goldman Sachs March 2013 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, credit 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 seven 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. Since March 2012, the firm has redeemed approximately $1.32 billion of these interests in hedge funds, including approximately $260 million during the three months ended March 2013.

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

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
Fair Value of
Investments
  
  
    
 
Unfunded
Commitments
  
  
       
 
Fair Value of
Investments
  
  
    
 
Unfunded
Commitments
  
  

Private equity funds 1

    $  7,183         $2,453          $  7,680         $2,778   
   

Credit funds 2

    3,976         2,884          3,927         2,843   
   

Hedge funds 3

    2,339                  2,167           
   

Real estate funds 4

    2,058         868            2,006         870   

Total

    $15,556         $6,205            $15,780         $6,491   

 

1.

These funds primarily invest in a broad range of industries worldwide in a variety of situations, including leveraged buyouts, recapitalizations, growth investments and distressed 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 March 2013 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 traded on an exchange (exchange-traded) or they may be privately negotiated contracts, which are usually referred to as over-the-counter (OTC) derivatives. Certain of the firm’s OTC derivatives are cleared and settled through central clearing counterparties (OTC-cleared), while others are bilateral contracts between two counterparties (bilateral OTC).

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 deposits.

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 enforceable 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.”

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

 

 

 

    As of March 2013         As of December 2012  
in millions    
 
Derivative
Assets
  
  
      
 
Derivative
Liabilities
  
  
       
 
Derivative
Assets
  
  
      
 
Derivative
Liabilities
  
  

Exchange-traded

    $  4,455           $  3,581          $  3,772           $  2,937   
   

OTC

    63,585           48,766            67,404           47,490   

Total

    $68,040           $52,347            $71,176           $50,427   

 

    Goldman Sachs March 2013 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 and the notional amount of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting and collateral, and therefore are not representative of the firm’s exposure. OTC derivatives that are cleared with certain clearing organizations are reflected as settled each day. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the condensed consolidated statements of financial condition, as well as cash and securities collateral

posted and received under enforceable credit support agreements that do not meet the criteria for netting under U.S. GAAP. Where the firm has received or posted collateral under credit support agreements, but has not yet determined such agreements are enforceable, the related collateral has not been netted in the table below. Notional amounts, which represent the sum of gross long and short derivative contracts, provide an indication of the volume of the firm’s derivative activity, and do not represent anticipated losses.

 

 

 

    As of March 2013         As of December 2012  
in millions    

 

Derivative

Assets

  

  

   

 

Derivative

Liabilities

  

  

   

 

Notional

Amount

  

  

       

 

Derivative

Assets

  

  

   

 

Derivative

Liabilities

  

  

   

 

Notional

Amount

  

  

Derivatives not accounted for as hedges

             

Interest rates

    $ 518,022        $ 482,433        $36,083,019          $ 584,584        $ 545,605        $34,891,763   
   

Exchange-traded

    86        70        2,621,038          47        26        2,502,867   
   

OTC-cleared

    14,700        15,837        16,298,152          8,847        11,011        14,678,349   
   

Bilateral OTC

    503,236        466,526        17,163,829          575,690        534,568        17,710,547   
   

Credit

    81,669        72,495        3,632,242          85,816        74,927        3,615,757   
   

OTC-cleared

    3,595        3,348        323,457          3,359        2,638        304,100   
   

Bilateral OTC

    78,074        69,147        3,308,785          82,457        72,289        3,311,657   
   

Currencies

    69,534        62,197        4,053,493          72,128        60,808        3,833,114   
   

Exchange-traded

    45        68        13,815          31        82        12,341   
   

OTC-cleared

    31        20        8,723          14        14        5,487   
   

Bilateral OTC

    69,458        62,109        4,030,955          72,083        60,712        3,815,286   
   

Commodities

    22,246        21,752        819,726          23,320        24,350        774,115   
   

Exchange-traded

    5,491        4,640        396,230          5,360        5,040        344,823   
   

OTC-cleared

    31        40        874          26        23        327   
   

Bilateral OTC

    16,724        17,072        422,622          17,934        19,287        428,965   
   

Equities

    51,672        48,082        1,339,285          49,483        43,681        1,202,181   
   

Exchange-traded

    9,636        9,606        495,994          9,409        8,864        441,494   
   

Bilateral OTC

    42,036        38,476        843,291            40,074        34,817        760,687   

Subtotal

    743,143        686,959        45,927,765            815,331        749,371        44,316,930   

Derivatives accounted for as hedges

             

Interest rates

    20,825        180        132,886          23,772        66        128,302   
   

OTC-cleared

    9               66                          
   

Bilateral OTC

    20,816        180        132,820          23,772        66        128,302   
   

Currencies

    37        39        8,427          21        86        8,452   
   

OTC-cleared

                  84                        3   
   

Bilateral OTC

    37        39        8,343            21        86        8,449   

Subtotal

    20,862        219        141,313            23,793        152        136,754   

Gross fair value/notional amount of derivatives

    $ 764,005  1      $ 687,178  1      $46,069,078            $ 839,124  1      $ 749,523  1      $44,453,684   

Amounts that have been offset in the condensed consolidated statements of financial condition

             

Counterparty netting

    (607,096     (607,096         (668,460     (668,460  
   

Exchange-traded

    (10,803     (10,803         (11,075     (11,075  
   

OTC-cleared

    (17,146     (17,146         (11,507     (11,507  
   

Bilateral OTC

    (579,147     (579,147         (645,878     (645,878  
   

Cash collateral

    (88,869     (27,735         (99,488     (30,636  
   

OTC-cleared

    (335     (2,028         (468     (2,160  
   

Bilateral OTC

    (88,534     (25,707                 (99,020     (28,476        

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

    $   68,040        $   52,347                    $   71,176        $   50,427           

Amounts that have not been offset in the condensed consolidated statements of financial condition

             

Cash collateral received/posted

    (937     (3,706         (812     (2,994  
   

Securities collateral received/posted

    (16,172     (14,384                 (17,225     (14,262        

Total

    $   50,931        $   34,257                    $   53,139        $   33,171           

 

1.

Includes derivative assets and derivative liabilities of $25.43 billion and $27.30 billion, respectively, as of March 2013, and derivative assets and derivative liabilities of $24.62 billion and $25.73 billion, respectively, as of December 2012, which are not subject to an enforceable netting agreement or are subject to a netting agreement that the firm has not yet determined to be enforceable.

 

26   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation Techniques for Derivatives

The firm’s level 2 and level 3 derivatives are valued using derivative pricing models (e.g., models that incorporate option pricing methodologies, Monte Carlo simulations and discounted cash flows). 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 OTC derivatives for which all significant valuation inputs are corroborated by market evidence and exchange-traded derivatives that are not actively traded and/or that are valued using models that calibrate to market-clearing levels of OTC derivatives.

The selection of a particular model to value a 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. For 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 March 2013 Form 10-Q   27


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Valuation models require a variety of inputs, such as contractual terms, market prices, yield curves, discount rates (including those derived from interest rates on collateral received and posted as specified in credit support agreements for collateralized derivatives), credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. Inputs to the valuations of level 2 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.

Level 3 Derivatives

Level 3 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 unobservable inputs include illiquid credit spreads, which are unique to specific reference obligations and reference entities, recovery rates and certain correlations required to value credit and mortgage derivatives (e.g., the likelihood of default of the underlying reference obligation relative to one another).

 

Ÿ  

For level 3 equity derivatives, significant unobservable 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 correlation inputs, such as 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 unobservable 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 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 significant unobservable inputs used in the valuation of level 3 derivatives.

Valuation Adjustments

Valuation adjustments are integral to determining the fair value of derivative portfolios 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 the uncollateralized portion of 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 March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The tables below present 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. The ranges, averages and medians of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one derivative.

For example, the highest correlation presented in the tables below 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.

 

 

 

Level 3 Derivative
Product Type
 

Net Level 3 Assets/(Liabilities)     

as of March 2013     

(in millions)     

  Significant Unobservable Inputs
of Derivative Pricing Models
 

Range of Significant Unobservable

Inputs (Average / Median) 1

as of March 2013

 

Interest rates

 

 

$(305)

 

 

Correlation 2

 

Volatility

 

 

22% to 84% (64% / 65%)

 

37 basis points per annum (bpa) to 59 bpa (48 bpa / 47 bpa)

 

 

 

 

Credit

 

 

$5,882

 

 

Correlation 2

 

Credit spreads

 

Recovery rates

 

 

5% to 96% (52% / 50%)

 

3 bps to 6,149 bps

(319 bps / 136 bps) 3

 

20% to 88% (53% / 50%)

 

 

Currencies

 

 

$(289)

 

 

Correlation 2

 

 

 

 

65% to 84% (75% / 77%)

 

Commodities

 

 

$(27)

 

 

Volatility

 

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

 

Price per megawatt hour of power

 

Price per barrel of oil

 

 

 

9% to 56% (23% / 23%)

 

$(0.71) to $3.80 ($(0.02) / $(0.01))

 

 

$17.26 to $60.18 ($36.21 / $35.82)

 

$88.68 to $103.73 ($94.06 / $94.31)

 

Equities

 

 

$(1,135)

 

 

Correlation 2

 

Volatility

 

 

 

29% to 98% (55% / 53%)

 

9% to 67% (27% / 25%)

 

1.

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average.

 

2.

The range of unobservable inputs for correlation across derivative product types (i.e., cross-asset correlation) was (58)% to 82% (Average: 24% / Median: 33%) as of March 2013.

 

3.

The difference between the average and the median for the credit spreads input indicates that the majority of the inputs fall in the lower end of the range.

 

    Goldman Sachs March 2013 Form 10-Q   29


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Derivative
Product Type
 

Net Level 3 Assets/(Liabilities)     

as of December 2012     

(in millions)     

  Significant Unobservable Inputs of
Derivative Pricing Models
 

Range of Significant Unobservable

Inputs (Average / Median) 1

as of December 2012

 

Interest rates

 

 

$(355)

 

 

Correlation 2

 

Volatility

 

 

 

 

 

22% to 97% (67% / 68%)

 

37 bpa to 59 bpa (48 bpa / 47 bpa)

 

Credit

 

 

$6,228

 

 

Correlation 2

 

Credit spreads

 

 

Recovery rates

 

 

 

5% to 95% (50% / 50%)

 

9 bps to 2,341 bps

(225 bps / 140 bps) 3

 

15% to 85% (54% / 53%)

 

Currencies

 

 

$35

 

 

Correlation 2

 

 

 

 

65% to 87% (76% / 79%)

 

Commodities

 

 

$(304)

 

 

Volatility

 

Spread per MMBTU of natural gas

 

Price per megawatt hour of power

 

Price per barrel of oil

 

 

 

13% to 53% (30% / 29%)

 

$(0.61) to $6.07 ($0.02 / $0.00)

 

$17.30 to $57.39 ($33.17 / $32.80)

 

$86.64 to $98.43 ($92.76 / $93.62)

 

Equities

 

 

$(1,248)

 

 

Correlation 2

 

Volatility

 

 

 

48% to 98% (68% / 67%)

 

15% to 73% (31% / 30%)

 

1.

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average.

 

2.

The range of unobservable inputs for correlation across derivative product types (i.e., cross-asset correlation) was (51)% to 66% (Average: 30% / Median: 35%) as of December 2012.

 

3.

The difference between the average and the median for the credit spreads input indicates that the majority of the inputs fall in the lower end of the range.

 

30   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Range of Significant Unobservable Inputs

The following provides further information about the ranges of significant unobservable inputs used to value the firm’s level 3 derivative instruments.

 

Ÿ  

Correlation: Ranges for correlation cover a variety of underliers both within one market (e.g., equity index and equity single stock names) and across markets (e.g., correlation of a commodity price and a foreign exchange rate), as well as across regions. Generally, cross-asset correlation inputs are used to value more complex instruments and are lower than correlation inputs on assets within the same derivative product type.

 

Ÿ  

Volatility: Ranges for volatility cover numerous underliers across a variety of markets, maturities and strike prices. For example, volatility of equity indices is generally lower than volatility of single stocks.

 

Ÿ  

Credit spreads and recovery rates: The ranges for credit spreads and recovery rates cover a variety of underliers (index and single names), regions, sectors, maturities and credit qualities (high-yield and investment-grade). The broad range of this population gives rise to the width of the ranges of significant unobservable inputs.

 

Ÿ  

Commodity prices and spreads: The ranges for commodity prices and spreads cover variability in products, maturities and locations, as well as peak and off-peak prices.

Sensitivity of Fair Value Measurement to Changes in Significant Unobservable Inputs

The following provides a description of 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.

 

Ÿ  

Correlation: In general, 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 results in a higher fair value measurement.

 

Ÿ  

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

 

Ÿ  

Credit spreads and recovery rates: In general, the fair value of purchased credit protection increases as credit spreads increase or recovery rates decrease. Credit spreads and recovery rates 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.

 

Ÿ  

Commodity prices and spreads: In general, 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 results in a higher fair value measurement.

 

 

    Goldman Sachs March 2013 Form 10-Q   31


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 exclude the effects of both counterparty

netting and collateral, and therefore are not representative of the firm’s exposure.

 

 

 

    Derivative Assets at Fair Value as of March 2013  
in millions     Level 1           Level 2           Level 3          
 
Cross-Level
Netting
  
  
       Total   

Interest rates

    $  26           $ 538,655           $     166           $       —           $  538,847   
   

Credit

              71,039           10,630                     81,669   
   

Currencies

              68,953           618                     69,571   
   

Commodities

              21,765           481                     22,246   
   

Equities

    28           51,062           582                     51,672   

Gross fair value of derivative assets

    54           751,474           12,477                     764,005   
   

Counterparty netting 1

              (601,944        (3,193        (1,959 ) 3         (607,096

Subtotal

    $  54           $ 149,530           $  9,284           $(1,959        $  156,909   
   

Cash collateral 2

                                                (88,869

Fair value included in financial instruments owned

                                                $    68,040   
    Derivative Liabilities at Fair Value as of March 2013  
in millions     Level 1           Level 2           Level 3          

 

Cross-Level

Netting

  

  

       Total   

Interest rates

    $  29           $ 482,113           $     471           $       —           $  482,613   
   

Credit

              67,747           4,748                     72,495   
   

Currencies

              61,329           907                     62,236   
   

Commodities

              21,244           508                     21,752   
   

Equities

    119           46,246           1,717                     48,082   

Gross fair value of derivative liabilities

    148           678,679           8,351                     687,178   
   

Counterparty netting 1

              (601,944        (3,193        (1,959 ) 3         (607,096

Subtotal

    $148           $   76,735           $  5,158           $(1,959        $    80,082   
   

Cash collateral 2

                                                (27,735

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

                                                $    52,347   

 

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 enforceable credit support agreements.

 

3.

Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.

 

32   Goldman Sachs March 2013 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Derivative Assets at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3          
 
Cross-Level
Netting
  
  
       Total   

Interest rates

    $13           $ 608,151           $     192           $       —           $ 608,356   
   

Credit

              74,907           10,909                     85,816   
   

Currencies

              71,157           992                     72,149   
   

Commodities

              22,697           623                     23,320   
   

Equities

    43           48,698           742                     49,483   

Gross fair value of derivative assets

    56           825,610           13,458                     839,124   
   

Counterparty netting 1

              (662,798        (3,538        (2,124 ) 3         (668,460

Subtotal

    $56           $ 162,812           $ 9,920           $(2,124        $ 170,664   
   

Cash collateral 2

                                                (99,488

Fair value included in financial instruments owned

                                                $   71,176   
    Derivative Liabilities at Fair Value as of December 2012  
in millions     Level 1           Level 2           Level 3          

 

Cross-Level

Netting

  

  

       Total   

Interest rates

    $14           $ 545,110           $     547           $       —           $ 545,671   
   

Credit

              70,246           4,681                     74,927   
   

Currencies

              59,937           957                     60,894   
   

Commodities

              23,423           927                     24,350   
   

Equities

    50           41,641           1,990                     43,681   

Gross fair value of derivative liabilities

    64           740,357           9,102                     749,523   
   

Counterparty netting 1

              (662,798        (3,538        (2,124 ) 3         (668,460

Subtotal

    $64           $   77,559           $ 5,564           $(2,124        $   81,063   
   

Cash collateral 2

                                                (30,636

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

                                                $   50,427   

 

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 enforceable credit support agreements.

 

3.

Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.

 

    Goldman Sachs March 2013 Form 10-Q   33


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

If a derivative was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3. Transfers between levels are reported at the beginning of the reporting period in which they occur. In the tables below, negative amounts for transfers into level 3 and positive amounts for transfers out of level 3 represent net transfers of derivative liabilities.

Gains and losses on level 3 derivatives should be considered in the context of the following:

 

Ÿ  

A derivative with level 1 and/or level 2 inputs is classified in level 3 in its entirety if it has at least one significant level 3 input.

 

Ÿ  

If there is one significant level 3 input, the entire gain or loss from adjusting only observable inputs (i.e., level 1 and level 2 inputs) is classified as level 3.

Ÿ  

Gains or losses that have been reported in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to level 1 or level 2 derivatives and/or level 1, level 2 and level 3 cash instruments. As a result, gains/(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 derivatives categorized as level 3 as of the end of the period.

 

 

 

    Level 3 Derivative Assets and Liabilities at Fair Value for the Three Months Ended March 2013  
in millions    

 
 
 
 

Asset/

(liability)
balance,
beginning
of period

  

  
  
  
  

   

 
 
 

Net

realized
gains/
(losses)

  

  
  
  

   
 
 
 
 
 
Net unrealized
gains/(losses)
relating to
instruments
still held at
period-end
  
  
  
  
  
  
    Purchases         Sales        Settlements       
 

 

Transfers
into

level 3

  
  

  

   

 

 

Transfers

out of

level 3

  

  

  

   

 

 
 

 

Asset/

(liability)

balance,
end of

period

  

  

  
  

  

Interest rates — net

    $   (355     $  (6     $   30        $    5         $    —        $   51