10-Q 1 y71546e10vq.htm FORM 10-Q FORM 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 August 29, 2008
 
or
     
o
  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.)
     
85 Broad Street, New York, NY   10004
(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  o  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 o
 
Non-accelerated filer o (Do not check if a smaller reporting company)  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     o  Yes  x  No
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
As of September 26, 2008, there were 395,441,815 shares of the registrant’s common stock outstanding.
 


 

 
THE GOLDMAN SACHS GROUP, INC.
 
QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED AUGUST 29, 2008
 
INDEX
 
             
    Page
Form 10-Q Item Number:
 
No.
 
           
         
           
         
        2  
        3  
        4  
        5  
        6  
        7  
        63  
           
      64  
           
      122  
           
      122  
           
         
           
      123  
           
      125  
           
      126  
       
    127  
 EX-4.2: FORM OF WARRANT TO PURCHASE SHARES OF COMMON STOCK
 EX-10.1: SECURITIES PURCHASE AGREEMENT
 EX-10.2: GENERAL GUARANTEE AGREEMENT
 EX-12.1: STATEMENT RE: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND RATIOS OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
 EX-15.1: LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION
 EX-31.1: RULE 13A-14(A) CERTIFICATIONS
 EX-32.1: SECTION 1350 CERTIFICATIONS


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PART I: FINANCIAL INFORMATION
 
Item 1:   Financial Statements (Unaudited)
 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
    (in millions, except per share amounts)
 
Revenues
                               
Investment banking
  $ 1,294     $ 2,145     $ 4,145     $ 5,581  
Trading and principal investments
    2,440       7,576       12,556       22,891  
Asset management and securities services
    1,174       1,272       3,736       3,512  
Interest income
    8,717       12,810       29,460       34,450  
                                 
Total revenues
    13,625       23,803       49,897       66,434  
                                 
Interest expense
    7,582       11,469       26,097       31,188  
                                 
Revenues, net of interest expense
    6,043       12,334       23,800       35,246  
                                 
Operating expenses
                               
Compensation and benefits
    2,901       5,920       11,424       16,918  
                                 
Brokerage, clearing, exchange and distribution fees
    734       795       2,265       1,984  
Market development
    119       148       389       424  
Communications and technology
    192       169       571       481  
Depreciation and amortization
    251       145       604       417  
Amortization of identifiable intangible assets
    49       53       170       154  
Occupancy
    237       218       707       632  
Professional fees
    168       188       531       510  
Other expenses
    432       439       1,204       1,177  
                                 
Total non-compensation expenses
    2,182       2,155       6,441       5,779  
                                 
Total operating expenses
    5,083       8,075       17,865       22,697  
                                 
                                 
Pre-tax earnings
    960       4,259       5,935       12,549  
Provision for taxes
    115       1,405       1,492       4,165  
                                 
Net earnings
    845       2,854       4,443       8,384  
Preferred stock dividends
    35       48       115       143  
                                 
Net earnings applicable to common shareholders
  $ 810     $ 2,806     $ 4,328     $ 8,241  
                                 
Earnings per common share
                               
Basic
  $ 1.89     $ 6.54     $ 10.08     $ 18.89  
Diluted
    1.81       6.13       9.62       17.75  
                                 
Dividends declared and paid per common share
  $ 0.35     $ 0.35     $ 1.05     $ 1.05  
                                 
Average common shares outstanding
                               
Basic
    427.6       429.0       429.3       436.2  
Diluted
    448.3       457.4       449.7       464.3  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
                 
    As of
    August
  November
    2008   2007
    (in millions, except share
    and per share amounts)
Assets
               
Cash and cash equivalents
  $ 12,160     $ 11,882  
Cash and securities segregated for regulatory and other purposes (includes $79,191 and $94,018 at fair value as of August 2008 and November 2007, respectively)
    99,430       119,939  
Receivables from brokers, dealers and clearing organizations
    21,038       19,078  
Receivables from customers and counterparties (includes $1,866 and $1,950 at fair value as of August 2008 and November 2007, respectively)
    83,187       129,105  
Collateralized agreements:
               
Securities borrowed (includes $88,617 and $83,277 at fair value as of August 2008 and November 2007, respectively)
    302,676       277,413  
Financial instruments purchased under agreements to resell, at fair value
    135,415       85,717  
                 
Financial instruments owned, at fair value
    362,779       406,457  
Financial instruments owned and pledged as collateral, at fair value
    37,341       46,138  
                 
Total financial instruments owned, at fair value
    400,120       452,595  
Other assets
    27,747       24,067  
                 
Total assets
  $ 1,081,773     $ 1,119,796  
                 
                 
Liabilities and shareholders’ equity
               
Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $32,275 and $48,331 at fair value as of August 2008 and November 2007, respectively)
  $ 64,653     $ 71,557  
Bank deposits (includes $655 and $463 at fair value as of August 2008 and November 2007, respectively)
    29,051       15,370  
Payables to brokers, dealers and clearing organizations
    12,115       8,335  
Payables to customers and counterparties
    346,073       310,118  
Collateralized financings:
               
Securities loaned (includes $9,255 and $5,449 at fair value as of August 2008 and November 2007, respectively)
    29,424       28,624  
Financial instruments sold under agreements to repurchase, at fair value
    110,204       159,178  
Other secured financings (includes $24,208 and $33,581 at fair value as of August 2008 and November 2007, respectively)
    52,821       65,710  
Financial instruments sold, but not yet purchased, at fair value
    186,441       215,023  
Other liabilities and accrued expenses (includes $1,343 at fair value as of August 2008)
    29,025       38,907  
                 
Unsecured long-term borrowings (includes $21,493 and $15,928 at fair value as of August 2008 and November 2007, respectively)
    176,367       164,174  
                 
Total liabilities
    1,036,174       1,076,996  
                 
Commitments, contingencies and guarantees
               
                 
Shareholders’ equity
               
Preferred stock, par value $0.01 per share; 150,000,000 shares authorized, 124,000 shares issued and outstanding as of both August 2008 and November 2007, with liquidation preference of $25,000 per share
    3,100       3,100  
Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 632,949,974 and 618,707,032 shares issued as of August 2008 and November 2007, respectively, and 394,533,477 and 390,682,013 shares outstanding as of August 2008 and November 2007, respectively
    6       6  
Restricted stock units and employee stock options
    8,936       9,302  
Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding
           
Additional paid-in capital
    23,597       22,027  
Retained earnings
    42,301       38,642  
Accumulated other comprehensive income/(loss)
    (165 )     (118 )
Common stock held in treasury, at cost, par value $0.01 per share; 238,416,497 and 228,025,019 shares as of August 2008 and November 2007, respectively
    (32,176 )     (30,159 )
                 
Total shareholders’ equity
    45,599       42,800  
                 
Total liabilities and shareholders’ equity
  $ 1,081,773     $ 1,119,796  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
 
                 
    Period Ended
    August
  November
    2008   2007
    (in millions, except
    per share amounts)
 
Preferred stock
               
Balance, beginning of year
  $ 3,100     $ 3,100  
Issued
           
                 
Balance, end of period
    3,100       3,100  
Common stock, par value $0.01 per share
               
Balance, beginning of year
    6       6  
Issued
           
                 
Balance, end of period
    6       6  
Restricted stock units and employee stock options
               
Balance, beginning of year
    9,302       6,290  
Issuance and amortization of restricted stock units and employee stock options
    1,822       4,684  
Delivery of common stock underlying restricted stock units
    (1,998 )     (1,548 )
Forfeiture of restricted stock units and employee stock options
    (187 )     (113 )
Exercise of employee stock options
    (3 )     (11 )
                 
Balance, end of period
    8,936       9,302  
Additional paid-in capital
               
Balance, beginning of year
    22,027       19,731  
Issuance of common stock, including the delivery of common stock underlying restricted stock units and proceeds from the exercise of employee stock options
    2,242       2,338  
Cancellation of restricted stock units in satisfaction of withholding tax requirements
    (1,314 )     (929 )
Stock purchase contract fee related to automatic preferred enhanced capital securities
          (20 )
Excess net tax benefit related to share-based compensation
    642       908  
Cash settlement of share-based compensation
          (1 )
                 
Balance, end of period
    23,597       22,027  
Retained earnings
               
Balance, beginning of year, as previously reported
    38,642       27,868  
Cumulative effect of adjustment from adoption of FIN 48
    (201 )      
Cumulative effect of adjustment from adoption of SFAS No. 157, net of tax
          51  
Cumulative effect of adjustment from adoption of SFAS No. 159, net of tax
          (45 )
                 
Balance, beginning of year, after cumulative effect of adjustments
    38,441       27,874  
Net earnings
    4,443       11,599  
Dividends and dividend equivalents declared on common stock and restricted stock units
    (468 )     (639 )
Dividends declared on preferred stock
    (115 )     (192 )
                 
Balance, end of period
    42,301       38,642  
Accumulated other comprehensive income/(loss)
               
Balance, beginning of year
    (118 )     21  
Adjustment from adoption of SFAS No. 158, net of tax
          (194 )
Currency translation adjustment, net of tax
    (37 )     39  
Pension and postretirement liability adjustment, net of tax
    9       38  
Net gains/(losses) on cash flow hedges, net of tax
          (2 )
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (19 )     (12 )
Reclassification to retained earnings from adoption of SFAS No. 159, net of tax
          (8 )
                 
Balance, end of period
    (165 )     (118 )
Common stock held in treasury, at cost
               
Balance, beginning of year
    (30,159 )     (21,230 )
Repurchased
    (2,035 )     (8,956 )
Reissued
    18       27  
                 
Balance, end of period
    (32,176 )     (30,159 )
                 
Total shareholders’ equity
  $ 45,599     $ 42,800  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
 
                 
    Nine Months
    Ended August
    2008   2007
    (in millions)
 
Cash flows from operating activities
               
Net earnings
  $ 4,443     $ 8,384  
Non-cash items included in net earnings
               
Depreciation and amortization
    876       636  
Amortization of identifiable intangible assets
    170       200  
Share-based compensation
    1,195       1,038  
Changes in operating assets and liabilities
               
Cash and securities segregated for regulatory and other purposes
    20,715       (16,767 )
Net receivables from brokers, dealers and clearing organizations
    1,820       (2,076 )
Net payables to customers and counterparties
    82,244       22,721  
Securities borrowed, net of securities loaned
    (24,463 )     (46,307 )
Financial instruments sold under agreements to repurchase, net of financial instruments purchased under agreements to resell
    (98,672 )     14,393  
Financial instruments owned, at fair value
    37,946       (92,725 )
Financial instruments sold, but not yet purchased, at fair value
    (28,582 )     39,345  
Other, net
    (8,296 )     6,929  
                 
Net cash used for operating activities
    (10,604 )     (64,229 )
Cash flows from investing activities
               
Purchase of property, leasehold improvements and equipment
    (1,529 )     (1,483 )
Proceeds from sales of property, leasehold improvements and equipment
    70       55  
Business acquisitions, net of cash acquired
    (2,517 )     (1,385 )
Proceeds from sales of investments
    384       2,783  
Purchase of available-for-sale securities
    (3,240 )     (675 )
Proceeds from sales of available-for-sale securities
    2,825       628  
                 
Net cash used for investing activities
    (4,007 )     (77 )
Cash flows from financing activities
               
Unsecured short-term borrowings, net
    (10,061 )     12,548  
Other secured financings (short-term), net
    (5,545 )     9,355  
Proceeds from issuance of other secured financings (long-term)
    9,870       21,391  
Repayment of other secured financings (long-term), including the current portion
    (9,343 )     (6,372 )
Proceeds from issuance of unsecured long-term borrowings
    37,143       43,945  
Repayment of unsecured long-term borrowings, including the current portion
    (19,190 )     (11,785 )
Derivative contracts with a financing element, net
    73       3,887  
Bank deposits, net
    13,681       3,389  
Common stock repurchased
    (2,032 )     (6,269 )
Dividends and dividend equivalents paid on common stock, preferred stock and restricted stock units
    (587 )     (624 )
Proceeds from issuance of common stock
    261       530  
Excess tax benefit related to share-based compensation
    619       674  
Cash settlement of share-based compensation
          (1 )
                 
Net cash provided by financing activities
    14,889       70,668  
Net increase/(decrease) in cash and cash equivalents
    278       6,362  
Cash and cash equivalents, beginning of year
    11,882       6,293  
                 
Cash and cash equivalents, end of period
  $ 12,160     $ 12,655  
                 
 
SUPPLEMENTAL DISCLOSURES:
 
Cash payments for interest, net of capitalized interest, were $26.13 billion and $30.47 billion during the nine months ended August 2008 and August 2007, respectively.
 
Cash payments for income taxes, net of refunds, were $2.46 billion and $4.45 billion during the nine months ended August 2008 and August 2007, respectively.
 
Non-cash activities:
The firm assumed $610 million and $137 million of debt in connection with business acquisitions during the nine months ended August 2008 and August 2007, respectively. The firm issued $17 million of common stock in connection with business acquisitions for the nine months ended August 2007.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
    (in millions)
 
Net earnings
  $ 845     $ 2,854     $ 4,443     $ 8,384  
Currency translation adjustment, net of tax
    (25 )     10       (37 )     30  
Pension and postretirement liability adjustment, net of tax
    3             9        
Net gains/(losses) on cash flow hedges, net of tax
                      (2 )
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (7 )     (3 )     (19 )     (11 )
                                 
Comprehensive income
  $ 816     $ 2,861     $ 4,396     $ 8,401  
                                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
(UNAUDITED)
 
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 services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. On September 21, 2008, Group Inc. became a bank holding company regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the U.S. Bank Holding Company Act of 1956. See Note 16 for further information.
 
The firm’s activities are divided into three segments:
 
  •  Investment Banking.  The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals.
 
  •  Trading and Principal Investments.  The firm facilitates client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, the firm engages in market-making and specialist activities on equities and options exchanges and clears client transactions on major stock, options and futures exchanges worldwide. In connection with the firm’s merchant banking and other investing activities, the firm makes principal investments directly and through funds that the firm raises and manages.
 
  •  Asset Management and Securities Services.  The firm provides investment advisory and financial planning 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 group of institutions and individuals worldwide and provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.
 
Note 2.   Significant Accounting Policies
 
Basis of Presentation
 
These condensed consolidated financial statements include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. All material intercompany transactions and balances have been eliminated.
 
The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity, a variable interest entity (VIE) or a qualifying special-purpose entity (QSPE) under generally accepted accounting principles.
 
  •  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 obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. Voting interest entities are consolidated in accordance with Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” as amended. The usual condition for a controlling financial interest in an entity is ownership of a majority voting interest. Accordingly, the firm consolidates voting interest entities in which it has a majority voting interest.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
  •  Variable Interest Entities.  VIEs are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. In accordance with Financial Accounting Standards Board (FASB) Interpretation (FIN) 46-R, “Consolidation of Variable Interest Entities,” the firm consolidates VIEs for which it is the primary beneficiary. The firm determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE’s expected losses and expected residual returns. This analysis includes a review of, among other factors, the VIE’s capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE. Where qualitative analysis is not conclusive, the firm performs a quantitative analysis. For purposes of allocating a VIE’s expected losses and expected residual returns to its variable interest holders, the firm utilizes the “top down” method. Under that method, the firm calculates its share of the VIE’s expected losses and expected residual returns using the specific cash flows that would be allocated to it, based on contractual arrangements and/or the firm’s position in the capital structure of the VIE, under various probability-weighted scenarios. The firm reassesses its initial evaluation of an entity as a VIE and its initial determination of whether the firm is the primary beneficiary of a VIE upon the occurrence of certain reconsideration events as defined in FIN 46-R.
 
  •  QSPEs.  QSPEs are passive entities that are commonly used in mortgage and other securitization transactions. Statement of Financial Accounting Standards (SFAS) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” sets forth the criteria an entity must satisfy to be a QSPE. These criteria include the types of assets a QSPE may hold, limits on asset sales, the use of derivatives and financial guarantees, and the level of discretion a servicer may exercise in attempting to collect receivables. These criteria may require management to make judgments about complex matters, such as whether a derivative is considered passive and the level of discretion a servicer may exercise, including, for example, determining when default is reasonably foreseeable. In accordance with SFAS No. 140 and FIN 46-R, the firm does not consolidate QSPEs.
 
  •  Equity-Method Investments.  When the firm does not have a controlling financial interest in an entity but exerts significant influence over the entity’s operating and financial policies (generally defined as owning a voting interest of 20% to 50%) and has an investment in common stock or in-substance common stock, the firm accounts for its investment either in accordance with Accounting Principles Board Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” or at fair value in accordance with SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” In general, the firm accounts for investments acquired subsequent to the adoption of SFAS No. 159 at fair value. In certain cases, the firm may apply the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, where the firm has a significant degree of involvement in the cash flows or operations of the investee, or where cost-benefit considerations are less significant. See “— Revenue Recognition — Other Financial Assets and Financial Liabilities at Fair Value” below for a discussion of the firm’s application of SFAS No. 159.
 
  •  Other.  If the firm does not consolidate an entity or apply the equity method of accounting, the firm accounts for its investment at fair value. The firm also has formed numerous nonconsolidated investment funds with third-party investors that are typically organized as


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
  limited partnerships. The firm acts as general partner for these funds and generally does not hold a majority of the economic interests in these funds. The firm has generally provided the third-party investors with rights to terminate the funds or to remove the firm as the general partner. As a result, the firm does not consolidate these funds. These fund investments are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.
 
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 fiscal year ended November 30, 2007. The condensed consolidated financial information as of November 30, 2007 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.
 
Unless specifically stated otherwise, all references to August 2008, May 2008 and August 2007 refer to the firm’s fiscal periods ended, or the dates, as the context requires, August 29, 2008, May 30, 2008 and August 31, 2007, respectively. All references to November 2007, unless specifically stated otherwise, refer to the firm’s fiscal year ended, or the date, as the context requires, November 30, 2007. All references to 2008, unless specifically stated otherwise, refer to the firm’s fiscal year ending, or the date, as the context requires, November 28, 2008. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
 
Use of Estimates
 
These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles that require management to make certain estimates and assumptions. The most important of these estimates and assumptions relate to fair value measurements, the accounting for goodwill and identifiable intangible assets and the provision for potential losses that may arise from litigation and regulatory proceedings and tax audits. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.
 
Revenue Recognition
 
Investment Banking.  Underwriting revenues and fees from mergers and acquisitions and other financial advisory assignments are recognized in the condensed consolidated statements of earnings when the services related to the underlying transaction are completed under the terms of the engagement. Expenses associated with such transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. Underwriting revenues are presented net of related expenses. Expenses associated with financial advisory transactions are recorded as non-compensation expenses, net of client reimbursements.
 
Financial Instruments.  “Total financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value” are reflected in the condensed consolidated statements of financial condition on a trade-date basis. Related unrealized gains or losses are generally recognized in “Trading and principal investments” in the condensed consolidated statements of earnings. The fair value of a financial instrument is the amount that would be received to sell an


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Instruments that the firm owns (long positions) are marked to bid prices, and instruments that the firm has sold, but not yet purchased (short positions), are marked to offer prices. Fair value measurements do not include transaction costs.
 
SFAS No. 157, “Fair Value Measurements,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Basis of Fair Value Measurement
 
  Level 1   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
 
  Level 2   Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;
 
  Level 3   Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
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.
 
In determining fair value, the firm separates its “Financial instruments owned, at fair value” and its “Financial instruments sold, but not yet purchased, at fair value” into two categories: cash instruments and derivative contracts.
 
  •  Cash Instruments.  The firm’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include most U.S. government and sovereign obligations, active listed equities and certain money market securities. Such instruments are generally classified within level 1 of the fair value hierarchy. The firm does not adjust the quoted price for such instruments, even in situations where the firm holds a large position and a sale could reasonably impact the quoted price.
 
The types of instruments that trade in markets that are not considered to be active, but are valued based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most government agency securities, investment-grade corporate bonds, certain mortgage products, certain bank loans and bridge loans, less liquid listed equities, state, municipal and provincial obligations, most physical commodities and certain money market securities and loan commitments. Such instruments are generally classified within level 2 of the fair value hierarchy.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Certain cash instruments are classified within level 3 of the fair value hierarchy because they trade infrequently and therefore have little or no price transparency. Such instruments include private equity and real estate fund investments, certain bank loans and bridge loans (including certain mezzanine financing, leveraged loans arising from capital market transactions and other corporate bank debt), less liquid corporate debt securities and other debt obligations (including less liquid high-yield corporate bonds, distressed debt instruments and collateralized debt obligations (CDOs) backed by corporate obligations), less liquid mortgage whole loans and securities (backed by either commercial or residential real estate), and acquired portfolios of distressed loans. The transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. This valuation is adjusted only when changes to inputs and assumptions are corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows.
 
For positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
  •  Derivative Contracts.  Derivative contracts can be exchange-traded or over-the-counter (OTC). Exchange-traded derivatives typically fall within level 1 or level 2 of the fair value hierarchy depending on whether they are deemed to be actively traded or not. The firm generally values exchange-traded derivatives within portfolios using models which calibrate to market-clearing levels and eliminate timing differences between the closing price of the exchange-traded derivatives and their underlying instruments. In such cases, exchange-traded derivatives are classified within level 2 of the fair value hierarchy.
 
OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. The firm generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be verified and model selection does not involve significant management judgment. OTC derivatives are classified within level 2 of the fair value hierarchy when all of the significant inputs can be corroborated to market evidence.
 
Certain OTC derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. Such instruments are classified within level 3 of the fair value hierarchy. Where the firm does not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. The valuations of these less


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
liquid OTC derivatives are typically based on level 1 and/or level 2 inputs that can be observed in the market, as well as unobservable level 3 inputs. Subsequent to initial recognition, the firm updates the level 1 and level 2 inputs to reflect observable market changes, with resulting gains and losses reflected within level 3. Level 3 inputs are only 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 to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value.
 
When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
Other Financial Assets and Financial Liabilities at Fair Value.  The firm has elected to account for certain of the firm’s other financial assets and financial liabilities at fair value under SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140,” or SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (i.e., the fair value option). The primary reasons for electing the fair value option are mitigating volatility in earnings from using different measurement attributes, simplification and cost-benefit considerations.
 
Such financial assets and financial liabilities accounted for at fair value include (i) certain unsecured short-term borrowings, consisting of all promissory notes and commercial paper and certain hybrid financial instruments; (ii) certain other secured financings, primarily transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings; (iii) certain unsecured long-term borrowings, including prepaid physical commodity transactions; (iv) resale and repurchase agreements; (v) securities borrowed and loaned within Trading and Principal Investments, consisting of the firm’s matched book and certain firm financing activities; (vi) corporate loans, loan commitments and certain certificates of deposit issued by Goldman Sachs Bank USA (GS Bank USA) as well as securities held by GS Bank USA (which would otherwise be accounted for as available-for-sale); (vii) receivables from customers and counterparties arising from transfers accounted for as secured loans rather than purchases under SFAS No. 140; (viii) certain insurance and reinsurance contracts; and (ix) in general, investments acquired after the adoption of SFAS No. 159 where the firm has significant influence over the investee and would otherwise apply the equity method of accounting.
 
Collateralized Agreements and Financings.  Collateralized agreements consist of resale agreements and securities borrowed. Collateralized financings consist of repurchase agreements, securities loaned and other secured financings. Interest on collateralized agreements and collateralized financings is recognized in “Interest income” and “Interest expense,” respectively, over the life of the transaction.
 
  •  Resale and Repurchase Agreements.  Financial instruments purchased under agreements to resell and financial instruments sold under agreements to repurchase, principally U.S. government, federal agency and investment-grade sovereign obligations, represent collateralized financing transactions. The firm receives financial instruments purchased under agreements to resell, makes delivery of financial instruments sold under agreements to repurchase, monitors the market value of these financial instruments on a daily basis and delivers or obtains additional collateral as appropriate. As noted above, resale and repurchase agreements are carried in the condensed consolidated statements of financial condition at fair value under SFAS No. 159. Resale and repurchase agreements are generally valued based on


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
  inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy. Resale and repurchase agreements are presented on a net-by-counterparty basis when the requirements of FIN 41, “Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements,” or FIN 39, “Offsetting of Amounts Related to Certain Contracts,” are satisfied.
 
  •  Securities Borrowed and Loaned.  Securities borrowed and loaned are generally collateralized by cash, securities or letters of credit. The firm receives securities borrowed, makes delivery of securities loaned, monitors the market value of securities borrowed and loaned, and delivers or obtains additional collateral as appropriate. Securities borrowed and loaned within Securities Services, relating to both customer activities and, to a lesser extent, certain firm financing activities, are recorded based on the amount of cash collateral advanced or received plus accrued interest. As these arrangements generally can be terminated on-demand, they exhibit little, if any, sensitivity to changes in interest rates. As noted above, securities borrowed and loaned within Trading and Principal Investments, which are related to the firm’s matched book and certain firm financing activities, are recorded at fair value under SFAS No. 159. These securities borrowed and loaned transactions are generally valued based on inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy.
 
  •  Other Secured Financings.  In addition to repurchase agreements and securities loaned, the firm funds assets through the use of other secured financing arrangements and pledges financial instruments and other assets as collateral in these transactions. As noted above, the firm has elected to apply SFAS No. 159 to transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings, for which the use of fair value eliminates non-economic volatility in earnings that would arise from using different measurement attributes. These other secured financing transactions are generally valued based on inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy. Other secured financings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest. See Note 3 for further information regarding other secured financings.
 
Hybrid Financial Instruments.  Hybrid financial instruments are instruments that contain bifurcatable embedded derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and do not require settlement by physical delivery of non-financial assets (e.g., physical commodities). If the firm elects to bifurcate the embedded derivative, it is accounted for at fair value and the host contract is accounted for at amortized cost, adjusted for the effective portion of any fair value hedge accounting relationships. If the firm does not elect to bifurcate, the entire hybrid financial instrument is accounted for at fair value under SFAS No. 155. See Notes 3 and 4 for additional information about hybrid financial instruments.
 
Transfers of Financial Assets.  In general, transfers of financial assets are accounted for as sales under SFAS No. 140 when the firm has relinquished control over the transferred assets. For transfers accounted for as sales, any related gains or losses are recognized in net revenues. Transfers that are not accounted for as sales are accounted for as collateralized financings, with the related interest expense recognized in net revenues over the life of the transaction.
 
Commissions.  Commission revenues from executing and clearing client transactions on stock, options and futures markets are recognized in “Trading and principal investments” in the condensed consolidated statements of earnings on a trade-date basis.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Insurance Activities.  Certain of the firm’s insurance and reinsurance contracts are accounted for at fair value under SFAS No. 159, with changes in fair value included in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
Revenues from variable annuity and life insurance and reinsurance contracts not accounted for at fair value under SFAS No. 159 generally consist of fees assessed on contract holder account balances for mortality charges, policy administration and surrender charges, and are recognized within “Trading and principal investments” in the condensed consolidated statements of earnings in the period that services are provided.
 
Interest credited to variable annuity and life insurance and reinsurance contracts account balances and changes in reserves are recognized in “Other expenses” in the condensed consolidated statements of earnings.
 
Premiums earned for underwriting property catastrophe reinsurance are recognized within “Trading and principal investments” in the condensed consolidated statements of earnings over the coverage period, net of premiums ceded for the cost of reinsurance. Expenses for liabilities related to property catastrophe reinsurance claims, including estimates of losses that have been incurred but not reported, are recognized within “Other expenses” in the condensed consolidated statements of earnings.
 
Merchant Banking Overrides.  The firm is entitled to receive merchant banking overrides (i.e., an increased share of a fund’s income and gains) when the return on the funds’ investments exceeds certain threshold returns. Overrides are based on investment performance over the life of each merchant banking fund, and future investment underperformance may require amounts of override previously distributed to the firm to be returned to the funds. Accordingly, overrides are recognized in the condensed consolidated statements of earnings only when all material contingencies have been resolved. Overrides are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
Asset Management.  Management fees are recognized over the period that the related service is provided based upon average net asset values. In certain circumstances, the firm is also entitled to receive incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds specified benchmark returns or other performance targets. Incentive fees are generally based on investment performance over a 12-month period and are subject to adjustment prior to the end of the measurement period. Accordingly, incentive fees are recognized in the condensed consolidated statements of earnings when the measurement period ends. Asset management fees and incentive fees are included in “Asset management and securities services” in the condensed consolidated statements of earnings.
 
Share-Based Compensation
 
The firm accounts for share-based compensation in accordance with SFAS No. 123-R, “Share-Based Payment.” 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 employee 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 adopted SFAS No. 123-R under the modified prospective adoption method. Under that method of adoption, the provisions of SFAS No. 123-R are generally applied only to share-based awards granted subsequent to adoption. Share-based awards


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R must continue to be amortized over the stated service period of the award (and accelerated if the employee actually retires).
 
The firm pays cash dividend equivalents on outstanding restricted stock units. Dividend equivalents paid on restricted stock units are generally charged to retained earnings. Dividend equivalents paid on restricted stock units expected to be forfeited are included in compensation expense. The tax benefit related to dividend equivalents paid on restricted stock units is accounted for as a reduction of income tax expense. See “— Recent Accounting Developments” for a discussion of Emerging Issues Task Force (EITF) Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.”
 
In certain cases, primarily related to the death of an employee or conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards. For awards accounted for as equity instruments, “Additional paid-in capital” is adjusted to the extent of the difference between the current value of the award and the grant-date value of the award.
 
Goodwill
 
Goodwill is the cost of acquired companies in excess of the fair value of identifiable net assets at acquisition date. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is tested at least annually for impairment. An impairment loss is recognized if the estimated fair value of an operating segment, which is a component one level below the firm’s three business segments, is less than its estimated net book value. Such loss is calculated as the difference between the estimated fair value of goodwill and its carrying value.
 
Identifiable Intangible Assets
 
Identifiable intangible assets, which consist primarily of customer lists, specialist rights and the value of business acquired (VOBA) and deferred acquisition costs (DAC) in the firm’s insurance subsidiaries, are amortized over their estimated lives in accordance with SFAS No. 142 or, in the case of insurance contracts, in accordance with SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” and SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” Identifiable intangible assets are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS No. 60 and SFAS No. 97. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
 
Property, Leasehold Improvements and Equipment
 
Property, leasehold improvements and equipment, net of accumulated depreciation and amortization, are included in “Other assets” in the condensed consolidated statements of financial condition.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Substantially all property and equipment are depreciated on a straight-line basis over the useful life of the asset. Leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter. Certain costs of software developed or obtained for internal use are capitalized and amortized on a straight-line basis over the useful life of the software.
 
Property, leasehold improvements and equipment are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the expected undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
 
The firm’s operating leases include space held in excess of current requirements. Rent expense relating to space held for growth is included in “Occupancy” in the condensed consolidated statements of earnings. In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” the firm records a liability, based on the fair value of the remaining lease rentals reduced by any potential or existing sublease rentals, for leases where the firm has ceased using the space and management has concluded that the firm will not derive any future economic benefits. Costs to terminate a lease before the end of its term are recognized and measured at fair value upon termination.
 
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 statement of financial condition, and revenues and expenses are translated at average rates of exchange for the period. 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. The firm seeks to reduce its net investment exposure to fluctuations in foreign exchange rates through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts, hedge effectiveness is assessed based on changes in forward exchange rates; accordingly, forward points are reflected as a component of the currency translation adjustment in the condensed consolidated statements of comprehensive income. For foreign currency-denominated debt, hedge effectiveness is assessed based on changes in spot rates. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are included in the condensed consolidated statements of earnings.
 
Income Taxes
 
Deferred tax assets and liabilities are recognized for temporary differences between the financial reporting and tax bases of the firm’s assets and liabilities. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. The firm’s tax assets and liabilities are presented as a component of “Other assets” and “Other liabilities and accrued expenses,” respectively, in the condensed consolidated statements of financial condition. Tax provisions are computed in accordance with SFAS No. 109, “Accounting for Income Taxes.”


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The firm adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” as of December 1, 2007, and recorded a transition adjustment resulting in a reduction of $201 million to beginning retained earnings. See Note 13 for further information regarding the firm’s adoption of FIN 48. A tax position can be recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized upon settlement. A liability is established for differences between positions taken in a tax return and amounts recognized in the financial statements. FIN 48 also provides guidance on derecognition, classification, interim period accounting and accounting for interest and penalties. Prior to the adoption of FIN 48, contingent liabilities related to income taxes were recorded when the criteria for loss recognition under SFAS No. 5, “Accounting for Contingencies,” as amended, had been met.
 
Earnings Per Common Share (EPS)
 
Basic EPS is calculated by dividing net earnings applicable to common shareholders by the weighted average number of common shares outstanding. Common shares outstanding includes common stock and restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable pursuant to stock options and to restricted stock units for which future service is required as a condition to the delivery of the underlying common stock.
 
Cash and Cash Equivalents
 
The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business.
 
Recent Accounting Developments
 
EITF Issue No. 06-11.  In June 2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF Issue No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units, which are expected to vest, be recorded as an increase to additional paid-in capital. The firm currently accounts for this tax benefit as a reduction to income tax expense. EITF Issue No. 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007, and the firm expects to adopt the provisions of EITF Issue No. 06-11 beginning in the first quarter of 2009. The firm does not expect the adoption of EITF Issue No. 06-11 to have a material effect on its financial condition, results of operations or cash flows.
 
FASB Staff Position FAS No. 140-3.  In February 2008, the FASB issued FASB Staff Position (FSP) FAS No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” FSP FAS No. 140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS No. 140 unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. FSP FAS No. 140-3 is effective for fiscal years beginning after November 15, 2008, and will be applied to new transactions entered into after the date of adoption. Early adoption is prohibited. The firm is currently evaluating the impact of adopting FSP FAS No. 140-3 on its financial condition and cash flows. Adoption of FSP FAS No. 140-3 will have no effect on the firm’s results of operations.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
SFAS No. 161.  In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, and is effective for financial statements issued for reporting periods beginning after November 15, 2008, with early application encouraged. Since SFAS No. 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS No. 161 will not affect the firm’s financial condition, results of operations or cash flows.
 
FASB Staff Position EITF No. 03-6-1.  In June 2008, the FASB issued FSP EITF No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, “Earnings per Share.” The FSP requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. The FSP is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The firm does not expect adoption of FSP EITF No. 03-6-1 to have a material effect on its results of operations or earnings per share.
 
FASB Staff Position FAS No. 133-1 and FIN 45-4.  In September 2008, the FASB issued FSP FAS No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” FSP FAS No. 133-1 and FIN 45-4 requires enhanced disclosures about credit derivatives and guarantees and amends FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” to exclude derivative instruments accounted for at fair value under SFAS No. 133. The FSP is effective for financial statements issued for reporting periods ending after November 15, 2008. Since FSP FAS No. 133-1 and FIN 45-4 only requires additional disclosures concerning credit derivatives and guarantees, adoption of FSP FAS No. 133-1 and FIN 45-4 will not affect the firm’s financial condition, results of operations or cash flows.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 3.   Financial Instruments
 
Fair Value of Financial Instruments
 
The following table sets forth 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. At any point in time, the firm may use cash instruments as well as derivatives to manage a long or short risk position.
 
                                 
    As of
    August 2008   November 2007
   
Assets
 
Liabilities
 
Assets
 
Liabilities
        (in millions)    
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 17,405  (1)   $     $ 8,985  (1)   $  
U.S. government, federal agency and sovereign obligations
    81,232       43,811       70,774       58,637  
Mortgage and other asset-backed loans and securities
    29,540       254       54,073  (6)      
Bank loans and bridge loans
    29,045       2,012  (4)     49,154       3,563  (4)
Corporate debt securities and
other debt obligations
    32,683       6,886       39,219       8,280  
Equities and convertible debentures
    87,278       29,380       122,205       45,130  
Physical commodities
    1,374       194       2,571       35  
Derivative contracts
    121,563  (2)     103,904  (5)     105,614  (2)     99,378  (5)
                                 
Total
  $ 400,120  (3)   $ 186,441     $ 452,595  (3)   $ 215,023  
                                 
 
 
(1) Includes $4.90 billion and $6.17 billion as of August 2008 and November 2007, respectively, of money market instruments held by William Street Funding Corporation (Funding Corp.) to support the William Street credit extension program. See Note 6 for further information regarding the William Street program.
 
(2) Net of cash received pursuant to credit support agreements of $98.78 billion and $59.05 billion as of August 2008 and November 2007, respectively.
 
(3) Includes $1.63 billion and $1.17 billion as of August 2008 and November 2007, respectively, of securities held within the firm’s insurance subsidiaries which are accounted for as available-for-sale under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”
 
(4) Includes the fair value of commitments to extend credit.
 
(5) Net of cash paid pursuant to credit support agreements of $26.26 billion and $27.76 billion as of August 2008 and November 2007, respectively.
 
(6) Includes $7.64 billion as of November 2007, of mortgage whole loans that were transferred to securitization vehicles where such transfers were accounted for as secured financings rather than sales under SFAS No. 140. The firm distributed to investors the securities that were issued by the securitization vehicles and therefore did not bear economic exposure to the underlying mortgage whole loans.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Fair Value Hierarchy
 
The firm’s financial assets at fair value classified within level 3 of the fair value hierarchy are summarized below:
 
                         
    As of
    August
  May
  November
    2008   2008   2007
    ($ in millions)
 
Total level 3 assets
  $ 67,868     $ 78,088     $ 69,151  
Level 3 assets for which the firm bears economic exposure (1)
    58,270       67,341       54,714  
                         
Total assets
    1,081,773       1,088,145       1,119,796  
Total financial assets at fair value
    705,209       676,123       717,557  
                         
Total level 3 assets as a percentage of Total assets
    6 %     7 %     6 %
Level 3 assets for which the firm bears economic exposure as a percentage of Total assets
    5       6       5  
                         
Total level 3 assets as a percentage of Total financial assets at fair value
    10       12       10  
Level 3 assets for which the firm bears economic exposure as a percentage of Total financial assets at fair value
    8       10       8  
 
 
(1) Excludes assets which are financed by nonrecourse debt, attributable to minority investors or attributable to employee interests in certain consolidated funds.
 
The following tables set forth by level within the fair value hierarchy “Financial instruments owned, at fair value,” “Financial instruments sold, but not yet purchased, at fair value” and other financial assets and financial liabilities accounted for at fair value under SFAS No. 155 and SFAS No. 159 as of August 2008 and November 2007. See Note 2 for further information on the fair value hierarchy. As required by SFAS No. 157, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Assets at Fair Value as of August 2008
                Netting and
   
   
Level 1
 
Level 2
 
Level 3
 
Collateral
 
Total
    (in millions)
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 5,965     $ 11,440     $     $     $ 17,405  
U.S. government, federal agency and sovereign obligations
    41,439       39,793                   81,232  
Mortgage and other asset-backed loans and securities
          11,325       18,215             29,540  
Bank loans and bridge loans
          18,089       10,956             29,045  
Corporate debt securities and
other debt obligations
    212       25,004       7,467             32,683  
Equities and convertible debentures
    45,571       24,222       17,485   (6)           87,278  
Physical commodities
          1,374                   1,374  
                                         
Cash instruments
    93,187       131,247       54,123             278,557  
Derivative contracts
    34       208,783       13,745       (100,999 (7)     121,563  
                                         
Financial instruments owned, at fair value
    93,221       340,030       67,868       (100,999 )     400,120  
Securities segregated for regulatory
and other purposes
    22,743  (4)     56,448  (5)                 79,191  
Receivables from customers and counterparties (1)
          1,866                   1,866  
Securities borrowed (2)
          88,617                   88,617  
Financial instruments purchased under agreements to resell, at fair value
          135,415                   135,415  
                                         
Total assets at fair value
  $ 115,964     $ 622,376     $ 67,868     $ (100,999 )   $ 705,209  
                                         
Level 3 assets for which the firm does not bear economic exposure (3)
                    (9,598 )                
                                         
Level 3 assets for which the firm bears economic exposure
                  $ 58,270                  
                                         
 
 
(1)  Principally consists of transfers accounted for as secured loans rather than purchases under SFAS No. 140 and prepaid variable share forwards.
 
(2)  Reflects securities borrowed within Trading and Principal Investments. Excludes securities borrowed within Securities Services, which are accounted for based on the amount of cash collateral advanced plus accrued interest.
 
(3)  Consists of level 3 assets which are financed by nonrecourse debt, attributable to minority investors or attributable to employee interests in certain consolidated funds.
 
(4)  Consists of U.S. Treasury securities and money market instruments as well as insurance separate account assets measured at fair value under AICPA SOP 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.”
 
(5)  Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
(6)  Consists of private equity and real estate fund investments.
 
(7)  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.
 


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Liabilities at Fair Value as of August 2008
                Netting and
   
   
Level 1
 
Level 2
 
Level 3
 
Collateral
 
Total
    (in millions)
U.S. government, federal agency
and sovereign obligations
  $ 43,012     $ 799     $     $     $ 43,811  
Mortgage and other asset-backed loans and securities
          235       19             254  
Bank loans and bridge loans
          1,757       255             2,012  
Corporate debt securities and other debt obligations
          6,574       312             6,886  
Equities and convertible debentures
    28,722       647       11             29,380  
Physical commodities
          194                   194  
                                         
Cash instruments
    71,734       10,206       597             82,537  
Derivative contracts
    54       123,622       8,706       (28,478 (8)     103,904  
                                         
Financial instruments sold, but not yet purchased, at fair value
    71,788       133,828       9,303       (28,478 )     186,441  
Unsecured short-term borrowings (1)
          27,524       4,751             32,275  
Bank deposits (2)
          655                   655  
Securities loaned (3)
          9,255                   9,255  
Financial instruments sold under agreements to repurchase, at fair value
          110,204                   110,204  
Other secured financings (4)
          19,842       4,366             24,208  
Other liabilities and accrued expenses (5)
                1,343             1,343  
Unsecured long-term borrowings (6)
          19,575       1,918             21,493  
                                         
Total liabilities at fair value
  $ 71,788     $ 320,883     $ 21,681  (7)   $ (28,478 )   $ 385,874  
                                         
 
 
(1)  Consists of promissory notes, commercial paper and hybrid financial instruments.
 
(2)  Consists of certain certificates of deposit issued by GS Bank USA.
 
(3)  Reflects securities loaned within Trading and Principal Investments. Excludes securities loaned within Securities Services, which are accounted for based on the amount of cash collateral received plus accrued interest.
 
(4)  Primarily includes transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings.
 
(5)  Consists of liabilities related to insurance contracts.
 
(6)  Primarily includes hybrid financial instruments and prepaid physical commodity transactions.
 
(7)  Level 3 liabilities were 6% of Total liabilities at fair value.
 
(8)  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Assets at Fair Value as of November 2007
                Netting and
   
   
Level 1
 
Level 2
 
Level 3
 
Collateral
 
Total
    (in millions)
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 6,237     $ 2,748     $     $     $ 8,985  
U.S. government, federal agency and sovereign obligations
    37,966       32,808                   70,774  
Mortgage and other asset-backed loans and securities
          38,073       16,000             54,073  
Bank loans and bridge loans
          35,820       13,334             49,154  
Corporate debt securities and other debt obligations
    915       32,193       6,111             39,219  
Equities and convertible debentures
    68,727       35,472       18,006   (6)           122,205  
Physical commodities
          2,571                   2,571  
                                         
Cash instruments
    113,845       179,685       53,451             346,981  
Derivative contracts
    286       153,065       15,700       (63,437 (7)     105,614  
                                         
Financial instruments owned, at fair value
    114,131       332,750       69,151       (63,437 )     452,595  
Securities segregated for regulatory and other purposes
    24,078  (4)     69,940  (5)                 94,018  
Receivables from customers and counterparties (1)
          1,950                   1,950  
Securities borrowed (2)
          83,277                   83,277  
Financial instruments purchased under agreements to resell, at fair value
          85,717                   85,717  
                                         
Total assets at fair value
  $ 138,209     $ 573,634     $ 69,151     $ (63,437 )   $ 717,557  
                                         
Level 3 assets for which the firm does not bear economic exposure (3)
                    (14,437 )                
                                         
Level 3 assets for which the firm bears economic exposure
                  $ 54,714                  
                                         
 
 
(1)  Consists of transfers accounted for as secured loans rather than purchases under SFAS No. 140 and prepaid variable share forwards.
 
(2)  Reflects securities borrowed within Trading and Principal Investments. Excludes securities borrowed within Securities Services, which are accounted for based on the amount of cash collateral advanced plus accrued interest.
 
(3)  Consists of level 3 assets which are financed by nonrecourse debt, attributable to minority investors or attributable to employee interests in certain consolidated funds.
 
(4)  Consists of U.S. Treasury securities and money market instruments as well as insurance separate account assets measured at fair value under AICPA SOP 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.”
 
(5)  Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
(6)  Consists of private equity and real estate fund investments.
 
(7)  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.
 


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Liabilities at Fair Value as of November 2007
                Netting and
   
   
Level 1
 
Level 2
 
Level 3
 
Collateral
 
Total
    (in millions)
 
U.S. government, federal agency and sovereign obligations
  $ 57,714     $ 923     $     $     $ 58,637  
Bank loans and bridge loans
          3,525       38             3,563  
Corporate debt securities and other debt obligations
          7,764       516             8,280  
Equities and convertible debentures
    44,076       1,054                   45,130  
Physical commodities
          35                   35  
                                         
Cash instruments
    101,790       13,301       554             115,645  
Derivative contracts
    212       117,794       13,644       (32,272 (7)     99,378  
                                         
Financial instruments sold, but not yet purchased, at fair value
    102,002       131,095       14,198       (32,272 )     215,023  
Unsecured short-term borrowings (1)
          44,060       4,271             48,331  
Bank deposits (2)
          463                   463  
Securities loaned (3)
          5,449                   5,449  
Financial instruments sold under agreements to repurchase, at fair value
          159,178                   159,178  
Other secured financings (4)
          33,581                   33,581  
Unsecured long-term borrowings (5)
          15,161       767             15,928  
                                         
Total liabilities at fair value
  $ 102,002     $ 388,987     $ 19,236  (6)   $ (32,272 )   $ 477,953  
                                         
 
 
(1)  Consists of promissory notes, commercial paper and hybrid financial instruments.
 
(2)  Consists of certain certificates of deposit issued by GS Bank USA.
 
(3)  Reflects securities loaned within Trading and Principal Investments. Excludes securities loaned within Securities Services, which are accounted for based on the amount of cash collateral received plus accrued interest.
 
(4)  Primarily includes transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings.
 
(5)  Primarily includes hybrid financial instruments and prepaid physical commodity transactions.
 
(6)  Level 3 liabilities were 4% of Total liabilities at fair value.
 
(7)  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Level 3 Unrealized Gains/(Losses)
 
The table below sets forth a summary of unrealized gains/(losses) on the firm’s level 3 financial assets and financial liabilities still held at the reporting date for the three and nine months ended August 2008 and August 2007.
 
                                 
    Level 3 Unrealized Gains/(Losses)
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
    (in millions)
 
Cash Instruments — Assets
  $ (2,207 )   $ (1,607 )   $ (4,249 )   $ (662 )
Cash Instruments — Liabilities
    (104 )     (558 )     (246 )     (569 )
                                 
Net unrealized gains/(losses) on level 3 cash instruments
    (2,311 )     (2,165 )     (4,495 )     (1,231 )
Derivative Contracts — Net
    3,216       2,624       5,623       2,812  
Unsecured Short-Term Borrowings
    310       92       306       21  
Other Secured Financings
    99             263        
Other Liabilities and Accrued Expenses
    (20 )           (20 )      
Unsecured Long-Term Borrowings
    217       69       264       71  
                                 
Total level 3 unrealized gains/(losses)
  $ 1,511     $ 620     $ 1,941     $ 1,673  
                                 
 
Cash Instruments
 
The net unrealized loss on level 3 cash instruments of $2.31 billion for the three months ended August 2008 primarily consisted of unrealized losses on loans and securities backed by commercial real estate and bank loans and bridge loans. The net unrealized loss on level 3 cash instruments of $4.50 billion for the nine months ended August 2008 primarily consisted of unrealized losses on loans and securities backed by commercial and residential real estate and certain bank loans and bridge loans. Losses in the three and nine month periods reflect the continued weakness in the global credit markets.
 
Level 3 cash instruments are frequently economically hedged with instruments classified within level 1 and level 2, and accordingly, gains or losses that have been reported in level 3 are frequently offset by gains or losses attributable to instruments classified within level 1 or level 2 or by gains or losses on derivative contracts classified in level 3 of the fair value hierarchy.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Derivative Contracts
 
The net unrealized gain on level 3 derivative contracts of $3.22 billion for the three months ended August 2008 and net unrealized gain of $5.62 billion for the nine months ended August 2008 was primarily attributable to changes in observable credit spreads (which are level 2 inputs) on the underlying instruments. Level 3 gains and losses on derivative contracts should be considered in the context of the following:
 
  •  A derivative contract with level 1 and/or level 2 inputs is classified as a level 3 financial instrument in its entirety if it has at least one significant level 3 input.
 
  •  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) is still classified as level 3.
 
  •  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 instruments classified within level 1 or level 2 or by cash instruments reported in level 3 of the fair value hierarchy.
 
The tables below set forth a summary of changes in the fair value of the firm’s level 3 financial assets and financial liabilities for the three and nine months ended August 2008 and August 2007. The tables reflect gains and losses, including gains and losses on financial assets and financial liabilities that were transferred to level 3 during the period, for the three and nine month periods for all financial assets and financial liabilities categorized as level 3 as of August 2008 and August 2007, respectively. The tables do not include gains or losses that were reported in level 3 in prior periods for instruments that were sold or transferred out of level 3 prior to the end of the period presented.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                                         
    Level 3 Financial Assets and Financial Liabilities
    Three Months Ended August 2008
                        Other
   
    Cash
  Cash
  Derivative
  Unsecured
  Other
  Liabilities
  Unsecured
    Instruments
  Instruments
  Contracts
  Short-Term
  Secured
  and Accrued
  Long-Term
   
- Assets
 
- Liabilities
 
- Net
 
Borrowings
 
Financings
 
Expenses
 
Borrowings
    (in millions)
 
Balance, beginning of period
  $ 59,671     $ (581 )   $ 6,508     $ (3,837 )   $ (880 )   $     $ (2,002 )
Realized gains/(losses)
    598   (1)     (1 (3)     (381 (3)     33   (3)     25   (3)     (8 (3)     (5 (3)
Unrealized gains/(losses) relating to instruments still held at the reporting date
    (2,207 (1)     (104 (3)     3,216   (3)(4)     310   (3)     99   (3)     (20 (3)     217   (3)
Purchases, issuances and settlements
    (5,837 )     100       40       (787 )     352       (1,315 )     (202 )
Transfers in and/or out of level 3
    1,898   (2)     (11 )     (4,344 (5)     (470 )     (3,962 (6)           74  
                                                         
Balance, end of period
  $ 54,123     $ (597 )   $ 5,039     $ (4,751 )   $ (4,366 )   $ (1,343 )   $ (1,918 )
                                                         
                                                         
                                                         
    Level 3 Financial Assets and Financial Liabilities
    Three Months Ended August 2007
                        Other
   
    Cash
  Cash
  Derivative
  Unsecured
  Other
  Liabilities
  Unsecured
    Instruments
  Instruments
  Contracts
  Short-Term
  Secured
  and Accrued
  Long-Term
   
- Assets
 
- Liabilities
 
- Net
 
Borrowings
 
Financings
 
Expenses
 
Borrowings
    (in millions)
 
Balance, beginning of period
  $ 45,141     $ (849 )   $ 399     $ (5,507 )   $     $     $ (503 )
Realized gains/(losses)
    251   (1)     7   (3)     313   (3)     (41 (3)                   (3)
Unrealized gains/(losses) relating to instruments still held at the reporting date
    (1,607 (1)     (558 (3)     2,624   (3)(4)     92   (3)                 69   (3)
Purchases, issuances and settlements
    5,682       140       (1,180 )     (232 )                 (250 )
Transfers in and/or out of level 3
    6,736   (7)     (5 )     (3,189 (8)     2,407   (9)                 32  
                                                         
Balance, end of period
  $ 56,203     $ (1,265 )   $ (1,033 )   $ (3,281 )   $     $     $ (652 )
                                                         
 
 
(1)  The aggregate amounts include approximately $(2.23) billion and $623 million reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the three months ended August 2008. The aggregate amounts include approximately $(1.93) billion and $574 million reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the three months ended August 2007.
 
(2)  Principally reflects transfers from level 2 within the fair value hierarchy of loans and securities backed by commercial real estate and private equity investments, reflecting reduced price transparency for these financial instruments, partially offset by transfers of corporate debt securities and other debt obligations to level 2 within the fair value hierarchy, reflecting improved price transparency for these financial instruments, largely as a result of sales and partial sales.
 
(3)  Substantially all is reported in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
(4)  Principally resulted from changes in level 2 inputs.
 
(5)  Principally reflects transfers to level 2 within the fair value hierarchy of mortgage-related derivative assets, as recent trading activity provided improved transparency of correlation inputs.
 
(6)  Consists of transfers from level 2 within the fair value hierarchy.
 
(7)  Principally reflects transfers from level 2 within the fair value hierarchy of loans and securities backed by commercial and residential real estate and certain bank loans and bridge loans, reflecting reduced price transparency for these financial instruments.
 
(8)  Principally reflects transfers from level 2 within the fair value hierarchy of structured credit derivative liabilities, due to reduced transparency of correlation inputs.
 
(9)  Principally reflects transfers to level 2 within the fair value hierarchy.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                                         
    Level 3 Financial Assets and Financial Liabilities
    Nine Months Ended August 2008
                        Other
   
    Cash
  Cash
  Derivative
  Unsecured
  Other
  Liabilities
  Unsecured
    Instruments
  Instruments
  Contracts
  Short-Term
  Secured
  and Accrued
  Long-Term
   
- Assets
 
- Liabilities
 
- Net
 
Borrowings
 
Financings
 
Expenses
 
Borrowings
    (in millions)
 
Balance, beginning of period
  $ 53,451     $ (554 )   $ 2,056     $ (4,271 )   $     $     $ (767 )
Realized gains/(losses)
    2,103   (1)     2   (3)     362   (3)     (19 (3)     25   (3)     (8 (3)     (10 (3)
Unrealized gains/(losses) relating to instruments still held at the reporting date
    (4,249 (1)     (246 (3)     5,623   (3)(4)     306   (3)     263   (3)     (20 (3)     264   (3)
Purchases, issuances and settlements
    426       167       (1,331 )     (283 )     271       (1,315 )     (1,304 )
Transfers in and/or out of level 3
    2,392   (2)     34       (1,671 (5)     (484 )     (4,925 (6)           (101 )
                                                         
Balance, end of period
  $ 54,123     $ (597 )   $ 5,039     $ (4,751 )   $ (4,366 )   $ (1,343 )   $ (1,918 )
                                                         
                                                         
                                                         
    Level 3 Financial Assets and Financial Liabilities
    Nine Months Ended August 2007
                        Other
   
    Cash
  Cash
  Derivative
  Unsecured
  Other
  Liabilities
  Unsecured
    Instruments
  Instruments
  Contracts
  Short-Term
  Secured
  and Accrued
  Long-Term
   
- Assets
 
- Liabilities
 
- Net
 
Borrowings
 
Financings
 
Expenses
 
Borrowings
    (in millions)
 
Balance, beginning of period
  $ 29,905     $ (223 )   $ 580     $ (3,253 )   $     $     $ (135 )
Realized gains/(losses)
    1,363   (1)     14   (3)     1,135   (3)     (100 (3)                 1   (3)
Unrealized gains/(losses) relating to instruments still held at the reporting date
    (662 (1)     (569 (3)     2,812   (3)(4)     21   (3)                 71   (3)
Purchases, issuances and settlements
    18,886       (489 )     (3,154 )     (985 )                 (559 )
Transfers in and/or out of level 3
    6,711   (7)     2       (2,406 (8)     1,036                   (30 )
                                                         
Balance, end of period
  $ 56,203     $ (1,265 )   $ (1,033 )   $ (3,281 )   $     $     $ (652 )
                                                         
 
 
(1)  The aggregate amounts include approximately $(4.09) billion and $1.94 billion reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the nine months ended August 2008. The aggregate amounts include approximately $(789) million and $1.49 billion reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the nine months ended August 2007.
 
(2)  Principally reflects transfers from level 2 within the fair value hierarchy of loans and securities backed by commercial real estate, reflecting reduced price transparency for these financial instruments.
 
(3)  Substantially all is reported in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
(4)  Principally resulted from changes in level 2 inputs.
 
(5)  Principally reflects transfers to level 2 within the fair value hierarchy of mortgage-related derivative assets, as recent trading activity provided improved transparency of correlation inputs.
 
(6)  Consists of transfers from level 2 within the fair value hierarchy.
 
(7)  Principally reflects transfers from level 2 within the fair value hierarchy of loans and securities backed by commercial and residential real estate and certain bank loans and bridge loans, reflecting reduced price transparency for these financial instruments.
 
(8)  Principally reflects transfers from level 2 within the fair value hierarchy of structured credit derivative liabilities, due to reduced transparency of correlation inputs.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Credit risk is an essential component of fair value (i.e., exit price). Cash products (e.g., bonds and loans) and derivative instruments (particularly those with significant future projected cash flows) trade in the market at levels which reflect credit considerations. The firm calculates the fair value of derivative assets by discounting future cash flows at a rate which incorporates counterparty credit spreads and on derivative liabilities at a rate which incorporates the firm’s own credit spreads. In doing so, credit exposures are adjusted to reflect mitigants, namely collateral agreements which reduce exposures based on triggers and contractual posting requirements. The firm manages its exposure to credit risk as it does other market risks and will price, economically hedge, facilitate and intermediate trades which involve credit risk. The firm records liquidity valuation adjustments to reflect the cost of exiting concentrated risk positions, including exposure to the firm’s own credit spreads.
 
On an ongoing basis, the firm realizes gains or losses relating to changes in credit risk on derivative contracts through changes in credit mitigants or the sale or unwind of the contracts. The net gain attributable to the impact of changes in credit exposure and credit spreads on derivative contracts was $257 million and $128 million for the three and nine months ended August 2008.
 
The following table sets forth the gains/(losses) attributable to the impact of changes in the firm’s own credit spreads on unsecured borrowings for which the fair value option was elected. The firm calculates the fair value of unsecured borrowings by discounting future cash flows at a rate which incorporates the firm’s observable credit spreads.
 
                                 
    Three Months Ended August   Nine Months Ended August
    2008   2007   2008   2007
        (in millions)    
Gains/(losses) including hedges
  $ 176     $ 256     $ 331     $ 254  
Gains/(losses) excluding hedges
    248       271       391       269  
 
For the three and nine months ended August 2008 and August 2007, the changes in the fair value of receivables (including securities borrowed and resale agreements) for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were not material. As of August 2008 and November 2007, the difference between the fair value and the aggregate contractual principal amount of both long-term receivables and long-term debt instruments (principal and non-principal protected) for which the fair value option was elected was not material to the carrying value of either the long-term receivables or the long-term debt.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The following table sets forth the gains/(losses) included in earnings for the three and nine months ended August 2008 and August 2007 related to financial assets and financial liabilities for which the firm has elected to apply the fair value option under SFAS No. 155 and SFAS No. 159. The table does not reflect the impact to the firm’s earnings of applying SFAS No. 159 because a significant amount of these gains and losses would have also been recognized under previously issued generally accepted accounting principles, or are economically hedged with instruments accounted for at fair value under other generally accepted accounting principles that are not reflected in the table below.
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
        (in millions)    
Other secured financings
  $ 232     $ 897     $ 1,397  (1)   $ 772  
Financial instruments owned, at fair value (2)
    (528 )     (33 )     (930 )     39  
Unsecured short-term borrowings
    1,921       (51 )     2,149       (403 )
Unsecured long-term borrowings
    1,737       (226 )     (387 )     (957 )
Other (3)
    (66 )     11       (87 )     10  
                                 
Total (4)
  $ 3,296     $ 598     $ 2,142     $ (539 )
                                 
 
 
(1) Includes $870 million for the nine months ended August 2008, related to financings recorded as a result of certain mortgage securitizations that were accounted for as secured financings rather than sales under SFAS No. 140. Changes in the fair value of these secured financings are equally offset by changes in the fair value of the related mortgage whole loans, which were included within the firm’s “Financial instruments owned, at fair value” in the condensed consolidated statement of financial condition.
 
(2) Primarily consists of investments for which the firm would otherwise have applied the equity method of accounting as well as securities held in GS Bank USA (which would otherwise be accounted for as available-for-sale).
 
(3) Primarily consists of certain insurance and reinsurance contracts, resale and repurchase agreements and securities borrowed and loaned within Trading and Principal Investments.
 
(4) Reported within “Trading and principal investments” within the condensed consolidated statements of earnings. The amounts exclude contractual interest, which is included in “Interest income” and “Interest expense,” for all instruments other than hybrid financial instruments.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Derivative Activities
 
Derivative contracts are instruments, such as futures, forwards, swaps or option contracts, that derive their value from underlying assets, indices, reference rates or a combination of these factors. Derivative instruments may be privately negotiated contracts, which are often referred to as OTC derivatives, or they may be listed and traded on an exchange. Derivatives may involve future commitments to purchase or sell financial instruments or commodities, or to exchange currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, securities, commodities, currencies or indices.
 
Certain cash instruments, such as mortgage-backed securities, interest-only and principal-only obligations, and indexed debt instruments, are not considered derivatives even though their values or contractually required cash flows are derived from the price of some other security or index. However, certain commodity-related contracts are included in the firm’s derivatives disclosure, as these contracts may be settled in cash or the assets to be delivered under the contract are readily convertible into cash.
 
The firm enters into derivative transactions to facilitate client transactions, to take proprietary positions and as a means of risk management. Risk exposures are managed through diversification, by controlling position sizes and by entering into offsetting positions. For example, the firm may manage the risk related to a portfolio of common stock by entering into an offsetting position in a related equity-index futures contract.
 
The firm applies hedge accounting under SFAS No. 133 to certain derivative contracts. The firm uses these derivatives to manage certain interest rate and currency exposures, including the firm’s net investment in non-U.S. operations. The firm designates certain interest rate swap contracts as fair value hedges. These interest rate swap contracts hedge changes in the relevant benchmark interest rate (e.g., London Interbank Offered Rate (LIBOR)), effectively converting a substantial portion of the firm’s unsecured long-term and certain unsecured short-term borrowings into floating rate obligations. See Note 2 for information regarding the firm’s accounting policy for foreign currency forward contracts used to hedge its net investment in non-U.S. operations.
 
The firm applies a long-haul method to all of its hedge accounting relationships to perform an ongoing assessment of the effectiveness of these relationships in achieving offsetting changes in fair value or offsetting cash flows attributable to the risk being hedged. The firm utilizes a dollar-offset method, which compares the change in the fair value of the hedging instrument to the change in the fair value of the hedged item, excluding the effect of the passage of time, to prospectively and retrospectively assess hedge effectiveness. The firm’s prospective dollar-offset assessment utilizes scenario analyses to test hedge effectiveness via simulations of numerous parallel and slope shifts of the relevant yield curve. Parallel shifts change the interest rate of all maturities by identical amounts. Slope shifts change the curvature of the yield curve. For both the prospective assessment, in response to each of the simulated yield curve shifts, and the retrospective assessment, a hedging relationship is deemed to be effective if the fair value of the hedging instrument and the hedged item change inversely within a range of 80% to 125%.
 
For fair value hedges, gains or losses on derivative transactions are recognized in “Interest expense” in the condensed consolidated statements of earnings. The change in fair value of the hedged item attributable to the risk being hedged is reported as an adjustment to its carrying value and is subsequently amortized into interest expense over its remaining life. Gains or losses related to hedge ineffectiveness for all hedges are generally included in “Interest expense.” These gains or losses and the component of gains or losses on derivative transactions excluded from the assessment


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
of hedge effectiveness (e.g., the effect of the passage of time on fair value hedges of the firm’s borrowings) were not material to the firm’s results of operations for the three and nine months ended August 2008 or August 2007. Gains and losses on derivatives used for trading purposes are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
The fair value of the firm’s derivative contracts is reflected net of cash paid or received pursuant to credit support agreements and is reported on a net-by-counterparty basis in the firm’s condensed consolidated statements of financial condition when management believes a legal right of setoff exists under an enforceable netting agreement. The fair value of derivative financial instruments, presented in accordance with the firm’s netting policy, is set forth below:
 
                                 
    As of
    August 2008   November 2007
   
Assets
 
Liabilities
 
Assets
 
Liabilities
        (in millions)    
Contract Type
                               
Forward settlement contracts
  $ 30,146     $ 32,372     $ 22,561     $ 27,138  
Swap agreements
    141,338       57,693       104,793       62,697  
Option contracts
    64,582       55,826       53,056       53,047  
                                 
Subtotal
    236,066       145,891       180,410       142,882  
Netting across contract types (1)
    (15,725 )     (15,725 )     (15,746 )     (15,746 )
Cash collateral netting (2)
    (98,778 )     (26,262 )     (59,050 )     (27,758 )
                                 
Total
  $ 121,563     $ 103,904     $ 105,614     $ 99,378  
                                 
 
(1) Represents the netting of receivable balances with payable balances for the same counterparty across contract types pursuant to credit support agreements.
 
(2) Represents the netting of cash collateral received and posted on a counterparty basis pursuant to credit support agreements.
 
The fair value of derivatives accounted for as qualifying hedges under SFAS No. 133 consisted of $11.33 billion and $5.15 billion in assets as of August 2008 and November 2007, respectively, and $409 million and $355 million in liabilities as of August 2008 and November 2007, respectively.
 
The firm also has embedded derivatives that have been bifurcated from related borrowings under SFAS No. 133. Such derivatives, which are classified in unsecured short-term and unsecured long-term borrowings, had a carrying value of $(320) million and $463 million (excluding the debt host contract) as of August 2008 and November 2007, respectively. See Notes 4 and 5 for further information regarding the firm’s unsecured borrowings.
 
Securitization Activities
 
The firm securitizes commercial and residential mortgages, home equity and auto loans, government and corporate bonds and other types of financial assets. The firm acts as underwriter of the beneficial interests that are sold to investors. The firm derecognizes financial assets transferred in securitizations, provided it has relinquished control over such assets. Transferred assets are accounted for at fair value prior to securitization. Net revenues related to these underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.
 
The firm may retain interests in securitized financial assets, primarily in the form of senior or subordinated securities, including residual interests. Retained interests are accounted for at fair value and are included in “Total financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
The following table sets forth the amount of financial assets the firm securitized, as well as cash flows received on retained interests:
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
        (in millions)    
Residential mortgages
  $ 1,375     $ 2,856     $ 5,486     $ 22,852  
Commercial mortgages
          14,250       773       15,611  
Other financial assets
    4,476  (1)     6,833  (2)     6,130  (1)     31,282  (2)
                                 
Total
  $ 5,851     $ 23,939     $ 12,389     $ 69,745  
                                 
Cash flows received on retained interests
  $ 133     $ 183     $ 404     $ 548  
                                 
 
 
(1) Primarily in connection with collateralized loan obligations (CLOs).
 
(2) Primarily in connection with CDOs and CLOs.
 
As of August 2008 and November 2007, the firm held $2.53 billion and $4.57 billion of retained interests, respectively, from these securitization activities, including $2.04 billion and $2.72 billion, respectively, held in QSPEs.
 
The following table sets forth the weighted average key economic assumptions used in measuring the fair value of the firm’s retained interests and the sensitivity of this fair value to immediate adverse changes of 10% and 20% in those assumptions:
 
                                 
    As of August 2008   As of November 2007
    Type of Retained Interests   Type of Retained Interests
    Mortgage-
  CDOs and
  Mortgage-
  CDOs and
   
Backed
 
CLOs (4)
 
Backed
 
CLOs (4)
        ($ in millions)    
Fair value of retained interests
  $ 1,879     $ 650     $ 3,378     $ 1,188  
                                 
Weighted average life (years)
    4.9       4.5       6.6       2.7  
                                 
Constant prepayment rate (1)
    16.9 %     10.1 %     15.1 %     11.9 %
Impact of 10% adverse change (1)
  $ (16 )   $ (4 )   $ (50 )   $ (43 )
Impact of 20% adverse change (1)
    (33 )     (9 )     (91 )     (98 )
                                 
Anticipated credit losses (2)
    1.6 %     N/A       4.3 %     N/A  
Impact of 10% adverse change (3)
  $ (2 )   $     $ (45 )   $  
Impact of 20% adverse change (3)
    (4 )           (72 )      
                                 
Discount rate
    13.0 %     25.8 %     8.4 %     23.1 %
Impact of 10% adverse change
  $ (53 )   $ (31 )   $ (89 )   $ (46 )
Impact of 20% adverse change
    (103 )     (60 )     (170 )     (92 )
 
 
(1) Constant prepayment rate is included only for positions for which constant prepayment rate is a key assumption in the determination of fair value.
 
(2) Anticipated credit losses are computed only on positions for which expected credit loss is a key assumption in the determination of fair value or positions for which expected credit loss is not reflected within the discount rate.
 
(3) The impacts of adverse change take into account credit mitigants incorporated in the retained interests, including over-collateralization and subordination provisions.
 
(4) Includes $323 million and $905 million as of August 2008 and November 2007, respectively, of retained interests related to transfers of securitized assets that were accounted for as secured financings rather than sales under SFAS No. 140.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
The preceding table does not give effect to the offsetting benefit of other financial instruments that are held to mitigate risks inherent in these retained interests. Changes in fair value based on an adverse variation in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value is not usually linear. In addition, the impact of a change in a particular assumption is calculated independently of changes in any other assumption. In practice, simultaneous changes in assumptions might magnify or counteract the sensitivities disclosed above.
 
In addition to the retained interests described above, the firm also held interests in residential mortgage QSPEs purchased in connection with secondary market-making activities. These purchased interests were approximately $4 billion and $6 billion as of August 2008 and November 2007, respectively.
 
As of August 2008 and November 2007, the firm held mortgage servicing rights with a fair value of $240 million and $93 million, respectively. These servicing assets represent the firm’s right to receive a future stream of cash flows, such as servicing fees, in excess of the firm’s obligation to service residential mortgages. The fair value of mortgage servicing rights will fluctuate in response to changes in certain economic variables, such as discount rates and loan prepayment rates. The firm estimates the fair value of mortgage servicing rights by using valuation models that incorporate these variables in quantifying anticipated cash flows related to servicing activities. Mortgage servicing rights are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition and are classified within level 3 of the fair value hierarchy. The following table sets forth changes in the firm’s mortgage servicing rights, as well as servicing fees earned:
 
                 
    Three Months Ended
  Nine Months Ended
    August 2008   August 2008
    (in millions)
Balance, beginning of period
  $ 248     $ 93  
Purchases
    27       239  (2)
Servicing assets that resulted from transfers of financial assets
          3  
Changes in fair value due to changes in valuation inputs and assumptions
    (35 )     (95 )
                 
Balance, end of period (1)
  $ 240     $ 240  
                 
                 
Contractually specified servicing fees
  $ 87     $ 224  
                 
 
 
(1) Fair value as of August 2008 was estimated using a weighted average discount rate of approximately 16% and a weighted average prepayment rate of approximately 28%.
 
(2) Primarily related to the acquisition of Litton Loan Servicing LP.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Variable Interest Entities (VIEs)
 
The firm, in the ordinary course of business, retains interests in VIEs in connection with its securitization activities. The firm also purchases and sells variable interests in VIEs, which primarily issue mortgage-backed and other asset-backed securities, CDOs and CLOs, in connection with its market-making activities and makes investments in and loans to VIEs that hold performing and nonperforming debt, equity, real estate, power-related and other assets. In addition, the firm utilizes VIEs to provide investors with principal-protected notes, credit-linked notes and asset-repackaged notes designed to meet their objectives.
 
VIEs generally purchase assets by issuing debt and equity instruments. In certain instances, the firm provides guarantees to VIEs or holders of variable interests in VIEs. In such cases, the maximum exposure to loss included in the tables set forth below is the notional amount of such guarantees. Such amounts do not represent anticipated losses in connection with these guarantees.
 
The firm’s variable interests in VIEs include senior and subordinated debt; loan commitments; limited and general partnership interests; preferred and common stock; interest rate, foreign currency, equity, commodity and credit derivatives; guarantees; and residual interests in mortgage-backed and asset-backed securitization vehicles, CDOs and CLOs. The firm’s exposure to the obligations of VIEs is generally limited to its interests in these entities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The following tables set forth total assets in nonconsolidated VIEs in which the firm holds significant variable interests and the firm’s maximum exposure to loss associated with these variable interests. The firm has aggregated nonconsolidated VIEs based on principal business activity, as reflected in the first column. The nature of the firm’s variable interests can take different forms, as described in the columns under maximum exposure to loss.
 
These tables do not give effect to the benefit of any offsetting financial instruments that are held to mitigate risks related to the firm’s interests in nonconsolidated VIEs.
 
                                                   
    As of August 2008
          Maximum Exposure to Loss in Nonconsolidated VIEs (1)
          Purchased
  Commitments
           
          and Retained
  and
      Loans and
   
   
VIE Assets
   
Interests
 
Guarantees
 
Derivatives
 
Investments
 
Total
          (in millions)    
Mortgage CDOs
  $ 15,895       $ 386     $     $ 6,663  (4)   $     $ 7,049  
Corporate CDOs and CLOs
    13,503         306             3,187  (5)           3,493  
Real estate, credit-related and other investing (2)
    26,788               8             3,636       3,644  
Municipal bond securitizations
    146               146                   146  
Other asset-backed
    1,643                     894             894  
Power-related
    830               37             215       252  
Principal-protected notes (3)
    6,299                     6,274             6,274  
                                                   
Total
  $ 65,104       $ 692     $ 191     $ 17,018     $ 3,851     $ 21,752  
                                                   
 
                                                   
    As of November 2007
          Maximum Exposure to Loss in Nonconsolidated VIEs (1)
          Purchased
  Commitments
           
          and Retained
  and
      Loans and
   
   
VIE Assets
   
Interests
 
Guarantees
 
Derivatives
 
Investments
 
Total
          (in millions)    
Mortgage CDOs
  $ 18,914       $ 1,011     $     $ 10,089  (4)   $     $ 11,100  
Corporate CDOs and CLOs
    10,750         411             2,218  (5)           2,629  
Real estate, credit-related and other investing (2)
    17,272               107       12       3,141       3,260  
Municipal bond securitizations
    1,413               1,413                   1,413  
Other mortgage-backed
    3,881         719                         719  
Other asset-backed
    3,771                     1,579             1,579  
Power-related
    438         2       37             16       55  
Principal-protected notes (3)
    5,698                     5,186             5,186  
                                                   
Total
  $ 62,137       $ 2,143     $ 1,557     $ 19,084     $ 3,157     $ 25,941  
                                                   
 
 
(1)  Such amounts do not represent the anticipated losses in connection with these transactions.
 
(2)  The firm obtains interests in these VIEs in connection with making proprietary investments in real estate, distressed loans and other types of debt, mezzanine instruments and equities.
 
(3)  Consists of out-of-the-money written put options that provide principal protection to clients invested in various fund products, with risk to the firm mitigated through portfolio rebalancing.
 
(4)  Primarily consists of written protection on investment-grade, short-term collateral held by VIEs that have issued CDOs.
 
(5)  Primarily consists of total return swaps on CDOs and CLOs. The firm has generally transferred the risks related to the underlying securities through derivatives with non-VIEs.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
The following table sets forth the firm’s total assets and maximum exposure to loss associated with its significant variable interests in consolidated VIEs where the firm does not hold a majority voting interest. The firm has aggregated consolidated VIEs based on principal business activity, as reflected in the first column.
 
The table does not give effect to the benefit of any offsetting financial instruments that are held to mitigate risks related to the firm’s interests in consolidated VIEs.
 
                                 
    As of August 2008   As of November 2007
        Maximum
      Maximum
        Exposure
      Exposure
   
VIE Assets (1)
 
to Loss (2)
 
VIE Assets (1)
 
to Loss (2)
        (in millions)    
Real estate, credit-related and other investing
  $ 1,741     $ 467     $ 2,118     $ 525  
Municipal bond securitizations
    1,368       1,368       1,959       1,959  
CDOs, mortgage-backed and other asset-backed
    206       174       604       109  
Foreign exchange and commodities
    566       593       300       329  
Principal-protected notes
    395       389       1,119       1,118  
                                 
Total
  $ 4,276     $ 2,991     $ 6,100     $ 4,040  
                                 
 
 
(1) Consolidated VIE assets include assets financed on a nonrecourse basis.
 
(2) Such amounts do not represent the anticipated losses in connection with these transactions.
 
While the firm is routinely involved with VIEs and QSPEs in connection with its securitization activities, the firm did not have off-balance-sheet commitments to purchase or finance CDOs held by structured investment vehicles as of August 2008 or November 2007.
 
Collateralized Transactions
 
The firm receives financial instruments as collateral, primarily in connection with resale agreements, securities borrowed, derivative transactions and customer margin loans. Such financial instruments may include obligations of the U.S. government, federal agencies, sovereigns and corporations, as well as equities and convertibles.
 
In many cases, the firm is permitted to deliver or repledge these financial instruments in connection with entering into repurchase agreements, securities lending agreements and other secured financings, collateralizing derivative transactions and meeting firm or customer settlement requirements. As of August 2008 and November 2007, the fair value of financial instruments received as collateral by the firm that it was permitted to deliver or repledge was $831.85 billion and $891.05 billion, respectively, of which the firm delivered or repledged $691.94 billion and $785.62 billion, respectively.
 
The firm also pledges assets that it owns to counterparties who may or may not have the right to deliver or repledge them. Financial instruments owned and pledged to counterparties that have the right to deliver or repledge are reported as “Financial instruments owned and pledged as collateral, at fair value” in the condensed consolidated statements of financial condition and were $37.34 billion and $46.14 billion as of August 2008 and November 2007, respectively. Financial instruments owned and pledged in connection with repurchase agreements, securities lending agreements and other secured financings to counterparties that did not have the right to sell or repledge are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition and


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
were $105.19 billion and $156.92 billion as of August 2008 and November 2007, respectively. Other assets (primarily real estate and cash) owned and pledged in connection with other secured financings to counterparties that did not have the right to sell or repledge were $9.03 billion and $5.86 billion as of August 2008 and November 2007, respectively.
 
In addition to repurchase agreements and securities lending agreements, the firm obtains secured funding through the use of other arrangements. Other secured financings include arrangements that are nonrecourse, that is, only the subsidiary that executed the arrangement or a subsidiary guaranteeing the arrangement is obligated to repay the financing. Other secured financings consist of liabilities related to the firm’s William Street program, consolidated VIEs, collateralized central bank financings, transfers of financial assets that are accounted for as financings rather than sales under SFAS No. 140 (primarily pledged bank loans and mortgage whole loans) and other structured financing arrangements.
 
Other secured financings by maturity are set forth in the table below:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Other secured financings (short-term) (1)(2)
  $ 27,212     $ 32,410  
Other secured financings (long-term):
               
2009
    289       2,903  
2010
    2,417       2,301  
2011
    5,929       2,427  
2012
    4,195       4,973  
2013
    1,466       702  
2014-thereafter
    11,313       19,994  
                 
Total other secured financings (long-term) (3)(4)
    25,609       33,300  
                 
Total other secured financings (5)
  $ 52,821     $ 65,710  
                 
 
 
(1) As of August 2008, consists of U.S. dollar-denominated financings of $17.21 billion with a weighted average interest rate of 2.82% and non-U.S. dollar-denominated financings of $10.00 billion with a weighted average interest rate of 1.09%, after giving effect to hedging activities. As of November 2007, consists of U.S. dollar-denominated financings of $18.47 billion with a weighted average interest rate of 5.32% and non-U.S. dollar-denominated financings of $13.94 billion with a weighted average interest rate of 0.91%, after giving effect to hedging activities. The weighted average interest rates as of August 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 159.
 
(2) Includes other secured financings maturing within one year of the financial statement date and other secured financings that are redeemable within one year of the financial statement date at the option of the holder.
 
(3) As of August 2008, consists of U.S. dollar-denominated financings of $12.34 billion with a weighted average interest rate of 4.05% and non-U.S. dollar-denominated financings of $13.27 billion with a weighted average interest rate of 4.74%, after giving effect to hedging activities. As of November 2007, consists of U.S. dollar-denominated financings of $22.13 billion with a weighted average interest rate of 5.73% and non-U.S. dollar-denominated financings of $11.17 billion with a weighted average interest rate of 4.28%, after giving effect to hedging activities. The weighted average interest rates as of August 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 159.
 
(4) Secured long-term financings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates. Secured long-term financings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
(5) As of August 2008, $43.46 billion of these financings were collateralized by financial instruments and $9.36 billion by other assets (primarily real estate and cash). As of November 2007, $61.34 billion of these financings were collateralized by financial instruments and $4.37 billion by other assets (primarily real estate and cash). Other secured financings include $17.89 billion and $25.37 billion of nonrecourse obligations as of August 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 4.   Unsecured Short-Term Borrowings
 
As of August 2008 and November 2007, unsecured short-term borrowings were $64.65 billion and $71.56 billion, respectively. Such amounts also include the portion of unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder. The firm accounts for promissory notes, commercial paper and certain hybrid financial instruments at fair value under SFAS No. 155 or SFAS No. 159. Short-term borrowings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest, and such amounts approximate fair value due to the short-term nature of the obligations.
 
Unsecured short-term borrowings are set forth below:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Current portion of unsecured long-term borrowings
  $ 27,385     $ 22,740  
Hybrid financial instruments
    18,894       22,318  
Promissory notes
    8,005       13,251  
Commercial paper
    1,365       4,343  
Other short-term borrowings
    9,004       8,905  
                 
Total (1)
  $ 64,653     $ 71,557  
                 
 
 
(1) The weighted average interest rates for these borrowings, after giving effect to hedging activities, were 2.77% and 5.05% as of August 2008 and November 2007, respectively. The weighted average interest rates as of August 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 5.   Unsecured Long-Term Borrowings
 
The firm’s unsecured long-term borrowings extend through 2043 and consist principally of senior borrowings.
 
Unsecured long-term borrowings are set forth below:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Fixed rate obligations (1)
               
U.S. dollar
  $ 63,818     $ 55,281  
Non-U.S. dollar
    36,673       29,139  
Floating rate obligations (2)
               
U.S. dollar
    38,283       47,308  
Non-U.S. dollar
    37,593       32,446  
                 
Total (3)
  $ 176,367     $ 164,174  
                 
 
 
(1) As of August 2008 and November 2007, interest rates on U.S. dollar fixed rate obligations ranged from 3.60% to 10.04% and from 3.88% to 10.04%, respectively. As of both August 2008 and November 2007, interest rates on non-U.S. dollar fixed rate obligations ranged from 0.67% to 8.88%.
 
(2) Floating interest rates generally are based on LIBOR or the federal funds target rate. Equity-linked and indexed instruments are included in floating rate obligations.
 
(3) Includes $2.95 billion and $3.05 billion as of August 2008 and November 2007, respectively, of foreign currency-denominated debt designated as hedges of net investments in non-U.S. subsidiaries under SFAS No. 133.
 
Unsecured long-term borrowings by maturity date are set forth below:
 
                                                 
    As of
    August 2008 (1)(2)   November 2007 (1)(2)
    U.S.
  Non-U.S.
      U.S.
  Non-U.S.
   
   
Dollar
 
Dollar
 
Total
 
Dollar
 
Dollar
 
Total
            (in millions)        
2009
  $ 3,754     $ 962     $ 4,716     $ 20,204     $ 2,978     $ 23,182  
2010
    9,389       6,754       16,143       7,989       5,714       13,703  
2011
    7,009       5,321       12,330       5,848       4,839       10,687  
2012
    13,196       3,704       16,900       14,913       3,695       18,608  
2013
    9,138       13,865       23,003       6,490       9,326       15,816  
2014-thereafter
    59,615       43,660       103,275       47,145       35,033       82,178  
                                                 
Total
  $ 102,101     $ 74,266     $ 176,367     $ 102,589     $ 61,585     $ 164,174  
                                                 
 
 
(1) Unsecured long-term borrowings maturing within one year of the financial statement date and certain unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder are included as unsecured short-term borrowings in the condensed consolidated statements of financial condition.
 
(2) Unsecured long-term borrowings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates. Unsecured long-term borrowings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The firm enters into derivative contracts, such as interest rate futures contracts, interest rate swap agreements, currency swap agreements, commodity contracts and equity-linked and indexed contracts, to effectively convert a substantial portion of its unsecured long-term borrowings into U.S. dollar-based floating rate obligations. Accordingly, excluding the cumulative impact of changes in the firm’s credit spreads, the carrying value of unsecured long-term borrowings approximated fair value as of August 2008 and November 2007. For unsecured long-term borrowings for which the firm did not elect the fair value option, the cumulative impact due to the widening of the firm’s own credit spreads was a reduction in the fair value of total unsecured long-term borrowings of approximately 6% and 1% as of August 2008 and November 2007, respectively.
 
The effective weighted average interest rates for unsecured long-term borrowings are set forth below:
 
                                 
    As of
    August 2008   November 2007
   
Amount
 
Rate
 
Amount
 
Rate
        ($ in millions)    
Fixed rate obligations
  $ 4,341       4.81 %   $ 3,787       5.28 %
Floating rate obligations (1)
    172,026       3.52       160,387       5.68  
                                 
Total (2)
  $ 176,367       3.55     $ 164,174       5.67  
                                 
 
 
(1) Includes fixed rate obligations that have been converted into floating rate obligations through derivative contracts.
 
(2) The weighted average interest rates as of August 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.
 
Subordinated Borrowings
 
Unsecured long-term borrowings include subordinated borrowings with outstanding principal amounts of $19.89 billion and $16.32 billion as of August 2008 and November 2007, respectively, as set forth below.
 
Subordinated Debt.  As of August 2008, the firm had $14.80 billion of senior subordinated debt outstanding with maturities ranging from 2009 to 2038. The effective weighted average interest rate on this debt was 3.77%, after giving effect to derivative contracts used to convert fixed rate obligations into floating rate obligations. As of November 2007, the firm had $11.23 billion of senior subordinated debt outstanding with maturities ranging from fiscal 2009 to 2037. The effective weighted average interest rate on this debt was 5.75%, after giving effect to derivative contracts used to convert fixed rate obligations into floating rate obligations. This debt is junior in right of payment to all of the firm’s senior indebtedness.
 
Junior Subordinated Debt Issued to a Trust in Connection with Trust Preferred Securities.  The firm issued $2.84 billion of junior subordinated debentures in 2004 to Goldman Sachs Capital I (the Trust), a Delaware statutory trust that, in turn, issued $2.75 billion of guaranteed preferred beneficial interests to third parties and $85 million of common beneficial interests to the firm and invested the proceeds from the sale in junior subordinated debentures issued by the firm. The Trust is a wholly owned finance subsidiary of the firm for regulatory and legal purposes but is not consolidated for accounting purposes.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
The firm pays interest semi-annually on these debentures at an annual rate of 6.345% and the debentures mature on February 15, 2034. The coupon rate and the payment dates applicable to the beneficial interests are the same as the interest rate and payment dates applicable to the debentures. The firm has the right, from time to time, to defer payment of interest on the debentures, and, therefore, cause payment on the Trust’s preferred beneficial interests to be deferred, in each case up to ten consecutive semi-annual periods. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common stock. The Trust is not permitted to pay any distributions on the common beneficial interests held by the firm unless all dividends payable on the preferred beneficial interests have been paid in full. These debentures are junior in right of payment to all of the firm’s senior indebtedness and all of the firm’s subordinated borrowings, other than the junior subordinated debt issued in connection with the Normal Automatic Preferred Enhanced Capital Securities (see discussion below).
 
Junior Subordinated Debt Issued to Trusts in Connection with Fixed-to-Floating and Floating Rate Normal Automatic Preferred Enhanced Capital Securities.  In 2007, the firm issued a total of $2.25 billion of remarketable junior subordinated debt to Goldman Sachs Capital II and Goldman Sachs Capital III (the APEX Trusts), Delaware statutory trusts that, in turn, issued $2.25 billion of guaranteed perpetual Automatic Preferred Enhanced Capital Securities (APEX) to third parties and a de minimis amount of common securities to the firm. The firm also entered into contracts with the APEX Trusts to sell $2.25 billion of perpetual non-cumulative preferred stock to be issued by the firm (the stock purchase contracts). The APEX Trusts are wholly owned finance subsidiaries of the firm for regulatory and legal purposes but are not consolidated for accounting purposes.
 
The firm pays interest semi-annually on $1.75 billion of junior subordinated debt issued to Goldman Sachs Capital II at a fixed annual rate of 5.59% and the debt matures on June 1, 2043. The firm pays interest quarterly on $500 million of junior subordinated debt issued to Goldman Sachs Capital III at a rate per annum equal to three-month LIBOR plus 0.57% and the debt matures on September 1, 2043. In addition, the firm makes contract payments at a rate of 0.20% per annum on the stock purchase contracts held by the APEX Trusts. The firm has the right to defer payments on the junior subordinated debt and the stock purchase contracts, subject to limitations, and therefore cause payment on the APEX to be deferred. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common or preferred stock. The junior subordinated debt is junior in right of payment to all of the firm’s senior indebtedness and all of the firm’s other subordinated borrowings.
 
In connection with the APEX issuance, the firm covenanted in favor of certain of its debtholders, who are initially the holders of the firm’s 6.345% Junior Subordinated Debentures due February 15, 2034, that, subject to certain exceptions, the firm would not redeem or purchase (i) the firm’s junior subordinated debt issued to the APEX Trusts prior to the applicable stock purchase date or (ii) APEX or shares of the firm’s Series E or Series F Preferred Stock prior to the date that is ten years after the applicable stock purchase date, unless the applicable redemption or purchase price does not exceed a maximum amount determined by reference to the aggregate amount of net cash proceeds that the firm has received from the sale of qualifying equity securities during the 180-day period preceding the redemption or purchase.
 
The firm has accounted for the stock purchase contracts as equity instruments under EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” and, accordingly, recorded the cost of the stock purchase contracts as a reduction to additional paid-in capital. See Note 7 for information on the preferred stock that the firm will issue in connection with the stock purchase contracts.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 6.   Commitments, Contingencies and Guarantees
 
Commitments
 
Forward Starting Collateralized Agreements and Financings.  The firm had forward starting resale agreements and securities borrowing agreements of $41.04 billion and $28.14 billion as of August 2008 and November 2007, respectively. The firm had forward starting repurchase agreements and securities lending agreements of $13.84 billion and $15.39 billion as of August 2008 and November 2007, respectively.
 
Commitments to Extend Credit.  In connection with its lending activities, the firm had outstanding commitments to extend credit of $54.80 billion and $82.75 billion as of August 2008 and November 2007, respectively. The firm’s commitments to extend credit are agreements to lend to counterparties that have fixed termination dates and are contingent on the satisfaction of all conditions to borrowing set forth in the contract. Since these commitments may expire unused or be reduced or cancelled at the counterparty’s request, the total commitment amount does not necessarily reflect the actual future cash flow requirements. The firm accounts for these commitments at fair value. To the extent that the firm recognizes losses on these commitments, such losses are recorded within the firm’s Trading and Principal Investments segment net of any related underwriting fees.
 
The following table summarizes the firm’s commitments to extend credit, net of amounts syndicated to third parties, as of August 2008 and November 2007:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Commercial lending commitments
               
Investment-grade
  $ 14,051     $ 11,719  
Non-investment-grade
    13,523       41,930  
William Street program
    24,456       24,488  
Warehouse financing
    2,773       4,610  
                 
Total commitments to extend credit
  $ 54,803     $ 82,747  
                 
 
  •  Commercial lending commitments.  The firm’s commercial lending commitments are generally extended in connection with contingent acquisition financing and other types of corporate lending as well as commercial real estate financing. The total commitment amount does not necessarily reflect the actual future cash flow requirements, as the firm may syndicate all or substantial portions of these commitments in the future, the commitments may expire unused, or the commitments may be cancelled or reduced at the request of the counterparty. In addition, commitments that are extended for contingent acquisition financing are often intended to be short-term in nature, as borrowers often seek to replace them with other funding sources.
 
Included within non-investment-grade commitments as of August 2008 was $2.91 billion of exposure to leveraged lending capital market transactions, $293 million related to commercial real estate transactions and $10.32 billion arising from other unfunded credit facilities. Included within the non-investment-grade amount as of November 2007 was $26.09 billion of exposure to leveraged lending capital market transactions, $3.50 billion related to commercial real estate transactions and $12.34 billion arising from other unfunded credit facilities. Including funded loans, the firm’s total exposure to leveraged lending capital market transactions was $9.54 billion and $43.06 billion as of August 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
  •  William Street program.  Substantially all of the commitments provided under the William Street credit extension program are to investment-grade corporate borrowers. Commitments under the program are extended by William Street Commitment Corporation (Commitment Corp.), a consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are legally separated from other assets and liabilities of the firm, William Street Credit Corporation, GS Bank USA, Goldman Sachs Credit Partners L.P. or other consolidated wholly owned subsidiaries of Group Inc. The commitments extended by Commitment Corp. are supported, in part, by funding raised by William Street Funding Corporation (Funding Corp.), another consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are also legally separated from other assets and liabilities of the firm. The assets of Commitment Corp. and of Funding Corp. will not be available to their respective shareholders until the claims of their respective creditors have been paid. In addition, no affiliate of either Commitment Corp. or Funding Corp., except in limited cases as expressly agreed in writing, is responsible for any obligation of either entity. With respect to most of the William Street commitments, Sumitomo Mitsui Financial Group, Inc. (SMFG) provides the firm with credit loss protection that is generally limited to 95% of the first loss the firm realizes on approved loan commitments, up to a maximum of $1.00 billion. In addition, subject to the satisfaction of certain conditions, upon the firm’s request, SMFG will provide protection for 70% of the second loss on such commitments, up to a maximum of $1.13 billion. The firm also uses other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG.
 
  •  Warehouse financing.  The firm provides financing for the warehousing of financial assets. These arrangements are secured by the warehoused assets, primarily consisting of corporate bank loans and commercial mortgages as of August 2008 and November 2007. In connection with its warehouse financing activities, the firm had loans of $8 million and $44 million collateralized by subprime mortgages as of August 2008 and November 2007, respectively.
 
Letters of Credit.  The firm provides letters of credit issued by various banks to counterparties in lieu of securities or cash to satisfy various collateral and margin deposit requirements. Letters of credit outstanding were $9.68 billion and $8.75 billion as of August 2008 and November 2007, respectively.
 
Investment Commitments.  In connection with its merchant banking and other investing activities, the firm invests in private equity, real estate and other assets directly and through funds that it raises and manages. In connection with these activities, the firm had commitments to invest up to $13.99 billion and $17.76 billion as of August 2008 and November 2007, respectively, including $11.08 billion and $12.32 billion, respectively, of commitments to invest in funds managed by the firm.
 
Construction-Related Commitments.  As of August 2008 and November 2007, the firm had construction-related commitments of $480 million and $769 million, respectively, including commitments of $337 million and $642 million as of August 2008 and November 2007, respectively, related to the firm’s new world headquarters in New York City, which is expected to cost between $2.3 billion and $2.5 billion. The firm has partially financed this construction project with $1.65 billion of tax-exempt Liberty Bonds.
 
Underwriting Commitments.  As of August 2008, the firm had no commitments to purchase securities in connection with its underwriting activities. As of November 2007, the firm had commitments to purchase $88 million of securities in connection with its underwriting activities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Other.  The firm had other purchase commitments of $1.95 billion (including $768 million related to the firm’s offer to repurchase auction rate securities and a $760 million commitment to purchase mortgage loan and servicing assets) as of August 2008 and $1.76 billion (including a $1.34 billion commitment for the acquisition of Litton Loan Servicing LP) as of November 2007.
 
Leases.  The firm has contractual obligations under long-term noncancelable lease agreements, principally for office space, expiring on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. Future minimum rental payments, net of minimum sublease rentals are set forth below:
 
         
    (in millions)
Minimum rental payments
       
Remainder of 2008
  $ 115  
2009
    471  
2010
    439  
2011
    330  
2012
    266  
2013-thereafter
    2,017  
         
Total
  $ 3,638  
         
 
Contingencies
 
The firm is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its businesses. Management believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the firm’s financial condition, but may be material to the firm’s operating results for any particular period, depending, in part, upon the operating results for such period. Given the inherent difficulty of predicting the outcome of the firm’s litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, the firm cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
 
In connection with its insurance business, the firm is contingently liable to provide guaranteed minimum death and income benefits to certain contract holders and has established a reserve related to $8.31 billion and $10.84 billion of contract holder account balances as of August 2008 and November 2007, respectively, for such benefits. The weighted average attained age of these contract holders was 68 years and 67 years as of August 2008 and November 2007, respectively. The net amount at risk, representing guaranteed minimum death and income benefits in excess of contract holder account balances, was $1.58 billion and $1.04 billion as of August 2008 and November 2007, respectively. See Note 10 for more information on the firm’s insurance liabilities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Guarantees
 
The firm enters into various derivative contracts that meet the definition of a guarantee under FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Such derivative contracts include credit default and total return swaps, written equity and commodity put options, written currency contracts and interest rate caps, floors and swaptions. FIN 45 does not require disclosures about derivative contracts if such contracts may be cash settled and the firm has no basis to conclude it is probable that the counterparties held, at inception, the underlying instruments related to the derivative contracts. The firm has concluded that these conditions have been met for certain large, internationally active commercial and investment bank end users and certain other users. Accordingly, the firm has not included such contracts in the tables below.
 
The firm, in its capacity as an agency lender, indemnifies most of its securities lending customers against losses incurred in the event that borrowers do not return securities and the collateral held is insufficient to cover the market value of the securities borrowed.
 
In the ordinary course of business, the firm provides other financial guarantees of the obligations of third parties (e.g., performance bonds, standby letters of credit and other guarantees to enable clients to complete transactions and merchant banking fund-related guarantees). These guarantees represent obligations to make payments to beneficiaries if the guaranteed party fails to fulfill its obligation under a contractual arrangement with that beneficiary.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The following tables set forth certain information about the firm’s derivative contracts that meet the definition of a guarantee and certain other guarantees as of August 2008 and November 2007:
 
                                         
    As of August 2008
    Maximum Payout/Notional Amount by Period of Expiration (1)
    Remainder
  2009-
  2011-
  2013-
   
   
of 2008
 
2010
 
2012
 
Thereafter
 
Total
    (in millions)
Derivatives (2)
  $ 177,757     $ 468,630     $ 415,677     $ 537,606     $ 1,599,670  
Securities lending indemnifications (3)
    30,132                         30,132  
Performance bonds (4)
    2,047                         2,047  
Other financial guarantees (5)
    161       394       325       410       1,290  
                                         
                                         
    As of November 2007
    Maximum Payout/Notional Amount by Period of Expiration (1)
        2009-
  2011-
  2013-
   
   
2008
 
2010
 
2012
 
Thereafter
 
Total
    (in millions)
Derivatives (2)
  $ 580,769     $ 492,563     $ 457,511     $ 514,498     $ 2,045,341  
Securities lending indemnifications (3)
    26,673                         26,673  
Performance bonds (4)
    2,046                         2,046  
Other financial guarantees (5)
    381       121       258       46       806  
 
 
(1) Such amounts do not represent the anticipated losses in connection with these contracts.
 
(2) The aggregate carrying value of these derivatives was a liability of $49.10 billion and $33.10 billion as of August 2008 and November 2007, respectively. The carrying value excludes the effect of a legal right of setoff that may exist under an enforceable netting agreement. These derivative contracts are risk managed together with derivative contracts that are not considered guarantees under FIN 45, and therefore, these amounts do not reflect the firm’s overall risk related to its derivative activities.
 
(3) Collateral held by the lenders in connection with securities lending indemnifications was $31.05 billion and $27.49 billion as of August 2008 and November 2007, respectively.
 
(4) Excludes collateral of $2.05 billion related to these obligations as of both August 2008 and November 2007.
 
(5) The carrying value of these guarantees was a liability of $68 million and $43 million as of August 2008 and November 2007, respectively.
 
The firm has established trusts, including Goldman Sachs Capital I, II and III, and other entities for the limited purpose of issuing securities to third parties, lending the proceeds to the firm and entering into contractual arrangements with the firm and third parties related to this purpose. See Note 5 for information regarding the transactions involving Goldman Sachs Capital I, II and III. The firm effectively provides for the full and unconditional guarantee of the securities issued by these entities, which are not consolidated for accounting purposes. Timely payment by the firm of amounts due to these entities under the borrowing, preferred stock and related contractual arrangements will be sufficient to cover payments due on the securities issued by these entities. Management believes that it is unlikely that any circumstances will occur, such as nonperformance on the part of paying agents or other service providers, that would make it necessary for the firm to make payments related to these entities other than those required under the terms of the borrowing, preferred stock and related contractual arrangements and in connection with certain expenses incurred by these entities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
In the ordinary course of business, the firm indemnifies and guarantees certain service providers, such as clearing and custody agents, trustees and administrators, against specified potential losses in connection with their acting as an agent of, or providing services to, the firm or its affiliates. The firm also indemnifies some clients against potential losses incurred in the event specified third-party service providers, including sub-custodians and third-party brokers, improperly execute transactions. In addition, the firm is a member of payment, clearing and settlement networks as well as securities exchanges around the world that may require the firm to meet the obligations of such networks and exchanges in the event of member defaults. In connection with its prime brokerage and clearing businesses, the firm agrees to clear and settle on behalf of its clients the transactions entered into by them with other brokerage firms. The firm’s obligations in respect of such transactions are secured by the assets in the client’s account as well as any proceeds received from the transactions cleared and settled by the firm on behalf of the client. In connection with joint venture investments, the firm may issue loan guarantees under which it may be liable in the event of fraud, misappropriation, environmental liabilities and certain other matters involving the borrower. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these guarantees and indemnifications have been recognized in the condensed consolidated statements of financial condition as of August 2008 and November 2007.
 
The firm provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. The firm may also provide indemnifications protecting against changes in or adverse application of certain U.S. tax laws in connection with ordinary-course transactions such as securities issuances, borrowings or derivatives. In addition, the firm may provide indemnifications to some counterparties to protect them in the event additional taxes are owed or payments are withheld, due either to a change in or an adverse application of certain non-U.S. tax laws. These indemnifications generally are standard contractual terms and are entered into in the ordinary course of business. Generally, there are no stated or notional amounts included in these indemnifications, and the contingencies triggering the obligation to indemnify are not expected to occur. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these arrangements have been recognized in the condensed consolidated statements of financial condition as of August 2008 and November 2007.
 
Note 7.   Shareholders’ Equity
 
On September 15, 2008, the Board of Directors of Group Inc. (the Board) declared a dividend of $0.35 per common share with respect to the firm’s third quarter of 2008 to be paid on November 24, 2008 to common shareholders of record on October 27, 2008.
 
During the three and nine months ended August 2008, the firm repurchased 1.5 million and 10.5 million shares of its common stock for a total cost of $271 million and $2.03 billion, respectively. The average cost per share for repurchased shares was $180.07 and $193.41 for the three and nine months ended August 2008, respectively. In addition, to satisfy minimum statutory employee tax withholding requirements related to the delivery of common stock underlying restricted stock units, the firm cancelled 6.7 million of restricted stock units with a total value of $1.31 billion in the first nine months of 2008.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The firm’s share repurchase program is intended to help maintain the appropriate level of common equity and to substantially offset increases in share count over time resulting from employee share-based compensation. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by the firm’s current and projected capital positions (i.e., comparisons of the firm’s desired level of capital to its actual level of capital) but which may also be influenced by general market conditions and the prevailing price and trading volumes of the firm’s common stock.
 
As of August 2008, the firm had 124,000 shares of perpetual non-cumulative preferred stock issued and outstanding in four series as set forth in the following table:
 
                                 
    Shares
  Shares
      Earliest
  Redemption Value
Series
 
Issued
 
Authorized
 
Dividend Rate
 
Redemption Date
 
(in millions)
A
    30,000       50,000     3 month LIBOR + 0.75%,
with floor of 3.75% per annum
  April 25, 2010   $ 750  
                                 
B
    32,000       50,000     6.20% per annum   October 31, 2010     800  
                                 
C
    8,000       25,000     3 month LIBOR + 0.75%,
with floor of 4.00% per annum
  October 31, 2010     200  
                                 
D
    54,000       60,000     3 month LIBOR + 0.67%,
with floor of 4.00% per annum
  May 24, 2011     1,350  
                                 
      124,000       185,000             $ 3,100  
                                 
 
Each share of preferred stock issued and outstanding has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option at a redemption price equal to $25,000 plus declared and unpaid dividends. Dividends on each series of preferred stock, if declared, are payable quarterly in arrears. The firm’s ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, its common stock is subject to certain restrictions in the event that the firm fails to pay or set aside full dividends on the preferred stock for the latest completed dividend period. All series of preferred stock are pari passu and have a preference over the firm’s common stock upon liquidation.
 
In 2007, the Board authorized 17,500.1 shares of perpetual Non-Cumulative Preferred Stock, Series E and 5,000.1 shares of perpetual Non-Cumulative Preferred Stock, Series F in connection with the APEX issuance. See Note 5 for further information on the APEX issuance. Under the stock purchase contracts, the firm will issue on the relevant stock purchase dates (on or before June 1, 2013 and September 1, 2013 for Series E and Series F preferred stock, respectively) one share of Series E and Series F preferred stock to Goldman Sachs Capital II and III, respectively, for each $100,000 principal amount of subordinated debt held by these trusts. When issued, each share of Series E and Series F preferred stock will have a par value of $0.01 and a liquidation preference of $100,000 per share. Dividends on Series E preferred stock, if declared, will be payable semi-annually at a fixed annual rate of 5.79% if the stock is issued prior to June 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.77% and (ii) 4.00%. Dividends on Series F preferred stock, if declared, will be payable quarterly at a rate per annum equal to three-month LIBOR plus 0.77% if the stock is issued prior to September 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.77% and (ii) 4.00%. The preferred stock may be redeemed at the option of the firm on the stock purchase dates or any day thereafter, subject to regulatory approval and certain covenant restrictions governing the firm’s ability to redeem or purchase the preferred stock without issuing common stock or other instruments with equity-like characteristics.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
On September 15, 2008, the Board declared a dividend per preferred share of $236.98, $387.50, $252.78 and $252.78 for Series A, Series B, Series C and Series D preferred stock, respectively, to be paid on November 10, 2008 to preferred shareholders of record on October 26, 2008.
 
Subsequent to August 2008, the firm issued preferred and common stock and warrants to purchase common stock. See Note 16 for further information.
 
The following table sets forth the firm’s accumulated other comprehensive income/(loss) by type:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Adjustment from adoption of SFAS No. 158, net of tax
  $ (194 )   $ (194 )
Currency translation adjustment, net of tax
    31       68  
Net unrealized gains/(losses) on available-for-sale securities, net of tax (1)
    (11 )     8  
Pension and postretirement liability adjustment, net of tax
    9        
                 
Total accumulated other comprehensive income/(loss), net of tax
  $ (165 )   $ (118 )
                 
(1) Consists of net unrealized losses of $23 million on available-for-sale securities held by the firm’s insurance subsidiaries and net unrealized gains of $12 million on available-for-sale securities held by investees accounted for under the equity method as of August 2008. Consists of net unrealized gains of $9 million on available-for-sale securities held by investees accounted for under the equity method and net unrealized losses of $1 million on available-for-sale securities held by the firm’s insurance subsidiaries as of November 2007.
 
Note 8.   Earnings Per Common Share
 
The computations of basic and diluted earnings per common share are set forth below:
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
    (in millions, except per share amounts)
Numerator for basic and diluted EPS — net earnings applicable to common shareholders
  $ 810     $ 2,806     $ 4,328     $ 8,241  
                                 
Denominator for basic EPS — weighted average number of common shares
    427.6       429.0       429.3       436.2  
Effect of dilutive securities (1)
                               
Restricted stock units
    11.2       14.4       9.8       13.2  
Stock options
    9.5       14.0       10.6       14.9  
                                 
Dilutive potential common shares
    20.7       28.4       20.4       28.1  
                                 
Denominator for diluted EPS — weighted average number of common shares and dilutive potential common shares
    448.3       457.4       449.7       464.3  
                                 
Basic EPS
  $ 1.89     $ 6.54     $ 10.08     $ 18.89  
Diluted EPS
    1.81       6.13       9.62       17.75  
 
(1) The diluted EPS computations do not include the antidilutive effect of the following restricted stock units and stock options:
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
        (in millions)    
 
Number of antidilutive restricted stock units and stock options, end of period
    6.1             6.7        
                                 


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 9.   Goodwill and Identifiable Intangible Assets
 
Goodwill
 
The following table sets forth the carrying value of the firm’s goodwill by operating segment, which is included in “Other assets” in the condensed consolidated statements of financial condition:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Investment Banking
               
Underwriting
  $ 125     $ 125  
Trading and Principal Investments
               
FICC
    275       123  
Equities (1)
    2,389       2,381  
Principal Investments
    80       11  
Asset Management and Securities Services
               
Asset Management (2)
    567       564  
Securities Services
    117       117  
                 
Total
  $ 3,553     $ 3,321  
                 
 
 
(1) Primarily related to SLK LLC (SLK).
 
(2) Primarily related to The Ayco Company, L.P. (Ayco).


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Identifiable Intangible Assets
 
The following table sets forth the gross carrying amount, accumulated amortization and net carrying amount of the firm’s identifiable intangible assets:
 
                     
        As of
        August
  November
        2008   2007
        (in millions)
 
Customer lists (1)
  Gross carrying amount   $ 1,129     $ 1,086  
    Accumulated amortization     (416 )     (354 )
                     
    Net carrying amount   $ 713     $ 732  
                     
New York Stock
  Gross carrying amount   $ 714     $ 714  
Exchange (NYSE)
  Accumulated amortization     (242 )     (212 )
                     
specialist rights
  Net carrying amount   $ 472     $ 502  
                     
Insurance-related
  Gross carrying amount   $ 444     $ 461  
assets (2)
  Accumulated amortization     (123 )     (89 )
                     
    Net carrying amount   $ 321     $ 372  
                     
Exchange-traded
  Gross carrying amount   $ 138     $ 138  
fund (ETF) lead
  Accumulated amortization     (42 )     (38 )
                     
market maker rights
  Net carrying amount   $ 96     $ 100  
                     
Other (3)
  Gross carrying amount   $ 147     $ 360  
    Accumulated amortization     (69 )     (295 )
                     
    Net carrying amount   $ 78     $ 65  
                     
Total
  Gross carrying amount   $ 2,572     $ 2,759  
    Accumulated amortization     (892 )     (988 )
                     
    Net carrying amount   $ 1,680     $ 1,771  
                     
 
 
(1) Primarily includes the firm’s clearance and execution and NASDAQ customer lists related to SLK and financial counseling customer lists related to Ayco.
 
(2) Consists of VOBA and DAC. VOBA represents the present value of estimated future gross profits of the variable annuity and life insurance business. DAC results from commissions paid by the firm to the primary insurer (ceding company) on life and annuity reinsurance agreements as compensation to place the business with the firm and to cover the ceding company’s acquisition expenses. VOBA and DAC are amortized over the estimated life of the underlying contracts based on estimated gross profits, and amortization is adjusted based on actual experience. The weighted average remaining amortization period for VOBA and DAC is seven years as of August 2008.
 
(3) Primarily includes marketing-related assets and power contracts.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Substantially all of the firm’s identifiable intangible assets are considered to have finite lives and are amortized over their estimated lives. The weighted average remaining life of the firm’s identifiable intangibles is approximately 11 years.
 
The estimated future amortization for existing identifiable intangible assets through 2013 is set forth below:
 
         
    (in millions)
Remainder of 2008
  $ 45  
2009
    176  
2010
    157  
2011
    150  
2012
    140  
2013
    127  
 
Note 10.   Other Assets and Other Liabilities
 
Other Assets
 
Other assets are generally less liquid, nonfinancial assets. The following table sets forth the firm’s other assets by type:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Property, leasehold improvements and equipment (1)
  $ 10,717     $ 8,975  
Goodwill and identifiable intangible assets (2)
    5,233       5,092  
Income tax-related assets
    5,184       4,177  
Equity-method investments (3)
    1,766       2,014  
Miscellaneous receivables and other
    4,847       3,809  
                 
Total
  $ 27,747     $ 24,067  
                 
 
 
(1) Net of accumulated depreciation and amortization of $6.47 billion and $5.88 billion as of August 2008 and November 2007, respectively.
 
(2) See Note 9 for further information regarding the firm’s goodwill and identifiable intangible assets.
 
(3) Excludes investments of $3.71 billion and $2.25 billion accounted for at fair value under SFAS No. 159 as of August 2008 and November 2007, respectively, which are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Other Liabilities
 
The following table sets forth the firm’s other liabilities and accrued expenses by type:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
Insurance-related liabilities (1)
  $ 10,603     $ 10,344  
Minority interest (2)
    3,621       7,265  
Compensation and benefits
    7,551       11,816  
Income tax-related liabilities
    2,123       2,546  
Accrued expenses and other payables
    4,619       4,749  
Employee interests in consolidated funds
    508       2,187  
                 
Total
  $ 29,025     $ 38,907  
                 
 
 
(1) Insurance-related liabilities are set forth in the table below:
 
                 
    As of
    August
  November
    2008   2007
    (in millions)
 
Separate account liabilities
  $ 5,430     $ 7,039  
Liabilities for future benefits and unpaid claims
    4,071       2,142  
Contract holder account balances
    861       937  
Reserves for guaranteed minimum death and income benefits
    241       226  
                 
Total insurance-related liabilities
  $ 10,603     $ 10,344  
                 
 
Separate account liabilities are supported by separate account assets, representing segregated contract holder funds under variable annuity and life insurance contracts. Separate account assets are included in “Cash and securities segregated for regulatory and other purposes” in the condensed consolidated statements of financial condition.
 
Liabilities for future benefits and unpaid claims include liabilities arising from reinsurance provided by the firm to other insurers. The firm had a receivable for $1.29 billion and $1.30 billion as of August 2008 and November 2007, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. In addition, the firm has ceded risks to reinsurers related to certain of its liabilities for future benefits and unpaid claims and had a receivable of $1.34 billion and $785 million as of August 2008 and November 2007, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. Contracts to cede risks to reinsurers do not relieve the firm from its obligations to contract holders. Liabilities for future benefits and unpaid claims include $1.34 billion carried at fair value under SFAS No. 159.
 
Reserves for guaranteed minimum death and income benefits represent a liability for the expected value of guaranteed benefits in excess of projected annuity account balances. These reserves are computed in accordance with AICPA SOP 03-1 and are based on total payments expected to be made less total fees expected to be assessed over the life of the contract.
 
(2) Includes $2.31 billion and $5.95 billion related to consolidated investment funds as of August 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 11.   Employee Benefit Plans
 
The firm sponsors various pension plans and certain other postretirement benefit plans, primarily healthcare and life insurance. The firm also provides certain benefits to former or inactive employees prior to retirement.
 
Defined Benefit Pension Plans and Postretirement Plans
 
Employees of certain non-U.S. subsidiaries participate in various defined benefit pension plans. These plans generally provide benefits based on years of credited service and a percentage of the employee’s eligible compensation. The firm maintains a defined benefit pension plan for substantially all U.K. employees. As of April 2008, this plan has been closed to new participants, but will continue to accrue benefits for existing participants.
 
The firm also maintains a defined benefit pension plan for substantially all U.S. employees hired prior to November 1, 2003. As of November 2004, this plan was closed to new participants and frozen such that existing participants would not accrue any additional benefits. In addition, the firm maintains unfunded postretirement benefit plans that provide medical and life insurance for eligible retirees and their dependents covered under these programs.
 
The components of pension expense/(income) and postretirement expense are set forth below:
 
                                 
    Three Months
  Nine Months
    Ended August   Ended August
    2008   2007   2008   2007
        (in millions)    
U.S. pension
                               
Interest cost
  $ 7     $ 5     $ 18     $ 16  
Expected return on plan assets
    (9 )     (8 )     (25 )     (24 )
Net amortization
    (1 )           (1 )     1  
                                 
Total
  $ (3 )   $ (3 )   $ (8 )   $ (7 )
                                 
Non-U.S. pension
                               
Service cost
  $ 22     $ 18     $ 64     $ 55  
Interest cost
    10       8       31       24  
Expected return on plan assets
    (10 )     (8 )     (31 )     (25 )
Net amortization
          2       1       7  
                                 
Total
  $ 22     $ 20     $ 65     $ 61  
                                 
Postretirement
                               
Service cost
  $ 6     $ 7     $ 16     $ 16  
Interest cost
    7       7       20       17  
Net amortization
    4       6       13       14  
                                 
Total
  $ 17     $ 20     $ 49     $ 47  
                                 
 
The firm expects to contribute a minimum of $133 million to its pension plans and $7 million to its postretirement plans in 2008.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 12.   Transactions with Affiliated Funds
 
The firm has formed numerous nonconsolidated investment funds with third-party investors. The firm generally acts as the investment manager for these funds and, as such, is entitled to receive management fees and, in certain cases, advisory fees, incentive fees or overrides from these funds. These fees amounted to $2.55 billion and $2.76 billion for the nine months ended August 2008 and August 2007, respectively. As of August 2008 and November 2007, the fees receivable from these funds were $769 million and $596 million, respectively. Additionally, the firm may invest alongside the third-party investors in certain funds. The aggregate carrying value of the firm’s interests in these funds was $16.66 billion and $12.90 billion as of August 2008 and November 2007, respectively. In the ordinary course of business, the firm may also engage in other activities with these funds, including, among others, securities lending, trade execution, trading, custody, and acquisition and bridge financing. See Note 6 for the firm’s commitments related to these funds.
 
Note 13.   Income Taxes
 
FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold required before a tax position can be recognized in the financial statements. FIN 48 also provides guidance on measurement, derecognition, classification, interim period accounting and accounting for interest and penalties. The firm adopted the provisions of FIN 48 as of December 1, 2007 and recorded a transition adjustment resulting in a reduction of $201 million to beginning retained earnings.
 
FIN 48 requires disclosure of the following amounts as of the date of adoption, and on an annual basis thereafter. As of December 1, 2007 (date of adoption), the firm’s liability for unrecognized tax benefits reported in “Other liabilities and accrued expenses” in the condensed consolidated statement of financial condition was $1.04 billion. The firm reported a related deferred tax asset of $497 million in “Other assets” in the condensed consolidated statement of financial condition. If recognized, the net liability of $545 million would reduce the firm’s effective income tax rate. As of December 1, 2007, the firm’s accrued liability for interest expense related to income tax matters and income tax penalties was $79 million. The firm reports interest expense related to income tax matters in “Provision for taxes” in the condensed consolidated statements of earnings and income tax penalties in “Other expenses” in the condensed consolidated statements of earnings.
 
During the nine months ended August 29, 2008, the net liability of $545 million as of December 1, 2007 increased by approximately $164 million. The firm does not expect unrecognized tax benefits to change significantly during the twelve months subsequent to August 29, 2008.
 
The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. During fiscal 2007, the IRS substantially concluded its examination of fiscal years 2003 and 2004. Tax audits that have been substantially concluded in other jurisdictions in which the firm has significant business operations include New York State’s examination of fiscal years through 2003, the United Kingdom’s review of fiscal years through 2004 and Hong Kong’s review of fiscal years through 2001. The firm does not expect that potential additional assessments from these examinations will be material to its results of operations.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Below is a table of the earliest tax years that remain subject to examination by major jurisdiction:
 
         
    Earliest
    Tax Year
    Subject to
Jurisdiction
 
Examination
U.S. Federal
    2005  (1)
New York State and City
    2004  (2)
United Kingdom
    2005  
Japan
    2005  
Hong Kong
    2002  
Korea
    2003  
 
 
(1) IRS examination of fiscal 2005, 2006 and 2007 began during 2008.
 
(2) New York State and City examination of fiscal 2004, 2005 and 2006 began in 2008.
 
All years subsequent to the above years remain open to examination by the taxing authorities. The firm believes that the liability for unrecognized tax benefits it has established is adequate in relation to the potential for additional assessments. The resolution of tax matters is not expected to have a material effect on the firm’s financial condition but may be material to the firm’s operating results for a particular period, depending, in part, upon the operating results for that period.
 
Note 14.   Regulation
 
As of August 2008, the firm was regulated by the U.S. Securities and Exchange Commission (SEC) as a Consolidated Supervised Entity (CSE) and, as such, was subject to group-wide supervision and examination by the SEC and to minimum capital adequacy standards on a consolidated basis as set out in the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee on Banking Supervision. The firm was in compliance with the CSE capital adequacy standards as of August 2008 and November 2007. On September 21, 2008, Group Inc. became a bank holding company regulated by the Federal Reserve Board under the U.S. Bank Holding Company Act of 1956. On September 26, 2008, the SEC announced that it was ending the CSE program. As a bank holding company, the firm is now subject to Federal Reserve Board regulations and policies which, among other things, may, under certain circumstances, limit the amount of dividends Group Inc. can pay to its shareholders. In addition, the firm will now be subject to Federal Reserve Board scrutiny of its leverage ratio. See Note 16 for further information.
 
The firm’s U.S. regulated broker-dealer subsidiaries include Goldman, Sachs & Co. (GS&Co.) and Goldman Sachs Execution & Clearing, L.P. (GSEC). GS&Co. and GSEC are registered U.S. broker-dealers and futures commission merchants subject to Rule 15c3-1 of the SEC and Rule 1.17 of the Commodity Futures Trading Commission, which specify uniform minimum net capital requirements, as defined, for their registrants, and also require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1. As of August 2008, GS&Co. had regulatory net capital, as defined by Rule 15c3-1, of $11.37 billion, which exceeded the amounts required by $8.53 billion. As of August 2008, GSEC had regulatory net capital, as defined by Rule 15c3-1, of $1.27 billion, which exceeded the amounts required by $1.19 billion. In addition to its alternative minimum net capital requirements, GS&Co. is


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
also required to hold tentative net capital in excess of $1 billion and net capital in excess of $500 million in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1. GS&Co. is also required to notify the SEC in the event that its tentative net capital is less than $5 billion. As of August 2008 and November 2007, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements.
 
As of August 2008, GS Bank USA, a wholly owned industrial bank, was regulated by the State of Utah Department of Financial Institutions and was a member of the Federal Deposit Insurance Corporation (FDIC). On September 26, 2008, GS Bank USA became a member of the Federal Reserve System and is now regulated by the Federal Reserve Board and by the State of Utah Department of Financial Institutions, and continues to be a member of the FDIC. The deposits of GS Bank USA are insured by the FDIC to the extent provided by law. Goldman Sachs Bank Europe PLC (GS Bank Europe), a wholly owned credit institution, is regulated by the Irish Financial Services Regulatory Authority. Both entities are subject to minimum capital requirements and as of August 2008, both were in compliance with all regulatory capital requirements. As of August 2008 and November 2007, substantially all bank deposits were held at GS Bank USA and GS Bank Europe. Deposits at GS Bank USA were $22.17 billion and $15.26 billion as of August 2008 and November 2007, respectively, all of which were U.S. dollar-denominated and the weighted average interest rates for these deposits were 2.39% and 4.71% as of August 2008 and November 2007, respectively. As of August 2008, deposits at GS Bank Europe were $6.80 billion, substantially all of which were either U.S. dollar or Euro-denominated and the weighted average interest rate for these deposits was 3.04%. Substantially all of these deposits have no stated maturity and can be withdrawn upon short notice. The carrying value of bank deposits approximated fair value as of August 2008 and November 2007.
 
The firm has U.S. insurance subsidiaries that are subject to state insurance regulation and oversight in the states in which they are domiciled and in the other states in which they are licensed. In addition, certain of the firm’s insurance subsidiaries outside of the U.S. are regulated by the Bermuda Registrar of Companies and the U.K.’s Financial Services Authority (FSA). The firm’s insurance subsidiaries were in compliance with all regulatory capital requirements as of August 2008 and November 2007.
 
The firm’s principal non-U.S. regulated subsidiaries include Goldman Sachs International (GSI) and Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, the firm’s regulated U.K. broker-dealer, is subject to the capital requirements of the FSA. GSJCL, the firm’s regulated Japanese broker-dealer, is subject to the capital requirements of Japan’s Financial Services Agency. As of August 2008 and November 2007, GSI and GSJCL were in compliance with their local capital adequacy requirements. Certain other non-U.S. subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of August 2008 and November 2007, these subsidiaries were in compliance with their local capital adequacy requirements.
 
Note 15.   Business Segments
 
In reporting to management, the firm’s operating results are categorized into the following three business segments: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.
 
Basis of Presentation
 
In reporting segments, certain of the firm’s business lines have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate.
 
The cost drivers of the firm taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of the firm’s business segments. Compensation and benefits expenses within the firm’s segments reflect, among other factors, the overall performance of the firm as well as the performance of individual business units. Consequently, pre-tax margins in one segment of the firm’s business may be significantly affected by the performance of the firm’s other business segments. The timing and magnitude of changes in the firm’s bonus accruals can have a significant effect on segment results in a given period.
 
The firm allocates revenues and expenses among the three business segments. Due to the integrated nature of these segments, estimates and judgments have been made in allocating certain revenue and expense items. Transactions between segments are based on specific criteria or approximate third-party rates. Total operating expenses include corporate items that have not been allocated to individual business segments. The allocation process is based on the manner in which management views the business of the firm.
 
The segment information presented in the table below is prepared according to the following methodologies:
 
  •  Revenues and expenses directly associated with each segment are included in determining pre-tax earnings.
 
  •  Net revenues in the firm’s segments include allocations of interest income and interest expense to specific securities, commodities and other positions in relation to the cash generated by, or funding requirements of, such underlying positions. Net interest is included within segment net revenues as it is consistent with the way in which management assesses segment performance.
 
  •  Overhead expenses not directly allocable to specific segments are allocated ratably based on direct segment expenses.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Segment Operating Results
 
Management believes that the following information provides a reasonable representation of each segment’s contribution to consolidated pre-tax earnings and total assets:
 
                                     
        As of or for the
  As of or for the
        Three Months
  Nine Months
        Ended August   Ended August
        2008   2007   2008   2007
        (in millions)
 
Investment
  Net revenues   $ 1,294     $ 2,145     $ 4,151     $ 5,582  
Banking
  Operating expenses     772       1,291       2,867       3,831  
                                     
    Pre-tax earnings   $ 522     $ 854     $ 1,284     $ 1,751  
                                     
    Segment assets   $ 3,663     $ 5,051     $ 3,663     $ 5,051  
                                     
Trading and
  Net revenues   $ 2,704     $ 8,229     $ 13,419     $ 24,295  
Principal
  Operating expenses     3,465       5,344       11,169       14,934  
                                     
Investments
  Pre-tax earnings/(loss)   $ (761 )   $ 2,885     $ 2,250     $ 9,361  
                                     
    Segment assets   $ 724,717     $ 712,236     $ 724,717     $ 712,236  
                                     
Asset Management
  Net revenues   $ 2,045     $ 1,960     $ 6,230     $ 5,369  
and Securities
  Operating expenses     833       1,405       3,803       3,895  
                                     
Services
  Pre-tax earnings   $ 1,212     $ 555     $ 2,427     $ 1,474  
                                     
    Segment assets   $ 353,393     $ 328,491     $ 353,393     $ 328,491  
                                     
Total
  Net revenues (1)   $ 6,043     $ 12,334     $ 23,800     $ 35,246