10-Q 1 d369549d10q.htm FORM 10-Q Form 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

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

For the quarterly period ended March 31, 2017

or

 

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

 

For the transition period from                                             to

  

Commission File Number: 001-14965

The Goldman Sachs Group, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   13-4019460

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

200 West Street, New York, N.Y.   10282
(Address of principal executive offices)   (Zip Code)

(212) 902-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

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

☒ Yes ☐ No

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

 

  Large accelerated filer  ☒                     Accelerated filer  ☐
Non-accelerated filer  ☐ (Do not check if a smaller reporting company)          Smaller reporting company  ☐
Emerging growth company  ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

☐ Yes ☒ No

APPLICABLE ONLY TO CORPORATE ISSUERS

As of April 21, 2017, there were 393,630,833 shares of the registrant’s common stock outstanding.


Table of Contents

THE GOLDMAN SACHS GROUP, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2017

 

INDEX

 

Form 10-Q Item Number   Page No.
 

PART I

FINANCIAL INFORMATION

    1  
 

Item 1

Financial Statements (Unaudited)

  1  
 

Condensed Consolidated Statements of Earnings

  1  
         

Condensed Consolidated Statements of Comprehensive Income

  2  
         

Condensed Consolidated Statements of Financial Condition

  3  
         

Condensed Consolidated Statements of Changes in Shareholders’ Equity

  4  
         

Condensed Consolidated Statements of Cash Flows

  5  
     

Notes to Condensed Consolidated Financial Statements

  6  
     

Note 1.   Description of Business

  6  
     

Note 2.   Basis of Presentation

  6  
     

Note 3.   Significant Accounting Policies

  7  
     

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

  14  
         

Note 5.   Fair Value Measurements

  15  
     

Note 6.   Cash Instruments

  16  
     

Note 7.   Derivatives and Hedging Activities

  22  
     

Note 8.   Fair Value Option

  33  
     

Note 9.   Loans Receivable

  39  
     

Note 10. Collateralized Agreements and Financings

  43  
     

Note 11. Securitization Activities

  47  
     

Note 12. Variable Interest Entities

  49  
     

Note 13. Other Assets

  53  
     

Note 14. Deposits

  55  
     

Note 15. Short-Term Borrowings

  56  
     

Note 16. Long-Term Borrowings

  56  
     

Note 17. Other Liabilities and Accrued Expenses

  59  
     

Note 18. Commitments, Contingencies and Guarantees

  59  
     

Note 19. Shareholders’ Equity

  63  
     

Note 20. Regulation and Capital Adequacy

  65  
     

Note 21. Earnings Per Common Share

  75  
     

Note 22. Transactions with Affiliated Funds

  75  
     

Note 23. Interest Income and Interest Expense

  76  
     

Note 24. Income Taxes

  76  
     

Note 25. Business Segments

  77  
     

Note 26. Credit Concentrations

  79  
     

Note  27. Legal Proceedings

  80  
     Page No.
 

Report of Independent Registered Public Accounting Firm

  87  
     

Statistical Disclosures

  88  
     

Item 2

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

  90  
     

Introduction

  90  
     

Executive Overview

  90  
     

Business Environment

  91  
     

Critical Accounting Policies

  92  
     

Recent Accounting Developments

  94  
     

Use of Estimates

  94  
     

Results of Operations

  95  
     

Balance Sheet and Funding Sources

  104  
     

Equity Capital Management and Regulatory Capital

  109  
     

Regulatory Developments

  115  
     

Off-Balance-Sheet Arrangements and Contractual Obligations

  117  
     

Risk Management

  119  
     

Overview and Structure of Risk Management

  119  
     

Liquidity Risk Management

  124  
     

Market Risk Management

  131  
     

Credit Risk Management

  136  
     

Operational Risk Management

  141  
     

Model Risk Management

  143  
     

Available Information

  144  
     

Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995

  145  
     

Item 3

Quantitative and Qualitative Disclosures About Market Risk

  146  
     

Item 4

Controls and Procedures

  146  
     

PART II

OTHER INFORMATION

  146  
     

Item 1

Legal Proceedings

  146  
     

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

  146  
     

Item 6

Exhibits

  147  
     

SIGNATURES

  147  
 

 

    Goldman Sachs March 2017 Form 10-Q


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)

 

   

Three Months

Ended March

 
in millions, except per share amounts     2017        2016  

Revenues

    

Investment banking

    $1,703        $1,463  
   

Investment management

    1,397        1,262  
   

Commissions and fees

    771        917  
   

Market making

    2,418        1,862  
   

Other principal transactions

    1,221        (49

Total non-interest revenues

    7,510        5,455  
   

 

Interest income

    2,746        2,348  
   

Interest expense

    2,230        1,465  

Net interest income

    516        883  

Net revenues, including net interest income

    8,026        6,338  

 

Operating expenses

    

Compensation and benefits

    3,291        2,662  
   

 

Brokerage, clearing, exchange and distribution fees

    615        691  
   

Market development

    134        122  
   

Communications and technology

    223        197  
   

Depreciation and amortization

    257        239  
   

Occupancy

    176        183  
   

Professional fees

    205        220  
   

Other expenses

    586        448  

Total non-compensation expenses

    2,196        2,100  

Total operating expenses

    5,487        4,762  

 

Pre-tax earnings

    2,539        1,576  
   

Provision for taxes

    284        441  

Net earnings

    2,255        1,135  
   

Preferred stock dividends

    93        (65

Net earnings applicable to common shareholders

    $2,162        $1,200  

 

Earnings per common share

    

Basic

    $  5.23        $  2.71  
   

Diluted

    $  5.15        $  2.68  
   

 

Dividends declared per common share

    $  0.65        $  0.65  
   

 

Average common shares

    

Basic

    412.5        440.8  
   

Diluted

    420.1        447.4  

 

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

 

    Goldman Sachs March 2017 Form 10-Q   1


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Net earnings

    $2,255        $1,135  
   

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

    

Currency translation

    (16      (17
   

Debt valuation adjustment

    (139      (12
   

Pension and postretirement liabilities

    1        (36

Other comprehensive loss

    (154      (65

Comprehensive income

    $2,101        $1,070  

 

 

 

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

 

2   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Financial Condition

(Unaudited)

 

    As of  
$ in millions, except per share amounts    

March

2017

 

 

    

December

2016

 

 

Assets

    

Cash and cash equivalents

    $123,035        $121,711  
   

Collateralized agreements:

    

Securities purchased under agreements to resell and federal funds sold (includes $116,546 and $116,077 at fair value)

    117,278        116,925  
   

Securities borrowed (includes $79,893 and $82,398 at fair value)

    187,446        184,600  
   

Receivables:

    

Brokers, dealers and clearing organizations

    25,750        18,044  
   

Customers and counterparties (includes $3,644 and $3,266 at fair value)

    54,460        47,780  
   

Loans receivable

    50,385        49,672  
   

Financial instruments owned, at fair value (includes $53,389 and $51,278 pledged as collateral)

    308,871        295,952  
   

Other assets

    26,844        25,481  

Total assets

    $894,069        $860,165  

 

Liabilities and shareholders’ equity

    

Deposits (includes $19,480 and $13,782 at fair value)

    $127,929        $124,098  
   

Collateralized financings:

    

Securities sold under agreements to repurchase, at fair value

    88,533        71,816  
   

Securities loaned (includes $4,403 and $2,647 at fair value)

    9,698        7,524  
   

Other secured financings (includes $21,960 and $21,073 at fair value)

    22,376        21,523  
   

Payables:

    

Brokers, dealers and clearing organizations

    8,589        4,386  
   

Customers and counterparties

    187,669        184,069  
   

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

    115,927        117,143  
   

Unsecured short-term borrowings (includes $13,900 and $14,792 at fair value)

    35,872        39,265  
   

Unsecured long-term borrowings (includes $32,075 and $29,410 at fair value)

    199,370        189,086  
   

Other liabilities and accrued expenses (includes $806 and $621 at fair value)

    11,189        14,362  

Total liabilities

    807,152        773,272  
   

 

Commitments, contingencies and guarantees

    

 

Shareholders’ equity

    

Preferred stock, par value $0.01 per share; aggregate liquidation preference of $11,203 and $11,203

    11,203        11,203  
   

Common stock, par value $0.01 per share; 4,000,000,000 and 4,000,000,000 shares authorized, 881,753,381 and 873,608,100 shares issued, and 394,791,563 and 392,632,230 shares outstanding

    9        9  
   

Share-based awards

    3,155        3,914  
   

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

            
   

Additional paid-in capital

    53,185        52,638  
   

Retained earnings

    90,904        89,039  
   

Accumulated other comprehensive loss

    (1,370      (1,216
   

Stock held in treasury, at cost, par value $0.01 per share; 486,961,820 and 480,975,872 shares

    (70,169      (68,694

Total shareholders’ equity

    86,917        86,893  

Total liabilities and shareholders’ equity

    $894,069        $860,165  

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

 

    Goldman Sachs March 2017 Form 10-Q   3


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

$ in millions    
Three Months Ended
March 2017
 
 
           
Year Ended
December 2016
 
 

Preferred stock

     

Beginning balance

    $ 11,203         $ 11,200  
   

Issued

            1,325  
   

Redeemed

                  (1,322

Ending balance

    11,203         11,203  
   

Common stock

     

Beginning balance

    9         9  
   

Issued

                   

Ending balance

    9         9  
   

Share-based awards

     

Beginning balance, as previously reported

    3,914         4,151  
   

Cumulative effect of the change in accounting principle related to forfeiture of share-based awards

    35                

Beginning balance, adjusted

    3,949         4,151  
   

Issuance and amortization of share-based awards

    1,271         2,143  
   

Delivery of common stock underlying share-based awards

    (1,954       (2,068
   

Forfeiture of share-based awards

    (5       (102
   

Exercise of share-based awards

    (106             (210

Ending balance

    3,155         3,914  
   

Additional paid-in capital

     

Beginning balance

    52,638         51,340  
   

Delivery of common stock underlying share-based awards

    2,045         2,282  
   

Cancellation of share-based awards in satisfaction of withholding tax requirements

    (1,495       (1,121
   

Preferred stock issuance costs, net

            (10
   

Excess net tax benefit related to share-based awards

            147  
   

Cash settlement of share-based awards

    (3              

Ending balance

    53,185         52,638  
   

Retained earnings

     

Beginning balance, as previously reported

    89,039         83,386  
   

Cumulative effect of the change in accounting principle related to debt valuation adjustment, net of tax

            (305
   

Cumulative effect of the change in accounting principle related to forfeiture of share-based awards, net of tax

    (24              

Beginning balance, adjusted

    89,015         83,081  
   

Net earnings

    2,255         7,398  
   

Dividends and dividend equivalents declared on common stock and share-based awards

    (273       (1,129
   

Dividends declared on preferred stock

    (93       (577
   

Preferred stock redemption discount

                  266  

Ending balance

    90,904         89,039  
   

Accumulated other comprehensive loss

     

Beginning balance, as previously reported

    (1,216       (718
   

Cumulative effect of the change in accounting principle related to debt valuation adjustment, net of tax

                  305  

Beginning balance, adjusted

    (1,216       (413
   

Other comprehensive loss

    (154             (803

Ending balance

    (1,370       (1,216
   

Stock held in treasury, at cost

     

Beginning balance

    (68,694       (62,640
   

Repurchased

    (1,500       (6,069
   

Reissued

    27         22  
   

Other

    (2             (7

Ending balance

    (70,169             (68,694

Total shareholders’ equity

    $ 86,917               $ 86,893  

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

 

4   Goldman Sachs March 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Cash flows from operating activities

    

Net earnings

    $    2,255        $   1,135  
   

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

    

Depreciation and amortization

    257        239  
   

Share-based compensation

    1,272        1,665  
   

Changes in operating assets and liabilities:

    

Receivables and payables (excluding loans receivable), net

    (6,658      19  
   

Collateralized transactions (excluding other secured financings), net

    15,692        (26,632
   

Financial instruments owned, at fair value

    (13,634      11,480  
   

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

    (1,216      11,697  
   

Other, net

    (1,332      (2,145

Net cash used for operating activities

    (3,364      (2,542
   

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (838      (573
   

Proceeds from sales of property, leasehold improvements and equipment

    77        210  
   

Net cash used for business acquisitions

    (512      (562
   

Proceeds from sales of investments

    539        322  
   

Loans receivable, net

    (839      (2,537

Net cash used for investing activities

    (1,573      (3,140
   

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    (1,007      1,970  
   

Other secured financings (short-term), net

    (1,771      775  
   

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

    2,622        933  
   

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

    (1,377      (1,118
   

Purchase of APEX

           (505
   

Proceeds from issuance of unsecured long-term borrowings

    19,502        14,752  
   

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

    (13,087      (11,801
   

Derivative contracts with a financing element, net

    912        16  
   

Deposits, net

    3,831        7,347  
   

Common stock repurchased

    (1,503      (1,556
   

Settlement of share-based awards in satisfaction of withholding tax requirements

    (1,498      (888
   

Dividends and dividend equivalents paid on common stock, preferred stock and share-based awards

    (366      (387
   

Proceeds from issuance of preferred stock, net of issuance costs

           655  
   

Proceeds from issuance of common stock, including exercise of share-based awards

    6        1  
   

Cash settlement of share-based awards

    (3       

Net cash provided by financing activities

    6,261        10,194  

Net increase in cash and cash equivalents

    1,324        4,512  
   

Cash and cash equivalents, beginning balance

    121,711        93,439  

Cash and cash equivalents, ending balance

    $123,035        $ 97,951  

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $2.31 billion and $2.25 billion, and cash payments for income taxes, net of refunds, were $257 million and $266 million during the three months ended March 2017 and March 2016, respectively.

Cash flows related to common stock repurchased includes common stock repurchased in the prior period for which settlement occurred during the current period and excludes common stock repurchased during the current period for which settlement occurred in the following period.

Non-cash activities during the three months ended March 2016:

 

 

The impact of adoption of ASU No. 2015-02 was a net reduction to both total assets and liabilities of approximately $200 million. See Note 3 for further information.

 

 

The firm sold assets and liabilities of $1.81 billion and $697 million, respectively, that were previously classified as held for sale, in exchange for $1.11 billion of financial instruments.

 

 

The firm exchanged $505 million of APEX for $666 million of Series E and Series F Preferred Stock. See Note 19 for further information.

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

 

    Goldman Sachs March 2017 Form 10-Q   5


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1.

Description of Business

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

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

Investment Banking

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

Institutional Client Services

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

Investing & Lending

The firm invests in and originates loans to provide financing to clients. These investments and loans are typically longer-term in nature. The firm makes investments, some of which are consolidated, directly and indirectly through funds that the firm manages, in debt securities and loans, public and private equity securities, infrastructure and real estate entities. The firm also makes unsecured loans to individuals through its online platform.

Investment Management

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

Note 2.

Basis of Presentation

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

These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the firm’s Annual Report on Form 10-K for the year ended December 31, 2016. References to “the 2016 Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2016. The condensed consolidated financial information as of December 31, 2016 has been derived from audited consolidated financial statements not included herein.

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

All references to March 2017 and March 2016 refer to the firm’s periods ended, or the dates, as the context requires, March 31, 2017 and March 31, 2016, respectively. All references to December 2016 refer to the date December 31, 2016. Any reference to a future year refers to a year ending on December 31 of that year. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

 

 

6   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 3.

Significant Accounting Policies

 

The firm’s significant accounting policies include when and how to measure the fair value of assets and liabilities, accounting for goodwill and identifiable intangible assets, and when to consolidate an entity. See Notes 5 through 8 for policies on fair value measurements, Note 13 for policies on goodwill and identifiable intangible assets, and below and Note 12 for policies on consolidation accounting. All other significant accounting policies are either described below or included in the following footnotes:

 

Financial Instruments Owned, at Fair Value and Financial

Instruments Sold, But Not Yet Purchased, at Fair Value

    Note 4  

Fair Value Measurements

    Note 5  

Cash Instruments

    Note 6  

Derivatives and Hedging Activities

    Note 7  

Fair Value Option

    Note 8  

Loans Receivable

    Note 9  

Collateralized Agreements and Financings

    Note 10  

Securitization Activities

    Note 11  

Variable Interest Entities

    Note 12  

Other Assets

    Note 13  

Deposits

    Note 14  

Short-Term Borrowings

    Note 15  

Long-Term Borrowings

    Note 16  

Other Liabilities and Accrued Expenses

    Note 17  

Commitments, Contingencies and Guarantees

    Note 18  

Shareholders’ Equity

    Note 19  

Regulation and Capital Adequacy

    Note 20  

Earnings Per Common Share

    Note 21  

Transactions with Affiliated Funds

    Note 22  

Interest Income and Interest Expense

    Note 23  

Income Taxes

    Note 24  

Business Segments

    Note 25  

Credit Concentrations

    Note 26  

Legal Proceedings

    Note 27  

Consolidation

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

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

Variable Interest Entities. A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. The firm has a controlling financial interest in a VIE when the firm has a variable interest or interests that provide it with (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 12 for further information about VIEs.

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

In general, the firm accounts for investments acquired after the fair value option became available, at fair value. In certain cases, the firm applies the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, when the firm has a significant degree of involvement in the cash flows or operations of the investee or when cost-benefit considerations are less significant. See Note 13 for further information about equity-method investments.

 

 

    Goldman Sachs March 2017 Form 10-Q   7


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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

Use of Estimates

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

Revenue Recognition

Financial Assets and Financial Liabilities at Fair Value. Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value are recorded at fair value either under the fair value option or in accordance with other U.S. GAAP. In addition, the firm has elected to account for certain of its other financial assets and financial liabilities at fair value by electing the fair value option. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Fair value gains or losses are generally included in “Market making” for positions in Institutional Client Services and “Other principal transactions” for positions in Investing & Lending. See Notes 5 through 8 for further information about fair value measurements.

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

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

The firm makes payments to brokers and advisors related to the placement of the firm’s investment funds. These payments are calculated based on either a percentage of the management fee or the investment fund’s net asset value. Where the firm is principal to the arrangement, such costs are recorded on a gross basis and included in “Brokerage, clearing, exchange and distribution fees,” and where the firm is agent to the arrangement, such costs are recorded on a net basis in “Investment management” revenues.

 

 

8   Goldman Sachs March 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Commissions and Fees. The firm earns “Commissions and fees” from executing and clearing client transactions on stock, options and futures markets, as well as over-the-counter (OTC) transactions. Commissions and fees are recognized on the day the trade is executed.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when the firm has relinquished control over the assets transferred. For transfers of financial assets accounted for as sales, any gains or losses are recognized in net revenues. Assets or liabilities that arise from the firm’s continuing involvement with transferred financial assets are initially recognized at fair value. For transfers of financial assets that are not accounted for as sales, the assets generally remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Note 10 for further information about transfers of financial assets accounted for as collateralized financings and Note 11 for further information about transfers of financial assets accounted for as sales.

Cash and Cash Equivalents

The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business. As of March 2017 and December 2016, “Cash and cash equivalents” included $14.27 billion and $11.15 billion, respectively, of cash and due from banks, and $108.77 billion and $110.56 billion, respectively, of interest-bearing deposits with banks. The firm segregates cash for regulatory and other purposes related to client activity. As of March 2017 and December 2016, $15.18 billion and $14.65 billion, respectively, of “Cash and cash equivalents” were segregated for regulatory and other purposes. See “Recent Accounting Developments” for further information.

In addition, the firm segregates securities for regulatory and other purposes related to client activity. See Note 10 for further information about segregated securities.

Receivables from and Payables to Brokers, Dealers and Clearing Organizations

Receivables from and payables to brokers, dealers and clearing organizations are accounted for at cost plus accrued interest, which generally approximates fair value. While these receivables and payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these receivables and payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2017 and December 2016.

Receivables from Customers and Counterparties Receivables from customers and counterparties generally relate to collateralized transactions. Such receivables are primarily comprised of customer margin loans, certain transfers of assets accounted for as secured loans rather than purchases at fair value and collateral posted in connection with certain derivative transactions. Substantially all of these receivables are accounted for at amortized cost net of estimated uncollectible amounts. Certain of the firm’s receivables from customers and counterparties are accounted for at fair value under the fair value option, with changes in fair value generally included in “Market making” revenues. See Note 8 for further information about receivables from customers and counterparties accounted for at fair value under the fair value option. In addition, as of March 2017 and December 2016, the firm’s receivables from customers and counterparties included $2.91 billion and $2.60 billion, respectively, of loans held for sale, accounted for at the lower of cost or fair value. See Note 5 for an overview of the firm’s fair value measurement policies.

As of March 2017 and December 2016, the carrying value of receivables not accounted for at fair value generally approximated fair value. While these receivables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these receivables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2017 and December 2016. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in “Interest income.”

Payables to Customers and Counterparties

Payables to customers and counterparties primarily consist of customer credit balances related to the firm’s prime brokerage activities. Payables to customers and counterparties are accounted for at cost plus accrued interest, which generally approximates fair value. While these payables are carried at amounts that approximate fair value, they are not accounted for at fair value under the fair value option or at fair value in accordance with other U.S. GAAP and therefore are not included in the firm’s fair value hierarchy in Notes 6 through 8. Had these payables been included in the firm’s fair value hierarchy, substantially all would have been classified in level 2 as of March 2017 and December 2016. Interest on payables to customers and counterparties is recognized over the life of the transaction and included in “Interest expense.”

 

 

    Goldman Sachs March 2017 Form 10-Q   9


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Offsetting Assets and Liabilities

To reduce credit exposures on derivatives and securities financing transactions, the firm may enter into master netting agreements or similar arrangements (collectively, netting agreements) with counterparties that permit it to offset receivables and payables with such counterparties. A netting agreement is a contract with a counterparty that permits net settlement of multiple transactions with that counterparty, including upon the exercise of termination rights by a non-defaulting party. Upon exercise of such termination rights, all transactions governed by the netting agreement are terminated and a net settlement amount is calculated. In addition, the firm receives and posts cash and securities collateral with respect to its derivatives and securities financing transactions, subject to the terms of the related credit support agreements or similar arrangements (collectively, credit support agreements). An enforceable credit support agreement grants the non-defaulting party exercising termination rights the right to liquidate the collateral and apply the proceeds to any amounts owed. In order to assess enforceability of the firm’s right of setoff under netting and credit support agreements, the firm evaluates various factors including applicable bankruptcy laws, local statutes and regulatory provisions in the jurisdiction of the parties to the agreement.

Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) in the condensed consolidated statements of financial condition when a legal right of setoff exists under an enforceable netting agreement. Resale and repurchase agreements and securities borrowed and loaned transactions with the same term and currency are presented on a net-by-counterparty basis in the condensed consolidated statements of financial condition when such transactions meet certain settlement criteria and are subject to netting agreements.

In the condensed consolidated statements of financial condition, derivatives are reported net of cash collateral received and posted under enforceable credit support agreements, when transacted under an enforceable netting agreement. In the condensed consolidated statements of financial condition, resale and repurchase agreements, and securities borrowed and loaned, are not reported net of the related cash and securities received or posted as collateral. See Note 10 for further information about collateral received and pledged, including rights to deliver or repledge collateral. See Notes 7 and 10 for further information about offsetting.

Share-based Compensation

The cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based awards that require future service are amortized over the relevant service period. Effective January 2017, forfeitures are recorded when they occur. Prior to January 2017, expected forfeitures were estimated and recorded over the vesting period. See “Recent Accounting Developments — Improvements to Employee Share-Based Payment Accounting (ASC 718)” for additional information.

The firm pays cash dividend equivalents on outstanding restricted stock units (RSUs), which are charged to retained earnings. If RSUs that require future service are forfeited, the related dividend equivalents originally charged to retained earnings are reclassified to compensation expense in the period in which forfeiture occurs.

The firm generally issues new shares of common stock upon delivery of share-based awards. In certain cases, primarily related to conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards accounted for as equity instruments. For these awards, whose terms allow for cash settlement, additional paid-in capital is adjusted to the extent of the difference between the value of the award at the time of cash settlement and the grant-date value of the award.

Foreign Currency Translation

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

 

 

10   Goldman Sachs March 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Recent Accounting Developments

Revenue from Contracts with Customers (ASC 606). In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU, as amended, provides comprehensive guidance on the recognition of revenue from customers arising from the transfer of goods and services, guidance on accounting for certain contract costs, and new disclosures.

The ASU is effective for the firm in January 2018 under a modified retrospective approach or retrospectively to all periods presented. The firm’s implementation efforts include identifying revenues and costs within the scope of the ASU, reviewing contracts, and analyzing any changes to its existing revenue recognition policies. As a result of adopting this ASU, the firm may, among other things, be required to recognize incentive fees earlier than under the firm’s current revenue recognition policy, which defers recognition until all contingencies are resolved. The firm may also be required to change the current presentation of certain costs from a net presentation within net revenues to a gross basis, or vice versa. Based on implementation work to date, the firm does not currently expect that the ASU will have a material impact on its financial condition, results of operations or cash flows on the date of adoption.

Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (ASC 810). In August 2014, the FASB issued ASU No. 2014-13, “Consolidation (Topic 810) — Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (CFE).” This ASU provides an alternative to reflect changes in the fair value of the financial assets and the financial liabilities of the CFE by measuring either the fair value of the assets or liabilities, whichever is more observable, and provides new disclosure requirements for those electing this approach.

The firm adopted the ASU in January 2016. Adoption of the ASU did not materially affect the firm’s financial condition, results of operations or cash flows.

Amendments to the Consolidation Analysis (ASC 810). In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810) — Amendments to the Consolidation Analysis.” This ASU eliminates the deferral of the requirements of ASU No. 2009-17, “Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” for certain interests in investment funds and provides a scope exception for certain investments in money market funds. It also makes several modifications to the consolidation guidance for VIEs and general partners’ investments in limited partnerships, as well as modifications to the evaluation of whether limited partnerships are VIEs or voting interest entities.

The firm adopted the ASU in January 2016, using a modified retrospective approach. The impact of adoption was a net reduction to both total assets and total liabilities of approximately $200 million, substantially all included in “Financial instruments owned, at fair value” and in “Other liabilities and accrued expenses,” respectively. Adoption of this ASU did not have an impact on the firm’s results of operations. See Note 12 for further information about the adoption.

Simplifying the Accounting for Measurement-Period Adjustments (ASC 805). In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805) — Simplifying the Accounting for Measurement-Period Adjustments.” This ASU eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively.

The firm adopted the ASU in January 2016. Adoption of the ASU did not materially affect the firm’s financial condition, results of operations or cash flows.

Recognition and Measurement of Financial Assets and Financial Liabilities (ASC 825). In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments (Topic 825) — Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU amends certain aspects of recognition, measurement, presentation and disclosure of financial instruments. It includes a requirement to present separately in other comprehensive income changes in fair value attributable to a firm’s own credit spreads (debt valuation adjustment or DVA), net of tax, on financial liabilities for which the fair value option was elected.

 

 

    Goldman Sachs March 2017 Form 10-Q   11


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The ASU is effective for the firm in January 2018. Early adoption is permitted under a modified retrospective approach for the requirements related to DVA. In January 2016, the firm early adopted this ASU for the requirements related to DVA and reclassified the cumulative DVA, a gain of $305 million (net of tax), from retained earnings to accumulated other comprehensive loss. The firm does not expect the adoption of the remaining provisions of the ASU to have a material impact on its financial condition, results of operations or cash flows.

Leases (ASC 842). In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” This ASU requires that, for leases longer than one year, a lessee recognize in the statements of financial condition a right-of-use asset, representing the right to use the underlying asset for the lease term, and a lease liability, representing the liability to make lease payments. It also requires that for finance leases, a lessee recognize interest expense on the lease liability, separately from the amortization of the right-of-use asset in the statements of earnings, while for operating leases, such amounts should be recognized as a combined expense. In addition, this ASU requires expanded disclosures about the nature and terms of lease agreements.

The ASU is effective for the firm in January 2019 under a modified retrospective approach. Early adoption is permitted. The firm’s implementation efforts include reviewing existing leases and service contracts, which may include embedded leases. The firm expects a gross up on its consolidated statements of financial condition upon recognition of the right-of-use assets and lease liabilities and does not expect the amount of the gross up to have a material impact on its financial condition.

Improvements to Employee Share-Based Payment Accounting (ASC 718). In March 2016, the FASB issued ASU No. 2016-09, “Compensation — Stock Compensation (Topic 718) — Improvements to Employee Share-Based Payment Accounting.” This ASU includes a requirement that the tax effect related to the settlement of share-based awards be recorded in income tax benefit or expense in the statements of earnings rather than directly to additional paid-in capital. This change has no impact on total shareholders’ equity and is required to be adopted prospectively. The ASU also allows for forfeitures to be recorded when they occur rather than estimated over the vesting period. This change is required to be applied on a modified retrospective basis.

The firm adopted the ASU in January 2017 and the impact of the RSU deliveries and option exercises in the first quarter of 2017 was a reduction to the provision for taxes of $475 million, which was recognized in the condensed consolidated statements of earnings. The impact will vary in future periods depending upon, among other things, the number of RSUs delivered and their change in value since grant. Prior to the adoption of this ASU, this amount would have been recorded directly to additional paid-in capital. The firm also elected to account for forfeitures as they occur, rather than to estimate forfeitures over the vesting period, and the cumulative effect of this election upon adoption was an increase of $35 million to “Share-based awards” and a decrease of $24 million (net of tax of $11 million) to “Retained earnings” within the condensed consolidated statements of changes in shareholders’ equity.

In addition, the ASU modifies the classification of certain share-based payment activities within the statements of cash flows. As a result, the firm reclassified, on a retrospective basis, a cash outflow of $888 million related to the settlement of share-based awards in satisfaction of withholding tax requirements from operating activities to financing activities and a cash inflow of $54 million of excess tax benefits related to share-based awards from financing activities to operating activities within the condensed consolidated statements of cash flows for the three months ended March 2016.

Measurement of Credit Losses on Financial Instruments (ASC 326). In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments — Credit Losses (Topic 326) — Measurement of Credit Losses on Financial Instruments.” This ASU amends several aspects of the measurement of credit losses on financial instruments, including replacing the existing incurred credit loss model and other models with the Current Expected Credit Losses (CECL) model and amending certain aspects of accounting for purchased financial assets with deterioration in credit quality since origination.

 

 

12   Goldman Sachs March 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Under CECL, the allowance for losses for financial assets that are measured at amortized cost should reflect management’s estimate of credit losses over the remaining expected life of the financial assets. Expected credit losses for newly recognized financial assets, as well as changes to expected credit losses during the period, would be recognized in earnings. For certain purchased financial assets with deterioration in credit quality since origination, an initial allowance would be recorded for expected credit losses and recognized as an increase to the purchase price rather than as an expense. Expected credit losses, including losses on off-balance-sheet exposures such as lending commitments, will be measured based on historical experience, current conditions and forecasts that affect the collectability of the reported amount.

The ASU is effective for the firm in January 2020 under a modified retrospective approach. Early adoption is permitted in January 2019. Adoption of the ASU will result in earlier recognition of credit losses and an increase in the recorded allowance for certain purchased loans with deterioration in credit quality since origination with a corresponding increase to their gross carrying value. The impact of adoption of this ASU on the firm’s financial condition, results of operations and cash flows will depend on, among other things, the economic environment and the type of financial assets held by the firm on the date of adoption.

Classification of Certain Cash Receipts and Cash Payments (ASC 230). In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) — Classification of Certain Cash Receipts and Cash Payments.” This ASU provides guidance on the disclosure and classification of certain items within the statements of cash flows.

The ASU is effective for the firm in January 2018 under a retrospective approach. Early adoption is permitted. Since the ASU only impacts classification in the statements of cash flows, adoption will not affect the firm’s cash and cash equivalents.

Restricted Cash (ASC 230). In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230) — Restricted Cash.” This ASU requires that cash segregated for regulatory and other purposes be included in cash and cash equivalents disclosed in the statements of cash flows and is required to be applied retrospectively.

The firm early adopted the ASU in December 2016 and reclassified cash segregated for regulatory and other purposes into “Cash and cash equivalents” disclosed in the consolidated statements of cash flows. The impact of adoption was an increase of $448 million for the three months ended March 2016 to “Net cash used for operating activities.” In addition, in December 2016, to be consistent with the presentation of segregated cash in the consolidated statements of cash flows under the ASU, the firm reclassified amounts previously included in “Cash and securities segregated for regulatory and other purposes” into “Cash and cash equivalents,” “Securities purchased under agreements to resell and federal funds sold,” “Securities borrowed” and “Financial instruments owned, at fair value,” in the consolidated statements of financial condition. Previously reported amounts in the condensed consolidated statements of cash flows and notes to the condensed consolidated financial statements have been conformed to the current presentation.

Clarifying the Definition of a Business (ASC 805). In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805) — Clarifying the Definition of a Business.” The ASU amends the definition of a business and provides a threshold which must be considered to determine whether a transaction is an acquisition (or disposal) of an asset or a business. The ASU is effective for the firm in January 2018 under a prospective approach. Early adoption is permitted. The impact of this ASU will depend on the nature of the firm’s activities after adoption, although the firm expects that fewer transactions will be treated as acquisitions (or disposals) of businesses.

Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (ASC 610-20). In February 2017, the FASB issued ASU No. 2017-05, “Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20) — Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.” The ASU clarifies the scope of guidance applicable to sales of nonfinancial assets and also provides guidance on accounting for partial sales of such assets.

The ASU is effective for the firm in January 2018 under a retrospective or modified retrospective approach. The firm is still evaluating the effect of the ASU on its financial condition, results of operations and cash flows.

 

 

    Goldman Sachs March 2017 Form 10-Q   13


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 4.

 

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

    

 

Financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value are accounted for at fair value either under the fair value option or in accordance with other U.S. GAAP. See Note 8 for further information about other financial assets and financial liabilities accounted for at fair value primarily under the fair value option.

The table below presents the firm’s financial instruments owned, at fair value, and financial instruments sold, but not yet purchased, at fair value.

 

$ in millions    

Financial

Instruments

Owned

 

 

 

   

Financial

Instruments

Sold, But

Not Yet

Purchased

 

 

 

 

 

As of March 2017

   

Money market instruments

    $    1,735       $         —  
   

U.S. government and federal agency obligations

    71,035       20,181   
   

Non-U.S. government and agency obligations

    35,614       23,285  
   

Loans and securities backed by:

   

Commercial real estate

    3,602        
   

Residential real estate

    12,133        
   

Corporate loans and debt securities

    31,721       7,258  
   

State and municipal obligations

    1,108        
   

Other debt obligations

    1,364       1  
   

Equity securities

    95,539       26,195  
   

Commodities

    3,643        
   

Investments in funds at NAV

    6,183        

Subtotal

    263,677       76,920  
   

Derivatives

    45,194       39,007  

Total

    $308,871       $115,927  

 

As of December 2016

   

Money market instruments

    $    1,319       $            —  
   

U.S. government and federal agency obligations

    57,657       16,627  
   

Non-U.S. government and agency obligations

    29,381       20,502  
   

Loans and securities backed by:

   

Commercial real estate

    3,842        
   

Residential real estate

    12,195       3  
   

Corporate loans and debt securities

    28,659       6,570  
   

State and municipal obligations

    1,059        
   

Other debt obligations

    1,358       1  
   

Equity securities

    94,692       25,941  
   

Commodities

    5,653        
   

Investments in funds at NAV

    6,465        

Subtotal

    242,280       69,644  
   

Derivatives

    53,672       47,499  

Total

    $295,952       $117,143  

In the table above:

 

 

Money market instruments include commercial paper, certificates of deposit and time deposits, substantially all of which have a maturity of less than one year.

 

 

Equity securities include public and private equities, exchange-traded funds and convertible debentures.

Gains and Losses from Market Making and Other Principal Transactions

The table below presents “Market making” revenues by major product type, as well as “Other principal transactions” revenues.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Interest rates

    $1,364        $1,177  
   

Credit

    544        618  
   

Currencies

    (318      (908
   

Equities

    578        691  
   

Commodities

    250        284  

Market making

    2,418        1,862  

Other principal transactions

    1,221        (49

Total

    $3,639        $1,813  

In the table above:

 

 

Gains/(losses) include both realized and unrealized gains and losses, and are primarily related to the firm’s financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, including both derivative and non-derivative financial instruments.

 

 

Gains/(losses) exclude related interest income and interest expense. See Note 23 for further information about interest income and interest expense.

 

 

Gains/(losses) on other principal transactions are included in the firm’s Investing & Lending segment. See Note 25 for net revenues, including net interest income, by product type for Investing & Lending, as well as the amount of net interest income included in Investing & Lending.

 

 

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

 

 

14   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5.

Fair Value Measurements

 

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

The best evidence of fair value is a quoted price in an active market. If quoted prices in active markets are not available, fair value is determined by reference to prices for similar instruments, quoted prices or recent transactions in less active markets, or internally developed models that primarily use market-based or independently sourced inputs including, but not limited to, interest rates, volatilities, equity or debt prices, foreign exchange rates, commodity prices, credit spreads and funding spreads (i.e., the spread or difference between the interest rate at which a borrower could finance a given financial instrument relative to a benchmark interest rate).

U.S. GAAP has a three-level fair value hierarchy for disclosure of fair value measurements. This hierarchy prioritizes inputs to the valuation techniques used to measure fair value, giving the highest priority to level 1 inputs and the lowest priority to level 3 inputs. A financial instrument’s level in this hierarchy is based on the lowest level of input that is significant to its fair value measurement. In evaluating the significance of a valuation input, the firm considers, among other factors, a portfolio’s net risk exposure to that input. The fair value hierarchy is as follows:

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

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

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

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

See Notes 6 through 8 for further information about fair value measurements of cash instruments, derivatives and other financial assets and financial liabilities accounted for at fair value primarily under the fair value option (including information about unrealized gains and losses related to level 3 financial assets and financial liabilities, and transfers in and out of level 3), respectively.

The table below presents financial assets and financial liabilities accounted for at fair value under the fair value option or in accordance with other U.S. GAAP.

 

    As of  
$ in millions    

March

2017

 

 

    

December

2016

 

 

Total level 1 financial assets

    $151,691        $135,401  
   

Total level 2 financial assets

    406,332        419,585  
   

Total level 3 financial assets

    23,288        23,280  
   

Investments in funds at NAV

    6,183        6,465  
   

Counterparty and cash collateral netting

    (78,540      (87,038

Total financial assets at fair value

    $508,954        $497,693  

Total assets

    $894,069        $860,165  
   

Total level 3 financial assets divided by:

    

Total assets

    2.6%        2.7%  
   

Total financial assets at fair value

    4.6%        4.7%  

Total level 1 financial liabilities

    $  67,732        $  62,504  
   

Total level 2 financial liabilities

    246,087        232,027  
   

Total level 3 financial liabilities

    21,067        21,448  
   

Counterparty and cash collateral netting

    (37,802      (44,695

Total financial liabilities at fair value

    $297,084        $271,284  

 

Total level 3 financial liabilities divided by total financial liabilities at fair value

    7.1%        7.9%  

In the table above:

 

 

Counterparty netting among positions classified in the same level is included in that level.

 

 

Counterparty and cash collateral netting represents the impact on derivatives of netting across levels of the fair value hierarchy.

 

 

Total assets includes $867 billion and $835 billion as of March 2017 and December 2016, respectively, that is carried at fair value or at amounts that generally approximate fair value.

 

 

    Goldman Sachs March 2017 Form 10-Q   15


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents a summary of level 3 financial assets.

 

    As of  
$ in millions    
March
2017
 
 
    
December
2016
 
 

Cash instruments

    $18,324        $18,035  
   

Derivatives

    4,950        5,190  
   

Other financial assets

    14        55  

Total

    $23,288        $23,280  

Level 3 financial assets as of March 2017 were essentially unchanged compared with December 2016. See Notes 6 through 8 for further information about level 3 financial assets.

Note 6.

Cash Instruments

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

Level 1 Cash Instruments

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

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

Level 2 Cash Instruments

Level 2 cash instruments include most money market instruments, most government agency obligations, certain non-U.S. government obligations, most mortgage-backed loans and securities, most corporate loans and debt securities, most state and municipal obligations, most other debt obligations, restricted or less liquid listed equities, commodities and certain lending commitments.

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

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

Level 3 Cash Instruments

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

Valuation Techniques and Significant Inputs of Level 3 Cash Instruments

Valuation techniques of level 3 cash instruments vary by instrument, but are generally based on discounted cash flow techniques. The valuation techniques and the nature of significant inputs used to determine the fair values of each type of level 3 cash instrument are described below:

Loans and Securities Backed by Commercial Real Estate. Loans and securities backed by commercial real estate are directly or indirectly collateralized by a single commercial real estate property or a portfolio of properties, and may include tranches of varying levels of subordination. Significant inputs are generally determined based on relative value analyses and include:

 

 

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

 

 

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

 

 

16   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

A measure of expected future cash flows in a default scenario (recovery rates) implied by the value of the underlying collateral, which is mainly driven by current performance of the underlying collateral, capitalization rates and multiples. Recovery rates are expressed as a percentage of notional or face value of the instrument and reflect the benefit of credit enhancements on certain instruments; and

 

 

Timing of expected future cash flows (duration) which, in certain cases, may incorporate the impact of other unobservable inputs (e.g., prepayment speeds).

Loans and Securities Backed by Residential Real Estate. Loans and securities backed by residential real estate are directly or indirectly collateralized by portfolios of residential real estate and may include tranches of varying levels of subordination. Significant inputs are generally determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles. Significant inputs include:

 

 

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

 

 

Market yields implied by transactions of similar or related assets;

 

 

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

 

 

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

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

 

 

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

 

 

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

 

 

Duration.

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

 

 

Industry multiples (primarily EBITDA multiples) and public comparables;

 

 

Transactions in similar instruments;

 

 

Discounted cash flow techniques; and

 

 

Third-party appraisals.

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

 

 

Market and transaction multiples;

 

 

Discount rates and capitalization rates; and

 

 

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

Other Cash Instruments. Other cash instruments consists of non-U.S. government and agency obligations, state and municipal obligations, and other debt obligations. Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying instrument or entity and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 

 

Market yields implied by transactions of similar or related assets and/or current levels and trends of market indices;

 

 

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

 

 

Duration.

 

 

    Goldman Sachs March 2017 Form 10-Q   17


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Cash Instruments by Level

The tables below present cash instrument assets and liabilities at fair value by level within the fair value hierarchy.

 

    As of March 2017  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Money market instruments

    $       307       $  1,428       $       —       $    1,735  
   

U.S. government and federal agency obligations

    44,423       26,612             71,035  
   

Non-U.S. government and agency obligations

    29,523       6,061       30       35,614  
   

Loans and securities backed by:

       

Commercial real estate

          1,998       1,604       3,602  
   

Residential real estate

          11,303       830       12,133  
   

Corporate loans and debt securities

    410       26,758       4,553       31,721  
   

State and municipal obligations

          1,012       96       1,108  
   

Other debt obligations

          868       496       1,364  
   

Equity securities

    76,969       7,855       10,715       95,539  
   

Commodities

          3,643             3,643  

Subtotal

    $151,632       $87,538       $18,324       $257,494  
   

Investments in funds at NAV

                            6,183  

Total cash instrument assets

                            $263,677  

Liabilities

       

U.S. government and federal agency obligations

    $ (19,827     $    (354     $       —       $ (20,181
   

Non-U.S. government and agency obligations

    (21,532     (1,753           (23,285
   

Corporate loans and debt securities

    (8     (7,208     (42     (7,258
   

Other debt obligations

          (1           (1
   

Equity securities

    (25,900     (288     (7     (26,195

Total cash instrument liabilities

    $ (67,267     $ (9,604     $      (49     $ (76,920
    As of December 2016  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Money market instruments

    $       188       $  1,131       $       —       $    1,319  
   

U.S. government and federal agency obligations

    35,254       22,403             57,657  
   

Non-U.S. government and agency obligations

    22,433       6,933       15       29,381  
   

Loans and securities backed by:

       

Commercial real estate

          2,197       1,645       3,842  
   

Residential real estate

          11,350       845       12,195  
   

Corporate loans and debt securities

    215       23,804       4,640       28,659  
   

State and municipal obligations

          960       99       1,059  
   

Other debt obligations

          830       528       1,358  
   

Equity securities

    77,276       7,153       10,263       94,692  
   

Commodities

          5,653             5,653  

Subtotal

    $135,366       $82,414       $18,035       $235,815  
   

Investments in funds at NAV

                            6,465  

Total cash instrument assets

                            $242,280  

Liabilities

       

U.S. government and federal agency obligations

    $ (16,615     $      (12     $       —       $ (16,627
   

Non-U.S. government and agency obligations

    (19,137     (1,364     (1     (20,502
   

Loans and securities backed by residential real estate

          (3           (3
   

Corporate loans and debt securities

    (2     (6,524     (44     (6,570
   

Other debt obligations

          (1           (1
   

Equity securities

    (25,768     (156     (17     (25,941

Total cash instrument liabilities

    $ (61,522     $ (8,060     $      (62     $ (69,644

In the tables above:

 

 

Cash instrument assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.

 

 

Cash instrument assets are shown as positive amounts and cash instrument liabilities are shown as negative amounts.

 

 

Money market instruments include commercial paper, certificates of deposit and time deposits.

 

 

Equity securities include public and private equities, exchange-traded funds and convertible debentures.

 

 

As of March 2017 and December 2016, substantially all of the firm’s level 3 equity securities were comprised of private equity securities.

 

 

Total cash instrument assets include collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs) backed by real estate and corporate obligations of $414 million and $461 million in level 2, and $527 million and $624 million in level 3 as of March 2017 and December 2016, respectively.

 

 

18   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Significant Unobservable Inputs

The table below presents the amount of level 3 assets, and ranges and weighted averages of significant unobservable inputs used to value the firm’s level 3 cash instruments.

 

   

Level 3 Assets and Range of Significant

Unobservable Inputs (Weighted Average) as of

 
$ in millions    

March

2017

 

 

   

December

2016

 

 

Loans and securities backed by commercial real estate

 

Level 3 assets

    $1,604       $1,645  
   

Yield

    4.5% to 22.0% (12.3%     3.7% to 23.0% (13.0%
   

Recovery rate

    17.4% to 97.9% (61.3%     8.9% to 99.0% (60.6%
   

Duration (years)

    0.7 to 6.1 (1.9     0.8 to 6.2 (2.1

Loans and securities backed by residential real estate

 

Level 3 assets

    $830       $845  
   

Yield

    1.9% to 15.0% (8.3%     0.8% to 15.6% (8.7%
   

Cumulative loss rate

    9.4% to 46.8% (25.7%     8.9% to 47.1% (24.2%
   

Duration (years)

    1.1 to 14.6 (6.8     1.1 to 16.1 (7.3

Corporate loans and debt securities

 

Level 3 assets

    $4,553       $4,640  
   

Yield

    2.6% to 24.5% (10.4%     2.5% to 25.0% (10.3%
   

Recovery rate

    0.0% to 94.0% (56.5%     0.0% to 85.0% (56.5%
   

Duration (years)

    0.3 to 5.4 (2.9     0.6 to 15.7 (2.9

Equity securities

 

Level 3 assets

    $10,715       $10,263  
   

Multiples

    0.8x to 24.6x (7.0x     0.8x to 19.7x (6.8x
   

Discount rate/yield

    6.5% to 30.0% (16.2%     6.5% to 25.0% (16.0%
   

Capitalization rate

    4.1% to 12.9% (6.6%     4.2% to 12.5% (6.8%

Other cash instruments

 

Level 3 assets

    $622       $642  
   

Yield

    2.4% to 16.1% (9.0%     1.9% to 14.0% (8.8%
   

Recovery rate

    2.7% to 93.0% (82.6%     0.0% to 93.0% (61.4%
   

Duration (years)

    0.8 to 12.0 (3.9     0.9 to 12.0 (4.3

In the table above:

 

 

Ranges represent the significant unobservable inputs that were used in the valuation of each type of cash instrument.

 

 

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

 

 

The ranges and weighted averages of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one cash instrument. For example, the highest multiple for private equity securities is appropriate for valuing a specific private equity security but may not be appropriate for valuing any other private equity security. Accordingly, the ranges of inputs do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 cash instruments.

 

Increases in yield, discount rate, capitalization rate, duration or cumulative loss rate used in the valuation of the firm’s level 3 cash instruments would result in a lower fair value measurement, while increases in recovery rate or multiples would result in a higher fair value measurement. Due to the distinctive nature of each of the firm’s level 3 cash instruments, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

Equity securities include private equity securities and convertible debentures.

 

 

Loans and securities backed by commercial and residential real estate, corporate loans and debt securities and other cash instruments are valued using discounted cash flows, and equity securities are valued using market comparables and discounted cash flows.

 

 

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

Transfers Between Levels of the Fair Value Hierarchy Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. See “Level 3 Rollforward” below for information about transfers between level 2 and level 3.

During the three months ended March 2017, transfers into level 2 from level 1 of cash instruments were $182 million, reflecting transfers of public equity securities due to decreased market activity in these instruments. Transfers into level 1 from level 2 of cash instruments were $33 million, reflecting transfers of public equity securities due to increased market activity in these instruments.

During the three months ended March 2016, transfers into level 2 from level 1 of cash instruments were $137 million, reflecting transfers of public equity securities primarily due to decreased market activity in these instruments. Transfers into level 1 from level 2 of cash instruments were $195 million, primarily reflecting transfers of public equity securities principally due to increased market activity in these instruments.

 

 

    Goldman Sachs March 2017 Form 10-Q   19


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

The table below presents a summary of the changes in fair value for level 3 cash instrument assets and liabilities.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Total cash instrument assets

    

Beginning balance

    $18,035        $18,131  
   

Net realized gains/(losses)

    131        150  
   

Net unrealized gains/(losses)

    402        (40
   

Purchases

    683        1,418  
   

Sales

    (687      (794
   

Settlements

    (716      (986
   

Transfers into level 3

    1,605        1,568  
   

Transfers out of level 3

    (1,129      (978

Ending balance

    $18,324        $18,469  

Total cash instrument liabilities

    

Beginning balance

    $      (62      $    (193
   

Net realized gains/(losses)

           3  
   

Net unrealized gains/(losses)

    4        8  
   

Purchases

    36        58  
   

Sales

    (28      (26
   

Settlements

    (2      (1
   

Transfers into level 3

    (2      (18
   

Transfers out of level 3

    5        31  

Ending balance

    $      (49      $    (138

In the table above:

 

 

Changes in fair value are presented for all cash instrument assets and liabilities that are classified in level 3 as of the end of the period.

 

 

Net unrealized gains/(losses) relate to instruments that were still held at period-end.

 

 

Purchases include originations and secondary purchases.

 

 

If a cash instrument asset or liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is classified in level 3. For level 3 cash instrument assets, increases are shown as positive amounts, while decreases are shown as negative amounts. For level 3 cash instrument liabilities, increases are shown as negative amounts, while decreases are shown as positive amounts.

 

 

Level 3 cash instruments are frequently economically hedged with level 1 and level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. Accordingly, gains or losses that are classified in level 3 can be partially offset by gains or losses attributable to level 1 or level 2 cash instruments and/or level 1, level 2 or level 3 derivatives. As a result, gains or losses included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

The table below disaggregates, by product type, the information for cash instrument assets included in the summary table above.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Loans and securities backed by commercial real estate

 

  

Beginning balance

    $  1,645        $1,924  
   

Net realized gains/(losses)

    16        21  
   

Net unrealized gains/(losses)

    51        (8
   

Purchases

    47        340  
   

Sales

    (55      (135
   

Settlements

    (130      (123
   

Transfers into level 3

    147        253  
   

Transfers out of level 3

    (117      (104

Ending balance

    $  1,604        $2,168  

Loans and securities backed by residential real estate

 

  

Beginning balance

    $     845        $1,765  
   

Net realized gains/(losses)

    9        12  
   

Net unrealized gains/(losses)

    35        45  
   

Purchases

    149        61  
   

Sales

    (156      (298
   

Settlements

    (49      (82
   

Transfers into level 3

    39        132  
   

Transfers out of level 3

    (42      (201

Ending balance

    $     830        $1,434  

Corporate loans and debt securities

    

Beginning balance

    $  4,640        $5,242  
   

Net realized gains/(losses)

    66        74  
   

Net unrealized gains/(losses)

    69        8  
   

Purchases

    306        587  
   

Sales

    (375      (137
   

Settlements

    (330      (492
   

Transfers into level 3

    762        802  
   

Transfers out of level 3

    (585      (293

Ending balance

    $  4,553        $5,791  

Equity securities

    

Beginning balance

    $10,263        $8,549  
   

Net realized gains/(losses)

    29        32  
   

Net unrealized gains/(losses)

    252        (82
   

Purchases

    103        380  
   

Sales

    (56      (96
   

Settlements

    (142      (250
   

Transfers into level 3

    616        295  
   

Transfers out of level 3

    (350      (354

Ending balance

    $10,715        $8,474  

Other cash instruments

    

Beginning balance

    $     642        $   651  
   

Net realized gains/(losses)

    11        11  
   

Net unrealized gains/(losses)

    (5      (3
   

Purchases

    78        50  
   

Sales

    (45      (128
   

Settlements

    (65      (39
   

Transfers into level 3

    41        86  
   

Transfers out of level 3

    (35      (26

Ending balance

    $     622        $   602  
 

 

20   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended March 2017. The net realized and unrealized gains on level 3 cash instrument assets of $533 million (reflecting $131 million of net realized gains and $402 million of net unrealized gains) for the three months ended March 2017 include gains/(losses) of approximately $(10) million, $396 million and $147 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

The net unrealized gain on level 3 cash instrument assets for the three months ended March 2017 primarily reflected gains on private equity securities, principally driven by strong corporate performance and company-specific events.

Transfers into level 3 during the three months ended March 2017 primarily reflected transfers of certain corporate loans and debt securities and private equity securities from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer transactions in these instruments.

Transfers out of level 3 during the three months ended March 2017 primarily reflected transfers of certain corporate loans and debt securities to level 2, principally due to certain unobservable duration and yield inputs no longer being significant to the valuation of these instruments and certain private equity securities to level 2, principally due to increased price transparency as a result of market evidence, including new transactions in these instruments.

Three Months Ended March 2016. The net realized and unrealized gains on level 3 cash instrument assets of $110 million (reflecting $150 million of realized gains and $40 million of unrealized losses) for the three months ended March 2016 include gains/(losses) of approximately $(115) million, $9 million and $216 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

The net unrealized loss on level 3 cash instrument assets for the three months ended March 2016 reflected losses on private equity securities principally driven by lower global equity prices and corporate performance.

Transfers into level 3 during the three months ended March 2016 primarily reflected transfers of certain corporate loans and debt securities, private equity securities and loans and securities backed by commercial real estate from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments, and transfers of certain other corporate loans and debt securities from level 2 principally due to certain unobservable yield inputs becoming significant to the valuation of these instruments.

Transfers out of level 3 during the three months ended March 2016 primarily reflected transfers of certain private equity securities, corporate loans and debt securities and loans and securities backed by residential real estate to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments.

Investments in Funds at Net Asset Value Per Share Cash instruments at fair value include investments in funds that are measured at NAV of the investment fund. The firm uses NAV to measure the fair value of its fund investments when (i) the fund investment does not have a readily determinable fair value and (ii) the NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the investments at fair value.

Substantially all of the firm’s investments in funds at NAV consist of investments in firm-sponsored private equity, credit, real estate and hedge funds where the firm co-invests with third-party investors.

Private equity funds primarily invest in a broad range of industries worldwide, including leveraged buyouts, recapitalizations, growth investments and distressed investments. Credit funds generally invest in loans and other fixed income instruments and are focused on providing private high-yield capital for leveraged and management buyout transactions, recapitalizations, financings, refinancings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers. Real estate funds invest globally, primarily in real estate companies, loan portfolios, debt recapitalizations and property. Private equity, credit and real estate funds are closed-end funds in which the firm’s investments are generally not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated or distributed.

The firm also invests in hedge funds, primarily multi-disciplinary hedge funds that employ a fundamental bottom-up investment approach across various asset classes and strategies. The firm’s investments in hedge funds primarily include interests where the underlying assets are illiquid in nature, and proceeds from redemptions will not be received until the underlying assets are liquidated or distributed.

 

 

    Goldman Sachs March 2017 Form 10-Q   21


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Many of the funds described above are “covered funds” as defined by the Volcker Rule of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Board of Governors of the Federal Reserve System (Federal Reserve Board) extended the conformance period for investments in, and relationships with, covered funds that were in place prior to December 2013 through July 2017, and in December 2016 issued guidance that permitted banking entities to apply for an extension of up to an additional five years (through July 2022) for certain legacy “illiquid funds” (as defined by the Volcker Rule). The firm received this extension for substantially all of its remaining investments in, and relationships with, covered funds in the table below. The firm will continue to manage and conform its investments in, and relationships with, such covered funds, taking into account the extended conformance period under the Volcker Rule.

The table below presents the fair value of the firm’s investments in funds at NAV and related unfunded commitments.

 

$ in millions    

Fair Value of

Investments

 

 

    

Unfunded

Commitments

 

 

As of March 2017

    

Private equity funds

    $4,514        $1,397  
   

Credit funds

    418        190  
   

Hedge funds

    337         
   

Real estate funds

    914        270  

Total

    $6,183        $1,857  

 

As of December 2016

    

Private equity funds

    $4,628        $1,393  
   

Credit funds

    421        166  
   

Hedge funds

    410         
   

Real estate funds

    1,006        272  

Total

    $6,465        $1,831  

Note 7.

Derivatives and Hedging Activities

Derivative Activities

Derivatives are instruments that derive their value from underlying asset prices, indices, reference rates and other inputs, or a combination of these factors. Derivatives may be traded on an exchange (exchange-traded) or they may be privately negotiated contracts, which are usually referred to as OTC derivatives. Certain of the firm’s OTC derivatives are cleared and settled through central clearing counterparties (OTC-cleared), while others are bilateral contracts between two counterparties (bilateral OTC).

Market-Making. As a market maker, the firm enters into derivative transactions to provide liquidity to clients and to facilitate the transfer and hedging of their risks. In this role, the firm typically acts as principal and is required to commit capital to provide execution, and maintains inventory in response to, or in anticipation of, client demand.

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

The firm enters into various types of derivatives, including:

 

 

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

 

 

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

 

 

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

Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement (counterparty netting). Derivatives are accounted for at fair value, net of cash collateral received or posted under enforceable credit support agreements (cash collateral netting). Derivative assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively. Realized and unrealized gains and losses on derivatives not designated as hedges under ASC 815 are included in “Market making” and “Other principal transactions” in Note 4.

 

 

22   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The tables below present the gross fair value and the notional amounts of derivative contracts by major product type, the amounts of counterparty and cash collateral netting in the condensed consolidated statements of financial condition, as well as cash and securities collateral posted and received under enforceable credit support agreements that do not meet the criteria for netting under U.S. GAAP.

 

    As of March 2017         As of December 2016  
$ in millions    

Derivative

Assets

 

 

   

Derivative

Liabilities

 

 

       

Derivative

Assets

 

 

   

Derivative

Liabilities

 

 

Not accounted for as hedges

 

Exchange-traded

    $        461       $        495         $        443       $        382  
                                     

OTC-cleared

    145,594       122,472         189,471       168,946  
   

Bilateral OTC

    292,542       271,992           309,037       289,491  

Total interest rates

    438,597       394,959           498,951       458,819  

OTC-cleared

    4,901       4,984         4,837       4,811  
   

Bilateral OTC

    19,850       16,746           21,530       18,770  

Total credit

    24,751       21,730           26,367       23,581  

Exchange-traded

    10       16         36       176  
   

OTC-cleared

    736       729         796       798  
   

Bilateral OTC

    80,074       81,025           111,032       106,318  

Total currencies

    80,820       81,770           111,864       107,292  

Exchange-traded

    3,018       3,100         3,219       3,187  
   

OTC-cleared

    189       236         189       197  
   

Bilateral OTC

    7,670       8,984           8,945       10,487  

Total commodities

    10,877       12,320           12,353       13,871  

Exchange-traded

    8,953       8,634         8,576       8,064  
   

Bilateral OTC

    37,790       43,259           39,516       45,826  

Total equities

    46,743       51,893           48,092       53,890  

Subtotal

    601,788       562,672           697,627       657,453  

Accounted for as hedges

 

OTC-cleared

    4,216       185         4,347       156  
   

Bilateral OTC

    3,858       10           4,180       10  

Total interest rates

    8,074       195           8,527       166  

OTC-cleared

    22       31         30       40  
   

Bilateral OTC

    22       83           55       64  

Total currencies

    44       114           85       104  

Subtotal

    8,118       309           8,612       270  

Total gross fair value

    $ 609,906       $ 562,981           $ 706,239       $ 657,723  

Offset in condensed consolidated statements of financial condition

 

Exchange-traded

    $  (10,406     $  (10,406       $    (9,727     $    (9,727
   

OTC-cleared

    (128,189     (128,189       (171,864     (171,864
   

Bilateral OTC

    (349,176     (349,176         (385,647     (385,647

Total counterparty netting

    (487,771     (487,771         (567,238     (567,238

OTC-cleared

    (26,963     (233       (27,560     (2,940
   

Bilateral OTC

    (49,978     (35,970         (57,769     (40,046

Total cash collateral netting

    (76,941     (36,203         (85,329     (42,986

Total amounts offset

    $(564,712     $(523,974         $(652,567     $(610,224

Included in condensed consolidated statements of financial condition

 

Exchange-traded

    $     2,036       $     1,839         $     2,547       $     2,082  
   

OTC-cleared

    506       215         246       144  
   

Bilateral OTC

    42,652       36,953           50,879       45,273  

Total

    $   45,194       $   39,007           $   53,672       $   47,499  

Not offset in condensed consolidated statements of financial condition

 

Cash collateral

    $       (338     $    (1,306       $       (535     $    (2,085
   

Securities collateral

    (13,403     (9,032         (15,518     (10,224

Total

    $   31,453       $   28,669           $   37,619       $   35,190  
    Notional Amounts as of  
$ in millions    

March

2017

 

 

    

December

2016

 

 

Not accounted for as hedges

    

Exchange-traded

    $  7,103,874        $  4,425,532  
   

OTC-cleared

    16,790,485        16,646,145  
   

Bilateral OTC

    11,633,305        11,131,442  

Total interest rates

    35,527,664        32,203,119  

OTC-cleared

    382,658        378,432  
   

Bilateral OTC

    1,009,141        1,045,913  

Total credit

    1,391,799        1,424,345  

Exchange-traded

    16,912        13,800  
   

OTC-cleared

    77,380        62,799  
   

Bilateral OTC

    6,552,532        5,576,748  

Total currencies

    6,646,824        5,653,347  

Exchange-traded

    291,840        227,707  
   

OTC-cleared

    3,961        3,506  
   

Bilateral OTC

    206,679        196,899  

Total commodities

    502,480        428,112  

Exchange-traded

    701,664        605,335  
   

Bilateral OTC

    1,024,526        959,112  

Total equities

    1,726,190        1,564,447  

Subtotal

    45,794,957        41,273,370  

Accounted for as hedges

    

OTC-cleared

    55,009        55,328  
   

Bilateral OTC

    32,754        36,607  

Total interest rates

    87,763        91,935  

OTC-cleared

    2,266        1,703  
   

Bilateral OTC

    9,674        8,544  

Total currencies

    11,940        10,247  

Subtotal

    99,703        102,182  

Total notional amounts

    $45,894,660        $41,375,552  

In the tables above:

 

 

Gross fair values exclude the effects of both counterparty netting and collateral, and therefore are not representative of the firm’s exposure.

 

 

Where the firm has received or posted collateral under credit support agreements, but has not yet determined such agreements are enforceable, the related collateral has not been netted.

 

 

Notional amounts, which represent the sum of gross long and short derivative contracts, provide an indication of the volume of the firm’s derivative activity and do not represent anticipated losses.

 

 

Total gross fair value of derivatives includes derivative assets and derivative liabilities of $11.91 billion and $15.46 billion, respectively, as of March 2017, and derivative assets and derivative liabilities of $19.92 billion and $20.79 billion, respectively, as of December 2016, which are not subject to an enforceable netting agreement or are subject to a netting agreement that the firm has not yet determined to be enforceable.

 

 

    Goldman Sachs March 2017 Form 10-Q   23


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Pursuant to a rule change at a clearing organization in the first quarter of 2017, transactions with this clearing organization are considered settled each day. The impact of reflecting transactions with this clearing organization as settled would have been a reduction in gross interest rate and credit derivative assets and liabilities as of December 2016 of $24.58 billion and $27.36 billion, respectively, and a corresponding decrease in counterparty and cash collateral netting, with no impact to the condensed consolidated statements of financial condition.

Valuation Techniques for Derivatives

The firm’s level 2 and level 3 derivatives are valued using derivative pricing models (e.g., discounted cash flow models, correlation models, and models that incorporate option pricing methodologies, such as Monte Carlo simulations). Price transparency of derivatives can generally be characterized by product type, as described below.

 

 

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

 

 

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

 

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

 

 

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

 

 

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

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

Level 1 Derivatives

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

Level 2 Derivatives

Level 2 derivatives include OTC derivatives for which all significant valuation inputs are corroborated by market evidence and exchange-traded derivatives that are not actively traded and/or that are valued using models that calibrate to market-clearing levels of OTC derivatives.

 

 

24   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The selection of a particular model to value a derivative depends on the contractual terms of and specific risks inherent in the instrument, as well as the availability of pricing information in the market. For derivatives that trade in liquid markets, model selection does not involve significant management judgment because outputs of models can be calibrated to market-clearing levels.

Valuation models require a variety of inputs, such as contractual terms, market prices, yield curves, discount rates (including those derived from interest rates on collateral received and posted as specified in credit support agreements for collateralized derivatives), credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. Significant inputs to the valuations of level 2 derivatives can be verified to market transactions, broker or dealer quotations or other alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.

Level 3 Derivatives

Level 3 derivatives are valued using models which utilize observable level 1 and/or level 2 inputs, as well as unobservable level 3 inputs. The significant unobservable inputs used to value the firm’s level 3 derivatives are described below.

 

 

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

 

 

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

 

 

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

 

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

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

Valuation Adjustments

Valuation adjustments are integral to determining the fair value of derivative portfolios and are used to adjust the mid-market valuations produced by derivative pricing models to the appropriate exit price valuation. These adjustments incorporate bid/offer spreads, the cost of liquidity, credit valuation adjustments and funding valuation adjustments, which account for the credit and funding risk inherent in the uncollateralized portion of derivative portfolios. The firm also makes funding valuation adjustments to collateralized derivatives where the terms of the agreement do not permit the firm to deliver or repledge collateral received. Market-based inputs are generally used when calibrating valuation adjustments to market-clearing levels.

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

 

 

    Goldman Sachs March 2017 Form 10-Q   25


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Derivatives by Level

The tables below present the fair value of derivatives on a gross basis by level and major product type as well as the impact of netting, included in the condensed consolidated statements of financial condition.

 

    As of March 2017  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Interest rates

    $   65       $ 446,015       $    591       $ 446,671  
   

Credit

          20,152       4,599       24,751  
   

Currencies

          80,673       191       80,864  
   

Commodities

          10,531       346       10,877  
   

Equities

          46,321       422       46,743  

Gross fair value

    65       603,692       6,149       609,906  
   

Counterparty netting in levels

    (6     (484,967     (1,199     (486,172

Subtotal

    $   59       $ 118,725       $ 4,950       $ 123,734  
   

Cross-level counterparty netting

 

    (1,599
   

Cash collateral netting

                            (76,941

Net fair value

 

    $   45,194  

Liabilities

       

Interest rates

    $  (52     $(394,229     $   (873     $(395,154
   

Credit

          (19,370     (2,360     (21,730
   

Currencies

          (81,717     (167     (81,884
   

Commodities

          (12,052     (268     (12,320
   

Equities

    (419     (49,090     (2,384     (51,893

Gross fair value

    (471     (556,458     (6,052     (562,981
   

Counterparty netting in levels

    6       484,967       1,199       486,172  

Subtotal

    $(465     $  (71,491     $(4,853     $  (76,809
   

Cross-level counterparty netting

 

    1,599  
   

Cash collateral netting

                            36,203  

Net fair value

 

    $  (39,007

 

    As of December 2016  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Interest rates

    $   46       $ 506,818       $    614       $ 507,478  
   

Credit

          21,388       4,979       26,367  
   

Currencies

          111,762       187       111,949  
   

Commodities

          11,950       403       12,353  
   

Equities

    1       47,667       424       48,092  

Gross fair value

    47       699,585       6,607       706,239  
   

Counterparty netting in levels

    (12     (564,100     (1,417     (565,529

Subtotal

    $   35       $ 135,485       $ 5,190       $ 140,710  
   

Cross-level counterparty netting

 

    (1,709
   

Cash collateral netting

                            (85,329

Net fair value

 

    $   53,672  

Liabilities

       

Interest rates

    $  (27     $(457,963     $   (995     $(458,985
   

Credit

          (21,106     (2,475     (23,581
   

Currencies

          (107,212     (184     (107,396
   

Commodities

          (13,541     (330     (13,871
   

Equities

    (967     (49,083     (3,840     (53,890

Gross fair value

    (994     (648,905     (7,824     (657,723
   

Counterparty netting in levels

    12       564,100       1,417       565,529  

Subtotal

    $(982     $  (84,805     $(6,407     $  (92,194
   

Cross-level counterparty netting

 

    1,709  
   

Cash collateral netting

                            42,986  

Net fair value

 

    $  (47,499

In the tables above:

 

 

The gross fair values exclude the effects of both counterparty netting and collateral netting, and therefore are not representative of the firm’s exposure.

 

 

Counterparty netting is reflected in each level to the extent that receivable and payable balances are netted within the same level and is included in counterparty netting in levels. Where the counterparty netting is across levels, the netting is reflected in cross-level counterparty netting.

 

 

Derivative assets are shown as positive amounts and derivative liabilities are shown as negative amounts.

Significant Unobservable Inputs

The table below presents the amount of level 3 assets (liabilities), and ranges, averages and medians of significant unobservable inputs used to value the firm’s level 3 derivatives.

 

   

Level 3 Assets (Liabilities) and Range of Significant

Unobservable Inputs (Average/Median) as of

 
$ in millions    

March

2017

 

 

   

December

2016

 

 

Interest rates, net

    $(282)       $(381)  
   

Correlation

    (10)% to 86% (56%/60%)       (10)% to 86% (56%/60%)  
   

Volatility (bps)

    31 to 151 (84/57)       31 to 151 (84/57)  

Credit, net

    $2,239       $2,504  
   

Correlation

    36% to 90% (67%/70%)       35% to 91% (65%/68%)  
   

Credit spreads (bps)

    1 to 962 (88/49)       1 to 993 (122/73)  
   

Upfront credit points

    0 to 99 (41/35)       0 to 100 (43/35)  
   

Recovery rates

    20% to 97% (59%/65%)       1% to 97% (58%/70%)  

Currencies, net

    $24       $3  
   

Correlation

    25% to 70% (50%/55%)       25% to 70% (50%/55%)  

Commodities, net

    $78       $73  
   

Volatility

    10% to 59% (29%/28%)       13% to 68% (33%/33%)  
   

Natural gas spread

   
$(1.68) to $3.47
($(0.22)/$(0.13))
 
 
   
$(1.81) to $4.33
($(0.14)/$(0.05))
 
 
   

Oil spread

   
$(9.31) to $63.63
($7.62/$(0.41))
 
 
   
$(19.72) to $64.92
($25.30/$16.43)
 
 

Equities, net

    $(1,962)       $(3,416)  
   

Correlation

    (30)% to 89% (42%/41%)       (39)% to 88% (41%/41%)  
   

Volatility

    5% to 80% (23%/22%)       5% to 72% (24%/23%)  

In the table above:

 

 

Derivative assets are shown as positive amounts and derivative liabilities are shown as negative amounts.

 

 

Ranges represent the significant unobservable inputs that were used in the valuation of each type of derivative.

 

 

Averages represent the arithmetic average of the inputs and are not weighted by the relative fair value or notional of the respective financial instruments. An average greater than the median indicates that the majority of inputs are below the average. For example, the difference between the average and the median for credit spreads and oil spread inputs indicates that the majority of the inputs fall in the lower end of the range.

 

 

26   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

The ranges, averages and medians of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one derivative. For example, the highest correlation for interest rate derivatives is appropriate for valuing a specific interest rate derivative but may not be appropriate for valuing any other interest rate derivative. Accordingly, the ranges of inputs do not represent uncertainty in, or possible ranges of, fair value measurements of the firm’s level 3 derivatives.

 

 

Interest rates, currencies and equities derivatives are valued using option pricing models, credit derivatives are valued using option pricing, correlation and discounted cash flow models, and commodities derivatives are valued using option pricing and discounted cash flow models.

 

 

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

 

 

Correlation within currencies and equities includes cross-product correlation.

 

 

Natural gas spread represents the spread per million British thermal units of natural gas.

 

 

Oil spread represents the spread per barrel of oil and refined products.

Range of Significant Unobservable Inputs

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

 

 

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

 

 

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

 

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

 

 

Commodity prices and spreads. The ranges for commodity prices and spreads cover variability in products, maturities and delivery locations.

Sensitivity of Fair Value Measurement to Changes in Significant Unobservable Inputs

The following is a description of the directional sensitivity of the firm’s level 3 fair value measurements to changes in significant unobservable inputs, in isolation:

 

 

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

 

 

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

 

 

Credit spreads, upfront credit points and recovery rates. In general, the fair value of purchased credit protection increases as credit spreads or upfront credit points increase or recovery rates decrease. Credit spreads, upfront credit points and recovery rates are strongly related to distinctive risk factors of the underlying reference obligations, which include reference entity-specific factors such as leverage, volatility and industry, market-based risk factors, such as borrowing costs or liquidity of the underlying reference obligation, and macroeconomic conditions.

 

 

Commodity prices and spreads. In general, for contracts where the holder is receiving a commodity, an increase in the spread (price difference from a benchmark index due to differences in quality or delivery location) or price results in a higher fair value measurement.

Due to the distinctive nature of each of the firm’s level 3 derivatives, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

    Goldman Sachs March 2017 Form 10-Q   27


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

The table below presents a summary of the changes in fair value for all level 3 derivatives.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Total level 3 derivatives

    

Beginning balance

    $(1,217      $    495  
   

Net realized gains/(losses)

    (15      (79
   

Net unrealized gains/(losses)

    769        461  
   

Purchases

    79        115  
   

Sales

    (458      (1,825
   

Settlements

    871        106  
   

Transfers into level 3

    (10      (16
   

Transfers out of level 3

    78        798  

Ending balance

    $      97        $      55  

In the table above:

 

 

Changes in fair value are presented for all derivative assets and liabilities that are classified in level 3 as of the end of the period.

 

 

Net unrealized gains/(losses) relate to instruments that were still held at period-end.

 

 

If a derivative was transferred into level 3 during a reporting period, its entire gain or loss for the period is classified in level 3. Transfers between levels are reported at the beginning of the reporting period in which they occur.

 

 

Positive amounts for transfers into level 3 and negative amounts for transfers out of level 3 represent net transfers of derivative assets. Negative amounts for transfers into level 3 and positive amounts for transfers out of level 3 represent net transfers of derivative liabilities.

 

 

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

 

 

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

 

 

Gains or losses that have been classified in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to level 1 or level 2 derivatives and/or level 1, level 2 and level 3 cash instruments. As a result, gains/(losses) included in the level 3 rollforward below do not necessarily represent the overall impact on the firm’s results of operations, liquidity or capital resources.

The table below disaggregates, by major product type, the information for level 3 derivatives included in the summary table above.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Interest rates, net

    

Beginning balance

    $   (381      $   (398
   

Net realized gains/(losses)

    (22      (11
   

Net unrealized gains/(losses)

    103        28  
   

Purchases

    4        3  
   

Sales

    (9      (10
   

Settlements

    46        17  
   

Transfers into level 3

    (10       
   

Transfers out of level 3

    (13      (12

Ending balance

    $   (282      $   (383

Credit, net

    

Beginning balance

    $ 2,504        $ 2,793  
   

Net realized gains/(losses)

    43        (26
   

Net unrealized gains/(losses)

    (174      210  
   

Purchases

    16        33  
   

Sales

    (20      (57
   

Settlements

    (135      (75
   

Transfers into level 3

    13        8  
   

Transfers out of level 3

    (8      (65

Ending balance

    $ 2,239        $ 2,821  

Currencies, net

    

Beginning balance

    $        3        $     (34
   

Net realized gains/(losses)

    (22      (21
   

Net unrealized gains/(losses)

    (13      (5
   

Purchases

    2        6  
   

Sales

           (1
   

Settlements

    51        61  
   

Transfers into level 3

    (2       
   

Transfers out of level 3

    5        3  

Ending balance

    $      24        $        9  

Commodities, net

    

Beginning balance

    $      73        $   (262
   

Net realized gains/(losses)

           (5
   

Net unrealized gains/(losses)

    20        41  
   

Purchases

    13        47  
   

Sales

    (13      (18
   

Settlements

    (21      (37
   

Transfers into level 3

    (9      (26
   

Transfers out of level 3

    15        (31

Ending balance

    $      78        $   (291

Equities, net

    

Beginning balance

    $(3,416      $(1,604
   

Net realized gains/(losses)

    (14      (16
   

Net unrealized gains/(losses)

    833        187  
   

Purchases

    44        26  
   

Sales

    (416      (1,739
   

Settlements

    930        140  
   

Transfers into level 3

    (2      2  
   

Transfers out of level 3

    79        903  

Ending balance

    $(1,962      $(2,101
 

 

28   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended March 2017. The net realized and unrealized gains on level 3 derivatives of $754 million (reflecting $15 million of net realized losses and $769 million of net unrealized gains) include gains/(losses) of $848 million and $(94) million reported in “Market making” and “Other principal transactions” respectively.

The net unrealized gain on level 3 derivatives for the three months ended March 2017 was primarily attributable to gains on certain equity derivatives, reflecting the impact of an increase in equity prices.

Transfers into level 3 derivatives during the three months ended March 2017 were not material.

Transfers out of level 3 derivatives during the three months ended March 2017 primarily reflected transfers of certain equity derivative liabilities to level 2, principally due to certain unobservable volatility inputs not being significant to the valuation of these derivatives.

Three Months Ended March 2016. The net realized and unrealized gains on level 3 derivatives of $382 million (reflecting $79 million of realized losses and $461 million of unrealized gains) include gains/(losses) of $393 million and $(11) million reported in “Market making” and “Other principal transactions” respectively.

The net unrealized gain on level 3 derivatives for the three months ended March 2016 was primarily attributable to gains on certain credit derivatives, reflecting the impact of changes in interest rates and widening of certain credit spreads, and gains on certain equity derivatives, reflecting the impact of changes in equity prices.

Transfers into level 3 derivatives during the three months ended March 2016 were not material.

Transfers out of level 3 derivatives during the three months ended March 2016 primarily reflected transfers of certain equity derivative liabilities to level 2, principally due to certain unobservable inputs no longer being significant to the valuation of these derivatives.

OTC Derivatives

The table below presents the fair values of OTC derivative assets and liabilities by tenor and major product type.

 

$ in millions    

Less than

1 Year

 

 

   

1 - 5

Years

 

 

   

Greater than

5 Years

 

 

    Total  

As of March 2017

       

Assets

       

Interest rates

    $  5,419       $17,823       $77,258       $100,500  
   

Credit

    1,295       3,476       4,161       8,932  
   

Currencies

    9,715       6,246       8,154       24,115  
   

Commodities

    3,103       1,252       175       4,530  
   

Equities

    3,299       6,955       1,294       11,548  
   

Counterparty netting in tenors

    (2,965     (5,174     (3,966     (12,105

Subtotal

    $19,866       $30,578       $87,076       $137,520  
   

Cross-tenor counterparty netting

 

        (17,421
   

Cash collateral netting

                            (76,941

Total

                            $  43,158  

Liabilities

       

Interest rates

    $  5,086       $  9,749       $34,116       $  48,951  
   

Credit

    1,298       3,082       1,531       5,911  
   

Currencies

    11,591       8,502       5,035       25,128  
   

Commodities

    2,387       1,067       2,437       5,891  
   

Equities

    7,859       6,298       2,859       17,016  
   

Counterparty netting in tenors

    (2,965     (5,174     (3,966     (12,105

Subtotal

    $25,256       $23,524       $42,012       $  90,792  
   

Cross-tenor counterparty netting

 

        (17,421
   

Cash collateral netting

                            (36,203

Total

                            $  37,168  

 

As of December 2016

       

Assets

       

Interest rates

    $  5,845       $18,376       $79,507       $103,728  
   

Credit

    1,763       2,695       4,889       9,347  
   

Currencies

    18,344       8,292       8,428       35,064  
   

Commodities

    3,273       1,415       179       4,867  
   

Equities

    3,141       9,249       1,341       13,731  
   

Counterparty netting in tenors

    (3,543     (5,550     (3,794     (12,887

Subtotal

    $28,823       $34,477       $90,550       $153,850  
   

Cross-tenor counterparty netting

 

        (17,396
   

Cash collateral netting

                            (85,329

Total

                            $  51,125  

Liabilities

       

Interest rates

    $  5,679       $10,814       $38,812       $  55,305  
   

Credit

    2,060       3,328       1,167       6,555  
   

Currencies

    14,720       9,771       5,879       30,370  
   

Commodities

    2,546       1,555       2,315       6,416  
   

Equities

    7,000       10,426       2,614       20,040  
   

Counterparty netting in tenors

    (3,543     (5,550     (3,794     (12,887

Subtotal

    $28,462       $30,344       $46,993       $105,799  
   

Cross-tenor counterparty netting

 

        (17,396
   

Cash collateral netting

                            (42,986

Total

                            $  45,417  
 

 

    Goldman Sachs March 2017 Form 10-Q   29


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In the table above:

 

 

Tenor is based on expected duration for mortgage-related credit derivatives and generally on remaining contractual maturity for other derivatives.

 

 

Counterparty netting within the same product type and tenor category is included within such product type and tenor category.

 

 

Counterparty netting across product types within the same tenor category is included in counterparty netting in tenors. Where the counterparty netting is across tenor categories, the netting is reflected in cross-tenor counterparty netting.

Credit Derivatives

The firm enters into a broad array of credit derivatives in locations around the world to facilitate client transactions and to manage the credit risk associated with market-making and investing and lending activities. Credit derivatives are actively managed based on the firm’s net risk position.

Credit derivatives are generally individually negotiated contracts and can have various settlement and payment conventions. Credit events include failure to pay, bankruptcy, acceleration of indebtedness, restructuring, repudiation and dissolution of the reference entity.

The firm enters into the following types of credit derivatives:

 

 

Credit Default Swaps. Single-name credit default swaps protect the buyer against the loss of principal on one or more bonds, loans or mortgages (reference obligations) in the event the issuer (reference entity) of the reference obligations suffers a credit event. The buyer of protection pays an initial or periodic premium to the seller and receives protection for the period of the contract. If there is no credit event, as defined in the contract, the seller of protection makes no payments to the buyer of protection. However, if a credit event occurs, the seller of protection is required to make a payment to the buyer of protection, which is calculated in accordance with the terms of the contract.

 

 

Credit Options. In a credit option, the option writer assumes the obligation to purchase or sell a reference obligation at a specified price or credit spread. The option purchaser buys the right, but does not assume the obligation, to sell the reference obligation to, or purchase it from, the option writer. The payments on credit options depend either on a particular credit spread or the price of the reference obligation.

 

Credit Indices, Baskets and Tranches. Credit derivatives may reference a basket of single-name credit default swaps or a broad-based index. If a credit event occurs in one of the underlying reference obligations, the protection seller pays the protection buyer. The payment is typically a pro-rata portion of the transaction’s total notional amount based on the underlying defaulted reference obligation. In certain transactions, the credit risk of a basket or index is separated into various portions (tranches), each having different levels of subordination. The most junior tranches cover initial defaults and once losses exceed the notional amount of these junior tranches, any excess loss is covered by the next most senior tranche in the capital structure.

 

 

Total Return Swaps. A total return swap transfers the risks relating to economic performance of a reference obligation from the protection buyer to the protection seller. Typically, the protection buyer receives from the protection seller a floating rate of interest and protection against any reduction in fair value of the reference obligation, and in return the protection seller receives the cash flows associated with the reference obligation, plus any increase in the fair value of the reference obligation.

The firm economically hedges its exposure to written credit derivatives primarily by entering into offsetting purchased credit derivatives with identical underliers. Substantially all of the firm’s purchased credit derivative transactions are with financial institutions and are subject to stringent collateral thresholds. In addition, upon the occurrence of a specified trigger event, the firm may take possession of the reference obligations underlying a particular written credit derivative, and consequently may, upon liquidation of the reference obligations, recover amounts on the underlying reference obligations in the event of default.

As of March 2017, written and purchased credit derivatives had total gross notional amounts of $669.66 billion and $722.22 billion, respectively, for total net notional purchased protection of $52.56 billion. As of December 2016, written and purchased credit derivatives had total gross notional amounts of $690.47 billion and $733.98 billion, respectively, for total net notional purchased protection of $43.51 billion. Substantially all of the firm’s written and purchased credit derivatives are credit default swaps.

 

 

30   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents certain information about credit derivatives.

 

    Credit Spread on Underlier (basis points)  
$ in millions     0 - 250      
251 -
500
 
 
   
501 -
1,000
 
 
   

Greater
than
1,000
 
 
 
    Total  

As of March 2017

 

       

Maximum Payout/Notional Amount of Written Credit Derivatives by Tenor

 

Less than 1 year

    $207,898       $  8,016       $  1,629       $  5,065       $222,608  
   

1 - 5 years

    337,949       10,995       8,711       7,428       365,083  
   

Greater than 5 years

    73,908       5,972       1,564       528       81,972  

Total

    $619,755       $24,983       $11,904       $13,021       $669,663  

Maximum Payout/Notional Amount of Purchased Credit Derivatives

 

Offsetting

    $531,632       $16,116       $10,521       $10,873       $569,142  
   

Other

    138,756       9,863       2,082       2,380       153,081  

Fair Value of Written Credit Derivatives

 

Asset

    $  14,252       $     650       $     192       $       59       $  15,153  
   

Liability

    1,844       538       904       4,271       7,557  

Net asset/(liability)

    $  12,408       $     112       $    (712     $ (4,212     $    7,596  

 

As of December 2016

 

     

Maximum Payout/Notional Amount of Written Credit Derivatives by Tenor

 

Less than 1 year

    $207,727       $  5,819       $  1,016       $  8,629       $223,191  
   

1 - 5 years

    375,208       17,255       8,643       7,986       409,092  
   

Greater than 5 years

    52,977       3,928       1,045       233       58,183  

Total

    $635,912       $27,002       $10,704       $16,848       $690,466  

Maximum Payout/Notional Amount of Purchased Credit Derivatives

 

Offsetting

    $558,305       $20,588       $10,133       $15,186       $604,212  
   

Other

    119,509       7,712       1,098       1,446       129,765  

Fair Value of Written Credit Derivatives

 

Asset

    $  13,919       $     606       $     187       $       45       $  14,757  
   

Liability

    2,436       902       809       5,686       9,833  

Net asset/(liability)

    $  11,483       $    (296     $    (622     $ (5,641     $    4,924  

In the table above:

 

 

Fair values exclude the effects of both netting of receivable balances with payable balances under enforceable netting agreements, and netting of cash received or posted under enforceable credit support agreements, and therefore are not representative of the firm’s credit exposure.

 

 

Tenor is based on expected duration for mortgage-related credit derivatives and on remaining contractual maturity for other credit derivatives.

 

 

The credit spread on the underlier, together with the tenor of the contract, are indicators of payment/performance risk. The firm is less likely to pay or otherwise be required to perform where the credit spread and the tenor are lower.

 

 

Offsetting purchased credit derivatives represent the notional amount of purchased credit derivatives that economically hedge written credit derivatives with identical underliers and are included in offsetting.

 

 

Other purchased credit derivatives represent the notional amount of all other purchased credit derivatives not included in offsetting.

Impact of Credit Spreads on Derivatives

On an ongoing basis, the firm realizes gains or losses relating to changes in credit risk through the unwind of derivative contracts and changes in credit mitigants.

The net gain, including hedges, attributable to the impact of changes in credit exposure and credit spreads (counterparty and the firm’s) on derivatives was $11 million and $132 million for the three months ended March 2017 and March 2016, respectively.

Bifurcated Embedded Derivatives

The table below presents the fair value and the notional amount of derivatives that have been bifurcated from their related borrowings.

 

    As of  
$ in millions    
March
2017
 
 
    
December
2016
 
 

Fair value of assets

    $   734        $   676  
   

Fair value of liabilities

    981        864  

Net liability

    $   247        $   188  

 

Notional amount

    $8,495        $8,726  

In the table above, these derivatives, which are recorded at fair value, primarily consist of interest rate, equity and commodity products and are included in “Unsecured short-term borrowings” and “Unsecured long-term borrowings” with the related borrowings. See Note 8 for further information.

Derivatives with Credit-Related Contingent Features

Certain of the firm’s derivatives have been transacted under bilateral agreements with counterparties who may require the firm to post collateral or terminate the transactions based on changes in the firm’s credit ratings. The firm assesses the impact of these bilateral agreements by determining the collateral or termination payments that would occur assuming a downgrade by all rating agencies. A downgrade by any one rating agency, depending on the agency’s relative ratings of the firm at the time of the downgrade, may have an impact which is comparable to the impact of a downgrade by all rating agencies.

 

 

    Goldman Sachs March 2017 Form 10-Q   31


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the aggregate fair value of net derivative liabilities under such agreements (excluding application of collateral posted to reduce these liabilities), the related aggregate fair value of the assets posted as collateral and the additional collateral or termination payments that could have been called at the reporting date by counterparties in the event of a one-notch and two-notch downgrade in the firm’s credit ratings.

 

    As of  
$ in millions    
March
2017
 
 
   
December
2016
 
 

Net derivative liabilities under bilateral agreements

    $28,517       $32,927  
   

Collateral posted

    $24,530       $27,840  
   

Additional collateral or termination payments:

   

One-notch downgrade

    $     367       $     677  
   

Two-notch downgrade

    $  1,880       $  2,216  

Hedge Accounting

The firm applies hedge accounting for (i) certain interest rate swaps used to manage the interest rate exposure of certain fixed-rate unsecured long-term and short-term borrowings and certain fixed-rate certificates of deposit and (ii) certain foreign currency forward contracts and foreign currency-denominated debt used to manage foreign currency exposures on the firm’s net investment in certain non-U.S. operations.

To qualify for hedge accounting, the hedging instrument must be highly effective at reducing the risk from the exposure being hedged. Additionally, the firm must formally document the hedging relationship at inception and test the hedging relationship at least on a quarterly basis to ensure the hedging instrument continues to be highly effective over the life of the hedging relationship.

Fair Value Hedges

The firm designates certain interest rate swaps as fair value hedges. These interest rate swaps hedge changes in fair value attributable to the designated benchmark interest rate (e.g., London Interbank Offered Rate (LIBOR) or Overnight Index Swap Rate), effectively converting a substantial portion of fixed-rate obligations into floating-rate obligations.

The firm applies a statistical method that utilizes regression analysis when assessing the effectiveness of its fair value hedging relationships in achieving offsetting changes in the fair values of the hedging instrument and the risk being hedged (i.e., interest rate risk). An interest rate swap is considered highly effective in offsetting changes in fair value attributable to changes in the hedged risk when the regression analysis results in a coefficient of determination of 80% or greater and a slope between 80% and 125%.

For qualifying fair value hedges, gains or losses on derivatives are included in “Interest expense.” 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 resulting from hedge ineffectiveness are included in “Interest expense.” When a derivative is no longer designated as a hedge, any remaining difference between the carrying value and par value of the hedged item is amortized to interest expense over the remaining life of the hedged item using the effective interest method. See Note 23 for further information about interest income and interest expense.

The table below presents the gains/(losses) from interest rate derivatives accounted for as hedges, the related hedged borrowings and deposits, and the hedge ineffectiveness on these derivatives, which primarily consists of amortization of prepaid credit spreads resulting from the passage of time.

 

   

Three Months

Ended March

 
$ in millions     2017        2016  

Interest rate hedges

    $(754      $ 1,990  
   

Hedged borrowings and deposits

    554        (2,028

Hedge ineffectiveness

    $(200      $     (38

Net Investment Hedges

The firm seeks to reduce the impact of fluctuations in foreign exchange rates on its net investments in certain non-U.S. operations through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts designated as hedges, the effectiveness of the hedge is assessed based on the overall changes in the fair value of the forward contracts (i.e., based on changes in forward rates). For foreign currency-denominated debt designated as a hedge, the effectiveness of the hedge is assessed based on changes in spot rates.

For qualifying net investment hedges, the gains or losses on the hedging instruments, to the extent effective, are included in “Currency translation” in the condensed consolidated statements of comprehensive income.

 

 

32   Goldman Sachs March 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below presents the gains/(losses) from net investment hedging.

 

    Three Months
Ended March
 
$ in millions     2017        2016  

Hedges:

    

Foreign currency forward contract

    $(349      $(356
   

Foreign currency-denominated debt

    $  (82      $(150

The gain/(loss) related to ineffectiveness and the gain/(loss) reclassified to earnings from accumulated other comprehensive loss were not material for the three months ended March 2017 or March 2016.

As of March 2017 and December 2016, the firm had designated $1.77 billion and $1.69 billion, respectively, of foreign currency-denominated debt, included in “Unsecured long-term borrowings” and “Unsecured short-term borrowings,” as hedges of net investments in non-U.S. subsidiaries.

Note 8.

Fair Value Option

Other Financial Assets and Financial Liabilities at Fair Value

In addition to all cash and derivative instruments included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” the firm accounts for certain of its other financial assets and financial liabilities at fair value primarily under the fair value option. The primary reasons for electing the fair value option are to:

 

 

Reflect economic events in earnings on a timely basis;

 

 

Mitigate volatility in earnings from using different measurement attributes (e.g., transfers of financial instruments owned accounted for as financings are recorded at fair value whereas the related secured financing would be recorded on an accrual basis absent electing the fair value option); and

 

 

Address simplification and cost-benefit considerations (e.g., accounting for hybrid financial instruments at fair value in their entirety versus bifurcation of embedded derivatives and hedge accounting for debt hosts).

Hybrid financial instruments are instruments that contain bifurcatable embedded derivatives and do not require settlement by physical delivery of nonfinancial assets (e.g., physical commodities). If the firm elects to bifurcate the embedded derivative from the associated debt, the derivative 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 hedges. If the firm does not elect to bifurcate, the entire hybrid financial instrument is accounted for at fair value under the fair value option.

Other financial assets and financial liabilities accounted for at fair value under the fair value option include:

 

 

Repurchase agreements and substantially all resale agreements;

 

 

Securities borrowed and loaned within Fixed Income, Currency and Commodities Client Execution (FICC Client Execution);

 

 

Substantially all other secured financings, including transfers of assets accounted for as financings rather than sales;

 

 

Certain unsecured short-term borrowings, substantially all of which are hybrid financial instruments;

 

 

Certain unsecured long-term borrowings, including certain prepaid commodity transactions and hybrid financial instruments;

 

 

Certain receivables from customers and counterparties, including transfers of assets accounted for as secured loans rather than purchases and certain margin loans;

 

 

Certain time deposits issued by the firm’s bank subsidiaries (deposits with no stated maturity are not eligible for a fair value option election), including structured certificates of deposit, which are hybrid financial instruments; and

 

 

Certain subordinated liabilities of consolidated VIEs.

 

 

    Goldman Sachs March 2017 Form 10-Q   33


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Fair Value of Other Financial Assets and Financial Liabilities by Level

The table below presents, by level within the fair value hierarchy, other financial assets and financial liabilities accounted for at fair value primarily under the fair value option.

 

$ in millions     Level 1       Level 2       Level 3       Total  

As of March 2017

       

Assets

       

Securities purchased under agreements to resell

    $  —       $ 116,546       $         —       $ 116,546  
   

Securities borrowed

          79,893             79,893  
   

Receivables from customers and counterparties

          3,630       14       3,644  

Total

    $  —       $ 200,069       $        14       $ 200,083  

Liabilities

       

Deposits

    $  —       $  (16,132     $  (3,348     $  (19,480
   

Securities sold under agreements to repurchase

          (88,469     (64     (88,533
   

Securities loaned

          (4,403           (4,403
   

Other secured financings

          (21,392     (568     (21,960
   

Unsecured borrowings:

       

Short-term

          (9,656     (4,244     (13,900
   

Long-term

          (24,197     (7,878     (32,075
   

Other liabilities and accrued expenses

          (743     (63     (806

Total

    $  —       $(164,992     $(16,165     $(181,157

 

As of December 2016

       

Assets

       

Securities purchased under agreements to resell

    $  —       $ 116,077       $         —       $ 116,077  
   

Securities borrowed

          82,398             82,398  
   

Receivables from customers and counterparties

          3,211       55       3,266  

Total

    $  —       $ 201,686