10-Q 1 d416122d10q.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 June 30, 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 July 21, 2017, there were 386,875,130 shares of the registrant’s common stock outstanding.

 


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 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 and Financial Instruments Sold, But Not Yet Purchased

  14  
     

Note 5.   Fair Value Measurements

  15  
     

Note 6.   Cash Instruments

  16  
     

Note 7.   Derivatives and Hedging Activities

  22  
     

Note 8.   Fair Value Option

  34  
     

Note 9.   Loans Receivable

  41  
     

Note 10. Collateralized Agreements and Financings

  44  
     

Note 11. Securitization Activities

  48  
     

Note 12. Variable Interest Entities

  50  
     

Note 13. Other Assets

  54  
     

Note 14. Deposits

  56  
     

Note 15. Short-Term Borrowings

  57  
     

Note 16. Long-Term Borrowings

  57  
     

Note 17. Other Liabilities and Accrued Expenses

  60  
     

Note 18. Commitments, Contingencies and Guarantees

  60  
     

Note 19. Shareholders’ Equity

  64  
     

Note 20. Regulation and Capital Adequacy

  67  
     

Note 21. Earnings Per Common Share

  76  
     

Note 22. Transactions with Affiliated Funds

  76  
     

Note 23. Interest Income and Interest Expense

  77  
     

Note 24. Income Taxes

  77  
     

Note 25. Business Segments

  78  
     

Note 26. Credit Concentrations

  80  
     

Note  27. Legal Proceedings

  81  
     Page No.
 

Report of Independent Registered Public Accounting  Firm

  89  
 

Statistical Disclosures

  90  
     

Item 2

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

  92  
     

Introduction

  92  
     

Executive Overview

  92  
     

Business Environment

  93  
     

Critical Accounting Policies

  94  
     

Recent Accounting Developments

  96  
     

Use of Estimates

  96  
 

Results of Operations

  97  
 

Balance Sheet and Funding Sources

  108  
 

Equity Capital Management and Regulatory Capital

  113  
 

Regulatory Matters and Developments

  118  
     

Off-Balance-Sheet Arrangements and Contractual Obligations

  121  
     

Risk Management

  123  
     

Overview and Structure of Risk Management

  123  
     

Liquidity Risk Management

  127  
     

Market Risk Management

  135  
     

Credit Risk Management

  140  
     

Operational Risk Management

  146  
     

Model Risk Management

  147  
     

Available Information

  148  
     

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

  149  
     

Item 3

Quantitative and Qualitative Disclosures About Market Risk

  150  
     

Item 4

Controls and Procedures

  150  
     

PART II

OTHER INFORMATION

  150  
     

Item 1

Legal Proceedings

  150  
     

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

  150  
     

Item 6

Exhibits

  151  
     

SIGNATURES

  151  
 

 

    Goldman Sachs June 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 June
       

Six Months

Ended June

 
in millions, except per share amounts     2017        2016           2017        2016  

Revenues

           

Investment banking

    $1,730        $1,787         $  3,433        $  3,250  
   

Investment management

    1,433        1,260         2,830        2,522  
   

Commissions and fees

    794        777         1,565        1,694  
   

Market making

    1,915        2,490         4,333        4,352  
   

Other principal transactions

    1,227        864           2,448        815  

Total non-interest revenues

    7,099        7,178         14,609        12,633  
   

 

Interest income

    3,220        2,530         5,966        4,878  
   

Interest expense

    2,432        1,776           4,662        3,241  

Net interest income

    788        754           1,304        1,637  

Net revenues, including net interest income

    7,887        7,932           15,913        14,270  

 

Operating expenses

           

Compensation and benefits

    3,233        3,331         6,524        5,993  
   

 

Brokerage, clearing, exchange and distribution fees

    663        625         1,278        1,316  
   

Market development

    141        112         275        234  
   

Communications and technology

    224        205         447        402  
   

Depreciation and amortization

    265        245         522        484  
   

Occupancy

    190        181         366        364  
   

Professional fees

    229        231         434        451  
   

Other expenses

    433        539           1,019        987  

Total non-compensation expenses

    2,145        2,138           4,341        4,238  

Total operating expenses

    5,378        5,469           10,865        10,231  

 

Pre-tax earnings

    2,509        2,463         5,048        4,039  
   

Provision for taxes

    678        641           962        1,082  

Net earnings

    1,831        1,822         4,086        2,957  
   

Preferred stock dividends

    200        188           293        123  

Net earnings applicable to common shareholders

    $1,631        $1,634           $  3,793        $  2,834  

 

Earnings per common share

           

Basic

    $  4.00        $  3.77         $    9.24        $    6.47  
   

Diluted

    $  3.95        $  3.72         $    9.10        $    6.39  
   

 

Dividends declared per common share

    $  0.75        $  0.65         $    1.40        $    1.30  
   

 

Average common shares

           

Basic

    406.1        431.9         409.3        436.2  
   

Diluted

    413.3        439.2           416.7        443.2  

 

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

 

1   Goldman Sachs June 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

   

Three Months

Ended June

       

Six Months

Ended June

 
$ in millions     2017        2016           2017        2016  

Net earnings

    $1,831        $1,822         $4,086        $2,957  
   

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

           

Currency translation

    29        (22       13        (39
   

Debt valuation adjustment

    (275      (50       (414      (62
   

Pension and postretirement liabilities

           (1       1        (37
   

Available-for-sale securities

    1                  1         

Other comprehensive loss

    (245      (73         (399      (138

Comprehensive income

    $1,586        $1,749           $3,687        $2,819  

 

 

 

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

 

    Goldman Sachs June 2017 Form 10-Q   2


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    

June

2017

 

 

    
December
2016
 
 

Assets

    

Cash and cash equivalents

    $110,888        $121,711  
   

Collateralized agreements:

    

Securities purchased under agreements to resell and federal funds sold (includes $115,121 and $116,077 at fair value)

    115,553        116,925  
   

Securities borrowed (includes $70,298 and $82,398 at fair value)

    178,301        184,600  
   

Receivables:

    

Brokers, dealers and clearing organizations

    32,291        18,044  
   

Customers and counterparties (includes $4,895 and $3,266 at fair value)

    59,343        47,780  
   

Loans receivable

    53,952        49,672  
   

Financial instruments owned (at fair value and includes $52,773 and $51,278 pledged as collateral)

    327,740        295,952  
   

Other assets

    28,450        25,481  

Total assets

    $906,518        $860,165  

 

Liabilities and shareholders’ equity

    

Deposits (includes $20,686 and $13,782 at fair value)

    $125,544        $124,098  
   

Collateralized financings:

    

Securities sold under agreements to repurchase (at fair value)

    83,635        71,816  
   

Securities loaned (includes $4,753 and $2,647 at fair value)

    12,005        7,524  
   

Other secured financings (includes $21,967 and $21,073 at fair value)

    22,433        21,523  
   

Payables:

    

Brokers, dealers and clearing organizations

    10,604        4,386  
   

Customers and counterparties

    188,958        184,069  
   

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

    117,979        117,143  
   

Unsecured short-term borrowings (includes $15,945 and $14,792 at fair value)

    42,966        39,265  
   

Unsecured long-term borrowings (includes $33,760 and $29,410 at fair value)

    203,647        189,086  
   

Other liabilities and accrued expenses (includes $64 and $621 at fair value)

    12,072        14,362  

Total liabilities

    819,843        773,272  
   

 

Commitments, contingencies and guarantees

    

 

Shareholders’ equity

    

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

    11,203        11,203  
   

Common stock, $0.01 par value; 4,000,000,000 and 4,000,000,000 shares authorized, 881,816,771 and 873,608,100 shares issued, and 388,213,152 and 392,632,230 shares outstanding

    9        9  
   

Share-based awards

    3,308        3,914  
   

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

            
   

Additional paid-in capital

    53,187        52,638  
   

Retained earnings

    92,225        89,039  
   

Accumulated other comprehensive loss

    (1,615      (1,216
   

Stock held in treasury, at cost, $0.01 par value; 493,603,621 and 480,975,872 shares

    (71,642      (68,694

Total shareholders’ equity

    86,675        86,893  

Total liabilities and shareholders’ equity

    $906,518        $860,165  

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

 

3   Goldman Sachs June 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

$ in millions    
Six Months Ended
June 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

    1,460         2,143  
   

Delivery of common stock underlying share-based awards

    (1,959       (2,068
   

Forfeiture of share-based awards

    (34       (102
   

Exercise of share-based awards

    (108         (210

Ending balance

    3,308         3,914  
   

Additional paid-in capital

     

Beginning balance

    52,638         51,340  
   

Delivery of common stock underlying share-based awards

    2,056         2,282  
   

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

    (1,504       (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

    53,187         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

    4,086         7,398  
   

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

    (583       (1,129
   

Dividends declared on preferred stock

    (293       (577
   

Preferred stock redemption discount

              266  

Ending balance

    92,225         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

    (399         (803

Ending balance

    (1,615       (1,216
   

Stock held in treasury, at cost

     

Beginning balance

    (68,694       (62,640
   

Repurchased

    (2,966       (6,069
   

Reissued

    28         22  
   

Other

    (10         (7

Ending balance

    (71,642         (68,694

Total shareholders’ equity

    $ 86,675           $ 86,893  

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

 

    Goldman Sachs June 2017 Form 10-Q   4


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   

Six Months

Ended June

 
$ in millions     2017        2016  

Cash flows from operating activities

    

Net earnings

    $    4,086        $    2,957  
   

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

    

Depreciation and amortization

    522        484  
   

Share-based compensation

    1,452        1,814  
   

Gain related to extinguishment of subordinated borrowings

    (108       
   

Changes in operating assets and liabilities:

    

Receivables and payables (excluding loans receivable), net

    (14,527      738  
   

Collateralized transactions (excluding other secured financings), net

    23,971        (19,350
   

Financial instruments owned

    (31,640      17,274  
   

Financial instruments sold, but not yet purchased

    472        7,766  
   

Other, net

    1,919        (4,141

Net cash provided by/(used for) operating activities

    (13,853      7,542  
   

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (1,521      (1,242
   

Proceeds from sales of property, leasehold improvements and equipment

    202        282  
   

Net cash acquired in/(used for) business acquisitions

    (1,086      15,882  
   

Purchase of investments

    (728       
   

Proceeds from sales and paydowns of investments

    877        818  
   

Loans receivable, net

    (4,686      (2,925

Net cash provided by/(used for) investing activities

    (6,942      12,815  
   

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    (28      839  
   

Other secured financings (short-term), net

    (881      1,450  
   

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

    4,683        1,995  
   

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

    (3,151      (3,849
   

Purchase of APEX, senior guaranteed securities and trust preferred securities

    (62      (632
   

Proceeds from issuance of unsecured long-term borrowings

    31,654        25,965  
   

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

    (19,343      (22,612
   

Derivative contracts with a financing element, net

    1,002        27  
   

Deposits, net

    1,446        9,937  
   

Common stock repurchased

    (2,969      (3,294
   

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

    (1,507      (902
   

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

    (876      (860
   

Proceeds from issuance of preferred stock, net of issuance costs

           655  
   

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

    7        1  
   

Cash settlement of share-based awards

    (3       

Net cash provided by financing activities

    9,972        8,720  

Net increase/(decrease) in cash and cash equivalents

    (10,823      29,077  
   

Cash and cash equivalents, beginning balance

    121,711        93,439  

Cash and cash equivalents, ending balance

    $110,888        $122,516  

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $6.28 billion and $3.47 billion, and cash payments for income taxes, net of refunds, were $464 million and $400 million during the six months ended June 2017 and June 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 six months ended June 2017:

 

 

The firm exchanged $62 million of Trust Preferred Securities and common beneficial interests for $67 million of the firm’s junior subordinated debt.

Non-cash activities during the six months ended June 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.

 

5   Goldman Sachs June 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1.

Description of Business

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 June 2017, March 2017 and June 2016 refer to the firm’s periods ended, or the dates, as the context requires, June 30, 2017, March 31, 2017 and June 30, 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.

 

 

    Goldman Sachs June 2017 Form 10-Q   6


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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 and Financial Instruments

Sold, But Not Yet Purchased

    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.

 

 

7   Goldman Sachs June 2017 Form 10-Q    


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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.” 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 and Financial instruments sold, but not yet purchased 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.

 

 

    Goldman Sachs June 2017 Form 10-Q   8


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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” 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 June 2017 and December 2016, “Cash and cash equivalents” included $15.18 billion and $11.15 billion, respectively, of cash and due from banks, and $95.71 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 June 2017 and December 2016, $18.64 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 June 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 June 2017 and December 2016, the firm’s receivables from customers and counterparties included $2.81 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 June 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 June 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 June 2017 and December 2016. Interest on payables to customers and counterparties is recognized over the life of the transaction and included in “Interest expense.”

 

 

9   Goldman Sachs June 2017 Form 10-Q    


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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.

Cash dividend equivalents paid on outstanding restricted stock units (RSUs) 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.

 

 

    Goldman Sachs June 2017 Form 10-Q   10


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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. Based on implementation work to date, as a result of adopting this ASU, the firm expects that it will, among other things, be required to recognize certain investment management fees earlier than under the firm’s current revenue recognition policy. The firm will 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. The firm will adopt this ASU in January 2018 using a modified retrospective approach. 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” 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.

 

 

11   Goldman Sachs June 2017 Form 10-Q    


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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 half of 2017 was a reduction to the provision for taxes of $485 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 $902 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 $78 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 six months ended June 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.

Under CECL, the allowance for losses for financial assets that are measured at amortized cost reflects 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.

 

 

    Goldman Sachs June 2017 Form 10-Q   12


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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 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 $889 million for the six months ended June 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” 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.

Simplifying the Test for Goodwill Impairment (ASC 350). In January 2017, the FASB issued ASU No. 2017-04, “Intangibles — Goodwill and Other (Topic 350) — Simplifying the Test for Goodwill Impairment.” The ASU simplifies the quantitative goodwill impairment test by eliminating the second step of the test. Under this ASU, impairment will be measured by comparing the estimated fair value of the reporting unit with its carrying value.

The ASU is effective for the firm in 2020. Early adoption is permitted. The firm does not expect adoption will have a material impact to its goodwill impairment test.

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 will adopt this ASU using a modified retrospective approach and does not expect adoption of the ASU will have a material impact on its financial condition, results of operations or cash flows.

 

 

13   Goldman Sachs June 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 4.

 

Financial Instruments Owned and Financial

Instruments Sold, But Not Yet Purchased

 

Financial instruments owned and financial instruments sold, but not yet purchased 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 and financial instruments sold, but not yet purchased.

 

$ in millions    

Financial
Instruments
Owned
 
 
 
   



Financial
Instruments
Sold, But
Not Yet
Purchased
 
 
 
 
 

As of June 2017

   

Money market instruments

    $    1,649       $          —  
   

U.S. government and agency obligations

    74,238       17,746  
   

Non-U.S. government and agency obligations

    35,011       26,754  
   

Loans and securities backed by:

   

Commercial real estate

    4,364       5  
   

Residential real estate

    9,816       1  
   

Corporate loans and debt securities

    33,735       8,654  
   

State and municipal obligations

    783        
   

Other debt obligations

    1,592       1  
   

Equity securities

    109,002       25,065  
   

Commodities

    3,225        
   

Investments in funds at NAV

    5,910        

Subtotal

    279,325       78,226  
   

Derivatives

    48,415       39,753  

Total

    $327,740       $117,979  

 

As of December 2016

   

Money market instruments

    $    1,319       $          —  
   

U.S. government and 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 includes commercial paper, certificates of deposit and time deposits, substantially all of which have a maturity of less than one year.

 

 

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

 

Financial instruments owned included $330 million and $89 million of debt securities accounted for as available-for-sale as of June 2017 and December 2016, respectively. As of both June 2017 and December 2016, these securities were primarily comprised of U.S. government and agency obligations and other debt obligations. As of June 2017, substantially all of these securities had maturities of greater than five years (half of which had maturities of greater than ten years). As of December 2016, these securities primarily had maturities of greater than ten years. The gross unrealized gains/(losses) included in “Accumulated other comprehensive loss” related to available-for-sale securities were not material as of both June 2017 and December 2016.

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 June

         

Six Months

Ended June

 
$ in millions     2017       2016               2017       2016  

Interest rates

    $ 2,625       $  (907       $ 3,989       $   270  
   

Credit

    382       630         926       1,248  
   

Currencies

    (2,422 )      1,618         (2,740 )      710  
   

Equities

    1,293       861         1,871       1,552  
   

Commodities

    37       288               287       572  

Market making

    1,915       2,490               4,333       4,352  

Other principal transactions

    1,227       864               2,448       815  

Total

    $ 3,142       $3,354               $ 6,781       $5,167  

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 and financial instruments sold, but not yet purchased, 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.

 

 

    Goldman Sachs June 2017 Form 10-Q   14


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

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.

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 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, 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    

June

2017

 

 

   

March

2017

 

 

   
December
2016
 
 

Total level 1 financial assets

    $163,555       $151,691       $135,401  
   

Total level 2 financial assets

    407,480       406,332       419,585  
   

Total level 3 financial assets

    20,847       23,288       23,280  
   

Investments in funds at NAV

    5,910       6,183       6,465  
   

Counterparty and cash collateral netting

    (79,738 )      (78,540     (87,038

Total financial assets at fair value

    $518,054       $508,954       $497,693  

Total assets

    $906,518       $894,069       $860,165  
   

Total level 3 financial assets divided by:

     

Total assets

    2.3%       2.6%       2.7%  
   

Total financial assets at fair value

    4.0%       4.6%       4.7%  

Total level 1 financial liabilities

    $  68,534       $  67,732       $  62,504  
   

Total level 2 financial liabilities

    248,257       246,087       232,027  
   

Total level 3 financial liabilities

    19,595       21,067       21,448  
   

Counterparty and cash collateral netting

    (37,597 )      (37,802     (44,695

Total financial liabilities at fair value

    $298,789       $297,084       $271,284  

 

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

    6.6%       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 included $878 billion, $867 billion and $835 billion as of June 2017, March 2017 and December 2016, respectively, that is carried at fair value or at amounts that generally approximate fair value.

 

 

15   Goldman Sachs June 2017 Form 10-Q    


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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    
June
2017
 
 
    
March
2017
 
 
    
December
2016
 
 

Cash instruments

    $16,196        $18,324        $18,035  
   

Derivatives

    4,650        4,950        5,190  
   

Other financial assets

    1        14        55  

Total

    $20,847        $23,288        $23,280  

Level 3 financial assets as of June 2017 decreased compared with March 2017 and December 2016, primarily reflecting a decrease in level 3 cash instruments. See Notes 6 through 8 for further information about level 3 financial assets (including information about unrealized gains and losses related to level 3 financial assets and financial liabilities, and transfers in and out of level 3).

Note 6.

Cash Instruments

Cash instruments include U.S. government and 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:

 

 

    Goldman Sachs June 2017 Form 10-Q   16


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

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);

 

 

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 includes 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.

 

 

17   Goldman Sachs June 2017 Form 10-Q    


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 June 2017  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Money market instruments

    $       266       $   1,383       $       —       $    1,649  
   

U.S. government and agency obligations

    44,431       29,807             74,238  
   

Non-U.S. government and agency obligations

    27,787       7,222       2       35,011  
   

Loans and securities backed by:

       

Commercial real estate

          2,964       1,400       4,364  
   

Residential real estate

          9,009       807       9,816  
   

Corporate loans and debt securities

    702       29,388       3,645       33,735  
   

State and municipal obligations

          684       99       783  
   

Other debt obligations

          1,182       410       1,592  
   

Equity securities

    90,264       8,905       9,833       109,002  
   

Commodities

          3,225             3,225  

Subtotal

    $163,450       $ 93,769       $16,196       $273,415  
   

Investments in funds at NAV

                            5,910  

Total cash instrument assets

                            $279,325  

Liabilities

       

U.S. government and agency obligations

    $ (17,738     $         (8     $       —       $ (17,746
   

Non-U.S. government and agency obligations

    (25,097     (1,657           (26,754
   

Loans and securities backed by:

       

Commercial real estate

          (5           (5
   

Residential real estate

          (1           (1
   

Corporate loans and debt securities

    (6     (8,616     (32     (8,654
   

Other debt obligations

          (1           (1
   

Equity securities

    (24,765     (290     (10     (25,065

Total cash instrument liabilities

    $ (67,606     $(10,578     $      (42     $ (78,226
    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 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 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” and “Financial instruments sold, but not yet purchased,” respectively.

 

 

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

 

 

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

 

 

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

 

 

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

 

 

Total cash instrument assets included collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs) backed by real estate and corporate obligations of $490 million and $461 million in level 2, and $477 million and $624 million in level 3 as of June 2017 and December 2016, respectively.

 

 

    Goldman Sachs June 2017 Form 10-Q   18


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    

June

2017


 

   

December

2016


 

Loans and securities backed by commercial real estate

 

Level 3 assets

    $1,400       $1,645  
   

Yield

    3.9% to 22.0% (11.4%     3.7% to 23.0% (13.0%
   

Recovery rate

    15.9% to 98.7% (50.8%     8.9% to 99.0% (60.6%
   

Duration (years)

    0.8 to 5.9 (2.2     0.8 to 6.2 (2.1

Loans and securities backed by residential real estate

 

Level 3 assets

    $807       $845  
   

Yield

    1.8% to 18.0% (8.0%     0.8% to 15.6% (8.7%
   

Cumulative loss rate

    1.3% to 46.3% (20.8%     8.9% to 47.1% (24.2%
   

Duration (years)

    1.2 to 15.1 (7.7     1.1 to 16.1 (7.3

Corporate loans and debt securities

 

Level 3 assets

    $3,645       $4,640  
   

Yield

    2.9% to 20.3% (10.7%     2.5% to 25.0% (10.3%
   

Recovery rate

    0.0% to 94.7% (56.9%     0.0% to 85.0% (56.5%
   

Duration (years)

    1.2 to 6.6 (3.0     0.6 to 15.7 (2.9

Equity securities

 

 

Level 3 assets

    $9,833       $10,263  
   

Multiples

    0.9x to 18.6x (7.5x     0.8x to 19.7x (6.8x
   

Discount rate/yield

    6.5% to 29.5% (16.3%     6.5% to 25.0% (16.0%
   

Capitalization rate

    4.5% to 12.5% (6.7%     4.2% to 12.5% (6.8%

Other cash instruments

 

Level 3 assets

    $511       $642  
   

Yield

    3.0% to 15.0% (8.2%     1.9% to 14.0% (8.8%
   

Recovery rate

    N/A       0.0% to 93.0% (61.4%
   

Duration (years)

    0.7 to 11.9 (4.5     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 includes 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.

 

 

Recovery rate was not significant to the valuation of level 3 other cash instrument assets as of June 2017.

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 and six months ended June 2017, transfers into level 2 from level 1 of cash instruments were $66 million and $168 million, respectively, reflecting transfers of public equity securities due to decreased market activity in these instruments. Transfers into level 1 from level 2 of cash instruments during the three and six months ended June 2017, were $138 million and $178 million, respectively, reflecting transfers of public equity securities due to increased market activity in these instruments.

During the three and six months ended June 2016, transfers into level 2 from level 1 of cash instruments were $82 million and $162 million, respectively, 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 during the three and six months ended June 2016, were $6 million and $195 million, respectively, reflecting transfers of public equity securities principally due to increased market activity in these instruments.

 

 

19   Goldman Sachs June 2017 Form 10-Q    


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 June

         

Six Months

Ended June

 
$ in millions     2017       2016               2017       2016  

Total cash instrument assets

         

Beginning balance

    $18,324       $18,469         $18,035       $18,131  
   

Net realized gains/(losses)

    119       157         230       292  
   

Net unrealized gains/(losses)

    554       50         892       (69
   

Purchases

    518       708         1,026       2,096  
   

Sales

    (693     (480       (1,299     (1,169
   

Settlements

    (697     (1,014       (1,281     (1,763
   

Transfers into level 3

    774       1,599         1,717       2,239  
   

Transfers out of level 3

    (2,703     (1,358             (3,124     (1,626

Ending balance

    $16,196       $18,131               $16,196       $18,131  

Total cash instrument liabilities

         

Beginning balance

    $      (49     $    (138       $      (62     $    (193
   

Net realized gains/(losses)

    1                     2  
   

Net unrealized gains/(losses)

    (1     17         3       19  
   

Purchases

    40       23         50       69  
   

Sales

    (27     (24       (33     (39
   

Settlements

    (5     (5       (1     (11
   

Transfers into level 3

    (6     (1       (2     (4
   

Transfers out of level 3

    5       5               3       34  

Ending balance

    $      (42     $    (123             $      (42     $    (123

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 includes 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 June
         

Six Months

Ended June

 
$ in millions     2017        2016               2017        2016  

Loans and securities backed by commercial real estate

 

  

Beginning balance

    $  1,604        $2,168         $  1,645        $1,924  
   

Net realized gains/(losses)

    12        18         23        41  
   

Net unrealized gains/(losses)

    57        (38       78        (55
   

Purchases

    116        104         166        466  
   

Sales

    (60      (100       (110      (207
   

Settlements

    (167      (175       (298      (286
   

Transfers into level 3

    82        438         134        480  
   

Transfers out of level 3

    (244      (303             (238      (251

Ending balance

    $  1,400        $2,112               $  1,400        $2,112  

Loans and securities backed by residential real estate

 

  

Beginning balance

    $     830        $1,434         $     845        $1,765  
   

Net realized gains/(losses)

    11        12         27        18  
   

Net unrealized gains/(losses)

    60        19         80        67  
   

Purchases

    93        56         121        141  
   

Sales

    (158      (143       (214      (463
   

Settlements

    (38      (64       (69      (131
   

Transfers into level 3

    38        85         40        106  
   

Transfers out of level 3

    (29      (99             (23      (203

Ending balance

    $     807        $1,300               $     807        $1,300  

Corporate loans and debt securities

 

  

Beginning balance

    $  4,553        $5,791         $  4,640        $5,242  
   

Net realized gains/(losses)

    55        94         105        176  
   

Net unrealized gains/(losses)

    20        (15       108        (72
   

Purchases

    200        255         491        589  
   

Sales

    (212      (174       (630      (235
   

Settlements

    (289      (601       (507      (918
   

Transfers into level 3

    527        587         806        1,023  
   

Transfers out of level 3

    (1,209      (604             (1,368      (472

Ending balance

    $  3,645        $5,333               $  3,645        $5,333  

Equity securities

 

  

Beginning balance

    $10,715        $8,474         $10,263        $8,549  
   

Net realized gains/(losses)

    38        26         65        47  
   

Net unrealized gains/(losses)

    402        80         618        (13
   

Purchases

    90        254         186        706  
   

Sales

    (256      (49       (290      (113
   

Settlements

    (163      (118       (330      (350
   

Transfers into level 3

    124        374         726        558  
   

Transfers out of level 3

    (1,117      (336             (1,405      (679

Ending balance

    $  9,833        $8,705               $  9,833        $8,705  

Other cash instruments

 

  

Beginning balance

    $     622        $   602         $     642        $   651  
   

Net realized gains/(losses)

    3        7         10        10  
   

Net unrealized gains/(losses)

    15        4         8        4  
   

Purchases

    19        39         62        194  
   

Sales

    (7      (14       (55      (151
   

Settlements

    (40      (56       (77      (78
   

Transfers into level 3

    3        115         11        72  
   

Transfers out of level 3

    (104      (16             (90      (21

Ending balance

    $     511        $   681               $     511        $   681  
 

 

    Goldman Sachs June 2017 Form 10-Q   20


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended June 2017. The net realized and unrealized gains on level 3 cash instrument assets of $673 million (reflecting $119 million of net realized gains and $554 million of net unrealized gains) for the three months ended June 2017 included gains/(losses) of approximately $(26) million, $556 million and $143 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

The net unrealized gains on level 3 cash instrument assets for the three months ended June 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 June 2017 primarily reflected transfers of certain corporate loans and debt 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 June 2017 primarily reflected transfers of certain corporate loans and debt securities to level 2, principally due to certain unobservable yield and duration inputs no longer being significant to the valuation of these instruments, and transfers of certain private equity securities and corporate loans and debt securities to level 2, principally due to increased price transparency as a result of market evidence, including new transactions in these instruments.

Six Months Ended June 2017. The net realized and unrealized gains on level 3 cash instrument assets of $1.12 billion (reflecting $230 million of net realized gains and $892 million of net unrealized gains) for the six months ended June 2017 included gains/(losses) of approximately $(35) million, $884 million and $273 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

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

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

Three Months Ended June 2016. The net realized and unrealized gains on level 3 cash instrument assets of $207 million (reflecting $157 million of net realized gains and $50 million of net unrealized gains) for the three months ended June 2016 included gains/(losses) of approximately $(83) million, $90 million and $200 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

The net unrealized gains on level 3 cash instrument assets for the three months ended June 2016 were not material.

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

Six Months Ended June 2016. The net realized and unrealized gains on level 3 cash instrument assets of $223 million (reflecting $292 million of net realized gains and $69 million of net unrealized losses) for the six months ended June 2016 included gains/(losses) of approximately $(195) million, $22 million and $396 million reported in “Market making,” “Other principal transactions” and “Interest income,” respectively.

The net unrealized losses on level 3 cash instrument assets for the six months ended June 2016 were not material.

 

 

21   Goldman Sachs June 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Transfers into level 3 during the six months ended June 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 transactions in these instruments.

Transfers out of level 3 during the six months ended June 2016 primarily reflected transfers of certain private equity securities, corporate loans and debt securities, loans and securities backed by commercial real estate, 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.

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 to July 2022 for the firm’s investments in, and relationships with, certain legacy “illiquid covered funds” (as defined by the Volcker Rule) that were in place prior to December 2013. This extension is applicable to substantially all of the firm’s 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 conformance period.

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 June 2017

    

Private equity funds

    $4,346        $   629  
   

Credit funds

    295        408  
   

Hedge funds

    321         
   

Real estate funds

    948        270  

Total

    $5,910        $1,307  

 

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).

 

 

    Goldman Sachs June 2017 Form 10-Q   22


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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” and “Financial instruments sold, but not yet purchased,” 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.

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 June 2017         As of December 2016  
$ in millions    
Derivative
Assets
 
 
   
Derivative
Liabilities
 
 
       
Derivative
Assets
 
 
   
Derivative
Liabilities
 
 

Not accounted for as hedges

 

     

Exchange-traded

    $        455       $        582         $        443       $        382  
                                     

OTC-cleared

    143,572       121,483         189,471       168,946  
                                     

Bilateral OTC

    279,604       256,454           309,037       289,491  

Total interest rates

    423,631       378,519           498,951       458,819  

OTC-cleared

    5,390       5,212         4,837       4,811  
                                     

Bilateral OTC

    18,542       16,667           21,530       18,770  

Total credit

    23,932       21,879           26,367       23,581  

Exchange-traded

    37       49         36       176  
                                     

OTC-cleared

    594       516         796       798  
                                     

Bilateral OTC

    104,801       102,717           111,032       106,318  

Total currencies

    105,432       103,282           111,864       107,292  

Exchange-traded

    2,852       2,866         3,219       3,187  
                                     

OTC-cleared

    211       226         189       197  
                                     

Bilateral OTC

    7,259       9,413           8,945       10,487  

Total commodities

    10,322       12,505           12,353       13,871  

Exchange-traded

    9,329       8,826         8,576       8,064  
                                     

Bilateral OTC

    38,557       43,501           39,516       45,826  

Total equities

    47,886       52,327           48,092       53,890  

Subtotal

    611,203       568,512           697,627       657,453  

Accounted for as hedges

 

     

OTC-cleared

    5,539       161         4,347       156  
                                     

Bilateral OTC

    2,928       7           4,180       10  

Total interest rates

    8,467       168           8,527       166  

OTC-cleared

    4       12         30       40  
                                     

Bilateral OTC

    10       189           55       64  

Total currencies

    14       201           85       104  

Subtotal

    8,481       369           8,612       270  

Total gross fair value

    $ 619,684       $ 568,881           $ 706,239       $ 657,723  

Offset in condensed consolidated statements of financial condition

 

Exchange-traded

    $  (10,719     $  (10,719       $    (9,727     $    (9,727
                                     

OTC-cleared

    (127,416     (127,416       (171,864     (171,864
                                     

Bilateral OTC

    (354,816     (354,816         (385,647     (385,647

Counterparty netting

    (492,951     (492,951         (567,238     (567,238

OTC-cleared

    (27,282     (97       (27,560     (2,940
                                     

Bilateral OTC

    (51,036     (36,080         (57,769     (40,046

Cash collateral netting

    (78,318     (36,177         (85,329     (42,986

Total amounts offset

    $(571,269     $(529,128         $(652,567     $(610,224

Included in condensed consolidated statements of financial condition

 

Exchange-traded

    $     1,954       $     1,604         $     2,547       $     2,082  
                                     

OTC-cleared

    612       97         246       144  
                                     

Bilateral OTC

    45,849       38,052           50,879       45,273  

Total

    $   48,415       $   39,753           $   53,672       $   47,499  

Not offset in condensed consolidated statements of financial condition

 

Cash collateral

    $       (565     $    (1,935       $       (535     $    (2,085
                                     

Securities collateral

    (14,056     (8,848         (15,518     (10,224

Total

    $   33,794       $   28,970           $   37,619       $   35,190  
 

 

23   Goldman Sachs June 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

    Notional Amounts as of  
$ in millions    

June

2017

 

 

    

December

2016

 

 

Not accounted for as hedges

    

Exchange-traded

    $  8,554,128        $  4,425,532  
   

OTC-cleared

    18,107,397        16,646,145  
   

Bilateral OTC

    13,050,799        11,131,442  

Total interest rates

    39,712,324        32,203,119  

OTC-cleared

    384,450        378,432  
   

Bilateral OTC

    940,436        1,045,913  

Total credit

    1,324,886        1,424,345  

Exchange-traded

    16,169        13,800  
   

OTC-cleared

    89,197        62,799  
   

Bilateral OTC

    7,232,483        5,576,748  

Total currencies

    7,337,849        5,653,347  

Exchange-traded

    261,911        227,707  
   

OTC-cleared

    4,055        3,506  
   

Bilateral OTC

    219,218        196,899  

Total commodities

    485,184        428,112  

Exchange-traded

    712,038        605,335  
   

Bilateral OTC

    1,111,737        959,112  

Total equities

    1,823,775        1,564,447  

Subtotal

    50,684,018        41,273,370  

Accounted for as hedges

    

OTC-cleared

    54,847        55,328  
   

Bilateral OTC

    21,555        36,607  

Total interest rates

    76,402        91,935  

OTC-cleared

    2,898        1,703  
   

Bilateral OTC

    8,138        8,544  

Total currencies

    11,036        10,247  

Subtotal

    87,438        102,182  

Total notional amounts

    $50,771,456        $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 $13.88 billion and $16.07 billion, respectively, as of June 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.

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.

 

 

    Goldman Sachs June 2017 Form 10-Q   24


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

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

 

 

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

 

 

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

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

Level 1 Derivatives

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

Level 2 Derivatives

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

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

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.

 

 

25   Goldman Sachs June 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

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.

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 June 2017  
$ in millions     Level 1       Level 2       Level 3       Total  

Assets

       

Interest rates

    $   92       $ 431,419       $    587       $ 432,098  
   

Credit

          19,515       4,417       23,932  
   

Currencies

          105,269       177       105,446  
   

Commodities

          9,945       377       10,322  
   

Equities

    13       47,365       508       47,886  

Gross fair value

    105       613,513       6,066       619,684  
   

Counterparty netting in levels

          (490,115     (1,416     (491,531

Subtotal

    $ 105       $ 123,398       $ 4,650       $ 128,153  
   

Cross-level counterparty netting

 

    (1,420
   

Cash collateral netting

                            (78,318

Net fair value

 

    $   48,415  

Liabilities

       

Interest rates

    $(542     $(377,239     $   (906     $(378,687
   

Credit

          (19,461     (2,418     (21,879
   

Currencies

          (103,331     (152     (103,483
   

Commodities

          (12,246     (259     (12,505
   

Equities

    (386     (50,570     (1,371     (52,327

Gross fair value

    (928     (562,847     (5,106     (568,881
   

Counterparty netting in levels

          490,115       1,416       491,531  

Subtotal

    $(928     $  (72,732     $(3,690     $  (77,350
   

Cross-level counterparty netting

 

    1,420  
   

Cash collateral netting

                            36,177  

Net fair value

 

    $  (39,753
    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
 

 

    Goldman Sachs June 2017 Form 10-Q   26


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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 included 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    

June

2017


 

   

December

2016


 

Interest rates, net

    $(319)       $(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

    $1,999       $2,504  
   

Correlation

    36% to 88% (66%/67%)       35% to 91% (65%/68%)  
   

Credit spreads (bps)

    1 to 737 (89/44)       1 to 993 (122/73)  
   

Upfront credit points

    0 to 99 (47/40)       0 to 100 (43/35)  
   

Recovery rates

    22% to 93% (57%/60%)       1% to 97% (58%/70%)  

Currencies, net

    $25       $3  
   

Correlation

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

Commodities, net

    $118       $73  
   

Volatility

    9% to 61% (27%/26%)       13% to 68% (33%/33%)  
   

Natural gas spread

   

$(1.61) to $3.60

($(0.18)/$(0.09))

 

 

   

$(1.81) to $4.33

($(0.14)/$(0.05))

 

 

   

Oil spread

   

$(11.13) to $58.64

($11.49/$0.33)

 

 

   

$(19.72) to $64.92

($25.30/$16.43)

 

 

Equities, net

    $(863)       $(3,416)  
   

Correlation

    (35)% to 92% (43%/41%)       (39)% to 88% (41%/41%)  
   

Volatility

    5% to 85% (24%/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.

 

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.

 

 

27   Goldman Sachs June 2017 Form 10-Q    


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

 

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.

Level 3 Rollforward

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

 

   

Three Months

Ended June

    

Six Months

Ended June

 
$ in millions     2017        2016        2017        2016  

Total level 3 derivatives

 

     

Beginning balance

    $   97        $     55        $(1,217      $   495  
   

Net realized gains/(losses)

    (125      (60      (163      (136
   

Net unrealized gains/(losses)

    103        440        (43      947  
   

Purchases

    75        110        234        171  
   

Sales

    (200      (150      (313      (249
   

Settlements

    506        1,587        1,681        918  
   

Transfers into level 3

    (39      426        25        359  
   

Transfers out of level 3

    543        22        756        (75

Ending balance

    $ 960        $2,430        $    960        $2,430  

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.

 

 

    Goldman Sachs June 2017 Form 10-Q   28


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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

 

   

Three Months

Ended June

    

Six Months

Ended June

 
$ in millions     2017        2016        2017        2016  

Interest rates, net

 

     

Beginning balance

    $   (282      $   (383      $   (381      $   (398
   

Net realized gains/(losses)

    (6      (6      (24      (16
   

Net unrealized gains/(losses)

    (45      98        56        182  
   

Purchases

    1               3        2  
   

Sales

                  (3      (8
   

Settlements

    (5      (20      40        36  
   

Transfers into level 3

    7        375        (10      288  
   

Transfers out of level 3

    11        (8             (30

Ending balance

    $   (319      $      56        $   (319      $      56  

Credit, net

 

     

Beginning balance

    $ 2,239        $ 2,821        $ 2,504        $ 2,793  
   

Net realized gains/(losses)

    10        (40      60        (59
   

Net unrealized gains/(losses)

    1        5        (192      349  
   

Purchases

    9        14        64        41  
   

Sales

    (17      (2      (66      (39
   

Settlements

    (177      49        (334      (150
   

Transfers into level 3

    48        78        49        98  
   

Transfers out of level 3

    (114      17        (86      (91

Ending balance

    $ 1,999        $ 2,942        $ 1,999        $ 2,942  

Currencies, net

 

     

Beginning balance

    $      24        $        9        $        3        $     (34
   

Net realized gains/(losses)

    (7      (7      (33      (33
   

Net unrealized gains/(losses)

    (13      20        (20      9  
   

Purchases

    1        2        4        11  
   

Sales

                         (3
   

Settlements

    18        (14      66        56  
   

Transfers into level 3

    2        6               2  
   

Transfers out of level 3

           1        5        9  

Ending balance

    $      25        $      17        $      25        $      17  

Commodities, net

 

     

Beginning balance

    $      78        $   (291      $      73        $   (262
   

Net realized gains/(losses)

    1        14        10        18  
   

Net unrealized gains/(losses)

    63        141        131        160  
   

Purchases

    6        23        23        34  
   

Sales

    (39      (99      (51      (123
   

Settlements

    21        21        (37      8  
   

Transfers into level 3

    (32      (8      (38      (10
   

Transfers out of level 3

    20        (23      7        (47

Ending balance

    $    118        $   (222      $    118        $   (222

Equities, net

 

     

Beginning balance

    $(1,962      $(2,101      $(3,416      $(1,604
   

Net realized gains/(losses)

    (123      (21      (176      (46
   

Net unrealized gains/(losses)

    97        176        (18      247  
   

Purchases

    58        71        140        83  
   

Sales

    (144      (49      (193      (76
   

Settlements

    649        1,551        1,946        968  
   

Transfers into level 3

    (64      (25      24        (19
   

Transfers out of level 3

    626        35        830        84  

Ending balance

    $   (863      $   (363      $   (863      $   (363

Level 3 Rollforward Commentary

Three Months Ended June 2017. The net realized and unrealized losses on level 3 derivatives of $22 million (reflecting $125 million of net realized losses and $103 million of net unrealized gains) for the three months ended June 2017 included gains/(losses) of $59 million and $(81) million reported in “Market making” and “Other principal transactions,” respectively.

The net unrealized gains on level 3 derivatives for the three months ended June 2017 were primarily attributable to gains on certain equity derivatives, reflecting the impact of changes in the prices of underlying indices.

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

Transfers out of level 3 derivatives during the three months ended June 2017 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.

Six Months Ended June 2017. The net realized and unrealized losses on level 3 derivatives of $206 million (reflecting $163 million of net realized losses and $43 million of net unrealized losses) for the six months ended June 2017 included losses of $33 million and $173 million reported in “Market making” and “Other principal transactions,” respectively.

The net unrealized losses on level 3 derivatives for the six months ended June 2017 were primarily attributable to losses on certain credit derivatives, reflecting the impact of tighter credit spreads, partially offset by gains on certain commodity derivatives, reflecting the impact of a decrease in commodity prices.

Transfers into level 3 derivatives during the six months ended June 2017 were not material.

Transfers out of level 3 derivatives during the six months ended June 2017 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.

 

 

29   Goldman Sachs June 2017 Form 10-Q    


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Three Months Ended June 2016. The net realized and unrealized gains on level 3 derivatives of $380 million (reflecting $60 million of net realized losses and $440 million of net unrealized gains) for the three months ended June 2016 included gains/(losses) of $450 million and $(70) million reported in “Market making” and “Other principal transactions,” respectively.

The net unrealized gains on level 3 derivatives for the three months ended June 2016 were primarily attributable to gains on certain equity derivatives reflecting the impact of changes in equity prices, and gains on certain commodity derivatives, reflecting the impact of an increase in commodity prices.

Transfers into level 3 derivatives during the three months ended June 2016 primarily reflected transfers of certain interest rate derivative assets from level 2, principally due to reduced transparency of certain unobservable inputs used to value these derivatives.

Transfers out of level 3 derivatives during the three months ended June 2016 were not material.

Six Months Ended June 2016. The net realized and unrealized gains on level 3 derivatives of $811 million (reflecting $136 million of net realized losses and $947 million of net unrealized gains) for the six months ended June 2016 included gains/(losses) of $893 million and $(82) million reported in “Market making” and “Other principal transactions,” respectively.

The net unrealized gains on level 3 derivatives for the six months ended June 2016 were primarily attributable to gains on certain credit derivatives, principally reflecting the impact of a decrease in interest rates, and gains on certain equity derivatives reflecting the impact of changes in equity prices.

Transfers into level 3 derivatives during the six months ended June 2016 primarily reflected transfers of certain interest rate derivative assets from level 2, principally due to reduced transparency of certain unobservable inputs used to value these derivatives.

Transfers out of level 3 derivatives during the six months ended June 2016 were not material.

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 June 2017

       

Assets

       

Interest rates

    $  4,710       $19,949       $76,881       $101,540  
   

Credit

    1,019       3,795       3,746       8,560  
   

Currencies

    13,965       6,635       8,812       29,412  
   

Commodities

    2,644       1,492       169       4,305  
   

Equities

    3,237       6,009       1,389       10,635  
   

Counterparty netting in tenors

    (2,611     (5,268     (3,754     (11,633

Subtotal

    $22,964       $32,612       $87,243       $142,819  
   

Cross-tenor counterparty netting

 

        (18,040
   

Cash collateral netting

                            (78,318

Total

                            $  46,461  

Liabilities

       

Interest rates

    $  5,742       $10,153       $32,110       $  48,005  
   

Credit

    1,848       3,378       1,281       6,507  
   

Currencies

    15,041       7,782       4,612       27,435  
   

Commodities

    2,519       1,502       2,452       6,473  
   

Equities

    6,743       5,709       3,127       15,579  
   

Counterparty netting in tenors

    (2,611     (5,268     (3,754     (11,633

Subtotal

    $29,282       $23,256       $39,828       $  92,366  
   

Cross-tenor counterparty netting

 

        (18,040
   

Cash collateral netting

                            (36,177

Total

                            $  38,149  

 

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