10-Q 1 d631824d10q.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 September 30, 2018

    
    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 every Interactive Data File required to be submitted 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 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  ☐
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 October 19, 2018, there were 371,973,740 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 SEPTEMBER 30, 2018

 

INDEX

 

Form 10-Q Item Number   Page No.

PART I

   

 

FINANCIAL INFORMATION

  1  

 

Item 1

 

 

Financial Statements (Unaudited)

  1  

 

Consolidated Statements of Earnings

  1  

 

Consolidated Statements of Comprehensive Income

  2  

 

Consolidated Statements of Financial Condition

  3  

 

Consolidated Statements of Changes in Shareholders’ Equity

  4  

 

Consolidated Statements of Cash Flows

  5  

 

Notes to 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

  15  

 

Note 5.  Fair Value Measurements

  16  

 

Note 6.  Cash Instruments

  17  

 

Note 7.  Derivatives and Hedging Activities

  24  

 

Note 8.  Fair Value Option

  36  

 

Note 9.  Loans Receivable

  43  

 

Note 10. Collateralized Agreements and Financings

  47  

 

Note 11. Securitization Activities

  51  

 

Note 12. Variable Interest Entities

  53  

 

Note 13. Other Assets

  56  

 

Note 14. Deposits

  59  

 

Note 15. Short-Term Borrowings

  60  

 

Note 16. Long-Term Borrowings

  60  

 

Note 17. Other Liabilities

  62  

 

Note 18. Commitments, Contingencies and Guarantees

  63  

 

Note 19. Shareholders’ Equity

  67  

 

Note 20. Regulation and Capital Adequacy

  70  

 

Note 21. Earnings Per Common Share

  78  

 

Note 22. Transactions with Affiliated Funds

  78  

 

Note 23. Interest Income and Interest Expense

  79  

 

Note 24. Income Taxes

  79  

 

Note 25. Business Segments

  80  

 

Note 26. Credit Concentrations

  82  

 

Note 27. Legal Proceedings

  83  
     Page No.

 

Report of Independent Registered Public Accounting Firm

  90  

 

Statistical Disclosures

  91  

 

Item 2

 

 

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

  93  

 

Introduction

  93  

 

Executive Overview

  93  

 

Business Environment

  94  

 

Critical Accounting Policies

  95  

 

Recent Accounting Developments

  97  

 

Use of Estimates

  97  

 

Results of Operations

  98  

 

Balance Sheet and Funding Sources

  110  

 

Equity Capital Management and Regulatory Capital

  115  

 

Regulatory Matters and Developments

  119  

 

Off-Balance-Sheet Arrangements and Contractual Obligations

  120  

 

Risk Management

  122  

 

Overview and Structure of Risk Management

  122  

 

Liquidity Risk Management

  127  

 

Market Risk Management

  134  

 

Credit Risk Management

  139  

 

Operational Risk Management

  145  

 

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 September 2018 Form 10-Q


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements (Unaudited)

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)

 

   

Three Months

Ended September

       

Nine Months

Ended September

 
in millions, except per share amounts     2018        2017           2018        2017  

Revenues

           

Investment banking

    $1,980        $1,797         $  5,818        $  5,230  

Investment management

    1,580        1,419         4,947        4,249  

Commissions and fees

    704        714         2,361        2,279  

Market making

    2,281        2,112         8,031        6,445  

Other principal transactions

    1,245        1,554           4,151        4,002  

Total non-interest revenues

    7,790        7,596           25,308        22,205  

 

Interest income

    5,061        3,411         14,211        9,377  

Interest expense

    4,205        2,681           11,435        7,343  

Net interest income

    856        730           2,776        2,034  

Net revenues, including net interest income

    8,646        8,326           28,084        24,239  

 

Operating expenses

           

Compensation and benefits

    3,091        3,172         10,672        9,696  

 

Brokerage, clearing, exchange and distribution fees

    714        711         2,370        2,144  

Market development

    167        138         532        413  

Communications and technology

    250        220         761        667  

Depreciation and amortization

    317        280         951        802  

Occupancy

    203        177         594        543  

Professional fees

    238        227         696        661  

Other expenses

    588        425           1,735        1,289  

Total non-compensation expenses

    2,477        2,178           7,639        6,519  

Total operating expenses

    5,568        5,350           18,311        16,215  

 

Pre-tax earnings

    3,078        2,976         9,773        8,024  

Provision for taxes

    554        848           1,852        1,810  

Net earnings

    2,524        2,128           7,921        6,214  

Preferred stock dividends

    71        93           383        386  

Net earnings applicable to common shareholders

    $2,453        $2,035           $  7,538        $  5,828  

 

Earnings per common share

           

Basic

    $  6.35        $  5.09         $  19.42        $  14.32  

Diluted

    $  6.28        $  5.02         $  19.21        $  14.11  

 

Dividends declared per common share

    $  0.80        $  0.75         $    2.35        $    2.15  

 

Average common shares

           

Basic

    385.4        398.2         387.4        405.6  

Diluted

    390.5        405.7           392.3        413.0  

 

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

 

1   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)

 

   

Three Months

Ended September

       

Nine Months

Ended September

 
$ in millions     2018        2017           2018        2017  

Net earnings

    $2,524        $2,128         $7,921        $6,214  

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

           

Currency translation

    (3      6         (3      19  

Debt valuation adjustment

    (787      (104       361        (518

Pension and postretirement liabilities

    (1      1         (6      2  

Available-for-sale securities

    (90      (4         (311      (3

Other comprehensive income/(loss)

    (881      (101         41        (500

Comprehensive income

    $1,643        $2,027           $7,962        $5,714  

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

 

Goldman Sachs September 2018 Form 10-Q   2


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Financial Condition

(Unaudited)

 

    As of  
$ in millions    
September
2018
 
 
   
December
2017
 
 

Assets

   

Cash and cash equivalents

    $118,871       $110,051  

Collateralized agreements:

   

Securities purchased under agreements to resell (includes $143,370 and $120,420 at fair value)

    143,447       120,822  

Securities borrowed (includes $33,450 and $78,189 at fair value)

    154,891       190,848  

Receivables:

   

Brokers, dealers and clearing organizations

    28,330       24,676  

Customers and counterparties (includes $4,733 and $3,526 at fair value)

    54,985       60,112  

Loans receivable

    76,011       65,933  

Financial instruments owned (at fair value and includes $63,626 and $50,335 pledged as collateral)

    351,028       315,988  

Other assets

    29,627       28,346  

Total assets

    $957,190       $916,776  

 

Liabilities and shareholders’ equity

   

Deposits (includes $22,310 and $22,902 at fair value)

    $151,518       $138,604  

Collateralized financings:

   

Securities sold under agreements to repurchase (at fair value)

    85,920       84,718  

Securities loaned (includes $3,522 and $5,357 at fair value)

    16,201       14,793  

Other secured financings (includes $26,157 and $24,345 at fair value)

    26,484       24,788  

Payables:

   

Brokers, dealers and clearing organizations

    9,693       6,672  

Customers and counterparties

    180,275       171,497  

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

    113,067       111,930  

Unsecured short-term borrowings (includes $21,011 and $16,904 at fair value)

    41,735       46,922  

Unsecured long-term borrowings (includes $45,749 and $38,638 at fair value)

    229,387       217,687  

Other liabilities (includes $63 and $268 at fair value)

    16,148       16,922  

Total liabilities

    870,428       834,533  

 

Commitments, contingencies and guarantees

   

 

Shareholders’ equity

   

Preferred stock; aggregate liquidation preference of $11,203 and $11,853

    11,203       11,853  

Common stock; 890,745,015 and 884,592,863 shares issued, and 372,739,352 and 374,808,805 shares outstanding

    9       9  

Share-based awards

    2,716       2,777  

Nonvoting common stock; no shares issued and outstanding

           

Additional paid-in capital

    54,012       53,357  

Retained earnings

    98,083       91,519  

Accumulated other comprehensive loss

    (1,839     (1,880

Stock held in treasury, at cost; 518,005,665 and 509,784,060 shares

    (77,422     (75,392

Total shareholders’ equity

    86,762       82,243  

Total liabilities and shareholders’ equity

    $957,190       $916,776  

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

 

3   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

   

Three Months

Ended September

       

Nine Months

Ended September

 
$ in millions     2018        2017           2018        2017  

Preferred stock

           

Beginning balance

    $ 11,203        $ 11,203         $ 11,853        $ 11,203  

Issued

                           

Redeemed

                     (650       

Ending balance

    11,203        11,203           11,203        11,203  

Common stock

           

Beginning balance

    9        9         9        9  

Issued

                             

Ending balance

    9        9           9        9  

Share-based awards

           

Beginning balance, as previously reported

    2,581        3,308         2,777        3,914  

Cumulative effect of change in accounting principle for forfeiture of share-based awards

                            35  

Beginning balance, adjusted

    2,581        3,308         2,777        3,949  

Issuance and amortization of share-based awards

    179        171         1,170        1,631  

Delivery of common stock underlying share-based awards

    (22      (82       (1,170      (2,041

Forfeiture of share-based awards

    (20      (20       (49      (54

Exercise of share-based awards

    (2      (22         (12      (130

Ending balance

    2,716        3,355           2,716        3,355  

Additional paid-in capital

           

Beginning balance

    54,000        53,187         53,357        52,638  

Delivery of common stock underlying share-based awards

    28        159         1,705        2,215  

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

    (16      (52       (1,065      (1,556

Preferred stock issuance costs, net of reversals upon redemption

                   15         

Cash settlement of share-based awards

                            (3

Ending balance

    54,012        53,294           54,012        53,294  

Retained earnings

           

Beginning balance, as previously reported

    95,941        92,225         91,519        89,039  

Cumulative effect of change in accounting principle for:

           

Revenue recognition from contracts with clients, net of tax

                   (53       

Forfeiture of share-based awards, net of tax

                            (24

Beginning balance, adjusted

    95,941        92,225         91,466        89,015  

Net earnings

    2,524        2,128         7,921        6,214  

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

    (311      (302       (921      (885

Dividends declared on preferred stock

    (71      (93       (368      (386

Preferred stock redemption premium

                     (15       

Ending balance

    98,083        93,958           98,083        93,958  

Accumulated other comprehensive loss

           

Beginning balance

    (958      (1,615       (1,880      (1,216

Other comprehensive income/(loss)

    (881      (101         41        (500

Ending balance

    (1,839      (1,716         (1,839      (1,716

Stock held in treasury, at cost

           

Beginning balance

    (76,177      (71,642       (75,392      (68,694

Repurchased

    (1,244      (2,169       (2,044      (5,135

Reissued

                   16        28  

Other

    (1                (2      (10

Ending balance

    (77,422      (73,811         (77,422      (73,811

Total shareholders’ equity

    $ 86,762        $ 86,292           $ 86,762        $ 86,292  

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

 

Goldman Sachs September 2018 Form 10-Q   4


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

   

Nine Months

Ended September

 
$ in millions     2018        2017  

Cash flows from operating activities

    

Net earnings

    $    7,921        $    6,214  

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

    

Depreciation and amortization

    951        802  

Share-based compensation

    1,671        1,610  

Gain related to extinguishment of unsecured borrowings

    (160      (108

Changes in operating assets and liabilities:

    

Receivables and payables (excluding loans receivable), net

    13,043        (8,650

Collateralized transactions (excluding other secured financings), net

    15,942        20,842  

Financial instruments owned (excluding available-for-sale securities)

    (36,747      (35,261

Financial instruments sold, but not yet purchased

    857        (2,430

Other, net

    (1,158      5,597  

Net cash provided by/(used for) operating activities

    2,320        (11,384

Cash flows from investing activities

    

Purchase of property, leasehold improvements and equipment

    (5,947      (2,209

Proceeds from sales of property, leasehold improvements and equipment

    2,486        436  

Net cash used for business acquisitions

    (146      (1,848

Purchase of investments

    (3,224      (3,271

Proceeds from sales and paydowns of investments

    361        1,288  

Loans receivable, net

    (10,365      (12,225

Net cash used for investing activities

    (16,835      (17,829

Cash flows from financing activities

    

Unsecured short-term borrowings, net

    3,638        907  

Other secured financings (short-term), net

    3,831        (1,757

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

    3,897        6,518  

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

    (6,761      (3,605

Purchase of Trust Preferred Securities

    (35      (62

Proceeds from issuance of unsecured long-term borrowings

    40,603        44,831  

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

    (30,655      (25,099

Derivative contracts with a financing element, net

    938        1,684  

Deposits, net

    12,914        8,664  

Preferred stock redemption

    (650       

Common stock repurchased

    (2,044      (5,143

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

    (1,065      (1,559

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

    (1,289      (1,271

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

    13        7  

Cash settlement of share-based awards

           (3

Net cash provided by financing activities

    23,335        24,112  

Net increase/(decrease) in cash and cash equivalents

    8,820        (5,101

Cash and cash equivalents, beginning balance

    110,051        121,711  

Cash and cash equivalents, ending balance

    $118,871        $116,610  

SUPPLEMENTAL DISCLOSURES:

Cash payments for interest, net of capitalized interest, were $12.13 billion during the nine months ended September 2018 and $12.11 billion during the nine months ended September 2017, and cash payments for income taxes, net of refunds, were $933 million during the nine months ended September 2018 and $671 million during the nine months ended September 2017. 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 nine months ended September 2018:

 

 

The firm received $558 million of loans receivable and $90 million of held-to-maturity securities in connection with the securitization of financial instruments owned and held for sale loans included in receivables from customers and counterparties.

 

 

The firm exchanged $35 million of Trust Preferred Securities and common beneficial interests for $35 million of certain of the firm’s junior subordinated debt.

Non-cash activities during the nine months ended September 2017:

 

 

The firm received $245 million of loans receivable and $16 million of held-to-maturity securities in connection with the securitization of financial instruments owned and held for sale loans included in receivables from customers and counterparties.

 

 

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

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

 

5   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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, including through its Merchant Banking business and its Special Situations Group, in debt securities and loans, public and private equity securities, infrastructure and real estate entities. Some of these investments are made indirectly through funds that the firm manages. The firm also makes unsecured and secured loans through its digital platforms, Marcus: by Goldman Sachs (Marcus) and Goldman Sachs Private Bank Select (GS Select), respectively.

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 provided by the firm’s subsidiary, The Ayco Company, L.P., including portfolio management and financial planning and counseling, and brokerage and other transaction services to high-net-worth individuals and families.

Note 2.

Basis of Presentation

These 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 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, 2017. References to “the 2017 Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2017. Certain disclosures included in the annual financial statements have been condensed or omitted from these financial statements as they are not required for interim financial statements under U.S. GAAP and the rules of the Securities and Exchange Commission.

These unaudited 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 September 2018, June 2018 and September 2017 refer to the firm’s periods ended, or the dates, as the context requires, September 30, 2018, June 30, 2018 and September 30, 2017, respectively. All references to December 2017 refer to the date December 31, 2017. 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 September 2018 Form 10-Q   6


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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

    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 September 2018 Form 10-Q


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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 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, income tax expense related to the Tax Cuts and Jobs Act (Tax Legislation), provisions for losses that may arise from litigation and regulatory proceedings (including governmental investigations), the allowance for losses on loans receivable and lending commitments held for investment, and provisions for losses that may arise from tax audits. These estimates and assumptions are based on the best available information but actual results could be materially different.

Revenue Recognition

Financial Assets and Financial Liabilities at Fair Value. Financial instruments owned 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.

Revenue from Contracts with Clients. Beginning in January 2018, the firm accounts for revenue earned from contracts with clients for services such as investment banking, investment management, and execution and clearing (contracts with clients) under ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” As such, revenues for these services are recognized when the performance obligations related to the underlying transaction are completed. See “Recent Accounting Developments — Revenue from Contracts with Customers (ASC 606)” for further information.

The firm’s net revenues from contracts with clients subject to this ASU represent approximately 50% of the firm’s total net revenues for the three months ended September 2018 and approximately 45% of the firm’s total net revenues for the nine months ended September 2018. This includes approximately 80% of the firm’s investment banking revenues, substantially all of the investment management revenues, and commissions and fees for both the three and nine months ended September 2018. See Note 25 for information about the firm’s net revenues by business segment.

Investment Banking

Advisory. Fees from financial advisory assignments are recognized in revenues when the services related to the underlying transaction are completed under the terms of the assignment. Beginning in January 2018, non-refundable deposits and milestone payments in connection with financial advisory assignments are recognized in revenues upon completion of the underlying transaction or when the assignment is otherwise concluded. Prior to January 2018, non-refundable deposits and milestone payments were recognized in revenues in accordance with the terms of the contract.

Beginning in January 2018, non-compensation expenses associated with financial advisory assignments are recognized when incurred. Client reimbursements for such expenses are included in financial advisory revenues. Prior to January 2018, such expenses were deferred until the related revenue was recognized or the assignment was otherwise concluded and were presented net of client reimbursements.

 

 

Goldman Sachs September 2018 Form 10-Q   8


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Underwriting. Fees from underwriting assignments are recognized in revenues upon completion of the underlying transaction based on the terms of the assignment.

Non-compensation expenses associated with underwriting assignments are deferred until the related revenue is recognized or the assignment is otherwise concluded. Beginning in January 2018, such expenses are presented as non-compensation expenses. Prior to January 2018, such expenses were presented net within underwriting revenues.

Investment Management

The firm earns management fees and incentive fees for investment management services, which are included in investment management revenues. The firm makes payments to brokers and advisors related to the placement of the firm’s investment funds (distribution fees), which are included in brokerage, clearing, exchange and distribution fees.

Management Fees. 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 committed capital and are received quarterly, semi-annually or annually, depending on the fund. Management fees are recognized over time in the period the investment management services are provided.

Distribution fees paid by the firm are calculated based on either a percentage of the management fee, the investment fund’s net asset value or the committed capital. Beginning in January 2018, the firm presents such fees in brokerage, clearing, exchange and distribution fees. Prior to January 2018, where the firm was considered an agent to the arrangement, such fees were presented on a net basis in investment management revenues.

Incentive Fees. 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 twelve-month period or over the life of a fund. Fees that are based on performance over a twelve-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.

Beginning in January 2018, incentive fees earned from a fund or separately managed account are recognized when it is probable that a significant reversal of such fees will not occur, which is generally when such fees are no longer subject to fluctuations in the market value of investments held by the fund or separately managed account. Therefore, incentive fees recognized during the period may relate to performance obligations satisfied in previous periods. Prior to January 2018, incentive fees were recognized only when all material contingencies were resolved.

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. The firm also provides third-party research services to clients in connection with certain soft-dollar arrangements.

Beginning in January 2018, costs incurred by the firm for research are presented net within commissions and fees. Prior to January 2018, costs incurred by the firm for research for certain soft-dollar arrangements were presented in brokerage, clearing, exchange and distribution fees.

Remaining Performance Obligations

Remaining performance obligations are services that the firm has committed to perform in the future in connection with its contracts with clients. The firm’s remaining performance obligations are generally related to its financial advisory assignments and certain investment management activities. Revenues associated with remaining performance obligations relating to financial advisory assignments cannot be determined until the outcome of the transaction. For the firm’s investment management activities, where fees are calculated based on the net asset value of the fund or separately managed account, future revenues associated with remaining performance obligations cannot be determined as such fees are subject to fluctuations in the market value of investments held by the fund or separately managed account.

The firm is able to determine the future revenues associated with management fees calculated based on committed capital. As of September 2018, substantially all of the firm’s future net revenues associated with remaining performance obligations will be recognized through 2023. Annual revenues associated with such performance obligations average less than $250 million through 2023.

 

 

9   Goldman Sachs September 2018 Form 10-Q


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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 are generally included 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. Cash and cash equivalents included cash and due from banks of $12.21 billion as of September 2018 and $10.79 billion as of December 2017. Cash and cash equivalents also included interest-bearing deposits with banks of $106.66 billion as of September 2018 and $99.26 billion as of December 2017.

The firm segregates cash for regulatory and other purposes related to client activity. Cash and cash equivalents segregated for regulatory and other purposes were $20.99 billion as of September 2018 and $18.44 billion as of December 2017. 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. As these receivables and payables are not accounted for at fair value, they 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 both September 2018 and December 2017.

Receivables from Customers and Counterparties

Receivables from customers and counterparties generally relate to collateralized transactions. Such receivables primarily consist 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, the firm’s receivables from customers and counterparties included $3.01 billion as of September 2018 and $4.63 billion as of December 2017 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 both September 2018 and December 2017, the carrying value of receivables not accounted for at fair value generally approximated fair value. As these receivables are not accounted for at fair value, they 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 both September 2018 and December 2017. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in interest income.

Receivables from customers and counterparties includes receivables from contracts with clients and, beginning in January 2018, also includes contract assets. Contract assets represent the firm’s right to receive consideration for services provided in connection with its contracts with clients for which collection is conditional and not merely subject to the passage of time. As of September 2018, the firm’s receivables from contracts with clients were $1.99 billion and contract assets were not material.

 

 

Goldman Sachs September 2018 Form 10-Q   10


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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. As these payables are not accounted for at fair value, they 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 both September 2018 and December 2017. Interest on payables to customers and counterparties is recognized over the life of the transaction and included in interest expense.

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 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 consolidated statements of financial condition when such transactions meet certain settlement criteria and are subject to netting agreements.

In the 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 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. Forfeitures are recorded when they occur. See “Recent Accounting Developments — Improvements to Employee Share-Based Payment Accounting (ASC 718)” for further 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 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 consolidated statements of comprehensive income.

 

 

11   Goldman Sachs September 2018 Form 10-Q


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Recent Accounting Developments

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

The firm adopted this ASU in January 2018 under a modified retrospective approach. As a result of adopting this ASU, the firm, among other things, delays recognition of non-refundable and milestone payments on financial advisory assignments until the assignments are completed, and recognizes certain investment management fees earlier than under the firm’s previous revenue recognition policies.

The firm also prospectively changed the presentation of certain costs from a net presentation within revenues to a gross basis, and vice versa. Beginning in 2018, certain underwriting expenses, which were netted against investment banking revenues and certain distribution fees, which were netted against investment management revenues, are presented gross as non-compensation expenses. Costs incurred in connection with certain soft-dollar arrangements, which were presented gross as non-compensation expenses, are presented net within commissions and fees.

Net revenues for the three months ended September 2018 were lower by approximately $35 million, reflecting certain investment management fees, which were recognized during the three months ended June 2018 but would have been recognized during the current quarter under the firm’s previous revenue recognition policies. In addition, net revenues and non-compensation expenses were both higher by approximately $85 million for the three months ended September 2018 and approximately $215 million for the nine months ended September 2018, due to the changes in the presentation of certain costs from a net presentation within revenues to a gross basis.

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.

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 adoption of the remaining provisions of the ASU in January 2018 did not have a material impact on the firm’s 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. It also requires that for qualifying sale-leaseback transactions the seller recognize any gain or loss (based on the estimated fair value of the asset at the time of sale) when control of the asset is transferred instead of amortizing it over the lease period. 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. The firm’s implementation efforts include reviewing the terms of existing leases and service contracts, which may include embedded leases. Based on the implementation efforts to date, the firm expects a gross up of approximately $2 billion on its consolidated statements of financial condition upon recognition of the right-of-use assets and lease liabilities.

 

 

Goldman Sachs September 2018 Form 10-Q   12


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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 subsequent to the adoption, the tax effect related to the settlement of share-based awards is recognized in the statements of earnings rather than 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.

In addition, the ASU modifies the classification of certain share-based payment activities within the statements of cash flows. Upon adoption, the firm reclassified amounts related to such activities within the consolidated statements of cash flows, on a retrospective basis.

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.

The ASU is effective for the firm in January 2020 under a modified retrospective approach. Early adoption is permitted beginning 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 firm is currently in the process of identifying and developing the changes to the firm’s existing allowance models and processes that will be required under CECL. 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 firm adopted this ASU in January 2018 under a retrospective approach. The impact of adoption was an increase of $265 million to net cash used for operating activities, a decrease of $257 million to net cash used for investing activities and an increase of $8 million to net cash provided by financing activities for the nine months ended September 2017.

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 firm adopted this ASU in January 2018 under a prospective approach. Adoption of the ASU did not have a material impact on the firm’s financial condition, results of operations or cash flows. The firm expects that fewer transactions will be treated as acquisitions (or disposals) of businesses as a result of adopting this ASU.

 

 

13   Goldman Sachs September 2018 Form 10-Q


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THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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 firm early adopted this ASU in the fourth quarter of 2017. Adoption of the ASU did not have a material impact on the results of the firm’s 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 firm adopted this ASU in January 2018 under a modified retrospective approach. Adoption of the ASU did not have an impact on the firm’s financial condition, results of operations or cash flows.

Targeted Improvements to Accounting for Hedging Activities (ASC 815). In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815) — Targeted Improvements to Accounting for Hedging Activities.” The ASU amends certain rules for hedging relationships, expands the types of strategies that are eligible for hedge accounting treatment to more closely align the results of hedge accounting with risk management activities and amends disclosure requirements related to fair value and net investment hedges.

The firm early adopted this ASU in January 2018 under a modified retrospective approach for hedge accounting treatment, and under a prospective approach for the amended disclosure requirements. Adoption of this ASU did not have a material impact on the firm’s financial condition, results of operations or cash flows. See Note 7 for further information.

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASC 220). In February 2018, the FASB issued ASU No. 2018-02, “Income Statement — Reporting Comprehensive Income (Topic 220) — Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU permits a reporting entity to reclassify the income tax effects of Tax Legislation on items within accumulated other comprehensive income to retained earnings.

The ASU is effective for the firm in January 2019 under a retrospective or a modified retrospective approach. Since this ASU only permits reclassification within shareholders’ equity, adoption of this ASU will not have a material impact on the firm’s financial condition.

Changes to the Disclosure Requirements for Fair Value Measurement (ASC 820). In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820) — Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU, among other amendments, eliminates the requirement to disclose the amounts and reasons for transfers between level 1 and level 2 of the fair value hierarchy and modifies the disclosure requirement relating to investments in funds at NAV. The firm early adopted this ASU in the third quarter of 2018 and disclosures were modified in accordance with the ASU. See Notes 6 through 8 for further information.

 

 

Goldman Sachs September 2018 Form 10-Q   14


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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 information about other financial assets and financial liabilities at fair value.

The table below presents 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 September 2018

    

Money market instruments

    $    3,478        $           –  

Government and agency obligations:

    

U.S.

    79,656        13,107  

Non-U.S.

    45,201        23,769  

Loans and securities backed by:

    

Commercial real estate

    3,065         

Residential real estate

    14,290        6  

Corporate debt instruments

    33,096        11,210  

State and municipal obligations

    1,516        8  

Other debt obligations

    1,793        1  

Equity securities

    115,945        25,645  

Commodities

    3,331         

Investments in funds at NAV

    3,979         

Subtotal

    305,350        73,746  

Derivatives

    45,678        39,321  

Total

    $351,028        $113,067  

 

As of December 2017

    

Money market instruments

    $    1,608        $             

Government and agency obligations:

    

U.S.

    76,418        17,911  

Non-U.S.

    33,956        23,311  

Loans and securities backed by:

    

Commercial real estate

    3,436        1  

Residential real estate

    11,993         

Corporate debt instruments

    33,683        7,153  

State and municipal obligations

    1,471         

Other debt obligations

    2,164        1  

Equity securities

    96,132        23,882  

Commodities

    3,194        40  

Investments in funds at NAV

    4,596         

Subtotal

    268,651        72,299  

Derivatives

    47,337        39,631  

Total

    $315,988        $111,930  

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.

 

 

Corporate debt instruments includes corporate loans and debt securities.

 

 

Equity securities includes public and private equities, exchange-traded funds and convertible debentures. Such amounts include investments accounted for at fair value under the fair value option where the firm would otherwise apply the equity method of accounting of $8.06 billion as of September 2018 and $8.49 billion as of December 2017.

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 September

         

Nine Months

Ended September

 
$ in millions     2018        2017               2018        2017  

Interest rates

    $     13        $1,492         $ (2,304      $  5,481  

Credit

    292        471         1,158        1,397  

Currencies

    373        (960       3,868        (3,700

Equities

    1,520        971         4,681        2,842  

Commodities

    83        138               628        425  

Market making

    2,281        2,112               8,031        6,445  

Other principal transactions

    1,245        1,554               4,151        4,002  

Total

    $3,526        $3,666               $12,182        $10,447  

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.

 

 

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.

 

 

15   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 5.

Fair Value Measurements

 

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

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

U.S. GAAP has a three-level 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 at fair value.

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    
September
2018
 
 
   
June
2018

 
   
December
2017
 
 

Total level 1 financial assets

    $186,882       $180,345       $155,086  

Total level 2 financial assets

    374,820       378,977       395,606  

Total level 3 financial assets

    21,096       20,516       19,201  

Investments in funds at NAV

    3,979       4,020       4,596  

Counterparty and cash collateral netting

    (54,196     (56,699     (56,366

Total financial assets at fair value

    $532,581       $527,159       $518,123  

 

Total assets 

    $957,190       $968,610       $916,776  

 

Total level 3 financial assets divided by:

 

   

Total assets

    2.2%       2.1%       2.1%  

Total financial assets at fair value

    4.0%       3.9%       3.7%  

Total level 1 financial liabilities

    $  60,784       $  62,401       $  63,589  

Total level 2 financial liabilities

    269,155       279,805       261,719  

Total level 3 financial liabilities

    22,998       21,193       19,620  

Counterparty and cash collateral netting

    (35,138     (37,538     (39,866

Total financial liabilities at fair value

    $317,799       $325,861       $305,062  

 

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

    7.2%       6.5%       6.4%  

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.

 

 

Goldman Sachs September 2018 Form 10-Q   16


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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

 

    As of  
$ in millions    
September
2018
 
 
    
June
2018
 
 
    
December
2017
 
 

Cash instruments

    $16,665        $16,216        $15,395  

Derivatives

    4,421        4,293        3,802  

Other financial assets

    10        7        4  

Total

    $21,096        $20,516        $19,201  

Level 3 financial assets as of September 2018 increased compared with June 2018 and December 2017, reflecting an increase 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 debt instruments, 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 instruments 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 debt instruments, 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.

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:

 

 

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);

 

 

17   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

 

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

 

 

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:

 

 

Market yields implied by transactions of similar or related assets;

 

 

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

 

 

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 Debt Instruments. Corporate debt instruments includes corporate loans and debt securities. Significant inputs for corporate debt instruments 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 the CDX (an index that tracks the performance of corporate credit);

 

 

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.

 

 

Goldman Sachs September 2018 Form 10-Q   18


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Fair Value of Cash Instruments by Level

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

 

$ in millions     Level 1       Level 2       Level 3       Total  

As of September 2018

       

Assets

       

Money market instruments

    $    1,164       $   2,314       $         –       $    3,478  

Government and agency obligations:

       

U.S.

    53,000       26,656             79,656  

Non-U.S.

    36,627       8,571       3       45,201  

Loans and securities backed by:

 

     

Commercial real estate

          2,108       957       3,065  

Residential real estate

          13,638       652       14,290  

Corporate debt instruments

    621       28,586       3,889       33,096  

State and municipal obligations

          1,483       33       1,516  

Other debt obligations

          1,433       360       1,793  

Equity securities

    95,409       9,765       10,771       115,945  

Commodities

          3,331             3,331  

Subtotal

    $186,821       $ 97,885       $16,665       $301,371  

Investments in funds at NAV

                            3,979  

Total cash instrument assets

                            $305,350  

Liabilities

       

Government and agency obligations:

       

U.S.

    $ (13,104     $         (3     $         –       $ (13,107

Non-U.S.

    (22,055     (1,714           (23,769

Loans and securities backed by residential real estate

          (6           (6

Corporate debt instruments

    (1     (11,164     (45     (11,210

State and municipal obligations

          (8           (8

Other debt obligations

          (1           (1

Equity securities

    (25,434     (190     (21     (25,645

Total cash instrument liabilities

    $ (60,594     $(13,086     $      (66     $ (73,746

 

As of December 2017

       

Assets

       

Money market instruments

    $       398       $   1,209       $         1       $    1,608  

Government and agency obligations:

       

U.S.

    50,796       25,622             76,418  

Non-U.S.

    27,070       6,882       4       33,956  

Loans and securities backed by:

       

Commercial real estate

          2,310       1,126       3,436  

Residential real estate

          11,325       668       11,993  

Corporate debt instruments

    752       29,661       3,270       33,683  

State and municipal obligations

          1,401       70       1,471  

Other debt obligations

          1,812       352       2,164  

Equity securities

    76,044       10,184       9,904       96,132  

Commodities

          3,194             3,194  

Subtotal

    $155,060       $ 93,600       $15,395       $264,055  

Investments in funds at NAV

                            4,596  

Total cash instrument assets

                            $268,651  

Liabilities

       

Government and agency obligations:

       

U.S.

    $ (17,845     $       (66     $                $ (17,911

Non-U.S.

    (21,820     (1,491           (23,311

Loans and securities backed by commercial real estate

          (1           (1

Corporate debt instruments

    (2     (7,099     (52     (7,153

Other debt obligations

          (1           (1

Equity securities

    (23,866           (16     (23,882

Commodities

          (40           (40

Total cash instrument liabilities

    $ (63,533     $  (8,698     $      (68     $ (72,299

In the table 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, substantially all of which have a maturity of less than one year.

 

 

Corporate debt instruments includes corporate loans and debt securities.

 

 

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

 

 

As of both September 2018 and December 2017, substantially all level 3 equity securities consisted of private equity securities.

 

 

Total cash instrument assets included collateralized loan obligations backed by corporate obligations of $503 million as of September 2018 and $912 million as of December 2017 in level 2, and $248 million as of September 2018 and $166 million as of December 2017 in level 3. Collateralized debt obligations (CDOs) included in cash instruments were not material as of both September 2018 and December 2017.

 

 

19   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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 level 3 cash instruments.

 

   

Level 3 Assets and Range of Significant

Unobservable Inputs (Weighted Average) as of

 
$ in millions    
September
2018

 
   
December
2017

 

Loans and securities backed by commercial real estate

 

Level 3 assets

    $957       $1,126  

Yield

    5.0% to 22.0% (12.9%     4.6% to 22.0% (13.4%

Recovery rate

    10.0% to 91.0% (49.6%     14.3% to 89.0% (43.8%

Duration (years)

    0.3 to 6.3 (2.3     0.8 to 6.4 (2.1

Loans and securities backed by residential real estate

 

Level 3 assets

    $652       $668  

Yield

    2.6% to 16.4% (10.7%     2.3% to 15.0% (8.3%

Cumulative loss rate

    7.9% to 38.0% (18.9%     12.5% to 43.0% (21.8%

Duration (years)

    1.4 to 14.2 (6.4     0.7 to 14.0 (6.9

Corporate debt instruments

 

Level 3 assets

    $3,889       $3,270  

Yield

    2.6% to 25.9% (11.5%     3.6% to 24.5% (12.3%

Recovery rate

    0.0% to 85.0% (56.7%     0.0% to 85.3% (62.8%

Duration (years)

    0.2 to 6.3 (3.3     0.5 to 7.6 (3.2

Equity securities

 

 

Level 3 assets

    $10,771       $9,904  

Multiples

    0.9x to 26.0x (8.8x     1.1x to 30.5x (8.9x

Discount rate/yield

    6.5% to 25.0% (14.7%     3.0% to 20.3% (14.0%

Capitalization rate

    4.3% to 13.2% (6.1%     4.3% to 12.0% (6.1%

Other cash instruments

 

Level 3 assets

    $396       $427  

Yield

    4.3% to 9.4% (8.6%     4.0% to 11.7% (8.4%

Duration (years)

    2.6 to 5.3 (4.0     3.5 to 11.4 (5.1

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 level 3 cash instruments.

 

Increases in yield, discount rate, capitalization rate, duration or cumulative loss rate used in the valuation of level 3 cash instruments would have resulted in a lower fair value measurement, while increases in recovery rate or multiples would have resulted in a higher fair value measurement as of both September 2018 and December 2017. Due to the distinctive nature of each level 3 cash instrument, the interrelationship of inputs is not necessarily uniform within each product type.

 

 

Loans and securities backed by commercial and residential real estate, corporate debt instruments 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.

 

 

Goldman Sachs September 2018 Form 10-Q   20


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to 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 September

       

Nine Months

Ended September

 
$ in millions     2018       2017           2018       2017  

Total cash instrument assets

         

Beginning balance

    $16,216       $16,196         $15,395       $18,035  

Net realized gains/(losses)

    122       109         350       349  

Net unrealized gains/(losses)

    481       332         585       1,146  

Purchases

    581       524         1,685       1,381  

Sales

    (249     (736       (1,871     (1,775

Settlements

    (605     (581       (1,487     (1,651

Transfers into level 3

    1,289       1,287         3,848       2,307  

Transfers out of level 3

    (1,170     (666         (1,840     (3,327

Ending balance

    $16,665       $16,465           $16,665       $16,465  

Total cash instrument liabilities

 

     

Beginning balance

    $      (53     $      (42       $      (68     $      (62

Net realized gains/(losses)

          (2       4       (7

Net unrealized gains/(losses)

    (3     5         2       (10

Purchases

    17       34         26       67  

Sales

    (30     (34       (44     (35

Settlements

    1               17        

Transfers into level 3

    (17     (28       (9     (17

Transfers out of level 3

    19       8           6       5  

Ending balance

    $      (66     $      (59         $      (66     $      (59

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) relates to instruments that were still held at period-end.

 

 

Purchases includes originations and secondary purchases.

 

 

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. 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 September

       

Nine Months

Ended September

 
$ in millions     2018       2017           2018       2017  

Loans and securities backed by commercial real estate

 

 

Beginning balance

    $  1,094       $  1,400         $  1,126       $  1,645  

Net realized gains/(losses)

    16       8         58       37  

Net unrealized gains/(losses)

    4       29         (25     168  

Purchases

    22       56         105       178  

Sales

    (49     (84       (125     (165

Settlements

    (49     (58       (248     (358

Transfers into level 3

    44       156         275       222  

Transfers out of level 3

    (125     (63         (209     (283

Ending balance

    $     957       $  1,444           $     957       $  1,444  

Loans and securities backed by residential real estate

 

 

Beginning balance

    $     789       $     807         $     668       $     845  

Net realized gains/(losses)

    12       10         41       34  

Net unrealized gains/(losses)

    21       17         17       87  

Purchases

    22       34         84       142  

Sales

    (75     (56       (192     (220

Settlements

    (61     (44       (130     (95

Transfers into level 3

    17       30         237       20  

Transfers out of level 3

    (73     (24         (73     (39

Ending balance

    $     652       $     774           $     652       $     774  

Corporate debt instruments

 

 

Beginning balance

    $  3,391       $  3,645         $  3,270       $  4,640  

Net realized gains/(losses)

    52       45         137       151  

Net unrealized gains/(losses)

    25       (7       (10     33  

Purchases

    278       178         693       568  

Sales

    (65     (265       (325     (795

Settlements

    (281     (259       (648     (653

Transfers into level 3

    830       567         1,201       1,023  

Transfers out of level 3

    (341     (337         (429     (1,400

Ending balance

    $  3,889       $  3,567           $  3,889       $  3,567  

Equity securities

 

 

Beginning balance

    $10,561       $  9,833         $  9,904       $10,263  

Net realized gains/(losses)

    42       42         109       111  

Net unrealized gains/(losses)

    429       289         591       846  

Purchases

    226       219         729       401  

Sales

    (46     (319       (1,180     (548

Settlements

    (205     (161       (392     (399

Transfers into level 3

    393       530         2,133       1,030  

Transfers out of level 3

    (629     (228         (1,123     (1,499

Ending balance

    $10,771       $10,205           $10,771       $10,205  

Other cash instruments

 

 

Beginning balance

    $     381       $     511         $     427       $     642  

Net realized gains/(losses)

          4         5       16  

Net unrealized gains/(losses)

    2       4         12       12  

Purchases

    33       37         74       92  

Sales

    (14     (12       (49     (47

Settlements

    (9     (59       (69     (146

Transfers into level 3

    5       4         2       12  

Transfers out of level 3

    (2     (14         (6     (106

Ending balance

    $     396       $     475           $     396       $     475  
 

 

21   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended September 2018. The net realized and unrealized gains on level 3 cash instrument assets of $603 million (reflecting $122 million of net realized gains and $481 million of net unrealized gains) for the three months ended September 2018 included gains/(losses) of $(3) million reported in market making, $466 million reported in other principal transactions and $140 million reported in interest income.

The net unrealized gains on level 3 cash instrument assets for the three months ended September 2018 primarily reflected gains on private equity securities, principally driven by strong corporate performance.

Transfers into level 3 during the three months ended September 2018 primarily reflected transfers of certain corporate debt instruments and private equity securities from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments.

Transfers out of level 3 during the three months ended September 2018 primarily reflected transfers of certain private equity securities and corporate debt instruments to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments, and transfers of certain other corporate debt instruments to level 2, principally due to certain unobservable yield and duration inputs no longer being significant to the valuation of these instruments.

Nine Months Ended September 2018. The net realized and unrealized gains on level 3 cash instrument assets of $935 million (reflecting $350 million of net realized gains and $585 million of net unrealized gains) for the nine months ended September 2018 included gains/(losses) of $(48) million reported in market making, $621 million reported in other principal transactions and $362 million reported in interest income.

The net unrealized gains on level 3 cash instrument assets for the nine months ended September 2018 primarily reflected gains on private equity securities, principally driven by strong corporate performance and company-specific events.

Transfers into level 3 during the nine months ended September 2018 primarily reflected transfers of certain private equity securities and corporate debt instruments from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments.

Transfers out of level 3 during the nine months ended September 2018 primarily reflected transfers of certain private equity securities and corporate debt instruments to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments, and transfers of certain other corporate debt instruments 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 September 2017. The net realized and unrealized gains on level 3 cash instrument assets of $441 million (reflecting $109 million of net realized gains and $332 million of net unrealized gains) for the three months ended September 2017 included gains/(losses) of $(44) million reported in market making, $360 million reported in other principal transactions and $125 million reported in interest income.

The net unrealized gains on level 3 cash instrument assets for the three months ended September 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 September 2017 primarily reflected transfers of certain corporate debt instruments and private equity securities from level 2, principally due to reduced price transparency as a result of a lack of market evidence, including fewer market transactions in these instruments.

Transfers out of level 3 during the three months ended September 2017 primarily reflected transfers of certain corporate debt instruments and private equity securities to level 2, principally due to increased price transparency as a result of market evidence, including market transactions in these instruments.

Nine Months Ended September 2017. The net realized and unrealized gains on level 3 cash instrument assets of $1.50 billion (reflecting $349 million of net realized gains and $1.15 billion of net unrealized gains) for the nine months ended September 2017 included gains/(losses) of $(77) million reported in market making, $1.21 billion reported in other principal transactions and $365 million reported in interest income.

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

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

 

 

Goldman Sachs September 2018 Form 10-Q   22


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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

Available-for-Sale Securities

The table below presents information about cash instruments that are accounted for as available-for-sale.

 

$ in millions    
Amortized
Cost
 
 
   
Fair
Value
 
 
   

Weighted
Average
Yield
 
 
 

As of September 2018

 

   

Less than 5 years

    $  5,980       $  5,801       2.10%  

Greater than 5 years

    6,261       6,010       2.44%  

Total U.S. government obligations

    12,241       11,811       2.28%  

Total available-for-sale securities

    $12,241       $11,811       2.28%  

 

As of December 2017

 

   

Less than 5 years

    $  3,834       $  3,800       1.95%  

Greater than 5 years

    5,207       5,222       2.41%  

Total U.S. government obligations

    9,041       9,022       2.22%  

Less than 5 years

    19       19       0.43%  

Greater than 5 years

    233       235       4.62%  

Total other available-for-sale securities

    252       254       4.30%  

Total available-for-sale securities

    $  9,293       $  9,276       2.27%  

In the table above:

 

 

U.S. government obligations were classified in level 1 of the fair value hierarchy as of both September 2018 and December 2017.

 

 

Other available-for-sale securities included corporate debt securities, other debt obligations, securities backed by commercial real estate and money market instruments, substantially all of which were classified in level 2 of the fair value hierarchy as of December 2017.

 

 

The gross unrealized losses included in accumulated other comprehensive loss were $430 million as of September 2018 and primarily related to U.S. government obligations in a continuous unrealized loss position for less than a year. Such losses were not material as of December 2017.

 

 

Available-for-sale securities in an unrealized loss position are periodically reviewed for other-than-temporary impairment. The firm considers various factors, including market conditions, changes in issuer credit ratings, severity and duration of the unrealized losses, and the intent and ability to hold the security until recovery to determine if the securities are other-than-temporarily impaired. There were no such impairments during either the nine months ended September 2018 or the year ended December 2017.

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 timing of which is uncertain.

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, the timing of which is uncertain.

 

 

23   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Many of the funds described above are “covered funds” as defined in 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 (FRB) extended the conformance period to July 2022 for the firm’s investments in, and relationships with, certain legacy “illiquid funds” (as defined in 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, such covered funds.

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

 

$ in millions    
Fair Value of
Investments
 
 
    
Unfunded
Commitments
 
 

As of September 2018

    

Private equity funds

    $2,754        $   794  

Credit funds

    470        828  

Hedge funds

    171         

Real estate funds

    584        201  

Total

    $3,979        $1,823  

 

As of December 2017

    

Private equity funds

    $3,478        $   614  

Credit funds

    266        985  

Hedge funds

    223         

Real estate funds

    629        201  

Total

    $4,596        $1,800  

Note 7.

Derivatives and Hedging Activities

Derivative Activities

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

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

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

The firm enters into various types of derivatives, including:

 

 

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

 

 

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

 

 

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

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

 

 

Goldman Sachs September 2018 Form 10-Q   24


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

The tables below present the gross fair value and the notional amounts of derivative contracts by major product type, the amounts of counterparty and cash collateral netting in the 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 September 2018         As of December 2017  
$ in millions    
Derivative
Assets
 
 
   
Derivative
Liabilities
 
 
       
Derivative
Assets
 
 
   
Derivative
Liabilities
 
 

Not accounted for as hedges

 

     

Exchange-traded

    $     1,108       $     1,346         $        554       $        644  

OTC-cleared

    1,974       1,515         5,392       2,773  

Bilateral OTC

    223,385       203,511           274,986       249,750  

Total interest rates

    226,467       206,372           280,932       253,167  

OTC-cleared

    5,993       5,510         5,727       5,670  

Bilateral OTC

    14,956       14,012           16,966       15,600  

Total credit

    20,949       19,522           22,693       21,270  

Exchange-traded

    21       31         23       363  

OTC-cleared

    1,489       1,262         988       847  

Bilateral OTC

    91,274       86,566           94,481       95,127  

Total currencies

    92,784       87,859           95,492       96,337  

Exchange-traded

    5,001       4,660         4,135       3,854  

OTC-cleared

    260       265         197       197  

Bilateral OTC

    13,953       15,751           9,748       12,097  

Total commodities

    19,214       20,676           14,080       16,148  

Exchange-traded

    11,938       11,373         10,552       10,335  

Bilateral OTC

    43,546       46,570           40,735       45,253  

Total equities

    55,484       57,943           51,287       55,588  

Subtotal

    414,898       392,372           464,484       442,510  

Accounted for as hedges

 

     

OTC-cleared

    2               21        

Bilateral OTC

    2,742       13           2,309       3  

Total interest rates

    2,744       13           2,330       3  

OTC-cleared

    108       14         15       30  

Bilateral OTC

    84       20           34       114  

Total currencies

    192       34           49       144  

Subtotal

    2,936       47           2,379       147  

Total gross fair value

    $ 417,834       $ 392,419           $ 466,863       $ 442,657  

Offset in consolidated statements of financial condition

 

Exchange-traded

    $  (14,237     $  (14,237       $  (12,963     $  (12,963

OTC-cleared

    (8,400     (8,400       (9,267     (9,267

Bilateral OTC

    (296,350     (296,350         (341,824     (341,824

Counterparty netting

    (318,987     (318,987         (364,054     (364,054

OTC-cleared

    (1,105             (2,423     (180

Bilateral OTC

    (52,064     (34,111         (53,049     (38,792

Cash collateral netting

    (53,169     (34,111         (55,472     (38,972

Total amounts offset

    $(372,156     $(353,098         $(419,526     $(403,026

Included in consolidated statements of financial condition

 

Exchange-traded

    $     3,831       $     3,173         $     2,301       $     2,233  

OTC-cleared

    321       166         650       70  

Bilateral OTC

    41,526       35,982           44,386       37,328  

Total

    $   45,678       $   39,321           $   47,337       $   39,631  

Not offset in consolidated statements of financial condition

 

Cash collateral

    $       (575     $    (1,600       $       (602     $    (2,375

Securities collateral

    (12,448     (8,029         (13,947     (8,722

Total

    $   32,655       $   29,692           $   32,788       $   28,534  
    Notional Amounts as of  
$ in millions    
September
2018
 
 
    
December
2017
 
 

Not accounted for as hedges

    

Exchange-traded

    $11,716,983        $10,212,510  

OTC-cleared

    16,940,763        14,739,556  

Bilateral OTC

    17,127,815        12,862,328  

Total interest rates

    45,785,561        37,814,394  

OTC-cleared

    405,303        386,163  

Bilateral OTC

    770,732        868,226  

Total credit

    1,176,035        1,254,389  

Exchange-traded

    6,328        10,450  

OTC-cleared

    113,192        98,549  

Bilateral OTC

    6,802,229        7,331,516  

Total currencies

    6,921,749        7,440,515  

Exchange-traded

    312,798        239,749  

OTC-cleared

    1,145        3,925  

Bilateral OTC

    262,073        250,547  

Total commodities

    576,016        494,221  

Exchange-traded

    702,478        655,485  

Bilateral OTC

    1,235,952        1,127,812  

Total equities

    1,938,430        1,783,297  

Subtotal

    56,397,791        48,786,816  

Accounted for as hedges

    

OTC-cleared

    84,380        52,785  

Bilateral OTC

    12,033        15,188  

Total interest rates

    96,413        67,973  

OTC-cleared

    2,837        2,210  

Bilateral OTC

    7,199        8,347  

Total currencies

    10,036        10,557  

Subtotal

    106,449        78,530  

Total notional amounts

    $56,504,240        $48,865,346  

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 included derivative assets of $10.91 billion as of September 2018 and $11.24 billion as of December 2017, and derivative liabilities of $11.68 billion as of September 2018 and $13.00 billion as of December 2017, 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.

 

 

25   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

 

During the second quarter of 2018, consistent with the rules of a clearing organization, the firm elected to consider its transactions with that clearing organization as settled each day. As of December 2017, the impact of this change would have been a reduction in gross interest rate derivative assets of $3.6 billion and gross interest rate derivative liabilities of $1.9 billion, and a corresponding decrease in counterparty and cash collateral netting, with no impact to the consolidated statements of financial condition.

Valuation Techniques for Derivatives

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

 

 

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

 

 

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

 

 

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

 

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

 

 

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

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

Level 1 Derivatives

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

Level 2 Derivatives

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

 

 

Goldman Sachs September 2018 Form 10-Q   26


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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

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

Level 3 Derivatives

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

 

 

For level 3 interest rate and currency derivatives, significant unobservable inputs include correlations of certain currencies and interest rates (e.g., the correlation between Euro inflation and Euro interest rates). In addition, for level 3 interest rate derivatives, significant unobservable inputs include specific interest rate volatilities.

 

 

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

 

 

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

 

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

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

Valuation Adjustments

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

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

 

 

27   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Fair Value of Derivatives by Level

The table below presents 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 consolidated statements of financial condition.

 

$ in millions     Level 1       Level 2       Level 3       Total  

As of September 2018

       

Assets

       

Interest rates

    $   32       $ 228,754       $    425       $ 229,211  

Credit

          17,472       3,477       20,949  

Currencies

          92,600       376       92,976  

Commodities

          18,834       380       19,214  

Equities

    30       54,795       659       55,484  

Gross fair value

    62       412,455       5,317       417,834  

Counterparty netting in levels

    (1     (317,063     (896     (317,960

Subtotal

    $   61       $   95,392       $ 4,421       $   99,874  

Cross-level counterparty netting

 

    (1,027

Cash collateral netting

                            (53,169

Net fair value

 

    $   45,678  

Liabilities

       

Interest rates

    $    (1     $(205,667       (717     $(206,385

Credit

          (17,795     (1,727     (19,522

Currencies

          (87,716     (177     (87,893

Commodities

          (20,431     (245     (20,676

Equities

    (190     (56,012     (1,741     (57,943

Gross fair value

    (191     (387,621     (4,607     (392,419

Counterparty netting in levels

    1       317,063       896       317,960  

Subtotal

    $(190     $  (70,558     $(3,711     $  (74,459

Cross-level counterparty netting

 

    1,027  

Cash collateral netting

                            34,111  

Net fair value

 

    $  (39,321

 

As of December 2017

       

Assets

       

Interest rates

    $   18       $ 282,933       $    311       $ 283,262  

Credit

          19,053       3,640       22,693  

Currencies

          95,401       140       95,541  

Commodities

          13,727       353       14,080  

Equities

    8       50,870       409       51,287  

Gross fair value

    26       461,984       4,853       466,863  

Counterparty netting in levels

          (362,109     (1,051     (363,160

Subtotal

    $   26       $   99,875       $ 3,802       $ 103,703  

Cross-level counterparty netting

 

    (894

Cash collateral netting

                            (55,472

Net fair value

 

    $   47,337  

Liabilities

       

Interest rates

    $  (28     $ (252,421     $   (721     $ (253,170

Credit

          (19,135     (2,135     (21,270

Currencies

          (96,160     (321     (96,481

Commodities

          (15,842     (306     (16,148

Equities

    (28     (53,902     (1,658     (55,588

Gross fair value

    (56     (437,460     (5,141     (442,657

Counterparty netting in levels

          362,109       1,051       363,160  

Subtotal

    $  (56     $  (75,351     $ (4,090     $  (79,497

Cross-level counterparty netting

 

    894  

Cash collateral netting

                            38,972  

Net fair value

 

    $  (39,631

In the table 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 level 3 derivatives.

 

   

Level 3 Assets (Liabilities) and Range of Significant

Unobservable Inputs (Average/Median) as of

 
$ in millions    

September

2018

 

 

   

December

2017

 

 

Interest rates, net

    $(292)       $(410)  

 

Correlation

    (10)% to 96% (79%/85%)       (10)% to 95% (71%/79%)  

 

Volatility (bps)

    31 to 150 (83/77)       31 to 150 (84/78)  

Credit, net

    $1,750        $1,505   

 

Correlation

    N/A       28% to 84% (61%/60%)  

 

Credit spreads (bps)

    1 to 612 (83/41)       1 to 633 (69/42)  

 

Upfront credit points

    2 to 97 (40/36)       0 to 97 (42/38)  

 

Recovery rates

    25% to 70% (43%/40%)       22% to 73% (68%/73%)  

Currencies, net

    $199        $(181)  

 

Correlation

    10% to 70% (41%/47%)       49% to 72% (61%/62%)  

Commodities, net

    $135        $47   

 

Volatility

    10% to 69% (25%/26%)       9% to 79% (24%/24%)  

 

Natural gas spread

 

 

 

 

$(1.77) to $3.81 

($(0.27)/$(0.33))

 

 

 

   

$(2.38) to $3.34 

($(0.22)/$(0.12))

 

 

Oil spread

 

 

 

 

$2.77 to $14.58 

($6.39/$5.22)

 

 

 

   
$(2.86) to $23.61 
($6.47/$2.35)
 
 

Equities, net

    $(1,082)       $(1,249)  

 

Correlation

    (68)% to 97% (43%/45%)       (36)% to 94% (50%/52%)  

 

Volatility

    3% to 85% (19%/17%)       4% to 72% (24%/22%)  

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 indicates that the majority of the inputs fall in the lower end of the range.

 

 

Goldman Sachs September 2018 Form 10-Q   28


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

 

The ranges, averages and medians of these inputs are not representative of the appropriate inputs to use when calculating the fair value of any one derivative. For example, the highest correlation for interest rate derivatives is appropriate for valuing a specific interest rate derivative but may not be appropriate for valuing any other interest rate derivative. Accordingly, the ranges of inputs do not represent uncertainty in, or possible ranges of, fair value measurements of 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 was not significant to the valuation of level 3 credit derivatives as of September 2018.

 

 

Correlation within currencies and equities includes cross-product type 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 product type (e.g., equity index and equity single stock names) and across product types (e.g., correlation of an interest rate and a currency), as well as across regions. Generally, cross-product type correlation inputs are used to value more complex instruments and are lower than correlation inputs on assets within the same derivative product type.

 

 

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

 

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

 

 

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

Sensitivity of Fair Value Measurement to Changes in Significant Unobservable Inputs

The following is a description of the directional sensitivity of the firm’s level 3 fair value measurements, as of both September 2018 and December 2017, 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.

 

 

29   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward

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

 

    Three Months
Ended September
        Nine Months
Ended September
 
$ in millions     2018        2017           2018        2017  

Total level 3 derivatives

 

      

Beginning balance

    $ 736        $ 960         $(288      $(1,217

Net realized gains/(losses)

    57        (24       102        (82

Net unrealized gains/(losses)

    (108      12         394        (144

Purchases

    145        48         325        146  

Sales

    (138      (786       (366      (935

Settlements

    (71      (299       368        2,163  

Transfers into level 3

    (119      (34       82        (6

Transfers out of level 3

    208        6           93        (42

Ending balance

    $ 710        $(117         $ 710        $   (117

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) relates to instruments that were still held at period-end.

 

 

Transfers between levels of the fair value hierarchy are reported at the beginning of the reporting period in which they occur. 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.

 

 

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

 

 

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

 

 

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

 

 

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

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

 

    Three Months
Ended September
        Nine Months
Ended September
 
$ in millions     2018       2017           2018       2017  

Interest rates, net

         

Beginning balance

    $   (166     $   (319       $   (410     $   (381

Net realized gains/(losses)

    (25     (34       (40     (77

Net unrealized gains/(losses)

    (110     38         (54     68  

Purchases

          1         7       5  

Sales

    (2     (4       (8     (12

Settlements

    32       5         178       78  

Transfers into level 3

    (18             31       (11

Transfers out of level 3

    (3     (14         4       3  

Ending balance

    $   (292     $   (327         $   (292     $   (327

Credit, net

         

Beginning balance

    $ 1,779       $ 1,999         $ 1,505       $ 2,504  

Net realized gains/(losses)

    42       23         45       52  

Net unrealized gains/(losses)

    (164     54         (95     (149

Purchases

    45       15         60       30  

Sales

    (9     (27       (41     (40

Settlements

    52       (356       202       (607

Transfers into level 3

    (3     8         25       45  

Transfers out of level 3

    8       45           49       (74

Ending balance

    $ 1,750       $ 1,761           $ 1,750       $ 1,761  

Currencies, net

         

Beginning balance

    $    218       $      25         $   (181     $        3  

Net realized gains/(losses)

    (19     (9       (37     (30

Net unrealized gains/(losses)

    104       (52       181       (87

Purchases

    7       1         22       3  

Sales

    (26             (30      

Settlements

    (59     26         216       88  

Transfers into level 3

    3       3         28       11  

Transfers out of level 3

    (29     (30               (24

Ending balance

    $    199       $     (36         $    199       $     (36

Commodities, net

         

Beginning balance

    $    148       $    118         $      47       $      73  

Net realized gains/(losses)

    5       (4       69       23  

Net unrealized gains/(losses)

    23       80         119       135  

Purchases

    25       3         37       19  

Sales

    (19     (58       (55     (120

Settlements

    (8     (1       (132     (42

Transfers into level 3

    (39     (47       44       (40

Transfers out of level 3

          (25         6       18  

Ending balance

    $     135       $      66           $    135       $      66  

Equities, net

         

Beginning balance

    $(1,243     $   (863       $(1,249     $(3,416

Net realized gains/(losses)

    54               65       (50

Net unrealized gains/(losses)

    39       (108       243       (111

Purchases

    68       28         199       89  

Sales

    (82     (697       (232     (763

Settlements

    (88     27         (96     2,646  

Transfers into level 3

    (62     2         (46     (11

Transfers out of level 3

    232       30           34       35  

Ending balance

    $(1,082     $(1,581         $(1,082     $(1,581
 

 

Goldman Sachs September 2018 Form 10-Q   30


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

Level 3 Rollforward Commentary

Three Months Ended September 2018. The net realized and unrealized losses on level 3 derivatives of $51 million (reflecting $57 million of net realized gains and $108 million of net unrealized losses) for the three months ended September 2018 included gains/(losses) of $27 million reported in market making and $(78) million reported in other principal transactions.

The net unrealized losses on level 3 derivatives for the three months ended September 2018 were primarily attributable to losses on certain credit derivatives, primarily reflecting the impact of tighter credit spreads, and losses on certain interest rate derivatives, primarily reflecting the impact of an increase in interest rates, partially offset by gains on certain currency derivatives, primarily reflecting the impact of changes in foreign exchange rates.

Transfers into level 3 derivatives during the three months ended September 2018 primarily reflected transfers of certain equity derivative liabilities from level 2, primarily due to reduced transparency of volatility inputs used to value these derivatives and transfers of certain commodity derivative liabilities from level 2, primarily due to reduced transparency of natural gas spread inputs used to value these derivatives.

Transfers out of level 3 derivatives during the three months ended September 2018 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.

Nine Months Ended September 2018. The net realized and unrealized gains on level 3 derivatives of $496 million (reflecting $102 million of net realized gains and $394 million of net unrealized gains) for the nine months ended September 2018 included gains of $446 million reported in market making and $50 million reported in other principal transactions.

The net unrealized gains on level 3 derivatives for the nine months ended September 2018 were primarily attributable to gains on certain equity derivatives, reflecting the impact of a decrease in certain equity prices, gains on certain currency derivatives, primarily reflecting the impact of changes in foreign exchange rates, and gains on certain commodity derivatives, reflecting the impact of an increase in commodity prices, partially offset by losses on certain credit derivatives, primarily reflecting the impact of an increase in interest rates.

Both transfers into level 3 derivatives and transfers out of level 3 derivatives during the nine months ended September 2018 were not material.

Three Months Ended September 2017. The net realized and unrealized losses on level 3 derivatives of $12 million (reflecting $24 million of net realized losses and $12 million of net unrealized gains) for the three months ended September 2017 included gains/(losses) of $63 million reported in market making and $(75) million reported in other principal transactions.

The drivers of the net unrealized gains on level 3 derivatives for the three months ended September 2017 were not material.

Both transfers into level 3 derivatives and transfers out of level 3 derivatives during the three months ended September 2017 were not material.

Nine Months Ended September 2017. The net realized and unrealized losses on level 3 derivatives of $226 million (reflecting $82 million of net realized losses and $144 million of net unrealized losses) for the nine months ended September 2017 included gains/(losses) of $28 million reported in market making and $(254) million reported in other principal transactions.

The net unrealized losses on level 3 derivatives for the nine months ended September 2017 were primarily attributable to losses on certain credit derivatives, reflecting the impact of tighter credit spreads, and losses on certain equity derivatives, reflecting the impact of changes in equity prices, partially offset by gains on certain commodity derivatives, reflecting the impact of an increase in commodity prices.

Both transfers into level 3 derivatives and transfers out of level 3 derivatives during the nine months ended September 2017 were not material.

 

 

31   Goldman Sachs September 2018 Form 10-Q


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

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 September 2018

       

Assets

       

Interest rates

    $  4,161       $12,203       $47,612       $  63,976  

Credit

    775       3,833       3,569       8,177  

Currencies

    13,173       6,248       6,355       25,776  

Commodities

    4,316       3,797       129       8,242  

Equities

    4,460       6,826       1,843       13,129  

Counterparty netting in tenors

    (2,564     (4,190     (2,457     (9,211

Subtotal

    $24,321       $28,717       $57,051       $110,089  

Cross-tenor counterparty netting

 

        (15,073

Cash collateral netting

                            (53,169

Total

                            $  41,847  

Liabilities

       

Interest rates

    $  3,897       $  8,750       $28,264       $  40,911  

Credit

    1,168       3,914       1,668       6,750  

Currencies

    11,089       5,726       3,868       20,683  

Commodities

    4,153       3,027       2,865       10,045  

Equities

    6,475       6,912       2,767       16,154  

Counterparty netting in tenors

    (2,564     (4,190     (2,457     (9,211

Subtotal

    $24,218       $24,139       $36,975       $  85,332  

Cross-tenor counterparty netting

 

        (15,073

Cash collateral netting

                            (34,111

Total

                            $  36,148  

 

As of December 2017

       

Assets

       

Interest rates

    $  3,717       $15,445       $57,200       $  76,362  

Credit

    760       4,079       3,338       8,177  

Currencies

    12,184       6,219       7,245       25,648  

Commodities

    3,175       2,526       181       5,882  

Equities

    4,969       5,607       1,387       11,963  

Counterparty netting in tenors

    (3,719     (4,594     (2,807     (11,120

Subtotal

    $21,086       $29,282       $66,544       $116,912  

Cross-tenor counterparty netting

 

        (16,404

Cash collateral netting

                            (55,472

Total

                            $  45,036  

Liabilities

       

Interest rates

    $  4,517       $  8,471       $33,193       $  46,181  

Credit

    2,078       3,588       1,088       6,754  

Currencies

    14,326       7,119       4,802       26,247  

Commodities

    3,599       2,167       2,465       8,231  

Equities

    6,453       6,647       3,381       16,481  

Counterparty netting in tenors

    (3,719     (4,594     (2,807     (11,120

Subtotal

    $27,254       $23,398       $42,122       $  92,774  

Cross-tenor counterparty netting

 

        (16,404

Cash collateral netting

                            (38,972

Total

                            $  37,398  

In the table above:

 

 

Tenor is based on remaining contractual maturity.

 

 

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

 

 

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

Credit Derivatives

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

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

The firm enters into the following types of credit derivatives:

 

 

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

 

 

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

 

 

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

 

 

Goldman Sachs September 2018 Form 10-Q   32


Table of Contents

THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

 

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

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

As of September 2018, written credit derivatives had a total gross notional amount of $573.41 billion and purchased credit derivatives had a total gross notional amount of $602.65 billion, for total net notional purchased protection of $29.24 billion. As of December 2017, written credit derivatives had a total gross notional amount of $611.04 billion and purchased credit derivatives had a total gross notional amount of $643.37 billion, for total net notional purchased protection of $32.33 billion. Substantially all of the firm’s written and purchased credit derivatives are credit default swaps.

The table below presents information about credit derivatives.

 

    Credit Spread on Underlier (basis points)  
$ in millions     0 - 250      

251 -

500

 

 

   

501 -

1,000

 

 

   

Greater
than

1,000

 
 

 

    Total  

As of September 2018

 

     

Maximum Payout/Notional Amount of Written Credit Derivatives by Tenor

 

Less than 1 year

    $136,481       $  8,178       $     630       $  3,213       $148,502  

1 – 5 years

    300,104       15,624       9,279       5,731       330,738  

Greater than 5 years

    79,858       11,322       2,648       337       94,165  

Total

    $516,443       $35,124       $12,557       $  9,281       $573,405  

Maximum Payout/Notional Amount of Purchased Credit Derivatives

 

Offsetting

    $448,097       $25,275       $10,406       $  7,210       $490,988  

Other

    100,073       7,661       1,585       2,344       111,663  

Fair Value of Written Credit Derivatives

 

Asset

    $  11,911       $     716       $     170       $       98       $  12,895  

Liability

    1,485       1,412       706       2,615       6,218  

Net asset/(liability)

    $  10,426       $   (696     $   (536     $ (2,517     $    6,677  

 

As of December 2017

 

       

Maximum Payout/Notional Amount of Written Credit Derivatives by Tenor

 

Less than 1 year

    $182,446       $  8,531       $     705       $  4,067       $195,749  

1 – 5 years

    335,872       10,201       8,747       7,553       362,373  

Greater than 5 years

    49,440       2,142