FORM 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
     
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
    For the quarterly period ended August 25, 2006
 
or
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
    For the transition period            to
Commission File Number: 001-14965
The Goldman Sachs Group, Inc.
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction
of incorporation or organization)
  13-4019460
(I.R.S. Employer
Identification No.)
 
85 Broad Street, New York, NY
(Address of principal executive offices)
  10004
(Zip Code)
(212) 902-1000
(Registrant’s telephone number, including area code)
        Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.          x     Yes     o     No
          Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
          Large accelerated filer     x       Accelerated filer     o       Non-accelerated filer     o     
          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).          o     Yes     x     No
APPLICABLE ONLY TO CORPORATE ISSUERS
          As of September 22, 2006 there were 425,832,104 shares of the registrant’s common stock outstanding.
 
 


 

THE GOLDMAN SACHS GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED AUGUST 25, 2006
INDEX
             
        Page
Form 10-Q Item Number:
  No.
     
         
 
         
 
        2  
        3  
        4  
        5  
        6  
        7  
        47  
 
      48  
 
      93  
 
      98  
 
         
 
      99  
 
      100  
 
      101  
 
 SIGNATURES     102  
 EX-10.1: GS&CO. EXECUTIVE LIFE INSURANCE POLICY AND CERTIFICATE - MET LIFE
 EX-10.2: FORM OF GS&CO. EXECUTIVE LIFE INSURANCE POLICY - PACIFIC LIFE
 EX-12.1: STATEMENT RE: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND RATIOS OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
 EX-15.1: LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION
 EX-31.1: RULE 13a-14(a) CERTIFICATIONS
 EX-32.1: SECTION 1350 CERTIFICATIONS

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PART I: FINANCIAL INFORMATION
Item 1:     Financial Statements (Unaudited)
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
                                   
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions, except per share amounts)
Revenues
                               
Investment banking
  $ 1,285     $ 998     $ 4,276     $ 2,667  
Trading and principal investments
    4,368       4,842       17,976       11,545  
Asset management and securities services
    975       772       3,545       2,270  
Interest income
    9,351       5,721       25,430       14,764  
                                 
 
Total revenues
    15,979       12,333       51,227       31,246  
Interest expense
    8,395       4,940       22,969       12,411  
Cost of power generation
    121       108       363       339  
                                 
 
Revenues, net of interest expense and cost of power generation
    7,463       7,285       27,895       18,496  
Operating expenses
                               
Compensation and benefits
    3,510       3,642       13,897       9,248  
Brokerage, clearing and exchange fees
    454       271       1,208       797  
Market development
    117       92       338       268  
Communications and technology
    141       124       396       365  
Depreciation and amortization
    126       125       378       371  
Amortization of identifiable intangible assets
    50       31       128       93  
Occupancy
    221       200       613       534  
Professional fees
    135       117       367       322  
Other expenses
    347       278       995       704  
                                 
 
Total non-compensation expenses
    1,591       1,238       4,423       3,454  
                                 
 
 
Total operating expenses
    5,101       4,880       18,320       12,702  
                                 
 
Pre-tax earnings
    2,362       2,405       9,575       5,794  
Provision for taxes
    768       788       3,190       1,800  
                                 
Net earnings
    1,594       1,617       6,385       3,994  
Preferred stock dividends
    39       9       91       9  
                                 
Net earnings applicable to common shareholders
  $ 1,555     $ 1,608     $ 6,294     $ 3,985  
                                 
Earnings per common share
                               
Basic
  $ 3.46     $ 3.40     $ 13.92     $ 8.23  
Diluted
    3.26       3.25       13.12       7.89  
Dividends declared and paid per common share
  $ 0.35     $ 0.25     $ 0.95     $ 0.75  
Average common shares outstanding
                               
Basic
    449.4       473.3       452.1       484.3  
Diluted
    477.4       494.2       479.7       505.2  
The accompanying notes are an integral part of these condensed consolidated financial statements.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
                   
    As of
     
    August   November
    2006   2005
         
    (in millions, except share
    and per share amounts)
Assets
               
Cash and cash equivalents
  $ 10,063     $ 10,261  
Cash and securities segregated for regulatory and other purposes
    76,309       51,405  
Receivables from brokers, dealers and clearing organizations
    13,200       15,150  
Receivables from customers and counterparties
    76,112       60,231  
Securities borrowed
    210,190       191,800  
Financial instruments purchased under agreements to resell
    82,958       83,619  
Financial instruments owned, at fair value
    269,238       238,043  
Financial instruments owned and pledged as collateral, at fair value
    39,936       38,983  
                 
 
Total financial instruments owned, at fair value
    309,174       277,026  
Other assets
    20,303       17,312  
                 
 
Total assets
  $ 798,309     $ 706,804  
                 
 
Liabilities and shareholders’ equity
               
Secured short-term borrowings
  $ 18,850     $ 7,972  
Unsecured short-term borrowings
    53,814       47,247  
                 
 
Total short-term borrowings, including the current portion of long-term borrowings
    72,664       55,219  
Payables to brokers, dealers and clearing organizations
    5,056       10,014  
Payables to customers and counterparties
    215,396       178,304  
Securities loaned
    26,409       23,331  
Financial instruments sold under agreements to repurchase
    128,132       149,026  
Financial instruments sold, but not yet purchased, at fair value
    156,557       149,071  
Other liabilities and accrued expenses
    31,271       13,830  
Secured long-term borrowings
    19,553       15,669  
Unsecured long-term borrowings
    109,778       84,338  
                 
 
Total long-term borrowings
    129,331       100,007  
                 
 
Total liabilities
    764,816       678,802  
Commitments, contingencies and guarantees
               
Shareholders’ equity
               
Preferred stock, par value $0.01 per share; 150,000,000 shares authorized, 124,000 and 70,000 shares issued and outstanding as of August 2006 and November 2005, respectively, with liquidation preference of $25,000 per share
    3,100       1,750  
Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 595,168,224 and 573,970,935 shares issued as of August 2006 and November 2005, respectively, and 428,909,579 and 437,170,695 shares outstanding as of August 2006 and November 2005, respectively
    6       6  
Restricted stock units and employee stock options
    3,812       3,415  
Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding
           
Additional paid-in capital
    19,213       17,159  
Retained earnings
    24,927       19,085  
Accumulated other comprehensive income
    13        
Common stock held in treasury, at cost, par value $0.01 per share; 166,258,645 and 136,800,240 shares as of August 2006 and November 2005, respectively
    (17,578 )     (13,413 )
                 
 
Total shareholders’ equity
    33,493       28,002  
                 
 
Total liabilities and shareholders’ equity
  $ 798,309     $ 706,804  
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
                   
    Period Ended
     
    August   November
    2006   2005
         
    (in millions, except
    per share amounts)
Preferred stock
               
 
Balance, beginning of year
  $ 1,750     $  
 
Issued
    1,350       1,750  
                 
 
Balance, end of period
    3,100       1,750  
 
Common stock, par value $0.01 per share
               
 
Balance, beginning of year
    6       6  
 
Issued
           
                 
 
Balance, end of period
    6       6  
 
Restricted stock units and employee stock options
               
 
Balance, beginning of year
    3,415       2,013  
 
Issued
    1,295       1,871  
 
Delivered
    (776 )     (423 )
 
Forfeited
    (121 )     (37 )
 
Options exercised
    (1 )     (9 )
                 
 
Balance, end of period
    3,812       3,415  
 
Additional paid-in capital
               
 
Balance, beginning of year
    17,159       15,501  
 
Issuance of common stock
    1,560       1,417  
 
Preferred stock issuance costs
    (1 )     (31 )
 
Excess tax benefit related to share-based compensation
    495       272  
                 
 
Balance, end of period
    19,213       17,159  
 
Retained earnings
               
 
Balance, beginning of year
    19,085       13,970  
 
Net earnings
    6,385       5,626  
 
Dividends declared on common stock
    (452 )     (494 )
 
Dividends declared on preferred stock
    (91 )     (17 )
                 
 
Balance, end of period
    24,927       19,085  
 
Unearned compensation
               
 
Balance, beginning of year
          (117 )
 
Amortization of restricted stock units
          117  
                 
 
Balance, end of period
           
 
Accumulated other comprehensive income
               
 
Balance, beginning of year
          11  
 
Currency translation adjustment, net of tax
    30       (27 )
 
Minimum pension liability adjustment, net of tax
          (11 )
 
Net gains/(losses) on cash flow hedges, net of tax
    (12 )     9  
 
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (5 )     18  
                 
 
Balance, end of period
    13        
 
Common stock held in treasury, at cost
               
 
Balance, beginning of year
    (13,413 )     (6,305 )
 
Repurchased
    (4,165 )     (7,108 )
                 
 
Balance, end of period
    (17,578 )     (13,413 )
                 
 
Total shareholders’ equity
  $ 33,493     $ 28,002  
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
                       
    Nine Months
    Ended August
     
    2006   2005
         
    (in millions)
Cash flows from operating activities
               
 
Net earnings
  $ 6,385     $ 3,994  
 
Non-cash items included in net earnings
               
   
Depreciation and amortization
    547       511  
   
Amortization of identifiable intangible assets
    182       127  
   
Share-based compensation
    848       643  
 
Changes in operating assets and liabilities
               
   
Cash and securities segregated for regulatory and other purposes
    (16,364 )     1,687  
   
Net receivables from brokers, dealers and clearing organizations
    (3,009 )     (1,321 )
   
Net payables to customers and counterparties
    22,009       419  
   
Securities borrowed, net of securities loaned
    (15,312 )     (34,851 )
   
Financial instruments sold under agreements to repurchase, net of financial instruments purchased under agreements to resell
    (20,233 )     36,472  
   
Financial instruments owned, at fair value
    (31,535 )     (40,673 )
   
Financial instruments sold, but not yet purchased, at fair value
    7,136       17,241  
   
Other, net
    7,779       2,787  
                 
     
Net cash used for operating activities
    (41,567 )     (12,964 )
 
Cash flows from investing activities
               
 
Purchase of property, leasehold improvements and equipment
    (1,785 )     (1,025 )
 
Proceeds from sales of property, leasehold improvements and equipment
    175       621  
 
Business acquisitions, net of cash acquired
    (780 )     (523 )
 
Proceeds from sales of investments
    1,197        
 
Purchase of available-for-sale securities
    (6,363 )      
 
Proceeds from sales of available-for-sale securities
    4,193        
                 
     
Net cash used for investing activities
    (3,363 )     (927 )
 
Cash flows from financing activities
               
 
Short-term borrowings, net
    11,477       172  
 
Issuance of long-term borrowings
    47,602       35,669  
 
Repayment of long-term borrowings, including the current portion of
long-term borrowings
    (15,732 )     (16,806 )
 
Derivative contracts with a financing element, net
    3,195       823  
 
Common stock repurchased
    (4,165 )     (4,646 )
 
Dividends paid on common and preferred stock
    (543 )     (385 )
 
Proceeds from issuance of common stock
    1,200       738  
 
Proceeds from issuance of preferred stock, net of issuance costs
    1,349       856  
 
Excess tax benefit related to share-based compensation
    349        
                 
 
     
Net cash provided by financing activities
    44,732       16,421  
 
   
Net (decrease)/increase in cash and cash equivalents
    (198 )     2,530  
Cash and cash equivalents, beginning of year
    10,261       4,365  
                 
Cash and cash equivalents, end of period
  $ 10,063     $ 6,895  
                 
 
SUPPLEMENTAL DISCLOSURES:
Cash payments for interest, net of capitalized interest, were $22.56 billion and $12.48 billion during the nine months ended August 2006 and August 2005, respectively.
Cash payments for income taxes, net of refunds, were $2.85 billion and $1.69 billion during the nine months ended August 2006 and August 2005, respectively.
Non-cash activities:
The firm assumed $352 million and $1.15 billion of debt in connection with business acquisitions during the nine months ended August 2006 and August 2005, respectively.
The accompanying notes are an integral part of these condensed consolidated financial statements.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions)
Net earnings
  $ 1,594     $ 1,617     $ 6,385     $ 3,994  
Currency translation adjustment, net of tax
    3       2       30       (15 )
Net gains/(losses) on cash flow hedges, net of tax
    (10 )     3       (12 )     7  
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    9       15       (5 )     15  
                                 
Comprehensive income
  $ 1,596     $ 1,637     $ 6,398     $ 4,001  
                                 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Description of Business
       The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, together with its consolidated subsidiaries (collectively, the firm), is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.
       The firm’s activities are divided into three segments:
  •  Investment Banking. The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, governments and individuals.
 
  •  Trading and Principal Investments. The firm facilitates client transactions with a diverse group of corporations, financial institutions, governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on such products. In addition, the firm engages in specialist and market-making activities on equities and options exchanges and clears client transactions on major stock, options and futures exchanges worldwide. In connection with the firm’s merchant banking and other investing activities, the firm makes principal investments directly and through funds that the firm raises and manages.
 
  •  Asset Management and Securities Services. The firm provides investment advisory and financial planning services and offers investment products across all major asset classes to a diverse group of institutions and individuals worldwide, and provides prime brokerage services, financing services and securities lending services to mutual funds, pension funds, hedge funds, foundations and high-net-worth individuals worldwide.
Note 2. Significant Accounting Policies
Basis of Presentation
       These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles that require management to make certain estimates and assumptions. The most important of these estimates and assumptions relate to fair value measurements, the accounting for goodwill and identifiable intangible assets, the determination of compensation and benefits expenses for interim periods, and the provision for potential losses that may arise from litigation and regulatory proceedings and tax audits. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.
       These condensed consolidated financial statements include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. All material intercompany transactions and balances have been eliminated.
       The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity, a variable interest entity (VIE) or a qualifying special-purpose entity (QSPE) under generally accepted accounting principles.
  •  Voting Interest Entities. Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. Voting interest entities

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  are consolidated in accordance with Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements,” as amended. ARB No. 51 states that the usual condition for a controlling financial interest in an entity is ownership of a majority voting interest. Accordingly, the firm consolidates voting interest entities in which it has a majority voting interest.
 
  •  Variable Interest Entities. VIEs are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. In accordance with Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 46-R, “Consolidation of Variable Interest Entities,” the firm consolidates VIEs of which it is the primary beneficiary.
 
     The firm determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes a review of, among other factors, its capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE. Where qualitative analysis is not conclusive, the firm performs a quantitative analysis. For purposes of allocating a VIE’s expected losses and expected residual returns to its variable interest holders, the firm utilizes the “top down” method. Under that method, the firm calculates its share of the VIE’s expected losses and expected residual returns using the specific cash flows that would be allocated to it, based on contractual arrangements and/or the firm’s position in the capital structure of the VIE, under various probability-weighted scenarios.
 
  •  QSPEs. QSPEs are passive entities that are commonly used in mortgage and other securitization transactions. Statement of Financial Accounting Standards (SFAS) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” sets forth the criteria an entity must satisfy to be a QSPE. These criteria include the types of assets a QSPE may hold, limits on asset sales, the use of derivatives and financial guarantees, and the level of discretion a servicer may exercise in attempting to collect receivables. These criteria may require management to make judgments about complex matters, including whether a derivative is considered passive and the degree of discretion a servicer may exercise. In accordance with SFAS No. 140 and FIN No. 46-R, the firm does not consolidate QSPEs.
 
  •  Equity-Method Investments. When the firm does not have a controlling financial interest in an entity but exerts significant influence over the entity’s operating and financial policies (generally defined as owning a voting interest of 20% to 50%) and has an investment in common stock or in-substance common stock, the firm accounts for its investment in accordance with the equity method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.”
 
  •  Other. If the firm does not consolidate an entity or apply the equity method of accounting, the firm accounts for its investment at fair value. The firm also has formed numerous nonconsolidated investment funds with third-party investors that are typically organized as limited partnerships. The firm acts as general partner for these funds and does not hold a majority of the economic interests in any fund. For funds established on or before June 29, 2005 in which the firm holds more than a minor interest and for funds established or modified after June 29, 2005, the firm has provided the third-party investors with rights to remove the

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  firm as the general partner or to terminate the funds (see “— Recent Accounting Developments” below for a discussion of the impact of Emerging Issues Task Force (EITF) Issue No. 04-5). These fund investments are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.
       These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements incorporated by reference in the firm’s Annual Report on Form 10-K for the fiscal year ended November 25, 2005. The condensed consolidated financial information as of November 25, 2005 has been derived from audited consolidated financial statements not included herein.
       These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.
       Unless specifically stated otherwise, all references to August 2006 and August 2005 refer to the firm’s fiscal periods ended, or the dates, as the context requires, August 25, 2006 and August 26, 2005, respectively. All references to November 2005, unless specifically stated otherwise, refer to the firm’s fiscal year ended, or the date, as the context requires, November 25, 2005. All references to 2006, unless specifically stated otherwise, refer to the firm’s fiscal year ending, or the date, as the context requires, November 24, 2006. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
  Revenue Recognition
       Investment Banking. Underwriting revenues and fees from mergers and acquisitions and other financial advisory assignments are recognized in the condensed consolidated statements of earnings when the services related to the underlying transaction are completed under the terms of the engagement. Expenses associated with such transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. Underwriting revenues are presented net of related expenses. Expenses associated with financial advisory transactions are recorded as non-compensation expenses, net of client reimbursements.
       Financial Instruments. “Total financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value” are reflected in the condensed consolidated statements of financial condition on a trade-date basis and consist of financial instruments carried at fair value or amounts that approximate fair value, with related unrealized gains or losses generally recognized in the condensed consolidated statements of earnings. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
       In determining fair value, the firm separates its financial instruments into three categories — cash (i.e., nonderivative) trading instruments, derivative contracts and principal investments.
  •  Cash Trading Instruments. Fair values of the firm’s cash trading instruments are generally obtained from quoted market prices in active markets, broker or dealer price quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued in this manner include U.S. government and agency securities, other sovereign government obligations, liquid mortgage products, investment-grade and high-yield

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  corporate bonds, listed equities, money market securities, state, municipal and provincial obligations, and physical commodities.
 
     Certain cash trading instruments trade infrequently and have little or no price transparency. Such instruments may include certain corporate bank loans, mortgage whole loans and distressed debt. The firm values these instruments initially at cost and generally does not adjust valuations unless there is substantive evidence supporting a change in the value of the underlying instrument or valuation assumptions (such as similar market transactions, changes in financial ratios or changes in the credit ratings of the underlying companies). Where there is evidence supporting a change in the value, the firm uses valuation methodologies such as the present value of known or estimated cash flows.
 
     Cash trading instruments owned by the firm (long positions) are marked to bid prices, and instruments sold but not yet purchased (short positions) are marked to offer prices. If liquidating a position is expected to affect its prevailing market price, the valuation is adjusted generally based on market evidence or predetermined policies. In certain circumstances, such as for highly illiquid positions, management’s estimates are used to determine this adjustment.
 
  •  Derivative Contracts. Fair values of the firm’s derivative contracts consist of exchange-traded and over-the-counter (OTC) derivatives and are reflected net of cash that the firm has paid and received (for example, option premiums or cash paid or received pursuant to credit support agreements). Fair values of the firm’s exchange-traded derivatives are generally determined from quoted market prices. OTC derivatives are valued using valuation models. The firm uses a variety of valuation models including the present value of known or estimated cash flows and option-pricing models. The valuation models used to derive the fair values of the firm’s OTC derivatives require inputs including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. The selection of a model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. The firm generally uses similar models to value similar instruments. Where possible, the firm verifies the values produced by its pricing models to market transactions. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model selection does not involve significant judgment because market prices are readily available. For OTC derivatives that trade in less liquid markets, model selection requires more judgment because such instruments tend to be more complex and pricing information is less available in these markets. Price transparency is inherently more limited for more complex structures because they often combine one or more product types, requiring additional inputs such as correlations and volatilities. As markets continue to develop and more pricing information becomes available, the firm continues to review and refine the models it uses.
 
     At the inception of an OTC derivative contract (day one), the firm values the contract at the model value if the firm can verify all of the significant model inputs to observable market data and verify the model to market transactions. When appropriate, valuations are adjusted to reflect various factors such as liquidity, bid/offer spreads and credit considerations. These adjustments are generally based on market evidence or predetermined policies. In certain circumstances, such as for highly illiquid positions, management’s estimates are used to determine these adjustments.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
     Where the firm cannot verify all of the significant model inputs to observable market data and verify the model to market transactions, the firm values the contract at the transaction price at inception and, consequently, records no day one gain or loss in accordance with EITF Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (see “— Recent Accounting Developments” below for a discussion of the impact of SFAS No. 157 on EITF Issue No. 02-3).
 
     Following day one, the firm adjusts the inputs to its valuation models only to the extent that changes in these inputs can be verified by similar market transactions, third-party pricing services and/or broker quotes, or can be derived from other substantive evidence such as empirical market data. In circumstances where the firm cannot verify the model to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value.
 
  •  Principal Investments. In valuing corporate and real estate principal investments, the firm’s portfolio is separated into investments in private companies (including the firm’s investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC)), investments in public companies (excluding the firm’s investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc. (SMFG)) and the firm’s investment in SMFG.
 
     The firm’s private principal investments, by their nature, have little or no price transparency. Such investments (including the firm’s investment in ICBC) are initially carried at cost as an approximation of fair value. Adjustments to carrying value are made if there are third-party transactions evidencing a change in value. Downward adjustments are also made, in the absence of third-party transactions, if it is determined that the expected realizable value of the investment is less than the carrying value. In reaching that determination, many factors are considered including, but not limited to, the operating cash flows and financial performance of the companies or properties relative to budgets or projections, trends within sectors and/or regions, underlying business models, expected exit timing and strategy, and any specific rights or terms associated with the investment, such as conversion features and liquidation preferences.
 
     The firm’s public principal investments, which tend to be large, concentrated holdings that result from initial public offerings or other corporate transactions, are valued using quoted market prices discounted based on predetermined written policies for nontransferability and illiquidity.
 
     The firm’s investment in the convertible preferred stock of SMFG is carried at fair value, which is derived from a model that incorporates SMFG’s common stock price and credit spreads, the impact of nontransferability and illiquidity, and the downside protection on the conversion strike price. The firm’s investment in the convertible preferred stock of SMFG is generally nontransferable, but is freely convertible into SMFG common stock. Restrictions on the firm’s ability to hedge or sell two-thirds of the common stock underlying its investment in SMFG lapsed in equal installments on February 7, 2005 and March 9, 2006. As of the date of this filing, the firm has fully hedged the first one-third installment of the unrestricted shares and has hedged a majority of the second one-third installment of the unrestricted shares. Restrictions on the firm’s ability to hedge or sell the remaining one-third installment lapse on February 7, 2007. As of the date of this filing, the conversion price of the firm’s SMFG preferred stock into shares of SMFG common stock was ¥319,700. This price is subject to

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  downward adjustment if the price of SMFG common stock at the time of conversion is less than the conversion price (subject to a floor of ¥105,400).
       In general, transfers of financial assets are accounted for as sales under SFAS No. 140 when the firm has relinquished control over the transferred assets. For transfers accounted for as sales, any related gains or losses are recognized in net revenues. Transfers that are not accounted for as sales are accounted for as collateralized financing arrangements and secured borrowings, with the related interest expense recognized in net revenues over the lives of the transactions.
       Collateralized Financing Arrangements. Collateralized financing arrangements consist of resale and repurchase agreements, securities borrowed and loaned, and secured short and long-term borrowings. Interest income or expense on collateralized financing arrangements is recognized in net revenues over the life of the transaction.
  •  Resale and Repurchase Agreements. Financial instruments purchased under agreements to resell and financial instruments sold under agreements to repurchase, principally U.S. government, federal agency and investment-grade foreign sovereign obligations, represent short-term collateralized financing transactions and are carried in the condensed consolidated statements of financial condition at their contractual amounts plus accrued interest. These amounts are presented on a net-by-counterparty basis when the requirements of FIN No. 41, “Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements,” or FIN No. 39, “Offsetting of Amounts Related to Certain Contracts,” are satisfied. The firm receives financial instruments purchased under agreements to resell, makes delivery of financial instruments sold under agreements to repurchase, monitors the market value of these financial instruments on a daily basis and delivers or obtains additional collateral as appropriate.
 
  •  Securities Borrowed and Loaned. Securities borrowed and loaned are recorded based on the amount of cash collateral advanced or received. These transactions are generally collateralized by cash, securities or letters of credit. The firm receives securities borrowed, makes delivery of securities loaned, monitors the market value of securities borrowed and loaned, and delivers or obtains additional collateral as appropriate.
 
  •  Secured Short and Long-Term Borrowings. The firm also obtains financing through the use of secured short and long-term borrowings. The firm pledges financial instruments and other assets as collateral for such borrowings. See Notes 3, 4 and 5 for further information regarding the firm’s secured short and long-term borrowings.
       Power Generation. Power generation revenues associated with the firm’s consolidated power generation facilities are included in “Trading and principal investments” in the condensed consolidated statements of earnings when power is delivered. “Cost of power generation” in the condensed consolidated statements of earnings includes all of the direct costs of these facilities (e.g., fuel, operations and maintenance), as well as the depreciation and amortization associated with the facilities and related contractual assets.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       The following table sets forth the power generation revenues and costs directly associated with the firm’s consolidated power generation facilities:
                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
        (in millions)    
Revenues (1)
  $146   $132   $436   $377
Cost of power generation
  121   108   363   339
 
(1)  Excludes revenues from nonconsolidated power generation facilities, accounted for in accordance with the equity method of accounting, as well as revenues associated with the firm’s power trading activities.
       Commissions. Commission revenues from executing and clearing client transactions on stock, options and futures markets worldwide are recognized in “Trading and principal investments” in the condensed consolidated statements of earnings on a trade-date basis.
       Insurance Contracts. Revenues from variable annuity and variable life insurance contracts, and from providing reinsurance of such contracts, generally consist of fees assessed on contract holder account balances for mortality charges, policy administration and surrender charges. These fees are recognized in the condensed consolidated statements of earnings in the period that services are provided. Premiums earned for providing catastrophe reinsurance are recognized in revenues over the coverage period, net of premiums ceded for the cost of reinsurance. Insurance revenues are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
       Merchant Banking Overrides. The firm is entitled to receive merchant banking overrides (i.e., an increased share of a fund’s income and gains) when the return on the funds’ investments exceeds certain threshold returns. Overrides are based on investment performance over the life of each merchant banking fund, and future investment underperformance may require amounts of override previously distributed to the firm to be returned to the funds. Accordingly, overrides are recognized in the condensed consolidated statements of earnings only when all material contingencies have been resolved. Overrides are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
       Asset Management. Management fees are recognized over the period that the related service is provided based upon average net asset values. In certain circumstances, the firm is also entitled to receive asset management incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds specified benchmark returns or other performance targets. Incentive fees are generally based on investment performance over a 12-month period and are subject to adjustment prior to the end of the measurement period. Accordingly, incentive fees are recognized in the condensed consolidated statements of earnings when the measurement period ends. Asset management fees and incentive fees are included in “Asset management and securities services” in the condensed consolidated statements of earnings.
  Share-Based Compensation
       In the first quarter of fiscal 2006, the firm adopted SFAS No. 123-R, “Share-Based Payment,” which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123-R focuses primarily on accounting for transactions in which an entity obtains employee services in exchange for share-based payments. Under SFAS No. 123-R, share-based awards that do not require future service (i.e., vested awards) are expensed immediately. Share-based employee

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
awards that require future service are amortized over the relevant service period. The firm adopted SFAS No. 123-R under the modified prospective adoption method. Under that method of adoption, the provisions of SFAS No. 123-R are generally applied only to share-based awards granted subsequent to adoption. The accounting treatment of share-based awards granted to retirement-eligible employees prior to the firm’s adoption of SFAS No. 123-R has not changed and financial statements for periods prior to adoption are not restated for the effects of adopting SFAS No. 123-R.
       Two key differences between SFAS No. 123-R and SFAS No. 123 are:
       First, SFAS No. 123-R requires expected forfeitures to be included in determining share-based employee compensation expense. Prior to the adoption of SFAS No. 123-R, forfeiture benefits were recorded as a reduction to compensation expense when an employee left the firm and forfeited the award. In the first quarter of fiscal 2006, the firm recorded a benefit for expected forfeitures on all outstanding share-based awards. The transition impact of adopting SFAS No. 123-R as of the first day of the firm’s 2006 fiscal year, including the effect of accruing for expected forfeitures on outstanding share-based awards, was not material to the firm’s results of operations for that quarter.
       Second, SFAS No. 123-R requires the immediate expensing of share-based awards granted to retirement-eligible employees, including awards subject to non-compete agreements. Share-based awards granted to retirement-eligible employees prior to the adoption of SFAS No. 123-R must continue to be amortized over the stated service period of the award (and accelerated if the employee actually retires). Consequently, the firm’s compensation and benefits expenses in fiscal 2006 (and, to a lesser extent, in fiscal 2007 and fiscal 2008) will include both the amortization (and acceleration) of awards granted to retirement-eligible employees prior to the adoption of SFAS No. 123-R as well as the full grant-date fair value of new awards granted to such employees under SFAS No. 123-R. The estimated annual non-cash expense in fiscal 2006 associated with the continued amortization of share-based awards granted to retirement-eligible employees prior to the adoption of SFAS No. 123-R is approximately $650 million, of which $133 million and $508 million were recognized in the three and nine months ended August 2006, respectively.
       The firm began to account for share-based awards in accordance with the fair value method prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” in 2003. Share-based employee awards granted for the year ended November 29, 2002 and prior years were accounted for under the intrinsic-value-based method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees,” as permitted by SFAS No. 123. Therefore, no compensation expense was recognized for unmodified stock options issued for years prior to fiscal 2003 that had no intrinsic value on the date of grant.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       If the firm were to recognize compensation expense over the relevant service period, generally three years, under the fair value method per SFAS No. 123 with respect to stock options granted for the year ended November 29, 2002 and prior years, net earnings would have decreased for the three and nine months ended August 2005, resulting in pro forma net earnings and earnings per common share (EPS) as set forth below:
                   
    Three Months Ended   Nine Months Ended
    August 2005   August 2005
         
    (in millions, except per share amounts)
Net earnings applicable to common shareholders, as reported
  $ 1,608     $ 3,985  
Add:       Share-based compensation expense, net of related tax
               effects, included in reported net earnings
    144       415  
Deduct:  Share-based compensation expense, net of related tax
               effects, determined under the fair value method for all
               awards
    (156 )     (451 )
                 
Pro forma net earnings applicable to common shareholders
  $ 1,596     $ 3,949  
                 
Earnings per common share, as reported
               
 
Basic
  $ 3.40     $ 8.23  
 
Diluted
    3.25       7.89  
Pro forma earnings per common share
               
 
Basic
  $ 3.37     $ 8.15  
 
Diluted
    3.23       7.82  
       The firm pays cash dividend equivalents on outstanding restricted stock units. Dividend equivalents paid on restricted stock units accounted for under SFAS No. 123 and SFAS No. 123-R are charged to retained earnings when paid. SFAS No. 123-R requires dividend equivalents paid on restricted stock units expected to be forfeited to be included in compensation expense. Prior to the adoption of SFAS No. 123-R, dividend equivalents paid on restricted stock units that were later forfeited by employees were reclassified to compensation expense from retained earnings. Dividend equivalents paid on restricted stock units granted prior to 2003 were accounted for under APB Opinion No. 25 and charged to compensation expense.
       Prior to the adoption of SFAS No. 123-R, the firm presented all tax benefits resulting from share-based compensation as cash flows from operating activities in the condensed consolidated statements of cash flows. SFAS No. 123-R requires cash flows resulting from tax deductions in excess of the grant-date fair value of share-based awards to be included in cash flows from financing activities.
  Goodwill
       Goodwill is the cost of acquired companies in excess of the fair value of identifiable net assets at acquisition date. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is tested at least annually for impairment. An impairment loss is triggered if the estimated fair value of an operating segment is less than its estimated net book value. Such loss is calculated as the difference between the estimated fair value of goodwill and its carrying value.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Identifiable Intangible Assets
       Identifiable intangible assets, which consist primarily of customer lists, above-market power contracts, specialist rights and the value of business acquired (VOBA) and deferred acquisition costs (DAC) in the firm’s insurance subsidiaries, are amortized over their estimated useful lives. Identifiable intangible assets are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
  Property, Leasehold Improvements and Equipment
       Property, leasehold improvements and equipment, net of accumulated depreciation and amortization, are included in “Other assets” in the condensed consolidated statements of financial condition.
       Property and equipment placed in service prior to December 1, 2001 are depreciated under the accelerated cost recovery method. Property and equipment placed in service on or after December 1, 2001 are depreciated on a straight-line basis over the useful life of the asset. Leasehold improvements for which the useful life of the improvement is shorter than the term of the lease are amortized under the accelerated cost recovery method if placed in service prior to December 1, 2001. All other leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter. Certain costs of software developed or obtained for internal use are capitalized and amortized on a straight-line basis over the useful life of the software.
       Property, leasehold improvements and equipment are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the expected undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
       The firm’s operating leases include space held in excess of current requirements. Rent expense relating to space held for growth is included in “Occupancy” in the condensed consolidated statements of earnings. In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” the firm records a liability, based on the remaining lease rentals reduced by any potential or existing sublease rentals, for leases where the firm has ceased using the space and management has concluded that the firm will not derive any future economic benefits. Costs to terminate a lease before the end of its term are recognized and measured at fair value upon termination.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Foreign Currency Translation
       Assets and liabilities denominated in non-U.S. currencies are translated at rates of exchange prevailing on the date of the condensed consolidated statement of financial condition, and revenues and expenses are translated at average rates of exchange for the fiscal period. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, on the condensed consolidated statements of comprehensive income. The firm seeks to reduce its net investment exposure to fluctuations in foreign exchange rates through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts, hedge effectiveness is assessed based on changes in forward exchange rates; accordingly, forward points are reflected as a component of the currency translation adjustment in the condensed consolidated statements of comprehensive income. For foreign currency-denominated debt, hedge effectiveness is assessed based on changes in spot rates. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are included in the condensed consolidated statements of earnings.
  Income Taxes
       Deferred tax assets and liabilities are recognized for temporary differences between the financial reporting and tax bases of the firm’s assets and liabilities. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. The firm’s tax assets and liabilities are presented as a component of “Other assets” and “Other liabilities and accrued expenses,” respectively, in the condensed consolidated statements of financial condition. Tax provisions are computed in accordance with SFAS No. 109, “Accounting for Income Taxes.” Contingent liabilities related to income taxes are recorded when the criteria for loss recognition under SFAS No. 5, “Accounting for Contingencies,” as amended, have been met (see “— Recent Accounting Developments” below for a discussion of the impact of FIN No. 48 on SFAS No. 109).
  Earnings Per Common Share
       Basic EPS is calculated by dividing net earnings applicable to common shareholders by the weighted average number of common shares outstanding. Common shares outstanding includes common stock and restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable pursuant to stock options and to restricted stock units for which future service is required as a condition to the delivery of the underlying common stock.
  Cash and Cash Equivalents
       The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Recent Accounting Developments
       In June 2005, the EITF reached consensus on Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” which requires general partners (or managing members in the case of limited liability companies) to consolidate their partnerships or to provide limited partners with rights to remove the general partner or to terminate the partnership. The firm, as the general partner of numerous merchant banking and asset management partnerships, is required to adopt the provisions of EITF Issue No. 04-5 (i) immediately for partnerships formed or modified after June 29, 2005 and (ii) in the first quarter of fiscal 2007 for partnerships formed on or before June 29, 2005 that have not been modified. The firm generally expects to provide limited partners in these funds with rights to remove the firm as the general partner or to terminate the partnerships and, therefore, does not expect that EITF Issue No. 04-5 will have a material effect on the firm’s financial condition, results of operations or cash flows.
       In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140.” SFAS No. 155 permits an entity to measure at fair value any financial instrument that contains an embedded derivative that otherwise would require bifurcation. As permitted, the firm early adopted SFAS No. 155 in the first quarter of fiscal 2006. Adoption did not have a material effect on the firm’s financial condition, results of operations or cash flows.
       Effective for the first quarter of fiscal 2006, the firm adopted SFAS No. 156, “Accounting for Servicing of Financial Assets — an amendment of FASB Statement No. 140,” which permits entities to elect to measure servicing assets and servicing liabilities at fair value and report changes in fair value in earnings. The firm acquires residential mortgage servicing rights in connection with its mortgage securitization activities and has elected under SFAS No. 156 to account for these servicing rights at fair value. Adoption did not have a material effect on the firm’s financial condition, results of operations or cash flows.
       In April 2006, the FASB issued FASB Staff Position (FSP) FIN No. 46-R-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46-R.” This FSP addresses how a reporting enterprise should determine the variability to be considered in applying FIN No. 46-R by requiring an analysis of the purpose for which an entity was created and the variability that the entity was designed to create. This FSP must be applied prospectively to all entities with which a reporting enterprise first becomes involved and to all entities previously required to be analyzed under FIN No. 46-R when a reconsideration event has occurred. As permitted, the firm early adopted FSP FIN No. 46-R-6 in the third quarter of fiscal 2006. Adoption did not have a material effect on the firm’s financial condition, results of operations or cash flows.
       In June 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109.” FIN No. 48 requires that the firm determine whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets this recognition threshold, the position is measured to determine the amount of benefit to be recognized in the financial statements. The firm expects to adopt the provisions of FIN No. 48 beginning in the first quarter of fiscal 2008. The firm is currently evaluating the impact of adopting FIN No. 48 on its financial condition, results of operations and cash flows.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies that fair value is the amount that would be exchanged to sell an asset or transfer a liability, in an orderly transaction between market participants. SFAS No. 157 nullifies the consensus reached in EITF Issue No. 02-3 prohibiting the recognition of day one gain or loss on derivative contracts (and hybrid instruments measured at fair value under SFAS No. 133 as modified by SFAS No. 155) where the firm cannot verify all of the significant model inputs to observable market data and verify the model to market transactions. However, SFAS No. 157 requires that a fair value measurement technique include an adjustment for risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model, if market participants would also include such an adjustment. In addition, SFAS No. 157 prohibits the recognition of “block discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available in an active market. The provisions of SFAS No. 157 are to be applied prospectively, except for changes in fair value measurements that result from the initial application of SFAS No. 157 to existing derivative financial instruments measured under EITF Issue No. 02-3, existing hybrid instruments measured at fair value, and block discounts, which are to be recorded as an adjustment to opening retained earnings in the year of adoption. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The firm is evaluating whether it will early adopt SFAS No. 157 as of the first quarter of fiscal 2007 as permitted, and is currently evaluating the impact adoption may have on its financial condition, results of operations and cash flows.
       In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132-R.” SFAS No. 158 requires an entity to recognize in its statement of financial condition the funded status of its defined benefit postretirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation. SFAS No. 158 also requires an entity to recognize changes in the funded status of a defined benefit postretirement plan within accumulated other comprehensive income, net of tax, to the extent such changes are not recognized in earnings as components of periodic net benefit cost. SFAS No. 158 is effective as of the end of the fiscal year ending after December 15, 2006. The firm will adopt SFAS No. 158 as of the end of fiscal 2007. The firm does not expect that the adoption of SFAS No. 158 will have a material effect on the firm’s financial condition, results of operations or cash flows.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 3. Financial Instruments
  Fair Value of Financial Instruments
       The following table sets forth the firm’s financial instruments owned, at fair value, including those pledged as collateral, and financial instruments sold, but not yet purchased, at fair value:
                                   
    As of
     
    August 2006   November 2005
         
    Assets   Liabilities   Assets   Liabilities
                 
    (in millions)
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 10,641   (1)   $     $ 14,609   (1)   $  
U.S. government, federal agency and sovereign obligations
    67,436       57,720       68,688       51,458  
Corporate and other debt obligations
                               
 
Mortgage whole loans and collateralized debt obligations
    36,507       507       31,459       223  
 
Investment-grade corporate bonds
    17,515       4,326       12,415       4,232  
 
Bank loans
    27,254       722       13,843       288  
 
High-yield securities
    8,318       2,125       8,822       2,072  
 
Preferred stock
    7,631       395       7,315       71  
 
Other
    1,187       356       877       278  
                                 
      98,412       8,431       74,731       7,164  
Equities and convertible debentures
    66,826       32,457       56,656       32,565  
State, municipal and provincial obligations
    3,550             2,524        
Derivative contracts
    60,181   (2)     57,196   (3)     58,532   (2)     57,829   (3)
Physical commodities
    2,128       753       1,286       55  
                                 
Total
  $ 309,174   (4)   $ 156,557     $ 277,026     $ 149,071  
                                 
 
 
  (1)  Includes $7.28 billion and $6.12 billion, as of August 2006 and November 2005, respectively, of money market instruments held by William Street Funding Corporation to support the William Street credit extension program.
 
  (2)  Net of cash received pursuant to credit support agreements of $22.24 billion and $22.61 billion as of August 2006 and November 2005, respectively.
 
  (3)  Net of cash paid pursuant to credit support agreements of $17.27 billion and $16.10 billion as of August 2006 and November 2005, respectively.
 
  (4)  Includes securities held by the firm’s bank and insurance subsidiaries, which are accounted for as “available-for-sale” (AFS) under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The following table sets forth the types of AFS securities and their maturity profile:
                                         
    Under           Over    
    One Year   1-5 Years   6-10 Years   10 Years   Total
                     
    (in millions)
Mortgage-backed and other federal agency securities
  $ 826     $ 794     $ 146     $ 7     $ 1,773  
Investment-grade corporate bonds
    50       564       66       52       732  
Collateralized debt obligations
    7       645       20             672  
Other investment-grade debt securities
    42       8       58       111       219  
                                         
Total
  $ 925     $ 2,011     $ 290     $ 170     $ 3,396  
                                         

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

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
all hedges are generally included in “Interest expense.” These gains or losses and the component of gains or losses on derivative transactions excluded from the assessment of hedge effectiveness (e.g., the effect of the passage of time on fair value hedges of the firm’s borrowings) were not material to the firm’s results of operations for the three and nine months ended August 2006. Gains and losses on derivatives used for trading purposes are generally included in “Trading and principal investments” in the condensed consolidated statements of earnings.
       Fair values of the firm’s derivative contracts are reflected net of cash paid or received pursuant to credit support agreements and are reported on a net-by-counterparty basis in the firm’s condensed consolidated statements of financial condition when management believes a legal right of setoff exists under an enforceable netting agreement. The fair value of derivative financial instruments, computed in accordance with the firm’s netting policy, is set forth below:
                                 
    As of
     
    August 2006   November 2005
         
    Assets   Liabilities   Assets   Liabilities
                 
    (in millions)
Forward settlement contracts
  $ 10,779     $ 11,373     $ 13,921     $ 15,345  
Swap agreements
    25,652       20,902       25,865       22,001  
Option contracts
    23,750       24,921       18,746       20,483  
                                 
Total
  $ 60,181     $ 57,196     $ 58,532     $ 57,829  
                                 
       The fair values of derivatives accounted for as qualifying hedges under SFAS No. 133 consisted of $1.69 billion and $2.10 billion in assets as of August 2006 and November 2005, respectively, and $991 million and $443 million in liabilities as of August 2006 and November 2005, respectively.
       The firm also has embedded derivatives that have been bifurcated from related borrowings under SFAS No. 133. Such derivatives, which are classified in short-term and long-term borrowings, had a carrying value of $1.18 billion and $607 million (excluding the debt host contract) as of August 2006 and November 2005, respectively. See Notes 4 and 5 for further information regarding the firm’s borrowings.
  Securitization Activities
       The firm securitizes commercial and residential mortgages, home equity and auto loans, government and corporate bonds and other types of financial assets. The firm acts as underwriter of the beneficial interests that are sold to investors. The firm derecognizes financial assets transferred in securitizations provided it has relinquished control over such assets. Transferred assets are accounted for at fair value prior to securitization. Net revenues related to these underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.
       The firm may retain interests in securitized financial assets, primarily in the form of senior or subordinated securities, including residual interests. Retained interests are accounted for at fair value and included in “Total financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.
       During the nine months ended August 2006 and August 2005, the firm securitized $78.77 billion and $65.10 billion, respectively, of financial assets, including $55.20 billion and $45.39 billion, respectively, of residential mortgage loans and securities. Cash flows received on

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
retained interests were approximately $613 million and $655 million for the nine months ended August 2006 and August 2005, respectively.
       As of August 2006 and November 2005, the firm held $8.28 billion and $6.07 billion of retained interests, respectively, including $6.26 billion and $5.62 billion, respectively, held in QSPEs. The fair value of retained interests valued using quoted market prices in active markets was $1.27 billion and $1.34 billion as of August 2006 and November 2005, respectively.
       The following table sets forth the weighted average key economic assumptions used in measuring retained interests for which fair value is based on alternative pricing sources with reasonable, little or no price transparency and the sensitivity of those fair values to immediate adverse changes of 10% and 20% in those assumptions:
                                                   
    As of August 2006   As of November 2005
         
    Type of Retained Interests   Type of Retained Interests
         
    Mortgage-       Corporate   Mortgage-       Corporate
    Backed   CDOs   Debt (3)   Backed   CDOs   Debt (3)
                         
    ($ in millions)
Fair value of retained interests
  $ 3,841     $ 2,101     $ 1,071     $ 2,928     $ 516     $ 1,283  
Weighted average life (years)
    6.6       5.2       2.4       5.7       4.9       2.2  
Constant prepayment rate
    19.1 %     24.7 %     N/A %     18.6 %     21.5 %     N/A %
 
Impact of 10% adverse change
  $ (90 )   $ (4 )   $     $ (44 )   $ (2 )   $  
 
Impact of 20% adverse change
    (162 )     (7 )           (73 )     (4 )      
Anticipated credit losses (1)
    3.7 %     2.1 %     N/A %     5.0 %     2.5 %     N/A %
 
Impact of 10% adverse change (2)
  $ (92 )   $ (3 )   $     $ (25 )   $ (4 )   $  
 
Impact of 20% adverse change (2)
    (172 )     (5 )           (48 )     (9 )      
Discount rate
    8.8 %     5.8 %     2.3 %     7.4 %     6.1 %     3.7 %
 
Impact of 10% adverse change
  $ (137 )   $ (40 )   $ (9 )   $ (70 )   $ (3 )   $ (10 )
 
Impact of 20% adverse change
    (263 )     (80 )     (18 )     (136 )     (8 )     (21 )

 
(1)  Anticipated credit losses are computed only on positions in which expected credit loss is a key assumption in the determination of fair values.
 
(2)  The impacts of adverse change take into account credit mitigants incorporated in the retained interests, including over- collateralization and subordination provisions.
 
(3)  Includes retained interests in bonds and other types of financial assets that are not subject to prepayment risk.
       The preceding table does not give effect to the offsetting benefit of other financial instruments that are held to mitigate risks inherent in these retained interests. Changes in fair value based on an adverse variation in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value is not usually linear. In addition, the impact of a change in a particular assumption is calculated independently of changes in any other assumption. In practice, simultaneous changes in assumptions might magnify or counteract the sensitivities disclosed above.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       In addition to the retained interests described above, the firm also held interests in residential mortgage QSPEs purchased in connection with secondary market-making activities. These purchased interests approximated $7 billion and $5 billion as of August 2006 and November 2005, respectively.
  Variable Interest Entities (VIEs)
       The firm, in the ordinary course of business, retains interests in VIEs in connection with its securitization activities. The firm also purchases and sells variable interests in VIEs, which primarily issue mortgage-backed and other asset-backed securities and collateralized debt obligations (CDOs), in connection with its market-making activities and makes investments in and loans to VIEs that hold performing and nonperforming debt, equity, real estate, power-related and other assets. In addition, the firm utilizes VIEs to provide investors with credit-linked and asset-repackaged notes designed to meet their objectives.
       VIEs generally purchase assets by issuing debt and equity instruments. In certain instances, the firm provides guarantees to VIEs or holders of variable interests in VIEs. In such cases, the maximum exposure to loss included in the tables set forth below is the notional amount of such guarantees. Such amounts do not represent anticipated losses in connection with these guarantees.
       The firm’s variable interests in VIEs include senior and subordinated debt; limited and general partnership interests; preferred and common stock; interest rate, foreign currency, equity, commodity and credit derivatives; guarantees; and residual interests in mortgage-backed and asset-backed securitization vehicles and CDOs. The firm’s exposure to the obligations of VIEs is generally limited to its interests in these entities.
       The following table sets forth the firm’s total assets and maximum exposure to loss associated with its significant variable interests in consolidated VIEs where the firm does not hold a majority voting interest. The firm has aggregated consolidated VIEs based on principal business activity, as reflected in the first column.
                                 
    As of August 2006   As of November 2005
         
        Maximum       Maximum
    VIE   Exposure   VIE   Exposure
    Assets (1)   to Loss   Assets (1)   to Loss
                 
    (in millions)
Investments in loans and real estate
  $ 1,788     $ 637     $ 2,081     $ 717  
Municipal bonds
    2,568       2,568       1,587       1,587  
Mortgage-backed and other asset-backed
    457       117       522       55  
Asset repackagings and credit-linked notes
    1,246       929       1,266       880  
Investments in preferred stock
    425       244       416       221  
Foreign exchange and commodities
    554       412       600       205  
Other
    150       286       152       279  
                                 
Total
  $ 7,188     $ 5,193     $ 6,624     $ 3,944  
                                 
 
 
  (1)  Consolidated VIE assets include assets financed by nonrecourse short-term and long-term debt. Nonrecourse debt is debt that only the issuing subsidiary or, if applicable, a subsidiary guaranteeing the debt is obligated to repay.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       The following tables set forth total assets in nonconsolidated VIEs in which the firm holds significant variable interests and the firm’s maximum exposure to loss associated with these interests. The firm has aggregated nonconsolidated VIEs based on principal business activity, as reflected in the first column. The nature of the firm’s variable interests can take different forms, as described in the columns under maximum exposure to loss.
                                                 
     As of August 2006
         
        Maximum Exposure to Loss in Nonconsolidated VIEs
         
        Purchased   Commitments    
    VIE   and Retained   and       Loans and    
    Assets   Interests   Guarantees   Derivatives (1)   Investments   Total
                         
            (in millions)        
Collateralized debt obligations
  $ 40,916     $ 2,170     $     $ 9,439     $     $ 11,609  
Asset repackagings and credit-linked notes
    4,778                   3,237             3,237  
Power-related
    3,398       2       73             618       693  
Investments in loans and real estate
    14,086             34       15       1,658       1,707  
Mortgage-backed and other asset-backed
    4,714       62       1,256       63       260       1,641  
                                                 
Total
  $ 67,892     $ 2,234     $ 1,363     $ 12,754     $ 2,536     $ 18,887  
                                                 
 
     As of November 2005
         
        Maximum Exposure to Loss in Nonconsolidated VIEs
         
        Purchased   Commitments    
    VIE   and Retained   and       Loans and    
    Assets   Interests   Guarantees   Derivatives (1)   Investments   Total
                         
            (in millions)        
Collateralized debt obligations
  $ 24,295     $ 780     $     $ 4,536     $     $ 5,316  
Asset repackagings and credit-linked notes
    2,568                   1,527             1,527  
Power-related
    6,667       2       95             1,070       1,167  
Investments in loans and real estate
    14,232             11             1,082       1,093  
Mortgage-backed and other asset-backed
    6,378       208       248       52       426       934  
                                                 
Total
  $ 54,140     $ 990     $ 354     $ 6,115     $ 2,578     $ 10,037  
                                                 
 
 
  (1)  Derivatives related to CDOs consist of total return swaps on investment-grade securities issued by VIEs as well as out-of-the-money written put options that provide protection on investment-grade collateral held by VIEs. Derivatives related to asset repackagings and credit-linked notes consist of out-of-the-money written put options that provide principal protection on notes issued by VIEs. Neither the total return swaps nor the written put options expose the firm to a majority of the VIE’s expected losses or expected residual returns.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Secured Borrowing and Lending Activities
       The firm obtains secured short-term financing principally through the use of repurchase agreements, securities lending agreements and other financings. In these transactions, the firm receives cash or financial instruments in exchange for other financial instruments, including U.S. government, federal agency and sovereign obligations, corporate debt and other debt obligations, equities and convertibles, letters of credit and other assets.
       The firm obtains financial instruments as collateral principally through the use of resale agreements, securities borrowing agreements, derivative transactions, customer margin loans and other secured borrowing activities to finance inventory positions, to meet customer needs and to satisfy settlement requirements. In many cases, the firm is permitted to sell or repledge financial instruments held as collateral. These financial instruments may be used to secure repurchase agreements, to enter into securities lending or derivative transactions, or to cover short positions. As of August 2006 and November 2005, the fair value of financial instruments received as collateral by the firm that it was permitted to sell or repledge was $691.85 billion and $629.94 billion, respectively, of which the firm sold or repledged $585.06 billion and $550.33 billion, respectively.
       The firm also pledges financial instruments it owns. Counterparties may or may not have the right to sell or repledge the financial instruments. Financial instruments owned and pledged to counterparties that have the right to sell or repledge are reported as “Financial instruments owned and pledged as collateral, at fair value” in the condensed consolidated statements of financial condition and were $39.94 billion and $38.98 billion as of August 2006 and November 2005, respectively. Financial instruments owned and pledged in connection with repurchase and securities lending agreements to counterparties that did not have the right to sell or repledge are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition and were $83.71 billion and $93.90 billion as of August 2006 and November 2005, respectively.
       In addition to repurchase and securities lending agreements, the firm also pledges financial instruments and other assets it owns to counterparties that do not have the right to sell or repledge, in order to collateralize secured short-term and long-term borrowings. In connection with these transactions, the firm pledged assets of $45.08 billion and $27.84 billion as collateral as of August 2006 and November 2005, respectively. See Note 4 and Note 5 for further information regarding the firm’s secured short-term and long-term borrowings.
Note 4. Short-Term Borrowings
       The firm obtains short-term borrowings primarily through the use of promissory notes, commercial paper, secured debt and bank loans. As of August 2006 and November 2005, secured short-term borrowings were $18.85 billion and $7.97 billion, respectively. Unsecured short-term borrowings were $53.81 billion and $47.25 billion as of August 2006 and November 2005, respectively. Short-term borrowings also include the portion of long-term borrowings maturing within one year of the financial statement date and certain long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder. The carrying value of these short-term obligations approximates fair value due to their short-term nature.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       Short-term borrowings are set forth below:
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
Promissory notes
  $ 18,277     $ 17,339  
Commercial paper
    2,437       5,154  
Secured debt, bank loans and other
    35,586       15,975  
Current portion of secured and unsecured long-term borrowings
    16,364       16,751  
                 
Total (1) (2)
  $ 72,664     $ 55,219  
                 
 
 
  (1)  As of August 2006 and November 2005, the weighted average interest rates for short-term borrowings, including commercial paper, were 5.04% and 3.98%, respectively. The weighted average interest rates, after giving effect to hedging activities, were 4.97% and 3.86% as of August 2006 and November 2005, respectively.
 
  (2)  Short-term borrowings as of August 2006 include $8.38 billion of hybrid financial instruments accounted for at fair value under SFAS No. 155.
Note 5. Long-Term Borrowings
       The firm obtains secured and unsecured long-term borrowings, which consist principally of senior borrowings with maturities extending to 2036. As of August 2006 and November 2005, secured long-term borrowings were $19.55 billion and $15.67 billion, respectively. Unsecured long-term borrowings were $109.78 billion and $84.34 billion as of August 2006 and November 2005, respectively.
       Long-term borrowings are set forth below:
                   
    As of
     
    August   November
    2006   2005
         
    (in millions)
Fixed rate obligations (1)
               
 
U.S. dollar
  $ 38,866     $ 35,530  
 
Non-U.S. dollar
    20,427       16,224  
Floating rate obligations (2)
               
 
U.S. dollar
    44,473       31,952  
 
Non-U.S. dollar
    25,565       16,301  
                 
Total (3)
  $ 129,331     $ 100,007  
                 
 
 
  (1)  As of August 2006 and November 2005, interest rates on U.S. dollar fixed rate obligations ranged from 3.88% to 12.00% and from 3.72% to 12.00%, respectively. As of August 2006 and November 2005, interest rates on non-U.S. dollar fixed rate obligations ranged from 0.31% to 10.00% and from 0.65% to 8.88%, respectively.
 
  (2)  Floating interest rates generally are based on LIBOR or the federal funds rate. Certain equity-linked and indexed instruments are included in floating rate obligations.
 
  (3)  Long-term borrowings as of August 2006 include $5.51 billion of hybrid financial instruments accounted for at fair value under SFAS No. 155.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       Long-term borrowings include nonrecourse debt issued by the following subsidiaries, as set forth in the table below. Nonrecourse debt is debt that only the issuing subsidiary or, if applicable, a subsidiary guaranteeing the debt is obligated to repay.
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
William Street Funding Corporation
  $ 6,225     $ 5,107  
Variable interest entities
    6,131       5,568  
Other subsidiaries
    4,055       2,951  
                 
Total (1)
  $ 16,411     $ 13,626  
                 
 
 
  (1)  Includes $1.10 billion and $1.33 billion of nonrecourse debt related to the firm’s consolidated power generation facilities as of August 2006 and November 2005, respectively.
       Long-term borrowings by fiscal maturity date are set forth below:
                                                 
    As of
     
    August 2006 (1) (2)   November 2005 (1) (2)
         
    U.S.   Non-U.S.       U.S.   Non-U.S.    
    Dollar   Dollar   Total   Dollar   Dollar   Total
                         
    (in millions)
2007
  $ 7,058     $ 72     $ 7,130     $ 13,662     $ 861     $ 14,523  
2008
    10,310       2,778       13,088       6,218       2,872       9,090  
2009
    12,031       3,446       15,477       9,241       3,094       12,335  
2010
    6,200       6,163       12,363       6,411       7,698       14,109  
2011
    7,071       5,894       12,965       4,840       1,430       6,270  
2012-thereafter
    40,669       27,639       68,308       27,110       16,570       43,680  
                                                 
Total
  $ 83,339     $ 45,992     $ 129,331     $ 67,482     $ 32,525     $ 100,007  
                                                 
 
 
  (1)  Long-term borrowings maturing within one year of the financial statement date and certain long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder are included as short-term borrowings in the condensed consolidated statements of financial condition.
 
  (2)  Long-term borrowings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates. Long-term borrowings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
       The firm enters into derivative contracts, such as interest rate futures contracts, interest rate swap agreements, currency swap agreements, equity-linked and indexed contracts, to effectively convert a substantial portion of its long-term borrowings into U.S. dollar-based floating rate obligations. Accordingly, the aggregate carrying value of these long-term borrowings and related derivatives approximates fair value.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
The effective weighted average interest rates for long-term borrowings are set forth below:
                                 
    As of
     
    August 2006   November 2005
         
    Amount   Rate   Amount   Rate
                 
    ($ in millions)
Fixed rate obligations
  $ 2,671       5.94 %   $ 3,468       5.48 %
Floating rate obligations (1)
    126,660       5.56       96,539       4.31  
                             
Total
  $ 129,331       5.57     $ 100,007       4.35  
                             
 
 
  (1)  Includes fixed rate obligations that have been converted into floating rate obligations through derivative contracts.
  Subordinated Borrowings
       Long-term borrowings include $1.50 billion of subordinated notes as of August 2006 and $2.84 billion of junior subordinated debentures as of August 2006 and November 2005.
       Subordinated Notes. The firm issued $1.50 billion of subordinated notes in its second quarter of fiscal 2006. The firm pays interest semiannually on these notes at an annual rate of 6.45% and the notes mature on May 1, 2036. These notes are junior in right of payment to all of the firm’s senior indebtedness.
       Junior Subordinated Debentures. The firm issued $2.84 billion of junior subordinated debentures in its first quarter of fiscal 2004 to Goldman Sachs Capital Trust I (the Trust), a Delaware statutory trust created for the exclusive purposes of (i) issuing $2.75 billion of guaranteed preferred beneficial interests and $85 million of common beneficial interests in the Trust, (ii) investing the proceeds from the sale to purchase junior subordinated debentures issued by the firm and (iii) engaging in only those other activities necessary or incidental to these purposes. The preferred beneficial interests were purchased by third parties, and, as of August 2006 and November 2005, the firm held all the common beneficial interests. The Trust is a wholly owned finance subsidiary of the firm for regulatory and legal purposes but is not consolidated for accounting purposes.
       The firm pays interest semiannually on these debentures at an annual rate of 6.345% and the debentures mature on February 15, 2034. The coupon rate and the payment dates applicable to the beneficial interests are the same as the interest rate and payment dates applicable to the debentures. The firm has the right, from time to time, to defer payment of interest on the debentures, and, therefore, cause payment on the Trust’s preferred beneficial interests to be deferred, in each case up to ten consecutive semiannual periods. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common stock. The Trust is not permitted to pay any distributions on the common beneficial interests held by the firm unless all dividends payable on the preferred beneficial interests have been paid in full. These notes are junior in right of payment to all of the firm’s senior indebtedness and all of the firm’s subordinated notes (described above). See Note 6 for information regarding the firm’s guarantee of the preferred beneficial interests issued by the Trust.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 6. Commitments, Contingencies and Guarantees
  Commitments
       Forward Secured Financings. The firm had commitments to enter into forward secured financing transactions, including certain repurchase and resale agreements and secured borrowing and lending arrangements, of $53.31 billion and $49.93 billion as of August 2006 and November 2005, respectively.
       Commitments to Extend Credit. In connection with its lending activities, the firm had outstanding commitments to extend credit of $70.20 billion and $61.12 billion as of August 2006 and November 2005, respectively. The firm’s commitments to extend credit are agreements to lend to counterparties that have fixed termination dates and are contingent on the satisfaction of all conditions to borrowing set forth in the contract. Since these commitments may expire unused, the total commitment amount does not necessarily reflect the actual future cash flow requirements. The firm accounts for these commitments at fair value.
       The following table summarizes the firm’s commitments to extend credit at August 2006 and November 2005:
Commitments to Extend Credit
                   
    As of
     
    August   November
    2006   2005
         
    (in millions)
William Street program
  $ 17,958     $ 14,505  
Other commercial lending commitments
               
 
Investment-grade
    11,901       17,592  
 
Non-investment-grade
    24,978       18,536  
Warehouse financing
    15,364       10,489  
                 
Total commitments to extend credit
  $ 70,201     $ 61,122  
                 
  •  William Street program. Substantially all of the commitments provided under the William Street credit extension program are to investment-grade corporate borrowers. Commitments under the William Street credit extension program are issued by William Street Commitment Corporation (Commitment Corp.), a consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are legally separated from other assets and liabilities of the firm, and also by other subsidiaries of Group Inc. William Street Funding Corporation (Funding Corp.), another consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are legally separated from other assets and liabilities of the firm, was formed to raise funding to support the William Street credit extension program. The assets of Commitment Corp. and of Funding Corp. will not be available to their respective shareholders until the claims of their respective creditors have been paid. In addition, no affiliate of either Commitment Corp. or Funding Corp., except in limited cases as expressly agreed in writing, is responsible for any obligation of either entity. With respect to these commitments, the firm has credit loss protection provided to it by SMFG, which is generally limited to 95% of the first loss the firm realizes on approved loan commitments, subject to a maximum of $1.00 billion. In addition, subject to the satisfaction of certain conditions, upon the firm’s request, SMFG will provide protection for 70% of the second loss on such commitments,

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  subject to a maximum of $1.13 billion. The firm also uses other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG.
 
  •  Other commercial lending commitments. In addition to the commitments issued under the William Street credit extension program, the firm extends other credit commitments, primarily in connection with contingent acquisition financing and other types of corporate lending. As part of its ongoing credit origination activities, the firm may reduce its credit risk on commitments by syndicating all or substantial portions of commitments to other investors. In addition, commitments that are extended for contingent acquisition financing are often short-term in nature, as borrowers often replace them with other funding sources.
 
  •  Warehouse financing. The firm provides financing for the warehousing of financial assets to be securitized, primarily in connection with CDOs and mortgage securitizations. These financings are expected to be repaid from the proceeds of the related securitizations for which the firm may or may not act as underwriter. These arrangements are secured by the warehoused assets, primarily consisting of mortgage-backed and other asset-backed securities, residential and commercial mortgages and corporate debt instruments.
       Letters of Credit. The firm provides letters of credit issued by various banks to counterparties in lieu of securities or cash to satisfy various collateral and margin deposit requirements. Letters of credit outstanding were $6.40 billion and $9.23 billion as of August 2006 and November 2005, respectively.
       Merchant Banking Commitments. The firm acts as an investor in merchant banking transactions, which includes making long-term investments in equity and debt instruments in privately negotiated transactions, corporate acquisitions and real estate transactions. In connection with these activities, the firm had commitments to invest up to $4.56 billion and $3.54 billion in corporate and real estate investment funds as of August 2006 and November 2005, respectively.
       Construction-Related Commitments. As of August 2006 and November 2005, the firm had construction-related commitments of $1.62 billion and $579 million, respectively, including commitments of $1.26 billion and $481 million, respectively, related to the development of wind energy projects. Construction-related commitments also include outstanding commitments of $306 million and $47 million as of August 2006 and November 2005, respectively, related to the firm’s new world headquarters in New York City, which is expected to cost between $2.3 billion and $2.5 billion.
       Underwriting Commitments. As of August 2006, the firm had commitments to purchase $85 million of securities in connection with its underwriting activities. As of November 2005, the firm had no such commitments.
       Other. The firm had other purchase commitments of $828 million and $644 million as of August 2006 and November 2005, respectively.
       Leases. The firm has contractual obligations under long-term noncancelable lease agreements, principally for office space, expiring on various dates through 2069. Certain agreements

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
are subject to periodic escalation provisions for increases in real estate taxes and other charges. Future minimum rental payments, net of minimum sublease rentals, are set forth below:
           
    (in millions)
Minimum rental payments
       
 
Remainder of 2006
  $ 104  
 
2007
    575  
 
2008
    394  
 
2009
    373  
 
2010
    285  
 
2011-thereafter
    2,359  
         
Total
  $ 4,090  
         
  Contingencies
       The firm is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its businesses. Management believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the firm’s financial condition, but may be material to the firm’s operating results for any particular period, depending, in part, upon the operating results for such period. Given the inherent difficulty of predicting the outcome of the firm’s litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, the firm cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
       The firm is contingently liable to provide guaranteed mortality benefits in connection with its insurance business. The net amount at risk, representing guaranteed mortality benefits in force under annuity contracts in excess of contract holder account balances, was $1.55 billion as of August 2006. The average attained age of contract holders was 70 years as of August 2006.
  Guarantees
       The firm enters into various derivative contracts that meet the definition of a guarantee under FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Such derivative contracts include credit default and total return swaps, written equity and commodity put options, written currency contracts and interest rate caps, floors and swaptions. FIN No. 45 does not require disclosures about derivative contracts if such contracts may be cash settled and the firm has no basis to conclude it is probable that the counterparties held, at inception, the underlying instruments related to the derivative contracts. The firm has concluded that these conditions have been met for certain large, internationally active commercial and investment bank end users and certain other users. Accordingly, the firm has not included such contracts in the tables below.
       The firm, in its capacity as an agency lender, indemnifies most of its securities lending customers against losses incurred in the event that borrowers do not return securities and the collateral held is insufficient to cover the market value of the securities borrowed.
       In connection with the firm’s establishment of the Trust, Group Inc. effectively provided for the full and unconditional guarantee of the beneficial interests in the Trust held by third parties. Timely payment by Group Inc. of interest on the junior subordinated debentures and other amounts due and performance of its other obligations under the transaction documents will be sufficient to cover

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
payments due by the Trust on its beneficial interests. As a result, management believes that it is unlikely the firm will have to make payments related to the Trust other than those required under the junior subordinated debentures and in connection with certain expenses incurred by the Trust.
       In the ordinary course of business, the firm provides other financial guarantees of the obligations of third parties (e.g., letters of credit and other guarantees to enable clients to complete transactions and merchant banking fund-related guarantees). These guarantees represent obligations to make payments to beneficiaries if the guaranteed party fails to fulfill its obligation under a contractual arrangement with that beneficiary.
       The following tables set forth certain information about the firm’s derivative contracts that meet the definition of a guarantee and certain other guarantees as of August 2006 and November 2005:
                                                 
    As of August 2006
         
        Maximum Payout/ Notional Amount by Period of Expiration (5)
         
    Carrying   Remainder   2007-   2009-   2011-    
    Value   of 2006   2008   2010   Thereafter   Total
                         
        (in millions)
Derivatives (1) (2)
  $ 1,100     $ 218,807     $ 438,715     $ 329,366     $ 606,804     $ 1,593,692  
Securities lending indemnifications (3)
          16,050                         16,050  
Guarantees of trust preferred beneficial interest (4)
                349       349       6,850       7,548  
Other financial guarantees
    36       459       497       161       170       1,287  
 
    As of November 2005
         
        Maximum Payout/ Notional Amount by Period of Expiration (5)
         
    Carrying       2007-   2009-   2011-    
    Value   2006   2008   2010   Thereafter   Total
                         
        (in millions)
Derivatives (1) (2)
  $ 8,217     $ 356,131     $ 244,163     $ 259,332     $ 289,459     $ 1,149,085  
Securities lending indemnifications (3)
          16,324                         16,324  
Guarantees of trust preferred beneficial interest (4)
          174       349       349       6,851       7,723  
Other financial guarantees
    4       516       144       230       177       1,067  
 
 
  (1)  The carrying value excludes the effect of a legal right of setoff that may exist under an enforceable netting agreement.
 
  (2)  The carrying value consists of $8.03 billion of assets and $9.13 billion of liabilities as of August 2006 and $1.91 billion of assets and $10.13 billion of liabilities as of November 2005.
 
  (3)  Collateral held by the lenders in connection with securities lending indemnifications was $16.62 billion and $16.89 billion as of August 2006 and November 2005, respectively.
 
  (4)  Includes the guarantee of all payments scheduled to be made over the life of the Trust, which could be shortened in the event the firm redeemed the junior subordinated debentures issued to fund the Trust. See Note 5 for further information regarding the Trust.
 
  (5)  Such amounts do not represent the anticipated losses in connection with these contracts.
       In the ordinary course of business, the firm indemnifies and guarantees certain service providers, such as clearing and custody agents, trustees and administrators, against specified potential losses in connection with their acting as an agent of, or providing services to, the firm or its affiliates. The firm also indemnifies some clients against potential losses incurred in the event specified third-party service providers, including sub-custodians and third-party brokers, improperly

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
execute transactions. In addition, the firm is a member of payment, clearing and settlement networks as well as securities exchanges around the world that may require the firm to meet the obligations of such networks and exchanges in the event of member defaults. In connection with its prime brokerage and clearing businesses, the firm agrees to clear and settle on behalf of its clients the transactions entered into by them with other brokerage firms. The firm’s obligations in respect of such transactions are secured by the assets in the client’s account as well as any proceeds received from the transactions cleared and settled by the firm on behalf of the client. In connection with joint venture investments, the firm may issue loan guarantees under which it may be liable in the event of fraud, misappropriation, environmental liabilities and certain other matters involving the borrower. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these guarantees and indemnifications have been recognized in the condensed consolidated statements of financial condition as of August 2006 and November 2005.
       The firm provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. The firm may also provide indemnifications protecting against changes in or adverse application of certain U.S. tax laws in connection with ordinary-course transactions such as securities issuances, borrowings or derivatives. In addition, the firm may provide indemnifications to some counterparties to protect them in the event additional taxes are owed or payments are withheld, due either to a change in or an adverse application of certain non-U.S. tax laws. These indemnifications generally are standard contractual terms and are entered into in the ordinary course of business. Generally, there are no stated or notional amounts included in these indemnifications, and the contingencies triggering the obligation to indemnify are not expected to occur. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these arrangements have been recognized in the condensed consolidated statements of financial condition as of August 2006 and November 2005.
Note 7. Shareholders’ Equity
       On September 11, 2006, the Board of Directors of Group Inc. (the Board) declared a dividend of $0.35 per common share with respect to the firm’s third quarter of fiscal 2006 to be paid on November 20, 2006, to common shareholders of record on October 23, 2006.
       During the third quarter of fiscal 2006, the firm repurchased 3.8 million shares of its common stock at a total cost of $573 million. In the first nine months of fiscal 2006, the firm repurchased a total of 29.5 million shares of its common stock at a total cost of $4.17 billion. The average price paid per share for repurchased shares was $148.90 and $141.40 for the three and nine months ended August 2006, respectively. In addition, to satisfy minimum statutory employee tax withholding requirements related to the delivery of shares underlying restricted stock units, the firm cancelled 3.0 million restricted stock units with a total value of $375 million during the first nine months of fiscal 2006.
       On July 24, 2006, the firm issued an additional 20,000 shares of perpetual Floating Rate Non-Cumulative Preferred Stock, Series D.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       As of August 2006, the firm had 124,000 shares of perpetual non-cumulative preferred stock outstanding in four series as set forth in the following table:
Preferred Stock by Series
                                     
    Shares   Shares       Earliest   Redemption Value
Series   Issued   Authorized   Dividend Rate   Redemption Date   (in millions)
                     
  A       30,000       50,000     3 month LIBOR + 0.75%,
with floor of 3.75% per annum
  April 25, 2010   $ 750  
  B       32,000       50,000     6.20% per annum   October 31, 2010     800  
  C       8,000       25,000     3 month LIBOR + 0.75%,
with floor of 4% per annum
  October 31, 2010     200  
  D       54,000       60,000     3 month LIBOR + 0.67%,
with floor of 4% per annum
  May 24, 2011     1,350  
                                   
          124,000       185,000             $ 3,100  
                                   
       Each share of preferred stock has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option at a redemption price equal to $25,000 plus declared and unpaid dividends. Dividends on each series of preferred stock, if declared, are payable quarterly in arrears. The firm’s ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, its common stock is subject to certain restrictions in the event that the firm fails to pay or set aside full dividends on the preferred stock for the latest completed dividend period. All preferred stock also has a preference over the firm’s common stock upon liquidation.
       On September 11, 2006, the Board declared a dividend per preferred share of $395.85, $387.50, $395.85 and $390.74 for Series A, Series B, Series C and Series D preferred stock, respectively, to be paid on November 10, 2006 to preferred shareholders of record on October 26, 2006.
       The following table sets forth the firm’s accumulated other comprehensive income by type:
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
Currency translation adjustment, net of tax
  $ 14     $ (16 )
Minimum pension liability adjustment, net of tax
    (11 )     (11 )
Net gains/(losses) on cash flow hedges, net of tax
    (3 )     9  
Net unrealized gains on available-for-sale securities, net of tax
    13   (1)     18  
                 
Total accumulated other comprehensive income, net of tax
  $ 13     $  
                 
 
 
  (1)  Consists of net unrealized losses of $4 million on available-for-sale securities held by the firm’s bank and insurance subsidiaries and net unrealized gains of $17 million on available-for-sale securities held by investees accounted for under the equity method.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 8. Earnings Per Common Share
The computations of basic and diluted earnings per common share are set forth below:
                                   
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions, except per share amounts)
Numerator for basic and diluted EPS — net earnings applicable to common shareholders
  $ 1,555     $ 1,608     $ 6,294     $ 3,985  
                                 
Denominator for basic EPS — weighted average number of common shares
    449.4       473.3       452.1       484.3  
Effect of dilutive securities
                               
 
Restricted stock units
    14.4       10.4       12.9       9.2  
 
Stock options
    13.6       10.5       14.7       11.7  
                                 
Dilutive potential common shares
    28.0       20.9       27.6       20.9  
                                 
Denominator for diluted EPS — weighted average number of common shares and dilutive potential common shares (1)
    477.4       494.2       479.7       505.2  
                                 
Basic EPS
  $ 3.46     $ 3.40     $ 13.92     $ 8.23  
Diluted EPS
    3.26       3.25       13.12       7.89  
 
 
  (1)  The diluted EPS computations do not include the antidilutive effect of the following options:
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions)
Number of antidilutive options, end of period
          1             1  
                                 

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 9. Goodwill and Identifiable Intangible Assets
  Goodwill
       The following table sets forth the carrying value of the firm’s goodwill by operating segment, which is included in “Other assets” in the condensed consolidated statements of financial condition:
                   
    As of
     
    August   November
    2006   2005
         
    (in millions)
Investment Banking
               
 
Financial Advisory
  $     $  
 
Underwriting
    125       125  
Trading and Principal Investments
               
 
FICC
    155       91  
 
Equities (1)
    2,387       2,390  
 
Principal Investments
    22       1  
Asset Management and Securities Services
               
 
Asset Management (2)
    421       424  
 
Securities Services
    117       117  
                 
Total
  $ 3,227     $ 3,148  
                 
 
 
  (1)  Primarily related to SLK LLC (SLK).
 
  (2)  Primarily related to The Ayco Company, L.P. (Ayco).

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 Identifiable Intangible Assets
       The following table sets forth the gross carrying amount, accumulated amortization and net carrying amount of identifiable intangible assets:
                     
        As of
         
        August   November
        2006   2005
             
        (in millions)
Customer lists (1)
  Gross carrying amount   $ 1,034     $ 1,021  
    Accumulated amortization     (285 )     (244 )
                     
    Net carrying amount   $ 749     $ 777  
                     
 
Power contracts (2)
  Gross carrying amount   $ 754     $ 497  
    Accumulated amortization     (63 )     (16 )
                     
    Net carrying amount   $ 691     $ 481  
                     
 
New York Stock
  Gross carrying amount   $ 714     $ 714  
Exchange (NYSE)
  Accumulated amortization     (161 )     (134 )
                     
specialist rights
  Net carrying amount   $ 553     $ 580  
                     
 
Insurance-related
  Gross carrying amount   $ 406     $  
assets (3)
  Accumulated amortization     (24 )      
                     
    Net carrying amount   $ 382     $  
                     
 
Exchange-traded
  Gross carrying amount   $ 138     $ 138  
fund (ETF)
  Accumulated amortization     (31 )     (27 )
                     
specialist rights
  Net carrying amount   $ 107     $ 111  
                     
 
Other (4)
  Gross carrying amount   $ 348     $ 312  
    Accumulated amortization     (236 )     (206 )
                     
    Net carrying amount   $ 112     $ 106  
                     
 
Total
  Gross carrying amount   $ 3,394     $ 2,682  
    Accumulated amortization     (800 )     (627 )
                     
    Net carrying amount   $ 2,594     $ 2,055  
                     
 
 
  (1)  Primarily includes the firm’s clearance and execution and NASDAQ customer lists related to SLK and financial counseling customer lists related to Ayco.
 
  (2)  Primarily relates to above-market power contracts of consolidated power generation facilities related to Cogentrix Energy, Inc. and National Energy & Gas Transmission, Inc. (NEGT). Substantially all of these power contracts have been pledged as collateral to counterparties in connection with certain of the firm’s secured short-term and long-term borrowings. The weighted average remaining life of these power contracts is approximately 11 years.
 
  (3)  Consists of VOBA and DAC. VOBA represents the present value of estimated future gross profits of the variable annuity and variable life insurance business acquired in fiscal 2006. DAC represents commissions paid by the firm in connection with providing reinsurance. VOBA and DAC are amortized over the estimated life of the underlying contracts based on estimated gross profits, and amortization is adjusted based on actual experience. The weighted average remaining amortization period for VOBA and DAC is six years as of the end of the third quarter.
 
  (4)  Primarily includes technology-related and other assets related to SLK.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       Substantially all of the firm’s identifiable intangible assets are considered to have finite lives and are amortized over their estimated useful lives. The weighted average remaining life of the firm’s identifiable intangibles is approximately 12 years.
       Amortization expense associated with identifiable intangible assets was $69 million and $34 million for the three months ended August 2006 and August 2005, respectively, and $182 million and $127 million for the nine months ended August 2006 and August 2005, respectively, including amortization associated with the firm’s consolidated power generation facilities reported within “Cost of power generation” in the condensed consolidated statements of earnings.
       The estimated future amortization for existing identifiable intangible assets through 2011 is set forth below:
         
    (in millions)
Remainder of 2006
  $ 67  
2007
    234  
2008
    212  
2009
    200  
2010
    192  
2011
    184  
Note 10. Other Assets and Other Liabilities
  Other Assets
       Other assets are generally less liquid, nonfinancial assets. The following table sets forth the firm’s other assets by type:
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
Goodwill and identifiable intangible assets (1)
  $ 5,821     $ 5,203  
Property, leasehold improvements and equipment (2)
    6,916       5,097  
Equity-method investments and joint ventures
    2,633       2,965  
Income tax-related assets
    1,811       1,304  
Miscellaneous receivables and other
    3,122       2,743  
                 
Total
  $ 20,303     $ 17,312  
                 
 
 
  (1)  See Note 9 for further information regarding the firm’s goodwill and identifiable intangible assets.
 
  (2)  Net of accumulated depreciation and amortization of $5.04 billion and $4.62 billion for August 2006 and November 2005, respectively.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Other Liabilities
       Other liabilities and accrued expenses primarily includes insurance-related liabilities, compensation and benefits, minority interest in consolidated entities, litigation liabilities, tax-related payables, deferred revenue and other payables. The following table sets forth the firm’s other liabilities and accrued expenses by type:
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
Insurance-related liabilities (1)
  $ 11,398     $  
Compensation and benefits
    10,401       6,598  
Minority interest
    4,321       3,164  
Income tax-related liabilities
    1,339       868  
Accrued expenses and other payables
    3,812       3,200  
                 
Total
  $ 31,271     $ 13,830  
                 
 
 
  (1)  Insurance-related liabilities are set forth in the table below:
                 
    As of
     
    August   November
    2006   2005
         
    (in millions)
Separate account liabilities
  $ 7,798     $  
Liabilities for future benefits and unpaid claims
    2,161        
Contract holder account balances
    1,165        
Reserves for guaranteed minimum death and income benefits
    274        
                 
Total insurance-related liabilities
  $ 11,398     $  
                 
  Separate account liabilities are offset by separate account assets, representing segregated contract holder funds under variable annuity and variable life insurance contracts. Separate account assets are included in “Cash and securities segregated for regulatory and other purposes” in the condensed consolidated statements of financial condition.
 
  Liabilities for future benefits and unpaid claims include liabilities arising from reinsurance provided by the firm to other insurers. The firm has a receivable for $1.36 billion related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. In addition, the firm has ceded risks to reinsurers related to certain of its liabilities for future benefits and unpaid claims and has a receivable of $799 million related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. Contracts to cede risks to reinsurers do not relieve the firm from its obligations to contract holders.
 
  Reserves for guaranteed minimum death and income benefits represent a liability for the expected value of guaranteed benefits in excess of projected annuity account balances. These reserves are computed in accordance with AICPA Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts,” and are based on total payments expected to be made less total fees expected to be assessed over the life of the contract.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 11. Employee Benefit Plans
       The firm sponsors various pension plans and certain other postretirement benefit plans, primarily healthcare and life insurance. The firm also provides certain benefits to former or inactive employees prior to retirement.
  Defined Benefit Pension Plans and Postretirement Plans
       The firm maintains a defined benefit pension plan for substantially all U.S. employees hired prior to November 1, 2003. As of November 2004, this plan has been closed to new participants and no further benefits will be accrued to existing participants. Employees of certain subsidiaries participate in various defined benefit pension plans. These plans generally provide benefits based on years of credited service and a percentage of the employee’s eligible compensation. In addition, the firm has unfunded postretirement benefit plans that provide medical and life insurance for eligible retirees and their dependents covered under the U.S. benefits program.
       The components of pension expense/(income) and postretirement expense are set forth below:
                                   
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions)
U.S. pension
                               
 
Service cost
  $     $     $     $  
 
Interest cost
    5       5       15       15  
 
Expected return on plan assets
    (7 )     (7 )     (20 )     (20 )
 
Net amortization
    2       1       5       4  
                                 
Total
  $     $ (1 )   $     $ (1 )
                                 
Non-U.S. pension
                               
 
Service cost
  $ 14     $ 11     $ 42     $ 34  
 
Interest cost
    6       5       18       15  
 
Expected return on plan assets
    (7 )     (5 )     (21 )     (17 )
 
Net amortization
    3       3       8       9  
 
Other (1)
                      (17 )
                                 
Total
  $ 16     $ 14     $ 47     $ 24  
                                 
Postretirement
                               
 
Service cost
  $ 4     $ 3     $ 12     $ 10  
 
Interest cost
    4       3       13       9  
 
Net amortization
    5       1       15       3  
                                 
Total
  $ 13     $ 7     $ 40     $ 22  
                                 
 
 
  (1)  Represents a benefit as a result of the termination of a Japanese pension plan.
       The firm expects to contribute a minimum of $23 million to its pension plans and $9 million to its postretirement plans in fiscal 2006.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
Note 12. Employee Incentive Plans
  Stock Incentive Plan
       The firm sponsors a stock incentive plan, The Goldman Sachs Amended and Restated Stock Incentive Plan (the Amended SIP), which provides for grants of incentive stock options, nonqualified stock options, stock appreciation rights, dividend equivalent rights, restricted stock, restricted stock units and other share-based awards. In the second quarter of fiscal 2003, the Amended SIP was approved by the firm’s shareholders, effective for grants after April 1, 2003, and no further awards were or will be made under the original plan after that date, although awards granted under the original plan prior to that date remain outstanding.
       The total number of shares of common stock that may be issued under the Amended SIP through fiscal 2008 may not exceed 250 million shares and, in each fiscal year thereafter, may not exceed 5% of the issued and outstanding shares of common stock, determined as of the last day of the immediately preceding fiscal year, increased by the number of shares available for awards in previous fiscal years but not covered by awards granted in such years. As of August 2006 and November 2005, 196.3 million and 196.6 million shares, respectively, were available for grant under the Amended SIP.
  Restricted Stock Units
       The firm issued restricted stock units to employees under the Amended SIP, primarily in connection with year-end compensation and acquisitions. Of the total restricted stock units outstanding as of August 2006 and November 2005, (i) 28.3 million units and 30.1 million units, respectively, required future service as a condition to the delivery of the underlying shares of common stock and (ii) 18.9 million units and 25.0 million units, respectively, did not require future service. In all cases, delivery of the underlying shares of common stock is conditioned on the grantees satisfying certain other requirements outlined in the award agreements. When delivering the underlying shares to employees, the firm generally issues new shares of common stock, as opposed to reissuing treasury shares.
       The activity related to these restricted stock units is set forth below:
                                   
            Weighted Average
        Grant-Date Fair Value
    Restricted Stock   of Restricted Stock
    Units Outstanding   Units Outstanding
         
    Future   No Future   Future   No Future
    Service   Service   Service   Service
    Required   Required   Required   Required
                 
Outstanding, November 2005 (1)
    30,117,820       24,993,866     $ 112.01     $ 107.18  
 
Granted (2) (3)
    1,015,239       145,270       143.64       138.09  
 
Forfeited
    (649,649 )     (209,085 )     110.83       100.08  
 
Delivered
          (8,229,059 )           91.72  
 
Vested (3)
    (2,210,062 )     2,210,062       106.67       106.67  
                             
Outstanding, August 2006
    28,273,348       18,911,054     $ 113.59     $ 114.16  
                             
 
 
  (1)  Includes restricted stock units granted to employees during the nine-month period ended August 2006 as part of compensation for fiscal 2005.
 
  (2)  The weighted average grant-date fair value of restricted stock units granted during the nine-month period ended August 2006 was $142.95 per unit, compared with $108.89 per unit for the same prior year period.
 
  (3)  The aggregate fair value of awards vested during the nine-month period ended August 2006 was $333 million.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Stock Options
       As of November 2004, all stock options granted to employees in May 1999 in connection with the firm’s initial public offering became fully vested and exercisable. Stock options granted to employees subsequent to the firm’s initial public offering generally vest as outlined in the applicable stock option agreement and first become exercisable on the third anniversary of the grant date. Year-end stock options for 2005 become exercisable in January 2009 and expire on November 27, 2015. Shares received on exercise prior to January 2010 will not be transferable until January 2010. All employee stock option agreements provide that vesting is accelerated in certain circumstances, such as upon retirement, death and extended absence. In general, all stock options expire on the tenth anniversary of the grant date, although they may be subject to earlier termination or cancellation in certain circumstances in accordance with the terms of the Amended SIP and the applicable stock option agreement. The dilutive effect of the firm’s outstanding stock options is included in “Average common shares outstanding — Diluted” on the condensed consolidated statements of earnings.
       The activity related to these stock options is set forth below:
                                   
                Weighted
        Weighted   Aggregate   Average
    Options   Average   Intrinsic Value   Remaining Life
    Outstanding   Exercise Price   (in millions)   (in years)
                 
Outstanding, November 2005 (1)
    64,237,687     $ 83.24                  
 
Granted
                           
 
Exercised
    (16,753,885 )     77.67                  
 
Forfeited
    (203,751 )     98.57                  
                           
Outstanding, August 2006
    47,280,051     $ 85.15     $ 3,069       5.2  
                           
Exercisable, August 2006
    43,329,313       81.59       2,967       4.9  
 
 
  (1)  Includes stock options granted to employees in the nine months ended August 2006 as part of compensation for fiscal 2005.
       The total intrinsic value of options exercised during the nine months ended August 2006 and August 2005 was $1.09 billion and $566 million, respectively.
       The following table sets forth share-based compensation and the related tax benefit:
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions)
Share-based compensation
  $ 239     $ 223     $ 851     $ 643  
Cash settled share-based compensation
    110             127        
                                 
Total share-based compensation
    349       223       978       643  
Excess tax benefit related to options exercised
    50       41       387       201  
Excess tax benefit related to share-based compensation (1)
  $ 60     $ 40     $ 495     $ 205  
 
 
  (1)  Represents the tax benefit, recognized in additional paid-in capital, on stock options exercised and the delivery of shares underlying vested restricted stock units.
       As of August 2006, there was $1.61 billion of total unrecognized compensation cost related to nonvested share-based compensation arrangements. This cost is expected to be recognized over a weighted average period of 1.95 years.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       The firm’s stock repurchase program is intended to maintain its total shareholders’ equity at appropriate levels and to substantially offset increases in share count over time resulting from employee share-based compensation. The repurchase program has been effected primarily through regular open-market purchases and is influenced by, among other factors, the level of the firm’s common shareholders’ equity, its overall capital position, share-based awards and exercises of employee stock options, the prevailing market price of its common stock and general market conditions.
Note 13. Affiliated Funds
       The firm has formed numerous nonconsolidated investment funds with third-party investors. The firm generally acts as the investment manager for these funds and, as such, is entitled to receive management fees and, in certain cases, advisory fees, incentive fees or overrides from these funds. These fees amounted to $2.56 billion and $1.62 billion for the nine months ended August 2006 and August 2005, respectively. As of August 2006 and November 2005, the fees receivable from these funds were $383 million and $388 million, respectively. Additionally, the firm may invest alongside the third-party investors in certain funds. The aggregate carrying value of the firm’s interests in these funds was $3.48 billion and $2.17 billion as of August 2006 and November 2005, respectively. In the ordinary course of business, the firm may also engage in other activities with these funds, including, among others, securities lending, trade execution, trading and custody. See Note 6 for the firm’s commitments related to these funds.
Note 14. Regulation
       The firm is regulated by the U.S. Securities and Exchange Commission (SEC) as a Consolidated Supervised Entity (CSE). As such, it is subject to group-wide supervision and examination by the SEC and to minimum capital requirements on a consolidated basis. As of August 2006 and November 2005, the firm was in compliance with the CSE capital requirements.
       The firm’s principal U.S. regulated subsidiaries include Goldman, Sachs & Co. (GS&Co.) and Goldman Sachs Execution & Clearing, L.P. (GSEC). GS&Co. and GSEC are registered U.S. broker-dealers and futures commission merchants subject to Rule 15c3-1 of the SEC and Rule 1.17 of the Commodity Futures Trading Commission, which specify uniform minimum net capital requirements, as defined, for their registrants. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1. As of August 2006 and November 2005, GS&Co. and GSEC had net capital in excess of their minimum capital requirements. In addition to its alternative minimum net capital requirements, GS&Co. is also required to hold tentative net capital in excess of $1 billion and net capital in excess of $500 million in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1. GS&Co. is also required to notify the SEC in the event that its tentative net capital is less than $5 billion. As of August 2006 and November 2005, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements.
       Goldman Sachs Bank USA (GS Bank), a wholly owned industrial loan corporation, is regulated by the Federal Deposit Insurance Corporation and the State of Utah Department of Financial Institutions and is subject to minimum capital requirements. As of August 2006, GS Bank was in compliance with all federal and state regulatory capital requirements. GS Bank had approximately $8 billion of interest-bearing deposits as of August 2006, which are included in “Payables to customers and counterparties” in the condensed consolidated statements of financial condition.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
       The firm’s principal non-U.S. regulated subsidiaries include Goldman Sachs International (GSI) and Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, a regulated U.K. broker-dealer, is subject to the capital requirements of the U.K.’s Financial Services Authority. GSJCL, a Japanese regulated broker-dealer, is subject to the capital requirements of Japan’s Financial Services Agency. Prior to October 1, 2006, Goldman Sachs (Japan) Ltd. (GSJL) was the primary regulated subsidiary based in Japan. As of August 2006 and November 2005, GSI, GSJCL and GSJL were in compliance with their local capital adequacy requirements. Certain other non-U.S. subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of August 2006 and November 2005, these subsidiaries were in compliance with their local capital adequacy requirements.
Note 15. Business Segments
       In reporting to management, the firm’s operating results are categorized into the following three segments: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.
  Basis of Presentation
       In reporting segments, certain of the firm’s business lines have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate.
       The cost drivers of the firm taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of the firm’s business segments. Compensation expenses within the firm’s segments reflect, among other factors, the overall performance of the firm as well as the performance of individual business units. Consequently, pre-tax margins in one segment of the firm’s business may be significantly affected by the performance of the firm’s other business segments. The timing and magnitude of changes in the firm’s bonus accruals can have a significant effect on segment results in a given period.

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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
  Segment Operating Results
       Management believes that the following information provides a reasonable representation of each segment’s contribution to consolidated pre-tax earnings and total assets:
                                     
        As of or for the
         
        Three Months   Nine Months
        Ended August   Ended August
             
        2006   2005   2006   2005
                     
            (in millions)    
Investment
 
Net revenues
  $ 1,288     $ 1,015     $ 4,285     $ 2,723  
Banking
 
Operating expenses
    940       887       3,223       2,392  
                                     
   
Pre-tax earnings
  $ 348     $ 128     $ 1,062     $ 331  
                                     
   
Segment assets
  $ 3,060     $ 3,048     $ 3,060     $ 3,048  
                                     
Trading and Principal
 
Net revenues
  $ 4,720     $ 5,062     $ 18,565     $ 12,258  
Investments
 
Operating expenses
    3,199       3,231       11,900       8,025  
                                     
   
Pre-tax earnings
  $ 1,521     $ 1,831     $ 6,665     $ 4,233  
                                     
   
Segment assets
  $ 547,662     $ 482,905     $ 547,662     $ 482,905  
                                     
Asset Management and
 
Net revenues
  $ 1,455     $ 1,208     $ 5,045     $ 3,515  
Securities Services
 
Operating expenses
    970       754       3,157       2,254  
                                     
   
Pre-tax earnings
  $ 485     $ 454     $ 1,888     $ 1,261  
                                     
   
Segment assets
  $ 247,587     $ 183,565     $ 247,587     $ 183,565  
                                     
Total
 
Net revenues (1)
  $ 7,463     $ 7,285     $ 27,895     $ 18,496  
   
Operating expenses (2)
    5,101       4,880       18,320       12,702  
                                     
   
Pre-tax earnings (3)
  $ 2,362     $ 2,405     $ 9,575     $ 5,794  
                                     
   
Total assets
  $ 798,309     $ 669,518     $ 798,309     $ 669,518  
                                     
 
(1)  Net revenues include net interest and cost of power generation as set forth in the table below:
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
        (in millions)    
Investment Banking
  $ 3     $ 17     $ 9     $ 56  
Trading and Principal Investments
    352       220       589       713  
Asset Management and Securities Services
    480       436       1,500       1,245  
                                 
Total net interest and cost of power generation
  $ 835     $ 673     $ 2,098     $ 2,014  
                                 
(2)  Includes net provisions for a number of litigation and regulatory proceedings of $(8) million and $8 million for the three months ended August 2006 and August 2005, respectively, and $40 million and $31 million for the nine months ended August 2006 and August 2005, respectively, that have not been allocated to the firm’s segments.
 
(3)  Pre-tax earnings include total depreciation and amortization as set forth in the table below:
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
        (in millions)    
Investment Banking
  $ 26     $ 35     $ 90     $ 113  
Trading and Principal Investments
    192       139       526       417  
Asset Management and Securities Services
    33       36       113       108  
                                 
Total depreciation and amortization
  $ 251     $ 210     $ 729     $ 638  
                                 

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Report of Independent Registered Public Accounting Firm
To the Directors and Shareholders of
The Goldman Sachs Group, Inc.:
       We have reviewed the accompanying condensed consolidated statement of financial condition of The Goldman Sachs Group, Inc. and its subsidiaries (the Company) as of August 25, 2006, the related condensed consolidated statements of earnings for the three and nine months ended August 25, 2006 and August 26, 2005, the condensed consolidated statement of changes in shareholders’ equity for the nine months ended August 25, 2006, the condensed consolidated statements of cash flows for the nine months ended August 25, 2006 and August 26, 2005, and the condensed consolidated statements of comprehensive income for the three and nine months ended August 25, 2006 and August 26, 2005. These condensed consolidated interim financial statements are the responsibility of the Company’s management.
       We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
       Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
       We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition as of November 25, 2005 and the related consolidated statements of earnings, changes in shareholders’ equity, cash flows and comprehensive income for the year then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of November 25, 2005 and the effectiveness of the Company’s internal control over financial reporting as of November 25, 2005; and in our report dated February 3, 2006, we expressed unqualified opinions thereon. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of November 25, 2005, and the condensed consolidated statement of changes in shareholders’ equity for the year ended November 25, 2005, is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived.
/s/ PricewaterhouseCoopers LLP
New York, New York
September 28, 2006

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Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
INDEX
         
    Page
    No.
     
    49  
 
    50  
 
    53  
 
    54  
    54  
    59  
 
    62  
 
    63  
    63  
    68  
 
    75  
    75  
    79  
    80  
    81  
 
    84  
 
    90  
 
    92  
 
    93  

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Introduction
       Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.
       Our activities are divided into three segments:
  •  Investment Banking. We provide a broad range of investment banking services to a diverse group of corporations, financial institutions, governments and individuals.
 
  •  Trading and Principal Investments. We facilitate client transactions with a diverse group of corporations, financial institutions, governments and individuals and take proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on such products. In addition, we engage in specialist and market-making activities on equities and options exchanges and we clear client transactions on major stock, options and futures exchanges worldwide. In connection with our merchant banking and other investing activities, we make principal investments directly and through funds that we raise and manage.
 
  •  Asset Management and Securities Services. We provide investment advisory and financial planning services and offer investment products across all major asset classes to a diverse group of institutions and individuals worldwide, and provide prime brokerage services, financing services and securities lending services to mutual funds, pension funds, hedge funds, foundations and high-net-worth individuals worldwide.
       This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended November 25, 2005. References herein to the Annual Report on Form 10-K are to our Annual Report on Form 10-K for the fiscal year ended November 25, 2005.
       Unless specifically stated otherwise, all references to August 2006 and August 2005 refer to our fiscal periods ended, or the dates, as the context requires, August 25, 2006 and August 26, 2005, respectively. All references to November 2005, unless specifically stated otherwise, refer to our fiscal year ended, or the date, as the context requires, November 25, 2005. All references to 2006, unless specifically stated otherwise, refer to our fiscal year ending, or the date, as the context requires, November 24, 2006.
       When we use the terms “Goldman Sachs,” “we,” “us” and “our,” we mean The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, and its consolidated subsidiaries.

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Executive Overview
       Our diluted earnings per common share were $3.26, annualized return on average tangible common shareholders’ equity (1) was 24.9% and annualized return on average common shareholders’ equity was 20.9% for the third quarter of 2006. Excluding incremental non-cash expenses of $133 million related to the accounting for certain share-based awards under SFAS No. 123-R (2), diluted earnings per common share were $3.45 (2), annualized return on average tangible common shareholders’ equity (1) was 26.5% (2) and annualized return on average common shareholders’ equity was 22.2% (2) for the third quarter of 2006. Diluted earnings per common share for the third quarter of 2005 were $3.25.
       Our third quarter results reflected solid performances in each of our three segments. Net revenues in Investment Banking increased compared with the third quarter of 2005, reflecting significantly higher net revenues in Underwriting, as both debt and equity underwriting results improved, as well as higher net revenues in Financial Advisory, reflecting increased client activity. Our investment banking backlog was essentially unchanged during the quarter (3). Strong net revenue growth in our Asset Management and Securities Services businesses primarily reflected significantly higher management and other fees as well as continued strength in our prime brokerage business. Assets under management increased significantly from a year ago, including net asset inflows of $30 billion during the quarter. Net revenues in Trading and Principal Investments were lower than a particularly strong third quarter of 2005. Net revenues in Principal Investments decreased reflecting a smaller gain related to our investment in the convertible preferred stock of Sumitomo Mitsui Financial Group, Inc. (SMFG) as well as lower net revenues from our other principal investments. In addition, net revenues in Equities were lower than the same prior year period, while net revenues in Fixed Income, Currency and Commodities (FICC) were higher than a strong third quarter of 2005. During the quarter, Equities operated in a less favorable environment as equity prices lacked direction and customer-driven activity declined from the first half of the year. In addition, although FICC performed well, the business operated in a less favorable environment, as customer-driven activity declined from the first half of the year and volatility levels were generally low.
       Our diluted earnings per common share were $13.12 for the nine months ended August 2006 compared with $7.89 for the same period last year. Annualized return on average tangible common shareholders’ equity (1) was 35.6% and annualized return on average common shareholders’ equity was 29.6%. Excluding incremental non-cash expenses of $508 million related to the accounting for certain share-based awards under SFAS No. 123-R (2), diluted earnings per common share were $13.83 (2), annualized return on average tangible common shareholders’ equity (1) was 37.6% (2) and annualized return on average common shareholders’ equity was 31.4% (2) for the nine months ended August 2006. Our results for the first nine months of 2006 reflected strong net revenue growth in each of our three segments as compared with the same period last year.
       During the first nine months of 2006, each of our segments achieved record results reflecting generally favorable market conditions and strong customer activity. Trading and Principal Investments results reflected significantly higher net revenues in FICC and Equities and a strong performance in Principal Investments. Net revenues in FICC reflected particularly strong results across all major businesses, and net revenues in Equities reflected significant growth in our customer franchise business, while results in principal strategies, although strong, were lower than the same prior year period. In our trading businesses, we saw generally favorable trading and investing opportunities for our clients and ourselves, and consequently increased our market risk in the first half of the year. However, as the environment became more challenging during the third quarter of 2006, our market risk declined, reflecting fewer opportunities in the markets. In Investment Banking, net revenues reflected strong growth in Underwriting and Financial Advisory as industry-wide volumes across equity underwriting and mergers and acquisitions were significantly ahead of the same prior year period and debt underwriting volumes remained at high levels. In Asset Management and Securities

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Services, revenue growth was driven by record assets under management and significantly higher incentive fees, as well as significantly higher global customer balances in Securities Services.
       We continued to focus on managing our capital base, with the goal of optimizing our returns while, at the same time, growing our businesses. During the third quarter of 2006, we repurchased 3.8 million shares of our common stock at a total cost of $573 million. In the first nine months of 2006, we repurchased 29.5 million shares of our common stock at a total cost of $4.17 billion. On September 11, 2006, the Board of Directors of Goldman Sachs authorized the repurchase of an additional 60.0 million shares of common stock pursuant to the existing repurchase program. With respect to the regulatory environment, financial services firms continued to be under intense scrutiny, with the volume and amount of claims against financial institutions and other related costs remaining significant. Given the range of litigation and investigations presently under way, our litigation expenses can be expected to remain high.
       Though our operating results were very strong in the first nine months of 2006, our business, by its nature, does not produce predictable earnings. Our results in any given period can be materially affected by conditions in global financial markets and economic conditions generally. For a further discussion of the factors that may affect our future operating results, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.
 
(1)  Annualized return on average tangible common shareholders’ equity is computed by dividing annualized net earnings applicable to common shareholders by average monthly tangible common shareholders’ equity. See “— Results of Operations — Financial Overview” below for further information regarding our calculation of annualized return on average tangible common shareholders’ equity.
 
(2)  Statement of Financial Accounting Standards (SFAS) No. 123-R, “Share-Based Payment,” focuses primarily on accounting for transactions in which an entity obtains employee services in exchange for share-based payments. In the first quarter of 2006, we adopted SFAS No. 123-R, which requires that share-based awards granted to retirement-eligible employees, including those subject to non-compete agreements, be expensed in the year of grant. In addition to expensing current year awards, prior year awards must continue to be amortized over the relevant service period. Therefore, our compensation and benefits expenses in fiscal 2006 (and, to a lesser extent, in fiscal 2007 and fiscal 2008) will include both amortization of prior year awards and new awards granted to retirement-eligible employees for services rendered in fiscal 2006. We believe that presenting our results excluding the impact of the continued amortization of prior year share-based awards granted to retirement-eligible employees increases the comparability of period-to-period operating results and allows for a more meaningful representation of the relationship of current period compensation to net revenues.
  The following tables set forth a reconciliation of diluted earnings per common share, common shareholders’ equity and net earnings applicable to common shareholders as reported, to these items excluding the impact of the continued amortization of prior year share-based awards granted to retirement-eligible employees:
                 
    Three Months   Nine Months
    Ended   Ended
    August 2006   August 2006
         
Diluted earnings per common share
  $ 3.26     $ 13.12  
Impact of the continued amortization of prior year share-based awards,
net of tax
    0.19       0.71  
                 
Diluted earnings per common share, excluding the impact of the continued amortization of prior year share-based awards
  $ 3.45     $ 13.83  
                 

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    Average for the
     
    Three Months   Nine Months
    Ended   Ended
    August 2006   August 2006
         
    (in millions)
Total shareholders’ equity
  $ 32,618     $ 30,498  
Preferred stock
    (2,850 )     (2,190 )
                 
Common shareholders’ equity
    29,768       28,308  
Impact of the continued amortization of prior year share-based awards, net of tax
    (147 )     (98 )
                 
Common shareholders’ equity, excluding the impact of the continued amortization of prior year share-based awards
    29,621       28,210  
Goodwill and identifiable intangible assets, excluding power contracts and insurance-related intangible assets (see footnote 1 above)
    (4,745 )     (4,709 )
                 
Tangible common shareholders’ equity (see footnote 1 above), excluding the impact of the continued amortization of prior year share-based awards
  $ 24,876     $ 23,501  
                 
                 
    Three Months   Nine Months
    Ended   Ended
    August 2006   August 2006
         
    (in millions)
Net earnings applicable to common shareholders
  $ 1,555     $ 6,294  
Impact of the continued amortization of prior year share-based awards, net of tax
    90       340  
                 
Net earnings applicable to common shareholders, excluding the impact of the continued amortization of prior year share-based awards
  $ 1,645     $ 6,634  
                 
(3)  Our investment banking backlog represents an estimate of our future net revenues from investment banking transactions where we believe that future revenue realization is more likely than not.

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Business Environment
       Global economic conditions remained generally favorable during our third quarter of fiscal 2006, although economic growth in the U.S. and, to a lesser extent, in Europe, slowed from the first half of the year. Business and consumer confidence remained generally high across the major economies, although consumer confidence appeared to decline toward the end of our third fiscal quarter, particularly in the U.S. Concerns over inflationary pressures in the U.S. early in the fiscal quarter subsided toward the end of the quarter. In the equity markets, global equity prices lacked direction and generally ended only slightly above or below levels at the beginning of our fiscal quarter. In the fixed income markets, yield curves in both the U.S. and Europe flattened and corporate credit spreads remained narrow. Investment banking activity levels decreased during the fiscal quarter, as evidenced by lower industry-wide announced and completed mergers and acquisitions and equity underwritings.
       In the U.S., economic growth continued to slow from stronger levels seen in the beginning of the fiscal year, as consumer spending continued to decline, reflecting the effects of higher interest rates, high energy prices and the decline in the housing market. Unemployment remained at low levels, although it increased slightly during the fiscal quarter. While concerns over inflationary pressures near the end of our second fiscal quarter continued into June, growth in measures of core inflation subsided in July and August. The U.S. Federal Reserve raised its federal funds target rate by 25 basis points to 5.25% in June, its 17th consecutive increase, but held the target rate steady during its August meeting. Long-term bond yields fell, with the 10-year U.S. Treasury note yield ending the quarter down 27 basis points at 4.78%. In the equity markets, the S&P 500 Index and the Dow Jones Industrial Average ended the quarter essentially unchanged, while the NASDAQ Composite Index fell by 3%.
       In Europe, economic growth moderated slightly during our third fiscal quarter, but remained solid, with increasing industrial and construction activity, particularly in Germany. The modest decrease in economic growth was evident in surveys of business activity, which declined slightly during the quarter, but remained at high levels. In addition, consumer confidence remained at high levels, as private consumption and employment both increased during the quarter. The European Central Bank increased its main refinancing operations rate by 50 basis points during the fiscal quarter to 3.0%, its highest level in nearly five years. In the U.K., although financial conditions became less accommodative, the economy showed continued modest growth. The Bank of England raised its official bank rate by 25 basis points to 4.75%, its first change since August 2005. European equity markets ended the quarter modestly higher, while long-term yields remained essentially unchanged.
       In Japan, real gross domestic product growth softened during our third fiscal quarter, reflecting a slowdown in domestic demand, although growth in exports remained solid. Unemployment levels remained low and wages increased moderately. During the quarter, the Bank of Japan ended its five year zero interest rate policy and set the target overnight call rate at 0.25%. Despite a sharp decline early in the fiscal quarter, the Nikkei 225 Index ended the fiscal quarter essentially unchanged. In China, economic growth remained solid, driven by strength in both exports and domestic demand. The People’s Bank of China increased the one-year benchmark lending rate by 27 basis points to 6.12%. Elsewhere in Asia, growth in exports and domestic demand softened, but remained steady. Equity markets ended our fiscal quarter higher in Hong Kong, essentially unchanged in South Korea and China, and lower in Taiwan.

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Critical Accounting Policies
Fair Value
       The use of fair value to measure our financial instruments, with related unrealized gains or losses generally recognized immediately in our results of operations, is fundamental to our financial statements and is our most critical accounting policy. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
       In determining fair value, we separate our financial instruments into three categories — cash (i.e., nonderivative) trading instruments, derivative contracts and principal investments, as set forth in the following table:
Financial Instruments by Category
(in millions)
                                 
    As of August 2006   As of November 2005
         
        Financial       Financial
    Financial   Instruments Sold,   Financial   Instruments Sold,
    Instruments   But Not Yet   Instruments   But Not Yet
    Owned, At   Purchased, At   Owned, At   Purchased, At
    Fair Value   Fair Value   Fair Value   Fair Value
                 
Cash trading instruments
  $ 233,985   (1)   $ 96,291     $ 210,042     $ 89,735  
Derivative contracts
    60,181       57,196       58,532       57,829  
Principal investments
    11,371   (2)     3,070  (3)     6,526   (2)     1,507  (3)
                                 
Total
  $ 305,537     $ 156,557     $ 275,100     $ 149,071  
                                 
 
 
  (1)  Includes securities held by our bank and insurance subsidiaries which are accounted for as “available-for-sale” (AFS) under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The following table sets forth the types of AFS securities and their maturity profile:
                                         
    Under           Over    
    One Year   1-5 Years   6-10 Years   10 Years   Total
                     
    (in millions)
Mortgage-backed and other federal agency securities
  $ 826     $ 794     $ 146     $ 7     $ 1,773  
Investment-grade corporate bonds
    50       564       66       52       732  
Collateralized debt obligations
    7       645       20             672  
Other investment-grade debt securities
    42       8       58       111       219  
                                         
Total
  $ 925     $ 2,011     $ 290     $ 170     $ 3,396  
                                         
  (2)  Excludes assets for which Goldman Sachs is not at risk (e.g., assets related to consolidated merchant banking funds) of $3.64 billion and $1.93 billion as of August 2006 and November 2005, respectively.
 
  (3)  Represents an economic hedge on the unrestricted shares of common stock underlying our investment in the convertible preferred stock of SMFG. For a further discussion of our investment in SMFG, see “— Principal Investments” below.

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       Cash Trading Instruments. The following table sets forth the valuation of our cash trading instruments by level of price transparency:
Cash Trading Instruments by Price Transparency
(in millions)
                                 
    As of August 2006   As of November 2005
         
        Financial       Financial
    Financial   Instruments Sold,   Financial   Instruments Sold,
    Instruments   But Not Yet   Instruments   But Not Yet
    Owned, At   Purchased, At   Owned, At   Purchased, At
    Fair Value   Fair Value   Fair Value   Fair Value
                 
Quoted prices or alternative pricing sources with reasonable price transparency
  $ 219,785     $ 96,176     $ 198,233     $ 89,565  
Little or no price transparency
    14,200       115       11,809       170  
                                 
Total
  $ 233,985     $ 96,291     $ 210,042     $ 89,735  
                                 
      
 
       Fair values of our cash trading instruments are generally obtained from quoted market prices in active markets, broker or dealer price quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued in this manner include U.S. government and agency securities, other sovereign government obligations, liquid mortgage products, investment-grade and high-yield corporate bonds, listed equities, money market securities, state, municipal and provincial obligations, and physical commodities.
       Certain cash trading instruments trade infrequently and have little or no price transparency. Such instruments may include certain corporate bank loans, mortgage whole loans and distressed debt. We value these instruments initially at cost and generally do not adjust valuations unless there is substantive evidence supporting a change in the value of the underlying instrument or valuation assumptions (such as similar market transactions, changes in financial ratios or changes in the credit ratings of the underlying companies). Where there is evidence supporting a change in the value, we use valuation methodologies such as the present value of known or estimated cash flows.
       Cash trading instruments we own (long positions) are marked to bid prices, and instruments we have sold but not yet purchased (short positions) are marked to offer prices. If liquidating a position is expected to affect its prevailing market price, our valuation is adjusted generally based on market evidence or predetermined policies. In certain circumstances, such as for highly illiquid positions, management’s estimates are used to determine this adjustment.

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       Derivative Contracts. Derivative contracts consist of exchange-traded and over-the-counter (OTC) derivatives. The following table sets forth the fair value of our exchange-traded and OTC derivative assets and liabilities:
Derivative Assets and Liabilities
(in millions)
                                 
    As of August 2006   As of November 2005
         
    Assets   Liabilities   Assets   Liabilities
                 
Exchange-traded derivatives
  $ 11,735     $ 10,681     $ 10,869     $ 9,083  
OTC derivatives
    48,446       46,515       47,663       48,746  
                                 
Total
  $ 60,181   (1)   $ 57,196   (2)   $ 58,532   (1)   $ 57,829   (2)
                                 
 
 
  (1)  Net of cash received pursuant to credit support agreements of $22.24 billion and $22.61 billion as of August 2006 and November 2005, respectively.
 
  (2)  Net of cash paid pursuant to credit support agreements of $17.27 billion and $16.10 billion as of August 2006 and November 2005, respectively.
      
 
       Fair values of our exchange-traded derivatives are generally determined from quoted market prices. OTC derivatives are valued using valuation models. We use a variety of valuation models including the present value of known or estimated cash flows and option-pricing models. The valuation models that we use to derive the fair values of our OTC derivatives require inputs including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. The selection of a model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. We generally use similar models to value similar instruments. Where possible, we verify the values produced by our pricing models to market transactions. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model selection does not involve significant judgment because market prices are readily available. For OTC derivatives that trade in less liquid markets, model selection requires more judgment because such instruments tend to be more complex and pricing information is less available in these markets. Price transparency is inherently more limited for more complex structures because they often combine one or more product types, requiring additional inputs such as correlations and volatilities. As markets continue to develop and more pricing information becomes available, we continue to review and refine the models that we use.
       At the inception of an OTC derivative contract (day one), we value the contract at the model value if we can verify all of the significant model inputs to observable market data and verify the model to market transactions. When appropriate, valuations are adjusted to reflect various factors such as liquidity, bid/offer spreads and credit considerations. These adjustments are generally based on market evidence or predetermined policies. In certain circumstances, such as for highly illiquid positions, management’s estimates are used to determine these adjustments.
       Where we cannot verify all of the significant model inputs to observable market data and verify the model to market transactions, we value the contract at the transaction price at inception and, consequently, record no day one gain or loss in accordance with Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.” Following day one, we adjust the inputs to our valuation models only to the extent that changes in these inputs can be verified by similar market transactions, third-party pricing services and/or broker quotes, or can be derived from other substantive evidence such as empirical market data. In circumstances where we cannot verify the model to market transactions, it is possible that a different valuation model

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could produce a materially different estimate of fair value. See “— Recent Accounting Developments” below for a discussion of the impact of SFAS No. 157 on EITF Issue No. 02-3.
       The following tables set forth the fair values of our OTC derivative assets and liabilities by product and by remaining contractual maturity:
OTC Derivatives
(in millions)
                                                 
    As of August 2006
     
Assets   0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates
  $ 2,455     $ 341     $ 5,926     $ 3,427     $ 6,119     $ 18,268  
Currencies
    4,014       565       2,503       1,191       1,079       9,352  
Commodities
    4,195       1,561       7,302       1,344       141       14,543  
Equities
    1,612       790       930       2,091       860       6,283  
                                                 
Total
  $ 12,276     $ 3,257     $ 16,661     $ 8,053     $ 8,199     $ 48,446  
                                                 
                                                 
     
Liabilities   0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates
  $ 3,155     $ 764     $ 5,194     $ 3,324     $ 4,321     $ 16,758  
Currencies
    4,146       1,148       2,744       420       617       9,075  
Commodities
    3,087       779       4,548       1,932       96       10,442  
Equities
    3,748       2,047       1,955       2,135       355       10,240  
                                                 
Total
  $ 14,136     $ 4,738     $ 14,441     $ 7,811     $ 5,389     $ 46,515  
                                                 
                                                 
    As of November 2005
     
Assets   0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates
  $ 1,898     $ 467     $ 4,634     $ 5,310     $ 5,221     $ 17,530  
Currencies
    5,825       1,031       1,843       919       1,046       10,664  
Commodities
    3,772       1,369       8,130       1,374       120       14,765  
Equities
    1,168       1,171       832       1,403       130       4,704  
                                                 
Total
  $ 12,663     $ 4,038     $ 15,439     $ 9,006     $ 6,517     $ 47,663  
                                                 
                                                 
     
Liabilities   0 - 6   6 - 12   1 - 5   5 - 10   10 Years    
Contract Type   Months   Months   Years   Years   or Greater   Total
                         
Interest rates
  $ 1,956     $ 590     $ 5,327     $ 3,142     $ 4,970     $ 15,985  
Currencies
    6,295       575       3,978       436       924       12,208  
Commodities
    3,852       2,080       5,904       1,865       162       13,863  
Equities
    1,308       1,068       2,079       1,993       242       6,690  
                                                 
Total
  $ 13,411     $ 4,313     $ 17,288     $ 7,436     $ 6,298     $ 48,746  
                                                 
 
       We enter into certain OTC option transactions that provide us or our counterparties with the right to extend the maturity of the underlying contract. The fair value of these option contracts is not material to the aggregate fair value of our OTC derivative portfolio. In the tables above, for option contracts that require settlement by delivery of an underlying derivative instrument, the remaining contractual maturity is generally classified based upon the maturity date of the underlying derivative

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instrument. In those instances where the underlying instrument does not have a maturity date or either counterparty has the right to settle in cash, the remaining contractual maturity is generally based upon the option expiration date.
       Principal Investments. The following table sets forth the carrying value of our corporate and real estate principal investments in private companies (excluding our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC)), in public companies (excluding our investment in the convertible preferred stock of SMFG) and our investments in SMFG and ICBC:
Principal Investments
(in millions)
                                                 
    As of August 2006   As of November 2005
         
    Corporate   Real Estate   Total   Corporate   Real Estate   Total
                         
Private
  $ 2,359     $ 616     $ 2,975     $ 1,538     $ 716     $ 2,254  
Public
    848       5       853       185       29       214  
                                                 
Subtotal (1)
    3,207       621       3,828       1,723       745       2,468  
SMFG convertible preferred stock (2) (3)
    4,938             4,938       4,058             4,058  
ICBC ordinary shares (4)
    2,605             2,605                    
                                                 
Total
  $ 10,750     $ 621     $ 11,371     $ 5,781     $ 745     $ 6,526  
                                                 
 
 
  (1)  Excludes assets for which Goldman Sachs is not at risk (e.g., assets related to consolidated merchant banking funds) of $3.64 billion and $1.93 billion as of August 2006 and November 2005, respectively.
 
  (2)  The fair value of our Japanese yen-denominated investment in the convertible preferred stock of SMFG includes the effect of foreign exchange revaluation. We mitigate our economic exposure to exchange rate movements on our investment in SMFG by borrowing Japanese yen. Foreign exchange revaluation on the investment and the related borrowing are generally equal and offsetting. For example, if the Japanese yen appreciates against the U.S. dollar, the U.S. dollar carrying value of our SMFG investment will increase and the U.S. dollar carrying value of the related borrowing will also increase by an amount that is generally equal and offsetting.
 
  (3)  Excludes an economic hedge on the unrestricted shares of common stock underlying our investment in the convertible preferred stock of SMFG. The fair value of this hedge was $3.07 billion and $1.51 billion as of August 2006 and November 2005, respectively, and is reflected in “Financial instruments sold, but not yet purchased, at fair value” in the condensed consolidated statements of financial condition. For a further discussion of the restrictions on our ability to hedge or sell the common stock underlying our investment in SMFG, see below.
 
  (4)  Includes economic interests of $1.65 billion as of August 2006 assumed by investment funds managed by Goldman Sachs. The fair value of our Chinese renminbi-denominated investment in the ordinary shares of ICBC includes the effect of foreign exchange revaluation.
      
 
       Our private principal investments, by their nature, have little or no price transparency. Such investments (including our investment in ICBC) are initially carried at cost as an approximation of fair value. Adjustments to carrying value are made if there are third-party transactions evidencing a change in value. Downward adjustments are also made, in the absence of third-party transactions, if we determine that the expected realizable value of the investment is less than the carrying value. In reaching that determination, we consider many factors including, but not limited to, the operating cash flows and financial performance of the companies or properties relative to budgets or projections, trends within sectors and/or regions, underlying business models, expected exit timing and strategy, and any specific rights or terms associated with the investment, such as conversion features and liquidation preferences.
       Our public principal investments, which tend to be large, concentrated holdings that result from initial public offerings or other corporate transactions, are valued using quoted market prices discounted based on predetermined written policies for nontransferability and illiquidity.

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       Our investment in the convertible preferred stock of SMFG is carried at fair value, which is derived from a model that incorporates SMFG’s common stock price and credit spreads, the impact of nontransferability and illiquidity, and the downside protection on the conversion strike price. The fair value of our investment is particularly sensitive to movements in the SMFG common stock price. As a result of transfer restrictions and the downside protection on the conversion strike price, the relationship between changes in the fair value of our investment and changes in SMFG’s common stock price is nonlinear. During the third quarter, the fair value of our investment (excluding the economic hedge on the unrestricted shares of common stock) increased 11% (expressed in Japanese yen), primarily reflecting an increase in the SMFG common stock price and, to a lesser extent, the impact of passage of time in respect of the transfer restrictions on the underlying common stock.
       Our investment in the convertible preferred stock of SMFG is generally nontransferable, but is freely convertible into SMFG common stock. Restrictions on our ability to hedge or sell two-thirds of the common stock underlying our investment in SMFG lapsed in equal installments on February 7, 2005 and March 9, 2006. As of the date of this filing, we have fully hedged the first one-third installment of the unrestricted shares and have hedged a majority of the second one-third installment of the unrestricted shares. Restrictions on our ability to hedge or sell the remaining one-third installment lapse on February 7, 2007. As of the date of this filing, the conversion price of our SMFG preferred stock into shares of SMFG common stock was ¥319,700. This price is subject to downward adjustment if the price of SMFG common stock at the time of conversion is less than the conversion price (subject to a floor of ¥105,400).
       Controls Over Valuation of Financial Instruments. A control infrastructure, independent of the trading and investing functions, is fundamental to ensuring that our financial instruments are appropriately valued and that fair value measurements are reliable. This is particularly important in valuing instruments with lower levels of price transparency.
       We employ an oversight structure that includes appropriate segregation of duties. Senior management, independent of the trading functions, is responsible for the oversight of control and valuation policies and for reporting the results of these policies to our Audit Committee. We seek to maintain the necessary resources to ensure that control functions are performed to the highest standards. We employ procedures for the approval of new transaction types and markets, price verification, review of daily profit and loss, and review of valuation models by personnel with appropriate technical knowledge of relevant products and markets. These procedures are performed by personnel independent of the revenue-producing units. For trading and principal investments with little or no price transparency, we employ, where possible, procedures that include comparisons with similar observable positions, analysis of actual to projected cash flows, comparisons with subsequent sales and discussions with senior business leaders. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Management” in Part II, Item 7 of the Annual Report on Form 10-K for a further discussion on how we manage the risks inherent in our trading and principal investing businesses.
Goodwill and Identifiable Intangible Assets
       As a result of our acquisitions, principally SLK LLC (SLK) in fiscal 2000, The Ayco Company, L.P. (Ayco) in fiscal 2003, Cogentrix Energy, Inc. (Cogentrix) in fiscal 2004, National Energy & Gas Transmission, Inc. (NEGT) in fiscal 2005 and the acquisition of the variable annuity and variable life insurance business of The Hanover Insurance Group, Inc. (formerly Allmerica Financial Corporation) in fiscal 2006, we have acquired goodwill and identifiable intangible assets. Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date.

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       Goodwill. We test the goodwill in each of our operating segments for impairment at least annually in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” by comparing the estimated fair value of each operating segment with its estimated net book value. We derive the fair value of each of our operating segments primarily based on price-earnings multiples. We derive the net book value of our operating segments by estimating the amount of shareholders’ equity required to support the assets of each operating segment. Our last annual impairment test was performed during our fiscal 2005 fourth quarter and no impairment was identified.
       The following table sets forth the carrying value of our goodwill by operating segment:
Goodwill by Operating Segment
(in millions)
                   
    As of
     
    August   November
    2006   2005
         
Investment Banking
               
 
Financial Advisory
  $     $  
 
Underwriting
    125       125  
Trading and Principal Investments
               
 
FICC
    155       91  
 
Equities (1)
    2,387       2,390  
 
Principal Investments
    22       1  
Asset Management and Securities Services
               
 
Asset Management (2)
    421       424  
 
Securities Services
    117       117  
                 
Total
  $ 3,227     $ 3,148  
                 
 
 
  (1)  Primarily related to SLK.
 
  (2)  Primarily related to Ayco.
      
 
       Identifiable Intangible Assets. We amortize our identifiable intangible assets over their estimated useful lives in accordance with SFAS No. 142, and test for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.

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       The following table sets forth the carrying value and range of remaining useful lives of our identifiable intangible assets by major asset class:
Identifiable Intangible Assets by Asset Class
($ in millions)
                         
    As of August 2006   As of November 2005
         
        Range of Remaining    
    Carrying   Useful Lives   Carrying
    Value   (in years)   Value
             
Customer lists (1)
  $ 749       5 - 19     $ 777  
Power contracts (2)
    691       2 - 22       481  
New York Stock Exchange (NYSE) specialist rights
    553       16  (5)     580  
Insurance-related assets (3)
    382       6        
Exchange-traded fund (ETF) specialist rights
    107       21       111  
Other (4)
    112       1 - 8       106  
                       
Total
  $ 2,594             $ 2,055  
                       
 
 
  (1)  Primarily includes our clearance and execution and NASDAQ customer lists related to SLK and financial counseling customer lists related to Ayco.
 
  (2)  Primarily relates to above-market power contracts of consolidated power generation facilities related to Cogentrix and NEGT. Substantially all of these power contracts have been pledged as collateral to counterparties in connection with certain of our secured short-term and long-term borrowings.
 
  (3)  Consists of the value of business acquired (VOBA) and deferred acquisition costs (DAC). VOBA represents the present value of estimated future gross profits of the variable annuity and variable life insurance business acquired in fiscal 2006. DAC represents commissions paid in connection with providing reinsurance. VOBA and DAC are amortized over the estimated life of the underlying contracts based on estimated gross profits, and amortization is adjusted based on actual experience. The six year useful life represents the weighted average remaining amortization period of the underlying contracts (certain of which extend approximately 30 years).
 
  (4)  Primarily includes technology-related and other assets related to SLK.
 
  (5)  During the first quarter of 2006, we reduced the estimated useful lives of our NYSE specialist rights from 22-24 years to 16 years. This change was due to higher than expected attrition in acquired NYSE specialist rights, primarily from mergers and delistings.
      
 
       A prolonged period of weakness in global equity markets and the trading of securities in multiple markets and on multiple exchanges could adversely impact our businesses and impair the value of our goodwill and/or identifiable intangible assets. In addition, certain events could indicate a potential impairment of our identifiable intangible assets, including (i) changes in market structure that could adversely affect our specialist businesses, (ii) an adverse action or assessment by a regulator, (iii) a default event under a power contract or physical damage or other adverse events impacting the underlying power generation facilities, or (iv) adverse actual experience on the contracts in our variable annuity and variable life insurance business.

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Use of Estimates
       The use of generally accepted accounting principles requires management to make certain estimates. In addition to the estimates we make in connection with fair value measurements and the accounting for goodwill and identifiable intangible assets, the use of estimates is also important in determining compensation and benefits expenses for interim periods and in determining provisions for potential losses that may arise from litigation and regulatory proceedings and tax audits.
       A substantial portion of our compensation and benefits represents discretionary bonuses, which are determined at year end. We believe the most appropriate way to allocate estimated annual discretionary bonuses among interim periods is in proportion to the net revenues earned in such periods. In addition to the level of net revenues, our overall compensation expense in any given year is also influenced by, among other factors, prevailing labor markets, business mix and the structure of our share-based compensation programs. We generally target compensation and benefits at 50% (plus or minus a few percentage points) of consolidated net revenues. During the first nine months of 2006, our ratio of compensation and benefits to net revenues was 49.8%. Excluding the $508 million impact of the continued amortization of prior year share-based awards under SFAS No. 123-R, our ratio of compensation and benefits to net revenues was 48.0% (1).
       We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings and tax audits to the extent that such losses are probable and can be estimated, in accordance with SFAS No. 5, “Accounting for Contingencies.” Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. Given the inherent difficulty of predicting the outcome of our litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred. See “Legal Proceedings” in Part I, Item 3 of the Annual Report on Form 10-K, and in Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarters ended May 26, 2006 and February 24, 2006 and in Part II, Item 1 of this Quarterly Report on Form 10-Q for information on our judicial, regulatory and arbitration proceedings.
 
(1)  Our ratio of compensation and benefits to net revenues, excluding the impact of the continued amortization of prior year share-based awards, is computed by dividing compensation and benefits, excluding the impact of the continued amortization of prior year share-based awards, by net revenues. We believe that presenting the ratio of compensation and benefits to net revenues excluding the impact of the continued amortization of prior year share-based awards granted to retirement-eligible employees increases the comparability of period-to-period operating results and allows for a more meaningful representation of the relationship of current period compensation to net revenues. The following table sets forth the reconciliation of the ratio of compensation and benefits to net revenues, as reported, to the ratio of compensation and benefits to net revenues excluding the impact of the continued amortization of prior year share-based awards:
                         
    Three Months   Nine Months   Six Months
    Ended   Ended   Ended
    August 2006   August 2006   May 2006
             
    ($ in millions)
Compensation and benefits
  $ 3,510     $ 13,897     $ 10,387  
Impact of the continued amortization of prior year share-based awards
    (133 )     (508 )     (375 )
                         
Compensation and benefits, excluding the impact of the continued amortization of prior year share-based awards
  $ 3,377     $ 13,389     $ 10,012  
                         
Net revenues
  $ 7,463     $ 27,895     $ 20,432  
Ratio of compensation and benefits to net revenues, excluding the impact of the continued amortization of prior year share-based awards
    45.2 %     48.0 %     49.0 %

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Results of Operations
       The composition of our net revenues has varied over time as financial markets and the scope of our operations have changed. The composition of net revenues can also vary over the shorter term due to fluctuations in U.S. and global economic and market conditions. For a further discussion of the impact of economic and market conditions on our results of operations, see “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K.
Financial Overview
       The following table sets forth an overview of our financial results:
Financial Overview
($ in millions, except per share amounts)
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
Net revenues
  $ 7,463     $ 7,285     $ 27,895     $ 18,496  
Pre-tax earnings
    2,362       2,405       9,575       5,794  
Net earnings
    1,594       1,617       6,385       3,994  
Net earnings applicable to common shareholders
    1,555       1,608       6,294       3,985  
Diluted earnings per common share
    3.26       3.25       13.12       7.89  
Annualized return on average common shareholders’ equity (1)
    20.9 %     25.1 %     29.6 %     20.7 %
Annualized return on average tangible common shareholders’ equity (2)
    24.9 %     30.7 %     35.6 %     25.3 %
 
 
 
(1) 
Annualized return on average common shareholders’ equity is computed by dividing annualized net earnings applicable to common shareholders by average monthly common shareholders’ equity.
 
 
(2) 
Tangible common shareholders’ equity equals total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets, excluding power contracts and insurance-related intangible assets. Insurance-related intangible assets consist of the value of business acquired (VOBA) and deferred acquisition costs (DAC). VOBA represents the present value of estimated future gross profits of the variable annuity and variable life insurance business acquired in fiscal 2006. DAC represents commissions paid in connection with providing reinsurance. In fiscal 2006, we amended our calculation of tangible common shareholders’ equity. We no longer deduct identifiable intangible assets associated with power contracts and insurance-related assets from common shareholders’ equity, in each case because, unlike other intangible assets, we do not hold material amounts of common shareholders’ equity to support these assets. Prior periods have been restated to conform to the current period presentation.


We believe that annualized return on average tangible common shareholders’ equity is meaningful because it measures the performance of businesses consistently, whether they were acquired or developed internally. Annualized return on average tangible common shareholders’ equity is computed by dividing annualized net earnings applicable to common shareholders by average monthly tangible common shareholders’ equity.


The following table sets forth a reconciliation of average total shareholders’ equity to average tangible common shareholders’ equity:
                                 
    Average for the
     
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
    (in millions)
Total shareholders’ equity
  $ 32,618     $ 26,405     $ 30,498     $ 26,100  
Preferred stock
    (2,850 )     (750 )     (2,190 )     (375 )
                                 
Common shareholders’ equity
    29,768     $ 25,655       28,308     $ 25,725  
Goodwill and identifiable intangible assets, excluding power contracts and insurance-related intangible assets
    (4,745 )     (4,709 )     (4,709 )     (4,746 )
                                 
Tangible common shareholders’ equity
  $ 25,023     $ 20,946     $ 23,599     $ 20,979  
                                 

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  Net Revenues
       Three Months Ended August 2006 versus August 2005. Our net revenues were $7.46 billion for the third quarter of 2006, an increase of 2% compared with the third quarter of 2005, reflecting significantly higher net revenues in Investment Banking and Asset Management and Securities Services, partially offset by lower net revenues in Trading and Principal Investments. The increase in Investment Banking reflected significantly higher net revenues in Underwriting, as both debt and equity underwriting results improved, as well as higher net revenues in Financial Advisory, reflecting increased client activity. Strong net revenue growth in our Asset Management and Securities Services businesses primarily reflected significantly higher management and other fees as well as continued strength in our prime brokerage business. Assets under management increased significantly from a year ago, including net asset inflows of $30 billion during the quarter. Net revenues in Trading and Principal Investments were lower than a particularly strong third quarter of 2005. Net revenues in Principal Investments decreased reflecting a smaller gain related to our investment in the convertible preferred stock of SMFG as well as lower net revenues from our other principal investments. In addition, net revenues in Equities were lower than the same prior year period, while net revenues in FICC were higher than a strong third quarter of 2005. During the quarter, Equities operated in a less favorable environment as equity prices lacked direction and customer-driven activity declined from the first half of the year. In addition, although FICC performed well, the business operated in a less favorable environment, as customer-driven activity declined from the first half of the year and volatility levels were generally low.
       Nine Months Ended August 2006 versus August 2005. Our net revenues were $27.90 billion for the first nine months of 2006, an increase of 51% compared with the same period last year, reflecting strong net revenue growth in each of our three segments. Trading and Principal Investments results reflected significantly higher net revenues in FICC and Equities and a strong performance in Principal Investments. Net revenues in FICC reflected particularly strong results across all major businesses, and net revenues in Equities reflected significant growth in our customer franchise business, while results in principal strategies, although strong, were lower than the same prior year period. In our trading businesses, we saw generally favorable trading and investing opportunities for our clients and ourselves, and consequently increased our market risk in the first half of the year. However, as the environment became more challenging during the third quarter of 2006, our market risk declined, reflecting fewer opportunities in the markets. In Investment Banking, net revenues reflected strong growth in Underwriting and Financial Advisory as industry-wide volumes across equity underwriting and mergers and acquisitions were significantly ahead of the same prior year period and debt underwriting volumes remained at high levels. In Asset Management and Securities Services, revenue growth was driven by record assets under management and significantly higher incentive fees, as well as significantly higher global customer balances in Securities Services.

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  Operating Expenses
       Our operating expenses are primarily influenced by compensation, headcount and levels of business activity. A substantial portion of our compensation expense represents discretionary bonuses, with our overall compensation and benefits expenses generally targeted at 50% (plus or minus a few percentage points) of consolidated net revenues. In addition to the level of net revenues, our compensation expense in any given year is influenced by, among other factors, prevailing labor markets, business mix and the structure of our share-based compensation programs. During the first nine months of 2006, our ratio of compensation and benefits to net revenues was 49.8%. Excluding the $508 million impact of the continued amortization under SFAS No. 123-R of prior year share-based awards granted to retirement-eligible employees, for the first nine months of 2006, our ratio of compensation and benefits to net revenues was 48.0%, down from 49.0% for the first six months of 2006. This lower compensation ratio reflects our strong net revenues in 2006 as well as greater visibility into expected compensation levels as year end approaches. See “— Use of Estimates” above for more information on our ratio of compensation and benefits to net revenues.
       The following table sets forth our operating expenses and number of employees:
Operating Expenses and Employees
($ in millions)
                                 
    Three Months   Nine Months
    Ended August   Ended August
         
    2006   2005   2006   2005
                 
Compensation and benefits (1)
    $3,510       $3,642       $13,897       $9,248  
Brokerage, clearing and exchange fees
    454       271       1,208       797  
Market development
    117       92       338       268  
Communications and technology
    141       124       396       365  
Depreciation and amortization
    126       125       378       371  
Amortization of identifiable intangible assets
    50       31       128       93  
Occupancy
    221       200       613       534  
Professional fees
    135       117       367       322  
Other expenses
    347       278       995       704  
                                 
Total non-compensation expenses
    1,591       1,238       4,423       3,454  
                                 
Total operating expenses
    $5,101       $4,880      <