e10vq
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 March 31, 2011
 
or
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
     
    For the transition period from                        to
 
Commission File Number: 001-14965
 
The Goldman Sachs Group, Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware   13-4019460
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
200 West Street, New York, NY   10282
(Address of principal executive offices)   (Zip Code)
 
(212) 902-1000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x  Yes  o  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x  Yes  o  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x      Accelerated filer o
 
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o  Yes  x  No
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
As of April 21, 2011, there were 517,735,289 shares of the registrant’s common stock outstanding.
 


 

 
THE GOLDMAN SACHS GROUP, INC.
 
QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED MARCH 31, 2011
 
INDEX
 
                 
 
Form 10-Q Item Number   Page No.    
 
      2      
             
        2      
        3      
        4      
        5      
        6      
        7      
        7      
        7      
        8      
        12      
        13      
        19      
        26      
        39      
        43      
        46      
        49      
        54      
        55      
        57      
        57      
        58      
        61      
        62      
        68      
        70      
        74      
        74      
        75      
        75      
        76      
        80      
        81      
        92      
        93      
      96      
      149      
      149      
      149      
      149      
      150      
      150      
      151      
    152      
 
 
 EX-3.1 : CERTIFICATE OF ELIMINATION OF 10% CUMULATIVE PERPETUAL PREFERRED STOCK, SERIES G, OF THE GOLDMAN SACHS GROUP, INC.
 EX-3.2: RESTATED CERTIFICATE OF INCORPORATION OF THE GOLDMAN SACHS GROUP, INC.
 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
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

1


Table of Contents

 
PART I. FINANCIAL INFORMATION
 
Item 1.  Financial Statements (Unaudited)
 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
 
                     
 
    Three Months
    Ended March
in millions, except per share amounts   2011     2010      
 
Revenues
                   
Investment banking
  $ 1,269     $ 1,203      
Investment management
    1,174       1,008      
Commissions and fees
    1,019       880      
Market making
    4,462       6,385      
Other principal transactions
    2,612       1,881      
 
 
Total non-interest revenues
    10,536       11,357      
                     
Interest income
    3,107       3,001      
Interest expense
    1,749       1,583      
 
 
Net interest income
    1,358       1,418      
 
 
Net revenues, including net interest income
    11,894       12,775      
 
 
                     
Operating expenses
                   
Compensation and benefits
    5,233       5,493      
                     
Brokerage, clearing, exchange and distribution fees
    620       562      
Market development
    179       110      
Communications and technology
    198       176      
Depreciation and amortization
    590       372      
Occupancy
    267       256      
Professional fees
    233       182      
Other expenses
    534       465      
 
 
Total non-compensation expenses
    2,621       2,123      
 
 
Total operating expenses
    7,854       7,616      
 
 
                     
Pre-tax earnings
    4,040       5,159      
Provision for taxes
    1,305       1,703      
 
 
Net earnings
    2,735       3,456      
Preferred stock dividends
    1,827       160      
 
 
Net earnings applicable to common shareholders
  $ 908     $ 3,296      
 
 
                     
Earnings per common share
                   
Basic
  $ 1.66     $ 6.02      
Diluted
    1.56       5.59      
                     
Dividends declared per common share
  $ 0.35     $ 0.35      
                     
Average common shares outstanding
                   
Basic
    540.6       546.0      
Diluted
    583.0       590.0      
 
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

2


Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
 
                     
 
    As of 
    March
    December
     
in millions, except share and per share amounts   2011     2010      
 
Assets
                   
Cash and cash equivalents
  $ 42,683     $ 39,788      
Cash and securities segregated for regulatory and other purposes (includes $34,325 and $36,182 at fair value as of March 2011 and December 2010, respectively)
    53,512       53,731      
Collateralized agreements:
                   
Securities purchased under agreements to resell and federal funds sold (includes $162,094 and $188,355 at fair value as of March 2011 and December 2010, respectively)
    162,094       188,355      
Securities borrowed (includes $62,236 and $48,822 at fair value as of March 2011 and December 2010, respectively)
    184,217       166,306      
Receivables from brokers, dealers and clearing organizations
    12,207       10,437      
Receivables from customers and counterparties (includes $8,095 and $7,202 at fair value as of March 2011 and December 2010, respectively)
    75,412       67,703      
Financial instruments owned, at fair value (includes $47,268 and $51,010 pledged as collateral as of March 2011 and December 2010, respectively)
    374,806       356,953      
Other assets
    28,358       28,059      
 
 
Total assets
  $ 933,289     $ 911,332      
 
 
                     
Liabilities and shareholders’ equity
                   
Deposits (includes $1,914 and $1,975 at fair value as of March 2011 and December 2010, respectively)
  $ 38,727     $ 38,569      
Collateralized financings:
                   
Securities sold under agreements to repurchase, at fair value
    165,475       162,345      
Securities loaned (includes $1,430 and $1,514 at fair value as of March 2011 and December 2010, respectively)
    12,222       11,212      
Other secured financings (includes $25,153 and $31,794 at fair value as of March 2011 and December 2010, respectively)
    36,914       38,377      
Payables to brokers, dealers and clearing organizations
    5,572       3,234      
Payables to customers and counterparties
    187,824       187,270      
Financial instruments sold, but not yet purchased, at fair value
    150,998       140,717      
Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $22,212 and $22,116 at fair value as of March 2011 and December 2010, respectively)
    53,746       47,842      
Unsecured long-term borrowings (includes $20,665 and $18,171 at fair value as of March 2011 and December 2010, respectively)
    173,793       174,399      
Other liabilities and accrued expenses (includes $7,400 and $2,972 at fair value as of March 2011 and December 2010, respectively)
    35,549       30,011      
 
 
Total liabilities
    860,820       833,976      
                     
Commitments, contingencies and guarantees
                   
                     
Shareholders’ equity
                   
Preferred stock, par value $0.01 per share; aggregate liquidation preference of $3,100 and $8,100 as of March 2011 and December 2010, respectively
    3,100       6,957      
Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 790,021,786 and 770,949,268 shares issued as of March 2011 and December 2010, respectively, and 517,917,496 and 507,530,772 shares outstanding as of March 2011 and December 2010, respectively
    8       8      
Restricted stock units and employee stock options
    4,759       7,706      
Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding
               
Additional paid-in capital
    44,852       42,103      
Retained earnings
    57,803       57,163      
Accumulated other comprehensive loss
    (330 )     (286 )    
Stock held in treasury, at cost, par value $0.01 per share; 272,104,292 and 263,418,498 shares as of March 2011 and December 2010, respectively
    (37,723 )     (36,295 )    
 
 
Total shareholders’ equity
    72,469       77,356      
 
 
Total liabilities and shareholders’ equity
  $ 933,289     $ 911,332      
 
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
                     
    Three Months Ended     Year Ended      
    March
    December
     
in millions   2011     2010      
 
Preferred stock
                   
Balance, beginning of year
    $ 6,957     $ 6,957      
Repurchased
    (3,857 )          
 
 
Balance, end of period
    3,100       6,957      
Common stock
                   
Balance, beginning of year
    8       8      
Issued
               
 
 
Balance, end of period
    8       8      
Restricted stock units and employee stock options
                   
Balance, beginning of year
    7,706       6,245      
Issuance and amortization of restricted stock units and employee stock options
    1,541       4,137      
Delivery of common stock underlying restricted stock units
    (4,448 )     (2,521 )    
Forfeiture of restricted stock units and employee stock options
    (38 )     (149 )    
Exercise of employee stock options
    (2 )     (6 )    
 
 
Balance, end of period
    4,759       7,706      
Additional paid-in capital
                   
Balance, beginning of year
    42,103       39,770      
Delivery of common stock underlying restricted stock units and proceeds from the exercise of employee stock options
    4,461       3,067      
Cancellation of restricted stock units in satisfaction of withholding tax requirements
    (1,782 )     (972 )    
Excess net tax benefit related to share-based compensation
    105       239      
Cash settlement of share-based compensation
    (35 )     (1 )    
 
 
Balance, end of period
    44,852       42,103      
Retained earnings
                   
Balance, beginning of year
    57,163       50,252      
Net earnings
    2,735       8,354      
Dividends and dividend equivalents declared on common stock and restricted stock units
    (198 )     (802 )    
Dividends on preferred stock
    (1,897 )     (641 )    
 
 
Balance, end of period
    57,803       57,163      
Accumulated other comprehensive income/(loss)
                   
Balance, beginning of year
    (286 )     (362 )    
Currency translation adjustment, net of tax
    (22 )     (38 )    
Pension and postretirement liability adjustments, net of tax
    1       88      
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (23 )     26      
 
 
Balance, end of period
    (330 )     (286 )    
Stock held in treasury, at cost
                   
Balance, beginning of year
    (36,295 )     (32,156 )    
Repurchased
    (1,482 )     (4,185 )    
Reissued
    54       46      
 
 
Balance, end of period
    (37,723 )     (36,295 )    
 
 
Total shareholders’ equity
    $ 72,469     $ 77,356      
 
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

4


Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Cash flows from operating activities
                   
Net earnings
  $ 2,735     $ 3,456      
Non-cash items included in net earnings
                   
Depreciation and amortization
    594       375      
Share-based compensation
    1,512       2,160      
Changes in operating assets and liabilities
                   
Cash and securities segregated for regulatory and other purposes
    219       (6,378 )    
Net receivables from brokers, dealers and clearing organizations
    568       (1,540 )    
Net payables to customers and counterparties
    (9,671 )     (1,793 )    
Securities borrowed, net of securities loaned
    (16,901 )     (13,269 )    
Securities sold under agreements to repurchase, net of securities purchased under agreements to resell and federal funds sold
    29,391       3,068      
Financial instruments owned, at fair value
    (14,701 )     6,986      
Financial instruments sold, but not yet purchased, at fair value
    10,278       11,056      
Other, net
    (2,124 )     (11,625 )    
 
 
Net cash provided by/(used for) operating activities
    1,900       (7,504 )    
Cash flows from investing activities
                   
Purchase of property, leasehold improvements and equipment
    (277 )     (278 )    
Proceeds from sales of property, leasehold improvements and equipment
    9       28      
Business acquisitions, net of cash acquired
    (5 )     (699 )    
Proceeds from sales of investments
    216       173      
Purchase of available-for-sale securities
    (761 )     (864 )    
Proceeds from sales of available-for-sale securities
    930       674      
 
 
Net cash provided by/(used for) investing activities
    112       (966 )    
Cash flows from financing activities
                   
Unsecured short-term borrowings, net
    1,501       525      
Other secured financings (short-term), net
    1,340       (312 )    
Proceeds from issuance of other secured financings (long-term)
    1,291       1,541      
Repayment of other secured financings (long-term), including the current portion
    (3,580 )     (1,880 )    
Proceeds from issuance of unsecured long-term borrowings
    8,805       6,081      
Repayment of unsecured long-term borrowings, including the current portion
    (7,364 )     (5,584 )    
Derivative contracts with a financing element, net
    210       110      
Deposits, net
    158       (987 )    
Common stock repurchased
    (1,481 )     (2,269 )    
Dividends and dividend equivalents paid on common stock, preferred stock and restricted stock units
    (358 )     (363 )    
Proceeds from issuance of common stock, including stock option exercises
    63       138      
Excess tax benefit related to share-based compensation
    333       243      
Cash settlement of share-based compensation
    (35 )          
 
 
Net cash provided by/(used for) financing activities
    883       (2,757 )    
 
 
Net increase/(decrease) in cash and cash equivalents
    2,895       (11,227 )    
Cash and cash equivalents, beginning of year
    39,788       38,291      
 
 
Cash and cash equivalents, end of period
  $ 42,683     $ 27,064      
 
 
SUPPLEMENTAL DISCLOSURES:
 
Cash payments for interest, net of capitalized interest, were $2.71 billion and $2.01 billion during the three months ended March 2011 and March 2010, respectively.
 
Cash payments for income taxes, net of refunds, were $296 million and $778 million during the three months ended March 2011 and March 2010, respectively.
 
Non-cash activities:
 
The firm assumed $90 million of debt in connection with business acquisitions during the three months ended March 2010. In addition, in the first quarter of 2010, the firm recorded an increase of approximately $3 billion in both assets (primarily financial instruments owned, at fair value) and liabilities (primarily unsecured short-term borrowings and other liabilities) upon adoption of Accounting Standards Update (ASU) No. 2009-17, “Consolidations (Topic 810) — Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.”
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

5


Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Net earnings
  $ 2,735     $ 3,456      
Currency translation adjustment, net of tax
    (22 )     (4 )    
Pension and postretirement liability adjustments, net of tax
    1       6      
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (23 )     4      
 
 
Comprehensive income
  $ 2,691     $ 3,462      
 
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

6


Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 

Note 1.  Description of Business
 
The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, together with its consolidated subsidiaries (collectively, the firm), is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.
 
The firm reports its activities in the following four business segments:
 
Investment Banking
The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds and governments. Services include advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, risk management, restructurings and spin-offs, and debt and equity underwriting of public offerings and private placements, as well as derivative transactions directly related to these activities.
 
Institutional Client Services
The firm facilitates client transactions and makes markets in fixed income, equity, currency and commodity products, primarily with institutional clients such as corporates, financial institutions, investment funds and governments. The firm also makes markets and clears client transactions on major stock, options and futures exchanges worldwide and provides financing, securities lending and prime brokerage services to institutional clients.
 
Investing & Lending
The firm invests in and originates loans to provide financing to clients. These investments and loans are typically longer-term in nature. The firm makes investments, directly and indirectly through funds that the firm manages, in debt securities, loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities.

Investment Management
The firm provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. The firm also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.
 
Note 2.  Basis of Presentation
 
These condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. Intercompany transactions and balances have been eliminated.
 
These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements included in the firm’s Annual Report on Form 10-K for the year ended December 31, 2010. References to “the firm’s Annual Report on Form 10-K” are to the firm’s Annual Report on Form 10-K for the year ended December 31, 2010. The condensed consolidated financial information as of December 31, 2010 has been derived from audited consolidated financial statements not included herein.
 
These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.
 
All references to March 2011 and March 2010, unless specifically stated otherwise, refer to the firm’s periods ended, or the dates, as the context requires, March 31, 2011 and March 31, 2010, respectively. All references to December 2010, unless specifically stated otherwise, refer to the date December 31, 2010. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
 
 


7


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 3.  Significant Accounting Policies
 

The firm’s significant accounting policies include when and how to measure the fair value of assets and liabilities, accounting for goodwill and identifiable intangible assets, and when to consolidate an entity. See Notes 5 through 8 for policies on fair value measurements, Note 13 for policies on goodwill and identifiable intangible assets, and below and Note 11 for policies on consolidation accounting. All other significant accounting policies are either discussed below or included in the following footnotes:
 
     
Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value   Note 4
Fair Value Measurements
  Note 5
Cash Instruments
  Note 6
Derivatives and Hedging Activities
  Note 7
Fair Value Option
  Note 8
Collateralized Agreements and Financings
  Note 9
Securitization Activities
  Note 10
Variable Interest Entities
  Note 11
Other Assets
  Note 12
Goodwill and Identifiable Intangible Assets
  Note 13
Deposits
  Note 14
Short-Term Borrowings
  Note 15
Long-Term Borrowings
  Note 16
Other Liabilities and Accrued Expenses
  Note 17
Commitments, Contingencies and Guarantees
  Note 18
Shareholders’ Equity
  Note 19
Regulation and Capital Adequacy
  Note 20
Earnings Per Common Share
  Note 21
Transactions with Affiliated Funds
  Note 22
Interest Income and Interest Expense
  Note 23
Income Taxes
  Note 24
Business Segments
  Note 25
Credit Concentrations
  Note 26
Legal Proceedings
  Note 27

Consolidation
The firm consolidates entities in which the firm has a controlling financial interest. The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (VIE).
 
Voting Interest Entities.  Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the power to direct the activities of the entity that most significantly impact its economic performance, the obligation to absorb the losses of the entity and the right to receive the residual returns of the entity. The usual condition for a controlling financial interest in a voting interest entity is ownership of a majority voting interest. If the firm has a majority voting interest in a voting interest entity, the entity is consolidated.
 
Variable Interest Entities.  A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. The firm has a controlling financial interest in a VIE when the firm has a variable interest or interests that provide it with (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. See Note 11 for further information about VIEs.
 
Equity-Method Investments.  When the firm does not have a controlling financial interest in an entity but can exert significant influence over the entity’s operating and financial policies, the investment is accounted for either (i) under the equity method of accounting or (ii) at fair value by electing the fair value option available under U.S. GAAP. Significant influence generally exists when the firm owns 20% to 50% of the entity’s common stock or in-substance common stock.
 
In general, the firm accounts for investments acquired subsequent to November 24, 2006, when the fair value option became available, at fair value. In certain cases, the firm applies the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, when the firm has a significant degree of involvement in the cash flows or operations of the investee or when cost-benefit considerations are less significant. See Note 12 for further information about equity-method investments.


8


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Investment Funds.  The firm has formed numerous investment funds with third-party investors. These funds are typically organized as limited partnerships or limited liability companies for which the firm acts as general partner or manager. Generally, the firm does not hold a majority of the economic interests in these funds. These funds are usually voting interest entities and generally are not consolidated because third-party investors typically have rights to terminate the funds or to remove the firm as general partner or manager. Investments in these funds are included in “Financial instruments owned, at fair value.” See Notes 6, 18 and 22 for further information about investments in funds.
 
Use of Estimates
Preparation of these condensed consolidated financial statements requires management to make certain estimates and assumptions, the most important of which relate to fair value measurements, accounting for goodwill and identifiable intangible assets, discretionary compensation accruals and the provision for losses that may arise from litigation, regulatory proceedings and tax audits. These estimates and assumptions are based on the best available information but actual results could be materially different.
 
Revenue Recognition
Financial Assets and Financial Liabilities at Fair Value.  Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value are recorded at fair value either under the fair value option or in accordance with other U.S. GAAP. In addition, the firm has elected to account for certain of its other financial assets and financial liabilities at fair value by electing the fair value option. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs. Fair value gains or losses are generally included in “Market making” for positions in Institutional Client Services and “Other principal transactions” for positions in Investing & Lending. See Notes 5 through 8 for further information about fair value measurements.

Investment Banking.  Fees from financial advisory assignments and underwriting revenues are recognized in earnings when the services related to the underlying transaction are completed under the terms of the assignment. Expenses associated with such transactions are deferred until the related revenue is recognized or the assignment is otherwise concluded. Expenses associated with financial advisory assignments are recorded as non-compensation expenses, net of client reimbursements. Underwriting revenues are presented net of related expenses.
 
Investment Management.  The firm earns management fees and incentive fees for investment management services. Management fees are calculated as a percentage of net asset value, invested capital or commitments, and are recognized over the period that the related service is provided. Incentive fees are calculated as a percentage of a fund’s or separately managed account’s return, or excess return above a specified benchmark or other performance target. Incentive fees are generally based on investment performance over a 12-month period or over the life of a fund. Fees that are based on performance over a 12-month period are subject to adjustment prior to the end of the measurement period. For fees that are based on investment performance over the life of the fund, future investment underperformance may require fees previously distributed to the firm to be returned to the fund. Incentive fees are recognized only when all material contingencies have been resolved. Management and incentive fee revenues are included in “Investment management” revenues.
 
Commissions and Fees.  The firm earns “Commissions and fees” from executing and clearing client transactions on stock, options and futures markets. Commissions and fees are recognized on the day the trade is executed.


9


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Transfers of Assets
Transfers of assets are accounted for as sales when the firm has relinquished control over the assets transferred. For transfers of assets accounted for as sales, any related gains or losses are recognized in net revenues. Assets or liabilities that arise from the firm’s continuing involvement with transferred assets are measured at fair value. For transfers of assets that are not accounted for as sales, the assets remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Note 9 for further information about transfers of assets accounted for as collateralized financings and Note 10 for further information about transfers of assets accounted for as sales.
 
Receivables from Customers and Counterparties
Receivables from customers and counterparties generally consist of collateralized receivables, primarily customer margin loans, related to client transactions. Certain of the firm’s receivables from customers and counterparties are accounted for at fair value under the fair value option, with changes in fair value generally included in “Market making” revenues. See Note 8 for further information about the fair values of these receivables. Receivables from customers and counterparties not accounted for at fair value are accounted for at amortized cost net of estimated uncollectible amounts, which generally approximates fair value. Interest on receivables from customers and counterparties is recognized over the life of the transaction and included in “Interest income.”

Insurance Activities
Certain of the firm’s insurance and reinsurance contracts are accounted for at fair value under the fair value option, with changes in fair value included in “Market making” revenues. See Note 8 for further information about the fair values of these insurance and reinsurance contracts.
 
Revenues from variable annuity and life insurance and reinsurance contracts not accounted for at fair value generally consist of fees assessed on contract holder account balances for mortality charges, policy administration fees and surrender charges. These revenues are recognized in earnings over the period that services are provided and are included in “Market making” revenues. Interest credited to variable annuity and life insurance and reinsurance contract account balances and changes in reserves are recognized in “Other expenses.”
 
Premiums earned for underwriting property catastrophe reinsurance are recognized in earnings over the coverage period, net of premiums ceded for the cost of reinsurance, and are included in “Market making” revenues. Expenses for liabilities related to property catastrophe reinsurance claims, including estimates of losses that have been incurred but not reported, are included in “Other expenses.”


10


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Share-based Compensation
The cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based employee awards that require future service are amortized over the relevant service period. Expected forfeitures are included in determining share-based employee compensation expense.
 
The firm pays cash dividend equivalents on outstanding restricted stock units (RSUs). Dividend equivalents paid on RSUs are generally charged to retained earnings. Dividend equivalents paid on RSUs expected to be forfeited are included in compensation expense.
 
The firm accounts for the tax benefit related to dividend equivalents paid on RSUs as an increase to additional paid-in capital.
 
In certain cases, primarily related to the death of an employee or conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation awards. For awards accounted for as equity instruments, additional paid-in capital is adjusted to the extent of the difference between the current value of the award and the grant-date value of the award.
 
Foreign Currency Translation
Assets and liabilities denominated in non-U.S. currencies are translated at rates of exchange prevailing on the date of the condensed consolidated statements of financial condition and revenues and expenses are translated at average rates of exchange for the period. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are recognized in earnings. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, in the condensed consolidated statements of comprehensive income.

Cash and Cash Equivalents
The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business. As of March 2011 and December 2010, “Cash and cash equivalents” included $3.23 billion and $5.75 billion, respectively, of cash and due from banks and $39.45 billion and $34.04 billion, respectively, of interest-bearing deposits with banks.
 
Recent Accounting Developments
Improving Disclosures about Fair Value Measurements.  In January 2010, the FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements.” ASU No. 2010-06 provides amended disclosure requirements related to fair value measurements. Certain of these disclosure requirements became effective for the firm beginning in the first quarter of 2010, while others became effective for the firm beginning in the first quarter of 2011. Since these amended principles require only additional disclosures concerning fair value measurements, adoption did not affect the firm’s financial condition, results of operations or cash flows.
 
Reconsideration of Effective Control for Repurchase Agreements. In April 2011, the FASB issued ASU No. 2011-03, “Transfers and Servicing (Topic 860) — Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 changes the assessment of effective control by removing (i) the criterion that requires the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee, and (ii) the collateral maintenance implementation guidance related to that criterion. ASU No. 2011-03 is effective for periods beginning after December 15, 2011. The adoption of ASU No. 2011-03 will not affect the firm’s financial condition, results of operations or cash flows.
 


11


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 4.  Financial Instruments Owned, at Fair Value and Financial Instruments Sold, But Not Yet Purchased, at Fair Value
 

Financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value are accounted for at fair value either under the fair value option or in accordance with other U.S. GAAP. See Note 8 for further information about the fair value option. The table below presents 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. Financial instruments owned, at fair value included $3.41 billion and $3.67 billion as of March 2011 and December 2010, respectively, of securities accounted for as available-for-sale, substantially all of which are held in the firm’s insurance subsidiaries.
 


 
                                     
 
    As of March 2011     As of December 2010
          Financial
          Financial
     
          Instruments
          Instruments
     
    Financial
    Sold, But
    Financial
    Sold, But
     
    Instruments
    Not Yet
    Instruments
    Not Yet
     
in millions   Owned     Purchased     Owned     Purchased      
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
    $ 13,100  2   $       $ 11,262  2   $      
U.S. government and federal agency obligations
    100,222       30,138       84,928       23,264      
Non-U.S. government obligations
    44,540       28,423       40,675       29,009      
Mortgage and other asset-backed loans and securities:
                                   
Loans and securities backed by commercial real estate
    5,912             6,200       5      
Loans and securities backed by residential real estate
    8,426       5       9,404       6      
Loan portfolios
    1,314  3           1,438  3          
Bank loans and bridge loans
    18,063       1,428  4     18,039       1,487  4    
Corporate debt securities
    26,515       7,745       24,719       7,219      
State and municipal obligations
    2,718             2,792            
Other debt obligations
    3,599             3,232            
Equities and convertible debentures
    75,343       31,861       67,833       24,988      
Commodities
    5,911       7       13,138       9      
Derivatives 1
    69,143       51,391       73,293       54,730      
 
 
Total
    $374,806     $ 150,998       $356,953     $ 140,717      
 
 
 
1.   Net of cash collateral received or posted under credit support agreements and reported on a net-by-counterparty basis when a legal right of setoff exists under an enforceable netting agreement.
 
2.   Includes $2.91 billion and $4.06 billion as of March 2011 and December 2010, respectively, of money market instruments held by William Street Funding Corporation (Funding Corp.) to support the William Street credit extension program. See Note 18 for further information about the William Street credit extension program.
 
3.   Consists of acquired portfolios of distressed loans, primarily backed by commercial and residential real estate.
 
4.   Includes the fair value of unfunded commitments to extend credit. The fair value of partially funded commitments is primarily included in “Financial instruments owned, at fair value.”

12


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
 

Gains and Losses from Market Making and Other Principal Transactions
The table below presents, by major product type, the firm’s “Market making” and “Other principal transactions” revenues. These gains/(losses) are primarily related to the firm’s financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, including both derivative and non-derivative financial instruments. These gains/(losses) exclude related interest income and interest expense. See Note 23 for further information about interest income and interest expense.
 
The gains/(losses) in the table are not representative of the manner in which the firm manages its business activities because many of the firm’s market making, client facilitation, and investing and lending strategies utilize financial instruments across various product types. Accordingly, gains or losses in one product type frequently offset gains or losses in other product types.
 
For example, most of the firm’s longer-term derivatives are sensitive to changes in interest rates and may be economically hedged with interest rate swaps. Similarly, a significant portion of the firm’s cash instruments and derivatives has exposure to foreign currencies and may be economically hedged with foreign currency contracts.
 
                     
 
    Three Months Ended March
in millions   2011     2010      
 
Interest rates
  $ 2,406     $ (1,932 )    
Credit
    2,051       4,233      
Currencies
    (1,606 )     3,439      
Equities
    2,850       1,381      
Commodities
    957       609      
Other
    416       536      
 
 
Total
  $ 7,074     $ 8,266      
 
 
 
Note 5.  Fair Value Measurements
 
The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets are marked to bid prices and financial liabilities are marked to offer prices. Fair value measurements do not include transaction costs.

The best evidence of fair value is a quoted price in an active market. If listed prices or quotations are not available, fair value is determined by reference to prices for similar instruments, quoted prices or recent transactions in less active markets, or internally developed models that primarily use, as inputs, market-based or independently sourced parameters, including but not limited to interest rates, volatilities, equity or debt prices, foreign exchange rates, commodities prices and credit curves.
 
U.S. GAAP has a three-level fair value hierarchy for disclosure of fair value measurements. The fair value hierarchy prioritizes inputs to the valuation techniques used to measure fair value, giving the highest priority to level 1 inputs and the lowest priority to level 3 inputs. A financial instrument’s level in the fair value hierarchy is based on the lowest level of any input that is significant to its fair value measurement.
 
The fair value hierarchy is as follows:
 
Level 1.  Inputs are unadjusted quoted prices in active markets to which the firm had access at the measurement date for identical, unrestricted assets or liabilities.
 
Level 2.  Inputs to valuation techniques are observable, either directly or indirectly.
 
Level 3.  One or more inputs to valuation techniques are significant and unobservable.
 
See Notes 6 and 7 for further information about fair value measurements of cash instruments and derivatives, respectively.
 
The fair value of certain level 2 and level 3 financial assets and financial liabilities may include valuation adjustments for counterparty and the firm’s credit quality, transfer restrictions, large and/or concentrated positions, illiquidity and bid/offer inputs. See Notes 6 and 7 for further information about valuation adjustments.
 
 


13


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Level 3 financial assets are summarized below.
 
                     
 
    As of
    March
    December
     
in millions   2011     2010      
 
Total level 3 assets
  $ 45,843     $ 45,377      
Total assets
  $ 933,289     $ 911,332      
Total financial assets at fair value
  $ 641,556     $ 637,514      
Total level 3 assets as a percentage of Total assets
    4.9%       5.0%      
Total level 3 assets as a percentage of Total financial assets at fair value
    7.1%       7.1%      
 
 
 
Financial Assets and Financial Liabilities by Level

The tables below present, by level within the fair value hierarchy, financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value, and other financial assets and financial liabilities accounted for at fair value under the fair value option. See Notes 6 and 7 for further information on the assets

and liabilities included in cash instruments and derivatives, respectively, and their valuation methodologies and inputs. See Note 8 for the valuation methodologies and inputs for other financial assets and financial liabilities accounted for at fair value under the fair value option.
 


                                             
 
    Financial Assets at Fair Value as of March 2011 
                      Netting and
           
in millions   Level 1     Level 2     Level 3     Collateral     Total      
 
Total cash instruments
  $ 132,377     $ 139,760     $ 33,526     $     $ 305,663      
Total derivatives
    43       164,843       11,837       (107,580 ) 3     69,143      
 
 
Financial instruments owned, at fair value
    132,420       304,603       45,363       (107,580 )     374,806      
Securities segregated for regulatory and other purposes
    19,584  1     14,741  2                 34,325      
Securities purchased under agreements to resell
          161,936       158             162,094      
Securities borrowed
          62,236                   62,236      
Receivables from customers and counterparties
          7,773       322             8,095      
 
 
Total
  $ 152,004     $ 551,289     $ 45,843     $ (107,580 )   $ 641,556      
 
 
 
                                             
 
    Financial Liabilities at Fair Value as of March 2011 
                      Netting and
           
in millions   Level 1     Level 2     Level 3     Collateral     Total      
 
Total cash instruments
  $ 88,633     $ 10,492     $ 482     $     $ 99,607      
Total derivatives
    167       63,838       5,034       (17,648 ) 3     51,391      
 
 
Financial instruments sold, but not yet purchased, at fair value
    88,800       74,330       5,516       (17,648 )     150,998      
Deposits
          1,914                   1,914      
Securities sold under agreements to repurchase
          163,529       1,946             165,475      
Securities loaned
          1,430                   1,430      
Other secured financings
          18,046       7,107             25,153      
Unsecured short-term borrowings
          19,003       3,209             22,212      
Unsecured long-term borrowings
          18,261       2,404             20,665      
Other liabilities and accrued expenses
          548       6,852             7,400      
 
 
Total
  $ 88,800     $ 297,061     $ 27,034  4   $ (17,648 )   $ 395,247      
 
 
 
1.   Principally consists of U.S. Department of the Treasury (U.S. Treasury) securities and money market instruments as well as insurance separate account assets measured at fair value.
 
2.   Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
3.   Represents cash collateral and the impact of netting across levels of the fair value hierarchy. Netting among positions classified in the same level is included in that level.
 
4.   Level 3 liabilities were 6.8% of total financial liabilities at fair value.
 

14


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                             
 
    Financial Assets at Fair Value as of December 2010 
                      Netting and
           
in millions   Level 1     Level 2     Level 3     Collateral     Total      
 
Total cash instruments
  $ 117,800     $ 133,653     $ 32,207     $     $ 283,660      
Total derivatives
    93       172,513       12,772       (112,085 3     73,293      
 
 
Financial instruments owned, at fair value
    117,893       306,166       44,979       (112,085 )     356,953      
Securities segregated for regulatory and other purposes
    19,794  1     16,388  2                 36,182      
Securities purchased under agreements to resell
          188,255       100             188,355      
Securities borrowed
          48,822                   48,822      
Receivables from customers and counterparties
          6,904       298             7,202      
 
 
Total
  $ 137,687     $ 566,535     $ 45,377     $ (112,085 )   $ 637,514      
 
 
 
                                             
 
    Financial Liabilities at Fair Value as of December 2010 
                      Netting and
           
in millions   Level 1     Level 2     Level 3     Collateral     Total      
 
Total cash instruments
  $ 75,668     $ 9,873     $ 446     $     $ 85,987      
Total derivatives
    45       66,963       5,210       (17,488 3     54,730      
 
 
Financial instruments sold, but not yet purchased, at fair value
    75,713       76,836       5,656       (17,488 )     140,717      
Deposits
          1,975                   1,975      
Securities sold under agreements to repurchase
          160,285       2,060             162,345      
Securities loaned
          1,514                   1,514      
Other secured financings
          23,445       8,349             31,794      
Unsecured short-term borrowings
          18,640       3,476             22,116      
Unsecured long-term borrowings
          16,067       2,104             18,171      
Other liabilities and accrued expenses
          563       2,409             2,972      
 
 
Total
  $ 75,713     $ 299,325     $ 24,054  4   $ (17,488 )   $ 381,604      
 
 
 
1.   Principally consists of U.S. Treasury securities and money market instruments as well as insurance separate account assets measured at fair value.
 
2.   Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
3.   Represents cash collateral and the impact of netting across levels of the fair value hierarchy. Netting among positions classified in the same level is included in that level.
 
4.   Level 3 liabilities were 6.3% of total financial liabilities at fair value.

15


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Level 3 Unrealized Gains/(Losses)

Cash Instruments.  Level 3 cash instruments are frequently economically hedged with level 1 and level 2 cash instruments and/or level 1, level 2 and level 3 derivatives. Accordingly, gains or losses that are reported in level 3 can be partially offset by gains or losses attributable to level 1 or level 2 cash instruments and/or level 1, level 2 and level 3 derivatives.
 
Derivatives.  Gains and losses on level 3 derivatives should be considered in the context of the following:
 
•   A derivative with level 1 and/or level 2 inputs is classified in level 3 in its entirety if it has at least one significant level 3 input.
 
•   If there is one significant level 3 input, the entire gain or loss from adjusting only observable inputs (i.e., level 1 and level 2 inputs) is classified as level 3.

•   Gains or losses that have been reported in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to level 1 or level 2 derivatives and/or level 1, level 2 and level 3 cash instruments.
 
The table below presents the unrealized gains/(losses) on level 3 financial assets and financial liabilities at fair value still held at the period-end. See Notes 6 and 7 for further information about level 3 cash instruments and derivatives, respectively. See Note 8 for further information about other financial assets and financial liabilities at fair value under the fair value option.
 


 
                     
 
    Level 3 Unrealized
    Gains/(Losses)
    Three Months
    Ended March
in millions   2011     2010      
 
Cash instruments — assets
  $ 1,262     $ 833      
Cash instruments — liabilities
    (41 )     34      
 
 
Net unrealized gains on level 3 cash instruments
    1,221       867      
Derivatives — net
    (560 )     1,568      
Receivables from customers and counterparties
    16       (28 )    
Other secured financings
    (9 )     (10 )    
Unsecured short-term borrowings
    204       82      
Unsecured long-term borrowings
    (45 )     12      
Other liabilities and accrued expenses
    (152 )     64      
 
 
Total
  $ 675     $ 2,555      
 
 
 
 

Gains and losses in the table above include:
 
Three Months Ended March 2011
 
•   A net unrealized gain on cash instruments of $1.22 billion primarily consisting of unrealized gains on bank loans and bridge loans, private equity investments, and corporate debt securities. Gains during the first quarter of 2011 reflected strengthening global credit markets and equity markets.
 
•   A net unrealized loss on derivatives of $560 million primarily attributable to increases in equity index prices, tighter credit spreads and changes in foreign exchange rates (all of which are level 2 observable inputs) on the underlying instruments.

Three Months Ended March 2010
 
•   A net unrealized gain on cash instruments of $867 million, primarily consisting of unrealized gains on corporate debt securities, bank loans and bridge loans, loans and securities backed by commercial real estate, and loans and securities backed by residential real estate reflecting a decrease in market yields evidenced by sales of similar assets during the period.
 
•   A net unrealized gain on derivatives of $1.57 billion, primarily attributable to changes in foreign exchange rates and interest rates (which are level 2 inputs) underlying certain credit derivatives. These unrealized gains were substantially offset by unrealized losses on currency, interest rate and credit derivatives which are classified within level 2 and are used to economically hedge derivatives classified within level 3.
 
 


16


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Level 3 Rollforward

If a financial asset or financial liability was transferred to level 3 during a reporting period, its entire gain or loss for the period is included in level 3. Transfers between levels are recognized at the beginning of the reporting period in which they occur.
 
See Notes 6 and 7 for further information about cash instruments and derivatives included in level 3,

respectively. See Note 8 for other financial assets and financial liabilities at fair value under the fair value option.
 
The tables below present changes in fair value for all financial assets and financial liabilities categorized as level 3 as of the end of the period.
 


 
                                                                     
 
    Level 3 Financial Assets at Fair Value for the Three Months Ended March 2011 
                Net unrealized
                                   
                gains/(losses)
                      Net
           
          Net
    relating to
                      transfers
           
    Balance,
    realized
    instruments
                      in and/or
    Balance,
     
    beginning
    gains/
    still held at
                      (out) of
    end of
     
in millions   of period     (losses)     period-end     Purchases     Sales     Settlements     level 3     period      
 
Total cash instruments — assets
  $ 32,207     $ 434  1   $ 1,262  1   $ 2,816     $ (1,944 )   $ (1,412 )   $ 163     $ 33,526      
Total derivatives — net
    7,562       74  2     (560 ) 2, 3     796       (945 )     (567 )     443       6,803      
Securities purchased under agreements to resell
    100       2             64             (8 )           158      
Receivables from customers and counterparties
    298             16       14             (6 )           322      
 
 
 
1.   The aggregate amounts include approximately $1.26 billion and $432 million reported in “Non-interest revenues” (“Market making” and “Other principal transactions”) and “Interest income,” respectively.
 
2.   Substantially all is reported in “Non-interest revenues” (“Market making” and “Other principal transactions”).
 
3.   Principally resulted from changes in level 2 inputs.
 
                                                                             
 
    Level 3 Financial Liabilities at Fair Value for the Three Months Ended March 2011 
                Net unrealized
                                         
                (gains)/losses
                            Net
           
          Net
    relating to
                            transfers
           
    Balance,
    realized
    instruments
                            in and/or
    Balance,
     
    beginning
    (gains)/
    still held at
                            (out) of
    end of
     
in millions   of period     losses     period-end     Purchases     Sales     Issuances     Settlements     level 3     period      
 
Total cash instruments — liabilities
  $ 446     $ (22 )   $ 41     $ (59 )   $ 90     $     $ 8     $ (22 )   $ 482      
Securities sold under agreements to repurchase, at fair value
    2,060                                     (114 )           1,946      
Other secured financings
    8,349             9                   11       (1,262 )           7,107      
Unsecured short-term borrowings
    3,476       60       (204 )                 562       (153 )     (532 )     3,209      
Unsecured long-term borrowings
    2,104       4       45                   241       (72 )     82       2,404      
Other liabilities and accrued expenses
    2,409             152       4,337                   (46 )           6,852      
 
 
 



17


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Significant transfers in or out of level 3 during the three months ended March 2011, included:
 
•   Unsecured short-term borrowings and Unsecured long-term borrowings: net transfer out of level 3 of $532 million and net transfer into level 3 of $82 million, respectively, principally due to a transfer of approximately $230 million from level 3

  Unsecured short-term borrowings to level 3 Unsecured long-term borrowings related to an extension in the tenor of certain borrowings and the transfer to level 2 of certain short-term and long-term hybrid financial instruments due to improved transparency of the equity price inputs used to value these financial instruments.


 
                                                     
 
    Level 3 Financial Assets at Fair Value for the Three Months Ended March 2010 
                Net unrealized
                       
                gains/(losses)
    Net
                 
          Net
    relating to
    purchases,
    Net
           
    Balance,
    realized
    instruments
    issuances
    transfers in
    Balance,
     
    beginning
    gains/
    still held at
    and
    and/or (out)
    end of
     
in millions   of period     (losses)     period-end     settlements     of level 3     period      
 
Total cash instruments — assets
      $34,879     $ 501  1   $ 833  1   $ (2,064 )   $ (1,621 )   $ 32,528      
Total derivatives — net
    5,196       369  2     1,568  2, 3     (917 )     120       6,336      
Securities purchased under agreements to resell
                            268       268      
Receivables from customers and counterparties
          6       (28 )           256       234      
 
 
 
1.   The aggregate amounts include approximately $961 million and $373 million reported in “Non-interest revenues” (“Market making” and “Other principal transactions”) and “Interest income,” respectively.
 
2.   Substantially all is reported in “Non-interest revenues” (“Market making” and “Other principal transactions”).
 
3.   Principally resulted from changes in level 2 inputs.
 
                                                     
 
    Level 3 Financial Liabilities at Fair Value for the Three Months Ended March 2010 
                Net unrealized
                       
                (gains)/losses
    Net
                 
          Net
    relating to
    purchases,
    Net
           
    Balance,
    realized
    instruments
    issuances
    transfers in
    Balance,
     
    beginning
    (gains)/
    still held at
    and
    and/or(out)
    end of
     
in millions   of period     losses     period-end     settlements     of level 3     period      
 
Total cash instruments — liabilities
    $  572     $ (14 )   $ (34 )   $ (10 )   $ (31 )   $ 483      
Securities sold under agreements to repurchase, at fair value
    394                   494       167       1,055      
Other secured financings
    6,756       9       10       1,172       192       8,139      
Unsecured short-term borrowings
    2,310       21       (82 )     (139 )     884       2,994      
Unsecured long-term borrowings
    3,077       13       (12 )     33       (1,396 )     1,715      
Other liabilities and accrued expenses
    1,913       3       (64 )           475       2,327      
 
 
 

Significant transfers in or out of level 3 during the three months ended March 2010, which were principally due to the consolidation of certain VIEs upon adoption of ASU No. 2009-17 as of January 1, 2010, included:
 
•   Unsecured long-term borrowings: net transfer out of level 3 of $1.40 billion, principally due to the consolidation of certain VIEs which caused the firm’s borrowings from these VIEs to become intercompany borrowings which were eliminated in consolidation. Substantially all of these borrowings were level 3.

•   Unsecured short-term borrowings: net transfer into level 3 of $884 million, principally due to the consolidation of certain VIEs.
 
•   Other liabilities and accrued expenses: net transfer into level 3 of $475 million, principally due to an increase in subordinated liabilities issued by certain consolidated VIEs.


18


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 



Note 6.  Cash Instruments
 

Cash instruments include U.S. government and federal agency obligations, non-U.S. government obligations, bank loans and bridge loans, corporate debt securities, equities and convertible debentures, and other non-derivative financial instruments owned and financial instruments sold, but not yet purchased. See below for the types of cash instruments included in each level of the fair value hierarchy and the valuation techniques and significant inputs used to determine their fair values. See Note 5 for an overview of the firm’s fair value measurement policies and the fair value hierarchy.
 
Level 1 Cash Instruments
Level 1 cash instruments include U.S. government obligations and most non-U.S. government obligations, actively traded listed equities and certain money market instruments. These instruments are valued using quoted prices for identical unrestricted instruments in active markets.
 
The firm defines active markets for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalization for the instrument. The firm defines active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity.
 
The fair value of a level 1 instrument is calculated as quantity held multiplied by quoted market price. U.S. GAAP prohibits valuation adjustments being applied to level 1 instruments even in situations where the firm holds a large position and a sale could impact the quoted price.

Level 2 Cash Instruments
Level 2 cash instruments include commercial paper, certificates of deposit, time deposits, most government agency obligations, most corporate debt securities, commodities, certain mortgage-backed loans and securities, certain bank loans and bridge loans, less liquid publicly listed equities, certain state and municipal obligations and certain money market instruments and lending commitments.
 
Valuations of level 2 cash instruments can be verified to quoted prices, recent trading activity for identical or similar instruments, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.
 
Valuation adjustments are typically made to level 2 cash instruments (i) if the cash instrument is subject to transfer restrictions, and/or (ii) for other premiums and discounts that a market participant would require to arrive at fair value. Valuation adjustments are generally based on market evidence.
 
Level 3 Cash Instruments
Level 3 cash instruments have one or more significant valuation inputs that are not observable. Absent evidence to the contrary, level 3 cash instruments are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequently, the firm uses other methodologies to determine fair value, which vary based on the type of instrument. Valuation inputs and assumptions are changed when corroborated by substantive observable evidence, including values realized on sales of level 3 assets.
 
The table below presents the valuation techniques and the nature of significant inputs generally used to determine the fair values of each class of level 3 cash instrument.


19


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 



       
 Level 3 Cash Instrument     Valuation Techniques and Significant Inputs
 
Loans and securities backed by commercial real estate

•  Collateralized by a single commercial real estate property or a portfolio of properties

•  May include tranches of varying levels of subordination
    Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

Significant inputs for these valuations include:

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

 •  Current levels and changes in market indices such as the CMBX (an index that tracks
       the performance of commercial mortgage bonds)

 •  Market yields implied by transactions of similar or related assets

 •  Current performance of the underlying collateral

 •  Capitalization rates and multiples
 
 
Loans and securities backed by residential real estate

•  Collateralized by portfolios of residential real estate

•  May include tranches of varying levels of subordination
   
Valuation techniques vary by instrument, but are generally based on relative value analyses, discounted cash flow techniques or a combination thereof.

Significant inputs are determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles, including relevant indices such as the ABX (an index that tracks the performance of subprime residential mortgage bonds). Significant inputs include:

 •  Home price projections, residential property liquidation timelines and related costs

 •  Underlying loan prepayment, default and cumulative loss expectations

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

 •  Market yields implied by transactions of similar or related assets
 
 
Loan portfolios

•  Acquired portfolios of distressed loans

•  Primarily backed by commercial and residential real estate collateral
    Valuations are based on discounted cash flow techniques.

Significant inputs are determined based on relative value analyses which incorporate comparisons to recent auction data for other similar loan portfolios. Significant inputs include:

 •  Amount and timing of expected future cash flows

 •  Market yields implied by transactions of similar or related assets
 
 
Bank loans and bridge loans

Corporate debt securities

State and municipal obligations

Other debt obligations
   
Valuation techniques vary by instrument, but are generally based on discounted cash flow techniques.

Significant inputs are generally determined based on relative value analyses, which incorporate comparisons both to prices of credit default swaps that reference the same or similar underlying credit risk and to other debt instruments for the same issuer for which observable prices or broker quotations are available. Significant inputs include:

 •  Amount and timing of expected future cash flows

 •  Current levels and trends of market indices such as CDX, LCDX and MCDX (indices that track the performance of corporate credit, loans and municipal obligations, respectively)

 •  Market yields implied by transactions of similar or related assets

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

•  Private equity investments
    Recent third-party investments or pending transactions are considered to be the best evidence for any change in fair value. When these are not available, the following valuation methodologies are used, as appropriate and available:

 •  Transactions in similar instruments

 •  Discounted cash flow techniques

 •  Third-party appraisals

 •  Industry multiples and public comparables

Evidence includes recent or pending reorganizations (e.g., merger proposals, tender offers, debt restructurings) and significant changes in financial metrics, such as:

 •  Current financial performance as compared to projected performance

 •  Capitalization rates and multiples

 •  Market yields implied by transactions of similar or related assets
 
 

20


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Cash Instruments by Level

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

included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.
 


 
                                     
 
    Cash Instrument Assets at Fair Value as of March 2011 
in millions   Level 1     Level 2     Level 3     Total      
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 6,181     $ 6,919     $     $ 13,100      
U.S. government and federal agency obligations
    39,466       60,756             100,222      
Non-U.S. government obligations
    39,420       5,120             44,540      
Mortgage and other asset-backed loans and securities 1:
                                   
Loans and securities backed by commercial real estate
          3,391       2,521       5,912      
Loans and securities backed by residential real estate
          5,790       2,636       8,426      
Loan portfolios
          2       1,312       1,314      
Bank loans and bridge loans
          8,134       9,929       18,063      
Corporate debt securities 2
    118       23,259       3,138       26,515      
State and municipal obligations
          1,976       742       2,718      
Other debt obligations 2
          2,116       1,483       3,599      
Equities and convertible debentures
    47,192  3     16,386  4     11,765  5     75,343      
Commodities
          5,911             5,911      
 
 
Total
  $ 132,377     $ 139,760     $ 33,526     $ 305,663      
 
 
                                     
 
    Cash Instrument Liabilities at Fair Value as of March 2011 
in millions   Level 1     Level 2     Level 3     Total      
 
U.S. government and federal agency obligations
  $ 29,933     $ 205     $     $ 30,138      
Non-U.S. government obligations
    27,860       563             28,423      
Mortgage and other asset-backed loans and securities:
                                   
Loans and securities backed by residential real estate
          1       4       5      
Bank loans and bridge loans
          987       441       1,428      
Corporate debt securities 6
    27       7,693       25       7,745      
Equities and convertible debentures 7
    30,813       1,036       12       31,861      
Commodities
          7             7      
 
 
Total
  $ 88,633     $ 10,492     $ 482     $ 99,607      
 
 
 
1.   Includes $371 million and $607 million of collateralized debt obligations (CDOs) backed by real estate in level 2 and level 3, respectively.
 
2.   Includes $624 million and $1.61 billion of CDOs and collateralized loan obligations (CLOs) backed by corporate obligations in level 2 and level 3, respectively.
 
3.   Consists of publicly listed equity securities.
 
4.   Principally consists of restricted and less liquid publicly listed securities.
 
5.   Includes $10.54 billion of private equity investments, $1.13 billion of real estate investments and $93 million of convertible debentures.
 
6.   Includes $8 million and $19 million of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.
 
7.   Substantially all consists of publicly listed equity securities.
 
 

21


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                     
 
    Cash Instrument Assets at Fair Value as of December 2010 
in millions   Level 1     Level 2     Level 3     Total      
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 4,344     $ 6,918     $     $ 11,262      
U.S. government and federal agency obligations
    36,184       48,744             84,928      
Non-U.S. government obligations
    35,504       5,171             40,675      
Mortgage and other asset-backed loans and securities 1:
                                   
Loans and securities backed by commercial real estate
          3,381       2,819       6,200      
Loans and securities backed by residential real estate
          7,031       2,373       9,404      
Loan portfolios
          153       1,285       1,438      
Bank loans and bridge loans
          8,134       9,905       18,039      
Corporate debt securities 2
    108       21,874       2,737       24,719      
State and municipal obligations
          2,038       754       2,792      
Other debt obligations
          1,958       1,274       3,232      
Equities and convertible debentures
    41,660  3     15,113  4     11,060  5     67,833      
Commodities
          13,138             13,138      
 
 
Total
  $ 117,800     $ 133,653     $ 32,207     $ 283,660      
 
 
                                     
 
    Cash Instrument Liabilities at Fair Value as of December 2010 
in millions   Level 1     Level 2     Level 3     Total      
 
U.S. government and federal agency obligations
  $ 23,191     $ 73     $     $ 23,264      
Non-U.S. government obligations
    28,168       841             29,009      
Mortgage and other asset-backed loans and securities:
                                   
Loans and securities backed by commercial real estate
          5             5      
Loans and securities backed by residential real estate
          6             6      
Bank loans and bridge loans
          1,107       380       1,487      
Corporate debt securities 6
    26       7,133       60       7,219      
Equities and convertible debentures 7
    24,283       699       6       24,988      
Commodities
          9             9      
 
 
Total
  $ 75,668     $ 9,873     $ 446     $ 85,987      
 
 
 
1.   Includes $212 million and $565 million of CDOs backed by real estate in level 2 and level 3, respectively.
 
2.   Includes $368 million and $1.07 billion of CDOs and CLOs backed by corporate obligations in level 2 and level 3, respectively.
 
3.   Consists of publicly listed equity securities.
 
4.   Substantially all consists of restricted and less liquid publicly listed securities.
 
5.   Includes $10.03 billion of private equity investments, $874 million of real estate investments and $156 million of convertible debentures.
 
6.   Includes $35 million of CDOs and CLOs backed by corporate obligations in level 3.
 
7.   Substantially all consists of publicly listed equity securities.

22


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
 
Level 3 Rollforward

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

The tables below present changes in fair value for all cash instrument assets and liabilities categorized as level 3 as of the end of the period.
 


 
                                                                     
 
    Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended March 2011 
                Net unrealized
                                   
                gains/(losses)
                      Net
           
                relating to
                      transfers
           
    Balance,
    Net realized
    instruments
                      in and/or
    Balance,
     
    beginning
    gains/
    still held at
                      (out) of
    end of
     
in millions   of period     (losses)     period-end     Purchases 1     Sales     Settlements     level 3     period      
 
Mortgage and other asset-backed loans and securities:
                                                                   
Loans and securities backed by commercial real estate
    $  2,819     $ 38     $ 141     $ 374     $ (504 )   $ (195 )   $ (152 )   $ 2,521      
Loans and securities backed by residential real estate
    2,373       48       48       573       (215 )     (193 )     2       2,636      
Loan portfolios
    1,285       22       23       17       (38 )     (141 )     144       1,312      
Bank loans and bridge loans
    9,905       169       568       491       (274 )     (604 )     (326 )     9,929      
Corporate debt securities
    2,737       92       216       789       (459 )     (104 )     (133 )     3,138      
State and municipal obligations
    754       1       13       7       (3 )     (1 )     (29 )     742      
Other debt obligations
    1,274       24       20       297       (149 )     (53 )     70       1,483      
Equities and convertible debentures
    11,060       40       233       268       (302 )     (121 )     587       11,765      
 
 
Total
    $32,207     $ 434     $ 1,262     $ 2,816     $ (1,944 )   $ (1,412 )   $ 163     $ 33,526      
 
 
 
                                                                     
 
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 2011 
                Net unrealized
                                   
                (gains)/losses
                      Net
           
                relating to
                      transfers
           
    Balance,
    Net realized
    instruments
                      in and/or
    Balance,
     
    beginning
    (gains)/
    still held at
                      (out) of
    end of
     
in millions   of period     losses     period-end       Purchases     Sales     Settlements     level 3     period      
 
Total
    $446     $ (22 )   $ 41     $ (59 )   $ 90     $ 8     $ (22 )   $ 482      
 
 
 
1.   Includes both originations and secondary market purchases.
 

Significant transfers in or out of level 3 during the three months ended March 2011 included:
 
•   Bank loans and bridge loans: net transfer out of level 3 of $326 million, principally due to transfers to level 2 of certain loans due to improved transparency of market prices as a result of market transactions in these financial instruments, partially offset by transfers to level 3 of certain loans due to reduced transparency of market prices as a result of less market activity in these financial instruments.

•   Equities and convertible debentures: net transfer into level 3 of $587 million, principally due to transfers to level 3 of certain private equity investments due to reduced transparency of market prices as a result of less market activity in these financial instruments, partially offset by transfers to level 2 of certain equity investments due to improved transparency of market prices as a result of initial public offerings.
 


23


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                                     
 
    Level 3 Cash Instrument Assets at Fair Value for the Three Months Ended March 2010 
                Net unrealized
                       
                gains/(losses)
    Net
    Net
           
                relating to
    purchases,
    transfers
           
    Balance,
    Net
    instruments
    issuances
    in and/or
    Balance,
     
    beginning
    realized
    still held at
    and
    (out) of
    end of
     
in millions   of period     gains/(losses)     period-end     settlements     level 3     period      
 
Mortgage and other asset-backed loans and securities:
                                                   
Loans and securities backed by commercial real estate
  $ 4,620     $ 63     $ 184     $ (506 )   $ (291 )   $ 4,070      
Loans and securities backed by residential real estate
    1,880       37       102       (141 )     253       2,131      
Loan portfolios
    1,364       28       3       (116 )     12       1,291      
Bank loans and bridge loans
    9,560       180       202       (655 )     36       9,323      
Corporate debt securities
    2,235       82       260       707       (581 )     2,703      
State and municipal obligations
    1,114       1       5       (225 )     (25 )     870      
Other debt obligations
    2,235       (5 )     94       (75 )     (762 )     1,487      
Equities and convertible debentures
    11,871       115       (17 )     (1,053 )     (263 )     10,653      
 
 
Total
  $ 34,879     $ 501     $ 833     $ (2,064 )   $ (1,621 )   $ 32,528      
 
 
                                                     
                                                     
 
    Level 3 Cash Instrument Liabilities at Fair Value for the Three Months Ended March 2010 
                Net unrealized
                       
                (gains)/losses
    Net
    Net
           
                relating to
    purchases,
    transfers
           
    Balance,
    Net
    instruments
    issuances
    in and/or
    Balance,
     
    beginning
    realized
    still held at
    and
    (out) of
    end of
     
in millions   of period     (gains)/losses     period-end     settlements     level 3     period      
 
Total
  $ 572     $ (14 )   $ (34 )   $ (10 )   $ (31 )   $ 483      
 
 
 

Significant transfers in or out of level 3 during the three months ended March 2010 included:
 
•   Corporate debt securities: net transfer out of level 3 of $581 million, principally due to a reduction in financial instruments as a result of the consolidation of a VIE which holds intangible assets.

•   Other debt obligations: net transfer out of level 3 of $762 million, principally due to a reduction in financial instruments as a result of the consolidation of a VIE. The VIE holds real estate assets which are included in “Other assets.”
 


24


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Investments in Funds That Calculate Net Asset
Value Per Share

Cash instruments at fair value include investments in funds that are valued based on the net asset value per share (NAV) of the investment fund. The firm uses NAV as its measure of fair value for fund investments when (i) the fund investment does not have a readily determinable fair value and (ii) the NAV of the investment fund is calculated in a manner consistent with the measurement principles of investment company accounting, including measurement of the underlying investments at fair value.
 
The firm’s investments in funds that calculate NAV primarily consist of investments in firm-sponsored funds where the firm co-invests with third-party investors. The private equity, private debt and real

estate funds are primarily closed-end funds in which the firm’s investments are not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated and it is estimated that substantially all of the underlying assets of existing funds will be liquidated over the next 10 years. The firm’s investments in hedge funds are generally redeemable on a quarterly basis with 91 days’ notice, subject to a maximum redemption level of 25% of the firm’s initial investments at any quarter-end.
 
The table below presents the fair value of the firm’s investments in, and unfunded commitments to, funds that calculate NAV.


 
                                     
 
    As of March 2011     As of December 2010 
    Fair Value of
    Unfunded
    Fair Value of
    Unfunded
     
in millions   Investments     Commitments     Investments     Commitments      
 
Private equity funds 1
    $  8,627     $ 4,215       $  7,911     $   4,816      
Private debt funds 2
    3,954       3,542       4,267       3,721      
Hedge funds 3
    3,280             3,169            
Real estate and other funds 4
    1,251       1,840       1,246       1,884      
 
 
Total
    $17,112     $ 9,597       $16,593     $ 10,421      
 
 
 
1.   These funds primarily invest in a broad range of industries worldwide in a variety of situations, including leveraged buyouts, recapitalizations and growth investments.
 
2.   These funds generally invest in loans and other fixed income instruments and are focused on providing private high-yield capital for mid- to large-sized leveraged and management buyout transactions, recapitalizations, financings, refinancings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers.
 
3.   These funds are primarily multi-disciplinary hedge funds that employ a fundamental bottom-up investment approach across various asset classes and strategies including long/short equity, credit, convertibles, risk arbitrage/special situations and capital structure arbitrage.
 
4.   These funds invest globally, primarily in real estate companies, loan portfolios, debt recapitalizations and direct property.
 

25


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 7.  Derivatives and Hedging Activities
 
Derivative Activities

Derivatives are instruments that derive their value from underlying asset prices, indices, reference rates and other inputs, or a combination of these factors. Derivatives may be privately negotiated contracts, which are usually referred to as over-the-counter (OTC) derivatives, or they may be listed and traded on an exchange (exchange-traded).
 
Market-Making.  As a market maker, the firm enters into derivative transactions with clients and other market participants to provide liquidity and to facilitate the transfer and hedging of risk. In this capacity, the firm typically acts as principal and is consequently required to commit capital to provide execution. As a market maker, it is essential to maintain an inventory of financial instruments sufficient to meet expected client and market demands.
 
Risk Management.  The firm also enters into derivatives to actively manage risk exposures that arise from market-making and investing and lending activities in derivative and cash instruments. In addition, the firm may enter into derivatives designated as hedges under U.S. GAAP. These derivatives are used to manage foreign currency exposure on the net investment in certain non-U.S. operations and to manage interest rate exposure in certain fixed-rate unsecured long-term and short-term borrowings, and certificates of deposit.

The firm enters into various types of derivatives, including:
 
•   Futures and Forwards.  Contracts that commit counterparties to purchase or sell financial instruments, commodities or currencies in the future.
 
•   Swaps.  Contracts that require counterparties to exchange cash flows such as currency or interest payment streams. The amounts exchanged are based on the specific terms of the contract with reference to specified rates, financial instruments, commodities, currencies or indices.
 
•   Options.  Contracts in which the option purchaser has the right but not the obligation to purchase from or sell to the option writer financial instruments, commodities or currencies within a defined time period for a specified price.
 
Derivatives are accounted for at fair value, net of cash collateral received or posted under credit support agreements. Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement. Derivative assets and liabilities are included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” respectively.
 
Substantially all gains and losses on derivatives not designated as hedges under U.S. GAAP, are included in “Market making” and “Other principal transactions.”
 
 


26


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
The table below presents the fair value of exchange-traded and OTC derivatives on a net-by-counterparty basis.
 
                                     
 
    As of March 2011     As of December 2010 
    Derivative
    Derivative
    Derivative
    Derivative
     
in millions   Assets     Liabilities     Assets     Liabilities      
 
Exchange-traded
  $ 6,221     $ 3,888     $ 7,601     $ 2,794      
Over-the-counter
    62,922       47,503       65,692       51,936      
 
 
Total
  $ 69,143     $ 51,391     $ 73,293     $ 54,730      
 
 
 

The table below presents the fair value, and the number, of derivative contracts by major product type on a gross basis. Gross fair values in the table below exclude the effects of both netting under enforceable netting

agreements and netting of cash collateral received or posted under credit support agreements, and therefore are not representative of the firm’s exposure.


                                                     
  
 
    As of March 2011     As of December 2010 
    Derivative
    Derivative
    Number of
    Derivative
    Derivative
    Number of
     
in millions, except number of contracts   Assets     Liabilities     Contracts     Assets     Liabilities     Contracts      
 
Derivatives not accounted for as hedges
                                                   
Interest rates
  $ 394,777     $ 355,140       273,435     $ 463,145     $ 422,514       272,279      
Credit
    116,384       95,927       364,851       127,153       104,407       367,779      
Currencies
    84,190       68,064       305,920       87,959       70,273       222,706      
Commodities
    50,010       53,712       73,852       36,689       41,666       70,890      
Equities
    67,464       53,743       366,032       65,815       51,948       289,059      
 
 
Subtotal
    712,825       626,586       1,384,090       780,761       690,808       1,222,713      
 
 
Derivatives accounted for as hedges
                                                   
Interest rates
    21,552       27       957       23,396       33       997      
Currencies
    2       82       73       6       162       72      
 
 
Subtotal
    21,554       109       1,030       23,402       195       1,069      
 
 
Gross fair value of derivatives
  $ 734,379     $ 626,695       1,385,120     $ 804,163     $ 691,003       1,223,782      
 
 
Counterparty netting 1
    (559,990 )     (559,990 )             (620,553 )     (620,553 )            
Cash collateral netting 2
    (105,246 )     (15,314 )             (110,317 )     (15,720 )            
 
 
Fair value included in financial instruments owned
  $ 69,143                     $ 73,293                      
 
 
Fair value included in financial instruments sold, but not yet purchased
          $ 51,391                     $ 54,730              
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.
 
2.   Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.

27


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Valuation Techniques for Derivatives
See Note 5 for an overview of the firm’s fair value measurement policies and the fair value hierarchy.
 
Level 1 Derivatives
Exchange-traded derivatives fall within level 1 if they are actively traded and are valued at their quoted market price.
 
Level 2 Derivatives
Level 2 derivatives include exchange-traded derivatives that are not actively traded and OTC derivatives for which all significant valuation inputs are corroborated by market evidence.
 
Level 2 exchange-traded derivatives are valued using models that calibrate to market-clearing levels of OTC derivatives. Inputs to the valuations of level 2 OTC derivatives can be verified to market-clearing transactions, broker or dealer quotations or other alternative pricing sources with reasonable levels of price transparency. Consideration is given to the nature of the quotations (e.g., indicative or firm) and the relationship of recent market activity to the prices provided from alternative pricing sources.
 
Where models are used, the selection of a particular model to value an OTC derivative depends on the contractual terms of and specific risks inherent in the instrument, as well as the availability of pricing information in the market. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, loss severity rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, model selection does not involve significant management judgment because outputs of models can be calibrated to market-clearing levels.
 
Price transparency of OTC derivatives can generally be characterized by product type.
 
Interest Rate.  In general, the prices and other inputs used to value interest rate derivatives are transparent, even for long-dated contracts. Interest rate swaps and options denominated in the currencies of leading industrialized nations are characterized by high trading volumes and tight bid/offer spreads. Interest rate derivatives that reference indices, such as an inflation index, or the shape of the yield curve (e.g., 10-year swap rate vs. 2-year swap rate), are more complex and are therefore less transparent, but the prices and other inputs are generally observable.

Credit.  Price transparency for credit default swaps, including both single names and baskets of credits, varies by market and underlying reference entity or obligation. Credit default swaps that reference indices, large corporates and major sovereigns generally exhibit the most price transparency. For credit default swaps with other underliers, price transparency varies based on credit rating, the cost of borrowing the underlying reference obligations, and the availability of the underlying reference obligations for delivery upon the default of the issuer. Credit default swaps that reference loans, asset-backed securities and emerging market debt instruments tend to be less transparent than those that reference corporate bonds. In addition, more complex credit derivatives, such as those sensitive to the correlation between two or more underlying reference obligations, generally have less price transparency.
 
Currency.  Prices for currency derivatives based on the exchange rates of leading industrialized nations, including those with longer tenors, are generally transparent. The primary difference between the transparency of developed and emerging market currency derivatives is that emerging markets tend to be observable for contracts with shorter tenors.
 
Commodity.  Commodity derivatives include transactions referenced to energy (e.g., oil and natural gas), metals (e.g., precious and base) and soft commodities (e.g., agricultural). Price transparency varies based on the underlying commodity, delivery location, tenor and product quality (e.g., diesel fuel compared to unleaded gasoline). In general, price transparency for commodity derivatives is greater for contracts with shorter tenors and contracts that are more closely aligned with major and/or benchmark commodity indices.


28


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Equity.  Price transparency for equity derivatives varies by market and underlier. Options on indices and the common stock of corporates included in major equity indices exhibit the most price transparency. Exchange-traded and OTC equity derivatives generally have observable market prices, except for contracts with long tenors or reference prices that differ significantly from current market prices. More complex equity derivatives, such as those sensitive to the correlation between two or more individual stocks, generally have less price transparency.
 
Liquidity is essential to observability of all product types. If transaction volumes decline, previously transparent prices and other inputs may become unobservable. Conversely, even highly structured products may at times have trading volumes large enough to provide observability of prices and other inputs.
 
Level 3 Derivatives
Level 3 OTC derivatives are valued using models which utilize observable level 1 and/or level 2 inputs, as well as unobservable level 3 inputs.
 
•   For the majority of the firm’s interest rate and currency derivatives classified within level 3, the significant unobservable inputs are correlations of certain currencies and interest rates (e.g., the correlation of Japanese yen foreign exchange rates to U.S. dollar interest rates).
 
•   For credit derivatives classified within level 3, significant level 3 inputs include long-dated credit and funding spreads as well as certain correlation inputs required to value credit and mortgage derivatives (e.g., the likelihood of default of the underlying reference obligations relative to one another).

•   For level 3 equity derivatives, significant level 3 inputs generally include equity volatility inputs for options that are very long-dated and/or have strike prices that differ significantly from current market prices. In addition, the valuation of certain structured trades requires the use of level 3 inputs for the correlation of the price performance for two or more individual stocks.
 
•   For level 3 commodity derivatives, significant level 3 inputs include volatilities for options with strike prices that differ significantly from current market prices and prices for certain products for which the product quality is not aligned with benchmark indices.
 
Subsequent to the initial valuation of a level 3 OTC derivative, the firm updates the level 1 and level 2 inputs to reflect observable market changes and any resulting gains and losses are recorded in level 3. Level 3 inputs are changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations or other empirical market data. In circumstances where the firm cannot verify the model value by reference to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value.


29


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Valuation Adjustments
Valuation adjustments are integral to determining the fair value of derivatives and are used to adjust the mid-market valuations, produced by derivative pricing models, to the appropriate exit price valuation. These adjustments incorporate bid/offer spreads, the cost of liquidity on large or illiquid positions and credit valuation adjustments (CVA) which account for the credit risk inherent in derivative portfolios. Market-based inputs are generally used when calibrating valuation adjustments to market-clearing levels.
 
In addition, for derivatives that include significant unobservable inputs, the firm makes model or exit

price adjustments to account for the valuation uncertainty present in the transaction.
 
Fair Value of Derivatives by Level
The tables below present the fair value of derivatives on a gross basis by level and major product type. Gross fair values in the tables below exclude the effects of both netting under enforceable netting agreements and netting of cash received or posted under credit support agreements both in and across levels of the fair value hierarchy, and therefore are not representative of the firm’s exposure.


 
                                             
 
    Derivative Assets at Fair Value as of March 2011 
                      Cross-Level
           
in millions   Level 1     Level 2     Level 3     Netting     Total      
 
Interest rates
  $ 16     $ 416,216     $ 97     $     $ 416,329      
Credit
          105,737       10,647             116,384      
Currencies
          82,283       1,909             84,192      
Commodities
          48,095       1,915             50,010      
Equities
    27       65,825       1,612             67,464      
 
 
Gross fair value of derivative assets
    43       718,156       16,180             734,379      
Counterparty netting 1
          (553,313 )     (4,343 )     (2,334 3     (559,990 )    
 
 
Subtotal
  $ 43     $ 164,843     $ 11,837     $ (2,334 )   $ 174,389      
Cash collateral netting 2
                                    (105,246 )    
 
 
Fair value included in financial instruments owned
                                  $ 69,143      
 
 
 
                                             
 
    Derivative Liabilities at Fair Value as of March 2011 
                      Cross-Level
           
in millions   Level 1     Level 2     Level 3     Netting     Total      
 
Interest rates
  $ 9     $ 354,964     $ 194     $     $ 355,167      
Credit
          91,871       4,056             95,927      
Currencies
          67,369       777             68,146      
Commodities
          51,990       1,722             53,712      
Equities
    158       50,957       2,628             53,743      
 
 
Gross fair value of derivative liabilities
    167       617,151       9,377             626,695      
Counterparty netting 1
          (553,313 )     (4,343 )     (2,334 ) 3     (559,990 )    
 
 
Subtotal
  $ 167     $ 63,838     $ 5,034     $ (2,334 )   $ 66,705      
Cash collateral netting 2
                                    (15,314 )    
 
 
Fair value included in financial instruments sold, but not yet purchased
                                  $ 51,391      
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.
 
2.   Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.
 
3.   Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.
 

 


 

30


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                             
 
    Derivative Assets at Fair Value as of December 2010 
                      Cross-Level
           
in millions   Level 1     Level 2     Level 3     Netting     Total      
 
Interest rates
  $ 49     $ 486,037     $ 455     $     $ 486,541      
Credit
          115,519       11,634             127,153      
Currencies
          86,158       1,807             87,965      
Commodities
          34,511       2,178             36,689      
Equities
    44       64,267       1,504             65,815      
 
 
Gross fair value of derivative assets
    93       786,492       17,578             804,163      
Counterparty netting 1
          (613,979 )     (4,806 )     (1,768 3     (620,553 )    
 
 
Subtotal
  $ 93     $ 172,513     $ 12,772     $ (1,768 )   $ 183,610      
Cash collateral netting 2
                                    (110,317 )    
 
 
Fair value included in financial instruments owned
                                  $ 73,293      
 
 
                                             
 
    Derivative Liabilities at Fair Value as of December 2010 
                      Cross-Level
           
in millions   Level 1     Level 2     Level 3     Netting     Total      
 
Interest rates
  $ 18     $ 422,267     $ 262     $     $ 422,547      
Credit
          99,813       4,594             104,407      
Currencies
          69,726       709             70,435      
Commodities
          39,709       1,957             41,666      
Equities
    27       49,427       2,494             51,948      
 
 
Gross fair value of derivative liabilities
    45       680,942       10,016             691,003      
Counterparty netting 1
          (613,979 )     (4,806 )     (1,768 3     (620,553 )    
 
 
Subtotal
  $ 45     $ 66,963     $ 5,210     $ (1,768 )   $ 70,450      
Cash collateral netting 2
                                    (15,720 )    
 
 
Fair value included in financial instruments sold, but not yet purchased
                                  $ 54,730      
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty under enforceable netting agreements.
 
2.   Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.
 
3.   Represents the netting of receivable balances with payable balances for the same counterparty across levels of the fair value hierarchy under enforceable netting agreements.

31


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Level 3 Rollforward

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

The tables below present changes in fair value for all derivatives categorized as level 3 as of the end of the period.
 


                                                                     
 
    Level 3 Derivative Assets and Liabilities at Fair Value for the Three Months Ended March 2011
                Net unrealized
                                   
    Asset/
          gains/(losses)
                      Net
    Asset/
     
    (liability)
    Net
    relating to
                      transfers
    (liability)
     
    balance,
    realized
    instruments
                      in and/or
    balance,
     
    beginning
    gains/
    still held at
                      (out) of
    end of
     
in millions   of period     (losses)     period-end     Purchases     Sales     Settlements     level 3     period      
 
Interest rates — net
  $ 194     $ (26 )   $ (58 )   $ 1     $     $ 13     $ (221 )   $ (97 )    
Credit — net
    7,040       3       (104 )     70       (81 )     (722 )     385       6,591      
Currencies — net
    1,098       (1 )     (194 )     25       (6 )     (31 )     241       1,132      
Commodities — net
    220       (78 )     90       241       (233 )     115       (162 )     193      
Equities — net
    (990 )     176       (294 )     459       (625 )     58       200       (1,016 )    
 
 
Total derivatives — net
  $ 7,562     $ 74     $ (560 )   $ 796     $ (945 )   $ (567 )   $ 443     $ 6,803      
 
 
 
                                                     
 
    Level 3 Derivative Assets and Liabilities at Fair Value for the Three Months Ended March 2010 
                Net unrealized
                       
    Asset/
          gains/(losses)
    Net
    Net
    Asset/
     
    (liability)
    Net
    relating to
    purchases,
    transfers
    (liability)
     
    balance,
    realized
    instruments
    issuances
    in and/or
    balance,
     
    beginning
    gains/
    still held at
    and
    (out) of
    end of
     
in millions   of period     (losses)     period-end     settlements     level 3     period      
 
Interest rates — net
  $ (71 )   $ 9     $ (43 )   $ (1 )   $ 200     $ 94      
Credit — net
    6,366       332       1,459       (755 )     (265 )     7,137      
Currencies — net
    215       (18 )     5       9       257       468      
Commodities — net
    (90 )     6       71       3       (234 )     (244 )    
Equities — net
    (1,224 )     40       76       (173 )     162       (1,119 )    
 
 
Total derivatives — net
  $ 5,196     $ 369     $ 1,568     $ (917 )   $ 120     $ 6,336      
 
 
 
 

Significant transfers in or out of level 3 during the three months ended March 2011 included:
 
•   Credit — net: net transfer to level 3 of $385 million, principally due to reduced transparency of the correlation inputs used to value certain mortgage derivatives.
 
There were no significant transfers in or out of level 3 during the three months ended March 2010.
 
Impact of Credit Spreads on Derivatives
On an ongoing basis, the firm realizes gains or losses relating to changes in credit risk on derivatives through changes in credit mitigants or the sale or unwind of the contracts.
 
The net gain/(loss) attributable to the impact of changes in credit exposure and credit spreads on derivatives

were $(25) million and $44 million for the three months ended March 2011 and March 2010, respectively.
 
Bifurcated Embedded Derivatives
The table below presents derivatives, primarily equity and interest rate products, that have been bifurcated from their related borrowings. These derivatives are recorded at fair value and included in “Unsecured short-term borrowings” and “Unsecured long-term borrowings.” See Note 8 for further information.
 
                     
 
    As of
in millions, except number
  March
    December
     
of contracts   2011     2010      
 
Fair value of assets
  $ 393     $ 383      
Fair value of liabilities
    276       267      
 
 
Net
  $ 117     $ 116      
 
 
Number of contracts
    358       338      
 
 
 


32


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
OTC Derivatives

The tables below present the fair values of OTC derivative assets and liabilities by tenor and by product type. Tenor is based on expected duration for

mortgage-related credit derivatives and generally on remaining contractual maturity for other derivatives.
 


 
                                     
 
in millions   OTC Derivatives as of March 2011      
 
Assets
                           
    0-12
    1-5
    5 Years or
           
Product Type   Months     Years     Greater     Total      
 
Interest rates
  $ 6,175     $ 28,913     $ 59,106     $ 94,194      
Credit
    2,716       13,956       12,408       29,080      
Currencies
    9,528       11,746       14,472       35,746      
Commodities
    7,514       5,902       535       13,951      
Equities
    5,158       12,187       6,496       23,841      
Netting across product types 1
    (2,503 )     (5,898 )     (4,500 )     (12,901 )    
 
 
Subtotal
  $ 28,588     $ 66,806     $ 88,517     $ 183,911      
Cross maturity netting 2
                            (15,743 )    
Cash collateral netting 3
                            (105,246 )    
 
 
Total
                          $ 62,922      
 
 
 
                                     
Liabilities
                           
    0-12
    1-5
    5 Years or
           
Product Type   Months     Years     Greater     Total      
 
Interest rates
  $ 3,885     $ 12,663     $ 16,495     $ 33,043      
Credit
    1,029       4,329       3,265       8,623      
Currencies
    9,002       5,590       5,014       19,606      
Commodities
    8,185       7,889       1,718       17,792      
Equities
    4,240       4,869       3,288       12,397      
Netting across product types 1
    (2,503 )     (5,898 )     (4,500 )     (12,901 )    
 
 
Subtotal
  $ 23,838     $ 29,442     $ 25,280     $ 78,560      
Cross maturity netting 2
                            (15,743 )    
Cash collateral netting 3
                            (15,314 )    
 
 
Total
                          $ 47,503      
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty across product types within a tenor category under enforceable netting agreements. Receivable and payable balances with the same counterparty in the same product type and tenor category are netted within such product type and tenor category.
 
2.   Represents the netting of receivable balances with payable balances for the same counterparty across tenor categories under enforceable netting agreements.
 
3.   Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.
 

 


 

33


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                     
 
in millions   OTC Derivatives as of December 2010      
 
Assets
                           
    0-12
    1-5
    5 Years or
           
Product Type   Months     Years     Greater     Total      
 
Interest rates
  $ 7,137     $ 34,384     $ 60,750     $ 102,271      
Credit
    2,777       16,145       13,525       32,447      
Currencies
    9,968       10,696       14,868       35,532      
Commodities
    5,664       5,996       248       11,908      
Equities
    4,795       10,942       7,037       22,774      
Netting across product types 1
    (2,937 )     (5,513 )     (5,077 )     (13,527 )    
 
 
Subtotal
  $ 27,404     $ 72,650     $ 91,351     $ 191,405      
Cross maturity netting 2
                            (15,396 )    
Cash collateral netting 3
                            (110,317 )    
 
 
Total
                          $ 65,692      
 
 
 
                                     
Liabilities
                           
    0-12
    1-5
    5 Years or
           
Product Type   Months     Years     Greater     Total      
 
Interest rates
  $ 4,470     $ 14,072     $ 19,760     $ 38,302      
Credit
    1,024       4,862       3,816       9,702      
Currencies
    8,036       5,219       4,986       18,241      
Commodities
    7,279       7,838       2,528       17,645      
Equities
    3,962       4,977       3,750       12,689      
Netting across product types 1
    (2,937 )     (5,513 )     (5,077 )     (13,527 )    
 
 
Subtotal
  $ 21,834     $ 31,455     $ 29,763     $ 83,052      
Cross maturity netting 2
                            (15,396 )    
Cash collateral netting 3
                            (15,720 )    
 
 
Total
                          $ 51,936      
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty across product types within a tenor category under enforceable netting agreements. Receivable and payable balances with the same counterparty in the same product type and tenor category are netted within such product type and tenor category.
 
2.   Represents the netting of receivable balances with payable balances for the same counterparty across tenor categories under enforceable netting agreements.
 
3.   Represents the netting of cash collateral received and posted on a counterparty basis under credit support agreements.

34


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Derivatives with Credit-Related
Contingent Features
Certain of the firm’s derivatives have been transacted under bilateral agreements with counterparties who may require the firm to post collateral or terminate the transactions based on changes in the firm’s credit ratings. The table below presents the aggregate fair value of net derivative liabilities under such agreements (excluding application of collateral posted to reduce these liabilities), the related aggregate fair value of the assets posted as collateral, and the additional collateral or termination payments that could have been called at the reporting date by counterparties in the event of a one-notch and two-notch downgrade in the firm’s credit ratings.
 
                     
 
    As of
    March
    December
     
in millions   2011     2010      
 
Net derivative liabilities under bilateral agreements
  $ 21,498     $ 23,843      
Collateral posted
    15,415       16,640      
Additional collateral or termination payments for a one-notch downgrade
    925       1,353      
Additional collateral or termination payments for a two-notch downgrade
    2,211       2,781      
 
 
 
Credit Derivatives
The firm enters into a broad array of credit derivatives in locations around the world to facilitate client transactions and to manage the credit risk associated with market-making and investing and lending activities. Credit derivatives are actively managed based on the firm’s net risk position.
 
Credit derivatives are individually negotiated contracts and can have various settlement and payment conventions. Credit events include failure to pay, bankruptcy, acceleration of indebtedness, restructuring, repudiation and dissolution of the reference entity.

Credit Default Swaps.  Single-name credit default swaps protect the buyer against the loss of principal on one or more bonds, loans or mortgages (reference obligations) in the event the issuer (reference entity) of the reference obligations suffers a credit event. The buyer of protection pays an initial or periodic premium to the seller and receives protection for the period of the contract. If there is no credit event, as defined in the contract, the seller of protection makes no payments to the buyer of protection. However, if a credit event occurs, the seller of protection is required to make a payment, which is calculated in accordance with the terms of the contract, to the buyer of protection.
 
Credit Indices, Baskets and Tranches.  Credit derivatives may reference a basket of single-name credit default swaps or a broad-based index. If a credit event occurs in one of the underlying reference obligations, the protection seller pays the protection buyer. The payment is typically a pro-rata portion of the transaction’s total notional amount based on the underlying defaulted reference obligation. In certain transactions, the credit risk of a basket or index is separated into various portions (tranches) each having different levels of subordination. The most junior tranches cover initial defaults and once losses exceed the notional amount of these junior tranches, any excess loss is covered by the next most senior tranche in the capital structure.
 
Total Return Swaps.  A total return swap transfers the risks relating to economic performance of a reference obligation from the protection buyer to the protection seller. Typically, the protection buyer receives from the protection seller a floating rate of interest and protection against any reduction in fair value of the reference obligation, and in return the protection seller receives the cash flows associated with the reference obligation, plus any increase in the fair value of the reference obligation.


35


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Credit Options.  In a credit option, the option writer assumes the obligation to purchase or sell a reference obligation at a specified price or credit spread. The option purchaser buys the right but not the obligation to sell the reference obligation to, or purchase it from, the option writer. The payments on credit options depend either on a particular credit spread or the price of the reference obligation.
 
The firm economically hedges its exposure to written credit derivatives primarily by entering into offsetting purchased credit derivatives with identical underlyings. Substantially all of the firm’s purchased credit derivative transactions are with financial institutions and are subject to stringent collateral thresholds. In addition, upon the occurrence of a specified trigger event, the firm may take possession of the reference obligations underlying a particular written credit derivative, and consequently may, upon liquidation of the reference obligations, recover amounts on the underlying reference obligations in the event of default.
 
As of March 2011, written and purchased credit derivatives had total gross notional amounts of $2.09 trillion and $2.25 trillion, respectively, for total

net notional purchased protection of $156.69 billion. As of December 2010, written and purchased credit derivatives had total gross notional amounts of $2.05 trillion and $2.19 trillion, respectively, for total net notional purchased protection of $140.63 billion.
 
The table below presents certain information about credit derivatives. In the table below:
 
•   Fair values exclude the effects of both netting under enforceable netting agreements and netting of cash received or posted under credit support agreements, and therefore are not representative of the firm’s exposure;
 
•   Tenor is based on expected duration for mortgage-related credit derivatives and on remaining contractual maturity for other credit derivatives; and
 
•   The credit spread on the underlying, together with the tenor of the contract, are indicators of payment/performance risk. The firm is less likely to pay or otherwise be required to perform where the credit spread and the tenor are lower.


 
                                                                             
 
          Maximum Payout/Notional
     
    Maximum Payout/Notional Amount
    Amount of Purchased
    Fair Value of
    of Written Credit Derivatives by Tenor     Credit Derivatives     Written Credit Derivatives
                            Offsetting
    Other
                       
                5 Years
          Purchased
    Purchased
                Net
     
    0 – 12
    1 – 5
    or
          Credit
    Credit
                Asset/
     
$ in millions   Months     Years     Greater     Total     Derivatives 1     Derivatives 2     Asset     Liability     (Liability)      
 
As of March 2011
Credit spread on
underlying
(basis points)
0-250
  $ 259,213     $ 1,140,722     $ 316,731     $ 1,716,666     $ 1,605,632     $ 265,675     $ 33,580     $ 12,853     $ 20,727      
251-500
    8,950       120,985       48,707       178,642       145,696       26,657       7,620       4,184       3,436      
501-1,000
    7,959       81,869       31,846       121,674       102,500       21,578       2,212       11,498       (9,286 )    
Greater than 1,000
    7,848       57,459       11,770       77,077       63,395       19,620       621       28,974       (28,353 )    
 
 
Total
  $ 283,970     $ 1,401,035     $ 409,054     $ 2,094,059     $ 1,917,223     $ 333,530     $ 44,033     $ 57,509     $ (13,476 )    
 
 

36


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                                                             
 
          Maximum Payout/Notional
     
    Maximum Payout/Notional Amount
    Amount of Purchased
    Fair Value of
    of Written Credit Derivatives by Tenor     Credit Derivatives     Written Credit Derivatives
                            Offsetting
    Other
                       
                5 Years
          Purchased
    Purchased
                Net
     
    0 – 12
    1 – 5
    or
          Credit
    Credit
                Asset/
     
$ in millions   Months     Years     Greater     Total     Derivatives 1     Derivatives 2     Asset     Liability     (Liability)      
 
As of December 2010
Credit spread on
underlying
(basis points)
0-250
  $ 235,798     $ 1,094,308     $ 288,851     $ 1,618,957     $ 1,511,113     $ 232,506     $ 32,071     $ 14,780     $ 17,291      
251-500
    14,412       144,448       52,072       210,932       183,613       36,713       7,368       7,739       (371 )    
501-1,000
    6,384       89,212       33,553       129,149       110,019       18,686       2,571       11,256       (8,685 )    
Greater than 1,000
    11,721       63,982       12,022       87,725       70,945       23,795       483       33,670       (33,187 )    
 
 
Total
  $ 268,315     $ 1,391,950     $ 386,498     $ 2,046,763     $ 1,875,690     $ 311,700     $ 42,493     $ 67,445     $ (24,952 )    
 
 
 
1.   Offsetting purchased credit derivatives represent the notional amount of purchased credit derivatives to the extent they economically hedge written credit derivatives with identical underlyings.
 
2.   Comprised of purchased protection in excess of the amount of written protection on identical underlyings and purchased protection on other underlyings on which the firm has not written protection.

37


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Hedge Accounting
The firm applies hedge accounting for (i) certain interest rate swaps used to manage the interest rate exposure of certain fixed-rate unsecured long-term and short-term borrowings and certain fixed-rate certificates of deposit and (ii) certain foreign currency forward contracts and foreign currency-denominated debt used to manage foreign currency exposures on the firm’s net investment in certain non-U.S. operations.
 
To qualify for hedge accounting, the derivative hedge must be highly effective at reducing the risk from the exposure being hedged. Additionally, the firm must formally document the hedging relationship at inception and test the hedging relationship at least on a quarterly basis to ensure the derivative hedge continues to be highly effective over the life of the hedging relationship.
 
Interest Rate Hedges
The firm designates certain interest rate swaps as fair value hedges. These interest rate swaps hedge changes in fair value attributable to the relevant benchmark interest rate (e.g., London Interbank Offered Rate (LIBOR)), effectively converting a substantial portion of fixed-rate obligations into floating-rate obligations.
 
The firm applies the “long-haul method” in assessing the effectiveness of its fair value hedging relationships in achieving offsetting changes in the fair values of the hedging instrument and the risk being hedged (i.e., interest rate risk).
 
During the three months ended March 2010, the firm changed its method of prospectively and retrospectively assessing the effectiveness of all of its fair value hedging relationships from a dollar-offset method, which is a non-statistical method, to regression analysis, which is a statistical method.
 
An interest rate swap is considered highly effective in offsetting changes in fair value attributable to changes in the hedged risk when the regression analysis results in a coefficient of determination of 80% or greater and a slope between 80% and 125%.

The dollar-offset method compared 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. The prospective dollar-offset assessment used scenario analyses to test hedge effectiveness through simulations of numerous parallel and slope shifts of the relevant yield curve. Parallel shifts changed the interest rate of all maturities by identical amounts. Slope shifts changed the curvature of the yield curve. For both the prospective assessment, in response to each of the simulated yield curve shifts, and the retrospective assessment, a hedging relationship was considered effective if the fair value of the hedging instrument and the hedged item changed inversely within a range of 80% to 125%.
 
For qualifying fair value hedges, gains or losses on derivatives are included in “Interest expense.” The change in fair value of the hedged item attributable to the risk being hedged is reported as an adjustment to its carrying value and is subsequently amortized into interest expense over its remaining life. Gains or losses resulting from hedge ineffectiveness are included in “Interest expense.” See Note 23 for further information about interest income and interest expense.
 
For the three months ended March 2011 and March 2010, the gain/(loss) recognized on interest rate derivatives accounted for as hedges was $(2.66) billion and $687 million, respectively, and the related gain/(loss) recognized on the hedged borrowings and bank deposits was $2.16 billion and $(1.10) billion, respectively. The hedge ineffectiveness recognized on these derivatives for the three months ended March 2011 and March 2010 was a loss of $495 million and a loss of $413 million, respectively. These losses consisted primarily of the amortization of prepaid credit spreads. The gain/(loss) excluded from the assessment of hedge effectiveness was not material for the three months ended March 2011 and March 2010.


38


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Net Investment Hedges
The firm seeks to reduce the impact of fluctuations in foreign exchange rates on its net investment in certain non-U.S. operations through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts designated as hedges, the effectiveness of the hedge is assessed based on the overall changes in the fair value of the forward contracts (i.e., based on changes in forward rates). For foreign currency-denominated debt designated as a hedge, the effectiveness of the hedge is assessed based on changes in spot rates.
 
For qualifying net investment hedges, the gains or losses on the hedging instruments, to the extent effective, are included in the condensed consolidated statements of comprehensive income.
 
The table below presents the gains/(losses) from net investment hedging. The gains/(losses) below are included in “Currency translation adjustment, net of tax.”
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Currency hedges
  $ (225 )   $ 121      
Foreign currency-denominated debt
    82       12      
 
 
 
The gain/(loss) related to ineffectiveness and the gain/(loss) reclassified to earnings from accumulated other comprehensive income was not material for the three months ended March 2011 and March 2010.
 
As of March 2011 and December 2010, the firm had designated $2.88 billion and $3.88 billion, respectively, of foreign currency-denominated debt, included in “Unsecured long-term borrowings” and “Unsecured short-term borrowings,” as hedges of net investments in non-U.S. subsidiaries.

Note 8.  Fair Value Option
 
Other Financial Assets and Financial Liabilities at Fair Value
In addition to all cash and derivative instruments included in “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value,” the firm has elected to account for certain of its other financial assets and financial liabilities at fair value under the fair value option.
 
The primary reasons for electing the fair value option are to:
 
•   reflect economic events in earnings on a timely basis;
 
•   mitigate volatility in earnings from using different measurement attributes (e.g., transfers of financial instruments owned accounted for as financings are recorded at fair value whereas the related secured financing would be recorded on an accrual basis absent electing the fair value option); and
 
•   address simplification and cost-benefit considerations (e.g., accounting for hybrid financial instruments at fair value in their entirety versus bifurcation of embedded derivatives and hedge accounting for debt hosts).
 
Hybrid financial instruments are instruments that contain bifurcatable embedded derivatives and do not require settlement by physical delivery of non-financial assets (e.g., physical commodities). If the firm elects to bifurcate the embedded derivative from the associated debt, the derivative is accounted for at fair value and the host contract is accounted for at amortized cost, adjusted for the effective portion of any fair value hedges. If the firm does not elect to bifurcate, the entire hybrid financial instrument is accounted for at fair value under the fair value option.


39


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Other financial assets and financial liabilities accounted for at fair value under the fair value option include:
 
•   resale and repurchase agreements;
 
•   securities borrowed and loaned within Fixed Income, Currency and Commodities Client Execution;
 
•   certain other secured financings, primarily transfers of assets accounted for as financings rather than sales, debt raised through the firm’s William Street credit extension program and certain other nonrecourse financings;
 
•   certain unsecured short-term borrowings, consisting of all promissory notes and commercial paper and certain hybrid financial instruments;
 
•   certain unsecured long-term borrowings, including prepaid commodity transactions and certain hybrid financial instruments;
 
•   certain receivables from customers and counterparties, including certain margin loans, transfers of assets accounted for as secured loans rather than purchases and prepaid variable share forwards;
 
•   certain insurance and reinsurance contract assets and liabilities and certain guarantees;
 
•   certain deposits issued by the firm’s bank subsidiaries, as well as securities held by Goldman Sachs Bank USA (GS Bank USA);
 
•   certain subordinated liabilities issued by consolidated VIEs; and
 
•   in general, investments acquired after November 24, 2006, when the fair value option became available, where the firm has significant influence over the investee and would otherwise apply the equity method of accounting.
 
These financial assets and financial liabilities at fair value are generally valued based on discounted cash flow techniques, which incorporate inputs with reasonable levels of price transparency, and are generally classified as level 2 because the inputs are observable. Valuation adjustments may be made for counterparty and the firm’s credit quality.
 
Significant inputs for each category of other financial assets and financial liabilities at fair value are as follows:

Resale and Repurchase Agreements and Securities Borrowed and Loaned.  The significant inputs to the valuation of resale and repurchase agreements and securities borrowed and loaned are the amount and timing of expected future cash flows, interest rates and collateral funding spreads. See Note 9 for further information.
 
Other Secured Financings.  The significant inputs to the valuation of other secured financings at fair value are the amount and timing of expected future cash flows, interest rates, the fair value of the collateral delivered by the firm (which is determined using the amount and timing of expected future cash flows, market yields and recovery assumptions), the frequency of additional collateral calls and the credit spreads of the firm. See Note 9 for further information.
 
Unsecured Short-term and Long-term Borrowings.  The significant inputs to the valuation of unsecured short-term and long-term borrowings at fair value are the amount and timing of expected future cash flows, interest rates, the credit spreads of the firm, as well as commodity prices in the case of prepaid commodity transactions and, for certain hybrid financial instruments, equity prices, inflation rates and index levels. See Notes 15 and 16 for further information.
 
Receivables from Customers and Counterparties.  The significant inputs to the valuation of certain receivables from customers and counterparties are commodity prices, interest rates and the amount and timing of expected future cash flows.
 
Insurance and Reinsurance Contracts.  Insurance and reinsurance contracts at fair value are included in “Receivables from customers and counterparties” and “Other liabilities and accrued expenses.” These contracts are valued using market transactions and other market evidence where possible, including market-based inputs to models, calibration to market-clearing transactions or other alternative pricing sources with reasonable levels of price transparency. Significant level 2 inputs typically include interest rates and inflation risk. Significant level 3 inputs typically include mortality or funding benefit assumptions. When unobservable inputs to a valuation model are significant to the fair value measurement of an instrument, the instrument is classified in level 3.
 
Deposits.  The significant inputs to the valuation of deposits are interest rates.
 


40


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Gains and Losses on Other Financial Assets and
Financial Liabilities at Fair Value

The “Fair Value Option” columns in the table below present the gains and losses recognized as a result of the firm electing to apply the fair value option to certain financial assets and financial liabilities. These gains and losses are included in “Market making” and “Other principal transactions” revenues.
 
The amounts in the table exclude contractual interest, which is included in “Interest income” and “Interest expense,” for all instruments other than hybrid financial instruments. See Note 23 for further information about interest income and interest expense. The table also excludes gains and losses related to financial instruments owned, at fair value and financial instruments sold, but not yet purchased, at fair value.
 
Included in the “Other” columns in the table below are:
 
•   Gains and losses on the embedded derivative component of hybrid financial instruments included in unsecured short-term borrowings and unsecured

  long-term borrowings. These gains and losses would have been recognized under other U.S. GAAP even if the firm had not elected to account for the entire hybrid instrument at fair value.
 
•   Gains and losses on secured financings related to transfers of assets accounted for as financings rather than sales. These gains and losses are offset by gains and losses on the related instruments included in “Financial instruments owned, at fair value” and “Receivables from customers and counterparties.”
 
•   Gains and losses on receivables from customers and counterparties related to transfers of assets accounted for as receivables rather than purchases. These gains and losses are offset by gains and losses on the related financial instruments included in “Other secured financings.”
 
•   Gains and losses on subordinated liabilities issued by consolidated VIEs. These gains and losses are offset by gains and losses on the financial assets held by the consolidated VIEs.


 
                                     
 
    Gains/(Losses) on Financial Assets and
    Financial Liabilities at Fair Value 
    Three Months Ended March
    2011     2010
    Fair
          Fair
           
    Value
          Value
           
in millions   Option     Other     Option     Other      
 
Receivables from customers and counterparties 1
  $ 1     $ 319     $ (38 )   $      
Other secured financings
    4       (415 )     (4 )     (5 )    
Unsecured short-term borrowings
    7       (224 )     13       (205 )    
Unsecured long-term borrowings
    3       (1,271 )     84       575      
Other liabilities and accrued expenses 2
    (189 )     87       69       107      
Other 3
    35             (3 )          
 
 
Total
  $ (139 )   $ (1,504 )   $ 121     $ 472      
 
 
 
1.   Primarily consists of gains/(losses) on certain transfers accounted for as receivables rather than purchases and certain reinsurance contracts.
 
2.   Primarily consists of gains/(losses) on certain insurance and reinsurance contracts.
 
3.   Primarily consists of gains/(losses) on resale and repurchase agreements, securities borrowed and loaned and deposits.

41


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Excluding the gains and losses on the instruments accounted for under the fair value option described above, “Market making” and “Other principal transactions” primarily represents gains and losses on “Financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value.”
 
Loans and Lending Commitments
The table below presents the difference between the aggregate fair value and the aggregate contractual principal amount for loans and long-term receivables for which the fair value option was elected.
 
                     
 
    As of
    March
    December
     
in millions   2011     2010      
 
Aggregate contractual principal amount of performing loans and long-term receivables in excess of the related fair value
  $ 3,144     $ 3,090      
Aggregate contractual principal amount of loans on nonaccrual status and/or more than 90 days past due in excess of the related fair value
    24,259       26,653      
 
 
Total 1
  $ 27,403     $ 29,743      
 
 
Aggregate fair value of loans on nonaccrual status and/or more than 90 days past due
  $ 3,631     $ 3,994      
 
 
 
1.   The aggregate contractual principal exceeds the related fair value primarily because the firm regularly purchases loans, such as distressed loans, at values significantly below contractual principal amounts.
 
 
As of March 2011 and December 2010, the fair value of unfunded lending commitments for which the fair value option was elected was a liability of $1.24 billion and $1.26 billion, respectively, and the related total contractual amount of these lending commitments was $59.43 billion and $51.20 billion, respectively.

Long-term Debt Instruments
The aggregate contractual principal amount of long-term debt instruments (principal and non-principal protected) for which the fair value option was elected exceeded the related fair value by $924 million and $701 million as of March 2011 and December 2010, respectively. Of these amounts, $642 million and $349 million as of March 2011 and December 2010, respectively, related to unsecured long-term borrowings and the remainder related to long-term other secured financings.
 
Impact of Credit Spreads on Loans and Lending Commitments
The net gains/(losses) attributable to changes in instrument-specific credit spreads on loans and lending commitments for which the fair value option was elected were $756 million and $1.07 billion for the three months ended March 2011 and March 2010, respectively. Changes in the fair value of floating-rate loans and lending commitments are attributable to changes in instrument-specific credit spreads. For fixed-rate loans and lending commitments the firm allocates changes in fair value between interest rate-related changes and credit spread-related changes based on changes in interest rates.
 
Impact of Credit Spreads on Borrowings
The table below presents the net gains attributable to the impact of changes in the firm’s own credit spreads on borrowings for which the fair value option was elected. The firm calculates the fair value of borrowings by discounting future cash flows at a rate which incorporates the firm’s credit spreads.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Net gains including hedges
  $ 41     $ 107      
Net gains excluding hedges
    44       109      
 
 
 


42


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 9.  Collateralized Agreements and Financings
 

Collateralized agreements are securities purchased under agreements to resell (resale agreements or reverse repurchase agreements) and securities borrowed. Collateralized financings are securities sold under agreements to repurchase (repurchase agreements), securities loaned and other secured financings. The firm enters into these transactions in order to, among other things, facilitate client activities, invest excess cash, acquire securities to cover short positions and finance certain firm activities.
 
Collateralized agreements and financings are presented on a net-by-counterparty basis when a legal right of setoff exists. Interest on collateralized agreements and collateralized financings is recognized over the life of the transaction and included in “Interest income” and “Interest expense,” respectively. See Note 23 for further information about interest income and interest expense.
 
The table below presents the carrying value of resale and repurchase agreements and securities borrowed and loaned transactions.
 
                     
 
    As of
    March
    December
     
in millions   2011     2010      
 
Securities purchased under agreements to resell 1
  $ 162,094     $ 188,355      
Securities borrowed 2
    184,217       166,306      
Securities sold under agreements to repurchase 1
    165,475       162,345      
Securities loaned 2
    12,222       11,212      
 
 
 
1.   Resale and repurchase agreements are carried at fair value under the fair value option. See Note 8 for further information about the valuation techniques and significant inputs used to determine fair value.
 
2.   As of March 2011 and December 2010, $62.24 billion and $48.82 billion of securities borrowed and $1.43 billion and $1.51 billion of securities loaned were at fair value, respectively.
 
Resale and Repurchase Agreements
A resale agreement is a transaction in which the firm purchases financial instruments from a seller, typically in exchange for cash, and simultaneously enters into an agreement to resell the same or substantially the same financial instruments to the seller at a stated price plus accrued interest at a future date.

A repurchase agreement is a transaction in which the firm sells financial instruments to a buyer, typically in exchange for cash, and simultaneously enters into an agreement to repurchase the same or substantially the same financial instruments from the buyer at a stated price plus accrued interest at a future date.
 
The financial instruments purchased or sold in resale and repurchase agreements typically include U.S. government and federal agency, and investment-grade sovereign obligations.
 
The firm receives financial instruments purchased under resale agreements, makes delivery of financial instruments sold under repurchase agreements, monitors the market value of these financial instruments on a daily basis, and delivers or obtains additional collateral due to changes in the market value of the financial instruments, as appropriate. For resale agreements, the firm typically requires delivery of collateral with a fair value approximately equal to the carrying value of the relevant assets in the condensed consolidated statements of financial condition.
 
Even though repurchase and resale agreements involve the legal transfer of ownership of financial instruments, they are accounted for as financing arrangements because they require the financial instruments to be repurchased or resold at the maturity of the agreement. However, “repos to maturity” are accounted for as sales. A repo to maturity is a transaction in which the firm transfers a security that has very little, if any, default risk under an agreement to repurchase the security where the maturity date of the repurchase agreement matches the maturity date of the underlying security. Therefore, the firm effectively no longer has a repurchase obligation and has relinquished control over the underlying security and, accordingly, accounts for the transaction as a sale. The firm had no such transactions outstanding as of March 2011 or December 2010.


43


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Securities Borrowed and Loaned Transactions
In a securities borrowed transaction, the firm borrows securities from a counterparty in exchange for cash. When the firm returns the securities, the counterparty returns the cash. Interest is generally paid periodically over the life of the transaction.
 
In a securities loaned transaction, the firm lends securities to a counterparty typically in exchange for cash or securities, or a letter of credit. When the counterparty returns the securities, the firm returns the cash or securities posted as collateral. Interest is generally paid periodically over the life of the transaction.
 
The firm receives securities borrowed, makes delivery of securities loaned, monitors the market value of these securities on a daily basis, and delivers or obtains additional collateral due to changes in the market value of the securities, as appropriate. For securities borrowed transactions, the firm typically requires delivery of collateral with a fair value approximately equal to the carrying value of the securities borrowed transaction.
 
Securities borrowed and loaned within Fixed Income, Currency and Commodities Client Execution, are recorded at fair value under the fair value option.
 
Securities borrowed and loaned within Securities Services are recorded based on the amount of cash collateral advanced or received plus accrued interest. As these arrangements generally can be terminated on demand, they exhibit little, if any, sensitivity to changes in interest rates.
 
As of March 2011 and December 2010, the firm had $11.60 billion and $12.86 billion, respectively, of securities received under resale agreements and securities borrowed transactions that were segregated to satisfy certain regulatory requirements. These securities are included in “Cash and securities segregated for regulatory and other purposes.”

Other Secured Financings
In addition to repurchase agreements and securities lending transactions, the firm funds certain assets through the use of other secured financings and pledges financial instruments and other assets as collateral in these transactions. These other secured financings consist of:
 
•   debt raised through the firm’s William Street credit extension program;
 
•   liabilities of consolidated VIEs;
 
•   transfers of assets accounted for as financings rather than sales (primarily collateralized central bank financings, pledged commodities, bank loans and mortgage whole loans); and
 
•   other structured financing arrangements.
 
Other secured financings include arrangements that are nonrecourse. As of March 2011 and December 2010, nonrecourse other secured financings were $6.96 billion and $8.42 billion, respectively.
 
The firm has elected to apply the fair value option to the following other secured financings because the use of fair value eliminates non-economic volatility in earnings that would arise from using different measurement attributes:
 
•   debt raised through the firm’s William Street credit extension program;
 
•   transfers of assets accounted for as financings rather than sales; and
 
•   certain other nonrecourse financings.
 
See Note 8 for further information about other secured financings that are accounted for at fair value. Other secured financings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest, which generally approximates fair value.
 


44


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

The table below presents information about other secured financings. In the table below:
 
•   short-term secured financings include financings maturing within one year of the financial statement date and financings that are redeemable within one year of the financial statement date at the option of the holder;

•   long-term secured financings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates; and
 
•   long-term secured financings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.


 
                                                     
 
    As of March 2011     As of December 2010 
    U.S.
    Non-U.S.
          U.S.
    Non-U.S.
           
$ in millions   Dollar     Dollar     Total     Dollar     Dollar     Total      
 
Other secured financings (short-term):
                                                   
At fair value
  $ 14,892     $ 3,173     $ 18,065     $ 16,404     $ 3,684     $ 20,088      
At amortized cost
    101       9,488       9,589       99       4,342       4,441      
Interest rates 1
    3.48%       0.26%               2.96%       0.71%              
Other secured financings (long-term):
                                                   
At fair value
    4,435       2,653       7,088       9,594       2,112       11,706      
At amortized cost
    1,575       597       2,172       1,565       577       2,142      
Interest rates 1
    2.15%       2.51%               2.14%       1.94%              
 
 
Total 2
  $ 21,003     $ 15,911     $ 36,914     $ 27,662     $ 10,715     $ 38,377      
 
 
Amount of other secured financings collateralized by:
                                                   
Financial instruments 3
  $ 20,410     $ 14,162     $ 34,572     $ 27,014     $ 8,760     $ 35,774      
Other assets 4
    593       1,749       2,342       648       1,955       2,603      
 
 
 
1.   The weighted average interest rates exclude secured financings at fair value and include the effect of hedging activities. See Note 7 for further information about hedging activities.
 
2.   Includes $13.97 billion and $8.32 billion related to transfers of financial assets accounted for as financings rather than sales as of March 2011 and December 2010, respectively. Such financings were collateralized by financial assets included in “Financial instruments owned, at fair value” of $14.21 billion and $8.53 billion as of March 2011 and December 2010, respectively.
 
3.   Includes $20.61 billion and $25.63 billion of other secured financings collateralized by financial instruments owned, at fair value and $13.96 billion and $10.14 billion of other secured financings collateralized by financial instruments received as collateral and repledged as of March 2011 and December 2010, respectively.
 
4.   Primarily real estate and cash.
 

The table below presents other secured financings by maturity.
 
             
 
    As of
     
in millions   March 2011      
 
Other secured financings (short-term)
  $ 27,654      
Other secured financings (long-term):
           
2012
    2,741      
2013
    1,976      
2014
    1,653      
2015
    546      
2016
    108      
2017-thereafter
    2,236      
 
 
Total other secured financings (long-term)
    9,260      
 
 
Total other secured financings
  $ 36,914      
 
 

The aggregate contractual principal amount of other secured financings (long-term) for which the fair value option was elected exceeded the related fair value by $282 million and $352 million as of March 2011 and December 2010, respectively.
 
Collateral Received and Pledged
The firm receives financial instruments (e.g., U.S. government and federal agency, other sovereign and corporate obligations, as well as equities and convertible debentures) as collateral, primarily in connection with resale agreements, securities borrowed, derivative transactions and customer margin loans.


45


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

In many cases, the firm is permitted to deliver or repledge these financial instruments when entering into repurchase agreements, securities lending agreements and other secured financings, collateralizing derivative transactions and meeting firm or customer settlement requirements.
 
The table below presents financial instruments at fair value received as collateral that were available to be delivered or repledged and were delivered or repledged by the firm.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Collateral available to be delivered or repledged
  $ 622,855     $ 618,423      
Collateral that was delivered or repledged
    459,273       447,882      
 
 
 
The firm also pledges certain financial instruments owned, at fair value in connection with repurchase agreements, securities lending agreements and other secured financings, and other assets (primarily real estate and cash) in connection with other secured financings to counterparties who may or may not have the right to deliver or repledge them. The table below presents information about assets pledged by the firm.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Financial instruments owned, at fair value pledged to counterparties that:
                   
Had the right to deliver or repledge
  $ 47,268     $ 51,010      
Did not have the right to deliver or repledge
    131,685       112,750      
Other assets pledged to counterparties that:
                   
Did not have the right to deliver or repledge
    4,217       4,482      
 
 

Note 10.  Securitization Activities
 
The firm securitizes residential and commercial mortgages, corporate bonds, loans and other types of financial assets by selling these assets to securitization vehicles (e.g., trusts, corporate entities, and limited liability companies) and acts as underwriter of the beneficial interests that are sold to investors. The firm’s residential mortgage securitizations are substantially all in connection with government agency securitizations.
 
Beneficial interests issued by securitization entities are debt or equity securities that give the investors rights to receive all or portions of specified cash inflows to a securitization vehicle and include senior and subordinated shares of principal, interest and/or other cash inflows. The proceeds from the sale of beneficial interests are used to pay the transferor for the financial assets sold to the securitization vehicle or to purchase securities which serve as collateral.
 
The firm accounts for a securitization as a sale when it has relinquished control over the transferred assets. Prior to securitization, the firm accounts for assets pending transfer at fair value and therefore does not typically recognize gains or losses upon the transfer of assets. Net revenues from underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.
 
For transfers of assets that are not accounted for as sales, the assets remain in “Financial instruments owned, at fair value” and the transfer is accounted for as a collateralized financing, with the related interest expense recognized over the life of the transaction. See Notes 9 and 23 for further information about collateralized financings and interest expense, respectively.
 
The firm generally receives cash in exchange for the transferred assets but may also have continuing involvement with transferred assets, including ownership of beneficial interests in securitized financial assets, primarily in the form of senior or subordinated securities, and servicing rights that the firm retains at the time of securitization. The firm may also purchase senior or subordinated securities issued by securitization vehicles (which are typically VIEs) in connection with secondary market-making activities.


46


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Beneficial interests and other interests from the firm’s continuing involvement with securitization vehicles are accounted for at fair value and are included in “Financial instruments owned, at fair value” and are generally classified in level 2 of the fair value hierarchy. See Notes 5 through 8 for further information about fair value measurements.
 
The table below presents the amount of financial assets securitized and the cash flows received on retained interests in securitization entities in which the firm had continuing involvement.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Residential mortgages
  $ 7,703     $ 9,959      
Commercial mortgages
    325            
Other financial assets
    32       14      
 
 
Total
  $ 8,060     $ 9,973      
 
 
                     
 
 
Cash flows on retained interests
  $ 228     $ 199      
 
 

The table below presents the firm’s continuing involvement in nonconsolidated securitization entities to which the firm sold assets, as well as the total outstanding principal amount of transferred assets in which the firm has continuing involvement. In this table:
 
•   the outstanding principal amount is presented for the purpose of providing information about the size of the securitization entities in which the firm has continuing involvement and is not representative of the firm’s risk of loss;
 
•   for retained or purchased interests, the firm’s risk of loss is limited to the fair value of these interests; and
 
•   purchased interests represent senior and subordinated interests, purchased in connection with secondary market-making activities, in securitization entities in which the firm also holds retained interests.
 


 
                                                     
 
    As of March 2011     As of December 2010 
    Outstanding
    Fair Value of
    Fair Value of
    Outstanding
    Fair Value of
    Fair Value of
     
    Principal
    Retained
    Purchased
    Principal
    Retained
    Purchased
     
in millions   Amount     Interests     Interests     Amount     Interests     Interests      
 
Residential mortgage-backed
    $72,240     $ 5,083     $ 5       $73,670     $ 6,054     $ 5      
Commercial mortgage-backed
    5,428       884       100       5,040       849       82      
CDOs, CLOs and other
    12,575       75       237       12,872       62       229      
 
 
Total 1
    $90,243     $ 6,042     $ 342       $91,582     $ 6,965     $ 316      
 
 
 
1.   Outstanding principal amount and fair value of retained interests include $7.38 billion and $13 million, respectively, as of March 2011, and $7.64 billion and $16 million, respectively, as of December 2010, related to securitization entities in which the firm’s only continuing involvement is retained servicing which is not a variable interest.
 

47


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

In addition to the interests in the table above, the firm had other continuing involvement in the form of derivative transactions and guarantees with certain nonconsolidated VIEs. The carrying value of these derivatives and guarantees was a net liability of $110 million and $98 million as of March 2011 and December 2010, respectively. The notional amounts of these derivatives and guarantees are included in

maximum exposure to loss in the nonconsolidated VIE tables in Note 11.
 
The table below presents the weighted average key economic assumptions used in measuring the fair value of retained interests and the sensitivity of this fair value to immediate adverse changes of 10% and 20% in those assumptions.


 
                                     
 
    As of March 2011     As of December 2010 
    Type of Retained Interests     Type of Retained Interests 
$ in millions   Mortgage-Backed     Other 1     Mortgage-Backed     Other 1      
 
Fair value of retained interests
    $5,967     $ 75     $ 6,903     $ 62      
Weighted average life (years)
    6.5       3.5       7.4       4.2      
Constant prepayment rate 2
    9.6%       N.M.       11.6%       N.M.      
Impact of 10% adverse change 2
    $   (41 )     N.M.     $ (62 )     N.M.      
Impact of 20% adverse change 2
    (83 )     N.M.       (128 )     N.M.      
Discount rate 3
    5.1%       N.M.       5.3%       N.M.      
Impact of 10% adverse change
    $  (135 )     N.M.     $ (175 )     N.M.      
Impact of 20% adverse change
    (263 )     N.M.       (341 )     N.M.      
 
 
 
1.   Due to the nature and current fair value of certain of these retained interests, the weighted average assumptions for constant prepayment and discount rates and the related sensitivity to adverse changes are not meaningful as of March 2011 and December 2010. The firm’s maximum exposure to adverse changes in the value of these interests is the carrying value of $75 million and $62 million as of March 2011 and December 2010, respectively.
 
2.   Constant prepayment rate is included only for positions for which constant prepayment rate is a key assumption in the determination of fair value.
 
3.   The majority of mortgage-backed retained interests are U.S. government agency-issued collateralized mortgage obligations, for which there is no anticipated credit loss. For the remainder of retained interests, the expected credit loss assumptions are reflected in the discount rate.
 

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 in the preceding table is calculated independently of changes in any other assumption. In practice, simultaneous changes in assumptions might magnify or counteract the sensitivities disclosed above.
 


48


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 11.  Variable Interest Entities
 

VIEs generally finance the purchase of assets by issuing debt and equity securities that are either collateralized by or indexed to the assets held by the VIE. The debt and equity securities issued by a VIE may include tranches of varying levels of subordination. The firm’s involvement with VIEs includes securitization of financial assets, as described in Note 10, and investments in and loans to other types of VIEs, as described below. See Note 10 for additional information about securitization activities, including the definition of beneficial interests. See Note 3 for the firm’s consolidation policies, including the definition of a VIE.
 
The firm is principally involved with VIEs through the following business activities:
 
Mortgage-Backed VIEs and Corporate CDO and CLO VIEs.  The firm sells residential and commercial mortgage loans and securities to mortgage-backed VIEs and corporate bonds and loans to corporate CDO and CLO VIEs and may retain beneficial interests in the assets sold to these VIEs. The firm purchases and sells beneficial interests issued by mortgage-backed and corporate CDO and CLO VIEs in connection with market-making activities. In addition, the firm may enter into derivatives with certain of these VIEs, primarily interest rate swaps, which are typically not variable interests. The firm generally enters into derivatives with other counterparties to mitigate its risk from derivatives with these VIEs.
 
Certain mortgage-backed and corporate CDO and CLO VIEs, usually referred to as synthetic CDOs or credit-linked note VIEs, synthetically create the exposure for the beneficial interests they issue by entering into credit derivatives, rather than purchasing the underlying assets. These credit derivatives may reference a single asset, an index, or a portfolio/basket of assets or indices. See Note 7 for further information on credit derivatives. These VIEs use the funds from the sale of beneficial interests and the premiums received from credit derivative counterparties to purchase securities which serve to collateralize the beneficial interest holders and/or the credit derivative counterparty. These VIEs may enter into other derivatives, primarily interest rate swaps, which are typically not variable interests. The firm may be a counterparty to derivatives with these VIEs and generally enters into derivatives with other counterparties to mitigate its risk.

Real Estate, Credit-Related and Other Investing VIEs.  The firm purchases equity and debt securities issued by and makes loans to VIEs that hold real estate, performing and nonperforming debt, distressed loans and equity securities.
 
Other Asset-Backed VIEs.  The firm structures VIEs that issue notes to clients and purchases and sells beneficial interests issued by other asset-backed VIEs in connection with market-making activities. In addition, the firm may enter into derivatives with certain other asset-backed VIEs, primarily total return swaps on the collateral assets held by these VIEs under which the firm pays the VIE the return due to the note holders and receives the return on the collateral assets owned by the VIE. The firm generally can be removed as the total return swap counterparty. The firm generally enters into derivatives with other counterparties to mitigate its risk from derivatives with these VIEs. The firm typically does not sell assets to the other asset-backed VIEs it structures.
 
Power-Related VIEs.  The firm purchases debt and equity securities issued by and may provide guarantees to VIEs that hold power-related assets. The firm typically does not sell assets to or enter into derivatives with these VIEs.
 
Investment Funds.  The firm purchases equity securities issued by and may provide guarantees to certain of the investment funds it manages. The firm typically does not sell assets to or enter into derivatives with these VIEs.
 
Principal-Protected Note VIEs.  The firm structures VIEs that issue principal-protected notes to clients. These VIEs own portfolios of assets, principally with exposure to hedge funds. Substantially all of the principal protection on the notes issued by these VIEs is provided by the asset portfolio rebalancing that is required under the terms of the notes. The firm enters into total return swaps with these VIEs under which the firm pays the VIE the return due to the principal-protected note holders and receives the return on the assets owned by the VIE. The firm may enter into derivatives with other counterparties to mitigate the risk it has from the derivatives it enters into with these VIEs. The firm also obtains funding through these VIEs. These VIEs were consolidated by the firm upon adoption of changes to U.S. GAAP on January 1, 2010.


49


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Municipal Bond Securitizations.  The firm sells municipal securities to VIEs that issue short-term qualifying tax-exempt securities. The firm consolidates these VIEs because it owns the residual interests, which allows the firm to make decisions that significantly impact the economic performance of these VIEs.
 
VIE Consolidation Analysis
A variable interest in a VIE is an investment (e.g., debt or equity securities) or other interest (e.g., derivatives or loans and lending commitments) in a VIE that will absorb portions of the VIE’s expected losses or receive portions of the VIE’s expected residual returns.
 
The firm’s variable interests in VIEs include senior and subordinated debt in residential and commercial mortgage-backed and other asset-backed securitization entities, CDOs and CLOs; loans and lending commitments; limited and general partnership interests; preferred and common equity; derivatives that may include foreign currency, equity and/or credit risk; guarantees; and certain of the fees the firm receives from investment funds. Certain interest rate, foreign currency and credit derivatives the firm enters into with VIEs are not variable interests because they create rather than absorb risk.
 
The enterprise with a controlling financial interest in a VIE is known as the primary beneficiary and consolidates the VIE. The firm determines whether it is the primary beneficiary of a VIE by performing an analysis that principally considers:
 
•   which variable interest holder has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance;
 
•   which variable interest holder has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE;
 
•   the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders;
 
•   the VIE’s capital structure;
 
•   the terms between the VIE and its variable interest holders and other parties involved with the VIE; and
 
•   related party relationships.

The firm reassesses its initial evaluation of whether an entity is a VIE when certain reconsideration events occur. The firm reassesses its determination of whether it is the primary beneficiary of a VIE on an ongoing basis based on current facts and circumstances.
 
 
Nonconsolidated VIEs
The firm’s exposure to the obligations of VIEs is generally limited to its interests in these entities. In certain instances, the firm provides guarantees, including derivative guarantees, to VIEs or holders of variable interests in VIEs.
 
The tables below present information about nonconsolidated VIEs in which the firm holds variable interests. Nonconsolidated VIEs are aggregated based on principal business activity. The nature of the firm’s variable interests can take different forms, as described in the rows under maximum exposure to loss. In the tables below:
 
•   The maximum exposure to loss excludes the benefit of offsetting financial instruments that are held to mitigate the risks associated with these variable interests.
 
•   For retained and purchased interests and loans and investments, the maximum exposure to loss is the carrying value of these interests.
 
•   For commitments and guarantees, and derivatives, the maximum exposure to loss is the notional amount, which does not represent anticipated losses and also has not been reduced by unrealized losses already recorded. As a result, the maximum exposure to loss exceeds liabilities recorded for commitments and guarantees, and derivatives provided to VIEs.
 
The carrying values of the firm’s variable interests in nonconsolidated VIEs are included in the condensed consolidated statement of financial condition as follows:
 
•   Substantially all assets held by the firm related to mortgage-backed, corporate CDO and CLO and other asset-backed VIEs and investment funds are included in “Financial instruments owned, at fair value.” Substantially all liabilities held by the firm related to mortgage-backed, corporate CDO and CLO and other asset-backed VIEs are included in “Financial instruments sold, but not yet purchased, at fair value.”


50


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

•   Assets and liabilities held by the firm related to real estate, credit-related and other investing VIEs are primarily included in “Financial instruments owned, at fair value” and “Payables to customers and counterparties,” respectively.

•   Assets and liabilities held by the firm related to power-related VIEs are primarily included in “Other assets” and “Other liabilities and accrued expenses,” respectively.


                                                             
 
    Nonconsolidated VIEs
    As of March 2011
          Corporate
    Real estate, credit-
    Other
                       
    Mortgage-
    CDOs and
    related and
    asset-
    Power-
    Investment
           
in millions   backed     CLOs     other investing     backed     related     funds     Total      
 
Assets in VIE
  $ 85,156  2   $ 27,894     $ 9,787     $ 7,589     $ 565     $ 2,587     $ 133,578      
Carrying Value of the Firm’s Variable Interests
                                                           
    Assets     6,895       1,254       1,398       731       270       5       10,553      
    Liabilities           90       1       32       9             132      
Maximum Exposure to Loss in Nonconsolidated VIEs
                                                           
    Retained interests     5,954       55             20                   6,029      
    Purchased interests     596       650             704                   1,950      
    Commitments and guarantees 1           1       228             52             281      
    Derivatives 1     2,909       8,650             1,167                   12,726      
    Loans and investments     111             1,398             270       5       1,784      
 
 
Total
  $ 9,570  2   $ 9,356     $ 1,626     $ 1,891     $ 322     $ 5     $ 22,770      
 
 
 
                                                             
 
    Nonconsolidated VIEs
    As of December 2010
          Corporate
    Real estate, credit-
    Other
                       
    Mortgage-
    CDOs and
    related and
    asset-
    Power-
    Investment
           
in millions   backed     CLOs     other investing     backed     related     funds     Total      
 
Assets in VIE
  $ 88,755  2   $ 21,644     $ 12,568     $ 5,513     $ 552     $ 2,330     $ 131,362      
Carrying Value of the Firm’s Variable Interests
                                                           
    Assets     8,076       909       1,063       266       239       5       10,558      
    Liabilities           114       1       19       14             148      
Maximum Exposure to Loss in Nonconsolidated VIEs
                                                           
    Retained interests     6,887       50             12                   6,949      
    Purchased interests     839       353             247                   1,439      
    Commitments and guarantees 1           1       125             69             195      
    Derivatives 1     3,128       7,593             1,105                   11,826      
    Loans and investments     104             1,063             239       5       1,411      
 
 
Total
  $ 10,958  2   $ 7,997     $ 1,188     $ 1,364     $ 308     $ 5     $ 21,820      
 
 
 
1.   The aggregate amounts include $4.23 billion and $4.52 billion as of March 2011 and December 2010, respectively, related to guarantees and derivative transactions with VIEs to which the firm transferred assets.
 
2.   Assets in VIE and maximum exposure to loss include $6.01 billion and $3.04 billion, respectively, as of March 2011, and $6.14 billion and $3.25 billion, respectively, as of December 2010, related to CDOs backed by mortgage obligations.

51


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Consolidated VIEs

The tables below present the carrying amount and classification of assets and liabilities in consolidated VIEs, excluding the benefit of offsetting financial instruments that are held to mitigate the risks associated with the firm’s variable interests. Consolidated VIEs are aggregated based on principal business activity and their assets and liabilities are presented net of intercompany eliminations. The majority of the assets in principal-protected notes VIEs are intercompany and are eliminated in consolidation.

Substantially all the assets in consolidated VIEs can only be used to settle obligations of the VIE.
 
The tables below exclude VIEs in which the firm holds a majority voting interest if (i) the VIE meets the definition of a business and (ii) the VIE’s assets can be used for purposes other than the settlement of its obligations.
 
The liabilities of real estate, credit-related and other investing VIEs and CDOs, mortgage-backed and other asset-backed VIEs do not have recourse to the general credit of the firm.


 
                                             
 
    Consolidated VIEs
    As of March 2011
                CDOs,
                 
    Real estate,
          mortgage-
                 
    credit-related
    Municipal
    backed and
    Principal-
           
    and other
    bond
    other asset-
    protected
           
in millions   investing     securitizations     backed     notes     Total      
 
Assets
                                           
Cash and cash equivalents
  $ 236     $     $ 23     $ 34     $ 293      
Cash and securities segregated for regulatory and other purposes
    195                         195      
Receivables from brokers, dealers and clearing organizations
    4                         4      
Receivables from customers and counterparties
    1             67             68      
Financial instruments owned, at fair value
    2,369       552       644       722       4,287      
Other assets
    2,867             484             3,351      
 
 
Total
  $ 5,672     $ 552     $ 1,218     $ 756     $ 8,198      
 
 
Liabilities
                                           
Other secured financings
  $ 2,081     $ 619     $ 561     $ 3,235     $ 6,496      
Payables to customers and counterparties
                9       25       34      
Financial instruments sold, but not yet purchased, at fair value
                53             53      
Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings
    73                   2,200       2,273      
Unsecured long-term borrowings
    142                         142      
Other liabilities and accrued expenses
    1,820             41             1,861      
 
 
Total
  $ 4,116     $ 619     $ 664     $ 5,460     $ 10,859      
 
 
 

52


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
                                             
 
    Consolidated VIEs
    As of December 2010
                CDOs,
                 
    Real estate,
          mortgage-
                 
    credit-related
    Municipal
    backed and
    Principal-
           
    and other
    bond
    other asset-
    protected
           
in millions   investing     securitizations     backed     notes     Total      
 
Assets
                                           
Cash and cash equivalents
  $ 248     $     $ 39     $ 52     $ 339      
Cash and securities segregated for regulatory and other purposes
    205                         205      
Receivables from brokers, dealers and clearing organizations
    4                         4      
Receivables from customers and counterparties
    1             27             28      
Financial instruments owned, at fair value
    2,531       547       550       648       4,276      
Other assets
    3,369             499             3,868      
 
 
Total
  $ 6,358     $ 547     $ 1,115     $ 700     $ 8,720      
 
 
Liabilities
                                           
Other secured financings
  $ 2,434     $ 630     $ 417     $ 3,224     $ 6,705      
Payables to customers and counterparties
                12             12      
Financial instruments sold, but not yet purchased, at fair value
                55             55      
Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings
    302                   2,359       2,661      
Unsecured long-term borrowings
    6                         6      
Other liabilities and accrued expenses
    2,004             32             2,036      
 
 
Total
  $ 4,746     $ 630     $ 516     $ 5,583     $ 11,475      
 
 
 

53


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 12.  Other Assets
 

Other assets are generally less liquid, non-financial assets. The table below presents other assets by type.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Property, leasehold improvements and equipment 1
  $ 10,184     $ 11,106      
Goodwill and identifiable intangible assets 2
    5,238       5,522      
Income tax-related assets 3
    5,021       6,239      
Equity-method investments 4
    1,165       1,445      
Miscellaneous receivables and other 5
    6,750       3,747      
 
 
Total
  $ 28,358     $ 28,059      
 
 
 
1.   Net of accumulated depreciation and amortization of $7.86 billion and $7.87 billion as of March 2011 and December 2010, respectively.
 
2.   See Note 13 for further information about goodwill and identifiable intangible assets.
 
3.   See Note 24 for further information about income taxes.
 
4.   Excludes investments of $3.78 billion and $3.77 billion accounted for at fair value under the fair value option as of March 2011 and December 2010, respectively, which are included in “Financial instruments owned, at fair value.” See Note 8 for further information.
 
5.   Includes $2.93 billion of assets held for sale as of March 2011, primarily consisting of servicing advances.
 
Property, Leasehold Improvements and Equipment
Property, leasehold improvements and equipment included $6.49 billion and $6.44 billion as of March 2011 and December 2010, respectively, related to property, leasehold improvements and equipment that the firm uses in connection with its operations. The remainder is held by investment entities, including VIEs, consolidated by the firm.

Substantially all property and equipment are depreciated on a straight-line basis over the useful life of the asset.
 
Leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter.
 
Certain costs of software developed or obtained for internal use are capitalized and amortized on a straight-line basis over the useful life of the software.
 
Property, leasehold improvements and equipment are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable. The firm’s policy for impairment testing of property, leasehold improvements and equipment is the same as is used for identifiable intangible assets with finite lives. See Note 13 for further information.
 
Assets Held for Sale
In the first quarter of 2011, the firm classified certain assets as held for sale, primarily related to Litton Loan Servicing LP (Litton), the firm’s residential mortgage servicing subsidiary, and recognized impairment losses of approximately $220 million, principally in the firm’s Institutional Client Services segment. These impairment losses, which were included in “Depreciation and amortization,” represent the excess of (i) the carrying value of the assets held for sale over (ii) their estimated fair value less estimated cost to sell. The firm expects to sell these assets in the next twelve months.
 
 


54


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 13.  Goodwill and Identifiable Intangible Assets
 

The tables below present, by operating segment, the carrying values of goodwill and identifiable intangible assets, which are included in “Other assets.”
 
                     
 
    Goodwill
    As of
    March
    December
     
in millions   2011     2010      
 
Investment Banking:
                   
Underwriting
    $   125     $ 125      
Institutional Client Services:
                   
Fixed Income, Currency and Commodities Client Execution 1
    5       159      
Equities Client Execution
    2,361       2,361      
Securities Services
    117       117      
Investing & Lending
    153       172      
Investment Management
    561       561      
 
 
Total
    $3,322     $ 3,495      
 
 
 
                     
 
    Identifiable
    Intangible Assets
    As of
    March
    December
     
in millions   2011     2010      
 
Institutional Client Services:
                   
Fixed Income, Currency and
Commodities Client Execution
    $   539     $ 608      
Equities Client Execution
    709       718      
Investing & Lending
    550       579      
Investment Management
    118       122      
 
 
Total
    $1,916     $ 2,027      
 
 
 
1.   The decrease from December 2010 to March 2011 is related to the classification of Litton as held for sale. See Note 12 for further information.

Goodwill
Goodwill is the cost of acquired companies in excess of the fair value of identifiable net assets at acquisition date.
 
Goodwill is tested annually for impairment or more frequently if events occur or circumstances change that indicate an impairment may exist.
 
The goodwill impairment test consists of two steps.
 
•   The first step compares the fair value of each reporting unit with its estimated net book value (including goodwill and identified intangible assets). If the reporting unit’s fair value exceeds its estimated net book value, goodwill is not impaired.
 
•   If the estimated fair value of a reporting unit is less than its estimated net book value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. An impairment loss is equal to the excess of the carrying amount of goodwill over its fair value.
 
Goodwill was tested for impairment during the fourth quarter of 2010 and no impairment was identified.
 
To estimate the fair value of each reporting unit, both relative value and residual income valuation techniques are used because the firm believes market participants would use these techniques to value the firm’s reporting units.
 
Relative value techniques apply average observable price-to-earnings multiples of comparable competitors to certain reporting units’ net earnings. For other reporting units, fair value is estimated using price-to-book multiples based on residual income techniques, which compare excess reporting unit returns on equity to the firm’s cost of equity capital over a long-term stable growth period. The net book value of each reporting unit reflects the estimated amount of shareholders’ equity required to support the activities of the reporting unit.
 


55


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Identifiable Intangible Assets

The table below presents the gross carrying amount, accumulated amortization and net carrying amount of

identifiable intangible assets and their weighted average remaining lives.


                             
 
        As of
        March
    Weighted Average
  December
     
$ in millions       2011     Remaining Lives    2010      
 
Customer lists
  Gross carrying amount   $ 1,104         $ 1,104      
    Accumulated amortization     (545 )         (529 )    
 
 
    Net carrying amount   $ 559     10   $ 575      
                             
Commodities-related intangibles 1
  Gross carrying amount   $ 616         $ 667      
    Accumulated amortization     (72 )         (52 )    
 
 
    Net carrying amount   $ 544     19   $ 615      
                             
Broadcast royalties 2
  Gross carrying amount   $ 560         $ 560      
    Accumulated amortization     (77 )         (61 )    
 
 
    Net carrying amount   $ 483     8   $ 499      
                             
Insurance-related intangibles 3
  Gross carrying amount   $ 292         $ 292      
    Accumulated amortization     (140 )         (146 )    
 
 
    Net carrying amount   $ 152     7   $ 146      
                             
Other 4
  Gross carrying amount   $ 942         $ 953      
    Accumulated amortization     (764 )         (761 )    
 
 
    Net carrying amount   $ 178     13   $ 192      
                             
Total
  Gross carrying amount   $ 3,514         $ 3,576      
    Accumulated amortization     (1,598 )         (1,549 )    
 
 
    Net carrying amount   $ 1,916     12   $ 2,027      
 
 
 
1.   Primarily includes commodity-related customer contracts and relationships, permits and access rights.
 
2.   Represents television broadcast royalties held by a consolidated VIE.
 
3.   Represents value of business acquired related to the firm’s insurance businesses.
 
4.   Primarily includes the firm’s NYSE DMM rights and exchange-traded fund (ETF) lead market maker rights.
 



56


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Substantially all of the firm’s identifiable intangible assets are considered to have finite lives and are amortized over their estimated lives or, in the case of insurance contracts, in proportion to estimated gross profits or premium revenues. Amortization expense for identifiable intangible assets is included in “Depreciation and amortization.”
 
The tables below present amortization expense for identifiable intangible assets for the three months ended March 2011 and March 2010, and the estimated future amortization expense through 2016 for identifiable intangible assets as of March 2011.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Amortization expense
  $ 57     $ 44      
 
 
 
             
 
    As of
     
in millions   March 2011      
 
Estimated future amortization expense:
           
Remainder of 2011
  $ 179      
2012
    262      
2013
    246      
2014
    216      
2015
    184      
2016
    184      
 
 
 
Identifiable intangible assets are tested for recoverability whenever events or changes in circumstances indicate that an asset’s or asset group’s carrying value may not be recoverable.
 
If a recoverability test is necessary, the carrying value of an asset or asset group is compared to the total of the undiscounted cash flows expected to be received over the remaining useful life and from the disposition of the asset or asset group.
 
•   If the total of the undiscounted cash flows exceeds the carrying value, the asset or asset group is not impaired.
 
•   If the total of the undiscounted cash flows is less than the carrying value, the asset or asset group is not fully recoverable and an impairment loss is recognized as the difference between the carrying amount of the asset or asset group and its estimated fair value.

Note 14.  Deposits
 
The tables below present deposits held in U.S. and non-U.S. offices and the maturities of time deposits. Substantially all U.S. deposits were held at GS Bank USA and were interest-bearing and substantially all non-U.S. deposits were held at Goldman Sachs Bank (Europe) PLC (GS Bank Europe) and were interest-bearing.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
U.S. offices
  $ 32,370     $ 32,353      
Non-U.S. offices
    6,357       6,216      
 
 
Total
  $ 38,727     $ 38,569      
 
 
 
                             
 
    As of March 2011 
in millions   U.S.     Non-U.S.     Total      
 
Remainder of 2011
  $ 1,210     $ 1,096     $ 2,306      
2012
    1,015       28       1,043      
2013
    1,988             1,988      
2014
    494             494      
2015
    791             791      
2016
    81             81      
2017 − thereafter
    1,340             1,340      
 
 
Total
  $ 6,919  1   $ 1,124  2   $ 8,043      
 
 
 
1.   Includes $120 million greater than $100,000, of which $19 million matures within three months, $16 million matures within three to six months, $23 million matures within six to twelve months, and $62 million matures after twelve months.
 
2.   Substantially all were greater than $100,000.
 
Note 15.  Short-Term Borrowings
 
Short-term borrowings were comprised of the following:
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Other secured financings (short-term)
  $ 27,654     $ 24,529      
Unsecured short-term borrowings
    53,746       47,842      
 
 
Total
  $ 81,400     $ 72,371      
 
 
 
 
See Note 9 for further information about other secured financings.


57


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Unsecured short-term borrowings include the portion of unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder.
 
The firm accounts for promissory notes, commercial paper and certain hybrid financial instruments at fair value under the fair value option. See Note 8 for further information about unsecured short-term borrowings that are accounted for at fair value. Short-term borrowings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest, and such amounts approximate fair value due to the short-term nature of the obligations.

The table below presents unsecured short-term borrowings.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Current portion of unsecured long-term borrowings 1
  $ 30,086     $ 25,396      
Hybrid financial instruments
    14,366       13,223      
Promissory notes
    3,041       3,265      
Commercial paper
    1,006       1,306      
Other short-term borrowings
    5,247       4,652      
 
 
Total
  $ 53,746     $ 47,842      
 
 
                     
Weighted average interest rate 2
    1.56%       1.77%      
 
 
 
1.   Includes $11.54 billion and $10.43 billion as of March 2011 and December 2010, respectively, guaranteed by the Federal Deposit Insurance Corporation (FDIC) under the Temporary Liquidity Guarantee Program (TLGP).
 
2.   The weighted average interest rates for these borrowings include the effect of hedging activities and exclude financial instruments accounted for at fair value under the fair value option. See Note 7 for further information about hedging activities.


Note 16.  Long-Term Borrowings
 
Long-term borrowings were comprised of the following:
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Other secured financings (long-term)
  $ 9,260     $ 13,848      
Unsecured long-term borrowings
    173,793       174,399      
 
 
Total
  $ 183,053     $ 188,247      
 
 
 
 

See Note 9 for further information about other secured financings. The table below presents unsecured

long-term borrowings extending through 2060 and consisting principally of senior borrowings.
 


 
                                                     
 
    As of March 2011     As of December 2010 
    U.S.
    Non-U.S.
          U.S.
    Non-U.S.
           
in millions   Dollar     Dollar     Total     Dollar     Dollar     Total      
 
Fixed-rate obligations 1
  $ 82,057     $ 36,323     $ 118,380     $ 82,814     $ 35,885     $ 118,699      
Floating-rate obligations 2
    26,769       28,644       55,413       27,316       28,384       55,700      
 
 
Total 3
  $ 108,826     $ 64,967     $ 173,793     $ 110,130     $ 64,269     $ 174,399      
 
 
 
1.   Interest rates on U.S. dollar-denominated debt ranged from 0.20% to 10.04% (with a weighted average rate of 5.48%) and 0.20% to 10.04% (with a weighted average rate of 5.52%) as of March 2011 and December 2010, respectively. Interest rates on non-U.S. dollar-denominated debt ranged from 0.85% to 14.85% (with a weighted average rate of 4.70%) and 0.85% to 14.85% (with a weighted average rate of 4.65%) as of March 2011 and December 2010, respectively.
 
2.   Floating interest rates generally are based on LIBOR or the federal funds target rate. Equity-linked and indexed instruments are included in floating-rate obligations.
 
3.   Includes $5.56 billion and $8.58 billion as of March 2011 and December 2010, respectively, guaranteed by the FDIC under the TLGP.

58


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

The table below presents unsecured long-term borrowings by maturity date. In the table below:
 
•   unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder are included as unsecured short-term borrowings;
 
•   unsecured long-term borrowings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates; and
 
•   unsecured long-term borrowings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
The aggregate contractual principal amount of unsecured long-term borrowings (principal and non-principal protected) for which the fair value option was elected exceeded the related fair value by $642 million and $349 million as of March 2011 and December 2010, respectively.
 
             
 
    As of
     
in millions   March 2011      
 
2012
  $ 16,952      
2013
    24,375      
2014
    19,089      
2015
    17,325      
2016
    23,369      
2017 − thereafter
    72,683      
 
 
Total 1
  $ 173,793      
 
 
 
1.   Amount includes an increase of $6.74 billion to the carrying amount of certain unsecured long-term borrowings related to hedge accounting. The amounts related to the carrying value of unsecured long-term borrowings associated with the effect of hedge accounting by year of maturity are as follows: $304 million in 2012, $551 million in 2013, $594 million in 2014, $237 million in 2015, $497 million in 2016 and $4.56 billion in 2017 and thereafter.

The firm designates certain derivatives as fair value hedges to effectively convert a substantial portion of its fixed-rate unsecured long-term borrowings which are not accounted for at fair value into floating-rate obligations. Accordingly, excluding the cumulative impact of changes in the firm’s credit spreads, the carrying value of unsecured long-term borrowings approximated fair value as of March 2011 and December 2010. For unsecured long-term borrowings for which the firm did not elect the fair value option, the cumulative impact due to changes in the firm’s own credit spreads would be a reduction in the carrying value of total unsecured long-term borrowings of less than 1% as of both March 2011 and December 2010. See Note 7 for further information about hedging activities.
 
The table below presents unsecured long-term borrowings, after giving effect to hedging activities that converted a substantial portion of fixed-rate obligations to floating-rate obligations.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Fixed-rate obligations
                   
At fair value
  $ 243     $ 22      
At amortized cost 1
    5,881       5,877      
Floating-rate obligations
                   
At fair value
    20,422       18,148      
At amortized cost 1
    147,247       150,352      
 
 
Total
  $ 173,793     $ 174,399      
 
 
 
1.   The weighted average interest rates on the aggregate amounts were 1.93% (5.77% related to fixed-rate obligations and 1.77% related to floating-rate obligations) and 1.90% (5.69% related to fixed-rate obligations and 1.74% related to floating-rate obligations) as of March 2011 and December 2010, respectively. These rates exclude financial instruments accounted for at fair value under the fair value option.
 
 


59


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Subordinated Borrowings

Unsecured long-term borrowings include subordinated debt and junior subordinated debt. Junior subordinated debt is junior in right of payment to other subordinated borrowings, which are junior to senior borrowings. As of

both March 2011 and December 2010, subordinated debt had maturities ranging from 2012 to 2038. The table below presents subordinated borrowings.


 
                                                     
 
    As of March 2011     As of December 2010 
    Par
    Carrying
          Par
    Carrying
           
in millions   Amount     Amount     Rate 1     Amount     Amount     Rate 1      
 
Subordinated debt
    $14,468     $ 16,662       1.18 %     $14,345     $ 16,977       1.19 %    
Junior subordinated debt
    5,085       5,622       2.49 %     5,082       5,716       2.50 %    
 
 
Total subordinated borrowings
    $19,553     $ 22,284       1.52 %     $19,427     $ 22,693       1.54 %    
 
 
 
1.   Weighted average interest rate after giving effect to fair value hedges used to convert these fixed-rate obligations into floating-rate obligations. See Note 7 for further information about hedging activities. See below for information about interest rates on junior subordinated debt.
 
Junior Subordinated Debt

Junior Subordinated Debt Issued to APEX Trusts.  In 2007, Group Inc. issued a total of $2.25 billion of remarketable junior subordinated debt to Goldman Sachs Capital II and Goldman Sachs Capital III (APEX Trusts), Delaware statutory trusts. The APEX Trusts issued $2.25 billion of guaranteed perpetual Normal Automatic Preferred Enhanced Capital Securities (APEX) to third parties and a de minimis amount of common securities to Group Inc. Group Inc. also entered into contracts with the APEX Trusts to sell $2.25 billion of Group Inc. perpetual non-cumulative preferred stock (the stock purchase contracts).
 
The APEX Trusts are wholly owned finance subsidiaries of the firm for regulatory and legal purposes but are not consolidated for accounting purposes.
 
The firm accounted for the stock purchase contracts as equity instruments and, accordingly, recorded the cost of the stock purchase contracts as a reduction to additional paid-in capital. See Note 19 for information on the preferred stock that Group Inc. will issue in connection with the stock purchase contracts.
 
The firm pays interest semi-annually on $1.75 billion of junior subordinated debt issued to Goldman Sachs Capital II at a fixed annual rate of 5.59% and the debt matures on June 1, 2043. The firm pays interest quarterly on $500 million of junior subordinated debt issued to Goldman Sachs Capital III at a rate per annum equal to three-month LIBOR plus 0.57% and the debt matures on September 1, 2043. In addition, the firm makes contract payments at a rate of 0.20% per annum on the stock purchase contracts held by the APEX Trusts.

The firm has the right to defer payments on the junior subordinated debt and the stock purchase contracts, subject to limitations, and therefore cause payment on the APEX to be deferred. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common or preferred stock.
 
In connection with the APEX issuance, the firm covenanted in favor of certain of its debtholders, who were initially and are currently the holders of Group Inc.’s 6.345% Junior Subordinated Debentures due February 15, 2034, that, subject to certain exceptions, the firm would not redeem or purchase (i) Group Inc.’s junior subordinated debt issued to the APEX Trusts prior to the applicable stock purchase date or (ii) APEX or shares of Group Inc.’s perpetual Non-Cumulative Preferred Stock, Series E (Series E Preferred Stock) or perpetual Non-Cumulative Preferred Stock, Series F (Series F Preferred Stock) prior to the date that is ten years after the applicable stock purchase date, unless the applicable redemption or purchase price does not exceed a maximum amount determined by reference to the aggregate amount of net cash proceeds that the firm has received from the sale of qualifying equity securities during the 180-day period preceding the redemption or purchase.


60


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Junior Subordinated Debt Issued in Connection with Trust Preferred Securities.  Group Inc. issued $2.84 billion of junior subordinated debentures in 2004 to Goldman Sachs Capital I (Trust), a Delaware statutory trust. The Trust issued $2.75 billion of guaranteed preferred beneficial interests to third parties and $85 million of common beneficial interests to Group Inc. and used the proceeds from the issuances to purchase the junior subordinated debentures from Group Inc. 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 semi-annually on the 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 for the debentures. The firm has the right, from time to time, to defer payment of interest on the debentures, and therefore cause payment on the Trust’s preferred beneficial interests to be deferred, in each case up to ten consecutive semi-annual periods. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common stock. The Trust is not permitted to pay any distributions on the common beneficial interests held by Group Inc. unless all dividends payable on the preferred beneficial interests have been paid in full.
 


Note 17.  Other Liabilities and Accrued Expenses
 
The table below presents other liabilities and accrued expenses by type.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Compensation and benefits
  $ 5,396     $ 9,089      
Insurance-related liabilities
    15,930       11,381      
Noncontrolling interests 1
    882       872      
Income tax-related liabilities 2
    1,684       2,042      
Employee interests in consolidated funds
    430       451      
Subordinated liabilities issued by consolidated VIEs
    1,352       1,526      
Accrued expenses and other 3
    9,875       4,650      
 
 
Total
  $ 35,549     $ 30,011      
 
 
 
1.   Includes $571 million and $593 million related to consolidated investment funds as of March 2011 and December 2010, respectively.
 
2.   See Note 24 for further information about income taxes.
 
3.   Includes $5.59 billion related to the redemption of the firm’s 10% Cumulative Perpetual Preferred Stock, Series G (Series G Preferred Stock) as of March 2011.
 
The table below presents insurance-related liabilities by type.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Separate account liabilities
  $ 4,035     $ 4,024      
Liabilities for future benefits and unpaid claims 1
    10,861       6,308      
Contract holder account balances
    811       801      
Reserves for guaranteed minimum death and income benefits
    223       248      
 
 
Total
  $ 15,930     $ 11,381      
 
 
 
1.   Includes increased liabilities as of March 2011 related to the acquisition of Paternoster U.K. Limited, a U.K. life insurance company, in the first quarter of 2011. In connection with this acquisition, the firm acquired $4.75 billion of assets (primarily financial instruments owned, at fair value, principally consisting of corporate debt securities) and assumed $4.35 billion of liabilities.
 

61


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Separate account liabilities are supported by separate account assets, representing segregated contract holder funds under variable annuity and life insurance contracts. Separate account assets are included in “Cash and securities segregated for regulatory and other purposes.”
 
Liabilities for future benefits and unpaid claims include liabilities arising from reinsurance provided by the firm to other insurers. The firm had a receivable of $1.31 billion and $1.26 billion as of March 2011 and December 2010, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties.” In addition, the firm has ceded risks to reinsurers related to certain of its liabilities for future benefits and unpaid claims and had a receivable of $842 million and

$839 million as of March 2011 and December 2010, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties.” Contracts to cede risks to reinsurers do not relieve the firm of its obligations to contract holders. Liabilities for future benefits and unpaid claims include $6.57 billion and $2.05 billion carried at fair value under the fair value option as of March 2011 and December 2010, respectively.
 
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 based on total payments expected to be made less total fees expected to be assessed over the life of the contract.
 
 


Note 18.  Commitments, Contingencies and Guarantees
 
Commitments
The table below presents the firm’s commitments.
 
                                                     
 
    Commitment Amount by Period
     
    of Expiration as of March 2011     Total Commitments as of
    Remainder
    2012-
    2014-
    2016-
    March
    December
     
in millions   of 2011     2013     2015     Thereafter     2011     2010      
 
Commitments to extend credit 1
                                                   
Commercial lending:
                                                   
Investment-grade
    $ 2,839     $ 8,998     $ 2,183     $ 1,756       $ 15,776       $ 12,330      
Non-investment-grade
    1,530       5,111       3,727       4,231       14,599       11,919      
William Street credit extension program
    4,124       15,328       7,297       2,371       29,120       27,383      
Warehouse financing
    32       150                   182       265      
 
 
Total commitments to extend credit
    8,525       29,587       13,207       8,358       59,677       51,897      
Contingent and forward starting resale and securities borrowing agreements 2
    55,003                         55,003       46,886      
Forward starting repurchase and securities lending agreements 2
    12,497                         12,497       12,509      
Underwriting commitments
    354                         354       835      
Letters of credit 3
    1,528       474                   2,002       2,210      
Investment commitments
    2,402       6,846       324       715       10,287       11,093      
Other
    345       83       37       15       480       389      
 
 
Total commitments
    $80,654     $ 36,990     $ 13,568     $ 9,088       $140,300       $125,819      
 
 
 
1.   Commitments to extend credit are presented net of amounts syndicated to third parties.
 
2.   These agreements generally settle within three business days.
 
3.   Consists of commitments under letters of credit issued by various banks which the firm provides to counterparties in lieu of securities or cash to satisfy various collateral and margin deposit requirements.

62


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Commitments to Extend Credit
The firm’s commitments to extend credit are agreements to lend with fixed termination dates and depend on the satisfaction of all contractual conditions to borrowing. The total commitment amount does not necessarily reflect actual future cash flows because the firm may syndicate all or substantial portions of these commitments and commitments can expire unused or be reduced or cancelled at the counterparty’s request.
 
The firm generally accounts for commitments to extend credit at fair value. Losses, if any, are generally recorded, net of any fees in “Other principal transactions.”
 
Commercial Lending.  The firm’s commercial lending commitments are generally extended in connection with contingent acquisition financing and other types of corporate lending as well as commercial real estate financing. Commitments that are extended for contingent acquisition financing are often intended to be short-term in nature, as borrowers often seek to replace them with other funding sources.
 
William Street Credit Extension Program.  Substantially all of the commitments provided under the William Street credit extension program are to investment-grade corporate borrowers. Commitments under the program are principally extended by William Street Commitment Corporation (Commitment Corp.), a consolidated wholly owned subsidiary of GS Bank USA, GS Bank USA, and other subsidiaries of GS Bank USA. Historically, commitments extended by Commitment Corp. were supported, in part, by funding raised by Funding Corp., another consolidated wholly owned subsidiary of GS Bank USA. As of April 26, 2011, the funding raised by Funding Corp. had been repaid in its entirety. The commitments extended by Commitment Corp. that had been supported by this funding are now supported by funding from GS Bank USA.
 
The assets and liabilities of Commitment Corp. are legally separated from other assets and liabilities of the firm. The assets of Commitment Corp. will not be available to its shareholders until the claims of its creditors have been paid. In addition, no affiliate of Commitment Corp., except in limited cases as expressly agreed in writing, is responsible for any obligation of Commitment Corp.

Sumitomo Mitsui Financial Group, Inc. (SMFG) provides the firm with credit loss protection that is generally limited to 95% of the first loss the firm realizes on approved loan commitments, up to a maximum of approximately $950 million, with respect to most of the William Street commitments. In addition, subject to the satisfaction of certain conditions, upon the firm’s request, SMFG will provide protection for 70% of additional losses on such commitments, up to a maximum of $1.13 billion, of which $375 million of protection had been provided as of both March 2011 and December 2010. The firm also uses other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG.
 
Warehouse Financing.  The firm provides financing to clients who warehouse financial assets. These arrangements are secured by the warehoused assets, primarily consisting of residential and commercial mortgages.
 
Contingent and Forward Starting Resale and Securities Borrowing Agreements/Forward Starting Repurchase and Securities Lending Agreements
The firm enters into resale and securities borrowing agreements and repurchase and securities lending agreements that settle at a future date. The firm also enters into commitments to provide contingent financing to its clients through resale agreements. The firm’s funding of these commitments depends on the satisfaction of all contractual conditions to the resale agreement and these commitments can expire unused.
 
Investment Commitments
The firm’s investment commitments consist of commitments to invest in private equity, real estate and other assets directly and through funds that the firm raises and manages. These commitments include $1.91 billion and $1.97 billion as of March 2011 and December 2010, respectively, related to real estate private investments and $8.38 billion and $9.12 billion as of March 2011 and December 2010, respectively, related to corporate and other private investments. Of these amounts, $9.48 billion and $10.10 billion as of March 2011 and December 2010, respectively, relate to commitments to invest in funds managed by the firm, which will be funded at market value on the date of investment.


63


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Leases
The firm has contractual obligations under long-term noncancelable lease agreements, principally for office space, expiring on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. The table below presents future minimum rental payments, net of minimum sublease rentals.
 
             
 
    As of
     
in millions   March 2011      
 
Remainder of 2011
  $ 356      
2012
    447      
2013
    377      
2014
    351      
2015
    320      
2016
    284      
2017-thereafter
    1,324      
 
 
Total
  $ 3,459      
 
 
 
Operating leases include office space held in excess of current requirements. Rent expense relating to space held for growth is included in “Occupancy.” The firm records a liability, based on the fair value of the remaining lease rentals reduced by any potential or existing sublease rentals, for leases where the firm has ceased using the space and management has concluded that the firm will not derive any future economic benefits. Costs to terminate a lease before the end of its term are recognized and measured at fair value on termination.
 
Contingencies
Legal Proceedings.  See Note 27 for information on legal proceedings, including certain mortgage-related matters.
 
Certain Mortgage-Related Contingencies.  There are multiple areas of focus by regulators, governmental agencies and others within the mortgage market that may impact originators, issuers, servicers and investors. There remains significant uncertainty surrounding the nature and extent of any potential exposure for participants in this market.
 
•   Representations and Warranties.  The firm was not a significant originator of residential mortgage loans. The firm did purchase loans originated by others and generally received loan-level representations of the type described below from the originators. During the period 2005 through

  2008, the firm sold approximately $10 billion of loans to government-sponsored enterprises and approximately $11 billion of loans to other third parties. In addition, the firm transferred loans to trusts and other mortgage securitization vehicles. As of March 2011, the outstanding balance of the loans transferred to trusts and other mortgage securitization vehicles during the period 2005 through 2008 was approximately $47 billion. This amount reflects paydowns and cumulative losses of approximately $78 billion ($15 billion of which are cumulative losses). A small number of these Goldman Sachs-issued securitizations with an outstanding principal balance of $712 million and total paydowns and cumulative losses of $1.35 billion ($420 million of which are cumulative losses) were structured with credit protection obtained from monoline insurers. In connection with both sales of loans and securitizations, the firm provided loan level representations of the type described below and/or assigned the loan level representations from the party from whom the firm purchased the loans.
 
    The loan level representations made in connection with the sale or securitization of mortgage loans varied among transactions but were generally detailed representations applicable to each loan in the portfolio and addressed matters relating to the property, the borrower and the note. These representations generally included, but were not limited to, the following: (i) certain attributes of the borrower’s financial status; (ii) loan-to-value ratios, owner occupancy status and certain other characteristics of the property; (iii) the lien position; (iv) the fact that the loan was originated in compliance with law; and (v) completeness of the loan documentation.
 
    To date, repurchase claims and actual repurchases of residential mortgage loans based upon alleged breaches of representations have not been significant and have mainly involved government-sponsored enterprises. During the three months ended March 2011, the firm incurred an immaterial loss on the repurchase of less than $10 million of loans. As of March 2011, outstanding repurchase claims were not material.
 
    Ultimately, the firm’s exposure to claims for repurchase of residential mortgage loans based on alleged breaches of representations will


64


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

  depend on a number of factors including the following: (i) the extent to which these claims are actually made; (ii) the extent to which there are underlying breaches of representations that give rise to valid claims for repurchase; (iii) in the case of loans originated by others, the extent to which the firm could be held liable and, if it is, the firm’s ability to pursue and collect on any claims against the parties who made representations to the firm; (iv) macro-economic factors, including developments in the residential real estate market; and (v) legal and regulatory developments.
 
    Based upon the large number of defaults in residential mortgages, including those sold or securitized by the firm, there is a potential for increasing claims for repurchases. However, the firm is not in a position to make a meaningful estimate of that exposure at this time.
 
•   Foreclosure and Other Mortgage Loan Servicing Practices and Procedures. The firm has received a number of requests for information from regulators and other agencies, including state attorneys general and banking regulators, as part of an industry-wide focus on the practices of lenders and servicers in connection with foreclosure proceedings and other aspects of mortgage loan servicing practices and procedures. The requests seek information about the foreclosure and servicing protocols and activities of Litton, the firm’s residential mortgage servicing subsidiary, and any deviations therefrom. The firm is cooperating with the requests and is reviewing Litton’s practices in this area. These inquiries may result in the imposition of fines or other regulatory action. Litton temporarily suspended evictions and foreclosure and real estate owned sales in a number of states, including those with judicial foreclosure procedures. Litton has recently resumed some of these activities. As of the date of this filing, the firm is not aware of foreclosures where the underlying foreclosure decision was not warranted. As of March 2011, the value of the firm’s mortgage servicing rights was not material and any impact on their value would not be material to the firm. Similarly, at this time the firm does not expect the suspension of evictions and foreclosure and real estate owned sales to lead to a material increase in its mortgage servicing-related advances.

Guaranteed Minimum Death and Income Benefits.  In connection with its insurance business, the firm is contingently liable to provide guaranteed minimum death and income benefits to certain contract holders and has established a reserve related to $6.30 billion and $6.11 billion of contract holder account balances as of March 2011 and December 2010, respectively, for such benefits. The weighted average attained age of these contract holders was 69 years for both March 2011 and December 2010.
 
The net amount at risk, representing guaranteed minimum death and income benefits in excess of contract holder account balances, was $1.35 billion and $1.60 billion as of March 2011 and December 2010, respectively. See Note 17 for further information about insurance liabilities.
 
Guarantees
The firm enters into various derivatives that meet the definition of a guarantee under U.S. GAAP, including written equity and commodity put options, written currency contracts and interest rate caps, floors and swaptions. Disclosures about derivatives are not required if they may be cash settled and the firm has no basis to conclude it is probable that the counterparties held the underlying instruments at inception of the contract. The firm has concluded that these conditions have been met for certain large, internationally active commercial and investment bank counterparties and certain other counterparties. Accordingly, the firm has not included such contracts in the table below.
 
The firm, in its capacity as an agency lender, indemnifies most of its securities lending customers against losses incurred in the event that borrowers do not return securities and the collateral held is insufficient to cover the market value of the securities borrowed.
 
In the ordinary course of business, the firm provides other financial guarantees of the obligations of third parties (e.g., standby letters of credit and other guarantees to enable clients to complete transactions and 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.


65


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

The table below presents certain information about derivatives that meet the definition of a guarantee and certain other guarantees. The maximum payout in the table below is based on the notional amount of the contract and therefore does not represent anticipated losses. See Note 7 for further information about credit derivatives that meet the definition of a guarantee which are not included below.

Because derivatives are accounted for at fair value, carrying value is considered the best indication of payment/performance risk for individual contracts. However, the carrying values below exclude the effect of a legal right of setoff that may exist under an enforceable netting agreement and the effect of netting of cash collateral posted under credit support agreements.


                                                     
 
    As of March 2011
    Carrying
    Maximum Payout/Notional Amount by Period of Expiration
    Value of
    Remainder
    2012-
    2014-
    2016-
           
in millions   Net Liability     of 2011     2013     2015     Thereafter     Total      
 
Derivatives 1
  $ 7,908       $396,305     $ 312,769     $ 65,548       $68,270     $ 842,892      
Securities lending indemnifications 2
          31,322                         31,322      
Other financial guarantees 3
    28       328       1,642       431       834       3,235      
 
 
 
1.   These derivatives are risk managed together with derivatives that do not meet the definition of a guarantee, and therefore these amounts do not reflect the firm’s overall risk related to its derivative activities.
 
2.   Collateral held by the lenders in connection with securities lending indemnifications was $32.38 billion as of March 2011. Because the contractual nature of these arrangements requires the firm to obtain collateral with a market value that exceeds the value of the securities lent to the borrower, there is minimal performance risk associated with these guarantees.
 
3.   Other financial guarantees excludes certain commitments to issue standby letters of credit that are included in “Commitments to extend credit.” See table in “Commitments” above for a summary of the firm’s commitments.
 

As of December 2010, the carrying value of the net liability related to derivative guarantees and other financial guarantees was $8.26 billion and $28 million, respectively.
 
Guarantees of Securities Issued by Trusts.  The firm has established trusts, including Goldman Sachs Capital I, II and III, and other entities for the limited purpose of issuing securities to third parties, lending the proceeds to the firm and entering into contractual arrangements with the firm and third parties related to this purpose. The firm does not consolidate these entities. See Note 16 for further information about the transactions involving Goldman Sachs Capital I, II and III.
 
The firm effectively provides for the full and unconditional guarantee of the securities issued by these entities. Timely payment by the firm of amounts due to these entities under the borrowing, preferred stock and related contractual arrangements will be sufficient to cover payments due on the securities issued by these entities.

Management believes that it is unlikely that any circumstances will occur, such as nonperformance on the part of paying agents or other service providers, that would make it necessary for the firm to make payments related to these entities other than those required under the terms of the borrowing, preferred stock and related contractual arrangements and in connection with certain expenses incurred by these entities.
 
Indemnities and Guarantees of Service Providers.  In the ordinary course of business, the firm indemnifies and guarantees certain service providers, such as clearing and custody agents, trustees and administrators, against specified potential losses in connection with their acting as an agent of, or providing services to, the firm or its affiliates.
 
The firm also indemnifies some clients against potential losses incurred in the event specified third-party service providers, including sub-custodians and third-party brokers, improperly execute transactions. In addition, the firm is a member of payment, clearing and settlement networks as well as securities exchanges around the world that may require the firm to meet the obligations of such networks and exchanges in the event of member defaults.


66


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

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 material liabilities related to these guarantees and indemnifications have been recognized in the condensed consolidated statements of financial condition as of March 2011 and December 2010.
 
Other Representations, Warranties and Indemnifications.  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 material liabilities related to these arrangements have been recognized in the condensed consolidated statements of financial condition as of March 2011 and December 2010.
 
Guarantees of Subsidiaries.  Group Inc. fully and unconditionally guarantees the securities issued by GS Finance Corp., a wholly owned finance subsidiary of the firm.
 
Group Inc. has guaranteed the payment obligations of Goldman, Sachs & Co. (GS&Co.), GS Bank USA, GS Bank Europe and Goldman Sachs Execution & Clearing, L.P. (GSEC), subject to certain exceptions.
 
In November 2008, the firm contributed subsidiaries into GS Bank USA, and Group Inc. agreed to guarantee certain losses, including credit-related losses, relating to assets held by the contributed entities. In connection with this guarantee, Group Inc. also agreed to pledge to GS Bank USA certain collateral, including interests in subsidiaries and other illiquid assets.
 
In addition, Group Inc. guarantees many of the obligations of its other consolidated subsidiaries on a transaction-by-transaction basis, as negotiated with counterparties. Group Inc. is unable to develop an estimate of the maximum payout under its subsidiary guarantees; however, because these guaranteed obligations are also obligations of consolidated subsidiaries included in the table above, Group Inc.’s liabilities as guarantor are not separately disclosed.


67


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 



Note 19.  Shareholders’ Equity
 

Common Equity
On April 18, 2011, Group Inc. declared a dividend of $0.35 per common share to be paid on June 29, 2011 to common shareholders of record on June 1, 2011.
 
The firm’s share repurchase program is intended to substantially offset increases in share count over time resulting from employee share-based compensation and to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by the firm’s issuance of shares resulting from employee share-based compensation as well as its current and projected capital position (i.e., comparisons of the firm’s desired level of capital to its actual level of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of the firm’s common stock. Any repurchase of the firm’s common stock requires approval by the Board of Governors of the Federal Reserve System (Federal Reserve Board).

During the three months ended March 2011, the firm repurchased 9.0 million shares of its common stock at an average cost per share of $163.22, for a total cost of $1.47 billion, under the share repurchase program. In addition, pursuant to the terms of certain share-based compensation plans, employees may remit shares to the firm or the firm may cancel RSUs to satisfy minimum statutory employee tax withholding requirements. Under these plans, during the three months ended March 2011, employees remitted 75,378 shares with a total value of $12 million and the firm cancelled 11.0 million of RSUs with a total value of $1.78 billion.
 
Preferred Equity
The table below presents perpetual preferred stock issued and outstanding.


                                     
 
                        Redemption
     
    Shares
  Shares
  Shares
      Earliest
  Value
     
Series   Authorized   Issued   Outstanding   Dividend Rate   Redemption Date   (in millions)      
 
A
  50,000     30,000     29,999   3 month LIBOR + 0.75%,
with floor of 3.75% per annum
  April 25, 2010   $ 750      
B
  50,000     32,000     32,000   6.20% per annum   October 31, 2010     800      
C
  25,000     8,000     8,000   3 month LIBOR + 0.75%,
with floor of 4.00% per annum
  October 31, 2010     200      
D
  60,000     54,000     53,999   3 month LIBOR + 0.67%,
with floor of 4.00% per annum
  May 24, 2011     1,350      
 
 
    185,000     124,000     123,998           $ 3,100      
 
 
 
 

Each share of non-cumulative Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock issued and outstanding has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option, subject to the approval of the Federal Reserve Board, at a redemption price equal to $25,000 plus declared and unpaid dividends.
 
All series of preferred stock are pari passu and have a preference over the firm’s common stock on liquidation. 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.

In 2007, the Board of Directors of Group Inc. (Board) authorized 17,500.1 shares of Series E Preferred Stock, and 5,000.1 shares of Series F Preferred Stock, in connection with the APEX Trusts. See Note 16 for further information.
 
Under the stock purchase contracts with the APEX Trusts, Group Inc. will issue on the relevant stock purchase dates (on or before June 1, 2013 and September 1, 2013 for Series E and Series F Preferred Stock, respectively) one share of Series E and Series F Preferred Stock to Goldman Sachs Capital II and III, respectively, for each $100,000 principal amount of subordinated debt held by these trusts. When issued, each share of Series E and Series F Preferred Stock will have a par value of $0.01 and a liquidation preference of $100,000 per share.


68


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Dividends on Series E Preferred Stock, if declared, will be payable semi-annually at a fixed annual rate of 5.79% if the stock is issued prior to June 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.77% and (ii) 4.00%.
 
Dividends on Series F Preferred Stock, if declared, will be payable quarterly at a rate per annum equal to three-month LIBOR plus 0.77% if the stock is issued prior to September 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus 0.77% and (ii) 4.00%.
 
The preferred stock may be redeemed at the option of the firm on the stock purchase dates or any day thereafter, subject to approval from the Federal Reserve Board and certain covenant restrictions governing the firm’s ability to redeem or purchase the preferred stock without issuing common stock or other instruments with equity-like characteristics.
 
In March 2011, the firm provided notice to Berkshire Hathaway Inc. and certain of its subsidiaries (collectively, Berkshire Hathaway) that it would redeem in full the 50,000 shares of the firm’s Series G Preferred Stock held by Berkshire Hathaway for the stated redemption price of $5.50 billion ($110,000 per share), plus accrued and unpaid dividends. In connection with this notice, the firm recognized a preferred dividend of $1.64 billion (calculated as the difference between the carrying value and redemption value of the preferred stock), which was recorded as a reduction to the firm’s first quarter earnings applicable to common shareholders and common shareholders’ equity. The redemption also resulted in the acceleration of $24 million of preferred dividends related to the period from April 1, 2011 to the redemption date, which was included in the firm’s results for the three months ended March 2011. The Series G Preferred Stock was redeemed on April 18, 2011. Berkshire Hathaway continues to hold a five-year warrant, issued in October 2008, to purchase up to 43.5 million shares of common stock at an exercise price of $115.00 per share.

The table below presents preferred dividends declared on preferred stock.
 
                                     
 
    Three Months
    Ended March 
    2011     2010
    per share     in millions     per share     in millions      
 
Series A
  $ 239.58     $ 7     $ 239.58     $ 7      
Series B
    387.50       12       387.50       12      
Series C
    255.56       2       255.56       2      
Series D
    255.56       14       255.56       14      
Series G
    2,500.00       125  1     2,500.00       125      
 
 
Total
          $ 160             $ 160      
 
 
 
1.   Excludes preferred dividends related to the redemption of the firm’s Series G Preferred Stock.
 
Accumulated Other Comprehensive Income/(Loss)
The table below presents accumulated other comprehensive income/(loss) by type.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Currency translation adjustment, net of tax
  $ (192 )   $ (170 )    
Pension and postretirement liability adjustments, net of tax
    (228 )     (229 )    
Net unrealized gains on available-for-sale securities, net of tax 1
    90       113      
 
 
Total accumulated other comprehensive loss, net of tax
  $ (330 )   $ (286 )    
 
 
 
1.   Substantially all consists of net unrealized gains on available-for-sale securities held by the firm’s insurance subsidiaries as of both March 2011 and December 2010.


69


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 



Note 20.  Regulation and Capital Adequacy
 
 

The Federal Reserve Board is the primary regulator of Group Inc., a bank holding company and a financial holding company under the U.S. Bank Holding Company Act of 1956. As a bank holding company, the firm is subject to consolidated regulatory capital requirements that are computed in accordance with the Federal Reserve Board’s capital adequacy regulations currently applicable to bank holding companies (Basel 1). These capital requirements, which are based on the Capital Accord of the Basel Committee on Banking Supervision (Basel Committee), are expressed as capital ratios that compare measures of capital to risk-weighted assets (RWAs). The firm’s bank depository institution subsidiaries, including GS Bank USA, are subject to similar capital requirements.
 
Under the Federal Reserve Board’s capital adequacy requirements and the regulatory framework for prompt corrective action that is applicable to GS Bank USA, the firm and its bank depository institution subsidiaries must meet specific capital requirements that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory reporting practices. The firm and its bank depository institution subsidiaries’ capital amounts, as well as GS Bank USA’s prompt corrective action classification, are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
 
Many of the firm’s subsidiaries, including GS&Co. and the firm’s other broker-dealer subsidiaries, are subject to separate regulation and capital requirements as described below.
 
Group Inc.
Federal Reserve Board regulations require bank holding companies to maintain a minimum Tier 1 capital ratio of 4% and a minimum total capital ratio of 8%. The required minimum Tier 1 capital ratio and total capital ratio in order to be considered a “well-capitalized” bank holding company under the Federal Reserve Board guidelines are 6% and 10%, respectively. Bank holding companies may be expected to maintain ratios well above the minimum

levels, depending on their particular condition, risk profile and growth plans. The minimum Tier 1 leverage ratio is 3% for bank holding companies that have received the highest supervisory rating under Federal Reserve Board guidelines or that have implemented the Federal Reserve Board’s risk-based capital measure for market risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of 4%.
 
The table below presents information regarding Group Inc.’s regulatory capital ratios.
 
                     
 
    As of 
    March
    December
     
$ in millions   2011     2010      
 
Tier 1 capital
  $ 66,387     $ 71,233      
Tier 2 capital
    13,782       13,660      
Total capital
    80,169       84,893      
Risk-weighted assets
    455,811       444,290      
Tier 1 capital ratio
    14.6%       16.0%      
Total capital ratio
    17.6%       19.1%      
Tier 1 leverage ratio
    7.5%       8.0%      
 
 
 
RWAs under the Federal Reserve Board’s risk-based capital guidelines are calculated based on the amount of market risk and credit risk. RWAs for market risk are determined by reference to the firm’s Value-at-Risk (VaR) models, supplemented by other measures to capture risks not reflected in VaR models. Credit risk for on-balance sheet assets is based on the balance sheet value. For off-balance sheet exposures, including OTC derivatives and commitments, a credit equivalent amount is calculated based on the notional amount of each trade. All such assets and amounts are then assigned a risk weight depending on, among other things, whether the counterparty is a sovereign, bank or qualifying securities firm or other entity (or if collateral is held, depending on the nature of the collateral).
 
Tier 1 leverage ratio is defined as Tier 1 capital under Basel 1 divided by average adjusted total assets (which includes adjustments for disallowed goodwill and intangible assets, and the carrying value of equity investments in non-financial companies that are subject to deductions from Tier 1 capital).
 
 


70


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Regulatory Reform

The firm is currently working to implement the requirements set out in the Federal Reserve Board’s Capital Adequacy Guidelines for Bank Holding Companies: Internal-Ratings-Based and Advanced Measurement Approaches, which are based on the advanced approaches under the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee as applicable to Group Inc. as a bank holding company (Basel 2). U.S. banking regulators have incorporated the Basel 2 framework into the existing risk-based capital requirements by requiring that internationally active banking organizations, such as Group Inc., transition to Basel 2 following the successful completion of a parallel run.
 
In addition, the Basel Committee has undertaken a program of substantial revisions to its capital guidelines. In particular, the changes in the “Basel 2.5” guidelines will result in increased capital requirements for market risk; additionally, the Basel 3 guidelines issued by the Basel Committee in December 2010 revise the definition of Tier 1 capital, introduce Tier 1 common equity as a regulatory metric, set new minimum capital ratios (including a new “capital conservation buffer,” which must be composed exclusively of Tier 1 common equity and will be in addition to the other capital ratios), introduce a Tier 1 leverage ratio within international guidelines for the first time, and make substantial revisions to the computation of risk-weighted assets for credit exposures. Implementation of the new requirements is expected to take place over an extended transition period, starting at the end of 2011 (for Basel 2.5) and end of 2012 (for Basel 3). Although the U.S. federal banking agencies have now issued proposed rules that are intended to implement certain aspects of the Basel 2.5 guidelines, they have not yet addressed all aspects of those guidelines or the Basel 3 changes. In addition, both the Basel Committee and U.S. banking regulators implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank

Act) have indicated that they will impose more stringent capital standards on systemically important financial institutions. Although the criteria for treatment as a systemically important financial institution have not yet been determined, it is probable that they will apply to the firm. Therefore, the regulations ultimately applicable to the firm may be substantially different from those that have been published to date.
 
The Dodd-Frank Act will subject the firm at a firmwide level to the same leverage and risk-based capital requirements that apply to depository institutions and directs banking regulators to impose additional capital requirements as disclosed above. The Federal Reserve Board will be required to begin implementing the new leverage and risk-based capital regulation by January 2012. As a consequence of these changes, Tier 1 capital treatment for the firm’s junior subordinated debt issued to trusts will be phased out over a three-year period beginning on January 1, 2013. The interaction between the Dodd-Frank Act and the Basel Committee’s proposed changes adds further uncertainty to the firm’s future capital requirements.
 
A number of other governmental entities and regulators, including the U.S. Treasury, the European Union and the U.K.’s Financial Services Authority (FSA), have also proposed or announced changes which will result in increased capital requirements for financial institutions.
 
As a consequence of these developments, the firm expects minimum capital ratios required to be maintained under Federal Reserve Board regulations will be increased and changes in the prescribed calculation methodology are expected to result in higher RWAs and lower capital ratios than those currently computed.
 
The capital requirements of several of the firm’s subsidiaries will also be impacted in the future by the various proposals from the Basel Committee, the Dodd-Frank Act, and other governmental entities and regulators.
 
 


71


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Bank Subsidiaries

GS Bank USA, an FDIC-insured, New York State-chartered bank and a member of the Federal Reserve System and the FDIC, is regulated by the Federal Reserve Board and the New York State Banking Department and is subject to minimum capital requirements (described further below) that are calculated in a manner similar to those applicable to bank holding companies. GS Bank USA computes its capital ratios in accordance with the regulatory capital guidelines currently applicable to state member banks, which are based on Basel 1 as implemented by the Federal Reserve Board, for purposes of assessing the adequacy of its capital. In order to be considered a “well-capitalized” depository institution under the Federal Reserve Board guidelines, GS Bank USA must maintain a Tier 1 capital ratio of at least 6%, a total capital ratio of at least 10% and a Tier 1 leverage ratio of at least 5%. In November 2008, the firm contributed subsidiaries into GS Bank USA. In connection with this contribution, GS Bank USA agreed with the Federal Reserve Board to minimum capital ratios in excess of these “well-capitalized” levels. Accordingly, for a period of time, GS Bank USA is expected to maintain a Tier 1 capital ratio of at least 8%, a total capital ratio of at least 11% and a Tier 1 leverage ratio of at least 6%.
 
The table below presents information regarding GS Bank USA’s regulatory capital ratios under Basel 1 as implemented by the Federal Reserve Board.
 
                     
 
    As of 
    March
    December
     
    2011     2010      
 
Tier 1 capital ratio
    19.7%       18.8%      
Total capital ratio
    20.8%  1     23.9%      
Tier 1 leverage ratio
    20.4%       19.5%      
 
 
 
1.   The decrease from December 2010 to March 2011 is primarily related to GS Bank USA’s repayment of $4.00 billion of subordinated debt to Group Inc. and $1.00 billion dividend to Group Inc. in the first quarter of 2011.

GS Bank USA is currently working to implement the Basel 2 framework. Similar to the firm’s requirement as a bank holding company, GS Bank USA is required to transition to Basel 2 following the successful completion of a parallel run. In addition, the capital requirements for GS Bank USA are expected to be impacted by changes to the Basel Committee’s capital guidelines and by the Dodd-Frank Act, as outlined above.
 
The deposits of GS Bank USA are insured by the FDIC to the extent provided by law. The Federal Reserve Board requires depository institutions to maintain cash reserves with a Federal Reserve Bank. The amount deposited by the firm’s depository institution subsidiaries held at the Federal Reserve Bank was approximately $27.27 billion and $28.12 billion as of March 2011 and December 2010, respectively, which exceeded required reserve amounts by $26.71 billion and $27.45 billion as of March 2011 and December 2010, respectively. GS Bank Europe, a wholly owned credit institution, is regulated by the Central Bank of Ireland and is subject to minimum capital requirements. As of March 2011 and December 2010, GS Bank USA and GS Bank Europe were both in compliance with all regulatory capital requirements.
 
Transactions between GS Bank USA and its subsidiaries and Group Inc. and its subsidiaries and affiliates (other than, generally, subsidiaries of GS Bank USA) are regulated by the Federal Reserve Board. These regulations generally limit the types and amounts of transactions (including loans to and borrowings from GS Bank USA) that may take place and generally require those transactions to be on an arm’s-length basis.
 
 


72


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Broker-Dealer Subsidiaries
The firm’s U.S. regulated broker-dealer subsidiaries include GS&Co. and GSEC. GS&Co. and GSEC are registered U.S. broker-dealers and futures commission merchants, and are subject to regulatory capital requirements, including those imposed by the SEC, the U.S. Commodity Futures Trading Commission (CFTC), Chicago Mercantile Exchange, the Financial Industry Regulatory Authority, Inc. (FINRA) and the National Futures Association. Rule 15c3-1 of the SEC and Rule 1.17 of the Commodity Futures Trading Commission specify uniform minimum net capital requirements, as defined, for their registrants, and also effectively require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1.
 
As of March 2011, GS&Co. had regulatory net capital, as defined by Rule 15c3-1, of $10.51 billion, which exceeded the amount required by $8.55 billion. As of March 2011, GSEC had regulatory net capital, as defined by Rule 15c3-1, of $1.78 billion, which exceeded the amount required by $1.66 billion.
 
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 March 2011 and December 2010, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements.
 
Insurance Subsidiaries
The firm has U.S. insurance subsidiaries that are subject to state insurance regulation and oversight in the states in which they are domiciled and in the other states in which they are licensed. In addition, certain of

the firm’s insurance subsidiaries outside of the U.S. are regulated by the FSA and certain are regulated by the Bermuda Monetary Authority. The firm’s insurance subsidiaries were in compliance with all regulatory capital requirements as of March 2011 and December 2010.
 
Other Non-U.S. Regulated Subsidiaries
The firm’s principal non-U.S. regulated subsidiaries include Goldman Sachs International (GSI) and Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, the firm’s regulated U.K. broker-dealer, is subject to the capital requirements of the FSA. GSJCL, the firm’s regulated Japanese broker-dealer, is subject to the capital requirements imposed by Japan’s Financial Services Agency. As of March 2011 and December 2010, GSI and GSJCL were in compliance with their local capital adequacy requirements. Certain other non-U.S. subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of March 2011 and December 2010, these subsidiaries were in compliance with their local capital adequacy requirements.
 
Restrictions on Payments
The regulatory requirements referred to above restrict Group Inc.’s ability to withdraw capital from its regulated subsidiaries. As of March 2011 and December 2010, approximately $24.24 billion and $24.70 billion, respectively, of net assets of regulated subsidiaries were restricted as to the payment of dividends to Group Inc. In addition to limitations on the payment of dividends imposed by federal and state laws, the Federal Reserve Board, the FDIC and the New York State Banking Department have authority to prohibit or to limit the payment of dividends by the banking organizations they supervise (including GS Bank USA) if, in the relevant regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in the light of the financial condition of the banking organization.
 
 


73


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Note 21.  Earnings Per Common Share
 
Basic earnings per common share (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 RSUs 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 for stock warrants and options and for RSUs for which future service is required as a condition to the delivery of the underlying common stock. The firm treats unvested share-based payment awards that have non-forfeitable rights to dividends or dividend equivalents as a separate class of securities in calculating EPS.
 
The table below presents the computations of basic and diluted EPS.
 
                     
 
    Three Months
    Ended March
in millions, except per share amounts   2011     2010      
 
Numerator for basic and diluted EPS — net earnings applicable to common shareholders
  $ 908     $ 3,296      
 
 
Denominator for basic EPS — weighted average number of common shares
    540.6       546.0      
Effect of dilutive securities:
                   
RSUs
    12.5       12.3      
Stock options and warrants
    29.9       31.7      
 
 
Dilutive potential common shares
    42.4       44.0      
 
 
Denominator for diluted EPS — weighted average number of common shares and dilutive potential common shares
    583.0       590.0      
 
 
                     
Basic EPS
  $ 1.66     $ 6.02      
Diluted EPS
    1.56       5.59      
 
 
 
 
In the table above, unvested share-based payment awards that have non-forfeitable rights to dividends or dividend equivalents are treated as a separate class of securities in calculating EPS. The impact of applying this methodology was a reduction to basic EPS of $0.02 for both the three months ended March 2011 and March 2010.
 
The diluted EPS computations in the table above do not include the antidilutive effect as follows:
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Number of antidilutive RSUs and common shares underlying antidilutive stock options and warrants
    6.3       6.0      
 
 

Note 22.  Transactions with Affiliated Funds
 
The firm has formed numerous nonconsolidated investment funds with third-party investors. The firm generally acts as the investment manager for these funds and, as such, is entitled to receive management fees and, in certain cases, advisory fees or incentive fees from these funds. Additionally, the firm invests alongside the third-party investors in certain funds.
 
The tables below present fees earned from affiliated funds, fees receivable from affiliated funds and the aggregate carrying value of the firm’s interests in affiliated funds.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Fees earned from affiliated funds
  $ 852     $ 553      
 
 
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
Fees receivable from funds
  $ 618     $ 886      
Aggregate carrying value of interests in funds
    15,216       14,773      
 
 
 
 
The firm has provided voluntary financial support to certain of its funds that have experienced significant reductions in capital and liquidity or had limited access to the debt markets during the financial crisis. As of March 2011 and December 2010, the firm had exposure to these funds in the form of loans and guarantees of $240 million and $253 million, respectively, primarily related to certain real estate funds. In addition, as of December 2010, the firm had outstanding commitments to extend credit to these funds of $160 million. No such commitments were outstanding as of March 2011.
 
The firm may provide additional voluntary financial support to these funds if they were to experience significant financial distress; however, such amounts are not expected to be material to the firm. In the ordinary course of business, the firm may also engage in other activities with these funds, including, among others, securities lending, trade execution, market making, custody, and acquisition and bridge financing. See Note 18 for the firm’s investment commitments related to these funds.
 


74


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 23.  Interest Income and Interest Expense
 

Interest income is recorded on an accrual basis based on contractual interest rates. The table below presents

the sources of interest income and interest expense.
 


 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Interest income
                   
Deposits with banks
  $ 29     $ 15      
Securities borrowed, securities purchased under agreements to resell and federal funds sold
    169       79      
Financial instruments owned, at fair value
    2,515       2,621      
Other interest 1
    394       286      
 
 
Total interest income
    3,107       3,001      
 
 
                     
Interest expense
                   
Deposits
    72       68      
Securities loaned and securities sold under agreements to repurchase
    201       136      
Financial instruments sold, but not yet purchased, at fair value
    496       495      
Short-term borrowings 2
    129       118      
Long-term borrowings 2
    786       746      
Other interest 3
    65       20      
 
 
Total interest expense
    1,749       1,583      
 
 
Net interest income
  $ 1,358     $ 1,418      
 
 
 
1.   Primarily includes interest income on customer debit balances and other interest-earning assets.
 
2.   Includes interest on unsecured borrowings and other secured financings.
 
3.   Primarily includes interest expense on customer credit balances and other interest-bearing liabilities.
 
Note 24.  Income Taxes
 

Provision for Income Taxes
Income taxes are provided for using the asset and liability method under which deferred tax assets and liabilities are recognized for temporary differences between the financial reporting and tax bases of assets and liabilities. The firm reports interest expense related to income tax matters in “Provision for taxes” and income tax penalties in “Other expenses.”

Deferred Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities. These temporary differences result in taxable or deductible amounts in future years and are measured using the tax rates and laws that will be in effect when such differences are expected to reverse. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. Tax assets and liabilities are presented as a component of “Other assets” and “Other liabilities and accrued expenses,” respectively.
 
 


75


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Unrecognized Tax Benefits
The firm recognizes tax positions in the financial statements only when it is more likely than not that the position will be sustained on examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized on settlement. A liability is established for differences between positions taken in a tax return and amounts recognized in the financial statements.
 
Regulatory Tax Examinations
The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. The firm believes that during 2011, certain audits have a reasonable possibility of being completed. The firm does not expect completion of these audits to have a material impact on the firm’s financial condition but it may be material to operating results for a particular period, depending, in part, on the operating results for that period.
 
The table below presents the earliest tax years that remain subject to examination by major jurisdiction.
 
             
 
    As of
     
Jurisdiction   March 2011      
 
U.S. Federal 1
    2005      
New York State and City 2
    2004      
United Kingdom
    2007      
Japan 3
    2005      
Hong Kong
    2004      
Korea
    2008      
 
 
 
1.   IRS examination of fiscal 2005, 2006 and 2007 began during 2008. IRS examination of fiscal 2003 and 2004 has been completed but the liabilities for those years are not yet final.
 
2.   New York State and City examination of fiscal 2004, 2005 and 2006 began in 2008.
 
3.   Japan National Tax Agency examination of fiscal 2005 through 2009 began during the first quarter of 2010.

All years subsequent to the above remain open to examination by the taxing authorities. The firm believes that the liability for unrecognized tax benefits it has established is adequate in relation to the potential for additional assessments.
 
Note 25.  Business Segments
 
In the fourth quarter of 2010, the firm reorganized its three previous reportable business segments into four new reportable business segments: Investment Banking, Institutional Client Services, Investing & Lending and Investment Management. Prior periods are presented on a comparable basis.
 
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 and benefits expenses in the firm’s segments reflect, among other factors, the overall performance of the firm as well as the performance of individual businesses. 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 firm allocates revenues and expenses among the four reportable business segments. Due to the integrated nature of these segments, estimates and judgments are made in allocating certain revenue and expense items. Transactions between segments are based on specific criteria or approximate third-party rates. Total operating expenses include corporate items that have not been allocated to individual business segments. The allocation process is based on the manner in which management views the business of the firm.
 
 


76


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Management believes that the following information provides a reasonable representation of each

segment’s contribution to consolidated pre-tax earnings and total assets.


 
                         
 
        For the Three 
        Months Ended 
        or as of March 
in millions       2011     2010      
 
Investment Banking
  Net revenues   $ 1,269     $ 1,203      
    Operating expenses     923       880      
 
 
    Pre-tax earnings   $ 346     $ 323      
 
 
    Segment assets   $ 1,775     $ 1,553      
 
 
                         
Institutional Client Services
  Net revenues 1   $ 6,647     $ 8,507      
    Operating expenses     4,584       4,831      
 
 
    Pre-tax earnings   $ 2,063     $ 3,676      
 
 
    Segment assets   $ 840,970     $ 784,608      
 
 
                         
Investing & Lending
  Net revenues   $ 2,705     $ 1,970      
    Operating expenses     1,231       908      
 
 
    Pre-tax earnings   $ 1,474     $ 1,062      
 
 
    Segment assets   $ 79,996     $ 83,472      
 
 
                         
Investment Management
  Net revenues   $ 1,273     $ 1,095      
    Operating expenses     1,067       949      
 
 
    Pre-tax earnings   $ 206     $ 146      
 
 
    Segment assets   $ 10,548     $ 10,895      
 
 
                         
Total
  Net revenues   $ 11,894     $ 12,775      
    Operating expenses     7,854       7,616      
 
 
    Pre-tax earnings   $ 4,040     $ 5,159      
 
 
    Total assets   $ 933,289     $ 880,528      
 
 
 
1.   Includes $29 million and $26 million for the three months ended March 2011 and March 2010, respectively, of realized gains on securities held in the firm’s insurance subsidiaries which are accounted for as available-for-sale.

77


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Operating expenses in the table above include the following expenses that have not been allocated to the firm’s segments:
 
•   charitable contributions of $25 million for both the three months ended March 2011 and March 2010;
 
•   net provisions for a number of litigation and regulatory proceedings of $24 million and $21 million for the three months ended March 2011 and March 2010, respectively; and
 
•   real estate-related exit costs of $2 million for the three months ended March 2010.
 
The tables below present the amounts of net interest income included in net revenues, and the amounts of depreciation and amortization expense included in pre-tax earnings.
 
                     
 
    Three Months 
    Ended March 
in millions   2011     2010      
 
Investment Banking
  $     $      
Institutional Client Services
    1,214       1,278      
Investing & Lending
    93       89      
Investment Management
    51       51      
 
 
Total net interest
  $ 1,358     $ 1,418      
 
 
 
                     
 
    Three Months 
    Ended March 
in millions   2011     2010      
 
Investment Banking
  $ 51     $ 44      
Institutional Client Services
    331       223      
Investing & Lending
    168       61      
Investment Management
    44       47      
 
 
Total depreciation and amortization
  $ 594     $ 375      
 
 

Geographic Information
Due to the highly integrated nature of international financial markets, the firm manages its businesses based on the profitability of the enterprise as a whole. The methodology for allocating profitability to geographic regions is dependent on estimates and management judgment because a significant portion of the firm’s activities require cross-border coordination in order to facilitate the needs of the firm’s clients. Specifically, in interim periods, the firm generally allocates compensation and benefits to geographic regions based upon the firmwide compensation to net revenues ratio. In the fourth quarter when compensation by employee is finalized, compensation and benefits are allocated to the geographic regions based upon total actual compensation during the year.
 
Geographic results are generally allocated as follows:
 
•   Investment Banking: location of the client and investment banking team.
 
•   Institutional Client Services: Fixed Income, Currency and Commodities Client Execution, and Equities (excluding Securities Services): location of the market-making desk; Securities Services: location of the primary market for the underlying security.
 
•   Investing & Lending: Investing: location of the investment; Lending: location of the client.
 
•   Investment Management: location of the sales team.
 


78


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

The table below presents the total net revenues and pre-tax earnings of the firm by geographic region allocated based on the methodology referred to

above, as well as the percentage of total net revenues and pre-tax earnings (excluding Corporate) for each geographic region.


                                     
 
    Three Months Ended March 
$ in millions   2011     2010      
 
Net revenues
                                   
Americas 1
  $ 6,839       58 %   $ 7,131       55 %    
EMEA 2
    2,874       24       3,905       31      
Asia
    2,181       18       1,739       14      
 
 
Total net revenues
  $ 11,894       100 %   $ 12,775       100 %    
 
 
                                     
Pre-tax earnings
                                   
Americas 1
  $ 2,273       55 %   $ 2,789       53 %    
EMEA 2
    1,088       27       1,800       35      
Asia
    728       18       618       12      
 
 
Subtotal
    4,089       100 %     5,207       100 %    
Corporate 3
    (49 )             (48 )            
 
 
Total pre-tax earnings
  $ 4,040             $ 5,159              
 
 
 
1.   Substantially all relates to the U.S.
 
2.   EMEA (Europe, Middle East and Africa).
 
3.   Consists of net provisions for a number of litigation and regulatory proceedings of $24 million and $21 million for the three months ended March 2011 and March 2010, respectively; charitable contributions of $25 million for both the three months ended March 2011 and March 2010; and real estate-related exit costs of $2 million for the three months ended March 2010.

79


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 26.  Credit Concentrations
 

Credit concentrations may arise from market making, client facilitation, investing, underwriting, lending and collateralized transactions and may be impacted by changes in economic, industry or political factors. The firm seeks to mitigate credit risk by actively monitoring exposures and obtaining collateral from counterparties as deemed appropriate.
 
While the firm’s activities expose it to many different industries and counterparties, the firm routinely executes a high volume of transactions with asset managers, investment funds, commercial banks, brokers and dealers, clearing houses and exchanges, which results in significant credit concentrations.
 
In the ordinary course of business, the firm may also be subject to a concentration of credit risk to a particular counterparty, borrower or issuer, including sovereign issuers, or to a particular clearing house or exchange.

The table below presents the credit concentrations in assets held by the firm. As of March 2011 and December 2010, the firm did not have credit exposure to any other counterparty that exceeded 2% of total assets.
 
                     
 
    As of 
    March
    December
     
$ in millions   2011     2010      
 
U.S. government and federal agency obligations 1
  $ 111,765     $ 96,350      
% of total assets
    12.0%       10.6%      
Other sovereign obligations 2
  $ 44,126     $ 40,379      
% of total assets
    4.7%       4.4%      
 
 
 
1.   Included in “Financial instruments owned, at fair value” and “Cash and securities segregated for regulatory and other purposes.”
 
2.   Principally consisting of securities issued by the governments of the United Kingdom, Japan and Germany as of March 2011, and the United Kingdom, Japan and France as of December 2010.
 
The table below presents collateral posted to the firm by counterparties to resale agreements and securities borrowed transactions (including those in “Cash and securities segregated for regulatory and other purposes”). See Note 9 for further information about collateralized agreements and financings.
 
                     
 
    As of 
    March
    December
     
in millions   2011     2010      
 
U.S. government and federal agency obligations
  $ 114,644     $ 121,366      
Other sovereign obligations 1
    82,701       73,357      
 
 
 
1.   Principally consisting of securities issued by the governments of France and Germany.
 


80


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 27.  Legal Proceedings
 
 

The firm is involved in a number of judicial, regulatory and arbitration proceedings (including those described below) concerning matters arising in connection with the conduct of the firm’s businesses. Many of these proceedings are at preliminary stages, and many of these cases seek an indeterminate amount of damages.
 
With respect to matters described below, management has estimated the upper end of the range of reasonably possible loss as being equal to (i) the amount of money damages claimed, where applicable, (ii) the amount of securities that the firm sold in cases involving underwritings where the firm is being sued by purchasers and is not being indemnified by a party that the firm believes will pay any judgment, or (iii) in cases where the purchasers are demanding that the firm repurchase securities, the price that purchasers paid for the securities less the estimated value, if any, as of March 2011 of the relevant securities. As of March 2011, the firm has estimated the aggregate amount of reasonably possible losses for these matters to be approximately $2.7 billion.
 
Under ASC 450 an event is “reasonably possible” if “the chance of the future event or events occurring is more than remote but less than likely” and an event is “remote” if “the chance of the future event or events occurring is slight.” Thus, references to the upper end of the range of reasonably possible loss for cases in which the firm is able to estimate a range of reasonably possible loss mean the upper end of the range of loss for cases for which the firm believes the risk of loss is more than slight. The amounts reserved against such matters are not significant as compared to the upper end of the range of reasonably possible loss.
 
Management is unable to estimate a range of reasonably possible loss for cases described below in which damages have not been specified and (i) the proceedings are in early stages, (ii) there is uncertainty as to the likelihood of a class being certified or the ultimate size of the class, (iii) there is uncertainty as to the outcome of pending appeals or motions, (iv) there are significant factual issues to be

resolved, and/or (v) there are novel legal issues presented. However, for these cases, management does not believe, based on currently available information, that the outcomes of these proceedings will have a material adverse effect on the firm’s financial condition, though the outcomes could be material to the firm’s operating results for any particular period, depending, in part, upon the operating results for such period.
 
IPO Process Matters.  Group Inc. and GS&Co. are among the numerous financial services companies that have been named as defendants in a variety of lawsuits alleging improprieties in the process by which those companies participated in the underwriting of public offerings in recent years.
 
GS&Co. has, together with other underwriters in certain offerings as well as the issuers and certain of their officers and directors, been named as a defendant in a number of related lawsuits filed in the U.S. District Court for the Southern District of New York alleging, among other things, that the prospectuses for the offerings violated the federal securities laws by failing to disclose the existence of alleged arrangements tying allocations in certain offerings to higher customer brokerage commission rates as well as purchase orders in the aftermarket, and that the alleged arrangements resulted in market manipulation. On October 5, 2009, the district court approved a settlement agreement entered into by the parties. The firm has paid into a settlement fund the full amount that GS&Co. would contribute in the proposed settlement. On October 23, 2009, certain objectors filed a petition in the U.S. Court of Appeals for the Second Circuit seeking review of the district court’s certification of a class for purposes of the settlement, and various objectors appealed certain aspects of the settlement’s approval. Certain of the appeals have been withdrawn, and on December 8, 2010, January 14, 2011 and February 3, 2011, plaintiffs moved to dismiss the remaining appeals.
 
 


81


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

GS&Co. is among numerous underwriting firms named as defendants in a number of complaints filed commencing October 3, 2007, in the U.S. District Court for the Western District of Washington alleging violations of Section 16 of the Exchange Act in connection with offerings of securities for 15 issuers during 1999 and 2000. The complaints generally assert that the underwriters, together with each issuer’s directors, officers and principal shareholders, entered into purported agreements to tie allocations in the offerings to increased brokerage commissions and aftermarket purchase orders. The complaints further allege that, based upon these and other purported agreements, the underwriters violated the reporting provisions of, and are subject to short-swing profit recovery under, Section 16 of the Exchange Act. The district court granted defendants’ motions to dismiss by a decision dated March 12, 2009. On December 2, 2010, the appellate court affirmed in part and reversed in part, upholding the dismissal of seven of the actions in which GS&Co. is a defendant but remanding the remaining eight actions in which GS&Co. is a defendant for consideration of other bases for dismissal. On December 16, 2010, the underwriters and the plaintiff filed petitions for rehearing and/or rehearing en banc, which were denied on January 18, 2011. The issuance of the mandate has been stayed to permit the parties to seek Supreme Court review, and both plaintiffs and defendants have sought such review.
 
GS&Co. has been named as a defendant in an action commenced on May 15, 2002 in New York Supreme Court, New York County, by an official committee of unsecured creditors on behalf of eToys, Inc., alleging that the firm intentionally underpriced eToys, Inc.’s initial public offering. The action seeks, among other things, unspecified compensatory damages resulting from the alleged lower amount of offering proceeds. On appeal from rulings on GS&Co.’s motion to dismiss, the New York Court of Appeals dismissed claims for breach of contract, professional malpractice and unjust enrichment, but permitted claims for breach of fiduciary duty and fraud to continue. On remand to the lower court, GS&Co. moved to dismiss the surviving claims or, in the alternative, for summary judgment, but the motion was denied by a decision

dated March 21, 2006, and the court subsequently permitted plaintiff to amend the complaint again. On November 8, 2010, GS&Co.’s motion for summary judgment was granted by the lower court; plaintiff has appealed.
 
Group Inc. and certain of its affiliates have, together with various underwriters in certain offerings, received subpoenas and requests for documents and information from various governmental agencies and self-regulatory organizations in connection with investigations relating to the public offering process. Goldman Sachs has cooperated with these investigations.
 
World Online Litigation.  In March 2001, a Dutch shareholders association initiated legal proceedings for an unspecified amount of damages against GSI and others in Amsterdam District Court in connection with the initial public offering of World Online in March 2000, alleging misstatements and omissions in the offering materials and that the market was artificially inflated by improper public statements and stabilization activities. Goldman Sachs and ABN AMRO Rothschild served as joint global coordinators of the approximately €2.9 billion offering. GSI underwrote 20,268,846 shares and GS&Co. underwrote 6,756,282 shares for a total offering price of approximately €1.16 billion.
 
The district court rejected the claims against GSI and ABN AMRO, but found World Online liable in an amount to be determined. On appeal, the Netherlands Court of Appeals affirmed in part and reversed in part the decision of the district court holding that certain of the alleged disclosure deficiencies were actionable as to GSI and ABN AMRO. On further appeal, the Netherlands Supreme Court on November 27, 2009 affirmed the rulings of the Court of Appeals, except that it found certain additional aspects of the offering materials actionable and held that GSI and ABN AMRO could potentially be held responsible for certain public statements and press releases by World Online and its former CEO. On November 18, 2010, the parties reached a settlement in principle, subject to documentation, pursuant to which GSI will contribute up to €48 million to a settlement fund. The firm has reserved the full amount of GSI’s proposed contribution to the settlement.
 
 


82


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Research Matters.  GS&Co. was one of several investment firms that were named as defendants in substantively identical purported class actions filed in the U.S. District Court for the Southern District of New York alleging violations of the federal securities laws in connection with research coverage of certain issuers and seeking compensatory damages. One such action, relating to coverage of RSL Communications, Inc., commenced on July 15, 2003. The parties entered into a settlement agreement on August 23, 2010, which has become final. Under the settlement agreement, GS&Co. paid approximately $3.38 million.
 
Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations relating to research practices, including communications among research analysts, sales and trading personnel and clients. The firm is in discussions with representatives of the Massachusetts Securities Division regarding potential administrative proceedings against the firm in connection with its practices relating to such communications, and other regulators, including the SEC and FINRA, have been investigating similar matters. Goldman Sachs is cooperating with the investigations and reviews.
 
Adelphia Communications Fraudulent Conveyance Litigation.  GS&Co. is among numerous entities named as defendants in two adversary proceedings commenced in the U.S. Bankruptcy Court for the Southern District of New York, one on July 6, 2003 by a creditors committee, and the second on or about July 31, 2003 by an equity committee of Adelphia Communications, Inc. Those proceedings were consolidated in a single amended complaint filed by the Adelphia Recovery Trust on October 31, 2007. The complaint seeks, among other things, to recover, as fraudulent conveyances, payments made allegedly by Adelphia Communications, Inc. and its affiliates to certain brokerage firms, including approximately $62.9 million allegedly paid to GS&Co., in respect of margin calls made in the ordinary course of business on accounts owned by members of the family that formerly controlled Adelphia Communications, Inc. The district court assumed jurisdiction over the action and on April 8, 2011 granted GS&Co.’s motion for summary judgment. On May 6, 2011, the plaintiff filed a notice of appeal.

Specialist Matters.  Spear, Leeds & Kellogg Specialists LLC (SLKS) and certain affiliates have received requests for information from various governmental agencies and self-regulatory organizations as part of an industry-wide investigation relating to activities of floor specialists in recent years. Goldman Sachs has cooperated with the requests.
 
On March 30, 2004, certain specialist firms on the NYSE, including SLKS, without admitting or denying the allegations, entered into a final global settlement with the SEC and the NYSE covering certain activities during the years 1999 through 2003. The SLKS settlement involves, among other things, (i) findings by the SEC and the NYSE that SLKS violated certain federal securities laws and NYSE rules, and in some cases failed to supervise certain individual specialists, in connection with trades that allegedly disadvantaged customer orders, (ii) a cease and desist order against SLKS, (iii) a censure of SLKS, (iv) SLKS’ agreement to pay an aggregate of $45.3 million in disgorgement and a penalty to be used to compensate customers, (v) certain undertakings with respect to SLKS’ systems and procedures, and (vi) SLKS’ retention of an independent consultant to review and evaluate certain of SLKS’ compliance systems, policies and procedures. Comparable findings were made and sanctions imposed in the settlements with other specialist firms. The settlement did not resolve the related private civil actions against SLKS and other firms or regulatory investigations involving individuals or conduct on other exchanges.
 
SLKS, Spear, Leeds & Kellogg, L.P. and Group Inc. are among numerous defendants named in purported class actions brought beginning in October 2003 on behalf of investors in the U.S. District Court for the Southern District of New York alleging violations of the federal securities laws and state common law in connection with NYSE floor specialist activities. The actions, which have been consolidated, seek unspecified compensatory damages, restitution and disgorgement on behalf of purchasers and sellers of unspecified securities between October 17, 1998 and October 15, 2003. By a decision dated March 14, 2009, the district court granted plaintiffs’ motion for class certification. The defendants’ petition with the U.S. Court of Appeals for the Second Circuit seeking review of the certification ruling was denied by an order dated October 1, 2009. The specialist defendants’ petition for a rehearing and/or rehearing en banc was denied on February 24, 2010.
 


83


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Treasury Matters.  GS&Co. has been named as a defendant in a purported class action filed on March 10, 2004 in the U.S. District Court for the Northern District of Illinois on behalf of holders of short positions in 30-year U.S. Treasury futures and options on the morning of October 31, 2001. The complaint alleges that the firm purchased 30-year bonds and futures prior to a forthcoming Treasury refunding announcement that morning based on non-public information about that announcement, and that such purchases increased the costs of covering such short positions. The complaint also names as defendants the Washington, D.C.-based political consultant who allegedly was the source of the information, a former GS&Co. economist who allegedly received the information, and another company and one of its employees who also allegedly received and traded on the information prior to its public announcement. The complaint alleges violations of the federal commodities and antitrust laws, as well as Illinois statutory and common law, and seeks, among other things, unspecified damages including treble damages under the antitrust laws. The district court dismissed the antitrust and Illinois state law claims but permitted the federal commodities law claims to proceed. Plaintiff’s motion for class certification was denied by a decision dated August 22, 2008. GS&Co. moved for summary judgment, and the district court granted the motion but only insofar as the claim relates to the trading of treasury bonds. On October 13, 2009, the parties filed an offer of judgment and notice of acceptance with respect to plaintiff’s individual claim. On December 11, 2009, the plaintiff purported to appeal with respect to the district court’s prior denial of class certification, and GS&Co. moved to dismiss the appeal on January 25, 2010. By an order dated April 13, 2010, the U.S. Court of Appeals for the Seventh Circuit ruled that GS&Co.’s motion would be entertained together with the merits of the appeal.

Fannie Mae Litigation.  GS&Co. was added as a defendant in an amended complaint filed on August 14, 2006 in a purported class action pending in the U.S. District Court for the District of Columbia. The complaint asserts violations of the federal securities laws generally arising from allegations concerning Fannie Mae’s accounting practices in connection with certain Fannie Mae-sponsored REMIC transactions that were allegedly arranged by GS&Co. The complaint does not specify a dollar amount of damages. The other defendants include Fannie Mae, certain of its past and present officers and directors, and accountants. By a decision dated May 8, 2007, the district court granted GS&Co.’s motion to dismiss the claim against it. The time for an appeal will not begin to run until disposition of the claims against other defendants.
 
Beginning in September 2006, Group Inc. and/or GS&Co. were named as defendants in four Fannie Mae shareholder derivative actions in the U.S. District Court for the District of Columbia. The complaints generally allege that the Goldman Sachs defendants aided and abetted a breach of fiduciary duty by Fannie Mae’s directors and officers in connection with certain Fannie Mae-sponsored REMIC transactions and one of the complaints also asserts a breach of contract claim. The complaints also name as defendants certain former officers and directors of Fannie Mae as well as an outside accounting firm. The complaints seek, inter alia, unspecified damages. The Goldman Sachs defendants were dismissed without prejudice from the first filed of these actions, and the remaining claims in that action were dismissed for failure to make a demand on Fannie Mae’s board of directors. That dismissal has been affirmed on appeal. The district court dismissed the remaining three actions on July 28, 2010. The plaintiffs filed motions for reconsideration, which were denied on October 22, 2010, and have revised their notices of appeal in these actions. On January 20, 2011, the appellate court consolidated all actions on appeal.
 
 


84


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Compensation-Related Litigation. On January 17, 2008, Group Inc., its Board, executive officers and members of its management committee were named as defendants in a purported shareholder derivative action in the U.S. District Court for the Eastern District of New York predicting that the firm’s 2008 Proxy Statement would violate the federal securities laws by undervaluing certain stock option awards and alleging that senior management received excessive compensation for 2007. The complaint seeks, among other things, an equitable accounting for the allegedly excessive compensation. Plaintiff’s motion for a preliminary injunction to prevent the 2008 Proxy Statement from using options valuations that the plaintiff alleges are incorrect and to require the amendment of SEC Form 4s filed by certain of the executive officers named in the complaint to reflect the stock option valuations alleged by the plaintiff was denied, and plaintiff’s appeal from this denial was dismissed. On February 13, 2009, the plaintiff filed an amended complaint, which added purported direct (i.e., non-derivative) claims based on substantially the same theory. The plaintiff filed a further amended complaint on March 24, 2010, and the defendants’ motion to dismiss this further amended complaint was granted on September 30, 2010. On October 22, 2010, the plaintiff filed a notice of appeal from the dismissal of his complaint.
 
On March 24, 2009, the same plaintiff filed an action in New York Supreme Court, New York County against Group Inc., its directors and certain senior executives alleging violation of Delaware statutory and common law in connection with substantively similar allegations regarding stock option awards. On January 7, 2011, the plaintiff filed an amended complaint. Defendants moved to dismiss the amended complaint on March 4, 2011.

Purported shareholder derivative actions have been commenced in New York Supreme Court, New York County and the Delaware Court of Chancery beginning on December 14, 2009, alleging that the Board breached its fiduciary duties in connection with setting compensation levels for the year 2009 and that such levels are excessive. The complaints name as defendants Group Inc., the Board and certain senior executives. The complaints seek, inter alia, unspecified damages, restitution of certain compensation paid, and an order requiring the firm to adopt corporate reforms. In the actions in New York state court, on April 8, 2010, the plaintiffs filed a motion indicating that they no longer intend to pursue their claims but are seeking an award of attorney’s fees in connection with bringing the suit, which the defendants have opposed. In the actions brought in the Delaware Court of Chancery, the defendants moved to dismiss on March 9, 2010, and the plaintiffs amended their complaint on April 28, 2010 to include, among other things, the allegations included in the SEC’s action described in the “Mortgage-Related Matters” section below. The defendants moved to dismiss this amended complaint on May 12, 2010. In lieu of responding to defendants’ motion, plaintiffs moved on December 8, 2010 for permission to file a further amended complaint, which the defendants had opposed. The court granted plaintiffs’ motion to amend on January 19, 2011, and the defendants moved to dismiss the second amended complaint on February 4, 2011.
 
Group Inc. and certain of its affiliates are subject to a number of investigations and reviews from various governmental agencies and self-regulatory organizations regarding the firm’s compensation processes. The firm is cooperating with the investigations and reviews.
 
 


85


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Mortgage-Related Matters.  On April 16, 2010, the SEC brought an action (SEC Action) under the U.S. federal securities laws in the U.S. District Court for the Southern District of New York against GS&Co. and Fabrice Tourre, one of its employees, in connection with a CDO offering made in early 2007 (ABACUS 2007-AC1 transaction), alleging that the defendants made materially false and misleading statements to investors and seeking, among other things, unspecified monetary penalties. Investigations of GS&Co. by FINRA and of GSI by the FSA were subsequently initiated, and Group Inc. and certain of its affiliates have received subpoenas and requests for information from other regulators, regarding CDO offerings, including the ABACUS 2007-AC1 transaction, and related matters.
 
On July 14, 2010, GS&Co. entered into a consent agreement with the SEC, settling all claims made against GS&Co. in the SEC Action (SEC Settlement), pursuant to which, GS&Co. paid $550 million of disgorgement and civil penalties, and which was approved by the U.S. District Court for the Southern District of New York on July 20, 2010.
 
On September 9, 2010, the FSA announced a settlement with GSI pursuant to which the FSA found that GSI violated certain FSA principles by failing to (i) provide notification about the SEC Wells Notice issued to Mr. Tourre (who worked on the ABACUS 2007-AC1 transaction but subsequently transferred to GSI and became registered with the FSA) and (ii) have procedures and controls to ensure that GSI’s Compliance Department would be alerted to various aspects of the SEC investigation so as to be in a position to determine whether any aspects were reportable to the FSA. The FSA assessed a fine of £17.5 million.
 
On November 9, 2010, FINRA announced a settlement with GS&Co. relating to GS&Co.’s failure to file Form U4 updates within 30 days of learning of the receipt of Wells Notices by Mr. Tourre and another employee as well as deficiencies in the firm’s systems and controls for such filings. FINRA assessed a fine of $650,000 and GS&Co. agreed to undertake a review and remediation of the applicable systems and controls.

On January 6, 2011, ACA Financial Guaranty Corp. filed an action against GS&Co. in respect of the ABACUS 2007-AC1 transaction in New York Supreme Court, New York County. The complaint includes allegations of fraudulent inducement, fraudulent concealment and unjust enrichment and seeks at least $30 million in compensatory damages, at least $90 million in punitive damages and unspecified disgorgement. On March 8, 2011, GS&Co. filed a motion to compel arbitration and/or to dismiss the complaint. On April 25, 2011, the plaintiff filed an amended complaint.
 
Since April 22, 2010, a number of putative shareholder derivative actions have been filed in New York Supreme Court, New York County, and the U.S. District Court for the Southern District of New York against Group Inc., the Board and certain officers and employees of Group Inc. and its affiliates in connection with mortgage-related matters between 2004 and 2007, including the ABACUS 2007-AC1 transaction and other CDO offerings. These derivative complaints generally include allegations of breach of fiduciary duty, corporate waste, abuse of control, mismanagement, unjust enrichment, misappropriation of information, securities fraud and insider trading, and challenge the accuracy and adequacy of Group Inc.’s disclosure. These derivative complaints seek, among other things, declaratory relief, unspecified compensatory damages, restitution and certain corporate governance reforms. The New York Supreme Court has consolidated the two actions pending in that court. The federal court cases have also been consolidated. In addition, as described in the “Compensation-Related Litigation” section above, the plaintiffs in the compensation-related Delaware Court of Chancery actions have amended their complaint to assert, among other things, allegations similar to those in the derivative claims referred to above, the defendants moved to dismiss this amended complaint, the plaintiffs amended the complaint further and the defendants moved to dismiss the second amended complaint on February 4, 2011.
 
 


86


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Since April 23, 2010, the Board has received letters from shareholders demanding that the Board take action to address alleged misconduct by GS&Co., the Board and certain officers and employees of Group Inc. and its affiliates. The demands generally allege misconduct in connection with the ABACUS 2007-AC1 transaction, the alleged failure by Group Inc. to adequately disclose the SEC investigation that led to the SEC Action, and Group Inc.’s 2009 compensation practices. The demands include a letter from a Group Inc. shareholder, which previously made a demand that the Board investigate and take action in connection with auction products matters, and expanded its demand to address the foregoing matters. The Board previously rejected the demands relating to auction products matters.
 
In addition, beginning April 26, 2010, a number of purported securities law class actions have been filed in the U.S. District Court for the Southern District of New York challenging the adequacy of Group Inc.’s public disclosure of, among other things, the firm’s activities in the CDO market and the SEC investigation that led to the SEC Action. The purported class action complaints, which name as defendants Group Inc. and certain officers and employees of Group Inc. and its affiliates, have been consolidated, generally allege violations of Sections 10(b) and 20(a) of the Exchange Act and seek unspecified damages.
 
GS&Co., Goldman Sachs Mortgage Company and GS Mortgage Securities Corp. and three current or former Goldman Sachs employees are defendants in a putative class action commenced on December 11, 2008 in the U.S. District Court for the Southern District of New York brought on behalf of purchasers of various mortgage pass-through certificates and asset-backed certificates issued by various securitization trusts established by the firm and underwritten by GS&Co. in 2007. The complaint generally alleges that the registration statement and prospectus supplements for the certificates violated the federal securities laws, and seeks unspecified compensatory damages and rescission or recessionary damages. On January 28, 2010, the defendants’ motion to dismiss the second amended complaint was granted with leave to replead certain claims. On March 31, 2010, the plaintiff filed a third amended complaint relating to two offerings, which the defendants moved to dismiss on June 22, 2010. This motion to dismiss was denied as to the plaintiff’s Section 12(a)(2) claims and granted as

to the plaintiff’s Section 11 claims, and the plaintiff’s motion for reconsideration was denied on November 17, 2010. The plaintiff filed a motion for entry of final judgment or certification of an interlocutory appeal as to plaintiff’s Section 11 claims, which was denied on January 11, 2011. The plaintiff then filed a motion for leave to amend to reinstate the damages claims based on allegations that it had now sold its securities, which was denied on March 3, 2011. On May 5, 2011, the court granted plaintiff’s motion for entry of a final judgment dismissing all its claims. Plaintiff has stated that it will appeal. On June 3, 2010, another investor (who had unsuccessfully sought to intervene in the action) filed a separate putative class action asserting substantively similar allegations relating to an additional offering pursuant to the 2007 registration statement. The defendants moved to dismiss this separate action on November 1, 2010. These trusts issued, and GS&Co. underwrote, approximately $785 million principal amount of certificates to all purchasers in the offerings at issue in the complaint (excluding those offerings for which the claims have been dismissed).
 
Group Inc., GS&Co., Goldman Sachs Mortgage Company and GS Mortgage Securities Corp. are among the defendants in a separate putative class action commenced on February 6, 2009 in the U.S. District Court for the Southern District of New York brought on behalf of purchasers of various mortgage pass-through certificates and asset-backed certificates issued by various securitization trusts established by the firm and underwritten by GS&Co. in 2006. The other defendants include three current or former Goldman Sachs employees and various rating agencies. The second amended complaint generally alleges that the registration statement and prospectus supplements for the certificates violated the federal securities laws, and seeks unspecified compensatory and rescissionary damages. Defendants moved to dismiss the second amended complaint. On January 12, 2011, the district court granted the motion to dismiss with respect to offerings in which plaintiff had not purchased securities, but denied the motion to dismiss with respect to a single offering in which the plaintiff allegedly purchased securities. These trusts issued, and GS&Co. underwrote, approximately $698 million principal amount of certificates to all purchasers in the offerings at issue in the complaint (excluding those offerings for which the claims have been dismissed).
 
 


87


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

On September 30, 2010, a putative class action was filed in the U.S. District Court for the Southern District of New York against GS&Co., Group Inc. and two former GS&Co. employees on behalf of investors in notes issued in 2006 and 2007 by two synthetic CDOs (Hudson Mezzanine 2006-1 and 2006-2). The complaint, which was amended on February 4, 2011, asserts federal securities law and common law claims, and seeks unspecified compensatory, punitive and other damages. The defendants moved to dismiss on April 5, 2011.
 
Various alleged purchasers of, and counterparties involved in transactions relating to, mortgage pass-through certificates, CDOs and other mortgage-related products (including the Federal Home Loan Banks of Seattle, Chicago, Indianapolis and Boston, the Charles Schwab Corporation, Cambridge Place Investment Management Inc., Heungkuk Life Insurance Co. Limited, Basis Yield Alpha Fund (Master), Landesbank Baden-Württemberg and Massachusetts Mutual Life Insurance Company, among others) have filed complaints in state and federal court against firm affiliates, generally alleging that the offering documents for the securities that they purchased contained untrue statements of material facts and material omissions and generally seeking rescission and damages. Certain of these complaints also name other firms as defendants. Additionally, the National Credit Union Administration (NCUA) has stated that it intends to pursue similar claims on behalf of certain credit unions for which it acts as conservator, and the firm and the NCUA have entered into an agreement tolling the relevant statutes of limitation. A number of other entities have threatened to assert claims against the firm in connection with various mortgage-related offerings, and the firm has entered into agreements with a number of these entities to toll the relevant statute of limitations. The firm estimates, based on currently available information, that the aggregate cumulative losses experienced by the plaintiffs with respect to the securities at issue in active cases brought against the firm where purchasers are seeking rescission of mortgage-related securities was approximately $514 million as of March 2011. This amount was calculated as the aggregate amount by which the initial purchase price for the securities allegedly purchased by the plaintiffs exceeds the estimated March 2011 value of those securities. This estimate does not include the potential NCUA claims or any claims by other purchasers in the same or other mortgage-related offerings that have not actually brought claims against the firm.

The firm has also received subpoenas and requests for information from regulators relating to the mortgage-related securitization process, subprime mortgages, CDOs, synthetic mortgage-related products, particular transactions, and servicing and foreclosure activities, and is cooperating with these regulators.
 
The firm expects to be the subject of additional putative shareholder derivative actions, purported class actions, rescission and “put back” claims and other litigation, additional investor and shareholder demands, and additional regulatory and other investigations and actions with respect to mortgage-related offerings, loan sales, CDOs, and servicing and foreclosure activities. See Note 18 for further information regarding mortgage-related contingencies.
 
GS&Co., along with numerous other financial institutions, was a defendant in an action brought by the City of Cleveland alleging that the defendants’ activities in connection with securitizations of subprime mortgages created a “public nuisance” in Cleveland. The complaint sought, among other things, unspecified compensatory damages. The U.S. District Court for the Northern District of Ohio granted defendants’ motion to dismiss by a decision dated May 15, 2009. The appellate court affirmed the dismissal by a decision dated July 27, 2010 and, on October 14, 2010, denied the City’s petition for rehearing en banc. The City filed a petition for writ of certiorari with the U.S. Supreme Court, which was denied on March 21, 2011.
 
Auction Products Matters.  On August 21, 2008, GS&Co. entered into a settlement in principle with the Office of the Attorney General of the State of New York and the Illinois Securities Department (on behalf of the North American Securities Administrators Association) regarding auction rate securities. Under the agreement, Goldman Sachs agreed, among other things, (i) to offer to repurchase at par the outstanding auction rate securities that its private wealth management clients purchased through the firm prior to February 11, 2008, with the exception of those auction rate securities where auctions are clearing, (ii) to continue to work with issuers and other interested parties, including regulatory and governmental entities, to expeditiously provide liquidity solutions for institutional investors, and (iii) to pay a $22.5 million fine. The settlement is subject to definitive documentation and approval by the various states. On June 2, 2009, GS&Co. entered into an Assurance of Discontinuance with the New York State Attorney General. On March 19, 2010, GS&Co. entered into an Administrative Consent Order with the Illinois


88


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Secretary of State, Securities Department, which had conducted an investigation on behalf of states other than New York. GS&Co has entered into similar consent orders with most states and is in the process of doing so with the remaining states.
 
On August 28, 2008, a putative shareholder derivative action was filed in the U.S. District Court for the Southern District of New York naming as defendants Group Inc., the Board, and certain senior officers. The complaint alleges generally that the Board breached its fiduciary duties and committed mismanagement in connection with its oversight of auction rate securities marketing and trading operations, that certain individual defendants engaged in insider selling by selling shares of Group Inc., and that the firm’s public filings were false and misleading in violation of the federal securities laws by failing to accurately disclose the alleged practices involving auction rate securities. The complaint seeks damages, injunctive and declaratory relief, restitution, and an order requiring the firm to adopt corporate reforms. On May 19, 2009, the district court granted defendants’ motion to dismiss, and on July 20, 2009 denied plaintiffs’ motion for reconsideration. Following the dismissal of the shareholder derivative action, the named plaintiff in such action sent the Board a letter demanding that the Board investigate the allegations set forth in the complaint, and the Board ultimately rejected the demand.
 
On September 4, 2008, Group Inc. was named as a defendant, together with numerous other financial services firms, in two complaints filed in the U.S. District Court for the Southern District of New York alleging that the defendants engaged in a conspiracy to manipulate the auction securities market in violation of federal antitrust laws. The actions were filed, respectively, on behalf of putative classes of issuers of and investors in auction rate securities and seek, among other things, treble damages in an unspecified amount. Defendants’ motion to dismiss was granted on January 26, 2010. On March 1, 2010, the plaintiffs filed a notice of appeal from the dismissal of their complaints.
 
Private Equity-Sponsored Acquisitions Litigation.  Group Inc. and “GS Capital Partners” are among numerous private equity firms and investment banks named as defendants in a federal antitrust action filed in the U.S. District Court for the District of Massachusetts in December 2007. As amended, the complaint generally alleges that the defendants have colluded to limit competition in bidding for private equity-sponsored acquisitions of public companies, thereby resulting in lower prevailing bids and, by extension, less consideration for shareholders of

those companies in violation of Section 1 of the U.S. Sherman Antitrust Act and common law. The complaint seeks, among other things, treble damages in an unspecified amount. Defendants moved to dismiss on August 27, 2008. The district court dismissed claims relating to certain transactions that were the subject of releases as part of the settlement of shareholder actions challenging such transactions, and by an order dated December 15, 2008 otherwise denied the motion to dismiss. On April 26, 2010, the plaintiffs moved for leave to proceed with a second phase of discovery encompassing additional transactions. On August 18, 2010, the court permitted discovery on eight additional transactions, and the plaintiffs filed a fourth amended complaint on October 7, 2010. The defendants filed a motion to dismiss certain aspects of the fourth amended complaint on October 21, 2010, and the court granted that motion on January 13, 2011. On January 21, 2011, certain defendants, including Group Inc., filed a motion to dismiss another claim of the fourth amended complaint on the grounds that the transaction was the subject of a release as part of the settlement of a shareholder action challenging the transaction. The court granted that motion on March 1, 2011.
 
Washington Mutual Securities Litigation.  GS&Co. is among numerous underwriters named as defendants in a putative securities class action amended complaint filed on August 5, 2008 in the U.S. District Court for the Western District of Washington. As to the underwriters, plaintiffs allege that the offering documents in connection with various securities offerings by Washington Mutual, Inc. failed to describe accurately the company’s exposure to mortgage-related activities in violation of the disclosure requirements of the federal securities laws. The defendants include past and present directors and officers of Washington Mutual, the company’s former outside auditors, and numerous underwriters. By a decision dated October 27, 2009, the federal district court granted and denied in part the underwriters’ motion to dismiss the plaintiffs’ amended complaint. On October 12, 2010, the court granted class certification (except as to one transaction). On December 1, 2010, the defendants moved for partial judgment on the pleadings as to two of the offerings. By a decision dated January 28, 2011, the district court denied the defendants’ motion for partial judgment on the pleadings. On March 30, 2011, the parties reached a settlement in principle, subject to negotiation of definitive documentation and court approval, pursuant to which GS&Co. would contribute to a settlement fund. The firm has reserved the full amount of GS&Co.’s proposed contribution to the settlement.
 
 


89


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

GS&Co. underwrote approximately $520 million principal amount of securities to all purchasers in the offerings at issue in the complaint (excluding those offerings for which the claims have been dismissed).
 
On September 25, 2008, the FDIC took over the primary banking operations of Washington Mutual, Inc. and then sold them. On September 27, 2008, Washington Mutual, Inc. filed for Chapter 11 bankruptcy in the U.S. bankruptcy court in Delaware.
 
IndyMac Pass-Through Certificates Litigation.  GS&Co. is among numerous underwriters named as defendants in a putative securities class action filed on May 14, 2009 in the U.S. District Court for the Southern District of New York. As to the underwriters, plaintiffs allege that the offering documents in connection with various securitizations of mortgage-related assets violated the disclosure requirements of the federal securities laws. The defendants include IndyMac-related entities formed in connection with the securitizations, the underwriters of the offerings, certain ratings agencies which evaluated the credit quality of the securities, and certain former officers and directors of IndyMac affiliates. On November 2, 2009, the underwriters moved to dismiss the complaint. The motion was granted in part on February 17, 2010 to the extent of dismissing claims based on offerings in which no plaintiff purchased, and the court reserved judgment as to the other aspects of the motion. By a decision dated June 21, 2010, the district court formally dismissed all claims relating to offerings in which no named plaintiff purchased certificates (including all offerings underwritten by GS&Co.), and both granted and denied the defendants’ motions to dismiss in various other respects. On May 17, 2010, four additional investors filed a motion seeking to intervene in order to assert claims based on additional offerings (including two underwritten by GS&Co.). On July 6, 2010, another additional investor filed a motion to intervene in order to assert claims based on additional offerings (none of which were underwritten by GS&Co.).
 
GS&Co. underwrote approximately $751 million principal amount of securities to all purchasers in the offerings at issue in the May 2010 motion to intervene. On July 11, 2008, IndyMac Bank was placed under an FDIC receivership, and on July 31, 2008, IndyMac

Bancorp, Inc. filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court in Los Angeles, California.
 
Employment-Related Matters.  On May 27, 2010, a putative class action was filed in the U.S. District Court for the Southern District of New York by several contingent technology workers who were employees of third-party vendors. The plaintiffs are seeking overtime pay for alleged hours worked in excess of 40 per work week. The complaint alleges that the plaintiffs were de facto employees of GS&Co. and that GS&Co. is responsible for the overtime pay under federal and state overtime laws. The complaint seeks class action status and unspecified damages. On March 21, 2011, the parties reached a settlement in principle, subject to negotiation of definitive documentation and court approval. The firm has reserved the full amount of the proposed settlement.
 
On September 15, 2010, a putative class action was filed in the U.S. District for the Southern District of New York by three former female employees alleging that Group Inc. and GS&Co. have systematically discriminated against female employees in respect of compensation, promotion, assignments, mentoring and performance evaluations. The complaint alleges a class consisting of all female employees employed at specified levels by Group Inc. and GS&Co. since July 2002, and asserts claims under federal and New York City discrimination laws. The complaint seeks class action status, injunctive relief and unspecified amounts of compensatory, punitive and other damages. On November 22, 2010, Group Inc. and GS&Co. filed a motion to stay the claims of one of the named plaintiffs and to compel individual arbitration with that individual, based on an arbitration provision contained in an employment agreement between Group Inc. and the individual. On April 28, 2011, the magistrate judge to whom the district judge assigned the motion denied the motion.
 
Transactions with the Hellenic Republic (Greece).  Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations in connection with the firm’s transactions with the Hellenic Republic (Greece), including financing and swap transactions. Goldman Sachs is cooperating with the investigations and reviews.
 
 


90


Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 

Sales, Trading and Clearance Practices.  Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations relating to the sales, trading and clearance of corporate and government securities and other financial products, including compliance with the SEC’s short sale rule, algorithmic and quantitative trading, futures trading, securities lending practices, trading and clearance of credit derivative instruments, commodities trading, private placement practices and the effectiveness of insider trading controls and internal information barriers.
 
The European Commission announced in April 2011 that it is initiating proceedings to investigate further numerous financial services companies, including Group Inc., in connection with the supply of data related to credit default swaps and in connection with fee arrangements for clearing of credit default swaps, including potential anti-competitive practices. The U.S. Department of Justice (DOJ) has been investigating similar matters.
 
The CFTC has been investigating the role of GSEC as the clearing broker for an SEC-registered broker-dealer client. The CFTC staff has orally advised GSEC that it intends to recommend that the CFTC bring aiding and abetting, civil fraud and supervision-related charges against GSEC arising from its provision of clearing services to this broker-dealer client based on allegations that GSEC knew or should have known that the client’s subaccounts maintained at GSEC were actually accounts belonging to customers of the broker-dealer client and not the client’s proprietary accounts.
 
Goldman Sachs is cooperating with the investigations and reviews.
 
Municipal Securities Matters.  Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations relating to transactions involving municipal securities, including wall-cross procedures and conflict of interest disclosure with respect to state and municipal clients, the trading and structuring of municipal derivative instruments in connection with municipal offerings, political contribution rules, underwriting of Build America Bonds and the possible impact of credit default swap transactions on municipal issuers. Goldman Sachs is cooperating with the investigations and reviews.

Group Inc., Goldman Sachs Mitsui Marine Derivative Products, L.P. (GSMMDP) and GS Bank USA are among numerous financial services firms that have been named as defendants in numerous substantially identical individual antitrust actions filed beginning on November 12, 2009 that have been coordinated with related antitrust class action litigation and individual actions, in which no Goldman Sachs affiliate is named, for pre-trial proceedings in the U.S. District Court for the Southern District of New York. The plaintiffs include individual California municipal entities and three New York non-profit entities. On April 26, 2010, the Goldman Sachs defendants’ motion to dismiss complaints filed by several individual California municipal plaintiffs was denied. All of these complaints against Group Inc., GSMMDP and GS Bank USA generally allege that the Goldman Sachs defendants participated in a conspiracy to arrange bids, fix prices and divide up the market for derivatives used by municipalities in refinancing and hedging transactions from 1992 to 2008. The complaints assert claims under the federal antitrust laws and either California’s Cartwright Act or New York’s Donnelly Act, and seek, among other things, treble damages under the antitrust laws in an unspecified amount and injunctive relief.
 
Financial Crisis-Related Matters.  Group Inc. and certain of its affiliates are subject to a number of investigations and reviews by various governmental and regulatory bodies and self-regulatory organizations and litigation relating to the 2008 financial crisis, including the establishment and unwind of credit default swaps between Goldman Sachs and American International Group, Inc. (AIG) and other transactions with, and in the securities of, AIG, The Bear Stearns Companies Inc., Lehman Brothers Holdings Inc. and other firms. Goldman Sachs is cooperating with the investigations and reviews.
 
In April 2011, a Staff Report of the Senate Permanent Subcommittee on Investigations concerning the key causes of the financial crisis was issued. Using Goldman Sachs and another financial institution as case studies with respect to the role of investment banks, the report recommended, among other things, that Federal regulators review the mortgage-related activities described therein. Press reports have indicated that the Subcommittee has referred the report to the DOJ and the SEC for review, and that those regulators are reviewing the report.
 


91


Table of Contents

 
Report of Independent Registered Public Accounting Firm
 
 
To the Board of Directors and the 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 March 31, 2011, the related condensed consolidated statements of earnings for the three months ended March 31, 2011 and March 31, 2010, the condensed consolidated statement of changes in shareholders’ equity for the three months ended March 31, 2011, the condensed consolidated statements of cash flows for the three months ended March 31, 2011 and March 31, 2010, and the condensed consolidated statements of comprehensive income for the three months ended March 31, 2011 and March 31, 2010. 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 previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition as of December 31, 2010, and the related consolidated statements of earnings, changes in shareholders’ equity, cash flows and comprehensive income for the year then ended (not presented herein), and in our report dated February 28, 2011, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of December 31, 2010 and the condensed consolidated statement of changes in shareholders’ equity for the year ended December 31, 2010, 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
May 9, 2011
 


92


Table of Contents

 
STATISTICAL DISCLOSURES
 
Distribution of Assets, Liabilities and Shareholders’ Equity
The table below presents a summary of consolidated average balances and interest rates.
 
                                                     
 
    Three Months Ended March 
    2011     2010      
                Average
                Average
     
    Average
          rate
    Average
          rate
     
in millions, except rates   balance     Interest     (annualized)     balance     Interest     (annualized)      
 
Assets
                                                   
Deposits with banks
    $ 34,094     $ 29       0.34 %     $ 25,706     $ 15       0.24 %    
U.S. 
    29,814       22       0.30       19,941       11       0.22      
Non-U.S. 
    4,280       7       0.66       5,765       4       0.28      
Securities borrowed, securities purchased under agreements to resell, at fair value, and federal funds sold
    345,021       169       0.20       352,607       79       0.09      
U.S. 
    225,247                   242,394       (27 )     (0.05 )    
Non-U.S. 
    119,774       169       0.57       110,213       106       0.39      
Financial instruments owned, at fair value 1, 2
    284,548       2,515       3.58       270,056       2,621       3.94      
U.S. 
    184,064       1,814       4.00       186,455       1,964       4.27      
Non-U.S. 
    100,484       701       2.83       83,601       657       3.19      
Other interest-earning assets 3
    137,437       394       1.16       108,298       286       1.07      
U.S. 
    94,839       203       0.87       75,028       146       0.79      
Non-U.S. 
    42,598       191       1.82       33,270       140       1.71      
 
 
Total interest-earning assets
    801,100       3,107       1.57       756,667       3,001       1.61      
Cash and due from banks
    4,134                       2,690                      
Other non-interest-earning assets 2
    112,904                       109,130                      
 
 
Total Assets
    $918,138                       $868,487                      
 
 
Liabilities
                                                   
Interest-bearing deposits
    $ 38,775     $ 72       0.75 %     $ 39,026     $ 68       0.71 %    
U.S. 
    32,652       65       0.81       32,336       63       0.79      
Non-U.S. 
    6,123       7       0.46       6,690       5       0.30      
Securities loaned and securities sold under agreements to repurchase, at fair value
    169,094       201       0.48       149,691       136       0.37      
U.S. 
    110,953       87       0.32       107,259       55       0.21      
Non-U.S. 
    58,141       114       0.80       42,432       81       0.77      
Financial instruments sold, but not yet purchased 1, 2
    95,388       496       2.11       83,875       495       2.39      
U.S. 
    49,231       223       1.84       45,440       229       2.04      
Non-U.S. 
    46,157       273       2.40       38,435       266       2.81      
Commercial paper
    1,444       1       0.18       1,693       1       0.26      
U.S. 
    51             0.16       322             0.10      
Non-U.S. 
    1,393       1       0.18       1,371       1       0.30      
Other borrowings 4, 5
    69,915       128       0.74       49,261       117       0.96      
U.S. 
    45,418       120       1.07       29,520       98       1.35      
Non-U.S. 
    24,497       8       0.13       19,741       19       0.39      
Long-term borrowings 5, 6
    185,509       786       1.72       193,471       746       1.56      
U.S. 
    179,082       734       1.66       182,695       679       1.51      
Non-U.S. 
    6,427       52       3.28       10,776       67       2.52      
Other interest-bearing liabilities 7
    194,388       65       0.14       189,072       20       0.04      
U.S. 
    143,293       (54 )     (0.15 )     143,894       (84 )     (0.24 )    
Non-U.S. 
    51,095       119       0.94       45,178       104       0.93      
 
 
Total interest-bearing liabilities
    754,513       1,749       0.94       706,089       1,583       0.91      
Non-interest-bearing deposits
    119                       239                      
Other non-interest-bearing liabilities 2
    87,454                       89,727                      
 
 
Total liabilities
    842,086                       796,055                      
Shareholders’ equity
                                                   
Preferred stock
    5,993                       6,957                      
Common stock
    70,059                       65,475                      
 
 
Total shareholders’ equity
    76,052                       72,432                      
Total liabilities, preferred stock and shareholders’ equity
    $918,138                       $868,487                      
 
 
Interest rate spread
                    0.63 %                     0.70 %    
Net interest income and net yield on interest-earning assets
          $ 1,358       0.69             $ 1,418       0.76      
U.S. 
            864       0.66               1,054       0.82      
Non-U.S. 
            494       0.75               364       0.63      
Percentage of interest-earning assets and interest-bearing liabilities attributable to non-U.S. operations 8
                                                   
Assets
                    33.35 %                     30.77 %    
Liabilities
                    25.69                       23.31      
 
 

93


Table of Contents

STATISTICAL DISCLOSURES
 
1.   Consists of cash financial instruments, including equity securities and convertible debentures.
 
2.   Derivative instruments and commodities are included in other non-interest-earning assets and other non-interest-bearing liabilities.
 
3.   Primarily consists of cash and securities segregated for regulatory and other purposes and certain receivables from customers and counterparties.
 
4.   Consists of short-term other secured financings and unsecured short-term borrowings, excluding commercial paper.
 
5.   Interest rates include the effects of interest rate swaps accounted for as hedges.
 
6.   Consists of long-term other secured financings and unsecured long-term borrowings.
 
7.   Primarily consists of certain payables to customers and counterparties.
 
8.   Assets, liabilities and interest are attributed to U.S. and non-U.S. based on the location of the legal entity in which the assets and liabilities are held.

94


Table of Contents

STATISTICAL DISCLOSURES
 
Ratios
The table below presents selected financial ratios.
 
                     
 
    Three Months 
    Ended March 
    2011     2010      
 
Annualized net earnings to average assets
    1.2 %     1.6 %    
Annualized return on average common shareholders’ equity 1
    12.2  3     20.1      
Annualized return on average total shareholders’ equity 2
    14.4       19.1      
Total average equity to average assets
    8.3       8.3      
 
 
 
1.   Based on net earnings applicable to common shareholders divided by average monthly common shareholders’ equity.
 
2.   Based on net earnings divided by average monthly total shareholders’ equity.
 
3.   The $1.64 billion Series G Preferred Stock dividend was not annualized in the calculation of annualized net earnings applicable to common shareholders since it has no impact on other quarters in the year.
 
Cross-border Outstandings

Cross-border outstandings are based upon the Federal Financial Institutions Examination Council’s (FFIEC) regulatory guidelines for reporting cross-border risk. Claims include cash, receivables, securities purchased under agreements to resell, securities borrowed and cash financial instruments, but exclude derivative instruments and commitments. Securities purchased under agreements to resell and securities

borrowed are presented based on the domicile of the counterparty, without reduction for related securities collateral held.
 
The tables below present cross-border outstandings for each country in which cross-border outstandings exceed 0.75% of consolidated assets in accordance with the FFIEC guidelines.


                                     
 
    As of March 2011 
in millions   Banks     Governments     Other     Total      
 
Country
                                   
United Kingdom
  $ 5,319     $ 2,800     $ 34,083     $ 42,202      
Japan
    31,897       223       6,387       38,507      
Cayman Islands
    13       66       38,175       38,254      
France
    27,307       5,791       5,044       38,142      
Germany
    3,663       11,582       3,371       18,616      
China
    11,833       1,432       3,858       17,123      
Switzerland
    2,541       110       6,479       9,130      
Ireland
    562       22       7,755       8,339      
 
 
 
                                     
 
    As of December 2010 
in millions   Banks     Governments     Other     Total      
 
Country
                                   
France
  $ 29,380     $ 7,369     $ 4,326     $ 41,075      
United Kingdom
    5,630       4,833       26,516       36,979      
Cayman Islands
    7             35,949       35,956      
Japan
    28,579       49       4,936       33,564      
Germany
    3,897       15,791       2,186       21,874      
China
    10,724       700       2,705       14,129      
Switzerland
    2,464       150       6,875       9,489      
 
 

95


Table of Contents

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
INDEX
 
             
 
    Page No.      
    97      
    97      
    99      
    100      
    103      
    104      
    112      
    118      
    123      
    126      
    130      
    136      
    141      
    146      
    147      
    147      
    148      
 
 

96


Table of Contents

 

Introduction
 
The Goldman Sachs Group, Inc. (Group Inc.) is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.
 
We report our activities in the following four business segments: Investment Banking, Institutional Client Services, Investing & Lending and Investment Management. See “Results of Operations” below for further information about our business segments.
 
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 year ended December 31, 2010. References to “our Annual Report on Form 10-K” are to our Annual Report on Form 10-K for the year ended December 31, 2010.
 
When we use the terms “Goldman Sachs,” “the firm,” “we,” “us” and “our,” we mean Group Inc., a Delaware corporation, and its consolidated subsidiaries.
 
References to “this Form 10-Q” are to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011. All references to March 2011 and March 2010, unless specifically stated otherwise, refer to our periods ended, or the dates, as the context requires, March 31, 2011 and March 31, 2010, respectively. All references to December 2010, unless specifically stated otherwise, refer to the date December 31, 2010. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.

Executive Overview
 
Our diluted earnings per common share were $1.56 for the first quarter of 2011 compared with $5.59 for the first quarter of 2010. Annualized return on average common shareholders’ equity (ROE) 1 was 12.2% for the first quarter of 2011. During the quarter we gave notice of redemption for the 50,000 shares of our 10% Cumulative Perpetual Preferred Stock, Series G (Series G Preferred Stock) held by Berkshire Hathaway Inc. and certain of its subsidiaries (collectively, Berkshire Hathaway) and we redeemed this preferred stock on April 18, 2011. The redemption included a preferred dividend of $1.64 billion, which was included in our results for the first quarter of 2011. Excluding the impact of this preferred dividend, diluted earnings per common share were $4.38 2 and annualized ROE was 14.5% 2 for the first quarter of 2011.
 
Despite the impact of the preferred dividend of $1.64 billion related to the redemption of our Series G Preferred Stock, both book value per common share and tangible book value per common share 3 increased slightly during the quarter to $129.40 and $119.63, respectively. Excluding the impact of this preferred dividend, both book value per common share and tangible book value per common share 3 increased approximately 3% 3 during the quarter. Under Basel 1, our Tier 1 capital ratio 4 was 14.6% as of March 2011, compared with 16.0% as of December 2010. Substantially all of the decrease in our Tier 1 capital ratio reflected the impact of the redemption of our Series G Preferred Stock. Our Tier 1 common ratio 4 was 12.8% as of March 2011, compared with 13.3% as of December 2010.
 
The firm generated net revenues of $11.89 billion and net earnings of $2.74 billion for the first quarter of 2011. These results reflected solid, but significantly lower, net revenues in Institutional Client Services compared with a strong first quarter of 2010. This decrease was partially offset by significantly higher net revenues in Investing & Lending, as well as higher net revenues in both Investment Management and Investment Banking compared with the first quarter of 2010. The results for each of our business segments are discussed below.
 



1. See “Results of Operations — Financial Overview” below for further information about our calculation of ROE.
2. We believe that presenting our results excluding the impact of the $1.64 billion preferred dividend related to the redemption of our Series G Preferred Stock (calculated as the difference between the carrying value and the redemption value of the preferred stock) is meaningful because it increases the comparability of period-to-period results. See “Results of Operations — Financial Overview” below for further information about our calculation of diluted earnings per common share and ROE excluding the impact of this dividend.
3. We believe that tangible common shareholders’ equity and tangible book value per common share are meaningful because they are measures that we and investors use to assess capital adequacy. In addition, we believe that presenting the change in book value and tangible book value per common share excluding the impact of the $1.64 billion Series G Preferred Stock dividend provides a meaningful period-to-period comparison of these measures. See “Equity Capital — Other Capital Metrics” below for further information about our calculation of tangible book value per common share, and book value and tangible book value per common share excluding the impact of this dividend.
4. See “Equity Capital — Consolidated Regulatory Capital Ratios” below for further information about our Tier 1 capital ratio and Tier 1 common ratio.

97


Table of Contents

 

Institutional Client Services
The decrease in Institutional Client Services primarily reflected significantly lower net revenues in Fixed Income, Currency and Commodities Client Execution compared with a particularly strong first quarter of 2010. Client activity levels in Fixed Income, Currency and Commodities Client Execution improved during the first quarter of 2011, resulting in solid performances in credit products, interest rate products, currencies and mortgages, although net revenues in each were lower compared with the first quarter of 2010. Net revenues in commodities were also solid and were higher compared with the same prior year period.
 
Net revenues in Equities also declined compared with the first quarter of 2010, reflecting lower net revenues in equities client execution. The decline in equities client execution compared with the first quarter of 2010 reflected lower net revenues in derivatives and shares. This decrease was partially offset by higher commissions and fees, reflecting higher transaction volumes. Securities services net revenues were essentially unchanged compared with the first quarter of 2010. During the first quarter of 2011, Equities operated in an environment generally characterized by an increase in global equity prices and slightly lower average volatility levels.
 
Investing & Lending
Net revenues in Investing & Lending generally reflected an increase in global equity prices and favorable credit markets during the quarter. These results primarily included a gain of $316 million from our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC), net gains of $1.05 billion from equity securities (excluding ICBC), and net gains and net interest of $1.02 billion from debt securities and loans.

Investment Management
The increase in Investment Management was primarily due to an increase in management and other fees, reflecting favorable changes in the mix of assets under management, as well as higher incentive fees. Assets under management were $840 billion as of March 2011, unchanged compared with the end of 2010, reflecting net market appreciation of $12 billion, offset by net outflows in money market and fixed income assets of $12 billion.
 
Investment Banking
The increase in Investment Banking reflected higher net revenues in our Underwriting business, partially offset by lower net revenues in Financial Advisory. The increase in Underwriting reflected strong net revenues in debt underwriting, which were significantly higher compared with the first quarter of 2010, as well as higher net revenues in equity underwriting. The increase in both debt and equity underwriting primarily reflected an increase in client activity.
 
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, economic conditions generally and other factors. For a further discussion of the factors that may affect our future operating results, see “Certain Risk Factors That May Affect Our Businesses” below, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.
 


98


Table of Contents

 
Business Environment
 

Global
The global economy grew at a solid pace during the first quarter of 2011, as real gross domestic product (GDP) increased in most economies. However, certain unfavorable market conditions that emerged in 2010 continued during the quarter, including concerns about European sovereign debt risk and uncertainty regarding financial regulatory reform. Additional concerns that affected our businesses during the quarter included political unrest in the Middle East, the earthquake and tsunami in Japan and inflation in emerging markets. Although equity markets were volatile near the end of the quarter, global equity prices generally increased and average volatility levels for the first quarter declined slightly. The price of crude oil increased significantly during the quarter. The U.S. dollar depreciated against the Euro and the British pound, but appreciated slightly against the Japanese yen. Industry-wide announced and completed mergers and acquisitions volumes and debt offerings volumes increased during the quarter. However, equity and equity-related offerings volumes decreased significantly, particularly in initial public offerings.
 
United States
In the United States, real GDP increased during the first quarter, although at a slower pace than in the fourth quarter of 2010. Unemployment levels declined during the quarter, although the rate of unemployment remained elevated, and industrial production increased. Measures of core inflation increased during the quarter from low levels. The U.S. Federal Reserve maintained its federal funds rate at a target range of zero to 0.25% and continued quantitative easing measures, including the purchase of significant amounts of U.S. Treasury debt. The 10-year U.S. Treasury note yield ended the quarter at 3.47%, 17 basis points higher than the end of 2010. In equity markets, the Dow Jones Industrial Average increased by 6% and the S&P 500 Index and the NASDAQ Composite Index each increased by 5% during the quarter.
 
Europe
In the Eurozone economies, real GDP growth appeared to accelerate during the first quarter, reflecting strong growth in Germany. In addition, surveys of business confidence improved during the quarter. However, concerns about fiscal challenges in several Eurozone economies persisted through the quarter, weighing on

economic growth in these economies. Measures of core inflation increased during the first quarter. The European Central Bank maintained its main refinancing operations rate at 1.00% during the quarter, although markets reflected expectations of an increase in the rate. The Euro appreciated by 6% against the U.S. dollar. In the United Kingdom, real GDP increased during the first quarter, following a decline in the fourth quarter of 2010. The Bank of England maintained its official bank rate at 0.50% and the British pound appreciated by 3% against the U.S. dollar. Long-term government bond yields in the Eurozone and the U.K. increased during the first quarter. Equity markets in continental Europe generally increased during the quarter, while equity markets in the U.K. were essentially unchanged.
 
Asia
In Japan, real GDP appeared to increase early in the quarter; however, the extent of the impact of the earthquake and tsunami on economic growth for the first quarter remains uncertain. Measures of core inflation remained negative during the quarter. The Bank of Japan left its target overnight call rate unchanged at a range of zero to 0.10%. In addition, The Bank of Japan expanded its liquidity and asset purchase program significantly during the quarter in order to promote economic stability following the earthquake and tsunami. The yield on 10-year Japanese government bonds increased during the quarter. The Japanese yen depreciated by 2% against the U.S. dollar and the Nikkei 225 Index ended the quarter 5% lower. In China, real GDP growth remained strong during the first quarter, although the pace of growth moderated compared with the fourth quarter of 2010. Measures of inflation remained elevated during the quarter. The People’s Bank of China increased the reserve requirement ratio by 150 basis points during the quarter. The Chinese yuan appreciated slightly against the U.S. dollar and the Shanghai Composite Index increased by 4% during the quarter. Equity markets in Hong Kong and South Korea also increased during the quarter. In India, economic growth appeared to remain strong, supported by continued strength in domestic demand. In addition, measures of inflation remained elevated. The Indian rupee was essentially unchanged against the U.S. dollar and equity markets in India declined.
 


99


Table of Contents

 
Critical Accounting Policies
 
Fair Value

Fair Value Hierarchy.  Financial instruments owned, at fair value and Financial instruments sold, but not yet purchased, at fair value (i.e., inventory), as well as certain other financial assets and financial liabilities, are reflected in our condensed consolidated statements of financial condition at fair value (i.e., marked-to-market), with related gains or losses generally recognized in our condensed consolidated statements of earnings. The use of fair value to measure financial instruments is fundamental to our risk management practices and is our most critical accounting policy.
 
The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the hierarchy under U.S. generally accepted accounting principles (U.S. GAAP) gives (i) the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 inputs), (ii) the next priority to inputs other than level 1 inputs that are observable either directly or indirectly (level 2 inputs), and (iii) the lowest priority to inputs that cannot be observed in market activity (level 3 inputs). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement.
 
The fair values for substantially all of our financial assets and financial liabilities, including derivatives, are based on observable prices and inputs and are classified in levels 1 and 2 of the hierarchy. Certain level 2 financial instruments may require appropriate discounts (i.e., valuation adjustments) for factors such as:
 
•   transfer restrictions;
 
•   the credit quality of a counterparty or the firm; and
 
•   other premiums and discounts that a market participant would require to arrive at fair value.
 
Valuation adjustments are generally based on market evidence.

Instruments categorized within level 3 of the fair value hierarchy, which represent approximately 5% of the firm’s total assets, require one or more significant inputs that are not observable. Absent evidence to the contrary, instruments classified within level 3 of the fair value hierarchy are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the transaction date, we use other methodologies to determine fair value, which vary based on the type of instrument. Estimating the fair value of level 3 financial instruments may require judgments to be made. These judgments include:
 
•   determining the appropriate valuation methodology and/or model for each type of level 3 financial instrument;
 
•   determining model inputs based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations; and
 
•   determining appropriate valuation adjustments related to illiquidity or counterparty credit quality.
 
Regardless of the methodology, valuation inputs and assumptions are only changed when corroborated by substantive evidence.
 
Controls Over Valuation of Financial Instruments.  Our control infrastructure is independent of the revenue-producing units and is fundamental to ensuring that all of our financial instruments are appropriately valued at market-clearing levels. In particular, our independent price verification process is critical to ensuring that financial instruments are properly valued.
 


100


Table of Contents

 

Price Verification.  The objective of price verification is to have an informed and independent opinion with regard to the valuation of financial instruments under review. Instruments that have one or more significant inputs which cannot be corroborated by external market data are classified within level 3 of the fair value hierarchy.
 
In situations where there is a question about a valuation, the ultimate valuation is determined by senior managers in control and support functions that are independent of the revenue-producing units (independent control and support functions). Price verification strategies utilized by our independent control and support functions include:
 
•   Trade Comparison.  Analysis of trade data (both internal and external where available) is used to determine the most relevant pricing inputs and valuations.
 
•   External Price Comparison.  Valuations and prices are compared to pricing data obtained from third parties (e.g., broker or dealers, MarkIt, Bloomberg, IDC, TRACE). Data obtained from various sources is compared to ensure consistency and validity. When broker or dealer quotations or third-party pricing vendors are used for valuation or price verification, greater priority is generally given to executable quotations.
 
•   Calibration to Market Comparables.  Market-based transactions are used to corroborate the valuation of positions with similar characteristics, risks and components.
 
•   Relative Value Analyses.  Market-based transactions are analyzed to determine the similarity, measured in terms of risk, liquidity and return, of one instrument relative to another, or for a given instrument, of one maturity relative to another.
 
•   Collateral Analyses.  Margin disputes on derivatives are examined and investigated to determine the impact, if any, on our valuations.
 
•   Execution of Trades.  Where appropriate, trading desks are instructed to execute trades in order to provide evidence of market-clearing levels.
 
•   Backtesting.  Valuations are corroborated by comparison to values realized upon sales.
 
See Notes 5 through 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about fair value measurements.

Review of Net Revenues.  Independent control and support functions ensure adherence to our pricing policy through a combination of daily procedures, one of which is the process of validating and understanding results by attributing and explaining net revenues by the underlying factors. Through this process we independently validate net revenues, identify and resolve potential fair value or trade booking issues on a timely basis and ensure that risks are being properly categorized and quantified.
 
Review of Valuation Models.  Quantitative professionals within our Market Risk Management department (Market Risk Management) perform an independent model approval process. This process incorporates a review of a diverse set of model and trade parameters across a broad range of values (including extreme and/or improbable conditions) in order to critically evaluate:
 
•   a model’s suitability for valuation and risk management of a particular instrument type;
 
•   the model’s accuracy in reflecting the characteristics of the related product and its significant risks;
 
•   the suitability and properties of the numerical algorithms incorporated in the model;
 
•   the model’s consistency with models for similar products; and
 
•   the model’s sensitivity to input parameters and assumptions.
 
New or changed models are reviewed and approved. Models are evaluated and re-approved annually to assess the impact of any changes in the product or market and any market developments in pricing theories.
 
See “Market Risk Management” and “Credit Risk Management” for a further discussion of how we manage the risks inherent in our businesses.
 


101


Table of Contents

 

Level 3 Financial Assets at Fair Value.  The table below presents financial assets measured at fair value and the amount of such assets that are classified within level 3 of the fair value hierarchy.
 
Total level 3 assets were $45.84 billion and $45.38 billion as of March 2011 and December 2010, respectively. The increase in level 3 assets during the first quarter of 2011 primarily reflected (i) an increase in private equity investments and real estate investments

principally due to transfers from level 2 and (ii) an increase in corporate debt securities principally due to purchases. This increase was partially offset by a decrease in derivatives primarily due to settlements and unrealized losses.
 
See Notes 5 through 8 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about fair value measurements.
 


                                     
 
    As of March 2011     As of December 2010 
    Total at
    Level 3
    Total at
    Level 3
     
in millions   Fair Value     Total     Fair Value     Total      
 
Commercial paper, certificates of deposit, time deposits and
other money market instruments
  $ 13,100     $     $ 11,262     $      
U.S. government and federal agency obligations
    100,222             84,928            
Non-U.S. government obligations
    44,540             40,675            
Mortgage and other asset-backed loans and securities:
                                   
Loans and securities backed by commercial real estate
    5,912       2,521       6,200       2,819      
Loans and securities backed by residential real estate
    8,426       2,636       9,404       2,373      
Loan portfolios 1
    1,314       1,312       1,438       1,285      
Bank loans and bridge loans
    18,063       9,929  2     18,039       9,905  2    
Corporate debt securities
    26,515       3,138       24,719       2,737      
State and municipal obligations
    2,718       742       2,792       754      
Other debt obligations
    3,599       1,483       3,232       1,274      
Equities and convertible debentures
    75,343       11,765       67,833       11,060      
Commodities
    5,911             13,138            
 
 
Total cash instruments
    305,663       33,526       283,660       32,207      
Derivatives
    69,143       11,837       73,293       12,772      
 
 
Financial instruments owned, at fair value
    374,806       45,363       356,953       44,979      
Securities segregated for regulatory and other purposes
    34,325             36,182            
Securities purchased under agreements to resell
    162,094       158       188,355       100      
Securities borrowed
    62,236             48,822            
Receivables from customers and counterparties
    8,095       322       7,202       298      
 
 
Total
  $ 641,556     $ 45,843     $ 637,514     $ 45,377      
 
 
 
1.   Consists of acquired portfolios of distressed loans, primarily backed by commercial and residential real estate.
 
2.   Includes certain mezzanine financing, leveraged loans arising from capital market transactions and other corporate bank debt.

102


Table of Contents

 

Goodwill and Identifiable Intangible Assets
Goodwill.  Goodwill is the cost of acquired companies in excess of the fair value of net assets, including identifiable intangible assets, at the acquisition date. We test the goodwill in each of our reporting units for impairment at least annually, by comparing the estimated fair value of each reporting unit with its estimated net book value. We derive the fair value based on valuation techniques we believe market participants would use (i.e., observable price-to-earnings multiples and price-to-book multiples). We derive the net book value by estimating the amount of shareholders’ equity required to support the activities of each reporting unit. Estimating the fair value of our reporting units requires management to make judgments. Critical inputs include (i) projected earnings, (ii) estimated long-term growth rates and (iii) cost of equity. Our last annual impairment test was performed during our 2010 fourth quarter and no impairment was identified. See Note 13 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for the carrying value of our goodwill by operating segment.
 
Identifiable Intangible Assets.  We amortize our identifiable intangible assets over their estimated lives or, in the case of insurance contracts, in proportion to estimated gross profits or premium revenues. Identifiable intangible assets are tested for impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable.
 
An impairment loss, generally 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. See Note 13 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for the carrying value and estimated remaining lives of our identifiable intangible assets by major asset class and the carrying value of our identifiable intangible assets by operating segment.
 
A prolonged period of market weakness could adversely impact our businesses and impair the value of our identifiable intangible assets. In addition, certain events could indicate a potential impairment of our identifiable intangible assets, including (i) decreases in revenues from commodity-related customer contracts and relationships, (ii) decreases in cash receipts from television broadcast royalties, (iii) an adverse action or assessment by a regulator or (iv) adverse actual experience on the contracts in our variable annuity and life insurance business. Management judgment is required to evaluate whether indications of potential impairment have

occurred, and to test intangibles for impairment if required.
 
Use of Estimates
 
 
The use of generally accepted accounting principles requires management to make certain estimates and assumptions. In addition to the estimates we make in connection with fair value measurements, the accounting for goodwill and identifiable intangible assets, and discretionary compensation accruals, the use of estimates and assumptions is also important 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 compensation, which is finalized at year-end. We believe the most appropriate way to allocate estimated annual discretionary compensation 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, the structure of our share-based compensation programs and the external environment. See “Results of Operations — Financial Overview — Operating Expenses” below for information regarding our ratio of compensation and benefits to net revenues.
 
We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. In accounting for income taxes, we estimate and provide for potential liabilities that may arise out of tax audits to the extent that uncertain tax positions fail to meet the recognition standard under ASC 740. See Note 24 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about accounting for income taxes.
 
Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated 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. See Notes 18 and 27 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on certain judicial, regulatory and legal proceedings.
 
 


103


Table of Contents

 
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. See “Certain Risk Factors That May Affect Our Businesses” below and “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for a further discussion of the impact of economic and market conditions on our results of operations.
 
 


Financial Overview
The table below presents an overview of our financial results.
 
                     
 
    Three Months
    Ended March
$ in millions, except per share amounts   2011     2010      
 
Net revenues
  $ 11,894     $ 12,775      
Pre-tax earnings
    4,040       5,159      
Net earnings
    2,735       3,456      
Net earnings applicable to common shareholders
    908       3,296      
Diluted earnings per common share
    1.56       5.59      
Annualized return on average common shareholders’ equity 1
    12.2 %     20.1 %    
Diluted earnings per common share, excluding the impact of the Series G Preferred Stock dividend 2
  $ 4.38       N/A      
Annualized return on average common shareholders’ equity, excluding the impact of the Series G
Preferred Stock dividend 2
    14.5 %     N/A      
 
 
 
1.   Annualized ROE is computed by dividing annualized net earnings applicable to common shareholders by average monthly common shareholders’ equity. The impact of the $1.64 billion Series G Preferred Stock dividend was not annualized in the calculation of annualized net earnings applicable to common shareholders as this amount has no impact on other quarters in the year. The table below presents our average common shareholders’ equity.
 
                     
 
    Average for the
    Three Months
    Ended March
in millions   2011     2010      
 
Total shareholders’ equity
  $ 76,052     $ 72,432      
Preferred stock
    (5,993 )     (6,957 )    
 
 
Common shareholders’ equity
  $ 70,059     $ 65,475      
 
 
 
2.   We believe that presenting our results excluding the impact of the $1.64 billion preferred dividend related to the redemption of our Series G Preferred Stock (calculated as the difference between the carrying value and the redemption value of the preferred stock) is meaningful because it increases the comparability of period-to-period results. The tables below present the calculation of net earnings applicable to common shareholders, diluted earnings per common share and average common shareholders’ equity excluding the impact of this dividend.
 
             
 
    Three Months Ended
     
in millions, except per share amount   March 2011      
 
Net earnings applicable to common shareholders
  $ 908      
Impact of the Series G Preferred Stock dividend
    1,643      
 
 
Net earnings applicable to common shareholders, excluding the impact of the Series G Preferred Stock dividend
    2,551      
Divided by: average diluted common shares outstanding
    583.0      
 
 
Diluted earnings per common share, excluding the impact of the Series G Preferred Stock dividend
  $ 4.38      
 
 
 
             
 
    Average for the
     
    Three Months Ended
     
in millions   March 2011      
 
Total shareholders’ equity
  $ 76,052      
Preferred stock
    (5,993 )    
 
 
Common shareholders’ equity
    70,059      
Impact of the Series G Preferred Stock dividend
    411      
 
 
Common shareholders’ equity, excluding the impact of the Series G Preferred Stock dividend
  $ 70,470      
 
 

104


Table of Contents

 

Net Revenues
Three Months Ended March 2011 versus March 2010.  Net revenues were $11.89 billion for the first quarter of 2011, 7% lower than a particularly strong first quarter of 2010, reflecting solid, but significantly lower, net revenues in Institutional Client Services compared with a strong first quarter of 2010. This decrease was partially offset by significantly higher net revenues in Investing & Lending, as well as higher net revenues in both Investment Management and Investment Banking compared with the first quarter of 2010.
 
Institutional Client Services
The decrease in Institutional Client Services primarily reflected significantly lower net revenues in Fixed Income, Currency and Commodities Client Execution compared with a particularly strong first quarter of 2010. Client activity levels in Fixed Income, Currency and Commodities Client Execution improved during the first quarter of 2011, resulting in solid performances in credit products, interest rate products, currencies and mortgages, although net revenues in each were lower compared with the first quarter of 2010. Net revenues in commodities were also solid and were higher compared with the same prior year period.
 
Net revenues in Equities also declined compared with the first quarter of 2010, reflecting lower net revenues in equities client execution. The decline in equities client execution compared with the first quarter of 2010 reflected lower net revenues in derivatives and shares. This decrease was partially offset by higher commissions and fees, reflecting higher transaction volumes. Securities services net revenues were essentially unchanged compared with the first quarter of 2010. During the first quarter of 2011, Equities operated in an environment generally characterized by an increase in global equity prices and slightly lower average volatility levels.
 
Investing & Lending
Net revenues in Investing & Lending generally reflected an increase in global equity prices and favorable credit markets during the quarter. These results primarily included a gain of $316 million from our investment in the ordinary shares of ICBC, net gains of $1.05 billion from equity securities (excluding ICBC), and net gains and net interest of $1.02 billion from debt securities and loans. In the first quarter of 2010, net revenues in Investing & Lending primarily reflected net gains and net interest of $1.13 billion from debt securities and loans, net gains of $847 million from equity securities (excluding ICBC) and a loss of $222 million from our investment in the ordinary shares of ICBC.

Investment Management
The increase in Investment Management was primarily due to an increase in management and other fees, reflecting favorable changes in the mix of assets under management, as well as higher incentive fees. Assets under management were $840 billion as of March 2011, unchanged compared with the end of 2010, reflecting net market appreciation of $12 billion, offset by net outflows in money market and fixed income assets of $12 billion.
 
Investment Banking
The increase in Investment Banking reflected higher net revenues in our Underwriting business, partially offset by lower net revenues in Financial Advisory. The increase in Underwriting reflected strong net revenues in debt underwriting, which were significantly higher compared with the first quarter of 2010, as well as higher net revenues in equity underwriting. The increase in both debt and equity underwriting primarily reflected an increase in client activity.
 
Net Interest Income
Three Months Ended March 2011 versus March 2010.  Net revenues for the first quarter of 2011 included net interest income of $1.36 billion, 4% lower than the first quarter of 2010. The decrease compared with the first quarter of 2010 was primarily due to lower average yields on financial instruments owned, at fair value and higher interest expense related to our long-term borrowings.
 
Operating Expenses
Our operating expenses are primarily influenced by compensation, headcount and levels of business activity. Compensation and benefits includes salaries, estimated year-end discretionary compensation, amortization of equity awards and other items such as benefits. Discretionary compensation is significantly impacted by, among other factors, the level of net revenues, prevailing labor markets, business mix, the structure of our share-based compensation programs and the external environment.
 


105


Table of Contents

 

The table below presents our operating expenses and total staff.
 
                     
 
    Three Months
    Ended March
$ in millions   2011     2010      
 
Compensation and benefits
  $ 5,233     $ 5,493      
Brokerage, clearing, exchange and distribution fees
    620       562      
Market development
    179       110      
Communications and technology
    198       176      
Depreciation and amortization
    590       372      
Occupancy
    267       256      
Professional fees
    233       182      
Other expenses
    534       465      
 
 
Total non-compensation expenses
    2,621       2,123      
 
 
Total operating expenses
  $ 7,854     $ 7,616      
 
 
Total staff at period-end 1
    35,400       33,100      
Total staff at period-end including consolidated entities held for investment purposes 2
    38,300       38,500      
 
 
 
1.   Includes employees, consultants and temporary staff.
 
2.   Compensation and benefits and non-compensation expenses related to consolidated entities held for investment purposes are included in their respective line items in the condensed consolidated statements of earnings. Consolidated entities held for investment purposes are entities that are held strictly for capital appreciation, have a defined exit strategy and are engaged in activities that are not closely related to our principal businesses.
 
 
Three Months Ended March 2011 versus March 2010.  Operating expenses were $7.85 billion for the first quarter of 2011, 3% higher than the first quarter of 2010. The accrual for compensation and benefits expenses was $5.23 billion for the first quarter of 2011, a 5% decline compared with the first quarter of 2010. The ratio of compensation and benefits to net revenues for the first

quarter of 2011 was 44.0%, compared with 43.0% for the first quarter of 2010. Total staff and total staff including consolidated entities held for investment purposes decreased slightly during the first quarter of 2011.
 
Non-compensation expenses were $2.62 billion, 23% higher than the first quarter of 2010. The increase compared with the first quarter of 2010 reflected the impact of impairment charges of approximately $220 million related to assets classified as held for sale during the first quarter of 2011, primarily related to Litton Loan Servicing LP, our residential mortgage servicing subsidiary. The remainder of the increase compared with the first quarter of 2010 generally reflected increased levels of business activity, including higher operating expenses related to our consolidated entities held for investment purposes. The first quarter of 2011 included net provisions for litigation and regulatory proceedings of $24 million.
 
Provision for Taxes
The effective income tax rate for the first quarter of 2011 was 32.3%, compared with 32.7%1 for 2010, which excluded the impact of the $465 million U.K. bank payroll tax and the $550 million SEC settlement, substantially all of which was non-deductible. Including the impact of these items, the effective income tax rate was 35.2% for 2010.
 
In December 2010, the rules related to the deferral of U.S. tax on certain non-repatriated active financing income were extended retroactively to January 1, 2010 through December 31, 2011. If these rules are not extended beyond December 31, 2011, the expiration may materially increase our effective income tax rate beginning in 2012.
 


 
 
1.   We believe that presenting our effective income tax rate for 2010 excluding the impact of the U.K. bank payroll tax and the SEC settlement, substantially all of which was non-deductible, is meaningful as excluding these items increases the comparability of period-to-period results. The table below presents the calculation of the effective income tax rate excluding the impact of these amounts.
 
                             
 
    Year Ended December 2010 
    Pre-tax
    Provision
    Effective income
     
$ in millions   earnings     for taxes     tax rate      
 
As reported
  $ 12,892     $ 4,538       35.2 %    
Add back:
                           
Impact of the U.K. bank payroll tax
    465                    
Impact of the SEC settlement
    550       6              
 
 
As adjusted
  $ 13,907     $ 4,544       32.7 %    
 
 
 

106


Table of Contents

Segment Operating Results
The table below presents the net revenues, operating expenses and pre-tax earnings of our segments.
 
                         
 
        Three Months
        Ended March
in millions       2011     2010      
 
Investment Banking
  Net revenues   $ 1,269     $ 1,203      
    Operating expenses     923       880      
 
 
    Pre-tax earnings   $ 346     $ 323      
 
 
                         
Institutional Client Services
  Net revenues   $ 6,647     $ 8,507      
    Operating expenses     4,584       4,831      
 
 
    Pre-tax earnings   $ 2,063     $ 3,676      
 
 
                         
Investing & Lending
  Net revenues   $ 2,705     $ 1,970      
    Operating expenses     1,231       908      
 
 
    Pre-tax earnings   $ 1,474     $ 1,062      
 
 
                         
Investment Management
  Net revenues   $ 1,273     $ 1,095      
    Operating expenses     1,067       949      
 
 
    Pre-tax earnings   $ 206     $ 146      
 
 
                         
Total
  Net revenues   $ 11,894     $ 12,775      
    Operating expenses 1     7,854       7,616      
 
 
    Pre-tax earnings   $ 4,040     $ 5,159      
 
 
 
1.   Includes the following expenses that have not been allocated to our segments: (i) charitable contributions of $25 million for both the three months ended March 2011 and March 2010; (ii) net provisions for a number of litigation and regulatory proceedings of $24 million and $21 million for the three months ended March 2011 and March 2010, respectively; and (iii) real estate-related exit costs of $2 million for the three months ended March 2010.
 

Net revenues in our segments include allocations of interest income and interest expense to specific securities, commodities and other positions in relation to the cash generated by, or funding requirements of, such underlying positions. See Note 25 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our business segments.

The cost drivers of Goldman Sachs taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of our business segments. Compensation and benefits expenses within our segments reflect, among other factors, the overall performance of Goldman Sachs as well as the performance of individual businesses. Consequently, pre-tax margins in one segment of our business may be significantly affected by the performance of our other business segments. A discussion of segment operating results follows.
 


107


Table of Contents

 

Investment Banking
Our Investment Banking segment is comprised of:
 
Financial Advisory.  Includes advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, risk management, restructurings and spin-offs.
 
Underwriting.  Includes public offerings and private placements of a wide range of securities, loans and other financial instruments, and derivative transactions directly related to these client underwriting activities.
 
The table below presents the operating results of our Investment Banking segment.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Financial Advisory
  $ 357     $ 464      
Equity underwriting
    426       372      
Debt underwriting
    486       367      
 
 
Total Underwriting
    912       739      
 
 
Total net revenues
    1,269       1,203      
Operating expenses
    923       880      
 
 
Pre-tax earnings
  $ 346     $ 323      
 
 
 
The table below presents our financial advisory and underwriting transaction volumes.1
 
                     
 
    Three Months
    Ended March
in billions   2011     2010      
 
Announced mergers and acquisitions
  $ 163     $ 125      
Completed mergers and acquisitions
    167       97      
Equity and equity-related offerings 2
    26       14      
Debt offerings 3
    70       63      
 
 
 
1.   Source: Thomson Reuters. Announced and completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related offerings and debt offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or a change in the value of a transaction.
 
2.   Includes Rule 144A and public common stock offerings, convertible offerings and rights offerings.
 
3.   Includes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and taxable municipal debt. Includes publicly registered and Rule 144A issues. Excludes leveraged loans.

Three Months Ended March 2011 versus March 2010.  Net revenues in Investment Banking were $1.27 billion, 5% higher than the first quarter of 2010.
 
Net revenues in Financial Advisory were $357 million, 23% lower than the first quarter of 2010. Net revenues in our Underwriting business were $912 million, 23% higher than the first quarter of 2010, due to strong net revenues in debt underwriting, which were significantly higher compared with the first quarter of 2010, as well as higher net revenues in equity underwriting. The increase in both debt and equity underwriting primarily reflected an increase in client activity.
 
Our investment banking transaction backlog increased compared with the end of 2010. Our investment banking transaction 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. The increase compared with the end of 2010 was primarily due to potential debt and equity underwriting transactions, primarily reflecting a significant increase in client mandates to underwrite leveraged finance transactions and an increase in client mandates to underwrite initial public offerings. Estimated net revenues from potential advisory transactions increased slightly compared with the end of 2010.
 
Operating expenses were $923 million for the first quarter of 2011, 5% higher than the first quarter of 2010, due to increased compensation and benefits expenses. Pre-tax earnings were $346 million in the first quarter of 2011, 7% higher than the first quarter of 2010.
 
 
Institutional Client Services
Our Institutional Client Services segment is comprised of:
 
Fixed Income, Currency and Commodities Client Execution.  Includes client execution activities related to making markets in interest rate products, credit products, mortgages, currencies and commodities.
 
Equities.  Includes client execution activities related to making markets in equity products, as well as commissions and fees from executing and clearing institutional client transactions on major stock, options and futures exchanges worldwide. Equities also includes our securities services business, which provides financing, securities lending and other prime brokerage services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and generates revenues primarily in the form of interest rate spreads or fees.


108


Table of Contents

The table below presents the operating results of our Institutional Client Services segment.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Fixed Income, Currency and Commodities Client Execution
  $ 4,325     $ 6,017      
Equities client execution
    979       1,287      
Commissions and fees
    971       844      
Securities services
    372       359      
 
 
Total Equities
    2,322       2,490      
 
 
Total net revenues
    6,647       8,507      
Operating expenses
    4,584       4,831      
 
 
Pre-tax earnings
  $ 2,063     $ 3,676      
 
 
 
Three Months Ended March 2011 versus March 2010.  Net revenues in Institutional Client Services were $6.65 billion, 22% lower than a strong first quarter of 2010.
 
Net revenues in Fixed Income, Currency and Commodities Client Execution were $4.33 billion, 28% lower than a particularly strong first quarter of 2010. Client activity levels improved during the first quarter of 2011, resulting in solid performances in credit products, interest rate products, currencies and mortgages, although net revenues in each were lower compared with the first quarter of 2010. Net revenues in commodities were also solid and were higher compared with the same prior year period.
 
The improvement in client activity levels reflected higher origination activity in credit markets, improved volumes in mortgages, largely in non-agency products, and generally higher activity levels in interest rate products, currencies and commodities, as continued uncertainty in the macroeconomic outlook impacted the business needs of our clients. The continued uncertainty reflected certain trends that emerged during the second quarter of 2010, including concerns about European sovereign debt risk and uncertainty over financial regulatory reform. Additional concerns during the first quarter of 2011 included political unrest in the Middle East, the earthquake and tsunami in Japan and inflation in emerging markets. If these concerns were to continue over the long term, net revenues in Fixed Income, Currency and Commodities Client Execution and Equities would likely be negatively impacted.

Net revenues in Equities were $2.32 billion, 7% lower than the first quarter of 2010, reflecting lower net revenues in equities client execution. The decline in equities client execution compared with the first quarter of 2010 reflected lower net revenues in derivatives and shares. This decrease was partially offset by higher commissions and fees, reflecting higher transaction volumes. Securities services net revenues were essentially unchanged compared with the first quarter of 2010. During the first quarter of 2011, Equities operated in an environment generally characterized by an increase in global equity prices and slightly lower average volatility levels.
 
Operating expenses were $4.58 billion for the first quarter of 2011, 5% lower than the first quarter of 2010, due to decreased compensation and benefits expenses. This decrease was partially offset by the impact of impairment charges related to assets classified as held for sale during the first quarter of 2011 for Litton Loan Servicing LP and expenses related to increased levels of business activity. Pre-tax earnings were $2.06 billion in the first quarter of 2011, 44% lower than the first quarter of 2010.
 
Investing & Lending
Investing & Lending includes our investing activities and the origination of loans to provide financing to clients. These investments and loans are typically longer-term in nature. We make investments, directly and indirectly through funds that we manage, in debt securities, loans, public and private equity securities, real estate, consolidated investment entities and power generation facilities.
 
The table below presents the operating results of our Investing & Lending segment.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
ICBC
  $ 316     $ (222 )    
Equity securities (excluding ICBC)
    1,054       847      
Debt securities and loans
    1,024       1,130      
Other 1
    311       215      
 
 
Total net revenues
    2,705       1,970      
Operating expenses
    1,231       908      
 
 
Pre-tax earnings
  $ 1,474     $ 1,062      
 
 
 
1.   Primarily includes net revenues related to our consolidated entities held for investment purposes.


109


Table of Contents

Three Months Ended March 2011 versus March 2010.  Net revenues in Investing & Lending were $2.71 billion for the first quarter of 2011. These results generally reflected an increase in global equity prices and favorable credit markets during the quarter. Results for the first quarter of 2011 primarily included a gain of $316 million from our investment in the ordinary shares of ICBC, net gains of $1.05 billion from equity securities (excluding ICBC), and net gains and net interest of $1.02 billion from debt securities and loans. In the first quarter of 2010, net revenues in Investing & Lending primarily reflected net gains and net interest of $1.13 billion from debt securities and loans, net gains of $847 million from equity securities (excluding ICBC) and a loss of $222 million from our investment in the ordinary shares of ICBC.
 
Operating expenses were $1.23 billion for the first quarter of 2011, 36% higher than the first quarter of 2010, due to higher expenses related to our consolidated entities held for investment purposes, as well as increased compensation and benefits expenses. Pre-tax earnings were $1.47 billion in the first quarter of 2011, 39% higher than the first quarter of 2010.
 
Investment Management
Investment Management provides investment management services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse set of institutional and individual clients. Investment Management also offers wealth advisory services, including portfolio management and financial counseling, and brokerage and other transaction services to high-net-worth individuals and families.
 
Assets under management typically generate fees as a percentage of net asset value, which vary by asset class and are affected by investment performance as well as asset inflows and redemptions. In certain circumstances, we are also entitled to receive incentive fees based on a percentage of a fund’s return or when the return exceeds a specified benchmark or other performance targets. Incentive fees are recognized when all material contingencies are resolved.

The table below presents the operating results of our Investment Management segment.
 
                     
 
    Three Months
    Ended March
in millions   2011     2010      
 
Management and other fees
  $ 1,048     $ 932      
Incentive fees
    74       26      
Transaction revenues
    151       137      
 
 
Total net revenues
    1,273       1,095      
Operating expenses
    1,067       949      
 
 
Pre-tax earnings
  $ 206     $ 146      
 
 
 
Assets under management include only client assets where we earn a fee for managing assets on a discretionary basis. This includes assets in our mutual funds, hedge funds, private equity funds and separately managed accounts for institutional and individual investors. Assets under management do not include the self-directed assets of our clients, including brokerage accounts, or interest-bearing deposits held through our bank depository institution subsidiaries.
 
The tables below present our assets under management by asset class and a summary of the changes in our assets under management.
 
                                     
 
    As of 
    March 31,     December 31,      
in billions   2011     2010     2010     2009      
 
Alternative investments 1
  $ 151     $ 147     $ 148     $ 146      
Equity
    150       150       144       146      
Fixed income
    338       324       340       315      
 
 
Total non-money market assets
    639       621       632       607      
Money markets
    201       219       208       264      
 
 
Total assets under management
  $ 840     $ 840     $ 840     $ 871      
 
 
 
1.   Primarily includes hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies.
 
                     
 
    Three Months
    Ended March 31,
in billions   2011     2010      
 
Balance, beginning of period
  $ 840     $ 871      
Net inflows/(outflows)
                   
Alternative investments
          1      
Equity
          (2 )    
Fixed income
    (5 )     7      
 
 
Total non-money market net inflows/(outflows)
    (5 )     6      
Money markets
    (7 )     (45 )    
 
 
Total net inflows/(outflows)
    (12 )     (39 )    
Net market appreciation/(depreciation)
    12       8      
 
 
Balance, end of period
  $ 840     $ 840      
 
 


110


Table of Contents

Three Months Ended March 2011 versus March 2010.  Net revenues in Investment Management were $1.27 billion, 16% higher than the first quarter of 2010. The increase in net revenues compared with the first quarter of 2010 was primarily due to an increase in management and other fees, reflecting favorable changes in the mix of assets under management, as well as higher incentive fees. Assets under management were $840 billion as of March 2011, unchanged compared with the end of 2010, reflecting net market appreciation of $12 billion, offset by net outflows in money market and fixed income assets of $12 billion.
 
Operating expenses were $1.07 billion for the first quarter of 2011, 12% higher than the first quarter of 2010, due to increased compensation and benefits expenses. Pre-tax earnings were $206 million in the first quarter of 2011, 41% higher than the first quarter of 2010.
 
Geographic Data
See Note 25 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for a summary of our total net revenues and pre-tax earnings by geographic region.

Regulatory Reform
The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), enacted in July 2010, significantly restructures the financial regulatory regime under which we operate. The implications of the Dodd-Frank Act for our businesses will depend to a large extent on the provisions of required future rulemaking by the Board of Governors of the Federal Reserve System (Federal Reserve Board), the Federal Deposit Insurance Corporation (FDIC), the SEC, the U.S. Commodity Futures Trading Commission (CFTC) and other agencies, as well as the development of market practices and structures under the regime established by the legislation and the rules adopted pursuant to it. However, we expect that there will be two principal areas of impact for us:
 
•   the prohibition on “proprietary trading” and the limitation on the sponsorship of, and investment in, hedge funds and private equity funds by banking entities, including bank holding companies; and
 
•   increased regulation of and restrictions on over-the-counter (OTC) derivatives markets and transactions.
 
In addition, the legislation creates a new systemic risk oversight body to oversee and coordinate the efforts of the primary U.S. financial regulatory agencies in establishing regulations to address financial stability concerns, including more stringent supervisory requirements and prudential standards applicable to systemically important financial institutions. Legal and regulatory changes under consideration in other jurisdictions could also have an impact on our activities in markets outside the United States. See “Business — Regulation” in Part I, Item 1 of our Annual Report on Form 10-K for more information.
 
The full impact of the Dodd-Frank Act and other regulatory reforms on our businesses, our clients and the markets in which we operate will depend on the manner in which the relevant authorities develop and implement the required rules and the reaction of market participants to these regulatory developments over the next several years. We will continue to assess our business, risk management, and compliance practices to conform to developments in the regulatory environment.


111


Table of Contents

 
Balance Sheet and Funding Sources
 
Balance Sheet Management

One of our most important risk management disciplines is our ability to manage the size and composition of our balance sheet. While our asset base changes due to client activity, market fluctuations and business opportunities, the size and composition of our balance sheet reflect (i) our overall risk tolerance, (ii) our ability to access stable funding sources and (iii) the amount of equity capital we hold.
 
Although our balance sheet fluctuates on a day-to-day basis, our total assets and adjusted assets at quarterly and year-end dates are generally not materially different from those occurring within our reporting periods.
 
In order to ensure appropriate risk management, we seek to maintain a liquid balance sheet and have processes in place to dynamically manage our assets and liabilities which include:
 
•   quarterly planning;
 
•   business-specific limits;
 
•   monitoring of key metrics; and
 
•   scenario analyses.
 
Quarterly Planning.  We prepare a quarterly balance sheet plan that combines our projected total assets and composition of assets with our expected funding sources and capital levels for the upcoming quarter. The objectives of this quarterly planning process are:
 
•   to develop our near-term balance sheet projections, taking into account the general state of the financial markets and expected client-driven and firm-driven activity levels;
 
•   to ensure that our projected assets are supported by an adequate level and tenor of funding and that our projected capital and liquidity metrics are within management guidelines; and
 
•   to allow business risk managers and managers from our independent control and support functions to objectively evaluate balance sheet limit requests from business managers in the context of the firm’s overall balance sheet constraints. These constraints include the firm’s liability profile and equity capital levels, maturities and plans for new debt and equity issuances, share repurchases, deposit trends and secured funding transactions.

To prepare our quarterly balance sheet plan, business risk managers and managers from our independent control and support functions meet with business managers to review current and prior period metrics and discuss expectations for the upcoming quarter. The specific metrics reviewed include asset and liability size and composition, aged inventory, limit utilization, risk and performance measures, and capital usage.
 
Our consolidated quarterly plan, including our balance sheet plans by business, funding and capital projections, and projected capital and liquidity metrics, is reviewed by the Finance Committee. See “Overview and Structure of Risk Management.”
 
Business-Specific Limits.  The Finance Committee sets asset and liability limits for each business and aged inventory limits for certain financial instruments as a disincentive to hold inventory over longer periods of time. These limits are set at levels which are close to actual operating levels in order to ensure prompt escalation and discussion among business managers and managers in our independent control and support functions on a routine basis. The Finance Committee reviews and approves balance sheet limits on a quarterly basis and may also approve changes in limits on an ad hoc basis in response to changing business needs or market conditions.
 
Monitoring of Key Metrics.  We monitor key balance sheet metrics daily both by business and on a consolidated basis, including asset and liability size and composition, aged inventory, limit utilization, risk measures and capital usage. In our consolidated balance sheet, we allocate assets to businesses and review and analyze movements resulting from new business activity as well as market fluctuations.
 


112


Table of Contents

 

Scenario Analyses.  We conduct scenario analyses to determine how we would manage the size and composition of our balance sheet and maintain appropriate funding, liquidity and capital positions in a variety of situations:
 
•   These scenarios cover short-term and long-term time horizons using various macro-economic and firm-specific assumptions. We use these analyses to assist us in developing longer-term funding plans, including the level of unsecured debt issuances, the size of our secured funding program and the amount and composition of our equity capital. We also consider any potential future constraints, such as limits on our ability to grow our asset base in the absence of appropriate funding.
 
•   Through our Internal Capital Adequacy Assessment Process (ICAAP) and our resolution and recovery planning, we further analyze how we would manage our balance sheet through the duration of a severe crisis and we develop plans for mitigating actions to access funding, generate liquidity, and/or redeploy equity capital, as appropriate.
 
Balance Sheet Allocation
In addition to preparing our condensed consolidated statement of financial condition in accordance with U.S. GAAP, we prepare a balance sheet that generally allocates assets to our businesses. We believe that presenting our assets on this basis is meaningful because it is consistent with the way management views and manages risks associated with the firm’s assets and better enables investors to assess the liquidity of the firm’s assets. The table below presents a summary of this balance sheet allocation.
 
                     
 
    As of
    March
    December
     
in millions   2011     2010      
 
Excess liquidity (Global Core Excess)
  $ 170,686     $ 174,776      
Other cash
    7,359       7,565      
 
 
Excess liquidity and cash
    178,045       182,341      
Secured client financing
    272,710       279,291      
Inventory
    276,595       260,406      
Secured financing agreements
    81,667       70,921      
Receivables
    36,474       32,396      
 
 
Institutional Client Services
    394,736       363,723      
ICBC
    8,456       7,589      
Equity (excluding ICBC)
    25,488       22,972      
Debt
    21,755       24,066      
Receivables and other
    3,741       3,291      
 
 
Investing & Lending
    59,440       57,918      
 
 
Total inventory and related assets
    454,176       421,641      
Other assets
    28,358       28,059      
 
 
Total assets
  $ 933,289     $ 911,332      
 
 

The following is a description of the captions in the table above.
 
Excess Liquidity and Cash.  We maintain substantial excess liquidity to meet a broad range of potential cash outflows and collateral needs in the event of a stressed environment. See “Liquidity Risk Management” below for details on the composition and sizing of our excess liquidity pool or “Global Core Excess” (GCE). In addition to our excess liquidity, we maintain other operating cash balances, primarily for use in specific currencies, entities, or jurisdictions where we do not have immediate access to parent company liquidity.
 
Secured Client Financing.  We provide collateralized financing for client positions, including margin loans secured by client collateral, securities borrowed, and resale agreements primarily collateralized by government obligations. As a result of client activities, we are required to segregate cash and securities to satisfy regulatory requirements. Our secured client financing arrangements, which are generally short-term, are accounted for at fair value or at amounts that approximate fair value, and include daily margin requirements to mitigate counterparty credit risk.
 
Institutional Client Services.  In Institutional Client Services, we maintain inventory positions to facilitate market-making in fixed income, equity, currency and commodity products. Additionally, as part of client market-making activities, we enter into resale or securities borrowing arrangements to obtain securities which we can use to cover transactions in which we or our clients have sold securities that have not yet been purchased. The receivables in Institutional Client Services primarily relate to securities transactions.
 
Investing & Lending.  In Investing & Lending, we make investments and originate loans to provide financing to clients. These investments and loans are typically longer-term in nature. We make investments, directly and indirectly through funds that we manage, in debt securities, loans, public and private equity securities, real estate and other investments.
 
Other Assets.  Other assets are generally less liquid, non-financial assets, including property, leasehold improvements and equipment, goodwill and identifiable intangible assets, income tax-related receivables, equity-method investments and miscellaneous receivables.
 


113


Table of Contents

 

The tables below present the reconciliation of this balance sheet allocation to our U.S. GAAP balance sheet. In the tables below, total assets for Institutional Client Services and Investing & Lending represent the inventory and related assets. These amounts differ from total assets by business segment disclosed in Note 25

to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q because total assets disclosed in Note 25 include allocations of our excess liquidity and cash, secured client financing and other assets.


                                                     
 
    As of March 2011
    Excess
    Secured
    Institutional
                       
    Liquidity
    Client
    Client
    Investing &
    Other
    Total
     
in millions   and Cash 1     Financing     Services     Lending     Assets     Assets      
 
Cash and cash equivalents
  $ 42,683     $     $     $     $     $ 42,683      
Cash and securities segregated for regulatory and other purposes
          53,512                         53,512      
Securities purchased under agreements to resell and federal funds sold
    51,948       85,703       24,285       158             162,094      
Securities borrowed
    41,266       85,569       57,382                   184,217      
Receivables from brokers, dealers and clearing organizations
          3,385       8,804       18             12,207      
Receivables from customers and counterparties
          44,541       27,670       3,201             75,412      
Financial instruments owned, at fair value
    42,148             276,595       56,063             374,806      
Other assets
                            28,358       28,358      
 
 
Total assets
  $ 178,045     $ 272,710     $ 394,736     $ 59,440     $ 28,358     $ 933,289      
 
 
 
                                                     
 
    As of December 2010
    Excess
    Secured
    Institutional
                       
    Liquidity
    Client
    Client
    Investing &
    Other
    Total
     
in millions   and Cash 1     Financing     Services     Lending     Assets     Assets      
 
Cash and cash equivalents
  $ 39,788     $     $     $     $     $ 39,788      
Cash and securities segregated for regulatory and other purposes
          53,731                         53,731      
Securities purchased under agreements to resell and federal funds sold
    62,854       102,537       22,866       98             188,355      
Securities borrowed
    37,938       80,313       48,055                   166,306      
Receivables from brokers, dealers and clearing organizations
          3,702       6,698       37             10,437      
Receivables from customers and counterparties
          39,008       25,698       2,997             67,703      
Financial instruments owned, at fair value
    41,761             260,406       54,786             356,953      
Other assets
                            28,059       28,059      
 
 
Total assets
  $ 182,341     $ 279,291     $ 363,723     $ 57,918     $ 28,059     $ 911,332      
 
 
 
1.   Includes unencumbered cash, U.S. government and federal agency obligations, (including highly liquid U.S. federal agency mortgage-backed obligations) and French, German, United Kingdom and Japanese government obligations.
 

114


Table of Contents

 

Less Liquid Inventory Composition.  We seek to maintain a liquid balance sheet comprised of assets that can be readily sold or funded on a secured basis. However, we do hold certain financial instruments that may be more difficult to sell, or fund on a secured basis, especially during times of market stress. We focus on funding these assets with liabilities that have longer-term contractual maturities to reduce the need to refinance in periods of market stress, and generally hold higher levels of total capital for these assets than for more liquid types of financial instruments. The table below presents our aggregate holdings in these categories of financial instruments.
 
                     
 
    As of      
    March
    December
     
in millions   2011     2010      
 
Mortgage and other asset-backed loans and securities
  $ 15,652     $ 17,042      
Bank loans and bridge loans 1
    18,063       18,039      
Emerging market debt securities
    4,293       3,931      
High-yield and other debt obligations
    13,618       11,553      
Private equity investments and real estate fund investments 2
    15,575       14,807      
Emerging market equity securities
    5,933       5,784      
ICBC ordinary shares 3
    8,456       7,589      
Other restricted public equity securities
    121       116      
Other investments in funds 4
    3,340       3,212      
 
 
 
1.   Includes funded commitments and inventory held in connection with our origination, investing and market-making activities.
 
2.   Includes interests in funds that we manage. Such amounts exclude assets for which the firm does not bear economic exposure of $2.53 billion and $1.68 billion as of March 2011 and December 2010, respectively, including assets related to consolidated investment funds and consolidated VIEs.
 
3.   Includes interests of $5.26 billion and $4.73 billion as of March 2011 and December 2010, respectively, held by investment funds managed by Goldman Sachs.
 
4.   Includes interests in other investment funds that we manage.
 
See Notes 4 through 6 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about the financial instruments we hold.

Balance Sheet Analysis and Metrics
As of March 2011, total assets on our condensed consolidated statement of financial condition were $933.29 billion, an increase of $21.96 billion from December 2010. This increase is primarily due to an increase in financial instruments owned, at fair value of $17.85 billion, primarily due to increases in U.S. and non-U.S. government and federal agency obligations, and equities and convertible debentures, partially offset by a decrease in physical commodities, within Institutional Client Services.
 
As of March 2011, total liabilities on our condensed consolidated statement of financial condition were $860.82 billion, an increase of $26.84 billion from December 2010. This increase is primarily due to (i) an increase in financial instruments sold, but not yet purchased, at fair value of $10.28 billion, primarily due to increases in U.S. government and federal agency obligations and equities and convertible debentures, (ii) an increase in unsecured borrowings of $5.30 billion, primarily due to new issuances, partially offset by maturities, and (iii) an increase in other liabilities and accrued expenses of $5.54 billion, primarily due to the accrual of the redemption price of our Series G Preferred Stock.
 
As of March 2011 and December 2010, our total securities sold under agreements to repurchase, accounted for as collateralized financings, were $165.48 billion and $162.35 billion, respectively, which were 6% higher and 2% higher, respectively, than the daily average amount of repurchase agreements over the respective quarters. As of March 2011, the increase in our repurchase agreements relative to the daily average during the quarter was due to an increase in firm financing activities and an increase in client-driven activity at the end of the quarter. The level of our repurchase agreements fluctuates between and within periods, primarily due to providing clients with access to highly liquid collateral, such as U.S. government, federal agency and investment-grade sovereign obligations through collateralized financing activities.
 


115


Table of Contents

 

The table below presents information on our assets, shareholders’ equity and leverage ratios.
 
                     
 
    As of      
    March
    December
     
$ in millions   2011     2010      
 
Total assets
  $ 933,289     $ 911,332      
Adjusted assets
    633,073       588,927      
Total shareholders’ equity
    72,469       77,356      
Leverage ratio
    12.9x       11.8x      
Adjusted leverage ratio
    8.7x       7.6x      
Debt to equity ratio
    2.4x       2.3x      
 
 
 
Adjusted assets.  Adjusted assets equals total assets less (i) low-risk collateralized assets generally associated with our secured client financing transactions, federal funds sold and excess liquidity and (ii) cash and securities we segregate for regulatory and other purposes.
 
The table below presents the reconciliation of total assets to adjusted assets.
 
                         
 
    As of      
        March
    December
     
in millions   2011     2010      
 
Total assets
  $ 933,289     $ 911,332      
Deduct:
 
Securities borrowed
    (184,217 )     (166,306 )    
   
Securities purchased
under agreements
to resell and federal
funds sold
    (162,094 )     (188,355 )    
Add:
 
Financial instruments
sold, but not yet
purchased, at
fair value
    150,998       140,717      
   
Less derivative
liabilities
    (51,391 )     (54,730 )    
 
 
   
Subtotal
    99,607       85,987      
Deduct:
 
Cash and securities
segregated for
regulatory and other
purposes
    (53,512 )     (53,731 )    
 
 
Adjusted assets
  $ 633,073     $ 588,927      
 
 
 
Leverage ratio.  The leverage ratio equals total assets divided by total shareholders’ equity and measures the proportion of equity and debt the firm is using to finance assets. This ratio is different from the Tier 1 leverage ratio included in “Equity Capital — Consolidated Regulatory Capital Ratios” below, and further described in Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

Adjusted leverage ratio.  The adjusted leverage ratio equals adjusted assets divided by total shareholders’ equity. We believe that the adjusted leverage ratio is a more meaningful measure of our capital adequacy than the leverage ratio because it excludes certain low-risk collateralized assets that are generally supported with little or no capital.
 
Our adjusted leverage ratio increased to 8.7x as of March 2011 from 7.6x as of December 2010 as our adjusted assets increased and our total shareholders’ equity decreased, primarily reflecting the redemption of the firm’s Series G Preferred Stock.
 
Debt to equity ratio.  The debt to equity ratio equals unsecured long-term borrowings divided by total shareholders’ equity.
 
Funding Sources
Our primary sources of funding are secured financings, unsecured long-term and short-term borrowings, and deposits. We seek to maintain broad and diversified funding sources globally.
 
We raise funding through a number of different products, including:
 
•   collateralized financings, such as repurchase agreements, securities loaned and other secured financings;
 
•   long-term unsecured debt through syndicated U.S. registered offerings, U.S. registered and 144A medium-term note programs, offshore medium-term note offerings and other debt offerings;
 
•   short-term unsecured debt through U.S. and non-U.S. commercial paper and promissory note issuances and other methods; and
 
•   demand and savings deposits through cash sweep programs and time deposits through internal and third-party broker networks.
 
We generally distribute our funding sources through our own sales force to a large, diverse creditor base in a variety of markets in the Americas, Europe and Asia. We believe that our relationships with our creditors are critical to our liquidity. Our creditors include banks, governments, securities lenders, pension funds, insurance companies, mutual funds and individuals. We have imposed various internal guidelines to monitor creditor concentration across our funding programs.
 


116


Table of Contents

 

Secured Funding.  We fund a significant amount of our inventory on a secured basis. Secured funding is less sensitive to changes in our credit quality than unsecured funding due to the nature of the collateral we post to our lenders. However, because the terms or availability of secured funding, particularly short-dated funding, can deteriorate rapidly in a difficult environment, we generally do not rely on short-dated secured funding unless it is collateralized with highly liquid securities such as government obligations.
 
Substantially all of our other secured funding is executed for tenors of one month or greater. Additionally, we monitor counterparty concentration and hold a portion of our GCE for refinancing risk associated with our secured funding transactions. We seek longer terms for secured funding collateralized by lower-quality assets because these funding transactions may pose greater refinancing risk.

The weighted average maturity of our secured funding, excluding funding collateralized by highly liquid securities eligible for inclusion in our GCE, exceeded 100 days as of March 2011.
 
A majority of our secured funding for securities not eligible for inclusion in the GCE is executed through term repurchase agreements and securities lending contracts. We also raise financing through other types of collateralized financings, such as secured loans and notes.
 
Unsecured Long-Term Borrowings.  We issue unsecured long-term borrowings as a source of funding to meet our long-term financing requirements and to finance a portion of our GCE. We issue in different tenors, currencies, and products to maximize the diversification of our investor base. The table below presents our quarterly unsecured long-term borrowings maturity profile through the first quarter of 2017 as of March 2011.
 


 
 

117


Table of Contents

 

The weighted average maturity of our unsecured long-term borrowings as of March 2011 was approximately eight years. To mitigate refinancing risk, we seek to limit the principal amount of debt maturing on any one day or during any week or year. We enter into interest rate swaps to convert a substantial portion of our long-term borrowings into floating-rate obligations in order to minimize our exposure to interest rates. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unsecured long-term borrowings.
 
Temporary Liquidity Guarantee Program (TLGP).  As of March 2011, we had $17.10 billion of senior unsecured debt outstanding (comprised of $11.54 billion of short-term and $5.56 billion of long-term) guaranteed by the FDIC under the TLGP, all of which will mature on or prior to June 15, 2012. We have not issued long-term debt under the TLGP since March 2009 and the program has expired for new issuances.
 
Unsecured Short-Term Borrowings.  A significant portion of our short-term borrowings were originally long-term debt that is scheduled to mature within one year of the reporting date. We use short-term borrowings to finance liquid assets and for other cash management purposes. We primarily issue commercial paper, promissory notes, and other hybrid instruments. We prefer issuing promissory notes, in which we do not make a market, over commercial paper, which we may repurchase prior to maturity through the ordinary course of business as a market maker.
 
As of March 2011, our unsecured short-term borrowings, including the current portion of unsecured long-term borrowings, were $53.75 billion. See Note 15 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unsecured short-term borrowings.
 
Deposits.  As of March 2011, our bank depository institution subsidiaries had $38.73 billion in customer deposits, including $8.04 billion of certificates of deposit and other time deposits with a weighted average maturity of three years, and $30.69 billion of other deposits, substantially all of which were from cash sweep programs. We utilize deposits to finance lending activities in our bank subsidiaries and to support potential outflows, such as lending commitments.

Goldman Sachs Bank USA (GS Bank USA) has access to funding through the Federal Reserve Bank discount window. While we do not rely on this funding in our liquidity planning and stress testing, we maintain policies and procedures necessary to access this funding and test discount window borrowing procedures.
 
Equity Capital
 
The level and composition of our equity capital are determined by multiple factors including our consolidated regulatory capital requirements and ICAAP, and may also be influenced by other factors such as rating agency guidelines, subsidiary capital requirements, the business environment, conditions in the financial markets and assessments of potential future losses due to adverse changes in our business and market environments. In addition, we maintain a contingency capital plan which provides a framework for analyzing and responding to an actual or perceived capital shortfall.
 
Our consolidated regulatory capital requirements are determined by the Federal Reserve Board, as described below. Our ICAAP incorporates an internal risk-based capital assessment designed to identify and measure material risks associated with our business activities, including market risk, credit risk and operational risk, in a manner that is closely aligned with our risk management practices. Our internal risk-based capital assessment is supplemented with the results of stress tests.
 
As of March 2011, our total shareholders’ equity was $72.47 billion (consisting of common shareholders’ equity of $69.37 billion and preferred stock of $3.10 billion). As of December 2010, our total shareholders’ equity was $77.36 billion (consisting of common shareholders’ equity of $70.40 billion and preferred stock of $6.96 billion). In addition, our $5.00 billion of junior subordinated debt issued to trusts qualifies as equity capital for regulatory and certain rating agency purposes. See “— Consolidated Regulatory Capital Ratios” below for information regarding the impact of regulatory developments.
 


118


Table of Contents

 

Consolidated Regulatory Capital
The Federal Reserve Board is the primary regulator of Group Inc., a bank holding company and a financial holding company under the U.S. Bank Holding Company Act of 1956. As a bank holding company, we are subject to consolidated regulatory capital requirements that are computed in accordance with the Federal Reserve Board’s capital adequacy regulations currently applicable to bank holding companies (Basel 1). These capital requirements, which are based on the Capital Accord of the Basel Committee on Banking Supervision (Basel Committee), are expressed as capital ratios that compare measures of capital to risk-weighted assets (RWAs). See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information regarding the firm’s RWAs. The firm’s capital levels are also subject to qualitative judgments by its regulators about components, risk weightings and other factors.
 
Federal Reserve Board regulations require bank holding companies to maintain a minimum Tier 1 capital ratio of 4% and a minimum total capital ratio of 8%. The required minimum Tier 1 capital ratio and total capital ratio in order to be considered a “well-capitalized” bank holding company under the Federal Reserve Board guidelines are 6% and 10%, respectively. Bank holding companies may be expected to maintain ratios well above the minimum levels, depending on their particular condition, risk profile and growth plans. The minimum Tier 1 leverage ratio is 3% for bank holding companies that have received the highest supervisory rating under Federal Reserve Board guidelines or that have implemented the Federal Reserve Board’s risk-based capital measure for market risk. Other bank holding companies must have a minimum Tier 1 leverage ratio of 4%.

Consolidated Regulatory Capital Ratios
The table below presents information about our regulatory capital ratios.
 
                     
 
    As of      
    March
    December
     
$ in millions   2011     2010      
 
Common shareholders’ equity
  $ 69,369     $ 70,399      
Less: Goodwill
    (3,322 )     (3,495 )    
Less: Disallowable intangible assets
    (1,916 )     (2,027 )    
Less: Other deductions 1
    (5,844 )     (5,601 )    
 
 
Tier 1 Common Capital
    58,287       59,276      
Preferred stock
    3,100       6,957      
Junior subordinated debt issued to trusts
    5,000       5,000      
 
 
Tier 1 Capital
    66,387       71,233      
Qualifying subordinated debt 2
    14,019       13,880      
Less: Other deductions 1
    (237 )     (220 )    
 
 
Tier 2 Capital
    13,782       13,660      
Total Capital
  $ 80,169     $ 84,893      
Risk-Weighted Assets 3
  $ 455,811     $ 444,290      
Tier 1 Capital Ratio
    14.6%       16.0%      
Total Capital Ratio
    17.6%       19.1%      
Tier 1 Leverage Ratio 3
    7.5%       8.0%      
Tier 1 Common Ratio 4
    12.8%       13.3%      
 
 
 
1.   Principally includes equity investments in non-financial companies and the cumulative change in the fair value of our unsecured borrowings attributable to the impact of changes in our own credit spreads, disallowed deferred tax assets, and investments in certain nonconsolidated entities.
 
2.   Substantially all of our subordinated debt qualifies as Tier 2 capital for Basel 1 purposes.
 
3.   See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about the firm’s RWAs and Tier 1 leverage ratio.
 
4.   The Tier 1 common ratio equals Tier 1 common capital divided by RWAs. We believe that the Tier 1 common ratio is meaningful because it is one of the measures that we and investors use to assess capital adequacy.
 
Our Tier 1 capital ratio decreased to 14.6% as of March 2011 from 16.0% as of December 2010. Our Tier 1 leverage ratio decreased to 7.5% as of March 2011 from 8.0% as of December 2010. Substantially all of the decrease in our Tier 1 capital ratio and Tier 1 leverage ratio reflected the impact of the redemption of the firm’s Series G Preferred Stock.


119


Table of Contents

We are currently working to implement the requirements set out in the Federal Reserve Board’s Capital Adequacy Guidelines for Bank Holding Companies: Internal Ratings-Based and Advanced Measurement Approaches, which are based on the advanced approaches under the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee as applicable to us as a bank holding company (Basel 2). U.S. banking regulators have incorporated the Basel 2 framework into the existing risk-based capital requirements by requiring that internationally active banking organizations, such as us, transition to Basel 2 following the successful completion of a parallel run.
 
In addition, the Basel Committee has undertaken a program of substantial revisions to its capital guidelines. In particular, the changes in the “Basel 2.5” guidelines will result in increased capital requirements for market risk; additionally, the Basel 3 guidelines issued by the Basel Committee in December 2010 revise the definition of Tier 1 capital, introduce Tier 1 common equity as a regulatory metric, set new minimum capital ratios (including a new “capital conservation buffer,” which must be composed exclusively of Tier 1 common equity and will be in addition to the other capital ratios), introduce a Tier 1 leverage ratio within international guidelines for the first time, and make substantial revisions to the computation of RWAs for credit exposures. Implementation of the new requirements is expected to take place over an extended transition period, starting at the end of 2011 (for Basel 2.5) and end of 2012 (for Basel 3). Although the U.S. federal banking agencies have now issued proposed rules that are intended to implement certain aspects of the Basel 2.5 guidelines, they have not yet addressed all aspects of those guidelines or the Basel 3 changes. In addition, both the Basel Committee and U.S. banking regulators implementing the Dodd-Frank Act have indicated that they will impose more stringent capital standards on systemically important financial institutions. Although the criteria for treatment as a systemically important financial institution have not yet been determined, it is probable that they will apply to us. Therefore, the regulations ultimately applicable to us may be substantially different from those that have been published to date.

The Dodd-Frank Act will subject us at a firmwide level to the same leverage and risk-based capital requirements that apply to depository institutions and directs banking regulators to impose additional capital requirements as disclosed above. The Federal Reserve Board will be required to begin implementing the new leverage and risk-based capital regulation by January 2012. As a consequence of these changes, Tier 1 capital treatment for our junior subordinated debt issued to trusts will be phased out over a three-year period beginning on January 1, 2013. The interaction between the Dodd-Frank Act and the Basel Committee’s proposed changes adds further uncertainty to our future capital requirements.
 
A number of other governmental entities and regulators, including the U.S. Treasury, the European Union and the Financial Services Authority in the United Kingdom, have also proposed or announced changes which will result in increased capital requirements for financial institutions.
 
As a consequence of these developments, we expect minimum capital ratios required to be maintained under Federal Reserve Board regulations will be increased and changes in the prescribed calculation methodology are expected to result in higher RWAs and lower capital ratios than those currently computed.
 
See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information about our regulatory capital ratios and the related regulatory requirements.
 
Internal Capital Adequacy Assessment Process
We perform an ICAAP with the objective of ensuring that the firm is appropriately capitalized relative to the risks in our business.
 
As part of our ICAAP, we perform an internal risk-based capital assessment. This assessment incorporates market risk, credit risk and operational risk. Market risk is calculated by using Value-at-Risk (VaR) calculations supplemented by risk-based add-ons which include risks related to rare events (tail risks). Credit risk utilizes assumptions about our counterparties’ probability of default, the size of our losses in the event of a default and the maturity of our counterparties’ contractual obligations to us. Operational risk is calculated based on scenarios incorporating multiple types of operational failures. Backtesting is used to gauge the effectiveness of models at capturing and measuring relevant risks.


120


Table of Contents

 

We evaluate capital adequacy based on the result of our internal risk-based capital assessment, supplemented with the results of stress tests which measure the firm’s performance under various market conditions. Our goal is to hold sufficient capital, under our internal risk-based capital framework, to ensure we remain adequately capitalized after experiencing a severe stress event. Our assessment of capital adequacy is viewed in tandem with our assessment of liquidity adequacy and integrated into the overall risk management structure, governance and policy framework of the firm.
 
We attribute capital usage to each of our businesses based upon our internal risk-based capital and regulatory frameworks and manage the levels of usage based upon the balance sheet and risk limits established.
 
Rating Agency Guidelines
The credit rating agencies assign credit ratings to the obligations of Group Inc., which directly issues or guarantees substantially all of the firm’s senior unsecured obligations. GS Bank USA has also been assigned long-term issuer ratings as well as ratings on its long-term and short-term bank deposits. In addition, credit rating agencies have assigned ratings to debt obligations of certain other subsidiaries of Group Inc.
 
The level and composition of our equity capital are among the many factors considered in determining our credit ratings. Each agency has its own definition of eligible capital and methodology for evaluating capital adequacy, and assessments are generally based on a combination of factors rather than a single calculation. See “Liquidity Risk Management — Credit Ratings” for further information about our credit ratings.
 
Subsidiary Capital Requirements
Many of our subsidiaries, including GS Bank USA and our broker-dealer subsidiaries, are subject to separate regulation and capital requirements in jurisdictions throughout the world. For purposes of assessing the adequacy of its capital, GS Bank USA has established an ICAAP which is similar to that used by Group Inc. GS Bank USA’s capital levels and prompt corrective action classification are subject to qualitative judgments by its regulators about components, risk weightings and other factors.

We expect that the capital requirements of several of our subsidiaries will be impacted in the future by the various developments arising from the Basel Committee, the Dodd-Frank Act, and other governmental entities and regulators.
 
See Note 20 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information about GS Bank USA’s capital ratios under Basel 1 as implemented by the Federal Reserve Board, and for further information about the capital requirements of our other regulated subsidiaries and the potential impact of regulatory reform.
 
Subsidiaries not subject to separate regulatory capital requirements may hold capital to satisfy local tax guidelines, rating agency requirements (for entities with assigned credit ratings) or internal policies, including policies concerning the minimum amount of capital a subsidiary should hold based on its underlying level of risk. In certain instances, Group Inc. may be limited in its ability to access capital held at certain subsidiaries as a result of regulatory, tax or other constraints. As of March 2011 and December 2010, Group Inc.’s equity investment in subsidiaries was $69.32 billion and $71.30 billion, respectively, compared with its total shareholders’ equity of $72.47 billion and $77.36 billion, respectively.
 
Group Inc. has guaranteed the payment obligations of GS&Co., GS Bank USA, Goldman Sachs Bank (Europe) PLC and GSEC subject to certain exceptions. In November 2008, we contributed subsidiaries into GS Bank USA, and Group Inc. agreed to guarantee certain losses, including credit-related losses, relating to assets held by the contributed entities. In connection with this guarantee, Group Inc. also agreed to pledge to GS Bank USA certain collateral, including interests in subsidiaries and other illiquid assets.
 
Our capital invested in non-U.S. subsidiaries is generally exposed to foreign exchange risk, substantially all of which is managed through a combination of derivatives and non-U.S. denominated debt.
 


121


Table of Contents

 

Preferred Stock.  In March 2011, we provided notice to Berkshire Hathaway that we would redeem in full the 50,000 shares of our Series G Preferred Stock held by Berkshire Hathaway for the stated redemption price of $5.50 billion ($110,000 per share), plus accrued and unpaid dividends. In connection with this notice, we recognized a preferred dividend of $1.64 billion (calculated as the difference between the carrying value and redemption value of the preferred stock), which was recorded as a reduction to our first quarter earnings applicable to common shareholders and common shareholders’ equity, and reduced our earnings per common share and book value per common share by $2.82 and $3.06, respectively, in the first quarter of 2011. The redemption also resulted in the acceleration of $24 million of preferred dividends related to the period from April 1, 2011 to the redemption date, which was included in our results for the three months ended March 2011. The Series G Preferred Stock was redeemed on April 18, 2011. Berkshire Hathaway continues to hold a five-year warrant, issued in October 2008, to purchase up to 43.5 million shares of common stock at an exercise price of $115.00 per share.
 
Contingency Capital Plan
Our contingency capital plan outlines the appropriate communication procedures to follow during a crisis period, including internal dissemination of information as well as ensuring timely communication with external stakeholders. It also provides a framework for analyzing and responding to a perceived or actual capital deficiency, including, but not limited to, identification of drivers of a capital deficiency, as well as mitigants and potential actions.
 
Equity Capital Management
Our objective is to maintain a sufficient level and optimal composition of equity capital. We principally manage our capital through issuances and repurchases of our common stock. We may also, from time to time, issue or repurchase our preferred stock, junior subordinated debt issued to trusts and other subordinated debt as business conditions warrant and subject to any regulatory approvals. We manage our capital requirements principally by setting limits on balance sheet assets and/or limits on risk, in each case both at the consolidated and business levels. We attribute capital usage to each of our businesses based upon our internal risk-based capital and regulatory frameworks and manage the levels of usage based upon the balance sheet and risk limits established.

Share Repurchase Program.  We seek to use our share repurchase program to substantially offset increases in share count over time resulting from employee share-based compensation and to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by our issuance of shares resulting from employee share-based compensation as well as our current and projected capital position (i.e., comparisons of our desired level of capital to our actual level of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of our common stock.
 
As of March 2011, under the existing share repurchase program approved by the Board of Directors of Group Inc. (Board), we can repurchase up to 26.6 million additional shares of common stock; however, any such repurchases are subject to the approval of the Federal Reserve Board. See “Unregistered Sales of Equity Securities and Use of Proceeds” in Part II, Item 2 and Note 19 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional information on our repurchase program.
 
See Notes 16 and 19 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our preferred stock, junior subordinated debt issued to trusts and other subordinated debt.
 
Other Capital Metrics
The table below presents information on our shareholders’ equity and book value per common share.
 
                     
 
    As of      
    March
    December
     
$ in millions, except per share amounts   2011     2010      
 
Total shareholders’ equity
  $ 72,469     $ 77,356      
Common shareholders’ equity
    69,369       70,399      
Tangible common shareholders’ equity
    64,131       64,877      
Book value per common share
    129.40       128.72      
Tangible book value per common share
    119.63       118.63      
 
 
 


122


Table of Contents

 

Tangible common shareholders’ equity.  Tangible common shareholders’ equity equals total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets. Tangible book value per common share is computed by dividing tangible common shareholders’ equity by the number of common shares outstanding, including RSUs granted to employees with no future service requirements. We believe that tangible common shareholders’ equity and tangible book value per common share are meaningful because they are measures that we and investors use to assess capital adequacy. In addition, we believe that presenting the change in book value and tangible book value per common share excluding the impact of the $1.64 billion Series G Preferred Stock dividend provides a meaningful period-to-period comparison of these measures.
 
The tables below present the reconciliation of total shareholders’ equity to tangible common shareholders’ equity, as well as the calculation of common shareholders’ equity and tangible common shareholders’ equity as of March 2011, excluding the impact of the $1.64 billion Series G Preferred Stock dividend.
 
                     
 
    As of      
    March
    December
     
in millions   2011     2010      
 
Total shareholders’ equity
  $ 72,469     $ 77,356      
Deduct: Preferred stock
    (3,100 )     (6,957 )    
 
 
Common shareholders’ equity
    69,369       70,399      
Deduct: Goodwill and identifiable intangible assets
    (5,238 )     (5,522 )    
 
 
Tangible common shareholders’ equity
  $ 64,131     $ 64,877      
 
 
 
                     
 
    As of March 2011
          Tangible
     
    Common
    Common
     
    Shareholders’
         Shareholders’
     
in millions   Equity     Equity      
 
Including the impact of the Series G Preferred Stock dividend
    $69,369       $64,131      
Impact of the Series G Preferred Stock dividend
    1,643       1,643      
 
 
Excluding the impact of the Series G Preferred Stock dividend
    $71,012       $65,774      
 
 
 
 
Book value and tangible book value per common share.  Book value and tangible book value per common share are based on common shares outstanding, including RSUs granted to employees with no future service requirements, of 536.1 million and 546.9 million as of March 2011 and December 2010, respectively.

Off-Balance-Sheet Arrangements
and Contractual Obligations
 
Off-Balance-Sheet Arrangements
We have various types of off-balance-sheet arrangements that we enter into in the ordinary course of business. Our involvement in these arrangements can take many different forms, including:
 
•   purchasing or retaining residual and other interests in special purpose entities such as mortgage-backed and other asset-backed securitization vehicles;
 
•   holding senior and subordinated debt, interests in limited and general partnerships, and preferred and common stock in other nonconsolidated vehicles;
 
•   entering into interest rate, foreign currency, equity, commodity and credit derivatives, including total return swaps;
 
•   entering into operating leases; and
 
•   providing guarantees, indemnifications, loan commitments, letters of credit and representations and warranties.
 
We enter into these arrangements for a variety of business purposes, including securitizations. The securitization vehicles that purchase mortgages, corporate bonds, and other types of financial assets are critical to the functioning of several significant investor markets, including the mortgage-backed and other asset-backed securities markets, since they offer investors access to specific cash flows and risks created through the securitization process.
 
We also enter into these arrangements to underwrite client securitization transactions; provide secondary market liquidity; make investments in performing and nonperforming debt, equity, real estate and other assets; provide investors with credit-linked and asset-repackaged notes; and receive or provide letters of credit to satisfy margin requirements and to facilitate the clearance and settlement process.
 
Our financial interests in, and derivative transactions with, such nonconsolidated entities are accounted for at fair value, in the same manner as our other financial instruments, except in cases where we apply the equity method of accounting.
 
When we transfer a security that has very little, if any, default risk under an agreement to repurchase the security where the maturity date of the repurchase agreement matches the maturity date of the underlying security (such that we effectively no longer have a repurchase obligation) and we have relinquished control over the underlying security, we record such transactions as sales. These transactions are referred to as “repos to maturity.” We had no such transactions outstanding as of March 2011 or December 2010.
 


123


Table of Contents

 

The table below presents where a discussion of our various off-balance-sheet arrangements may be found in Part I, Items 1 and 2 of this Form 10-Q. In addition,

see Note 3 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for a discussion of our consolidation policies.
 


     
Type of Off-Balance-Sheet Arrangement   Disclosure in Form 10-Q
 
 
Variable interests and other obligations, including contingent obligations, arising from variable interests in nonconsolidated VIEs   See Note 11 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Leases, letters of credit, and lending and other commitments   See below and Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Guarantees   See below and Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Derivatives   See Notes 4, 5, 7 and 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
 
 

124


Table of Contents

Contractual Obligations

We have certain contractual obligations which require us to make future cash payments. These contractual obligations include our unsecured long-term borrowings, secured long-term financings, time deposits, contractual interest payments and insurance agreements, all of which are included in our condensed consolidated statement of financial condition. Our obligations to make future cash payments also

include certain off-balance-sheet contractual obligations such as purchase obligations, minimum rental payments under noncancelable leases and commitments and guarantees.
 
The table below presents our contractual obligations, commitments and guarantees as of March 2011.


                                             
 
    Remainder
                2016-
           
in millions   of 2011     2012-2013     2014-2015     Thereafter     Total      
 
Amounts related to on-balance-sheet obligations
                                           
Time deposits 1
  $     $ 2,479     $ 1,285     $ 1,421     $ 5,185      
Secured long-term financings 2
          4,717       2,199       2,344       9,260      
Unsecured long-term borrowings 3
          41,327       36,414       96,052       173,793      
Contractual interest payments 4
    4,744       12,839       9,740       34,631       61,954      
Insurance liabilities 5
    683       1,645       1,541       16,720       20,589      
Subordinated liabilities issued by consolidated VIEs
          51       112       1,189       1,352      
                                             
Amounts related to off-balance-sheet arrangements
                                           
Commitments to extend credit
    8,525       29,587       13,207       8,358       59,677      
Contingent and forward starting resale and securities borrowing agreements
    55,003                         55,003      
Forward starting repurchase and securities lending agreements
    12,497                         12,497      
Underwriting commitments
    354                         354      
Letters of credit
    1,528       474                   2,002      
Investment commitments
    2,402       6,846       324       715       10,287      
Minimum rental payments
    356       824       671       1,608       3,459      
Purchase obligations
    345       83       37       15       480      
Derivative guarantees
    396,305       312,769       65,548       68,270       842,892      
Securities lending indemnifications
    31,322                         31,322      
Other financial guarantees
    328       1,642       431       834       3,235      
 
 
 
1.   Excludes $2.86 billion of time deposits maturing within one year of our financial statement date.
 
2.   The aggregate contractual principal amount of secured long-term financings for which the fair value option was elected, primarily consisting of debt raised through our William Street credit extension program, transfers of financial assets accounted for as financings rather than sales and certain other nonrecourse financings, exceeded their related fair value by $282 million.
 
3.   Includes an increase of $6.74 billion to the carrying amount of certain of our unsecured long-term borrowings related to fair value hedges. In addition, the aggregate contractual principal amount of unsecured long-term borrowings (principal and non-principal protected) for which the fair value option was elected exceeded the related fair value by $642 million.
 
4.   Represents estimated future interest payments related to unsecured long-term borrowings, secured long-term financings and time deposits based on applicable interest rates as of March 2011. Includes stated coupons, if any, on structured notes.
 
5.   Represents estimated undiscounted payments related to future benefits and unpaid claims arising from policies associated with our insurance activities, excluding separate accounts and estimated recoveries under reinsurance contracts.

125


Table of Contents

 

In the table above:
 
•   Obligations maturing within one year of our financial statement date or redeemable within one year of our financial statement date at the option of the holder are excluded and are treated as short-term obligations.
 
•   Obligations that are repayable prior to maturity at the option of Goldman Sachs are reflected at their contractual maturity dates and obligations that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
•   Amounts included in the table do not necessarily reflect the actual future cash flow requirements for these arrangements because commitments and guarantees represent notional amounts and may expire unused or be reduced or cancelled at the counterparty’s request.
 
•   Due to the uncertainty of the timing and amounts that will ultimately be paid, our liability for unrecognized tax benefits has been excluded. See Note 24 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unrecognized tax benefits.
 
See Notes 15 and 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our short-term borrowings, and commitments and guarantees.
 
As of March 2011, our unsecured long-term borrowings were $173.79 billion, with maturities extending to 2060, and consisted principally of senior borrowings. See Note 16 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our unsecured long-term borrowings.
 
As of March 2011, our future minimum rental payments net of minimum sublease rentals under noncancelable leases were $3.46 billion. These lease commitments, principally for office space, expire on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. See Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our leases.

Our occupancy expenses include costs associated with office space held in excess of our current requirements. This excess space, the cost of which is charged to earnings as incurred, is being held for potential growth or to replace currently occupied space that we may exit in the future. We regularly evaluate our current and future space capacity in relation to current and projected staffing levels. During the three months ended March 2011, total occupancy expenses for space held in excess of our current requirements were $29 million, which includes costs related to the transition to our new headquarters in New York City. In addition, during the three months ended March 2011, we did not incur any exit costs related to our office space. We may incur exit costs in the future to the extent we (i) reduce our space capacity or (ii) commit to, or occupy, new properties in the locations in which we operate and, consequently, dispose of existing space that had been held for potential growth. These exit costs may be material to our results of operations in a given period.
 
Overview and Structure of Risk Management
 
Overview
We believe that effective risk management is of primary importance to the success of the firm. Accordingly, we have comprehensive risk management processes through which we monitor, evaluate and manage the risks we assume in conducting our activities. These include market, credit, liquidity, operational, legal, regulatory and reputational risk exposures. Our risk management framework is built around three core components: governance, processes and people.
 
Governance.  Risk management governance starts with our Board, which plays an important role in reviewing and approving risk management policies and practices, both directly and through its Risk Committee, which consists of all of our independent directors. The Board also receives periodic updates on firmwide risks from our independent control and support functions. Next, at the most senior levels of the firm, our leaders are experienced risk managers, with a sophisticated and detailed understanding of the risks we take. Our senior managers lead and participate in risk-oriented committees, as do the leaders of our independent control and support functions — including those in internal audit, compliance, controllers, credit risk management, human capital management, legal, market risk management, operations, operational risk management, tax, technology and treasury.
 


126


Table of Contents

 

The firm’s governance structure provides the protocol and responsibility for decision-making on risk management issues and ensures implementation of those decisions. We make extensive use of risk-related committees that meet regularly and serve as an important means to facilitate and foster ongoing discussions to identify, manage and mitigate risks.
 
We maintain strong communication about risk and we have a culture of collaboration in decision-making among the revenue-producing units, independent control and support functions, committees and senior management. While we believe that the first line of defense in managing risk rests with the managers in our revenue-producing units, we dedicate extensive resources to independent control and support functions in order to ensure a strong oversight structure and an appropriate segregation of duties.
 
Processes.  We maintain various processes and procedures that are critical components of our risk management. First and foremost is our daily discipline of marking substantially all of the firm’s inventory to current market levels. Goldman Sachs carries its inventory at fair value, with changes in valuation reflected immediately in our risk management systems and in net revenues. We do so because we believe this discipline is one of the most effective tools for assessing and managing risk and that it provides transparent and realistic insight into our financial exposures.
 
We also apply a rigorous framework of limits to control risk across multiple transactions, products, businesses and markets. This includes setting credit and market risk limits at a variety of levels and monitoring these limits on a daily basis. Limits are typically set at levels that will be periodically exceeded, rather than at levels which reflect our maximum risk appetite. This fosters an ongoing dialogue on risk among revenue-producing units, independent control and support functions, committees and senior management, as well as rapid escalation of risk-related matters. See “Market Risk Management” and “Credit Risk Management” for further information on our risk limits.
 
Active management of our positions is another important process. Proactive mitigation of our market and credit exposures minimizes the risk that we will be required to take outsized actions during periods of stress.

We also focus on the rigor and effectiveness of the firm’s risk systems. The goal of our risk management technology is to get the right information to the right people at the right time, which requires systems that are comprehensive, reliable and timely. We devote significant time and resources to our risk management technology to ensure that it consistently provides us with complete, accurate and timely information.
 
People.  Even the best technology serves only as a tool for helping to make informed decisions in real time about the risks we are taking. Ultimately, effective risk management requires our people to interpret our risk data on an ongoing and timely basis and adjust risk positions accordingly. In both our revenue-producing units and our independent control and support functions, the experience of our professionals, and their understanding of the nuances and limitations of each risk measure, guide the firm in assessing exposures and maintaining them within prudent levels.
 
Structure
Ultimate oversight of risk is the responsibility of the firm’s Board. The Board oversees risk both directly and through its Risk Committee. Within the firm, a series of committees with specific risk management mandates have oversight or decision-making responsibilities for risk management activities. Committee membership generally consists of senior managers from both our revenue-producing units and our independent control and support functions. We have established procedures for these committees to ensure that appropriate information barriers are in place. Our primary risk committees, most of which also have additional sub-committees or working groups, are described below. In addition to these committees, we have other risk-oriented committees which provide oversight for different businesses, activities, products, regions and legal entities.
 
Membership of the firm’s risk committees is reviewed regularly and updated to reflect changes in the responsibilities of the committee members. Accordingly, the length of time that members serve on the respective committees varies as determined by the relevant committee charter or the committee chairs, and based on the responsibilities of the members within the firm.
 
In addition, independent control and support functions, which report to the chief financial officer, general counsels, chief administrative officer, or in the case of Internal Audit, to the Audit Committee of the Board, are responsible for day-to-day oversight of risk, as discussed in greater detail in the following sections.
 


127


Table of Contents

 

The chart below presents an overview of our risk management governance structure, highlighting the oversight of our Board, our key risk-related

committees and the independence of our control and support functions.
 
 


 
 
 

Management Committee.  The Management Committee oversees the global activities of the firm, including all of the firm’s independent control and support functions. It provides this oversight directly and through authority delegated to committees it has established. This committee is comprised of the most senior leaders of the firm, and is chaired by the firm’s chief executive officer. The Management Committee has established various committees with delegated authority and appoints the chairpersons of these committees (the chairpersons then appoint the other members of the committees). All of these committees (and other committees established by such committees) report, directly or indirectly, to the Management Committee. Most members of the Management Committee are also members of other firmwide, divisional and regional committees. The following are the committees established by the Management Committee that are principally involved in firmwide risk management.

Firmwide Client and Business Standards Committee.  The Firmwide Client and Business Standards Committee assesses and makes determinations regarding business standards and practices, reputational risk management, client relationships and client service, and is chaired by the firm’s president and chief operating officer. This committee also has responsibility for overseeing the implementation of the recommendations of the Business Standards Committee. This committee has established the following two committees that report to it and is responsible for appointing the chairpersons of these committees and other committee members:


128


Table of Contents

•   Firmwide New Activity Committee.  The Firmwide New Activity Committee is responsible for reviewing new activities and establishing a process to identify and review previously approved activities that are significant and that have changed in complexity and/or structure or present different reputational and suitability concerns over time to consider whether these activities remain appropriate. This committee is co-chaired by the firm’s head of operations and the chief administrative officer of our Investment Management Division.
 
•   Firmwide Suitability Committee.  The Firmwide Suitability Committee is responsible for setting standards and policies for product, transaction and client suitability and providing a forum for consistency across divisions, regions and products on suitability assessments. This committee also reviews suitability matters escalated from other firm committees. This committee is co-chaired by the firm’s international general counsel and the chief operating officer of our Investment Management Division.
 
Firmwide Risk Committee.  The Firmwide Risk Committee is responsible for the ongoing monitoring and control of the firm’s global financial risks. Through both direct and delegated authority, the Firmwide Risk Committee approves firmwide, product, divisional and business-level limits for both market and credit risks, approves sovereign credit risk limits and reviews results of stress tests and scenario analyses. This committee is co-chaired by the firm’s chief financial officer and a senior managing director from the firm’s executive office. The following four committees report to the Firmwide Risk Committee, which is responsible for appointing the chairperson of each of these committees, who then appoints the other committee members:
 
•   Securities Division Risk Committee.  The Securities Division Risk Committee sets market risk limits, subject to overall firmwide risk limits, for our Fixed Income, Currency and Commodities Client Execution and Equities Client Execution businesses based on a number of risk measures, including VaR, stress tests, scenario analyses, and inventory levels. This committee is chaired by the chief risk officer of our Securities Division.
 
•   Credit Policy Committee.  The Credit Policy Committee establishes and reviews broad credit policies and parameters that are implemented by our Credit Risk Management department (Credit Risk Management). This committee is chaired by the firm’s chief credit officer.

•   Operational Risk Committee.  The Operational Risk Committee provides oversight of the ongoing development and implementation of our operational risk policies, framework and methodologies, and monitors the effectiveness of operational risk management. This committee is chaired by the chief risk officer of GS Bank USA.
 
•   Finance Committee.  The Finance Committee has oversight of firmwide liquidity, the size and composition of our balance sheet and capital base, and our credit ratings. This committee regularly reviews our liquidity, balance sheet, funding position and capitalization, and makes adjustments in light of current events, risks and exposures, and regulatory requirements. This committee is also responsible for reviewing and approving balance sheet limits and the size of our GCE. This committee is co-chaired by the firm’s chief financial officer and the firm’s global treasurer.
 
The following committees report jointly to the Firmwide Risk Committee and the Firmwide Client and Business Standards Committee, which also appoint the chairpersons of these committees (who then appoint the members of the committees).
 
•   Firmwide Capital Committee.  The Firmwide Capital Committee provides approval and oversight of debt-related underwriting transactions, including related commitments of the firm’s capital. This committee aims to ensure that business and reputational standards for underwritings and capital commitments are maintained on a global basis. This committee is chaired by the global head of the firm’s Financing Group and head of the firm’s independent control and support functions in Europe, Middle East and Africa.
 
•   Firmwide Commitments Committee.  The Firmwide Commitments Committee reviews the firm’s underwriting and distribution activities with respect to equity and equity-related product offerings, and sets and maintains policies and procedures designed to ensure that legal, reputational, regulatory and business standards are maintained on a global basis. In addition to reviewing specific transactions, this committee periodically conducts general strategic reviews of sectors and products and establishes policies in connection with transaction practices. This committee is co-chaired by the head of our Latin America Group and the head of the firm’s independent control and support functions in Europe, Middle East and Africa.


129


Table of Contents

 

Investment Management Division Risk Committee.  The Investment Management Division Risk Committee is responsible for the ongoing monitoring and control of global market, counterparty credit and liquidity risks associated with the activities of our investment management businesses. The head of Investment Management Division risk management is the chair of this committee and appoints the other members.
 
Liquidity Risk Management
 
Liquidity is of critical importance to financial institutions. Most of the recent failures of financial institutions have occurred in large part due to insufficient liquidity. Accordingly, the firm has in place a comprehensive and conservative set of liquidity and funding policies to address both firm-specific and broader industry or market liquidity events. Our principal objective is to be able to fund the firm and to enable our core businesses to continue to generate revenues, even under adverse circumstances.
 
We manage liquidity risk according to the following principles:
 
Excess Liquidity.  We maintain substantial excess liquidity to meet a broad range of potential cash outflows and collateral needs in a stressed environment.
 
Asset-Liability Management.  We assess anticipated holding periods for our assets and their potential illiquidity in a stressed environment. We manage the maturities and diversity of our funding across markets, products and counterparties; and seek to maintain liabilities of appropriate tenor relative to our asset base.
 
Contingency Funding Plan.  We maintain a contingency funding plan to provide a framework for analyzing and responding to a liquidity crisis situation or periods of market stress. This framework sets forth the plan of action to fund normal business activity in emergency and stress situations. These principles are discussed in more detail below.
 
Excess Liquidity
Our most important liquidity policy is to pre-fund our estimated potential cash needs during a liquidity crisis and hold this excess liquidity in the form of unencumbered, highly liquid securities and cash. We believe that this global core excess would be readily convertible to cash in a matter of days, through liquidation, by entering into repurchase agreements or from maturities of reverse repurchase agreements, and that this cash would allow us to meet immediate obligations without needing to sell other assets or depend on additional funding from credit-sensitive markets.

As of March 2011 and December 2010, the fair value of the securities and certain overnight cash deposits included in our GCE totaled $170.69 billion and $174.78 billion, respectively. Based on the results of our internal liquidity risk model, discussed below, as well as our consideration of other factors including but not limited to a qualitative assessment of the condition of the financial markets and the firm, we believe our liquidity position as of March 2011 was appropriate.
 
The table below presents the fair value of the securities and certain overnight cash deposits that are included in our GCE.
 
                     
 
    Average for the 
    Three Months
    Year
     
    Ended
    Ended
     
    March
    December
     
in millions   2011     2010      
 
U.S. dollar-denominated
    $130,557       $130,072      
Non-U.S. dollar-denominated
    37,493       37,942      
 
 
Total
    $168,050       $168,014      
 
 
 
The U.S. dollar-denominated excess is composed of unencumbered U.S. government and federal agency obligations (including highly liquid U.S. federal agency mortgage-backed obligations), all of which are eligible as collateral in Federal Reserve open market operations and certain overnight U.S. dollar cash deposits. The non-U.S. dollar-denominated excess is composed of only unencumbered French, German, United Kingdom and Japanese government obligations and certain overnight cash deposits in highly liquid currencies. We strictly limit our excess liquidity to this narrowly defined list of securities and cash because they are highly liquid, even in a difficult funding environment. We do not include other potential sources of excess liquidity, such as lower-quality unencumbered securities or committed credit facilities, in our GCE.
 


130


Table of Contents

 

The table below presents the fair value of our GCE by asset class.
 
                     
 
    Average for the 
    Three Months
    Year
     
    Ended
    Ended
     
    March
    December
     
in millions   2011     2010      
 
Overnight cash deposits
  $ 30,418     $ 25,040      
Federal funds sold
          75      
U.S. government obligations
    94,069       102,937      
U.S. federal agency obligations, including highly liquid U.S. federal agency mortgage-backed obligations
    7,371       3,194      
French, German, United Kingdom and Japanese government obligations
    36,192       36,768      
 
 
Total
  $ 168,050     $ 168,014      
 
 
 
The GCE is held at Group Inc. and our major broker-dealer and bank subsidiaries, as presented in the table below.
 
                     
 
    Average for the 
    Three Months
    Year
     
    Ended
    Ended
     
    March
    December
     
in millions   2011     2010      
 
Group Inc. 
  $ 52,055     $ 53,757      
Major broker-dealer subsidiaries
    73,215       69,223      
Major bank subsidiaries
    42,780       45,034      
 
 
Total
  $ 168,050     $ 168,014      
 
 
 
Our GCE reflects the following principles:
 
•   The first days or weeks of a liquidity crisis are the most critical to a company’s survival.
 
•   Focus must be maintained on all potential cash and collateral outflows, not just disruptions to financing flows. Our businesses are diverse, and our liquidity needs are determined by many factors, including market movements, collateral requirements and client commitments, all of which can change dramatically in a difficult funding environment.
 
•   During a liquidity crisis, credit-sensitive funding, including unsecured debt and some types of secured financing agreements, may be unavailable, and the terms (e.g., interest rates, collateral provisions and tenor) or availability of other types of secured financing may change.
 
•   As a result of our policy to pre-fund liquidity that we estimate may be needed in a crisis, we hold more unencumbered securities and have larger debt balances than our businesses would otherwise require. We believe that our liquidity is stronger with greater balances of highly liquid unencumbered securities, even though it increases our total assets and our funding costs.

We believe that our GCE provides us with a resilient source of funds that would be available in advance of potential cash and collateral outflows and gives us significant flexibility in managing through a difficult funding environment.
 
In order to determine the appropriate size of our GCE, we use an internal liquidity model, referred to as the Modeled Liquidity Outflow, which captures and quantifies the firm’s liquidity risks. We also consider other factors including but not limited to a qualitative assessment of the condition of the financial markets and the firm.
 
We distribute our GCE across subsidiaries, asset types, and clearing agents to provide us with sufficient operating liquidity to ensure timely settlement in all major markets, even in a difficult funding environment.
 
We maintain our GCE to enable us to meet current and potential liquidity requirements of our parent company, Group Inc., and our major broker-dealer and bank subsidiaries. The Modeled Liquidity Outflow incorporates a consolidated requirement as well as a standalone requirement for each of our major broker-dealer and bank subsidiaries. Liquidity held directly in each of these subsidiaries is intended for use only by that subsidiary to meet its liquidity requirements and is assumed not to be available to Group Inc. unless (i) legally provided for and (ii) there are no additional regulatory, tax or other restrictions. We hold a portion of our GCE directly at Group Inc. to support consolidated requirements not accounted for in the major subsidiaries. In addition to the GCE held at our major broker-dealer and bank subsidiaries, we maintain operating cash balances in several of our other operating entities, primarily for use in specific currencies, entities, or jurisdictions where we do not have immediate access to parent company liquidity.
 
In addition to our GCE, we have a significant amount of other unencumbered cash and financial instruments, including other government obligations, high-grade money market securities, corporate obligations, marginable equities, loans and cash deposits not included in our GCE. The fair value of these assets averaged $77.78 billion and $72.98 billion for the three months ended March 2011 and year ended December 2010, respectively. We do not consider these assets liquid enough to be eligible for our GCE liquidity pool and therefore conservatively do not assume we will generate liquidity from these assets in a short-term stress scenario.
 


131


Table of Contents

 

Modeled Liquidity Outflow.  Our Modeled Liquidity Outflow is based on a scenario that includes both a market-wide stress and a firm-specific stress, characterized by some or all of the following qualitative elements:
 
•   Global recession, default by a medium-sized sovereign, low consumer and corporate confidence, and general financial instability.
 
•   Severely challenged market environment with material declines in equity markets and widening of credit spreads.
 
•   Damaging follow-on impacts to financial institutions leading to the failure of a large bank.
 
•   A firm-specific crisis potentially triggered by material losses, reputational damage, litigation, executive departure, and/or a ratings downgrade.
 
The following are the critical modeling parameters of the Modeled Liquidity Outflow:
 
•   Liquidity needs over a 30-day scenario.
 
•   A two-notch downgrade of the firm’s long-term senior unsecured credit ratings.
 
•   A combination of contractual outflows, such as upcoming maturities of unsecured debt, and contingent outflows (e.g., actions though not contractually required, we may deem necessary in a crisis). We assume that most contingent outflows will occur within the initial days and weeks of a crisis.
 
•   No issuance of equity or unsecured debt.
 
•   No support from government funding facilities.  Although we have access to various central bank funding programs, we do not assume reliance on them as a source of funding in a liquidity crisis.
 
•   No diversification benefit across liquidity risks.  We assume that liquidity risks are additive.
 
•   Maintenance of our normal business levels.  We do not assume asset liquidation, other than the GCE.
 
The Modeled Liquidity Outflow is calculated and reported to senior management on a daily basis. We regularly refine our model to reflect changes in market or economic conditions and the firm’s business mix.

The potential contractual and contingent cash and collateral outflows covered in our Modeled Liquidity Outflow include:
 
Unsecured Funding
•   Contractual:  All upcoming maturities of unsecured long-term debt, commercial paper, promissory notes and other unsecured funding products. We assume that we will be unable to issue new unsecured debt or rollover any maturing debt.
 
•   Contingent:  Repurchases of our outstanding long-term debt, commercial paper and hybrid financial instruments in the ordinary course of business as a market maker.
 
Deposits
•   Contractual:  All upcoming maturities of term deposits. We assume that we will be unable to raise new term deposits or rollover any maturing term deposits.
 
•   Contingent:  Withdrawals of bank deposits that have no contractual maturity. The withdrawal assumptions reflect, among other factors, the type of deposit, whether the deposit is insured or uninsured, and the firm’s relationship with the depositor.
 
Secured Funding
•   Contractual:  A portion of upcoming contractual maturities of secured funding trades due to either the inability to refinance or the ability to refinance only at wider haircuts (i.e., on terms which require us to post additional collateral). Our assumptions reflect, among other factors, the quality of the underlying collateral and counterparty concentration.
 
•   Contingent:  A decline in value of financial assets pledged as collateral for financing transactions, which would necessitate additional collateral postings under those transactions.
 
OTC Derivatives
•   Contingent:  Collateral postings to counterparties due to adverse changes in the value of our OTC derivatives.
 
•   Contingent:  Other outflows of cash or collateral related to OTC derivatives, including the impact of trade terminations, collateral substitutions, collateral disputes, collateral calls or termination payments required by a two-notch downgrade in our credit ratings, and collateral that has not been called by counterparties, but is available to them.
 
Exchange-Traded Derivatives
•   Contingent:  Variation margin postings required due to adverse changes in the value of our outstanding exchange-traded derivatives.


132


Table of Contents

•   Contingent:  An increase in initial margin and guaranty fund requirements by derivative clearing houses.
 
Customer Cash and Securities
•   Contingent:  Liquidity outflows associated with our prime brokerage business, including withdrawals of customer credit balances, and a reduction in customer short positions, which serve as a funding source for long positions.
 
Unfunded Commitments
•   Contingent:  Draws on our unfunded commitments. Draw assumptions reflect, among other things, the type of commitment and counterparty.
 
Other
•   Other upcoming large cash outflows, such as tax payments.
 
Asset-Liability Management
Our liquidity risk management policies are designed to ensure we have a sufficient amount of financing, even when funding markets experience persistent stress. We seek to maintain a long-dated and diversified funding profile, taking into consideration the characteristics and liquidity profile of our assets.
 
Our approach to asset-liability management includes:
 
•   Conservatively managing the overall characteristics of our funding book, with a focus on maintaining long-term, diversified sources of funding in excess of our current requirements. See “Balance Sheet and Funding Sources — Funding Sources” for additional details.
 
•   Actively managing and monitoring our asset base, with particular focus on the liquidity, holding period and our ability to fund assets on a secured basis. This enables us to determine the most appropriate funding products and tenors. Less liquid assets are more difficult to fund and therefore require funding that has longer tenors with a greater proportion of unsecured debt. See “Balance Sheet and Funding Sources — Balance Sheet Management” for more detail on our balance sheet management process.

•   Raising secured and unsecured financing that has a sufficiently longer term than the anticipated holding period of our assets. This reduces the risk that our liabilities will come due in advance of our ability to generate liquidity from the sale of our assets. Because we maintain a highly liquid balance sheet, the holding period of certain of our assets may be materially shorter than their contractual maturity dates.
 
Our goal is to have sufficient total capital (unsecured long-term borrowings plus total shareholders’ equity) so that we can avoid reliance on asset sales (other than our GCE). However, we recognize that orderly asset sales may be prudent or necessary in a severe or persistent liquidity crisis. The target amount of our total capital is based on an internal funding model which incorporates the following long-term financing requirements:
 
•   The portion of financial instruments owned, at fair value that we believe could not be funded on a secured basis in periods of market stress, assuming stressed fair values.
 
•   Goodwill and identifiable intangible assets, property, leasehold improvements and equipment, and other illiquid assets.
 
•   Derivative and other margin and collateral requirements.
 
•   Anticipated draws on our unfunded loan commitments.
 
•   Regulatory requirements to hold capital or other forms of financing in excess of what we would otherwise hold in regulated subsidiaries.
 
Subsidiary Funding Policies.  The majority of our unsecured funding is raised by Group Inc. which lends the necessary funds to its subsidiaries, some of which are regulated, to meet their asset financing, liquidity and capital requirements. In addition, Group Inc. provides its regulated subsidiaries with the necessary capital to meet their regulatory requirements. The benefits of this approach to subsidiary funding are enhanced control and greater flexibility to meet the funding requirements of our subsidiaries. Funding is also raised at the subsidiary level through a variety of products, including secured funding, unsecured borrowings and deposits.


133


Table of Contents

Our intercompany funding policies assume that, unless legally provided for, a subsidiary’s funds or securities are not freely available to its parent company or other subsidiaries. In particular, many of our subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to Group Inc. Regulatory action of that kind could impede access to funds that Group Inc. needs to make payments on its obligations. Accordingly, we assume that the capital provided to our regulated subsidiaries is not available to Group Inc. or other subsidiaries and any other financing provided to our regulated subsidiaries is not available until the maturity of such financing.
 
Group Inc. has provided substantial amounts of equity and subordinated indebtedness, directly or indirectly, to its regulated subsidiaries. For example, as of March 2011, Group Inc. had $29.47 billion of equity and subordinated indebtedness invested in GS&Co., its principal U.S. registered broker-dealer; $43.19 billion invested in GSI, a regulated U.K. broker-dealer; $2.73 billion invested in Goldman Sachs Execution & Clearing, L.P., a U.S. registered broker-dealer; $3.08 billion invested in Goldman Sachs Japan Co., Ltd., a regulated Japanese broker-dealer; and $19.06 billion invested in GS Bank USA, a regulated New York State-chartered bank. Group Inc. also had $73.92 billion of unsubordinated loans and $12.02 billion of collateral provided to these entities as of March 2011 and significant amounts of capital invested in and loans to its other regulated subsidiaries.

Contingency Funding Plan
The Goldman Sachs contingency funding plan sets out the plan of action we would use to fund business activity in crisis situations and periods of market stress. The contingency funding plan outlines a list of potential risk factors, key reports and metrics that are reviewed on an ongoing basis to assist in assessing the severity of, and managing through, a liquidity crisis and/or market dislocation. The contingency funding plan also describes in detail the firm’s potential responses if our assessments indicate that the firm has entered a liquidity crisis, which include pre-funding for what we estimate will be our potential cash and collateral needs as well as utilizing secondary sources of liquidity. Mitigants and action items to address specific risks which may arise are also described and assigned to individuals responsible for execution.
 
The contingency funding plan identifies key groups of individuals to foster effective coordination, control and distribution of information, all of which are critical in the management of a crisis or period of market stress. The contingency funding plan also details the responsibilities of these groups and individuals, which include making and disseminating key decisions, coordinating all contingency activities throughout the duration of the crisis or period of market stress, implementing liquidity maintenance activities and managing internal and external communication.
 
Credit Ratings
The table below presents our unsecured credit ratings (excluding debt guaranteed by the FDIC under the TLGP) and outlook.
 


                                                     
 
    As of March 2011
    Short-Term
    Long-Term
    Subordinated
    Trust
    Preferred
    Rating
     
    Debt     Debt     Debt     Preferred 1     Stock 2     Outlook      
 
DBRS, Inc. 
    R-1 (middle )     A (high )     A       A       BBB       Stable 5      
Fitch, Inc. 3
    F1+       A+       A       A-       A-       Negative 6      
Moodys Investors Service 4
    P-1       A1       A2       A3       Baa2       Negative 7      
Standard & Poors Ratings Services
    A-1       A       A-       BBB-       BBB-       Negative 7      
Rating and Investment Information, Inc. 
    a-1+       AA-       A+       N/A       N/A       Negative 8      
 
 
 
1.   Trust preferred securities issued by Goldman Sachs Capital I.
 
2.   Includes Group Inc.’s non-cumulative preferred stock and the Normal Automatic Preferred Enhanced Capital Securities (APEX) issued by Goldman Sachs Capital II and Goldman Sachs Capital III.
 
3.   GS Bank USA has been assigned a rating of AA- for long-term bank deposits, F1+ for short-term bank deposits and A+ for long-term issuer.
 
4.   GS Bank USA has been assigned a rating of Aa3 for long-term bank deposits, P-1 for short-term bank deposits and Aa3 for long-term issuer.
 
5.   Applies to long-term and short-term ratings.
 
6.   Applies to long-term issuer default ratings.
 
7.   Applies to long-term ratings.
 
8.   Applies to issuer rating.

134


Table of Contents

On April 8, 2011, Fitch, Inc. affirmed Group Inc.’s long-term debt rating and raised its outlook from “negative” to “stable.”
 
We rely on the short-term and long-term debt capital markets to fund a significant portion of our day-to-day operations and the cost and availability of debt financing is influenced by our credit ratings. Credit ratings are also important when we are competing in certain markets, such as OTC derivatives, and when we seek to engage in longer-term transactions. See “Certain Risk Factors That May Affect Our Businesses” below and “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for a discussion of the risks associated with a reduction in our credit ratings.
 
We believe our credit ratings are primarily based on the credit rating agencies’ assessment of:
 
•   our liquidity, market, credit and operational risk management practices;
 
•   the level and variability of our earnings;
 
•   our capital base;
 
•   our franchise, reputation and management;
 
•   our corporate governance; and
 
•   the external operating environment, including the assumed level of government support.
 
We allocate a portion of our GCE to ensure we would be able to make the additional collateral or termination payments that may be required in the event of a two-notch reduction in our long-term credit ratings, as well as collateral that has not been called by counterparties, but is available to them. The table below presents the additional collateral or termination payments that could have been called at the reporting date by counterparties in the event of a one-notch and two-notch downgrade in our credit ratings.
 
                     
 
    As of      
    March
    December
     
in millions   2011     2010      
 
Additional collateral or termination payments for a one-notch downgrade
  $ 925     $ 1,353      
Additional collateral or termination payments for a two-notch downgrade
    2,211       2,781      
 
 

The Basel Committee on Banking Supervision’s international framework for liquidity risk measurement, standards and monitoring calls for imposition of a liquidity coverage ratio, designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets based on expected cash outflows under an acute liquidity stress scenario, and a net stable funding ratio, designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. The liquidity coverage ratio would be implemented subject to an observation period beginning in 2011, but would not be introduced as a requirement until January 1, 2015, and the net stable funding ratio would not be introduced as a requirement until January 1, 2018. While the principles behind the new framework are broadly consistent with our current liquidity management framework, it is possible that the implementation of these standards could impact our liquidity and funding requirements and practices.
 
Cash Flows
As a global financial institution, our cash flows are complex and bear little relation to our net earnings and net assets. Consequently, we believe that traditional cash flow analysis is less meaningful in evaluating our liquidity position than the excess liquidity and asset-liability management policies described above. Cash flow analysis may, however, be helpful in highlighting certain macro trends and strategic initiatives in our businesses.
 
Three Months Ended March 2011.  Our cash and cash equivalents increased by $2.90 billion to $42.68 billion at the end of the first quarter of 2011. We generated $1.90 billion in net cash from operating activities. We generated net cash of $1.00 billion in investing and financing activities, primarily from the net issuance of secured and unsecured borrowings.
 
Three Months Ended March 2010.  Our cash and cash equivalents decreased by $11.23 billion to $27.06 billion at the end of the first quarter of 2010. We used net cash of $8.47 billion in our operating and investing activities, primarily to fund securities borrowed and securities purchased under agreements to resell. We used net cash in financing activities of $2.76 billion, primarily due to repurchases of common stock.
 


135


Table of Contents

 
Market Risk Management
 

Overview
Market risk is the risk of loss in the value of our inventory due to changes in market prices. We hold inventory primarily for market making for our clients and for our investing and lending activities. Our inventory therefore changes based on client demands and our investment opportunities. Our inventory is accounted for at fair value and therefore fluctuates on a daily basis. Categories of market risk include the following:
 
•   Interest rate risk:  primarily results from exposures to changes in the level, slope and curvature of yield curves, the volatilities of interest rates, mortgage prepayment speeds and credit spreads.
 
•   Equity price risk:  results from exposures to changes in prices and volatilities of individual equities, baskets of equities and equity indices.
 
•   Currency rate risk:  results from exposures to changes in spot prices, forward prices and volatilities of currency rates.
 
•   Commodity price risk:  results from exposures to changes in spot prices, forward prices and volatilities of commodities, such as electricity, natural gas, crude oil, petroleum products, and precious and base metals.
 
Market Risk Management Process
We manage our market risk by diversifying exposures, controlling position sizes and establishing economic hedges in related securities or derivatives. This includes:
 
•   accurate and timely exposure information incorporating multiple risk metrics;
 
•   a dynamic limit setting framework; and
 
•   constant communication among revenue-producing units, risk managers and senior management.
 
Market Risk Management, which is independent of the revenue-producing units and reports to the firm’s chief risk officer, has primary responsibility for assessing, monitoring and managing market risk at the firm. We monitor and control risks through strong firmwide oversight and independent control and support functions across the firm’s global businesses.

Managers in revenue-producing units are accountable for managing risk within prescribed limits. These managers have in-depth knowledge of their positions, of markets and the instruments available to hedge their exposures.
 
Managers in revenue-producing units and Market Risk Management discuss market information, positions and estimated risk and loss scenarios on an ongoing basis.
 
Risk Measures
Market Risk Management produces risk measures and monitors them against market risk limits set by our firm’s risk committees. These measures reflect an extensive range of scenarios and the results are aggregated at trading desk, business and firmwide levels.
 
We use a variety of risk measures to estimate the size of potential losses for both moderate and more extreme market moves over both short-term and long-term time horizons. Risk measures used for shorter-term periods include VaR and sensitivity metrics. For longer-term horizons, our primary risk measures are stress tests. Our risk reports detail key risks, drivers and changes for each desk and business, and are distributed daily to senior management of both our revenue-producing units and our independent control and support functions.
 
Systems
We have made a significant investment in technology to monitor market risk including:
 
•   an independent calculation of VaR and stress measures;
 
•   risk measures calculated at individual position levels;
 
•   attribution of risk measures to individual risk factors of each position;
 
•   the ability to report many different views of the risk measures (e.g., by desk, business, product type or legal entity); and
 
•   the ability to produce ad hoc analyses in a timely manner.


136


Table of Contents

Value-at-Risk
VaR is the potential loss in value of inventory positions due to adverse market movements over a defined time horizon with a specified confidence level. We typically employ a one-day time horizon with a 95% confidence level. Thus, we would expect to see reductions in the fair value of inventory positions at least as large as the reported VaR once per month. The VaR model captures risks including interest rates, equity prices, currency rates and commodity prices. As such, VaR facilitates comparison across portfolios of different risk characteristics. VaR also captures the diversification of aggregated risk at the firmwide level.
 
Inherent limitations to VaR include:
 
•   VaR does not estimate potential losses over longer time horizons where moves may be extreme.
 
•   VaR does not take account of the relative liquidity of different risk positions.
 
•   Previous moves in market risk factors may not produce accurate predictions of all future market moves.
 
The historical data used in our VaR calculation is weighted to give greater importance to more recent observations and reflect current asset volatilities. This improves the accuracy of our estimates of potential loss. As a result, even if our inventory positions were unchanged, our VaR would increase with increasing market volatility and vice versa.
 
Given its reliance on historical data, VaR is most effective in estimating risk exposures in markets in which there are no sudden fundamental changes or shifts in market conditions.
 
We evaluate the accuracy of our VaR model through daily backtesting (i.e., comparing daily trading net revenues to the VaR measure calculated as of the prior business day) at the firmwide level and for each of our businesses and major regulated subsidiaries.
 
VaR does not include:
 
•   positions that are best measured and monitored using sensitivity measures; and
 
•   the impact of changes in counterparty and our own credit spreads on derivatives as well as changes in our own credit spreads on unsecured borrowings for which the fair value option was elected.

Stress Testing
We use stress testing to examine risks of specific portfolios as well as the potential impact of significant risk exposures across the firm. We use a variety of scenarios to calculate the potential loss from a wide range of market moves on the firm’s portfolios. These scenarios include the default of single corporate or sovereign entities, the impact of a move in a single risk factor across all positions (e.g., equity prices or credit spreads) or a combination of two or more risk factors.
 
Unlike VaR measures, which have an implied probability because they are calculated at a specified confidence level, there is generally no implied probability that our stress test scenarios will occur. Instead, stress tests are used to model both moderate and more extreme moves in underlying market factors. When estimating potential loss, we generally assume that our positions cannot be reduced or hedged (although experience demonstrates that we are generally able to do so).
 
Stress test scenarios are conducted on a regular basis as part of the firm’s routine risk management process and on an ad hoc basis in response to market events or concerns. Stress testing is an important part of the firm’s risk management process because it allows us to highlight potential loss concentrations, undertake risk/reward analysis, and assess and mitigate our risk positions.
 
Limits
We use risk limits at various levels in the firm (including firmwide, product and business) to govern risk appetite by controlling the size of our exposures to market risk. Limits are reviewed frequently and amended on a permanent or temporary basis to reflect changing market conditions, business conditions or tolerance for risk.
 
The Firmwide Risk Committee sets market risk limits at firmwide and product levels and our Securities Division Risk Committee sets sub-limits for market-making and investing activities at a business level. The purpose of the firmwide limits is to assist senior management in controlling the firm’s overall risk profile. Sub-limits set the desired maximum amount of exposure that may be managed by any particular business on a day-to-day basis without additional levels of senior management approval, effectively leaving day-to-day trading decisions to individual desk managers and traders. Accordingly, sub-limits are a management tool designed to ensure appropriate escalation rather than to establish maximum risk tolerance. Sub-limits also distribute risk among various businesses in a manner that is consistent with their level of activity and client demand, taking into account the relative performance of each area.


137


Table of Contents

Our market risk limits are monitored daily by Market Risk Management, which is responsible for identifying and escalating, on a timely basis, instances where limits have been exceeded. The business-level limits that are set by the Securities Division Risk Committee are subject to the same scrutiny and limit escalation policy as the firmwide limits.
 
When a risk limit has been exceeded (e.g., due to changes in market conditions, such as increased volatilities or changes in correlations), it is reported to the appropriate risk committee and a discussion takes place with the relevant desk managers, after which either the risk position is reduced or the risk limit is temporarily or permanently increased.
 
Metrics
We analyze VaR at the firmwide level and a variety of more detailed levels, including by risk category, business, and region. The tables below present average daily VaR and year-end VaR by risk category.
 
Average Daily VaR
 
                     
 
    Three Months 
in millions
  Ended March 
Risk Categories   2011     2010      
 
Interest rates
  $ 87     $ 109      
Equity prices
    49       88      
Currency rates
    24       35      
Commodity prices
    37       49      
Diversification effect 1
    (84 )     (120 )    
 
 
Total
  $ 113     $ 161      
 
 
 
1.   Equals the difference between total VaR and the sum of the VaRs for the four risk categories. This effect arises because the four market risk categories are not perfectly correlated.
 
Our average daily VaR decreased to $113 million for the first quarter of 2011 from $161 million for the first quarter of 2010, due to decreases across all risk categories. The decreases in the equity prices, interest rates and currency rates categories were primarily due to reduced exposures and lower levels of volatility. The decrease in the commodity prices category was primarily due to lower levels of volatility.

Quarter-End VaR and High and Low VaR
 
                                         
 
              Three Months 
    As of         Ended 
in millions
  March
    December
        March 2011 
Risk Categories   2011     2010         High     Low      
 
Interest rates
  $ 82     $ 78         $ 98     $ 76      
Equity prices
    42       51           119       32      
Currency rates
    26       27           31       18      
Commodity prices
    49       25           51       20      
Diversification effect 1
    (87 )     (70 )                        
                     
                     
Total
  $ 112     $ 111         $ 153     $ 99      
 
 
 
1.   Equals the difference between total VaR and the sum of the VaRs for the four risk categories. This effect arises because the four market risk categories are not perfectly correlated.
 
Our daily VaR was essentially unchanged from December 2010 to March 2011, reflecting an increase in the commodity prices and interest rates categories, largely offset by an increase in the diversification benefit across risk categories and a decrease in the equity prices category. The increases in the commodity prices and interest rates categories were due to increased exposures. The decrease in the equity prices category was due to reduced exposures and lower levels of volatility.
 
During the first quarter of 2011, the firmwide VaR risk limit was not exceeded, raised or reduced.


138


Table of Contents



The chart below reflects the VaR over the last four quarters.
 
 
chart
 
 

The chart below presents the frequency distribution of our daily trading net revenues for substantially all

inventory positions included in VaR for the quarter ended March 2011.
 


 
chart
 
 

As noted above, daily trading net revenues are compared with VaR calculated as of the end of the prior business day. Trading losses incurred on a

single day did not exceed our 95% one-day VaR during the first quarter of 2011.
 


139


Table of Contents

Sensitivity Measures

As noted above, certain portfolios and individual positions are not included in VaR because VaR is not the most appropriate risk measure. The market risk of these positions is determined by estimating the potential reduction in net revenues of a 10% decline in the underlying asset value. The market risk related to our investment in the ordinary shares of ICBC excludes interests held by investment funds managed by Goldman Sachs.
 
The table below presents market risk for positions that are not included in VaR. These measures do not reflect diversification benefits across asset categories and therefore have not been aggregated.
 
                     
 
Asset Categories   10% Sensitivity      
 
    Amount as of 
    March
    December
     
in millions   2011     2010      
 
ICBC
  $ 319     $ 286      
Equity (excluding ICBC) 1
    2,596       2,529      
Debt 2
    1,483       1,655      
 
 
 
1.   Relates to private and restricted public equity securities, including interests in firm-sponsored funds that invest in corporate equities and real estate and interests in firm-sponsored hedge funds.
 
2.   Relates to corporate bank debt, loans backed by commercial and residential real estate, and other corporate debt, including acquired portfolios of distressed loans and interests in our firm-sponsored funds that invest in corporate mezzanine and senior debt instruments.
 
 
As noted above, VaR excludes the impact of changes in counterparty and our own credit spreads on derivatives as well as changes in our own credit spreads on unsecured borrowings for which the fair value option was elected. The estimated sensitivity of our net revenues to a one basis point increase in credit spreads (counterparty and our own) on derivatives was a $4 million gain as of March 2011. In addition, the estimated sensitivity of our net revenues to a one basis point increase in our own credit spreads on unsecured borrowings for which the fair value option was elected was an $8 million gain (including hedges) as of March 2011.

In addition to the positions included in VaR and the sensitivity measures described above, as of March 2011, we held $3.41 billion of securities accounted for as available-for-sale primarily consisting of $1.30 billion of corporate debt securities, the majority of which will mature after five years, with an average yield of 6%, $791 million of mortgage and other asset-backed loans and securities, which will mature after ten years, with an average yield of 11%, and $641 million of U.S. government and federal agency obligations, the majority of which will mature after five years, with an average yield of 3%. As of December 2010, we held $3.67 billion of securities accounted for as available-for-sale primarily consisting of $1.69 billion of corporate debt securities, the majority of which will mature after five years, with an average yield of 6%, $670 million of mortgage and other asset-backed loans and securities, which will mature after ten years, with an average yield of 11%, and $637 million of U.S. government and federal agency obligations, the majority of which will mature after ten years, with an average yield of 4%.
 
In addition, as of March 2011 and December 2010, we held money market instruments, commitments and loans under the William Street credit extension program. See Note 18 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for further information about our William Street credit extension program.
 
Additionally, we make investments accounted for under the equity method and we also make direct investments in real estate, both of which are included in “Other assets” in the condensed consolidated statements of financial condition. Direct investments in real estate are accounted for at cost less accumulated depreciation. See Note 12 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on “Other assets.”
 


140


Table of Contents

 
Credit Risk Management
 

Overview
Credit risk represents the potential for loss due to the default or deterioration in credit quality of a counterparty (e.g., an OTC derivatives counterparty or a borrower) or an issuer of securities or other instruments we hold. Our exposure to credit risk comes mostly from client transactions in OTC derivatives and loans and lending commitments. Credit risk also comes from cash placed with banks, securities financing transactions (i.e., resale and repurchase agreements and securities borrowing and lending activities) and receivables from brokers, dealers, clearing organizations, customers and counterparties.
 
Credit Risk Management, which is independent of the revenue-producing units and reports to the firm’s chief risk officer, has primary responsibility for assessing, monitoring and managing credit risk at the firm. The Credit Policy Committee and the Firmwide Risk Committee establish and review credit policies and parameters. In addition, we hold other positions that give rise to credit risk (e.g., bonds held in our inventory and secondary bank loans). These credit risks are captured as a component of market risk measures, which are monitored and managed by Market Risk Management, consistent with other inventory positions.
 
Policies authorized by the Firmwide Risk Committee and the Credit Policy Committee prescribe the level of formal approval required for the firm to assume credit exposure to a counterparty across all product areas, taking into account any enforceable netting provisions, collateral or other credit risk mitigants.
 
Credit Risk Management Process
Effective management of credit risk requires accurate and timely information, a high level of communication and knowledge of customers, countries, industries and products. Our process for managing credit risk includes:
 
•   approving transactions and setting and communicating credit exposure limits;
 
•   monitoring compliance with established credit exposure limits;
 
•   assessing the likelihood that a counterparty will default on its payment obligations;
 
•   measuring the firm’s current and potential credit exposure and losses resulting from counterparty default;
 
•   reporting of credit exposures to senior management, the Board and regulators;

•   use of credit risk mitigants, including collateral and hedging; and
 
•   communication and collaboration with other independent control and support functions such as operations, legal and compliance.
 
As part of the risk assessment process, Credit Risk Management performs credit reviews which include initial and ongoing analyses of our counterparties. A credit review is an independent judgment about the capacity and willingness of a counterparty to meet its financial obligations. For substantially all of our credit exposures, the core of our process is an annual counterparty review. A counterparty review is a written analysis of a counterparty’s business profile and financial strength resulting in an internal credit rating which represents the probability of default on financial obligations to the firm. The determination of internal credit ratings incorporates assumptions with respect to the counterparty’s future business performance, the nature and outlook for the counterparty’s industry, and the economic environment. Senior personnel within Credit Risk Management, with expertise in specific industries, inspect and approve credit reviews and internal credit ratings.
 
Our global credit risk management systems capture credit exposure to individual counterparties and on an aggregate basis to counterparties and their subsidiaries (economic groups). These systems also provide management with comprehensive information on our aggregate credit risk by product, internal credit rating, industry, country and region.
 
Risk Measures and Limits
We measure our credit risk based on the potential loss in an event of non-payment by a counterparty. For derivatives and securities financing transactions, the primary measure is potential exposure, which is our estimate of the future exposure that could arise over the life of a transaction based on market movements within a specified confidence level. Potential exposure takes into account netting and collateral arrangements. For loans and lending commitments, the primary measure is a function of the notional amount of the position. We also monitor credit risk in terms of current exposure, which is the amount presently owed to the firm after taking into account applicable netting and collateral.


141


Table of Contents

We use credit limits at various levels (counterparty, economic group, industry, country) to control the size of our credit exposures. Limits for counterparties and economic groups are reviewed regularly and revised to reflect changing appetites for a given counterparty or group of counterparties. Limits for industries and countries are based on the firm’s risk tolerance and are designed to allow for regular monitoring, review, escalation and management of credit risk concentrations.
 
Stress Tests/Scenario Analysis
We use regular stress tests to calculate the credit exposures, including potential concentrations that would result from applying shocks to counterparty credit ratings or credit risk factors (e.g., currency rates, interest rates, equity prices). These shocks include a wide range of moderate and more extreme market movements. Some of our stress tests include shocks to multiple risk factors, consistent with the occurrence of a severe market or economic event. Unlike potential exposure, which is calculated within a specified confidence level, with a stress test there is generally no assumed probability of these events occurring.
 
We run stress tests on a regular basis as part of our routine risk management processes and conduct tailored stress tests on an ad hoc basis in response to market developments. Stress tests are regularly conducted jointly with the firm’s market and liquidity risk functions.
 
Risk Mitigants
To reduce our credit exposures on derivatives and securities financing transactions, we may enter into netting agreements with counterparties that permit us to offset receivables and payables with such counterparties. We may also reduce credit risk with counterparties by entering into agreements that enable us to obtain collateral from them on an upfront or contingent basis and/or to terminate transactions if the counterparty’s credit rating falls below a specified level.

For loans and lending commitments, we typically employ a variety of potential risk mitigants, depending on the credit quality of the borrower and other characteristics of the transaction. Risk mitigants include: collateral provisions, guarantees, covenants, structural seniority of the bank loan claims and, for certain lending commitments, provisions in the legal documentation that allow the firm to adjust loan amounts, pricing, structure and other terms as market conditions change. The type and structure of risk mitigants employed can significantly influence the degree of credit risk involved in a loan.
 
When we do not have sufficient visibility into a counterparty’s financial strength or when we believe a counterparty requires support from its parent company, we may obtain third-party guarantees of the counterparty’s obligations. We may also mitigate our credit risk using credit derivatives or participation agreements.
 
Credit Exposures
The firm’s credit exposures are described further below.
 
Cash and Cash Equivalents.  Cash and cash equivalents include both interest-bearing and non-interest bearing deposits. To mitigate the risk of credit loss, we place substantially all of our deposits with highly rated banks and central banks.
 
OTC Derivatives.  Derivatives are reported on a net-by-counterparty basis (i.e., the net payable or receivable for derivative assets and liabilities for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement.
 
Derivatives are accounted for at fair value net of cash collateral received or posted under credit support agreements. As credit risk is an essential component of fair value, the firm includes a credit valuation adjustment (CVA) in the fair value of derivatives to reflect counterparty credit risk, as described in Note 7 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q. CVA is a function of the present value of expected exposure, the probability of counterparty default and the assumed recovery upon default.


142


Table of Contents

The tables below present the distribution of our exposure to OTC derivatives by tenor, based on expected duration for mortgage-related credit derivatives and generally on remaining contractual

maturity for other derivatives, both before and after the effect of collateral and netting agreements. The categories shown reflect our internally determined public rating agency equivalents.


                                                             
 
in millions   As of March 2011 
                5 Years
                      Exposure
     
    0-12
    1-5
    or
                      Net of
     
Credit Rating Equivalent   Months     Years     Greater     Total     Netting 1     Exposure     Collateral      
 
AAA/Aaa
  $ 561     $ 1,048     $ 2,277     $ 3,886     $ (403 )   $ 3,483     $ 3,075      
AA/Aa2
    5,244       7,917       16,576       29,737       (17,993 )     11,744       6,528      
A/A2
    12,983       35,187       46,176       94,346       (69,552 )     24,794       15,109      
BBB/Baa2
    4,672       15,988       15,320       35,980       (23,664 )     12,316       8,236      
BB/Ba2 or lower
    4,504       5,305       7,982       17,791       (9,361 )     8,430       5,615      
Unrated
    624       1,361       186       2,171       (16 )     2,155       1,664      
 
 
Total
  $ 28,588     $ 66,806     $ 88,517     $ 183,911     $ (120,989 )   $ 62,922     $ 40,227      
 
 
 
                                                             
 
in millions   As of December 2010
                5 Years
                      Exposure
     
    0-12
    1-5
    or
                      Net of
     
Credit Rating Equivalent   Months     Years     Greater     Total     Netting 1     Exposure     Collateral      
 
AAA/Aaa
  $ 504     $ 728     $ 2,597     $ 3,829     $ (491 )   $ 3,338     $ 3,088      
AA/Aa2
    5,234       8,875       15,579       29,688       (18,167 )     11,521       6,935      
A/A2
    13,556       38,522       49,568       101,646       (74,650 )     26,996       16,839      
BBB/Baa2
    3,818       18,062       19,625       41,505       (27,832 )     13,673       8,182      
BB/Ba2 or lower
    3,583       5,382       3,650       12,615       (4,553 )     8,062       5,439      
Unrated
    709       1,081       332       2,122       (20 )     2,102       1,539      
 
 
Total
  $ 27,404     $ 72,650     $ 91,351     $ 191,405     $ (125,713 )   $ 65,692     $ 42,022      
 
 
 
1.   Represents the netting of receivable balances with payable balances for the same counterparty across tenor categories under enforceable netting agreements, and the netting of cash collateral received under credit support agreements. Receivable and payable balances with the same counterparty in the same tenor category are netted within such tenor category.

143


Table of Contents

 

Lending Activities.  We manage the firm’s traditional credit origination activities, including funded loans, lending commitments and the William Street credit extension program, using the credit risk process, measures and limits described above. Other lending positions, including secondary trading positions, are risk-managed as a component of market risk.
 
Resale Agreements and Securities Borrowed.  The firm bears credit risk related to resale agreements and securities borrowed only to the extent that cash advanced to the counterparty exceeds the value of the collateral received. Therefore, the firm’s credit exposure on these transactions is significantly lower than the amounts recorded on the condensed consolidated statement of financial condition (which represent fair value or contractual value before consideration of collateral received). The firm also has credit exposure on repurchase agreements and securities loaned, which are liabilities on our condensed consolidated statement of financial condition, to the extent that the value of collateral pledged to the counterparty for these transactions exceeds the amount of cash received.
 
Other Credit Exposures.  The firm is exposed to credit risk from its receivables from brokers, dealers and clearing organizations and customers and counterparties. Receivables from brokers, dealers and clearing organizations are primarily comprised of initial margin placed with clearing organizations and receivables related to sales of securities which have traded, but not yet settled. These receivables have minimal credit risk due to the low probability of clearing organization default and the short-term nature of receivables related to securities settlements. Receivables from customers and counterparties are generally comprised of collateralized receivables related to customer securities transactions and have minimal credit risk due to both the value of the collateral received and the short-term nature of these receivables.

Credit Exposures
The tables below present the firm’s credit exposures related to cash, OTC derivatives, loans and lending commitments associated with traditional credit origination activities, and securities financing transactions, broken down by industry, region and internal credit rating.
 
During the three months ended March 2011, total credit exposures increased by $16.25 billion reflecting growth in loans and lending commitments as well as an increase in exposure from securities financing transactions. Counterparty defaults and the associated credit losses remained at low levels during the three months ended March 2011. The credit quality of the overall portfolio as of March 2011 was relatively unchanged from December 2010.


144


Table of Contents



                                                                                     
Credit Exposure by Industry
 
                Loans and
    Securities
     
                Lending
    Financing
     
    Cash     OTC Derivatives     Commitments 1     Transactions 2     Total
    As of     As of     As of     As of     As of
    March
    December
    March
    December
    March
    December
    March
    December
    March
    December
     
in millions   2011     2010     2011     2010     2011     2010     2011     2010     2011     2010      
 
Asset Managers & Funds
  $     $     $ 8,751     $ 8,760     $ 1,318     $ 1,317     $ 5,588     $ 4,999     $ 15,657     $ 15,076      
Banks, Brokers & Other Financial Institutions
    9,512       11,020       22,687       23,255       3,284       3,485       5,520       5,592       41,003       43,352      
Consumer Products, Non-Durables, and Retail
                1,343       1,082       10,579       8,141                   11,922       9,223      
Government & Central Banks
    33,164       28,766       10,044       11,705       1,446       1,370       9,937       2,401       54,591       44,242      
Healthcare & Education
                2,141       2,161       6,184       5,754       186       199       8,511       8,114      
Insurance
    2       1       2,401       2,462       3,063       3,054       543       521       6,009       6,038      
Natural Resources & Utilities
                5,876       5,259       14,032       11,021       6       5       19,914       16,285      
Real Estate
                552       528       1,629       1,523       3       3       2,184       2,054      
Technology, Media, Telecommunications & Services
          1       1,376       1,694       9,603       7,690       17       13       10,996       9,398      
Transportation
                902       962       4,562       3,822       7       2       5,471       4,786      
Other
    5             6,849       7,824       5,540       6,007       55       59       12,449       13,890      
 
 
Total
  $ 42,683     $ 39,788     $ 62,922     $ 65,692     $ 61,240     $ 53,184     $ 21,862     $ 13,794     $ 188,707     $ 172,458      
 
 
                                                                                     
                                                                                     
Credit Exposure by Region
 
                Loans and
    Securities
     
                Lending
    Financing
     
    Cash     OTC Derivatives     Commitments 1     Transactions 2     Total
    As of     As of     As of     As of     As of
    March
    December
    March
    December
    March
    December
    March
    December
    March
    December
     
in millions   2011     2010     2011     2010     2011     2010     2011     2010     2011     2010      
 
Americas
  $ 31,216     $ 34,528     $ 32,404     $ 34,468     $ 43,247     $ 38,151     $ 7,790     $ 7,634     $ 114,657     $ 114,781      
EMEA 3
    889       810       23,530       23,396       17,323       14,451       12,689       4,953       54,431       43,610      
Asia
    10,578       4,450       6,988       7,828       670       582       1,383       1,207       19,619       14,067      
 
 
Total
  $ 42,683     $ 39,788     $ 62,922     $ 65,692     $ 61,240     $ 53,184     $ 21,862     $ 13,794     $ 188,707     $ 172,458      
 
 
                                                                                     
                                                                                     
Credit Exposure by Credit Quality
 
                Loans and
    Securities
     
                Lending
    Financing
     
    Cash     OTC Derivatives     Commitments 1     Transactions 2     Total
    As of     As of     As of     As of     As of
    March
    December
    March
    December
    March
    December
    March
    December
    March
    December
     
in millions   2011     2010     2011     2010     2011     2010     2011     2010     2011     2010      
 
Credit Rating Equivalent
                                                                                   
                                                                                     
AAA/Aaa
  $ 26,843     $ 27,851     $ 3,483     $ 3,338     $ 1,804     $ 1,783     $ 1,192     $ 877     $ 33,322     $ 33,849      
AA/Aa2
    8,510       4,547       11,744       11,521       5,714       5,273       9,850       2,510       35,818       23,851      
A/A2
    6,014       5,603       24,794       26,996       19,136       15,766       9,295       8,771       59,239       57,136      
BBB/Baa2
    252       1,007       12,316       13,673       19,789       17,544       1,369       1,466       33,726       33,690      
BB/Ba2 or lower
    1,042       764       8,430       8,062       14,797       12,774       111       130       24,380       21,730      
Unrated
    22       16       2,155       2,102             44       45       40       2,222       2,202      
 
 
Total
  $ 42,683     $ 39,788     $ 62,922     $ 65,692     $ 61,240     $ 53,184     $ 21,862     $ 13,794     $ 188,707     $ 172,458      
 
 
 
1.   Includes approximately $4 billion of loans as of both March 2011 and December 2010, and approximately $57 billion and $49 billion of lending commitments as of March 2011 and December 2010, respectively. Excludes approximately $14 billion of loans as of both March 2011 and December 2010, and lending commitments with a total notional value of approximately $3 billion as of both March 2011 and December 2010, that are risk managed as part of market risk using VaR and sensitivity measures.
 
2.   Represents credit exposure, net of securities collateral received on resale agreements and securities borrowed and net of cash received on repurchase agreements and securities loaned. These amounts are significantly lower than the amounts recorded on the condensed consolidated statements of financial condition, which represent fair value or contractual value before consideration of collateral received.
 
3.   EMEA (Europe, Middle East and Africa).

145


Table of Contents

 
Operational Risk Management
 

Overview
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Our exposure to operational risk arises from routine processing errors as well as extraordinary incidents, such as major systems failures. Potential types of loss events related to internal and external operational risk include:
 
•   clients, products and business practices;
 
•   execution, delivery and process management;
 
•   business disruption and system failures;
 
•   employment practices and workplace safety;
 
•   damage to physical assets;
 
•   internal fraud; and
 
•   external fraud.
 
The firm maintains a comprehensive control framework designed to provide a well-controlled environment to minimize operational risks. The Firmwide Operational Risk Committee provides oversight of the ongoing development and implementation of our operational risk policies and framework. Our Operational Risk Management department (Operational Risk Management) is a risk management function independent of our revenue-producing units and is responsible for developing and implementing policies, methodologies and a formalized framework for operational risk management with the goal of minimizing our exposure to operational risk.
 
Operational Risk Management Process
Managing operational risk requires timely and accurate information as well as a strong control culture. We seek to manage our operational risk through:
 
•   the training, supervision and development of our people;
 
•   the active participation of senior management in identifying and mitigating key operational risks across the firm;
 
•   independent control and support functions that monitor operational risk on a daily basis and have instituted extensive policies and procedures and implemented controls designed to prevent the occurrence of operational risk events;
 
•   proactive communication between our revenue-producing units and our independent control and support functions; and
 
•   a network of systems throughout the firm to facilitate the collection of data used to analyze and assess our operational risk exposure.

We combine top-down and bottom-up approaches to manage and measure operational risk. From a top-down perspective, the firm’s senior management assesses firmwide and business level operational risk profiles. From a bottom-up perspective, revenue-producing units and independent control and support functions are responsible for risk management on a day-to-day basis, including identifying, mitigating, and escalating operational risks to senior management.
 
Our operational risk framework is in part designed to comply with the operational risk measurement rules under Basel 2 and has evolved based on the changing needs of our businesses and regulatory guidance. Our framework includes the following practices:
 
•   Risk identification and reporting;
 
•   Risk measurement; and
 
•   Risk monitoring.
 
Internal Audit performs a review of our operational risk framework, including our key controls, processes and applications, on an annual basis to ensure the effectiveness of our framework.
 
Risk Identification and Reporting
The core of our operational risk management framework is risk identification and reporting. We have a comprehensive data collection process, including firmwide policies and procedures, for operational risk events.
 
We have established policies that require managers in our revenue-producing units and our independent control and support functions to escalate operational risk events. When operational risk events are identified, our policies require that the events be documented and analyzed to determine whether changes are required in the firm’s systems and/or processes to further mitigate the risk of future events.
 
In addition, our firmwide systems capture internal operational risk event data, key metrics such as transaction volumes, and statistical information such as performance trends. We use an internally-developed operational risk management application to aggregate and organize this information. Managers from both revenue-producing units and independent control and support functions analyze the information to evaluate operational risk exposures and identify businesses, activities or products with heightened levels of operational risk. We also provide operational risk reports to senior management, risk committees and the Board periodically.


146


Table of Contents

Risk Measurement
We measure the firm’s operational risk exposure over a twelve-month time horizon using scenario analyses, together with qualitative assessments of the potential frequency and extent of potential operational risk losses, for each of the firm’s businesses. Operational risk measurement incorporates qualitative and quantitative assessments of factors including:
 
•   internal and external operational risk event data;
 
•   assessments of the firm’s internal controls;
 
•   evaluations of the complexity of the firm’s business activities;
 
•   the degree of and potential for automation in the firm’s processes;
 
•   new product information;
 
•   the legal and regulatory environment;
 
•   changes in the markets for the firm’s products and services, including the diversity and sophistication of the firm’s customers and counterparties; and
 
•   the liquidity of the capital markets and the reliability of the infrastructure that supports the capital markets.
 
The results from these scenario analyses are used to monitor changes in operational risk and to determine business lines that may have heightened exposure to operational risk. These analyses ultimately are used to determine the appropriate level of operational risk capital to hold.
 
Risk Monitoring
We evaluate changes in the operational risk profile of the firm and its businesses, including changes in business mix or jurisdictions in which the firm operates, by monitoring these factors at a firmwide, entity and business level. The firm has both detective and preventive internal controls, which are designed to reduce the frequency and severity of operational risk losses and the probability of operational risk events. We monitor the results of assessments and independent internal audits of these internal controls.
 
Recent Accounting Developments
 
See Note 3 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information about Recent Accounting Developments.

Certain Risk Factors That May Affect Our Businesses
 
We face a variety of risks that are substantial and inherent in our businesses, including market, liquidity, credit, operational, legal, regulatory and reputational risks. For a discussion of how management seeks to manage some of these risks, see “Overview and Structure of Risk Management.” A summary of the more important factors that could affect our businesses follows. For a further discussion of these and other important factors that could affect our businesses, financial condition, results of operations, cash flows and liquidity, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.
 
•   Our businesses have been and may continue to be adversely affected by conditions in the global financial markets and economic conditions generally.
 
•   Our businesses have been and may be adversely affected by declining asset values. This is particularly true for those businesses in which we have net “long” positions, receive fees based on the value of assets managed, or receive or post collateral.
 
•   Our businesses have been and may be adversely affected by disruptions in the credit markets, including reduced access to credit and higher costs of obtaining credit.
 
•   Our market-making activities have been and may be affected by changes in the levels of market volatility.
 
•   Our investment banking, client execution and investment management businesses have been adversely affected and may continue to be adversely affected by market uncertainty or lack of confidence among investors and CEOs due to general declines in economic activity and other unfavorable economic, geopolitical or market conditions.
 
•   Our investment management business may be affected by the poor investment performance of our investment products.
 
•   We may incur losses as a result of ineffective risk management processes and strategies.
 
•   Our liquidity, profitability and businesses may be adversely affected by an inability to access the debt capital markets or to sell assets or by a reduction in our credit ratings or by an increase in our credit spreads.
 
•   Conflicts of interest are increasing and a failure to appropriately identify and address conflicts of interest could adversely affect our businesses.


147


Table of Contents

•   Group Inc. is a holding company and is dependent for liquidity on payments from its subsidiaries, many of which are subject to restrictions.
 
•   Our businesses, profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money, securities or other assets or whose securities or obligations we hold.
 
•   Concentration of risk increases the potential for significant losses in our market-making, underwriting, investing and lending activities.
 
•   The financial services industry is highly competitive.
 
•   We face enhanced risks as new business initiatives lead us to transact with a broader array of clients and counterparties and expose us to new asset classes and new markets.
 
•   Derivative transactions and delayed settlements may expose us to unexpected risk and potential losses.
 
•   Our businesses may be adversely affected if we are unable to hire and retain qualified employees.
 
•   Our businesses and those of our clients are subject to extensive and pervasive regulation around the world.
 
•   We may be adversely affected by increased governmental and regulatory scrutiny or negative publicity.
 
•   A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our businesses, result in the disclosure of confidential information, damage our reputation and cause losses.
 
•   Substantial legal liability or significant regulatory action against us could have material adverse financial effects or cause us significant reputational harm, which in turn could seriously harm our business prospects.
 
•   The growth of electronic trading and the introduction of new trading technology may adversely affect our business and may increase competition.
 
•   Our commodities activities, particularly our power generation interests and our physical commodities activities, subject us to extensive regulation, potential catastrophic events and environmental, reputational and other risks that may expose us to significant liabilities and costs.

•   In conducting our businesses around the world, we are subject to political, economic, legal, operational and other risks that are inherent in operating in many countries.
 
•   We may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks or natural disasters.
 
Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995
 
We have included or incorporated by reference in this Form 10-Q, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts, but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. It is possible that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. For a discussion of some of the risks and important factors that could affect our future results and financial condition, see “Certain Risk Factors That May Affect Our Businesses” above, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.
 
Statements about our investment banking transaction backlog also may constitute forward-looking statements. Such statements are subject to the risk that the terms of these transactions may be modified or that they may not be completed at all; therefore, the net revenues, if any, that we actually earn from these transactions may differ, possibly materially, from those currently expected. Important factors that could result in a modification of the terms of a transaction or a transaction not being completed include, in the case of underwriting transactions, a decline or continued weakness in general economic conditions, outbreak of hostilities, volatility in the securities markets generally or an adverse development with respect to the issuer of the securities and, in the case of financial advisory transactions, a decline in the securities markets, an inability to obtain adequate financing, an adverse development with respect to a party to the transaction or a failure to obtain a required regulatory approval. For a discussion of other important factors that could adversely affect our investment banking transactions, see “Certain Risk Factors That May Affect Our Businesses” above, as well as “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.


148


Table of Contents

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
Quantitative and qualitative disclosures about market risk are set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk Management” in Part I, Item 2 above.
 
Item 4.  Controls and Procedures
 
As of the end of the period covered by this report, an evaluation was carried out by Goldman Sachs’ management, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION
 
Item 1.  Legal Proceedings
 
We are involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of our businesses. Many of these proceedings are at preliminary stages, and many of these cases seek an indeterminate amount of damages. However, we believe, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on our financial condition, but may be material to our operating results for any particular period, depending, in part, upon the operating results for such period. Given the range of litigation and investigations presently under way, our litigation expenses can be expected to remain high. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Use of Estimates” in Part I, Item 2 of this Form 10-Q. See Note 27 to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for information on certain judicial, regulatory and legal proceedings.


149


Table of Contents



Item 2.  Unregistered Sales of Equity Securities
and Use of Proceeds
 

The table below sets forth the information with respect to purchases made by or on behalf of The Goldman Sachs Group, Inc. or any “affiliated purchaser” (as

defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) of our common stock during the three months ended March 31, 2011.


                                     
 
                Total Number of Shares
    Maximum Number of
     
    Total Number
    Average Price
    Purchased as Part of
    Shares That May Yet Be
     
    of Shares
    Paid per
    Publicly Announced
    Purchased Under the
     
Period   Purchased     Share     Plans or Programs 1     Plans or Programs 1      
 
Month #1
(January 1, 2011 to
January 31, 2011)
    1,675,378 2   $ 164.03       1,600,000       33,956,376      
Month #2
(February 1, 2011 to
February 28, 2011)
    3,900,000       165.76       3,900,000       30,056,376      
Month #3
(March 1, 2011 to
March 31, 2011)
    3,500,000       160.06       3,500,000       26,556,376      
 
 
Total
    9,075,378               9,000,000              
 
 
 
1.   On March 21, 2000, we announced that the Board of Directors of Group Inc. (Board) had approved a repurchase program, pursuant to which up to 15 million shares of our common stock may be repurchased. This repurchase program was increased by an aggregate of 280 million shares by resolutions of our Board adopted on June 18, 2001, March 18, 2002, November 20, 2002, January 30, 2004, January 25, 2005, September 16, 2005, September 11, 2006 and December 17, 2007. We seek to use our share repurchase program to substantially offset increases in share count over time resulting from employee share-based compensation and to help maintain the appropriate level of common equity.
 
The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by our issuance of shares resulting from employee share-based compensation as well as our current and projected capital position (i.e., comparisons of our desired level of capital to our actual level of capital), but which may also be influenced by general market conditions and the prevailing price and trading volumes of our common stock.
 
The total remaining authorization under the firm’s repurchase program was 26,317,556 shares as of April 21, 2011; the repurchase program has no set expiration or termination date. Any repurchase of our common stock requires approval by the Board of Governors of the Federal Reserve System.
 
2.   Includes 75,378 shares remitted by employees to satisfy minimum statutory withholding taxes on equity-based awards that were delivered to employees during the period.
 
Item 5.  Other Information
 
Amendment to Restated Certificate of Incorporation

On May 6, 2011, The Goldman Sachs Group, Inc. filed a Certificate of Elimination with the Secretary of State of the State of Delaware which, upon filing, had the effect of eliminating from our Restated Certificate of Incorporation all matters set forth therein with respect to the 50,000 shares of our 10% Cumulative Perpetual Preferred Stock, Series G, which had previously been redeemed in full from Berkshire Hathaway Inc. and

certain of its subsidiaries. A copy of the Certificate of Elimination is attached as Exhibit 3.1 to this Form 10-Q and incorporated by reference herein. A Restated Certificate of Incorporation reflecting these changes was filed with the Secretary of State of the State of Delaware on May 6, 2011, and a copy is attached as Exhibit 3.2 to this Form 10-Q.
 


150


Table of Contents

 
Item 6.  Exhibits
 
Exhibits
 
         
  3 .1   Certificate of Elimination of 10% Cumulative Perpetual Preferred Stock, Series G, of The Goldman Sachs Group, Inc.
  3 .2   Restated Certificate of Incorporation of The Goldman Sachs Group, Inc.
  12 .1   Statement re: Computation of Ratios of Earnings to Fixed Charges and Ratios of Earnings to Combined Fixed Charges and Preferred Stock Dividends.
  15 .1   Letter re: Unaudited Interim Financial Information.
  31 .1   Rule 13a-14(a) Certifications.*
  32 .1   Section 1350 Certifications.*
  101     Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Condensed Consolidated Statements of Earnings for the three months ended March 31, 2011 and March 31, 2010, (ii) the Condensed Consolidated Statements of Financial Condition as of March 31, 2011 and December 31, 2010, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2011 and year ended December 31, 2010, (iv) the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and March 31, 2010, (v) the Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2011 and March 31, 2010, and (vi) the notes to the Condensed Consolidated Financial Statements.*
 
 
  This information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

151


Table of Contents

 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
The Goldman Sachs Group, Inc.
 
  By: 
/s/  DAVID A. VINIAR
Name: David A. Viniar
  Title:   Chief Financial Officer
 
  By: 
/s/  SARAH E. SMITH
Name: Sarah E. Smith
  Title:   Principal Accounting Officer
 
Date: May 9, 2011

152