The Goldman Sachs Group, Inc. Q2 2009 (Qtr End 06/26/09) Earnings Call Transcript

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 |  About: Goldman Sachs Group Inc. (GS)
by: SA Transcripts

The Goldman Sachs Group, Inc. (NYSE:GS)

Q2 2009 Earnings Call

July 14, 2009 11:00 am ET

Executives

Dane Holmes – Director IR

David Viniar - CFO

Analysts

Guy Moszkowski - BAS-ML

Glenn Schorr – UBS

Howard Chen - Credit Suisse

Meredith Whitney - Meredith Whitney Advisory

Roger Freeman – Barclays Capital

Jeffery Harte - Sandler O'Neill

Kian Abouhossein – JPMorgan

Michael Mayo - Calyon Securities

Chris Kotowski – Oppenheimer

James Mitchell – Buckingham Research

Robert Lee – KBW

Douglas Sipkin – Pali Research

Steve Stelmach - FBR Capital Markets

Richard Staite - Atlantic Equities

Michael Hecht - JMP Securities

Matt Burnell – Wells Fargo Securities

Ron Mandle – GIC

Operator

Good morning. I would like to welcome everyone to the Goldman Sachs second quarter 2009 earnings conference call. (Operator Instructions) Mr. Holmes, you may begin your conference.

Dane Holmes

Good morning. This is Dane Holmes, Director of Investor Relations at Goldman Sachs. Welcome to our second quarter earnings conference call.

Today's call may include forward-looking statements. These statements represent the firm's belief regarding future events that by their nature are uncertain and outside of the firm's control. The firm's actual results and financial condition may differ, possibly materially, from what is indicated in these forward-looking statements.

For a discussion of some of the risks and factors that could affect the firm's future results, please see the description of risk factors in our current Annual Report on Form 10-K for the fiscal year ended November, 2008.

I would also direct you to read the forward-looking disclaimers in our quarterly earnings release, particularly as it relates to our investment banking transaction backlog, and you should also read the information on the calculation of non-GAAP financial measures that is posted on the Investor Relations portion of our website at www.gs.com.

This audio cast is copyrighted material of The Goldman Sachs Group, Inc. and may not be duplicated, reproduced, or rebroadcast without our consent.

Our Chief Financial Officer, David Viniar, will now review the firm's results.

David Viniar

Thanks Dane, I’d like to thank all of you for listening today. I’ll give an overview of our second quarter results and then take your questions.

I’m pleased to report strong second quarter results for Goldman Sachs. Second quarter net revenues were $13.8 billion, net earnings were $3.4 billion, and earnings per diluted share were $4.93.

Excluding $426 million in preferred dividends associated with TARP repayment, earnings per diluted share were $5.71 and our annualized return on common equity was 23.8%. Our second quarter results are a product of the breadth, resilience and adaptability of our client franchise. We continue to believe that a diverse set of global businesses, staffed by dedicated professionals will be the critical driver of our long-term performance.

Several of the favorable conditions that we experienced in the first quarter of 2009 extended into the second quarter. The competitive environment in the second quarter remained fragmented and levels of available risk capital remained low.

Our ability to stay focused on serving our clients yielded strong results particularly within our multifaceted FICC business. Importantly while first quarter 2009 FICC results reflected strength in our rates and commodities businesses, second quarter performance was driven by higher contribution from our credit and currencies businesses.

This further demonstrates the benefits of having a diversified business model. The quarterly improvement in our results was also a function of a more favorable operating environment for several of our other businesses largely driven by higher equity market prices and activity levels.

As a result we posted strong revenues in our equity underwriting business within investment banking and in our equity sales and trading business within trading and principal investments. Our principal investment segment also benefited from higher equity prices particularly as it relates to our ICBC investment.

Nevertheless we faced headwinds in the second quarter of 2009. The operating environment for several of our businesses, including M&A advisory and security services remains challenging. And uncertain macroeconomic outlook coupled with low CEO confidence has resulted in lower M&A activity.

Given the industry-wide reduction in hedge fund assets and leverage, the results within our security service business were lower than in prior years. Despite the challenging environment we maintained market leading positions in both of these businesses.

In addition our results include fair value losses due to downward price pressure in commercial real estate. Second quarter results were negatively impacted by approximately $700 million of fair value losses associated with commercial real estate loans within FICC, nearly $500 million of losses within [RIPEA] and $170 million in non-compensation expenses reflecting impairment charges related to real estate assets.

Results in the second quarter also included a $426 million preferred dividend associated with the repayment of the TARP preferred stock and approximately $300 million in CVA losses associated with the tightening of our credit spreads.

In light of the difficult macro environment we continue to conservatively manage our risk, capital, and liquidity levels. The risk reduction efforts that we undertook in prior quarters lessened the negative impact of further declines in asset values in the second quarter.

We also continue to benefit from having virtually no direct exposure to the retail consumer business. Given our cautious outlook, maintaining robust levels of risk adjusted capital for the time being is appropriate.

At the end of the quarter we had a Tier 1 ratio under Basel I of 13.8% and a Tier 1 ratio under Basel II of 16.1%. We also maintained a record liquidity pool with our global core access averaging $171 billion during the quarter.

We have an established track record of dynamically managing our capital and liquidity based on our assessment of the operating environment and potential opportunities. Our current levels of capital and liquidity reflect both the potential for further market disruptions as well as the opportunity to capitalize on distressed opportunities.

I’ll now review each of our businesses; investment banking produced net revenues of $1.4 billion, up 75% from the first quarter. Second quarter advisory revenues were $368 million, down 30% from the first quarter. Goldman Sachs ranked first in announced M&A globally as we advised on a number of important transactions that were announced during the quarter.

These include BHP Billiton’s 73.1 billion Australian dollar joint venture with Rio Tinto; Liberty Entertainment’s $14.5 billion sale to Direct TV; and Sumitomo’s $5.8 billion acquisition of Nikko Cordial.

We were also advisor on a number of significant closed transactions, including Roman Haas’ $18.6 billion sale to Dow Chemical; NL’s 9.6 billion euro acquisition of Indessa; and Hutchison Telecom’s 3.6 billion Australia dollar merger with Vodafone’s Australian Telecom operations.

Second quarter underwriting net revenues were $1.1 billion. Equity underwriting revenues were $736 million, up significantly from the first quarter. The increase in activity reflected our clients’ capital needs particularly in the financial institution sector which coincided with greater investor appetite for equity assets.

The activity was further enhanced by stabilizing equity market values. Debt underwriting improved 35% to $336 million given the strength in investment grade municipal issuance during the quarter.

During the second quarter we participated in many noteworthy underwriting transactions including HSBC’s $19.6 billion rights offering; the state of California’s $6.9 billion municipal bond offerings; and ArcelorMittal’s $4 billion common stock and convertible notes offering.

Our investment banking backlog declined during the quarter. Let me now turn to trading and principal investments, which is comprised of FICC, equities and principal investments. Net revenues were $10.8 billion in the second quarter reflecting particular strength across our FICC and equities client franchise.

FICC net revenues were $6.8 billion in the second quarter representing a 4% increase from the first quarter. Our FICC performance continued to be driven by historically wide margins, strong market share, and a focus on more liquid plain vanilla transactions.

Credit products net revenues were up substantially due to higher levels of customer activity, across both investment grade and high yield products, largely in cash and other liquid markets. Net revenues in currencies were up sequentially on higher trading volumes in volatile yet trending markets.

Interest rate net revenues were strong but down from a record first quarter as client activity levels declined and spreads narrowed modestly. Commodities revenues were also solid but down sequentially on lower customer activity levels. Mortgage results improved sequentially but continued to be negatively impacted by losses within our commercial real estate loan portfolio which totaled approximately $700 million.

Turning to equities net revenues for the second quarter were $3.2 billion, up 59% sequentially. Equities trading net revenues were up over 100% as equity values increased leading to more active new issue markets and higher customer volumes across both cash trading and derivatives.

Net revenues from our principal strategies business were positive but not a significant revenue driver in the quarter. Equities commissions were up 5% sequentially to $1 billion. Turning to risk, average daily value at risk in the second quarter was $245 million, up modestly due to an increase in equity VaR, offsetting a decrease in interest rate VaR.

Let me now review principal investments, which produced net revenues of $811 million in the second quarter. Our investment in ICBC generated net revenues of $948 million, driven largely by a 30% increase in ICBC stock price during the quarter. Our corporate principal investing portfolio generated net gains of $343 million and real estate principal investments generated approximately $500 million in losses.

In asset management and security services, we reported second quarter net revenues of $1.5 billion, up 6% from the first quarter. Asset management produced net revenues of $922 million which was down 3% from the first quarter.

Assets under management grew 6% sequentially to $819 billion largely as a result of market appreciation. Security services net revenues of $615 million were up 22% sequentially due to the seasonally stronger second quarter.

Now let me turn to expenses, compensation and benefits expense in the second quarter were $6.6 billion, accrued at 49% of year to date net revenues. As I’ve highlighted previously this number includes salaries, discretionary compensation, amortization of prior year equity rewards and other items such as payroll taxes, severance cost and benefits.

As in every other year we much accrue compensation and based on our expectation of the full year expense. But incentive compensation [inaudible] are not made until year end and thus compensation will ultimately reflect the firm’s performance for the entire year.

Second quarter non-compensation expenses excluding those related to consolidated investments were $1.8 billion, 11% higher than the first quarter driven by higher brokerage clearing and distribution expenses and other expenses which included a $50 million special assessment by the FDIC.

Total staff at the end of the second quarter was approximate 29,400, down 1% from the first quarter. Our effective tax rate was approximately 31.7% for the second quarter. For the past two years we have operated in an extremely challenging environment. Our performance in this cycle has been guided by several principals including putting our clients’ needs first, executing our stated strategy and acting as a good steward of the firm.

We adhere to these philosophies to enhance and preserve our franchise and protect the interest of our shareholders. These are long standing principals and we remain committed to them. Furthermore their value is amplified in a difficult environment.

Thus we will continue to focus on maintaining our leading global franchise, serving the world’s most important corporations, financial institutions, governments, and high net worth individuals. In the current environment our clients’ demand for effective advice and execution is elevated. To meet these demands we will continue to provide a broad set of solutions on an integrated basis, seeking to serve as a trusted advisor, financier, asset manager, co-investor, and market marker.

This environment is not conducive to straightforward solutions. Our culture of innovation and nimbleness allows us to react quickly in this dynamic environment. Financial markets and businesses are increasingly global and our geographic reach uniquely positions us to serve our clients anywhere in the world.

Being a good steward of our financial position means that we will continue to manage our capital and liquidity levels based upon a conservative assessment of the potential risks and opportunities that may lie ahead.

This allows us to provide risk capital where it is scarce, and stay focused externally. We believe that our commitment to these principals represents the best strategy for delivering attractive returns through the cycle.

With that, I’d like to thank you again for listening today and I’m now happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Guy Moszkowski - BAS-ML

Guy Moszkowski - BAS-ML

First one very factual question, what was your risk weighted assets at the end of the quarter.

David Viniar

Our risk weighted assets were on a Basel I basis about $409 billion, and on a Basel II basis about $382 billion.

Guy Moszkowski - BAS-ML

So based on a sort of flat to smaller average balance sheet I guess relative to the prior quarter and improved FICC and equity trading revenues, it would seem that your bid offer spreads on average seemed to have actually improved based on, compared to the first quarter, is that fair.

David Viniar

I would say they were kind of flattish and that what really drove it were activity levels which kind of didn’t result in a whole lot of assets on our balance sheet because the velocity of assets was quite high.

Guy Moszkowski - BAS-ML

And you alluded in your comments to the fact that a lot of the focus really is on very liquid and kind of plain vanilla stuff, and when I met with you and your team a few weeks ago there was even some discussion of distressed and the fact that you really weren’t seeing good risk adjusted returns on a lot of the distressed deal flow that you were seeing so you weren’t doing much there, is that still fair.

David Viniar

Hasn’t changed at all.

Guy Moszkowski - BAS-ML

So then I guess the follow-up question to all of that is, if your core excess is around $170 billion and I think your Tier 1 comment to RWA is something approaching 11%, and I think the government’s hurdle for exiting TARP sounds like based on some other firms that it must have been around 6%, 6.5%, how do you think about deploying what looks like pretty significant excess liquid capital over time and I guess the corollary to that would be do the results of the first half which were obviously very encouraging, do they encourage you to raise your targeted ROE from the 20% kind of return on tangible goal that you’ve talked about.

David Viniar

Well let me answer that question first, no. Our target as you know has not changed since we went public and I don’t think it’s going to change for now. That’s what we say over the cycle and there are good parts of the cycle and bad parts of the cycle and I think that’s a fair target for over the cycle.

As far as deploying capital a couple of things I would say, first of all the world is still not a great place. There are, the economies are still in difficult situations in many parts of the world. Second we are hopeful that we will see opportunities although we’re a buyer, but there have not been a lot of sellers. Certainly not at prices we’d deem attractive so I don’t know when that’s going to happen or if it’s going to happen.

And the third thing is that there are going to be new capital regulations coming out. We don’t know what they’re going to be. So we have to wait and see.

Operator

Your next question comes from the line of Glenn Schorr – UBS

Glenn Schorr – UBS

Let’s talk about funding needs just for a second, I look at your debt maturity schedule and its actually in a lot better shape than most, but you still have some coming due each year, 10 or so for the next, who knows, eight years or whatever. How much have you pre-funded in terms of the near-term and obviously I take that in the context of, as Guy just pointed out, really high capital ratios and FICC liquidity buffer, but where I’m getting at is that people are issuing in this market, you’ve been able to issue in this market at tighter spreads but still not tight enough spreads.

David Viniar

I think that in a way you just answered the question. We have a lot more cash than we have debt maturities coming due. We’re not forced to issue debt for quite a while if we didn’t want to. I think we will still want to continue to issue small amounts over time at various maturities. We’d like to keep walking our spreads in which has actually been happening as I think the world is getting better and people are getting again more comfortable with us.

So I wouldn’t tell you we’re going to be out of the market. I would expect we’ll be in the market periodically, more to continue to have access than because we have to.

Glenn Schorr – UBS

On this phenomena of the wider spreads and I think you’ve spoken well enough to, its not at its [wides] but its also not going to necessarily go back to where we come from, help us walk through how much of its reduced competitive landscape and how much of that is temporary from the standpoint of because some of its coming into more liquid products its not necessarily all being earned in high risk weighted asset businesses. These are businesses that are actually flow businesses that are more of a if anything people are going to allocate more resources to going forward.

David Viniar

Look, it’s very hard to quantify. I think you’ve hit on what a big driver of the performance has been and I don’t, I think some part of it is sustainable and some part of it is not. Over time firms will recover, firms will be willing to provide more risk capital and its going to happen over time. It will drive spreads narrower. That is, it just will happen over time, it always does.

Of course as you know in some of the other businesses we have they’re in some ways lower than we expected to see. I would expect that as you see more and more people willing to provide risk capital, you’ll see the merger business start to pick up. So you have some things that hopefully will offset.

Glenn Schorr – UBS

One last one, I know the answer but I have to ask it anyway, a bunch of companies take a look at the new environment with new regulations coming down the pipe and think about what’s happening in the funding markets and have gone through some rigorous business line rationalization processes. I think Goldman’s DNA is more of capital [inaudible] and it kind of goes towards with client needs and where the investment opportunities are but has there been any “business line rationalization” you need to see any need for that, and is it how dramatically is the answer based on where the new capital requirements shake out.

David Viniar

We have of course have to see what the capital requirements are. We don’t really think that’s going to change the way we do business. And you know we’ve been quite consistent in saying that we like our business model, that we think our business lines are good business lines. We’re always looking to expand them where we think there are opportunities; we largely expand them in different locations around the world.

And they ebb and flow at different times. Rather than getting out of businesses which actually I think we think has been problematic for some, when you tend to get in and out of businesses, you tend to get out at the bottom, in at the top and we try not to do that. We try and be pretty consistent.

So no, we’re pretty happy with the business mix we have right now.

Operator

Your next question comes from the line of Howard Chen - Credit Suisse

Howard Chen - Credit Suisse

Somewhat of a follow-up to Guy’s question on capital, with respect to liquidity [inaudible] liquidity continues to grow as you noted, how do you think about the potential drag that’s having on the returns if at all.

David Viniar

It has a fairly big drag on our returns, $172 billion of capital, of excess liquidity where we’re funding kind of at unsecured rates rather than secured rates and in this environment there’s a pretty big spread. So it has a pretty big drag but in the risk reward of having that drag and having enough liquidity under any and all circumstances versus not having the drag and potentially not having enough liquidity, we’ll take the [drag].

We’ve always thought that liquidity risk management was the single most important thing for any financial firm including ours. We continue to think that and so I think we’re at the very conservative end right now, but we’ll always be at the conservative end.

Howard Chen - Credit Suisse

And then second, I know you mentioned the $700 million of commercial real estate write-downs in your commentary, but could you just provide us with where gross exposure levels and marks stood at the end of the quarter, in the usual hotspots, I think we’re really just down to the commercial real estate now.

David Viniar

I think that’s really the only thing and if you look across all of our commercial real estate within FICC, we had round numbers $8 billion, about $1.6 billion of that was securities so you really have market value about $6.4 billion of loans. And that’s marked really in the low 50's.

Howard Chen - Credit Suisse

A lot of real time industry discussion right now on OTC market regulation and more recently the energy trading markets, any evolved thoughts on your end on how all this plays out and how you are potentially weighing the positives and negatives for the firm.

David Viniar

Look, it’s too early to tell. Again all the things that have been proposed have been at very high levels right now. On OTC derivatives we are a believer in central clearing. Wherever things can be standardized and be cleared centrally, we think that’s good and its good for the market and actually its good for us because it levels the playing field in some ways.

We’re always kind of at the very conservative end in our credit terms and so we think that this will level the playing field so we like that. There’s always going to be a need for non-standardized OTC derivatives to help our clients manage their risk. I mean there are a lot of corporations that need the risk management services and that don’t want to provide the initial margin of trading on the exchange.

So we’re supportive of it where it makes sense and as far as in commodities, again we believe very strongly that supply and demand is what drives the markets more than anything else and whenever we’re doing transactions tend to be on the other side of our corporate clients. So consumers need hedging, producers need hedging and you need financial intermediaries to help do that.

But we’ll see what the regulations show.

Howard Chen - Credit Suisse

Okay, thanks for the thoughts and congrats on the quarter.

Operator

Your next question comes from the line of Meredith Whitney - Meredith Whitney Advisory

Meredith Whitney - Meredith Whitney Advisory

Good thing I’m not a tech analyst, I had a glitch there.

David Viniar

I didn’t know what happened to you Meredith.

Meredith Whitney - Meredith Whitney Advisory

Yes, I was on mute. My question relates to once you have established or the government has established, the regulators have established clear capital levels that they deem appropriate, when would you update your shelf because that looks a little light in context of what you could repurchase and then as a follow-on, what’s your appetite in terms of sequencing to repurchase.

David Viniar

Well first shelf really is for issuing not repurchasing. So I think we can from a just purely technical matter we don’t need to update the shelf to repurchase. So I think we’re fine there and we’re always reviewing our, both our equity and our debt shelf so that we have sufficient powder whenever we need to issue and so we review it constantly. We talk to our Board about it and whenever we need to update it we just go back to the Board and subject to their agreement we would update it. But I wouldn’t read much into it one way or the other.

Again as far as timing and sequencing, it’s too early to say anything. As I said before first of all we’re going to manage things conservatively because the environment is still a very tricky environment and you know as you well know, and I know you believe, we’re way far away from being out of the woods in our environment. So we’re going to be at the conservative end on our capital plus there’s going to be new capital regulations coming out and we have to look and see what they are before we make any decisions.

Meredith Whitney - Meredith Whitney Advisory

Would you talk about sort of the sequencing month to month in terms of activity and then how this month is shaping up so far?

David Viniar

We don’t normally go through month to month. We disclose quarterly not monthly. But I would tell you there wasn’t that big a difference across the second quarter. It was pretty standard across really the entire quarter. And it’s just much too early to tell this month. We’re two weeks into it and one of the weeks was July 4th so that was naturally a very, very quiet week. So it’s really hard to say.

Operator

Your next question comes from the line of Roger Freeman – Barclays Capital

Roger Freeman – Barclays Capital

I guess on the credit trading side, can you talk to, I understand its sort of been flow driven revenues there but we’ve gone through the best six month period for high yield and high grade returns in history and I’m wondering how much of the revenues are inventory benefits because it’s an inventory business trading corporate credit and did you take a view on spread tightening where you didn’t hedge out that exposure, and then if we’re not going to have that in the back half of the year, how much of an impact would that be.

David Viniar

Virtually none was based purely on spreads tightening and inventory markups. We don’t, we tend to move around whether we’re long or short on a daily basis. Most of the P&L coming from our credit trading business was in a variety of ways, a slow business. That was really the biggest driver. It was not just markups of inventory.

Roger Freeman – Barclays Capital

Okay so you had hedged out the credit spread tightening.

David Viniar

Yes, pretty much so and in our legacy leverage loan positions we’re down to a little over $2 billion of market value and that is largely hedged as well. So there’s very little of that. That doesn’t mean in the future someday we wouldn’t take a view either bullish or bearish but that was very little.

Roger Freeman – Barclays Capital

Okay and then on equity trading, I guess one thing that I’m trying to reconcile is the relative strength of the trading line item versus the commissions, trading was right up at a record, commissions were strong but not at the same level of strength and trading deal flow you would think would generate outsize commissions, so I guess the question is how much of that was derivatives trading and then also you look at the VaR, it was the one area where VaR really picked up a lot so it looks like a lot more risk was taken in equities trading. Can you try and reconcile some of those pieces.

David Viniar

Sure, well first of all it was really strong across both derivatives and cash and I would say, and you see this some times. You go back in history you will see times where when I would say trading activity levels were not consistent with commission levels which are just really what is on the exchange and so the two are not necessarily related to each other.

And one of the things we’ve always done and you know, is we will take risk where our clients want us to and where there are opportunities. So it’s not unusual for our risk to be up in one area and down in another area, where we see opportunities and where our clients want us to.

So there was more activity in the equity, equity risk was up because there was more activity and interest rate risk was down because there was less activity.

Roger Freeman – Barclays Capital

And is it fair to say within cash trading that the facilitation was up a fair amount in the quarter.

David Viniar

Yes.

Roger Freeman – Barclays Capital

Okay, and then I guess on commodities, just to drill a little into what Howard was asking so, you’ve historically talked about commodities I think being 20% of FICC and is that still sort of a range that we’re in right now.

David Viniar

There’s a very wide range around that. That’s a number that we’ve given you at times of what it’s been since we’ve gone public in total. But there’s a really wide range quarter to quarter.

Roger Freeman – Barclays Capital

Are we in the upper or lower end of that right now.

David Viniar

One or the other.

Roger Freeman – Barclays Capital

Let me ask this, when you think about the regulatory changes here again, a lot of high level stuff has been discussed, but if position limits are put in place but the hedge exemptions remain, it sounds to me based on what you said before that that would not have any material impact on your business because you really are just hedging client risk as opposed to doing a lot of prop trading [and] energy.

David Viniar

Right, that is right but boy the devil is in the details. So it’s hard to say until you see—

Roger Freeman – Barclays Capital

The question is how do you define hedges, right.

David Viniar

That’s exactly right.

Roger Freeman – Barclays Capital

On [TLGP] debt there’s been some discussion about you taking that out, is there a call, are you able to call that debt.

David Viniar

No, I don’t think any of the debt we’ve issued has call features. So no, we have no ability just go take it out.

Operator

Your next question comes from the line of Jeffery Harte - Sandler O'Neill

Jeffery Harte - Sandler O'Neill

A couple of things, investment banking obviously underwriting is very strong, you mentioned the backlog was down some and how good [FIG] specifically was this quarter, as we start looking forward, does the FIG capital raise environment still have legs to run through the back half of the year or are there kind of other areas you could see picking that up, how are you looking at the underwriting businesses in the second half.

David Viniar

Well first one interesting thing to always think about when you think of the backlog, a lot of equity deals actually never get in the backlog. M&A deals always get in the backlog because they take time. But it’s not unusual in today’s environment for at least with some number of equity deals for them to come up because the client decides on a Tuesday they want to do an equity raise, they call us on Tuesday afternoon and we do a book build over Wednesday and do the deal on Thursday.

So the backlog is a very good indication on mergers and it’s somewhat an indication on equities too but you have to be a little careful of looking at backlog as an indicator what’s going to happen later in the year in underwritings. At lot of financial institution equity was issued but I think there is still a lot of corporations around the world that need to rebuild their balance sheet.

And as, if markets stay okay and stay receptive I think there’ll be a lot equity offerings.

Operator

Your next question comes from the line of Kian Abouhossein – JPMorgan

Kian Abouhossein – JPMorgan

Equity derivatives, can you talk a little bit about the business in terms of performance because if you look on a quarter on quarter basis, clearly equity numbers were very strong and just trying to understand if this was a very important driver also on a quarter on quarter basis.

David Viniar

Yes, our equity derivatives business as you know is a very good business for Goldman Sachs. Both our derivatives and our cash businesses were very strong in the quarter although derivatives was up more quarter over quarter then cash was.

Kian Abouhossein – JPMorgan

Okay and you mentioned FX being very strong, but volatility came down quite materially in the second quarter which I assume impacts margins, can you explain the strengths in FX.

David Viniar

It was, there was a lot of activity and you had pretty good trending markets which is always good for us.

Kian Abouhossein – JPMorgan

And on margins, we’re hearing some of the European banks indicating some margin pressure starting to come in at fixed income, do you see any regional difference between US emerging market Europe.

David Viniar

Not significantly.

Kian Abouhossein – JPMorgan

And how do you see margins in fixed income, if I compare them to two, two and a half years ago, at what level would you say they are in the fixed income worlds on a comparable basis.

David Viniar

I’d say they were better than they were two, two and a half years ago.

Kian Abouhossein – JPMorgan

But not two or three times better.

David Viniar

It’s hard to quantify to that level of precision.

Kian Abouhossein – JPMorgan

And lastly in respect to fixed income do you believe there’s a real structural change in the way fixed income will be priced or do you think it’s a lack of capital which will flow back over time into the business and reduce margins to the levels that we’ve seen two, two and a half years ago.

David Viniar

I think that clearly margins are up now. I think it is unrealistic to think that some amount of capital won’t flow back. I think some amount of capital will which will reduce margin to some extent but I’m not convinced it will go all the way back to where it was.

Operator

Your next question comes from the line of Michael Mayo - Calyon Securities

Michael Mayo - Calyon Securities

Can you quantify the change in the backlogs from the first to the second quarter.

David Viniar

It was down.

Michael Mayo - Calyon Securities

Okay, non-US versus US revenues, can you talk about that linked quarter.

David Viniar

Yes, one of the things we always tell you is you have to be careful about that quarter over quarter because we have global books and global trading. Best estimate it was roughly 50/50 US, non-US; actually something like 51/49 US, non-US, but pretty close to 50/50.

Michael Mayo - Calyon Securities

And any non-US countries that stand out in particular as doing a little bit better.

David Viniar

No, it was a little bit more in Europe than in Asia, but not dramatically more.

Michael Mayo - Calyon Securities

Okay, and then you replaced a [lost] revenues a lot, and just when we look at the underwritings in the second quarter it looks like most of the underwriting revenues came from banks, I’m just looking at the same Dealogic data you’d have, but as you point out 19 of the 20 biggest equity deals you did were to banks and financial firms. So my question is if the banking industry is saying they have enough capital now and you might not believe that, but does that mean you’ll be hard pressed to replace those underwriting revenues from the second quarter.

David Viniar

Well you know I never talk about consistency of revenues, so don’t know is one answer. But as I just said there are a lot of companies around the world that still need to fix balance sheets. And I think that if the markets stay receptive, that there will be a lot of equity issuance going on over the rest of the year.

Michael Mayo - Calyon Securities

And by receptive do you mean simply the level of the stock markets.

David Viniar

Both the level and the willingness of buyers to buy. You had a lot of cash, a lot of investors wanted to take equity positions over the course of the second quarter. They need to stay, they need to continue to feel that way.

Michael Mayo - Calyon Securities

And last question, we’ve talked about the multiplier effect, how much does trading go up for every dollar of underwriting you do, and can you say what the multiplier effect was say in your underwriting business, in other words if I look year over year on your published data, equity trading went up six times relative to the increase in equity underwriting. Now I know there’s a lot of data in that equity trading number, would you say the multiplier is six to one, or two to one.

David Viniar

Actually I don’t know. And I think it’s not necessarily consistent but clearly around equity underwritings you’re going to see a lot of trading activity. It’s not linear at all. And so I’d be hard pressed to give you an exact number there. I’d really be making it up if I gave it to you.

Operator

Your next question comes from the line of Chris Kotowski – Oppenheimer

Chris Kotowski – Oppenheimer

I noticed that corporate private equity investments were up about $500 million from last quarter to this quarter and I was wondering is that indicative of new investing or is it marking to market up positions that were there and does it relate to like willingness to put dry powder to use.

David Viniar

It was largely marking to market things that were there. There were some new investments but more of it was things that we already had.

Chris Kotowski – Oppenheimer

Okay, and then just like some of my brethren on the phone, I’m stunned to sort of see your TCE levels about 50% above where they were just 18 months ago and I guess we’re all wondering what do you do with all this capital and how long do you warehouse it and I’m curious what capital ratio do you think is the most relevant that we should be looking at and any idea kind of what you think a long-term target is.

David Viniar

So I’ll give you the same answer I gave everyone else on the capital which is we’re not out of the woods. The world is still a tough place. We’re going to be conservative. There’s new capital regulations coming. We’re hoping we’ll see opportunities. And as far as a number, like with all things, with risk with other things, we don’t think there is a single number that people should look at. We think you should look at a variety of numbers; TCE, Tier 1 capital ratios.

We’re a believer and Basel II being a very, a reasonably good measure of risk and a good capital ratio and everyone is going to be moving on to Basel II over the next several years so I think that will be a consistent measure over the next couple of years. I think it’s a good one to look at.

Operator

Your next question comes from the line of James Mitchell – Buckingham Research

James Mitchell – Buckingham Research

A quick question on asset management business, assets under management up, revenues down, can you talk to the dynamic there, is it just some beginning of period pricing in the institutional business or is there something else going on there.

David Viniar

No, it’s actually, the two things where one is you know assets under management did not come in all at the beginning of the quarter so it took awhile for them to go up. But really what it was, it’s a small difference and there were a couple of items in the first quarter that were some one-time fees that were not repeated in the second quarter and if they hadn’t been there, its small, but if it hadn’t been there then you would have seen what you would have expected which is up second quarter, first quarter aligned with assets. There was nothing else to it.

James Mitchell – Buckingham Research

Okay, and then maybe just following up on the equity VaR question, the one situation is if you looking in equities, volatility was down quite a bit, so I would have thought that would help dampen any increase in the VaR. Is it the trading side or is it really just the underwriting business was so strong and you have some capital and risk allocation to the big up tick in the equity underwriting book, just trying to understand.

David Viniar

No, it was really the trading side much more than the underwriting side and yes, volatility was down and that would help dampen it but there was just a lot more activity.

James Mitchell – Buckingham Research

And was that more driven by cash or the derivatives business.

David Viniar

Both. There was a lot of activity on both sides.

James Mitchell – Buckingham Research

And maybe lastly on just M&A, obviously there is a cycle, it tends to take a while. Balance sheets need to be repaired for it, but what’s your sense of I guess the dialogue and the outlook as we go forward here. Do you think there’s, given that the markets have been stable for a little while and if that lasts, do you think we finally start to see some up tick there or do we still have to get through a few more quarters of people repairing balance sheets.

David Viniar

I think that if the markets stay stable you will start to see a big up tick in activity but you won’t see an up tick in revenues for a number of quarters. But I think if you really have stable markets for another few months and see how confidence starts to get a little better, then I think you’ll start to see some up tick there.

James Mitchell – Buckingham Research

But you’re seeing good levels of dialogue.

David Viniar

Yes but we have for awhile and it hasn’t translated into deals. So you really need that stability for it to happen.

James Mitchell – Buckingham Research

On the CRE investments, do you disclose what your commitments are. Obviously you wrote off about $500 million on the investment line but I think total outstanding only fell around $100 million so are you, is there draw downs on commitments—

David Viniar

There were a couple hundred million dollars of draw downs and I think we disclosed it in the Q, its all in the Q.

Operator

Your next question comes from the line of Robert Lee – KBW

Robert Lee – KBW

Most of my question were asked but I did have one or two quick ones, first actually relates to the money fund business, obviously within the scheme of Goldman its not huge but in that industry you’re a pretty big player, can you give us your thoughts on where you see capital, if you see capital requirements starting to come into that business as its one of the proposals out there.

David Viniar

Again, too early, I’m sorry to be not answering these questions, but it’s just too early to tell. There’s a bunch of proposals out there. They are at the very high level. That is one of the things that’s on the table and we just don’t know exactly where that’s going to end up.

Robert Lee – KBW

And maybe in the security services business and it clearly as you point out, its been impacted a lot by variety of issues, lower customer balances, etc. but as you look out what are you kind of hearing from your clients. Are you seeing that, it seems like we’re getting through the redemption cycle, that industry is starting to talk about maybe even flows at some point later in the year. Is that, are you hearing that reflected back from your clientele.

David Viniar

Yes, I think that’s absolutely right. I think we’re, assuming performance stays okay which it’s been the first half of this year, performance has been pretty good. It feels like we’re pretty much through the redemption cycle and it actually looks like you’re going to start to see some money flowing into hedge funds. How that continues will be really dependant upon performance but that’s certainly what it feels like right now.

Operator

Your next question comes from the line of Douglas Sipkin – Pali Research

Douglas Sipkin – Pali Research

Just two questions, one obviously tremendous pricing improvement in the fixed income trading business, is that carrying over into the underwriting side as well, are you seeing maybe the ability to raise prices a little bit there.

David Viniar

No I think underwriting spreads have been largely flat and they have been for awhile. They haven’t really changed.

Douglas Sipkin – Pali Research

Even for like rights offerings and things of that nature.

David Viniar

Not materially different.

Douglas Sipkin – Pali Research

Secondly in terms of FICC, what percentage of the volume increase would you attribute to maybe investors getting in front of potential regulatory changes or thinking about CDS moving more to exchanges versus sort of just people getting more involved in risk assets.

David Viniar

I think it was largely driven by the latter. It was really people having much more of a desire to get involved in risk assets over the course of the quarter.

Douglas Sipkin – Pali Research

And then can you update us on when you officially are changing locations and are there any thing we need to be thinking about in terms of occupancy expenses after that.

David Viniar

We will begin to move into our new building in the fourth quarter of this year and then we’ll continue to move in over the course of next year and I think you will see an increase in occupancy expenses over the fourth quarter of this year and across next year as we’re kind of in two buildings and then you’ll see it decline again.

Operator

Your next question comes from the line of Steve Stelmach - FBR Capital Markets

Steve Stelmach - FBR Capital Markets

Just real quick question on the competitive landscape post TARP repayment, are you seeing those who have repaid TARP become a little bit more aggressive since the TARP repayment or is the competitive landscape pretty much as it was for most of the quarter.

David Viniar

I don’t think it’s really changed at all based on TARP repayment.

Steve Stelmach - FBR Capital Markets

Okay so people are still generally risk averse, at least your competitors.

David Viniar

Most are and some are not but most are.

Steve Stelmach - FBR Capital Markets

And then maybe I’ll ask that capital question one last time but when you think about your capital levels, how should we think about what you think the regulatory environment is going to look like versus just your general risk aversion out there. How should we think about that split.

David Viniar

I think they both influence us right now. We don’t know where the regulatory environment is going to change be also are very cognizant that the environment is still risky. It’s not that long since we were in a really risky time and its not like economies around the world are booming and so there’s a lot of risk out there. Both of those things are influencing us.

Steve Stelmach - FBR Capital Markets

General mantra is just more the better at this point.

David Viniar

Yes.

Operator

Your next question comes from the line of Richard Staite - Atlantic Equities

Richard Staite - Atlantic Equities

Can you give updates on a plan to grow the asset management and private banking businesses going forward. I think this is an area where you’ve mentioned the possibility of acquisitions in the past and given the strength of your balance sheet you’re obviously in a good position to do that. So do you see opportunities out there at the moment.

David Viniar

Sure, look we’ve always felt the same way about that business which is if there were an acquisition that made sense financially for us to do we would certainly consider it. When we look at the prices of most of the acquisitions we think that they haven’t made sense and that you’ve had to assume really heroic growth rates that we don’t think are realistic.

In a way sometimes when you make acquisitions you have to pay for them twice as well because you generally have to buy them and then you have to give big guarantees to the people to keep them. And we’ve been able to grow that business organically. It’s taken awhile but we’ve grown it quite successfully, almost exclusively organically.

And the high likelihood is that’s the way we’re going to continue to grow it in the future.

Operator

Your next question comes from the line of Michael Hecht - JMP Securities

Michael Hecht - JMP Securities

I just wanted to come back to the equity trading number and sustainability there, $2.2 billion is obviously just a monster number and I know you said it wasn’t a big portion from principal to strategies or prop trading and you note the derivatives were strong but just trying to think about any of the other drivers there. I think you report insurance activities there, and then how do we think about just the 15% positive move in the equity markets here and do we need to see a strong equity market environment like that to drive that type of quarter in equity trading.

David Viniar

The biggest driver has continued to be cash and derivatives trading. So the insurance is in there, GSP is in there, but they’re not drivers. Its really cash and derivatives trading is the biggest driver. And the issue about the equity markets is it probably has the most correlation of any market between the direction of prices and how we do not because we’re long or short but because it is the one market where you tend to see more activity when the market is going up.

Because people are more confident they feel better, they do more. That’s not an absolute so you could see a situation where equity markets are flattish, or up a little or down a little and we do quite well. But as you know we are, our results are really tied more to activity levels than anything and in equity markets people tend to do more when markets are improving.

And so it usually is helpful to us.

Michael Hecht - JMP Securities

And then just on FICC and maybe trading broadly it sounds like you’re saying that the trading spreads we’re seeing are likely to continue for the near-term, over the longer-term we’ll have to see but I’m just wondering about how we think about normal kind of third quarter and even like second half seasonality in trading, particularly when we’ve seen such a very strong first half result.

David Viniar

There is no normal. I wish I could tell you that [there’s] something that was normal in our business but I wouldn’t know how to define it and we’ll just have to see over the second half of this year.

Michael Hecht - JMP Securities

I just wanted to follow-up on your comments on the M&A cycle and what we need to see to spur more activity, I think you used to kind of speak to, you kind of tracking the level of conversations the bankers were having with corporate CEOs, in other words some sense of like a pre-pipeline of deals, how is that tracking these days.

David Viniar

It’s pretty high. There’s a lot of conversation but it’s been pretty high for a while and it hasn’t translated into deals. Now it’s a little bit higher now. I think people are feeling a little bit better but not enough better to really pull the trigger yet and so it’s going to have, confidence is going to need to go up even higher.

Michael Hecht - JMP Securities

And then so if we’re thinking about an M&A recovery means definitely not going to be a second half or 2009 story, maybe 2010, maybe longer.

David Viniar

That’s what I think. I think you’ll start to see it, you might see more activity pickup in the second half of this year but you won’t see revenues until next year.

Michael Hecht - JMP Securities

And then on expense trends, $2.1 billion of non-comp kind of flat quarter over quarter I thought was pretty impressive particularly with the tick up in the trading businesses, equities in particular, I was just surprised we didn’t see more of the variable non-comp expenses pick up, any color for the outlook on non-comp expense.

David Viniar

In some ways we hope it goes up because we’d like to see our [BC&E] go up because volumes explode. We’d like to see more travel and more things that because business is up a lot but we’re keeping a tight lid on expenses because we’re not out of the woods by any means. And I think you’ll see it go up with activity.

Operator

Your next question comes from the line of Matt Burnell – Wells Fargo Securities

Matt Burnell – Wells Fargo Securities

I hate to beat a dead horse on the equity but let me try to take this in another direction, as you look at your adjusted leverage targets over the next year or two, three years, away from looking at a quarter to quarter, how should we think about where you sit today and where those ratios conceptually might move given where we’ve been over the past two to three years.

David Viniar

We actually don’t necessarily target balance sheet leverage either gross leverage or adjusted leverage because we think in some ways that’s not a good measure. Now we know a lot of people focus on it so we’re cognizant of it. But we’ve had this conversation, depending on how liquid your assets are, you can be more highly levered and less risky or less highly levered and more risky.

But I will tell you that the adjusted leverage ratios are at the low end of where we’ve been historically and I would not expect them to continue to stay this low over time. If the world stays really risky then we might keep them low. But if the world starts to improve a little bit I would expect to see those leverages start to go up.

Matt Burnell – Wells Fargo Securities

And I guess one question in terms specifically to Goldman Sachs Bank, has there been any material change to the deposits in that bank over the quarter or just the broad funding mix of the bank over the quarter.

David Viniar

No I think that they’ve been largely stable over the course of the quarter both in deposits and the funding mix.

Matt Burnell – Wells Fargo Securities

And then in terms of liquidity you’ve given us the average core liquidity number, can you give us the trend for the quarter end balance relative to the beginning of the quarter balance.

David Viniar

It was pretty stable over the course of the quarter. It went down a little bit right at the end of the quarter because we repaid the TARP by the $10 billion. But other than that it’s been pretty stable over the course of the quarter.

Operator

Your final question comes from the line of Ron Mandle – GIC

Ron Mandle – GIC

I have two questions, one I was wondering if you could comment on your credit facility with CIT and what your exposure might be if things go materially badly for them from here. And then the second question was in regard to buying back the TARP warrants where you stand, how we should think about how that much that might cost and so on.

David Viniar

Sure, CIT we are between our collateral and our hedges we think we are well secured and well protected so we think we’re fine there.

Ron Mandle – GIC

What does that mean, well secured, well hedged. Do you mean if they draw down you have collateral that would fully cover the amounts of the draw.

David Viniar

Yes. And on warrants we are in discussions with the Treasury.

Ron Mandle – GIC

And do you think you’ll be buying them or will you go to arbitration or will they auctioned, what do you think.

David Viniar

We don’t know. We’re in discussions right now. Too early to tell.

Ron Mandle – GIC

What kind of time frame should we be thinking of in that regard.

David Viniar

Again, not sure. We’re in the middle of discussions.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Dane Holmes

Thank you everyone for joining us for our second quarter earnings call. If you have any addition questions please feel free to give us a call in the Investor Relations Department, otherwise, please enjoy the rest of your day.

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