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Goldman Sachs Group Inc. (NYSE:GS)

F4Q07 Earnings Call

December 18, 2007 11:00 am ET

Executives

Dane Holmes - Director of Investor Relations

David A. Viniar - Executive Vice President and Chief Financial Officer

Analysts

Guy Moszkowski - Merrill Lynch

Glen Schorr - UBS

Meredith Whitney - CIBC World Markets

Roger Freeman - Lehman Brothers

Mike Mayo - Deutsche Bank

Jeff Harte - Sandler O'Neill

Douglas Sipkin - Wachovia

James Mitchell - Buckingham Research

Prashant Bhatia - Citigroup

Steven Wharton - J.P. Morgan

Michael Hecht - Banc of America

Presentation

Operator

I would like to welcome everyone to the Goldman Sachs fourth quarter 2007 earnings conference call. (Operator Instructions) Mr. Holmes, you may begin your conference.

Dane Holmes

Good morning, everyone. This is Dane Holmes, Director of Investor Relations at Goldman Sachs. Welcome to our fourth quarter earnings conference call. Today’s call may include forward-looking statements. These statements represent the firm’s belief regarding future events, but 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 our fiscal year ending November 2006. 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, www.gs.com.

This audio telecast 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 and would also like to wish everyone happy holidays. I’ll give a brief overview of our results and then take questions.

I’m very pleased to report a record year for Goldman Sachs. Net revenues were $46 billion, net earnings were $11.6 billion, and earnings per diluted share were $24.73. These results generated a return on common equity of 32.7%. Book value per share was $90.43, an increase of 25% over year end 2006, despite the repurchase of 41 million shares for nearly $9 billion.

For the fourth quarter, net revenues were $10.7 billion, net earnings were $3.2 billion, and earnings per diluted share were $7.01. I’d like to begin by noting that our record results in 2007 were not driven by the outperformance of any individual business, but rather by the cumulative impact of record performances across each of our businesses.

In favorable environments, Goldman Sachs, like the rest of our peers, is expected to produce strong results. However, we believe that the true test of our franchise is relative performance throughout the cycle. In light of the recently more challenging market conditions, our record results demonstrate the diversity of our business mix, the breadth of our global footprint, and most importantly, the strength of the Goldman Sachs client franchise. Our performance is also a direct by product of the talent of our people and their tireless commitment to our culture of risk management, teamwork, and excellence.

I will now review each of our businesses. Investment Banking posted its second best quarter with net revenues of $2 billion, down 8% from the record third quarter. For the full year, Investment Banking net revenues were a record $7.6 billion, up 34% from 2006, the previous record.

Within Investment Banking, fourth quarter advisory revenues were $1.2 billion, down 12% from the record third quarter. Goldman Sachs once again ranked first in announced M&A globally for calendar 2007 through November. We advised on a number of important transactions that closed in the fourth quarter, including the € 72.1 billion sale of ABN Amro to a consortium led by Royal Bank of Scotland; Norsk Hydro’s $32 billion sale to Statoil and TransOcean’s $17.4 billion acquisition of Global Santa Fe.

We were also advisor in a number of significant announced transactions, including Commerce Bank Corp’s $8.6 billion sale to Toronto Dominion Bank, ICBC’s $5.6 billion acquisition of a 20% stake in South Africa’s Standard Bank, and Abu Dhabi National Energy’s $4.6 billion acquisition of PrimeWest Energy Trust.

Fourth quarter underwriting net revenues were $733 million, unchanged from the third quarter as equity underwriting revenues grew 14% to $403 million and debt underwriting declined 13% to $330 million. While global equity markets revolved over much of the quarter, the strength in equity underwriting was driven by a robust and diversified portfolio of transactions. Debt underwriting revenues declined given continued dislocation in leverage finance markets.

During the fourth quarter, we participated in many noteworthy underwriting transactions, including Bovespa’s $3.7 billion IPO, NearStar’s $2.5 billion IPO and Freddie Mac’s $6 billion preferred share offer.

While we can’t predict the environment for Investment Banking in 2008, the current level of strategic dialogue with our clients remains high. However, continued capital market dislocation and concerns about the broader economic environment, could impact the pace of Investment Banking business in 2008.

Underwriting activity has remained robust as global equity assurances offset recent weakness in leverage finance markets. Our backlog declined during the fourth quarter, but remains higher than year end 2006 levels and is well diversified by both geography and sector.

Let me now turn to Trading and Principal Investments, which is comprised of FICC, Equities and Principal Investments. Net revenues were $6.9 billion in the fourth quarter, down 16% from the third quarter. Full year net revenues were up 22% over fiscal 2006 to a record $31.2 billion.

FICC quarterly net revenues of $3.3 billion were down 32% from the record third quarter. For the full year, FICC net revenues were a record $16.2 billion, 13% higher than fiscal 2006. FICC continues to benefit from significant diversity across both product mix and geography and a robust client franchise.

The operating environment for FICC was less favorable for much of the fourth quarter due to lower levels of client activity, particularly in the month of November. Wider credit spreads, heightened volatility, and reduced market liquidity kept many market participants on the sidelines. Credit revenues decreased sequentially as gains on certain equity investments, including $900 million for a [inaudible] win were included in third quarter revenues.

The sequential decline was reduced by gains of approximately $500 million related to our leverage finance business in the fourth quarter. Commodities net revenues were up sequentially, largely driven by approximately $800 million in gains associated with the partial sale of the Cogentrix Power Plant portfolio. Currencies, rates and mortgages continued to be solid, though down from the record third quarter.

Turning to Equities, net revenues for the fourth quarter were $2.6 billion, down 17%, reflecting declines in both our principal activities and our customer franchise compared to a record third quarter. Equities commissions were down 7% from the record third quarter to $1.2 billion. For the full year, Equities produced record net revenues of $11.3 billion, up 33% over fiscal 2006. These results reflect the strength of the operating environment for Equities as most major industries rose during the year. We also continued to benefit from meaningful growth in our equity derivatives franchise and market share gains in our electronic trading business.

Turning to risk, average daily value at risk in the fourth quarter was $151 million, compared to $139 million for the third quarter. The increase in VAR was driven by higher volatility across mortgage and equity markets.

Let me now review Principal Investments, which produced net revenues of $1 billion in the fourth quarter. Our investment in ICBC produced $163 million gain and we generated $838 million in gains and overrides from a diverse portfolio of corporate real estate Principal Investments. For the full year, Principal Investments produced net revenues of $3.8 billion. Excluding SMFG and ICBC, we generated a record $3.4 billion in gains and overrides from corporate and real estate Principal Investments in 2007, more than doubling the $1.4 billion we earned in fiscal 2006. This performance reflects the continued execution of our strategy to be an advisor, financier, and co-investor with our clients.

Asset Management and Securities Services reported fourth quarter net revenues of $1.8 billion, down 6% from the third quarter. Full year revenues were up 11% to $7.2 billion. Asset Management produced net revenues of $1.2 billion, down 3% from the third quarter. Management fees were down 2% sequentially to $1.1 billion. For the full year, Asset Management net revenues were a record $4.5 billion; management fees were $4.3 billion, up 29% sequentially.

During the fourth quarter, assets under management grew 9% to a record $868 billion. Total inflows during the quarter were $58 billion, including $42 billion into money markets, as investors continued to seek higher quality assets; and $16 billion of additional inflows, largely in fixed income. We also benefited from $14 billion in market appreciation during the quarter, mainly in fixed income.

For the full year, assets under management increased 28% or a record $192 billion. Total inflows during the year were $161 billion, including $88 billion into money market and $73 billion across fixed income equity and alternative investment assets.

We also benefited from $31 billion of net market appreciation, mostly in fixed income and equities. We continue to be focused on the build out of our private capabilities, particularly in actively managed alternative assets, and remain very optimistic about the growth prospects for Asset Management.

Securities Services produced net revenues of $672 million in the fourth quarter, down 12% sequentially, largely due to seasonality. For the full year, Securities Services net revenues were a record $2.7 billion, up 25% annually. These strong results reflect our market-leading franchise in prime brokerage and our success in winning new client mandates.

Now let me turn to expenses. Compensation and benefits expense in the quarter was $3.3 billion. This results in a full year compensation to net revenue ratio of 43.9%. Non-compensation expenses were $2.4 billion in the fourth quarter, up 12% sequentially. This increase was primarily due to market development and occupancy costs, as we continue to expand our global footprint. Occupancy costs included $128 million of exit costs related to the firm’s office space.

For the full year, non-compensation expenses were $8.2 billion, up 23% over 2006. Half of the annual increase was due to activity related to brokerage clearing exchange and distribution fees.

Headcount at the end of the fourth quarter was approximately 30,500 up 15% over 2006 and 2% from the third quarter.

Our effective tax rate was 34.1% for the full year.

During the quarter, the firm repurchased 11.6 million shares for approximately $2.7 billion. For the full year, we repurchased 41.2 million shares representing $9 billion of capital. We currently have approximately 71 million shares remaining under the firm’s existing authorization. This includes 60 million shares of an increased authorization recently approved by our board.

We faced significant challenges in 2007. The fact that we produced record net revenues and earnings serves as a confirmation of several strategic initiatives which we implemented over the last several years. Principally, our commitment to serving as advisor, financier, and co-investor to our clients, our consistent focus on product innovation to meet their needs, and the continued expansion of our global footprint.

Within Investment Banking, we believe a key driver of our growth will come from the continued expansion of our business model into developing markets. We find in many of these markets that our clients are as focused on expanding their global presence as building domestic market share. Investment Banking continues to drive various revenue streams across the firm, particularly within the context of our principal investing businesses, where almost two-thirds of our investing opportunities are sourced through our client facing franchise.

FICC produced another record year in arguably the most challenging mortgage and credit markets we’ve seen in almost a decade. At the core of FICC’s success is the strength of its client franchise. Clients come to us for best-in-class execution, especially in dislocated markets. We remained committed to making markets for our clients, even at the height of market difficulty and illiquidity. While we can’t predict that FICC will experience another year of double-digit revenue growth in 2008, we see tremendous opportunities across each of our five businesses to continue product innovation and expand our footprint.

Our Equities business continues to benefit from a bifurcated high touch and low touch business model. Our expertise in pricing and risk managing large high touch transactions, coupled with our robust electronic trading capabilities, have allowed us to continue to gain market share and leverage the expense structure.

Our Principal Investing business had a record year as our investments have continued to perform well and provide significant opportunities for harvesting. We have a diverse portfolio of corporate and real estate principal investments around the world and continue to see compelling investing opportunities.

Within Asset Management, we’ve continued to grow and diversify our product offerings and expand our international reach. In the last two years, we’ve increased assets under management by over $330 billion. Building out our private wealth management business remains a key strategic priority and we expect that the strength of our brand and the diversity of our product offerings will position us to be successful in this pursuit.

Our prime brokerage business demonstrated significant revenue growth in 2007 by maintaining a leading market share and securing many new client mandates. We believe that growth in hedge fund assets will continue to drive compelling opportunities for this business.

Given the current dislocation in certain of the world’s capital markets, we are of course cautious about the near-term outlook for our business. However, we remain very optimistic about the medium- and long-term outlook for Goldman Sachs as we continue to chase GDP around the world.

Long term, global economic growth will continue to be the fundamental driver of our business. Although many are concerned about the potential for slow down in domestic and/or global economies, we feel confident about the strategic steps we have taken thus far and will look to leverage our global client franchise, firm culture and the talent of our people to maximize shareholder returns over the long term.

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) And your first question will come from the line of Guy Moszkowski with Merrill Lynch.

Guy Moszkowski - Merrill Lynch

Good morning.

David Viniar

Good morning, Guy.

Guy Moszkowski - Merrill Lynch

I wanted to ask you first if you could elaborate a little bit on the tenor of strategic dialogues that you’re having with Investment Banking clients and the degree to which your banker sense that CEOs, Board of Directors, are getting more cautious inthe US and possibly in Europe and how that might affect strategic activity over the next year or so.

David Viniar

The dialogue is quite broad and quite widespread. It’s really... It’s not concentrated inan industry group, it’s not concentrated ina region. As I said, it’s quite, quite broad, quite widespread, and I think we have not seen the cautiousness in the dialogue yet but I think how things unfold will be directly correlated to what happens inthe world. I think many of these conversations will turn into transactions if markets recover, if economies grow, and if markets don’t and economies are slower, than I think many of them will not turn into transactions.

Guy Moszkowski - Merrill Lynch

David, could you give us a little bit more elaboration sort of numerically on your comment about the backlog?

David Viniar

We don’t disclose numbers, Guy, and we don’t disclose percentages, but it is... If you look at it from the third quarter to the fourth quarter, the decline was largely in mergers and it was largely because a lot of the deals were closed and not as many came in and if you look at it from year over year, it’s kind of flattish and mergers and FICC and fixed income and it’s up in equity underwritings.

Guy Moszkowski - Merrill Lynch

Okay, thanks. That’s helpful. You had mentioned, or rather I think in the Q3 10-Q you alluded to about a $1.8 billion CDO exposure and I think on the tapes this morning I’ve seen that you’ve said something about $400 million. Are those comparable numbers and if so, was the reduction all due to write downs or were you actually able to sell some?

David Viniar

No, they’re not completely comparable. The $1.8 was CDOs and residuals and CLOs and a couple other things. I think the comparable number was about a little under $1 billion to a little under $400 million and more of it was write downs than sales.

Guy Moszkowski - Merrill Lynch

Okay and the $500 million that you referred to in credit, was that basically a recovery on some of the $2 billion plus gross leverage finance write down inthe third quarter?

David Viniar

Correct.

Guy Moszkowski - Merrill Lynch

Realized recoveries, right?

David Viniar

Most of that was sales above the marks.

Guy Moszkowski - Merrill Lynch

Okay and a small question, the $104 million in overrides that you referred to, is that all realized or is there some difference inthe way that you report that now under FAS 157 and 159 where you would have a sort of accrual that could bounce around?

David Viniar

All of our overrides are realized.

Guy Moszkowski - Merrill Lynch

Okay and I guess a final question I’d like to ask is just on comp. When we look atthe comp each year is up a tad and of course if we were to back out the non-recurring portion of last years 123-R charge, it would be up a little bit more than that. I’m just wondering why given the strength of revenue that you had on the one hand and the much weaker sort of employment environment that we’re seeing inthe industry here atthe end of the year, why we couldn’t have seen maybe a little bit more comp leverage?

David Viniar

I think you know I think people pay too much attention to the ratio as a ratio. As we’ve told you before, we compensate our people individually. We don’t start with a ratio and give it out. We look at each person. We reward people for their performance, for the firm’s performance, for their business unit’s performance. We also look atthe market environments or look at all those things. We also did have 15% head count growth over the course of the year and when we took all those things into consideration, we felt that that was fair compensation for our employees and fair income for our shareholders.

Guy Moszkowski - Merrill Lynch

Fair enough. Hard to argue with the latter. Thank you.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Glen Schorr with UBS.

Glen Schorr - UBS

Thanks. Hey, Dave.

David Viniar

Good morning, Glen.

Glen Schorr - UBS

Good morning. In Principal Investments, you had a couple of comments that are interesting. If you take out and put aside SMFG and ICBC for a second, you have about $12 billion in principal investments that you note inthe press release. Based on your comments as advisor, financier, and co-investor, looking atthe $12 billion, even if you put a 20-25% ROI over time over that which would be great, you’ve been producing higher than that. Where else do the gains on other corporate and real estate flow through and where are the assets that are not being included in that principal investment table, because it’s obviously coming from several places.

David Viniar

Well first of allthe principal investment gains on the principal investment line areall related to the assets on that table. So there’s on other assets that flow into that line in our financial statements. First of allthe returns on our principal investments have been quite good and we have a very diverse portfolio. It is very diverse by industry, it is very diverse by geography, and it is both real estate and corporate and it’s just a good business. We have the ability through our client franchise to source a lot of investments, so it’s just been a very... It’s a good business for us. Now I’m not going to tell you as you know that it’s going to be $800 million every quarter but I think it’s going to bea good and growing business for us.

Glen Schorr - UBS

And the funds that you all manage, do they have the ability to co-invest along with your co-investments?

David Viniar

What do you mean, co-invest? The funds are for a large principal investment, the fund would be the principal vehicle for us co-investing with our clients.

Glen Schorr - UBS

Okay. That’s what I was just checking and then maybe can you help us with the book growth, and this is always screwy, especially inthe fourth quarter, but just maybe conceptually. I know you’re not going to give the numbers on. You have $7 in earnings, you pay dividends, you buy a bunch of... you have some buy backs but somehow book grows by about $7. Thinking through the inputs, I know that you give out equity and comp and you have some tax benefits, but help me make sense of that.

David Viniar

We can get back to you offline and go through exactly the numbers, but I think it’s pretty much what you said. You start with earnings, you also have to add... I’m sorry, the one thing I think you missed from your calculation inthe fourth quarter is allthe equity-based compensation. So you have earnings, you have equity-based compensation, and you take away from that dividends and share repurchases and you end up with the book value.

Glen Schorr - UBS

And no major changes to the equity base?

David Viniar

Roughly no material changes.

Glen Schorr - UBS

Okay and I didn’t hear if you said in your prepared remarks, any major movements between Level 2-3?

David Viniar

No, well, yes, movements between Level 2-3. There are always lots of movements. The net number will be fairly similar. We had atthe end of the second quarter it was roughly 6% of our assets. Atthe end of the third quarter it was roughly 7%. Atthe end of the fourth quarter I think it’s back to about 6% but you have things... You know we think that there’s much more focus on it than there should be. There are things like Level 3 assets atthe end of the third quarter included a lot of leverage loans. Some of those were sold. Some of those moved into Level 2 because there’s a much more active market in leverage loans. On the flip side, Principal Investments, by definition, are Level 3 assets and we made more principal investments inthe fourth quarter. Soit goes up for that. So roughly flat, a little bit down on a percentage basis.

Glen Schorr - UBS

And maybe last, in general I’ve seen larger balance sheets in general for everybody. Part of that is growing with your equity, but I would think that some people in these uncertain times might want to take down the size of the balance sheet a little bit. You guys don’t disclose it but if you could just make a comment on.

David Viniar

Our balance sheet will be up a little bit and our leverage is going to... I think it’s roughly flat versus the third quarter, if you look at assets to equities, so it’s grown pretty much in line with equities from the third quarter to the fourth quarter.

Glen Schorr - UBS

Okay, thanks Dave.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Meredith Whitney with CIBC World Markets.

Meredith Whitney - CIBC World Markets

Good morning and happy holidays. I have two unrelated questions and I’m going to ask them both at once so I can have my associates hear on speakerphone. But as the history of available information on Goldman is limited, only back to ’99, I want to try to do some tealeaf reading with respect to your comments on FICC. Soin not one of this... this turn and in most, almost all but one did you have single digit growth year and then you had negative growth on the equity lines and the obvious negative growth years ’01 and ’02. Under what circumstances could you fathom a not just not double-digit growth but a negative growth scenario in FICC? Then the second question is if you would please, because I geta lot of questions on this, walk through how you manage counter party risk in your various businesses.

David Viniar

Okay. First one, I’ll give you an easy answer to the first one. Environment like the month of November that lasts for the entire year of 2008. Clearly we would not see growth in FICC revenues if that happened because basically what happened because of the lack of liquidity, because of the volatility, clients sat on the sidelines. They was just not a lot of activity and for us, and we’ve said this before, that’s really what drives our revenues and really inall of our businesses but in FICC as well. It’s not the direction of interest rates or the direction of commodity prices or the directions of currencies, it’s activity levels. Inthe month of November, there was a big lack of liquidity in the markets and very little activity so that would certainly not bea good environment for FICC. We would not have double-digit growth. I doubt we would have any growth if that happened.

Okay, your second question counter party risk management. That is all part of our risk management. Counter party risk, credit risk, market risk. We don’t separate them. We have a large group of people who look at our credit risk around the world and therefore counter party risk and we have just like in market risk, in credit risk, we have risk limits. We have risk limits by counter party, by industry, by geography, so it’s cut in many different ways and what we tend to put in place to enable us to continue to do business with counter parties if we get near or at their limits is we put mitigates in place like collateral. So we will have collateral-based triggers of credit exposure to firms or we will hedge certain things with CDS depending on what’s happening but we look at our counter party exposure as closely as we look at any other risk and we set a whole series of limits and that’s how we operate.

Meredith Whitney - CIBC World Markets

Okay, if I could just follow up on that. Do you see in ’08 as that being a major factor for a major risk for the industry or are there others larger than that?

David Viniar

Counter party risk?

Meredith Whitney - CIBC World Markets

Yes.

David Viniar

I don’t view it as being any... I am sure there are some counter parties for whom where it will be a bigger risk to them in 2008 than the past and some where it won’t. I don’t seeit being any... We always look at this as a really big risk and so I don’t think it’s going to bea bigger risk in 2008 than it was prior.

Meredith Whitney - CIBC World Markets

Okay, thanks so much.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Roger Freeman with Lehman Brothers.

Roger Freeman - Lehman Brothers

Hi, good morning David.

David Viniar

Good morning, Roger.

Roger Freeman - Lehman Brothers

I guess with respect to any net impact of your positioning in mortgage credit this quarter looks like it was pretty much a push where it was a positive last quarter, is that a fair --

David Viniar

I think what we said was it was still strong or solid but lower than the record third quarter.

Roger Freeman - Lehman Brothers

Okay. Where would you characterize your positioning there right now? Are you net long or short mortgage credit?

David Viniar

I think you can assume that the fact that we told you we were short atthe end of the third quarter was a moment in time thing. That is not likely to happen very often because it’s not good for us to disclose we’re long or short in a trading position and it’s something that can change every day and so I think you shouldn’t expect to see that very often.

Roger Freeman - Lehman Brothers

Okay so let me just ask this. Last quarter you thought that we were sort of closer to the bottom in valuation. What do you think about the market right now and specifically when do you think there’s going to bea bid for some of the maybe higher quality, say CDO, the higher quality tranches in CDOs; do you expect to actually be a liquidity provider in that area?

David Viniar

I think we are still closer to the bottom and I don’t think there’s a problem with the bid. I think there’s a bid, I don’t think there are many offers. So I think it’s a question of people actually being willing to sell what they have, not the fact that there aren’t buyers. I think there are buyers there and for the right assets at the right price, yes, we would bea buyer.

Roger Freeman - Lehman Brothers

The transactions that have occurred have largely been institutions that arein a distressed situation. I guess the question is when does that bid narrow to a point where you actually get, sort of a liquid secondary market?

David Viniar

That’s the question and I’m not smart enough to know the answer but I think it’s really going to bea question of sellers being willing to sell things atthe then-prevailing market price.

Roger Freeman - Lehman Brothers

Okay, what about the commercial mortgage market? I think that’s a bigger business for you than residential, right, and can you talk about your hedging? Do you have sufficient credit hedges?

David Viniar

You know, it’s not really a bigger business for us than the residential business. We area big player in it. We provide financing for people and we trade CMBS and it’s a risk that we manage just like all of our other risks. It’s not different than anything else. We look on a day-to-day basis at our exposure. We look at if we have commitments. How do we hedge them? We look at times to go long and times to go short. It’s really... It’s not necessarily a bigger business than the residential business. It’s part of our mortgage business which is an important business but certainly not outsized inthe context of our FICC business.

Roger Freeman - Lehman Brothers

You wouldn’t consider the widening and spread of CMBS as a significant contributor to the sequential results?

David Viniar

No.

Roger Freeman - Lehman Brothers

Lastly, can you just maybe expand a little bit more on the level of client engagement. Specifically talk about December now versus November so far and maybe by product. Where did you seethe weakest client engagement and where was it still relatively strong last month?

David Viniar

December is two weeks old so it’s very hard to say how things are going to unfold and our expectation is for the rest of December, which there is not going to be that much going on because we’re getting towards the holidays and a lot of people go away, and hopefully it will pick up in January. The weakest thing in environmentally in the fourth quarter was the credit markets in November. They were very volatile. As I said, there was a lack of liquidity, there were very difficult markets and it’s too early to tell in December.

Roger Freeman - Lehman Brothers

Okay. Thanks for the comments.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Mike Mayo with Deutsche Bank.

Mike Mayo - Deutsche Bank

Good morning.

David Viniar

Good morning, Mike.

Mike Mayo - Deutsche Bank

I might have missed it, but how much in total write downs did you take? You said maybe $800 million on CDOs and CLOs or from that also do you have write downs on mortgages or CDOs elsewhere?

David Viniar

We didn’t sayso you didn’t miss it. It’s not a number we disclose. Our mortgage business was profitable over the year. We took some write downs on our long mortgage inventory and in cases where we had hedges or other short positions, they were up, and they were up more than over the course of the year more than longs were down, but on both sides of it, and we’re not going to disclose the number, inthe context of some numbers you’ve seen, both sides were relatively modest.

Mike Mayo - Deutsche Bank

But the write downs have been more than the $500 million of recoveries from the leveraged loans?

David Viniar

We’re not going to disclose a number.

Mike Mayo - Deutsche Bank

Okay and your leveraged loans, you had $42 billion atthe end of the third quarter. Where is that now and how did it get there?

David Viniar

We had $42 billion of unfunded commitments atthe end of the third quarter. Inthe fourth quarter we sold or canceled $16 billion. $9 billion was funded. We made $10 billion of new commitments and that leaves us with $27 billion of unfunded commitments atthe end of the fourth quarter. Those numbers add up.

Mike Mayo - Deutsche Bank

And you had gains even though some of the leverage loan indices kind of round tripped and then more. Can you talk about what you’re seeing in that market?

David Viniar

Virtually all of those gains were realized gains, Mike, so virtually all of them were realized, so things that were sold above the marks. I think what you’ve seen is it was a... We went through a whole cycle in the fourth quarter in the leverage loan market. It started off basically closed then through late September and most of October it was quite robust. Then in November it was quite slow again. I think the market is difficult but the difference between now and August is... And we were getting deals done last week and the week before and the week before that, so for well-structured, correctly levered, correctly priced transactions, you can get them done. There are buyers.

Mike Mayo - Deutsche Bank

And then lastly, non-US, you talked about, can you talk about your non-US growth inthe fourth quarter versus your US growth and kind of what you’re seeing by geography. How much is the rest of the world getting dragged down by the credit situation in theUS?

David Viniar

You know towards the end of the fourth quarter you saw some of the non-US markets were affected as much as theUS markets. Markets inAsia were down quite a bit over the course of November so I think you did certainly see that affecting the markets overseas as much as they affected theUS. When we look out though, the trajectory remains the same, and that we expect our business to grow faster outside the US, especially in Asia, especially in some of the brick countries and you have Korea and the Middle East for that, than we doin theUS so we expect the US will grow as well. So no change inthe trajectory at all.

Mike Mayo - Deutsche Bank

All right, thanks.

David Viniar

You’re welcome

Operator

Your next question will come from the line of Jeff Harte with Sandler O'Neill.

Jeff Harte - Sandler O'Neill

Good morning.

David Viniar

Good morning, Jeff.

Jeff Harte - Sandler O'Neill

As we think to 2008, can you talk a little bit about your budgeting process? I guess I’m trying to getat in such a volatile environment where things went from feast to famine, you know, October to November, how do you try to plan for 2008?

David Viniar

It is a volatile environment but I will tell you it’s not harder now than it is any other year because one of the things we know for sure is if things seem stable, we’re probably wrong, because the world has evolved in place and whatever we think is going to happen, what we know for sure is it will be something different. It will be better or it will be worse but it will not be exactly what we think. So budgeting is a very difficult process and it’s why it’s not a one time a year thing for us. We’re going through it right now. We will look at people’s best estimates of where there business will be. We’ll give, we’ll allocate resources based on that, and that will be head count and that will be capital and that will be balance sheet, and then we’ll go a couple of months into the year and we will reassess, and we are constantly reassessing that and we’ll doa mini budgeting process several times a year because we know the market’s changing.

Jeff Harte - Sandler O'Neill

And maybe getting even a little more touchy-feely off of that, I think back to a slide you’ve shown before showing M&A activity as a percent of global market cap and indicating that yes, things are real good in ’06 and early ’07 but not nearly to the level they had been in prior peaks. As far as some of the froth or kind of peak cyclic activity level we saw in something like an M&A based on a metric like that, how do you look at things going forward? I mean, are things really different this time or is there really the potential for a big ’08-’09 near term increase in something like M&A activity with LBOs, big LBOs being sidelined?

David Viniar

You know Jeff I actually don’t have those in front of me so we’ll get back to you on those, but just environmentally, we’re likely to see fewer of the mega public-to-private LBOs than we saw. I think that’s pretty clear. The business is not over or in debt or anything, they’re using lots of leverage on reasonable sized deals either on whole companies or on divisions of companies. They just don’t think we’ll seethe mega public-to-privates we saw, so that will be in decline, and the real question is that going to be replaced by the strategic activity? We’ve seen a bunch of fairly large strategic deals announced. There is a lot of dialogue going on and I think whether that dialogue becomes transactions is going to be very much related to do the markets recover and dothe economies continue to grow, and if they do, then we’ll seea lot of them become transactions.

Jeff Harte - Sandler O'Neill

Okay, thank you.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Douglas Sipkin with Wachovia.

Douglas Sipkin - Wachovia

Good morning, David.

David Viniar

Good morning Doug.

Douglas Sipkin - Wachovia

Just a couple of questions here. First off, how would you categorize the market for gaining prime brokerage business this year versus last and maybe I would say more near term over the last half of 2007 versus maybe ’06 and ’05?

David Viniar

The business is growing. It continues to grow. I think the hedge fund as a class, as an asset class, is going to keep growing. People are putting money into hedge funds and we are one of the leaders in that business and we have a very high share in the business and I think we continue to gain a very high share of clients in that business.

Douglas Sipkin - Wachovia

Okay and then secondly, obviously as it relates to the mortgage asset class, you guys did a phenomenal job this year. Any thought process within the firm to maybe get bigger in selling these distressed businesses that obviously now valuations are much more compelling while some of your competitors probably are backtracking, so it seems like it’s a pretty good opportunity to get larger in that asset class.

David Viniar

Looking for opportunities to buy distressed assets has been a good business for Goldman Sachs for many years. It was in Asia, it was inEurope, it was going back to the RTC in theUS inthe early 90’s. Ithas been a business that we have been in for a long time and I would expect that hopefully we’ll see some opportunities in the mortgage world for us to buy distressed assets and it’s just in different asset classes in different locations at different times it is acore competency at Goldman Sachs.

Douglas Sipkin - Wachovia

Isn’t it great? And then just shifting to the Asset Management business, obviously very strong flows on liquidity not surprising. I was surprised to seethe very large and substantial fixed income flows. Is there anything specific to the fourth quarter for you guys? Is ita function of allocations or good performance? Anything outside of just people putting money into fixed income that you could point to because it just seemed like such abig number for you guys.

David Viniar

I didn’t getit as what you said. I think as people looking for high quality assets and I think it’s been our performance which has been pretty good in that space.

Douglas Sipkin - Wachovia

Great. Thanks for taking my questions.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of James Mitchell with Buckingham Research.

James Mitchell - Buckingham Research

Good morning.

David Viniar

Good morning, Jim.

James Mitchell - Buckingham Research

Most of my questions are answered, but a couple of more minor ones maybe. First off, on the buy back, you bought about 41 million shares. I flashed here out of the 60, now you’re up to 71. Do you think you would accelerate that into ’08 given that you weren’t as aggressive in ’07 and probably rightfully soin the second half of this year?

David Viniar

We bought back a few fewer shares in ’07 than in ’06. I think the best thing to use is what we did in ’07 for looking at ’08 but it can vary from that by a little bit. We increased the authorization because we were down to 11 million shares and we could use that up and we wanted to make sure that we had the dry powder if we wanted to buy back more. We’ll see how things unfold, but I think it’s going to be somewhere in that same range.

James Mitchell - Buckingham Research

Okay, fair enough and then just the other question on the advisory fees. The last two quarters seems to have been from a realization rate a few low versus at least publicly announced completed volumes. Have you seen a step up in sort of non-M&A advisory revenues given the amount of turmoil in the market? Has that been a part of that or is it just simply every quarter it’s a little different in terms of the profitability of each deal?

David Viniar

It’s both. It’s the latter. It really is the latter.

James Mitchell - Buckingham Research

Okay great. Thanks.

David Viniar

You’re welcome.

Operator

(Operator Instructions) Your next question will come from the line of Prashant Bhatia with Citigroup.

Prashant Bhatia - Citigroup

Hi.

David Viniar

Good morning.

Prashant Bhatia - Citigroup

Just on the fixed income trading revenue, in looking at it backing out Horizon and Cogentrix and so on, it looks like the revenue fell from $5 billion last quarter to about $2 billion this quarter. I know you talked about activity levels being a lot lighter on the sideline but can you elaborate a little more? Was the whole decline just clients really pulling back?

David Viniar

The whole decline can never be explained by just one thing. There was a lot less activity in the quarter. There were certain things like as we mentioned within FICC we end up with certain equity positions as well like Horizon that was sold inthe third quarter that we didn’t have in the fourth quarter, so you don’t see things like that sometimes. Markets were difficult, activity was lower, and soit was really a variety of things.

Prashant Bhatia - Citigroup

Okay, and November was still a positive month?

David Viniar

We don’t disclose our P&L by month.

Prashant Bhatia - Citigroup

Okay. Also on taking advantage of distressed assets, can you talk a little bit about the mortgage servicer you just purchased and is that more to help you take advantage of some of the distress in the CDO marketplace or is that more just a general investment?

Prashant Bhatia - Citigroup

It’s both. It’s not just to help us take advantage of the distressed environment that we think we’re in. There’s going to bea mortgage market inthe United States going forward and it’s going to bea big market and it’s going to bea good business and being able to service assets is akey to being successful in that business. We think Litton is one of the best servicers around and we think they have the right standards, very good quality people, and so we think being able to purchase them is going to help us as the whole mortgage market kind of unfolds going forward.

Prashant Bhatia - Citigroup

Okay, so it’s a little of both, strategic and business that you want to be in.

David Viniar

Yes. Absolutely. It’s more strategic than anything.

Prashant Bhatia - Citigroup

Great and then on the Asset Management side, I think $80-90 billion in money fund flows that have come in. Can you just give a feel if you have one on how much of that can potentially stick and how much of that is just taking advantage of the natural arbitrage when the Fed cuts rate.

David Viniar

That’s a very fair question. It’s hard to say. I don’t think it’s the Fed cutting rates so much as I think it is people looking for flex quality and looking for the highest quality investments they can. I think we will keep some of that but I think those assets are probably less sticky than other assets.

Prashant Bhatia - Citigroup

Okay, great. Thank you.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Steven Wharton with J.P. Morgan.

Steven Wharton - J.P. Morgan

Hi David.

David Viniar

Good morning Steve.

Steven Wharton - J.P. Morgan

Did you disclose your structure note gains or losses or liabilities?

David Viniar

No. We didn’t because they were basically negligible. We had losses that were less than $50 million. It was really tiny.

Steven Wharton - J.P. Morgan

Okay, thank you.

David Viniar

Because our spreads basically tightened a tiny bit over the course of the quarter.

Steven Wharton - J.P. Morgan

Can you just refresh my memory what that number was last quarter?

David Viniar

It was a gain of about $300 million. Round numbers.

Steven Wharton - J.P. Morgan

All right, thanks.

David Viniar

You’re welcome.

Operator

Your next question will come from the line of Michael Hecht with Banc of America.

Michael Hecht - Banc of America

Hey David, good morning.

David Viniar

Good morning Mike.

Michael Hecht - Banc of America

Just to follow up on the Level 3 assets, you said pretty much unchanged from last quarter or it sounds like there were some moving parts. Are there any big unrealized gains or losses we’ll seein terms of marks from Level 3 assets once theK comes out or whatever?

David Viniar

I don’t think you will see anything that is unusual compared to what you’ve seen before.

Michael Hecht - Banc of America

Okay and then on the Prime Brokerage business, obviously the trend is pretty good year over year. The sequential decline, any sign of kind of de-leveraging across the customer base or is the sequential decline just related to typical seasonality that you guys usually see?

David Viniar

Totally seasonality. If you look you will see every year, second, third quarters arethe highest and first lower. You seethe year over year increase. That’s why we generally tell people don’t look at year over year because our business moves sequentially. That is the one business where I would not say that, the one business where I would tell you not to look year over year and you seea pretty strong growth. It’s purely just the seasonality.

Michael Hecht - Banc of America

Sure and then would balances kind of still be up kind of quarter over quarter?

David Viniar

Yes.

Michael Hecht - Banc of America

Okay and then just shifting over to Asset Management, any update on performance of kind of global outlook? I think I saw some things atthe tape, I guess particularly GO, and then just kind of pace of investor redemptions and then any update on the investment you guys made last quarter and any contribution that had to, I guess that flows to equity trading inthe quarter?

David Viniar

Yes. I’ll do them in reverse order. The investment in GO went down over the fourth quarter but still up for the year. Alpha continued to have difficult performance in the fourth quarter. The performance was difficult. We had redemptions as expected. Redemptions across our quant funds inthe fourth quarter were around $3 billion. Close to half of that was in Alpha and we think redemptions inthe first quarter from what we can see will be even greater than that and again about half of that is going to be going to Alpha. We are okay with those funds being smaller, especially Global Alpha, because we think we’ve finally gotten too big, and we think it’ll allow us to be more nimble and be able to react to the market faster.

Michael Hecht - Banc of America

Okay and then sticking inthe Asset Management segment just for a second, quarter over quarter the decline in kind of core fees, nothing major, but you did see about a 7 or 8% increase in average assets quarter to quarter, so just trying to understand the drop off I guess in theC rate?

David Viniar

So Mike we got to the last question before someone asked me about that and it’s interesting. It’s an anomaly of the calendar. Nothing else. You know we area fiscal year, fiscal quarter firm, last Friday of every quarter in every month. Therefore in most years we have 52 weeks. Every 5-7 years we have a 53rd week. In most quarters we have 13 weeks and every 5-7 years we have a 14 week quarter and the third quarter was a 14 week quarter. Sole explanation for the decrease was that we had one fewer week. One more week last quarter.

Michael Hecht - Banc of America

Okay, that makes sense and then I was just hoping we could back up and talk a little bit more about equity trading which for the year obviously up like 35%. I know there’s a lot of things that go through there, crop activities, equity derivatives, principally oriented kind of cash equity trades. I guess I’m just trying to geta sense as to any outsize drivers of the business last year, not just last quarter but last year, and what’s kind of driving the results you guys are seeing there.

David Viniar

Very widespread. The business in general has grown. It is, as we said a little bit, we have both a high touch and a low touch strategy. The high touch strategy includes both clients and [inaudible]. It is where we have a pure [inaudible] business. That was very profitable during the year. Our client franchise business in shares and equity derivatives grew quite well and we also have alow touch strategy where we are one of the leaders in electronic trading and we continue to gain market share too and soit was really across all of the various products within equities. No outlier, no one thing drove it. It was across all the products.

Michael Hecht - Banc of America

Okay, great, and just last housekeeping question. The tax rate last year was about 34.1%. If we assume maybe non-US continues to pick up atthe percentage as a whole, is there room for the tax rate to drift a bit lower?

David Viniar

It is driven a lot by geographic earnings. It’s also driven a little bit by just the size of the earnings so we have some tax credits that becomes smaller percentages as earnings grow. I think it’s always hard for me to predict. I think it’s best to assume what we had this year for next year, but it could vary by a little bit, one way or the other.

Operator

Thank you. I will now turn the call over to Mr. Holmes for any closing remarks.

Dane Holmes

I just wanted to thank everyone for joining us on our fourth quarter earnings conference call. If there are any additional questions that you have, please direct them to Investor Relations and we’ll deal with them there.

Thanks, have a good day, and happy holidays.

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Source: Goldman Sachs F4Q07 (Qtr End 11/30/07) Earnings Call Transcript
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