高盛 (GS) 2010 Q3 法說會逐字稿

Good morning, my name is Rachel and I will be your conference facilitator today.

I would like to welcome everyone to the Goldman Sachs third-quarter 2010 earnings conference call.

This call is being recorded today, Tuesday, October 19, 2010.

Thank you.

Mr.

Holmes, you may begin your conference.

Thank you, Rachel.

Good morning everyone.

This is Dane Holmes, Director of Investor Relations at Goldman Sachs.

Welcome to our third-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 those 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 fiscal year ended December 2009.

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, capital ratios, risk-weighted assets and global core excess and you should also read the information on the calculation of non-GAAP financial measures and the impact of Basel III that is posted on the Investor Relations portion of our website, www.GS.com.

This audiocast 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?

Thanks, Dane.

I would like to thank all of you for listening today.

I will give a brief overview of our third-quarter results and then take your questions.

Third-quarter net revenues were $8.9 billion.

Net earnings were $1.9 billion and earnings per diluted share were $2.98.

Our annualized return on common equity was 10.3%.

Our performance in the third quarter resulted in a year-to-date annualized return on common equity of 13.2%, excluding the impact of the UK bank payroll tax and SEC settlement.

Our book value per share has grown 8% to $127.08 year to date.

Many of the market concerns that were most prevalent in the second quarter of 2010 continued into the third quarter with our client base remaining focused on the macroeconomic outlook, particularly in the United States and Western Europe.

Markets are also focused on the implications of global financial regulation, specifically implementation of the Dodd-Frank Act and Basel III.

Consequently, investment conviction among institutional asset managers remains low and while CEO confidence seems to be improving, it remains fragile.

These factors, combined with the seasonal dynamics of the third quarter, negatively impacted activity levels within many of our businesses.

While we experienced a modest improvement in activity levels in September, third-quarter activity levels for many of our businesses were at or below second-quarter levels.

For example, NYSE, NASDAQ and LSE average daily share volumes declined significantly compared with the second quarter, down 27%, 20%, and 18% respectively.

On September 12, the Basel committee on banking supervision announced its capital framework, generally referred to as Basel III.

This announcement represented an important step in providing greater clarity on global regulatory capital requirements.

Ultimately, the Board of Governors of the Federal Reserve system have determined how the capital framework will be implemented for financial institutions in the United States.

Understandably, our shareholders have been interested in how this development could impact our business.

While there are many aspects of Basel III that still require rule writing, in many rules that require significant guidance and interpretation, we wanted to provide our best estimate of our position on the Basel III with the caveat that these numbers and assumptions could and almost certainly will change.

At the end of the third quarter, we had a Basel I Tier 1 capital ratio of 15.7% and a Tier 1 common ratio of 13%.

We estimate that our current robust capitalization positions the firm to exceed requirements under the Basel III framework.

If we calculate Basel III requirements with actual second-quarter numbers as of June 30, 2010, our estimated Tier 1 common ratio will be nearly 8.8% before considering any mitigating actions.

This assumes risk-weighted assets of approximately $750 billion and Tier 1 common of approximately $59 billion.

The principal drivers of the increase in the total risk-weighted assets are higher credit risk-weighted assets from private equity investments in CVA and higher market risk-weighted assets for securitization and correlation risk exposures.

If we assume a contractual roll-off of our correlation portfolio, the expected duration of our mortgage securitization book, coupled with 2.5 years of forward earnings at the 2010 consensus estimates, our Tier 1 common ratio would increase to 11% by the end of 2012.

Of course, there are many additional steps that we can and will take to further increase our capital ratios.

We also continue to maintain significant excess liquidity, which averaged $173 billion during the third quarter.

While we are awaiting more clarity on rules for the liquidity coverage ratio under Basel III, the concept is very similar to how we manage liquidity with our global core excess and internal liquidity model.

We estimate that our current global core excess will comfortably exceed requirements under the new rule set.

Another area of investor focus has been the procedural concerns associated with foreclosure affidavits.

In December of 2007, we acquired Litton Loan Servicing, a subprime loan servicer.

Litton is well known for providing borrowers with alternatives to foreclosure, particularly modifications.

Since 2008, Litton has completed over 80,000 permanent loan modifications.

Additionally, approximately one out of every four loans currently serviced has been modified.

In the states where the foreclosure process has been suspended, Litton currently has approximately 23,000 loans in the foreclosure process.

Litton has initiated an extensive review of its foreclosure procedures.

While certain process issues were identified as part of the review to date, Litton believes the underlying foreclosure decisions were warranted.

I will now review each of our businesses.

Investment Banking produced net revenues of $1.1 billion, up 22% from the second quarter.

Third-quarter advisory revenues were $496 million, up 5% from the second quarter.

Goldman Sachs ranked first in announced and completed M&A [global] to date, year to date, and advised on a number of important transactions that were announced during the third quarter.

These include GDF Suez's $21.5 billion transaction with International Power; Intel's $7.7 billion acquisition of McAfee; and Dynegy's $4.7 billion sale to Blackstone.

We were also adviser on a number of significant completed transactions, including Novartis' $28.4 billion acquisition of a stake in Alcon; Schlumberger's $11 billion acquisition of Smith International; and Millipore's $7 billion sale to Merck.

Third-quarter underwriting net revenues were $623 million.

Equity underwriting revenues were up 30% from the second quarter to $288 million, driven by stronger client activity, particularly in Asia.

Goldman Sachs ranked first year to date in common stock offering globally.

Debt underwriting was up 50% to $335 million as primary issuance is robust across both leverage finance and investment-grade markets.

During the third quarter, we participated in many noteworthy underwriting transactions, including Agricultural Bank of China's $22.1 billion initial public offering; [Impex] Corporation's $6.2 billion [following] offering; and Valiant Pharmaceuticals' combined $1.2 billion high-yield notes offering and $1.6 billion term loan.

Our Investment Banking backlog was flat with the second quarter.

Let me now turn to Trading and Principal Investments, which are comprised of FICC, equities and principal investments.

Net revenues were $6.4 billion in the third quarter and include CVA losses of approximately $200 million associated with the tightening of credit spreads on our own debt, mostly in FICC.

FICC net revenues were $3.8 billion in the quarter, down 14% from the second quarter.

During the third quarter, continued macroeconomic uncertainty exacerbated seasonally slower customer activity levels and drove weaker sequential revenues across interest rates, mortgages and commodities.

Currency revenues were up modestly from the second-quarter levels.

Our credit business improved sequentially as a strong issue issuance calendar and technical support from solid flows into fixed income funds provided a favorable backdrop.

Turning to equities, net revenues from the third quarter were $1.9 billion, up 53% sequentially.

Equities trading net revenues of $1.1 billion represented a significant improvement compared to the second quarter and reflect a more normalized contribution from our derivatives franchise.

Equities commissions were down 18% to $806 million reflecting lower client activity levels during the quarter.

Turning to risk, average daily value of risk in the third quarter was $121 million, down 11% from the second quarter on lower volatility and continued low activity levels.

Let me now review Principal Investments, which produced net revenues of $754 million in the third quarter.

Our Principal Investment portfolio generated net gains of $613 million, largely on corporate public equity investments.

We also benefited from overrides of $132 million that were principally driven by the $2.25 billion partial sale of the investment in ICBC during the quarter.

In Asset Management and Securities Services, we reported third-quarter net revenues of $1.4 billion, up 2% from the second quarter.

Asset Management produced net revenues of $1 billion, up 5% from the second quarter.

Assets under management increased $21 billion sequentially to $823 billion, driven largely by market appreciation, partially offset by money market and equity outflows.

Securities Services produced net revenues of $383 million, down 4% from the seasonally stronger second quarter.

Now let me turn to expenses.

Compensation and benefits expense, which, as a reminder, includes salaries, bonuses, amortization of prior-year equity awards and other items, was accrued at a compensation of net revenues ratio of 43%, consistent with the first two quarters of 2010 and our lowest nine-month ratio as a public company.

Third-quarter non-compensation expenses decreased 24% sequentially to $2.3 billion, primarily driven by the SEC settlement that was included in the second-quarter results.

Total staff at the end of the third quarter was approximately 35,400, up 4% from the second quarter, reflecting the normal seasonal pattern of new college and business school hires starting in the summer.

In keeping with the firm's long-standing policy of repurchasing shares to offset increases in share count over time resulting from employee share-based compensation, we've repurchased 5.4 million shares of common stock during the third quarter for a total cost of approximately $800 million.

Even after this share repurchase, common shareholders' equity increased almost $2 billion during the quarter to $68.7 billion.

The operating environment during the third quarter was dominated by heightened uncertainty surrounding the global economic outlook, which contributed to lower activity levels across our global client base.

As you know, our ability to generate revenues and returns for our shareholders is dependent on our clients transacting in the marketplace.

Whether it is a CEO who wants to expand through an acquisition or a portfolio manager deciding to allocate capital to different investment strategies, the opportunity for our firm begins with a client's decision to act.

While we have seen some modestly positive signs in recent weeks, it is difficult to predict the catalyst for improved client activity, especially since human psychology can be an important driver.

However, we believe that it is critical to remain focused on serving our clients and executing our strategy.

We believe that these efforts will ultimately drive the strength of our franchise and the value that it can generate for investors over the longer term.

With that, I would like to thank you again for listening today and I am now happy to take your questions.

Guy Moszkowski, Bank of America-Merrill Lynch.

Good morning, David.

I just wanted to go back to your comments on Basel III.

And obviously, I know it is very preliminary, as you have said.

First of all, can you just give us a sense for what your asset growth assumptions are underlying the runoff of the asset classes that you alluded to?

In the numbers that we gave, and I am glad you mentioned what you did, Guy, because I gave a lot of caveats about how preliminary these numbers are, so I just want to emphasize that.

All we did was take our assets as they stand now with no growth of any kind and we took earnings for -- as I said, we took 2010 consensus and we assumed that that is what the earnings were going to be for the next 2.5 years and then we just assumed contractual roll-offs of the correlation book and basically duration rate of roll-off of mortgage securitizations, but with no active mitigation, no growth, no decline, just those assumptions.

We made no other adjustments.

Right.

So you also assumed no return of capital other than the existing dividend, is that fair?

We assumed no return of capital, we assumed no equity-based compensation that would grow it.

Only the three assumptions I mentioned, those were the only changes we put in to that 11% number.

And since you mentioned that you didn't do any -- in this exercise, you didn't do any active mitigation, can you give us a sense for what types of active mitigation you might consider?

Sure.

Let me give you just a couple of quick things that could help.

For example, we didn't assume that we made any attempt to reduce the correlation book through tear-ups with other dealers.

We didn't assume the same thing with mortgage securitizations.

We didn't assume that any of the -- we have a few assets that are subtractions from our capital because they are intangibles that we can probably sell and probably will sell over time.

We didn't assume that.

We didn't assume any roll-offs of our Principal Investment portfolio either just from things being sold or from attempts to sell them.

Those are just a few of the things that come to mind quickly.

We didn't make any of those assumptions at all.

That's helpful.

And then just a final question on this topic.

From what you can see right now, how might the implementation of Basel III impact your traditional approach to capital management, if at all?

I don't think it is going to change our approach to capital management, but there are some businesses that -- like the ones I've mentioned like correlation and securitization businesses -- that, given the very, very high capital charges, might be diminished.

Now none of those, as you know, have been that big for us over time, but they still would -- certainly, we would probably do less of them.

And then just to follow up, you mentioned -- you obviously mentioned Dodd-Frank in your remarks and the uncertainty that that has created.

Can you give us any update as to what changes you might be making either strategically or tactically to address some of the elements of Dodd-Frank, such as Volcker or changes in derivatives?

Well, it is too early on some of the things because, as you know, certainly on derivatives, most of the rules are not written yet.

We are still working on that.

There are some things that have been pretty public.

It has been written and it is accurate that our GSPS business, which is the one walled-off proprietary trading business, is essentially wound down.

So that is the one thing.

And the other thing is we are waiting to see how the rules unfold.

Final question, just as a follow-up to that, how do you see it potentially affecting special situations?

Again, we are waiting to see how those rules unfold, but the predominant part of that business is a business that is actually a lending business, which we think is not only okay under the rules, but is actually something that is encouraged because it obviously helps the economy grow.

Fair enough.

Thanks very much, David.

Howard Chen, Credit Suisse.

Good morning, David.

I appreciate you taking a crack at the Basel III impact.

Just as a follow-up on the mitigation efforts, whether it is run off or (inaudible) or mitigation, how do you think about the P&L impact and maybe the current ROA of those businesses or portfolios that might be running off or shedding?

Well, again, it is a little hard to tell and again, the caveats that all of the numbers are very preliminary, but the businesses that we have talked about have not been that big in the context of the firm.

It hasn't -- none of the things we have talked about are our basic client franchise trading business that are really the core of Goldman Sachs.

So it is very hard to estimate that there will be any material change from that, but we don't know yet.

We are going to have to wait and see.

Okay.

And then just in your mindset, David, not big or material, is 5% a ballpark range for that?

You are being more prescriptive than I was trying to be, but I wouldn't dispute those numbers.

Okay.

And then even with whatever buffers come down the path, 11%, again, with all the caveats to the assumptions, it seems like a very strong and healthy level of capital.

When would you and the management team feel comfortable ramping up the share repurchase to maybe do more than just offset the recent share issuance?

Well, our first hope would be that we don't and that we see tremendous opportunities out there, which give an ability to use our capital to produce returns.

So that would be first.

Our first goal would be to do it that way as opposed to give it back, but if we don't, then, over the next several years, we would certainly consider giving back more capital to shareholders.

Great.

And then I guess finally, David, I think just thinking about the summer environment and the record levels of debt underwriting we have seen, I know historically, just to paraphrase, maybe you and the management team have stated maybe in certain times not -- that it doesn't make sense to be a top three debt underwriter.

Just given where we are in the world today, you extend zero rates, etc., the liquidity that is out there, does your view change at all just given that with respect to where you want to be as a debt underwriter globally?

Look, debt underwriting, as you know -- investment-grade debt underwriting is not the highest margin of business we have.

It is an important business to the firm.

We would like to be a leader in that business.

I think a lot of that business is based, to some extent, on using balance sheet and we are not going to be a leader in that.

So I think the chances that you would see us be a top three investment-grade debt underwriter are not high.

But we always want to be a major player because it is important for our clients.

And so we are going to be one of the leaders, but probably not one of the top three in the league tables in that business.

And maybe just a quick follow-up of that, David.

It doesn't -- looking at who has reported of your peers to date, it doesn't feel like you have given up any share or relative revenue share on FICC trading, but how do you think that positioning in debt underwriting changes your relative stance with respect to kind of the FICC trading environment and the credit subcluster?

I think it has very little effect.

I think we are a big enough player there and I think our willingness to commit our capital on behalf of our clients, help them with their risk management I think is a much bigger factor.

Great.

Thanks so much for taking all the questions.

Glenn Schorr, Nomura.

Hi, thanks, Dave.

So you guys were never a huge originator, but given all the attention on mortgage putback risk and all the related issues, can you just maybe frame how you see Goldman's position in the food chain and maybe any experience you have had so far?

Sure.

I know you have heard this from others, but I would, again, give a caveat that it is a very fluid and evolving situation, but we really are pretty small.

As you know, mortgages, while important to Goldman Sachs, has always been the smallest of our FICC businesses, never a very large business.

To put it in context in the origination, we had a tiny underwriter.

I looked at the statistics.

The 40th largest underwriter from 2005 to 2008 -- I am sorry -- 40th largest originator originated $30 billion of loans over that period of time and we originated $1.75 billion.

So we are really tiny in the market and that drove us to not be one of the leaders in underwriting either.

I mean we were an underwriter, we did it, we are a player in the market, but we are just not one of the leading players.

So while it is something we continue to watch and as you heard from others, there hasn't been that much experience at some parts of it yet.

We just don't view our exposure there as being large in the context of the market.

Great.

Switching gears, just a numbers thing, the staff at [Peridan], and I know that is employees, consultants and temp staff, and I hear you on the 4% seasonal pickup, but it is up 12% year-on-year.

It is a little bit of a head-scratcher considering the environment and what has happened with revs.

Can you give a little color on where that has taken place?

Sure.

I think what I would tell you is a fair amount of it, on a percentage basis, is outside the United States where, as you know, is where we have targeted a lot of our growth.

Also a lot on the risk management side and the control side of the firm as we get on some of the new regulatory environment and so we thought that that was appropriate.

As you said, the 4% this quarter was probably 80% with campus hiring.

So that is really to be expected, but that was really the -- the areas of growth were some of the [players] we have talked (inaudible) outside of the US, control and our Investment Management division.

Great.

And then I just want to touch on something that you said.

In terms of the netting out of contracts with other broker-dealers that are going to be facing the same increase in risk-weighted assets, to me, that that seems like an incredibly real and logical place for everyone to go play and there has got to be places where we owe you $80 and they owe you $80 and you net things out.

How real is that on the active mitigation front?

It gets thrown in as a one-liner, but it seems like a big deal.

Again, as I mentioned, we assumed none of it in the numbers that I gave you.

I am with you.

But is it real?

It should be real.

It is complicated because every one of these transactions individually is different.

So to pare them off, you have to make sure that you are not accidentally increasing your risk by doing it, but it is something that should be able to happen over time.

And is that process full force right now?

Do you have people behind the scenes, some of that increased headcount looking at this exclusively?

I think there is some of it going on, but there is still -- people are still interpreting the rules as they go forward to mitigate some of the issues.

All right.

Cool.

Thank you, Dave.

Michael Carrier, Deutsche Bank.

Thanks, David.

Just one more question on the Basel III.

If we think that we get the disclosure from Basel in November and then based on the clarity that you have given now, from the clarity from the Fed for a timeframe, when would you expect to be in a fairly good position where you cannot just do the buyback to offset dilution or you can start looking for opportunities in the market and redeploying the capital?

Well, I am not one who is going to try to anticipate when our regulators might act.

So what they do is completely up to them.

But as I said before, our hope is that we are not giving capital back.

Our hope is that we are finding opportunities to use it and if we can't, I would suspect that, as these rules get more and more clarified over the next several years, we would be in a position to give more capital back.

It's hard to pin down an exact date though.

Okay.

Then on the [ROTC] side, you obviously still have a lot of rulemaking needed to be done there, but when you look at the likely changes, do you see -- and a lot of firms are announcing it -- but like a technology-driven opportunity for clearing like you guys developed in the equities business for DMA?

And then what would you expect the capital and risk-weighted asset benefits to be from using a clearinghouse versus having trade bilateral on the balance sheet?

And then finally I guess just based on the rules under consideration, are there a few of them out there that you are focused on in terms of that could be harmful to the market or to the liquidity in the markets?

Again, it is very hard for me to give you exact numbers on what capital metrics freed up.

As I mentioned, we didn't assume any capital being freed up in the numbers that I gave.

But as things move to central clearing and central exchanges, there should be some opportunities for capital to be freed up, but it is very hard for us to quantify.

So I just didn't assume any of that in the numbers I gave you.

That will be just an additional benefit.

As far as the rules, we are focused on -- the things that affect us are the whole question of derivatives, and all the various parts of it, the Volcker rule and how that is interpreted and how market-making is ultimately interpreted.

And those are probably the biggest things we are looking at.

Okay.

And then last one, smaller business, but on the Asset Management side, you still have like about a 5% decay rate on the outflows, mostly on equity as the industry has been challenged there.

But just given your weighting more on the institutional side, I guess from an allocation perspective, are you seeing any changes there?

Is there anything at issue in terms of performance?

You have had a little bit of turnover.

Just more of the outlook on that business.

No, it is really -- what you have seen with us is you have seen the outflow from equities, which you are seeing across the entire industry.

It has had a slight inflow into fixed income, which is what you have seen.

We had some more money market outflows.

I think that is partially because we have a somewhat more conservative credit posture in our money market business.

And when you do that, it costs you a few basis points.

If money markets are only returning a few basis points, it is a bigger percentage.

And so we are okay with that because we think that conservative credit view is warranted.

So I think it is really just more industry dynamics than anything else at this point.

Okay, thanks a lot.

Ed Najarian, ISI Group.

Yes, good morning.

I just actually had a quick question on some of the numbers you threw out around Basel III.

Correct me if I am wrong, but I think you said that if you adjusted your Tier 1 common ratio at the end of the second quarter to a Basel III basis, you would be at 8.8%.

No, that might've been the way it came out because I stuttered a little, but I said nearly 8%.

Oh, okay.

That works.

Thank you.

(inaudible) question.

No problem.

Sorry about that.

Roger Freeman, Barclays Capital.

Hey, good morning, David.

So I guess you commented on one of Howard's questions.

You hope you have a reason to deploy capital really rather than buy back stock, which obviously would be ideal.

But then I'm kind of tying back to your liquidity levels and you are running at basically the levels you were during the height of the credit crisis.

And I am wondering is that a function of that there isn't an outlet to deploy that capital today or is that more a function of just where you think it is best, safest to be invested right now particularly given that rates have been coming in?

I would say it is a combination of the two, but probably a little bit more the former.

We are running really higher than at the height of the credit crisis right now.

Well -- right.

I think we want to be high.

The world is still not a very safe place.

There are issues out there.

There is uncertain economic outlook in many places.

And so we would want to be running a higher-than-normal liquidity reserve, but one of the reasons that it is as high as it is is there is just no call on it right now.

We just have -- the same reason our risk is so low and our balance sheet really hasn't grown.

There has just been no call.

There has been very, very little activity from our clients.

Okay.

Then I guess just to follow up on Volcker.

So GSPS gets wound down, you are defending SSG, the direct corporate equity in real estate investments, it seems like those are probably okay as well because they are not addressed by the short-term trading rules.

Is that fair to say?

I think we are just waiting to see what the final rules say there

Okay.

I had thought that maybe the challenge there would be the Basel rules, applying a higher RWA, but it sounds like you have kind of come out so well on the pro forma calcs, that probably would not be a driver of your thinking, right?

All it does is it affects the return.

You have to make sure that you have -- that whatever you do, given what the capital charges are, have high enough returns and if it does, then we will continue to do business and if not, then we won't.

Okay.

Compensation, you are running 43% year to date.

Is it fair to assume that that is a reasonable full-year run rate?

It is fair to assume that it is a reasonable three quarters run rate.

I thought I would try.

Okay, last question.

Equity trading, can you quantify how much the [Valshort] impact was because there is just such a discrepancy, even relative to I think what people thought the impact was, like $300 million or $400 million given that commissions were down and you were up like $600 million or $700 million?

I am not going to give you exact numbers, but suffice it to say, and I think I said it last quarter, the biggest driver of what has gone on is activity levels, not the pickup in vol last quarter and tick down.

That had some effect on it, but while it recovered this quarter, you can see that by historical measures, it still wasn't a great quarter.

I think it was fine and it was good given what you saw available in the markets, but if you think of normal -- I don't want to say normal activity levels because I don't think anything is normal.

If you think of historical activity levels and historical performance in equities trading, it still wasn't such a great quarter.

And so while the vol trading had something -- the movement had something to do with it, it just wasn't as material as people think it was.

Okay, but the quarter-to-quarter swing relative to the 17% decline in commissions, if you back out vol, it sounds like there is still not going to be a lot of consistency between those two numbers.

I'm sorry.

I missed the end of your question.

It just sounds like there is still, relative to the activity levels, and what you saw in the commissions, there still seems to be somewhat of a disconnect.

Again, you have seen this over time.

You have seen there be a disconnect between commissions and equities trading because commission is just plain vanilla share purchases whereas trading is driven much more by corporate activity and when they want to risk manage.

You saw a slight pickup, and I don't want to overstate this at all, a slight pickup in that activity in September, which was helpful.

And I think that is really what drove the change, as well as some impact of the difference in vol trade.

Okay, great.

Thanks, David.

Jim Mitchell, Buckingham Research.

Good morning.

Maybe just a quick question on just the risk-weighting issue.

If we look at your latest disclosure in 3Q '09 on sort of the buckets of risk-weighting between market risk, operational risk, credit risk, your market risk was dramatically higher than when we look at the European banks.

And there seems to be a very large disconnect on the market risk side.

And it seems to me based on current disclosures that that is going to persist under Basel III and as sort of the risk-adjusted ratio minimums increase, how much of a worry is that for you as the absolute capital levels that you are carrying at the same level of assets versus your European counterparts, does that create some sort of ability for them to underprice you in fixed income trading or other businesses?

We are hopeful that there will be international harmonization of rules.

We don't know there are going to be, but we hope there will be.

We hope people don't use regulatory arbitrage.

But there has always been some of that out there.

It hasn't had a major effect in the past and we will do what, A, our regulators tell us is appropriate and B, what we think is appropriate for safety and soundness regardless of what others do.

Sure.

I just think as ratios go higher though, that difference becomes bigger, right, and that is -- at some point, is there kind of a critical mass where it does become an issue?

It hasn't been, but does it become one?

It is hard to predict, but all I can tell you is it hasn't been so far.

True.

One last question on the securitization side, there has been a lot of questioning around the securitization just as a whole, if there is a way to put back the whole securitization.

It seems more focused on the issuers, but as an underwriter and a sponsor of securitizations, do you feel that there is any risk there?

As I said when asked first, it is very fluid, so I don't want to give you a definitive answer and have you say, well, you said this.

It is very fluid, but we think most of the risk is as an originator and even as an underwriter, our position in the markets was just -- we were not one of the biggest players.

So we don't think our exposures are that big.

Got you.

All right.

Thanks.

Kian Abouhossein, JPMorgan.

Yes, hi.

On Basel 2.5 where the rules are final, I was wondering and they are coming in at the end of 2011, I was wondering if you can give us also an indication how your Basel 2.5 equity Tier 1 number would look like?

I don't have them separated out into 2.5 and 3 here, but we can certainly get back to you off-line and give you those numbers.

Okay.

And on Basel III, what do you see as your kind of minimum level of equity Tier 1 that you think you should be having in your business and what is your view on contingent capital?

You asked several questions, but they are actually several good questions.

So the one on what minimum -- as you know, when all is said and done, the minimum requirement, as we know now before any other things are put in, is 7% on Tier 1 common.

Now it is a while before that is actually in place, but that is ultimately what it is going to be.

There may be things on top of that; we don't know.

And exactly where we are going to run if that is the minimum, I can't tell you, but we will run with a buffer as we always have.

We are never going to run very, very close to the line.

We don't think that would be a prudent way to manage our business so we will always run with some amount of buffer and it is going to depend on the market environment, earnings, risk and other things.

So we will just have to see that over time.

I think as far as contingent capital goes, I think contingent capital, if structured correctly, could be a useful part of people's capital structures.

Again, we are going to have to see what the rules are, how it can be structured, what the market reaction is going to be.

There is a lot of unanswered questions at this point.

And on the $59 billion on Basel III equity Tier 1, what is the major negative adjustment because clearly that is a net number, but I would be quite interested, even if in subjective terms, what the major negative adjustments are to understand maybe what you could potentially mitigate there.

The single biggest negative adjustment is that cumulative preferred no longer counts as good Tier 1 capital and we have about $5 billion of that.

That is the biggest negative adjustment.

Then there is a few other smaller ones and that $5 billion obviously could be replaced, but it can't be mitigated.

Then there is a few other smaller ones having to do with some of the way different things are calculated, some of which might be mitigatable and some which won't.

But that's the biggest one by far.

And if I may ask one more question, we hear from most banks that want to reduce correlation book/illiquid exposure securitization books, but who is going to be on the other side do you think refinancing or buying these assets?

Well, again, a fair number of the trades are dealers to dealers.

So as was asked before, you can get tear-ups amongst a number of dealers, which does not necessarily increase risk, that you had a fair amount of balance sheet being used because it was low capital without a lot of risk being taken.

So I think some number can be rolled off that way.

I think the other places is there where there might be private pools of capital out there that don't have similar capital charges and could become bigger players in this business.

And I think the third piece is, as these things roll off, I think in some cases they are not going to be replaced.

Great.

Thank you very much for the answers.

Mike Mayo, CLSA.

Hi, good morning.

So just to follow up on Basel III, so you have $750 billion of risk-weighted assets under Basel III as of the second quarter?

Approximately.

Yes, roughly.

So how low could that go?

I mean what are some kind of ranges after you take some of the mitigation actions?

I think some of the things we talked about on -- some of the things just from what I have talked about get you down to the $700 million range.

And then there are other active mitigations that could take it lower than that.

And when you are say taking it lower, some other banks have talked about cutting it, the increase, in half.

Is that reasonable?

I think that sounds pretty big to me, but I don't want to say we can't.

I mean it depends -- look, if it were a really slow world and we reduced our balance sheet dramatically, maybe we would.

But in a more normal operating environment, that would seem like a pretty big -- that would seem like a bigger increase than I would anticipate.

Bigger decrease -- sorry -- than I would anticipate.

All right.

So maybe of the $300 billion increase, maybe you could cut off $100 billion or so, is that fair?

With the things I told you, we would get down to $700 million and maybe we could go lower from there.

Passed that, Mike, I think I would just be making up numbers and I don't want to do that.

Okay.

And then separately, can you give some sense of linked quarter revenue trends by region, especially Asia?

I believe, and I will come back to you if what I am telling you is not correct, but I believe that the revenue trends you saw for the overall firm were not all that different by region.

And how much is Asia and non-US this quarter?

Round numbers, I always tell you be careful quarter over quarter, round numbers, US is 55%, non-US is 45% and Europe is a little bigger than Asia of the non-US.

All right.

And then lastly, as far as the trends in the quarter, risk appetite, trading, how would you characterize say September versus the prior two months and is that continuing into this quarter or is that falling off?

Okay, so here is what I would say with the very, very big caveat that you can't read anything into a model.

September was an uptick from July and August, but July and August were really slow.

Now it was modestly better.

It wasn't -- the things weren't roaring in September.

As I said, modestly better September than July and August and October is continuing for now more like September.

But I really caution you not to read very much into it because it could change quickly.

Got it.

Thank you.

Chris Kotowski, Oppenheimer.

Most of my questions have been asked and answered, but maybe you could flesh out a little bit the overseas expansion that you are talking about.

It is it more people-based or capital-based?

Is it origination or trading?

Can you flesh it out a bit for us?

Look, I think you have heard us say before that we think the biggest growth opportunities we see as a firm are going to be in the growth markets.

And we think, as you have heard us say many times before, the most important thing for us is activity and activity tends to go with economic growth.

So we think there is going to be more growth in growth markets than in developed markets.

Not that there won't be growth in the developed markets and so we are growing our headcount and we are committing capital in those markets faster than in the developed markets and it is really for all of our businesses.

It is for our Investment Banking business, our trading business, our Asset Management business, all of them.

Okay, thanks.

Mark Lane, William Blair & Co.

Good morning.

So I just have a question, a quick one on the backlog.

I would have thought that with dialogue levels up, it seems to be building a little bit that the backlog would have improved sequentially.

Have you changed your views in terms of the success, probability of success on the current pipeline or how are you looking at that?

No, backlog, while directionally it can sometimes tell you things, you have to be careful with backlog because, for example, merger deals always get into backlog because they take a while.

Equity deals, IPOs would tend to get into backlog because they take a while.

Following offerings quite often don't get into backlog because you might get a call in the one day and do a block or do an accelerated book/build and get done in a couple of days.

Also, between quarters, something might come in and out in the same quarter.

So I think it is more of a timing question of accruals versus when things hit than anything else.

I think -- I would characterize the Investment Banking activity as up somewhat from what you have seen.

But again, the caution is, if the economy is turned down and more bad news comes out, then a lot of equity deals won't get done, a lot of mergers won't happen.

But if things stay stable or trend up a little bit, then I think you'll see a pretty big pickup.

Okay, thanks for that clarification.

Jeff Harte, Sandler O'Neill.

Good morning.

A couple of things.

As we talk about what the outlook will be, you mentioned a lot of things.

As far as what to watch, I mean does it really come down to a macro call and watch how the global economy performs and if growth resumes, business levels will pick up?

I think if growth resumes and regulation gets clarified, then you should see business start to pick up.

Then you should see activity levels start to pick up.

Then it is up to us to take advantage of that and do what our clients need and be able to be there for them and hopefully profit from them.

Okay.

We have seen some more distressed assets, some distressed debt activities in the markets.

It seems as though quarter after quarter we talk about you guys having capital to deploy, but prices not necessarily getting low enough.

It seems like some of the banks are starting to be some sellers of distressed portfolios.

Do you have a feel for whether offers are coming down versus bids going up and how you are kind of looking at distressed opportunities?

I think you're seeing both of those things.

I think offers are coming down and bids are going up.

We have seen a few more deals than we have seen in the past, but so far, we haven't seen very many -- we haven't seen a material amount that we thought met our return hurdles.

But you are seeing a little bit more activity than you have seen.

So there are possibilities that more of those will happen.

There are also possibilities that more will happen at prices that we don't think give us the return hurdles.

And so it won't be something that is major for us.

We just don't know yet.

Okay, and finally, this has been hit on, but I want to make sure I got it correctly.

When it comes to be kind of the putback and rep and warranty type stuff, I mean certainly your role as a mortgage originator was small.

The role of securitizing or mortgage CDOs was bigger, still smaller than most, but bigger.

I mean it sounds as though you are saying from a securitizer of mortgage CDOs where you weren't the underlying asset originator, there is not a whole lot of risk of things coming back to you.

Am I putting words into your mouth?

Yes.

What I said was we weren't that big -- in the context of the market, we weren't that big.

The situation is fluid.

There is not a lot we have seen so far that causes us to think we are going to have that much exposure, but it is very fluid and we don't know yet.

Okay, thanks.

Douglas Sipkin, Ticonderoga.

Yes, thank you and good morning, David.

Just two questions, one, obviously, the backlog is flat.

Maybe from a geographical standpoint, I was just curious.

We have seen a little bit of life, just a touch of life in Europe in terms of secondary equities.

Just curious if you guys expect to see more of a pickup there with a couple of institutions getting ahead of some of these regulatory requirements.

And then secondly, I know you guys have talked about the low rate environment impacting returns.

Is there sort of like obviously a steep curve, but a magic type of level where you like to see the 10 year at where you think it is optimal for you guys?

On your first question, it is very hard for me to predict what companies are going to do and obviously, if I knew, I couldn't tell you.

So it is very hard to answer that question.

Where we have seen the most pickup over the last several months has been Asia.

You have seen more deals coming out of Asia than anywhere and not a surprise given the growth trajectory there.

And as far as -- it is very hard to give you a magic number on the 10-year rate.

As I think you've heard me say before, the real key is for growth to pick up again.

Obviously, as rates continue to come down, it tends to imply that growth is slower, not higher.

So slightly higher rates would be better, not because it is higher rates, but because it probably means that we will see more growth and that leads to more activity.

But just to come back to the first question, and I probably know the answer, I mean if there were activities, sort of like a secondary, it is very possible it is not even in a backlog right now because it is something that sort of comes together quicker, not asking you to comment on anything specific, but I am just trying to understand the dynamics of the way you guys calculate the backlog.

No, that is absolutely correct.

A European bank could decide on Wednesday that they want to do a rights offering and they want to announce it on Friday and it would never go into backlog.

We'd talk to them.

Hopefully, we would be one of the leads or they could announce they want to do an accelerated book/build and do it the next day.

So that might never get into the backlog.

Okay, great.

Thanks for taking my questions.

Matt Burnell, Wells Fargo Securities.

Good morning.

Most of my questions have been asked and answered.

I just have a couple of clarifications.

David, when you were going through the pro forma Basel III capital ratios, the $59 billion number that you quoted, that is Tier 1 common, correct?

Tier 1 common, that is correct.

Okay, okay.

And then the modest DVA number in the quarter was $200 million across both equity and debt, but largely in FICC?

That is correct.

Okay.

Thanks very much.

Steve Stelmach, FBR Capital Markets.

Hi, good morning.

You just mentioned Asia, and it looks, by some accounts, that China actually may have more equity capital raised in China than the US for the first time ever I believe this year if current trends hold.

Do you think -- and you obviously have a leading share there.

Do you think you are adequately sized for the opportunity there or are you and everyone else sort of trying to catch up to the opportunity?

I think what you said is absolutely correct.

If you look at the trends, there is a chance that will happen.

As you know, we have been talking about that being a big opportunity for a long time.

We think we have a pretty big competitive advantage there.

We probably have been there for longer.

We have a bigger presence than others.

We would like to be bigger.

We are held back by making sure we can build the infrastructure and find the right people.

And other than that, we are growing as fast as we think is prudent.

Got it.

Okay.

And then just putting a finer point on global core excess, you are carrying on a lot obviously and you mentioned a little bit of it, but is it simply a function of client activity and pending regulation or is that also sort of expressing a view of where opportunities are right now versus where you expect them to be going forward over the next 12 to 18 months?

It is a combination of all those things, but it is much more the former than the latter.

Perfect.

Thank you very much.

Richard Staite, Atlantic Equities.

Do you guys ever consider raising the dividend and if not, why not?

My thinking around this is that, going forward, if your proprietary trading drops and your income becomes more stable, are you not in a better position to have a higher payout ratio?

We consider everything.

We have, generally over time, felt that, for us and for the types of shareholders that we have, if we were going to choose to return capital, that buying back shares is a better way to give it back to our shareholders, but that is not to say that we wouldn't raise our dividends going forward.

There is nothing on the table right now, but we look at and consider everything over time.

Okay.

And a second question just in terms of your latest thinking on acquisitions.

Would that most likely come in Asset Management or do you think there are other businesses you would consider?

Again, we have talked over time.

We, as you know, have not made a lot of acquisitions over time.

There aren't that many examples of successful acquisitions in the financial services industry and there is many more examples of unsuccessful ones.

It is hard to combine cultures.

It is just a people business.

We are not necessarily averse to them.

If we found something that made sense, we would think about it.

We just haven't seen any over time that have made sense for us.

They might make sense for other people, but given our mix of businesses, they haven't made sense for us.

Okay, great.

Thanks.

Carole Berger, Soleil.

Good morning.

Sometimes I get a little dense, so I would like you to help me with this a little bit.

When you talk about mitigation in regard to risk-weighted assets for your calculations, is it because there is sort of two ways to structure a transaction for a client and therefore you might choose a less capital-intensive way to do the business?

Or is it because the capital required for some of these assets is so significant that it is no longer really an economic or doesn't meet the kind of hurdle returns you would like in that business?

So could you tell us how you would choose to change the way you do stuff?

Sure.

Carole, what I was really talking about is partially the latter, that the capital requirements are too high.

But it is also partially that occasionally you will find that we and others will have assets on our balance sheet that aren't earning very much, aren't giving you a lot of risk, but you might have offsetting assets, you might have -- offsetting asset liability, a long and a short or a long with someone and a short with someone else, which completely mitigates the risk.

And when you put those trades on, you could have tried to just take off the first trade, but it was -- maybe saved you a little bit of transaction expenses.

Maybe it was just easier to just put on an offsetting trade and the capital charges were low enough that it was fine that you had those on your balance sheet.

But you sit here today and all of a sudden the capital charges, even though they may not have a lot of risk, are quite high and you say, well, this doesn't make sense, let's work with counterparties on both sides to just tear up those trades and you can not affect risk very much, not affect revenues very much, but affect capital a fair amount.

And so that is really what I mean by more active mitigation.

Okay.

In some cases, you may say there are revenues, but the revenues just aren't worth the capital charges anymore and so that is another way.

So it's either of those things is really what I was talking about.

Okay.

And secondarily, given the fact that you are accruing comp at the lowest rate ever, do you still have the same kind of flexibility going into the fourth quarter that you would normally have?

I think we have told you every quarter in our history that we accrue at where we think is reasonable at that time, but that the final comp numbers are determined at the end of the year and it is hard to know until the end of the year where they are going to be.

And it is going to be based on our competitive position, our actual earnings, the environment and many other things.

So I can't give you a lot more guidance on that.

Thank you.

Roger Freeman, Barclays Capital.

Hey, David, just a couple of follow-ups.

Is the reason that -- as you kind of go through, and again, it is early, but the RWA calc under Basel III -- is the reason it maybe doesn't go down as much as for some of the other banks we have been hearing is just because so much of the higher RWA is charged back on the correlation book around the mortgage businesses and since that wasn't as big for you, there is just not as much of an opportunity set for you to reduce that?

It is very hard for me to compare us to others because I don't know what others have.

I have seen headline numbers, but I never know what is in there.

So I only know what our numbers are, but I don't know theirs.

One possibility is we do have a somewhat larger principle investment portfolio than others and so I think some of those have higher risk-weighted assets under the new rules.

As I said, we have made no assumptions of any of that rolling off even though some of that is going to.

So that might be one of the things contributing.

Okay.

And then just on this netting thing, I missed a little bit of what you said on the last question.

Are you just talking about between dealer and dealer, sort of the capital benefits that you might get from tearing it up as opposed to say between dealer and buy side?

Yes.

Okay.

And is there any way to entice the buy side and how much is the split?

Do you think like half and half of it is dealer versus buy side in terms of the swaps?

I think it is more dealer.

More dealer.

Okay.

But given there is no retroactive clearing requirement then there is really nothing you can do to push the buy side.

(multiple speakers)

It is just a question of whether it is attractive enough for them.

Right.

Okay.

And then just lastly, the FX VAR, so that was the biggest reason for your VAR coming down and volatility obviously was down, but your revenues were up.

Can you just talk a little bit to that dynamic?

I guess in the second quarter, you were kind of long in euros, right, I think you had mentioned and that was a negative then?

I don't think I mentioned that.

That would have not been like me to say that.

Again, just nothing specific that I would say of currency versus anything else other than, again, lower activity levels, lower volatility across the board.

But good trading environment, I guess, if the revenues were up.

Okay.

When I say they were up, they were up, don't read a lot into that.

It wasn't like it was a blowout quarter in any way, shape or form in any business.

Okay, great.

All right, thanks.

I would now like to turn the call back over to management for any final remarks.

Thank you, everyone, for joining.

If you have any additional follow-up questions, please feel free to contact us in the Investor Relations department.

Otherwise, have a nice day.

Thank you, ladies and gentlemen, for your participation in Goldman Sachs' third-quarter earnings conference call.

You may now disconnect.