FORM 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
FORM 10-Q
 
     
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
     
    For the quarterly period ended February 29, 2008
 
or
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
     
    For the transition period from                 to
 
Commission File Number: 001-14965
 
The Goldman Sachs Group, Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware   13-4019460
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
85 Broad Street, New York, NY
  10004
(Address of principal executive offices)   (Zip Code)
 
(212) 902-1000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     x  Yes  o  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x     Accelerated filer o
 
Non-accelerated filer (Do not check if a smaller reporting company) o  Smaller reporting company o
                 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     o  Yes  x  No
 
APPLICABLE ONLY TO CORPORATE ISSUERS
 
As of March 28, 2008, there were 394,203,409 shares of the registrant’s common stock outstanding.
 


 

 
THE GOLDMAN SACHS GROUP, INC.
 
QUARTERLY REPORT ON FORM 10-Q FOR THE FISCAL QUARTER ENDED FEBRUARY 29, 2008
 
INDEX
 
             
    Page
Form 10-Q Item Number:
 
No.
 
         
           
         
        2  
        3  
        4  
        5  
        6  
        7  
        57  
           
      58  
           
      107  
           
      107  
           
         
           
      108  
           
      109  
           
      110  
       
    111  
 EX-10.1: FORM OF ONE-TIME RSU AWARD AGREEMENT
 EX-10.2: DESCRIPTION OF PMD RETIREE MEDICAL PROGRAM
 EX-12.1: STATEMENT RE: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND RATIOS OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
 EX-15.1: LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION
 EX-31.1: RULE 13A-14(A) CERTIFICATIONS
 EX-32.1: SECTION 1350 CERTIFICATIONS


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Table of Contents

 
PART I: FINANCIAL INFORMATION
 
Item 1:   Financial Statements (Unaudited)
 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
 
                 
    Three Months
    Ended February
   
2008
 
2007
    (in millions, except
    per share amounts)
 
Revenues
               
Investment banking
    $ 1,166       $ 1,716  
Trading and principal investments
    4,877       9,073  
Asset management and securities services
    1,341       1,133  
Interest income
    11,245       10,358  
                 
Total revenues
    18,629       22,280  
                 
Interest expense
    10,294       9,550  
                 
Revenues, net of interest expense
    8,335       12,730  
                 
Operating expenses
               
Compensation and benefits
    4,001       6,111  
                 
Brokerage, clearing, exchange and distribution fees
    790       551  
Market development
    144       132  
Communications and technology
    187       151  
Depreciation and amortization
    170       132  
Amortization of identifiable intangible assets
    84       51  
Occupancy
    236       204  
Professional fees
    178       161  
Other expenses
    402       378  
                 
Total non-compensation expenses
    2,191       1,760  
                 
Total operating expenses
    6,192       7,871  
                 
                 
Pre-tax earnings
    2,143       4,859  
Provision for taxes
    632       1,662  
                 
Net earnings
    1,511       3,197  
Preferred stock dividends
    44       49  
                 
Net earnings applicable to common shareholders
    $ 1,467       $ 3,148  
                 
Earnings per common share
               
Basic
    $  3.39       $  7.08  
Diluted
    3.23       6.67  
                 
Dividends declared and paid per common share
    $  0.35       $  0.35  
                 
Average common shares outstanding
               
Basic
    432.8       444.5  
Diluted
    453.5       471.9  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions, except share
 
    and per share amounts)  
 
Assets
               
Cash and cash equivalents
  $ 12,715     $ 11,882  
Cash and securities segregated for regulatory and other purposes (includes $82,038 and $94,018 at fair value as of February 2008 and November 2007, respectively)
    104,496       119,939  
Receivables from brokers, dealers and clearing organizations
    30,412       19,078  
Receivables from customers and counterparties (includes $1,809 and $1,950 at fair value as of February 2008 and November 2007, respectively)
    113,911       129,105  
Collateralized agreements:
               
Securities borrowed (includes $80,440 and $83,277 at fair value as of February 2008 and November 2007, respectively)
    294,047       277,413  
Financial instruments purchased under agreements to resell, at fair value
    107,800       85,717  
                 
Financial instruments owned, at fair value
    459,346       406,457  
Financial instruments owned and pledged as collateral, at fair value
    39,509       46,138  
                 
Total financial instruments owned, at fair value
    498,855       452,595  
Other assets
    26,770       24,067  
                 
Total assets
  $ 1,189,006     $ 1,119,796  
                 
                 
Liabilities and shareholders’ equity
               
Unsecured short-term borrowings, including the current portion of unsecured long-term borrowings (includes $45,864 and $48,331 at fair value as of February 2008 and November 2007, respectively)
  $ 72,789     $ 71,557  
Bank deposits (includes $739 and $463 at fair value as of February 2008 and November 2007, respectively)
    26,961       15,370  
Payables to brokers, dealers and clearing organizations
    12,435       8,335  
Payables to customers and counterparties
    336,763       310,118  
Collateralized financings:
               
Securities loaned (includes $3,658 and $5,449 at fair value as of February 2008 and November 2007, respectively)
    26,130       28,624  
Financial instruments sold under agreements to repurchase, at fair value
    161,498       159,178  
Other secured financings (includes $32,317 and $33,581 at fair value as of February 2008 and November 2007, respectively)
    70,127       65,710  
Financial instruments sold, but not yet purchased, at fair value
    230,060       215,023  
Other liabilities and accrued expenses
    30,139       38,907  
                 
Unsecured long-term borrowings (includes $19,303 and $15,928 at fair value as of February 2008 and November 2007, respectively)
    179,475       164,174  
                 
Total liabilities
    1,146,377       1,076,996  
                 
Commitments, contingencies and guarantees
               
Shareholders’ equity
               
Preferred stock, par value $0.01 per share; 150,000,000 shares authorized, 124,000 shares issued and outstanding as of both February 2008 and November 2007, with liquidation preference of $25,000 per share
    3,100       3,100  
Common stock, par value $0.01 per share; 4,000,000,000 shares authorized, 630,296,649 and 618,707,032 shares issued as of February 2008 and November 2007, respectively, and 394,473,924 and 390,682,013 shares outstanding as of February 2008 and November 2007, respectively
    6       6  
Restricted stock units and employee stock options
    8,322       9,302  
Nonvoting common stock, par value $0.01 per share; 200,000,000 shares authorized, no shares issued and outstanding
           
Additional paid-in capital
    23,306       22,027  
Retained earnings
    39,751       38,642  
Accumulated other comprehensive income/(loss)
    (144 )     (118 )
Common stock held in treasury, at cost, par value $0.01 per share; 235,822,725 and 228,025,019 shares as of February 2008 and November 2007, respectively
    (31,712 )     (30,159 )
                 
Total shareholders’ equity
    42,629       42,800  
                 
Total liabilities and shareholders’ equity
  $ 1,189,006     $ 1,119,796  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
                 
    Period Ended
    February
  November
    2008   2007
    (in millions, except
    per share amounts)
 
Preferred stock
               
Balance, beginning of year
    $    3,100       $    3,100  
Issued
           
                 
Balance, end of period
    3,100       3,100  
Common stock, par value $0.01 per share
               
Balance, beginning of year
    6       6  
Issued
           
                 
Balance, end of period
    6       6  
Restricted stock units and employee stock options
               
Balance, beginning of year
    9,302       6,290  
Issuance and amortization of restricted stock units and employee stock options
    1,023       4,684  
Delivery of common stock underlying restricted stock units
    (1,980 )     (1,548 )
Forfeiture of restricted stock units and employee stock options
    (22 )     (113 )
Exercise of employee stock options
    (1 )     (11 )
                 
Balance, end of period
    8,322       9,302  
Additional paid-in capital
               
Balance, beginning of year
    22,027       19,731  
Issuance of common stock, including the delivery of common stock underlying restricted stock units and proceeds from the exercise of employee stock options
    2,035       2,338  
Cancellation of restricted stock units in satisfaction of withholding tax requirements
    (1,310 )     (929 )
Stock purchase contract fee related to automatic preferred enhanced capital securities
          (20 )
Excess net tax benefit related to share-based compensation
    554       908  
Cash settlement of share-based compensation
          (1 )
                 
Balance, end of period
    23,306       22,027  
Retained earnings
               
Balance, beginning of year, as previously reported
    38,642       27,868  
Cumulative effect of adjustment from adoption of FIN No. 48
    (201 )      
Cumulative effect of adjustment from adoption of SFAS No. 157, net of tax
          51  
Cumulative effect of adjustment from adoption of SFAS No. 159, net of tax
          (45 )
                 
Balance, beginning of year, after cumulative effect of adjustments
    38,441       27,874  
Net earnings
    1,511       11,599  
Dividends and dividend equivalents declared on common stock and restricted
stock units
    (157 )     (639 )
Dividends declared on preferred stock
    (44 )     (192 )
                 
Balance, end of period
    39,751       38,642  
Accumulated other comprehensive income/(loss)
               
Balance, beginning of year
    (118 )     21  
Adjustment from adoption of SFAS No. 158, net of tax
          (194 )
Currency translation adjustment, net of tax
    9       39  
Minimum pension liability adjustment, net of tax
          38  
Net gains/(losses) on cash flow hedges, net of tax
          (2 )
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (35 )     (12 )
Reclassification to retained earnings from adoption of SFAS No. 159, net of tax
          (8 )
                 
Balance, end of period
    (144 )     (118 )
Common stock held in treasury, at cost
               
Balance, beginning of year
    (30,159 )     (21,230 )
Repurchased
    (1,561 )     (8,956 )
Reissued
    8       27  
                 
Balance, end of period
    (31,712 )     (30,159 )
                 
Total shareholders’ equity
    $ 42,629       $ 42,800  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    (in millions)  
 
Cash flows from operating activities
               
Net earnings
  $ 1,511     $ 3,197  
Non-cash items included in net earnings
               
Depreciation and amortization
    259       204  
Amortization of identifiable intangible assets
    84       68  
Share-based compensation
    480       362  
Changes in operating assets and liabilities
               
Cash and securities segregated for regulatory and other purposes
    15,650       2,664  
Net receivables from brokers, dealers and clearing organizations
    (7,234 )     390  
Net payables to customers and counterparties
    42,226       (21,019 )
Securities borrowed, net of securities loaned
    (19,127 )     (17,802 )
Financial instruments sold under agreements to repurchase, net of
financial instruments purchased under agreements to resell
    (19,763 )     45,413  
Financial instruments owned, at fair value
    (46,347 )     (36,953 )
Financial instruments sold, but not yet purchased, at fair value
    15,037       10,676  
Other, net
    (5,425 )     (3,435 )
                 
Net cash used for operating activities
    (22,649 )     (16,235 )
Cash flows from investing activities
               
Purchase of property, leasehold improvements and equipment
    (403 )     (580 )
Proceeds from sales of property, leasehold improvements and equipment
    42       12  
Business acquisitions, net of cash acquired
    (2,156 )     (55 )
Proceeds from sales of investments
    26       199  
Purchase of available-for-sale securities
    (1,109 )     (89 )
Proceeds from sales of available-for-sale securities
    647       105  
                 
Net cash used for investing activities
    (2,953 )     (408 )
Cash flows from financing activities
               
Unsecured short-term borrowings, net
    879       1,652  
Other secured financings (short-term), net
    2,384       241  
Proceeds from issuance of other secured financings (long-term)
    4,107       400  
Repayment of other secured financings (long-term), including the current portion
    (2,373 )     (1,134 )
Proceeds from issuance of unsecured long-term borrowings
    19,874       17,741  
Repayment of unsecured long-term borrowings, including the current portion
    (8,461 )     (3,325 )
Derivative contracts with a financing element, net
    (420 )     1,495  
Bank deposits, net
    11,591       2,197  
Common stock repurchased
    (1,561 )     (2,685 )
Dividends and dividend equivalents paid on common stock, preferred stock
and restricted stock units
    (201 )     (212 )
Proceeds from issuance of common stock
    64       308  
Excess tax benefit related to share-based compensation
    552       559  
                 
Net cash provided by financing activities
    26,435       17,237  
                 
Net increase/(decrease) in cash and cash equivalents
    833       594  
                 
Cash and cash equivalents, beginning of year
    11,882       6,293  
                 
Cash and cash equivalents, end of period
  $ 12,715     $ 6,887  
                 
 
SUPPLEMENTAL DISCLOSURES:
 
Cash payments for interest, net of capitalized interest, were $10.64 billion and $9.51 billion during the three months ended February 2008 and February 2007, respectively.
 
Cash payments for income taxes, net of refunds, were $670 million and $1.51 billion during the three months ended February 2008 and February 2007, respectively.
 
Non-cash activities:
The firm assumed $534 million of debt in connection with business acquisitions during the three months ended February 2008. The firm issued $17 million of common stock in connection with business acquisitions for the three months ended February 2007.
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    (in millions)  
 
Net earnings
  $ 1,511     $ 3,197  
Currency translation adjustment, net of tax
    9       5  
Net gains/(losses) on cash flow hedges, net of tax
          2  
Net unrealized gains/(losses) on available-for-sale securities, net of tax
    (35 )     (2 )
                 
Comprehensive income
  $ 1,485     $ 3,202  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Note 1.   Description of Business
 
The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, together with its consolidated subsidiaries (collectively, the firm), is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.
 
The firm’s activities are divided into three segments:
 
  •  Investment Banking.  The firm provides a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals.
 
  •  Trading and Principal Investments.  The firm facilitates client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, the firm engages in market-making and specialist activities on equities and options exchanges and clears client transactions on major stock, options and futures exchanges worldwide. In connection with the firm’s merchant banking and other investing activities, the firm makes principal investments directly and through funds that the firm raises and manages.
 
  •  Asset Management and Securities Services.  The firm provides investment advisory and financial planning services and offers investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse group of institutions and individuals worldwide and provides prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.
 
Note 2.   Significant Accounting Policies
 
Basis of Presentation
 
These condensed consolidated financial statements include the accounts of Group Inc. and all other entities in which the firm has a controlling financial interest. All material intercompany transactions and balances have been eliminated.
 
The firm determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity, a variable interest entity (VIE) or a qualifying special-purpose entity (QSPE) under generally accepted accounting principles.
 
  •  Voting Interest Entities.  Voting interest entities are entities in which (i) the total equity investment at risk is sufficient to enable the entity to finance its activities independently and (ii) the equity holders have the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. Voting interest entities are consolidated in accordance with Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements,” as amended. ARB No. 51 states that the usual condition for a controlling financial interest in an entity is ownership of a majority voting interest. Accordingly, the firm consolidates voting interest entities in which it has a majority voting interest.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
  •  Variable Interest Entities.  VIEs are entities that lack one or more of the characteristics of a voting interest entity. A controlling financial interest in a VIE is present when an enterprise has a variable interest, or a combination of variable interests, that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. In accordance with Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 46-R, “Consolidation of Variable Interest Entities,” the firm consolidates VIEs for which it is the primary beneficiary. The firm determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes a review of, among other factors, its capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE. Where qualitative analysis is not conclusive, the firm performs a quantitative analysis. For purposes of allocating a VIE’s expected losses and expected residual returns to its variable interest holders, the firm utilizes the “top down” method. Under that method, the firm calculates its share of the VIE’s expected losses and expected residual returns using the specific cash flows that would be allocated to it, based on contractual arrangements and/or the firm’s position in the capital structure of the VIE, under various probability-weighted scenarios.
 
  •  QSPEs.  QSPEs are passive entities that are commonly used in mortgage and other securitization transactions. Statement of Financial Accounting Standards (SFAS) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” sets forth the criteria an entity must satisfy to be a QSPE. These criteria include the types of assets a QSPE may hold, limits on asset sales, the use of derivatives and financial guarantees, and the level of discretion a servicer may exercise in attempting to collect receivables. These criteria may require management to make judgments about complex matters, such as whether a derivative is considered passive and the level of discretion a servicer may exercise, including, for example, determining when default is reasonably foreseeable. In accordance with SFAS No. 140 and FIN No. 46-R, the firm does not consolidate QSPEs.
 
  •  Equity-Method Investments.  When the firm does not have a controlling financial interest in an entity but exerts significant influence over the entity’s operating and financial policies (generally defined as owning a voting interest of 20% to 50%) and has an investment in common stock or in-substance common stock, the firm accounts for its investment either in accordance with Accounting Principles Board Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” or at fair value in accordance with SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” In general, the firm accounts for investments acquired subsequent to the adoption of SFAS No. 159 at fair value. In certain cases, the firm may apply the equity method of accounting to new investments that are strategic in nature or closely related to the firm’s principal business activities, where the firm has a significant degree of involvement in the cash flows or operations of the investee, or where cost-benefit considerations are less significant. See “— Revenue Recognition — Other Financial Assets and Financial Liabilities at Fair Value” below for a discussion of the firm’s application of SFAS No. 159.
 
  •  Other.  If the firm does not consolidate an entity or apply the equity method of accounting, the firm accounts for its investment at fair value. The firm also has formed numerous nonconsolidated investment funds with third-party investors that are typically organized as limited partnerships. The firm acts as general partner for these funds and generally does not hold a majority of the economic interests in these funds. The firm has generally provided the third-party investors with rights to terminate the funds or to remove the firm as the general


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
partner. These fund investments are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.
 
These condensed consolidated financial statements are unaudited and should be read in conjunction with the audited consolidated financial statements incorporated by reference in the firm’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007. The condensed consolidated financial information as of November 30, 2007 has been derived from audited consolidated financial statements not included herein.
 
These unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. These adjustments are of a normal, recurring nature. Interim period operating results may not be indicative of the operating results for a full year.
 
Unless specifically stated otherwise, all references to February 2008 and February 2007 refer to the firm’s fiscal periods ended, or the dates, as the context requires, February 29, 2008 and February 23, 2007, respectively. All references to November 2007, unless specifically stated otherwise, refer to the firm’s fiscal year ended, or the date, as the context requires, November 30, 2007. All references to 2008, unless specifically stated otherwise, refer to the firm’s fiscal year ending, or the date, as the context requires, November 28, 2008. Certain reclassifications have been made to previously reported amounts to conform to the current presentation.
 
Use of Estimates
 
These condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles that require management to make certain estimates and assumptions. The most important of these estimates and assumptions relate to fair value measurements, the accounting for goodwill and identifiable intangible assets and the provision for potential losses that may arise from litigation and regulatory proceedings and tax audits. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.
 
Revenue Recognition
 
Investment Banking.  Underwriting revenues and fees from mergers and acquisitions and other financial advisory assignments are recognized in the condensed consolidated statements of earnings when the services related to the underlying transaction are completed under the terms of the engagement. Expenses associated with such transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. Underwriting revenues are presented net of related expenses. Expenses associated with financial advisory transactions are recorded as non-compensation expenses, net of client reimbursements.
 
Financial Instruments.  “Total financial instruments owned, at fair value” and “Financial instruments sold, but not yet purchased, at fair value” are reflected in the condensed consolidated statements of financial condition on a trade-date basis. Related unrealized gains or losses are generally recognized in “Trading and principal investments” in the condensed consolidated statements of earnings. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Instruments that the firm owns (long positions) are marked to bid prices, and instruments that the firm has sold, but not yet purchased (short positions), are marked to offer prices. Fair value measurements are not adjusted for transaction costs.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
SFAS No. 157, “Fair Value Measurements,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Basis of Fair Value Measurement
 
  Level 1   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
 
  Level 2   Quoted prices in markets that are not considered to be active or financial instruments for which all significant inputs are observable, either directly or indirectly;
 
  Level 3   Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
In determining fair value, the firm separates its “Financial instruments owned, at fair value” and its “Financial instruments sold, but not yet purchased, at fair value” into two categories: cash instruments and derivative contracts.
 
  •  Cash Instruments.  The firm’s cash instruments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include most U.S. government and sovereign obligations, active listed equities and most money market securities. Such instruments are generally classified within level 1 of the fair value hierarchy. The firm does not adjust the quoted price for such instruments, even in situations where the firm holds a large position and a sale could reasonably impact the quoted price.
 
The types of instruments that trade in markets that are not considered to be active, but are valued based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most government agency securities, investment-grade corporate bonds, certain mortgage products, certain corporate bank and bridge loans, less liquid listed equities, state, municipal and provincial obligations, most physical commodities and certain loan commitments. Such instruments are generally classified within level 2 of the fair value hierarchy.
 
Certain cash instruments are classified within level 3 of the fair value hierarchy because they trade infrequently and therefore have little or no price transparency. Such instruments include private equity and real estate fund investments, certain corporate loans (including certain mezzanine financing, leveraged loans arising from capital market transactions and other corporate bank debt), less liquid corporate debt securities and other debt obligations (including high-yield corporate bonds, distressed debt instruments and collateralized debt obligations (CDOs) backed by corporate obligations), less liquid mortgage whole loans and securities (backed by either commercial or residential real estate), and acquired portfolios of distressed loans. The transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. This valuation is adjusted only when


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
changes to inputs and assumptions are corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows.
 
For positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
  •  Derivative Contracts.  Derivative contracts can be exchange-traded or over-the-counter (OTC). Exchange-traded derivatives typically fall within level 1 or level 2 of the fair value hierarchy depending on whether they are deemed to be actively traded or not. The firm generally values exchange-traded derivatives within portfolios using models which calibrate to market-clearing levels and eliminate timing differences between the closing price of the exchange-traded derivatives and their underlying cash instruments. In such cases, exchange-traded derivatives are classified within level 2 of the fair value hierarchy.
 
OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. The firm generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be verified and model selection does not involve significant management judgment. Such instruments are typically classified within level 2 of the fair value hierarchy.
 
Certain OTC derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. Such instruments are classified within level 3 of the fair value hierarchy. Where the firm does not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. The valuations of these less liquid OTC derivatives are typically based on level 1 and/or level 2 inputs that can be observed in the market, as well as unobservable level 3 inputs. Subsequent to initial recognition, the firm updates the level 1 and level 2 inputs to reflect observable market changes, with resulting gains and losses reflected within level 3. Level 3 inputs are only changed when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations, or other empirical market data. In circumstances where the firm cannot verify the model value to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value.
 
When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Other Financial Assets and Financial Liabilities at Fair Value.  The firm has elected to account for certain of the firm’s other financial assets and financial liabilities at fair value under SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140,” or SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” The primary reasons for electing the fair value option are mitigating volatility in earnings from using different measurement attributes, simplification and cost-benefit considerations.
 
Such financial assets and financial liabilities accounted for at fair value include (i) certain unsecured short-term borrowings, consisting of all promissory notes and commercial paper and certain hybrid financial instruments; (ii) certain other secured financings, primarily transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings; (iii) certain unsecured long-term borrowings, including prepaid physical commodity transactions; (iv) resale and repurchase agreements; (v) securities borrowed and loaned within Trading and Principal Investments, consisting of the firm’s matched book and certain firm financing activities; (vi) corporate loans, loan commitments and certain certificates of deposit issued by Goldman Sachs Bank USA (GS Bank USA) as well as securities held by GS Bank USA (which would otherwise be accounted for as available-for-sale); (vii) receivables from customers and counterparties arising from transfers accounted for as secured loans rather than purchases under SFAS No. 140; and (viii) in general, investments acquired after the adoption of SFAS No. 159 where the firm has significant influence over the investee and would otherwise apply the equity method of accounting.
 
Collateralized Agreements and Financings.  Collateralized agreements consist of resale agreements and securities borrowed. Collateralized financings consist of repurchase agreements, securities loaned and other secured financings. Interest on collateralized agreements and collateralized financings is recognized in “Interest income” and “Interest expense,” respectively, over the life of the transaction.
 
  •  Resale and Repurchase Agreements.  Financial instruments purchased under agreements to resell and financial instruments sold under agreements to repurchase, principally U.S. government, federal agency and investment-grade sovereign obligations, represent collateralized financing transactions. The firm receives financial instruments purchased under agreements to resell, makes delivery of financial instruments sold under agreements to repurchase, monitors the market value of these financial instruments on a daily basis and delivers or obtains additional collateral as appropriate. As noted above, resale and repurchase agreements are carried in the condensed consolidated statements of financial condition at fair value as allowed by SFAS No. 159. Resale and repurchase agreements are generally valued based on inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy. Resale and repurchase agreements are presented on a net-by-counterparty basis when the requirements of FIN No. 41, “Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements,” or FIN No. 39, “Offsetting of Amounts Related to Certain Contracts,” are satisfied.
 
  •  Securities Borrowed and Loaned.  Securities borrowed and loaned are generally collateralized by cash, securities or letters of credit. The firm receives securities borrowed, makes delivery of securities loaned, monitors the market value of securities borrowed and loaned, and delivers or obtains additional collateral as appropriate. Securities borrowed and loaned within Securities Services, relating to both customer activities and, to a lesser extent, certain firm financing activities, are recorded based on the amount of cash collateral advanced or received plus accrued interest. As these arrangements are generally transacted on-demand, they exhibit little, if any, sensitivity to changes in interest rates. As noted above, securities


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
borrowed and loaned within Trading and Principal Investments, which are related to the firm’s matched book and certain firm financing activities, are recorded at fair value as allowed by SFAS No. 159. These securities borrowed and loaned transactions are generally valued based on inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy.
 
  •  Other Secured Financings.  In addition to repurchase agreements and securities loaned, the firm funds assets through the use of other secured financing arrangements and pledges financial instruments and other assets as collateral in these transactions. As noted above, the firm has elected to apply SFAS No. 159 to transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings, for which the use of fair value eliminates non-economic volatility in earnings that would arise from using different measurement attributes. These other secured financing transactions are generally valued based on inputs with reasonable levels of price transparency and are classified within level 2 of the fair value hierarchy. Other secured financings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest. See Note 3 for further information regarding other secured financings.
 
Hybrid Financial Instruments.  Hybrid financial instruments are instruments that contain bifurcatable embedded derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and do not require settlement by physical delivery of non-financial assets (e.g., physical commodities). If the firm elects to bifurcate the embedded derivative, it is accounted for at fair value and the host contract is accounted for at amortized cost, adjusted for the effective portion of any fair value hedge accounting relationships. If the firm does not elect to bifurcate, the entire hybrid financial instrument is accounted for at fair value under SFAS No. 155. See Notes 3 and 4 for additional information about hybrid financial instruments.
 
Transfers of Financial Assets.  In general, transfers of financial assets are accounted for as sales under SFAS No. 140 when the firm has relinquished control over the transferred assets. For transfers accounted for as sales, any related gains or losses are recognized in net revenues. Transfers that are not accounted for as sales are accounted for as collateralized financings, with the related interest expense recognized in net revenues over the life of the transaction.
 
Commissions.  Commission revenues from executing and clearing client transactions on stock, options and futures markets are recognized in “Trading and principal investments” in the condensed consolidated statements of earnings on a trade-date basis.
 
Insurance Activities.  Revenues from variable annuity and life insurance contracts, and from providing reinsurance of such contracts, generally consist of fees assessed on contract holder account balances for mortality charges, policy administration and surrender charges. These fees are recognized within “Trading and principal investments” in the condensed consolidated statements of earnings in the period that services are provided.
 
Interest credited to variable annuity and life insurance account balances and changes in reserves are recognized in “Other expenses” in the condensed consolidated statements of earnings.
 
Premiums earned for providing property catastrophe reinsurance are recognized within “Trading and principal investments” in the condensed consolidated statements of earnings over the coverage period, net of premiums ceded for the cost of reinsurance. Expenses for liabilities related to property catastrophe reinsurance claims, including estimates of claims that have been incurred but not


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
reported, are recognized within “Other expenses” in the condensed consolidated statements of earnings.
 
Merchant Banking Overrides.  The firm is entitled to receive merchant banking overrides (i.e., an increased share of a fund’s income and gains) when the return on the funds’ investments exceeds certain threshold returns. Overrides are based on investment performance over the life of each merchant banking fund, and future investment underperformance may require amounts of override previously distributed to the firm to be returned to the funds. Accordingly, overrides are recognized in the condensed consolidated statements of earnings only when all material contingencies have been resolved. Overrides are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
Asset Management.  Management fees are recognized over the period that the related service is provided based upon average net asset values. In certain circumstances, the firm is also entitled to receive incentive fees based on a percentage of a fund’s return or when the return on assets under management exceeds specified benchmark returns or other performance targets. Incentive fees are generally based on investment performance over a 12-month period and are subject to adjustment prior to the end of the measurement period. Accordingly, incentive fees are recognized in the condensed consolidated statements of earnings when the measurement period ends. Asset management fees and incentive fees are included in “Asset management and securities services” in the condensed consolidated statements of earnings.
 
Share-Based Compensation
 
The firm accounts for share-based compensation in accordance with SFAS No. 123-R, “Share-Based Payment.” Under SFAS No. 123-R, the cost of employee services received in exchange for a share-based award is generally measured based on the grant-date fair value of the award. Under SFAS No. 123-R, share-based awards that do not require future service (i.e., vested awards, including awards granted to retirement-eligible employees) are expensed immediately. Share-based employee awards that require future service are amortized over the relevant service period. The firm adopted SFAS No. 123-R under the modified prospective adoption method. Under that method of adoption, the provisions of SFAS No. 123-R are generally applied only to share-based awards granted subsequent to adoption. Share-based awards held by employees that were retirement-eligible on the date of adoption of SFAS No. 123-R must continue to be amortized over the stated service period of the award (and accelerated if the employee actually retires). SFAS No. 123-R requires expected forfeitures to be included in determining share-based employee compensation expense.
 
The firm pays cash dividend equivalents on outstanding restricted stock units. Dividend equivalents paid on restricted stock units accounted for under SFAS No. 123-R are charged to retained earnings. SFAS No. 123-R requires dividend equivalents paid on restricted stock units expected to be forfeited to be included in compensation expense. Prior to the adoption of SFAS No. 123-R, dividend equivalents paid on restricted stock units that were later forfeited by employees were reclassified to compensation expense from retained earnings. The tax benefit related to dividend equivalents paid on restricted stock units is accounted for as a reduction of income tax expense (see “— Recent Accounting Developments” for a discussion of Emerging Issues Task Force (EITF) Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards”).
 
In certain cases, primarily related to the death of an employee or conflicted employment (as outlined in the applicable award agreements), the firm may cash settle share-based compensation


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
awards. For awards accounted for as equity instruments, “Additional paid-in capital” is adjusted to the extent of the difference between the current value of the award and the grant-date value of the award.
 
Goodwill
 
Goodwill is the cost of acquired companies in excess of the fair value of identifiable net assets at acquisition date. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is tested at least annually for impairment. An impairment loss is triggered if the estimated fair value of an operating segment, which is a component one level below the firm’s three business segments, is less than its estimated net book value. Such loss is calculated as the difference between the estimated fair value of goodwill and its carrying value.
 
Identifiable Intangible Assets
 
Identifiable intangible assets, which consist primarily of customer lists, specialist rights and the value of business acquired (VOBA) and deferred acquisition costs (DAC) in the firm’s insurance subsidiaries, are amortized over their estimated useful lives in accordance with SFAS No. 142. Identifiable intangible assets are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
 
Property, Leasehold Improvements and Equipment
 
Property, leasehold improvements and equipment, net of accumulated depreciation and amortization, are included in “Other assets” in the condensed consolidated statements of financial condition.
 
Substantially all property and equipment are depreciated on a straight-line basis over the useful life of the asset. Leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter. Certain costs of software developed or obtained for internal use are capitalized and amortized on a straight-line basis over the useful life of the software.
 
Property, leasehold improvements and equipment are tested for potential impairment whenever events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable in accordance with SFAS No. 144. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of an asset or asset group, is recognized if the sum of the expected undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value.
 
The firm’s operating leases include space held in excess of current requirements. Rent expense relating to space held for growth is included in “Occupancy” in the condensed consolidated statements of earnings. In accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” the firm records a liability, based on the fair value of the remaining lease rentals reduced by any potential or existing sublease rentals, for leases where the firm has ceased using the space and management has concluded that the firm will not derive any future economic benefits. Costs to terminate a lease before the end of its term are recognized and measured at fair value upon termination.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Foreign Currency Translation
 
Assets and liabilities denominated in non-U.S. currencies are translated at rates of exchange prevailing on the date of the condensed consolidated statement of financial condition, and revenues and expenses are translated at average rates of exchange for the period. Gains or losses on translation of the financial statements of a non-U.S. operation, when the functional currency is other than the U.S. dollar, are included, net of hedges and taxes, in the condensed consolidated statements of comprehensive income. The firm seeks to reduce its net investment exposure to fluctuations in foreign exchange rates through the use of foreign currency forward contracts and foreign currency-denominated debt. For foreign currency forward contracts, hedge effectiveness is assessed based on changes in forward exchange rates; accordingly, forward points are reflected as a component of the currency translation adjustment in the condensed consolidated statements of comprehensive income. For foreign currency-denominated debt, hedge effectiveness is assessed based on changes in spot rates. Foreign currency remeasurement gains or losses on transactions in nonfunctional currencies are included in the condensed consolidated statements of earnings.
 
Income Taxes
 
Deferred tax assets and liabilities are recognized for temporary differences between the financial reporting and tax bases of the firm’s assets and liabilities. Valuation allowances are established to reduce deferred tax assets to the amount that more likely than not will be realized. The firm’s tax assets and liabilities are presented as a component of “Other assets” and “Other liabilities and accrued expenses,” respectively, in the condensed consolidated statements of financial condition. Tax provisions are computed in accordance with SFAS No. 109, “Accounting for Income Taxes.”
 
The firm adopted the provisions of FIN No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” as of December 1, 2007, and recorded a transition adjustment resulting in a reduction of $201 million to beginning retained earnings (see Note 13 for further information regarding the firm’s adoption of FIN No. 48). Under FIN No. 48, a tax position can be recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized upon settlement. A FIN No. 48 liability is established for differences between positions taken in a tax return and amounts recognized in the financial statements. FIN No. 48 also provides guidance on derecognition, classification, interim period accounting and accounting for interest and penalties. Prior to the adoption of FIN No. 48, contingent liabilities related to income taxes were recorded when the criteria for loss recognition under SFAS No. 5, “Accounting for Contingencies,” as amended, had been met.
 
Earnings Per Common Share (EPS)
 
Basic EPS is calculated by dividing net earnings applicable to common shareholders by the weighted average number of common shares outstanding. Common shares outstanding includes common stock and restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock. Diluted EPS includes the determinants of basic EPS and, in addition, reflects the dilutive effect of the common stock deliverable pursuant to stock options and to restricted stock units for which future service is required as a condition to the delivery of the underlying common stock.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Cash and Cash Equivalents
 
The firm defines cash equivalents as highly liquid overnight deposits held in the ordinary course of business.
 
Recent Accounting Developments
 
EITF Issue No. 06-11.  In June 2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF Issue No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units, which are expected to vest, be recorded as an increase to additional paid-in capital. The firm currently accounts for this tax benefit as a reduction to income tax expense. EITF Issue No. 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007, and the firm expects to adopt the provisions of EITF Issue No. 06-11 beginning in the first quarter of 2009. The firm does not expect the adoption of EITF Issue No. 06-11 to have a material effect on its financial condition, results of operations or cash flows.
 
FASB Staff Position (FSP) FAS No. 140-3.  In February 2008, the FASB issued FSP FAS No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” FSP No. 140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS No. 140 unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. FSP No. 140-3 is effective for fiscal years beginning after November 15, 2008, and will be applied to new transactions entered into after the date of adoption. Early adoption is prohibited. The firm is currently evaluating the impact of adopting FSP No. 140-3 on its financial condition and cash flows. Adoption of FSP No. 140-3 will have no effect on the firm’s results of operations.
 
SFAS No. 161.  In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, and is effective for financial statements issued for fiscal years beginning after November 15, 2008, with early application encouraged. The firm will adopt SFAS No. 161 in the first quarter of 2009. Since SFAS No. 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS No. 161 will not affect the firm’s financial condition, results of operations or cash flows.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 3.   Financial Instruments
 
Fair Value of Financial Instruments
 
The following table sets forth the firm’s financial instruments owned, at fair value, including those pledged as collateral, and financial instruments sold, but not yet purchased, at fair value. At any point in time, the firm may use cash instruments as well as derivatives to manage a long or short risk position.
 
                                 
    As of  
    February 2008     November 2007  
   
Assets
   
Liabilities
   
Assets
   
Liabilities
 
    (in millions)  
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 17,731  (1)   $     $ 8,985  (1)   $  
U.S. government, federal agency
and sovereign obligations
    95,241       61,857       70,774       58,637  
Mortgage and other asset-backed
loans and securities
    51,852  (2)           54,073  (2)      
Bank loans
    43,188       2,376       49,154       3,563  
Corporate debt securities and
other debt obligations
    37,089       8,544       39,219       8,280  
Equities and convertible debentures
    111,081       38,277       122,205       45,130  
Physical commodities
    1,985       230       2,571       35  
Derivative contracts
    140,688  (3)     118,776  (5)     105,614  (3)     99,378  (5)
                                 
Total
  $ 498,855  (4)   $ 230,060     $ 452,595  (4)   $ 215,023  
                                 
 
 
(1) Includes $5.34 billion and $6.17 billion as of February 2008 and November 2007, respectively, of money market instruments held by William Street Funding Corporation (Funding Corp.) to support the William Street credit extension program (see Note 6 for further information regarding the William Street program).
 
(2) Includes $6.60 billion and $7.64 billion as of February 2008 and November 2007, respectively, of mortgage whole loans that were transferred to securitization vehicles where such transfers were accounted for as secured financings rather than sales under SFAS No. 140. The firm distributed to investors the securities that were issued by the securitization vehicles and therefore does not bear economic exposure to the underlying mortgage whole loans.
 
(3) Net of cash received pursuant to credit support agreements of $77.57 billion and $59.05 billion as of February 2008 and November 2007, respectively.
 
(4) Includes $1.93 billion and $1.17 billion as of February 2008 and November 2007, respectively, of securities held within the firm’s insurance subsidiaries which are accounted for as available-for-sale under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”
 
(5) Net of cash paid pursuant to credit support agreements of $30.63 billion and $27.76 billion as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Fair Value Hierarchy
 
The following tables set forth by level within the fair value hierarchy “Financial instruments owned, at fair value,” “Financial instruments sold, but not yet purchased, at fair value” and financial assets and financial liabilities accounted for at fair value under SFAS No. 155 and SFAS No. 159 as of February 2008 and November 2007 (see Note 2 for further information on the fair value hierarchy). As required by SFAS No. 157, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
Total financial assets at fair value classified within level 3 were $96.39 billion and $69.15 billion as of February 2008 and November 2007, respectively. Such amounts were 8% and 6% of “Total assets” on the condensed consolidated statement of financial condition as of February 2008 and November 2007, respectively. Excluding assets for which the firm does not bear economic exposure, level 3 assets were 7% and 5% of “Total assets” as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Assets at Fair Value as of February 2008  
                      Netting and
       
   
Level 1
   
Level 2
   
Level 3
   
Collateral
   
Total
 
    (in millions)  
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 6,778     $ 10,953     $     $     $ 17,731  
U.S. government, federal agency and sovereign obligations
    41,819       53,422                   95,241  
Mortgage and other asset-backed loans and securities
          26,866       24,986             51,852  
Bank loans
          25,512       17,676             43,188  
Corporate debt securities and other debt obligations
    1,232       25,980       9,877             37,089  
Equities and convertible debentures
    63,818       28,429       18,834  (6)           111,081  
Physical commodities
          1,985                   1,985  
                                         
Cash instruments
    113,647       173,147       71,373             358,167  
Derivative contracts
    169       197,362       25,013       (81,856 (8)     140,688  
                                         
Financial instruments owned, at fair value
    113,816       370,509       96,386       (81,856 )     498,855  
Securities segregated for regulatory and other purposes
    21,610  (4)     60,428  (5)                 82,038  
Receivables from customers and counterparties (1)
          1,809                   1,809  
Securities borrowed (2)
          80,440                   80,440  
Financial instruments purchased under agreements to resell, at fair value
          107,800                   107,800  
                                         
Total assets at fair value
  $ 135,426     $ 620,986     $ 96,386  (7)   $ (81,856 )   $ 770,942  
                                         
Level 3 assets for which the firm does not bear economic exposure (3)
                    (14,069 )                
                                         
Level 3 assets for which the firm bears economic exposure
                  $ 82,317  (7)                
                                         
(1) Principally consists of transfers accounted for as secured loans rather than purchases under SFAS No. 140 and prepaid variable share forwards.
 
(2) Reflects securities borrowed within Trading and Principal Investments. Excludes securities borrowed within Securities Services, which are accounted for based on the amount of cash collateral advanced plus accrued interest.
 
(3) Consists of level 3 assets which are financed by nonrecourse debt, attributable to minority investors or attributable to employee interests in certain consolidated funds.
 
(4) Consists of U.S. Treasury securities and money market instruments as well as insurance separate account assets measured at fair value under AICPA SOP 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.”
 
(5) Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
(6) Consists of private equity and real estate fund investments.
 
(7) Level 3 assets were 13% of Total assets at fair value and Level 3 assets for which the firm bears economic exposure were 11% of Total assets at fair value.
 
(8) Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.


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Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Liabilities at Fair Value as of February 2008  
                      Netting and
       
   
Level 1
   
Level 2
   
Level 3
    Collateral    
Total
 
    (in millions)  
 
U.S. government, federal agency and sovereign obligations
  $ 60,071     $ 1,786     $     $     $ 61,857  
Bank loans
          1,791       585             2,376  
Corporate debt securities and other debt obligations
          8,152       392             8,544  
Equities and convertible debentures
    37,599       678                   38,277  
Physical commodities
          230                   230  
                                         
Cash instruments
    97,670       12,637       977             111,284  
Derivative contracts
    113       137,951       15,619       (34,907 (7)     118,776  
                                         
Financial instruments sold, but not yet purchased, at fair value
    97,783       150,588       16,596       (34,907 )     230,060  
Unsecured short-term borrowings (1)
          42,025       3,839             45,864  
Bank deposits (2)
          739                   739  
Securities loaned (3)
          3,658                   3,658  
Financial instruments sold under agreements to repurchase, at fair value
          161,498                   161,498  
Other secured financings (4)
          32,317                   32,317  
Unsecured long-term borrowings (5)
          18,056       1,247             19,303  
                                         
Total liabilities at fair value
  $ 97,783     $ 408,881     $ 21,682  (6)   $ (34,907 )   $ 493,439  
                                         
 
 
(1)  Consists of promissory notes, commercial paper and hybrid financial instruments.
 
(2)  Consists of certain certificates of deposit issued by GS Bank USA.
 
(3)  Reflects securities loaned within Trading and Principal Investments. Excludes securities loaned within Securities Services, which are accounted for based on the amount of cash collateral received plus accrued interest.
 
(4)  Primarily includes transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings.
 
(5)  Primarily includes hybrid financial instruments and prepaid physical commodity transactions.
 
(6)  Level 3 liabilities were 4% of Total liabilities at fair value.
 
(7)  Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Assets at Fair Value as of November 2007  
                      Netting and
       
   
Level 1
   
Level 2
   
Level 3
   
Collateral
   
Total
 
    (in millions)  
 
Commercial paper, certificates of deposit, time deposits and other money market instruments
  $ 6,237     $ 2,748     $     $     $ 8,985  
U.S. government, federal agency and sovereign obligations
    37,966       32,808                   70,774  
Mortgage and other asset-backed loans and securities
          38,073       16,000             54,073  
Bank loans
          35,820       13,334             49,154  
Corporate debt securities and other debt obligations
    915       32,193       6,111             39,219  
Equities and convertible debentures
    68,727       35,472       18,006  (6)           122,205  
Physical commodities
          2,571                   2,571  
                                         
Cash instruments
    113,845       179,685       53,451             346,981  
Derivative contracts
    286       153,065       15,700       (63,437 (8)     105,614  
                                         
Financial instruments owned, at fair value
    114,131       332,750       69,151       (63,437 )     452,595  
Securities segregated for regulatory and other purposes
    24,078  (4)     69,940  (5)                 94,018  
Receivables from customers and counterparties (1)
          1,950                   1,950  
Securities borrowed (2)
          83,277                   83,277  
Financial instruments purchased under agreements to resell, at fair value
          85,717                   85,717  
                                         
Total assets at fair value
  $ 138,209     $ 573,634     $ 69,151  (7)   $ (63,437 )   $ 717,557  
                                         
Level 3 assets for which the firm does not bear economic exposure (3)
                    (14,437 )                
                                         
Level 3 assets for which the firm bears economic exposure
                  $ 54,714  (7)                
                                         
 
(1) Consists of transfers accounted for as secured loans rather than purchases under SFAS No. 140 and prepaid variable share forwards.
 
(2) Reflects securities borrowed within Trading and Principal Investments. Excludes securities borrowed within Securities Services, which are accounted for based on the amount of cash collateral advanced plus accrued interest.
 
(3) Consists of level 3 assets which are financed by nonrecourse debt, attributable to minority investors or attributable to employee interests in certain consolidated funds.
 
(4) Consists of U.S. Treasury securities and money market instruments as well as insurance separate account assets measured at fair value under AICPA SOP 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts.”
 
(5) Principally consists of securities borrowed and resale agreements. The underlying securities have been segregated to satisfy certain regulatory requirements.
 
(6) Consists of private equity and real estate fund investments.
 
(7) Level 3 assets were 10% of Total assets at fair value and Level 3 assets for which the firm bears economic exposure were 8% of Total assets at fair value.
 
(8) Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                         
    Financial Liabilities at Fair Value as of November 2007  
                      Netting and
       
   
Level 1
   
Level 2
   
Level 3
   
Collateral
   
Total
 
    (in millions)  
 
U.S. government, federal agency and sovereign obligations
  $ 57,714     $ 923     $     $     $ 58,637  
Bank loans
          3,525       38             3,563  
Corporate debt securities and other debt obligations
          7,764       516             8,280  
Equities and convertible debentures
    44,076       1,054                   45,130  
Physical commodities
          35                   35  
                                         
Cash instruments
    101,790       13,301       554             115,645  
Derivative contracts
    212       117,794       13,644       (32,272 (7)     99,378  
                                         
Financial instruments sold, but not yet purchased, at fair value
    102,002       131,095       14,198       (32,272 )     215,023  
Unsecured short-term borrowings (1)
          44,060       4,271             48,331  
Bank deposits (2)
          463                   463  
Securities loaned (3)
          5,449                   5,449  
Financial instruments sold under agreements to repurchase, at fair value
          159,178                   159,178  
Other secured financings (4)
          33,581                   33,581  
Unsecured long-term borrowings (5)
          15,161       767             15,928  
                                         
Total liabilities at fair value
  $ 102,002     $ 388,987     $ 19,236  (6)   $ (32,272 )   $ 477,953  
                                         
 
 
(1) Consists of promissory notes, commercial paper and hybrid financial instruments.
 
(2) Consists of certain certificates of deposit issued by GS Bank USA.
 
(3) Reflects securities loaned within Trading and Principal Investments. Excludes securities loaned within Securities Services, which are accounted for based on the amount of cash collateral received plus accrued interest.
 
(4) Primarily includes transfers accounted for as financings rather than sales under SFAS No. 140, debt raised through the firm’s William Street program and certain other nonrecourse financings.
 
(5) Primarily includes hybrid financial instruments and prepaid physical commodity transactions.
 
(6) Level 3 liabilities were 4% of Total liabilities at fair value.
 
(7) Represents cash collateral and the impact of netting across the levels of the fair value hierarchy. Netting among positions classified within the same level is included in that level.


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Table of Contents

 
THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Level 3 Gains and Losses
 
The tables below set forth a summary of changes in the fair value of the firm’s level 3 financial assets and financial liabilities for the three months ended February 2008 and February 2007. The tables reflect gains and losses for each quarter for all financial assets and financial liabilities categorized as level 3 as of February 2008 and February 2007, respectively. As reflected in the tables below, the net unrealized gain on level 3 financial assets and financial liabilities was $2.07 billion (principally comprised of $5.09 billion of unrealized gains on derivative contracts and $3.23 billion of unrealized losses on cash instruments) and $1.22 billion (principally comprised of $1.06 billion of unrealized gains on cash instruments and $193 million of unrealized gains on derivative contracts) for the three months ended February 2008 and February 2007, respectively. This net unrealized gain should be considered in the context of the factors discussed below.
 
Cash Instruments
 
The net unrealized loss on level 3 cash instruments was $3.23 billion for the three months ended February 2008 (which included $2.91 billion of unrealized losses on assets and $318 million of unrealized losses on liabilities), primarily consisting of unrealized losses on loans and securities backed by commercial and residential real estate as well as certain bank loans, reflecting continued deterioration in the broader credit markets. The net unrealized gain on level 3 cash instruments was $1.06 billion for the three months ended February 2007 (which included $1.08 billion of unrealized gains on assets and $25 million of unrealized losses on liabilities), primarily consisting of unrealized gains relating to the firm’s private principal investments.
 
Level 3 cash instruments are frequently hedged with instruments classified within level 1 and level 2, and accordingly, gains or losses that have been reported in level 3 are frequently offset by gains or losses attributable to instruments classified within level 1 or level 2 or by gains or losses on derivative contracts classified in level 3 of the fair value hierarchy.
 
Derivative Contracts
 
The net unrealized gain on level 3 derivative contracts was $5.09 billion, primarily attributable to observable changes in credit spreads reflecting continued deterioration in the broader credit markets, and $193 million for the three months ended February 2008 and February 2007, respectively. Level 3 gains and losses on derivative contracts should be considered in the context of the following factors:
 
  •  A derivative contract with level 1 and/or level 2 inputs is classified as a level 3 financial instrument in its entirety if it has at least one significant level 3 input.
 
  •  If there is one significant level 3 input, the entire gain or loss from adjusting only observable inputs (i.e., level 1 and level 2) is still classified as level 3.
 
  •  Gains or losses that have been reported in level 3 resulting from changes in level 1 or level 2 inputs are frequently offset by gains or losses attributable to instruments classified within level 1 or level 2 or by cash instruments reported in level 3 of the fair value hierarchy.
 
The unrealized gains referenced above principally resulted from changes in level 2 inputs, as opposed to changes in level 3 inputs.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
                                                 
    Level 3 Financial Assets and Financial Liabilities
    Three Months Ended February 2008
    Cash
  Cash
  Derivative
  Unsecured
  Unsecured
   
    Instruments
  Instruments
  Contracts
  Short-Term
  Long-Term
  Total
    - Assets   - Liabilities   - Net   Borrowings   Borrowings  
Gains
    (in millions)
 
Balance, beginning of year
    $53,451       $(554 )     $2,056       $(4,271 )     $   (767 )     N/A  
Realized gains/(losses)
    675  (1)     5  (3)     214  (3)     (80 ) (3)     (1 ) (3)   $ 813  
Unrealized gains/(losses) relating to instruments still held at the reporting date
    (2,912 ) (1)     (318 ) (3)     5,087  (3)(4)     95  (3)     113  (3)   $ 2,065  
Purchases, issuances and settlements
    5,586       (6 )     (360 )     535       (396 )     N/A  
Transfers in and/or out of level 3
    14,573  (2)     (104 )     2,397  (5)     (118 )     (196 )     N/A  
                                                 
Balance, end of period
    $71,373       $(977 )     $9,394       $(3,839 )     $(1,247 )     N/A  
                                                 
 
                                                 
    Level 3 Financial Assets and Financial Liabilities
    Three Months Ended February 2007
    Cash
  Cash
  Derivative
  Unsecured
  Unsecured
   
    Instruments
  Instruments
  Contracts
  Short-Term
  Long-Term
  Total
    - Assets   - Liabilities   - Net   Borrowings   Borrowings  
Gains
    (in millions)
 
Balance, beginning of year
    $29,905       $(223 )     $ 580       $(3,253 )     $(135 )     N/A  
Realized gains/(losses)
    822  (1)     24  (3)     288  (3)                 $1,134  
Unrealized gains/(losses) relating to instruments still held at the reporting date
    1,083  (1)     (25 ) (3)     193  (3)(4)     (61 ) (3)     34  (3)     $1,224  
Purchases, issuances and settlements
    7,059       (4 )     (227 )     (703 )     (472 )     N/A  
Transfers in and/or out of level 3
    (1,021 )     4       (493 )     191       (204 )     N/A  
                                             
Balance, end of period
    $37,848       $(224 )     $ 341       $(3,826 )     $(777 )     N/A  
                                             
 
 
(1) The aggregate amounts include approximately $(3.09) billion and $853 million reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the three months ended February 2008. The aggregate amounts include approximately $1.60 billion and $303 million reported in “Trading and principal investments” and “Interest income,” respectively, in the condensed consolidated statements of earnings for the three months ended February 2007.
 
(2) Principally reflects transfers of commercial and residential mortgage loans and securities from level 2 within the fair value hierarchy, reflecting reduced price transparency for these financial instruments. Related gains and losses are included in the above table.
 
(3) Substantially all is reported in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
(4) Principally resulted from changes in level 2 inputs.
 
(5) Principally reflects transfers of mortgage-related derivative assets due to reduced transparency of the correlation inputs used to value mortgage instruments.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
For the three months ended February 2008 and February 2007, the changes in the fair value of receivables (including securities borrowed and resale agreements) for which the fair value option was elected that were attributable to changes in instrument-specific credit spreads were not material. During the three months ended February 2008, the firm recognized a gain of $333 million, net of hedges ($518 million before hedges), attributable to the observable impact of the market’s widening of the firm’s own credit spread on liabilities for which the fair value option was elected. During the three months ended February 2007, the observable impact of the market’s widening of the firm’s own credit spread on liabilities for which the fair value option was elected was $26 million. The firm calculates the impact of its own credit spread on liabilities carried at fair value by discounting future cash flows at a rate which incorporates the firm’s observable credit spreads. As of February 2008 and November 2007, the difference between the fair value and the aggregate contractual principal amount of both long-term receivables and long-term debt instruments (principal and non-principal protected) for which the fair value option was elected was not material.
 
The following table sets forth the gains and (losses) included in earnings for the three months ended February 2008 and February 2007 related to financial assets and financial liabilities for which the firm has elected to apply the fair value option under SFAS No. 155 and SFAS No. 159. The table does not reflect the impact to the firm’s earnings of applying SFAS No. 159 because a significant amount of these gains and losses would have also been recognized under previously issued generally accepted accounting principles, or are economically hedged with instruments accounted for at fair value under other generally accepted accounting principles that are not reflected in the table below.
 
                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    (in millions)  
 
Other secured financings
  $ 1,031  (1)   $ (130 )
Financial instruments owned, at fair value (2)
    (305 )     7  
Unsecured short-term borrowings
    262       (244 )
Unsecured long-term borrowings
    (218 )     (792 )
Other (3)
    6       (1 )
                 
Total (4)
  $ 776     $ (1,160 )
                 
 
 
(1) Includes gains of $800 million related to financings recorded as a result of certain mortgage securitizations that are accounted for as secured financings rather than sales under SFAS No. 140 as of February 2008. Changes in the fair value of these secured financings are equally offset by changes in the fair value of the related mortgage whole loans, which are included within the firm’s “Financial instruments owned, at fair value” in the condensed consolidated statement of financial condition.
 
(2) Consists of investments for which the firm would otherwise have applied the equity method of accounting as well as securities held in GS Bank USA (which would otherwise be accounted for as available-for-sale).
 
(3) Consists of resale and repurchase agreements and securities borrowed and loaned within Trading and Principal Investments and certain certificates of deposit issued by GS Bank USA.
 
(4) Reported within “Trading and principal investments” within the condensed consolidated statements of earnings. The amounts exclude contractual interest, which is included in “Interest Income” and “Interest Expense,” for all instruments other than hybrid financial instruments.


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


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
February 2008 or February 2007. Gains and losses on derivatives used for trading purposes are included in “Trading and principal investments” in the condensed consolidated statements of earnings.
 
The fair value of the firm’s derivative contracts is reflected net of cash paid or received pursuant to credit support agreements and is reported on a net-by-counterparty basis in the firm’s condensed consolidated statements of financial condition when management believes a legal right of setoff exists under an enforceable netting agreement. The fair value of derivative financial instruments, computed in accordance with the firm’s netting policy, is set forth below:
 
                                 
    As of  
    February 2008     November 2007  
   
Assets
   
Liabilities
   
Assets
   
Liabilities
 
    (in millions)  
Contract Type
                               
Forward settlement contracts
  $ 25,778     $ 28,983     $ 22,561     $ 27,138  
Swap agreements
    145,997       77,392       104,793       62,697  
Option contracts
    63,593       60,133       53,056       53,047  
                                 
Subtotal
  $ 235,368     $ 166,508     $ 180,410     $ 142,882  
Netting across contract types (1)
    (17,107 )     (17,107 )     (15,746 )     (15,746 )
Cash collateral netting (2)
    (77,573 )     (30,625 )     (59,050 )     (27,758 )
                                 
Total
  $ 140,688     $ 118,776     $ 105,614     $ 99,378  
                                 
 
(1) Represents the netting of receivable balances with payable balances for the same counterparty across contract types pursuant to credit support agreements.
 
(2) Represents the netting of cash collateral received and posted on a counterparty basis pursuant to credit support agreements.
 
The fair value of derivatives accounted for as qualifying hedges under SFAS No. 133 consisted of $10.10 billion and $5.12 billion in assets as of February 2008 and November 2007, respectively, and $230 million and $354 million in liabilities as of February 2008 and November 2007, respectively.
 
The firm also has embedded derivatives that have been bifurcated from related borrowings under SFAS No. 133. Such derivatives, which are classified in unsecured short-term and unsecured long-term borrowings, had a carrying value of $234 million and $463 million (excluding the debt host contract) as of February 2008 and November 2007, respectively. See Notes 4 and 5 for further information regarding the firm’s unsecured borrowings.
 
Securitization Activities
 
The firm securitizes commercial and residential mortgages, home equity and auto loans, government and corporate bonds and other types of financial assets. The firm acts as underwriter of the beneficial interests that are sold to investors. The firm derecognizes financial assets transferred in securitizations, provided it has relinquished control over such assets. Transferred assets are accounted for at fair value prior to securitization. Net revenues related to these underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.
 
The firm may retain interests in securitized financial assets, primarily in the form of senior or subordinated securities, including residual interests. Retained interests are accounted for at fair value and are included in “Total financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
During the three months ended February 2008, the firm securitized $2.57 billion of financial assets ($1.52 billion of residential mortgages and $1.05 billion of other financial assets, primarily in connection with collateralized loan obligations (CLOs)). During the three months ended February 2007, the firm securitized $24.45 billion of financial assets ($9.65 billion of residential mortgages and $14.80 billion of other financial assets, primarily in connection with CDOs and CLOs). Cash flows received on retained interests were approximately $116 million and $162 million for the three months ended February 2008 and February 2007, respectively.
 
As of February 2008 and November 2007, the firm held $2.92 billion and $4.57 billion of retained interests, respectively, from these securitization activities, including $1.61 billion and $2.72 billion, respectively, held in QSPEs.
 
The following table sets forth the weighted average key economic assumptions used in measuring the fair value of the firm’s retained interests and the sensitivity of this fair value to immediate adverse changes of 10% and 20% in those assumptions:
 
                                 
    As of February 2008   As of November 2007
    Type of Retained Interests   Type of Retained Interests
    Mortgage-
  CDOs and
  Mortgage-
  CDOs and
   
Backed
 
CLOs (3)
 
Backed
 
CLOs (3)
    ($ in millions)
 
Fair value of retained interests
  $ 2,266     $ 655     $ 3,378     $ 1,188  
                                 
Weighted average life (years)
    5.5       2.3       6.6       2.7  
                                 
Constant prepayment rate
    14.8 %     14.3 %     15.1 %     11.9 %
Impact of 10% adverse change
  $ (29 )   $ (5 )   $ (50 )   $ (43 )
Impact of 20% adverse change
    (50 )     (13 )     (91 )     (98 )
                                 
Anticipated credit losses (1)
    3.9 %     N/A       4.3 %     N/A  
Impact of 10% adverse change (2)
  $ (15 )   $     $ (45 )   $  
Impact of 20% adverse change (2)
    (20 )           (72 )      
                                 
Discount rate
    10.8 %     26.8 %     8.4 %     23.1 %
Impact of 10% adverse change
  $ (59 )   $ (23 )   $ (89 )   $ (46 )
Impact of 20% adverse change
    (113 )     (42 )     (170 )     (92 )
 
(1)  Anticipated credit losses are computed only on positions for which expected credit loss is a key assumption in the determination of fair value or positions for which expected credit loss is not reflected within the discount rate.
(2)  The impacts of adverse change take into account credit mitigants incorporated in the retained interests, including over-collateralization and subordination provisions.
(3)  Includes $395 million and $905 million as of February 2008 and November 2007, respectively, of retained interests related to transfers of securitized assets that were accounted for as secured financings rather than sales under SFAS No. 140.
 
The preceding table does not give effect to the offsetting benefit of other financial instruments that are held to mitigate risks inherent in these retained interests. Changes in fair value based on an adverse variation in assumptions generally cannot be extrapolated because the relationship of the change in assumptions to the change in fair value is not usually linear. In addition, the impact of a change in a particular assumption is calculated independently of changes in any other assumption. In practice, simultaneous changes in assumptions might magnify or counteract the sensitivities disclosed above.
 
In addition to the retained interests described above, the firm also held interests in residential mortgage QSPEs purchased in connection with secondary market-making activities. These purchased interests approximated $7 billion and $6 billion as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
As of February 2008 and November 2007, the firm held mortgage servicing rights with a fair value of $283 million and $93 million, respectively. These servicing assets represent the firm’s right to receive a future stream of cash flows, such as servicing fees, in excess of the firm’s obligation to service residential mortgages. The fair value of mortgage servicing rights will fluctuate in response to changes in certain economic variables, such as interest rates, loan prepayment assumptions and default rates. The firm estimates the fair value of mortgage servicing rights by using valuation models that incorporate these variables in quantifying anticipated cash flows related to servicing activities. Mortgage servicing rights are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition and are classified within level 3 of the fair value hierarchy. The following table sets forth changes in the firm’s mortgage servicing rights, as well as servicing fees earned:
 
         
    Three Months Ended
    February 2008
    (in millions)
 
Balance, beginning of period
    $  93  
Purchases (1)
    212  
Servicing assets that result from transfers of financial assets
    3  
Changes in fair value due to changes in valuation inputs and assumptions
    (25 )
         
Balance, end of period
    $283  
         
         
Contractually specified servicing fees
    $  65  
         
 
 
(1)  Related to the acquisition of Litton Loan Servicing LP.
 
Variable Interest Entities (VIEs)
 
The firm, in the ordinary course of business, retains interests in VIEs in connection with its securitization activities. The firm also purchases and sells variable interests in VIEs, which primarily issue mortgage-backed and other asset-backed securities, CDOs and CLOs, in connection with its market-making activities and makes investments in and loans to VIEs that hold performing and nonperforming debt, equity, real estate, power-related and other assets. In addition, the firm utilizes VIEs to provide investors with principal-protected notes, credit-linked notes and asset-repackaged notes designed to meet their objectives.
 
VIEs generally purchase assets by issuing debt and equity instruments. In certain instances, the firm provides guarantees to VIEs or holders of variable interests in VIEs. In such cases, the maximum exposure to loss included in the tables set forth below is the notional amount of such guarantees. Such amounts do not represent anticipated losses in connection with these guarantees.
 
The firm’s variable interests in VIEs include senior and subordinated debt; loan commitments; limited and general partnership interests; preferred and common stock; interest rate, foreign currency, equity, commodity and credit derivatives; guarantees; and residual interests in mortgage-backed and asset-backed securitization vehicles, CDOs and CLOs. The firm’s exposure to the obligations of VIEs is generally limited to its interests in these entities.
 
The following tables set forth total assets in nonconsolidated VIEs in which the firm holds significant variable interests and the firm’s maximum exposure to loss associated with these variable interests. The firm has aggregated nonconsolidated VIEs based on principal business activity, as reflected in the first column. The nature of the firm’s variable interests can take different forms, as described in the columns under maximum exposure to loss.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
These tables do not give effect to the benefit of any offsetting financial instruments that are held to mitigate risks related to the firm’s interests in nonconsolidated VIEs.
 
                                                   
    As of February 2008  
            Maximum Exposure to Loss in Nonconsolidated VIEs (1)  
            Purchased
    Commitments
                   
    VIE
      and Retained
    and
          Loans and
       
   
Assets
     
Interests
   
Guarantees
   
Derivatives
   
Investments
   
Total
 
            (in millions)        
Mortgage CDOs (2)
  $ 19,796       $ 473     $     $ 9,052     $     $ 9,525  
Corporate CDOs and CLOs (3)
    11,272         414             1,319             1,733  
Real estate, credit-related and other investing (4)
    25,669               13             3,409       3,422  
Municipal bond securitizations
    534               534                   534  
Other asset-backed
    4,402                     1,792             1,792  
Power-related
    438         2       37             16       55  
Principal-protected notes (5)
    5,902                     5,372             5,372  
                                                   
Total
  $ 68,013       $ 889     $ 584     $ 17,535     $ 3,425     $ 22,433  
                                                   
 
                                                   
    As of November 2007  
            Maximum Exposure to Loss in Nonconsolidated VIEs (1)  
            Purchased
    Commitments
                   
    VIE
      and Retained
    and
          Loans and
       
   
Assets
     
Interests
   
Guarantees
   
Derivatives
   
Investments
   
Total
 
            (in millions)        
Mortgage CDOs (2)
  $ 18,914       $ 1,011     $     $ 10,089     $     $ 11,100  
Corporate CDOs and CLOs (3)
    10,750         411             2,218             2,629  
Real estate, credit-related and other investing (4)
    17,272               107       12       3,141       3,260  
Municipal bond securitizations
    1,413               1,413                   1,413  
Other mortgage-backed
    3,881         719                         719  
Other asset-backed
    3,771                     1,579             1,579  
Power-related
    438         2       37             16       55  
Principal-protected notes (5)
    5,698                     5,186             5,186  
                                                   
Total
  $ 62,137       $ 2,143     $ 1,557     $ 19,084     $ 3,157     $ 25,941  
                                                   
 
 
(1) Such amounts do not represent the anticipated losses in connection with these transactions.
 
(2) Derivatives related to mortgage CDOs primarily consist of written protection on investment-grade, short-term collateral held by VIEs that have issued CDOs.
 
(3) Derivatives related to corporate CDOs and CLOs primarily consist of total return swaps on CDOs and CLOs. The firm has generally transferred the risks related to the underlying securities through derivatives with non-VIEs.
 
(4) The firm obtains interests in these VIEs in connection with making proprietary investments in real estate, distressed loans and other types of debt, mezzanine instruments and equities.
 
(5) Derivatives related to principal-protected notes consist of out-of-the-money written put options that provide principal protection to clients invested in various fund products, with risk to the firm mitigated through portfolio rebalancing.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The following table sets forth the firm’s total assets and maximum exposure to loss associated with its significant variable interests in consolidated VIEs where the firm does not hold a majority voting interest. The firm has aggregated consolidated VIEs based on principal business activity, as reflected in the first column.
 
The table does not give effect to the benefit of any offsetting financial instruments that are held to mitigate risks related to the firm’s interests in consolidated VIEs.
 
                                 
    As of February 2008     As of November 2007  
          Maximum
          Maximum
 
          Exposure
          Exposure
 
   
VIE Assets (1)
   
to Loss (2)
   
VIE Assets (1)
   
to Loss (2)
 
          (in millions)        
 
Real estate, credit-related and other
investing
  $ 2,098     $ 563     $ 2,118     $ 525  
Municipal bond securitizations
    1,763       1,763       1,959       1,959  
CDOs, mortgage-backed and other
asset-backed
    283       176       604       109  
Foreign exchange and commodities
    461       491       300       329  
Principal-protected notes
    977       989       1,119       1,118  
                                 
Total
  $ 5,582     $ 3,982     $ 6,100     $ 4,040  
                                 
 
 
(1) Consolidated VIE assets include assets financed on a nonrecourse basis.
 
(2) Such amounts do not represent the anticipated losses in connection with these transactions.
 
Collateralized Transactions
 
The firm receives financial instruments as collateral, primarily in connection with resale agreements, securities borrowed, derivative transactions and customer margin loans. Such financial instruments may include obligations of the U.S. government, federal agencies, sovereigns and corporations, as well as equities and convertibles.
 
In many cases, the firm is permitted to deliver or repledge these financial instruments in connection with entering into repurchase agreements, securities lending agreements and other secured financings, collateralizing derivative transactions and meeting firm or customer settlement requirements. As of February 2008 and November 2007, the fair value of financial instruments received as collateral by the firm that it was permitted to deliver or repledge was $843.42 billion and $891.05 billion, respectively, of which the firm delivered or repledged $734.22 billion and $785.62 billion, respectively.
 
The firm also pledges assets that it owns to counterparties who may or may not have the right to deliver or repledge them. Financial instruments owned and pledged to counterparties that have the right to deliver or repledge are reported as “Financial instruments owned and pledged as collateral, at fair value” in the condensed consolidated statements of financial condition and were $39.51 billion and $46.14 billion as of February 2008 and November 2007, respectively. Financial instruments owned and pledged in connection with repurchase agreements, securities lending agreements and other secured financings to counterparties that did not have the right to sell or repledge are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition and were $158.09 billion and $156.92 billion as of February 2008 and November 2007, respectively. Other assets (primarily real estate and cash) owned and pledged in connection with other secured financings to counterparties that did not have the right to sell or repledge were $7.35 billion and $5.86 billion as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
In addition to repurchase agreements and securities lending agreements, the firm obtains secured funding through the use of other arrangements. Other secured financings include arrangements that are nonrecourse, that is, only the subsidiary that executed the arrangement or a subsidiary guaranteeing the arrangement is obligated to repay the financing. Other secured financings consist of liabilities related to the firm’s William Street program, consolidated variable interest entities, collateralized central bank financings, transfers of financial assets that are accounted for as financings rather than sales under SFAS No. 140 (primarily pledged bank loans and mortgage whole loans) and other structured financing arrangements.
 
Other secured financings by maturity are set forth in the table below:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Other secured financings (short-term) (1)(2)
  $ 37,550     $ 32,410  
Other secured financings (long-term):
               
2009
    989       2,903  
2010
    3,049       2,301  
2011
    4,196       2,427  
2012
    4,396       4,973  
2013
    1,683       702  
2014-thereafter
    18,264       19,994  
                 
Total other secured financings (long-term) (3)(4)
    32,577       33,300  
                 
Total other secured financings (5)
  $ 70,127     $ 65,710  
                 
 
 
  (1)  As of February 2008, consists of U.S. dollar-denominated financings of $22.22 billion with a weighted average interest rate of 3.61% and non-U.S. dollar-denominated financings of $15.33 billion with a weighted average interest rate of 0.86%, after giving effect to hedging activities. As of November 2007, consists of U.S. dollar-denominated financings of $18.47 billion with a weighted average interest rate of 5.32% and non-U.S. dollar-denominated financings of $13.94 billion with a weighted average interest rate of 0.91%, after giving effect to hedging activities. The weighted average interest rates as of February 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.
 
  (2)  Includes other secured financings maturing within one year of the financial statement date and other secured financings that are redeemable within one year of the financial statement date at the option of the holder.
 
  (3)  As of February 2008, consists of U.S. dollar-denominated financings of $19.08 billion with a weighted average interest rate of 4.85% and non-U.S. dollar-denominated financings of $13.50 billion with a weighted average interest rate of 4.20%, after giving effect to hedging activities. As of November 2007, consists of U.S. dollar-denominated financings of $22.13 billion with a weighted average interest rate of 5.73% and non-U.S. dollar-denominated financings of $11.17 billion with a weighted average interest rate of 4.28%, after giving effect to hedging activities. The weighted average interest rates as of February 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.
 
  (4)  Secured long-term financings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates. Secured long-term financings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
  (5)  As of February 2008, $63.91 billion of these financings were collateralized by financial instruments and $6.22 billion by other assets (primarily real estate and cash). As of November 2007, $61.34 billion of these financings were collateralized by financial instruments and $4.37 billion by other assets (primarily real estate and cash). Other secured financings include $25.40 billion and $25.37 billion of nonrecourse obligations as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
 
Note 4.  Unsecured Short-Term Borrowings
 
The firm obtains unsecured short-term borrowings primarily through the issuance of promissory notes, commercial paper and hybrid financial instruments. As of February 2008 and November 2007, these borrowings were $72.79 billion and $71.56 billion, respectively. Such amounts also include the portion of unsecured long-term borrowings maturing within one year of the financial statement date and unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder. The firm accounts for promissory notes, commercial paper and certain hybrid financial instruments at fair value under SFAS No. 155 or SFAS No. 159. Short-term borrowings that are not recorded at fair value are recorded based on the amount of cash received plus accrued interest, and such amounts approximate fair value due to the short-term nature of the obligations.
 
Unsecured short-term borrowings are set forth below:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Promissory notes
  $ 11,444     $ 13,251  
Commercial paper
    4,384       4,343  
Current portion of unsecured long-term borrowings
    23,315       22,740  
Hybrid financial instruments
    22,236       22,318  
Other short-term borrowings
    11,410       8,905  
                 
Total (1)
  $ 72,789     $ 71,557  
                 
 
 
  (1)  The weighted average interest rates for these borrowings, after giving effect to hedging activities, were 3.65% and 5.05% as of February 2008 and November 2007, respectively. The weighted average interest rates as of February 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 5.   Unsecured Long-Term Borrowings
 
The firm’s unsecured long-term borrowings extend through 2043 and consist principally of senior borrowings. As of February 2008 and November 2007, these borrowings were $179.48 billion and $164.17 billion, respectively.
 
Unsecured long-term borrowings are set forth below:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Fixed rate obligations (1)
               
U.S. dollar
  $ 62,174     $ 55,281  
Non-U.S. dollar
    35,808       29,139  
Floating rate obligations (2)
               
U.S. dollar
    45,225       47,308  
Non-U.S. dollar
    36,268       32,446  
                 
Total
  $ 179,475     $ 164,174  
                 
 
 
  (1)  As of February 2008 and November 2007, interest rates on U.S. dollar fixed rate obligations ranged from 3.87% to 10.04% and from 3.88% to 10.04%, respectively. As of both February 2008 and November 2007, interest rates on non-U.S. dollar fixed rate obligations ranged from 0.67% to 8.88%.
 
  (2)  Floating interest rates generally are based on LIBOR or the federal funds target rate. Equity-linked and indexed instruments are included in floating rate obligations.
 
Unsecured long-term borrowings by maturity date are set forth below:
 
                                                 
    As of  
    February 2008 (1)(2)     November 2007 (1)(2)  
    U.S.
    Non-U.S.
          U.S.
    Non-U.S.
       
   
Dollar
   
Dollar
   
Total
   
Dollar
   
Dollar
   
Total
 
    (in millions)  
 
2009
  $ 14,459     $ 2,874     $ 17,333     $ 20,204     $ 2,978     $ 23,182  
2010
    9,003       5,970       14,973       7,989       5,714       13,703  
2011
    6,177       5,136       11,313       5,848       4,839       10,687  
2012
    15,758       3,921       19,679       14,913       3,695       18,608  
2013
    6,726       14,252       20,978       6,490       9,326       15,816  
2014-thereafter
    55,276       39,923       95,199       47,145       35,033       82,178  
                                                 
Total
  $ 107,399     $ 72,076     $ 179,475     $ 102,589     $ 61,585     $ 164,174  
                                                 
 
 
  (1)  Unsecured long-term borrowings maturing within one year of the financial statement date and certain unsecured long-term borrowings that are redeemable within one year of the financial statement date at the option of the holder are included as unsecured short-term borrowings in the condensed consolidated statements of financial condition.
 
  (2)  Unsecured long-term borrowings that are repayable prior to maturity at the option of the firm are reflected at their contractual maturity dates. Unsecured long-term borrowings that are redeemable prior to maturity at the option of the holder are reflected at the dates such options become exercisable.
 
The firm enters into derivative contracts, such as interest rate futures contracts, interest rate swap agreements, currency swap agreements, commodity contracts and equity-linked and indexed contracts, to effectively convert a substantial portion of its unsecured long-term borrowings into U.S. dollar-based floating rate obligations. Accordingly, the carrying value of unsecured long-term borrowings approximated fair value as of February 2008 and November 2007.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The effective weighted average interest rates for unsecured long-term borrowings are set forth below:
 
                                 
    As of  
    February 2008     November 2007  
   
Amount
   
Rate
   
Amount
   
Rate
 
    ($ in millions)  
 
Fixed rate obligations
  $ 4,022       4.98 %   $ 3,787       5.28 %
Floating rate obligations (1)
    175,453       4.59       160,387       5.68  
                                 
Total (2)
  $ 179,475       4.60     $ 164,174       5.67  
                                 
 
 
  (1)  Includes fixed rate obligations that have been converted into floating rate obligations through derivative contracts.
 
  (2)  The weighted average interest rates as of February 2008 and November 2007 excluded financial instruments accounted for at fair value under SFAS No. 155 or SFAS No. 159.
 
  Subordinated Borrowings
 
Unsecured long-term borrowings include subordinated borrowings with outstanding principal amounts of $20.07 billion and $16.32 billion as of February 2008 and November 2007, respectively, as set forth below.
 
Subordinated Notes.  As of February 2008, the firm had $14.98 billion of subordinated notes outstanding with maturities ranging from 2009 to 2038. The effective weighted average interest rate on these subordinated notes was 4.78%, after giving effect to derivative contracts used to convert fixed rate obligations into floating rate obligations. As of November 2007, the firm had $11.23 billion of subordinated notes outstanding with maturities ranging from fiscal 2009 to 2037. The effective weighted average interest rate on these subordinated notes was 5.75%, after giving effect to derivative contracts used to convert fixed rate obligations into floating rate obligations. These notes are junior in right of payment to all of the firm’s senior indebtedness.
 
Junior Subordinated Debt Issued to a Trust in Connection with Trust Preferred Securities.  The firm issued $2.84 billion of junior subordinated debentures in 2004 to Goldman Sachs Capital I (the Trust), a Delaware statutory trust that, in turn, issued $2.75 billion of guaranteed preferred beneficial interests to third parties and $85 million of common beneficial interests to the firm and invested the proceeds from the sale in junior subordinated debentures issued by the firm. The Trust is a wholly owned finance subsidiary of the firm for regulatory and legal purposes but is not consolidated for accounting purposes.
 
The firm pays interest semi-annually on these debentures at an annual rate of 6.345% and the debentures mature on February 15, 2034. The coupon rate and the payment dates applicable to the beneficial interests are the same as the interest rate and payment dates applicable to the debentures. The firm has the right, from time to time, to defer payment of interest on the debentures, and, therefore, cause payment on the Trust’s preferred beneficial interests to be deferred, in each case up to ten consecutive semi-annual periods. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common stock. The Trust is not permitted to pay any distributions on the common beneficial interests held by the firm unless all dividends payable on the preferred beneficial interests have been paid in full. These debentures are junior in right of payment to all of the firm’s senior indebtedness and all of the firm’s subordinated borrowings, other than the junior subordinated debt issued in connection with the Normal Automatic Preferred Enhanced Capital Securities (see discussion below).


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Junior Subordinated Debt Issued to Trusts in Connection with Fixed-to-Floating and Floating Rate Normal Automatic Preferred Enhanced Capital Securities.  In 2007, the firm issued a total of $2.25 billion of remarketable junior subordinated notes to Goldman Sachs Capital II and Goldman Sachs Capital III (the Trusts), Delaware statutory trusts that, in turn, issued $2.25 billion of guaranteed perpetual Automatic Preferred Enhanced Capital Securities (APEX) to third parties and a de minimis amount of common securities to the firm. The firm also entered into contracts with the Trusts to sell $2.25 billion of perpetual non-cumulative preferred stock to be issued by the firm (the stock purchase contracts). The Trusts are wholly owned finance subsidiaries of the firm for regulatory and legal purposes but are not consolidated for accounting purposes.
 
The firm pays interest semi-annually on $1.75 billion of junior subordinated notes issued to Goldman Sachs Capital II at a fixed annual rate of 5.59% and the notes mature on June 1, 2043. The firm pays interest quarterly on $500 million of junior subordinated notes issued to Goldman Sachs Capital III at a rate per annum equal to three-month LIBOR plus .57% and the notes mature on September 1, 2043. In addition, the firm makes contract payments at a rate of .20% per annum on the stock purchase contracts held by the Trusts. The firm has the right to defer payments on the junior subordinated notes and the stock purchase contracts, subject to limitations, and therefore cause payment on the APEX to be deferred. During any such extension period, the firm will not be permitted to, among other things, pay dividends on or make certain repurchases of its common or preferred stock. The junior subordinated notes are junior in right of payment to all of the firm’s senior indebtedness and all of the firm’s other subordinated borrowings.
 
In connection with the APEX issuance, the firm covenanted in favor of certain of its debtholders, who are initially the holders of the firm’s 6.345% Junior Subordinated Debentures due February 15, 2034, that, subject to certain exceptions, the firm would not redeem or purchase (i) the firm’s junior subordinated debt issued to the APEX trusts prior to the applicable stock purchase date or (ii) APEX or shares of the firm’s Series E or Series F Preferred Stock prior to the date that is ten years after the applicable stock purchase date, unless the applicable redemption or purchase price does not exceed a maximum amount determined by reference to the aggregate amount of net cash proceeds that the firm has received from the sale of qualifying equity securities during the 180-day period preceding the redemption or purchase.
 
The firm has accounted for the stock purchase contracts as equity instruments under EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” and, accordingly, recorded the cost of the stock purchase contracts as a reduction to additional paid-in capital. See Note 7 for information on the preferred stock that the firm will issue in connection with the stock purchase contracts.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 6.   Commitments, Contingencies and Guarantees
 
Commitments
 
Forward Starting Collateralized Agreements and Financings.  The firm had forward starting resale agreements and securities borrowing agreements of $33.11 billion and $28.14 billion as of February 2008 and November 2007, respectively. The firm had forward starting repurchase agreements and securities lending agreements of $14.53 billion and $15.39 billion as of February 2008 and November 2007, respectively.
 
Commitments to Extend Credit.  In connection with its lending activities, the firm had outstanding commitments to extend credit of $74.94 billion and $82.75 billion as of February 2008 and November 2007, respectively. The firm’s commitments to extend credit are agreements to lend to counterparties that have fixed termination dates and are contingent on the satisfaction of all conditions to borrowing set forth in the contract. Since these commitments may expire unused or be reduced or cancelled at the counterparty’s request, the total commitment amount does not necessarily reflect the actual future cash flow requirements. The firm accounts for these commitments at fair value. To the extent that the firm recognizes losses on these commitments, such losses are recorded within the firm’s Trading and Principal Investments segment net of any related underwriting fees.
 
The following table summarizes the firm’s commitments to extend credit as of February 2008 and November 2007:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Commercial lending commitments
               
Investment-grade
  $ 19,909     $ 11,719  
Non-investment-grade
    21,672       41,930  
William Street program
    24,617       24,488  
Warehouse financing
    8,745       4,610  
                 
Total commitments to extend credit
  $ 74,943     $ 82,747  
                 
 
  •  Commercial lending commitments.  The firm extends commercial lending commitments primarily in connection with contingent acquisition financing and other types of corporate lending as well as commercial real estate financing. The total commitment amount does not necessarily reflect the actual future cash flow requirements, as the firm often syndicates all or substantial portions of these commitments, the commitments may expire unused, or the commitments may be cancelled or reduced at the request of the counterparty. In addition, commitments that are extended for contingent acquisition financing are often intended to be short-term in nature, as borrowers often seek to replace them with other funding sources.
 
Included within the non-investment-grade amount as of February 2008 was $9.13 billion of exposure to leveraged lending capital market transactions, $1.60 billion related to commercial real estate transactions and $10.94 billion arising from other unfunded credit facilities. Included within the non-investment-grade amount as of November 2007 was $26.09 billion of exposure to leveraged lending capital market transactions, $3.50 billion related to commercial real estate transactions and $12.34 billion arising from other unfunded credit facilities. Including funded loans, the firm’s total exposure to leveraged lending capital market transactions was $27.25 billion and $43.06 billion as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
  •  William Street program.  Substantially all of the commitments provided under the William Street credit extension program are to investment-grade corporate borrowers. Commitments under the program are extended by William Street Commitment Corporation (Commitment Corp.), a consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are legally separated from other assets and liabilities of the firm, William Street Credit Corporation, GS Bank USA, Goldman Sachs Credit Partners L.P. or other consolidated wholly owned subsidiaries of Group Inc. The commitments extended by Commitment Corp. are supported, in part, by funding raised by William Street Funding Corporation (Funding Corp.), another consolidated wholly owned subsidiary of Group Inc. whose assets and liabilities are also legally separated from other assets and liabilities of the firm. The assets of Commitment Corp. and of Funding Corp. will not be available to their respective shareholders until the claims of their respective creditors have been paid. In addition, no affiliate of either Commitment Corp. or Funding Corp., except in limited cases as expressly agreed in writing, is responsible for any obligation of either entity. With respect to most of the William Street commitments, Sumitomo Mitsui Financial Group, Inc. (SMFG) provides the firm with credit loss protection that is generally limited to 95% of the first loss the firm realizes on approved loan commitments, up to a maximum of $1.00 billion. In addition, subject to the satisfaction of certain conditions, upon the firm’s request, SMFG will provide protection for 70% of the second loss on such commitments, up to a maximum of $1.13 billion. The firm also uses other financial instruments to mitigate credit risks related to certain William Street commitments not covered by SMFG.
 
  •  Warehouse financing.  The firm provides financing for the warehousing of financial assets to be securitized. These financings generally are expected to be repaid from the proceeds of the related securitizations for which the firm may or may not act as underwriter. These arrangements are secured by the warehoused assets, primarily consisting of corporate bank loans and commercial mortgages as of February 2008 and November 2007. In connection with its warehouse financing activities, the firm had loans of $37 million and $44 million collateralized by subprime mortgages as of February 2008 and November 2007, respectively.
 
Letters of Credit.  The firm provides letters of credit issued by various banks to counterparties in lieu of securities or cash to satisfy various collateral and margin deposit requirements. Letters of credit outstanding were $9.82 billion and $8.75 billion as of February 2008 and November 2007, respectively.
 
Investment Commitments.  In connection with its merchant banking and other investing activities, the firm invests in private equity, real estate and other assets directly and through funds that it raises and manages. In connection with these activities, the firm had commitments to invest up to $15.45 billion and $17.76 billion as of February 2008 and November 2007, respectively, including $11.13 billion and $12.32 billion, respectively, of commitments to invest in funds managed by the firm.
 
Construction-Related Commitments.  As of February 2008 and November 2007, the firm had construction-related commitments of $709 million and $769 million, respectively, including outstanding commitments of $554 million and $642 million as of February 2008 and November 2007, respectively, related to the firm’s new world headquarters in New York City, which is expected to cost between $2.3 billion and $2.5 billion. The firm has partially financed this construction project with $1.65 billion of tax-exempt Liberty Bonds.
 
Underwriting Commitments.  As of February 2008 and November 2007, the firm had commitments to purchase $1.01 billion and $88 million, respectively, of securities in connection with its underwriting activities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Other.  The firm had other purchase commitments of $516 million and $420 million as of February 2008 and November 2007, respectively.
 
In addition, in February 2008, Rothesay Life Limited, a wholly owned subsidiary of the firm, entered into an agreement with The Rank Group Plc to acquire its defined benefit pension plan, which has both assets and pension obligations of approximately $1.4 billion. The purchase price is not material to the firm’s financial condition. The transaction is expected to close by the end of the firm’s third fiscal quarter, subject to closing conditions.
 
Leases.  The firm has contractual obligations under long-term noncancelable lease agreements, principally for office space, expiring on various dates through 2069. Certain agreements are subject to periodic escalation provisions for increases in real estate taxes and other charges. Future minimum rental payments, net of minimum sublease rentals are set forth below:
 
         
    (in millions)  
 
Minimum rental payments
       
Remainder of 2008
  $ 353  
2009
    496  
2010
    417  
2011
    325  
2012
    262  
2013-thereafter
    1,999  
         
Total
  $ 3,852  
         
 
Contingencies
 
The firm is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its businesses. Management believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the firm’s financial condition, but may be material to the firm’s operating results for any particular period, depending, in part, upon the operating results for such period. Given the inherent difficulty of predicting the outcome of the firm’s litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, the firm cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred.
 
In connection with its insurance business, the firm is contingently liable to provide guaranteed minimum death and income benefits to certain contract holders and has established a reserve related to $9.38 billion and $10.84 billion of contract holder account balances as of February 2008 and November 2007, respectively, for such benefits. The weighted average attained age of these contract holders was 68 years and 67 years as of February 2008 and November 2007, respectively. The net amount at risk, representing guaranteed minimum death and income benefits in excess of contract holder account balances, was $1.33 billion and $1.04 billion as of February 2008 and November 2007, respectively. See Note 10 for more information on the firm’s insurance liabilities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Guarantees
 
The firm enters into various derivative contracts that meet the definition of a guarantee under FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Such derivative contracts include credit default and total return swaps, written equity and commodity put options, written currency contracts and interest rate caps, floors and swaptions. FIN No. 45 does not require disclosures about derivative contracts if such contracts may be cash settled and the firm has no basis to conclude it is probable that the counterparties held, at inception, the underlying instruments related to the derivative contracts. The firm has concluded that these conditions have been met for certain large, internationally active commercial and investment bank end users and certain other users. Accordingly, the firm has not included such contracts in the tables below.
 
The firm, in its capacity as an agency lender, indemnifies most of its securities lending customers against losses incurred in the event that borrowers do not return securities and the collateral held is insufficient to cover the market value of the securities borrowed.
 
In the ordinary course of business, the firm provides other financial guarantees of the obligations of third parties (e.g., performance bonds, standby letters of credit and other guarantees to enable clients to complete transactions and merchant banking fund-related guarantees). These guarantees represent obligations to make payments to beneficiaries if the guaranteed party fails to fulfill its obligation under a contractual arrangement with that beneficiary.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The following tables set forth certain information about the firm’s derivative contracts that meet the definition of a guarantee and certain other guarantees as of February 2008 and November 2007:
 
                                         
    As of February 2008  
    Maximum Payout/Notional Amount by Period of Expiration (1)  
    Remainder
    2009-
    2011-
    2013-
       
   
of 2008
   
2010
   
2012
   
Thereafter
   
Total
 
    (in millions)  
 
Derivatives (2)
  $ 400,880     $ 487,273     $ 453,554     $ 601,242     $ 1,942,949  
Securities lending indemnifications (3)
    24,650                         24,650  
Performance bonds (4)
    2,123                         2,123  
Other financial guarantees (5)
    210       130       254       41       635  
 
                                         
    As of November 2007  
    Maximum Payout/Notional Amount by Period of Expiration (1)  
          2009-
    2011-
    2013-
       
   
2008
   
2010
   
2012
   
Thereafter
   
Total
 
    (in millions)  
 
Derivatives (2)
  $ 580,769     $ 492,563     $ 457,511     $ 514,498     $ 2,045,341  
Securities lending indemnifications (3)
    26,673                         26,673  
Performance bonds (4)
    2,046                         2,046  
Other financial guarantees (5)
    381       121       258       46       806  
 
 
  (1)  Such amounts do not represent the anticipated losses in connection with these contracts.
 
  (2)  The aggregate carrying value of these derivatives was a liability of $65.69 billion and $33.10 billion as of February 2008 and November 2007, respectively. The carrying value excludes the effect of a legal right of setoff that may exist under an enforceable netting agreement. These derivative contracts are risk managed together with derivative contracts that are not considered guarantees under FIN No. 45, and therefore, these amounts do not reflect the firm’s overall risk related to its derivative activities.
 
  (3)  Collateral held by the lenders in connection with securities lending indemnifications was $25.45 billion and $27.49 billion as of February 2008 and November 2007, respectively.
 
  (4)  Excludes collateral of $2.12 billion and $2.05 billion related to these obligations as of February 2008 and November 2007, respectively.
 
  (5)  The carrying value of these guarantees was a liability of $57 million and $43 million as of February 2008 and
November 2007, respectively.
 
The firm has established trusts, including Goldman Sachs Capital I, II and III, and other entities for the limited purpose of issuing securities to third parties, lending the proceeds to the firm and entering into contractual arrangements with the firm and third parties related to this purpose. (See Note 5 for information regarding the transactions involving Goldman Sachs Capital I, II and III.) The firm effectively provides for the full and unconditional guarantee of the securities issued by these entities, which are not consolidated for accounting purposes. Timely payment by the firm of amounts due to these entities under the borrowing, preferred stock and related contractual arrangements will be sufficient to cover payments due on the securities issued by these entities. Management believes that it is unlikely that any circumstances will occur, such as nonperformance on the part of paying agents or other service providers, that would make it necessary for the firm to make payments related to these entities other than those required under the terms of the borrowing, preferred stock and related contractual arrangements and in connection with certain expenses incurred by these entities.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
In the ordinary course of business, the firm indemnifies and guarantees certain service providers, such as clearing and custody agents, trustees and administrators, against specified potential losses in connection with their acting as an agent of, or providing services to, the firm or its affiliates. The firm also indemnifies some clients against potential losses incurred in the event specified third-party service providers, including sub-custodians and third-party brokers, improperly execute transactions. In addition, the firm is a member of payment, clearing and settlement networks as well as securities exchanges around the world that may require the firm to meet the obligations of such networks and exchanges in the event of member defaults. In connection with its prime brokerage and clearing businesses, the firm agrees to clear and settle on behalf of its clients the transactions entered into by them with other brokerage firms. The firm’s obligations in respect of such transactions are secured by the assets in the client’s account as well as any proceeds received from the transactions cleared and settled by the firm on behalf of the client. In connection with joint venture investments, the firm may issue loan guarantees under which it may be liable in the event of fraud, misappropriation, environmental liabilities and certain other matters involving the borrower. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these guarantees and indemnifications have been recognized in the condensed consolidated statements of financial condition as of February 2008 and November 2007.
 
The firm provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. The firm may also provide indemnifications protecting against changes in or adverse application of certain U.S. tax laws in connection with ordinary-course transactions such as securities issuances, borrowings or derivatives. In addition, the firm may provide indemnifications to some counterparties to protect them in the event additional taxes are owed or payments are withheld, due either to a change in or an adverse application of certain non-U.S. tax laws. These indemnifications generally are standard contractual terms and are entered into in the ordinary course of business. Generally, there are no stated or notional amounts included in these indemnifications, and the contingencies triggering the obligation to indemnify are not expected to occur. The firm is unable to develop an estimate of the maximum payout under these guarantees and indemnifications. However, management believes that it is unlikely the firm will have to make any material payments under these arrangements, and no liabilities related to these arrangements have been recognized in the condensed consolidated statements of financial condition as of February 2008 and November 2007.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 7.   Shareholders’ Equity
 
On March 17, 2008, the Board of Directors of Group Inc. (the Board) declared a dividend of $0.35 per common share with respect to the firm’s first quarter of 2008 to be paid on May 29, 2008, to common shareholders of record on April 29, 2008.
 
During the three months ended February 2008, the firm repurchased 7.9 million shares of its common stock at a total cost of $1.56 billion. The average price paid per share for repurchased shares was $198.87 for the three months ended February 2008. In addition, to satisfy minimum statutory employee tax withholding requirements related to the delivery of common stock underlying restricted stock units, the firm cancelled 6.7 million of restricted stock units with a total value of $1.31 billion in the first quarter of 2008.
 
The firm’s share repurchase program is intended to help maintain the appropriate level of common equity and to substantially offset increases in share count over time resulting from employee share-based compensation. The repurchase program is effected primarily through regular open-market purchases, the amounts and timing of which are determined primarily by the firm’s current and projected capital positions (i.e., comparisons of the firm’s desired level of capital to its actual level of capital) but which may also be influenced by general market conditions and the prevailing price and trading volumes of the firm’s common stock.
 
As of February 2008, the firm had 124,000 shares of perpetual non-cumulative preferred stock issued and outstanding in four series as set forth in the following table:
 
                             
    Shares
  Shares
      Earliest
  Redemption Value
Series
 
Issued
  Authorized  
Dividend Rate
 
Redemption Date
  (in millions)
 
A
  30,000     50,000     3 month LIBOR + 0.75%,
with floor of 3.75% per annum
  April 25, 2010     $  750  
B
  32,000     50,000     6.20% per annum   October 31, 2010     800  
C
  8,000     25,000     3 month LIBOR + 0.75%,
with floor of 4% per annum
  October 31, 2010     200  
D
  54,000     60,000     3 month LIBOR + 0.67%,
with floor of 4% per annum
  May 24, 2011     1,350  
                             
    124,000     185,000               $3,100  
                             
 
Each share of preferred stock issued and outstanding has a par value of $0.01, has a liquidation preference of $25,000, is represented by 1,000 depositary shares and is redeemable at the firm’s option at a redemption price equal to $25,000 plus declared and unpaid dividends. Dividends on each series of preferred stock, if declared, are payable quarterly in arrears. The firm’s ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, its common stock is subject to certain restrictions in the event that the firm fails to pay or set aside full dividends on the preferred stock for the latest completed dividend period. All series of preferred stock are pari passu and have a preference over the firm’s common stock upon liquidation.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
In 2007, the Board authorized 17,500.1 shares of perpetual Non-Cumulative Preferred Stock, Series E and 5,000.1 shares of perpetual Non-Cumulative Preferred Stock, Series F in connection with the APEX issuance (see Note 5 for further information on the APEX issuance). Under the stock purchase contracts, the firm will issue on the relevant stock purchase dates (on or before June 1, 2013 and September 1, 2013 for Series E and Series F preferred stock, respectively) one share of Series E and Series F preferred stock to Goldman Sachs Capital II and III, respectively, for each $100,000 principal amount of subordinated notes held by these trusts. When issued, each share of Series E and Series F preferred stock will have a par value of $0.01 and a liquidation preference of $100,000 per share. Dividends on Series E preferred stock, if declared, will be payable semi-annually at a fixed annual rate of 5.79% if the stock is issued prior to June 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus .77% and (ii) 4%. Dividends on Series F preferred stock, if declared, will be payable quarterly at a rate per annum equal to three-month LIBOR plus .77% if the stock is issued prior to September 1, 2012 and quarterly thereafter, at a rate per annum equal to the greater of (i) three-month LIBOR plus .77% and (ii) 4%. The preferred stock may be redeemed at the option of the firm on the stock purchase dates or any day thereafter, subject to the approval of the U.S. Securities and Exchange Commission (SEC) and certain covenant restrictions governing the firm’s ability to redeem or purchase the preferred stock without issuing common stock or other instruments with equity-like characteristics.
 
On March 17, 2008, the Board declared a dividend per preferred share of $243.06, $387.50, $252.78 and $252.78 for Series A, Series B, Series C and Series D preferred stock, respectively, to be paid on May 12, 2008 to preferred shareholders of record on April 27, 2008.
 
The following table sets forth the firm’s accumulated other comprehensive income/(loss) by type:
 
                 
    As of
    February
  November
    2008   2007
    (in millions)
 
Adjustment from adoption of SFAS No. 158, net of tax
    $(194 )     $(194 )
Currency translation adjustment, net of tax
    77       68  
Net unrealized gains/(losses) on available-for-sale securities, net of tax (1)
    (27 )     8  
                 
Total accumulated other comprehensive income, net of tax
    $(144 )     $(118 )
                 
 
 
  (1)  Consists of net unrealized losses of $24 million on available-for-sale securities held by investees accounted for under the equity method and net unrealized losses of $3 million on available-for-sale securities held by the firm’s insurance subsidiaries as of February 2008. Consists of net unrealized gains of $9 million on available-for-sale securities held by investees accounted for under the equity method and net unrealized losses of $1 million on available-for-sale securities held by the firm’s insurance subsidiaries as of November 2007.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 8.   Earnings Per Common Share
 
The computations of basic and diluted earnings per common share are set forth below:
 
                 
    Three Months
    Ended February
   
2008
 
2007
    (in millions, except per share amounts)
 
Numerator for basic and diluted EPS — net earnings applicable to common shareholders
    $1,467       $3,148  
                 
Denominator for basic EPS — weighted average number of common shares
    432.8       444.5  
Effect of dilutive securities (1)
               
Restricted stock units
    8.6       11.7  
Stock options
    12.1       15.7  
                 
Dilutive potential common shares
    20.7       27.4  
                 
Denominator for diluted EPS — weighted average number of common shares and dilutive potential common shares
    453.5       471.9  
                 
Basic EPS
    $  3.39       $  7.08  
Diluted EPS
    3.23       6.67  
 
 
  (1)  The diluted EPS computations do not include the antidilutive effect of the following restricted stock units and stock options:
 
                 
    Three Months
 
    Ended February  
    2008     2007  
    (in millions)  
 
Number of antidilutive restricted stock units and stock options, end of period
    7.5        
                 
 
Note 9.  Goodwill and Identifiable Intangible Assets
 
Goodwill
 
The following table sets forth the carrying value of the firm’s goodwill by operating segment, which is included in “Other assets” in the condensed consolidated statements of financial condition:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Investment Banking
               
Underwriting
  $    125     $    125  
Trading and Principal Investments
               
FICC
    301       123  
Equities (1)
    2,389       2,381  
Principal Investments
    11       11  
Asset Management and Securities Services
               
Asset Management (2)
    564       564  
Securities Services
    117       117  
                 
Total
  $ 3,507     $ 3,321  
                 
 
 
  (1)  Primarily related to SLK LLC (SLK).
 
  (2)  Primarily related to The Ayco Company, L.P. (Ayco).


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
  Identifiable Intangible Assets
 
The following table sets forth the gross carrying amount, accumulated amortization and net carrying amount of the firm’s identifiable intangible assets:
 
                     
        As of  
        February
    November
 
        2008     2007  
        (in millions)  
 
Customer lists (1)
  Gross carrying amount   $ 1,095     $ 1,086  
    Accumulated amortization     (377 )     (354 )
 
   
                   
    Net carrying amount   $ 718     $ 732  
 
   
                   
New York Stock
  Gross carrying amount   $ 714     $ 714  
Exchange (NYSE)
  Accumulated amortization     (222 )     (212 )
                     
specialist rights
  Net carrying amount   $ 492     $ 502  
                     
Insurance-related
  Gross carrying amount   $ 433     $ 461  
assets (2)
  Accumulated amortization     (106 )     (89 )
 
   
                   
    Net carrying amount   $ 327     $ 372  
 
   
                   
Exchange-traded
  Gross carrying amount   $ 138     $ 138  
fund (ETF) lead
  Accumulated amortization     (39 )     (38 )
                     
market maker rights
  Net carrying amount   $ 99     $ 100  
                     
Other (3)
  Gross carrying amount   $ 375     $ 360  
    Accumulated amortization     (298 )     (295 )
 
   
                   
    Net carrying amount   $ 77     $ 65  
 
   
                   
                     
Total
  Gross carrying amount   $ 2,755     $ 2,759  
    Accumulated amortization     (1,042 )     (988 )
                     
    Net carrying amount   $ 1,713     $ 1,771  
                     
 
 
  (1)  Primarily includes the firm’s clearance and execution and NASDAQ customer lists related to SLK and financial counseling customer lists related to Ayco.
 
  (2)  Consists of VOBA and DAC. VOBA represents the present value of estimated future gross profits of the variable annuity and life insurance business. DAC results from commissions paid by the firm to the primary insurer (ceding company) on life and annuity reinsurance agreements as compensation to place the business with the firm and to cover the ceding company’s acquisition expenses. VOBA and DAC are amortized over the estimated life of the underlying contracts based on estimated gross profits, and amortization is adjusted based on actual experience. The weighted average remaining amortization period for VOBA and DAC is seven years as of February 2008.
 
  (3)  Primarily includes marketing and technology-related assets, and power contracts.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Substantially all of the firm’s identifiable intangible assets are considered to have finite lives and are amortized over their estimated useful lives. The weighted average remaining life of the firm’s identifiable intangibles is approximately 12 years.
 
The estimated future amortization for existing identifiable intangible assets through 2013 is set forth below:
 
         
    (in millions)
 
Remainder of 2008
  $ 143  
2009
    168  
2010
    151  
2011
    143  
2012
    135  
2013
    123  
 
Note 10.   Other Assets and Other Liabilities
 
Other Assets
 
Other assets are generally less liquid, nonfinancial assets. The following table sets forth the firm’s other assets by type:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Property, leasehold improvements and equipment (1)
  $ 10,057     $ 8,975  
Goodwill and identifiable intangible assets (2)
    5,220       5,092  
Income tax-related assets
    4,259       4,177  
Equity-method investments (3)
    1,854       2,014  
Miscellaneous receivables and other
    5,380       3,809  
                 
Total
  $ 26,770     $ 24,067  
                 
 
 
  (1)  Net of accumulated depreciation and amortization of $6.11 billion and $5.88 billion as of February 2008 and November 2007, respectively.
 
  (2)  See Note 9 for further information regarding the firm’s goodwill and identifiable intangible assets.
 
  (3)  Excludes investments of $2.87 billion and $2.25 billion accounted for at fair value under SFAS No. 159 as of February 2008 and November 2007, respectively, which are included in “Financial instruments owned, at fair value” in the condensed consolidated statements of financial condition.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Other Liabilities
 
The following table sets forth the firm’s other liabilities and accrued expenses by type:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Insurance-related liabilities (1)
  $ 10,110     $ 10,344  
Minority interest (2)
    7,687       7,265  
Compensation and benefits
    4,614       11,816  
Income tax-related liabilities
    2,211       2,546  
Accrued expenses and other payables
    4,880       4,749  
Employee interests in consolidated funds
    637       2,187  
                 
Total
  $ 30,139     $ 38,907  
                 
 
 
  (1)  Insurance-related liabilities are set forth in the table below:
 
                 
    As of  
    February
    November
 
    2008     2007  
    (in millions)  
 
Separate account liabilities
  $ 6,170     $ 7,039  
Liabilities for future benefits and unpaid claims
    2,769       2,142  
Contract holder account balances
    925       937  
Reserves for guaranteed minimum death and income benefits
    246       226  
                 
Total insurance-related liabilities
  $ 10,110     $ 10,344  
                 
 
Separate account liabilities are offset by separate account assets, representing segregated contract holder funds under variable annuity and life insurance contracts. Separate account assets are included in “Cash and securities segregated for regulatory and other purposes” in the condensed consolidated statements of financial condition.
 
Liabilities for future benefits and unpaid claims include liabilities arising from reinsurance provided by the firm to other insurers. The firm had a receivable for $1.26 billion and $1.30 billion as of February 2008 and November 2007, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. In addition, the firm has ceded risks to reinsurers related to certain of its liabilities for future benefits and unpaid claims and had a receivable of $736 million and $785 million as of February 2008 and November 2007, respectively, related to such reinsurance contracts, which is reported in “Receivables from customers and counterparties” in the condensed consolidated statements of financial condition. Contracts to cede risks to reinsurers do not relieve the firm from its obligations to contract holders.
 
Reserves for guaranteed minimum death and income benefits represent a liability for the expected value of guaranteed benefits in excess of projected annuity account balances. These reserves are computed in accordance with AICPA SOP 03-1 and are based on total payments expected to be made less total fees expected to be assessed over the life of the contract.
 
  (2)  Includes $6.21 billion and $5.95 billion related to consolidated investment funds as of February 2008 and November 2007, respectively.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 11.   Employee Benefit Plans
 
The firm sponsors various pension plans and certain other postretirement benefit plans, primarily healthcare and life insurance. The firm also provides certain benefits to former or inactive employees prior to retirement.
 
Defined Benefit Pension Plans and Postretirement Plans
 
Employees of certain non-U.S. subsidiaries participate in various defined benefit pension plans. These plans generally provide benefits based on years of credited service and a percentage of the employee’s eligible compensation. The firm maintains a defined benefit pension plan for substantially all U.K. employees. As of April 2008, this plan has been closed to new participants, but will continue to accrue benefits for existing participants.
 
The firm also maintains a defined benefit pension plan for substantially all U.S. employees hired prior to November 1, 2003. As of November 2004, this plan has been closed to new participants and no further benefits will be accrued to existing participants. In addition, the firm has unfunded postretirement benefit plans that provide medical and life insurance for eligible retirees and their dependents covered under these programs.
 
The components of pension expense/(income) and postretirement expense are set forth below:
 
                 
    Three Months
 
    Ended February  
    2008     2007  
    (in millions)  
 
U.S. pension
               
Interest cost
  $ 5     $ 6  
Expected return on plan assets
    (8 )     (8 )
                 
Total
  $ (3 )   $ (2 )
                 
Non-U.S. pension
               
Service cost
  $ 21     $ 18  
Interest cost
    10       8  
Expected return on plan assets
    (10 )     (8 )
Net amortization
    1       2  
                 
Total
  $ 22     $ 20  
                 
Postretirement
               
Service cost
  $ 5     $ 5  
Interest cost
    7       5  
Net amortization
    4       4  
                 
Total
  $ 16     $ 14  
                 
 
The firm expects to contribute a minimum of $133 million to its pension plans and $8 million to its postretirement plans in 2008.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Note 12.   Transactions with Affiliated Funds
 
The firm has formed numerous nonconsolidated investment funds with third-party investors. The firm generally acts as the investment manager for these funds and, as such, is entitled to receive management fees and, in certain cases, advisory fees, incentive fees or overrides from these funds. These fees amounted to $990 million and $1.04 billion for the three months ended February 2008 and February 2007, respectively. As of February 2008 and November 2007, the fees receivable from these funds were $813 million and $596 million, respectively. Additionally, the firm may invest alongside the third-party investors in certain funds. The aggregate carrying value of the firm’s interests in these funds was $13.88 billion and $12.90 billion as of February 2008 and November 2007, respectively. In the ordinary course of business, the firm may also engage in other activities with these funds, including, among others, securities lending, trade execution, trading, custody, and acquisition and bridge financing. See Note 6 for the firm’s commitments related to these funds.
 
Note 13.   Income Taxes
 
FIN No. 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold required before a tax position can be recognized in the financial statements. FIN No. 48 also provides guidance on measurement, derecognition, classification, interim period accounting and accounting for interest and penalties. The firm adopted the provisions of FIN No. 48 as of December 1, 2007 and recorded a transition adjustment resulting in a reduction of $201 million to beginning retained earnings.
 
FIN No. 48 requires disclosure of the following amounts as of the date of adoption, and on an annual basis thereafter. As of December 1, 2007 (date of adoption), the firm’s liability for unrecognized tax benefits reported in “Other liabilities and accrued expenses” in the condensed consolidated statement of financial condition was $1.04 billion. The firm reported a related deferred tax asset of $497 million in “Other assets” in the condensed consolidated statement of financial condition. If recognized, the net liability of $545 million would reduce the firm’s effective income tax rate. As of December 1, 2007, the firm’s accrued liability for interest expense related to income tax matters and income tax penalties was $79 million. The firm reports interest expense related to income tax matters in “Provision for taxes” in the condensed consolidated statements of earnings and income tax penalties in “Other expenses” in the condensed consolidated statements of earnings.
 
The firm is subject to examination by the U.S. Internal Revenue Service (IRS) and other taxing authorities in jurisdictions where the firm has significant business operations, such as the United Kingdom, Japan, Hong Kong, Korea and various states, such as New York. The tax years under examination vary by jurisdiction. During fiscal 2007, the IRS substantially concluded its examination of fiscal years 2003 and 2004. Tax audits that have been substantially concluded in other jurisdictions in which the firm has significant business operations include New York State’s examination of fiscal years through 2003, the United Kingdom’s review of fiscal years through 2003 and Hong Kong’s review of fiscal years through 2001. The firm does not expect that potential additional assessments from these examinations will be material to its results of operations.
 
The firm does not expect unrecognized tax benefits to change significantly during the twelve months subsequent to February 29, 2008.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Below is a table of the earliest tax years that remain subject to examination by major jurisdiction:
 
         
    Earliest
    Tax Year
    Subject to
Jurisdiction
  Examination
 
U.S. Federal
    2005  (1)
New York State and City
    2004  (2)
United Kingdom
    2004  
Japan
    2005  
Hong Kong
    2002  
Korea
    2003  
 
 
  (1)  IRS examination of fiscal 2005 and 2006 is expected to begin during 2008.
 
  (2)  New York State and City examination of fiscal 2004, 2005 and 2006 began in 2008.
 
All years subsequent to the above years remain open to examination by the taxing authorities. The firm believes that the liability for unrecognized tax benefits it has established is adequate in relation to the potential for additional assessments. The resolution of tax matters is not expected to have a material effect on the firm’s financial condition but may be material to the firm’s operating results for a particular period, depending, in part, upon the operating results for that period.
 
Note 14.   Regulation
 
The firm is regulated by the SEC as a Consolidated Supervised Entity (CSE) and, as such, is subject to group-wide supervision and examination by the SEC and to minimum capital adequacy standards on a consolidated basis. The firm was in compliance with the CSE capital adequacy standards as of February 2008 and November 2007.
 
The firm’s principal U.S. regulated subsidiaries include Goldman, Sachs & Co. (GS&Co.) and Goldman Sachs Execution & Clearing, L.P. (GSEC). GS&Co. and GSEC are registered U.S. broker-dealers and futures commission merchants subject to Rule 15c3-1 of the SEC and Rule 1.17 of the Commodity Futures Trading Commission, which specify uniform minimum net capital requirements, as defined, for their registrants, and also require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. and GSEC have elected to compute their minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1. As of February 2008 and November 2007, GS&Co. and GSEC had net capital in excess of their minimum capital requirements. In addition to its alternative minimum net capital requirements, GS&Co. is also required to hold tentative net capital in excess of $1 billion and net capital in excess of $500 million in accordance with the market and credit risk standards of Appendix E of Rule 15c3-1. GS&Co. is also required to notify the SEC in the event that its tentative net capital is less than $5 billion. As of February 2008 and November 2007, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
GS Bank USA, a wholly owned industrial bank, is regulated by the Federal Deposit Insurance Corporation and the State of Utah Department of Financial Institutions. Goldman Sachs Bank Europe PLC (GS Bank Europe), a wholly owned credit institution, is regulated by the Irish Financial Regulator. Both entities are subject to minimum capital requirements and as of February 2008, both were in compliance with all regulatory capital requirements. As of February 2008, all deposits at GS Bank USA were U.S. dollar-denominated and substantially all of the deposits at GS Bank Europe were either U.S. dollar or Euro-denominated. These deposits have no stated maturity and can be withdrawn upon short notice. The weighted average interest rates for deposits at GS Bank USA were 3.30% and 4.71% as of February 2008 and November 2007, respectively. The weighted average interest rate for deposits at GS Bank Europe as of February 2008 was 3.73%. The carrying value of deposits approximated fair value as of February 2008 and November 2007.
 
The firm has U.S. insurance subsidiaries that are subject to state insurance regulation and oversight in the states in which they are domiciled and in the other states in which they are licensed. In addition, certain of the firm’s insurance subsidiaries outside of the U.S. are regulated by the Bermuda Registrar of Companies and the U.K.’s Financial Services Authority (FSA). The firm’s insurance subsidiaries were in compliance with all regulatory capital requirements as of February 2008 and November 2007.
 
The firm’s principal non-U.S. regulated subsidiaries include Goldman Sachs International (GSI) and Goldman Sachs Japan Co., Ltd. (GSJCL). GSI, the firm’s regulated U.K. broker-dealer, is subject to the capital requirements of the FSA. GSJCL, the firm’s regulated Japanese broker-dealer, is subject to the capital requirements of Japan’s Financial Services Agency. As of February 2008 and November 2007, GSI and GSJCL were in compliance with their local capital adequacy requirements. Certain other non-U.S. subsidiaries of the firm are also subject to capital adequacy requirements promulgated by authorities of the countries in which they operate. As of February 2008 and November 2007, these subsidiaries were in compliance with their local capital adequacy requirements.
 
Note 15.   Business Segments
 
In reporting to management, the firm’s operating results are categorized into the following three business segments: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.
 
Basis of Presentation
 
In reporting segments, certain of the firm’s business lines have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate.
 
The cost drivers of the firm taken as a whole — compensation, headcount and levels of business activity — are broadly similar in each of the firm’s business segments. Compensation and benefits expenses within the firm’s segments reflect, among other factors, the overall performance of the firm as well as the performance of individual business units. Consequently, pre-tax margins in one segment of the firm’s business may be significantly affected by the performance of the firm’s other business segments. The timing and magnitude of changes in the firm’s bonus accruals can have a significant effect on segment results in a given period.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
The firm allocates revenues and expenses among the three business segments. Due to the integrated nature of these segments, estimates and judgments have been made in allocating certain revenue and expense items. Transactions between segments are based on specific criteria or approximate third-party rates. Total operating expenses include corporate items that have not been allocated to individual business segments. The allocation process is based on the manner in which management views the business of the firm.
 
The segment information presented in the table below is prepared according to the following methodologies:
 
  •  Revenues and expenses directly associated with each segment are included in determining pre-tax earnings.
 
  •  Net revenues in the firm’s segments include allocations of interest income and interest expense to specific securities, commodities and other positions in relation to the cash generated by, or funding requirements of, such underlying positions. Net interest is included within segment net revenues as it is consistent with the way in which management assesses segment performance.
 
  •  Overhead expenses not directly allocable to specific segments are allocated ratably based on direct segment expenses.


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Segment Operating Results
 
Management believes that the following information provides a reasonable representation of each segment’s contribution to consolidated pre-tax earnings and total assets:
 
                     
        As of or for the
 
        Three Months
 
        Ended February  
       
2008
   
2007
 
        (in millions)  
 
Investment
  Net revenues   $ 1,172     $ 1,716  
Banking
  Operating expenses     940       1,294  
 
   
                   
    Pre-tax earnings   $ 232     $ 422  
 
   
                   
    Segment assets   $ 7,466     $ 3,883  
 
   
                   
                     
Trading and
  Net revenues   $ 5,124     $ 9,417  
Principal
  Operating expenses     3,743       5,394  
                     
Investments
  Pre-tax earnings   $ 1,381     $ 4,023  
                     
    Segment assets   $ 809,059     $ 621,281  
                     
                     
Asset Management
  Net revenues   $ 2,039     $ 1,597  
and Securities
  Operating expenses     1,493       1,183  
 
   
                   
Services
  Pre-tax earnings   $ 546     $ 414  
 
   
                   
    Segment assets   $ 372,481     $ 287,331  
 
   
                   
                     
Total
  Net revenues (1)   $ 8,335     $ 12,730  
    Operating expenses (2)     6,192       7,871  
                     
    Pre-tax earnings (3)   $ 2,143     $ 4,859  
                     
    Total assets   $ 1,189,006     $ 912,495  
                     
 
(1) Net revenues include net interest as set forth in the table below:
 
                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    (in millions)  
 
Investment Banking
  $ 6     $  
Trading and Principal Investments
    247       344  
Asset Management and Securities Services
    698       464  
                 
Total net interest
  $ 951     $ 808  
                 
 
(2) Operating expenses include net provisions for a number of litigation and regulatory proceedings of $16 million for the three months ended February 2008 that have not been allocated to the firm’s segments.
 
(3) Pre-tax earnings include total depreciation and amortization as set forth in the table below:
 
                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    (in millions)  
 
Investment Banking
  $ 38     $ 33  
Trading and Principal Investments
    246       197  
Asset Management and Securities Services
    59       42  
                 
Total depreciation and amortization
  $ 343     $ 272  
                 


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THE GOLDMAN SACHS GROUP, INC. and SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)
 
Geographic Information
 
Due to the highly integrated nature of international financial markets, the firm manages its businesses based on the profitability of the enterprise as a whole. Since a significant portion of the firm’s activities require cross-border coordination in order to facilitate the needs of the firm’s clients, the methodology for allocating the firm’s profitability to geographic regions is dependent on the judgment of management.
 
Geographic results are generally allocated as follows:
 
  •  Investment Banking: location of the client and investment banking team.
 
  •  Fixed Income, Currency and Commodities, and Equities: location of the trading desk.
 
  •  Principal Investments: location of the investment.
 
  •  Asset Management: location of the sales team.
 
  •  Securities Services: location of the primary market for the underlying security.
 
The following table sets forth the total net revenues of the firm and its consolidated subsidiaries by geographic region allocated on the methodology described above, as well as the percentage of total net revenues for each geographic region:
 
                                 
    Three Months
 
    Ended February  
   
2008
   
2007
 
    ($ in millions)  
 
Net revenues
                               
Americas (1)
  $ 4,207       51 %   $ 6,263       49 %
EMEA (2)
    2,674       32       4,167       33  
Asia
    1,454       17       2,300       18  
                                 
Total net revenues
  $ 8,335       100 %   $ 12,730       100 %
                                 
 
 
  (1)  Substantially all relates to the U.S.
 
  (2)  EMEA (Europe, Middle East and Africa).


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Report of Independent Registered Public Accounting Firm
 
To the Directors and Shareholders of
The Goldman Sachs Group, Inc.:
 
We have reviewed the accompanying condensed consolidated statement of financial condition of The Goldman Sachs Group, Inc. and its subsidiaries (the Company) as of February 29, 2008, the related condensed consolidated statements of earnings for the three months ended February 29, 2008 and February 23, 2007, the condensed consolidated statement of changes in shareholders’ equity for the three months ended February 29, 2008, the condensed consolidated statements of cash flows for the three months ended February 29, 2008 and February 23, 2007, and the condensed consolidated statements of comprehensive income for the three months ended February 29, 2008 and February 23, 2007. These condensed consolidated interim financial statements are the responsibility of the Company’s management.
 
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
 
We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of financial condition as of November 30, 2007, and the related consolidated statements of earnings, changes in shareholders’ equity, cash flows and comprehensive income for the year then ended (not presented herein), and in our report dated January 24, 2008 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated statement of financial condition as of November 30, 2007 and the condensed consolidated statement of changes in shareholders’ equity for the year ended November 30, 2007, is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived.
 
/s/ PricewaterhouseCoopers LLP
 
New York, New York
April 3, 2008


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Item 2:   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
INDEX
 
         
    Page
   
No.
 
    59  
       
    60  
       
    61  
       
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    68  
       
    70  
       
    71  
       
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    75  
       
    81  
       
    81  
       
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    88  
       
    90  
       
    94  
       
    95  
       
    99  
       
    106  
       
    107  
       
    107  


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Introduction
 
Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals.
 
Our activities are divided into three segments:
 
  •  Investment Banking.  We provide a broad range of investment banking services to a diverse group of corporations, financial institutions, investment funds, governments and individuals.
 
  •  Trading and Principal Investments.  We facilitate client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and take proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. In addition, we engage in market-making and specialist activities on equities and options exchanges and clear client transactions on major stock, options and futures exchanges worldwide. In connection with our merchant banking and other investing activities, we make principal investments directly and through funds that we raise and manage.
 
  •  Asset Management and Securities Services.  We provide investment advisory and financial planning services and offer investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes to a diverse group of institutions and individuals worldwide and provide prime brokerage services, financing services and securities lending services to institutional clients, including hedge funds, mutual funds, pension funds and foundations, and to high-net-worth individuals worldwide.
 
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended November 30, 2007. References herein to the Annual Report on Form 10-K are to our Annual Report on Form 10-K for the fiscal year ended November 30, 2007.
 
Unless specifically stated otherwise, all references to February 2008 and February 2007 refer to our fiscal periods ended, or the dates, as the context requires, February 29, 2008 and February 23, 2007, respectively. All references to November 2007, unless specifically stated otherwise, refer to our fiscal year ended, or the date, as the context requires, November 30, 2007. All references to 2008, unless specifically stated otherwise, refer to our fiscal year ending, or the date, as the context requires, November 28, 2008.
 
When we use the terms “Goldman Sachs,” “we,” “us” and “our,” we mean The Goldman Sachs Group, Inc. (Group Inc.), a Delaware corporation, and its consolidated subsidiaries.


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Executive Overview
 
Our diluted earnings per common share were $3.23 for the first quarter of 2008 compared with $6.67 for the first quarter of 2007. Annualized return on average tangible common shareholders’ equity (1) was 17.0% and annualized return on average common shareholders’ equity was 14.8% for the first quarter of 2008. During the quarter, we repurchased 7.9 million shares of our common stock for a total cost of $1.56 billion.
 
Our results for the first quarter of 2008 reflected particularly challenging market conditions compared with recent quarters. Although a broad-based asset repricing across credit and equity markets adversely affected results in certain of our businesses, levels of client activity in our Fixed Income, Currency and Commodities (FICC) and Equities businesses remained strong. Net revenues in Trading and Principal Investments decreased significantly compared with a strong first quarter of 2007, reflecting significant decreases in Principal Investments, FICC and Equities. The decline in Principal Investments reflected a $135 million loss related to our investment in the ordinary shares of Industrial and Commercial Bank of China Limited (ICBC) and losses from other corporate principal investments, compared with strong results in the same prior year period. Results in FICC were adversely affected by continued deterioration in the broader credit markets. Net losses on residential mortgage loans and securities were approximately $1 billion. In addition, credit products included a loss of approximately $1 billion ($1.4 billion before hedges) related to non-investment-grade credit origination activities, as well as lower results from investments compared with the first quarter of 2007. Across the broader franchise in FICC, activity levels were high and results were strong. Net revenues in interest rate products, currencies and commodities were significantly higher compared with the first quarter of 2007. The decrease in Equities was principally due to significantly lower results in principal strategies. During the quarter, Equities operated in an environment characterized by significantly lower equity prices. However, volatility levels continued to increase and customer activity levels were strong, which contributed to a significant increase in commissions compared with the same prior year period.
 
Net revenues in Investment Banking also declined compared with a strong first quarter of 2007, due to significant decreases in both Underwriting and Financial Advisory, reflecting difficult market conditions. The decrease in Underwriting primarily reflected reduced leveraged finance and mortgage-related activity, as well as a decline in industry-wide common stock offerings. The decrease in Financial Advisory reflected a decline in industry-wide completed mergers and acquisitions. Our investment banking transaction backlog decreased during the quarter. (2)
 
Net revenues in Asset Management and Securities Services increased significantly compared with the first quarter of 2007. Asset Management net revenues increased compared with the first quarter of 2007, reflecting higher management and other fees, and higher incentive fees. During the quarter, assets under management increased $5 billion to a record $873 billion, including $29 billion of net inflows. Securities Services also increased compared with the same prior year period, reflecting significantly higher customer balances.
 
Our business, by its nature, does not produce predictable earnings. Our results in any given period can be materially affected by conditions in global financial markets and economic conditions generally. For a further discussion of the factors that may affect our future operating results, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K.
 
 
 
(1)  Return on average tangible common shareholders’ equity (ROTE) is computed by dividing net earnings (or annualized net earnings for annualized ROTE) applicable to common shareholders by average monthly tangible common shareholders’ equity. See “— Results of Operations — Financial Overview” below for further information regarding our calculation of ROTE.
 
(2)  Our investment banking transaction backlog represents an estimate of our future net revenues from investment banking transactions where we believe that future revenue realization is more likely than not.


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Business Environment
 
Global economic growth continued to slow during our first quarter of fiscal 2008, with weakness most evident in the United States. While economic growth in emerging economies generally remained strong, growth in the major economies slowed as business and consumer confidence continued to decline. Fixed income and equity markets experienced particularly high levels of volatility and a broad-based repricing of assets, as conditions in the credit markets deteriorated further. In particular, leveraged lending markets and mortgage markets (across residential and commercial asset classes) experienced weakness. In addition to reducing its federal funds target rate, the U.S. Federal Reserve took measures to address elevated pressures in short-term funding markets. Major global equity markets ended the quarter significantly lower. Commodity prices rose significantly during the quarter, with oil and gold reaching record price levels, while the U.S. dollar depreciated further against the Euro and the Japanese yen. Investment banking activity levels slowed significantly in the fiscal quarter, with significant declines in industry-wide completed mergers and acquisitions, and common stock offerings.
 
In the U.S., the pace of real gross domestic product (GDP) growth appeared to slow significantly during our first quarter. Domestic demand contracted, with negative growth in both business fixed investment and residential investment. Growth in consumer spending also slowed and surveys of business and consumer confidence deteriorated during the quarter. However, international trade provided support for the economy as export growth accelerated and import growth slowed. The rate of unemployment increased, with a contraction in private-sector employment in February. Concerns over the impact on economic growth of further tightening in credit conditions, deterioration in the broader financial markets and continued weakness in the housing market intensified. Although measures of core inflation increased, the U.S. Federal Reserve reduced its federal funds target rate by 150 basis points to 3.00% during our fiscal quarter. The 10-year U.S. Treasury note yield ended our quarter 44 basis points lower at 3.53%. In the equity markets, the NASDAQ Composite Index, the S&P 500 Index and the Dow Jones Industrial Average declined by 15%, 10% and 8%, respectively.
 
In the Eurozone economies, real GDP growth in our first quarter appeared to slow compared with the pace during 2007. The pace of growth in industrial production and consumer expenditure weakened. Surveys of business confidence declined in the first two months of our fiscal quarter but recovered slightly in February, while surveys of consumer confidence continued to decline throughout the quarter. The unemployment rate continued to decrease. Measures of core inflation remained elevated during the quarter. The European Central Bank left its main refinancing operations rate unchanged at 4.00%. The Euro appreciated by 4% against the U.S. dollar. In the U.K., the pace of real GDP growth also appeared to slow. Surveys of consumer confidence worsened during the quarter and concerns over the impact on economic growth due to tightening credit conditions and weakness in the housing market intensified. Although inflationary pressures remained elevated, the Bank of England reduced its official bank rate by 50 basis points to 5.25% during our fiscal quarter. The British pound depreciated by 3% against the U.S. dollar. Equity markets in both the U.K. and continental Europe declined sharply during our fiscal quarter, and long-term government bond yields decreased during the quarter.
 
In Japan, real GDP growth appeared to decline significantly during our first quarter. Growth in industrial production improved but remained at a modest level, while housing sector activity remained weak and surveys of business confidence deteriorated. Measures of inflation increased slightly during the quarter. The Bank of Japan left its target overnight call rate unchanged at 0.50%, while the yield on 10-year Japanese government bonds declined during the quarter. The Nikkei 225 Index ended our fiscal quarter 13% lower. The yen appreciated by 6% against the U.S. dollar.
 
In China, real GDP growth remained strong, but the pace appeared to moderate during our first quarter, reflecting slower growth in industrial production and weaker exports. Measures of inflation rose sharply during our fiscal quarter. The People’s Bank of China raised its one-year benchmark lending rate by 18 basis points to 7.47%, and raised the reserve requirement ratio by 150 basis points. The Chinese yuan continued to appreciate against the U.S. dollar, increasing by nearly 4%. The Shanghai Composite Index declined sharply, ending our fiscal quarter 11% lower. In India, economic growth appeared to moderate during the quarter due to slower growth in agriculture as well as in industrial production and services. Inflationary pressures increased, reflecting the impact of higher food and commodity prices. The Indian rupee depreciated slightly against the U.S. dollar. Equity markets in India and elsewhere in Asia generally ended our fiscal quarter significantly lower.


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Critical Accounting Policies
 
Fair Value
 
The use of fair value to measure financial instruments, with related unrealized gains or losses generally recognized in “Trading and principal investments” in our condensed consolidated statements of earnings, is fundamental to our financial statements and our risk management processes and is our most critical accounting policy. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Instruments that we own (long positions) are marked to bid prices, and instruments that we have sold, but not yet purchased (short positions) are marked to offer prices.
 
In determining fair value, we separate our “Financial instruments, owned at fair value” and “Financial instruments sold, but not yet purchased, at fair value” into two categories: cash instruments and derivative contracts, as set forth in the following table:
 
Financial Instruments by Category
(in millions)
 
                                 
    As of February 2008   As of November 2007
        Financial
      Financial
    Financial
  Instruments Sold,
  Financial
  Instruments Sold,
    Instruments
  but not Yet
  Instruments
  but not Yet
    Owned, at
  Purchased, at
  Owned, at
  Purchased, at
    Fair Value   Fair Value   Fair Value   Fair Value
 
Cash trading instruments
    $334,378       $107,783       $324,181       $112,018  
ICBC
    6,504 (1)           6,807 (1)      
SMFG
    3,551       3,501 (4)     4,060       3,627 (4)
Other principal investments
    13,734 (2)           11,933 (2)      
                                 
Principal investments
    23,789       3,501       22,800       3,627  
                                 
Cash instruments
    358,167       111,284       346,981       115,645  
Exchange-traded
    16,279       14,439       13,541       12,280  
Over-the-counter
    124,409       104,337       92,073       87,098  
                                 
Derivative contracts
    140,688 (3)     118,776 (5)     105,614 (3)     99,378 (5)
                                 
Total
    $498,855       $230,060       $452,595       $215,023  
                                 
 
 
(1) Includes interests of $4.11 billion and $4.30 billion as of February 2008 and November 2007, respectively, held by investment funds managed by Goldman Sachs. The fair value of our investment in the ordinary shares of ICBC, which trade on The Stock Exchange of Hong Kong, includes the effect of foreign exchange revaluation for which we maintain an economic currency hedge.
 
(2) The following table sets forth the principal investments (in addition to our investments in ICBC and SMFG) included within the Principal Investments component of our Trading and Principal Investments segment:
 
                                                 
    As of February 2008   As of November 2007
   
Corporate
 
Real Estate
 
Total
 
Corporate
 
Real Estate
 
Total
    (in millions)
 
Private
    $  8,240       $3,210       $11,450       $7,297       $2,361       $  9,658  
Public
    2,227       57       2,284       2,208       67       2,275  
                                                 
Total
    $10,467       $3,267       $13,734       $9,505       $2,428       $11,933  
                                                 
 
(3) Net of cash received pursuant to credit support agreements of $77.57 billion and $59.05 billion as of February 2008 and November 2007, respectively.
 
(4) Represents an economic hedge on the shares of common stock underlying our investment in the convertible preferred stock of SMFG.
 
(5) Net of cash paid pursuant to credit support agreements of $30.63 billion and $27.76 billion as of February 2008 and November 2007, respectively.


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Cash Instruments.  Cash instruments include cash trading instruments, public principal investments and private principal investments.
 
  •  Cash Trading Instruments.  Our cash trading instruments are generally valued using quoted market prices in active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include most U.S. government and sovereign obligations, active listed equities and most money market securities.
 
The types of instruments that trade in markets that are not considered to be active, but are valued based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most government agency securities, investment-grade corporate bonds, certain mortgage products, certain corporate bank and bridge loans, less liquid listed equities, state, municipal and provincial obligations, most physical commodities and certain loan commitments.
 
Certain cash trading instruments trade infrequently and therefore have little or no price transparency. Such instruments include private equity and real estate fund investments, certain corporate loans (including certain mezzanine financing, leveraged loans arising from capital market transactions and other corporate bank debt), less liquid corporate debt securities and other debt obligations (including high-yield corporate bonds, distressed debt instruments and collateralized debt obligations (CDOs) backed by corporate obligations), less liquid mortgage whole loans and securities (backed by either commercial or residential real estate), and acquired portfolios of distressed loans. The transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. This valuation is adjusted only when changes to inputs and assumptions are corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows.
 
For positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
  •  Public Principal Investments.  Our public principal investments held within the Principal Investments component of our Trading and Principal Investments segment tend to be large, concentrated holdings resulting from initial public offerings or other corporate transactions, and are valued based on quoted market prices. For positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
Our most significant public principal investment is our investment in the ordinary shares of ICBC. Our investment in ICBC is valued using the quoted market prices adjusted for transfer restrictions. The ordinary shares acquired from ICBC are subject to transfer restrictions that, among other things, prohibit any sale, disposition or other transfer until April 28, 2009. From April 28, 2009 to October 20, 2009, we may transfer up to 50% of the aggregate ordinary shares of ICBC that we owned as of October 20, 2006. We may transfer the remaining shares after October 20, 2009. A portion of our interest is held by investment funds managed by Goldman Sachs.
 
We also have an investment in the convertible preferred stock of SMFG. This investment is valued using a model that is principally based on SMFG’s common stock price. As of February 2008, we had hedged all of the common stock underlying our investment in SMFG.


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  •  Private Principal Investments.  Our private principal investments held within the Principal Investments component of our Trading and Principal Investments segment include investments in private equity, debt and real estate, primarily held through investment funds. By their nature, these investments have little or no price transparency. We value such instruments initially at transaction price and adjust valuations when evidence is available to support such adjustments. Such evidence includes transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt capital markets, and changes in financial ratios or cash flows.
 
Derivative Contracts.  Derivative contracts can be exchange-traded or over-the-counter (OTC). We generally value exchange-traded derivatives within portfolios using models which calibrate to market-clearing levels and eliminate timing differences between the closing price of the exchange-traded derivatives and their underlying cash instruments.
 
OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. We generally use similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be verified and model selection does not involve significant management judgment.
 
Certain OTC derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. Where we do not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so that the model value at inception equals the transaction price. Subsequent to initial recognition, we only update valuation inputs when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations, or other empirical market data. In circumstances where we cannot verify the model value to market transactions, it is possible that a different valuation model could produce a materially different estimate of fair value. See “— Derivatives” below for further information on our OTC derivatives.
 
When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
Controls Over Valuation of Financial Instruments.  A control infrastructure, independent of the trading and investing functions, is fundamental to ensuring that our financial instruments are appropriately valued at market-clearing levels (i.e., exit prices) and that fair value measurements are reliable.
 
We employ an oversight structure that includes appropriate segregation of duties. Senior management, independent of the trading and investing functions, is responsible for the oversight of control and valuation policies and for reporting the results of these policies to our Audit Committee. We seek to maintain the necessary resources to ensure that control functions are performed to the highest standards. We employ procedures for the approval of new transaction types and markets, price verification, review of daily profit and loss, and review of valuation models by personnel with appropriate technical knowledge of relevant products and markets. These procedures are performed by personnel independent of the trading and investing functions. For trading and principal investments where prices or valuations that require inputs are less observable, we employ, where possible, procedures that include comparisons with similar observable positions, analysis of actual to projected cash flows, comparisons with subsequent sales and discussions with senior business leaders. See “— Market Risk” and “— Credit Risk” below for a further discussion of how we manage the risks inherent in our trading and principal investing businesses.


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Fair Value Hierarchy — Level 3.  Statement of Financial Accounting Standards (SFAS) No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The objective of a fair value measurement is to determine the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
Instruments that trade infrequently and therefore have little or no price transparency are classified within level 3 of the fair value hierarchy. We determine which instruments are classified within level 3 based on the results of our price verification process. This process is performed by personnel independent of our trading and investing functions who corroborate valuations to external market data (e.g., quoted market prices, broker or dealer quotations, third-party pricing vendors, recent trading activity and comparative analyses to similar instruments). The methodologies we use to value instruments classified within level 3 are described in the table on the following page. See Notes 2 and 3 to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information regarding SFAS No. 157.
 
The increase in level 3 assets during the first quarter of 2008 primarily reflected reduced levels of liquidity, and therefore reduced price transparency, related to loans and securities backed by commercial real estate, loans and securities backed by residential real estate, and corporate debt securities and other debt obligations, as well as the funding of certain bank loans.


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The following table sets forth the fair values of assets classified as level 3 within the fair value hierarchy, along with a brief description of the valuation technique for each type of asset:
 
Level 3 Financial Assets at Fair Value
(in millions)
 
<
                         
    As of          
    February
    November
        Valuation
Description
  2008     2007         Technique
 
Private equity and real estate fund
                       
investments (1)
    $18,834       $18,006         Initially valued at transaction price. Subsequently
                        valued based on third-party investments, pending
                        transactions or changes in financial ratios (e.g., earnings multiples) and discounted cash flows.
                         
Bank loans (2)
    17,676       13,334       Initially valued at transaction price. Subsequently valued using market data for similar instruments (e.g., recent transactions or broker quotes), comparisons to benchmark derivative indices or movements in underlying credit spreads.
                 
Corporate debt securities and other
debt obligations (3)
    9,877

      6,111

 
                         
                         
Mortgage and other asset-backed loans and securities
                       
                         
Loans and securities backed by
                       
commercial real estate
    14,550       7,410         Initially valued at transaction price. Subsequently
                        valued by comparison to transactions in instruments with similar collateral and risk profiles (including
                        relevant indices, such as the CMBX (4)) and
                        discounted cash flow techniques (calibrated to
                        trading activity, where applicable).
Loans and securities backed
                       
by residential real estate
    5,067       2,484         Initially valued at transaction price. Subsequently
                        valued by comparison to transactions in
                        instruments with similar collateral and risk profiles (including relevant indices, such as the ABX (4)),
                        discounted cash flow techniques, option adjusted
                        spread analyses, and hypothetical
                        securitization analyses.
                         
Loan portfolios (5)
    5,369


      6,106


        Initially valued at transaction price. Subsequently valued using transactions for similar instruments and discounted cash flow techniques.
                         
Cash instruments
    71,373       53,451          
                         
Derivative contracts
    25,013       15,700