Goldman Sachs Group's CEO Hosts Fixed Income Investor Conference (Transcript)

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Goldman Sachs Group Inc. (GS) Fixed Income Investor Conference Call November 6, 2013 12:00 PM ET

Executives

Heather Miner – IR

Harvey Schwartz – CFO

Elizabeth Robinson – Chairman and CEO

Analysts

David Macgown – Morgan Stanley

Operator

Good morning. My name is Denis and I will be your conference facilitator today. I would like to welcome everyone to the Goldman Sachs Fixed Income Investor Call. This call is being recorded today Wednesday, November 6, 2013. Thank you Ms. Miner. You may begin your conference.

Heather Miner

Good afternoon. This is Heather Miner from Investor Relations at Goldman Sachs. Welcome to our Fixed Income Investor Conference Call.

Today’s call may include forward-looking statements. These statements represent the firm’s belief regarding future events that by their nature are uncertain and outside of the firm’s control. The firm’s actual results and financial condition may differ, possibly materially, from what is indicated in those forward-looking statements. For a discussion of some of the risks and factors that could affect the firm’s future results and financial condition please see the description of risk factors in our current annual report on Form 10-K for the year-ended December 2012.

I would also direct you to read the forward-looking disclaimers in our quarterly earnings release, particularly as it relates to our estimated capital ratio, estimated risk-weighted assets, total assets and Global Core Excess. And you should also read the information on the calculation of non-GAAP financial measures that’s posted on the Investor Relations portion of our website www.gs.com.

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

Our Chief Financial Officer, Harvey Schwartz, will give a brief overview of the firm’s year-to-date operating results, balance sheet and capital management strategy and our treasurer, Liz Robinson will review the firm’s liquidity position and funding strategy. Following the prepared comments Harvey and Liz will be happy to take your questions. Harvey?

Harvey Schwartz

Thanks Heather and thanks to all of you for dialing in today. I apologize for starting a few minutes late. We know a few of you were having a hard time dialing in and we just want to give everyone a chance to participate in the call.

In terms of today’s discussion Liz and I are going to walk you through some slides. They have been posted on the investor relations website at gs.com.

Turning to the first page we want to start with a quick overview of Goldman Sachs financial profile by examining our key credit characteristics. As you know there’s been a fundamental transformation of our balance sheet and credit profile since 2007. As we’ll discuss throughout this presentation liquidity and capital are up significantly while risk is down.

We continue to finance our assets with term funding across unsecured, secured and deposit channels, underpinning our strong credit profile is our risk management infrastructure. The risk infrastructure is built on conservative limits, stress testing and a single technology platform.

Before Liz and I delve deep into credit related topics let’s spend a moment on slide two reviewing our year-to-date performance. Year-to-date we generated net revenues of $25.4 billion, net earnings of $5.7 billion and earnings per diluted share of $10.89. This translated into an annualized return on common equity of 10.4%.

You can see on the right side of the slide the revenue mix has been diverse and broad. While there were some headwinds in the third quarter our year-to-date performance remains solid in what continues to be a somewhat challenging macro environment. This difficult operating environment has impacted client activity during the course of the year. In the U.S. clients are focused on mixed economic data, political uncertainty and the potential for changes in monetary policy.

While Europe has been less of a focus, at least compared to last year, the real European economy remains challenged. In Asia we have seen [varied] trends. There has been a significant shift in Japanese monetary policy and concerns about growth in China earlier in the year have moderated given better recent economic data. This somewhat complex and uneven backdrop for the macro economic outlook combined with the uncertainty surrounding Central Bank activity has led to client risk erosion and lower activity levels at certain points of the year.

As a financial institution we operate in a cyclical industry and the environment can fluctuate from year-to-year or quarter-to-quarter, like this year. We can’t control the operating environment but we can control our financial profile and our response to changing conditions.

Turning to slide three, we ended the third quarter with our balance sheet at $923 billion, down slightly this year. We have shed certain assets including our America’s reinsurance business, our investment in ICBC and we’re in the process of selling our European insurance business. In addition, there continues to be less demand for our balance sheet given lower client activity levels and reduced risk appetite.

On the left side of the slide we show the composition of our balance sheet as of the third quarter. The most important point is that cash and secured client financing represents half of the balance sheet. The remainder is mainly institutional client services which represents our client facing inventory.

On the right side of the slide you can see the significant improvement in liquidity of our balance sheet since 2007. Total assets are down 18% and level 3 assets are down nearly 40%. Although assets have declined our Global Core Excess has nearly tripled. We continue to be vigilant about properly sizing our less liquid exposures. In addition we have a high velocity balance sheet which off-course is characteristic of market making businesses.

Turning to slide four you can see an update on our capital levels. At the top left you can see our estimated fully loaded Basel III tier one common ratio under the advanced approach is 9.8% as of the third quarter. His is up 50 basis points from the second quarter. We show our estimated risk weighted assets on the right side of the slide at approximately $590 billion which breaks down as follows: $345 billion in credit risk; a $165 billion in market risk and about $80 billion in operational risk.

As you are aware under the regulatory process there are transitional provisions which phase in over time. Using these provisions our estimated Basel III tier one common ratio is roughly a 100 basis points higher.

On the bottom left side of the slide we show our best estimate for the supplementary leverage ratio. Based on the U.S. rules our estimated leverage ratio is approximately 5% for the firm and approximately 6% for the bank. Of course this is our best estimate and subject to change. Like all other regulatory requirements we will work closely with our regulators as they evaluate and finalize the rules.

We believe it is our obligation to support safety and soundness within the financial services industry and more broadly the global financial system. As it relates to how we will run the business similar to other regulatory metrics, the supplementary leverage ratio would be an important input.

With that I’ll turn it over to Liz who will provide an update on our liquidity and funding strategy.

Elizabeth Robinson

Thanks Harvey. On slide five maintain abundant liquidity remains the single most important risk management principle for the firm. As we discussed during our previous calls we hold material quantities of cash and cash equivalents to prefund potential liquidity needs in a stressed environment. Our liquidity pool continues to be a significant portion of the balance sheet at $187 billion on average in the third quarter.

You can see the mix of our liquidity on the right side of the table. It remains largely unchanged with the most significant portion made up of U.S. government obligations and overnight cash deposits which are mainly at the federal reserve. There continues to be a focus in the market on Basel liquidity requirements and the liquidity coverage ratio. As you know the federal reserve recently released a proposal – a notice of proposed rulemaking on the liquidity coverage ratio.

With $187 billion of average global core excess our initial interpretation is that the firm is well positioned to meet the requirements. However the proposed rule requires further clarification and obviously is subject to change as we move through the rule making process.

Moving to slide six, let’s turn to our secured funding. Our total on balance sheet collateralized financing of approximately $204 billion principally comprises liquid government securities and federal agency obligations in our interest rate business. Our firm specific financing is approximately $100 billion for non-GCE eligible assets financed from our principal broker dealer entities.

As we’ve discussed in the past we’ve raised secured funding with a term that is appropriate for the liquidity risk associated with the type of assets that are being financed. Given the high turnover of our assets we believe a weighted average maturity of greater than 100 days is appropriately conservative for our non-GCE secured fundings.

Our long term strategic initiative coming out of the financial crisis has been to expand the number of counterparties who finance our non-GCE secured funding books. Since 2008 this number has nearly tripled. We’ve seen significant growth across a variety of sources including insurance companies and pensions endowments and foundations.

Given the significant reduction in the size of our non-GCE funding book post the crisis as well the growth in funding counterparties the average funding per counter party has dropped by 75% from $2 billion to roughly $500 million.

Moving to slide seven, we show our long term unsecured funding. Here we continue to focus on ensuring stability and reducing refinancing requirements through appropriately long dated and conservatively spaced maturities. Given our focus on term our long term unsecured debt currently has a weighted average maturity of eight years.

As you can see on the top right portion of the slide our issuance over the past three years has roughly kept pace with our maturities. Key issuance priorities continue to be diversification and maintaining manageable maturities in any given year or quarter.

In terms of diversification we are focused on diversity across both currency and distribution channels. We regularly assess pricing versus our U.S. dollar institutional funding curve to judge the attractiveness of non-U.S. issuance.

As you can see on the bottom right part of the slide the 2013 contribution of non-USD issuance has increased by 12 percentage points to 35% relative to 2012. We have also focused on growing our retail program with approximately 17% of the 2013 program issued through retail networks.

From a regulatory capital perspective we have continued to opportunistically build towards future Basel III total capital requirements and we executed a $1 billion non-cumulative perpetual preferred offering during the second quarter. This follows our $850 million preferred offering in the fourth quarter of 2012.

As we think about our issuance strategy for 2014 we will remain opportunistic while being focused on diversification by markets and by distribution channel. Given the current size of our liquidity flow we may not choose to match new issuance with maturities.

Let me now turn it back to Harvey to wrap up.

Harvey Schwartz

Thanks Liz. Slide eight is a wrap up of all the credit characteristics we discussed today.

The evolution of our balance sheet since the crisis has been material. Our liquidity pool is up nearly three times. Common equity has increased 75% and level 3 assets and leverage are down meaningfully, all-in a significantly stronger credit profile.

Before we conclude let me take a step back and highlight a few broader points that we believe are important for debt investors in U.S. financial institutions.

In response to the crisis and regulatory change across the industry all U.S. funds holding higher levels of capital and higher levels of liquidity, obviously a significant credit positive. As we show on slide nine the improvement in credit profiles across the industry has been reinforced by new regulatory requirements. The cautious belt and suspender approach taken by regulators will help reduce systemic risk and contribute to safer individual institutions for the foreseeable future.

On capital, the industry is now subject to many different requirements; risk-based capital, leverage and CCAR. The goal of this multi-pronged approach is to reduce risk not only from specific risk but also system-wide risk. On liquidity, the story is similar with the introduction of conservative Basel requirements.

Finally, there has been considerable focus on recovery and resolution. As global regulators add to recovering resolution requirements for individual funds they are improving the safety and soundness of the entire system. Regulator’s focus on recovery and resolution will create strong management incentives to act conservatively and will mandate early communication to board and regulators during periods of stress.

Ultimately, the collective actions taken by individual funds since the crisis combined with new regulations have fundamentally changed the risk profile and practices for the financial services industry.

With that Liz and I want to thank you for participating in today’s call and we’re happy to take your questions.

Earnings Call Part 2:

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