Goldman Sachs 2007 Annual Report Download - page 54

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Management’s Discussion and Analysis
2006 VERSUS 2005. Our net revenues were $37.67 billion in
2006, an increase of 49% compared with 2005, reflecting
significantly higher net revenues in Trading and Principal
Investments, Investment Banking, and Asset Management and
Securities Services. The increase in Trading and Principal
Investments reflected significantly higher net revenues in FICC,
Equities and Principal Investments. The increase in FICC
reflected particularly strong performances across all major
businesses. During 2006, FICC operated in an environment
characterized by strong customer-driven activity and favorable
market opportunities. In addition, corporate credit spreads
tightened, the yield curve flattened and volatility levels were
generally low in interest rate and currency markets. The
increase in Equities primarily reflected significantly higher net
revenues in our customer franchise businesses. During 2006,
Equities operated in a favorable environment characterized by
strong customer-driven activity, generally higher equity prices
and favorable market opportunities, although volatility levels
were generally low. The increase in Principal Investments
reflected a significant gain related to our investment in the
ordinary shares of ICBC and higher gains and overrides from
other principal investments, partially offset by a smaller, but
still significant, gain related to our investment in the convertible
preferred stock of SMFG.
The increase in Investment Banking was due to significantly
higher net revenues in Underwriting and Financial Advisory,
as we benefited from strong client activity levels, reflecting
favorable equity and financing markets, strong CEO confidence
and growth in financial sponsor activity.
The increase in Asset Management and Securities Services was
primarily due to higher assets under management and
significantly higher incentive fees, as well as significantly
higher global customer balances in Securities Services. Assets
under management increased $144 billion or 27% to a
record $676 billion, including net asset inflows of $94 billion
during 2006.
Operating Expenses
Our operating expenses are primarily influenced by compensation,
headcount and levels of business activity. A substantial portion
of our compensation expense represents discretionary bonuses
which are significantly impacted by, among other factors, the
level of net revenues, prevailing labor markets, business mix
and the structure of our share-based compensation programs.
For 2007, our ratio of compensation and benefits to net revenues
was 43.9% compared with 43.7% for 2006.
Net Revenues
2007 VERSUS 2006. Our net revenues were $45.99 billion in
2007, an increase of 22% compared with 2006, reflecting
significantly higher net revenues in Trading and Principal
Investments and Investment Banking, and higher net revenues
in Asset Management and Securities Services. The increase in
Trading and Principal Investments reflected higher net revenues
in Equities, FICC and Principal Investments. Net revenues
in Equities increased 33% compared with 2006, reflecting
significantly higher net revenues in both our customer franchise
businesses and principal strategies. During 2007, Equities
operated in an environment characterized by strong customer-
driven activity, generally higher equity prices and higher levels
of volatility, particularly during the second half of the year. The
increase in FICC reflected significantly higher net revenues in
currencies and interest rate products. In addition, net revenues
in mortgages were higher despite a significant deterioration in the
mortgage market throughout the year, while net revenues in
credit products were strong, but slightly lower compared with
2006. Credit products included substantial gains from equity
investments, including a gain of approximately $900 million
related to the disposition of Horizon Wind Energy L.L.C.,
as well as a loss of approximately $1 billion, net of hedges,
related to non-investment-grade credit origination activities.
During 2007, FICC operated in an environment generally
characterized by strong customer-driven activity and favorable
market opportunities. However, during the year, the mortgage
market experienced significant deterioration and, in the second
half of the year, the broader credit markets were characterized
by wider spreads and reduced levels of liquidity. The increase in
Principal Investments reflected strong results in both corporate
and real estate investing.
The increase in Investment Banking reflected a 64% increase
in Financial Advisory net revenues and a strong performance
in our Underwriting business. The increase in Financial Advisory
primarily reflected growth in industry-wide completed mergers
and acquisitions. The increase in Underwriting reflected higher
net revenues in debt underwriting, as leveraged finance activity
was strong during the first half of our fiscal year, while net
revenues in equity underwriting were strong but essentially
unchanged from 2006.
Net revenues in Asset Management and Securities Services also
increased. The increase in Securities Services primarily reflected
significant growth in global customer balances. The increase
in Asset Management reflected significantly higher asset
management fees, partially offset by significantly lower incentive
fees. During the year, assets under management increased
$192 billion, or 28%, to a record $868 billion, including net
inflows of $161 billion.
52 Goldman Sachs 2007 Annual Report