Goldman Sachs 2007 Annual Report Download - page 60

Management’s Discussion and Analysis
2006 VERSUS 2005. Net revenues in Trading and Principal
Investments of $25.56 billion for 2006 increased 52% compared
with 2005.
Net revenues in FICC of $14.26 billion increased 60%
compared with 2005, primarily due to significantly higher net
revenues in credit products (which includes distressed investing)
and commodities. In addition, net revenues were higher in
interest rate products, currencies and mortgages. During 2006,
the business 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.
Net revenues in Equities of $8.48 billion increased 50%
compared with 2005, primarily reflecting significantly higher
net revenues in derivatives, across all regions, as well as higher
net revenues in shares. The increase also reflected the contribution
from our insurance business, which was acquired in 2006. In
addition, principal strategies performed well, although net
revenues were lower than a particularly strong 2005. 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.
Principal Investments recorded net revenues of $2.82 billion
for 2006, reflecting a $937 million gain related to our investment
in the ordinary shares of ICBC, a $527 million gain related to
our investment in the convertible preferred stock of SMFG and
$1.35 billion in gains and overrides from other principal
investments.
Operating expenses of $14.96 billion for 2006 increased 41%
compared with 2005, due to increased compensation and
benefits expenses, primarily resulting from higher levels of
discretionary compensation due to higher net revenues and
increased levels of employment, as well as higher non-compensation
expenses. Excluding non-compensation expenses related to
consolidated entities held for investment purposes, the increase
in non-compensation expenses was primarily due to higher
brokerage, clearing, exchange and distribution fees, in Equities
and FICC, and increased other expenses, primarily due to costs
related to our insurance business, which was acquired in 2006,
and higher levels of business activity. In addition, professional
fees were higher, due to increased legal and consulting fees.
Pre-tax earnings of $10.60 billion in 2006 increased 70%
compared with 2005.
2007 VERSUS 2006. Net revenues in Trading and Principal
Investments of $31.23 billion for 2007 increased 22% compared
with 2006.
Net revenues in FICC of $16.17 billion for 2007 increased
13% compared with 2006, reflecting 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 2007, 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. Net revenues in commodities were also strong but
lower compared with 2006. During 2007, FICC operated in
an environment generally characterized by strong customer-
driven activity and favorable market opportunities. However,
during 2007, 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.
Net revenues in Equities of $11.30 billion for 2007 increased
33% compared with 2006, reflecting significantly higher net
revenues in both our customer franchise businesses and principal
strategies. The customer franchise businesses benefited from
significantly higher commission volumes. 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.
Principal Investments recorded net revenues of $3.76 billion
for 2007, reflecting gains and overrides from corporate and real
estate principal investments. Results in Principal Investments
included a $495 million gain related to our investment in the
ordinary shares of ICBC and a $129 million loss related to our
investment in the convertible preferred stock of SMFG.
Operating expenses of $18.00 billion for 2007 increased 20%
compared with 2006, primarily due to increased compensation
and benefits expenses, resulting from higher discretionary
compensation and growth in employment levels. Non-
compensation expenses increased due to the impact of higher
levels of business activity and continued geographic expansion.
The majority of this increase was in brokerage, clearing,
exchange and distribution fees, which primarily reflected higher
transaction volumes in Equities. Other expenses and professional
fees also increased, reflecting increased business activity. Pre-tax
earnings of $13.23 billion in 2007 increased 25% compared
with 2006.
58 Goldman Sachs 2007 Annual Report