Goldman Sachs 2009 Annual Report Download - page 44

assets. An overview of methodologies used to value our level3
assets subsequent to the transaction date is as follows:
▪ Equities and convertible debentures. Substantially all of our
level 3 equities and convertible debentures consist of private
equity investments and real estate fund investments. For
private equity investments, recent third-party investments or
pending transactions are considered to be the best evidence
for any change in fair value. In the absence of such evidence,
valuations are based on one or more of the following
methodologies, as appropriate and available: transactions
in similar instruments, discounted cash  ow techniques,
third-party independent appraisals, valuation multiples
and public comparables. Such evidence includes pending
reorganizations (e.g.,merger proposals, tender offers or
debt restructurings); and signi cant changes in  nancial
metrics (e.g.,operating results as compared to previous
projections, industry multiples, credit ratings and balance
sheet ratios). Real estate fund investments are carried at
net asset valueper share. The underlying investments in
the funds are generally valued using discounted cash  ow
techniques, for which the key inputs are the amount and
timing of expected future cash  ows, capitalization rates
and valuation multiples.
▪ Bank loans and bridge loans and Corporate debt securities
and other debt obligations. Valuations are generally based
on discounted cash  ow techniques, for which the key
inputs are the amount and timing of expected future cash
 ows, market yields for such instruments and recovery
assumptions. Inputs are generally determined based on
relative value analyses, which incorporate comparisons both
to credit default swaps that reference the same underlying
credit risk and to other debt instruments for the same issuer
for which observable prices or broker quotes are available.
▪ Loans and securities backed by commercial real estate.
Loans and securities backed by commercial real estate are
collateralized by speci c assets and may be tranched into
varying levels of subordination. Due to the nature of these
instruments, valuation techniques vary by instrument.
Methodologies include relative value analyses across
different tranches, comparisons to transactions in both
the underlying collateral and instruments with the same or
substantially the same underlying collateral, market indices
(such as the CMBX (1)), and credit default swaps, as well as
discounted cash  ow techniques.
in an orderly transaction between market participants at
the measurement date (i.e.,the 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 classi ed in their
entirety based on the lowest level of input that is signi cant to the
fair valuemeasurement.
Instruments that trade infrequently and therefore have little
or no price transparency are classi ed within level 3 of the fair
value hierarchy. We determine which instruments are classi ed
within level 3 based on the results of our price veri cation
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). Instruments with valuations which cannot be
corroborated to external market data are classi ed within
level 3 of the fair value hierarchy.
When broker or dealer quotations or third-party pricing
vendors are used for valuation or price veri cation, greater
priority is given to executable quotes. As part of our
price veri cation process, valuations based on quotes are
corroborated by comparison both to other quotes and to
recent trading activity in the same or similar instruments. The
number of quotes obtained varies by instrument and depends
on the liquidity of the particular instrument. See Notes2
and 3 to the consolidated  nancial statements for further
information regarding fair value measurements.
Valuation Methodologies for Level 3 Assets. Instruments
classi ed within level 3 of the fair value hierarchy are initially
valued at transaction price, which is considered to be the
best initial estimate of fair value. As time passes, transaction
price becomes less reliable as an estimate of fair value and
accordingly, we use other methodologies to determine
fair value, which vary based on the type of instrument, as
described below. Regardless of the methodology, valuation
inputs and assumptions are only changed when corroborated
by substantive evidence. Senior management in control
functions, independent of the trading and investing functions,
reviews all signi cant unrealized gains/losses, including the
primary drivers of the change in value. Valuations are further
corroborated by values realized upon sales of our level3
(1) The CMBX and ABX are indices that track the performance of commercial
mortgage bonds and subprime residential mortgage bonds, respectively.
Goldman Sachs 2009 Annual Report
42
Management’s Discussion and Analysis