By U.S. Mail, Facsimile to (202) 772-9369 and EDGAR*
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November 8, 2007
United States Securities and Exchange Commission
Division of Corporation Finance
100 F Street, NE
Washington, D.C. 20549
Attention: Mr. Terence O'Brien
Accounting Branch Chief
Mail Stop 7010
Re: The Goldman Sachs Group, Inc.
Form 10-K for the Fiscal Year Ended November 24, 2006
Filed February 6, 2007
File No. 001-14965
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Dear Mr. O'Brien:
We are in receipt of the letter, dated October 17, 2007, to David A. Viniar,
Chief Financial Officer of The Goldman Sachs Group, Inc. (the "Company"), from
the Staff (the "Staff") of the Securities and Exchange Commission (the
"Commission") relating to our letter in which we responded to the Staff's
letter, dated September 20, 2007, regarding the above-referenced filing. We
thank the Staff for its careful consideration of our response letter, and we
look forward to resolving the Staff's final two comments.
For your convenience, we have reproduced the Staff's comments below, which are
numbered to correspond to the comments in your letter of October 17, 2007. Our
responses immediately follow.
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* Certain confidential portions of this letter were omitted by means of
redacting a portion of the text. The word "[Redacted]" has been inserted in
place of the portions so omitted. Copies of the letter containing the
redacted portions have been filed separately with the Commission subject to
a request for confidential treatment pursuant to Rule 83 of the
Commission's Rules on Information and Requests.
With respect to our response to your question 2, where you have asked us to
quantify amounts as of a point in time, we have included information as of
November 24, 2006, the end of our last full fiscal year, and August 31, 2007,
the end of our last full fiscal quarter. Where you have asked us to quantify
amounts for a period, we have included information for the fiscal years ended
2006, 2005, and 2004 and for the nine months ended August 31, 2007.
General
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1. Please submit your facsimile response dated October 1, 2007, on EDGAR, as a
correspondence file.
Response:
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We submitted our response on EDGAR on October 30, 2007.
2. We have reviewed your proposed response to our prior comment 1 related to
your subprime lending activities and have the following additional
comments.
o We note you "agree with the definition of what constitutes a sub-prime
residential loan" that we provided in our letter dated September 20,
2007. Note, however that in our letter we indicated that although
there may be differing definitions of subprime residential mortgage
loans, we identified eight common features of subprime loans. By
agreeing with our definition, do you mean that you identify a
residential loan as subprime if it has any of the features we
identified? If not, please provide us with a more comprehensive
understanding of how you define a subprime residential loan.
Response:
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We consider the credit score of a residential mortgage borrower to be the
principal factor in making the determination of whether a mortgage is considered
to be "subprime" (generally we refer to mortgages with credit scores below 660
as "subprime").
While credit score is the principal factor in the classification of a mortgage
as subprime, we agree that the presence of any one of the following
characteristics generally qualifies a loan as subprime. We do note, however,
that it is possible for a prime loan to have one or more of these
characteristics (e.g., a prime interest only loan).
o A rate above prime to borrowers who do not qualify for prime rate
loans;
o Interest-only or negative amortization loans;
o High initial loan-to-value ratios;
o Low initial payments based on a fixed introductory rate that expires
after a short initial period then adjusts to a variable index rate
plus a margin for the remaining term of the loan;
o Borrowers with less than conventional documentation of their income
and/or net assets;
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o Very high limits on how much the payment amount or the interest rate
may increase at reset periods, potentially causing a substantial
increase in the monthly payment amount, and/or;
o Including substantial prepayment penalties.
o We note from your response that although your mortgage activities are
an important business for you they do not represent a material
percentage of revenues (only 3% in each of the two fiscal years ending
November 2005 and 2006 and for the nine months ending August 2007,
roughly half of which was contributed by sub-prime activities).
Similarly, in each of the years ending November 2005 and 2006 and for
the nine months ending August 2007, your long balance sheet exposure
to all sub-prime mortgage products was less than 2% of your total
assets. However, since your total assets as of November 24, 2006 were
$838 billion and your net earnings were $9.5 billion for the year
ended November 24, 2006, it appears this exposure could be material to
your net income. As such, please respond in detail to the items
contained in our prior comment 1. In this regard, we note your
discussion of mitigated exposure in the fifth paragraph of your
response. If this information will provide us a better understanding
of your overall risk related to your subprime lending activities,
please provide an expanded discussion in your response.
o Provide us with your risk management philosophy as it specifically
relates to subprime loans. Please address:
o Your origination policies;
o The purchase and securitization of loans;
o Investments in subprime mortgage-backed securities; and
o Loans, commitments and investments in subprime lenders.
Response:
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We securitize, underwrite and make markets in mortgage securities and trade them
for our clients and ourselves. Our activities are in commercial and residential
mortgages, including prime, subprime and other non-traditional mortgage
products. We have historically not originated residential mortgages although we
have recently acquired a very small originator.
We acquire residential mortgage loans in two contexts:
-- through bulk purchases, generally consisting of a mortgage loan
pool greater than $50 million; and
-- through smaller correspondent purchases
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As a general matter, prior to acquiring any residential mortgage loans, we will
conduct a thorough review of the seller. Our process consists of reviewing
select financial information for credit and market risk assessment, undertaking
a review of the underwriting standards employed by the mortgage originator,
engaging in senior management discussions, conducting an operational review and
performing background checks.
The review of underwriting standards considers mortgage credit; the operational
review considers loan origination processes and systems. These reviews consider
corporate policy and procedures relating to state and federal predatory lending
and high cost lending laws, origination practices by jurisdiction, historical
loan level loss experience, quality control practices, significant litigation
and material investors in the seller.
In addition to the review of the seller, we review residential mortgage loans in
advance of acquisition. The scope of the due diligence we perform depends on the
credit quality of the mortgage loans and our past experience with the loan
seller. Due diligence may include: review for adherence to the seller's
underwriting and compliance standards, examination of loan documents,
verification of recorded liens, review of insurance certificates and requesting
independent valuations. Pools are also analyzed to identify loans with a high
potential risk of fraud to be included in the due diligence sample. We will not
knowingly purchase "predatory" or similarly designated loans as defined under
any other applicable federal, state, county or municipal statute, regulation or
ordinance, or mortgage loans that violate any applicable federal, state, county
or municipal statute, regulation or ordinance.
Like all mortgage products, subprime mortgages are sensitive to the following
valuation parameters:
-- Credit spreads: probability of default and recovery assumptions
-- Maturity/duration: prepayment speeds and home price appreciation
-- Interest rates
Since credit performance is one of the primary drivers in valuing subprime
mortgage collateral, our long subprime cash inventory exposure has been
primarily hedged with a combination of:
-- ABX index hedges: The ABX Index is a series of credit default
swaps based on 20 bonds that are backed by subprime mortgages.
ABX contracts are commonly used by investors to take a position
in or to hedge against the risk that the underlying mortgage
securities are not repaid as expected. The ABX swaps offer
protection if the securities are not repaid as expected, in
return for periodic premiums. A decline in the ABX Index
signifies investor sentiment that subprime mortgage holders will
suffer increased financial losses from those investments.
Likewise, an increase in the ABX Index signifies investor
sentiment looking for subprime mortgage holdings to perform
better as investments. The ABX index has robust levels of trading
activity and liquidity.
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-- Single name credit default swaps ("CDS"): Similar to the ABX
index, single name CDS contracts offer protection if an
underlying mortgage security is not repaid as expected.
Individual single name CDS contracts are over-the-counter
contracts that are less actively traded and quoted in comparison
to the ABX index. However, they can be customized to provide
protection against non-performance of highly specific reference
obligations.
-- Credit linked notes: We may also purchase credit protection via
the issuance of credit linked notes which reference underlying
subprime mortgage securities. In return for a specified coupon,
note holders guarantee performance of underlying subprime
mortgage reference obligations (in addition to other sectors).
We use fair value to measure our financial instruments, which is fundamental to
our risk management process and financial statements. It is essential for us to
understand the value of what we hold so that we can manage the associated risk.
Because we mark our financial instruments, including our mortgage loans, to fair
value, with related unrealized gains or losses generally recognized immediately
in our results of operations, we do not maintain an allowance for loan losses,
or provisions for loan losses, asset write-offs or impairments.
Our Firmwide Risk Committee periodically reviews the existing mortgage business
and approves our firmwide and divisional market risk limits. Additionally, they
review scenario analyses based on abnormal or "catastrophic" market movements.
Our Divisional Risk Committee is responsible for setting market risk limits over
mortgage inventories by trading desk based on a number of measures, including
Value-at-Risk (VaR) exposure limits, stress tests and scenario analyses. VaR
represents the potential loss in value of trading positions due to adverse
market movements over a defined time horizon with a specific confidence level.
On a daily basis, the market risk group, which is independent of the trading
desk, is responsible for the calculation of VaR at a portfolio level (i.e.,
taking both subprime exposure and hedging activity into account) and monitoring
actual levels of exposure against limits set by our Divisional Risk Committee.
Limit violations are reported to the appropriate risk committee and business
unit managers and addressed, as necessary.
The trading desk managers within the mortgage department are responsible for
managing risk within the prescribed limits. These managers have in-depth
knowledge of the primary sources of risk in the mortgage market and the
instruments available to hedge their exposure.
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Our long cash subprime mortgage exposure consists of mortgage loans and
mortgage-backed securities. [Redacted] However, during most of 2007, we
maintained a net short subprime position, as our long cash subprime mortgage
exposure was more than offset by net short ABX index contracts and single name
CDS.
o Quantify your portfolio of subprime residential mortgages. If
practicable, please breakout the portfolio to show the underlying
reason for subprime definition (i.e., subject to payment increase,
high LTV ratio, interest only, negative amortizing).
Response:
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Our portfolio of subprime mortgage loans, stratified by the characteristics
highlighted in your request, is reflected below:
[Redacted]
The percentages in the above tables will not add to 100% as many loans exhibit
more than one of the listed characteristics.
o Quantify the following regarding subprime residential mortgages.
Explain how you define each category.
o Non-performing loans;
o Non-accrual loans;
o The allowance for loan losses; and
o The most recent provision for loan losses.
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Response:
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Distinct from our subprime loan inventory discussed above, we maintain a
non-performing loan portfolio consisting of delinquent residential mortgages
made to prime and subprime borrowers. We consider mortgages which have been
delinquent for a period of 3 months or more to be "non-performing". We do not
accrue interest on this portfolio (interest is recognized upon receipt).
[Redacted] As noted above, we mark our financial instruments, including our
mortgage loans, to fair value. Therefore, we do not have any allowance for loan
losses.
o Quantify the principal amount and nature of any retained securitized
interests in subprime residential mortgages.
Response:
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We securitize subprime residential mortgages and CDOs, which are collateralized
by cash or synthetic bonds with subprime mortgage exposure. [Redacted]
o Quantify your investments in any securities backed by subprime
mortgages.
Response:
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[Redacted]
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o Quantify the current delinquencies in retained securitized subprime
residential mortgages.
Response:
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The current delinquencies as a percentage of retained securitized subprime
residential mortgages are: [Redacted]
o Quantify any write-offs/impairments related to retained interests in
subprime residential mortgages.
Response:
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As noted above, we mark our financial instruments, including our mortgage loans,
to fair value. Therefore, we do not have any explicit write-offs/impairments.
o Please address all involvement with special purpose entities and
variable interest entities and quantify the subprime exposure related
to such entities, regardless of whether they are consolidated for the
purposes of generally accepted accounting principles.
Response:
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Our involvement with special purpose entities and variable interest entities
with subprime exposure includes the following:
-- We retain and purchase securitized products from variable interest
entities ("VIEs") as quantified above.
-- [Redacted] Through these CDS, the VIEs assume credit risk on a
reference portfolio and owe us money when a credit event occurs.
This contributed to our overall net short position in the third
quarter. [Redacted]
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-- In addition, we have written put options to the VIEs that require us
to purchase the collateral securities at par. Our exposure in this
case is to the AAA-rated short duration collateral securities, not to
the reference portfolio underlying the CDS. [Redacted] Losses
recorded on these put options reduce the gains recognized on the
CDS described above.
-- We also enter into total rate of return swaps with VIEs where we
typically are long the underlying reference asset or portfolio. We
have hedged substantially all of this risk with offsetting
transactions with other counterparties. [Redacted]
After incorporating the exposures reflected above into our other subprime
exposures, we had an overall net short position as of August 31, 2007.
o Quantify and describe any and all potential repurchase commitments you
have regarding subprime residential mortgages.
Response:
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In the normal course of business, we provide warehouse lines and repo financing
which is collateralized by subprime residential mortgage-backed loans and
securities. [Redacted]
o Quantify and describe any loans to, commitments in, or investments in
subprime lenders. Describe any other potential exposures you may be
subject to, such as repurchase commitments related to the receipt of
assets in bankruptcy, for example.
Response:
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In addition to the warehouse lines and repo financing described above, we
purchased Senderra, a South Carolina based subprime mortgage originator, in
March of 2007 for $14 million.
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o Quantify your revenues from involvement in subprime loans. Break out
such revenues based on fees, interest earned, servicing rights and
other sources.
Response:
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[Redacted] As we mark our financial instruments to fair value, we have not
maintained a detailed break-out of revenues into the categories noted above.
Note 6 - Contingencies, page 143
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3. We appreciate your response to our prior comment 2. In order for us to
better evaluate your accounting for contingencies as well as the
appropriate level of disclosures for these contingencies, please provide us
with a table that identifies each of the legal proceedings that you have
disclosed under Item 3 beginning on page 30. For each legal proceeding,
identify (i) any and all damages sought, (ii) the amounts accrued, and
(iii) the possible loss or range of loss when there is at least a
reasonable possibility that a loss or an additional loss in excess of
amounts accrued may have been incurred. If you have determined that it is
not possible to estimate the range of loss, please provide an explanation
as to why this is not possible. In addition, please provide to us your
legal expense accounting policy.
Response:
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We note your request for further detail as to damages sought, amounts accrued,
and the possible loss or range of loss when there is at least a reasonable
possibility that a loss or additional loss has been incurred, for each case
discussed under Item 3 of our Form 10-K for the fiscal year ended November 24,
2006 ("Form 10-K").
Damages sought
We have disclosed and will continue to disclose in our filings any and all
damages sought related to the legal proceedings discussed under Item 3 to the
extent damages are quantified in individual complaints. Most of the matters
described in our Form 10-Ks and Form 10-Qs are purported class actions or other
commercial litigation or regulatory matters that do not quantify a claim for
damages (other than perhaps to state a minimum for the purpose of satisfying any
applicable jurisdictional limit).
Amounts accrued
Reserves are determined on a case by case basis. No individual reserve is
material to our financial condition. [Redacted]
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In addition, we have disclosed and will continue to disclose the overall
earnings impact related to provisions for litigation and regulatory proceedings
recorded during the periods presented in our filings. Such disclosures appear on
pages 72 and 162 of our Form 10-K.
Reasonably possible losses or additional losses
As noted on pages 64 and 143 of our Form 10-K, we are not able to estimate
losses or ranges of losses for legal proceedings where there is only a
reasonable possibility that a loss or additional loss may have been incurred due
to the inherent difficulty of predicting the outcome of litigation matters. This
is largely due to the specific nature of the litigation and regulatory
proceedings in which we are involved, most of which involve complex and
sometimes novel factual and legal issues and typically do not quantify a maximum
claim for damages. This is true even for proceedings that have been pending for
a considerable length of time.
With respect to our overall exposure to litigation, we make the following
statement on pages 30 and 143 of our Form 10-K, "We believe, based on currently
available information, that the results of such proceedings, in the aggregate,
will not have a material adverse effect on our financial condition, but might be
material to our operating results for any particular period." This is a
qualitative assessment based on our experience and the experience of others in
resolving litigation and regulatory proceedings, input from legal counsel and
legal precedents.
Legal expense accounting policy
Legal fees due to external counsel in connection with litigation matters are
accounted for on an accrual basis as they are incurred.
We evaluate claims and assessments in accordance with FASB Statement of
Financial Accounting Standards No. 5, Accounting for Contingencies. Losses are
accrued when probable and reasonably estimable.
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* * * *
As requested in your letter, the Company hereby acknowledges that: the Company
is responsible for the adequacy and accuracy of the disclosure in the
above-captioned filing; Staff comments or changes to disclosure in response to
Staff comments do not foreclose the Commission from taking any action with
respect to this filing; and the Company may not assert Staff comments as a
defense in any proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
* * * *
We look forward to working with you further to address these comments. If you
have any questions with respect to the foregoing responses or need any
additional information, please feel free to contact me at (212) 902-5675.
Sincerely,
/s/ Sarah Smith
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Sarah Smith
Controller and Chief Accounting Officer
cc: David Viniar
Chief Financial Officer
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