GS Financials Positioning For The Next Leg of The Rally

April 7, 2010 United States: Financial Services
Financials DESKTOP
Positioning for the next leg of the rally
Fundamentals suggest further upside Best Buy ideas
We see the best opportunities in Large Cap Banks, We focus investors on our top stock ideas
Brokers, Asset Managers, and Homebuilders including JPM and BAC in large-cap banks; STI,
given the backdrop of low rates, higher asset CMA, FITB and KEY in regional banks; UNM, XL
prices, moderating credit costs and improving PGR, and ACE in insurance; BEN and BX in asset
capital markets activity. Higher interest rates and managers; EVR, LAZ and PJC in brokers; NDAQ
regulatory overhang are the big downside risks. and CME in market structure; CBG in Real Estate
and DHI in Homebuilders. In credit, we favor BAC,
Our investment framework LLOYDS, BPCEGP, STANLN in Banks and Farmers,
Four themes guide us: (1) Potential for consumer CNA and RDN in Insurance.
provision leverage, (2) a focus on those
Jessica Binder, CFA
companies that can return capital to shareholders, Best Sell ideas (212) 902-7693 | jessica.binder@gs.com
(3) improving capital market activity in 2010 and We remain concerned on CRE given the long-tail Goldman Sachs & Co.
(4) stabilizing real estate prices as the hunt for nature of losses; avoid BRE, REG, DRE and ESS.
yield hits real assets. Prime jumbo losses likely to worsen; avoid HCBK. Richard Ramsden
(212) 357-9981 | richard.ramsden@gs.com
Goldman Sachs & Co.
Financials as a part of your portfolio What we are watching
Financials are now the second largest sector in We highlight four sections of this report for PMs: Brian Foran
(212) 855-9908 | brian.foran@gs.com
the S&P 500 and we think there is further upside (1) an in-depth analysis of mutual fund
Goldman Sachs & Co.
as we move towards normalized returns given positioning across the Financials sector (p. 5); (2)
attractive valuation. Investors have moved a closer look at the idea of Financials being Louise Pitt
towards a neutral weighting in the sector, but are “cheap cyclicals” (p. 7); (3) capital management (212) 902-3644 | louise.pitt@gs.com
underweight regional banks. The best performers across the sector (p. 14); (4) initial thoughts Goldman Sachs & Co.
YTD have been the most underweighted sectors. around Basel III (p. 30).
The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of
interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the
end of the text. Other important disclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not
registered/qualified as research analysts with FINRA in the U.S.
The Goldman Sachs Group, Inc. Global Investment Research

Goldman Sachs Global Investment Research 1
Table of contents
Portfolio Manager Summary: Life after the crisis 3

Thinking about Financials in the context of a portfolio 5
A return to micro from macro 10
Theme #1: Provision leverage in consumer loan portfolios 11
Theme #2: Capital management is beginning to be a key differentiator across the sector 14
Theme #3: Capital market should bounce from a disappointing 4Q2009 17
Theme #4: Real estate prices are stabilizing as the hunt for yield hits real assets 20
Short rates are likely to stay lower for longer, but have to go up eventually 26
Regulatory issues likely to remain a topic for the foreseeable future 30
Sector views: Attractive Large Banks, Asset Managers, Homebuilders and Brokers 34
Disclosures 37
GS Financials Equity Research Team

Banks Insurance Asset Managers Market Structure & Real Estate/REITs Homebuilders
Brokers
Richard Ramsden Christopher M. Neczypor Marc Irizarry Dan Harris, CFA Jonathan Habermann Joshua Pollard
Brian Foran Christopher Giovanni Alexander Blostein, CFA Jason Harbes, CFA Sloan Bohlen Anto Savarirajan
Adriana Kalova Eric Fraser Neha Killa Jehan Mahmood
Quan Mai Cooper McGuire Siddharth Raizada
Vikas Jain
GS Financials Credit Research Team Financials Specialist

Banks Insurance and Financials Sector
Managed Care Specialist
Louise Pitt Donna Halverstadt Jessica Binder, CFA
Amanda Lynam

Portfolio Manager Summary: Positioning for the next leg of the rally
We remain bullish on Financials given the backdrop of low rates, higher asset prices, moderating credit costs and improving
capital markets activity and see the best opportunities in Large Cap Banks, Brokers, Asset Managers, and Homebuilders.
Higher interest rates and the regulatory overhang are the biggest downside risks, although appear manageable near-term.
Financials are now the second largest sector in the S&P 500, and we think there could be further upside given attractive valuation
levels even after the rally. While investors have largely closed out underweight positions from last year, they remain underweight
many of the regional banks. Positioning has been a big driver of returns thus far this year, and correlation across stocks in the
sector has fallen dramatically since the start of the year.
We highlight four key themes for stock-picking across the sector:

 Provision leverage in consumer loan portfolios: The credit cycle is moderating as non-performing asset formation is slowing
and reserves are closer to peak levels. The improvement is most clear in consumer and in commercial (C&I) loans, and should
current trends continue, we see the potential for reserve releases later this year. Key stock ideas: BAC, JPM. Avoid HCBK.
 Returning capital to shareholders: Buybacks and dividends have become a bigger differentiator across the sector. We
highlight companies that screen well on these metrics and highlight potential new entrants, which could result in significant
relative outperformance. Within the banks sector, high free cash yields imply dividend yields should be attractive once
regulatory pressure eases. Key stock ideas: BEN, JPM, NDAQ, UNM, XL.
 Capital market should bounce from a disappointing 4Q: Trading activity was weaker than many expected in the first quarter,
but FICC should show qoq improvement. Investment banking got off to a slow start this year, but has recently started to pick
up. We believe this is just the beginning of a multi-year recovery in M&A. Smid-cap brokers and alternative asset managers
are well-positioned to benefit, as are some of the large-cap banks. Key stock ideas: BAC, BEN, BX, CBG, EVR, JPM, NDAQ.
 Real estate prices are stabilizing as the hunt for yield hits real assets: While we may just be in the eye of the storm, low
interest rates have helped push some issues further into the future. Homebuilders are well positioned to benefit from an
improvement in new home sales from the depressed levels of 2009. Shadow inventory remains a concern, but is more likely to
limit the strength of the recovery rather than creating another downturn in the very short-term. On the commercial side,
sentiment is better than reality; the few recent transactions that have occurred imply that prices are recovering faster than the
fundamentals would suggest. Key stock ideas: BAC, CBG, DHI, JPM, MTG, STI, BX. Avoid BRE, REG, DRE and ESS.
Despite this positive backdrop, investors remain focused more on potential downside risks:
 Rates: Low rates have unquestionably helped to stimulate the economy, not only by lowering funding costs, but also by
supporting housing demand and boosting capital market activity. The improvement in credit can in part be attributed to low
rates, given that the majority of loans in the United States are floating rate. Our economists forecast the Fed Funds rate will
stay near-zero through 2011. However, even if rates were to increase, we expect money market outflows to continue. Avoid FII.
 Regulatory outlook: While it is difficult to know what the exact timing and impact of regulation will be, it is clear this is an
area of focus for the foreseeable future. Banks are likely to be the most impacted across the space, and issues fall within two
areas right now: the potential impact on normalized earnings, and the push for companies to hold more capital. One potential
beneficiary will likely be exchanges if volume is pushed towards exchanges and clearinghouses. Other sectors where new
regulatory proposals are likely to have an impact are Insurance, Rating Agencies and some Asset Managers/Discount Brokers
that have money market funds.

Exhibit 1: Top Ideas across the Financials sector

Stock ideas from the Financials business unit; priced as of the market close of April 7; $ millions, except per-share data
Key Financials investing themes
Upside/downside Provision Capital Capital
Company name Ticker Sector Market cap (current) Price Target price to target price Leverage Allocation Markets Real Estate
Buy
Bank of America Corporation BAC Banks 185.0 18.62 20.00 7%   
Franklin Resources, Inc. BEN Asset Managers 25.9 112.83 130.00 15%  
The Blackstone Group L.P. BX Asset Managers 16.6 14.68 18.00 23%  
CB Richard Ellis Group Inc. CBG REITS 3.9 16.23 18.00 11%  
D.R. Horton, Inc. DHI Homebuilders 3.8 11.93 17.00 42% 
Evercore Partners Inc. EVR MktStructure 1.2 30.68 40.00 30% 
J.P. Morgan Chase & Co. JPM Banks 178.7 45.32 54.00 19%    
The Nasdaq Stock Market, Inc. NDAQ MktStructure 4.6 21.42 25.00 17%  
SunTrust Banks, Inc. STI Banks 14.2 28.53 35.00 23% 
Unum Group UNM Insurance 8.4 25.36 26.00 3% 
XL Capital Ltd. XL Insurance 6.7 19.47 23.00 18% 
Sell
BRE Properties, Inc. BRE REITS 1.9 37.05 25.00 -33% 
Duke Realty Corp. DRE REITS 3.0 13.01 10.00 -23% 
Essex Property Trust, Inc. ESS REITS 2.6 94.92 72.00 -24% 
Federated Investors, Inc. FII Asset Managers 2.7 26.52 21.00 -21%
Hudson City Bancorp, Inc. HCBK Banks 7.5 14.20 13.00 -8% 
Regency Centers Corporation REG REITS 2.6 38.12 33.00 -13% 
For important disclosures, please go to http://www.gs.com/research/hedge.html.

For methodology and risks associated with our price targets, please see our previously published research.
Source: Goldman Sachs Research estimates.
Exhibit 2: GS Financials: Summary of rankings by sub-sectors Exhibit 3: Financials have underperformed since October
19 1300
Equity Coverage Views Performance
Attractive Neutral Cautious 17
6-Mar-09 13-Oct-09 6-Mar-09
1200
13-Oct-09 7-Apr-10 7-Apr-10
Asset Managers Credit Cards Life Insurance XLF 146% 7% 165%
Brokers Discount Brokers Specialty Finance 15 SPX 57% 10% 73% 1100
Homebuilders Insurance Brokers
Large-cap Banks Market Structure 13 1000
Mortgage Insurance
11 900
Non-Life Insurance
Regional Banks 9 800
REITs
Trust Banks 7 700
Credit Coverage Views 5 600

Attractive Neutral Cautious
7-May-09
7-Nov-08
7-Mar-09
7-Apr-09
7-Aug-09
7-Nov-09
7-Mar-10
7-Apr-10
7-Oct-08
7-Dec-08
7-Jan-09
7-Feb-09
7-Jun-09
7-Jul-09
7-Sep-09
7-Oct-09
7-Dec-09
7-Jan-10
7-Feb-10
US Banks Insurance
European Banks Mortgage Insurance
Source: Goldman Sachs Research. Source: Bloomberg, Goldman Sachs Research.

Thinking about Financials in the context of a portfolio

This section was Mutual funds generally outperformed their benchmarks in 2009, due largely to an underweight position in Financials, and in
written in conjunction particular, an underweight position in large-cap banks. However, they have not fared as well this year, and as of March 31,
with David Kostin and
those funds in the Lipper Large-Cap Core Index were trailing the benchmark by about 80 bp on average. Within the Financials
the Portfolio Strategy
sector at least, part of this is due to the fact that they were underweight the sectors that have performed the best, including
team.
Regional Banks, Life & Health Insurance and REITs, and as investors have increased their weights towards those sectors, they have
driven them even higher. As a result, we view the recent rally as largely positioning-driven and over time, think fundamentals will
once again become the bigger driver. Our favorite sectors are Large-Cap Banks, Asset Managers, Brokers and Homebuilders. See
Exhibit 4.
Exhibit 4: The ‘pain trade’ in Financials: those sectors that were most underweight have rallied the most year-to-date
40 Current Current SPX Current (bp)

y = -0.1x + 14.2 Mutual Fund Weight Overweight/
Regional Banks
35 R2 = 0.3 S&P 500 Sub-sector Weight (bp) (bp) (Underweight)
Property & Casualty Insurance 280 209 71
30 Consumer Finance 138 78 60
Life & Health Insurance Asset Management & Custody Banks 185 127 58
25 Investment Banking & Brokerage 173 144 30
Total Return YTD
Multi-line Insurance Real Estate Services Diversified Banks 223 206 17

20 Residential REITs Diversified Banks Real Estate Services 7 4 3
Office REITs
Other Diversified
Multi-Sector Holdings 5 4 0
Specialized Finance 42 44 -1
15 Financial Services Diversified REITs
Specialized REITs Office REITs 6 10 -4
Retail REITs Insurance Brokers
Industrial REITs 1 6 -4
10 Consumer Finance Multi-line Insurance 35 40 -5
Multi-Sector Holdings Property & Casualty
Asset Management & Thrifts & Mortgage Finance 6 12 -6
Industrial REITs Insurance
5 Custody Banks Diversified REITs 1 11 -11
Investment Banking & Insurance Brokers 9 23 -14
Specialized Finance
0 Brokerage
Thrifts & Mortgage
Residential REITs 3 19 -16
Retail REITs 8 29 -21
Finance
-5 Regional Banks 74 109 -34
Life & Health Insurance 79 114 -35
-100 -50 0 50 100 150 200
Specialized REITs 5 48 -43
Mutual Fund Overweight/(Underweight) as of 12/31/09 Other Diversified Financial Services 370 413 -43
Source: Lionshare via FactSet and Goldman Sachs ECS Research.
Despite the outperformance of Regional banks, most mutual funds remain underweight the group. While funds have
increased their weighting in certain regionals over the last few months, they have not been able to keep up with the
benchmark. While a large part of this is due to an underweight in BBT, which tends to have a large retail ownership base, mutual
funds appear to be underweight every single regional bank with the exception of Marshall & Ilsley. The stocks that have seen the
biggest increase in mutual fund ownership are MI, RF, STI, CMA, KEY and MTB. However, funds have largely closed out their
underweights in the large-cap banks sector over the last few quarters. Funds are now much closer to a benchmark weight. The
big increases have been in BAC and WFC, while mutual funds have taken down their exposure to JPM and C. See Exhibits 5-8.

Exhibit 5: Mutual funds are still underweight regional banks Exhibit 6: How mutual funds are positioned within Regional Banks
200 Position Size (bp) Change in
Current Current Current (bp) Mutual Fund Wgt
150
Mutual Fund SPX Weight Overweight/ Jun-09 to Current
100 Weight (bp) (bp) (Underweight) (bp)
BBT 3 21 -18 -7
50
FITB 3 10 -7 1
Mutual Fund SPX
PBCT 0 5 -5 0
0
RF 5 9 -4 4
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Dec-08
Jun-09
Dec-09
Current
CINF 1 4 -3 -1
0
HCBK 3 6 -3 -2
Overweight/(Underweight) FHN 0 3 -3 -1
-20
STI 10 13 -3 4
-40
CMA 4 6 -3 3
-60
HBAN 1 4 -3 1
-80 KEY 4 6 -2 3
-100 MTB 4 6 -2 3
-120 ZION 2 3 -1 0
-140 SNV 0 0 0 0
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Dec-08
Jun-09
Dec-09
Current
FNFG 0 0 0 0
CYN 0 0 0 0
MI 6 4 2 5
Source: Lionshare via FactSet and Goldman Sachs ECS Research Source: Lionshare via FactSet and Goldman Sachs ECS Research
Exhibit 7: Mutual funds have largely closed out their underweight position Exhibit 8: How positioning has changed within large-cap banks since last
in Large-cap banks summer
1200 Position Size (bp) Current (bp) June-09 (bp)
1000 Overweight/ Overweight/ Change
800 (Underweight) (Underweight) (bp)
600 BAC 2 -46 47
400 WFC 21 -2 24
200
Mutual Fund SPX USB -15 -20 5
0 MS 6 7 -1
PNC -1 2 -3
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Dec-08
Jun-09
Dec-09
Current
JPM 8 27 -19
0 C -53 -10 -43
-50 Overweight/(Underweight)
-100
-150
-200
-250
-300
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Dec-08
Jun-09
Dec-09
Current
Source: Lionshare via FactSet and Goldman Sachs ECS Research Source: Lionshare via FactSet and Goldman Sachs ECS Research

Financials are currently the second largest sector of the S&P 500, accounting for 16.5% of the total market cap. This is up
from a low of 11% in January 2009, but it still a fraction of the 22% weight at the peak. While much of this increase stems from the
relative outperformance of the sector since the market bottom, the sector weighting has also been boosted by the addition of
Berkshire Hathaway to the S&P 500 Index. Berkshire is now the fourth largest company in the sector, and the largest company by
far in Non-Life Insurance. Looking at the sector, almost half the market cap is in the Banks sector, with Bank of America, JP Morgan
and Wells Fargo accounting for 30% of the sector market cap alone.
Exhibit 9: Financials as a percentage of the S&P 500 Exhibit 10: Sub-sector breakdown of the Financials sector
25%
Insurance Brokers
1% Discount Brokers
Market Structure
1% Specialty Finance
20%
SPX Weight 2%
1%
Asset Managers
4%
15% Banks: Trust
4%
Specialty Finance
10% Credit Cards Banks: Large-cap
4% 48%
Banks: Regional
5% 6%
LifeInsure
6%
0%
REITS
Dec-74
Dec-76
Dec-78
Dec-80
Dec-82
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
Dec-94
Dec-96
Dec-98
Dec-00
Dec-02
Dec-04
Dec-06
Dec-08
Dec-10
8%
NonLifeInsurance
15%
Source: Compustat and Goldman Sachs Research. Source: Compustat and Goldman Sachs Research.
One of the big questions that comes up is whether Financials can outperform further, and potentially even become the
largest sector of the market again. We see more room to run as Financials returns continue to recover towards normalized
levels and there is room for multiple expansion. Many financial sub-sectors are trading at a discount to historical valuations (see
Exhibit 11). In comparison, other cyclical sectors are now back to trading at a premium to their historical valuation, which has led
some to suggest that Financials, and in particular the banks, are “cheap” cyclicals that offer leverage to the market recovery.
One pushback to this argument is that Banks should trade at a discount to history as it is unlikely that returns ever reach historical
levels. However, based on our estimates, we expect banks to generate a normalized return on tangible equity of 15%, which is still
lower than average returns in the 2000s, but in-line with the early-1990s. If this were the case, it suggests that banks should trade at
2.5x tangible book, significantly higher than the current 1.4x multiple they are currently trading at. Even if returns end up being
below that 15% level, there is still room for multiple expansion, as Exhibit 12 shows. In thinking about the normalized return on
tangible equity, one key factor is leverage, which is an increasingly regulated metric. We have more comfort in our sustainable
ROA forecast, which we expect to be 1.1%, lower than the average over the last 15 years (1.18%), but higher than the average since

1934 (75 bp). To get to 15% return on tangible equity, we assume that banks are required to hold 8% Tier 1 common capital,
although this is clearly still an area of debate among regulators.
Exhibit 11: Financials mostly trade at a discount to history Exhibit 12: Even adjusting for lower ROE, banks trade at a discount to
history
Current Historical avg Premium / Discount to 25%
multiple multiple historical average R2 = 73%
Mortgage Insurance (2) 1.2x 1.2x 0% Eventually should get back here
Life insurance (2) 0.9x 1.7x -48% 20%
2003 2006
2005 1999
Banks (1) 1.9x 2.7x -30% 2004
2002
Non-life insurance (2) 0.9x 1.6x -43% 19941993 1996 2000 1997 1998
Return on Tangible Equity

2001
15%
Market structure 13.3x 23.3x -43% 1995
Normalized 2007
1992
Asset Managers 17.0x 18.0x -6%
Discount brokers 20.8x 18.4x 13% 10%
REITs (3) 15.9x 12.2x 30% 1991
1990 We may never see this again
Average -- -- -16%
5% 2010
Current Historical avg Premium / Discount to
2008
multiple multiple historical average 2009
0%
Price to Earnings
Industrials 17.7x 11.8x 51%
Materials 17.8x 12.8x 39% -5%
Discretionary 16.8x 13.2x 27% 50% 100% 150% 200% 250% 300% 350% 400% 450%
Energy 13.4x 11.4x 17% Price to Tangible Book
Info Tech 15.5x 18.5x -16%
Average (P/E) 16.2x 13.5x 24%
(1): Price / Tangible Book; (2) Price / Book; (3) Price/FFO
Source: Goldman Sachs Research estimates. Source: Goldman Sachs Research estimates.
One other issue that investors are wrestling with is the impact of dilution on earnings. The dilution in Financials stocks has been
extreme over the last two years, particularly when compared to other sectors in the market. We calculate that shares are up
60% on average across Financials, with most of the dilution being caused by the Banks. Despite the increase in shares, most banks
have not seen a comparable increase in earning assets. Citigroup exemplifies this story; even if pre-provision were to return to its
previous run-rate, earnings per share would still be significantly depressed due to the increase in share count. But in many cases, C
is an extreme example, and even adjusted for dilution, most banks are still trading at a substantial discount to the historical
average. We believe the large caps are trading at a bigger discount to their long-term average earnings multiples than regionals
and thus rate the large cap banks Attractive and the regionals Neutral. See Exhibits 13-15.

Exhibit 13: There has been significant dilution in Financials over the last Exhibit 14: Pre-provision shrinkage and increase in share count has resulted
year in a big decline in normalized earning power
Change in Share Count (2007-2009) 40,000 Gov't announced its intention to convert
Average* Median
Shares (mm)
into common shares
30,000
Consumer Discretionary -3% -1%
20,000
Information Technology -3% -2%
Consumer Staples -3% -3% 10,000
Telecom Services -1% -1% 0
Industrials 0% 0% 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09
Energy 1% 2%
Health Care 3% 0%
$4.30
Implied Normalized EPS

Materials 4% 1%
$3.80
Utilities 5% 4%
$3.30
Financials 59% 12%
$2.80
* market-cap weighted $2.30
$1.80
$1.30 Pro-forma for gov't conversion
$0.80 $0.65 $0.62
$0.30 $0.39
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09
Source: Goldman Sachs Research estimates. Source: Company data, Goldman Sachs Research estimates.
Exhibit 15: Large banks and regionals are trading at a 24% discount to long-term multiples
price to normalized EPS by bank, GS-coverage
18.0x Indicates "Buy" rated stock
16.0x
14.0x
Price to Normalized EPS
12.0x Price to Earnings

Normalized Long-term Avg Difference
10.0x Large banks 8.5x 11.2x -24%
Regionals 10.4x 12.8x -19%
8.0x
Average 9.5x 12.0x -21%
6.0x Note: regionals ex Northeast. Long-term avg since 1985 where available.
4.0x
2.0x
0.0x
FNFG
NTRS
FITB
JPM
FHN
ZION
PNC
PBCT
COF
HCBK
DFS
MI
STI
WFC
RF
STT
USB
CMA
MS
CYN
HBAN
BBT
AXP
BK
KEY
BAC
WAL
Source: FactSet, Goldman Sachs Research estimates..

A return to micro from macro

Financials are often considered one of the most macro-driven sectors in the market, with many of the stocks trading in lock-step
with one another (see Exhibit 16). While that has certainly been the case over the last few years, correlation across the group has
started to fall dramatically in recent days (see Exhibit 17). In some ways, this is not surprising; as regulatory fears from earlier this
year dissipate, investors are starting, once again, to concentrate on the fundamental issues, and realize that there are many ways to
differentiate across the group. While we still see some key themes helping drive returns, many of these are more stock-specific and
cut across sectors (consumer provision leverage and capital management) as opposed to being large macro themes. The upcoming
earnings season should provide investors with evidence as to these differentiating trends and provide opportunities for generating
alpha.
Exhibit 16: Financials tend to be one of the most highly correlated sectors Exhibit 17: Financials correlation is at the lowest level since 2006
ranked by 5-year percentile realized correlation across stocks
1-year 1-year 5-year 5-year

100%
ETF S&P Sector Current median percentile median percentile
90%
S&P 500
XLF Financials 0.29 0.59 0.02 0.60 0.03
80% Financials
XLY Discretionary 0.19 0.40 0.02 0.40 0.11
70%
XLU Utilities 0.34 0.61 0.03 0.54 0.13
XLV Healthcare 0.25 0.48 0.02 0.44 0.14 60%
XLB Materials 0.27 0.40 0.09 0.42 0.16 50%
XLE Energy 0.62 0.63 0.38 0.70 0.21 40%
XLP Staples 0.26 0.33 0.38 0.33 0.32
30%
XLK Technology 0.47 0.54 0.22 0.52 0.34
XLI Industrials 0.64 0.60 0.60 0.58 0.65 20%
SPX S&P 500 0.46 0.38 0.69 0.34 0.76 10%
0%
Jun-06
Oct-06
Dec-06
Feb-07
Jun-07
Oct-07
Dec-07
Feb-08
Jun-08
Oct-08
Dec-08
Feb-09
Jun-09
Oct-09
Dec-09
Feb-10
Jun-10
Note: The percentile is the rank of the current value as a percentage of the total observations.
Apr-06
Aug-06
Apr-07
Aug-07
Apr-08
Aug-08
Apr-09
Aug-09
Apr-10
Source: Goldman Sachs Research. Source: Goldman Sachs Research.

Theme #1: Provision leverage in consumer loan portfolios

The credit cycle is clearly moderating, as non-performing asset formation is slowing and reserves are closer to peak levels.
The improvement is most clear in consumer and commercial (C&I), and should current trends continue, we see potential for
reserve releases later this year. On the other hand, some prime jumbo mortgages and CRE continue to get worse. See
Exhibits 18-21.
Exhibit 18: Credit card delinquencies have been better thus far in 2010 Exhibit 19: C&I defaults have started to slow down as well
Credit Card Leveraged Loans (proxy for C&I)

60 12%
Lagging 12-month Default Rate

Avg chg delinquency Ann. Defaults $ #
50 2Q09 -13bps 1Q09 19.8% 8.2%
Month over month change
10%
40 3Q09 +4bps 2Q09 16.8% 12.1%
4Q09 +3bps 8% # of defaults
30 3Q09 5.0% 8.7%
1Q10 -12bps 4Q09 8.4% 8.3%
20 6% 1Q10 TD 3.6% 6.5%
10
4% $ of defaults
0
-10 2%
-20 0%
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
-30
July 09
Jan 06
Apr 06
Jul 06
Jan 07
Apr 07
Jul 07
Jan 08
Apr 08
Jul 08
Jan 09
Apr 09
Jan 10
Oct 06
Oct 07
Oct 08
Oct 09
Source: Company data, Loanperformance, Trepp, S&P LCD, Goldman Sachs Research. Source: Company data, Loanperformance, Trepp, S&P LCD, Goldman Sachs Research.
Exhibit 20: Within resi mortgages, prime jumbo is getting worse Exhibit 21: CRE delinquencies continue to trend up
MBS (2006 & 2007 vintages) CMBS

1Q08 2Q08
CMBS - MoM change, 60+ Delinquency

700 bps 70 bps
QoQ Change in 30+ Delinquency
3Q08 3Q09 Avg chg in delinquency

600 bps 60 bps
1Q09 2Q09 1Q09 +19bps
500 bps 3Q09 4Q09 50 bps 2Q09 +32bps
400 bps 1Q10 TD
3Q09 +37bps
300 bps 40 bps
4Q09 +56bps
200 bps 30 bps 1Q10 TD +80bps
100 bps
20 bps
0 bps
-100 bps 10 bps
-200 bps 0 bps
-300 bps
-10 bps
-400 bps
May-
May-
Mar-08
Nov-08
Mar-09
Nov-09
Dec-07
Jan-08
Feb-08
Apr-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Dec-08
Jan-09
Feb-09
Apr-09
Jun-09
Jul-09
Aug-09
Sep-09
Oct-09
Dec-09
Jan-10
Feb-10
Subprime Op ARM Alt-A Prime Home FRE/FNM
Jumbo Equity
Source: Company data, Loanperformance, Trepp, S&P LCD, Goldman Sachs Research. Source: Company data, Loanperformance, Trepp, S&P LCD, Goldman Sachs Research.

Consumer credit, in particular, continues to improve, as evident in the most recent credit card master trust data. Total
delinquency was down 6 bp month on month while early delinquencies are down for the fourth straight month (see Exhibit 22).
Since the peak in October, early delinquencies are down 14%. We continue to believe high but stable unemployment leads to lower
delinquency, while seasonally March to May are always strong on tax refunds and other factors. Delinquencies usually fall 8% over
those months. On this theme, we favor the large banks and credit card issuers vs. the regional banks. In particular, BAC and JPM
are our best ideas given leverage to consumer credit improvement and attractive valuation at 7X our normalized earnings
estimates.
Exhibit 22: Scorecard – stocks with leverage to US consumer credit moderation
US consumer credit cost as % of US consumer credit cost as % of US consumer credit as % of

of revenue total credit cost * normalized earnings **
DFS 70% DFS 100% DFS 70%
COF 35% AXP 85% COF 60%
AXP 23% COF 77% JPM 30%
BAC 6% JPM 51% AXP 30%
JPM 5% BAC 47% BAC 25%
USB 3% USB 40% USB 20%
WFC 2% WFC 29% WFC 15%
Average 16% Average 62% Average 28%
Source: Company reports, FactSet, Goldman Sachs Research.
Looking ahead to earnings, bank charge-offs typically fall over 20% in 1Q relative to 4Q based on data since 1985. Half of this
seasonal decline is driven by declines in commercial charge-offs (C&I) with the remainder driven by commercial real estate and
auto. This year losses look set to fall although by a smaller degree, as C&I is likely in-line with historical seasonal patterns based on
commercial bankruptcies and leveraged loan defaults (although as a caveat, this regression approach tends to undershoot as
losses are peaking), and auto charge-offs have tracked down 12% using monthly data through February from Capital One and
AmeriCredit. Commercial real estate may be the one outlier in seasonality as delinquency data from the CMBS market implies that
commercial mortgage issues are still increasing. See Exhibit 23.

Exhibit 23: The seasonality of credit – losses typically fall over 20% in 1Q vs. 4Q, with improvement in C&I, CRE and auto
avg quarter over quarter change in net charge-offs since 1985; left chart on dollar losses, right table on % NCOs (1992 = 1Q 92 vs. 4Q 91)
Year 4Q FY0 1Q FY1 1Q vs. 4Q (bps)

40% 1992 1.86% 1.25% -61 bps
1990 1.90% 1.30% -60 bps
1987 1.33% 0.76% -57 bps
30% 1993 1.41% 0.86% -55 bps
1986 1.26% 0.75% -51 bps
1991 1.65% 1.20% -45 bps
20% 1989 1.20% 0.76% -44 bps
Avg QoQ change since 1985

1988 1.32% 0.89% -43 bps
1994 0.92% 0.49% -43 bps
2006 0.64% 0.34% -30 bps
10%
2004 0.90% 0.65% -25 bps
2002 1.30% 1.08% -22 bps
2001 0.91% 0.71% -20 bps
0% 2003 1.06% 0.88% -18 bps
1Q vs. 4Q 2Q vs. 1Q 3Q vs. 2Q 4Q vs. 3Q 1995 0.55% 0.38% -17 bps
2000 0.70% 0.56% -14 bps
-10% 2005 0.62% 0.49% -13 bps
1999 0.70% 0.60% -10 bps
1998 0.69% 0.61% -8 bps
1997 0.64% 0.58% -6 bps
-20%
1996 0.62% 0.56% -6 bps
2007 0.53% 0.48% -5 bps
2009 2.04% 2.00% -4 bps
-30% 2008 0.86% 0.95% 9 bps
Average 1.07% 0.79% -28 bps
Source: Federal Reserve, Goldman Sachs Research.

Theme #2: Capital management is beginning to be a key differentiator across the sector
While banks tend to receive a lot of focus for their inability to pay dividends, many Financials have accumulated excess
capital positions and are increasingly willing to put cash to work, either by paying dividends or by buying back stock. M&A is
also a possibility, but has to date largely been limited in the sector.
The dividend yield of the sector has fallen from an average of 2.5% in the years leading up to the crisis to about 1.5% currently (see
Exhibit 24). REITs are still one of the highest yielding sectors, and are expected to increase dividends by 7% this year. Large banks
are still at the low end of the spectrum and bring down the sector average, but could start to normalize in 2011. Exhibit 25
highlights the 28 companies across our coverage universe that are expected to grow dividends by 5% this year. Companies in the
Insurance, REIT and Asset Manager sectors screen especially well on this metric.
Exhibit 24: Financials sector dividend yield Exhibit 25: Companies expected to grow their dividend by 5%+ this year
3.5%
70%
3.0%
CBL
AB
2.5% 60%
Dividend Yield
2.0%
Dividend Growth (2009-2010)

50% CNS
1.5%
CLMS
1.0% 40%
0.5%
DUF PL
0.0% 30%
REITs
Market Structure
Mortgage Insurance
Insurance Brokers
Regional Banks
Credit Cards
Trust Banks
Homebuilders
Specialty Finance
Non-Life Insurance
Financials
Brokers
Large Banks
Life Insurance
Asset Managers
BXP
20%
EVR PSA
PTP LAZ MHP
10% TROW VR
UNM PRE
MS RE TRV VNO
AON AWH ACE CB
0%
0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0%
Dividend Yield (2009)
While banks are currently limited in terms of how much capital they are able to return to shareholders in the form of
buybacks and dividends, we believe that once regulatory uncertainty clears, the potential payouts may be substantial. In our
opinion, dividends are much more likely than buybacks, at least initially. That being said, some companies (such as BAC) have
expressed a desire to buy back stock and reduce some of the dilution that occurred as a result of large capital raises in 2009.
Some banks, such as JPM, USB and NTRS, have already expressed a desire to increase the dividend back to a more “normalized”
level. In order to estimate what the yield could potentially be, we look at historical payout ratios and apply them to our normalized
EPS levels. Historically, payout ratios averaged 37% since 1992, but more recently have been closer to 45%. This implies that
dividend yields could be 5%-6%, significantly higher than the current S&P 500 average of 1.9% (see Exhibits 26-27).

Exhibit 26: Banks pay 30-40% of earnings in dividend Exhibit 27: Normalized dividend yields could be significant
55.0% Div Payout Ratio* Normalized Div Yield on Normal Div

GS
50.0%
Normalized Peak LT Avg Peak LT Avg Peak LT Avg
2004-2007 average = 45% EPS
45.0%
BAC $2.40 45% 37% 1.08 0.89 6% 5%
40.0% Long-term average = 37%
WFC $4.35 45% 37% 1.96 1.61 6% 5%
35.0%
JPM $6.50 45% 37% 2.93 2.41 6% 5%
30.0%
USB $2.85 45% 37% 1.28 1.05 5% 4%
25.0%
PNC $6.50 45% 37% 2.93 2.41 5% 4%
20.0%
AVG 6% 5%
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Source: Goldman Sachs Research. Source: Goldman Sachs Research.
Buybacks have also picked up recently – since the start of the year, nine companies in Financials have announced new
buyback programs, primarily in the Non-Life Insurance, Market Structure and Asset Management space. We highlight the
groups and stocks that have the highest remaining authorized share repurchases as a percentage of market cap (see Exhibits 28-29).
For these names, completion of these programs has the potential to drive upside and significant EPS accretion.
Exhibit 28: Sectors with the largest remaining repurchase authorizations as Exhibit 29: Buy and Neutral rated companies with the largest remaining
a percentage of market cap repurchase authorizations as a percentage of market cap
14.0% Remaining
Remaining buyback authorization / market cap
12.0% buyback
authorization /
10.0%
Company Name Ticker Sector market cap
8.0%
The Travelers Companies, Inc. TRV NonLifeInsurance 25.5%
6.0% Arch Capital Group Ltd. ACGL NonLifeInsurance 25.3%
4.0%
Janus Capital Group Inc. JNS Asset Managers 23.2%
Validus Holdings, Ltd. VR NonLifeInsurance 21.8%
2.0% Moody's Corporation MCO Specialty Finance 20.9%
0.0% Meritage Homes Corp. MTH Homebuilders 19.8%
Aon Corp. AON Insurance Brokers 19.6%
REITs
Market Structure
Mortgage Insurance
Insurance Brokers
Credit Cards
Trust Banks
Regional Banks
Homebuilders
Specialty Finance
Non-Life Insurance
Financials
Large Banks
Brokers
Life Insurance
Asset Managers
The PMI Group, Inc. PMI Mortgage Insurance 17.7%

Knight Capital Group, Inc. NITE Market Structure 17.0%
Platinum Underwriters Holdings PTP NonLifeInsurance 15.5%

Our focus on buybacks in the context of capital allocation is largely aimed at identifying supports to both the market and
company stock prices. With these as a backdrop we are aware of investor focus on the impact of buybacks on stocks. Recent
analysis by John Marshall of our Cross-Product team suggests that stocks that announced buybacks during the past year
outperformed the S&P 500 by 290 bp in the four days around the buyback announcement (see Exhibit 30). We have seen this in the
financial space as well. For example, UnumProvident (UNM) and StanCorp (SFG) are smid-cap life insurance companies with
similar underlying businesses (i.e., disability insurance), and while the two traded together for most of the year, SFG can be shown
to have significantly outperformed UNM following the announcement of its share repurchase (see Exhibit 31).
There are a number of stocks that we expect will begin to buyback stock this year, including Unum Group (UNM), XL Capital
(XL) and Public Storage (PSA).
Exhibit 30: Stock reactions around share repurchase announcements Exhibit 31: Shares have reacted favorably to SFG’s buyback announcement
Through February, 2010
Stock return (%) Stock return (%) - SPX return (%) 4.0
9%
4 day return (%) around authorization
SFG
8% 3.5
Indexed Price Performance

7%
6% 3.0
UNM
5%
2.5
4%
3% 3%
3%
2.0
2%
Increased buyback
1% 1.5 program
Announces intention to
0%
resum e share repurchases
-1% 1.0
03/09/2009
03/24/2009
04/08/2009
04/24/2009
05/11/2009
05/27/2009
06/11/2009
06/26/2009
07/14/2009
07/29/2009
08/13/2009
08/28/2009
09/15/2009
09/30/2009
10/15/2009
10/30/2009
11/16/2009
12/02/2009
12/17/2009
01/05/2010
01/21/2010
02/05/2010
02/23/2010
03/10/2010
03/25/2010
Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- AVG
09 09 09 09 09 09 09 09 09 09 10 10
Source: Biryini Associates, Goldman Sachs Research. Source: Factset.

Theme #3: Capital market should bounce from a disappointing 4Q2009

While 1Q2010 did not shape up quite as strongly as many had hoped or expected, we remain upbeat regarding trends for the
remainder of 2010. FICC results this quarter should show a seasonal improvement, driven primarily by volume increases in rates
and credit, while F/X and commodities have lagged somewhat. Low interest rates and a steep yield curve should continue to
support a variety of carry trade strategies this year, and the Goldman Sachs economists do not expect much of a change over the
course of 2010. However, equities appear to be off to a very slow start this year despite the fact that 1Q is typically the strongest
quarter of the year. Sluggish equity volumes and low volatility has hurt commission growth, and issuance has been weaker than
expected, also hurting revenues. Equities could pick up over the course of this year if we start to see inflows into US domestic
funds, which has started to occur very recently, but it is too soon to call it a trend. See Exhibits 32-33.
Exhibit 32: Client activity across various products remains strong in 1Q2010 Exhibit 33: Although equity trading is down year-over-year
AVD volumes; debt issuance for 1Q10 is quarter-ized; QTD change for indices average daily trading volumes for Tape A/B/C shares in bn
40% 12
38% 4Q09 Tape C
Tape B
35% 1Q10
Tape A
30% 9
25%
20% 19%
17%
QoQ change
6
14%
15%
10%
6%
4% 4% 3
5%
1%
0%
-5% -2% 0
-4%
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
-10%
Debt issuance Interest Rate FX volumes Commodities Credit indices
volumes volumes
Source: CME, Dealogic, Markit, Goldman Sachs Research. Source: BATS, Goldman Sachs Research.
The big focus area is M&A, which started off the year slowly but has picked up in recent weeks. We remain optimistic that
trends will improve over the course of this year, helped by rising global GDP, improving sentiment, CEO confidence and
access to credit markets. Thus far in 2010, announced global M&A volumes are up 12% vs. the same period in 2009, with notable
improvement in Asia-based activity outweighing an 11% yoy decline in European volumes. We expect US-based M&A to increased
10-20% over 2009, using a three-factor regression model based on business fixed investment, real GDP, and unemployment trends
as the input variables. Since 1982, these three variables have had a 90% correlation (81% R-squared) to US M&A volumes, and in all
but three of the years (1989, 1996, 2000) the model accurately predicted at least the directionality of announced US M&A.

Given our belief that we are in the first year of a multi-year recovery in global M&A volumes, we remain Attractive on the
smid-cap brokers and boutiques, which are the most leveraged to a rebound. Lazard has the largest backlog across the smid-
cap broker space, and notably, Evercore has advised on some of the largest transactions of the past year, including BNSF/Berkshire
and ACS/Xerox. Larger firms, such as Morgan Stanley and JPMorgan, have less exposure to M&A as a percent of their overall
revenues (6% and 3%, respectively) given their more diversified business models, but we note that M&A has likely benefited their
other businesses, such as lending, underwriting, and trading. See Exhibits 34-35.
Emerging markets have also become an increasingly important area for M&A. Since 1996, Asia has had the most growth in M&A
volumes, with an annual CAGR of 18%, compared with 8% in EMEA and just 3% in the United States. JPMorgan and Morgan
Stanley are among the strongest large-cap participants in Asia-based M&A thus far in 2010, and Lazard and Blackstone increased
their presence as well, as evidenced by their recently announced advisory mandates for Prudential plc’s pending acquisition of AIA.
Exhibit 34: The pace of M&A announcements has quickened in the past six Exhibit 35: …and the boutiques are the most leveraged to M&A trends
months, led by a recovery in the Americas… advisory revenues as % of total revenues, 2006-9
1,600,000
Announced Global M&A Deal Volumes ($ mn) 100%
Americas EMEA Asia-Pac
1,400,000
90%
1,200,000 80%
1,000,000 70%
60%
800,000
50%
600,000
40% Average = 36%
400,000
30%
200,000 20%
0 10%
1Q10 (Q-ized)
1Q98
3Q98
1Q99
3Q99
1Q00
3Q00
1Q01
3Q01
1Q02
3Q02
1Q03
3Q03
1Q04
3Q04
1Q05
3Q05
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
0%
EVR GHL LAZ JEF DUF PJC RJF SF
Source: Company reports, Goldman Sachs Research. Source: Company reports, Goldman Sachs Research.
Alternative asset managers are also well-positioned for a recovery considering record levels of dry powder and improving
financing conditions for deals. Despite a soft start to the year, Blackstone remains our top Buy (CL) idea among the alternative
asset managers. BX is well positioned to deploy capital amid improving credit availability and attractive valuation prospects as it
currently has $28 billion in dry powder (29% of AUM). In addition, sponsor-backed IPOs are likely to pick-up given the current
backlog. Over the last two quarters sponsor-backed IPO filings reached $6 billion in value across 31 deals, which could come to
market if conditions continue to stabilize. See Exhibits 36-37.

Exhibit 36: Financial sponsor M&A volumes are off to a soft start in 2010 Exhibit 37: …but dry powder remains at record levels
Financial sponsor backed M&A announcements ($ billions) Committed but not yet invested private equity capital globally (as of Dec ’09)
350 25% 600
503
300 501
20% 500
462
Private Equity Dry Powder ($ bn)

62 Asia
Sponsor Volumes ($ bn)
250
379
15% 400 EU
% of total
200
163
150 300
10% 259
100 186
200 178
5% US
50
280
100
0 0%
2000 Q3
2001 Q1
2001 Q3
2002 Q1
2002 Q3
2003 Q1
2003 Q3
2004 Q1
2004 Q3
2005 Q1
2005 Q3
2006 Q1
2006 Q3
2007 Q1
2007 Q3
2008 Q1
2008 Q3
2009 Q1
2009 Q3
2010 Q1
-
2003
2004
2005
2006
2007
2008
2009
Sponsor Volumes ($ mn) - left axis % of total M&A - right axis
Source: Dealogic, Goldman Sachs Research. Source: Prequin, Goldman Sachs Research.

Theme #4: Real estate prices are stabilizing as the hunt for yield hits real assets
While we may just be in the eye of the storm, as there is still the risk from ARM resets and CRE debt re-financing, low interest rates
have pushed these issues further out into the future. On the residential side, prices have recently shown more stability, aided by a
lower mix of distressed sales. On the commercial side, sentiment appears to have moved ahead of the fundamentals, but there is
potential for more transactions over the course of 2010 and into 2011.
Residential real estate showing signs of stabilization

Homebuilders are well positioned to benefit from an improvement in new home sales from the very depressed levels of
2009. Better industry figures and significant share shift to the large public builders and away from small, private developers sets
the stage for better equity prices across the builder space. We expect three distinct periods of sales activity for the group.
 The strong spring selling season (late January-end of April): We expect positive macro and micro data points suggesting
that the Spring, when 50-60% of a builder’s annual deliveries are pre-ordered, is going well. We have already heard plenty of
positive micro data points and expect the macro data to reflect this soon.
 The brief slowdown (May-June): As the tax credit draws to a close, we expect 1-2 months of pulled-forward demand due to
the expiration of the government’s homebuyer tax credit. The likely effect is a much strong March and April than expected but
a more subdued May and June.
 The resumption of growth (July-December): We expect new home sales to return to positive growth as three factors drive
growth: (1) the Goldman Sachs economists are expecting non-farm payrolls to begin to grow in March and to continue to do so
throughout 2010; (2) we expect mortgage rates to remain low; and (3) we expect stability in house prices as lenders continue to
work with borrowers to avoid foreclosures. All in, affordability combined with a return of jobs and confidence sets the stage for
higher sales from current trough levels. See Exhibits 38-39.
Exhibit 38: New home sales are unsustainably low Exhibit 39: Great affordability sets the stage for better sales ahead
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Affordability = Mortgage/Income +1 SD Average - 1 SD
Source: US Census Bureau. Source: US Census Bureau.

Historically, new home sales have doubled off the bottom over a two-year period. The high level of shadow inventory has
the potential to make this adjustment this cycle take a lot longer. Consider:
 There are 18.5 months of total inventory across the United States today with an approximate split of 1:2, with 6.5 months of
“regular inventory” and 12 months of “shadow”. While it may seem that we have never had these levels of inventory we note
that there were 16 months ahead of the 1982-84 doubling of new home sales. Although we are not expecting a quick doubling
of sales, we continue to believe that these currently low levels of housing starts and new home sales will not be sustained in a
growing economy. One big question on this topic is what the impact of rates will be, as rates feel in the early 80’s but are
unlikely to fall from current levels. See Exhibit 40.
 The cash on banks’ balance sheets is at much higher levels than ever before, creating lower urgency to move distressed
properties from a bank perspective (see Exhibit 41). After liquidating many foreclosed properties in 2008 banks are much more
sensitive to home prices driving lower supply to the market than would otherwise be the case. Our conversations with banks
and distressed real estate investors suggest that further accommodative policies are being implemented internally. We have
seen principal reductions and mortgage term extensions grow as percentage of usage in aggregate loan modifications.
Historically, banks have not been price sensitive with delinquent and foreclosed properties but we believe this time is different,
given the magnitude of the potential issues if a bank’s entire balance sheet had to be written down to reflect another material
decline in home prices.
Within the homebuilder space, DR Horton (DHI) is our favorite name. It is one of the few builders that will be profitable in
2010, and the number of spec homes it has should enable the company to take share from other builders.
Exhibit 40: Inventory is about 18 months, only slightly higher than in 1982 Exhibit 41: Cash at banks has created low urgency in moving distressed
Current + shadow inventory properties at lower prices
25.0 1,400
Total Months Supply of Home Inventory
Adjusted m onths' supply w as Cash at $1.3TN = 11% of total assets

21.5 as of 3Q09 * 1,200
20.0
US Banking Industry Cash Assets ($bn)

1,000
15.0
800
Foreclosures
10.0
600
90D+
5.0 400
Norm al Supply
200
0.0
Mar-94
Feb-96
Jul-86
Jun-88
May-90
Jan-98
Dec-99
Nov-01
Oct-03
Jul-09
Sep-82
Sep-05
Aug-84
Apr-92
Aug-07
0
01/03/73
01/03/75
01/03/77
01/03/79
01/03/81
01/03/83
01/03/85
01/03/87
01/03/89
01/03/91
01/03/93
01/03/95
01/03/97
01/03/99
01/03/01
01/03/03
01/03/05
01/03/07
01/03/09
Note: Data based on quarterly filings; however, monthly data points suggest recent decline as sales have
increased.
Source: US Census Bureau. Source: Federal Reserve.

While shadow inventory continues to grow, it theoretically does so in part due to anticipation of successful mortgage
modifications. While not yet material to the overall 4.5 million borrowers behind on their payments, the most recent data point
(January HAMP report from the Treasury) suggests some early signs of success (see Exhibit 42). Specifically, cumulative
permanent modifications increased to 160,000, a 75% increase in one month. Furthermore, there are an additional 76,000 loans
which have been permanently modified by the servicers and are pending final borrower approval. While the sum of these two
(192,000) is a mere 3.5% of delinquent mortgages (60 day+), the rate of acceleration is meaningful. In addition, recent news from
Bank of America that they are willing to forgiveness principal for borrowers where loan-to-value ratios are above 120% imply that
banks are willing to work with some borrowers, particularly in those circumstances where losses are likely to be significant anyway.
Exhibit 42: HAMP continues to grow which could begin to meaningfully benefit MI losses on a go-forward basis
Mortgage Insurance Industry Participation in Home Affordable Modification Program
120,000 116,297
HAMP Permanent Mods (# of loans)
MTG
RDN
PMI
100,000 GNW
Other MIs
Incremental 1Q2010 Reserve Implied Cure
80,000 ► X =
Jan. Mods Implied Mod Per Loan Benefit
66,465
MTG 1,874 5,623 $26,773 $150,546,621
60,000 RDN 1,312 3,936 $19,421 $76,444,116
PMI 1,221 3,662 $18,611 $68,150,613
40,000 GNW 1,499 4,498 $19,265 $86,665,198
20,000
17,860
10,207
MIs = 15%
MIs = 15%
0
Implied
Mortgage
HAMP HAMP Mortgage
Insurers
Insurers
4Q 2009 Jan. 2010
Source: United States Treasury Department, Goldman Sachs Research, company commentaries.
One issue that has come up a lot more recently is rep and warranty charges, which are likely to be a risk to banks earnings this year.
Recent data points suggest continued acceleration of put-back requests from the GSEs. Fannie Mae has been driving most of the
volume and the focus is still on the 2007 vintage. A big swing factor, therefore, is whether Freddie Mac steps up its put back rate.
More importantly, this issue will likely last for several quarters / years as it’s still unclear how much ultimately gets put back at this
point. See Exhibit 43.

Exhibit 43: Bank repurchases continue to increase, although data is skewed by GNMA put-backs where underlying risk is guaranteed by HUD
$25 bn Estimated Gov't Insured Mortgage Repurchases

Estimated Non Gov't Insured Mortgage Repurchases
Provisions ($mn) Reserves ($mn)

$19.7 bn
$20 bn
Amount of Mortgage Repurchases
Repuchases by Vintage * Ticker 3Q09 4Q09 Ticker 3Q09 4Q09

Vintage % of Total
Pre-2007 20% BAC * 322 450 JPM nr 1,500
2007 60%
$15 bn 2008 20% JPM * 300 400 STI 123 200
*: based on JPM, STI and FHN. WFC 146 316 FHN 61 106
STI 136 220 FITB 10 nr

$10 bn
FHN 26 59 BAC * nr nr
$7.9 bn
Total 930 1,445

*: mgmt indicated that the reserves were
$4.9 bn original established as part of the CFC
$5 bn $4.1 bn 2006 origination share 49%
acquisition and are currently "in the billions".
$2.8 bn
Implied market run rate 2,950
$1.9 bn
$1.3 bn
$0.4 bn
*: 4Q09 estimated.
$0 bn
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09
Note: estimates based on BAC's 3Q and 4Q disclosure of gov't vs. non-gov't insured repurchases.
Source: SNL DataSource, Goldman Sachs research, and company data.
CRE pricing stabilizing but on low volume; refi gap remains a question
In the current low rate environment, the commercial real estate crisis seems to be on hold and in certain examples pricing
and fundamentals have improved from the bottom. That said, data points are limited thus far as asset transaction and lease
activity to date has been low. We maintain that CRE values are highly dependant on funding costs as rent and occupancy growth
should be modest beyond 2010. Lastly, “extend and pretend” loan modifications by banks remain prevalent, which make timing of
CRE loan losses difficult to predict.
 We maintain our Neutral coverage view on REIT equities as current valuation has already discounted a robust recovery
in fundamentals. REITs now trade at 17x our 2010 FFO estimates vs. a long-term average of 12x.
 Similarly, we maintain our Neutral coverage view on Regional Bank stocks. Capitalization has improved across the sector but
on average, CRE as a percentage of total risk based capital remains high at 107%.
Pricing – It has been difficult to assess a base level of CRE pricing as financing remains limited (lack of CMBS) and transactions
volumes are off 80% from peak levels of 2007 (see Exhibit 44). That said, recent data points indicate that CRE prices have tightened
as it seems that there is too much capital chasing too few deals for high-quality assets (see Exhibit 45). While this is encouraging,
we believe there should be a bifurcation in pricing for Class A assets vs. properties with more challenging capital or leasing hurdles.

Exhibit 44: CRE values are still off 30-40% but may be inflecting Exhibit 45: Spreads still wide but recent deals show tighter bids can be hit
indexed as of YE-2000 as of March 2010
10-Year Treasury avg cap rate spread (bps)

10% 200
12.0% 600
8%
6% 180 10.0% 500
4% 8.0% 400
2% 160
6.0% 300
0%
-2% 140 4.0% 200
-4% 2.0% 100

J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A J O J A J O J
-6% 120 '01 '02 '03 '04 '05 '06 '07 '09 '10
-8%
Recent CRE Transactions
-10% 100
Asset Value Date Cap rate Buyer Seller
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Griffin Towers (office) $90.0mn Mar-10 8.1% Angelo Gordon JV Maguire Properties
Columbia Uptown (apt) 11.8mn Mar-10 5.0% Van Metre Compaies Pennrose Properties
The Palatine (apt) 118.0mn Feb-10 4.5% Crescent Heights Monument Realty
Monthly Price Change Index Value (Right Axis) 8599 Rochester Ave (ind) 12.3mn Jan-10 7.3% KTR Capital Partners Panattoni Dev'l
Source: Moody’s, Real Capital Analytics. Source: Real Capital Analytics, Bloomberg.
Fundamentals – In most markets, signs of the bottom for rents and occupancy are emerging and we expect comparisons to
improve on a quarterly basis over the course of this year. For REITs specifically, we expect FFO growth to be flat by year-end and
turn positive in early 2011. Market rents have started to flatten out after a period of steep declines in late 2008 and much of 2009.
That being said, a true recovery may take longer than in prior cycles, as our economists expect the unemployment rate to pick up
over the course of this year and not peak until the first half of 2011. See Exhibits 46-47.
Exhibit 46: FFO year-on-year growth comparison to improve incrementally Exhibit 47: CRE fundamentals lag the broader economy – we do not
in 2010 anticipate a recovery until 2012 / 2013
20%
FFO growth by sector 1Q10E 2Q10E 3Q10E 4Q10E 2010E 2011E Office
CRE fundamentals typically lag the
Regional Malls -32.9% -16.5% -10.2% -9.5% -18.3% 7.3% 18%
economy by 18-24 months
Retail
Vacancy Rate, by sector
Office -20.6% -19.6% -7.2% 2.6% -16.1% 2.6% 16%
Apartments -20.0% -22.7% -14.1% -2.5% -16.4% 3.8% 14% Industrial
Industrial -41.3% -19.9% -15.7% -12.4% -25.7% 5.8% 12%

Shopping Centers -30.6% -18.6% -15.4% -1.7% -18.2% 3.0% M ultifamily
10%
REIT Average -29.1% -19.5% -12.5% -4.7% -18.9% 4.5%
8%
6%
We expect FFO growth to improve on
quarterly basis going into 2010 with modest 4%
recovery in 2H and 2011.
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Source: Goldman Sachs Research estimates. Source: PPR.

Bank losses – The key concern for banks are what losses may ultimately total. To date, banks have recognized losses of about 2.5%,
a fraction of the 7% we expect them to eventually realize. Part of the issue is persistency – given the long-tailed nature, we expect it
could take up to 15 years for banks to fully realize the losses on CRE. See Exhibits 48-49.
Exhibit 48: Banks recognized losses are a fraction of what they may Exhibit 49: It will take 10 years to reach cumulative default
ultimately end up being
100%
8.0%
99%
99%
99%
98%
97%
Cumulative recognized to date by banks
95%
93%
91%
100%
88%
7.0%
85%
83%
Commercial Mortgage Losses:
90%
79%
CRE cumulative default profile
6.0%
74%
80%
69%
64%
5.0% 70%
57%
60%
4.0%
47%
50%
38%
3.0%
40%
28%
2.0% 30%
18%
1.0% 20%
9%
10%
2%
0%
0.0%
0%
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
GS est
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
Years since origination
Source: Goldman Sachs Research estimates. Source: PPR.

Short rates are likely to stay lower for longer, but have to go up eventually
Low rates has unquestionably helped to stimulate the economy, not only by cutting funding costs, but also by supporting
housing demand and boosting capital market activity. If and as rates start to increase, we would likely review our
positioning across the sector. Discount brokers are one of the areas that have the most to gain given their sensitivity to the short
end of the curve. Regional banks will also likely see an improvement in margins, although higher rates may hurt credit trends.
While money market funds could also gain as yields move back to normal levels, if rates start to increase because of stronger
growth, outflows are likely to continue as investors move into higher risk-reward assets.
While our economists do expect the Fed to reverse most “technical” factors in the near term, including increasing the spread
between the discount rate and the Fed Funds rate, and reducing the outstanding balances in the Term Auction Facility towards zero,
they forecast the Fed Funds rate to stay near-zero through 2011. Using the CME curve as a proxy, the market expects rates to start
increasing as early as the second half of this year, but investors have tempered their expectations in recent months. See Exhibits
50-51.
Exhibit 50: Fed moving discount rate back toward more normalized levels Exhibit 51: CBOT Fed fund futures now imply 100 bps of Fed rate hikes
relative to Fed Funds through May 2011 (vs prior expectations of such hikes by October 2010)
discount rate vs. target Fed funds Implied Fed funds rate
8.00% Target Fed Funds Discount Rate vs. Target Fed Funds *
2 .5 0
Discount Rate Prior to Yesterday's
7.00% 38 bp
Discount Rate Increase
2003 - 2007 Median 100 bp
6.00%
*: using mid point of target ranges. 2 .0 0
5.00% Febr ua ry 2 01 0 Impl ied

September 2 00 9 Implied
4.00% 1 .5 0
3.00%
2.00%
1 .0 0
1.00%
0.00%
0 .5 0
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jan-03
Oct-03
Jan-04
Oct-04
Jan-05
Oct-05
Jan-06
Oct-06
Jan-07
Oct-07
Jan-08
Oct-08
Jan-09
Oct-09
Jan-10
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
0 .0 0
FEB M AR APR M AY JUN JLY A UG SEP OC T NOV DEC JAN FEB M AR AP R MA Y JUN JLY AUG SEP OC T NOV DEC JAN
10 10 10 10 10 10 10 10 10 10 10 11 11 11 11 11 11 11 11 11 11 11 11 12
Source: Federal Reserve, Goldman Sachs Research. Source: CME/CBOT, Goldman Sachs Research.
One of the big questions with regards to interest rates is whether an increase will cause a new round of credit problems.
Over 60% of loans in the United States are floating rate, so low rates have helped keep borrowing costs quite low. For example, we
estimate that the rate on home equity loans is as low as 2.75% from some providers and construction loans is around 3%-4%. So
while many properties have loan-to-value readings above 100% as a result of falling prices, debt service coverage has stayed above
1X (see Exhibit 52). In addition, another positive impact of low rates is that as rates on option ARMs reset, it is less likely that there
will be much payment shock. Typically, option ARMs are originated with a fixed teaser rate that is good for a defined period of time,

often five years. After that period, the rate is reset and then floats based on a specified index (often the Monthly Treasury Average
(MTA), plus a spread. Currently, payment shock is approximately 30%-40%, which is down considerably from 160% at the end of
2007. Low rates imply that payment shock will fall even further to 20%-30% next year as interest rates stay near zero. Historically,
delinquencies have picked up following the reset, particularly when the payment shock is high. Given that 2010 and 2011 are peak
years for option ARM resets, there is some concern that an increase in rates may result in a new round of losses (see Exhibit 52). A
significant amount of CRE matures over the next few years as well and likely will need to be re-financed.
Exhibit 52: Debt service coverage vs. Loan to value Exhibit 53: Delinquencies positively correlated with payment shock
70%
2007
Today Change
Origination 60%
Annual cash flow 5 4 -20%
% D60 6m after reset

50%
Cap rate 5% 8% 1.6x
Property value 100 50 -50% 40%
Loan 70 70 0% 30%
Loan to value (LTV) 70% 140% 2.0x
20%
Loan rate* 5.50% 1.50% -73%
Annual debt expense 4.8 2.9 -39% 10%
Debt service coverage (DSC**) 1.0x 1.4x 1.3x
0%
1-25% 25-50% 51-75% 76-100% 101+%
*Assume 30y amortization schedule, floating rate LIB+50bp w ith 100bp floor
paym ent shock at reset
**Cash flow divided by debt expense
Source: Goldman Sachs Research Source: Loanperformance.
One of the biggest beneficiaries of rate increases across the space would be the discount brokers. When the Fed does begin to
tighten its fiscal policy and short-term yields begin to shift higher, net interest margins should move back to more normalized levels.
We estimate that the average EPS effect on the Discounters for the first 100 bp move in Fed Funds/Treasury yields will be roughly
24% on our 2011 estimates (see Exhibit 54). Similarly, a rising Fed Funds rate should benefit security lending spreads at trust banks,
as these companies typically invest cash collateral in LIBOR-based securities but pay out Fed Funds-based rates. Exhibit 55
summarizes how we would be positioned should rates start to increase.

Exhibit 54: SCHW and TRAD most sensitive to a 100 bp shift higher in rates Exhibit 55: The outlook for different sectors when rates rise
2011E EPS Impact % Change Best Interest Income
Fed Funds Rationale(s)
Performance
Charles Schwab $0.80 $0.33 41%
Discount Brokers Immediate leverage to higher rates
TradeStation $0.40 $0.17 41%
0% - 1% Business model has become more asset sensitive but it is hard to
TD Ameritrade $1.50 $0.28 19% Cards (ex AXP)
pass on to customers with Fed funds above 1%
optionsXpress $1.30 $0.24 18% Below 1%, regionals don't benefit much given interest rate floors
E*TRADE Financial $0.11 ($0.00) (0%) 1% - 3% Regionals Above 3%, deposit mix shift from non-interest bearing to CDs
becomes a headwind
Average 24%
Trust banks benefit most in a high rate environment after the Fed
Above 3% Trust Banks has stopped rising rates. The first few increases in rates are usually
Note: TRAD estimate based on 100 bps increase in US Treasury yield neutral to negative for trust banks NII.
Source: Goldman Sachs Research estimates. Source: Company data, Goldman Sachs Research.
However, higher rates do not necessarily imply that money market outflows will reverse. In the first quarter, money market
funds saw outflows of nearly $325 billion, approximately 10% of total industry assets or 40% annualized organic decay.
This would mark a record quarterly outflow for the industry. The yield differential between money market funds and CDs remains
at the historically wide level of 125 bp, which is likely to keep pushing investors out of money funds. While higher yields should
theoretically also help money market funds given the more attractive yield, what is important is what is driving the higher rates. If
rates are going up because of inflation concerns, then money markets should see inflows as investors flock to safety. But if rates
rise because of better growth expectations, money markets actually see more dramatic outflows as investors move up the risk
curve. FII is one of the most leveraged names to money market funds, and is one of the key reasons behind our CL-Sell rating
on the stock. See Exhibits 56-57.

Exhibit 56: Money market funds are on track to see record outflows in 1Q10 Exhibit 57: The yield differential between MMFs and CDs remains wide
Quarterly money market fund flows; 1Q2010 data is quarterized based on 2/18 data 7-day annualized MMF yield versus 1-year CD rate
500,000 50% 6.0%
400,000 40%
5.0%
Annualized Organic Growth Rate

30%
Money Market Flows ($ mm)
300,000
4.0%
20%
200,000
3.0%
10%
100,000
0% 2.0%
0
-10%
1.0%
125 bps
-100,000
-20%
0.0%
-200,000
Oct-06
Dec-06
Feb-07
Apr-07
Jun-07
Aug-07
Oct-07
Dec-07
Feb-08
Apr-08
Jun-08
Aug-08
Oct-08
Dec-08
Feb-09
Apr-09
Jun-09
Aug-09
Oct-09
Dec-09
Feb-10
-30%
-300,000 -40%
Money Market Yield 1-Year CD Rate
1Q09*
1Q01
3Q01
1Q02
3Q02
1Q03
3Q03
1Q04
3Q04
1Q05
3Q05
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
Flows (left axis) Organic growth (right axis)
*1Q10 is "quarterized"
Source: Investment Company Institute, Goldman Sachs Research. Source: Bloomberg, Goldman Sachs Research.

Regulatory issues likely to remain a topic for the foreseeable future

While most of the focus recently has been on the Senate version of the financial regulatory reform bill, there are also many
regulatory and legislative proposals related to capital and liquidity levels that are likely to have an impact on the sector. We
note there is still a great deal of uncertainty around many of the outstanding issues.
Looking first at some of the proposals that would have a direct effect on earnings, we expect the net effect to be manageable for
most banks under coverage, although one risk investors struggle with is the final, cumulative outcome. So far, none of the
legislation, regulation and proposals has a major impact on its own. But, given a TARP tax (Financial Crisis Responsibility Fee) +
CARD Act + balance sheet caps + overdraft fee limitations, and potentially more to come, the cumulative effects add up quickly.
Specifically, we estimate the cumulative impact of potential regulation actions as 9% of our normalized earnings on an equal-
weighted basis. That said, (1) it is unclear which proposals will ultimately pass, (2) banks may pass on costs to customers, and (3)
some of the impact is already reflected in our estimates (e.g., the CARD act). See Exhibit 58.
Exhibit 58: We estimate that regulatory actions could negatively impact banks’ normalized earnings by 9%
Large Banks Trust Banks Cards Regionals

$bn BAC C JPM MS WFC PNC USB BK NTRS STT AXP COF DFS BBT CYN CMA FITB FHN FNFG HCBK HBAN KEY MI PBCT RF STI WAL ZION Avg
Regulatory Impact (pre-tax)
OD / NSF Fees (1) 0.8 0.1 0.8 0.0 0.9 0.2 0.3 0.0 0.0 0.0 0.0 0.1 0.0 0.1 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.0
CARD Act (2) 1.2 0.5 0.9 -- -- -- -- -- -- -- 0.6 0.8 0.3 -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Financial Crisis Responsibility Fee (3) 1.4 1.9 1.6 0.8 0.6 0.1 0.1 0.2 0.1 0.2 0.1 0.1 0.0 0.1 -- 0.0 0.0 -- -- 0.0 0.0 0.0 0.0 -- 0.1 0.1 -- 0.0
Restrictions on "Liabilities" (4) 1.7 1.4 1.6 -- -- -- -- 0.2 0.1 0.1 -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Restrictions on "Prop" (5) 0.5 1.3 1.0 0.6 0.0 -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
Total Regulatory Impact 5.7 5.2 5.8 1.4 1.4 0.3 0.4 0.4 0.1 0.3 0.7 0.9 0.3 0.2 0.0 0.1 0.1 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.2 0.2 0.0 0.0
After-tax Impact 3.7 3.4 3.8 0.9 0.9 0.2 0.3 0.3 0.1 0.2 0.5 0.6 0.2 0.1 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.0
S/O (bn) 9.9 29.9 3.9 1.4 5.2 0.5 1.9 1.2 0.2 0.5 1.2 0.5 0.5 0.7 0.1 0.2 0.8 0.2 0.2 0.5 0.7 0.9 0.5 0.3 1.2 0.5 0.1 0.15
"Gross" EPS hit $0.37 $0.11 $0.96 $0.67 $0.18 $0.43 $0.14 $0.21 $0.39 $0.39 $0.41 $1.33 $0.32 $0.15 $0.10 $0.23 $0.10 $0.07 $0.00 $0.04 $0.04 $0.05 $0.04 $0.00 $0.10 $0.24 $0.01 $0.16
% of Normalized EPS 15% 23% 15% 15% 4% 7% 6% 8% 12% 8% 13% 24% 16% 5% 2% 5% 6% 6% 0% 3% 7% 7% 7% 0% 13% 7% 2% 7% 9%
Impact by Regulatory Action

OD / NSF Fees (1) 2% 0% 2% 0% 2% 5% 4% 0% 0% 0% 0% 2% 0% 3% 2% 3% 4% 6% 0% 0% 6% 5% 4% 0% 9% 5% 2% 6% 3%
CARD Act (2) 3% 2% 2% 0% 0% 0% 0% 0% 0% 0% 11% 21% 15% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 2%
Financial Crisis Responsibility Fee (3) 4% 8% 4% 9% 2% 2% 2% 4% 6% 5% 2% 2% 1% 2% 0% 2% 2% 0% 0% 3% 1% 2% 3% 0% 4% 2% 0% 1% 3%
Restrictions on "Liabilities" (4) 5% 6% 4% 0% 0% 0% 0% 3% 5% 3% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 1%
Restrictions on "Prop" (5) 1% 6% 3% 6% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 1%
Total 15% 23% 15% 15% 4% 7% 6% 8% 12% 8% 13% 24% 16% 5% 2% 5% 6% 6% 0% 3% 7% 7% 7% 0% 13% 7% 2% 7% 9%
(1): estimated using 15% of annual deposit servicing charges (5% for trust banks), similar to banks that provide guidance.
(2): estimated where not provided.
(3): estimated using 15bps of Total Assets - Tier 1 Capital - FDIC-assessed deposits - UST Repos. Assuming USB reports make up 80% of total repo outstanding.
(4) assuming 10% decline in b/s size for big 3 banks. Also assuming 10% for trust banks as they reduce the repo books.
(5): using disclosed % of revenue by bank where applicable.
Source: Company reports, Goldman Sachs Research estimates.
On the capital side, there has been a lot of focus recently on the Basel III proposals, which are currently under development.
One of the main concerns for investors has been the grossed-up leverage ratio, where netting of most derivatives is no longer
allowed, which would affect large US banks with capital market operations such as MS, JPM, BAC and C, along with major

international banks such as Credit Suisse, Deutsche Bank, UBS, etc. Based on our calculations, the average gross leverage ratio for
the major US banks could quadruple from the current level (see Exhibit 59). While the leverage threshold has not been set, a
stringent requirement would likely result in further deleveraging at large banks. In addition, under the proposed market risk
framework, risk weighting for most assets held on banks’ trading books would increase significantly. For example, non-agency
RMBS capital utilization would likely increase to 33% from 5% currently under the new proposal, based on our estimates. RMBS
only accounts for 5% of total trading revenue, and as a result, banks may choose to exit this market as it becomes prohibitively
capital intensive (see Exhibit 60).
Exhibit 59: Basel III gross leverage with no netting of derivatives could Exhibit 60: Non-agency mortgage could turn prohibitively capital intensive
quadruple leverage ratios under market risk proposals
current leverage (TCE as denominatory) vs. leverage on Basel III proposal our estimate of non-agency mortgage revenues currently as % of total across
industry, and capital utilization under proposed market risk framework
180x 100%
160x 90%
140x 80%
Basel III as proposed:
120x 78X average gross 70%
Leverage Ratios
leverage ratio All Other

60%
100x
50% Mortgages*
80x
40%
60x Current: 19X average
gross leverage ratio 30%
40x
20%
20x
10%
0x
0%
C BAC WFC JPM MS WFC C BAC JPM MS
Revenues Capital Utilization
M easured as 4Q09 = current, B asel III o n a pro -forma basis with no future earnings, changes in b/s size etc.
Leverage measured using tangible co mmo n equity. * excluding agency M BS
Source: Company data, Goldman Sachs Research estimates. Source: Goldman Sachs Research estimates.
Part of the reason there is such a focus is the potential impact these new capital requirements will have on credit growth. So far this
cycle, bank lending and securitization have shrunk by over $1 trillion, which has been offset by government lending (via Fannie,
Freddie and the FHA). For the longer term, private markets must take up the slack, but at the same time regulatory efforts to make
banks hold more capital or to limit non-deposit liabilities both imply that the banking industry would become smaller, not bigger
(see Exhibit 61).

Exhibit 61: Where credit comes from – banks vs. non-banks/securitization and the government/GSEs
based on total US mortgage, commercial real estate, consumer and corporate credit outstanding of approximately $23 trillion
Outstanding % of US YoY % YoY $bn
($TN)* Credit Market Change Change
Non-banks and securitization account for biggest piece of
Non-banks + securitization 9.2 40% -12% -607
credit outstanding and credit shrinkage
Bank loans 7.2 31% -7% -552

Private credit is being transferred to Government balance
Government incl GSEs 6.5 29% +8% +495
sheet
Total 22.9 100% -3% -664
*: non-financial non-government credit outstanding.
Source: Federal Reserve, Goldman Sachs Research.
In addition, most proposed bank reforms have been targeted at the large banks. The unintended consequence, in our view, is a
likely further reduction in credit availability and liquidity across markets and products. The top 5 banks in the United States (BAC,
JPM, C, WFC and MS) have an almost 60% share of total assets and total liabilities (broadly defined) and about 40% of total loans
and deposits in the United States. Forcing large banks to shrink their balance sheets would disproportionately hit consumer credit
availability and would also be an issue for agency MBS demand. Specifically, the top 5 banks have more than 50% market share of
total credit card outstanding, home equity, other consumer, and C&I. In addition they have +40% of the banking system’s holdings
in US Treasuries, agency MBS and mortgages (see Exhibits 62-63).
Exhibit 62: The top 5 banks have more than 50% share of liabilities & assets Exhibit 63: The top 5 banks have large market shares across most products
top 5 banks as % of total US banking industry top 5 banks as % of total US banking industry
60% 57% 60% 56%
54%
56% 51%
Top 5 Banks' Share by Loan Type

55% 50% 48% 47%
45%
43%
Top 5 Banks' Market Share
50%
40%
45%
42% 30%
40%
40%
20% 16%
35%
10%
30%
0%
25% Cards Other Home C&I US Agency Mortgages CRE
Liabilities Assets Loans Deposits (Managed) Consumer Equity Treasuries MBS
Source: Company reports, SNL, Goldman Sachs Research. Source: Company reports, SNL, Goldman Sachs Research.

On the derivatives side, while various regulatory changes have been discussed in both houses of congress and by the regulatory
bodies (SEC, CFTC), there has been little actual change in the past year. However, should Basel III or similar measures be
implemented, thereby driving up the risk weighting of non-cleared assets, more trading assets are likely to be cleared, benefitting
the exchanges or entities that control the clearinghouses for those products. Moreover, calls for improved trading transparency
should help exchanges and firms with electronic trading platforms to attract higher share from OTC markets. Downside risk to
volumes remains as well, however, with any implementation of a transaction tax or curtailment of risk-taking.
This is not to say that all of the regulatory reforms are solely directed at the banking sector. Other sectors likely to be impacted
include Insurance, the Rating Agencies and Asset Managers/Discount Brokers. We summarize these proposals in Exhibit 64.
Exhibit 64: Current regulatory proposals likely to affect Financials
Sector Topic Description

Solvency II/International The aim of these proposals is to incentivize firms to use modern, firm-appropriate risk management
Insurance Financial Reporting Standard practices, rewarding those firms that effectively do so with increased capital flexibility. Possible excess
(IFRS) capital would be free to support new business, boost investment returns or be returned to shareholders
The current House and Senate versions of the Financial Reform bill have language that would negatively
impact the rating agencies from a legal risk perspective. Currently plaintiffs must prove that rating
Financial reform and legal agencies have knowingly and maliciously committed fraud in rating practices for financial gain. Under the
Rating Agencies
risk proposed bill that legal pleading standard would be changed to recklessness or negligence, which has a
much lower burden of proof and consequently would significantly increase legal risk for both MCO and
MHP. The probability of passing this piece of reform remains largely unknown.
As part of the SEC's MMF reform, funds now have to disclose "shadow" NAV, or the mark-to-market value
Asset Managers/ of the fund's net assets, rather than the stable $1.00 NAV on a monthly basis - an unexpected move,
Money Market Reform
Discount Brokers pushing the industry one step closer to a floating NAV structure, in our view. In addition, Paul Volcker is
pushing for higher capital requirements.
Source: Goldman Sachs Research.

Sector views: Attractive Large Banks, Asset Managers, Homebuilders and Brokers
Exhibit 65: Key themes across Financials (* are stocks on the Conviction List; coverage view for each sector is shown)
Sector Analyst Key Themes Top Stock Ideas

Equity research
We are Attractive on large cap banks given a) outsized exposure to consumer credit which will improve even in a high but
Large Banks Buy: JPM*, BAC*
Richard Ramsden stable unemployment environment, b) the benefit from low rates in fee businesses - mortgage and capital markets, and c)
(Attractive)
attractive valuation at ~7X normalized earnings.
We are Neutral on regional banks. The credit cycle is moderating and net interest margins are expanding, but on the flip side Buy: STI*, CMA, FITB,
Regional Banks
Brian Foran loans are shrinking and valuation is ~10X normalized EPS. We prefer names that are inexpensive on normalized earnings KEY
(Neutral)
and/or exposed to corporate credit which is improving quickly. Sell: HCBK
Trust banks are in the right place, but at the wrong time. These are good businesses that generate lots of capital, but ~40%
Trust Banks
Brian Foran of revenues are tied to interest rates and FX volatility and right now both are a big drag. As a result, trust banks are stuck with na
(Neutral)
trough earnings and trough valuations.
Credit quality is rapidly improving, as our thesis that high but stable unemployment = lower delinquencies is now playing out.
Credit Cards That said, loans are shrinking at over 10% per year as well making the risk/reward more balanced. We prefer names with Buy: DFS
Brian Foran
(Neutral) leverage to credit but also the ability to grow assets outside of card, while the big banks also provide an avenue to play the
credit theme.
In the context of our Cautious coverage view for Life insurance, we have a positive bias toward the small and mid-cap
companies. We believe the smid-caps have simpler business models with more stable returns, are potential acquisition
Life Insurance Chris Neczypor/ Buy: UNM, LNC
targets, and thus have unwarranted valuations compared to larger peers given strong capital positions and less risky
(Cautious) Chris Giovanni Sell: HIG
portfolios. We believe the large caps face weak organic growth prospects and that investors are still focused on tail risk and
capital given regulatory and rating agency uncertainties.
We maintain our Neutral coverage view for Non-life insurance as we lack conviction that the next two years will bring evidence
Non-Life Insurance of a turn in the pricing cycle. The key cycle drivers-a collapse in ROEs, realization of large reserve deficiencies, and a decline Buy: XL, PGR, ACE
Chris Neczypor
(Neutral) in cash flow-have yet to emerge. Personal lines, however, stand out as an exception as we are starting to see some price Sell: ALL
increases there. Our framework for picking stocks in a soft market focuses on finding relative value within the space.
While we continue to believe valuing the mortgage insurers is best done on a residual value basis, the near term implications
from recent proposals to incorporate principal forgiveness into mortgage modification programs has the potential to be a
Mortgage Insurance significant positive for the mortgage insurers. We believe residual value represents the best proxy for potential value as the Buy: MTG
Chris Neczypor
(Neutral) uncertainty around GSE reform, future leverage, future pricing, and future appetite from mortgage originators for private Sell: PMI
mortgage insurance is at best unclear. Our top pick in the space remains MTG where we estimate residual value to be
between $15-16.
We maintain our Attractive view on the Asset managers as we believe 2010 will be a year of both retail and institutional re-
Asset Managers Marc Irizarry/ risking, driving stronger flows into long-dated asset classes and away from lowering yielding money market funds. Buy: BEN*, BX*
(Attractive) Alex Blostein Consequently, this shift should drive higher fee rates and further margin improvement at still palatable group valuation of 17X Sell:FII*
2010E P/E.
We have a Neutral view on Market Structure, with a favorable bias towards NDAQ and CME. Overall, Volume trends in certain
Market Structure asset classes, notably interest rates and F/X, remain comfortably above last year's levels, while equity options and cash Buy: NDAQ*, CME
Dan Harris
(Neutral) equities are lower. Regulatory changes remain significant catalysts and overhangs, though we generally believe exchanges Sell: X.TO
and more specifically those with clearing houses, will benefit most.

Exhibit 65 cont'd: Key themes across Financials (* are stocks on the Conviction List; coverage view for each sector is shown)
Sector Analyst Key Themes Top Stock Ideas

Our Attractive coverage view is based on a longer term improvement in capital markets, though 1Q results are likely to be
Smid-cap Brokers/
soft. Announced M&A is up, though completed trends are lower, suggesting advisory firms will have strong backlogs and Buy: EVR*, LAZ, PJC
Boutique M&A Dan Harris
somewhat softer results. Equities trading is likely lower, while FICC should increase up to 50% QoQ. We favor Evercore and Sell: JEF
(Attractive)
Lazard for their opportunity to gain market share in M&A over the next year.
Our Neutral coverage view is predicated on the offset of slowing trading trends offset by the longer term opportunity for
Discount Brokers earnings improvement through interest rate changes. However, given our 'lower for longer' interest rate view, we believe 2011 Buy: ETFC
Dan Harris
(Neutral) EPS estimates remain too high, though the leverage to rising rates is significant. We favor ETFC for its credit exposure rather Sell: na
than rates exposure.
We remain Neutral rated on REITs and while the shares seem expensive on most commonly used metrics such as P / FFO
REITs Jay Habermann/ or NAV and dividend yield, we view valuation as fair from an implied cap rate basis. Today REITs trade at implied cap rates Buy: CBG*
(Neutral) Sloan Bohlen close to 7% which we believe is acceptable given how risk free rates currently are. We continue to highlight REITs with Sell: BRE*
discounted multiples vs. peers as our top REIT stock picks (CBL, BPO and TCO).
We maintain a Neutral ratings for both Moody's Corporation (MCO) and McGraw-Hill (MHP) but believe double-digit earnings
Rating Agencies growth potential and highly efficient cash flow conversion are compelling drivers as the global debt markets continue to recover
Sloan Bohlen na
(Cauious**) and grow. That said, we also maintain a Cautious outlook as we believe upside for investors remains hindered through 2010
due to unclear risks posed by potential regulatory and legal reform.
We remain Neutral rated on HRB but keep a Cautious outlook given headwinds presented by both the macro environment
Tax Preparers (high unemployment) and changing consumer preferences (shift to digital). Both HRB and JTX have lost market share season-
Sloan Bohlen na
(Cautious**) to-date for various reasons but in summary we believe pricing power for traditional "brick and mortar" tax prep services has
been impaired and presents potential structural challenges to the current business model.
We are Attractive on the homebuilders as five factors are like to drive higher equity prices for the space: (1) a solid spring
Homebuilders selling season (2) further stability in home prices (3) low mortgage rates (4) a return to positive non farm payrolls and (5) the Buy: DHI*
Josh Pollard
(Attractive) share shift to large public builders away form small private developers. The investing framework within our coverage is to "Buy Sell:
the Profits." After 3 straight years of losses we believe that builders with 2010 profits will outperform the space.
Credit research
Concerns over regulatory reform, capital guidelines and resulting rating agency downgrades dominate the sector once again
US Banks OP: BAC
Louise Pitt as issuance volumes are light and spreads continue to remain firm. 1Q earnings less of a driver of performance in our view as
(Attractive) U: WFC
investors focus on the longer term reform implications.
Focus remains on restructuring stories as liability management transactions continue and the divergence in spreads is still
OP: LLOYDS,
European Banks wider than in the US banks. Concerns over new capital guidelines also worrying investors but realization of bondholder losses
Louise Pitt BPCEGP, STANLN
(Attractive) in stress scenarios has been more prevalent in parts of Europe so this is less of a “new” risk. Spreads offer better value in our
U: ISPIM, ACAFP, BNP
view in both cash and CDS with exception of Italian and most of French banks where spreads remain tight.
Within the non-life space, we prefer relatively wider triple-B names to the much tighter “top of class” names. The pricing cycle
remains a defining industry issue, and within our preferred triple-B p/c space we favor short-tail personal lines writers such as
Donna Halverstadt/ Farmers. While the intensity of concerns over capital and asset quality in the Life space have subsided, they have not OP: Farmers, CNA
Insurance
Amanda Lynam disappeared. One of our favorite names from a fundamental perspective has been Unum, which has been/remains in a much U: ENH
more stable space compared to traditional ‘life’ names. Relatively tight spreads drive our Neutral rating on the UNM bond, but
relative to other insurance names we find it attractive in CDS.
We are Neutral on the MI space as we see potentially positive swing factors being counter-acted by continuing uncertainties.
Recent positive news include an increased focus on principal forgiveness on the part of both private and public entities and a
Donna Halverstadt/ OP: RDN
Mortgage Insurance reported jump in cure rates. Continuing concerns include GSE-resolution (the debate is just beginning but contains potential
Amanda Lynam U: PMI
seeds of uncertainty over the future demand for private MI), still-nascent economic and housing recoveries, and the ability to
support both embedded losses and more robust new business with current capital bases.
** Rating Agencies and Tax Preparers fall into our Specialty Finance coverage group.

Exhibit 66: Price target data for select financial stocks
Target price Upside/downside

Company name Ticker Sector Rating Market cap (current) Price Target price period to target price Analyst
ACE Limited ACE Insurance Buy 18.0 53.56 61.00 12 months 14% Christopher M. Neczypor
The Allstate Corp. ALL Insurance Sell 17.6 32.77 28.00 12 months -15% Christopher M. Neczypor
Bank of America Corporation BAC Banks Buy* 185.0 18.62 20.00 12 months 7% Richard Ramsden
Franklin Resources, Inc. BEN Asset Managers Buy* 25.9 112.83 130.00 12 months 15% Marc Irizarry
BRE Properties, Inc. BRE REITS Sell* 1.9 37.05 25.00 12 months -33% Jonathan Habermann
The Blackstone Group L.P. BX Asset Managers Buy* 16.6 14.68 18.00 12 months 23% Marc Irizarry
CB Richard Ellis Group Inc. CBG REITS Buy* 3.9 16.23 18.00 12 months 11% Sloan Bohlen
Comerica, Inc. CMA Banks Buy 6.1 40.79 44.00 12 months 8% Brian Foran
Comerica, Inc. CMA Banks Buy 6.1 40.79 44.00 12 months 8% Brian Foran
CME Group Inc. CME MktStructure Buy 20.9 314.31 375.00 12 months 19% Daniel Harris, CFA
Discover Financial Services DFS Banks Buy 8.2 15.17 16.00 12 months 5% Brian Foran
D.R. Horton, Inc. DHI Homebuilders Buy* 3.8 11.93 17.00 6 months 42% Joshua Pollard
E*TRADE Financial Corp. ETFC MktStructure Buy 3.2 1.71 1.90 12 months 11% Daniel Harris, CFA
Evercore Partners Inc. EVR MktStructure Buy* 1.2 30.68 40.00 12 months 30% Daniel Harris, CFA
Federated Investors, Inc. FII Asset Managers Sell* 2.7 26.52 21.00 12 months -21% Marc Irizarry
Fifth Third Bancorp FITB Banks Buy 11.4 14.30 16.00 12 months 12% Brian Foran
Hudson City Bancorp, Inc. HCBK Banks Sell 7.5 14.20 13.00 12 months -8% Brian Foran
The Hartford Financial Services HIG Insurance Sell 9.3 28.50 25.00 12 months -12% Christopher M. Neczypor
Jefferies Group Inc. JEF MktStructure Sell 5.1 25.49 26.00 6 months 2% Daniel Harris, CFA
J.P. Morgan Chase & Co. JPM Banks Buy* 178.7 45.32 54.00 12 months 19% Richard Ramsden
KeyCorp KEY Banks Buy 7.5 8.52 10.00 12 months 17% Brian Foran
Lazard Ltd. LAZ MktStructure Buy 4.9 36.40 47.00 12 months 29% Daniel Harris, CFA
Lincoln National Corp. LNC Insurance Buy 9.5 31.36 27.00 12 months -14% Christopher M. Neczypor
MGIC Investment Corp. MTG Insurance Buy 1.4 11.51 10.00 12 months -13% Christopher M. Neczypor
The Nasdaq Stock Market, Inc. NDAQ MktStructure Buy* 4.6 21.42 25.00 12 months 17% Daniel Harris, CFA
The Progressive Corporation PGR Insurance Buy 13.2 19.45 20.00 12 months 3% Christopher M. Neczypor
Piper Jaffray Companies Inc. PJC MktStructure Buy 0.7 42.67 55.00 12 months 29% Daniel Harris, CFA
The PMI Group, Inc. PMI Insurance Sell 0.6 6.81 3.00 12 months -56% Christopher M. Neczypor
SunTrust Banks, Inc. STI Banks Buy* 14.2 28.53 35.00 12 months 23% Brian Foran
Unum Group UNM Insurance Buy 8.4 25.36 26.00 12 months 3% Christopher Giovanni
TSX Group, Inc. X.TO MktStructure Sell 2.2 29.54 28.00 12 months -5% Daniel Harris, CFA
XL Capital Ltd. XL Insurance Buy 6.7 19.47 23.00 12 months 18% Christopher M. Neczypor
For important disclosures, please go to http://www.gs.com/research/hedge.html.
For methodology and risks associated with our price targets, please see our previously published research.

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GS Financials Positioning For The Next Leg of The Rally

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GS Financials Positioning For The Next Leg of The Rally

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April 7, 2010 United States: Financial Services

The Goldman Sachs Group, Inc. Global Investment Research

Portfolio Manager Summary: Life after the crisis 3

GS Financials Equity Research Team

GS Financials Credit Research Team Financials Specialist

Goldman Sachs Global Investment Research 2

We highlight four key themes for stock-picking across the sector:

Goldman Sachs Global Investment Research 3

Exhibit 1: Top Ideas across the Financials sector

For important disclosures, please go to http://www.gs.com/research/hedge.html.

Source: Goldman Sachs Research estimates.

Credit Coverage Views 5 600

Goldman Sachs Global Investment Research 4

Thinking about Financials in the context of a portfolio

40 Current Current SPX Current (bp)

Multi-line Insurance Real Estate Services Diversified Banks 223 206 17

Source: Lionshare via FactSet and Goldman Sachs ECS Research.

Goldman Sachs Global Investment Research 5

Goldman Sachs Global Investment Research 6

Goldman Sachs Global Investment Research 7

Return on Tangible Equity

Goldman Sachs Global Investment Research 8

Implied Normalized EPS

18.0x Indicates "Buy" rated stock

12.0x Price to Earnings

Source: FactSet, Goldman Sachs Research estimates..

Goldman Sachs Global Investment Research 9

A return to micro from macro

1-year 1-year 5-year 5-year

SPX S&P 500 0.46 0.38 0.69 0.34 0.76 10%

Goldman Sachs Global Investment Research 10

Theme #1: Provision leverage in consumer loan portfolios

Credit Card Leveraged Loans (proxy for C&I)

Lagging 12-month Default Rate

MBS (2006 & 2007 vintages) CMBS

CMBS - MoM change, 60+ Delinquency

3Q08 3Q09 Avg chg in delinquency

Goldman Sachs Global Investment Research 11

Exhibit 22: Scorecard – stocks with leverage to US consumer credit moderation

US consumer credit cost as % of US consumer credit cost as % of US consumer credit as % of

Source: Company reports, FactSet, Goldman Sachs Research.

Goldman Sachs Global Investment Research 12

Year 4Q FY0 1Q FY1 1Q vs. 4Q (bps)

Avg QoQ change since 1985

Source: Federal Reserve, Goldman Sachs Research.

Goldman Sachs Global Investment Research 13

Dividend Growth (2009-2010)

Goldman Sachs Global Investment Research 14

55.0% Div Payout Ratio* Normalized Div Yield on Normal Div

The PMI Group, Inc. PMI Mortgage Insurance 17.7%

Goldman Sachs Global Investment Research 15

Indexed Price Performance

Source: Biryini Associates, Goldman Sachs Research. Source: Factset.

Goldman Sachs Global Investment Research 16

Theme #3: Capital market should bounce from a disappointing 4Q2009

Goldman Sachs Global Investment Research 17

Goldman Sachs Global Investment Research 18

350 25% 600

Private Equity Dry Powder ($ bn)

Goldman Sachs Global Investment Research 19

Residential real estate showing signs of stabilization

Source: US Census Bureau. Source: US Census Bureau.