SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 28, 2003
Commission File Number 1-7182
MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-2740599
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(State of incorporation) (I.R.S. Employer Identification No.)
4 World Financial Center
New York, New York 10080
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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Registrant's telephone number, including area code
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES X NO
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
926,945,008 shares of Common Stock and 3,377,809 Exchangeable Shares as of the
close of business on May 2, 2003. The Exchangeable Shares, which were issued by
Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland
Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one
basis and entitle holders to dividend, voting, and other rights equivalent to
Common Stock.
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Three Months Ended
-----------------------------
Mar. 28, Mar. 29, Percent
(in millions, except per share amounts) 2003 2002 Inc. (Dec.)
------- ------- ---------
NET REVENUES
Commissions $ 1,069 $ 1,242 (13.9)%
Principal transactions 1,010 877 15.2
Investment banking
Underwriting 368 466 (21.0)
Strategic advisory 125 183 (31.7)
Asset management and portfolio service fees 1,127 1,293 (12.8)
Other 205 219 (6.4)
------- -------
Subtotal 3,904 4,280 (8.8)
------- -------
Interest and dividend revenues 3,021 3,284 (8.0)
Less interest expense 2,071 2,474 (16.3)
------- -------
Net interest profit 950 810 17.3
------- -------
TOTAL NET REVENUES 4,854 5,090 (4.6)
------- -------
NON-INTEREST EXPENSES
Compensation and benefits 2,496 2,646 (5.7)
Communications and technology 403 474 (15.0)
Occupancy and related depreciation 216 238 (9.2)
Brokerage, clearing, and exchange fees 170 198 (14.1)
Advertising and market development 121 150 (19.3)
Professional fees 144 130 10.8
Office supplies and postage 58 69 (15.9)
Other 224 173 29.5
------- -------
TOTAL NON-INTEREST EXPENSES 3,832 4,078 (6.0)
------- -------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,022 1,012 1.0
Income tax expense 289 316 (8.5)
Dividends on preferred securities issued by subsidiaries 48 49 (2.0)
------- -------
NET EARNINGS $ 685 $ 647 5.9
======= =======
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 676 $ 638 6.0
======= =======
EARNINGS PER COMMON SHARE
Basic $ 0.76 $ 0.75
======= =======
Diluted $ 0.72 $ 0.67
======= =======
DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16
======= =======
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 887.6 854.8
======= =======
Diluted 939.2 949.2
======= =======
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See Notes to Condensed Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 28, Dec. 27,
(dollars in millions) 2003 2002
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ASSETS
CASH AND CASH EQUIVALENTS $ 14,132 $ 10,211
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 7,585 7,375
SECURITIES FINANCING TRANSACTIONS
Receivables under resale agreements 78,434 75,292
Receivables under securities borrowed transactions 48,067 45,543
-------- --------
126,501 120,835
TRADING ASSETS, AT FAIR VALUE (includes securities pledged as collateral of
$15,910 in 2003 and $11,344 in 2002)
Contractual agreements 38,140 38,728
Corporate debt and preferred stock 19,329 18,569
Mortgages, mortgage-backed, and asset-backed 15,578 14,987
Non-U.S. governments and agencies 13,959 10,095
Equities and convertible debentures 13,003 13,530
U.S. Government and agencies 9,607 10,116
Municipals and money markets 4,793 5,535
-------- --------
114,409 111,560
INVESTMENT SECURITIES 77,911 81,787
SECURITIES RECEIVED AS COLLATERAL 2,261 2,020
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $77 in 2003 and $79 in 2002) 35,476 35,317
Brokers and dealers 8,485 8,485
Interest and other 9,408 10,581
-------- --------
53,369 54,383
-------- --------
LOANS, NOTES, AND MORTGAGES (net of allowances of $301 in 2003 and $265 in 2002) 34,451 34,735
SEPARATE ACCOUNTS ASSETS 12,937 13,042
EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization
of $4,771 in 2003 and $4,671 in 2002) 3,105 3,080
GOODWILL (net of accumulated amortization of $973 in 2003 and $984 in 2002) 4,362 4,446
OTHER ASSETS 4,564 4,454
-------- --------
TOTAL ASSETS $455,587 $447,928
======== ========
3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 28, Dec. 27,
(dollars in millions, except per share amount) 2003 2002
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LIABILITIES
SECURITIES FINANCING TRANSACTIONS
Payables under repurchase agreements $ 85,278 $ 85,378
Payables under securities loaned transactions 8,642 7,640
-------- --------
93,920 93,018
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 3,509 5,353
DEPOSITS 81,883 81,842
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 42,590 45,202
U.S. Government and agencies 15,736 14,678
Non-U.S. governments and agencies 11,542 7,952
Equities and convertible debentures 7,923 4,864
Corporate debt, municipals and preferred stock 7,918 6,500
-------- --------
85,709 79,196
-------- --------
OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 2,261 2,020
OTHER PAYABLES
Customers 28,397 28,569
Brokers and dealers 21,758 16,541
Interest and other 18,408 20,724
-------- --------
68,563 65,834
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 3,492 3,566
SEPARATE ACCOUNTS LIABILITIES 12,937 13,042
LONG-TERM BORROWINGS 77,014 78,524
-------- --------
TOTAL LIABILITIES 429,288 422,395
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,660 2,658
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY (42,500 SHARES ISSUED AND OUTSTANDING, 425 425
LIQUIDATION PREFERENCE $10,000 PER SHARE) -------- --------
COMMON STOCKHOLDERS' EQUITY
Shares exchangeable into common stock 55 58
Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares;
issued: 2003 - 1,040,382,957 shares; 2002 - 983,502,078 shares) 1,387 1,311
Paid-in capital 5,918 5,315
Accumulated other comprehensive loss (net of tax) (540) (570)
Retained earnings 18,605 18,072
-------- --------
25,425 24,186
Less: Treasury stock, at cost: 2003 - 116,944,375 shares; 2002 - 116,211,158 shares 1,096 961
Unamortized employee stock grants 1,115 775
-------- --------
Total Common Stockholders' Equity 23,214 22,450
-------- --------
Total Stockholders' Equity 23,639 22,875
-------- --------
Total Liabilities, Preferred Securities Issued by Subsidiaries,
and Stockholders' Equity $455,587 $447,928
======== ========
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See Notes to Condensed Consolidated Financial Statements
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Three Months Ended
-----------------------------
(dollars in millions) Mar. 28, Mar. 29,
2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 685 $ 647
Noncash items included in earnings:
Depreciation and amortization 148 170
Policyholder reserves 40 46
Amortization of stock-based compensation 168 176
Deferred taxes 440 218
Other 51 658
Changes in operating assets and liabilities:
Trading assets (2,923) 3,585
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations (210) (1,235)
Receivables under resale agreements (3,141) (1,062)
Receivables under securities borrowed transactions (2,524) (5,123)
Customer receivables (699) (487)
Brokers and dealers receivables - (5,652)
Trading liabilities 6,513 (17)
Payables under repurchase agreements (100) 10,621
Payables under securities loaned transactions 1,002 (2,141)
Customer payables (172) 989
Brokers and dealers payables 5,217 (836)
Other, net (1,459) 812
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Cash provided by operating activities 3,036 1,369
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 6,200 6,864
Sales of available-for-sale securities 15,277 7,146
Purchases of available-for-sale securities (15,805) (9,875)
Maturities of held-to-maturity securities 39 74
Purchases of held-to-maturity securities (203) (185)
Loans, notes, and mortgages 245 (2,661)
Other investments and other assets (1,385) 77
Equipment and facilities (173) (365)
------- --------
Cash provided by investing activities 4,195 1,075
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (1,844) (548)
Deposits 41 65
Issuance and resale of long-term borrowings 5,863 9,212
Settlement and repurchases of long-term borrowings (7,311) (8,149)
Issuance of common stock 117 99
Issuance of treasury stock 2 2
Other common stock transactions (26) (10)
Dividends (152) (149)
------- --------
Cash (used for) provided by financing activities (3,310) 522
------- --------
Increase in cash and cash equivalents 3,921 2,966
Cash and cash equivalents, beginning of year 10,211 11,070
------- --------
Cash and cash equivalents, end of period $14,132 $ 14,036
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 30 $ 41
Interest 2,031 2,091
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See Notes to Condensed Consolidated Financial Statements
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 28, 2003
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NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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For a complete discussion of Merrill Lynch's accounting policies, refer to the
excerpt of the Annual Report included as an exhibit to Form 10-K for the year
ended December 27, 2002 ("2002 Annual Report").
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of Merrill
Lynch & Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch").
All material intercompany balances have been eliminated. The interim
consolidated financial statements for the three-month periods are unaudited;
however, in the opinion of Merrill Lynch management, all adjustments (consisting
of normal recurring accruals) necessary for a fair statement of the consolidated
financial statements have been included.
These unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the audited consolidated financial statements included in the
2002 Annual Report. The December 27, 2002 unaudited Condensed Consolidated
Balance Sheet was derived from the audited 2002 financial statements. The nature
of Merrill Lynch's business is such that the results of any interim period are
not necessarily indicative of results for a full year. In presenting the
Condensed Consolidated Financial Statements, management makes estimates that
affect the reported amounts and disclosures in the financial statements.
Estimates, by their nature, are based on judgment and available information.
Therefore, actual results could differ from those estimates and could have a
material impact on the Condensed Consolidated Financial Statements, and it is
possible that such changes could occur in the near term. Certain
reclassifications have been made to prior period financial statements, where
appropriate, to conform to the current period presentation.
New Accounting Pronouncements
On April 30, 2003, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The new guidance
amends SFAS No. 133 for decisions made as part of the Derivatives Implementation
Group ("DIG") process that effectively required amendments to SFAS No. 133, and
decisions made in connection with other FASB projects dealing with financial
instruments and in connection with implementation issues raised in relation to
the application of the definition of a derivative and characteristics of a
derivative that contains financing components. In addition, it clarifies when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. Merrill Lynch is currently assessing the impact of SFAS No. 149 on the
Consolidated Financial Statements.
On July 31, 2002, the AICPA issued a Proposed Statement of Position ("SOP")
Accounting and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts. The proposed Statement
provides guidance on accounting and reporting by insurance companies for certain
nontraditional long-duration contracts and for separate accounts. A final SOP
would be effective for financial statements for Merrill Lynch beginning in 2004.
The SOP would require the establishment of a liability for contracts that
contain death or other insurance benefits using a specified reserve methodology
that is different from the methodology that Merrill Lynch currently employs.
Depending on market conditions at the time of adoption, the impact of
implementing this reserve methodology may have a material impact on the
Consolidated Statement of Earnings.
On January 17, 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46") which
clarifies when an entity should consolidate another entity known as a Variable
Interest Entity ("VIE"), more commonly referred to as an SPE. A VIE is an entity
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties, and may include many types of qualifying special purpose entities
("QSPEs"). FIN 46 requires that an entity consolidate a VIE if that enterprise
has a variable interest that will absorb a majority of the VIE's expected
losses, receive a majority of the VIE's expected residual returns, or both. FIN
46 does not apply to QSPEs, the accounting for which is governed by Statement of
Financial Accounting Standards ("SFAS") No. 140. FIN 46 is effective for VIEs
created on or after February 1, 2003 and for existing VIEs as of the third
quarter of 2003. See Note 8 to the Consolidated Financial Statements in the 2002
Annual Report for disclosures regarding the expected impact of adoption of FIN
46 on Merrill Lynch's Consolidated Balance Sheets.
6
On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of SFAS No. 123. SFAS No.
148 permits three alternative methods for a voluntary transition to the fair
value-based method of accounting for employee stock-based compensation. SFAS No.
148 continues to permit prospective application for companies that adopt prior
to the beginning of fiscal year 2004. SFAS No. 148 also allows for a modified
prospective application, which requires the fair value of all unvested awards to
be amortized over the remaining service period, as well as a restatement of
prior years' expense. The transition guidance and annual disclosure provisions
of SFAS No. 148 are effective for fiscal years ending after December 15, 2002,
with earlier application permitted in certain circumstances.
On November 25, 2002, the FASB issued FIN 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others - an Interpretation of FASB Statements No. 5, 57, and 107
and Rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to
disclose their obligations under certain guarantees. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN 45 apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosures are
effective for financial statements of interim or annual periods ending after
December 15, 2002. See Note 10 to the Condensed Consolidated Financial
Statements for these disclosures.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This standard requires companies to recognize
certain costs associated with exit or disposal activities when they are incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.
146 will replace the existing guidance provided by EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring).
Merrill Lynch adopted SFAS No. 146 as of January 1, 2003, which had no material
impact on the Condensed Consolidated Financial Statements.
7
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NOTE 2. OTHER SIGNIFICANT EVENTS
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Restructuring and Other Charges
During the fourth quarter of 2001, Merrill Lynch's management formally committed
to a restructuring plan designed to position Merrill Lynch for improved
profitability and growth, which included the resizing of selected businesses and
other structural changes. As a result, Merrill Lynch incurred a fourth quarter
2001 pre-tax charge to earnings of $2.2 billion, which included restructuring
costs of $1.8 billion and other charges of $396 million. Utilization of the
restructuring reserve and a rollforward of staff reductions at March 28, 2003 is
as follows:
(dollars in millions)
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Utilized in
------------------------------ Balance
Initial Mar. 28,
Balance 2001 2002(1) 2003 2003
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Category:
Severance costs $1,133 $ (214) $ (874) $ (16) $ 29
Facilities costs 299 - (15) (14) 270
Technology and fixed asset write-offs 187 (187) - - -
Other Costs 178 - (119) (1) 58
------ ------ ------- ------ ------
$1,797 $ (401) $(1,008) $ (31) $ 357
------ ------ ------- ------ ------
Staff Reductions 6,205 (749) (5,233) (58) 165
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(1) The 2002 utilization included changes in estimates which are attributable to
differences in actual costs from initial estimates in implementing the original
restructuring plan. As a result of changes in estimates, net reserves of $9
million were reversed in 2002. Refer to Note 3 in the 2002 Annual Report for
additional information.
8
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NOTE 3. SEGMENT INFORMATION
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In reporting to management, Merrill Lynch's operating results are categorized
into three business segments: the Global Markets and Investment Banking Group
("GMI"), Global Private Client ("GPC") and Merrill Lynch Investment Managers
("MLIM"). Prior period amounts have been restated to conform to the current
period presentation. For information on each segment's business activities, see
the 2002 Annual Report.
Operating results by business segment are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Corporate
THREE MONTHS ENDED GMI GPC MLIM Items TOTAL
MARCH 28, 2003 -------- ------- ------ --------- --------
Non-interest revenues $ 1,807 $ 1,779 $ 330 $ (12) (1) $ 3,904
Net interest income(2) 653 323 7 (33) (3) 950
-------- ------- ------ ------ --------
Net revenues 2,460 2,102 337 (45) 4,854
Non-interest expenses 1,675 1,833 290 34 (4) 3,832
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 785 $ 269 $ 47 $ (79) $ 1,022
======== ======= ====== ====== ========
Quarter-end total assets $386,329 $59,718 $5,178 $4,362 $455,587
======== ======= ====== ====== ========
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Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
THREE MONTHS ENDED
MARCH 29, 2002
Non-interest revenues $ 1,908 $ 1,953 $ 439 $ (20) (1) $ 4,280
Net interest income(2) 477 346 3 (16) (3) 810
-------- ------- ------ ------ --------
Net revenues 2,385 2,299 442 (36) 5,090
Non-interest expenses 1,742 2,027 328 (19) (4) 4,078
--------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 643 $ 272 $ 114 $ (17) $ 1,012
======== ======= ====== ====== ========
Quarter-end total assets $371,994 $63,037 $5,841 $3,999 $444,871
======== ======= ====== ====== ========
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(1) Primarily represents the elimination of intersegment revenues and expenses.
(2) Management views interest income net of interest expense in evaluating results.
(3) Represents acquisition financing costs and other corporate interest.
(4) Represents elimination of intersegment revenues and expenses, and in 2003
includes a $50 million litigation provision. This litigation provision will be
charged to the business segments when the amounts are fixed and determined.
9
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NOTE 4. INVESTMENT SECURITIES
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Investment securities at March 28, 2003 and December 27, 2002 are presented
below:
(dollars in millions)
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Mar. 28, 2003 Dec. 27, 2002
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Investment securities
Available-for-sale $66,917 $72,229
Trading 3,320 3,337
Held-to-maturity 810 638
Non-qualifying: (1)
Deferred compensation hedges (2) 1,677 1,927
Other (3) 5,187 3,656
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Total $77,911 $81,787
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(1) Non-qualifying for SFAS No. 115 purposes.
(2) Represents investments economically hedging deferred compensation liabilities.
(3) Includes insurance policy loans, merchant banking investments and other
non-qualifying investments.
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NOTE 5. SECURITIZATION TRANSACTIONS
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In the normal course of business, Merrill Lynch securitizes commercial and
residential mortgage and home equity loans; municipal, government, and corporate
bonds; and other types of financial assets. SPEs are often used when entering
into or facilitating securitization transactions. Merrill Lynch's involvement
with SPEs used to securitize financial assets includes: establishing SPEs;
selling assets to SPEs; underwriting, distributing, making loans to SPEs; making
markets in securities issued by SPEs; engaging in derivative transactions with
SPEs; owning notes or certificates issued by SPEs; and/or providing liquidity
facilities and other guarantees to SPEs.
Merrill Lynch securitized assets of $20.5 billion for the three months ended
March 28, 2003. For the three months ended March 28, 2003 and March 29, 2002,
Merrill Lynch received $20.9 billion and $9.8 billion, respectively, of
proceeds, and other cash inflows, from new securitization transactions, and
recognized net securitization gains, excluding gains on related derivative
transactions, of $14.6 million and $13.2 million, respectively in Merrill
Lynch's Condensed Consolidated Statements of Earnings. Merrill Lynch generally
records assets prior to securitization at fair value.
For the first three months of 2003 and 2002, cash inflows from securitizations
related to the following asset types:
(dollars in millions)
- --------------------------------------------------------------------------------------
Mar. 28, 2003 Mar. 29, 2002
- --------------------------------------------------------------------------------------
Asset category
Residential mortgage loans $18,313 $6,724
Municipal bonds 1,352 1,500
Corporate and government bonds 223 278
Commercial loans and other 1,010 1,253
------- -------
$20,898 $9,755
- --------------------------------------------------------------------------------------
10
Retained interests in SPEs were approximately $4.0 billion and $3.3 billion at
March 28, 2003 and December 27, 2002, respectively, which related primarily to
residential mortgage loan and municipal bond securitization transactions. The
majority of the retained interest balance consists of mortgage-backed securities
that have observable market prices. These retained interests include
mortgage-backed securities that Merrill Lynch has committed to purchase and
expects to sell to investors in the normal course of its underwriting activity.
Approximately 72% and 77% at March 28, 2003 and December 27, 2002, respectively,
of residential mortgage loan retained interests consist of interests in U.S.
Government agency sponsored securitizations, which are guaranteed with respect
to principal and interest. In addition, $967 million and $851 million at March
28, 2003 and December 27, 2002, respectively, of the retained interest balance
relates to municipal bond transactions where observable market prices are
available for the underlying assets, which provide the inputs and parameters
used to calculate the fair value of the retained interest.
The following table presents information on retained interests, excluding the
offsetting benefit of financial instruments used to hedge risks, held by Merrill
Lynch as of March 28, 2003 arising from Merrill Lynch's residential mortgage
loan, commercial mortgage loan, and municipal bond securitization transactions.
The sensitivity of the current fair value of the retained interests to immediate
10% and 20% adverse changes in those assumptions and parameters is also shown.
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- -------------------------------------------------------------------------------------------------------------
Retained interest amount $ 2,787 $ 967 $ 222
Weighted average life (in years) 2.8 4.2 N/A
Range 0.0-22.0 0.0-8.0 N/A
Weighted average credit losses (rate per annum) 0.5% 0% 2.2%
Range 0.0-5.5% 0% 0.0-20.0%
Impact on fair value of 10% adverse change $ (5) $ - $ (4)
Impact on fair value of 20% adverse change $ (11) $ - $ (5)
Weighted average discount rate 6.0% 2.6% 4.9%
Range 0.0-75.0% 1.1-6.5% 1.3-22.0%
Impact on fair value of 10% adverse change $ (35) $ (56) $ (2)
Impact on fair value of 20% adverse change $ (68) $ (109) $ (4)
Weighted average prepayment speed (CPR) 22.6% 13.6% N/A
Range 0.0-50.0% 6.0-30.0% N/A
Impact on fair value of 10% adverse change $ (12) $ (2) N/A
Impact on fair value of 20% adverse change $ (21) $ (3) N/A
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N/A=Not Applicable
CPR=Constant Prepayment Rate
The preceding table does not include the offsetting benefit of financial
instruments that Merrill Lynch utilizes to hedge risks including credit,
interest rate, and prepayment risk that are inherent in the retained interests.
Merrill Lynch employs hedging strategies that are structured to take into
consideration the hypothetical stress scenarios above such that they would be
effective in principally offsetting Merrill Lynch's exposure to loss in the
event these scenarios occur. In addition, the sensitivity analysis is
hypothetical and should be used with caution. In particular, the effect of a
variation in a particular assumption on the fair value of the retained interest
is calculated independent of changes in any other assumption; in practice,
changes in one factor may result in changes in another, which might magnify or
counteract the sensitivities. Further, changes in fair value based on a 10% or
20% variation in an assumption or parameter generally cannot be extrapolated
because the relationship of the change in the assumption to the change in fair
value may not be linear.
11
The assumptions and parameters used initially to value retained interests
relating to securitizations effected in 2003 that were still held by Merrill
Lynch as of March 28, 2003 are as follows:
- ------------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- ------------------------------------------------------------------------------------------------------------
Weighted average life (in years) 4.1 0.0-8.0 N/A
Credit losses (rate per annum) 0.2% 0% 0.9-1.2%
Weighted average discount rate 5.6% 2.3-6.8% 0.1-15.0%
Prepayment speed assumption(CPR) 18.8% 6.0-18.0% N/A
- ------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
CPR=Constant Prepayment Rate
For residential mortgage loan and other securitizations, the investors and the
securitization trust have no recourse to Merrill Lynch's other assets for
failure of mortgage holders to pay when due.
For municipal bond securitization SPEs, in the normal course of dealer
market-making activities, Merrill Lynch acts as liquidity provider.
Specifically, the holders of beneficial interests issued by municipal bond
securitization SPEs have the right to tender their interests for purchase by
Merrill Lynch on specified dates at a specified price. Beneficial interests that
are tendered are then sold by Merrill Lynch to investors through a best efforts
remarketing where Merrill Lynch is remarketing agent. If the beneficial
interests are not successfully remarketed, the holders of beneficial interests
are paid from funds drawn under a standby liquidity letter of credit issued by
Merrill Lynch.
Merrill Lynch also provides default protection or credit enhancement to
investors in securities issued by certain municipal bond securitization SPEs.
Interest and principal payments on beneficial interests issued by these SPEs are
secured by a guarantee issued by Merrill Lynch. In the event that the issuer of
the underlying municipal bond defaults on any payment of principal and/or
interest when due, the payments on the bonds will be made to beneficial interest
holders from an irrevocable guarantee by Merrill Lynch.
The maximum commitment under these liquidity and default guarantees totaled
$16.9 billion and $13.7 billion at March 28, 2003 and December 27, 2002,
respectively. The fair value of the commitments approximates $36 million and $69
million at March 28, 2003 and December 27, 2002, respectively, which is
reflected in the Condensed Consolidated Financial Statements. Of these
arrangements, $3.8 billion and $2.3 billion at March 28, 2003 and December 27,
2002, respectively, represent agreements where the guarantee is provided to the
SPE by a third party financial intermediary and Merrill Lynch enters into a
reimbursement agreement with the financial intermediary. In these arrangements,
if the financial intermediary incurs losses, Merrill Lynch has up to one year to
fund those losses. Additional information regarding these commitments is
provided in Note 10 to the Condensed Consolidated Financial Statements and in
Note 14 in the 2002 Annual Report.
12
The following table summarizes principal amounts outstanding, delinquencies, and
net credit losses of securitized financial assets as of March 28, 2003 and
December 27, 2002.
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
-------------- --------- -----
March 28, 2003
Principal Amount Outstanding $39,500 $19,974 $1,931
Delinquencies 78 - -
Net Credit Losses 2 - 21
- -----------------------------------------------------------------------------------------------------------
December 27, 2002
Principal Amount Outstanding $23,107 $18,379 $2,476
Delinquencies 90 - 3
Net Credit Losses 5 - 44
- -----------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 6. LOANS, NOTES, AND MORTGAGES AND RELATED COMMITMENTS TO EXTEND CREDIT
- --------------------------------------------------------------------------------
Loans, Notes, and Mortgages and related commitments to extend credit at March
28, 2003 and December 27, 2002, are presented below:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------
Loans Commitments
------------------------ ------------------------
Mar. 28, Dec. 27, Mar. 28, Dec. 27,
2003 2002 2003(1) 2002
- --------------------------------------------------------------------- ------------------------
Consumer and small and middle-market $ 24,719 $ 23,749 $ 9,422 $ 8,318
business - secured
Commercial:
Secured 7,064 6,873 4,193 4,450
Unsecured investment grade 2,208 3,434 11,180 10,882
Unsecured non-investment
grade 460 679 258 293
-------- -------- -------- --------
Total $ 34,451 $ 34,735 $ 25,053 $ 23,943
- ----------------------------------------------------------------------------------------------------------
(1) See Note 10 for a maturity profile of these commitments.
The loan amounts are net of an allowance for loan losses of $301 million and
$265 million as of March 28, 2003 and December 27, 2002, respectively.
Consumer and small and middle-market business loans, which at March 28, 2003
consisted of approximately 100,000 individual loans, include residential
mortgages, home equity loans, small and middle-market business loans, and other
loans to individuals for household, family, or other personal expenditures.
Commercial loans, which at March 28, 2003 consisted of approximately 5,000
individual loans, include syndicated loans and other loans to corporations and
other businesses. Secured loans and commitments include lending activities made
in the normal course of Merrill Lynch's securities and financing businesses. The
investment grade and non-investment grade categorization is determined using the
credit rating agency equivalent of internal credit ratings. Non-investment grade
counterparties are those rated lower than BBB. Merrill Lynch enters into credit
default swaps to mitigate credit exposure primarily related to funded and
unfunded unsecured commercial loans. The notional value of these swaps totaled
$3.8 billion at March 28, 2003 and December 27, 2002.
13
The above amounts include $6.1 billion and $6.2 billion of loans held for sale
at March 28, 2003 and December 27, 2002, respectively. Loans held for sale are
loans which management expects to sell prior to maturity. At March 28, 2003,
such loans consisted of $3.2 billion of consumer loans, primarily residential
mortgages, and $2.9 billion of commercial loans, approximately 35% of which are
to investment grade counterparties. At December 27, 2002, such loans consisted
of $3.2 billion of consumer loans, primarily residential mortgages, and $3.0
billion of commercial loans, approximately 49% of which were to investment grade
counterparties. For information on the accounting policy related to loans, notes
and mortgages, see Note 1 to the Consolidated Financial Statements in the 2002
Annual Report.
- --------------------------------------------------------------------------------
NOTE 7. SHORT-TERM BORROWINGS AND DEPOSITS
- --------------------------------------------------------------------------------
Short-term borrowings and Deposits at March 28, 2003 and December 27, 2002 are
presented below:
(dollars in millions)
- --------------------------------------------------------------------------------------
Mar. 28, 2003 Dec. 27, 2002
- --------------------------------------------------------------------------------------
Commercial paper and other short-term
borrowings
Commercial paper $ 2,967 $ 3,966
Other 542 1,387
-------- -------
Total $ 3,509 $ 5,353
-------- -------
Deposits
U.S. $ 68,825 $68,550
Non U.S. 13,058 13,292
-------- -------
Total $ 81,883 $81,842
- --------------------------------------------------------------------------------------
14
- --------------------------------------------------------------------------------
NOTE 8. COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The components of comprehensive income are as follows:
(dollars in millions)
- ---------------------------------------------------------------------------------------------
Three Months Ended
---------------------------
Mar. 28, Mar. 29,
2003 2002
---------------------------
Net Earnings $ 685 $ 647
------- -------
Other comprehensive income (loss), net of tax:
Currency translation adjustment 6 (15)
Net unrealized gain on investment
securities available-for-sale 18 17
Deferred gain (loss) on cash flow hedges 6 (35)
------- -------
Total other comprehensive income (loss),
net of tax 30 (33)
------- -------
Comprehensive income $ 715 $ 614
- ---------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 9. EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
The computation of earnings per common share is as follows:
(dollars in millions, except per share amounts)
- ---------------------------------------------------------------------------------------------
Three Months Ended
----------------------------
Mar. 28, Mar. 29,
2002 2003
-------- --------
Net Earnings $ 685 $ 647
Preferred stock dividends 9 9
-------- --------
Net earnings applicable to common stockholders $ 676 $ 638
-------- --------
- ---------------------------------------------------------------------------------------------
(shares in thousands)
Weighted-average shares outstanding 887,553 854,815
-------- --------
Effect of dilutive instruments(1) (2):
Employee stock options 18,453 45,023
Financial Advisor Capital Accumulation
Award Plan shares 20,373 24,913
Restricted shares and units 12,723 24,372
Employee Stock Purchase Plan shares 118 114
-------- --------
Dilutive potential common shares 51,667 94,422
-------- --------
Total weighted-average diluted shares 939,220 949,237
-------- --------
- ---------------------------------------------------------------------------------------------
Basic earnings per common share $0.76 $0.75
Diluted earnings per common share $0.72 $0.67
- ---------------------------------------------------------------------------------------------
(1) During the 2003 and 2002 first quarter there were 130 million and 69
million instruments, respectively, that were considered antidilutive and
not included in the above computations.
(2) See Note 16 to the Consolidated Financial Statements in the 2002 Annual
Report for a description of these instruments.
15
- --------------------------------------------------------------------------------
NOTE 10. COMMITMENTS, CONTINGENCIES AND GUARANTEES
- --------------------------------------------------------------------------------
Litigation
Merrill Lynch has been named as a defendant in various legal actions, including
arbitrations, class actions, and other litigation arising in connection with its
activities as a global diversified financial services institution. The general
decline of equity securities prices that began in 2000 has resulted in increased
legal actions against many firms, including Merrill Lynch, and will likely
result in higher professional fees and litigation expenses than those incurred
in the past.
Some of the legal actions include claims for substantial compensatory and/or
punitive damages or claims for indeterminate amounts of damages. In some cases,
the issuers who would otherwise be the primary defendants in such cases are
bankrupt or otherwise in financial distress. Merrill Lynch is also involved,
from time to time, in investigations and proceedings by governmental and
self-regulatory agencies. The number of these investigations has also increased
in recent years with regard to many firms, including Merrill Lynch.
Some of these legal actions, investigations or proceedings are likely to result
in adverse judgments, penalties, injunctions or fines. Merrill Lynch believes it
has strong defenses to, and where appropriate, will vigorously contest these
actions. In view of the inherent difficulty of predicting the outcome of such
matters, particularly in cases in which claimants seek substantial or
indeterminate damages, Merrill Lynch often cannot predict what the eventual loss
or range of loss related to such matters will be. Merrill Lynch believes, based
on information available to us, that the resolution of these actions will not
have a material adverse effect on the financial condition of Merrill Lynch as
set forth in the Condensed Consolidated Financial Statements, but may be
material to Merrill Lynch's operating results or cash flows for any particular
period and may impact ML & Co.'s credit ratings.
Commitments
At March 28, 2003, Merrill Lynch commitments had the following expirations:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Commitment expiration
---------------------------------------------------
Less than
Total 1 year 1 - 3 years 4 - 5 years Over 5 years
- ----------------------------------------------------------------------------------------------------------------
Commitments to extend credit(1) $25,053 $13,088 $2,938 $6,086 $2,941
Binding margin commitments 5,147 5,147 - - -
Partnership interests 517 240 20 120 137
Other commitments 2,021 1,470 325 67 159
Operating leases 4,144 525 1,019 866 1,734
Resale agreements 7,705 7,705 - - -
Repurchase agreements 4,074 4,074 - - -
------- ------- ------ ------ ------
Total $48,661 $32,249 $4,302 $7,139 $4,971
- ----------------------------------------------------------------------------------------------------------------
(1) See Note 6 to the Condensed Consolidated Financial Statements and Note 14 in
the 2002 Annual Report for additional details.
16
Other Commitments
Merrill Lynch also obtains commercial letters of credit from issuing banks to
satisfy various counterparty collateral requirements in lieu of depositing cash
or securities collateral. Commercial letters of credit aggregated $388 million
and $434 million at March 28, 2003 and December 27, 2002, respectively.
Merrill Lynch has entered into agreements with providers of market data,
communications, and systems consulting services. Minimum fee commitments over
the remaining life of these agreements aggregated $572 million and $527 million
at March 28, 2003 and December 27, 2002, respectively. Merrill Lynch has entered
into other purchasing commitments totaling $1.3 billion and $1.4 billion at
March 28, 2003 and December 27, 2002, respectively.
Leases
Merrill Lynch has entered into various noncancellable long-term lease agreements
for premises that expire through 2024. Merrill Lynch has also entered into
various noncancellable short-term lease agreements, which are primarily
commitments of less than one year under equipment leases.
Merrill Lynch established two SPEs to finance its Hopewell, New Jersey campus
and an aircraft. Merrill Lynch leases the facilities and the aircraft from the
SPEs. The assets and liabilities of these SPEs are not consolidated in the
financial statements of Merrill Lynch as they meet the accounting requirements
of EITF Issue No. 90-15. More specifically, in addition to the other
requirements of EITF No. 90-15, both of these SPEs have third-party investors
who have made a substantive capital investment in the SPEs in the amount of 3%
that is at risk during the entire term of the lease. The total amount of funds
raised by the SPEs to finance these transactions was $383 million at March 28,
2003 and December 27, 2002.
Guarantees
Merrill Lynch issues various guarantees to counterparties in connection with
certain leasing, securitization and other transactions. In addition, Merrill
Lynch enters into certain derivative contracts that meet the accounting
definition of a guarantee under FIN 45. FIN 45 defines guarantees to include
derivative contracts that contingently require a guarantor to make payment to a
guaranteed party based on changes in an underlying (such as changes in the value
of interest rates, security prices, currency rates, commodity prices, indices,
etc.) that relate to an asset, liability or equity security of a guaranteed
party. Derivatives that meet the FIN 45 definition of guarantees include certain
written options and credit default swaps (contracts that require Merrill Lynch
to pay the counterparty the par value of a referenced security if that
referenced security defaults). Merrill Lynch does not track, for accounting
purposes, whether its clients enter into these derivative contracts for
speculative or hedging purposes. Accordingly, Merrill Lynch has disclosed
information about all credit default swaps and certain types of written options
that can potentially be used by clients to protect against changes in an
underlying, regardless of how the contracts are used by the client.
For certain derivative contracts such as written interest rate caps and written
currency options, the maximum payout is not quantifiable, because, for example,
the rise in interest or foreign exchange rates could theoretically be unlimited.
In addition, Merrill Lynch does not monitor its exposure to derivatives in this
manner. As such, rather than including the maximum payout, the notional value of
these contracts has been included to provide information about the magnitude of
involvement with these types of contracts. However, it should be noted that the
notional value generally overstates Merrill Lynch's exposure to these contracts.
17
Merrill Lynch records all derivative transactions at fair value on its Condensed
Consolidated Balance Sheets. As previously noted, Merrill Lynch does not monitor
its exposure to derivative contracts in terms of maximum payout. Instead, a risk
framework is used to define risk tolerances and establish limits to ensure that
certain risk-related losses occur within acceptable, predefined limits. Merrill
Lynch economically hedges its exposure to these contracts by entering into a
variety of offsetting derivative contracts and security positions. See Note 1 to
the Consolidated Financial Statements in the 2002 Annual Report, Derivatives
section for further discussion of risk management of derivatives.
Merrill Lynch also provides guarantees to SPEs in the form of liquidity
facilities, credit default protection and residual value guarantees for
equipment leasing entities.
The liquidity facilities and credit default protection relate primarily to
municipal bond securitization SPEs. Merrill Lynch acts as liquidity provider to
municipal bond securitization SPEs. Specifically, the holders of beneficial
interests issued by these SPEs have the right to tender their interests for
purchase by Merrill Lynch on specified dates at a specified price. If the
beneficial interests are not successfully remarketed, the holders of beneficial
interests are paid from funds drawn under a standby facility issued by Merrill
Lynch (or by third party financial institutions where Merrill Lynch has agreed
to reimburse the financial institution if a draw occurs). If the standby
facility is drawn, Merrill Lynch may claim the underlying assets held by the
SPEs. In general, standby facilities that are not coupled with default
protection are not exercisable in the event of a downgrade below investment
grade or default of the assets held by the SPEs. In addition, the value of the
assets held by the SPE plus any additional collateral pledged to Merrill Lynch
exceeds the amount of beneficial interests issued, which provides additional
support to Merrill Lynch in the event that the standby facility is drawn. The
assets to which Merrill Lynch has recourse are on a deal-by-deal basis and is
not part of a cross collateralized pool. As of March 28, 2003, the value of the
municipal bond assets to which Merrill Lynch has recourse in the event of a draw
was $19.5 billion and the maximum payout if the standby facilities are drawn was
$13.7 billion.
In certain instances, Merrill Lynch also provides default protection in addition
to liquidity facilities. Specifically, in the event that an issuer of a
municipal bond held by the SPE defaults on any payment of principal and/or
interest when due, the payments on the bonds will be made to beneficial interest
holders from an irrevocable guarantee by Merrill Lynch (or by third party
financial institutions where Merrill Lynch has agreed to reimburse the financial
institution if losses occur). If the default protection is drawn, Merrill Lynch
may claim the underlying assets held by the SPEs. As of March 28, 2003, the
value of the assets to which Merrill Lynch has recourse in the event that an
issuer of a municipal bond held by the SPE defaults on any payment of principal
and/or interest when due, was $4.1 billion; the maximum payout if an issuer
defaults was $3.2 billion. As described in the preceding paragraph, the
assets to which Merrill Lynch has recourse are not part of a cross
collateralized pool.
Further, to protect against declines in the value of the assets held by SPEs for
which Merrill Lynch provides either liquidity facilities or default protection,
ML economically hedges its exposure though derivative positions that principally
offset the risk of loss arising from these guarantees.
Merrill Lynch also provides residual value guarantees to leasing SPEs where
either Merrill Lynch or a third party is the lessee. For transactions where
Merrill Lynch is not the lessee, the guarantee provides loss coverage for any
shortfalls in the proceeds from assets sales beyond 75 - 90% of the current book
value of the asset to which the guarantee pertains. As of March 28, 2003, the
value of the assets for which Merrill Lynch provides residual value guarantees
and is not the lessee was $640 million. Where Merrill Lynch is the lessee, it
provides a guarantee that any proceeds from the sale of the assets will amount
to at least 85% of the acquisition cost of the assets.
18
Merrill Lynch also enters into reimbursement agreements in conjunction with
sales of loans originated under its Mortgage 100SM program. Under this program,
borrowers can pledge marketable securities in lieu of making a cash down
payment. Upon sale of these mortgage loans, purchasers may require a surety bond
that reimburses for certain shortfalls in the borrowers' securities accounts.
Merrill Lynch provides this reimbursement through a financial intermediary.
Merrill Lynch requires borrowers to meet daily collateral calls to ensure that
the securities pledged as down payment are sufficient at all times. Merrill
Lynch believes that its potential for loss under these arrangements is remote.
Accordingly, no liability is recorded in the Condensed Consolidated Financial
Statements.
In addition, Merrill Lynch makes guarantees to counterparties in the form of
standby letters of credit. Merrill Lynch holds marketable securities of $191
million as collateral to secure these guarantees. In addition, standby letters
of credit include $111 million of financial guarantees for which Merrill Lynch
has recourse to the guaranteed party upon draw down.
These guarantees are summarized at March 28, 2003 as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------
Maximum
Type of Guarantee Payout/ Notional Carrying Value
- --------------------------------------------------------------------------------------------------
Derivative contracts(1) $721,721 $23,132
Liquidity facilities with SPEs(2) 13,663 36
Liquidity and default facilities with SPEs 3,231 -
Residual value guarantees(3)(4) 1,782 -
Standby letters of credit and other performance
guarantees(5) 471 1
- ---------------------------------------------------------------------------------------------------
(1) As noted above, the notional value of derivative contracts is provided
rather than the maximum payout amount, although the notional value should
not be considered as a substitute for maximum payout.
(2) Amounts relate primarily to facilities provided to municipal bond
securitization SPEs includes $3.8 billion of guarantees provided to SPEs by
third party financial institutions where Merrill Lynch has agreed to
reimburse the financial institution if losses occur, and has up to one year
to fund losses.
(3) Includes residual value guarantees associated with the Hopewell campus and
aircraft SPEs of $325 million.
(4) Includes $773 million of reimbursement agreements with the Mortgage 100SM
program.
(5) Marketable securities are posted as collateral.
Expiration information for these contracts is as follows:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Maximum
Payout/ Less than Over 5
Notional 1 year 1 - 3 years 4 - 5 years years
- ----------------------------------------------------------------------------------------------------------------
Derivative contracts(1) $721,721 $221,291 $197,761 $132,657 $170,012
Liquidity facilities with SPEs(2) 13,663 10,341 3,322 - -
Liquidity and default facilities
with SPEs 3,231 2,654 577 - -
Residual value guarantees(3)(4) 1,782 70 128 276 1,308
Standby letters of credit and other
performance guarantees 471 209 107 37 118
- ----------------------------------------------------------------------------------------------------------------
(1) As noted above, the notional value of derivative contracts is provided
rather than the maximum payout amount, although the notional value should
not be considered as a substitute for maximum payout.
(2) Amounts relate primarily to facilities provided to municipal bond
securitization SPEs. Includes $3.8 billion of guarantees provided to SPEs by
third party financial institutions where Merrill Lynch has agreed to
reimburse the financial institution if losses occur, and has up to one year
to fund losses.
(3) Includes residual value guarantees associated with the Hopewell campus and
aircraft SPEs of $325 million.
(4) Includes $773 million of reimbursement agreements with the Mortgage 100SM
program.
See Note 14 in the 2002 Annual Report for additional information on guarantees.
19
- --------------------------------------------------------------------------------
NOTE 11. EMPLOYEE INCENTIVE PLANS
- --------------------------------------------------------------------------------
Stock-Based Compensation
Merrill Lynch accounts for stock-based compensation in accordance with the
intrinsic value-based method in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, rather than the fair value-based
method in SFAS No. 123, Accounting for Stock-Based Compensation. Refer to Note 1
to the 2002 Annual Report for accounting policy. For the three-month periods
ended March 28, 2003 and March 29, 2002, $201 million ($125 million after-tax)
and $209 million ($130 million after-tax), respectively, of pre-tax compensation
expense related to employee stock compensation awards was recorded in earnings.
Compensation expense for stock options is not recognized since Merrill Lynch
grants stock options that have no intrinsic value. Had Merrill Lynch adopted the
provisions of SFAS No. 123 and accounted for all employee stock awards at fair
value, Merrill Lynch would have recognized additional pre-tax compensation
expense related to employee stock awards of $61 million ($38 million after-tax)
and $402 million ($249 million after-tax), respectively, for the three-month
periods ended March 28, 2003 and March 29, 2002, respectively. The decrease in
expense reflects the change in vesting period for stock options from six months
for 2002 grants, to four years for 2003 grants. Pro forma net earnings and
earnings per share are as follows:
(dollars in millions, except per share amounts)
- --------------------------------------------------------------------------------------
Three Months Ended
- --------------------------------------------------------------------------------------
Mar. 28, 2003 Mar. 29, 2002
------------- -------------
Net Earnings, as reported $ 685 $ 647
Less: stock-based compensation determined
under Black-Scholes method, net of taxes (38) (249)
----- -----
Pro forma net earnings $ 647 $ 398
----- -----
Earnings per share
As reported:
Basic $0.76 $0.75
Diluted 0.72 0.67
Pro forma:
Basic 0.72 0.45
Diluted 0.68 0.41
- --------------------------------------------------------------------------------------
Restricted Unit Conversion
During the first quarter of 2003 a total of 18,656,866 Restricted Units were
converted to Restricted Shares and remain outstanding; no change was made to the
remaining vesting periods and the restricted periods were removed. Additionally,
16,049,636 fully vested Restricted Units were released as a result of the early
removal of the restricted period.
This conversion had no impact on earnings per share as the dilutive impact of
Restricted Units and Restricted Shares has always been included in the diluted
earnings per share calculation. However, book value per common share was
impacted by this conversion as Restricted Shares are included in total shares
outstanding and Restricted Units are not. Book value per common share declined
to $24.97 at March 28, 2003 from $25.69 at December 27, 2002.
20
- --------------------------------------------------------------------------------
NOTE 12. REGULATORY REQUIREMENTS
- --------------------------------------------------------------------------------
Certain U.S. and non-U.S. subsidiaries are subject to various securities and
banking regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which they operate.
Merrill Lynch's principal regulated subsidiaries are discussed below.
Securities Regulation
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S. registered
broker-dealer and futures commission merchant, is subject to the net capital
requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 and the
capital requirements of the Commodities Futures Trading Commission ("CFTC").
Under the alternative method permitted by Rule 15c3-1, the minimum required net
capital, as defined, shall not be less than 2% of aggregate debit items ("ADI")
arising from customer transactions. The CFTC also requires that minimum net
capital should not be less than 4% of segregated and secured requirements. At
March 28, 2003, MLPF&S's regulatory net capital of $3,097 million was
approximately 22% of ADI, and its regulatory net capital in excess of the
minimum required was $2,819 million at 2% of ADI.
Merrill Lynch International ("MLI"), a U.K. regulated investment firm, is
subject to capital requirements of the Financial Services Authority ("FSA").
Financial resources, as defined, must exceed the total financial resources
requirement of the FSA. At March 28, 2003, MLI's financial resources were $5,572
million, exceeding the minimum requirement by $1,176 million.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities, is subject to the capital adequacy requirements of the
Government Securities Act of 1986. This rule requires dealers to maintain liquid
capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1
capital-to-risk standard). At March 28, 2003, MLGSI's liquid capital of $3,087
million was 215% of its total market and credit risk, and liquid capital in
excess of the minimum required was $1,361 million.
Banking Regulation
Two of the subsidiaries of ML & Co., Merrill Lynch Bank USA ("MLBUSA") and
Merrill Lynch Bank & Trust Co. ("MLB&T"), are each subject to certain minimum
aggregate capital requirements under applicable federal banking laws. Among
other things, Part 325 of the FDIC Regulations establishes levels of Risk-Based
Capital ("RBC") each institution must maintain and identifies the possible
actions the federal supervisory agency may take if a bank does not maintain
certain capital levels. RBC is defined as the ratios of (i) Tier I Capital or
Total Capital to (ii) average assets or risk-weighted assets. The following
table presents the actual capital ratios and amounts for MLBUSA and MLB&T at
March 28, 2003 and December 27, 2002.
21
As shown below, MLBUSA and MLB&T each exceed the minimum bank regulatory
requirement for classification as a well-capitalized bank for Tier I leverage --
5%, Tier I capital -- 6% and Total capital -- 10%:
(dollars in millions)
- -------------------------------------------------------------------------------- ------------------------------------
Mar. 28, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------------------------------------------
Tier I leverage (to average assets) Actual Ratio Amount Actual Ratio Amount
------------ ------ ------------ ------
MLBUSA 5.79% $3,920 5.35% $3,740
MLB&T 5.51 821 5.42 848
Tier I capital (to risk-weighted assets)
MLBUSA 11.97 3,920 11.48 3,740
MLB&T 18.40 821 20.53 848
Total capital (to risk-weighted assets)
MLBUSA 12.54 4,107 12.04 3,924
MLB&T 18.41 821 20.54 848
- ---------------------------------------------------------------------------------------------------------------------
22
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of
Merrill Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of March 28,
2003, and the related condensed consolidated statements of earnings and cash
flows for the three-month periods ended March 28, 2003 and March 29, 2002. These
financial statements are the responsibility of Merrill Lynch's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Merrill Lynch as of December 27, 2002, and the related consolidated statements
of earnings, changes in stockholders' equity, comprehensive income and cash
flows for the year then ended (not presented herein); and in our report dated
February 24, 2003, we expressed an unqualified opinion on those consolidated
financial statements and included an explanatory paragraph for the change in
accounting method for goodwill amortization to conform to Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 27, 2002 is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/ Deloitte & Touche LLP
New York, New York
May 8, 2003
23
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Merrill Lynch & Co., Inc. ("ML&Co." and, together with its subsidiaries,
"Merrill Lynch") is a holding company that, through its subsidiaries, provides
broker-dealer, investment banking, financing, advisory, wealth management,
asset management, insurance, lending, and related products and services on a
global basis. In addition, Merrill Lynch makes principal investments for
market making on behalf of its clients and for its own account. The financial
services industry, in which Merrill Lynch is a leading participant, is highly
competitive and highly regulated. This industry and the global financial
markets are influenced by numerous unpredictable factors. These factors
include economic conditions, monetary and fiscal policies, the liquidity of
global markets, international and regional political events, acts of war or
terrorism, changes in applicable laws and regulations, the competitive
environment, and investor sentiment. In addition to these factors, Merrill
Lynch and other financial services companies may be affected by the regulatory
and legislative initiatives which may affect the conduct of its business,
including increased regulation, and by the outcome of legal and regulatory
proceedings. These conditions or events can significantly affect the
volatility of the financial markets as well as the volumes and revenues in
businesses such as brokerage, trading, investment banking, wealth management
and asset management. Revenues and net earnings may vary significantly from
period to period due to these unpredictable factors and the resulting market
volatility and trading volumes.
The financial services industry continues to be affected by an intensifying
competitive environment, as demonstrated by consolidation through mergers,
competition from new and established competitors using the internet or other
technology to provide financial services and diminishing margins in many
mature products and services. Commercial and investment bank consolidations,
which were made possible by the enactment of the Gramm-Leach-Bliley Act, have
also increased the competition for investment banking business in part through
the extension of credit in conjunction with investment banking and capital
raising activities. In 2002, the U.S. Congress passed the Sarbanes-Oxley Act
of 2002 which is a broad overhaul of existing corporate and securities laws.
In addition, various Federal and state securities regulators, self-regulatory
organizations (including the New York Stock Exchange) and industry
participants reviewed and in many cases adopted sweeping changes to their
established rules including rules in the areas of corporate governance,
research analyst conflicts of interest and auditor independence. Changes
pertaining to the role of research analysts in connection with providing
financial services may also affect how financial services companies interact
with their clients and the cost structure for such services. Outside the
United States, there is continued focus by regulators and legislators on
regulatory supervision of both banks and investment firms on a consolidated
and individual basis, especially in the area of risk management.
Certain statements contained in this Report may be considered forward-looking,
including statements about management expectations, strategic objectives,
business prospects, anticipated expense savings and financial results,
anticipated results of litigation and regulatory proceedings, and other
similar matters. These forward-looking statements are not statements of
historical fact and represent only Management's beliefs regarding future
events, which are inherently uncertain. There are a variety of factors, many
of which are beyond Merrill Lynch's control, which affect its operations,
performance, business strategy and results and could cause its actual results
and experience to differ materially from the expectations and objectives
expressed in any forward-looking statements. These factors include, but are
not limited to, the factors listed in the previous two paragraphs, as well as
actions and initiatives taken by both current and potential competitors, the
effect of current, pending and future legislation and regulation, and the
other risks and uncertainties detailed in Merrill Lynch's Form 10-K and in the
following sections. Accordingly, readers are cautioned not to place undue
reliance on forward-looking statements, which speak only as of the dates on
which they are made. Merrill Lynch does not undertake to update
forward-looking statements to reflect the impact of circumstances or events
that arise after the dates the forward-looking statements are made. The reader
should, however, consult any further disclosures Merrill Lynch may make in its
Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q and its
Current Reports on Form 8-K.
24
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Equity market conditions remained challenging during the first quarter of 2003.
Most equity markets continued to decline as the combination of the war in Iraq
and continued restrained economic activity globally caused investors to reduce
equity market activity and shift to less volatile, fixed-income investments.
With interest rates falling to 30 year lows, the volume of global fixed-income
underwriting set a new quarterly record of $1.24 trillion, up 11% from the
previous record in the first quarter of last year.
Although many investors continued to seek a safe alternative to stocks, there
was a shift by some investors from Treasury bonds to corporate and high-yield
bonds. As a result, long-term interest rates, as measured by the 10-year U.S.
Treasury bond, ended the quarter at 3.81%, not much changed from the 3.82% at
the beginning of 2003. The U.S. Federal Reserve Bank kept the federal funds rate
unchanged at 1.25%.
U.S. equity indices continued to decline in the first quarter of 2003. The Dow
Jones Industrial Average finished down 4.2% for the first quarter and 26.0% from
year-ago levels. The Nasdaq Composite fared better, up 0.4% in the quarter, but
down 27.3% from year-ago levels.
Despite a powerful rally in March, global stock markets continued to decline in
the first quarter of 2003. The Dow Jones World Index, excluding the United
States, was down 23.1% from the first quarter of 2002. In Europe, all major
markets closed the first quarter lower as reflected by the 13% decline in the
Dow Jones Stoxx Index of 600 European blue chips. In Japan, stocks continued to
struggle as the Nikkei 225 index ended the first quarter down 7%, a two-decade
low. Although they continued to outperform most other countries, emerging
markets suffered in the first quarter, with a loss of 5%.
Despite a 54% decrease in volume of global stock and stock-related offerings,
the boom in bonds produced a modest increase in overall stock and bond
underwriting volume, which rose 5.6% to set a quarterly record of $1.29
trillion, according to Thomson Financial Securities Data. However, the steep
drop-off in Initial Public Offerings ("IPOs"), which reached a 10-year low in
the U.S., dragged down disclosed fees for all underwriting by 31%, as IPOs carry
higher fees than bond sales. With just five IPOs globally, this year's first
quarter was the poorest for new issues since the fourth quarter of 1990,
according to Thomson Financial Securities Data.
Despite strong activity in Europe, declining equity values, concerns about the
economy and global uncertainty all continued to affect the merger and
acquisition market in the first quarter of 2003. The value of global mergers and
acquisitions edged up 9% from year-earlier levels to $280 billion, according to
Thomson Financial Securities Data. The volume of announced deals was down 11%
from the year-earlier period. In the United States, the value of first-quarter
mergers and acquisitions was $82 billion, down 9% from the first quarter of
2002.
Merrill Lynch continually evaluates its businesses for profitability and
performance under varying market conditions and, in light of the evolving
conditions in its competitive environment, for alignment with its long-term
strategic objectives. The strategy of maintaining long-term client
relationships, closely monitoring costs and risks, diversifying revenue sources,
and growing fee-based revenues all continue as objectives to mitigate the
effects of a volatile market environment on Merrill Lynch's business as a whole.
25
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
For the Three Months Ended
---------------------------
Mar. 28, Mar. 29,
(dollars in millions, except per share amounts) 2003 2002
------- -------
Net Revenues
Commissions $ 1,069 $ 1,242
Principal transactions 1,010 877
Investment banking
Underwriting 368 466
Strategic advisory 125 183
Asset management and portfolio service fees 1,127 1,293
Other 205 219
------- -------
Subtotal 3,904 4,280
Interest and dividend revenues 3,021 3,284
Less interest expense 2,071 2,474
------- -------
Net interest profit 950 810
------- -------
Total Net Revenues 4,854 5,090
------- -------
Non-interest expenses:
Compensation and benefits 2,496 2,646
Communications and technology 403 474
Occupancy and related depreciation 216 238
Brokerage, clearing, and exchange fees 170 198
Advertising and market development 121 150
Professional fees 144 130
Office supplies and postage 58 69
Other 224 173
------- -------
Total non-interest expenses 3,832 4,078
------- -------
Earnings before income taxes and dividends on
preferred securities issued by subsidiaries $ 1,022 $ 1,012
======= =======
Net earnings $ 685 $ 647
======= =======
Earnings per common share:
Basic $ 0.76 $ 0.75
Diluted 0.72 0.67
Annualized return on average common
stockholders' equity 11.8 % 12.7 %
Pre-tax profit margin 21.1 19.9
- -----------------------------------------------------------------------------------
Compensation and benefits
as a percentage of net revenues 51.4 % 52.0 %
Non-compensation expenses
as a percentage of net revenues 27.5 28.1 %
- -----------------------------------------------------------------------------------
26
Consolidated Results of Operations
Merrill Lynch's net earnings were $685 million for the 2003 first quarter, 6%
higher than the $647 million reported in the first quarter of 2002. Earnings per
common share were $0.76 basic and $0.72 diluted, compared with $0.75 basic and
$0.67 diluted in the year-ago quarter. The pre-tax profit margin for the first
quarter of 2003 was 21.1% up from 19.9% in the prior year quarter.
Net revenues were $4.9 billion in the first quarter of 2003, 5% lower than the
2002 first quarter. Commissions revenues were $1.1 billion, 14% below the 2002
first quarter, due primarily to a global decline in client transaction volumes,
particularly in listed equities and mutual funds. Principal transactions
revenues increased 15% from the first quarter of 2002, to $1.0 billion, due to
increased debt trading revenues, partially offset by lower equity trading
revenues. Net interest profit was $950 million, up 17% from the 2002 first
quarter, due primarily to a favorable yield curve environment. Underwriting
revenues were $368 million, 21% lower than the 2002 first quarter. Strategic
advisory revenues declined 32% from the 2002 first quarter, to $125 million.
These decreases reflect an industry-wide decline in activity levels, as well as
lower market shares, as reduced equity underwriting and completed mergers and
acquisitions were partially offset by increased debt underwriting. Asset
management and portfolio service fees were $1.1 billion, down 13% from the first
quarter of 2002. This decrease is primarily the result of a market-driven
decline in equity assets under management and a reduction in portfolio servicing
fees, which are calculated on beginning-of-period asset values. Other revenues
were $205 million in the first quarter of 2003, down 6% from the year-ago
quarter. The 2002 first quarter included aggregate pre-tax gains totaling $101
million related to the sales of the Securities Pricing Services business and the
Canadian private client and asset management businesses, partially offset by
increased realized gains related to sales of mortgages in the 2003 first
quarter.
Compensation and benefits expenses were $2.5 billion in the 2003 first quarter,
a decrease of $150 million, or 6%, from the 2002 first quarter. The decrease is
due primarily to lower incentive compensation accruals and reduced staffing
levels. Compensation and benefits expenses were 51.4% of net revenues for the
first quarter of 2003, compared to 52.0% in the year-ago quarter.
Non-compensation expenses were $1.3 billion in the first quarter of 2003, a
decrease of $96 million, or 7%, from the 2002 first quarter. Communications and
technology costs were $403 million, down 15% from the first quarter of 2002 due
primarily to reduced communications costs and systems consulting costs.
Occupancy and related depreciation was $216 million in the 2003 first quarter, a
decline of 9% from the year-ago quarter, due primarily to lower rental and
occupancy costs resulting from actions taken in the 2002 fourth quarter to
consolidate office space. Brokerage, clearing, and exchange fees were $170
million, down 14% from the 2002 first quarter. Advertising and market
development expenses were $121 million, down 19% from the first quarter of 2002
due primarily to reduced spending on travel due to lower business activity and
travel concerns, as well as lower levels of advertising. Professional fees
increased 11% from the first quarter of 2002, to $144 million, due principally
to increased legal expenses. Office supplies and postage was $58 million in the
first quarter of 2003, a decrease of 16% from the year-ago quarter, due to lower
levels of business activity and efficiency initiatives. Other expenses were $224
million in the 2003 first quarter, an increase of $51 million from the 2002
first quarter, principally due to a $50 million provision for litigation
relating to various business matters, which is included in the Corporate
segment. Merrill Lynch's effective tax rate was 28.3% for the first quarter of
2003 as compared to 28.0% for the full year of 2002.
27
- --------------------------------------------------------------------------------
BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
Merrill Lynch reports its results in three business segments: the Global
Markets and Investment Banking Group ("GMI"), Global Private Client ("GPC"),
and Merrill Lynch Investment Managers ("MLIM"). GMI provides capital markets
and investment banking services to corporate, institutional, and governmental
clients around the world. GPC provides global wealth management products and
services to individuals, small- to mid-size businesses, and employee benefit
plans. MLIM provides asset management services to individual, institutional
and corporate clients.
Certain MLIM and GMI products are distributed through GPC distribution
channels, and, to a lesser extent, certain MLIM products are distributed
through GMI. Revenues and expenses associated with these inter-segment
activities are recognized in each segment and eliminated at the corporate
level. In addition, revenue and expense sharing agreements for shared
activities between segments are in place and the results of each segment
reflect the agreed-upon portion of these activities. The following segment
results represent the information that is relied upon by management in its
decision-making processes. These results exclude items reported in the
Corporate segment. Business segment results are restated to reflect
reallocations of revenues and expenses which result from changes in Merrill
Lynch's business strategy and structure.
- --------------------------------------------------------------------------------
Global Markets and Investment Banking
- --------------------------------------------------------------------------------
GMI's Results of Operations
- --------------------------------------------------------------------
For the Three Months Ended
- --------------------------------------------------------------------
Mar. 28, Mar. 29, % Inc.
(dollars in millions) 2003 2002 (Dec.)
- ---------------------------------------------------------------------
Commissions $ 511 $ 542 (6)
Principal transactions and
net interest profit 1,428 1,102 30
Investment banking 433 590 (27)
Other revenues 88 151 (42)
------ ------
Total net revenues 2,460 2,385 3
------ ------
Non-interest expenses 1,675 1,742 (4)
------ ------
Pre-tax earnings $ 785 $ 643 22
------ ------
Pre-tax profit margin 31.9 % 27.0 %
- ---------------------------------------------------------------------
In an environment that remained challenging for equities and investment banking,
GMI's results were driven by its debt markets franchise. Debt markets' strong
trading and distribution capabilities and product breadth took advantage of a
favorable market environment, generating record revenues and profits for the
first quarter of 2003. GMI also benefited from strong operating leverage,
created through effective expense management and focus on capacity, as well as a
selective approach to risk-taking.
GMI's pre-tax earnings were $785 million, 22% higher than the year-ago quarter.
Net revenues were $2.5 billion, a 3% increase from the first quarter of 2002.
This revenue increase was complemented by ongoing operating discipline that
drove a 4% decline in non-interest expenses and resulted in a pre-tax margin of
31.9%, up from 27.0% in the first quarter of 2002.
28
Client Facilitation and Trading
Commissions
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, money market instruments, options and
commodities.
Commissions revenues decreased 6% to $511 million in the first quarter of 2003,
compared to the year-ago quarter as a result of a global decline in equity
trading volumes and prices.
Principal transactions and net interest profit
- -----------------------------------------------------------------------
For the Three Months Ended
- -----------------------------------------------------------------------
Mar. 28, Mar. 29, % Inc.
(dollars in millions) 2003 2002 (Dec.)
- -----------------------------------------------------------------------
Debt and debt derivatives $ 1,224 $ 719 70
Equities and equity derivatives 204 383 (47)
------- -------
Total $ 1,428 $ 1,102 30
- -----------------------------------------------------------------------
Principal transactions revenues include realized gains and losses from the
purchase and sale of securities in which Merrill Lynch acts as principal, and
unrealized gains and losses on trading assets and liabilities. In addition,
principal transactions revenues include unrealized gains related to equity
investments held by Merrill Lynch's broker-dealers.
Net interest profit is a function of the level and mix of total assets and
liabilities, including trading assets owned, the investment portfolio of
Merrill Lynch's U.S. banks, financing and lending transactions, trading
strategies associated with GMI's institutional securities business, and the
prevailing level, term structure, and volatility of interest rates. Net
interest profit is an integral component of trading activity.
In assessing the profitability of its client facilitation and trading
activities, Merrill Lynch views principal transactions and net interest profit
in the aggregate as net trading revenues. Changes in the composition of
trading inventories and hedge positions can cause the mix of principal
transactions and net interest profit to fluctuate. Net trading revenues were
$1.4 billion in the first quarter of 2003, up 30% from $1.1 billion in the
first quarter of 2002. Debt and debt derivatives net trading revenues were
$1.2 billion, up 70% from the first quarter of 2002, reflecting increased
trading of interest rate and credit products due to a favorable yield curve
environment and proprietary positioning. Equities and equity derivatives net
trading revenues decreased 47% from the first quarter of 2002 to $204 million,
primarily due to reduced customer flows.
Investment Banking
- ---------------------------------------------------------------------
For the Three Months Ended
- ---------------------------------------------------------------------
Mar. 28, Mar. 29, Inc.
(dollars in millions) 2003 2002 % (Dec.)
- ---------------------------------------------------------------------
Debt underwriting $ 176 $ 100 76
Equity underwriting 132 307 (57)
----- -----
Total underwriting 308 407 (24)
Strategic advisory services 125 183 (32)
----- -----
Total $ 433 $ 590 (27)
- ---------------------------------------------------------------------
29
Underwriting
------------
Underwriting revenues represent fees earned from the underwriting of debt and
equity and equity-linked securities as well as loan syndication and commitment
fees.
Underwriting revenues in the 2003 first quarter were $308 million, down 24%
from the $407 million recorded in the first quarter of 2002. This decrease is
the result of sharply lower equity underwriting revenues, which declined 57%
to $132 million, as equity origination activity continued to contract and
market share declined. Partially offsetting this decline were higher debt
underwriting revenues, which increased 76% from the first quarter of 2002, to
$176 million primarily due to the completion of more profitable transactions
in the first quarter of 2003. Merrill Lynch ranked third in global debt and
fifth in global equity and equity-linked underwriting in the first quarter of
2003 with a 7.1% and 7.8% market share, respectively. Merrill Lynch's debt
underwriting focus has shifted toward higher margin businesses and away from
the achievement of aggregate market share goals; however debt transactions are
highly competitive and not all transactions are profitable.
- ----------------------------------------------------------------------------------------
For the Three Months Ended
-------------------------------------------------
March 2003 March 2002
---------------- -----------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Global proceeds
Debt and Equity 7.1 % 4 9.0 % 2
Debt 7.1 3 8.5 2
Equity and equity-linked 7.8 5 14.5 2
U.S. proceeds
Debt and Equity 9.2 % 2 11.6 % 2
Debt 9.1 2 10.9 2
Equity and equity-linked 12.2 3 20.9 2
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager.
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, were $125 million in the first quarter of 2003, down 32%
from the first quarter of 2002 as industry-wide completed mergers and
acquisitions activity continued to contract and market share globally declined.
Merrill Lynch's merger and acquisition market share information based on
transaction value is as follows:
- ----------------------------------------------------------------------------------------
For the Three Months Ended
------------------------------------------------
March 2003 March 2002
--------------- ----------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Completed transactions
Global 16.6 % 4 22.1 % 3
U.S. 25.2 3 20.7 5
Announced transactions
Global 13.8 % 5 23.0 % 2
U.S. 8.8 5 14.0 7
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to both target
and acquiring companies' advisors.
30
Other Revenues
Other revenues, which include realized investment gains and losses and
distributions on equity investments, were $88 million in the first quarter of
2003 as compared to $151 million in the year-ago quarter. Other revenues in
the first quarter of 2002 included a $45 million pre-tax gain on the sale of
the Securities Pricing Services business.
- --------------------------------------------------------------------------------
Global Private Client
- --------------------------------------------------------------------------------
GPC's Results of Operations
- -------------------------------------------------------------------------------------
For the Three Months Ended
--------------------------
Mar. 28, Mar. 29, % Inc.
(dollars in millions) 2003 2002 (Dec.)
------------------------------------
Commissions $ 538 $ 667 (19)
Principal transactions and
new issue revenues 299 315 (5)
Asset management and
portfolio service fees 812 913 (11)
Net interest profit 323 346 (7)
Other revenues 130 58 124
------ ------
Total net revenues 2,102 2,299 (9)
------ ------
Non-interest expenses 1,833 2,027 (10)
------ ------
Pre-tax earnings $ 269 $ 272 (1)
------ ------
Pre-tax profit margin 12.8% 11.8%
- -------------------------------------------------------------------------------------
GPC's first quarter 2003 pre-tax earnings were $269 million essentially
unchanged from the 2002 first quarter, despite net revenues that declined 9% to
$2.1 billion. First quarter 2002 revenues included a residual pre-tax gain of
$39 million related to the sale of the Canadian private client business. GPC's
pre-tax margin was 12.8%, one percentage point higher than the year-ago quarter,
as non-interest expenses were reduced by 10%, to $1.8 billion. A continued high
percentage of revenues from fee-based and recurring sources provided stability
as transaction activity eroded.
GPC employed approximately 13,600 Financial Advisors at the end of the 2003
first quarter, down from 14,000 at the end of 2002 due to attrition combined
with reduced hiring in the United States.
Commissions
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds, insurance
products, and options.
Commissions revenues declined 19% to $538 million in the first quarter of 2003
from $667 million in the first quarter of 2002 primarily due to a global decline
in client transaction volumes, particularly in equity securities and mutual
funds. Commissions have also been negatively affected by the ongoing transition
of GPC assets to asset-priced accounts.
Principal transactions and new issue revenues
GPC's principal transactions and new issue revenues primarily represent
bid-offer revenues in over-the-counter equity securities, government bonds and
municipal securities, as well as selling concessions on underwriting of debt and
equity products. GPC does not take any significant principal trading risk
positions.
31
Principal transactions and new issue revenues declined 5% to $299 million in the
2003 first quarter from the year-ago quarter primarily as a result of a decline
in new issue volume in a less favorable market environment.
Asset management and portfolio service fees
Asset management and portfolio service fees include asset management fees from
taxable and tax-exempt money market funds which totaled $66 billion and $75
billion on an average basis at March 28, 2003 and March 29, 2002, respectively.
Also included are portfolio fees from fee-based accounts such as Unlimited
AdvantageSM and Merrill Lynch Consults(R) as well as servicing fees related to
these accounts, and certain other account-related fees.
Asset management and portfolio service fees totaled $812 million, down 11% from
the $913 million recorded in the first quarter of 2002, primarily as a result of
a market-driven decline in equity assets under management and a reduction in
portfolio servicing fees, which are calculated on beginning-of-period asset
values.
An analysis of changes in assets in GPC accounts from March 29, 2002 to March
28, 2003 is detailed below:
- ----------------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------------
Mar. 29, New Asset Mar. 28,
(dollars in billions) 2002 Money Depreciation Other (1) 2003
- ----------------------------------------------------------------------------------------------------------
Assets in GPC accounts
U.S. $1,158 $15 $(164) $ - $1,009
Non U.S. 96 (3) (6) (1) 86
---------------------------------------------------------------
Total $1,254 $12 $(170) $(1) $1,095
- ----------------------------------------------------------------------------------------------------------
(1) Represents business divestitures.
Total assets in GPC accounts in the United States declined 13% from the end of
the 2002 first quarter, to $1.0 trillion at March 28, 2003 as a result of
market-driven declines in asset values, partially offset by net new money
inflows of $15 billion. Outside the United States, client assets were $86
billion, down from $96 billion at the end of the year-ago quarter, largely due
to market-driven declines. Total assets in asset-priced accounts were $181
billion at the end of the 2003 first quarter, a decrease of 12% from the
year-ago period primarily due to market-driven declines.
Net interest profit
Net interest profit for GPC includes GPC's allocation of the interest spread
earned in Merrill Lynch's banks for deposits as well as interest earned on
margin and other loans.
Net interest profit was $323 million in the 2003 first quarter, down 7% from
$346 million in the first quarter of 2002. The decrease in net interest profit
resulted from lower margin balances and a reduction in the related interest
rates.
Other revenues
Other revenues were $130 million in the first quarter of 2003, compared to $58
million in the year-ago period. Other revenues for the first quarter of 2003
increased, in part, due to realized gains related to sales of mortgages. Other
revenues in the first quarter of 2002 included a residual pre-tax gain of $39
million related to the sale of GPC's Canadian business, and pre-tax losses
related to asset writedowns.
32
- --------------------------------------------------------------------------------
Merrill Lynch Investment Managers
- --------------------------------------------------------------------------------
MLIM's Results of Operations
- --------------------------------------------------------------------------------
For the Three Months Ended
--------------------------
Mar. 28, Mar. 29,
(dollars in millions) 2003 2002 %(Dec.)
- --------------------------------------------------------------------------
Commissions $ 31 $ 54 (43)
Asset management fees 300 367 (18)
Other revenues 6 21 (71)
----- -----
Total net revenues 337 442 (24)
Non-interest expenses 290 328 (12)
----- -----
Pre-tax earnings $ 47 $ 114 (59)
-----
Pre-tax profit margin 14.0 % 25.8 %
- --------------------------------------------------------------------------
MLIM continued to generate strong relative investment performance. Nearly 70% of
its assets under management were ahead of benchmark or median category for the
1-, 3-, and 5-year periods ending March 2003 despite difficult equity market
conditions for most of the quarter. Lower equity market levels adversely
affected MLIM's first quarter results.
MLIM's pre-tax earnings in the 2003 first quarter were $47 million, down 59%
from $114 million in the 2002 first quarter. Net revenues decreased 24% from the
year ago period to $337 million primarily reflecting a market-driven decline in
equity assets under management. MLIM's first quarter 2002 results included a
pre-tax gain on the sale of its Canadian asset management business. Net revenues
are dependent on levels of assets under management, and accordingly, are
susceptible to a decline in equity market valuations. The pre-tax margin was
14.0% in the first quarter of 2003 compared to 25.8% in the year-ago quarter as
a decline in non-interest expenses of 12% was more than offset by the revenue
decline.
Commissions
Commissions for MLIM principally consist of distribution fees and redemption
fees related to mutual funds. The distribution fees represent revenues earned
for promoting and distributing mutual funds ("12b-1 fees"). As a result of lower
transaction volumes and the impact of lower market values, commissions decreased
43% to $31 million in the 2003 first quarter from the year-ago quarter.
Asset management fees
Asset management fees primarily consist of fees earned from the management and
administration of funds as well as performance fees earned by MLIM on separately
managed accounts. Asset management fees were $300 million, a decline of 18% from
the first quarter of 2002 primarily as a result of market-driven declines in the
value of equity assets under management as well as the shift of assets by
clients from higher yielding equity funds to lower yielding fixed income and
money market funds. At the end of the first quarter of 2003, assets under
management totaled $442 billion, compared with $518 billion at the end of the
first quarter of 2002.
An analysis of changes in assets under management from March 29, 2002 to March
28, 2003 is as follows:
- ----------------------------------------------------------------------------------------------------
Net Changes Due To
-------------------------------------------
Mar. 29, New Asset Mar. 28,
(dollars in billions) 2002 Money Depreciation Other (1) 2003
- ----------------------------------------------------------------------------------------------------
Assets under management $518 $(23) $(57) $4 $442
- ----------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends, the impact of foreign exchange movements, net
outflows of retail money market funds and other changes.
33
Other Revenues
Other revenues, which primarily include net interest profit and investment gains
and losses, totaled $6 million and $21 million for the first quarter of 2003 and
2002, respectively. Other revenues for the first quarter of 2002 included a $17
million pre-tax gain on the sale of the Canadian retail asset management
business.
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
Management continually monitors and evaluates the level and composition of the
balance sheet.
For the first three months of 2003, average total assets were $476 billion, up
4% from $459 billion for the full-year 2002. Average total liabilities also
increased 4% to $450 billion from $435 billion for the full-year 2002. Average
total assets and liabilities for the first three months of 2003 include the
following changes as compared to the full-year 2002:
- -----------------------------------------------------------------------------------------
Increase/
(dollars in millions) (Decrease) Change
- -----------------------------------------------------------------------------------------
Average assets
Loans, notes and mortgages (net) $ 8,845 31%
Receivables under resale agreements 7,514 10
Trading assets 7,249 7
Receivables under securities borrowed transactions (6,601) (10)
Average liabilities
Payables under repurchase agreements $ 8,092 8%
Trading liabilities 7,475 11
- -----------------------------------------------------------------------------------------
Loans, notes and mortgages were up substantially from 2002 due to increased GPC
mortgage and small and middle market business loan originations by Merrill Lynch
Bank USA and its subsidiaries. Additionally, securities financing transactions
rose primarily due to increased inventory financing.
34
- --------------------------------------------------------------------------------
OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
- --------------------------------------------------------------------------------
As a part of its normal operating strategy, Merrill Lynch enters into various
contractual obligations, contingent liabilities and commitments which may
require future payments. The table below outlines the significant contractual
obligations, contingent liabilities, and commitments, as well as the future
expiration as of March 28, 2003:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Commitment expiration
----------------------------------------------------------------
Less than Over 5
Total 1 year 1 - 3 years 4 - 5 years years
- ----------------------------------------------------------------------------------------------------------------
Total commitments $48,661 $32,249 $ 4,302 $ 7,139 $ 4,971
Long-term borrowings 77,014 19,013 24,864 14,453 18,684
Short-term borrowings 3,509 3,509 - - -
Contractual agreements(1) 42,590 9,767 9,508 6,144 17,171
Liquidity and facilities with SPEs(2)(3) 13,663 10,341 3,322 - -
Liquidity and default facilities with
SPEs 3,231 2,654 577 - -
Residual value guarantees 1,782 70 128 276 1,308
Standby letters of credit and other
performance guarantees 471 209 107 37 118
- ----------------------------------------------------------------------------------------------------------------
(1) Represents the liability balance of contractual agreements at March 28, 2003.
(2) Amounts relate primarily to facilities provided to municipal bond securitization SPEs.
(3) Includes $3.8 billion of guarantees provided to SPEs by third party financial institutions where Merrill Lynch
has agreed to reimburse the financial institution if losses occur, and has up to one year to fund losses.
Refer to Note 10 to the Condensed Consolidated Financial Statements for
additional information.
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY AND FUNDING
- --------------------------------------------------------------------------------
The primary objectives of Merrill Lynch's capital structure and funding policies
are to support the successful execution of the firm's business strategies while
ensuring:
o sufficient equity capital to absorb losses and,
o liquidity at all times, across market cycles, and through periods of
financial stress.
These objectives and Merrill Lynch's capital structure and funding policies are
discussed more fully in the Annual Report on Form 10-K for the year ended
December 27, 2002.
Capital Adequacy
At March 28, 2003, Merrill Lynch's equity capital was comprised of $23.2 billion
in common equity, $425 million in preferred stock, and $2.7 billion of preferred
securities issued by subsidiaries. Preferred securities issued by subsidiaries
are Trust Originated Preferred SecuritiesSM ("TOPrS"SM). Based on the risks
and equity needs of its businesses, Merrill Lynch believes that its equity
capital base of $26.3 billion is adequate.
35
Funding
Commercial paper outstanding totaled $3.0 billion at March 28, 2003 and $4.0
billion at December 27, 2002, which was approximately 4% of total unsecured
borrowings at March 28, 2003 and year-end 2002. Deposits at Merrill Lynch's
banking subsidiaries totaled $81.9 billion at March 28, 2003, essentially
unchanged from year-end 2002. Of the $81.9 billion of deposits in Merrill Lynch
banking subsidiaries as of March 28, 2003, $68.8 billion were in U.S. banks.
Outstanding long-term borrowings decreased to $77.0 billion at March 28, 2003
from $78.5 billion at December 27, 2002. Major components of the change in
long-term borrowings during the first three months of 2003 are as follows:
(dollars in billions)
- -------------------------------------------------------
Balance at December 27, 2002 $78.5
Issuances 5.9
Maturities (7.3)
Other, net (0.1)
-----
Balance at March 28, 2003 (1) $77.0
- -------------------------------------------------------
(1) At March 28, 2003, $58.0 billion of long-term borrowings had maturity dates
beyond one year.
As a part of its overall liquidity risk management practices, Merrill Lynch
seeks to ensure availability of sufficient alternative funding sources to enable
the repayment of all unsecured debt obligations maturing within one year without
issuing new unsecured debt or requiring liquidation of business assets. The main
alternative funding sources to unsecured borrowings are repurchase agreements,
securities loaned, and other secured borrowings, which require pledging
unencumbered securities held for trading or investment purposes.
Merrill Lynch also maintains a separate liquidity portfolio of U.S. Government
and agency obligations and asset-backed securities of high credit quality that
is funded with debt with an average maturity greater than one year. The carrying
value of this portfolio, net of related hedges, was $13.2 billion and $12.6
billion at March 28, 2003 and December 27, 2002, respectively. These assets may
be sold or pledged to provide immediate liquidity to ML & Co. to repay maturing
debt obligations. In addition to this portfolio, the firm monitors the extent to
which other unencumbered assets are available as a source of funds during a
liquidity event.
Merrill Lynch also maintained a committed, multi-currency, unsecured bank credit
facility that totaled $3.5 billion at March 28, 2003 and December 27, 2002 and
was not drawn upon. On May 8, 2003, Merrill Lynch renewed the bank credit
facility in the amount of $3.0 billion for 364 days. Merrill Lynch elected to
reduce the amount of the facility considering the company's funding profile and
the availability of the liquidity portfolio of segregated securities that may be
sold or pledged to provide immediate liquidity.
Credit Ratings
The cost and availability of unsecured funding are impacted by credit ratings
and market conditions. In addition, credit ratings are important when competing
in certain markets and when seeking to engage in long-term transactions
including over-the-counter derivatives. Factors that influence Merrill Lynch's
credit ratings include the rating agencies' assessment of the general operating
environment, Merrill Lynch's relative positions in the markets in which it
competes, reputation, level and volatility of earnings, risk management
policies, liquidity and capital management.
Merrill Lynch's senior long-term debt, preferred stock, and TOPrSSM were rated
by several recognized credit rating agencies at May 7, 2003 as indicated below.
These ratings do not reflect outlooks that may be expressed by the rating
agencies from time to time, which are currently stable or negative.
36
- -------------------------------------------------------------------------------------------------------------------
Rating Agency Senior Debt Ratings Preferred Stock Ratings TOPrSSM Ratings
- -------------------------------------------------------------------------------------------------------------------
Dominion Bond Rating Service Ltd AA(Low) Not Rated Not Rated
Fitch Ratings AA- A+ A+
Moody's Investors Service, Inc. Aa3 A2 A1
Rating and Investment Information, Inc. (1) AA A+ A+
Standard & Poor's Ratings Services A+ A- A-
- --------------------------------------------------------------------------------------------------------------
(1) Located in Japan
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Risk-taking is an integral part of Merrill Lynch's core business activities. In
the course of conducting its business operations, Merrill Lynch is exposed to a
variety of risks. These risks include market, credit, liquidity, process, and
other risks that are material and require comprehensive controls and management.
The responsibility and accountability for these risks remain primarily with the
individual business units. For a full discussion of Merrill Lynch's risk
management framework, see the Annual Report on Form 10-K for the year ended
December 27, 2002.
Market Risk
Value-at-risk ("VaR") is an estimate within a specified degree of confidence of
the amount that Merrill Lynch's present portfolios could lose over a given time
interval. Merrill Lynch's overall VaR is less than the sum of the VaRs for
individual risk categories because movements in different risk categories occur
at different times and, historically, extreme movements have not occurred in all
risk categories simultaneously. The difference between the sum of the VaRs for
individual risk categories and the VaR calculated for all risk categories is
shown in the following tables and may be viewed as a measure of the
diversification within Merrill Lynch's portfolios. Merrill Lynch believes that
the tabulated risk measures provide some guidance as to the amount Merrill Lynch
could lose in future periods and it works continuously to improve the
methodology and measurement of its VaR. However, like all statistical measures,
especially those that rely heavily on historical data, VaR needs to be
interpreted with a clear understanding of its assumptions and limitations.
The Merrill Lynch VaR system uses a historical simulation approach to estimate
VaR across several confidence levels and holding periods. Sensitivities to
market risk factors are aggregated and combined with a database of historical
weekly changes in market factors to simulate a series of profits and losses. The
level of loss that is exceeded in that series 5% of the time is used as the
estimate for the 95% confidence level VaR. The tables below show VaR using a 95%
confidence level and a weekly holding period for trading and non-trading
portfolios. In addition to the overall VaR, which reflects diversification in
the portfolio, VaR amounts are presented for major risk categories, including
exposure to volatility risk found in certain products, e.g., options. The table
that follows presents Merrill Lynch's VaR for its trading portfolios at March
28, 2003 and December 27, 2002 as well as daily average VaR for the three months
ended March 28, 2003. Additionally, high and low VaR for the first quarter of
2003 is presented independently for each risk category and overall.
37
- ------------------------------------------------------------------------------------------------------
Daily
Mar. 28, Dec. 27, Average High Low
(dollars in millions) 2003 2002 1Q03 1Q03 1Q03
- ------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 56 $ 42 $ 59 $ 87 $ 40
Equity 27 36 36 50 26
Commodity - - - 1 -
Currency 2 3 4 13 -
Volatility 19 19 19 27 15
-----------------------------------------------------
104 100 118
Diversification benefit (47) (48) (54)
----------------------------
Overall(2) $ 57 $ 52 $ 64 $ 84 $ 50
============================
- ------------------------------------------------------------------------------------------------------
(1) Based on a 95% confidence level and a one-week holding period.
(2) Overall VaR using a 95% confidence level and a one-day holding period was
$29 million at March 28, 2003 and $25 million at year-end 2002.
The following table presents Merrill Lynch's VaR for its non-trading portfolios
(including Merrill Lynch's U.S. banks and Merrill Lynch's LYONS(R) ):
- --------------------------------------------------------------------------
Mar. 28, Dec. 27,
(dollars in millions) 2003 2002
- --------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 90 $ 89
Equity 25 27
Currency 2 3
Volatility 13 13
---- ----
130 132
Diversification benefit (33) (42)
---- ----
Overall $ 97 $ 90
==== ====
- --------------------------------------------------------------------------
(1) Based on a 95% confidence level and a one-week holding period.
38
Credit Risk
Merrill Lynch enters into International Swaps and Derivatives Association, Inc.
master agreements or their equivalent ("master netting agreements") with
substantially all of its derivative counterparties as soon as possible. The
agreements are negotiated with each counterparty and are complex in nature.
While every effort is taken to execute such agreements, it is possible that a
counterparty may be unwilling to sign such an agreement, and as a result, would
subject Merrill Lynch to additional credit risk. Master netting agreements
provide protection in bankruptcy in certain circumstances and, in some cases,
enable receivables and payables with the same counterparty to be offset on the
Consolidated Balance Sheets, providing for a more meaningful balance sheet
presentation of credit exposure. However, the enforceability of master netting
agreements under bankruptcy laws in certain countries or in certain industries
is not free from doubt and receivables and payables with counterparties in these
countries or industries are accordingly recorded on a gross basis.
In addition, to reduce default risk, Merrill Lynch requires collateral,
principally cash and U.S. Government and agency securities, on certain
derivative transactions. From an economic standpoint, Merrill Lynch evaluates
default risk exposures net of related collateral. The following is a summary of
counterparty credit ratings for the replacement cost (net of $10.2 billion of
collateral) of trading derivatives in a gain position by maturity at March 28,
2003. (Please note that the following table is inclusive of credit exposure from
derivative transactions only and does not include other material credit
exposures).
(dollars in millions)
- -----------------------------------------------------------------------------------------
Credit Years to Maturity Cross-
--------------------------------------------------- Maturity
Rating(1) 0-3 3+- 5 5+- 7 Over 7 Netting(2) Total
- -----------------------------------------------------------------------------------------
AAA $ 1,744 $ 717 $ 428 $1,652 $ (399) $ 4,142
AA 3,665 1,772 919 2,637 (2,149) 6,844
A 6,210 1,660 1,180 3,723 (1,182) 11,591
BBB 1,346 752 459 1,451 (562) 3,446
Other 1,041 524 188 285 (129) 1,909
----------------------------------------------------------------------
Total $14,006 $5,425 $3,174 $9,748 $(4,421) $27,932
- -----------------------------------------------------------------------------------------
(1) Represents credit rating agency equivalent of internal credit ratings.
(2) Represents netting of payable balances with receivable balances for the same
counterparty across maturity band categories. Receivable and payable
balances with the same counterparty in the same maturity category, however,
are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate its
default risk on derivatives whenever possible by entering into transactions with
provisions that enable Merrill Lynch to terminate or reset the terms of its
derivative contracts.
In March 2003, Merrill Lynch invested approximately $1 billion in UFJ Strategic
Partner Co., Ltd., a UFJ Holdings subsidiary created to hold, manage, and
resolve various non-performing and sub-performing UFJ loans.
39
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve risks
related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes that
these risks are inherent in the business and may employ strategies to mitigate
exposures. The specific components and overall level of non-investment grade and
highly-leveraged positions may vary significantly from period to period as a
result of inventory turnover, investment sales, and asset redeployment.
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment banking,
market-making, and derivative structuring activities. Non-investment grade
holdings have been defined as debt and preferred equity securities rated lower
than BBB, or equivalent ratings by recognized credit rating agencies, sovereign
debt in emerging markets, amounts due under derivative contracts from
non-investment grade counterparties, and other instruments that, in the opinion
of management, are non-investment grade.
In addition to the amounts included in the following table, derivatives may also
expose Merrill Lynch to credit risk related to the underlying security where a
derivative contract either synthesizes ownership of the underlying security
(e.g., long total return swaps) or can potentially force ownership of the
underlying security (e.g., short put options). Derivatives may also subject
Merrill Lynch to credit spread or issuer default risk, in that changes in credit
spreads or in the credit quality of the underlying securities may adversely
affect the derivatives' fair values. Merrill Lynch may seek to mitigate these
risks in certain circumstances by engaging in various hedging strategies to
reduce its exposure associated with non-investment grade positions, such as
purchasing an option to sell the related security or entering into other
offsetting derivative contracts.
Merrill Lynch provides financing and advisory services to, and invests in,
companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides
extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch may syndicate loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will be made on a select basis.
40
- --------------------------------------------------------------------------------
Trading Exposures
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's trading exposure to
non-investment grade or highly leveraged issuers or counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Mar. 28, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Trading assets:
Cash instruments $ 5,742 $ 4,825
Derivatives 4,006 5,016
Trading liabilities - cash instruments (1,607) (1,352)
Collateral on derivative assets (2,097) (2,581)
------- -------
Net trading asset exposure $ 6,044 $ 5,908
- ---------------------------------------------------------------------------------
Included in the preceding table are debt and equity securities and bank loans of
companies in various stages of bankruptcy proceedings or in default. At March
28, 2003, the carrying value of such debt and equity securities totaled $88
million, of which 38% resulted from Merrill Lynch's market-making activities in
such securities. This compared with $140 million at December 27, 2002, of which
29% related to market-making activities. Also included are distressed bank loans
totaling $97 million and $203 million at March 28, 2003 and December 27, 2002,
respectively.
- --------------------------------------------------------------------------------
Non-Trading Exposures
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's non-trading exposures to
non-investment grade or highly leveraged corporate issuers or counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Mar. 28, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Investment securities $ 197 $ 300
Commercial loans (net of allowance for loan
losses):
Bridge loans 131 131
Other loans(1) 3,202 2,740
Other investments:
Partnership interests(2) 1,748 1,749
Other equity investments(3) 784 583
- ---------------------------------------------------------------------------------
(1) Includes accrued interest.
(2) Includes $864 million and $877 million in investments at March 28, 2003 and
December 27, 2002, respectively, related to deferred compensation plans,
for which a portion of the default risk of the investments rests with the
participating employees.
(3) Includes investments in 170 and 158 enterprises at March 28, 2003 and December 27, 2002,
respectively.
41
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly-leveraged counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Mar. 28, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Additional commitments to invest in
partnerships (1) $ 517 $ 500
Unutilized revolving lines of credit and
other lending commitments 1,204 1,550
- ---------------------------------------------------------------------------------
(1) Includes $110 million at March 28, 2003 and December 27, 2002, related to
deferred compensation plans.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- --------------------------------------------------------------------------------
The following is a summary of Merrill Lynch's critical accounting policies. For
a full description of these and other accounting policies see Note 1 to the
Consolidated Financial Statements in the 2002 Annual Report.
Use of Estimates
In presenting the Condensed Consolidated Financial Statements, Management makes
estimates regarding certain trading inventory valuations, the outcome of
litigation, the carrying amount of goodwill, the allowance for loan losses, the
realization of deferred tax assets, tax reserves, insurance reserves, recovery
of insurance deferred acquisition costs, and other matters that affect the
reported amounts and disclosure of contingencies in the financial statements.
Estimates, by their nature, are based on judgment and available information.
Therefore, actual results could differ from those estimates and could have a
material impact on the Condensed Consolidated Financial Statements, and it is
possible that such changes could occur in the near term. For more information
regarding the specific methodologies used in determining estimates, refer to Use
of Estimates in Note 1 to the Consolidated Financial Statements in the 2002
Annual Report.
Valuation of Financial Instruments
Fair values for exchange traded securities and certain exchange-traded
derivatives, principally futures and certain options, are based on quoted market
prices. Fair values for OTC derivative financial instruments, principally
forwards, options, and swaps, represent amounts estimated to be received from or
paid to a third party in settlement of these instruments. These derivatives are
valued using pricing models based on the net present value of estimated future
cash flows, and directly observed prices from exchange-traded derivatives, other
OTC trades, or external pricing services. Obtaining the fair value for OTC
derivative contracts requires the use of management judgment and estimates.
New and/or complex instruments may have immature or limited markets. As a
result, the pricing models used for valuation often incorporate significant
estimates and assumptions, which may impact the level of precision in the
financial statements. For long-dated and illiquid contracts, extrapolation
methods are applied to observed market data in order to estimate inputs and
assumptions that are not directly observable. This enables Merrill Lynch to mark
all positions consistently when only a subset of prices are directly observable.
Values for non-exchange-traded derivatives are verified using observed
information about the costs of hedging out the risk and other trades in the
market. As the markets for these products develop, Merrill Lynch continually
refines its pricing models based on experience to correlate more closely to the
market risk of these instruments. Unrealized gains for these instruments are not
recognized unless the valuation model incorporates significant observable market
inputs.
42
Merrill Lynch holds investments that may have quoted market prices but that are
subject to restrictions (e.g., consent of other investors to sell) that may
limit Merrill Lynch's ability to realize the quoted market price. Accordingly,
Merrill Lynch estimates the fair value of these securities based on management's
best estimate which incorporates pricing models based on projected cash flows,
earnings multiples, comparisons based on similar market transactions and/or
review of underlying financial conditions and other market factors.
Valuation adjustments are an integral component of the mark-to-market process
and are taken for individual positions where either the sheer size of the trade
or other specific features of the trade or particular market (such as
counterparty credit quality, concentration or market liquidity) requires more
than the simple application of the pricing models.
Assets recorded on the balance sheet can therefore be broadly categorized as
follows:
1. highly liquid cash and derivative instruments for which quoted market prices
are readily available (for example, exchange-traded equity securities and
derivatives such as listed options)
2. liquid instruments, including
a) cash instruments for which quoted prices are available but which may
trade less frequently such that there is not complete pricing transparency
for these instruments across all market cycles (for example, corporate and
municipal bonds);
b) derivative instruments that are valued using a model, where inputs to the
model are directly observable in the market (for example, U.S. dollar
interest rate swaps);
c) instruments that are priced with reference to comparable financial
instruments whose parameters can be directly observed; and
d) consumer and small and middle-market business loans and performing
commercial loans held for investment purposes (which are carried at their
principal amount outstanding)
3. less liquid instruments that are valued using management's best
estimate of fair value, and instruments which are valued using a model,
where either the inputs to the model and/or the models themselves require
significant judgement by management (for example, private equity
investments, long dated or complex derivatives such as certain foreign
exchange options and credit default swaps, distressed debt, aged inventory
positions, including aged commercial loans held for sale (which are
reported at the lower of cost or estimated fair value) and non-performing
commercial loans held for investment purposes).
Merrill Lynch continually refines the process used to determine the appropriate
categorization of its assets and liabilities. At March 28, 2003, assets and
liabilities on the Condensed Consolidated Balance Sheets can be categorized as
follows:
(dollars in millions)
- ------------------------------------------------------------------------------------------------
Category 1 Category 2 Category 3 Total
- ------------------------------------------------------------------------------------------------
Assets
Trading assets, excluding
contractual agreements $36,831 $38,227 $1,211 $76,269
Contractual agreements 3,950 31,157 3,033 38,140
Loans, notes, and mortgages (net) - 31,244 3,207 34,451
Investment securities 11,483 61,908 4,520 77,911
- ------------------------------------------------------------------------------------------------
Liabilities
Trading liabilities, excluding
contractual agreements $30,655 $11,559 $ 905 $43,119
Contractual agreements 2,730 37,104 2,756 42,590
- ------------------------------------------------------------------------------------------------
In addition, other trading-related assets recorded in the Condensed Consolidated
Balance Sheet at March 28, 2003 include $126.5 billion of securities financing
transactions (receivables under resale agreements and receivables under
securities borrowed transactions) which are recorded at their contractual
amounts plus accrued interest and for which little or no estimation is required
by management.
43
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
On April 30, 2003, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies accounting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The new guidance
amends SFAS No. 133 for decisions made as part of the Derivatives Implementation
Group ("DIG") process that effectively required amendments to SFAS No. 133, and
decisions made in connection with other FASB projects dealing with financial
instruments and in connection with implementation issues raised in relation to
the application of the definition of a derivative and characteristics of a
derivative that contains financing components. In addition, it clarifies when a
derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. Merrill Lynch is currently assessing the impact of SFAS No. 149 on the
Consolidated Financial Statements.
On July 31, 2002, the American Institute of Certified Public Accountants
("AICPA") issued a Proposed Statement of Position ("SOP"), Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts. The proposed SOP provides guidance on
accounting and reporting by insurance companies for certain nontraditional
long-duration contracts and for separate accounts. A final SOP would be
effective for financial statements for Merrill Lynch beginning in 2004. The SOP
would require the establishment of a liability for contracts that contain death
or other insurance benefits using a specified reserve methodology that is
different from the methodology that Merrill Lynch employs. Depending on market
conditions at the time of adoption, the impact of implementing this reserve
methodology may have a material impact on the Condensed Consolidated Statement
of Earnings.
On January 17, 2003, the FASB issued FIN 46, which clarifies when an entity
should consolidate another entity known as a Variable Interest Entity ("VIE"),
more commonly referred to as an SPE. A VIE is an entity in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties, and may
include many types of SPEs. FIN 46 requires that an entity consolidate a VIE if
that enterprise has a variable interest that will absorb a majority of the VIE's
expected losses, receive a majority of the VIE's expected residual returns, or
both. FIN 46 does not apply to QSPEs, the accounting for which is governed by
SFAS No. 140. FIN 46 is effective for VIEs created on or after February 1, 2003
and for existing VIEs as of the third quarter of 2003. See Note 8 to the
Consolidated Financial Statements in the 2002 Annual Report for disclosures
regarding the expected impact of adoption of FIN 46 on Merrill Lynch's
Consolidated Balance Sheet.
On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123, Accounting for Stock-Based Compensation. SFAS No. 148 permits three
alternative methods for a voluntary transition to the fair value based method of
accounting for employee stock-based compensation. SFAS No. 148 continues to
permit prospective application for companies that adopt prior to the beginning
of fiscal year 2004. SFAS No. 148 also allows for a modified prospective
application, which requires the fair value of all unvested awards to be
amortized over the remaining service period, as well as restatement of prior
years' expense. The transition guidance and annual disclosure provisions of SFAS
No. 148 are effective for fiscal years ending after December 15, 2002, with
earlier application permitted in certain circumstances.
On November 25, 2002, the FASB issued FIN 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107
and Rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to
disclose their obligations under certain guarantees. It also requires a
guarantor to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of FIN 45 apply on a prospective basis to
guarantees issued or modified after December 31, 2002. The disclosures are
effective for financial statements of interim or annual periods ending after
December 15, 2002. See Note 10 to the Condensed Consolidated Financial
Statements for these disclosures.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces
the guidance provided by EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring). Merrill Lynch adopted SFAS No. 146
as of January 1, 2003, which had no material impact on the Condensed
Consolidated Financial Statements.
44
- --------------------------------------------------------------------------------
Statistical Data
- --------------------------------------------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr.
2002 2002 2002 2002 2003
-------- -------- -------- -------- --------
Assets in GPC accounts (dollars in billions):
U.S. $ 1,158 $ 1,076 $ 997 $ 1,021 $ 1,009
Non-U.S. 96 94 87 89 86
-------- -------- -------- -------- --------
Total Assets in GPC Accounts 1,254 1,170 1,084 1,110 1,095
======== ======== ======== ======== ========
Assets in Asset-Priced Accounts $ 206 $ 192 $ 177 $ 182 $ 181
Assets Under Management:
Retail $ 215 $ 203 $ 182 $ 189 $ 187
Institutional 262 257 234 235 220
Private Investors(1) 41 39 36 38 35
Equity 257 234 190 191 183
Fixed-income 119 121 119 122 108
Money market 142 144 143 149 151
U.S. 323 319 305 313 303
Non-U.S. 195 180 147 149 139
- ---------------------------------------------------------------------------------------------------------------------------------
Underwriting:
Global Equity and Equity-Linked:
Volume (dollars in billions) $ 15 $ 10 $ 3 $ 6 $ 4
Market share 14.5% 9.4% 6.0% 10.6% 7.8
Global debt:
Volume (dollars in billions) $ 96 $ 86 $ 65 $ 59 $ 88
Market share 8.5% 8.4% 7.7% 6.6% 7.1
- ----------------------------------------------------------------------------------------------------------------------------------
Full-Time Employees:
U.S. 43,100 42,400 41,800 40,000 39,200
Non-U.S. 13,000 12,000 11,400 10,900 10,400
-------- -------- -------- -------- --------
Total 56,100 54,400 53,200 50,900 49,600
======== ======== ======== ======== ========
Private Client Financial Advisors 15,900 15,100 14,600 14,000 13,600
- ----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet (dollars in millions,
except per share amounts)
Total assets $444,871 $453,834 $452,140 $447,928 $455,587
Total stockholders' equity $ 20,906 $ 21,592 $ 22,299 $ 22,875 $ 23,639
Book value per common share $ 23.73 $ 24.46 $ 25.17 $ 25.69 $ 24.97
Share Information (in thousands)
Weighted-average shares outstanding:
Basic 854,815 861,742 864,629 868,160 887,553
Diluted 949,237 942,560 934,477 942,893 939,220
Common shares outstanding 862,946 865,398 869,019 873,780 929,768
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Represents segregated portfolios for individuals, small corporations and
institutions.
45
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The information under the caption Item 2. "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Risk Management" above in
this Report is incorporated herein by reference.
Item 4. Controls and Procedures
-----------------------
In 2002, ML & Co. formed a Disclosure Committee to assist with the monitoring
and evaluation of our disclosure controls and procedures. ML & Co.'s Chief
Executive Officer, Chief Financial Officer and Disclosure Committee have
evaluated the effectiveness of ML & Co.'s disclosure controls and procedures as
of a date within ninety days prior to the filing date of this Form 10-Q. Based
on this evaluation, ML & Co.'s Chief Executive Officer and Chief Financial
Officer have concluded that ML & Co.'s disclosure controls and procedures (as
defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934)
are effective. There have been no significant changes in internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
46
PART II - OTHER INFORMATION
---------------------------
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
On April 28, 2003, ML & Co. held its Annual Meeting of Stockholders, at which
approximately 88% of the shares of ML & Co. common stock outstanding and
eligible to vote, either in person or by proxy, were represented, constituting a
quorum. At the Annual Meeting, the following matters were voted upon: (i) the
election of three directors to the Board of Directors to hold office for a term
of three years; (ii) a proposal to approve the Merrill Lynch Employee Stock
Compensation Plan; and (iii) a stockholder proposal concerning cumulative voting
in the election of directors. Proxies for the Annual Meeting were solicited by
the Board of Directors pursuant to Regulation 14A of the Securities Exchange Act
of 1934.
The stockholders elected all three nominees to the Board of Directors as set
forth in ML & Co.'s Proxy Statement. There was no solicitation in opposition to
the nominees. The votes cast for or withheld from the election of directors were
as follows: W. H. Clark received 792,141,984 votes in favor and 23,677,905 votes
were withheld; Aulana L. Peters received 765,849,839 votes in favor and
49,970,050 votes were withheld; and John J. Phelan, Jr. received 765,653,012
votes in favor and 50,166,877 votes were withheld.
The stockholders approved the Merrill Lynch Employee Stock Compensation Plan.
The votes cast for and against, as well as the number of abstentions and broker
non-votes for this proposal were as follows: 470,937,079 votes in favor,
195,147,014 votes against, 7,570,499 shares abstained, and 142,165,297 shares
represented broker non-votes.
The stockholders did not approve the stockholder proposal concerning cumulative
voting in the election of directors. The votes cast for and against, as well as
the number of abstentions and broker non-votes for this proposal were as
follows: 210,205,262 votes in favor, 455,091,217 votes against, 8,358,113 shares
abstained, and 142,165,297 shares represented broker non-votes.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
3 By-Laws of ML&Co. , effective as of April 28, 2003
4 Instruments defining the rights of security holders,
including indentures:
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, ML &
Co. hereby undertakes to furnish to the Securities and
Exchange Commission, upon request, copies of the
instruments defining the rights of holders of long-term
debt securities of ML & Co. that authorize an amount of
securities constituting 10% or less of the total assets of
ML & Co. and its subsidiaries on a consolidated basis.
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
47
99.3 Computation of Adjusted Leverage Ratios
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed with or furnished
to the Securities and Exchange Commission during the quarterly period
covered by this report:
(i) Current Report dated December 30, 2002 for the purpose of
filing the form of ML & Co.'s 7% Callable STock Return Income
DEbt SecuritiesSM due January 3, 2005, payable at maturity
with General Electric Company common stock.
(ii) Current Report dated January 15, 2003 for the purpose of
furnishing notice of a webcast of a conference call scheduled
for January 22, 2003 to review ML & Co.'s operating results.
(iii) Current Report dated January 22, 2003 for the purpose of filing
ML & Co.'s Preliminary Unaudited Earnings Summaries for the
three months and the year ended December 27, 2002.
(iv) Current Report dated January 23, 2003 for the purpose of
furnishing notice of a webcast of a presentation by ML & Co.'s
chief executive officer scheduled for January 29, 2003.
(v) Current Report dated January 31, 2003 for the purpose of filing
the form of ML & Co.'s Market Recovery NotesSM Linked to the
Nasdaq-100 Index(R) due March 31, 2005.
(vi) Current Report dated January 31, 2003 for the purpose of filing
the form of ML & Co.'s 6.5% Callable STock Return Income DEbt
SecuritiesSM due February 1, 2005, payable at maturity with
International Business Machines Corporation common stock.
(vii) Current Report dated February 20, 2003 for the purpose of
reporting Merrill Lynch's agreeing with the Securities and
Exchange Commission to a settlement in principle that would
resolve the Commission's investigation regarding two
transactions between Merrill Lynch and Enron in 1999.
(viii) Current Report dated February 25, 2003 for the purpose of
filing ML & Co.'s Preliminary Unaudited Consolidated Balance
Sheet as of December 27, 2002.
(ix) Current Report dated February 27, 2003 for the purpose of
filing the form of ML & Co.'s 7% Callable STock Return Income
DEbt SecuritiesSM due February 28, 2005, payable at maturity
with Cisco Systems, Inc. common stock.
(x) Current Report dated February 28, 2003 for the purpose of
filing the form of ML & Co.'s Strategic Return Notes(R) Linked
to the Select Ten Index due February 28, 2008.
(xi) Current Report dated March 17, 2003 for the purpose of
reporting Merrill Lynch's announcement that it had entered into
a final settlement agreement with the Securities and Exchange
Commission regarding the previously disclosed investigation
into two 1999 transactions with Enron.
(xii) Current Report dated March 27, 2003 for the purpose of filing
the form of ML & Co.'s 6% Callable STock Return Income DEbt
SecuritiesSM due March 28, 2005, payable at maturity with Merck
& Co., Inc. common stock.
(xiii) Current Report dated March 28, 2003 for the purpose of filing
the form of ML & Co.'s Market Recovery NotesSM Linked to the
S&P 500(R) Index due May 28, 2004.
48
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized.
MERRILL LYNCH & CO., INC.
---------------------------------
(Registrant)
By: /s/ Ahmass L. Fakahany
----------------------------------
Ahmass L. Fakahany
Executive Vice President and
Chief Financial Officer
By: /s/ John J. Fosina
----------------------------------
John J. Fosina
Controller
Principal Accounting Officer
Date: May 8, 2003
49
Certification of Chief Executive Officer
----------------------------------------
I, E. Stanley O'Neal, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Merrill Lynch & Co.,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ E. Stanley O'Neal
------------------------------------------------
E. Stanley O'Neal
Chairman of the Board and
Chief Executive Officer
Dated: May 8, 2003
50
Certification of Chief Financial Officer
----------------------------------------
I, Ahmass L. Fakahany, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Merrill Lynch & Co.,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Ahmass L. Fakahany
------------------------------------------------
Ahmass L. Fakahany
Executive Vice President and
Chief Financial Officer
Dated: May 8, 2003
51
INDEX TO EXHIBITS
Exhibits
3 By-Laws of ML&Co. , effective as of April 28, 2003
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.3 Computation of Adjusted Leverage Ratios
52