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 September 26, 2003
Commission File Number 1-7182
MERRILL LYNCH & CO., INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-2740599
- --------------------------------------------------------------------------------
(State of incorporation) (I.R.S. Employer Identification No.)
4 World Financial Center
New York, New York 10080
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(212) 449-1000
- --------------------------------------------------------------------------------
Registrant's telephone number, including area code
- --------------------------------------------------------------------------------
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.
942,398,722 shares of Common Stock and 2,901,850 Exchangeable Shares as of the
close of business on October 31, 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
------------------------------
Sept. 26, Sept. 27, Percent
(in millions, except per share amounts) 2003 2002 Inc. (Dec.)
-------- --------- ----------
NET REVENUES
Asset management and portfolio service fees $ 1,184 $ 1,217 (2.7)%
Commissions 1,120 1,125 (0.4)
Principal transactions 705 377 87.0
Investment banking
Underwriting 545 329 65.7
Strategic advisory 133 163 (18.4)
Other 300 165 81.8
-------- ---------
Subtotal 3,987 3,376 18.1
-------- ---------
Interest and dividend revenues 2,873 3,484 (17.5)
Less interest expense 1,794 2,498 (28.2)
-------- ---------
Net interest profit 1,079 986 9.4
-------- ---------
TOTAL NET REVENUES 5,066 4,362 16.1
-------- ---------
NON-INTEREST EXPENSES
Compensation and benefits 2,393 2,228 7.4
Communications and technology 352 421 (16.4)
Occupancy and related depreciation 226 218 3.7
Brokerage, clearing, and exchange fees 188 182 3.3
Advertising and market development 89 125 (28.8)
Professional fees 146 135 8.1
Office supplies and postage 46 62 (25.8)
Other 138 130 6.2
Net recoveries related to September 11 (21) (191) (89.0)
Restructuring - related credit - (2) (100.0)
-------- ---------
TOTAL NON-INTEREST EXPENSES 3,557 3,308 7.5
-------- ---------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,509 1,054 43.2
Income tax expense 422 313 34.8
Dividends on preferred securities issued by subsidiaries 48 48 -
-------- ---------
NET EARNINGS $ 1,039 $ 693 49.9
======== =========
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,030 $ 683 50.8
======== =========
EARNINGS PER COMMON SHARE
Basic $ 1.14 $ 0.79
======== =========
Diluted $ 1.04 $ 0.73
======== =========
DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16
======== =========
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 904.8 864.6
======== =========
Diluted 991.1 934.5
======== =========
- -----------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Nine Months Ended
--------------------------------
Sept. 26, Sept. 27, Percent
(in millions, except per share amounts) 2003 2002 Inc. (Dec.)
---------- --------- ----------
NET REVENUES
Asset management and portfolio service fees $ 3,465 $ 3,808 (9.0)%
Commissions 3,233 3,579 (9.7)
Principal transactions 2,815 1,982 42.0
Investment banking
Underwriting 1,478 1,296 14.0
Strategic advisory 391 540 (27.6)
Other 776 603 28.7
---------- ---------
Subtotal 12,158 11,808 3.0
---------- ---------
Interest and dividend revenues 8,922 9,966 (10.5)
Less interest expense 5,841 7,371 (20.8)
---------- ---------
Net interest profit 3,081 2,595 18.7
---------- ---------
TOTAL NET REVENUES 15,239 14,403 5.8
---------- ---------
NON-INTEREST EXPENSES
Compensation and benefits 7,567 7,443 1.7
Communications and technology 1,112 1,307 (14.9)
Occupancy and related depreciation 663 684 (3.1)
Brokerage, clearing, and exchange fees 527 552 (4.5)
Advertising and market development 323 426 (24.2)
Professional fees 430 397 8.3
Office supplies and postage 154 196 (21.4)
Other 548 466 17.6
Net recoveries related to September 11 (82) (191) (57.1)
Restructuring - related credit - (2) (100.0)
Research - related expenses - 111 (100.0)
---------- ---------
TOTAL NON-INTEREST EXPENSES 11,242 11,389 (1.3)
---------- ---------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 3,997 3,014 32.6
Income tax expense 1,109 896 23.8
Dividends on preferred securities issued by subsidiaries 143 144 (0.7)
---------- ---------
NET EARNINGS $ 2,745 $ 1,974 39.1
========== =========
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 2,717 $ 1,945 39.7
========== =========
EARNINGS PER COMMON SHARE
Basic $ 3.03 $ 2.26
========== =========
Diluted $ 2.81 $ 2.07
========== =========
DIVIDEND PAID PER COMMON SHARE $ 0.48 $ 0.48
========== =========
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 896.5 860.4
========== =========
Diluted 965.2 942.0
========== =========
- -------------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 26, Dec. 27,
(dollars in millions) 2003 2002
- ----------------------------------------------------------------------------------- -------- --------
ASSETS
CASH AND CASH EQUIVALENTS $ 15,532 $ 10,211
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 6,371 7,375
SECURITIES FINANCING TRANSACTIONS
Receivables under resale agreements 79,116 75,292
Receivables under securities borrowed transactions 45,556 45,543
-------- --------
124,672 120,835
TRADING ASSETS, AT FAIR VALUE (includes securities pledged as collateral of
$18,081 in 2003 and $11,344 in 2002)
Contractual agreements 39,343 38,728
Corporate debt and preferred stock 22,169 18,569
Equities and convertible debentures 17,938 13,530
Non-U.S. governments and agencies 17,407 10,095
Mortgages, mortgage-backed, and asset-backed 16,552 14,987
U.S. Government and agencies 13,414 10,116
Municipals and money markets 4,730 5,535
-------- --------
131,553 111,560
INVESTMENT SECURITIES 79,558 81,787
SECURITIES RECEIVED AS COLLATERAL 5,148 2,020
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $60 in 2003 and $79 in 2002) 41,913 35,317
Brokers and dealers 3,454 8,485
Interest and other 10,195 10,581
-------- --------
55,562 54,383
-------- --------
LOANS, NOTES, AND MORTGAGES (net of allowances of $274 in 2003 and $265 in 2002) 40,370 34,735
SEPARATE ACCOUNTS ASSETS 15,513 13,042
EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization
of $4,984 in 2003 and $4,671 in 2002) 2,606 3,080
GOODWILL (net of accumulated amortization of $1,011 in 2003 and $984 in 2002) 4,596 4,446
OTHER ASSETS 4,286 4,454
-------- --------
TOTAL ASSETS $485,767 $447,928
======== ========
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 26, Dec. 27,
(dollars in millions, except per share amount) 2003 2002
- ------------------------------------------------------------------------------------- -------- --------
LIABILITIES
SECURITIES FINANCING TRANSACTIONS
Payables under repurchase agreements $ 95,939 $ 85,378
Payables under securities loaned transactions 7,391 7,640
-------- --------
103,330 93,018
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 3,015 5,353
DEPOSITS 79,312 81,842
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 45,198 45,202
U.S. Government and agencies 17,119 14,678
Non-U.S. governments and agencies 12,257 7,952
Corporate debt, municipals and preferred stock 8,894 6,500
Equities and convertible debentures 8,084 4,864
-------- --------
91,552 79,196
-------- --------
OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 5,148 2,020
Other payables
Customers 34,525 28,569
Brokers and dealers 16,509 16,541
Interest and other 24,017 20,724
-------- --------
75,051 65,834
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 3,397 3,566
SEPARATE ACCOUNTS LIABILITIES 15,513 13,042
LONG-TERM BORROWINGS 80,706 78,524
-------- --------
TOTAL LIABILITIES 457,024 422,395
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,666 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 43 58
Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares;
issued: 2003 - 1,056,070,197 shares; 2002 - 983,502,078 shares) 1,408 1,311
Paid-in capital 6,385 5,315
Accumulated other comprehensive loss (net of tax) (511) (570)
Retained earnings 20,344 18,072
-------- --------
27,669 24,186
Less: Treasury stock, at cost: 2003 - 117,516,610 shares; 2002 - 116,211,158 shares 1,207 961
Unamortized employee stock grants 810 775
-------- --------
TOTAL COMMON STOCKHOLDERS' EQUITY 25,652 22,450
-------- --------
TOTAL STOCKHOLDERS' EQUITY 26,077 22,875
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES,
AND STOCKHOLDERS' EQUITY $485,767 $447,928
======== -=======
- --------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Nine Months Ended
------------------------------
(dollars in millions) Sept. 26, Sept. 27,
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 2,745 $ 1,974
Noncash items included in earnings:
Depreciation and amortization 430 491
Policyholder reserves 120 127
Amortization of stock-based compensation 449 493
Deferred taxes 134 29
Undistributed (earnings) loss from equity investments (82) 30
Other (40) 539
Changes in operating assets and liabilities:
Trading assets (20,089) (8,400)
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations 1,004 (3,506)
Receivables under resale agreements (3,829) (5,608)
Receivables under securities borrowed transactions (13) 2,668
Customer receivables (6,577) 3,170
Brokers and dealers receivables 5,031 (1,914)
Trading liabilities 12,015 12,380
Payables under repurchase agreements 10,561 12,898
Payables under securities loaned transactions (249) (2,643)
Customer payables 5,956 423
Brokers and dealers payables (32) 313
Other, net 3,882 6,446
------- -------
Cash provided by operating activities 11,416 19,910
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 22,498 20,350
Sales of available-for-sale securities 49,960 36,646
Purchases of available-for-sale securities (65,568) (52,619)
Maturities of held-to-maturity securities 998 145
Purchases of held-to-maturity securities (1,288) (282)
Loans, notes, and mortgages (6,063) (11,770)
Other investments and other assets (3,303) (1,755)
Equipment and facilities 44 (658)
------- -------
Cash used for investing activities (2,722) (9,943)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (2,338) 1,478
Deposits (2,530) (4,994)
Issuance and resale of long-term borrowings 22,037 18,313
Settlement and repurchases of long-term borrowings (20,908) (22,970)
Derivative financing transactions 341 -
Issuance of common stock 440 225
Issuance of treasury stock 10 5
Other common stock transactions 48 (58)
Dividends (473) (443)
------- -------
Cash used for financing activities (3,373) (8,444)
------- -------
Increase in cash and cash equivalents 5,321 1,523
Cash and cash equivalents, beginning of year 10,211 11,070
------- -------
Cash and cash equivalents, end of period $15,532 $12,593
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 59 $ 631
Interest 5,726 7,535
- ------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
6
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 26, 2003
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
For a complete discussion of Merrill Lynch's accounting policies, refer to 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 condensed
consolidated financial statements for the three-and nine-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
condensed 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 July 7, 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts. The SOP provides guidance on accounting and reporting by
insurance companies for certain nontraditional long-duration contracts and for
separate accounts. The SOP is effective for financial statements for Merrill
Lynch beginning in 2004. The SOP requires 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. Had Merrill Lynch adopted SOP 03-1 at September 26, 2003, the
estimated pre-tax impact to the Condensed Consolidated Statement of Earnings
would be between $90 million and $100 million of additional expense; however,
the ultimate impact of adoption in 2004 will depend on market conditions at that
time.
On May 15, 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 changes the accounting for certain financial instruments,
including mandatorily redeemable preferred stock and certain freestanding equity
derivatives, which under previous guidance were accounted for as equity. SFAS
No. 150 requires that mandatorily redeemable preferred shares, written put
options and physically settled forward purchase contracts on an issuer's shares,
and certain financial instruments that must be settled by issuing a variable
number of an issuer's shares, be classified as liabilities in the Condensed
Consolidated Balance Sheets. SFAS No. 150 must be applied immediately to
instruments entered into or modified after May 31, 2003 and to all other
preexisting instruments beginning in the third quarter of this year. The
adoption of SFAS No. 150 did not have a material impact on the Condensed
Consolidated Financial Statements.
7
On April 30, 2003, the 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. During the third quarter of 2003,
in accordance with SFAS No. 149, Merrill Lynch modified its classification
within the Condensed Consolidated Statement of Cash Flows. Certain derivative
instruments entered into or modified after June 30, 2003, and that have been
determined to contain a financing element at inception and where Merrill Lynch
is deemed the borrower, are now included as a separate component within Cash
flows from financing activities. Prior to July 1, 2003, the activity associated
with such derivative instruments is included within Cash flows from operating
activities. The adoption of SFAS No. 149 did not have a material impact on the
Condensed Consolidated Financial Statements.
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, or
special purpose entity. 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 qualifying special purpose entities ("QSPEs"),
the accounting for which is governed by SFAS No. 140. Merrill Lynch adopted FIN
46 on February 1, 2003 for VIEs with which it became involved after January 31,
2003. On October 8, 2003, the FASB deferred the effective date for preexisting
VIEs to the period ending after December 15, 2003. As a result, Merrill Lynch
will adopt FIN 46 for pre-existing contracts in the fourth quarter of this year
and does not expect the adoption to have a material impact on the Consolidated
Financial Statements. See Note 5 to the Condensed Consolidated Financial
Statements for additional FIN 46 disclosure.
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 this standard 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 disclosure provisions of SFAS No.
148 were effective for fiscal years ending after December 15, 2002. See Note 11
to the Condensed Consolidated Financial Statements for these disclosures.
Merrill Lynch is continuing to evaluate the transition guidance of SFAS No. 148
and currently 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.
8
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 Nos. 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 were
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.
- --------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
- --------------------------------------------------------------------------------
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 September 26,
2003 are as follows:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------------
Utilized in
-------------------------------- Balance
Initial Sept. 26,
Balance 2001 2002(1) 2003 2003
- -------------------------------------------------------------------------------------------------------------------
Category:
Severance costs $ 1,133 $ (214) $ (874) $(27) $ 18
Facilities costs 299 - (15) (72) 212
Technology and fixed asset write-offs 187 (187) - - -
Other Costs 178 - (119) - 59
------- ------ ------- ---- ------
$ 1,797 $ (401) $(1,008) $(99) $ 289
------- ------ ------- ---- ------
Staff Reductions 6,205 (749) (5,233) (102) 121
- -------------------------------------------------------------------------------------------------------------------
(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.
9
- --------------------------------------------------------------------------------
NOTE 3. SEGMENT INFORMATION
- --------------------------------------------------------------------------------
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.
Results by business segment are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
THREE MONTHS ENDED
SEPTEMBER 26, 2003
Non-interest revenues $ 1,690 $ 1,958 $ 346 $ (7) (1) $ 3,987
Net interest profit(2) 796 350 6 (73) (3) 1,079
-------- ------- ------ ------ --------
Net revenues 2,486 2,308 352 (80) 5,066
Non-interest expenses 1,464 1,842 275 (24) (4) 3,557
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 1,022 $ 466 $ 77 $ (56) $ 1,509
======== ======= ====== ====== ========
Quarter-end total assets $411,447 $64,224 $5,500 $4,596 $485,767
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ ------------ --------
THREE MONTHS ENDED
SEPTEMBER 27, 2002
Non-interest revenues $ 1,270 $ 1,762 $ 356 $ (12)(1) $ 3,376
Net interest profit(2) 652 323 4 7 (3) 986
-------- ------- ----- ------ --------
Net revenues 1,922 2,085 360 (5) 4,362
Non-interest expenses 1,378 1,768 293 (131)(4) 3,308
-------- ------- ------ ------ --------
Pre-tax earnings $ 544 $ 317 $ 67 $ 126 $ 1,054
======== ======= ====== ====== ========
Quarter-end total assets $384,267 $58,154 $5,398 $4,321 $452,140
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
(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. 2003 also
includes September 11-related expenses and a litigation credit. 2002 also
included a September 11-related net recovery.
10
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
NINE MONTHS ENDED
SEPTEMBER 26, 2003
Non-interest revenues $ 5,651 $ 5,532 $1,001 $ (26) (1) $ 12,158
Net interest profit(2) 2,183 1,004 18 (124) (3) 3,081
-------- ------- ------ ------ --------
Net revenues 7,834 6,536 1,019 (150) 15,239
Non-interest expenses 4,906 5,465 830 41 (4) 11,242
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 2,928 $ 1,071 $ 189 $ (191) $ 3,997
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
Corporate
GMI GPC MLIM Items Total
-------- ------- ------ --------- --------
NINE MONTHS ENDED
SEPTEMBER 27, 2002
Non-interest revenues $ 5,028 $ 5,636 $1,199 $ (55)(1) $ 11,808
Net interest profit(2) 1,590 1,015 13 (23)(3) 2,595
-------- ------- ------ ------ --------
Net revenues 6,618 6,651 1,212 (78) 14,403
Non-interest expenses 4,786 5,719 943 (59)(4) 11,389
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 1,832 $ 932 $ 269 $ (19) $ 3,014
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
(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. 2003 also
includes September 11-related expenses and a litigation provision. This
litigation provision will be charged to the business segments when the
amounts are fixed and determined. 2002 also included a September 11-related
net recovery and research settlement-related expenses.
11
- --------------------------------------------------------------------------------
NOTE 4. INVESTMENT SECURITIES
- --------------------------------------------------------------------------------
Investment securities at September 26, 2003 and December 27, 2002 are presented
below:
(dollars in millions)
- --------------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- --------------------------------------------------------------------------------------
Investment securities
Available-for-sale $65,886 $72,229
Trading 4,475 3,337
Held-to-maturity 942 638
Non-qualifying: (1)
Deferred compensation hedges (2) 632 1,927
Other (3) 7,623 3,656
------- -------
Total $79,558 $81,787
- --------------------------------------------------------------------------------------
(1) Non-qualifying for SFAS No. 115 purposes.
(2) Represents investments economically hedging deferred compensation
liabilities.
(3) Includes insurance policy loans, merchant banking investments, preferred
stock and other non-qualifying investments.
During the third quarter of 2003, Merrill Lynch invested in approximately $2.4
billion of investment grade preferred stock. This investment is included in
Non-qualifying - Other in the table above.
Also, during the third quarter, Other revenues include a write-down of $114
million related to certain available-for-sale securities that were considered to
be impaired on an other than temporary basis. Unrealized losses on these
securities were included in Accumulated other comprehensive loss at June 27,
2003. During the third quarter, the write-down was charged to earnings and
removed from Accumulated other comprehensive loss.
- --------------------------------------------------------------------------------
NOTE 5. SECURITIZATION TRANSACTIONS
- --------------------------------------------------------------------------------
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; structuring SPEs; underwriting, distributing; and 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 $48.5 billion for the nine months ended
September 26, 2003. For the nine months ended September 26, 2003 and September
27, 2002, Merrill Lynch received $49.1 billion and $32.3 billion, respectively,
of proceeds, and other cash inflows, from new securitization transactions, and
recognized net securitization gains, excluding gains on related derivative
transactions, of $66.8 million and $39.7 million, respectively in Merrill
Lynch's Condensed Consolidated Statements of Earnings. Merrill Lynch generally
records assets prior to securitization at fair value.
12
For the first nine months of 2003 and 2002, cash inflows from securitizations
related to the following asset types:
(dollars in millions)
- --------------------------------------------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002
- --------------------------------------------------------------------------------------
Asset category
Residential mortgage loans $35,105 $21,841
Municipal bonds 8,409 5,652
Corporate and government bonds 1,330 1,932
Commercial loans and other 4,304 2,832
------- ------
$49,148 $32,257
- --------------------------------------------------------------------------------------
Retained interests in securitized assets were approximately $2.9 billion and
$3.3 billion at September 26, 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 67% and 77% at September 26, 2003 and
December 27, 2002, respectively, of residential mortgage loan retained interests
consists of interests in U.S. Government agency sponsored securitizations, which
are guaranteed with respect to principal and interest. In addition, $702 million
and $851 million at September 26, 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 September 26, 2003 arising from Merrill Lynch's residential mortgage
loan, municipal bond and other 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 $2,077 $ 702 $ 106
Weighted average life (in years) 4.6 4.0 N/A
Range 0.0-19.0 0.1-25.3 N/A
Weighted average credit losses (rate per annum) 0.5% 0% 0.7%
Range 0.0-3.5% 0% 0.0-3.4%
Impact on fair value of 10% adverse change $ (4) $ - $ -
Impact on fair value of 20% adverse change $ (9) $ - $ (1)
Weighted average discount rate 6.2% 2.4% 5.7%
Range 0.0-75.0% 0.9-7.8% 1.0-25.0%
Impact on fair value of 10% adverse change $(15) $ (49) $ (1)
Impact on fair value of 20% adverse change $(24) $ (96) $ (3)
Weighted average prepayment speed (CPR) 19.0% 15.1% N/A
Range 0.0-65.0% 11.3-15.9% N/A
Impact on fair value of 10% adverse change $ (8) $ (1) N/A
Impact on fair value of 20% adverse change $(15) $ (2) N/A
- -----------------------------------------------------------------------------------------------------------
N/A=Not Applicable
CPR=Constant Prepayment Rate
13
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.
The weighted average assumptions and parameters used initially to value retained
interests relating to securitizations effected in 2003 that were still held by
Merrill Lynch as of September 26, 2003 are as follows:
- -----------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- -----------------------------------------------------------------------------------------------------------
Weighted average life (in years) 5.3 N/A N/A
Credit losses (rate per annum) 0.8% 0% 0.2%
Weighted average discount rate 6.1% 3.8% 2.9%
Prepayment speed assumption (CPR) 14.6% N/A 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
$17.5 billion and $13.7 billion at September 26, 2003 and December 27, 2002,
respectively. The fair value of the commitments approximated $10 million and $69
million at September 26, 2003 and December 27, 2002, respectively, which is
reflected in the Condensed Consolidated Financial Statements. Of these
arrangements, $3.1 billion and $2.3 billion at September 26, 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.
14
The following table summarizes principal amounts outstanding, delinquencies, and
net credit losses of securitized financial assets as of September 26, 2003 and
December 27, 2002.
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------
Residential Municipal
Mortgage Loans Bonds Other
- -----------------------------------------------------------------------------------------------------------
September 26, 2003
Principal Amount Outstanding $41,424 $17,343 $4,356
Delinquencies 68 - -
Net Credit Losses 3 - 6
- -----------------------------------------------------------------------------------------------------------
December 27, 2002
Principal Amount Outstanding $23,107 $18,379 $2,476
Delinquencies 90 - 3
Net Credit Losses 5 - 44
- -----------------------------------------------------------------------------------------------------------
Variable Interest Entities
- --------------------------
In January 2003, the FASB issued FIN 46, which clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial Statements, for
enterprises that have interests in entities that meet the definition of a VIE. 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. FIN 46 requires that an entity shall 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.
In accordance with the transition guidance in FIN 46, Merrill Lynch adopted the
standard on February 1, 2003 for VIEs with which Merrill Lynch became involved
after January 31, 2003. On October 8, 2003, the FASB deferred the effective date
for preexisting VIEs to periods ending after December 15, 2003. As a result,
Merrill Lynch will adopt FIN 46 for contracts entered into prior to February 1,
2003 in the fourth quarter of this year.
In the normal course of business, Merrill Lynch acts as a transferor, derivative
counterparty, investor, arranger, structurer, underwriter, market-maker,
guarantor, and/or liquidity provider to many VIEs. In addition, Merrill Lynch
acts as transferor to certain entities that meet the requirements of qualifying
special purpose entities, which are not consolidated in the Merrill Lynch
Financial Statements in accordance with SFAS No. 140, but which are disclosed
herein where Merrill Lynch typically holds a significant variable interest and
the transaction type represents a significant Merrill Lynch sponsored program.
Merrill Lynch has entered into transactions with a number of VIEs of which it is
(or is likely to be deemed) the primary beneficiary and therefore must
consolidate; or is (or is likely to be deemed) a significant variable interest
holder. These VIEs are as follows:
15
o Merrill Lynch is (or is likely to be deemed) the primary beneficiary of
VIEs that own convertible bonds purchased from Merrill Lynch, in which
Merrill Lynch maintains a call option to repurchase the convertible
bonds from the VIE. The purpose of these VIEs is to market convertible
bonds to a broad investor base by separating the bonds into callable
debt and a conversion call option. Assets held by these VIEs are
reported in Equities and convertible debentures in the Condensed
Consolidated Balance Sheet. Holders of the beneficial interests in
these VIEs have no recourse to the general credit of Merrill Lynch;
rather their investment is paid exclusively from the convertible bonds
held by the VIE. Assets held by these VIEs are currently reflected on
the Condensed Consolidated Balance Sheet as a result of preexisting
accounting guidance.
o Merrill Lynch is (or is likely to be deemed) the primary beneficiary of
"maturity shortening transactions", in which the VIE serves to shorten
the maturity of a fixed income security, and, at the maturity date of
the VIE, Merrill Lynch has the obligation to repurchase some or all of
the securities held by the VIE. Assets held by these VIEs are reported
in Corporate debt and preferred stock. The beneficial interest holders
in these VIEs have recourse to Merrill Lynch to the extent that the
underlying assets that Merrill Lynch is required to repurchase have
declined in value from the initial transaction date. Assets held by
these VIEs are currently reflected on the Condensed Consolidated
Balance Sheet as a result of preexisting accounting guidance.
o Merrill Lynch structures and manages collateralized debt and
collateralized loan obligation (CDOs and CLOs, respectively) VIEs that
hold financial assets, such as fixed income securities and loan
receivables. These VIEs are used by investors to acquire an interest in
a certain risk profile associated with a pool of assets. Merrill Lynch
anticipates that it will be the primary beneficiary of certain of these
VIEs and a significant variable interest holder in others. The
beneficial interest holders of these VIEs do not have recourse to
Merrill Lynch, but are paid solely from the assets in the VIEs.
o Merrill Lynch is the sponsor and guarantor of VIEs that provide a
guarantee of principal to beneficial interest holders, thereby limiting
investors' losses generated from the assets. In certain VIEs of this
nature, Merrill Lynch will likely be considered the primary
beneficiary. Investors in these VIEs have recourse to Merrill Lynch to
the extent that the value of the assets held by the VIEs at maturity is
less than the investors' initial investment. The guarantees related to
these funds are reflected in Note 10 to the Condensed Consolidated
Financial Statements.
o Merrill Lynch has made loans to VIEs that invest in loan receivable
assets and real estate, and as a result of these loan investments
Merrill Lynch is (or is likely to be deemed) the primary beneficiary.
These VIEs are primarily designed to provide temporary financing to
clients. Assets held by these VIEs are (or are likely to be) recorded
in Other assets and/or Loans, notes and mortgages in the Condensed
Consolidated Balance Sheet. The beneficial interest holders in these
VIEs have no recourse to the general credit of Merrill Lynch; rather
their investments are paid exclusively from the assets in the VIE.
o Merrill Lynch has entered into transactions with VIEs where Merrill
Lynch is a derivative counterparty to a VIE that serves to
synthetically expose investors to a specific credit risk. Merrill Lynch
is (or is likely to be deemed) a significant variable interest holder
in these VIEs.
o Merrill Lynch has entered into transactions with VIEs that are used, in
part, to provide foreign tax planning strategies to investors. Merrill
Lynch is (or is likely to be deemed) a significant variable interest
holder in these VIEs.
o Merrill Lynch has (or is likely to be deemed to have) a significant
variable interest in municipal bond securitization QSPEs to which it
provides liquidity and default facilities. Additional information on
these programs is provided in the retained interest securitization
disclosures above and in Note 10 to the Condensed Consolidated
Financial Statements.
16
The below tables summarize Merrill Lynch's involvement with the VIEs listed
above for the period after February 1, 2003. Where an entity is a significant
variable interest holder, FIN 46 requires that entity to disclose its maximum
exposure to loss as a result of its interest in the VIE. It should be noted that
this measure does not reflect Merrill Lynch's estimate of the actual losses that
could result from adverse changes, nor does it reflect the economic hedges
Merrill Lynch enters into to reduce its exposure.
- -----------------------------------------------------------------------------------------
Post February 1, 2003 (adopted)
(in millions)
------------------------------------------------------
Primary Beneficiary Significant Variable Interest
Holder
- -----------------------------------------------------------------------------------------
Asset Recourse to Asset Maximum
Description Size Merrill Lynch(4) Size Exposure
- -----------------------------------------------------------------------------------------
Convertible Bond Stripping $351 None
Maturity Shortening $266 $76
Loan and Real Estate VIEs $ 84 None
Synthetic Credit Risk VIEs(1) $1,196 $ 112
Foreign Tax Planning VIEs(2) $ 354 $ 31
Municipal Bond
Securitizations (3) $4,800 $4,800
- -----------------------------------------------------------------------------------------
(1) The maximum exposure for Synthetic Credit Risk VIEs is the asset
carrying value of the derivatives entered into with the VIEs as of
September 26, 2003.
(2) The maximum exposure for Foreign Tax Planning VIEs reflects the fair
value of derivatives entered into with the VIEs, as well as the maximum
exposure to loss associated with indemnifications made to investors in
the VIEs.
(3) The maximum exposure for Municipal Bond Securitizations reflects
Merrill Lynch's potential liability as a result of the liquidity and
default facilities entered into with the VIEs. It significantly
overestimates Merrill Lynch's probability weighted exposure to these
VIEs. In addition, Merrill Lynch enters into economic hedges that are
designed to be effective in principally offsetting Merrill Lynch's
exposure to loss.
(4) This column reflects the extent, if any, to which investors have
recourse to Merrill Lynch beyond the assets held in the VIE.
As noted above, Merrill Lynch has not adopted FIN 46 for VIE transactions
entered into prior to February 1, 2003. Merrill Lynch does not expect the fourth
quarter adoption to have a material impact on the Consolidated Financial
Statements. Based on the current requirements of FIN 46 and Merrill Lynch's best
estimate of the impact of adoption, Merrill Lynch expects to be the primary
beneficiary and therefore required to consolidate assets estimated to equal $2.8
billion, which would result an estimated increase of assets on the Consolidated
Balance Sheet of $1.1 billion (based on September 26, 2003 values). In addition,
Merrill Lynch expects to disclose as a significant variable interest holder its
involvement with VIEs that hold an estimated $22.0 billion of assets.
17
- --------------------------------------------------------------------------------
NOTE 6. LOANS, NOTES, AND MORTGAGES AND RELATED COMMITMENTS TO EXTEND CREDIT
- --------------------------------------------------------------------------------
Loans, Notes, and Mortgages and related commitments to extend credit at
September 26, 2003 and December 27, 2002, are presented below:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Loans Commitments
-------------------------------- --------------------------------
Sept. 26, 2003 Dec. 27, 2002 Sept. 26, 2003(1) Dec. 27, 2002
- ----------------------------------------------------------------------------------------------------------------
Consumer and small and middle-market $25,687 $22,638 $ 9,397 $ 7,687
business - secured
Commercial:
Secured 12,857 7,966 8,406 5,074
Unsecured investment grade 1,323 3,434 14,201 10,882
Unsecured non-investment grade 503 697 756 300
------- ------- ------- -------
Total $40,370 $34,735 $32,760 $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 $274 million and
$265 million as of September 26, 2003 and December 27, 2002, respectively.
Consumer and small and middle-market business loans consisted of approximately
190,000 individual loans at September 26, 2003 and included residential
mortgages, home equity loans, small and middle-market business loans, and other
loans to individuals for household, family, or other personal expenditures,
substantially all of which are secured by real and/or personal property.
Commercial loans, which at September 26, 2003 consisted of approximately 6,000
separate loans, included 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
$4.4 billion and $3.8 billion at September 26, 2003 and December 27, 2002,
respectively.
The above amounts include $5.8 billion and $6.2 billion of loans held for sale
at September 26, 2003 and December 27, 2002, respectively. Loans held for sale
are loans which management expects to sell prior to maturity. At September 26,
2003, such loans consisted of $4.3 billion of consumer loans, primarily
residential mortgages, and $1.5 billion of commercial loans, approximately 47%
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 in the 2002 Annual Report.
18
- --------------------------------------------------------------------------------
NOTE 7. SHORT-TERM BORROWINGS AND DEPOSITS
- --------------------------------------------------------------------------------
Short-term borrowings and Deposits at September 26, 2003 and December 27, 2002
are presented below:
(dollars in millions)
- --------------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- --------------------------------------------------------------------------------------
Commercial paper and other short-term
borrowings
Commercial paper $ 2,203 $ 3,966
Other 812 1,387
------- -------
Total $ 3,015 $ 5,353
------- -------
Deposits
U.S. $65,569 $68,550
Non U.S. 13,743 13,292
------- -------
Total $79,312 $81,842
- --------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 8. COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The components of comprehensive income are as follows:
(dollars in millions)
- ------------------------------------------------------------------------------- -----------------------------
Three Months Ended Nine Months Ended
-------------------- ----------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
-------- -------- -------- -------------
Net Earnings $1,039 $693 $2,745 $1,974
------ ---- ------ ------
Other comprehensive income (loss), net of tax:
Currency translation adjustment 16 (5) 20 (29)
Net unrealized gain (loss) on investment
securities available-for-sale (35) (50) 32 (14)
Deferred gain (loss) on cash flow hedges 13 (6) 7 (20)
------ ---- ------ ------
Total other comprehensive income (loss), (6) (61) 59 (63)
net of tax ------ ---- ------ ------
Comprehensive income $1,033 $632 $2,804 $1,911
- -------------------------------------------------------------------------------------------------------------
19
- --------------------------------------------------------------------------------
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 Nine Months Ended
------------------------ --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
-------- -------- -------- --------
Net Earnings $ 1,039 $ 693 $ 2,745 $ 1,974
Preferred stock dividends 9 10 28 29
-------- -------- -------- --------
Net earnings applicable to common stockholders $ 1,030 $ 683 $ 2,717 $ 1,945
-------- -------- -------- --------
- --------------------------------------------------------------------------------------------------------------------
(shares in thousands)
Weighted-average shares outstanding 904,829 864,629 896,528 860,370
-------- -------- -------- --------
Effect of dilutive instruments(1) (2):
Employee stock options 37,512 21,917 27,249 33,038
Financial Advisor Capital Accumulation
Award Plan shares 24,158 23,083 22,167 24,080
Restricted shares and units 24,526 24,787 19,175 24,433
Employee Stock Purchase Plan shares 41 61 72 80
-------- -------- -------- --------
Dilutive potential common shares 86,237 69,848 68,663 81,631
-------- -------- -------- --------
Total weighted-average diluted shares 991,066 934,477 965,191 942,001
-------- -------- -------- --------
- --------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $1.14 $0.79 $3.03 $2.26
Diluted earnings per common share $1.04 $0.73 $2.81 $2.07
- --------------------------------------------------------------------------------------------------------------------
(1) During the 2003 and 2002 third quarter there were 78 million and 179
million instruments, respectively, that were considered antidilutive and
not included in the above computations.
(2) See Note 16 to the 2002 Annual Report for a description of these
instruments.
- --------------------------------------------------------------------------------
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 in
investigations and/or 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.
20
Given the number of these legal actions, investigations and proceedings, some
are likely to result in adverse judgments, settlements, penalties, injunctions,
fines, or other relief. 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
it, 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 September 26, 2003, Merrill Lynch's commitments had the following
expirations:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Commitment expiration
---------------------------------------------------
Less than
Total 1 year 1- 3 years 3+ - 5 years Over 5 years
- ----------------------------------------------------------------------------------------------------------------
Commitments to extend credit(1) $32,760 $14,623 $7,127 $6,757 $4,253
Partnership interests 446 170 107 56 113
Other commitments 7,588 6,642 745 69 132
Operating leases 3,872 525 989 840 1,518
Resale agreements 11,688 10,557 627 127 377
Repurchase agreements 6,295 6,295 - - -
------- ------- ------ ------ ------
Total $62,649 $38,812 $9,595 $7,849 $6,393
- -----------------------------------------------------------------------------------------------------------------
(1) See Note 6 to the Condensed Consolidated Financial Statements and Note 14 in
the 2002 Annual Report for additional details.
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 $474 million
and $434 million at September 26, 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 $456 million and $527 million
at September 26, 2003 and December 27, 2002, respectively. Merrill Lynch has
entered into purchasing and other commitments totaling $7.0 billion and $1.4
billion at September 26, 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.
In 1999 and 2000, Merrill Lynch established two SPEs to finance its Hopewell,
New Jersey campus and an aircraft. Merrill Lynch leased the facilities and the
aircraft from the SPEs. The total amount of funds raised by the SPEs to finance
these transactions was $383 million. These SPEs were not consolidated by Merrill
Lynch pursuant to accounting guidance, which was then in effect. In the second
quarter of 2003, the facilities and aircraft owned by these SPEs were acquired
by a newly created limited partnership, which is unaffiliated with Merrill
Lynch. The limited partnership acquired the assets subject to the leases with
Merrill Lynch as well as the existing indebtedness incurred by the original
SPEs. The proceeds from the sale of the assets to the limited partnership, net
of the debt assumed by the limited partnership, were used to repay the equity
investors in the original SPEs. After the transaction was completed, the
original SPEs were dissolved. The limited partnership has also entered into
leases with third parties unrelated to Merrill Lynch.
21
The leases with the limited partnership mature in 2005 and 2006, and each lease
has a renewal term to 2008. In addition, Merrill Lynch has entered into
guarantees with the limited partnership, whereby if Merrill Lynch does not renew
the lease or purchase the assets under its lease at the end of either the
initial or the renewal lease term, the underlying assets will be sold to a third
party, and Merrill Lynch has guaranteed that the proceeds of such sale will
amount to at least 84% of the acquisition cost of the assets. The maximum
exposure to Merrill Lynch as a result of this residual value guarantee is
approximately $325 million as of September 26, 2003. As of September 26, 2003,
the carrying value of the liability on the Condensed Consolidated Financial
Statements is $36 million. Merrill Lynch's residual value guarantee does not
comprise more than half of the limited partnership's assets. Merrill Lynch had
entered into a similar residual value guarantee with the previous SPEs; the
maximum exposure under the previous guarantee was approximately $325 million as
of December 27, 2002.
The limited partnership does not meet the definition of a variable interest
entity as defined in FIN 46. Merrill Lynch does not have a partnership or other
interest in the limited partnership. Accordingly, Merrill Lynch is not required
to consolidate the limited partnership in its financial statements. The leases
with the limited partnership are accounted for as operating leases.
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 rates or changes in 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 overstates
Merrill Lynch's exposure to these contracts.
22
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 the
Derivatives section of Note 1 in the 2002 Annual Report 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 are
not part of a cross collateralized pool. As of September 26, 2003, the value of
the municipal bond assets to which Merrill Lynch has recourse in the event of a
draw was $19.8 billion and the maximum payout if the standby facilities are
drawn was $14.6 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 September 26, 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 $3.5 billion; the maximum payout if an issuer
defaults was $2.8 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,
Merrill Lynch 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 September 26, 2003,
the value of the assets for which Merrill Lynch provides residual value
guarantees and is not the lessee was $553 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 84% of the acquisition cost of the assets.
23
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 $241
million as collateral to secure these guarantees. In addition, standby letters
of credit include $68 million of financial guarantees for which Merrill Lynch
has recourse to the guaranteed party upon draw down.
Further, in conjunction with certain principal protected mutual funds and
managed futures funds, Merrill Lynch guarantees the return of the initial
principal investment at the termination date of the fund. These funds are
generally managed based on a formula that requires the fund to hold a
combination of general investments and either highly liquid risk-free assets or
in-the-money put options purchased from AAA credit rated counterparties that
when combined will result in the return of principal at the maturity date unless
there is a significant market event. Merrill Lynch's maximum potential exposure
to loss with respect to these guarantees is $723 million assuming that the funds
are invested exclusively in other investments (i.e., the funds hold no risk-free
assets or all of the put option counterparties default), and that those other
investments suffer a total loss. As such, this measure significantly overstates
Merrill Lynch's exposure or expected loss at September 26, 2003. The carrying
value for these guarantees at September 26, 2003 was $19 million, which includes
a reserve for probable and estimable losses of $10 million and a $9 million
liability recorded pursuant to FIN 45 for a newly created fund.
These guarantees and their expiration are summarized at September 26, 2003 as
follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
Maximum
Payout/ Less than 1 - 3 3+ - 5 Over 5 Carrying
Notional 1 year years years years Value
- --------------------------------------------------------------------------------------------------------------------
Derivative contracts(1) $ 894,501 $321,374 $243,315 $192,361 $137,451 $19,788
Liquidity facilities with SPEs(2) 14,640 12,762 1,878 - - 8
Liquidity and default facilities
with SPEs 2,867 2,060 503 1 303 2
Residual value guarantees(3)(4) 1,767 64 58 357 1,288 36
Standby letters of credit and other
performance guarantees(5) 1,205 471 121 341 272 20
- --------------------------------------------------------------------------------------------------------------------
(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 $3.1 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 leases of $325 million.
(4) Includes $843 million of reimbursement agreements with the Mortgage 100SM
program.
(5) Marketable securities are posted as collateral.
See Note 14 in the 2002 Annual Report for additional information on guarantees.
24
- --------------------------------------------------------------------------------
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
in the 2002 Annual Report for accounting policy. Merrill Lynch changed the
vesting period for stock options from six months, for 2002 grants, to four
years, for 2003 grants. For the nine-month periods ended September 26, 2003 and
September 27, 2002, $581 million ($360 million after-tax) and $602 million ($373
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 $192 million ($119 million after-tax) and
$1,170 million ($726 million after-tax), respectively, for the nine-month
periods ended September 26, 2003 and September 27, 2002, respectively. This
decrease reflects the change in vesting period. Pro forma net earnings and
earnings per share are as follows:
(dollars in millions, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
- ----------------------------------------------------------------------------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002 Sept. 26, 2003 Sept. 27, 2002
-------------- -------------- -------------- --------------
Net Earnings, as reported $1,039 $693 $2,745 $1,974
Less: stock-based compensation determined
under Black-Scholes method, net of taxes (42) (132) (119) (726)
------ ----- ------ ------
Pro forma net earnings $ 997 $ 561 $2,626 $1,248
------ ----- ------ ------
Earnings per share
As reported:
Basic $ 1.14 $0.79 $ 3.03 $ 2.26
Diluted 1.04 0.73 2.81 2.07
Pro forma:
Basic 1.09 0.64 2.90 1.42
Diluted 1.00 0.58 2.69 1.29
- ----------------------------------------------------------------------------------------------------------------------
25
- --------------------------------------------------------------------------------
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
September 26, 2003, MLPF&S's regulatory net capital of $3,859 million was
approximately 27.4% of ADI, and its regulatory net capital in excess of the
minimum required was $3,577 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 September 26, 2003, MLI's financial resources were
$5,657 million, exceeding the minimum requirement by $1,230 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 September 26, 2003, MLGSI's liquid capital of
$2,755 million was 258% of its total market and credit risk, and liquid capital
in excess of the minimum required was $1,473 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
September 26, 2003 and December 27, 2002.
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)
- ---------------------------------------------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------------------------------------------
Actual Ratio Amount Actual Ratio Amount
------------ ------ ------------ ------
Tier I leverage (to average assets)
MLBUSA 6.22% $4,488 5.35% $3,740
MLB&T 5.50 882 5.42 848
Tier I capital (to risk-weighted assets)
MLBUSA 12.08 4,488 11.48 3,740
MLB&T 20.05 882 20.53 848
Total capital (to risk-weighted assets)
MLBUSA 12.63 4,692 12.04 3,924
MLB&T 20.10 884 20.54 848
- ---------------------------------------------------------------------------------------------------------------------
26
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 September 26,
2003, and the related condensed consolidated statements of earnings for the
three-month and nine-month periods ended September 26, 2003 and September 27,
2002, and the condensed consolidated statements of cash flows for the nine-month
periods ended September 26, 2003 and September 27, 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
November 5, 2003
27
- --------------------------------------------------------------------------------
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 investment
banking and capital raising activities are affecting how financial services
companies interact with their clients and may affect the cost structure for
such activities. 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
areas of capital and risk management.
28
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.
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Global financial markets continued to improve during the third quarter 2003.
Global equity markets recorded improved results during the quarter. The
improvement in the economy and the sharp rise in equity markets have encouraged
investors to realign their investments from bonds to stocks.
In a volatile quarter, long-term U.S. interest rates, as measured by the yield
on the 10-year U.S.Treasury bond, reached a 14-month peak in mid-August at 4.6%
and ended the quarter at 3.93%, up from 3.51% at the end of the second quarter
of 2003. The U.S. Federal Reserve Bank kept the federal funds rate unchanged
during the quarter at 1.00%.
Despite continued worries about the falling dollar, rising oil prices and the
still-uncertain prospects for the economy and corporate earnings, all major U.S.
indexes were up slightly this quarter. Although the Dow Jones Industrial Average
increased by only 3.2% in the third quarter, it rose 22.2% from the end of the
third quarter of 2002 and 11% during 2003. The NASDAQ Composite Index, dominated
by large-cap technology stocks, fared better with gains of 10.1% during the
quarter, and 52.5% from the 2002 third quarter. The Standard & Poor's 500 stock
index rose 2.2% in the third quarter, and was up 22.2% from the year-ago
quarter.
Global equity markets rose sharply for the second consecutive quarter. The Dow
Jones World Index, excluding the United States, increased 8.9% in the third
quarter of 2003 and 26.5% from the third quarter of 2002. In Europe, the
dollar's renewed decline against the euro and weak growth prospects affected all
major markets, as reflected by the modest 1.9% gain of the Dow Jones Stoxx 600
index of European blue chips. In Japan, with an annualized growth rate of 3.9%
during the second quarter, the Nikkei 225 Stock Average Index reached a 15-month
high during the month of September and ended the quarter with an overall gain of
12.5%. In Hong Kong, the Hang Seng Index increased 17.3% for the quarter. From
Asia to Latin America, global emerging markets posted strong results during the
quarter.
29
Global debt and equity underwriting increased 29% in the third quarter of 2003
from the comparable period of 2002, according to Thomson Financial Securities
Data. In a marked shift from last year, stock underwriting started to rebound.
Proceeds from global equity and equity-related issues nearly doubled in the
third quarter 2003 to $101.7 billion compared to $51.7 billion in the year-ago
period. The increased stock issuances helped raise total underwriting fees by
22% compared to the 2002 third quarter. The IPO business improved substantially
with 21 IPOs in the third quarter 2003 compared to 10 IPOs in the year-ago
quarter, according to Thomson Financial Securities Data.
Despite a strong start in early July, mergers and acquisition activity lost
momentum by the end of the third quarter, with a noticeable slowdown outside the
United States. According to Thomson Financial Securities Data, the value of
global announced deals in the third quarter of 2003 was $278 billion, down 6%
from $296 billion in the comparable period of 2002. In the United States,
although activity improved on a sequential quarter basis, the value of announced
deals in the 2003 third quarter was down 16% from the year-ago level.
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.
30
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
---------------------------- ----------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(dollars in millions, except per share amounts) 2003 2002 2003 2002
-------- -------- -------- --------
Net Revenues
Asset management and portfolio service fees $ 1,184 $ 1,217 $ 3,465 $ 3,808
Commissions 1,120 1,125 3,233 3,579
Principal transactions 705 377 2,815 1,982
Investment banking
Underwriting 545 329 1,478 1,296
Strategic advisory 133 163 391 540
Other 300 165 776 603
-------- -------- -------- --------
Subtotal 3,987 3,376 12,158 11,808
Interest and dividend revenues 2,873 3,484 8,922 9,966
Less interest expense 1,794 2,498 5,841 7,371
-------- -------- -------- --------
Net interest profit 1,079 986 3,081 2,595
-------- -------- -------- --------
Total Net Revenues 5,066 4,362 15,239 14,403
-------- -------- -------- --------
Non-interest expenses:
Compensation and benefits 2,393 2,228 7,567 7,443
Communications and technology 352 421 1,112 1,307
Occupancy and related depreciation 226 218 663 684
Brokerage, clearing, and exchange fees 188 182 527 552
Advertising and market development 89 125 323 426
Professional fees 146 135 430 397
Office supplies and postage 46 62 154 196
Other 138 130 548 466
Net recoveries related to September 11 (21) (191) (82) (191)
Restructuring-related credit - (2) - (2)
Research-related expenses - - - 111
-------- -------- -------- --------
Total non-interest expenses 3,557 3,308 11,242 11,389
-------- -------- -------- --------
Earnings before income taxes and dividends on
preferred securities issued by subsidiaries $ 1,509 $ 1,054 $ 3,997 $ 3,014
======== ======== ======== ========
Net earnings $ 1,039 $ 693 $ 2,745 $ 1,974
======== ======== ======== ========
Earnings per common share:
Basic $ 1.14 $ 0.79 $ 3.03 $ 2.26
Diluted 1.04 0.73 2.81 2.07
Annualized return on average common
stockholders' equity 16.5 % 12.7 % 15.2 % 12.5 %
Pre-tax profit margin 29.8 24.2 26.2 20.9
- -------------------------------------------------------------------------------------------------------------------------
31
Quarterly Results of Operations
Merrill Lynch's net earnings were $1.039 billion for the 2003 third quarter, 50%
higher than the $693 million reported in the third quarter of 2002. Earnings per
common share were $1.14 basic and $1.04 diluted, compared with $0.79 basic and
$0.73 diluted in the 2002 third quarter. The third quarter pre-tax margin rose
to 29.8%, up from 24.2% in the prior-year quarter. Third quarter 2003 net
earnings include $13 million, $0.01 per diluted share, ($21 million pre-tax)
attributable to a September 11-related net insurance recovery. Third quarter
2002 net earnings included $115 million, $0.12 per diluted share ($193 million
pre-tax) related primarily to September 11-related net recoveries.
Net revenues were $5.1 billion in the third quarter of 2003, 16% higher than the
2002 third quarter. Asset management and portfolio service fees were $1.2
billion, down 3% from the third quarter of 2002 largely as a result of a
reduction in portfolio servicing fees, a large portion of which are calculated
on beginning-of-period asset values. Commission revenues were $1.1 billion,
essentially unchanged from the 2002 third quarter. Principal transactions
revenues increased 87% from the third quarter of 2002 to $705 million, due
principally to increased debt and equity markets trading revenues. Underwriting
revenues were $545 million, 66% higher than the 2002 third quarter, reflecting
higher levels of equity underwriting revenues, which are reflected in GMI
underwriting revenues and GPC principal transactions and new issue revenues.
Strategic advisory revenues declined 18% to $133 million from the 2002 third
quarter due to reduced market activity levels and lower market share. Other
revenues were $300 million, 82% higher than the 2002 third quarter due to
increased revenues from investments and sales of mortgages. Net interest profit
was $1.1 billion, up 9% from the 2002 third quarter due primarily to a more
favorable yield curve environment.
Compensation and benefits expenses were 47.2% of net revenues for the third
quarter of 2003, compared to 51.1% in the year-ago quarter. Compensation and
benefits expenses of $2.4 billion in the third quarter of 2003 increased 7% from
the 2002 third quarter due primarily to higher incentive compensation accruals
reflecting increased net revenues.
Non-compensation expenses were $1.2 billion in the third quarter of 2003, an
increase of 8% from the 2002 third quarter (a decline of 7% excluding September
11-related net recoveries and the restructuring-related credit in the third
quarter of 2002). Communications and technology costs were $352 million, down
16% from the third quarter of 2002 due primarily to reduced communications costs
and lower technology equipment depreciation and rental costs. Occupancy and
related depreciation expense was up 4% in the 2003 third quarter compared to the
year ago period. As a result of eliminating certain excess capacity, these
expenses are expected to increase in the fourth quarter of 2003. Advertising and
market development expenses were $89 million, down 29% from the third quarter of
2002 due primarily to lower advertising and sales promotion expenses. Office
supplies and postage expenses were $46 million in the 2003 third quarter, a 26%
decrease from the year-ago quarter, due to efficiency initiatives.
The September 11-related net recovery in the third quarter of 2003 includes a
partial pre-tax insurance reimbursement of $25 million, offset by September
11-related costs of $4 million. The insurance reimbursement represents a partial
business interruption settlement for GMI and is recorded as a reduction of
expenses in that segment. The costs were recorded in the Corporate segment.
Third quarter 2002 net earnings includes $191 million of September 11-related
net recoveries. The net recoveries include partial business interruption
settlements for GMI and GPC of $50 million and $25 million, respectively, which
were recorded as a reduction of non-interest expenses. The Corporate segment
includes $116 million of net insurance recoveries for a portion of the
replacement and recovery costs.
32
Year-to-date Results of Operations
For the first nine months of 2003, net earnings were $2.7 billion, up 39% from
$2.0 billion for the corresponding period in 2002, as net revenues increased 6%,
to $15.2 billion. Compensation and benefits expenses for the first nine months
of 2003 increased 2% from the year-ago period, to $7.6 billion as higher
earnings-related compensation was partially offset by lower staffing levels.
Non-compensation expenses totaled $3.7 billion for the first nine months of
2003, a decline of 7% from the year-ago period. This decrease reflects the
results of the 2001 restructuring program and continued operating discipline in
managing costs. Year-to-date earnings per common share were $3.03 basic and
$2.81 diluted, compared with $2.26 basic and $2.07 diluted in the first nine
months of 2002. The pre-tax profit margin for the first nine months of 2003 was
26.2%, up from 20.9% in the year-ago period. Annualized return on average common
stockholder's equity was 15.2% for the first nine months of 2003 compared to
12.5% for the comparable period in 2002.
Year-to-date 2003 net earnings include $49 million, $0.05 per diluted share,
($82 million pre-tax) attributable to September 11-related net insurance
recoveries. Year-to-date 2002 net earnings included $114 million, ($191 million
pre-tax) of September 11-related net recoveries, $78 million ($111 million
pre-tax) of research-related expenses and a $1 million ($2 million pre-tax)
restructuring-related credit. The net result of these items increased diluted
earnings per share by $.04 for the first nine months of 2002. The 2002
year-to-date pre-tax profit margin was 20.4% excluding these items.
Merrill Lynch's year-to-date effective tax rate was 27.7%. The full year 2002
effective tax rate was 28.0%.
- --------------------------------------------------------------------------------
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.
33
- --------------------------------------------------------------------------------
GLOBAL MARKETS AND INVESTMENT BANKING
- --------------------------------------------------------------------------------
GMI's Results of Operations
- -----------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
------------------------------------------------------------------------
Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, % Inc.
(dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.)
- -----------------------------------------------------------------------------------------------------------
Commissions $ 469 $ 515 (9) $ 1,456 $ 1,587 (8)
Principal transactions and
net interest profit 1,286 856 50 4,369 2,908 50
Investment banking 555 428 30 1,517 1,643 (8)
Other revenues 176 123 43 492 480 3
-------- -------- -------- --------
Total net revenues 2,486 1,922 29 7,834 6,618 18
-------- -------- -------- --------
Non-interest expenses 1,464 1,378 6 4,906 4,786 3
-------- -------- -------- --------
Pre-tax earnings $ 1,022 $ 544 88 $ 2,928 $ 1,832 60
-------- -------- -------- --------
Pre-tax profit margin 41.1 % 28.3 % 37.4 % 27.7 %
- -----------------------------------------------------------------------------------------------------------
GMI achieved a strong year-over-year growth in net revenues and pre-tax earnings
and set a record pre-tax profit margin for the second consecutive quarter. In
debt markets, GMI experienced strong growth in credit products, principal
investments and foreign exchange, as well as solid results in interest rate
trading. Net revenues in GMI's equity business improved across all components of
equity trading, origination and financing activities. Geographically, the
Pacific Rim debt business and the European and Pacific Rim equity businesses
contributed strongly to the year-over-year revenue increase.
GMI net revenues were $2.5 billion in the 2003 third quarter, an increase of 29%
from the year-ago quarter. Pre-tax earnings increased 88% from the third quarter
of 2002, to $1.0 billion. GMI's 2003 and 2002 third quarter results included
September 11-related partial pre-tax insurance reimbursements, which were
recorded as reductions of non-interest expenses, of $25 million and $50 million,
respectively. GMI's pre-tax profit margin was 41.1%, up from 28.3% in the third
quarter of 2002. Excluding the insurance recoveries, GMI's pre-tax profit
margins were 40.1% and 25.7% in the 2003 and 2002 third quarter, respectively.
Total non-interest expenses were $1.5 billion during the 2003 third quarter, up
from $1.4 billion in the year-ago period, due primarily to higher incentive
compensation accruals associated with increased net revenues.
For the first nine months of 2003, GMI pre-tax earnings were $2.9 billion, up
60% from the prior year period, on net revenues that rose 18%, to $7.8 billion.
The year-to-date pre-tax profit margin increased to 37.4%, compared with 27.7%
in the same period last year. Excluding the $100 million of insurance
recoveries, GMI's year-to-date 2003 pre-tax earnings were $2.8 billion and the
pre-tax profit margin was 36.1%. Year-to-date 2002 pre-tax earnings and pre-tax
profit margin, excluding the $50 million of insurance recoveries, were $1.8
billion and 26.9%, respectively.
Client Facilitation and Trading
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, money market instruments and options.
Commission revenues in the third quarter of 2003 decreased 9% compared to the
year-ago quarter, to $469 million, primarily as a result of a global decline in
equity trading volumes. Year-to-date commissions revenues decreased 8% compared
to the first nine months of 2002, to $1.5 billion.
34
Principal transactions and net interest profit
- ------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
---------------------------------- ---------------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(dollars in millions) 2003 2002 % Inc. 2003 2002 % Inc.
- ------------------------------------------------------------------------------------------------------------------
Debt and debt derivatives $ 981 $ 771 27 $ 3,585 $ 2,317 55
Equities and equity derivatives 305 85 259 784 591 33
-------- ----- ------- -------
Total $ 1,286 $ 856 50 $ 4,369 $ 2,908 50
- ------------------------------------------------------------------------------------------------------------------
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
$1.3 billion in the third quarter of 2003, up 50% from $856 million in the
third quarter of 2002. Debt and debt derivatives net trading revenues were
$981 million, up 27% from the third 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 increased 259% from the third quarter of 2002 to $305
million, due to higher equity trading revenues resulting from the improvement
in equity market conditions.
Principal transactions revenues for the third quarter of 2003 includes $71
million of net revenue related to a privately-held equity investment held by a
Merrill Lynch broker-dealer which has been adjusted to fair market value by
utilizing a discounted cash flow method.
On a year-to-date basis, net trading revenues increased 50% from the first
nine months of 2002, to $4.4 billion, consisting of increases of 55% in debt
and debt derivatives revenues and 33% in equities and equity derivatives
revenues.
Investment Banking
- ---------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
-------------------------- --------------------------
Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, %Inc.
(dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.)
- ---------------------------------------------------------------------------------------------------------------
Debt underwriting $ 190 $ 168 13 $ 595 $ 462 29
Equity underwriting 232 97 139 531 641 (17)
----- ----- ------ ------
Total underwriting 422 265 59 1,126 1,103 2
Strategic advisory services 133 163 (18) 391 540 (28)
----- ----- ------- ------
Total $ 555 $ 428 30 $ 1,517 $1,643 (8)
- ---------------------------------------------------------------------------------------------------------------
35
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 third quarter were $422 million, up 59% from
the $265 million recorded in the third quarter of 2002, due principally to
increased equity underwriting revenues resulting from a higher volume of
transactions. Merrill Lynch ranked fourth in global debt and sixth in global
equity and equity-linked underwriting in the third quarter of 2003 with a 8.0%
and 7.5% 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.
Year-to-date underwriting revenues were $1.1 billion, up 2% from the first
nine months of 2002, as a 29% increase in debt underwriting revenues was
substantially offset by a 17% decrease in equity underwriting revenues.
Merrill Lynch's underwriting market share information based on transaction
value follows:
- ----------------------------------------------------------------------------------------
For the Three Months Ended
-------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002
---------------- -----------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Global proceeds
Debt and Equity 7.9% 3 7.5% 3
Debt 8.0 4 7.6 3
Equity and equity-linked 7.5 6 5.9 5
U.S. proceeds
Debt and Equity 9.5% 4 9.0% 3
Debt 9.7 4 9.1 3
Equity and equity-linked 6.6 5 7.8 6
- ----------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager.
- ----------------------------------------------------------------------------------------
For the Nine Months Ended
-------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002
---------------- -----------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Global proceeds
Debt and Equity 7.2% 3 8.4% 2
Debt 7.1 3 8.2 2
Equity and equity-linked 7.7 5 10.7 3
U.S. proceeds
Debt and Equity 9.0% 4 10.5% 2
Debt 8.9 3 10.2 2
Equity and equity-linked 10.3 5 16.3 3
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager
36
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, were $133 million in the third quarter of 2003, down 18%
from the third quarter of 2002 as industry-wide completed mergers and
acquisitions activity continued to contract and market share globally declined.
Year-to-date strategic advisory services revenues similarly decreased from the
year-ago period by 28%, to $391 million. Merrill Lynch's merger and acquisition
market share information based on transaction value is as follows:
- ----------------------------------------------------------------------------------------
For the Three Months Ended
------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002
--------------- --------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Completed transactions
Global 21.3 % 4 23.7 % 3
U.S. 9.2 8 40.9 2
Announced transactions
Global 13.1 % 7 13.7 % 4
U.S. 12.5 6 15.8 5
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to both target
and acquiring companies' advisors.
- ----------------------------------------------------------------------------------------
For the Nine Months Ended
------------------------------------------------
Sept. 26, 2003 Sept. 27, 2002
--------------- --------------
Market Market
Share Rank Share Rank
- ----------------------------------------------------------------------------------------
Completed transactions
Global 15.7 % 6 21.8 % 3
U.S. 14.1 6 26.0 4
Announced transactions
Global 15.0 % 4 14.6 % 4
U.S. 15.5 6 12.7 8
- ----------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to both target
and acquiring companies' advisors.
Other Revenues
Other revenues, which include realized investment gains and losses, equity
income from unconsolidated subsidiaries and distributions on equity
investments, were $176 million in the third quarter of 2003 compared to $123
million in the year-ago quarter.
During the third quarter of 2003, GMI's Other revenues includes a write-down
of $114 million related to certain available-for-sale securities that were
considered to be impaired on an other than temporary basis. In addition, 2003
third quarter Other revenues includes approximately $110 million in net
revenues related to equity method investments.
Year-to-date other revenues were $492 million, up from $480 million in the
year-ago period. Included in the year-to-date 2002 other revenues was a $45
million pre-tax gain on the sale of the Securities Pricing Services business.
For additional information on GMI's segment results, refer to Note 3 to the
Condensed Consolidated Financial Statements.
37
- --------------------------------------------------------------------------------
GLOBAL PRIVATE CLIENT
- --------------------------------------------------------------------------------
GPC's Results of Operations
- -----------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
-------------------------------- -------------------------------
Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, % Inc.
(dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.)
- -----------------------------------------------------------------------------------------------------------------------
Asset management and
portfolio service fees $ 855 $ 879 (3) $ 2,500 $ 2,728 (8)
Commissions 624 581 7 1,703 1,900 (10)
Principal transactions and
new issue revenues 340 242 40 991 874 13
Net interest profit 350 323 8 1,004 1,015 (1)
Other revenues 139 60 132 338 134 152
-------- -------- -------- --------
Total net revenues 2,308 2,085 11 6,536 6,651 (2)
-------- -------- -------- --------
Non-interest expenses 1,842 1,768 4 5,465 5,719 (4)
-------- -------- -------- --------
Pre-tax earnings $ 466 $ 317 47 $ 1,071 $ 932 15
-------- -------- -------- --------
Pre-tax profit margin 20.2 % 15.2 % 16.4 % 14.0 %
- -----------------------------------------------------------------------------------------------------------------------
GPC's third quarter 2003 pre-tax earnings were $466 million, up 47% from the
2002 third quarter. Excluding a $25 million September 11-related insurance
recovery, and a $2 million restructuring-related net credit, which were recorded
in the 2002 third quarter, GPC pre-tax earnings increased 61% from the year-ago
quarter. Net revenues increased 11% from the 2002 third quarter to $2.3 billion.
The net revenues and pre-tax earnings growth from the prior-year quarter
reflected increased client transaction activity, higher demand for fee-based
services and credit products and continued operating discipline. GPC's pre-tax
margin was 20.2%, up five percentage points from the year-ago quarter.
GPC's year-to-date net revenues were $6.5 billion, down 2% from the
corresponding period of 2002. Pre-tax earnings were $1.1 billion, up 15% from
the first nine months of 2002. GPC's year-to-date pre-tax margin was 16.4%, up
from 14.0% in the year-ago period (13.6 % excluding the insurance recovery and
restructuring-related credit in 2002).
GPC employed approximately 13,400 Financial Advisors at the end of the 2003
third quarter, down from 14,600 at the end of the 2002 third quarter but up from
13,300 at the end of the 2003 second quarter.
Asset management and portfolio service fees
Asset management and portfolio service fees include asset management fees from
taxable and tax-exempt money market funds as well as portfolio fees from
fee-based accounts such as Unlimited AdvantageSM and Merrill Lynch Consults(R).
Also included are servicing fees related to these accounts, and certain other
account-related fees.
Asset management and portfolio service fees totaled $855 million, down 3% from
the $879 million recorded in the third quarter of 2002. On a year-to-date basis,
asset management and portfolio service fees totaled $2.5 billion, down 8% from
the year-ago period. These declines result primarily from lower portfolio
servicing fees, a large portion of which are calculated on beginning-of-period
asset values.
38
Commissions
Commission 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.
Commission revenues increased 7% to $624 million in the third quarter of 2003
from $581 million in the third quarter of 2002, due primarily to increased
transaction volumes related to mutual funds and equities. Commission revenues
for the first nine months of 2003 were $1.7 billion, 10% lower than the
corresponding period of 2002 due primarily to lower transaction volumes.
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.
Principal transactions and new issue revenues were $340 million, 40% higher than
the 2002 third quarter due to an increase in equity new issue revenues.
Year-to-date revenues were $991 million, up 13% from the year year-ago period.
An analysis of changes in assets in GPC accounts from September 27, 2002 to
September 26, 2003 is detailed below:
- -----------------------------------------------------------------------------------------------------
Net Changes Due To
-----------------------------------------
Sept. 27, New Asset Sept. 26,
(dollars in billions) 2002 Money Appreciation Other(1) 2003
- -----------------------------------------------------------------------------------------------------
Assets in GPC accounts
U.S. $ 997 $9 $87 $ - $1,093
Non U.S. 87 - 7 (2) 92
----------------------------------------------------------
Total $1,084 $9 $94 $(2) $1,185
- -----------------------------------------------------------------------------------------------------
(1) Represents accounts related to the sale of Japan's call center business.
Total assets in GPC accounts in the United States were $1.1 trillion at
September 26, 2003 up from $1.0 trillion at the end of the 2002 third quarter as
a result of market-driven increases in asset values and net new money of $9
billion. Outside the United States, client assets were $92 billion, up from $87
billion at the end of the year-ago quarter. Total assets in asset-priced
accounts were $206 billion at the end of the 2003 third quarter, up 16% from
$177 billion at the end of the 2002 third quarter.
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 $350 million in the 2003 third quarter, up 8% from $323
million in the third quarter of 2002. Net interest profit for the first nine
months of 2003 was $1.0 billion, essentially unchanged from the comparable
period of 2002.
Other revenues
Other revenues were $139 million in the third quarter of 2003, compared to $60
million in the year-ago period. Other revenues for the first nine months of 2003
increased to $338 million from $134 million in the same period in 2002. These
increases are due primarily to increased realized gains related to sales of
mortgages.
For additional information on GPC's segment results, refer to Note 3 to the
Condensed Consolidated Financial Statements.
39
- --------------------------------------------------------------------------------
MERRILL LYNCH INVESTMENT MANAGERS
- --------------------------------------------------------------------------------
MLIM's Results of Operations
- ------------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
--------------------------- --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(dollars in millions) 2003 2002 % (Dec.) 2003 2002 % (Dec.)
- ------------------------------------------------------------------------------------------------------------------------
Asset management fees $ 323 $ 332 (3) $ 932 $ 1,054 (12)
Commissions 33 40 (18) 100 145 (31)
Other revenues (4) (12) (67) (13) 13 (200)
-------- -------- -------- --------
Total net revenues 352 360 (2) 1,019 1,212 (16)
Non-interest expenses 275 293 (6) 830 943 (12)
-------- -------- -------- --------
Pre-tax earnings $ 77 $ 67 15 $ 189 $ 269 (30)
-------- -------- -------- --------
Pre-tax profit margin 21.9 % 18.6 % 18.5 % 22.2 %
- ------------------------------------------------------------------------------------------------------------------------
MLIM continued to demonstrate superior relative investment performance for the
1-, 3- and 5-year periods ended September 2003. For each of these periods, more
than 70% of MLIM's global assets under management were ahead of their benchmark
or category median.
MLIM's pre-tax earnings in the 2003 third quarter were $77 million, up 15% from
$67 million in the 2002 third quarter on net revenues that were essentially
unchanged from the year ago period at $352 million. Non-interest expenses
declined 6% from the year ago period, to $275 million primarily reflecting
reduced litigation expenses. Continued resolution of litigation issues will
likely impact MLIM's future results. Net revenues are dependent on levels of
assets under management, and, accordingly, are correlated to equity market
valuations. The pre-tax margin was 21.9% in the third quarter of 2003 compared
to 18.6% in the year-ago quarter.
Year-to-date, MLIM's pre-tax earnings were $189 million, 30% lower than for the
first nine months of 2002 on net revenues that were 16% lower at $1.0 billion.
MLIM's year-to-date pre-tax margin was 18.5%, compared with 22.2% for the same
period last year.
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 $323 million, down slightly from
$332 million in the third quarter of 2002. On a year-to-date basis, asset
management fees decreased 12% to $932 million. At the end of the third quarter
of 2003, assets under management totaled $473 billion, an increase of 5% from
$452 billion at the end of the third quarter of 2002 due primarily to higher
market values, partially offset by net new money outflows of $6 billion.
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
18% to $33 million in the 2003 third quarter from the year-ago quarter.
Year-to-date commissions decreased 31%, to $100 million.
40
An analysis of changes in assets under management from September 27, 2002 to
September 26, 2003 is as follows:
- -----------------------------------------------------------------------------------------------------------
Net Changes Due To
---------------------------------------------
Sept. 27, New Asset Sept. 26,
(dollars in billions) 2002 Money Appreciation Other (1) 2003
- -----------------------------------------------------------------------------------------------------------
Assets under management $452 $(6) $28 $(1) $473
- ------------------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends, the impact of foreign exchange movements, net
outflows of retail money market funds and other changes.
Other Revenues
Other revenues, which primarily include net interest profit and investment gains
and losses, totaled $(4) million and $(12) million for the third quarter of 2003
and 2002, respectively. Other revenues in the first nine months of 2003 totaled
$(13) million and included the write-down of certain assets. Other revenues for
the first nine months of 2002 were $13 million and included a $17 million
pre-tax gain on the sale of the Canadian retail asset management business.
For additional information on MLIM's segment results, refer to Note 3 to the
Condensed Consolidated Financial Statements.
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
Management continually monitors and evaluates the level and composition of the
balance sheet.
For the first nine months of 2003, average total assets were $513 billion, up 9%
from $469 billion for the full-year 2002. Average total liabilities increased 9%
to $486 billion from $445 billion for the full-year 2002. Average total assets
and liabilities for the first nine months of 2003 include the following changes
as compared to the full-year 2002:
- -----------------------------------------------------------------------------------------
Increase/
(dollars in millions) (Decrease) Change
- -----------------------------------------------------------------------------------------
AVERAGE ASSETS
Trading assets $19,704 17%
Receivables under resale agreements 10,220 14
Loans, notes and mortgages (net) 10,219 36
AVERAGE LIABILITIES
Payables under repurchase agreements $16,432 15%
Trading liabilities 14,685 18
- -----------------------------------------------------------------------------------------
Loans, notes and mortgages were up substantially from 2002 due to increased
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.
Average total assets during the third quarter of 2003 were $531 billion, $45
billion higher than at the end of the third quarter principally due to higher
levels of securities financing transactions, and increases in other receivables
primarily from failed securities transactions that were prevalent in the U.S.
Government securities and mortgage markets.
41
- --------------------------------------------------------------------------------
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 September 26, 2003:
(dollars in millions)
- ----------------------------------------------------------------------------------------------------------------
Commitment expiration
----------------------------------------------------------------------
Less than 1 - 3 3+ - 5 Over 5
Total 1 year years years years
- ----------------------------------------------------------------------------------------------------------------
Total commitments (Note 10) $62,649 $38,812 $ 9,595 $ 7,849 $ 6,393
Long-term borrowings 80,706 18,701 24,510 16,956 20,539
Short-term borrowings 3,015 3,015 - - -
Contractual agreements(1) 45,198 10,204 9,059 7,385 18,550
Liquidity and facilities with SPEs(2) 14,640 12,762 1,878 - -
Liquidity and default facilities with
SPEs 2,867 2,060 503 1 303
Residual value guarantees(3) (4) 1,767 64 58 357 1,288
Standby letters of credit and other
performance guarantees 1,205 471 121 341 272
- ----------------------------------------------------------------------------------------------------------------
(1) Represents the liability balance of contractual agreements at September 26,
2003.
(2) Amounts relate primarily to facilities provided to municipal bond
securitization SPEs.
(3) Includes residual value guarantees associated with the
Hopewell campus and aircraft leases of $325 million.
(4) Includes $843 million of reimbursement agreements with the Mortgage 100SM
program.
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 September 26, 2003, Merrill Lynch's equity capital was comprised of $25.7
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 $28.7 billion is adequate.
42
Funding
Commercial paper outstanding totaled $2.2 billion at September 26, 2003 and $4.0
billion at December 27, 2002, which was approximately 3% and 5% of total
unsecured borrowings at September 26, 2003 and year-end 2002, respectively.
Deposits at Merrill Lynch's banking subsidiaries totaled $79.3 billion at
September 26, 2003, down from $81.8 billion at year-end 2002. Of the $79.3
billion of deposits in Merrill Lynch banking subsidiaries as of September 26,
2003, $65.6 billion were in U.S. banks. Outstanding long-term borrowings
increased to $80.7 billion at September 26, 2003 from $78.5 billion at December
27, 2002. Major components of the change in long-term borrowings during the
first nine months of 2003 are as follows:
(dollars in billions)
- -------------------------------------------------------
Balance at December 27, 2002 $78.5
Issuances 22.0
Maturities (20.9)
Other, net 1.1
-----
Balance at September 26, 2003 (1) $80.7
- -------------------------------------------------------
(1) At September 26, 2003, $62.0 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, asset-backed securities and other instruments 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 $14.3
billion and $12.6 billion at September 26, 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 $3.0 billion at September 26, 2003 and $3.5 billion at
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 November 4, 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.
43
- --------------------------------------------------------------------------------------------------------------
Preferred TOPrSSM
Rating Agency Senior Debt Ratings Stock Ratings 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
September 26, 2003 and December 27, 2002 as well as daily average VaR for the
three months ended September 26, 2003 and June 27, 2003. Additionally, high and
low VaR for the third quarter of 2003 is presented independently for each risk
category and overall.
44
- ------------------------------------------------------------------------------------------------------------------
Daily Daily
Sept. 26, Dec. 27, High Low Average Average
(dollars in millions) 2003 2002 3Q03 3Q03 3Q03 2Q03
- ------------------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 50 $ 42 $ 81 $ 45 $ 59 $ 52
Equity 34 36 38 18 29 29
Commodity 2 - 4 - 2 -
Currency 3 3 9 - 2 2
Volatility 22 19 39 21 30 24
------------------------------------------------------------------
111 100 122 107
Diversification benefit (58) (48) (63) (48)
---------------- ----------------
Overall(2) $ 53 $ 52 $ 78 $ 44 $ 59 $ 59
================ ================
- ------------------------------------------------------------------------------------------------------------------
(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
$27 million at September 26, 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) ):
- --------------------------------------------------------------------------
Sept. 26, Dec. 27,
(dollars in millions) 2003 2002
- --------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 93 $ 89
Equity 28 27
Currency 6 3
Volatility 17 13
----- ----
144 132
Diversification benefit (38) (42)
----- ----
Overall $ 106 $ 90
===== ====
- --------------------------------------------------------------------------
(1) Based on a 95% confidence level and a one-week holding period.
45
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 $9.8 billion of
collateral) of trading derivatives in a gain position by maturity at September
26, 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)
- -----------------------------------------------------------------------------------------
Years to Maturity Cross-
Credit -------------------------------------------------Maturity
Rating(1) 0-3 3+- 5 5+- 7 Over 7 Netting(2) Total
- -----------------------------------------------------------------------------------------
AAA $ 1,330 $ 992 $ 618 $ 1,980 $ (474) $ 4,446
AA 3,640 2,412 1,311 2,342 (2,398) 7,307
A 6,928 1,718 1,019 4,248 (1,356) 12,557
BBB 1,547 906 531 1,019 (837) 3,166
Other 1,401 325 142 243 (43) 2,068
---------------------------------------------------------------------------
Total $14,846 $ 6,353 $ 3,621 $ 9,832 $ (5,108) $29,544
- -----------------------------------------------------------------------------------------
(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.
46
- --------------------------------------------------------------------------------
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.
47
- --------------------------------------------------------------------------------
Trading Exposures
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's trading exposure to
non-investment grade or highly leveraged issuers or counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Trading assets:
Cash instruments $6,678 $4,825
Derivatives 4,024 5,016
Trading liabilities - cash instruments (2,060) (1,352)
Collateral on derivative assets (1,956) (2,581)
------- ------
Net trading asset exposure $6,686 $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
September 26, 2003, the carrying value of such debt and equity securities
totaled $151 million, of which 34% 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 $67 million and $203 million at September 26,
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)
- ---------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Investment securities $ 217 $ 300
Commercial loans (net of allowance for loan
losses):
Bridge loans - 131
Other loans(1) 5,369 3,660
Other investments:
Partnership interests(2) 1,608 1,749
Other equity investments(3) 480 583
- ---------------------------------------------------------------------------------
(1) Includes accrued interest.
(2) Includes $807 million and $877 million in investments at September 26, 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 119 and 129 enterprises at September 26, 2003 and
December 27, 2002, respectively.
48
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly leveraged counterparties:
(dollars in millions)
- ---------------------------------------------------------------------------------
Sept. 26, 2003 Dec. 27, 2002
- ---------------------------------------------------------------------------------
Additional commitments to invest in
partnerships (1) $ 446 $ 500
Unutilized revolving lines of credit and
other lending commitments 3,939 2,026
- ---------------------------------------------------------------------------------
(1) Includes $110 million at September 26, 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.
Merrill Lynch is party to various legal actions, including arbitrations, class
actions, and other litigation for which the ultimate outcome is uncertain and
cannot be reasonably estimated. Accordingly, no provisions for these matters
have been made in the Consolidated 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 of 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.
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. Obtaining the fair value for OTC derivative
contracts requires the use of management judgment and estimates. Unrealized
gains for these instruments are not recognized unless the valuation model
incorporates significant observable market inputs.
49
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.
Merrill Lynch also has investments in certain non-U.S. GAAP entities, which are
accounted for under the equity method of accounting. U.S. GAAP requires that
management make certain estimates in determining income recognition. In
addition, management makes judgments regarding the allocation of the cost basis
of certain investments to the underlying assets in determining valuation of
these investments. During the 2003 third quarter Merrill Lynch recorded
approximately $110 million of net revenues related to equity method investments.
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 and liabilities 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 financial instruments
whose parameters can be directly observed; and
d) all consumer and small and middle-market business loans as well as
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 judgment 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 September 26, 2003, assets and
liabilities on the Condensed Consolidated Balance Sheets can be categorized as
follows:
50
(dollars in millions)
- ------------------------------------------------------------------------------------------------
Category 1 Category 2 Category 3 Total
- ------------------------------------------------------------------------------------------------
Assets
Trading assets, excluding
contractual agreements $49,145 $41,743 $1,322 $92,210
Contractual agreements 4,738 31,055 3,550 39,343
Loans, notes, and mortgages (net) - 38,893 1,477 40,370
Investment securities 11,605 63,976 3,977 79,558
- ------------------------------------------------------------------------------------------------
Liabilities
Trading liabilities, excluding
contractual agreements $35,602 $9,613 $1,139 $46,354
Contractual agreements 5,402 36,189 3,607 45,198
- ------------------------------------------------------------------------------------------------
In addition, other trading-related assets recorded in the Condensed Consolidated
Balance Sheet at September 26, 2003 include $124.7 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.
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
On July 7, 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts. The SOP provides guidance on accounting and reporting by
insurance companies for certain nontraditional long-duration contracts and for
separate accounts. The SOP is effective for financial statements for Merrill
Lynch beginning in 2004. The SOP requires 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. Had Merrill Lynch adopted SOP 03-1 at September 26, 2003, the
estimated impact to the Condensed Consolidated Statement of Earnings would be
between $90 and $100 million of additional expense; however, the ultimate impact
of adoption in 2004 will depend on market conditions at that time.
On May 15, 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 changes the accounting for certain financial instruments,
including mandatorily redeemable preferred stock and certain freestanding equity
derivatives, which under previous guidance were accounted for as equity. SFAS
No. 150 requires that mandatorily redeemable preferred shares, written put
options and physically settled forward purchase contracts on an issuer's shares,
and certain financial instruments that must be settled by issuing a variable
number of an issuer's shares, be classified as liabilities in the Condensed
Consolidated Balance Sheets. SFAS No. 150 must be applied immediately to
instruments entered into or modified after May 31, 2003 and to all other
preexisting instruments beginning in the third quarter of this year. The
adoption of SFAS No. 150 did not have a material impact on the Condensed
Consolidated Financial Statements.
51
On April 30, 2003, the 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. During the third quarter of 2003,
in accordance with SFAS No. 149, Merrill Lynch modified its classification
within the Condensed Consolidated Statement of Cash Flows. Certain derivative
instruments entered into or modified after June 30, 2003, and that have been
determined to contain a financing element at inception and where Merrill Lynch
is deemed the borrower, are now included as a separate component within Cash
flows from financing activities. Prior to July 1, 2003, the activity associated
with such derivative instruments is included within Cash flows from operating
activities. The adoption of SFAS No. 149 did not have a material impact on the
Condensed Consolidated Financial Statements.
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, or
special purpose entity. 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 qualifying special purpose entities ("QSPEs"),
the accounting for which is governed by SFAS No. 140. Merrill Lynch adopted FIN
46 on February 1, 2003 for VIEs with which it became involved after January 31,
2003. On October 8, 2003, the FASB deferred the effective date for preexisting
VIEs to the period ending after December 15, 2003. As a result, Merrill Lynch
will adopt FIN 46 for pre-existing contracts in the fourth quarter of this year
and does not expect the adoption to have a material impact on the Consolidated
Financial Statements. See Note 5 to the Condensed Consolidated Financial
Statements for additional FIN 46 disclosure.
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 this standard 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 disclosure provisions of SFAS No.
148 were effective for fiscal years ending after December 15, 2002. See Note 11
to the Condensed Consolidated Financial Statements for these disclosures.
Merrill Lynch is continuing to evaluate the transition guidance of SFAS No. 148
and currently 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.
52
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 Nos. 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 were
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.
53
- ----------------------------------------------------------------------------------------------------------------------------------
STATISTICAL DATA
- ----------------------------------------------------------------------------------------------------------------------------------
3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr. 3rd Qtr.
Client Assets (dollars in billions) 2002 2002 2003 2003 2003
-------- -------- -------- -------- --------
GPC:
U.S. $ 997 $ 1,021 $ 1,009 $ 1,076 $ 1,093
Non-U.S. 87 89 86 92 92
-------- -------- -------- -------- --------
Total GPC Assets 1,084 1,110 1,095 1,168 1,185
MLIM direct sales 205 201 193 205 202
-------- -------- -------- -------- --------
Total Client Assets $ 1,289 $ 1,311 $ 1,288 $ 1,373 $ 1,387
======== ======== ======== ======== ========
ASSETS IN ASSET-PRICED ACCOUNTS $ 177 $ 182 $ 181 $ 200 $ 206
ASSETS UNDER MANAGEMENT:
Retail $ 182 $ 189 $ 187 $ 195 $ 194
Institutional 234 235 220 239 241
Private Investors(1) 36 38 35 37 38
U.S. 305 313 303 320 327
Non-U.S. 147 149 139 151 146
Equity 190 191 183 209 202
Fixed-income 119 122 108 108 125
Money market 143 149 151 154 146
- ----------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING (dollars in billions):
Global Equity and Equity-Linked:
Volume $ 3 $ 6 $ 4 $ 8 $ 8
Market share 5.9 % 10.4 % 8.1 % 7.8 % 7.5 %
Global debt:
Volume $ 65 $ 59 $ 95 $ 86 $ 85
Market share 7.6 % 6.5 % 7.1 % 6.5 % 8.0 %
- ----------------------------------------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES:
U.S. 41,800 40,000 39,100 38,200 37,800
Non-U.S. 11,400 10,900 10,400 10,000 10,000
-------- -------- -------- -------- --------
Total 53,200 50,900 49,500 48,200 47,800
======== ======== ======== ======== ========
Private Client Financial Advisors 14,600 14,000 13,600 13,300 13,400
- ----------------------------------------------------------------------------------------------------------------------------------
Balance Sheet (dollars in millions,
except per share amounts)
Total assets $452,140 $447,928 $455,587 $481,075 $485,767
Total stockholders' equity $ 22,299 $ 22,875 $ 23,639 $ 24,781 $ 26,077
Book value per common share $ 25.17 $ 25.69 $ 24.97 $ 26.04 $ 27.21
SHARE INFORMATION (in thousands)
Weighted-average shares outstanding:
Basic 864,629 868,160 887,553 897,202 904,829
Diluted 934,477 942,893 939,220 965,288 991,066
Common shares outstanding 869,019 873,780 929,768 935,152 942,637
- ----------------------------------------------------------------------------------------------------------------------------------
(1) Represents segregated portfolios for individuals, small corporations and
institutions.
54
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 the end of the period covered by 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-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are effective. There have
been no significant changes in ML & Co.'s internal control over financial
reporting that occurred during the period covered by this Form 10-Q that have
materially affected, or are reasonably likely to materially affect, ML & Co.'s
internal control over financial reporting.
55
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
The following information supplements the discussion in Part I, Item 3 "Legal
Proceedings" in ML & Co.'s Annual Report on Form 10-K for the fiscal year ended
December 27, 2002, Quarterly Report on Form 10-Q for the quarter ended June 27,
2003 and Current Reports on Form 8-K dated March 17, 2003, April 28, 2003, and
September 17, 2003:
Research-Related Litigation.
- ---------------------------
On August 12, 2003, and August 19, 2003, the United States District Court for
the Southern District of New York denied plaintiffs' motion for reconsideration
of the court's decisions dismissing their complaints. Plaintiffs have appealed
from these decisions. On October 29, 2003, the United States District Court for
the Southern District of New York granted Merrill Lynch's motions to dismiss
nine additional research-related class actions. Merrill Lynch intends to move to
dismiss the remaining class actions that are pending before the Court. On
October 31, 2003, the United States District Court for the Southern District of
New York entered final judgments in connection with the April 28, 2003, research
settlements between the SEC and ten investment banking firms, including Merrill
Lynch. Merrill Lynch is one of ten defendants in an action brought by the
Attorney General of West Virginia seeking relief from firms that were parties to
the April 28, 2003, research settlement. Merrill Lynch and the other defendants
have filed motions to dismiss the complaint and disqualify plaintiff's counsel,
and are awaiting a ruling on these motions.
Enron-Related Litigation
- ------------------------
Merrill Lynch is among dozens of defendants named in approximately twenty
lawsuits involving the collapse of Enron, including actions brought by Enron
investors, Enron employees, and Enron itself. On or about October 14, 2003, a
fourth former Merrill Lynch employee was indicted for alleged criminal
misconduct in connection with a Nigerian Barge transaction that the government
alleged helped Enron inflate its 1999 earnings by $12 million.
IPO Allocation Class Actions
- ----------------------------
On November 3, 2003, the United States District Court for the Southern District
of New York granted the defendants', including Merrill Lynch's, motion to
dismiss the claims brought under the antitrust laws. The defendants, including
Merrill Lynch, are continuing to defend against the claims brought under the
federal securities laws.
Shareholder Derivative Action
- -----------------------------
On October 24, 2003, the Supreme Court of the State of New York granted Merrill
Lynch's motion to dismiss Spear v. Conway, et al., a shareholder derivative
action related to Merrill Lynch's research activities.
Other
- -----
Merrill Lynch has been named as a defendant in various other 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 in
investigations and/or 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.
56
Given the number of these legal actions, investigations and proceedings, some
are likely to result in adverse judgments, settlements, penalties, injunctions,
fines, or other relief. 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
it, 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.
Item 5. Other Information
-----------------
The 2004 Annual Meeting of Shareholders will be held at 10:00 a.m. on Friday,
April 23, 2004 at the Merrill Lynch Conference and Training Center, 800 Scudders
Mill Road, Plainsboro, New Jersey. Any shareholder of record entitled to vote
generally for the election of directors may nominate one or more persons for
election at the Annual Meeting only if proper written notice, as set forth in ML
& Co.'s Certificate of Incorporation, has been given to the Secretary of ML &
Co., 222 Broadway, 17th Floor, New York, New York 10038, no earlier than
February 8, 2004 and no later than March 4, 2004. In addition, any shareholder
intending to bring any other business before the meeting must provide proper
written notice, as set forth in ML & Co.'s By-Laws, to the Secretary of ML & Co.
on or before March 4, 2004. In order to be included in ML & Co.'s proxy
statement, shareholder proposals must be received by ML & Co. no later than
November 17, 2003.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
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.
10 Merrill Lynch & Co., Inc. 2004 Deferred Compensation Plan
for a Select Group of Eligible Employees Dated as of
September 1, 2003.
12 Statement re: computation of ratios.
15 Letter re: unaudited interim financial information.
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
57
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.1 Merrill Lynch & Co., Inc. Code of Ethics for Finance
Professionals.
(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 July 2, 2003 for the purpose of filing
the form of ML & Co.'s SUMmation Securities SM Linked to the
Performance of the S&P 500 (R) Index due July 2, 2010.
(ii) Current Report dated July 3, 2003 for the purpose of filing
the form of ML & Co.'s 6.5% Callable STock Return Income DEbt
Securities SM due July 5, 2005, payable at maturity with
Intuit Inc. common stock.
(iii) Current Report dated July 3, 2003 for the purpose of filing
the form of ML & Co.'s Currency Notes Linked to the Norwegian
Krone/Swiss Franc Exchange Rate due January 4, 2005.
(iv) Current Report dated July 8, 2003 for the purpose of
furnishing notice of a webcast of a conference call scheduled
for July 15, 2003 to review ML & Co.'s operating results.
(v) Current Report dated July 15, 2003 for the purpose of filing
ML & Co.'s Preliminary Unaudited Earnings Summaries for the
three months ended June 27, 2003.
(vi) Current report dated July 29, 2003 for the purpose of filing
ML & Co.'s Preliminary Unaudited Consolidated Balance Sheet
as of June 27, 2003.
(vii) Current Report dated August 1, 2003 for the purpose of filing
the form of ML & Co.'s Global Currency Basket Notes due
August 2, 2004.
(viii) Current Report dated August 1, 2003 for the purpose of filing
the form of ML & Co.'s 9% Callable STock Return Income Debt
Securities SM due August 1, 2005, payable at maturity with
Brocade Communications Systems, Inc. common stock.
(ix) Current Report dated August 5, 2003 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes (R) Linked to
the Industrial 15 Index due August 5, 2008.
(x) Current Report dated August 5, 2003 for the purpose of
filing the form of ML & Co.'s S&P 500(R)Market Index
Target-Term Securities(R)due August 5, 2010.
(xi) Current Report dated August 5, 2003 for the purpose of filing
the form of ML & Co.'s Accelerated Return Notes Linked to the
Amex Biotechnology Index SM due October 5, 2004.
(xii) Current Report dated August 18, 2003 for the purpose of filing
the form of ML & Co.'s 6% Callable STock Return Income DEbt
Securities SM due August 18, 2005, payable at maturity with
The Walt Disney Company common stock.
(xiii) Current Report dated August 29, 2003 for the purpose of filing
the form of ML & Co.'s Interest Rate Call Warrants Linked to
the Ten Year Constant Maturity U.S. Treasury Yield Expiring
August 29, 2005.
58
(xiv) Current Report dated September 3, 2003 for the purpose of
filing the form of ML & Co.'s S&P 500(R)Market Index
Target-Term Securities(R)due September 3, 2008.
(xv) Current Report dated September 3, 2003 for the purpose of
filing the form of ML & Co.'s Market Recovery Notes SM Linked
to the Nasdaq-100 Index (R) due November 24, 2004.
(xvi) Current Report dated September 17, 2003 for the purpose of
reporting the unsealing of an indictment against three former
Merrill Lynch employees and that the Department of Justice has
agreed not to prosecute Merrill Lynch for crimes that may have
been committed by its former employees related to the
transaction, subject to certain understandings.
(xvii) Current Report dated September 23, 2003 for the purpose of
filing the form of ML & Co.'s Multi-Currency Notes due
September 23, 2005.
(xviii) Current Report dated September 23, 2003 for the purpose of
filing the form of ML & Co.'s Accelerated Return Notes linked
to Pfizer Inc. common stock due November 23, 2004.
59
SIGNATURES
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 thereunto 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: November 5, 2003
60
INDEX TO EXHIBITS
Exhibits
10 Merrill Lynch & Co., Inc. 2004 Deferred Compensation Plan for a
Select Group of Eligible Employees Dated as of September 1, 2003.
12 Statement re: computation of ratios.
15 Letter re: unaudited interim financial information.
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1 Merrill Lynch & Co., Inc. Code of Ethics for Finance Professionals.
61