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10-K - FORM 10-K - MERRILL LYNCH PREFERRED FUNDING III LP | c98330e10vk.htm |
EX-12 - EXHIBIT 12 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv12.htm |
EX-32.2 - EXHIBIT 32.2 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv32w2.htm |
EX-23.2 - EXHIBIT 23.2 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv23w2.htm |
EX-23.1 - EXHIBIT 23.1 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv23w1.htm |
EX-31.1 - EXHIBIT 31.1 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv31w1.htm |
EX-31.2 - EXHIBIT 31.2 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv31w2.htm |
EX-32.1 - EXHIBIT 32.1 - MERRILL LYNCH PREFERRED FUNDING III LP | c98330exv32w1.htm |
Exhibit 99.1
Item 1A. Risk Factors
In the course of conducting our business operations, we are exposed to a variety of risks that are
inherent to the financial services industry. The following discusses some of the key inherent risk
factors that could affect our business and operations, as well as other risk factors which are
particularly relevant to us in the current period of significant economic and market disruption.
Other factors besides those discussed below or elsewhere in this report could also adversely affect
our business and operations, and these risk factors should not be considered a complete list of
potential risks that may affect us.
Our businesses and earnings have been, and may continue to be, negatively affected by adverse
business and economic conditions. Our businesses and earnings are affected by general business and
economic conditions in the U.S. and abroad. General business and economic conditions that could
affect us include the level and volatility of short-term and long-term interest rates, fluctuations
in both debt and equity capital markets, liquidity of the global financial markets, the
availability and cost of credit, investor confidence, and the strength of the U.S. economy and the
other economies in which we operate. The deterioration of any of these conditions could adversely
affect the value of our assets, as well as our results of operations.
Economic conditions in the U.S. and abroad deteriorated significantly in 2008 and to a lesser
extent in 2009. While there are early indications that these conditions are stabilizing, we do not
expect them to significantly improve in the near future. A protracted continuation or worsening of
these difficult business or economic conditions would likely exacerbate the adverse effects on us.
Adverse changes in legislative and regulatory initiatives may significantly impact our earnings,
operations and ability to pursue business opportunities. We are heavily regulated by regulatory
agencies at the federal, state and international levels. As a result of the recent financial crisis
and economic downturn, we have faced and expect to continue to face increased regulation and
regulatory and political scrutiny, which creates significant uncertainty for us and the financial
services industry in general.
In December 2009, the Basel Committee on Banking Supervision released consultative documents on
both capital and liquidity. These proposals currently include a leverage ratio that could prove
more restrictive than the current risk-based measure. The capital proposal would increase
significantly the capital charges imposed on certain assets, including trading assets, thereby
potentially making those businesses more expensive to conduct. Full implementation of these
proposals is currently projected by the end of 2012, although delays are possible, and it is likely
that many elements of the proposals will change prior to adoption. U.S. regulatory agencies have
not opined on these proposals for U.S. implementation. We continue to assess the potential impact
of these proposals.
As a result of the financial crisis, the financial services industry is facing the possibility of
legislative and regulatory changes that could impose significant, adverse changes on our ability to
serve our clients. A proposal is currently being considered to levy a tax or fee on financial
institutions with assets in excess of $50 billion to repay the costs of the Troubled Asset Relief
Program (TARP), although the proposed tax would continue even after those costs are repaid. If
enacted as proposed, the tax could significantly affect our earnings, either by increasing the
costs of our liabilities or causing us to reduce our assets. It remains uncertain whether the tax
will be enacted, to whom it would apply, or the amount of the tax we would be required to pay. It
is also unclear the extent to which the costs of such a tax could be recouped through higher
pricing.
In addition, various proposals for broad-based reform of the financial regulatory system are
pending. A majority of these proposals would not disrupt our core businesses, but a proposal could
ultimately be adopted that adversely affects certain of our businesses. The proposals would require
divestment of certain proprietary trading activities, or limit private equity investments. Other
proposals, which include limiting the scope of an institutions derivatives activities, or forcing
certain derivatives activities to be traded on exchanges, would diminish the demand for, and
profitability of, certain businesses. Several other proposals would require issuers to retain
unhedged interests in any asset that is securitized, potentially severely restricting the secondary
market as a source of funding for consumer or commercial lending. There are also numerous proposals
pending on how to resolve a failed systemically important institution. Following the passage of a
bill in the U.S. House of Representatives and the possibility of similar provisions in a U.S.
Senate bill, one rating agency has placed the credit ratings of Bank of America, us and other banks
on negative credit watch, and therefore adoption
of such provisions may adversely affect Bank of Americas access to capital markets. It remains
unclear whether any of these proposals will ultimately be enacted, and what form they may take.
In addition, other countries, including the United Kingdom (U.K.) and France, have proposed and
in some cases adopted, certain reforms targeted at financial institutions, including, but not
limited to, increased capital and liquidity requirements for local entities, including regulated
U.K. subsidiaries of foreign companies and other financial institutions as well as branches of
foreign banks located in the U.K., the creation and production of recovery and resolutions plans
(commonly referred to as living wills) by such entities, and a significant payroll tax on bank
bonuses paid to employees over a certain threshold.
In addition, the U.S. Congress is currently considering reinstating income tax provisions that have
recently expired whereby income of certain foreign subsidiaries would not be subject to current
U.S. income tax as a result of long-standing deferral provisions applicable to active finance
income. These provisions, which in the past have expired and been extended, expired for taxable
years beginning on or after January 1, 2010. Absent an extension of these provisions, active
financing income earned by our foreign subsidiaries after January 1, 2010 will generally be subject
to a tax that considers the incremental U.S. income tax. The impact of the expiration of the
provisions should they not be extended would be significant. The exact impact would depend upon the
amount, composition and geographic mix of our future earnings.
Compliance with current or future legislative and regulatory initiatives could require us to change
certain of our business practices, impose significant additional costs on us, limit the products
that we offer, result in a significant loss of revenue, limit our ability to pursue business
opportunities in an efficient manner, require us to increase our regulatory capital, cause business
disruptions, impact the value of assets that we hold or otherwise adversely affect our business,
results of operations or financial condition. We have recently witnessed the introduction of an
ever-increasing number of regulatory proposals that could substantially impact us and others in the
financial services industry. The extent of changes imposed by, and frequency of adoption of, any
regulatory initiatives could make it more difficult for us to comply in a timely manner, which
could further limit our operations, increase compliance costs or divert management attention or
other resources. The long-term impact of these initiatives on our business practices and revenues
will depend upon the successful implementation of our strategies and competitors responses to such
initiatives, both of which are difficult to predict.
We could suffer losses as a result of the actions of or deterioration in the commercial soundness
of other financial services institutions and counterparties, including as a result of derivatives
transactions. Our ability to engage in routine trading and funding transactions could be adversely
affected by the actions and commercial soundness of other market participants. Financial services
institutions are interrelated as a result of trading, funding, clearing, counterparty or other
relationships. We have exposure to many different industries and counterparties, and we routinely
execute transactions with counterparties in the financial services industry, including brokers and
dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional
clients. As a result, defaults by, or even rumors or questions about, one or more financial
services institutions, or the financial services industry generally, have led to market-wide
liquidity disruptions and could lead to future losses or defaults by us or by other institutions.
Many of these transactions expose us to credit risk in the event of default of a counterparty or
client, and our results of operations in 2008 and to a lesser extent in 2009 were materially
affected by the credit valuation adjustments described in Item 7 Managements Discussion and
Analysis of Financial Condition and Results of Operations U.S. ABS CDO and Other Mortgage-Related
Activities Monoline Financial Guarantors. In addition, our credit risk may be exacerbated when
the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover
the full amount of the loan or derivative exposure due to us. There is no assurance that any such
losses would not materially and adversely affect our results of operations or financial condition.
We are party to a large number of derivative transactions, including credit derivatives. Many of
these derivative instruments are individually negotiated and non-standardized, which can make
exiting, transferring or settling some positions difficult. Many credit derivatives require that we
deliver to the counterparty the underlying security, loan or other obligation in order to receive
payment. In a number of cases, we do not hold, and may not be able to obtain, the underlying
security, loan or other obligation. This could cause us to forfeit the payments due to us under
these contracts or result in settlement delays with the attendant credit and operational risk as
well as increased costs to us.
Derivative contracts and other transactions entered into with third parties are not always
confirmed by the counterparties on a timely basis. While the transaction remains unconfirmed, we
are subject to heightened credit and operational risk and in the event of default may find it more
difficult to enforce the contract. In addition, as new and more complex derivative products have
been created, covering a wider array of underlying credit and other instruments, disputes
about the terms of the underlying contracts may arise, which could impair our ability to
effectively manage our risk exposures from these products and subject us to increased costs.
For further discussion of our exposure to derivatives, see Note 6 to the Consolidated Financial
Statements.
Changes in accounting standards or inaccurate estimates or assumptions in the application of
accounting policies could adversely affect our financial results. Our accounting policies and
methods are fundamental to how we record and report our financial condition and results of
operations. Some of these policies require use of estimates and assumptions that may affect the
reported value of our assets or liabilities and financial results and are critical because they
require management to make difficult, subjective and complex judgments about matters that are
inherently uncertain.
Recently, the Financial Accounting Standards Board (FASB) and the SEC have adopted new guidance
or rules relating to financial accounting such as, among other things, new FASB guidance on the
consolidation of variable interest entities. In addition, accounting standard setters and those who
interpret the accounting standards (such as the FASB, the SEC and our independent registered public
accounting firm) may amend or even reverse their previous interpretations or positions on how these
standards should be applied. These changes can be hard to predict and can materially impact how we
record and report our financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in the restatement of prior
period financial statements.
For a further discussion of some of our significant accounting policies and recent accounting
changes, see Note 1 to the Consolidated Financial Statements.
Our ability to attract and retain clients and employees could be adversely affected to the extent
our reputation is harmed. Our actual or perceived failure to address various issues could give
rise to reputational risk that could harm us and our business prospects. These issues include, but
are not limited to, legal and regulatory requirements, privacy, properly maintaining client and
employee personal information, record keeping, money-laundering, sales and trading practices,
ethical issues, appropriately addressing potential conflicts of interest, and the proper
identification of the legal, reputational, credit, liquidity and market risks inherent in our
products. Failure to appropriately address any of these issues could also give rise to additional
regulatory restrictions, reputational harm and legal risks, which could increase the size and
number of litigation claims and damages asserted or subject us to enforcement actions, fines and
penalties and cause us to incur related costs and expenses.
We face substantial potential legal liability and significant regulatory action, which could have
materially adverse financial consequences or cause significant reputational harm to us. We face
significant legal risks in our businesses, and the volume of claims, amount of damages and
penalties claimed in litigation, and regulatory proceedings against us and other financial
institutions remain high and are increasing. Increased litigation costs, substantial legal
liability or significant regulatory action against Bank of America or us could have material
adverse financial effects or cause significant reputational harm to us, which in turn could
seriously harm our business prospects. These litigation and regulatory matters and any related
settlements could adversely impact our earnings.
For a further discussion of litigation risks, see Note 14 to the Consolidated Financial Statements.
Our liquidity could be impaired by an inability of Bank of America to access the capital markets on
favorable terms. Liquidity is essential to our businesses. Since we were acquired by Bank of
America, we established intercompany lending and borrowing arrangements with Bank of America to
facilitate centralized liquidity management and as a result, our liquidity risk is derived in large
part from Bank of Americas liquidity risk. Bank of Americas liquidity could be impaired by an
inability to access the capital markets or by unforeseen outflows of cash, including deposits. This
situation may arise due to circumstances that Bank of America or we may be unable to control, such
as a general market disruption, negative views about the financial services industry generally, or
an operational problem that affects third parties or us. Bank of Americas ability to raise certain
types of funds has been and could continue to be adversely affected by conditions in the United
States and international markets and economies. In 2009, global capital and credit markets
continued to experience volatility and disruptions. As a result, Bank of America utilized several
of the U.S. Government liquidity programs, which are temporary in nature, to enhance its liquidity
position. Bank of Americas ability and our ability to borrow from other financial institutions or
to engage in securitization funding transactions on favorable terms could be adversely affected by
continued disruptions in the capital markets or other events, including actions by rating agencies
or deteriorating investor expectations.
Our credit ratings and Bank of Americas credit ratings are important to our liquidity. Rating
agencies regularly evaluate Bank of America and us. Their ratings of our long-term and short-term
debt and other securities are based on a number of factors, including Bank of Americas and our
financial strength as well as factors not entirely within our control, including conditions
affecting the financial services industry generally. During 2009, the rating agencies took numerous
actions with respect to Bank of Americas and our credit ratings and outlooks, many of which were
negative. The rating agencies have indicated that our credit ratings currently reflect their
expectation that, if necessary, Bank of America would receive significant support from the
U.S. Government. In February 2010, a rating agency affirmed our current credit ratings but revised
the outlook to negative from stable, based on their belief that it is less certain whether the
U.S. Government would be willing to provide extraordinary support to Bank of America. In light of
the difficulties in the financial services industry and the financial markets, there can be no
assurance that we will maintain our current ratings. Failure to maintain those ratings could
adversely affect our liquidity and competitive position, by materially increasing our borrowing
costs or significantly limiting our access to the capital markets. A reduction in our credit
ratings also could have a significant impact on certain trading revenues, particularly in those
businesses where counterparty credit-worthiness is critical. In connection with certain trading
agreements, we may be required to provide additional collateral in the event of a credit ratings
downgrade.
For a further discussion of our liquidity position and other liquidity matters and the policies and
procedures we use to manage our liquidity risks, see Liquidity Risk in Item 7 Managements
Discussion and Analysis of Financial Condition and Results of Operations.
Changes in financial or capital market conditions could cause our earnings and the value of our
assets to decline. Market risk generally represents the risk that values of assets and liabilities
or revenues will be adversely affected by changes in market conditions. As a result, we are
directly and indirectly affected by changes in market conditions. For example, changes in interest
rates could adversely affect our principal transaction revenues and net interest profit (which we
view together as our trading revenues), which could in turn affect our net earnings. Market risk is
inherent in the financial instruments associated with our operations and activities including
securities, derivatives, loans, deposits, short-term borrowings and long-term debt. Just a few of
the market conditions that may shift from time to time, thereby exposing us to market risk, include
fluctuations in interest and currency exchange rates, equity and futures prices, changes in the
implied volatility of interest rates, foreign exchange rates, credit spreads and price
deterioration or changes in value due to changes in market perception or actual credit quality of
either the issuer or its country of origin. Accordingly, depending on the instruments or activities
impacted, market risks can have wide ranging, complex adverse effects on our results from
operations and our overall financial condition. In addition, we also may incur significant
unrealized gains or losses as a result of changes in our credit spreads or those of third parties,
which may affect the fair value of derivative instruments and debt securities that we hold or
issue.
The models that we use to assess and control our risk exposures reflect assumptions about the
degree of correlation or lack thereof among prices of various asset classes or other market
indicators. In times of market stress or other unforeseen circumstances, such as the market
conditions experienced in 2008 and early 2009, previously uncorrelated indicators may become
correlated, or previously correlated indicators may move in different directions. These types of
market movements have at times limited the effectiveness of our hedging strategies and have caused
us to incur significant losses, and they may do so in the future. These changes in correlation can
be exacerbated where other market participants are using risk or trading models with assumptions or
algorithms that are similar to ours. In these and other cases, it may be difficult to reduce our
risk positions due to the activity of other market participants or widespread market dislocations,
including circumstances where asset values are declining significantly or no market exists for
certain assets. To the extent that we make investments directly in securities that do not have an
established liquid trading market or are otherwise subject to restrictions on sale or hedging, we
may not be able to reduce our positions and therefore reduce our risk associated with such
positions.
For a further discussion of our market risk and our risk management policies and procedures, see
Item 7A Quantitative and Qualitative Disclosures About Market Risk.
Our increased credit risk could result in higher credit losses and reduced earnings. When we enter
into trading positions, loan money, commit to loan money or enter into a letter of credit or other
contract with a counterparty, we incur credit risk, or the risk of losses if our borrowers do not
repay their loans or our counterparties fail to perform according to the terms of their agreements.
A number of our products expose us to credit risk, including trading positions, derivatives,
including credit default swaps, loans, and lending commitments.
We estimate and establish reserves or make credit valuation adjustments for credit risks and credit
losses inherent in our credit exposure (including unfunded lending commitments). This process,
which is critical to our financial results and condition, requires difficult, subjective and
complex judgments, including forecasts of economic conditions and how our borrowers and
counterparties will react to these conditions. The ability of our borrowers to repay their loans or
counterparties to honor their obligations will likely be affected by changes in economic
conditions, which in turn could impact the accuracy of our forecasts. As with any such assessments,
there is also the chance that we will fail to identify the proper factors or that we will fail to
accurately estimate the impacts of factors that we identify.
In the ordinary course of our business, we also may be subject to a concentration of credit risk to
a particular industry, counterparty, borrower or issuer. A deterioration in the financial condition
or prospects of a particular industry or a failure or downgrade of, or default by, any particular
entity or group of entities could negatively impact our businesses, perhaps materially, and the
systems by which we set limits and monitor the level of our credit exposure to individual entities,
industries and countries may not function as we have anticipated. While our activities expose us to
many different industries and counterparties, we routinely execute a high volume of transactions
with counterparties in the financial services industry, including brokers and dealers, commercial
banks, investment funds and insurers, including financial guarantors. This has resulted in
significant credit concentration with respect to this industry.
For a further discussion of credit risk, see Concentrations of Credit Risk in Note 4 to the
Consolidated Financial Statements.
Our ability to successfully identify and manage our compliance and other risks is an important
factor that can significantly impact our results. We seek to monitor and control our risk exposure
through a variety of separate but complementary financial, credit, operational, compliance and
legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk
mitigation techniques, those techniques and the judgments that accompany their application cannot
anticipate every economic and financial outcome or the specifics and timing of such outcomes.
Accordingly, our ability to successfully identify and manage risks facing us is an important factor
that can significantly impact our results. Recent economic conditions, increased legislative and
regulatory scrutiny and increased complexity of our operations, among other things, have increased
and made it more difficult for us to manage our operational, compliance and other risks. For a
further discussion of our risk management policies and procedures, see Item 7A Quantitative and
Qualitative Disclosures About Market Risk.
We may be unable to compete successfully as a result of the evolving financial services industry
and market conditions. We operate in a highly competitive environment. Over time, there has been
substantial consolidation among companies in the financial services industry, and this trend
accelerated in 2008 and 2009 as the credit crisis has led to numerous mergers and asset
acquisitions among industry participants and in certain cases reorganization, restructuring, or
even bankruptcy. This trend also has hastened the globalization of the securities and financial
services markets. We will continue to experience intense competition as continued consolidation in
the financial services industry may produce larger and better-capitalized companies that are
capable of offering a wider array of financial products and services at more competitive prices. To
the extent we expand into new business areas and new geographic regions, we may face competitors
with more experience and more established relationships with clients, regulators and industry
participants in the relevant market, which could adversely affect our ability to compete. Increased
competition may affect our results by creating pressure to lower prices on our products and
services and reducing market share.
Our continued ability to compete effectively in our businesses, including management of our
existing businesses as well as expansion into new businesses and geographic areas, depends on our
ability to retain and motivate our existing employees and attract new employees. We face
significant competition for qualified employees both within and outside the financial services
industry, including non-U.S. institutions and institutions not subject to compensation or hiring
restrictions imposed under any U.S. Government initiatives or not subject to the same regulatory
scrutiny. This is particularly the case in emerging markets, where we are often competing for
qualified employees with entities that may have a significantly greater presence or more extensive
experience in the region. A substantial portion of our annual bonus compensation paid to our senior
employees has in recent years been paid in the form of equity-based awards, which are now payable
in Bank of Americas common stock. The value of these awards has been impacted by the significant
decline in the market price of Bank of Americas common stock. We also reduced the number of
employees across nearly all of our businesses in 2008 and 2009. In addition, the consolidation in
the financial services industry has intensified the inherent challenges of cultural integration
between differing types of financial services institutions. The combination of these events could
have a significant adverse impact on our ability to retain and hire the most qualified employees.
We may be adversely impacted by business, economic and political conditions in the
non-U.S. jurisdictions in which we operate. We do business throughout the world, including in
developing regions of the world commonly known as emerging markets. As a result, we are exposed to
a number of risks in non-U.S. jurisdictions, including economic, market, reputational, litigation
and regulatory risks. Our businesses and revenues derived from non-U.S. jurisdictions
are subject to risk of loss from currency fluctuations, social or political instability, changes in
governmental policies or policies of central banks, expropriation, nationalization, confiscation of
assets, unfavorable political and diplomatic developments and changes in legislation. Also, as in
the United States, many non-U.S. jurisdictions in which we do business have been negatively
impacted by recessionary conditions. While a number of these jurisdictions are showing signs of
recovery, others continue to experience increasing levels of stress. In addition, the risk of
default on sovereign debt in some non-U.S. jurisdictions is increasing and could expose us to
losses.
In many countries, the laws and regulations applicable to the financial services industry are
uncertain and evolving, and it may be difficult for us to determine the exact requirements of local
laws in every market or manage our relationships with multiple regulators in various jurisdictions.
Our inability to remain in compliance with local laws in a particular market and manage our
relationships with regulators could have a significant and negative effect not only on our business
in that market but also on our reputation generally.
We also invest or trade in the securities of corporations and governments located in
non-U.S. jurisdictions, including emerging markets. Revenues from the trading of
non-U.S. securities may be subject to negative fluctuations as a result of the above factors.
Furthermore, the impact of these fluctuations could be magnified, because generally
non-U.S. trading markets, particularly in emerging market countries, are smaller, less liquid and
more volatile than U.S. trading markets.
We are subject to geopolitical risks, including acts or threats of terrorism, and actions taken by
the United States or other governments in response and/or military conflicts could adversely affect
business and economic conditions abroad as well as in the U.S.
Changes in governmental fiscal and monetary policy could adversely affect our business. Our
businesses and earnings are affected by domestic and international fiscal and monetary policy. For
example, the Federal Reserve Board regulates the supply of money and credit in the United States
and its policies determine in large part our cost of funds for lending, investing and capital
raising activities and the return we earn on those loans and investments, both of which affect our
net interest profit. The actions of the Federal Reserve Board also can materially affect the value
of financial instruments we hold, such as debt securities, and its policies also can affect our
borrowers, potentially increasing the risk that they may fail to repay their loans. Our businesses
and earnings also are affected by the fiscal or other policies that are adopted by various
regulatory authorities of the U.S., non-U.S. governments and international agencies. Changes in
domestic and international fiscal and monetary policies are beyond our control and difficult to
predict.
We may suffer losses as a result of operational risk or technical system failures. The potential
for operational risk exposure exists throughout our organization. Integral to our performance is
the continued efficacy of our internal processes, systems, relationships with third parties and the
vast array of employees and key executives in our day-to-day and ongoing operations. Operational
risk also encompasses the failure to implement strategic objectives in a successful, timely and
cost-effective manner.
Failure to properly manage operational risk subjects us to risks of loss that may vary in size,
scale and scope, including loss of clients. This also includes but is not limited to operational or
technical failures, unlawful tampering with our technical systems, ineffectiveness or exposure due
to interruption in third party support, the loss of key individuals or failure on the part of the
key individuals to perform properly and losses resulting from unauthorized trading activity by our
employees.
Our dependence upon funds from our subsidiaries and our parent could adversely impact our
liquidity. ML & Co. is a holding company that is a separate and distinct legal entity from its
parent, Bank of America, and our broker-dealer, banking and non-banking subsidiaries. We therefore
depend on dividends, distributions and borrowings or other payments from our subsidiaries and may
depend in large part on financing from Bank of America to fund payments on our obligations,
including debt obligations. Bank of America may in some instances, because of its regulatory
requirements as a bank holding company, be unable to provide us with the funding we need to fund
payments on our obligations. Many of our subsidiaries are subject to laws that authorize regulatory
agencies to block or reduce the flow of funds from those subsidiaries to us. Regulatory action of
that kind could impede access to funds we need to make payments on our obligations.