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 June 29, 2001
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Commission File Number 1-7182
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MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-2740599
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(State of incorporation) (I.R.S. Employer Identification No.)
4 World Financial Center
New York, New York 10080
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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Registrant's telephone number, including area code
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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.
839,640,110 shares of Common Stock and 4,197,721 Exchangeable Shares as of the
close of business on August 3, 2001. 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
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ITEM 1. Financial Statements
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Merrill Lynch & Co., Inc. and Subsidiaries
Consolidated Statements of Earnings (Unaudited)
For the Three Months Ended
----------------------------
Jun. 29, Jun. 30, Percent
(in millions, except per share amounts) 2001 2000 Inc. (Dec.)
------- ------- ----------
Net Revenues
Commissions $ 1,362 $ 1,647 (17.3)%
Principal transactions 911 1,548 (41.1)
Investment banking
Underwriting 662 734 (9.8)
Strategic advisory 313 353 (11.3)
Asset management and portfolio service fees 1,356 1,413 (4.0)
Other 153 282 (45.7)
------- -------
Subtotal 4,757 5,977 (20.4)
------- -------
Interest and dividend revenues 5,563 5,067 9.8
Less interest expense 4,747 4,204 12.9
------- -------
Net interest profit 816 863 (5.4)
------- -------
Total Net Revenues 5,573 6,840 (18.5)
------- -------
Non-Interest Expenses
Compensation and benefits 2,977 3,508 (15.1)
Communications and technology 568 584 (2.7)
Occupancy and related depreciation 270 258 4.7
Advertising and market development 202 263 (23.2)
Brokerage, clearing, and exchange fees 243 233 4.3
Professional fees 151 168 (10.1)
Goodwill amortization 51 54 (5.6)
Other 259 359 (27.9)
------- -------
Total Non-Interest Expenses 4,721 5,427 (13.0)
------- -------
Earnings Before Income Taxes and Dividends on
Preferred Securities Issued by Subsidiaries 852 1,413 (39.7)
Income tax expense 262 443 (40.9)
Dividends on preferred securities issued by subsidiaries 49 49 -
------- -------
Net Earnings $ 541 $ 921 (41.3)
======= =======
Net Earnings Applicable to Common Stockholders $ 532 $ 912 (41.7)
======= =======
Earnings Per Common Share
Basic $ 0.63 $ 1.15
======= =======
Diluted $ 0.56 $ 1.01
======= =======
Dividend Paid Per Common Share $ 0.16 $ 0.15
======= =======
Average Shares Used in Computing
Earnings Per Common Share
Basic 841.4 795.1
======= =======
Diluted 943.8 904.2
======= =======
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See Notes to Consolidated Financial Statements
2
Merrill Lynch & Co., Inc. and Subsidiaries
Consolidated Statements of Earnings (Unaudited)
For the Six Months Ended
----------------------------
Jun. 29, Jun. 30, Percent
(in millions, except per share amounts) 2001 2000 Inc. (Dec.)
------- ------- ----------
Net Revenues
Commissions $ 2,867 $ 3,807 (24.7)%
Principal transactions 2,651 3,586 (26.1)
Investment banking
Underwriting 1,291 1,404 (8.0)
Strategic advisory 597 679 (12.1)
Asset management and portfolio service fees 2,735 2,803 (2.4)
Other 317 531 (40.3)
------- -------
Subtotal 10,458 12,810 (18.4)
------- -------
Interest and dividend revenues 11,796 9,533 23.7
Less interest expense 10,271 7,986 28.6
------- -------
Net interest profit 1,525 1,547 (1.4)
------- -------
Total Net Revenues 11,983 14,357 (16.5)
------- -------
Non-Interest Expenses
Compensation and benefits 6,221 7,426 (16.2)
Communications and technology 1,166 1,168 (0.2)
Occupancy and related depreciation 540 511 5.7
Advertising and market development 410 508 (19.3)
Brokerage, clearing, and exchange fees 478 466 2.6
Professional fees 293 315 (7.0)
Goodwill amortization 103 110 (6.4)
Other 569 755 (24.6)
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Total Non-Interest Expenses 9,780 11,259 (13.1)
------- -------
Earnings Before Income Taxes and Dividends on
Preferred Securities Issued by Subsidiaries 2,203 3,098 (28.9)
Income tax expense 690 978 (29.4)
Dividends on preferred securities issued by subsidiaries 98 98 -
------- -------
Net Earnings $ 1,415 $ 2,022 (30.0)
======= =======
Net Earnings Applicable to Common Stockholders $ 1,396 $ 2,003 (30.3)
======= =======
Earnings Per Common Share
Basic $ 1.67 $ 2.54
======= =======
Diluted $ 1.48 $ 2.24
======= =======
Dividend Paid Per Common Share $ 0.32 $ 0.29
======= =======
Average Shares Used in Computing
Earnings Per Common Share
Basic 836.8 787.6
======= =======
Diluted 940.9 893.0
======= =======
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See Notes to Consolidated Financial Statements
3
Merrill Lynch & Co., Inc. and Subsidiaries
Consolidated Balance Sheets (Unaudited)
Jun. 29, Dec. 29,
(dollars in millions) 2001 2000
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ASSETS
Cash and cash equivalents $ 16,412 $ 23,205
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations 4,955 6,092
Receivables under resale agreements and securities borrowed transactions 125,443 114,581
Marketable investment securities 67,898 49,251
Trading assets, at fair value
Equities and convertible debentures 21,811 20,232
Corporate debt and preferred stock 17,519 17,377
Contractual agreements 22,637 20,361
U.S. Government and agencies 13,677 17,519
Mortgages, mortgage-backed, and asset-backed 8,693 8,225
Non-U.S. governments and agencies 4,549 5,009
Municipals and money markets 3,811 2,791
-------- --------
92,697 91,514
Securities pledged as collateral 11,507 9,097
-------- --------
Securities received as collateral 3,747 -
-------- --------
Other receivables
Customers (net of allowance for doubtful accounts of $85 in 2001 and $68 in 2000) 41,400 41,613
Brokers and dealers 13,267 26,421
Interest and other 8,353 8,879
-------- --------
63,020 76,913
-------- --------
Investments of insurance subsidiaries 3,944 4,002
Loans, notes, and mortgages (net of allowance for loan losses of $257 in 2001 and $176 in 2000) 18,986 17,472
Other investments 4,958 4,938
Equipment and facilities (net of accumulated depreciation and
amortization of $4,867 in 2001 and $4,658 in 2000) 3,515 3,444
Goodwill (net of accumulated amortization of $790 in 2001 and $720 in 2000) 4,095 4,407
Other assets 1,894 2,284
-------- --------
Total Assets $423,071 $407,200
======== ========
4
Merrill Lynch & Co., Inc. and Subsidiaries
Consolidated Balance Sheets (Unaudited)
Jun. 29, Dec. 29,
(dollars in millions, except per share amount) 2001 2000
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LIABILITIES
Payables under repurchase agreements and
securities loaned transactions $ 91,437 $103,883
Commercial paper and other short-term borrowings 6,855 15,183
Deposits 79,431 67,648
Trading liabilities, at fair value
Contractual agreements 23,709 21,587
Equities and convertible debentures 19,708 18,535
U.S. Government and agencies 19,745 14,466
Non-U.S. governments and agencies 6,393 7,135
Corporate debt, municipals and preferred stock 8,793 7,134
-------- --------
78,348 68,857
-------- --------
Obligation to return securities received as collateral 3,747 -
-------- --------
Other payables
Customers 26,206 24,762
Brokers and dealers 13,336 9,514
Interest and other 16,993 22,204
-------- --------
56,535 56,480
-------- --------
Liabilities of insurance subsidiaries 3,814 3,908
Long-term borrowings 79,506 70,223
-------- --------
Total Liabilities 399,673 386,182
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,707 2,714
-------- --------
STOCKHOLDERS' EQUITY
Preferred Stockholders' Equity (42,500 shares issued, liquidation preference $10,000 per share) 425 425
-------- --------
Common Stockholders' Equity
Shares exchangeable into common stock 62 68
Common stock (par value $1.33 1/3 per share; authorized: 2001 - 3,000,000,000 shares; 2000
1,000,000,000 shares; issued: 2001 and 2000 - 962,533,498 shares) 1,283 1,283
Paid-in capital 4,198 2,843
Accumulated other comprehensive loss (net of tax) (324) (345)
Retained earnings 17,290 16,156
-------- --------
22,509 20,005
Less: Treasury stock, at cost: 2001 - 124,931,509 shares; 2000 - 154,578,945 shares 1,000 1,273
Employee stock transactions 1,243 853
-------- --------
Total Common Stockholders' Equity 20,266 17,879
-------- --------
Total Stockholders' Equity 20,691 18,304
-------- --------
Total Liabilities, Preferred Securities Issued by Subsidiaries,
and Stockholders' Equity $423,071 $407,200
======== ========
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See Notes to Consolidated Financial Statements
5
Merrill Lynch & Co., Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
For the Six Months Ended
------------------------
(dollars in millions) Jun. 29, Jun. 30,
2001 2000
------- -------
Cash flows from operating activities:
Net earnings $ 1,415 $ 2,022
Noncash items included in earnings:
Depreciation and amortization 438 408
Policyholder reserves 93 97
Goodwill amortization 103 110
Amortization of stock-based compensation 335 243
Other 1,360 251
Changes in operating assets and liabilities:
Trading assets and securities pledged as collateral (3,615) 4,669
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations 1,137 (42)
Receivables under resale agreements and securities borrowed transactions (10,862) (8,838)
Customer receivables 197 (4,835)
Brokers and dealers receivables 13,154 (6,512)
Trading liabilities 9,491 (3,309)
Payables under repurchase agreements and securities loaned transactions (12,446) 12,241
Customer payables 1,444 465
Brokers and dealers payables 3,822 (2,539)
Other, net (5,139) (237)
-------- --------
Cash provided by (used for) by operating activities 927 (5,806)
-------- --------
Cash flows from investing activities:
Proceeds from (payments for):
Maturities of available-for-sale securities 15,217 4,575
Sales of available-for-sale securities 8,804 2,308
Purchases of available-for-sale securities (41,964) (16,036)
Maturities of held-to-maturity securities 385 464
Purchases of held-to-maturity securities (356) (337)
Loans, notes, and mortgages (1,578) (960)
Other investments and other assets (287) (491)
Equipment and facilities (508) (471)
-------- --------
Cash used for investing activities (20,287) (10,948)
-------- --------
Cash flows from financing activities:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (8,328) (5,039)
Deposits 11,783 12,300
Issuance and resale of long-term borrowings 24,812 17,178
Maturities and repurchases of long-term borrowings (15,469) (8,396)
Issuance of treasury stock 403 413
Other common and preferred stock transactions (353) 12
Dividends (281) (239)
-------- --------
Cash provided by financing activities 12,567 16,229
-------- --------
Decrease in cash and cash equivalents (6,793) (525)
Cash and cash equivalents, beginning of year 23,205 12,155
-------- --------
Cash and cash equivalents, end of period $ 16,412 $ 11,630
======== ========
Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Income taxes $ 272 $ 363
Interest 10,719 7,635
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See Notes to Consolidated Financial Statements
6
Merrill Lynch & Co., Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
June 29, 2001
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Note 1. Summary of Significant Accounting Policies
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Basis of Presentation
The 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 December 29, 2000
unaudited Consolidated Balance Sheet was derived from the audited financial
statements. The interim consolidated financial statements for the three- and
six- month periods are unaudited; however, in the opinion of Merrill Lynch
management, all adjustments necessary for a fair statement of the consolidated
financial statements have been included.
These unaudited financial statements should be read in conjunction with the
audited financial statements included in Merrill Lynch's Annual Report included
as an exhibit to Form 10-K for the year ended December 29, 2000. 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. Certain reclassifications
have also been made to prior period financial statements, where appropriate, to
conform to the current period presentation.
New Accounting Pronouncements
On the first day of fiscal year 2001, Merrill Lynch adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No. 133"). On adoption,
all existing hedge relationships were designated anew. Merrill Lynch recorded a
pre-tax loss of $32 million ($22 million after-tax) in interest expense upon
adoption of SFAS No. 133.
SFAS No.133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts ("embedded derivatives"), and for hedging activities. It requires that
an entity recognize all derivatives as either assets or liabilities in the
Consolidated Balance Sheet and measure those instruments at fair value. The
accounting for changes in fair value of a derivative instrument depends on its
intended use and the resulting designation.
The majority of Merrill Lynch's derivatives are recognized at fair value as
trading assets and liabilities, as they are entered into in a dealing capacity.
As part of its trading activities, Merrill Lynch uses derivatives to facilitate
customer transactions, to take proprietary positions and as a means of risk
management. The Corporate Risk Management group monitors and manages these risks
in accordance with established risk management policies and procedures that
include risk tolerance levels. For further information on Merrill Lynch's risk
management see the Annual Report on Form 10-K for the year ended December 29,
2000.
As part of its overall risk management strategy, Merrill Lynch uses derivatives
to manage its risk exposures arising from non-trading assets and liabilities,
some of which, depending on the nature of the derivative and the related hedged
item, were not previously carried at fair value. These derivatives are typically
designated as fair-value hedges, to manage the interest rate and non-U.S. dollar
exposure on long-term borrowings and marketable investment securities. These
derivatives generally include interest rate and currency swap agreements that
are primarily used to convert fixed rate assets and liabilities into U.S.
dollar-based floating rate instruments.
The net gain associated with the ineffective portion (the extent to which exact
offset is not achieved) of the fair value hedges was not material for the six
months ended June 29, 2001.
7
Merrill Lynch also uses derivatives and foreign-currency-denominated debt to
manage its exposure to foreign exchange rate movements related to investments in
non-U.S. operations. These derivatives generally include forward exchange
contracts and cross currency interest rate swaps.
For the three and six month periods ended June 29, 2001, $114 million and $310
million, respectively of net gains related to non-U.S. dollar net investment
hedges, which were principally offset by net losses on these investments, were
included in "Accumulated other comprehensive loss" on the Consolidated Balance
Sheet.
Merrill Lynch issues long-term obligations whose repayment terms are linked to
the performance of equity or other indexes (e.g., S&P 500), baskets of
securities, or individual securities. The contingent components of these indexed
debt obligations may be embedded derivatives. If the contingent component is
determined to be a derivative it is separated from the underlying obligation and
carried at fair value. The separated embedded derivative is reported in
long-term borrowings on the Consolidated Balance Sheet with the underlying
obligation. The embedded derivatives are hedged with derivatives that are
carried at fair value.
In addition, Merrill Lynch enters into cash flow hedges to hedge interest rate
risk. All of these hedges qualify for the "short-cut method" as defined by SFAS
No. 133. As such, no ineffectiveness related to these hedges is reported in
earnings.
Derivative instruments are reported on a net-by-counterparty basis on the
Consolidated Balance Sheet where management believes a legal right of setoff
exists under an enforceable netting agreement. The fair value of derivative
instruments is set forth below:
(dollars in millions)
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Jun. 29, 2001 Dec. 29, 2000
------------------------- --------------------------
Assets Liabilities Assets Liabilities
------ ----------- -------- -----------
Swap agreements $20,521 $21,667 $17,283 $18,819
Forwards and options 8,430 9,742 8,339 11,922
- ---------------------------------------------------------------------------------------------------
In September 2000, the Financial Accounting Standards Board released SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities, a replacement of SFAS No. 125, which revises the
standards for accounting for securitizations and other transfers of financial
assets and collateral. On April 1, 2001, Merrill Lynch adopted the provisions of
this statement that were required to be adopted in the second quarter of 2001.
These provisions changed the accounting for certain securities lending
transactions. Under the new provisions, when Merrill Lynch acts as the lender in
a securities lending agreement and receives securities as collateral that can be
pledged or sold, it recognizes on the Consolidated Balance Sheet the securities
received as well as an obligation to return the securities lent. Accordingly,
Merrill Lynch's accompanying Consolidated Balance Sheet as of June 29, 2001
separately reflects these assets and liabilities.
In July 2001, the Financial Accounting Standards Board released SFAS No. 141,
Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets.
SFAS No. 141 requires all business combinations initiated after June 30, 2001,
to be accounted for using the purchase method. Merrill Lynch adopted the
provisions of SFAS No. 141 on July 1, 2001. Under SFAS No. 142, intangible
assets with indefinite lives and goodwill will no longer be amortized. Instead,
these assets will be tested annually for impairment. Merrill Lynch will adopt
the provisions of SFAS No. 142 at the beginning of fiscal year 2002. The full
impact of adoption is yet to be determined, however, annual reported
amortization expense related to these assets approximates $200 million.
8
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Note 2. Short-Term Borrowings
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Short-term borrowings at June 29, 2001 and December 29, 2000 are presented
below:
(dollars in millions)
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Jun. 29, Dec. 29,
2001 2000
------- --------
Payables under repurchase agreements
and securities loaned transactions
Repurchase agreements $82,070 $ 89,901
Securities loaned transactions 9,367 13,982
------- --------
Total $91,437 $103,883
======= ========
Commercial paper and other short-term
borrowings
Commercial paper $ 5,467 $ 14,022
Other 1,388 1,161
------- --------
Total $ 6,855 $ 15,183
======= ========
Deposits
U.S. $66,928 $ 54,887
Non-U.S. 12,503 12,761
------- --------
Total $79,431 $ 67,648
======= ========
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9
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Note 3. Segment Information
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In reporting to management, Merrill Lynch's operating results are categorized
into three business segments: the Corporate and Institutional Client Group
("CICG"), the Private Client Group ("PCG") 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 activities, see the
portions of the 2000 Annual Report included as an exhibit to Form 10-K.
Operating results by business segment follow:
(dollars in millions)
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Corporate
Three Months Ended CICG PCG MLIM Items (1) Total
-------- -------- ------ --------- --------
June 29, 2001
Non-interest revenues $ 2,115 $ 2,166 $ 544 $ (68)(2) $ 4,757
Net interest revenue(3) 404 409 15 (12)(4) 816
-------- -------- ------ --------- --------
Net revenues 2,519 2,575 559 (80) 5,573
Non-interest expenses 1,985 2,282 453 1 (5) 4,721
-------- -------- ------ --------- --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 534 $ 293 $ 106 $ (81) $ 852
======== ======== ====== ========= ========
Quarter-end total assets $289,013 $127,603 $2,360 $ 4,095 $423,071
======== ======== ====== ========= ========
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Corporate
CICG PCG MLIM Items (1) Total
-------- -------- ------ --------- --------
Three Months Ended
June 30, 2000
Non-interest revenues $ 2,838 $ 2,593 $ 587 $ (41)(2) $ 5,977
Net interest revenue(3) 485 384 19 (25)(4) 863
-------- -------- ------ --------- --------
Net revenues 3,323 2,977 606 (66) 6,840
Non-interest expenses 2,279 2,666 469 13 (5) 5,427
-------- -------- ------ --------- --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 1,044 $ 311 $ 137 $ (79) $ 1,413
======== ======== ====== ========= ========
Quarter-end total assets $257,650 $ 70,435 $2,198 $ 4,592 $334,875
======== ======== ====== ========= ========
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(1) Including intersegment eliminations.
(2) Primarily represents the elimination of intersegment revenues.
(3) Management views interest income net of interest expense in evaluating
results.
(4) Represents Mercury financing costs.
(5) Represents goodwill amortization of $51 million and $54 million, net of
elimination of intersegment expenses of $50 million and $41 million, for the
three months ended June 29, 2001 and June 30, 2000, respectively.
10
(dollars in millions)
- -------------------------------------------------------------------------------------------
Corporate
Six Months Ended CICG PCG MLIM Items (1) Total
-------- -------- ------ --------- --------
June 29, 2001
Non-interest revenues $ 5,070 $ 4,442 $1,097 $ (151)(2) $ 10,458
Net interest revenue(3) 686 834 31 (26)(4) 1,525
-------- -------- ------ --------- --------
Net revenues 5,756 5,276 1,128 (177) 11,983
Non-interest expenses 4,251 4,624 919 (14)(5) 9,780
-------- -------- ------ --------- --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 1,505 $ 652 $ 209 $ (163) $ 2,203
======== ======== ====== ========= ========
- -------------------------------------------------------------------------------------------
Corporate
CICG PCG MLIM Items (1) Total
-------- -------- ------ --------- --------
Six Months Ended
June 30, 2000
Non-interest revenues $ 6,170 $ 5,589 $1,184 $ (133)(2) $ 12,810
Net interest revenue(3) 804 765 34 (56)(4) 1,547
-------- -------- ------ --------- --------
Net revenues 6,974 6,354 1,218 (189) 14,357
Non-interest expenses 4,720 5,559 979 1 (5) 11,259
-------- -------- ------ --------- --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 2,254 $ 795 $ 239 $ (190) $ 3,098
======== ======== ====== ========= ========
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(1) Including intersegment eliminations.
(2) Primarily represents the elimination of intersegment revenues.
(3) Management views interest income net of interest expense in evaluating
results.
(4) Represents Mercury financing costs.
(5) Represents goodwill amortization of $103 million and $110 million, net of
elimination of intersegment expenses of $117 million and $109 million, for
the six months ended June 29, 2001 and June 30, 2000, respectively.
11
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Note 4. Comprehensive Income
- --------------------------------------------------------------------------------
The components of comprehensive income are as follows:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
----------------------- ----------------------
Jun. 29, Jun. 30, Jun. 29, Jun. 30,
2001 2000 2001 2000
------- ------- ------- -------
Net earnings $ 541 $ 921 $ 1,415 $ 2,022
------- ------- ------- -------
Other comprehensive income (loss), net of tax:
Currency translation adjustment (49) (59) (11) (67)
Net unrealized gain (loss) on investment
securities available-for-sale (6) 47 (7) 57
Deferred gain on cash flow hedges 18 - 39 -
------- ------- ------- -------
Total other comprehensive income (loss), net of tax (37) (12) 21 (10)
------- ------- ------- -------
Comprehensive income $ 504 $ 909 $ 1,436 $ 2,012
======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Note 5. Earnings Per Common Share
- --------------------------------------------------------------------------------
Information relating to earnings per common share computations follows:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
----------------------- ----------------------
Jun. 29, Jun. 30, Jun. 29, Jun. 30,
2001 2000 2001 2000
------- ------- ------- -------
Net earnings $ 541 $ 921 $ 1,415 $ 2,022
Preferred stock dividends 9 9 19 19
------- ------- --------- -------
Net earnings applicable to
common stockholders $ 532 $ 912 $ 1,396 $ 2,003
======= ======= ======= =======
(shares in thousands)
Weighted-average shares outstanding 841,394 795,070 836,794 787,645
------- ------- ------- -------
Effect of dilutive instruments(1) (2):
Employee stock options 60,058 65,815 62,219 63,872
FCCAAP shares 27,669 29,334 27,679 28,774
Restricted Units 14,671 13,977 14,129 12,569
ESPP shares 44 50 74 103
------- ------- ------- -------
Dilutive potential common shares 102,442 109,176 104,101 105,318
------- ------- ------- -------
Total weighted-average diluted shares 943,836 904,246 940,895 892,963
======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 0.63 $ 1.15 $ 1.67 $ 2.54
Diluted earnings per common share $ 0.56 $ 1.01 $ 1.48 $ 2.24
- -------------------------------------------------------------------------------------------------------------
(1) During the 2001 and 2000 second quarter there were 49 million and 807
thousand instruments, respectively, that were considered antidilutive and
were not included in the above computations.
(2) See Note 11 to Consolidated Financial Statements in the 2000 Annual Report
included as an exhibit to Form 10-K for a description of these instruments.
12
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Note 6. Commitments, and Other Contingencies
- --------------------------------------------------------------------------------
In the normal course of business, Merrill Lynch enters into underwriting
commitments and commitments to extend credit. As of June 29, 2001, these
commitments are not material to the financial condition of Merrill Lynch.
As of June 29, 2001, Merrill Lynch has been named as parties in various actions,
some of which involve claims for substantial amounts. Although the results of
legal actions cannot be predicted with certainty, it is the opinion of
management 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
Consolidated Financial Statements, but may be material to Merrill Lynch's
operating results for any particular period. Refer to Part II - Other
Information for additional information on legal proceedings.
- --------------------------------------------------------------------------------
Note 7. Regulatory Requirements
- --------------------------------------------------------------------------------
Certain U.S. and non-U.S. subsidiaries are subject to various securities,
banking and insurance 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, is subject to the net capital requirements of Rule 15c3-1 under
the Securities Exchange Act of 1934. Under the alternative method permitted by
this rule, the minimum required net capital, as defined, shall not be less than
2% of aggregate debit items arising from customer transactions. At June 29,
2001, MLPF&S's regulatory net capital of $3,015 million was 14% of aggregate
debit items, and its regulatory net capital in excess of the minimum required
was $2,586 million.
Merrill Lynch International ("MLI"), a U.K. registered broker-dealer, 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 June 29, 2001, MLI's financial resources were $4,790 million,
exceeding the minimum requirement by $990 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 June 29, 2001, MLGSI's liquid capital of $1,287
million was 235% of its total market and credit risk, and liquid capital in
excess of the minimum required was $629 million.
Banking Regulation
Two of the direct subsidiaries of ML & Co., Merrill Lynch Bank USA ("MLBUSA"),
an FDIC-insured Utah chartered depository institution, and Merrill Lynch Bank &
Trust Co. ("MLB&T"), an FDIC-insured New Jersey chartered depository
institution, 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. RBC is defined as the ratio of (i) Tier 1 capital or Total
capital to (ii) risk-weighted assets, as those terms are defined in the FDIC
regulations. As of June 29, 2001, MLBUSA had a Tier I RBC ratio of 10.30% and a
Total RBC ratio of 10.93% and MLB&T had a Tier I RBC ratio of 14.14% and a Total
RBC ratio of 14.16%. At June 29, 2001 MLBUSA had Tier I capital of $3,473
million and MLB&T had Tier I capital of $1,022 million.
13
MLBUSA and MLB&T have each entered into a synthetic securitization of specified
reference portfolios of asset-backed securities ("ABS") owned by each
institution totaling in aggregate up to $20 billion. MLBUSA has also entered
into a second synthetic securitization of a specified reference portfolio of ABS
owned by the institution of up to $20 billion. All the ABS in the reference
portfolios are rated AAA and all are further insured as to principal and
interest payments by an insurer rated AAA. The synthetic securitizations have
allowed MLBUSA and MLB&T to reduce the credit risk on the respective reference
portfolios by means of credit default swaps with bankruptcy-remote special
purpose vehicles ("SPV"). In turn, each of the SPVs has issued a $20 million
credit linked note ($40 million in total) to unaffiliated buyers. These
transactions have resulted in reductions in each institution's risk-weighted
assets. MLBUSA has retained a first risk of loss equity tranche of $1 million in
each of these transactions ($2 million in total).
As a result of these transactions, MLBUSA has been able to reduce risk-weighted
assets by $17,805 million at June 29, 2001, thereby increasing its Tier I and
Total RBC ratios by 356 basis points and 378 basis points, respectively. MLB&T
has been able to reduce risk-weighted assets by $2,090 million at June 29, 2001,
thereby increasing its Tier I and Total RBC ratios by 317 and 318 basis points,
respectively. These structures have not resulted in a material change in the
distribution or concentration of risk in the retained portfolio.
14
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 June 29,
2001, and the related condensed consolidated statements of earnings for the
three-month and six-month periods ended June 29, 2001 and June 30, 2000, and the
consolidated statements of cash flows for the six-month periods ended June 29,
2001 and June 30, 2000. 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 29, 2000, 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 26, 2001, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 29, 2000 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, NY
August 10, 2001
15
- --------------------------------------------------------------------------------
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 and
affiliates, "Merrill Lynch") is a holding company that, through its subsidiaries
and affiliates, provides investment, financing, advisory, insurance, and related
services worldwide. 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 uncontrollable
factors. These factors include economic conditions, monetary and fiscal
policies, the liquidity of global markets, international and regional political
events, regulatory developments, the competitive environment, and investor
sentiment. These conditions or events can significantly affect the volatility of
financial markets. While greater volatility may increase risk, it may also
increase order flow and revenues in businesses such as trading and brokerage.
Revenues and net earnings may vary significantly from period to period due to
these unpredictable factors and the resulting market volatility and volumes.
The financial services industry continues to be affected by the intensifying
competitive environment, as demonstrated by consolidation through mergers and
acquisitions and competition from new entrants as well as established
competitors using the Internet or other technology to establish or expand their
businesses, and diminishing margins in many mature products and services. The
Gramm-Leach-Bliley Act, passed in 1999, which repealed laws that separated
commercial banking, investment banking and insurance activities, together with
changes to the industry resulting from previous reforms, has increased the
number of companies competing for a similar customer base.
In addition to providing historical information, Merrill Lynch may make or
publish forward-looking statements about management expectations, strategic
objectives, business prospects, anticipated financial performance, and other
similar matters. A variety of factors, many of which are beyond its control,
affect the operations, performance, business strategy, and results of Merrill
Lynch and could cause actual results and experience to differ materially from
the expectations and objectives expressed in these 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 both in the United States and throughout the world, and the other
risks detailed in Merrill Lynch's 2000 Form 10-K and in this Form 10-Q.
Merrill Lynch undertakes no responsibility to update or revise any
forward-looking statements.
- --------------------------------------------------------------------------------
Business Environment
- --------------------------------------------------------------------------------
Global financial markets continued to face difficult and challenging market
environments in the second quarter of 2001, as global economies slowed and
corporate earnings declined. During the same period, however, U.S. debt
underwriting remained strong, as the U.S. Federal Reserve Bank continued to
reduce interest rates in an effort to bring life into the sluggish economy.
Long-term U.S. interest rates, as measured by the yield on the 10-year U.S.
Treasury bond, climbed to 5.40% during the quarter, from 4.92% at the end of the
2001 first quarter. The yield on the longer-term 30-year Treasury bond rose to
5.75% during the quarter, from 5.46% at the end of the 2001 first quarter. The
U.S. Federal Reserve Bank cut 125 basis points off both the federal funds rate
and the discount rate during the 2001 second quarter. Credit spreads, which
represent the risk premium over the risk-free rate paid by an issuer (based on
the issuer's perceived creditworthiness), contracted slightly in the second
quarter of 2001.
16
Despite numerous corporate profit warnings and uncertain market conditions, U.S.
equity indices finished the second quarter up from the levels at the end of the
first quarter. The Nasdaq Composite Index surged 17.4% in the three-month
period, but remained 45.5% below the 2000 second quarter level. The Dow Jones
Industrial Average was up 6.3% in the second quarter, but remained virtually
unchanged from the end of the second quarter 2000. The S&P 500 advanced 5.5% in
the second quarter 2001, but was down 15.8% from the end of the 2000 second
quarter.
The Dow Jones World Index rose 1.2% in the second quarter of 2001, but slipped
23.8% since the same period a year ago. The stock market in Japan, as measured
by the Dow Jones Global Index, rose 2.3% in yen terms during the 2001 second
quarter. With the overnight inter-bank rate at essentially 0%, and low consumer
spending and exports, the Bank of Japan left its monetary policy unchanged. The
economic slowdowns in Germany and France led the European Central Bank to reduce
interest rates by a quarter of a percentage point to 4.5%. Emerging markets
turned in the best performance of the quarter, including the Mexican stock
market, which, aided by the strong peso and a steady stream of foreign direct
investments, jumped 24.2% in U.S. dollar terms and 18.7% in peso terms when
measured by the Dow Jones Global Index.
Global stock and debt issuance increased 35% from the year-ago quarter. Global
debt underwriting volume rose 42% from the year-ago quarter, as issuers took
advantage of favorable interest rates. Global equity underwriting volume was up
only 3.5% from the weak second quarter of 2000, as the Initial Public Offering
("IPO") market continued to be weak. According to Thomson Financial Securities
Data, the number of companies brought public in the first half of 2001 was the
lowest in nearly 20 years.
Merger and acquisition activity remained at low levels in the second quarter as
a result of economic uncertainty. Both global and U.S. announced merger and
acquisition volumes dropped approximately 40% from the second quarter of 2000,
but remained virtually unchanged from last quarter, according to Thomson
Financial Securities Data.
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. Maintaining long-term client relationships, closely
monitoring costs and risks, diversifying revenue sources, and growing fee-based
revenues, all contribute to mitigating the effects of market volatility on
Merrill Lynch's business as a whole.
- --------------------------------------------------------------------------------
Results of Operations
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
--------------------------- ------------------------
(dollars in millions, Jun. 29, Jun. 30, Jun. 29, Jun. 30,
except per share amounts) 2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------
Total revenues $10,320 $11,044 $22,254 $22,343
Net revenues 5,573 6,840 11,983 14,357
Pre-tax earnings 852 1,413 2,203 3,098
Net earnings 541 921 1,415 2,022
Earnings per common share:
Basic 0.63 1.15 1.67 2.54
Diluted 0.56 1.01 1.48 2.24
Annualized return on average common
stockholders' equity 10.7% 24.4% 14.5% 28.2%
Pre-tax profit margin 15.3 20.7 18.4 21.6
- -----------------------------------------------------------------------------------------------
17
Merrill Lynch's net earnings were $541 million for the 2001 second quarter, 41%
lower than the $921 million reported in the second quarter of 2000. Earnings per
common share were $0.63 basic and $0.56 diluted, compared with $1.15 basic and
$1.01 diluted in the 2000 second quarter.
Net revenues were $5.6 billion, 19% lower than the 2000 second quarter. This
decline was primarily due to lower equity trading revenues. Compensation and
benefits expenses, which were 53.4% of net revenues, included severance expense
of $129 million associated with a reduction of employees. Excluding severance,
compensation and benefits expenses were 51.1% of net revenues in the 2001 second
quarter, down slightly from 51.3% in last year's second quarter. Severance costs
are included in the results of each business segment. Non-compensation expenses
were $1.7 billion, 9% lower than the 2000 second quarter. The pre-tax profit
margin for the quarter was 15.3%, compared to 20.7% in the 2000 second quarter.
For the first half of 2001, net earnings were $1.4 billion, compared to $2.0
billion for the corresponding period in 2000. Net revenues were $12.0 billion,
down 17% from the first six months of 2000. The effect of declining revenues on
earnings was limited by a 13% reduction in year-to-date expenses, including a 7%
reduction in non-compensation costs. Year-to-date earnings per common share were
$1.67 basic and $1.48 diluted, compared with $2.54 basic and $2.24 diluted in
the first half of 2000. The pre-tax margin for the first half of 2001 was 18.4%,
approximately 3 percentage points lower than the year-ago period. Annualized
return on average common stockholder's equity was 14.5% for the first six months
of 2001.
Net revenues in June 2001 were particularly weak and without a significant
improvement in market conditions, management believes that third quarter 2001
net revenues and earnings will be below the second quarter 2001 levels.
- --------------------------------------------------------------------------------
Business Segments
- --------------------------------------------------------------------------------
Merrill Lynch reports its results in three business segments: Corporate and
Institutional Client Group ("CICG"), Private Client Group ("PCG"), and Merrill
Lynch Investment Managers ("MLIM"). CICG provides investment banking and capital
market services to corporate, institutional, and governmental clients throughout
the world. PCG provides wealth management services and products to individuals,
small- to mid-size businesses and employee benefit plans for clients globally.
MLIM provides investment management services to a wide variety of retail and
institutional clients. For further information on services provided to clients
within these segments, see the 2000 Form 10-K and the portions of the 2000
Annual Report included as an exhibit thereto.
Certain MLIM and CICG products are distributed by PCG distribution channels, and
to a lesser extent, certain MLIM products are distributed through the
distribution capabilities of CICG. Revenues and expenses associated with these
intersegment activities are recognized in each segment and eliminated at the
corporate level. In addition, revenue and expense sharing agreements for shared
activities are in place and the results of each segment reflect the agreed upon
portion of these activities. The operating results of the segments exclude
certain corporate items and represent the information that is relied upon by
management in their decision-making processes. Restatements occur to reflect
reallocations of revenues and expenses which result from changes in Merrill
Lynch's business strategy and structure.
18
- --------------------------------------------------------------------------------
Corporate and Institutional Client Group
- --------------------------------------------------------------------------------
CICG's Results of Operations
- ---------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
Jun. 29, Jun. 30, % Inc. Jun. 29, Jun. 30, % Inc.
(dollars in millions) 2001 2000 (Dec.) 2001 2000 (Dec.)
- ---------------------------------------------------------------------------------------------------------------------
Commissions $ 548 $ 600 (9)% $1,159 $1,348 (14)%
Principal transactions and net interest profit 953 1,638 (42) 2,660 3,581 (26)
Investment banking 865 878 (1) 1,668 1,660 -
Other revenues 153 207 (26) 269 385 (30)
------ ------ ------ ------
Total net revenues $2,519 $3,323 (24) $5,756 $6,974 (17)
------ ------ ------ ------
Pre-tax earnings $ 534 $1,044 (49) $1,505 $2,254 (33)
------ ------ ------ ------
Pre-tax profit margin 21.2% 31.4% 26.1% 32.3%
- ----------------------------------------------------------------------------------------------------------------------
CICG continued to face a difficult market environment in the second quarter of
2001. Net revenues were $2.5 billion for the quarter, compared to $3.3 billion
in the second quarter of 2000. CICG's pre-tax earnings were $534 million in the
second quarter of 2001, a decline of 49% from the second quarter of 2000. The
pre-tax profit margin was 21.2%, compared to 31.4% in the second quarter of
2000. CICG's results included severance expenses incurred in the 2001 second
quarter.
CICG's year-to-date net revenues were $5.8 billion, down 17% from the comparable
period a year ago and year-to-date pre-tax earnings were $1.5 billion, down 33%
from the record set in the first half of 2000. CICG's year-to-date pre-tax
margin was 26.1%, down from 32.3% in the same period last year.
Client Facilitation and Trading
Commissions
Commissions revenue primarily arises from agency transactions in listed and
over-the-counter equity securities and commodities, money market instruments and
options.
Commissions revenues fell 9% in the second quarter of 2001 to $548 million from
$600 million in the second quarter of 2000, primarily as a result of a decline
in equity trading volume. Year-to-date commissions revenues decreased by 14% to
$1.2 billion as compared to the record first half of 2000.
Principal transactions and net interest profit
- ---------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
Jun. 29, Jun. 30, % Inc. Jun. 29, Jun. 30, % Inc.
(dollars in millions) 2001 2000 (Dec.) 2001 2000 (Dec.)
- ---------------------------------------------------------------------------------------------------------------------
Equities and equity derivatives $ 438 $1,096 (60)% $1,127 $2,412 (53)%
Debt and debt derivatives 515 542 (5) 1,533 1,169 31
----- ------ ------ ------
Total $ 953 $1,638 (42) $2,660 $3,581 (26)
- ---------------------------------------------------------------------------------------------------------------------
Principal transactions and net interest profit includes realized and unrealized
gains and losses from the purchase and sale of securities in which CICG acts as
principal. Changes in the composition of trading inventories and hedge positions
can cause the recognition of principal transactions and net interest profit to
fluctuate.
19
Net interest profit is a function of the level and mix of total assets and
liabilities, including financial instruments owned, reverse repurchase and
repurchase agreements, trading strategies associated with CICG'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 net interest profit and principal transactions
in the aggregate.
Principal transactions and net interest profit were $953 million in the second
quarter of 2001, down 42% from $1.6 billion in the second quarter of 2000. The
decrease from the year-ago quarter primarily reflects significantly lower
revenues from equities and equity derivatives. This reduction was driven by
significantly lower market volatility and equity valuations and the additional
impact of decimalization on trading spreads in the Nasdaq market. Reduced order
flow and spread compression resulting from declining stock prices also
contributed to the decline in equity trading revenues. Net trading revenues from
debt and debt derivatives decreased slightly from the 2000 second quarter.
On a year-to-date basis, principal transactions and net interest revenues were
down 26% compared to the first half of 2000, as a significant decrease in equity
and equity derivatives revenues more than offset the 31% increase in debt
trading revenues. Debt trading revenues benefited from improved results in debt
derivatives and sovereign debt trading. Also included in this category is the
positive impact of the first quarter 2001 sale of certain energy-trading assets.
Investment Banking
- -------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
Jun. 29, Jun. 30, % Inc. Jun. 29, Jun. 30, % Inc.
(dollars in millions) 2001 2000 (Dec.) 2001 2000 (Dec.)
- -------------------------------------------------------------------------------------------------------
Debt underwriting $175 $ 86 103% $ 367 $ 176 109%
Equity underwriting 377 440 (14) 704 807 (13)
Strategic advisory services 313 352 (11) 597 677 (12)
---- ---- ------ ------
Total $865 $878 (1) $1,668 $1,660 -
- -------------------------------------------------------------------------------------------------------
Underwriting
- ------------
Underwriting revenues represent fees earned from the underwriting of debt and
equity securities as well as loan syndication and commitment fees.
Underwriting revenues in the second quarter of 2001 were $552 million, up 5%
from the $526 million recorded in the second quarter of 2000. Sharply higher
revenues from corporate debt issuances more than offset a 14% decline in equity
underwriting revenues, which resulted from an industry-wide slowdown in equity
issuances. Merrill Lynch continued to demonstrate leadership in debt and equity
origination, ranking #1 in global debt and #2 in global equity and equity-linked
underwriting during the second quarter of 2001. In global debt underwriting,
Merrill Lynch benefited from strong leadership positions in Europe and Asia. In
equity-linked underwriting, Merrill Lynch's new innovative LYONs products helped
sustain a market share of 21.7% in the first six months of 2001.
Year-to-date underwriting revenues increased 9% to $1.1 billion from $983
million in the first half of 2000, as a significant increase in debt
underwriting revenues more than offset the decrease in equity underwriting
revenues. Merrill Lynch maintained leadership in the market by maintaining
year-to-date market shares of 12.1% and 15.0% in global debt and global equity
and equity-linked underwriting, respectively. Merrill Lynch's underwriting
market share information based on transaction value follows:
20
- ------------------------------------------------------------------------------------------
For the Three Months Ended
--------------------------------------------
Jun. 2001 Jun. 2000
------------------ ----------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
Global proceeds
Debt and equity 11.9% 1 12.1% 1
Debt 11.5 1 12.1 1
Equity and equity-linked 15.1 2 10.9 4
U.S. proceeds
Debt and equity 13.8% 1 14.2% 1
Debt 13.6 1 13.6 1
Equity and equity-linked 16.3 2 16.0 2
- ------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
book manager.
- ------------------------------------------------------------------------------------------
For the Six Months Ended
--------------------------------------------
Jun. 2001 Jun. 2000
------------------ ----------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
Global proceeds
Debt and equity 12.2% 1 11.3% 1
Debt 12.1 1 11.4 1
Equity and equity-linked 15.0 2 9.4 5
U.S. proceeds
Debt and equity 14.8% 1 13.8% 1
Debt 14.6 1 14.0 1
Equity and equity-linked 17.7 2 10.5 5
- ------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
book manager.
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, were $313 million in the second quarter of 2001, down 11%
from the second quarter of 2000. Poor securities market conditions continue to
have a negative impact on global merger and acquisition activity. In the first
half of 2001, Merrill Lynch ranked #2 with a market share of 22.4% in global
announced transactions. Merrill Lynch's merger and acquisition market share
information based on transaction value follows:
- ------------------------------------------------------------------------------------------
For the Three Months Ended
--------------------------------------------
Jun. 2001 Jun. 2000
------------------ ----------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
Completed transactions
Global 23.7% 3 43.5% 3
U.S. 22.1 3 44.1 2
Announced transactions
Global 23.3% 2 22.8% 4
U.S. 19.5 5 25.4 3
- ------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors
21
- ------------------------------------------------------------------------------------------
For the Six Months Ended
--------------------------------------------
Jun. 2001 Jun. 2000
------------------ ----------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
Completed transactions
Global 32.3% 2 38.7% 3
U.S. 42.5 2 35.8 3
Announced transactions
Global 22.4% 2 25.4% 3
U.S. 21.4 4 36.8 3
- ------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors
Other Revenues
Other revenues which include investment gains and losses and partnership
distributions, declined 26% to $153 million in the second quarter of 2001 and
30% to $269 million in the first six months of 2001 as the result of lower gains
on investments.
- --------------------------------------------------------------------------------
Private Client Group
- --------------------------------------------------------------------------------
PCG's Results of Operations
- --------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
Jun. 29, Jun. 30, % Inc. Jun. 29, Jun. 30, % Inc.
(dollars in millions) 2001 2000 (Dec.) 2001 2000 (Dec.)
- --------------------------------------------------------------------------------------------------------
Commissions $ 770 $ 978 (21)% $1,634 $2,370 (31)%
Principal transactions and
new issue revenues 455 596 (24) 872 1,227 (29)
Asset management and
portfolio service fees 910 956 (5) 1,839 1,857 (1)
Net interest profit 409 384 7 834 765 9
Other revenues 31 63 (51) 97 135 (28)
------ ------- ------- ------
Total net revenues $2,575 $2,977 (14) $5,276 $6,354 (17)
------ ------- ------- ------
Pre-tax earnings $ 293 $ 311 (6) $ 652 $ 795 (18)
------ ------- ------- ------
Pre-tax profit margin 11.4% 10.4% 12.4% 12.5%
- --------------------------------------------------------------------------------------------------------
Second quarter 2001 net revenues for PCG were $2.6 billion, 14% below the second
quarter of last year and pre-tax earnings were $293 million, 6% lower than the
second quarter of 2000. The 2001 second quarter pre-tax profit margin was 11.4%,
up from 10.4% in the second quarter of 2000. This improved pre-tax margin was
achieved despite the inclusion of severance expenses and charges related to the
sale or exit of various business components in PCG's second quarter 2001
results. Excluding these items, PCG's pre-tax margin for the quarter was 14.4 %.
In the United States, the second quarter pre-tax earnings increased and the
pre-tax margin was nearly two percentage points above the second quarter a
year-ago. Outside the United States, the impact of lower revenues in the 2001
second quarter compared to the year-ago quarter was principally offset by a
significant reduction in expenses.
PCG's year-to-date net revenues were $5.3 billion, down 17% from the
corresponding period in 2000 and pre-tax earnings were $652 million, 18% lower
than for the first six months of 2000. PCG's year-to-date pre-tax margin was
12.4%, approximately equal to the comparable period a year ago.
22
PCG employed approximately 18,600 financial advisors at the end of the 2001
second quarter, compared with 19,800 at the end of the 2000 second quarter and
20,200 at year-end 2000. The reduction in the first six months of 2001 is the
result of attrition, significantly reduced hiring of trainees and the
consolidation of offices.
Commissions
Commissions revenue primarily arises from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds, insurance
products, and options.
Commissions revenues declined 21% to $770 million in the second quarter of 2001
from $978 million in the second quarter of 2000. Commissions revenues for the
first half of 2001 were $1.6 billion, 31% lower than the first half of 2000.
These decreases are primarily due to a global decline in client transaction
volumes, particularly in equities and mutual funds. In addition, as assets have
moved from traditional transaction-priced accounts to asset-priced services,
there has been a shift in revenue from commissions to portfolio service fees.
Principal transactions and new issue revenues
PCG'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 debt and equity products.
Principal transactions and new issue revenues declined 24% to $455 million in
the 2001 second quarter, as trading and equity new issue volume declined in a
less favorable market environment, compared with the second quarter of 2000.
Year-to-date revenues similarly decreased from $1.2 billion in 2000 to $872
million in 2001.
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 Advantage (Service Mark) and Merrill Lynch
Consults (Registered Trademark) and servicing fees related to such accounts.
Asset management and portfolio service fees declined 5% to $910 million in the
second quarter of 2001 largely as a result of a reduction in money market fund
balances, as assets have migrated to bank deposits. On a year-to-date basis,
asset management and portfolio service fees have essentially remained flat.
An analysis of changes in assets in Private Client accounts from June 30, 2000
to June 29, 2001 is detailed below:
- ---------------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------
Jun. 30, New Asset Jun. 29,
(dollars in billions) 2000 Money Depreciation 2001
- ---------------------------------------------------------------------------------------------------------
Assets in Private Client accounts $ 1,561 $ 106 $ (213) $ 1,454
- ---------------------------------------------------------------------------------------------------------
Total assets in U.S. Private Client accounts declined 7% from the end of the
2000 second quarter, to $1.3 trillion, as a result of market declines, partially
offset by net new money inflows of $85 billion since the second quarter of 2000.
Outside the United States, client assets were $136 billion, with $4 billion of
net new money in the 2001 second quarter and $21 billion since the end of the
2000 second quarter. Total assets in asset-priced accounts were $208 billion,
unchanged from a year ago.
Net interest profit
Interest revenue for PCG is primarily derived from interest earned on the
investment portfolio, primarily related to Merrill Lynch's U.S. banks, as well
as interest earned on margin and other loans. Interest expense consists of
interest paid on bank deposits and other borrowings.
23
Net interest profit was $409 million, up 7% from $384 million in the second
quarter of 2000. Net interest profit for the six months of 2001 was $834
million, 9% higher than in the comparable period in 2000. The increases in net
interest profit resulted from growth in deposits and the related investment
portfolios at Merrill Lynch's U.S. banks, partially offset by a decline in net
interest revenue from margin loans.
Other revenues
Other revenues, which is primarily comprised of investment gains, decreased from
$63 million in the 2000 second quarter to $31 million in the second quarter of
2001. Other revenues for the first half of 2001 decreased to $97 million from
$135 million for the same period in 2000.
- --------------------------------------------------------------------------------
Merrill Lynch Investment Managers
- --------------------------------------------------------------------------------
MLIM's Results of Operations
- -----------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- ------------------------
Jun. 29, Jun. 30, % Inc. Jun. 29, Jun. 30, % Inc.
(dollars in millions) 2001 2000 (Dec.) 2001 2000 (Dec.)
- -----------------------------------------------------------------------------------------------------------------
Commissions $ 80 $110 (27)% $ 158 $ 222 (29)%
Asset management fees 441 453 (3) 887 937 (5)
Other revenues 38 43 (12) 83 59 41
---- ---- ------- ------
Total net revenues $559 $606 (8) $1,128 $1,218 (7)
---- ---- ------- ------
Pre-tax earnings $106 $137 (23) $ 209 $ 239 (13)
---- ---- ------- ------
Pre-tax profit margin 19.0% 22.6% 18.5% 19.6%
- -----------------------------------------------------------------------------------------------------------------
MLIM's investment performance continues to be strong. More than 70% of U.S.
equity mutual fund assets have above-median performance for the 1, 3, and 5 year
periods. Two-thirds of global retail and institutional assets under management
outperformed their relevant median or benchmark over the past year. Net revenues
for MLIM declined 8% from the second quarter of last year to $559 million,
primarily due to a market-driven decline in the value of assets under
management. Pre-tax earnings were $106 million in the second quarter of 2001, a
decline of 23% from the second quarter of 2000. The pre-tax profit margin
dropped from 22.6% in the second quarter of 2000 to 19.0% in the second quarter
of 2001. MLIM's second quarter 2001 results include severance costs.
Year-to-date, MLIM's net revenues were $1.1 billion, down 7% from the year-ago
period and pre-tax earnings were $209 million, 13% lower than the first six
months of 2000. MLIM's year-to-date pre-tax margin was 18.5%, down from 19.6%
for the same period last year.
Commissions
Commissions for MLIM predominately consist of distribution fees and redemption
fees related to mutual funds. The distribution fees represent fees for promoting
and distributing mutual funds ("12b-1 fees").
Commissions revenues declined 27% to $80 million in the 2001 second quarter due
to reduced levels of outstanding mutual funds with associated 12b-1 distribution
fees resulting primarily from redemptions and market-driven declines in assets
under management. For the first half of 2001, commissions revenues decreased 29%
from the same period a year ago.
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.
24
Asset management fees were $441 million, a decline of 3% from the second quarter
of 2000 due to a decrease in management fees, resulting from the market-driven
decline in assets under management. At the end of the second quarter of 2001,
assets under management totaled $533 billion, compared with $585 billion at the
end of the second quarter 2000. MLIM has attracted positive net new money for
seven consecutive quarters, including $4 billion in the second quarter of 2001,
excluding the impact of money flows from money market funds to deposits at
Merrill Lynch's U.S. banks. On a year-to-date basis, asset management fees
decreased 5% to $887 million.
MLIM's assets under management include taxable and tax-exempt money market
funds, the fees for which are included in the results of PCG. These funds
totaled $79 billion at June 29, 2001. An analysis of changes in assets under
management from June 30, 2000 to June 29, 2001 is as follows:
- --------------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------------
Jun. 30, New Asset Jun. 29,
(dollars in billions) 2000 Money Depreciation (1) Other(2) 2001
- --------------------------------------------------------------------------------------------------------
Assets under management $ 585 $ 24 $ (53) $ (23) $ 533
- --------------------------------------------------------------------------------------------------------
(1) Includes $(17) billion impact of foreign exchange.
(2) Includes reinvested dividends of $10 billion and net outflows of $31 billion
of retail money market funds which were transferred to bank deposits at
Merrill Lynch's U.S. banks.
Other Revenues
Other revenues decreased 12% from the second quarter of 2000 to $38 million in
the second quarter of 2001. On a year-to-date basis, other revenues increased
41% to $83 million.
- --------------------------------------------------------------------------------
Non-Interest Expenses
- --------------------------------------------------------------------------------
Merrill Lynch's non-interest expenses are summarized below:
- -------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
-------------------------- -------------------------
Jun. 29, Jun. 30, Jun. 29, Jun. 30,
(dollars in millions) 2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------
Compensation and benefits $2,977 $3,508 $6,221 $ 7,426
------ ------ ------ -------
Non-compensation expenses:
Communications and technology 568 584 1,166 1,168
Occupancy and related depreciation 270 258 540 511
Advertising and market development 202 263 410 508
Brokerage, clearing, and exchange fees 243 233 478 466
Professional fees 151 168 293 315
Goodwill amortization 51 54 103 110
Other 259 359 569 755
------ ------ ------ -------
Total non-compensation expenses 1,744 1,919 3,559 3,833
------ ------ ------ -------
Total non-interest expenses $4,721 $5,427 $9,780 $11,259
====== ====== ====== =======
Compensation and benefits
as a percentage of net revenues 53.4% 51.3% 51.9% 51.7%
Non-compensation expenses
as a percentage of net revenues 31.3 28.0 29.7 26.7
- -------------------------------------------------------------------------------------------------------------
Compensation and benefits, which included $129 million of severance expenses,
decreased 15% from the 2000 second quarter to $3.0 billion. Compensation and
benefits as a percentage of net revenues was 53.4% for the second quarter of
2001 (51.1% excluding severance costs), compared to 51.3% in the year ago
quarter. Non-compensation expenses were 9% lower than the 2000 second
25
quarter, as the result of actions initiated in the second half of 2000 to
contain expenses, consolidate offices, and more effectively allocate resources.
Communications and technology expenses were $568 million, down 3% from the
second quarter of 2000 primarily due to reduced systems consulting costs.
Occupancy and related depreciation expense was $270 million in the second
quarter of 2001, 5% higher than the second quarter of 2000 principally due to
increased rental and other occupancy costs.
Advertising and market development expenses declined 23% from the 2000 second
quarter to $202 million, due to continued lower levels of advertising and travel
expenses.
Brokerage, clearing, and exchange fees were $243 million, up $10 million from
second quarter of 2000.
Professional fees decreased 10% to $151 million primarily due to reduced
spending on employment and consulting services.
Goodwill amortization was $51 million in the second quarter of 2001, virtually
unchanged from the 2000 second quarter. Other expenses were $259 million, 28%
lower than the 2000 second quarter, due to a reduction in provisions for various
business matters.
The effective tax rate was 31.3% for the first six months of 2001, up from the
full-year 2000 rate of 30.4%.
- --------------------------------------------------------------------------------
Average Assets and Liabilities
- --------------------------------------------------------------------------------
Management continually monitors and evaluates on a daily basis the level and
composition of the balance sheet.
For the first six months of 2001, average total assets were $428 billion, up 15%
from $371 billion for the full-year 2000. Average total liabilities increased
15% to $406 billion from $352 billion for the full-year 2000. The major
components in the changes in average total assets and liabilities for the first
six months of 2001 as compared to the full-year 2000 are summarized as follows:
- ------------------------------------------------------------------------------------------------------
(dollars in millions) Increase/(Decrease) Change
- ------------------------------------------------------------------------------------------------------
Average assets
Marketable investment securities $ 34,464 139%
Receivables under resale agreements and securities
borrowed transactions 12,995 12
Loans, notes and mortgages (net) 5,619 43
Average liabilities
Deposits $ 41,274 120%
Long-term borrowings 12,277 20
Commercial paper and other short-term borrowings (8,107) (34)
Payables under repurchase agreements and
securities loaned transactions 16,756 18
- ------------------------------------------------------------------------------------------------------
The significant growth in deposits in the first six months of 2001 reflects the
cash inflows from certain CMA(Registered Trademark) and other types of accounts
from taxable money market funds, which are included in
26
assets under management, to bank deposits at Merrill Lynch's U.S. banks. This
increase in deposits was used by the U.S. banks to fund the growth in marketable
investment securities. Additionally, receivables under resale agreements and
securities borrowed transactions rose due to increased matched-book activity.
- --------------------------------------------------------------------------------
Capital Adequacy and Liquidity
- --------------------------------------------------------------------------------
The primary objectives of Merrill Lynch's capital structure and funding policies
are to:
1. Ensure sufficient equity capital to absorb losses,
2. Support the business strategies, and
3. Assure 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 29, 2000.
At June 29, 2001, Merrill Lynch's equity capital was comprised of $20.3 billion
in common equity, $425 million in preferred stock, and $2.7 billion of preferred
securities issued by subsidiaries. Preferred securities issued by subsidiaries
consist primarily of Trust Originated Preferred Securities (Service Mark)
("TOPrS"(Service Mark)). Based on various analyses and criteria, management
believes that Merrill Lynch's equity capital base of $23.4 billion is adequate.
Merrill Lynch's leverage ratios were as follows:
- ----------------------------------------------------------------------
Adjusted
Leverage Leverage
Ratio(1) Ratio(2)
- ----------------------------------------------------------------------
Period-end
June 29, 2001 18.1x 12.6x
December 29, 2000 19.4x 13.9x
Average (3)
Six months ended June 29, 2001 19.1x 13.5x
Year ended December 29, 2000 19.0x 13.2x
- ----------------------------------------------------------------------
(1) Total assets to total stockholders' equity and preferred securities issued
by subsidiaries.
(2) Total assets less (a)receivables under resale agreements and securities
borrowed transactions and (b)securities received as collateral to total
stockholders' equity and preferred securities issued by subsidiaries.
(3) Computed using month-end balances.
An asset-to-equity leverage ratio does not reflect the risk profile of assets,
hedging strategies, or off-balance sheet exposures. Thus, Merrill Lynch does not
rely on overall leverage ratios to assess risk-based capital adequacy.
Commercial paper outstanding totaled $5.5 billion at June 29, 2001 and $14.0
billion at December 29, 2000, which was 1% and 3% of total assets at June 29,
2001 and year-end 2000, respectively. Deposits at Merrill Lynch's banking
subsidiaries have increased from $67.6 billion at year-end 2000 to $79.4 billion
at June 29, 2001, including $66.9 billion at Merrill Lynch's U.S. banks. The
U.S. bank deposits were primarily invested in high quality marketable investment
securities. Outstanding long-term borrowings increased to $79.5 billion at June
29, 2001 from $70.2 billion at December 29, 2000. In the second quarter of 2001,
Merrill Lynch issued $2.3 billion of Liquid Yield Option (Trademark) Notes
("LYONs"(Registered Trademark)) due in 2031. LYONs are zero-coupon senior debt
instruments convertible into Merrill Lynch common stock at a premium under
certain defined terms and conditions. Major components of the change in
long-term borrowings during the first six months of 2001 follow:
27
- ----------------------------------------------
(dollars in billions)
- ----------------------------------------------
Balance at December 29, 2000 $70.2
Issuances 24.8
Maturities (15.5)
-------
Balance at June 29, 2001 (1) $79.5
=======
- ----------------------------------------------
(1) At June 29, 2001, $55.2 billion of long-term borrowings had maturity dates
beyond one year.
In addition to equity capital sources, Merrill Lynch views long-term debt as a
stable funding source for its core balance sheet assets. Another source of
liquidity is a committed, senior, unsecured bank credit facility which at June
29, 2001 totaled $7 billion and was not drawn upon. Additionally, Merrill Lynch
maintains access to significant uncommitted credit lines, both secured and
unsecured, from a large group of banks.
The cost and availability of unsecured financing generally are dependent on
credit ratings. Merrill Lynch's senior long-term debt, preferred stock, and
TOPrS were rated by several recognized credit rating agencies at June 29, 2001
as follows:
- ---------------------------------------------------------------------------------------------
Senior Preferred Stock
Debt and TOPrS
Rating Agency Ratings Ratings
- ---------------------------------------------------------------------------------------------
Dominion Bond Rating Service Ltd AA (Low) Not Rated
Fitch AA AA-
Moody's Investors Service, Inc. Aa3 aa3
Rating and Investment Information, Inc. AA A+
Standard & Poor's Rating Service AA- A
- ---------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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, see the Annual Report on Form 10-K for the year ended December 29,
2000.
Market Risk
Value-at-risk ("VaR") is an estimate of the amount that Merrill Lynch's present
portfolios could lose with a specified degree of confidence over a given time
interval. The VaR for Merrill Lynch's overall portfolios 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
value-at-risk using a 99% confidence level and a two-week holding period for
trading and non-trading portfolios. Sensitivities to market risk factors are
aggregated and combined with a database of historical biweekly changes in market
factors to simulate a series of profits and losses. The level of loss that is
28
exceeded in that series 1% of the time is used as the estimate for the 99%
confidence level VaR. 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 June 29, 2001 and December 29, 2000 as well as daily
average VaR for the three months ended June 29, 2001. Additionally, high and low
VaR for the second quarter of 2001 is presented independently for each risk
category and overall.
- -------------------------------------------------------------------------------------------------------
Daily
Jun. 29, Dec. 29, Average High Low
(dollars in millions) 2001 2000 2Q01 2Q01 2Q01
- -------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 93 $ 81 $ 80 $122 $ 56
Equity 57 77 34 66 20
Commodity 5 9 4 6 2
Currency 13 14 9 18 4
Volatility 36 34 43 67 18
---- ---- ---- ---- ----
204 215 170
Diversification benefit (95) (116) (79)
---- ---- ---- ---- ----
Overall(2) $109 $ 99 $ 91 $110 $ 74
==== ==== ==== ==== ====
- -------------------------------------------------------------------------------------------------------
(1) Based on a 99% confidence level and a two-week holding period.
(2) Overall VaR using a 95% confidence level and a one-day holding period was
$20 million at both June 29, 2001 and December 29, 2000.
Overall VaR at June 29, 2001 was higher than the year-end level as the impact of
an increase in interest and credit spread VaR and a decrease in the
diversification benefit was partially offset by a decrease in equity VaR.
Merrill Lynch's energy trading business, for which VaR has severe limitations
as a risk measure, has been excluded from the table above. During the first
quarter of 2001, Merrill Lynch sold the majority of its energy-trading assets.
Although Merrill Lynch entered into a thirty-month non-compete covenant in
connection with this asset sale, some energy-trading positions remain.
The following table presents Merrill Lynch's VaR for its non-trading portfolios
(excluding U.S. banks):
- ------------------------------------------------------------------------
Jun. 29, Dec. 29,
(dollars in millions) 2001 2000
- ------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 78 $ 67
Currency 24 23
Equity 52 47
Volatility 6 3
---- ----
160 140
Diversification benefit (46) (44)
---- ----
Overall $114 $ 96
==== ====
- ------------------------------------------------------------------------
(1) Based on a 99% confidence level and a two-week holding period.
29
Non-trading VaR does not include risk related to Merrill Lynch's $2.3 billion of
outstanding LYONs since management expects that the LYONs will be converted to
common stock and will not be replaced by fixed income securities. The increase
in non-trading VaR since year-end 2000 is primarily due to higher interest rate
and credit spread risk.
In addition to the amounts reported in the accompanying table, non-trading
interest rate VaR associated with Merrill Lynch's TOPrS at June 29, 2001 and
December 29, 2000 was $77 million and $138 million, respectively. TOPrS, which
are fixed-rate perpetual preferred securities, are considered a component of
Merrill Lynch's equity capital and, therefore, the associated interest rate
sensitivity is not hedged.
Beginning in 2000, cash flows from client funds in certain CMA and other types
of accounts were redirected from taxable money market funds to bank deposits at
Merrill Lynch's U.S. banks. This increase in deposits was used to fund the
growth in high credit quality marketable investment securities. The overall VaR
for the U.S. banks, driven largely by these securities and based on a 99%
confidence interval and a two-week holding period, was $183 million and $113
million at June 29, 2001 and December 29, 2000, respectively. The December 29,
2000 amount has been restated to reflect improvements in VaR measurement. The
increase in the banks' VaR is primarily due to the growth in asset levels.
Credit Risk
Merrill Lynch enters into International Swaps and Derivatives Association, Inc.
master agreements or their equivalent ("master netting agreements") with each of
its derivative counterparties as soon as possible. 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.
In addition, to reduce default risk, Merrill Lynch requires collateral,
principally 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 $4.9 billion of collateral) of
trading derivatives in a gain position by maturity at June 29, 2001. (Please
note that the following table is inclusive of credit exposure from derivative
transactions only and does not include other credit exposures, which may be
material).
- -----------------------------------------------------------------------------------------
Credit Years to Maturity Cross-
------------------------------------------------ Maturity
Rating(1) 0-3 3 - 5 5-7 Over 7 Netting(2) Total
- -----------------------------------------------------------------------------------------
AAA $ 3,317 $1,123 $ 837 $1,455 $ (727) $ 6,005
AA 3,897 1,613 853 4,089 (1,682) 8,770
A 3,748 1,568 470 1,401 (1,172) 6,015
BBB 910 238 225 397 (182) 1,588
Other 928 508 262 185 (166) 1,717
---------------------------------------------------------------------------
Total $12,800 $5,050 $2,647 $7,527 $(3,929) $24,095
- -----------------------------------------------------------------------------------------
(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.
30
- --------------------------------------------------------------------------------
Non-Investment Grade Holdings
- --------------------------------------------------------------------------------
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 these
risks and, whenever possible, employs 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 as BB+
or lower, 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 seeks to manage these risks
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 syndicates 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.
- --------------------------------------------------------------------------------
Trading Exposures
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's trading exposure to
non-investment grade or highly-leveraged issuers or counterparties:
- --------------------------------------------------------------------------------
(dollars in millions) Jun. 29, 2001 Dec. 29, 2000
- --------------------------------------------------------------------------------
Trading assets:
Cash instruments $ 5,024 $ 5,227
Derivatives 4,276 3,982
Trading liabilities - cash instruments (1,320) (1,087)
Collateral on derivative assets (2,559) (1,796)
------- --------
Net trading asset exposure $ 5,421 $ 6,326
======= ========
- --------------------------------------------------------------------------------
31
Among the trading exposures included in the preceding table are distressed bank
loans and debt and equity securities of companies in various stages of
bankruptcy proceedings or in default. At June 29, 2001, the carrying value of
such securities totaled $221 million, compared with $165 million at December
29, 2000.
- --------------------------------------------------------------------------------
Non-Trading Exposures
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's non-trading exposures to
non-investment grade or highly leveraged corporate issuers or counterparties:
- ----------------------------------------------------------------------------------------
Jun. 29, Dec. 29,
(dollars in millions) 2001 2000
- ----------------------------------------------------------------------------------------
Marketable investment securities $ 101 $ 199
Investments of insurance subsidiaries 130 136
Loans (net of allowance for loan losses):
Bridge loans(1) 879 524
Other loans(2) 3,079 2,741
Other investments:
Partnership interests (3) 1,271 993
Other equity investments (4) 183 284
- ----------------------------------------------------------------------------------------
(1) Subsequent to June 29, 2001, $675 million of these loans were repaid.
(2) Represents outstanding loans to 145 and 135 companies at June 29, 2001 and
December 29, 2000, respectively.
(3) Includes $760 million and $504 million in investments at June 29, 2001,
and December 29, 2000, respectively, related to deferred compensation plans,
for which the default risk of the investments generally rests with the
participating employees.
(4) Includes investments in 79 and 98 enterprises at June 29, 2001 and
December 29, 2000, respectively.
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly-leveraged counterparties:
- --------------------------------------------------------------------------------------------
Jun. 29, Dec. 29,
(dollars in millions) 2001 2000
- --------------------------------------------------------------------------------------------
Additional commitments to invest in partnerships $ 308 $ 467
Unutilized revolving lines of credit and other
lending commitments 2,132 3,664
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
New Accounting Pronouncements
- --------------------------------------------------------------------------------
In September 2000, the Financial Accounting Standards Board released SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities, a replacement of SFAS No. 125, which revises the
standards for accounting for securitizations and other transfers of financial
assets and collateral. On April 1, 2001, Merrill Lynch adopted the provisions of
this statement that were required to be adopted in the second quarter of 2001.
These provisions changed the accounting for certain securities lending
transactions. Under the new provisions, when Merrill Lynch acts as the lender in
a securities lending agreement and receives securities as collateral that can be
pledged or sold, it recognizes on the Consolidated Balance Sheet, the securities
received as well as an obligation to return the securities lent. Accordingly,
Merrill Lynch's accompanying Consolidated Balance Sheet as of June 29, 2001
separately reflects these assets and liabilities.
32
In July 2001, the Financial Accounting Standards Board released Statement of
Financial Accounting Standards (SFAS) No. 141, Business Combinations and No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires all business
combinations initiated after June 30, 2001, to be accounted for using the
purchase method. Merrill Lynch adopted the provisions of SFAS No. 141 on July 1,
2001. Under SFAS No. 142, intangible assets with indefinite lives and goodwill
will no longer be amortized. Instead, these assets will be tested annually for
impairment. Merrill Lynch will adopt the provisions of SFAS No. 142 at the
beginning of fiscal year 2002. The full impact of adoption is yet to be
determined, however, annual reported amortization expense related to these
assets approximates $200 million.
33
- ----------------------------------------------------------------------------------------------------------------------
Statistical Data
- ----------------------------------------------------------------------------------------------------------------------
2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr.
2000 2000 2000 2001 2001
-------- -------- -------- -------- --------
Client Assets (dollars in billions):
Private Client
U.S. $ 1,415 $ 1,417 $ 1,337 $ 1,254 $ 1,318
Non-U.S. 146 148 140 131 136
-------- -------- -------- -------- --------
Total Private Client Assets 1,561 1,565 1,477 1,385 1,454
MLIM direct sales (1) 211 203 204 179 181
-------- -------- -------- -------- --------
Total Client Assets $ 1,772 $ 1,768 $ 1,681 $ 1,564 $ 1,635
======== ======== ======== ======== ========
Assets in Asset-Priced Accounts $ 208 $ 220 $ 209 $ 193 $ 208
Assets Under Management:
Retail $ 282 $ 274 $ 250 $ 233 $ 230
Institutional 258 252 262 250 260
Private Investors 45 45 45 42 43
Equity 343 337 321 282 286
Fixed-income 104 101 108 118 118
Money market 138 133 128 125 129
U.S. 356 351 333 319 325
Non-U.S. 229 220 224 206 208
U.S. Bank Deposits $ 19 $ 38 $ 55 $ 66 $ 67
- ----------------------------------------------------------------------------------------------------------------------
Underwriting:
Global Debt and Equity:
Volume (dollars in billions) $ 92 $ 108 $ 76 $ 134 $ 121
Market share 12.1% 13.8% 11.8% 12.9% 11.9%
U.S. debt and equity:
Volume (dollars in billions) $ 69 $ 77 $ 55 $ 113 $ 100
Market share 14.2% 14.7% 12.6% 15.9% 13.8%
- ----------------------------------------------------------------------------------------------------------------------
Full-Time Employees:
U.S. 52,300 52,700 51,800 50,400 49,100
Non-U.S. 19,200 20,000 20,200 19,900 19,100
-------- ------------- -------- -------- --------
Total 71,500 72,700 72,000 70,300 68,200
======== ============= ======== ======== ========
Financial advisors and
other investment professionals 20,700 21,200 21,200 20,500 19,600
- ----------------------------------------------------------------------------------------------------------------------
Income Statement:
Net earnings (dollars in millions) $ 921 $ 885 $ 877 $ 874 $ 541
Annualized return on average
common stockholders' equity 24.4% 21.6% 20.0% 18.4% 10.7%
Earnings per common share:
Basic $ 1.15 $ 1.09 $ 1.07 $ 1.04 $ 0.63
Diluted 1.01 0.94 0.93 0.92 0.56
- ----------------------------------------------------------------------------------------------------------------------
Balance Sheet (dollars in millions):
Total assets $334,875 $361,691 $407,200 $431,604 $423,071
Total stockholders' equity $ 16,014 $ 17,171 $ 18,304 $ 19,939 $ 20,691
Book value per common share $ 19.47 $ 20.70 $ 21.95 $ 23.28 $ 24.02
Share Information (in thousands):
Weighted-average shares outstanding:
Basic 795,070 805,855 811,943 832,195 841,394
Diluted 904,246 929,048 930,688 937,954 943,836
Common shares outstanding 800,863 809,069 814,572 838,389 843,772
- ----------------------------------------------------------------------------------------------------------------------
(1) Reflects funds managed by MLIM not sold through Private Client channels.
34
PART II - OTHER INFORMATION
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Item 1. Legal Proceedings
-----------------
The following supplements the discussion under Item 3. Legal Proceedings in ML &
Co.'s Annual Report on Form 10-K for the fiscal year ended December 29, 2000.
IPO Allocation Cases. Merrill Lynch is one of numerous financial services firms
that have been named as defendants in a large number of purported class actions
involving the allocation of securities in initial public offerings (IPOs). These
actions have been filed in the U.S. District Courts for the Southern District of
New York and the District of New Jersey, and allege that defendants violated
antitrust and securities laws by allegedly requiring customers who were
allocated IPO securities to pay back some of their profits in the form of higher
commissions and to buy securities in the aftermarket. Some of the complaints
also allege that research issued by the financial services firms, including
Merrill Lynch, improperly increased the price of the IPO securities in the
aftermarket. Although the ultimate outcome of these actions cannot be predicted
with certainty, it is the opinion of management that the resolution of these
actions will not have a material adverse effect on the financial condition of
Merrill Lynch, but may be material to Merrill Lynch's operating results for any
particular period.
On June 14, 2001, ML & Co. and members of its Board of Directors were named as
defendants in a purported shareholder derivative action filed in the U.S.
District Court for the Southern District of New York. The complaint alleges that
the directors breached their duties by causing and/or allowing Merrill Lynch to
engage in the purported conduct alleged in the IPO Allocation Cases.
The complaints seek unspecified damages and other relief. Merrill Lynch intends
to defend itself vigorously against the claims asserted in the complaints.
Item 4. Submission of Matters to a Vote of Security Holders
----------------------------------------------------
On April 27, 2001, ML & Co. held its Annual Meeting of Stockholders. Further
details concerning matters submitted for stockholder vote can be found in ML &
Co.'s Quarterly Report on Form 10-Q for the 2001 first quarter.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(3) ML & Co.'s By-Laws effective as of July 23, 2001
(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) (i) Merrill Lynch & Co., Inc. Long-Term Incentive Compensation
Plan, as amended on April 27, 2001
(ii) Merrill Lynch & Co., Inc. Program for Deferral of Stock
Option Gains for a Select Group of Eligible Employees, as
amended on July 12, 2001
(iii) Merrill Lynch & Co., Inc. 1986 Employee Stock Purchase Plan,
as amended on April 27, 2001
(12) Statement re: computation of ratios
(15) Letter re: unaudited interim financial information
35
(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 April 11, 2001 for the purpose of
furnishing notice of a webcast of a conference call scheduled
for April 18, 2001 to review ML & Co.'s operating results.
(ii) Current Report dated April 18, 2001 for the purpose of
filing ML & Co.'s Preliminary Unaudited Earnings Summary for
the three months ended March 30, 2001.
(iii) Current Report dated April 30, 2001 for the purpose of
filing the form ML & Co.'s Nikkei 225 Market Index Target-Term
Securities due June 27, 2007.
(iv) Current Report dated May 2, 2001 for the purpose of
filing ML & Co.'s Preliminary Unaudited Consolidated Balance
Sheet as of March 30, 2001.
(v) Current Report dated May 4, 2001 for the purpose of filing the
form of ML & Co.'s Strategic Return Notes linked to the
Nasdaq-100 Index (Registered Trademark) due November 30, 2004.
(vi) Current Report dated May 7, 2001 for the purpose of furnishing
notice of a webcast of a presentation by ML & Co.'s chairman and
chief executive officer scheduled for May 14, 2001.
(vii) Current Report dated May 23, 2001 for the purpose of filing the
form of ML & Co.'s Liquid Yield Option Notes due 2031.
(viii) Current Report dated June 1, 2001 for the purpose of filing the
form of ML & Co.'s Strategic Return Notes linked to the Select
Ten Index (Registered Trademark) due May 30, 2006.
(ix) Current Report dated June 26, 2001 for the purpose of
announcing expected earnings for the 2001 second quarter.
(x) Current Report dated June 29, 2001 for the purpose of filing the
form of ML & Co.'s Strategic Return Notes linked to the
Industrial 15 Index due June 26, 2006.
36
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
MERRILL LYNCH & CO., INC.
----------------------------
(Registrant)
Date: August 10, 2001 By: /s/ Thomas H. Patrick
----------------------------
Thomas H. Patrick
Executive Vice President and
Chief Financial Officer
37
INDEX TO EXHIBITS
Exhibits
3 ML & Co.'s By-Laws effective as of July 23, 2001
10 (i) Merrill Lynch & Co., Inc. Long-Term Incentive Compensation Plan,
as amended on April 27, 2001
(ii) Merrill Lynch & Co., Inc. Program for Deferral of Stock Option Gains
for a Select Group of Eligible Employees, as amended on July 12, 2001
(iii) Merrill Lynch & Co., Inc. 1986 Employee Stock Purchase Plan, as
amended on April 27, 2001
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
38