SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 26, 2003 Commission File Number 1-7182 MERRILL LYNCH & CO., INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 13-2740599 - -------------------------------------------------------------------------------- (State of incorporation) (I.R.S. Employer Identification No.) 4 World Financial Center New York, New York 10080 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 449-1000 - -------------------------------------------------------------------------------- Registrant's telephone number, including area code - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES X NO APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 942,398,722 shares of Common Stock and 2,901,850 Exchangeable Shares as of the close of business on October 31, 2003. The Exchangeable Shares, which were issued by Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one basis and entitle holders to dividend, voting, and other rights equivalent to Common Stock. PART I. FINANCIAL INFORMATION ----------------------------- ITEM 1. FINANCIAL STATEMENTS - ---------------------------- MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Three Months Ended ------------------------------ Sept. 26, Sept. 27, Percent (in millions, except per share amounts) 2003 2002 Inc. (Dec.) -------- --------- ---------- NET REVENUES Asset management and portfolio service fees $ 1,184 $ 1,217 (2.7)% Commissions 1,120 1,125 (0.4) Principal transactions 705 377 87.0 Investment banking Underwriting 545 329 65.7 Strategic advisory 133 163 (18.4) Other 300 165 81.8 -------- --------- Subtotal 3,987 3,376 18.1 -------- --------- Interest and dividend revenues 2,873 3,484 (17.5) Less interest expense 1,794 2,498 (28.2) -------- --------- Net interest profit 1,079 986 9.4 -------- --------- TOTAL NET REVENUES 5,066 4,362 16.1 -------- --------- NON-INTEREST EXPENSES Compensation and benefits 2,393 2,228 7.4 Communications and technology 352 421 (16.4) Occupancy and related depreciation 226 218 3.7 Brokerage, clearing, and exchange fees 188 182 3.3 Advertising and market development 89 125 (28.8) Professional fees 146 135 8.1 Office supplies and postage 46 62 (25.8) Other 138 130 6.2 Net recoveries related to September 11 (21) (191) (89.0) Restructuring - related credit - (2) (100.0) -------- --------- TOTAL NON-INTEREST EXPENSES 3,557 3,308 7.5 -------- --------- EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,509 1,054 43.2 Income tax expense 422 313 34.8 Dividends on preferred securities issued by subsidiaries 48 48 - -------- --------- NET EARNINGS $ 1,039 $ 693 49.9 ======== ========= NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,030 $ 683 50.8 ======== ========= EARNINGS PER COMMON SHARE Basic $ 1.14 $ 0.79 ======== ========= Diluted $ 1.04 $ 0.73 ======== ========= DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16 ======== ========= AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE Basic 904.8 864.6 ======== ========= Diluted 991.1 934.5 ======== ========= - ----------------------------------------------------------------------------------------------------------------------- See Notes to Condensed Consolidated Financial Statements
2 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Nine Months Ended -------------------------------- Sept. 26, Sept. 27, Percent (in millions, except per share amounts) 2003 2002 Inc. (Dec.) ---------- --------- ---------- NET REVENUES Asset management and portfolio service fees $ 3,465 $ 3,808 (9.0)% Commissions 3,233 3,579 (9.7) Principal transactions 2,815 1,982 42.0 Investment banking Underwriting 1,478 1,296 14.0 Strategic advisory 391 540 (27.6) Other 776 603 28.7 ---------- --------- Subtotal 12,158 11,808 3.0 ---------- --------- Interest and dividend revenues 8,922 9,966 (10.5) Less interest expense 5,841 7,371 (20.8) ---------- --------- Net interest profit 3,081 2,595 18.7 ---------- --------- TOTAL NET REVENUES 15,239 14,403 5.8 ---------- --------- NON-INTEREST EXPENSES Compensation and benefits 7,567 7,443 1.7 Communications and technology 1,112 1,307 (14.9) Occupancy and related depreciation 663 684 (3.1) Brokerage, clearing, and exchange fees 527 552 (4.5) Advertising and market development 323 426 (24.2) Professional fees 430 397 8.3 Office supplies and postage 154 196 (21.4) Other 548 466 17.6 Net recoveries related to September 11 (82) (191) (57.1) Restructuring - related credit - (2) (100.0) Research - related expenses - 111 (100.0) ---------- --------- TOTAL NON-INTEREST EXPENSES 11,242 11,389 (1.3) ---------- --------- EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 3,997 3,014 32.6 Income tax expense 1,109 896 23.8 Dividends on preferred securities issued by subsidiaries 143 144 (0.7) ---------- --------- NET EARNINGS $ 2,745 $ 1,974 39.1 ========== ========= NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 2,717 $ 1,945 39.7 ========== ========= EARNINGS PER COMMON SHARE Basic $ 3.03 $ 2.26 ========== ========= Diluted $ 2.81 $ 2.07 ========== ========= DIVIDEND PAID PER COMMON SHARE $ 0.48 $ 0.48 ========== ========= AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE Basic 896.5 860.4 ========== ========= Diluted 965.2 942.0 ========== ========= - ------------------------------------------------------------------------------------------------------------------------- See Notes to Condensed Consolidated Financial Statements
3 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 26, Dec. 27, (dollars in millions) 2003 2002 - ----------------------------------------------------------------------------------- -------- -------- ASSETS CASH AND CASH EQUIVALENTS $ 15,532 $ 10,211 CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES OR DEPOSITED WITH CLEARING ORGANIZATIONS 6,371 7,375 SECURITIES FINANCING TRANSACTIONS Receivables under resale agreements 79,116 75,292 Receivables under securities borrowed transactions 45,556 45,543 -------- -------- 124,672 120,835 TRADING ASSETS, AT FAIR VALUE (includes securities pledged as collateral of $18,081 in 2003 and $11,344 in 2002) Contractual agreements 39,343 38,728 Corporate debt and preferred stock 22,169 18,569 Equities and convertible debentures 17,938 13,530 Non-U.S. governments and agencies 17,407 10,095 Mortgages, mortgage-backed, and asset-backed 16,552 14,987 U.S. Government and agencies 13,414 10,116 Municipals and money markets 4,730 5,535 -------- -------- 131,553 111,560 INVESTMENT SECURITIES 79,558 81,787 SECURITIES RECEIVED AS COLLATERAL 5,148 2,020 OTHER RECEIVABLES Customers (net of allowance for doubtful accounts of $60 in 2003 and $79 in 2002) 41,913 35,317 Brokers and dealers 3,454 8,485 Interest and other 10,195 10,581 -------- -------- 55,562 54,383 -------- -------- LOANS, NOTES, AND MORTGAGES (net of allowances of $274 in 2003 and $265 in 2002) 40,370 34,735 SEPARATE ACCOUNTS ASSETS 15,513 13,042 EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization of $4,984 in 2003 and $4,671 in 2002) 2,606 3,080 GOODWILL (net of accumulated amortization of $1,011 in 2003 and $984 in 2002) 4,596 4,446 OTHER ASSETS 4,286 4,454 -------- -------- TOTAL ASSETS $485,767 $447,928 ======== ========
4 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 26, Dec. 27, (dollars in millions, except per share amount) 2003 2002 - ------------------------------------------------------------------------------------- -------- -------- LIABILITIES SECURITIES FINANCING TRANSACTIONS Payables under repurchase agreements $ 95,939 $ 85,378 Payables under securities loaned transactions 7,391 7,640 -------- -------- 103,330 93,018 -------- -------- COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 3,015 5,353 DEPOSITS 79,312 81,842 TRADING LIABILITIES, AT FAIR VALUE Contractual agreements 45,198 45,202 U.S. Government and agencies 17,119 14,678 Non-U.S. governments and agencies 12,257 7,952 Corporate debt, municipals and preferred stock 8,894 6,500 Equities and convertible debentures 8,084 4,864 -------- -------- 91,552 79,196 -------- -------- OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 5,148 2,020 Other payables Customers 34,525 28,569 Brokers and dealers 16,509 16,541 Interest and other 24,017 20,724 -------- -------- 75,051 65,834 -------- -------- LIABILITIES OF INSURANCE SUBSIDIARIES 3,397 3,566 SEPARATE ACCOUNTS LIABILITIES 15,513 13,042 LONG-TERM BORROWINGS 80,706 78,524 -------- -------- TOTAL LIABILITIES 457,024 422,395 -------- -------- PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,666 2,658 -------- -------- STOCKHOLDERS' EQUITY PREFERRED STOCKHOLDERS' EQUITY (42,500 shares issued and outstanding, 425 425 liquidation preference $10,000 per share) -------- -------- COMMON STOCKHOLDERS' EQUITY Shares exchangeable into common stock 43 58 Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares; issued: 2003 - 1,056,070,197 shares; 2002 - 983,502,078 shares) 1,408 1,311 Paid-in capital 6,385 5,315 Accumulated other comprehensive loss (net of tax) (511) (570) Retained earnings 20,344 18,072 -------- -------- 27,669 24,186 Less: Treasury stock, at cost: 2003 - 117,516,610 shares; 2002 - 116,211,158 shares 1,207 961 Unamortized employee stock grants 810 775 -------- -------- TOTAL COMMON STOCKHOLDERS' EQUITY 25,652 22,450 -------- -------- TOTAL STOCKHOLDERS' EQUITY 26,077 22,875 -------- -------- TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES, AND STOCKHOLDERS' EQUITY $485,767 $447,928 ======== -======= - -------------------------------------------------------------------------------------------------------------------- See Notes to Condensed Consolidated Financial Statements
5 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Nine Months Ended ------------------------------ (dollars in millions) Sept. 26, Sept. 27, 2003 2002 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 2,745 $ 1,974 Noncash items included in earnings: Depreciation and amortization 430 491 Policyholder reserves 120 127 Amortization of stock-based compensation 449 493 Deferred taxes 134 29 Undistributed (earnings) loss from equity investments (82) 30 Other (40) 539 Changes in operating assets and liabilities: Trading assets (20,089) (8,400) Cash and securities segregated for regulatory purposes or deposited with clearing organizations 1,004 (3,506) Receivables under resale agreements (3,829) (5,608) Receivables under securities borrowed transactions (13) 2,668 Customer receivables (6,577) 3,170 Brokers and dealers receivables 5,031 (1,914) Trading liabilities 12,015 12,380 Payables under repurchase agreements 10,561 12,898 Payables under securities loaned transactions (249) (2,643) Customer payables 5,956 423 Brokers and dealers payables (32) 313 Other, net 3,882 6,446 ------- ------- Cash provided by operating activities 11,416 19,910 ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from (payments for): Maturities of available-for-sale securities 22,498 20,350 Sales of available-for-sale securities 49,960 36,646 Purchases of available-for-sale securities (65,568) (52,619) Maturities of held-to-maturity securities 998 145 Purchases of held-to-maturity securities (1,288) (282) Loans, notes, and mortgages (6,063) (11,770) Other investments and other assets (3,303) (1,755) Equipment and facilities 44 (658) ------- ------- Cash used for investing activities (2,722) (9,943) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments for): Commercial paper and other short-term borrowings (2,338) 1,478 Deposits (2,530) (4,994) Issuance and resale of long-term borrowings 22,037 18,313 Settlement and repurchases of long-term borrowings (20,908) (22,970) Derivative financing transactions 341 - Issuance of common stock 440 225 Issuance of treasury stock 10 5 Other common stock transactions 48 (58) Dividends (473) (443) ------- ------- Cash used for financing activities (3,373) (8,444) ------- ------- Increase in cash and cash equivalents 5,321 1,523 Cash and cash equivalents, beginning of year 10,211 11,070 ------- ------- Cash and cash equivalents, end of period $15,532 $12,593 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Income taxes $ 59 $ 631 Interest 5,726 7,535 - ------------------------------------------------------------------------------------------------------------ See Notes to Condensed Consolidated Financial Statements
6 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 26, 2003 - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------- For a complete discussion of Merrill Lynch's accounting policies, refer to the Annual Report included as an exhibit to Form 10-K for the year ended December 27, 2002 ("2002 Annual Report"). Basis of Presentation The Condensed Consolidated Financial Statements include the accounts of Merrill Lynch & Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch"). All material intercompany balances have been eliminated. The interim condensed consolidated financial statements for the three-and nine-month periods are unaudited; however, in the opinion of Merrill Lynch management, all adjustments (consisting of normal recurring accruals) necessary for a fair statement of the condensed consolidated financial statements have been included. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements included in the 2002 Annual Report. The December 27, 2002 unaudited Condensed Consolidated Balance Sheet was derived from the audited 2002 financial statements. The nature of Merrill Lynch's business is such that the results of any interim period are not necessarily indicative of results for a full year. In presenting the Condensed Consolidated Financial Statements, management makes estimates that affect the reported amounts and disclosures in the financial statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the Condensed Consolidated Financial Statements, and it is possible that such changes could occur in the near term. Certain reclassifications have been made to prior period financial statements, where appropriate, to conform to the current period presentation. New Accounting Pronouncements On July 7, 2003, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. The SOP provides guidance on accounting and reporting by insurance companies for certain nontraditional long-duration contracts and for separate accounts. The SOP is effective for financial statements for Merrill Lynch beginning in 2004. The SOP requires the establishment of a liability for contracts that contain death or other insurance benefits using a specified reserve methodology that is different from the methodology that Merrill Lynch currently employs. Had Merrill Lynch adopted SOP 03-1 at September 26, 2003, the estimated pre-tax impact to the Condensed Consolidated Statement of Earnings would be between $90 million and $100 million of additional expense; however, the ultimate impact of adoption in 2004 will depend on market conditions at that time. On May 15, 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 changes the accounting for certain financial instruments, including mandatorily redeemable preferred stock and certain freestanding equity derivatives, which under previous guidance were accounted for as equity. SFAS No. 150 requires that mandatorily redeemable preferred shares, written put options and physically settled forward purchase contracts on an issuer's shares, and certain financial instruments that must be settled by issuing a variable number of an issuer's shares, be classified as liabilities in the Condensed Consolidated Balance Sheets. SFAS No. 150 must be applied immediately to instruments entered into or modified after May 31, 2003 and to all other preexisting instruments beginning in the third quarter of this year. The adoption of SFAS No. 150 did not have a material impact on the Condensed Consolidated Financial Statements. 7 On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group ("DIG") process that effectively required amendments to SFAS No. 133, and decisions made in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative and characteristics of a derivative that contains financing components. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. During the third quarter of 2003, in accordance with SFAS No. 149, Merrill Lynch modified its classification within the Condensed Consolidated Statement of Cash Flows. Certain derivative instruments entered into or modified after June 30, 2003, and that have been determined to contain a financing element at inception and where Merrill Lynch is deemed the borrower, are now included as a separate component within Cash flows from financing activities. Prior to July 1, 2003, the activity associated with such derivative instruments is included within Cash flows from operating activities. The adoption of SFAS No. 149 did not have a material impact on the Condensed Consolidated Financial Statements. On January 17, 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), which clarifies when an entity should consolidate another entity known as a Variable Interest Entity ("VIE"), more commonly referred to as an SPE, or special purpose entity. A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties, and may include many types of SPEs. FIN 46 requires that an entity consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the VIE's expected losses, receive a majority of the VIE's expected residual returns, or both. FIN 46 does not apply to qualifying special purpose entities ("QSPEs"), the accounting for which is governed by SFAS No. 140. Merrill Lynch adopted FIN 46 on February 1, 2003 for VIEs with which it became involved after January 31, 2003. On October 8, 2003, the FASB deferred the effective date for preexisting VIEs to the period ending after December 15, 2003. As a result, Merrill Lynch will adopt FIN 46 for pre-existing contracts in the fourth quarter of this year and does not expect the adoption to have a material impact on the Consolidated Financial Statements. See Note 5 to the Condensed Consolidated Financial Statements for additional FIN 46 disclosure. On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 permits three alternative methods for a voluntary transition to the fair value based method of accounting for employee stock-based compensation. SFAS No. 148 continues to permit prospective application for companies that adopt this standard prior to the beginning of fiscal year 2004. SFAS No. 148 also allows for a modified prospective application, which requires the fair value of all unvested awards to be amortized over the remaining service period, as well as restatement of prior years' expense. The transition guidance and disclosure provisions of SFAS No. 148 were effective for fiscal years ending after December 15, 2002. See Note 11 to the Condensed Consolidated Financial Statements for these disclosures. Merrill Lynch is continuing to evaluate the transition guidance of SFAS No. 148 and currently accounts for stock based compensation in accordance with the intrinsic value-based method in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. 8 On November 25, 2002, the FASB issued FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements Nos. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to disclose their obligations under certain guarantees. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosures were effective for financial statements of interim or annual periods ending after December 15, 2002. See Note 10 to the Condensed Consolidated Financial Statements for these disclosures. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces the guidance provided by EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Merrill Lynch adopted SFAS No. 146 as of January 1, 2003, which had no material impact on the Condensed Consolidated Financial Statements. - -------------------------------------------------------------------------------- NOTE 2. OTHER SIGNIFICANT EVENTS - -------------------------------------------------------------------------------- Restructuring and Other Charges During the fourth quarter of 2001, Merrill Lynch's management formally committed to a restructuring plan designed to position Merrill Lynch for improved profitability and growth, which included the resizing of selected businesses and other structural changes. As a result, Merrill Lynch incurred a fourth quarter 2001 pre-tax charge to earnings of $2.2 billion, which included restructuring costs of $1.8 billion and other charges of $396 million. Utilization of the restructuring reserve and a rollforward of staff reductions at September 26, 2003 are as follows:
(dollars in millions) - ------------------------------------------------------------------------------------------------------------------- Utilized in -------------------------------- Balance Initial Sept. 26, Balance 2001 2002(1) 2003 2003 - ------------------------------------------------------------------------------------------------------------------- Category: Severance costs $ 1,133 $ (214) $ (874) $(27) $ 18 Facilities costs 299 - (15) (72) 212 Technology and fixed asset write-offs 187 (187) - - - Other Costs 178 - (119) - 59 ------- ------ ------- ---- ------ $ 1,797 $ (401) $(1,008) $(99) $ 289 ------- ------ ------- ---- ------ Staff Reductions 6,205 (749) (5,233) (102) 121 - ------------------------------------------------------------------------------------------------------------------- (1) The 2002 utilization included changes in estimates which are attributable to differences in actual costs from initial estimates in implementing the original restructuring plan. As a result of changes in estimates, net reserves of $9 million were reversed in 2002. Refer to Note 3 in the 2002 Annual Report for additional information.
9 - -------------------------------------------------------------------------------- NOTE 3. SEGMENT INFORMATION - -------------------------------------------------------------------------------- In reporting to management, Merrill Lynch's operating results are categorized into three business segments: the Global Markets and Investment Banking Group ("GMI"), Global Private Client ("GPC") and Merrill Lynch Investment Managers ("MLIM"). Prior period amounts have been restated to conform to the current period presentation. For information on each segment's business activities, see the 2002 Annual Report. Results by business segment are as follows:
(dollars in millions) - -------------------------------------------------------------------------------------------------------------------- Corporate GMI GPC MLIM Items Total -------- ------- ------ --------- -------- THREE MONTHS ENDED SEPTEMBER 26, 2003 Non-interest revenues $ 1,690 $ 1,958 $ 346 $ (7) (1) $ 3,987 Net interest profit(2) 796 350 6 (73) (3) 1,079 -------- ------- ------ ------ -------- Net revenues 2,486 2,308 352 (80) 5,066 Non-interest expenses 1,464 1,842 275 (24) (4) 3,557 -------- ------- ------ ------ -------- Pre-tax earnings (loss) $ 1,022 $ 466 $ 77 $ (56) $ 1,509 ======== ======= ====== ====== ======== Quarter-end total assets $411,447 $64,224 $5,500 $4,596 $485,767 ======== ======= ====== ====== ======== - -------------------------------------------------------------------------------------------------------------------- Corporate GMI GPC MLIM Items Total -------- ------- ------ ------------ -------- THREE MONTHS ENDED SEPTEMBER 27, 2002 Non-interest revenues $ 1,270 $ 1,762 $ 356 $ (12)(1) $ 3,376 Net interest profit(2) 652 323 4 7 (3) 986 -------- ------- ----- ------ -------- Net revenues 1,922 2,085 360 (5) 4,362 Non-interest expenses 1,378 1,768 293 (131)(4) 3,308 -------- ------- ------ ------ -------- Pre-tax earnings $ 544 $ 317 $ 67 $ 126 $ 1,054 ======== ======= ====== ====== ======== Quarter-end total assets $384,267 $58,154 $5,398 $4,321 $452,140 ======== ======= ====== ====== ======== - -------------------------------------------------------------------------------------------------------------------- (1) Primarily represents the elimination of intersegment revenues and expenses. (2) Management views interest income net of interest expense in evaluating results. (3) Represents acquisition financing costs and other corporate interest. (4) Represents elimination of intersegment revenues and expenses. 2003 also includes September 11-related expenses and a litigation credit. 2002 also included a September 11-related net recovery.
10
(dollars in millions) - -------------------------------------------------------------------------------------------------------------------- Corporate GMI GPC MLIM Items Total -------- ------- ------ --------- -------- NINE MONTHS ENDED SEPTEMBER 26, 2003 Non-interest revenues $ 5,651 $ 5,532 $1,001 $ (26) (1) $ 12,158 Net interest profit(2) 2,183 1,004 18 (124) (3) 3,081 -------- ------- ------ ------ -------- Net revenues 7,834 6,536 1,019 (150) 15,239 Non-interest expenses 4,906 5,465 830 41 (4) 11,242 -------- ------- ------ ------ -------- Pre-tax earnings (loss) $ 2,928 $ 1,071 $ 189 $ (191) $ 3,997 ======== ======= ====== ====== ======== - -------------------------------------------------------------------------------------------------------------------- Corporate GMI GPC MLIM Items Total -------- ------- ------ --------- -------- NINE MONTHS ENDED SEPTEMBER 27, 2002 Non-interest revenues $ 5,028 $ 5,636 $1,199 $ (55)(1) $ 11,808 Net interest profit(2) 1,590 1,015 13 (23)(3) 2,595 -------- ------- ------ ------ -------- Net revenues 6,618 6,651 1,212 (78) 14,403 Non-interest expenses 4,786 5,719 943 (59)(4) 11,389 -------- ------- ------ ------ -------- Pre-tax earnings (loss) $ 1,832 $ 932 $ 269 $ (19) $ 3,014 ======== ======= ====== ====== ======== - -------------------------------------------------------------------------------------------------------------------- (1) Primarily represents the elimination of intersegment revenues and expenses. (2) Management views interest income net of interest expense in evaluating results. (3) Represents acquisition financing costs and other corporate interest. (4) Represents elimination of intersegment revenues and expenses. 2003 also includes September 11-related expenses and a litigation provision. This litigation provision will be charged to the business segments when the amounts are fixed and determined. 2002 also included a September 11-related net recovery and research settlement-related expenses.
11 - -------------------------------------------------------------------------------- NOTE 4. INVESTMENT SECURITIES - -------------------------------------------------------------------------------- Investment securities at September 26, 2003 and December 27, 2002 are presented below:
(dollars in millions) - -------------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - -------------------------------------------------------------------------------------- Investment securities Available-for-sale $65,886 $72,229 Trading 4,475 3,337 Held-to-maturity 942 638 Non-qualifying: (1) Deferred compensation hedges (2) 632 1,927 Other (3) 7,623 3,656 ------- ------- Total $79,558 $81,787 - -------------------------------------------------------------------------------------- (1) Non-qualifying for SFAS No. 115 purposes. (2) Represents investments economically hedging deferred compensation liabilities. (3) Includes insurance policy loans, merchant banking investments, preferred stock and other non-qualifying investments.
During the third quarter of 2003, Merrill Lynch invested in approximately $2.4 billion of investment grade preferred stock. This investment is included in Non-qualifying - Other in the table above. Also, during the third quarter, Other revenues include a write-down of $114 million related to certain available-for-sale securities that were considered to be impaired on an other than temporary basis. Unrealized losses on these securities were included in Accumulated other comprehensive loss at June 27, 2003. During the third quarter, the write-down was charged to earnings and removed from Accumulated other comprehensive loss. - -------------------------------------------------------------------------------- NOTE 5. SECURITIZATION TRANSACTIONS - -------------------------------------------------------------------------------- In the normal course of business, Merrill Lynch securitizes commercial and residential mortgage and home equity loans; municipal, government, and corporate bonds; and other types of financial assets. SPEs are often used when entering into or facilitating securitization transactions. Merrill Lynch's involvement with SPEs used to securitize financial assets includes: establishing SPEs; selling assets to SPEs; structuring SPEs; underwriting, distributing; and making loans to SPEs; making markets in securities issued by SPEs; engaging in derivative transactions with SPEs; owning notes or certificates issued by SPEs; and/or providing liquidity facilities and other guarantees to SPEs. Merrill Lynch securitized assets of $48.5 billion for the nine months ended September 26, 2003. For the nine months ended September 26, 2003 and September 27, 2002, Merrill Lynch received $49.1 billion and $32.3 billion, respectively, of proceeds, and other cash inflows, from new securitization transactions, and recognized net securitization gains, excluding gains on related derivative transactions, of $66.8 million and $39.7 million, respectively in Merrill Lynch's Condensed Consolidated Statements of Earnings. Merrill Lynch generally records assets prior to securitization at fair value. 12 For the first nine months of 2003 and 2002, cash inflows from securitizations related to the following asset types:
(dollars in millions) - -------------------------------------------------------------------------------------- Sept. 26, 2003 Sept. 27, 2002 - -------------------------------------------------------------------------------------- Asset category Residential mortgage loans $35,105 $21,841 Municipal bonds 8,409 5,652 Corporate and government bonds 1,330 1,932 Commercial loans and other 4,304 2,832 ------- ------ $49,148 $32,257 - --------------------------------------------------------------------------------------
Retained interests in securitized assets were approximately $2.9 billion and $3.3 billion at September 26, 2003 and December 27, 2002, respectively, which related primarily to residential mortgage loan and municipal bond securitization transactions. The majority of the retained interest balance consists of mortgage-backed securities that have observable market prices. These retained interests include mortgage-backed securities that Merrill Lynch has committed to purchase and expects to sell to investors in the normal course of its underwriting activity. Approximately 67% and 77% at September 26, 2003 and December 27, 2002, respectively, of residential mortgage loan retained interests consists of interests in U.S. Government agency sponsored securitizations, which are guaranteed with respect to principal and interest. In addition, $702 million and $851 million at September 26, 2003 and December 27, 2002, respectively, of the retained interest balance relates to municipal bond transactions where observable market prices are available for the underlying assets, which provide the inputs and parameters used to calculate the fair value of the retained interest. The following table presents information on retained interests, excluding the offsetting benefit of financial instruments used to hedge risks, held by Merrill Lynch as of September 26, 2003 arising from Merrill Lynch's residential mortgage loan, municipal bond and other securitization transactions. The sensitivity of the current fair value of the retained interests to immediate 10% and 20% adverse changes in those assumptions and parameters is also shown.
(dollars in millions) - ----------------------------------------------------------------------------------------------------------- Residential Municipal Mortgage Loans Bonds Other - ----------------------------------------------------------------------------------------------------------- Retained interest amount $2,077 $ 702 $ 106 Weighted average life (in years) 4.6 4.0 N/A Range 0.0-19.0 0.1-25.3 N/A Weighted average credit losses (rate per annum) 0.5% 0% 0.7% Range 0.0-3.5% 0% 0.0-3.4% Impact on fair value of 10% adverse change $ (4) $ - $ - Impact on fair value of 20% adverse change $ (9) $ - $ (1) Weighted average discount rate 6.2% 2.4% 5.7% Range 0.0-75.0% 0.9-7.8% 1.0-25.0% Impact on fair value of 10% adverse change $(15) $ (49) $ (1) Impact on fair value of 20% adverse change $(24) $ (96) $ (3) Weighted average prepayment speed (CPR) 19.0% 15.1% N/A Range 0.0-65.0% 11.3-15.9% N/A Impact on fair value of 10% adverse change $ (8) $ (1) N/A Impact on fair value of 20% adverse change $(15) $ (2) N/A - ----------------------------------------------------------------------------------------------------------- N/A=Not Applicable CPR=Constant Prepayment Rate
13 The preceding table does not include the offsetting benefit of financial instruments that Merrill Lynch utilizes to hedge risks including credit, interest rate, and prepayment risk that are inherent in the retained interests. Merrill Lynch employs hedging strategies that are structured to take into consideration the hypothetical stress scenarios above such that they would be effective in principally offsetting Merrill Lynch's exposure to loss in the event these scenarios occur. In addition, the sensitivity analysis is hypothetical and should be used with caution. In particular, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. Further, changes in fair value based on a 10% or 20% variation in an assumption or parameter generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. The weighted average assumptions and parameters used initially to value retained interests relating to securitizations effected in 2003 that were still held by Merrill Lynch as of September 26, 2003 are as follows:
- ----------------------------------------------------------------------------------------------------------- Residential Municipal Mortgage Loans Bonds Other - ----------------------------------------------------------------------------------------------------------- Weighted average life (in years) 5.3 N/A N/A Credit losses (rate per annum) 0.8% 0% 0.2% Weighted average discount rate 6.1% 3.8% 2.9% Prepayment speed assumption (CPR) 14.6% N/A N/A - ----------------------------------------------------------------------------------------------------------- N/A=Not Applicable CPR=Constant Prepayment Rate
For residential mortgage loan and other securitizations, the investors and the securitization trust have no recourse to Merrill Lynch's other assets for failure of mortgage holders to pay when due. For municipal bond securitization SPEs, in the normal course of dealer market-making activities, Merrill Lynch acts as liquidity provider. Specifically, the holders of beneficial interests issued by municipal bond securitization SPEs have the right to tender their interests for purchase by Merrill Lynch on specified dates at a specified price. Beneficial interests that are tendered are then sold by Merrill Lynch to investors through a best efforts remarketing where Merrill Lynch is remarketing agent. If the beneficial interests are not successfully remarketed, the holders of beneficial interests are paid from funds drawn under a standby liquidity letter of credit issued by Merrill Lynch. Merrill Lynch also provides default protection or credit enhancement to investors in securities issued by certain municipal bond securitization SPEs. Interest and principal payments on beneficial interests issued by these SPEs are secured by a guarantee issued by Merrill Lynch. In the event that the issuer of the underlying municipal bond defaults on any payment of principal and/or interest when due, the payments on the bonds will be made to beneficial interest holders from an irrevocable guarantee by Merrill Lynch. The maximum commitment under these liquidity and default guarantees totaled $17.5 billion and $13.7 billion at September 26, 2003 and December 27, 2002, respectively. The fair value of the commitments approximated $10 million and $69 million at September 26, 2003 and December 27, 2002, respectively, which is reflected in the Condensed Consolidated Financial Statements. Of these arrangements, $3.1 billion and $2.3 billion at September 26, 2003 and December 27, 2002, respectively, represent agreements where the guarantee is provided to the SPE by a third party financial intermediary and Merrill Lynch enters into a reimbursement agreement with the financial intermediary. In these arrangements, if the financial intermediary incurs losses, Merrill Lynch has up to one year to fund those losses. Additional information regarding these commitments is provided in Note 10 to the Condensed Consolidated Financial Statements and in Note 14 in the 2002 Annual Report. 14 The following table summarizes principal amounts outstanding, delinquencies, and net credit losses of securitized financial assets as of September 26, 2003 and December 27, 2002.
(dollars in millions) - ----------------------------------------------------------------------------------------------------------- Residential Municipal Mortgage Loans Bonds Other - ----------------------------------------------------------------------------------------------------------- September 26, 2003 Principal Amount Outstanding $41,424 $17,343 $4,356 Delinquencies 68 - - Net Credit Losses 3 - 6 - ----------------------------------------------------------------------------------------------------------- December 27, 2002 Principal Amount Outstanding $23,107 $18,379 $2,476 Delinquencies 90 - 3 Net Credit Losses 5 - 44 - -----------------------------------------------------------------------------------------------------------
Variable Interest Entities - -------------------------- In January 2003, the FASB issued FIN 46, which clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, for enterprises that have interests in entities that meet the definition of a VIE. A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires that an entity shall consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the VIE's expected losses; receive a majority of the VIE's expected residual returns; or both. In accordance with the transition guidance in FIN 46, Merrill Lynch adopted the standard on February 1, 2003 for VIEs with which Merrill Lynch became involved after January 31, 2003. On October 8, 2003, the FASB deferred the effective date for preexisting VIEs to periods ending after December 15, 2003. As a result, Merrill Lynch will adopt FIN 46 for contracts entered into prior to February 1, 2003 in the fourth quarter of this year. In the normal course of business, Merrill Lynch acts as a transferor, derivative counterparty, investor, arranger, structurer, underwriter, market-maker, guarantor, and/or liquidity provider to many VIEs. In addition, Merrill Lynch acts as transferor to certain entities that meet the requirements of qualifying special purpose entities, which are not consolidated in the Merrill Lynch Financial Statements in accordance with SFAS No. 140, but which are disclosed herein where Merrill Lynch typically holds a significant variable interest and the transaction type represents a significant Merrill Lynch sponsored program. Merrill Lynch has entered into transactions with a number of VIEs of which it is (or is likely to be deemed) the primary beneficiary and therefore must consolidate; or is (or is likely to be deemed) a significant variable interest holder. These VIEs are as follows: 15 o Merrill Lynch is (or is likely to be deemed) the primary beneficiary of VIEs that own convertible bonds purchased from Merrill Lynch, in which Merrill Lynch maintains a call option to repurchase the convertible bonds from the VIE. The purpose of these VIEs is to market convertible bonds to a broad investor base by separating the bonds into callable debt and a conversion call option. Assets held by these VIEs are reported in Equities and convertible debentures in the Condensed Consolidated Balance Sheet. Holders of the beneficial interests in these VIEs have no recourse to the general credit of Merrill Lynch; rather their investment is paid exclusively from the convertible bonds held by the VIE. Assets held by these VIEs are currently reflected on the Condensed Consolidated Balance Sheet as a result of preexisting accounting guidance. o Merrill Lynch is (or is likely to be deemed) the primary beneficiary of "maturity shortening transactions", in which the VIE serves to shorten the maturity of a fixed income security, and, at the maturity date of the VIE, Merrill Lynch has the obligation to repurchase some or all of the securities held by the VIE. Assets held by these VIEs are reported in Corporate debt and preferred stock. The beneficial interest holders in these VIEs have recourse to Merrill Lynch to the extent that the underlying assets that Merrill Lynch is required to repurchase have declined in value from the initial transaction date. Assets held by these VIEs are currently reflected on the Condensed Consolidated Balance Sheet as a result of preexisting accounting guidance. o Merrill Lynch structures and manages collateralized debt and collateralized loan obligation (CDOs and CLOs, respectively) VIEs that hold financial assets, such as fixed income securities and loan receivables. These VIEs are used by investors to acquire an interest in a certain risk profile associated with a pool of assets. Merrill Lynch anticipates that it will be the primary beneficiary of certain of these VIEs and a significant variable interest holder in others. The beneficial interest holders of these VIEs do not have recourse to Merrill Lynch, but are paid solely from the assets in the VIEs. o Merrill Lynch is the sponsor and guarantor of VIEs that provide a guarantee of principal to beneficial interest holders, thereby limiting investors' losses generated from the assets. In certain VIEs of this nature, Merrill Lynch will likely be considered the primary beneficiary. Investors in these VIEs have recourse to Merrill Lynch to the extent that the value of the assets held by the VIEs at maturity is less than the investors' initial investment. The guarantees related to these funds are reflected in Note 10 to the Condensed Consolidated Financial Statements. o Merrill Lynch has made loans to VIEs that invest in loan receivable assets and real estate, and as a result of these loan investments Merrill Lynch is (or is likely to be deemed) the primary beneficiary. These VIEs are primarily designed to provide temporary financing to clients. Assets held by these VIEs are (or are likely to be) recorded in Other assets and/or Loans, notes and mortgages in the Condensed Consolidated Balance Sheet. The beneficial interest holders in these VIEs have no recourse to the general credit of Merrill Lynch; rather their investments are paid exclusively from the assets in the VIE. o Merrill Lynch has entered into transactions with VIEs where Merrill Lynch is a derivative counterparty to a VIE that serves to synthetically expose investors to a specific credit risk. Merrill Lynch is (or is likely to be deemed) a significant variable interest holder in these VIEs. o Merrill Lynch has entered into transactions with VIEs that are used, in part, to provide foreign tax planning strategies to investors. Merrill Lynch is (or is likely to be deemed) a significant variable interest holder in these VIEs. o Merrill Lynch has (or is likely to be deemed to have) a significant variable interest in municipal bond securitization QSPEs to which it provides liquidity and default facilities. Additional information on these programs is provided in the retained interest securitization disclosures above and in Note 10 to the Condensed Consolidated Financial Statements. 16 The below tables summarize Merrill Lynch's involvement with the VIEs listed above for the period after February 1, 2003. Where an entity is a significant variable interest holder, FIN 46 requires that entity to disclose its maximum exposure to loss as a result of its interest in the VIE. It should be noted that this measure does not reflect Merrill Lynch's estimate of the actual losses that could result from adverse changes, nor does it reflect the economic hedges Merrill Lynch enters into to reduce its exposure.
- ----------------------------------------------------------------------------------------- Post February 1, 2003 (adopted) (in millions) ------------------------------------------------------ Primary Beneficiary Significant Variable Interest Holder - ----------------------------------------------------------------------------------------- Asset Recourse to Asset Maximum Description Size Merrill Lynch(4) Size Exposure - ----------------------------------------------------------------------------------------- Convertible Bond Stripping $351 None Maturity Shortening $266 $76 Loan and Real Estate VIEs $ 84 None Synthetic Credit Risk VIEs(1) $1,196 $ 112 Foreign Tax Planning VIEs(2) $ 354 $ 31 Municipal Bond Securitizations (3) $4,800 $4,800 - -----------------------------------------------------------------------------------------
(1) The maximum exposure for Synthetic Credit Risk VIEs is the asset carrying value of the derivatives entered into with the VIEs as of September 26, 2003. (2) The maximum exposure for Foreign Tax Planning VIEs reflects the fair value of derivatives entered into with the VIEs, as well as the maximum exposure to loss associated with indemnifications made to investors in the VIEs. (3) The maximum exposure for Municipal Bond Securitizations reflects Merrill Lynch's potential liability as a result of the liquidity and default facilities entered into with the VIEs. It significantly overestimates Merrill Lynch's probability weighted exposure to these VIEs. In addition, Merrill Lynch enters into economic hedges that are designed to be effective in principally offsetting Merrill Lynch's exposure to loss. (4) This column reflects the extent, if any, to which investors have recourse to Merrill Lynch beyond the assets held in the VIE. As noted above, Merrill Lynch has not adopted FIN 46 for VIE transactions entered into prior to February 1, 2003. Merrill Lynch does not expect the fourth quarter adoption to have a material impact on the Consolidated Financial Statements. Based on the current requirements of FIN 46 and Merrill Lynch's best estimate of the impact of adoption, Merrill Lynch expects to be the primary beneficiary and therefore required to consolidate assets estimated to equal $2.8 billion, which would result an estimated increase of assets on the Consolidated Balance Sheet of $1.1 billion (based on September 26, 2003 values). In addition, Merrill Lynch expects to disclose as a significant variable interest holder its involvement with VIEs that hold an estimated $22.0 billion of assets. 17 - -------------------------------------------------------------------------------- NOTE 6. LOANS, NOTES, AND MORTGAGES AND RELATED COMMITMENTS TO EXTEND CREDIT - -------------------------------------------------------------------------------- Loans, Notes, and Mortgages and related commitments to extend credit at September 26, 2003 and December 27, 2002, are presented below:
(dollars in millions) - ---------------------------------------------------------------------------------------------------------------- Loans Commitments -------------------------------- -------------------------------- Sept. 26, 2003 Dec. 27, 2002 Sept. 26, 2003(1) Dec. 27, 2002 - ---------------------------------------------------------------------------------------------------------------- Consumer and small and middle-market $25,687 $22,638 $ 9,397 $ 7,687 business - secured Commercial: Secured 12,857 7,966 8,406 5,074 Unsecured investment grade 1,323 3,434 14,201 10,882 Unsecured non-investment grade 503 697 756 300 ------- ------- ------- ------- Total $40,370 $34,735 $32,760 $23,943 - --------------------------------------- ------------------------------------------------------------------------ (1) See Note 10 for a maturity profile of these commitments.
The loan amounts are net of an allowance for loan losses of $274 million and $265 million as of September 26, 2003 and December 27, 2002, respectively. Consumer and small and middle-market business loans consisted of approximately 190,000 individual loans at September 26, 2003 and included residential mortgages, home equity loans, small and middle-market business loans, and other loans to individuals for household, family, or other personal expenditures, substantially all of which are secured by real and/or personal property. Commercial loans, which at September 26, 2003 consisted of approximately 6,000 separate loans, included syndicated loans and other loans to corporations and other businesses. Secured loans and commitments include lending activities made in the normal course of Merrill Lynch's securities and financing businesses. The investment grade and non-investment grade categorization is determined using the credit rating agency equivalent of internal credit ratings. Non-investment grade counterparties are those rated lower than BBB. Merrill Lynch enters into credit default swaps to mitigate credit exposure primarily related to funded and unfunded unsecured commercial loans. The notional value of these swaps totaled $4.4 billion and $3.8 billion at September 26, 2003 and December 27, 2002, respectively. The above amounts include $5.8 billion and $6.2 billion of loans held for sale at September 26, 2003 and December 27, 2002, respectively. Loans held for sale are loans which management expects to sell prior to maturity. At September 26, 2003, such loans consisted of $4.3 billion of consumer loans, primarily residential mortgages, and $1.5 billion of commercial loans, approximately 47% of which are to investment grade counterparties. At December 27, 2002, such loans consisted of $3.2 billion of consumer loans, primarily residential mortgages, and $3.0 billion of commercial loans, approximately 49% of which were to investment grade counterparties. For information on the accounting policy related to loans, notes and mortgages, see Note 1 in the 2002 Annual Report. 18 - -------------------------------------------------------------------------------- NOTE 7. SHORT-TERM BORROWINGS AND DEPOSITS - -------------------------------------------------------------------------------- Short-term borrowings and Deposits at September 26, 2003 and December 27, 2002 are presented below:
(dollars in millions) - -------------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - -------------------------------------------------------------------------------------- Commercial paper and other short-term borrowings Commercial paper $ 2,203 $ 3,966 Other 812 1,387 ------- ------- Total $ 3,015 $ 5,353 ------- ------- Deposits U.S. $65,569 $68,550 Non U.S. 13,743 13,292 ------- ------- Total $79,312 $81,842 - --------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- NOTE 8. COMPREHENSIVE INCOME - -------------------------------------------------------------------------------- The components of comprehensive income are as follows:
(dollars in millions) - ------------------------------------------------------------------------------- ----------------------------- Three Months Ended Nine Months Ended -------------------- ---------------------- Sept. 26, Sept. 27, Sept. 26, Sept. 27, 2003 2002 2003 2002 -------- -------- -------- ------------- Net Earnings $1,039 $693 $2,745 $1,974 ------ ---- ------ ------ Other comprehensive income (loss), net of tax: Currency translation adjustment 16 (5) 20 (29) Net unrealized gain (loss) on investment securities available-for-sale (35) (50) 32 (14) Deferred gain (loss) on cash flow hedges 13 (6) 7 (20) ------ ---- ------ ------ Total other comprehensive income (loss), (6) (61) 59 (63) net of tax ------ ---- ------ ------ Comprehensive income $1,033 $632 $2,804 $1,911 - -------------------------------------------------------------------------------------------------------------
19 - -------------------------------------------------------------------------------- NOTE 9. EARNINGS PER COMMON SHARE - -------------------------------------------------------------------------------- The computation of earnings per common share is as follows:
(dollars in millions, except per share amounts) - -------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended ------------------------ -------------------------- Sept. 26, Sept. 27, Sept. 26, Sept. 27, 2003 2002 2003 2002 -------- -------- -------- -------- Net Earnings $ 1,039 $ 693 $ 2,745 $ 1,974 Preferred stock dividends 9 10 28 29 -------- -------- -------- -------- Net earnings applicable to common stockholders $ 1,030 $ 683 $ 2,717 $ 1,945 -------- -------- -------- -------- - -------------------------------------------------------------------------------------------------------------------- (shares in thousands) Weighted-average shares outstanding 904,829 864,629 896,528 860,370 -------- -------- -------- -------- Effect of dilutive instruments(1) (2): Employee stock options 37,512 21,917 27,249 33,038 Financial Advisor Capital Accumulation Award Plan shares 24,158 23,083 22,167 24,080 Restricted shares and units 24,526 24,787 19,175 24,433 Employee Stock Purchase Plan shares 41 61 72 80 -------- -------- -------- -------- Dilutive potential common shares 86,237 69,848 68,663 81,631 -------- -------- -------- -------- Total weighted-average diluted shares 991,066 934,477 965,191 942,001 -------- -------- -------- -------- - -------------------------------------------------------------------------------------------------------------------- Basic earnings per common share $1.14 $0.79 $3.03 $2.26 Diluted earnings per common share $1.04 $0.73 $2.81 $2.07 - -------------------------------------------------------------------------------------------------------------------- (1) During the 2003 and 2002 third quarter there were 78 million and 179 million instruments, respectively, that were considered antidilutive and not included in the above computations. (2) See Note 16 to the 2002 Annual Report for a description of these instruments.
- -------------------------------------------------------------------------------- NOTE 10. COMMITMENTS, CONTINGENCIES AND GUARANTEES - -------------------------------------------------------------------------------- Litigation Merrill Lynch has been named as a defendant in various legal actions, including arbitrations, class actions, and other litigation arising in connection with its activities as a global diversified financial services institution. The general decline of equity securities prices that began in 2000 has resulted in increased legal actions against many firms, including Merrill Lynch, and will likely result in higher professional fees and litigation expenses than those incurred in the past. Some of the legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the issuers who would otherwise be the primary defendants in such cases are bankrupt or otherwise in financial distress. Merrill Lynch is also involved in investigations and/or proceedings by governmental and self-regulatory agencies. The number of these investigations has also increased in recent years with regard to many firms, including Merrill Lynch. 20 Given the number of these legal actions, investigations and proceedings, some are likely to result in adverse judgments, settlements, penalties, injunctions, fines, or other relief. Merrill Lynch believes it has strong defenses to, and where appropriate, will vigorously contest these actions. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases in which claimants seek substantial or indeterminate damages, Merrill Lynch often cannot predict what the eventual loss or range of loss related to such matters will be. Merrill Lynch believes, based on information available to it, that the resolution of these actions will not have a material adverse effect on the financial condition of Merrill Lynch as set forth in the Condensed Consolidated Financial Statements, but may be material to Merrill Lynch's operating results or cash flows for any particular period and may impact ML & Co.'s credit ratings. Commitments At September 26, 2003, Merrill Lynch's commitments had the following expirations:
(dollars in millions) - ---------------------------------------------------------------------------------------------------------------- Commitment expiration --------------------------------------------------- Less than Total 1 year 1- 3 years 3+ - 5 years Over 5 years - ---------------------------------------------------------------------------------------------------------------- Commitments to extend credit(1) $32,760 $14,623 $7,127 $6,757 $4,253 Partnership interests 446 170 107 56 113 Other commitments 7,588 6,642 745 69 132 Operating leases 3,872 525 989 840 1,518 Resale agreements 11,688 10,557 627 127 377 Repurchase agreements 6,295 6,295 - - - ------- ------- ------ ------ ------ Total $62,649 $38,812 $9,595 $7,849 $6,393 - ----------------------------------------------------------------------------------------------------------------- (1) See Note 6 to the Condensed Consolidated Financial Statements and Note 14 in the 2002 Annual Report for additional details.
Other Commitments Merrill Lynch also obtains commercial letters of credit from issuing banks to satisfy various counterparty collateral requirements in lieu of depositing cash or securities collateral. Commercial letters of credit aggregated $474 million and $434 million at September 26, 2003 and December 27, 2002, respectively. Merrill Lynch has entered into agreements with providers of market data, communications, and systems consulting services. Minimum fee commitments over the remaining life of these agreements aggregated $456 million and $527 million at September 26, 2003 and December 27, 2002, respectively. Merrill Lynch has entered into purchasing and other commitments totaling $7.0 billion and $1.4 billion at September 26, 2003 and December 27, 2002, respectively. Leases Merrill Lynch has entered into various noncancellable long-term lease agreements for premises that expire through 2024. Merrill Lynch has also entered into various noncancellable short-term lease agreements, which are primarily commitments of less than one year under equipment leases. In 1999 and 2000, Merrill Lynch established two SPEs to finance its Hopewell, New Jersey campus and an aircraft. Merrill Lynch leased the facilities and the aircraft from the SPEs. The total amount of funds raised by the SPEs to finance these transactions was $383 million. These SPEs were not consolidated by Merrill Lynch pursuant to accounting guidance, which was then in effect. In the second quarter of 2003, the facilities and aircraft owned by these SPEs were acquired by a newly created limited partnership, which is unaffiliated with Merrill Lynch. The limited partnership acquired the assets subject to the leases with Merrill Lynch as well as the existing indebtedness incurred by the original SPEs. The proceeds from the sale of the assets to the limited partnership, net of the debt assumed by the limited partnership, were used to repay the equity investors in the original SPEs. After the transaction was completed, the original SPEs were dissolved. The limited partnership has also entered into leases with third parties unrelated to Merrill Lynch. 21 The leases with the limited partnership mature in 2005 and 2006, and each lease has a renewal term to 2008. In addition, Merrill Lynch has entered into guarantees with the limited partnership, whereby if Merrill Lynch does not renew the lease or purchase the assets under its lease at the end of either the initial or the renewal lease term, the underlying assets will be sold to a third party, and Merrill Lynch has guaranteed that the proceeds of such sale will amount to at least 84% of the acquisition cost of the assets. The maximum exposure to Merrill Lynch as a result of this residual value guarantee is approximately $325 million as of September 26, 2003. As of September 26, 2003, the carrying value of the liability on the Condensed Consolidated Financial Statements is $36 million. Merrill Lynch's residual value guarantee does not comprise more than half of the limited partnership's assets. Merrill Lynch had entered into a similar residual value guarantee with the previous SPEs; the maximum exposure under the previous guarantee was approximately $325 million as of December 27, 2002. The limited partnership does not meet the definition of a variable interest entity as defined in FIN 46. Merrill Lynch does not have a partnership or other interest in the limited partnership. Accordingly, Merrill Lynch is not required to consolidate the limited partnership in its financial statements. The leases with the limited partnership are accounted for as operating leases. Guarantees Merrill Lynch issues various guarantees to counterparties in connection with certain leasing, securitization and other transactions. In addition, Merrill Lynch enters into certain derivative contracts that meet the accounting definition of a guarantee under FIN 45. FIN 45 defines guarantees to include derivative contracts that contingently require a guarantor to make payment to a guaranteed party based on changes in an underlying (such as changes in the value of interest rates, security prices, currency rates, commodity prices, indices, etc.) that relate to an asset, liability or equity security of a guaranteed party. Derivatives that meet the FIN 45 definition of guarantees include certain written options and credit default swaps (contracts that require Merrill Lynch to pay the counterparty the par value of a referenced security if that referenced security defaults). Merrill Lynch does not track, for accounting purposes, whether its clients enter into these derivative contracts for speculative or hedging purposes. Accordingly, Merrill Lynch has disclosed information about all credit default swaps and certain types of written options that can potentially be used by clients to protect against changes in an underlying, regardless of how the contracts are used by the client. For certain derivative contracts such as written interest rate caps and written currency options, the maximum payout is not quantifiable, because, for example, the rise in interest rates or changes in foreign exchange rates could theoretically be unlimited. In addition, Merrill Lynch does not monitor its exposure to derivatives in this manner. As such, rather than including the maximum payout, the notional value of these contracts has been included to provide information about the magnitude of involvement with these types of contracts. However, it should be noted that the notional value overstates Merrill Lynch's exposure to these contracts. 22 Merrill Lynch records all derivative transactions at fair value on its Condensed Consolidated Balance Sheets. As previously noted, Merrill Lynch does not monitor its exposure to derivative contracts in terms of maximum payout. Instead, a risk framework is used to define risk tolerances and establish limits to ensure that certain risk-related losses occur within acceptable, predefined limits. Merrill Lynch economically hedges its exposure to these contracts by entering into a variety of offsetting derivative contracts and security positions. See the Derivatives section of Note 1 in the 2002 Annual Report for further discussion of risk management of derivatives. Merrill Lynch also provides guarantees to SPEs in the form of liquidity facilities, credit default protection and residual value guarantees for equipment leasing entities. The liquidity facilities and credit default protection relate primarily to municipal bond securitization SPEs. Merrill Lynch acts as liquidity provider to municipal bond securitization SPEs. Specifically, the holders of beneficial interests issued by these SPEs have the right to tender their interests for purchase by Merrill Lynch on specified dates at a specified price. If the beneficial interests are not successfully remarketed, the holders of beneficial interests are paid from funds drawn under a standby facility issued by Merrill Lynch (or by third party financial institutions where Merrill Lynch has agreed to reimburse the financial institution if a draw occurs). If the standby facility is drawn, Merrill Lynch may claim the underlying assets held by the SPEs. In general, standby facilities that are not coupled with default protection are not exercisable in the event of a downgrade below investment grade or default of the assets held by the SPEs. In addition, the value of the assets held by the SPE plus any additional collateral pledged to Merrill Lynch exceeds the amount of beneficial interests issued, which provides additional support to Merrill Lynch in the event that the standby facility is drawn. The assets to which Merrill Lynch has recourse are on a deal-by-deal basis and are not part of a cross collateralized pool. As of September 26, 2003, the value of the municipal bond assets to which Merrill Lynch has recourse in the event of a draw was $19.8 billion and the maximum payout if the standby facilities are drawn was $14.6 billion. In certain instances, Merrill Lynch also provides default protection in addition to liquidity facilities. Specifically, in the event that an issuer of a municipal bond held by the SPE defaults on any payment of principal and/or interest when due, the payments on the bonds will be made to beneficial interest holders from an irrevocable guarantee by Merrill Lynch (or by third party financial institutions where Merrill Lynch has agreed to reimburse the financial institution if losses occur). If the default protection is drawn, Merrill Lynch may claim the underlying assets held by the SPEs. As of September 26, 2003, the value of the assets to which Merrill Lynch has recourse in the event that an issuer of a municipal bond held by the SPE defaults on any payment of principal and/or interest when due, was $3.5 billion; the maximum payout if an issuer defaults was $2.8 billion. As described in the preceding paragraph, the assets to which Merrill Lynch has recourse are not part of a cross collateralized pool. Further, to protect against declines in the value of the assets held by SPEs for which Merrill Lynch provides either liquidity facilities or default protection, Merrill Lynch economically hedges its exposure though derivative positions that principally offset the risk of loss arising from these guarantees. Merrill Lynch also provides residual value guarantees to leasing SPEs where either Merrill Lynch or a third party is the lessee. For transactions where Merrill Lynch is not the lessee, the guarantee provides loss coverage for any shortfalls in the proceeds from assets sales beyond 75 - 90% of the current book value of the asset to which the guarantee pertains. As of September 26, 2003, the value of the assets for which Merrill Lynch provides residual value guarantees and is not the lessee was $553 million. Where Merrill Lynch is the lessee, it provides a guarantee that any proceeds from the sale of the assets will amount to at least 84% of the acquisition cost of the assets. 23 Merrill Lynch also enters into reimbursement agreements in conjunction with sales of loans originated under its Mortgage 100SM program. Under this program, borrowers can pledge marketable securities in lieu of making a cash down payment. Upon sale of these mortgage loans, purchasers may require a surety bond that reimburses for certain shortfalls in the borrowers' securities accounts. Merrill Lynch provides this reimbursement through a financial intermediary. Merrill Lynch requires borrowers to meet daily collateral calls to ensure that the securities pledged as down payment are sufficient at all times. Merrill Lynch believes that its potential for loss under these arrangements is remote. Accordingly, no liability is recorded in the Condensed Consolidated Financial Statements. In addition, Merrill Lynch makes guarantees to counterparties in the form of standby letters of credit. Merrill Lynch holds marketable securities of $241 million as collateral to secure these guarantees. In addition, standby letters of credit include $68 million of financial guarantees for which Merrill Lynch has recourse to the guaranteed party upon draw down. Further, in conjunction with certain principal protected mutual funds and managed futures funds, Merrill Lynch guarantees the return of the initial principal investment at the termination date of the fund. These funds are generally managed based on a formula that requires the fund to hold a combination of general investments and either highly liquid risk-free assets or in-the-money put options purchased from AAA credit rated counterparties that when combined will result in the return of principal at the maturity date unless there is a significant market event. Merrill Lynch's maximum potential exposure to loss with respect to these guarantees is $723 million assuming that the funds are invested exclusively in other investments (i.e., the funds hold no risk-free assets or all of the put option counterparties default), and that those other investments suffer a total loss. As such, this measure significantly overstates Merrill Lynch's exposure or expected loss at September 26, 2003. The carrying value for these guarantees at September 26, 2003 was $19 million, which includes a reserve for probable and estimable losses of $10 million and a $9 million liability recorded pursuant to FIN 45 for a newly created fund. These guarantees and their expiration are summarized at September 26, 2003 as follows:
(dollars in millions) - -------------------------------------------------------------------------------------------------------------------- Maximum Payout/ Less than 1 - 3 3+ - 5 Over 5 Carrying Notional 1 year years years years Value - -------------------------------------------------------------------------------------------------------------------- Derivative contracts(1) $ 894,501 $321,374 $243,315 $192,361 $137,451 $19,788 Liquidity facilities with SPEs(2) 14,640 12,762 1,878 - - 8 Liquidity and default facilities with SPEs 2,867 2,060 503 1 303 2 Residual value guarantees(3)(4) 1,767 64 58 357 1,288 36 Standby letters of credit and other performance guarantees(5) 1,205 471 121 341 272 20 - -------------------------------------------------------------------------------------------------------------------- (1) As noted above, the notional value of derivative contracts is provided rather than the maximum payout amount, although the notional value should not be considered as a substitute for maximum payout. (2) Amounts relate primarily to facilities provided to municipal bond securitization SPEs. Includes $3.1 billion of guarantees provided to SPEs by third party financial institutions where Merrill Lynch has agreed to reimburse the financial institution if losses occur, and has up to one year to fund losses. (3) Includes residual value guarantees associated with the Hopewell campus and aircraft leases of $325 million. (4) Includes $843 million of reimbursement agreements with the Mortgage 100SM program. (5) Marketable securities are posted as collateral.
See Note 14 in the 2002 Annual Report for additional information on guarantees. 24 - -------------------------------------------------------------------------------- NOTE 11. EMPLOYEE INCENTIVE PLANS - -------------------------------------------------------------------------------- Stock-Based Compensation Merrill Lynch accounts for stock-based compensation in accordance with the intrinsic value-based method in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, rather than the fair value-based method in SFAS No. 123, Accounting for Stock-Based Compensation. Refer to Note 1 in the 2002 Annual Report for accounting policy. Merrill Lynch changed the vesting period for stock options from six months, for 2002 grants, to four years, for 2003 grants. For the nine-month periods ended September 26, 2003 and September 27, 2002, $581 million ($360 million after-tax) and $602 million ($373 million after-tax), respectively, of pre-tax compensation expense related to employee stock compensation awards was recorded in earnings. Compensation expense for stock options is not recognized since Merrill Lynch grants stock options that have no intrinsic value. Had Merrill Lynch adopted the provisions of SFAS No. 123 and accounted for all employee stock awards at fair value, Merrill Lynch would have recognized additional pre-tax compensation expense related to employee stock awards of $192 million ($119 million after-tax) and $1,170 million ($726 million after-tax), respectively, for the nine-month periods ended September 26, 2003 and September 27, 2002, respectively. This decrease reflects the change in vesting period. Pro forma net earnings and earnings per share are as follows:
(dollars in millions, except per share amounts) - ---------------------------------------------------------------------------------------------------------------------- Three Months Ended Nine Months Ended - ---------------------------------------------------------------------------------------------------------------------- Sept. 26, 2003 Sept. 27, 2002 Sept. 26, 2003 Sept. 27, 2002 -------------- -------------- -------------- -------------- Net Earnings, as reported $1,039 $693 $2,745 $1,974 Less: stock-based compensation determined under Black-Scholes method, net of taxes (42) (132) (119) (726) ------ ----- ------ ------ Pro forma net earnings $ 997 $ 561 $2,626 $1,248 ------ ----- ------ ------ Earnings per share As reported: Basic $ 1.14 $0.79 $ 3.03 $ 2.26 Diluted 1.04 0.73 2.81 2.07 Pro forma: Basic 1.09 0.64 2.90 1.42 Diluted 1.00 0.58 2.69 1.29 - ----------------------------------------------------------------------------------------------------------------------
25 - -------------------------------------------------------------------------------- NOTE 12. REGULATORY REQUIREMENTS - -------------------------------------------------------------------------------- Certain U.S. and non-U.S. subsidiaries are subject to various securities and banking regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. Merrill Lynch's principal regulated subsidiaries are discussed below. Securities Regulation Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S. registered broker-dealer and futures commission merchant, is subject to the net capital requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 and the capital requirements of the Commodities Futures Trading Commission ("CFTC"). Under the alternative method permitted by Rule 15c3-1, the minimum required net capital, as defined, shall not be less than 2% of aggregate debit items ("ADI") arising from customer transactions. The CFTC also requires that minimum net capital should not be less than 4% of segregated and secured requirements. At September 26, 2003, MLPF&S's regulatory net capital of $3,859 million was approximately 27.4% of ADI, and its regulatory net capital in excess of the minimum required was $3,577 million at 2% of ADI. Merrill Lynch International ("MLI"), a U.K. regulated investment firm, is subject to capital requirements of the Financial Services Authority ("FSA"). Financial resources, as defined, must exceed the total financial resources requirement of the FSA. At September 26, 2003, MLI's financial resources were $5,657 million, exceeding the minimum requirement by $1,230 million. Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S. Government securities, is subject to the capital adequacy requirements of the Government Securities Act of 1986. This rule requires dealers to maintain liquid capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At September 26, 2003, MLGSI's liquid capital of $2,755 million was 258% of its total market and credit risk, and liquid capital in excess of the minimum required was $1,473 million. Banking Regulation Two of the subsidiaries of ML & Co., Merrill Lynch Bank USA ("MLBUSA") and Merrill Lynch Bank & Trust Co. ("MLB&T"), are each subject to certain minimum aggregate capital requirements under applicable federal banking laws. Among other things, Part 325 of the FDIC Regulations establishes levels of Risk-Based Capital ("RBC") each institution must maintain and identifies the possible actions the federal supervisory agency may take if a bank does not maintain certain capital levels. RBC is defined as the ratios of (i) Tier I Capital or Total Capital to (ii) average assets or risk-weighted assets. The following table presents the actual capital ratios and amounts for MLBUSA and MLB&T at September 26, 2003 and December 27, 2002. As shown below, MLBUSA and MLB&T each exceed the minimum bank regulatory requirement for classification as a well-capitalized bank for Tier I leverage -- 5%, Tier I capital -- 6% and Total capital -- 10%:
(dollars in millions) - --------------------------------------------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - --------------------------------------------------------------------------------------------------------------------- Actual Ratio Amount Actual Ratio Amount ------------ ------ ------------ ------ Tier I leverage (to average assets) MLBUSA 6.22% $4,488 5.35% $3,740 MLB&T 5.50 882 5.42 848 Tier I capital (to risk-weighted assets) MLBUSA 12.08 4,488 11.48 3,740 MLB&T 20.05 882 20.53 848 Total capital (to risk-weighted assets) MLBUSA 12.63 4,692 12.04 3,924 MLB&T 20.10 884 20.54 848 - ---------------------------------------------------------------------------------------------------------------------
26 INDEPENDENT ACCOUNTANTS' REPORT To the Board of Directors and Stockholders of Merrill Lynch & Co., Inc.: We have reviewed the accompanying condensed consolidated balance sheet of Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of September 26, 2003, and the related condensed consolidated statements of earnings for the three-month and nine-month periods ended September 26, 2003 and September 27, 2002, and the condensed consolidated statements of cash flows for the nine-month periods ended September 26, 2003 and September 27, 2002. These financial statements are the responsibility of Merrill Lynch's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Merrill Lynch as of December 27, 2002, and the related consolidated statements of earnings, changes in stockholders' equity, comprehensive income and cash flows for the year then ended (not presented herein); and in our report dated February 24, 2003, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph for the change in accounting method for goodwill amortization to conform to Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 27, 2002 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ Deloitte & Touche LLP New York, New York November 5, 2003 27 - -------------------------------------------------------------------------------- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Merrill Lynch & Co., Inc. ("ML&Co." and, together with its subsidiaries, "Merrill Lynch") is a holding company that, through its subsidiaries, provides broker-dealer, investment banking, financing, advisory, wealth management, asset management, insurance, lending, and related products and services on a global basis. In addition, Merrill Lynch makes principal investments for market making on behalf of its clients and for its own account. The financial services industry, in which Merrill Lynch is a leading participant, is highly competitive and highly regulated. This industry and the global financial markets are influenced by numerous unpredictable factors. These factors include economic conditions, monetary and fiscal policies, the liquidity of global markets, international and regional political events, acts of war or terrorism, changes in applicable laws and regulations, the competitive environment, and investor sentiment. In addition to these factors, Merrill Lynch and other financial services companies may be affected by the regulatory and legislative initiatives which may affect the conduct of its business, including increased regulation, and by the outcome of legal and regulatory proceedings. These conditions or events can significantly affect the volatility of the financial markets as well as the volumes and revenues in businesses such as brokerage, trading, investment banking, wealth management and asset management. Revenues and net earnings may vary significantly from period to period due to these unpredictable factors and the resulting market volatility and trading volumes. The financial services industry continues to be affected by an intensifying competitive environment, as demonstrated by consolidation through mergers, competition from new and established competitors using the internet or other technology to provide financial services and diminishing margins in many mature products and services. Commercial and investment bank consolidations, which were made possible by the enactment of the Gramm-Leach-Bliley Act, have also increased the competition for investment banking business in part through the extension of credit in conjunction with investment banking and capital raising activities. In 2002, the U.S. Congress passed the Sarbanes-Oxley Act of 2002, which is a broad overhaul of existing corporate and securities laws. In addition, various Federal and state securities regulators, self-regulatory organizations (including the New York Stock Exchange) and industry participants reviewed and in many cases adopted sweeping changes to their established rules including rules in the areas of corporate governance, research analyst conflicts of interest and auditor independence. Changes pertaining to the role of research analysts in connection with investment banking and capital raising activities are affecting how financial services companies interact with their clients and may affect the cost structure for such activities. Outside the United States, there is continued focus by regulators and legislators on regulatory supervision of both banks and investment firms on a consolidated and individual basis, especially in the areas of capital and risk management. 28 Certain statements contained in this Report may be considered forward-looking, including statements about management expectations, strategic objectives, business prospects, anticipated expense savings and financial results, anticipated results of litigation and regulatory proceedings, and other similar matters. These forward-looking statements are not statements of historical fact and represent only Management's beliefs regarding future events, which are inherently uncertain. There are a variety of factors, many of which are beyond Merrill Lynch's control, which affect its operations, performance, business strategy and results and could cause its actual results and experience to differ materially from the expectations and objectives expressed in any forward-looking statements. These factors include, but are not limited to, the factors listed in the previous two paragraphs, as well as actions and initiatives taken by both current and potential competitors, the effect of current, pending and future legislation and regulation, and the other risks and uncertainties detailed in Merrill Lynch's Form 10-K and in the following sections. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the dates on which they are made. Merrill Lynch does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the dates the forward-looking statements are made. The reader should, however, consult any further disclosures Merrill Lynch may make in its Annual Reports on Form 10-K, its Quarterly Reports on Form 10-Q and its Current Reports on Form 8-K. - -------------------------------------------------------------------------------- BUSINESS ENVIRONMENT - -------------------------------------------------------------------------------- Global financial markets continued to improve during the third quarter 2003. Global equity markets recorded improved results during the quarter. The improvement in the economy and the sharp rise in equity markets have encouraged investors to realign their investments from bonds to stocks. In a volatile quarter, long-term U.S. interest rates, as measured by the yield on the 10-year U.S.Treasury bond, reached a 14-month peak in mid-August at 4.6% and ended the quarter at 3.93%, up from 3.51% at the end of the second quarter of 2003. The U.S. Federal Reserve Bank kept the federal funds rate unchanged during the quarter at 1.00%. Despite continued worries about the falling dollar, rising oil prices and the still-uncertain prospects for the economy and corporate earnings, all major U.S. indexes were up slightly this quarter. Although the Dow Jones Industrial Average increased by only 3.2% in the third quarter, it rose 22.2% from the end of the third quarter of 2002 and 11% during 2003. The NASDAQ Composite Index, dominated by large-cap technology stocks, fared better with gains of 10.1% during the quarter, and 52.5% from the 2002 third quarter. The Standard & Poor's 500 stock index rose 2.2% in the third quarter, and was up 22.2% from the year-ago quarter. Global equity markets rose sharply for the second consecutive quarter. The Dow Jones World Index, excluding the United States, increased 8.9% in the third quarter of 2003 and 26.5% from the third quarter of 2002. In Europe, the dollar's renewed decline against the euro and weak growth prospects affected all major markets, as reflected by the modest 1.9% gain of the Dow Jones Stoxx 600 index of European blue chips. In Japan, with an annualized growth rate of 3.9% during the second quarter, the Nikkei 225 Stock Average Index reached a 15-month high during the month of September and ended the quarter with an overall gain of 12.5%. In Hong Kong, the Hang Seng Index increased 17.3% for the quarter. From Asia to Latin America, global emerging markets posted strong results during the quarter. 29 Global debt and equity underwriting increased 29% in the third quarter of 2003 from the comparable period of 2002, according to Thomson Financial Securities Data. In a marked shift from last year, stock underwriting started to rebound. Proceeds from global equity and equity-related issues nearly doubled in the third quarter 2003 to $101.7 billion compared to $51.7 billion in the year-ago period. The increased stock issuances helped raise total underwriting fees by 22% compared to the 2002 third quarter. The IPO business improved substantially with 21 IPOs in the third quarter 2003 compared to 10 IPOs in the year-ago quarter, according to Thomson Financial Securities Data. Despite a strong start in early July, mergers and acquisition activity lost momentum by the end of the third quarter, with a noticeable slowdown outside the United States. According to Thomson Financial Securities Data, the value of global announced deals in the third quarter of 2003 was $278 billion, down 6% from $296 billion in the comparable period of 2002. In the United States, although activity improved on a sequential quarter basis, the value of announced deals in the 2003 third quarter was down 16% from the year-ago level. Merrill Lynch continually evaluates its businesses for profitability and performance under varying market conditions and, in light of the evolving conditions in its competitive environment, for alignment with its long-term strategic objectives. The strategy of maintaining long-term client relationships, closely monitoring costs and risks, diversifying revenue sources, and growing fee-based revenues all continue as objectives to mitigate the effects of a volatile market environment on Merrill Lynch's business as a whole. 30 - -------------------------------------------------------------------------------- RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------- For the Three Months Ended For the Nine Months Ended ---------------------------- ---------------------------- Sept. 26, Sept. 27, Sept. 26, Sept. 27, (dollars in millions, except per share amounts) 2003 2002 2003 2002 -------- -------- -------- -------- Net Revenues Asset management and portfolio service fees $ 1,184 $ 1,217 $ 3,465 $ 3,808 Commissions 1,120 1,125 3,233 3,579 Principal transactions 705 377 2,815 1,982 Investment banking Underwriting 545 329 1,478 1,296 Strategic advisory 133 163 391 540 Other 300 165 776 603 -------- -------- -------- -------- Subtotal 3,987 3,376 12,158 11,808 Interest and dividend revenues 2,873 3,484 8,922 9,966 Less interest expense 1,794 2,498 5,841 7,371 -------- -------- -------- -------- Net interest profit 1,079 986 3,081 2,595 -------- -------- -------- -------- Total Net Revenues 5,066 4,362 15,239 14,403 -------- -------- -------- -------- Non-interest expenses: Compensation and benefits 2,393 2,228 7,567 7,443 Communications and technology 352 421 1,112 1,307 Occupancy and related depreciation 226 218 663 684 Brokerage, clearing, and exchange fees 188 182 527 552 Advertising and market development 89 125 323 426 Professional fees 146 135 430 397 Office supplies and postage 46 62 154 196 Other 138 130 548 466 Net recoveries related to September 11 (21) (191) (82) (191) Restructuring-related credit - (2) - (2) Research-related expenses - - - 111 -------- -------- -------- -------- Total non-interest expenses 3,557 3,308 11,242 11,389 -------- -------- -------- -------- Earnings before income taxes and dividends on preferred securities issued by subsidiaries $ 1,509 $ 1,054 $ 3,997 $ 3,014 ======== ======== ======== ======== Net earnings $ 1,039 $ 693 $ 2,745 $ 1,974 ======== ======== ======== ======== Earnings per common share: Basic $ 1.14 $ 0.79 $ 3.03 $ 2.26 Diluted 1.04 0.73 2.81 2.07 Annualized return on average common stockholders' equity 16.5 % 12.7 % 15.2 % 12.5 % Pre-tax profit margin 29.8 24.2 26.2 20.9 - -------------------------------------------------------------------------------------------------------------------------
31 Quarterly Results of Operations Merrill Lynch's net earnings were $1.039 billion for the 2003 third quarter, 50% higher than the $693 million reported in the third quarter of 2002. Earnings per common share were $1.14 basic and $1.04 diluted, compared with $0.79 basic and $0.73 diluted in the 2002 third quarter. The third quarter pre-tax margin rose to 29.8%, up from 24.2% in the prior-year quarter. Third quarter 2003 net earnings include $13 million, $0.01 per diluted share, ($21 million pre-tax) attributable to a September 11-related net insurance recovery. Third quarter 2002 net earnings included $115 million, $0.12 per diluted share ($193 million pre-tax) related primarily to September 11-related net recoveries. Net revenues were $5.1 billion in the third quarter of 2003, 16% higher than the 2002 third quarter. Asset management and portfolio service fees were $1.2 billion, down 3% from the third quarter of 2002 largely as a result of a reduction in portfolio servicing fees, a large portion of which are calculated on beginning-of-period asset values. Commission revenues were $1.1 billion, essentially unchanged from the 2002 third quarter. Principal transactions revenues increased 87% from the third quarter of 2002 to $705 million, due principally to increased debt and equity markets trading revenues. Underwriting revenues were $545 million, 66% higher than the 2002 third quarter, reflecting higher levels of equity underwriting revenues, which are reflected in GMI underwriting revenues and GPC principal transactions and new issue revenues. Strategic advisory revenues declined 18% to $133 million from the 2002 third quarter due to reduced market activity levels and lower market share. Other revenues were $300 million, 82% higher than the 2002 third quarter due to increased revenues from investments and sales of mortgages. Net interest profit was $1.1 billion, up 9% from the 2002 third quarter due primarily to a more favorable yield curve environment. Compensation and benefits expenses were 47.2% of net revenues for the third quarter of 2003, compared to 51.1% in the year-ago quarter. Compensation and benefits expenses of $2.4 billion in the third quarter of 2003 increased 7% from the 2002 third quarter due primarily to higher incentive compensation accruals reflecting increased net revenues. Non-compensation expenses were $1.2 billion in the third quarter of 2003, an increase of 8% from the 2002 third quarter (a decline of 7% excluding September 11-related net recoveries and the restructuring-related credit in the third quarter of 2002). Communications and technology costs were $352 million, down 16% from the third quarter of 2002 due primarily to reduced communications costs and lower technology equipment depreciation and rental costs. Occupancy and related depreciation expense was up 4% in the 2003 third quarter compared to the year ago period. As a result of eliminating certain excess capacity, these expenses are expected to increase in the fourth quarter of 2003. Advertising and market development expenses were $89 million, down 29% from the third quarter of 2002 due primarily to lower advertising and sales promotion expenses. Office supplies and postage expenses were $46 million in the 2003 third quarter, a 26% decrease from the year-ago quarter, due to efficiency initiatives. The September 11-related net recovery in the third quarter of 2003 includes a partial pre-tax insurance reimbursement of $25 million, offset by September 11-related costs of $4 million. The insurance reimbursement represents a partial business interruption settlement for GMI and is recorded as a reduction of expenses in that segment. The costs were recorded in the Corporate segment. Third quarter 2002 net earnings includes $191 million of September 11-related net recoveries. The net recoveries include partial business interruption settlements for GMI and GPC of $50 million and $25 million, respectively, which were recorded as a reduction of non-interest expenses. The Corporate segment includes $116 million of net insurance recoveries for a portion of the replacement and recovery costs. 32 Year-to-date Results of Operations For the first nine months of 2003, net earnings were $2.7 billion, up 39% from $2.0 billion for the corresponding period in 2002, as net revenues increased 6%, to $15.2 billion. Compensation and benefits expenses for the first nine months of 2003 increased 2% from the year-ago period, to $7.6 billion as higher earnings-related compensation was partially offset by lower staffing levels. Non-compensation expenses totaled $3.7 billion for the first nine months of 2003, a decline of 7% from the year-ago period. This decrease reflects the results of the 2001 restructuring program and continued operating discipline in managing costs. Year-to-date earnings per common share were $3.03 basic and $2.81 diluted, compared with $2.26 basic and $2.07 diluted in the first nine months of 2002. The pre-tax profit margin for the first nine months of 2003 was 26.2%, up from 20.9% in the year-ago period. Annualized return on average common stockholder's equity was 15.2% for the first nine months of 2003 compared to 12.5% for the comparable period in 2002. Year-to-date 2003 net earnings include $49 million, $0.05 per diluted share, ($82 million pre-tax) attributable to September 11-related net insurance recoveries. Year-to-date 2002 net earnings included $114 million, ($191 million pre-tax) of September 11-related net recoveries, $78 million ($111 million pre-tax) of research-related expenses and a $1 million ($2 million pre-tax) restructuring-related credit. The net result of these items increased diluted earnings per share by $.04 for the first nine months of 2002. The 2002 year-to-date pre-tax profit margin was 20.4% excluding these items. Merrill Lynch's year-to-date effective tax rate was 27.7%. The full year 2002 effective tax rate was 28.0%. - -------------------------------------------------------------------------------- BUSINESS SEGMENTS - -------------------------------------------------------------------------------- Merrill Lynch reports its results in three business segments: the Global Markets and Investment Banking Group ("GMI"), Global Private Client ("GPC"), and Merrill Lynch Investment Managers ("MLIM"). GMI provides capital markets and investment banking services to corporate, institutional, and governmental clients around the world. GPC provides global wealth management products and services to individuals, small- to mid-size businesses, and employee benefit plans. MLIM provides asset management services to individual, institutional and corporate clients. Certain MLIM and GMI products are distributed through GPC distribution channels, and, to a lesser extent, certain MLIM products are distributed through GMI. Revenues and expenses associated with these inter-segment activities are recognized in each segment and eliminated at the corporate level. In addition, revenue and expense sharing agreements for shared activities between segments are in place and the results of each segment reflect the agreed-upon portion of these activities. The following segment results represent the information that is relied upon by management in its decision-making processes. These results exclude items reported in the Corporate segment. Business segment results are restated to reflect reallocations of revenues and expenses, which result from changes in Merrill Lynch's business strategy and structure. 33 - -------------------------------------------------------------------------------- GLOBAL MARKETS AND INVESTMENT BANKING - --------------------------------------------------------------------------------
GMI's Results of Operations - ----------------------------------------------------------------------------------------------------------- For the Three Months Ended For the Nine Months Ended ------------------------------------------------------------------------ Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, % Inc. (dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.) - ----------------------------------------------------------------------------------------------------------- Commissions $ 469 $ 515 (9) $ 1,456 $ 1,587 (8) Principal transactions and net interest profit 1,286 856 50 4,369 2,908 50 Investment banking 555 428 30 1,517 1,643 (8) Other revenues 176 123 43 492 480 3 -------- -------- -------- -------- Total net revenues 2,486 1,922 29 7,834 6,618 18 -------- -------- -------- -------- Non-interest expenses 1,464 1,378 6 4,906 4,786 3 -------- -------- -------- -------- Pre-tax earnings $ 1,022 $ 544 88 $ 2,928 $ 1,832 60 -------- -------- -------- -------- Pre-tax profit margin 41.1 % 28.3 % 37.4 % 27.7 % - -----------------------------------------------------------------------------------------------------------
GMI achieved a strong year-over-year growth in net revenues and pre-tax earnings and set a record pre-tax profit margin for the second consecutive quarter. In debt markets, GMI experienced strong growth in credit products, principal investments and foreign exchange, as well as solid results in interest rate trading. Net revenues in GMI's equity business improved across all components of equity trading, origination and financing activities. Geographically, the Pacific Rim debt business and the European and Pacific Rim equity businesses contributed strongly to the year-over-year revenue increase. GMI net revenues were $2.5 billion in the 2003 third quarter, an increase of 29% from the year-ago quarter. Pre-tax earnings increased 88% from the third quarter of 2002, to $1.0 billion. GMI's 2003 and 2002 third quarter results included September 11-related partial pre-tax insurance reimbursements, which were recorded as reductions of non-interest expenses, of $25 million and $50 million, respectively. GMI's pre-tax profit margin was 41.1%, up from 28.3% in the third quarter of 2002. Excluding the insurance recoveries, GMI's pre-tax profit margins were 40.1% and 25.7% in the 2003 and 2002 third quarter, respectively. Total non-interest expenses were $1.5 billion during the 2003 third quarter, up from $1.4 billion in the year-ago period, due primarily to higher incentive compensation accruals associated with increased net revenues. For the first nine months of 2003, GMI pre-tax earnings were $2.9 billion, up 60% from the prior year period, on net revenues that rose 18%, to $7.8 billion. The year-to-date pre-tax profit margin increased to 37.4%, compared with 27.7% in the same period last year. Excluding the $100 million of insurance recoveries, GMI's year-to-date 2003 pre-tax earnings were $2.8 billion and the pre-tax profit margin was 36.1%. Year-to-date 2002 pre-tax earnings and pre-tax profit margin, excluding the $50 million of insurance recoveries, were $1.8 billion and 26.9%, respectively. Client Facilitation and Trading Commissions Commission revenues primarily arise from agency transactions in listed and over-the-counter equity securities, money market instruments and options. Commission revenues in the third quarter of 2003 decreased 9% compared to the year-ago quarter, to $469 million, primarily as a result of a global decline in equity trading volumes. Year-to-date commissions revenues decreased 8% compared to the first nine months of 2002, to $1.5 billion. 34
Principal transactions and net interest profit - ------------------------------------------------------------------------------------------------------------------ For the Three Months Ended For the Nine Months Ended ---------------------------------- --------------------------------- Sept. 26, Sept. 27, Sept. 26, Sept. 27, (dollars in millions) 2003 2002 % Inc. 2003 2002 % Inc. - ------------------------------------------------------------------------------------------------------------------ Debt and debt derivatives $ 981 $ 771 27 $ 3,585 $ 2,317 55 Equities and equity derivatives 305 85 259 784 591 33 -------- ----- ------- ------- Total $ 1,286 $ 856 50 $ 4,369 $ 2,908 50 - ------------------------------------------------------------------------------------------------------------------
Principal transactions revenues include realized gains and losses from the purchase and sale of securities in which Merrill Lynch acts as principal, and unrealized gains and losses on trading assets and liabilities. In addition, principal transactions revenues include unrealized gains related to equity investments held by Merrill Lynch's broker-dealers. Net interest profit is a function of the level and mix of total assets and liabilities, including trading assets owned, the investment portfolio of Merrill Lynch's U.S. banks, financing and lending transactions, trading strategies associated with GMI's institutional securities business, and the prevailing level, term structure, and volatility of interest rates. Net interest profit is an integral component of trading activity. In assessing the profitability of its client facilitation and trading activities, Merrill Lynch views principal transactions and net interest profit in the aggregate as net trading revenues. Changes in the composition of trading inventories and hedge positions can cause the mix of principal transactions and net interest profit to fluctuate. Net trading revenues were $1.3 billion in the third quarter of 2003, up 50% from $856 million in the third quarter of 2002. Debt and debt derivatives net trading revenues were $981 million, up 27% from the third quarter of 2002, reflecting increased trading of interest rate and credit products due to a favorable yield curve environment and proprietary positioning. Equities and equity derivatives net trading revenues increased 259% from the third quarter of 2002 to $305 million, due to higher equity trading revenues resulting from the improvement in equity market conditions. Principal transactions revenues for the third quarter of 2003 includes $71 million of net revenue related to a privately-held equity investment held by a Merrill Lynch broker-dealer which has been adjusted to fair market value by utilizing a discounted cash flow method. On a year-to-date basis, net trading revenues increased 50% from the first nine months of 2002, to $4.4 billion, consisting of increases of 55% in debt and debt derivatives revenues and 33% in equities and equity derivatives revenues. Investment Banking
- --------------------------------------------------------------------------------------------------------------- For the Three Months Ended For the Nine Months Ended -------------------------- -------------------------- Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, %Inc. (dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.) - --------------------------------------------------------------------------------------------------------------- Debt underwriting $ 190 $ 168 13 $ 595 $ 462 29 Equity underwriting 232 97 139 531 641 (17) ----- ----- ------ ------ Total underwriting 422 265 59 1,126 1,103 2 Strategic advisory services 133 163 (18) 391 540 (28) ----- ----- ------- ------ Total $ 555 $ 428 30 $ 1,517 $1,643 (8) - ---------------------------------------------------------------------------------------------------------------
35 Underwriting ------------ Underwriting revenues represent fees earned from the underwriting of debt and equity and equity-linked securities as well as loan syndication and commitment fees. Underwriting revenues in the 2003 third quarter were $422 million, up 59% from the $265 million recorded in the third quarter of 2002, due principally to increased equity underwriting revenues resulting from a higher volume of transactions. Merrill Lynch ranked fourth in global debt and sixth in global equity and equity-linked underwriting in the third quarter of 2003 with a 8.0% and 7.5% market share, respectively. Merrill Lynch's debt underwriting focus has shifted toward higher margin businesses and away from the achievement of aggregate market share goals; however, debt transactions are highly competitive and not all transactions are profitable. Year-to-date underwriting revenues were $1.1 billion, up 2% from the first nine months of 2002, as a 29% increase in debt underwriting revenues was substantially offset by a 17% decrease in equity underwriting revenues. Merrill Lynch's underwriting market share information based on transaction value follows:
- ---------------------------------------------------------------------------------------- For the Three Months Ended ------------------------------------------------- Sept. 26, 2003 Sept. 27, 2002 ---------------- ----------------- Market Market Share Rank Share Rank - ---------------------------------------------------------------------------------------- Global proceeds Debt and Equity 7.9% 3 7.5% 3 Debt 8.0 4 7.6 3 Equity and equity-linked 7.5 6 5.9 5 U.S. proceeds Debt and Equity 9.5% 4 9.0% 3 Debt 9.7 4 9.1 3 Equity and equity-linked 6.6 5 7.8 6 - ---------------------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to book manager. - ---------------------------------------------------------------------------------------- For the Nine Months Ended ------------------------------------------------- Sept. 26, 2003 Sept. 27, 2002 ---------------- ----------------- Market Market Share Rank Share Rank - ---------------------------------------------------------------------------------------- Global proceeds Debt and Equity 7.2% 3 8.4% 2 Debt 7.1 3 8.2 2 Equity and equity-linked 7.7 5 10.7 3 U.S. proceeds Debt and Equity 9.0% 4 10.5% 2 Debt 8.9 3 10.2 2 Equity and equity-linked 10.3 5 16.3 3 - ---------------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to book manager
36 Strategic Advisory Services - --------------------------- Strategic advisory services revenues, which include merger and acquisition and other advisory fees, were $133 million in the third quarter of 2003, down 18% from the third quarter of 2002 as industry-wide completed mergers and acquisitions activity continued to contract and market share globally declined. Year-to-date strategic advisory services revenues similarly decreased from the year-ago period by 28%, to $391 million. Merrill Lynch's merger and acquisition market share information based on transaction value is as follows:
- ---------------------------------------------------------------------------------------- For the Three Months Ended ------------------------------------------------ Sept. 26, 2003 Sept. 27, 2002 --------------- -------------- Market Market Share Rank Share Rank - ---------------------------------------------------------------------------------------- Completed transactions Global 21.3 % 4 23.7 % 3 U.S. 9.2 8 40.9 2 Announced transactions Global 13.1 % 7 13.7 % 4 U.S. 12.5 6 15.8 5 - ---------------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to both target and acquiring companies' advisors. - ---------------------------------------------------------------------------------------- For the Nine Months Ended ------------------------------------------------ Sept. 26, 2003 Sept. 27, 2002 --------------- -------------- Market Market Share Rank Share Rank - ---------------------------------------------------------------------------------------- Completed transactions Global 15.7 % 6 21.8 % 3 U.S. 14.1 6 26.0 4 Announced transactions Global 15.0 % 4 14.6 % 4 U.S. 15.5 6 12.7 8 - ---------------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to both target and acquiring companies' advisors.
Other Revenues Other revenues, which include realized investment gains and losses, equity income from unconsolidated subsidiaries and distributions on equity investments, were $176 million in the third quarter of 2003 compared to $123 million in the year-ago quarter. During the third quarter of 2003, GMI's Other revenues includes a write-down of $114 million related to certain available-for-sale securities that were considered to be impaired on an other than temporary basis. In addition, 2003 third quarter Other revenues includes approximately $110 million in net revenues related to equity method investments. Year-to-date other revenues were $492 million, up from $480 million in the year-ago period. Included in the year-to-date 2002 other revenues was a $45 million pre-tax gain on the sale of the Securities Pricing Services business. For additional information on GMI's segment results, refer to Note 3 to the Condensed Consolidated Financial Statements. 37 - -------------------------------------------------------------------------------- GLOBAL PRIVATE CLIENT - -------------------------------------------------------------------------------- GPC's Results of Operations
- ----------------------------------------------------------------------------------------------------------------------- For the Three Months Ended For the Nine Months Ended -------------------------------- ------------------------------- Sept. 26, Sept. 27, % Inc. Sept. 26, Sept. 27, % Inc. (dollars in millions) 2003 2002 (Dec.) 2003 2002 (Dec.) - ----------------------------------------------------------------------------------------------------------------------- Asset management and portfolio service fees $ 855 $ 879 (3) $ 2,500 $ 2,728 (8) Commissions 624 581 7 1,703 1,900 (10) Principal transactions and new issue revenues 340 242 40 991 874 13 Net interest profit 350 323 8 1,004 1,015 (1) Other revenues 139 60 132 338 134 152 -------- -------- -------- -------- Total net revenues 2,308 2,085 11 6,536 6,651 (2) -------- -------- -------- -------- Non-interest expenses 1,842 1,768 4 5,465 5,719 (4) -------- -------- -------- -------- Pre-tax earnings $ 466 $ 317 47 $ 1,071 $ 932 15 -------- -------- -------- -------- Pre-tax profit margin 20.2 % 15.2 % 16.4 % 14.0 % - -----------------------------------------------------------------------------------------------------------------------
GPC's third quarter 2003 pre-tax earnings were $466 million, up 47% from the 2002 third quarter. Excluding a $25 million September 11-related insurance recovery, and a $2 million restructuring-related net credit, which were recorded in the 2002 third quarter, GPC pre-tax earnings increased 61% from the year-ago quarter. Net revenues increased 11% from the 2002 third quarter to $2.3 billion. The net revenues and pre-tax earnings growth from the prior-year quarter reflected increased client transaction activity, higher demand for fee-based services and credit products and continued operating discipline. GPC's pre-tax margin was 20.2%, up five percentage points from the year-ago quarter. GPC's year-to-date net revenues were $6.5 billion, down 2% from the corresponding period of 2002. Pre-tax earnings were $1.1 billion, up 15% from the first nine months of 2002. GPC's year-to-date pre-tax margin was 16.4%, up from 14.0% in the year-ago period (13.6 % excluding the insurance recovery and restructuring-related credit in 2002). GPC employed approximately 13,400 Financial Advisors at the end of the 2003 third quarter, down from 14,600 at the end of the 2002 third quarter but up from 13,300 at the end of the 2003 second quarter. Asset management and portfolio service fees Asset management and portfolio service fees include asset management fees from taxable and tax-exempt money market funds as well as portfolio fees from fee-based accounts such as Unlimited AdvantageSM and Merrill Lynch Consults(R). Also included are servicing fees related to these accounts, and certain other account-related fees. Asset management and portfolio service fees totaled $855 million, down 3% from the $879 million recorded in the third quarter of 2002. On a year-to-date basis, asset management and portfolio service fees totaled $2.5 billion, down 8% from the year-ago period. These declines result primarily from lower portfolio servicing fees, a large portion of which are calculated on beginning-of-period asset values. 38 Commissions Commission revenues primarily arise from agency transactions in listed and over-the-counter equity securities, as well as sales of mutual funds, insurance products, and options. Commission revenues increased 7% to $624 million in the third quarter of 2003 from $581 million in the third quarter of 2002, due primarily to increased transaction volumes related to mutual funds and equities. Commission revenues for the first nine months of 2003 were $1.7 billion, 10% lower than the corresponding period of 2002 due primarily to lower transaction volumes. Principal transactions and new issue revenues GPC's principal transactions and new issue revenues primarily represent bid-offer revenues in over-the-counter equity securities, government bonds and municipal securities, as well as selling concessions on underwriting of debt and equity products. GPC does not take any significant principal trading risk positions. Principal transactions and new issue revenues were $340 million, 40% higher than the 2002 third quarter due to an increase in equity new issue revenues. Year-to-date revenues were $991 million, up 13% from the year year-ago period. An analysis of changes in assets in GPC accounts from September 27, 2002 to September 26, 2003 is detailed below:
- ----------------------------------------------------------------------------------------------------- Net Changes Due To ----------------------------------------- Sept. 27, New Asset Sept. 26, (dollars in billions) 2002 Money Appreciation Other(1) 2003 - ----------------------------------------------------------------------------------------------------- Assets in GPC accounts U.S. $ 997 $9 $87 $ - $1,093 Non U.S. 87 - 7 (2) 92 ---------------------------------------------------------- Total $1,084 $9 $94 $(2) $1,185 - ----------------------------------------------------------------------------------------------------- (1) Represents accounts related to the sale of Japan's call center business.
Total assets in GPC accounts in the United States were $1.1 trillion at September 26, 2003 up from $1.0 trillion at the end of the 2002 third quarter as a result of market-driven increases in asset values and net new money of $9 billion. Outside the United States, client assets were $92 billion, up from $87 billion at the end of the year-ago quarter. Total assets in asset-priced accounts were $206 billion at the end of the 2003 third quarter, up 16% from $177 billion at the end of the 2002 third quarter. Net interest profit Net interest profit for GPC includes GPC's allocation of the interest spread earned in Merrill Lynch's banks for deposits as well as interest earned on margin and other loans. Net interest profit was $350 million in the 2003 third quarter, up 8% from $323 million in the third quarter of 2002. Net interest profit for the first nine months of 2003 was $1.0 billion, essentially unchanged from the comparable period of 2002. Other revenues Other revenues were $139 million in the third quarter of 2003, compared to $60 million in the year-ago period. Other revenues for the first nine months of 2003 increased to $338 million from $134 million in the same period in 2002. These increases are due primarily to increased realized gains related to sales of mortgages. For additional information on GPC's segment results, refer to Note 3 to the Condensed Consolidated Financial Statements. 39 - -------------------------------------------------------------------------------- MERRILL LYNCH INVESTMENT MANAGERS - --------------------------------------------------------------------------------
MLIM's Results of Operations - ------------------------------------------------------------------------------------------------------------------------ For the Three Months Ended For the Nine Months Ended --------------------------- -------------------------- Sept. 26, Sept. 27, Sept. 26, Sept. 27, (dollars in millions) 2003 2002 % (Dec.) 2003 2002 % (Dec.) - ------------------------------------------------------------------------------------------------------------------------ Asset management fees $ 323 $ 332 (3) $ 932 $ 1,054 (12) Commissions 33 40 (18) 100 145 (31) Other revenues (4) (12) (67) (13) 13 (200) -------- -------- -------- -------- Total net revenues 352 360 (2) 1,019 1,212 (16) Non-interest expenses 275 293 (6) 830 943 (12) -------- -------- -------- -------- Pre-tax earnings $ 77 $ 67 15 $ 189 $ 269 (30) -------- -------- -------- -------- Pre-tax profit margin 21.9 % 18.6 % 18.5 % 22.2 % - ------------------------------------------------------------------------------------------------------------------------
MLIM continued to demonstrate superior relative investment performance for the 1-, 3- and 5-year periods ended September 2003. For each of these periods, more than 70% of MLIM's global assets under management were ahead of their benchmark or category median. MLIM's pre-tax earnings in the 2003 third quarter were $77 million, up 15% from $67 million in the 2002 third quarter on net revenues that were essentially unchanged from the year ago period at $352 million. Non-interest expenses declined 6% from the year ago period, to $275 million primarily reflecting reduced litigation expenses. Continued resolution of litigation issues will likely impact MLIM's future results. Net revenues are dependent on levels of assets under management, and, accordingly, are correlated to equity market valuations. The pre-tax margin was 21.9% in the third quarter of 2003 compared to 18.6% in the year-ago quarter. Year-to-date, MLIM's pre-tax earnings were $189 million, 30% lower than for the first nine months of 2002 on net revenues that were 16% lower at $1.0 billion. MLIM's year-to-date pre-tax margin was 18.5%, compared with 22.2% for the same period last year. Asset management fees Asset management fees primarily consist of fees earned from the management and administration of funds as well as performance fees earned by MLIM on separately managed accounts. Asset management fees were $323 million, down slightly from $332 million in the third quarter of 2002. On a year-to-date basis, asset management fees decreased 12% to $932 million. At the end of the third quarter of 2003, assets under management totaled $473 billion, an increase of 5% from $452 billion at the end of the third quarter of 2002 due primarily to higher market values, partially offset by net new money outflows of $6 billion. Commissions Commissions for MLIM principally consist of distribution fees and redemption fees related to mutual funds. The distribution fees represent revenues earned for promoting and distributing mutual funds ("12b-1 fees"). As a result of lower transaction volumes and the impact of lower market values, commissions decreased 18% to $33 million in the 2003 third quarter from the year-ago quarter. Year-to-date commissions decreased 31%, to $100 million. 40 An analysis of changes in assets under management from September 27, 2002 to September 26, 2003 is as follows:
- ----------------------------------------------------------------------------------------------------------- Net Changes Due To --------------------------------------------- Sept. 27, New Asset Sept. 26, (dollars in billions) 2002 Money Appreciation Other (1) 2003 - ----------------------------------------------------------------------------------------------------------- Assets under management $452 $(6) $28 $(1) $473 - ------------------------------------------------------------------------------------------------------------ (1) Includes reinvested dividends, the impact of foreign exchange movements, net outflows of retail money market funds and other changes.
Other Revenues Other revenues, which primarily include net interest profit and investment gains and losses, totaled $(4) million and $(12) million for the third quarter of 2003 and 2002, respectively. Other revenues in the first nine months of 2003 totaled $(13) million and included the write-down of certain assets. Other revenues for the first nine months of 2002 were $13 million and included a $17 million pre-tax gain on the sale of the Canadian retail asset management business. For additional information on MLIM's segment results, refer to Note 3 to the Condensed Consolidated Financial Statements. - -------------------------------------------------------------------------------- AVERAGE ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- Management continually monitors and evaluates the level and composition of the balance sheet. For the first nine months of 2003, average total assets were $513 billion, up 9% from $469 billion for the full-year 2002. Average total liabilities increased 9% to $486 billion from $445 billion for the full-year 2002. Average total assets and liabilities for the first nine months of 2003 include the following changes as compared to the full-year 2002:
- ----------------------------------------------------------------------------------------- Increase/ (dollars in millions) (Decrease) Change - ----------------------------------------------------------------------------------------- AVERAGE ASSETS Trading assets $19,704 17% Receivables under resale agreements 10,220 14 Loans, notes and mortgages (net) 10,219 36 AVERAGE LIABILITIES Payables under repurchase agreements $16,432 15% Trading liabilities 14,685 18 - -----------------------------------------------------------------------------------------
Loans, notes and mortgages were up substantially from 2002 due to increased mortgage and small and middle market business loan originations by Merrill Lynch Bank USA and its subsidiaries. Additionally, securities financing transactions rose primarily due to increased inventory financing. Average total assets during the third quarter of 2003 were $531 billion, $45 billion higher than at the end of the third quarter principally due to higher levels of securities financing transactions, and increases in other receivables primarily from failed securities transactions that were prevalent in the U.S. Government securities and mortgage markets. 41 - -------------------------------------------------------------------------------- OFF BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS - -------------------------------------------------------------------------------- As a part of its normal operating strategy, Merrill Lynch enters into various contractual obligations, contingent liabilities and commitments, which may require future payments. The table below outlines the significant contractual obligations, contingent liabilities, and commitments, as well as the future expiration as of September 26, 2003:
(dollars in millions) - ---------------------------------------------------------------------------------------------------------------- Commitment expiration ---------------------------------------------------------------------- Less than 1 - 3 3+ - 5 Over 5 Total 1 year years years years - ---------------------------------------------------------------------------------------------------------------- Total commitments (Note 10) $62,649 $38,812 $ 9,595 $ 7,849 $ 6,393 Long-term borrowings 80,706 18,701 24,510 16,956 20,539 Short-term borrowings 3,015 3,015 - - - Contractual agreements(1) 45,198 10,204 9,059 7,385 18,550 Liquidity and facilities with SPEs(2) 14,640 12,762 1,878 - - Liquidity and default facilities with SPEs 2,867 2,060 503 1 303 Residual value guarantees(3) (4) 1,767 64 58 357 1,288 Standby letters of credit and other performance guarantees 1,205 471 121 341 272 - ---------------------------------------------------------------------------------------------------------------- (1) Represents the liability balance of contractual agreements at September 26, 2003. (2) Amounts relate primarily to facilities provided to municipal bond securitization SPEs. (3) Includes residual value guarantees associated with the Hopewell campus and aircraft leases of $325 million. (4) Includes $843 million of reimbursement agreements with the Mortgage 100SM program.
Refer to Note 10 to the Condensed Consolidated Financial Statements for additional information. - -------------------------------------------------------------------------------- CAPITAL ADEQUACY AND FUNDING - -------------------------------------------------------------------------------- The primary objectives of Merrill Lynch's capital structure and funding policies are to support the successful execution of the firm's business strategies while ensuring: o sufficient equity capital to absorb losses and, o liquidity at all times, across market cycles, and through periods of financial stress. These objectives and Merrill Lynch's capital structure and funding policies are discussed more fully in the Annual Report on Form 10-K for the year ended December 27, 2002. Capital Adequacy At September 26, 2003, Merrill Lynch's equity capital was comprised of $25.7 billion in common equity, $425 million in preferred stock, and $2.7 billion of preferred securities issued by subsidiaries. Preferred securities issued by subsidiaries are Trust Originated Preferred SecuritiesSM ("TOPrS"SM). Based on the risks and equity needs of its businesses, Merrill Lynch believes that its equity capital base of $28.7 billion is adequate. 42 Funding Commercial paper outstanding totaled $2.2 billion at September 26, 2003 and $4.0 billion at December 27, 2002, which was approximately 3% and 5% of total unsecured borrowings at September 26, 2003 and year-end 2002, respectively. Deposits at Merrill Lynch's banking subsidiaries totaled $79.3 billion at September 26, 2003, down from $81.8 billion at year-end 2002. Of the $79.3 billion of deposits in Merrill Lynch banking subsidiaries as of September 26, 2003, $65.6 billion were in U.S. banks. Outstanding long-term borrowings increased to $80.7 billion at September 26, 2003 from $78.5 billion at December 27, 2002. Major components of the change in long-term borrowings during the first nine months of 2003 are as follows:
(dollars in billions) - ------------------------------------------------------- Balance at December 27, 2002 $78.5 Issuances 22.0 Maturities (20.9) Other, net 1.1 ----- Balance at September 26, 2003 (1) $80.7 - ------------------------------------------------------- (1) At September 26, 2003, $62.0 billion of long-term borrowings had maturity dates beyond one year.
As a part of its overall liquidity risk management practices, Merrill Lynch seeks to ensure availability of sufficient alternative funding sources to enable the repayment of all unsecured debt obligations maturing within one year without issuing new unsecured debt or requiring liquidation of business assets. The main alternative funding sources to unsecured borrowings are repurchase agreements, securities loaned, and other secured borrowings, which require pledging unencumbered securities held for trading or investment purposes. Merrill Lynch also maintains a separate liquidity portfolio of U.S. Government and agency obligations, asset-backed securities and other instruments of high credit quality that is funded with debt with an average maturity greater than one year. The carrying value of this portfolio, net of related hedges, was $14.3 billion and $12.6 billion at September 26, 2003 and December 27, 2002, respectively. These assets may be sold or pledged to provide immediate liquidity to ML & Co. to repay maturing debt obligations. In addition to this portfolio, the firm monitors the extent to which other unencumbered assets are available as a source of funds during a liquidity event. Merrill Lynch also maintained a committed, multi-currency, unsecured bank credit facility that totaled $3.0 billion at September 26, 2003 and $3.5 billion at December 27, 2002 and was not drawn upon. On May 8, 2003, Merrill Lynch renewed the bank credit facility in the amount of $3.0 billion for 364 days. Merrill Lynch elected to reduce the amount of the facility considering the company's funding profile and the availability of the liquidity portfolio of segregated securities that may be sold or pledged to provide immediate liquidity. Credit Ratings The cost and availability of unsecured funding are impacted by credit ratings and market conditions. In addition, credit ratings are important when competing in certain markets and when seeking to engage in long-term transactions including over-the-counter derivatives. Factors that influence Merrill Lynch's credit ratings include the rating agencies' assessment of the general operating environment, Merrill Lynch's relative positions in the markets in which it competes, reputation, level and volatility of earnings, risk management policies, liquidity and capital management. Merrill Lynch's senior long-term debt, preferred stock, and TOPrSSM were rated by several recognized credit rating agencies at November 4, 2003 as indicated below. These ratings do not reflect outlooks that may be expressed by the rating agencies from time to time, which are currently stable. 43
- -------------------------------------------------------------------------------------------------------------- Preferred TOPrSSM Rating Agency Senior Debt Ratings Stock Ratings Ratings - -------------------------------------------------------------------------------------------------------------- Dominion Bond Rating Service Ltd AA(Low) Not Rated Not Rated Fitch Ratings AA- A+ A+ Moody's Investors Service, Inc. Aa3 A2 A1 Rating and Investment Information, Inc. (1) AA A+ A+ Standard & Poor's Ratings Services A+ A- A- - -------------------------------------------------------------------------------------------------------------- (1) Located in Japan
- -------------------------------------------------------------------------------- RISK MANAGEMENT - -------------------------------------------------------------------------------- Risk-taking is an integral part of Merrill Lynch's core business activities. In the course of conducting its business operations, Merrill Lynch is exposed to a variety of risks. These risks include market, credit, liquidity, process, and other risks that are material and require comprehensive controls and management. The responsibility and accountability for these risks remain primarily with the individual business units. For a full discussion of Merrill Lynch's risk management framework, see the Annual Report on Form 10-K for the year ended December 27, 2002. Market Risk Value-at-risk ("VaR") is an estimate within a specified degree of confidence of the amount that Merrill Lynch's present portfolios could lose over a given time interval. Merrill Lynch's overall VaR is less than the sum of the VaRs for individual risk categories because movements in different risk categories occur at different times and, historically, extreme movements have not occurred in all risk categories simultaneously. The difference between the sum of the VaRs for individual risk categories and the VaR calculated for all risk categories is shown in the following tables and may be viewed as a measure of the diversification within Merrill Lynch's portfolios. Merrill Lynch believes that the tabulated risk measures provide some guidance as to the amount Merrill Lynch could lose in future periods and it works continuously to improve the methodology and measurement of its VaR. However, like all statistical measures, especially those that rely heavily on historical data, VaR needs to be interpreted with a clear understanding of its assumptions and limitations. The Merrill Lynch VaR system uses a historical simulation approach to estimate VaR across several confidence levels and holding periods. Sensitivities to market risk factors are aggregated and combined with a database of historical weekly changes in market factors to simulate a series of profits and losses. The level of loss that is exceeded in that series 5% of the time is used as the estimate for the 95% confidence level VaR. The tables below show VaR using a 95% confidence level and a weekly holding period for trading and non-trading portfolios. In addition to the overall VaR, which reflects diversification in the portfolio, VaR amounts are presented for major risk categories, including exposure to volatility risk found in certain products, e.g., options. The table that follows presents Merrill Lynch's VaR for its trading portfolios at September 26, 2003 and December 27, 2002 as well as daily average VaR for the three months ended September 26, 2003 and June 27, 2003. Additionally, high and low VaR for the third quarter of 2003 is presented independently for each risk category and overall. 44
- ------------------------------------------------------------------------------------------------------------------ Daily Daily Sept. 26, Dec. 27, High Low Average Average (dollars in millions) 2003 2002 3Q03 3Q03 3Q03 2Q03 - ------------------------------------------------------------------------------------------------------------------ Trading value-at-risk(1) Interest rate and credit spread $ 50 $ 42 $ 81 $ 45 $ 59 $ 52 Equity 34 36 38 18 29 29 Commodity 2 - 4 - 2 - Currency 3 3 9 - 2 2 Volatility 22 19 39 21 30 24 ------------------------------------------------------------------ 111 100 122 107 Diversification benefit (58) (48) (63) (48) ---------------- ---------------- Overall(2) $ 53 $ 52 $ 78 $ 44 $ 59 $ 59 ================ ================ - ------------------------------------------------------------------------------------------------------------------ (1) Based on a 95% confidence level and a one-week holding period. (2) Overall VaR using a 95% confidence level and a one-day holding period was $27 million at September 26, 2003 and $25 million at year-end 2002.
The following table presents Merrill Lynch's VaR for its non-trading portfolios (including Merrill Lynch's U.S. banks and Merrill Lynch's LYONS(R) ):
- -------------------------------------------------------------------------- Sept. 26, Dec. 27, (dollars in millions) 2003 2002 - -------------------------------------------------------------------------- Non-trading value-at-risk(1) Interest rate and credit spread $ 93 $ 89 Equity 28 27 Currency 6 3 Volatility 17 13 ----- ---- 144 132 Diversification benefit (38) (42) ----- ---- Overall $ 106 $ 90 ===== ==== - -------------------------------------------------------------------------- (1) Based on a 95% confidence level and a one-week holding period.
45 Credit Risk Merrill Lynch enters into International Swaps and Derivatives Association, Inc. master agreements or their equivalent ("master netting agreements") with substantially all of its derivative counterparties as soon as possible. The agreements are negotiated with each counterparty and are complex in nature. While every effort is taken to execute such agreements, it is possible that a counterparty may be unwilling to sign such an agreement, and as a result, would subject Merrill Lynch to additional credit risk. Master netting agreements provide protection in bankruptcy in certain circumstances and, in some cases, enable receivables and payables with the same counterparty to be offset on the Consolidated Balance Sheets, providing for a more meaningful balance sheet presentation of credit exposure. However, the enforceability of master netting agreements under bankruptcy laws in certain countries or in certain industries is not free from doubt and receivables and payables with counterparties in these countries or industries are accordingly recorded on a gross basis. In addition, to reduce default risk, Merrill Lynch requires collateral, principally cash and U.S. Government and agency securities, on certain derivative transactions. From an economic standpoint, Merrill Lynch evaluates default risk exposures net of related collateral. The following is a summary of counterparty credit ratings for the replacement cost (net of $9.8 billion of collateral) of trading derivatives in a gain position by maturity at September 26, 2003. (Please note that the following table is inclusive of credit exposure from derivative transactions only and does not include other material credit exposures).
(dollars in millions) - ----------------------------------------------------------------------------------------- Years to Maturity Cross- Credit -------------------------------------------------Maturity Rating(1) 0-3 3+- 5 5+- 7 Over 7 Netting(2) Total - ----------------------------------------------------------------------------------------- AAA $ 1,330 $ 992 $ 618 $ 1,980 $ (474) $ 4,446 AA 3,640 2,412 1,311 2,342 (2,398) 7,307 A 6,928 1,718 1,019 4,248 (1,356) 12,557 BBB 1,547 906 531 1,019 (837) 3,166 Other 1,401 325 142 243 (43) 2,068 --------------------------------------------------------------------------- Total $14,846 $ 6,353 $ 3,621 $ 9,832 $ (5,108) $29,544 - ----------------------------------------------------------------------------------------- (1) Represents credit rating agency equivalent of internal credit ratings. (2) Represents netting of payable balances with receivable balances for the same counterparty across maturity band categories. Receivable and payable balances with the same counterparty in the same maturity category, however, are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate its default risk on derivatives whenever possible by entering into transactions with provisions that enable Merrill Lynch to terminate or reset the terms of its derivative contracts. 46 - -------------------------------------------------------------------------------- NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS - -------------------------------------------------------------------------------- Non-investment grade holdings and highly leveraged transactions involve risks related to the creditworthiness of the issuers or counterparties and the liquidity of the market for such investments. Merrill Lynch recognizes that these risks are inherent in the business and may employ strategies to mitigate exposures. The specific components and overall level of non-investment grade and highly-leveraged positions may vary significantly from period to period as a result of inventory turnover, investment sales, and asset redeployment. In the normal course of business, Merrill Lynch underwrites, trades, and holds non-investment grade cash instruments in connection with its investment banking, market-making, and derivative structuring activities. Non-investment grade holdings have been defined as debt and preferred equity securities rated lower than BBB, or equivalent ratings by recognized credit rating agencies, sovereign debt in emerging markets, amounts due under derivative contracts from non-investment grade counterparties, and other instruments that, in the opinion of management, are non-investment grade. In addition to the amounts included in the following table, derivatives may also expose Merrill Lynch to credit risk related to the underlying security where a derivative contract either synthesizes ownership of the underlying security (e.g., long total return swaps) or can potentially force ownership of the underlying security (e.g., short put options). Derivatives may also subject Merrill Lynch to credit spread or issuer default risk, in that changes in credit spreads or in the credit quality of the underlying securities may adversely affect the derivatives' fair values. Merrill Lynch may seek to mitigate these risks in certain circumstances by engaging in various hedging strategies to reduce its exposure associated with non-investment grade positions, such as purchasing an option to sell the related security or entering into other offsetting derivative contracts. Merrill Lynch provides financing and advisory services to, and invests in, companies entering into leveraged transactions, which may include leveraged buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides extensions of credit to leveraged companies in the form of senior and subordinated debt, as well as bridge financing on a select basis. In addition, Merrill Lynch may syndicate loans for non-investment grade companies or in connection with highly leveraged transactions and may retain a residual portion of these loans. Merrill Lynch holds direct equity investments in leveraged companies and interests in partnerships that invest in leveraged transactions. Merrill Lynch has also committed to participate in limited partnerships that invest in leveraged transactions. Future commitments to participate in limited partnerships and other direct equity investments will be made on a select basis. 47 - -------------------------------------------------------------------------------- Trading Exposures - -------------------------------------------------------------------------------- The following table summarizes Merrill Lynch's trading exposure to non-investment grade or highly leveraged issuers or counterparties:
(dollars in millions) - --------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - --------------------------------------------------------------------------------- Trading assets: Cash instruments $6,678 $4,825 Derivatives 4,024 5,016 Trading liabilities - cash instruments (2,060) (1,352) Collateral on derivative assets (1,956) (2,581) ------- ------ Net trading asset exposure $6,686 $5,908 - ---------------------------------------------------------------------------------
Included in the preceding table are debt and equity securities and bank loans of companies in various stages of bankruptcy proceedings or in default. At September 26, 2003, the carrying value of such debt and equity securities totaled $151 million, of which 34% resulted from Merrill Lynch's market-making activities in such securities. This compared with $140 million at December 27, 2002, of which 29% related to market-making activities. Also included are distressed bank loans totaling $67 million and $203 million at September 26, 2003 and December 27, 2002, respectively. - -------------------------------------------------------------------------------- Non-Trading Exposures - -------------------------------------------------------------------------------- The following table summarizes Merrill Lynch's non-trading exposures to non-investment grade or highly leveraged corporate issuers or counterparties:
(dollars in millions) - --------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - --------------------------------------------------------------------------------- Investment securities $ 217 $ 300 Commercial loans (net of allowance for loan losses): Bridge loans - 131 Other loans(1) 5,369 3,660 Other investments: Partnership interests(2) 1,608 1,749 Other equity investments(3) 480 583 - --------------------------------------------------------------------------------- (1) Includes accrued interest. (2) Includes $807 million and $877 million in investments at September 26, 2003 and December 27, 2002, respectively, related to deferred compensation plans, for which a portion of the default risk of the investments rests with the participating employees. (3) Includes investments in 119 and 129 enterprises at September 26, 2003 and December 27, 2002, respectively.
48 The following table summarizes Merrill Lynch's commitments with exposure to non-investment grade or highly leveraged counterparties:
(dollars in millions) - --------------------------------------------------------------------------------- Sept. 26, 2003 Dec. 27, 2002 - --------------------------------------------------------------------------------- Additional commitments to invest in partnerships (1) $ 446 $ 500 Unutilized revolving lines of credit and other lending commitments 3,939 2,026 - --------------------------------------------------------------------------------- (1) Includes $110 million at September 26, 2003 and December 27, 2002, related to deferred compensation plans.
- -------------------------------------------------------------------------------- CRITICAL ACCOUNTING POLICIES AND ESTIMATES - -------------------------------------------------------------------------------- The following is a summary of Merrill Lynch's critical accounting policies. For a full description of these and other accounting policies see Note 1 to the Consolidated Financial Statements in the 2002 Annual Report. Use of Estimates In presenting the Condensed Consolidated Financial Statements, Management makes estimates regarding certain trading inventory valuations, the outcome of litigation, the carrying amount of goodwill, the allowance for loan losses, the realization of deferred tax assets, tax reserves, insurance reserves, recovery of insurance deferred acquisition costs, and other matters that affect the reported amounts and disclosure of contingencies in the financial statements. Merrill Lynch is party to various legal actions, including arbitrations, class actions, and other litigation for which the ultimate outcome is uncertain and cannot be reasonably estimated. Accordingly, no provisions for these matters have been made in the Consolidated Financial Statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the Condensed Consolidated Financial Statements, and it is possible that such changes could occur in the near term. For more information regarding the specific methodologies used in determining estimates, refer to Use of Estimates in Note 1 of the 2002 Annual Report. Valuation of Financial Instruments Fair values for exchange traded securities and certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices. Fair values for OTC derivative financial instruments, principally forwards, options, and swaps, represent amounts estimated to be received from or paid to a third party in settlement of these instruments. These derivatives are valued using pricing models based on the net present value of estimated future cash flows, and directly observed prices from exchange-traded derivatives, other OTC trades, or external pricing services. New and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation often incorporate significant estimates and assumptions, which may impact the level of precision in the financial statements. For long-dated and illiquid contracts, extrapolation methods are applied to observed market data in order to estimate inputs and assumptions that are not directly observable. This enables Merrill Lynch to mark all positions consistently when only a subset of prices are directly observable. Values for non-exchange-traded derivatives are verified using observed information about the costs of hedging out the risk and other trades in the market. As the markets for these products develop, Merrill Lynch continually refines its pricing models based on experience to correlate more closely to the market risk of these instruments. Obtaining the fair value for OTC derivative contracts requires the use of management judgment and estimates. Unrealized gains for these instruments are not recognized unless the valuation model incorporates significant observable market inputs. 49 Merrill Lynch holds investments that may have quoted market prices but that are subject to restrictions (e.g., consent of other investors to sell) that may limit Merrill Lynch's ability to realize the quoted market price. Accordingly, Merrill Lynch estimates the fair value of these securities based on management's best estimate which incorporates pricing models based on projected cash flows, earnings multiples, comparisons based on similar market transactions and/or review of underlying financial conditions and other market factors. Merrill Lynch also has investments in certain non-U.S. GAAP entities, which are accounted for under the equity method of accounting. U.S. GAAP requires that management make certain estimates in determining income recognition. In addition, management makes judgments regarding the allocation of the cost basis of certain investments to the underlying assets in determining valuation of these investments. During the 2003 third quarter Merrill Lynch recorded approximately $110 million of net revenues related to equity method investments. Valuation adjustments are an integral component of the mark-to-market process and are taken for individual positions where either the sheer size of the trade or other specific features of the trade or particular market (such as counterparty credit quality, concentration or market liquidity) requires more than the simple application of the pricing models. Assets and liabilities recorded on the balance sheet can therefore be broadly categorized as follows: 1. highly liquid cash and derivative instruments for which quoted market prices are readily available (for example, exchange-traded equity securities and derivatives such as listed options) 2. liquid instruments, including a) cash instruments for which quoted prices are available but which may trade less frequently such that there is not complete pricing transparency for these instruments across all market cycles (for example, corporate and municipal bonds); b) derivative instruments that are valued using a model, where inputs to the model are directly observable in the market (for example, U.S. dollar interest rate swaps); c) instruments that are priced with reference to financial instruments whose parameters can be directly observed; and d) all consumer and small and middle-market business loans as well as performing commercial loans held for investment purposes (which are carried at their principal amount outstanding) 3. less liquid instruments that are valued using management's best estimate of fair value, and instruments which are valued using a model, where either the inputs to the model and/or the models themselves require significant judgment by management (for example, private equity investments, long dated or complex derivatives such as certain foreign exchange options and credit default swaps, distressed debt, aged inventory positions, including aged commercial loans held for sale (which are reported at the lower of cost or estimated fair value) and non-performing commercial loans held for investment purposes). Merrill Lynch continually refines the process used to determine the appropriate categorization of its assets and liabilities. At September 26, 2003, assets and liabilities on the Condensed Consolidated Balance Sheets can be categorized as follows: 50
(dollars in millions) - ------------------------------------------------------------------------------------------------ Category 1 Category 2 Category 3 Total - ------------------------------------------------------------------------------------------------ Assets Trading assets, excluding contractual agreements $49,145 $41,743 $1,322 $92,210 Contractual agreements 4,738 31,055 3,550 39,343 Loans, notes, and mortgages (net) - 38,893 1,477 40,370 Investment securities 11,605 63,976 3,977 79,558 - ------------------------------------------------------------------------------------------------ Liabilities Trading liabilities, excluding contractual agreements $35,602 $9,613 $1,139 $46,354 Contractual agreements 5,402 36,189 3,607 45,198 - ------------------------------------------------------------------------------------------------
In addition, other trading-related assets recorded in the Condensed Consolidated Balance Sheet at September 26, 2003 include $124.7 billion of securities financing transactions (receivables under resale agreements and receivables under securities borrowed transactions) which are recorded at their contractual amounts plus accrued interest and for which little or no estimation is required by management. - -------------------------------------------------------------------------------- NEW ACCOUNTING PRONOUNCEMENTS - -------------------------------------------------------------------------------- On July 7, 2003, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. The SOP provides guidance on accounting and reporting by insurance companies for certain nontraditional long-duration contracts and for separate accounts. The SOP is effective for financial statements for Merrill Lynch beginning in 2004. The SOP requires the establishment of a liability for contracts that contain death or other insurance benefits using a specified reserve methodology that is different from the methodology that Merrill Lynch currently employs. Had Merrill Lynch adopted SOP 03-1 at September 26, 2003, the estimated impact to the Condensed Consolidated Statement of Earnings would be between $90 and $100 million of additional expense; however, the ultimate impact of adoption in 2004 will depend on market conditions at that time. On May 15, 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 changes the accounting for certain financial instruments, including mandatorily redeemable preferred stock and certain freestanding equity derivatives, which under previous guidance were accounted for as equity. SFAS No. 150 requires that mandatorily redeemable preferred shares, written put options and physically settled forward purchase contracts on an issuer's shares, and certain financial instruments that must be settled by issuing a variable number of an issuer's shares, be classified as liabilities in the Condensed Consolidated Balance Sheets. SFAS No. 150 must be applied immediately to instruments entered into or modified after May 31, 2003 and to all other preexisting instruments beginning in the third quarter of this year. The adoption of SFAS No. 150 did not have a material impact on the Condensed Consolidated Financial Statements. 51 On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made as part of the Derivatives Implementation Group ("DIG") process that effectively required amendments to SFAS No. 133, and decisions made in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative and characteristics of a derivative that contains financing components. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. During the third quarter of 2003, in accordance with SFAS No. 149, Merrill Lynch modified its classification within the Condensed Consolidated Statement of Cash Flows. Certain derivative instruments entered into or modified after June 30, 2003, and that have been determined to contain a financing element at inception and where Merrill Lynch is deemed the borrower, are now included as a separate component within Cash flows from financing activities. Prior to July 1, 2003, the activity associated with such derivative instruments is included within Cash flows from operating activities. The adoption of SFAS No. 149 did not have a material impact on the Condensed Consolidated Financial Statements. On January 17, 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), which clarifies when an entity should consolidate another entity known as a Variable Interest Entity ("VIE"), more commonly referred to as an SPE, or special purpose entity. A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties, and may include many types of SPEs. FIN 46 requires that an entity consolidate a VIE if that enterprise has a variable interest that will absorb a majority of the VIE's expected losses, receive a majority of the VIE's expected residual returns, or both. FIN 46 does not apply to qualifying special purpose entities ("QSPEs"), the accounting for which is governed by SFAS No. 140. Merrill Lynch adopted FIN 46 on February 1, 2003 for VIEs with which it became involved after January 31, 2003. On October 8, 2003, the FASB deferred the effective date for preexisting VIEs to the period ending after December 15, 2003. As a result, Merrill Lynch will adopt FIN 46 for pre-existing contracts in the fourth quarter of this year and does not expect the adoption to have a material impact on the Consolidated Financial Statements. See Note 5 to the Condensed Consolidated Financial Statements for additional FIN 46 disclosure. On December 31, 2002 the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 permits three alternative methods for a voluntary transition to the fair value based method of accounting for employee stock-based compensation. SFAS No. 148 continues to permit prospective application for companies that adopt this standard prior to the beginning of fiscal year 2004. SFAS No. 148 also allows for a modified prospective application, which requires the fair value of all unvested awards to be amortized over the remaining service period, as well as restatement of prior years' expense. The transition guidance and disclosure provisions of SFAS No. 148 were effective for fiscal years ending after December 15, 2002. See Note 11 to the Condensed Consolidated Financial Statements for these disclosures. Merrill Lynch is continuing to evaluate the transition guidance of SFAS No. 148 and currently accounts for stock based compensation in accordance with the intrinsic value-based method in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. 52 On November 25, 2002, the FASB issued FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements Nos. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 requires guarantors to disclose their obligations under certain guarantees. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosures were effective for financial statements of interim or annual periods ending after December 15, 2002. See Note 10 to the Condensed Consolidated Financial Statements for these disclosures. In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS No. 146 replaces the guidance provided by EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Merrill Lynch adopted SFAS No. 146 as of January 1, 2003, which had no material impact on the Condensed Consolidated Financial Statements. 53
- ---------------------------------------------------------------------------------------------------------------------------------- STATISTICAL DATA - ---------------------------------------------------------------------------------------------------------------------------------- 3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr. 3rd Qtr. Client Assets (dollars in billions) 2002 2002 2003 2003 2003 -------- -------- -------- -------- -------- GPC: U.S. $ 997 $ 1,021 $ 1,009 $ 1,076 $ 1,093 Non-U.S. 87 89 86 92 92 -------- -------- -------- -------- -------- Total GPC Assets 1,084 1,110 1,095 1,168 1,185 MLIM direct sales 205 201 193 205 202 -------- -------- -------- -------- -------- Total Client Assets $ 1,289 $ 1,311 $ 1,288 $ 1,373 $ 1,387 ======== ======== ======== ======== ======== ASSETS IN ASSET-PRICED ACCOUNTS $ 177 $ 182 $ 181 $ 200 $ 206 ASSETS UNDER MANAGEMENT: Retail $ 182 $ 189 $ 187 $ 195 $ 194 Institutional 234 235 220 239 241 Private Investors(1) 36 38 35 37 38 U.S. 305 313 303 320 327 Non-U.S. 147 149 139 151 146 Equity 190 191 183 209 202 Fixed-income 119 122 108 108 125 Money market 143 149 151 154 146 - ---------------------------------------------------------------------------------------------------------------------------------- UNDERWRITING (dollars in billions): Global Equity and Equity-Linked: Volume $ 3 $ 6 $ 4 $ 8 $ 8 Market share 5.9 % 10.4 % 8.1 % 7.8 % 7.5 % Global debt: Volume $ 65 $ 59 $ 95 $ 86 $ 85 Market share 7.6 % 6.5 % 7.1 % 6.5 % 8.0 % - ---------------------------------------------------------------------------------------------------------------------------------- FULL-TIME EMPLOYEES: U.S. 41,800 40,000 39,100 38,200 37,800 Non-U.S. 11,400 10,900 10,400 10,000 10,000 -------- -------- -------- -------- -------- Total 53,200 50,900 49,500 48,200 47,800 ======== ======== ======== ======== ======== Private Client Financial Advisors 14,600 14,000 13,600 13,300 13,400 - ---------------------------------------------------------------------------------------------------------------------------------- Balance Sheet (dollars in millions, except per share amounts) Total assets $452,140 $447,928 $455,587 $481,075 $485,767 Total stockholders' equity $ 22,299 $ 22,875 $ 23,639 $ 24,781 $ 26,077 Book value per common share $ 25.17 $ 25.69 $ 24.97 $ 26.04 $ 27.21 SHARE INFORMATION (in thousands) Weighted-average shares outstanding: Basic 864,629 868,160 887,553 897,202 904,829 Diluted 934,477 942,893 939,220 965,288 991,066 Common shares outstanding 869,019 873,780 929,768 935,152 942,637 - ---------------------------------------------------------------------------------------------------------------------------------- (1) Represents segregated portfolios for individuals, small corporations and institutions.
54 Item 3. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- The information under the caption Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management" above in this Report is incorporated herein by reference. Item 4. Controls and Procedures ----------------------- In 2002, ML & Co. formed a Disclosure Committee to assist with the monitoring and evaluation of our disclosure controls and procedures. ML & Co.'s Chief Executive Officer, Chief Financial Officer and Disclosure Committee have evaluated the effectiveness of ML & Co.'s disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based on this evaluation, ML & Co.'s Chief Executive Officer and Chief Financial Officer have concluded that ML & Co.'s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective. There have been no significant changes in ML & Co.'s internal control over financial reporting that occurred during the period covered by this Form 10-Q that have materially affected, or are reasonably likely to materially affect, ML & Co.'s internal control over financial reporting. 55 PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings ----------------- The following information supplements the discussion in Part I, Item 3 "Legal Proceedings" in ML & Co.'s Annual Report on Form 10-K for the fiscal year ended December 27, 2002, Quarterly Report on Form 10-Q for the quarter ended June 27, 2003 and Current Reports on Form 8-K dated March 17, 2003, April 28, 2003, and September 17, 2003: Research-Related Litigation. - --------------------------- On August 12, 2003, and August 19, 2003, the United States District Court for the Southern District of New York denied plaintiffs' motion for reconsideration of the court's decisions dismissing their complaints. Plaintiffs have appealed from these decisions. On October 29, 2003, the United States District Court for the Southern District of New York granted Merrill Lynch's motions to dismiss nine additional research-related class actions. Merrill Lynch intends to move to dismiss the remaining class actions that are pending before the Court. On October 31, 2003, the United States District Court for the Southern District of New York entered final judgments in connection with the April 28, 2003, research settlements between the SEC and ten investment banking firms, including Merrill Lynch. Merrill Lynch is one of ten defendants in an action brought by the Attorney General of West Virginia seeking relief from firms that were parties to the April 28, 2003, research settlement. Merrill Lynch and the other defendants have filed motions to dismiss the complaint and disqualify plaintiff's counsel, and are awaiting a ruling on these motions. Enron-Related Litigation - ------------------------ Merrill Lynch is among dozens of defendants named in approximately twenty lawsuits involving the collapse of Enron, including actions brought by Enron investors, Enron employees, and Enron itself. On or about October 14, 2003, a fourth former Merrill Lynch employee was indicted for alleged criminal misconduct in connection with a Nigerian Barge transaction that the government alleged helped Enron inflate its 1999 earnings by $12 million. IPO Allocation Class Actions - ---------------------------- On November 3, 2003, the United States District Court for the Southern District of New York granted the defendants', including Merrill Lynch's, motion to dismiss the claims brought under the antitrust laws. The defendants, including Merrill Lynch, are continuing to defend against the claims brought under the federal securities laws. Shareholder Derivative Action - ----------------------------- On October 24, 2003, the Supreme Court of the State of New York granted Merrill Lynch's motion to dismiss Spear v. Conway, et al., a shareholder derivative action related to Merrill Lynch's research activities. Other - ----- Merrill Lynch has been named as a defendant in various other legal actions, including arbitrations, class actions, and other litigation arising in connection with its activities as a global diversified financial services institution. The general decline of equity securities prices that began in 2000 has resulted in increased legal actions against many firms, including Merrill Lynch, and will likely result in higher professional fees and litigation expenses than those incurred in the past. Some of the legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the issuers who would otherwise be the primary defendants in such cases are bankrupt or otherwise in financial distress. Merrill Lynch is also involved in investigations and/or proceedings by governmental and self-regulatory agencies. The number of these investigations has also increased in recent years with regard to many firms, including Merrill Lynch. 56 Given the number of these legal actions, investigations and proceedings, some are likely to result in adverse judgments, settlements, penalties, injunctions, fines, or other relief. Merrill Lynch believes it has strong defenses to, and where appropriate, will vigorously contest these actions. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases in which claimants seek substantial or indeterminate damages, Merrill Lynch often cannot predict what the eventual loss or range of loss related to such matters will be. Merrill Lynch believes, based on information available to it, that the resolution of these actions will not have a material adverse effect on the financial condition of Merrill Lynch as set forth in the Condensed Consolidated Financial Statements, but may be material to Merrill Lynch's operating results or cash flows for any particular period and may impact ML & Co.'s credit ratings. Item 5. Other Information ----------------- The 2004 Annual Meeting of Shareholders will be held at 10:00 a.m. on Friday, April 23, 2004 at the Merrill Lynch Conference and Training Center, 800 Scudders Mill Road, Plainsboro, New Jersey. Any shareholder of record entitled to vote generally for the election of directors may nominate one or more persons for election at the Annual Meeting only if proper written notice, as set forth in ML & Co.'s Certificate of Incorporation, has been given to the Secretary of ML & Co., 222 Broadway, 17th Floor, New York, New York 10038, no earlier than February 8, 2004 and no later than March 4, 2004. In addition, any shareholder intending to bring any other business before the meeting must provide proper written notice, as set forth in ML & Co.'s By-Laws, to the Secretary of ML & Co. on or before March 4, 2004. In order to be included in ML & Co.'s proxy statement, shareholder proposals must be received by ML & Co. no later than November 17, 2003. Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits 4 Instruments defining the rights of security holders, including indentures: Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, ML & Co. hereby undertakes to furnish to the Securities and Exchange Commission, upon request, copies of the instruments defining the rights of holders of long-term debt securities of ML & Co. that authorize an amount of securities constituting 10% or less of the total assets of ML & Co. and its subsidiaries on a consolidated basis. 10 Merrill Lynch & Co., Inc. 2004 Deferred Compensation Plan for a Select Group of Eligible Employees Dated as of September 1, 2003. 12 Statement re: computation of ratios. 15 Letter re: unaudited interim financial information. 31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 57 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Merrill Lynch & Co., Inc. Code of Ethics for Finance Professionals. (b) Reports on Form 8-K The following Current Reports on Form 8-K were filed with or furnished to the Securities and Exchange Commission during the quarterly period covered by this report: (i) Current Report dated July 2, 2003 for the purpose of filing the form of ML & Co.'s SUMmation Securities SM Linked to the Performance of the S&P 500 (R) Index due July 2, 2010. (ii) Current Report dated July 3, 2003 for the purpose of filing the form of ML & Co.'s 6.5% Callable STock Return Income DEbt Securities SM due July 5, 2005, payable at maturity with Intuit Inc. common stock. (iii) Current Report dated July 3, 2003 for the purpose of filing the form of ML & Co.'s Currency Notes Linked to the Norwegian Krone/Swiss Franc Exchange Rate due January 4, 2005. (iv) Current Report dated July 8, 2003 for the purpose of furnishing notice of a webcast of a conference call scheduled for July 15, 2003 to review ML & Co.'s operating results. (v) Current Report dated July 15, 2003 for the purpose of filing ML & Co.'s Preliminary Unaudited Earnings Summaries for the three months ended June 27, 2003. (vi) Current report dated July 29, 2003 for the purpose of filing ML & Co.'s Preliminary Unaudited Consolidated Balance Sheet as of June 27, 2003. (vii) Current Report dated August 1, 2003 for the purpose of filing the form of ML & Co.'s Global Currency Basket Notes due August 2, 2004. (viii) Current Report dated August 1, 2003 for the purpose of filing the form of ML & Co.'s 9% Callable STock Return Income Debt Securities SM due August 1, 2005, payable at maturity with Brocade Communications Systems, Inc. common stock. (ix) Current Report dated August 5, 2003 for the purpose of filing the form of ML & Co.'s Strategic Return Notes (R) Linked to the Industrial 15 Index due August 5, 2008. (x) Current Report dated August 5, 2003 for the purpose of filing the form of ML & Co.'s S&P 500(R)Market Index Target-Term Securities(R)due August 5, 2010. (xi) Current Report dated August 5, 2003 for the purpose of filing the form of ML & Co.'s Accelerated Return Notes Linked to the Amex Biotechnology Index SM due October 5, 2004. (xii) Current Report dated August 18, 2003 for the purpose of filing the form of ML & Co.'s 6% Callable STock Return Income DEbt Securities SM due August 18, 2005, payable at maturity with The Walt Disney Company common stock. (xiii) Current Report dated August 29, 2003 for the purpose of filing the form of ML & Co.'s Interest Rate Call Warrants Linked to the Ten Year Constant Maturity U.S. Treasury Yield Expiring August 29, 2005. 58 (xiv) Current Report dated September 3, 2003 for the purpose of filing the form of ML & Co.'s S&P 500(R)Market Index Target-Term Securities(R)due September 3, 2008. (xv) Current Report dated September 3, 2003 for the purpose of filing the form of ML & Co.'s Market Recovery Notes SM Linked to the Nasdaq-100 Index (R) due November 24, 2004. (xvi) Current Report dated September 17, 2003 for the purpose of reporting the unsealing of an indictment against three former Merrill Lynch employees and that the Department of Justice has agreed not to prosecute Merrill Lynch for crimes that may have been committed by its former employees related to the transaction, subject to certain understandings. (xvii) Current Report dated September 23, 2003 for the purpose of filing the form of ML & Co.'s Multi-Currency Notes due September 23, 2005. (xviii) Current Report dated September 23, 2003 for the purpose of filing the form of ML & Co.'s Accelerated Return Notes linked to Pfizer Inc. common stock due November 23, 2004. 59 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MERRILL LYNCH & CO., INC. ---------------------------------------------------- (Registrant) By: /s/ Ahmass L. Fakahany ---------------------------------------------------- Ahmass L. Fakahany Executive Vice President and Chief Financial Officer By: /s/ John J. Fosina ---------------------------------------------------- John J. Fosina Controller Principal Accounting Officer Date: November 5, 2003 60 INDEX TO EXHIBITS Exhibits 10 Merrill Lynch & Co., Inc. 2004 Deferred Compensation Plan for a Select Group of Eligible Employees Dated as of September 1, 2003. 12 Statement re: computation of ratios. 15 Letter re: unaudited interim financial information. 31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Merrill Lynch & Co., Inc. Code of Ethics for Finance Professionals. 61