UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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X | | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012 |
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MERRILL LYNCH & CO., INC. |
(Exact name of Registrant as specified in its charter) |
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Delaware | | 13-2740599 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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Bank of America Corporate Center 100 N. Tryon Street Charlotte, North Carolina | | 28255 |
(Address of principal executive offices) | | (Zip Code) |
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(704) 386-5681 |
Registrant’s telephone number, including area code: |
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Securities registered pursuant to Section 12(b) of the Act: | | |
Title of Each Class | | Name of Each Exchange on Which Registered |
Trust Preferred Securities of Merrill Lynch Capital Trust I (and the guarantee of the Registrant with respect thereto); Trust Preferred Securities of Merrill Lynch Capital Trust II (and the guarantee of the Registrant with respect thereto); Trust Preferred Securities of Merrill Lynch Capital Trust III (and the guarantee of the Registrant with respect thereto) | | New York Stock Exchange |
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Securities registered pursuant to Section 12(g) of the Act: None |
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
X YES NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
X YES NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer | Accelerated filer | Non-accelerated filer X | Smaller reporting company |
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Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES X NO
As of the close of business on June 30, 2012, there was no voting common equity of the Registrant ("Common Stock") held by non-affiliates. The Registrant has no non-voting Common Stock.
As of the close of business on February 28, 2013, there were 1,000 shares of Common Stock outstanding, all of which were held by Bank of America Corporation.
The Registrant is a wholly-owned subsidiary of Bank of America Corporation and meets the conditions set forth in General Instructions I(1)(a) and (b) of Form 10-K and is therefore filing this Form with a reduced disclosure format as permitted by Instruction I (2).
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2012
TABLE OF CONTENTS
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Consolidated Financial Statements | |
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EX-12 |
EX-23 |
EX-24 |
EX-31.1 |
EX-31.2 |
EX-32.1 |
EX-32.2 |
EX-101 |
PART I
Merrill Lynch & Co., Inc. (“ML & Co.” and together with its subsidiaries, “Merrill Lynch”, or the “Company”) is a holding company that, through its subsidiaries, is one of the world's leading capital markets, advisory and wealth management companies. The Company was founded in 1914 and became a publicly traded company on June 23, 1971. In 1973, the holding company ML & Co., a Delaware corporation, was created. Through our subsidiaries, we are a leading global market-maker and underwriter of securities and derivatives across a broad range of asset classes, and we serve as a strategic advisor to corporations, governments, institutions and individuals worldwide. When used in this report, “we”, “us” and “our” may refer to ML & Co. individually, ML & Co. and its subsidiaries, or certain of ML & Co.'s subsidiaries or affiliates.
We are a wholly-owned subsidiary of Bank of America Corporation (“Bank of America”) and meet the requirements to omit certain information from this Form 10-K as permitted by General Instruction I (2) of Form 10-K. We have also provided a brief description of our business activities in Item 1 as permitted by General Instruction I (2).
Pursuant to Accounting Standards Codification (“ASC”) 280, Segment Reporting (“Segment Reporting”), operating segments represent components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in determining how to allocate resources and in assessing performance. The business activities of Merrill Lynch are included within certain of the operating segments of Bank of America. Detailed financial information of the nature that could be used to allocate resources and assess the performance and operations for components of Merrill Lynch, however, is not provided to Merrill Lynch's chief operating decision maker. As a result, Merrill Lynch does not contain any identifiable operating segments under Segment Reporting, and therefore the financial information of Merrill Lynch is presented as a single segment.
The following is a brief discussion of the nature and scope of our activities in 2012.
Capital Markets and Advisory Activities. We conduct sales and trading activities and act as a market maker in securities, derivatives, currencies, and other financial instruments to satisfy client demands. In addition, we distribute fixed income, currency, commodity and equity products, and derivatives. We also provide clients with financing, securities clearing, settlement, and custody services, and engage in select principal investing activities.
We also assist clients in raising capital through underwritings and private placements of equity, debt and related securities, and loan syndications and offer advisory services to clients on strategic issues, valuation, mergers, acquisitions and restructurings.
Wealth and Investment Management Activities. We provide brokerage, investment advisory and financial planning services, offering a broad range of both proprietary and third-party wealth management products and services globally to individuals, small- to mid-size businesses, and employee benefit plans. We also create and manage wealth management products, including alternative investment products for clients.
Research. We also provide a variety of research services on a global basis. These services are at the core of the value proposition we offer to institutional and individual investor clients and are an integral component of our product offerings.
For additional information about our business, see Note 1 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Regulation
Certain aspects of our business, and the business of our competitors and the financial services industry in general, are subject to extensive regulation by United States (“U.S.”) federal and state regulatory agencies and securities exchanges and by various non-U.S. government agencies or regulatory bodies, securities exchanges, self-regulatory organizations and central banks.
United States Regulatory Oversight and Supervision
Holding Company Supervision
As a wholly-owned subsidiary of Bank of America, a bank holding company that is also a financial holding company, we are subject to the oversight of, and inspection by, the Board of Governors of the Federal Reserve System (the “Federal Reserve”).
Broker-Dealer Regulation
Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S”), Merrill Lynch Professional Clearing Corp. (“ML Pro”) and certain other subsidiaries of ML & Co. are registered as broker-dealers with the Securities Exchange Commission (“SEC”) and, as such, are subject to regulation by the SEC and by self-regulatory organizations, such as the Financial Industry Regulatory Authority. Certain of our subsidiaries and affiliates, including MLPF&S, are registered as investment advisors with the SEC.
Our subsidiaries that are broker-dealers registered with the SEC are subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (“Exchange Act”) which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, these entities are required to maintain the minimum net capital deemed necessary to meet broker-dealers’ continuing commitments to customers and others. Under certain circumstances, this rule limits the ability of such broker-dealers to allow withdrawal of such capital by ML & Co. or other Merrill Lynch subsidiaries. Additional information regarding certain net capital requirements is in Note 18 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Financial Reform Act
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Financial Reform Act”) was signed into law. As a result of the Financial Reform Act, several significant regulatory developments occurred in 2012, and additional regulatory developments may occur in 2013 and beyond. The Financial Reform Act has impacted and will continue to impact our earnings through revenue reductions, higher costs and imposition of new restrictions on us. For a description of significant developments, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Overview - Other Events - Financial Reform Act” in Part II, Item 7 of this Form 10-K.
Non-U.S. Regulatory Oversight and Supervision
Our business is also subject to extensive regulation by various non-U.S. regulators including governments, securities exchanges, central banks and other regulatory bodies. Certain of our subsidiaries are regulated as broker-dealers under the laws of the jurisdictions in which they operate. Subsidiaries engaged in banking and trust activities outside the U.S. are regulated by various government entities in the particular jurisdiction where they are chartered, incorporated and/or conduct their business activities. In some cases, the legislative and regulatory developments outside the U.S. applicable to these subsidiaries may have an impact on our business and results of operations. Our financial services operations in the United Kingdom (“U.K.”) are subject to regulation by and supervision of the Financial Services Authority (the “FSA”). In July of 2010, the U.K. proposed abolishing the FSA and replacing it with the Financial Policy Committee within the Bank of England (the “FPC”) and two new regulators, the Prudential Regulatory Authority (the “PRA”) and the Consumer Protection and Markets Authority (the “CPMA”). Under the proposal, our U.K. regulated entities will be subject to the supervision of the FPC and the PRA for prudential matters and the CPMA for conduct of business matters. The new financial regulatory structure is scheduled to be formally established on April 1, 2013. We continue to monitor the development and potential impact of this regulatory restructuring.
In the course of conducting our business operations, we are exposed to a variety of risks, some of which are inherent in the financial services industry and others of which are more specific to our own businesses. The discussion below addresses the most significant factors of which we are aware that could affect our businesses,
operations, and financial condition. Additional factors that could affect our financial condition and operations are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-Looking Statements.” However, other factors not discussed below or elsewhere in this Annual Report on Form 10-K could also adversely affect our businesses, operations, and financial condition. Therefore, the risk factors below should not be considered a complete list of potential risks that we may face.
Any risk factor described in this Annual Report on Form 10-K or in any of our other SEC filings could by itself, or together with other factors, materially adversely affect our liquidity, cash flows, competitive position, business, results of operations and financial condition.
General Economic and Market Conditions Risk
Our businesses and results of operations may be adversely affected by the U.S. and international financial markets and economic conditions generally. Our businesses and results of operations are affected by the financial markets and general economic conditions in the U.S. and abroad, including factors such as the level and volatility of short-term and long-term interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer spending, fluctuations in both debt and equity capital markets, liquidity of the global financial markets, the availability and cost of capital and credit, investor sentiment and confidence in the financial markets, European sovereign debt risks and the strength of the U.S. economy and the non-U.S. economies in which we operate. The deterioration of any of these conditions could adversely affect our business and securities portfolios, our level of charge-offs and provision for credit losses, the carrying value of our deferred tax assets, our capital levels and liquidity and our results of operations.
Continued elevated unemployment, under-employment and household debt, along with continued stress in the consumer real estate market and certain commercial real estate markets in the U.S., pose challenges for domestic economic performance and the financial services industry. The sustained high unemployment rate and the lengthy duration of unemployment have directly impaired consumer finances and pose risks to the financial services industry. Continued uncertainty in the housing markets and elevated levels of distressed and delinquent mortgages pose further risks to the housing market. The current environment of heightened scrutiny of financial institutions has resulted in increased public awareness of and sensitivity to financial services industry fees and practices. Each of these factors may adversely affect our fees and costs.
Liquidity Risk
Liquidity risk is the potential inability to meet our contractual and contingent financial obligations, on- or off-balance sheet, as they become due.
Adverse changes to Bank of America’s or our credit ratings from the major credit rating agencies could significantly limit our access to funding or the capital markets, increase our borrowing costs, or trigger additional collateral or funding requirements. Our borrowing costs and ability to raise funds are directly impacted by our credit ratings. In addition, credit ratings may be important to customers or counterparties when we compete in certain markets and when we seek to engage in certain transactions, including over-the-counter (“OTC”) derivatives.
Credit ratings and outlooks are opinions expressed by rating agencies on our creditworthiness and that of our obligations or securities, including long-term debt, short-term borrowings and other securities, including asset securitizations. Following the acquisition of Merrill Lynch by Bank of America, the major credit rating agencies have indicated that the primary drivers of Merrill Lynch's credit ratings are Bank of America's credit ratings. Bank of America's credit ratings are subject to ongoing review by the rating agencies, which consider a number of factors, including Bank of America's financial strength, performance, prospects and operations as well as factors not under Bank of America's control.
On June 21, 2012, Moody's Investors Service, Inc. ("Moody's") completed its previously-announced review for possible downgrade of financial institutions with global capital markets operations, downgrading the ratings of 15 banks and securities firms, including the ratings of Bank of America and ML & Co. Bank of America's and ML &
Co.'s long-term debt ratings were downgraded one notch as part of this action. Each of the three major rating agencies downgraded the ratings of Bank of America and ML & Co. in late 2011.
Currently, Bank of America's and ML & Co.'s long-term/short-term senior debt ratings and outlooks expressed by the rating agencies are as follows: Baa2/P-2 (negative) by Moody's; A-/A-2 (negative) by Standard & Poor's Ratings Services (“S&P”); and A/F1 (stable) by Fitch Ratings (“Fitch”). The rating agencies could make further adjustments to Bank of America's (and consequently, our) credit ratings at any time. There can be no assurance that additional downgrades will not occur.
A further reduction in certain of our credit ratings could negatively affect our liquidity, access to credit markets, the related cost of funds, our businesses and certain trading revenues, particularly in those businesses where counterparty creditworthiness is critical. If Bank of America’s or Merrill Lynch’s (including our bank's or broker dealer subsidiaries') short-term credit ratings were downgraded by one or more levels, we may suffer the potential loss of access to short-term funding sources such as repurchase agreement financing and/or increased cost of funds.
In addition, under the terms of certain OTC derivative contracts and other trading agreements, in the event of a further downgrade of the credit ratings of ML & Co. or certain subsidiaries, counterparties to those agreements may require ML & Co. or certain subsidiaries to provide additional collateral, terminate these contracts or agreements, or provide other remedies. At December 31, 2012, if the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by one incremental notch, the amount of additional collateral contractually required by derivative contracts and other trading agreements would have been approximately $0.4 billion. If the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by a second incremental notch, approximately $4.0 billion in additional incremental collateral would have been required.
Also, if the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by one incremental notch, the derivative liability that would be subject to unilateral termination by counterparties as of December 31, 2012 was $1.9 billion, against which $1.2 billion of collateral has been posted. If the rating agencies had downgraded their long-term debt ratings for ML & Co. or certain subsidiaries by a second incremental notch, the derivative liability that would be subject to unilateral termination by the counterparties as of December 31, 2012 was an incremental $1.3 billion, against which $0.7 billion of collateral has been posted.
While certain potential impacts are contractual and quantifiable, the full consequences of a credit ratings downgrade to a financial institution are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including whether any downgrade of a firm's long-term credit ratings precipitates downgrades to its short-term credit ratings, and assumptions about the potential behaviors of various customers, investors and counterparties.
For a further discussion of our liquidity matters, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Funding and Liquidity.”
If we or Bank of America are unable to access the capital markets or our borrowing costs increase, our liquidity and competitive position will be negatively affected. Liquidity is essential to our business. We fund our assets primarily with a mix of secured and unsecured liabilities through a globally coordinated funding strategy with Bank of America. We have established intercompany lending and borrowing arrangements to facilitate centralized liquidity management. As a result, our liquidity risk is derived in large part from Bank of America’s liquidity risk. Bank of America’s and our liquidity could be adversely affected by any inability to access the capital markets; illiquidity or volatility in the capital markets; unforeseen outflows of cash, including customer deposits, funding for commitments and contingencies; the ability to sell assets on favorable terms; increased liquidity requirements on our banking or nonbanking subsidiaries imposed by their home countries; or negative perceptions about Bank of America’s and our short- or long-term business prospects, including downgrades of credit ratings. Several of these factors may arise due to circumstances that neither we nor Bank of America may be able to control, such as a general market disruption, negative views about the financial services industry generally, changes in the regulatory environment, actions by credit rating agencies or an operational problem that affects third parties, us or Bank of America.
Our and Bank of America’s cost of obtaining funding is directly related to prevailing market interest rates and to credit spreads. Credit spreads are the amount in excess of the interest rate of U.S. Treasury securities, or other benchmark securities, of a similar maturity that we or Bank of America need to pay to funding providers. Increases in interest rates and such credit spreads can significantly increase the cost of funding for us and Bank of America. Changes in credit spreads are market-driven and may be influenced by market perceptions of the creditworthiness of us and Bank of America. Changes to interest rates and credit spreads occur continuously and may be unpredictable and highly volatile.
For additional information about our liquidity, including credit ratings and outlooks, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Funding and Liquidity.”
Our dependence upon funds from our subsidiaries and our parent could adversely impact our liquidity. ML & Co. is a holding company that is a separate and distinct legal entity from its parent, Bank of America, and our broker-dealers and other subsidiaries. We evaluate and manage liquidity on a legal entity basis. Legal entity liquidity is an important consideration as there are legal and other limitations on our ability to utilize liquidity from one legal entity to satisfy the liquidity requirements of another, including ML & Co. For instance, ML & Co. depends on dividends, distributions and borrowings or other payments from its subsidiaries and may depend in large part on financing from Bank of America to fund payments on our obligations, including debt obligations. Bank of America may, in some instances, be unable to provide us with the funding we need to fund payments on our obligations. Many of our subsidiaries, including our broker-dealer subsidiaries, are subject to laws that restrict dividend payments to ML & Co. In addition, our broker-dealer subsidiaries are subject to restrictions on their ability to lend or transact with affiliates and to minimum regulatory capital and liquidity requirements, as well as restrictions on their ability to use funds deposited with them in brokerage accounts to fund their businesses. Additional restrictions on related party transactions, increased capital and liquidity requirements and additional limitations on the use of funds on deposit in brokerage accounts, as well as lower earnings, can reduce the amount of funds available to meet the obligations of ML & Co. and even require ML & Co. to provide additional funding to such subsidiaries. Regulatory action of that kind could impede access to funds we need to make payments on our obligations. In addition, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. For additional information about regulatory capital requirements and limitations on our subsidiaries' ability to pay dividends, see Note 18 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Mortgage and Housing Market-Related Risk
Our mortgage loan repurchase obligations or claims from third parties could result in additional material losses. In connection with residential mortgage loans sold directly to government sponsored enterprises (the "GSEs"), and residential mortgage loans sold to investors other than GSEs as whole loans or private-label securitizations, Merrill Lynch and certain of its subsidiaries made various representations and warranties, breaches of which may result in a requirement that we repurchase the mortgage loans or otherwise make whole or provide other remedies to counterparties. For example, Merrill Lynch and certain of its subsidiaries, including First Franklin Financial Corporation ("First Franklin"), sold approximately $132 billion in original principal balance of such loans originated from 2004 to 2008 (primarily subprime and alt-A) through private-label securitizations or whole loan sales. Most of the loans sold in the form of whole loans were subsequently pooled into private-label securitizations sponsored by the third-party buyer of the whole loans. For the outstanding balance of these loans as of December 31, 2012 and December 31, 2011, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet Exposures - Representations and Warranties - Experience with Non-GSE Investors” in Part II, Item 7 of this Form 10-K. In addition, Merrill Lynch and First Franklin securitized first-lien residential mortgage loans, generally in the form of mortgage-backed securities ("MBS") guaranteed by the GSEs.
At December 31, 2012, the total notional amount of our unresolved representations and warranties repurchase claims from all sources totaled approximately $6.0 billion compared with $1.3 billion at December 31, 2011. The total amount of our recorded liability related to representations and warranties repurchase exposures was $2.0 billion at December 31, 2012. We currently estimate that the range of possible loss for representations and warranties exposures could be up to $1.1 billion over accruals at December 31, 2012. This range of possible loss does not represent a probable loss. For information concerning the changes to our liability for representations and
warranties recorded in 2012 and 2011 for our repurchase exposure on private-label securitizations, see Note 14 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Our estimated liability and range of possible loss for representations and warranties exposures is based on currently available information and is necessarily dependent on, and limited by, a number of factors, including our historical claims and settlement experience and the experience of our affiliates with non-GSE counterparties, projections of future defaults and, for private-label securitizations, the implied repurchase experience based on the BNY Mellon Settlement (as defined below), as well as significant judgment and a number of assumptions that are subject to change, including the assumption that the conditions to the BNY Mellon Settlement are satisfied. As a result, our liability and estimated range of possible loss related to our representations and warranties exposures may materially change in the future based on factors beyond our control. Future provisions and/or estimated ranges of possible loss for representations and warranties may be significantly impacted if actual experiences are different from our assumptions in our predictive models, including, without limitation, the ultimate resolution of the BNY Mellon Settlement, estimated repurchase rates, economic conditions, home prices, consumer and counterparty behavior, and a variety of judgmental factors. In addition, we have not recorded any representations and warranties liability for certain private-label securitizations sponsored by whole-loan investors, where we have little to no claim experience.
Adverse developments with respect to one or more of the assumptions underlying the liability for representations and warranties and the corresponding estimated range of possible loss could result in significant increases to future provisions and/or the estimated range of possible loss. For example, if courts, in the context of claims brought by private-label securitization trustees, were to disagree with our interpretation that the underlying agreements require a claimant to prove that the representations and warranties breach was the cause of the loss, it could significantly impact the estimated range of possible loss. Additionally, if recent court rulings related to monoline litigation, including one related to an affiliate of ours, that have allowed sampling of loan files instead of requiring a loan-by-loan review to determine if a representations and warranties breach has occurred, are followed generally by the courts in other monoline litigation, private-label securitization counterparties may view litigation as a more attractive alternative compared to loan-by-loan review.
If future representations and warranties losses occur in excess of our recorded liability and estimated range of possible loss, including as a result of the factors set forth above, such losses could have a material adverse effect on our cash flows, financial condition and results of operations.
The liability for representations and warranties exposures and the corresponding estimated range of possible loss for these representations and warranties exposures do not consider any losses related to litigation matters disclosed in Note 14 to the Consolidated Financial Statements, nor do they include any potential securities law or fraud claims or potential indemnity or other claims against us. Merrill Lynch is not able to reasonably estimate the amount of any possible loss with respect to any such securities law, fraud or other claims against us, except to the extent reflected in the aggregate range of possible loss for litigation and regulatory matters disclosed in Note 14 to the Consolidated Financial Statements; however, such loss could have a material adverse effect on our cash flows, financial condition and results of operations.
For additional information about our representations and warranties exposure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Off-Balance Sheet Exposures — Representations and Warranties” and Note 14 to the Consolidated Financial Statements.
Our representations and warranties losses could be substantially higher than existing accruals and the existing estimated range of possible loss for representations and warranties liability if court approval of the BNY Mellon Settlement is not obtained or if it is otherwise abandoned. On June 28, 2011, Bank of America and certain of its non-Merrill Lynch subsidiaries entered into a settlement agreement with The Bank of New York Mellon (“BNY Mellon”), as trustee, to resolve, among other claims, all outstanding and potential claims related to alleged representations and warranties breaches (including repurchase claims) with respect to the 525 legacy first-lien and five second-lien non-GSE residential mortgage-backed securitization trusts containing loans principally originated between 2004 and 2008 and for which BNY Mellon acts as trustee or indenture trustee (the “BNY Mellon Settlement”). The BNY Mellon Settlement is subject to final court approval and certain other conditions. Although
the final court hearings on the settlement are scheduled to begin on May 2, 2013, we cannot currently predict the timing or ultimate outcome of the court approval process, which can include appeals and could take a substantial period of time. There can be no assurance that final court approval of the BNY Mellon Settlement will be obtained, that all conditions will be satisfied (including the receipt of private letter rulings from the Internal Revenue Service (the “IRS”) and other tax rulings and opinions) or, if certain conditions to the BNY Mellon Settlement permitting withdrawal are met, that Bank of America and certain of its non-Merrill Lynch subsidiaries will not withdraw from the BNY Mellon Settlement agreement.
If final court approval is not obtained with respect to the BNY Mellon Settlement, or if Bank of America and certain of its non-Merrill Lynch subsidiaries determine to withdraw from the BNY Mellon Settlement agreement in accordance with its terms, Merrill Lynch's future representations and warranties losses with respect to non-GSEs could substantially exceed our non-GSE reserve, together with our estimated range of reasonably possible loss for all representations and warranties exposures of up to $1.1 billion over existing accruals at December 31, 2012. Developments with respect to one or more of the assumptions underlying the estimated range of possible loss for representations and warranties (including the timing and ultimate outcome of the court approval process relating to the BNY Mellon Settlement) could result in significant increases in our non-GSE reserve and/or this estimated range of possible loss. For additional information regarding the BNY Mellon Settlement, see “Management's Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet Exposures - Representations and Warranties”.
If the U.S. housing market weakens or home prices decline, our consumer loan portfolios, credit quality, credit losses, representations and warranties exposures, and earnings may be adversely affected. Although U.S. home prices have shown signs of improvement during 2012, the declines over the past several years negatively impacted the credit performance of certain of our portfolios.
Conditions in the U.S. housing market over the past several years also resulted in significant write-downs of asset values in several asset classes, notably mortgage-backed securities and exposure to monolines. If the U.S. housing market were to weaken, the value of real estate could decline, which could negatively affect our exposure to representations and warranties. While there were indications in 2012 that the U.S. economy is stabilizing, the performance of our overall portfolios may not significantly improve in the near future. A protracted continuation or worsening of difficult U.S. housing market conditions may exacerbate the adverse effects outlined above and could have a significant adverse effect on our financial condition and results of operations.
Credit Risk
Credit risk is the risk of loss arising from a borrower, obligor or counterparty default when a borrower, obligor or counterparty does not meet its obligations.
Economic or market disruptions, insufficient credit loss reserves or concentration of credit risk, may necessitate an increase in the provision for credit losses, which could have an adverse effect on our financial condition and results of operations. When we buy debt securities, loan money, commit to loan money or enter into a letter of credit or other contract with a counterparty, we incur credit risk, or the risk of losses if our borrowers do not repay their loans or our counterparties fail to perform according to the terms of their agreements. A number of our products expose us to credit risk, including loans, lending commitments, derivatives, trading account assets and assets held-for-sale. The credit quality of our portfolios has a significant impact on our earnings.
Global and U.S. economic conditions may impact our credit portfolios. To the extent economic or market disruptions occur, such disruptions would likely increase our credit exposure to customers, obligors or other counterparties due to the increased risk that they may default on their obligations to us.
We estimate and establish an allowance for credit losses for losses inherent in our lending activities (including unfunded lending commitments), excluding those measured at fair value, through a charge to earnings. The amount of allowance is determined based on our evaluation of the potential credit losses included within our loan portfolio. The process for determining the amount of the allowance requires difficult, subjective and complex judgments. Our ability to assess future economic conditions or the creditworthiness of our customers, obligors or other counterparties is imperfect. We may suffer unexpected losses if the models and assumptions we use to establish
reserves and make judgments in extending credit to our borrowers and other counterparties become less predictive of future events. In such an event, we might need to increase the size of our allowance, which reduces our earnings.
In the ordinary course of our business, we also may be subject to a concentration of credit risk in a particular industry, country, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively affect our businesses, and the processes by which we set limits and monitor the level of our credit exposure to individual entities, industries and countries may not function as we have anticipated. While our activities expose us to many different industries and counterparties, we routinely execute a high volume of transactions with counterparties in the financial services industry, including broker-dealers, commercial banks, investment funds and insurers. This has resulted in significant credit concentration with respect to this industry.
In the ordinary course of business, we also enter into transactions with sovereign nations, U.S. states and U.S. municipalities. Unfavorable economic or political conditions, disruptions to capital markets, currency fluctuations, social instability and changes in government policies could impact the operating budgets or credit ratings of sovereign nations, U.S. states and U.S. municipalities and expose us to credit risk.
For additional information about our credit risk and credit risk management policies and procedures, see “Quantitative and Qualitative Disclosures about Market Risk — Credit Risk Management.”
We could suffer losses and our ability to engage in routine trading and funding transactions could be adversely affected as a result of the actions or deterioration in the commercial soundness of our counterparties and other financial services institutions. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including broker-dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. Financial services institutions and other counterparties are inter-related because of trading, funding, clearing or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to significant future liquidity problems, including losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of a counterparty or client. In addition, our credit risk may be impacted when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivatives exposure due us.
Our derivatives businesses may expose us to unexpected risks and potential losses. We are party to a large number of derivatives transactions, including credit derivatives. Our derivatives businesses may expose us to unexpected market, credit and operational risks that could cause us to suffer unexpected losses. Severe declines in asset values, unanticipated credit events or unforeseen circumstances that may cause previously uncorrelated factors to become correlated (and vice versa) may create losses resulting from risks not appropriately taken into account in the development, structuring or pricing of a derivative instrument. The terms of certain of our OTC derivative contracts and other trading agreements provide that upon the occurrence of certain specified events, such as a change in our credit ratings, we may be required to provide additional collateral or to provide other remedies, or our counterparties may have the right to terminate or otherwise diminish our rights under these contracts or agreements.
Many derivative instruments are individually negotiated and non-standardized, which can make exiting, transferring or settling some positions difficult. Many derivatives require that we deliver to the counterparty the underlying security, loan or other obligation in order to receive payment. In a number of cases, we do not hold, and may not be able to obtain, the underlying security, loan or other obligation.
In the event of a further downgrade of the credit ratings of ML & Co. and certain subsidiaries, certain derivative and other counterparties may request we substitute our affiliate, Bank of America, N.A. ("BANA") as counterparty for certain derivative contracts and other trading agreements. Our ability to substitute or make changes to these agreements to meet counterparties' requests may be subject to certain limitations, including counterparty willingness, regulatory limitations on naming BANA as the new counterparty, and the type or amount of collateral required. It is possible that such limitations on our ability to substitute or make changes to these agreements, including naming BANA as the new counterparty, could adversely affect our results of operations.
Derivatives contracts and other transactions entered into with third parties are not always confirmed by the counterparties or settled on a timely basis. While a transaction remains unconfirmed or during any delay in settlement, we are subject to heightened credit and operational risk and in the event of default may find it more difficult to enforce the contract. In addition, as new and more complex derivatives products have been created, covering a wider array of underlying credit and other instruments, disputes about the terms of the underlying contracts may arise, which could impair our ability to effectively manage our risk exposures from these products and subject us to increased costs.
For additional information on our derivatives exposure, see Note 6 to the Consolidated Financial Statements.
Market Risk
Market risk is the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions such as market volatility. Market risk is inherent in the financial instruments associated with our operations, including loans, deposits, securities, short-term borrowings, long-term debt, trading account assets and liabilities, and derivatives.
Negative changes in the levels of market volatility and other financial or capital market conditions may increase our market risk. Our liquidity, cash flows, competitive position, business, results of operations and financial condition are affected by market risk factors such as changes in interest and currency exchange rates, equity and futures prices, the implied volatility of interest rates, credit spreads and other economic and business factors. These market risks may adversely affect, among other things, (i) the value of our on- and off-balance sheet securities, trading assets, and other financial instruments, (ii) the cost of debt capital and our access to credit markets, (iii) the value of assets under management, (iv) fee income relating to assets under management, (v) customer allocation of capital among investment alternatives, (vi) the volume of client activity in our trading operations, (vii) investment banking fees, and (viii) the general profitability and risk level of the transactions in which we engage. For example, the value of certain of our assets is sensitive to changes in market interest rates. If the Federal Reserve changes or signals a change in its current mortgage securities repurchase program, market interest rates could be affected, which could adversely impact the value of such assets.
We use various models and strategies to assess and control our market risk exposures but those are subject to inherent limitations. Our models, which rely on historical trends and assumptions, may not be sufficiently predictive of future results due to limited historical patterns, extreme or unanticipated market movements and illiquidity, especially during severe market downturns or stress events. The models that we use to assess and control our market risk exposures also reflect assumptions about the degree of correlation among prices of various asset classes or other market indicators.
In times of market stress or other unforeseen circumstances, such as the market conditions experienced in 2008 and 2009, previously uncorrelated indicators may become correlated, or previously correlated indicators may move in different directions. These types of market movements have at times limited the effectiveness of our hedging strategies and have caused us to incur significant losses, and they may do so in the future. These changes in correlation can be exacerbated where other market participants are using risk or trading models with assumptions or algorithms that are similar to ours. In these and other cases, it may be difficult to reduce our risk positions due to the activity of other market participants or widespread market dislocations, including circumstances where asset values are declining significantly or no market exists for certain assets. To the extent that we own securities that do not have an established liquid trading market or are otherwise subject to restrictions on sale or hedging, we may not be able to reduce our positions and therefore reduce our risk associated with such positions. In addition, challenging market conditions may also adversely affect our investment banking fees.
For additional information about market risk and our market risk management policies and procedures, see “Quantitative and Qualitative Disclosures about Market Risk” in Part II, Item 7A of this Form 10-K.
Further downgrades in the U.S. government's sovereign credit rating, or in the credit ratings of instruments issued, insured or guaranteed by related institutions, agencies or instrumentalities, could result in risks to Merrill Lynch and its credit ratings and general economic conditions that we are not able to predict.
On June 8, 2012, S&P affirmed its AA+ long-term and A-1+ short-term sovereign credit rating on the U.S. government. The outlook remains negative. On July 10, 2012, Fitch affirmed its AAA long-term and F1+ short-term sovereign credit rating on the U.S. government. The outlook remains negative. Moody's also rates the U.S. government AAA with a negative outlook. All three rating agencies have indicated that they will continue to assess fiscal projections and consolidation measures, as well as the medium-term economic outlook for the U.S.
There continues to be the perceived risk of a sovereign credit ratings downgrade of the U.S. government, including the ratings of U.S. Treasury securities and other government-backed securities. It is foreseeable that the ratings and perceived creditworthiness of instruments issued, insured or guaranteed by institutions, agencies or instrumentalities directly linked to the U.S. government could also be correspondingly affected by any such downgrade. Instruments of this nature are key assets on the balance sheets of financial institutions, including Merrill Lynch, and are widely used as collateral by financial institutions to meet their day-to-day cash flows in the short-term debt market. A downgrade of the sovereign credit ratings of the U.S. government and perceived creditworthiness of U.S. government-related obligations could impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. A downgrade may also adversely affect the market value of such instruments.
We cannot predict if, when or how any changes to the credit ratings or perceived creditworthiness of these organizations will affect economic conditions. The credit rating agencies’ ratings for Bank of America (and consequently, Merrill Lynch) could be directly or indirectly impacted by a downgrade of the U.S. government’s sovereign rating because the credit ratings of large systemically important financial institutions currently incorporate a degree of uplift due to assumptions concerning government support.
A downgrade of the sovereign credit ratings of the U.S. government or the credit ratings of related institutions, agencies or instrumentalities would significantly exacerbate the other risks to which Merrill Lynch is subject and any related adverse effects on our business, financial condition and results of operations.
Our business may be affected by uncertainty about the financial stability of several European Union ("EU") countries, the risk that those countries may default on their sovereign debt and related stresses on financial markets, the Euro and the EU. Risks and ongoing concerns about the debt crisis in Europe could have a detrimental impact on the global economic recovery, sovereign and non-sovereign debt in these countries and the financial condition of European financial institutions, and international financial institutions with exposure to the region, including us. Market and economic disruptions have affected, and may continue to affect, consumer confidence levels and spending, personal bankruptcy rates, levels of incurrence and default on consumer debt and residential mortgages, and housing prices, among other factors. There can be no assurance that the market disruptions in Europe, including the increased cost of funding for certain governments and financial institutions, and the possible loss of EU member states, will not spread, nor can there be any assurance that future assistance packages will be available or, even if provided, will be sufficient to stabilize the affected countries and markets in Europe or elsewhere. To the extent European economic recovery uncertainty continues to negatively impact consumer confidence and consumer credit factors, or should the EU enter a deep recession, both the U.S. economy and our business and results of operations could be adversely affected.
Merrill Lynch has substantial U.K. net deferred tax assets, which consist primarily of net operating losses ("NOLs") that are realizable by a few non-U.S. subsidiaries that have a recent history of cumulative losses. These net deferred tax assets relate to NOLs that may be realized over an extended number of years. Management has concluded that no valuation allowance is necessary with respect to such net deferred tax assets, based in part on current expectations, including regarding the cessation of certain business activities, changes to capital and funding, forecasts of business activities and the indefinite period to carry forward NOLs. Significant changes to those expectations, such as would be caused by a substantial and prolonged worsening of the condition of Europe's capital markets, could lead management to reassess its valuation allowance conclusions.
Global economic uncertainty, regulatory initiatives and reform have impacted, and will likely continue to impact, non-U.S. credit and trading portfolios. There can be no assurance our risk mitigation efforts in this respect will be sufficient or successful. Our total sovereign and non-sovereign exposure to Greece, Italy, Ireland, Portugal, and
Spain was $2.9 billion at December 31, 2012. Our total net sovereign and non-sovereign exposure to these countries was $1.5 billion at December 31, 2012, after taking into account net credit default protection. At December 31, 2012, the fair value of net credit default protection purchased was $1.4 billion. Losses could still result because our credit protection contracts pay out only under certain scenarios.
For additional information regarding our direct sovereign and non-sovereign exposures in Europe, see “Quantitative and Qualitative Disclosures about Market Risk - Credit Risk Management” in Part II, Item 7A of this Form 10-K.
We may incur losses if the values of certain assets decline. We have a large portfolio of financial instruments, including, among others, certain corporate loans and loan commitments, loans held-for-sale, repurchase agreements, long-term deposits, trading assets and liabilities, derivatives assets and liabilities, available-for-sale securities and certain other assets and liabilities that we measure at fair value. We determine the fair values of these instruments based on the fair value hierarchy under applicable accounting guidance. The fair values of these financial instruments include adjustments for market liquidity, credit quality and other transaction-specific factors, where appropriate.
Gains or losses on these instruments can have a direct and significant impact on our results of operations, unless we have effectively hedged our exposures. Fair values may be impacted by declining values of the underlying assets or the prices at which observable market transactions occur and the continued availability of these transactions. The financial strength of counterparties with whom we have economically hedged some of our exposure to these assets, also will affect the fair value of these assets. Sudden declines and volatility in the prices of assets may substantially curtail or eliminate the trading activity for these assets, which may make it difficult to sell, hedge or value such assets. The inability to sell or effectively hedge assets reduces our ability to limit losses in such positions and the difficulty in valuing assets may increase our risk-weighted assets, which requires us to maintain additional capital and increases our funding costs.
Asset values also directly impact revenues in our asset management businesses. We receive asset-based management fees based on the value of our clients’ portfolios or investments in funds managed by us and, in some cases, we also receive incentive fees based on increases in the value of such investments. Declines in asset values can reduce the value of our clients’ portfolios or fund assets, which in turn can result in lower fees earned for managing such assets.
For additional information about fair value measurements, see Note 4 and Note 5 to the Consolidated Financial Statements.
Changes in the method of determining the London Interbank Offered Rate (“LIBOR”) or other reference rates may adversely impact the value of debt securities and other financial instruments we hold or issue that are linked to LIBOR or other reference rates in ways that are difficult to predict and could adversely impact our financial condition or results of operations. In recent years, concerns have been raised about the accuracy of the calculation of the daily LIBOR. The method for determining how LIBOR is formulated and its use in the market going forward may change, including, but not limited to, replacing the administrator of LIBOR, reducing the currencies and tenors for which LIBOR is calculated and requiring banks to provide LIBOR submissions based on actual transaction data or otherwise changing the structure of LIBOR, each of which could impact the volatility of LIBOR. Similar changes may occur with respect to other reference rates. Accordingly, it is not currently possible to determine whether, or to what extent, any such changes would impact the value of any debt securities we hold or issue that are linked to LIBOR or other reference rates, or any loans, derivatives and other financial obligations or extensions of credit we hold or which are due to us, or for which we are an obligor, that are linked to LIBOR or other reference rates, or whether, or to what extent, such changes would impact our financial condition or results of operations.
Regulatory and Legal Risk
Government measures to regulate the financial services industry, including the Financial Reform Act, have increased and will continue to increase our compliance and operating costs and could require us to change certain of our business practices, limit our product offerings, limit our ability to efficiently pursue business opportunities, require an increase to our capital, impact asset values, and reduce our revenues. As a financial institution, we are heavily regulated at the state, federal and international levels. Following the financial crisis and related global
economic downturn, we have faced and expect to continue to face increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our business. These regulatory and legislative measures, either individually, in combination or in the aggregate, could require us to further change our business practices, impose additional costs on us, limit our product offerings, limit our ability to efficiently pursue business opportunities, require an increase to our capital, impact asset values and reduce our revenues.
Federal banking and regulatory agencies have proposed regulations under the Financial Reform Act to limit proprietary trading as well as the sponsorship of or investment in hedge funds and private equity funds (the “Volcker Rule”). The proposed regulations include clarifications to the definition of proprietary trading and distinctions between permitted and prohibited activities. Although the comment period for these proposed regulations has expired, the regulatory agencies have not finalized the Volcker Rule regulations.
The statutory provisions of the Volcker Rule became effective on July 21, 2012 and gave financial institutions two years from the effective date, with the possibility for extensions for certain investments, to bring activities and investments into compliance with the statutory provisions and final regulations. Although Merrill Lynch exited its stand-alone proprietary trading business as of June 30, 2011 in anticipation of the Volcker Rule and to further our initiative to optimize our balance sheet, the ultimate impact of the Volcker Rule on us remains uncertain as the regulations implementing the Volcker Rule are not final. However, based on the content of the proposed regulations, it is possible the Volcker Rule implementation could limit or restrict our remaining trading activities. If exemptions in the Volcker Rule and the proposed regulations are not available, the Volcker Rule could also limit or restrict our ability to sponsor and hold ownership interests in hedge funds, private equity funds and other subsidiary operations. Additionally, the Volcker Rule could increase our operational and compliance costs, reduce our trading revenues and adversely affect our results of operations. The date on which final regulations will be issued is currently uncertain.
Additionally, the Financial Reform Act includes measures to broaden the scope of derivative instruments subject to regulation by requiring clearing and exchange trading of certain derivatives; imposing new capital, margin, reporting, registration and business conduct requirements for certain market participants; and imposing position limits on certain OTC derivatives. The Financial Reform Act grants the U.S. Commodity Futures Trading Commission (the "CFTC") and the SEC substantial new authority and requires numerous rulemakings by these agencies. Swaps dealers conducting dealing activity with U.S. persons above a specified dollar threshold were required to register with the CFTC on or before December 31, 2012. Upon registration, swap dealers became subject to additional CFTC rules relating to business conduct and reporting, and will continue to become subject to additional CFTC rules as and when such rules take effect.
The Financial Reform Act required regulators to promulgate the rulemakings necessary to implement these regulations by July 16, 2011. However, the rulemaking process was not completed as of that date, and is not expected to conclude until well into 2013. Further, the regulators granted temporary relief from certain requirements that would have taken effect on July 16, 2011 absent any rulemaking. The SEC temporary relief is effective until final rules relevant to each requirement become effective. The CFTC temporary relief largely expired on December 31, 2012. The CFTC also granted relief from some of the rules that would have become effective during the fourth quarter of 2012, either completely suspending or delaying the application of some requirements.
While the CFTC has provided temporary exemptive relief from application of derivatives requirements of the Financial Reform Act for certain non-U.S. derivatives activity, there remains some uncertainty as to how the derivatives requirements of the Financial Reform Act will apply to non-U.S. derivatives activity because the CFTC has not yet adopted final cross-border guidance. The CFTC has completed much of its other rulemakings, with the exception of final margin, capital and exchange trading rules, while the SEC has finalized a small number of clearing-related rules. The ultimate impact of the derivatives regulations that have not yet been finalized, and the time it will take to comply, continue to remain uncertain. The final regulations will impose additional operational and compliance costs on us and may require us to restructure certain businesses and may negatively impact our results of operations.
Similarly, in the U.K., the FSA has issued proposed rules requiring the submission of significant information about certain U.K. incorporated subsidiaries and other financial institutions, as well as branches of non-U.K. banks located in the U.K (including information on intra-group dependencies, legal entity separation and barriers to resolution) to allow the FSA to develop resolution plans. As a result of the FSA review, we could be required to take certain actions over the next several years, which could impose operational costs and potentially result in the restructuring of certain businesses and subsidiaries.
Many of the provisions under the Financial Reform Act have only begun to be implemented or remain to be implemented in the future and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. The Financial Reform Act will continue to impact our earnings through revenue reductions, higher costs and imposition of new restrictions on us. The Financial Reform Act may also continue to have a material adverse impact on the value of certain assets and liabilities held on our balance sheet. The ultimate impact of the Financial Reform Act on our business will depend on regulatory interpretation and rulemaking, as well as the success of any of our actions to mitigate the negative impacts of certain provisions.
Changes in the structure of the GSEs and the relationship among the GSEs, the government and the private markets, or the conversion of the current conservatorship of the GSEs into receivership, could result in significant changes to our business operations and may adversely impact our business. Each GSE is currently in a conservatorship, with its primary regulator, the Federal Housing Finance Agency (the "FHFA"), acting as conservator. During these conservatorships the FHFA may increasingly converge certain risk management and other standards and practices of each enterprise, which could result in a more uniform market for delivering agency conforming mortgage loans. We cannot predict if, when or how the conservatorships will end, or any associated changes to the GSEs' business structure that could result. We also cannot predict whether the conservatorships will end in receivership. There are several proposed approaches to reform the GSEs which, if enacted, could change the structure of the GSEs and the relationship among the GSEs, the government and the private markets, including the trading markets for agency conforming mortgage loans and markets for mortgage-related securities in which we participate. We cannot predict the prospects for the enactment, timing or content of legislative or rulemaking proposals regarding the future status of the GSEs. Accordingly, there continues to be uncertainty regarding the future of the GSEs, including whether they will continue to exist in their current form.
We are subject to significant financial and reputational risks from potential legal liability and regulatory action. We face significant legal risks in our business, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against us and other financial institutions remain high and are increasing. Increased litigation costs, substantial legal liability or significant regulatory action against us could have material adverse effects on our financial condition and results of operations or cause significant reputational harm to us, which in turn could adversely impact our business prospects. In addition, we continue to face increased litigation risk and regulatory scrutiny. We continue to experience increased litigation and other disputes with counterparties regarding relative rights and responsibilities. Consumers, clients and other counterparties have grown more litigious. Our experience with certain regulatory authorities suggests a migration towards an increasing supervisory focus on enforcement, including in connection with alleged violations of law and customer harm. The current environment of additional regulation, increased regulatory compliance burdens, and enhanced regulatory enforcement, combined with ongoing uncertainty related to the continuing evolution of the regulatory environment, has resulted in significant operational and compliance costs and may limit our ability to continue providing certain products and services.
For information concerning certain litigation-related expenses recognized for 2012 and 2011, the estimated aggregate range of possible losses in excess of the accrued liability (if any) related to litigation matters (where an estimate is possible) at December 31, 2012, as well as a further discussion of litigation risks, see Note 14 to the Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Our business prospects are vulnerable to changes in governmental fiscal and monetary policy. Our businesses and earnings are affected by domestic and international fiscal and monetary policy. The Federal Reserve regulates the supply of money and credit in the U.S. and its policies affect our cost of funds for lending, investing and capital raising activities and the return we earn on those loans and investments, both of which affect our net interest revenue. The Federal Reserve's actions also can affect the value of financial instruments and other assets, such as
debt securities, and its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Our businesses and earnings are also affected by the fiscal or other policies that are adopted by the U.S. government, various U.S. regulatory authorities and non-U.S. governments and regulatory authorities. Changes in domestic and international fiscal and monetary policies are beyond our control and difficult to predict, but could have an adverse impact on our capital requirements and the costs of running our business.
We may be adversely affected by changes in U.S. and non-U.S. tax and other laws and regulations. The U.S. Congress and the Administration have signaled interest in reforming the U.S. corporate income tax code. Possible approaches include lowering the 35% corporate tax rate, modifying the taxation of income earned outside of the U.S. and limiting or eliminating various other deductions, tax credits and/or other tax preferences. It is not possible at this time to quantify either the one-time impact from remeasuring deferred tax assets and liabilities that might result upon tax reform enactment or the ongoing impact reform might have on income tax expense.
In addition, income from certain non-U.S. subsidiaries has not been subject to U.S. income tax as a result of long-standing deferral provisions applicable to income that is derived in the active conduct of a banking and financing business abroad (active finance income). The U.S. Congress has extended the application of these deferral provisions several times, most recently in January 2013. These provisions now are set to expire for taxable years beginning on or after January 1, 2014. Absent an extension of these provisions, active financing income earned by certain non-U.S. subsidiaries will generally be subject to a tax provision that considers incremental U.S. income tax. The impact of the expiration of these provisions would depend upon the amount, composition and geographic mix of our future earnings.
Other countries have also proposed and adopted certain regulatory changes targeted at financial institutions or that otherwise affect us. The EU has adopted increased capital requirements and the U.K. has (i) increased liquidity requirements for local financial institutions, including regulated U.K. subsidiaries of non-U.K. bank holding companies and other financial institutions as well as branches of non-U.K. banks located in the U.K.; (ii) adopted a Bank Levy, which will apply to the aggregate balance sheet of branches and subsidiaries of non-U.K. banks and banking groups operating in the U.K.; and (iii) proposed the creation and production of recovery and resolution plans by U.K.-regulated entities.
On July 17, 2012, the U.K. 2012 Finance Bill was enacted, which reduced the corporate income tax rate by two percent to 23%. The first one percent reduction was effective April 1, 2012 and the second will be effective April 1, 2013. These rate reductions favorably affect income tax expense on future U.K. earnings, but also required us to remeasure our U.K. net deferred tax assets using the lower tax rates. The income tax benefit for the year ended December 31, 2012 included a $781 million charge for the remeasurement. If the U.K. corporate income tax rate were to be reduced to 21% by 2014, as suggested in U.K. Treasury announcements and assuming no change in the deferred tax asset balance, we would record a charge to income tax expense of approximately $800 million in the period of enactment. We are also monitoring other international legislative proposals that could impact us, such as changes to corporate income tax laws. Currently, in the U.K., NOL carryforwards have an indefinite life. Were the U.K. taxing authorities to introduce limitations on the future utilization of NOLs and we were unable to document our continued ability to fully utilize our NOLs, we would be required to establish a valuation allowance by a charge to income tax expense.
Risk of the Competitive Environment in Which We Operate
We face significant and increasing competition in the financial services industry. We operate in a highly competitive environment. Over time, there has been substantial consolidation among companies in the financial services industry, and this trend accelerated in recent years. This trend has also hastened the globalization of the securities and financial services markets. We will continue to experience intensified competition as consolidation and globalization of the financial services industry may produce larger, better-capitalized and more geographically diverse companies that are capable of offering a wider array of financial products and services at more competitive prices. To the extent we expand into new business areas and new geographic regions, we may face competitors with more experience and more established relationships with clients, regulators and industry participants in the relevant market, which could adversely affect our ability to compete. In addition, technological advances and the growth of e-commerce have made it possible for non-depository institutions to offer products and services that traditionally
were banking products, and for financial institutions to compete with technology companies in providing electronic and internet-based financial solutions. Increased competition may negatively affect our earnings by creating pressure to lower prices on our products and services and/or reducing market share.
Damage to our reputation could significantly harm our businesses, including our competitive position and business prospects. Our ability to attract and retain customers, clients, investors and employees is impacted by our reputation. We continue to face increased public and regulatory scrutiny resulting from the financial crisis and economic downturn, as well as our acquisition by Bank of America and the suitability or reasonableness of recommending particular trading or investment strategies.
Significant harm to our reputation can also arise from other sources, including indirectly as a result of actions by Bank of America or damage to its reputation, employee misconduct, litigation or regulatory outcomes, failing to deliver minimum or required standards of service and quality, compliance failures, unethical behavior, unintended disclosure of confidential information, and the activities of our clients, customers and counterparties, including vendors. Actions by the financial services industry generally or by certain members or individuals in the industry also can significantly adversely affect our reputation.
We are subject to complex and evolving laws and regulations regarding privacy, data protections and other matters.
Principles concerning the appropriate scope of consumer and commercial privacy vary considerably in different jurisdictions, and regulatory and public expectations regarding the definition and scope of consumer and commercial privacy may remain fluid in the future. It is possible that these laws may be interpreted and applied by various jurisdictions in a manner inconsistent with our current or future practices, or that is inconsistent with one another. We face regulatory, reputational and operational risks if personal, confidential or proprietary information of customers or clients in our possession is mishandled or misused.
We could suffer significant reputational harm if we fail to properly identify and manage potential conflicts of interest. Management of potential conflicts of interest has become increasingly complex as we expand our business activities through more numerous transactions, obligations and interests with and among our clients. The failure to adequately address, or the perceived failure to adequately address, conflicts of interest could affect the willingness of clients to deal with us, or give rise to litigation or enforcement actions, which could adversely affect our businesses.
Our actual or perceived failure to address these and other issues gives rise to reputational risk that could cause significant harm to us and our business prospects, including failure to properly address operational risks. Failure to appropriately address any of these issues could also give rise to additional regulatory restrictions, legal risks and reputational harm, which could, among other consequences, increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause us to incur related costs and expenses.
Our ability to attract and retain qualified employees is critical to the success of our business and failure to do so could hurt our business prospects and competitive position. Our performance is heavily dependent on the talents and efforts of highly skilled individuals. Competition for qualified personnel within the financial services industry and from businesses outside the financial services industry has been, and is expected to continue to be, intense. Our competitors include non-U.S.-based institutions and institutions subject to different compensation and hiring regulations than those imposed on U.S. institutions and financial institutions. The difficulty we face in competing for key personnel is exacerbated in emerging markets, where we are often competing for qualified employees with entities that may have a significantly greater presence or more extensive experience in the region.
In order to attract and retain qualified personnel, we must provide market-level compensation. As a subsidiary of Bank of America, we may be subject to limitations on compensation practices (which may or may not affect our competitors) by regulators in the U.S. or around the world. Any future limitations on executive compensation imposed by legislation or regulation could adversely affect our ability to attract and maintain qualified employees. Furthermore, a substantial portion of our annual incentive compensation paid to our senior employees has in recent years taken the form of long-term equity awards. Therefore, the ultimate value of of this compensation depends on the price of Bank of America's common stock when the awards vest. If we are unable to continue to attract and retain qualified individuals, our business prospects and competitive position could be adversely affected.
In addition, if we fail to retain the wealth advisors that we employ in our wealth and investment management business, particularly those with significant client relationships, such failure could result in a significant loss of clients or the withdrawal of significant client assets.
We may not be able to achieve expected cost savings from cost-saving initiatives, including from Project New BAC, or in accordance with currently anticipated time frames. We are currently engaged in numerous efforts to achieve certain cost savings, including, among other things, Project New BAC.
Project New BAC is a two-phase, enterprise-wide initiative to simplify and streamline workflows and processes, align businesses and costs more closely with Bank of America's overall strategic plan and operating principles, and increase revenues. Phase 1 focused on Bank of America's consumer businesses and related support, technology and operations functions. Phase 2 focuses on businesses and related support, technology and operations functions not subject to evaluation in Phase 1. All aspects of Phase 1 of Project New BAC are currently expected to be implemented by the end of 2013, with Phase 2 expected to be fully implemented by mid-2015.
We may be unable to fully realize the cost savings and other anticipated benefits from our cost saving initiatives, or in accordance with currently anticipated timeframes.
Our inability to adapt our products and services to evolving industry standards and consumer preferences could harm our business. Our success depends on our ability to adapt our products and services to evolving industry standards. There is increasing pressure by competitors to provide products and services at lower prices. This can reduce our revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, could require us to incur substantial expenditures to modify or adapt our existing products and services. We might not be successful in developing or introducing new products and services, responding or adapting to changes in consumer spending and saving habits, achieving market acceptance of our products and services, or sufficiently developing and maintaining loyal customers.
Risks Related to Risk Management
Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses. Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our exposure to the types of risk to which we are subject, including strategic, credit, market, liquidity, compliance, operational and reputational risks, among others. While we employ a broad and diversified set of risk monitoring and mitigation techniques, those techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions, heightened legislative and regulatory scrutiny of the financial services industry and increases in the overall complexity of our operations, among other developments, have resulted in a heightened level of risk for us. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.
A failure in or breach of our operational or security systems or infrastructure, or those of third parties with which we do business, including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses. Our business is highly dependent on our ability to process, record and monitor, on a continuous basis, a large number of transactions, many of which are highly complex, across numerous and diverse markets in many currencies. The potential for operational risk exposure exists throughout our organization, and is not limited to operations functions. Operational risk exposures can impact our results of operations, such as losses resulting from unauthorized trades by employees, and their impact may extend beyond financial losses.
Integral to our performance is the continued efficacy of our internal processes, systems, relationships with third parties and the vast array of employees and key executives in our day-to-day and ongoing operations. With regard to the physical infrastructure and systems that support our operations, we have taken measures to implement backup systems and other safeguards, but our ability to conduct business may be adversely affected by any significant and widespread disruption to our infrastructure or systems. Our financial, accounting, data processing, backup or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control and adversely affect our ability to process these transactions or provide these services. There could be sudden increases in customer transaction volume;
electrical or telecommunications outages; natural disasters such as earthquakes, tornadoes and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and cyber attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones.
Information security risks for large financial institutions such as Bank of America and Merrill Lynch have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks. We rely on our digital technologies, computer and email systems, software, and networks to conduct our operations. In addition, to access our products and services, our customers may use personal smartphones, PCs and other computing devices, tablet PCs, and other mobile devices that are beyond our control systems. Our technologies, systems, networks, and our customers' devices have been subject to, and are likely to continue to be the target of, cyber attacks, computer viruses, malicious code, phishing attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers' confidential, proprietary and other information, or otherwise disrupt our or our customers' or other third parties' business operations. For example, our websites have been subject to a series of distributed denial of service cyber security incidents. Although these incidents have not had a material impact on Merrill Lynch, nor have they resulted in unauthorized access to our or our customers' confidential, proprietary or other information, because of our prominence, we believe that such incidents may continue.
Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the prominent size and scale of Bank of America and Merrill Lynch and their roles in the financial services industry, their expanded geographic footprint and international presence, the outsourcing of some of their business operations, the continued uncertain global economic environment, threats of cyberterrorism, and system and customer account conversions. As a result, cybersecurity and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
In addition, we also face the risk of operational failure, termination or capacity constraints of any of the third parties with which we do business or that facilitate our business activities, including clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions. In recent years, there has been significant consolidation among clearing agents, exchanges and clearing houses and increased interconnectivity of multiple financial institutions with central agents, exchanges and clearing houses. This consolidation and interconnectivity increases the risk of operational failure, on both individual and industry-wide bases, as disparate complex systems need to be integrated, often on an accelerated basis. Any such failure, termination or constraint could adversely affect our ability to effect transactions, service our clients, manage our exposure to risk or expand our businesses and could have an adverse impact on our liquidity, financial condition and results of operations.
Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in the loss of customers and business opportunities, significant business disruption to our operations and business, misappropriation of our confidential information and/or that of our customers, or damage to our computers or systems and those of our customers and/or counterparties, and could result in violations of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, and additional compliance costs.
Risk of Being an International Business
We are subject to numerous political, economic, market, reputational, operational, legal, regulatory and other risks in the non-U.S. jurisdictions in which we operate. We do business throughout the world, including in developing regions of the world commonly known as emerging markets. Our businesses and revenues derived from non-U.S. jurisdictions are subject to risk of loss from currency fluctuations, social or judicial instability, changes in governmental policies or policies of central banks, expropriation, nationalization and/or confiscation of assets, price controls, capital controls, exchange controls, other restrictive actions, unfavorable political and diplomatic developments and changes in legislation. These risks are especially acute in emerging markets. Many non-U.S. jurisdictions in which we do business have been negatively impacted by recessionary conditions. While a number of these jurisdictions are showing signs of recovery, others continue to experience increasing levels of stress. In addition, the increasing potential risk of default on sovereign debt in some non-U.S. jurisdictions could expose us to substantial losses. Risks in one country can affect our operations in another country or countries, including our operations in the U.S. As a result, any such unfavorable conditions or developments could have an adverse impact on our company.
Our non-U.S. businesses are also subject to extensive regulation by various non-U.S. regulators, including governments, securities exchanges, central banks and other regulatory bodies, in the jurisdictions in which those businesses operate. In many countries, the laws and regulations applicable to the financial services and securities industries are uncertain and evolving, and it may be difficult for us to determine the exact requirements of local laws in every market or manage our relationships with multiple regulators in various jurisdictions. Our inability to remain in compliance with local laws in a particular market and manage our relationships with regulators could have an adverse effect not only on our businesses in that market but also on our reputation generally.
We also invest or trade in the securities of corporations and governments located in non-U.S. jurisdictions, including emerging markets. Revenues from the trading of non-U.S. securities may be subject to negative fluctuations as a result of the above factors. Furthermore, the impact of these fluctuations could be magnified because non-U.S. trading markets, particularly in emerging market countries, are generally smaller, less liquid and more volatile than U.S. trading markets.
In addition to non-U.S. legislation, our international operations are also subject to U.S. legal requirements. For example, our international operations are subject to U.S. laws on foreign corrupt practices, the Office of Foreign Assets Control, and anti-money laundering regulations. Additionally, we are subject to Section 13(r) of the Securities Exchange Act of 1934, which requires a registrant to provide disclosure in its periodic reports and file a notice with the SEC if it or its affiliates knowingly engage in certain activities identified under the Iran Threat Reduction and Syria Human Rights Act of 2012. The SEC is required to report any such disclosure to the U.S. President and certain Congressional committees. The President thereafter is required to initiate an investigation into the reported activity and, within 180 days of initiating such an investigation, determine whether sanctions should be imposed. If we are required to report any such activities, whether or not any sanctions are actually imposed on us or our affiliates as a result of these activities, our reputation could be harmed and our results of operations could be adversely impacted.
We are subject to geopolitical risks, including acts or threats of terrorism, and actions taken by the U.S. or other governments in response thereto and/or military conflicts that could adversely affect business and economic conditions abroad as well as in the U.S.
Risk from Accounting Changes
Changes in accounting standards or inaccurate estimates or assumptions in applying accounting policies could adversely affect us. Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the reported value of our assets or liabilities and results of operations and are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. If those assumptions, estimates or judgments were incorrectly made, we could be required to correct and restate prior-period financial statements.
Accounting standard-setters and those who interpret the accounting standards (such as the Financial Accounting Standards Board (the "FASB"), the SEC and our independent registered public accounting firm) may also amend or even reverse their previous interpretations or positions on how various standards should be applied. These changes may be difficult to predict and could impact how we prepare and report our financial statements. In some cases, we could be required to apply a new or revised standard retroactively, resulting in Merrill Lynch needing to revise and republish prior-period financial statements.
On December 20, 2012, the FASB issued a proposed standard on accounting for expected credit losses. The standard would replace multiple existing impairment models, including replacing an “incurred loss” model for loans with an “expected credit loss” model. The FASB announced it will establish the effective date when it issues the final standard. We cannot predict whether or when a final standard will be issued, when it will be effective or what its final provisions will be. It is possible that the final standard could have a material adverse impact on our consolidated results of operations once it is issued and becomes effective.
For further information on some of our critical accounting policies and standards and recent accounting changes, see Note 1 to the Consolidated Financial Statements.
Risk of Being a Wholly-Owned Subsidiary
We are a direct wholly-owned subsidiary of Bank of America and therefore are subject to strategic decisions of Bank of America and affected by Bank of America’s performance. We are fundamentally affected by our relationship with Bank of America. As a direct wholly-owned subsidiary of Bank of America, we are subject to a wide range of possible strategic decisions that Bank of America may make from time to time. Those strategic decisions could include the level and types of financing and other support made available to us by Bank of America. In addition, circumstances and events affecting Bank of America can significantly affect us. For example, the primary drivers of our credit ratings are Bank of America’s credit ratings, and when rating agencies take actions regarding Bank of America’s credit ratings and outlooks, they generally take the same actions with respect to our ratings and outlooks. Also, we have several borrowing arrangements and a globally coordinated funding strategy with Bank of America. Significant changes in Bank of America’s strategy or its relationship with us could have a material adverse effect on our business. Material adverse changes in the performance of Bank of America or its other subsidiaries could have a material adverse effect on our results of operations, financial condition and liquidity. We are indirectly exposed, therefore, to many of the risks to which Bank of America is directly exposed. Bank of America has not assumed or guaranteed the long-term debt that was issued or guaranteed by ML & Co. or its subsidiaries prior to the acquisition of Merrill Lynch by Bank of America.
As a wholly-owned subsidiary of Bank of America, a bank holding company that is also a financial holding company, we are subject to the oversight of, and inspection by, the Federal Reserve. If Bank of America does not comply with regulatory requirements applicable to banking institutions with respect to regulatory capital, capital ratios and liquidity and required increases in the foregoing, our liquidity would be adversely affected. In order to comply with such requirements, Bank of America may be required to liquidate company assets, among other actions. Our activities are limited to those that are permissible for Bank of America under applicable laws and regulations. As a financial holding company, Bank of America (directly or through its subsidiaries) may engage in activities that are “financial in nature.” Bank of America’s status as a financial holding company requires, among other conditions, that each of its subsidiary insured depository institutions be well-capitalized and well-managed. Failure to satisfy these conditions may result in the Federal Reserve limiting the activities of Bank of America, which thereby could restrict our current business activities, require divestiture of certain of our assets and operations or limit potential future strategic plans.
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Item 1B. | Unresolved Staff Comments |
Not applicable.
As of December 31, 2012, our principal offices and other materially important properties consisted of the following:
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Facility Name | Location | General Character of the Physical Property | Property Status | Property Sq. Ft. (1) |
4 World Financial Center | New York, NY | 34 Story Building | Leased | 1,636,512 |
2 World Financial Center | New York, NY | 44 Story Building | Leased | 674,726 |
Hopewell Campus | Hopewell, NJ | 8 Building Campus with 4 Ancillary Buildings | Leased | 1,788,961 |
Jacksonville Campus | Jacksonville, FL | 4 Building Campus | Owned | 577,402 |
Merrill Lynch Financial Centre | London, UK | 4 Building Campus | Leased | 568,256 |
Nihonbashi 1-Chome Building | Tokyo, Japan | 24 Story Building | Leased | 208,498 |
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(1) For leased properties, Property Sq. Ft. represents the square footage occupied by Merrill Lynch.
Our principal executive offices are located at Bank of America Corporate Center in Charlotte, North Carolina, which is owned by one of Bank of America's subsidiaries. In addition, we have employees located at Bank of America Tower at One Bryant Park in New York, New York.
We believe our owned and leased properties are adequate for our business needs and are well maintained. We continue to evaluate our owned and leased real estate and may determine from time to time that certain of our premises and facilities, or ownership structures, are no longer necessary for our operations. In connection therewith, we are evaluating the sale or sale / leaseback of certain properties and we may incur costs in connection with any such transactions.
Refer to "Litigation and Regulatory Matters" in Note 14 to the Consolidated Financial Statements in Part II, Item 8, which is incorporated herein by reference.
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Item 4. | Mine Safety Disclosures |
None.
PART II
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Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
ML & Co. made no purchases of its common stock during the year ended December 31, 2012. There were 1,000 shares of ML & Co. common stock outstanding as of December 31, 2012, all of which were held by Bank of America Corporation.
Dividends Per Common Share
As of the date of this report, Bank of America is the sole holder of the outstanding common stock of ML & Co. There is no trading market for ML & Co. common stock. No cash dividends were declared or paid for the years ended December 31, 2012 and 2011. With the exception of regulatory restrictions on subsidiaries’ abilities to pay dividends, there were no restrictions on ML & Co.’s present ability to pay dividends on common stock, other than ML & Co.’s obligation to make payments on its junior subordinated debt related to trust preferred securities, and the governing provisions of Delaware General Corporation Law.
Securities Authorized for Issuance under Equity Compensation Plans
There are no equity securities of ML & Co. that are authorized for issuance under any equity compensation plans. Refer to Note 15 and Note 16 to the Consolidated Financial Statements for further information on employee benefit and equity compensation plans.
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Item 6. | Selected Financial Data |
Not required pursuant to General Instruction I (2).
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This report on Form 10-K, the documents that it incorporates by reference and the documents into which it may be
incorporated by reference may contain, and from time to time Merrill Lynch & Co., Inc. (“ML & Co. and, collectively with its subsidiaries, “Merrill Lynch,” the “Company,” "we,” “our” or “us”) and its management may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, “we,” “us” and “our” may refer to ML & Co. individually, ML & Co. and its subsidiaries, or certain of ML & Co.'s subsidiaries or affiliates. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as “expects,” “anticipates,” “believes,” “estimates,” “targets,” “intends,” “plans,” “goal” and other similar expressions or future or conditional verbs such as “will,” “may,” “might,” “should,” “would” and “could.” The forward-looking statements made represent the current expectations, plans or forecasts of Merrill Lynch regarding its future results and revenues and future business and economic conditions more generally, including statements concerning: that Merrill Lynch would record a charge to income tax expense of approximately $800 million if the income tax rate were reduced to 21% by 2014 as suggested in United Kingdom ("U.K.") Treasury announcements and assuming no change in the deferred tax asset balance; the expectation that unresolved repurchase claims related to private-label securitization trustees will continue to increase; the resolution of representations and warranties repurchase and other claims; the final resolution of the BNY Mellon Settlement; the estimates of liability and range of possible loss for representations and warranties repurchase claims; the possibility that future representations and warranties losses may occur in excess of the amounts recorded for those exposures; Merrill Lynch's intention to vigorously contest any requests for repurchase for which it concludes that a valid basis does not exist; that swap dealers will continue to be subject to additional Commodity Futures Trading Commission rules as and when such rules take effect; the realizability of deferred tax assets prior to expiration of any carryforward periods; effects of the ongoing debt crisis in Europe, including the expectation of continued volatility as long as challenges remain, the expectation that Merrill Lynch will continue to support client activities in the region and that exposures may vary over time as Merrill Lynch monitors the situation and manages its risk profile; liquidity; the revenue impact resulting from, and any mitigation actions taken in response to, the Dodd-Frank Wall Street Reform and Consumer Protection Act, including, but not limited to, the Volcker Rule; that it is our objective to maintain high-quality credit ratings; the estimated range of possible loss from and the impact on Merrill Lynch of various legal proceedings discussed in Note 14 to the Consolidated Financial Statements; our trading risk management processes; Bank of America's intentions to streamline its organizational structure and reduce complexity and costs by reducing the number of its subsidiaries, and that Bank of America may, subject to applicable regulatory approvals, consents and other conditions of closing, merge ML & Co. with and into Bank of America Corporation; and other matters relating to Merrill Lynch. The foregoing is not an exclusive list of all forward-looking statements we make. These statements are not guarantees of future results or performance and involve certain risks, uncertainties and assumptions that are difficult to predict and often are beyond our control. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.
You should not place undue reliance on any forward-looking statement and should consider the following uncertainties and risks, as well as the risks and uncertainties more fully discussed elsewhere in this report, under Item 1A. “Risk Factors” of this report, and in any of ML & Co.'s subsequent Securities and Exchange Commission (“SEC”) filings: Merrill Lynch's ability to resolve its representations and warranties repurchase claims made by monolines and private-label and other investors, including as a result of any adverse court rulings, and the chance that we could face related securities, fraud, indemnity or other claims from one or more of the monolines or private-label and other investors; uncertainties about the financial stability of several countries in the European Union (the "EU"), the risk that those countries may default on their sovereign debt and related stresses on financial markets, the Euro and the EU and Merrill Lynch's exposures to such risks, including direct, indirect and operational; the negative impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act on Merrill Lynch's businesses and earnings, including as a result of additional regulatory interpretation and rulemaking and the success of
Merrill Lynch's actions to mitigate such impacts; adverse changes to Merrill Lynch's credit ratings from the major credit rating agencies; estimates of the fair value of certain of Merrill Lynch's assets and liabilities; unexpected claims, damages and fines resulting from pending or future litigation and regulatory proceedings; Merrill Lynch's ability to fully realize the cost savings and other anticipated benefits from Project New BAC, including in accordance with currently anticipated timeframes; decisions to downsize, sell or close units or otherwise change the business mix of Merrill Lynch; and other similar matters.
Forward-looking statements speak only as of the date they are made, and Merrill Lynch undertakes no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.
The Notes to the Consolidated Financial Statements referred to in Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") are incorporated by reference into MD&A. Certain prior-period amounts have been reclassified in order to conform with the current year's presentation.
Introduction
Merrill Lynch was founded in 1914 and became a publicly traded company on June 23, 1971. In 1973, the holding company ML & Co. was created. Through our subsidiaries, we are one of the world's leading capital markets, advisory and wealth management companies. We are a leading global market-maker and underwriter of securities and derivatives across a broad range of asset classes, and we serve as a strategic advisor to corporations, governments, institutions and individuals worldwide. On January 1, 2009, Merrill Lynch was acquired by, and became a wholly-owned subsidiary of, Bank of America Corporation (“Bank of America”).
Intragroup Reorganization
On November 1, 2012, in connection with an intragroup reorganization involving Bank of America and a number of its subsidiaries, Merrill Lynch acquired two affiliated companies and their respective subsidiaries from Bank of America. The acquisition was effected through a non-cash capital contribution from Bank of America. In accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations, Merrill Lynch's Consolidated Financial Statements appearing in Part II, Item 8 of this Form 10-K include the historical results of the acquired affiliated companies and their subsidiaries as if the transaction had occurred as of January 1, 2009, the date at which all the affected entities were first under the common control of Bank of America. Merrill Lynch has recorded the assets and liabilities acquired in connection with the transaction at their historical carrying values, which resulted in increases to stockholder's equity and receivables from Bank of America of approximately $13.5 billion, $9.1 billion and $9.0 billion as of December 31, 2012, 2011 and 2010, respectively.
Business Segments
Pursuant to ASC 280, Segment Reporting, operating segments represent components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in determining how to allocate resources and in assessing performance. The business activities of Merrill Lynch are included within certain of the operating segments of Bank of America. Detailed financial information of the nature that could be used to allocate resources and assess the performance and operations for components of Merrill Lynch, however, is not provided to Merrill Lynch's chief operating decision maker. As a result, Merrill Lynch does not contain any identifiable operating segments under Segment Reporting, and therefore the financial information of Merrill Lynch is presented as a single segment.
Form 10-K Presentation
As a result of the acquisition of Merrill Lynch by Bank of America, certain information is not required in this Form 10-K as permitted by General Instruction I (2) of Form 10-K. We have also abbreviated the MD&A as permitted by General Instruction I (2).
We reported net income of $290 million for the year ended December 31, 2012 as compared with a net loss of $1.6 billion for the year ended December 31, 2011. Revenues, net of interest expense (“net revenues”) for 2012 were $20.2 billion compared with $24.4 billion in 2011. Our pre-tax loss was $2.3 billion in 2012 and $4.6 billion in 2011.
The improvement in our after-tax results for the year ended December 31, 2012 was primarily driven by lower non-interest expenses and certain income tax benefits reflected in our effective income tax rate, partially offset by lower net revenues.
The decline in non-interest expenses was primarily associated with our liability for representations and warranties related to our repurchase exposure on certain private-label securitizations. In the year ended December 31, 2011, we recorded a $2.7 billion provision for representations and warranties due to our determination that we had sufficient experience related to our exposure on certain private-label securitizations as a result of Bank of America's settlement with the Bank of New York Mellon during that period. In the year ended December 31, 2012, we recorded a reduction to non-interest expenses of $754 million that lowered our liability for representations and warranties exposures, since recent levels of claims and file requests with certain counterparties have been less than originally anticipated and, as a result, a portion of the loss was no longer deemed probable. See “Off-Balance Sheet Exposures - Representations and Warranties” for further information. The decline in non-interest expenses also included lower compensation and benefits and other expenses.
Our effective income tax rate was 112.8% in the year ended December 31, 2012 compared with 64.1% in the prior year. The effective income tax rate in 2012 was primarily driven by certain income tax benefits. See "Results of Operations - Year Ended December 31, 2012 Compared With Year Ended December 31, 2011" for further information.
The decline in our net revenues for the year ended December 31, 2012 was primarily attributable to lower principal transactions revenues due to the valuation of certain of our liabilities as compared with the prior year. During the year ended December 31, 2012, we recorded net losses of $3.2 billion due to the impact of the narrowing of our credit spreads on the carrying value of certain of our long-term debt liabilities, primarily structured notes, while in the year ended December 31, 2011, we recorded net gains of $2.0 billion due to the widening of our credit spreads. We also recorded losses of $1.1 billion in the year ended December 31, 2012 due to the impact of net valuation adjustments associated with the narrowing of our credit spreads on the fair value of certain derivative liabilities (i.e., the debit valuation adjustment or "DVA") as compared with gains from DVA due to the widening of our credit spreads of $493 million in the prior year. These decreases in principal transactions revenues were partially offset by improved results from our fixed income trading activities.
Transactions with Bank of America
We have entered into various transactions with Bank of America, including transactions in connection with certain sales and trading and financing activities, as well as the allocation of certain shared services. Total net revenues and non-interest expenses related to transactions with Bank of America for the year ended December 31, 2012 were $1.6 billion and $2.2 billion, respectively. Such net revenues and non-interest expenses for the year ended December 31, 2011 were $1.5 billion and $2.5 billion, respectively. Net revenues and non-interest expenses for both periods included intercompany service fee revenues and expenses from Bank of America associated with allocations of certain centralized or shared business activities between Merrill Lynch and Bank of America. See Note 2 to the Consolidated Financial Statements for further information.
On January 6, 2013, Bank of America entered into an agreement with Fannie Mae ("FNMA") to resolve substantially all outstanding and potential repurchase and certain other claims relating to the origination, sale and delivery of certain residential mortgage loans. As part of the agreement, Bank of America repurchased for $6.6 billion certain residential mortgage loans that had previously been sold to FNMA, which Bank of America valued at less than the purchase price. The majority of such loans are held by Merrill Lynch.
Other Events
Sale of International Wealth Management Businesses and Brokerage Joint Venture Investment
In 2012, we entered into agreements to sell our International Wealth Management ("IWM") businesses based outside of the U.S., subject to regulatory approval in multiple jurisdictions, and the first of a series of closings occurred in February 2013. Also, in late 2012, Merrill Lynch sold its investment in a Japanese brokerage joint venture, which resulted in a gain of approximately $370 million. The IWM businesses and the Japanese brokerage joint venture had combined client balances of approximately $115 billion.
Financial Reform Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Financial Reform Act"), which was signed into law on July 21, 2010, enacted sweeping financial regulatory reform and has altered and will continue to alter the way in which we conduct certain businesses, increase our costs and reduce our revenues. Many aspects of the Financial Reform Act remain subject to final rulemaking and will take effect over several years, making it difficult to anticipate the precise impact on Merrill Lynch, our customers or the financial services industry.
Limitations on Proprietary Trading; Sponsorship and Investment in Hedge Funds and Private Equity Funds
On October 11, 2011, the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Office of the Comptroller of the Currency (the "OCC"), the Federal Deposit Insurance Corporation (the "FDIC") and the Securities and Exchange Commission (the "SEC"), representing four of the five regulatory agencies charged with promulgating regulations implementing limitations on proprietary trading as well as the sponsorship of or investment in hedge funds and private equity funds (the "Volcker Rule") established by the Financial Reform Act, released for comment proposed implementing regulations. On January 11, 2012, the Commodity Futures Trading Commission (the "CFTC"), the fifth agency, released for comment its proposed regulations under the Volcker Rule. The proposed regulations include clarifications to the definition of proprietary trading and distinctions between permitted and prohibited activities. However, in light of the complexity of the proposed regulations and the large volume of comments received (the proposal requested comments on over 1,300 questions on 400 different topics), it is not possible to predict the content of the final regulations or when they will be issued.
The statutory provisions of the Volcker Rule became effective on July 21, 2012 and gave financial institutions two years from the effective date, with the possibility for extensions for certain investments, to bring activities and investments into compliance with the statutory provisions and final regulations. Although we exited our stand-alone proprietary trading business as of June 30, 2011 in anticipation of the Volcker Rule and to further our initiative to optimize our balance sheet, the ultimate impact of the Volcker Rule on us remains uncertain as the regulations implementing the Volcker Rule are not final. However, based on the contents of the proposed regulations, it is possible the Volcker Rule implementation could limit or restrict our remaining trading activities. If exemptions in the Volcker Rule and the proposed regulations are not available, the Volcker Rule could also limit or restrict our ability to sponsor and hold ownership interests in hedge funds, private equity funds, commodity pools and other subsidiary operations. Additionally, the Volcker Rule could increase our operational and compliance costs, reduce our trading revenues and adversely affect our results of operations.
Derivatives
The Financial Reform Act includes measures to broaden the scope of derivative instruments subject to regulation by requiring clearing and exchange trading of certain derivatives; imposing new capital, margin, reporting, registration
and business conduct requirements for certain market participants; and imposing position limits on certain over-the-counter ("OTC") derivatives. The Financial Reform Act grants the CFTC and the SEC substantial new authority and requires numerous rulemakings by these agencies. Swap dealers conducting dealing activity with U.S. persons above a specified threshold were required to register with the CFTC on or before December 31, 2012. We registered Merrill Lynch Commodities Inc., Merrill Lynch Capital Services, Inc., Merrill Lynch Financial Markets, Inc., Merrill Lynch International and Merrill Lynch International Bank Limited as swap dealers on December 31, 2012. Upon registration, swap dealers became subject to additional CFTC rules relating to business conduct and reporting, and will continue to become subject to additional CFTC rules as and when such rules take effect. Those rules include, but are not limited to, measures that require clearing and exchange trading of certain derivatives, new capital and margin requirements for certain market participants, and additional reporting requirements for derivatives under the jurisdiction of the CFTC. The CFTC also granted relief from some of the rules that would have become effective during the fourth quarter of 2012, either completely suspending or delaying the application of some requirements.
While the CFTC has provided temporary exemptive relief from application of derivatives requirements of the Financial Reform Act for certain non-U.S. derivatives activity, there remains some uncertainty as to how the derivatives requirements of the Financial Reform Act will apply to non-U.S. derivatives activity because the CFTC has not yet adopted final cross-border guidance. The CFTC has completed much of its other rulemakings, with the exception of final margin, capital and exchange trading rules, while the SEC has finalized a small number of clearing-related rules. The ultimate impact of the derivatives regulations that have not been finalized, and the time it will take to comply, remain uncertain. The final regulations will impose additional operational and compliance costs on us and may require us to restructure certain businesses and may negatively impact our results of operations.
Transactions with Affiliates
The terms of certain of our OTC derivative contracts and other trading agreements provide that upon the occurrence of certain specified events, such as a change in our credit ratings, we may be required to provide additional collateral or to provide other remedies, or our counterparties may have the right to terminate or otherwise diminish our rights under these contracts or agreements. In the event of further downgrades of our credit ratings, we may engage in discussions with certain derivative and other counterparties regarding their rights under these agreements,
including potentially naming new counterparties. Our ability to substitute or make changes to these agreements to meet counterparties’ requests may be subject to certain limitations, including counterparty willingness, regulatory limitations on naming our affiliate, Bank of America, N.A. ("BANA"), as the new counterparty, and the type or amount of collateral required. It is possible that such limitations on our ability to substitute or make changes to these agreements, including naming BANA as the new counterparty, could adversely affect our results of operations.
Other Matters
Bank of America and Merrill Lynch have established guidelines and policies for managing capital across their respective subsidiaries. The guidance for our subsidiaries with regulatory capital requirements, including branch operations of banking subsidiaries, requires each entity to maintain satisfactory capital levels. The U.K. has adopted increased capital and liquidity requirements for local financial institutions, including regulated U.K. subsidiaries of non-U.K. bank holding companies and other financial institutions as well as branches of non-U.K. banks located in the U.K. In addition, the U.K. has proposed the creation and production of recovery and resolution plans, commonly referred to as living wills, by significant regulated legal entities.
|
| | | | | | | | | | |
RESULTS OF OPERATIONS |
(dollars in millions) |
| For the Year Ended December 31, 2012 | | | For the Year Ended December 31, 2011 | | % Change between the
Year Ended
December 31, 2012 and the Year Ended December 31, 2011 |
Revenues | |
| | | |
| | |
Principal transactions | $ | 2,306 |
| | | $ | 5,876 |
| | (61)% |
Commissions | 5,079 |
| | | 5,698 |
| | (11) |
Managed account and other fee-based revenues | 5,427 |
| | | 5,203 |
| | 4 |
Investment banking | 4,914 |
| | | 5,179 |
| | (5) |
Earnings from equity method investments | 285 |
| | | 347 |
| | (18) |
Intercompany service fee revenue from Bank of America | 986 |
| | | 944 |
| | 4 |
Other revenues(1) | 1,923 |
| | | 1,749 |
| | 10 |
Subtotal | 20,920 |
| | | 24,996 |
| | (16) |
Interest and dividend revenues | 6,395 |
| | | 8,186 |
| | (22) |
Less interest expense | 7,098 |
| | | 8,785 |
| | (19) |
Net interest expense | (703 | ) | | | (599 | ) | | 17 |
Revenues, net of interest expense | 20,217 |
| | | 24,397 |
| | (17) |
Non-interest expenses | |
| | | |
| | |
Compensation and benefits | 14,608 |
| | | 15,773 |
| | (7) |
Communications and technology | 1,588 |
| | | 1,771 |
| | (10) |
Occupancy and related depreciation | 1,204 |
| | | 1,367 |
| | (12) |
Brokerage, clearing, and exchange fees | 951 |
| | | 1,121 |
| | (15) |
Advertising and market development | 501 |
| | | 500 |
| | — |
Professional fees | 921 |
| | | 1,029 |
| | (10) |
Office supplies and postage | 104 |
| | | 126 |
| | (17) |
Representations and warranties | (754 | ) | | | 2,731 |
| | N/M |
Intercompany service fee expense from Bank of America | 1,798 |
| | | 2,320 |
| | (23) |
Other | 1,554 |
| | | 2,250 |
| | (31) |
Total non-interest expenses | 22,475 |
| | | 28,988 |
| | (22) |
Pre-tax loss | (2,258 | ) | | | (4,591 | ) | | (51) |
Income tax benefit | (2,548 | ) | | | (2,944 | ) | | (13) |
Net earnings (loss) | $ | 290 |
| | | $ | (1,647 | ) | | N/M |
| | | | | | |
| |
(1) | Amounts include other income and other-than-temporary impairment losses on available-for-sale debt securities. The other-than-temporary impairment losses were $6 million and $59 million for the years ended December 31, 2012 and December 31, 2011, respectively. |
N/M = Not meaningful.
Consolidated Results of Operations
Our net earnings for the year ended December 31, 2012 were $290 million compared with a net loss of $1.6 billion for the year ended December 31, 2011. Net revenues for 2012 were $20.2 billion compared with $24.4 billion in 2011.
Year Ended December 31, 2012 Compared With Year Ended December 31, 2011
Principal transactions revenues include both realized and unrealized gains and losses on trading assets and trading liabilities and investment securities classified as trading. Principal transactions revenues were $2.3 billion for the year ended December 31, 2012 compared with $5.9 billion for the year ended December 31, 2011. The decline was primarily due to a decrease in revenue associated with the valuation of certain of our liabilities. During the year ended December 31, 2012, we recorded net losses of $3.2 billion due to the impact of the narrowing of Merrill Lynch's credit spreads on the carrying value of certain of our long-term debt liabilities, primarily structured notes, while in the year ended December 31, 2011, we recorded net gains of $2.0 billion due to the widening of our credit spreads. We also recorded losses from DVA of $1.1 billion in the year ended December 31, 2012 as compared with
gains from DVA of $493 million in the prior year. In addition, as discussed below, principal transactions revenues in 2011 included $418 million of net revenues associated with our stand-alone proprietary trading business, which we exited in June 2011. These decreases in principal transactions revenues were partially offset by improved results from our fixed income trading activities, primarily in our mortgage, credit and rates and currencies businesses. Conditions in the fixed income markets were generally more favorable in 2012 due to an improved global economic climate. During 2011, market conditions were generally difficult as a result of concerns over global and U.S. economic conditions, regulatory uncertainty and the implications of the European sovereign debt crisis, which contributed to heightened market volatility and increased risk aversion among investors. Revenues from our mortgage products business improved, as the results from the year ended December 31, 2011 reflected the more difficult market conditions and included losses from credit valuation adjustments related to financial guarantors. Revenues from credit products increased as lower market volatility drove credit spreads tighter. Investor demand for investment grade and high yield corporate instruments also increased as a result of the lower volatility and relative outperformance compared with 2011. Revenues from rates and currency products also increased, resulting from the improvement in market conditions as compared with the prior year as well as improved positioning.
Included in principal transactions revenues for the year ended December 31, 2011 were net revenues associated with activities we identified as “proprietary trading,” which was conducted separately from our customer trading activities. Our stand-alone proprietary trading operations engaged in trading activities in a variety of products, including stocks, bonds, currencies and commodities. In connection with regulatory reform measures and our initiative to optimize our balance sheet, we exited our stand-alone proprietary trading business as of June 30, 2011. The revenues from these operations for the year ended December 31, 2011 were $442 million, of which $418 million were included within principal transactions revenues. The remainder of the revenues for these operations were primarily recorded within net interest revenues. See also “Executive Overview - Other Events - Limitations on Proprietary Trading; Sponsorship and Investment in Hedge Funds and Private Equity Funds."
Net interest expense is a function of (i) the level and mix of total assets and liabilities, including trading assets, deposits, financing and lending transactions, and trading strategies associated with our businesses, and (ii) the prevailing level, term structure and volatility of interest rates. Net interest expense is an integral component of trading activity. In assessing the profitability of our client facilitation and trading activities, we view principal transactions and net interest expense in the aggregate as net trading revenues. Changes in the composition of trading inventories and hedge positions can cause the mix of principal transactions revenue and net interest expense to fluctuate from period to period. Net interest expense was $703 million for the year ended December 31, 2012 as compared with net interest expense of $599 million in the year ended December 31, 2011. The increase in net interest expense was primarily due to lower net interest revenues generated from our fixed income trading activities, partially offset by lower financing costs.
Commissions revenues primarily arise from agency transactions in listed and OTC equity securities and commodities and options. Commissions revenues also include distribution fees for promoting and distributing mutual funds. Commissions revenues were $5.1 billion for the year ended December 31, 2012, a decrease of 11% from the prior year. The decline was primarily attributable to our global equity products trading business, and included the impact of lower trading volumes globally, as average trading volumes as measured by the major market indices in the U.S., Europe and Pacific Rim regions declined by approximately 27%, 9% and 5%, respectively. Commissions revenues from our global wealth management businesses also declined as a result of lower transaction volumes as compared with the prior year.
Managed account and other fee-based revenues primarily consist of asset-priced portfolio service fees earned from the administration of separately managed and other investment accounts for retail investors, annual account fees, and certain other account-related fees. Managed account and other fee-based revenues were $5.4 billion for the year ended December 31, 2012, an increase of 4% from the prior year. The increase was driven by higher fee-based revenues from our global wealth management activities, reflecting higher levels of fee-based assets from which such revenues are generated as well as increased revenues from fees on new accounts and asset management fees. The increase in fee-based assets was due to both strong client flows into long-term products and market appreciation.
Investment banking revenues include (i) origination revenues representing fees earned from the underwriting of debt, equity and equity-linked securities, as well as loan syndication and commitment fees and (ii) advisory services revenues including merger and acquisition and other investment banking advisory fees. Total investment banking revenues were $4.9 billion for the year ended December 31, 2012, a decrease of 5% from the prior year. Underwriting revenues decreased 2% to $3.9 billion, as lower revenues from equity issuances were partially offset by an increase in revenues from debt issuances. Revenues from advisory services decreased 15% to $1.0 billion, reflecting reduced global merger and acquisition transaction fee pools. Investment banking revenues from transactions involving Bank of America were $125 million in the year ended December 31, 2012 and $322 million in the year ended December 31, 2011.
Earnings from equity method investments include our pro rata share of income and losses associated with investments accounted for under the equity method of accounting. Earnings from equity method investments were $285 million for the year ended December 31, 2012 compared with $347 million for the year ended December 31, 2011. The decrease reflected lower revenues from certain equity method investments. Refer to Note 8 to the Consolidated Financial Statements for further information on equity method investments.
Intercompany service fee revenues from Bank of America include revenues associated with the provision of certain shared business activities with Bank of America. Intercompany service fee revenues from Bank of America were $986 million in the year ended December 31, 2012, an increase of 4% from the prior year. The increase was driven by higher fees earned from Bank of America in connection with certain shared brokerage and trading activities.
Other revenues include gains and losses on investment securities, including certain available-for-sale securities, gains and losses on private equity investments, and gains and losses on loans and other miscellaneous items. Other revenues were $1.9 billion in the year ended December 31, 2012 as compared with $1.7 billion in the year ended December 31, 2011. Other revenues for the year ended December 31, 2012 included a gain of approximately $370 million from the sale of a Japanese brokerage joint venture investment and gains of $405 million resulting from the repurchase and retirement of certain of our long-term borrowings, while Other revenues for the year ended December 31, 2011 included a gain of $377 million from the sale of our remaining investment in BlackRock, Inc. Other revenues in 2012 also reflected lower gains from certain private equity investments.
Compensation and benefits expenses were $14.6 billion in the year ended December 31, 2012, a decrease of 7% from the prior year period. The decrease included lower amortization expense associated with stock-based compensation awards, including awards granted to retirement-eligible employees, as compared with the prior year. Salary and other compensation costs also decreased, which was related to a decline in employee headcount. Incentive-based compensation expense also declined as compared with the prior year.
Non-compensation expenses were $7.9 billion in the year ended December 31, 2012 compared with $13.2 billion in the prior year. Non-compensation expenses in the year ended December 31, 2012 included an expense reduction of $754 million to lower our liability for representations and warranties exposures, while the year ended December 31, 2011 included a provision for representations and warranties of $2.7 billion. See “Off-Balance Sheet Exposures - Representations and Warranties” for further information. Excluding the impact of these items, non-compensation expenses were $8.6 billion and $10.5 billion in the years ended December 31, 2012 and December 31, 2011, respectively. Communications and technology expenses were $1.6 billion and decreased 10%, primarily due to lower costs for technology equipment and systems consulting. Occupancy and related depreciation expenses were $1.2 billion, a decrease of 12%, reflecting lower rental and other occupancy costs. Brokerage, clearing and exchange fees were $951 million and decreased 15%, primarily due to lower brokerage and other fees due to lower transaction volumes. Professional fees were $921 million, a decrease of 10% due to lower legal, consulting and employment services fees. Intercompany service fee expenses from Bank of America were $1.8 billion in the year ended December 31, 2012 compared with $2.3 billion in the prior year. The decline reflected a lower level of intercompany service fees from Bank of America. Other expenses were $1.6 billion, a decrease of 31%, reflecting a decline in litigation-related expenses as well as certain other expenses.
The income tax benefit was $2.5 billion for the year ended December 31, 2012 compared with an income tax benefit of $2.9 billion for 2011, resulting in effective tax rates of 112.8% and 64.1%, respectively.
Included in the income tax benefit for 2012 was a $1.7 billion tax benefit attributable to the excess of foreign tax credits recognized in the U.S. upon repatriation of the earnings of certain non-U.S. subsidiaries over the related U.S. tax liability. A portion of the foreign taxes that resulted in the credits were paid in the past by a certain Bank of America subsidiary that was part of the 2012 intragroup reorganization. As discussed below, also included in the income tax benefit was a $781 million charge to reduce the carrying value of certain U.K. net deferred tax assets due to the 2% U.K. corporate income tax rate reduction that was enacted during the third quarter of 2012. Our effective tax rate for 2012 excluding these two items was 72.2% and was greater than the statutory rate due to the impact of other non-U.S. items, including an increase in our accumulated earnings presumed to be permanently reinvested in non-U.S. subsidiaries.
The income tax benefit for 2011 was driven by our recurring tax preference items, a $1.0 billion benefit from the release of the remaining valuation allowance applicable to capital loss carryover deferred tax asset and a benefit of $593 million for planned realization of previously unrecognized deferred tax assets related to the tax basis in certain subsidiaries. These benefits were partially offset by a $774 million charge for the U.K. corporate income tax rate reduction enacted in 2011 and by a $258 million charge to establish a valuation allowance for a portion of certain non-U.S. deferred tax assets.
On July 17, 2012, the U.K. 2012 Finance Bill was enacted, which reduced the U.K. corporate income tax rate by two percent to 23%. The first one percent reduction was effective April 1, 2012 and the second will be effective April 1, 2013. These reductions favorably affect income tax expense on future U.K. earnings, but also required us to remeasure our U.K. net deferred tax assets using the lower tax rates. If the U.K. corporate income tax rate were to be reduced to 21% by 2014, as suggested in U.K. Treasury announcements and assuming no change in the deferred tax asset balance, we would record a charge to income tax expense of approximately $800 million in the period of enactment.
|
|
OFF-BALANCE SHEET EXPOSURES |
As a part of our normal operations, we enter into various off-balance sheet arrangements that may require future payments. The table and discussion below outline our significant off-balance sheet arrangements, as well as their future expirations, as of December 31, 2012. Refer to Note 14 to the Consolidated Financial Statements for further information.
|
| | | | | | | | | | | | | | | | | | | |
(dollars in millions) |
| | | Expiration |
| Maximum Payout | | Less than 1 Year | | 1 - 3 Years | | 3 - 5 Years | | Over 5 Years |
Standby liquidity facilities | $ | 125 |
| | $ | 106 |
| | $ | — |
| | $ | 3 |
| | $ | 16 |
|
Residual value guarantees | 320 |
| | 320 |
| | — |
| | — |
| | — |
|
Standby letters of credit and other guarantees | 491 |
| | 333 |
| | 112 |
| | 37 |
| | 9 |
|
Standby Liquidity Facilities
We provide standby liquidity facilities primarily to certain unconsolidated municipal bond securitization variable interest entities (“VIEs”). In these arrangements, we are required to fund these standby liquidity facilities if certain contingent events take place (e.g., a failed remarketing) and in certain cases if the fair value of the assets held by the VIE declines below the stated amount of the liquidity obligation. The potential exposure under the facilities is mitigated by economic hedges and/or other contractual arrangements entered into by Merrill Lynch. Refer to Note 9 to the Consolidated Financial Statements for further information.
Residual Value Guarantees
At December 31, 2012, residual value guarantees of $320 million consist of amounts associated with certain power plant facilities. Payments under these guarantees would only be required if the fair value of such assets declined below their guaranteed value. As of December 31, 2012, no payments have been made under these guarantees and the carrying value of the associated liabilities was not material, as (i) Merrill Lynch believes that the estimated fair value of such assets was in excess of their guaranteed value and/or (ii) there is a very remote risk of future payment pursuant to the remaining contractual provisions.
Standby Letters of Credit
At December 31, 2012, we provided guarantees to certain counterparties in the form of standby letters of credit in the amount of $0.5 billion.
Representations and Warranties
In prior years, Merrill Lynch and certain of its subsidiaries, including First Franklin Financial Corporation (“First Franklin”), sold pools of first-lien residential mortgage loans and home equity loans as private-label securitizations (in a limited number of these securitizations, monolines insured all or some of the securities) or in the form of whole loans. Most of the loans sold in the form of whole loans were subsequently pooled into private-label securitizations sponsored by the third-party buyer of the whole loans. In addition, Merrill Lynch and First Franklin securitized first-lien residential mortgage loans generally in the form of mortgage-backed securities guaranteed by the government sponsored enterprises (the "GSEs"). In connection with these transactions, we made various representations and warranties. Breaches of these representations and warranties may result in the requirement to repurchase mortgage loans or to otherwise make whole or provide other remedies to the GSEs, whole-loan investors, securitization trusts or monoline insurers (collectively, “repurchases”). In all such cases, we would be exposed to any credit loss on the repurchased mortgage loans after accounting for any mortgage insurance or mortgage guarantee payments that we may receive.
Subject to the requirements and limitations of the applicable sales and securitization agreements, these representations and warranties can be enforced by the GSEs, the whole-loan investor, the securitization trustee, or others as governed by the applicable agreement or, in a limited number of first-lien and home equity securitizations where monoline insurers have insured all or some of the securities issued, by the monoline insurer, where the contract so provides. In the case of loans sold to parties other than the GSEs, the contractual liability to repurchase typically arises only if there is a breach of the representations and warranties that materially and adversely affects the interest of the investor, or investors, or of the monoline insurer (as applicable) in the loan. Contracts with the GSEs do not contain equivalent language.
For additional information about accounting for representations and warranties and our representations and warranties repurchase claims and exposures, see Note 14 to the Consolidated Financial Statements.
We have vigorously contested any request for repurchase when we conclude that a valid basis for repurchase does not exist and will continue to do so in the future. We may reach settlements in the future if opportunities arise on terms we believe to be advantageous.
Recent Developments Related to the Bank of America BNY Mellon Settlement
As a result of Bank of America's settlement (the “BNY Mellon Settlement”) with the Bank of New York Mellon, as trustee (the “Trustee”) in the second quarter of 2011, Merrill Lynch determined that it had sufficient experience to record a liability of $2.7 billion in that period related to its exposure on certain private-label securitizations. Recent levels of claims and file requests with certain counterparties have been less than originally anticipated and, as a result, we recorded a reduction to non-interest expenses of $754 million in the year ended December 31, 2012 that lowered the liability for representations and warranties exposures, as a portion of the loss was no longer deemed probable.
The BNY Mellon Settlement is subject to final court approval and certain other conditions. On August 10, 2012, the court issued an order setting a schedule for discovery and other proceedings, and setting May 2, 2013 as the date for the final court hearing on the settlement to begin. Bank of America and Merrill Lynch are not parties to the proceeding. If final court approval is not obtained by December 31, 2015, Bank of America may withdraw from the BNY Mellon Settlement, if the Trustee consents. The BNY Mellon Settlement also provides that if trusts among the 525 first-lien and five second-lien non-GSE securitization trusts holding loans with an unpaid principal balance exceeding a specified amount are excluded from the final BNY Mellon Settlement, based on investor objections or otherwise, Bank of America has the option to withdraw from the BNY Mellon Settlement pursuant to the terms of the BNY Mellon Settlement agreement.
It is not currently possible to predict how many parties will ultimately object to the BNY Mellon Settlement, whether the objections will prevent receipt of final court approval or the ultimate outcome of the court approval process, which can include appeals and could take a substantial period of time. In particular, conduct of discovery and the resolution of the objections to the settlement and any appeals could take a substantial period of time and these factors could materially delay the timing of final court approval. Accordingly, it is not possible to predict when the court approval process will be completed.
There can be no assurance that final court approval of the BNY Mellon Settlement will be obtained, that all conditions to the BNY Mellon Settlement will be satisfied or, if certain conditions to the BNY Mellon Settlement permitting withdrawal are met, that Bank of America will not withdraw from the settlement. If final court approval is not obtained or if Bank of America withdraws from the BNY Mellon Settlement in accordance with its terms, Merrill Lynch's future representations and warranties losses could be substantially different than existing accruals and the estimated range of possible loss over existing accruals.
Unresolved Repurchase Claims
Unresolved representations and warranties repurchase claims represent the notional amount of repurchase claims made by counterparties, typically the outstanding principal balance or the unpaid principal balance at the time of default. In the case of first-lien mortgages, this amount is often significantly greater than the expected loss amount due to the benefit of collateral and, in some cases, mortgage insurance or mortgage guarantee payments. Claims received from a counterparty remain outstanding until the underlying loan is repurchased, the claim is rescinded by the counterparty, or the claim is otherwise resolved.
The notional amount of unresolved repurchase claims from private-label securitization trustees, whole-loan investors and others increased to $5.8 billion at December 31, 2012 compared with $1.1 billion at December 31, 2011. The increase in the notional amount of unresolved repurchase claims is primarily due to increases in the submission of claims by private-label securitization trustees; the level of detail, support and analysis impacting overall claim quality, and, therefore, claims resolution; and the lack of an established process to resolve disputes related to these claims. We anticipated an increase in aggregate non-GSE claims at the time of the BNY Mellon Settlement in June 2011, and such increase in aggregate non-GSE claims was taken into consideration in developing the increase in our representations and warranties liability at that time. Although recent claims activity has been lower than anticipated, we expect unresolved repurchase claims related to private-label securitizations to continue to increase as claims continue to be submitted by private-label securitization trustees, and there is not an established process for the ultimate resolution of claims on which there is a disagreement. The documents governing private-label securitizations require repurchase claimants to show that a breach of representations and warranties had a material adverse impact on the claimant. We believe this to mean that the claimant is required to prove that the breach caused a loss to investors in the trust (or in certain cases, to the monoline insurer or other financial guarantor). We also believe that many of the defaults observed in private-label securitizations have been, and continue to be, driven by external factors, such as the substantial depreciation in home prices, persistently high unemployment and other negative economic trends, diminishing the likelihood that breaches of representations and warranties, where present, caused a loss.
The table below presents unresolved representations and warranties claims by counterparty at December 31, 2012 and December 31, 2011. The unresolved repurchase claims include only claims where we believe that the counterparty has a basis to submit claims. During the year ended December 31, 2012, we received $4.8 billion of new repurchase claims, which consists of approximately $4.7 billion from private-label securitization trustees, $54 million from GSEs, $22 million from whole-loan investors and $17 million from monoline investors.
|
| | | | | | |
Unresolved Repurchase Claims by Counterparty |
(dollars in millions) | | |
| December 31, |
| 2012 | 2011 |
GSEs | $ | 93 |
| $ | 65 |
|
Monoline | 147 |
| 136 |
|
Whole-loan investors, private-label securitization trustees and other | 5,805 |
| 1,101 |
|
Total | $ | 6,045 |
| $ | 1,302 |
|
At December 31, 2012, the notional amount of unresolved repurchase claims was $6,045 million. We have performed an initial review with respect to $4,922 million of these claims and do not believe a valid basis for repurchase has been established by the claimants. We are still in the process of reviewing the remaining $1,123 million of these claims. When a claim has been denied and there has not been communication with the counterparty for six months, Merrill Lynch views these claims as inactive; however, they remain in the unresolved repurchase claims balance until resolution.
In addition to the total unresolved repurchase claims above, there are $1.3 billion in repurchase demands outstanding from a master servicer where we believe the claimant has not satisfied the contractual thresholds to direct the securitization trustee to take action and/or that these demands are otherwise procedurally or substantively invalid. We do not believe the $1.3 billion in demands received are valid repurchase claims, and therefore it is not possible to predict the resolution with respect to such demands.
Cash Settlements
As presented in the table below, during the year ended December 31, 2012, we paid $73 million to resolve $73 million of repurchase claims through repurchase or reimbursement to investors or securitization trusts for losses they incurred, resulting in a loss on the related loans at the time of repurchase or reimbursement of $62 million. During the year ended December 31, 2011, we paid $58 million to resolve $62 million of repurchase claims through repurchase or reimbursement to investors or securitization trusts for losses they incurred, resulting in a loss on the related loans at the time of repurchase or reimbursement of $48 million. Cash paid for loan repurchases includes the unpaid principal balance of the loan plus past due interest. The amount of loss for loan repurchases is reduced by the fair value of the underlying loan collateral. The repurchase of loans and indemnification payments related to repurchase claims generally resulted from material breaches of representations and warranties related to the loans' material compliance with the applicable underwriting standards, including borrower misrepresentation, credit exceptions without sufficient compensating factors and non-compliance with underwriting procedures. The actual representations and warranties made in a sales transaction and the resulting repurchase and indemnification activity can vary by transaction or investor. A direct relationship between the type of defect that causes the breach of representations and warranties and the severity of the realized loss has not been observed.
|
| | | | | | |
(dollars in millions) | | |
| Year Ended December 31, |
| 2012 | 2011 |
Claims resolved (1) | $ | 73 |
| $ | 62 |
|
| | |
Repurchases | 14 |
| 12 |
|
Indemnification payments | 59 |
| 46 |
|
Total payments | $ | 73 |
| $ | 58 |
|
(1) Represents unpaid principal balance.
Liability for Representations and Warranties
The liability for representations and warranties is included in Interest and other payables on the Consolidated Balance Sheets, and the related provision is included in Non-interest expenses on the Consolidated Statements of Earnings (Loss).
Our estimate of the liability for representations and warranties exposures and the corresponding range of possible loss is based on currently available information, significant judgment, and a number of other factors and assumptions that are subject to change. For additional information, see Note 14 to the Consolidated Financial Statements.
The liability for representations and warranties exposures and the corresponding estimated range of possible loss for these representations and warranties exposures do not consider any losses related to litigation matters disclosed in Note 14 to the Consolidated Financial Statements, nor do they include any potential securities law or fraud claims or potential indemnity or other claims against us. We are not able to reasonably estimate the amount of any possible loss with respect to any such securities law, fraud or other claims against us, except to the extent reflected in the aggregate range of possible loss for litigation and regulatory matters disclosed in Note 14 to the Consolidated Financial Statements; however, such loss could be material.
At December 31, 2012 and December 31, 2011, the liability for representations and warranties was $2.0 billion and $2.8 billion. As a result of the BNY Mellon Settlement in the second quarter of 2011, we determined that we had sufficient experience to record a liability of $2.7 billion in that period related to our exposure on certain private-label securitizations. Recent levels of claims and file requests with certain counterparties have been less than originally anticipated and, as a result, we recorded a reduction to non-interest expenses of $754 million in the year ended December 31, 2012 that lowered the liability for representations and warranties exposures, as a portion of the loss was no longer deemed probable.
Estimated Range of Possible Loss
Our estimated liability at December 31, 2012 for obligations under representations and warranties is necessarily dependent on, and limited by, a number of factors, including for private-label securitizations, the implied repurchase experience based on the BNY Mellon Settlement, as well as certain other assumptions and judgmental factors. Accordingly, future provisions associated with obligations under representations and warranties may be materially impacted if actual experiences are different from our historical experience or our understandings, interpretations or assumptions.
The representations and warranties liability represents our best estimate of probable incurred losses as of December 31, 2012. However, it is reasonably possible that future representations and warranties losses may occur in excess of the amounts recorded for these exposures. In addition, we have not recorded any representations and warranties liability for certain private-label securitizations sponsored by whole-loan investors, where we have little to no claim experience. We currently estimate that the range of possible loss for representations and warranties exposures, consisting primarily of non-GSE exposures, could be up to $1.1 billion over accruals at December 31, 2012, an increase of $0.6 billion from December 31, 2011. The increase in the range of possible loss was primarily
attributable to the reduction in our liability for representations and warranties exposures discussed above. The estimated range of possible loss related to these representations and warranties exposures does not represent a probable loss and is based on currently available information, significant judgment, and a number of assumptions that are subject to change. For additional information about the methodology used to estimate the representations and warranties liability and the corresponding range of possible loss, see Note 14 to the Consolidated Financial Statements.
Future provisions and/or ranges of possible loss for representations and warranties may be significantly impacted if actual experiences are different from our assumptions in our predictive models, including, without limitation, the ultimate resolution of the BNY Mellon Settlement, estimated repurchase rates, economic conditions, estimated home prices, consumer and counterparty behavior, and a variety of other judgmental factors. Adverse developments with respect to one or more of the assumptions underlying the liability for representations and warranties and the corresponding estimated range of possible loss could result in significant increases to future provisions and/or this estimated range of possible loss. For example, if courts, in the context of claims brought by private-label securitization trustees, were to disagree with our interpretation that the underlying agreements require a claimant to prove that the representations and warranties breach was the cause of the loss, it could significantly impact the estimated range of possible loss.
Additionally, if recent court rulings related to monoline litigation, including one related to an affiliate of ours, that have allowed sampling of loan files instead of requiring a loan-by-loan review to determine if a representations and warranties breach has occurred, are followed generally by the courts in other monoline litigation, private-label securitization counterparties may view litigation as a more attractive alternative as compared to a loan-by-loan review. Finally, although we believe that the representations and warranties typically given in non-GSE transactions are less rigorous and actionable than those given in GSE transactions, we do not have significant experience resolving loan-level claims in non-GSE transactions to measure the impact of these differences on the probability that a loan will be required to be repurchased.
Experience with Non-GSE Investors
As presented in the table below, Merrill Lynch, including First Franklin, sold loans originated from 2004 to 2008 (primarily subprime and alt-A) with an original principal balance of $132 billion to investors other than the GSEs (although the GSEs are investors in certain private-label securitizations), of which approximately $65 billion in principal has been paid off and $45 billion has defaulted or is severely delinquent (i.e., 180 days or more past due) at December 31, 2012.
As it relates to private-label securitizations, a contractual liability to repurchase mortgage loans generally arises only if counterparties prove there is a breach of the representations and warranties that materially and adversely affects the interest of the investor or all investors in a securitization trust or of the monoline insurer (as applicable). We believe that the longer a loan performs, the less likely it is that an alleged representations and warranties breach had a material impact on the loan's performance or that a breach even exists. Because the majority of the borrowers in this population would have made a significant number of payments if they are not yet 180 days or more past due, we believe that the principal balance at the greatest risk for repurchase claims in this population of private-label securitization investors are loans that already have defaulted and those that are currently severely delinquent. Additionally, only counterparties with the contractual right to demand repurchase of a loan can present valid repurchase claims. In the case of private-label securitization trust investors, they generally have to meet certain presentation thresholds in order to require trustees to present repurchase claims.
While we believe the agreements for private-label securitizations generally contain less rigorous representations and warranties and place higher burdens on investors seeking repurchases than the explicit provisions of the comparable agreements with the GSEs, without regard to any variations that may have arisen as a result of dealings with the GSEs, the agreements generally include a representation that underwriting practices were prudent and customary.
The following table details the population of loans originated between 2004 and 2008 and the population of loans sold as whole loans or in non-GSE private-label securitizations by entity together with the defaulted and severely
delinquent loans stratified by the number of payments the borrower made prior to default or becoming severely delinquent as of December 31, 2012. In connection with these transactions, we provided representations and warranties, and the whole-loan investors may retain those rights even when the whole loans were aggregated with other collateral into private-label securitizations sponsored by the whole-loan investors. At least 25 payments have been made on approximately 60% of the defaulted and severely delinquent loans. In the current year, we have received approximately $4.7 billion of representations and warranties claims from private-label securitization trustees related to these vintages, and approximately $22 million from whole-loan investors related to these vintages. We believe that many of the defaults observed in these securitizations have been, and continue to be, driven by external factors, such as the substantial depreciation in home prices, persistently high unemployment and other negative economic trends, diminishing the likelihood that any loan defect (assuming one exists at all) was the cause of a loan's default. As of December 31, 2012, approximately 34% of the loans sold to non-GSE counterparties that were originated between 2004 and 2008 have defaulted or are severely delinquent.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(dollars in billions) | | | | | | | | | | | | | | | | | |
| Principal Balance | | | | | | | | Principal at Risk |
Entity | Original
Principal Balance | | Outstanding
Principal
Balance December 31, 2012 | | Outstanding
Principal
Balance Over 180 Days | | Defaulted Principal Balance | | Defaulted
or Severely Delinquent | | Borrower
Made Less
than 13 Payments | | Borrower
Made 13 to 24 Payments | | Borrower
Made 25 to 36 Payments | | Borrower
Made More
Than 36 Payments |
Merrill Lynch (excluding First Franklin) | $ | 50 |
| | $ | 14 |
| | $ | 4 |
| | $ | 13 |
| | $ | 17 |
| | $ | 3 |
| | $ | 4 |
| | $ | 3 |
| | $ | 7 |
|
First Franklin | 82 |
| | 18 |
| | 5 |
| | 23 |
| | 28 |
| | 5 |
| | 6 |
| | 5 |
| | 12 |
|
Total (1) | $ | 132 |
| | $ | 32 |
| | $ | 9 |
| | $ | 36 |
| | $ | 45 |
| | $ | 8 |
| | $ | 10 |
| | $ | 8 |
| | $ | 19 |
|
| | | | | | | | | | | | | | | | | |
(1) Excludes transactions sponsored by Merrill Lynch where no representations or warranties were made.
Legal Matters
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. Refer to Note 14 to the Consolidated Financial Statements for further information, including the estimated aggregate range of possible loss.
Derivatives
We record all derivative transactions at fair value on our Consolidated Balance Sheets. We do not monitor our exposure to derivatives based on the notional amount because that amount is not a relevant indicator of our risk to these contracts, as it is generally not indicative of the amount that we would owe on the contract. Instead, a risk framework is used to define risk tolerances and establish limits to help to ensure that certain risk-related losses occur within acceptable, predefined limits. Derivatives that meet the accounting definition of a guarantee and credit derivatives are included in Note 6 to the Consolidated Financial Statements.
Involvement with VIEs
We transact with VIEs in a variety of capacities, including those that we help establish as well as those initially established by third parties. We utilize VIEs in the ordinary course of business to support our own and our customers' financing and investing needs. Merrill Lynch securitizes loans and debt securities using VIEs as a source of funding and a means of transferring the economic risk of the loans or debt securities to third parties. We also administer, structure or invest in or enter into derivatives with other VIEs, including multi-seller conduits, municipal bond trusts, collateralized debt obligations ("CDOs") and other entities. Our involvement with VIEs can vary and we are required to continuously reassess prior consolidation and disclosure conclusions (refer to Note 9 to the Consolidated Financial Statements). Refer to Note 1 to the Consolidated Financial Statements for a discussion of our consolidation accounting policy.
Contractual Obligations
We have contractual obligations to make future payments of debt, lease and other agreements. Additionally, in the normal course of business, we enter into contractual arrangements whereby we commit to future purchases of products or services from unaffiliated parties. Other obligations include our contractual funding obligations related to our employee benefit plans. See Notes 12, 14 and 15 to the Consolidated Financial Statements.
In the normal course of business, we periodically guarantee the obligations of affiliates in a variety of transactions including International Swaps and Derivatives Association, Inc. ("ISDA") -related and non ISDA-related transactions such as commodities trading, repurchase agreements, prime brokerage agreements and other transactions. We have also entered into an agreement with a non-U.S. regulator that could allow it, in its capacity as regulator, to request payments from us to support obligations to clients of the regulated non-U.S. branch. We believe the likelihood of payment under the terms of this agreement to be remote.
Funding
We fund our assets primarily with a mix of secured and unsecured liabilities through a globally coordinated funding strategy with Bank of America. We fund a portion of our trading assets with secured liabilities, including repurchase agreements, securities loaned and other short-term secured borrowings, which are less sensitive to our credit ratings due to the underlying collateral. Refer to Note 12 to the Consolidated Financial Statements for additional information regarding our borrowings.
Beginning late in the third quarter of 2009, in connection with the update or renewal of certain Merrill Lynch international securities offering programs, Bank of America agreed to guarantee debt securities, warrants and/or certificates issued by certain subsidiaries of ML & Co. on a going forward basis. All existing ML & Co. guarantees of securities issued by those same Merrill Lynch subsidiaries under various international securities offering programs will remain in full force and effect as long as those securities are outstanding, and Bank of America has not assumed any of those prior ML & Co. guarantees or otherwise guaranteed such securities. There were approximately $7.0 billion of securities guaranteed by Bank of America at December 31, 2012. In addition, Bank of America has guaranteed the performance of Merrill Lynch on certain derivative transactions. The aggregate amount of such derivative liabilities was approximately $1.3 billion at December 31, 2012.
Following the completion of Bank of America's acquisition of Merrill Lynch, ML & Co. became a subsidiary of Bank of America and established intercompany lending and borrowing arrangements to facilitate centralized liquidity management. Included in these intercompany agreements is a $75 billion one-year revolving unsecured line of credit that allows ML & Co. to borrow funds from Bank of America at a spread to the London Interbank Offered Rate ("LIBOR") that is reset periodically and is consistent with other intercompany agreements. This credit line was renewed effective January 1, 2013 with a maturity date of January 1, 2014. The credit line will automatically be extended by one year to the succeeding January 1st unless Bank of America provides written notice not to extend at least 45 days prior to the maturity date. The agreement does not contain any financial or other covenants. There were no outstanding borrowings under the line of credit at December 31, 2012 and December 31, 2011.
In addition to the $75 billion unsecured line of credit, there is also a revolving unsecured line of credit that allows ML & Co. to borrow up to $25 billion from Bank of America. Interest on borrowings under the line of credit is based on prevailing short-term market rates. The line of credit does not contain any financial or other covenants. The line of credit matures on February 11, 2014. There were no outstanding borrowings under the line of credit at December 31, 2012 and December 31, 2011.
Merrill Lynch Pierce Fenner & Smith Incorporated ("MLPF&S") also has the following borrowing agreements with Bank of America:
| |
• | A $4 billion one-year revolving unsecured line of credit - Interest on the line of credit is based on prevailing short-term market rates. The credit line matures on November 1, 2013 and may automatically be extended by one year to the succeeding November 1st unless Bank of America provides written notice not to extend at least 45 days prior to the maturity date. At both December 31, 2012 and December 31, 2011, there were no outstanding borrowings under the line of credit. |
| |
• | A $15 billion 364-day revolving unsecured line of credit - Interest on the line of credit is based on prevailing short-term market rates. The line of credit matures on February 18, 2014. At December 31, 2012 and December 31, 2011, approximately $0.9 billion and $1.5 billion, respectively, was outstanding under the line of credit. |
During the year ended December 31, 2012, $2.6 billion that was outstanding under the following MLPF&S borrowing agreements with Bank of America was repaid and the agreements were terminated. The two terminated agreements below were replaced by intercompany funding arrangements between MLPF&S and ML & Co.
| |
• | A subordinated loan agreement for approximately $1.5 billion - Interest under this agreement was calculated based on a spread to LIBOR. |
| |
• | A $7.0 billion revolving subordinated line of credit - Interest under this agreement was calculated based on a spread to LIBOR. |
Bank of America and Merrill Lynch have entered into certain intercompany lending and borrowing arrangements to facilitate centralized liquidity management. Included in these arrangements is a $50 billion extendible one-year revolving credit facility that allows Bank of America to borrow funds from Merrill Lynch at a spread to LIBOR that is reset periodically and is consistent with other intercompany agreements. The credit facility matures on January 1, 2014 and will automatically be extended by one year to the succeeding January 1st unless Merrill Lynch provides written notice not to extend at least 45 days prior to the maturity date. There were no amounts outstanding at both December 31, 2012 and December 31, 2011 under this credit facility. There is also a short-term revolving credit facility that allows Bank of America to borrow up to an additional $25 billion. Interest on borrowings under the credit facility is based on prevailing short-term market rates. The line of credit matures on February 11, 2014. At December 31, 2012 and December 31, 2011, approximately $16.2 billion and $3.7 billion, respectively, was outstanding under this credit facility.
Credit Ratings
Our borrowing costs and ability to raise funds are impacted by our credit ratings. In addition, credit ratings may be important to customers or counterparties when we compete in certain markets and when we seek to engage in certain transactions, including OTC derivatives. Thus, it is our objective to maintain high-quality credit ratings.
Credit ratings and outlooks are opinions expressed by rating agencies on our creditworthiness and that of our obligations or securities, including long-term debt, short-term borrowings and other securities, including asset securitizations. Following the acquisition of Merrill Lynch by Bank of America, the major credit rating agencies have indicated that the primary drivers of Merrill Lynch's credit ratings are Bank of America's credit ratings. Bank of America's credit ratings are subject to ongoing review by the rating agencies, which consider a number of factors, including Bank of America's financial strength, performance, prospects and operations as well as factors not under Bank of America's control. The rating agencies could make adjustments to our ratings at any time and they provide no assurances that they will maintain our ratings at current levels.
Other factors that influence Bank of America's and our credit ratings include changes to the rating agencies' methodologies for our industry or certain security types, the rating agencies' assessment of the general operating environment for financial services companies, our mortgage exposures, our relative positions in the markets in
which we compete, reputation, liquidity position, diversity of funding sources, funding costs, the level and volatility of earnings, corporate governance and risk management policies, capital position, capital management practices, and current or future regulatory and legislative initiatives.
On December 20, 2012, Standard & Poor's Ratings Services ("S&P") published a full credit analysis report on Bank of America, leaving the credit ratings for Bank of America and, consequently, ML & Co. unchanged as of that date. On October 10, 2012, Fitch Ratings ("Fitch") announced the results of its periodic review of its ratings for 12 large, complex securities trading and universal banks, including Bank of America. As part of this action, Fitch affirmed Bank of America's and ML & Co.'s credit ratings. On June 21, 2012, Moody's Investors Service, Inc. ("Moody's") completed its previously-announced review for possible downgrade of financial institutions with global capital markets operations, downgrading the ratings of 15 banks and securities firms, including the ratings of Bank of America and ML & Co. Bank of America's and ML & Co.'s long-term debt ratings were downgraded one notch as part of this action. The Moody's downgrade has not had a material impact on our financial condition, results of operations or liquidity. Each of the three major rating agencies, Moody's, S&P and Fitch, downgraded the ratings of Bank of America and ML & Co. in late 2011.
Currently, Bank of America's and ML & Co.'s long-term/short-term senior debt ratings and outlooks expressed by the rating agencies are as follows: Baa2/P-2 (negative) by Moody's; A-/A-2 (negative) by S&P; and A/F1 (stable) by Fitch. MLPF&S's long-term/short-term senior debt ratings and outlooks are A/A-1 (negative) by S&P and A/F1 (stable) by Fitch. Merrill Lynch International, a U.K.-based registered investment firm and subsidiary of ML & Co., has a long-term/short-term senior debt rating and outlook of A/A-1 (negative) by S&P. Merrill Lynch International Bank Limited, an Ireland-based bank subsidiary of ML & Co., has a long-term/short-term senior debt rating and outlook of A/F1 (stable) by Fitch.
The major rating agencies have each indicated that, as a systemically important financial institution, Bank of America's (and consequently ML & Co.'s) credit ratings currently reflect their expectation that, if necessary, Bank of America would receive significant support from the U.S. government, and that they will continue to assess such support in the context of sovereign financial strength and regulatory and legislative developments.
A further reduction in certain of our credit ratings may have a material adverse effect on our liquidity, potential loss of access to credit markets, the related cost of funds, our businesses and on certain trading revenues, particularly in those businesses where counterparty creditworthiness is critical. In addition, under the terms of certain OTC derivative contracts and other trading agreements, in the event of further downgrades of our credit ratings, the counterparties to those agreements may require us to provide additional collateral, or to terminate these contracts or agreements, which could cause us to sustain losses and/or adversely impact our liquidity. If Bank of America's or ML & Co.'s short-term credit ratings, or those of our bank or broker-dealer subsidiaries, were downgraded by one or more levels, the potential loss of access to short-term funding sources, such as repurchase agreement financing, and the effect on our incremental cost of funds could be material.
At December 31, 2012, if the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by one incremental notch, the amount of additional collateral contractually required by derivative contracts and other trading agreements would have been approximately $0.4 billion. If the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by a second incremental notch, approximately $4.0 billion in additional incremental collateral would have been required.
Also, if the rating agencies had downgraded their long-term senior debt ratings for ML & Co. or certain subsidiaries by one incremental notch, the derivative liability that would be subject to unilateral termination by counterparties as of December 31, 2012 was $1.9 billion, against which $1.2 billion of collateral has been posted. If the rating agencies had downgraded their long-term debt ratings for ML & Co. or certain subsidiaries by a second incremental notch, the derivative liability that would be subject to unilateral termination by counterparties as of December 31, 2012 was an incremental $1.3 billion, against which $0.7 billion of collateral has been posted.
While certain potential impacts are contractual and quantifiable, the full scope of consequences of a credit ratings downgrade to a financial institution is inherently uncertain, as it depends upon numerous dynamic, complex and inter-related factors and assumptions, including whether any downgrade of a firm's long-term credit ratings precipitates downgrades to its short-term credit ratings, and assumptions about the potential behaviors of various customers, investors and counterparties.
For information regarding the additional collateral and termination payments that would be required in connection with certain OTC derivative contracts and other trading agreements as a result of such a credit ratings downgrade, see Note 6 to the Consolidated Financial Statements and Item 1A. "Risk Factors."
As part of Bank of America's efforts to streamline its organizational structure and reduce complexity and costs, it has reduced and intends to continue to reduce the number of its subsidiaries, including through intercompany mergers. In connection with these efforts, Bank of America may merge ML & Co. with and into Bank of America Corporation. There is no assurance such merger will occur or the timing thereof. Any such merger would be subject to applicable regulatory approvals, consents and other conditions of closing.
U.S. Sovereign Credit Ratings
On June 8, 2012, S&P affirmed its AA+ long-term and A-1+ short-term sovereign credit rating on the U.S. government. The outlook remains negative. On July 10, 2012, Fitch affirmed its AAA long-term and F1+ short-term sovereign credit rating on the U.S. government. The outlook remains negative. Moody's also rates the U.S. government AAA with a negative outlook. All three rating agencies have indicated that they will continue to assess fiscal projections and consolidation measures, as well as the medium-term economic outlook for the U.S.
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Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Market Risk Management
Merrill Lynch defines market risk as the potential change in value of financial instruments caused by fluctuations in interest rates, exchange rates, equity and commodity prices, credit spreads, and related risks.
Control and Governance Structure
On January 1, 2009, pursuant to the acquisition of Merrill Lynch by Bank of America, Merrill Lynch adopted Bank of America's risk management and governance practices to maintain consistent risk measurement and disciplined risk taking. Bank of America's risk management structure as applicable to Merrill Lynch is described below.
The Global Markets Risk Committee (“GMRC”), chaired by the Global Markets Risk Executive, has been designated by the Asset, Liability and Market Risk Committee (“ALMRC”) as the primary governance authority for global markets risk management including trading risk management. The GMRC's focus is to take a forward-looking view of the primary credit and market risks impacting Bank of America's Global Markets business (which includes Merrill Lynch's sales and trading businesses) and prioritize those that need a proactive risk mitigation strategy. Market risks that impact businesses outside of the Global Markets business are monitored and governed by their respective governance authorities.
The GMRC monitors significant daily revenues and losses by business and the primary drivers of the revenues or losses. Thresholds are in place for each of our businesses in order to determine if the revenue or loss is considered to be significant for that business. If any of the thresholds are exceeded, an explanation of the variance is provided to the GMRC. The thresholds are developed in coordination with the respective risk managers to highlight those revenues or losses that exceed what is considered to be normal daily income statement volatility.
Value-at-Risk (“VaR”)
To evaluate risk in our trading activities, we focus on the actual and potential volatility of individual positions as well as portfolios. VaR is a key statistic used to measure market risk. In order to manage day-to-day risks, VaR is subject to trading limits both for our overall trading portfolio and within individual businesses. All trading limit excesses are communicated to management for review.
A VaR model simulates the value of a portfolio under a range of hypothetical scenarios in order to generate a distribution of potential gains and losses. VaR represents the loss the portfolio is expected to experience within a given confidence level based on historical data. With any VaR model, there are significant and numerous assumptions that will differ from company to company. In addition, the accuracy of a VaR model depends on the availability and quality of historical data for each of the positions in the portfolio. A VaR model may require additional modeling assumptions for new products that do not have extensive historical price data or for illiquid positions for which accurate daily prices are not consistently available.
A VaR model is an effective tool in estimating ranges of potential gains and losses on our trading portfolios. There are, however, many limitations inherent in a VaR model as it utilizes historical results over a defined time period to estimate future performance. Historical results may not always be indicative of future results and changes in market conditions or in the composition of the underlying portfolio could have a material impact on the accuracy of the VaR model. In order for the VaR model to reflect current market conditions, we update the historical data underlying our VaR model on a bi-weekly basis and regularly review the assumptions underlying the model. Our VaR model utilizes three years of historical data. This time period was chosen to ensure that VaR reflects both a broad range of market movements as well as being sensitive to recent changes in market volatility. In addition, certain types of risks associated with positions that are illiquid and/or unobservable are not included in VaR. If these risks are determined to be material, the VaR model results will be supplemented.
We continually review, evaluate and enhance our VaR model so that it reflects the material risks in our trading portfolio. Changes to the VaR model are reviewed and approved prior to implementation and any material changes
are reported to management through the appropriate governance committees. Nevertheless, due to the limitations previously discussed, we have historically used the VaR model as only one of the components in managing our trading risk and also use other techniques such as stress testing and desk level limits. Periods of extreme market stress influence the reliability of these techniques to various degrees.
The accompanying table presents year-end, average, high and low daily trading VaR for the year ended December 31, 2012, as well as a comparison to the year-end and average VaR for the year ended December 31, 2011.
2012 Trading Activities Market Risk VaR
|
| | | | | | | | | | | | | | | | | | | | | | | |
(dollars in millions) | | |
| 2012 Year End | | 2012
Quarterly Average(3) | | 2012 High | | 2012 Low | | 2011 Year End | | 2011 Quarterly Average (4) |
Trading value-at-risk(1) | |
| | |
| | |
| | |
| | |
| | |
Foreign exchange | $ | 23 |
| | $ | 20 |
| | $ | 24 |
| | $ | 14 |
| | $ | 14 |
| | $ | 15 |
|
Interest rate | 43 |
| | 38 |
| | 43 |
| | 33 |
| | 39 |
| | 40 |
|
Credit | 88 |
| | 49 |
| | 88 |
| | 27 |
| | 56 |
| | 102 |
|
Real estate / mortgage | 16 |
| | 27 |
| | 36 |
| | 16 |
| | 32 |
| | 64 |
|
Commodities | 13 |
| | 13 |
| | 16 |
| | 10 |
| | 14 |
| | 18 |
|
Equities | 19 |
| | 20 |
| | 24 |
| | 16 |
| | 18 |
| | 33 |
|
Subtotal(2) | 202 |
| | 167 |
| | |
| | |
| | 173 |
| | 272 |
|
Diversification benefit | (102 | ) | | (99 | ) | | |
| | |
| | (93 | ) | | (130 | ) |
Overall | $ | 100 |
| | $ | 68 |
| | |
| | |
| | $ | 80 |
| | $ | 142 |
|
| | | | | | | | | | | |
| |
(1) | Based on a 99% confidence level and a one-day holding period. |
| |
(2) | Subtotals are not provided for highs and lows as they are not meaningful. |
| |
(3) | Amounts represent the average of the quarter-end VaR results for 2012. |
| |
(4) | Amounts represent the average of the quarter-end VaR results for 2011. |
The decrease in average VaR for 2012 was driven by reduced risk across most asset classes, with the largest reductions coming from the Credit, Real estate / mortgage and Equities asset classes. In addition, volatile market data from 2008, which was a material contribution to the 2011 average VaR, was no longer included in the three-year historical data for the 2012 average VaR.
Credit Risk Management
Counterparty Credit Risk
Credit risk is the risk of loss arising from the inability or failure of a borrower or counterparty to meet its obligations. Credit risk can also arise from operational failures that result in an erroneous advance, commitment or investment of funds. Merrill Lynch defines the credit exposure to a borrower or counterparty as the loss potential arising from all product classifications, including loans, derivatives, assets held-for-sale and unfunded lending commitments, which include loan commitments, letters of credit and financial guarantees. Derivative positions are recorded at fair value and assets held-for-sale are recorded at either the lower of cost or fair value. Certain loans and unfunded commitments are accounted for under the fair value option. Credit risk for these categories of assets is not accounted for as part of the allowance for credit losses but as part of the fair value adjustments recorded in earnings. For derivative positions, our credit risk is measured as the net cost in the event the counterparties with contracts in which we are in a gain position fail to perform under the terms of those contracts. We use the current mark-to-market value to represent credit exposure without giving consideration to future mark-to-market changes. The credit risk amounts take into consideration the effects of legally enforceable master netting agreements and
cash collateral. Our consumer and commercial credit extension and review procedures take into account funded and unfunded credit exposures.
We manage credit risk based on the risk profile of the borrower or counterparty, repayment sources, the nature of underlying collateral, and other support given current events, conditions and expectations. We classify our portfolios as either consumer or commercial and monitor credit risk in each as discussed below.
Commercial Portfolio
Credit risk management for the commercial portfolio begins with an assessment of the credit risk profile of the borrower or counterparty based on an analysis of its financial position. As part of the overall credit risk assessment, our commercial credit exposures are assigned a risk rating and are subject to approval based on defined credit approval standards. Subsequent to loan origination, risk ratings are monitored on an ongoing basis, and if necessary, adjusted to reflect changes in the financial condition, cash flow, risk profile or outlook of a borrower or counterparty. In making credit decisions, we consider risk rating, collateral, country, industry and single name concentration limits while also balancing the total borrower or counterparty relationship. Our business and risk management personnel use a variety of tools to continuously monitor the ability of a borrower or counterparty to perform under its obligations. We use risk rating aggregations to measure and evaluate concentrations within portfolios. In addition, risk ratings are a factor in determining the level of assigned economic capital and the allowance for credit losses.
Commercial credit risk is evaluated and managed with the goal that concentrations of credit exposure do not result in undesirable levels of risk. We review, measure and manage concentrations of credit exposure by industry, product, geography, customer relationship and loan size. We also review, measure and manage commercial real estate loans by geographic location and property type. In addition, within our international portfolio, we evaluate exposures by region and by country. We also utilize syndications of exposure to third parties, loan sales, hedging and other risk mitigation techniques to manage the size and risk profile of the commercial credit portfolio.
We account for certain large corporate loans and loan commitments, including issued but unfunded letters of credit which are considered utilized for credit risk management purposes, that exceed our single name credit risk concentration guidelines under the fair value option. Lending commitments, both funded and unfunded, are actively managed and monitored, and as appropriate, credit risk for these lending relationships may be mitigated through the use of credit derivatives, with our credit view and market perspectives determining the size and timing of the hedging activity. In addition, we purchase credit protection to cover the funded portion as well as the unfunded portion of certain other credit exposures. To lessen the cost of obtaining our desired credit protection levels, credit exposure may be added within an industry, borrower or counterparty group by selling protection. These credit derivatives do not meet the requirements for treatment as accounting hedges. They are carried at fair value with changes in fair value recorded in earnings.
Consumer Portfolio
Credit risk management for the consumer portfolio begins with initial underwriting and continues throughout a borrower's credit cycle. Statistical techniques in conjunction with experiential judgment are used in all aspects of portfolio management including underwriting, product pricing, risk appetite, setting credit limits, and establishing operating processes and metrics to quantify and balance risks and returns. Statistical models are built using detailed behavioral information from external sources such as credit bureaus and/or internal historical experience. These models are a component of our consumer credit risk management process and are used in part to help make both new and existing credit decisions, as well as portfolio management strategies, including authorizations and line management, collection practices and strategies, determination of the allowance for loan losses, and economic capital allocations for credit risk.
European Exposures
Certain European countries, including Greece, Ireland, Italy, Portugal and Spain, have experienced varying degrees of financial stress in recent years. Risks from the ongoing debt crisis in these countries could continue to disrupt the financial markets, which could have a detrimental impact on global economic conditions and sovereign and non-sovereign debt in these countries. In the fourth quarter of 2012, European policymakers continued to make incremental progress toward greater fiscal and monetary unity; however, fundamental issues of competitiveness, growth and fiscal solvency remain as challenges. As a result, volatility is expected to continue. We expect to continue to support client activities in the region and our exposures may vary over time as we monitor the situation and manage our risk profile.
The table below presents our direct sovereign and non-sovereign exposures in these countries at December 31, 2012. Our total sovereign and non-sovereign exposure to these countries was $2.9 billion at December 31, 2012 compared with $2.7 billion at December 31, 2011. The total exposure to these countries, net of all hedges, was $1.5 billion at December 31, 2012 compared with $1.1 billion at December 31, 2011. The fair value of hedges and credit default protection purchased, net of credit default protection sold, was $1.4 billion and $1.6 billion at December 31, 2012 and December 31, 2011, respectively.
|
| | | | | | | | | | | | | | | | | | | | | |
Select European Countries | | | | | | |
| | | | | Country | Hedges and | Net Country |
| Funded Loans | | Net | | Exposure | Credit | Exposure |
| and Loan | Unfunded | Counterparty | Securities/Other | December 31, | Default | December 31, |
(dollars in millions) | Equivalents | Commitments | Exposure (1) | Investments (2) | 2012 | Protection (3) | 2012 (4) |
Country | | | | | | | |
| | | | | | | |
Greece | | | | | | | |
Sovereign | $ | — |
| $ | — |
| $ | — |
| $ | 2 |
| $ | 2 |
| $ | — |
| $ | 2 |
|
Financial Institutions | — |
| — |
| — |
| — |
| — |
| (23 | ) | (23 | ) |
Corporates | — |
| — |
| 1 |
| 52 |
| 53 |
| (2 | ) | 51 |
|
Total Greece | $ | — |
| $ | — |
| $ | 1 |
| $ | 54 |
| $ | 55 |
| $ | (25 | ) | $ | 30 |
|
| | | | | | | |
Ireland | | | | | | | |
Sovereign | $ | 12 |
| $ | — |
| $ | 27 |
| $ | — |
| $ | 39 |
| $ | (10 | ) | $ | 29 |
|
Financial Institutions | 19 |
| 12 |
| 55 |
| 15 |
| 101 |
| (9 | ) | 92 |
|
Corporates | — |
| — |
| 6 |
| 37 |
| 43 |
| (9 | ) | 34 |
|
Total Ireland | $ | 31 |
| $ | 12 |
| $ | 88 |
| $ | 52 |
| $ | 183 |
| $ | (28 | ) | $ | 155 |
|
| | | | | | | |
Italy | | | | | | | |
| | | | | | | |
Sovereign | $ | — |
| $ | — |
| $ | 558 |
| $ | 350 |
| $ | 908 |
| $ | (724 | ) | $ | 184 |
|
Financial Institutions | — |
| — |
| 180 |
| 342 |
| 522 |
| (36 | ) | 486 |
|
Corporates | — |
| — |
| 243 |
| 160 |
| 403 |
| (239 | ) | 164 |
|
Total Italy | $ | — |
| $ | — |
| $ | 981 |
| $ | 852 |
| $ | 1,833 |
| $ | (999 | ) | $ | 834 |
|
| | | | | | | |
Portugal | | | | | | | |
| | | | | | | |
Sovereign | $ | — |
| $ | — |
| $ | 31 |
| $ | 27 |
| $ | 58 |
| $ | (26 | ) | $ | 32 |
|
Financial Institutions | — |
| — |
| 1 |
| 24 |
| 25 |
| (1 | ) | 24 |
|
Corporates | — |
| — |
| 4 |
| 85 |
| 89 |
| (138 | ) | (49 | ) |
Total Portugal | $ | — |
| $ | — |
| $ | 36 |
| $ | 136 |
| $ | 172 |
| $ | (165 | ) | $ | 7 |
|
| | | | | | | |
Spain | | | | | | | |
| | | | | | | |
Sovereign | $ | — |
| $ | — |
| $ | 64 |
| $ | 144 |
| $ | 208 |
| $ | (61 | ) | $ | 147 |
|
Financial Institutions | 1 |
| — |
| 64 |
| 83 |
| 148 |
| (29 | ) | 119 |
|
Corporates | 30 |
| 21 |
| 46 |
| 175 |
| 272 |
| (59 | ) | 213 |
|
Total Spain | $ | 31 |
| $ | 21 |
| $ | 174 |
| $ | 402 |
| $ | 628 |
| $ | (149 | ) | $ | 479 |
|
| | | | | | | |
Total | | | | | | | |
| | | | | | | |
Sovereign | $ | 12 |
| $ | — |
| $ | 680 |
| $ | 523 |
| $ | 1,215 |
| $ | (821 | ) | $ | 394 |
|
Financial Institutions | 20 |
| 12 |
| 300 |
| 464 |
| 796 |
| (98 | ) | 698 |
|
Corporates | 30 |
| 21 |
| 300 |
| 509 |
| 860 |
| (447 | ) | 413 |
|
Total | $ | 62 |
| $ | 33 |
| $ | 1,280 |
| $ | 1,496 |
| $ | 2,871 |
| $ | (1,366 | ) | $ | 1,505 |
|
(1)Net counterparty exposure includes the fair value of derivatives including the counterparty risk associated with credit default protection and secured financing transactions. Derivatives have been reduced by all eligible
collateral pledged under legally enforceable netting agreements. Secured financing transactions have been reduced by eligible cash or securities pledged. The notional amount of reverse repurchase transactions was $1.3 billion at December 31, 2012. Counterparty exposure is not presented net of hedges or credit default protection.
(2)Long securities exposures have been netted on a single-name basis to, but not below, zero by hedges and short positions.
(3)Represents credit default protection purchased, net of credit default protection sold, which is used to mitigate our risk to country exposures as listed, including $(463) million in net credit default protection purchased to hedge loans and securities and short positions, and $(903) million in additional credit default protection purchased to hedge derivative assets. Amounts are calculated based on the credit default protection notional amount assuming zero recovery adjusted for any fair value receivable or payable.
(4)Represents country exposure less hedges and credit default protection.
We hedge certain of our selected European country exposure with credit default swaps (“CDS”). The majority of our CDS contracts on reference assets in Greece, Ireland, Italy, Portugal and Spain are with highly-rated financial institutions primarily outside of the Eurozone and we work to limit or eliminate correlated CDS. Due to our engagement in market-making activities, our CDS portfolio contains contracts with various maturities to a diverse set of counterparties. We work to limit mismatches in maturities between our exposures and the CDS we use to hedge them. However, there may be instances where the protection purchased has a different maturity from the exposure for which the protection was purchased, in which case, those exposures and hedges are subject to more active monitoring and management.
The table below presents the notional and fair value amounts of single-name CDS purchased and sold on reference assets in Greece, Ireland, Italy, Portugal and Spain at December 31, 2012.
|
| | | | | | | | | | | | | |
Single-Name CDS with Reference Assets in Greece, Ireland, Italy, Portugal and Spain(1) |
| Notional | | Fair Value |
(dollars in millions) | Purchased | Sold | | Purchased | Sold |
Greece | | | | | |
Aggregate | $ | 76 |
| $ | 51 |
| | $ | 5 |
| $ | 5 |
|
After Legally Netting (2) | 39 |
| 14 |
| | 1 |
| 1 |
|
| | | | | |
Ireland | | | | | |
Aggregate | 1,090 |
| 889 |
| | 128 |
| 77 |
|
After Legally Netting (2) | 1,041 |
| 841 |
| | 122 |
| 75 |
|
| | | | | |
Italy | | | | | |
Aggregate | 10,460 |
| 7,333 |
| | 1,240 |
| 634 |
|
After Legally Netting (2) | 6,165 |
| 3,037 |
| | 988 |
| 392 |
|
| | | | | |
Portugal | | | | | |
Aggregate | 1,017 |
| 758 |
| | 67 |
| 49 |
|
After Legally Netting (2) | 370 |
| 111 |
| | 34 |
| 9 |
|
| | | | | |
Spain | | | | | |
Aggregate | 2,002 |
| 2,243 |
| | 110 |
| 139 |
|
After Legally Netting (2) | 821 |
| 1,062 |
| | 47 |
| 73 |
|
(1) The majority of our CDS contracts on reference assets in Greece, Ireland, Italy, Portugal and Spain are primarily with non-Eurozone counterparties.
(2) Amounts listed are after consideration of legally enforceable counterparty master netting agreements.
Losses could result even if there is credit default protection purchased because the purchased credit protection contracts only pay out under certain scenarios and thus not all losses may be covered by the credit protection contracts. The effectiveness of our CDS protection as a hedge of these risks is influenced by a number of factors, including the contractual terms of the CDS. Generally, only the occurrence of a credit event as defined by the CDS terms (which may include, among other events, the failure to pay by, or restructuring of, the reference entity) results in a payment under the purchased credit protection contracts. The determination as to whether a credit event has occurred is made by the relevant ISDA Determination Committee (comprised of various ISDA member firms) based on the terms of the CDS and facts and circumstances for the event. Accordingly, uncertainties exist as to whether any particular strategy or policy action for addressing the European debt crisis would constitute a credit event under the CDS. A voluntary restructuring may not trigger a credit event under CDS terms and consequently may not trigger a payment under the CDS contract.
In addition to our direct sovereign and non-sovereign exposures, a significant deterioration of the European debt crisis could result in material reductions in the value of sovereign debt and other asset classes, disruptions in capital markets, widening of credit spreads of U.S. and other financial institutions, loss of investor confidence in the financial services industry, a slowdown in global economic activity and other adverse developments. For additional information on the debt crisis in Europe, see Item 1A. "Risk Factors".
Derivatives
We enter into ISDA master netting agreements or their equivalent (“master netting agreements”) with almost all of our derivative counterparties. Master netting agreements provide protection in bankruptcy in certain circumstances and, where legally enforceable, enable receivables and payables with the same counterparty to be offset for accounting and risk management purposes. Netting agreements are generally negotiated bilaterally and can require complex terms. While we make reasonable efforts to execute such agreements, it is possible that a counterparty may be unwilling to sign such an agreement and, as a result, would subject us to additional credit risk. 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.
To reduce the risk of loss, we require collateral, principally cash and U.S. government and agency securities, on certain derivative transactions. From an economic standpoint, we evaluate risk exposures net of related collateral that meets specified standards. In addition to obtaining collateral, we attempt to mitigate counterparty default risk on derivatives whenever possible by entering into transactions with provisions that enable us to terminate or reset the terms of our derivative contracts.
| |
Item 8. | Financial Statements and Supplementary Data |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of Merrill Lynch & Co., Inc.:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of earnings (loss), comprehensive (loss) income, changes in stockholder's equity and cash flows present fairly, in all material respects, the financial position of Merrill Lynch & Co., Inc. and its subsidiaries (the "Company") at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 28, 2013
Merrill Lynch & Co., Inc. and Subsidiaries Consolidated Statements of Earnings (Loss) |
| | | | | | | | | | | |
| | | | | |
| For the Year Ended | | For the Year Ended | | For the Year Ended |
(dollars in millions) | December 31, 2012 | | December 31, 2011 | | December 31, 2010 |
Revenues | |
| | |
| | |
|
Principal transactions | $ | 2,306 |
| | $ | 5,876 |
| | $ | 7,092 |
|
Commissions | 5,079 |
| | 5,698 |
| | 5,760 |
|
Managed account and other fee-based revenues | 5,427 |
| | 5,203 |
| | 4,516 |
|
Investment banking | 4,914 |
| | 5,179 |
| | 5,313 |
|
Earnings from equity method investments | 285 |
| | 347 |
| | 898 |
|
Intercompany service fee revenue from Bank of America | 986 |
| | 944 |
| | 329 |
|
Other revenues | 1,929 |
| | 1,808 |
| | 4,473 |
|
Other-than-temporary impairment losses on available-for-sale debt securities: | | | | | |
Total other-than-temporary impairment losses | (6 | ) | | (69 | ) | | (174 | ) |
Less: Portion of other-than-temporary impairment losses recognized in | | | | | |
other comprehensive income | — |
| | 10 |
| | 2 |
|
Subtotal | 20,920 |
| | 24,996 |
| | 28,209 |
|
Interest and dividend revenues | 6,395 |
| | 8,186 |
| | 9,352 |
|
Less interest expense | 7,098 |
| | 8,785 |
| | 9,610 |
|
Net interest expense | (703 | ) | | (599 | ) | | (258 | ) |
Revenues, net of interest expense | 20,217 |
| | 24,397 |
| | 27,951 |
|
| |
| | |
| | |
|
Non-interest expenses | | | | | |
Compensation and benefits | 14,608 |
| | 15,773 |
| | 15,069 |
|
Communications and technology | 1,588 |
| | 1,771 |
| | 1,993 |
|
Occupancy and related depreciation | 1,204 |
| | 1,367 |
| | 1,395 |
|
Brokerage, clearing, and exchange fees | 951 |
| | 1,121 |
| | 1,022 |
|
Advertising and market development | 501 |
| | 500 |
| | 444 |
|
Professional fees | 921 |
| | 1,029 |
| | 986 |
|
Office supplies and postage | 104 |
| | 126 |
| | 157 |
|
Representations and warranties | (754 | ) | | 2,731 |
| | (120 | ) |
Intercompany service fee expense from Bank of America | 1,798 |
| | 2,320 |
| | 538 |
|
Other | 1,554 |
| | 2,250 |
| | 2,439 |
|
Total non-interest expenses | 22,475 |
| | 28,988 |
| | 23,923 |
|
Pre-tax (loss) earnings | (2,258 | ) | | (4,591 | ) | | 4,028 |
|
Income tax (benefit) expense | (2,548 | ) | | (2,944 | ) | | 148 |
|
Net earnings (loss) | $ | 290 |
| | $ | (1,647 | ) | | $ | 3,880 |
|
Preferred stock dividends | — |
| | — |
| | 134 |
|
Net earnings (loss) applicable to common stockholder | $ | 290 |
| | $ | (1,647 | ) | | $ | 3,746 |
|
See Notes to Consolidated Financial Statements.
Merrill Lynch & Co., Inc. and Subsidiaries Consolidated Statements of Comprehensive (Loss) Income |
| | | | | | | | | | | |
| | | | | |
| For the Year Ended | | For the Year Ended | | For the Year Ended |
(dollars in millions) | December 31, 2012 | | December 31, 2011 | | December 31, 2010 |
Net earnings (loss) | $ | 290 |
| | $ | (1,647 | ) | | $ | 3,880 |
|
Other comprehensive (loss) income: | |
| | |
| | |
|
Foreign currency translation adjustment: | |
| | |
| | |
|
Foreign currency translation (losses) gains | (26 | ) | | 50 |
| | (197 | ) |
Income tax benefit (expense) | 49 |
| | (166 | ) | | 240 |
|
Total | 23 |
| | (116 | ) | | 43 |
|
Net unrealized gains (losses) on investment securities available-for-sale: | | | | | |
|
Net unrealized holding gains (losses) arising during the period | — |
| | 57 |
| | (168 | ) |
Reclassification adjustment for realized (gains) losses included in net (loss) earnings | — |
| | (3 | ) | | 9 |
|
Net unrealized gains (losses) on investment securities available-for-sale | — |
| | 54 |
| | (159 | ) |
Income tax benefit (expense) | 30 |
| | (21 | ) | | 46 |
|
Total | 30 |
| | 33 |
| | (113 | ) |
Deferred (losses) gains on cash flow hedges: | |
| | |
| | |
|
Deferred (losses) gains on cash flow hedges | — |
| | (3 | ) | | 32 |
|
Reclassification adjustment for realized gains included in net (loss) earnings | — |
| | (6 | ) | | (25 | ) |
Income tax benefit (expense) | — |
| | 4 |
| | (3 | ) |
Total | — |
| | (5 | ) | | 4 |
|
Defined benefit pension and postretirement plans: | |
| | |
| | |
|
Net actuarial (losses) gains | (537 | ) | | 111 |
| | (56 | ) |
Prior service credit (cost) | 3 |
| | 24 |
| | (59 | ) |
Income tax benefit (expense) | 189 |
| | (28 | ) | | 39 |
|
Total | (345 | ) | | 107 |
| | (76 | ) |
Total other comprehensive (loss) income | (292 | ) | | 19 |
| | (142 | ) |
Comprehensive (loss) income | $ | (2 | ) | | $ | (1,628 | ) | | $ | 3,738 |
|
| | | | | |
Merrill Lynch & Co., Inc. and Subsidiaries Consolidated Balance Sheets |
| | | | | | | |
(dollars in millions, except per share amounts) | December 31,
2012 | | December 31,
2011 |
ASSETS | | | |
Cash and cash equivalents | $ | 12,911 |
| | $ | 13,733 |
|
Cash and securities segregated for regulatory purposes or deposited with clearing organizations | 14,031 |
| | 11,757 |
|
Securities financing transactions | | | |
|
Receivables under resale agreements (includes $93,715 in 2012 and $85,652 in 2011 measured at fair value in accordance with the fair value option election) | 148,817 |
| | 143,491 |
|
Receivables under securities borrowed transactions (includes $961 in 2012 and $259 in 2011 measured at fair value in accordance with the fair value option election) | 60,992 |
| | 58,109 |
|
| 209,809 |
| | 201,600 |
|
Trading assets, at fair value (includes securities pledged as collateral that can be sold or repledged of $36,268 in 2012 and $34,932 in 2011) | |
| | |
|
Derivative contracts | 24,851 |
| | 35,091 |
|
Equities and convertible debentures | 40,618 |
| | 25,619 |
|
Non-U.S. governments and agencies | 37,845 |
| | 30,239 |
|
Corporate debt and preferred stock | 18,337 |
| | 17,305 |
|
Mortgages, mortgage-backed, and asset-backed | 10,613 |
| | 8,254 |
|
U.S. Government and agencies | 54,564 |
| | 43,003 |
|
Municipals, money markets, physical commodities and other | 12,480 |
| | 13,044 |
|
| 199,308 |
| | 172,555 |
|
Investment securities (includes $162 in 2012 and $244 in 2011 measured at fair value in accordance with the fair value option election) | 5,903 |
| | 6,684 |
|
Securities received as collateral, at fair value | 16,013 |
| | 13,716 |
|
Receivables from Bank of America | 45,830 |
| | 59,945 |
|
Other receivables | | | |
|
Customers (net of allowance for doubtful accounts of $9 in 2012 and $15 in 2011) (includes $271 in 2012 and $0 in 2011 measured at fair value in accordance with the fair value option election) | 20,265 |
| | 20,512 |
|
Brokers and dealers | 21,792 |
| | 8,691 |
|
Interest and other | 9,244 |
| | 9,130 |
|
| 51,301 |
| | 38,333 |
|
Loans, notes, and mortgages (net of allowances for loan losses of $57 in 2012 and $72 in 2011) (includes $3,077 in 2012 and $2,322 in 2011 measured at fair value in accordance with the fair value option election) | 19,545 |
| | 20,574 |
|
Equipment and facilities, net | 1,031 |
| | 1,385 |
|
Goodwill and intangible assets | 9,782 |
| | 10,079 |
|
Other assets | 17,464 |
| | 15,155 |
|
Total Assets | $ | 602,928 |
| | $ | 565,516 |
|
| | | |
Assets of Consolidated VIEs Included in Total Assets Above (isolated to settle the liabilities of the VIEs) | |
| | |
|
Trading assets, excluding derivative contracts | $ | 7,847 |
| | $ | 8,800 |
|
Investment securities | 41 |
| | 162 |
|
Loans, notes, and mortgages (net) | 206 |
| | 94 |
|
Other assets | 764 |
| | 3,022 |
|
Total Assets of Consolidated VIEs | $ | 8,858 |
| | $ | 12,078 |
|
| | | |
See Notes to Consolidated Financial Statements. | | | |
Merrill Lynch & Co., Inc. and Subsidiaries Consolidated Balance Sheets |
| | | | | | | |
(dollars in millions, except per share amounts) | December 31,
2012 | | December 31,
2011 |
LIABILITIES | |
| | |
|
Securities financing transactions | |
| | |
|
Payables under repurchase agreements (includes $42,639 in 2012 and $34,235 in 2011 measured at fair value in accordance with the fair value option election) | $ | 219,710 |
| | $ | 173,767 |
|
Payables under securities loaned transactions | 18,305 |
| | 11,460 |
|
| 238,015 |
| | 185,227 |
|
Short-term borrowings (includes $3,283 in 2012 and $5,908 in 2011 measured at fair value in accordance with the fair value option election) | 3,376 |
| | 6,051 |
|
Deposits | 12,873 |
| | 12,364 |
|
Trading liabilities, at fair value | | | |
|
Derivative contracts | 20,568 |
| | 26,239 |
|
Equities and convertible debentures | 18,957 |
| | 12,223 |
|
Non-U.S. governments and agencies | 19,707 |
| | 16,554 |
|
Corporate debt and preferred stock | 8,026 |
| | 7,084 |
|
U.S. Government and agencies | 20,186 |
| | 16,976 |
|
Municipals, money markets and other | 562 |
| | 645 |
|
| 88,006 |
| | 79,721 |
|
Obligation to return securities received as collateral, at fair value | 16,013 |
| | 13,716 |
|
Payables to Bank of America | 8,752 |
| | 31,731 |
|
Other payables | | | |
|
Customers | 52,053 |
| | 40,153 |
|
Brokers and dealers | 4,748 |
| | 8,667 |
|
Interest and other (includes $57 in 2012 and $173 in 2011 measured at fair value in accordance with the fair value option election) | 18,634 |
| | 18,128 |
|
| 75,435 |
| | 66,948 |
|
Long-term borrowings (includes $30,875 in 2012 and $30,325 in 2011 measured at fair value in accordance with the fair value option election) | 92,249 |
| | 106,929 |
|
Junior subordinated notes (related to trust preferred securities) | 3,809 |
| | 3,789 |
|
Total Liabilities | 538,528 |
| | 506,476 |
|
| | | |
COMMITMENTS AND CONTINGENCIES |
|
| |
|
|
| | | |
|
STOCKHOLDER'S EQUITY | | | |
| | | |
Common stock (par value $1.331/3 per share; authorized: 3,000,000,000 shares; issued: 2012 and 2011 — 1,000 shares) | — |
| | — |
|
Paid-in capital | 56,127 |
| | 50,765 |
|
Accumulated other comprehensive loss (net of tax) | (527 | ) | | (235 | ) |
Retained earnings | 8,800 |
| | 8,510 |
|
Total Stockholder's Equity | 64,400 |
| | 59,040 |
|
| | | |
Total Liabilities and Stockholder's Equity | $ | 602,928 |
| | $ | 565,516 |
|
| | | |
Liabilities of Consolidated VIEs Included in Total Liabilities Above | |
| | |
|
Short-term borrowings (includes $81 in 2012 and $0 in 2011 of non-recourse debt) | $ | 2,940 |
| | $ | 4,939 |
|
Derivative contracts | 19 |
| | 4 |
|
Payables to Bank of America | 1,157 |
| | — |
|
Long-term borrowings (includes $2,335 in 2012 and $2,579 in 2011 of non-recourse debt) | 6,292 |
| | 6,595 |
|
Other payables | 14 |
| | 186 |
|
Total Liabilities of Consolidated VIEs | $ | 10,422 |
| | $ | 11,724 |
|
| | | |
|
| | | | | | | | | | | | | | | | | | |
Merrill Lynch & Co. Inc. and Subsidiaries |
Consolidated Statements of Changes in Stockholder's Equity |
(dollars in millions) | Preferred Stock | Common Stock | Additional Paid-in-Capital | Retained Earnings | Accumulated Other Comprehensive (Loss) Income | Total Stockholder's Equity |
Balance December 31, 2009 | $ | 1,541 |
| $ | — |
| $ | 48,214 |
| $ | 6,556 |
| $ | (112 | ) | $ | 56,199 |
|
Mandatory conversion of preferred stock | (1,541 | ) | — |
| — |
| — |
| — |
| (1,541 | ) |
Capital contribution associated with stock-based compensation awards | — |
| — |
| 1,447 |
| — |
| — |
| 1,447 |
|
Other capital contributions from Bank of America | — |
| — |
| 228 |
| — |
| — |
| 228 |
|
Foreign currency translation adjustment | — |
| — |
| — |
| — |
| 43 |
| 43 |
|
Net unrealized losses on investment securities available-for-sale | — |
| — |
| — |
| — |
| (113 | ) | (113 | ) |
Net deferred gains on cash flow hedges | — |
| — |
| — |
| — |
| 4 |
| 4 |
|
Change in funded status of defined benefit pension and post retirement plans | — |
| — |
| — |
| — |
| (76 | ) | (76 | ) |
Cumulative adjustments for accounting changes: | | | | | | |
Consolidation of certain variable interest entities | — |
| — |
| — |
| (145 | ) | — |
| (145 | ) |
Net earnings | — |
| — |
| — |
| |