Graph Titled "NET EARNINGS"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s net earnings of
$894, $1,359, $1,017, $1,114, and $1,619 for the years 1992 through 1996,
respectively. Graph is shown in millions.
Graph Titled "STOCKHOLDERS' EQUITY"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s stockholders'
equity of $4,569, $5,486, $5,818, $6,141, and $6,892 for the years ended 1992
through 1996, respectively. Graph is shown in millions.
Graph Titled "RETURN ON AVERAGE COMMON STOCKHOLDERS' EQUITY"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s return on
average common stockholders' equity of 22.0%, 27.3%, 18.6%, 20.1%, and 26.8%
for the years 1992 through 1996, respectively.
Graph Titled "PRIMARY EARNINGS PER SHARE"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s primary earnings
per share of $3.92, $5.98, $4.75, $5.44, and $8.20 for the years 1992 through
1996, respectively.
Graph Titled "DIVIDENDS PAID PER COMMON SHARE"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s dividends paid
per common share of $.575, $.70, $.89, $1.01, and $1.16 for the years 1992
through 1996, respectively.
Graph Titled "BOOK VALUE PER COMMON SHARE"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s book value per
common share of $21.37, $26.17, $28.87, $32.41, and $38.38 for the years ended
1992 through 1996, respectively.
Year Ended Last Friday in December
----------------------------------------------------------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1992 1993 1994 1995 1996
- --------------------------------------------------------------------------------------------------------------------
(52 Weeks) (53 Weeks) (52 Weeks) (52 Weeks) (52 Weeks)
OPERATING RESULTS
Total Revenues $ 13,413 $ 16,588 $ 18,234 $ 21,513 $ 25,011
Net Revenues $ 8,577 $ 10,558 $ 9,625 $ 10,265 $ 13,116
Net Earnings $ 894 $ 1,359 $ 1,017 $ 1,114 $ 1,619
Pretax Margin (a) 18.9% 23.0% 18.0% 17.6% 19.6%
Profit Margin (b) 11.1% 13.2% 10.6% 10.8% 12.3%
Return on Average Common
Stockholders' Equity 22.0% 27.3% 18.6% 20.1% 26.8%
- --------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total Assets $107,024 $152,910 $163,749 $176,857 $213,016
Total Stockholders' Equity $ 4,569 $ 5,486 $ 5,818 $ 6,141 $ 6,892
- --------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Primary Earnings $ 3.92 $ 5.98 $ 4.75 $ 5.44 $ 8.20
Fully Diluted Earnings $ 3.91 $ 5.95 $ 4.74 $ 5.42 $ 8.06
Dividends Paid $ .575 $ .70 $ .89 $ 1.01 $ 1.16
Book Value $ 21.37 $ 26.17 $ 28.87 $ 32.41 $ 38.38
- --------------------------------------------------------------------------------------------------------------------
CLIENT ASSETS (IN BILLIONS)
Assets in Worldwide Client
Accounts $ 487 $ 557 $ 568 $ 703 $ 839
Assets Under Management $ 139 $ 161 $ 164 $ 196 $ 234
- --------------------------------------------------------------------------------------------------------------------
UNDERWRITING (DOLLARS IN BILLIONS)(c)
Global Debt and Equity:
Volume $ 149.9 $ 191.9 $ 137.1 $ 147.0 $ 187.7
Market Share 13.0% 12.9% 12.6% 13.7% 12.9%
U.S. Debt and Equity:
Volume $ 139.6 $ 172.5 $ 116.1 $ 126.6 $ 155.9
Market Share 16.4% 16.4% 16.4% 17.8% 16.3%
- --------------------------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES 40,100 41,900 43,800 46,000 49,800
- --------------------------------------------------------------------------------------------------------------------
COMMON SHARES
OUTSTANDING (d)(in Millions) 207.2 204.0 181.5 171.4 164.1
(a) Earnings Before Income Taxes and Cumulative Effect of Changes in Accounting Principles to Net Revenues.
(b) Earnings Before Cumulative Effect of Changes in Accounting Principles to Net Revenues.
(c) Full credit to book manager. All market share data are derived from Securities Data Co.
(d) Does not include unallocated reversion shares held in the Employee Stock Ownership Plan, which are not considered outstanding
for accounting purposes.
SELECTED FINANCIAL DATA
Year Ended Last Friday in December
----------------------------------------------------------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------------------------------------------
(52 Weeks) (52 Weeks) (52 Weeks) (53 Weeks) (52 Weeks)
OPERATING RESULTS
Revenues $ 25,011 $ 21,513 $ 18,234 $ 16,588 $ 13,413
Interest Expense 11,895 11,248 8,609 6,030 4,836
-------- -------- -------- -------- --------
Net Revenues 13,116 10,265 9,625 10,558 8,577
Non-Interest Expenses 10,550 8,454 7,895 8,133 6,956
-------- -------- -------- -------- --------
Earnings Before Income Taxes and Cumulative Effect
of Changes in Accounting Principles 2,566 1,811 1,730 2,425 1,621
Income Tax Expense 947 697 713 1,031 669
-------- -------- -------- -------- --------
Earnings Before Cumulative Effect of Changes in
Accounting Principles $ 1,619 $ 1,114 $ 1,017 $ 1,394 $ 952
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net Earnings $ 1,619 $ 1,114 $ 1,017 $ 1,359 $ 894
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net Earnings Applicable to Common Stockholders $ 1,572 $ 1,066 $ 1,004 $ 1,354 $ 887
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
- ------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total Assets $213,016 $176,857 $163,749 $152,910 $107,024
Short-Term Borrowings (a) $102,002 $ 86,363 $ 78,304 $ 79,632 $ 51,180
Long-Term Borrowings $ 26,102 $ 17,340 $ 14,863 $ 13,469 $ 10,871
Preferred Securities Issued by Subsidiaries $ 327 $ 51 $ 51 $ 51 $ 51
Total Stockholders' Equity $ 6,892 $ 6,141 $ 5,818 $ 5,486 $ 4,569
- ------------------------------------------------------------------------------------------------------------------
TAX INFORMATION
Other Taxes, Principally Payroll and Property $ 341 $ 291 $ 255 $ 223 $ 222
Total Taxes (b) $ 1,288 $ 988 $ 968 $ 1,254 $ 891
- ------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Primary:
Earnings Before Cumulative Effect of Changes in
Accounting Principles $ 8.20 $ 5.44 $ 4.75 $ 6.14 $ 4.18
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net Earnings $ 8.20 $ 5.44 $ 4.75 $ 5.98 $ 3.92
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Fully Diluted:
Earnings Before Cumulative Effect of Changes in
Accounting Principles $ 8.06 $ 5.42 $ 4.74 $ 6.11 $ 4.17
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net Earnings $ 8.06 $ 5.42 $ 4.74 $ 5.95 $ 3.91
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Weighted-Average Shares Outstanding:
Primary 191,836 195,997 211,241 226,331 226,402
Fully Diluted 195,175 196,660 211,695 227,480 226,854
Shares Outstanding at Year-End (c) 164,086 171,388 181,479 203,990 207,203
Shares Repurchased 18,579 20,012 29,989 16,346 10,654
Average Share Repurchase Price $ 62.60 $ 46.95 $ 37.96 $ 42.55 $ 24.36
Book Value $ 38.38 $ 32.41 $ 28.87 $ 26.17 $ 21.37
Total Taxes (b) $ 6.72 $ 5.04 $ 4.58 $ 5.54 $ 3.94
Dividends Paid $ 1.16 $ 1.01 $ .89 $ .70 $ .575
- ------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Pretax Margin (d) 19.6% 17.6% 18.0% 23.0% 18.9%
Profit Margin (e) 12.3% 10.8% 10.6% 13.2% 11.1%
Common Dividend Payout Ratio 12.5% 16.9% 17.5% 10.9% 13.5%
Return on Average Assets 0.7% 0.6% 0.6% 1.0% 0.8%
Return on Average Common Stockholders' Equity 26.8% 20.1% 18.6% 27.3% 22.0%
Average Leverage (f) 33.5x 32.4x 31.7x 27.1x 24.8x
Average Adjusted Leverage (g) 19.9x 19.3x 18.7x 16.4x 15.7x
- -------------------------------------------------------------------------------------------------------------------
EMPLOYEE STATISTICS
Full-Time Employees:
U.S 42,200 39,250 38,750 37,500 36,100
Non-U.S 7,600 6,750 5,050 4,400 4,000
-------- -------- -------- -------- --------
Total 49,800 46,000 43,800 41,900 40,100
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Financial Consultants and Account Executives Worldwide 14,400 13,900 13,500 13,200 12,700
(a) Short-Term Borrowings include repurchase agreements and commercial paper
and other short-term borrowings.
(b) Excludes the effect of $25 and $73 of income taxes in 1993 and 1992,
respectively, related to the cumulative effect of changes in accounting
principles.
(c) Does not include 1,539, 4,013, 6,427, 8,932, and 11,202 unallocated
reversion shares held in the Employee Stock Ownership Plan at year-end
1996, 1995, 1994, 1993, and 1992, respectively, which are not considered
outstanding for accounting purposes.
(d) Earnings Before Income Taxes and Cumulative Effect of Changes in Accounting
Principles to Net Revenues.
(e) Earnings Before Cumulative Effect of Changes in Accounting Principles to
Net Revenues.
(f) Average total assets to average total stockholders' equity and preferred
securities issued by subsidiaries.
(g) Average total assets less average resale agreements and securities borrowed
to average total stockholders' equity and preferred securities issued by
subsidiaries.
BUSINESS ENVIRONMENT
Merrill Lynch & Co., Inc. and its subsidiaries (collectively referred to as
"Merrill Lynch") is a client-focused, financial management and advisory company,
concentrating on client relationships and on integrated delivery of services
worldwide. Merrill Lynch serves its clients and conducts its businesses in
global financial markets that are influenced by many factors, including economic
and market conditions, political events, and investor sentiment. The reaction of
issuers and investors to a particular condition or event is unpredictable and
can increase volatility in the marketplace. While high volatility increases
risk, it may also increase order flow, which drives many of Merrill Lynch's
businesses. Earnings also can be affected by other global market and economic
conditions, including the liquidity of secondary markets; the level and
volatility of interest rates, currency exchange rates, and security valuations;
competitive conditions; and the size, number, and timing of transactions. As a
result, revenues and net earnings can vary significantly from quarter to
quarter, and from year to year.
The robust global financial markets of 1995 continued in 1996, led by a stable
U.S. economy and heightened individual and institutional investor activity. Low
interest rates, a favorable economic environment, and strong cash flows into
mutual funds combined to make 1996 a record year in U.S. equity markets and led
to significant gains in most non-U.S. markets.
U.S. equity markets continued to post significant gains in 1996, as evidenced by
a 26% rise in the Dow Jones Industrial Average. Individuals invested record
amounts into mutual funds, boosting demand for new issuances and driving both
average daily trading volumes and stock indices to record levels.
U.S. bond markets, which advanced on steady declines in interest rates
throughout 1995, were more volatile in 1996. Expectations that the Federal
Reserve Board would raise rates, combined with inflationary fears and a
stronger-than-expected economy, led to a modest rise in long-term rates in the
first half of the year. This trend reversed late in the third quarter as
inflationary fears eased, leading to a decrease in long-term interest rates. The
yield on the 30-year bond ended the year at 6.54%, higher than the 1995 year-end
rate of 5.95%, but lower than the high of 7.20%, which occurred in June.
The Dow Jones World Index rose approximately 11% during 1996. Relatively low
inflation and interest rates, combined with growing investor confidence in
emerging markets, contributed to year-over-year gains in many non-U.S. equity
and bond markets.
Global underwriting volume rose from the first quarter of 1995 throughout most
of 1996. Rising stock prices and relatively low interest rates created
attractive market conditions for issuers, while demand for new issues benefited
from record inflows of cash into mutual funds. Industrywide disclosed fees from
U.S. and global debt and equity underwriting reached records of $9.2 billion and
$17.6 billion, respectively, according to Securities Data Co. ("SDC").
Strategic services activities in 1996 also reached record levels, reflecting
a continuation of the high degree of mergers and acquisitions activity seen
in 1995. Driven by globalization and other competitive and economic factors,
companies continued to seek strategic alliances to increase earnings growth
and expand into new markets and businesses.
Fiscal 1996 was characterized by strong financial markets and favorable economic
conditions. Due to the cyclical nature of the financial services industry,
however, Merrill Lynch continually evaluates its businesses across market cycles
for profitability and alignment with long-term strategic objectives. Merrill
Lynch seeks to mitigate the effect of market downturns by expanding its global
presence, developing and maintaining long-term client relationships, closely
monitoring costs and risks, and continuing to diversify revenue sources.
- -------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
(IN MILLIONS, EXCEPT 1996 vs.
--------
PER SHARE AMOUNTS) 1996 1995 1994 1995 1994
- -------------------------------------------------------------------------------
Total revenues $25,011 $21,513 $18,234 16.3% 37.2%
Net revenues 13,116 10,265 9,625 27.8 36.3
Net earnings 1,619 1,114 1,017 45.3 59.2
Net earnings
applicable to
common
stockholders 1,572 1,066 1,004 47.5 56.6
Earnings per
common share:
Primary 8.20 5.44 4.75 50.7 72.6
Fully diluted 8.06 5.42 4.74 48.7 70.0
Return on
average common
stockholders' equity 26.8% 20.1% 18.6% 33.3 44.1
- -------------------------------------------------------------------------------
Merrill Lynch's record net earnings for 1996 surpassed its previous record in
1993 of $1.4 billion by 19%. Record revenues in all major categories, partially
offset by increased costs, particularly compensation and technology-related
expenses, led to record net earnings.
Merrill Lynch made several strategic acquisitions in 1996 to help expand its
global presence and client base for aggregate consideration paid of $232
million, recognizing $167 million of goodwill. The impact of these acquisitions
was not material to Merrill Lynch's 1996 results of operations.
In 1995, Merrill Lynch acquired Smith New Court PLC ("Smith New Court"), a
U.K.-based global securities firm, for $803 million. Merrill Lynch recorded $533
million of goodwill related to the acquisition. Merrill Lynch's 1995 results
included Smith New Court operations since mid-August 1995 and related goodwill
amortization.
The following discussion provides details of major categories of revenues and
expenses and other pertinent information regarding Merrill Lynch's business
activities, financial condition, liquidity, and risks. Certain limited
reclassification and format changes have been made to prior years' amounts to
conform to the current year presentation.
- --------------------------------------------------------------------------------
COMMISSIONS
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Listed and over-the-counter $2,039 $1,678 $1,437
Mutual funds 1,192 906 879
Other 555 542 555
------ ------ ------
TOTAL $3,786 $3,126 $2,871
------ ------ ------
------ ------ ------
- --------------------------------------------------------------------------------
Commissions revenues advanced 21% in 1996 to a record $3.8 billion due primarily
to higher levels of listed and over-the-counter securities transactions and
mutual fund commissions.
Commissions from listed and over-the-counter securities increased 21% from 1995
as a result of higher trading volumes on the New York Stock Exchange, Nasdaq,
and most non-U.S. exchanges. Mutual fund commissions revenues rose 32% to a
record $1.2 billion, primarily benefiting from strong sales of U.S. funds and
higher distribution fees from deferred-charge funds.
Other commissions revenues rose 2% in 1996 largely due to increased sales of
over-the-counter options and third party annuity contracts.
Commissions revenues in 1995 increased 9% over 1994 levels. Higher revenues
from listed and over-the-counter securities and mutual fund sales were
partially offset by lower revenues from commodities.
- --------------------------------------------------------------------------------
INTEREST AND DIVIDENDS
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
INTEREST AND DIVIDEND REVENUES
Trading assets $ 4,170 $ 3,832 $3,431
Securities borrowed 2,821 2,940 2,285
Resale agreements 2,977 2,810 1,807
Margin lending 1,542 1,394 1,018
Other 1,389 1,245 1,037
- --------------------------------------------------------------------------------
Subtotal 12,899 12,221 9,578
- --------------------------------------------------------------------------------
INTEREST EXPENSE
Borrowings 4,873 4,330 3,381
Repurchase agreements 3,576 3,680 2,414
Trading liabilities 2,451 2,205 1,997
Other 995 1,033 817
- --------------------------------------------------------------------------------
Subtotal 11,895 11,248 8,609
- --------------------------------------------------------------------------------
NET INTEREST AND DIVIDEND PROFIT $ 1,004 $ 973 $ 969
------- ------- ------
------- ------- ------
- --------------------------------------------------------------------------------
Merrill Lynch hedges its long- and short-term payment obligations with interest
rate and currency swaps. The effect of these hedges, which is included in
"Borrowings" above, decreased interest expense for 1996, 1995, and 1994 by $64
million, $45 million, and $153 million, respectively (see Note 5 to the
Consolidated Financial Statements).
Interest and dividend revenues and expenses are a function of the level and mix
of interest-earning assets and interest-bearing liabilities and the prevailing
level, term structure, and volatility of interest rates.
Net interest and dividend profit was up 3% from 1995 resulting from increases
in interest spreads as the U.S. Treasury yield curve steepened for a portion
of the year.
In 1995, interest and dividend profit was virtually unchanged from 1994 with
increases in net interest-earning assets offset by declining interest spreads
due to the flattening of the U.S. Treasury yield curve.
- -----------------------------------------------------------------------------
PRINCIPAL TRANSACTIONS
- -----------------------------------------------------------------------------
The table that follows provides information on aggregate trading profits,
including related net interest. Interest revenue and expense amounts are based
on financial reporting categories and management's assessment of the cost to
finance trading positions, after consideration of the underlying liquidity of
these positions.
NET
PRINCIPAL INTEREST NET
TRANSACTIONS REVENUES TRADING
(IN MILLIONS) REVENUES (EXPENSES) REVENUES
- --------------------------------------------------------------------------------
1996
Equities and equity derivatives $1,138 $ (87) $1,051
Taxable fixed-income 966 250 1,216
Interest rate and currency swaps 893 (56) 837
Municipals 323 12 335
Foreign exchange and
commodities 134 (16) 118
------ ----- ------
TOTAL $3,454 $ 103 $3,557
------ ----- ------
------ ----- ------
- --------------------------------------------------------------------------------
1995
Equities and equity derivatives $ 912 $ (89) $ 823
Taxable fixed-income 516 256 772
Interest rate and currency swaps 732 (65) 667
Municipals 273 1 274
Foreign exchange and
commodities 86 (9) 77
------ ----- ------
TOTAL $2,519 $ 94 $2,613
------ ----- ------
------ ----- ------
- --------------------------------------------------------------------------------
1994
Equities and equity derivatives $ 625 $(106) $ 519
Taxable fixed-income 471 359 830
Interest rate and currency swaps 750 (14) 736
Municipals 380 7 387
Foreign exchange and
commodities 109 (8) 101
------ ----- ------
TOTAL $2,335 $ 238 $2,573
------ ----- ------
------ ----- ------
- --------------------------------------------------------------------------------
Principal transactions revenues rose 37% from 1995 to a record $3.5 billion due
to favorable market conditions highlighted by rising stock prices, low interest
rates, and narrowing credit spreads. These conditions led to increased customer
demand for higher-yielding securities.
Trading and related hedging and financing activities affect the recognition of
both principal transactions revenues and net interest and dividend profit. In
assessing the profitability of its trading activities, Merrill Lynch aggregates
net interest and principal transactions revenues. For financial reporting
purposes, however, realized and unrealized gains and losses on trading
positions, including hedges, are recorded in principal transactions revenues.
The net interest carry (i.e., the spread representing interest earned less
financing costs) for trading positions, including hedges, is recorded either as
principal transactions revenues or net interest profit, depending on the nature
of the specific instruments. Changes in the composition of trading inventories
and hedge positions can cause the recognition of revenues within these
categories to fluctuate.
Equities and equity derivative trading revenues were up 25% from 1995 due
principally to higher revenues from non-U.S. equities and over-the-counter
securities. Non- U.S. equities trading revenues benefited primarily from
improved market conditions and increased capacity related to the acquisition of
Smith New Court in the second half of 1995. Trading revenues from
over-the-counter securities were up as a result of record Nasdaq volume.
Taxable fixed-income trading revenues increased 87% from 1995, primarily due to
higher revenues from mortgage-backed products, non-U.S. governments and agencies
securities, and money market instruments. The increase in mortgage-backed
securities trading revenues was attributable to improved liquidity in this
market and increased customer demand compared with a year ago. Improved
economies in many emerging market countries and low interest rates contributed
to the increase in trading revenues from non-U.S. governments and agencies
securities as customers sought higher-yielding securities. Trading revenues from
money market instruments benefited from increased floating-rate note activity in
European markets.
Interest rate and currency swaps trading revenues rose 22% due to higher
revenues from both non-U.S. and U.S. dollar-denominated transactions. In
particular, increased customer demand for higher-yielding instruments led to
considerable growth in the trading activity of derivatives related to emerging
market securities. Municipal securities trading revenues were up 19% from 1995
primarily due to increased investor demand for tax-advantaged products. Foreign
exchange and commodities trading revenues, in the aggregate, increased 56% from
1995. Higher volume led to increased foreign exchange trading revenues as the
U.S. dollar strengthened versus most currencies, particularly the Japanese yen
and German mark.
In 1995, principal transactions revenues were up 8% from 1994. Higher stock
prices and the acquisition of Smith New Court led to increases in equities
and equity derivatives trading revenues (up 46%). Lower interest rates and
tighter credit spreads in 1995 led to increased demand and higher inventory
values for taxable fixed-income products (up 10%). Offsetting these increases
were declines in trading revenues from municipal securities (down 28%),
foreign exchange and commodities (down 22%), and interest rate and currency
swaps (down 2%), due in part to reduced demand for these products.
- --------------------------------------------------------------------------------
INVESTMENT BANKING
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Underwriting revenues $1,514 $ 964 $ 989
Strategic services revenues 431 344 251
------ ------ ------
TOTAL $1,945 $1,308 $1,240
------ ------ ------
------ ------ ------
- --------------------------------------------------------------------------------
Investment banking revenues advanced 49% in 1996 to a record $1.9 billion,
benefiting from record levels of equity and debt underwriting and mergers and
acquisitions activity industrywide. Merrill Lynch was the first investment bank
to underwrite over 1,000 U.S. issues in a single year, retaining its position as
top underwriter of total debt and equity securities for the ninth consecutive
year in the U.S. and for the eighth consecutive year globally. Merrill Lynch's
U.S. and global market shares of debt and equity underwriting volume in 1996
were 16.3% and 12.9%, respectively, compared with 17.8% and 13.7% in 1995,
according to SDC. SDC statistics are based on full credit to book manager.
Strategic services revenues increased 25% from 1995 to a record $431 million,
benefiting from strong mergers and acquisitions activity and significant gains
in market share. Merrill Lynch's market share information regarding mergers and
acquisitions activity for the last three years, according to SDC, is summarized
as follows:
- ----------------------------------------------------------------------------
1996 1995 1994
-------------- -------------- --------------
MARKET MARKET MARKET
SHARE RANK SHARE RANK SHARE RANK
- ----------------------------------------------------------------------------
COMPLETED
TRANSACTIONS
U.S. 24.7% 2 9.0% 8 17.3% 4
Global 16.3 3 6.4 9 12.1 5
ANNOUNCED
TRANSACTIONS
U.S. 27.9 1 17.7 4 13.3 3
Global 18.6 2 11.3 4 9.8 4
- ---------------------------------------------------------------------------
SDC gives full credit to both target and acquiring companies' advisors based on
transaction value.
Investment banking revenues increased 5% in 1995 from 1994, mainly due to a
37% increase in strategic services revenues resulting from stronger mergers
and acquisitions activity. This increase was offset by a 3% decline in
underwriting revenues due to decreases in equities, private placements,
high-yield debt, and mortgage-backed securities underwritings, partially
offset by increased revenues from corporate bonds and preferred stock and
defined asset funds.
- -------------------------------------------------------------------------------
ASSET MANAGEMENT AND PORTFOLIO SERVICE FEES
- -------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Asset management fees $ 997 $ 856 $ 794
Portfolio service fees 609 477 437
Account fees 373 338 323
Other fees 282 219 185
------ ------ ------
TOTAL $2,261 $1,890 $1,739
------ ------ ------
------ ------ ------
- --------------------------------------------------------------------------------
Revenues from asset management and portfolio service fees rose 20% in 1996 to a
record $2.3 billion primarily due to strong client asset growth. Assets under
management and total client assets for the last three years are summarized as
follows:
- --------------------------------------------------------------------------------
1996 vs.
-------------
(IN BILLIONS) 1996 1995 1994 1995 1994
- --------------------------------------------------------------------------------
Assets in U.S.
client accounts $ 792 $ 665 $ 537 19.1% 47.4%
Assets in non-U.S
client accounts 47 38 31 24.8 50.2
---- ----- ----
Total assets in
client accounts $ 839 $ 703 $ 568 19.4 47.6
---- ----- ----
---- ----- ----
Assets under
management:
Money market $ 90 $ 82 $ 67 9.4 34.3
Equity 59 47 37 25.9 61.4
Fixed-income 43 41 36 6.0 21.2
Private portfolio 38 22 20 70.0 90.1
Insurance 4 4 4 -- --
------ ------ ------
Total assets under
management $ 234 $ 196 $ 164 19.2 42.9
------ ------ ------
------ ------ ------
Merrill Lynch Consults
(Registered trademark) $ 21 $ 17 $ 14 22.4 44.4
Mutual Fund Advisor(Service mark)
and Asset Power
(Registered trademark) $ 9 $ 6 $ 3 50.0 191.9
- -------------------------------------------------------------------------------
Asset management fees in 1996, which primarily include fees earned on mutual
funds sponsored by Merrill Lynch, increased 16% due to strong inflows during
the year and net asset appreciation. New money investments accounted for
approximately 51% of the 1996 increase in client assets and approximately 61%
of the increase in assets under management by Merrill Lynch Asset Management.
In addition to new money investments, the fourth quarter acquisition of
Hotchkis and Wiley, a Los Angeles-based asset management company, added
approximately $10 billion of assets, principally in private portfolio funds.
Portfolio service fees increased 28% in 1996, benefiting from inflows of client
assets. Increases in the number of accounts and asset levels led to higher fee
revenues from asset-based fee products, primarily Merrill Lynch Consults, Asset
Power, and Mutual Fund Advisor.
Account fees rose 10% principally due to an increase in the number of customer
and custodial accounts. Other fee-based revenues were up 29%, due primarily to
increased revenues from transfer agency and mortgage servicing activities.
In 1995, asset management and portfolio service fees increased 9% from 1994, due
principally to growth in equity and money market funds and higher revenues from
Asset Power and Mutual Fund Advisor.
- --------------------------------------------------------------------------------
OTHER REVENUES
- --------------------------------------------------------------------------------
Other revenues were $666 million in 1996, up $217 million (48%) from 1995. Other
revenues include investment gains and losses, partnership distributions, and
fees from transaction processing and proxy activities. The increase in 1996 was
primarily attributable to incremental realized investment gains of $171 million,
of which $155 million related to the sale of one-third of Merrill Lynch's
minority interest in Bloomberg L.P., and a $40 million increase in gains from
real estate transactions, primarily sales of mortgages to Real Estate Mortgage
Investment Conduits.
In 1995, other revenues decreased 5% to $449 million. A decrease in net
investment gains related to merchant banking activities was partially offset by
distributions from partnership investments and revenues generated from
transaction processing and other activities.
- --------------------------------------------------------------------------------
NON-INTEREST EXPENSES
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Compensation and benefits $ 6,704 $5,270 $4,952
------- ------ ------
Non-interest expenses, excluding
compensation and benefits:
Communications and
equipment rental 559 487 432
Occupancy 508 449 436
Depreciation and amortization 411 367 325
Professional fees 582 425 367
Advertising and market
development 514 398 375
Brokerage, clearing, and
exchange fees 413 361 338
Other 859 697 670
------ ------ ------
Total non-interest expenses,
excluding compensation
and benefits 3,846 3,184 2,943
------- ------ ------
Total non-interest expenses $10,550 $8,454 $7,895
------- ------ ------
------- ------ ------
Compensation and benefits
as a percentage of net revenues 51.1% 51.3% 51.5%
Compensation and benefits as a
percentage of pretax earnings
before compensation and benefits 72.3% 74.4% 74.1%
- --------------------------------------------------------------------------------
Non-interest expenses were up 25% over the prior year. A significant
component of this increase related to ongoing strategic investments to
upgrade technology and processing capabilities - particularly the Merrill
Lynch Trusted Global Advisor(Service Mark) initiative, a new technology
platform designed to enable Financial Consultants to provide enhanced
services to clients.
The largest expense category, compensation and benefits, increased 27% from 1995
due to higher incentive and production-related compensation and an 8% increase
in the number of full-time employees. Incentive compensation rose as a result of
Merrill Lynch's increased profitability and return on average common
stockholders' equity, while production-related compensation was up due to higher
business activity.
Full-time employees totaled 49,800 at year-end 1996, compared with 46,000 a year
ago. Selective hirings, which consisted primarily of revenue producers and sales
assistants in Private Client and non-U.S. business areas, were responsible for
approximately 70% of the increase. The remainder of the increase resulted from
business acquisitions and additional technology support personnel. As a result,
the ratio of support employees and sales assistants to producers increased from
1.43 to 1 in 1995 to 1.50 to 1 in 1996.
Communications and equipment rental expense was up 15% from 1995 due to
increased computer maintenance costs related to systems initiatives, as well
as higher levels of business activity. Depreciation and amortization expense
rose 12% from 1995 primarily as a result of purchases of technology-related
equipment during the past year. Higher systems development and management
consulting costs led to a 37% increase in professional fees.
Occupancy costs rose $59 million (13%) primarily as a result of a nonrecurring
pretax charge of $40 million. This charge related to the rejection in bankruptcy
of the long-term sublease agreement with Olympia & York for space in the World
Financial Center South Tower, which led to a difference between expected rents
from subleases and Merrill Lynch's lease obligation for the space.
Advertising and market development expense rose 29% due to increased
international travel and higher production-related recognition programs.
Brokerage, clearing, and exchange fees were up 15% as a result of higher
securities volume, particularly in non-U.S. markets. Other expenses were up 23%
from 1995, due in part to provisions related to various business activities and
goodwill amortization.
In 1995, non-interest expenses increased 7% to $8.5 billion. Higher
production-related and incentive compensation and 5% growth in the number of
full-time employees, led to a 6% increase in compensation and benefits expense.
Communications and equipment rental expense was up 13% due to heightened levels
of business activity and expanded use of market data services. Occupancy costs
increased 3% due to international growth and the addition of Smith New Court
facilities. Depreciation and amortization expense rose 13% due primarily to
purchases of technology-related equipment. Professional fees increased 16% as a
result of higher legal fees and systems development costs. Brokerage, clearing,
and exchange fees were up 7% due to increased trading volume, particularly in
non-U.S. equity markets. Other expenses rose 4%, resulting from a first quarter
charge for the write-off of assets related to a technology contract and goodwill
amortization related to the Smith New Court acquisition.
The following graph illustrates fee-based revenues as a percentage of fixed and
semi-fixed expenses.
Graph Titled "FEE-BASED REVENUES AS A PERCENTAGE OF FIXED AND SEMI-FIXED
EXPENSES"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s fee-based
revenues as a percentage of fixed and semi-fixed expenses. The graph is
presented in millions with fixed and semi-fixed expenses of $3,656, $4,085,
$4,255, $4,664, and $5,440 for the years 1992 through 1996, respectively.
Fee-based revenues as a percentage of fixed and semi-fixed expenses are
expressed as points on the bars and were 55%, 59%, 67%, 65%, and 65% for
the years 1992 through 1996, respectively. Fee-based revenues principally
include asset management and portfolio service fees and net margin interest.
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INCOME TAXES
- --------------------------------------------------------------------------------
Merrill Lynch's 1996 income tax provision of $947 million represented a 36.9%
effective tax rate. In 1995 and 1994, income tax provisions were $697 million
and $713 million, respectively, resulting in effective tax rates of 38.5% in
1995 and 41.2% in 1994. The effective tax rate decreased in 1996 due in part to
tax benefits associated with non-U.S. operations.
Deferred tax assets are recorded for the effects of temporary differences
between the tax basis of an asset or liability and its reported amount in the
financial statements. Merrill Lynch assessed its ability to realize deferred tax
assets primarily on a strong earnings history and the absence of negative
evidence as discussed in Statement of Financial Accounting Standards ("SFAS")
No. 109, "Accounting for Income Taxes." During the last 10 years, average pretax
earnings were $1.2 billion per year. Accordingly, it is more likely than not
that the deferred tax assets will be realized.
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GLOBAL OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch's non-U.S. operations are organized into three geographic regions:
Europe, Africa, and the Middle East; Asia and Australia; and the Americas,
excluding the U.S. In 1996, Merrill Lynch continued to strategically expand its
non-U.S. operations. This expansion coupled with previous acquisitions enabled
Merrill Lynch to continue to benefit from the globalization of financial
markets, the increase in cross-border transactions, and client demand for global
investments.
In 1996, Merrill Lynch's non-U.S. businesses were influenced by many of the same
market conditions that positively impacted U.S. operating results, including
rising stock prices, relatively low interest rates, and narrowing credit
spreads, which led to increased demand for higher-yielding securities. The
combination of these favorable market conditions, synergies from acquisitions,
and expanded global presence resulted in increases from 1995 levels in total
revenues, net revenues, and earnings before income taxes in each geographic
region.
- --------------------------------------------------------------------------------
EUROPE, AFRICA, AND THE MIDDLE EAST
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Total revenues $ 5,336 $ 3,981 $ 3,464
Net revenues $ 1,837 $ 1,319 $ 1,134
Earnings before income taxes $ 387 $ 155 $ 176
Total assets $75,901 $56,948 $44,297
Total full-time employees 4,600 4,100 2,850
- --------------------------------------------------------------------------------
Merrill Lynch operates in Europe, Africa, and the Middle East as a dealer in a
full range of debt and equity products and also provides investment banking,
private banking, and research services.
Merrill Lynch continued its commitment to expand its presence in Europe, Africa,
and the Middle East through the 1996 acquisition of the business of FG
Inversiones Bursatiles, the largest independent Spanish broker-dealer, and its
agreement to purchase the business of Carnegie Italia, a Milan-based equity
research and sales team. In addition, the integration of Smith New Court, which
was acquired in the second half of 1995, led to significant expansion of global
equity trading and research capabilities during 1996. These factors contributed
to record results for the region.
In 1996, total and net revenues for the region increased 34% and 39% from 1995,
respectively, while earnings before income taxes more than doubled from 1995.
The increases were primarily due to higher trading, underwriting, and
commissions revenues. Trading revenues rose due to higher revenues from
equities, foreign exchange, and emerging market trading activities. Equities
trading revenues were up due to improved market conditions and increased
capacity related to the acquisition of Smith New Court. Investment banking
revenues increased in the region as Merrill Lynch retained the leading position
in underwriting new bond issues. Merrill Lynch was also a leader in underwriting
new equity issues and in providing mergers and acquisitions advisory services to
clients across the region. In addition, the region benefited from strong
commission revenues, particularly sales of mutual funds, and higher fees from
private banking products.
The increase in earnings before income taxes from 1995 resulted from both higher
revenues and strong cost control measures across the region. Compensation and
benefits costs rose due to increased headcount and improved regional
profitability. Occupancy costs were up due to the new and expanded facilities in
the region.
In 1995, total and net revenues for Europe, Africa, and the Middle East
increased 15% and 16% from 1994, respectively. The region's earnings before
income taxes decreased 12%. Trading results for the region improved from 1994
due in part to higher equity trading revenues resulting from strong European
equity market activity and the Smith New Court acquisition. Earnings before
income taxes decreased due to higher trading-related costs, compensation and
benefits expenses, and start-up costs resulting from ongoing expansion.
- --------------------------------------------------------------------------------
ASIA AND AUSTRALIA
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Total revenues $ 1,539 $ 1,232 $ 963
Net revenues $ 984 $ 701 $ 554
Earnings before income taxes $ 199 $ 81 $ 75
Total assets $17,905 $16,914 $11,389
Total full-time employees 2,075 1,775 1,400
- --------------------------------------------------------------------------------
Merrill Lynch serves a broad retail and institutional client base throughout
the Asia and Australia region. In Japan and China, the focus is principally
on institutional business opportunities, while in other locations, such as
Australia, Hong Kong, Korea, Singapore, and Taiwan, both retail and
institutional activities are conducted. Merrill Lynch has securities and
futures exchange memberships in the major regional financial centers and has
increased its trading and product capacity in Australia, Hong Kong,
Singapore, and Tokyo. In 1996, "Euromoney" named Merrill Lynch Foreign
Securities Firm of the Year in Japan. In December 1996, Merrill Lynch
acquired McIntosh Securities Limited, one of the largest securities brokerage
firms in Australia with approximately 500 employees (not included in the
table above). Additionally, Merrill Lynch continued to make strategic
investments in the region by entering into joint ventures.
Total and net revenues in Asia and Australia were up 25% and 40% from 1995,
respectively. In Japan, trading revenues for local products were negatively
impacted by difficult financial market conditions, mostly offset by increased
sales of cross-border products. Results in the rest of the region, particularly
Hong Kong, benefited from increased investment banking and trading revenues.
Investment banking revenues were up from the prior year due to higher equity
underwriting activity, while the integration of Smith New Court added
significantly to equity trading activities. Increased commissions on regional
equities and mutual funds also contributed to higher revenues.
Earnings before income taxes more than doubled in 1996. Variable costs, such as
incentive and production-related compensation, increased with higher revenues;
however, fixed costs remained relatively constant with 1995 levels.
Total and net revenues in Asia and Australia in 1995 were up 28% and 27% from
1994, respectively. Earnings before income taxes rose 8% from 1994. An improved
bond market led to increased trading revenues from Japanese Government bonds and
other fixed-income securities. In addition, equity trading increased as a result
of improved corporate earnings and more favorable market conditions.
- --------------------------------------------------------------------------------
AMERICAS
- --------------------------------------------------------------------------------
(IN MILLIONS) 1996 1995 1994
- --------------------------------------------------------------------------------
Total revenues $ 826 $ 704 $ 617
Net revenues $ 472 $ 347 $ 333
Earnings before income taxes $ 139 $ 127 $ 137
Total assets $5,205 $4,997 $4,216
Total full-time employees 925 875 800
- --------------------------------------------------------------------------------
In Latin America, Merrill Lynch provides varied brokerage and investment
services. Included in the Latin America region are certain U.S. offices that
primarily serve Latin American clients. The economic environment in this region
improved in 1996 as inflation steadily declined and equity indices increased
significantly. Merrill Lynch also continued its commitment to expand its
business in Latin America by initiating an equity trading presence in Argentina.
In Canada, Merrill Lynch provides investment banking and fixed-income sales and
trading services.
Total and net revenues for the Americas increased 17% and 36% from 1995,
respectively. Trading and underwriting activities in Latin America were up from
1995 levels due to the stronger economic environment, increased investor demand
for higher-yielding securities, and rising bond prices. In addition, Latin
American results benefited from increased commissions due to higher mutual fund
sales and trading volume for equity and fixed-income products. Canadian results
increased due to higher trading revenues resulting from the favorable
interest-rate environment, and strong cross-border revenues for debt and equity
underwriting.
Earnings before income taxes rose 9%. Higher regional trading, sales, and
underwriting activities led to increases in variable expenses, such as
compensation costs and brokerage, clearing, and exchange fees. Higher
compensation and infrastructure costs also resulted from the additional
commitment of resources to the region in 1996.
Total and net revenues in the Americas in 1995 increased 14% and 4% from 1994,
respectively, while earnings before income taxes decreased 7% from 1994.
Increased revenues from high-yield financing and advisory activity, mergers and
acquisitions, global bond issuances, and fixed-income sales to private banking
clients were partially offset by reduced investment banking activity due to
market and political uncertainty. The reduction in earnings before income taxes
resulted from higher compensation and benefits expenses and initial start-up
costs, both associated with the growth in the region.
- --------------------------------------------------------------------------------
BALANCE SHEET
- --------------------------------------------------------------------------------
Securities trading, derivatives dealing, and related activities result in
trading asset/liability, repurchase/resale, securities borrowed/loaned, and
certain receivable/payable balances. As presented below, these trading-related
balances accounted for approximately 88% of assets and 64% of liabilities at
December 27, 1996.
Presented are two pie charts showing Merrill Lynch & Co., Inc.'s
trading-related balances as percentages of assets and liabilities. At
December 27, 1996, 88% of assets (consisting of trading assets, resale
agreements, securities borrowed, and receivables which were 36%, 27%, 12%,
and 13% of assets, respectively) and 64% of liabilities (consisting of
trading liabilities, repurchase agreements, securities loaned, and payables
which were 21%, 30%, 2%, and 11% of liabilities, respectively) were
considered trading-related. Non-trading-related assets and liabilities at
December 27, 1996 were 12% and 36%, respectively.
Although the trading-related balances represent a significant portion of the
balance sheet, these amounts do not necessarily convey the risks assumed or
mitigated by Merrill Lynch. Hedging strategies and compliance with collateral
maintenance policies, as further discussed, are used to mitigate exposures.
- --------------------------------------------------------------------------------
TRADING ASSETS AND LIABILITIES
Trading assets and liabilities principally represent securities purchased
("long" positions) and securities sold but not yet purchased ("short"
positions), respectively. Trading assets and liabilities also include
receivables and payables, respectively, that represent the fair value of
derivatives (see Note 1 to the Consolidated Financial Statements).
Merrill Lynch acts as a market maker in many securities, maintaining a
significant amount of trading inventory to facilitate customer transaction flow.
To a lesser degree, Merrill Lynch also maintains proprietary trading inventory
in seeking to profit from existing or projected market opportunities.
Traders use hedging techniques to manage trading inventory market risks (see
Note 3 to the Consolidated Financial Statements). A significant portion of
trading assets and liabilities, including derivatives, represents hedges of
other trading positions. Many short U.S. Government securities and futures
positions, for example, hedge various interest-sensitive trading assets. Hedging
techniques at the trading unit level are supplemented by corporate risk
management policies and procedures (see "Risk Management" section).
The effectiveness of hedging techniques and corporate risk management
policies and procedures is illustrated by analyzing actual net
trading-related revenues over time. The nature of Merrill Lynch's
trading-related activities, which are principally client order flow-driven,
combined with its risk management strategies, help reduce volatility in
earnings. A distribution of weekly net trading-related revenues (which
include principal transactions revenues, net interest, and selling
concessions) by product for the last four years is presented in the graph
below.
Graph Titled "DISTRIBUTION OF WEEKLY NET REVENUES BY PRODUCT"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s distribution of
weekly net revenues by product for the last four years. The graph illustrates
the percentage of weeks that net trading-related revenues (which include
principal transactions revenues, net interest, and selling concessions) fell
within the specified dollar ranges (in millions) for each product presented
below.
$(10)-0 $0-20 $20-40 $40-60 Over $60
Taxable Fixed-Income 1% 14% 61% 19% 5%
Municipals 2 98 - - -
Interest Rate & Currency Swaps 3 87 10 - -
Foreign Exchange & Commodities 11 89 - - -
Equities & Equity Derivatives - 3 50 41 6
- --------------------------------------------------------------------------------
REPURCHASE/RESALE AGREEMENTS AND SECURITIES LOANED/BORROWED TRANSACTIONS
Repurchase agreements and securities loaned transactions are used to fund a
significant portion of trading assets. Likewise, Merrill Lynch uses resale
agreements or securities borrowed transactions to obtain the securities needed
for delivery on short positions. "Matched-book" repurchase and resale agreements
or securities borrowed and loaned transactions use the same underlying
securities, with different counterparties, to generate a spread between the
interest revenue on the resale agreements or securities borrowed transactions
and the interest expense on the repurchase agreements or securities loaned
transactions. Exposures on these transactions are limited by their typically
short-term nature and collateral maintenance policies (see "Collateral"
section). The following graph illustrates the balances related to these
activities at December 27, 1996.
Graph Titled "REPURCHASE/RESALE AGREEMENTS AND SECURITIES LOANED/BORROWED
TRANSACTIONS"
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s
repurchase/resale agreements and securities loaned/borrowed balances
separated between matched-book and other activity. The graph is presented
in millions with resale agreements, repurchase agreements, securities
borrowed, and securities loaned balances of $58,402, $62,669, $24,692, and
$2,751, respectively, at December 27, 1996. Matched-book activity represented
74%, 68%, 10% and 91% of resale agreements, repurchase agreements, securities
borrowed, and securities loaned balances at year end, respectively.
- --------------------------------------------------------------------------------
TRADING-RELATED RECEIVABLES AND PAYABLES
Securities trading transactions may result in various customer or broker-dealer
balances. Broker-dealer balances may result from recording trading inventory on
a trade date basis. Certain receivable and payable balances also arise when
customers or broker-dealers fail to pay for securities purchased or fail to
deliver securities sold, respectively. These receivables are generally fully
collateralized by the securities that the customer or broker-dealer purchased
but did not receive. Customer receivables also include margin loans
collateralized by customer-owned securities held by Merrill Lynch. Collateral
policies significantly limit Merrill Lynch's credit exposure to customers and
broker-dealers. Merrill Lynch, in accordance with regulatory requirements, will
sell securities that have not been paid for, or purchase securities sold but not
delivered, after a relatively short period of time, or will require additional
margin collateral as necessary. These measures reduce market risk exposure
related to these balances.
Interest receivable and payable balances related to trading inventory are
principally short-term in nature. Interest balances for repurchase and resale
agreements, securities borrowed and loaned transactions, and customer margin
loans are generally considered when determining the collateral requirements
related to these transactions.
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COLLATERAL
The table below presents reported assets at December 27, 1996 and the related
collateral maintained to reduce default risk exposure.
- -------------------------------------------------------------------------------
BALANCE COLLATERAL
(IN MILLIONS) SHEET MAINTAINED
- --------------------------------------------------------------------------------
Cash and cash equivalents $ 3,375 $ --
Cash and securities segregated for
regulatory purposes or deposited
With clearing organizations 5,628 --
Marketable investment securities 2,180 --
Trading assets, at fair value(a) 75,524 3,213
Resale agreements(b) 58,402 60,213
Securities borrowed(b) 24,692 24,167
Receivables (net)(c) 29,794 22,288
Investments of insurance
subsidiaries 5,107 --
Loans, notes, and mortgages (net)(d) 3,334 4,308
Other investments 1,125 --
Property, leasehold improvements,
and equipment (net) 1,670 --
Other assets 2,185 --
-------- --------
Total Assets $213,016 $114,189
-------- --------
-------- --------
(a) Various techniques reduce credit risk on trading assets, including
maintaining collateral on derivative contract receivables.
(b) The risk of default on receivables under resale agreements and securities
borrowed arrangements is substantially eliminated by maintaining related
securities with fair values in accordance with specific collateral
guidelines.
(c) To the extent possible, collateral is taken to secure receivables. For
instance, Merrill Lynch maintains collateral substantially in excess of
customer margin loan receivables, and broker-dealer receivables are
substantially collateralized by the related securities.
(d) Merrill Lynch generally maintains collateral on these extensions of credit
in the form of liens on real estate, perfected security interests in other
assets of the borrower, and guarantees.
Besides requiring collateral, Merrill Lynch's Corporate Credit group uses
other techniques to manage credit risk (see "Risk Management" section).
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
Merrill Lynch monitors changes in its balance sheet using average daily balances
which are determined on a settlement date basis and reported for management
information purposes. Financial statement balances are recorded on a trade date
basis as required under generally accepted accounting principles. The following
discussion compares changes in settlement date average daily balances. These
changes were consistent with the growth in the year-end financial statement
balances.
In 1996, average daily assets were $216 billion, up 13% from $191 billion in
1995. Average daily liabilities in 1996 rose 14% to $209 billion from $185
billion in 1995.
The major components in the growth of average assets and liabilities are
summarized as follows:
- --------------------------------------------------------------------------------
INCREASE
IN AVERAGE PERCENT
(IN MILLIONS) ASSETS INCREASE
- --------------------------------------------------------------------------------
Resale agreements and
securities borrowed $10,402 12%
Trading assets 9,390 15
Customer receivables 2,494 13
- --------------------------------------------------------------------------------
INCREASE
IN AVERAGE PERCENT
LIABILITIES INCREASE
- --------------------------------------------------------------------------------
Repurchase agreements and
securities loaned $7,737 10%
Long-term borrowings 6,702 42
Commercial paper and other
short-term borrowings 5,201 20
Trading liabilities 4,306 29
- --------------------------------------------------------------------------------
During 1996, trading assets and liabilities (which include on-balance-sheet
hedges used to manage trading risks) and customer receivables rose as trading
activity increased to meet higher customer demand. Customer receivables were
also up as a result of higher secured lending in the form of margin and other
collateralized loans.
Repurchase agreements and securities loaned transactions and resale agreements
and securities borrowed transactions rose to meet higher funding requirements
for increased trading activity. In addition, these transactions increased as a
result of expanded matched-book activity, primarily involving governments and
agencies securities.
Assets are funded through diversified sources which include repurchase
agreements, commercial paper and other unsecured short-term borrowings,
long-term borrowings, and equity. In addition to the increases in repurchase
agreements and securities loaned transactions, the growth in average assets was
also funded by higher long-term borrowings, particularly medium-term notes, and
commercial paper.
- --------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Stockholders' equity at December 27, 1996 increased 12% to $6.9 billion from
$6.1 billion at year-end 1995. The 1996 increase resulted from net earnings,
partially offset by common share repurchases and dividends. In 1996, Merrill
Lynch repurchased 18.6 million common shares at an average price of $62.60 per
share for employee benefit plans and general corporate purposes.
At December 27, 1996, total common shares outstanding, excluding the unallocated
Employee Stock Ownership Plan ("ESOP") reversion shares of 1.5 million, were
164.1 million, 4% lower than the 171.4 million shares (excluding unallocated
ESOP reversion shares of 4.0 million) outstanding at December 29, 1995. The
decrease was principally attributable to common share repurchases, partially
offset by employee stock grants and option exercises.
Subsequent to year-end, the parent company implemented a plan to redeem all
of the outstanding Remarketed Preferred(Service mark) Stock, Series C ("RP
Stock"). Redemptions of RP Stock commenced on January 22, 1997 and are
expected to be completed by March 4, 1997. As of February 19, 1997, $155
million of RP Stock, representing 1,548 shares, had been redeemed.
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LIQUIDITY AND LIABILITY MANAGEMENT
- --------------------------------------------------------------------------------
The primary objective of Merrill Lynch's funding policies is to assure liquidity
at all times. Merrill Lynch's liquidity management strategy has three key
components: (i) to maintain alternative funding sources such that all debt
obligations maturing within one year can be funded when due without issuing new
unsecured debt or liquidating any business assets; (ii) to concentrate
unsecured, general purpose borrowings at the parent company level; and (iii) to
expand and diversify Merrill Lynch's funding programs.
Merrill Lynch's primary alternative funding sources to unsecured borrowings
are repurchase agreements and secured bank loans, which require pledging
unhypothecated marketable securities. Other funding sources include
liquidating cash equivalents; securitizing loan assets; and drawing on
committed, unsecured credit facilities ("Credit Facilities") provided by
banks, which at December 27, 1996, totaled $6.2 billion and were not drawn
upon. Merrill Lynch regularly reviews the level and mix of its assets and
liabilities to assess its ability to conduct core business activities without
issuing new unsecured debt or drawing upon the Credit Facilities. The mix of
assets and liabilities provides flexibility in managing liquidity since a
significant portion of assets turn over frequently and are typically
match-funded with liabilities having similar maturities and cash flow
characteristics. At December 27, 1996, substantially all of Merrill Lynch's
assets were considered readily marketable by management.
Merrill Lynch concentrates its unsecured, general purpose borrowings at the
parent company level, except where tax regulations, time zone differences, or
other business considerations make this impractical. The benefits of this
strategy are reduced financing costs; simplicity, control, and wider name
recognition by creditors of Merrill Lynch; and enhanced flexibility to meet
fluctuating funding requirements across subsidiaries.
Finally, Merrill Lynch strives to expand and diversify its funding programs and
investor and creditor base. Merrill Lynch benefits by distributing its debt
through its own sales force to a large, diversified customer base. Additionally,
Merrill Lynch maintains strict concentration standards for short-term
borrowings, including limits for any single investor.
Commercial paper is the major source of short-term general purpose funding.
Commercial paper outstanding totaled $23.6 billion at December 27, 1996 and
$17.0 billion at December 29, 1995, which represented 11% and 10% of total
assets at year-end 1996 and 1995, respectively.
Outstanding long-term debt at December 27, 1996 increased to $26.1 billion
from $17.3 billion at December 29, 1995. Long-term debt issuance of $15.0
billion in 1996 exceeded 1995 issuance of $9.6 billion as financing activity
expanded in both U.S. and non-U.S. markets. During 1996, maturities and
repurchases of long-term debt were $6.1 billion, while subsidiaries purchased
and sold $1.4 billion of the parent company's long-term debt securities. At
December 27, 1996, $20.1 billion of long-term debt had maturities beyond one
year. The average maturity of outstanding long-term debt was 3.5 years at
both year-end 1996 and 1995, when measured to maturity, and 3.2 years and 3.1
years, respectively, when measured to the earlier of the call or put date.
Merrill Lynch's senior long-term debt and preferred stock were upgraded by
several credit rating agencies during 1996, and were rated by recognized credit
rating agencies at December 27, 1996 as follows:
- --------------------------------------------------------------------------------
SENIOR PREFERRED
DEBT STOCK
RATING AGENCY RATING RATING
- --------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. AA AA-
Fitch Investors Service, L.P. AA AA-
IBCA Inc. AA- Not Rated
The Japan Bond Research Institute AA Not Rated
Moody's Investors Service, Inc. Aa3 aa3
Standard & Poor's AA- A
Thomson BankWatch, Inc. AA+ Not Rated
- --------------------------------------------------------------------------------
Approximately $53.0 billion of indebtedness at December 27, 1996 is considered
senior indebtedness as defined under various indentures.
As part of Merrill Lynch's overall liquidity management strategy, its insurance
subsidiaries regularly review the funding requirements of their contractual
obligations for in-force, fixed-rate life insurance and annuity contracts and
expected future acquisition and maintenance expenses for all contracts.
Insurance subsidiaries market primarily variable life insurance and variable
annuity products. These products are not subject to the interest rate,
asset/liability matching, and credit risks attributable to fixed-rate products,
thereby reducing the risk profile and liquidity demands on the insurance
subsidiaries. At December 27, 1996, approximately 85% of invested assets of
insurance subsidiaries were considered liquid by management.
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND CAPITAL ADEQUACY
- --------------------------------------------------------------------------------
Merrill Lynch remains one of the most highly capitalized U.S. institutions in
the global financial services business, with $6.3 billion in common equity
and $619 million in preferred stock at December 27, 1996 (see "Stockholders'
Equity" in the "Balance Sheet" section). In December 1996, a subsidiary of
Merrill Lynch issued $275 million of perpetual Trust Originated Preferred
Securities(Service mark) ("TOPrS"). These subsidiary-issued preferred
securities, in addition to $52 million of preferred securities outstanding in
other subsidiaries, further strengthen Merrill Lynch's equity capital base.
Subsequent to year end, a Merrill Lynch subsidiary issued an additional $300
million of TOPrS.
Merrill Lynch's leverage ratios were as follows:
ADJUSTED
LEVERAGE LEVERAGE
RATIO(1) RATIO(2)
- --------------------------------------------------------------------------------
YEAR END
December 27, 1996 29.5x 18.0x
December 29, 1995 28.6x 18.1x
AVERAGE FOR YEAR ENDED(3)
December 27, 1996 33.5x 19.9x
December 29, 1995 32.4x 19.3x
- --------------------------------------------------------------------------------
(1) Total assets to total stockholders' equity and preferred securities issued
by subsidiaries.
(2) Total assets less resale agreements and securities borrowed to total
stockholders' equity and preferred securities issued by subsidiaries.
(3) Computed using month-end balances.
Overall capital needs are continually reviewed to ensure that Merrill Lynch's
capital base can support the estimated risks of its businesses as well as the
regulatory and legal capital requirements of its subsidiaries. Statistically
based product risk models are used to estimate potential losses arising from
market and credit risks. These dynamic models incorporate changes in business
risk into Merrill Lynch's equity requirements. Based upon these analyses and
other criteria, management believes that Merrill Lynch's equity base is
adequate.
Merrill Lynch operates in many regulated businesses that require various minimum
levels of capital (see Note 11 to the Consolidated Financial Statements).
Merrill Lynch's broker-dealer, banking, insurance, and futures commission
merchant activities are subject to regulatory requirements that may restrict the
free flow of funds to affiliates. Regulatory approval is generally required for
paying dividends in excess of certain established levels, making affiliated
investments, and entering into management and service agreements with affiliated
companies.
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch's operating activities expose it to many risks that are
continually monitored, evaluated, and managed. Proper management of these risks
helps reduce the likelihood of earnings volatility. Trading units typically
hedge risks arising either from individual transactions or portfolios of similar
transactions to manage risk at the legal entity level. Hedging techniques will
vary based on many factors, including the nature and extent of the risks
involved.
To supplement risk management at the trading unit level, Merrill Lynch has
developed corporate governance policies and procedures that require specific
areas and units to assist in the identification, assessment, and control of
these risks. These policies and procedures are performed by many units,
including the Global Risk Management Group ("Risk Management"), the Credit
Division ("Corporate Credit"), and other control units, including Finance,
Audit, Operations, and Law and Compliance ("Control Units"). In addition to
independent risk management responsibilities, senior management from Risk
Management, Corporate Credit, and the Control Units take an active role in the
oversight of the risk management process through the Risk Control and Reserve
Committees.
The Risk Control Committee and Risk Management provide general risk oversight
for all institutional trading activities. The Risk Control Committee reports
periodically to the Audit and Finance Committee of the Board of Directors and is
independent of Merrill Lynch's trading units. The Risk Control Committee's
activities are designed to ensure compliance with Merrill Lynch's commitment
under the Derivatives Policy Group's Framework for Voluntary Oversight.
The Reserve Committee monitors valuation and certain other risks associated with
assets and liabilities. Merrill Lynch establishes reserves in the Consolidated
Balance Sheets for existing conditions, events, or circumstances that may reduce
the carrying value of an asset or incur a liability. The Reserve Committee,
chaired by the Chief Financial Officer, reviews and approves firmwide reserve
levels, as well as changes in reserve methodologies. The Reserve Committee meets
monthly to review current market conditions and acts on specific issues. Merrill
Lynch's reserves take into account management's judgment and are generally based
on (i) identification of risks and exposures, (ii) formulas, and (iii) aging,
concentration, and liquidity analyses.
The following discussions of "Market Risk", "Credit Risk", and "Other Risks"
highlight the corporate policies and procedures for risk identification,
assessment, and control. Further discussion of market and credit risk is
contained in Note 3 to the Consolidated Financial Statements.
- --------------------------------------------------------------------------------
MARKET RISK
Market risk is the potential change in a financial instrument's value caused by
fluctuations in interest and currency exchange rates, equity and commodity
prices, and credit spreads. Over the last several years, measuring market risk
with mathematical models has become the focal point of many risk management
efforts worldwide, with the term "risk management" becoming almost synonymous
with "risk measurement."
Merrill Lynch believes that the use of mathematical risk models alone may
provide a greater sense of security than warranted and therefore reliance on
these models should be limited. In fact, because of the inability of
mathematical risk models to quantify large-scale potential financial events with
any precision, Merrill Lynch only employs these models to supplement other risk
management efforts.
In general, Merrill Lynch believes that the primary risk of a product is not in
the product itself, but in the way in which the product is managed. Breaches of
discipline or lapses in supervision can result in losses irrespective of the
products involved or the mathematical models used.
Nearly ten years ago, Merrill Lynch implemented a firmwide risk process based on
the belief that there is more to risk management than identifying and measuring
risk. The process itself has been strengthened by experience, but the underlying
philosophy is essentially unchanged. This philosophy is based on the following
six principles:
o The most important tools in any risk process are experience, judgment, and
constant communication with risk-takers.
o Vigilance, discipline, and an awareness of risk must be continuously
emphasized throughout the firm.
o Management must provide a clear and simple statement as to what can and
cannot be done in committing capital.
o Risk Management must consider the unexpected, to probe for potential
problems, to test for weaknesses, and to help identify potential for loss.
o The process must be flexible, to permit adaptation to changing
environments, including the evolving goals of Merrill Lynch itself.
o The key objective must be to minimize the possibility of incurring
unacceptable loss. Such losses usually arise from unexpected events that
most statistical and model-based risk methodologies cannot predict.
- --------------------------------------------------------------------------------
RISK MANAGEMENT PROCESS
In keeping with these principles, Merrill Lynch's risk management process relies
on three key elements: (i) communication, (ii) controls and guidelines, and
(iii) risk technology.
Risk Management is organized along geographic and product lines to ensure
direct, frequent communication with specific trading areas. In addition, Risk
Management performs regular, formal risk reviews with senior trading
managers.
Risk Management has established certain controls and guidelines to supplement
hedging techniques at the trading unit level (see "Trading Assets and
Liabilities" in the "Balance Sheet" section for further information on these
techniques). Risk Management sets and monitors trading limits, which may not
be exceeded without prior approval. In addition, Risk Management and
representatives from other Control Units approve new types of transactions as
part of the new product review process. The commitment process subjects
certain commitments, including equity, high-yield, and emerging market
securities underwritings; real estate financings; and bridge loans, to prior
approval from Risk Management and other Control Units. Risk Management also
has the authority to require reductions in specific trading desk exposures or
to veto proposed transactions.
Risk Management uses several risk technology tools, including a risk
inventory database, a trading limit monitoring system, trading systems
access, and stress scenarios. The risk inventory database provides a daily
consolidation of securities inventory exposure by product, credit rating,
country, etc., along with concentrations of exposure. The trading limit
monitoring system enables Risk Management to review compliance with
established limits. Access to trading systems allows Risk Management to
monitor positions and perform computerized analytics.
Stress scenarios estimate gains or losses under both moderate and severe market
movements. Each scenario considers a specific change in key risk factors, such
as interest and currency exchange rates, equity and commodity prices, credit
spreads, and volatilities, holding all other variables constant. Based on these
scenarios, market risks can be monitored firmwide and portfolios rebalanced, as
necessary.
- --------------------------------------------------------------------------------
CREDIT RISK
Credit risk represents the amount of loss that Merrill Lynch would incur if a
counterparty or client failed to perform its contractual obligations. Policies
and procedures have been established with the objective of protecting against
such losses, which include reviewing and establishing limits for credit
exposures, limiting transactions with specific counterparties or clients,
obtaining rights to collect collateral or terminate transactions in the event of
a credit downgrade, maintaining collateral, and continually assessing the
creditworthiness of counterparties and clients. The responsibility for
compliance with these policies and procedures rests with business units, and is
monitored by Corporate Credit.
Corporate Credit is centralized and organized geographically. Credit officers
analyze and determine the creditworthiness of counterparties and clients, which,
in many cases, is enhanced by due diligence meetings. Credit officers also set
initial and ongoing credit limits by counterparty or client, recommend credit
reserves, manage credit exposures, and participate in the new product review
process.
Many types of transactions, including most derivatives and syndicated
loans, are subject to prior approval from Corporate Credit. Within Corporate
Credit, required approval levels have been established based on counterparty or
client credit quality and the potential risk of the transaction. Transactions
that exceed prescribed levels must be approved by the Credit Committee, which
includes several Directors of Credit and the Chief Credit Officer.
The credit system tracks information from automated and manual sources to enable
Corporate Credit to monitor counterparty/client, product, and country
concentrations. This system aggregates credit exposure by counterparty/client,
maintains overall counterparty/client and specific product limits, and
identifies limit review dates by counterparty/client. Detailed information on
firmwide inventory positions and executed transactions, including current and
potential credit exposure, is updated frequently and compared with limits.
Collateral, which reduces credit exposure, is obtained as needed and tracked on
the credit system.
Corporate Credit works with the trading units to develop and refine credit risk
measurement models and to analyze potential credit exposures for complex
derivative transactions. Corporate Credit also monitors credit exposures related
to Merrill Lynch's retail customer business, including mortgages and home equity
lines of credit, customer margin accounts, and working capital facilities to
small businesses.
- --------------------------------------------------------------------------------
OTHER RISKS
Concentration risk, the risk that Merrill Lynch's businesses will be dependent
upon a single source of revenue, product, or market, is periodically reviewed as
part of Merrill Lynch's ongoing strategic and business planning process. In
recent years, Merrill Lynch has diversified its global revenue sources to help
ensure that it is less dependent on any single financial product, customer base,
or market to generate revenues.
Operational risk focuses on Merrill Lynch's ability to accumulate, process, and
communicate information necessary to conduct business in a global market
environment. Merrill Lynch manages operational risk in many ways, including
maintaining backup facilities, using technology, and employing experienced
personnel. Information systems provide operational risk assessments on
transactions in major markets which allow Merrill Lynch to promptly respond to
changing market conditions worldwide. Management information reports enable
senior management to effectively identify potential risk and control risk
exposures, and promote compliance with both internal management policies and
regulatory requirements. Experienced operations personnel provide support and
control for trading, clearance, and settlement activities, and perform custodial
functions for customer and proprietary assets. Operations and trading personnel
report independently to senior management.
- --------------------------------------------------------------------------------
DERIVATIVE FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
Merrill Lynch trades derivative financial instruments and provides clients with
customized derivative products. These transactions allow clients to manage their
exposure to interest and currency exchange rate, equity and commodity price, and
credit spread risks. Merrill Lynch also uses derivative instruments to manage
its own risks related to its proprietary trading strategies, client
transactions, and financing activities. See Notes 1, 3, and 5 to the
Consolidated Financial Statements for a description of derivatives, accounting
and valuation policies for derivatives, and further details on the role of
derivatives in trading and financing activities.
Derivatives activities are conducted through a number of subsidiaries as part of
client-driven and proprietary business transactions. Merrill Lynch Capital
Services, Inc. ("MLCS") is Merrill Lynch's principal swaps dealer. Merrill Lynch
Derivative Products AG, a "AAA" rated entity, is a swap subsidiary that provides
credit intermediation for interest rate and currency swaps, options, and similar
transactions between highly-rated or otherwise acceptable counterparties and
MLCS. Various subsidiaries deal in currency derivatives, including certain
banking subsidiaries and MLCS. Effective January 1997, Merrill Lynch
International became the primary equity derivatives dealer for new business,
replacing Merrill Lynch Capital Markets PLC. In connection with these derivative
activities, certain of these subsidiaries purchase and sell securities for
hedging purposes.
As a dealer, Merrill Lynch enters into derivative transactions to hedge certain
inventory positions, including other derivatives. As an end-user, Merrill Lynch
enters into interest rate, currency, or other derivative contracts with its
derivatives dealer subsidiaries to hedge exposures arising from debt issuances.
These subsidiaries then enter into contracts with third parties as part of
Merrill Lynch's trading and risk management strategies.
Derivatives facilitate risk transfer and enhance liquidity in the marketplace.
For issuers, derivatives may provide cost-effective funding alternatives, while
for investors, derivatives may provide alternative investment options and the
ability to hedge risk. Market participants include dealers, such as banks and
other financial institutions, and end-users such as corporations, governments,
pension funds, mutual funds, and other institutions.
Expanded market participation and competition have helped increase liquidity
in conventional derivatives, such as interest rate swaps. Greater familiarity
with, and increased understanding of the benefits of derivatives have also
contributed to the continued development of complex products structured for
specific clients. Increasing complexity and highly publicized losses,
however, have led to concerns that these products possess greater risk to
users and to financial markets. Although different in form, both derivative
and cash instruments are subject to market, credit, and operational risks.
Credit considerations, for example, exist for a corporate bond as well as an
interest rate swap. In addition, both of these instruments are sensitive to
market risk due to movements in interest rates that affect their respective
pricing. The risks inherent in both types of instruments are managed in a
manner consistent with a company's overall risk management policies (see "Risk
Management" section).
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve risks
related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes these
risks and, whenever possible, employs strategies to mitigate exposures. The
specific components and overall level of non-investment grade and highly
leveraged positions may vary significantly from period to period as a result of
inventory turnover, investment sales, and asset redeployment.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment banking,
market-making, and derivative structuring activities. During the past year,
non-investment grade trading inventories increased to satisfy growing client
demand for higher-yielding investments, including emerging market and other
non-U.S. securities. Non-investment grade securities have been defined as debt
and preferred equity securities rated as BB+ or lower, or equivalent ratings by
recognized credit rating agencies, certain sovereign debt in emerging markets,
amounts due under various derivative contracts from non-investment grade
counterparties, and other instruments that, in the opinion of management, are
non-investment grade. Non-investment grade trading inventories are carried at
fair value.
Merrill Lynch's insurance subsidiaries also hold non-investment grade securities
that are classified as available-for-sale and are carried at fair value.
A summary of positions with non-investment grade issuers (for cash instruments)
or counterparties (for derivatives in a gain position) follows:
(in millions) 1996 1995
- --------------------------------------------------------------------------------
Trading assets:
Cash instruments $7,585 $4,605
Derivatives(1) 2,470 1,808
Trading liabilities - cash instruments 905 351
Insurance subsidiaries' investments 206 234
- --------------------------------------------------------------------------------
(1) Collateral of $848 and $672 was obtained at December 27, 1996 and December
29, 1995, respectively, to reduce risk related to these derivative
balances.
Included in the preceding table are debt and equity securities and bank loans of
companies in various stages of bankruptcy proceedings or in default. At December
27, 1996, the carrying value of such debt and equity securities totaled $133
million, of which 58% resulted from Merrill Lynch's market-making activities in
such securities. This compared with $189 million at December 29, 1995, of which
66% related to market-making activities. In addition, Merrill Lynch held
distressed bank loans totaling $351 million and $274 million at year-end 1996
and 1995, respectively.
Derivatives may also expose Merrill Lynch to credit risk related to the
underlying security where a derivative contract can either synthesize ownership
of the underlying security (e.g., long total return swap) or potentially force
ownership of the underlying security (e.g., short put option). In addition,
derivatives may subject Merrill Lynch to credit spread risk in that changes in
the credit quality of the underlying securities may impact the derivatives' fair
values. A summary of exposures related to derivatives with non-investment grade
underlying securities follows:
(in millions) 1996 1995
- --------------------------------------------------------------------------------
Derivative fair values:
Trading assets(1) $ 63 $ 10
Trading liabilities 64 --
Derivative notionals (off-balance-sheet)(2) 2,895 1,259
- --------------------------------------------------------------------------------
(1) Included in these amounts are $9 and $6 at year-end 1996 and 1995,
respectively, that are also exposed to credit risk related to a
non-investment grade counterparty, which are included in the preceding
table.
(2) Calculated as notional subject to strike or reference price.
Merrill Lynch engages in hedging strategies to reduce its exposure associated
with non-investment grade positions by purchasing an option to sell the related
security or by entering into other offsetting derivative contracts. Merrill
Lynch also uses non-investment grade trading inventories, principally non-U.S.
governments and agencies securities, to hedge the exposure arising from
structured derivative transactions.
A summary of cash instruments and derivatives used to hedge the credit risk of
non-investment grade positions follows:
(in millions) 1996 1995
- --------------------------------------------------------------------------------
Trading assets - cash instruments $ 905 $580
Derivative notionals (off-balance-sheet)(1) 1,311 611
- --------------------------------------------------------------------------------
(1) Calculated as notional subject to strike or reference price.
At December 27, 1996, the largest non-investment grade concentration consisted
of various sovereign and corporate issues of a South American country totaling
$1.0 billion, which primarily represented hedges of other financial instruments.
- --------------------------------------------------------------------------------
HIGHLY LEVERAGED TRANSACTIONS
Merrill Lynch provides financing and advisory services to, and invests in,
companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides
extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch syndicates loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will be determined on a select
basis. A summary of loans, investments, and commitments related to highly
leveraged transactions follows:
(in millions) 1996 1995
- --------------------------------------------------------------------------------
Loans (net of allowance for loan losses)(1) $340 $489
Equity investments(2) 113 211
Partnership interests 104 91
Bridge loan(3) 31 --
Additional commitments to invest in partnerships 82 79
Unutilized revolving lines of credit and other
lending commitments(4) 301 127
- --------------------------------------------------------------------------------
(1) Represented outstanding loans to 36 and 30 medium-sized companies at
year-end 1996 and 1995, respectively.
(2) Invested in 48 and 62 enterprises at year-end 1996 and 1995, respectively.
(3) Repaid subsequent to year end.
(4) Subsequent to year end, a $125 million loan was extended which was reduced
to $10 million through syndication.
At December 27, 1996, no one industry sector accounted for more than 24% of
total non-investment grade positions and highly leveraged transactions.
- --------------------------------------------------------------------------------
CASH FLOWS
- --------------------------------------------------------------------------------
Merrill Lynch's cash flows are principally associated with operating and
financing activities, which support Merrill Lynch's trading, customer, and
investment banking activities. Merrill Lynch's cash and cash equivalents totaled
$3.4 billion at December 27, 1996, up $284 million and $1.1 billion,
respectively, from 1995 and 1994.
Cash flows of $8.7 billion in 1996 were used for operating activities, primarily
to fund higher net trading assets generated by increased levels of business
activity. Merrill Lynch's investing activities used cash of $593 million in
1996, primarily to acquire technology-related equipment and other assets.
Financing activities provided Merrill Lynch with $9.6 billion of cash in 1996,
reflecting proceeds from net issuances of long-term debt and commercial paper,
partially offset by increases in net resale/repurchase agreements.
In 1995, cash and cash equivalents increased $779 million to $3.1 billion. Cash
used for operating and investing activities totaled $7.9 billion and $873
million, respectively, while cash provided by financing activities totaled $9.5
billion.
Cash and cash equivalents increased $529 million to $2.3 billion in 1994.
Cash provided by operating and investing activities totaled $7.4 billion and
$322 million, respectively, while cash used for financing activities totaled
$7.2 billion.
- --------------------------------------------------------------------------------
LITIGATION
- --------------------------------------------------------------------------------
Certain actions have been filed against Merrill Lynch by Orange County,
California and others in connection with Merrill Lynch's business activities
with the Orange County Treasurer-Tax Collector or from the purchase of debt
instruments issued by Orange County that were underwritten by Merrill Lynch's
subsidiary, Merrill Lynch, Pierce, Fenner & Smith Incorporated. The information
set forth under the caption "Litigation" in Note 7 to the Consolidated Financial
Statements is incorporated by reference herein. Although the ultimate outcome of
these actions cannot be ascertained at this time and the results of legal
proceedings cannot be predicted with certainty, it is the opinion of management
that the resolution of these actions will not have a material adverse effect on
the financial condition or the results of operations of Merrill Lynch as set
forth in the Consolidated Financial Statements contained herein.
- --------------------------------------------------------------------------------
RECENT DEVELOPMENTS
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities", which is effective for transactions occurring
after December 31, 1996. SFAS No. 125 provides guidance for determining whether
a transfer of a financial asset is treated as a sale versus a financing.
Additionally, if a transfer qualifies as a financing transaction, the statement
contains provisions that may require the recognition of collateral received or
provided, in addition to the financing balance.
In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date
of Certain Provisions of FASB Statement No. 125", which defers for one year the
effective date of the collateral provisions for all transactions and the sale
provisions for repurchase agreement, securities lending, and similar
transactions. These provisions will be applied prospectively to transactions
entered into after December 31, 1997; accordingly, the expected impact of
adopting such provisions on Merrill Lynch's results of operations cannot be
determined.
The provisions of SFAS No. 125 not deferred by SFAS No. 127 have been adopted as
of January 1, 1997. Since these provisions are only applicable to future
transactions, the impact of adoption cannot be quantified.
STATEMENTS OF CONSOLIDATED EARNINGS
Year Ended Last Friday in December
----------------------------------
(Dollars in Millions, Except Per Share Amounts) 1996 1995 1994
- --------------------------------------------------------------------------------
REVENUES
Commissions $ 3,786 $ 3,126 $ 2,871
Interest and dividends 12,899 12,221 9,578
Principal transactions 3,454 2,519 2,335
Investment banking 1,945 1,308 1,240
Asset management and portfolio service fees 2,261 1,890 1,739
Other 666 449 471
------ ------- -------
TOTAL REVENUES 25,011 21,513 18,234
Interest Expense 11,895 11,248 8,609
------ ------- -------
NET REVENUES 13,116 10,265 9,625
------ ------- -------
NON-INTEREST EXPENSES
Compensation and benefits 6,704 5,270 4,952
Communications and equipment rental 559 487 432
Occupancy 508 449 436
Depreciation and amortization 411 367 325
Professional fees 582 425 367
Advertising and market development 514 398 375
Brokerage, clearing, and exchange fees 413 361 338
Other 859 697 670
------- ------- -------
TOTAL NON-INTEREST EXPENSES 10,550 8,454 7,895
------- ------- -------
EARNINGS BEFORE INCOME TAXES 2,566 1,811 1,730
Income Tax Expense 947 697 713
------- ------- -------
NET EARNINGS $ 1,619 $ 1,114 $ 1,017
------- ------- -------
------- ------- -------
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,572 $ 1,066 $ 1,004
------- ------- -------
------- ------- -------
EARNINGS PER COMMON SHARE
Primary $ 8.20 $ 5.44 $ 4.75
------- ------- -------
------- ------- -------
Fully Diluted $ 8.06 $ 5.42 $ 4.74
------- ------- -------
------- ------- -------
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
December 27, December 29,
(Dollars in Millions, Except Per Share Amounts) 1996 1995
- -------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 3,375 $ 3,091
-------- --------
Cash and securities segregated for regulatory
purposes or deposited with clearing organizations 5,628 5,412
-------- --------
Marketable investment securities 2,180 2,365
-------- --------
Trading assets, at fair value
Corporate debt and preferred stock 24,270 17,581
Contractual agreements 13,465 11,833
Equities and convertible debentures 13,153 10,843
U.S. Government and agencies 9,304 6,672
Non-U.S. governments and agencies 7,758 6,744
Mortgages, mortgage-backed, and asset-backed 5,189 3,749
Money markets 1,209 1,680
Municipals 1,176 1,001
-------- --------
Total 75,524 60,103
-------- --------
Resale agreements 58,402 44,257
-------- --------
Securities borrowed 24,692 20,645
-------- --------
Receivables
Customers (net of allowance for doubtful
accounts of $39 in 1996 and $37 in 1995) 18,309 14,783
Brokers and dealers 6,205 9,267
Interest and other 5,280 4,741
-------- --------
Total 29,794 28,791
-------- --------
Investments of insurance subsidiaries 5,107 5,619
Loans, notes, and mortgages (net of allowance for
loan losses of $117 in 1996 and $131 in 1995) 3,334 2,172
Other investments 1,125 961
Property, leasehold improvements, and equipment
(net of accumulated depreciation and amortization
of $2,523 in 1996 and $2,239 in 1995) 1,670 1,605
Other assets 2,185 1,836
-------- --------
TOTAL ASSETS $213,016 $176,857
-------- --------
-------- --------
December 27, December 29,
1996 1995
- --------------------------------------------------------------------------------
LIABILITIES, PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY
LIABILITIES
Repurchase agreements $ 62,669 $ 56,817
-------- --------
Commercial paper and other short-term borrowings 39,333 29,546
-------- --------
Trading liabilities, at fair value
U.S. Government and agencies 13,965 9,089
Contractual agreements 11,221 10,907
Equities and convertible debentures 8,332 6,642
Non-U.S. governments and agencies 7,135 4,418
Corporate debt and preferred stock 2,762 2,199
Municipals 130 95
-------- --------
Total 43,545 33,350
-------- --------
Customers 11,758 11,391
Insurance 5,010 5,391
Brokers and dealers 3,407 6,366
Other liabilities and accrued interest 13,973 10,464
Long-term borrowings 26,102 17,340
-------- --------
Total Liabilities 205,797 170,665
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 327 51
-------- --------
STOCKHOLDERS' EQUITY
Preferred Stockholders' Equity 619 619
-------- --------
Common Stockholders' Equity
Common stock, par value $1.33 1/3 per share;
authorized: 500,000,000 shares; issued:
1996 and 1995-236,330,162 shares 315 315
Paid-in capital 1,304 1,237
Foreign currency translation adjustment 10 11
Net unrealized gains on investment securities
available-for-sale (net of applicable income
tax expense of $5 in 1996 and $13 in 1995) 9 25
Retained earnings 7,868 6,492
-------- --------
Subtotal 9,506 8,080
Less:
Treasury stock, at cost:
1996-70,705,598 shares
1995-60,929,278 shares 2,895 2,241
Unallocated ESOP reversion shares, at cost:
1996-1,538,778 shares
1995-4,012,519 shares 24 63
Employee stock transactions 314 254
-------- --------
Total Common Stockholders' Equity 6,273 5,522
-------- --------
Total Stockholders' Equity 6,892 6,141
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY $213,016 $176,857
-------- --------
-------- --------
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN CONSOLIDATED STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Year Ended Last Friday in December
----------------------------------
(Dollars in Millions, Except Per Share Amounts) 1996 1995 1994
- -------------------------------------------------------------------------------
PREFERRED STOCKHOLDERS' EQUITY
9% Cumulative Preferred Stock, Series A
$10,000 liquidation preference per share
Balance, beginning of year $ 425 $ 425 $ --
Issued (42,500 shares in 1994) -- -- 425
------- ------- -------
BALANCE, END OF YEAR (42,500 shares in 1996,
1995, and 1994) 425 425 425
------- ------- -------
Remarketed Preferred Stock, Series C
$100,000 liquidation preference per share
Balance, beginning and end of year (3,000
shares in 1996, 1995, and 1994) 300 300 300
Remarketed Preferred Treasury Stock, at cost
Balance, beginning and end of year (1,062
shares in 1996, 1995, and 1994) (106) (106) (106)
------- ------- -------
BALANCE, END OF YEAR 194 194 194
------- ------- -------
TOTAL PREFERRED STOCKHOLDERS' EQUITY $ 619 $ 619 $ 619
------- ------- -------
------- ------- -------
COMMON STOCKHOLDERS' EQUITY
Common Stock, par value $1.33 1/3
Balance, beginning and end of year
(236,330,162 shares in 1996,
1995, and 1994) $ 315 $ 315 $ 315
------- ------- -------
------- ------- -------
Paid-In Capital
Balance, beginning of year $ 1,237 $ 1,196 $ 1,156
Issuance of stock:
To employees (8) (2) (9)
For other activity, including employee
stock grants (8) (13) 13
To ESOP, including share allocations 83 56 36
------- ------- -------
BALANCE, END OF YEAR $ 1,304 $ 1,237 $ 1,196
------- ------- -------
------- ------- -------
Foreign Currency Translation Adjustment
Balance, beginning of year $ 11 $ 4 $ (18)
Translation adjustment (a) (1) 7 22
------- ------- -------
BALANCE, END OF YEAR $ 10 $ 11 $ 4
------- ------- -------
------- ------- -------
Year Ended Last Friday in December
----------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------------------------
Net Unrealized Gains (Losses) on Investment Securities
Available-for-Sale (net of applicable income taxes)
Balance, beginning of year $ 25 $ (57) $ 21
Net unrealized (losses) gains on investment
securities available-for-sale (97) 335 (410)
Other adjustments (b) 81 (253) 332
------- ------- -------
BALANCE, END OF YEAR $ 9 $ 25 $ (57)
------- ------- -------
------- ------- -------
Retained Earnings
Balance, beginning of year $ 6,492 $ 5,606 $ 4,777
Net earnings 1,619 1,114 1,017
Cash dividends declared:
9% Cumulative Preferred stock (38) (38) (6)
Remarketed Preferred stock (9) (10) (7)
Common stock ($1.16 per share in 1996;
$1.01 in 1995; $.89 in 1994) (196) (180) (175)
------- ------- -------
BALANCE, END OF YEAR $ 7,868 $ 6,492 $ 5,606
------- ------- -------
------- ------- -------
Common Treasury Stock, at cost
Balance, beginning of year (60,929,278 shares
in 1996; 48,423,944 in 1995; 23,408,139 in 1994) $(2,241) $(1,627) $ (696)
Treasury stock purchased (18,578,817 shares in
1996; 20,011,821 in 1995; 29,988,523 in 1994) (1,163) (939) (1,138)
Issued out of treasury (net of reacquisitions):
Employees (844,887 shares in 1996; 822,818
in 1995; 1,026,321 in 1994) 51 37 42
Employee stock grants (7,957,610 shares in
1996; 6,683,669 in 1995; 3,946,397 in 1994) 458 288 165
------- ------- -------
BALANCE, END OF YEAR (70,705,598 shares in 1996;
60,929,278 in 1995; 48,423,944 in 1994) $(2,895) $(2,241) $(1,627)
------- ------- -------
------- ------- -------
Unallocated ESOP Reversion Shares, at cost
Balance, beginning of year (4,012,519 shares in
1996; 6,427,091 in 1995; 8,932,332 in 1994) $ (63) $ (101) $ (140)
Allocation of shares to participants (2,473,741
shares in 1996; 2,414,572 in 1995; 2,505,241 in 1994) 39 38 39
------- ------- -------
BALANCE, END OF YEAR (1,538,778 shares in 1996;
4,012,519 in 1995; 6,427,091 in 1994) $ (24) $ (63) $ (101)
------- ------- -------
------- ------- -------
Employee Stock Transactions
Balance, beginning of year $ (254) $ (137) $ (123)
Net issuance of employee stock grants (251) (192) (121)
Amortization of employee stock grants 183 68 100
Repayment of employee loans 8 7 7
------- ------- -------
BALANCE, END OF YEAR $ (314) $ (254) $ (137)
------- ------- -------
------- ------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 6,273 $ 5,522 $ 5,199
------- ------- -------
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY $ 6,892 $ 6,141 $ 5,818
------- ------- -------
------- ------- -------
- --------------------------------------------------------------------------------------------
(a) Net of income tax benefit (expense) of $16 in 1996, $19 in 1995, and $(8) in
1994.
(b) Other adjustments consist of policyholder liabilities, deferred policy
acquisition costs, and deferred income taxes.
See Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
STATEMENTS OF CONSOLIDATED CASH FLOWS
- -------------------------------------------------------------------------------
Year Ended Last Friday in December
----------------------------------
(Dollars in Millions) 1996 1995 1994
- -------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net Earnings $ 1,619 $ 1,114 $ 1,017
Noncash items included in earnings:
Depreciation and amortization 411 367 325
Policyholder reserves 269 297 354
Other 919 672 658
(Increase) decrease in operating assets:
Trading assets (15,378) (6,375) 6,610
Cash and securities segregated for regulatory
purposes or deposited with clearing organizations (198) (459) (884)
Securities borrowed (4,047) 348 (1,992)
Customers (3,543) (771) (826)
Maturities and sales of trading investment
securities 98 -- 197
Purchases of trading investment securities (67) -- (213)
Other 1,125 250 (273)
Increase (decrease) in operating liabilities:
Trading liabilities 10,195 (2,608) 5,642
Customers 366 (1,377) (1,962)
Insurance (587) (732) (1,855)
Other 75 1,405 607
----- ----- -----
Cash (Used for) Provided by Operating Activities (8,743) (7,869) 7,405
----- ----- -----
Cash Flows from Investing Activities:
Proceeds from (payments for):
Maturities of available-for-sale securities 3,057 1,453 2,610
Sales of available-for-sale securities 1,341 1,029 1,377
Purchases of available-for-sale securities (4,374) (2,387) (2,296)
Maturities of held-to-maturity securities 920 1,217 1,965
Purchases of held-to-maturity securities (555) (1,094) (2,537)
Acquisitions, net of cash acquired (135) (601) --
Other investments and other assets (384) (138) (391)
Property, leasehold improvements, and equipment (463) (352) (406)
----- ----- -----
Cash (Used for) Provided by Investing Activities (593) (873) 322
----- ----- -----
Cash Flows from Financing Activities:
Proceeds from (payments for):
Resale agreements, net of repurchase agreements (8,293) 5,155 (10,875)
Commercial paper and other short-term borrowings 9,787 3,106 3,225
Issuance and resale of long-term borrowings 16,454 10,353 10,353
Settlement and repurchases of long-term borrowings (7,440) (7,971) (9,090)
Issuance of subsidiaries' preferred securities 276 -- --
Issuance of 9% Cumulative Preferred Stock -- -- 425
Common stock transactions (921) (894) (1,048)
Dividends (243) (228) (188)
----- ------ ------
Cash Provided by (Used for) Financing Activities 9,620 9,521 (7,198)
----- ------ ------
INCREASE IN CASH AND CASH EQUIVALENTS 284 779 529
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,091 2,312 1,783
----- ------ ------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 3,375 $ 3,091 $ 2,312
----- ------ ------
----- ------ ------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for:
Income taxes totaled $1,108 in 1996, $557 in 1995, and $1,190 in 1994.
Interest totaled $11,612 in 1996, $11,229 in 1995, and $8,452 in 1994.
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITY
In 1995, as part of the consideration for Smith New Court, Merrill Lynch issued
approximately $115 of unsecured floating-rate notes due December 31, 2000 (the
"Notes"). The Notes are redeemable at the option of the holders on any quarterly
interest payment date on or after December 31, 1996.
See Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements
(Dollars in millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Merrill Lynch &
Co., Inc. (the "Company") and subsidiaries (collectively, "Merrill Lynch"). All
material intercompany balances have been eliminated. Certain limited
reclassification and format changes have been made to prior years' amounts to
conform to the current year presentation.
Merrill Lynch provides investment, financing, insurance, and related services to
individuals and institutions on a global basis through its principal
broker-dealer subsidiary, Merrill Lynch, Pierce, Fenner & Smith Incorporated
("MLPF&S"), and its broker, dealer, banking, insurance, and other financial
services subsidiaries. Such services include securities brokerage, trading,
underwriting, and clearance; investment banking and other corporate finance
advisory activities; investment advisory and other asset management services;
trading of foreign exchange instruments, futures, commodities, and other
derivatives; banking, trust, and lending services; and insurance sales and
underwriting services.
The Consolidated Financial Statements are presented in accordance with generally
accepted accounting principles and prevailing industry practices, both of which
require management to make estimates regarding certain trading inventory
valuations, the outcome of litigation, goodwill, deferred tax asset realization,
insurance deferred acquisition costs, and other matters that affect the reported
amounts and disclosure of contingencies in the financial statements. Estimates,
by their nature, are based on judgment and available information. As such,
actual results could differ materially from those estimates.
- -------------------------------------------------------------------------------
TRADING INSTRUMENTS
Trading assets and trading liabilities consist of cash instruments, such as
securities, and derivative instruments used for trading purposes or to hedge
trading inventory. Included in trading liabilities are securities that Merrill
Lynch has sold but does not currently own and will therefore be obligated to
purchase at a future date ("short sales"). Trading inventory is recorded on a
trade date basis at fair value. Fair value is based on quoted market prices,
pricing models (utilizing indicators of general market conditions or other
economic measurements), or management's estimates of amounts to be realized on
settlement, assuming current market conditions and an orderly disposition over a
reasonable period of time.
- -------------------------------------------------------------------------------
Derivatives
A derivative is typically defined as an instrument whose value is "derived" from
an underlying instrument or index, such as a future, forward, swap, or option
contract, or other financial instrument with similar characteristics. The
derivative definition excludes all cash instruments, including those that derive
their values or contractually required cash flows from an underlying instrument
or index, such as mortgage-backed securities, interest-only and principal-only
obligations, and indexed debt instruments. It also excludes option features
embedded in cash instruments such as conversion features and call provisions
embedded in bonds.
Derivative contracts often involve future commitments to exchange interest
payment streams or currencies based on a notional or contractual amount (e.g.,
interest rate swaps or currency forwards) or to purchase or sell other financial
instruments at specified terms on a specified date (e.g., options to buy or sell
securities, currencies, and commodities). Different types of derivatives can
also be combined to meet specialized needs (e.g., swap options).
Derivatives are often referred to as off-balance-sheet instruments since their
notional amounts or underlying instruments are not reflected on the balance
sheet; however, the fair values of trading derivatives are recorded in trading
inventory.
Fair values for certain exchange-traded derivatives, principally futures and
certain options, are based on quoted market prices. Fair values for
over-the-counter ("OTC") derivative financial instruments, principally forwards,
options, and swaps, represent amounts that would be received from or paid to a
third party in settlement of the instruments. These amounts are determined using
pricing models based on the present value of future cash flows using mid-market
valuations with appropriate adjustments. These adjustments are integral
components of the mark-to-market process and relate to credit quality and
concentration, market liquidity, and exposure close-out costs associated with
unmatched positions. Adjustments are also made for administrative costs incurred
to service periodic cash flows and maintain hedges over the life of the
contract. A portion of income related to longer-term contracts is recognized as
the administrative costs pertaining to these contracts are incurred.
New, complex products may have immature or limited two-way markets. The
precision of the pricing model for a complex product, which involves multiple
variables and assumptions, will evolve over time. As these products develop,
Merrill Lynch continually refines its pricing models based on experience to
correlate more closely to the market risk of these instruments.
Derivatives are reported separately as assets and liabilities unless a legal
right of setoff exists under a master netting agreement enforceable at law.
Balances related to swap and forward transactions and foreign currency options
are included in "Contractual agreements" on the Consolidated Balance Sheets. All
other derivative balances are recorded in the related cash instrument caption.
The fair value of equity options purchased, for example, is recorded in the
"Equities and convertible debentures" trading asset caption.
Merrill Lynch enters into when-issued and delayed delivery transactions.
Unrealized gains and losses from these forward transactions are recorded in
the related cash instrument caption.
- -------------------------------------------------------------------------------
Revenue Recognition
Principal transactions revenues are recognized on a trade date basis and include
net unrealized gains or losses from marking-to-market all trading instruments.
Realized gains and losses on trading instruments and any related interest
amounts are included in principal transactions revenues and interest revenues
and expenses, respectively.
- -------------------------------------------------------------------------------
FINANCING AND RELATED ACTIVITIES
Merrill Lynch strives to match-fund the interest rate sensitivity of its
assets and liabilities. Funding is principally obtained from repurchase
agreements, commercial paper, and long-term borrowings. Merrill Lynch
utilizes derivatives to reduce risk by managing interest rate, foreign
currency, and other exposures. Derivatives that modify the interest rate
characteristics of specified non-trading assets and liabilities are accounted
for on an accrual basis, with amounts to be paid or received recognized as
adjustments to the related interest income or expense. Unrealized gains and
losses on other financing derivatives are recognized currently. Realized
gains and losses on early terminations of interest rate contracts are
deferred over the remaining lives of the hedged assets or liabilities. At
December 27, 1996, there were no deferred amounts related to terminated
contracts.
Repurchase and resale agreements are accounted for as collateralized financing
transactions and are recorded at their contractual amounts, plus accrued
interest. Merrill Lynch's policy is to obtain possession of collateral with a
market value equal to or in excess of the principal amount loaned under resale
agreements. To ensure that the market value of the underlying collateral remains
sufficient, collateral is valued daily, and Merrill Lynch may require
counterparties to deposit additional collateral or return collateral pledged,
when appropriate. Substantially all repurchase and resale activities are
transacted under master netting agreements that give Merrill Lynch the right, in
the event of default, to liquidate collateral held and to set off receivables
and payables with the same counterparty. Merrill Lynch offsets certain
repurchase and resale agreement balances with the same counterparty on the
Consolidated Balance Sheets.
Securities borrowed and loaned are recorded at the amount of cash collateral
advanced or received. Securities borrowed transactions require Merrill Lynch
to provide the counterparty with collateral in the form of cash, letters of
credit, or other securities. Merrill Lynch receives collateral in the form of
cash or other securities for securities loaned transactions. For these
transactions, the fee received or paid by Merrill Lynch is recorded as
interest revenue or expense. On a daily basis, Merrill Lynch monitors the
market value of securities borrowed or loaned against the collateral value.
Although substantially all securities borrowing and lending activities are
transacted under master netting agreements, Merrill Lynch does not offset
such receivables and payables with the same counterparty on the Consolidated
Balance Sheets.
- -------------------------------------------------------------------------------
INVESTMENT SECURITIES
Merrill Lynch holds debt and equity investments principally in non-broker-dealer
subsidiaries. These investments are classified as held-to-maturity, trading, or
available-for-sale.
Held-to-maturity investments are debt securities that Merrill Lynch has the
positive intent and ability to hold to maturity. These investments are recorded
at amortized cost unless a decline in value is deemed other than temporary, in
which case the carrying value is adjusted. The amortization of premium or
accretion of discount and any unrealized loss deemed other-than-temporary are
included in current period earnings.
Debt and equity securities purchased principally for the purpose of resale in
the near-term are classified as trading investments and are reported at fair
value. Unrealized gains or losses on these investments are included in
current period earnings.
Other debt and equity securities that are not categorized as held-to-maturity or
trading are classified as available-for-sale and reported at fair value.
Unrealized gains or losses on these securities are reported as a separate
component of stockholders' equity, net of applicable income taxes and other
related items.
Restricted equity investment securities or equity investment securities
without available market quotations are reported at the lower of cost or
estimated net realizable value. Adjustments in carrying values are included
in current period earnings.
Realized gains and losses on investments are included in current period
earnings. The cost basis of each investment sold is specifically identified for
purposes of computing realized gains and losses.
- -------------------------------------------------------------------------------
COMMISSIONS AND RELATED EXPENSES
Commissions charged for executing customer transactions are accrued on a trade
date basis and are included in current period earnings. Production-related
compensation and benefits expense is accrued to match revenue recognition.
- -------------------------------------------------------------------------------
INVESTMENT BANKING
Underwriting revenues and fees for mergers and acquisitions and advisory
assignments are recorded when services for the transaction are substantially
completed. Deal-related expenses are deferred and later expensed to match
revenue recognition.
- -------------------------------------------------------------------------------
RECEIVABLES FROM AND PAYABLES TO CUSTOMERS
Customer securities and commodities transactions are recorded on a settlement
date basis. Receivables from and payables to customers include amounts due on
cash and margin transactions. Securities owned by customers, including those
that collateralize margin or other transactions, are not reflected on the
Consolidated Balance Sheets.
- -------------------------------------------------------------------------------
INCOME TAXES
The Company and certain of its wholly-owned subsidiaries file a consolidated
Federal income tax return. Merrill Lynch uses the asset and liability method in
providing income taxes on all transactions that have been recognized in the
Consolidated Financial Statements. The asset and liability method requires that
deferred taxes be adjusted to reflect the tax rates at which future taxable
amounts will be settled or realized. The effects of tax rate changes on future
deferred tax liabilities and deferred tax assets, as well as other changes in
income tax laws, are recognized in net earnings in the period such changes are
enacted. Valuation allowances are established when necessary to reduce deferred
tax assets to the amounts expected to be realized. Merrill Lynch does not
provide for deferred income taxes on the undistributed earnings of foreign
subsidiaries, which are considered to be permanently reinvested.
- -------------------------------------------------------------------------------
PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT
Property (excluding land), leasehold improvements, and equipment are reported at
historical cost, net of accumulated depreciation and amortization. Land is
reported at historical cost.
Depreciation and amortization are computed using the straight-line method.
Property and equipment are depreciated over the estimated useful lives of the
assets, while leasehold improvements are amortized over the lesser of the
estimated economic useful life of the asset or the term of the lease. Most of
Merrill Lynch's fixed assets are technology-based and have short lives,
generally three to five years. Maintenance and repair costs are expensed as
incurred.
Facilities-related depreciation and amortization expense was $151, $142, and
$135 in 1996, 1995, and 1994, respectively. Non-facilities-related depreciation
and amortization expense for 1996, 1995, and 1994 was $260, $225, and $190,
respectively.
- -------------------------------------------------------------------------------
GOODWILL
Goodwill, which represents the cost of acquired businesses in excess of fair
value of the related net assets at acquisition, is amortized on a straight-line
basis over periods not exceeding fifteen years and is evaluated periodically for
impairment.
- -------------------------------------------------------------------------------
INSURANCE
Insurance liabilities are future benefits payable under annuity and
interest-sensitive life contracts and include deposits received plus interest
credited during the contract accumulation period, the present value of future
payments for contracts which have annuitized, and a mortality provision for
certain products. Certain policyholder liabilities are also adjusted for those
investments classified as available-for-sale. Liabilities for unpaid claims
consist of the mortality benefit for reported claims and an estimate of
unreported claims based upon prior experience.
Substantially all investments of insurance subsidiaries, principally debt
securities, are classified as available-for-sale and recorded at fair value.
These investments support Merrill Lynch's in-force, universal life-type
contracts. Merrill Lynch records adjustments to deferred acquisition costs and
policyholder account balances which, when combined, are equal to the adjustment
that would have been recorded if those available-for-sale investments had been
sold at their estimated fair values and the proceeds reinvested at current
yields. The corresponding credits or charges for these adjustments are recorded
as unrealized gains or losses in stockholders' equity, net of applicable income
taxes.
Certain variable costs related to the sale or acquisition of new and renewal
insurance contracts have been deferred, to the extent deemed recoverable, and
amortized over the lives of the contracts in proportion to the estimated gross
profit for each group of contracts.
Merrill Lynch maintains separate accounts representing segregated funds held for
purposes of funding variable life and annuity contracts. Separate account assets
are accounted for as customer assets since the contract holders bear the risk of
ownership, consistent with Merrill Lynch's other investment products.
Accordingly, separate account assets and the related liabilities are not
consolidated with the assets and liabilities of Merrill Lynch.
- -------------------------------------------------------------------------------
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities of foreign subsidiaries are translated at year-end
currency exchange rates, while revenues and expenses are translated at average
currency exchange rates during the year. Adjustments that result from
translating foreign currency financial statements, net of hedging gains or
losses and related tax effects, are reported as a separate component of
stockholders' equity. Gains or losses resulting from the effect of exchange rate
changes on foreign currency transactions are included in earnings of the current
period.
- -------------------------------------------------------------------------------
CASH FLOWS
For purposes of the Statements of Consolidated Cash Flows, Merrill Lynch defines
cash equivalents as short-term, highly liquid securities and interest-earning
deposits with original maturities of 90 days or less, other than those used for
trading purposes.
- -------------------------------------------------------------------------------
FAIR VALUE OF FINANCIAL INSTRUMENTS
At December 27, 1996 and December 29, 1995, substantially all financial
instrument assets are carried at fair value or amounts that approximate fair
value. Fair values of financial instruments are disclosed in Notes 3, 4, 5, and
7.
- -------------------------------------------------------------------------------
INTEREST EXPENSE
Interest expense includes payments in lieu of dividends of $9, $10, and $23 in
1996, 1995, and 1994, respectively.
- --------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
- --------------------------------------------------------------------------------
ACCOUNTING CHANGES
In 1995, Merrill Lynch adopted Statement of Financial Accounting Standards
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan"; SFAS No.
118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures"; and SFAS No. 122, "Accounting for Mortgage Servicing Rights". The
impact of adopting these pronouncements was not material.
- -------------------------------------------------------------------------------
ACQUISITIONS
Merrill Lynch completed several acquisitions in 1996, including two non-U.S.
securities firms and a U.S. asset manager, for aggregate consideration paid of
$232. Goodwill of $167 was recorded in connection with these acquisitions.
In 1995, Merrill Lynch acquired Smith New Court PLC ("Smith New Court"), a
U.K.-based global securities firm, for $803, and recorded $533 of goodwill
related to the acquisition.
The operating results of acquired companies are included in Merrill Lynch's
results of operations as of the acquisition date.
- --------------------------------------------------------------------------------
NOTE 3. TRADING ACTIVITIES
- --------------------------------------------------------------------------------
Merrill Lynch's trading activities include providing securities brokerage,
derivatives dealing, and underwriting services to clients. While trading
activities are primarily generated by client order flow, Merrill Lynch also
takes proprietary positions based on expectations of future market movements and
conditions. Merrill Lynch's trading strategies rely on the integrated management
of its client-driven and proprietary transactions, along with the hedging and
financing of these positions.
Principal transactions revenues by product category follow(1):
1996 1995 1994
------ ------ -----
Equities and equity derivatives $1,138 $ 912 $ 625
Taxable fixed-income 966 516 471
Interest rate and currency swaps 893 732 750
Municipals 323 273 380
Foreign exchange and commodities 134 86 109
------ ------ ------
TOTAL $3,454 $2,519 $2,335
------ ------ ------
------ ------ ------
(1) The revenue amounts presented include gains and losses from both cash and
related derivative instruments.
Interest revenue and expense are integral components of trading activities. In
assessing the profitability of trading activities, Merrill Lynch views net
interest and principal transactions revenues in the aggregate. For further
information on Merrill Lynch's net trading results, see "Principal Transactions"
in Management's Discussion and Analysis (unaudited).
Certain trading activities expose Merrill Lynch to market and credit risks.
These risks are managed in accordance with established risk management policies
and procedures that are described in the "Risk Management" section of
Management's Discussion and Analysis (unaudited).
- -------------------------------------------------------------------------------
MARKET RISK
Market risk is the potential change in an instrument's value caused by
fluctuations in interest and currency exchange rates, equity and commodity
prices, and credit spreads. The level of market risk is influenced by the
volatility and the liquidity in the markets in which financial instruments are
traded.
Merrill Lynch seeks to mitigate market risk associated with trading inventories
by employing hedging strategies that correlate rate, price, and spread movements
of trading inventories and related financing and hedging activities. Merrill
Lynch uses a combination of cash instruments and derivatives to hedge its market
exposures. The following discussion describes the types of market risk faced by
Merrill Lynch.
- -------------------------------------------------------------------------------
Interest Rate Risk
Interest rate risk arises from the possibility that changes in interest rates
will affect the value of financial instruments. Interest rate swap agreements
and Eurodollar and U.S. Treasury securities and futures are common interest rate
risk management tools. The decision to manage interest rate risk using futures
or swap contracts, as opposed to buying or selling short U.S. Treasury or other
securities, depends on current market conditions and funding considerations.
Interest rate swap agreements used by Merrill Lynch include caps, collars,
floors, basis swaps, and leveraged swaps. Interest rate caps and floors provide
the purchaser protection against rising and falling interest rates,
respectively. Interest rate collars combine a cap and a floor, providing the
purchaser with a predetermined interest rate range. Basis swaps are a type of
interest rate swap agreement where rates received and paid are variable based on
different index rates. Leveraged swaps are another type of interest rate swap
where changes in the variable rate are multiplied by a contractual leverage
factor, such as four times three-month LIBOR (London Interbank Offered Rate).
Merrill Lynch's exposure to interest rate risk resulting from these leverage
factors is typically hedged with other financial instruments.
- -------------------------------------------------------------------------------
Currency Risk
Currency risk arises from the possibility that fluctuations in foreign exchange
rates will impact the value of financial instruments. Currency forwards and
options are commonly used to manage currency risk. Currency swaps are also used
in situations where a long-dated forward market is not available or where the
end-user needs a customized instrument to hedge a foreign currency cash flow
stream. Typically, parties to a currency swap initially exchange principal
amounts
in two currencies, agreeing to exchange interest payments and to re-exchange
the currencies at a future date and exchange rate. Merrill Lynch's currency
contracts relate primarily to major currencies such as the Japanese yen,
German mark, Swiss franc, British pound, and French franc.
- -------------------------------------------------------------------------------
Equity Price Risk
Equity price risk arises from the possibility that equity security prices will
fluctuate, affecting the value of equity securities and other instruments that
derive their value from a particular stock, a defined basket of stocks, or a
stock index. Typical instruments used to manage equity price risk include equity
options and warrants. Equity options, for example, can require the writer to
purchase or sell a specified stock or to make a cash payment based on changes in
the market price of that stock, basket of stocks, or stock index.
- -------------------------------------------------------------------------------
Commodity Price Risk
Merrill Lynch views its commodity contracts as financial instruments since they
are generally settled in cash and not by delivery of the underlying commodity.
Commodity price risk results from the possibility that the price of the
underlying commodity may rise or fall. Cash flows from commodity contracts are
based on the difference between an agreed-upon fixed price and a price that
varies with changes in a specified commodity price or index. Commodity contracts
held by Merrill Lynch principally relate to energy, precious metals, and base
metals.
- -------------------------------------------------------------------------------
Credit Spread Risk
Credit spread risk arises from the possibility that changes in an issuer's
credit rating or credit perception affect the value of financial instruments.
Certain derivatives may be used to manage this type of credit risk. Total return
swaps, for instance, are typically designed to transfer all the risks and
rewards of ownership of an underlying debt instrument from one party in the swap
agreement to the other party, in exchange for a specified interest rate. Credit
risk resulting from default on counterparty obligations is discussed in the
following "Credit Risk" section.
- -------------------------------------------------------------------------------
CREDIT RISK
Merrill Lynch is exposed to the risk of loss if an issuer or a counterparty
failed to perform its obligations under contractual terms and the collateral
held, if any, were deemed worthless ("default risk"). Both cash instruments and
derivatives expose Merrill Lynch to default risk. Credit risk arising from
changes in credit spreads is discussed in the "Market Risk" section.
Merrill Lynch has established policies and procedures for mitigating credit
risk on principal transactions, including reviewing and establishing limits
for credit exposure, obtaining the right to collect collateral or terminate
transactions in the event of a credit rating downgrade, limiting transactions
with specific counterparties, maintaining collateral, and continually
assessing the creditworthiness of counterparties. For further information,
see "Credit Risk" in the "Risk Management" section of Management's Discussion
and Analysis (unaudited).
In the normal course of business, Merrill Lynch executes, settles, and finances
various customer securities transactions. Execution of these transactions
includes the purchase and sale of securities by Merrill Lynch. These activities
may expose Merrill Lynch to default risk arising from the potential that
customers or counterparties may fail to satisfy their obligations. In these
situations, Merrill Lynch may be required to purchase or sell financial
instruments at unfavorable market prices to satisfy obligations to other
customers or counterparties. In addition, Merrill Lynch seeks to control the
risks associated with its customer margin activities by requiring customers to
maintain collateral in compliance with regulatory and internal guidelines.
Liabilities to other brokers and dealers related to unsettled transactions
(i.e., securities failed-to-receive) are recorded at the amount for which the
securities were acquired and are paid upon receipt of the securities from other
brokers or dealers. In the case of aged securities failed-to-receive, Merrill
Lynch may purchase the underlying security in the market and seek reimbursement
for losses from the counterparty.
Merrill Lynch uses repurchase and resale agreements and securities loaned and
borrowed transactions to finance securities, to facilitate settlement
processes, and to meet customers' needs. Under these agreements and
transactions, Merrill Lynch either receives or provides collateral, including
U.S. Government and agencies, asset-backed, corporate debt, equity, and
non-U.S. government and agencies securities. When providing collateral for
these transactions, Merrill Lynch delivers its own securities, securities
borrowed from counterparties, and securities owned by customers
collateralizing margin loans and other obligations.
The market value of securities owned by Merrill Lynch that have been loaned
or pledged to counterparties as collateral for obligations of Merrill Lynch,
primarily related to repurchase agreements, were $27,810 and $27,501 at
December 27, 1996 and December 29, 1995, respectively.
- -------------------------------------------------------------------------------
Concentrations of Credit Risk
Merrill Lynch's exposure to credit risk, both default and credit spread,
associated with its trading and other activities is measured on an individual
counterparty basis, as well as by groups of counterparties that share similar
attributes. Concentrations of credit risk can be affected by changes in
political, industry, or economic factors. To reduce the potential for risk
concentration, credit limits are established and monitored in light of changing
counterparty and market conditions.
At December 27, 1996, Merrill Lynch's most significant concentration of credit
risk was with the U.S. Government and its agencies. This concentration, which
primarily arises from taking trading asset and investment security positions and
maintaining collateral on resale agreements, totaled $41,482 at December 27,
1996 and $35,769 at December 29, 1995.
At December 27, 1996, Merrill Lynch had concentrations of credit risk with
other counterparties, including a European and a South American sovereign
rated AA and B+, respectively, by recognized credit rating agencies and an
investment company whose holdings primarily consist of various sovereign debt
instruments. The total exposure to these counterparties, excluding collateral
held, was $3,912, or 1.8% of total assets. At December 29, 1995, Merrill
Lynch had concentrations of credit risk with an Asian and a European
sovereign totaling $3,642 or 2.1% of total assets, excluding collateral held.
Merrill Lynch's most significant industry credit concentration is with U.S.
and non-U.S. financial institutions. Financial institutions include other
brokers and dealers, commercial banks, financing companies, insurance
companies, and mutual funds. This concentration arises in the normal course
of Merrill Lynch's brokerage, trading, financing, and underwriting
activities. Merrill Lynch also monitors credit exposures worldwide by region.
Within these regions, sovereign governments represent the most significant
concentration, followed by financial institutions and non-financial
institutions.
In the normal course of business, Merrill Lynch purchases, sells,
underwrites, and makes markets in non-investment grade instruments. In
conjunction with merchant banking activities, Merrill Lynch also provides
extensions of credit and makes equity investments to facilitate leveraged
transactions. These activities expose Merrill Lynch to a higher degree of
credit risk than is associated with trading, investing in, and underwriting
investment grade instruments and extending credit to investment grade
counterparties. See "Non-Investment Grade Holdings and Highly Leveraged
Transactions" in Management's Discussion and Analysis (unaudited) for further
information.
- -------------------------------------------------------------------------------
DERIVATIVES USED IN TRADING ACTIVITIES
The fair values of derivatives used in trading activities at year-end 1996 and
1995 follow:
DECEMBER 27, 1996 DECEMBER 29, 1995
----------------- -----------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
Swap agreements $11,553 $9,370 $10,008 $8,966
Forward contracts 1,304 1,403 1,159 1,506
Options 2,618 3,203 2,631 1,261
The table below presents the average fair values of Merrill Lynch's trading
derivatives for 1996 and 1995, calculated on a monthly basis:
- -------------------------------------------------------------------------------
AVERAGE FAIR VALUE
---------------------------------------------
1996 1995
--------------------- ----------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
Swap agreements $9,872 $8,404 $10,226 $9,049
Forward contracts 1,192 1,260 1,543 1,915
Options 2,573 1,964 2,400 1,368
- -------------------------------------------------------------------------------
The notional or contractual amounts of derivatives provide only a measure of
involvement in these types of transactions and represent neither the amounts
subject to the various types of market risk nor the future cash requirements
under these instruments. The notional or contractual amounts of derivatives used
for trading purposes by type of risk follow:
- -------------------------------------------------------------------------------
INTEREST EQUITY COMMODITY
RATE CURRENCY PRICE PRICE
(in billions) RISK(1)(2) RISK(3) RISK RISK
- -------------------------------------------------------------------------------
DECEMBER 27, 1996
- -----------------
Swap agreements $1,212 $140 $13 $ 3
Forward contracts 24 147 1 17
Futures contracts 126 2 7 5
Options purchased 85 76 21 3
Options written 118 72 31 3
DECEMBER 29, 1995
- -----------------
Swap agreements $ 851 $106 $ 7 $ 3
Forward contracts 33 118 -- 25
Futures contracts 215 1 2 2
Options purchased 45 24 38 5
Options written 64 24 41 6
- -------------------------------------------------------------------------------
(1) Certain derivatives subject to interest rate risk are also exposed to the
credit spread risk of the underlying financial instrument, such as total
return swaps and similar instruments.
(2) Forward contracts subject to interest rate risk principally represent "To
Be Announced" mortgage pools that bear interest rate as well as principal
prepayment risk.
(3) Included in the currency risk category are certain contracts that are also
subject to interest rate risk.
Most of Merrill Lynch's trading derivative transactions are short-term
in duration with a weighted-average maturity of approximately 2.66 years at
December 27, 1996 and 2.24 years at December 29, 1995. For trading
derivatives outstanding at December 27, 1996, the following table presents
the notional or contractual amounts that would be outstanding at subsequent
year ends based on contractual maturities.
Presented is a bar graph showing Merrill Lynch & Co., Inc.'s trading
derivatives at December 27, 1996 that would be outstanding at subsequent year
ends based on contractual maturities. The graph is presented in billions
with trading derivatives comprised of swap agreements, forward contracts,
futures contracts, options purchased, and options written. Remaining
maturities for these products in the aggregate total $2,106, $1,220, $925,
$711, $546, $407, $327 and $244 at year-end December 1996 through December
2003, respectively.
The notional or contractual values of derivatives do not represent default risk
exposure. Default risk is limited to the current cost of replacing derivative
contracts in a gain position.
Default risk exposure varies by type of derivative. Swap agreements and forward
contracts are generally OTC-transacted and thus are exposed to default risk to
the extent of their replacement cost. Since futures contracts are
exchange-traded and usually require daily cash settlement, the related risk of
accounting loss is generally limited to a one-day net positive change in market
value. Option contracts can be exchange-traded or OTC-transacted contracts.
Purchased options have default risk to the extent of their replacement cost.
Written options represent a potential obligation to counterparties and,
accordingly, do not subject Merrill Lynch to default risk.
Merrill Lynch attempts to enter into International Swaps and Derivatives
Association, Inc. master agreements or their equivalent ("master netting
agreements") with each of its counterparties. Master netting agreements provide
protection in bankruptcy in certain circumstances and, in some cases, enable
receivables and payables with the same counterparty to be presented net on the
Consolidated Balance Sheets, providing for a more meaningful balance sheet
presentation of credit exposure.
To reduce default risk, Merrill Lynch requires collateral, principally U.S.
Government and agencies securities, on certain derivative transactions. From
an economic standpoint, Merrill Lynch evaluates default risk exposures net of
related collateral. Presented below is a summary of counterparty credit
ratings for the replacement cost (net of $3,213 of collateral) of trading
derivatives in a gain position by maturity at December 27, 1996.
- -------------------------------------------------------------------------------
YEARS TO MATURITY CROSS-
--------------------------------- MATURITY
0-3 3-5 5-7 OVER 7 NETTING(1) TOTAL
---------------------------------------------------------
CREDIT
RATING(2)
AAA $ 437 $ 89 $ 28 $ 284 $ (42) $ 796
AA+/AA 993 189 160 359 (99) 1,602
AA- 1,501 514 483 385 (669) 2,214
A+/A 1,591 631 535 279 (390) 2,646
A- 1,906 601 259 341 (809) 2,298
BBB 762 289 123 137 (227) 1,084
BB 475 170 41 193 (164) 715
Other 529 138 21 240 (21) 907
------ ------ ------ ------ ------- -------
TOTAL $8,194 $2,621 $1,650 $2,218 $(2,421) $12,262
------ ------ ------ ------ ------- -------
------ ------ ------ ------ ------- -------
(1) Represents netting of payable balances with receivable balances for the
same counterparty across maturity year categories. Receivable and payable
balances with the same counterparty in the same maturity category, however,
are net within the maturity category.
(2) Represents rating agency equivalent.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate default
risk on derivatives by entering into transactions with provisions that enable
Merrill Lynch to terminate or reset the terms of the derivative contract.
- --------------------------------------------------------------------------------
NOTE 4. INVESTMENTS AND OTHER NON-TRADING ASSETS
- --------------------------------------------------------------------------------
INVESTMENTS
Merrill Lynch has several broad categories of investments on its Consolidated
Balance Sheets, including Investments of insurance subsidiaries, Marketable
investment securities, and Other investments.
Investments of insurance subsidiaries, primarily debt securities, are used to
fund policyholder liabilities. Marketable investment securities consist of
equity and debt securities primarily held for rating agency purposes or to
manage cash flows related to certain liabilities of Merrill Lynch's banking
subsidiaries. Other investments consist principally of equity and debt
securities that were acquired primarily in connection with merchant banking
activities. Certain merchant banking investments are subject to restrictions
that may limit Merrill Lynch's ability to realize its investment until such
restrictions expire.
Marketable investment securities and certain insurance subsidiaries' and other
investments are carried as held-to-maturity, trading, or available-for-sale
securities as described in Note 1. Investment securities reported on the
Consolidated Balance Sheets at December 27, 1996 and December 29, 1995 are
presented below:
- -------------------------------------------------------------------------------
1996 1995
------ ------
INVESTMENTS OF INSURANCE SUBSIDIARIES
Available-for-sale $3,624 $4,145
Non-qualifying(1) 1,483 1,474
------ ------
TOTAL $5,107 $5,619
------ ------
------ ------
MARKETABLE INVESTMENT SECURITIES
Available-for-sale $1,523 $1,064
Held-to-maturity 653 1,268
Trading 4 33
------ ------
TOTAL $2,180 $2,365
------ ------
------ ------
OTHER INVESTMENTS
Available-for-sale $ 142 $ 165
Held-to-maturity 328 43
Trading 3 --
Non-qualifying(2) 652 753
------ ------
TOTAL $1,125 $ 961
------ ------
------ ------
- -------------------------------------------------------------------------------
(1) Primarily consists of insurance policy loans.
(2) Includes merchant banking investments.
Information regarding investment securities subject to SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, follows:
- ----------------------------------------------------------------------------------------------------------------------------------
December 27, 1996 December 29, 1995
-------------------------------------------------- --------------------------------------------------
Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
AVAILABLE-FOR-SALE(1) Cost Gains Losses Value Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------------------------
Corporate debt $3,016 $ 72 $(12) $3,076 $2,999 $145 $(7) $3,137
U.S. Government and agencies 399 3 (1) 401 631 8 -- 639
Municipals 276 3 -- 279 168 1 -- 169
Mortgage-backed securities 1,029 21 (3) 1,047 1,290 35 (2) 1,323
Other debt securities 417 8 (9) 416 57 1 -- 58
------ ---- ---- ------ ------ ---- ---- ------
Total debt securities 5,137 107 (25) 5,219 5,145 190 (9) 5,326
Equity securities 70 5 (5) 70 50 5 (7) 48
------ ---- ---- ------ ------ ---- ---- ------
TOTAL $5,207 $112 $(30) $5,289 $5,195 $195 $(16) $5,374
------ ---- ---- ------ ------ ---- ---- ------
------ ---- ---- ------ ------ ---- ---- ------
- ----------------------------------------------------------------------------------------------------------------------------------
December 27, 1996 December 29, 1995
-------------------------------------------------- --------------------------------------------------
Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
HELD-TO-MATURITY(1) Cost Gains Losses Value Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------------------------
Corporate debt $483 $ 4 -- $ 487 $1,051 $13 -- $1,064
U.S. Government and agencies 37 -- -- 37 23 -- -- 23
Municipals 122 15 -- 137 1 -- -- 1
Mortgage-backed securities 281 2 -- 283 169 -- -- 169
Other debt securities 58 -- -- 58 67 1 -- 68
---- ---- ---- ------ ------ --- ---- ------
TOTAL $981 $21 -- $1,002 $1,311 $14 -- $1,325
---- ---- ---- ------ ------ --- ---- ------
---- ---- ---- ------ ------ --- ---- ------
- -------------------------------------------------------------------------------
(1) In accordance with Financial Accounting Standards Board implementation
guidance on SFAS No. 115, Merrill Lynch reassessed the classification of
all such securities and transferred held-to-maturity securities with an
amortized cost of $385 to the available-for-sale category on
December 29, 1995. Net unrealized gains for these securities on the date
of transfer were $4.
The amortized cost and estimated fair value of debt securities at December 27,
1996, by contractual maturity, for available-for-sale and held-to-maturity
investments follow:
AVAILABLE-FOR-SALE HELD-TO-MATURITY
------------------ ----------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------------------------------------
Due in one year
or less $1,118 $1,119 $417 $ 418
Due after one year
through five years 1,691 1,729 149 153
Due after five years
through ten years 808 826 99 100
Due after ten years 491 498 35 48
------ ------ ---- -----
Subtotal 4,108 4,172 700 719
Mortgage-backed
securities 1,029 1,047 281 283
------ ------ ----- ------
TOTAL(1) $5,137 $5,219 $981 $1,002
------ ------ ----- ------
------ ------ ----- ------
(1) Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
Merrill Lynch's insurance subsidiaries are required to adjust deferred
acquisition costs and certain policyholder liabilities associated with
investments classified as available-for-sale. These adjustments are recorded in
stockholders' equity and assume that the unrealized gain or loss on
available-for-sale securities was realized. The table below provides the
activity for the net unrealized gains (losses) recorded in stockholders' equity
for available-for-sale investments.
- --------------------------------------------------------------------------------
1996 1995 1994
---- ---- ----
Net unrealized (losses) gains
on investment securities
available-for-sale $(97) $ 335 $(410)
Adjustments for policyholder
liabilities 64 (137) 215
Adjustments for deferred
policy acquisition costs 9 (72) 74
Deferred income taxes 8 (44) 43
---- ---- ----
Net activity (16) 82 (78)
Net unrealized gains (losses)
on investment securities
classified as available-for-sale:
Beginning of year 25 (57) 21
---- ------ -----
End of year $ 9 $ 25 $ (57)
---- ------ -----
---- ------ -----
- --------------------------------------------------------------------------------
The proceeds and gross realized gains (losses) from the sale of
available-for-sale investments are as follows:
- -------------------------------------------------------------------------------
1996 1995 1994
------ ------ ------
Proceeds $ 1,341 $ 1,029 $ 1,377
Gross realized gains 41 26 31
Gross realized losses (12) (28) (34)
- -------------------------------------------------------------------------------
Net unrealized (losses) gains from trading investment securities included in the
1996 and 1995 Statements of Consolidated Earnings were $(1) and $1,
respectively.
- -------------------------------------------------------------------------------
OTHER NON-TRADING ASSETS
Most other financial instrument assets are carried at amounts that approximate
fair value. Such assets include cash and cash equivalents, cash and securities
segregated for regulatory purposes or deposited with clearing organizations,
most resale agreements, securities borrowed, and receivables.
Other financial instrument assets with carrying values that differ from their
fair values are presented below:
- -------------------------------------------------------------------------------
December 27, 1996 December 29, 1995
------------------- ------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ------- -------- -------
Merchant banking
equity investment
and loan portfolio(1) $ 202 $ 362 $ 394 $ 595
Loans, notes, and
mortgages(2) 3,313 3,347 2,082 2,149
Mortgage servicing
assets and related
residual interests 374 393 255 303
- -------------------------------------------------------------------------------
(1) Equity investments are non-qualifying for SFAS No. 115 purposes.
(2) Excludes loans related to merchant banking activities.
In connection with its merchant banking activities, Merrill Lynch holds certain
equity instruments, including partnership interests (included in Other
investments on the Consolidated Balance Sheets), and loans consisting primarily
of senior and subordinated debt. Fair value for equity instruments is estimated
using a number of methods, including earnings multiples, cash flow analyses, and
review of underlying financial conditions and other market factors. These
instruments may be subject to restrictions (e.g., consent of other investors)
that may limit Merrill Lynch's ability to realize currently the estimated fair
value. Accordingly, Merrill Lynch's current estimate of fair value and the
ultimate realization on these instruments may differ.
Loans made in the course of merchant banking activities are carried at unpaid
principal balances. Fair value for loans made in connection with merchant
banking activities is estimated using discounted cash flows. Merrill Lynch's
estimate of fair value for other loans, notes, and mortgages is determined
based on loan characteristics. For certain homogeneous categories of loans,
including residential mortgages and home equity loans, fair value is
estimated using market price quotations or previously executed transactions
for securities backed by similar loans, adjusted for credit risk and other
individual loan characteristics. For Merrill Lynch's variable-rate loan
receivables, carrying value approximates fair value.
Mortgage servicing assets and residual interests in the mortgage loans
underlying various Real Estate Mortgage Investment Conduits ("REMICS") and
revolving trusts are primarily included in Other assets on the Consolidated
Balance Sheets. Servicing assets and residual interests are (i) recognized upon
sales of loans for which servicing is retained, (ii) amortized in proportion to
and over the estimated life of the projected servicing revenues, and (iii)
periodically evaluated for impairment. Fair value of servicing assets is
computed based on the present value of estimated future normal servicing
revenues (net of servicing expenses), using current market assumptions for
discount rates, prepayment speeds, default estimates, and interest rates. Fair
value of residual interests in REMICS and revolving trusts is calculated based
on the present value of estimated future servicing revenues in excess of normal
servicing revenues, using current market assumptions for discount rates,
prepayment speeds, default estimates, and interest rates.
Merrill Lynch holds a passive minority interest in Bloomberg L.P., a privately
held limited partnership that provides information services. In 1996, Merrill
Lynch sold one-third of its interest to the majority interest holder, resulting
in a gain of $155. Due to the nature and terms of the sale, the sale price is
not necessarily indicative of the fair value of Merrill Lynch's remaining
investment. In addition, given the contractual restrictions on the disposition
of Merrill Lynch's interest, the fair value of the remaining investment is not
readily determinable as of December 27, 1996. Management believes, however, that
the fair value of this investment significantly exceeds its carrying value of
$28.
Merrill Lynch enters into derivative hedges of interest rate risk on various
non-trading assets, including certain long-term resale agreements. At December
27, 1996 and December 29, 1995, the notional amounts of derivatives hedging
these assets were $7 billion. The combined carrying value of hedged non-trading
assets and related hedges approximates their combined fair value at both dates.
- -------------------------------------------------------------------------------
NOTE 5. SHORT-TERM AND LONG-TERM BORROWINGS AND OTHER NON-TRADING LIABILITIES
- -------------------------------------------------------------------------------
SHORT-TERM AND LONG-TERM BORROWINGS
Merrill Lynch issues U.S. dollar- and foreign currency-denominated debt
instruments with both variable and fixed interest rates. These financing
activities may create exposure to market risk, most notably interest rate and
currency risk. To better match the interest rate characteristics of assets and
liabilities, Merrill Lynch generally enters into swap agreements to convert
fixed-rate interest payments on its debt obligations into variable-rate
payments. Interest obligations on variable-rate long-term borrowings and
commercial paper may also be modified through swap agreements that change the
underlying interest rate basis or reset frequency. Foreign currency payments on
debt obligations may be swapped to U.S. dollar payments.
Merrill Lynch also issues debt containing embedded options that link the
repayment of these obligations to the performance of an equity or other index
(e.g., S&P 500), an industry basket of stocks, or an individual stock. The
contingent components of these indexed debt obligations are hedged with
derivatives.
Borrowings at December 27, 1996 and December 29, 1995 are presented below:
- --------------------------------------------------------------------------------
1996 1995
------- -------
COMMERCIAL PAPER AND OTHER
SHORT-TERM BORROWINGS
Commercial paper $23,558 $16,969
Demand and time deposits 9,311 8,182
Securities loaned 2,751 2,857
Bank loans and other 3,713 1,538
------- -------
TOTAL $39,333 $29,546
------- -------
------- -------
LONG-TERM BORROWINGS
Fixed-rate obligations(1):
U.S. dollar-denominated $ 5,770 $ 4,670
Foreign currency-denominated 1,737 1,157
Variable-rate obligations(2)(3):
U.S. dollar-denominated 1,944 630
Foreign currency-denominated 690 222
Medium-term notes(4):
U.S. dollar-denominated 10,532 7,650
Foreign currency-denominated 5,429 3,011
------- -------
TOTAL $26,102 $17,340
------- -------
------- -------
- --------------------------------------------------------------------------------
(1) At December 27, 1996, U.S. dollar-denominated fixed-rate obligations are
due 1997 to 2019 at interest rates ranging from 5.50% to 10.38%; foreign
currency-denominated fixed-rate obligations are due 1997 to 2002 at
interest rates ranging from 2.55% to 12.10%.
(2) Variable interest rates are generally based on rates such as LIBOR, the
U.S. Treasury Bill Rate, or the Federal Funds Rate.
(3) Included in variable-rate obligations are various equity-linked or indexed
instruments issued by Merrill Lynch.
(4) Medium-term notes may bear fixed or variable interest rates and have
maturities that may range from nine months to 30 years from the date of
issue.
Maturities of long-term borrowings at December 27, 1996 consisted of the
following:
- -------------------------------------------------------------------------------
1997 $5,986
1998 4,150
1999 4,353
2000 2,945
2001 3,214
2002 and thereafter 5,454
-------
TOTAL $26,102
-------
-------
- --------------------------------------------------------------------------------
The notional or contractual amounts of derivatives used to hedge exposures
related to borrowings at December 27, 1996 and December 29, 1995 follow:
- -------------------------------------------------------------------------------
(IN BILLIONS) 1996 1995
----- -----
Interest rate derivatives(1) $32 $26
Currency derivatives(1) 4 3
Equity derivatives 2 1
- -------------------------------------------------------------------------------
(1) Includes swap contracts totaling $1 billion notional that contain
embedded options hedging callable debt at both dates.
Most of these derivatives are entered into with Merrill Lynch's derivative
dealer subsidiaries, which intermediate interest rate, currency, and equity
risks with third parties in the normal course of their trading activities.
Effective weighted-average interest rates for borrowings, which include the
impact of hedges, at December 27, 1996 and December 29, 1995 were:
- -------------------------------------------------------------------------------
1996 1995
------ ------
SHORT-TERM BORROWINGS(1) 5.69% 6.18%
LONG-TERM BORROWINGS
Fixed-rate obligations 7.41% 6.47%
Variable-rate obligations 5.82% 6.38%
Medium-term notes 5.68% 5.87%
- -------------------------------------------------------------------------------
(1) Consists of repurchase agreements, commercial paper, and other short-term
borrowings.
The fair value of borrowings and related hedges is estimated using current
market prices and pricing models. The carrying and fair values of these
instruments are summarized as follows:
- -------------------------------------------------------------------------------
December 27, 1996 December 29, 1995
------------------- -------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------------- -------------------
COMMERCIAL PAPER
AND OTHER SHORT-TERM
BORROWINGS $ 39,333 $ 39,342 $ 29,546 $ 29,567
Related derivative:
Assets (15) (12) (19) (21)
Liabilities 5 5 1 2
-------- -------- -------- --------
TOTAL $ 39,323 $ 39,335 $ 29,528 $ 29,548
-------- -------- -------- --------
-------- -------- -------- --------
LONG-TERM
BORROWINGS $ 26,102 $ 26,850 $ 17,340 $ 17,901
Related derivative:
Assets (257) (769) (260) (781)
Liabilities 370 448 176 154
-------- -------- -------- --------
TOTAL $ 26,215 $ 26,529 $ 17,256 $ 17,274
-------- -------- -------- --------
-------- -------- -------- --------
- --------------------------------------------------------------------------------
Certain long-term borrowing agreements contain provisions whereby the borrowings
are redeemable at the option of the holder at specified dates prior to maturity.
Management believes, however, that a significant portion of such borrowings may
remain outstanding beyond their earliest redemption date.
Subsequent to year-end 1996, and through February 20, 1997, long-term
borrowings, net of repayments and repurchases, increased approximately $2,810.
- -------------------------------------------------------------------------------
Borrowing Facilities
Merrill Lynch has obtained committed, unsecured revolving credit facilities
aggregating $6,225 under agreements with 73 banks. The agreements contain
covenants requiring, among other things, that Merrill Lynch maintain specified
levels of net worth, as defined in the agreements, on the date of an advance. At
December 27, 1996, none of these credit facilities had been drawn upon.
The credit quality, amounts, and terms of the credit facilities are continually
monitored and modified as warranted by business conditions. Under the existing
agreements, the credit facilities mature as follows: $1,120 in February 1997;
$1,540 in May 1997; $1,760 in June 1997; and $1,805 in October 1997. At
maturity, Merrill Lynch may convert amounts borrowed, if any, into term loans
which would mature in two years.
- --------------------------------------------------------------------------------
OTHER NON-TRADING LIABILITIES
Other financial instrument liabilities are carried at amounts that approximate
fair value. Such liabilities include repurchase agreements, payables to
customers and brokers and dealers, and insurance and other liabilities.
- --------------------------------------------------------------------------------
NOTE 6. PREFERRED SECURITIES ISSUED BY SUBSIDIARIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES
In December 1996, Merrill Lynch Preferred Capital Trust I (the "Trust") issued
$275 of its 7.75% Trust Originated Preferred Securities (the "Trust Preferred")
to unrelated parties and $9 in common securities to the Company. Concurrently,
Merrill Lynch Preferred Funding I, L.P. (the "Partnership") issued $284 of its
7.75% Partnership Preferred Securities representing limited partner interests
(the "LP Interests") to the Trust, and received capital of $50 from the Company
representing the general partner interest in the Partnership. The Trust and
Partnership are consolidated subsidiaries of the Company.
The Trust's sole asset is the Partnership's LP Interests. The Partnership's
assets consist of $330 million in debentures issued by the Company and a
subsidiary (the "Debentures") and $4 million in other debt securities. The
Debentures have a term of approximately 20 years and bear interest at 7.75%.
The interest payment dates and redemption provisions of the Debentures, which
include an option to redeem the debentures on or after December 30, 2006,
correspond to the distribution payment dates and redemption provisions of
both the LP Interests and the Trust Preferred.
The Company has guaranteed the payment in full of all distributions and other
payments on the Trust Preferred to the extent that the Trust has funds legally
available. The Company has also guaranteed the payment of distributions by the
Partnership on the LP Interests if, as, and when declared out of funds legally
available and payments upon liquidation of the Partnership or the redemption of
LP Interests to the extent of funds legally available. In addition, payments in
respect of the subsidiary Debentures are guaranteed by the Company for the
benefit of the LP Interest holders. The guarantees are subordinated to all other
liabilities and rank pari passu with the most senior preferred stock of the
Company and, when taken together with the Debentures and the Company's
obligations to pay all fees and expenses of the Trust and the Partnership,
constitute a full and unconditional guarantee of the distribution, redemption,
and liquidation payments payable to the holders of the Trust Preferred.
Subsequent to year-end, Merrill Lynch Capital Trust II, a consolidated Merrill
Lynch subsidiary, issued $300 of 8% Trust Originated Preferred Securities. The
proceeds of the offering were invested in 8% Partnership Preferred Securities of
Merrill Lynch Preferred Funding II, L.P., also a consolidated Merrill Lynch
subsidiary, which, in turn, invested in debentures issued by the Company and a
subsidiary.
- --------------------------------------------------------------------------------
PREFERRED EQUITY
The Company is authorized to issue 25,000,000 shares of undesignated
preferred stock, $1.00 par value per share. All shares of currently
outstanding preferred stock constitute one and the same class and have equal
rank and priority over common stockholders as to dividends and in the event
of liquidation.
- --------------------------------------------------------------------------------
9% Cumulative Preferred Stock, Series A
In 1994, the Company issued 17,000,000 Depositary Shares, each representing a
one-four-hundredth interest in a share of 9% Cumulative Preferred Stock,
Series A, $10,000 liquidation preference per share ("9% Preferred Stock").
The 9% Preferred Stock is a single series consisting of 42,500 shares with an
aggregate liquidation preference of $425.
Dividends on the 9% Preferred Stock are cumulative from the date of original
issue and are payable quarterly when declared by the authority of the Board.
The 9% Preferred Stock is redeemable on or after December 30, 2004 at the
option of the Company, in whole or in part, at a redemption price equal to
$10,000 per share, plus accrued and unpaid dividends (whether or not
declared) to the date fixed for redemption.
- --------------------------------------------------------------------------------
Remarketed Preferred(service mark) Stock, Series C
The Company has issued 3,000 shares of Remarketed Preferred Stock, Series C ("RP
Stock"), of which 1,938 shares were outstanding as of December 27, 1996.
Dividend rates in effect during 1996 on the RP Stock ranged from 3.80% to 4.56%
per annum.
Subsequent to year-end, the Company implemented a plan to redeem all of the
outstanding RP Stock. The RP Stock will be redeemed on the dividend reset date
of each series, and the redemptions are expected to be completed by March 4,
1997. As of February 19,1997, $155 of RP Stock, representing 1,548 shares, had
been redeemed.
- --------------------------------------------------------------------------------
STOCKHOLDER RIGHTS PLAN
The Company's Stockholder Rights Plan provides for the distribution of preferred
purchase rights ("Rights") to common stockholders. The Rights separate from the
common stock ten days following: (a) an announcement of an acquisition by a
person or group ("acquiring party") of 20% or more of the
outstanding common shares of the Company; or (b) the commencement of a tender
or exchange offer for 30% or more of the common shares outstanding. One-half
of a Right is attached to each outstanding share of common stock and will
attach to all subsequently issued shares. The Rights entitle the holder to
purchase fractions of a share ("Units") of Series A Junior Preferred Stock,
par value $1.00 per share, at an exercise price of $100 per Unit. The Units
are nonredeemable and have voting privileges and certain preferential
dividend rights. The exercise price and the number of Units issuable are
subject to adjustment to prevent dilution.
If, after the Rights have been distributed, either the acquiring party holds 25%
or more of the Company's outstanding shares or the Company is a party to a
business combination or other specifically defined transaction, each Right
(other than those held by the acquiring party) will entitle the holder to
receive, upon exercise, Units of preferred stock or shares of common stock of
the surviving company with a value equal to two times the exercise price of the
Right. The Rights expire December 16,1997 and are redeemable at the option of a
majority of the independent directors of the Company at $.01 per Right at any
time until the tenth day following an announcement of the acquisition of 20% or
more of the Company's common stock.
- --------------------------------------------------------------------------------
PER COMMON SHARE COMPUTATION
Earnings per common share were computed using the modified treasury stock method
("modified method") in accordance with Accounting Principles Board Opinion
("APB") No. 15. The modified method is used when the number of shares obtainable
upon exercise of outstanding options, warrants, and their equivalents exceeds
20% of the Company's outstanding common stock.
Under this method, all options, warrants, and their equivalents are assumed
exercised (whether dilutive or antidilutive), using the aggregate exercise
proceeds to repurchase up to 20% of the Company's outstanding common stock,
subject to certain limitations. If the combined effect of the assumed exercise
is dilutive, all options, warrants, and their equivalents are included in the
computation.
Primary earnings per common share is computed by dividing net earnings, after
deducting preferred stock dividend requirements of $47, $48, and $13, for 1996,
1995, and 1994, respectively, by the weighted-average number of common shares
and common stock equivalents outstanding during each year. Shares of common
stock issuable under various employee incentive plans are considered common
stock equivalents ("incremental shares").
The weighted-average number of common shares and incremental shares included in
the primary and fully diluted earnings per common share computations follow:
- --------------------------------------------------------------------------------
(in thousands) 1996 1995 1994
------ ------ ------
PRIMARY
Weighted-average
common shares 168,897 176,563 195,661
Incremental shares 22,939 19,434 15,580
------- ------- -------
TOTAL 191,836 195,997 211,241
------- ------- -------
------- ------- -------
FULLY DILUTED
Weighted-average
common shares 168,897 176,563 195,661
Incremental shares 26,278 20,097 16,034
------- ------- -------
TOTAL 195,175 196,660 211,695
------- ------- -------
------- ------- -------
- -------------------------------------------------------------------------------
NOTE 7. COMMITMENTS AND CONTINGENCIES
- -------------------------------------------------------------------------------
LITIGATION
There are civil actions, arbitration proceedings, and claims pending against
Merrill Lynch as of December 27, 1996, some of which involve claims for
substantial amounts.
Included among these matters is an action that is pending in the United States
District Court for the Central District of California, commenced on January 12,
1995 by Orange County, California (the "County") and the Orange County
Investment Pools (the "Pools"), both of which filed bankruptcy petitions in the
United States Bankruptcy Court for the Central District of California (the
"Bankruptcy Court") on December 6, 1994. The Company and certain of its
subsidiaries are named as defendants in connection with Merrill Lynch's business
activities with the Orange County Treasurer-Tax Collector. The Pools' bankruptcy
petition subsequently was dismissed. On May 17, 1996, the Bankruptcy Court
confirmed a plan pursuant to which Orange County emerged from bankruptcy.
The County and its current Treasurer-Tax Collector seek relief totaling in
excess of $2 billion in connection with various securities transactions
between the Orange County Treasurer-Tax Collector and the Company and its
subsidiaries. As subsequently amended, the complaint alleges, among other
things, that these transactions violated California law and should be
adjudged null and void, that the Company and its subsidiaries violated
various provisions of the Bankruptcy Code and Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that the
Company and its subsidiaries breached a fiduciary duty owed to the County and
conspired to make unauthorized use of public funds.
In addition, other actions are pending against or on behalf of the Company,
and/or against certain of its officers, directors, and employees and certain
of its subsidiaries in the United States District Court for the Central
District of California, the United States District Court for the Southern
District of New York, and in state courts in California and New York. These
include class actions and stockholder derivative actions brought by persons
alleging harm to themselves or to Merrill Lynch arising out of
Merrill Lynch's dealings with the Orange County Treasurer-Tax Collector, or
the purchase of debt instruments issued by Orange County or other public
entities with funds controlled by the Orange County Treasurer-Tax Collector
that were underwritten by the Company's subsidiary, MLPF&S.
Although the ultimate outcome of these actions cannot be ascertained at this
time and the results of legal proceedings cannot be predicted with certainty,
it is the opinion of management that the resolution of these matters will not
have a material adverse effect on the Consolidated Financial Statements of
Merrill Lynch contained herein.
- --------------------------------------------------------------------------------
LENDING
Merrill Lynch enters into commitments to extend credit, predominantly at
variable interest rates, in connection with certain merchant banking and loan
syndication transactions. Customers may also be extended loans or lines of
credit collateralized by first and second mortgages on real estate, certain
liquid assets of small businesses, or securities. Merrill Lynch also issues
various guarantees to counterparties in connection with certain leasing, agency
securities lending, securitization, and other transactions. These commitments
and guarantees usually have a fixed expiration date and are contingent on
certain contractual conditions that may require payment of a fee by the
counterparty. Once commitments are drawn upon or guarantees are issued, Merrill
Lynch may require the counterparty to post collateral depending upon the
counterparty's creditworthiness and market conditions.
The contractual amounts of these commitments and guarantees represent the
amounts at risk should the contract be fully drawn upon, the client default, and
the value of the existing collateral become worthless. The total amount of
outstanding commitments and guarantees may not represent future cash
requirements, as guarantees and commitments may expire without being drawn upon.
At December 27, 1996 and December 29, 1995, Merrill Lynch had the following
commitments and guarantees:
- --------------------------------------------------------------------------------
1996 1995
------ ------
Commitments to extend credit(1) $4,780 $3,555
Third party guarantees 1,975 887
- --------------------------------------------------------------------------------
(1) Subsequent to year end, Merrill Lynch entered into a $1.9 billion loan
commitment to a company in connection with a proposed acquisition.
If extended, Merrill Lynch intends to syndicate the loan but may retain a
residual portion.
The fair value of the outstanding guarantees was $24 and $31 at December 27,
1996 and December 29, 1995, respectively.
- --------------------------------------------------------------------------------
LEASES
Merrill Lynch has entered into various noncancelable long-term lease agreements
for premises and equipment that expire through 2024, including the World
Financial Center Headquarters ("WFC"). During 1996, Merrill Lynch incurred a
pretax charge of $40 million related to the resolution of Olympia & York's
bankruptcy that affected Merrill Lynch's long-term sublease agreements in the
WFC. Merrill Lynch has also entered into various noncancelable short-term lease
agreements which are primarily commitments of less than one year under equipment
leases.
At December 27, 1996, future minimum rental commitments under noncancelable
leases with initial or remaining terms exceeding one year are presented below:
- --------------------------------------------------------------------------------
WFC Other Total
------ ------ ------
1997 $ 119 $ 264 $ 383
1998 125 263 388
1999 140 262 402
2000 144 261 405
2001 145 256 401
2002 and thereafter 2,009 2,052 4,061
------ ------ ------
TOTAL $2,682 $3,358 $6,040
------ ------ ------
------ ------ ------
- -------------------------------------------------------------------------------
The minimum rental commitments shown above have not been reduced by $838 of
minimum sublease rentals to be received in the future under noncancelable
subleases. Certain leases contain renewal or purchase options, or escalation
clauses providing for increased rental payments based upon maintenance, utility,
and tax increases.
Rent expense net of sublease revenue for each of the last three years is
presented below:
- --------------------------------------------------------------------------------
1996 1995 1994
----- ----- -----
Rent expense $ 420 $ 399 $ 395
Less: sublease revenue (48) (87) (79)
----- ----- -----
Net rent expense $ 372 $ 312 $ 316
----- ----- -----
----- ----- -----
- --------------------------------------------------------------------------------
OTHER COMMITMENTS
In the normal course of business, Merrill Lynch enters into commitments for
securities underwriting and when-issued transactions. Settlement of these
transactions as of December 27, 1996 would not have a material effect on the
consolidated financial condition of Merrill Lynch.
In connection with financing activities, Merrill Lynch had commitments at
December 27, 1996 and December 29, 1995 to enter into resale and repurchase
agreements as follows:
- --------------------------------------------------------------------------------
1996 1995
------ ------
Resale agreements $3,653 $1,845
Repurchase agreements 976 --
- --------------------------------------------------------------------------------
Merrill Lynch also obtains letters of credit from issuing banks to satisfy
various counterparty collateral requirements in lieu of depositing collateral of
cash or securities. Letters of credit aggregated $2,065 and $2,352 at December
27, 1996 and December 29, 1995, respectively.
In connection with merchant banking activities, Merrill Lynch has committed to
purchase $101 and $107 of partnership interests at December 27, 1996 and
December 29, 1995, respectively.
Merrill Lynch has entered into agreements with providers of market data,
communications, and systems consulting services. At December 27, 1996 and
December 29, 1995, minimum fee commitments under these contracts aggregated $481
and $30, respectively.
- -------------------------------------------------------------------------------
NOTE 8. EMPLOYEE BENEFIT PLANS
- -------------------------------------------------------------------------------
Merrill Lynch provides retirement and other postemployment benefits to its
employees worldwide through defined contribution and defined benefit pension
plans and other postretirement and postemployment benefit plans. Merrill Lynch
reserves the right to amend or terminate these plans at any time.
- --------------------------------------------------------------------------------
DEFINED CONTRIBUTION PENSION PLANS
The domestic defined contribution plans consist of the Retirement Accumulation
Plan ("RAP"), the Employee Stock Ownership Plan ("ESOP"), and the 401(k) Savings
& Investment Plan ("SIP"). The RAP, ESOP, and SIP cover substantially all U.S.
employees who have met age and service requirements.
Merrill Lynch established the RAP and the ESOP, collectively known as the
"Retirement Program," for the benefit of employees over the age of 21 with
one year of service. A separate retirement account is maintained for each
participant.
In 1989, the ESOP trust purchased from Merrill Lynch 24,341,470 shares of the
Company's common stock with residual funds from a terminated defined benefit
pension plan ("Reversion Shares") and loan proceeds from a subsidiary of Merrill
Lynch ("Leveraged Shares").
Merrill Lynch credits a participant's account and records pension expense under
the Retirement Program based on years of service and eligible compensation. This
expense is funded by quarterly allocations of Leveraged and Reversion Shares
and, if necessary, cash, to participants' accounts based on a specified formula.
Leveraged and Reversion Shares are released in accordance with the terms of the
ESOP. If the fair market value of the shares released is less than the formula
allocation to participants' accounts, cash contributions are made to the RAP.
Reversion Shares are allocated to participants' accounts over a period of not
more than eight years, ending in June 1997. Leveraged Shares are allocated to
participants' accounts as principal is repaid on the loan to the ESOP, which
matures in 1999. Principal and interest on the loan are payable quarterly upon
receipt of dividends on certain shares of common stock or other cash
contributions.
ESOP shares are considered to be either allocated (contributed to
participants' accounts), committed (scheduled to be contributed at a
specified future date but not yet released), or unallocated (not committed or
allocated). Share information at December 27, 1996 is as follows:
- --------------------------------------------------------------------------------
REVERSION LEVERAGED
SHARES SHARES
---------- ---------
Allocated 17,923,585 2,689,896
Committed 434,663 92,805
Unallocated 1,538,778 1,661,743
- --------------------------------------------------------------------------------
The remaining cost of the unallocated Reversion and Leveraged Shares of $24 and
$25, respectively, at December 27, 1996 is recorded as a reduction of
stockholders' equity. The remaining cost of unallocated Leveraged Shares
represents the ESOP loan balance.
Additional information on ESOP activity follows:
- --------------------------------------------------------------------------------
1996 1995 1994
----- ----- ----
Dividends used for debt service(1) $ 8 $ 9 $ 11
Compensation costs funded
with ESOP shares 190 143 109
- --------------------------------------------------------------------------------
(1) Dividends on all Leveraged and unallocated and committed Reversion Shares
are used for debt service on the ESOP loan. Dividends on allocated
Reversion Shares are credited to participants' accounts.
Employees can participate in the SIP by contributing, on a tax-deferred basis,
up to 15% of their eligible compensation but not more than the maximum annual
amount allowed by law. Merrill Lynch's contributions are equal to one-half of
the first 4% of each participant's eligible compensation contributed to the SIP,
up to a maximum of fifteen hundred dollars annually. No corporate contributions
are made for participants who are also Employee Stock Purchase Plan participants
(see Note 9).
In addition, Merrill Lynch sponsors various non-U.S. defined contribution plans.
The costs of benefits under the RAP, SIP, and non-U.S. plans are expensed during
the related service period.
- -------------------------------------------------------------------------------
DEFINED BENEFIT PENSION PLANS
Merrill Lynch has purchased a group annuity contract that guarantees the payment
of benefits vested under a U.S. defined benefit plan that was terminated in
accordance with the applicable provisions of the Employee Retirement Income
Security Act of 1974 ("ERISA"). At December 27, 1996 and December 29, 1995, a
substantial portion of the assets supporting the annuity contract was invested
in U.S. Government and agencies securities. Merrill Lynch, under a supplemental
agreement, may be responsible for, or benefit from, actuarial experience and
investment performance of these annuity assets. Merrill Lynch also maintains
supplemental defined benefit plans for certain U.S. employees.
Employees of certain non-U.S. subsidiaries participate in various local defined
benefit plans. These plans provide benefits that are generally based on years of
credited service and a percentage of the employee's eligible compensation during
the final years of employment. Merrill Lynch's funding policy has been to
contribute annually the amount necessary to satisfy local funding standards.
The funded status of the defined benefit plans (including the terminated plan)
follows:
- ----------------------------------------------------------------------------------------------------------------------------
1996 1995
----------------------- -----------------------
PENSION PLANS IN WHICH: PENSION PLANS IN WHICH:
----------------------- -----------------------
ASSETS ACCUMULATED ASSETS ACCUMULATED
EXCEEDED BENEFITS EXCEEDED BENEFITS
ACCUMULATED EXCEEDED ACCUMULATED EXCEEDED
BENEFITS ASSETS(1) BENEFITS ASSETS(1)
ACCUMULATED BENEFIT OBLIGATION ------- ----- ------- -----
Vested $(1,447) $(118) $(1,429) $(110)
Non-vested (3) (8) (3) (7)
------- ----- ------- -----
TOTAL (1,450) (126) (1,432) (117)
Effect of assumed increase in compensation levels (24) (25) (23) (29)
------- ----- ------- -----
Projected benefit obligation (1,474) (151) (1,455) (146)
Plan assets at fair value 1,673 85 1,735 72
------- ----- ------- -----
Plan assets in excess of (less than) projected benefit obligation 199 (66) 280 (74)
Unrecognized net liability at transition 3 2 3 2
Unrecognized prior service benefit (3) (1) (7) (1)
Unrecognized net (gain) loss (4) 14 (106) 27
------- ----- ------- -----
Prepaid (accrued) benefit cost $ 195 $ (51) $ 170 $ (46)
------- ----- ------- -----
------- ----- ------- -----
- -------------------------------------------------------------------------------------------------------------------------
(1) Consists primarily of domestic supplemental plans not subject to ERISA and
non-U.S. plans where funding strategies vary due to legal requirements and
local practice.
Net periodic pension cost includes the following components:
- --------------------------------------------------------------------------------
1996 1995 1994
----- ----- -----
Defined contribution plan cost $ 223 $ 169 $ 165
----- ----- -----
Defined benefit plans(1):
Service cost for benefits earned
during the year 24 19 16
Interest cost on projected
benefit obligation 103 105 92
Actual return on plan assets 19 (480) 146
Deferral and amortization
of unrecognized items (133) 373 (243)
----- ----- ------
Total defined benefit plan cost 13 17 11
----- ----- ------
Total pension cost $ 236 $ 186 $ 176
----- ----- ------
----- ----- ------
- -------------------------------------------------------------------------------
(1) The following actuarial assumptions were used in calculating the defined
benefit cost and benefit obligations. Weighted-average rates as of the
beginning of the year are:
1997 1996 1995
------ ------ ------
Weighted-average discount rate 6.7% 6.5% 8.1%
Rate of compensation increase 5.4% 5.5% 6.0%
Expected long-term rate of return
on plan assets 6.9% 6.7% 8.2%
- --------------------------------------------------------------------------------
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Merrill Lynch provides health and life insurance benefits to retired employees
under a plan that covers substantially all U.S. employees who have met age and
service requirements. The health care component is contributory, with retiree
contributions adjusted periodically; the life insurance component of the plan is
noncontributory. The accounting for costs of health care benefits anticipates
future changes in cost-sharing provisions. Merrill Lynch pays claims as
incurred. Full-time employees of Merrill Lynch become eligible for these
benefits upon attainment of age 55 and completion of ten years of service.
Merrill Lynch also sponsors similar plans that provide health care benefits to
retired employees of certain non-U.S. subsidiaries. As of December 27, 1996,
none of these plans had been funded.
Net periodic postretirement benefit expense included the following components:
- --------------------------------------------------------------------------------
1996 1995 1994
----- ----- -----
Service cost $ 6 $ 4 $ 4
Interest cost on accumulated
postretirement benefit obligation 11 10 9
Amortization of unrecognized gain -- (1) --
----- ----- -----
Total postretirement benefit cost $ 17 $ 13 $ 13
----- ----- -----
----- ----- -----
- --------------------------------------------------------------------------------
The amounts recognized for Merrill Lynch's postretirement benefit plans follow:
- --------------------------------------------------------------------------------
1996 1995
----- -----
ACCUMULATED POSTRETIREMENT
BENEFIT OBLIGATION
Retirees $ (73) $ (80)
Fully eligible active plan participants (37) (34)
Other active plan participants (62) (57)
----- ----
TOTAL (172) (171)
Unrecognized net (gain) loss (7) 3
----- ----
Postretirement benefits accrued liability $(179) $(168)
----- ----
----- ----
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The following actuarial assumptions were used in calculating the postretirement
benefit cost and obligations. Weighted-average rates as of the beginning of the
year are:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
Weighted-average discount rate 6.8% 6.5% 8.2%
Health care cost trend rates(1) :
Initial 8.0% 9.0% 11.0%
2011 and thereafter 5.5% 5.5% 6.0%
- -------------------------------------------------------------------------------
(1) Assumed to decrease gradually until the year 2011 and remain constant
thereafter.
The assumed health care cost trend rate has a significant effect on the amounts
reported above. Increasing the assumed trend rate by one percentage point per
year would increase the accumulated postretirement benefit obligation at
December 27, 1996 and December 29, 1995 by $28 and $29, respectively, and
increase the aggregate of service and interest costs for 1996 and 1995 by $3 for
both years.
- --------------------------------------------------------------------------------
POSTEMPLOYMENT BENEFITS
Merrill Lynch provides certain postemployment benefits for employees on extended
leave due to injury or illness and for terminated employees. Employees who are
disabled due to non-work-related illness or injury are entitled to disability
income, medical coverage, and life insurance. Merrill Lynch also provides
severance benefits to terminated employees. In addition, Merrill Lynch is
mandated by state and Federal regulations to provide certain other
postemployment benefits. Merrill Lynch funds these benefits through a
combination of self-insured and insured plans.
Merrill Lynch recognized $30, $76, and $76 in 1996, 1995, and 1994,
respectively, of postemployment benefits expense, which included severance costs
for terminated employees of $14, $54, and $66 in 1996, 1995, and 1994,
respectively. Although all full-time employees are eligible for severance
benefits, no additional amounts were accrued as of December 27, 1996 since
future severance costs are not estimable.
- --------------------------------------------------------------------------------
NOTE 9. EMPLOYEE INCENTIVE PLANS
- --------------------------------------------------------------------------------
To align the interests of employees with those of stockholders, Merrill Lynch
sponsors several employee compensation plans that provide eligible employees
with stock or options to purchase shares. The total compensation cost recognized
in earnings for stock-based compensation plans for 1996, 1995, and 1994 was
$269, $131, and $138, respectively. Merrill Lynch also sponsors deferred cash
compensation plans for eligible employees.
- --------------------------------------------------------------------------------
LONG-TERM INCENTIVE COMPENSATION PLANS ("LTIC PLANS") AND EQUITY CAPITAL
ACCUMULATION PLAN ("ECAP")
LTIC Plans and ECAP provide for grants of equity and equity-related instruments
to certain key employees. LTIC Plans provide for the issuance of Restricted
Shares, Restricted Units, and Nonqualified Stock Options, as well as Incentive
Stock Options, Performance Shares, Performance Units, Stock Appreciation Rights,
and other securities of Merrill Lynch. ECAP provides for the issuance of
Restricted Shares, as well as Performance Shares. As of December 27, 1996, no
instruments other than Restricted Shares, Restricted Units, and Nonqualified
Stock Options had been granted.
- --------------------------------------------------------------------------------
Restricted Shares and Units
Restricted Shares are shares of Merrill Lynch's common stock carrying voting and
dividend rights. A Restricted Unit is deemed equivalent in fair market value to
one share of Merrill Lynch's common stock, is payable in cash, and receives cash
payments equivalent to dividends. Under both plans, such shares and units are
restricted from sale, transfer, or assignment until the end of the restricted
period and are subject to forfeiture during a vesting period for grants under
LTIC Plans or the restricted period for grants under ECAP.
The activity for Restricted Shares and Units under these plans during 1996 and
1995 follows:
- --------------------------------------------------------------------------------
LTIC PLANS ECAP
------------------------- ----------
RESTRICTED RESTRICTED RESTRICTED
SHARES UNITS SHARES
---------- ---------- ----------
Authorized for issuance at:
December 27, 1996 100,000,000 --(1) 26,200,000
----------- ----------- ----------
----------- ----------- ----------
December 29, 1995 80,000,000 80,000,000 26,200,000
----------- ----------- ----------
----------- ----------- ----------
Available for issuance at(2):
December 27, 1996 30,945,605 --(1) 1,349,415
----------- ----------- ----------
----------- ----------- ----------
December 29, 1995 18,266,797 67,179,006 2,821,181
----------- ----------- ----------
----------- ----------- ----------
Outstanding, beginning of 1995 2,950,801 3,213,394 1,940,496
Granted - 1995 2,158,209 2,084,721 541,960
Paid, forfeited, or released
from contingencies (1,837,250) (1,974,341) (1,876,465)
----------- ----------- ----------
Outstanding, end of 1995 3,271,760 3,323,774 605,991
Granted - 1996 1,457,422 1,555,285 1,677,854
Paid, forfeited, or released
from contingencies (247,701) (241,609) (217,973)
----------- ----------- ----------
Outstanding, end of 1996(3) 4,481,481 4,637,450 2,065,872
----------- ----------- ----------
----------- ----------- ----------
- --------------------------------------------------------------------------------
(1) Due to changes in regulatory requirements, authorization limits for LTIC
Plans are no longer required.
(2) Includes shares reserved for issuance upon the exercise of stock options.
(3) Subsequent to year end through February 1, 1997, 1,432,771 and 1,583,974
Restricted Shares and Units under LTIC Plans, respectively, and 925 ECAP
Restricted Shares were granted to eligible employees.
The weighted-average fair value per share or unit for 1996, 1995, and 1994
grants follow:
- --------------------------------------------------------------------------------
1996 1995 1994
------ ------ ------
LTIC Plans:
Restricted Shares $57.94 $41.71 $43.99
Restricted Units 57.38 41.44 44.63
ECAP Restricted Shares 57.52 52.46 37.41
- --------------------------------------------------------------------------------
Merrill Lynch sponsors other plans similar to LTIC Plans in which restricted
shares and units are granted to employees and non-employee directors. At
December 27, 1996, 850,000 restricted shares and 200,000 restricted units were
authorized under these plans. At that date, 60,745 restricted shares and 8,067
restricted units were outstanding under these plans.
- --------------------------------------------------------------------------------
Nonqualified Stock Options
Nonqualified Stock Options granted under LTIC Plans in 1989 through 1995
generally become exercisable over four years in equal installments commencing
one year after the date of grant. Options granted in 1996 and thereafter
generally are exercisable over five years. The exercise price of these options
is equal to 100% of the fair market value (as defined in LTIC Plans) of a share
of common stock on the date of grant. Nonqualified Stock Options expire ten
years after their grant date.
The activity for Nonqualified Stock Options under LTIC Plans for 1996, 1995, and
1994 follows:
- --------------------------------------------------------------------------------
OPTIONS WEIGHTED-AVERAGE
OUTSTANDING EXERCISE PRICE
Outstanding, beginning ------------ ----------------
of 1994 27,004,771 $19.60
Granted - 1994 4,527,100 40.63
Exercised (2,649,411) 14.20
Forfeited (474,527) 28.10
-----------
Outstanding, end of 1994 28,407,933 23.31
Granted - 1995 6,456,462 39.63
Exercised (3,959,949) 16.79
Forfeited (831,129) 36.96
-----------
Outstanding, end of 1995 30,073,317 27.29
Granted - 1996 6,816,970 54.56
Exercised (4,240,515) 20.89
Forfeited (743,444) 50.85
-----------
Outstanding, end of 1996(1) 31,906,328 33.43
-----------
-----------
- --------------------------------------------------------------------------------
(1) In January 1997, eligible participants were granted stock options for
7,102,360 shares.
At December 27, 1996, December 29, 1995, and December 30, 1994, options
exercisable under LTIC Plans were 17,766,167, 17,059,375, and 14,301,246,
respectively.
The table below summarizes information related to outstanding and exercisable
options at December 27, 1996.
- --------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ -------------------
WEIGHTED- WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE REMAINING NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING PRICE LIFE (YEARS)(1) EXERCISABLE PRICE
- --------------- ----------- -------- --------------- ----------- ------
$10.00 - $20.99 8,367,975 $11.28 3.6 8,367,975 $11.28
$21.00 - $30.99 3,400,359 29.66 5.1 3,400,357 29.66
$31.00 - $40.99 12,723,883 36.32 7.1 5,829,299 36.07
$41.00 - $50.99 -- -- -- -- --
$51.00 - $63.99 7,414,111 55.22 9.0 168,536 59.92
- --------------------------------------------------------------------------------
(1) Based on contractual life of ten years.
The weighted-average fair value of options granted in 1996 and 1995 is $15.16
and $11.34 per option, respectively. Fair value is estimated as of the grant
date based on a Black-Scholes option pricing model using the following
weighted-average assumptions:
- --------------------------------------------------------------------------------
1996 1995
------ ------
Risk-free interest rate 5.68% 7.61%
Expected life 5 yrs. 5 yrs.
Expected volatility 26.35% 25.00%
Dividend yield 1.91% 2.45%
- --------------------------------------------------------------------------------
See "Pro Forma Compensation Expense" in the following "Employee Stock
Purchase Plan" section for additional information.
- --------------------------------------------------------------------------------
EMPLOYEE STOCK PURCHASE PLAN ("ESPP")
ESPP allows eligible employees to invest from 1% to 10% of their eligible
compensation to purchase Merrill Lynch's common stock at a price equal to 85%
of its fair market value. These purchases are made on four quarterly
investment dates through payroll deductions. Up to 25,000,000 shares of
Merrill Lynch's common stock have been authorized for issuance under ESPP.
The activity in ESPP during 1996 and 1995 follows:
- --------------------------------------------------------------------------------
ESPP SHARES
---------------------------
1996 1995
--------- ---------
Available, beginning of year 4,996,263 5,857,449
Purchased through plan (862,583) (861,186)
--------- ---------
Available, end of year 4,133,680 4,996,263
--------- ---------
--------- ---------
- --------------------------------------------------------------------------------
The weighted-average fair value of ESPP stock purchase rights exercised by
employees in 1996, 1995, and 1994 is $8.76, $7.20, and $5.61 per right,
respectively.
- --------------------------------------------------------------------------------
Pro Forma Compensation Expense
Merrill Lynch accounts for costs of stock-based compensation in accordance
with APB No. 25, "Accounting for Stock Issued to Employees", rather than the
fair value based method in SFAS No. 123, "Accounting for Stock-Based
Compensation". No compensation expense has been recognized for Merrill
Lynch's grants of stock options under LTIC Plans or ESPP purchase rights.
Based on the fair value of stock options and purchase rights, Merrill Lynch
would have recognized compensation expense, net of taxes, of $26 and $12 for
1996 and 1995, respectively, resulting in pro forma net earnings and earnings
per share as follows:
- --------------------------------------------------------------------------------
1996 1995
------- -------
NET EARNINGS
As reported $ 1,619 $ 1,114
Pro forma 1,593 1,102
EARNINGS PER COMMON SHARE
As reported:
Primary $ 8.20 $ 5.44
Fully diluted 8.06 5.42
Pro forma:
Primary 8.06 5.38
Fully diluted 7.93 5.36
- --------------------------------------------------------------------------------
Pro forma compensation expense associated with option grants is recognized over
the vesting period. The initial impact of applying SFAS No. 123 on pro forma
disclosure is not representative of the potential impact on pro forma net
earnings for future years, which will include compensation expense related to
vesting of 1995, 1996, and subsequent grants.
- --------------------------------------------------------------------------------
FINANCIAL CONSULTANT CAPITAL ACCUMULATION AWARD PLANS ("FCCAAP")
Under FCCAAP, eligible employees in Merrill Lynch's private client group are
granted awards generally based upon their prior year's performance. Payment for
an award is contingent upon continued employment for a period of time and is
subject to forfeiture during that period. The award is generally payable ten
years from the date of grant in a fixed number of shares of Merrill Lynch's
common stock unless the fair market value of such shares is less than a
specified minimum value plus interest, in which case the minimum value is paid
in cash. Eligible participants may defer awards beyond the scheduled payment
date.
A total of 30,207,642 shares of Merrill Lynch's common stock are authorized
for issuance under FCCAAP. Only shares of common stock held as treasury stock
may be issued under FCCAAP. At December 27, 1996, shares subject to
outstanding awards totaled 16,550,574, while 12,316,183 shares were available
for issuance through future awards. The fair value of awards granted under
FCCAAP during 1996, 1995, and 1994 is $50.69, $36.13, and $42.25 per award,
respectively.
- --------------------------------------------------------------------------------
INCENTIVE EQUITY PURCHASE PLAN ("IEPP")
IEPP allowed selected employees to purchase shares of Merrill Lynch's common
stock ("Book Value Shares") at a price equal to book value per common share.
Book Value Shares, which otherwise may not be resold, may be sold back to
Merrill Lynch at book value or exchanged at any time for a specified number of
freely transferable common shares. Book Value Shares outstanding under IEPP were
1,137,200 at December 27, 1996 and 1,221,500 at December 29, 1995,
respectively. In 1995, IEPP was amended to reduce the authorized shares to zero
and prohibit the reuse of any surrendered shares. No further offerings will be
made under this plan.
- --------------------------------------------------------------------------------
MERRILL LYNCH INVESTMENT CERTIFICATE PROGRAM ("MLICP")
Under MLICP, eligible employees in Merrill Lynch's private client group are
issued investment certificates based on their performance. The certificates
mature ten years from the date issued and are payable in cash if certain
performance criteria are achieved and the employee is continuously employed for
the ten-year period, with certain exceptions. The certificates bear interest
commencing with the date on which the performance requirements are achieved. As
of December 27, 1996 and December 29, 1995, $235 and $188, respectively, were
accrued under this plan.
- --------------------------------------------------------------------------------
OTHER DEFERRED COMPENSATION PLANS
Merrill Lynch sponsors other deferred compensation plans in which eligible
employees may participate. Generally, contributions to the plans are made on a
tax-deferred basis to participants. Contributions are invested by Merrill Lynch,
principally in mutual funds sponsored by Merrill Lynch. The plans' investments
and the amounts accrued by Merrill Lynch under the plans are both included in
the Consolidated Balance Sheets. Plan investments totaled $211 and $133,
respectively, at December 27, 1996 and December 29, 1995. Accrued liabilities at
those dates were $220 and $142, respectively.
- --------------------------------------------------------------------------------
NOTE 10. INCOME TAXES
- --------------------------------------------------------------------------------
Income tax provisions (benefits) on earnings consisted of:
- --------------------------------------------------------------------------------
1996 1995 1994
----- ----- -----
FEDERAL
Current $ 515 $ 788 $ 680
Deferred (119) (164) (150)
STATE AND LOCAL
Current 198 81 158
Deferred (54) (30) 2
FOREIGN
Current 460 (39) 5
Deferred (53) 61 18
----- ------ ------
Total $ 947 $ 697 $ 713
----- ------ ------
----- ------ ------
- --------------------------------------------------------------------------------
The corporate statutory tax rate was 35.0% for the three years presented. A
reconciliation of statutory Federal income taxes to Merrill Lynch's income tax
provisions for earnings follows:
- --------------------------------------------------------------------------------
1996 1995 1994
------ ------ ------
Federal income tax
at statutory rate $ 898 $ 634 $ 605
State and local income
taxes, net 94 33 104
Pension plan transaction 12 13 14
Foreign operations (8) (4) 23
Tax-exempt interest (21) (14) (18)
Dividends received deduction (34) (19) (17)
Other, net 6 54 2
------ ------ ------
Total $ 947 $ 697 $ 713
------ ------ ------
------ ------ ------
- --------------------------------------------------------------------------------
For financial reporting purposes, Merrill Lynch had no unrecognized net
operating loss or alternative minimum tax benefit carryforwards at December 27,
1996.
Deferred income taxes are provided for the effects of temporary differences
between the tax basis of an asset or liability and its reported amount in the
Consolidated Financial Statements. These temporary differences result in taxable
or deductible amounts in future years. Details of Merrill Lynch's deferred tax
assets and liabilities follow:
- --------------------------------------------------------------------------------
1996 1995 1994
------ ------ ------
DEFERRED TAX ASSETS
Valuation and other reserves(1) $ 831 $ 700 $ 638
Deferred compensation 349 228 192
Other 429 364 338
------ ------ ------
Total deferred tax assets 1,609 1,292 1,168
------ ------ ------
DEFERRED TAX LIABILITIES
Lease transactions 114 100 113
Accelerated tax depreciation 44 70 92
Unrealized gains on inventory 9 18 29
Other 131 88 73
------ ------ ------
Total deferred tax liabilities 298 276 307
------ ------ ------
NET DEFERRED TAX ASSET $1,311 $1,016 $ 861
------ ------ ------
------ ------ ------
- --------------------------------------------------------------------------------
(1) Primarily related to Trading assets and Other liabilities.
Income tax benefits of $30, $34, and $5 were allocated to stockholders' equity
related to employee compensation transactions for 1996, 1995, and 1994,
respectively.
Earnings before income taxes included approximately $738, $128, and $48 of
earnings attributable to foreign entities for 1996, 1995, and 1994,
respectively. Cumulative undistributed earnings of foreign subsidiaries were
approximately $1,206 at December 27, 1996. No deferred Federal income taxes have
been provided for the undistributed earnings as these earnings have been
reinvested in Merrill Lynch's foreign operations. Assuming utilization of
foreign tax credits, Merrill Lynch estimates that approximately $118 of Federal
income taxes and $52 of foreign withholding taxes would be incurred on the
repatriation of the foreign subsidiaries' earnings.
- --------------------------------------------------------------------------------
NOTE 11. REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS
- --------------------------------------------------------------------------------
MLPF&S, a registered broker-dealer and a subsidiary of the Company, is subject
to the net capital requirements of Rule 15c3-1 of the Securities Exchange Act of
1934. Under the alternative method permitted by this rule, the minimum required
net capital, as defined, shall not be less than 2% of aggregate debit items
arising from customer transactions. At December 27, 1996, MLPF&S's regulatory
net capital of $1,598 was 10% of aggregate debit items, and its regulatory net
capital in excess of the minimum required was $1,276.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities and a subsidiary of the Company, is subject to the capital
adequacy requirements of the Government Securities Act of 1986. This rule
requires dealers to maintain liquid capital in excess of market and credit risk,
as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At December 27, 1996,
MLGSI's liquid capital of $886 was 240% of its total market and credit risk, and
liquid capital in excess of the minimum required was $442.
Merrill Lynch International ("MLI"), a registered U.K. broker-dealer and a
subsidiary of Merrill Lynch, is subject to capital requirements of the
Securities and Futures Authority ("SFA"). Financial resources, as defined, must
exceed the total financial resources requirement of the SFA. At December 27,
1996, MLI's financial resources were $1,374, and exceeded the minimum
requirement by $335.
Merrill Lynch Capital Markets PLC ("MLCM"), a U.K. subsidiary of Merrill Lynch
and a dealer in over-the-counter equity derivatives, became subject to the
capital requirements of the SFA on January 1, 1997. In anticipation, MLCM had
$855 of regulatory capital at December 27, 1996 and received another $600 on
December 31, 1996 from Merrill Lynch. Subsequent to year end, MLI became the
primary equity derivatives dealer for new business.
Merrill Lynch's insurance subsidiaries are subject to various regulatory
restrictions that limit the amount available for distribution as dividends. As
of December 27, 1996, $436, representing 88% of the insurance subsidiaries' net
assets, was unavailable for distribution to Merrill Lynch.
Over 55 other subsidiaries are subject to regulatory requirements promulgated by
the regulatory and exchange authorities of the countries in which they operate.
These regulatory restrictions may limit the amounts that these subsidiaries can
pay in dividends or advance to Merrill Lynch. At December 27, 1996, restricted
net assets of all subsidiaries were $5,985.
In addition, to satisfy rating agency standards, a credit intermediary
subsidiary of Merrill Lynch must also meet certain minimum capital requirements.
At December 27, 1996, this minimum capital requirement was $350.
With the exception of regulatory restrictions on subsidiaries' abilities to pay
dividends, there are no restrictions on Merrill Lynch's present ability to pay
dividends on common stock, other than (a) Merrill Lynch's obligation first to
make dividend payments on its preferred stock and (b) the governing provisions
of the Delaware General Corporation Law.
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NOTE 12. INDUSTRY AND GLOBAL OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch operates principally in the financial services industry and
provides services to individual and institutional clients. These services, due
to certain legal requirements, are conducted through various subsidiaries,
including those operating as brokers, dealers, banks, insurance, and other
financial services companies.
Merrill Lynch operates in both U.S. and non-U.S. markets. Merrill Lynch's
non-U.S. business activities are conducted through offices in three regions:
Europe, Africa, and the Middle East; Asia and Australia; and the Americas,
excluding the U.S.
European, African, and Middle Eastern operations offer international investment
and private banking services, research, and dealer services in equity and
fixed-income securities, swaps, futures, commodity contracts, and options.
Merrill Lynch's Asian and Australian operations conduct business throughout
various countries including Australia, China, Hong Kong, Japan, and Singapore.
Merrill Lynch has exchange memberships in the region's major financial centers.
Traditional retail and institutional services are provided in virtually all
locations.
In Canada, Merrill Lynch is a broker for securities and commodities and a market
maker for bonds and money market instruments. Merrill Lynch also provides
investment banking and research for Canadian customers. In Latin America,
Merrill Lynch provides international banking, brokerage, and trust services and
has been instrumental in the privatization of many Latin American companies. For
further information, see "Global Operations" in Management's Discussion and
Analysis (unaudited).
The principal methodology used in preparing the geographic data in the table
below includes: (i) commission revenues are recorded based on the location of
the sales force; (ii) trading revenues are principally recorded based on the
location of the trader; (iii) investment banking revenues are recorded based on
the location of the client; and (iv) asset management and portfolio service fees
are recorded based on the location of the fund manager. Earnings before income
taxes include the allocation of certain shared expenses among regions. In
addition, intercompany transfers are based primarily on service agreements.
The information presented below, in management's judgment, provides a reasonable
representation of each region's contribution to the consolidated amounts.
- -----------------------------------------------------------------------------------------------------------------
1996 1995 1994 1996 1995 1994
--------------------------------- ----------------------------------
TOTAL REVENUES NET REVENUES
--------------------------------- ----------------------------------
Europe, Africa, and Middle East $ 5,336 $ 3,981 $ 3,464 $ 1,837 $ 1,319 $ 1,134
Asia and Australia 1,539 1,232 963 984 701 554
Americas 826 704 617 472 347 333
-------- -------- -------- -------- -------- -------
Subtotal 7,701 5,917 5,044 3,293 2,367 2,021
United States 19,221 16,107 13,754 10,603 8,092 7,703
Eliminations (1,911) (511) (564) (780) (194) (99)
-------- -------- -------- -------- -------- -------
TOTAL $ 25,011 $ 21,513 $ 18,234 $ 13,116 $ 10,265 $ 9,625
-------- -------- -------- -------- -------- -------
-------- -------- -------- -------- -------- -------
EARNINGS BEFORE INCOME TAXES TOTAL ASSETS
------------------------------------ -------------------------------------
Europe, Africa, and Middle East $ 387 $ 155 $ 176 $ 75,901 $ 56,948 $ 44,297
Asia and Australia 199 81 75 17,905 16,914 11,389
Americas 139 127 137 5,205 4,997 4,216
-------- -------- -------- -------- -------- -------
Subtotal 725 363 388 99,011 78,859 59,902
United States 1,841 1,448 1,342 126,784 105,702 108,147
Eliminations -- -- -- (12,779) (7,704) (4,300)
-------- -------- -------- -------- -------- -------
TOTAL $2,566 $1,811 $1,730 $ 213,016 $ 176,857 $ 163,749
-------- -------- -------- -------- -------- -------
-------- -------- -------- -------- -------- -------
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INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF MERRILL LYNCH & CO., INC.:
We have audited the accompanying consolidated balance sheets of Merrill Lynch
& Co.,Inc. and subsidiaries ("Merrill Lynch") as of December 27,1996 and
December 29,1995 and the related statements of consolidated earnings,
changes in consolidated stockholders' equity and consolidated cash flows for
each of the three years in the period ended December 27, 1996. These
financial statements are the responsibility of Merrill Lynch's management.
Our responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Merrill Lynch at December 27, 1996
and December 29, 1995, and the results of its operations and its cash flows for
each of the three years in the period ended December 27, 1996 in conformity with
generally accepted accounting principles.
/S/ Deloitte & Touche LLP
New York, New York
February 24, 1997
- --------------------------------------------------------------------------------
QUARTERLY INFORMATION
- --------------------------------------------------------------------------------
The unaudited quarterly results of operations of Merrill Lynch for 1996 and 1995
are prepared in conformity with generally accepted accounting principles and
reflect all adjustments (which consist of only normal recurring accruals and the
nonrecurring $40 million pretax lease charge related to the resolution of
Olympia & York's bankruptcy in the fourth quarter of 1996) that are, in the
opinion of management, necessary for a fair presentation of the results of
operations for the periods presented. Results of any interim period are not
necessarily indicative of results for a full year.
(Dollars in Millions, For the Quarter Ended
Except Per Share Amounts) -------------------------------------------------------------------------------------
Dec. 27, Sept. 27, June 28, Mar. 29, Dec. 29, Sept. 29, June 30, Mar. 31,
1996 1996 1996 1996 1995 1995 1995 1995
------ ------ ------ ------ ------ ------ ------ ------
Total Revenues $6,601 $6,201 $6,190 $6,019 $5,293 $5,431 $5,585 $5,204
Interest Expense 3,219 3,108 2,810 2,758 2,680 2,749 3,036 2,783
------ ------ ------ ------ ------ ------ ------ ------
Net Revenues 3,382 3,093 3,380 3,261 2,613 2,682 2,549 2,421
Non-Interest Expenses 2,707 2,571 2,682 2,590 2,131 2,197 2,085 2,041
------ ------ ------ ------ ------ ------ ------ ------
Earnings Before Income Taxes 675 522 698 671 482 485 464 380
Income Tax Expense 230 191 265 261 179 185 181 152
------ ------ ------ ------ ------ ------ ------ ------
Net Earnings $ 445 $ 331 $ 433 $ 410 $ 303 $ 300 $ 283 $ 228
------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------
Earnings Per Common Share:
Primary $ 2.29 $ 1.69 $ 2.19 $ 2.03 $ 1.49 $ 1.47 $ 1.40 $ 1.08
------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------
Fully Diluted $ 2.27 $ 1.68 $ 2.19 $ 2.03 $ 1.49 $ 1.46 $ 1.39 $ 1.08
------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------
- --------------------------------------------------------------------------------
DIVIDENDS PER COMMON SHARE
- --------------------------------------------------------------------------------
(Declared and paid)
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
-------- -------- -------- --------
1996 $.26 $.30 $.30 $.30
1995 .23 .26 .26 .26
- --------------------------------------------------------------------------------
With the exception of regulatory restrictions on subsidiaries' abilities to pay
dividends, there are no restrictions on Merrill Lynch's present ability to pay
dividends on common stock, other than (a) Merrill Lynch's obligation first to
make dividend payments on its preferred stock and (b) the governing provisions
of the Delaware General Corporation Law. Certain subsidiaries' ability to
declare dividends may also be limited (see Note 11 to the Consolidated Financial
Statements).
- --------------------------------------------------------------------------------
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
Consolidated Transaction Reporting System prices for the specified calendar
quarters are noted below.
- --------------------------------------------------------------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
------------------- ----------------- ------------------ ----------------------
High Low High Low High Low High Low
------- ------- ------- ------- ----- ------- ------- --------
1996 $62 1/2 $49 3/8 $68 1/8 $56 1/4 $66 3/4 $54 1/4 $85 1/8 $65 1/8
1995 45 34 5/8 53 1/4 42 5/8 63 3/4 51 7/8 64 3/4 50 1/8
- -------------------------------------------------------------------------------------------------
The approximate number of record holders of common stock as of February 7,
1997 was 13,300.