SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 28, 1996 ------------- COMMISSION FILE NUMBER 1-7182 -------------- MERRILL LYNCH & CO., INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 13-2740599 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) WORLD FINANCIAL CENTER, NORTH TOWER, NEW YORK, NEW YORK 10281-1332 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 449-1000 - -------------------------------------------------------------------------------- Registrant's telephone number, including area code - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 168,660,915 shares of Common Stock* (as of the close of business on August 2, 1996) * Does not include 2,529,387 unallocated reversion shares held in the Employee Stock Ownership Plan that are not considered outstanding for accounting purposes. Part I. FINANCIAL INFORMATION ----------------------------- ITEM 1. Financial Statements -------------------- MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED EARNINGS (UNAUDITED) FOR THE THREE MONTHS ENDED PERCENT(1) -------------------------- JUNE 28, JUNE 30, INCREASE (In Millions, Except Per Share Amounts) 1996 1995 (DECREASE) ---------- ---------- ---------- REVENUES Commissions . . . . . . . . . . . . . . . $ 970 $ 765 27% Interest and dividends . . . . . . . . . 3,040 3,295 (8) Principal transactions . . . . . . . . . 908 615 48 Investment banking . . . . . . . . . . . 580 335 73 Asset management and portfolio service fees . . . . . . . . . . . . . . 553 464 19 Other . . . . . . . . . . . . . . . . . . 139 111 26 ------ ------ Total Revenues . . . . . . . . . . . . . 6,190 5,585 11 Interest Expense . . . . . . . . . . . 2,810 3,036 (7) ------ ------ Net Revenues . . . . . . . . . . . . . . 3,380 2,549 33 ------ ------ NON-INTEREST EXPENSES Compensation and benefits . . . . . . . . 1,741 1,309 33 Communications and equipment rental . . . 137 117 17 Occupancy . . . . . . . . . . . . . . . . 113 110 3 Depreciation and amortization . . . . . . 98 88 11 Professional fees . . . . . . . . . . . . 140 105 33 Advertising and market development. . . . 124 96 30 Brokerage, clearing, and exchange fees. . 101 94 8 Other . . . . . . . . . . . . . . . . . . 228 166 37 ------ ------ Total Non-Interest Expenses . . . . . . . 2,682 2,085 29 ------ ------ EARNINGS BEFORE INCOME TAXES . . . . . . 698 464 50 Income tax expense . . . . . . . . . . . 265 181 46 ------ ------ NET EARNINGS . . . . . . . . . . . . . . $ 433 $ 283 53 ====== ====== NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS . . . . . . . . . . . . . . $ 422 $ 271 ====== ====== EARNINGS PER COMMON SHARE: Primary . . . . . . . . . . . . . . . . $ 2.19 $ 1.40 ====== ====== Fully diluted . . . . . . . . . . . . . $ 2.19 $ 1.39 ====== ====== DIVIDEND PAID PER COMMON SHARE. . . . . . $ .30 $ .26 ====== ====== AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE: Primary . . . . . . . . . . . . . . . . 192.9 193.3 ====== ====== Fully diluted . . . . . . . . . . . . . 192.9 195.2 ====== ====== (1) Percentages are based on actual numbers before rounding. See Notes to Consolidated Financial Statements 2 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED EARNINGS (UNAUDITED)
FOR THE SIX MONTHS ENDED PERCENT(1) -------------------------- JUNE 28, JUNE 30, INCREASE (In Millions, Except Per Share Amounts) 1996 1995 (DECREASE) ---------- ---------- ---------- REVENUES Commissions . . . . . . . . . . . . . . . . $ 1,959 $ 1,450 35% Interest and dividends . . . . . . . . . . 6,050 6,325 (4) Principal transactions . . . . . . . . . . 1,891 1,289 47 Investment banking . . . . . . . . . . . . 958 584 64 Asset management and portfolio service fees . . . . . . . . . . . . . . . 1,090 913 19 Other . . . . . . . . . . . . . . . . . . . 261 228 15 ------- ------- Total Revenues . . . . . . . . . . . . . . 12,209 10,789 13 Interest Expense . . . . . . . . . . . . 5,568 5,819 (4) ------- ------- Net Revenues . . . . . . . . . . . . . . . 6,641 4,970 34 ------- ------- NON-INTEREST EXPENSES Compensation and benefits . . . . . . . . . 3,432 2,579 33 Communications and equipment rental . . . . 268 229 17 Occupancy . . . . . . . . . . . . . . . . . 229 219 4 Depreciation and amortization . . . . . . . 196 175 12 Professional fees . . . . . . . . . . . . . 270 204 32 Advertising and market development. . . . . 239 182 31 Brokerage, clearing, and exchange fees. . . 207 178 17 Other . . . . . . . . . . . . . . . . . . . 431 361 20 ------- ------- Total Non-Interest Expenses . . . . . . . . 5,272 4,127 28 ------- ------- EARNINGS BEFORE INCOME TAXES . . . . . . . 1,369 843 62 Income tax expense . . . . . . . . . . . . 526 333 58 ------- ------- NET EARNINGS . . . . . . . . . . . . . . . $ 843 $ 510 65 ======= ======= NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS . . . . . . . . . . . . . . . $ 820 $ 486 ======= ======= EARNINGS PER COMMON SHARE: Primary . . . . . . . . . . . . . . . . . $ 4.22 $ 2.48 ======= ======= Fully diluted . . . . . . . . . . . . . . $ 4.21 $ 2.46 ======= ======= DIVIDENDS PAID PER COMMON SHARE . . . . . . $ .56 $ .49 ======= ======= AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE: Primary . . . . . . . . . . . . . . . . . 194.3 196.2 ======= ======= Fully diluted . . . . . . . . . . . . . . 194.6 197.5 ======= =======
(1) Percentages are based on actual numbers before rounding. See Notes to Consolidated Financial Statements 3 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in Millions, Except Per Share Amounts) JUNE 28, DEC. 29, ASSETS 1996 1995 - ------------------------------------------------------- -------- -------- CASH AND CASH EQUIVALENTS . . . . . . . . . . . . . . . $ 2,751 $ 3,091 -------- -------- CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES OR DEPOSITED WITH CLEARING ORGANIZATIONS . . . . . . . 5,011 5,412 -------- -------- MARKETABLE INVESTMENT SECURITIES . . . . . . . . . . . 2,146 2,365 -------- -------- TRADING ASSETS, AT FAIR VALUE Corporate debt and preferred stock . . . . . . . . . . 20,138 17,581 Contractual agreements . . . . . . . . . . . . . . . . 10,981 11,833 Equities and convertible debentures . . . . . . . . . . 14,011 10,843 Non-U.S. governments and agencies . . . . . . . . . . . 9,255 6,744 U.S. Government and agencies . . . . . . . . . . . . . 8,247 6,672 Mortgages, mortgage-backed, and asset-backed . . . . . 3,740 3,749 Money markets . . . . . . . . . . . . . . . . . . . . . 1,666 1,680 Municipals . . . . . . . . . . . . . . . . . . . . . . 1,094 1,001 -------- -------- Total . . . . . . . . . . . . . . . . . . . . . . . . . 69,132 60,103 -------- -------- RESALE AGREEMENTS . . . . . . . . . . . . . . . . . . . 52,322 44,257 -------- -------- SECURITIES BORROWED . . . . . . . . . . . . . . . . . . 23,985 20,645 -------- -------- RECEIVABLES Customers (net of allowance for doubtful accounts of $49 in 1996 and $37 in 1995) . . . . . . . . . . . . . 17,405 14,783 Brokers and dealers . . . . . . . . . . . . . . . . . . 14,972 9,267 Interest and other . . . . . . . . . . . . . . . . . . 4,710 4,741 -------- -------- Total . . . . . . . . . . . . . . . . . . . . . . . . . 37,087 28,791 -------- -------- INVESTMENTS OF INSURANCE SUBSIDIARIES . . . . . . . . . 5,365 5,619 LOANS, NOTES, AND MORTGAGES (NET OF ALLOWANCE FOR LOAN LOSSES OF $141 IN 1996 AND $131 IN 1995) . . . . 2,705 2,172 OTHER INVESTMENTS . . . . . . . . . . . . . . . . . . . 1,128 961 PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION AND AMORTIZATION OF $2,331 IN 1996 AND $2,239 IN 1995) . . . . . . . . 1,582 1,605 OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . 1,961 1,836 -------- -------- TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . $205,175 $176,857 ======== ======== See Notes to Consolidated Financial Statements 4 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in Millions, Except Per Share Amounts) JUNE 28, DEC. 29, LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995 - --------------------------------------------------- -------- --------- LIABILITIES REPURCHASE AGREEMENTS . . . . . . . . . . . . . . . $ 62,865 $ 56,817 -------- -------- COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS . 32,702 29,546 -------- -------- TRADING LIABILITIES, AT FAIR VALUE . . . . . . . . Contractual agreements . . . . . . . . . . . . . . 9,115 10,907 U.S. Government and agencies . . . . . . . . . . . 12,673 9,089 Equities and convertible debentures . . . . . . . . 8,247 6,642 Non-U.S. governments and agencies . . . . . . . . . 6,718 4,418 Corporate debt and preferred stock . . . . . . . . 2,143 2,199 Municipals . . . . . . . . . . . . . . . . . . . . 58 95 -------- -------- Total . . . . . . . . . . . . . . . . . . . . . . . 38,954 33,350 -------- -------- CUSTOMERS . . . . . . . . . . . . . . . . . . . . . 10,112 11,391 INSURANCE . . . . . . . . . . . . . . . . . . . . . 5,107 5,391 BROKERS AND DEALERS . . . . . . . . . . . . . . . . 14,852 6,366 OTHER LIABILITIES AND ACCRUED INTEREST . . . . . . 11,429 10,515 LONG-TERM BORROWINGS . . . . . . . . . . . . . . . 22,640 17,340 -------- -------- TOTAL LIABILITIES . . . . . . . . . . . . . . . . . 198,661 170,716 -------- -------- 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 . . . . . . . . . . . . . . . . . . 1,312 1,237 Foreign currency translation adjustment . . . . . . (4) 11 Net unrealized gains on investment securities available-for-sale (net of applicable income tax expense of $4 in 1996 and $13 in 1995) . . . . . 8 25 Retained earnings . . . . . . . . . . . . . . . . . 7,215 6,492 -------- -------- Subtotal . . . . . . . . . . . . . . . . . . . 8,846 8,080 Less: Treasury stock, at cost: 1996 - 64,876,357 shares; 1995 - 60,929,278 shares . . . . . . . . . . 2,502 2,241 Unallocated ESOP reversion shares, at cost: 1996 - 2,529,387 shares; 1995 - 4,012,519 shares . . . . . . . . . . 40 63 Employee stock transactions . . . . . . . . . . . 409 254 -------- -------- TOTAL COMMON STOCKHOLDERS' EQUITY . . . . . . . . . 5,895 5,522 -------- -------- TOTAL STOCKHOLDERS' EQUITY . . . . . . . . . . . . 6,514 6,141 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . . . . $205,175 $176,857 ======== ======== BOOK VALUE PER COMMON SHARE . . . . . . . . . . . . $ 35.07 $ 32.41 ======== ======== See Notes to Consolidated Financial Statements 5 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED) FOR THE SIX MONTHS ENDED --------------------------- (In Millions) JUNE 28, JUNE 30, 1996 1995 -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings . . . . . . . . . . . . . . . . . . . . $ 843 $ 510 Noncash items included in earnings: Depreciation and amortization . . . . . . . . . . . 196 175 Policyholder reserves . . . . . . . . . . . . . . . 138 152 Other . . . . . . . . . . . . . . . . . . . . . . . 307 294 (Increase) decrease in operating assets: Trading assets . . . . . . . . . . . . . . . . . . (8,999) (3,982) Cash and securities segregated for regulatory purposes or deposited with clearing organizations. 401 (1,205) Securities borrowed . . . . . . . . . . . . . . . . (3,340) (759) Customers . . . . . . . . . . . . . . . . . . . . . (2,638) 595 Other . . . . . . . . . . . . . . . . . . . . . . . (6,460) (3,312) Increase (decrease) in operating liabilities: Trading liabilities . . . . . . . . . . . . . . . . 5,604 965 Customers . . . . . . . . . . . . . . . . . . . . . (1,280) (88) Insurance . . . . . . . . . . . . . . . . . . . . . (330) (396) Other . . . . . . . . . . . . . . . . . . . . . . . 9,326 5,830 ------- ------- CASH USED FOR OPERATING ACTIVITIES . . . . . . . . . (6,232) (1,221) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from (payments for): Maturities of available-for-sale securities . . . . 1,570 819 Sales of available-for-sale securities . . . . . . 784 680 Purchases of available-for-sale securities . . . . (2,160) (1,579) Maturities of held-to-maturity securities . . . . . 385 589 Purchases of held-to-maturity securities . . . . . (244) (635) Other investments and other assets . . . . . . . . (340) (88) Property, leasehold improvements, and equipment . . (173) (163) ------- ------- CASH USED FOR INVESTING ACTIVITIES . . . . . . . . . (178) (377) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments for): Repurchase agreements, net of resale agreements . . (2,017) (217) Commercial paper and other short-term borrowings. . 3,156 2,958 Issuance and resale of long-term borrowings . . . . 9,371 4,850 Settlement and repurchase of long-term borrowings . (3,842) (4,327) Common stock transactions . . . . . . . . . . . . . (479) (538) Dividends . . . . . . . . . . . . . . . . . . . . . (119) (112) ------- ------- Cash provided by financing activities . . . . . . . . 6,070 2,614 ------- ------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS . . (340) 1,016 Cash and cash equivalents, beginning of year . . . . 3,091 2,312 ------- ------- CASH AND CASH EQUIVALENTS, END OF PERIOD . . . . . . $ 2,751 $ 3,328 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Income taxes totaled $633 in 1996 and $136 in 1995. Interest totaled $5,359 in 1996 and $5,695 in 1995. See Notes to Consolidated Financial Statements 6 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JUNE 28, 1996 (DOLLARS IN MILLIONS) BASIS OF PRESENTATION The consolidated financial statements include the accounts of Merrill Lynch & Co., Inc. and subsidiaries (collectively referred to as the "Corporation"). All material intercompany balances have been eliminated. The December 29, 1995 consolidated balance sheet was derived from the audited financial statements. The interim consolidated financial statements for the three- and six-month periods are unaudited; however, in the opinion of the management of the Corporation, all adjustments, consisting only of normal recurring accruals, necessary for a fair statement of the results of operations have been included. These unaudited financial statements should be read in conjunction with the audited financial statements included in the Corporation's Annual Report on Form 10-K for the year ended December 29, 1995 ("1995 10-K"). Because of the nature of the Corporation's business, the results of any interim period are not necessarily indicative of results for a full year. Prior period financial statements have been reclassified, where appropriate, to conform to the 1996 presentation. NEW ACCOUNTING PRONOUNCEMENTS In October 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards("SFAS") No. 123, "Accounting for Stock-Based Compensation", which is effective for fiscal years beginning after December 15, 1995. The Corporation has decided not to adopt the cost recognition provisions of SFAS No. 123 but will disclose, as required, the pro- forma impact of these provisions in its 1996 year-end financial statements. In June 1996, the 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. The Corporation has not yet quantified the impact of adopting SFAS No. 125. COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS Commercial paper and other short-term borrowings at June 28, 1996 and December 29, 1995 are presented below: June 28, Dec. 29, 1996 1995 -------- -------- Commercial paper $18,393 $16,969 Demand and time deposits 7,824 8,182 Securities loaned 3,591 2,857 Bank loans and other 2,894 1,538 ------- ------- Total $32,702 $29,546 ======= ======= 7 FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Corporation enters into various derivative contracts to meet clients' needs and to manage its own market risks. Derivative contracts often involve future commitments to exchange interest payment streams or currencies (such as interest rate and currency swaps or foreign exchange forwards) or to purchase or sell other financial instruments at specified terms on a specified date. Options, for example, can be purchased or written on a wide range of financial instruments such as securities, currencies, futures, and various market indices. The contractual or notional 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 contractual or notional amounts of derivatives used for trading purposes by type of risk follow:
(Notional amounts in billions) - ------------------------------ Interest Rate Currency Equity Price Commodity Price June 28, 1996 Risk(1)(2) Risk (3) Risk Risk - ------------- ----------------- -------------- ------------ -------------- Swap agreements $1,064 $ 118 $ 10 $ 2 Futures contracts 133 1 4 24 Options purchased 86 49 27 3 Options written 96 47 26 3 Forward contracts 34 158 - 7 December 29, 1995 - ----------------- Swap agreements $ 851 $ 106 $ 7 $ 3 Futures contracts 215 1 2 2 Options purchased 45 24 38 5 Options written 64 24 41 6 Forward contracts 33 118 - 25
(1) Certain derivatives subject to interest rate risk are also exposed to credit 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 which bear interest rate as well as principal prepayment risk. (3) Included in the currency risk category are certain contracts which are also subject to interest rate risk. The contractual or notional amounts of derivative financial instruments used for financing and other non-trading purposes follow: (Notional amounts in billions) June 28, December 29, - ------------------------------ 1996 1995 ---------- ---------- Interest rate swap contracts(1) $33 $31 Foreign exchange contracts(1) 2 3 Equity options purchased 1 1 (1) Includes options embedded in swap contracts which hedge callable debt totaling $1 billion notional. Most of the above transactions are entered into with the Corporation's swap and foreign exchange dealer subsidiaries, which intermediate interest rate 8 and currency risk with third parties in the normal course of their trading activities. In the normal course of business, the Corporation also enters into underwriting commitments, when-issued transactions, and commitments to extend credit. Settlement of these commitments as of June 28, 1996 would not have a material effect on the consolidated financial condition of the Corporation. REGULATORY REQUIREMENTS Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a registered broker-dealer and a subsidiary of the Corporation, is subject to the net capital requirements of Rule 15c3-1 under the Securities Exchange Act of 1934. Under the alternative method permitted by this rule, the minimum required net capital, as defined, shall not be less than 2% of aggregate debit items arising from customer transactions. At June 28, 1996, MLPF&S's regulatory net capital of $1,472 was 10% of aggregate debit items, and its regulatory net capital in excess of the minimum required was $1,168. Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S. Government securities and a subsidiary of the Corporation, is subject to the capital adequacy requirements of the Government Securities Act of 1986. This rule requires dealers to maintain liquid capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At June 28, 1996, MLGSI's liquid capital of $749 was 275% of its total market and credit risk, and liquid capital in excess of the minimum required was $422. Merrill Lynch International ("MLI"), a United Kingdom registered broker-dealer and a subsidiary of the Corporation, is subject to the capital requirements of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial resources, as defined, must exceed the total financial resources requirement of the SFA. At June 28, 1996, MLI's financial resources were $1,259 and exceeded the minimum requirement by $224. INTEREST AND DIVIDEND EXPENSE Interest expense includes payments in lieu of dividends of $1.4 and $3.8 for the second quarters of 1996 and 1995, respectively. For the six-month periods ended June 28, 1996 and June 30, 1995, payments in lieu of dividends were $3.0 and $6.2, respectively. LITIGATION MATTER On January 12, 1995, an action was commenced in the United States Bankruptcy Court for the Central District of California by Orange County, California (the "County") and the Orange County Investment Pools (the "Pools"), both of which filed bankruptcy petitions in that Court on December 6, 1994, against the Corporation and certain of its subsidiaries in connection with the Corporation's business activities with the Orange County Treasurer-Tax Collector. In addition, other actions have been brought against the Corporation and/or certain of its officers, directors, and employees and certain of its subsidiaries in federal and state courts in California, Illinois, and New York. These include class actions and 9 stockholder derivative actions brought by persons alleging harm to themselves or to the Corporation arising out of the Corporation's dealings with the Orange County Treasurer-Tax Collector, or from the purchase of debt instruments issued by the County that were underwritten by the Corporation's subsidiary, MLPF&S. See "Commitments and Contingencies" in the notes to the Corporation's audited consolidated financial statements contained in the 1995 10-K as well as "Legal Proceedings" in the 1995 10-K and the 1996 quarterly reports on Form 10-Q. 10 INDEPENDENT ACCOUNTANTS' REPORT - ------------------------------- To the Board of Directors and Stockholders of Merrill Lynch & Co., Inc.: We have reviewed the accompanying condensed consolidated balance sheet of Merrill Lynch & Co., Inc. and subsidiaries as of June 28, 1996, and the related condensed statements of consolidated earnings for the three- and six-month periods ended June 28, 1996 and June 30, 1995 and consolidated cash flows for the six-month periods ended June 28, 1996 and June 30, 1995. These financial statements are the responsibility of the management of Merrill Lynch & Co., Inc. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Merrill Lynch & Co., Inc. and subsidiaries as of December 29, 1995, and the related statements of consolidated earnings, changes in consolidated stockholders' equity and consolidated cash flows for the year then ended (not presented herein); and in our report dated February 26, 1996, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 29, 1995 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ Deloitte & Touche LLP New York, New York August 9, 1996 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS ------------- Merrill Lynch & Co., Inc. and its subsidiaries (collectively referred to as the "Corporation") conduct their businesses in global financial markets that are influenced by a number of 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 higher volatility increases risk, it may also increase order flow, which drives many of the Corporation's businesses. 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 may also affect earnings. As a result, revenues and net earnings can vary significantly from quarter to quarter, and from year to year. Global financial markets continued to be buoyant throughout the 1996 first half, after strong performances in 1995. Issuer and investor demand and lower interest rates relative to a year ago led to higher industrywide revenues from underwriting, trading, commissions, and merger and acquisition services. U.S. equity markets continued to rise to record price levels in the 1996 first half, although the rate of advance slowed in the second quarter. Individual investors deposited record amounts into mutual funds, fueling demand for new issues and driving many domestic stock indices, including the Dow Jones Industrial Average and the Nasdaq Composite Index, to record levels. Nasdaq average daily trading volumes also achieved a record high in the 1996 second quarter. U.S. bond markets, which advanced strongly on steady declines in interest rates throughout 1995, became more volatile during the 1996 first half. Long-term interest rates remained low in the first two months of 1996, but inflationary fears fueled a marked increase in interest rates beginning in March 1996 that continued throughout the second quarter. The U.S. Treasury yield curve (the relationship between interest rates and maturities) steepened midway through the first half as long-term interest rates increased more than short-term rates. Nevertheless, the overall level of interest rates in the 1996 first half was lower than in the year-ago period. Global equity markets rose on average approximately 6% during the 1996 first half, as measured by the Dow Jones World Stock Index, with most of the increase occurring during January through April of 1996. Many Asian and European equity markets advanced, but U.K. and Japanese markets ended the 1996 first half only marginally ahead of 1995 year-end levels in U.S. dollar terms. Interest rates in most global bond markets rose during the six-month period, but remained low relative to the first six months of 1995. U.S. underwriting volume benefited from a substantial increase in new issue volumes due to higher equity prices and continued demand from both institutional and individual investors. Industrywide disclosed fees from U.S. public debt and equity underwriting reached a record $2.9 billion during the 1996 second quarter, up 70% from the year-earlier period, according to Securities Data Co. 12 Strategic services activities were strong throughout the 1996 first half. The value of global mergers and acquisitions completed industrywide exceeded $495 billion in the 1996 period, up 26% from the 1995 first half, according to Securities Data Co. Companies continued to seek strategic alliances to increase earnings growth and expand into new markets or businesses. Factors contributing to the increased level of merger and acquisition activity included steady economic growth, relatively low inflation and interest rates, appreciated stock values, increased global competition, and continued deregulation in certain industries. The robust financial markets that characterized 1995 continued throughout the first six months of 1996, as many financial services firms, including the Corporation, reported record earnings during the 1996 second quarter. Nevertheless, the industry is cyclical. As a result, the Corporation's businesses are evaluated across market cycles for profitability and alignment with long-term strategic objectives. The Corporation seeks to mitigate the effect of market downturns by expanding its global presence, developing long- term client relationships, closely monitoring costs and risks, and continuing to diversify revenue sources. SECOND QUARTER 1996 VERSUS SECOND QUARTER 1995 The discussion that follows emphasizes the comparison between the second quarters of 1996 and 1995 and presents additional information on the comparison between the six-month periods, when relevant. Net earnings for the 1996 second quarter were a record $433 million, up $150 million (53%) from the $283 million reported in last year's second quarter. Second quarter earnings per common share were $2.19 primary and fully diluted, compared with $1.40 primary and $1.39 fully diluted in the 1995 second quarter. After deducting preferred stock dividends, net earnings applicable to common stockholders totaled $422 million in the 1996 second quarter, up $151 million (56%) from $271 million in the prior year's quarter. Annualized return on average common stockholders' equity was 29.2% versus 21.0% in the year-ago period. The Corporation's pretax profit margin in the 1996 second quarter was 20.6% versus 18.2% in the year-ago period. The net profit margin increased to 12.8% in the 1996 second quarter, compared with 11.1% in the 1995 second quarter. For the first six months of 1996, net earnings were $843 million, up $333 million (65%) from the $510 million reported in the prior year period. Earnings per common share were $4.22 primary and $4.21 fully diluted, compared with $2.48 primary and $2.46 fully diluted in the corresponding 1995 period. After deducting preferred stock dividends, net earnings applicable to common stockholders in the first half of 1996 totaled $820 million, up $334 million (69%) from $486 million in the comparable 1995 period. Annualized return on average common stockholders' equity was 28.7% for the 1996 first half, compared with 18.8% for the year-ago period. The Corporation's pretax profit margin in the 1996 first half was 20.6% versus 17.0% in the 1995 first half. The net profit margin increased to 12.7% in the first six months of 1996, compared with 10.3% in the year-ago period. Total revenues increased 11% from the 1995 second quarter to $6.2 billion, with record revenues in investment banking and asset management and portfolio 13 service fees. Net revenues (revenues after interest expense) increased 33% from the year-ago period to $3.4 billion. Commissions revenues are summarized as follows: Three Months Ended Six Months Ended ------------------ ---------------- (In millions) June 28, June 30, % June 28, June 30, % ------------- 1996 1995 Incr. 1996 1995 Incr. ------ ------ ----- -------- ------- ----- Listed and over-the-counter $517 $415 25% $1,064 $ 780 37% Mutual funds 309 217 43 608 404 51 Other 144 133 8 287 266 7 ---- ---- ------ ------ Total $970 $765 27 $1,959 $1,450 35 ==== ==== ====== ====== Commissions revenues from listed and over-the-counter securities increased because of higher trading volumes on most major U.S. and international exchanges. Mutual fund commissions revenues rose to a record level due primarily to strong sales of U.S. and offshore funds and higher distribution fees. Significant components of interest and dividend revenues and interest expense for the three- and six-month periods ended June 28, 1996 and June 30, 1995 follow: Three Months Ended Six Months Ended ------------------ ------------------- (In millions) June 28, June 30, June 28, June 30, - ------------ 1996 1995 1996 1995 -------- -------- -------- -------- Interest and dividend revenues: Trading assets $ 986 $1,071 $1,945 $2,010 Resale agreements 714 770 1,404 1,541 Securities borrowed 644 826 1,319 1,512 Margin lending 369 334 742 659 Other 327 294 640 603 ------ ------ ------ ------ Total 3,040 3,295 6,050 6,325 ------ ------ ------ ------ Interest expense: Borrowings 1,131 1,126 2,248 2,137 Repurchase agreements 854 1,015 1,702 1,971 Trading liabilities 580 626 1,132 1,201 Other 245 269 486 510 ------ ------ ------ ------ Total 2,810 3,036 5,568 5,819 ------ ------ ------ ------- Net interest and dividend profit $ 230 $ 259 $ 482 $ 506 ====== ====== ====== ====== The Corporation hedges its long-term payment obligations with interest rate and currency swaps. The effect of these hedges, which is included in the "Borrowings" caption above, decreased interest expense by approximately $23 million for the 1996 second quarter and approximately $21 million for the 1995 second quarter. 14 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 declined 11% to $230 million from the 1995 second quarter as a result of reduced levels of interest-earning assets. Principal transactions revenues were up 48% from the 1995 second quarter to $908 million. Increased client order flow and effective risk management in volatile markets led to broad-based increases in most product categories. Revenues from principal transactions in the 1996 second quarter were the second highest ever, 8% below the record $982 million in the 1996 first quarter. Trading, 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, the Corporation views net interest and principal transactions revenues in the aggregate. For financial reporting purposes, however, realized and unrealized gains and losses on trading positions, including hedges, are recorded in principal transaction revenues. The net interest carry (i.e., the spread representing interest earned versus 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. The following table provides information on aggregate trading profits, including related net interest revenue (expense). Interest revenue and expense components 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. 15 (In millions) Principal Net Interest Net - ------------- Transactions Revenue Trading Revenues (Expense) Revenue ---------------- --------------- --------------- Three Months 1996 1995 1996 1995 1996 1995 - ------------ ------ ------ ------ ------ ------ ------ Equity and equity derivatives $ 290 $ 228 $ (31) $ (6) $ 259 $ 222 Taxable fixed-income 243 130 63 71 306 201 Interest rate and currency swaps 249 195 (10) (15) 239 180 Municipals 94 51 2 - 96 51 Foreign exchange and commodities 32 11 (4) 1 28 12 ------ ------ ------ ------ ------ ------ Total $ 908 $ 615 $ 20 $ 51 $ 928 $ 666 ====== ====== ====== ====== ====== ====== Six Months - ---------- Equity and equity derivatives $ 637 $ 393 $ (49) $ (31) $ 588 $ 362 Taxable fixed-income 509 294 116 150 625 444 Interest rate and currency swaps 505 429 (12) (32) 493 397 Municipals 168 141 4 (1) 172 140 Foreign exchange and commodities 72 32 (7) (2) 65 30 ------ ------ ------ ----- ------ ------ Total $1,891 $1,289 $ 52 $ 84 $1,943 $1,373 ====== ====== ====== ===== ====== ====== Equities and equity derivatives trading revenues were $290 million, up 27% from the 1995 second quarter due principally to higher trading revenues in non-U.S. and over-the-counter equities, partially offset by lower revenues from convertible securities. International equities trading revenues benefited from the addition of trading activity related to Smith New Court PLC ("Smith New Court"), which was acquired in the third quarter of 1995. Over-the-counter equity trading revenues rose due to increased client order flow. Convertible securities revenues decreased as a result of lower trading volume. Taxable fixed-income trading revenues increased to $243 million, up 88% from the 1995 second quarter, primarily due to higher revenues from mortgage-backed products, corporate bonds, and money market instruments. The increase in mortgage-backed securities trading revenues was attributable to improved liquidity and increased customer demand, compared with the year-ago period. Trading revenues from corporate bonds advanced due primarily to higher demand for U.S. and U.K. debt products. Trading revenues from money markets instruments benefited from increased floating rate note activity in European markets. Interest rate and currency swap trading revenues increased 28% to $249 million due to higher revenues from both U.S. dollar-denominated and non-U.S. dollar-denominated transactions. Municipal securities trading revenues were up 83% from last year's second quarter to $94 million primarily due to increased investor demand for tax-exempt investments. Foreign exchange and commodities trading revenues, in the aggregate, rose to $32 million, up 183% 16 from the 1995 second quarter. Strong customer activity fueled by increased volatility in exchange rates led to higher foreign exchange trading revenues. A summary of the Corporation's investment banking revenues follows: Three Months Ended Six Months Ended ------------------------ ------------------------- (In millions) June 28, June 30, % June 28, June 30, % - ------------- 1996 1995 Incr. 1996 1995 Incr. ---------------- ----- ---------------- ----- Underwriting $469 $251 87% $762 $413 85% Strategic services 111 84 32 196 171 14 ---- ---- ---- ---- Total $580 $335 73 $958 $584 64 ==== ==== ==== ==== Underwriting and strategic services revenues reached record levels, benefiting from strong levels of equity and debt underwriting and mergers and acquisitions activity industrywide. Common equity underwriting revenues, in particular, more than doubled compared to both the 1995 second quarter and the 1996 first quarter. Underwriting revenues from high-yield, mortgage- and asset-backed, and other debt products also rose. The Corporation retained its position as top underwriter of total debt and equity securities in the 1996 second quarter with market shares of 16.1% in the U.S. and 12.8% globally, compared with 15.3% in the U.S. and 12.2% globally in the 1995 second quarter, according to Securities Data Co. ("SDC"). SDC statistics are based on full credit to the book manager. Strategic services revenues advanced to a record, benefiting from strong merger and acquisition activity and significant gains in market share. For transactions completed during the 1996 second quarter, the Corporation was the second-ranked advisor globally with a 21.1% market share, compared with the fifth-ranked advisor globally and a 10.6% market share in last year's second quarter, according to SDC. SDC data gives full credit to both target and acquiring companies' advisors. In addition, the Corporation was the leading advisor in announced U.S. and global mergers and acquisitions for the 1996 second quarter. Increased transaction volumes as well as improved market shares for strategic services led to higher investment banking revenues for the 1996 six-month period. Revenues from equity, high-yield debt, and corporate bond and preferred stock underwritings were approximately double those of the 1995 first half. The Corporation retained its position as top underwriter of total debt and equity securities, with U.S. and global year-to-date market shares of 16.1% and 12.4%, respectively, according to SDC. These market shares were comparable to those of the 1995 first half. Strategic services revenues benefited from increased fees from mergers and acquisitions. The Corporation was the third-ranked advisor globally on transactions completed during the 1996 first half with a 15.0% market share, compared to an 8.8% market share as fifth-ranked advisor in the 1995 first half, according to SDC. The Corporation's asset management and portfolio service fees are summarized below: Three Months Ended Six Months Ended ------------------------ ----------------------- (In millions) June 28, June 30, % June 28, June 30, % - ------------- 1996 1995 Incr. 1996 1995 Incr. ---------------- ----- ---------------- ----- Asset management $245 $209 17% $ 483 $410 18% fees Portfolio service 147 113 31 288 220 31 fees Other fees 161 142 13 319 283 13 ---- ---- ------ ---- Total $553 $464 19 $1,090 $913 19 ==== ==== ====== ==== 17 Asset management fees, which include fees earned on mutual funds sponsored by the Corporation and third parties, increased due primarily to strong inflows of client assets. Total assets in worldwide private client accounts were a record $756 billion at quarter-end, compared with $643 billion at the end of the 1995 second quarter and $732 billion at the end of the 1996 first quarter. Assets under management by Merrill Lynch Asset Management were $207 billion at quarter- end, compared with $180 billion a year ago and $208 billion at the end of the 1996 first quarter. Portfolio service fees also benefited from inflows of client assets. Increases in the number of accounts and asset levels led to higher fee revenues for both Merrill Lynch Consults(Registered Trademark), a personalized portfolio management service, and Asset Power(Registered Trademark), an asset-based fee product. Other revenues were $139 million, up 26% from $111 million in the 1995 second quarter. The increase was primarily attributable to gains on sales from Real Estate Mortgage Investment Conduit ("REMIC") transactions. Non-interest expenses were $2.7 billion, up 29% from the 1995 second quarter. The largest expense category, compensation and benefits expense, increased 33% from the 1995 second quarter to $1.7 billion due to higher incentive and production-related compensation as well as a 9% increase in the number of full- time employees. Incentive compensation increased with improved profitability, while production-related compensation was up due to heightened activity and strong volumes in many businesses. Headcount increased by approximately 3,700 employees from the 1995 second quarter to approximately 47,000 at the end of the 1996 second quarter. Approximately half of the year-over-year increase resulted from the addition of employees through business acquisitions, including Smith New Court. Compensation and benefits expense as a percentage of net revenues was 51.5%, compared with 51.3% in the year-ago period. Non-interest expenses, excluding compensation and benefits, increased 21% to $941 million. Communications and equipment rental expense increased 17% from the 1995 second quarter to $137 million due to higher levels of business activity and increased computer-related maintenance costs. Occupancy costs were up 3% to $113 million because of international growth, including the addition of Smith New Court facilities. Depreciation and amortization expense rose 11% from the 1995 second quarter to $98 million due primarily to purchases of technology- related equipment over the past year. Professional fees increased 33% to $140 million primarily as a result of higher systems development costs related to upgrading technology and processing capabilities. Advertising and market development expense rose 30% to $124 million. Increased international travel and higher production-related recognition programs and client promotion costs contributed to this advance. Brokerage, clearing, and exchange fees were up 8% to $101 million, driven by higher trading volume, particularly in international equity markets. Other expenses totaled $228 million, up 37% from the 1995 second quarter, primarily due to provisions related to various business activities and amortization of goodwill related to Smith New Court. Income tax expense was $265 million in the 1996 second quarter. The effective tax rate in the 1996 second quarter was approximately 37.9%, compared with 39.1% in the year-ago period. The decrease in the effective tax rate was primarily attributable to lower state taxes and expanded international business activities. 18 For the 1996 first half, non-interest expenses increased 28% to $5.3 billion. The largest expense category, compensation and benefits, was up 33% to $3.4 billion due to higher variable compensation related to increased profitability and business volume. Compensation and benefits expense as a percentage of net revenue was 51.7% in the 1996 first half versus 51.9% in the 1995 first half. Other non-interest expenses increased 19% from the 1995 first half due primarily to increased levels of global business activity, higher systems development costs, provisions related to various business activities, and amortization of goodwill. LIQUIDITY AND LIABILITY MANAGEMENT The primary objective of the Corporation's funding policies is to assure liquidity at all times. There are three key elements to the Corporation's liquidity strategy. The first element is to maintain alternative funding sources such that all debt obligations maturing within one year, including commercial paper, uncommitted bank loans, and the current portion of long-term debt, can be funded when due without issuing new unsecured debt or liquidating any business assets. The most significant alternative funding sources are the proceeds from executing repurchase agreements and obtaining secured bank loans, both principally employing unencumbered investment grade marketable securities. Other alternative funding sources include liquidating cash equivalents; securitizing additional home equity and other mortgage loan assets; and drawing on committed, unsecured, revolving credit facilities ("Credit Facilities"), which at June 28, 1996 totaled $6.0 billion and had not been drawn upon. As an additional measure, the Corporation regularly reviews the level and mix of its assets and liabilities to ascertain its ability to conduct core businesses beyond one year without reliance on issuing new unsecured debt or drawing upon Credit Facilities. The composition of the Corporation's asset mix provides a great degree of flexibility in managing liquidity. The Corporation's liquidity position is enhanced since a significant portion of the Corporation's assets turn over frequently and is typically funded with liabilities whose cash-flow characteristics closely match those of the assets. At June 28, 1996, approximately 97% of the Corporation's assets were considered readily marketable by management. As part of the Corporation's overall liquidity program, 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. The Corporation's insurance subsidiaries primarily market 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 June 28, 1996, approximately 88% of invested assets of insurance subsidiaries were considered liquid by management. The second element of the Corporation's liquidity strategy is to concentrate general purpose borrowings at the Merrill Lynch & Co., Inc. level, except where tax regulations, time zone differences, or other business considerations make this impractical. The benefits of this strategy are lower financing costs; simplicity, control, and wider name recognition by creditors; and flexibility to meet varying funding requirements within subsidiaries. 19 The third element is to expand and diversify the Corporation's funding instruments and its investor and creditor base. The Corporation's funding programs benefit from the ability to market its debt instruments through its own sales force to a large, diversified customer base. The Corporation maintains strict concentration standards for short-term lenders, which include limits for any single investor. Commercial paper remains the Corporation's major source of short-term general purpose funding. Commercial paper outstanding totaled $18.4 billion at June 28, 1996 and $17.0 billion at December 29, 1995, which represented 9% and 10% of total assets at second quarter-end 1996 and year-end 1995, respectively. At June 28, 1996, total long-term debt was $22.6 billion, compared with $17.3 billion at year-end 1995. At July 31, 1996, the Corporation's senior long-term debt was rated by seven recognized credit rating agencies, as follows: Rating Agency Rating - -------------------------------------------------------------------------------- Duff & Phelps Credit Rating Co. (1) AA Fitch Investors Service, L.P. AA IBCA Ltd. AA- Japan Bond Research Institute AA Moody's Investors Service, Inc. A1 Standard & Poor's Ratings Group A+ Thomson BankWatch, Inc. AA - -------------------------------------------------------------------------------- (1) Upgraded from AA- in July 1996. During the first six months of 1996, the Corporation issued $8.9 billion in long-term debt. During the same period, maturities and repurchases were $3.5 billion. In addition, approximately $450 million of the Corporation's long-term debt securities held in inventory by subsidiaries were sold and $346 million were purchased. At June 28, 1996, $17.2 billion of term debt had maturity dates beyond one year. Approximately $45.2 billion of the Corporation's indebtedness at June 28, 1996 was considered senior indebtedness as defined under various indentures. CAPITAL RESOURCES AND CAPITAL ADEQUACY The Corporation remains one of the most highly capitalized institutions whose business is primarily in the securities industry. The Corporation had an equity base of $6.5 billion at June 28, 1996, including approximately $5.9 billion in common equity, supplemented by $619 million in preferred stock. The Corporation reacquired 10.6 million shares of its common stock in the first six months of 1996, compared with 12.9 million shares in the corresponding 1995 period. 20 The Corporation's leverage ratios were as follows: ADJUSTED LEVERAGE LEVERAGE RATIO(1) RATIO(2) - ----------------------------------------------------------------------------- Period-end June 28, 1996 31.5x 19.8x December 29, 1995 28.8x 18.2x Average (3) Six months ended June 28, 1996 33.5x 20.2x Year ended December 29, 1995 32.7x 19.5x - ----------------------------------------------------------------------------- (1) Ratio of total assets to total stockholders' equity. (2) Ratio of total assets, less resale agreements and securities borrowed, to total stockholders' equity. (3) Computed using month-end balances. The Corporation operates in many regulated businesses that require various minimum levels of capital to conduct business. (See Regulatory Requirements Note to the Consolidated Financial Statements - Unaudited.) The Corporation'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 required for payment of dividends in excess of certain established levels, making affiliated investments, and entering into management and service agreements with affiliated companies. The Corporation's overall capital needs are continually reviewed to ensure that its capital base can support the estimated risks of its businesses as well as the regulatory and legal capital requirements of subsidiaries. Based upon these analyses, management believes that the Corporation's equity base is adequate. ASSETS AND LIABILITIES The Corporation manages its balance sheet and risk limits according to market conditions and business needs, subject to profitability and control of risk. Asset and liability levels are primarily determined by order flow and fluctuate daily, sometimes significantly, depending upon volume and demand. The liquidity and maturity characteristics of assets and liabilities are monitored continually. The Corporation monitors and manages the change in its balance sheet using average daily balances. Average daily balances are derived from the Corporation's management information system, which summarizes balances on a settlement date basis. Financial statement balances, as required under generally accepted accounting principles, are recorded on a trade date basis. The discussion that follows compares the changes in settlement date average daily balances, not quarter-end balances. For the first six months of 1996, average daily assets were $203 billion, up 3% versus $197 billion in the 1995 fourth quarter. Average daily liabilities rose 3% to $197 billion from $191 billion for the 1995 fourth quarter. 21 The major components in the growth of average daily assets and liabilities are summarized as follows: Increase in (In millions) Average Assets Percent Increase - ------------- ---------------------- ----------------- Resale agreements and securities borrowed $6,462 8% Increase in Average Liabilities Percent Increase ---------------------- ---------------- Repurchase agreements and securities loaned $3,075 4% Long-term borrowings $2,950 17% In managing its balance sheet, the Corporation strives to match-fund its interest-earning assets with interest-bearing liabilities having similar maturities and cash flow characteristics, such as repurchase and resale agreements. In the 1996 period, repurchase and securities loaned transactions and resale and securities borrowed transactions rose as a result of an increase in match-funded activity involving primarily U.S. Government and agencies securities. In addition, resale and securities borrowed transactions increased to facilitate security deliveries to customers. The Corporation's assets, based on liquidity and maturity characteristics, are funded through diversified sources which include repurchase agreements, commercial paper and other short-term borrowings, long-term borrowings, and equity. A portion of the 1996 first half increase in average assets was funded through an increase in long-term borrowings, which included medium-term notes. NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS In the normal course of business, the Corporation underwrites, trades, and holds non-investment grade securities in connection with its investment banking, market making, and derivative structuring activities. During the past three years, the Corporation has increased its non-investment grade trading inventories to satisfy client demand for higher-yielding investments, including emerging market and other international 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. At June 28, 1996, long and short non-investment grade inventories accounted for 9.0% of aggregate consolidated trading inventories, compared with 6.3% at year- end 1995. Non-investment grade trading inventories are carried at fair value. The Corporation provides financing and advisory services to, and invests in, companies entering into leveraged transactions, which may include leveraged buyouts, recapitalizations, and mergers and acquisitions. The Corporation provides extensions of credit to leveraged companies in the form of senior and subordinated debt, as well as bridge financing on a select and limited basis. In addition, the Corporation syndicates loans for non-investment grade counterparties or in connection with highly leveraged transactions. The 22 Corporation may retain a residual portion of these syndicated loans. A $90 million bridge loan outstanding on March 29, 1996 was repaid during the 1996 second quarter, and a $100 million bridge loan commitment made after March 29, 1996 was canceled before June 28, 1996. Subsequent to June 28, 1996, the Corporation entered into a bridge loan commitment for $135 million to a non- investment grade counterparty. The Corporation intends to syndicate the loan, if extended, and may retain a residual portion. The Corporation holds direct equity investments in leveraged companies and interests in partnerships that invest in leveraged transactions. The Corporation 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 and limited basis. Investment in non-investment grade securities and involvement in highly leveraged transactions subject the Corporation to additional risks related to the creditworthiness of the issuers and the liquidity of the market for such securities. The Corporation recognizes such 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. The Corporation continually monitors credit risk by individual issuer and industry concentration. In certain instances, the Corporation engages in hedging strategies to reduce its exposure associated with owning a non-investment grade position by selling short the related equity security or by entering into an offsetting derivative contract. The Corporation also uses certain non-investment grade trading inventories, principally non-U.S. governments and agencies securities, to hedge the exposure arising from structured derivative transactions. Collateral, consisting principally of U.S. Government securities, may be obtained to reduce credit risk related to these transactions. The Corporation's insurance subsidiaries hold non-investment grade securities. As a percentage of total insurance investments, non-investment grade securities were 5.0%, compared with 4.2% at year-end 1995. Non-investment grade securities of insurance subsidiaries are classified as available-for-sale and are carried at fair value. 23 A summary of the Corporation's non-investment grade holdings and highly leveraged transactions follows: JUNE 28, DECEMBER 29, (In millions) 1996 1995 - ------------------------------------------------------------------- Trading assets $8,452 $5,489 Trading liabilities 1,282 353 Insurance subsidiaries' investments 269 234 Loans (net of allowance for loan losses) (1) 293 489 Equity investments (2) 161 211 Partnership interests 79 91 - ------------------------------------------------------------------- Additional commitments to invest in partnerships $ 80 $ 79 Unutilized revolving lines of credit and other lending commitments 117 127 - ------------------------------------------------------------------- (1) Represented outstanding loans to 37 and 30 medium-sized companies at June 28, 1996 and December 29, 1995, respectively. (2) Invested in 62 enterprises at both June 28, 1996 and December 29, 1995. At June 28, 1996, the largest non-investment grade concentration consisted of various sovereign and corporate issues of a South American country totaling $861 million, which primarily represented hedges of other financial instruments. No one industry sector accounted for more than 27% of total non-investment grade positions. Included in the preceding table are debt and equity securities of issuers in various stages of bankruptcy proceedings or in default. At June 28, 1996, the carrying value of these securities totaled $140 million, of which 70% resulted from the Corporation's market making activities in such securities. 24 Statistical Data Selected statistical data for the last five quarters is presented below for informational purposes:
2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr. 1995 1995 1995 1996 1996 -------- -------- -------- -------- --------- PRIVATE CLIENT ACCOUNTS (IN BILLIONS): Assets in Worldwide Private Client Accounts $ 643 $ 675 $ 703 $ 732 $ 756 Assets in U.S. Private Client Accounts $ 608 $ 639 $ 665 $ 692 $ 714 Assets under Professional Management: Money Markets $ 76 $ 80 $ 82 $ 89 $ 84 Equities 42 44 47 51 53 Fixed Income 38 39 41 41 41 Private Portfolio 20 22 22 23 25 Insurance 4 4 4 4 4 -------- -------- -------- -------- -------- Subtotal 180 189 196 208 207 ML Consults 16 17 17 18 19 Mutual Fund Advisor and Asset Power 4 5 6 7 7 -------- -------- -------- -------- -------- Total $ 200 $ 211 $ 219 $ 233 $ 233 ======== ======== ======== ======== ======== - ------------------------------------------------------------------------------------------------------------------------------------ UNDERWRITING (DOLLARS IN BILLIONS)(A): Global Debt and Equity: Volume $ 33 $ 41 $ 45 $ 45 $ 47 Market Share 12.2% 14.4% 15.3% 11.9% 12.8% U.S. Debt and Equity: Volume $ 28 $ 34 $ 40 $ 39 $ 39 Market Share 15.3% 17.5% 20.6% 16.0% 16.1% - ----------------------------------------------------------------------------------------------------------------------------------- FULL-TIME EMPLOYEES: U.S. 38,200 38,900 39,250 39,400 39,900 International 5,100 6,500 6,750 7,000 7,100 -------- ------- -------- -------- -------- TOTAL 43,300 45,400 46,000 46,400 47,000 ======== ======= ======== ======== ======== Financial Consultants and Account Executives Worldwide 13,600 13,700 13,800 13,700 13,800 Support Personnel to Producer ratio (b) 1.41 1.38 1.43 1.46 1.47 INCOME STATEMENT: Net Earnings (in millions) $ 283 $ 300 $ 303 $ 409 $ 433 Annualized Return on Average Common Stockholders' Equity 21.0% 21.5% 21.1% 28.2% 29.2% Earnings per Common Share: Primary $1.40 $1.47 $1.49 $2.03 $2.19 Fully Diluted $1.39 $1.46 $1.49 $2.03 $2.19 BALANCE SHEET (IN MILLIONS): Total Assets $174,853 $185,473 $176,857 $195,884 $205,175 Total Stockholders' Equity $ 5,883 $ 6,077 $ 6,141 $ 6,364 $ 6,514 SHARE INFORMATION (IN THOUSANDS): Weighted Average Shares Outstanding: Primary 193,267 196,395 195,148 196,225 192,933 Fully Diluted 195,159 197,157 195,148 196,225 192,933 Common Shares Outstanding (c) 175,460 175,501 171,388 173,040 168,924 Shares Repurchased 3,590 1,720 5,362 4,543 6,060 - ------------------------------------------------------------------------------------------------------------------------------------
(a) Full credit to book manager. All market share data are derived from Securities Data Co. (b) Support personnel includes sales assistants. (c) Does not include 4,809, 4,375, 4,013, 2,895 and 2,529 unallocated reversion shares held in the Employee Stock Ownership Plan at June 30, 1995 September 29, 1995, December 29, 1995, March 29, 1996, and June 28, 1996, respectively, which are not considered outstanding for accounting purposes. 25 PART II - OTHER INFORMATION --------------------------- Item 1. Legal Proceedings ----------------- Since the filing of the Corporation's 1995 Form 10-K and of the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 29, 1996 (the "First Quarter 1996 10-Q"), the following events have taken place with respect to several of the actions reported therein. Capitalized terms used herein without definition have the meanings set forth in the 1995 10-K. Orange County Litigation. In the DeLeon Action, the Superior Court for the - ------------------------- State of California, Orange County, entered an order on May 10, 1996 staying the action pending final resolution of the Orange County Action. In the Atascadero Federal Court Action and the Atascadero State Court Action, the two employees of the Corporation who were added as defendants in the amended complaints were dismissed as defendants without prejudice on May 15, 1996, and July 5, 1996, respectively. Pittleman Action. The Supreme Court of the State of New York, New York County, - ----------------- dismissed this action on July 2, 1996. GSLIC Litigation. On July 12, 1996, plaintiffs in the Receiver Action entered a - ----------------- stipulation of discontinuance with prejudice with respect to all claims asserted against all defendants, including the Merrill Lynch defendants. NASDAQ Antitrust Litigation. On July 17, 1996 the Antitrust Division of the - --------------------------- United State Department of Justice filed a civil antitrust complaint against firms that make markets in NASDAQ securities, including Merrill Lynch, Pierce, Fenner & Smith Incorporated. The complaint alleged that the firms violated Section 1 of the Sherman Act through a "common understanding" to follow a "quoting convention" that the complaint asserts had inflated the "inside spread" (the difference between the best quoted buying price and the best quoted selling price on NASDAQ) in certain NASDAQ stocks. This allegedly resulted in investors having to pay higher transaction costs for buying and selling stocks than they would have paid otherwise. At the same time the complaint was filed, a proposed settlement of the action was announced, pursuant to which the market maker defendants in the action have agreed not to engage in certain conduct. The proposed settlement, which is subject to court approval, provides, among other things, for the monitoring and tape recording by each of the market maker defendants of not less than 3.5 percent, or a maximum of 70 hours per week, of telephone conversations by its over-the-counter desk traders; the provision to the Department of Justice of any taped conversation that may violate the terms of the settlement; and for Department of Justice representatives to appear unannounced, during regular business hours, for the purpose of monitoring trader conversations as the conversations occur. For more detailed information regarding litigation matters involving the Corporation, see "Item 3. - Legal Proceedings" in the 1995 10-K. 26 Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------- On April 16, 1996, the Corporation held its Annual Meeting of Stockholders. Further details concerning matters submitted for vote of security holders can be found in the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 29, 1996. Item 5. Other Information ----------------- Effective July 22, 1996, the Board of Directors of the Corporation amended the Corporation's By-Laws. The principal change was to require that advance written notice (in most cases, 50 days) be given to the Secretary of the Corporation by stockholders wishing to, at any stockholders' meeting, offer for stockholder vote a proposal otherwise appropriate for stockholder action. A copy of the Corporation's By-Laws, as amended, is filed as Exhibit 3(i) under item 6(a). Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits (3) Articles of Incorporation and By-Laws (i) By-Laws of Merrill Lynch & Co., Inc., effective as of July 22, 1996 (4) Instruments defining the rights of security holders, including indentures: Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Corporation hereby undertakes to furnish to the Securities and Exchange Commission (the "Commission"), upon request, copies of the instruments defining the rights of holders of long-term debt securities of the Corporation that authorize an amount of securities constituting 10% or less of the total assets of the Corporation and its subsidiaries on a consolidated basis. (11) Statement re: computation of per common share earnings. (12) Statement re: computation of ratios. (15) Letter re: unaudited interim financial information. (27) Financial Data Schedule. 27 (b) Reports on Form 8-K The following Current Reports on Form 8-K were filed by the Corporation with the Commission during the quarterly period covered by this Report: (i) Current Report dated April 1, 1996 for the purpose of filing the form of Registrant's 6 1/2% Notes due April 1, 2001. (ii) Current Report dated April 15, 1995 for the purpose of filing the Preliminary Unaudited Earnings Summary of the Corporation for the three-month period ended March 29, 1996. (iii) Current Report dated May 1, 1996 for the purpose of filing the Preliminary Unaudited Consolidated Balance Sheet of the Corporation as of March 29, 1996. (iv) Current Report dated May 13, 1996 for the purpose of filing the form of Registrant's S&P 500 Market Index Target-Term Securities due May 10, 2001. (v) Current Report dated May 15, 1996 for the purpose of filing the form of Registrant's 7 3/8% Notes due May 15, 2006. (vi) Current Report dated May 28, 1996 for the purpose of filing the form of Registrant's 6% STRYPES due June 1, 1999 Payable with Shares of Common Stock of Cox Communications, Inc. (as amended by an 8-K/A dated June 7, 1996). 28 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. MERRILL LYNCH & CO., INC. --------------------------- (Registrant) Date: August 9, 1996 By: /s/ Joseph T. Willett ------------------------------- Joseph T. Willett Senior Vice President Chief Financial Officer 29 INDEX TO EXHIBITS Exhibits 3(i) By-Laws of Merrill Lynch & Co., effective as of July 22, 1996. 11 Statement re: Computation of per common share earnings. 12 Statement re: computation of ratios. 15 Letter re: unaudited interim financial information. 27 Financial Data Schedule.