UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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(Mark One)
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X
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended
September 28, 2007
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OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission file number 1-7182
MERRILL LYNCH & CO., INC.
(Exact name of Registrant as specified in its charter)
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Delaware
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13-2740599
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(State or Other Jurisdiction of
Incorporation or Organization)
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(I.R.S. Employer Identification No.)
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4 World Financial Center,
New York, New York
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10080
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(Address of Principal Executive Offices)
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(Zip Code)
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(212) 449-1000
Registrants telephone
number, including area code:
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
X YES NO
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act. (Check one):
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Large
Accelerated Filer X
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Accelerated
Filer
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Non-Accelerated
Filer
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange Act).
YES X NO
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the
issuers classes of common stock, as of the latest
practicable date.
853,434,567 shares of Common Stock and
2,596,282 Exchangeable Shares as of the close of business
on October 31, 2007. The Exchangeable Shares, which were
issued by Merrill Lynch & Co., Canada Ltd. in
connection with the merger with Midland Walwyn Inc., are
exchangeable at any time into Common Stock on a one-for-one
basis and entitle holders to dividend, voting, and other rights
equivalent to Common Stock.
MERRILL
LYNCH & CO., INC. QUARTERLY REPORT ON
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2007
TABLE OF CONTENTS
2
Available
Information
We file annual, quarterly and current reports, proxy statements
and other information with the Securities and Exchange
Commission (SEC). You may read and copy any document
we file with the SEC at the SECs Public Reference Room at
100 F Street, NE, Room 1580, Washington, DC
20549. Please call the SEC at
1-800-SEC-0330
for information on the Public Reference Room. The SEC maintains
an internet site that contains annual, quarterly and current
reports, proxy and information statements and other information
that we file electronically with the SEC. The SECs
internet site is www.sec.gov.
Our internet address is www.ml.com, and the investor relations
section of our website can be accessed directly at
www.ir.ml.com. We make available, free of charge, our proxy
statements, Annual Reports on
Form 10-K,
Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K
and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934. These reports are available through our website as soon as
reasonably practicable after such reports are electronically
filed with, or furnished to, the SEC. We have also posted on our
website corporate governance materials including our Guidelines
for Business Conduct, Code of Ethics for Financial
Professionals, Director Independence Standards, Corporate
Governance Guidelines, Related Party Transactions Policy and
charters for the committees of our Board of Directors. In
addition, our website includes information on purchases and
sales of our equity securities by our executive officers and
directors, as well as disclosures relating to certain non-GAAP
financial measures (as defined in the SECs
Regulation G) that we may make public orally,
telephonically, by webcast, by broadcast or by similar means
from time to time.
We will post on our website amendments to our Guidelines for
Business Conduct and Code of Ethics for Financial Professionals
and any waivers that are required to be disclosed by the rules
of either the SEC or the New York Stock Exchange. You can obtain
printed copies of these documents, free of charge, upon written
request to Judith A. Witterschein, Corporate Secretary, Merrill
Lynch & Co., Inc., 222 Broadway, 17th Floor, New
York, NY 10038 or by email at
corporate secretary@ml.com. The information on
websites referenced herein is not incorporated by reference into
this Report.
3
PART I.
FINANCIAL INFORMATION
ITEM 1.
Financial Statements
Merrill
Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(Unaudited)
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For the Three Months Ended
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Sept. 28,
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Sept. 29,
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(in millions, except per share
amounts)
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2007
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2006
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Net revenues
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|
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Principal transactions
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$
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(5,930
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)
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$
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1,673
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Commissions
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1,860
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1,345
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Investment banking
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1,281
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922
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Managed accounts and other fee-based revenues
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1,397
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1,714
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Revenues from consolidated investments
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508
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210
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Other
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(918
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)
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773
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Subtotal
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(1,802
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)
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6,637
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Interest and dividend revenues
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15,787
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10,651
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Less interest expense
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13,408
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9,424
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Net interest profit
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2,379
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1,227
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Gain on merger
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-
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1,969
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Total net revenues
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577
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9,833
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Non-interest expenses
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Compensation and benefits
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1,992
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3,942
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Communications and technology
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499
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484
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Brokerage, clearing, and exchange fees
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365
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278
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Occupancy and related depreciation
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297
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259
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Professional fees
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243
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223
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Advertising and market development
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182
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163
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Expenses of consolidated investments
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68
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142
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Office supplies and postage
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55
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53
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Other
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341
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199
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Total Non-Interest Expenses
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4,042
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5,743
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(Loss)/earnings from continuing operations before income
taxes
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(3,465
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)
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4,090
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Income tax (benefit)/expense
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(1,199
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)
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1,071
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Net (loss)/earnings from continuing operations
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(2,266
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)
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3,019
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Discontinued operations:
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Earnings from discontinued operations
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38
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38
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Income tax expense
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13
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12
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Net earnings from discontinued operations
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25
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26
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Net (loss)/earnings
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$
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(2,241
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)
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$
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3,045
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Preferred stock dividends
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73
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50
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Net (loss)/earnings applicable to common stockholders
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$
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(2,314
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)
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$
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2,995
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Basic (loss)/earnings per common share from continuing operations
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$
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(2.85
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)
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$
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3.47
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Basic earnings per common share from discontinued operations
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0.03
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0.03
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Basic (loss)/earnings per common share
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$
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(2.82
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)
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$
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3.50
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Diluted (loss)/earnings per common share from continuing
operations
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$
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(2.85
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)
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$
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3.14
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Diluted earnings per common share from discontinued operations
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0.03
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0.03
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Diluted (loss)/earnings per common share
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$
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(2.82
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)
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$
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3.17
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Dividend paid per common share
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$
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0.35
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$
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0.25
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Average shares used in computing earnings per common share
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Basic
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821.6
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855.8
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Diluted
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821.6
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945.3
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See Notes to Condensed
Consolidated Financial Statements.
4
Merrill
Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(Unaudited)
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For the Nine Months
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Ended
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Sept. 28,
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Sept. 29,
|
(In millions, except per share amounts)
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|
2007
|
|
2006
|
|
Net revenues
|
|
|
|
|
|
|
|
|
Principal transactions
|
|
$
|
351
|
|
|
$
|
4,841
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|
Commissions
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|
|
5,360
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|
4,462
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|
Investment banking
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|
|
4,333
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|
|
|
3,166
|
|
Managed accounts and other fee-based revenues
|
|
|
4,038
|
|
|
|
5,047
|
|
Revenues from consolidated investments
|
|
|
772
|
|
|
|
500
|
|
Other
|
|
|
880
|
|
|
|
2,436
|
|
|
|
|
|
|
|
|
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|
Subtotal
|
|
|
15,734
|
|
|
|
20,452
|
|
|
|
|
|
|
|
|
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Interest and dividend revenues
|
|
|
43,346
|
|
|
|
28,928
|
|
Less interest expense
|
|
|
39,055
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|
|
|
25,500
|
|
|
|
|
|
|
|
|
|
|
Net interest profit
|
|
|
4,291
|
|
|
|
3,428
|
|
|
|
|
|
|
|
|
|
|
Gain on merger
|
|
|
-
|
|
|
|
1,969
|
|
|
|
|
|
|
|
|
|
|
Total Net Revenues
|
|
|
20,025
|
|
|
|
25,849
|
|
|
|
|
|
|
|
|
|
|
Non-Interest Expenses
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
|
11,640
|
|
|
|
13,662
|
|
Communications and technology
|
|
|
1,462
|
|
|
|
1,365
|
|
Brokerage, clearing, and exchange fees
|
|
|
1,021
|
|
|
|
803
|
|
Occupancy and related depreciation
|
|
|
838
|
|
|
|
749
|
|
Professional fees
|
|
|
711
|
|
|
|
617
|
|
Advertising and market development
|
|
|
540
|
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|
|
498
|
|
Expenses of consolidated investments
|
|
|
170
|
|
|
|
334
|
|
Office supplies and postage
|
|
|
170
|
|
|
|
167
|
|
Other
|
|
|
910
|
|
|
|
687
|
|
|
|
|
|
|
|
|
|
|
Total Non-Interest Expenses
|
|
|
17,462
|
|
|
|
18,882
|
|
|
|
|
|
|
|
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|
|
Earnings from continuing operations before income taxes
|
|
|
2,563
|
|
|
|
6,967
|
|
Income tax expense
|
|
|
592
|
|
|
|
1,883
|
|
|
|
|
|
|
|
|
|
|
Net earnings from continuing operations
|
|
|
1,971
|
|
|
|
5,084
|
|
|
|
|
|
|
|
|
|
|
Discontinued operations:
|
|
|
|
|
|
|
|
|
Earnings from discontinued operations
|
|
|
128
|
|
|
|
103
|
|
Income tax expense
|
|
|
43
|
|
|
|
34
|
|
|
|
|
|
|
|
|
|
|
Net earnings from discontinued operations
|
|
|
85
|
|
|
|
69
|
|
|
|
|
|
|
|
|
|
|
Net Earnings
|
|
$
|
2,056
|
|
|
$
|
5,153
|
|
Preferred Stock Dividends
|
|
|
197
|
|
|
|
138
|
|
|
|
|
|
|
|
|
|
|
Net Earnings Applicable to Common Stockholders
|
|
$
|
1,859
|
|
|
$
|
5,015
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share from continuing operations
|
|
$
|
2.13
|
|
|
$
|
5.65
|
|
Basic earnings per common share from discontinued operations
|
|
|
0.10
|
|
|
|
0.08
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share
|
|
$
|
2.23
|
|
|
$
|
5.73
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per common share from continuing operations
|
|
$
|
1.94
|
|
|
$
|
5.12
|
|
Diluted earnings per common share from discontinued operations
|
|
|
0.09
|
|
|
|
0.07
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per common share
|
|
$
|
2.03
|
|
|
$
|
5.19
|
|
|
|
|
|
|
|
|
|
|
Dividend paid per common share
|
|
$
|
1.05
|
|
|
$
|
0.75
|
|
|
|
|
|
|
|
|
|
|
Average Shares Used in Computing Earnings Per Common Share
|
|
|
|
|
|
|
|
|
Basic
|
|
|
832.2
|
|
|
|
875.0
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
916.3
|
|
|
|
966.6
|
|
|
|
|
|
|
|
|
|
|
See Notes to Condensed
Consolidated Financial Statements.
5
Merrill
Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
(dollars in millions)
|
|
2007
|
|
2006
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
46,850
|
|
|
$
|
32,109
|
|
|
|
|
|
|
|
|
|
|
Cash and securities segregated for regulatory purposes or
deposited with clearing organizations
|
|
|
20,032
|
|
|
|
13,449
|
|
|
|
|
|
|
|
|
|
|
Securities financing transactions
|
|
|
|
|
|
|
|
|
Receivables under resale agreements (includes $110,472 measured
at fair value in 2007 in accordance with SFAS No. 159)
|
|
|
219,849
|
|
|
|
178,368
|
|
Receivables under securities borrowed transactions
|
|
|
172,479
|
|
|
|
118,610
|
|
|
|
|
|
|
|
|
|
|
|
|
|
392,328
|
|
|
|
296,978
|
|
|
|
|
|
|
|
|
|
|
Trading assets, at fair value (includes securities
pledged as collateral that can be sold or repledged of $73,788
in 2007 and $58,966 in 2006)
|
|
|
|
|
|
|
|
|
Equities and convertible debentures
|
|
|
66,290
|
|
|
|
48,527
|
|
Mortgages, mortgage-backed, and asset-backed
|
|
|
56,342
|
|
|
|
44,401
|
|
Contractual agreements
|
|
|
53,307
|
|
|
|
32,100
|
|
Corporate debt and preferred stock
|
|
|
40,499
|
|
|
|
32,854
|
|
Non-U.S.
governments and agencies
|
|
|
18,033
|
|
|
|
21,075
|
|
U.S. Government and agencies
|
|
|
13,647
|
|
|
|
13,086
|
|
Municipals and money markets
|
|
|
6,443
|
|
|
|
7,243
|
|
Commodities and related contracts
|
|
|
4,552
|
|
|
|
4,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
259,113
|
|
|
|
203,848
|
|
|
|
|
|
|
|
|
|
|
Investment securities (includes $3,534 measured at fair
value in 2007 in accordance with SFAS No. 159)
|
|
|
92,790
|
|
|
|
83,410
|
|
|
|
|
|
|
|
|
|
|
Securities received as collateral
|
|
|
45,785
|
|
|
|
24,929
|
|
|
|
|
|
|
|
|
|
|
Other receivables
|
|
|
|
|
|
|
|
|
Customers (net of allowance for doubtful accounts of $40 in 2007
and $41 in 2006)
|
|
|
61,400
|
|
|
|
49,427
|
|
Brokers and dealers
|
|
|
26,473
|
|
|
|
18,900
|
|
Interest and other
|
|
|
29,914
|
|
|
|
21,054
|
|
|
|
|
|
|
|
|
|
|
|
|
|
117,787
|
|
|
|
89,381
|
|
|
|
|
|
|
|
|
|
|
Loans, notes, and mortgages (net of allowances for loan
losses of $588 in 2007 and $478 in 2006) (includes $987 measured
at fair value in 2007 in accordance with SFAS No. 159)
|
|
|
94,185
|
|
|
|
73,029
|
|
|
|
|
|
|
|
|
|
|
Separate accounts assets
|
|
|
12,590
|
|
|
|
12,314
|
|
|
|
|
|
|
|
|
|
|
Equipment and facilities (net of accumulated depreciation
and amortization of $5,380 in 2007 and $5,213 in 2006)
|
|
|
2,956
|
|
|
|
2,924
|
|
|
|
|
|
|
|
|
|
|
Goodwill and other intangible assets
|
|
|
4,891
|
|
|
|
2,457
|
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
7,881
|
|
|
|
6,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
1,097,188
|
|
|
$
|
841,299
|
|
|
|
|
|
|
|
|
|
|
6
Merrill
Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
(dollars in millions, except per
share amount)
|
|
2007
|
|
2006
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities financing transactions
|
|
|
|
|
|
|
|
|
Payables under repurchase agreements (includes $117,536 measured
at fair value in 2007 in accordance with SFAS No. 159)
|
|
$
|
298,585
|
|
|
$
|
222,624
|
|
Payables under securities loaned transactions
|
|
|
46,961
|
|
|
|
43,492
|
|
|
|
|
|
|
|
|
|
|
|
|
|
345,546
|
|
|
|
266,116
|
|
|
|
|
|
|
|
|
|
|
Short-term borrowings
|
|
|
27,078
|
|
|
|
18,110
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
94,977
|
|
|
|
84,124
|
|
|
|
|
|
|
|
|
|
|
Trading liabilities, at fair value
|
|
|
|
|
|
|
|
|
Contractual agreements
|
|
|
61,674
|
|
|
|
38,434
|
|
Equities and convertible debentures
|
|
|
31,505
|
|
|
|
23,268
|
|
Non-U.S.
governments and agencies
|
|
|
13,677
|
|
|
|
13,385
|
|
U.S. Government and agencies
|
|
|
9,815
|
|
|
|
12,510
|
|
Corporate debt and preferred stock
|
|
|
6,973
|
|
|
|
6,323
|
|
Commodities and related contracts
|
|
|
2,447
|
|
|
|
3,606
|
|
Municipals, money markets and other
|
|
|
716
|
|
|
|
1,336
|
|
|
|
|
|
|
|
|
|
|
|
|
|
126,807
|
|
|
|
98,862
|
|
|
|
|
|
|
|
|
|
|
Obligation to return securities received as collateral
|
|
|
45,785
|
|
|
|
24,929
|
|
|
|
|
|
|
|
|
|
|
Other payables
|
|
|
|
|
|
|
|
|
Customers
|
|
|
62,942
|
|
|
|
49,414
|
|
Brokers and dealers
|
|
|
25,130
|
|
|
|
24,282
|
|
Interest and other
|
|
|
45,018
|
|
|
|
36,096
|
|
|
|
|
|
|
|
|
|
|
|
|
|
133,090
|
|
|
|
109,792
|
|
|
|
|
|
|
|
|
|
|
Liabilities of insurance subsidiaries
|
|
|
2,655
|
|
|
|
2,801
|
|
|
|
|
|
|
|
|
|
|
Separate accounts liabilities
|
|
|
12,590
|
|
|
|
12,314
|
|
|
|
|
|
|
|
|
|
|
Long-term borrowings (includes $70,129 measured at fair
value in 2007 in accordance with SFAS No. 159)
|
|
|
264,880
|
|
|
|
181,400
|
|
|
|
|
|
|
|
|
|
|
Junior subordinated notes (related to trust preferred
securities)
|
|
|
5,154
|
|
|
|
3,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
1,058,562
|
|
|
|
802,261
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred Stockholders Equity (liquidation
preference of $30,000 per share; issued:
|
|
|
|
|
|
|
|
|
2007 - 155,000 shares; 2006
105,000 shares; liquidation preference of $1,000 per share;
issued: 2007 - 115,000 shares)
|
|
|
4,754
|
|
|
|
3,145
|
|
Common Stockholders Equity
|
|
|
|
|
|
|
|
|
Shares exchangeable into common stock
|
|
|
39
|
|
|
|
39
|
|
Common stock (par value
$1.331/3
per share; authorized: 3,000,000,000 shares; issued:
2007 - 1,269,200,520 shares; 2006 -
1,215,381,006 shares)
|
|
|
1,691
|
|
|
|
1,620
|
|
Paid-in capital
|
|
|
22,809
|
|
|
|
18,919
|
|
Accumulated other comprehensive loss (net of tax)
|
|
|
(1,330
|
)
|
|
|
(784
|
)
|
Retained earnings
|
|
|
33,949
|
|
|
|
33,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57,158
|
|
|
|
53,011
|
|
Less: Treasury stock, at cost (2007 -
416,941,969 shares; 2006 - 350,697,271 shares)
|
|
|
23,286
|
|
|
|
17,118
|
|
|
|
|
|
|
|
|
|
|
Total Common Stockholders Equity
|
|
|
33,872
|
|
|
|
35,893
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Stockholders Equity
|
|
|
38,626
|
|
|
|
39,038
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders Equity
|
|
$
|
1,097,188
|
|
|
$
|
841,299
|
|
|
|
|
|
|
|
|
|
|
See Notes to Condensed
Consolidated Financial Statements.
7
Merrill
Lynch & Co., Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
|
|
|
Sept. 28,
|
|
Sept. 29,
|
(dollars in millions)
|
|
2007
|
|
2006
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
2,056
|
|
|
$
|
5,153
|
|
Non-cash items included in earnings:
|
|
|
|
|
|
|
|
|
Gain on merger
|
|
|
-
|
|
|
|
(1,969
|
)
|
Valuation adjustments for U.S. sub-prime residential
mortgage-related and ABS CDO activities
|
|
|
7,882
|
|
|
|
-
|
|
Depreciation and amortization
|
|
|
633
|
|
|
|
378
|
|
Share-based compensation expense
|
|
|
1,220
|
|
|
|
2,828
|
|
Deferred taxes
|
|
|
(1,380
|
)
|
|
|
(569
|
)
|
Policyholder reserves
|
|
|
8
|
|
|
|
92
|
|
Undistributed earnings from equity investments
|
|
|
(814
|
)
|
|
|
(304
|
)
|
Other
|
|
|
374
|
|
|
|
612
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Trading assets
|
|
|
(62,331
|
)
|
|
|
(35,461
|
)
|
Cash and securities segregated for regulatory purposes
|
|
|
|
|
|
|
|
|
or deposited with clearing organizations
|
|
|
(6,500
|
)
|
|
|
(1,952
|
)
|
Receivables under resale agreements
|
|
|
(41,479
|
)
|
|
|
(26,871
|
)
|
Receivables under securities borrowed transactions
|
|
|
(53,869
|
)
|
|
|
(12,979
|
)
|
Customer receivables
|
|
|
(11,977
|
)
|
|
|
(3,795
|
)
|
Brokers and dealers receivables
|
|
|
(7,574
|
)
|
|
|
(1,210
|
)
|
Proceeds from loans, notes, and mortgages held for sale
|
|
|
57,797
|
|
|
|
28,152
|
|
Other changes in loans, notes, and mortgages held for sale
|
|
|
(71,534
|
)
|
|
|
(33,882
|
)
|
Trading liabilities
|
|
|
5,096
|
|
|
|
2,954
|
|
Payables under repurchase agreements
|
|
|
75,961
|
|
|
|
37,915
|
|
Payables under securities loaned transactions
|
|
|
3,469
|
|
|
|
(1,255
|
)
|
Customer payables
|
|
|
13,495
|
|
|
|
8,846
|
|
Brokers and dealers payables
|
|
|
744
|
|
|
|
13,577
|
|
Other, net
|
|
|
8,838
|
|
|
|
4,593
|
|
|
|
|
|
|
|
|
|
|
Cash used for operating activities
|
|
|
(79,885
|
)
|
|
|
(15,147
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Proceeds from (payments for):
|
|
|
|
|
|
|
|
|
Maturities of available-for-sale securities
|
|
|
10,511
|
|
|
|
9,908
|
|
Sales of available-for-sale securities
|
|
|
25,830
|
|
|
|
13,413
|
|
Purchases of available-for-sale securities
|
|
|
(43,633
|
)
|
|
|
(22,381
|
)
|
Maturities of held-to-maturity securities
|
|
|
2
|
|
|
|
2
|
|
Purchases of held-to-maturity securities
|
|
|
(2
|
)
|
|
|
(3
|
)
|
Loans, notes, and mortgages held for investment
|
|
|
4,830
|
|
|
|
682
|
|
Acquisitions, net of cash
|
|
|
(1,826
|
)
|
|
|
(604
|
)
|
Other investments
|
|
|
(6,711
|
)
|
|
|
(1,196
|
)
|
Transfer of cash balances related to merger
|
|
|
-
|
|
|
|
(651
|
)
|
Equipment and facilities, net
|
|
|
(364
|
)
|
|
|
(734
|
)
|
|
|
|
|
|
|
|
|
|
Cash used for investing activities
|
|
|
(11,363
|
)
|
|
|
(1,564
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from (payments for):
|
|
|
|
|
|
|
|
|
Commercial paper and short-term borrowings
|
|
|
8,480
|
|
|
|
5,356
|
|
Issuance and resale of long-term borrowings
|
|
|
137,235
|
|
|
|
53,265
|
|
Settlement and repurchases of long-term borrowings
|
|
|
(60,620
|
)
|
|
|
(27,556
|
)
|
Deposits
|
|
|
874
|
|
|
|
(2,114
|
)
|
Derivative financing transactions
|
|
|
22,849
|
|
|
|
8,219
|
|
Issuance of common stock
|
|
|
760
|
|
|
|
1,148
|
|
Issuance of preferred stock, net
|
|
|
1,494
|
|
|
|
360
|
|
Common stock repurchases
|
|
|
(5,272
|
)
|
|
|
(6,321
|
)
|
Other common stock transactions
|
|
|
670
|
|
|
|
585
|
|
Excess tax benefits related to share-based compensation
|
|
|
643
|
|
|
|
386
|
|
Dividends
|
|
|
(1,124
|
)
|
|
|
(835
|
)
|
|
|
|
|
|
|
|
|
|
Cash provided by financing activities
|
|
|
105,989
|
|
|
|
32,493
|
|
|
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents
|
|
|
14,741
|
|
|
|
15,782
|
|
Cash and cash equivalents, beginning of period
|
|
|
32,109
|
|
|
|
14,586
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
46,850
|
|
|
$
|
30,368
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$
|
1,391
|
|
|
$
|
2,134
|
|
Interest
|
|
|
38,078
|
|
|
|
24,976
|
|
Non-cash investing and financing activities:
The investment recorded in connection with the merger of the
MLIM business with BlackRock in September 2006 totaled
$7.7 billion.
The book value of net asset transfers, derecognition of goodwill
and other adjustments totaled $4.9 billion.
Issuances of Common Stock and Preferred Stock of approximately
$865 million and $115 million, respectively, related
to the First Republic Bank acquisition in September 2007.
8
Merrill
Lynch & Co., Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 28, 2007
Note 1. Summary of
Significant Accounting Policies
For a complete discussion of Merrill Lynchs accounting
policies, refer to the Annual Report on
Form 10-K
for the year ended December 29, 2006 (2006 Annual
Report).
Basis of
Presentation
The Condensed Consolidated Financial Statements include the
accounts of Merrill Lynch & Co., Inc.
(ML & Co.) and subsidiaries (collectively,
Merrill Lynch). The Condensed Consolidated Financial
Statements are presented in accordance with U.S. Generally
Accepted Accounting Principles, which include industry
practices. Intercompany transactions and balances have been
eliminated. The interim Condensed Consolidated Financial
Statements for the three- and nine-month periods are unaudited;
however, in the opinion of Merrill Lynch management, all
adjustments (consisting of normal recurring accruals) necessary
for a fair statement of the Condensed Consolidated Financial
Statements have been included.
These unaudited Condensed Consolidated Financial Statements
should be read in conjunction with the audited Consolidated
Financial Statements included in the 2006 Annual Report. The
nature of Merrill Lynchs business is such that the results
of any interim period are not necessarily indicative of results
for a full year. In presenting the Condensed Consolidated
Financial Statements, management makes estimates that affect the
reported amounts and disclosures in the financial statements.
Estimates, by their nature, are based on judgment and available
information. Therefore, actual results could differ from those
estimates and could have a material impact on the Condensed
Consolidated Financial Statements, and it is possible that such
changes could occur in the near term. Certain reclassifications
have been made to the prior period financial statements to
conform to the current period presentation.
Merrill Lynch offers a broad array of products and services to
its diverse client base of individuals, small to mid-size
businesses, employee benefit plans, corporations, financial
institutions, and governments around the world. These products
and services are offered from a number of locations globally. In
some cases, the same or similar products and services may be
offered to both individual and institutional clients, utilizing
the same infrastructure. In other cases, a single infrastructure
may be used to support multiple products and services offered to
clients. When Merrill Lynch analyzes its profitability, it does
not focus on the profitability of a single product or service.
Instead, Merrill Lynch looks at the profitability of businesses
offering an array of products and services to various types of
clients. The profitability of the products and services offered
to individuals, small to mid-size businesses, and employee
benefit plans is analyzed separately from the profitability of
products and services offered to corporations, financial
institutions, and governments, regardless of whether there is
commonality in products and services infrastructure. As such,
Merrill Lynch does not separately disclose the costs associated
with the products and services sold or general and
administrative costs either in total or by product.
When determining the prices for products and services, Merrill
Lynch considers multiple factors, including prices being offered
in the market for similar products and services, the
competitiveness of its pricing compared to competitors, the
profitability of its businesses and its overall profitability,
as well as the profitability, creditworthiness, and importance
of the overall client relationships.
9
Shared expenses that are incurred to support products and
services and infrastructures are allocated to the businesses
based on various methodologies, which may include headcount,
square footage, and certain other criteria. Similarly, certain
revenues may be shared based upon agreed methodologies. When
looking at the profitability of various businesses, Merrill
Lynch considers all expenses incurred, including overhead and
the costs of shared services, as all are considered integral to
the operation of the businesses.
Discontinued
Operations
On August 13, 2007, Merrill Lynch announced that it had
agreed to sell Merrill Lynch Life Insurance Company and ML Life
Insurance Company of New York (together Merrill Lynch
Insurance Group or MLIG). Consequently, the
financial results of MLIG are reported as discontinued
operations for all periods presented. The results of MLIG were
formerly reported in the Global Wealth Management business
segment. Refer to Note 17 to the Condensed Consolidated
Financial Statements for additional information.
Consolidation
Accounting Policies
The Condensed Consolidated Financial Statements include the
accounts of Merrill Lynch, whose subsidiaries are generally
controlled through a majority voting interest. In certain cases,
Merrill Lynch subsidiaries may also be consolidated based on a
risks and rewards approach. Merrill Lynch does not consolidate
those special purpose entities that meet the criteria of a
qualified special purpose entity (QSPE).
Merrill Lynch determines whether it is required to consolidate
an entity by first evaluating whether the entity qualifies as a
voting rights entity (VRE), a variable interest
entity (VIE), or a QSPE.
VREs In accordance with the guidance in Financial
Accounting Standards Board (FASB) Interpretation
No. 46, Consolidation of Variable Interest
Entities an interpretation of ARB No. 51
(FIN 46R), VREs are defined to include
entities that have both equity at risk that is sufficient to
fund future operations and have equity investors with decision
making ability that absorb the majority of the expected losses
and expected returns of the entity. In accordance with Statement
of Financial Accounting Standards (SFAS)
No. 94, Consolidation of All Majority-Owned Subsidiaries
(SFAS No. 94), Merrill Lynch generally
consolidates those VREs where it holds a controlling financial
interest. For investments in limited partnerships and certain
limited liability corporations that Merrill Lynch does not
control, Merrill Lynch applies Emerging Issues Task Force
(EITF)
Topic D-46,
Accounting for Limited Partnership Investments, which
requires use of the equity method of accounting for investors
that have more than a minor influence, which is typically
defined as an investment of greater than 3% of the outstanding
equity in the entity. For more traditional corporate structures,
in accordance with Accounting Principles Board Opinion
No. 18, The Equity Method of Accounting for Investments
in Common Stock, Merrill Lynch applies the equity method of
accounting where it has significant influence over the investee.
Significant influence can be evidenced by a significant
ownership interest (which is generally defined as voting
interest of 20% to 50%), significant board of director
representation, or other contracts and arrangements.
VIEs Those entities that do not meet the VRE
criteria as defined in FIN 46R are generally analyzed for
consolidation as either VIEs or QSPEs. Merrill Lynch
consolidates those VIEs in which it absorbs the majority of the
variability in expected losses
and/or the
variability in expected returns of the entity as required by
FIN 46R. Merrill Lynch relies on a quantitative
and/or
qualitative analysis, including an analysis of the design of the
entity, to determine if it is the primary beneficiary of the VIE
and
10
therefore must consolidate the entity. Merrill Lynch reassesses
whether it is the primary beneficiary of a VIE upon the
occurrence of a reconsideration event.
QSPEs QSPEs are passive entities with significantly
limited permitted activities. QSPEs are generally used as
securitization vehicles and are limited in the type of assets
they may hold, the derivatives that they can enter into and the
level of discretion they may exercise through servicing
activities. In accordance with SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities
(SFAS No. 140), and FIN 46R,
Merrill Lynch does not consolidate QSPEs.
Revenue
Recognition
Principal transactions revenues include both realized and
unrealized gains and losses on trading assets, trading
liabilities and investment securities classified as trading
investments. Gains and losses are recognized on a trade date
basis.
Commissions revenues include commissions, mutual fund
distribution fees and contingent deferred sales charge revenue,
which are all accrued as earned. Commissions revenues also
include mutual fund redemption fees, which are recognized at the
time of redemption. Commissions revenues earned from certain
customer equity transactions are recorded net of related
brokerage, clearing and exchange fees.
Investment banking revenues include underwriting revenues and
fees for merger and acquisition advisory services, which are
accrued when services for the transactions are substantially
completed. Underwriting revenues are presented net of
transaction-related expenses. Transaction-related expenses are
deferred to match revenue recognition.
Managed accounts and other fee-based revenues primarily consist
of asset-priced portfolio service fees earned from the
administration of separately managed accounts and other
investment accounts for retail investors, annual account fees,
and certain other account-related fees. In addition, until the
merger of our Merrill Lynch Investment Management
(MLIM) business with BlackRock, Inc.
(BlackRock) at the end of the third quarter of 2006
(BlackRock merger), managed accounts and other
fee-based revenues also included fees earned from the management
and administration of retail mutual funds and institutional
funds such as pension assets, and performance fees earned on
certain separately managed accounts and institutional money
management arrangements. For additional information regarding
the BlackRock merger, refer to Note 2 of the 2006 Annual
Report.
Revenues from consolidated investments and expenses of
consolidated investments are related to special purpose entities
that are consolidated under SFAS No. 94 and
FIN 46R.
Other revenues include gains/(losses) on investment securities,
including unrealized losses on certain available-for-sale
securities, dividends on cost method investments, income from
equity method investments, gains/(losses) on private equity
investments that are held for capital appreciation
and/or
current income, gains/(losses) on loans and other miscellaneous
items.
Contractual interest and dividends received and paid on trading
assets and trading liabilities, excluding derivatives, are
recognized on an accrual basis as a component of interest and
dividend revenues and interest expense. Interest and dividends
on investment securities are recognized on an accrual basis as a
component of interest and dividend revenues. Interest related to
loans, notes, and mortgages, securities financing activities and
certain short- and long-term borrowings are recorded on an
accrual basis with related interest recorded as interest revenue
or interest expense, as applicable. Contractual interest expense
on structured notes is recorded as a component of interest
expense.
11
Financial
Instruments
Merrill Lynch accounts for a significant portion of its
financial instruments at fair value or considers fair value in
their measurement. Merrill Lynch accounts for certain financial
assets and liabilities at fair value under various accounting
literature, including SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities
(SFAS No. 115),
SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS No. 133),
and SFAS No. 159, Fair Value Option for Certain
Financial Assets and Liabilities
(SFAS No. 159). Merrill Lynch also
accounts for certain assets at fair value under applicable
industry guidance, namely broker-dealer and investment company
accounting guidance.
Merrill Lynch early adopted the provisions of
SFAS No. 157, Fair Value Measurements
(SFAS No. 157) in the first quarter of
2007. SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, establishes a fair value
hierarchy based on the quality of inputs used to measure fair
value and enhances disclosure requirements for fair value
measurements. SFAS No. 157 nullifies the guidance
provided by EITF Issue
No. 02-3,
Issues Involved in Accounting for Derivative Contracts Held
for Trading Purposes and Contracts Involved in Energy Trading
and Risk Management Activities
(EITF 02-3),
which prohibited recognition of day one gains or losses on
derivative transactions where model inputs that significantly
impact valuation are not observable.
Merrill Lynch also early adopted SFAS No. 159 in the
first quarter of 2007 for certain financial instruments. Such
instruments include certain structured debt, repurchase and
resale agreements, loans, available-for-sale securities and
non-qualifying investments. The changes in fair value of these
instruments are recorded in either principal transactions
revenues or other revenues in the Condensed Consolidated
Statement of Earnings. See Note 3 to the Condensed
Consolidated Financial Statements for further information.
In presenting the Condensed Consolidated Financial Statements,
management makes estimates regarding valuations of assets and
liabilities requiring fair value measurements. These assets and
liabilities include:
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Trading inventory and investment securities;
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Private equity and principal investments;
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Certain receivables under resale agreements and payables under
repurchase agreements;
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Loans and allowance for loan losses and liabilities recorded for
unrealized losses on unfunded commitments; and
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Certain long-term borrowings, primarily structured debt.
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A discussion of certain areas in which estimates are a
significant component of the amounts reported in the Condensed
Consolidated Financial Statements follows:
Trading
Assets and Liabilities
Trading assets and liabilities are accounted for at fair value
with realized and unrealized gains and losses reported in
earnings. Fair values of trading securities are based on quoted
market prices, pricing models (utilizing a variety of inputs
including contractual terms, market prices, yield curves, credit
curves, measures of volatility, prepayment rates, and
correlations of such inputs), or managements estimates of
amounts to be realized on settlement. Estimating the fair value
of certain illiquid securities requires significant management
judgment. Merrill Lynch values trading security assets at the
institutional bid price and recognizes bid-offer revenues when
the assets are sold. Trading security liabilities are valued at
the institutional offer price and bid-offer revenues are
recognized when the positions are closed.
12
Fair values for over-the-counter (OTC) derivative
financial instruments, principally forwards, options, and swaps,
represent the present value of amounts estimated to be received
from or paid to a marketplace participant in settlement of these
instruments (i.e., the amount Merrill Lynch would expect to
receive in a derivative asset assignment or would expect to pay
to have a derivative liability assumed). These derivatives are
valued using pricing models based on the net present value of
estimated future cash flows and directly observed prices from
exchange-traded derivatives, other OTC trades, or external
pricing services, while taking into account the
counterpartys credit ratings, or Merrill Lynchs own
credit ratings, as appropriate. Determining the fair value for
OTC derivative contracts can require a significant level of
estimation and management judgment.
New and/or
complex instruments may have immature or limited markets. As a
result, the pricing models used for valuation often incorporate
significant estimates and assumptions that market participants
would use in pricing the instrument, which may impact the
results of operations reported in the Condensed Consolidated
Financial Statements. For long-dated and illiquid contracts,
extrapolation methods are applied to observed market data in
order to estimate inputs and assumptions that are not directly
observable. This enables Merrill Lynch to mark to fair value all
positions consistently when only a subset of prices are directly
observable. Values for OTC derivatives are verified using
observed information about the costs of hedging the risk and
other trades in the market. As the markets for these products
develop, Merrill Lynch continually refines its pricing models to
correlate more closely to the market risk of these instruments.
Prior to adoption of SFAS No. 157, Merrill Lynch
followed the provisions of
EITF 02-3.
Under
EITF 02-3,
recognition of day one gains and losses on derivative
transactions where model inputs that significantly impact
valuation are not observable were prohibited. Day one gains and
losses deferred at inception under
EITF 02-3
were recognized at the earlier of when the valuation of such
derivative became observable or at the termination of the
contract. SFAS No. 157 nullifies this guidance in
EITF 02-3.
Although this guidance in
EITF 02-3
has been nullified, the recognition of significant inception
gains and losses that incorporate unobservable inputs are
reviewed by management to ensure such gains and losses are
derived from observable inputs
and/or
incorporate reasonable assumptions about the unobservable
component, such as implied bid-offer adjustments.
Certain financial instruments recorded at fair value are
initially measured using mid-market prices which results in
gross long and short positions marked-to-market at the same
pricing level prior to the application of position netting. The
resulting net positions are then adjusted to fair value
representing the exit price as defined in
SFAS No. 157. The significant adjustments include:
Liquidity
Merrill Lynch makes adjustments to bring a position from a
mid-market to a bid or offer price, depending upon the net open
position. Merrill Lynch values net long positions at bid prices
and net short positions at offer prices. These adjustments are
based upon either observable or implied bid-offer prices.
Credit
Risk
In determining fair value Merrill Lynch considers both the
credit risk of its counterparties, as well its own
creditworthiness. Credit risk to third parties is generally
mitigated by entering into netting and collateral arrangements.
Net exposure is then measured with consideration of market
observable pricing of a counterpartys credit risk and is
incorporated into the fair value of the respective instruments.
The calculation of the credit adjustment for derivatives is
generally based upon observable credit derivative spreads.
Alternatively, the calculation for cash products generally
considers observable bond spreads.
13
SFAS No. 157 requires that Merrill Lynchs own
creditworthiness be considered when determining the fair value
of an instrument. The approach to measuring the impact of
Merrill Lynchs own credit on an instrument is the same
approach as that used to measure third party credit risk.
Investment
Securities
Marketable
Investments
ML & Co. and certain of its non-broker-dealer
subsidiaries follow the guidance prescribed by
SFAS No. 115 when accounting for investments in debt
and publicly traded equity securities. Merrill Lynch classifies
those debt securities that it has the intent and ability to hold
to maturity as held-to-maturity securities. Held-to-maturity
securities are carried at cost unless a decline in value is
deemed other-than-temporary, in which case the carrying value is
reduced. For Merrill Lynch, the trading classification under
SFAS No. 115 generally includes those securities that
are bought and held principally for the purpose of selling them
in the near term, securities that are economically hedged, or
securities that contain an embedded derivative as defined in
SFAS No. 133. Securities classified as trading are
marked to fair value through earnings. All other qualifying
securities are classified as available-for-sale with unrealized
gains and losses reported in accumulated other comprehensive
loss. Any unrealized losses deemed other-than-temporary are
included in current period earnings and removed from accumulated
other comprehensive loss.
Investment securities are reviewed for other-than-temporary
impairment on a quarterly basis. The determination of
other-than-temporary impairment requires judgment and will
depend on several factors, including but not limited to the
severity and duration of the decline in value of the investment
securities and the financial condition of the issuer. To the
extent that Merrill Lynch has the ability and intent to hold the
investments for a period of time sufficient for a forecasted
market price recovery up to or beyond the cost of the
investment, no impairment charge will be recognized.
Private
Equity Investments
Private equity investments that are not strategic, have defined
exit strategies and are held for capital appreciation
and/or
current income are accounted for under the AICPA Accounting and
Auditing Guide, Investment Companies (the
Guide) and carried at fair value. Additionally, certain
private equity investments that are not accounted for under the
Guide may be carried at fair value under the fair value option
election in SFAS No. 159. Investments are adjusted to
fair value when changes in the underlying fair values are
readily ascertainable, generally based on specific events (for
example recapitalizations and initial public offerings), or by
using other valuation methodologies including expected cash
flows and market comparables of similar companies.
Securities
Financing Transactions
Merrill Lynch enters into repurchase and resale agreements and
securities borrowed and loaned transactions to accommodate
customers and earn residual interest rate spreads (also referred
to as matched-book transactions), obtain securities
for settlement and finance inventory positions.
Resale and repurchase agreements are accounted for as
collateralized financing transactions and may be recorded at
their contractual amounts plus accrued interest or at fair value
under the fair value option election in SFAS No. 159.
Resale and repurchase agreements recorded at fair value are
generally valued based on pricing models that use inputs with
observable levels of price transparency. Changes in the fair
value of resale and repurchase agreements are reflected in
principal transactions
14
revenues and the stated interest coupon is recorded as interest
revenue or interest expense, respectively. For further
information refer to Note 3 to the Condensed Consolidated
Financial Statements.
Merrill Lynchs 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 may
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 offset receivables and payables with the
same counterparty. Merrill Lynch offsets certain repurchase and
resale agreement balances with the same counterparty on the
Condensed Consolidated Balance Sheets.
Merrill Lynch may use securities received as collateral for
resale agreements to satisfy regulatory requirements such as
Rule 15c3-3
of the SEC.
Securities borrowed and loaned transactions 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 fees received or paid
by Merrill Lynch are 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, and
Merrill Lynch may require counterparties to deposit additional
collateral or may return collateral pledged, when appropriate.
All firm-owned securities pledged to counterparties where the
counterparty has the right, by contract or custom, to sell or
repledge the securities are disclosed parenthetically in trading
assets or, if applicable, in investment securities on the
Condensed Consolidated Balance Sheets.
In transactions where Merrill Lynch acts as the lender in a
securities lending agreement and receives securities that can be
pledged or sold as collateral, it recognizes an asset on the
Condensed Consolidated Balance Sheets, representing the
securities received (securities received as collateral), and a
liability for the same amount, representing the obligation to
return those securities (obligation to return securities
received as collateral). The amounts on the Condensed
Consolidated Balance Sheets result from non-cash transactions.
Loans and
Allowance for Loan Losses
Certain loans held by Merrill Lynch are carried at fair value or
lower of cost or fair value, and estimation is required in
determining these fair values. The fair value of loans made in
connection with commercial lending activity, consisting
primarily of senior debt, is primarily estimated using
discounted cash flows or the market value of publicly issued
debt instruments. Merrill Lynchs estimate of fair value
for other loans, notes, and mortgages is determined based on the
individual loan characteristics. For certain homogeneous
categories of loans, including residential mortgages, automobile
loans, and home equity loans, fair value is estimated using
market price quotations, previously executed transactions for
securities backed by similar loans, adjusted for credit risk and
other individual loan characteristics, the value of underlying
collateral, as well as valuation techniques including discounted
cash flow models.
Loans held for investment are carried at cost, less a provision
for loan losses. This provision for loan losses is based on
managements estimate of the amount necessary to maintain
the allowance at a level adequate to absorb probable incurred
loan losses. Managements estimate of loan losses is
influenced
15
by many factors, including adverse situations that may affect
the borrowers ability to repay, current economic
conditions, prior loan loss experience, and the estimated fair
value of any underlying collateral. The fair value of collateral
is generally determined by third-party appraisals in the case of
residential mortgages, quoted market prices for securities, or
other types of estimates for other assets. Managements
estimate of loan losses includes judgment about collectibility
based on available information at the balance sheet date, and
the uncertainties inherent in those underlying assumptions.
While management has based its estimates on the best information
available, future adjustments to the allowance may be necessary
as a result of changes in the economic environment or variances
between actual results and the original assumptions.
Derivatives
A derivative is an instrument whose value is derived from an
underlying instrument or index, such as interest rates, equity
securities, currencies, or credit spreads. Derivatives include
futures, forwards, swaps, or option contracts, or other
financial instruments with similar characteristics. 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 or
currencies). Derivative activity is subject to Merrill
Lynchs overall risk management policies and procedures.
SFAS No. 133, as amended, establishes accounting and
reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts
(embedded derivatives) and for hedging activities.
SFAS No. 133 requires that an entity recognize all
derivatives as either assets or liabilities in the Condensed
Consolidated Balance Sheets and measure those instruments at
fair value. The fair value of all derivatives is recorded on a
net-by-counterparty
basis on the Condensed Consolidated Balance Sheets where
management believes a legal right of setoff exists under an
enforceable netting agreement.
The accounting for changes in fair value of a derivative
instrument depends on its intended use and if it is designated
and qualifies as an accounting hedging instrument.
Merrill Lynch enters into derivatives to facilitate client
transactions, for proprietary trading and financing purposes,
and to manage risk exposures arising from trading assets and
liabilities. Derivatives entered into for these purposes are
recognized at fair value on the Condensed Consolidated Balance
Sheets as trading assets and liabilities in contractual
agreements, and changes in fair value are reported in current
period earnings as principal transactions revenues.
Merrill Lynch also enters into derivatives in order to manage
risk exposures arising from assets and liabilities not carried
at fair value as follows:
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Merrill Lynch routinely issues debt in a variety of maturities
and currencies to achieve the lowest cost financing possible. In
addition, Merrill Lynchs regulated bank entities accept
time deposits of varying rates and maturities. Merrill Lynch
enters into derivative transactions to hedge these liabilities.
Derivatives used most frequently include swap agreements that:
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Convert fixed-rate interest payments into variable payments;
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Change the underlying interest rate basis or reset
frequency; and
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Change the settlement currency of a debt instrument.
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Merrill Lynch enters into hedges on marketable investment
securities to manage the interest rate risk, currency risk, and
net duration of its investment portfolios.
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3.
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Merrill Lynch has fair value hedges of long-term fixed rate
resale and repurchase agreements to manage the interest rate
risk of these assets and liabilities. Subsequent to the adoption
of SFAS No. 159, Merrill Lynch elects to account for
these instruments on a fair value basis rather than apply hedge
accounting.
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Merrill Lynch uses foreign-exchange forward contracts,
foreign-exchange options, currency swaps, and
foreign-currency-denominated debt to hedge its net investments
in foreign operations. These derivatives and cash instruments
are used to mitigate the impact of changes in exchange rates.
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5.
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Merrill Lynch enters into futures, swaps, options and forward
contracts to manage the price risk of certain commodity
inventory.
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Derivatives entered into by Merrill Lynch to hedge its funding,
marketable investment securities and net investments in foreign
subsidiaries are reported at fair value in other assets or
interest and other payables on the Condensed Consolidated
Balance Sheets. Derivatives used to hedge commodity inventory
are included in trading assets and trading liabilities on the
Condensed Consolidated Balance Sheets.
Derivatives that qualify as accounting hedges under the guidance
in SFAS No. 133 are designated on the date they are
entered into as one of the following:
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A hedge of the fair value of a recognized asset or liability
(fair value hedge). Changes in the fair value of
derivatives that are designated and qualify as fair value hedges
of interest rate risk, along with the gain or loss on the hedged
asset or liability that is attributable to the hedged risk, are
recorded in current period earnings as interest revenue or
expense. Changes in the fair value of derivatives that are
designated and qualify as fair value hedges of commodity price
risk, along with the gain or loss on the hedged asset or
liability that is attributable to the hedged risk, are recorded
in current period earnings in principal transactions.
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A hedge of the variability of cash flows to be received or paid
related to a recognized asset or liability (cash
flow hedge). Changes in the fair value of derivatives that
are designated and qualify as cash flow hedges are recorded in
accumulated other comprehensive loss until earnings are affected
by the variability of cash flows of the hedged asset or
liability (e.g., when periodic interest accruals on a
variable-rate asset or liability are recorded in earnings).
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A hedge of a net investment in a foreign operation. Changes in
the fair value of derivatives that are designated and qualify as
hedges of a net investment in a foreign operation are recorded
in the foreign currency translation adjustment account within
accumulated other comprehensive loss. Changes in the fair value
of the hedge instruments that are associated with the difference
between the spot translation rate and the forward translation
rate are recorded in current period earnings in other revenues.
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Merrill Lynch formally assesses, both at the inception of the
hedge and on an ongoing basis, whether the hedging derivatives
are highly effective in offsetting changes in fair value or cash
flows of hedged items. When it is determined that a derivative
is not highly effective as a hedge, Merrill Lynch discontinues
hedge accounting. Under the provisions of
SFAS No. 133, 100% hedge effectiveness is assumed for
those derivatives whose terms meet the conditions of
SFAS No. 133 short-cut method.
As noted above, Merrill Lynch enters into fair value hedges of
interest rate exposure associated with certain investment
securities and debt issuances. Merrill Lynch uses interest rate
swaps to hedge this exposure. Hedge effectiveness testing is
required for certain of these hedging relationships on a
quarterly basis. Merrill Lynch assesses effectiveness on a
prospective basis by comparing the expected change in the price
of the hedge instrument to the expected change in the value of
the hedged item
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under various interest rate shock scenarios. In addition,
Merrill Lynch assesses effectiveness on a retrospective basis
using the dollar-offset ratio approach. When assessing hedge
effectiveness, there are no attributes of the derivatives used
to hedge the fair value exposure that are excluded from the
assessment. Merrill Lynch also enters into fair value hedges of
commodity price risk associated with certain commodity
inventory. For these hedges, Merrill Lynch assesses
effectiveness on a prospective and retrospective basis using
regression techniques. The difference between the spot rate and
the contracted forward rate which represents the time value of
money, is excluded from the assessment of hedge effectiveness
and is recorded in principal transactions revenues.
Ineffectiveness associated with these hedges was immaterial for
all periods presented.
Changes in the fair value of derivatives that are economically
used to hedge non-trading assets and liabilities, but that do
not meet the criteria in SFAS No. 133 to qualify as an
accounting hedge are reported in current period earnings as
either principal transactions revenues, other revenues or
expenses, or interest revenues or expense, depending on the
nature of the transaction.
Hybrid
Financial Instruments
Merrill Lynch issues structured debt instruments that have
coupons or repayment terms linked to the performance of debt or
equity securities, indices, currencies, or commodities,
generally referred to as hybrid debt instruments or structured
notes. The contingent payment components of these obligations
may meet the definition in SFAS No. 133 of an
embedded derivative. Historically, these hybrid debt
instruments were assessed to determine if the embedded
derivative required separate reporting and accounting, and if
so, the embedded derivative was accounted for at fair value and
reported in long-term borrowings on the Condensed Consolidated
Balance Sheets along with the debt obligation. Changes in the
fair value of the embedded derivative and related economic
hedges were reported in principal transactions revenues.
Separating an embedded derivative from its host contract
required careful analysis, judgment, and an understanding of the
terms and conditions of the instrument. Beginning in the first
quarter of 2007, Merrill Lynch elected the fair value option in
SFAS No. 159 for all hybrid debt instruments issued
subsequent to December 29, 2006. Changes in fair value of
the entire hybrid debt instrument are reflected in principal
transactions revenues and the stated interest coupon is recorded
as interest expense. For further information refer to
Note 3 to the Condensed Consolidated Financial Statements.
Merrill Lynch may also purchase financial instruments that
contain embedded derivatives. These instruments may be part of
either trading assets or trading marketable investment
securities. These instruments are generally accounted for at
fair value in their entirety; the embedded derivative is not
separately accounted for, and all changes in fair value are
reported in principal transactions revenues.
Securitization
Activities
In the normal course of business, Merrill Lynch securitizes:
commercial and residential mortgage loans and home equity loans;
municipal, government, and corporate bonds; and other types of
financial assets. Merrill Lynch may retain interests in the
securitized financial assets through holding tranches of the
securitization. In accordance with SFAS No. 140,
Merrill Lynch recognizes transfers of financial assets that
relinquish control as sales to the extent of cash and other
proceeds received. Control is considered to be relinquished when
all of the following conditions have been met:
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a.
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The transferred assets have been legally isolated from the
transferor even in bankruptcy or other receivership;
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b.
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The transferee has the right to pledge or exchange the assets it
received or, if the entity is a QSPE, the beneficial interest
holders have that right; and
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c.
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The transferor does not maintain effective control over the
transferred assets (e.g. the ability to unilaterally cause the
holder to return specific transferred assets).
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Stock
Based Compensation
Merrill Lynch adopted the provisions of Statement No. 123
(revised 2004), Share-Based Payment, a revision of
SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123R) beginning
in the first quarter of 2006. Under SFAS No. 123R,
compensation expenses for share-based awards that do not require
future service are recorded immediately, and share-based awards
that require future service continue to be amortized into
expense over the relevant service period. Merrill Lynch adopted
SFAS No. 123R under the modified prospective method
whereby the provisions of SFAS No. 123R are generally
applied only to share-based awards granted or modified
subsequent to adoption. Thus, for Merrill Lynch,
SFAS No. 123R required the immediate expensing of
share-based awards granted or modified in 2006 to
retirement-eligible employees, including awards that are subject
to non-compete provisions.
Prior to the adoption of SFAS No. 123R, Merrill Lynch
had recognized expense for share-based compensation over the
vesting period stipulated in the grant for all employees. This
included those who had satisfied retirement eligibility criteria
but were subject to a non-compete agreement that applied from
the date of retirement through each applicable vesting period.
Previously, Merrill Lynch had accelerated any unrecognized
compensation cost for such awards if a retirement-eligible
employee left Merrill Lynch. However, because
SFAS No. 123R applies only to awards granted or
modified in 2006, expenses for share-based awards granted prior
to 2006 to employees who were retirement-eligible with respect
to those awards must continue to be amortized over the stated
vesting period.
New
Accounting Pronouncements
In June 2007, the Accounting Standards Executive Committee of
the AICPA issued Statement of Position
07-1,
Clarification of the Scope of the Audit and Accounting Guide
Investment Companies and Accounting by Parent Companies and
Equity Method Investors for Investments in Investment Companies
(SOP 07-1).
The intent of
SOP 07-1
is to clarify which entities are within the scope of the AICPA
Audit and Accounting Guide, Investment Companies (the
Guide). For those entities that are investment
companies under
SOP 07-1,
the SOP also addresses whether the specialized industry
accounting principles of the Guide (referred to as
investment company accounting) should be retained by
the parent company in consolidation or by an investor that has
the ability to exercise significant influence over the
investment company and applies the equity method of accounting
to its investment in the entity. Under
SOP 07-1,
an investment company is generally defined as a separate legal
entity whose business purpose and activity are investing in
multiple substantive investments for current income, capital
appreciation, or both, with investment plans that include exit
strategies. The provisions of
SOP 07-1
as currently drafted are effective for fiscal years beginning on
or after December 15, 2007, with earlier application
permitted. Entities that previously applied the provisions of
the Guide, but that do not meet the provisions of
SOP 07-1
to be an investment company within the scope of the Guide, must
report the effects of adopting
SOP 07-1
prospectively by accounting for their investments in conformity
with applicable generally accepted accounting principles, other
than investment company accounting, as of the date of adoption.
Entities that are investment companies within the scope of the
Guide, but that previously had not followed the provisions of
the Guide, should report the cumulative effect of adopting
SOP 07-1
as an adjustment to beginning retained earnings as of the
beginning of the year in which
SOP 07-1
is adopted. Merrill Lynch is currently evaluating the
19
provisions of
SOP 07-1
and is assessing its potential impact on the Condensed
Consolidated Financial Statements. On October 17, 2007, the
FASB proposed an indefinite delay of the effective dates of
SOP 07-1
to allow the Board to address certain implementation issues that
have arisen and possibly revise
SOP 07-1.
In February 2007, the FASB issued SFAS No. 159, which
provides a fair value option election that allows companies to
irrevocably elect fair value as the initial and subsequent
measurement attribute for certain financial assets and
liabilities. Changes in fair value for assets and liabilities
for which the election is made will be recognized in earnings as
they occur. SFAS No. 159 permits the fair value option
election on an
instrument-by-instrument
basis at initial recognition of an asset or liability or upon an
event that gives rise to a new basis of accounting for that
instrument. SFAS No. 159 is effective as of the
beginning of an entitys first fiscal year that begins
after November 15, 2007. Early adoption is permitted as of
the beginning of a fiscal year that begins on or before
November 15, 2007 provided that the entity makes that
choice in the first 120 days of that fiscal year, has not
yet issued financial statements for any interim period of the
fiscal year of adoption, and also elects to apply the provisions
of SFAS No. 157 (described below). We early adopted
SFAS No. 159 in the first quarter of 2007. In
connection with this adoption management reviewed its treasury
liquidity portfolio and determined that we should decrease our
economic exposure to interest rate risk by eliminating long-term
fixed rate assets from the portfolio and replacing them with
floating rate assets. The fixed rate assets had been classified
as available-for-sale and the unrealized losses related to such
assets had been recorded in accumulated other comprehensive
loss. As a result of the adoption of SFAS No. 159, the
loss related to these assets was removed from accumulated other
comprehensive loss and a loss of approximately
$185 million, net of tax, primarily related to these
assets, was recorded as a cumulative-effect adjustment to
beginning retained earnings, with no material impact to total
stockholders equity. Refer to Note 3 to the Condensed
Consolidated Financial Statements for additional information.
In September 2006, the FASB issued SFAS No. 157.
SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, establishes a fair value
hierarchy based on the quality of inputs used to measure fair
value and enhances disclosure about fair value measurements.
SFAS No. 157 nullifies the guidance provided by
EITF 02-3
that prohibits recognition of day one gains or losses on
derivative transactions where model inputs that significantly
impact valuation are not observable. In addition,
SFAS No. 157 prohibits the use of block discounts for
large positions of unrestricted financial instruments that trade
in an active market and requires an issuer to incorporate
changes in its own credit spreads when determining the fair
value of its liabilities. SFAS No. 157 is effective
for fiscal years beginning after November 15, 2007 with
early adoption permitted provided that the entity has not yet
issued financial statements for that fiscal year, including any
interim periods. The provisions of SFAS No. 157 are to
be applied prospectively, except that the provisions related to
block discounts and existing derivative financial instruments
measured under
EITF 02-3
are to be applied as a one-time cumulative effect adjustment to
opening retained earnings in the year of adoption. We early
adopted SFAS No. 157 in the first quarter of 2007. The
cumulative-effect adjustment to beginning retained earnings was
an increase of approximately $53 million, net of tax,
primarily representing the difference between the carrying
amounts and fair value of derivative contracts valued using the
guidance in
EITF 02-3.
The impact of adopting SFAS No. 157 was not material
to our Condensed Consolidated Statement of Earnings. Refer to
Note 3 to the Condensed Consolidated Financial Statements
for additional information.
In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and
Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106 and 132R
(SFAS No. 158). SFAS No. 158
requires an employer to recognize the overfunded or underfunded
status of its defined benefit pension and other postretirement
plans, measured as the difference between the fair value of plan
assets and the benefit obligation as an asset or liability in
its statement of financial condition. Upon adoption,
SFAS No. 158 requires an entity to recognize
previously unrecognized actuarial gains and losses and prior
service costs within accumulated other
20
comprehensive income (loss), net of tax. In accordance with the
guidance in SFAS No. 158, we adopted this provision of
the standard for year-end 2006. The adoption of
SFAS No. 158 resulted in a net credit of
$65 million to accumulated other comprehensive loss
recorded on the Consolidated Financial Statements at
December 29, 2006. SFAS No. 158 also requires
defined benefit plan assets and benefit obligations to be
measured as of the date of the companys fiscal year-end.
We have historically used a September 30 measurement date. Under
the provisions of SFAS No. 158, we will be required to
change our measurement date to coincide with our fiscal
year-end. This provision of SFAS No. 158 will be
effective for us in fiscal 2008. We are currently assessing the
impact of adoption of this provision of SFAS No. 158
on the Condensed Consolidated Financial Statements.
In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, an Interpretation
of FASB Statement No. 109 (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in a companys financial statements and
prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The
Interpretation also provides guidance on derecognition,
classification, interest and penalties, accounting in interim
periods, disclosure and transition. We adopted FIN 48 in
the first quarter of 2007. The impact of the adoption of
FIN 48 resulted in a decrease to beginning retained
earnings and an increase to the liability for unrecognized tax
benefits of approximately $66 million. See Note 14 to
the Condensed Consolidated Financial Statements for further
information.
In March 2006, the FASB issued Statement No. 156,
Accounting for Servicing of Financial Assets
(SFAS No. 156). SFAS No. 156
amends Statement No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities, to require all separately recognized servicing
assets and servicing liabilities to be initially measured at
fair value, if practicable. SFAS No. 156 also permits
servicers to subsequently measure each separate class of
servicing assets and liabilities at fair value rather than at
the lower of amortized cost or market. For those companies that
elect to measure their servicing assets and liabilities at fair
value, SFAS No. 156 requires the difference between
the carrying value and fair value at the date of adoption to be
recognized as a cumulative-effect adjustment to retained
earnings as of the beginning of the fiscal year in which the
election is made. Prior to adoption of SFAS No. 156 we
accounted for servicing assets and servicing liabilities at the
lower of amortized cost or market. We adopted
SFAS No. 156 on December 30, 2006. We have not
elected to subsequently fair value those mortgage servicing
rights (MSR) held as of the date of adoption or
those MSRs acquired or retained after December 30, 2006.
The adoption of SFAS No. 156 did not have a material
impact on the Condensed Consolidated Financial Statements.
In February 2006, the FASB issued Statement No. 155,
Accounting for Certain Hybrid Financial Instruments an
amendment of FASB Statements No. 133 and 140
(SFAS No. 155). SFAS No. 155
clarifies the bifurcation requirements for certain financial
instruments and permits hybrid financial instruments that
contain a bifurcatable embedded derivative to be accounted for
as a single financial instrument at fair value with changes in
fair value recognized in earnings. This election is permitted on
an
instrument-by-instrument
basis for all hybrid financial instruments held, obtained, or
issued as of the adoption date. At adoption, any difference
between the total carrying amount of the individual components
of the existing bifurcated hybrid financial instruments and the
fair value of the combined hybrid financial instruments is
recognized as a cumulative-effect adjustment to beginning
retained earnings. We adopted SFAS No. 155 on a
prospective basis beginning in the first quarter of 2007. Since
SFAS No. 159 incorporates accounting and disclosure
requirements that are similar to SFAS No. 155, we
apply SFAS No. 159, rather than
SFAS No. 155, to our fair value elections for hybrid
financial instruments.
Merrill Lynch adopted the provisions of Statement No. 123
(revised 2004), Share-Based Payment, a revision of
SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123R) as of the
beginning of the first quarter of 2006. Under
SFAS No. 123R, compensation expenses for share-based
21
awards that do not require future service are recorded
immediately, and share-based awards that require future service
continue to be amortized into expense over the relevant service
period. We adopted SFAS No. 123R under the modified
prospective method whereby the provisions of
SFAS No. 123R are generally applied only to
share-based awards granted or modified subsequent to adoption.
Thus, for Merrill Lynch, SFAS No. 123R required the
immediate expensing of share-based awards granted or modified in
2006 to retirement-eligible employees, including awards that are
subject to non-compete provisions.
Prior to the adoption of SFAS No. 123R, we had
recognized expense for share-based compensation over the vesting
period stipulated in the grant for all employees. This included
those who had satisfied retirement eligibility criteria but were
subject to a non-compete agreement that applied from the date of
retirement through each applicable vesting period. Previously,
we had accelerated any unrecognized compensation cost for such
awards if a retirement-eligible employee left Merrill Lynch.
However, because SFAS No. 123R applies only to awards
granted or modified in 2006, expenses for share-based awards
granted prior to 2006 to employees who were retirement-eligible
with respect to those awards must continue to be amortized over
the stated vesting period.
In addition, beginning with performance year 2006, for which we
granted stock awards in January 2007, we accrued the expense for
future awards granted to retirement-eligible employees over the
award performance year instead of recognizing the entire expense
related to the award on the grant date. Compensation expense for
2006 performance year and all future stock awards granted to
employees not eligible for retirement with respect to those
awards will be recognized over the applicable vesting period.
SFAS No. 123R also requires expected forfeitures of
share-based compensation awards for non-retirement-eligible
employees to be included in determining compensation expense.
Prior to the adoption of SFAS No. 123R, any benefits
of employee forfeitures of such awards were recorded as a
reduction of compensation expense when the employee left Merrill
Lynch and forfeited the award. In the first quarter of 2006, we
recorded a benefit based on expected forfeitures which was not
material to the results of operations for the quarter.
The adoption of SFAS No. 123R resulted in a charge to
compensation expense of approximately $550 million on a
pre-tax basis and $370 million on an after-tax basis in the
first quarter of 2006.
The adoption of SFAS No. 123R, combined with other
business and competitive considerations, prompted us to
undertake a comprehensive review of our stock-based incentive
compensation awards, including vesting schedules and retirement
eligibility requirements, examining their impact to both Merrill
Lynch and its employees. Upon the completion of this review, the
Management Development and Compensation Committee of Merrill
Lynchs Board of Directors determined that to fulfill the
objective of retaining high quality personnel, future stock
grants should contain more stringent retirement provisions.
These provisions include a combination of increased age and
length of service requirements. While the stock awards of
employees who retire continue to vest, retired employees are
subject to continued compliance with the strict non-compete
provisions of those awards. To facilitate transition to the more
stringent future requirements, the terms of most outstanding
stock awards previously granted to employees, including certain
executive officers, were modified, effective March 31,
2006, to permit employees to be immediately eligible for
retirement with respect to those earlier awards. While we
modified the retirement-related provisions of the previous stock
awards, the vesting and non-compete provisions for those awards
remain in force.
Since the provisions of SFAS No. 123R apply to awards
modified in 2006, these modifications required us to record
additional one-time compensation expense in the first quarter of
2006 for the remaining unamortized amount of all awards to
employees who had not previously been retirement-eligible under
the original provisions of those awards.
22
The one-time, non-cash charge associated with the adoption of
SFAS No. 123R, and the policy modifications to
previous awards resulted in a net charge to compensation expense
in the first quarter of 2006 of approximately $1.8 billion
pre-tax, and $1.2 billion after-tax, or a net impact of
$1.34 and $1.21 on basic and diluted earnings per share,
respectively. Policy modifications to previously granted awards
amounted to $1.2 billion of the pre-tax charge and impacted
approximately 6,300 employees.
Prior to the adoption of SFAS No. 123R, we presented
the cash flows related to income tax deductions in excess of the
compensation expense recognized on share-based compensation as
operating cash flows in the Consolidated Statements of Cash
Flows. SFAS No. 123R requires cash flows resulting
from tax deductions in excess of the grant-date fair value of
share-based awards to be included in cash flows from financing
activities. The excess tax benefits of $283 million related
to total share-based compensation included in cash flows from
financing activities in the first quarter of 2006 would have
been included in cash flows from operating activities if we had
not adopted SFAS No. 123R.
As a result of adopting SFAS No. 123R, approximately
$600 million of liabilities associated with the Financial
Advisor Capital Accumulation Award Plan (FACAAP)
were reclassified to stockholders equity. In addition, as
a result of adopting SFAS No. 123R, the unamortized
portion of employee stock grants, which was previously reported
as a separate component of stockholders equity on the
Consolidated Balance Sheets, has been reclassified to Paid-in
capital.
In June 2005, the FASB ratified the consensus reached by the
Emerging Issues Task Force on Issue
04-5,
Determining Whether a General Partner, or the General
Partners as a Group, Controls a Limited Partnership or Similar
Entity When the Limited Partners Have Certain Rights
(EITF 04-5).
EITF 04-5
presumes that a general partner controls a limited partnership,
and should therefore consolidate a limited partnership, unless
the limited partners have the substantive ability to remove the
general partner without cause based on a simple majority vote or
can otherwise dissolve the limited partnership, or unless the
limited partners have substantive participating rights over
decision making. The guidance in
EITF 04-5
was effective beginning in the third quarter of 2005 for all new
limited partnership agreements and any limited partnership
agreements that were modified. For those partnership agreements
that existed at the date
EITF 04-5
was issued, the guidance became effective in the first quarter
of 2006. The adoption of this guidance did not have a material
impact on the Condensed Consolidated Financial Statements.
Note 2. Segment and
Geographic Information
Segment
Information
Merrill Lynchs operations are organized into two business
segments: Global Markets and Investment Banking
(GMI) and Global Wealth Management
(GWM). GMI provides full service global markets and
origination products and services to corporate, institutional,
and government clients around the world. GWM creates and
distributes investment products and services for individuals,
small- to mid-size businesses, and employee benefit plans. Prior
to the fourth quarter of 2006, Merrill Lynch reported its
business activities in three business segments: GMI, Global
Private Client (GPC) and MLIM. Effective with the
merger of the MLIM business with BlackRock in September 2006,
MLIM ceased to exist as a separate business segment. For
information regarding the BlackRock merger refer to Note 2
of the 2006 Annual Report.
Results for the nine months ended September 29, 2006
include one-time compensation expenses incurred in the first
quarter of 2006, as follows: $1.4 billion in GMI,
$281 million in GWM and $109 million in MLIM; refer to
Note 1, New Accounting Pronouncements, to the Condensed
Consolidated Financial Statements for further information on
one-time compensation expenses.
23
The following segment results represent the information that is
used by management in its decision-making processes and are
presented before discontinued operations. Prior period amounts
have been restated to conform to the current period presentation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
|
|
GMI
|
|
GWM
|
|
MLIM(1)
|
|
Corporate(2)
|
|
Total
|
|
|
|
|
Three Months Ended Sept. 28, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest revenues
|
|
$
|
(4,179
|
)
|
|
$
|
2,965
|
|
|
$
|
-
|
|
|
$
|
(588
|
)
|
|
$
|
(1,802
|
)
|
Net interest
profit(3)
|
|
|
1,198
|
|
|
|
573
|
|
|
|
-
|
|
|
|
608
|
|
|
|
2,379
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
|
(2,981
|
)
|
|
|
3,538
|
|
|
|
-
|
|
|
|
20
|
|
|
|
577
|
|
Non-interest expenses
|
|
|
1,458
|
|
|
|
2,585
|
|
|
|
-
|
|
|
|
(1
|
)
|
|
|
4,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax earnings (loss) from continuing
operations(4)
|
|
$
|
(4,439
|
)
|
|
$
|
953
|
|
|
$
|
-
|
|
|
$
|
21
|
|
|
$
|
(3,465
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter-end total assets
|
|
$
|
986,002
|
|
|
$
|
105,868
|
|
|
$
|
-
|
|
|
$
|
5,318
|
|
|
$
|
1,097,188
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended Sept. 29, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest revenues
|
|
$
|
3,664
|
|
|
$
|
2,251
|
|
|
$
|
693
|
|
|
$
|
1,998
|
|
|
$
|
8,606
|
|
Net interest
profit(3)
|
|
|
755
|
|
|
|
489
|
|
|
|
7
|
|
|
|
(24
|
)
|
|
|
1,227
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
|
4,419
|
|
|
|
2,740
|
|
|
|
700
|
|
|
|
1,974
|
|
|
|
9,833
|
|
Non-interest expenses
|
|
|
2,947
|
|
|
|
2,180
|
|
|
|
416
|
|
|
|
200
|
|
|
|
5,743
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax earnings from continuing
operations(4)
|
|
$
|
1,472
|
|
|
$
|
560
|
|
|
$
|
284
|
|
|
$
|
1,774
|
|
|
$
|
4,090
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter-end total assets
|
|
$
|
720,195
|
|
|
$
|
73,690
|
|
|
$
|
8,028
|
|
|
$
|
2,811
|
|
|
$
|
804,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended Sept. 28, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest revenues
|
|
$
|
7,706
|
|
|
$
|
8,680
|
|
|
$
|
-
|
|
|
$
|
(652
|
)
|
|
$
|
15,734
|
|
Net interest
profit(3)
|
|
|
2,042
|
|
|
|
1,746
|
|
|
|
-
|
|
|
|
503
|
|
|
|
4,291
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
|
9,748
|
|
|
|
10,426
|
|
|
|
-
|
|
|
|
(149
|
)
|
|
|
20,025
|
|
Non-interest expenses
|
|
|
9,742
|
|
|
|
7,710
|
|
|
|
-
|
|
|
|
10
|
|
|
|
17,462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax earnings (loss) from continuing
operations(4)
|
|
$
|
6
|
|
|
$
|
2,716
|
|
|
$
|
-
|
|
|
$
|
(159
|
)
|
|
$
|
2,563
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended Sept. 29, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest revenues
|
|
$
|
11,445
|
|
|
$
|
7,087
|
|
|
$
|
1,867
|
|
|
$
|
2,022
|
|
|
$
|
22,421
|
|
Net interest
profit(3)
|
|
|
2,107
|
|
|
|
1,532
|
|
|
|
33
|
|
|
|
(244
|
)
|
|
|
3,428
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenues
|
|
|
13,552
|
|
|
|
8,619
|
|
|
|
1,900
|
|
|
|
1,778
|
|
|
|
25,849
|
|
Non-interest expenses
|
|
|
10,399
|
|
|
|
7,034
|
|
|
|
1,263
|
|
|
|
186
|
|
|
|
18,882
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax earnings from continuing
operations(4)
|
|
$
|
3,153
|
|
|
$
|
1,585
|
|
|
$
|
637
|
|
|
$
|
1,592
|
|
|
$
|
6,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
MLIM ceased to exist in
connection with the BlackRock merger in September
2006. |
(2) |
|
Includes the impact of junior
subordinated notes (related to trust preferred securities) and
other corporate items. In addition, results for the three and
nine months ended September 28, 2007 include an allocation
of non-interest revenues (principal transactions) and net
interest profit among the business and corporate segments
associated with certain hybrid financing instruments accounted
for under SFAS No. 159. Results for the three and nine
months ended September 29, 2006 include $2.0 billion
of non-interest revenues and $202 million of non-interest
expenses related to the closing of the BlackRock
merger. |
(3) |
|
Management views interest
income net of interest expense in evaluating results. |
(4) |
|
See Note 17 to the
Condensed Consolidated Financial Statements for further
information on discontinued operations. |
24
Geographic
Information
Merrill Lynch conducts its business activities through offices
in the following five regions:
|
|
|
|
|
United States;
|
|
|
Europe, Middle East, and Africa;
|
|
|
Pacific Rim;
|
|
|
Latin America; and
|
|
|
Canada.
|
The principal methodologies used in preparing the geographic
information below are as follows:
|
|
|
|
|
Revenues and expenses are generally recorded based on the
location of the employee generating the revenue or incurring the
expense;
|
|
|
Pre-tax earnings from continuing operations include the
allocation of certain shared expenses among regions; and
|
|
|
Intercompany transfers are based primarily on service agreements.
|
The information that follows, in managements judgment,
provides a reasonable representation of each regions
contribution to the consolidated net revenues and pre-tax
earnings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
For the Three Months Ended
|
|
For the Nine Months Ended
|
|
|
|
|
|
Sept. 28, 2007
|
|
Sept. 29,
2006(1)
|
|
Sept. 28, 2007
|
|
Sept. 29,
2006(2)
|
|
|
Net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Europe, Middle East, and Africa
|
|
$
|
1,243
|
|
|
$
|
1,758
|
|
|
$
|
5,464
|
|
|
$
|
5,131
|
|
Pacific Rim
|
|
|
1,482
|
|
|
|
826
|
|
|
|
4,155
|
|
|
|
2,708
|
|
Latin America
|
|
|
374
|
|
|
|
223
|
|
|
|
1,124
|
|
|
|
766
|
|
Canada
|
|
|
75
|
|
|
|
88
|
|
|
|
367
|
|
|
|
273
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-U.S.
|
|
|
3,174
|
|
|
|
2,895
|
|
|
|
11,110
|
|
|
|
8,878
|
|
United
States(3)(5)(6)
|
|
|
(2,597
|
)
|
|
|
6,938
|
|
|
|
8,915
|
|
|
|
16,971
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenues
|
|
$
|
577
|
|
|
$
|
9,833
|
|
|
$
|
20,025
|
|
|
$
|
25,849
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax earnings from continuing
operations(4)(7)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Europe, Middle East, and Africa
|
|
$
|
148
|
|
|
$
|
593
|
|
|
$
|
1,624
|
|
|
$
|
1,291
|
|
Pacific Rim
|
|
|
786
|
|
|
|
313
|
|
|
|
2,068
|
|
|
|
835
|
|
Latin America
|
|
|
180
|
|
|
|
74
|
|
|
|
542
|
|
|
|
313
|
|
Canada
|
|
|
35
|
|
|
|
44
|
|
|
|
209
|
|
|
|
128
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Non-U.S.
|
|
|
1,149
|
|
|
|
1,024
|
|
|
|
4,443
|
|
|
|
2,567
|
|
United
States(3)(5)(6)
|
|
|
(4,614
|
)
|
|
|
3,066
|
|
|
|
(1,880
|
)
|
|
|
4,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total pre-tax (loss)/earnings from continuing
operations(7)
|
|
$
|
(3,465
|
)
|
|
$
|
4,090
|
|
|
$
|
2,563
|
|
|
$
|
6,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
The 2006 third quarter results
include net revenues earned by MLIM of $700 million, which
include non-U.S. net revenues of $378 million. |
(2) |
|
The 2006 nine-month results
include net revenues earned by MLIM of $1.9 billion, which
include non-U.S. net revenues of $1.0 billion. |
(3) |
|
Corporate revenues and
adjustments are reflected in the U.S. region. |
(4) |
|
For the nine months ended
September 29, 2006, pre-tax earnings include the impact of
the $1.8 billion of one-time compensation expenses incurred
in the first quarter of 2006. These costs have been allocated to
each of the regions, accordingly. |
(5) |
|
The U.S. results for the three
and nine months ended September 29, 2006 include
$2.0 billion of revenues and $202 million of
non-interest expenses related to the closing of the BlackRock
merger. |
25
|
|
(6)
|
The U.S. results for the three and nine months ended
September 28, 2007 include $7.9 billion of losses
related to U.S. sub-prime residential mortgage-related and
asset-backed securities (ABS) and collateralized
debt obligations (CDOs) in the third quarter of
2007.
|
(7)
|
See Note 17 to the Condensed Consolidated Financial
Statements for further information on discontinued
operations.
|
Note 3. Fair Value of Financial
Instruments
Merrill Lynch early adopted the provisions of
SFAS No. 157 and SFAS No. 159 in the first
quarter of 2007.
Fair
Value Measurements
SFAS No. 157 defines fair value, establishes a
framework for measuring fair value, establishes a fair value
hierarchy based on the quality of inputs used to measure fair
value, and enhances disclosure requirements for fair value
measurements. Merrill Lynch accounts for a significant portion
of its financial instruments at fair value or considers fair
value in their measurement. Merrill Lynch accounts for certain
financial assets and liabilities at fair value under various
accounting literature, including SFAS No. 115,
SFAS No. 133 and SFAS No. 159. Merrill Lynch
also accounts for certain assets at fair value under applicable
industry guidance, namely broker-dealer and investment company
accounting guidance.
Fair
Value Hierarchy
In accordance with SFAS No. 157, Merrill Lynch has
categorized its financial instruments, based on the priority of
the inputs to the valuation technique, into a three-level fair
value hierarchy. The fair value hierarchy gives the highest
priority to quoted prices in active markets for identical assets
or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). If the inputs used to
measure the financial instruments fall within different levels
of the hierarchy, the categorization is based on the lowest
level input that is significant to the fair value measurement of
the instrument.
Financial assets and liabilities recorded on the Condensed
Consolidated Balance Sheets are categorized based on the inputs
to the valuation techniques as follows:
|
|
Level 1.
|
Financial assets and liabilities whose values are based on
unadjusted quoted prices for identical assets or liabilities in
an active market that Merrill Lynch has the ability to access
(examples include active exchange-traded equity securities,
listed derivatives, most U.S. Government and agency
securities, and certain other sovereign government obligations).
|
|
Level 2.
|
Financial assets and liabilities whose values are based on
quoted prices in markets that are not active or model inputs
that are observable either directly or indirectly for
substantially the full term of the asset or liability.
Level 2 inputs include the following:
|
|
|
|
|
a)
|
Quoted prices for similar assets or liabilities in active
markets (for example, restricted stock);
|
|
|
|
|
b)
|
Quoted prices for identical or similar assets or liabilities in
non-active markets (examples include corporate and municipal
bonds, which trade infrequently);
|
26
|
|
|
|
c)
|
Pricing models whose inputs are observable for substantially the
full term of the asset or liability (examples include most
over-the-counter derivatives, including interest rate and
currency swaps); and
|
|
|
|
|
d)
|
Pricing models whose inputs are derived principally from or
corroborated by observable market data through correlation or
other means for substantially the full term of the asset or
liability (examples include certain residential and commercial
mortgage related assets, including loans, securities and
derivatives).
|
|
|
Level 3. |
Financial assets and liabilities whose values are based on
prices or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value
measurement. These inputs reflect managements own
assumptions about the assumptions a market participant would use
in pricing the asset or liability (examples include certain
private equity investments, certain residential and commercial
mortgage related assets (including loans, securities and
derivatives), and long-dated or complex derivatives including
certain foreign exchange options and long dated options on gas
and power).
|
As required by SFAS No. 157, when the inputs used to
measure fair value fall within different levels of the
hierarchy, the level within which the fair value measurement is
categorized is based on the lowest level input that is
significant to the fair value measurement in its entirety. Thus,
a Level 3 fair value measurement may include inputs that
are observable (Levels 1 and 2) and unobservable
(Level 3). Gains and losses for such assets and liabilities
categorized within the Level 3 table below may include
changes in fair value that are attributable to both observable
inputs (Levels 1 and 2) and unobservable inputs
(Level 3). Further, it should be noted that the following
tables do not take into consideration the effect of offsetting
Level 1 and 2 financial instruments entered into by Merrill
Lynch that economically hedge certain exposures to the
Level 3 positions.
A review of fair value hierarchy classifications is conducted on
a quarterly basis. Changes in the observability of valuation
inputs may result in a reclassification for certain financial
assets or liabilities. Reclassifications impacting Level 3
of the fair value hierarchy are reported as transfers in/out of
the Level 3 category as of the beginning of the quarter in
which the reclassifications occur. During the third quarter of
2007, a significant amount of assets and liabilities was
reclassified from Level 2 to Level 3. This
reclassification primarily relates to U.S. sub-prime
residential mortgage-related assets and liabilities, including
ABS CDOs, due to a significant decrease in the observability of
market pricing for these assets and liabilities in the third
quarter.
27
The following table presents Merrill Lynchs fair value
hierarchy for those assets and liabilities measured at fair
value on a recurring basis as of September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Fair Value Measurements on a Recurring Basis
|
|
|
as of September 28, 2007
|
|
|
|
|
|
|
|
|
Netting
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Adj(1)
|
|
Total
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities segregated for regulatory purposes or deposited with
clearing organizations
|
|
$
|
507
|
|
|
$
|
5,303
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
5,810
|
|
Receivables under resale agreements
|
|
|
-
|
|
|
|
110,472
|
|
|
|
-
|
|
|
|
-
|
|
|
|
110,472
|
|
Trading assets, excluding contractual agreements
|
|
|
89,351
|
|
|
|
102,653
|
|
|
|
9,733
|
|
|
|
-
|
|
|
|
201,737
|
|
Contractual
agreements(2)
|
|
|
4,487
|
|
|
|
272,288
|
|
|
|
11,753
|
|
|
|
(231,152
|
)
|
|
|
57,376
|
|
Investment securities
|
|
|
5,342
|
|
|
|
60,327
|
|
|
|
5,653
|
|
|
|
-
|
|
|
|
71,322
|
|
Loans, notes and mortgages
|
|
|
-
|
|
|
|
980
|
|
|
|
7
|
|
|
|
-
|
|
|
|
987
|
|
Other
assets(3)
|
|
|
8
|
|
|
|
923
|
|
|
|
-
|
|
|
|
(99
|
)
|
|
|
832
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payables under repurchase agreements
|
|
$
|
-
|
|
|
$
|
117,536
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
117,536
|
|
Trading liabilities, excluding contractual agreements
|
|
|
58,900
|
|
|
|
3,755
|
|
|
|
-
|
|
|
|
-
|
|
|
|
62,655
|
|
Contractual
agreements(2)
|
|
|
5,903
|
|
|
|
283,780
|
|
|
|
15,327
|
|
|
|
(240,858
|
)
|
|
|
64,152
|
|
Long-term
borrowings(4)
|
|
|
-
|
|
|
|
71,541
|
|
|
|
612
|
|
|
|
-
|
|
|
|
72,153
|
|
Other payables interest and
other(3)
|
|
|
12
|
|
|
|
619
|
|
|
|
-
|
|
|
|
(4
|
)
|
|
|
627
|
|
|
|
|
|
|
(1) |
|
Represents counterparty and
cash collateral netting. |
(2) |
|
Includes $4.1 billion and
$2.4 billion of derivative assets and liabilities,
respectively, that are included in commodities and related
contracts on the Condensed Consolidated Balance Sheet. |
(3) |
|
Primarily represents certain
derivatives used for non-trading purposes. |
(4) |
|
Includes bifurcated embedded
derivatives carried at fair value. |
Level 3
Assets and Liabilities
Level 3 trading assets primarily include
U.S. sub-prime residential mortgage-related and ABS CDO
positions of $2.5 billion and corporate bonds and loans of
$5.9 billion.
Level 3 contractual agreements (assets) primarily include
long-dated equity derivatives of $4.6 billion and
derivatives on U.S. sub-prime residential mortgage-related
and ABS CDO positions, primarily in the form of credit default
swaps of $3.8 billion.
Level 3 investment securities primarily relate to
U.S. sub-prime residential mortgage-related and ABS CDO
positions of $1.8 billion that are accounted for as trading
securities under SFAS No. 115 as well as certain
private equity and principal investment positions of
$3.6 billion.
Level 3 contractual agreements (liabilities) primarily
relate to long-dated equity derivatives of $5.5 billion and
derivatives on U.S. sub-prime residential mortgage-related
and ABS CDO positions, primarily in the form of total return
swaps and credit default swaps of $8.5 billion.
Level 3 long-term borrowings primarily relate to structured
notes with embedded long-dated currency derivatives of
$544 million.
28
U.S. sub-prime
residential mortgage-related and ABS CDO
activities
During the third quarter of 2007, Merrill Lynch recorded a net
loss of approximately $7.9 billion related to U.S. ABS CDO
securities positions and warehouses, as well as
U.S. sub-prime mortgage-related assets including whole
loans, warehouse lending, residual positions and residential
mortgage-backed securities. These losses primarily related to
assets and liabilities recorded at fair value on a recurring
basis and are included in principal transactions losses in the
table below.
At September 28, 2007, the remaining net exposure for these
positions was approximately $21.5 billion. This
$21.5 billion net exposure includes:
|
|
|
Assets and liabilities, including derivative positions, that are
recorded at fair value on a recurring basis of $5.0 billion
(includes Level 2 and Level 3);
|
|
|
Assets that are recorded at fair value on a non-recurring basis
of $2.3 billion (i.e., loans recorded at lower of cost or
market);
|
|
|
Additional off-balance sheet exposures on derivative positions
(i.e., notional amounts) of $13.6 billion; and
|
|
|
Additional off-balance sheet exposures on loan commitments of
$0.6 billion.
|
In addition, Merrill Lynch through its U.S. bank
subsidiaries has SFAS 115 investment securities and
off-balance sheet arrangements that have exposure to
U.S. sub-prime residential mortgage-related assets of
$5.7 billion at September 28, 2007.
Valuation of these exposures will continue to be impacted by
external market factors including default rates, rating agency
actions, and the prices at which observable market transactions
occur. Merrill Lynchs ability to mitigate its risk by
selling or hedging its exposures is limited by the market
environment. Merrill Lynchs future results may continue to
be materially impacted by the valuation adjustments applied to
these positions.
The following table provides a summary of changes in fair value
of Merrill Lynchs Level 3 financial assets and
liabilities for the three months ended September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Level 3 Financial Assets and Liabilities
|
|
|
Three months ended September 28, 2007
|
|
|
|
|
Total Realized and Unrealized
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains or (Losses)
|
|
Total Realized and
|
|
Purchases,
|
|
|
|
|
|
|
|
|
included in Income
|
|
Unrealized Gains
|
|
Issuances
|
|
|
|
|
|
|
Beginning
|
|
Principal
|
|
Other
|
|
|
|
or (Losses)
|
|
and
|
|
Transfers
|
|
Ending
|
|
|
Balance
|
|
Transactions
|
|
Revenue
|
|
Interest
|
|
included in Income
|
|
Settlements
|
|
in (out)
|
|
Balance
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading assets
|
|
$
|
3,648
|
|
|
$
|
(1,938
|
)
|
|
$
|
-
|
|
|
$
|
6
|
|
|
$
|
(1,932
|
)
|
|
$
|
1,608
|
|
|
$
|
6,409
|
|
|
$
|
9,733
|
|
Contractual agreements, net
|
|
|
229
|
|
|
|
(4,032
|
)
|
|
|
(2
|
)
|
|
|
11
|
|
|
|
(4,023
|
)
|
|
|
139
|
|
|
|
81
|
|
|
|
(3,574
|
)
|
Investment securities
|
|
|
5,784
|
|
|
|
(974
|
)
|
|
|
4
|
|
|
|
-
|
|
|
|
(970
|
)
|
|
|
938
|
|
|
|
(99
|
)
|
|
|
5,653
|
|
Loans, notes and mortgages
|
|
|
4
|
|
|
|
-
|
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
(4
|
)
|
|
|
(2
|
)
|
|
|
9
|
|
|
|
7
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term borrowings
|
|
$
|
282
|
|
|
$
|
280
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
280
|
|
|
$
|
81
|
|
|
$
|
529
|
|
|
$
|
612
|
|
|
|
Net losses in principal transactions were due primarily to
$7.9 billion of write-downs taken on U.S. sub-prime
residential mortgage-related and ABS CDO positions that are
classified as Level 3, partially offset by approximately
$0.9 billion of gains in other fixed income and equity
related products.
The increases attributable to purchases, issuances, and
settlements of Level 3 assets and liabilities were
primarily due to the exercise of certain purchase obligations
that required Merrill Lynch to buy
29
underlying assets, primarily U.S. sub-prime residential
mortgage-related and ABS CDO positions of $1.4 billion.
These purchase obligations were previously included in
contractual agreements and were primarily classified as
Level 2 in prior periods.
The increases attributable to net transfers in of Level 3
assets and liabilities were due primarily to the decrease in
observability of market pricing for instruments which had
previously been classified as Level 2, primarily
U.S. sub-prime residential mortgage-related and ABS CDO
positions and related instruments of $1.2 billion and other
notes and loans of $4.8 billion that are classified as
trading assets.
The following table provides a summary of changes in fair value
of Merrill Lynchs Level 3 financial assets and
liabilities for the nine months ended September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Level 3 Financial Assets and Liabilities
|
|
|
Nine months ended September 28, 2007
|
|
|
|
|
Total Realized and Unrealized
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains or (Losses)
|
|
Total Realized and
|
|
Purchases,
|
|
|
|
|
|
|
|
|
included in Income
|
|
Unrealized Gains
|
|
Issuances
|
|
|
|
|
|
|
Beginning
|
|
Principal
|
|
Other
|
|
|
|
or (Losses)
|
|
and
|
|
Transfers
|
|
Ending
|
|
|
Balance
|
|
Transactions
|
|
Revenue
|
|
Interest
|
|
included in Income
|
|
Settlements
|
|
in (out)
|
|
Balance
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading assets
|
|
$
|
2,021
|
|
|
$
|
(1,685
|
)
|
|
$
|
-
|
|
|
$
|
34
|
|
|
$
|
(1,651
|
)
|
|
$
|
2,111
|
|
|
$
|
7,252
|
|
|
$
|
9,733
|
|
Contractual
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
agreements, net
|
|
|
(2,030
|
)
|
|
|
(3,461
|
)
|
|
|
3
|
|
|
|
17
|
|
|
|
(3,441
|
)
|
|
|
946
|
|
|
|
951
|
|
|
|
(3,574
|
)
|
Investment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
securities
|
|
|
5,117
|
|
|
|
(1,404
|
)
|
|
|
484
|
|
|
|
5
|
|
|
|
(915
|
)
|
|
|
2,142
|
|
|
|
(691
|
)
|
|
|
5,653
|
|
Loans, notes and mortgages
|
|
|
7
|
|
|
|
-
|
|
|
|
(13
|
)
|
|
|
-
|
|
|
|
(13
|
)
|
|
|
(4
|
)
|
|
|
17
|
|
|
|
7
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term borrowings
|
|
$
|
-
|
|
|
$
|
280
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
280
|
|
|
$
|
81
|
|
|
$
|
811
|
|
|
$
|
612
|
|
|
|
The significant items affecting the rollforward for the nine
months ended September 28, 2007 generally occurred in the
three months ended September 28, 2007 and are described
above.
The following table provides the portion of gains or losses
included in income for the three and nine months ended
September 28, 2007 attributable to unrealized gains or
losses relating to those Level 3 assets and liabilities
still held at September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
Unrealized Gains or (Losses) for Level 3 Assets and
Liabilities
|
|
|
Still Held at September 28, 2007
|
|
|
Three Months Ended September 28, 2007
|
|
Nine Months Ended September 28, 2007
|
|
|
Principal
|
|
Other
|
|
|
|
|
|
Principal
|
|
Other
|
|
|
|
|
|
|
Transactions
|
|
Revenue
|
|
Interest
|
|
Total
|
|
Transactions
|
|
Revenue
|
|
Interest
|
|
Total
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading assets
|
|
$
|
(1,956
|
)
|
|
$
|
-
|
|
|
$
|
6
|
|
|
$
|
(1,950
|
)
|
|
$
|
(1,719
|
)
|
|
$
|
-
|
|
|
$
|
34
|
|
|
$
|
(1,685
|
)
|
Contractual agreements, net
|
|
|
(4,088
|
)
|
|
|
(2
|
)
|
|
|
11
|
|
|
|
(4,079
|
)
|
|
|
(3,589
|
)
|
|
|
(2
|
)
|
|
|
17
|
|
|
|
(3,574
|
)
|
Investment securities
|
|
|
(974
|
)
|
|
|
(6
|
)
|
|
|
-
|
|
|
|
(980
|
)
|
|
|
(1,404
|
)
|
|
|
393
|
|
|
|
7
|
|
|
|
(1,004
|
)
|
Loans, notes and mortgages
|
|
|
-
|
|
|
|
1
|
|
|
|
-
|
|
|
|
1
|
|
|
|
-
|
|
|
|
4
|
|
|
|
-
|
|
|
|
4
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term borrowings
|
|
$
|
280
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
280
|
|
|
$
|
280
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
280
|
|
|
|
Total net unrealized losses were primarily due to
$7.9 billion of write-downs of U.S. sub-prime
residential mortgage-related and ABS CDO securities and related
instruments that are classified as Level 3.
Certain assets and liabilities are measured at fair value on a
non-recurring basis and, as such, are not included in the tables
above. These assets and liabilities include loans and loan
commitments classified
30
as held for sale and reported at lower of cost or market and
assets that are measured at cost that have been written down to
fair value during the period as a result of an impairment. The
following table shows the fair value hierarchy for those assets
and liabilities measured at fair value on a non-recurring basis
as of September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
|
|
|
|
|
Losses
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
Nine Months
|
|
|
Non-Recurring Basis as of September 28, 2007
|
|
Ended
|
|
Ended
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Sept. 28, 2007
|
|
Sept. 28, 2007
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, notes, and
mortgages
|
|
$
|
-
|
|
|
$
|
15,784
|
|
|
$
|
6,585
|
|
|
$
|
22,369
|
|
|
$
|
(633
|
)
|
|
$
|
(626
|
)
|
Goodwill and other
intangible assets
|
|
|
-
|
|
|
|
-
|
|
|
|
53
|
|
|
|
53
|
|
|
|
(107
|
)
|
|
|
(107
|
)
|
Other assets
|
|
|
-
|
|
|
|
28
|
|
|
|
-
|
|
|
|
28
|
|
|
|
(1
|
)
|
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
$
|
-
|
|
|
$
|
471
|
|
|
$
|
-
|
|
|
$
|
471
|
|
|
$
|
(310
|
)
|
|
$
|
(355
|
)
|
|
|
Loans, notes, and mortgages include held for sale loans that are
carried at the lower of cost or market and for which the fair
value was below the cost basis at September 28, 2007. It
also includes certain impaired held for investment loans where
an allowance for loan losses has been calculated based upon the
fair value of the loans. Level 3 assets primarily relate to
residential and commercial real estate loans in the United
Kingdom that are classified as held for sale of
$4.8 billion. The losses on the Level 3 loans were
calculated primarily by models incorporating internally derived
credit spreads and discounted cash flow valuations of the
collateral. Losses related to Level 2 loans were calculated
by models incorporating significant observable market data.
Goodwill and other intangible assets measured at fair value on a
non-recurring basis relate to intangible assets (mortgage broker
relationships) that were acquired in connection with the First
Franklin acquisition. Losses of $107 million represent an
impairment charge related to these intangible assets recorded in
the third quarter of 2007. The fair value of these intangible
assets was calculated based upon discounted cash flow
projections.
Other liabilities include amounts recorded for loan commitments
in which the funded loan will be held for sale, particularly
leveraged loan commitments in the United States. The losses were
calculated by models incorporating significant observable market
data.
Fair
Value Option
SFAS No. 159 provides a fair value option election
that allows companies to irrevocably elect fair value as the
initial and subsequent measurement attribute for certain
financial assets and liabilities. Changes in fair value for
assets and liabilities for which the election is made will be
recognized in earnings as they occur. SFAS No. 159
permits the fair value option election on an instrument by
instrument basis at initial recognition of an asset or liability
or upon an event that gives rise to a new basis of accounting
for that instrument. As discussed above, certain of Merrill
Lynchs financial instruments are required to be accounted
for at fair value under SFAS No. 115 and
SFAS No. 133 as well as industry level guidance. For
certain financial instruments that are not accounted for at fair
value under other applicable accounting guidance, the fair value
option has been elected.
31
The following table presents a summary of eligible financial
assets and financial liabilities for which the fair value option
was elected on December 30, 2006 and the cumulative-effect
adjustment to retained earnings recorded in connection with the
initial adoption of SFAS No. 159.
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
Transition Adjustments
|
|
|
|
|
Carrying Value
|
|
to Retained Earnings
|
|
Carrying Value
|
|
|
Prior to Adoption
|
|
Gain/(Loss)
|
|
After Adoption
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities
|
|
$
|
8,723
|
|
|
$
|
(268
|
)
|
|
$
|
8,732
|
|
Loans, notes, and mortgages
|
|
|
1,440
|
|
|
|
2
|
|
|
|
1,442
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term borrowings
|
|
$
|
10,308
|
|
|
$
|
(29
|
)
|
|
$
|
10,337
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax cumulative-effect of adoption
|
|
|
|
|
|
$
|
(295
|
)
|
|
|
|
|
Deferred tax benefit
|
|
|
|
|
|
|
110
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative effect of adoption of the fair value option
|
|
|
|
|
|
$
|
(185
|
)
|
|
|
|
|
|
|
The following table provides information about where in the
Condensed Consolidated Statement of Earnings changes in fair
values, for which the fair value option has been elected, are
included for the three and nine month periods ended
September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
Changes in Fair Value
|
|
|
Changes in Fair Value for the Three
|
|
for the Nine Months Ended
|
|
|
Months Ended September 28, 2007,
|
|
September 28, 2007,
|
|
|
for Items Measured at Fair Value
|
|
for Items Measured at Fair Value
|
|
|
Pursuant to Fair Value Option
|
|
Pursuant to Fair Value Option
|
|
|
|
|
|
|
|
Gains/
|
|
Gains/
|
|
|
|
Gains/
|
|
|
|
|
|
|
(losses)
|
|
(losses)
|
|
Total
|
|
(losses)
|
|
Gains
|
|
Total
|
|
|
Principal
|
|
Other
|
|
Changes in
|
|
Principal
|
|
Other
|
|
Changes in
|
|
|
Transactions
|
|
Revenues
|
|
Fair Value
|
|
Transactions
|
|
Revenues
|
|
Fair Value
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Receivables under resale
agreements
|
|
$
|
62
|
|
|
$
|
-
|
|
|
$
|
62
|
|
|
$
|
67
|
|
|
$
|
-
|
|
|
$
|
67
|
|
Investment securities
|
|
|
(68
|
)
|
|
|
(1
|
)
|
|
|
(69
|
)
|
|
|
142
|
|
|
|
20
|
|
|
|
162
|
|
Loans, notes and mortgages
|
|
|
(3
|
)
|
|
|
20
|
|
|
|
17
|
|
|
|
(1
|
)
|
|
|
60
|
|
|
|
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payables under repurchase agreements
|
|
$
|
(10
|
)
|
|
$
|
-
|
|
|
$
|
(10
|
)
|
|
$
|
7
|
|
|
$
|
-
|
|
|
$
|
7
|
|
Long-term borrowings
|
|
|
576
|
|
|
|
-
|
|
|
|
576
|
|
|
|
1,417
|
|
|
|
-
|
|
|
|
1,417
|
|
|
|
The following describes the rationale for electing to account
for certain financial assets and liabilities at fair value, as
well as the impact of instrument-specific credit risk on the
fair value.
Resale
and repurchase agreements:
Merrill Lynch elected the fair value option on a prospective
basis for certain resale and repurchase agreements. The fair
value option election was made based on the tenor of the resale
and repurchase agreements, which reflects the magnitude of the
interest rate risk. Resale and repurchase agreements
collateralized by U.S. and Japanese government securities
were excluded from the fair value option election as these
contracts are generally short-dated and therefore the interest
rate risk is not considered significant. Resale and repurchase
agreements require collateral to be maintained with a market
value equal to or in excess of the principal amount loaned
resulting in immaterial credit risk for such transactions.
32
Investment
securities:
Merrill Lynch elected the fair value option for certain fixed
rate securities in its treasury liquidity portfolio previously
classified as available-for-sale securities as management
modified its investment strategy and economic exposure to
interest rate risk by eliminating long-term fixed rate assets in
its liquidity portfolio and replacing them with floating rate
assets. These securities were carried at fair value in
accordance with SFAS No. 115 prior to the adoption of
SFAS No. 159. An unrealized loss of $172 million,
net of tax, related to such securities was reclassified from
accumulated other comprehensive loss to retained earnings.
Loans,
notes, and mortgages:
Merrill Lynch elected the fair value option for automobile and
certain corporate loans because the loans are risk managed on a
fair value basis. The change in the fair value of loans, notes,
and mortgages for which the fair value option was elected that
was attributable to changes in borrower-specific credit risk was
not material for all periods presented.
Long-term
borrowings:
Merrill Lynch elected the fair value option for certain
long-term borrowings that are risk managed on a fair value basis
and for which hedge accounting under SFAS No. 133 had
been difficult to obtain. The changes in the fair value of
liabilities for which the fair value option was elected that was
attributable to changes in Merrill Lynch credit spreads were
$609 million and $656 million, respectively, for the
three and nine months ended September 28, 2007. Changes in
Merrill Lynch specific credit risk is derived by isolating fair
value changes due to changes in Merrill Lynchs credit
spreads as observed in the secondary cash market.
The following table presents the difference between fair values
and the aggregate contractual principal amounts of loans, notes,
and mortgages and long-term borrowings for which the fair value
option has been elected.
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
Principal
|
|
|
|
|
|
|
Amount
|
|
|
|
|
Fair Value at
|
|
Due Upon
|
|
|
|
|
September 28,
2007
|
|
Maturity
|
|
Difference
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, notes and
mortgages(1)
|
|
$
|
987
|
|
|
$
|
1,205
|
|
|
$
|
(218
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
borrowings(2)
|
|
$
|
70,129
|
|
|
$
|
71,990
|
|
|
$
|
(1,861
|
)
|
|
|
|
|
|
(1) |
|
The majority of the difference
relates to loans purchased at a substantial discount from the
principal amount. |
(2) |
|
The majority of the difference
relates to zero coupon notes issued at a substantial discount
from the principal amount and the impact of the widening of
Merrill Lynchs credit spreads. |
At September 28, 2007, the difference between the fair
value and the aggregate contractual principal amount of
receivables under resale agreements and payables under
repurchase agreements for which the fair value option has been
elected was not material to the Condensed Consolidated Financial
Statements.
33
For those loans, notes and mortgages for which the fair value
option has been elected, the aggregate fair value of loans that
are 90 days or more past due and in non-accrual status is
not material to the Condensed Consolidated Financial Statements.
Hybrid
Financial Instruments
In February 2006, the FASB issued SFAS No. 155, which
clarifies the bifurcation requirements for certain financial
instruments and permits hybrid financial instruments that
contain a bifurcatable embedded derivative to be accounted for
as a single financial instrument at fair value with changes in
fair value recognized in earnings. This election is permitted on
an
instrument-by-instrument
basis for all hybrid financial instruments held, obtained, or
issued as of the adoption date. At adoption, any difference
between the total carrying amount of the individual components
of the existing bifurcated hybrid financial instruments and the
fair value of the combined hybrid financial instruments is
recognized as a cumulative-effect adjustment to beginning
retained earnings. Merrill Lynch adopted SFAS No. 155
on a prospective basis beginning in the first quarter of 2007.
Since SFAS No. 159 incorporates accounting and
disclosure requirements that are similar to
SFAS No. 155, Merrill Lynch applies
SFAS No. 159, rather than SFAS No. 155, to
its fair value elections for hybrid financial instruments.
Note 4. Securities
Financing Transactions
Merrill Lynch enters into secured borrowing and lending
transactions in order to meet customers needs and earn
residual interest rate spreads, obtain securities for settlement
and finance trading inventory positions.
Under these transactions, Merrill Lynch either receives or
provides collateral, including U.S. Government and
agencies, asset-backed, corporate debt, equity, and
non-U.S. governments
and agencies securities. Merrill Lynch receives collateral in
connection with resale agreements, securities borrowed
transactions, customer margin loans, and other loans. Under many
agreements, Merrill Lynch is permitted to sell or repledge the
securities received (e.g., use the securities to secure
repurchase agreements, enter into securities lending
transactions, or deliver to counterparties to cover short
positions). At September 28, 2007 and December 29,
2006, the fair value of securities received as collateral where
Merrill Lynch is permitted to sell or repledge the securities
was $827 billion and $633 billion, respectively, and
the fair value of the portion that has been sold or repledged
was $656 billion and $498 billion, respectively.
Merrill Lynch may use securities received as collateral for
resale agreements to satisfy regulatory requirements such as
Rule 15c3-3
of the SEC. At September 28, 2007 and December 29,
2006, the fair value of collateral used for this purpose was
$11.7 billion, and $19.3 billion, respectively.
Merrill Lynch pledges firm-owned assets to collateralize
repurchase agreements and other secured financings. Pledged
securities that can be sold or repledged by the secured party
are parenthetically disclosed in trading assets on the Condensed
Consolidated Balance Sheets. The carrying value and
classification of securities owned by Merrill Lynch that have
been pledged to counterparties where
34
those counterparties do not have the right to sell or repledge
at September 28, 2007 and December 29, 2006 are as
follows:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Trading asset category
|
|
|
|
|
|
|
|
|
Mortgages, mortgage-backed, and asset-backed securities
|
|
$
|
27,253
|
|
|
$
|
34,475
|
|
U.S. Government and agencies
|
|
|
10,790
|
|
|
|
12,068
|
|
Corporate debt and preferred stock
|
|
|
16,326
|
|
|
|
11,454
|
|
Non-U.S.
governments and agencies
|
|
|
8,994
|
|
|
|
4,810
|
|
Equities and convertible debentures
|
|
|
920
|
|
|
|
4,812
|
|
Municipals and money markets
|
|
|
600
|
|
|
|
975
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
64,883
|
|
|
$
|
68,594
|
|
|
Note 5. Investment
Securities
Investment securities on the Condensed Consolidated Balance
Sheets include:
|
|
|
SFAS No. 115 investments held by ML & Co.
and certain of its non-broker-dealer entities, including Merrill
Lynch banks and insurance subsidiaries. SFAS No. 115
investments consist of:
|
|
|
|
|
|
Debt securities, including debt held for investment and
liquidity and collateral management purposes that are classified
as available-for-sale, debt securities held for trading
purposes, and debt securities that Merrill Lynch intends to hold
until maturity;
|
|
|
Marketable equity securities, which are generally classified as
available-for-sale.
|
|
|
|
Non-qualifying investments that do not fall within the scope of
SFAS No. 115.
|
Investment securities at September 28, 2007 and
December 29, 2006 are presented below:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Investment securities
|
|
|
|
|
|
|
|
|
Available-for-sale(1)
|
|
$
|
55,924
|
|
|
$
|
56,292
|
|
Trading
|
|
|
9,481
|
|
|
|
6,512
|
|
Held-to-maturity
|
|
|
263
|
|
|
|
269
|
|
Non-qualifying(2)
|
|
|
|
|
|
|
|
|
Equity
investments(3)
|
|
|
28,519
|
|
|
|
21,290
|
|
Investments of insurance
subsidiaries(4)
|
|
|
1,228
|
|
|
|
1,360
|
|
Deferred compensation
hedges(5)
|
|
|
1,800
|
|
|
|
1,752
|
|
Investments in trust preferred securities and other investments
|
|
|
438
|
|
|
|
715
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
97,653
|
|
|
$
|
88,190
|
|
|
|
|
|
(1) |
|
At September 28, 2007 and
December 29, 2006, includes $4.9 billion and
$4.8 billion, respectively, of investment securities
reported in cash and securities segregated for regulatory
purposes or deposited with clearing organizations. |
(2) |
|
Non-qualifying for
SFAS 115 purposes. |
(3) |
|
Includes Merrill Lynchs
investment in BlackRock. |
(4) |
|
Primarily represents insurance
policy loans held by MLIG. Refer to Note 17 to the Condensed
Consolidated Financial Statements for further information on
MLIG. |
(5) |
|
Represents investments that
economically hedge deferred compensation liabilities. |
Merrill Lynch reviews its held-to-maturity and
available-for-sale securities at least quarterly to determine
whether any impairment is other-than-temporary. Factors
considered in the review include
35
length of time and extent to which market value has been less
than cost, the financial condition and near term prospects of
the issuer, and Merrill Lynchs intent and ability to
retain the security to allow for an anticipated recovery in
market value. As of September 28, 2007, Merrill Lynch
determined that certain available-for-sale securities primarily
related to U.S. ABS CDO securities were other-than-temporarily
impaired and recognized a loss of approximately
$160 million for the nine months ended September 28,
2007, of which $140 million was recognized in the third
quarter of 2007. At December 29, 2006, Merrill Lynch did
not consider these securities to be other-than-temporarily
impaired.
Note 6. Securitization
Transactions and Transactions with Special Purpose Entities
(SPEs)
Securitizations
In the normal course of business, Merrill Lynch securitizes
commercial and residential mortgage loans, municipal,
government, and corporate bonds, and other types of financial
assets. SPEs, often referred to as Variable Interest Entities
(VIEs) are often used when entering into or facilitating
securitization transactions. Merrill Lynchs involvement
with SPEs used to securitize financial assets includes:
structuring
and/or
establishing SPEs; selling assets to SPEs; managing or servicing
assets held by SPEs; underwriting, distributing, and making
loans to SPEs; making markets in securities issued by SPEs;
engaging in derivative transactions with SPEs; owning notes or
certificates issued by SPEs;
and/or
providing liquidity facilities and other guarantees to, or for
the benefit of, SPEs.
Merrill Lynch securitized assets of approximately
$154.4 billion and $98.7 billion for the nine months
ended September 28, 2007 and September 29, 2006,
respectively. For the nine months ended September 28, 2007
and September 29, 2006, Merrill Lynch received
$156.8 billion and $99.1 billion, respectively, of
proceeds, and other cash inflows, from securitization
transactions, and recognized net securitization gains of
$286.8 million and $200.7 million, respectively, in
Merrill Lynchs Condensed Consolidated Statements of
Earnings.
For the first nine months of 2007 and 2006, cash inflows from
securitizations related to the following asset types:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
|
Asset category
|
|
|
|
|
|
|
|
|
Residential mortgage loans
|
|
$
|
92,558
|
|
|
$
|
67,777
|
|
Municipal bonds
|
|
|
46,358
|
|
|
|
18,994
|
|
Commercial loans and other
|
|
|
13,502
|
|
|
|
9,155
|
|
Corporate and government bonds
|
|
|
4,430
|
|
|
|
3,220
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
156,848
|
|
|
$
|
99,146
|
|
|
Retained interests in securitized assets were approximately
$10.1 billion and $6.8 billion at September 28,
2007 and December 29, 2006, respectively, which related
primarily to residential mortgage loan, commercial loan and
bond, and municipal bond securitization transactions. A portion
of the retained interest balance consists of mortgage-backed
securities that have limited price transparency. The majority of
these retained interests include mortgage-backed securities that
Merrill Lynch had expected to sell to investors in the normal
course of its underwriting activity. However, the timing of any
sale is subject to current and future market conditions. A
portion of the retained interests
36
represent residual interests in U.S. sub-prime mortgage
securitizations and is included in the Level 3 U.S. ABS CDO
exposure disclosed in Note 3 to the Condensed Consolidated
Financial Statements.
The following table presents information on retained interests,
excluding the offsetting benefit of financial instruments used
to hedge risks, held by Merrill Lynch as of September 28,
2007 arising from Merrill Lynchs residential mortgage
loan, municipal bond and other securitization transactions. The
pre-tax sensitivities of the current fair value of the retained
interests to immediate 10% and 20% adverse changes in
assumptions and parameters are also shown.
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Residential
|
|
|
|
|
|
|
Mortgage
|
|
Municipal
|
|
|
|
|
Loans
|
|
Bonds
|
|
Other
|
|
|
Retained interest amount
|
|
$
|
5,946
|
|
|
$
|
1,283
|
|
|
$
|
2,868
|
|
Weighted average credit losses (rate per annum)
|
|
|
1.7
|
%
|
|
|
0.0
|
%
|
|
|
0.2
|
%
|
Range
|
|
|
0-20.0
|
%
|
|
|
0.0
|
%
|
|
|
0-4.0
|
%
|
Impact on fair value of 10% adverse change
|
|
$
|
(94
|
)
|
|
$
|
-
|
|
|
$
|
(4
|
)
|
Impact on fair value of 20% adverse change
|
|
$
|
(185
|
)
|
|
$
|
-
|
|
|
$
|
(8
|
)
|
Weighted average discount rate
|
|
|
11.3
|
%
|
|
|
4.2
|
%
|
|
|
5.3
|
%
|
Range
|
|
|
0-76.4
|
%
|
|
|
3.5-8.0
|
%
|
|
|
0-26.6
|
%
|
Impact on fair value of 10% adverse change
|
|
$
|
(262
|
)
|
|
$
|
(87
|
)
|
|
$
|
(55
|
)
|
Impact on fair value of 20% adverse change
|
|
$
|
(506
|
)
|
|
$
|
(162
|
)
|
|
$
|
(107
|
)
|
Weighted average life (in years)
|
|
|
4.5
|
|
|
|
6.5
|
|
|
|
2.2
|
|
Range
|
|
|
0-29.6
|
|
|
|
0-12.2
|
|
|
|
1.7-9.8
|
|
Weighted average prepayment speed
(CPR)(1)
|
|
|
20.9
|
%
|
|
|
41.3
|
%
|
|
|
36.4
|
%
|
Range(1)
|
|
|
0-65.5
|
%
|
|
|
8.0-47.8
|
%
|
|
|
16-92
|
%
|
Impact on fair value of 10% adverse change
|
|
$
|
(136
|
)
|
|
$
|
-
|
|
|
$
|
(3
|
)
|
Impact on fair value of 20% adverse change
|
|
$
|
(235
|
)
|
|
$
|
-
|
|
|
$
|
(5
|
)
|
|
CPR=Constant Prepayment
Rate
|
|
|
(1) |
|
Relates to select
securitization transactions where assets are
prepayable. |
The preceding sensitivity analysis is hypothetical and should be
used with caution. In particular, the effect of a variation in a
particular assumption on the fair value of the retained interest
is calculated independent of changes in any other assumption; in
practice, changes in one factor may result in changes in
another, which might magnify or counteract the sensitivities.
Further, changes in fair value based on a 10% or 20% variation
in an assumption or parameter generally cannot be extrapolated
because the relationship of the change in the assumption to the
change in fair value may not be linear. Also, the sensitivity
analysis does not include the offsetting benefit of financial
instruments that Merrill Lynch utilizes to hedge risks,
including credit, interest rate, and prepayment risk, that are
inherent in the retained interests. These hedging strategies are
structured to take into consideration the hypothetical stress
scenarios above such that they would be effective in principally
offsetting Merrill Lynchs exposure to loss in the event
these scenarios occur.
The weighted average assumptions and parameters used initially
to value retained interests relating to securitizations that
were still held by Merrill Lynch as of September 28, 2007
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
|
|
|
|
|
|
Mortgage
|
|
Municipal
|
|
|
|
|
|
|
Loans
|
|
Bonds
|
|
Other
|
|
|
|
|
Credit losses (rate per annum)
|
|
|
1.6
|
%
|
|
|
0.0
|
%
|
|
|
0.2
|
%
|
|
|
|
|
Weighted average discount rate
|
|
|
9.8
|
%
|
|
|
3.9
|
%
|
|
|
6.1
|
%
|
|
|
|
|
Weighted average life (in years)
|
|
|
5.2
|
|
|
|
6.7
|
|
|
|
2.8
|
|
|
|
|
|
Prepayment speed assumption
(CPR)(1)
|
|
|
20.6
|
%
|
|
|
9.0
|
%
|
|
|
17.1
|
%
|
|
|
|
|
|
37
CPR=Constant Prepayment
Rate
|
|
|
(1) |
|
Relates to select
securitization transactions where assets are
prepayable. |
For residential mortgage loan and other securitizations, the
investors and the securitization trust generally have no
recourse to Merrill Lynch upon the event of a borrower default.
See Note 12 to the Condensed Consolidated Financial
Statements for information related to representations and
warranties.
For municipal bond securitization SPEs, in the normal course of
dealer market-making activities, Merrill Lynch acts as liquidity
provider. Specifically, the holders of beneficial interests
issued by municipal bond securitization SPEs have the right to
tender their interests for purchase by Merrill Lynch on
specified dates at a specified price. Beneficial interests that
are tendered are then sold by Merrill Lynch to investors through
a best efforts remarketing where Merrill Lynch is the
remarketing agent. If the beneficial interests are not
successfully remarketed, the holders of beneficial interests are
paid from funds drawn under a standby liquidity letter of credit
issued by Merrill Lynch.
In addition to standby letters of credit, Merrill Lynch also
provides default protection or credit enhancement to investors
in securities issued by certain municipal bond securitization
SPEs. Interest and principal payments on beneficial interests
issued by these SPEs are secured by a guarantee issued by
Merrill Lynch. In the event that the issuer of the underlying
municipal bond defaults on any payment of principal
and/or
interest when due, the payments on the bonds will be made to
beneficial interest holders from an irrevocable guarantee by
Merrill Lynch. Additional information regarding these
commitments is provided in Note 12 to the Condensed
Consolidated Financial Statements and in Note 12 of the
2006 Annual Report.
The following table summarizes the total principal amounts
outstanding and delinquencies of securitized financial assets
held in SPEs, where Merrill Lynch holds retained
interests, as of September 28, 2007 and December 29,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Residential
|
|
|
|
|
|
|
Mortgage
|
|
Municipal
|
|
|
|
|
Loans
|
|
Bonds
|
|
Other
|
|
|
September 28, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal Amount Outstanding
|
|
$
|
156,028
|
|
|
$
|
22,090
|
|
|
$
|
29,733
|
|
Delinquencies
|
|
|
9,705
|
|
|
|
-
|
|
|
|
19
|
|
December 29, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal Amount Outstanding
|
|
$
|
124,795
|
|
|
$
|
18,986
|
|
|
$
|
33,024
|
|
Delinquencies
|
|
|
3,493
|
|
|
|
-
|
|
|
|
10
|
|
|
Net credit losses associated with securitized financial assets
held in these SPEs for the nine months ended September 28,
2007 and September 29, 2006 approximated $427 million
and $79 million, respectively.
Mortgage
Servicing Rights
In connection with its residential mortgage business, Merrill
Lynch may retain or acquire servicing rights associated with
certain mortgage loans that are sold through its securitization
activities. These loan sale transactions create assets referred
to as mortgage servicing rights, or MSRs, which are included
within other assets on the Condensed Consolidated Balance Sheets.
In March 2006 the FASB issued SFAS No. 156, which
amends SFAS No. 140, and requires all separately
recognized servicing assets and servicing liabilities to be
initially measured at fair value, if
38
practicable. SFAS No. 156 also permits servicers to
subsequently measure each separate class of servicing assets and
liabilities at fair value rather than at the lower of amortized
cost or market. Merrill Lynch adopted SFAS No. 156 on
December 30, 2006. Merrill Lynch has not elected to
subsequently fair value those MSRs held as of the date of
adoption or those MSRs acquired or retained after
December 30, 2006.
Retained MSRs are initially recorded at fair value and
subsequently amortized in proportion to and over the period of
estimated future net servicing revenues. MSRs are assessed for
impairment, at a minimum, on a quarterly basis.
Managements estimates of fair value of MSRs are determined
using the net discounted present value of future cash flows,
which consists of projecting future servicing cash flows and
discounting such cash flows using an appropriate risk-adjusted
discount rate. These valuations require various assumptions,
including future servicing fees, servicing costs, credit losses,
discount rates and mortgage prepayment speeds. Due to subsequent
changes in economic and market conditions, these assumptions
can, and generally will, change from quarter to quarter.
Changes in Merrill Lynchs MSR balance are summarized below:
|
|
|
|
|
(dollars in millions)
|
|
|
|
Carrying Value
|
|
|
Mortgage servicing rights, December 29, 2006 (fair
value is $164)
|
|
$
|
122
|
|
Additions(1)
|
|
|
505
|
|
Amortization
|
|
|
(190
|
)
|
Valuation allowance adjustments
|
|
|
(1
|
)
|
|
|
|
|
|
Mortgage servicing rights, Sept. 28, 2007 (fair value is
$556 )
|
|
$
|
436
|
|
|
|
|
|
(1) |
|
Includes MSRs obtained in
connection with the acquisition of First Franklin and First
Republic. |
The amount of contractually specified revenues, which are
included within managed accounts and other fee-based revenues in
the Condensed Consolidated Statements of Earnings include:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
|
|
For the Three
|
|
For the Nine
|
|
|
Months Ended
|
|
Months Ended
|
|
|
Sept. 28,
|
|
Sept. 28,
|
|
|
2007
|
|
2007
|
|
|
Servicing fees
|
|
$
|
96
|
|
|
$
|
262
|
|
Ancillary and late fees
|
|
|
17
|
|
|
|
47
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
113
|
|
|
$
|
309
|
|
|
The following table presents Merrill Lynchs key
assumptions used in measuring the fair value of MSRs at
September 28, 2007 and the pre-tax sensitivity of the fair
values to an immediate 10% and 20% adverse change in these
assumptions:
|
|
|
|
|
(dollars in millions)
|
|
|
Fair value of capitalized MSRs
|
|
$
|
556
|
|
Weighted average prepayment speed (CPR)
|
|
|
30.5
|
%
|
Impact of fair value of 10% adverse change
|
|
$
|
(43
|
)
|
Impact of fair value of 20% adverse change
|
|
$
|
(58
|
)
|
Weighted average discount rate
|
|
|
16.9
|
%
|
Impact of fair value of 10% adverse change
|
|
$
|
(13
|
)
|
Impact of fair value of 20% adverse change
|
|
$
|
(27
|
)
|
|
39
The sensitivity analysis above is hypothetical and should be
used with caution. In particular, the effect of a variation in a
particular assumption on the fair value of MSRs is calculated
independent of changes in any other assumption; in practice,
changes in one factor may result in changes in another factor,
which may magnify or counteract the sensitivities. Further
changes in fair value based on a single variation in assumptions
generally cannot be extrapolated because the relationship of the
change in a single assumption to the change in fair value may
not be linear.
Variable
Interest Entities
FIN 46R requires an entity to consolidate a VIE if that
enterprise has a variable interest that will absorb a majority
of the variability of the VIEs expected losses, receive a
majority of the variability of the VIEs expected residual
returns, or both. The entity required to consolidate a VIE is
known as the primary beneficiary. A QSPE is a type of VIE that
holds financial instruments and distributes cash flows to
investors based on preset terms. QSPEs are commonly used in
mortgage and other securitization transactions. In accordance
with SFAS No. 140 and FIN 46R, Merrill
Lynch does not consolidate QSPEs. Information regarding QSPEs
can be found in the Securitization section of this Note and the
Guarantees section in Note 12 to the Condensed Consolidated
Financial Statements.
Where an entity is a significant variable interest holder,
FIN 46R requires that entity to disclose its maximum
exposure to loss as a result of its interest in the VIE. It
should be noted that this measure does not reflect Merrill
Lynchs estimate of the actual losses that could result
from adverse changes because it does not reflect the economic
hedges Merrill Lynch enters into to reduce its exposure.
The following tables summarize Merrill Lynchs involvement
with certain VIEs as of September 28, 2007 and
December 29, 2006, respectively. The table below does not
include information on QSPEs or those VIEs where Merrill Lynch
is the primary beneficiary and holds a majority of the voting
interests in the entity.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
|
|
|
|
Significant Variable
|
|
|
Primary Beneficiary
|
|
Interest Holder
|
|
|
|
|
|
Total
|
|
Net
|
|
Recourse
|
|
Total
|
|
|
|
|
Asset
|
|
Asset
|
|
to Merrill
|
|
Asset
|
|
Maximum
|
|
|
Size(4)
|
|
Size(5)
|
|
Lynch(6)
|
|
Size(4)
|
|
Exposure
|
|
|
September 28, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan and real estate VIEs
|
|
$
|
23,555
|
|
|
$
|
22,650
|
|
|
$
|
-
|
|
|
$
|
287
|
|
|
$
|
216
|
|
Tax planning
VIEs(1)
|
|
|
4,997
|
|
|
|
4,997
|
|
|
|
-
|
|
|
|
483
|
|
|
|
15
|
|
Guaranteed and other
funds(2)
|
|
|
4,150
|
|
|
|
3,350
|
|
|
|
156
|
|
|
|
2,237
|
|
|
|
2,997
|
|
Credit-linked note and other
VIEs(3)
|
|
|
663
|
|
|
|
87
|
|
|
|
-
|
|
|
|
7,329
|
|
|
|
9,934
|
|
|
|
December 29, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan and real estate VIEs
|
|
$
|
4,265
|
|
|
$
|
3,787
|
|
|
$
|
-
|
|
|
$
|
278
|
|
|
$
|
182
|
|
Tax planning
VIEs(1)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
483
|
|
|
|
15
|
|
Guaranteed and other
funds(2)
|
|
|
3,184
|
|
|
|
2,615
|
|
|
|
564
|
|
|
|
6,156
|
|
|
|
6,156
|
|
Credit-linked note and other
VIEs(3)
|
|
|
41
|
|
|
|
41
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
(1) |
|
The maximum exposure for tax
planning VIEs reflects indemnifications made by Merrill Lynch to
investors in the VIEs. |
(2) |
|
The maximum exposure for
guaranteed and other funds is the fair value of Merrill
Lynchs investments, derivatives entered into with the VIEs
if they are in an asset position, and liquidity and credit
facilities with certain VIEs. |
(3) |
|
The maximum exposure for
credit-linked note and other VIEs is the notional amount of
total return swaps that Merrill Lynch has entered into with the
VIEs. |
(4) |
|
This column reflects the total
size of the assets held in the VIE. |
(5) |
|
This column reflects the size
of the assets held in the VIE after accounting for intercompany
eliminations and any balance sheet netting of assets and
liabilities as permitted by FIN 39. |
40
|
|
|
(6) |
|
This column reflects the
extent, if any, to which investors have recourse to Merrill
Lynch beyond the assets held in the VIE. |
Merrill Lynch has entered into transactions with a number of
VIEs in which it is the primary beneficiary and therefore must
consolidate the VIE or is a significant variable interest holder
in the VIE. These VIEs are as follows:
Loan and
Real Estate VIEs
|
|
|
|
|
Merrill Lynch has investments in VIEs that hold loans or real
estate. Merrill Lynch may be either the primary beneficiary
which would result in consolidation of the VIE, or may be a
significant variable interest holder. These VIEs include
entities that are primarily designed to provide financing to
clients and to invest in real estate. In addition, these VIEs
include securitization vehicles that Merrill Lynch is required
to consolidate because QSPE status has not been met and Merrill
Lynch is the primary beneficiary as it retains the residual
interests. For consolidated VIEs that hold loans, the assets of
the VIEs are recorded in trading assets mortgages,
mortgage-backed and asset-backed, other assets, or loans, notes,
and mortgages in the Condensed Consolidated Balance Sheets. For
consolidated VIEs that hold real estate investments, these
assets are included in other assets in the Condensed
Consolidated Balance Sheets. The beneficial interest holders in
these VIEs have no recourse to the general credit of Merrill
Lynch; their investments are paid exclusively from the assets in
the VIE. The increase in total and net asset size in the table
above for Loan and Real Estate VIEs is a result of Merrill
Lynchs inability to sell mortgage related securities
because of the illiquidity in the securitization markets.
Merrill Lynchs inability to sell certain securities
disqualified the VIEs as QSPEs thereby resulting in Merrill
Lynchs consolidation of the VIEs.
|
Tax
Planning VIEs
|
|
|
|
|
Merrill Lynch has entered into transactions with VIEs that are
used, in part, to provide tax planning strategies to investors
and/or
Merrill Lynch through an enhanced yield investment security.
These structures typically provide financing to Merrill Lynch
and/or the
investor at enhanced rates. Merrill Lynch may be either the
primary beneficiary of and consolidate the VIE, or may be a
significant variable interest holder in the VIE. Where Merrill
Lynch is the primary beneficiary, the assets held by the VIEs
are primarily included in either trading assets or investment
securities.
|
Guaranteed
and Other Funds
|
|
|
|
|
Merrill Lynch is the sponsor of funds that provide a guaranteed
return to investors at the maturity of the VIE. This guarantee
may include a guarantee of the return of an initial investment
or of the initial investment plus an agreed upon return
depending on the terms of the VIE. Investors in certain of these
VIEs have recourse to Merrill Lynch to the extent that the value
of the assets held by the VIEs at maturity is less than the
guaranteed amount. In some instances, Merrill Lynch is the
primary beneficiary and must consolidate the fund. Assets held
in these VIEs are primarily classified in trading assets. In
instances where Merrill Lynch is not the primary beneficiary,
the guarantees related to these funds are further discussed in
Note 12 to the Condensed Consolidated Financial Statements.
|
|
|
|
Merrill Lynch has made certain investments in alternative
investment fund structures that are VIEs. Merrill Lynch is the
primary beneficiary of these funds as a result of its
substantial
|
41
|
|
|
|
|
investment in the vehicles. Merrill Lynch records its interests
in these VIEs primarily in investment securities in the
Condensed Consolidated Balance Sheets.
|
|
|
|
|
|
Merrill Lynch has established two asset-backed commercial paper
conduits (Conduits) for which it has significant
variable interests. Its significant variable interests are in
the form of 1) liquidity facilities that protect commercial
paper holders against short term changes in the fair value of
the assets held by the Conduits in the event of a disruption in
the commercial paper market, and 2) credit facilities to
the Conduits that protect commercial paper investors against
credit losses for up to a certain percentage of the portfolio of
assets held by the respective Conduits. During the third quarter
of 2007, Merrill Lynch purchased $5.1 billion of assets
held by the Conduits through the exercise of the liquidity
facilities. The decrease in total asset size and maximum
exposure for Guaranteed and Other funds in the table above is
primarily the result of the purchase of these assets. Merrill
Lynch also purchased $300 million of the commercial paper
issued by the Conduits. The liquidity and credit facilities are
further discussed in Note 12 to the Condensed Consolidated
Financial Statements.
|
Credit-linked
Note and Other VIEs
|
|
|
|
|
Merrill Lynch has entered into transactions with VIEs where
Merrill Lynch typically purchases credit protection from the VIE
in the form of a derivative in order to synthetically expose
investors to a specific credit risk. These are commonly known as
credit-linked note VIEs. Merrill Lynch also takes synthetic
exposure to the underlying investment grade collateral held in
these VIEs, which includes mortgage-related assets, through
total return swaps. Merrill Lynchs involvement with these
VIEs provides it with a significant variable interest. Merrill
Lynch records its transactions with these VIEs as contractual
agreements (derivatives) in the Condensed Consolidated Balance
Sheets.
|
|
|
|
In 2004, Merrill Lynch entered into a transaction with a VIE
whereby Merrill Lynch arranged for additional protection for
directors and employees to indemnify them against certain losses
that they may incur as a result of claims against them. Merrill
Lynch is the primary beneficiary and consolidates the VIE
because its employees benefit from the indemnification
arrangement. As of September 28, 2007 and December 29,
2006 the assets of the VIE totaled approximately
$16 million, representing a purchased credit default
agreement, which is recorded in other assets on the Condensed
Consolidated Balance Sheets. In the event of a Merrill Lynch
insolvency, proceeds of $140 million will be received by
the VIE to fund any claims. Neither Merrill Lynch nor its
creditors have any recourse to the assets of the VIE.
|
Note 7. Loans, Notes, Mortgages
and Related Commitments to Extend Credit
Loans, notes, mortgages and related commitments to extend credit
include:
|
|
|
|
|
Consumer loans, which are substantially secured, including
residential mortgages, home equity loans, and other loans to
individuals for household, family, or other personal
expenditures.
|
|
|
|
Commercial loans including corporate and institutional loans
(including corporate and financial sponsor, non-investment grade
lending commitments), commercial mortgages, asset-based loans,
small- and middle-market business loans, and other loans to
businesses.
|
42
Loans, notes, mortgages and related commitments to extend credit
at September 28, 2007 and December 29, 2006, are
presented below. This disclosure includes commitments to extend
credit that, if drawn upon, will result in loans held for
investment or loans held for sale.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Loans
|
|
Commitments(1)
|
|
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
2007(2)(3)
|
|
2006(3)
|
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgages
|
|
$
|
24,499
|
|
|
$
|
18,346
|
|
|
$
|
7,891
|
|
|
$
|
7,747
|
|
Other
|
|
|
6,276
|
|
|
|
4,224
|
|
|
|
1,471
|
|
|
|
547
|
|
Commercial and small- and middle-market business:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured investment grade
|
|
|
16,982
|
|
|
|
19,582
|
|
|
|
12,644
|
|
|
|
14,657
|
|
Secured non-investment grade
|
|
|
37,753
|
|
|
|
26,062
|
|
|
|
42,344
|
|
|
|
33,704
|
|
Unsecured investment grade
|
|
|
5,326
|
|
|
|
2,870
|
|
|
|
26,860
|
|
|
|
30,607
|
|
Unsecured non-investment grade
|
|
|
3,937
|
|
|
|
2,423
|
|
|
|
2,311
|
|
|
|
9,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
94,773
|
|
|
|
73,507
|
|
|
|
93,521
|
|
|
|
96,370
|
|
Allowance for loan losses
|
|
|
(588
|
)
|
|
|
(478
|
)
|
|
|
-
|
|
|
|
-
|
|
Reserve for lending-related commitments
|
|
|
-
|
|
|
|
-
|
|
|
|
(893
|
)
|
|
|
(381
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total, net
|
|
$
|
94,185
|
|
|
$
|
73,029
|
|
|
$
|
92,628
|
|
|
$
|
95,989
|
|
|
|
|
|
|
(1) |
|
Commitments are outstanding as
of the date the commitment letter is issued and are comprised of
closed and contingent commitments. Closed commitments represent
the unfunded portion of existing commitments available for draw
down. Contingent commitments are contingent on the borrower
fulfilling certain conditions or upon a particular event, such
as an acquisition. A portion of these contingent commitments may
be syndicated among other lenders or replaced with capital
markets funding. |
(2) |
|
See Note 12 to the
Condensed Consolidated Financial Statements for a maturity
profile of these commitments. |
(3) |
|
In addition to the loan
origination commitments included in the table above, at
September 28, 2007, Merrill Lynch entered into agreements
to purchase $524 million of loans that, upon settlement of
the commitment, will be classified in loans held for investment
and loans held for sale. Similar loan purchase commitments
totaled $1.2 billion at December 29, 2006. See
Note 12 to the Condensed Consolidated Financial Statements
for additional information. |
Activity in the allowance for loan losses is presented below:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
|
Allowance for loan losses, at beginning of period
|
|
$
|
478
|
|
|
$
|
406
|
|
Provision for loan losses
|
|
|
96
|
|
|
|
99
|
|
Charge-offs
|
|
|
(53
|
)
|
|
|
(37
|
)
|
Recoveries
|
|
|
25
|
|
|
|
12
|
|
|
|
|
|
|
|
|
|
|
Net charge-offs
|
|
|
(28
|
)
|
|
|
(25
|
)
|
Other(1)
|
|
|
42
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses, at end of period
|
|
$
|
588
|
|
|
$
|
481
|
|
|
|
|
|
|
(1) |
|
Other activity for the nine
months ended September 28, 2007 primarily relates to the
deconsolidation of two VIEs during the second quarter of 2007
and the First Republic acquisition in the third quarter of
2007. |
Consumer loans, which are substantially secured, consisted of
approximately 234,200 individual loans at September 28,
2007. Commercial loans consisted of approximately 18,400
separate loans. The principal balance of non-accrual loans was
$533 million at September 28, 2007 and
$209 million at December 29, 2006. The investment
grade and non-investment grade categorization is determined
using the credit rating agency equivalent of internal credit
ratings. Non-investment grade counterparties
43
are those rated lower than the BBB category. In some cases
Merrill Lynch enters into credit default swaps to mitigate
credit exposure related to funded and unfunded commercial loans.
The notional value of these swaps totaled $13.9 billion and
$10.3 billion at September 28, 2007 and
December 29, 2006, respectively. For information on credit
risk management see Note 6 of the 2006 Annual Report.
The above amounts include $32.4 billion and
$18.6 billion of loans held for sale at September 28,
2007 and December 29, 2006, respectively. Loans held for
sale are loans that management expects to sell prior to
maturity. At September 28, 2007, such loans consisted of
$10.6 billion of consumer loans, primarily residential
mortgages and automobile loans, and $21.8 billion of
commercial loans, approximately 26% of which are to investment
grade counterparties. At December 29, 2006, such loans
consisted of $7.4 billion of consumer loans, primarily
residential mortgages and automobile loans, and
$11.2 billion of commercial loans, approximately 38% of
which are to investment grade counterparties.
For additional information on loans, notes and mortgages, see
Notes 1 and 8 of the 2006 Annual Report.
Note 8. Goodwill and Other
Intangibles
Goodwill
Goodwill is the cost of an acquired company in excess of the
fair value of identifiable net assets at acquisition date.
Goodwill is tested annually (or more frequently under certain
conditions) for impairment at the reporting unit level in
accordance with SFAS No. 142, Goodwill and Other
Intangible Assets.
The following table sets forth the changes in the carrying
amount of Merrill Lynchs goodwill by business segment, for
the nine months ended September 28, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
GMI
|
|
GWM
|
|
Total
|
|
|
Goodwill:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 29, 2006
|
|
$
|
1,907
|
|
|
$
|
302
|
|
|
$
|
2,209
|
|
Goodwill acquired
|
|
|
1,003
|
|
|
|
1,071
|
|
|
|
2,074
|
|
Translation adjustment and other
|
|
|
52
|
|
|
|
2
|
|
|
|
54
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 28, 2007
|
|
$
|
2,962
|
|
|
$
|
1,375
|
|
|
$
|
4,337
|
|
|
|
GMI activity primarily relates to goodwill acquired in
connection with the acquisition of First Franklin whose
operations were integrated into GMIs mortgage
securitization business. GWM activity primarily relates to
goodwill acquired in connection with the acquisition of First
Republic. At September 28, 2007, in response to the
deterioration in the sub-prime mortgage markets, Merrill Lynch
performed a goodwill impairment test. Based on this test,
Merrill Lynch determined that there was no impairment of
goodwill on a consolidated basis.
Other
Intangible Assets
Other intangible assets consist primarily of value assigned to
customer relationships and core deposits. Other intangible
assets are tested annually (or more frequently under certain
conditions) for impairment in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, and are amortized over their
respective estimated useful lives.
44
In connection with the acquisition of First Franklin, Merrill
Lynch recorded identifiable intangible assets of
$185 million. In response to the deterioration in the
sub-prime mortgage markets, Merrill Lynch reviewed its
identifiable intangible assets for impairment at
September 28, 2007 and recorded an impairment charge of
$107 million related to mortgage broker relationships of
First Franklin.
The gross carrying amounts of other intangible assets were
$667 million and $321 million as of September 28,
2007 and December 29, 2006, respectively. Accumulated
amortization of other intangible assets amounted to
$113 million and $73 million at September 28,
2007 and December 29, 2006, respectively.
Amortization expense for the three and nine months ended
September 28, 2007 was $128 million and
$171 million, respectively, which included the write-off
above of identifiable intangible assets related to First
Franklin mortgage broker relationships in the third quarter of
2007. Amortization expense for the three and nine months ended
September 29, 2006 was $11 million and
$33 million, respectively.
Note 9. Borrowings and
Deposits
ML & Co. is the primary issuer of all of Merrill
Lynchs debt instruments. For local tax or regulatory
reasons, debt is also issued by certain subsidiaries.
The value of Merrill Lynchs debt instruments as recorded
on the Condensed Consolidated Balance Sheets does not
necessarily represent the amount at which they will be repaid at
maturity. This is due to the following:
|
|
|
|
|
Certain debt issuances are issued at a discount to their
redemption amount, which will accrete up to the redemption
amount as they approach maturity;
|
|
|
|
Certain debt issuances are accounted for at fair value and
incorporate changes in Merrill Lynchs creditworthiness as
well as other underlying risks (see Note 3 to the Condensed
Consolidated Financial Statements);
|
|
|
|
Certain structured notes whose coupon or repayment terms are
linked to the performance of debt and equity securities,
indices, currencies or commodities will take into consideration
the fair value of those risks; and
|
|
|
|
Certain debt issuances are adjusted for the impact of the
application of fair value hedge accounting (see Note 1 to
the Condensed Consolidated Financial Statements).
|
45
Total borrowings at September 28, 2007 and
December 29, 2006, which are comprised of short-term
borrowings, long-term borrowings and junior subordinated notes
(related to trust preferred securities), consisted of the
following:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Senior debt issued by ML & Co.
|
|
$
|
140,023
|
|
|
$
|
115,474
|
|
Senior debt issued by subsidiaries guaranteed by
ML & Co.
|
|
|
33,986
|
|
|
|
26,664
|
|
Subordinated debt issued by ML & Co.
|
|
|
10,875
|
|
|
|
6,429
|
|
Structured notes issued by ML & Co.
|
|
|
49,268
|
|
|
|
25,466
|
|
Structured notes issued by subsidiaries guaranteed
by ML & Co.
|
|
|
12,993
|
|
|
|
8,349
|
|
Junior subordinated notes (related to trust preferred securities)
|
|
|
5,154
|
|
|
|
3,813
|
|
Other subsidiary financing not guaranteed by
ML & Co.
|
|
|
5,396
|
|
|
|
4,316
|
|
Other subsidiary financing non-recourse
|
|
|
39,417
|
|
|
|
12,812
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
297,112
|
|
|
$
|
203,323
|
|
|
|
Borrowing activities may create exposure to market risk, most
notably interest rate, equity, commodity and currency risk.
Other subsidiary financing non-recourse is primarily
attributable to consolidated entities that are VIEs. Additional
information regarding VIEs is provided in Note 6 to the
Condensed Consolidated Financial Statements.
Borrowings and Deposits at September 28, 2007 and
December 29, 2006, are presented below:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Short-term borrowings
|
|
|
|
|
|
|
|
|
Commercial paper
|
|
$
|
11,237
|
|
|
$
|
6,357
|
|
Promissory notes
|
|
|
3,450
|
|
|
|
-
|
|
Secured short-term borrowings
|
|
|
7,728
|
|
|
|
9,800
|
|
Other unsecured short-term borrowings
|
|
|
4,663
|
|
|
|
1,953
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
27,078
|
|
|
$
|
18,110
|
|
|
|
|
|
|
|
|
|
|
Long-term
borrowings(1)
|
|
|
|
|
|
|
|
|
Fixed-rate
obligations(2)(4)
|
|
$
|
100,772
|
|
|
$
|
58,366
|
|
Variable-rate
obligations(3)(4)
|
|
|
161,898
|
|
|
|
120,794
|
|
Zero-coupon contingent convertible debt
(LYONs®)
|
|
|
2,210
|
|
|
|
2,240
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
264,880
|
|
|
$
|
181,400
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
U.S
|
|
$
|
69,461
|
|
|
$
|
62,294
|
|
Non U.S
|
|
|
25,516
|
|
|
|
21,830
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
94,977
|
|
|
$
|
84,124
|
|
|
|
|
|
|
(1) |
|
Excludes junior subordinated
notes (related to trust preferred securities). |
(2) |
|
Fixed-rate obligations are
generally swapped to floating rates. |
(3) |
|
Variable interest rates are
generally based on rates such as LIBOR, the U.S. Treasury Bill
Rate, or the Federal Funds Rate. |
(4) |
|
Included are various
equity-linked or other indexed instruments. |
46
At September 28, 2007, long-term borrowings mature as
follows:
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
Less than 1 year
|
|
$
|
56,613
|
|
|
|
21
|
%
|
|
|
1 - 2 years
|
|
|
49,451
|
|
|
|
19
|
|
|
|
2+ - 3 years
|
|
|
28,525
|
|
|
|
11
|
|
|
|
3+ - 4 years
|
|
|
14,559
|
|
|
|
5
|
|
|
|
4+ - 5 years
|
|
|
30,273
|
|
|
|
11
|
|
|
|
Greater than 5 years
|
|
|
85,459
|
|
|
|
33
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
264,880
|
|
|
|
100
|
%
|
|
|
|
|
Certain long-term borrowing agreements contain provisions
whereby the borrowings are redeemable at the option of the
holder at specified dates prior to maturity. These borrowings
are reflected in the above table as maturing at their put dates,
rather than their contractual maturities. Management believes,
however, that a portion of such borrowings will remain
outstanding beyond their earliest redemption date.
A limited number of notes whose coupon or repayment terms are
linked to the performance of debt and equity securities,
indices, currencies or commodities may be accelerated based on
the value of a referenced index or security, in which case
Merrill Lynch may be required to immediately settle the
obligation for cash or other securities. Refer to Note 1 of
the 2006 Annual Report, Embedded Derivatives section for
additional information.
Except for the $2.2 billion of aggregate principal amount
of floating rate zero-coupon contingently convertible liquid
yield option notes
(LYONs®)
that were outstanding at September 28, 2007, senior and
subordinated debt obligations issued by ML & Co. and
senior debt issued by subsidiaries and guaranteed by
ML & Co. do not contain provisions that could, upon an
adverse change in ML & Co.s credit rating,
financial ratios, earnings, cash flows, or stock price, trigger
a requirement for an early payment, additional collateral
support, changes in terms, acceleration of maturity, or the
creation of an additional financial obligation. See Note 9
of the 2006 Annual Report for additional information regarding
conditions surrounding
LYONs®
conversion.
The effective weighted-average interest rates for borrowings at
September 28, 2007 and December 29, 2006 were:
|
|
|
|
|
|
|
|
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Short-term borrowings
|
|
|
4.99
|
%
|
|
|
5.15
|
%
|
Long-term borrowings, contractual rate
|
|
|
4.67
|
|
|
|
4.23
|
|
Junior subordinated notes (related to trust preferred securities)
|
|
|
6.91
|
|
|
|
7.03
|
|
|
|
See Note 9 of the 2006 Annual Report for additional
information on Borrowings.
Merrill Lynch also obtains standby letters of credit from
issuing banks to satisfy various counterparty collateral
requirements, in lieu of depositing cash or securities
collateral. Such standby letters of credit aggregated
$4.4 billion and $2.5 billion at September 28,
2007 and December 29, 2006, respectively.
47
Note 10. Comprehensive
(Loss)/Income
The components of comprehensive (loss)/income are as follows:
(dollars in millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Net (loss)/earnings
|
|
$
|
(2,241
|
)
|
|
$
|
3,045
|
|
|
$
|
2,056
|
|
|
$
|
5,153
|
|
Other comprehensive (loss)/income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment
|
|
|
(9
|
)
|
|
|
48
|
|
|
|
15
|
|
|
|
4
|
|
Net unrealized (losses)/gains on investment securities
available-for-sale
|
|
|
(741
|
)
|
|
|
122
|
|
|
|
(765
|
)
|
|
|
(53
|
)
|
Deferred gains on cash flow hedges
|
|
|
46
|
|
|
|
17
|
|
|
|
19
|
|
|
|
17
|
|
Defined benefit pension and postretirement plans
|
|
|
4
|
|
|
|
(2
|
)
|
|
|
13
|
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive (loss)/income, net of tax
|
|
|
(700
|
)
|
|
|
185
|
|
|
|
(718
|
)
|
|
|
(33
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive (loss)/income
|
|
$
|
(2,941
|
)
|
|
$
|
3,230
|
|
|
$
|
1,338
|
|
|
$
|
5,120
|
|
|
|
The majority of the net unrealized losses on available-for-sale
investment securities for the three months and nine months ended
September 28, 2007 relates to mortgage- and asset-backed
securities. These securities are SFAS 115 investments held
by ML & Co. and certain of its non-broker-dealer
entities, including Merrill Lynchs banking subsidiaries.
48
Note 11. Stockholders
Equity and Earnings Per Share
The following table presents the computations of basic and
diluted earnings per share (EPS):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions, except per share amounts)
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Net (loss)/earnings from continuing operations
|
|
$
|
(2,266
|
)
|
|
$
|
3,019
|
|
|
$
|
1,971
|
|
|
$
|
5,084
|
|
Net earnings from discontinued operations
|
|
|
25
|
|
|
|
26
|
|
|
|
85
|
|
|
|
69
|
|
Preferred stock dividends
|
|
|
(73
|
)
|
|
|
(50
|
)
|
|
|
(197
|
)
|
|
|
(138
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss)/earnings applicable to common
shareholders - for basic EPS
|
|
$
|
(2,314
|
)
|
|
$
|
2,995
|
|
|
$
|
1,859
|
|
|
$
|
5,015
|
|
Interest expense on
LYONs®(1)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss)/earnings applicable to common
shareholders - for diluted EPS
|
|
$
|
(2,314
|
)
|
|
$
|
2,995
|
|
|
$
|
1,859
|
|
|
$
|
5,016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(shares in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average basic shares
outstanding(2)
|
|
|
821,565
|
|
|
|
855,844
|
|
|
|
832,222
|
|
|
|
874,985
|
|
Effect of dilutive instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee stock
options(3)
|
|
|
-
|
|
|
|
38,938
|
|
|
|
36,764
|
|
|
|
41,364
|
|
FACAAP
shares(3)
|
|
|
-
|
|
|
|
21,834
|
|
|
|
20,552
|
|
|
|
21,452
|
|
Restricted shares and
units(3)
|
|
|
-
|
|
|
|
28,235
|
|
|
|
23,524
|
|
|
|
27,884
|
|
Convertible
LYONs®(1)
|
|
|
-
|
|
|
|
415
|
|
|
|
3,213
|
|
|
|
865
|
|
ESPP
shares(3)
|
|
|
-
|
|
|
|
8
|
|
|
|
11
|
|
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive potential common shares
|
|
|
-
|
|
|
|
89,430
|
|
|
|
84,064
|
|
|
|
91,576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
Shares(4)(5)
|
|
|
821,565
|
|
|
|
945,274
|
|
|
|
916,286
|
|
|
|
966,561
|
|
|
|
Basic EPS from continuing operations
|
|
$
|
(2.85
|
)
|
|
$
|
3.47
|
|
|
$
|
2.13
|
|
|
$
|
5.65
|
|
Basic EPS from discontinued operations
|
|
$
|
0.03
|
|
|
$
|
0.03
|
|
|
$
|
0.10
|
|
|
$
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic EPS
|
|
$
|
(2.82
|
)
|
|
$
|
3.50
|
|
|
$
|
2.23
|
|
|
$
|
5.73
|
|
Diluted EPS from continuing operations
|
|
$
|
(2.85
|
)
|
|
$
|
3.14
|
|
|
$
|
1.94
|
|
|
$
|
5.12
|
|
Diluted EPS from discontinued operations
|
|
$
|
0.03
|
|
|
$
|
0.03
|
|
|
$
|
0.09
|
|
|
$
|
0.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS
|
|
$
|
(2.82
|
)
|
|
$
|
3.17
|
|
|
$
|
2.03
|
|
|
$
|
5.19
|
|
|
|
|
|
|
(1) |
|
See Note 9 of the 2006
Annual Report for additional information on
LYONs®. |
(2) |
|
Includes shares exchangeable
into common stock |
(3) |
|
See Note 14 of the 2006
Annual Report for a description of these instruments. |
(4) |
|
Excludes 10 million of
instruments for the nine month period ended September 28,
2007, and 33 million of instruments for the three and nine
months periods ended September 29, 2006, that were
considered antidilutive and thus were not included in the above
calculations. |
(5) |
|
Due to the net loss in the
third quarter of 2007, the Diluted EPS calculation excludes
112 million of employee stock options, 37 million of
FACAAP shares, 43 million of restricted shares and units,
and 183 thousand of ESPP shares, as they were
antidilutive. |
During the third quarter of 2007, Merrill Lynch repurchased
19.9 million common shares at an average repurchase price
of $73.91 per share.
At September 28, 2007, there was $4.0 billion of
authorized repurchase capacity remaining from the $6.0 billion
repurchase program authorized by the Board of Directors in April
2007.
On March 20, 2007, Merrill Lynch issued $1.5 billion
in aggregate principal amount of Floating Rate, Non-Cumulative,
Perpetual Preferred Stock, Series 5.
49
On September 21, 2007, in connection with the acquisition
of First Republic, Merrill Lynch issued two new series of
preferred stock, $65 million in aggregate principal amount
of 6.70% Non-Cumulative, Perpetual Preferred Stock,
Series 6, and $50 million in aggregate principal
amount of 6.25% Non-Cumulative, Perpetual Preferred Stock,
Series 7. Upon closing the First Republic acquisition,
Merrill Lynch also issued 11.6 million shares of common
stock, par value
$1.331/3
per share, as consideration.
Note 12. Commitments,
Contingencies and Guarantees
Litigation
Merrill Lynch has been named as a defendant in various legal
actions, including arbitrations, class actions, and other
litigation arising in connection with its activities as a global
diversified financial services institution.
Some of the legal actions include claims for substantial
compensatory
and/or
punitive damages or claims for indeterminate amounts of damages.
In some cases, the issuers that would otherwise be the primary
defendants in such cases are bankrupt or otherwise in financial
distress. Merrill Lynch is also involved in investigations
and/or
proceedings by governmental and self-regulatory agencies.
Merrill Lynch believes it has strong defenses to, and where
appropriate, will vigorously contest, many of these matters.
Given the number of these matters, some are likely to result in
adverse judgments, penalties, injunctions, fines, or other
relief. Merrill Lynch may explore potential settlements before a
case is taken through trial because of the uncertainty, risks,
and costs inherent in the litigation process. In accordance with
SFAS No. 5, Accounting for Contingencies,
Merrill Lynch will accrue a liability when it is probable
that a liability has been incurred and the amount of the loss
can be reasonably estimated. In many lawsuits and arbitrations,
including almost all of the class action lawsuits, it is not
possible to determine whether a liability has been incurred or
to estimate the ultimate or minimum amount of that liability
until the case is close to resolution, in which case no accrual
is made until that time. In view of the inherent difficulty of
predicting the outcome of such matters, particularly in cases in
which claimants seek substantial or indeterminate damages,
Merrill Lynch cannot predict what the eventual loss or range of
loss related to such matters will be. Merrill Lynch continues to
assess these cases and believes, based on information available
to it, that the resolution of these matters will not have a
material adverse effect on the financial condition of Merrill
Lynch as set forth in the Condensed Consolidated Financial
Statements, but may be material to Merrill Lynchs
operating results or cash flows for any particular period and
may impact ML & Co.s credit ratings.
Commitments
At September 28, 2007, Merrill Lynchs commitments had
the following expirations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
Commitment expiration
|
|
|
|
|
Less than
|
|
|
|
|
|
|
|
|
Total
|
|
1 year
|
|
1 - 3 years
|
|
3+- 5 years
|
|
Over 5 years
|
|
|
Commitments to extend
credit(1)
|
|
$
|
93,521
|
|
|
$
|
38,700
|
|
|
$
|
12,442
|
|
|
$
|
27,632
|
|
|
$
|
14,747
|
|
Purchasing and other commitments
|
|
|
9,990
|
|
|
|
5,774
|
|
|
|
539
|
|
|
|
845
|
|
|
|
2,832
|
|
Operating leases
|
|
|
3,967
|
|
|
|
612
|
|
|
|
1,169
|
|
|
|
953
|
|
|
|
1,233
|
|
Commitments to enter into resale agreements
|
|
|
6,988
|
|
|
|
6,988
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
114,466
|
|
|
$
|
52,074
|
|
|
$
|
14,150
|
|
|
$
|
29,430
|
|
|
$
|
18,812
|
|
|
|
|
|
|
(1) |
|
See Note 7 to the
Condensed Consolidated Financial Statements. |
50
Lending
Commitments
Merrill Lynch primarily enters into commitments to extend
credit, predominantly at variable interest rates, in connection
with corporate finance, corporate and institutional transactions
and asset-based lending transactions. Clients 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. These commitments 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, Merrill Lynch may
require the counterparty to post collateral depending upon
creditworthiness and general market conditions. See Note 7
to the Condensed Consolidated Financial Statements for
additional information.
The contractual amounts of these commitments represent the
amounts at risk should the contract be fully drawn upon, the
client defaults, and the value of the existing collateral
becomes worthless. The total amount of outstanding commitments
may not represent future cash requirements, as commitments may
expire without being drawn upon.
For lending commitments where the loan will be classified as
held for sale upon funding, liabilities are calculated at the
lower of cost or market, capturing declines in the fair value of
the respective credit risk. For loan commitments where the loan
will be classified as held for investment upon funding,
liabilities are calculated considering both market and
historical loss rates. Loan commitments held by entities that
apply broker-dealer industry level accounting are accounted for
at fair value.
Purchasing
and Other Commitments
In the normal course of business, Merrill Lynch enters into
institutional and margin-lending transactions, some of which are
on a committed basis, but most of which are not. Margin lending
on a committed basis only includes amounts where Merrill Lynch
has a binding commitment. These binding margin lending
commitments totaled $494 million at September 28, 2007
and $782 million at December 29, 2006.
Merrill Lynch had commitments to purchase partnership interests,
primarily related to private equity and principal investing
activities, of $1.9 billion and $928 million at
September 28, 2007 and December 29, 2006,
respectively. Merrill Lynch also has entered into agreements
with providers of market data, communications, systems
consulting, and other office-related services. At
September 28, 2007 and December 29, 2006, minimum fee
commitments over the remaining life of these agreements
aggregated $258 million and $357 million,
respectively. Merrill Lynch entered into commitments to purchase
loans of $6.4 billion (which upon settlement of the
commitment will be included in trading assets, loans held for
investment and loans held for sale) at September 28, 2007.
Such commitments totaled $10.3 billion at December 29,
2006. Other purchasing commitments amounted to $0.9 billion
and $2.1 billion at September 28, 2007 and
December 29, 2006, respectively.
In the normal course of business, Merrill Lynch enters into
commitments for underwriting transactions. Settlement of these
transactions as of September 28, 2007 would not have a
material effect on the consolidated financial condition of
Merrill Lynch.
In connection with trading activities, Merrill Lynch enters into
commitments to enter into resale agreements.
51
Leases
As disclosed in Note 12 of the 2006 Annual Report, Merrill
Lynch has entered into various noncancellable long-term lease
agreements for premises that expire through 2024. Merrill Lynch
has also entered into various noncancellable short-term lease
agreements, which are primarily commitments of less than one
year under equipment leases.
On June 19, 2007, Merrill Lynch sold its ownership interest
in Chapterhouse Holdings Limited, whose primary asset is Merrill
Lynchs London Headquarters, for approximately
$950 million. Merrill Lynch leased the premises back for an
initial term of 15 years under an agreement which is
classified as an operating lease. The leaseback also includes
renewal rights extending significantly beyond the initial term.
The sale resulted in a pre-tax gain of approximately
$370 million which was deferred and is being recognized
over the lease term as a reduction of occupancy expense.
Guarantees
Merrill Lynch issues various guarantees to counterparties in
connection with certain leasing, securitization and other
transactions. In addition, Merrill Lynch enters into certain
derivative contracts that meet the accounting definition of a
guarantee under Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indebtedness of Others
(FIN 45). These guarantees and their
expiration at September 28, 2007 are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Maximum
|
|
|
|
|
|
|
|
|
|
|
|
|
Payout /
|
|
Less than
|
|
|
|
|
|
Over
|
|
Carrying
|
|
|
Notional
|
|
1 year
|
|
1 - 3 years
|
|
3+- 5 years
|
|
5 years
|
|
Value
|
|
|
Derivative contracts
|
|
$
|
4,082,422
|
|
|
$
|
665,833
|
|
|
$
|
664,899
|
|
|
$
|
1,151,865
|
|
|
$
|
1,599,825
|
|
|
$
|
111,258
|
|
Liquidity and default facilities
|
|
|
52,461
|
|
|
|
50,156
|
|
|
|
2,206
|
|
|
|
99
|
|
|
|
-
|
|
|
|
129
|
|
Residual value guarantees
|
|
|
1,020
|
|
|
|
91
|
|
|
|
407
|
|
|
|
116
|
|
|
|
406
|
|
|
|
14
|
|
Standby letters of credit and other
guarantees
|
|
|
5,770
|
|
|
|
1,845
|
|
|
|
1,240
|
|
|
|
1,139
|
|
|
|
1,546
|
|
|
|
23
|
|
|
|
Derivative
Contracts
The derivatives in the above table meet the accounting
definition of a guarantee under FIN 45 and include certain
written options and credit default swaps that contingently
require Merrill Lynch to make payments based on changes in an
underlying. Because the maximum exposure to loss could be
unlimited for certain derivatives (e.g., interest rate caps) and
the maximum exposure to loss is not considered when assessing
the risk of contracts, the notional value of these contracts has
been included to provide information about the magnitude of
Merrill Lynchs involvement with these types of
transactions. Merrill Lynch records all derivative instruments
at fair value on its Condensed Consolidated Balance Sheets.
Merrill Lynch funds selected assets, including CDOs and
collateralized loan obligations (CLOs), via
derivative contracts with third party structures that are not
consolidated on its balance sheet. Approximately
$25 billion is term financed through facilities provided by
commercial banks, $35 billion of long term funding is
provided by third party special purpose vehicles and
$16 billion is financed with asset backed commercial paper
conduits. In certain circumstances, Merrill Lynch may be
required to purchase these assets which would not result in
additional gain or loss to the firm as such exposure is already
reflected in the fair value of Merrill Lynchs derivative
contracts.
52
Liquidity
and Default Facilities
The liquidity facilities and default facilities in the above
table relate primarily to municipal bond securitization SPEs and
asset-backed commercial paper conduits (Conduits).
Merrill Lynch acts as liquidity provider to municipal bond
securitization SPEs. As of September 28, 2007, the value of
the assets held by the SPE plus any additional collateral
pledged to Merrill Lynch exceeds the amount of beneficial
interests issued, which provides additional support to Merrill
Lynch in the event that the standby facility is drawn. As of
September 28, 2007, the maximum payout if the standby
facilities are drawn was $39.3 billion and the value of the
municipal bond assets to which Merrill Lynch has recourse in the
event of a draw was $42.8 billion. In certain instances,
Merrill Lynch also provides default protection in addition to
liquidity facilities. If the default protection is drawn,
Merrill Lynch may claim the underlying assets held by the SPEs.
As of September 28, 2007, the maximum payout if an issuer
defaults was $7.9 billion, and the value of the assets to
which Merrill Lynch has recourse, in the event that an issuer of
a municipal bond held by the SPE defaults on any payment of
principal
and/or
interest when due, was $8.8 billion.
In addition, Merrill Lynch, through a U.S. bank subsidiary
has liquidity and credit facilities outstanding to Conduits. The
assets in these Conduits are loans and asset-backed securities.
In the event of a disruption in the commercial paper market, the
Conduit may draw upon their liquidity facility and sell certain
of their assets to Merrill Lynch, thereby protecting commercial
paper holders against certain changes in the fair value of the
assets held by the Conduits. The credit facilities protect
commercial paper investors against credit losses for up to a
certain percentage of the portfolio of assets held by the
respective Conduits. The outstanding amount of the facilities is
approximately $4.8 billion as of September 28, 2007.
This amount is net of $5.1 billion of assets that Merrill
Lynch purchased and $1.2 billion that Merrill Lynch loaned
to the Conduits under these liquidity facilities during the
three months ended September 28, 2007. In addition, Merrill
Lynch purchased $523 million of commercial paper from these
Conduits, including $300 million from Conduits for which it
has a significant variable interest. These liquidity and credit
facilities are recorded off-balance sheet, unless a liability is
deemed necessary when a contingent payment is deemed probable
and estimable. A liability of $41 million related to this
contingency was recorded as of September 28, 2007.
Residual
Value Guarantees
The amounts in the above table include residual value guarantees
associated with the Hopewell campus and aircraft leases of
$322 million at September 28, 2007.
Stand-by
Letters of Credit and Other Guarantees
Merrill Lynch provides guarantees to counterparties in the form
of standby letters of credit in the amount of $2.7 billion.
Merrill Lynch held marketable securities of $563 million as
collateral to secure these guarantees at September 28, 2007.
Further, in conjunction with certain principal-protected mutual
funds, Merrill Lynch guarantees the return of the initial
principal investment at the termination date of the fund. At
September 28, 2007, Merrill Lynchs maximum potential
exposure to loss with respect to these guarantees is
$634 million assuming that the funds are invested
exclusively in other general investments (i.e., the funds hold
no risk-free assets), and that those other general investments
suffer a total loss. As such, this measure significantly
overstates Merrill Lynchs exposure or expected loss at
September 28, 2007. These transactions met the
SFAS No. 149 definition of derivatives and, as such,
were carried as a liability with a fair value of approximately
$6 million at September 28, 2007.
53
Merrill Lynch also provides indemnifications related to the
U.S. tax treatment of certain foreign tax planning
transactions. The maximum exposure to loss associated with these
transactions at September 28, 2007 is $165 million;
however, Merrill Lynch believes that the likelihood of loss with
respect to these arrangements is remote, and therefore has not
recorded any liabilities in respect of these guarantees.
In connection with certain asset sales and securitization
transactions, Merrill Lynch typically makes representations and
warranties about the underlying assets conforming to specified
guidelines. If the underlying assets do not conform to the
specifications, Merrill Lynch may have an obligation to
repurchase the assets or indemnify the purchaser against any
loss. To the extent these assets were originated by others and
purchased by Merrill Lynch, Merrill Lynch seeks to obtain
appropriate representations and warranties in connection with
its acquisition of the assets. For residential mortgage loan and
other securitizations, the maximum potential amount that could
be required to be repurchased is the current outstanding asset
balance. The liability recorded for losses under these
arrangements was approximately $205 million at
September 28, 2007. In all other arrangements, no liability
is carried in the Condensed Consolidated Balance Sheets because
Merrill Lynch believes the potential for loss is remote.
See Note 12 of the 2006 Annual Report for additional
information on guarantees.
Note 13. Employee Benefit
Plans
Merrill Lynch provides pension and other postretirement benefits
to its employees worldwide through defined contribution pension,
defined benefit pension, and other postretirement plans. These
plans vary based on the country and local practices. Merrill
Lynch reserves the right to amend or terminate these plans at
any time. Refer to Note 13 of the 2006 Annual Report for a
complete discussion of employee benefit plans.
Defined
Benefit Pension Plans
Pension cost for the three and nine months ended
September 28, 2007 and September 29, 2006, for Merrill
Lynchs defined benefit pension plans, included the
following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Three Months Ended
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
|
|
|
|
U.S.
|
|
Non-U.S.
|
|
|
|
U.S.
|
|
Non-U.S.
|
|
|
|
|
Plans
|
|
Plans
|
|
Total
|
|
Plans
|
|
Plans
|
|
Total
|
|
|
Service cost
|
|
$
|
-
|
|
|
$
|
7
|
|
|
$
|
7
|
|
|
$
|
-
|
|
|
$
|
7
|
|
|
$
|
7
|
|
Interest cost
|
|
|
24
|
|
|
|
20
|
|
|
|
44
|
|
|
|
24
|
|
|
|
16
|
|
|
|
40
|
|
Expected return on plan assets
|
|
|
(29
|
)
|
|
|
(21
|
)
|
|
|
(50
|
)
|
|
|
(28
|
)
|
|
|
(15
|
)
|
|
|
(43
|
)
|
Amortization of net (gains)/losses, prior
service costs and other
|
|
|
(1
|
)
|
|
|
7
|
|
|
|
6
|
|
|
|
-
|
|
|
|
5
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total defined benefit pension cost
|
|
$
|
(6
|
)
|
|
$
|
13
|
|
|
$
|
7
|
|
|
$
|
(4
|
)
|
|
$
|
13
|
|
|
$
|
9
|
|
54
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Nine Months Ended
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
|
|
|
|
U.S.
|
|
Non-U.S.
|
|
|
|
U.S.
|
|
Non-U.S.
|
|
|
|
|
Plans
|
|
Plans
|
|
Total
|
|
Plans
|
|
Plans
|
|
Total
|
|
|
Service cost
|
|
$
|
-
|
|
|
$
|
21
|
|
|
$
|
21
|
|
|
$
|
-
|
|
|
$
|
21
|
|
|
$
|
21
|
|
Interest cost
|
|
|
72
|
|
|
|
60
|
|
|
|
132
|
|
|
|
72
|
|
|
|
47
|
|
|
|
119
|
|
Expected return on plan assets
|
|
|
(87
|
)
|
|
|
(60
|
)
|
|
|
(147
|
)
|
|
|
(84
|
)
|
|
|
(45
|
)
|
|
|
(129
|
)
|
Amortization of net (gains)/losses, prior
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
service costs and other
|
|
|
(3
|
)
|
|
|
22
|
|
|
|
19
|
|
|
|
-
|
|
|
|
14
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total defined benefit pension cost
|
|
$
|
(18
|
)
|
|
$
|
43
|
|
|
$
|
25
|
|
|
$
|
(12
|
)
|
|
$
|
37
|
|
|
$
|
25
|
|
Merrill Lynch disclosed in its 2006 Annual Report that it
expected to pay $23 million of benefit payments to
participants in the U.S. non-qualified pension plan and
Merrill Lynch expected to contribute $70 million to its
non-U.S. defined
benefit pension plans in 2007. Merrill Lynch does not expect
contributions to differ significantly from amounts previously
disclosed.
Postretirement
Benefits Other Than Pensions
Other postretirement benefit cost for the three and nine months
ended September 28, 2007 and September 29, 2006,
included the following components:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Service cost
|
|
$
|
2
|
|
|
$
|
2
|
|
|
$
|
5
|
|
|
$
|
6
|
|
Interest cost
|
|
|
4
|
|
|
|
4
|
|
|
|
12
|
|
|
|
12
|
|
Amortization of net (gains)/losses, prior service costs and other
|
|
|
(2
|
)
|
|
|
1
|
|
|
|
(5
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other postretirement benefits cost
|
|
$
|
4
|
|
|
$
|
7
|
|
|
$
|
12
|
|
|
$
|
16
|
|
|
|
Approximately 90% of the postretirement benefit cost components
for the period relate to the U.S. postretirement plan.
Merrill Lynch adopted FIN 48 effective the beginning of the
first quarter of 2007 and recognized a decrease to beginning
retained earnings and an increase to the liability for
unrecognized tax benefits of approximately $66 million.
The total amount of unrecognized tax benefits as of the date of
adoption of FIN 48 was approximately $1.5 billion. Of
this total, approximately $1.0 billion (net of federal
benefit of state issues, competent authority and foreign tax
credit offsets) represents the amount of unrecognized tax
benefits that, if recognized, would favorably affect the
effective tax rate in future periods.
55
Merrill Lynch paid an assessment to Japan in 2005 for the fiscal
years April 1, 1998 through March 31, 2003, in
relation to the taxation of income that was originally reported
in other jurisdictions. During the third quarter of 2005,
Merrill Lynch started the process of obtaining clarification
from international tax authorities on the appropriate allocation
of income among multiple jurisdictions to prevent double
taxation. In addition, Merrill Lynch filed briefs with the
U.S. Tax Court in 2005 with respect to a tax case, which
had been remanded for further proceedings in accordance with a
2004 opinion of the U.S. Court of Appeals for the Second
Circuit. The U.S. Court of Appeals affirmed the initial
adverse conclusion of the U.S. Tax Court rendered in 2003
against Merrill Lynch, with respect to a 1987 transaction. The
U.S. Tax Court has yet to issue a decision on this remanded
matter, and it is uncertain as to when a decision will be
rendered. The unrecognized tax benefits with respect to this
case and the Japanese assessment, while paid, have been included
in the $1.5 billion and the $1.0 billion amounts above.
Merrill Lynch recognizes the accrual of interest and penalties
related to unrecognized tax benefits in income tax expense.
Interest and penalties accrued as of the beginning of the year
were approximately $107 million.
Merrill Lynch is under examination by the Internal Revenue
Service (IRS) and other tax authorities in countries
including Japan and the United Kingdom, and states in which
Merrill Lynch has significant business operations, such as New
York. The tax years under examination vary by jurisdiction. The
IRS audits are in progress for the tax years
2004-2006
and are expected to be completed in 2008. Japan tax authorities
have recently commenced the audit for the fiscal tax years
March 31, 2004 through March 31, 2007. In the United
Kingdom, the audit for the tax year 2005 is in progress. The
Canadian tax authorities have commenced the audit of the tax
years
2004-2005.
New York State and New York City audits are in progress for the
years
2002-2006.
As indicated above, the IRS audits for the years
2004-2006
are expected to be completed in 2008. It is also reasonably
possible that audits in other countries and states may conclude
in 2008. It is also reasonably possible that, in 2008, Merrill
Lynch will obtain clarification from international tax
authorities on the appropriate allocation of income among
multiple jurisdictions (transfer pricing) to prevent double
taxation resulting from the tax assessment paid to Japan in
2005. While it is reasonably possible that a significant
reduction in unrecognized tax benefits may occur within
12 months of September 28, 2007, quantification of an
estimated range cannot be made at this time due to the
uncertainty of the potential outcome of outstanding issues.
|
|
Note 15. |
Regulatory Requirements
|
Effective January 1, 2005, Merrill Lynch became a
consolidated supervised entity (CSE) as defined by
the SEC. As a CSE, Merrill Lynch is subject to group-wide
supervision, which requires Merrill Lynch to compute allowable
capital and risk allowances on a consolidated basis. At
September 28, 2007, Merrill Lynch was in compliance with
applicable CSE standards.
Certain U.S. and
non-U.S. subsidiaries
are subject to various securities, banking, and insurance
regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which
they operate. These regulatory restrictions may impose
regulatory capital requirements and limit the amounts that these
subsidiaries can pay in dividends or advance to Merrill Lynch.
Merrill Lynchs principal regulated subsidiaries are
discussed below.
56
Securities
Regulation
As a registered broker-dealer, Merrill Lynch, Pierce,
Fenner & Smith Incorporated (MLPF&S)
is subject to the net capital requirements of
Rule 15c3-1
under the Securities Exchange Act of 1934 (the
Rule). Under the alternative method permitted by the Rule,
the minimum required net capital, as defined, shall be the
greater of 2% of aggregate debit items (ADI) arising
from customer transactions or $500 million. At
September 28, 2007, MLPF&Ss regulatory net
capital of $3,970 million was approximately 14.0% of ADI,
and its regulatory net capital in excess of the minimum required
was $3,336 million.
As a futures commission merchant, MLPF&S is also subject to
the capital requirements of the Commodity Futures Trading
Commission (CFTC), which requires that minimum net
capital should not be less than 8% of the total customer risk
margin requirement plus 4% of the total non-customer risk margin
requirement. MLPF&S substantially exceeds both standards.
Merrill Lynch International (MLI), a U.K. regulated
investment firm, is subject to capital requirements of the
Financial Services Authority (FSA). Financial
resources, as defined and as such, must exceed the total
financial resources requirement set by the FSA. For
September 28, 2007, MLI reported $1,142 million in
excess capital prior to additional post-close write-downs for
the third quarter of 2007. These additional write-downs were
determined subsequent to MLIs September 28, 2007
regulatory filing. In support of the additional write-downs, MLI
received $3,500 million share capital during October 2007.
Merrill Lynch Government Securities Inc. (MLGSI), a
primary dealer in U.S. Government securities, is subject to
the capital adequacy requirements of the Government Securities
Act of 1986. This rule requires dealers to maintain liquid
capital in excess of market and credit risk, as defined, by 20%
(a 1.2-to-1 capital-to-risk standard). At September 28,
2007, MLGSIs liquid capital of $2,660 million was
318.0% of its total market and credit risk, and liquid capital
in excess of the minimum required was $1,658 million.
Merrill Lynch Japan Securities Co. Ltd. (MLJS), a
Japan-based regulated broker-dealer, is subject to capital
requirements of the Japanese Financial Services Agency
(JFSA). Net capital, as defined, must exceed 120% of
the total risk equivalents requirement of the JFSA. At
September 28, 2007, MLJSs net capital was
$1,595 million, exceeding the minimum requirement by
$943 million.
Banking
Regulation
Merrill Lynch Bank USA (MLBUSA) is a Utah-chartered
industrial bank, regulated by the Federal Deposit Insurance
Corporation (FDIC) and the State of Utah Department
of Financial Institutions (UTDFI). Merrill Lynch
Bank & Trust Co., FSB (MLBT-FSB) is a
full service thrift institution regulated by the Office of
Thrift Supervision (OTS), whose deposits are insured
by the FDIC. Both MLBUSA and MLBT-FSB are required to maintain
capital levels that at least equal minimum capital levels
specified in federal banking laws and regulations. Failure to
meet the minimum levels will result in certain mandatory, and
possibly additional discretionary, actions by the regulators
that, if undertaken,
57
could have a direct material effect on the banks. The following
table illustrates the actual capital ratios and capital amounts
for MLBUSA and MLBT-FSB as of September 28, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
|
|
MLBUSA
|
|
MLBT-FSB
|
|
|
|
|
|
|
|
Well
|
|
|
|
|
|
|
|
|
|
|
Capitalized
|
|
Actual
|
|
Actual
|
|
Actual
|
|
Actual
|
|
|
Minimum
|
|
Ratio
|
|
Amount
|
|
Ratio
|
|
Amount
|
|
|
Tier 1 leverage
|
|
|
5
|
%
|
|
|
9.76
|
%
|
|
$
|
6,616
|
|
|
|
8.19
|
%
|
|
$
|
2,344
|
|
Tier 1 capital
|
|
|
6
|
%
|
|
|
10.19
|
%
|
|
|
6,616
|
|
|
|
11.74
|
%
|
|
|
2,344
|
|
Total capital
|
|
|
10
|
%
|
|
|
11.62
|
%
|
|
|
7,546
|
|
|
|
15.07
|
%
|
|
|
3,007
|
|
|
|
As a result of its ownership of MLBT-FSB, ML & Co. is
registered with the OTS as a savings and loan holding company
(SLHC) and subject to regulation and examination by
the OTS as a SLHC. ML & Co. is classified as a unitary
SLHC, and will continue to be so classified as long as it and
MLBT-FSB continue to comply with certain conditions. Unitary
SLHCs are exempt from the material restrictions imposed upon the
activities of SLHCs that are not unitary SLHCs. SLHCs other than
unitary SLHCs are generally prohibited from engaging in
activities other than conducting business as a savings
association, managing or controlling savings associations,
providing services to subsidiaries or engaging in activities
permissible for bank holding companies. Should ML &
Co. fail to continue to qualify as a unitary SLHC, in order to
continue its present businesses that would not be permissible
for a SLHC, ML & Co. could be required to divest
control of MLBT-FSB.
Merrill Lynch International Bank Limited (MLIB), an
Ireland-based regulated bank, is subject to the capital
requirements of the Financial Regulator of Ireland. MLIB is
required to meet minimum regulatory capital requirements under
the European Union (EU) banking law as implemented
in Ireland by the Financial Regulator. At September 28,
2007, MLIBs capital ratio was above the minimum
requirement at 10.9% and its financial resources were
$10,293 million, exceeding the minimum requirement by
$811 million.
On December 30, 2006, Merrill Lynch acquired the First
Franklin mortgage origination franchise and related servicing
platform from National City Corporation for $1.3 billion.
First Franklin originates sub-prime residential mortgage loans
through a wholesale network. The results of operations of First
Franklin are included in GMI.
On September 21, 2007, Merrill Lynch acquired all of the
outstanding common shares of First Republic Bank (First
Republic) in exchange for a combination of cash and stock
for a total transaction value of $1.8 billion. First
Republic provides personalized, relationship-based banking
services, including private banking, private business banking,
real estate lending, trust, brokerage and investment management.
The results of operations of First Republic are included in GWM.
In conjunction with the acquisition of First Republic, Merrill
Lynch issued $65 million of 6.70% non-cumulative perpetual
preferred stock and $50 million of 6.25% non-cumulative
preferred stock in exchange for First Republic Banks
preferred stock Series A and B, respectively. Upon closing
the First Republic acquisition, Merrill Lynch also issued
11.6 million shares of common stock, par value
$1.331/3
per share, as consideration.
58
Note 17. Discontinued
Operations
On August 13, 2007, Merrill Lynch announced that it will
form a strategic business relationship with AEGON, N.V.
(AEGON) in the areas of insurance and investment
products. As part of this relationship, Merrill Lynch has agreed
to sell Merrill Lynch Life Insurance Company and ML Life
Insurance Company of New York (together Merrill Lynch
Insurance Group or MLIG) to AEGON for
$1.3 billion. Merrill Lynch will continue to serve the
insurance needs of its clients through its core distribution and
advisory capabilities. This transaction is expected to close by
the end of the fourth quarter of 2007, subject to regulatory
approvals. Results for MLIG have been included within
discontinued operations for all periods presented and the assets
and liabilities were not considered material for separate
presentation. The results of MLIG were formerly reported in the
Global Wealth Management business segment. Certain financial
information included in discontinued operations is shown below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29,
|
|
Sept. 28,
|
|
Sept. 29,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Total net revenues
|
|
$
|
65
|
|
|
$
|
73
|
|
|
$
|
199
|
|
|
$
|
202
|
|
Earnings before income taxes
|
|
|
38
|
|
|
|
38
|
|
|
|
128
|
|
|
|
103
|
|
Income taxes
|
|
|
13
|
|
|
|
12
|
|
|
|
43
|
|
|
|
34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings from discontinued operations
|
|
$
|
25
|
|
|
$
|
26
|
|
|
$
|
85
|
|
|
$
|
69
|
|
|
|
The following assets and liabilities are related to discontinued
operations as of September 28, 2007 and December 29,
2006:
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
|
|
Sept. 28,
|
|
Dec. 29,
|
|
|
2007
|
|
2006
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
Separate accounts assets
|
|
$
|
12,588
|
|
|
$
|
12,312
|
|
Other assets
|
|
|
3,242
|
|
|
|
3,497
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
15,830
|
|
|
$
|
15,809
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Separate accounts liabilities
|
|
$
|
12,588
|
|
|
$
|
12,312
|
|
Other payables
|
|
|
2,630
|
|
|
|
2,772
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
$
|
15,218
|
|
|
$
|
15,084
|
|
|
|
59
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Merrill
Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance
sheet of Merrill Lynch & Co., Inc. and subsidiaries
(Merrill Lynch) as of September 28, 2007, and
the related condensed consolidated statements of earnings for
the three-month and nine-month periods ended September 28,
2007 and September 29, 2006, and of cash flows for the
nine-month periods ended September 28, 2007 and
September 29, 2006. These interim financial statements are
the responsibility of Merrill Lynchs management.
We conducted our reviews in accordance with the standards of the
Public Company Accounting Oversight Board (United States). A
review of interim financial information consists principally of
applying analytical procedures and making inquiries of persons
responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in
accordance with the standards of the Public Company Accounting
Oversight Board (United States), 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 reviews, we are not aware of any material
modifications that should be made to such condensed consolidated
interim financial statements for them to be in conformity with
accounting principles generally accepted in the United States of
America.
As discussed in Notes 1, 3 and 14 to the condensed
consolidated interim financial statements, in 2007 Merrill Lynch
adopted Statement of Financial Accounting Standards
No. 157, Fair Value Measurement,
Statement of Financial Accounting Standards No. 159,
The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB
Statement No. 115, and FASB Interpretation
No. 48, Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement
No. 109.
We have previously audited, in accordance with the standards of
the Public Company Accounting Oversight Board (United States),
the consolidated balance sheet of Merrill Lynch as of
December 29, 2006, and the related consolidated statements
of earnings, changes in stockholders equity, comprehensive
income and cash flows for the year then ended (not presented
herein); and in our report dated February 26, 2007, we
expressed an unqualified opinion on those financial statements
and included an explanatory paragraph regarding the change in
accounting method in 2006 for share-based payments to conform to
Statement of Financial Accounting Standards No. 123
(revised 2004), Share-Based Payment. In our opinion, the
information set forth in the accompanying condensed consolidated
balance sheet as of December 29, 2006 is fairly stated, in
all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ Deloitte
& Touche LLP
New York, New York
November 7, 2007
60
|
|
ITEM 2.
|
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
Forward-Looking
Statements and Non-GAAP Financial Measures
Certain statements in this report may be considered
forward-looking, including those about management expectations,
strategic objectives, growth opportunities, business prospects,
anticipated financial results, the impact of off-balance sheet
arrangements, significant contractual obligations, anticipated
results of litigation and regulatory investigations and
proceedings, and other similar matters. These forward-looking
statements represent only Merrill Lynch & Co.,
Inc.s (ML & Co. and, together with
its subsidiaries, Merrill Lynch, we,
our or us) beliefs regarding future
performance, which is inherently uncertain. There are a variety
of factors, many of which are beyond our control, which affect
our operations, performance, business strategy and results and
could cause our actual results and experience to differ
materially from the expectations and objectives expressed in any
forward-looking statements. These factors include, but are not
limited to, actions and initiatives taken by both current and
potential competitors, general economic conditions, the effects
of current, pending and future legislation, regulation and
regulatory actions, and the other risks and uncertainties
detailed in this report. See Risk Factors that Could Affect Our
Business in the Annual Report on
Form 10-K
for the year ended December 29, 2006 (2006 Annual
Report). Accordingly, readers are cautioned not to place
undue reliance on forward-looking statements, which speak only
as of the dates on which they are made. We do not undertake to
update forward-looking statements to reflect the impact of
circumstances or events that arise after the dates they are
made. The reader should, however, consult further disclosures we
may make in future filings of our Annual Report on
Form 10-K,
Quarterly Reports on
Form 10-Q
and Current Reports on
Form 8-K.
From time to time, we may also disclose financial information on
a non-GAAP basis where management uses this information and
believes this information will be valuable to investors in
gauging the quality of our financial performance, identifying
trends in our results and providing more meaningful
period-to-period comparisons. For a reconciliation of non-GAAP
measures presented throughout this report see Exhibit 99.1.
Introduction
Merrill Lynch was formed in 1914 and became a publicly traded
company on June 23, 1971. In 1973, we created the holding
company, ML & Co., a Delaware corporation that,
through its subsidiaries, is one of the worlds leading
capital markets, advisory and wealth management companies with
offices in 38 countries and territories and total client assets
of approximately $1.8 trillion at September 28, 2007. As an
investment bank, we are a leading global trader and underwriter
of securities and derivatives across a broad range of asset
classes, and we serve as a strategic advisor to corporations,
governments, institutions and individuals worldwide. In
addition, we own a 45% voting interest and approximately half of
the economic interest of BlackRock, Inc.
(BlackRock), one of the worlds largest
publicly traded investment management companies with over $1
trillion in assets under management at September 28, 2007.
On August 13, 2007, we announced that we will form a
strategic business relationship with AEGON, N.V.
(AEGON) in the areas of insurance and investment
products. As part of this relationship, we have agreed to sell
Merrill Lynch Life Insurance Company and ML Life Insurance
Company of New York (together Merrill Lynch Insurance
Group or MLIG) to AEGON for $1.3 billion.
We will continue to serve the insurance needs of our clients
through our core distribution and advisory
61
capabilities. This transaction is expected to close by the end
of the fourth quarter of 2007, subject to regulatory approvals.
We have included results for MLIG within discontinued operations
for all periods presented. We previously reported the results of
MLIG in the Global Wealth Management (GWM) business
segment. Refer to Note 17 to the Condensed Consolidated
Financial Statements for additional information.
Since the fourth quarter of 2006, our business segment reporting
reflects the management reporting lines established after the
merger of our Merrill Lynch Investment Managers
(MLIM) business with BlackRock on September 29,
2006 (the BlackRock merger), as well as the economic
and long-term financial performance characteristics of the
underlying businesses.
Prior to the fourth quarter of 2006, we reported our business
activities in three business segments: Global Markets and
Investment Banking (GMI), Global Private Client
(GPC), and MLIM. Effective with the BlackRock
merger, MLIM ceased to exist as a separate business segment.
Accordingly, a new business segment, GWM, was created,
consisting of GPC and Global Investment Management
(GIM). GWM along with GMI are now our business
segments. We have restated prior period segment information to
conform to the current period presentation and, as a result, are
presenting GWM as if it had existed for these prior periods. See
Note 2 to the Condensed Consolidated Financial Statements
for further information on segments.
The BlackRock merger closed on the last day of our third fiscal
quarter of 2006. For more information on the BlackRock merger,
refer to Note 2 of the 2006 Annual Report.
The following is a description of our business segments,
including MLIM, which ceased to exist as a separate business
segment effective with the BlackRock merger:
|
|
|
GMI, our institutional business segment, provides
trading, capital markets services, investment banking and
advisory services to corporations, financial institutions,
institutional investors, and governments around the world.
GMIs Global Markets division facilitates client
transactions and is a market maker in securities, derivatives,
currencies, commodities and other financial instruments used to
satisfy client demands. In addition, GMI also engages in certain
proprietary trading activities. Global Markets also provides
clients with financing, securities clearing, settlement, and
custody services and also engages in principal and private
equity investing. GMIs Investment Banking division
provides a wide range of securities origination and strategic
advisory services for issuer clients, including underwriting and
placement of public and private equity, debt and related
securities, as well as lending and other financing activities
for clients globally. These services also include advising
clients on strategic issues, valuation, mergers, acquisitions
and restructurings. GMIs growth strategy entails a program
of investments in personnel and technology to gain further scale
in certain asset classes and geographies.
|
|
|
GWM, our full-service retail wealth management segment,
provides brokerage, investment advisory and financial planning
services, offering a broad range of both proprietary and
third-party wealth management products and services globally to
individuals, small- to mid-size businesses, and employee benefit
plans. Within the GPC division, most of our services are
delivered by our Financial Advisors (FAs) through a
global network of branch offices. GPCs offerings include
commission and fee-based investment accounts; banking, cash
management, and credit services, including consumer and small
business lending and
Visa®
cards; trust and generational planning; retirement services; and
insurance products. GWMs GIM division includes a business
that creates and manages hedge fund and other alternative
investment products for GPC clients, and Merrill Lynchs
share of net earnings from its ownership positions in other
investment management companies, including our investment in
BlackRock. GWMs growth priorities include continued growth
in client assets, the hiring of additional FAs, client
segmentation, annuitization of revenues through fee-based
products, diversification of revenues through adding products
and services, investments in technology to
|
62
|
|
|
enhance productivity and efficiency, and disciplined expansion
into additional geographic areas globally.
|
|
|
|
MLIM, our asset management segment prior to the BlackRock
merger, offered a wide range of investment management
capabilities to retail and institutional investors through
proprietary and third-party distribution channels globally.
Asset management capabilities included equity, fixed income,
money market, index, enhanced index and alternative investments,
which were offered through vehicles such as mutual funds,
privately managed accounts, and retail and institutional
separate accounts.
|
Critical
Accounting Policies And Estimates
The following is a summary of our critical accounting policies.
For a full description of these and other accounting policies
see Note 1 of the 2006 Annual Report and Note 1 to the
Condensed Consolidated Financial Statements.
Use of
Estimates
In presenting the Condensed Consolidated Financial Statements,
management makes estimates regarding:
|
|
|
Valuations of assets and liabilities requiring fair value
estimates including:
|
|
|
|
|
|
Trading inventory and investment securities;
|
|
|
Private equity and principal investments;
|
|
|
Certain receivables under resale agreements and payables under
repurchase agreements;
|
|
|
Loans and allowance for loan losses and liabilities recorded for
unfunded commitments;
|
|
|
Certain long-term borrowings, primarily structured debt;
|
|
|
|
The outcome of litigation;
|
|
The realization of deferred taxes and the recognition and
measurement of uncertain tax positions;
|
|
Assumptions and cash flow projections used in determining
whether VIEs should be consolidated and the determination of the
qualifying status of special purpose entities;
|
|
The carrying amount of goodwill and other intangible assets;
|
|
The amortization period of intangible assets with definite lives;
|
|
Valuation of share-based payment compensation arrangements;
|
|
Insurance reserves and recovery of 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. Therefore, actual results could differ from those
estimates and could have a material impact on the Condensed
Consolidated Financial Statements, and it is possible that such
changes could occur in the near term. For more information
regarding the specific methodologies used in determining
estimates, refer to Use of Estimates in Note 1 of the 2006
Annual Report.
Valuation
of Financial Instruments
Proper valuation of financial instruments is a critical
component of our financial statement preparation. Merrill Lynch
accounts for a significant portion of its financial instruments
at fair value or considers fair value in their measurement.
Merrill Lynch accounts for certain financial assets and
liabilities at fair value under various accounting literature,
including SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities,
SFAS No. 133, Accounting for Derivative Instruments
and
63
Hedging Activities, and SFAS No. 159, Fair
Value Option for Certain Financial Assets and Liabilities.
Merrill Lynch also accounts for certain assets at fair value
under applicable industry guidance, namely broker-dealer and
investment company accounting guidance.
In presenting the Condensed Consolidated Financial Statements,
management makes estimates regarding valuations of assets and
liabilities requiring fair value measurements. These assets and
liabilities include:
|
|
|
|
|
Trading inventory and investment securities;
|
|
|
Private equity and principal investments;
|
|
|
Certain receivables under resale agreements and payables under
repurchase agreements;
|
|
|
Loans and allowance for loan losses and liabilities recorded for
unrealized losses on unfunded commitments; and
|
|
|
Certain long-term borrowings, primarily structured debt.
|
See further discussion in Note 1 to our Condensed
Consolidated Financial Statements.
We early adopted the provisions of SFAS No. 157
Fair Value Measurements
(SFAS No. 157) in the first quarter of
2007. SFAS No. 157 defines fair value as the price
that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between marketplace
participants at the measurement date (i.e., the exit price). An
exit price notion does not assume that the transaction price is
the same as the exit price, thus permitting the recognition of
inception gains and losses on a transaction in certain
circumstances. In addition, an exit price notion requires the
valuation to consider what a marketplace participant would pay
to buy an asset or receive to assume a liability. Therefore,
Merrill Lynch must rely upon observable market data before it
can utilize internally derived valuations.
Fair values for exchange-traded securities and certain
exchange-traded derivatives, principally certain options
contracts, are based on quoted market prices. Fair values for
over-the-counter (OTC) derivatives, principally
forwards, options, and swaps, represent amounts estimated to be
received from or paid to a market participant in settlement of
these instruments. These derivatives are valued using pricing
models based on the net present value of estimated future cash
flows and directly observed prices from exchange-traded
derivatives, other OTC trades, or external pricing services and
other inputs such as quoted interest and currency indices, while
taking into account the counterpartys credit rating, or
our own credit rating as appropriate.
New and/or
complex instruments may have immature or limited markets. As a
result, the pricing models used for valuation often incorporate
significant estimates and assumptions that market participants
would use in pricing the instrument, which may impact the
results of operations reported in the Condensed Consolidated
Financial Statements. For long-dated and illiquid contracts, we
apply extrapolation methods to observed market data in order to
estimate inputs and assumptions that are not directly
observable. This enables us to mark to fair value all positions
consistently when only a subset of prices is directly
observable. Values for OTC derivatives are verified using
observed information about the costs of hedging the risk and
other trades in the market. As the markets for these products
develop, we continually refine our pricing models to correlate
more closely to the market risk of these instruments. Obtaining
the fair value for OTC derivative contracts requires the use of
management judgment and estimates. In addition, during periods
of market illiquidity, the valuation of certain cash products
can also require significant judgment and the use of estimates
by management.
Prior to adoption of SFAS No. 157, Merrill Lynch
followed the provisions of
EITF 02-3,
Issues Involved in Accounting for Derivative Contracts Held
for Trading Purposes and Contracts Involved in Energy Trading
and Risk Management Activities
(EITF 02-3).
Under
EITF 02-3,
recognition of day one gains and losses on derivative
transactions where model inputs that significantly impact
valuation are not observable were prohibited. Day one gains and
losses deferred at inception under
EITF 02-3
were recognized at the earlier of when the valuation of such
derivative became observable or at the
64
termination of the contract. SFAS No. 157 nullifies
this guidance in
EITF 02-3.
Although this guidance in
EITF 02-3
has been nullified, the recognition of significant inception
gains and losses that incorporate unobservable inputs are
reviewed by management to ensure such gains and losses are
derived from observable inputs
and/or
incorporate reasonable assumptions about the unobservable
component, such as implied bid-offer adjustments.
Valuation
adjustments
Certain financial instruments recorded at fair value are
initially measured using mid-market prices which results in
gross long and short positions marked-to-market at the same
pricing level prior to the application of position netting. The
resulting net positions are then adjusted to fair value
representing the exit price as defined in
SFAS No. 157. These significant adjustments include:
Liquidity
Merrill Lynch makes adjustments to bring a position from a
mid-market to a bid or offer price, depending upon the net open
position. Merrill Lynch values net long positions at bid prices
and net short positions at offer prices. These adjustments are
based upon either observable or implied bid-offer prices.
Credit
Risk
In determining fair value we consider both the credit risk of
our counterparties, as well as our own creditworthiness. Credit
risk to third parties is generally mitigated by entering into
netting and collateral arrangements. Net exposure is then
measured with consideration of market observable pricing of a
counterpartys credit risk and is incorporated into the
fair value of the respective instruments. The calculation of the
credit adjustment for derivatives is generally based upon
observable credit derivative spreads. Alternatively, the
calculation for cash products generally considers observable
bond spreads.
SFAS No. 157 also requires that Merrill Lynchs
own creditworthiness be considered when determining the fair
value of an instrument. The approach to measuring the impact of
Merrill Lynchs own credit on an instrument is the same
approach as that used to measure third party credit risk.
In accordance with SFAS No. 157, we have categorized
our financial instruments, based on the priority of the inputs
to the valuation technique, into a three level fair value
hierarchy. The fair value hierarchy gives the highest priority
to quoted prices in active markets for identical assets or
liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). If the inputs used to
measure the financial instruments fall within different levels
of the hierarchy, the categorization is based on the lowest
level input that is significant to the fair value measurement of
the instrument.
Financial assets and liabilities recorded on the Condensed
Consolidated Balance Sheets are categorized based on the inputs
to the valuation techniques as follows:
|
|
Level 1. |
Financial assets and liabilities whose values are based on
unadjusted quoted prices for identical assets or liabilities in
an active market that Merrill Lynch has the ability to access
(examples include active exchange-traded equity securities,
listed derivatives, most U.S. Government and agency
securities, and certain other sovereign government obligations).
|
65
|
|
Level 2. |
Financial assets and liabilities whose values are based on
quoted prices in markets that are not active or model inputs
that are observable either directly or indirectly for
substantially the full term of the asset or liability.
Level 2 inputs include the following:
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|
|
|
a)
|
Quoted prices for similar assets or liabilities in active
markets (for example, restricted stock);
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|
|
|
|
b)
|
Quoted prices for identical or similar assets or liabilities in
non-active markets (examples include corporate and municipal
bonds, which trade infrequently);
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|
|
|
|
c)
|
Pricing models whose inputs are observable for substantially the
full term of the asset or liability (examples include most
over-the-counter derivatives including interest rate and
currency swaps); and
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|
|
|
d)
|
Pricing models whose inputs are derived principally from or
corroborated by observable market data through correlation or
other means for substantially the full term of the asset or
liability (examples include certain residential and commercial
mortgage related assets, including loans, securities and
derivatives).
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Level 3. |
Financial assets and liabilities whose values are based on
prices or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value
measurement. These inputs reflect managements own
assumptions about the assumptions a market participant would use
in pricing the asset or liability (examples include certain
private equity investments, certain residential and commercial
mortgage related assets (including loans, securities and
derivatives), and long-dated or complex derivatives including
certain foreign exchange options and long-dated options on gas
and power). See Note 3 to the Condensed Consolidated
Financial Statements for additional information.
|
Valuation
controls
Given the prevalence of fair value measurement in our financial
statements, the control functions surrounding the fair valuation
process are a critical component of our business operations.
Prices and model inputs provided by the trading desk are
verified to external pricing sources to ensure that the use of
observable market data is used whenever possible. Similarly,
valuation models created by the trading desks are verified and
tested. These controls are performed by departments independent
of the trading desks with the appropriate levels of expertise to
verify the trading desks valuations.
Litigation
We have been named as a defendant in various legal actions,
including arbitrations, class actions, and other litigation
arising in connection with our activities as a global
diversified financial services institution. We are also involved
in investigations
and/or
proceedings by governmental and self-regulatory agencies. In
accordance with SFAS No. 5, Accounting for
Contingencies, we will accrue a liability when it is
probable that a liability has been incurred, and the amount of
the loss can be reasonably estimated. In many lawsuits and
arbitrations, including class action lawsuits, it is not
possible to determine whether a liability has been incurred or
to estimate the ultimate or minimum amount of that liability
until the case is close to resolution, in which case no accrual
is made until that time. In view of the inherent difficulty of
predicting the outcome of such matters, particularly in cases in
which claimants seek substantial or indeterminate damages, we
cannot predict what the eventual loss or range of loss related
to such matters will be. See Note 12 to the Condensed
Consolidated Financial Statements and Other
Information Legal Proceedings for further
information.
66
Variable
Interest Entities (VIEs)
In the normal course of business, we enter into a variety of
transactions with VIEs. The applicable accounting guidance
requires us to perform a qualitative
and/or
quantitative analysis of each new VIE at inception to determine
whether we must consolidate the VIE. In performing this
analysis, we make assumptions regarding future performance of
assets held by the VIE, taking into account estimates of credit
risk, estimates of the fair value of assets, timing of cash
flows, and other significant factors. Although a VIEs
actual results may differ from projected outcomes, a revised
consolidation analysis is generally not required subsequent to
the initial assessment unless a reconsideration event occurs. If
a VIE meets the conditions to be considered a QSPE, it is
typically not required to be consolidated by us. A QSPE is a
passive entity whose activities must be significantly limited. A
servicer of the assets held by a QSPE may have discretion in
restructuring or working out assets held by the QSPE, as long as
that discretion is significantly limited and the parameters of
that discretion are fully described in the legal documents that
established the QSPE. Determining whether the activities of a
QSPE and its servicer meet these conditions requires management
judgment.
Income
Taxes
Tax laws are complex and subject to different interpretations by
Merrill Lynch and the various taxing authorities. Merrill Lynch
regularly assesses the likelihood of assessments in each of the
taxing jurisdictions by making judgments and interpretations
about the application of these complex tax laws and estimating
the impact to our financial statements.
Merrill Lynch is under examination by the Internal Revenue
Service (IRS) and other tax authorities in countries
including Japan and the United Kingdom, and states in which
Merrill Lynch has significant business operations, such as New
York. The tax years under examination vary by jurisdiction. The
IRS audits are in progress for the tax years
2004-2006
and are expected to be completed in 2008. Japan tax authorities
have recently commenced the audit for the fiscal tax years
March 31, 2004 through March 31, 2007. In the United
Kingdom, the audit for the tax year 2005 is in progress. The
Canadian tax authorities have commenced the audit of the tax
years
2004-2005.
New York State and New York City audits are in progress for the
years
2002-2006.
Also, Merrill Lynch paid an assessment to Japan in 2005 for the
fiscal years April 1, 1998 through March 31, 2003, in
relation to the taxation of income that was originally reported
in other jurisdictions. During the third quarter of 2005, we
started the process of obtaining clarification from
international tax authorities on the appropriate allocation of
income among multiple jurisdictions to prevent double taxation.
Merrill Lynch believes that the estimate of the level of
unrecognized tax benefits is appropriate in relation to the
potential for additional assessments. Merrill Lynch adjusts the
level of unrecognized tax benefits when there is more
information available, or when an event occurs requiring a
change. The reassessment of unrecognized tax benefits could have
a material impact on Merrill Lynchs effective tax rate in
the period in which it occurs.
67
Global financial markets experienced significant stress during
the third quarter of 2007, primarily driven by challenging
conditions in the markets related to U.S. sub-prime
mortgages (including Collateralized Debt Obligations
(CDOs) based on sub-prime collateral), and the
markets for loans and bonds related to leveraged finance
transactions. This adverse market environment began to intensify
towards the end of July and was characterized by significant
credit spread widening, prolonged illiquidity, reduced price
transparency and increased volatility. As conditions in these
markets deteriorated, other areas such as the asset-backed
commercial paper market also experienced decreased liquidity,
and the equity markets experienced short-term weakness and
increased volatility. For example, during the third quarter ABX
indices experienced significant widening, with the A and AAA
classes moving substantially off par for the first time in 2007.
In response to these conditions, the Federal Reserve and other
central banks injected significant liquidity into the markets
during the quarter and in September the U.S. Federal
Reserve Systems Federal Open Market Committee lowered
benchmark interest rates by 50 basis points to 4.75%. These
actions helped to stabilize and improve market conditions.
Long-term interest rates, as measured by the
10-year
U.S. Treasury bond, ended the third quarter at 4.58%, down
from 5.03% at the end of the second quarter of 2007. In the
equity markets, despite significant volatility in August, major
U.S. equity indices increased slightly during the third
quarter of 2007 with the Dow Jones Industrial Average, the
NASDAQ Composite Index and the Standard & Poors
500 Index up by 4%, 4% and 2%, respectively. Oil prices hit a
record high and the U.S. dollar hit a low against the euro
during the quarter. Overall the global economy continued to grow
during the third quarter, albeit at a slower pace than during
the first half of the year.
Global fixed income trading volumes increased during the quarter
in asset classes such as Government and Agency securities with
average daily trading volumes up approximately 16% and 18%,
respectively. Volumes across mortgage-backed securities declined
approximately 7% during the quarter.
Global equity indices generally ended the quarter with mixed
results. In Europe, the Dow Jones STOXX 50 Index and the FTSE
100 Index fell 3% and 2%, respectively. Asian equity markets
were mixed as Japans Nikkei 225 Stock Average fell 7%
while Hong Kongs Hang Seng Index surged 25%. Indias
Sensex Index rose 18%. In Latin America, Brazils Bovespa
Index was up 11%.
U.S. Equity trading volumes increased in the third quarter
as both the dollar volume and number of shares traded on the New
York Stock Exchange and on the Nasdaq increased compared to the
second quarter of 2007. Equity market volatility increased
significantly for both the S&P 500 and the Nasdaq 100 in
the quarter, as indicated by higher average levels for the
Chicago Board Options Exchange SPX Volatility Index and the
American Stock Exchange QQQ Volatility Index, respectively. In
Europe, equity market volatility also increased, although not as
significantly, as indicated by a higher average level for the
VSTOXX Index.
Third quarter global debt and equity underwriting volumes of
$1.2 trillion were down 46% sequentially and down 23% from the
year-ago quarter. Global debt underwriting volumes of $1.1
trillion were down 46% sequentially and down 26% compared to the
year-ago quarter, while global equity underwriting volumes of
$161 billion were down 45% sequentially, but up 12%
compared to the year-ago quarter.
Merger and acquisition (M&A) activity was weak
during the quarter as the value of global announced deals was
$1.0 trillion, a decrease of 38% sequentially, but still up 29%
from the year-ago quarter. Global completed M&A activity
was $1.1 billion, up 3% sequentially and up 28% from the
year-ago quarter.
(1) Debt and equity underwriting and merger
and acquisition volumes were obtained from Dealogic.
68
Despite higher volatility and the typical seasonality associated
with the third quarter, money flows remained strong relative to
the year-ago quarter, including flows into money market funds.
While our results may vary based on global economic and market
trends, we believe that the outlook for growth in most of our
global businesses, including Equity Markets, Investment Banking,
Global Wealth Management and certain Fixed Income, Currencies
and Commodities (FICC) businesses remains favorable
due to positive underlying fundamentals, high market volumes,
and the resiliency of these markets. This remains especially
true for markets outside of the U.S., such as the Pacific Rim.
However, the challenging conditions in certain credit markets,
such as the CDO and related sub-prime mortgage markets, have
continued into the fourth quarter.
At the end of the third quarter, we maintained exposures to
these markets through cash positions, loans, derivatives and
commitments. During the third quarter, FICC revenues were
adversely affected by the substantial deterioration in the value
of many of these exposures, particularly towards quarter end.
See U.S. Sub-prime Residential Mortgage-Related and ABS
CDO Activities on page 73 for further detail.
The markets for U.S. ABS CDO exposures remain extremely illiquid
and as a result, valuation of these exposures is complex and
involves a comprehensive process including the use of
quantitative modeling and management judgment. Valuation of
these exposures will also continue to be impacted by external
market factors including default rates, rating agency actions,
and the prices at which observable market transactions occur.
Our ability to mitigate our risk by selling or hedging our
exposures is also limited by the market environment. Our future
results may continue to be materially impacted by the valuation
adjustments applied to these positions.
69
Consolidated
Results Of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions, except per share amounts)
|
|
|
|
For the Three Months Ended
|
|
For the Nine Months Ended
|
|
|
|
|
|
Sept. 28,
|
|
Sept. 29
|
|
%
|
|
Sept. 28,
|
|
Sept. 29
|
|
%
|
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
Change
|
|
|
Net revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal transactions
|
|
$
|
(5,930
|
)
|
|
$
|
1,673
|
|
|
|
N/M
|
%
|
|
$
|
351
|
|
|
$
|
4,841
|
|
|
|
(93
|
)%
|
Commissions
|
|
|
1,860
|
|
|
|
1,345
|
|
|
|
38
|
|
|
|
5,360
|
|
|
|
4,462
|
|
|
|
20
|
|
Investment banking
|
|
|
1,281
|
|
|
|
922
|
|
|
|
39
|
|
|
|
4,333
|
|
|
|
3,166
|
|
|
|
37
|
|
Managed accounts and other fee-based revenues
|
|
|
1,397
|
|
|
|
1,714
|
|
|
|
(18
|
)
|
|
|
4,038
|
|
|
|
5,047
|
|
|
|
(20
|
)
|
Revenues from consolidated investments
|
|
|
508
|
|
|
|
210
|
|
|
|
142
|
|
|
|
772
|
|
|
|
500
|
|
|
|
54
|
|
Other
|
|
|
(918
|
)
|
|
|
773
|
|
|
|
N/M
|
|
|
|
880
|
|
|
|
2,436
|
|
|
|
(64
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
(1,802
|
)
|
|
|
6,637
|
|
|
|
N/M
|
<