UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

Commission file number: 1-7182

 

MERRILL LYNCH & CO., INC.

(Exact name of Registrant as specified in its charter)

 

 

 

See the full list of securities listed on the NYSE Arca and The NASDAQ Stock Market on the pages directly following this cover.

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

X     YES             NO

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

 

       YES      X     NO

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     X

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “’smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

       YES      X     NO

 

As of the close of business on June 27, 2008, the aggregate market value of the voting stock, comprising the Common Stock and the Exchangeable Shares, held by non-affiliates of the Registrant was approximately $17.4 billion.

 

As of the close of business on February 20, 2009, there were 1,000 shares of Common Stock outstanding, all of which were held by Bank of America Corporation.

 

The registrant is a wholly owned subsidiary of Bank of America Corporation and meets the conditions set forth in General Instructions I(1)(a) and (b) of Form 10-K and is therefore filing this Form with a reduced disclosure format as permitted by Instruction I (2).

Securities registered pursuant to Section 12(b) of the Act and listed on the NYSE Arca are as follows:

 

Capped Leveraged Index Return Notes^® Linked to the S&P 500^® Index due February 26, 2010; Accelerated Return Bear Market Notes Linked to the S&P 500^® Index due October 30, 2009; Bear Market Strategic Accelerated Redemption Securities Linked to the Dow Jones U.S. Real Estate Index due March 2, 2010; Strategic Accelerated Redemption Securities Linked to the Dow Jones Industrial Average^SM due August 31, 2010; 9.25% Callable Stock Return Income Debt Securities^SM due September 1, 2010 (payable on the maturity date with Oracle Corporation common stock); Accelerated Return Bear Market Notes Linked to the Russell 2000^® Index due November 25, 2009; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index due October 5, 2010; Strategic Accelerated Redemption Securities^SM Linked to the iShares^® MSCI EAFE^® Index due October 5, 2010; 100% Principal Protected Range Notes Linked to the S&P 500^® Index due October 6, 2009; Accelerated Return Notes^SM Linked to the S&P 500^® Index due November 25, 2009; Capped Leverage Index Return Notes^® Linked to the S&P 500^® Index due April 5, 2010; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index due November 2, 2010; Accelerated Return Bear Market Notes Linked to the S&P 500^® Index due January 21, 2010; Accelerated Return Notes Linked to the S&P 500^® Index due January 21, 2010; Capped Leveraged Index Return Notes^® Linked to the S&P 500^® Index due April 30, 2010; Bear Market Strategic Accelerated Redemption Securities^SM Linked to the SPDR S&P Retail Exchange Traded Fund due May 4, 2010; 100% Principal Protected Bullish Range Notes Linked to the S&P 500^® Index due November 9, 2009; Accelerated Return Notes^SM Linked to the Consumer Staples Select Sector Index due January 29, 2010; 100% Principal Protected Conditional Participation Notes Linked to the S&P 500^® Index due December 2, 2009; Bear Market Strategic Accelerated Redemption Securities^SM Linked to the iShares^® Dow Jones U.S. Real Estate Index Fund due June 2, 2010; Capped Leveraged Index Return Notes^® Linked to the S&P 500^® Index due May 28, 2010; Accelerated Return Notes^SM Linked to the MSCI EAFE^® Index due January 29, 2010; Accelerated Return Notes^SM Linked to the S&P 500^® Index due January 29, 2010; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index due December 1, 2010; Accelerated Return Bear Market Notes Linked to the S&P 500^® Index due January 29, 2010; 12% Callable STock Return Income DEbt Securities^SM Due September 4, 2009 (payable on the stated maturity date with Apple Inc. common stock); STEP Income Securities^SM Due June 25, 2009 linked to the common stock of Apple Inc.; Bear Market Strategic Accelerated Redemption Securities^SM Linked to the S&P Small Cap Regional Banks Index Due February 2, 2010; Accelerated Return Bear Market Notes Linked to the Russell 3000^® Index due October 2, 2009; Bear Market Strategic Accelerated Redemption Securities^SM Linked to the Consumer Discretionary Select Sector Index Due December 28, 2009; 9% Callable STock Return Income DEbt Securities^SM due March 5, 2009 (payable on the maturity date with Best Buy Co., Inc. common stock); Capped Leveraged Index Return Notes^® Linked to the MSCI Brazil Index^SM due January 20, 2010; Accelerated Return Notes^SM Linked to the MSCI Brazil Index^SM Due May 5, 2009; 8% Monthly Income Strategic Return Notes^® Linked to the CBOE DJIA BuyWrite Index due November 9, 2010; 8% Monthly Income Strategic Return Notes^® Linked to the CBOE S&P 500^® BuyWrite Index due June 7, 2010; 10% Callable STock Return Income DEbt Securities^SM Due March 6, 2009 (payable on the stated maturity date with The Boeing Company common stock); 8% Monthly Income Strategic Return Notes^® Linked to the CBOE S&P 500^® BuyWrite Index due January 3, 2011; 11% Callable STock Return Income DEbt Securities^SM Due April 28, 2009 (payable on the maturity date with Cisco Systems, Inc. common stock); Strategic Accelerated Redemption Securities^SM Linked to the Dow Jones Industrial Average^SM due July 7, 2010; Strategic Accelerated Redemption Securities^SM Linked to the Dow Jones Industrial Average^SM Due April 2, 2010; Strategic Accelerated Redemption Securities^SM Linked to the Dow Jones EURO STOXX 50^SM Index Due November 9, 2009; STEP Income Securities^SM Due July 14, 2009 Linked to the common stock of Freeport-McMoRan Copper & Gold Inc.; 9% Callable STock Return Income DEbt Securities^SM Due March 1, 2010 (payable on the stated maturity date with Google Inc. common stock); Bear Market Strategic Accelerated Redemption Securities^SM Linked to the PHLX Housing Sector^SM Index due November 3, 2009; Strategic Return Notes^® Linked to the Merrill Lynch Factor Model^SM due November 7, 2012; 11% Callable STock Return Income DEbt Securities^SM Due February 8, 2010 (payable on the stated maturity date with The Home Depot, Inc. common stock); Accelerated Return Notes^SM Linked to the Health Care Select Sector Index due June 2, 2009; Accelerated Return Bear Market Notes Linked to the Energy Select Sector Index due June 29, 2009; Accelerated Return Bear Market Notes Linked to the Energy Select Sector Index due May 5, 2009; Strategic Return Notes^® Linked to the Industrial 15 Index due August 9, 2010; Accelerated Return Notes^SM Linked to the MSCI EAFE^® Index Due August 27, 2009; Callable Market Index Target-Term Securities^® due May 4, 2009 Linked to the S&P 500^® Index; Strategic Return Notes^® Linked to the Baby Boomer Consumption Index due September 6, 2011; Strategic Return Notes^® Linked to the Industrial 15 Index due February 2, 2012; 9% Callable STock Return Income DEbt Securities^SM Due December 4, 2009 (payable on the stated maturity date with Exxon Mobil Corporation common stock); Capped Leveraged Index Return Notes^® Linked to the MSCI Emerging Markets Index^SM due January 29, 2010; Market Index Target-Term Securities^® based upon the Dow Jones Industrial Average^SM due August 7, 2009; S&P 500^® Market Index Target-Term Securities^® due September 4, 2009; Accelerated Return Notes^SM Linked to the MSCI EAFE^® Index due October 5, 2009; Dow Jones EURO STOXX 50^SM Index Market Index Target-Term Securities^® due June 28, 2010; Strategic Return Notes^® Linked to the Value 30 Index due July 6, 2011; S&P 500^® Market Index Target-Term Securities^® due June 29, 2009; Nikkei 225 Market Index Target-Term Securities^® due March 30, 2009; Nikkei 225 Market Index Target-Term Securities^® due April 5, 2010; Strategic Return Notes^® Linked to the Select Ten Index due March 8, 2012; Strategic Return Notes^® Linked to the Value 30 Index due August 8, 2011; Accelerated Return Notes^SM Linked to the MSCI EAFE^® Index Due May 4, 2009; Strategic Return Notes^® Linked to the Merrill Lynch Factor Model^SM due December 6, 2012; 12% Callable STock Return Income DEbt Securities^SM due March 26, 2010 (payable on the stated maturity date with Monsanto Company common stock); STEP Income Securities^SM Due August 17, 2009 linked to the common stock of Monsanto Company; Nikkei 225^® Market Index Target-Term Securities^® due June 5, 2009; 50/100 Nikkei 225^® Index Notes due October 7, 2009; Accelerated Return Notes^SM Linked to the S&P 500^® Index Due April 6, 2009; Accelerated Return Notes^SM Linked to the Nikkei 225^® Index Due June 26, 2009; STEP Income Securities^SM Due June 4, 2009 Linked to the common stock of Qualcomm Incorporated; Strategic Accelerated Redemption Securities^SM Linked to the Russell 2000^® Index Due April 2, 2010; Capped Leveraged Index Return Notes^® Linked to the Russell 2000^® Index due January 20, 2010; Capped Leveraged Index Return Notes^® Linked to the Russell 2000^® Index Due October 30, 2009; Market Index Target-Term Securities^® based upon the Russell 2000^® Index due March 30, 2009; Strategic Return Notes^® Linked to the Select Ten Index due May 10, 2012; Strategic Return Notes^® Linked to the Select Ten Index due November 8, 2011; Accelerated Return Notes^SM Linked to the S&P 500^® Index due August 27, 2009; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index due March 8, 2010; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index due November 30, 2009; Strategic Return Notes^® Linked to the Industrial 15 Index due August 3, 2009; Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index Due May 4, 2010; 9% Callable STock Return Income DEbt Securities^SM Due September 24, 2009 (payable on the stated maturity date with Caterpillar Inc. common stock); Strategic Accelerated Redemption Securities^SM Linked to the S&P 500^® Index Due August 3, 2010; Strategic Accelerated Redemption Securities^SM Linked to

the S&P 500^® Index Due June 25, 2010; Strategic Return Notes^® Linked to the Select 10 Index due July 5, 2012; Strategic Return Notes^® Linked to the Select Utility Index due February 25, 2009; Strategic Return Notes^® Linked to the Select Utility Index due September 28, 2009; Accelerated Return Notes^SM Linked to the PHLX Gold and Silver Sector^SM Index Due June 2, 2009

 

Securities registered pursuant to Section 12(b) of the Act and listed on The NASDAQ Stock Market are as follows:

 

Strategic Return Notes^® Linked to the Industrial 15 Index due April 25, 2011; S&P 500^® Market Indexed Target-Term Securities^® due June 7, 2010; Leveraged Index Return Notes^® Linked to the Nikkei 225^® Index due March 2, 2009; S&P 500^® MITTS^® Securities due August 31, 2011; Strategic Return Notes^® Linked to the Select Ten Index due June 4, 2009; 97% Protected Notes Linked to Global Equity Basket due February 14, 2012; Strategic Return Notes^® Linked to the Industrial 15 Index due March 30, 2009; Strategic Return Notes^® Linked to the Select Ten Index due March 2, 2009; 97% Protected Notes Linked to the performance of the Dow Jones Industrial Average^SM due March 28, 2011; Dow Jones Industrial Average^SM MITTS^® Securities due December 27, 2010; Nikkei 225^® MITTS^® Securities due March 8, 2011; Nikkei 225^® MITTS^® Securities due September 30, 2010; S&P 500^® MITTS^® Securities due August 5, 2010; S&P 500^® MITTS^® Securities due June 3, 2010; Leveraged Index Return Notes^® Linked to Dow Jones Industrial Average^SM due September 28, 2009

 

S&P 100 and S&P 500 are registered trademarks of McGraw-Hill, Inc.; EAFE is a registered service mark of Morgan Stanley Capital International Inc.; DOW JONES INDUSTRIAL AVERAGE is a service mark of Dow Jones & Company, Inc.; RUSSELL 1000, RUSSELL 2000 AND RUSSELL 3000 are registered service marks of FRANK RUSSELL COMPANY; PHLX Gold and Silver Sector, PHLX Housing Sector and PHLX Semiconductor Sector are registered service marks of the Philadelphia Stock Exchange, Inc.; STOXX and EURO STOXX 50 are registered service marks of Stoxx Limited; NIKKEI is a registered trademark of KABUSHIKI KAISHA NIHON KEIZAI SHIMBUN SHA. All other trademarks and service marks are the property of Merrill Lynch & Co., Inc.

 

ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 26, 2008
TABLE OF CONTENTS

 

 

 

 

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 world’s leading capital markets, advisory and wealth management companies with offices in 40 countries and territories. In our Global Wealth Management (“GWM”) business, we had total client assets in GWM accounts of approximately $1.2 trillion at December 26, 2008. 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, as of December 26, 2008, we owned approximately half of the economic interest of BlackRock, Inc. (“BlackRock”), one of the world’s largest publicly traded investment management companies with approximately $1.3 trillion in assets under management at the end of 2008.

 

On September 15, 2008, we entered into an Agreement and Plan of Merger, as amended by Amendment No. 1 dated as of October 21, 2008 (the “Merger Agreement”) with Bank of America Corporation (“Bank of America”). Pursuant to the Merger Agreement, on January 1, 2009, a wholly-owned subsidiary of Bank of America (“Merger Sub”) merged with and into ML & Co., with ML & Co. continuing as the surviving corporation and a subsidiary of Bank of America (the “Merger”).

 

Our activities are conducted through two business segments: Global Markets and Investment Banking (“GMI”) and GWM. In addition, we provide a variety of research services on a global basis.

 

Global Markets and Investment Banking

 

The Global Markets division consists of the Fixed Income, Currencies and Commodities (“FICC”) and Equity Markets sales and trading activities for investor clients and on a proprietary basis, while the Investment Banking division provides a wide range of origination and strategic advisory services for issuer clients. Global Markets makes a market in securities, derivatives, currencies, and other financial instruments to satisfy client demands. In addition, Global Markets engages in certain proprietary trading activities. Global Markets is a leader in the global distribution of fixed income, currency and energy commodity products and derivatives. Global Markets also has one of the largest equity trading operations in the world and is a leader in the origination and distribution of equity and equity-related products. Further, Global Markets provides clients with financing, securities clearing, settlement, and custody services and also engages in principal investing in a variety of asset classes and private equity investing. The Investment Banking division raises capital for its clients through underwritings and private placements of equity, debt and related securities, and loan syndications. Investment Banking also offers advisory services to clients on strategic issues, valuation, mergers, acquisitions and restructurings.

 

Global Wealth Management

 

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. GWM is comprised of Global Private Client (“GPC”) and Global Investment Management (“GIM”).

 

GPC provides a full range of wealth management products and services to assist clients in managing all aspects of their financial profile through the Total Merrill^SM platform. Total Merrill^SM is the platform for GPC’s core strategy offering investment choices, brokerage, advice, planning and/or performance analysis to its clients. GPC’s 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.

GPC services individuals and small- and middle-market corporations and institutions through approximately 16,090 financial advisors as of December 26, 2008.

 

GIM includes our interests in creating and managing wealth management products, including alternative investment products for clients. GIM also includes our share of net earnings from our ownership positions in other investment management companies, including BlackRock.

 

Global Research

 

We also provide a variety of research services on a global basis. These services are at the core of the value proposition we offer to institutional and individual investor clients and are an integral component of the product offerings to GMI and GWM. This group distributes research focusing on three main disciplines globally: fundamental equity research, credit research and macro research. We rank among the leading research providers in the industry, and our analysts cover approximately 3,000 companies in equity research and 800 global bond issuers.

 

Regulation

 

Certain aspects of our business, and the business of our competitors and the financial services industry in general, are subject to stringent regulation by U.S. federal and state regulatory agencies and securities exchanges and by various non-U.S. government agencies or regulatory bodies, securities exchanges, self-regulatory organizations, and central banks, each of which has been charged with the protection of the financial markets and the interests of those participating in those markets.

 

United States Regulatory Oversight and Supervision

 

Holding Company Supervision

 

Prior to our acquisition by Bank of America, we were a consolidated supervised entity subject to group-wide supervision by the SEC and capital requirements generally consistent with the standards of the Basel Committee on Banking Supervision. As such, we computed allowable capital and risk allowances consistent with Basel II capital standards; permitted the SEC to examine the books and records of ML & Co. and any affiliate that did not have a principal regulator; and had various additional SEC reporting, record-keeping, and notification requirements.

 

As a wholly-owned subsidiary of Bank of America, a bank holding company that is also a financial holding company, we are subject to the oversight of, and inspection by, the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”).

 

Broker-Dealer Regulation

 

Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S”), Merrill Lynch Professional Clearing Corp. (“ML Pro”) and certain other subsidiaries of ML & Co. are registered as broker-dealers with the SEC and, as such, are subject to regulation by the SEC and by self-regulatory organizations, such as the Financial Industry Regulatory Authority (“FINRA”). Certain Merrill Lynch subsidiaries and affiliates, including MLPF&S, are registered as investment advisers with the SEC.

 

The Merrill Lynch entities that are broker-dealers registered with the SEC are subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (“Exchange Act”) which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, these entities are required to maintain the minimum net capital deemed necessary to meet broker-dealers’ continuing commitments to customers and others. Under certain circumstances, this rule limits the ability of such broker-dealers to allow withdrawal of such capital by ML & Co. or other Merrill Lynch subsidiaries. Additional information regarding certain net capital requirements is set forth in Note 15 to the Consolidated Financial Statements.

Non-U.S. Regulatory Oversight and Supervision

 

Merrill Lynch’s business is also subject to extensive regulation by various non-U.S. regulators including governments, securities exchanges, central banks and regulatory bodies. Certain Merrill Lynch subsidiaries are regulated as broker-dealers under the laws of the jurisdictions in which they operate. Subsidiaries engaged in banking and trust activities outside the United States are regulated by various government entities in the particular jurisdiction where they are chartered, incorporated and/or conduct their business activities. In some cases, the legislative and regulatory developments outside the U.S. applicable to these subsidiaries may have a global impact.

 

 

In the course of conducting our business operations, we are exposed to a variety of risks that are inherent to the financial services industry. The following discusses some of the key inherent risk factors that could affect our business and operations, as well as other risk factors which are particularly relevant to us in the current period of significant economic and market disruption. Other factors besides those discussed below or elsewhere in this report also could adversely affect our business and operations, and these risk factors should not be considered a complete list of potential risks that may affect us.

 

Business and economic conditions.  Our businesses and earnings are affected by general business and economic conditions in the United States and abroad. General business and economic conditions that could affect us include the level and volatility of short-term and long-term interest rates, inflation, home prices, employment levels, bankruptcies, household income, consumer spending, fluctuations in both debt and equity capital markets, liquidity of the global financial markets, the availability and cost of credit, investor confidence, and the strength of the U.S. economy and the local economies in which we operate.

 

Economic conditions in the United States and abroad deteriorated significantly during the second half of 2008, and the United States, Europe and Japan currently are in a recession. Dramatic declines in the housing market, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions, including government sponsored entities as well as major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivatives and cash securities, in turn, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions, reflecting concern about the stability of the financial markets generally and the strength of counterparties. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, a significant reduction in consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business, financial condition, results of operations, liquidity and access to capital and credit. We do not expect that the difficult conditions in the United States and international financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.

 

Instability of the U.S. financial system.  Beginning in the fourth quarter of 2008, the U.S. government has responded to the ongoing financial crisis and economic slowdown by enacting new legislation and expanding or establishing a number of programs and initiatives. Each of the U.S. Treasury, the FDIC and the Federal Reserve Board have developed programs and facilities, including, among others, the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) Capital Purchase Program and other efforts designed to increase inter-bank lending, improve funding for consumer receivables and restore consumer and counterparty confidence in the banking sector. In addition, Congress recently passed the

American Recovery and Reinvestment Act of 2009 (the “ARRA”), legislation intended to expand and establish government spending programs and provide tax cuts to stimulate the economy. Congress and the U.S. government continue to evaluate and develop various programs and initiatives designed to stabilize the financial and housing markets and stimulate the economy, including the U.S. Treasury’s recently announced Financial Stability Plan and the U.S. government’s recently announced foreclosure prevention program. The final form of any such programs or initiatives or related legislation cannot be known at this time. There can be no assurance as to the impact that ARRA, the Financial Stability Plan or any other such initiatives or governmental programs will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of these efforts to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit, or the trading price of our debt securities (including trust preferred securities).

 

International risk.  We do business throughout the world, including in developing regions of the world commonly known as emerging markets, and as a result, are exposed to a number of risks, including economic, market, reputational, litigation and regulatory risks, in non-U.S. markets. Our businesses and revenues derived from non-U.S. operations are subject to risk of loss from currency fluctuations, social or political instability, changes in governmental policies or policies of central banks, expropriation, nationalization, confiscation of assets, unfavorable political and diplomatic developments and changes in legislation relating to non-U.S. ownership. We also invest or trade in the securities of corporations located in non-U.S. jurisdictions, including emerging markets. Revenues from the trading of non-U.S. securities also may be subject to negative fluctuations as a result of the above factors. The impact of these fluctuations could be magnified, because generally non-U.S. trading markets, particularly in emerging market countries, are smaller, less liquid and more volatile than U.S. trading markets.

 

Soundness of other financial institutions.  Our ability to engage in routine trading and funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, funding, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even rumors or questions about the financial condition of, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client, and our results of operations in 2007 and 2008 have been materially affected by the credit valuation adjustments described in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations — U.S. ABS CDO and Other Mortgage-Related Activities — Monoline Financial Guarantors.” In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to us. There is no assurance that any such losses would not materially and adversely affect our future results of operations.

 

We are party to a large number of derivative transactions, including credit derivatives. Many of these derivative instruments are individually negotiated and non-standardized, which can make exiting, transferring or settling the position difficult. Many credit derivatives require that we deliver to the counterparty the underlying security, loan or other obligation in order to receive payment. In a number of cases, we do not hold, and may not be able to obtain, the underlying security, loan or other obligation. This could cause us to forfeit the payments due to us under these contracts or result in settlement delays with the attendant credit and operational risk as well as increased costs to us.

 

Derivative contracts and other transactions entered into with third parties are not always confirmed by the counterparties on a timely basis. While the transaction remains unconfirmed, we are subject to

heightened credit and operational risk and in the event of default may find it more difficult to enforce the contract. In addition, as new and more complex derivative products have been created, covering a wider array of underlying credit and other instruments, disputes about the terms of the underlying contracts may arise, which could impair our ability to effectively manage our risk exposures from these products and subject us to increased costs.

 

Access to funds from subsidiaries and parent.  We are a holding company that is a separate and distinct legal entity from its parent, Bank of America, and our broker-dealer, banking and nonbanking subsidiaries. We therefore depend on dividends, distributions and other payments from our broker-dealer, banking and nonbanking subsidiaries and borrowings and will depend in large part on financing from Bank of America to fund payments on our obligations, including debt obligations. Bank of America may in some instances, because of its regulatory requirements as a bank holding company, be unable to provide us with funding we need to fund payments on our obligations. Many of our subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to us. Regulatory action of that kind could impede access to funds we need to make payments on our obligations or dividend payments. In addition, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.

 

Changes in accounting standards.  Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results and are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. As a result of Bank of America’s acquisition of us, we may adopt different estimates and assumptions than those previously used in order to align our estimates, assumptions and policies with those of Bank of America. From time to time the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. In addition, accounting standard setters and those who interpret the accounting standards (such as the FASB, the SEC, banking regulators and our outside auditors) may change or even reverse their previous interpretations or positions on how these standards should be applied. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. For a further discussion of some of our significant accounting policies and standards and recent accounting changes, see Note 1 to the Consolidated Financial Statements.

 

Competition.  We operate in a highly competitive environment. Over time, there has been substantial consolidation among companies in the financial services industry, and this trend accelerated over the course of 2008 as the credit crisis has led to numerous mergers and asset acquisitions among industry participants and in certain cases reorganization, restructuring or even bankruptcy. This trend also has hastened the globalization of the securities and financial services markets. We will continue to experience intensified competition as continued consolidation in the financial services industry in connection with current market conditions may produce larger and better-capitalized companies that are capable of offering a wider array of financial products and services at more competitive prices. To the extent we expand into new business areas and new geographic regions, we may face competitors with more experience and more established relationships with clients, regulators and industry participants in the relevant market, which could adversely affect our ability to compete. Increased competition may affect our results by creating pressure to lower prices on our products and services and reducing market share.

 

Our continued ability to compete effectively in our businesses, including management of our existing businesses as well as expansion into new businesses and geographic areas, depends on our ability to retain and motivate our existing employees and attract new employees. We face significant competition for qualified employees both within the financial services industry, including foreign-based institutions and institutions not subject to compensation restrictions imposed under the TARP Capital Purchase

Program, the ARRA or any other U.S. government initiatives, and from businesses outside the financial services industry. This is particularly the case in emerging markets, where we are often competing for qualified employees with entities that may have a significantly greater presence or more extensive experience in the region. Over the past year, we have significantly reduced compensation levels. In January 2009, in connection with the U.S. Treasury’s purchase of an additional series of Bank of America’s preferred stock, Bank of America agreed to certain compensation limitations, and ARRA also includes certain additional restrictions, applicable to its senior executive officers and certain other senior managers. A substantial portion of the annual bonus compensation paid to our senior employees has in recent years been paid in the form of equity-based awards, which are now payable in Bank of America common stock. The value of these awards has been impacted by the significant decline in the market price of Bank of America’s common stock. We also have reduced the number of employees across nearly all of our businesses during 2008 and into 2009. In addition, the recent consolidation in the financial services industry has intensified the challenges of cultural integration between differing types of financial services institutions. The combination of these events could have a significant adverse impact on our ability to retain and hire the most qualified employees.

 

Credit concentration risk.  When we loan money, commit to loan money or enter into a letter of credit or other contract with a counterparty, we incur credit risk, or the risk of losses if our borrowers do not repay their loans or our counterparties fail to perform according to the terms of their contracts. A number of our products expose us to credit risk, including loans, leases and lending commitments, derivatives, including credit default swaps, trading account assets and assets held-for-sale.

 

We estimate and establish reserves or make credit valuation adjustments for credit risks and potential credit losses inherent in our credit exposure (including unfunded credit commitments). This process, which is critical to our financial results and condition, requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic predictions might impair the ability of our borrowers to repay their loans or counterparties to perform their obligations. As is the case with any such assessments, there is always the chance that we will fail to identify the proper factors or that we will fail to accurately estimate the impacts of factors that we identify. Our ability to assess the creditworthiness of our counterparties may be impaired if the models and approaches we use become less predictive of future behaviors, valuations, assumptions or estimates.

 

We have experienced concentration of risk with respect to the mortgage markets, including residential and commercial real estate, each of which represents a significant percentage of our overall credit portfolio. The current financial crisis and economic slowdown has adversely affected this concentration of risk. These exposures will also continue to be impacted by external market factors including default rates, a decline in the value of the underlying property, rating agency actions, the prices at which observable market transactions occur and the financial strength of counterparties, such as financial guarantors, with whom we have economically hedged some of our exposure to these assets.

 

In the ordinary course of our business, we also may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities, industries and countries may not function as we have anticipated. While our activities expose us to many different industries and counterparties, we routinely execute a high volume of transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment funds and insurers, including monolines and other financial guarantors. This has resulted in significant credit concentration with respect to this industry.

 

For a further discussion of credit risk, see “Concentrations of Credit Risk” in Note 3 to the Consolidated Financial Statements.

 

Liquidity risk.  Liquidity is essential to our businesses. Since we were acquired by Bank of America, we established intercompany lending and borrowing arrangements with Bank of America to facilitate

centralized liquidity management and as a result, our liquidity risk is derived in large part from Bank of America’s liquidity risk. Bank of America’s liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that Bank of America or we may be unable to control, such as a general market disruption, negative views about the financial services industry generally, or an operational problem that affects third parties or us. Bank of America’s ability to raise funding in the debt or equity capital markets has been and could continue to be adversely affected by conditions in the United States and international markets and economy. Global capital and credit markets have been experiencing volatility and disruption since the second half of 2007, and in the second half of 2008, volatility reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for issuers without regard to those issuers’ underlying financial strength. As a result of disruptions in the credit markets, Bank of America and Merrill Lynch have utilized several of the U.S. government’s liquidity programs. Bank of America’s ability and our ability to borrow from other financial institutions or to engage in securitization funding transactions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations.

 

Our credit ratings and Bank of America’s credit ratings are important to our liquidity. The ratings of Bank of America’s long-term debt have been downgraded during 2008 by all of the major rating agencies. These rating agencies regularly evaluate Bank of America, us and our securities, and their ratings of our long-term and short-term debt and other securities are based on a number of factors, including Bank of America’s and our financial strength as well as factors not entirely within our control, including conditions affecting the financial services industry generally. In light of the difficulties in the financial services industry and the financial markets, there can be no assurance that we will maintain our current ratings. Our failure to maintain those ratings could adversely affect our liquidity and competitive position, increase borrowing costs or limit access to the capital markets. While the impact on the incremental cost of funds and potential lost funding of an incremental downgrade of our long-term debt by one level might be negligible, a downgrade of Bank of America’s or our short-term credit rating could negatively impact our commercial paper program by materially affecting our incremental cost of funds and potential lost funding. A reduction in our credit ratings also could have a significant impact on certain trading revenues, particularly in those businesses where longer term counterparty performance is critical. In connection with certain trading agreements, we may be required to provide additional collateral in the event of a credit ratings downgrade.

 

For a further discussion of our liquidity position and other liquidity matters and the policies and procedures we use to manage our liquidity risks, see “Liquidity Risk” in Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Market risk.  We are directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. For example, changes in interest rates could adversely affect our net interest profit and principal transaction revenues (which we view together as our trading revenues) — which could in turn affect our net earnings. Market risk is inherent in the financial instruments associated with our operations and activities including loans, deposits, securities, derivatives, short-term borrowings and long-term debt. Just a few of the market conditions that may shift from time to time, thereby exposing us to market risk, include fluctuations in interest and currency exchange rates, equity and futures prices, changes in the implied volatility of interest rates, foreign exchange rates, credit spreads and price deterioration or changes in value due to changes in market perception or actual credit quality of either the issuer or its country of origin. Accordingly, depending on the instruments or activities impacted, market risks can have wide ranging, complex adverse effects on our results from operations and our overall financial condition.

 

The models that we use to assess and control our risk exposures reflect assumptions about the degrees of correlation or lack thereof among prices of various asset classes or other market indicators. In times of market stress or other unforeseen circumstances, such as the market conditions experienced during

2008, previously uncorrelated indicators may become correlated, or previously correlated indicators may move in different directions. These types of market movements have at times limited the effectiveness of our hedging strategies and have caused us to incur significant losses, and they may do so in the future. These changes in correlation can be exacerbated where other market participants are using risk or trading models with assumptions or algorithms that are similar to ours. In these and other cases, it may be difficult to reduce our risk positions due to the activity of other market participants or widespread market dislocations, including circumstances where asset values are declining significantly or no market exists for certain assets. To the extent that we make investments in securities that do not have an established liquid trading market or are otherwise subject to restrictions on sale or hedging, we may not be able to reduce our positions and therefore reduce our risk associated with such positions.

 

For a further discussion of market risk and our market risk management policies and procedures, see Item 7A — Quantitative and Qualitative Disclosures About Market Risk.

 

Risks Related to our Commodities Business.  We are exposed to environmental, reputational, regulatory, market and credit risk as a result of our commodities related activities. Through our commodities business, we enter into exchange-traded contracts, financially settled over-the-counter derivatives, contracts for physical delivery and contracts providing for the transportation, transmission and/or storage rights on or in vessels, barges, pipelines, transmission lines or storage facilities. Contracts relating to physical ownership, delivery and/or related activities can expose us to numerous risks, including performance, environmental and reputational risks. For example, we may incur civil or criminal liability under certain environmental laws and our business and reputation may be adversely affected. In addition, regulatory authorities have recently intensified scrutiny of certain energy markets, which has resulted in increased regulatory and legal enforcement, litigation and remedial proceedings involving companies engaged in the activities in which we are engaged.

 

Declining asset values.  We have large proprietary trading and investment positions in a number of our businesses. These positions are accounted for at fair value, and the declines in the values of assets had a direct and large negative impact on our earnings in 2008. We may incur additional losses as a result of increased market volatility or decreased market liquidity, which may adversely impact the valuation of our trading and investment positions. If an asset is marked-to-market, declines in asset values directly and immediately impact our earnings, unless we have effectively “hedged” our exposures to such declines. These exposures may continue to be impacted by declining values of the underlying assets. In addition, the prices at which observable market transactions occur and the continued availability of these transactions, and the financial strength of counterparties, such as financial guarantors, with whom we have economically hedged some of our exposure to these assets, will affect the value of these assets. Sudden declines and significant volatility in the prices of assets may substantially curtail or eliminate the trading activity for these assets, which may make it very difficult to sell, hedge or value such assets. The inability to sell or effectively hedge assets reduces our ability to limit losses in such positions and the difficulty in valuing assets may increase our risk-weighted assets which requires us to maintain additional capital and increases our funding costs.

 

Asset values also directly impact revenues from our wealth management business. We receive certain account fees based on the value of our clients’ portfolios or investment in funds managed by us and, in some cases, we also receive incentive fees based on increases in the value of such investments. Declines in asset values have reduced the value of our clients’ portfolios or fund assets, which in turn has reduced the fees we earn for managing such assets.

 

Merger risks.  There are significant risks and uncertainties associated with mergers. The success of Bank of America’s acquisition of us will depend, in part, on the ability of the combined company to realize the anticipated benefits and cost savings from combining our businesses with Bank of America’s businesses. If the combined company is unable to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected. For example, the combined company may fail to realize the growth opportunities and cost savings anticipated to be derived from the merger. Our businesses currently are experiencing

unprecedented challenges as a result of the current economic environment and ongoing financial crisis. It is possible that the integration process, including changes or perceived changes in our compensation practices, could result in the loss of key employees, the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients and employees or to achieve the anticipated benefits of the merger. Integration efforts also may divert management attention and resources. These integration matters could have an adverse effect on us for an undetermined period after consummation of the merger.

 

Regulatory considerations and restrictions on dividends.  As a subsidiary of Bank of America, we are, and certain of our bank and non-bank subsidiaries are heavily regulated by bank regulatory agencies at the federal and state levels. This regulatory oversight is established to protect depositors, federal deposit insurance funds and the banking system as a whole, not security holders. Bank of America, we and our broker-dealer and other non-bank subsidiaries are also heavily regulated by securities regulators, domestically and internationally. This regulation is designed to protect investors in securities we sell or underwrite and our clients’ assets. Congress and state legislatures and foreign, federal and state regulatory agencies continually review laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways including limiting the types of financial services and products we may offer and increasing the ability of non-banks to offer competing financial services and products.

 

As a result of the ongoing financial crisis and challenging market conditions, we expect to face increased regulation and regulatory and political scrutiny of the financial services industry, including as a result of Bank of America’s or our participation in the TARP Capital Purchase Program, the ARRA and the U.S. Treasury’s Financial Stability Plan. Compliance with such regulation may significantly increase our costs, impede the efficiency of our internal business processes, and limit our ability to pursue business opportunities in an efficient manner. The increased costs associated with anticipated regulatory and political scrutiny could adversely impact our results of operations.

 

Litigation risks.  Both Bank of America and Merrill Lynch face significant legal risks in our respective businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high and are increasing. Substantial legal liability or significant regulatory action against Bank of America or us could have material adverse financial effects or cause significant reputational harm to us, which in turn could seriously harm our business prospects. For a further discussion of litigation risks, see “Litigation and Regulatory Matters” in Note 11 to the Consolidated Financial Statements.

 

We may explore potential settlements before a case is taken through trial because of uncertainty, risks, and costs inherent in the litigation process. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, Accounting for Contingencies (“SFAS No. 5”), 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, arbitrations and investigations, including almost all of the class action lawsuits disclosed in “Litigation and Regulatory Matters” in Note 11 to the Consolidated Financial Statements, 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 matter 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 matters 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. Potential losses may be material to our operating results for any particular period and may impact our credit ratings. For a further discussion of litigation risks, see “Litigation and Regulatory Matters” in Note 11 to the Consolidated Financial Statements.

 

Governmental fiscal and monetary policy.  Our businesses and earnings are affected by domestic and international fiscal and monetary policy. For example, the Federal Reserve Board regulates the supply of money and credit in the United States and its policies determine in large part our cost of funds for

lending, investing and capital raising activities and the return we earn on those loans and investments, both of which affect our net interest profit. The actions of the Federal Reserve Board also can materially affect the value of financial instruments we hold, such as debt securities. Our businesses and earnings also are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States, non-U.S. governments and international agencies. Changes in domestic and international fiscal and monetary policy are beyond our control and hard to predict.

 

Operational risks.  The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and the vast array of associates and key executives in our day-to-day and ongoing operations. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or technical failures, unlawful tampering with our technical systems, terrorist activities, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of the key individuals to perform properly.

 

Products and services.  Our business model is based on a diversified mix of businesses that provides a broad range of financial products and services, delivered through multiple distribution channels. Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure by competition to provide products and services at lower prices. This can reduce our revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, could require us to incur substantial expenditures to modify or adapt our existing products and services. We might not be successful in developing and introducing new products and services, responding or adapting to changes in consumer spending and saving habits, achieving market acceptance of our products and services, or developing and maintaining loyal customers.

 

Reputational risks.  Our ability to attract and retain clients and employees could be adversely affected to the extent our reputation is damaged. Our actual or perceived failure to address various issues could give rise to reputational risk that could harm us or our business prospects. These issues include, but are not limited to, appropriately addressing potential conflicts of interest; legal and regulatory requirements; ethical issues; money-laundering; privacy; properly maintaining customer and associate personal information; record keeping; sales and trading practices; and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products.

 

Risk management processes and strategies.  We seek to monitor and control our risk exposure through a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application cannot anticipate every economic and financial outcome or the specifics and timing of such outcomes. Accordingly, our ability to successfully identify and manage risks facing us is an important factor that can significantly impact our results. For a further discussion of our risk management policies and procedures, see Item 7A — Quantitative and Qualitative Disclosures About Market Risk.

 

Geopolitical risks.  Geopolitical conditions can affect our earnings. Acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, could affect business and economic conditions in the United States and abroad.

 

Additional risks and uncertainties.  We are a diversified financial services company. Although we believe our diversity helps lessen the effect when downturns affect any one segment of our industry, it also means our earnings could be subject to different risks and uncertainties than the ones discussed herein. If any of the risks that we face actually occur, irrespective of whether those risks are described in this section or elsewhere in this report, our business, financial condition and operating results could be materially adversely affected.

 

There are no unresolved written comments that were received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Exchange Act.

 

 

We have offices in various locations throughout the world. Other than those described below as being owned, substantially all of our offices are located in leased premises. We believe that the facilities we own or lease are adequate for the purposes for which they are currently used and that they are well maintained. Set forth below is the location and the approximate square footage of our principal facilities. Each of these principal facilities supports our GMI and GWM businesses. Information regarding our property lease commitments is set forth in “Operating Leases” in Note 11 to the Consolidated Financial Statements.

 

Principal Facilities in the United States

 

Our executive offices and principal administrative offices are located in leased premises at the World Financial Center in New York City. We lease portions of 4 World Financial Center (1,800,000 square feet) and 2 World Financial Center (2,500,000 square feet); both leases expire in 2013. One of our subsidiaries is a partner in the partnership that holds the ground lessee’s interest in 4 World Financial Center. As of December 26, 2008, we occupied the entire 4 World Financial Center and approximately 27% of 2 World Financial Center.

 

We own a 760,000 square foot building at 222 Broadway, New York and occupy 92% of this building. We also lease and occupy, pursuant to an operating lease with an unaffiliated lessor, 1,251,000 square feet of office space and 273,000 square feet of ancillary buildings in Hopewell, New Jersey. One of our subsidiaries is the lessee under such operating lease and owns the underlying land upon which the Hopewell facilities are located. We also own a 54-acre campus in Jacksonville, Florida, with four buildings.

 

Principal Facilities Outside the United States

 

In London, we lease and occupy 100% of our 576,626 square foot London headquarters facility known as Merrill Lynch Financial Centre; this lease expires in 2022. In addition, we lease approximately 305,086 square feet in other London locations with various terms, the longest of which lasts until 2020. We occupy 134,375 square feet of this space and have sublet the remainder. In Tokyo, we have leased 292,349 square feet until 2014 for our Japan headquarters. Other leased facilities in the Pacific Rim are located in Hong Kong, Singapore, Seoul, South Korea, Mumbai and Chunnai, India, and Sydney and Melbourne, Australia.

 

 

Refer to Note 11 to the Consolidated Financial Statements in Part II, Item 8 for a discussion of litigation and regulatory matters.

 

 

Not required pursuant to instruction I(2).

 

 

The table below sets forth the information with respect to purchases made by or on behalf of us or any “affiliated purchaser” of our common stock during the year ended December 26, 2008.

 

 

Dividends Per Common Share

 

Prior to the acquisition by Bank of America, the principal market on which ML & Co. common stock was traded was the New York Stock Exchange. ML & Co. common stock was also listed on the Chicago Stock Exchange, the London Stock Exchange and the Tokyo Stock Exchange. Following the acquisition by Bank of America, there is no longer an established public trading market for ML & Co. common stock. Information relating to the amount of cash dividends declared for the two most recent fiscal years is set forth below.

 

 

As of the date of this report, Bank of America is the sole holder of the outstanding common stock of ML & Co. With the exception of regulatory restrictions on subsidiaries’ abilities to pay dividends, there were no restrictions on ML & Co.’s present ability to pay dividends on common stock, other than ML & Co.’s obligation to make payments on its mandatory convertible preferred stock, junior subordinated debt related to trust preferred securities, and the governing provisions of Delaware General Corporation Law. Certain subsidiaries’ ability to declare dividends may also be limited.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

As a result of the acquisition by Bank of America, there are no equity securities of ML & Co. that are authorized for issuance under any equity compensation plans. Refer to Note 12 and Note 13 of the Consolidated Financial Statements for further information on equity compensation and benefit plans.

 

 

Not required pursuant to instruction I(2).

 

Forward-Looking Statements and Non-GAAP Financial Measures

 

We have included certain statements in this report which may be considered forward-looking, including those about management expectations and intentions, the impact of off-balance sheet exposures, significant contractual obligations and anticipated results of litigation and regulatory investigations and proceedings. These forward-looking statements represent only Merrill Lynch & Co., Inc.’s (“ML & Co.” and, together with its subsidiaries, “Merrill Lynch”, the “Company”, the “Corporation”, “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 and counterparties, general economic conditions, market conditions, the effects of current, pending and future legislation, regulation and regulatory actions, the actions of rating agencies and the other risks and uncertainties detailed in this report. See “Risk Factors” in Part I, Item 1A of this Form 10-K. Accordingly, you should not 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 Reports 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.

 

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 world’s leading capital markets, advisory and wealth management companies. In our Global Wealth Management (“GWM”) business, we had total client assets in GWM accounts of approximately $1.2 trillion at December 26, 2008. 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, as of December 26, 2008, we owned approximately half of the economic interest of BlackRock, Inc. (“BlackRock”), one of the world’s largest publicly traded investment management companies with approximately $1.3 trillion in assets under management at the end of 2008.

 

On January 1, 2009, Merrill Lynch was acquired by, and became a wholly-owned subsidiary of, Bank of America Corporation (“Bank of America”). As a result of the acquisition, certain information is not required in this Form 10-K as permitted by general Instruction I of Form 10-K. We have also abbreviated Management’s Discussion and Analysis of Financial Condition and Results of Operations as permitted by general Instruction I.

Our activities are conducted through two business segments: Global Markets and Investment Banking (“GMI”) and GWM. The following is a description of our business segments:

 

 

 

Company Results

 

We reported a net loss from continuing operations for 2008 of $27.6 billion, or $24.82 per diluted share, compared with a net loss from continuing operations of $8.6 billion, or $10.73 per diluted share for 2007. Our net loss for 2008 was $27.6 billion, or $24.87 per diluted share, compared with a net loss of $7.8 billion, or $9.69 per diluted share for 2007. Revenues, net of interest expense (“net revenues”) for 2008 were negative $12.6 billion, compared with positive $11.3 billion in the prior-year, while the pre-tax loss from continuing operations was $41.8 billion for 2008 compared with $12.8 billion for 2007.

 

Net revenues and net earnings during 2008 were impacted by a number of significant items, including the following:

 

 

Our net loss applicable to common shareholders for 2008 included $2.1 billion of additional preferred stock dividends associated with the exchange of the mandatory convertible preferred stock.

 

In 2007, the net loss was primarily driven by write-downs within FICC of approximately $23.2 billion related to U.S. collateralized debt obligations comprised of U.S. ABS CDOs, U.S. sub-prime residential mortgages and securities, and credit valuation adjustments related to hedges with financial guarantors on U.S. ABS CDOs.

 

Strategic and Other Significant Transactions

 

Bank of America

 

On January 1, 2009, we were acquired by Bank of America through the merger of a wholly owned subsidiary of Bank of America with and into ML & Co. with ML & Co. continuing as the surviving corporation and a wholly owned subsidiary of Bank of America. Upon completion of the acquisition,

each outstanding share of ML & Co. common stock was converted into 0.8595 shares of Bank of America common stock. As of the completion of the acquisition, ML & Co. Series 1 through Series 8 preferred stock were converted into Bank of America preferred stock with substantially identical terms to the corresponding series of Merrill Lynch preferred stock (except for additional voting rights provided to the Bank of America securities). Our 9.00% Non-Voting Mandatory Convertible Non-Cumulative Preferred Stock, Series 2, and 9.00% Non-Voting Mandatory Convertible Non-Cumulative Preferred Stock, Series 3 that was outstanding immediately prior to the completion of the acquisition remained issued and outstanding subsequent to the acquisition, but are now convertible into Bank of America common stock.

 

Capital Transactions

 

On December 24, 2007, Merrill Lynch reached agreements with each of Temasek and Davis Selected Advisors LP (“Davis”) to sell an aggregate of 116.7 million shares of newly issued ML & Co. common stock, par value $1.331/3 per share, at $48.00 per share, for an aggregate purchase price of approximately $5.6 billion.

 

Davis purchased 25 million shares of Merrill Lynch common stock on December 27, 2007 at a price per share of $48.00, or an aggregate purchase price of $1.2 billion. Temasek purchased 55 million shares on December 28, 2007 and the remaining 36.7 million shares on January 11, 2008 for an aggregate purchase price of $4.4 billion. In addition, Merrill Lynch granted Temasek an option to purchase an additional 12.5 million shares of common stock under certain circumstances. This option was exercised, with 2.8 million shares issued on February 1, 2008 and 9.7 million shares issued on February 5, 2008, in each case at a purchase price of $48.00 per share for an aggregate purchase price of $600 million.

 

On various dates in January and February 2008, we issued an aggregate of 66,000 shares of newly issued 9% Non-Voting Mandatory Convertible Non-Cumulative Preferred Stock, Series 1, par value $1.00 per share and liquidation preference $100,000 per share, to several long-term investors at a price of $100,000 per share, for an aggregate purchase price of approximately $6.6 billion.

 

On April 29, 2008, Merrill Lynch issued $2.7 billion of new perpetual 8.625% Non-Cumulative Preferred Stock, Series 8.

 

On July 28, 2008, we announced a public offering of 437 million shares of common stock (including the exercise of the over-allotment option) at a price of $22.50 per share, for an aggregate amount of $9.8 billion.

 

In satisfaction of our obligations under the reset provisions contained in the investment agreement with Temasek, we paid Temasek $2.5 billion, which is recorded as a non-tax deductible expense in the Consolidated Statement of (Loss)/Earnings for the year-ended December 26, 2008.

 

Concurrent with the $9.8 billion common stock offering, holders of $4.9 billion of the $6.6 billion of our mandatory convertible preferred stock agreed to exchange their preferred stock for approximately 177 million shares of common stock, plus $65 million in cash. Holders of the remaining $1.7 billion of mandatory convertible preferred stock agreed to exchange their preferred stock for new mandatory convertible preferred stock. The price reset feature for all securities exchanged was eliminated. In connection with the elimination of the price reset feature of the $6.6 billion of preferred stock, we recorded additional preferred dividends of $2.1 billion in 2008.

 

CDO Sale and Termination of Monoline Hedges

 

On September 18, 2008, we sold $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds (“Lone Star”) for a sales price of $6.7 billion. In addition to the ABS CDO sale, we terminated certain hedges with monoline financial guarantors related to U.S. super senior ABS CDOs. We recorded net write-downs of $5.7 billion during 2008 as a result of this sale of

U.S. super senior ABS CDOs and the termination and potential settlement of related hedges with monoline guarantor counterparties.

 

Bloomberg, L.P.

 

On July 17, 2008, we sold our 20% ownership stake in Bloomberg, L.P. to Bloomberg Inc., for $4.4 billion. The sale resulted in a $4.3 billion net pre-tax gain. As consideration for the sale of our interest in Bloomberg L.P., we received notes issued by Bloomberg Inc. (the general partner and owner of substantially all of Bloomberg L.P.) with an aggregate face amount of approximately $4.3 billion and cash in the amount of approximately $110 million. The notes represent senior unsecured obligations of Bloomberg Inc. and are recorded as Investment Securities on our Consolidated Balance Sheet.

 

Auction Rate Securities

 

On August 21, 2008, we reached a global agreement with the New York Attorney General, the Securities and Exchange Commission, the Massachusetts Securities Division and other state securities regulators relating to sales of Auction Rate Securities (“ARS”). Under this agreement, eligible retail clients of Merrill Lynch were given a 12-month or 15-month period, depending on the level of assets held at Merrill Lynch by such client, in which to sell certain eligible ARS to Merrill Lynch at par. Merrill Lynch’s offer to purchase such ARS from those of its eligible clients or purchasers will remain open through January 15, 2010. In connection with this agreement, during 2008 we recorded a charge of $0.5 billion, which includes a fine of $125 million. The charge is recorded within Other expenses in the Consolidated Statement of (Loss)/Earnings.

 

Goodwill Impairment

 

Due to the severe deterioration in the financial markets in the fourth quarter of 2008 and the related impact on the fair value of Merrill Lynch’s reporting units, an impairment analysis was conducted in the fourth quarter of 2008. Based on this analysis, a non-cash impairment charge of $2.3 billion, primarily related to FICC, was recognized as a loss within the GMI business segment.

 

Restructuring Charge

 

During 2008, Merrill Lynch recorded a pre-tax restructuring charge of $486 million, primarily related to severance costs and the accelerated amortization of previously granted stock awards associated with headcount reduction initiatives. Refer to Note 17 to the Consolidated Financial Statements for additional information.

 

Emergency Economic Stabilization Act of 2008

 

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). Pursuant to the EESA, the United States Department of the Treasury (the “U.S. Treasury”) has the authority to, among other things, invest in financial institutions and purchase mortgages, mortgage-backed securities and certain other financial instruments from financial institutions, in an aggregate of up to $700 billion, for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the U.S. Treasury announced a plan (the “Capital Purchase Program” or “CPP”) to invest up to $250 billion of this $700 billion in certain eligible U.S. financial institutions in the form of non-voting, preferred stock initially paying quarterly dividends at a 5% annual rate.

 

On October 26, 2008, we entered into a securities purchase agreement with the U.S. Treasury setting forth the terms upon which we would issue a new series of preferred stock and warrants to the U.S. Treasury (the “TARP Purchase Agreement”). However, in view of the Bank of America acquisition, we determined that we would not sell securities to the U.S. Treasury under the CPP.

Additionally, in October 2008, the Federal Reserve announced the creation of the Commercial Paper Funding Facility to provide a liquidity backstop to U.S. issuers of commercial paper. A special purpose vehicle will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers through October 30, 2009. We were eligible for the Commercial Paper Funding Facility and began utilizing this program in October 2008 as an additional source of funding. Also, on October 14, 2008, the Federal Deposit Insurance Corporation (“FDIC”) announced a new program, the Temporary Liquidity Guarantee Program, under which specific categories of newly issued senior unsecured debt issued by eligible financial institutions on or before June 30, 2009 would be guaranteed until June 30, 2012. This program also provides deposit insurance for funds in non-interest bearing transaction deposit accounts at FDIC-insured institutions. We agreed to participate in this FDIC program and have issued FDIC guaranteed commercial paper.

 

On October 29, 2008, we had entered into a $10 billion committed unsecured bank revolving credit facility with Bank of America, N.A. with borrowings guaranteed under the FDIC’s guarantee program. There were no borrowings under this facility at December 26, 2008. Following the completion of Bank of America’s acquisition of ML & Co., this facility was terminated. For additional information on our other credit facilities, see “Liquidity Risk — Committed Credit Facilities.”

 

Other Events

 

On January 16, 2009, due to larger than expected fourth quarter losses of Merrill Lynch and as part of its commitment to support financial market stability, the U.S. government agreed to assist Bank of America in the Merrill Lynch acquisition by agreeing to provide certain guarantees and capital. With respect to the guarantees, the U.S. government agreed in principle to provide protection against the possibility of unusually large losses on a pool of certain domestic assets. It is anticipated that a portion of the exposures discussed in “Results of Operations”, including leveraged loans and commercial real estate loans, CDOs, certain trading counterparty exposure including monolines, and investment securities, would be part of this agreement.

Consolidated Results of Operations

 

Our net loss from continuing operations for 2008 was $27.6 billion compared with a net loss from continuing operations of $8.6 billion in 2007. Net revenues in 2008 were negative $12.6 billion compared with positive $11.3 billion for the prior year. The increase in the net loss and the decrease in net revenues were primarily driven by the significant write-downs recorded during 2008, including: credit valuation adjustments of $10.4 billion primarily related to certain hedges with financial guarantors; net write-downs of $10.2 billion related to U.S. ABS CDOs; net losses of $6.5 billion related to certain residential and commercial mortgage exposures; net losses of $4.1 billion in the investment securities portfolio of Merrill Lynch’s U.S. banks; and $4.2 billion of write-downs on leveraged finance loans and commitments. These net losses were partially offset by a net gain of $5.1 billion from the impact of the widening of credit spreads on the carrying value of certain of our long-term debt liabilities and a net pre-tax gain of $4.3 billion from the sale of our 20% ownership stake in Bloomberg, L.P.

 

Losses per diluted share from continuing operations were $24.82 for 2008 and $10.73 for the prior year. The net loss from discontinued operations was $61 million in 2008 compared with net earnings of $860 million in 2007. Our total net loss for 2008 was $27.6 billion, or $24.87 per diluted share, as compared with a net loss of $7.8 billion, or $9.69 per diluted share, in 2007.

 

2008 Compared With 2007

 

Principal transactions revenues include both realized and unrealized gains and losses on trading assets and trading liabilities and investment securities classified as trading investments. Principal transactions revenues were negative $27.2 billion in 2008 compared with negative $12.1 billion in 2007. The negative revenues in 2008 were driven primarily by net losses within FICC related to credit valuation adjustments related to hedges with financial guarantors, U.S. ABS CDOs, net losses associated with real estate-related assets, and net losses from credit spreads widening across most asset classes to significantly higher levels for the year. FICC also recorded net losses on various positions as a result of severe market dislocations, including significant asset price declines, high levels of volatility and reduced levels of liquidity, particularly following the default of a major U.S. broker-dealer and the U.S. government’s conservatorship of certain GSEs. These losses were partially offset by positive net revenues generated from our interest rate and currencies, commodities and cash equities businesses, as well as gains arising from the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain of our long-term debt liabilities. The negative net principal transactions revenues in 2007 were primarily driven by losses associated with U.S. ABS CDOs and our residential-mortgage-related businesses, partially offset by higher revenues generated by the rates and currencies, equity-linked, cash equities trading and financing and services businesses, as well as gains arising from the widening of Merrill Lynch’s credit spreads on the carrying value of certain of our long-term debt liabilities. Principal transactions revenues are primarily reported in our GMI business segment.

 

Net interest profit is a function of (i) the level and mix of total assets and liabilities, including trading assets owned, deposits, financing and lending transactions, and trading strategies associated with our businesses, and (ii) the prevailing level, term structure and volatility of interest rates. Net interest profit is an integral component of trading activity. In assessing the profitability of our client facilitation and trading activities, we view principal transactions and net interest profit in the aggregate as net trading revenues. Changes in the composition of trading inventories and hedge positions can cause the mix of principal transactions and net interest profit to fluctuate from period to period. Net interest profit was $4.0 billion in 2008, down 27% from 2007, primarily due to decreased interest revenues generated as a result of lower asset levels and stated interest rates on those assets, partially offset by lower interest expense associated with reduced funding levels in our GMI businesses. Net interest profit is reported in both our GMI and GWM business segments.

 

Commissions revenues primarily arise from agency transactions in listed and OTC equity securities and commodities, insurance products and options. Commissions revenues also include distribution fees for

promoting and distributing mutual funds and hedge funds. Commissions revenues were $6.9 billion in 2008, down 5% from the prior year, driven primarily by lower revenues from insurance sales and mutual funds within GWM due to challenging market conditions, which was partially offset by an increase in revenues from our global cash equity trading business resulting from higher volumes. Commissions revenues are generated by our GMI and GWM business segments.

 

Managed accounts and other fee-based revenues primarily consist of asset-priced portfolio service fees earned from the administration of separately managed and other investment accounts for retail investors, annual account fees, and certain other account-related fees. Managed accounts and other fee-based revenues were $5.5 billion in 2008, an increase of 1% from 2007, as higher revenues from the global markets financing and services and real estate principal investment businesses within GMI were offset by lower fee-based revenues in GWM due to lower asset levels as a result of difficult market conditions. Managed accounts and other fee-based revenues are primarily generated by our GWM business segment.

 

Investment banking revenues include (i) origination revenues representing fees earned from the underwriting of debt, equity and equity-linked securities, as well as loan syndication and commitment fees and (ii) strategic advisory services revenues including merger and acquisition and other investment banking advisory fees. Investment banking revenues were $3.7 billion in 2008, down 33% from 2007, driven by lower net revenues from equity origination, debt origination and M&A advisory revenues, reflecting significantly lower industry-wide underwriting and advisory transaction volumes compared with 2007. Investment banking revenues are primarily reported in our GMI business segment but also include origination revenues in GWM.

 

Earnings from equity method investments include our pro rata share of income and losses associated with investments accounted for under the equity method of accounting. Earnings from equity method investments were $4.5 billion in 2008, which includes a net pre-tax gain of $4.3 billion from the sale of our 20% ownership stake in Bloomberg, L.P. Excluding this gain, earnings from equity method investments were $0.2 billion, down from $1.6 billion in 2007 due largely to lower revenues from most investments, including alternative investment management companies. Earnings from equity method investments are reported in both our GMI and GWM business segments. Refer to Note 5 to the Consolidated Financial Statements for further information on equity method investments.

 

Other revenues include gains and losses on investment securities, including certain available-for-sale securities, gains and losses on private equity investments, and gains and losses on loans and other miscellaneous items. Other revenues were negative $10.1 billion in 2008, compared with negative $2.2 billion in 2007. The negative revenues for 2008 were primarily due to net losses from other-than-temporary impairment charges on available-for-sale securities within our U.S. banks’ investment securities portfolio of $4.1 billion, write-downs on our leveraged finance loans and commitments of $4.2 billion, and net losses of $1.9 billion related to our private equity investments due primarily to the decline in value of private and public investments. The negative net other revenues in 2007 were primarily driven by loan-related losses, other-than-temporary impairment charges on available-for-sale securities and write-downs on leveraged finance commitments.

 

Compensation and benefits expenses were $14.8 billion in 2008 and $15.9 billion in 2007. The year over year decrease primarily reflects lower incentive-based compensation costs as a result of lower net revenues and net earnings, as well as reduced headcount levels. The overall decrease in compensation and benefits expense was driven by a 30% decline in incentive-based compensation, partially offset by increased amortization of prior year stock compensation awards.

 

Non-compensation expenses were $14.5 billion, which included a $2.5 billion non-tax deductible payment to Temasek related to the July 2008 common stock offering; a $2.3 billion goodwill impairment charge related to the FICC and Investment Banking businesses; a $0.5 billion expense, including a $125 million fine, arising from Merrill Lynch’s offer to repurchase ARS from our private clients and the associated settlement with regulators; and a $0.5 billion restructuring charge associated with headcount reduction initiatives. Excluding the aforementioned items, non-compensation expenses

were $8.7 billion, up 6% from 2007. Communication and technology costs were $2.2 billion, up 7% due primarily to costs related to ongoing technology investments and system development initiatives. The increase also reflected higher costs associated with technology equipment depreciation and market data information costs. Occupancy and related depreciation costs were $1.3 billion, up 11% due principally to higher office rental expenses associated with data center growth and increased office space, including the impact of First Republic Bank (“First Republic”), which was acquired in September 2007. Advertising and market development costs were $652 million, down 17% due primarily to lower travel and entertainment expenses. Other expenses were $2.4 billion, which included the $0.5 billion expense related to the ARS settlement previously discussed and $1.1 billion of litigation accruals. The majority of the litigation accruals are related to class action litigation, including $0.6 billion of proposed settlements of sub-prime-related class actions that have been reached in connection with claims by persons who invested in Merrill Lynch securities (see Note 11 to the Consolidated Financial Statements). Excluding these items, other expenses were $0.8 billion, a decrease of 47% from 2007.

 

Income tax benefits from continuing operations were a net credit of $14.3 billion in 2008, reflecting tax benefits associated with our pre-tax losses. The effective tax rate in 2008 was 34.1% compared with 32.7% for 2007. The increase in the effective tax rate reflected changes in the firm’s geographic mix of earnings and the impact of tax benefits on losses.

U.S. ABS CDO and Other Mortgage-Related Activities

 

The challenging market conditions that have existed since the second half of 2007, particularly those relating to the credit markets, continued throughout 2008. Although the greatest impact to date had been on U.S. ABS CDOs and the U.S. sub-prime residential mortgage products, the adverse conditions in the credit markets have also affected other products, including U.S. Alt-A, non-U.S. residential mortgages and commercial real estate. In addition, these conditions also negatively affected the value of leveraged lending transactions and our exposure to monoline financial guarantors. The following discussion details our activities and net exposures as of December 26, 2008.

 

Residential Mortgage-Related Activities (excluding U.S. banks’ investment securities portfolio)

 

U.S. Prime: We had net exposures of $34.8 billion at December 26, 2008, which consisted primarily of prime mortgage whole loans, including approximately $31.1 billion of prime loans originated with GWM clients (of which $15.0 billion were originated by First Republic, an operating division of Merrill Lynch Bank & Trust Co., FSB (“MLBT-FSB”)). Net exposures related to U.S. prime residential mortgages increased 25% during 2008 as a result of loan originations within GWM’s high net worth client base.

 

In addition to our U.S. prime related net exposures, we also had net exposures related to other residential mortgage-related activities. These activities consisted of the following:

 

U.S. Sub-prime: We define sub-prime mortgages as single-family residential mortgages that have more than one high risk characteristic, such as: (i) the borrower has a low FICO score (generally below 660); (ii) the mortgage has a high loan-to-value (“LTV”) ratio (LTV greater than 80% without borrower paid mortgage insurance); (iii) the borrower has a high debt-to-income ratio (greater than 45%); or (iv) the mortgage was underwritten based on stated/limited income documentation. Sub-prime mortgage-related securities are those securities that derive more than 50% of their value from sub-prime mortgages.

 

We had net exposures of $195 million at December 26, 2008, down from $2.7 billion at December 28, 2007 primarily due to $1.4 billion in net losses, sales of whole loans, and increased short positions. Our U.S. Sub-prime exposures consisted primarily of non-performing loans (valued using discounted liquidation values) and secondary trading exposures related to our residential mortgage-backed securities business, which consist of trading activity including credit default swaps (“CDS”) on single names and indices. We value residential mortgage-backed securities based on observable prices and where prices are not observable, values are based on modeling the present value of projected cash flows that we expect to receive, based on the actual and projected performance of the mortgages underlying a particular securitization. Key determinants affecting our estimates of future cash flows include estimates for borrower prepayments, delinquencies, defaults and loss severities.

 

U.S. Alt-A: We define Alt-A mortgages as single-family residential mortgages that are generally higher credit quality than sub-prime loans but have characteristics that would disqualify the borrower from a traditional prime loan. Alt-A lending characteristics may include one or more of the following: (i) limited documentation; (ii) high combined-loan-to-value (“CLTV”) ratio (CLTV greater than 80%); (iii) loans secured by non-owner occupied properties; or (iv) debt-to-income ratio above normal limits.

 

We had net exposures of $27 million at December 26, 2008, down from $2.7 billion at December 28, 2007 primarily due to net losses of $1.5 billion and sales of related positions. These net exposures resulted from secondary market trading activity or were retained from our securitizations of Alt-A residential mortgages, which were purchased from third-party mortgage originators.

 

Non-U.S.: We had net exposures of $3.4 billion at December 26, 2008, which consisted primarily of residential mortgage whole loans originated in the U.K., as well as through mortgage originators in the Pacific Rim and asset-based lending facilities backed by residential whole loans. Non-U.S. net exposures decreased 64% during 2008 due primarily to net losses of $1.9 billion, paydowns of principal, sales of mortgage-backed securities, maturity of a warehouse lending facility and securitization activity in the U.K. Held for sale loans are carried at the lower of cost or market value;

for those loans carried at market value, given the significant illiquidity in the securitization market, values are based on modeling the present value of projected cash flows that we expect to receive, based on the actual and projected performance of the mortgages. Key determinants affecting our estimates of future cash flows include estimates for borrower prepayments, delinquencies, defaults, and loss severities.

 

The following table provides a summary of our residential mortgage-related net exposures and losses, excluding net exposures to residential mortgage-backed securities held in our U.S. banks’ investment securities portfolio, which are described in the U.S. Banks’ Investment Securities Portfolio section below.

 

 

U.S. ABS CDO Activities

 

In addition to our U.S. sub-prime residential mortgage-related exposures, we have exposure to U.S. ABS CDOs, which are securities collateralized by a pool of asset-backed securities (“ABS”), for which the underlying collateral is primarily sub-prime residential mortgage loans.

 

We engaged in the underwriting and sale of U.S. ABS CDOs, which involved the following steps: (i) determining investor interest or responding to inquiries or mandates received; (ii) engaging a collateralized debt obligation (“CDO”) collateral manager who is responsible for selection of the ABS securities that will become the underlying collateral for the U.S. ABS CDO securities; (iii) obtaining credit ratings from one or more rating agencies for U.S. ABS CDO securities; (iv) securitizing and pricing the various tranches of the U.S. ABS CDO at representative market rates; and (v) distributing the U.S. ABS CDO securities to investors or retaining them for Merrill Lynch. As a result of the continued deterioration in the sub-prime mortgage market, we did not underwrite any U.S. ABS CDOs in 2008.

 

Our U.S. ABS CDO net exposure primarily consists of our super senior ABS CDO portfolio, as well as secondary trading exposures related to our ABS CDO business.

 

Super senior positions represent our exposure to the senior most tranche in an ABS CDO’s capital structure. This tranche’s claims have priority to the proceeds from liquidated cash ABS CDO assets.

At the end of 2008, net exposures to U.S. super senior ABS CDOs were $708 million, down from $6.8 billion at the end of 2007. The remaining net exposure is predominantly comprised of U.S. super senior ABS CDOs based on mezzanine underlying collateral.

 

The aggregate U.S. super senior ABS CDO long exposures were $1.8 billion, substantially reduced from $30.4 billion at the end of 2007. The reduction predominantly resulted from the sale of ABS CDOs to an affiliate of Lone Star discussed below, which decreased long exposures by $11.1 billion, which includes a loss of $4.4 billion. Our long exposure was further reduced during the year by other mark-to-market adjustments, excluding credit valuation adjustments, of $13.4 billion, $3.2 billion of which related to additional sales in the fourth quarter of 2008, and $0.9 billion primarily related to amortization and liquidations.

 

At year end, the super senior ABS CDO long exposure was hedged with an aggregate of $1.1 billion of short exposure, which was down from $23.6 billion at the end of 2007. This reduction primarily reflected $7.8 billion from the termination and settlement of related hedges with monolines and insurance companies, $7.5 billion of mark-to-market gains, $6.5 billion of hedge ineffectiveness and $0.6 billion of amortization and liquidations.

 

The following table provides an overview of changes to our U.S. super senior ABS CDO net exposures from December 28, 2007 to December 26, 2008.

 

 

Merrill Lynch’s secondary trading exposure related to its ABS CDO business was ($281) million at December 26, 2008. As of December 28, 2007, secondary trading exposure was ($2.0) billion. The change in exposure was driven by liquidations, unwinds, and net gains / (losses) recognized.

 

On July 28, 2008, we agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs (the “Portfolio”) to an entity owned and controlled by Lone Star for a purchase price of $6.7 billion. The transaction closed on September 18, 2008. In connection with this sale we recorded a pre-tax write-down of $4.4 billion in 2008. We provided a financing loan to the purchaser for approximately 75% of the purchase price. The recourse on this loan is limited to the assets of the purchaser, which consist solely of the Portfolio. All cash flows and distributions from the Portfolio (including sale proceeds) will be applied in accordance with a specified priority of payments. The loan is carried at fair value. Events of default under the loan are customary events of default, including failure to pay interest when due and failure to pay principal at maturity. As of December 26, 2008, all scheduled payments on the loan have been received.

Monoline Financial Guarantors

 

We hedge a portion of our long exposures of U.S. super senior ABS CDOs with various market participants, including financial guarantors. We define financial guarantors as monoline insurance companies that provide credit support for a security either through a financial guaranty insurance policy on a particular security or through an instrument such as a credit default swap (“CDS”). Under a CDS, the financial guarantor generally agrees to compensate the counterparty to the swap for the deterioration in the value of the underlying security upon an occurrence of a credit event, such as a failure by the underlying obligor on the security to pay principal and/or interest.

 

We hedged a portion of our long exposures to U.S. super senior ABS CDOs with certain financial guarantors through the execution of CDS that are structured to replicate standard financial guaranty insurance policies, which provide for timely payment of interest and/or ultimate payment of principal at their scheduled maturity date. CDS gains and losses are based on the fair value of the referenced ABS CDOs. Depending upon the creditworthiness of the financial guarantor hedge counterparties, we may record credit valuation adjustments in estimating the fair value of the CDS.

 

At December 26, 2008, the carrying value of our hedges with financial guarantors related to U.S. super senior ABS CDOs was $1.5 billion, reduced from $3.5 billion at December 28, 2007. The decrease was primarily due to the termination and settlement of monoline hedges.

 

The following table provides a summary of our total financial guarantor exposures for U.S. super senior ABS CDOs from December 28, 2007 to December 26, 2008.

 

 

 

In addition to hedges with financial guarantors on U.S. super senior ABS CDOs, we also have hedges on certain long exposures related to corporate CDOs, Collateralized Loan Obligations (“CLOs”), Residential Mortgage-Backed Securities (“RMBS”) and Commercial Mortgage-Backed Securities (“CMBS”). At December 26, 2008, the carrying value of our hedges with financial guarantors related to these types of exposures was $7.8 billion, of which approximately 50% pertains to CLOs and various high grade basket trades. The other 50% relates primarily to CMBS and RMBS in the U.S. and Europe.

The following table provides a summary of our total financial guarantor exposures to other referenced assets, as described above, other than U.S. super senior ABS CDOs, as of December 26, 2008.

 

 

 

On February 18, 2009, one of the monoline financial guarantors included in the tables above with whom we have a significant relationship announced a reorganization plan. We are currently evaluating the impacts of the reorganization, including rating downgrades and the impact on our 2009 financial results. See “Executive Overview — Other Events” on page 21 for a discussion of the U.S. government’s agreement to provide assistance to Bank of America in the Merrill Lynch acquisition.

 

U.S. Banks’ Investment Securities Portfolio

 

The investment securities portfolio of Merrill Lynch Bank USA (“MLBUSA”) and MLBT-FSB includes investment securities comprising various asset classes. During the fourth quarter of 2008, in order to manage capital at MLBUSA, certain investment securities were transferred from MLBUSA to a consolidated non-bank entity. This transfer had no impact on how the investment securities were valued or the subsequent accounting treatment. As of December 26, 2008, the net exposure of this portfolio was $10.4 billion, which included investment securities of approximately $6.0 billion recorded in the non-bank legal entity. The cumulative pre-tax balance in other comprehensive (loss)/income related to this portfolio was approximately negative $9.3 billion as of December 26, 2008. We regularly (at least quarterly) evaluate each security whose value has declined below amortized cost to assess whether the decline in fair value is other-than-temporary. Within this investment securities portfolio, net pre-tax losses of approximately $4.1 billion were recognized through the statement of earnings during 2008. These net losses primarily reflected the other-than-temporary impairment in the value of certain securities, primarily U.S. Alt-A residential mortgage-backed securities.

 

We value RMBS based on observable prices and where prices are not observable, values are based on modeling the present value of projected cash flows that we expect to receive, based on the actual and projected performance of the mortgages underlying a particular securitization. Key determinants affecting our estimates of future cash flows include estimates for borrower prepayments, delinquencies, defaults, and loss severities.

 

A decline in a debt security’s fair value is considered to be other-than-temporary if it is probable that not all amounts contractually due will be collected. In assessing whether it is probable that all amounts contractually due will not be collected, we consider the following:

 

 

Refer to Note 5 to the Consolidated Financial Statements for additional information.

 

The following table provides a summary of our U.S. banks’ investment securities portfolio net exposures and losses.

 

 

 

The continued adverse market environment and its potential impact on the underlying securitized assets could result in further other-than-temporary impairments in our U.S. banks’ investment securities portfolio in 2009.

 

Commercial Real Estate

 

As of December 26, 2008, net exposures related to commercial real estate, excluding First Republic, totaled approximately $9.7 billion, down 49% from December 28, 2007, due primarily to asset sales of whole loan/conduit exposures in the U.S. and Europe and net write-downs. Net exposures related to First Republic were $3.1 billion at the end of 2008, up 36% from 2007 primarily due to new originations.

The following table provides a summary of our Commercial Real Estate portfolio net exposures from December 28, 2007 to December 26, 2008.

 

 

Business Segments

 

Our operations are organized into two business segments: GMI and GWM. We also record revenues and expenses within a “Corporate” category. Corporate results primarily include unrealized gains and losses related to interest rate hedges on certain debt. In addition, Corporate results for the year ended December 26, 2008 included expenses of $2.5 billion related to the payment to Temasek, $0.5 billion associated with the ARS repurchase program, and $0.7 billion of litigation accruals recorded in 2008. Net revenues and pre-tax losses recorded within Corporate for 2008 were $1.1 billion and $2.6 billion, respectively, as compared with net revenues and pre-tax losses of negative $103 million and $116 million, respectively, in the prior year period.

 

The following segment results represent the information that is relied upon by management in its decision-making processes. Revenues and expenses associated with inter-segment activities are recognized in each segment. In addition, revenue and expense sharing agreements for joint activities between segments are in place, and the results of each segment reflect their agreed-upon apportionment of revenues and expenses associated with these activities. See Note 2 to the Consolidated Financial Statements for further information. Segment results are presented from continuing operations and exclude results from discontinued operations. Refer to Note 16 to the Consolidated Financial Statements for additional information on discontinued operations.

 

Global Markets and Investment Banking

 

GMI provides trading, capital markets services, and investment banking services to issuer and investor clients around the world. The Global Markets division consists of the FICC and Equity Markets sales and trading activities for investor clients and on a proprietary basis, while the Investment Banking division provides a wide range of origination and strategic advisory services for issuer clients.

 

GMI Results of Operations

 

N/M = Not Meaningful

 

GMI recorded negative net revenues and a pre-tax loss from continuing operations in 2008 of $26.5 billion and $41.5 billion, respectively, as the difficult market conditions that existed during the year contributed to net losses in FICC and lower net revenues in Equity Markets and Investment Banking. The 2008 pre-tax loss was primarily driven by the net write-downs within FICC that are discussed below, as well as a $2.3 billion impairment charge related to goodwill. Partially offsetting these losses was a net gain of approximately $5.1 billion recorded by GMI during 2008 due to the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain of our long-term debt liabilities.

 

GMI’s 2007 net revenues were negative $2.7 billion, and the pre-tax loss from continuing operations was $16.3 billion. The 2007 loss was primarily driven by net write-downs within FICC, including $20.9 billion related to U.S. ABS CDOs and residential mortgage-related exposures and $3.1 billion related to valuation adjustments against guarantor counterparties. GMI’s 2007 net revenues also included a net gain of approximately $1.9 billion due to the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain of our long-term debt liabilities.

 

Fixed Income, Currencies and Commodities (FICC)

 

During 2008, FICC was adversely impacted by extremely difficult market conditions, particularly during the second half of the year. Such conditions included the continuing deterioration in the credit markets, lower levels of liquidity, reduced price transparency, asset price declines, increased volatility and severe market dislocations, particularly following the default of a major U.S. broker-dealer and the U.S. Government’s conservatorship of certain GSEs.

 

In 2008, FICC recorded approximately $10.2 billion of net write-downs related to U.S. ABS CDOs, approximately $4.4 billion of which related to the sale of U.S. super senior ABS CDOs conducted during the third quarter. In addition, as a result of the deteriorating environment for financial guarantors, FICC also recorded credit valuation adjustments related to hedges with financial guarantors of negative $10.4 billion. FICC’s net revenues were also adversely impacted by net losses related to our U.S. banks’ investment securities portfolio of $4.1 billion and certain of our U.S. sub-prime, U.S. Alt-A and Non-U.S. residential mortgage-related exposures aggregating approximately $4.6 billion. FICC also recognized net write-downs related to leveraged finance loans and commitments of approximately $4.2 billion and $1.9 billion of net write-downs related to commercial real estate. These losses were partially offset by a foreign currency gain of $2.6 billion related to currency hedges of our U.K. deferred tax assets recognized in the fourth quarter of 2008 and a net gain of approximately $3.7 billion related to the impact of the widening of our credit spreads on the carrying value of certain of our long-term debt liabilities. In addition, net revenues for most other FICC businesses declined from 2007, as the environment for those businesses was materially worse than the prior-year.

 

In 2007, FICC net revenues were negative $15.9 billion as strong revenues in global rates and global currencies were more than offset by declines in the global credit and structured finance and investments businesses. FICC’s 2007 net revenues included net writedowns of approximately $20.9 billion related to U.S. ABS CDOs and residential mortgage-related exposures and $3.1 billion related to valuation adjustments against guarantor counterparties, which were partially offset by a net benefit of approximately $1.2 billion related to the impact of the widening of our credit spreads on the carrying value of certain of our long-term debt liabilities.

 

Equity Markets

 

Equity Markets net revenues for 2008 were $7.7 billion compared with $8.3 billion in the prior-year period. Net revenues in 2008 included a gain of $4.3 billion from the sale of the investment in Bloomberg L.P. as well as a gain of $1.4 billion related to changes in the carrying value of certain of our long-term debt liabilities. These gains were more than offset by declines from other equity products, including cash and global equity-linked products. In addition, private equity recorded negative net revenues of $2.1 billion in 2008 as compared with net revenues of $0.4 billion in 2007.

For 2007, Equity Markets net revenues were a record $8.3 billion, driven by our equity-linked business, which was up nearly 80%, global cash equity trading business which was up over 30% and global markets financing and services business, which includes prime brokerage, which was up over 45%. Equity Markets 2007 net revenues included a gain of approximately $700 million related to changes in the carrying value of certain of our long-term debt liabilities.

 

Investment Banking

 

For 2008, Investment Banking net revenues were $3.3 billion, down 33% from a record $4.9 billion in the prior-year period, as the difficult market conditions that existed in 2008 resulted in lower industry-wide transaction volumes across all product lines.

 

Origination

 

Origination revenues represent fees earned from the underwriting of debt, equity, and equity-linked securities, as well as loan syndication fees.

 

For 2008, origination revenues were $2.0 billion, down 38% from the year-ago period. Debt and equity originations were down 40% and 36%, respectively, compared with 2007, primarily reflecting lower industry-wide transaction volumes in 2008.

 

Strategic Advisory Services

 

Strategic advisory services net revenues, which include merger and acquisition and other advisory fees, were $1.3 billion in 2008, a decrease of 24% from the prior-year. The decline was primarily due to lower industry-wide transaction activity, which reflected the high level of volatility in the global financial markets, economic uncertainty and a lack of available liquidity in the credit markets.

 

Global Wealth Management

 

GWM, our full-service retail wealth management segment, provides brokerage, investment advisory and financial planning services. GWM is comprised of GPC and GIM.

 

GPC provides a full range of wealth management products and services to assist clients in managing all aspects of their financial profile principally through our FA network.

 

GIM includes our interests in creating and managing wealth management products, including alternative investment products for clients. GIM also includes our share of net earnings from our ownership positions in other investment management companies, including BlackRock.

GWM Results of Operations

 

N/M = Not Meaningful

 

For 2008, GWM’s net revenues were $12.8 billion, down 9% from the prior-year period, primarily due to declines in transactional and origination revenues. GWM recorded $2.3 billion of pre-tax earnings from continuing operations, down 35% from the year-ago period. The pre-tax profit margin was 18.4%, down from 25.9% in the prior-year period. Excluding the impact of the $155 million restructuring charge, GWM’s pre-tax earnings were $2.5 billion, a decline of 31% from 2007. On the same basis, the pre-tax profit margin was 19.6%.

 

GWM’s net revenues in 2007 were $14.0 billion, reflecting strong growth in both GPC’s and GIM’s businesses. GWM generated $3.6 billion of pre-tax earnings from continuing operations. The pre-tax profit margin was 25.9% in 2007.

 

Global Private Client

 

GPC’s 2008 net revenues were $12.1 billion, down 6% from the year-ago period, driven by lower transactional and origination revenues, resulting from reduced client and origination activity in a challenging market environment.

 

Financial Advisor headcount was 16,090 at the end of 2008, a decrease of 650 FAs during the year.

 

Fee-Based Revenues

 

GPC generated $6.2 billion of fee-based revenues in 2008, down 2% from 2007, reflecting lower asset levels in annuitized fee-based products resulting from market declines, partially offset by the inclusion of fee-based accounts from First Republic, which was acquired in September 2007.

The value of client assets in GWM accounts at year-end 2008 and 2007 were as follows:

 

 

Total client assets in GWM accounts were $1.2 trillion, down from $1.8 trillion in 2007. Total net new money was negative $12 billion for 2008 and was adversely affected by client reaction to persistent volatility and significantly negative market movements during the year. GWM’s net inflows of client assets into annuitized-revenue products were $11 billion for 2008. Assets in annuitized-revenue products ended 2008 at $466 billion, down from $655 billion in 2007. The decrease in total client assets and assets in annuitized-revenue products in GWM accounts during 2008 was primarily due to market depreciation.

 

Transactional and Origination Revenues

 

Transactional and origination revenues were $3.3 billion in 2008, down 15% from the prior-year due to lower client transaction and origination volumes amidst increasingly challenging market conditions.

 

Net Interest Profit and Related Hedges

 

Net interest profit (interest revenues less interest expenses) and related hedges include GPC’s allocation of the interest spread earned in our banking subsidiaries for deposits, as well as interest earned, net of provisions for loan losses, on securities-based loans, mortgages, small- and middle-market business and other loans, corporate funding allocations, and the interest component of non-qualifying derivatives.

 

For 2008, net interest profit and related hedges were $2.3 billion, up slightly from 2007.

 

Other Revenues

 

For 2008, other revenues were down 31% to $288 million, primarily due to lower gains on sales of mortgages and markdowns on certain alternative investments.

 

Global Investment Management

 

GIM includes revenues from the creation and management of hedge fund and other alternative investment products for clients, as well as our share of net earnings from our ownership positions in other investment management companies, including BlackRock. Under the equity method of accounting, an estimate of the net earnings associated with our approximately half economic ownership interest in BlackRock is recorded in the GIM portion of the GWM segment.

 

GIM’s 2008 revenues were $669 million, down 40% from the year-ago period, primarily due to lower revenues from our investments in investment management companies.

 

As a part of our normal operations, we enter into various off-balance sheet arrangements that may require future payments. The table and discussion below outline our significant off-balance sheet

arrangements, as well as their future expirations, as of December 26, 2008. Refer to Note 11 to the Consolidated Financial Statements for further information:

 

 

Standby Liquidity Facilities

 

Merrill Lynch provides standby liquidity facilities to certain municipal bond securitization special purpose entities (“SPEs”). In these arrangements, Merrill Lynch is required to fund these standby liquidity facilities if the fair value of the assets held by the SPE declines below par value and certain other contingent events take place. In those instances where the residual interest in the securitized trust is owned by a third party, any payments under the facilities are offset by economic hedges entered into by Merrill Lynch. In those instances where the residual interest in the securitized trust is owned by Merrill Lynch, any requirement to pay under the facilities is considered remote because Merrill Lynch, in most instances, will purchase the senior interests issued by the trust at fair value as part of its dealer market-making activities. However, Merrill Lynch will have exposure to these purchased senior interests. Refer also to Note 6 to the Consolidated Financial Statements for further information.

 

Auction Rate Security Guarantees

 

Under the terms of its announced purchase program as augmented by the global agreement reached with the New York Attorney General, the Securities and Exchange Commission, the Massachusetts Securities Division and other state securities regulators, Merrill Lynch agreed to purchase ARS at par from its retail clients, including individual, not-for-profit, and small business clients. Certain retail clients with less than $4 million in assets with Merrill Lynch as of February 13, 2008 were eligible to sell eligible ARS to Merrill Lynch starting on October 1, 2008. Other eligible retail clients meeting specified asset requirements were eligible to sell ARS to Merrill Lynch beginning on January 2, 2009. The final date of the ARS purchase program is January 15, 2010. Under the ARS purchase program, the eligible ARS held in accounts of eligible retail clients at Merrill Lynch as of December 26, 2008 was $5.2 billion. As of December 26, 2008 Merrill Lynch had purchased $3.2 billion of ARS from eligible clients. In addition, under the ARS purchase program, Merrill Lynch has agreed to purchase ARS from retail clients who purchased their securities from Merrill Lynch and transferred their accounts to other brokers prior to February 13, 2008. At December 26, 2008, a liability of $278 million has been recorded for our estimated exposure related to this guarantee.

 

Residual Value Guarantees

 

At December 26, 2008 residual value guarantees of $738 million included amounts associated with the Hopewell, NJ campus, aircraft leases and certain power plant facilities.

 

Standby Letters of Credit and Other FIN 45 Guarantees

 

Merrill Lynch provides guarantees to certain counterparties in the form of standby letters of credit in the amount of $2.6 billion. At December 26, 2008, Merrill Lynch held marketable securities of $419 million as collateral to secure these guarantees.

 

In conjunction with certain mutual funds, Merrill Lynch guarantees the return of principal investments or distributions as contractually specified. At December 26, 2008, Merrill Lynch’s maximum potential

exposure to loss with respect to these guarantees is $298 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 Lynch’s exposure or expected loss at December 26, 2008.

 

In connection with residential mortgage loan and other securitization transactions, Merrill Lynch typically makes representations and warranties about the underlying assets. If there is a material breach of such representations and warranties, Merrill Lynch may have an obligation to repurchase the assets or indemnify the purchaser against any loss. For residential mortgage loan and other securitizations, the maximum potential amount that could be required to be repurchased is the current outstanding asset balance. Specifically related to First Franklin activities, there is currently approximately $36 billion (including loans serviced by others) of outstanding loans that First Franklin sold in various asset sales and securitization transactions where management believes we may have an obligation to repurchase the asset or indemnify the purchaser against the loss if claims are made and it is ultimately determined that there has been a material breach related to such loans. Merrill Lynch has recognized a repurchase reserve liability of approximately $560 million at December 26, 2008 arising from these First Franklin residential mortgage sales and securitization transactions.

 

Derivatives

 

We record all derivative transactions at fair value on our Consolidated Balance Sheets. We do not monitor our exposure to derivatives based on the notional amount because that amount is not a relevant indicator of our exposure to these contracts, as it is not indicative of the amount that we would owe on the contract. Instead, a risk framework is used to define risk tolerances and establish limits to help to ensure that certain risk-related losses occur within acceptable, predefined limits. Since derivatives are recorded on the Consolidated Balance Sheets at fair value and the disclosure of the notional amounts is not a relevant indicator of risk, notional amounts are not provided for the off-balance sheet exposure on derivatives. Derivatives that meet the definition of a guarantee under FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indebtedness of Others, and credit derivatives are included in Note 11 to the Consolidated Financial Statements.

 

We also fund selected assets, including CDOs and CLOs, via derivative contracts with third-party structures, the majority of which are not consolidated on our balance sheets. Of the total notional amount of these total return swaps, approximately $6 billion is term financed through facilities provided by commercial banks and $21 billion is financed by long term funding provided by third party special purpose vehicles. In certain circumstances, we may be required to purchase these assets, which would not result in additional gain or loss to us as such exposure is already reflected in the fair value of our derivative contracts.

 

In order to facilitate client demand for structured credit products, we sell protection on high-grade collateral to, and buy protection on lesser grade collateral from, certain SPEs, which then issue structured credit notes. We also enter into other derivatives with SPEs, both Merrill Lynch and third party sponsored, including interest rate swaps, credit default swaps and other derivative instruments.

 

Involvement with SPEs

 

We transact with SPEs in a variety of capacities, including those that we help establish as well as those initially established by third parties. Our involvement with SPEs can vary and, depending upon the accounting definition of the SPE (i.e., voting rights entity (“VRE”), variable interest entity (“VIE”) or qualified special purpose entity (“QSPE”)), we may be required to reassess prior consolidation and disclosure conclusions. An interest in a VRE requires reconsideration when our equity interest or management influence changes, an interest in a VIE requires reconsideration when an event occurs that was not originally contemplated (e.g., a purchase of the SPE’s assets or liabilities), and an interest in a QSPE requires reconsideration if the entity no longer meets the definition of a QSPE. Refer to Note 1

to the Consolidated Financial Statements for a discussion of our consolidation accounting policies. Types of SPEs with which we have historically transacted with include:

 

 

Our involvement with SPEs includes off-balance sheet arrangements discussed above, as well as the following activities:

 

 

 

Funding

 

We fund our assets primarily with a mix of secured and unsecured liabilities through a globally coordinated funding strategy. We fund a portion of our trading assets with secured liabilities, including repurchase agreements, securities loaned and other short-term secured borrowings, which are less sensitive to our credit ratings due to the underlying collateral. Refer to Note 9 to the Consolidated Financial Statements for additional information regarding our borrowings.

 

Credit Ratings

 

Our credit ratings affect the cost and availability of our unsecured funding, and it is our objective to maintain high quality credit ratings. In addition, credit ratings are important when we compete in certain markets and when we seek to engage in certain long-term transactions, including OTC derivatives. Following the acquisition by Bank of America, the major credit rating agencies have indicated that the primary drivers of Merrill Lynch’s credit ratings are Bank of America’s credit ratings. The rating agencies have also noted that Bank of America’s credit ratings currently reflect significant support from the U.S. government. In addition to Bank of America’s credit ratings, other factors that influence our credit ratings include rating agencies’ assessment of the general operating environment, our relative positions in the markets in which we compete, our reputation, our liquidity position, the level and volatility of our earnings, our corporate governance and risk management policies, and our capital management practices. Management maintains an active dialogue with the rating agencies.

 

The following table sets forth ML & Co.’s unsecured credit ratings as of February 20, 2009.

 

 

In connection with certain OTC derivatives transactions and other trading agreements, we could be required to provide additional collateral to or terminate transactions with certain counterparties in the

event of a downgrade of the senior debt ratings of ML & Co. The amount of additional collateral required depends on the contract and is usually a fixed incremental amount and/or the market value of the exposure. At December 26, 2008, the amount of additional collateral and termination payments that would be required for such derivatives transactions and trading agreements was approximately $1.6 billion in the event of a downgrade to mid single-A by all credit agencies. A further downgrade of ML & Co.’s long-term senior debt credit rating to the A- or equivalent level would require approximately an additional $232 million. Our liquidity risk analysis considers the impact of additional collateral outflows due to changes in ML & Co. credit ratings, as well as for collateral that is owed by us and is available for payment, but has not been called for by our counterparties.

 

Liquidity Risk

 

During 2008, the credit markets continued to experience significant deterioration, as spreads across the financial services sector widened dramatically, significantly increasing the cost and decreasing the availability of both secured and unsecured funding. Amidst these challenging conditions and in anticipation of our acquisition by Bank of America, Merrill Lynch continued to actively manage its liquidity position and reduce the size and risk of its balance sheet. Actions Merrill Lynch took in order to maintain significant excess liquidity included monetizing unencumbered assets through both sales and secured financing transactions, accessing U.S. and other government-sponsored liquidity facilities, and obtaining additional secured credit facilities from Bank of America.

 

Excess Liquidity and Unencumbered Assets

 

We maintained excess liquidity at ML & Co. and selected subsidiaries in the form of cash and high quality unencumbered liquid assets, which represents our “Global Liquidity Sources” and serves as our primary source of liquidity risk protection.

 

As of December 26, 2008 and December 28, 2007, the aggregate Global Liquidity Sources were $156 billion and $200 billion, respectively, consisting of the following:

 

 

The excess liquidity pool is maintained at, or readily available to, ML & Co. and our principal non-U.S. broker-dealer and can be deployed to meet cash outflow obligations under stressed liquidity conditions. The excess liquidity pool includes cash and cash equivalents, investments in short-term money market mutual funds, U.S. government and agency obligations and other liquid securities. At December 26, 2008 and December 28, 2007, the total carrying value of the excess liquidity pool, net of related hedges, was $56 billion and $79 billion, respectively, which included liquidity sources at subsidiaries that we believe are available to ML & Co.

 

During the fourth quarter of 2008, our excess liquidity pool was reduced primarily from the repayment of maturing long-term debt and funding business requirements. Following the completion of the Bank of America acquisition, ML & Co. became a subsidiary of Bank of America and established intercompany lending and borrowing arrangements to facilitate centralized liquidity management. Included in these intercompany agreements is an initial $75 billion one year, revolving unsecured line of credit that allows ML & Co. to borrow funds from Bank of America for operating needs. Immediately following the acquisition, we placed a substantial portion of our excess liquidity with Bank of America through an intercompany lending agreement.

At December 26, 2008 and December 28, 2007, unencumbered liquid assets of $58 billion and $57 billion, respectively, in the form of unencumbered investment grade asset-backed securities and prime residential mortgages were available at our regulated bank subsidiaries to meet potential deposit obligations, business activity demands and stressed liquidity needs of the bank subsidiaries. These unencumbered assets are generally restricted from transfer and unavailable as a liquidity source to ML & Co. and other non-bank subsidiaries.

 

At December 26, 2008 and December 28, 2007, our non-bank subsidiaries, including broker-dealer subsidiaries, maintained $42 billion and $64 billion, respectively, of unencumbered securities, including $7 billion of customer margin securities at December 26, 2008 and $10 billion at December 28, 2007. These unencumbered securities are an important source of liquidity for broker-dealer activities and other individual subsidiary financial commitments, and are generally restricted from transfer and therefore unavailable to support liquidity needs of ML & Co. or other subsidiaries. Proceeds from encumbering customer margin securities are further limited to supporting qualifying customer activities.

 

Committed Credit Facilities

 

In addition to the Global Liquidity Sources, we maintained external credit facilities that were available to cover regular and contingent funding needs. Following the Bank of America acquisition, certain sources of liquidity were centralized, and ML & Co. terminated all of its external committed credit facilities.

 

We maintained a committed, three-year multi-currency, unsecured bank credit facility that totaled $4.0 billion as of December 26, 2008. We borrowed regularly from this facility as an additional funding source to conduct normal business activities. At both December 26, 2008 and December 28, 2007, we had $1.0 billion of borrowings outstanding under this facility. Following the completion of the Bank of America acquisition, we repaid the outstanding borrowings and terminated the facility in January 2009.

 

We maintained a $2.7 billion committed, secured credit facility at December 26, 2008. There were no borrowings under the facility at December 26, 2008. Following the completion of the Bank of America acquisition, we terminated the facility in January 2009.

 

In December 2008 we decided not to seek a renewal of a $3.0 billion committed, secured credit facility. There were no borrowings under the facility at termination.

 

In October 2008, we entered into a $10.0 billion committed unsecured bank revolving credit facility with Bank of America, N.A. with borrowings guaranteed under the FDIC’s guarantee program. There were no borrowings under the facility at December 26, 2008. Following the completion of the Bank of America acquisition, the facility was terminated.

 

In September 2008, we established an additional $7.5 billion bilateral secured credit facility with Bank of America. There was $3.5 billion outstanding under this facility at year end. Following the completion of the Bank of America acquisition, we repaid the outstanding borrowings and the facility was terminated.

 

U.S. Government Liquidity Facilities

 

During 2008, the U.S. Government created several programs to enhance liquidity and provide stability to the financial markets. Merrill Lynch participated in a number of these programs throughout 2008.

 

In March 2008, the Federal Reserve announced an expansion of its securities lending program to promote liquidity in the financing markets for Treasury securities and other collateral. Under the Term Securities Lending Facility (“TSLF”), the Federal Reserve lends Treasury securities to primary dealers secured for a term of 28 days by a pledge of other securities, including U.S. Treasuries and Agencies and a range of investment grade corporate securities, municipal securities, mortgage-backed securities,

and asset-backed securities. We regularly participate in the TSLF auctions, but generally reduced our usage during the fourth quarter.

 

Also in March 2008, the Federal Reserve announced that the Federal Reserve Bank of New York has been granted the authority to establish a Primary Dealer Credit Facility (“PDCF”). The PDCF provides overnight funding to primary dealers in exchange for collateral that may include U.S. Treasuries and Agencies and a broad range of debt and equity securities. Following the further credit market disruptions in September, we began utilizing the PDCF as an additional source of funding. We reduced our usage of the PDCF during the fourth quarter.