Exhibit 13 FINANCIAL TABLE OF CONTENTS - --------------------------- 27 SELECTED FINANCIAL DATA 28 MANAGEMENT'S DISCUSSION AND ANALYSIS 28 Business Environment 29 Results of Operations 30 Commissions 30 Principal Transactions 31 Investment Banking 32 Asset Management and Portfolio Service Fees 32 Other Revenues 33 Interest and Dividends 33 Non-Interest Expenses 34 Income Taxes 35 Strategic Business Initiatives 36 Business Segments 39 Global Operations 42 Balance Sheet 45 Capital Adequacy and Liquidity 47 Capital Projects and Expenditures 47 Risk Management 51 Non-Investment Grade Holdings and Highly Leveraged Transactions 52 Cash Flows 52 Litigation 52 Recent Developments 53 MANAGEMENT'S DISCUSSION OF FINANCIAL RESPONSIBILITY 54 INDEPENDENT AUDITORS' REPORT 55 CONSOLIDATED FINANCIAL STATEMENTS 55 Consolidated Statements of Earnings 56 Consolidated Balance Sheets 58 Consolidated Statements of Changes in Stockholders' Equity 60 Consolidated Statements of Comprehensive Income 61 Consolidated Statements of Cash Flows 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 62 NOTE 1. Summary of Significant Accounting Policies 66 NOTE 2. Other Significant Events 67 NOTE 3. Trading and Related Activities 71 NOTE 4. Investments 72 NOTE 5. Borrowings 73 NOTE 6. Fair Value Information and Non-Trading Derivatives 74 NOTE 7. Preferred Securities Issued by Subsidiaries 75 NOTE 8. Stockholders' Equity and Earnings Per Share 76 NOTE 9. Commitments and Contingencies 77 NOTE 10. Employee Benefit Plans 80 NOTE 11. Employee Incentive Plans 83 NOTE 12. Income Taxes 84 NOTE 13. Regulatory Requirements and Dividend Restrictions 84 NOTE 14. Segment, Product, and Geographic Information 88 SUPPLEMENTAL FINANCIAL INFORMATION 88 Quarterly Information 88 Dividends Per Common Share 88 Stockholder Information 26 SELECTED FINANCIAL DATA - ----------------------- (dollars in millions, except per share amounts)
Year Ended Last Friday in December 1999 1998 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- (53 weeks) (52 weeks) (52 weeks) (52 weeks) (52 weeks) OPERATING RESULTS Total Revenues $ 34,879 $ 34,574 $ 31,209 $ 25,043 $ 21,501 Less Interest Expense 13,010 17,027 14,953 11,422 10,886 -------- -------- -------- -------- -------- Net Revenues 21,869 17,547 16,256 13,621 10,615 Non-Interest Expenses 17,791 15,451 13,145 10,993 8,779 -------- -------- -------- -------- -------- Earnings Before Income Taxes and Dividends on Preferred Securities Issued by Subsidiaries 4,078 2,096 3,111 2,628 1,836 Income Tax Expense 1,265 713 1,129 980 710 Dividends on Preferred Securities Issued by Subsidiaries 195 124 47 - - -------- -------- -------- -------- -------- Net Earnings $ 2,618 $ 1,259 $ 1,935 $ 1,648 $ 1,126 ======== ======== ======== ======== ======== Net Earnings Applicable to Common Stockholders(a) $ 2,580 $ 1,220 $ 1,896 $ 1,602 $ 1,078 ======== ======== ======== ======== ======== - ----------------------------------------------------------------------------------------------------------------------------- FINANCIAL POSITION Total Assets $328,071 $299,804 $296,980 $217,266 $179,452 Short-Term Borrowings(b) $114,775 $ 98,267 $123,400 $103,009 $ 86,663 Long-Term Borrowings $ 53,465 $ 57,563 $ 43,143 $ 26,206 $ 17,389 Preferred Securities Issued by Subsidiaries $ 2,725 $ 2,627 $ 627 $ 327 $ 51 Total Stockholders' Equity $ 12,802 $ 10,132 $ 8,539 $ 7,067 $ 6,288 - ----------------------------------------------------------------------------------------------------------------------------- COMMON SHARE DATA(C) (in thousands, except per share amounts) Earnings Per Share: Basic $ 7.00 $ 3.43 $ 5.57 $ 4.63 $ 2.98 ======== ======== ======== ======== ======== Diluted $ 6.17 $ 3.00 $ 4.79 $ 4.08 $ 2.68 ======== ======== ======== ======== ======== Weighted-Average Shares Outstanding: Basic 368,718 355,589 340,096 346,043 361,193 Diluted 418,131 406,262 395,855 392,990 402,852 Shares Outstanding at Year End(d) 367,765 356,284 339,259 332,349 346,953 Shares Repurchased(e) - - 13,301 36,606 39,861 Average Share Repurchase Price - - $ 48.91 $ 31.30 $ 23.48 Book Value Per Share $ 33.20 $ 26.89 $ 23.63 $ 19.24 $ 16.25 Dividends Paid Per Share $ 1.05 $ 0.92 $ 0.75 $ 0.58 $ 0.505 - ----------------------------------------------------------------------------------------------------------------------------- FINANCIAL RATIOS Pre-tax Margin(f) 18.6% 11.9% 19.1% 19.3% 17.3% Profit Margin(g) 12.0% 7.2% 11.9% 12.1% 10.6% Common Dividend Payout Ratio 15.0% 26.3% 13.4% 12.5% 17.0% Return on Average Assets 0.8% 0.3% 0.7% 0.7% 0.5% Return on Average Common Stockholders' Equity 23.5% 13.4% 26.5% 26.6% 19.8% Average Leverage(h) 23.2x 32.9x 35.3x 33.3x 32.1x Average Adjusted Leverage(i) 14.4x 19.2x 21.3x 19.8x 19.4x - ----------------------------------------------------------------------------------------------------------------------------- EMPLOYEE STATISTICS Full-Time Employees: U.S. 49,000 46,500 45,800 42,100 39,250 Non-U.S. 18,200 17,300 13,900 10,500 9,250 -------- -------- -------- -------- -------- Total 67,200 63,800 59,700 52,600 48,500 ======== ======== ======== ======== ======== Financial Consultants and Other Investment Professionals 19,000 18,100 16,600 15,600 14,900 - -----------------------------------------------------------------------------------------------------------------------------
(a) Net earnings less preferred stock dividends. (b) Consists of Payables under repurchase agreements and securities loaned transactions,Commercial paper and other short-term borrowings,and Demand and time deposits. (c) All share and per share data have been restated for the 1997 two-for-one common stock split (see Note 8 to the Consolidated Financial Statements). (d) Does not include 4,009, 4,506, 4,718, 4,134, and 3,932 shares exchangeable into common stock (see Note 8 to the Consolidated Financial Statements) at year-end 1999, 1998, 1997, 1996, and 1995, respectively. Also does not include 3,078, and 8,026 unallocated reversion shares held in the Employee Stock Ownership Plan at year-end 1996 and 1995, respectively,which are not considered outstanding for accounting purposes. (e) Does not include shares either (i) owned by employees and used to pay for the exercise of stock options or (ii) stock withheld from employee stock option exercises to pay associated taxes. (f) Earnings Before Income Taxes and Dividends on Preferred Securities Issued by Subsidiaries to Net Revenues. (g) Net Earnings to Net Revenues. (h) Average Total assets to average Total stockholders'equity and Preferred securities issued by subsidiaries. (i) Average Total assets less average (a) Securities received as collateral,net of securities pledged as collateral,(b) Securities pledged as collateral,(c) Receivables under resale agreements and securities borrowed transactions,to average Total stockholders'equity and Preferred securities issued by subsidiaries. Selected Financial Data 27 TABLE OF CONTENTS 28 Business Environment 29 Results of Operations 30 Commissions 30 Principal Transactions 31 Investment Banking 32 Asset Management and Portfolio Service Fees 32 Other Revenues 33 Interest and Dividends 33 Non-Interest Expenses 34 Income Taxes 35 Strategic Business Initiatives 36 Business Segments 39 Global Operations 42 Balance Sheet 45 Capital Adequacy and Liquidity 47 Capital Projects and Expenditures 47 Risk Management 51 Non-Investment Grade Holdings and Highly Leveraged Transactions 52 Cash Flows 52 Litigation 52 Recent Developments MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------ Merrill Lynch & Co., Inc. ("ML & Co.") is a holding company that, through its subsidiaries and affiliates, (therein "Merrill Lynch") provides investment, financing, advisory, insurance, and related services worldwide. The financial services industry, in which Merrill Lynch is a leading participant, is highly competitive and highly regulated. This industry and the global financial markets are influenced by numerous uncontrollable factors. These factors include economic conditions, monetary policies, the liquidity of global markets, international and regional political events, regulatory developments, the competitive environment, and investor sentiment. These conditions or events can significantly affect the volatility of financial markets. While greater volatility increases risk, it may also increase order flow in businesses such as trading and brokerage. Revenues and net earnings may vary significantly from period to period due to these unpredictable factors and the resulting market volatility. The financial services industry continues to be affected by the intensifying competitive environment, as demonstrated by consolidation through mergers and acquisitions, as well as diminishing margins in many mature products and services, and competition from new entrants as well as established competitors using the Internet to establish or expand their businesses. In addition, the passage of the Gramm-Leach-Bliley Act in November of 1999 represented a significant accomplishment in the effort to modernize the financial services industry in the U.S. by repealing anachronistic laws that separated commercial, investment banking, and insurance activities, which together with other recent changes in the financial services industry, have increased the number of companies competing for a similar customer base. In addition to providing historical information, Merrill Lynch may make or publish forward-looking statements about management expectations, strategic objectives, business prospects, anticipated financial performance, and other similar matters. A variety of factors, many of which are beyond its control, affect the operations, performance, and results of Merrill Lynch and could cause actual results and experience to differ materially from the expectations expressed in these statements. These factors include, but are not limited to, the factors listed in the previous paragraph, as well as actions and initiatives taken by both current and potential competitors, the effect of current, pending, and future legislation and regulation both in the United States and throughout the world, and the other risks detailed in the following sections. MERRILL LYNCH UNDERTAKES NO RESPONSIBILITY TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS. BUSINESS ENVIRONMENT - -------------------- Global financial markets rebounded significantly in 1999, after a very volatile second half of 1998. Markets benefited from tightening credit spreads, which represent the risk premium paid by an issuer over the risk-free rate (based on the issuer's credit rating or perceived creditworthiness), increased investor demand, and improved liquidity in debt markets. U.S. equity indices continued to advance to record levels for the fifth consecutive year, despite a midsummer downturn in the stock market, a series of interest rate hikes by the Federal Reserve beginning in June, and weakness in the U.S. dollar versus the Japanese yen. Most non-U.S. markets recovered sharply in 1999, posting significant gains in equity indices during the first six months of the year, but retreating somewhat in the third quarter due to U.S. interest rate concerns. Following the Federal Reserve's November 1999 announcement of a neutral bias toward interest 28 rates, global market indices soared, contributing to record trading and commissions revenues industrywide for 1999. U.S. bond rates steadily increased throughout 1999, as inflationary fears led the Federal Reserve to increase the overnight lending rate by twenty-five basis points three times, in June, August, and November. The yield on the 30-year U.S. Treasury bond reached 6.48% at year-end, up from 5.10% at the beginning of 1999. In Europe, a decline in industrial production and exports led the European Central Bank and the Bank of England to reduce short-term rates by fifty and twenty-five basis points, respectively. Long-term rates in Europe, however, increased modestly throughout 1999. Credit spreads generally tightened throughout 1999, with the exception of the 1999 third quarter, when spreads reached their widest point since the 1998 Russian debt crisis. U.S. equity markets experienced extraordinary gains during 1999, led by an unprecedented demand for communications and technology stocks. The Nasdaq advanced a record 85.6% in 1999, with more than half of the gain recorded during the last two months of the year. Despite a series of interest rate increases, a midsummer downturn in the stock market, and Year 2000 concerns, both the Dow Jones Industrial Average and S&P 500 reached record levels, up 25.2% and 19.5%, respectively, in 1999. Performances within these indices were mixed, however, as 67% of equities within these indices were down 20% or more from their fifty-two week highs. Global equity indices significantly advanced in 1999, as world markets recovered from the credit crisis that occurred during the latter half of 1998. Emerging market indices produced the biggest rally, led primarily by Brazil, South Korea, and Mexico, which all rose more than 80% in local currency terms. International Monetary Fund support, as well as a reduction in interest rates, helped Brazilian markets recover from a currency devaluation. The South Korean economy benefited from low interest rates and strong corporate earnings, while an increase in exports and investment from abroad fueled markets in Mexico. Demand by foreign investors for Japanese equities, in addition to government intervention to control the rise in the yen, contributed to the advance in Japanese market indices, which rose 50% in local currency terms during 1999. European markets, which experienced sluggish growth during most of the year, rebounded in the 1999 fourth quarter, led by an increase in manufacturing levels and exports in Germany. The euro, however, continued to weaken throughout most of 1999, sinking below $1 in December and declining 14% against the U.S. dollar in 1999. Global underwriting volume reached near record levels during 1999, led by record activity in equity underwriting and initial public offerings. Equity issuances totaled $173 billion during 1999, representing a 50% increase over 1998 levels and surpassing the previous record of $124 billion set in 1997. Initial public offerings surged to $69 billion during the year, a 38% increase from the record $50 billion recorded in 1996. Contributing to the increased volume was record demand for technology, media, and telecommunications offerings, which accounted for two-thirds of all new stock issues in 1999. Concerns over U.S. interest rates and inflation led to a modest decline in debt issuances during 1999. As a result, proceeds from U.S. debt issuances decreased 4% overall from 1998 to $1.9 trillion in 1999, representing the first year-over- year decline in debt underwriting since 1995. Strategic advisory services activities reached record levels in 1999, reflecting a continuation of the high level of merger and acquisition activity experienced during 1998. Companies continued to seek strategic alliances to increase earnings growth, better compete in existing markets, and expand into new markets and businesses. While announced mergers and acquisitions in the U.S. increased over 7% from 1998 to a record $1.8 trillion, European deals advanced to over $1.2 trillion, more than double the 1998 level. During 1999, the largest announced merger and acquisition deal ever and the largest announced cross-border transaction ever both occurred in Europe, contributing to the surge in activity for the year. Merrill Lynch continually evaluates its businesses for profitability and performance under varying market conditions and, in light of the evolving conditions in its competitive environment, for alignment with its long-term strategic objectives. Maintaining long-term client relationships, closely monitoring costs and risks, diversifying revenue sources, and expanding strategically, all contribute to mitigating the effects of volatility on Merrill Lynch's business as a whole. RESULTS OF OPERATIONS - --------------------- - -------------------------------------------------------------------------------- (in millions, except per share amounts) 1999 vs. --------------- 1999 1998 1997 1998 1997 - ------------------------------------------------------------------------------- Total revenues $34,879 $34,574 $31,209 0.9% 11.8% Net revenues 21,869 17,547 16,256 24.6 34.5 Earnings before income taxes and dividends on preferred securities issued by subsidiaries 4,078 2,096 3,111 94.6 31.1 Net earnings 2,618 1,259 1,935 107.9 35.3 Net earnings applicable to common stockholders 2,580 1,220 1,896 111.5 36.1 Earnings per common share: Basic 7.00 3.43 5.57 104.1 25.7 Diluted 6.17 3.00 4.79 105.7 28.8 Return on average common stockholders' equity 23.5% 13.4% 26.5% - -------------------------------------------------------------------------------- Management's Discussion and Analysis 29 During 1999, record revenues were achieved in all revenue categories, including commissions, principal transactions, investment banking, asset management and portfolio service fees, and net interest profit. These revenues were partially offset by increased costs related to compensation and benefits, advertising and market development, and communications and technology. Merrill Lynch reported 1999 net earnings of $2.6 billion, or $6.17 per diluted share with a return on average common stockholders' equity of 23.5%. This compares with $1.3 billion or $3.00 per diluted share reported in 1998, which included a $288 million after-tax provision for costs related to staff reductions. Excluding this provision, 1998 net earnings were $1.5 billion, or $3.71 per diluted share. Return on average common stockholders' equity on this basis was 16.4% in 1998. In 1997, Merrill Lynch reported net earnings of $1.9 billion, or $4.79 per diluted share. Return on average common stockholders' equity for 1997 was 26.5%. On a cash basis, which excludes goodwill amortization, earnings were $2.8 billion, up from $1.8 billion in 1998 excluding the staff reduction provision. On the same basis, diluted earnings per share were $6.71 versus $4.27 in 1998, and return on average common stockholders' equity in 1999 was 24.4%. In 1997, earnings on a cash basis were $2.0 billion, or $4.95 per diluted share. The 1999 results reflected record results in the equity markets and investment banking businesses, and a substantial increase in profitability from debt-related activities versus the difficulties encountered in the 1998 fixed-income markets. The Private Client and Asset Management businesses each recorded strong results on record revenues in Commissions and Asset management and portfolio service fees. The following discussion provides details of major revenue and expense categories and other pertinent information on Merrill Lynch's business activities, financial condition, liquidity, and risks. Certain prior year amounts have been restated to conform with the current year presentation. COMMISSIONS - ----------- - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Listed and over-the-counter $3,597 $3,185 $2,759 Mutual funds 1,868 1,871 1,594 Other 869 743 642 ------ ------ ------ Total $6,334 $5,799 $4,995 ====== ====== ====== - -------------------------------------------------------------------------------- Commissions revenues advanced 9% in 1999 to a record $6.3 billion, primarily due to increases in global listed securities volume and over-the-counter securities transactions. Commissions from listed securities were up 11% from 1998 as a result of higher trading volumes, particularly on non-U.S. exchanges. Mutual fund commissions were virtually unchanged, and other commissions revenues advanced 17% in 1999, primarily due to increased sales of money market instruments and third party annuity contracts. Commissions revenues rose 16% in 1998. Increased volume led to higher listed and over-the-counter securities transaction revenues, while strong sales of U.S. and non-U.S. mutual funds increased mutual fund commissions. PRINCIPAL TRANSACTIONS - ---------------------- The table that follows provides information on trading revenues, including related net interest. Interest revenue and expense amounts are based on management's assessment of the cost to finance trading positions, after consideration of the underlying liquidity of these positions. Trading and related hedging and financing activities affect the recognition of both principal transactions revenues and net interest and dividend revenues. In assessing the profitability of its trading activities, Merrill Lynch aggregates net interest and principal transactions revenues. For financial reporting purposes, realized and unrealized gains and losses on trading positions, including hedges, are recorded in principal transactions revenues. The net interest carry (i.e., the spread representing interest earned less financing costs) for trading positions, including hedges, is recorded either as principal transactions revenues or net interest revenues, depending on the nature of the specific instruments. Changes in the composition of trading inventories and hedge positions can cause the recognition of revenues within these categories to fluctuate. - -------------------------------------------------------------------------------- (in millions) Principal Net Net Transactions Interest Trading Revenues Revenues Revenues(1) - -------------------------------------------------------------------------------- 1999 Equities and equity derivatives $ 1,989 $ 226 $ 2,215 Debt and debt derivatives 2,170 282 2,452 Mortgages (5) 255 250 Foreign exchange 207 - 207 ------- ------- ------- Total $ 4,361 $ 763 $ 5,124 ======= ======= ======= - -------------------------------------------------------------------------------- 1998 Equities and equity derivatives $ 1,593 $ 9 $ 1,602 Debt and debt derivatives 890 (37) 853 Mortgages (33) 259 226 Foreign exchange 201 (3) 198 ------- ------- ------- Total $ 2,651 $ 228 $ 2,879 ======= ======= ======= - -------------------------------------------------------------------------------- 1997 Equities and equity derivatives $ 1,290 $ (54) $ 1,236 Debt and debt derivatives 2,335 35 2,370 Mortgages 28 160 188 Foreign exchange 174 1 175 ------- ------- ------- Total $ 3,827 $ 142 $ 3,969 ======= ======= ======= - -------------------------------------------------------------------------------- (1) Excludes commissions. For further information on trading results, see Note 3 to the Consolidated Financial Statements. 30 Management's Discussion and Analysis Net trading revenues were $5.1 billion in 1999, up 78% from 1998 due to significantly improved global market conditions in 1999 compared with 1998. Market conditions were generally favorable in 1999, including rising U.S. stock prices and narrowing credit spreads. Equities and equity derivatives net trading revenues advanced 38% from 1998 to $2.2 billion, due to significantly higher revenues from both U.S. and non-U.S. equities as well as convertibles. The increase in revenues was largely due to an increase in trading volumes in global markets, particularly in Europe and Japan, and higher market share. Net revenues from global convertibles benefited from improved market conditions, especially in the U.S. Debt and debt derivatives net trading revenues were $2.5 billion, up sharply from 1998, when revenues suffered from significant uncertainty in global debt markets, and an unprecedented widening of credit spreads and the absence of liquidity in debt markets led to severe losses in the third and fourth quarters. Increased volume, tightening credit spreads and a more stable global environment led to increased revenues in 1999, particularly in the U.S. Net revenues from mortgages were $250 million in 1999, up 11% from 1998. Foreign exchange net trading revenues remained virtually unchanged for the year. In 1998, net trading revenues were down 27% from 1997 due to the significant volatility in global debt markets. An increase in volume of non-U.S. equities and equity derivative transactions led to advances in equities and equity derivatives net trading revenues (up 30%). Debt and debt derivatives net trading revenues were $853 million compared to $2.4 billion in 1997, as valuations of corporate and emerging market bonds were significantly impacted by widening credit spreads and reduced liquidity in the third quarter of 1998. In addition, 1998 results reflect credit losses on emerging market-related debt derivatives in the latter half of the year. A more favorable mortgage environment led to increased net revenues (up 20%). Fluctuations in the U.S. dollar versus various currencies led to higher net foreign exchange revenues (up 13%). INVESTMENT BANKING - ------------------ - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Underwriting revenues $2,301 $2,162 $2,079 Strategic advisory services revenues 1,313 1,102 797 ------ ------ ------ Total $3,614 $3,264 $2,876 ====== ====== ====== - -------------------------------------------------------------------------------- Investment banking revenues rose 11% in 1999 to a record $3.6 billion, benefiting from increased revenues from underwriting and from record merger and acquisition advisory fees. Underwriting Increased equity underwriting revenues were partly offset by lower corporate bond and high yield underwriting revenues. Merrill Lynch retained its position as the leading underwriter of total debt and equity securities for the 12th consecutive year in the U.S. and for the 11th consecutive year globally. Merrill Lynch's underwriting market share information based on transaction value follows: - -------------------------------------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Market Market Market Share Rank Share Rank Share Rank - -------------------------------------------------------------------------------- U.S. PROCEEDS Debt 16.0% 1 14.9% 1 14.9% 1 Equity 12.5 3 15.8 1 14.8 1 Debt and Equity 15.8 1 15.4 1 15.1 1 GLOBAL PROCEEDS Debt 12.4% 1 13.1% 1 12.7% 1 Equity 12.2 3 13.4 2 13.2 2 Debt and Equity 12.6 1 13.5 1 13.0 1 - -------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to book manager. Strategic Advisory Services Strategic advisory services fees rose 19% in 1999 to a record $1.3 billion, benefiting from strong merger and acquisition activity, particularly in Europe. Merrill Lynch's merger and acquisition market share information based on transaction value follows: - -------------------------------------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ Market Market Market Share Rank Share Rank Share Rank - -------------------------------------------------------------------------------- COMPLETED TRANSACTIONS U.S. 22.8% 3 33.0% 1 28.3% 1 Global 22.4 3 25.3 2 18.9 3 ANNOUNCED TRANSACTIONS U.S. 27.6% 3 31.5% 2 28.0% 1 Global 32.0 3 25.1 3 18.7 3 - -------------------------------------------------------------------------------- Source: Thomson Financial Securities Data statistics based on full credit to both target and acquiring companies'advisors. Investment banking revenues in 1998 increased 13% from 1997 due to increased underwriting revenues and strong merger and acquisition advisory fees. Management's Discussion and Analysis 31 ASSET MANAGEMENT AND PORTFOLIO SERVICE FEES - ------------------------------------------- - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Asset management fees $2,263 $2,075 $1,232 Portfolio service fees 1,479 1,150 826 Account fees 499 451 422 Other fees 512 526 522 ------ ------ ------ Total $4,753 $4,202 $3,002 ====== ====== ====== - -------------------------------------------------------------------------------- Revenues from asset management and portfolio service fees rose 13% in 1999 to a record $4.8 billion, primarily due to strong growth in assets under management and assets in fee-based accounts. Asset management fees increased 9% in 1999 due to growth in assets under management attributable to market appreciation and net inflows of new money. Portfolio service fees were up 29% in 1999, benefiting from significant growth in client accounts and assets in fee-based accounts, including Merrill Lynch Consults(Registered Trademark) and Unlimited Advantage(Service Mark), Merrill Lynch's new total access fee-based account which was introduced in 1999. Account fees rose 11%, principally as a result of increases in the number of Working Capital Management Accounts ("WCMA(Registered Trademark)") and Cash Management Accounts ("CMA(Registered Trademark)"). In 1998, asset management and portfolio service fees advanced 40% from 1997, primarily due to the December 1997 acquisition of Mercury Asset Management Group ("Mercury") and growth in assets under management, which benefited from significant growth in both client accounts and assets in fee-based accounts. Merrill Lynch's year-end assets in Private Client accounts or under management for 1999, 1998, and 1997 are summarized as follows: - -------------------------------------------------------------------------------- (in billions) 1999 vs. ------------- 1999 1998 1997 1998 1997 - -------------------------------------------------------------------------------- ASSETS IN PRIVATE CLIENT ACCOUNTS OR UNDER MANAGEMENT(1) U.S. $1,338 $1,164 $ 979 15% 37% Non-U.S 358 282 250 27 43 ------ ------ ------ Total $1,696 $1,446 $1,229 17 38 ====== ====== ====== ASSETS UNDER MANAGEMENT Retail $ 291 $ 276 $ 240 5 21 Institutional 266 225 208 18 28 ------ ------ ------ Total $ 557 $ 501 $ 448 11 24 ====== ====== ====== U.S.FEE-BASED PROGRAM ASSETS(2) $ 151 $ 84 $ 60 80 152 401(K) ASSETS $ 111 $ 99 $ 74 12 50 - -------------------------------------------------------------------------------- (1) Includes certain assets that are also included in Assets Under Management. (2) Including Unlimited Advantage, Merrill Lynch Consults, Private Portfolio Group, and Mutual Fund Advisor(Service Mark). Changes in assets in Private Client accounts or under management from year-end 1998 to year-end 1999 are described below: - -------------------------------------------------------------------------------- (in billions) NET CHANGES DUE TO ----------------------- YEAR-END NEW ASSET YEAR-END 1998 MONEY(1) APPRECIATION 1999 - -------------------------------------------------------------------------------- Assets in Private Client accounts or under management $1,446 $ 104 $ 146 $1,696 Assets under management 501 18 38 557 - -------------------------------------------------------------------------------- (1) Includes reinvested dividends of $11 billion. OTHER REVENUES - -------------- Other revenues were $720 million in 1999, up 16% from 1998. Other revenues include investment and real estate gains and losses, and partnership distributions. The increase in other revenues during 1999 was primarily attributable to higher investment gains and partnership revenues. In 1998, other revenues increased 25% from 1997 to $623 million, principally due to a pre-tax gain of approximately $100 million from the sale of Merrill Lynch's New York Stock Exchange specialist business. 32 Management's Discussion and Analysis INTEREST AND DIVIDENDS - ---------------------- - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- INTEREST AND DIVIDEND REVENUES Resale agreements and securities borrowed transactions $ 5,761 $ 7,694 $ 6,831 Trading assets 3,931 5,218 5,240 Margin lending 2,982 2,757 2,207 Other 2,423 2,366 1,731 ------- ------- ------- 15,097 18,035 16,009 ------- ------- ------- INTEREST EXPENSE Repurchase agreements and securities loaned transactions 4,830 7,134 6,016 Borrowings 4,606 5,500 4,623 Trading liabilities 1,743 2,619 2,983 Other 1,831 1,774 1,331 ------- ------- ------- 13,010 17,027 14,953 ------- ------- ------- NET INTEREST AND DIVIDEND PROFIT $ 2,087 $ 1,008 $ 1,056 ======= ======= ======= - -------------------------------------------------------------------------------- Interest and dividend revenues and expenses are a function of the level and mix of interest-earning assets and interest-bearing liabilities, and the prevailing level and volatility of interest rates. Net interest and dividend profit was up sharply from 1998, principally due to increases in interest spreads attributable to a steepening yield curve and efficiencies in financing. In 1998, interest and dividend profit was down 5% from 1997, largely due to additional financing costs related to the December 1997 Mercury acquisition. Merrill Lynch hedges its long- and short-term borrowings, primarily with interest rate and currency swaps, to better match the interest rate and currency characteristics of the borrowings to the assets funded by borrowing proceeds. The effect of this hedging activity, which is included in "Borrowings" above, decreased interest expense for 1999, 1998, and 1997 by $269 million, $62 million, and $81 million, respectively (see Note 5 to the Consolidated Financial Statements). NON-INTEREST EXPENSES - --------------------- Merrill Lynch's non-interest expenses are summarized as follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Compensation and benefits $11,153 $ 9,199 $ 8,333 ------- ------- ------- Non-interest expenses,excluding compensation and benefits: Communications and technology 2,038 1,749 1,255 Occupancy and related depreciation 941 867 736 Advertising and market development 779 688 613 Brokerage,clearing,and exchange fees 678 683 525 Professional fees 567 552 520 Goodwill amortization 227 226 65 Provision for costs related to staff reductions - 430 - Other 1,408 1,057 1,098 ------- ------- ------- Total non-interest expenses,excluding compensation and benefits 6,638 6,252 4,812 ------- ------- ------- Total non-interest expenses $17,791 $15,451 $13,145 ======= ======= ======= Compensation and benefits as a percentage of net revenues 51.0% 52.4% 51.3% Compensation and benefits as a percentage of pre-tax earnings before compensation and benefits 73.2% 78.5%(1) 72.8% - -------------------------------------------------------------------------------- (1) Excluding provision for costs related to staff reductions. Non-interest expenses were $17.8 billion in 1999, compared with $15.5 billion in 1998. The largest expense category, compensation and benefits, was up 21% from 1998 due to higher incentive and Financial Consultant compensation, resulting from increased profitability and strong business volume. An increase in the number of full-time employees also contributed to this increase, including a full year of Merrill Lynch Japan Securities Co. ("MLJS") staff operating costs. The number of full-time employees was 67,200 at year-end 1999, up approximately 3,400 since the end of 1998. This increase is attributable to strategic business expansion, primarily in the Private Client Group and growth in existing businesses. Communications and technology expense rose 17% in 1999 to $2.0 billion due to higher technology-related depreciation and communication maintenance and support, partly related to new strategic online initiatives implemented in 1999. Occupancy and related depreciation increased 9% to $941 million as a result of continued global expansion. Advertising and market development expense was $779 million, up 13% from 1998 because of increased costs related to new advertising campaigns launched during the year, including those related to the new online initiatives. Brokerage, clearing, and exchange fees remained virtually unchanged from the prior year. Professional fees rose 3% to $567 million due in part to higher employment service fees. Goodwill amortization was substantially unchanged at $227 million for the year, and other Management's Discussion and Analysis 33 expenses rose 33% from 1998 due in part to higher provisions related to various business, operational, and legal matters and unfavorable foreign exchange movements related to the Japanese yen versus the U.S. dollar. Non-interest expenses in 1998 were up 18% compared to 1997. Approximately 60% of this increase was attributable to the acquisition of Mercury, the start-up of MLJS, and a 1998 staff reduction provision. In the 1998 third quarter, Merrill Lynch recorded a $430 million ($288 million after-tax) provision for costs related to staff reductions aimed at reducing fixed and semi-fixed costs and resizing certain debt trading businesses. The staff reduction provision covered primarily severance costs, as well as costs to terminate long-term contracts and leases related to personnel reductions and resized businesses (see Note 2 to the Consolidated Financial Statements). Compensation and benefits rose 10% in 1998 due to an increase in the number of full-time employees and higher Financial Consultant compensation, slightly offset by lower incentive compensation. Communications and technology expense advanced 39% in 1998, primarily due to increased systems consulting costs related to various initiatives, including Year 2000. Occupancy costs increased 18%, as a result of continued global expansion, particularly associated with MLJS and Mercury. Advertising and market development expense rose 12%, partly due to the start-up of MLJS and the Roth IRA campaign, and higher recognition program costs. Brokerage, clearing, and exchange fees were up 30%, principally due to custody and clearing costs for Mercury. Professional fees rose 6% due to higher costs for strategic market studies and one-time integration costs for Midland Walwyn Inc. ("Midland Walwyn"). Goodwill amortization increased $161 million to $226 million as a result of the Mercury acquisition. Other expenses were down 4% from 1997 due to reductions in provisions for various business activities and legal matters. The following bar graph illustrates fee-based revenues as a percentage of fixed and semi-fixed expenses for the past five years. - ------------------------------------------------------------------------------- FEE-BASED REVENUES AS A PERCENTAGE OF FIXED AND SEMI-FIXED EXPENSES ($ in millions) FIXED AND FEE-BASED SEMI-FIXED REVENUES(2) EXPENSES % ----------- ---------- ----- 1999 $6,842 $8,812 78 1998 6,042 7,930 76(1) 1997 4,364 6,569 66 1996 3,703 5,584 66 1995 3,188 4,671 68 (1) The increase in this percentage compared to 1997 is primarily due to higher fee-based revenues resulting from the Mercury acquisition. (2) Fee-based revenues principally include asset management and portfolio service fees and net margin interest. - ------------------------------------------------------------------------------- INCOME TAXES - ------------ Merrill Lynch's 1999 income tax provision was $1.3 billion, representing a 31.0% effective tax rate compared with 34.0% in 1998 and 36.3% in 1997. The decline in the 1999 effective tax rate was primarily attributable to additional lower-taxed non-U.S. income, higher tax-exempt income, and additional tax-advantaged financing. The 1998 decline was primarily attributable to higher tax-exempt income and additional tax-advantaged financing. Deferred tax assets and liabilities are recorded for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. Merrill Lynch assessed its ability to realize deferred tax assets primarily based on a strong earnings history and the absence of negative evidence as discussed in Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. During the last 10 years, average pre-tax earnings were $2.1 billion. Accordingly, management believes that it is more likely than not that deferred tax assets, net of related valuation allowances, will be realized (see Note 12 to the Consolidated Financial Statements). 34 Management's Discussion and Analysis STRATEGIC BUSINESS INITIATIVES - ------------------------------ Among Merrill Lynch's strategic initiatives were e-commerce developments in our evolving business model for the delivery of information and products and services to our clients. In the Private Client Group ("PCG"), this change means that online services and research may be combined with the personalized advice of a Merrill Lynch Financial Consultant. In the Corporate and Institutional Client Group ("CICG"), this change means the introduction of an enhanced business model for institutional debt and equity issuance, trading, and client activities. Examples of these, and other recent strategic initiatives, include the following: . Launched in July, Unlimited Advantage, a nondiscretionary brokerage service, with asset-based pricing, subject to a minimum annual charge of $1,500. Percentage rates charged to customers decline as assets increase. Unlimited Advantage offers U.S. clients a wide array of services, including virtually unlimited trading for most investors in most securities, unlimited enrolled accounts, traditional Financial Consultant relationships, a CMA(Registered Trademark)Visa(Registered Trademark) Signature(Service Mark)card with a travel rewards program, a financial plan, online capabilities, and access to Merrill Lynch research. . Introduced in October, International Asset Power(Service Mark)and Asset Partner(Service Mark), in Canada, the international versions of Unlimited Advantage. . Introduced in December, ML Direct(Service Mark), a new Internet account for U.S. clients preferring a self-directed approach to investing. The online service addresses investment and cash management needs to guide customer decision making. In addition to online equity trading for as little as $29.95 per trade, clients can purchase and sell mutual funds, receive Merrill Lynch research, and purchase fixed-income products. ML Direct also provides access to the Global Investor Network(Service Mark), Merrill Lynch's multimedia platform featuring timely audio and video reports from analysts, in addition to banking services and online shopping. . Formed the Direct Markets group to develop integrated, electronically- delivered products and services for CICG clients worldwide, including research, analytics, investment information, underwriting, trading, and account reporting. During the 1999 fourth quarter, Direct Markets introduced its first version of iDeal(Service Mark), a new software platform for offering all types of debt and equity securities that is designed to increase the efficiency of the underwriting process, enhance the dissemination of information, and broaden distribution. . Announced in December, a strategic alliance with Multex.com to co-develop global research and information web sites for Merrill Lynch's CICG clients, and to develop technology that will offer clients expanded market data and news, as well as interactive investor conference calls to give customers real-time access to Merrill Lynch's research analysts. . Invested in electronic trading and market systems, such as Primex, Archipelago, and TradeWeb. . Established an integrated global Asset Management Group ("AMG") with three regional operating units servicing a diverse worldwide clientele. In addition, the initiatives included the hire of new senior marketing officers and senior investment managers, including chief investment officers and senior portfolio managers, as well as a quantitative management team, Merrill Lynch Quantitative Advisors. These changes have contributed to expanded product lines, including both active and quantitative investment funds, improved investment performance across both retail and institutional funds, and expanded distribution through Merrill Lynch's sales channels and external distribution partners. . In January 2000, announced the expansion of Merrill Lynch's banking initiatives, which will include new deposit product offerings to be introduced in the first half of 2000. These new products will include Federally-insured interest-bearing bank deposits into which cash from certain Merrill Lynch client accounts, previously swept into money market mutual funds, will be swept. It is anticipated that the new deposit product offerings will enhance the deposit base at Merrill Lynch's two FDIC-insured U.S.banking subsidiaries. In 1998, Merrill Lynch executed its global business strategy by: . Opening 33 retail offices in Japan through MLJS, which resulted in $12 billion in client assets held by Merrill Lynch in Japan at year-end 1999, . Merging with Midland Walwyn, one of Canada's premier securities firms, . Purchasing a majority interest in Phatra Securities Company Limited, Thailand's leading investment bank, for $65 million, . Acquiring Howard Johnson & Co., a U.S. employee benefits consulting firm, for $27 million, and . Divesting a majority interest in Lender's Service, Inc., a residential real estate service subsidiary, and a 100% interest in Merrill Lynch's New York Stock Exchange specialist subsidiary. Acquisitions made in 1997 included Mercury, for which approximately $5.3 billion was paid, and MasterWorks, a 401(k) service provider, for which $13 million was paid. In addition, Merrill Lynch hired the employees of Centaurus Corporate Finance Group, a strategic advisor in Australia. Management's Discussion and Analysis 35 BUSINESS SEGMENTS - ----------------- Merrill Lynch reports the results of its business within three business segments: CICG, PCG, and AMG. CICG's activities primarily involve providing services to corporate, institutional, and government clients throughout the world. PCG provides investment, financing, insurance, tax, and other financial services and products to its clients, globally. AMG provides investment management services to a wide variety of retail and institutional clients. Certain AMG and CICG products are distributed by PCG distribution networks, and to a more limited extent, certain AMG products are distributed through the distribution capabilities of CICG. Costs and revenues associated with these intersegment activities are recognized in each segment and eliminated at the corporate level. In addition, revenue sharing agreements for shared activities are in place and the results of each segment reflect the agreed upon portion of these activities. The following segment operating results, which exclude certain corporate items, represent the information that is relied upon by management in its decision-making processes. In relying upon these numbers, management understands that restatements will occur to reflect reallocations of revenues and expenses which result from changes in Merrill Lynch's business strategy (see Note 14 to the Consolidated Financial Statements). CORPORATE AND INSTITUTIONAL CLIENT GROUP - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 9,328 $ 6,549 $ 6,789 Net earnings 1,906 961 1,186 - -------------------------------------------------------------------------------- Total employees 11,138 10,723 10,553 - -------------------------------------------------------------------------------- CICG provides investment banking and strategic merger and acquisition advisory services, as well as equity and debt trading and capital markets services to corporations, financial institutions, and governments around the world. CICG raises capital for its clients on favorable terms through securities underwriting, private placements, and loan syndications. CICG trades securities, currencies, and other products and contracts over-the-counter derivatives to satisfy customer demand for these instruments. With more than 2,000 equity research, sales, trading, and capital markets professionals and equity trading activities in 28 countries, Merrill Lynch maintains one of the most powerful equity trading and underwriting capabilities of any firm in the world. Through its expertise in government and corporate debt trading, CICG is also the leader in global distribution of new issue and secondary debt securities. CICG's client-focused strategy provides investors with opportunities to diversify their portfolios, manage risk, and enhance returns by tailoring investments and structuring derivatives to meet clients' customized needs. In line with the firmwide strategic initiative in e-commerce, in 1999, CICG established Direct Markets which will enhance existing CICG businesses by serving as a vehicle for creating the "next generation" business model for institutional debt and equity issuance, trading, and servicing activities and for capitalizing on the opportunities created by the Internet to reach institutional clients and investors. In 1999, CICG's net earnings were $1.9 billion, up nearly 100% from 1998 and 61% from 1997 levels. CICG's net revenues increased 42% from 1998 to $9.3 billion, primarily due to a significant improvement in global market conditions. In 1998, the highly volatile global markets, particularly in the latter half of the year, negatively impacted financial markets, especially debt markets. Revenues from CICG equity products were a record $4.7 billion in 1999 due to increased client demand for equities and equity derivatives in both the U.S. and Europe. CICG's global equities business has grown substantially over the last few years. In addition, CICG has substantially grown its equity derivatives and portfolio trading activities during this period. As a result, equity revenues, both trading and underwriting, have grown substantially since 1995, with 56% of 1999 revenues from non-U.S. locations. Debt trading revenues were significantly higher in 1999 compared to 1998, primarily due to a recovery from the global market turmoil experienced in the second half of 1998, when the unprecedented movement in credit spreads led to valuation and counterparty losses that significantly impacted certain of Merrill Lynch's debt trading businesses. Merrill Lynch's investment banking and strategic advisory services activities reached record levels in 1999. Merrill Lynch remained the leading underwriter of global debt and equity securities for the 11th consecutive year, with a 12.6% market share in 1999, according to Thomson Financial Securities Data. Origination revenues for debt and equity securities were $1.6 billion, up 14% from 1998 and 10% from 1997. Through the strengthening of its client relationships, CICG has increased its revenues from strategic advisory services by 17% and 66% as compared with 1998 and 1997, respectively. PRIVATE CLIENT GROUP - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 10,688 $ 9,596 $ 8,532 Net earnings 925 949 730 - -------------------------------------------------------------------------------- Total employees 44,946 42,543 38,856 - -------------------------------------------------------------------------------- During 1999, PCG announced evolutionary changes to its retail business, introducing major e-commerce initiatives, tailored by region, designed to provide clients greater choice and flexi- 36 Management's Discussion and Analysis bility, together with a wide range of products and services to meet their diverse financial needs. Major components of PCG's 1999 initiatives include: . The July, 1999 launch of Unlimited Advantage, a U.S. fee-based financial service that empowers Financial Consultants to compete aggressively for a total financial relationship with clients. Since its inception, Unlimited Advantage has been successful in its asset-gathering strategy, attracting assets at a rate more than 20 times faster than previous fee-based products. At year-end 1999, Unlimited Advantage accounts totaled over 260,000 with assets of $63 billion, of which $9 billion represented new money. Assets include approximately 81,000 ML Financial Advantage(Service Mark)and Asset Power(Service Mark)accounts containing $24 billion in total assets, which were converted to Unlimited Advantage accounts during the year. Over time, this initiative will lead to a shift from commissions revenues to asset management and portfolio service fees. However, we cannot predict with certainty the impact that this initiative will have on revenues or earnings. . The October, 1999 introduction of the international versions of Unlimited Advantage, International Asset Power in most regions, and Asset Partner in Canada. . The December, 1999 introduction of ML Direct, an online investing service for self-directed investors in the U.S. At year-end 1999, more than 5,300 ML Direct accounts had been opened with more than $300 million in assets. Due to the short time period since the inception of ML Direct, we cannot predict with certainty the impact that this initiative will have on revenues or earnings. The formation of MLJS in 1998 has proved essential in establishing Merrill Lynch's presence in Japan. During 1998, Merrill Lynch began offering individual investors in Japan the same consultative approach employed elsewhere in the world and became the first U.S. firm to operate a nationwide retail securities network within the country. In addition, PCG's global presence and position in Canada have strengthened since the 1998 merger with Midland Walwyn. Rebounding from the severe global market turmoil in 1998, Midland Walwyn client assets increased 24% in 1999 to $33 billion at year end. PCG provides a wide range of other fee-based products and services that assist clients around the world to build financial assets and maximize returns in relation to risk tolerance and investment objectives. These products and services include retail brokerage, asset and liability management, retail and private banking, trust and generational planning services, and insurance products. Outside the U.S., PCG's products and services also include private banking services, which provide high-net-worth individuals with a host of products and services to meet their financial objectives, including investing and borrowing strategies, investment management, trust and personal holding company services, and currency management. PCG products and services are provided to individual investors, corporations, and institutions through various distribution networks, including approximately 18,200 Financial Consultants in nearly 1,000 Private Client offices in 36 countries. Financial Consultants and other investment professionals work with individual investors, small and medium-sized corporations, and other organizations to address clients' financial concerns by matching the numerous products offered by Merrill Lynch with the clients' customized needs. These products include: . The CMA and CBA(Registered Trademark) accounts for individuals, WCMA account for small and mid-sized businesses, and EMA(Service Mark)account for foundations and non-profit organizations, all of which are types of flexible central asset accounts for securities transactions, money sweeps, electronic funds-transfer capabilities, debit card access, and many other financial management features. . A wide array of global mutual fund portfolios covering a cross section of industries and regions of the world. . Various advisory services and brokerage pricing alternatives, including Merrill Lynch Consults, Mutual Fund Advisor, and Global Funds Advisor(Service Mark). . Other services provided include mortgages and other consumer loans, margin lending, commercial financing, annuity and life products, trust and other estate planning techniques, and advisory and administrative activities for defined contribution, defined benefit, and various stock plans. Total Private Client customer assets reached $1.5 trillion at year-end 1999, up 17% for the year. Assets in U.S. Private Client fee-based programs were up 80% in 1999 to $151 billion on strong gains in ML Consults and Unlimited Advantage. Net earnings for PCG were $925 million in 1999, down 3% from $949 million in 1998 and up 27% from $730 million in 1997. Net revenues were $10.7 billion, up 11% and 25% from 1998 and 1997, respectively. Increased trading volumes on global exchanges and the continued growth in fee-based revenues have led to record revenues in both Commissions revenues and Asset management and portfolio service fees during 1999. The profitability of the PCG business decreased slightly in 1999 as a result of higher technology expenses and increased advertising expenses, including those related to Unlimited Advantage, ML Direct, and MLJS. PCG results in 1998 included start-up and integration costs associated with MLJS and Midland Walwyn, respectively. Management's Discussion and Analysis 37 ASSET MANAGEMENT GROUP - ------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - ------------------------------------------------------------------------------- Net revenues $ 2,268 $ 1,979 $ 1,239 Net earnings 335 292 264 - ------------------------------------------------------------------------------- Total employees 3,535 3,202 2,924 - ------------------------------------------------------------------------------- AMG provides investment management services to a diverse global clientele of institutions, including pension plans and corporations, high-net-worth individuals, mutual funds, and other investment vehicles. The December 1997 acquisition of Mercury has proved critical to Merrill Lynch's global asset- gathering strategy and, in combination with Merrill Lynch Asset Management ("MLAM"), is essential to the success of AMG's business. During 1999, AMG integrated its business into a single global organization with three regional operating units serving a wide variety of clients, with a special focus in the U.S., Japan, and Europe. In line with this realignment and focus, AMG expanded its products and services as well as its distribution channels. AMG services are now offered under three distinct brand names around the world, Merrill Lynch Asset Management, Merrill Lynch Mercury Asset Management, and Hotchkis and Wiley. In the U.S., Merrill Lynch branded products are available primarily through the PCG distribution channel, while the Mercury and Hotchkis and Wiley products are available through both PCG and third-party distribution networks. Outside the U.S., Merrill Lynch, Mercury, and Atlas (offered in Canada only) branded products are available through both the Merrill Lynch distribution network and other financial intermediaries. In 1999, the introduction of new senior management, including new chief investment and marketing officers, senior portfolio managers, and an experienced quantitative management team, contributed to improved investment performance across retail and institutional products and permitted enhanced product distribution. The U.S. retail mutual fund offerings were expanded to include greater representation in growth areas, particularly technology. In addition, quantitative management capabilities were enhanced with the formation of Merrill Lynch Quantitative Advisors, a management unit offering products that utilize quantitative techniques designed to provide consistent and high investment returns. AMG's sales capabilities through third-party and internal distribution channels also strengthened during 1999, particularly through increased wholesale product offerings. At year-end 1999, assets under management were a record $557 billion, up 11% during 1999, with increases across virtually all asset classes, client bases, and client locations. Of particular note were the increases in assets under management in Japan and Australia, two of AMG's target non-U.S. markets. Based on assets under management, Merrill Lynch is one of the largest investment managers in the world. Presented are three pie charts illustrating Merrill Lynch's assets under management in terms of Client Base, Client Location and Asset Class at year-end 1999. - -------------------------------------------------------------------------------- ASSETS UNDER MANAGEMENT AT YEAR-END 1999 - -------------------------------------------------------------------------------- CLIENT BASE Retail 52% Institutional 48% CLIENT LOCATION U.S. 58% Non-U.S. 42% ASSET CLASS Equity and Balanced 55% Fixed Income - Medium and Long Duration 17% Fixed Income - Short Duration 28% - -------------------------------------------------------------------------------- AMG's assets under management for each of the last three years were comprised of the following: - -------------------------------------------------------------------------------- (in billions) 1999 1998 1997 - -------------------------------------------------------------------------------- Equity and balanced $ 306 $ 267 $ 252 Fixed income: Medium and long duration 95 90 81 Short duration 156 144 115 - -------------------------------------------------------------------------------- Total assets under management $ 557 $ 501 $ 448 - -------------------------------------------------------------------------------- Net earnings for AMG were $335 million in 1999, up 15% from $292 million in 1998 and up 27% from $264 million in 1997. Results in 1999 include an after-tax investment gain of approximately $45 million. Net revenues were $2.3 billion, up 15% and 83% from 1998 and 1997, respectively. The 1998 increase reflects the December 1997 purchase of Mercury. Profitability of the AMG business also improved from 1998 and 1997 because of robust markets, increased productivity, and expanded product lines. 38 Management's Discussion and Analysis GLOBAL OPERATIONS - ----------------- Merrill Lynch's non-U.S. operations are organized into six geographic regions: . Europe, Middle East, and Africa, . Asia Pacific, . Australia and New Zealand, . Japan, . Canada, and . Latin America. The following summary of regional operating results excludes goodwill amortization, financing costs for the Mercury acquisition, and the 1998 staff reduction provision. EUROPE, MIDDLE EAST, AND AFRICA - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 4,222 $ 2,844 $ 1,949 Earnings before income taxes 1,290 452 328 - -------------------------------------------------------------------------------- Total full-time employees 7,658 7,178 6,477 - -------------------------------------------------------------------------------- Merrill Lynch operates in Europe, the Middle East, and Africa as a dealer in a wide array of equity and debt products, as well as providing asset management, investment banking, private banking, and research services. In line with its strategy of becoming a global leader with a strong local presence in key markets, Merrill Lynch now has 45 offices in 20 countries in the region. As a result of the December 1997 acquisition of Mercury, Merrill Lynch has preeminent asset management capabilities in this region. The asset management group is the largest active fund manager in Europe, with assets under management of $288 billion at year-end 1999. Merrill Lynch Mercury received a number of prestigious awards in Europe, including #1 Asset Management Group according to the 1999 Primark/Extel Survey, and #1 Fund Management Group as ranked by the 1999 Reuters UK Larger Companies Survey. All of the region's businesses achieved record results in 1999, with notable contributions from equity markets and investment banking. Merrill Lynch has established itself as the leading equities house in the region, and was ranked #1 Research House by Reuters and #1 All-Europe Research Team by the 1999 Institutional Investor Survey. 1999 was the most successful year ever for investment banking in Europe, as Merrill Lynch participated in a number of top deals in the region, including winning "Best M&A Deal of the Year" and "Best Buyout Deal of the Year" from Corporate Finance Magazine. Merrill Lynch was also awarded the #1 position in European IPOs after acting as lead manager on the "European IPO of the Year", as ranked by IFR Magazine. In addition, the international version of Unlimited Advantage, International Asset Power, was launched in October 1999, and in 2000 Merrill Lynch aims to establish leadership in e-commerce in Europe through aggressive development of a regional Direct Markets Group. Customers in this region will also have access to online trading in 2000. In 1999, net revenues for the region increased 48% from 1998, primarily due to higher investment banking and equity trading revenues, as well as increased asset management fees. Debt trading revenues also contributed to the increase, as market conditions stabilized compared to the second half of 1998. The $838 million increase from 1998 in earnings before income taxes was primarily attributable to significantly increased revenues resulting primarily from investment banking activities, partially offset by a rise in compensation costs. In 1998, net revenues for the region increased 46% from 1997, primarily attributable to asset management fees relating to Mercury, as well as higher investment banking and equity trading revenues, partly offset by lower debt trading revenues. Earnings before income taxes increased 38% from 1997. ASIA PACIFIC - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 813 $ 333 $ 478 Earnings (loss) before income taxes 230 (182) (26) - -------------------------------------------------------------------------------- Total full-time employees 1,605 1,516 1,624 - -------------------------------------------------------------------------------- Merrill Lynch serves a broad retail and institutional client base throughout the Asia Pacific region and offers a full range of Private Client, Asset Management, and CICG products. Merrill Lynch operates from offices in the People's Republic of China and its special administrative Hong Kong region, Singapore, Taiwan, South Korea, Thailand, Malaysia, Indonesia, India, and the Philippines. Merrill Lynch has an established trading presence and exchange memberships in all major financial markets in the region. The Private Client business operates seven Private Client offices throughout the Asia Pacific region, including two offices in the Western U.S., offering investment services and wealth management products to its clients. After a year of financial turbulence in 1998, Merrill Lynch had its best year ever in terms of financial performance in the region. Merrill Lynch completed deals across most Asian markets and was associated with some of the most complex and high profile transactions in the region. IFR Magazine ranked Merrill Lynch Asia Pacific Equity House of the Year and Asia Pacific Bond House of the Year. Merrill Lynch was also named Best Securities Firm in Asia by Euromoney, Best Bank for Equity Origination by Global Finance, and Institutional Investor Magazine ranked Merrill Lynch #1 in Asian Equity and Fixed Income Research. Net revenues in the region were up $480 million in 1999 as global markets stabilized. The increase resulted from strong revenues from equities and equity derivatives and record Private Management's Discussion and Analysis 39 Client revenues, as well as increased asset management fees, with a 20% increase in assets under management. Earnings before income taxes rose $412 million to $230 million, primarily as a result of increased equity and debt trading activity. In 1998, net revenues in the region were down 30% from 1997, as economic turmoil adversely impacted debt markets. However, solid equity trading results and Private Client revenues enabled Merrill Lynch to strengthen its leading position in these businesses across the region. AUSTRALIA AND NEW ZEALAND - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 253 $ 221 $ 163 Earnings before income taxes 32 22 12 - -------------------------------------------------------------------------------- Total full-time employees 865 827 852 - -------------------------------------------------------------------------------- In the Australia and New Zealand region, Merrill Lynch provides a broad mix of Private Client, Asset Management, and CICG products. Assets under management grew 77% during the year, with total net inflows tripling over 1998 levels. The increase in Private Client assets was due to an increased product range, a more focused and expanded sales force, and improved market conditions. The Private Client Group continued to focus on gathering client assets, resulting in a 62% increase in total client assets. In the third quarter of 1999, Merrill Lynch became the first U.S. asset manager to offer U.S.-registered mutual funds in Australia. International equities and mutual funds were introduced to Australian investors during the year, and three new fee-based products were offered in 1999, including the international version of Unlimited Advantage. In New Zealand, the International CMA account was successfully introduced, and customers in Australia will have access to self-directed Internet trading in early 2000. Merrill Lynch's Investment Banking team strengthened its role in the region as a preeminent strategic and financial advisor to Australian and New Zealand corporations in 1999. Merrill Lynch is one of the region's leading strategic advisors to listed companies, and advised on the two largest completed public company M&A transactions. Debt markets, which had its most profitable year ever, is recognized as a leading provider of structured and credit products, in addition to more traditional strengths in cross border origination. Equity markets also continued to perform well, characterized by structural innovation and landmark transactions, including the first major Australian Internet offering. Merrill Lynch was named Best Foreign Securities House in Australia by Finance Asia Magazine and Best Investment Bank in Australia and New Zealand by the Greenwich Survey. Net revenues for the region increased 14% from 1998 and 55% from 1997. The increase primarily resulted from growth in the Private Client and Asset Management businesses. Earnings before income taxes increased 45% from 1998 and nearly tripled since 1997. JAPAN - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 1,062 $ 592 $ 433 Earnings (loss) before income taxes 20 (108) 62 - -------------------------------------------------------------------------------- Total full-time employees 3,160 2,881 766 - -------------------------------------------------------------------------------- Following the establishment of MLJS and Merrill Lynch Mercury Asset Management Japan ("MLMJ") in 1998, Merrill Lynch continued to enhance its presence in the region during 1999 with the successful alignment of its various businesses in Japan. The firm now provides an integrated range of Private Client, Asset Management, and CICG products and services to individual, small to mid-sized corporate, and institutional clients. In 1999, synergies between CICG and Private Client resulted in the successful distribution of five notable public offerings through MLJS, in addition to numerous new products introduced and distributed by MLJS to the retail market. The firm's CICG business, which operates under the name Merrill Lynch Japan ("MLJ") continued to improve its performance in 1999, with record revenues in its debt, equity, and advisory businesses. Merrill Lynch has significantly expanded its origination activities and presence in Japan, ranking #2 in Japanese announced M&A, and #1 in foreign underwriting for both Japanese equity and debt issuances, according to Thomson Financial Securities Data. MLJ also became the first foreign financial institution in Japan to be a lead manager on a domestic equity new issuance, and has seized business opportunities arising from the ongoing restructuring of Japanese financial institutions. In 1999, MLJS began to capitalize on the shift in personal assets in Japan, from low-yielding deposits to equities, professionally managed funds, and higher yielding products, while operating under an environment of a more variable compensation structure for Financial Consultants, continued deregulation, innovative products, and robust equity markets. Client assets reached $12 billion at year-end 1999, an increase of $10 billion since year-end 1998, and the number of client accounts more than doubled during the year. MLMJ, one of the leading managers of Japanese pension funds and a provider of a wide range of mutual funds, is poised to capitalize on the continuing deregulation of the Japanese asset management industry. Assets under management continued to grow rapidly in both the institutional and retail areas while Japanese equity accounts managed in Tokyo for overseas clients also grew significantly due to strong performance. 40 Management's Discussion and Analysis Net revenues in the Japan region were up 79% from 1998, reflecting strong performance in all businesses. These higher revenues were offset by a full year of fixed expenses and higher production-related compensation costs associated with MLJS. Net revenues in the Japan region in 1998 were up 37% from 1997, primarily due to improved profitability from corporate bond trading, higher assets under management, and increased services provided to financial institutions resulting from regulatory reform. The pre-tax loss in 1998 was primarily the result of the start-up costs associated with MLJS. CANADA - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 619 $ 642 $ 708 Earnings before income taxes 65 25 99 - -------------------------------------------------------------------------------- Total full-time employees 3,744 3,703 3,288 - -------------------------------------------------------------------------------- In 1998, Merrill Lynch merged with Midland Walwyn, one of Canada's premier securities firms. With this transaction, Merrill Lynch significantly expanded its capabilities in Canada beyond its traditional strengths in investment banking and debt markets. Today, Merrill Lynch is a full-service firm in the region with a growing presence, serving individual and institutional clients, as well as corporate and government issuers. Merrill Lynch's Private Client business in Canada made significant progress in 1999. The company's Private Client business ranks as the third largest in Canada, with a team of more than 1,250 investment professionals serving approximately 600,000 individuals. MLAM Group Canada, which now includes Merrill Lynch Mercury, reached $4.8 billion in assets under management, an increase of 55% from the end of 1998. MLAM Group Canada also launched 17 new mutual funds and introduced a managed wrap program. In October 1999, Merrill Lynch introduced Asset Partner, the Canadian version of the Unlimited Advantage account. In CICG, Merrill Lynch was ranked the #1 Investment Bank and #1 in research by 174 Canadian-based corporations who took part in the 1999 Reuters Survey. The Debt Markets group jointly led a $2 billion Government Debt Offering which was voted "Sovereign Deal of the Year" by Euroweek, and also earned "Canadian Deal of the Year" from Euroweek as joint lead on a debt offering for a Canadian province. Net revenues for the region were down slightly from 1998. However, Merrill Lynch Canada gained significant market share within the Canadian market, and is positioned to build on this momentum if equity markets improve. Earnings before income taxes increased 160% from 1998, primarily due to costs incurred in 1998 due to the Midland Walwyn merger. Net revenues in 1998 declined 9% from 1997, due to decreased underwriting, debt trading, and commissions revenues caused by uncertainties in global markets. These declines were partially offset by strong growth in merger and acquisition advisory revenues and asset management fees. Earnings before income taxes dropped significantly from 1997 because of a decline in revenues and $40 million in merger and integration-related expenses. LATIN AMERICA - -------------------------------------------------------------------------------- (dollars in millions) 1999 1998 1997 - -------------------------------------------------------------------------------- Net revenues $ 614 $ 412 $ 523 Earnings (loss) before income taxes 137 (53) 123 - -------------------------------------------------------------------------------- Total full-time employees 1,172 1,192 904 - -------------------------------------------------------------------------------- In Latin America, Merrill Lynch provides various brokerage and investment services, including financial planning, investment banking, research, and asset management, including a newly established asset management presence in Brazil. Included in this region are certain U.S. offices that primarily serve Latin American clients. Volatility stemming from the fourth quarter 1998 emerging market crisis continued in the first quarter of 1999; high interest rates and increased foreign capital outflow resulted in a 70% devaluation in the Brazilian real in the first quarter of 1999. The devaluation had a ripple effect throughout all Latin American economies, as Brazil is the largest economy in the region. Subsequent to the first quarter of 1999, the Latin American economy rebounded due to political and structural changes, as well as robust global markets. In the second quarter of 1999, Merrill Lynch was appointed by the largest oil company in Spain as advisor on the significant acquisition of YPF, the large Argentine oil company. Merrill Lynch continued to receive high honors in numerous categories, including best M&A firm in Latin America according to Euromoney, and for the third consecutive year, Merrill Lynch received first place in Institutional Investor's 1999 Latin America Research Team. Merrill Lynch's private banking efforts in the region were significant in 1999, as assets in the region grew 20%. In early 2000, Santander Securities Corporation purchased Merrill Lynch's retail brokerage business in Puerto Rico. Net revenues for the region increased 49% from 1998 as trading and investment banking revenues were negatively impacted by volatile global markets throughout most of 1998. Pre-tax earnings rose $190 million from 1998 due to significantly improved performance by the debt markets group. Net revenues in 1998 decreased 21% from 1997 as trading and investment banking activities were adversely affected by the market turbulence that occurred throughout most of 1998. The pre-tax loss in 1998 resulted from increased variable compensation, brokerage, clearing, and exchange costs, and communication and technology expenses. Management's Discussion and Analysis 41 BALANCE SHEET - ------------- OVERVIEW Management continually monitors and evaluates on a daily basis the level and composition of the balance sheet. In 1999, average total assets were $331 billion, down 12% from $376 billion in 1998. Average total liabilities in 1999 decreased 13% to $317 billion from $365 billion in 1998. The major components of the decrease in average total assets and liabilities are summarized as follows: - -------------------------------------------------------------------------------- (in millions) INCREASE (DECREASE) CHANGE - -------------------------------------------------------------------------------- AVERAGE ASSETS Receivables under resale agreements and securities borrowed transactions $ (20,331) (16)% Trading assets (29,979) (21) Securities pledged as collateral (5,584) (31) Customer receivables 5,982 14 Loans,notes,and mortgages 2,361 35 AVERAGE LIABILITIES Payables under repurchase agreements and securities loaned transactions $ (27,394) (22)% Commercial paper and other short-term borrowings (17,726) (57) Obligation to return securities received as collateral (10,251) (32) Long-term borrowings 5,806 11 Demand and time deposits 2,529 23 - -------------------------------------------------------------------------------- Balance sheet levels were, on average, lower in 1999 compared to 1998. Year-end 1999 balances, however, were higher compared with year-end 1998 balances, primarily resulting from increases in secured financing transactions, customer receivables, marketable investment securities, and commercial paper and other short term borrowings. The discussion that follows analyzes the changes in year-end financial statement balances of major asset and liability categories. TRADING-RELATED ASSETS AND LIABILITIES Trading-related balances primarily consist of trading assets and liabilities, receivables under resale agreements and securities borrowed transactions, payables under repurchase agreements and securities loaned transactions, and certain receivable/payable balances that result from trading activities. At December 31, 1999 total trading-related assets and liabilities were $251 billion and $174 billion, respectively. Presented are two pie charts illustrating trading-related balances as a percentage of total assets and liabilities, excluding collateral recognized under SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. - -------------------------------------------------------------------------------- ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- TRADING-RELATED ASSETS: Trading Assets 32% Resale Agreements and Securities Borrowed 32 Receivables 18 --- 82 NON-TRADING-RELATED ASSETS 18 --- 100% === TRADING-RELATED LIABILITIES: Trading Liabilities 23% Repurchase Agreements and Securities Loaned 24 Payables 12 --- 59 NON-TRADING-RELATED LIABILITIES 41 --- 100% === - -------------------------------------------------------------------------------- Although trading-related balances comprise a significant portion of the balance sheet, the magnitude of these balances does not necessarily convey a sense of the risk profile assumed by Merrill Lynch. The market and credit risks associated with trading-related balances are mitigated through various hedging strategies, as discussed in the following sections (see Note 3 to the Consolidated Financial Statements for descriptions of market and credit risks). Merrill Lynch reduces a significant portion of the credit risk associated with trading-related receivables by requiring counterparties to post cash or securities as collateral in accordance with collateral maintenance policies. The bar graph that follows depicts the value of collateral maintained at December 31, 1999 for trading-related assets to reduce counterparty credit risk. 42 Management's Discussion and Analysis - -------------------------------------------------------------------------------- COLLATERALIZED TRADING-RELATED RECEIVABLES (in billions) - -------------------------------------------------------------------------------- TRADING-RELATED COLLATERAL RECEIVABLES MAINTAINED --------------- ---------- Derivative Contract Receivables(a) $ 28 $ 4 Receivables under Resale Agreements 58 62 Receivables under Securities Borrowed Transactions 42 41 Other Receivables(b) 56 39 - -------------------------------------------------------------------------------- (a) Included in trading assets. Collateral is not maintained for securities and other cash instruments. (b) Collateral presented does not include over collateralization, i.e., Merrill Lynch maintains collateral in excess of customer margin loan receivables. Trading Assets and Liabilities Trading inventory principally represents securities purchased ("long" positions), securities sold but not yet purchased ("short" positions), and the fair value of derivative contracts (see Note 1 to the Consolidated Financial Statements). These positions are primarily the result of market-making, hedging, and proprietary activities. Merrill Lynch acts as a market-maker in a wide range of securities, resulting in a significant amount of trading inventory to facilitate customer transaction flow. To a lesser degree, Merrill Lynch also maintains proprietary trading inventory in seeking to profit from existing or projected market opportunities. Merrill Lynch uses both cash instruments and derivatives to manage trading inventory market risks. As a result of these hedging techniques, a significant portion of trading assets and liabilities represents hedges of other trading positions. Long U.S. Government securities, for example, may be hedged with short interest rate futures contracts. These hedging techniques, which are generally initiated at the trading unit level, are supplemented by corporate risk management policies and procedures (see the Risk Management section for a description of risk management policies and procedures). Trading assets at year-end 1999, including the $10 billion of collateral recognized under SFAS No. 125, were down 1% from year-end 1998. Collateral recognized under SFAS No. 125 and contractual agreements increased, while non-U.S. Government and agencies securities declined. Trading liabilities increased from $64 billion to $68 billion, primarily as a result of higher levels of contractual agreements and U.S. Government and agencies, partially offset by declines in non-U.S. governments and agencies and equities and convertible debentures. Resale/Repurchase Agreements and Securities Borrowed/Loaned Transactions Repurchase agreements and, to a lesser extent, securities loaned transactions are used to fund a significant portion of trading assets. Likewise, Merrill Lynch uses resale agreements and securities borrowed transactions to obtain the securities needed for delivery on short positions. These transactions are typically short-term in nature since a significant portion are entered into on an overnight or open basis. Resale and repurchase agreements entered into on a term basis typically mature within 90 days. Merrill Lynch also enters into these transactions to meet customers' needs. These "matched-book" repurchase and resale agreements or securities borrowed and loaned transactions are entered into with different customers using the same underlying securities, generating a spread between the interest revenue on the resale agreements or securities borrowed transactions and the interest expense on the repurchase agreements or securities loaned transactions. Exposures on these transactions are limited by their typically short-term nature and collateral maintenance policies. Presented is a bar graph illustrating the nature of resale/repurchase agreements and securities borrowed/loaned transactions, differentiating between matched-book and non-matched-book for total resale agreements, repurchase agreements, securities borrowed, and securities loaned balances of $58,034 million, $64,954 million, $41,707 million, and $6,624 million, respectively. - -------------------------------------------------------------------------------- RESALE/REPURCHASE AGREEMENTS AND SECURITIES BORROWED/LOANED TRANSACTIONS - -------------------------------------------------------------------------------- MATCHED-BOOK NON-MATCHED-BOOK ------------ ---------------- Resale Agreements 51% 49% Repurchase Agreements 46 54 Securities Borrowed 11 89 Securities Loaned 71 29 - -------------------------------------------------------------------------------- Receivables under resale agreements and securities borrowed transactions and payables under repurchase agreements and securities loaned transactions in 1999 Management's Discussion and Analysis 43 increased 14% and 7% from year-end 1998, respectively, as a result of higher matched book activity. Other Trading-Related Receivables and Payables Securities trading may lead to various customer or broker-dealer balances. Broker-dealer balances may also result from recording trading inventory on a trade date basis. Certain receivable and payable balances also arise when customers or broker-dealers fail to pay for securities purchased or fail to deliver securities sold, respectively. These receivables are generally fully collateralized by the securities that the customer or broker-dealer purchased but did not receive. Customer receivables also include margin loans collateralized by customer-owned securities held by Merrill Lynch. Collateral policies significantly limit Merrill Lynch's credit exposure to customers and broker-dealers. Merrill Lynch, in accordance with regulatory requirements, will sell securities that have not been paid for, or purchase securities sold but not delivered, after a relatively short period of time, or will require additional margin collateral, as necessary. These measures reduce market risk exposure related to these balances. Interest receivable and payable balances related to trading inventory are principally short-term in nature. Interest balances for resale and repurchase agreements, securities borrowed and loaned transactions, and customer margin loans are generally considered when determining the collateral requirements related to these transactions. Trading-related receivables in 1999 were up $9 billion from 1998, primarily due to increases in margin and other collateralized loans. Trading-related payables increased $5 billion during 1999 due to heightened customer activity and a net payable that results from recording inventory on a trade date basis. NON-TRADING ASSETS Investments Merrill Lynch's investments, which includes Investments of Insurance Subsidiaries, primarily consist of holdings of liquid debt and equity securities for liquidity and asset/liability matching purposes, merchant banking and venture capital investments, including technology investments, such as Electronic Communications Networks, and investments to hedge deferred compensation liabilities (see Note 4 to the Consolidated Financial Statements for further information). Investments grew from $11.7 billion at year-end 1998 to $17.7 billion at year-end 1999, as a result of increases in most categories. Loans, Notes, and Mortgages Merrill Lynch's portfolio of loans, notes, and mortgages includes mortgage loans on residences, working capital loans to small and medium-sized businesses, and syndicated loans. Merrill Lynch generally maintains collateral on these extensions of credit in the form of securities, liens on real estate, perfected security interests in other assets of the borrower, and guarantees. Loans, notes, and mortgages rose $3.5 billion in 1999 to $11.2 billion due to increased consumer lending activities. Merrill Lynch maintained collateral of $6.8 billion at December 31, 1999 to reduce related default risk. Other Other non-trading assets, which include goodwill (related primarily to the Mercury acquisition), equipment and facilities, and other assets, were up slightly from year-end 1998 levels. NON-TRADING LIABILITIES Borrowings Portions of trading and non-trading assets are funded through borrowings, primarily commercial paper and long-term borrowings (see the Capital Adequacy and Liquidity section for more information on funding sources). Commercial paper increased from $16.8 billion at year-end 1998 to $24.2 billion at year-end 1999. Demand and time deposits increased $5.1 billion in 1999 as a result of higher customer deposits in banking subsidiaries. Outstanding long-term borrowings decreased to $53.5 billion at December 31, 1999 from $57.6 billion at December 25, 1998. Major components of the change in long-term borrowings for 1999 and 1998 follow: - -------------------------------------------------------------------------------- (dollars in billions) 1999 1998 - -------------------------------------------------------------------------------- Beginning of year $ 57.6 $ 43.1 Issuances 15.1 29.3 Maturities (18.6) (15.8) Other (.6) 1.0 ------ ------ End of year(1) $ 53.5 $ 57.6 ====== ====== Average maturity in years of long-term borrowings, when measured to: Maturity 4.8 4.4 Earlier of the call or put date 4.2 4.0 - -------------------------------------------------------------------------------- (1) At year-end 1999 and 1998, $45.0 billion and $43.9 billion of long-term borrowings had maturity dates beyond one year,respectively. Other Other non-trading liabilities, which include liabilities of insurance subsidiaries and other payables, increased slightly from year-end 1998 levels. PREFERRED SECURITIES ISSUED BY SUBSIDIARIES Preferred securities issued by subsidiaries consist primarily of Trust Originated Preferred Securities(Service Mark) ("TOPrS"(Service Mark)) (see Note 7 to the Consolidated Financial Statements for further information). TOPrS proceeds are utilized as part of general balance sheet funding (see the Capital Adequacy and Liquidity section Management's Discussion and Analysis 44 for more information). Preferred securities issued by subsidiaries rose $98 million during 1999 as a result of a yen-denominated TOPrS issuance. STOCKHOLDERS' EQUITY Stockholders' equity at December 31, 1999 increased 26% to $12.8 billion from $10.1 billion at year-end 1998. The 1999 increase resulted from net earnings and the net effect of employee stock transactions, partially offset by dividends. At December 31, 1999, total common shares outstanding, excluding shares exchangeable into common stock, were 367.8 million, 3% higher than the 356.3 million shares outstanding at December 25, 1998. The increase was attributable principally to employee stock grants and option exercises. Total shares exchangeable into common stock at year-end 1999, issued in connection with the Midland Walwyn merger, were 4.0 million, compared with 4.5 million at year-end 1998. As a result of the merger, Merrill Lynch also issued 4.2 million shares of common stock. There were no common stock repurchases during 1999. In 1998, Merrill Lynch rescinded its share repurchase authority in order to facilitate pooling-of- interests accounting for the Midland Walwyn merger. CAPITAL ADEQUACY AND LIQUIDITY - ------------------------------ The primary objectives of Merrill Lynch's capital structure and funding policies are to: . Ensure sufficient equity capital to absorb losses, . Support the business strategies, and . Assure liquidity at all times, across market cycles, and through periods of financial stress. CAPITAL ADEQUACY Among U.S. institutions engaged primarily in the global securities business, Merrill Lynch is one of the most highly capitalized, with $12.4 billion in common equity, $425 million in preferred stock, and $2.7 billion of TOPrS at December 31, 1999. Merrill Lynch continually reviews overall equity capital needs to ensure that its equity capital base can support the estimated risks and needs of its businesses, as well as the regulatory and legal capital requirements of its subsidiaries. Merrill Lynch uses statistically based risk models, developed in conjunction with risk management practices, to estimate potential losses arising from market and credit risks. Equity capital needs are determined based on these models, which dynamically capture changes in risk profile. Merrill Lynch also assesses the need for equity capital to support business risks that may not be adequately measured through these risk models, as well as the potential use of equity capital to support growth. Merrill Lynch determines the appropriateness of its equity capital composition, which includes common stock, preferred stock, and TOPrS, taking into account the perpetual nature of its preferred stock and TOPrS. Based on these analyses and criteria, management believes that Merrill Lynch's equity capital base of $15.5 billion is adequate. Merrill Lynch operates in many regulated businesses that require various minimum levels of capital (see Note 13 to the Consolidated Financial Statements for further information). Merrill Lynch's broker-dealer, banking, insurance, and futures commission merchant activities are subject to regulatory requirements that may restrict the free flow of funds to affiliates. Regulatory approval is generally required for paying dividends in excess of certain established levels and making affiliated investments. Merrill Lynch's leverage ratios were as follows: - -------------------------------------------------------------------------------- ADJUSTED LEVERAGE LEVERAGE RATIO(1) RATIO(2) - -------------------------------------------------------------------------------- PERIOD-END December 31,1999 21.1x 13.4x December 25,1998 23.5x 15.5x AVERAGE(3) Year ended December 31,1999 23.2x 14.4x Year ended December 25,1998 32.9x 19.2x - -------------------------------------------------------------------------------- (1) Total assets to Total stockholders' equity and Preferred securities issued by subsidiaries. (2) Total assets less (a) Securities received as collateral, net of securities pledged as collateral,(b) Securities pledged as collateral,(c) Receivables under resale agreements and securities borrowed transactions, to Total stockholders' equity and Preferred securities issued by subsidiaries. (3) Computed using month-end balances. An asset-to-equity leverage ratio does not reflect the risk profile of assets, hedging strategies, or off-balance-sheet exposures. Thus, Merrill Lynch does not rely on overall leverage ratios to assess risk-based capital adequacy. LIQUIDITY Liquidity risk occurs when there are timing differences between cash inflows from the businesses and cash outflows for business needs and maturing debt obligations. Merrill Lynch's liquidity policy is to maintain alternative funding sources such that all unsecured debt obligations maturing within one year can be repaid when due without issuing new unsecured debt or liquidating business assets. Primary alternative funding sources to unsecured borrowings are repurchase agreements, securities loaned, and secured bank loans, which require pledging unhypothecated marketable securities held for trading or liquidity purposes. Other funding sources include liquidating cash equivalents; securitizing loan assets; and drawing on a committed, senior, unsecured bank credit facility that, at December 31, Management's Discussion and Analysis 45 1999, totaled $8 billion and was not drawn upon. Merrill Lynch maintains a contingency funding plan, which out-lines actions that would be taken in the event of a severe funding disruption. Merrill Lynch regularly reviews the level and mix of its assets and liabilities to assess its ability to conduct core business activities without issuing new unsecured debt or drawing upon its bank credit facilities. The mix of assets and liabilities provides flexibility in managing liquidity since a significant portion of assets turns over frequently and is typically match- funded with liabilities having similar maturities and cash flow characteristics. At December 31, 1999, a significant portion of Merrill Lynch's assets was considered readily marketable by management. Merrill Lynch typically concentrates its unsecured, general-purpose funding at the ML & Co. level, except where tax regulations, time zone differences, or other business considerations make this impractical. The benefits of this strategy are enhanced control, reduced financing costs, wider name recognition by creditors, and greater flexibility to meet variable funding requirements of subsidiaries. Merrill Lynch strives to expand and diversify its funding programs, markets, and investor and creditor base. Merrill Lynch benefits by distributing a significant portion of its liabilities and equity through its own sales force to a large, diversified global client base. Available funding sources include: . repurchase agreements and securities loaned transactions, . U.S., Canadian, Euro, Japanese, and Australian commercial paper programs, . letters of credit, . master notes, . demand and time deposits issued through Merrill Lynch's banking subsidiaries, . bank loans, . long-term debt, . TOPrS, . preferred stock, and . common stock. Additionally, Merrill Lynch maintains access to significant uncommitted credit lines, both secured and unsecured, from a large group of banks. Commercial paper represented 7% and 6% of total assets at year-end 1999 and 1998, respectively. Merrill Lynch maintains strict concentration standards for commercial paper and other short-term borrowings, including limits for any single investor. In addition to equity capital sources, Merrill Lynch views long-term debt as a stable funding source for its core balance sheet assets. Long-term, less liquid assets are fully funded with long-term sources of capital, which include the non-current portion of long-term debt, TOPrS, preferred stock, and common equity. Generally, trading and other current assets are financed with a combination of short-term funding, long-term debt, and equity capital. As part of an overall liquidity management strategy, Merrill Lynch's insurance subsidiaries regularly review the funding requirements of their contractual obligations for in-force, fixed-rate life insurance and annuity contracts as well as expected future acquisition and maintenance expenses for all contracts. The insurance subsidiaries develop and market primarily variable life insurance and variable annuity products. These products are not subject to the interest rate, asset/liability matching, or credit risks attributable to fixed-rate products, thereby reducing the insurance subsidiaries' risk profile and liquidity demands. At December 31, 1999, approximately 84% of invested assets of insurance subsidiaries were considered liquid by management. Asset and Liability Management The relationship between assets and liabilities is managed on a consolidated basis across businesses and subsidiaries. Merrill Lynch routinely issues debt in a variety of maturities and currencies to achieve the lowest cost financing possible. Merrill Lynch uses derivative transactions, including interest rate swaps, to more closely match the duration of these borrowings to the duration of the assets being funded to minimize interest rate risk. Merrill Lynch also enters into currency swaps, to ensure that foreign-currency denominated assets are funded with like-currency denominated liabilities (to the extent that the currency cannot be sourced more efficiently through a direct debt issuance). Merrill Lynch uses swaps for asset and liability management to reduce its interest expense and effective borrowing rate. Credit Ratings The cost and availability of unsecured financing generally are dependent on credit ratings. Merrill Lynch's senior long-term debt, preferred stock, and TOPrS were rated by several recognized credit rating agencies at December 31, 1999 as follows: - -------------------------------------------------------------------------------- SENIOR PREFERRED STOCK DEBT AND RATING AGENCY RATINGS TOPrS RATINGS - -------------------------------------------------------------------------------- Duff & Phelps Credit Rating Co. AA AA- Fitch IBCA,Inc. AA AA- Japan Rating & Investment Information,Inc. AA A+ Moody's Investors Service,Inc. Aa3 aa3 Standard & Poor's AA- A Thomson BankWatch,Inc. AA+ Not Rated - -------------------------------------------------------------------------------- Approximately $78.1 billion of indebtedness at December 31, 1999 is considered senior indebtedness as defined under various indentures. 46 Management's Discussion and Analysis CAPITAL PROJECTS AND EXPENDITURES - --------------------------------- Merrill Lynch continually prepares for the future by expanding its operations and investing in new technology to improve service to clients. To support business expansion, for example, Merrill Lynch is building a new European headquarters in London, for approximately $650 million; approximately $180 million has been spent to date. Significant technology initiatives include decimalization, the Securities and Exchange Commission's mandated initiative, extended hours trading, and numerous other projects related to Merrill Lynch's e-commerce initiatives across all businesses. The decimalization project involves systems application alterations and upgrades in order to comply with the industry-mandated conversion of listed equities and options from fractional to decimal pricing beginning in July 2000. Extended hours trading involves systems remediations, and extended availability of online systems. YEAR 2000 COMPLIANCE INITIATIVE In 1999 Merrill Lynch completed its efforts to address the Year 2000 issue (the "Y2K issue"). The Y2K issue was the result of a widespread programming technique that caused computer systems to identify a date based on the last two numbers of a year, with the assumption that the first two numbers of the year are "19." As a result, the year 2000 would be stored as "00,"causing computers to incorrectly interpret the year as 1900. Left uncorrected, the Y2K issue may have caused serious failures in information technology systems and other systems. In 1995 Merrill Lynch established the Year 2000 Compliance Initiative to address the internal and external risks associated with the Y2K issue. The Initiative consisted of six phases, completed by the millennium: planning, pre-renovation, renovation, production testing, certification, and integration testing. Contingency plans were established in the event of any failures or disruptions. Through the date of this report, there have been no material failures or disruptions of systems or services at Merrill Lynch attributable to the Y2K issue. Similarly we have not been notified of any material failure or disruption of systems or services affecting third parties in their capacity to transact business with Merrill Lynch or in Merrill Lynch's capacity to transact business with others. Merrill Lynch continues to monitor the performance of its systems for any possible future failures or disruptions attributable to the Y2K issue. As of December 31, 1999 the total estimated expenditure of existing and incremental resources for the Year 2000 Compliance Initiative was approximately $510 million, including $102 million of occupancy, communications, and other related overhead expenditures, as Merrill Lynch is applying a fully costed pricing methodology for this project. At December 31, 1999, of the total estimated expenditures, approximately $12 million, related to continued testing, contingency planning, risk management, and the wind down of the efforts, had not yet been spent. RISK MANAGEMENT - --------------- RISK MANAGEMENT PHILOSOPHY Risk-taking is an integral part of Merrill Lynch's business. Through its operating activities, Merrill Lynch is exposed to a variety of risks, including market, credit, liquidity, and process risk. Merrill Lynch's business segments remain primarily accountable for managing the risks of their business activities. To ensure that these risks are effectively identified, evaluated, monitored, and managed, Merrill Lynch has established a comprehensive risk management process. Key components include: . a formal risk governance framework which defines the firm's risk oversight process, . review of the risk oversight process by the Audit and Finance Committee of the Board of Directors, . segregation of risk oversight responsibilities between Merrill Lynch's executive, business, and control functions and active communication and coordination among these functions, . clearly articulated risk tolerance levels, set by the Executive Management Committee ("EMC") and reviewed continually with the goal of ensuring that Merrill Lynch's risks are consistent with its strategies and capabilities, as well as current and anticipated business and market conditions, . risk policies and procedures, and . advanced analytic tools. The ultimate goal of the process is to ensure that Merrill Lynch's exposures are identified, acknowledged, and understood at the appropriate levels within the firm and that, to the extent possible, risk-related losses occur within acceptable, predetermined tolerance levels. Risk management is a dynamic function, influenced by industry, technology, regulatory, and market forces, and Merrill Lynch is continually refining its internal risk management processes. Enhancements are being created in a number of areas, including process risk management, scenario analysis, leveraged counterparty risk management, country risk management, stress testing, and risk-adjusted performance measurement. As the environment changes, Merrill Lynch will strive to maintain innovative policies and procedures in the management of its risk. The overall effectiveness of Merrill Lynch's risk management process is illustrated by analyzing actual net trading-related revenues over time. Merrill Lynch's trading-related activities, largely a client order flow-driven business, combined with its risk management strategies, help to reduce earnings volatility. Presented is a bar graph illustrating the distribution of weekly net trading-related revenues by revenue band for 1997, 1998, and 1999. Management's Discussion and Analysis 47 - -------------------------------------------------------------------------------- DISTRIBUTION OF WEEKLY NET TRADING-RELATED REVENUES BY YEAR (dollars in millions) - -------------------------------------------------------------------------------- Number of weeks ---------------------- 1997 1998 1999 ---- ---- ---- Less than $0 - 5 - $0-50 4 7 1 $50-100 12 9 5 $100-150 31 17 21 Over $150 5 14 26 --- --- --- 52 52 53 === === === - -------------------------------------------------------------------------------- Risk Governance Structure Merrill Lynch's risk governance structure involves the Audit and Finance Committee of the Board of Directors, the EMC, the Risk Oversight Committee ("ROC"), the business segments, Corporate Risk Management ("CRM"), and various corporate governance committees. . The Audit and Finance Committee of the Board of Directors, comprised entirely of external directors, has authorized the ROC to establish Merrill Lynch's risk management policies. . The EMC establishes risk tolerance for the firm and authorizes changes in Merrill Lynch's risk profile. It also ensures that the risks assumed by Merrill Lynch are managed within these tolerance levels, verifies that Merrill Lynch has implemented appropriate policies for the effective management of risks, and approves substantive changes to risk policies, including those proposed by the ROC. Particular attention is paid to risk concentration and illiquidity. . The ROC, comprised of senior business and control managers and chaired by the Head of CRM, oversees Merrill Lynch's risks, ensures that the business units create and implement processes to identify, measure, and monitor risks, assists the EMC in determining risk tolerance levels for Merrill Lynch's business units, monitors the activities of Merrill Lynch's corporate governance committees, and reports significant issues and transactions to the EMC and the Audit and Finance Committee. . Corporate governance committees exist to create policy, review activity, and ensure new and existing business initiatives remain within established risk tolerance levels. These committees include the New Product Review Committee, Debt and Equity Capital Commitment Committees, Reserve Committee, and Special Transactions Review Committee. Representatives of the principal independent control functions participate as voting members of these committees. These committees report regularly to the ROC. Risk Framework Merrill Lynch has developed a mechanism known as the Risk Framework to define and communicate its tolerance for risk and raise as exceptions certain areas of risk concentration. Risks are measured against Framework limits on a continuous basis, and exceptions and violations are reported, investigated, and addressed at the appropriate level of management. The Framework has been approved by the EMC and the risk parameters utilized by the Framework have been reviewed by the Audit and Finance Committee. The EMC reviews the Framework annually and approves material changes; the ROC reports substantive Framework changes to the Audit and Finance Committee. The Framework establishes broad risk limits for Merrill Lynch. Market risk limits are intended to constrain exposure to specific classes of market risk and Value-at-Risk ("VaR"). VaR is a statistical measure of the potential loss in the fair value of a portfolio due to adverse movements in underlying risk factors. Credit risk limits are intended to constrain the magnitude and duration of exposure to individual counterparties, types of counterparties, countries, and financing collateral. The Risk Framework has been established for CICG and is in the process of being expanded to other business units and Treasury. Business Segments Business segments are responsible for ensuring that appropriate processes are in place to identify, monitor, manage, and report the risks of their businesses working within the confines of the Risk Framework. Corporate Risk Management CRM is an independent control function responsible for Merrill Lynch's risk management process. The group is headed by a member of the EMC who reports to the Chief Financial Officer; the Head of CRM also chairs the ROC. CRM manages Merrill Lynch's market risks (representing the potential change in value of trading instruments caused by fluctuations in interest and currency exchange rates, equity and commodity prices, credit spreads or other risks) and credit risks (representing the potential for loss that can occur as a result of an impairment in the credit-worthiness of an issuer or counterparty or a default by an issuer or counterparty on its contractual obligations). CRM also provides 48 Management's Discussion and Analysis the firm with an overview of risks on a portfolio basis and develops systems and tools to facilitate the risk management process. CRM is comprised of the following groups: . The CICG Market Risk Management Group defines the products and markets in which CICG can transact, identifies and quantifies the market risks to which businesses are exposed, establishes limits within the CICG Risk Framework to constrain concentrations of risk, and monitors exposures against these limits. The Group also has a dedicated unit which reviews, tests, and stresses the mathematical models used by Merrill Lynch's business and control units and performs revaluations, stress tests, and hedging analyses. . The CICG Credit Risk and Capital Commitments Group assesses and rates the creditworthiness of potential and existing institutional counterparties and establishes credit limits within the Framework based on counterparty/issuer credit quality and the potential risk of transactions. The Group reviews and approves credit exposures and commitments to specific counterparties/issuers within CICG, and works with business managers to structure transactions in order to mitigate and/or manage credit risk within acceptable tolerance levels. . The Private Client Credit Group assesses the creditworthiness of potential and existing Private Client business unit counterparties, establishes credit limits within the Framework based on credit quality, risk, and diversification factors, reviews and approves credit exposures to specific clients within the PCG, and works with business managers to structure transactions in order to mitigate and/or manage credit risk within acceptable tolerance levels. . The Portfolio Risk Management Group integrates the disciplines of credit, market, and process risk management into a single framework that identifies and controls risks at a firmwide level. The Group develops management tools that guide judgement on the sources/magnitudes of risk and the use of capital in support of such risk, and creates and maintains a firmwide management control framework for process risk. The Portfolio Group also oversees market risk within Merrill Lynch's Treasury and PCG units and is responsible for developing and managing the firm's country risk process. . The Risk Infrastructure Group provides CRM with the technology, analytics, and resources to quantify, monitor, and manage Merrill Lynch's market, credit, and portfolio risks. The Group develops systems and analytic tools to facilitate the collation, aggregation, and analysis of transactions, positions, and exposures, and designs and implements methodologies for measuring and managing credit and market risks. MARKET RISK Merrill Lynch uses several mathematical techniques to assess the risk of its positions and portfolios. In particular, CRM quantifies the sensitivities of Merrill Lynch's trading portfolio to changes in market parameters and utilizes these sensitivities, together with historical data on benchmark market parameters, to estimate distributions of the potential earnings and losses that the portfolio would have incurred had it been subject to the market movements which occurred during the historic period. From these distributions are derived a number of risk statistics including VaR. VaR estimates the amount that Merrill Lynch could lose, with a specified degree of confidence, over a given time interval. The VaR statistic for a particular risk category represents the amount that Merrill Lynch could lose due to market movements in that risk category. The VaR for Merrill Lynch's portfolio is less than the sum of the VaRs for individual risk categories because movements in different risk categories occur at different times and, historically, extreme movements have not occurred in all risk categories simultaneously. The difference between the sum of the VaRs for individual risk categories and the VaR calculated for all the risk categories is shown in the following tables and may be viewed as a measure of the diversification within Merrill Lynch's portfolio. CRM believes that the tabulated risk measures provide some guidance as to the amount Merrill Lynch could lose in future periods. Like all statistics, however, they need to be interpreted with a clear understanding of their assumptions and limitations. For these disclosures, Merrill Lynch uses a historical simulation approach to estimate value-at-risk using a 99% confidence level and a two-week holding period for trading and non-trading instruments. Sensitivities to market risk factors are aggregated and combined with a database of historical biweekly changes in market factors to simulate a series of profits and losses. The level of loss that is exceeded in that series 1% of the time is used as the estimate for the 99% confidence level VaR. The overall total VaR amounts are presented across major risk categories, including exposure to volatility risk found in certain products, e.g., options. The table that follows presents Merrill Lynch's VaR for trading instruments at year-end 1999 and 1998 and the 1999 average VaR calculated on a quarterly basis. In late 1999, CRM enhanced its VaR model and thus for comparison purposes, year- end 1998 amounts have been restated. In addition, for purposes of calculating the 1999 average, the quarter-end data for the first three quarters of 1999 have also been restated. Management's Discussion and Analysis 49 - -------------------------------------------------------------------------------- (in millions) Year-end Year-end Average 1999 1998 1999 - -------------------------------------------------------------------------------- TRADING VALUE-AT-RISK(1) Interest rate and credit spread $ 111 $ 136 $ 114 Equity 34 28 44 Commodity 12 3 9 Currency 11 26 12 Volatility 53 24 39 -------- ------- ------- 221 217 218 Diversification benefit (69) (75) (73) -------- ------- ------- Overall(2) $ 152 $ 142 $ 145 ======== ======= ======= - -------------------------------------------------------------------------------- (1) Based on a 99% confidence level and a two-week holding period. (2) Overall VaR using a 95% confidence level and a one-day holding period was $19 million and $32 million at year-end 1999 and 1998, respectively. During 1999, overall VaR increased, primarily due to increases in the equity, commodity, and volatility VaR, partially offset by a decrease in interest rate and credit spread and currency VaR. The table that follows presents Merrill Lynch's VaR for non-trading instruments at year-end 1999 and 1998: - -------------------------------------------------------------------------------- (in millions) Year-end Year-end 1999 1998 - -------------------------------------------------------------------------------- NON-TRADING VALUE-AT-RISK(1) Interest rate and credit spread $ 20 $ 75 Currency 52 77 Equity 26 10 Volatility 1 - ---- ----- 99 162 Diversification benefit (35) (49) ---- ---- Overall $ 64 $ 113 ==== ===== - -------------------------------------------------------------------------------- (1) Based on a 99% confidence level and a two-week holding period. In addition to the amounts reported in the accompanying table, non-trading interest rate VaR associated with Merrill Lynch's TOPrS at year-end 1999 and 1998 was $102 million and $119 million, respectively. TOPrS, which are fixed-rate perpetual preferred securities, are considered a component of Merrill Lynch's equity capital and, therefore, the associated interest rate sensitivity is not hedged. The decrease in non-trading interest rate VaR is primarily due to a decrease in interest rate and credit spread risk (see the Capital Adequacy and Liquidity section for further information). CREDIT RISK Credit risk represents the loss that Merrill Lynch would incur if a counterparty or issuer failed to perform its contractual obligations. Policies and procedures have been established with the objective of protecting against unacceptable credit losses, including: reviewing and establishing limits for credit exposures, further mitigating counterparty credit exposures through various techniques, including maintaining collateral and obtaining the right to terminate transactions or collect collateral in the event of a credit rating downgrade, and continually assessing the credit-worthiness of counterparties and issuers. Credit exposures related to Merrill Lynch's retail customer business, including mortgages and home equity lines of credit, customer margin accounts, and working capital facilities to small businesses, are continually monitored. Merrill Lynch enters into International Swaps and Derivatives Association, Inc. master agreements or their equivalent ("master netting agreements") with each of its derivative counterparties whenever possible. Master netting agreements provide protection in bankruptcy in certain circumstances and, in some cases, enable receivables and payables with the same counterparty to be offset on the Consolidated Balance Sheets, providing for a more meaningful balance sheet presentation of credit exposure. In addition, to reduce default risk, Merrill Lynch requires collateral, principally U.S. Government and agencies securities, on certain derivative transactions. From an economic standpoint, Merrill Lynch evaluates default risk exposures net of related collateral. The following is a summary of counterparty credit ratings for the replacement cost (net of $4.2 billion of collateral) of trading derivatives in a gain position by maturity at December 31, 1999. - -------------------------------------------------------------------------------- YEARS TO MATURITY CROSS- CREDIT ------------------------------- MATURITY RATING(1) 0-3 3-5 5-7 OVER 7 NETTING(2) TOTAL - -------------------------------------------------------------------------------- AAA $ 753 $ 288 $ 91 $ 174 $ (288) $ 1,018 AA+/AA 2,013 597 208 528 (341) 3,005 AA- 4,115 2,626 1,106 3,467 (4,530) 6,784 A+/A 3,133 1,509 560 1,100 (1,840) 4,462 A- 1,656 895 414 400 (268) 3,097 BBB 1,600 876 335 204 (224) 2,791 BB+ 1,049 298 214 109 (498) 1,172 Other 808 215 369 198 (73) 1,517 -------- ------- ------- ------- -------- -------- Total $ 15,127 $ 7,304 $ 3,297 $ 6,180 $ (8,062) $ 23,846 ======== ======= ======= ======= ======== ======== - -------------------------------------------------------------------------------- (1) Represents credit rating agency equivalent. (2) Represents netting of payable balances with receivable balances for the same counterparty across maturity band categories.Receivable and payable balances with the same counterparty in the same maturity category, however, are net within the maturity category. In addition to obtaining collateral, Merrill Lynch mitigates default risk on derivatives whenever possible by entering into transactions with provisions that enable Merrill Lynch to terminate or reset the terms of the derivative contract. PROCESS RISK Process risk is the risk of direct or indirect loss resulting from inadequate controls or business disruption relating to people, internal processes, systems, or external events. Examples of process risks faced by the firm could be systems failure, human error, fraud, major fire, or other disasters. Merrill Lynch manages process risks in many ways including maintaining a comprehensive system of internal controls, using technology, employing experienced personnel, maintaining backup facilities, conducting internal audits, and emphasiz- 50 Management's Discussion and Analysis ing the importance of management oversight. In addition, Merrill Lynch has established a new process risk management function within CRM to focus on further enhancing the management of these risks. This new Group is charged with developing a firm-wide process risk management framework, as well as policies and procedures aimed at establishing a consistent approach to identify, monitor, and manage process risks across all business lines. The Group recognizes a variety of risk management tools and techniques to reinforce the firm's strong risk management culture. These include summarizing and monitoring process risk related losses on a regular basis, developing risk indicators to facilitate proactive risk management capabilities, and self-assessments to identify risks, corresponding controls, and measures for improvement. OTHER RISKS Liquidity risk arises in the course of Merrill Lynch's general funding activities and in the management of the balance sheet. This risk includes both the risk of being unable to raise funding with appropriate maturity and interest rate characteristics and the risk of being unable to liquidate an asset in a timely manner at a reasonable price. For more information on how Merrill Lynch manages liquidity risk, see the Capital Adequacy and Liquidity section. Other risks Merrill Lynch encounters include political, tax, and regulatory risks. These risks revolve around the impact that changes in local laws, regulatory requirements, or tax statutes would have on the viability, profitability, or cost-effectiveness of existing or future transactions. To help mitigate the effects of these risks, Merrill Lynch constantly reviews new and pending legislation and regulations by employing professionals in the jurisdictions in which the company operates to actively follow these issues and participate in related interest groups. NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS - --------------------------------------------------------------- Non-investment grade holdings and highly leveraged transactions involve risks related to the creditworthiness of the issuers or counterparties and the liquidity of the market for such investments. Merrill Lynch recognizes these risks and, whenever possible, employs strategies to mitigate exposures. The specific components and overall level of non-investment grade and highly leveraged positions may vary significantly from period to period as a result of inventory turnover, investment sales, and asset redeployment. In the normal course of business, Merrill Lynch underwrites, trades, and holds non-investment grade cash instruments in connection with its investment banking, market-making, and derivative structuring activities. Non-investment grade holdings have been defined as debt and preferred equity securities rated as BB+ or lower or equivalent ratings by recognized credit rating agencies, sovereign debt in emerging markets, amounts due under derivative contracts from non-investment grade counterparties, and other instruments that, in the opinion of management, are non-investment grade. In addition to the amounts included in the following table, derivatives may also expose Merrill Lynch to credit risk related to the underlying security where a derivative contract can either synthesize ownership of the underlying security (e.g., long total return swaps) or potentially force ownership of the underlying security (e.g., short put options). At year-end 1999 and 1998, Merrill Lynch had derivatives with notionals of $2.9 billion and $1.6 billion, respectively, with non-investment grade credit exposure. Derivatives may also subject Merrill Lynch to credit spread or issuer default risk, in that changes in credit spreads or in the credit quality of the underlying securities may adversely affect the derivatives' fair values. Merrill Lynch seeks to manage these risks by engaging in various hedging strategies to reduce its exposure associated with non-investment grade positions, such as purchasing an option to sell the related security or entering into other offsetting derivative contracts. At year-end 1999 and 1998, Merrill Lynch had derivatives with notionals of $3.8 billion and $4.7 billion, respectively, that hedge non- investment grade credit exposure. Merrill Lynch provides financing and advisory services to, and invests in, companies entering into leveraged transactions, which may include leveraged buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides extensions of credit to leveraged companies, in the form of senior and subordinated debt, as well as bridge financing on a select basis. In addition, Merrill Lynch syndicates loans for non-investment grade companies, or in connection with highly leveraged transactions and may retain a residual portion of these loans. Merrill Lynch holds direct equity investments in leveraged companies and interests in partnerships that invest in leveraged transactions. Merrill Lynch has also committed to participate in limited partnerships that invest in leveraged transactions. Future commitments to participate in limited partnerships and other direct equity investments will continue to be made on a select basis. TRADING EXPOSURES The following table summarizes trading exposures to non-investment grade or highly leveraged issuers or counterparties at year-end 1999 and 1998: - -------------------------------------------------------------------------------- (in millions) 1999 1998 - -------------------------------------------------------------------------------- Trading assets: Cash instruments $ 5,279 $ 7,462 Derivatives 4,033 4,675 Trading liabilities - cash instruments (997) (920) Collateral on derivative assets (1,344) (2,192) ------- ------- Net trading asset exposure $ 6,971 $ 9,025 ======= ======= - -------------------------------------------------------------------------------- Management's Discussion and Analysis 51 Included in the preceding table are debt and equity securities and bank loans of companies in various stages of bankruptcy proceedings or in default. At December 31, 1999, the carrying value of such debt and equity securities totaled $64 million, of which 78% resulted from Merrill Lynch's market-making activities in such securities. This compared with $72 million at December 25, 1998, of which 86% related to market-making activities. In addition, Merrill Lynch held distressed bank loans totaling $86 million and $156 million at year-end 1999 and 1998, respectively. NON-TRADING EXPOSURES The following table summarizes non-trading exposures to non-investment grade or highly leveraged issuers or counterparties at year-end 1999 and 1998: - -------------------------------------------------------------------------------- (in millions) 1999 1998 - -------------------------------------------------------------------------------- Marketable investment securities $ 58 $ 39 Investments of insurance subsidiaries 108 148 Loans (net of allowance for loan losses): Bridge loans(1) 68 66 Other loans(2) 1,169 1,058 Other investments: Partnership interests(3)(4) 1,368 852 Other equity investments(5) 369 459 - -------------------------------------------------------------------------------- (1) Subsequent to year-end, $40 million of this loan was repaid. In addition, Merrill Lynch extended a $56 million bridge loan to a counterparty in connection with an acquisition transaction. (2) Represents outstanding loans to 129 and 80 companies at year-end 1999 and 1998, respectively. (3) Includes $599 million and $279 million in investments at year-end 1999 and 1998, respectively, related to deferred compensation plans, for which the default risk of the investments rests with the participating employees. (4) Includes a $3 million and $300 million investment in the hedge fund Long Term Capital Portfolio, L.P. at year-end 1999 and 1998, respectively. (5) Includes investments in 62 and 89 enterprises at year-end 1999 and 1998, respectively. The following table summarizes Merrill Lynch's commitments with exposure to non-investment grade or highly leveraged counterparties at year-end 1999 and 1998: - -------------------------------------------------------------------------------- (in millions) 1999 1998 - -------------------------------------------------------------------------------- Additional commitments to invest in partnerships $ 200 $ 227 Unutilized revolving lines of credit and other lending commitments 2,585(1) 1,678 - -------------------------------------------------------------------------------- (1) Subsequent to year-end 1999, $900 million of these commitments were terminated. At December 31, 1999, the largest industry exposure was to the financial services sector, which accounted for 34% of total non-investment grade positions and highly leveraged transactions. CASH FLOWS - ---------- During 1998, Merrill Lynch disbursed $5.3 billion to acquire the outstanding shares of Mercury. This purchase was financed primarily with proceeds from long-term borrowings. LITIGATION - ---------- Certain actions have been filed against Merrill Lynch in connection with Merrill Lynch's business activities. Although the ultimate outcome of these actions cannot be ascertained at this time and the results of legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these actions will not have a material adverse effect on Merrill Lynch's financial condition; however, such resolution could have a material adverse impact on quarterly operating results in future periods, depending in part on the results for such periods. RECENT DEVELOPMENTS - ------------------- NEW ACCOUNTING PRONOUNCEMENTS In June 1999, the Financial Accounting Standards Board deferred for one year the effective date of the accounting and reporting requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133 requires Merrill Lynch to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. Currently, the majority of Merrill Lynch's derivatives are recognized at fair value in trading assets and liabilities, as they are entered into in a dealing capacity. However, Merrill Lynch also enters into derivatives to hedge its exposures relating to non-trading assets and liabilities, some of which are not carried at fair value depending on the nature of the derivative and the related hedged item. Merrill Lynch will adopt the provisions of SFAS No. 133 on January 1, 2001, which will primarily impact the accounting for derivatives used to hedge borrowings. Merrill Lynch has undertaken ongoing initiatives to address the adoption of SFAS No. 133. This evaluation includes the impact of implementation guidance under development. As the impact of adoption is largely dependent on the derivative positions existing at year-end 2000, Merrill Lynch is unable to quantify the impact of adoption at this time. 52 Management's Discussion and Analysis MANAGEMENT'S DISCUSSION OF FINANCIAL RESPONSIBILITY - --------------------------------------------------- Management of Merrill Lynch & Co., Inc. is responsible for preparing the financial statements and related notes contained in this Annual Report. The consolidated financial statements and notes are prepared in accordance with generally accepted accounting principles. Other financial data included in the Annual Report are consistent with those in the financial statements. Management recognizes the importance of safeguarding Merrill Lynch's assets and integrity. Therefore, Management devotes considerable attention to understanding the risks of its businesses, promoting the highest standards of ethical conduct, exercising responsible stewardship over Merrill Lynch's assets, and presenting fair financial statements. Merrill Lynch regularly reviews its framework of internal controls, taking into account changing circumstances. Corrective actions are taken to address control deficiencies, and other opportunities for improvement are implemented when cost effective. The framework of internal control includes policies, procedures, and organizational structures that are overseen by a predominantly independent Board of Directors. Several committees of the Board actively participate in setting policy and monitoring controls. The Audit and Finance Committee, which consists of five independent directors, examines Merrill Lynch's compliance with acceptable business standards and ethics in accordance with its written charter of responsibilities and duties. It also reviews significant financial issues and recommends overall policies regarding market and credit risk, as well as funding requirements. The Management Development and Compensation Committee, also composed entirely of independent directors, oversees procedures for developing and assessing the performance of Merrill Lynch's employees with an emphasis on ethical business behavior. Oversight is provided by independent units within Merrill Lynch, working together to maintain Merrill Lynch's internal control standards. Corporate Audit reports directly to the Audit and Finance Committee, providing independent appraisals of Merrill Lynch's internal accounting controls and compliance with established policies and procedures. Finance establishes accounting policies and procedures, measures and monitors financial risk, and prepares financial statements that fairly present the underlying transactions and events of Merrill Lynch. Corporate Risk Management is both independent from business line management and has oversight responsibility for Merrill Lynch's market and credit risks. This group has clear authority to enforce trading and credit limits using various systems and procedures to monitor positions and risks. Law and Compliance serves in a counseling and advisory role to Management. In this role, the group develops policies; monitors compliance with internal policies, external rules, and industry regulations; assesses litigation risk exposure; and provides support in connection with the execution of various transactions. The independent auditors, Deloitte & Touche LLP, perform annual audits of Merrill Lynch's financial statements in accordance with generally accepted auditing standards, including a review of the internal accounting control system. The independent auditors openly discuss with the Audit and Finance Committee their views on the quality of the financial statements and related disclosures and the adequacy of Merrill Lynch's internal accounting controls. Quarterly review reports on the interim financial statements are also issued by Deloitte & Touche LLP. Merrill Lynch's independent auditors are appointed each year by the Audit and Finance Committee and are given unrestricted access to all financial records and related data, including minutes of meetings of stockholders, Board of Directors, and committees of the Board. /s/ David H. Komansky David H. Komansky Chairman of the Board and Chief Executive Officer /s/ Thomas H. Patrick Thomas H. Patrick Executive Vice President and Chief Financial Officer Management's Discussion and Analysis 53 [LOGO OF DELOITTE & TOUCHE] INDEPENDENT AUDITORS' REPORT - ---------------------------- TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF MERRILL LYNCH & CO., INC.: We have audited the accompanying consolidated balance sheets of Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of December 31, 1999 and December 25, 1998 and the related consolidated statements of earnings, changes in stockholders' equity, comprehensive income, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of Merrill Lynch's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Merrill Lynch at December 31, 1999 and December 25, 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 1998 Merrill Lynch changed its method of accounting for certain internal-use software development costs to conform with Statement of Position 98-1. /s/ Deloitte & Touche LLP New York, New York February 28, 2000 54 CONSOLIDATED STATEMENTS OF EARNINGS - ----------------------------------- (dollars in millions, except per share amounts)
Year Ended Last Friday in December 1999 1998 1997 - -------------------------------------------------------------------------------------------------------------- (53 weeks) (52 weeks) (52 weeks) NET REVENUES Commissions $ 6,334 $ 5,799 $ 4,995 Principal transactions 4,361 2,651 3,827 Investment banking 3,614 3,264 2,876 Asset management and portfolio service fees 4,753 4,202 3,002 Other 720 623 500 ---------- ---------- ---------- Subtotal 19,782 16,539 15,200 Interest revenue and dividends 15,097 18,035 16,009 Less interest expense 13,010 17,027 14,953 ---------- ---------- ---------- Net interest profit 2,087 1,008 1,056 ---------- ---------- ---------- TOTAL NET REVENUES 21,869 17,547 16,256 ---------- ---------- ---------- NON-INTEREST EXPENSES Compensation and benefits 11,153 9,199 8,333 Communications and technology 2,038 1,749 1,255 Occupancy and related depreciation 941 867 736 Advertising and market development 779 688 613 Brokerage, clearing, and exchange fees 678 683 525 Professional fees 567 552 520 Goodwill amortization 227 226 65 Provision for costs related to staff reductions - 430 - Other 1,408 1,057 1,098 ---------- ---------- ---------- TOTAL NON-INTEREST EXPENSES 17,791 15,451 13,145 ---------- ---------- ---------- EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 4,078 2,096 3,111 Income Tax Expense 1,265 713 1,129 Dividends on Preferred Securities Issued by Subsidiaries 195 124 47 ---------- ---------- ---------- NET EARNINGS $ 2,618 $ 1,259 $ 1,935 ========== ========== ========== NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 2,580 $ 1,220 $ 1,896 ========== ========== ========== EARNINGS PER COMMON SHARE Basic $ 7.00 $ 3.43 $ 5.57 ========== ========== ========== Diluted $ 6.17 $ 3.00 $ 4.79 ========== ========== ========== - --------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. Consolidated Financial Statements 55 CONSOLIDATED BALANCE SHEETS - --------------------------- (dollars in millions, except per share amounts)
DECEMBER 31, 1999 DECEMBER 25, 1998 - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS CASH AND CASH EQUIVALENTS $ 10,827 $ 12,530 ---------- ---------- CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES OR DEPOSITED WITH CLEARING ORGANIZATIONS 5,880 6,590 ---------- ---------- RECEIVABLES UNDER RESALE AGREEMENTS AND SECURITIES BORROWED TRANSACTIONS 99,741 87,713 ---------- ---------- MARKETABLE INVESTMENT SECURITIES 10,145 4,605 ---------- ---------- TRADING ASSETS, AT FAIR VALUE Equities and convertible debentures 23,593 25,318 Contractual agreements 22,701 21,979 Corporate debt and preferred stock 20,346 21,166 U.S. Government and agencies 15,376 15,421 Mortgages, mortgage-backed, and asset-backed 7,394 7,023 Non-U.S. governments and agencies 4,892 7,474 Municipals and money markets 2,427 3,358 ---------- ---------- 96,729 101,739 Securities received as collateral, net of securities pledged as collateral 10,005 6,106 ---------- ---------- Total 106,734 107,845 ---------- ---------- SECURITIES PLEDGED AS COLLATERAL 9,699 8,184 ---------- ---------- OTHER RECEIVABLES Customers (net of allowance for doubtful accounts of $56 in 1999 and $48 in 1998) 39,850 29,559 Brokers and dealers 9,095 8,872 Interest and other 7,505 9,278 ---------- ---------- Total 56,450 47,709 ---------- ---------- INVESTMENTS OF INSURANCE SUBSIDIARIES 4,097 4,485 LOANS, NOTES, AND MORTGAGES (net of allowance for loan losses of $146 in 1999 and $124 in 1998) 11,187 7,684 OTHER INVESTMENTS 3,410 2,590 EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization of $4,069 in 1999 and $3,482 in 1998) 3,117 2,761 GOODWILL (net of accumulated amortization of $543 in 1999 and $338 in 1998) 4,952 5,364 OTHER ASSETS 1,832 1,741 ---------- ---------- TOTAL ASSETS $ 328,071 $ 299,804 ========== ========== - -----------------------------------------------------------------------------------------------------------------------------
56 Consolidated Financial Statements DECEMBER 31,1999 DECEMBER 25,1998 - ----------------------------------------------------------------------------------------------------------------------------- LIABILITIES PAYABLES UNDER REPURCHASE AGREEMENTS AND SECURITIES LOANED TRANSACTIONS $ 71,578 $ 67,127 ---------- ---------- COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 25,595 18,679 ---------- ---------- DEMAND AND TIME DEPOSITS 17,602 12,461 ---------- ---------- TRADING LIABILITIES, AT FAIR VALUE Contractual agreements 27,030 23,840 Equities and convertible debentures 20,231 21,558 U.S. Government and agencies 10,816 7,939 Non-U.S. governments and agencies 6,311 7,245 Corporate debt, preferred stock, and other 3,405 3,132 ---------- ---------- Total 67,793 63,714 ---------- ---------- OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 19,704 14,290 ---------- ---------- OTHER PAYABLES Customers 22,722 22,255 Brokers and dealers 11,397 7,899 Interest and other 18,601 18,738 ---------- ---------- Total 52,720 48,892 ---------- ---------- LIABILITIES OF INSURANCE SUBSIDIARIES 4,087 4,319 LONG-TERM BORROWINGS 53,465 57,563 ---------- ---------- TOTAL LIABILITIES 312,544 287,045 ---------- ---------- PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,725 2,627 ---------- ---------- STOCKHOLDERS' EQUITY PREFERRED STOCKHOLDERS' EQUITY 425 425 ---------- ---------- COMMON STOCKHOLDERS' EQUITY Shares exchangeable into common stock 59 66 Common stock (par value $1.33 1/3 per share; authorized: 1,000,000,000 shares; issued 1999-472,714,925 shares, 1998-472,660,324 shares) 630 630 Paid-in capital 1,863 1,427 Accumulated other comprehensive loss (net of tax) (389) (122) Retained earnings 12,667 10,475 ---------- ---------- 14,830 12,476 Less: Treasury stock, at cost (1999-104,949,595 shares; 1998-116,376,259 shares) 1,817 2,101 Employee stock transactions 636 668 ---------- ---------- TOTAL COMMON STOCKHOLDERS' EQUITY 12,377 9,707 ---------- ---------- TOTAL STOCKHOLDERS' EQUITY 12,802 10,132 ---------- ---------- TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES, AND STOCKHOLDERS' EQUITY $ 328,071 $ 299,804 ========== ========== - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. Consolidated Financial Statements 57 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY - ---------------------------------------------------------- (dollars in millions)
Year Ended Last Friday in December 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------- PREFERRED STOCKHOLDERS' EQUITY 9% CUMULATIVE PREFERRED STOCK, SERIES A Balance, beginning and end of year $ 425 $ 425 $ 425 ====== ====== ====== REMARKETED PREFERRED STOCK, SERIES C Balance, beginning of year - - 194 Redeemed - - (194) ------ ------ ------ Balance, end of year - - - ------ ------ ------ TOTAL PREFERRED STOCKHOLDERS' EQUITY $ 425 $ 425 $ 425 ====== ====== ====== COMMON STOCKHOLDERS' EQUITY SHARES EXCHANGEABLE INTO COMMON STOCK Balance, beginning of year $ 66 $ 66 $ 46 Net activity - 5 20 Exchanges (7) (5) - ------ ------ ------ Balance, end of year 59 66 66 ====== ====== ====== COMMON STOCK Balance, beginning and end of year 630 630 630 ====== ====== ====== PAID-IN CAPITAL Balance, beginning of year 1,427 1,001 925 Issuance of stock: To employees 440 430 76 Other (4) (4) - ------ ------ ------ Balance, end of year 1,863 1,427 1,001 ====== ====== ====== ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Foreign Currency Translation Adjustment (net of tax) Balance, beginning of year (138) (85) 7 Translation adjustment (164) (53) (92) ------ ------ ------ Balance, end of year (302) (138) (85) ------ ------ ------ Net Unrealized Gains (Losses) on Investment Securities Available-for-Sale (net of tax) Balance, beginning of year 16 38 9 Net unrealized gains (losses) on investment securities available-for-sale (223) (60) 34 Other adjustments(a) 120 38 (5) ------ ------ ------ Balance, end of year (87) 16 38 ------ ------ ------ Balance, end of year $ (389) $ (122) $ (47) ====== ====== ====== - ---------------------------------------------------------------------------------------------------------
58 Consolidated Financial Statements
Year Ended Last Friday in December 1999 1998 1997 - ----------------------------------------------------------------------------------------------------------------- RETAINED EARNINGS Balance, beginning of year $ 10,475 $ 9,579 $ 7,938 Net earnings 2,618 1,259 1,935 Cash dividends declared: 9% Cumulative Preferred stock (38) (38) (38) Remarketed Preferred stock - - (1) Common stock (388) (325) (255) -------- -------- ------- Balance, end of year 12,667 10,475 9,579 ======== ======== ======= TREASURY STOCK, AT COST Balance, beginning of year (2,101) (2,677) (2,769) Treasury stock purchased - - (644) Issued out of treasury (net of reacquisitions): Employees 273 556 736 Other 11 20 - -------- -------- ------- Balance, end of year (1,817) (2,101) (2,677) ======== ======== ======= UNALLOCATED ESOP REVERSION SHARES, AT COST Balance, beginning of year - - (24) Allocation of shares to participants - - 24 -------- -------- ------- Balance, end of year - - - ======== ======== ======= EMPLOYEE STOCK TRANSACTIONS Balance, beginning of year (668) (438) (314) Net issuance of employee stock grants (380) (599) (351) Amortization of employee stock grants 406 359 218 Repayment of employee loans 6 10 9 -------- -------- ------- Balance, end of year (636) (668) (438) ======== ======== ======= TOTAL COMMON STOCKHOLDERS' EQUITY $ 12,377 $ 9,707 $ 8,114 ======== ======== ======= TOTAL STOCKHOLDERS' EQUITY $ 12,802 $ 10,132 $ 8,539 ======== ======== ======= - ----------------------------------------------------------------------------------------------------------------- (a) Other adjustments relate to policyholder liabilities, deferred policy acquisition costs, and income taxes. See Notes to Consolidated Financial Statements.
Consolidated Financial Statements 59 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - ----------------------------------------------- (dollars in millions)
Year Ended Last Friday in December 1999 1998 1997 - --------------------------------------------------------------------------------------------------------- NET EARNINGS $ 2,618 $ 1,259 $ 1,935 ======= ======= ======= OTHER COMPREHENSIVE LOSS: Foreign currency translation adjustment: Foreign currency translation losses, net of gains (116) (131) (96) Income taxes (48) 78 4 ------- ------- ------- Total (164) (53) (92) ------- ------- ------- Net unrealized gains (losses) on investment securities available-for-sale: Net unrealized holding gains (losses) arising during the period (229) (10) 50 Reclassification adjustment for (gains) losses included in net earnings 6 (50) (16) ------- ------- ------- Net unrealized gains (losses) on investment securities (223) (60) 34 Adjustments for: Policyholder liabilities 35 16 10 Deferred policy acquisition costs 35 4 - Income taxes 50 18 (15) ------- ------- ------- Total (103) (22) 29 ------- ------- ------- Total Other Comprehensive Loss (267) (75) (63) ------- ------- ------- COMPREHENSIVE INCOME $ 2,351 $ 1,184 $ 1,872 ======= ======= ======= - ---------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 60 Consolidated Financial Statements CONSOLIDATED STATEMENTS OF CASH FLOWS - ------------------------------------- (dollars in millions)
Year Ended Last Friday in December 1999 1998 1997 - --------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net Earnings $ 2,618 $ 1,259 $ 1,935 Noncash items included in earnings: Depreciation and amortization 718 585 473 Policyholder reserves 205 227 240 Goodwill amortization 227 226 65 Amortization of stock-based compensation 406 359 218 Other 626 (34) 1,036 (Increase) decrease in operating assets:(a) Trading assets 4,177 6,332 (31,246) Cash and securities segregated for regulatory purposes or deposited with clearing organizations 710 (1,233) (2,242) Receivables under resale agreements and securities borrowed (12,028) 19,940 (22,373) transactions Customer receivables (10,304) (2,229) (7,957) Brokers and dealers receivables (223) (3,690) 1,132 Other 1,100 126 (4,068) Increase (decrease) in operating liabilities:(a) Trading liabilities 4,079 (7,474) 26,770 Payables under repurchase agreements and securities loaned 4,451 (12,040) 12,346 transactions Customer payables 467 3,922 5,091 Brokers and dealers payables 3,498 3,675 399 Other (546) 873 2,356 ------- ------- ------- CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES 181 10,824 (15,825) ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from (payments for): Maturities of available-for-sale securities 4,155 3,983 3,376 Sales of available-for-sale securities 3,071 3,426 2,198 Purchases of available-for-sale securities (11,802) (8,676) (6,383) Maturities of held-to-maturity securities 995 831 1,081 Purchases of held-to-maturity securities (1,015) (877) (752) Loans, notes, and mortgages (3,541) (3,405) (989) Acquisitions, net of cash acquired (20) (5,235) (13) Sales of subsidiaries, net of cash disposed - 202 - Other investments and other assets (855) (1,398) (240) Equipment and facilities (1,074) (1,231) (863) ------- ------- ------- CASH USED FOR INVESTING ACTIVITIES (10,086) (12,380) (2,585) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from (payments for): Commercial paper and other short-term borrowings 6,916 (15,661) 7,019 Demand and time deposits 5,141 2,568 976 Issuance and resale of long-term borrowings 15,057 29,269 25,087 Settlement and repurchase of long-term borrowings (18,598) (15,833) (8,242) Issuance of subsidiaries' preferred securities 98 2,000 300 Issuance of treasury stock 213 194 154 Other common and preferred stock transactions (199) (161) (848) Dividends (426) (363) (294) ------- ------- ------- CASH PROVIDED BY FINANCING ACTIVITIES 8,202 2,013 24,152 ------- ------- ------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,703) 457 5,742 CASH AND CASH EQUIVALENTS,BEGINNING OF YEAR 12,530 12,073 6,331 ------- ------- ------- CASH AND CASH EQUIVALENTS,END OF YEAR $ 10,827 $ 12,530 $ 12,073 ======= ======= ======= - --------------------------------------------------------------------------------------------------------- (a) Net of effects of acquisitions and divestitures. SUPPLEMENTAL DISCLOSURES Cash paid for: Income taxes $ 633 $ 579 $ 910 Interest 13,118 17,078 14,119
See Notes to Consolidated Financial Statements. Consolidated Financial Statements 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------ TABLE OF CONTENTS 62 NOTE 1. Summary of Significant Accounting Policies 66 NOTE 2. Other Significant Events 67 NOTE 3. Trading and Related Activities 71 NOTE 4. Investments 72 NOTE 5. Borrowings 73 NOTE 6. Fair Value Information and Non-Trading Derivatives 74 NOTE 7. Preferred Securities Issued by Subsidiaries 75 NOTE 8. Stockholders' Equity and Earnings Per Share 76 NOTE 9. Commitments and Contingencies 77 NOTE 10. Employee Benefit Plans 80 NOTE 11. Employee Incentive Plans 83 NOTE 12. Income Taxes 84 NOTE 13. Regulatory Requirements and Dividend Restrictions 84 NOTE 14. Segment, Product, and Geographic Information NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------- DESCRIPTION OF BUSINESS Merrill Lynch & Co., Inc. ("ML & Co.") provides investment, financing, insurance, and related services to individuals and institutions on a global basis through its broker, dealer, banking, insurance, and other financial services subsidiaries. Its principal subsidiaries include: . Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S.-based broker-dealer in securities; . Merrill Lynch International ("MLI"), a U.K.-based broker-dealer in securities and dealer in equity derivatives; . Merrill Lynch Government Securities Inc. ("MLGSI"), a dealer in U.S. Government securities; . Merrill Lynch Capital Services, Inc., a dealer in interest rate, currency, and credit derivatives; . Merrill Lynch Asset Management, LP, a U.S.-based asset management company; and . Merrill Lynch Mercury Asset Management, a U.K.-based asset management company. Services provided to clients by ML & Co. and subsidiaries (collectively, "Merrill Lynch") include: . securities brokerage, trading, and underwriting; . investment banking, strategic services, and other corporate finance advisory activities, including loan syndication; . asset management and other investment advisory and recordkeeping services; . dealing and brokerage of swaps, options, forwards, futures, and other derivatives; . securities clearance services; . debt, equity, and economic research activities; . banking, trust, and lending services; and . insurance sales and underwriting services. BASIS OF PRESENTATION The Consolidated Financial Statements include the accounts of Merrill Lynch and are presented in accordance with U.S. generally accepted accounting principles and prevailing industry practices. All material intercompany transactions and balances have been eliminated. Certain reclassifications and format changes have been made to prior year amounts to conform to the current year presentation. All 1997 amounts have been restated to reflect the 1998 merger of Midland Walwyn Inc. ("Midland Walwyn") with Merrill Lynch, which has been accounted for as a pooling-of-interests (see Note 2 for further information). The Consolidated Financial Statements are presented in U.S. dollars. Many non-U.S. subsidiaries have a functional currency (i.e., the currency in which activities are primarily conducted) that is other than the U.S. dollar, often the currency of the country in which a subsidiary is domiciled. Subsidiaries' assets and liabilities are translated to U.S. dollars at year-end exchange rates, while revenues and expenses are translated at average exchange rates during the year. Adjustments that result from translating amounts in a subsidiary's functional currency, net of hedging gains or losses and related tax effects, are reported in stockholders' equity as a component of Accumulated other comprehensive loss. All other translation adjustments are included in earnings. In presenting the Consolidated Financial Statements, management makes estimates regarding certain trading inventory valuations, the outcome of litigation, the carrying amount of 62 goodwill, the realization of deferred tax assets and insurance deferred acquisition costs, and other matters that affect the reported amounts and disclosure of contingencies in the financial statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ materially from those estimates. Merrill Lynch defines cash equivalents as short-term, highly liquid securities and interest-earning deposits with original maturities of 90 days or less, other than those used for trading purposes. For purposes of the Consolidated Statements of Cash Flows, cash flows from derivatives are classified in operating activities. At December 31, 1999 and December 25, 1998, substantially all financial instrument assets and the majority of financial instrument liabilities are carried at fair value or amounts that approximate fair value. Fair values of financial instruments are disclosed in Note 6. TRADING ACTIVITIES Merrill Lynch's trading activities consist primarily of securities brokerage, trading, and underwriting; derivatives dealing and brokerage; and securities financing transactions. Trading assets and trading liabilities consist of cash instruments (such as securities) and derivative instruments used for trading purposes or for hedging other trading inventory. Securities Trading securities and other cash instruments (e.g., loans held for trading purposes) are reported on a trade date basis at fair value. Included in trading liabilities are securities that Merrill Lynch has sold but did not own and will therefore be obligated to purchase at a future date ("short sales"). Changes in fair value (i.e., unrealized gains and losses) are recognized as principal transactions revenues in the current period. Realized gains and losses and any related interest amounts are included in principal transactions revenues and interest revenues and expenses, depending on the nature of the instrument. Fair values of trading securities are based on quoted market prices, pricing models (utilizing indicators of general market conditions or other economic measurements), or management's estimates of amounts to be realized on settlement, assuming current market conditions and an orderly disposition over a reasonable period of time. Derivatives A derivative is typically defined as an instrument whose value is "derived" from an underlying instrument or index such as a futures, forward, swap, or option contract, or other financial instrument with similar characteristics. Derivative contracts often involve future commitments to exchange interest payment streams or currencies based on a notional or contractual amount (e.g., interest rate swaps or currency forwards) or to purchase or sell other financial instruments at specified terms on a specified date (e.g., options to buy or sell securities or currencies). Derivatives are often referred to as off-balance-sheet instruments since neither their notional amounts nor the underlying instruments are reflected on the balance sheet; however, the fair values of trading derivatives are recorded in trading assets and liabilities. Derivatives are reported separately as assets and liabilities unless a legal right of setoff exists under a master netting agreement enforceable at law. Balances related to swap and forward transactions and foreign currency options are included in Contractual agreements on the Consolidated Balance Sheets. All other derivative balances are recorded in the related cash instrument caption. The fair value of equity options purchased, for example, is recorded in the Equities and convertible debentures trading asset caption. Changes in fair values of derivatives are recorded as principal transactions revenues in the current period. Fair values for certain exchange-traded derivatives, principally futures and certain options, are based on quoted market prices. Fair values for over-the-counter ("OTC") derivative financial instruments, principally forwards, options, and swaps, represent amounts that would be received from or paid to a third party in settlement of these instruments. These amounts are determined using pricing models based on the present value of estimated future cash flows employing mid-market valuations with appropriate adjustments. These adjustments are integral components of the mark-to-market process and relate to credit quality and concentration, market liquidity, and exposure close-out costs associated with unmatched positions. Adjustments are also made for administrative costs incurred to service periodic cash flows and to maintain hedges over the life of the contract. A portion of income related to long-term contracts is recognized as the related administrative costs are incurred. New, complex instruments may have immature or limited markets. The precision of the pricing model for a complex product, which involves multiple variables and assumptions, will evolve over time. As the markets for these products develop, Merrill Lynch continually refines its pricing models based on experience to correlate more closely to the market risk of these instruments. Securities Financing Transactions Merrill Lynch enters into repurchase and resale agreements and securities borrowed and loaned transactions to accommodate customers (i.e., matched-book), finance firm inventory positions, and obtain securities for settlement. Merrill Lynch also engages in securities financing for customers through margin lending (see Customer Transactions). Notes to Consolidated Financial Statements 63 Resale and repurchase agreements are accounted for as collateralized financing transactions and are recorded at their contractual amounts plus accrued interest. Merrill Lynch's policy it to obtain possession of collateral with a market value equal to or in excess of the principal amount loaned under resale agreements. To ensure that the market value of the underlying collateral remains sufficient, collateral is valued daily, and Merrill Lynch may require counterparties to deposit additional collateral or return collateral pledged, when appropriate. Substantially all repurchase and resale activities are transacted under master netting agreements that give Merrill Lynch the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty. Merrill Lynch offsets certain repurchase and resale agreement balances with the same counterparty on the Consolidated Balance Sheets. Securities borrowed and loaned transactions are recorded at the amount of cash collateral advanced or received. Securities borrowed transactions require Merrill Lynch to provide the counterparty with collateral in the form of cash, letters of credit, or other securities. Merrill Lynch receives collateral in the form of cash or other securities for securities loaned transactions. For these transactions, the fees received or paid by Merrill Lynch are recorded as interest revenue or expense. On a daily basis, Merrill Lynch monitors the market value of securities borrowed or loaned against the collateral value. Although substantially all securities borrowing and lending activities are transacted under master netting agreements, such receivables and payables with the same counterparty are not set off on the Consolidated Balance Sheets. Merrill Lynch recognizes collateral received or provided in certain resale and repurchase agreements in the following balance sheet captions: . Securities received as collateral, net of securities pledged as collateral; . Securities pledged as collateral; and . Obligation to return securities received as collateral. The balances reported under these captions primarily represent securities received as collateral in matched-book term resale and repurchase agreements for which the collateral provider does not have the explicit contractual right to substitute. Interest rate swaps may be used to modify the interest rate characteristics of long-term resale and repurchase agreements. These swaps are accounted for on an accrual basis, with amounts to be paid or received recognized as adjustments to interest expense or revenue. (See the Non-trading Derivatives section for additional information on accounting policy for non-trading derivatives.) INVESTMENT BANKING AND ADVISORY SERVICES Underwriting revenues and fees for merger and acquisition advisory services are accrued when services for the transactions are substantially completed. Transaction-related expenses are deferred to match revenue recognition. CUSTOMER TRANSACTIONS Customer securities and commodities transactions are recorded on a settlement date basis. Receivables from and payables to customers include amounts due on cash and margin transactions. Securities owned by customers, including those that collateralize margin or other similar transactions, are not reflected on the Consolidated Balance Sheets. Commissions charged for executing customer transactions are accrued on a trade date basis and are included in current period earnings. Financial Consultant compensation and benefits expense is accrued in the same period as revenue is recognized. Mutual fund distribution fee revenues are accrued as earned, and redemption fee revenues are recognized upon receipt. Certain compensation costs related to sales of rear-load open-end mutual funds are deferred to match revenue recognition. INVESTING ACTIVITIES Merrill Lynch's non-broker-dealer subsidiaries hold debt and equity investments, which are primarily classified as available-for-sale. Debt and marketable equity securities classified as available-for-sale are reported at fair value. Unrealized gains or losses on these securities are reported in stockholders' equity as a component of Accumulated other comprehensive loss, net of applicable income taxes and other related items. Debt securities that Merrill Lynch has the positive intent and ability to hold to maturity are classified as held-to-maturity. These investments are recorded at amortized cost unless a decline in value is deemed other than temporary, in which case the carrying value is reduced. The amortization of premiums or accretion of discounts and any unrealized losses deemed other than temporary are included in current period earnings. Debt and marketable equity securities purchased principally for the purpose of resale in the near-term are classified as trading investments and are reported at fair value. Unrealized gains or losses on these investments are included in current period earnings. Restricted equity investment securities or equity investment securities without available market quotations are reported at the lower of cost or estimated net realizable value. Adjustments in carrying values are included in current period earnings. Realized gains and losses on investments are included in current period earnings. The cost basis of each investment sold 64 Notes to Consolidated Financial Statements is specifically identified for purposes of computing realized gains and losses. Derivative contracts may be used to modify interest rate characteristics of available-for-sale securities. Merrill Lynch also uses derivatives to manage the currency exposure arising from investments in non-U.S. subsidiaries (see Basis of Presentation for accounting policy for these investments). Unrealized gains and losses on these derivatives are reported net of tax in stockholders' equity as a component of Accumulated other comprehensive loss, along with unrealized gains and losses from the hedged items. (See Non-trading Derivatives section for additional information on accounting policy for non-trading derivatives). LENDING ACTIVITIES Merrill Lynch's lending activities include loan originations, syndications, securitizations, and servicing. Merrill Lynch also engages in secondary market loan trading and margin lending (see Trading Activities and Customer Transactions, respectively). Loans held for investment purposes, including consumer and small business loans and the residual portion of commercial loans syndicated by Merrill Lynch, are carried at their principal amount outstanding. The allowance for loan losses is established through provisions that are based on management's assessment of the collectibility of the loan portfolio. Loans are charged off against the allowance for loan losses when management determines that collection of principal is unlikely. Loans held for sale, which include certain residential mortgage and home equity loans, are reported at the lower of cost (less allowance for loan losses) or estimated fair value determined on a portfolio basis. Mortgage servicing assets and residual interests in mortgage loans underlying Real Estate Mortgage Investment Conduits and revolving trusts are (1) recognized upon sales of loans when servicing is retained, and (2) amortized into income in proportion to and over the estimated life of the net servicing revenue. Mortgage servicing assets are recognized at the present value of future cash flows, periodically evaluated for impairment, and included in Other assets on the Consolidated Balance Sheets. Residual interests are categorized as available-for-sale (see Investing Activities) and reported in Other investments on the Consolidated Balance Sheets. BORROWING ACTIVITIES Merrill Lynch's unsecured general-purpose funding is principally obtained from commercial paper and long-term borrowings. Commercial paper, which is issued at a discount, is recorded at the proceeds received and accreted to its par value. Long-term borrowings are carried at the principal amount borrowed, net of unamortized discounts or premiums. Merrill Lynch uses derivatives to manage the interest rate, currency, and equity risk exposures of its borrowings. Derivatives that hedge the interest rate risk on borrowings are generally accounted for on an accrual basis, with amounts to be paid or received recognized as adjustments to the related interest expense. Unrealized gains and losses on other financing derivatives are recognized currently. (See following Non-trading Derivatives section for additional information on accounting policy for non-trading derivatives.) NON-TRADING DERIVATIVES As part of its overall risk management strategy, Merrill Lynch uses derivatives to manage its market risk exposures arising from non-trading assets and liabilities. These exposures include interest rate, currency, equity and other risks. Derivatives used for hedging borrowings and other non-trading assets and liabilities must be effective at reducing the risk being managed and be designated as a hedge at inception. Realized gains and losses on early terminations of derivatives are deferred over the remaining lives of the hedged assets or liabilities. At December 31, 1999, there was $27 million in deferred gains relating to a derivative contract terminated during 1999. At December 25, 1998, there were no such deferred amounts. INSURANCE ACTIVITIES Insurance liabilities are future benefits payable under annuity and interest-sensitive life insurance contracts and include deposits received plus interest credited during the contract accumulation period, the present value of future payments for contracts which have annuitized, and a mortality provision for certain products. Certain policyholder liabilities are also adjusted for those investments classified as available-for-sale. Liabilities for unpaid claims consist of the mortality benefit for reported claims and an estimate of unreported claims based upon prior experience. Substantially all security investments of insurance subsidiaries are classified as available-for-sale and recorded at fair value. These investments support Merrill Lynch's in-force, universal life-type contracts. Merrill Lynch records adjustments to deferred acquisition costs and policyholder account balances which, when combined, are equal to the adjustment that would have been recorded if those available-for-sale investments had been sold at their estimated fair values and the proceeds reinvested at current yields. The corresponding credits or charges for these adjustments are recorded in stockholders' equity as a component of Accumulated other comprehensive loss, net of applicable income taxes. Certain variable costs related to the sale or acquisition of new and renewal insurance contracts have been deferred, to the extent deemed recoverable, and amortized over the Notes to Consolidated Financial Statements 65 estimated lives of the contracts in proportion to the estimated gross profit for each group of contracts. Merrill Lynch maintains separate accounts representing segregated funds held for purposes of funding variable life and annuity contracts. Separate account assets are accounted for as customer assets since the contract holders bear the risk of ownership, consistent with Merrill Lynch's other investment products. Accordingly, separate account assets and the related liabilities are not consolidated with the assets and liabilities of Merrill Lynch. STOCK-BASED COMPENSATION Merrill Lynch accounts for stock-based compensation in accordance with the intrinsic value-based method in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, rather than the fair value-based method in Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. Compensation expense for stock options is not recognized since Merrill Lynch grants stock options without any intrinsic value. Compensation expense related to other stock-based compensation plans is recognized over the vesting period. For certain stock-based compensation grants, the unamortized portion of the grant value is reflected as a reduction of stockholders' equity in Employee stock transactions on the Consolidated Balance Sheets. GOODWILL Goodwill, which represents the cost of acquired businesses in excess of fair value of the related net assets at acquisition, is amortized on a straight-line basis. Goodwill associated with the purchase of the Mercury Asset Management Group ("Mercury") is amortized over 30 years (see Note 2 for additional information). Goodwill related to other acquisitions is amortized over periods generally not exceeding fifteen years. Goodwill is evaluated for impairment upon occurrence of an event that leads to a significant reduction in expected future cash flows associated with the acquired entity. These events could include, but are not limited to, the loss of a major client, the loss of market share, an unanticipated reduction in the revenue stream, or an unanticipated increase in the entity's cost structure. Once it has been determined that conditions for potential impairment exist, impairment assessment will be determined by comparing the carrying value of goodwill to its estimated value based on a discounted cash flow valuation model. Impairment is determined to occur when the estimated value of the goodwill falls significantly below its recorded value. This analysis is based on appropriate assumptions, including a discount rate that reflects the acquired entity's weighted average cost of capital. EQUIPMENT AND FACILITIES Equipment and facilities primarily consist of technology hardware and software, leasehold improvements, and owned facilities. Equipment and facilities are reported at historical cost, net of accumulated depreciation and amortization, except for land, which is reported at historical cost. Depreciation and amortization are computed using the straight-line method. Equipment is depreciated over its estimated useful life, while leasehold improvements are amortized over the lesser of the improvement's estimated economic useful life or the term of the lease. Maintenance and repair costs are expensed as incurred. Included in the Occupancy and related depreciation expense category was depreciation and amortization of $205 million, $190 million, and $167 million in 1999, 1998, and 1997, respectively. Depreciation and amortization recognized in the Communications and technology expense category was $513 million, $395 million, and $306 million for 1999, 1998, and 1997, respectively. In 1998, Merrill Lynch also began capitalizing certain costs incurred in the development of internal-use software (see Note 2). These amounts are amortized over the useful life of the developed software, generally not exceeding three years. INCOME TAXES ML & Co. and certain of its wholly owned subsidiaries file a consolidated U.S. federal income tax return. Merrill Lynch uses the asset and liability method in providing income taxes on all transactions that have been recognized in the Consolidated Financial Statements. The asset and liability method requires that deferred taxes be adjusted to reflect the tax rates at which future taxable amounts are expected to be settled or realized. The effects of tax rate changes on future deferred tax liabilities and deferred tax assets, as well as other changes in income tax laws, are recognized in net earnings in the period such changes are enacted. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. NOTE 2. OTHER SIGNIFICANT EVENTS - -------------------------------- ACCOUNTING CHANGES In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires capitalization of certain internal-use software development costs. The SOP was adopted early for 1998 and resulted in the capitalization of software development costs of $146 million in 1999 and $72 million in 1998. 66 Notes to Consolidated Financial Statements In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of Start-Up Activities, which requires that all start-up costs be expensed as incurred. Closed-end mutual fund distribution costs, previously deferred and amortized by Merrill Lynch over a four-year period, are required to be expensed under the SOP. The SOP was adopted early as of the beginning of 1998, and the impact of adoption was not material. MERGERS, ACQUISITIONS, AND DIVESTITURES In August 1998, Merrill Lynch acquired the outstanding shares of Midland Walwyn, a Canadian broker-dealer, in a share exchange. Each Midland Walwyn shareholder received either 0.24 shares of ML & Co. common stock or 0.24 exchangeable shares of Merrill Lynch & Co., Canada Ltd. for every Midland Walwyn share held (see Note 8). The merger was accounted for as a pooling-of-interests; the Consolidated Financial Statements reflect the results of operations, financial position, changes in stockholders' equity, and cash flows as if the two companies had always been combined. During 1998, Merrill Lynch acquired Howard Johnson & Co., a U.S. employee benefits consulting firm and a majority interest in a non-U.S. investment bank in transactions accounted for as purchases. Aggregate consideration of $92 million was paid, and goodwill of $56 million was recorded in connection with these acquisitions. In addition, Merrill Lynch sold a U.S. residential real estate services subsidiary and a New York Stock Exchange specialist subsidiary, recognizing pre-tax gains totaling $138 million. At year-end 1997, Merrill Lynch recorded the acquisition of Mercury, a U.K.-based global asset manager. In 1998, approximately $5.3 billion in cash was paid as consideration. Goodwill of approximately $4.8 billion was recorded related to the acquisition. In 1997, Merrill Lynch also acquired a 401(k) service provider for $13 million, recognizing goodwill of $10 million. For acquisitions accounted for as purchases, the operating results of acquired companies are included in Merrill Lynch's results of operations commencing with the acquisition date. PROVISION FOR COSTS RELATED TO STAFF REDUCTIONS During the 1998 third quarter, Merrill Lynch recognized a $430 million provision for costs related to staff reductions ($288 million after-tax). The provision covered primarily severance costs, but also included costs to terminate long-term contracts and leases related to personnel reductions and resized businesses. The staff reduction program included reductions, through termination and attrition, of approximately 3,400 personnel, or about 5% of the global workforce. At December 31, 1999, the remaining liability was $54 million, which primarily represents remaining severance payments for personnel receiving periodic payments. All staff reductions were fully completed during 1999 and all severance payments will be completed in 2000. NOTE 3. TRADING AND RELATED ACTIVITIES - -------------------------------------- As part of its trading activities, Merrill Lynch provides to clients brokerage, dealing, financing, and underwriting services for a broad range of products. While trading activities are primarily generated by client order flow, Merrill Lynch also takes selective proprietary positions based on expectations of future market movements and conditions. Merrill Lynch's trading strategies rely on the integrated management of its client-driven and proprietary positions, along with the related hedging and financing. Interest revenue and expense are integral components of trading activities. In assessing the profitability of trading activities, Merrill Lynch views net interest and principal transactions revenues in the aggregate. For further information on Merrill Lynch's net trading results, see Management's Discussion and Analysis (unaudited) - Principal Transactions. Certain trading activities expose Merrill Lynch to market and credit risks. These risks are managed in accordance with established risk management policies and procedures that are described in Management's Discussion and Analysis (unaudited) - Risk Management. MARKET RISK Market risk is the potential change in an instrument's value caused by fluctuations in interest and currency exchange rates, equity and commodity prices, credit spreads, or other risks. The level of market risk is influenced by the volatility and the liquidity in the markets in which financial instruments are traded. Merrill Lynch seeks to mitigate market risk associated with trading inventories by employing hedging strategies that correlate rate, price, and spread movements of trading inventories and related financing and hedging activities. Merrill Lynch uses a combination of cash instruments and derivatives to hedge its market exposures. The following discussion describes the types of market risk faced by Merrill Lynch. Interest Rate Risk Interest rate risk arises from the possibility that changes in interest rates will affect the value of financial instruments. Interest rate swap agreements, Eurodollar futures, and U.S. Treasury securities and futures are common interest rate risk management tools. The decision to manage interest rate risk using futures or swap contracts, as opposed to buying or selling short U.S. Treasury or other securities, depends on current market conditions and funding considerations. Notes to Consolidated Financial Statements 67 Interest rate swap agreements used by Merrill Lynch include caps, collars, floors, basis swaps, and leveraged swaps. Interest rate caps and floors provide the purchaser protection against rising and falling interest rates, respectively. Interest rate collars combine a cap and a floor, providing the purchaser with a predetermined interest rate range. Basis swaps are a type of interest rate swap agreement where variable rates are received and paid, but are based on different index rates. Leveraged swaps are another type of interest rate swap where changes in the variable rate are multiplied by a contractual leverage factor, such as four times three-month LIBOR (London Interbank Offered Rate). Merrill Lynch's exposure to interest rate risk resulting from these leverage factors is typically hedged with other financial instruments. Currency Risk Currency risk arises from the possibility that fluctuations in foreign exchange rates will impact the value of financial instruments. Merrill Lynch's trading assets and liabilities include both cash instruments denominated in and derivatives linked to over 70 currencies, including the euro, Japanese yen, German mark, Swiss franc, British pound, and Italian lira. Currency forwards and options are commonly used to manage currency risk associated with these instruments. Currency swaps may also be used in situations where a long-dated forward market is not available or where the end-user needs a customized instrument to hedge a foreign currency cash flow stream. Typically, parties to a currency swap initially exchange principal amounts in two currencies, agreeing to exchange interest payments and to re-exchange the currencies at a future date and exchange rate. Equity Price Risk Equity price risk arises from the possibility that equity security prices will fluctuate, affecting the value of equity securities and other instruments that derive their value from a particular stock, a defined basket of stocks, or a stock index. Instruments typically used by Merrill Lynch to manage equity price risk include equity options, warrants, and baskets of equity securities. Equity options, for example, can require the writer to purchase or sell a specified stock or to make a cash payment based on changes in the market price of that stock, basket of stocks, or stock index. Credit Spread Risk Credit spread risk arises from the possibility that changes in credit spreads will affect the value of financial instruments. Credit spreads represent the credit risk premiums required by market participants for a given credit quality, i.e., the additional yield that a debt instrument issued by a AA-rated entity must produce over a risk-free alternative (e.g., U.S. Treasury instrument). Certain instruments are used by Merrill Lynch to manage this type of risk. Swaps and options, for example, can be designed to mitigate losses due to changes in credit spreads, as well as the credit downgrade or default of the issuer. Credit risk resulting from default on counterparty obligations is discussed in the Credit Risk section. Commodity Price and Other Risks Merrill Lynch views its commodity contracts as financial instruments since they are generally settled in cash and not by delivery of the underlying commodity. Commodity price risk results from the possibility that the price of the underlying commodity may rise or fall. Cash flows from commodity contracts are based on the difference between an agreed-upon fixed price and a price that varies with changes in a specified commodity price or index. Commodity contracts held by Merrill Lynch principally relate to energy, precious metals, and base metals. Merrill Lynch is also a party to financial instruments that contain risks not correlated to typical financial risks. Securities or derivatives, for example, may be linked to the occurrence of certain weather conditions or natural catastrophes. Merrill Lynch generally mitigates the risk associated with these transactions by entering into offsetting derivative transactions. CREDIT RISK Merrill Lynch is exposed to risk of loss if an issuer or a counter-party fails to perform its obligations under contractual terms and the collateral held, if any, is deemed worthless ("default risk"). Both cash instruments and derivatives expose Merrill Lynch to default risk. Credit risk arising from changes in credit spreads was previously discussed in the Market Risk section. Merrill Lynch has established policies and procedures for mitigating credit risk on principal transactions, including reviewing and establishing limits for credit exposure, maintaining collateral, and continually assessing the creditworthiness of counterparties. For further information, see Management's Discussion and Analysis (unaudited) - Risk Management - Credit Risk. In the normal course of business, Merrill Lynch executes, settles, and finances various customer securities transactions. Execution of these transactions includes the purchase and sale of securities by Merrill Lynch. These activities may expose Merrill Lynch to default risk arising from the potential that customers or counterparties may fail to satisfy their obligations. In these situations, Merrill Lynch may be required to purchase or sell financial instruments at unfavorable market prices to satisfy obligations to other customers or counterparties. In addition, Merrill Lynch seeks to control the risks associated with its customer margin activities by requiring customers to maintain collateral in compliance with regulatory and internal guidelines. 68 Notes to Consolidated Financial Statements Liabilities to other brokers and dealers related to unsettled transactions (i.e., securities failed-to-receive) are recorded at the amount for which the securities were acquired, and are paid upon receipt of the securities from other brokers or dealers. In the case of aged securities failed-to-receive, Merrill Lynch may purchase the underlying security in the market and seek reimbursement for losses from the counterparty. Concentrations of Credit Risk Merrill Lynch's exposure to credit risk (both default and credit spread) associated with its trading and other activities is measured on an individual counterparty basis, as well as by groups of counterparties that share similar attributes. Concentrations of credit risk can be affected by changes in political, industry, or economic factors. To reduce the potential for risk concentration, credit limits are established and monitored in light of changing counterparty and market conditions. At December 31, 1999, Merrill Lynch's most significant concentration of credit risk was with the U.S. Government and its agencies. This concentration consists of both direct and indirect exposures. Direct exposure, which primarily results from trading asset and investment security positions in instruments issued by the U.S. Government and its agencies, amounted to $17.0 billion and $17.4 billion at December 31, 1999 and December 25, 1998, respectively. Merrill Lynch's indirect exposure results from maintaining U.S. Government and agencies securities as collateral for resale agreements and securities borrowed transactions. Merrill Lynch's direct credit exposure on these transactions is with the counterparty; thus Merrill Lynch has credit exposure to the U.S. Government and its agencies only in the event of the counterparty's default. Securities issued by the U.S. Government or its agencies held as collateral for resale agreements and securities borrowed transactions at December 31, 1999 and December 25, 1998 totaled $43.8 billion and $54.8 billion, respectively. At December 31, 1999, Merrill Lynch had concentrations of credit risk with other counterparties, including a corporate counterparty rated AAA by recognized credit rating agencies. Total unsecured exposure to this counterparty was $857 million, or 0.3% of total assets. Merrill Lynch's most significant industry credit concentration is with financial institutions. Financial institutions include other brokers and dealers, commercial banks, finance companies, insurance companies, and investment companies. This concentration arises in the normal course of Merrill Lynch's brokerage, trading, financing, and underwriting activities. Merrill Lynch also monitors credit exposures worldwide by region. Within these regions, sovereign governments represent the most significant concentration, followed by financial institutions. In the normal course of business, Merrill Lynch purchases, sells, underwrites, and makes markets in non-investment grade instruments. In conjunction with merchant banking activities, Merrill Lynch also provides extensions of credit and makes equity investments to facilitate leveraged transactions. These activities expose Merrill Lynch to a higher degree of credit risk than is associated with trading, investing in, and underwriting investment grade instruments and extending credit to investment grade counterparties. See Management's Discussion and Analysis (unaudited) - Non-Investment Grade Holdings and Highly Leveraged Transactions for further information. TRADING DERIVATIVES Merrill Lynch's trading derivatives consist of derivatives provided to customers and derivatives entered into for proprietary trading strategies or risk management purposes. The fair values of derivatives used in trading activities at year-end 1999 and 1998 follow: - -------------------------------------------------------------------------------- (in millions) December 31, 1999 December 25, 1998 --------------------- ---------------------- Assets Liabilities Assets Liabilities -------- ----------- -------- ----------- Swap agreements $ 19,984 $ 24,204 $ 17,938 $ 19,747 Forward contracts 2,232 2,385 2,882 2,822 Options 5,785 7,823 8,841 12,195 - -------------------------------------------------------------------------------- The following table presents the average fair values of Merrill Lynch's trading derivatives for 1999 and 1998, calculated using month-end balances: - -------------------------------------------------------------------------------- (in millions) Average Fair Value ------------------------------------------------ 1999 1998 --------------------- --------------------- Assets Liabilities Assets Liabilities -------- ----------- -------- ----------- Swap agreements $ 16,724 $ 20,575 $ 19,096 $ 17,272 Forward contracts 2,030 2,127 3,227 3,178 Options 7,358 8,333 8,551 11,420 - -------------------------------------------------------------------------------- The notional or contractual amounts of derivatives provide only a measure of involvement in these types of transactions and represent neither the amounts subject to the various types of market risk nor the future cash requirements under these instruments. The notional or contractual amounts of derivatives used for trading purposes by type of risk follow: Notes to Consolidated Financial Statements 69 - -------------------------------------------------------------------------------- (in billions) RISK ---------------------------------------------------------- INTEREST EQUITY COMMODITY RATE(1)(2) CURRENCY(3) PRICE AND OTHER -------------- ----------- ------ --------- DECEMBER 31, 1999 Swap agreements $ 2,470 $ 175 $ 27 $ 3 Forward contracts 94 153 3 1 Futures contracts 224 3 12 3 Options purchased 216 102 53 2 Options written 270 71 53 4 DECEMBER 25, 1998 Swap agreements $ 2,006 $ 170 $ 19 $ 5 Forward contracts 62 229 - 6 Futures contracts 184 2 10 3 Options purchased 254 93 71 4 Options written 192 96 58 6 - -------------------------------------------------------------------------------- (1) Certain derivatives subject to interest rate risk are also exposed to the credit spread risk of the underlying financial instrument. (2) Forward contracts subject to interest rate risk principally represent "To Be Announced" mortgage pools that bear interest rate as well as principal prepayment risk. (3) Included in the currency risk category are certain contracts that are also subject to interest rate risk. Most of Merrill Lynch's trading derivative transactions are relatively short-term in duration with a weighted-average maturity of approximately 2.9 years at December 31, 1999 and December 25, 1998. For trading derivatives outstanding at December 31, 1999, the following table presents the notional or contractual amounts of derivatives expiring in future years based on contractual expiration: - -------------------------------------------------------------------------------- (in billions) After 2000 2001 2002 2003 2003 Total -------- ----- ----- ----- ------- ------- Swap agreements $ 657 $ 373 $ 325 $ 243 $ 1,077 $ 2,675 Forward contracts 221 27 - - 3 251 Futures contracts 91 48 32 33 38 242 Options purchased 249 18 19 12 75 373 Options written 268 33 24 16 57 398 -------- ----- ----- ----- ------- ------- Total $ 1,486 $ 499 $ 400 $ 304 $ 1,250 $ 3,939 ======== ===== ===== ===== ======= ======= - -------------------------------------------------------------------------------- The notional or contractual values of derivatives do not represent default risk exposure. Default risk is limited to the current cost of replacing derivative contracts in a gain position. Default risk exposure varies by type of derivative. Swap agreements and forward contracts are generally OTC-transacted and thus are exposed to default risk to the extent of their replacement cost. Since futures contracts are exchange-traded and usually require daily cash settlement, the related risk of accounting loss is generally limited to a one- day net positive change in market value. Option contracts can be exchange-traded or OTC-transacted. Purchased options have default risk to the extent of their replacement cost. Written options represent a potential obligation to counterparties and, accordingly, do not subject Merrill Lynch to default risk. Merrill Lynch enters into International Swaps and Derivatives Association, Inc. master agreements or their equivalent ("master netting agreements") with each of its counterparties, whenever possible. Master netting agreements provide protection in bankruptcy in certain circumstances and, in some cases, enable receivables and payables with the same counterparty to be offset on the Consolidated Balance Sheets, providing for a more meaningful balance sheet presentation of credit exposure. To reduce default risk, Merrill Lynch requires collateral, principally U.S. Government and agencies securities, on certain derivative transactions. From an economic standpoint, Merrill Lynch evaluates default risk exposures net of related collateral. At December 31, 1999, such collateral amounted to $4.2 billion. In addition to obtaining collateral, Merrill Lynch attempts to mitigate default risk on derivatives by entering into transactions with provisions that enable Merrill Lynch to terminate or reset the terms of the derivative contract. See Management's Discussion and Analysis (unaudited) - Risk Management - Credit Risk for further information on credit risk related to derivatives. SECURITIES FINANCING TRANSACTIONS Merrill Lynch enters into secured borrowing and lending transactions to finance trading inventory positions, obtain securities for settlement, and to meet customers' needs (see Management's Discussion and Analysis (unaudited) - Balance Sheet for further information). Outstanding receivables and payables under resale and repurchase agreements and securities borrowed and loaned transactions at year-end 1999 and 1998 are as follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 -------- -------- RECEIVABLES UNDER: Resale agreements $ 58,034 $ 50,188 Securities borrowed transactions 41,707 37,525 -------- -------- Total $ 99,741 $ 87,713 ======== ======== - -------------------------------------------------------------------------------- PAYABLES UNDER: Repurchase agreements $ 64,954 $ 59,501 Securities loaned transactions 6,624 7,626 -------- -------- Total $ 71,578 $ 67,127 ======== ======== - -------------------------------------------------------------------------------- Under these agreements and transactions, Merrill Lynch either receives or provides collateral, including U.S. Government and agencies, asset-backed, corporate debt, equity, and non-U.S. governments and agencies securities. When providing collateral for these transactions, Merrill Lynch delivers its own securities, securities borrowed from counterparties, and securities owned by customers collateralizing margin loans and other obligations. The market value of securities owned by Merrill Lynch that have been loaned or pledged to counterparties as collateral for obligations of Merrill Lynch, primarily related to repurchase agreements, were 70 Notes to Consolidated Financial Statements $31,731 million and $35,762 million at December 31, 1999 and December 25, 1998, respectively. Merrill Lynch hedges interest rate risk exposures on long-dated resale and repurchase agreements (see Note 6). NOTE 4. INVESTMENTS - ------------------- Merrill Lynch has several broad categories of investments on its Consolidated Balance Sheets, including Marketable investment securities, Investments of insurance subsidiaries, and Other investments. Marketable investment securities consist of highly liquid debt and equity securities, including those held for liquidity management purposes and those held by a subsidiary for credit rating agency purposes. Investments of insurance subsidiaries, primarily debt securities, are used to fund policyholder liabilities. Other investments consist of equity and debt securities, including those acquired in connection with merchant banking activities. Certain merchant banking investments are subject to restrictions that may limit Merrill Lynch's ability to realize its investment until such restrictions expire. Marketable investment securities and certain investments of insurance subsidiaries and other investments are classified as available-for-sale, held-to-maturity, or trading as described in Note 1. Investment securities reported on the Consolidated Balance Sheets at December 31, 1999 and December 25, 1998 are as follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 ------- ------- MARKETABLE INVESTMENT SECURITIES Available-for-sale $ 9,484 $ 4,070 Held-to-maturity 362 354 Trading 299 181 ------- ------- Total $10,145 $ 4,605 ======= ======= - -------------------------------------------------------------------------------- INVESTMENTS OF INSURANCE SUBSIDIARIES Available-for-sale $ 2,499 $ 2,917 Trading 22 17 Non-qualifying(1)(2) 1,576 1,551 ------- ------- Total $ 4,097 $ 4,485 ======= ======= - -------------------------------------------------------------------------------- OTHER INVESTMENTS Available-for-sale $ 494 $ 435 Held-to-maturity 312 290 Non-qualifying(1)(3) 2,604 1,865 ------- ------- Total $ 3,410 $ 2,590 ======= ======= - -------------------------------------------------------------------------------- (1) Non-qualifying for SFAS No. 115 purposes. (2) Primarily consists of insurance policy loans. (3) Includes merchant banking investments and investments hedging deferred compensation liabilities. Information regarding investment securities subject to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, follows:
- ------------------------------------------------------------------------------------------------------------------------------------ (in millions) December 31, 1999 December 25, 1998 ------------------------------------------------------------------------------------------ Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value --------- ---------- ---------- --------- --------- ---------- ---------- --------- AVAILABLE-FOR-SALE Corporate debt $ 4,976 $ 10 $ (178) $ 4,808 $ 2,771 $ 61 $ (31) $ 2,801 U.S.Government and agencies 974 1 (18) 957 658 7 (1) 664 Municipals 2,120 7 (5) 2,122 1,721 15 (13) 1,723 Mortgage-backed securities 3,808 16 (26) 3,798 1,572 18 (2) 1,588 Other debt securities 293 - (6) 287 183 1 (4) 180 --------- ---------- ---------- --------- --------- ---------- ---------- --------- Total debt securities 12,171 34 (233) 11,972 6,905 102 (51) 6,956 Equity securities 528 12 (35) 505 447 26 (7) 466 --------- ---------- ---------- --------- --------- ---------- ---------- --------- Total $ 12,699 $ 46 $ (268) $ 12,477 $ 7,352 $ 128 $ (58) $ 7,422 ========= ========== ========== ========= ========= ========== ========== ========= - ------------------------------------------------------------------------------------------------------------------------------------ (in millions) December 31, 1999 December 25, 1998 ------------------------------------------------------------------------------------------ Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value --------- ---------- ---------- --------- --------- ---------- ---------- --------- HELD-TO-MATURITY Corporate debt $ - $ - $ - $ - $ 38 $ 1 $ - $ 39 U.S.Government and agencies 405 17 - 422 263 29 - 292 Municipals 66 12 (51) 27 144 64 (2) 206 Mortgage-backed securities 68 - (1) 67 87 - - 87 Other debt securities 135 - - 135 112 - (2) 110 --------- ---------- ---------- --------- --------- ---------- ---------- --------- Total $ 674 $ 29 $ (52) $ 651 $ 644 $ 94 $ (4) $ 734 ========= ========== ========== ========= ========= ========== ========== ========= - ------------------------------------------------------------------------------------------------------------------------------------
Notes to Consolidated Financial Statements 71 The amortized cost and estimated fair value of debt securities at December 31, 1999, by contractual maturity, for available-for-sale and held-to-maturity investments follow: - -------------------------------------------------------------------------------- (in millions) Available-for-Sale Held-to-Maturity ---------------------- ---------------------- Estimated Estimated Amortized Fair Amortized Fair Cost Value Cost Value --------- --------- --------- --------- Due in one year or less $ 2,807 $ 2,807 $ 231 $ 231 Due after one year through five years 1,846 1,816 197 205 Due after five years through ten years 1,003 962 29 11 Due after ten years 2,707 2,589 149 137 --------- --------- --------- --------- 8,363 8,174 606 584 Mortgage-backed securities 3,808 3,798 68 67 --------- --------- --------- --------- Total(1) $12,171 $11,972 $ 674 $ 651 ========= ========= ========= ========= - -------------------------------------------------------------------------------- (1) Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. The proceeds and gross realized gains (losses) from the sale of available-for-sale investments are as follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ------- ------- ------- Proceeds $ 3,071 $ 3,426 $ 2,198 Gross realized gains 22 74 27 Gross realized losses (28) (27) (11) - -------------------------------------------------------------------------------- Net unrealized gains (losses) from investment securities classified as trading included in the 1999, 1998, and 1997 Consolidated Statements of Earnings were $46 million, $6 million, and $(21) million, respectively. Merrill Lynch hedges interest rate risk exposures on certain investments (see Note 6 for further information). NOTE 5. BORROWINGS - ------------------ Merrill Lynch issues U.S. and non-U.S. dollar-denominated debt instruments with both variable and fixed interest rates, primarily at the ML & Co. level. These borrowing activities may create exposure to market risk, most notably interest rate and currency risk. Merrill Lynch typically uses derivatives to better match the interest rate and currency characteristics of assets and liabilities, thereby reducing risk exposures. Derivatives used most frequently include swap agreements that: . convert fixed-rate interest payments into variable payments, . change the underlying interest rate basis or reset frequency, and . convert non-U.S. dollar payments into U.S. dollars. Merrill Lynch also issues debt whose repayment terms are linked to the performance of an equity or other index (e.g., S&P 500), basket of securities, or an individual security. The contingent components of these indexed debt obligations are hedged with derivatives (see Note 6 for further information). Borrowings at December 31, 1999 and December 25, 1998 are presented below: - -------------------------------------------------------------------------------- (in millions) 1999 1998 ------- ------- COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS Commercial paper $24,198 $16,758 Other 1,397 1,921 ------- ------- Total $25,595 $18,679 ======= ======= - -------------------------------------------------------------------------------- DEMAND AND TIME DEPOSITS Demand $ 3,498 $ 3,171 Time 14,104 9,290 ------- ------- Total $17,602 $12,461 ======= ======= - -------------------------------------------------------------------------------- LONG-TERM BORROWINGS Fixed-rate obligations:(1) U.S.dollar-denominated $13,150 $12,595 Non-U.S. dollar-denominated 1,287 1,189 Variable-rate obligations:(2)(3) U.S.dollar-denominated 3,338 4,077 Non-U.S.dollar-denominated 1,918 1,303 Medium-term notes:(3)(4) U.S.dollar-denominated 22,166 24,916 Non-U.S.dollar-denominated 11,606 13,483 ------- ------- Total $53,465 $57,563 ======= ======= - -------------------------------------------------------------------------------- (1) At December 31, 1999, U.S.dollar-denominated fixed-rate obligations are due between 2000 and 2028 at interest rates ranging from 6.0% to 8.4%; non-U.S. dollar-denominated fixed-rate obligations are due between 2000 and 2002 at interest rates ranging from 2.6% to 9.3%. (2) Variable interest rates are generally based on rates such as LIBOR, the U.S. Treasury Bill Rate, or the Federal Funds Rate. (3) Included are various equity-linked or other indexed instruments. (4) The medium-term note program provides for issuances that may bear fixed or variable interest rates and may have maturities that range from nine months to 30 years from the date of issue. Long-term borrowings at December 31, 1999, based on their contractual terms, mature as follows: - -------------------------------------------------------------------------------- (in millions) 2000 $ 8,448 2001 9,280 2002 7,971 2003 5,825 2004 3,549 2005 and thereafter 18,392 ------- Total $53,465 ======= - -------------------------------------------------------------------------------- Certain long-term borrowing agreements contain provisions whereby the borrowings are redeemable at the option of the holder at specified dates prior to maturity. 72 Notes to Consolidated Financial Statements Management believes, however, that a significant portion of such borrowings will remain outstanding beyond their earliest redemption date. The effective weighted-average interest rates for borrowings, which include the impact of hedges, at December 31, 1999 and December 25, 1998 were: - -------------------------------------------------------------------------------- 1999 1998 ---- ---- COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 5.94% 5.28% DEMAND AND TIME DEPOSITS 4.34 4.54 LONG-TERM BORROWINGS Fixed-rate obligations 6.90 6.69 Variable-rate obligations 6.14 5.46 Medium-term notes 6.21 5.52 - -------------------------------------------------------------------------------- Subsequent to year-end 1999 and through February 25, 2000, long-term borrowings, net of repayments and repurchases, decreased approximately $505 million. Borrowing Facilities Merrill Lynch has obtained a committed, senior unsecured revolving credit facility aggregating $8 billion under an agreement with a bank. The agreement contains covenants requiring, among other things, that Merrill Lynch maintain specified levels of net worth, as defined in the agreement, on the date of an advance. At December 31, 1999, this credit facility was not drawn upon. The credit quality, amounts, and terms of this credit facility are continually monitored and modified as warranted by business conditions. Under the existing agreement, the credit facility will mature in May 2000. At maturity, Merrill Lynch may convert amounts borrowed, if any, into term loans that would mature in two years. NOTE 6. FAIR VALUE INFORMATION AND NON-TRADING DERIVATIVES - ---------------------------------------------------------- FAIR VALUE INFORMATION The following information is presented to help the reader gain an understanding of the relationship between the amounts reported in Merrill Lynch's financial statements and the related fair values. Specific accounting policies are discussed in Note 1. At December 31, 1999, $299 billion or 91% of Merrill Lynch's total assets and $229 billion or 73% of Merrill Lynch's total liabilities were carried at fair value or at amounts that approximate fair value. At December 25, 1998, $276 billion, or 92%, of Merrill Lynch's total assets and $204 billion, or 71%, of Merrill Lynch's liabilities were carried at fair value or at amounts that approximate such values. Financial instruments that are carried at fair value include cash and cash equivalents, cash segregated for regulatory purposes or deposited with clearing organizations, trading assets and liabilities, available-for-sale and trading securities included in marketable investment securities, certain investments of insurance subsidiaries, and certain other investments. (See Notes 3 and 4 for information related to these instruments). Financial instruments recorded at amounts that approximate fair value include most receivables under resale agreements and securities borrowed transactions, receivables, payables under repurchase agreements and securities loaned, commercial paper and other short-term borrowings, demand deposits, and other payables. The fair value of these items is not materially sensitive to shifts in market interest rates because of the limited term to maturity of many of these instruments and/or their variable interest rates. The following table shows financial instruments with carrying values that differ from their fair values. - -------------------------------------------------------------------------------- (in millions) Assets Liabilities ------------------ ------------------ Carrying Fair Carrying Fair Value Value Value Value -------- ------- -------- ------- DECEMBER 31, 1999 Held-to-maturity investments $ 674 $ 651 Merchant banking and other financial instruments(1) 2,605 2,917 Loans,notes,and mortgages 11,187 11,211 Long-term borrowings $53,465 $53,063 Non-trading derivatives 1,220 1,514 2,191 2,669 - -------------------------------------------------------------------------------- DECEMBER 25, 1998 Held-to-maturity investments $ 644 $ 734 Merchant banking and other financial instruments(1) 1,834 1,891 Loans,notes,and mortgages 7,687 7,712 Long-term borrowings $57,563 $58,237 Non-trading derivatives 1,429 2,725 794 1,269 - -------------------------------------------------------------------------------- (1) Merchant banking equity investments are non-qualifying for SFAS No. 115 purposes. Fair value for merchant banking equity investments, including partnership interests (included in Other investments on the Consolidated Balance Sheets), is estimated using a number of methods, including earnings multiples, cash flow analyses, and review of underlying financial conditions and other market factors. These instruments may be subject to restrictions (e.g., consent of other investors) that may limit Merrill Lynch's ability to realize currently the estimated fair value. Accordingly, Merrill Lynch's current estimate of fair value and the ultimate realization on these instruments may differ. Included in merchant banking and other financial instruments in the previous table is Merrill Lynch's investment in Long Term Capital Portfolio, L.P. ("LTCP"). In 1998, in conjunction with 13 other Notes to Consolidated Financial Statements 73 financial institutions, Merrill Lynch made a $300 million capital infusion to LTCP, a hedge fund significantly affected by the 1998 third quarter market turmoil. At December 31, 1999, this investment has been substantially repaid. In addition to investments noted in the previous table, Merrill Lynch also holds a passive minority interest in Bloomberg, L.P., a privately held limited partnership that provides information services to financial institutions. The fair value of the investment is not readily determinable as of December 31, 1999. Management believes, however, that the fair value of this instrument may significantly exceed its carrying value of $28 million. Fair value for loans made in connection with merchant banking activities, consisting primarily of senior and subordinated debt, is estimated using discounted cash flows. Merrill Lynch's estimate of fair value for other loans, notes, and mortgages is determined based on loan characteristics. For certain homogeneous categories of loans, including residential mortgages and home equity loans, fair value is estimated using market price quotations or previously executed transactions for securities backed by similar loans, adjusted for credit risk and other individual loan characteristics. For Merrill Lynch's variable-rate loan receivables, carrying value approximates fair value. The fair values of long-term borrowings and related hedges are estimated using current market prices and pricing models. The fair value of outstanding third party guarantees was $41 million and $54 million at December 31, 1999 and December 25, 1998, respectively. NON-TRADING DERIVATIVES The notional or contractual amounts of non-trading derivatives used to hedge market risk exposures on non-trading assets and liabilities at December 31, 1999 and December 25, 1998 follow: - -------------------------------------------------------------------------------- (in billions) 1999 1998 ---- ---- Borrowings: Interest rate risk(1) $ 44 $ 54 Currency risk 1 - Equity risk 3 1 Investment securities(2) 11 6 Resale and repurchase agreements(2) 6 8 Customer loans(2) 6 2 Investments in non-U.S.subsidiaries(3) 3 4 Other 3 4 - -------------------------------------------------------------------------------- (1) Includes $10 billion and $12 billion of instruments which also contain currency risk and $4 billion and $1 billion of instruments that also contain equity risk at year-end 1999 and 1998, respectively. (2) Primarily hedging interest rate risk. (3) Hedging currency risk. The combined fair value of hedged items and related derivative hedges approximates their combined carrying value at year-end 1999 and 1998. Most of these derivatives are entered into with Merrill Lynch's derivative dealer subsidiaries, which hedge interest rate, currency, and equity risks in the normal course of their trading activities. NOTE 7. PREFERRED SECURITIES ISSUED BY SUBSIDIARIES - --------------------------------------------------- Preferred securities issued by subsidiaries, which represent preferred minority interests in consolidated subsidiaries, primarily consist of perpetual trust- issued preferred securities. Trust Originated Preferred Securities(Service Mark) ("TOPrS"(Service Mark)) are issued to investors by trusts created by Merrill Lynch. Using the issuance proceeds, the trusts purchase Partnership Preferred Securities, representing limited partnership interests. Using the purchase proceeds, the limited partnerships extend loans to ML & Co. and one or more subsidiaries of ML & Co. The trusts and partnerships are consolidated subsidiaries of Merrill Lynch. ML & Co. has guaranteed, on a subordinated basis, the payment in full of all distributions and other payments on the TOPrS to the extent that the trusts have funds legally available. This guarantee and a similar partnership distribution guarantee are subordinated to all other liabilities of ML & Co. and rank equally with preferred stock of ML & Co. The table below presents data related to the issuance of TOPrS by Merrill Lynch Capital Trust I, II, III, IV, and V. All TOPrS issued have a liquidation value of $25 per security, have a perpetual life, and can be redeemed at the option of the trusts, in whole or in part, at the liquidation value on or after their respective optional redemption dates. Distributions are payable from the date of original issuance and are payable quarterly if, as, and when the trusts have funds available for payment. - -------------------------------------------------------------------------------- (in millions) Annual Optional Distribution Issue Redemption Liquidation TOPrS Rate Date Date Value - ----- ------------ --------- ---------- ----------- I 7.75% Dec. 1996 Dec. 2006 $ 275 II 8.00 Feb. 1997 Mar. 2007 300 III 7.00 Jan. 1998 Mar. 2008 750 IV 7.12 Jun. 1998 Jun. 2008 400 V 7.28 Nov. 1998 Sep. 2008 850 Other(1) 2.70 Jul. 1999 Jun. 2004 98 ------- $ 2,673 ======= - ------------------------------------------------------------------------------- (1) Represents Yen-denominated TOPrS issued by Merrill Lynch Yen TOPrS Trust I. In addition, $52 million of preferred securities of other subsidiaries were outstanding at year-end 1999 and 1998. 74 Notes to Consolidated Financial Statements NOTE 8. STOCKHOLDERS' EQUITY AND EARNINGS PER SHARE - --------------------------------------------------- PREFERRED EQUITY ML & Co. is authorized to issue 25,000,000 shares of undesignated preferred stock, $1.00 par value per share. All shares of currently outstanding preferred stock constitute one and the same class that have equal rank and priority over common stockholders as to dividends and in the event of liquidation. 9% Cumulative Preferred Stock, Series A ML & Co. has issued 17,000,000 Depositary Shares, each representing a one-four- hundredth interest in a share of 9% Cumulative Preferred Stock, Series A, liquidation preference value of $10,000 per share ("9% Preferred Stock"). The 9% Preferred Stock is a single series consisting of 42,500 shares with an aggregate liquidation preference of $425 million, all of which was outstanding at year-end 1999, 1998, and 1997. Dividends on the 9% Preferred Stock are cumulative from the date of original issue and are payable quarterly when declared by the authority of the Board of Directors. The 9% Preferred Stock is perpetual and redeemable on or after December 30, 2004 at the option of ML & Co., in whole or in part, at a redemption price equal to $10,000 per share, plus accrued and unpaid dividends (whether or not declared) to the date fixed for redemption. Remarketed Preferred(Service Mark) Stock, Series C During 1997, all outstanding shares of Remarketed Preferred Stock, Series C were redeemed. Dividend rates in effect prior to redemption ranged from 3.80% to 4.15% per annum. COMMON STOCK In 1999, ML & Co. issued 54,601 shares of common stock to certain non-U.S. employees in connection with an employee incentive plan grant, thereby increasing issued shares to 472,714,925. In 1998, stockholders approved the proposal to amend ML & Co.'s certificate of incorporation to increase the authorized number of shares of common stock from 500 million to 1 billion. In 1997, the Board of Directors declared a two-for-one common stock split effected in the form of a 100% stock dividend. The par value of the common stock remained at $1.33 1/3 per share. Accordingly, a transfer from paid-in capital to common stock of $315 million was made to preserve the par value of the post-split shares. All share and per share data have been restated for the effect of the split. Dividends paid on common stock were $1.05, $.92, and $.75 per share in 1999, 1998, and 1997, respectively. The following table summarizes the activity in outstanding common stock for 1999, 1998, and 1997: - -------------------------------------------------------------------------------- 1999 1998 1997 ------------ ------------ ------------ BEGINNING OF YEAR Issued 472,660,324 472,660,324 472,660,324 Shares in treasury (116,376,259) (133,400,971) (137,234,132) ESOP reversion shares - - (3,077,556) ------------ ------------ ------------ Outstanding 356,284,065 339,259,353 332,348,636 ------------ ------------ ------------ ACTIVITY Common stock issued 54,601 - - Shares purchased - - (13,301,100) Shares issued from treasury: To employees(1)(2) 10,930,248 16,291,477 20,211,817 Share exchanges 496,416 325,459 - Acquisition - 407,776 - ------------ ------------ ------------ Net activity 11,481,265 17,024,712 6,910,717 ------------ ------------ ------------ END OF YEAR Issued 472,714,925 472,660,324 472,660,324 Shares in treasury (104,949,595) (116,376,259) (133,400,971) ------------ ------------ ------------ Outstanding 367,765,330 356,284,065 339,259,353 ============ ============ ============ - -------------------------------------------------------------------------------- (1) Net of reacquisitions from employees of 177,066, 348,466, and 440,016 in 1999, 1998, and 1997, respectively. (2) See Note 11 for a description of employee incentive plans. SHARES EXCHANGEABLE INTO COMMON STOCK In 1998, Merrill Lynch & Co., Canada Ltd. issued 4,831,224 Exchangeable Shares in connection with Merrill Lynch's merger with Midland Walwyn (see Note 2). Holders of Exchangeable Shares have dividend, voting, and other rights equivalent to those of ML & Co. common stockholders. Exchangeable Shares may be exchanged at any time, at the option of the holder, on a one-for-one basis for ML & Co. common stock. Merrill Lynch may redeem all outstanding Exchangeable Shares for ML & Co. common stock after January 31, 2011, or earlier under certain circumstances. During 1999 and 1998, 496,416 and 325,459 Exchangeable Shares, respectively, were converted to ML & Co. common stock. At year-end 1999, 4,009,349 Exchangeable Shares were outstanding, compared with 4,505,765 at year-end 1998. ACCUMULATED OTHER COMPREHENSIVE LOSS Accumulated other comprehensive loss represents net cumulative gains and losses on items that are not reflected in earnings. The components at December 31, 1999 and December 25, 1998 are as follows: Notes to Consolidated Financial Statements 75 - -------------------------------------------------------------------------------- (in millions) 1999 1998 ----- ----- FOREIGN CURRENCY TRANSLATION ADJUSTMENT Unrealized losses,net of gains $(357) $(241) Income taxes 55 103 ----- ----- Total (302) (138) ----- ----- UNREALIZED GAINS (LOSSES) ON INVESTMENT SECURITIES AVAILABLE-FOR-SALE Net unrealized gains (losses) (167) 56 Adjustments for: Policyholder liabilities (3) (38) Deferred policy acquisition costs 35 - Income taxes 48 (2) ----- ----- Total (87) 16 ----- ----- TOTAL ACCUMULATED OTHER COMPREHENSIVE LOSS $(389) $(122) ===== ===== - -------------------------------------------------------------------------------- STOCKHOLDER RIGHTS PLAN In 1997, the Board of Directors approved and adopted the amended and restated Stockholder Rights Plan. The amended and restated Stockholder Rights Plan provides for the distribution of preferred purchase rights ("Rights") to common stockholders. The Rights separate from the common stock ten days following the earlier of: (a) an announcement of an acquisition by a person or group ("acquiring party") of 15% or more of the outstanding common shares of ML & Co., or (b) the commencement of a tender or exchange offer for 15% or more of the common shares outstanding. One Right is attached to each outstanding share of common stock and will attach to all subsequently issued shares. Each Right entitles the holder to purchase 1/100 of a share (a "Unit") of Series A Junior Preferred Stock, par value $1.00 per share, at an exercise price of $300 per Unit at any time after the distribution of the Rights. The Units are nonredeemable and have voting privileges and certain preferential dividend rights. The exercise price and the number of Units issuable are subject to adjustment to prevent dilution. If, after the Rights have been distributed, either the acquiring party holds 15% or more of ML & Co.'s outstanding shares or ML & Co. is a party to a business combination or other specifically defined transaction, each Right (other than those held by the acquiring party) will entitle the holder to receive, upon exercise, a Unit of preferred stock or shares of common stock of the surviving company with a value equal to two times the exercise price of the Right. The Rights expire in 2007, and are redeemable at the option of a majority of the directors of ML & Co. at $.01 per Right at any time until the tenth day following an announcement of the acquisition of 15% or more of ML & Co.'s common stock. EARNINGS PER SHARE Basic earnings per share ("EPS") is calculated by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding. Diluted EPS is similar to basic EPS, but adjusts for the effect of the potential issuance of common shares. The following table presents the computations of basic and diluted EPS: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ------ ------ ------ Net earnings $2,618 $1,259 $1,935 Preferred stock dividends 38 39 39 ------ ------ ------ Net earnings applicable to common stockholders $2,580 $1,220 $1,896 ====== ====== ====== - -------------------------------------------------------------------------------- (shares in thousands) Weighted-average shares outstanding (basic shares)(1) 368,718 355,589 340,096 ------- ------- ------- Effect of dilutive instruments(2) Employee stock options 27,850 29,184 29,748 FCCAAP shares 15,947 16,548 20,574 Restricted units 5,569 4,895 5,258 ESPP shares 47 46 45 Convertible debt - - 134 ------- ------- ------- Dilutive potential common shares 49,413 50,673 55,759 ------- ------- ------- Diluted shares(3) 418,131 406,262 395,855 ======= ======= ======= - -------------------------------------------------------------------------------- Basic EPS $7.00 $3.43 $5.57 Diluted EPS 6.17 3.00 4.79 - -------------------------------------------------------------------------------- (1) Includes shares exchangeable into common stock. (2) See Note 11 for a description of these instruments and issuances subsequent to December 31, 1999. (3) At year-end 1999, 1998, and 1997, there were 1,575, 486, and 7 instruments, respectively, that were considered antidilutive and thus were not included in the above calculations. NOTE 9. COMMITMENTS AND CONTINGENCIES - ------------------------------------- LITIGATION At December 31, 1999, Merrill Lynch has been named as parties in various actions, some of which involve claims for substantial amounts. Although the results of legal actions cannot be predicted with certainty, it is the opinion of management that the resolution of these actions will not have a material adverse effect on Merrill Lynch's financial condition; however, such resolution could have a material adverse impact on quarterly operating results in future periods, depending in part on the results for such periods. LENDING AND GUARANTEES Merrill Lynch enters into commitments to extend credit, predominantly at variable interest rates, in connection with certain merchant banking and loan syndication transactions. Customers may also be extended loans or lines of credit collateralized by first and second mortgages on real estate, certain liquid assets of small businesses, or securities. Merrill Lynch also issues various guarantees to counterparties in connection with certain leasing, securitization, and other transactions. These commit- 76 Notes to Consolidated Financial Statements ments and guarantees usually have a fixed expiration date and are contingent on certain contractual conditions that may require payment of a fee by the counterparty. Once commitments are drawn upon or guarantees are issued, Merrill Lynch may require the counterparty to post collateral depending upon creditworthiness and market conditions. The contractual amounts of these commitments and guarantees represent the amounts at risk should the contract be fully drawn upon, the client default, and the value of the existing collateral become worthless. The total amount of outstanding commitments and guarantees may not represent future cash requirements, as commitments and guarantees may expire without being drawn upon. At December 31, 1999 and December 25, 1998, Merrill Lynch had the following commitments and guarantees: - -------------------------------------------------------------------------------- (in millions) 1999 1998 ---- ---- Commitments to extend credit $ 14,871 $ 15,937 Third party guarantees 1,739 17,842 - -------------------------------------------------------------------------------- LEASES Merrill Lynch has entered into various noncancelable long-term lease agreements for premises that expire through 2025. Merrill Lynch has also entered into various noncancelable short-term lease agreements, which are primarily commitments of less than one year under equipment leases. At December 31, 1999, future noncancelable minimum rental commitments under leases with remaining terms exceeding one year are as follows: - -------------------------------------------------------------------------------- (in millions) WFC(1) Other Total ------ ------ ------ 2000 $ 144 $ 346 $ 490 2001 145 313 458 2002 150 272 422 2003 158 217 375 2004 179 176 355 2005 and thereafter 1,564 671 2,235 ------ ------ ------ Total $2,340 $1,995 $4,335 ====== ====== ====== - -------------------------------------------------------------------------------- (1) World Financial Center Headquarters. The minimum rental commitments shown above have not been reduced by $674 million of minimum sublease rentals to be received in the future under noncancelable subleases. Certain leases contain renewal or purchase options or escalation clauses providing for increased rental payments based upon maintenance, utility, and tax increases. Net rent expense for each of the last three years is presented below: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ----- ----- ----- Rent expense $ 585 $ 537 $ 468 Sublease revenue (101) (112) (104) ----- ----- ----- Net rent expense $ 484 $ 425 $ 364 ===== ===== ===== - -------------------------------------------------------------------------------- OTHER COMMITMENTS In the normal course of business, Merrill Lynch enters into commitments for underwriting transactions. Settlement of these transactions as of December 31, 1999, would not have a material effect on the consolidated financial condition of Merrill Lynch. In connection with trading activities, Merrill Lynch had commitments at December 31, 1999 and December 25, 1998 to enter into resale and repurchase agreements as follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 ------- ------- Resale agreements $ 850 $ 5,392 Repurchase agreements 1,624 4,456 - -------------------------------------------------------------------------------- Merrill Lynch also obtains letters of credit from issuing banks to satisfy various counterparty collateral requirements in lieu of depositing cash or securities collateral. Letters of credit aggregated $2,585 million and $2,222 million at December 31, 1999 and December 25, 1998, respectively. In connection with merchant banking activities, Merrill Lynch has committed to purchase $252 million and $369 million of partnership interests at December 31, 1999 and December 25, 1998, respectively. Merrill Lynch has entered into agreements with providers of market data, communications, and systems consulting services. At December 31, 1999, minimum fee commitments over the remaining life of these agreements aggregated $223 million. NOTE 10. EMPLOYEE BENEFIT PLANS - ------------------------------- Merrill Lynch provides retirement and other postemployment benefits to its employees worldwide through defined contribution and defined benefit pension plans and other postretirement benefit plans. Merrill Lynch reserves the right to amend or terminate these plans at any time. In 1999, Merrill Lynch changed its measurement date for both its defined benefit pension and other postretirement benefit plans from year-end to September quarter-end. Prior period information has not been restated since the impact of the change is not material. Notes to Consolidated Financial Statements 77 DEFINED CONTRIBUTION PENSION PLANS The U.S. defined contribution plans consist of the Retirement Accumulation Plan ("RAP"), the Employee Stock Ownership Plan ("ESOP"), and the 401(k) Savings & Investment Plan ("401K"). The RAP, ESOP, and 401K cover substantially all U.S. employees who have met service requirements. Merrill Lynch established the RAP and the ESOP, collectively known as the "Retirement Program," for the benefit of employees with one year of service. A separate retirement account is maintained for each participant. In 1989, the ESOP trust purchased from Merrill Lynch 47,851,236 shares of ML & Co. common stock with residual funds from a terminated defined benefit pension plan ("Reversion Shares") and loan proceeds from a subsidiary of Merrill Lynch ("Leveraged Shares"). Merrill Lynch credited a participant's account and recorded pension expense under the Retirement Program based on years of service and eligible compensation. This expense is funded by quarterly allocations of Leveraged and Reversion Shares and, when necessary, cash, to participants' accounts based on a specified formula. Leveraged and Reversion Shares are released in accordance with the terms of the ESOP. Reversion Shares were allocated to participants' accounts over a period of eight years, ending in 1997. Leveraged Shares were allocated to participants' accounts as principal was repaid on the loan to the ESOP, which matured in 1999. Principal and interest on the loan were payable quarterly upon receipt of dividends on certain shares of common stock or other cash contributions. At December 31, 1999, all Reversion and Leveraged Shares had been allocated. Additional information on ESOP activity follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ---- ---- ---- Compensation costs funded with ESOP shares $ 49 $ 49 $ 193 Dividends used for debt service(1) 2 7 7 - -------------------------------------------------------------------------------- (1) Dividends on all Leveraged Shares were used for debt service on the ESOP loan through April 1, 1999. Dividends on unallocated Leveraged Shares only were used for this purpose through the end of the 1999 third quarter, when the loan was repaid. Employees can participate in the 401K by contributing, on a tax-deferred basis, up to 15% of their eligible compensation, but not more than the maximum annual amount allowed by law. Merrill Lynch's contributions are equal to one-half of the first 4% of each participant's eligible compensation contributed to the 401K, up to a maximum of fifteen hundred dollars annually. No corporate contributions are made for participants who are also Employee Stock Purchase Plan participants (see Note 11). Merrill Lynch also sponsors various non-U.S. defined contribution plans. The costs of benefits under the RAP, 401K, and non-U.S. plans are expensed during the related service period. DEFINED BENEFIT PENSION PLANS Merrill Lynch has purchased a group annuity contract that guarantees the payment of benefits vested under a U.S. defined benefit plan that was terminated in accordance with the applicable provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). At year-end 1999 and 1998, a substantial portion of the assets supporting the annuity contract was invested in U.S. Government and agencies securities. Merrill Lynch, under a supplemental agreement, may be responsible for, or benefit from, actuarial experience and investment performance of the annuity assets. Merrill Lynch also maintains supplemental defined benefit plans for certain U.S. employees. Employees of certain non-U.S. subsidiaries participate in various local defined benefit plans. These plans provide benefits that are generally based on years of credited service and a percentage of the employee's eligible compensation during the final years of employment. Merrill Lynch's funding policy has been to contribute annually the amount necessary to satisfy local funding standards. The following table provides a summary of the changes in the plans' benefit obligations, assets, and funded status for the nine-month period ended September 24, 1999 and the year ended December 25, 1998 and the amounts recognized in the Consolidated Balance Sheets at year-end 1999 and 1998: 78 Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (in millions) 1999 1998 ------- ------- PROJECTED BENEFIT OBLIGATIONS Balance, beginning of year $ 2,090 $ 1,928 Service cost 49 54 Interest cost 114 122 Net actuarial (gain) loss (170) 55 Benefits paid (68) (77) Other (28) 8 ------- ------- Balance, end of period 1,987 2,090 ------- ------- FAIR VALUE OF PLAN ASSETS Balance, beginning of year 2,410 2,151 Actual return on plan assets (156) 282 Contributions 55 46 Benefits paid (68) (77) Other (25) 8 ------- ------- Balance, end of period 2,216 2,410 ------- ------- FUNDED STATUS 229 320 Unrecognized net actuarial gains (103) (215) Unrecognized prior service cost (benefit) (1) 3 Unrecognized net transition obligation 2 2 Fourth quarter activity net 11 - ------- ------- NET AMOUNT RECOGNIZED $ 138 $ 110 ======= ======= Assets $ 265 $ 234 Liabilities (127) (124) ------- ------- NET AMOUNT RECOGNIZED $ 138 $ 110 ======= ======= - -------------------------------------------------------------------------------- The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $119 million, $103 million, and $57 million, respectively, as of September 24, 1999, and $111 million, $96 million, and $50 million, respectively, as of December 25, 1998. These plans primarily represent U.S. supplemental plans not subject to ERISA or non-U.S. plans where funding strategies vary due to legal requirements and local practices. The actuarial assumptions used in calculating the projected benefit obligation at September 24, 1999 and December 25, 1998 are as follows: - -------------------------------------------------------------------------------- 1999 1998 ---- ---- Discount rate 6.5% 5.5% Rate of compensation increase 4.0 5.7 Expected rate of return on plan assets 6.7 6.2 - -------------------------------------------------------------------------------- Pension cost included the following components: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ----- ----- ----- DEFINED CONTRIBUTION PLAN COST $ 234 $ 177 $ 218 ----- ----- ----- DEFINED BENEFIT PLANS Service cost for benefits earned during the year 49 54 32 Interest cost on projected benefits obligation 114 122 109 Expected return on plan assets (136) (141) (121) Deferral and amortization of unrecognized items - 7 - ----- ----- ----- Total defined benefit plan cost 27 42 20 ----- ----- ----- TOTAL PENSION COST $ 261 $ 219 $ 238 ===== ===== ===== - -------------------------------------------------------------------------------- POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Merrill Lynch provides health and life insurance benefits to retired employees under a plan that covers substantially all U.S. employees who have met age and service requirements. The health care component is contributory, with certain retiree contributions adjusted periodically; the life insurance component of the plan is noncontributory. The accounting for costs of health care benefits anticipates future changes in cost-sharing provisions. Merrill Lynch pays claims as incurred. Full-time employees of Merrill Lynch become eligible for these benefits upon attainment of age 55 and completion of ten years of service. Merrill Lynch also sponsors similar plans that provide health care benefits to retired employees of certain non-U.S. subsidiaries. At December 31, 1999, none of these plans had been funded. The following table provides a summary of the changes in the plans' benefit obligations, assets, and funded status for the nine-month period ended September 24, 1999 and the year-ended December 25, 1998, and the amounts recognized in the Consolidated Balance Sheets at year-end 1999 and 1998: - -------------------------------------------------------------------------------- (in millions) 1999 1998 ----- ----- ACCUMULATED BENEFIT OBLIGATIONS Balance, beginning of year $ 214 $ 211 Service cost 9 8 Interest cost 14 13 Net actuarial gain (33) (12) Benefits paid (8) (7) Other (2) 1 ----- ----- Balance, end of period 194 214 ----- ----- FAIR VALUE OF PLAN ASSETS Balance, beginning of year - - Contributions 8 7 Benefits paid (8) (7) ----- ----- Balance, end of period - - ----- ----- FUNDED STATUS (194) (214) Unrecognized net actuarial gain (37) (3) Unrecognized prior service cost - (1) Fourth quarter activity, net 2 - ----- ----- ACCRUED BENEFIT LIABILITIES $(229) $(218) ===== ===== - -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements 79 The actuarial assumptions used in calculating the postretirement accumulated benefit obligations at September 24, 1999 and December 25, 1998 are as follows: - -------------------------------------------------------------------------------- 1999 1998 ---- ---- Discount rate 7.5% 6.3% Health care cost trend rates(1) Initial 8.4 7.0 2012 and thereafter 5.0 5.5 - -------------------------------------------------------------------------------- (1) Assumed to decrease gradually until 2012 and remain constant thereafter. Other postretirement benefits cost included the following components: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ---- ---- ---- Service cost $ 9 $ 8 $ 6 Interest cost 14 13 11 Other (4) - - ---- ---- ---- Total other postretirement benefits cost $ 19 $ 21 $ 17 ==== ==== ==== - -------------------------------------------------------------------------------- The assumed health care cost trend rate has a significant effect on the amounts reported for the health care plans. A one percent change in the assumed health care cost trend rate would have the following effects: - -------------------------------------------------------------------------------- (in millions) 1% INCREASE 1% DECREASE --------------- --------------- 1999 1998 1999 1998 ---- ---- ---- ---- Effect on: Other postretirement benefits cost $ 5 $ 4 $ (4) $ (4) Accumulated benefit obligation 29 35 (24) (30) - -------------------------------------------------------------------------------- POSTEMPLOYMENT BENEFITS Merrill Lynch provides certain postemployment benefits for employees on extended leave due to injury or illness and for terminated employees. Employees who are disabled due to non-work-related illness or injury are entitled to disability income, medical coverage, and life insurance. Merrill Lynch also provides severance benefits to terminated employees. In addition, Merrill Lynch is mandated by U.S. state and federal regulations to provide certain other postemployment benefits. Merrill Lynch funds these benefits through a combination of self-insured and insured plans. Merrill Lynch recognized $33 million, $439 million, and $30 million in 1999, 1998, and 1997, respectively, of postemployment benefits expense, which included severance costs for terminated employees of $26 million, $424 million, and $18 million in 1999, 1998, and 1997, respectively. The severance costs for 1998 include amounts related to the staff reduction provision (see Note 2). Although all full-time employees are eligible for severance benefits, no additional amounts were accrued as of December 31, 1999 since future severance costs are not estimable. NOTE 11. EMPLOYEE INCENTIVE PLANS - --------------------------------- To align the interests of employees with those of stockholders, Merrill Lynch sponsors several employee compensation plans that provide eligible employees with stock or options to purchase shares. The total compensation cost recognized in earnings for stock-based compensation plans for 1999, 1998, and 1997 was $463 million, $453 million, and $318 million, respectively. Merrill Lynch also sponsors deferred cash compensation plans for eligible employees. LONG-TERM INCENTIVE COMPENSATION PLANS ("LTIC PLANS") AND EQUITY CAPITAL ACCUMULATION PLAN ("ECAP") LTIC Plans and ECAP provide for grants of equity and equity-related instruments to certain employees. LTIC Plans provide for the issuance of Restricted Shares, Restricted Units, and Nonqualified Stock Options, as well as Incentive Stock Options, Performance Shares, Performance Units, Performance Options, Stock Appreciation Rights, and other securities of Merrill Lynch. ECAP provides for the issuance of Restricted Shares, as well as Performance Shares. As of December 31, 1999, no instruments other than Restricted Shares, Restricted Units, Nonqualified Stock Options, and Performance Options had been granted. Restricted Shares and Units Restricted Shares are shares of ML & Co. common stock carrying voting and dividend rights. A Restricted Unit is deemed equivalent in fair market value to one share of common stock, is payable in cash or shares of common stock, and receives cash payments equivalent to dividends. Under these plans, such shares and units are restricted from sale, transfer, or assignment until the end of the restricted period, and such shares and units are subject to forfeiture during the vesting period for grants under LTIC Plans or the restricted period for grants under ECAP. The activity for Restricted Shares and Units under these plans during 1999 and 1998 follows: 80 Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- LTIC Plans ECAP ----------------------- ---------- Restricted Restricted Restricted Shares Units Shares ---------- ---------- ---------- AUTHORIZED FOR ISSUANCE AT: December 31, 1999 240,000,000 N/A 52,400,000 December 25, 1998 240,000,000 N/A 52,400,000 - -------------------------------------------------------------------------------- AVAILABLE FOR ISSUANCE AT:(1) December 31, 1999 38,638,551 N/A 2,889,840 December 25, 1998 69,342,410 N/A 2,985,313 - -------------------------------------------------------------------------------- OUTSTANDING, END OF 1997 9,846,146 9,897,742 3,880,565 Granted - 1998 4,389,218 4,641,545 6,443 Paid, forfeited, or released from contingencies (519,246) (3,680,398) (68,398) ---------- ---------- ---------- OUTSTANDING, END OF 1998 13,716,118 10,858,889 3,818,610 Granted - 1999 181,785 5,012,283 207,900 Paid, forfeited, or released from contingencies (777,753) (3,288,730) (195,713) ---------- ---------- ---------- OUTSTANDING, END OF 1999(2) 13,120,150 12,582,442 3,830,797 ========== ========== ========== - -------------------------------------------------------------------------------- (1) Includes shares reserved for issuance upon the exercise of stock options. (2) In February 2000, 100,836 and 6,774,239 Restricted Shares and Units under LTIC Plans, respectively, were granted to eligible employees. The weighted-average fair value per share or unit for 1999, 1998, and 1997 grants follows: - -------------------------------------------------------------------------------- 1999 1998 1997 ------- ------- ------- LTIC Plans Restricted Shares $ 75.80 $ 65.95 $ 46.31 Restricted Units 74.98 64.77 44.47 ECAP Restricted Shares 85.36 81.78 66.99 - -------------------------------------------------------------------------------- Merrill Lynch sponsors other plans similar to LTIC Plans in which restricted shares and units are granted to employees and non-employee directors. The accompanying table summarizes information related to restricted shares and units for these other plans: - -------------------------------------------------------------------------------- Restricted Restricted Shares Units ---------- ---------- AUTHORIZED FOR ISSUANCE AT: December 31, 1999 6,300,000 400,000 December 25, 1998 6,300,000 400,000 OUTSTANDING AT: December 31, 1999 269,909 37,936 December 25, 1998 316,823 40,051 - -------------------------------------------------------------------------------- Nonqualified Stock Options Nonqualified Stock Options granted under LTIC Plans in 1989 through 1995 generally become exercisable over four years in equal installments commencing one year after the date of grant. Options granted in 1996 and thereafter generally are exercisable over five years. The exercise price of these options is equal to 100% of the fair market value (as defined in LTIC Plans) of a share of ML & Co. common stock on the date of grant. Nonqualified Stock Options expire ten years after their grant date. In 1999, Merrill Lynch granted performance options under the LTIC plan. These options vest based on Merrill Lynch's achievement of performance criteria over a period not exceeding nine years. At consummation of Merrill Lynch's merger with Midland Walwyn (see Note 2), each Midland Walwyn optionholder received 0.24 options on ML & Co. common stock, with the vesting period and contractual life identical to the terms of the original grant. The activity for Nonqualified Stock Options and Performance Options under LTIC Plans and Midland Walwyn options for 1999, 1998, and 1997 follows: - -------------------------------------------------------------------------------- Weighted- Options Average Outstanding Exercise Price ----------- -------------- OUTSTANDING, BEGINNING OF 1997 64,500,802 $ 16.84 Granted - 1997 15,564,256 42.15 Exercised (9,226,197) 12.46 Forfeited (1,387,935) 31.25 ---------- OUTSTANDING, END OF 1997 69,450,926 22.78 Granted - 1998 12,119,989 62.76 Exercised (7,968,828) 15.82 Forfeited (708,303) 44.88 ---------- OUTSTANDING, END OF 1998 72,893,784 29.97 Granted - 1999 29,924,940 72.00 Exercised (7,485,120) 17.90 Forfeited (2,818,160) 63.89 ---------- OUTSTANDING, END OF 1999(1) 92,515,444 55.97 ========== - -------------------------------------------------------------------------------- (1) In January 2000, 19,825,344 Nonqualified Stock Options were granted to eligible employees. At year-end 1999, 1998, and 1997, options exercisable were 41,784,354, 38,810,615, and 36,665,520, respectively. The table below summarizes information related to outstanding and exercisable options at year-end 1999.
- ------------------------------------------------------------------------------------------------------------------------------------ Options Outstanding Options Exercisable ------------------------------------------------------------- ------------------------------- Weighted- Weighted- Weighted- Average Average Average Number Exercise Remaining Number Exercise Exercise Price Outstanding Price Life (years)(1) Exercisable Price - --------------- ----------- --------- --------------- ----------- --------- $5.00 - $19.99 22,870,268 $ 13.57 2.88 22,870,268 $ 13.57 $20.00 - $39.99 17,439,967 25.37 5.42 12,300,933 24.49 $40.00 - $71.99 23,898,079 51.41 7.64 6,550,257 40.63 $72.00 - $89.99 28,307,130 72.55 9.20 62,896 89.53 - ------------------------------------------------------------------------------------------------------------------------------------
(1) Based on original contractual life of ten years. Notes to Consolidated Financial Statements 81 The weighted-average fair value of options granted in 1999, 1998, and 1997 was $24.78, $21.43, and $14.63 per option, respectively. Fair value is estimated as of the grant date based on a Black-Scholes option pricing model using the following weighted-average assumptions: - -------------------------------------------------------------------------------- 1999 1998 1997 ------ ------ ------ Risk-free interest rate 4.67% 5.81% 6.74% Expected life 5 yrs. 6 yrs. 6 yrs. Expected volatility 40.89% 28.10% 26.86% Dividend yield 1.33% 1.28% 1.47% - -------------------------------------------------------------------------------- See Pro Forma Compensation Expense in the following Employee Stock Purchase Plans section for additional information. EMPLOYEE STOCK PURCHASE PLANS ("ESPP") ESPP plans allow eligible employees to invest from 1% to 10% of their eligible compensation to purchase ML & Co. common stock at a price generally equal to 85% of its fair market value. These purchases are made on four quarterly investment dates through payroll deductions. Up to 50,300,000 shares of common stock have been authorized for issuance under ESPP. The activity in ESPP during 1999, 1998, and 1997 follows: - -------------------------------------------------------------------------------- 1999 1998 1997 --------- --------- --------- Available,beginning of year 5,990,095 7,251,343 8,267,360 Authorized during year - - 300,000 Purchased through plan (1,376,274) (1,261,248) (1,316,017) --------- --------- --------- Available,end of year 4,613,821 5,990,095 7,251,343 ========= ========= ========= - -------------------------------------------------------------------------------- The weighted-average fair value of ESPP stock purchase rights exercised by employees in 1999, 1998, and 1997 was $12.50, $11.31, and $7.66 per right, respectively. Pro Forma Compensation Expense No compensation expense has been recognized for Merrill Lynch's grants of stock options under LTIC Plans or ESPP purchase rights (see Note 1 for accounting policy). Pro forma compensation expense associated with option grants is recognized over the vesting period. Based on the fair value of stock options and purchase rights, Merrill Lynch would have recognized compensation expense, net of taxes, of $292 million, $95 million, and $56 million for 1999, 1998, and 1997, respectively, resulting in pro forma net earnings and earnings per share as follows: - -------------------------------------------------------------------------------- (in millions, except per share amounts) 1999 1998 1997 -------- -------- -------- NET EARNINGS As reported $ 2,618 $ 1,259 $ 1,935 Pro forma 2,326 1,164 1,879 EARNINGS PER SHARE As reported: Basic $ 7.00 $ 3.43 $ 5.57 Diluted 6.17 3.00 4.79 Pro forma: Basic 6.21 3.16 5.41 Diluted 5.47 2.77 4.65 - -------------------------------------------------------------------------------- FINANCIAL CONSULTANT CAPITAL ACCUMULATION AWARD PLANS ("FCCAAP") Under FCCAAP, eligible employees in Private Client are granted awards generally based upon their prior year's performance. Payment for an award is contingent upon continued employment for a period of time and is subject to forfeiture during that period. The award is generally payable ten years from the date of grant in a fixed number of shares of ML & Co. common stock unless the fair market value of such shares is less than a specified minimum value plus interest, in which case the minimum value is paid in cash. Eligible participants may defer awards beyond the scheduled payment date. FCCAAP may also provide for the issuance of Restricted Shares that vest ten years from the date of the original award and carry voting and dividend rights. Only shares of common stock held as treasury stock may be issued under FCCAAP. At December 31, 1999, shares subject to outstanding awards totaled 28,262,763, while 15,518,581 shares were available for issuance through future awards. The fair value of awards granted under FCCAAP during 1999, 1998, and 1997 was $71.44, $67.94, and $42.09 per award, respectively. INCENTIVE EQUITY PURCHASE PLAN ("IEPP") IEPP allowed selected employees to purchase shares of ML & Co. common stock ("Book Value Shares") at a price equal to book value per common share. Book Value Shares, which otherwise may not be resold, may be sold back to Merrill Lynch at book value or exchanged at any time for a specified number of freely transferable common shares. Book Value Shares outstanding under IEPP were 1,743,500 at December 31, 1999. In 1995, IEPP was amended to reduce the authorized shares to zero and prohibit the reuse of any surrendered shares. No further offerings will be made under this plan. MERRILL LYNCH INVESTMENT CERTIFICATE PROGRAM ("MLICP") Under MLICP, eligible employees in Private Client are issued investment certificates based on their performance. The certificates mature ten years from the date issued and are 82 Notes to Consolidated Financial Statements payable in cash if certain performance criteria are achieved and the employee is continuously employed for the ten-year period, with certain exceptions. The certificates bear interest commencing with the date on which the performance requirements are achieved. At year-end 1999 and 1998, $409 million and $353 million, respectively, were accrued under this plan. OTHER DEFERRED COMPENSATION PLANS Merrill Lynch sponsors other deferred compensation plans in which eligible employees may participate. Generally, contributions to the plans are made on a tax-deferred basis by participants. Contributions are invested by Merrill Lynch in mutual funds and other funds sponsored by Merrill Lynch, and the plans may include a leverage feature. The plans' investments and the amounts accrued by Merrill Lynch under the plans are both included in the Consolidated Balance Sheets. Plan investments totaled $1.2 billion and $648 million, respectively, at December 31, 1999 and December 25, 1998. Accrued liabilities at those dates were $1.0 billion and $587 million, respectively. NOTE 12. INCOME TAXES - --------------------- Income tax provisions (benefits) on earnings consisted of: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ------- ----- ------- U.S. FEDERAL Current $ 773 $ 673 $ 856 Deferred (80) (180) (94) U.S.STATE AND LOCAL Current (34) 105 (15) Deferred (42) 10 7 NON-U.S. Current 617 412 400 Deferred 31 (307) (25) ------- ----- ------- TOTAL $ 1,265 $ 713 $ 1,129 ======= ===== ======= - -------------------------------------------------------------------------------- The corporate statutory tax rate was 35.0% for the three years presented. A reconciliation of statutory U.S. federal income taxes to Merrill Lynch's income tax provisions for earnings follows: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ------- ----- ------- U.S.federal income tax at statutory rate $ 1,427 $ 734 $ 1,089 U.S.state and local income taxes,net(1) (49) 74 (5) Non-U.S.operations (80) (71) 1 Tax-exempt interest (64) (51) (26) Dividends received deduction (28) (30) (33) Other,net 59 57 103 ------- ----- ------- Income tax expense $ 1,265 $ 713 $ 1,129 ======= ===== ======= - -------------------------------------------------------------------------------- (1) Includes adjustments to prior year accruals. Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the Consolidated Balance Sheets. These temporary differences result in taxable or deductible amounts in future years. Details of Merrill Lynch's deferred tax assets and liabilities follow: - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 ------- ------- ------- DEFERRED TAX ASSETS Deferred compensation $ 1,020 $ 679 $ 478 Valuation and other reserves(1) 782 1,225 940 Employee benefits 185 120 109 Other 621 375 116 ------- ------- ------- Gross deferred tax assets 2,608 2,399 1,643 Valuation allowances(2) (82) (42) (26) ------- ------- ------- Total deferred tax assets 2,526 2,357 1,617 ------- ------- ------- DEFERRED TAX LIABILITIES Lease transactions 143 148 116 Employee benefits 74 64 58 Other 295 207 204 ------- ------- ------- Total deferred tax liabilities 512 419 378 ------- ------- ------- NET DEFERRED TAX ASSETS $ 2,014 $ 1,938 $ 1,239 ======= ======= ======= - -------------------------------------------------------------------------------- (1) Primarily related to Trading assets and Other payables. (2) Related to net operating loss carryforwards not expected to be realized. At December 31, 1999, Merrill Lynch had U.S. net operating loss carryforwards of $310 million and non-U.S. net operating loss carryforwards of $370 million. The U.S. amounts are primarily state carryforwards expiring in various years after 2005 and the non-U.S. amounts are primarily Japanese carryforwards expiring in various years after 2002. Income tax benefits of $281 million, $336 million, and $173 million were allocated to stockholders' equity related to employee compensation transactions for 1999, 1998, and 1997, respectively. Earnings before income taxes included approximately $1,447 million, $44 million, and $805 million of earnings attributable to non-U.S. subsidiaries for 1999, 1998, and 1997, respectively. Cumulative undistributed earnings of non-U.S. subsidiaries not previously taxed in the U.S. were approximately $3.3 billion at December 31, 1999. No deferred U.S. federal income taxes have been provided for the undistributed earnings to the extent that they are permanently reinvested in Merrill Lynch's non-U.S. operations. Merrill Lynch estimates that approximately $160 million of non-U.S. withholding taxes and, assuming utilization of foreign tax credits, approximately $300 million of U.S. federal income taxes would be incurred on the repatriation of such earnings. Notes to Consolidated Financial Statements 83 NOTE 13. REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS - ---------------------------------------------------------- MLPF&S, a U.S. registered broker-dealer, is subject to the net capital requirements of Rule 15c3-1 under the Securities Exchange Act of 1934. Under the alternative method permitted by this rule, the minimum required net capital, as defined, shall not be less than 2% of aggregate debit items arising from customer transactions. At December 31, 1999, MLPF&S's regulatory net capital of $3,352 million was 12% of aggregate debit items, and its regulatory net capital in excess of the minimum required was $2,780 million. MLI, a U.K. registered broker-dealer, is subject to capital requirements of the Financial Services Authority ("FSA"). Financial resources, as defined, must exceed the total financial resources requirement of the FSA. In 1997, MLI became Merrill Lynch's primary global equity derivatives dealer (previously Merrill Lynch Capital Markets PLC). At December 31, 1999, MLI's financial resources were $3,747 million, exceeding the minimum requirement by $492 million. MLGSI, a primary dealer in U.S. Government securities, is subject to the capital adequacy requirements of the Government Securities Act of 1986. This rule requires dealers to maintain liquid capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At December 31, 1999, MLGSI's liquid capital of $1,739 million was 481% of its total market and credit risk, and liquid capital in excess of the minimum required was $1,305 million. Merrill Lynch's insurance subsidiaries are subject to various regulatory restrictions that limit the amount available for distribution as dividends. At December 31, 1999, $444 million, representing 88% of the insurance subsidiaries' net assets, was unavailable for distribution to Merrill Lynch. Approximately 80 other subsidiaries are subject to regulatory and other requirements of the jurisdictions in which they operate. These regulatory restrictions may limit the amounts that these subsidiaries can pay in dividends or advance to Merrill Lynch. At December 31, 1999, restricted net assets of these subsidiaries were $5.3 billion. In addition, to satisfy rating agency standards, a credit intermediary subsidiary of Merrill Lynch must also meet certain minimum capital requirements. At December 31, 1999, this minimum capital requirement was $288 million. With the exception of regulatory restrictions on subsidiaries' abilities to pay dividends, there are no restrictions on ML & Co.'s present ability to pay dividends on common stock, other than (1) ML & Co.'s obligation to make payments on its TOPrS, and (2) the governing provisions of the Delaware General Corporation Law. NOTE 14. SEGMENT, PRODUCT, AND GEOGRAPHIC INFORMATION - ----------------------------------------------------- SEGMENT INFORMATION In reporting to management during 1999, Merrill Lynch's operating results were categorized into three business segments: the Corporate and Institutional Client Group ("CICG"), the Private Client Group ("PCG") and the Asset Management Group ("AMG"). Prior period amounts have been restated to conform to the 1999 presentation. For information on each segment's activities, see Management's Discussion and Analysis (unaudited) - Business Segments. The principal methodology used in preparing the segment results in the table that follows is: . Revenues and expenses are assigned to segments where directly attributable. . Principal transaction and investment banking revenues and related costs resulting from the client activities of PCG are allocated among CICG and PCG based on production credits, share counts, trade counts, and other measures which estimate relative value. . Revenues and expenses related to certain retail money market funds are assigned to PCG. . The 401(k) business is reported as a 50/50 joint venture between AMG and PCG. . Revenues and expenses related to mutual fund shares bearing a contingent deferred sales charge are reflected in segment results as if AMG and PCG were unrelated entities. . Interest (cost of carry) is allocated based on management's assessment of the relative risk of segment assets and liabilities. . Goodwill amortization, Mercury financing costs, and the staff reduction provision are not attributed to segments because management excludes these items from segment operating results in evaluating segment performance. The elimination of intersegment revenues and expenses is also included in Corporate items (including intersegment eliminations). . Residual revenues and expenses (i.e., those related to overhead and support units) are attributed to segments based on specific methodologies (e.g., headcount, square footage, intersegment agreements). . Income taxes are attributed based on tax rates in the tax jurisdictions in which the segment activity takes place. 84 Notes to Consolidated Financial Statements Management believes that the following information by business segment provides a reasonable representation of each segment's contribution to the consolidated amounts:
- ------------------------------------------------------------------------------------------------------------------------------------ (in millions) CORPORATE ITEMS (INCLUDING INTERSEGMENT CICG PCG AMG ELIMINATIONS) TOTAL -------------- ----------- ----------- ------------------- ------------- 1999 All other revenues $ 8,303 $ 9,450 $ 2,223 $ (194)(1) $ 19,782 Net interest revenue(2) 1,025 1,238 45 (221)(3) 2,087 ---------- ---------- ---------- --------- --------- Net revenues 9,328 10,688 2,268 (415) 21,869 Non-interest expenses 6,760 9,265 1,752 14(4) 17,791 ---------- ---------- ---------- --------- --------- Earnings (loss) before income taxes and dividends on preferred securities issued by subsidiaries 2,568 1,423 516 (429) 4,078 Income tax expense (benefit) 662 498 181 (76) 1,265 Dividends on preferred securities issued by subsidiaries - - - 195 195 ---------- ---------- ---------- --------- --------- Net earnings (loss) $ 1,906 $ 925 $ 335 $ (548) $ 2,618 ========== ========== ========== ========= ========= Year-end total assets $ 264,130 $ 56,579 $ 2,410 $ 4,952 $ 328,071 ========== ========== ========== ========= ========= - ------------------------------------------------------------------------------------------------------------------------------------ 1998 All other revenues $ 6,177 $ 8,678 $ 1,955 $ (271)(1) $ 16,539 Net interest revenue(2) 372 918 24 (306)(3) 1,008 ---------- ---------- ---------- --------- --------- Net revenues 6,549 9,596 1,979 (577) 17,547 Non-interest expenses,excluding staff reduction provision 5,453 8,101 1,529 (62)(4) 15,021 Provision for costs related to staff reduction - - - 430(5) 430 ---------- ---------- ---------- --------- --------- Earnings (loss) before income taxes and dividends on preferred securities issued by subsidiaries 1,096 1,495 450 (945) 2,096 Income tax expense (benefit) 135 546 158 (126) 713 Dividends on preferred securities issued by subsidiaries - - - 124 124 ---------- ---------- ---------- --------- --------- Net earnings (loss) $ 961 $ 949 $ 292 $ (943) $ 1,259 ========== ========== ========== ========= ========= Year-end total assets $ 247,646 $ 44,691 $ 2,103 $ 5,364 $ 299,804 ========== ========== ========== ========= ========= - ------------------------------------------------------------------------------------------------------------------------------------ 1997 All other revenues $ 6,557 $ 7,706 $ 1,241 $ (304)(1) $ 15,200 Net interest revenue(2) 232 826 (2) - 1,056 ---------- ---------- ---------- --------- --------- Net revenues 6,789 8,532 1,239 (304) 16,256 Non-interest expenses 5,166 7,374 834 (229)(4) 13,145 ---------- ---------- ---------- --------- --------- Earnings (loss) before income taxes and dividends on preferred securities issued by subsidiaries 1,623 1,158 405 (75) 3,111 Income tax expense 437 428 141 123 1,129 Dividends on preferred securities issued by subsidiaries - - - 47 47 ---------- ---------- ---------- --------- --------- Net earnings (loss) $ 1,186 $ 730 $ 264 $ (245) $ 1,935 ========== ========== ========== ========= ========= Year-end total assets $ 252,587 $ 38,061 $ 865 $ 5,467 $ 296,980 ========== ========== ========== ========= ========= - ------------------------------------------------------------------------------------------------------------------------------------
(1) Represents the elimination of intersegment revenues. (2) Management views interest income net of interest expense in evaluating results. (3) Represents Mercury financing costs. (4) Represents goodwill amortization of $227, $226, and $65, net of elimination of intersegment expenses $213, $288, and $294 for 1999, 1998, and 1997, respectively. (5) Had this amount been allocated to segments, $259, $88, and $83 would have been allocated to CICG, PCG, and AMG, respectively. Notes to Consolidated Financial Statements 85 PRODUCT INFORMATION Merrill Lynch delivers a wide variety of products to clients: . Brokerage: Executing or facilitating security and commodity trades for retail clients and assisting clients in allocating their assets. (Includes commissions, net interest, and principal transactions). . Asset management and portfolio services: Offering customers access to a wide array of asset management services and other fee-based products. . Lending: Serving investors' liability management needs by providing margin lending, mortgage and other consumer loans, and commercial financing. . Trading: Satisfying institutional customer demand for securities, currencies, and other products by maintaining securities inventories and writing over-the-counter derivatives. Through structured notes and derivatives, investors are provided with opportunities to diversify their portfolios, manage risk, and enhance returns. Also included are revenues related to proprietary positions. (Includes commissions, principal transactions revenues, and net interest). . Origination: Raising capital for clients through securities underwritings, private placements, and loan syndications. . Strategic advisory services: Providing advice on mergers and acquisitions, sales, divestitures, and joint ventures. The following table summarizes Merrill Lynch's net revenues by product. - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 -------- -------- ------- CICG Trading: Debt $ 2,397 $ 899 $ 2,232 Equity 3,638 2,722 2,052 -------- -------- ------- Total 6,035 3,621 4,284 -------- -------- ------- Origination: Debt 450 484 587 Equity 1,104 884 820 -------- -------- ------- Total 1,554 1,368 1,407 -------- -------- ------- Strategic advisory services 1,270 1,081 765 Other 469 479 333 -------- -------- ------- Total CICG 9,328 6,549 6,789 -------- -------- ------- PCG Brokerage 6,741 6,221 5,755 -------- -------- ------- Fee-based services: Portfolio service fees 1,459 1,134 805 Asset management fees 583 589 402 Other fees 1,042 988 944 -------- -------- ------- Total 3,084 2,711 2,151 -------- -------- ------- Lending 731 577 477 Other 132 87 149 -------- -------- ------- Total Private Client 10,688 9,596 8,532 -------- -------- ------- AMG Fee-based services: Asset management fees 1,680 1,486 830 Other fees 3 - 21 -------- -------- ------- Total 1,683 1,486 851 -------- -------- ------- Other 585 493 388 -------- -------- ------- Total Asset Management 2,268 1,979 1,239 -------- -------- ------- CORPORATE ITEMS (INCLUDING INTERSEGMENT ELIMINATIONS) (415) (577) (304) -------- -------- ------- Total $ 21,869 $ 17,547 $ 16,256 ======== ======== ======= - -------------------------------------------------------------------------------- 86 Notes to Consolidated Financial Statements GEOGRAPHIC INFORMATION Merrill Lynch operates in both U.S. and non-U.S. markets. Merrill Lynch's non-U.S. business activities are conducted through offices in six regions: . Europe, Middle East, and Africa, . Asia Pacific, . Australia and New Zealand, . Japan, . Canada, and . Latin America. For further information on activities in these regions, see Management's Discussion and Analysis (unaudited) - Global Operations. The principal methodology used in preparing the geographic data in the table that follows is: . Commissions revenues are recorded based on the location of the sales force, . Trading revenues are principally recorded based on the location of the trader, . Investment banking revenues are recorded based on the location of the client, . Asset management and portfolio service fees are recorded based on the location of the fund manager, . Earnings before income taxes include the allocation of certain shared expenses among regions, and . Intercompany transfers are based primarily on service agreements. The information that follows, in management's judgment, provides a reasonable representation of each region's contribution to the consolidated amounts. - -------------------------------------------------------------------------------- (in millions) 1999 1998 1997 -------- -------- -------- NET REVENUES Europe, Middle East, and Africa $ 4,222 $ 2,844 $ 1,949 Asia Pacific 813 333 478 Australia and New Zealand 253 221 163 Japan 1,062 592 433 Canada 619 642 708 Latin America 614 412 523 -------- -------- -------- Total Non-U.S. 7,583 5,044 4,254 U.S. 14,507 12,809 12,002 Corporate (221) (306) - -------- -------- -------- Total $ 21,869 $ 17,547 $ 16,256 ======== ======== ======== - -------------------------------------------------------------------------------- EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON PREFERRED SECURITIES ISSUED BY SUBSIDIARIES Europe,Middle East,and Africa $ 1,290 $ 452 $ 328 Asia Pacific 230 (182) (26) Australia and New Zealand 32 22 12 Japan 20 (108) 62 Canada 65 25 99 Latin America 137 (53) 123 -------- -------- -------- Total Non-U.S. 1,774 156 598 U.S. 2,733 2,885 2,588 Corporate (429) (945) (75) -------- -------- -------- Total $ 4,078 $ 2,096 $ 3,111 ======== ======== ======== - -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements 87 SUPPLEMENTAL FINANCIAL INFORMATION - ---------------------------------- QUARTERLY INFORMATION The unaudited quarterly results of operations of Merrill Lynch for 1999 and 1998 are prepared in conformity with generally accepted accounting principles and reflect all adjustments (which consist of normal recurring accruals and a provision for costs related to staff reductions) that are, in the opinion of management, necessary for a fair presentation of the results of operations for the periods presented. Results of any interim period are not necessarily indicative of results for a full year.
- --------------------------------------------------------------------------------------------------------------------- (dollars in millions, except per share amounts) For the Quarter Ended - --------------------------------------------------------------------------------------------------------------------- DEC.31, SEPT.24, JUNE 25, MAR.26, DEC.25, SEPT.25, JUNE 26, MAR.27, 1999 1999 1999 1999 1998 1998 1998 1998 ------- ------- ------- ------- ------- -------- -------- ------- Total Revenues $ 9,270 $ 8,412 $ 8,630 $ 8,567 $ 7,845 $ 8,345 $ 9,321 $ 9,062 Interest Expense 3,375 3,144 3,190 3,301 3,764 4,496 4,466 4,300 ------- ------- ------- ------- ------- -------- -------- ------- Net Revenues 5,895 5,268 5,440 5,266 4,081 3,849 4,855 4,762 Non-Interest Expenses 4,735 4,377 4,409 4,270 3,562 4,054(1) 3,940 3,895 ------- ------- ------- ------- ------- -------- -------- ------- Earnings (Loss) Before Income Taxes and Dividends on Preferred Securities Issued by Subsidiaries 1,160 891 1,031 996 519 (205) 915 867 Income Tax Expense (Benefit) 346 271 310 338 119 (75) 339 330 Dividends on Preferred Securities Issued by Subsidiaries 50 48 48 49 41 33 27 23 ------- ------- ------- ------- ------- -------- -------- ------- Net Earnings (Loss) $ 764 $ 572 $ 673 $ 609 $ 359 $ (163) $ 549 $ 514 ======= ======= ======= ======= ======= ======== ======== ======= Earnings (Loss) Per Common Share Basic $ 2.03 $ 1.52 $ 1.80 $ 1.65 $ .97 $ (.48) $ 1.52 $ 1.44 Diluted 1.80 1.34 1.57 1.44 .86 (.48) 1.31 1.26 - ---------------------------------------------------------------------------------------------------------------------
(1) Includes a $430 million provision for costs related to staff reductions. DIVIDENDS PER COMMON SHARE - -------------------------------------------------------------------------------- (declared and paid) 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- 1999 $ .24 $ .27 $ .27 $ .27 1998 .20 .24 .24 .24 - -------------------------------------------------------------------------------- With the exception of regulatory restrictions on subsidiaries' abilities to pay dividends, there are no restrictions on ML & Co.'s present ability to pay dividends on common stock, other than (a) ML & Co.'s obligation to make payments on its preferred stock and subsidiaries' preferred securities, and (b) the governing provisions of the Delaware General Corporation Law. Certain subsidiaries' ability to declare dividends may also be limited (see Note 13 to the Consolidated Financial Statements). STOCKHOLDER INFORMATION Consolidated Transaction Reporting System prices for the specified calendar quarters are noted below.
- -------------------------------------------------------------------------------------------------------------- (at calendar period-end) 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER -------------------- -------------------- -------------------- --------------------- HIGH LOW HIGH LOW HIGH LOW HIGH LOW -------- -------- -------- -------- -------- -------- -------- --------- 1999 $ 94 1/2 $ 65 5/8 $ 102 1/2 $ 66 1/16 $ 81 7/16 $ 62 $ 88 7/16 $ 62 3/8 1998 $ 87 1/2 $ 60 7/16 $ 100 $ 82 1/4 $ 109 1/8 $ 45 5/8 $ 80 $ 35 3/4 - --------------------------------------------------------------------------------------------------------------
The approximate number of record holders of ML & Co. common stock as of February 18, 2000 was 16,600. As of February 25, 2000, the closing price of ML & Co. common stock as reported on the Consolidated Transaction Reporting System was $95 7/8. 88 BOARD OF DIRECTORS - ------------------ W.H. CLARK Corporate Director...former Chairman of the Board and Chief Executive Officer of Nalco Chemical Company, a producer of specialty chemicals...67 years old...elected a Director of Merrill Lynch in 1995. JILL K. CONWAY Visiting Scholar, Massachusetts Institute of Technology... President of Smith College from 1975 to 1985...65 years old...elected a Director of Merrill Lynch in 1978. STEPHEN L. HAMMERMAN Vice Chairman of the Board of Merrill Lynch...62 years old... joined Merrill Lynch in 1978. GEORGE B. HARVEY Corporate Director...former Chairman of the Board, President and Chief Operating Officer of Pitney Bowes Inc., a provider of mailing, office and logistics systems and management and financial services...68 years old...elected a Director of Merrill Lynch in 1993. WILLIAM R. HOOVER Chairman of the Executive Committee of, Consultant to, and former Chairman of the Board, Chief Executive Officer and President of, Computer Sciences Corporation, a provider of information technology consulting, systems integration and outsourcing to industry and government...70 years old...elected a Director of Merrill Lynch in 1995. DAVID H. KOMANSKY Chairman of the Board and Chief Executive Officer of Merrill Lynch...60 years old...joined Merrill Lynch in 1968. ROBERT P. LUCIANO Corporate Director...Director, Chairman Emeritus and former Chairman of the Board and Chief Executive Officer of Schering-Plough Corporation, a health and personal care products company...66 years old...elected a Director of Merrill Lynch in 1989. DAVID K. NEWBIGGING Chairman of the Board of Friends' Provident Life Office, a United Kingdom-based life assurance company...former Chairman of the Board of Equitas Holdings Limited...former Chairman of the Board and Senior Managing Director of Jardine, Matheson & Co. Limited...66 years old...elected a Director of Merrill Lynch in 1996. AULANA L. PETERS Partner in the law firm of Gibson, Dunn & Crutcher LLP...former Commissioner of the U.S. Securities and Exchange Commission...58 years old...elected a Director of Merrill Lynch in 1994. JOHN J. PHELAN, JR. Corporate Director...former Chairman and Chief Executive Officer of the New York Stock Exchange, Inc....Senior Adviser, Boston Consulting Group...member of the Council on Foreign Relations... former President of the International Federation of Stock Exchanges...68 years old...elected a Director of Merrill Lynch in 1991. JOHN L. STEFFENS Vice Chairman of the Board and Chairman of U.S. Private Client Group of Merrill Lynch...58 years old...joined Merrill Lynch in 1963. WILLIAM L. WEISS Corporate Director...Chairman Emeritus and former Chairman of the Board and Chief Executive Officer of Ameritech Corporation, a provider of communications and information services...70 years old...elected a Director of Merrill Lynch in 1993. Board of Directors 89 EXECUTIVE MANAGEMENT - -------------------- On February 14, 2000, Merrill Lynch announced the following management changes. Merrill Lynch Vice Chairman John L. (Launny) Steffens was named Chairman of the U.S. Private Client Group. Executive Vice President E. Stanley O'Neal, who had been serving as Merrill Lynch's Chief Financial Officer, was named to succeed Mr. Steffens as President of U.S. Private Client Group. Mr. O'Neal will be succeeded as Chief Financial Officer by Executive Vice President Thomas H. Patrick, who had been serving as Chairman, Special Advisory Services. [PHOTO] DAVID H. KOMANSKY Chairman of the Board and Chief Executive Officer [PHOTO] JOHN L. STEFFENS Vice Chairman of the Board and Chairman of U.S. Private Client Group [PHOTO] STEPHEN L. HAMMERMAN Vice Chairman of the Board [PHOTO] PAUL W. CRITCHLOW Senior Vice President Communications and Public Affairs [PHOTO] THOMAS W. DAVIS Executive Vice President and President of Corporate and Institutional Client Group [PHOTO] RICHARD A. DUNN Senior Vice President and Head of Corporate Risk Management [PHOTO] BARRY S. FRIEDBERG Executive Vice President and Chairman of Corporate and Institutional Client Group 90 Executive Management [PHOTO] CAROL GALLEY Chief Operating Officer Asset Management Group [PHOTO] EDWARD L. GOLDBERG Executive Vice President Operations Services Group [PHOTO] JAMES P. GORMAN Executive Vice President and Chief Marketing Officer [PHOTO] JEROME P. KENNEY Executive Vice President Corporate Strategy and Research [PHOTO] MICHAEL J.P. MARKS Executive Chairman of Merrill Lynch Europe, Middle East & Africa [PHOTO] JOHN A. MCKINLEY, JR. Executive Vice President and Chief Technology Officer [PHOTO] E. STANLEY O'NEAL Executive Vice President and President of U.S. Private Client Group [PHOTO] THOMAS H. PATRICK Executive Vice President and Chief Financial Officer [PHOTO] JEFFREY M. PEEK Executive Vice President and President of Asset Management Group [PHOTO] WINTHROP H. SMITH, JR. Executive Vice President and Chairman, Merrill Lynch International Inc. and President of International Private Client Group [PHOTO] MARY E. TAYLOR Senior Vice President Human Resources [PHOTO] STEPHEN A. ZIMMERMAN Chief Operating Officer Asset Management Group Executive Management 91 MERRILL LYNCH & CO., INC. - ------------------------- EXECUTIVE OFFICES Merrill Lynch & Co., Inc. World Financial Center North Tower New York, New York 10281-1332 COMMON STOCK Exchange Listings The common stock of Merrill Lynch (trading symbol MER) is listed on the New York Stock Exchange, Chicago Stock Exchange, Pacific Exchange, Paris Bourse, London Stock Exchange and Tokyo Stock Exchange. Transfer Agent and Registrar Merrill Lynch & Co., Inc. is the principal transfer agent for its own common stock. Questions from registered stockholders on dividends, lost and stolen certificates, changes of legal or dividend addresses, and other matters relating to registered stockholder status should be sent to: Merrill Lynch & Co., Inc. P.O. Box 20, Church Street Station New York, NY 10277-1004 Attn: Darryl W. Colletti, Assistant Secretary However, registered stockholders wishing to transfer their stock should continue to do so through the following transfer agent and registrar: ChaseMellon Shareholder Services P.O. Box 3310 South Hackensack, NJ 07606-1910 1-800-851-9677 PREFERRED STOCK Exchange Listing Depositary Shares representing 1/400 of a share of 9% Cumulative Preferred Stock, Series A, are listed on the New York Stock Exchange. Transfer Agent and Registrar Citibank, N.A. 111 Wall Street, Fifth Floor New York, NY 10043 Attn: Corporate Trust Department FORM 10-K ANNUAL REPORT FOR 1999 This Annual Report of Merrill Lynch & Co., Inc. contains much of the financial information that will be included in the 1999 Annual Report on Form 10-K to be filed with the U.S. Securities and Exchange Commission. Merrill Lynch will furnish a copy of its 1999 Annual Report on Form 10-K (including financial statements and financial schedules but excluding other exhibits), without charge, to any person upon request addressed to Andrea L. Dulberg, Corporate Secretary, Merrill Lynch & Co., Inc., 222 Broadway, 17th Floor, New York, NY 10038. EQUAL EMPLOYMENT OPPORTUNITY Merrill Lynch is committed to Equal Employment Opportunity and to attracting and retaining the most qualified employees, regardless of race, national origin, religion, gender, age, or disability. For more information, write to Westina Matthews Shatteen, First Vice President, Corporate Responsibility, Merrill Lynch & Co., Inc., World Financial Center, North Tower, New York, NY 10281-1331. CHARITABLE CONTRIBUTIONS A summary of the Corporation's charitable contributions is available upon written request to the Secretary. ANNUAL MEETING The 2000 Annual Meeting of Merrill Lynch & Co., Inc. stockholders will take place at the Merrill Lynch Conference and Training Center, 800 Scudders Mill Road, Plainsboro, New Jersey. The meeting is scheduled for Tuesday, April 18, 2000, beginning at 10:00 a.m. (local time). Designed by DeSola Group, Inc. Executive portrait photography by Chris Jones VISIT OUR WEBSITE AT WWW.ML.COM 92 Corporate Information