EXHIBIT 13
Merrill Lynch 2001 Annual Report
[LOGO] Financial Table of Contents
16 Selected Financial Data 49 Notes to Consolidated Financial Statements
17 Management's Discussion and Analysis 49 Note 1. Summary of Significant Accounting Policies
17 Business Environment 59 Note 2. Other Significant Events
18 Results of Operations 60 Note 3. Segment and Geographic Information
19 Business Segments 62 Note 4. Securities Financing Transactions
25 Global Operations 62 Note 5. Investments
27 Non-Interest Expenses 63 Note 6. Trading Assets and Liabilities
29 Income Taxes 66 Note 7. Loans, Notes, and Mortgages
29 Balance Sheet 66 Note 8. Commercial Paper and Short- and
Long-Term Borrowings
31 Capital Adequacy and Funding
68 Note 9. Deposits
33 Capital Projects and Expenditures
68 Note 10. Preferred Securities Issued by Subsidiaries
34 Risk Management
68 Note 11. Stockholders' Equity and Earnings
37 Non-Investment Grade Holdings and Per Share
Highly Leveraged Transactions
70 Note 12. Commitments and Contingencies
39 Litigation
71 Note 13. Employee Benefit Plans
39 Critical Accounting Policies
74 Note 14. Employee Incentive Plans
40 Recent Developments
77 Note 15. Income Taxes
41 Management's Discussion of
Financial Responsibility 77 Note 16. Regulatory Requirements and
Dividend Restrictions
42 Independent Auditors' Report 79 Supplemental Financial Information
43 Consolidated Financial Statements 79 Quarterly Information
43 Consolidated Statements of Earnings 79 Dividends Per Common Share
44 Consolidated Balance Sheets 79 Stockholder Information
46 Consolidated Statements of
Changes in Stockholders' Equity
47 Consolidated Statements of
Comprehensive Income
48 Consolidated Statements of Cash Flows
PAGE 15
Merrill Lynch 2001 Annual Report
SELECTED FINANCIAL DATA
(dollars in millions, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------
YEAR ENDED LAST FRIDAY IN DECEMBER
---------------------------------------------------------
2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Total Revenues $ 38,757 $ 44,852 $ 35,332 $ 34,828 $ 31,460
Less Interest Expense 16,877 18,086 13,019 17,038 14,957
--------- ---------- --------- --------- ---------
Net Revenues 21,880 26,766 22,313 17,790 16,503
Non-Interest Expenses 20,503 21,049 18,107 15,670 13,401
--------- ---------- --------- --------- ---------
Earnings Before Income Taxes and Dividends on
Preferred Securities Issued by Subsidiaries 1,377 5,717 4,206 2,120 3,102
Income Tax Expense 609 1,738 1,319 725 1,127
Dividends on Preferred Securities Issued by
Subsidiaries 195 195 194 124 47
--------- ---------- --------- --------- ---------
Net Earnings $ 573 $ 3,784 $ 2,693 $ 1,271 $ 1,928
========= ========== ========= ========= =========
Net Earnings Applicable to Common Stockholders(a) $ 535 $ 3,745 $ 2,654 $ 1,233 $ 1,889
- -------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total Assets $ 419,419 $ 407,200 $ 309,850 $ 286,446 $ 298,057
Short-Term Borrowings(b) $ 178,146 $ 186,714 $ 115,409 $ 98,655 $ 123,946
Long-Term Borrowings $ 76,572 $ 70,223 $ 54,043 $ 57,599 $ 43,176
Preferred Securities Issued by Subsidiaries $ 2,695 $ 2,714 $ 2,725 $ 2,627 $ 627
Total Stockholders' Equity $ 20,008 $ 18,304 $ 13,004 $ 10,264 $ 8,663
- -------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA(c)
(in thousands, except per share amounts)
Earnings Per Share:
Basic $ 0.64 $ 4.69 $ 3.52 $ 1.69 $ 2.70
========= ========== ========= ========= =========
Diluted $ 0.57 $ 4.11 $ 3.11 $ 1.49 $ 2.33
========= ========== ========= ========= =========
Weighted-Average Shares Outstanding:
Basic 838,683 798,273 754,672 728,929 698,300
Diluted 938,555 911,416 853,499 830,276 809,819
Shares Outstanding at Year End(d) 843,474 807,955 752,501 729,981 696,611
Book Value Per Share $ 23.03 $ 21.95 $ 16.49 $ 13.31 $ 11.69
Dividends Paid Per Share $ 0.64 $ 0.61 $ 0.53 $ 0.46 $ 0.38
- -------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Pre-tax Profit Margin(e) 6.3% 21.4% 18.8% 11.9% 18.8%
Common Dividend Payout Ratio 100.0% 13.0% 15.1% 27.2% 14.1%
Return on Average Assets 0.1% 1.1% 0.9% 0.4% 0.7%
Return on Average Common Stockholders' Equity 2.7% 24.2% 23.8% 13.4% 25.9%
Average Leverage(f) 18.8x 19.0x 21.4x 29.9x 34.9x
Average Adjusted Leverage(g) 13.1x 13.2x 14.2x 19.0x 21.1x
- -------------------------------------------------------------------------------------------------------------------
OTHER STATISTICS
(dollars in billions)
Full-Time Employees:
U.S. 43,500 51,800 49,700 47,900 46,600
Non-U.S. 13,900 20,200 18,200 17,300 13,900
--------- ---------- --------- --------- ---------
Total(h) 57,400 72,000 67,900 65,200 60,500
========= ========== ========= ========= =========
Private Client Financial Advisors 16,400 20,200 18,600 17,800 14,900
Client Assets $ 1,458 $ 1,681 $ 1,696 $ 1,446 $ 1,229
- -------------------------------------------------------------------------------------------------------------------
(a) Net earnings less preferred stock dividends.
(b) Consists of Payables under repurchase agreements, Payables under securities
loaned transactions, Commercial paper and other short-term borrowings, and
Deposits.
(c) All share and per share data have been restated for the two-for-one common
stock split paid in August 2000 (see Note 11 to the Consolidated Financial
Statements).
(d) Does not include 4,195; 4,654; 8,019; 9,012; and 9,436 shares exchangeable
into common stock (see Note 11 to the Consolidated Financial Statements) at
year-end 2001, 2000, 1999, 1998, and 1997, respectively.
(e) Earnings before income taxes and dividends on preferred securities issued
by subsidiaries to Net revenues.
(f) Average total assets to average total stockholders' equity and Preferred
securities issued by subsidiaries.
(g) Average total assets less average (i) Receivables under resale agreements,
(ii) Receivables under securities borrowed transactions, and (iii)
Securities received as collateral to average total stockholders' equity and
Preferred securities issued by subsidiaries.
(h) Excludes 3,200 full-time employees on salary continuation severance at
year-end 2001.
PAGE 16
Merrill Lynch 2001 Annual Report
Management's Discussion and Analysis Table of Contents
17 Business Environment
18 Results of Operations
19 Business Segments
25 Global Operations
27 Non-Interest Expenses
29 Income Taxes
29 Balance Sheet
31 Capital Adequacy and Funding
33 Capital Projects and Expenditures
34 Risk Management
37 Non-Investment Grade Holdings and Highly Leveraged Transactions
39 Litigation
39 Critical Accounting Policies
40 Recent Developments
MANAGEMENT'S DISCUSSION AND ANALYSIS
Merrill Lynch & Co., Inc. ("ML & Co." and, together with its subsidiaries and
affiliates, "Merrill Lynch") is a holding company that, through its subsidiaries
and affiliates, provides investment, financing, advisory, insurance, banking,
and related products and services on a global basis. 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 unpredictable factors. These factors include economic
conditions, monetary and fiscal policies, the liquidity of global markets,
international and regional political events, acts of war or terrorism, changes
in applicable laws and regulations, the competitive environment, and investor
sentiment. These conditions or events can significantly affect the volatility
and trading volumes of financial markets. Greater volatility increases risk but
also could lead to increased order flow and revenues in the trading and
brokerage businesses. Revenues and net earnings may vary significantly from
period to period due to these unpredictable factors and the resulting market
volatility and volumes.
The financial services industry continues to be affected by an intensifying
competitive environment, as demonstrated by consolidation through mergers and
acquisitions, competition from new and established competitors using the
Internet or other technology, and diminishing margins in many mature products
and services. The trend of consolidation of commercial and investment banks made
possible by the Gramm-Leach-Bliley Act has also increased the competition for
investment banking business through the use of lending activities in conjunction
with investment banking activities.
In addition to providing historical information, Merrill Lynch may make or
publish forward-looking statements about management expectations, strategic
objectives, business prospects, anticipated expense savings and financial
results, and other similar matters. A variety of factors, many of which are
beyond Merrill Lynch's control, affect its operations, performance, business
strategy, and results and could cause actual results and experience to differ
materially from the expectations and objectives expressed in these statements.
These factors include, but are not limited to, the factors listed in the
previous two paragraphs, as well as actions and initiatives of 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 and uncertainties detailed in Merrill Lynch's Form 10-K and in the
following sections.
MERRILL LYNCH UNDERTAKES NO RESPONSIBILITY TO UPDATE OR REVISE ANY
FORWARD-LOOKING STATEMENTS.
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
Global financial markets, particularly equity markets, had a difficult year in
2001 as a slowdown in economic activity, reduced corporate earnings, widespread
corporate downsizing, the devaluation of technology and telecommunications
companies, and the September 11th terrorist attacks caused equity markets to
fall and investors to shift to less volatile, fixed-income investments. The U.S.
Federal Reserve's interest rate cuts during the year did little to help the
slumping U.S. economy. The September 11th terrorist attacks negatively impacted
stock markets around the world, and forced a suspension of trading in U.S.
equity markets for an unprecedented four consecutive business days. A modest
rally occurred in global equity markets during the fourth quarter 2001, but was
not enough to put global indices in positive territory for the year.
Long-term U.S. interest rates, as measured by the yield on the 10-year U.S.
Treasury note, slipped slightly from 5.11% at year-end 2000 to 5.02% at the end
of 2001. Treasury bond prices rose sharply in 2001, as demand grew from
investors seeking an alternative to the stock market. The Federal Reserve Bank
cut interest rates 11 times during 2001, for a total of 475 basis points on the
federal funds
PAGE 17
Merrill Lynch 2001 Annual Report
rate and the discount rate, bringing these rates to 40-year lows of 1.75% and
1.25%, respectively. Credit spreads, which represent the risk premium over the
risk-free rate paid by an issuer (based on the issuer's perceived
creditworthiness), tightened significantly through September 11th, after which
credit spreads widened.
Despite the fourth quarter rally, U.S. equity indices declined for the
second consecutive year. The Nasdaq Composite Index fell 21.1% in 2001, after
declining 39.3% in the prior year, as telecommunications and technology stocks
continued to perform poorly. The Dow Jones Industrial Average and the S&P 500
dropped 7.1% and 13.0%, respectively, for the year.
Equity indices around the world dropped to their lowest levels in more than
three years amid a global recession. The Dow Jones World Index, excluding the
United States, sank 21.0% from the end of 2000, the worst one-year performance
since inception of the index. European stock markets were hit hard, as virtually
all industry sectors declined, leading to one of the worst annual performances
ever. In Japan, the Nikkei 225 index fell 23.5%, marking the seventh losing year
since 1990. Latin American markets also performed poorly, led by Argentina,
where interest rates surged and the stock market declined 29.1% amid concerns
about that country's solvency.
The volume of global debt underwriting rose 24.7% in 2001, as U.S.
companies attempted to lock in low interest rates amid the series of short-term
interest rate cuts made by the U.S. Federal Reserve. Global equity and
equity-linked underwriting volumes decreased 29.8% in 2001, despite an increase
in U.S. convertible debt issuances, which reached a record $103 billion, nearly
double the previous record set in 2000. The volume of U.S. Initial Public
Offerings ("IPOs") sank 37.7% in 2001, while global IPOs fell 57.4%.
After reaching record levels in 2000, global announced mergers and
acquisitions slid 49.6% in 2001, while U.S. announced mergers and acquisitions
fell 52.9%, as the global economic slowdown and the volatile U.S. stock markets
negatively affected merger and acquisition activity.
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. The strategy of maintaining long-term client
relationships, closely monitoring costs and risks, diversifying revenue sources,
and growing fee-based revenues all continue as objectives to mitigate the
effects of a volatile market environment on Merrill Lynch's business as a whole.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
In the fourth quarter of 2001, Merrill Lynch recorded a pre-tax charge of $2.2
billion ($1.7 billion after-tax) related to the resizing of selected businesses
and other structural changes. This charge, which is recorded as Restructuring
and other charges on the Consolidated Statements of Earnings, was the result of
a detailed review of all businesses, with a focus on improving profit margins
and aligning capacity with growth initiatives. These actions are expected to
yield pre-tax annual expense savings of approximately $1.4 billion, a portion of
which will be reinvested in priority growth initiatives. The expense reductions
will result primarily from lower compensation and benefits, depreciation, and
occupancy expenses. For further information regarding the details of
restructuring and other charges see Note 2 to the Consolidated Financial
Statements and the sections that follow.
(dollars in millions, except per share amounts)
- -------------------------------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Total revenues $ 38,757 $ 44,852 $ 35,332
Net revenues 21,880 26,766 22,313
Pre-tax operating earnings, before
September 11th-related expenses
and restructuring and other charges in 2001 3,701 5,717 4,206
After-tax operating earnings,
before September 11th-related expenses
and restructuring and other charges in 2001 2,381 3,784 2,693
Net earnings 573 3,784 2,693
Operating earnings per common
share, before September 11th-related
expenses and restructuring
and other charges in 2001:
Basic 2.79 4.69 3.52
Diluted 2.50 4.11 3.11
Earnings per common share:
Basic 0.64 4.69 3.52
Diluted 0.57 4.11 3.11
Return on average common
stockholders' equity--
operating basis(1) 11.7% 24.2% 23.8%
Operating pre-tax profit margin(1) 16.9% 21.4% 18.8%
- -------------------------------------------------------------------------------------------------
(1) Before September 11th-related expenses ($131 million pre-tax and $83
million after-tax) and restructuring and other charges ($2,193 million
pre-tax and $1,725 million after-tax) in 2001.
Merrill Lynch reported net earnings of $573 million in 2001, or $0.57 per
diluted share, including after-tax restructuring and other charges of $1.7
billion ($2.2 billion pre-tax) and $83 million of after-tax September
11th-related expenses ($131 million pre-tax). Excluding these items, net
operating earnings were $2.4 billion, or $2.50 per diluted share in 2001, down
from $3.8 billion, or $4.11 per diluted share in 2000. Operating earnings, which
exclude September 11th-related expenses and restructuring and other charges,
should not be considered an alternative to net earnings (as determined in
accordance with accounting principles generally accepted in the United States),
but rather as a measure considered relevant by management in comparing current
year results with prior year results. These
PAGE 18
Merrill Lynch 2001 Annual Report
results represent a 37% decrease in operating earnings and an 18% decrease in
net revenues from 2000.
Operating return on average common stockholders' equity was 11.7% and the
operating pre-tax profit margin was 16.9%. In 2000, the return on average common
stockholders' equity was 24.2% and the pre-tax profit margin was 21.4%. Net
earnings in 1999 were $2.7 billion, or $3.11 per diluted share. Return on
average common stockholders' equity for 1999 was 23.8% and the pre-tax profit
margin was 18.8%.
The following chart illustrates the composition of net revenues by category
in 2001.
[PIE CHART]
2001 NET REVENUES BY CATEGORY
Commissions 24%
Principal transactions 18%
Investment banking 16%
Asset management and portfolio service fees 25%
Net interest profit 15%
Other 2%
The following discussion provides details of the operating performance for
each Merrill Lynch business segment, as well as details of products and services
offered. The discussion also includes details of net revenues by segment.
Certain prior year amounts have been restated to conform with the current year
presentation. For further segment information, see Note 3 to the Consolidated
Financial Statements.
BUSINESS SEGMENTS
Merrill Lynch reports its results in three business segments: Global Markets and
Investment Banking ("GMI") (previously known as the Corporate and Institutional
Client Group ("CICG")), the Private Client Group ("Private Client"), and Merrill
Lynch Investment Managers ("MLIM"). GMI provides investment banking and capital
markets services to corporate, institutional, and governmental clients around
the world. Private Client provides global wealth management services and
products to individuals, small- to mid-size businesses, and employee benefit
plans. MLIM provides investment management services to retail and institutional
clients.
[PIE CHART]
2001 NET REVENUES BY SEGMENT
GMI 45%
Private Client 46%
MLIM 9%
Certain MLIM and GMI products are distributed through Private Client
distribution channels, and to a lesser extent, certain MLIM products are
distributed through GMI. Revenues and expenses associated with these
intersegment activities are recognized in each segment and eliminated at the
corporate level. In addition, revenue and expense sharing agreements for shared
activities between segments are in place and the results of each segment reflect
the agreed-upon portion of these activities. The following segment results
represent the information that is relied upon by management in its
decision-making processes. These results exclude items reported in the Corporate
segment, including September 11th-related expenses. Restatements occur to
reflect reallocations of revenues and expenses which result from changes in
Merrill Lynch's business strategy and structure (see Note 3 to the Consolidated
Financial Statements for further information).
GLOBAL MARKETS AND INVESTMENT BANKING
GMI provides investment banking and strategic merger and acquisition advisory
services, as well as equity and debt trading and capital markets services to its
clients around the world. GMI raises capital for its clients through securities
underwriting, private placements, and loan syndications. GMI trades securities,
currencies, over-the-counter derivatives and other financial instruments to
satisfy customer demand for these instruments, and for proprietary positioning.
Merrill Lynch has one of the largest equity trading and underwriting operations
of any firm in the world. Through its expertise in fixed-income trading, GMI is
also a leader in the global distribution of debt market products. GMI'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 their customized needs. In addition, through
Merrill Lynch Securities Services Division ("SSD"), GMI provides clients with
financing, securities clearing, settlement, and custody services.
GMI faced a challenging market environment in 2001. Equity origination and
trading activity declined and global completed merger and acquisition volumes
decreased throughout the year. Offsetting these factors was a strong debt
market, as 11 interest rate cuts by the U.S. Federal Reserve were a catalyst for
significant origination and trading activity for most of the year.
In early 2001, Merrill Lynch sold essentially all of its energy trading
assets, effectively exiting the business. In 2000, the merger with Herzog,
Heine, Geduld, Inc. ("Herzog"), a leading Nasdaq market-maker, was completed.
During 2001, as part of Merrill Lynch's overall business review process,
GMI completed in-depth reviews of its businesses with the goal of improving
overall efficiency and operating flexibility. As a result of these reviews, GMI
streamlined its management and reorganized the investment banking division by
reducing the number of global industry teams, realigning sector coverage, and
broadening responsibilities. In addition, GMI consolidated trading operations
outside the United States to enhance client service and realize efficiencies.
The completion of these reviews led to a fourth quarter pre-tax charge of $833
million, primarily related to severance.
PAGE 19
Merrill Lynch 2001 Annual Report
GMI'S RESULTS OF OPERATIONS
(dollars in millions)
- -------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------
Commissions $ 2,128 $ 2,415 $ 2,037
Principal transactions
and net interest profit 4,137 6,003 4,194
Investment banking 3,126 3,449 3,060
Other revenues 598 813 527
------- ------- -------
Total net revenues $ 9,989 $12,680 $ 9,818
======= ======= =======
Pre-tax operating
earnings(1) $ 2,479 $ 3,963 $ 2,653
Pre-tax earnings $ 1,646 $ 3,963 $ 2,653
Pre-tax operating profit 24.8% 31.3% 27.0%
margin(1)
Total full-time employees 12,600 15,300 14,000
- -------------------------------------------------------------------
(1) Before $833 million of pre-tax restructuring and other charges in 2001.
In 2001, GMI's pre-tax operating earnings were $2.5 billion, 37% lower than
in 2000, with a pre-tax operating profit margin of 24.8%. GMI's net revenues in
2001 declined 21% from 2000 to $10.0 billion due principally to reduced equity
and equity-linked trading and origination. Additionally, lower strategic
advisory revenues and increased write-downs of credit and private equity
positions contributed to the decline. These declines were partially offset by
increased debt trading and origination revenues in 2001. Included in GMI's
results are net revenues related to investments, including dividend income and
realized and unrealized gains and losses. Investment-related net revenues were
$291 million in 2001, $611 million in 2000 and $206 million in 1999. In 2000,
pre-tax earnings and net revenues rose 49% and 29%, respectively, from 1999, due
primarily to strong performance in equity and equity-linked trading and
origination, and record strategic advisory fees.
The September 11th terrorist attacks on the World Trade Center had a
negative impact on GMI's 2001 results, as the temporary closure of markets, loss
of communication with key clients, and business disruption caused by the
relocation of approximately 9,000 Merrill Lynch employees led to lower than
normal market shares and reduced business activity in the period immediately
following the attacks. For further information regarding September 11th, see
Note 2 to the Consolidated Financial Statements.
A detailed discussion of GMI's revenues follows:
CLIENT FACILITATION AND TRADING
COMMISSIONS
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities and commodities, money market instruments,
and options. In addition, in late 2001 Merrill Lynch instituted a program for
providing enhanced brokerage services to certain of its customers with large
size Nasdaq orders in exchange for an agreed upon commission in lieu of the
traditional spread.
Commissions revenues decreased 12% in 2001 to $2.1 billion, due primarily
to a global decline in client transaction volumes. In 2000, commissions revenues
rose 19% from 1999 to $2.4 billion, due primarily to increased volumes of listed
and over-the-counter securities transactions.
PRINCIPAL TRANSACTIONS AND NET INTEREST PROFIT
(dollars in millions)
- -------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------
Equities and equity derivatives $1,929 $3,870 $2,366
Debt and debt derivatives 2,208 2,133 1,828
------ ------ ------
Total $4,137 $6,003 $4,194
- -------------------------------------------------------------------------
Principal transactions and net interest profit includes realized gains and
losses from the purchase and sale of securities in which Merrill Lynch acts as
principal and unrealized gains and losses on trading assets and liabilities. In
addition, principal transactions and net interest profit includes unrealized
gains of $213 million and $212 million in 2001 and 2000, respectively, related
to equity investments held by Merrill Lynch's broker-dealers. Changes in the
composition of trading inventories and hedge positions can cause the recognition
of principal transactions and net interest profit to fluctuate.
Net interest profit is a function of the level and mix of total assets and
liabilities, including financial instruments owned, repurchase and reverse
repurchase agreements, trading strategies associated with GMI's institutional
securities business, and the prevailing level, term structure, and volatility of
interest rates. Net interest profit is an integral component of trading
activity. In assessing the profitability of its client facilitation and trading
activities, Merrill Lynch views net interest profit and principal transactions
in the aggregate.
Net trading revenues, which include principal transactions and net interest
profit, were $4.1 billion in 2001, down 31% from 2000. Equities and equity
derivatives net trading revenues decreased 50% from 2000 to $1.9 billion, due to
reduced global transaction volumes and lower volatility through much of the
year. Debt and debt derivatives net trading revenues were $2.2 billion, up 4%
from 2000, as improvements in interest rate trading results were partially
offset by provisions and write-downs of credit positions of approximately $470
million. Included in debt and debt derivatives trading revenues in 2001 and 2000
are net revenues from the energy-trading business of $53 million and $38
million, respectively. The 2001 energy-trading net revenues include a first
quarter gain on the sale of essentially all of the assets of this business.
In 2000, net trading revenues were up $1.8 billion from 1999. Equities and
equity derivatives net trading revenues advanced 64% from 1999 to $3.9 billion
due to significantly higher revenues from both U.S. and non-U.S. equities, as
well as portfolio trading. Debt and debt derivatives net trading revenues were
$2.1 billion, up 17% from 1999 due to increased global derivative trading,
partially offset by lower trading revenue in investment-grade and emerging
market debt. Net revenues from the energy-trading business were $36 million in
1999.
PAGE 20
Merrill Lynch 2001 Annual Report
INVESTMENT BANKING
(dollars in millions)
- ---------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------
Debt underwriting $ 690 $ 441 $ 508
Equity underwriting 1,336 1,630 1,257
------ ------ ------
Total underwriting 2,026 2,071 1,765
Strategic advisory services 1,100 1,378 1,295
------ ------ ------
Total $3,126 $3,449 $3,060
- ---------------------------------------------------------------------
UNDERWRITING
Underwriting revenues represent fees earned from the underwriting of debt and
equity and equity-linked securities as well as loan syndication and commitment
fees.
Total underwriting revenues were $2.0 billion in 2001, essentially
unchanged from 2000, as a 56% increase in debt underwriting revenues was more
than offset by an 18% decline in equity and equity-linked underwriting revenues.
In global equity and equity-linked underwriting, Merrill Lynch ranked first for
the year with an increased market share of 14.4%. Merrill Lynch's debt
underwriting focus shifted during the year towards higher margin businesses and
away from the achievement of aggregate market share goals.
Merrill Lynch's underwriting market share information based on transaction
value is as follows:
- --------------------------------------------------------------------------------------
2001 2000 1999
-------------- -------------- --------------
MARKET MARKET MARKET
SHARE RANK SHARE RANK SHARE RANK
- --------------------------------------------------------------------------------------
GLOBAL PROCEEDS
Equity and
equity-linked 14.4% 1 10.4% 2 8.7% 4
Debt 10.2 2 11.6 1 12.8 1
Debt and equity 10.6 2 11.5 1 12.4 1
U.S. PROCEEDS
Equity and
equity-linked 17.4% 2 12.1% 4 10.6% 4
Debt 11.5 2 13.7 1 15.7 1
Debt and equity 12.2 2 14.2 1 15.8 1
- --------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
book manager.
STRATEGIC ADVISORY SERVICES
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, decreased 20% in 2001 to $1.1 billion, due to a reduced
volume of completed merger and acquisition transactions. Merrill Lynch ranked
second in global announced mergers and acquisitions, increasing market share to
27.4%. Merrill Lynch advised on 10 of the largest 25 global transactions
announced in 2001.
Merrill Lynch's merger and acquisition market share information based on
transaction values is as follows:
- --------------------------------------------------------------------------------
2001 2000 1999
--------------- --------------- ---------------
MARKET MARKET MARKET
SHARE RANK SHARE RANK SHARE RANK
- --------------------------------------------------------------------------------
ANNOUNCED
TRANSACTIONS
Global 27.4% 2 21.4% 4 34.5% 2
U.S. 35.3 2 26.8 4 30.0 3
COMPLETED
TRANSACTIONS
Global 27.4% 3 31.5% 3 21.7% 4
U.S. 33.2 3 29.2 3 22.2 4
- --------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors.
OTHER REVENUES
Other revenues, which include realized investment gains and losses and
partnership distributions, decreased 26% to $598 million in 2001. In 2001, other
revenues also included a pre-tax gain related to the sale of the Canadian
securities clearing business as well as write-downs of private equity
investments. The decrease from 2000 is primarily due to lower gains on
investments. Other revenues were up 54% in 2000 as compared with 1999 as a
result of higher investment gains recorded in 2000.
PRIVATE CLIENT GROUP
Private Client provides wealth management services to assist clients around the
world in building financial assets, and maximizing returns relative to risk
tolerance and investment objectives. Private Client offers a choice of
traditional commission-based investment accounts, a variety of asset-priced
investment services, and self-directed online accounts, many of which include
access to Merrill Lynch's award-winning research. Assets in Private Client
accounts totaled $1.3 trillion at December 28, 2001.
Private Client offers a wide range of products and services, including
retail brokerage, asset and liability management, retail and private banking,
trust and generational planning services, and insurance products. Private
Client's private banking services help high-net-worth individuals meet their
financial objectives with investing and borrowing strategies, investment
management, trust and personal holding company services, and currency
management. Private Client serves individual investors, corporations, and
institutions through various distribution networks, including nearly 16,400
Financial Advisors in approximately 750 Private Client offices around the world
at year-end 2001.
Financial Advisors and other investment professionals work to address
clients' financial concerns by matching Merrill Lynch and third-party product
offerings with clients' customized needs. These products include:
.The Cash Management Account ("CMA(R)") for individuals, and Working Capital
Management Account ("WCMA(R)") for small and mid-sized businesses, which
encompass securities transactions, money sweeps, electronic funds-transfer
capabilities, debit card access, and many other financial management features.
PAGE 21
Merrill Lynch 2001 Annual Report
.A global array of mutual fund products covering a wide cross section of
industries and regions of the world.
.Various brokerage and investment advisory services, including Merrill Lynch
Consults,(R) Unlimited Advantage,/SM/ and Merrill Lynch Mutual Fund
Advisor./SM/
.Other services provided include mortgages and other consumer loans, margin
lending, commercial financing, insurance products, and advisory and
administrative activities for defined contribution, defined benefit, and other
stock plans.
During 2001, Private Client conducted a detailed business review to
reallocate and focus the use of resources in its businesses. In the United
States, this process began in 2000 and resulted in the completion of several
actions in 2001, including: a long-term outsourcing arrangement for certain
mortgage origination and servicing operations of Merrill Lynch Credit
Corporation; outsourcing the administrative services for smaller U.S. 401(k)
plans; and the sale of the health and welfare division of Merrill Lynch's Howard
Johnson and Company. In addition, in 2001, Private Client consolidated certain
offices and announced the closing of one of three operation centers in the
United States. Outside the United States, Private Client is focusing on serving
high-net-worth and ultra-high-net-worth clients, Merrill Lynch's traditional
strength. This resulted in several strategic actions in 2001, including: the
sale of the Canadian Private Client business; the consolidation of branch
offices in Europe, the Middle East, and Asia Pacific; and the announced
refocusing of the Private Client business in Japan. These strategic changes were
made with the goal of retaining and growing the elements of the business where
Merrill Lynch can make the best returns on its investments.
To be more responsive to client needs and enhance the quality of our
clients' experience, Merrill Lynch adopted a multi-channel service model in the
United States, more closely aligning Financial Advisors with clients based on
levels of investable assets. For example, ultra-high-net-worth clients will be
aligned with Private Wealth Advisors ("PWAs"). PWAs are Financial Advisors who
have completed a rigorous accreditation program built around skill requirements
including trust, tax minimization, restricted stock, and executive stock
options, and focus on clients with more than $10 million of investable assets.
For clients with less than $100,000 of investable assets, Merrill Lynch
developed the Financial Advisory Center ("FAC") to more effectively serve these
clients. All FAC customers receive a team-based advisory relationship, with
24-hour-a-day, seven-day-a-week access by phone or online.
Beginning in mid-2000 Merrill Lynch modified the cash sweep options for
certain CMA(R) and other types of Merrill Lynch accounts to generally sweep
cash into interest-bearing bank deposits at Merrill Lynch's U.S. banks, rather
than MLIM-managed money market mutual funds. U.S. bank deposits, included in
Deposits on the Consolidated Balance Sheets grew to $73.6 billion at year-end
2001 from $54.9 billion at the end of 2000 primarily as a result of individual
investors increasing the cash component of their holdings. These deposits were
invested primarily in high-quality marketable investment securities. Interest
rates on the deposits are set at competitive levels based on prevailing interest
rate levels, and are tiered based on the scope of clients' relationships with
Merrill Lynch.
In April 2000, Merrill Lynch formed a 50/50 joint venture with HSBC
Holdings plc ("HSBC") to create a global online investment and banking services
company, serving individual self-directed customers outside the United States
("MLHSBC"). The venture launched online integrated investment and banking
services, including research, in Canada and Australia during 2000, and in the
United Kingdom in 2001. As the decline in worldwide equity markets has reduced
the demand for online trading, MLHSBC has not achieved the growth that was
forecast when the venture was formed and has not yet achieved profitability.
PRIVATE CLIENT'S RESULTS OF OPERATIONS
(dollars in millions)
- ------------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------------
Commissions $ 2,981 $ 4,394 $ 4,118
Principal transactions and
new issue revenues 1,546 2,000 2,023
Asset management and
portfolio service fees 3,608 3,760 3,055
Net interest profit 1,880 1,632 1,171
Other revenues 121 175 212
------- ------- -------
Total net revenues $10,136 $11,961 $10,579
======= ======= =======
Pre-tax operating earnings(1) $ 1,239 $ 1,561 $ 1,424
Pre-tax earnings $ 162 $ 1,561 $ 1,424
Pre-tax operating
profit margin(1) 12.2% 13.1% 13.5%
Total full-time employees 36,900 46,800 44,900
Total Financial Advisors 16,400 20,200 18,600
- ------------------------------------------------------------------------------
(1) Before $1,077 million of pre-tax restructuring and other charges in 2001.
Private Client's 2001 pre-tax operating earnings were $1.2 billion, a
decrease of 21% from 2000. Net revenues were $10.1 billion, down 15% from 2000.
The overall decline in net revenues and pre-tax operating earnings resulted from
lower transaction volumes and reduced demand for mutual fund and equity
products, partially offset by an increase in net interest profit. In addition,
as a result of the completion of a detailed business review, Private Client
recorded $1.1 billion of pre-tax restructuring and other charges in the fourth
quarter of 2001, primarily related to severance and the write-down of real
estate and technology assets. These charges include costs associated with a
decision to focus the non-U.S. business more exclusively on high-net-worth
individuals and institutional middle markets clients. In addition to the amounts
included in the fourth quarter restructuring charge, Private Client's pre-tax
operating earnings reflect severance expenses in both 2001 and 2000. In 2000,
pre-tax earnings increased 10% and net revenues rose 13% from 1999. The 2001
pre-tax operating profit margin was 12.2%, compared with 13.1% in 2000 and 13.5%
in 1999. The 2001 results reflect a solid performance
PAGE 22
Merrill Lynch 2001 Annual Report
in the United States and a weaker performance outside the United States. Pre-tax
operating earnings in the United States for 2001 were 9% lower than 2000 levels,
and a pre-tax operating loss was recorded outside the United States in 2001.
COMMISSIONS
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds, insurance
products, and options.
Commissions revenues decreased 32% to $3.0 billion in 2001, as a result of
a global decline in client transaction volume, particularly in mutual fund and
equity products. In addition, over the past two years, commissions revenues have
decreased as clients have opened asset-priced accounts, paying fees in place of
commissions. Commissions revenues increased 7% in 2000 compared with 1999
primarily as a result of increased mutual fund commissions.
PRINCIPAL TRANSACTIONS AND NEW ISSUE REVENUES
Private Client's principal transactions and new issue revenues primarily
represent bid-offer revenues in over-the-counter equity securities, government
bonds, and municipal securities as well as selling concessions on underwritings
of debt and equity products. Private Client does not take any significant
principal trading risk positions.
Principal transactions and new issue revenues decreased 23% to $1.5 billion
in 2001 due to a reduction in both debt and equity sales volume to retail
customers in a less favorable market environment compared with 2000. Principal
transactions and new issue revenues were essentially unchanged in 2000 from
1999.
ASSET MANAGEMENT AND PORTFOLIO SERVICE FEES
Asset management and portfolio service fees include asset management fees from
taxable and tax-exempt money market funds as well as portfolio fees from
fee-based accounts such as Unlimited Advantage/SM/ and Merrill Lynch
Consults,(R) servicing fees related to such accounts, as well as account and
other fees.
Asset management and portfolio service fees were $3.6 billion in 2001, 4%
lower than in 2000. This decrease primarily reflects a market-driven decline in
asset values in asset-priced accounts. In 2000 these fees were $3.8 billion, up
from $3.1 billion in 1999 primarily due to a rise in portfolio service fees as
assets shifted to asset-priced accounts such as Unlimited Advantage/SM/ and
Merrill Lynch Consults.(R)
The value of assets in Private Client accounts at year-end 2001, 2000, and
1999 is summarized as follows:
(dollars in billions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Assets in Private Client accounts
U.S. $1,185 $1,337 $1,338
Non-U.S. 101 140 137
------ ------ ------
Total $1,286 $1,477 $1,475
====== ====== ======
Assets in asset-priced accounts $ 205 $ 209 $ 168
- --------------------------------------------------------------------------------
Analysis of changes in assets in Private Client accounts from year-end 2000
to year-end 2001 are detailed below:
(dollars in billions)
- -------------------------------------------------------------------------------------------
NET CHANGES DUE TO
------------------------------------
YEAR-END NEW ASSET YEAR-END
2000 MONEY DEPRECIATION OTHER 2001
- -------------------------------------------------------------------------------------------
Assets in Private
Client accounts:
U.S. $1,337 $ 49 $ (198) $ (3) $1,185
Non-U.S. 140 13 (20) (32) 101
------ ------ ------ ------ ------
Total $1,477 $ 62 $ (218) $ (35) $1,286
- -------------------------------------------------------------------------------------------
[BAR CHART]
PRIVATE CLIENT ASSETS
(in billions of dollars)
- --------------------------------------------------------------------------------
2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------
U.S. $1,185 $1,337 $1,338 $1,164 $979
Non-U.S. 101 140 137 98 84
------ ------ ------ ------ ------
Total $1,286 $1,477 $1,475 $1,262 $1,063
- --------------------------------------------------------------------------------
Total assets in Private Client accounts in the United States declined 11%
to $1.2 trillion at the end of 2001, with net new money inflows of $49 billion
during the year. Outside the United States, client assets were $101 billion at
the end of 2001, down 28% from year-end 2000, due largely to the sale of the
Canadian Private Client business, with net new money inflows of $13 billion in
2001. Total assets in asset-priced accounts were $205 billion at the end of
2001, a decrease of 2% from the end of 2000. The decline in asset levels in 2001
is due primarily to market depreciation.
NET INTEREST PROFIT
Interest revenue for Private Client is derived primarily from interest earned on
the investment portfolio, principally related to Merrill Lynch's U.S. banks, as
well as interest earned on margin and other loans. Interest expense mainly
consists of interest paid on bank deposits and other borrowings.
Net interest profit was $1.9 billion, up 15% from $1.6 billion in 2000 and
$1.2 billion in 1999. The increase in net interest profit in 2001 and 2000
resulted from growth in deposits and the related investment portfolio at Merrill
Lynch's U.S. banks and, in 2001, an increase in investment portfolio spreads,
particularly following the rate cuts by the Federal Reserve.
OTHER REVENUES
Other revenues decreased 31% in 2001, from $175 million to $121 million.
Included in Private Client's other revenues are realized and unrealized gains
and losses associated with investments. Investment-related net revenues were a
loss of $52 million in 2001 and a gain of $18 million in 2000.
Investment-related net revenues in
PAGE 23
Merrill Lynch 2001 Annual Report
2001 include a pre-tax gain on the sale of the Canadian Private Client business
which was more than offset by losses on various e-commerce investments.
MERRILL LYNCH INVESTMENT MANAGERS
MLIM is among the world's largest asset managers with $529 billion of assets
under management at the end of 2001. MLIM offers a wide array of taxable
fixed-income, tax-exempt fixed-income, equity and balanced open-ended mutual
funds, private accounts, and alternative investments to a diverse global
clientele of institutions, including pension plans and corporations,
high-net-worth individuals, mutual funds, and other investment vehicles. In the
United States, MLIM-branded mutual fund products are available through the
Private Client distribution channel, and through GMI and third-party
distribution networks. Outside the United States, MLIM-branded mutual fund
products are available through Private Client and GMI distribution networks as
well as through other financial intermediaries. MLIM also maintains a
significant sales and marketing presence in both the United States and overseas
that is focused on acquiring and maintaining institutional investment management
relationships. MLIM markets its services both directly to these investors and
through pension consultants.
During 2001, MLIM reviewed all of its business activities to further
enhance future profit potential and target selected growth opportunities. As a
result of these in-depth reviews, MLIM consolidated the management of its Japan,
Asia Pacific and European activities into a single management structure, reduced
its staff by nearly 25%, and significantly reduced its global real estate
footprint by selling, closing or downsizing offices in Los Angeles, Korea, and
Singapore and consolidating its New York metropolitan area-based operations.
MLIM also undertook strategic outsourcing opportunities, consolidated real
estate in Tokyo and London, reduced technology spending, and exited its Defined
Asset Funds business. In addition, in January 2002, MLIM sold its Canadian
retail investment management operations.
MLIM'S RESULTS OF OPERATIONS
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Commissions $ 295 $ 392 $ 394
Asset management fees 1,722 1,913 1,684
Other revenues 76 148 169
------ ------ ------
Total net revenues $2,093 $2,453 $2,247
====== ====== ======
Pre-tax operating earnings(1) $ 307 $ 501 $ 483
Pre-tax earnings $ 24 $ 501 $ 483
Pre-tax operating profit margin(1) 14.7% 20.4% 21.5%
Total full-time employees 3,200 4,200 3,800
- --------------------------------------------------------------------------------
(1) Before $283 million of pre-tax restructuring and other charges in 2001.
Pre-tax operating earnings for MLIM were $307 million in 2001, down 39%
from $501 million in 2000. Net revenues decreased 15% from 2000 to $2.1 billion,
and the pre-tax operating profit margin in 2001 was 14.7%, compared with 20.4%
in 2000, and 21.5% in 1999. The reduction in pre-tax operating earnings was
primarily the result of a market-driven decline in assets under management
combined with an increase in costs related to litigation. In addition, as a
result of the completion of the previously mentioned detailed business review,
MLIM recorded $283 million of pre-tax restructuring and other charges in the
fourth quarter of 2001, primarily related to severance and costs associated with
the closing of certain mutual funds, including investment write-downs of $32
million principally related to mutual fund seed capital.
COMMISSIONS
Commissions for MLIM principally consist of distribution and redemption fees
related to mutual funds. The distribution fees represent revenues for promoting
and distributing mutual funds ("12b-1 fees"). As a result of lower transaction
volumes, commissions decreased 25% to $295 million in 2001. Commissions were
relatively unchanged in 2000 as compared with 1999.
ASSET MANAGEMENT FEES
Asset management fees primarily consist of fees earned from the management and
administration of funds as well as performance fees earned by MLIM. Asset
management fees declined 10% to $1.7 billion from a record $1.9 billion in 2000.
These fees were $1.7 billion in 1999. The reduction in 2001 is due to a
market-driven decline in assets under management as well as a shift from equity
funds to lower-fee fixed-income products. The increase in 2000 was primarily the
result of higher management and performance fees.
MLIM's assets under management for each of the last three years were
comprised of the following:
(dollars in billions)
- ------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------
Assets Under Management
Retail(1) $220 $250 $300
Institutional 266 262 255
Private investors(2) 43 45 39
---- ---- ----
Total $529 $557 $594
- ------------------------------------------------------------
(1) Net of outflows of $10 billion and $36 billion of money market funds, which
transferred to bank deposits at Merrill Lynch's U.S. banks in 2001 and
2000, respectively.
(2) Represents segregated portfolios for individuals, small corporations, and
institutions.
[BAR CHART]
ASSETS UNDER MANAGEMENT BY TYPE
(in billions of dollars)
-----------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------
Equity $229 $274 $296 $266 $245
Fixed income 110 113 108 104 95
Money market 147 125 151 139 115
Private investors 43 45 39 35 32
------ ------ ------ ------ ------
Total $529 $557 $594 $544 $487
-----------------------------------------------------------
PAGE 24
Merrill Lynch 2001 Annual Report
At year-end 2001, assets under management totaled $529 billion, a 5%
decline from 2000. This decline is primarily market-driven, partially offset by
$19 billion of global net inflows.
An analysis of changes in assets under management from year-end 2000 to
year-end 2001 is as follows:
(dollars in billions)
- --------------------------------------------------------------------------------
NET CHANGES DUE TO
---------------------------------
YEAR-END NEW ASSET YEAR-END
2000 MONEY DEPRECIATION OTHER(1) 2001
- --------------------------------------------------------------------------------
Assets under
management $557 $ 19 $(41) $(6) $529
- --------------------------------------------------------------------------------
(1) Includes reinvested dividends of $7 billion, net outflows of $10 billion of
retail money market funds which transferred to bank deposits at Merrill
Lynch's U.S. banks, and other changes, primarily related to foreign
exchange rate movements.
[PIE CHART]
2001 ASSETS UNDER MANAGEMENT
CLIENT TYPE
Institutional 50%
Retail 42%
Private Investors 8%
CLIENT LOCATION
Americas 65%
Europe 27%
Other Non-U.S. 8%
OTHER REVENUES
Other revenues, which primarily include net interest profit and investment
gains, fell 49% to $76 million in 2001. The decrease was due to losses on
investments. Other revenues in 2000 were $148 million, 12% lower than 1999
levels. In 1999, other revenues included a pre-tax gain of $89 million on the
sale of an investment.
GLOBAL OPERATIONS
Merrill Lynch's operations outside the United States are organized into five
geographic regions:
.Europe, Middle East, and Africa
.Japan
.Asia Pacific
.Canada, and
.Latin America
The following chart illustrates the regional operating results excluding
all items included in the corporate segment. For further geographic information
see Note 3 to the Consolidated Financial Statements.
[PIE CHART]
2001 NET REVENUES BY GEOGRAPHIC REGION
U.S. 69%
Europe 16%
Japan 5%
Other Non-U.S. 10%
EUROPE, MIDDLE EAST, AND AFRICA
(dollars in millions)
- -------------------------------------------------------------------------------
2001 2000 1999
- -------------------------------------------------------------------------------
Net revenues $3,640 $4,876 $3,976
Pre-tax operating earnings(1) 335 1,315 1,132
Pre-tax earnings 42 1,315 1,132
Total full-time employees 7,200 8,800 7,600
- -------------------------------------------------------------------------------
(1) Before $293 million of pre-tax restructuring and other charges in 2001.
Merrill Lynch operates in Europe, the Middle East, and Africa as a dealer
in a wide array of equity and debt products, and also provides asset management,
investment banking, private banking, and research services. Merrill Lynch
believes this region is poised for accelerated growth due to changes in
demographics, the growth in equity markets, and the development of the Euroland
economy. In line with its strategy of becoming a global leader with a strong
local presence in key markets, Merrill Lynch has offices in 18 countries in the
region. Merrill Lynch has preeminent asset management capabilities in this
region, operating under the Merrill Lynch Investment Managers brand.
As a result of a detailed business review in the fourth quarter of 2001,
Private Client consolidated offices in Europe and the Middle East, MLIM
consolidated its Japan, Asia Pacific and European activities into a single
management structure and GMI streamlined its management and reorganized its
investment banking division. These actions resulted in a fourth quarter pre-tax
charge of $293 million in the region, primarily related to severance.
In May 2001, following the launch in the United Kingdom of a free research
service by MLHSBC in 2000, a full transactional service for self-directed
investors was launched.
Merrill Lynch demonstrated leadership in investment banking in the region
in 2001, ranking first in equity origination, according to IFR magazine, with a
market share of 16.6% and third in announced mergers and acquisitions, up from
fifth in 2000, according to Thomson Financial Securities Data. In addition, in
the Reuters/Tempest Survey of U.K. Larger Companies, Merrill Lynch was ranked
top broker for research by corporations and managers and best firm for equity
derivatives for the third consecutive year. Merrill Lynch ranked second in the
Institutional Investor 2001 All-Europe Research Team Survey.
In 2001, net revenues for the region decreased 25% from 2000. Pre-tax
operating earnings decreased 75% from 2000 to $335 million due primarily to
decreased equity trading and origination revenues. In 2000, net revenues and
pre-tax earnings for the region were up 23% and 16%, respectively, from 1999,
primarily due to strong equity trading and advisory revenues.
PAGE 25
Merrill Lynch 2001 Annual Report
JAPAN
(dollars in millions)
- ----------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues $ 1,023 $ 1,511 $ 1,193
Pre-tax operating earnings (loss)(1) (7) 243 (33)
Pre-tax earnings (loss) (387) 243 (33)
Total full-time employees 2,900 3,500 3,200
- ----------------------------------------------------------------------------
(1) Before $380 million of pre-tax restructuring and other charges in 2001.
In Japan, Merrill Lynch provides an integrated range of GMI, Private
Client, and MLIM products and services to individual, corporate and
institutional clients. In March 2001, Merrill Lynch completed the consolidation
of GMI and Private Client businesses into the single Japan-incorporated entity,
Merrill Lynch Japan Securities Co., Ltd. ("MLJS"). GMI and Private Client
successfully distributed several debt and equity public offerings through MLJS
in 2001.
GMI maintained its strong presence in Japan in 2001. Despite the further
deterioration of the Japanese economy, the debt business achieved record
earnings and completed the consolidation of various management and support
units, resulting in a more cost-effective structure. Investment banking also
demonstrated its strong international network and ability to provide innovative
services in underwriting.
Private Client is sharpening its focus on small- to medium-sized business
clients and high-net-worth individual investors. To accomplish this, Private
Client will close a number of branch offices in 2002, but maintain several
smaller locations across Japan, including complexes in Tokyo and Osaka, and a
Financial Service Center in Tokyo to serve the non-Financial Advisor-assisted
client base. These actions resulted in a fourth quarter 2001 pre-tax charge of
$380 million and will result in additional wind-down expenses of $80-$100
million in 2002. While representing less than 20% of total accounts, the middle
markets and high-net-worth client base has accounted for the majority of Merrill
Lynch's Private Client assets in Japan since inception in 1998.
MLIM is one of the leading institutional money managers in Japan and,
despite the challenging economic conditions in 2001, MLIM attracted $1.5 billion
in net new money for institutional clients.
Net revenues in the Japan region in 2001 were down 32% from 2000 to $1.0
billion, reflecting weak market conditions, except in the GMI debt business. The
corresponding decrease in pre-tax operating earnings was partially alleviated by
the reduction in expenses as a result of strict cost management in 2001. In
2000, net revenues and pre-tax earnings were up $318 million and $276 million,
respectively, from 1999, reflecting increased debt and equity trading revenues
and higher asset management fees.
ASIA PACIFIC
(dollars in millions)
- ----------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues $ 874 $ 1,247 $ 1,018
Pre-tax operating earnings(1) 49 269 183
Pre-tax earnings (loss) (40) 269 183
Total full-time employees 2,200 2,700 2,500
- ----------------------------------------------------------------------------
(1) Before $89 million of pre-tax restructuring and other charges in 2001.
Merrill Lynch serves a broad retail and institutional client base
throughout the Asia Pacific region, and offers a full range of GMI, Private
Client, and MLIM products. Merrill Lynch has an established trading presence and
exchange memberships in major financial markets in the region. The Private
Client business operates 13 offices, including four in the Western United
States, offering investment services and wealth management products to its
clients. MLHSBC began providing online financial services to self-directed
investors in Australia in 2001. MLIM operates 10 offices offering a diverse mix
of investment management products and services to institutional and retail
clients.
As part of Merrill Lynch's detailed business review in 2001, Private Client
restructured its operations in Australia by moving the focus to high-net-worth
investors and consolidating offices. MLIM restructured its operations by
consolidating the investment management activities for the region into its
London location, and GMI sold its equity brokerage operation in the Philippines
to a local management team. As a result of the completion of these detailed
business reviews, a pre-tax charge of $89 million was recorded in the fourth
quarter of 2001.
In 2001, IFR magazine named Merrill Lynch "Asian Equity and Equity-Linked
House of the Year," the Far Eastern Economic Review named Merrill Lynch "Most
Respected Investment Bank in Asia," and Institutional Investor magazine ranked
Merrill Lynch first in Asian Equity Research for the third consecutive year.
Merrill Lynch experienced a reduction in business volumes in the region
during 2001. Net revenues in the region declined 30% in 2001 to $874 million.
Pre-tax operating earnings declined 82% to $49 million. The decline was a direct
result of the deterioration in business volumes related to a slowdown in the
regional economy. In 2000, net revenues in the region were $1.2 billion, up from
$1.0 billion in 1999, due to strong revenues in the equity markets and record
Private Client revenues, as well as higher advisory fees. Pre-tax earnings
increased 47% in 2000 to $269 million, primarily as a result of strong equity
markets.
CANADA
(dollars in millions)
- ------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------
Net revenues $ 877 $ 854 $ 652
Pre-tax operating earnings(1) 283 176 57
Pre-tax earnings 253 176 57
Total full-time employees 500 4,000 3,700
- ------------------------------------------------------------------------
(1) Before $30 million of pre-tax restructuring and other charges in 2001.
PAGE 26
Merrill Lynch 2001 Annual Report
During 2001 Merrill Lynch operated a full-service Canadian securities
firm, providing an integrated range of GMI, Private Client and MLIM products and
services. However, as a result of the completion of a detailed business review
in the fourth quarter of 2001, Merrill Lynch sold its Private Client and
securities clearing businesses in Canada in December and, in January 2002, sold
its MLIM retail investment management business. The 2001 sales resulted in a
significant reduction in the number of full-time employees in the region. MLHSBC
began providing online services to self-directed Canadian investors in late
2000.
All GMI businesses performed well in 2001, with notable contributions from
debt markets and investment banking. The fixed income markets performed at
record highs, resulting in increased debt underwriting and trading revenues.
Euromoney magazine named Merrill Lynch "Best Foreign Bond House" in Canada.
Merrill Lynch has been the leading non-domestic Canadian Dollar debt underwriter
for the last three years, according to Bloomberg rankings. In 2001, Merrill
Lynch ranked first in announced mergers and acquisitions, having advised on 10
of the 24 largest transactions in Canada. Equity trading continued its
significant progress and the Brendan Woods International Survey ranked Merrill
Lynch third in the institutional equity commission business in Canada, with the
largest year-over-year market share gain in the country.
In 2001, net revenues in the region were essentially unchanged as increases
in GMI revenues and a gain on the sale of businesses were principally offset by
decreases in Private Client operating revenues. Pre-tax operating earnings
increased to $283 million in 2001, due to record earnings in investment banking
and a pre-tax gain of $158 million on the sale of the Private Client and
securities clearing businesses. Excluding the impact of the sales, the Private
Client and securities clearing businesses contributed $358 million and $7
million to net revenues and pre-tax earnings, respectively, in Canada in 2001.
In 2000, net revenues and pre-tax earnings in the region increased 31% and 209%,
respectively, compared with 1999. These increases were primarily the result of
improvements in equity origination and trading as well as improved profitability
in Private Client.
LATIN AMERICA
(dollars in millions)
- ------------------------------------------------------------------------
2001 2000 1999
- ------------------------------------------------------------------------
Net revenues $ 475 $ 731 $ 672
Pre-tax operating earnings(1) 32 175 127
Pre-tax earnings 18 175 127
Total full-time employees 1,000 1,200 1,200
- ------------------------------------------------------------------------
(1) Before $ 14 million of pre-tax restructuring and other charges in 2001.
Merrill Lynch provides various brokerage and investment services, including
financial planning, investment banking, research, and asset management to Latin
American clients.
In July 2001, Merrill Lynch closed its broker-dealer in Argentina. The
economies of Latin America took a downward turn in 2001. Argentina suspended
payment on a portion of its $141 billion of debt, a prelude to the largest
sovereign default in history. The depreciation of Brazil's currency and an
energy crisis have also taken a toll on the Latin American economy.
In Institutional Investor's 2001 survey, Merrill Lynch's Latin American
Research team was ranked first, for the fifth year in a row.
Net revenues for the region in 2001 decreased 35% from 2000. Pre-tax
operating earnings were $32 million, a decrease of $143 million from 2000. A
major contributing factor to this decline was the volatility of the Latin
American economy. Despite the economic environment, Private Client's business in
Latin America has remained strong. Net revenues and pre-tax earnings in 2000
increased 9% and 38%, respectively, from 1999 due to higher commission revenues
and the gain on a sale of the Puerto Rico retail brokerage business in 2000.
NON-INTEREST EXPENSES
Merrill Lynch's non-interest expenses are summarized as follows:
(dollars in millions)
- ---------------------------------------------------------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------------
Compensation and benefits $11,269 $13,730 $11,337
------- ------- -------
Non-compensation expenses:
Communications and technology 2,232 2,320 2,053
Occupancy and related depreciation 1,077 1,006 953
Brokerage, clearing, and exchange fees 895 893 779
Advertising and market development 703 939 783
Professional fees 545 637 571
Office supplies and postage 349 404 346
Goodwill amortization 207 217 227
Other 902 903 1,058
------- ------- -------
Total non-compensation expenses, excluding
September 11th-related and restructuring and
other charges in 2001 6,910 7,319 6,770
September 11th-related 131 - -
Restructuring and other charges 2,193 - -
------- ------- -------
Total non-compensation expenses 9,234 7,319 6,770
------- ------- -------
Total non-interest expenses $20,503 $21,049 $18,107
======= ======= =======
Compensation and benefits as a
percentage of net revenues 51.5% 51.3% 50.8%
Non-compensation expenses, excluding
September 11th-related and
restructuring and other charges in 2001,
as a percentage of net revenues 31.6 27.3 30.3
Total full-time employees(1) 57,400 72,000 67,900
- ---------------------------------------------------------------------------------------------------
(1) Excludes 3,200 full-time employees on salary continuation severance at
year-end 2001.
Non-interest expenses were $20.5 billion in 2001, compared with $21.0
billion in 2000. Excluding September 11th-related expenses and restructuring and
other charges, non-interest expenses were $18.2 billion in 2001. Compensation
and benefits were down 18% from 2000 due to a
PAGE 27
Merrill Lynch 2001 Annual Report
decrease in incentive and production-related compensation, resulting from a
decline in revenue and a lower number of employees. Compensation and benefits
expenses include severance expenses not included in the restructuring charge of
$281 million and $70 million in 2001 and 2000, respectively. Compensation and
benefits were 51.5% of net revenues for 2001, relatively unchanged from 2000.
Non-compensation expenses, excluding September 11th-related expenses and
restructuring and other charges, were 31.6% of net revenues in 2001, compared
with 27.3% in 2000 and 30.3% in 1999.
Communications and technology expense declined 4% in 2001 to $2.2 billion
due to reduced systems consulting costs. Occupancy and related depreciation
increased 7% in 2001, primarily due to a new London headquarters building.
Brokerage, clearing, and exchange fees were $895 million, essentially
unchanged from 2000. Advertising and market development expense was $703
million, down 25% from 2000 due to reduced spending on travel, advertising, and
recognition programs. Professional fees decreased 14% to $545 million as a
result of a reduction in spending on employment and non-technology consulting
services. Office supplies and postage expense decreased 14% to $349 million due
primarily to lower expenses for supplies. Other expenses were $902 million,
essentially unchanged from 2000.
Non-interest expenses in 2000 were up 16% compared with 1999, largely due
to compensation and benefits, which rose 21% to $13.7 billion. This increase was
caused by higher incentive and production-related compensation resulting from
increased revenues.
Non-compensation expenses also increased in 2000 as compared with 1999, due
primarily to a 13% increase in communications and technology expenses that
resulted from higher technology-related depreciation and systems consulting, as
well as increased expenses related to market data services. Brokerage, clearing,
and exchange fees were 15% higher than 1999 due to higher execution and clearing
costs as a result of increased transaction volumes. Higher travel expenses and
sales promotion costs resulting from increased business activity were the cause
of a 20% increase in advertising and market development in 2000. Professional
fees rose 12% partly as a result of higher employment service fees. Office
supplies and postage expense increased 17% due primarily to higher printing
expenses.
SEPTEMBER 11TH-RELATED EXPENSES
September 11th-related expenses of $131 million pre-tax ($83 million after-tax)
were recorded in 2001. These amounts are net of an insurance recovery of $100
million and insurance receivables of $115 million. The majority of the September
11th-related gross expenses pertain to the write-off of damaged assets and
sublease income, the repair and replacement of equipment, as well as
transportation, moving, and related costs for displaced workers. For additional
information see Note 2 to the Consolidated Financial Statements.
RESTRUCTURING AND OTHER CHARGES
As a result of actions taken to position Merrill Lynch for improved
profitability and growth, including the resizing of selected businesses and
other structural changes, a pre-tax charge of $2.2 billion ($1.7 billion
after-tax) was recorded during the fourth quarter of 2001. A detailed review of
all businesses was conducted in the fourth quarter and these in-depth reviews
led to a number of actions, primarily focused on resizing the businesses for the
current environment. The charge included the following components:
.Approximately $1.2 billion of the charge is associated with severance costs
related to workforce reductions, and other staff-related costs. Workforce
reductions were made through a combination of divestitures, voluntary
separations, and managed reductions. The majority of the employee separations
associated with the fourth-quarter charges have been completed or announced,
and all have been identified. Approximately half of the 9,000 employee
separations are associated with divestitures and discontinued businesses; the
remainder result from voluntary separation, or targeted actions in selected
businesses.
.Real estate initiatives include the consolidation of Private Client offices in
the United States, Europe, Asia, and Australia and the closure or subletting of
excess office space in the United States. Approximately $500 million of the
charge is associated with real estate initiatives.
.Technology initiatives include the disposal of certain technology assets and
the sale-leaseback and related write-down of other technology assets.
Approximately $300 million of the charge is associated with technology
initiatives.
.Other business rationalization costs, which comprise $200 million of the
charge are principally related to costs associated with the refocusing of the
Private Client business in Japan.
Management expects the restructuring plan to yield pre-tax cost savings of
$1.4 billion annually, beginning in the first quarter of 2002, a portion of
which will be reinvested in priority growth initiatives. These savings largely
relate to reduced employee-related and facilities costs and are expected to be
realized in compensation and benefits, depreciation, and occupancy expenses.
Merrill Lynch expects to substantially complete the restructuring by the end of
2002. Management will continue to review its business groups and product
offerings throughout 2002 to meet the needs of the changing economic environment
and to ensure its goal of improved profitability.
For additional information on these charges, see Note 2 to the Consolidated
Financial Statements.
PAGE 28
Merrill Lynch 2001 Annual Report
INCOME TAXES
Merrill Lynch's 2001 income tax provision was $609 million, representing a 44.2%
effective tax rate compared with 30.4% in 2000 and 31.4% in 1999. The increase
in the 2001 effective tax rate is due primarily to prior and current year
non-deductible losses associated with the refocusing of the Japan Private Client
business, which were included in the fourth-quarter charge, including a
write-off of previously recognized deferred tax assets of approximately $135
million. The decline in the 2000 effective tax rate was primarily attributable
to an increase in lower-taxed non-U.S. 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 assesses 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 $2.7 billion. Accordingly,
management believes that it is more likely than not that remaining deferred tax
assets, net of the related valuation allowance, will be realized (see Note 15 to
the Consolidated Financial Statements).
- --------------------------------------------------------------------------------
BALANCE SHEET
OVERVIEW
Management continually monitors and evaluates the level and composition of the
balance sheet. The following chart illustrates the composition of the balance
sheet at December 28, 2001.
[PIE CHART]
ASSETS
Securities Financing Transactions 30%
Trading Assets 26%
Marketable Investment Securities 18%
Other 16%
Trading-Related Receivables 10%
LIABILITIES
Seurities Financing Transactions 22%
Deposits 22%
Trading Liabilities 20%
Long-Term Borrowings 19%
Trading-Related Payables 9%
Other 7%
Short-Term Borrowings 1%
In 2001, average total assets were $429 billion, up 16% from $371 billion
in 2000. Average total liabilities in 2001 increased 15% to $406 billion from
$352 billion in 2000, and average equity capital increased 23% to $23 billion
during 2001. The major components of the increase in average total assets and
liabilities are summarized as follows:
(dollars in millions)
- ---------------------------------------------------------------------------
2001 VS. 2000
-----------------------------
INCREASE
(DECREASE) CHANGE
- ---------------------------------------------------------------------------
AVERAGE ASSETS
Marketable investment securities $ 39,299 158%
Receivables under resale agreements 18,314 24
Loans, notes and mortgages 6,358 48
- ---------------------------------------------------------------------------
AVERAGE LIABILITIES
Deposits $ 46,219 134%
Payables under repurchase agreements 17,390 21
Long-term borrowings 14,908 24
Commercial paper and other short-term
borrowings (14,158) (59)
- ---------------------------------------------------------------------------
The significant growth in deposits in 2001 resulted from the mid-2000
modification of the cash sweep options for certain CMA(R) and other types of
Merrill Lynch accounts to generally sweep cash into interest-bearing bank
deposits at Merrill Lynch's U.S. banks, rather than MLIM-managed money market
mutual funds. This increase in deposits was primarily used by the U.S. banks to
purchase marketable investment securities. Receivables under resale agreements
and payables under repurchase agreements rose due to increased matched-book
activity. Additionally, the increase in long-term borrowings is related to the
reduction in the use of commercial paper and other short-term borrowings in
2001.
The discussion that follows analyzes the changes in year-end financial
statement balances of the major asset and liability categories.
TRADING-RELATED ASSETS AND LIABILITIES
Trading-related balances primarily consist of trading assets (including
securities pledged as collateral) 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 28, 2001 total
trading-related assets and liabilities were $273.6 billion and $203.4 billion,
respectively.
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 section (see Note 6 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.
Conversely, Merrill Lynch may be required to post cash or securities to
counterparties in accordance with similar policies.
PAGE 29
Merrill Lynch 2001 Annual Report
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 for related accounting policies). 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 represent 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, including securities pledged as collateral, at year-end
2001 were up 4% from year-end 2000, and trading liabilities increased 10% to
$75.9 billion.
SECURITIES FINANCING 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 with a significant portion 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.
Receivables under resale agreements and securities borrowed transactions at
year-end 2001 increased 9% from 2000, and payables under repurchase agreements
and securities loaned transactions decreased 16% from year-end 2000.
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 at year-end 2001 were $40.8 billion, down 32%
from 2000, and trading-related payables increased 55% to $37.1 billion from
year-end 2000, primarily due to changes in broker-dealer balances.
NON-TRADING ASSETS
INVESTMENTS
Marketable investment securities, including those held for liquidity management
purposes, consist of highly liquid debt and equity securities. Marketable
investment securities grew to $77.8 billion at December 28, 2001 from $49.3
billion at December 29, 2000, funded by increased bank deposits (see the
Non-Trading Liabilities -- Borrowings section for further information).
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, and venture capital investments, including technology investments,
and investments that economically hedge deferred compensation liabilities (see
Note 5 to the Consolidated Financial Statements).
LOANS, NOTES, AND MORTGAGES
Merrill Lynch's portfolio of loans, notes, and mortgages consists of mortgage
loans on residences, working capital loans to small- and medium-sized
businesses, and syndicated loans. Merrill Lynch generally maintains collateral
on some of 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 increased 9% in 2001 to $19.0 billion
due to
PAGE 30
Merrill Lynch 2001 Annual Report
increased consumer lending activities. Merrill Lynch maintained collateral of
$14.7 billion at December 28, 2001 to reduce related default risk against
certain of these credits.
OTHER
Other non-trading assets, which include cash and cash equivalents, goodwill,
equipment and facilities, and other assets, decreased $12.8 billion from
year-end 2000 levels. This decrease is primarily due to decreased cash
equivalent investment balances at Merrill Lynch's U.S. banks.
NON-TRADING LIABILITIES
BORROWINGS
Portions of trading and non-trading assets are funded through deposits,
long-term borrowings, and commercial paper (see the Capital Adequacy and Funding
section for further information on funding sources).
Commercial paper decreased from $14.0 billion at year-end 2000 to $3.0
billion at year-end 2001. Deposits increased $18.2 billion in 2001 as a result
of higher customer deposits in U.S. banking subsidiaries which resulted from the
mid-2000 modification of the cash sweep options for certain CMA(R) and other
types of Merrill Lynch accounts to generally sweep cash into interest-bearing
bank deposits at Merrill Lynch's U.S. banks, rather than MLIM-managed money
market mutual funds. Outstanding long-term borrowings increased to $76.6 billion
at December 28, 2001 from $70.2 billion at December 29, 2000. In the second
quarter of 2001, Merrill Lynch issued Liquid Yield Option/TM/ Notes
("LYONs"(R)) due in 2031. LYONs(R) are zero-coupon senior debt instruments
convertible into Merrill Lynch common stock at a premium under certain defined
terms and conditions. For additional information on LYONs(R) see Note 8 to the
Consolidated Financial Statements.
Major components of the changes in long-term borrowings for 2001 and 2000
follow:
(dollars in billions)
- ----------------------------------------------------------------------
2001 2000
- ----------------------------------------------------------------------
Beginning of year $ 70.2 $ 54.0
Issuances 38.5 33.7
Maturities (32.8) (15.7)
Other 0.7 (1.8)
------- -------
End of year(1) $ 76.6 $ 70.2
======= =======
Average maturity in years of long-term
borrowings, when measured to:
Maturity 4.1 3.6
Earlier of the call or put date 2.8 3.0
- ----------------------------------------------------------------------
(1) At year-end 2001 and 2000, $54.1 billion and $48.8 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 2000 levels.
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES
Preferred securities issued by subsidiaries consist primarily of Trust
Originated Preferred Securities/SM/ ("TOPrS"/SM/) (see Note 10 to the
Consolidated Financial Statements for further information). TOPrS/SM/ proceeds
are utilized as part of general balance sheet funding (see Capital Adequacy and
Funding section for more information).
STOCKHOLDERS' EQUITY
Stockholders' equity at December 28, 2001 increased 9% to $20.0 billion from
$18.3 billion at year-end 2000. This increase primarily resulted from net
earnings and the net effect of employee stock transactions, partially offset by
dividends.
At December 28, 2001, total common shares outstanding, excluding shares
exchangeable into common stock, were 843.5 million, 4% higher than the 808.0
million shares outstanding at December 29, 2000. The increase was attributable
principally to employee stock grants and option exercises. There were no common
stock repurchases during 2001 or 2000.
Total shares exchangeable into common stock at year-end 2001, issued in
connection with the 1998 merger with Midland Walwyn Inc., were 4.2 million,
compared with 4.7 million at year-end 2000. For additional information see Note
11 to the Consolidated Financial Statements.
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY AND FUNDING
The primary objectives of Merrill Lynch's capital structure and funding policies
are to support the successful execution of the firm's business strategies while
ensuring:
.sufficient equity capital to absorb losses and,
.liquidity at all times, across market cycles, and through periods of
financial stress.
CAPITAL ADEQUACY
At December 28, 2001, Merrill Lynch's equity capital was comprised of $19.6
billion in common equity, $425 million in preferred stock, and $2.7 billion of
TOPrS./SM/
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, such as process
risk, 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,/SM/ taking into account the perpetual nature
of its preferred stock and TOPrS./SM/ Based on these
PAGE 31
Merrill Lynch 2001 Annual Report
analyses and criteria, management believes that Merrill Lynch's equity capital
base of $22.7 billion is adequate.
Merrill Lynch operates in many regulated businesses that require various
minimum levels of capital (see Note 16 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 capital adequacy models and
planning take into account these regulatory considerations.
Merrill Lynch's leverage ratios were as follows:
- ------------------------------------------------------------------
ADJUSTED
LEVERAGE LEVERAGE
RATIO(1) RATIO(2)
- ------------------------------------------------------------------
YEAR-END
December 28, 2001 18.5x 12.8x
December 29, 2000 19.4x 13.9x
AVERAGE(3)
Year ended December 28, 2001 18.8x 13.1x
Year ended December 29, 2000 19.0x 13.2x
- ------------------------------------------------------------------
(1) Total assets to Total stockholders' equity and Preferred securities issued
by subsidiaries.
(2) Total assets less (a) Receivables under resale agreements (b) Receivables
under securities borrowed transactions and (c) Securities received as
collateral 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.
FUNDING
Merrill Lynch strives to continually expand and globally 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., Euro, Canadian, Japanese, and Australian commercial paper programs,
.deposits at Merrill Lynch's banking subsidiaries,
.bank loans,
.U.S., Euro, Canadian, and Australian medium- and long-term debt programs,
.letters of credit,
.TOPrS,/SM/
.preferred stock, and
.common stock.
Merrill Lynch typically concentrates its unsecured, non-deposit
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.
During 2001 and 2000, Merrill Lynch reduced its reliance on commercial
paper as a source of funding. Commercial paper represented 4% and 16% of total
unsecured borrowings at year-end 2001 and 2000, respectively. Merrill Lynch
diversifies its borrowings by maintaining various limits, including a limit on
the amount of commercial paper held by a single investor.
LIQUIDITY MANAGEMENT
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 requiring business assets
to be liquidated. The main alternative funding sources to unsecured borrowings
are repurchase agreements, securities loaned, and secured bank loans, which
require pledging unencumbered marketable securities held for trading or
investment purposes.
As an additional source of liquidity, Merrill Lynch maintains a portfolio
of segregated U.S. government and agency obligations, and asset-backed
securities of high credit quality, which had a carrying value, net of related
hedges of $8.4 billion at December 28, 2001 and $7.4 billion at December 29,
2000. These assets may be sold or pledged to provide immediate liquidity even
during periods of adverse market conditions.
For funding purposes, Merrill Lynch assesses its assets and commitments in
order to determine the appropriate level of short-term and long-term funding.
Long-term funding sources include a portion of deposits, the non-current portion
of long-term debt, TOPrS/SM/, preferred stock, and common equity. Generally,
trading and other current assets are financed with a combination of short-term
and long-term funding. Long-term, less liquid assets are fully financed with
long-term funding. Merrill Lynch also finances the long-term funding
requirements of commitments and other contingent obligations, including
additional collateral that may be required under derivative contracts in certain
rating downgrade scenarios. In assessing the appropriate tenor of its short-term
and long-term funding, Merrill Lynch seeks to ensure sufficient coverage over
the spectrum of maturities.
Merrill Lynch recognizes that regulatory restrictions may limit the free
flow of funds among affiliates. For example, a portion of deposits held by
Merrill Lynch bank subsidiaries fund securities that can be sold or pledged to
provide immediate liquidity for the banks. However, there are regulatory
restrictions on the use of this liquidity for non-bank affiliates of Merrill
Lynch.
PAGE 32
Merrill Lynch 2001 Annual Report
Approximately $81.7 billion of indebtedness at December 28, 2001 is
considered senior indebtedness as defined under various indentures. Merrill
Lynch's debt obligations do not contain provisions that could, upon an adverse
change in ML & Co.'s credit rating, financial ratios, earnings, cash flows, or
stock price, trigger a requirement for an early payment, additional collateral
support, changes in terms, acceleration of maturity, or the creation of an
additional financial obligation. Merrill Lynch may issue structured notes that,
under certain circumstances, require Merrill Lynch to immediately settle the
obligation for cash or other securities. A limited number of structured notes
may be accelerated based on the value of the underlying securities. Merrill
Lynch typically hedges these notes with positions in the underlying securities.
Merrill Lynch maintains a committed, senior, unsecured bank credit facility
that totaled $5 billion at December 28, 2001 and $8 billion at December 29,
2000. The current facility expires in May 2002. While Merrill Lynch expects to
renew the facility, it may choose to do so in a reduced amount. In 2001, Merrill
Lynch elected to reduce the amount of its credit facility. This reduction was
offset by an increase in the liquidity portfolio of unencumbered securities that
may be sold or pledged to provide immediate liquidity. At December 28, 2001 and
December 29, 2000, there were no borrowings outstanding under these credit
facilities. Merrill Lynch's revolving line of bank credit contains covenants,
including a minimum net worth requirement, with which Merrill Lynch has
maintained compliance at all times. The credit facility does not, however,
require Merrill Lynch to maintain specified credit ratings.
Merrill Lynch maintains a contingency funding plan that outlines actions
that would be taken in the event of a funding disruption.
ASSET AND LIABILITY MANAGEMENT
Merrill Lynch routinely issues debt in a variety of maturities and currencies to
achieve the lowest cost financing possible and an appropriate liability maturity
profile. Merrill Lynch uses derivative transactions to more closely match the
duration of these borrowings to the duration of the assets being funded to
enable interest rate risk to be managed within limits set by Corporate Risk
Management. Interest rate swaps also serve to reduce Merrill Lynch's interest
expense and effective borrowing rate, when interest rates decline. 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).
Investments in subsidiaries in foreign currencies are also effectively hedged to
a level which minimizes translation adjustments in the Cumulative Translation
Account. For further information, see Notes 1 and 6 to the Consolidated
Financial Statements.
CREDIT RATINGS
The cost and availability of unsecured funding generally are dependent on credit
ratings. Merrill Lynch's senior long-term debt, preferred stock, and TOPrS/SM/
were rated by several recognized credit rating agencies at February 25, 2002 as
indicated below. These ratings do not reflect outlooks that may be expressed by
the rating agencies from time to time, which are currently negative. Subsequent
to the announcement of Merrill Lynch's fourth quarter 2001 restructuring and
other charges, all of these rating agencies reaffirmed Merrill Lynch's current
ratings.
- --------------------------------------------------------------------------------
PREFERRED
SENIOR DEBT STOCK TOPrS/SM/
RATING AGENCY RATINGS RATINGS RATINGS
- --------------------------------------------------------------------------------
Dominion Bond Rating
Service Ltd. AA (low) Not Rated Not Rated
Fitch Ratings AA AA- AA-
Moody's Investors Service, Inc. Aa3 A2 A1
Rating & Investment
Information, Inc.(1) AA A+ A+
Standard & Poor's
Ratings Services AA- A A
- --------------------------------------------------------------------------------
(1) Located in Japan.
NON-TRADING RELATED CONTRACTUAL OBLIGATIONS
As a part of its normal operating strategy, Merrill Lynch enters into various
contractual obligations and commitments which may require future payments. The
table below outlines the significant contractual obligations outstanding as of
December 28, 2001 and provides reference to where further information on each
obligation can be found elsewhere in this document:
- --------------------------------------------------------------------------------
CONTRACTUAL OBLIGATION REFERENCE
- --------------------------------------------------------------------------------
Long-term borrowings Note 8
Leases Note 12
Deferred compensation plans Note 14
Additional commitments to Note 12 and Non-Investment
invest in partnerships Grade Holdings and Highly
Leveraged Transactions
Unutilized revolving lines of
credit and other commitments to
extend credit Note 12
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CAPITAL PROJECTS AND EXPENDITURES
Merrill Lynch continually prepares for the future by reviewing its operations
and investing in new technology to improve service to clients.
Merrill Lynch has agreed to invest not more than $600 million in MLHSBC,
the 50/50-owned corporation created to provide global online investment and
banking services. At December 28, 2001, Merrill Lynch had invested $197 million.
The timing of the funding of additional investments will be determined by the
Board of Directors of MLHSBC, which has equal representation from Merrill Lynch
and HSBC.
PAGE 33
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
RISK MANAGEMENT
RISK MANAGEMENT PHILOSOPHY
Risk-taking is an integral part of Merrill Lynch's core business activities. In
the course of conducting its business operations, Merrill Lynch is exposed to a
variety of risks including market, credit, liquidity, process, and other risks
that are material and require comprehensive controls and management. The
responsibility and accountability for these risks remain primarily with the
businesses. The Corporate Risk Management ("CRM") group along with other control
units, ensures that these risks are properly identified, monitored, and managed
throughout Merrill Lynch. To accomplish this, CRM has established a risk
management process, which includes:
.a formal risk governance organization that defines the oversight process
and its components;
.a regular review of the entire risk management process by the Audit
Committee of the Board of Directors;
.clearly defined risk management policies and procedures supported by
analytic tools;
.communication and coordination between the business, executive, and risk
functions while maintaining strict segregation of responsibilities,
controls, and oversight; and
.clearly articulated risk tolerance levels as defined by a group composed of
executive management ("the Management Group") that are regularly reviewed
to ensure that Merrill Lynch's risk-taking is consistent with its business
strategy, capital structure, and current and anticipated market conditions.
The risk management process, combined with CRM's personnel and analytic
infrastructure, works to ensure that Merrill Lynch's risk tolerance is
well-defined and understood by the firm's businesses as well as by its executive
management. Other groups, including Corporate Audit, Finance, Legal and
Treasury, work with CRM to establish this overall risk management control
process. While no risk management system can ever be absolutely complete, the
goal of CRM is to make certain that risk related losses occur within acceptable,
predefined levels.
RISK GOVERNANCE STRUCTURE
Merrill Lynch's risk governance structure is comprised of the Audit Committee,
the Management Group, the Risk Oversight Committee ("ROC"), the business units,
CRM, and various corporate governance committees. The roles of these respective
groups are as follows:
The Audit Committee is comprised entirely of external directors and has
authorized the ROC to establish Merrill Lynch's risk management policies.
The Management Group establishes risk tolerance levels for the firm and
authorizes material changes in Merrill Lynch's risk profile. It also ensures
that the risks assumed by Merrill Lynch are managed within these tolerance
levels and verifies that Merrill Lynch has implemented appropriate policies for
the effective management of risks. The Management Group must approve all
substantive changes to risk policies, including those proposed by the ROC. The
Management Group pays particular attention to risk concentrations and liquidity
concerns.
The ROC, comprised of senior business and control managers and currently
chaired by the Chief Financial Officer, oversees Merrill Lynch's risks and
ensures that the business units create and implement processes to identify,
measure, and monitor their risks. The ROC also assists the Management Group in
determining risk tolerance levels for the firm's business units and monitors the
activities of Merrill Lynch's corporate governance committees, reporting
significant issues and transactions to the Management Group and the Audit
Committee.
Various other governance committees exist to create policy, review
activity, and ensure that 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, Real Estate
Capital Commitment Committee, Credit Policy Committee, Corporate Transaction
Review Committee, and Reserve Committee. Representatives of the principal
independent control functions participate as voting members of these committees.
CORPORATE RISK MANAGEMENT
CRM is an independent control function responsible for Merrill Lynch's market
and credit risk management processes. The co-heads of CRM report directly to the
Chief Financial Officer who chairs the ROC and is a member of the Management
Group. Market risk is defined to be the potential change in value of financial
instruments caused by fluctuations in interest rates, exchange rates, equity and
commodity prices, credit spreads, and/or other risks. Credit risks are defined
to be the potential for loss that can occur as a result of impairment in the
creditworthiness of an issuer or counterparty or a default by an issuer or
counterparty on its contractual obligations. CRM also provides Merrill Lynch
with an overview of its risk for various aggregate portfolios and develops the
analytics, systems, and policies to conduct all risk management functions.
CRM's chief monitoring and risk measurement tool is Merrill Lynch's Risk
Framework. The Risk Framework defines and communicates Merrill Lynch's risk
tolerance and establishes aggregate and broad risk limits for the firm. Market
risk limits are intended to constrain exposure to specific classes and factors
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 tenor of exposure to individual counterparties and issuers, types
of counterparties and issuers, countries, and financing collateral. Risk
Framework exceptions and violations are reported and investigated at pre-defined
and appropriate levels of management. The Risk Framework and
PAGE 34
Merrill Lynch 2001 Annual Report
its limits have been approved by the Management Group and the risk parameters
that define the Risk Framework have been reviewed by the Audit Committee. The
Management Group reviews the Risk Framework annually and approves any material
changes. The ROC reports all substantive Risk Framework changes to the Audit
Committee.
The overall effectiveness of Merrill Lynch's risk processes and policies
can be seen on a broader level when analyzing weekly net trading revenues over
time. CRM policies and procedures of monitoring and controlling risk combined
with the businesses' focus on customer order-flow driven revenues and selective
proprietary positioning have helped Merrill Lynch to reduce earnings volatility
within its portfolios. While no guarantee can be given regarding future earnings
volatility, Merrill Lynch will continue to pursue policies and procedures that
assist the firm in measuring and monitoring its risks. A graph of Merrill
Lynch's weekly revenues from trading-related activities for 2001 follows:
[BAR CHART]
2001 DISTRIBUTION OF WEEKLY REVENUES FROM
TRADING-RELATED ACTIVITIES
(in millions of dollars)
Number of Weeks
---------------
Less than $50 2
$50 - 75 4
$75 - 100 4
$100 - 125 17
$125 - 150 11
$150 - 175 6
$175 - 200 5
Over $200 3
MARKET RISK
CRM's Market Risk Group is responsible for defining the products and markets in
which Merrill Lynch's major business units and functions will transact and take
risk. Moreover, it is responsible for identifying the risks to which these
businesses and units will be exposed in these approved products and markets. The
Market Risk Group uses a variety of quantitative metrics to assess the risk of
Merrill Lynch's positions and portfolios. In particular, the Market Risk Group
quantifies the sensitivities of Merrill Lynch's present portfolios to changes in
market variables. These sensitivities are then utilized in the context of
historical data to estimate earnings and loss distributions that Merrill Lynch's
present portfolios would have incurred throughout the historical period. From
these distributions, CRM derives a number of useful risk statistics including
VaR. VaR is an estimate of the amount that Merrill Lynch's present portfolios
could lose with a specified degree of confidence, over a given time interval.
The VaR for Merrill Lynch's overall portfolios 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 risk
categories is shown in the following tables and may be viewed as a measure of
the diversification within Merrill Lynch's portfolios. CRM believes that the
tabulated risk measures provide some guidance as to the amount Merrill Lynch
could lose in future periods and it works continuously to improve its
measurement and the methodology of VaR. However, calculation of VaR requires
numerous assumptions and thus VaR should not be viewed as a precise measure of
risk.
In the Merrill Lynch VaR system, CRM uses a historical simulation approach
to estimate VaR 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 market factor movements 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 2001 and 2000 and the 2001 average VaR. Additionally, high and low VaR
is presented independently for each risk category and overall. Because high and
low VaR numbers for these risk categories may have occurred on different days,
high and low numbers for diversification benefit would not be meaningful.
(dollars in millions)
- -------------------------------------------------------------------------------
DAILY
YEAR-END YEAR-END AVERAGE HIGH LOW
2001 2000 2001 2001 2001
- -------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 113 $ 81 $ 84 $ 124 $ 52
Equity 94 77 61 103 35
Commodity 2 9 3 14 0
Currency 3 14 11 50 1
Volatility 44 34 35 67 14
----- ----- ----- ----- ---
256 215 194
Diversification benefit (144) (116) (92)
----- ----- -----
Overall(2) $ 112 $ 99 $ 102 $ 138 $ 76
- -------------------------------------------------------------------------------
(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
$21 million and $20 million at year-end 2001 and 2000, respectively.
Due to the mix of the trading portfolio, overall VaR increased in 2001 due
to increases in interest rate and credit spread VaR and equity VaR. These
increases were partially offset by an increase in diversification benefit.
The following table presents Merrill Lynch's VaR for non-trading
instruments (excluding U.S. banks):
PAGE 35
Merrill Lynch 2001 Annual Report
(dollars in millions)
- -------------------------------------------------------------------------------
QUARTERLY
YEAR-END YEAR-END AVERAGE
2001 2000 2001
- -------------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 77 $ 67 $ 76
Currency 20 23 19
Equity 57 47 51
Volatility 11 3 9
----- ---- -----
165 140 155
Diversification benefit (59) (44) (45)
----- ---- -----
Overall $ 106 $ 96 $ 110
- --------------------------------------------------------------------------------
(1) Based on a 99% confidence level and a two-week holding period.
Non-trading VaR increased modestly during 2001 due to increases in interest
rate and credit spread VaR and equity VaR. The higher interest rate and credit
spread risk is primarily due to an increase in marketable investment securities
held for liquidity purposes. The increase in the non-trading equity VaR is
primarily due to the increased volatility in the U.S. equity markets.
Non-trading VaR does not include the risk related to Merrill Lynch's $2.4
billion of outstanding LYONs(R) since management expects that the LYONs(R)
will be converted to common stock and will not be replaced by fixed income
securities.
In addition to the amounts reported in the accompanying table, non-trading
interest rate VaR associated with Merrill Lynch's TOPrS/SM/ at year-end 2001 and
2000 was $82 million and $138 million, respectively. TOPrS,/SM/ 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.
Beginning in mid-2000 Merrill Lynch modified the cash sweep options for
certain CMA(R) and other types of Merrill Lynch accounts to generally sweep
cash into interest-bearing bank deposits at Merrill Lynch's U.S. banks, rather
than MLIM-managed money market mutual funds. This increase in deposits was used
to fund the growth in high quality marketable investment securities. The overall
VaR for the U.S. banks, driven largely by these securities and based on a 99%
confidence level and a two-week holding period, was $156 million at year-end
2001 compared with $113 million at year-end 2000. The increase in comparable
year-over-year measures reflects continued asset growth and changes in asset mix
within the banks. For more information on Merrill Lynch's U.S. banks see Capital
Adequacy and Funding.
CREDIT RISK
CRM's Credit Risk Group assesses the creditworthiness of existing and potential
individual clients, institutional counterparties and issuers, and determines
firm-wide credit risk levels within Framework limits. The Group reviews and
monitors specific transactions as well as portfolio and other credit risk
concentrations. It is also responsible for ongoing credit quality and limit
compliance, and the Group works with the business units of Merrill Lynch to
manage and mitigate credit risk.
The Credit Risk Group uses a variety of methodologies to set limits on
exposure resulting from a counterparty or issuer failing to perform on its
contractual obligations. The Group performs analysis in the context of
industrial, regional, and global economic trends and incorporates portfolio and
concentration effects when determining tolerance levels. Credit risk limits take
into account measures of both current and potential exposure and are set and
monitored by broad risk type, product type, and tenor to maturity. Credit risk
mitigation techniques include, where appropriate, the right to require initial
collateral or margin, the right to terminate transactions or obtain collateral
should unfavorable events occur, the right to call for collateral when certain
exposure thresholds are exceeded, and the purchase of credit default protection.
With senior management involvement, Merrill Lynch conducts regular portfolio
reviews, monitors counterparty creditworthiness, and evaluates transaction risk
with a view toward early problem identification and protection against
unacceptable credit-related losses. In 2001, the Credit Risk Group invested
additional resources to enhance its methods and policies to assist in the
management of Merrill Lynch's credit risk.
Credit risk and exposure that originates from Merrill Lynch's retail
customer business is monitored constantly by CRM. Exposures include credit risks
for mortgages, home equity lines of credit, margin accounts, and working capital
lines that Merrill Lynch maintains with certain small business clients. When
required, these exposures are collateralized in accordance with regulatory
requirements governing such activities. Credit risk in Merrill Lynch's U.S.
banks' investment portfolios is monitored within CRM and by credit risk
management analysts. In addition, Merrill Lynch's U.S. banks have independent
credit approval and monitoring processes.
Merrill Lynch enters into International Swaps and Derivatives Association,
Inc. master agreements or their equivalent ("master netting agreements") with
each of its derivative counterparties as soon as 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 the
replacement value of trading derivatives in a gain position (net of $7.3 billion
of collateral) by counterparty credit rating and maturity at December 28, 2001.
(Note that the following table is inclusive of credit exposure from derivative
transactions only and does not include other credit exposures, which may be
material.)
PAGE 36
Merrill Lynch 2001 Annual Report
(dollars in millions)
- --------------------------------------------------------------------------------
YEARS TO MATURITY CROSS-
CREDIT ---------------------------------------- MATURITY
RATING(1) 0-3 3-5 5-7 OVER 7 NETTING(2) TOTAL
- --------------------------------------------------------------------------------
AAA $ 4,013 $1,069 $ 987 $1,530 $ (822) $ 6,777
AA 4,397 2,599 912 1,838 (1,545) 8,201
A 2,696 1,309 436 891 (580) 4,752
BBB 1,605 602 266 343 (364) 2,452
Other 1,138 291 144 87 (116) 1,544
------- -------- ------ ------ -------- -------
Total $13,849 $5,870 $2,745 $4,689 $(3,427) $23,726
- --------------------------------------------------------------------------------
(1) Represents credit rating agency equivalent of internal credit ratings.
(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 attempts to mitigate its
default risk on derivatives whenever possible by entering into transactions with
provisions that enable Merrill Lynch to terminate or reset the terms of its
derivative contracts.
PROCESS RISK
Process Risk Management is an evolving risk management discipline. Merrill Lynch
defines process risk as the risk of 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 include systems failure,
human error, fraud, and major fire or other disasters. Merrill Lynch manages
process risks in a variety of ways including maintaining a comprehensive system
of internal controls, using technology to automate processes and reduce manual
errors, monitoring risk events, employing experienced personnel, monitoring
business activities by compliance professionals, maintaining backup facilities,
conducting internal audits, requiring education and training of employees, and
emphasizing the importance of management oversight.
On September 11th terrorists attacked the World Trade Center complex, which
subsequently collapsed and damaged surrounding buildings, including some
occupied by Merrill Lynch. These events precipitated the temporary relocation of
approximately 9,000 employees from Merrill Lynch's global headquarters in the
North Tower of the World Financial Center, and from offices at the South Tower
of the World Financial Center and 222 Broadway. Merrill Lynch has reoccupied the
North Tower of the World Financial Center and 222 Broadway and is restoring the
South Tower of the World Financial Center. Although some of Merrill Lynch's
businesses were temporarily disrupted, resulting in lower than normal market
shares and reduced business activity, all its businesses are now functioning and
serving clients worldwide. In certain instances, Merrill Lynch is utilizing
temporary locations and backup infrastructures.
OTHER RISKS
Liquidity Risks arise in the course of Merrill Lynch's general funding
activities and in the management of its balance sheet. This risk includes both
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 Funding section.
Merrill Lynch encounters a variety of other risks, which have the ability
to impact the viability, profitability, and cost effectiveness of present or
future transactions. Such risks include political, tax, and regulatory risks
that may arise due to changes in local laws, regulations, accounting standards,
or tax statutes. To assist in the mitigation of such risks, Merrill Lynch
rigorously reviews new and pending legislation and regulations. Additionally,
Merrill Lynch employs professionals in jurisdictions in which the company
operates to actively follow issues of potential concern or impact to the firm
and to participate in related interest groups.
In mid-2001, in a further effort to ensure the independence and objectivity
of its research, Merrill Lynch announced a new policy, which prohibits equity
analysts and their staff members from buying equity shares for companies they
cover. In addition, for shares they already hold, they must either divest,
transfer the securities to a managed account over which they have no discretion,
or maintain existing shares under stricter disclosure and disposition rules.
Further, the existence of any equity position maintained by any analyst with
responsibility for any security discussed in a research report will be described
in the research report.
- --------------------------------------------------------------------------------
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
PAGE 37
Merrill Lynch 2001 Annual Report
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). 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.
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 2001 and 2000:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Trading assets:
Cash instruments $ 4,597 $ 5,227
Derivatives 4,478 3,982
Trading liabilities--cash instruments (1,535) (1,087)
Collateral on derivative assets (2,934) (1,796)
------- -------
Net trading asset exposure $ 4,606 $ 6,326
- --------------------------------------------------------------------------------
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 28, 2001, the carrying value of such debt and equity securities totaled
$58 million, of which 18% resulted from Merrill Lynch's market-making activities
in such securities. This compared with $43 million at December 29, 2000, of
which 64% related to market-making activities. Also included are distressed bank
loans totaling $245 million and $122 million at year-end 2001 and 2000,
respectively.
NON-TRADING EXPOSURES
The following table summarizes non-trading exposures to non-investment grade or
highly leveraged issuers or counterparties at year-end 2001 and 2000:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Marketable investment securities $ 221 $ 199
Investments of insurance subsidiaries 114 136
Loans (net of allowance for loan losses):
Bridge loans 130 524
Other loans(1) 2,578 2,741
Other investments:
Partnership interests(2) 1,359 993
Other equity investments(3) 140 284
- --------------------------------------------------------------------------------
(1) Represents outstanding loans to 138 and 135 companies at year-end 2001 and
2000, respectively.
(2) Includes $712 million and $504 million in investments at year-end 2001 and
2000, respectively, related to deferred compensation plans, for which the
default risk of the investments rests with the participating employees.
(3) Includes investments in 81 and 98 enterprises at year-end 2001 and 2000,
respectively.
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly leveraged counterparties at year-end 2001 and
2000:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Additional commitments to invest
in partnerships $ 288 $ 467
Unutilized revolving lines of credit and
other lending commitments 1,947 3,664
- --------------------------------------------------------------------------------
At December 28, 2001, the largest industry exposure was to the financial
services sector, which accounted for 22% of total non-investment grade positions
and highly leveraged transactions.
Merrill Lynch sponsors certain deferred compensation plans in which eligible
employees, who meet certain minimum compensation and net worth levels, may
participate. 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 as directed by the employee, and the plans may include a leverage
feature which is non-recourse to the employees. In addition, certain Merrill
Lynch employees, who manage the assets of certain of these plan partnerships,
participate in the profits of these entities.
Merrill Lynch also allows certain qualified high-net-worth employees to
invest in certain private equity investments in selected third-party funds.
PAGE 38
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
LITIGATION
Certain actions have been filed against Merrill Lynch in connection with Merrill
Lynch's business activities. Although the ultimate outcome of legal actions,
arbitration proceedings, and claims pending against ML & Co. or its subsidiaries
cannot be ascertained at this time and the results of legal proceedings cannot
be predicted with certainty, it is the opinion of management that the resolution
of these actions will not have a material adverse effect on the financial
condition of Merrill Lynch as set forth in the Consolidated Financial
Statements, but may be material to Merrill Lynch's operating results for any
particular period.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The following is a summary of Merrill Lynch's critical accounting policies. For
a full description of these and other accounting policies see Note 1 to the
Consolidated Financial Statements.
USE OF ESTIMATES
In presenting the Consolidated Financial Statements, management makes estimates
regarding certain trading inventory valuations, the outcome of litigation, the
carrying amount of goodwill, the allowance for loan losses, the realization of
deferred tax assets, recovery of insurance deferred acquisition costs, September
11th-related insurance recoveries, restructuring and other charges, and other
matters that affect the reported amounts and disclosure of contingencies in the
financial statements. Estimates, by their nature, are based on judgment and
available information. Therefore, actual results could differ from those
estimates and could have a material impact on the Consolidated Financial
Statements and it is possible that such changes could occur in the near term.
For more information regarding the specific methodologies used in determining
estimates, refer to Use of Estimates in Note 1 to the Consolidated Financial
Statements.
USE OF VALUATION OF FINANCIAL INSTRUMENTS
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 estimated to be received from or paid to a
third party in settlement of these instruments. Obtaining the fair value for OTC
derivative contracts requires the use of management judgment and estimates.
These derivatives are valued using pricing models based on the net present value
of estimated future cash flows, and directly observed prices from
exchange-traded derivatives, other OTC trades, or external pricing services.
New, complex instruments may have immature or limited markets. As a result,
the pricing models used for valuation often incorporate significant estimates
and assumptions, which may impact the level of precision in the financial
statements. For long-dated and illiquid contracts, extrapolation methods are
applied to observed market data in order to estimate inputs and assumptions that
are not directly observable. This enables Merrill Lynch to mark all positions
consistently when only a subset of prices are directly observable. Values for
non-exchange-traded derivatives are verified using observed information about
the costs of hedging out the risk and other trades in the market. 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.
Merrill Lynch holds investments that may have quoted market prices but that
are subject to restrictions (e.g., consent of other investors) that may limit
Merrill Lynch's ability to realize the quoted market price. Accordingly, Merrill
Lynch estimates the fair value of these securities based on management's best
estimate which incorporates pricing models based on projected cash flows,
earnings multiples, comparisons based on similar market transactions and/or
review of underlying financial conditions and other market factors.
Valuation adjustments are an integral component of the mark-to-market
process and are taken for individual positions where either the sheer size of
the trade or other specific features of the trade or particular market (such as
counterparty credit quality or concentration or market liquidity) requires
greater attention than simple application of the pricing models.
CONSOLIDATION AND TRANSACTIONS INVOLVING SPECIAL PURPOSE ENTITIES
Special purpose entities ("SPEs") are trusts, partnerships, or corporations
established for a particular limited purpose. Merrill Lynch engages in
transactions with SPEs for a variety of reasons. Many of these SPEs are used to
facilitate the securitization of client assets whereby mortgages, loans or other
assets owned by clients are transformed into securities (securitized). SPEs are
also used to create securities with a specific risk profile desired by
investors. In the course of its normal business, Merrill Lynch, from time to
time, establishes SPEs; sells assets to SPEs; underwrites, distributes, and
makes markets in securities issued by SPEs; engages in derivative transactions
with SPEs; owns notes or certificates issued by SPEs; and provides liquidity
facilities or other guarantees to SPEs.
PAGE 39
Merrill Lynch 2001 Annual Report
Merrill Lynch follows the guidance in Statement of Financial Accounting
Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities" and Emerging Issues Task Force
("EITF") Topic D-14, "Transactions Involving Special-Purpose Entities" and EITF
Issue No. 90-15, "Impact of Nonsubstantive Lessors, Residual Value Guarantees,
and Other Provisions in Leasing Transactions" to determine whether or not an SPE
is required to be consolidated in its Consolidated Financial Statements. Many of
the SPEs with which Merrill Lynch enters into transactions meet the requirements
of qualifying special purpose entities ("QSPEs") as defined by SFAS No. 140.
Based on the requirements of SFAS No. 140, QSPEs are not consolidated by Merrill
Lynch.
Many SPEs do not qualify as QSPEs either because the SPEs' permitted
activities are not sufficiently limited, or because the SPE owns assets that are
not financial instruments, or otherwise does not meet all of the conditions of a
QSPE. In situations where Merrill Lynch is either the sponsor of the SPE or
where Merrill Lynch transfers assets to the SPE, Merrill Lynch relies on the
guidance provided by EITF Topic D-14 to determine whether consolidation of these
SPEs is required. Under this guidance, an SPE is not required to be consolidated
by a transferor or sponsor if the SPE issues equity in legal form to
unaffiliated third parties that is at least 3% of the value of the assets held
by the SPE, and the transferor or sponsor has not retained the substantive risks
and rewards of ownership of the SPE and does not have control over the
activities of the SPE. Merrill Lynch looks to a number of both qualitative and
quantitative factors in determining whether it is the sponsor of an SPE for
purposes of applying the guidance in EITF Topic D-14, and judgment is required
in making this determination.
Merrill Lynch may also act as a liquidity provider to investors in
securities issued by SPEs or enter into other guarantees related to SPEs.
Additional information regarding liquidity facilities and guarantees to SPEs is
provided in Note 12 to the Consolidated Financial Statements. Merrill Lynch may
also retain interests in assets securitized by an SPE, or enter into derivative
transactions with SPEs, both of which are recorded at estimated fair value in
the financial statements. Therefore, material economic exposures to SPEs related
to these transactions are recorded or disclosed in the Consolidated Financial
Statements. Refer to Balance Sheet Captions -- Marketable Investment Securities
in Note 1 to the Consolidated Financial Statements for more information on
interests retained in securitization transactions.
In addition to the SPEs described above, Merrill Lynch has entered into
transactions with two SPEs to facilitate the financing of physical property for
its own use (facilities and aircraft). Merrill Lynch's U.S. banking subsidiaries
have also entered into transactions with SPEs in order to improve the liquidity
of mortgage portfolios and reduce credit risk of investment portfolios, which
resulted in reduced regulatory capital requirements. See Note 16 to the
Consolidated Financial Statements for more information regarding these
transactions.
- -------------------------------------------------------------------------------
RECENT DEVELOPMENTS
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") released SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," for the disposal of
a segment of the business as previously defined in that opinion. SFAS No. 144
also amends Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" to eliminate the exception to consolidation for a subsidiary for
which control is likely to be temporary. SFAS No. 144 provides guidance on the
financial accounting and reporting for the impairment or disposal of long-lived
assets. Merrill Lynch will adopt the provisions of SFAS No. 144 in the first
quarter of 2002 and has not yet determined the impact of adoption.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, intangible assets with indefinite lives and
goodwill will no longer be amortized. Instead, these assets will be tested
annually for impairment. Merrill Lynch adopted the provisions of SFAS No. 142 at
the beginning of fiscal year 2002.
SFAS No. 142 will require that Merrill Lynch perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. This test is required to be completed within six months of the date of
adoption. If an indication of impairment exists, quantification of the
impairment is required to be completed as soon as possible, but no later than
the end of the year. Any impairment loss, as of the first day of fiscal year
2002, will be recognized as the cumulative effect of a change in accounting
principle in Merrill Lynch's statement of earnings upon adoption. Merrill Lynch
is currently assessing the impact of adopting this standard; annual amortization
expense related to goodwill approximated $200 million in 2001.
In July 2001, the FASB released SFAS No. 141, "Business Combinations." SFAS
No. 141 requires all business combinations initiated after June 30, 2001, to be
accounted for using the purchase method. Merrill Lynch adopted the provisions of
SFAS No. 141 on July 1, 2001.
PAGE 40
Merrill Lynch 2001 Annual Report
MANAGEMENT'S DISCUSSION OF FINANCIAL RESPONSIBILITY
Management of Merrill Lynch & Co., Inc. is responsible for preparing the
consolidated financial statements and related notes contained in this Annual
Report. The consolidated financial statements and related notes are prepared in
accordance with generally accepted accounting principles in the United States of
America. Other financial data included in the Annual Report are consistent with
those in the financial statements and related notes.
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 overseeing controls. The Audit Committee, which consists of five
independent directors, reviews the annual Consolidated Financial Statements with
management and Merrill Lynch's independent auditors. The Audit Committee also
recommends the appointment and reviews the performance, independence and fees of
the independent auditors and the professional services they provide. The Audit
Committee also oversees Merrill Lynch's system of internal accounting controls
and the internal audit function. In addition, the Audit Committee oversees
compliance with risk management and compliance policies, procedures, and
functions.
The Finance Committee, which consists of five independent directors,
reviews, recommends, and approves policies regarding financial commitments and
other expenditures. It also reviews and approves certain financial commitments,
acquisitions, divestitures, and proprietary investments. In addition, the
Finance Committee oversees corporate funding policies as well as reviewing
procedures for implementing and adhering to such policies.
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 Committee, providing
independent appraisals of Merrill Lynch's internal accounting controls and
compliance with established policies and procedures.
The Finance Division 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.
The Office of the General Counsel serves in a counseling and advisory role
to Management and the business groups. In this role, the group develops
policies; monitors compliance with internal policies, external rules, and
industry regulations; and provides legal advice, representation, execution, and
transaction support to the businesses.
The independent auditors, Deloitte & Touche LLP, perform annual audits of
Merrill Lynch's financial statements in accordance with generally accepted
auditing standards. The independent auditors openly discuss with the Audit
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. The Board of Directors, upon the recommendation of the
Audit Committee, appoints the independent auditors each year. The independent
auditors are given unrestricted access to all financial records and related
data, including minutes of meetings of stockholders, the Board of Directors, and
committees of the Board.
/s/ David H. Komansky /s/ E. Stanley O'Neal /s/ Thomas H. Patrick
David H. Komansky E. Stanley O'Neal Thomas H. Patrick
Chairman of the Board and President and Executive Vice President and
Chief Executive Officer Chief Operating Officer Chief Financial Officer
PAGE 41
Merrill Lynch 2001 Annual Report
Deloitte
INDEPENDENT AUDITORS' REPORT & Touche
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 28, 2001 and
December 29, 2000 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 28, 2001. 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 auditing standards generally
accepted in the United States of America. 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 28,
2001 and December 29, 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 28, 2001 in conformity
with accounting principles generally accepted in the United States of America.
/S/ Deloitte & Touche LLP
Deloitte & Touche LLP
New York, New York
February 25, 2002
PAGE 42
Merrill Lynch 2001 Annual Report
CONSOLIDATED STATEMENTS OF EARNINGS
(dollars in millions, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------------------
Year Ended Last Friday in December
----------------------------------------------
2001 2000 1999
(52 weeks) (52 weeks) (53 weeks)
- -----------------------------------------------------------------------------------------------------------------------
NET REVENUES
Commissions $ 5,266 $ 6,977 $ 6,355
Principal transactions 3,930 5,964 4,671
Investment banking
Underwriting 2,438 2,699 2,382
Strategic advisory 1,101 1,381 1,313
Asset management and portfolio service fees 5,351 5,688 4,753
Other 528 967 746
------- ------- -------
18,614 23,676 20,220
Interest and dividend revenues 20,143 21,176 15,112
Less interest expense 16,877 18,086 13,019
------- ------- -------
Net interest profit 3,266 3,090 2,093
------- ------- -------
Total Net Revenues 21,880 26,766 22,313
------- ------- -------
NON-INTEREST EXPENSES
Compensation and benefits 11,269 13,730 11,337
Communications and technology 2,232 2,320 2,053
Occupancy and related depreciation 1,077 1,006 953
Brokerage, clearing, and exchange fees 895 893 779
Advertising and market development 703 939 783
Professional fees 545 637 571
Office supplies and postage 349 404 346
Goodwill amortization 207 217 227
Other 902 903 1,058
September 11th-related 131 - -
Restructuring and other charges 2,193 - -
------- ------- -------
Total Non-Interest Expenses 20,503 21,049 18,107
------- ------- -------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,377 5,717 4,206
Income Tax Expense 609 1,738 1,319
Dividends on Preferred Securities Issued by Subsidiaries 195 195 194
------- ------- -------
NET EARNINGS $ 573 $ 3,784 $ 2,693
======= ======= =======
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 535 $ 3,745 $ 2,654
======= ======= =======
EARNINGS PER COMMON SHARE
Basic $ 0.64 $ 4.69 $ 3.52
======= ======= =======
Diluted $ 0.57 $ 4.11 $ 3.11
======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAGE 43
Merrill Lynch 2001 Annual Report
CONSOLIDATED BALANCE SHEETS
(dollars in millions, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------
December 28, 2001 December 29, 2000
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 11,070 $ 23,205
-------- --------
Cash and securities segregated for regulatory purposes or
deposited with clearing organizations 4,467 6,092
-------- --------
Securities financing transactions
Receivables under resale agreements 69,702 79,240
Receivables under securities borrowed transactions 54,930 35,341
-------- --------
124,632 114,581
-------- --------
Marketable investment securities 77,820 49,251
-------- --------
Trading assets, at fair value
Contractual agreements 31,040 25,614
Corporate debt and preferred stock 18,134 17,180
Equities and convertible debentures 13,923 15,425
Mortgages, mortgage-backed, and asset-backed 11,184 8,225
U.S. Government and agencies 9,445 17,270
Municipals and money markets 5,306 2,791
Non-U.S. governments and agencies 3,851 5,009
-------- --------
92,883 91,514
-------- --------
Securities pledged as collateral 12,084 9,097
-------- --------
Securities received as collateral 3,234 -
-------- --------
Other receivables
Customers (net of allowance for doubtful accounts of $81 in 2001 and $68 in 2000) 39,856 41,613
Brokers and dealers 6,868 26,421
Interest and other 8,226 8,879
-------- --------
54,950 76,913
-------- --------
Investments of insurance subsidiaries 3,983 4,002
Loans, notes, and mortgages (net of allowance for loan losses of $425
in 2001 and $176 in 2000) 19,005 17,472
Other investments 5,869 4,938
Equipment and facilities (net of accumulated depreciation and
amortization of $4,910 in 2001 and $4,658 in 2000) 2,873 3,444
Goodwill (net of accumulated amortization of $924 in 2001 and $720 in 2000) 4,071 4,407
Other assets 2,478 2,284
-------- --------
TOTAL ASSETS $419,419 $407,200
======== ========
- ------------------------------------------------------------------------------------------------------------------------------
PAGE 44
Merrill Lynch 2001 Annual Report
- ------------------------------------------------------------------------------------------------------------
December 28, 2001 December 29, 2000
- ------------------------------------------------------------------------------------------------------------
LIABILITIES
Securities financing transactions
Payables under repurchase agreements $ 74,895 $ 89,901
Payables under securities loaned transactions 12,291 13,982
--------- ---------
87,186 103,883
--------- ---------
Commercial paper and other short-term borrowings 5,141 15,183
--------- ---------
Deposits 85,819 67,648
--------- ---------
Trading liabilities, at fair value
Contractual agreements 36,679 30,683
U.S. Government and agencies 18,674 14,137
Equities and convertible debentures 9,911 10,387
Non-U.S. governments and agencies 5,857 7,135
Corporate debt, municipals, and preferred stock 4,796 6,515
--------- ---------
75,917 68,857
--------- ---------
Obligation to return securities received as collateral 3,234 -
--------- ---------
Other payables
Customers 28,704 24,762
Brokers and dealers 11,932 9,514
Interest and other 18,474 22,204
--------- ---------
59,110 56,480
--------- ---------
Liabilities of insurance subsidiaries 3,737 3,908
Long-term borrowings 76,572 70,223
--------- ---------
TOTAL LIABILITIES 396,716 386,182
--------- ---------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,695 2,714
--------- ---------
STOCKHOLDERS' EQUITY
Preferred Stockholders' Equity (42,500 shares issued and outstanding,
liquidation preference $10,000 per share) 425 425
--------- ---------
Common Stockholders' Equity
Shares exchangeable into common stock 62 68
Common stock (par value $1.33 1/3 per share; authorized:
3,000,000,000 shares; issued: 2001 and 2000-- 1,283 1,283
962,533,498 shares)
Paid-in capital 4,209 2,843
Accumulated other comprehensive loss (net of tax) (368) (345)
Retained earnings 16,150 16,156
--------- ---------
21,336 20,005
Less: Treasury stock at cost (2001 -- 119,059,651 shares;
2000 -- 154,578,945 shares) 977 1,273
Unamortized employee stock grants 776 853
--------- ---------
Total Common Stockholders' Equity 19,583 17,879
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 20,008 18,304
--------- ---------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES,
AND STOCKHOLDERS' EQUITY $ 419,419 $ 407,200
========= =========
- ------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAGE 45
Merrill Lynch 2001 Annual Report
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in millions)
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended Last Friday in December
-------------------------------------------------------------------------------
Amounts Shares
------------------------------- ------------------------------------------
2001 2000 1999 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------------------
PREFERRED STOCK, Balance, beginning and
end of year $ 425 $ 425 $ 425 42,500 42,500 42,500
===== ====== ====== ============ ============ ============
COMMON STOCKHOLDERS' EQUITY
Shares Exchangeable into Common Stock
Balance, beginning of year 68 118 133 4,654,378 8,018,698 9,011,530
Exchanges (6) (50) (15) (458,971) (3,364,320) (992,832)
----- ------ ------ ------------ ------------ ------------
Balance, end of year 62 68 118 4,195,407 4,654,378 8,018,698
===== ====== ====== ============ ============ ============
Common Stock
Balance, beginning of year 1,283 1,286 1,286 962,533,498 964,779,105 964,428,711
Shares issued to employees - - - - 203,483 350,394
Shares retired - (3) - - (2,449,090) -
----- ------ ------ ------------ ------------ ------------
Balance, end of year 1,283 1,283 1,286 962,533,498 962,533,498 964,779,105
===== ====== ====== ============ ============ ============
Paid-in Capital
Balance, beginning of year 2,843 1,156 711
Shares issued to employees 1,366 1,686 440
Other - 16 5
Shares retired - (15) -
------- ------- -------
Balance, end of year 4,209 2,843 1,156
======= ======= =======
Accumulated Other Comprehensive Loss
Foreign Currency Translation Adjustment
(net of tax)
Balance, beginning of year (309) (302) (138)
Translation adjustment 7 (7) (164)
------- ------- -------
Balance, end of year (302) (309) (302)
======= ======= =======
Net Unrealized Losses on Available-for-Sale
Securities (net of tax)
Balance, beginning of year (36) (88) 16
Net unrealized gains (losses) on
available-for-sale securities (70) 110 (223)
Other adjustments(a) 14 (58) 119
------- ------- -------
Balance, end of year (92) (36) (88)
======= ======= =======
Deferred Gains on Cash Flow Hedges
(net of tax)
Balance, beginning of year - - -
Net deferred gains on cash flow hedges 151 - -
Net reclassification adjustment to
earnings (115) - -
------- ------- -------
Balance, end of year 36 - -
======= ======= =======
Minimum Pension Liability
Balance, beginning of year - - -
Minimum pension liability adjustment (10) - -
------- ------- -------
Balance, end of year (10) - -
------- ------- -------
Balance, end of year (368) (345) (390)
======= ======= =======
Retained Earnings
Balance, beginning of year 16,156 12,887 10,620
Net earnings 573 3,784 2,693
9% Cumulative Preferred stock dividends
declared (38) (39) (39)
Common stock dividends declared (541) (476) (387)
------- ------- -------
Balance, end of year 16,150 16,156 12,887
======= ======= =======
Treasury Stock, at cost
Balance, beginning of year (1,273) (1,835) (2,113) (154,578,945) (212,278,192) (234,447,670)
Shares issued to employees(b) 291 488 267 35,060,323 51,885,837 21,176,646
Other 5 56 11 458,971 3,364,320 992,832
Shares retired - 18 - - 2,449,090 -
------- ------- ------- ------------ ------------ ------------
Balance, end of year (977) (1,273) (1,835) (119,059,651) (154,578,945) (212,278,192)
======= ======= ======= ============ ============ ============
Unamortized Employee Stock Grants
Balance, beginning of year (853) (643) (676)
Net issuance of employee stock grants (720) (709) (380)
Amortization of employee stock grants 797 510 407
Other - (11) 6
------- ------- -------
Balance, end of year (776) (853) (643)
------- ------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY 19,583 17,879 12,579
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY $20,008 $18,304 $13,004
======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Other adjustments relate to policyholder liabilities, deferred policy
acquisition costs, and income taxes.
(b) Shares are net of reacquisitions from employees of 4,756,694; 1,139,116;
and 1,037,982 in 2001, 2000, and 1999, respectively.
See Notes to Consolidated Financial Statements.
PAGE 46
Merrill Lynch 2001 Annual Report
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
- ------------------------------------------------------------------------------------------------------------
Year Ended Last Friday in December
---------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------
NET EARNINGS $ 573 $ 3,784 $ 2,693
------- ------- -------
Other Comprehensive Income (Loss)
Foreign currency translation adjustment:
Foreign currency translation gains (losses) 127 127 (116)
Income tax expense (120) (134) (48)
------- ------- -------
Total 7 (7) (164)
------- ------- -------
Net unrealized gains (losses) on investment
securities available-for-sale:
Net unrealized holding gains (losses)
arising during the period (51) 236 (229)
Reclassification adjustment for realized (gains) losses
included in net earnings (19) (126) 6
------- ------- -------
Net unrealized gains (losses) on investment securities
available-for-sale (70) 110 (223)
Adjustments for:
Policyholder liabilities (10) (15) 35
Deferred policy acquisition costs (13) (20) 35
Income tax (expense) benefit 37 (23) 49
------- ------- -------
Total (56) 52 (104)
------- ------- -------
Deferred gains on cash flow hedges 36 - -
Minimum pension liability (10) - -
------- ------- -------
Total Other Comprehensive Income (Loss) (23) 45 (268)
------- ------- -------
COMPREHENSIVE INCOME $ 550 $ 3,829 $ 2,425
======= ======= =======
- ------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
PAGE 47
Merrill Lynch 2001 Annual Report
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
- ------------------------------------------------------------------------------------------------
YEAR ENDED LAST FRIDAY IN DECEMBER
--------------------------------------
2001 2000 1999
- -----------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Earnings $ 573 $ 3,784 $ 2,693
Noncash items included in earnings:
Depreciation and amortization 888 846 723
Amortization of stock-based compensation 797 510 407
Deferred taxes (783) 202 (91)
Policyholder reserves 183 193 205
Goodwill amortization 207 217 227
Amortization of debt discount 327 152 54
Restructuring and other charges 491 - -
Other (38) (375) 547
CHANGES IN OPERATING ASSETS AND LIABILITIES(a):
Trading assets and securities pledged as
collateral (4,378) (4,236) 4,153
Cash and securities segregated for regulatory
purposes or deposited with clearing organizations 1,625 (14) 690
Receivables under resale agreements 9,538 (22,399) (6,652)
Receivables under securities borrowed transactions (19,589) 7,098 (4,507)
Customer receivables 1,741 (1,607) (10,371)
Brokers and dealers receivables 19,553 (17,217) (296)
Trading liabilities 7,060 1,581 3,538
Payables under repurchase agreements (15,006) 24,947 5,453
Payables under securities loaned transactions (1,691) 6,725 (757)
Customer payables 3,942 1,596 624
Brokers and dealers payables 2,418 (1,925) 3,531
Other, net (1,437) 1,226 709
-------- -------- --------
CASH PROVIDED BY OPERATING ACTIVITIES 6,421 1,304 880
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from (payments for):
Maturities of available-for-sale securities 33,135 10,643 4,155
Sales of available-for-sale securities 14,138 7,036 3,071
Purchases of available-for-sale securities (76,201) (57,822) (11,802)
Maturities of held-to-maturity securities 811 822 995
Purchases of held-to-maturity securities (757) (634) (1,015)
Loans, notes, and mortgages (1,882) (6,303) (3,541)
Proceeds from sale of business 344 - -
Other investments and other assets (801) (587) (876)
Equipment and facilities (663) (1,150) (1,090)
-------- -------- --------
CASH USED FOR INVESTING ACTIVITIES (31,876) (47,995) (10,103)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from (payments for):
Commercial paper and other short-term borrowings (10,042) (10,413) 6,917
Deposits 18,171 50,046 5,141
Issuance and resale of long-term borrowings 38,454 33,687 15,601
Settlement and repurchase of long-term borrowings (32,827) (15,719) (18,600)
Issuance of subsidiaries' preferred securities - - 98
Issuance of treasury stock 515 658 212
Other common stock transactions (372) (3) (203)
Dividends (579) (515) (426)
-------- -------- --------
CASH PROVIDED BY FINANCING ACTIVITIES 13,320 57,741 8,740
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,135) 11,050 (483)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 23,205 12,155 12,638
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 11,070 $ 23,205 $ 12,155
-------- -------- --------
- ------------------------------------------------------------------------------------------------
(a) Net of effects of acquisitions and divestitures.
SUPPLEMENTAL DISCLOSURES
Cash paid for:
Income taxes $ 887 $ 641 $ 669
Interest 18,042 17,311 13,125
See Notes to Consolidated Financial Statements.
PAGE 48
Merrill Lynch 2001 Annual Report
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS
49 Note 1. Summary of Significant Accounting Policies 68 Note 10. Preferred Securities Issued by Subsidiaries
59 Note 2. Other Significant Events 68 Note 11. Stockholders' Equity and
60 Note 3. Segment and Geographic Information Earnings Per Share
62 Note 4. Securities Financing Transactions 70 Note 12. Commitments and Contingencies
62 Note 5. Investments 71 Note 13. Employee Benefit Plans
63 Note 6. Trading Assets and Liabilities 74 Note 14. Employee Incentive Plans
66 Note 7. Loans, Notes, and Mortgages 77 Note 15. Income Taxes
66 Note 8. Commercial Paper and Short- and 77 Note 16. Regulatory Requirements and
Long-Term Borrowings Dividend Restrictions
68 Note 9. Deposits
Merrill Lynch Notes to Consolidated Financial Statements
- ---------------------------------
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 and futures commission merchant;
. Merrill Lynch International ("MLI"), a U.K.-based broker-dealer in securities
and dealer in equity derivatives;
. Merrill Lynch Government Securities Inc. ("MLGSI"), a U.S.-based dealer in
U.S. Government securities;
. Merrill Lynch Capital Services, Inc., a U.S.-based dealer in interest rate,
currency, and credit derivatives;
. Merrill Lynch Investment Managers, LP, a U.S.-based asset management company;
. Merrill Lynch Investment Managers Limited, a U.K.-based asset management
company;
. Merrill Lynch Bank USA ("MLBUSA"), a U.S.-based FDIC-insured depository;
. Merrill Lynch Bank & Trust Co. ("MLB&T"), a U.S.-based FDIC-insured
depository;
. Merrill Lynch International Bank Limited, a U.K.-based bank;
. Merrill Lynch Capital Markets Bank Limited, an Ireland-based bank;
. Merrill Lynch Japan Securities Co., Ltd., a Japan-based broker-dealer;
. Merrill Lynch Canada, Inc., a Canada-based broker-dealer; and
. Merrill Lynch Insurance Group, Inc., a U.S.-based provider of life insurance
and annuity products.
Services provided to clients by ML & Co. and subsidiaries (collectively,
"Merrill Lynch") include:
. securities brokerage, trading, and underwriting;
. investment banking, strategic services (including mergers and acquisitions),
and other corporate finance advisory activities;
. asset management;
. origination, brokerage, dealer, and related activities in swaps, options,
forwards, exchange-traded futures, other derivatives, and foreign exchange
products;
. securities clearance and settlement services;
. equity, debt, foreign exchange, and economic research;
. private equity investing activities;
. banking, trust, and lending services, including commercial and mortgage
lending and related services;
. insurance underwriting and sales; and
. investment advisory and related recordkeeping services.
BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Merrill Lynch and
are presented in accordance with accounting principles generally accepted in the
United States of America which include 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 1999 amounts have been
restated to reflect the 2000 merger of Herzog, Heine, Geduld, Inc. ("Herzog")
with Merrill Lynch, which was accounted for as a pooling-of-interests (see
Note 2 for further information).
On April 1, 2001, Merrill Lynch completed the adoption of the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities"
that were required to be adopted as of this date. These provisions changed the
accounting for certain securities lending transactions. Under the new
provisions, when Merrill
PAGE 49
Merrill Lynch 2001 Annual Report
Lynch acts as the lender in a securities lending agreement and receives
securities as collateral that can be pledged or sold, it recognizes on the
Consolidated Balance Sheet the securities received and an obligation to return
those securities. Accordingly, the Consolidated Balance Sheet separately
reflects these assets and liabilities as Securities received as collateral and
Obligation to return securities received as collateral, respectively. SFAS No.
140 does not require comparative information for prior periods. In addition,
this standard revised the accounting for securitizations and other transfers of
financial assets and collateral. This guidance clarifies and further restricts
the requirements for recording a transfer of financial assets as a sale. Under
this guidance, the accounting for transfers to Special Purpose Entities ("SPEs")
that were established prior to April 1, 2001, and that met the sale requirements
of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," and related guidance, is not affected by the
provisions of SFAS No. 140 as long as no additional assets are transferred into
the SPE and no additional beneficial interests are issued by the SPE. As such,
the adoption of this aspect of the guidance had no material effect on the
financial condition of Merrill Lynch. (See Consolidation and Transactions
Involving Special Purpose Entities section for additional information regarding
SPEs.)
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 and related hedging, net of related tax
effects, are reported in stockholders' equity as a component of Accumulated
other comprehensive loss. All other translation adjustments are included in
earnings. Merrill Lynch also uses derivatives to manage the currency exposure
arising from investments in non-U.S. subsidiaries. (See the Derivatives section
for additional information on accounting for derivatives.)
USE OF ESTIMATES
In presenting the Consolidated Financial Statements, management makes estimates
regarding certain trading inventory valuations, the outcome of litigation, the
carrying amount of goodwill, the allowance for loan losses, the realization of
deferred tax assets, recovery of insurance deferred acquisition costs, September
11th-related insurance recoveries, restructuring and other charges, and other
matters that affect the reported amounts and disclosure of contingencies in the
financial statements. Estimates, by their nature, are based on judgment and
available information. Therefore, actual results could differ from those
estimates and could have a material impact on the Consolidated Financial
Statements and it is possible that such changes could occur in the near term. A
discussion of the areas in which estimates are a significant component of the
amounts reported in the Consolidated Financial Statements follows:
Trading Assets and Liabilities
Fair values of trading securities are based on quoted market prices, pricing
models (utilizing indicators of general market conditions and 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. Estimating the fair value of certain illiquid
securities requires significant management judgment. Merrill Lynch values
trading security assets at the institutional bid price and recognizes bid-offer
revenues when assets are sold. Trading security liabilities are valued at the
institutional offer price and bid-offer revenues are recognized when the
positions are closed.
Fair values for over-the-counter ("OTC") derivative financial instruments,
principally forwards, options, and swaps, represent amounts estimated to be
received from or paid to a third party in settlement of these instruments.
Obtaining the fair value for OTC derivatives contracts requires the use of
management judgment and estimates. These derivatives are valued using pricing
models based on the net present value of estimated future cash flows and
directly observed prices from exchange-traded derivatives, other OTC trades, or
external pricing services.
New, complex instruments may have immature or limited markets. As a result,
the pricing models used for valuation often incorporate significant estimates
and assumptions, which may impact the level of precision in the financial
statements. For long-dated and illiquid contracts, extrapolation methods are
applied to observed market data in order to estimate inputs and assumptions that
are not directly observable. This enables Merrill Lynch to mark all positions
consistently when only a subset of prices are directly observable. Values for
non-exchange-traded derivatives are verified using observed information about
the costs of hedging out the risk and other trades in the market. 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.
Valuation adjustments are an integral component of the mark-to-market
process and are taken for individual positions where either the sheer size of
the trade or other specific features of the trade or particular market (such as
counterparty credit quality or concentration or market liquidity) requires
greater attention than simple application of the pricing models.
Restricted Investments
Merrill Lynch holds investments that may have quoted market prices but that are
subject to restrictions (e.g., consent of other investors) that may limit
Merrill Lynch's ability to realize the quoted market price. Accordingly, Merrill
Lynch estimates the fair value of these securities taking into
PAGE 50
Merrill Lynch 2001 Annual Report
account the restrictions using pricing models based on projected cash flows,
earnings multiples, comparisons based on similar transactions, and/or review of
underlying financial conditions and other market factors. Such estimation may
result in a fair value for a security that is less than its quoted market price.
Valuation Allowance for Deferred Tax Assets
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 assesses its ability to
realize deferred tax assets primarily based on the earnings history of the legal
entities to which the deferred tax assets are attributable and the absence of
negative evidence as discussed in SFAS No. 109, "Accounting for Income Taxes,"
such as circumstances that if unfavorably resolved would adversely affect future
operations or profit levels or a history of tax credit carryforwards expiring
unused.
Allowance for Loan Losses
The provision for loan losses is based on management's estimate of the amount
necessary to maintain the allowance at a level adequate to absorb probable loan
losses. Management's estimate of loan losses is influenced by many factors,
including adverse situations that may affect the borrower's ability to repay,
current economic conditions, prior loan loss experience and the estimated value
of any underlying collateral. The fair value of collateral is generally
determined by third party appraisals in the case of residential mortgages,
quoted market prices for securities and estimates of fair value for other
assets. Management's estimate of loan losses include considerable judgment about
collectibility based on available facts and evidence at the balance sheet date,
and the uncertainties inherent in those assumptions. While management uses the
best information available on which to base its estimates, future adjustments to
the allowance may be necessary based on changes in the economic environment or
variances between actual results and the original assumptions used by
management.
Deferred Acquisition Costs Relating to Insurance Policies
Deferred insurance policy acquisition costs are amortized in proportion to the
estimated future gross profits for each group of contracts over the anticipated
life of the insurance contracts utilizing an effective yield methodology. These
future gross profit estimates are subject to periodic evaluation by the Company,
with necessary revisions applied against amortization to date.
Legal and Other Reserves
Merrill Lynch is a party in various actions, some of which involve claims for
substantial amounts. Amounts are accrued for the financial resolution of claims
which have either been asserted or are deemed probable of assertion, and are
subject to significant estimation by management and outside counsel. Accruals
for other reserves are also subject to significant estimation.
CONSOLIDATION AND TRANSACTIONS INVOLVING SPECIAL PURPOSE ENTITIES
SPEs are trusts, partnerships, or corporations established for a particular
limited purpose. Merrill Lynch engages in transactions with SPEs for a variety
of reasons. Many of these SPEs are used to facilitate the securitization of
client assets whereby mortgages or loans owned by clients are transformed into
securities (securitized). SPEs are also used to create securities with a
specific risk profile desired by investors. Merrill Lynch, from time to time,
establishes SPEs; sells assets to SPEs; underwrites, distributes, and makes
markets in securities issued by SPEs; engages in derivative transactions with
SPEs; owns notes or certificates issued by SPEs; and provides liquidity
facilities or other guarantees to SPEs.
Merrill Lynch follows the guidance in SFAS No. 140 and Emerging Issues
Tasks Force ("EITF") Topic D-14, "Transactions Involving Special-Purpose
Entities" and EITF Issue No. 90-15, "Impact of Nonsubstantive Lessors, Residual
Value Guarantees, and Other Provisions in Leasing Transactions" to determine
whether or not an SPE is required to be consolidated in its Consolidated
Financial Statements. Many of the SPEs with which Merrill Lynch enters into
transactions meet the requirements of qualifying special purpose entities
("QSPEs") as defined by SFAS No. 140. Based on the requirements of SFAS No. 140,
QSPEs are not consolidated by Merrill Lynch.
Many SPEs do not qualify as QSPEs either because the SPEs' permitted
activities are not sufficiently limited, or because the SPE owns assets that are
not financial instruments, or otherwise does not meet all of the conditions of a
QSPE. In situations where Merrill Lynch is either the sponsor of the SPE or
where Merrill Lynch transfers assets to the SPE, Merrill Lynch relies on the
guidance provided by EITF Topic D-14 to determine whether consolidation of these
SPEs is required. Under this guidance, an SPE is not required to be consolidated
by a transferor or sponsor if the SPE issues equity in legal form to
unaffiliated third parties that is at least 3% of the value of the assets held
by the SPE, and the transferor or sponsor has not retained the substantive risks
and rewards of ownership of the SPE and does not have control over the
activities of the SPE. Merrill Lynch looks to a number of both qualitative and
quantitative factors in determining whether it is the sponsor of an SPE for
purposes of applying the guidance in EITF Topic D-14, and judgment is required
in making this determination.
Merrill Lynch may also act as a liquidity provider to investors in
securities issued by SPEs or enter into other guarantees related to SPEs.
Additional information regarding liquidity facilities and guarantees to SPEs is
provided in Note 12 -- Commitments and Contingencies. Merrill Lynch may also
retain interests in assets securitized by an SPE, or enter into derivative
transactions with SPEs, both of which
PAGE 51
Merrill Lynch 2001 Annual Report
are recorded at estimated fair value in the Consolidated Financial Statements.
Therefore, material economic exposures to SPEs related to these transactions are
recorded or disclosed in the financial statements. Refer to Marketable
Investment Securities section for more information on interests retained in
securitization transactions.
In addition to the SPEs described above, Merrill Lynch has entered into
transactions with SPEs to facilitate the financing of physical property for its
own use (facilities and aircraft). The physical property is purchased or
constructed by the SPE and leased to Merrill Lynch. For these structures,
Merrill Lynch follows the guidance in EITF Issue No. 90-15 and EITF Issue No.
97-10, "The Effect of Lessee Involvement in Asset Construction," to determine
whether or not consolidation of the SPE is required. Under this guidance, a
company that leases property from an SPE is not required to consolidate that SPE
if, among other conditions, a third-party investor has made a substantive
residual equity capital investment in the SPE that is at risk during the entire
term of the lease. Substantive residual equity capital is currently defined as
amounting to at least 3% of the value of the assets held by the SPE. Merrill
Lynch has met the requirements of EITF Issues No. 90-15 and 97-10 for these SPEs
and accordingly, these SPEs are not consolidated in the Consolidated Financial
Statements. See Note 12 -- Commitments and Contingencies, for additional detail
regarding these transactions.
Merrill Lynch's U.S. banking subsidiaries have also entered into
transactions with SPEs in order to improve the liquidity of mortgage portfolios
and reduce credit risk of investment portfolios, which resulted in reduced
regulatory capital requirements. Refer to Note 16 -- Regulatory Requirements and
Dividend Restrictions for more information regarding these transactions.
FAIR VALUE
At December 28, 2001, $384 billion, or 91%, of Merrill Lynch's total assets and
$304 billion, or 77%, of Merrill Lynch's total liabilities were carried at fair
value or at amounts that approximate fair value. At December 29, 2000, $371
billion, or 91%, of Merrill Lynch's total assets and $298 billion, or 77%, of
Merrill Lynch's total 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.
Financial instruments recorded at amounts that approximate fair value
include receivables under resale agreements, receivables under securities
borrowed transactions, other receivables, payables under repurchase agreements,
payables under securities loaned transactions, commercial paper and other
short-term borrowings, 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. Of the remaining liabilities not at fair value, the majority
relate to Merrill Lynch's borrowings, which are generally issued or swapped to a
floating rate.
The fair value amounts for financial instruments are disclosed in each
respective footnote.
SECURITIES ACCOUNTING
Merrill Lynch generally follows the guidance prescribed by SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," when
accounting for investment securities. Merrill Lynch classifies those debt
securities that it has the intent and ability to hold to maturity as
held-to-maturity securities, which are carried at cost unless a decline in value
is deemed other than temporary, in which case, the carrying value is reduced.
Those securities that are bought and held principally for the purpose of selling
them in the near-term are classified as trading and marked to fair value through
earnings. All other securities are classified as available-for-sale with
unrealized gains and losses reported in stockholders' equity. Securities held by
a broker-dealer subsidiary are subject to specialized industry guidance as
prescribed by the American Institute of Certified Public Accountants Audit and
Accounting Guide, Brokers and Dealers in Securities. Merrill Lynch accounts for
substantially all securities held by a broker-dealer subsidiary at fair value
with realized and unrealized gains and losses reported in earnings.
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.
Investment banking and advisory services revenues are presented net of
transaction-related expenses.
BALANCE SHEET CAPTIONS
The following are policies related to specific balance sheet captions. Refer to
the related footnotes for additional information.
Cash and Cash Equivalents
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 trading derivatives are classified in
operating activities.
Cash and Securities Segregated for Regulatory Purposes or Deposited with
Clearing Organizations
Cash and securities segregated for regulatory purposes or deposited with
clearing organizations contain cash and securities segregated in compliance with
federal and other
PAGE 52
Merrill Lynch 2001 Annual Report
regulations and represent funds deposited by customers and funds accruing to
customers as a result of trades or contracts. Also included are funds segregated
in a special reserve account for the benefit of customers under Rule 15c3-3 of
the Securities and Exchange Commission as well as funds segregated and held in
separate accounts in accordance with Section 4d(2) and Regulation 30.7 of the
Commodity Exchange Act.
Securities Financing Transactions
Merrill Lynch enters into repurchase and resale agreements and securities
borrowed and loaned transactions to accommodate customers (also referred to as
"matched-book transactions"), finance firm inventory positions, and obtain
securities for settlement. Merrill Lynch also engages in securities financing
for customers through margin lending (see Customer Receivables and Payables
section).
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 is to obtain possession of collateral
with a market value equal to or in excess of the principal amount loaned under
resale agreements. To ensure that the market value of the underlying collateral
remains sufficient, collateral is valued daily, and Merrill Lynch may require
counterparties to deposit additional collateral or return collateral pledged,
when appropriate. Substantially all repurchase and resale activities are
transacted under master netting agreements that give Merrill Lynch the right, in
the event of default, to liquidate collateral held and to 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.
On the Consolidated Balance Sheets as of December 28, 2001 and December 29,
2000, all firm-owned securities pledged to counterparties where the counterparty
has the right, by contract or custom, to sell or repledge the securities are
classified as Securities pledged as collateral as required by SFAS No. 140.
On the Consolidated Balance Sheet as of December 28, 2001, transactions
where Merrill Lynch acts as the lender in a securities lending agreement and
receives securities as collateral that can be pledged or sold are recognized as
Securities received as collateral and an Obligation to return securities
received as collateral.
Interest rate swaps may be used to modify the interest rate characteristics
of long-term resale and repurchase agreements. (See the Derivatives section for
additional information on accounting policy for derivatives.)
Marketable Investment Securities
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. Any
unrealized losses deemed other than temporary are included in current period
earnings.
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.
Realized gains and losses on investments are included in current period
earnings. The cost basis of each investment sold is specifically identified for
purposes of computing realized gains and losses.
Merrill Lynch securitizes commercial and residential mortgage and home
equity loans, government and corporate bonds, and lease and trade receivables.
Merrill Lynch may retain an interest in the securitized assets in the form of
residual interests or one or more subordinated tranches. The gain or loss on
sale of the receivables is determined with reference to the previous carrying
amount of the financial assets transferred, which is allocated between the
assets sold and the retained interests, if any, based on their relative fair
value at the date of transfer. To obtain fair values, quoted market prices are
used if available. Where quotes are unavailable for retained interests, Merrill
Lynch generally estimates fair value initially and on an on-going basis based on
the present value of expected future cash flows using management's best
estimates of the key assumptions, including credit losses, prepayment rates,
forward yield curves, and discount rates, commensurate with the risks involved.
Retained interests categorized as available-for-sale are reported in Other
Investments in the Consolidated Balance Sheets (see Note 5 -- Investments).
PAGE 53
Merrill Lynch 2001 Annual Report
Retained interests in securitized receivables were not material at December 28,
2001 and December 29, 2000. In 2001 and 2000, cash proceeds from securitizations
totaled $12.3 billion and $26.6 billion, respectively, related to the following
asset types:
(dollars in millions)
- -----------------------------------------------------------------------
2001 2000
- -----------------------------------------------------------------------
Asset category
Municipal bonds $ 7,402 $ 7,830
Residential mortgage loans 2,833 14,306
Corporate and government bonds 1,262 4,419
Commercial loans 810 -
-------- --------
$ 12,307 $ 26,555
- -----------------------------------------------------------------------
In 2001, Merrill Lynch recognized pre-tax gains of $18 million from the
securitization of residential mortgage loans, and $28 million from the
securitization of corporate and government bonds.
Trading Assets and Liabilities
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 managing risk exposures in other trading inventory. (See the
Derivatives section for additional information on accounting policy for
derivatives.)
Trading securities and other cash instruments (e.g., loans held for trading
purposes) are recorded 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 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. As previously noted, estimating the fair value of
long-dated derivative contracts and illiquid securities requires significant
management judgment.
Derivatives
A derivative is an instrument whose value is "derived" from an underlying
instrument or index such as a future, forward, swap, or option contract, or
other financial instrument with similar characteristics. 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).
The fair value of all derivatives is recorded on a net-by-counterparty
basis on the Consolidated Balance Sheets where management believes a legal right
of setoff exists under an enforceable netting agreement.
Valuation of Derivatives
Fair values for certain exchange-traded derivatives, principally futures and
certain options, are based on quoted market prices. Fair values for OTC
derivative financial instruments, principally forwards, options, and swaps,
represent amounts estimated to be received from or paid to a third party in
settlement of these instruments. These derivatives are valued using pricing
models based on the net present value of estimated future cash flows and
directly observed prices from exchange-traded derivatives, other OTC trades, or
external pricing services.
New, complex instruments may have immature or limited markets. As a result,
the pricing models used for valuation often incorporate significant estimates
and assumptions, which may impact the level of precision in the financial
statements. For long-dated and illiquid contracts, extrapolation methods are
applied to observed market data in order to estimate inputs and assumptions that
are not directly observable. This enables Merrill Lynch to mark all positions
consistently when only a subset of prices are directly observable. Values for
non-exchange-traded derivatives are verified using observed information about
the costs of hedging out the risk and other trades in the market. 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.
Valuation adjustments are an integral component of the mark-to-market
process and are taken for individual positions where either the sheer size of
the trade or other specific features of the trade or particular market (such as
counterparty credit quality or concentration or market liquidity) requires
greater attention than simple application of the pricing models.
Use of Derivatives
Merrill Lynch enters into derivatives in a dealing capacity, providing them to
clients and entering into them for proprietary trading and financing strategies
and to manage its risk exposures arising from trading assets and liabilities. As
a result of these hedging techniques, a significant portion of trading assets
and liabilities represents hedges of other trading positions.
Merrill Lynch also enters into derivatives in a non-dealing capacity, to
manage its risk exposures arising from non-trading assets and liabilities.
Merrill Lynch routinely issues debt in a variety of maturities and currencies to
achieve the lowest cost financing possible. Merrill Lynch uses derivative
transactions to more closely match the duration of these borrowings to the
duration of the assets being funded to
PAGE 54
Merrill Lynch 2001 Annual Report
minimize interest rate risk. Merrill Lynch also enters into currency swaps to
ensure that non-U.S. dollar-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). 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
. Convert non-U.S. dollar payments into U.S. dollars.
In addition, Merrill Lynch enters into hedges on marketable investment
securities to manage the interest rate risk and net duration of the investment
portfolio.
Merrill Lynch also uses forward-exchange contracts, currency swaps, and
foreign-currency-denominated debt to hedge its net investments in foreign
operations. These derivatives and cash instruments are used to mitigate the
impact of adverse movements in exchange rates.
Risk Management of Derivatives
Derivative activity is subject to Merrill Lynch's overall risk management
policies and procedures. In the course of conducting its business operations,
Merrill Lynch is exposed to a variety of risks. These risks include market,
credit, liquidity, process, and other risks that are material and require
comprehensive controls and management. (See Note 6 -- Trading Assets and
Liabilities, Market Risk and Credit Risk sections). The Corporate Risk
Management ("CRM") group, along with other control units, ensures that these
risks are properly identified, monitored, and managed throughout Merrill Lynch.
To accomplish this, CRM has established a risk management process which
includes:
. A formal risk governance organization that defines the oversight process
and its components.
. A regular review of the entire risk management process by the Audit Committee
of the Board of Directors.
. Clearly defined risk management policies and procedures supported by
analytic tools.
. Communication and coordination between the business, executive, and risk
functions while maintaining strict segregation of responsibilities, controls,
and oversight.
. Clearly articulated risk tolerance levels as defined by a group composed of
executive management that are regularly reviewed to ensure that Merrill
Lynch's risk-taking is consistent with its business strategy, capital
structure, and current and anticipated market conditions.
The risk management process, combined with CRM's personnel and analytic
infrastructure, works to ensure that Merrill Lynch's risk tolerance is
well-defined and understood by the firm's risk-takers as well as by its
executive management. Other groups, including Corporate Audit, Finance, Legal,
and Treasury, work with CRM to establish this overall risk management control
process. While no risk management system can ever be absolutely complete, the
goal of CRM is to make certain that risk-related losses occur within acceptable,
predefined levels.
Accounting for Derivatives and Hedging Activities
On the first day of fiscal year 2001, Merrill Lynch adopted the provisions of
SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts ("embedded derivatives") and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
Consolidated Balance Sheets and measure those instruments at fair value. The
accounting for changes in fair value of a derivative instrument depends on its
intended use and the resulting designation.
Derivatives entered into in a dealing capacity are recognized at fair value
on the Consolidated Balance Sheets as trading assets and liabilities in
Contractual agreements and the change in fair value is reported in current
period earnings as Principal transactions revenues.
Derivatives entered into in a non-dealing capacity are designated, on the
date they are entered into, as either (1) a hedge of the fair value of a
recognized asset or liability ("fair value" hedge), (2) a hedge of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash flow" hedge), or (3) a hedge of a net investment in a
foreign operation.
. Changes in the fair value of derivatives that are designated and qualify as
fair value hedges, along with the gain or loss on the hedged asset or
liability that is attributable to the hedged risk, are recorded in current
period earnings as interest revenue or expense.
. Changes in the fair value of derivatives that are designated and qualify
as cash flow hedges are recorded in Accumulated other comprehensive loss
until earnings are affected by the variability of cash flows of the hedged
asset or liability (e.g., when periodic settlements on a variable-rate asset
or liability are recorded in earnings).
. Changes in the fair value of derivatives that are designated and qualify as
hedges of a net investment in a foreign operation are recorded in the
Foreign currency translation adjustment account within Accumulated other
comprehensive loss.
. Changes in the fair value of derivatives that are economically used to hedge
non-trading assets and liabilities, but that do not meet the criteria in
SFAS No. 133 to qualify as an accounting hedge are reported in current
period earnings as either Principal transactions revenues or Other revenue.
Derivatives entered into by Merrill Lynch in a non-dealing capacity used to
hedge its funding and its net investments in foreign subsidiaries are reported
at fair value in Other assets or Other liabilities in the Consolidated Balance
Sheet at December 28, 2001. Derivatives are also used to hedge Merrill Lynch's
marketable investment securities portfolio. Prior to the adoption of SFAS No.
133, derivatives entered into in a non-dealing capacity were generally accounted
for on an accrual basis and reported in Other
PAGE 55
Merrill Lynch 2001 Annual Report
receivables and Other payables. SFAS No. 133 does not require restatement of
prior period balances.
Merrill Lynch documents its risk management objectives and strategies for
undertaking various hedge transactions. The risk management objectives and
strategies are monitored and managed by CRM in accordance with established risk
management policies and procedures that include risk tolerance levels. Merrill
Lynch also formally assesses, both at the inception of the hedge and on an
ongoing basis, whether the hedging derivatives are highly effective in
offsetting changes in fair value or cash flows of hedged items. When it is
determined that a derivative is not highly effective as a hedge, Merrill Lynch
discontinues hedge accounting. Under the provisions of SFAS No. 133, hedge
effectiveness may be assumed for those derivatives whose terms match the terms
of the asset or liability being hedged and that otherwise meet the conditions of
SFAS No. 133.
Merrill Lynch issues debt whose coupons or repayment terms are linked to
the performance of equity or other indices (e.g., S&P 500) or baskets of
securities. The contingent payment components of these debt obligations meet the
definition of an "embedded derivative." The debt instruments are assessed to
determine if the embedded derivative requires separate reporting and accounting,
and if so, the embedded derivative is separated and reported in Long-term
borrowings on the Consolidated Balance Sheet with the debt obligation; changes
in the fair value of the embedded derivative and related hedges are reported in
Interest expense. The risk exposures in embedded derivatives are economically
hedged with other derivatives reported at fair value.
Merrill Lynch may also purchase financial instruments that contain embedded
derivatives. These instruments may be part of either trading inventory or
trading marketable investment securities. These instruments are generally
accounted for at fair value in their entirety; the embedded derivative is not
separately accounted for, and all changes in fair value are reported in
earnings.
Upon adoption of SFAS No. 133, all existing hedge relationships were
designated anew. Merrill Lynch recorded a pre-tax loss of $32 million ($22
million after-tax) in interest expense upon adoption of SFAS No. 133.
For the year ended December 28, 2001, the amount of hedge ineffectiveness
on fair value hedges was not material. All components of each derivative's gain
or loss are included in the assessment of hedge effectiveness.
For the year ended December 28, 2001, $317 million of net gains related to
non-U.S. dollar net investment hedges were included in Accumulated other
comprehensive loss on the Consolidated Balance Sheet.
Substantially all deferred net gains on derivative instruments designated
as cash flow hedges that were accumulated in Other comprehensive income at
December 28, 2001 are expected to be reclassified into earnings as interest
income during the next twelve months. The amount of ineffectiveness related to
these hedges reported in earnings is not material.
Other Receivables and Payables
Customer Receivables and Payables
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 Advisors
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. Performance-based incentive fees are
recognized prior to the end of the contract measurement period based on
performance to date. Certain compensation costs related to sales of rear-load
open-end mutual funds are deferred to match revenue recognition. Amortization of
deferred amounts is accelerated when it is determined that deferred expenses
cannot be recovered.
Brokers and Dealers Receivables and Payables
Receivables from brokers and dealers include amounts receivable for securities
not delivered by Merrill Lynch to a purchaser by the settlement date ("fails to
deliver"), deposits for securities borrowed, margin deposits, commissions, and
net receivables arising from unsettled trades. Payables to brokers and dealers
include amounts payable for securities not received by Merrill Lynch from a
seller by the settlement date ("fails to receive"), deposits received for
securities loaned, and net payables arising from unsettled trades.
Interest and Other Receivables and Payables
Interest and other receivables include interest receivable on corporate and
governmental obligations, customer or other receivables, stock borrowed
transactions, receivables from commissions and fees and income taxes. Interest
and other payables include interest payable for stock loaned transactions, and
amounts payable for employee compensation and benefits, restructuring reserves
and income taxes.
Investments and Liabilities of Insurance Subsidiaries
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 mor-
PAGE 56
Merrill Lynch 2001 Annual Report
tality 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 gain or loss 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 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 of
approximately $12.3 billion are not consolidated with the assets and liabilities
of Merrill Lynch.
Loans, Notes, and Mortgages
Merrill Lynch's lending and related activities include loan originations,
syndications and securitizations. Merrill Lynch also engages in secondary market
loan trading and margin lending (see Trading assets and liabilities and Customer
receivables and payables sections, respectively).
Loans held for investment purposes, including consumer and small business
loans, 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, and commercial loans that are syndicated, are reported at the
lower of cost (less allowance for loan losses) or estimated fair value. The
impact of the loan loss provision, for syndicated loans not held by Merrill
Lynch's U.S. banks, is included in Principal transactions revenues in the
Consolidated Statements of Earnings. The loan loss provision related to other
loans is included in Interest revenue in the Consolidated Statements of
Earnings.
Other Investments
Other investments primarily consist of:
. Available-for-sale securities carried at fair value, with unrealized gains or
losses reported in Accumulated other comprehensive loss.
. Investments held by a regulated broker-dealer carried at fair value with gains
and losses reported in Principal transactions revenues. Certain of these
investments are subject to restrictions that may limit Merrill Lynch's ability
to realize currently the estimated fair value of its investment until such
restrictions expire. Accordingly, Merrill Lynch estimates the fair value of
these securities taking into account the restrictions using pricing models
based on projected cash flows, earnings multiples, comparisons based on
similar transactions, and/or review of underlying financial conditions and
other market factors.
. Merchant banking investments held by non-broker-dealer subsidiaries carried at
the lower of cost or net realizable value, or under the equity method
depending on Merrill Lynch's ability to exercise significant influence over
the investee. Gains and losses on these investments are reported in Other
revenues.
. Investments economically hedging deferred compensation liabilities carried at
fair value, with gains and losses reported in earnings.
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 $245 million, $235 million, and $207 million in
2001, 2000, and 1999, respectively. Depreciation and amortization recognized in
the Communications and technology expense category was $643 million, $611
million, and $516 million for 2001, 2000, and 1999, respectively.
Qualifying costs incurred in the development of internal-use software are
capitalized when costs exceed $5 million and are amortized over the useful life
of the developed software, generally not exceeding three years.
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 1997 purchase of the Mercury Asset
Management Group is amortized over 30 years. Goodwill related to other
acquisitions is amortized over periods generally not exceeding 15 years.
PAGE 57
Merrill Lynch 2001 Annual Report
Merrill Lynch periodically assesses the recoverability of goodwill by
comparing expected undiscounted future cash flows from the underlying business
operation with recorded goodwill balances. If such assessments indicate that the
undiscounted future cash flows are not sufficient to recover the related
carrying value, the assets are adjusted to fair values. Refer to the New
Accounting Pronouncements section for information regarding the change in
accounting for goodwill.
Other Assets
Other assets consist of unrealized gains on derivatives used to hedge Merrill
Lynch's borrowing activities. The majority of these derivatives are
marked-to-market with changes in fair value reflected in earnings (refer to
Derivatives section for more information). Other assets also include prepaid
pension expense related to plan contributions in excess of obligations, other
prepaid expenses, deferred deal-related expenses, and other deferred charges.
Refer to Note 13 -- Employee Benefit Plans for further information.
Commercial Paper and
Short- and Long-Term Borrowings
Merrill Lynch's unsecured general-purpose funding is principally obtained from
commercial paper and long-term borrowings. Commercial paper, when 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, adjusted for the effects of fair value
hedges.
Merrill Lynch uses derivatives to manage the interest rate, currency,
equity, and other risk exposures of its borrowings. (See the Derivatives section
for additional information on accounting policy for derivatives.)
Deposits
Savings deposits are interest-bearing accounts whereby the depositor is not
required by the deposit contract, but may at any time be required by the
depository institution, to give written notice of an intended withdrawal not
less than seven days before withdrawal is made, and that is not payable on a
specified date or at the expiration of a specified time after the date of
deposit. Time deposits are accounts that have a stipulated maturity and interest
rate. Depositors holding time deposits may recover their funds prior to the
stated maturity but may pay a penalty to do so.
STOCK-BASED COMPENSATION
Merrill Lynch accounts for stock-based compensation in accordance with the
intrinsic value-based method in Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," rather than the fair value-based
method in SFAS No. 123, "Accounting for Stock-Based Compensation." Compensation
expense for stock options is not recognized since Merrill Lynch grants stock
options with no intrinsic value. Compensation expense related to other
stock-based compensation plans is recognized over the vesting period. The
unamortized portion of the grant value for such plans is reflected as a
reduction of Stockholders' Equity in Unamortized employee stock grants on the
Consolidated Balance Sheets.
INCOME TAXES
ML & Co. and certain of its wholly-owned subsidiaries file a consolidated
U.S. federal income tax return. Certain other Merrill Lynch entities file tax
returns in their local jurisdictions.
Merrill Lynch uses the asset and liability method in providing income taxes
on all transactions that have been recognized in the Consolidated Financial
Statements. The asset and liability method requires that deferred taxes be
adjusted to reflect the tax rates at which future taxable amounts will likely 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.
NEW ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") released SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for the disposal of a
segment of the business as previously defined in that opinion. SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements"
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. SFAS No. 144 provides guidance on the financial
accounting and reporting for the impairment or disposal of long-lived assets.
Merrill Lynch will adopt the provisions of SFAS No. 144 in the first quarter of
2002 and has not yet determined the impact of adoption.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, intangible assets with indefinite lives and
goodwill will no longer be amortized. Instead, these assets will be tested
annually for impairment. Merrill Lynch adopted the provisions of SFAS No. 142 at
the beginning of fiscal year 2002.
SFAS No. 142 will require that Merrill Lynch perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. This test is required to be completed within six months of the date of
adoption. If an indication of impairment exists, quantification of the
impairment is required to be completed as soon as possible, but no later than
the end of the year. Any impairment loss, as of the first day of fiscal year
2002, will be recog-
PAGE 58
Merrill Lynch 2001 Annual Report
nized as the cumulative effect of a change in accounting principle in Merrill
Lynch's statement of earnings upon adoption. Merrill Lynch is currently
assessing the impact of adopting this standard; annual amortization expense
related to goodwill approximated $200 million in 2001.
In July 2001, the FASB released SFAS No. 141, "Business Combinations." SFAS
No. 141 requires all business combinations initiated after June 30, 2001, to be
accounted for using the purchase method. Merrill Lynch adopted the provisions of
SFAS No. 141 on July 1, 2001.
- --------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
RESTRUCTURING AND OTHER CHARGES
During the fourth quarter of 2001, Merrill Lynch's management formally committed
to a restructuring plan designed to position Merrill Lynch for improved
profitability and growth which included the resizing of selected businesses and
other structural changes. As a result, Merrill Lynch incurred a fourth quarter
pre-tax charge to earnings of $2.2 billion, which includes restructuring costs
of $1.8 billion and other one-time charges of $396 million. In addition, a
charge to deferred tax expense was recorded related to non-deductible prior and
current year losses associated with the refocusing of the Japan Private Client
business.
Restructuring Charge
Restructuring charges relate primarily to severance costs of $1.1 billion,
facilities costs of $299 million, technology and fixed asset write-offs of $187
million and other costs of $178 million. Structural changes include targeted
workforce reductions of approximately 6,200 through a combination of involuntary
and voluntary separations, across all business groups. At December 28, 2001, the
majority of employee separations were completed or announced and all had been
identified. The $1.1 billion of severance costs include non-cash charges related
to accelerated stock amortization for stock grants associated with employee
separations totaling $135 million. Cash payments of $79 million have been made
as of year-end. Facilities-related costs include the closure or subletting of
excess space, and the consolidation of Private Client offices in the United
States, Europe, Asia Pacific and Japan. Management expects both the remaining
branch closings and employee separations to be completed in 2002 and anticipates
that substantially all of the cash payments related to real estate and severance
will be funded by cash from operations. Asset write-offs primarily reflect the
write-off of technology assets and furniture and equipment which resulted from
management's decision to close Private Client branch offices.
Included in the restructuring charge are branch closing costs associated
with the refocusing of the Japan Private Client operations. As a result of the
restructuring of this business, revenues are initially expected to be lower than
the revenues reported in the region during 2001. Revenues for the Japan retail
operations being discontinued were not significant.
Other Charges
During 2001, Merrill Lynch also incurred one-time charges of $396 million. As
part of the resizing of Private Client branch offices, Merrill Lynch identified
branch office hardware that will need to be replaced in stages over the next
year in order to provide Financial Advisors with the most updated technology
with which to serve clients. To facilitate this transition, Merrill Lynch
entered into a sale-leaseback transaction on existing equipment with a third
party, which resulted in a loss of $133 million as technology assets were
written down to fair value. See Note 12 -- Commitments and Contingencies for
information regarding the future lease payments related to this equipment. Other
one-time charges include $99 million related to technology asset write-offs, $58
million associated with changes in compensation structures, $33 million of
charges related to a building held-for-sale, $32 million of investment
write-downs, $15 million of write-offs of deferred mutual fund distribution
costs, and other costs of $26 million.
SEPTEMBER 11TH-RELATED EXPENSES
On September 11th, terrorists attacked the World Trade Center complex, which
subsequently collapsed and damaged surrounding buildings, some of which were
occupied by Merrill Lynch. These events caused the temporary relocation of
approximately 9,000 employees from Merrill Lynch's global headquarters in the
North Tower of the World Financial Center, the South Tower of the World
Financial Center and from offices at 222 Broadway to backup facilities.
Some of Merrill Lynch's businesses were temporarily disrupted subsequent to
September 11th. During the fourth quarter, Merrill Lynch reoccupied and
reestablished business operations in the North Tower as well as in 222 Broadway.
The South Tower of the World Financial Center is in the process of being
restored.
For the year ended December 28, 2001, Merrill Lynch recorded September
11th-related expenses of $131 million ($83 million after-tax), which are net of
actual recoveries and insurance receivables booked to date. These expenses
include costs related to the write-off of damaged assets and sublease income;
the repair and replacement of equipment; and employee relocation, which required
reconfiguring alternative office facilities, technology, and telecommunications
and providing transportation. Merrill Lynch continues to incur additional
September 11th-related expenses, including the purchase of additional equipment
and the restoration of facilities. Merrill Lynch is also assessing the impact on
operations from physical damage to determine lost profits due to business
interruption. Therefore, the full financial impact to Merrill Lynch cannot be
currently determined.
Merrill Lynch is insured for loss caused by physical damage to property.
This coverage includes repair or replacement of property and lost profits due to
business interruption, including costs related to lack of access to facilities.
During the fourth quarter, Merrill Lynch received
PAGE 59
Merrill Lynch 2001 Annual Report
its first insurance advance payment related to September 11th of $100 million
and recognized an additional insurance receivable of $115 million. Merrill Lynch
expects to recognize additional insurance receivables in future periods.
Insurance payments are based on recoverable cash expenditures, which will not
necessarily be the same as expenses recognized under accounting principles
generally accepted in the United States of America.
MERGERS, ACQUISITIONS, AND DIVESTITURES
On December 28, 2001, Merrill Lynch sold its Canadian Private Client and
securities clearing businesses for $344 million in cash in connection with its
overall global business resizing. The sale resulted in a pre-tax gain of $158
million, which was included in Other Revenues on the Consolidated Statements of
Earnings, and accounted for a reduction of approximately 3,200 full-time
employees in the fourth quarter.
In July 2000, Merrill Lynch acquired Herzog, a leading Nasdaq market-maker,
through an exchange offer followed by a merger of a wholly-owned subsidiary of
Merrill Lynch & Co., Inc., with and into Herzog. Pursuant to the offer and the
merger, each Herzog shareholder, after giving effect to the ML & Co. two-for-one
common stock split, was entitled to receive 283.75502 shares of ML & Co. common
stock for each share held. A total of 17,100,602 shares of ML & Co. common stock
were issued in connection with this transaction. In addition, as specified in
the merger agreement, Herzog treasury shares (2,449,090 shares of ML & Co.
common stock) were cancelled and retired upon consummation of the merger.
The merger was accounted for as a pooling-of-interests, and accordingly,
prior period financial statements and footnotes were restated to reflect the
results of operations, financial position, and cash flows as if Merrill Lynch
and Herzog had always been combined. The effect of combining Herzog into the
results of operations, financial position, and cash flows of Merrill Lynch was
not material.
- --------------------------------------------------------------------------------
NOTE 3. SEGMENT AND GEOGRAPHIC INFORMATION
SEGMENT INFORMATION
In reporting to management during 2001, Merrill Lynch's operating results were
categorized into three business segments: Global Markets and Investment Banking
("GMI"), the Private Client Group ("Private Client"), and Merrill Lynch
Investment Managers ("MLIM"). Prior period amounts have been restated to conform
to the 2001 presentation.
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 Private Client are allocated among
GMI and Private Client 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
comprising an average of $81 billion, $105 billion, and $118 billion in
assets under management in 2001, 2000, and 1999, respectively, are assigned
to Private Client.
. The 401(k) business is reported as a 50/50 joint venture between MLIM and
Private Client.
. Revenues and expenses related to mutual fund shares bearing a contingent
deferred sales charge are reflected in segment results as if MLIM and
Private Client were unrelated entities.
. Interest (cost of carry) is allocated based on management's assessment of
the relative liquidity of segment assets and liabilities.
. Goodwill amortization, Mercury financing costs, and September 11th-related
expenses 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.
. Residual 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).
PAGE 60
Merrill Lynch 2001 Annual Report
Management believes that the following information by business segment
provides a reasonable representation of each segment's contribution to the
consolidated amounts:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------------------------
Corporate Items
(including
intersegment
GMI Private Client MLIM eliminations) Total
- -------------------------------------------------------------------------------------------------------------------------------
2001
Non-interest revenues $ 8,561 $ 8,256 $2,058 $ (261)(1) $ 18,614
Net interest revenue(2) 1,428 1,880 35 (77)(3) 3,266
-------- -------- ------ ------- --------
Net revenues 9,989 10,136 2,093 (338) 21,880
Non-interest expenses 8,343 9,974 2,069 117 (4) 20,503
-------- -------- ------ ------- --------
Earnings (loss) before income taxes $ 1,646 $ 162 $ 24 $ (455) $ 1,377
======== ======== ====== ======= ========
Earnings (loss) before income taxes,
September 11th-related and restructuring
and other charges $ 2,479 $ 1,239 $ 307 $ (324) $ 3,701
======== ======== ====== ======= ========
Year-end total assets $283,792 $128,965 $2,591 $ 4,071 $419,419
- -------------------------------------------------------------------------------------------------------------------------------
2000
Non-interest revenues $ 11,208 $ 10,329 $2,374 $ (235)(1) $ 23,676
Net interest revenue(2) 1,472 1,632 79 (93)(3) 3,090
-------- -------- ------ ------- --------
Net revenues 12,680 11,961 2,453 (328) 26,766
Non-interest expenses 8,717 10,400 1,952 (20)(5) 21,049
-------- -------- ------ ------- --------
Earnings (loss) before income taxes $ 3,963 $ 1,561 $ 501 $ (308) $ 5,717
======== ======== ====== ======= ========
Year-end total assets $281,976 $118,390 $2,427 $ 4,407 $407,200
- -------------------------------------------------------------------------------------------------------------------------------
1999
Non-interest revenues $ 8,781 $ 9,408 $2,225 $ (194)(1) $ 20,220
Net interest revenue(2) 1,037 1,171 22 (137)(3) 2,093
-------- -------- ------ ------- --------
Net revenues 9,818 10,579 2,247 (331) 22,313
Non-interest expenses 7,165 9,155 1,764 23 (5) 18,107
-------- -------- ------ ------- --------
Earnings (loss) before income taxes $ 2,653 $ 1,424 $ 483 $ (354) $ 4,206
======== ======== ====== ======= ========
Year-end total assets $246,984 $ 55,641 $2,273 $ 4,952 $309,850
- -------------------------------------------------------------------------------------------------------------------------------
(1) Primarily relates to 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 $207 and September 11th-related expenses
of $131, net of elimination of intersegment expenses of $221.
(5) Represents goodwill amortization of $217 and $227, net of elimination of
intersegment expenses and other corporate items of $237 and $202 for 2000
and 1999, respectively.
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 five regions:
. Europe, Middle East, and Africa
. Japan
. Asia Pacific
. Canada, and
. Latin America
The principal methodology used in preparing the geographic data in the table
that follows is:
. Revenue and expenses are generally recorded based on the location of the
employee generating the revenue or incurring the expense.
. 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:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Net revenues
Europe, Middle East, and Africa $ 3,640 $ 4,876 $ 3,976
Japan 1,023 1,511 1,193
Asia Pacific 874 1,247 1,018
Canada 877 854 652
Latin America 475 731 672
-------- -------- --------
Total Non-U.S. 6,889 9,219 7,511
United States 15,092 17,651 14,939
Corporate (101) (104) (137)
-------- -------- --------
Total $ 21,880 $ 26,766 $ 22,313
======== ======== ========
Earnings (loss)
before income taxes
Europe, Middle East, and Africa $ 42 $ 1,315 $ 1,132
Japan (387) 243 (33)
Asia Pacific (40) 269 183
Canada 253 176 57
Latin America 18 175 127
-------- -------- --------
Total Non-U.S. (114) 2,178 1,466
United States 1,946 3,847 3,094
Corporate (455) (308) (354)
-------- -------- --------
Total $ 1,377 $ 5,717 $ 4,206
- --------------------------------------------------------------------------------
PAGE 61
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
NOTE 4. SECURITIES FINANCING TRANSACTIONS
Merrill Lynch enters into secured borrowing and lending transactions to finance
trading inventory positions, obtain securities for settlement, and meet
customers' needs.
Under these agreements and transactions, Merrill Lynch either receives or
provides collateral, including U.S. Government and agencies, asset-backed,
corporate debt, equity, and non-U.S. governments and agencies securities.
Merrill Lynch receives collateral in connection with resale agreements,
securities borrowed transactions, customer margin loans, and other loans. Under
many agreements, Merrill Lynch is permitted to sell or repledge these securities
held as collateral and use the securities to secure repurchase agreements, enter
into securities lending transactions, or deliver to counterparties to cover
short positions. At December 28, 2001 and December 29, 2000, the fair value of
securities received as collateral where Merrill Lynch is permitted to sell or
repledge the securities was $246 billion and $217 billion, respectively, and the
fair value of the portion that has been sold or repledged was $221 billion and
$161 billion, respectively.
Merrill Lynch pledges firm-owned assets to collateralize repurchase
agreements and other secured financings. Pledged securities that can be sold or
repledged by the secured party are classified as Securities pledged as
collateral on the Consolidated Balance Sheets. The carrying value and
classification of securities owned by Merrill Lynch that have been loaned or
pledged to counterparties where those counterparties do not have the right to
sell or repledge at year-end 2001 and 2000 are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Trading asset category
Corporate debt and preferred stock $ 6,135 $ 3,039
Equities and convertible debentures 157 657
Mortgages, mortgage-backed, and
asset-backed 7,998 5,876
U.S. Government and agencies 10,634 11,048
Municipals and money markets 1,074 550
Non-U.S. governments and agencies 1,073 1,643
-------- --------
Total $ 27,071 $ 22,813
- --------------------------------------------------------------------------------
NOTE 5. 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 the
investment portfolio for Merrill Lynch's U.S. banks. 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.
The fair values of Other investments were $6.0 billion and $5.1 billion at
year-end 2001 and 2000, respectively. Fair value for non-qualifying investments
under SFAS No. 115, which include merchant banking and private equity
investments including partnership interests, 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 of these instruments may differ.
Included in Other investments on the Consolidated Balance Sheets are
private equity investments which resulted from Merrill Lynch's merchant banking
and other activities. Investment-related net revenues, which include dividend
income and realized and unrealized gains and losses, were $229 million, $618
million and $295 million in 2001, 2000 and 1999, respectively. These revenues
include net gains related to investments held by broker-dealer entities of $213
million and $212 million, which are included in Principal transactions revenues
in 2001 and 2000, respectively. The remaining investment-related net revenues
are included in Other revenues in the accompanying Consolidated Statements of
Earnings, and include the $158 million pre-tax gain from the sale of the Private
Client and securities clearing businesses in Canada in 2001.
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 28, 2001 and December
29, 2000 are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Marketable Investment Securities
Available-for-sale $ 70,320 $ 48,483
Trading 7,460(4) 632
Held-to-maturity 40(4) 136
-------- --------
Total $ 77,820 $ 49,251
======== ========
Investments of Insurance Subsidiaries
Available-for-sale $ 2,333 $ 2,382
Trading 24 25
Non-qualifying(1)(2) 1,626 1,595
-------- --------
Total $ 3,983 $ 4,002
======== ========
Other Investments
Available-for-sale $ 1,703 $ 1,746
Trading 358(4) -
Held-to-maturity 394 693
Non-qualifying(1)(3) 3,414 2,499
-------- --------
Total $ 5,869 $ 4,938
- --------------------------------------------------------------------------------
(1) Non-qualifying for SFAS No. 115 purposes.
(2) Primarily consists of insurance policy loans.
(3) Includes merchant banking investments and investments economically hedging
deferred compensation liabilities.
(4) During 2001 certain municipals and mortgage- and asset-backed securities
previously classified as available-for-sale or held-to-maturity were
transferred to trading.
PAGE 62
Merrill Lynch 2001 Annual Report
Information regarding investment securities subject to SFAS No. 115 follows:
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------------------------
December 28, 2001 December 29, 2000
--------------------------------------------- --------------------------------------------
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
Mortgage- and asset-backed
securities $ 58,880 $ 611 $ (665) $ 58,826 $ 35,698 $ 277 $ (241) $ 35,734
Corporate debt 5,382 78 (77) 5,383 4,298 24 (53) 4,269
U.S. Government and agencies 5,130 237 (231) 5,136 5,384 177 (3) 5,558
Municipals 16 1 - 17 1,838 44 (39) 1,843
Other debt securities 3,149 4 (1) 3,152 4,629 16 (9) 4,636
--------- --------- ---------- --------- --------- ---------- ---------- ---------
Total debt securities 72,557 931 (974) 72,514 51,847 538 (345) 52,040
Equity securities 1,854 6 (18) 1,842 616 12 (57) 571
--------- --------- ---------- --------- --------- ---------- ---------- ---------
Total $ 74,411 $ 937 $ (992) $ 74,356 $ 52,463 $ 550 $ (402) $ 52,611
- ---------------------------------------------------------------------------------------------------------------------------
Held-to-Maturity
U.S. Government and agencies $ 215 $ - $ - $ 215 $ 229 $ - $ - $ 229
Municipals - - - - 225 20 (2) 243
Mortgage- and asset-backed
securities 34 - - 34 54 - - 54
Other debt securities 185 - - 185 321 56 - 377
----- ---- ---- ----- ----- ---- ---- -----
Total $ 434 $ - $ - $ 434 $ 829 $ 76 $ (2) $ 903
- -----------------------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair value of debt securities at December
28, 2001, by contractual maturity, for available-for-sale and held-to-maturity
investments follow:
(dollars in millions)
- --------------------------------------------------------------------------------------------
Available-for-Sale Held-to-Maturity
---------------------- -----------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
- --------------------------------------------------------------------------------------------
Due in one year or less $ 4,036 $ 4,043 $ 3 $ 3
Due after one year through
five years 4,102 4,115 216 216
Due after five years through
ten years 4,011 4,015 - -
Due after ten years 1,528 1,515 181 181
-------- -------- ----- -----
13,677 13,688 400 400
Mortgage- and asset-
backed securities 58,880 58,826 34 34
-------- -------- ----- -----
Total(1) $ 72,557 $ 72,514 $ 434 $ 434
- --------------------------------------------------------------------------------------------
(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:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Proceeds $ 14,138 $ 7,036 $ 3,071
Gross realized gains 85 247 22
Gross realized losses (66) (121) (28)
- --------------------------------------------------------------------------------
Net unrealized gains (losses) from investment securities classified as
trading included in the 2001, 2000, and 1999 Consolidated Statements of Earnings
were $47 million, $(22) million, and $46 million, respectively.
Merrill Lynch has agreed to invest not more than $600 million in Merrill
Lynch HSBC ("MLHSBC"), the 50/50-owned corporation created to provide global
online investment and banking services to individual self-directed customers
outside the United States. MLHSBC is not a consolidated subsidiary of Merrill
Lynch. At December 28, 2001, Merrill Lynch had invested $197 million. The timing
of the funding of additional investments will be determined by the Board of
Directors of Merrill Lynch HSBC, which has equal representation from Merrill
Lynch and HSBC Holdings, plc ("HSBC").
- --------------------------------------------------------------------------------
NOTE 6. TRADING ASSETS AND LIABILITIES
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
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.
Certain trading activities expose Merrill Lynch to market and credit risks.
These risks are managed in accordance with established risk management policies
and procedures. Refer to Note 1 -- Summary of Significant Accounting Policies,
Derivatives, for additional information on Risk Management.
PAGE 63
Merrill Lynch 2001 Annual Report
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.
Interest rate agreements used by Merrill Lynch include caps, collars,
floors, basis swaps, leveraged swaps and options. 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 more than 50 currencies, including the euro, Japanese yen,
Swiss franc and British pound. 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 client 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 precious metals and base metals.
Merrill Lynch is also a party to financial instruments that contain risks
not correlated to typical financial risks. 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 counterparty fails
to perform its obligations under contractual terms ("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.
PAGE 64
Merrill Lynch 2001 Annual Report
In the normal course of business, Merrill Lynch executes, settles, and
finances various customer securities transactions. Execution of these
transactions includes the purchase and sale of securities by Merrill Lynch.
These activities may expose Merrill Lynch to default risk arising from the
potential that customers or counterparties may fail to satisfy their
obligations. In these situations, Merrill Lynch may be required to purchase or
sell financial instruments at unfavorable market prices to satisfy obligations
to other customers or counterparties. In addition, Merrill Lynch seeks to
control the risks associated with its customer margin activities by requiring
customers to maintain collateral in compliance with regulatory and internal
guidelines.
Liabilities to other brokers and dealers related to unsettled transactions
(i.e., securities failed-to-receive) are recorded at the amount for which the
securities were purchased, 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 28, 2001, 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 $15.6 billion and
$23.8 billion at December 28, 2001 and December 29, 2000, 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 28, 2001 and
December 29, 2000 totaled $102.9 billion and $62.8 billion, respectively.
At December 28, 2001, Merrill Lynch had concentrations of credit risk with
other counterparties, the largest of which were a financial institution rated AA
by recognized credit rating agencies and a government-sponsored agency rated AAA
by recognized credit rating agencies. Total unsecured exposure to each
counterparty was approximately $1.5 billion, or 0.4% 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, hedging, financing, and underwriting activities.
Merrill Lynch also monitors credit exposures worldwide by region. Outside the
United States, sovereign governments and financial institutions represent the
most significant concentrations.
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.
DERIVATIVES
Merrill Lynch's derivatives consist of derivatives provided to customers and
derivatives entered into for proprietary trading strategies or risk management
purposes.
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 by type of risk follow:
(dollars in billions)
- ------------------------------------------------------------------------------------
Risk
------------------------------------------------
Interest Equity Commodity
Rate(1)(2) Currency(3) Price and other
- ------------------------------------------------------------------------------------
December 28, 2001
Swap agreements $ 3,512 $ 235 $ 20 $ 38
Forward contracts 120 184 1 2
Futures contracts 617 2 38 1
Options purchased 35 61 143 2
Options written 42 73 41 3
December 29, 2000
Swap agreements $ 2,970 $ 51 $ 17 $ 31
Forward contracts 132 165 1 1
Futures contracts 273 3 17 -
Options purchased 48 92 63 5
Options written 59 60 67 1
- ------------------------------------------------------------------------------------
(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.
PAGE 65
Merrill Lynch 2001 Annual Report
For derivatives outstanding at December 28, 2001, the following table
presents the notional or contractual amounts of derivatives expiring in future
years based on contractual expiration:
(dollars in billions)
- ---------------------------------------------------------------------------------------------
After
2002 2003 2004 2005 2005 Total
- ---------------------------------------------------------------------------------------------
Swap agreements $ 546 $ 625 $ 477 $ 404 $ 1,753 $ 3,805
Forward contracts 242 61 3 - 1 307
Futures contracts 548 50 27 16 17 658
Options purchased 112 37 59 11 22 241
Options written 101 23 9 8 18 159
------- ----- ----- ----- ------- -------
Total $ 1,549 $ 796 $ 575 $ 439 $ 1,811 $ 5,170
- ---------------------------------------------------------------------------------------------
The notional or contractual values of derivatives do not represent default
risk exposure. Default risk is primarily limited to the current cost of
replacing derivative contracts in a gain position. Default risk can also occur
for the full notional amount of the trade where a final exchange of principal
takes place, as may be the case for currency swaps. 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. Such receivables and
payables are recorded in Customers receivables and payables on the Consolidated
Balance Sheets. 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 generally enters into International Swaps and Derivatives
Association, Inc. master agreements or their equivalent ("master netting
agreements") with each of its counterparties, as soon as 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 28, 2001, such collateral amounted to $7.3
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.
- --------------------------------------------------------------------------------
NOTE 7. LOANS, NOTES, AND MORTGAGES
Loans, Notes, and Mortgages at December 28, 2001 and December 29, 2000 are
presented below:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Commercial:
In U.S. offices $ 8,565 $ 9,399
In offices outside the U.S. 1,710 1,438
-------- --------
Total commercial 10,275 10,837
-------- --------
Consumer:
In U.S. offices 8,730 6,635
-------- --------
Total $ 19,005 $ 17,472
- --------------------------------------------------------------------------------
The above amounts are net of allowance for loan losses of $425 million and
$176 million as of December 28, 2001 and December 29, 2000, respectively. The
increase in the allowance for loan losses in 2001 is primarily due to provisions
made in 2001 for certain syndicated loans.
The fair values of Loans, Notes, and Mortgages were approximately $18.9
billion and $17.5 billion at December 28, 2001 and December 29, 2000,
respectively. Fair value for loans made in connection with merchant banking
activities, consisting primarily of senior 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.
- --------------------------------------------------------------------------------
NOTE 8. COMMERCIAL PAPER AND SHORT-AND LONG-TERM 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. Refer to Note 1 -- Summary of Significant Accounting
Policies, Derivatives section for additional information on the accounting
policy for derivatives.
PAGE 66
Merrill Lynch 2001 Annual Report
Borrowings at December 28, 2001 and December 29, 2000 are presented below:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Commercial paper and other
short-term borrowings
Commercial paper $ 2,950 $ 14,022
Other 2,191 1,161
-------- --------
Total $ 5,141 $ 15,183
======== ========
Long-term borrowings
Fixed-rate obligations:(1)
U.S. dollar-denominated $ 11,797 $ 12,680
Non-U.S. dollar-denominated 1,671 1,723
Zero-coupon contingent
convertible debt 2,383 -
Variable-rate obligations:(2)(3)
U.S. dollar-denominated 3,720 2,809
Non-U.S. dollar-denominated 4,014 2,089
Medium-term notes:(3)(4)
U.S. dollar-denominated 37,600 37,483
Non-U.S. dollar-denominated 15,387 13,439
-------- --------
Total $ 76,572 $ 70,223
- --------------------------------------------------------------------------------
(1) At December 28, 2001, U.S. dollar-denominated fixed-rate obligations are
due between 2002 and 2028 at interest rates ranging from 2.4% to 8.4%;
non-U.S. dollar-denominated fixed-rate obligations are due 2002 to 2019 at
interest rates ranging from 0.38% to 7.63%.
(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 up to 30 years
from the date of issue.
Long-term borrowings at December 28, 2001, based on their contractual
terms, mature as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2002 $ 22,448
2003 15,042
2004 11,191
2005 4,124
2006 7,187
2007 and thereafter 16,580
--------
Total $ 76,572
- --------------------------------------------------------------------------------
In May 2001, Merrill Lynch issued $4.6 billion of zero-coupon contingent
convertible debt (Liquid Yield Option/TM/ notes or LYONs(R)) at an issue price
of $511.08 per note, which resulted in gross proceeds of approximately $2.4
billion. The LYONs(R) are unsecured and unsubordinated indebtedness of Merrill
Lynch with a maturity date of 30 years. Merrill Lynch will pay no interest prior
to maturity unless, during any six-month period commencing June 1, 2006, the
average market price of the LYONs(R) for a certain period exceeds 120% or more
of the accreted value of the LYONs(R). In the case that payment is required,
contingent interest will be equal to the greater of the common stock dividend
for that period or $.16 multiplied by the initial amount of shares into which
the LYONs(R) are convertible. Each note has a yield to maturity of 2.25% with a
maturity value of $1,000 on May 23, 2031. Merrill Lynch is amortizing the issue
discount using the effective interest method over the term of the LYONs(R). Each
LYONs(R) is convertible into 5.6787 shares of common stock if certain conditions
are met. Holders may require Merrill Lynch to purchase all or a portion of their
LYONs(R) on May 23, 2004, 2005, 2006, 2011, 2016, 2021 and 2026 at accreted
value. Holders may also require Merrill Lynch to repurchase all or a portion of
the LYONs(R) upon a change in control occurring on or before May 23, 2006 at a
price equal to the accreted value. Merrill Lynch may elect to pay the purchase
price in cash, shares of common stock or any combination thereof. Merrill Lynch
may redeem all or a portion of the LYONs(R) at any time after May 23, 2006.
Certain long-term borrowing agreements contain provisions whereby the
borrowings are redeemable at the option of the holder at specified dates prior
to maturity. Management believes, however, that a significant portion of such
borrowings will remain outstanding beyond their earliest redemption date.
Merrill Lynch's debt obligations do not contain provisions that could, upon
an adverse change in ML & Co.'s credit rating, financial ratios, earnings, cash
flows, or stock price, trigger a requirement for an early payment, additional
collateral support, changes in terms, acceleration of maturity, or the creation
of an additional financial obligation. Merrill Lynch may issue structured notes
that, under certain circumstances, require Merrill Lynch to immediately settle
the obligation for cash or other securities. A limited number of structured
notes may be accelerated based on the value of the underlying securities.
Merrill Lynch typically hedges these notes with positions in the underlying
securities.
The effective weighted-average interest rates for borrowings, which include
the impact of hedges, at December 28, 2001 and December 29, 2000 were:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Commercial paper and other
short-term borrowings 2.00% 6.43%
Long-term borrowings 2.18 6.65
- --------------------------------------------------------------------------------
The fair values of long-term borrowings and related hedges were $76.6
billion and $71.0 billion at December 28, 2001 and December 29, 2000,
respectively. These fair values are estimated using current market prices and
pricing models.
Borrowing Facilities
Merrill Lynch has obtained a committed, senior unsecured revolving credit
facility aggregating $5 billion under an agreement with a syndicate of banks.
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 28, 2001, this credit facility was not drawn
upon.
The credit quality, amounts, and terms of this credit facility are
continually monitored and modified as warranted
PAGE 67
Merrill Lynch 2001 Annual Report
by business conditions. Under the existing agreement, the credit facility will
mature in May 2002.
- --------------------------------------------------------------------------------
NOTE 9. DEPOSITS
Deposits at December 28, 2001 and December 29, 2000 are presented below:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
U.S.
Savings Deposits $ 72,200 $ 52,275
Time Deposits 1,355 2,612
-------- --------
Total U.S. Deposits 73,555 54,887
-------- --------
Non-U.S.
Non-interest bearing 234 174
Interest bearing 12,030 12,587
-------- --------
Total Non-U.S. Deposits 12,264 12,761
-------- --------
Total Deposits $ 85,819 $ 67,648
- --------------------------------------------------------------------------------
The effective weighted-average interest rates for deposits, which include
the impact of hedges, at December 28, 2001 and December 29, 2000 were 1.74% and
5.71%, respectively. The fair values of deposits approximated carrying value at
December 28, 2001 and December 29, 2000.
- --------------------------------------------------------------------------------
NOTE 10. 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/SM/ ("TOPrS"/SM/) were issued to
investors by trusts created by Merrill Lynch and are registered with the
Securities and Exchange Commission. Using the issuance proceeds, the trusts
purchased Partnership Preferred Securities, representing limited partnership
interests. Using the purchase proceeds, the limited partnerships extended 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/SM/ 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 following table presents data related to the issuance of TOPrS/SM/ by
Merrill Lynch Capital Trust I, II, III, IV, and V. All TOPrS/SM/ 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 (see chart below).
The holders of the TOPrS/SM/ do not have the right to redeem the securities.
Distributions, which are deductible for U.S. federal tax purposes, are payable
from the date of original issuance and are payable quarterly if, as, and when
the trusts have funds available for payment.
(dollars 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 76
-------
$ 2,651
- --------------------------------------------------------------------------------
(1) Represents Yen-denominated TOPrS issued by Merrill Lynch Yen TOPrS Trust I.
In addition, $44 million of preferred securities of other subsidiaries were
outstanding at year-end 2001.
- --------------------------------------------------------------------------------
NOTE 11. 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 2001, 2000, and 1999.
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.
COMMON STOCK
In 2001, stockholders approved the proposal to amend ML & Co.'s certificate of
incorporation to increase the authorized number of shares of common stock from
1 billion to 3 billion.
In 2000, 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 and Exchangeable shares of $680 million was made to preserve the
par value of the post-split
Page 68
Merrill Lynch 2001 Annual Report
shares. All share and per share data have been restated for the effect of the
split. Dividends paid on common stock were $0.64, $0.61, and $0.53 per share in
2001, 2000, and 1999, respectively.
SHARES EXCHANGEABLE INTO COMMON STOCK
In 1998, Merrill Lynch & Co., Canada Ltd. issued 9,662,448 Exchangeable Shares
in connection with Merrill Lynch's merger with Midland Walwyn Inc. 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 2001 and 2000, 458,971 and 3,364,320 Exchangeable Shares,
respectively, were converted to ML & Co. common stock. At year-end 2001,
4,195,407 Exchangeable Shares were outstanding, compared with 4,654,378 at
year-end 2000.
ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss represents cumulative gains and losses on
items that are not reflected in earnings. The balances at December 28, 2001 and
December 29, 2000 are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Foreign currency translation adjustment
Unrealized (losses), net of gains $ (103) $ (230)
Income taxes (199) (79)
------ ------
Total (302) (309)
------ ------
Unrealized gains (losses) on investment
securities available-for-sale
Unrealized (losses), net of gains (127) (57)
Adjustments for:
Policyholder liabilities (28) (18)
Deferred policy acquisition costs 2 15
Income taxes 61 24
------ ------
Total (92) (36)
------ ------
Deferred gains on cash flow hedges 36 -
------ ------
Minimum pension liability (10) -
------ ------
Total accumulated other comprehensive loss $ (368) $ (345)
- --------------------------------------------------------------------------------
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 10 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 10th 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:
(dollars in millions, except per share amounts)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Net earnings $ 573 $ 3,784 $ 2,693
Preferred stock dividends 38 39 39
-------- -------- --------
Net earnings applicable to
common stockholders $ 535 $ 3,745 $ 2,654
- --------------------------------------------------------------------------------
(shares in thousands)
Weighted-average basic
shares outstanding(1) 838,683 798,273 754,672
-------- -------- --------
Effect of dilutive instruments(2)
Employee stock options 53,336 68,190 55,701
FACAAP shares 27,305 29,637 31,894
Restricted shares
and units 19,173 15,251 11,138
ESPP shares 58 65 94
-------- -------- --------
Dilutive potential
common shares 99,872 113,143 98,827
-------- -------- --------
Diluted shares(3) 938,555 911,416 853,499
- --------------------------------------------------------------------------------
Basic EPS $ 0.64 $ 4.69 $ 3.52
Diluted EPS 0.57 4.11 3.11
- --------------------------------------------------------------------------------
(1) Includes shares exchangeable into common stock.
(2) See Note 14 for a description of these instruments and issuances subsequent
to December 28, 2001.
(3) At year-end 2001, 2000, and 1999, there were 38,174; 1,456, and 3,150
instruments, respectively, that were considered antidilutive and thus were
not included in the above calculations.
PAGE 69
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
NOTE 12. COMMITMENTS AND CONTINGENCIES
LITIGATION
As of December 28, 2001, Merrill Lynch has been named as party 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 the financial position of Merrill Lynch as set forth in the
Consolidated Financial Statements, but may be material to Merrill Lynch's
operating results for any particular period.
LENDING AND GUARANTEES
Merrill Lynch enters into commitments to extend credit, predominantly at
variable interest rates, in connection with certain merchant banking, corporate
finance, 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 commitments and guarantees usually
have a fixed expiration date and are contingent on certain contractual
conditions that may require payment of a fee by the counterparty. Once
commitments are drawn upon or guarantees are issued, Merrill Lynch may require
the counterparty to post collateral depending upon 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 defaults,
and the value of the existing collateral becomes 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 28, 2001, Merrill Lynch had the following commitments and
guarantees with commitment expirations as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
Total Less
Commit- than 1-3 4-5 Over
ment 1 year years years 5 years
- --------------------------------------------------------------------------------
Commitments to
extend credit $ 17,833(1) $ 8,213 $ 3,945 $ 3,083 $ 2,592
Third-party
guarantees 316 205 94 7 10
SPE-related
commitments 12,647 11,441 65 581 560
- --------------------------------------------------------------------------------
(1) Approximately $5.4 billion relates to secured lending activities.
SPE-related commitments include liquidity facilities and default protection
to investors in securities issued by SPEs totaling $12 billion. The fair value
of these commitments approximate zero as of December 28, 2001 as these positions
are significantly overcollateralized. In addition, Merrill Lynch provides
guarantees to holders of notes issued by SPEs relating to the residual value of
property and equipment lease assets held by the SPEs.
The commitments to extend credit are comprised of commercial paper back-up
lines of credit, syndicated loans, mortgages and other institutional and retail
commitments to extend credit. The commitments do not include any amounts for
commitments related to margin lending.
LEASES
Merrill Lynch has entered into various noncancellable long-term lease agreements
for premises that expire through 2024. Merrill Lynch has also entered into
various noncancellable short-term lease agreements, which are primarily
commitments of less than one year under equipment leases.
Merrill Lynch established two SPEs to finance its newly constructed
Hopewell, New Jersey campus and an aircraft. Merrill Lynch leases the facilities
and the aircraft from the SPEs. The assets and liabilities of these SPEs are not
consolidated in the financial statements of Merrill Lynch as they meet the
accounting requirements of EITF Issue No. 90-15. More specifically, in addition
to the other requirements of EITF No. 90-15, both of these SPEs have third-party
investors who have made a substantive capital investment in the SPEs in the
amount of 3% that is at risk during the entire term of the lease. The total
amount of funds raised by the SPEs to finance these transactions was $321
million at December 28, 2001 and $217 million at December 29, 2000.
Merrill Lynch entered into a five-year lease with two five-year renewal
options with each of these SPEs. The minimum rental commitments for these
transactions are included in the table that follows. Merrill Lynch also has an
option to purchase the assets owned by the SPEs for the acquisition cost, upon
thirty days' notice.
If Merrill Lynch does not renew the leases or purchase the assets held by
the SPEs, the underlying assets will be sold to a third party. The proceeds of
such sale will be used to repay the notes and equity issued by the SPEs. Merrill
Lynch has guaranteed that the proceeds of such sale will amount to at least 85%
of the acquisition cost of the assets. This guarantee does not extend to the
equity investors. The maximum cash flow of this guarantee is reflected in the
preceding commitments and guarantees table.
PAGE 70
Merrill Lynch 2001 Annual Report
At December 28, 2001, future noncancellable minimum rental commitments
under leases with remaining terms exceeding one year are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
WFC(1) Other Total
- --------------------------------------------------------------------------------
2002 $ 150 $ 389(2) $ 539
2003 158 334 492
2004 179 298 477
2005 179 280 459
2006 179 247 426
2007 and
thereafter 1,207 884 2,091
------ ------ ------
Total $2,052 $2,432 $4,484
- --------------------------------------------------------------------------------
(1) World Financial Center Headquarters.
(2) Includes $4.7 million of lease payments related to a leaseback of Private
Client technology equipment.
The minimum rental commitments shown above have not been reduced by $594
million of minimum sublease rentals to be received in the future under
noncancellable 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:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Rent expense $ 651 $ 636 $ 589
Sublease revenue (106) (108) (101)
----- ----- -----
Net rent expense $ 545 $ 528 $ 488
- --------------------------------------------------------------------------------
OTHER COMMITMENTS
In the normal course of business, Merrill Lynch enters into commitments for
underwriting transactions. Settlement of these transactions as of December 28,
2001 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 28, 2001 and December 29, 2000 to enter into resale and repurchase
agreements as follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Resale agreements $ 7,046 $ 2,803
Repurchase agreements 4,142 3,504
- --------------------------------------------------------------------------------
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 $1,687 million and $1,241
million at December 28, 2001 and December 29, 2000, respectively.
In connection with merchant banking activities, Merrill Lynch has committed
to purchase $321 million and $670 million of partnership interests at December
28, 2001 and December 29, 2000, respectively.
Merrill Lynch has entered into agreements with providers of market data,
communications, and systems consulting services. At December 28, 2001 minimum
fee commitments over the remaining life of these agreements aggregated $349
million.
- --------------------------------------------------------------------------------
NOTE 13. 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.
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 a minimum of one year of
service. A separate retirement account is maintained for each participant. Under
the RAP, employees are given the opportunity to invest their retirement savings
in a number of different investment alternatives. Under the ESOP, all retirement
savings are in ML&Co. common stock, until employees reach the age of 55 and have
five years in the plan, when they are given the opportunity to diversify.
In 1989, the ESOP trust purchased from Merrill Lynch 95.7 million 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 each participant's account and recorded pension
expense under the Retirement Program based on years of service and eligible
compensation. This expense was 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 were 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 Leveraged and Reversion Shares had
been allocated.
PAGE 71
Merrill Lynch 2001 Annual Report
On July 17, 2001 Merrill Lynch merged the assets of the Herzog ESOP with
the Merrill Lynch ESOP. Merrill Lynch will allocate ESOP shares of Merrill Lynch
stock to all participants of the ESOP as principal and interest are repaid. A
loan payment of approximately $1 million was made in August 2001 and, as a
result, 75,768 shares are committed to participants as of year-end 2001. At
December 28, 2001, 1,124,260 shares were unallocated. These shares are scheduled
to be allocated to participants through 2006.
Additional information on ESOP activity follows:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Compensation costs funded
with ESOP shares $ 5 $ 11 $ 49
Dividends used for debt service - - 2(1)
- --------------------------------------------------------------------------------
(1) Dividends on all Merrill Lynch ESOP 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. Employees are given the opportunity to invest
their 401K contributions in a number of different investment alternatives
including ML&Co. common stock. Merrill Lynch's contributions are made in cash,
and are equal to one-half of the first 6% of each participant's eligible
compensation contributed to the 401K, up to a maximum of two thousand dollars
annually. No corporate contributions are made for participants who are also
Employee Stock Purchase Plan participants (see Note 14).
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 2001 and 2000, 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, actual 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 twelve-month periods ended
September 28, 2001 and September 29, 2000 and the amounts recognized in the
Consolidated Balance Sheets at year-end 2001 and 2000:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Projected benefit obligations
Balance, beginning of year $ 1,870 $ 1,987
Service cost 43 45
Interest cost 129 127
Net actuarial (gain) loss 108 (156)
Benefits paid (120) (89)
Other (16) (44)
------- -------
Balance, end of period 2,014 1,870
------- -------
Fair value of plan assets
Balance, beginning of year 2,379 2,216
Actual return on plan assets 188 247
Contributions 69 41
Benefits paid (120) (89)
Other (16) (36)
------- -------
Balance, end of period 2,500 2,379
------- -------
Funded status 486 509
Unrecognized net actuarial (gains) (255) (343)
Unrecognized prior service benefit (1) (1)
Unrecognized net transition obligation 1 1
Fourth-quarter activity, net 11 10
------- -------
Net amount recognized $ 242 $ 176
======= =======
Assets $ 282 $ 258
Liabilities (50) (82)
Other comprehensive income 10 -
------- -------
Net amount recognized $ 242 $ 176
- --------------------------------------------------------------------------------
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 $561 million, $461 million, and $416 million,
respectively, as of September 28, 2001, and $118 million, $111 million, and $61
million, respectively, as of September 29, 2000. 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 28, 2001 and September 29, 2000 are as follows:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Discount rate 6.7% 7.1%
Rate of compensation increase 4.3 4.4
Expected rate of return on plan assets 6.6 7.7
- --------------------------------------------------------------------------------
PAGE 72
Merrill Lynch 2001 Annual Report
Pension cost included the following components:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Defined contribution plan cost $ 256 $ 244 $ 234
----- ----- -----
Defined benefit plans
Service cost for benefits earned
during the year 43 45 49
Interest cost on
projected benefit obligations 129 127 114
Expected return on plan assets (157) (150) (136)
Amortization of unrecognized items
and other (9) (14) -
----- ----- -----
Total defined benefit plan cost 6 8 27
----- ----- -----
Total pension cost $ 262 $ 252 $ 261
- --------------------------------------------------------------------------------
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. As of December 28, 2001,
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 twelve-month periods ended
September 28, 2001 and September 29, 2000, and the amounts recognized in the
Consolidated Balance Sheets at year-end 2001 and 2000:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Accumulated benefit obligations
Balance, beginning of year $ 199 $ 194
Service cost 8 7
Interest cost 16 14
Net actuarial (gain) loss 44 (11)
Benefits paid (12) (9)
Other 5 4
----- -----
Balance, end of period 260 199
----- -----
Fair value of plan assets
Balance, beginning of year - -
Contributions 12 8
Benefits paid (12) (8)
----- -----
Balance, end of period - -
----- -----
Funded status (260) (199)
Unrecognized net actuarial (gains) (4) (47)
Unrecognized prior service cost 3 4
Fourth-quarter activity, net 3 2
----- -----
Accrued benefit liabilities $(258) $(240)
- --------------------------------------------------------------------------------
The actuarial assumptions used in calculating the postretirement
accumulated benefit obligations at September 28, 2001 and September 29, 2000
are as follows:
- --------------------------------------------------------------------------------
2001 2000
- --------------------------------------------------------------------------------
Discount rate 7.0% 7.5%
Health care cost trend rates(1)
Initial 8.9 7.9
2010 and thereafter 5.0 5.0
- --------------------------------------------------------------------------------
(1) Assumed to decrease gradually until 2010 and remain constant thereafter.
Other postretirement benefits cost included the following components:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Service cost $ 8 $ 7 $ 9
Interest cost 16 14 14
Other 8 - (4)
---- ---- ----
Total other postretirement
benefits cost $ 32 $ 21 $ 19
- --------------------------------------------------------------------------------
The assumed health care cost trend rate has a significant effect on the
amounts reported for the postretirement health care plans. A one percent change
in the assumed health care cost trend rate would have the following effects:
(dollars in millions)
- --------------------------------------------------------------------------------
1% Increase 1% Decrease
------------ ------------
2001 2000 2001 2000
- --------------------------------------------------------------------------------
Effect on:
Other postretirement
benefits cost $ 5 $ 4 $ (4) $ (3)
Accumulated benefit
obligation 45 31 (36) (25)
- --------------------------------------------------------------------------------
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 $298 million, $117 million, and $33 million in
2001, 2000, and 1999, respectively, of postemployment benefits expense, which
included severance costs for terminated employees of $281 million, $70 million,
and $26 million in 2001, 2000, and 1999, respectively. The 2001 severance costs
exclude costs related to the restructuring and other charges recorded in the
fourth quarter of 2001. (See Note 2 -- Other Significant Events for additional
information). Although all full-time employees are eligible for severance
benefits, no additional amounts were accrued as of December 28, 2001 since
future severance costs are not estimable.
PAGE 73
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
NOTE 14. 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 2001, 2000, and 1999 was $732
million, $633 million, and $463 million, respectively. The 2001 costs exclude
restructuring related costs discussed in Note 2 -- Other Significant Events.
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 Non-qualified 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. All plans
under both LTIC and ECAP may be satisfied using either treasury or newly issued
shares. As of December 28, 2001, no instruments other than Restricted Shares,
Restricted Units, Non-qualified 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. Awards are settled in shares of common stock.
Recipients of Restricted Unit awards receive 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, generally three
years, for grants under LTIC Plans or the restricted period for grants under
ECAP.
The activity for Restricted Shares and Units under these plans during 2001
and 2000 follows:
- -----------------------------------------------------------------------------
LTIC Plans ECAP
------------------------ ----------
Restricted Restricted Restricted
Shares Units Shares
- -----------------------------------------------------------------------------
Authorized for issuance at:
December 28, 2001 660,000,000 N/A 104,800,000
December 29, 2000 560,000,000 N/A 104,800,000
- -----------------------------------------------------------------------------
Available for issuance at:(1)
December 28, 2001 163,316,331 N/A 10,738,237
December 29, 2000 80,562,524 N/A 4,013,790
- -----------------------------------------------------------------------------
Outstanding, end of 1999 26,292,892 25,337,225 7,657,832
Granted - 2000 209,313 17,746,449 18,927
Paid, forfeited, or released
from contingencies (7,790,512) (7,925,185) (7,303,458)
----------- ---------- -----------
Outstanding, end of 2000 18,711,693 35,158,489 373,301
Granted - 2001 1,254,182 9,129,715 11,759
Paid, forfeited, or released
from contingencies (7,508,504) (9,340,931) (8,982)
----------- ---------- -----------
Outstanding, end of 2001(2) 12,457,371 34,947,273 376,078
- -----------------------------------------------------------------------------
(1) Includes shares reserved for issuance upon the exercise of stock options.
(2) In 2002, 1,353,481 and 12,353,105 Restricted Shares and Units under LTIC
Plans, respectively, were granted to eligible employees.
The weighted-average fair value per share or unit for 2001, 2000, and 1999
grants follows:
- -----------------------------------------------------------------------------
2001 2000 1999
- -----------------------------------------------------------------------------
LTIC Plans
Restricted Shares $ 75.76 $ 45.09 $ 37.90
Restricted Units 74.52 46.52 37.49
ECAP Restricted Shares 60.51 52.67 42.68
- -----------------------------------------------------------------------------
Merrill Lynch sponsors other plans similar to LTIC Plans in which
restricted shares and units are granted to employees and non-employee directors.
The table that follows summarizes information related to restricted shares and
units for these other plans:
PAGE 74
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
Restricted Restricted
Shares Units
- --------------------------------------------------------------------------------
Authorized for Issuance at:
December 28, 2001 3,800,000 N/A
December 29, 2000 3,800,000 N/A
Outstanding at:
December 28, 2001 99,567 23,225
December 29, 2000 278,177 43,190
- --------------------------------------------------------------------------------
NON-QUALIFIED STOCK OPTIONS
Non-qualified Stock Options granted under LTIC Plans in 1989 through 1995
generally became exercisable over four years in equal installments commencing
one year after the date of grant. Options granted in 1996 through 2000 generally
are exercisable over five years. Beginning in 2001, new option grants become
exercisable after approximately six months. 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. Non-qualified Stock Options
expire ten years after their grant date.
The activity for Non-qualified Stock Options under LTIC Plans for 2001,
2000, and 1999 follows:
- --------------------------------------------------------------------------------
Weighted-
Average
Options Exercise
Outstanding Price
- --------------------------------------------------------------------------------
Outstanding, beginning of 1999 148,761,186 $ 14.99
Granted -- 1999 59,849,880 36.00
Exercised (14,970,240) 8.95
Forfeited (5,636,320) 31.94
------------
Outstanding, end of 1999 188,004,506 27.99
Granted -- 2000 39,839,546 43.83
Exercised (35,672,581) 15.47
Forfeited (5,116,248) 34.47
------------
Outstanding, end of 2000 187,055,223 27.48
Granted -- 2001 35,136,631 76.49
Exercised (23,558,452) 17.19
Forfeited (4,182,983) 38.69
------------
Outstanding, end of 2001(1) 194,450,419 37.36
- --------------------------------------------------------------------------------
(1) In January 2002, 44,970,614 Non-qualified Stock Options were granted to
eligible employees.
At year-end 2001, 2000, and 1999, options exercisable under LTIC Plans were
126,979,165, 92,776,119, and 83,568,708, respectively.
The table below summarizes information related to outstanding and
exercisable options at year-end 2001:
- --------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
---------------------------------------------- --------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Number Exercise Remaining Number Exercise
Price Outstanding Price Life (Years)(1) Exercisable Price
- --------------------------------------------------------------------------------------------------------
$ 7.00 - $14.99 40,757,581 $10.69 2.78 40,757,581 $10.69
$15.00 - $31.99 38,486,727 25.59 5.68 27,375,103 24.85
$32.00 - $42.99 43,923,553 36.21 7.13 17,503,230 36.11
$43.00 - $60.99 37,649,508 43.88 8.09 7,710,201 43.87
$61.00 - $77.99 33,633,050 77.41 9.10 33,633,050 77.41
- --------------------------------------------------------------------------------------------------------
(1) Based on original contractual life of ten years.
The weighted-average fair value of options granted in 2001, 2000, and 1999
was $31.80, $18.05, and $12.39 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:
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Risk-free interest rate 5.05% 6.73% 4.67%
Expected life 5 yrs. 5 yrs. 5 yrs.
Expected volatility 42.84% 40.64% 40.89%
Dividend yield 0.84% 1.23% 1.33%
- --------------------------------------------------------------------------------
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 100,600,000 shares of common stock have
been authorized for issuance under ESPP. The activity in ESPP during 2001, 2000,
and 1999 follows:
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Available, beginning
of year 6,518,168 8,949,796 11,702,344
Authorized during year 25,000,000 - -
Purchased through
plan (2,093,101) (2,431,628) (2,752,548)
---------- ---------- ----------
Available, end of year 29,425,067 6,518,168 8,949,796
- --------------------------------------------------------------------------------
PAGE 75
Merrill Lynch 2001 Annual Report
The weighted-average fair value of ESPP stock purchase rights exercised by
employees in 2001, 2000, and 1999 was $8.78, $7.30, and $6.25 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 -- Summary of
Significant Accounting Policies, Stock-Based Compensation section 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 $854 million, $348 million, and $291 million for 2001, 2000, and
1999, respectively, resulting in pro forma net earnings (loss) and earnings
(loss) per share as follows:
(dollars in millions, except per share amounts)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Net earnings (loss)
As reported $ 573 $ 3,784 $ 2,693
Pro forma (281) 3,436 2,402
Earnings (loss) per share
As reported:
Basic $ 0.64 $ 4.69 $ 3.52
Diluted 0.57 4.11 3.11
Pro forma:
Basic (0.38) 4.26 3.13
Diluted (0.38) 3.73 2.77
- --------------------------------------------------------------------------------
FINANCIAL ADVISOR CAPITAL ACCUMULATION AWARD PLANS ("FACAAP")
Under FACAAP, eligible employees in Merrill Lynch's Private Client group are
granted awards generally based upon their prior year's performance. Payment for
an award is contingent upon continued employment for a period of time and is
subject to forfeiture during that period. The award is generally payable ten
years from the date of grant in a fixed number of shares of 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 plus interest, is
paid in cash. Eligible participants may defer awards beyond the scheduled
payment date. Only shares of common stock held as treasury stock may be issued
under FACAAP.
At December 28, 2001, shares subject to outstanding awards totaled
50,102,357, while 28,915,344 shares were available for issuance through future
awards. The fair value of awards granted under FACAAP during 2001, 2000, and
1999 was $64.60, $41.55, and $35.72 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
2,947,100 at December 28, 2001. In 1995, IEPP was amended to reduce the
authorized shares to zero and prohibit the reuse of any surrendered shares. No
further offerings will be made under this plan.
MERRILL LYNCH INVESTMENT CERTIFICATE PROGRAM ("MLICP")
Under MLICP, eligible employees in Merrill Lynch's Private Client group are
issued investment certificates based on their performance. The certificates
mature ten years from the date issued and are payable in cash if certain
performance criteria are achieved and the employee is continuously employed for
the ten-year period, with certain exceptions. The certificates bear interest
commencing with the date on which the performance requirements are achieved. As
of year-end 2001 and 2000, $138 million and $473 million, respectively, were
accrued under this plan.
OTHER COMPENSATION ARRANGEMENTS
Merrill Lynch sponsors other deferred compensation plans in which eligible
employees, who meet certain minimum compensation and net worth levels, may
participate. Contributions to the plans are made on a tax-deferred basis by
participants. As directed by the employee, contributions are invested by Merrill
Lynch in mutual funds and other funds including company-sponsored investment
vehicles that qualify as employee securities companies. Deferred amounts indexed
to this investment option are augmented by "leverage" by Merrill Lynch on a
two-for-one basis. This leverage bears interest and is repaid with accrued
interest as the distributions are made to participants. The plans' investments
and the amounts accrued by Merrill Lynch under the plans are both included in
the Consolidated Balance Sheets. Plan investments totaled $1.8 billion and $1.1
billion, respectively, at December 28, 2001 and December 29, 2000. Accrued
liabilities at year-end 2001 and 2000 were $1.1 billion and $1.0 billion,
respectively. Certain Merrill Lynch employees, who manage the assets of certain
of these plan partnerships, participate in the profits of these entities.
Merrill Lynch also allows certain qualified high-net-worth employees to
invest in certain private equity investments in selected third-party funds.
PAGE 76
Merrill Lynch 2001 Annual Report
- --------------------------------------------------------------------------------
NOTE 15. INCOME TAXES
Income tax provisions (benefits) on earnings consisted of:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
U.S. federal
Current $ 950 $ 861 $ 816
Deferred (573) 41 (80)
U.S. state and local
Current 38 101 (23)
Deferred (103) 29 (42)
Non-U.S.
Current 404 574 617
Deferred (107) 132 31
----- ------- --------
Total $ 609 $ 1,738 $ 1,319
- --------------------------------------------------------------------------------
The corporate statutory U.S. federal 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:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
U.S. federal income tax at
statutory rate $ 482 $ 2,001 $ 1,472
U.S. state and local
income taxes, net (43) 85 (40)
Non-U.S. operations (130) (194) (80)
Tax-exempt interest (90) (62) (64)
Dividends received deduction (29) (37) (28)
Valuation allowance related to
net operating losses 334 - -
Other, net 85 (55) 59
----- ------- -------
Income tax expense $ 609 $ 1,738 $ 1,319
- --------------------------------------------------------------------------------
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:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Deferred tax assets
Deferred compensation $ 1,268 $ 1,078 $ 1,020
Valuation and other reserves 843 546 783
Employee benefits 124 187 185
Restructuring related 616 - -
Other 771 559 621
------- ------- -------
Gross deferred tax assets 3,622 2,370 2,609
Valuation allowances (375) (41) (82)
------- ------- -------
Total deferred tax assets 3,247 2,329 2,527
------- ------- -------
Deferred tax liabilities
Lease transactions 178 202 143
Employee benefits 90 81 74
Other 467 364 296
------- ------- -------
Total deferred tax liabilities 735 647 513
------- ------- -------
Net deferred tax assets $ 2,512 $ 1,682 $ 2,014
- --------------------------------------------------------------------------------
At December 28, 2001, Merrill Lynch had U.S. net operating loss
carryforwards of approximately $200 million and non-U.S. net operating loss
carryforwards of $1.3 billion. The U.S. amounts are primarily state
carryforwards expiring in various years after 2005 and the non-U.S. amounts are
primarily U.K. carryforwards expiring in various years after 2002.
The valuation allowance in 2001 increased due to non-deductible prior and
current year losses associated with the refocusing of the Japan Private Client
business in connection with the restructuring. Refer to Note 2 -- Other
Significant Events for additional information.
Income tax benefits of $790 million, $800 million, and $281 million were
allocated to stockholders' equity related to employee compensation transactions
for 2001, 2000, and 1999, respectively.
Earnings before income taxes included approximately $755 million, $2,293
million, and $1,447 million of earnings attributable to non-U.S. subsidiaries
for 2001, 2000, and 1999, respectively. Cumulative undistributed earnings of
non-U.S. subsidiaries were approximately $4.8 billion at December 28, 2001. 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. It is not practicable to determine the amount of additional
tax that may be payable in the event these earnings are repatriated.
- --------------------------------------------------------------------------------
NOTE 16. REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS
Certain U.S. and non-U.S. subsidiaries are subject to various securities,
banking, and insurance regulations and capital adequacy requirements promulgated
by the regulatory and exchange authorities of the countries in which they
operate. Merrill Lynch's principal regulated subsidiaries are discussed below.
SECURITIES REGULATION
MLPF&S, a U.S. registered broker-dealer and futures commission merchant, is
subject to the net capital requirements of Rule 15c3-1 under the Securities
Exchange Act of 1934 and capital requirements of the Commodities Futures Trading
Commission ("CFTC"). Under the alternative method permitted by Rule 15c3-1, the
minimum required net capital, as defined, shall not be less than 2% of aggregate
debit items ("ADI") arising from customer transactions. The CFTC also requires
that minimum net capital should not be less than 4% of segregated and secured
requirements. At December 28, 2001, MLPF&S's regulatory net capital of $2,521
million was approximately 14% of aggregate debit items, and its regulatory net
capital in excess of the minimum required was $2,171 million at 2% of ADI. At
December 28, 2001, MLPF&S's regulatory net capital of $2,521 million exceeded
the CFTC minimum requirement of $187 million by $2,334 million.
PAGE 77
Merrill Lynch 2001 Annual Report
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. At December 28,
2001, MLI's financial resources were $5,006 million, exceeding the minimum
requirement by $1,181 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 28,
2001, MLGSI's liquid capital of $1,318 million was 254% of its total market and
credit risk, and liquid capital in excess of the minimum required was $695
million.
BANKING REGULATION
Two subsidiaries of ML & Co., MLBUSA, and MLB&T are subject to certain minimum
aggregate capital requirements under applicable federal banking laws. Among
other things, Part 325 of the FDIC Regulations establishes levels of Risk-Based
Capital ("RBC") each institution must maintain and identifies the possible
actions the federal supervisory agency may take if a bank does not maintain
certain capital levels. RBC is defined as the ratios of (i) Tier I Capital or
Total Capital to (ii) average assets or risk-weighted assets. The following
table presents the actual capital ratios and amounts, for MLBUSA and MLB&T at
December 28, 2001 and December 29, 2000.
As shown below, MLBUSA and MLB&T each exceed the minimum bank regulatory
requirement for classification as a well-capitalized bank for Tier 1 leverage --
5%, Tier 1 capital -- 6% and Total capital -- 10%:
(dollars in millions)
- --------------------------------------------------------------------------------
2001 2000
------------------ ------------------
Actual Actual
Ratio Amount Ratio Amount
- --------------------------------------------------------------------------------
Tier 1 leverage
(to average assets)
MLBUSA 5.61% $ 3,576 7.29% $ 3,017
MLB&T 6.90 1,047 5.89 841
Tier 1 capital
(to risk-weighted assets)
MLBUSA 14.30 3,576 10.60 3,017
MLB&T 20.47 1,047 10.26 841
Total capital
(to risk-weighted assets)
MLBUSA 15.44 3,860 10.79 3,072
MLB&T 20.48 1,048 10.28 843
- --------------------------------------------------------------------------------
In April 2001, MLBUSA entered into a synthetic securitization of specified
reference portfolios of asset-backed securities ("ABS") owned by the institution
totaling in aggregate up to $20 billion. This synthetic securitization remained
effective as of December 28, 2001. In December 2000, MLBUSA and MLB&T each
entered into a synthetic securitization of specified reference portfolios of ABS
owned by each institution totaling in aggregate up to $20 billion. This
synthetic securitization was terminated on December 12, 2001. For both synthetic
securitizations, all of the ABS in the reference portfolios were rated AAA and
all were further insured as to principal and interest payments by an insurer
rated AAA. The synthetic securitizations allowed MLBUSA and MLB&T to reduce the
credit risk on the respective reference portfolios by means of credit default
swaps with a bankruptcy remote SPE. In turn, each of the SPEs issued a $20
million credit linked note ($40 million in total) to unaffiliated buyers. These
transactions resulted in reductions in MLBUSA's risk-weighted assets as of
December 28, 2001, and MLBUSA's and MLB&T's respective risk-weighted assets as
of December 29, 2000. MLBUSA retained a first risk of loss equity tranche of $1
million in each of these transactions.
As a result of the April 2001 transaction, MLBUSA was able to reduce
risk-weighted assets by $211 million at December 28, 2001, thereby increasing
its Tier I and Total RBC ratios by 12 basis points and 13 basis points,
respectively. As a result of the December 2000 transaction, MLBUSA was able to
reduce risk-weighted assets by $5,949 million at December 29, 2000, thereby
increasing its Tier 1 and Total RBC ratios by 183 and 186 basis points,
respectively; and MLB&T reduced risk-weighted assets by $2,815 million at
December 29, 2000, thereby increasing its Tier 1 and Total RBC ratios by 262 and
263 basis points, respectively. These structures did not result in a material
change in the distribution or concentration risk in the retained portfolio.
INSURANCE REGULATION
Merrill Lynch's insurance subsidiaries are subject to various regulatory
restrictions that limit the amount available for distribution as dividends. At
December 28, 2001, $562 million, representing 83% of the insurance subsidiaries'
net assets, was unavailable for distribution to Merrill Lynch.
OTHER
Approximately 60 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 28, 2001, restricted net assets of
these subsidiaries were $3.9 billion.
In addition, to satisfy rating agency standards, a credit intermediary
subsidiary of Merrill Lynch must also meet certain minimum capital requirements.
At December 28, 2001, this minimum capital requirement was $225 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 preferred stock and TOPrS/SM/, and (2) the governing provisions of the
Delaware General Corporation Law.
PAGE 78
Merrill Lynch 2001 Annual Report
SUPPLEMENTAL FINANCIAL INFORMATION
(UNAUDITED)
- --------------------------------------------------------------------------------
QUARTERLY INFORMATION
The unaudited quarterly results of operations of Merrill Lynch for 2001 and 2000
are prepared in conformity with U.S. generally accepted accounting principles
and reflect all adjustments 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. 28, Sept. 28, June 29, Mar. 30, Dec. 29, Sept. 29, June 30, Mar. 31,
2001 2001 2001 2001 2000 2000 2000 2000
- -------------------------------------------------------------------------------------------------------------------------------
Total Revenues $ 7,574 $ 8,929 $ 10,320 $ 11,934 $ 11,661 $ 10,848 $ 11,044 $ 11,299
Interest Expense 2,822 3,784 4,747 5,524 5,396 4,704 4,204 3,782
-------- ------- -------- -------- -------- -------- -------- --------
Net Revenues 4,752 5,145 5,573 6,410 6,265 6,144 6,840 7,517
Non-Interest Expenses 6,264 4,459 4,721 5,059 4,957 4,833 5,427 5,832
-------- ------- -------- -------- -------- -------- -------- --------
Earnings (Loss) Before Income Taxes
and Dividends on Preferred Securities
Issued by Subsidiaries (1,512) 686 852 1,351 1,308 1,311 1,413 1,685
Income Tax Expense (Benefit) (297) 216 262 428 382 378 443 535
Dividends on Preferred Securities
Issued by Subsidiaries 49 48 49 49 49 48 49 49
-------- ------- -------- -------- -------- -------- -------- --------
Net Earnings (Loss) $ (1,264) $ 422 $ 541 $ 874 $ 877 $ 885 $ 921 $ 1,101
======== ======= ======== ======== ======== ======== ======== ========
Earnings (Loss) Per Common Share:
Basic $ (1.51) $ 0.49 $ 0.63 $ 1.04 $ 1.07 $ 1.09 $ 1.15 $ 1.40
Diluted (1.51) 0.44 0.56 0.92 0.93 0.94 1.01 1.24
- --------------------------------------------------------------------------------
DIVIDENDS PER COMMON SHARE
(declared and paid)
- --------------------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- --------------------------------------------------------------------------------
2001 $ .16 $ .16 $ .16 $ .16
2000 .14 .15 .16 .16
- --------------------------------------------------------------------------------
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 TOPrS/SM/, and (b) the governing provisions of the
Delaware General Corporation Law. Certain subsidiaries' ability to declare
dividends may also be limited (see Note 16 to the Consolidated Financial
Statements).
- --------------------------------------------------------------------------------
STOCKHOLDER INFORMATION
Consolidated Transaction Reporting System prices for ML & Co. common stock 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
- -----------------------------------------------------------------------------------------------------------
2001 $ 80.00 $ 50.31 $ 71.50 $ 51.15 $ 59.85 $ 33.50 $ 54.65 $38.49
2000 57.59 36.31 61.16 42.25 74.63 56.81 73.50 54.75
- -----------------------------------------------------------------------------------------------------------
The approximate number of holders of record of ML & Co. common stock as of
February 26, 2002 was 13,965. As of February 26, 2002, the closing price of ML &
Co. common stock as reported on the Consolidated Transaction Reporting System
was $48.50.
PAGE 79