SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1994 ------------------ Commission File Number 1-7182 ------------- MERRILL LYNCH & CO., INC. - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 13-2740599 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) WORLD FINANCIAL CENTER, NORTH TOWER, NEW YORK, NEW YORK 10281-1332 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (212) 449-1000 - ------------------------------------------------------------------------------- Registrant's telephone number, including area code - ------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. - ------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 190,470,498 shares of Common Stock* (as of the close of business on November 4, 1994) * Does not include 6,816,714 unallocated shares held in the Employee Stock Ownership Plan that are not considered outstanding for accounting purposes. Part I. FINANCIAL INFORMATION ----------------------------- ITEM 1. Financial Statements -------------------- MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED EARNINGS (UNAUDITED)
FOR THE THREE MONTHS ENDED ---------------------------------- PERCENT SEPT. 30, SEPT. 24, INCREASE (In Thousands, Except Per Share Amounts) 1994 1993 (DECREASE) ------------- ------------- ---------- REVENUES Commissions............................. $ 673,551 $ 696,036 (3)% Interest and dividends.................. 2,438,760 1,765,784 38 Principal transactions.................. 653,691 740,539 (12) Investment banking...................... 245,489 452,165 (46) Asset management and portfolio service fees........................... 431,374 396,458 9 Other................................... 87,358 89,066 (2) ---------- ---------- ------- Total Revenues.......................... 4,530,223 4,140,048 9 Interest Expense...................... 2,227,978 1,506,428 48 ---------- ---------- ------- Net Revenues............................ 2,302,245 2,633,620 (13) ---------- ---------- ------- NON-INTEREST EXPENSES Compensation and benefits............... 1,179,031 1,296,829 (9) Occupancy............................... 106,366 116,862 (9) Communications and equipment rental..... 110,945 98,140 13 Depreciation and amortization........... 83,301 73,780 13 Advertising and market development...... 96,321 98,900 (3) Professional fees....................... 88,799 70,807 25 Brokerage, clearing, and exchange fees.. 82,690 68,283 21 Other................................... 165,270 167,720 (1) ---------- ---------- ------- Total Non-Interest Expenses............. 1,912,723 1,991,321 (4) ---------- ---------- ------- EARNINGS BEFORE INCOME TAXES............ 389,522 642,299 (39) Income tax expense...................... 157,943 282,612 (44) ---------- ---------- ------- NET EARNINGS............................ $ 231,579 $ 359,687 (36)% ========== ========== ======= NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS........................... $ 229,861 $ 358,416 ========== ========== EARNINGS PER COMMON SHARE: Primary............................... $ 1.10 $ 1.57 ========== ========== Fully diluted......................... $ 1.10 $ 1.56 ========== ========== DIVIDEND PAID PER COMMON SHARE.......... $ .23 $ .175 ========== ========== AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE: Primary............................... 209,030 228,380 ========== ========== Fully diluted......................... 209,030 229,619 ========== ==========
See Notes to Consolidated Financial Statements 2 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED EARNINGS (UNAUDITED)
FOR THE NINE MONTHS ENDED ------------------------------- PERCENT SEPT. 30, SEPT. 24, INCREASE (In Thousands, Except Per Share Amounts) 1994 1993 (DECREASE) ----------- ----------- ------------ REVENUES Commissions........................................... $ 2,232,328 $ 2,088,553 7% Interest and dividends................................ 6,955,987 5,056,186 38 Principal transactions................................ 1,881,235 2,245,392 (16) Investment banking.................................... 1,011,890 1,311,367 (23) Asset management and portfolio service fees......................................... 1,307,532 1,139,007 15 Other................................................. 360,362 221,536 63 ----------- ----------- -------- Total Revenues........................................ 13,749,334 12,062,041 14 Interest Expense.................................... 6,217,542 4,261,808 46 ----------- ----------- -------- Net Revenues.......................................... 7,531,792 7,800,233 (3) ----------- ----------- -------- NON-INTEREST EXPENSES Compensation and benefits............................. 3,825,998 3,840,423 - Occupancy............................................. 327,948 456,634 (28) Communications and equipment rental................... 322,391 286,052 13 Depreciation and amortization......................... 238,067 216,819 10 Advertising and market development.................... 294,071 271,203 8 Professional fees..................................... 270,101 197,831 37 Brokerage, clearing, and exchange fees................ 256,645 209,668 22 Other................................................. 522,179 494,075 6 ----------- ----------- -------- Total Non-Interest Expenses........................... 6,057,400 5,972,705 1 ----------- ----------- -------- EARNINGS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE................................. 1,474,392 1,827,528 (19) Income tax expense.................................... 619,245 780,408 (21) ----------- ----------- -------- EARNINGS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE....................... 855,147 1,047,120 (18) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (NET OF APPLICABLE INCOME TAXES OF $25,075).................. - (35,420) N/M ----------- ----------- -------- NET EARNINGS.......................................... $ 855,147 $ 1,011,700 (15)% =========== =========== ======== NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS......................................... $ 850,553 $ 1,007,755 =========== =========== PRIMARY EARNINGS PER COMMON SHARE: Earnings Before Cumulative Effect of Change in Accounting Principle.................. $ 3.98 $ 4.61 Cumulative Effect of Change in Accounting Principle............................... - (.16) ----------- ----------- NET EARNINGS.......................................... $ 3.98 $ 4.45 =========== =========== FULLY DILUTED EARNINGS PER COMMON SHARE: Earnings Before Cumulative Effect of Change in Accounting Principle.................. $ 3.97 $ 4.58 Cumulative Effect of Change in Accounting Principle............................... - (.16) ----------- ----------- NET EARNINGS.......................................... $ 3.97 $ 4.42 =========== =========== DIVIDENDS PAID PER COMMON SHARE....................... $ .66 $ .50 =========== =========== AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE: Primary............................................. 213,935 226,635 =========== =========== Fully diluted....................................... 214,050 228,144 =========== ===========
See Notes to Consolidated Financial Statements 3 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in Thousands, Except Per Share Amounts) SEPT. 30, DEC. 31, ASSETS 1994 1993 - -------------------------------------------------------------- ------------ ------------ CASH AND CASH EQUIVALENTS..................................... $ 2,350,480 $ 1,783,408 ------------ ------------ CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES OR DEPOSITED WITH CLEARING ORGANIZATIONS..................... 5,313,256 4,069,424 ------------ ------------ MARKETABLE INVESTMENT SECURITIES.............................. 2,146,744 1,749,254 ------------ ------------ TRADING INVENTORIES, AT FAIR VALUE Corporate debt, contractual agreements, and preferred stock.......................................... 25,560,618 16,764,084 Non-U.S. governments and agencies............................. 6,354,539 9,260,725 U.S. Government and agencies.................................. 6,538,910 7,287,081 Equities and convertible debentures........................... 7,110,871 6,806,539 Mortgages and mortgage-backed................................. 5,716,300 6,486,464 Money markets................................................. 1,595,807 3,337,839 Municipals.................................................... 978,842 1,606,097 ------------ ------------ Total......................................................... 53,855,887 51,548,829 ------------ ------------ RESALE AGREEMENTS............................................. 47,438,355 38,137,528 ------------ ------------ SECURITIES BORROWED........................................... 20,561,976 19,001,061 ------------ ------------ RECEIVABLES Customers (net of allowance for doubtful accounts of $47,110 in 1994 and $47,953 in 1993)......................... 13,252,840 13,242,875 Brokers and dealers........................................... 9,380,993 7,292,332 Interest and other............................................ 2,818,136 2,758,768 ------------ ------------ Total......................................................... 25,451,969 23,293,975 ------------ ------------ INVESTMENTS OF INSURANCE SUBSIDIARIES......................... 6,029,482 7,841,444 LOANS, NOTES, AND MORTGAGES (NET OF ALLOWANCE FOR LOAN LOSSES OF $201,001 IN 1994 AND $142,414 IN 1993)........ 1,595,448 2,083,553 OTHER INVESTMENTS............................................. 857,353 873,806 PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT (NET OF ACCUMULATED DEPRECIATION AND AMORTIZATION OF $1,829,552 IN 1994 AND $1,677,334 IN 1993)................ 1,556,655 1,506,964 OTHER ASSETS.................................................. 1,237,301 1,021,116 ------------ ------------ TOTAL ASSETS.................................................. $168,394,906 $152,910,362 ============ ============
See Notes to Consolidated Financial Statements 4 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in Thousands, Except Per Share Amounts) SEPT. 30, DEC. 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1994 1993 - ----------------------------------------------------------- ------------ ------------ LIABILITIES REPURCHASE AGREEMENTS...................................... $ 56,635,531 $ 56,418,148 ------------ ------------ COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS........... 24,260,981 23,214,329 ------------ ------------ COMMITMENTS FOR SECURITIES SOLD BUT NOT YET PURCHASED, AT FAIR VALUE U.S. Government and agencies............................... 16,220,950 12,183,271 Equities and convertible debentures........................ 5,135,063 3,953,850 Corporate debt, contractual agreements, and preferred stock....................................... 12,930,569 3,577,056 Non-U.S. governments and agencies.......................... 1,485,145 1,762,154 Municipals................................................. 193,430 184,041 ------------ ------------ Total...................................................... 35,965,157 21,660,372 ------------ ------------ CUSTOMERS.................................................. 10,520,822 13,571,379 INSURANCE.................................................. 5,823,306 7,405,673 BROKERS AND DEALERS........................................ 6,240,925 4,862,584 OTHER LIABILITIES AND ACCRUED INTEREST..................... 7,395,476 6,823,064 LONG-TERM BORROWINGS....................................... 15,847,957 13,468,900 ------------ ------------ TOTAL LIABILITIES.......................................... 162,690,155 147,424,449 ------------ ------------ STOCKHOLDERS' EQUITY PREFERRED STOCKHOLDERS' EQUITY Preferred stock, par value $1.00 per share (Liquidation preference $100,000 per share); authorized: 25,000,000 shares; issued: 1994 and 1993 - 3,000 shares; outstanding: 1994 and 1993 - 1,938 shares................ 193,800 193,800 ------------ ------------ COMMON STOCKHOLDERS' EQUITY Common stock, par value $1.33 1/3 per share; authorized: 500,000,000 shares; issued: 1994 and 1993 - 236,330,162 shares............... 315,105 315,105 Paid-in capital............................................ 1,211,125 1,156,367 Foreign currency translation adjustment.................... 4,466 (18,305) Net unrealized (losses) gains on investment securities available-for-sale (net of applicable income tax (benefit) expense of $(24,751) in 1994 and $12,493 in 1993)......................................... (45,409) 21,355 Retained earnings.......................................... 5,495,685 4,777,142 ------------ ------------ Subtotal............................................... 6,980,972 6,251,664 Less: Treasury stock, at cost: 1994 - 36,701,040 shares; 1993 - 23,408,139 shares............................ 1,203,212 695,788 Unallocated ESOP shares, at cost: 1994 - 6,816,714 shares; 1993 - 8,932,332 shares............................. 107,363 140,684 Employee stock transactions.............................. 159,446 123,079 ------------ ------------ TOTAL COMMON STOCKHOLDERS' EQUITY.......................... 5,510,951 5,292,113 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY................................. 5,704,751 5,485,913 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................. $168,394,906 $152,910,362 ============ ============ BOOK VALUE PER COMMON SHARE................................ $ 28.80 $ 26.17 ============ ============
See Notes to Consolidated Financial Statements 5 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED ---------------------------- (In Thousands) SEPT. 30, SEPT. 24, 1994 1993 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings.............................................. $ 855,147 $ 1,011,700 Noncash items included in earnings: Cumulative effect of change in accounting principle..... - 35,420 Depreciation and amortization........................... 238,067 216,819 Policyholder reserves................................... 275,000 408,469 Other................................................... 582,145 330,543 (Increase) decrease in operating assets: Trading inventories..................................... (2,307,058) (12,013,948) Cash and securities segregated for regulatory purposes or deposited with clearing organizations............... (1,243,832) 100,729 Securities borrowed..................................... (1,560,915) (3,765,484) Customers............................................... (47,985) (2,997,529) Maturities and sales of trading investment securities... 128,387 - Purchases of trading investment securities.............. (125,079) - Other................................................... (1,611,000) (7,769,183) Increase (decrease) in operating liabilities: Commitments for securities sold but not yet purchased... 14,304,785 5,303,761 Customers............................................... (3,050,557) 1,698,954 Insurance............................................... (1,673,863) (1,357,822) Other................................................... 1,839,959 6,982,091 ----------- ----------- CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES.......... 6,603,201 (11,815,480) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from (payments for): Maturities of available-for-sale securities............. 2,147,478 - Sales of available-for-sale securities.................. 1,031,715 - Purchases of available-for-sale securities.............. (1,771,271) - Maturities of held-to-maturity securities............... 1,211,609 - Purchases of held-to-maturity securities................ (1,590,946) - Maturities and sales of investments by insurance subsidiaries........................................... - 2,438,380 Purchases of investments by insurance subsidiaries...... - (1,573,895) Marketable investment securities........................ - (581,583) Other investments and other assets...................... (235,280) (31,765) Property, leasehold improvements, and equipment......... (287,758) (274,850) ----------- ----------- CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES.......... 505,547 (23,713) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments for): Repurchase agreements, net of resale agreements......... (9,083,444) 6,388,005 Commercial paper and other short-term borrowings........ 1,046,652 3,955,312 Issuance and resale of long-term borrowings............. 9,063,820 6,379,240 Settlement and repurchase of long-term borrowings....... (6,827,946) (4,262,303) Other common stock transactions......................... (604,154) (57,834) Dividends............................................... (136,604) (109,213) ----------- ----------- CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES.......... (6,541,676) 12,293,207 ----------- ----------- INCREASE IN CASH AND CASH EQUIVALENTS..................... 567,072 454,014 Cash and cash equivalents, beginning of year.............. 1,783,408 1,251,572 ----------- ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD.................. $ 2,350,480 $ 1,705,586 =========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Income taxes totaled $1,051,784 in 1994 and $796,974 in 1993. Interest totaled $6,138,752 in 1994 and $4,135,163 in 1993. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES: The decrease in unrealized gain on investment securities available-for-sale totaled $66,764. See Notes to Consolidated Financial Statements 6 MERRILL LYNCH & CO., INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1994 BASIS OF PRESENTATION The consolidated financial statements, prepared in accordance with generally accepted accounting principles, include the accounts of Merrill Lynch & Co., Inc. and its subsidiaries (collectively referred to as the "Corporation"). All material intercompany balances and transactions have been eliminated. The December 31, 1993 consolidated balance sheet was derived from the audited financial statements. The interim consolidated financial statements for the three- and nine-month periods are unaudited; however, in the opinion of the management of the Corporation, all adjustments necessary for a fair statement of the results of operations have been included. The adjustments consist of normal recurring accruals and a non-recurring pretax lease charge of $103.0 million ($59.7 million after income taxes) previously reported in the 1993 first quarter. These unaudited financial statements should be read in conjunction with the audited financial statements included in the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993. The nature of the Corporation's business is such that the results of any interim period are not necessarily indicative of results for a full year. Prior period financial statements have been restated (see Note on Accounting Changes) and reclassified, where appropriate, to conform to the 1994 presentation. ACCOUNTING CHANGES On January 1, 1994, the Corporation adopted Financial Accounting Standards Board Interpretation No. 39 ("Interpretation No. 39"), "Offsetting of Amounts Related to Certain Contracts". Interpretation No. 39 affects the financial statement presentation of balances related to swap, forward, and other similar exchange or conditional type contracts, and unconditional type contracts. The Corporation is generally required to report separately on the balance sheet unrealized gains as assets, and unrealized losses as liabilities. For exchange or conditional contracts, netting is permitted only when a legal right of setoff exists with the same counterparty under a master netting arrangement. For unconditional contracts, such as resale and repurchase agreements, net cash settlement of the related receivable and payable balances is also required. Prior to the adoption of Interpretation No. 39, the Corporation followed industry practice in reporting balances related to certain types of contracts on a net basis. Unrealized gains and losses for swap, forward, and other similar contracts were reported net on the balance sheet by contract type, while certain receivables and payables related to resale and repurchase agreements were reported net by counterparty. At September 30, 1994, assets and liabilities increased approximately $12.0 billion for the effect of Interpretation No. 39. 7 The Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Postemployment Benefits", effective as of the 1993 first quarter. The cumulative effect of this change in accounting principle, reported in the 1993 Statement of Consolidated Earnings, resulted in a charge (net of applicable income tax benefit) of $35.4 million. The 1993 year-to-date Statement of Consolidated Earnings has been restated to reflect the impact of this pronouncement. INVESTMENTS On December 31, 1993, the Corporation adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 requires certain subsidiaries of the Corporation, principally insurance and banking, to classify their investments in debt and qualifying equity securities into three categories: "trading", "available-for-sale", or "held-to-maturity". Investments that are classified as trading and available-for-sale are recorded at fair value. Investments in debt securities classified as held-to-maturity continue to be carried at amortized cost. Other investments, including restricted equity securities, are excluded from the provisions of SFAS No. 115 and are classified as non-qualifying investments. Restricted equity investment securities are reported at the lower of cost or net realizable value. The Corporation has several broad categories of investments on its Consolidated Balance Sheets, including investments of insurance subsidiaries, marketable investment securities, and other investments. A reconciliation of the Corporation's investment securities to those reported in the Consolidated Balance Sheets is presented below:
Sept. 30, Dec. 31, (In thousands) 1994 1993 - -------------- ---------- ---------- Investments of insurance subsidiaries: Available-for-sale $4,380,956 $6,088,443 Trading 153,217 164,620 Non-qualifying 1,495,309 1,588,381 ---------- ---------- Total $6,029,482 $7,841,444 ========== ========== Marketable investment securities: Available-for-sale $ 518,632 $ 471,862 Held-to-maturity 1,628,112 1,277,392 ---------- ---------- Total $2,146,744 $1,749,254 ========== ========== Other investments: Available-for-sale $ 93,795 $ 151,801 Held-to-maturity 16,559 16,635 Non-qualifying 746,999 705,370 ---------- ---------- Total $ 857,353 $ 873,806 ========== ==========
For registrants subject to the information reporting requirements of the Securities Exchange Act of 1934, there are additional requirements under SFAS No. 115. The Corporation's insurance subsidiaries are required to adjust deferred acquisition costs and certain policyholder liabilities associated with investments classified as available-for-sale. These investments are primarily in-force, universal life-type contracts under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of 8 Investments". Adjustments to these investments are recorded in stockholders' equity and assume that the unrealized gain or loss on available-for-sale securities was realized. The table that follows provides the components of the net unrealized (loss) gain recorded in stockholders' equity for available-for-sale investments:
Sept. 30, Dec. 31, (In thousands) 1994 1993 - -------------- ---------- ---------- Net unrealized (losses) gains on investment securities available-for-sale $(335,431) $ 254,030 Adjustments for: Policyholder liabilities 183,504 (205,495) Deferred policy acquisition costs 47,919 (14,687) Deferred income taxes 37,244 (12,493) --------- --------- Net activity for the period (66,764) 21,355 Net unrealized gains on investment securities classified as available-for-sale, beginning of year 21,355 - --------- --------- Net unrealized (losses) gains on investment securities classified as available-for-sale, end of period $ (45,409) $ 21,355 ========= =========
In the 1994 third quarter, gross realized gains and losses related to available-for-sale investment securities were $14.0 million and $6.6 million, respectively. For the nine-month period ended September 30, 1994, gross realized gains and losses related to available-for-sale investment securities were $20.0 million and $14.3 million, respectively. The cost basis of each investment sold is specifically identified for purposes of computing realized gains and losses. Net unrealized gains and losses from trading investment securities included in the 1994 three- and nine-month Statements of Consolidated Earnings were gains of $2.4 million and losses of $9.1 million, respectively. INTEREST AND DIVIDEND EXPENSE Interest expense includes payments in lieu of dividends of $4.8 million and $5.9 million for the third quarters of 1994 and 1993, respectively. For the nine-month periods ended September 30, 1994 and September 24, 1993, payments in lieu of dividends were $19.5 million and $15.2 million, respectively. COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS Commercial paper and other short-term borrowings at September 30, 1994 and December 31, 1993 follow:
Sept. 30, Dec. 31, (In millions) 1994 1993 - ------------- --------- -------- Commercial paper $13,600 $14,896 Demand and time deposits 7,086 5,946 Securities loaned 2,128 1,047 Bank loans and other 1,447 1,325 ------- ------- Total $24,261 $23,214 ======= =======
9 COMMITMENTS The Corporation enters into certain contractual agreements, referred to as "derivatives" or off-balance-sheet financial instruments, involving futures, forwards (including mortgage-backed securities requiring forward settlement), options, and swap transactions, including swap options, caps, collars, and floors. The Corporation uses derivatives in conjunction with on-balance-sheet financial instruments to facilitate customer transactions, manage its own interest rate, currency, and market risk, and to meet trading and financing needs. Derivative contracts often involve future commitments to swap interest payment streams, to purchase or sell other financial instruments at specified terms on a specified date, or to exchange currencies. In addition, the Corporation writes options on a wide range of financial instruments such as securities, currencies, futures, and various market indices. The contractual or notional amounts of these instruments are set forth below:
Sept. 30, Dec. 31, (In billions) 1994 1993 - ------------- --------- -------- Forward contracts $137 $154 Futures contracts 404 105 Swap agreements 800 560 Options written 107 72
In the normal course of business, the Corporation obtains letters of credit to satisfy various collateral requirements in lieu of the Corporation depositing securities or cash. At September 30, 1994, letters of credit aggregating $1,467 million were used for this purpose. In the normal course of business, the Corporation also enters into underwriting commitments, when-issued transactions, and commitments to extend credit. Settlement of these commitments as of September 30, 1994 would not have a material effect on the consolidated financial condition of the Corporation. REGULATORY REQUIREMENTS Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a broker-dealer and a subsidiary of the Corporation, is subject to the Securities and Exchange Commission's Net Capital Rule. Under the alternative method permitted by this rule, the minimum required net capital, as defined, shall not be less than 2% of aggregate debit balances arising from customer transactions. At September 30, 1994, MLPF&S's regulatory net capital of $1,387 million was 11% of aggregate debit balances, and its regulatory net capital in excess of the minimum required was $1,144 million. Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S. Government securities and a subsidiary of the Corporation, is subject to the Capital Adequacy Rule required by the Government Securities Act of 10 1986. This rule requires dealers to maintain liquid capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At September 30, 1994, MLGSI's liquid capital of $918 million was 247% of its total market and credit risk, and liquid capital in excess of the minimum required was $471 million. Merrill Lynch International Limited ("MLIL"), a United Kingdom registered broker-dealer and a subsidiary of the Corporation, is subject to capital requirements of the Securities and Futures Authority ("SFA"). Regulatory capital, as defined, must exceed the financial resources requirement of the SFA. At September 30, 1994, MLIL's regulatory capital was $1,518 million, and exceeded the minimum requirement by $362 million. SUBSEQUENT EVENT The Corporation is authorized to issue 25 million shares of undesignated preferred stock, par value $1.00 per share. The Corporation's Board of Directors (the "Board") delegated to the Executive Committee of the Board the authority to authorize the issuance, from time to time, of up to 100,000 shares of previously undesignated preferred stock (having an aggregate liquidation preference not to exceed $600 million) in one or more offerings. Subsequent to quarter-end, the Corporation completed the public offering of 17 million Depositary Shares, each representing a one-four hundredth interest in a share of 9% Cumulative Preferred Stock, Series A, $10,000 liquidation preference 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. At the time of issuance, this series was rated A by Duff & Phelps Credit Rating Co., A+ by Fitch Investors Services, Inc., A by IBCA Ltd., "a1" by Moody's Investors Service, Inc., and A- by Standard & Poor's Ratings Group. Dividends on the 9% Preferred Stock are cumulative from the date of original issue and are payable quarterly. The 9% Preferred Stock is not redeemable prior to December 30, 2004 and, on or after that date, will be redeemable at the option of the Corporation in whole or, from time to time, in part. The Corporation intends to use the net proceeds from the sale of the Depositary Shares for general corporate purposes. 11 INDEPENDENT ACCOUNTANTS' REPORT - ------------------------------- To the Board of Directors and Stockholders of Merrill Lynch & Co., Inc.: We have reviewed the accompanying condensed consolidated balance sheet of Merrill Lynch & Co., Inc. and subsidiaries as of September 30, 1994, and the related condensed statements of consolidated earnings for the three- and nine-month periods ended September 30, 1994 and September 24, 1993 and consolidated cash flows for the nine-month periods ended September 30, 1994 and September 24, 1993. These financial statements are the responsibility of the management of Merrill Lynch & Co., Inc. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Merrill Lynch & Co., Inc. and subsidiaries as of December 31, 1993, and the related statements of consolidated earnings, changes in consolidated stockholders' equity and consolidated cash flows for the year then ended (not presented herein); and in our report dated February 28, 1994, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balanced sheet as of December 31, 1993 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. As discussed in the note to the condensed consolidated financial statements entitled, "Accounting Changes", in 1993 the Corporation and its subsidiaries changed their method of accounting for postemployment benefits to conform with Statement of Financial Accounting Standards No. 112. /s/ Deloitte & Touche LLP November 10, 1994 New York, New York 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- Merrill Lynch & Co., Inc. and its subsidiaries (collectively referred to as the "Corporation") conduct their businesses in global financial markets that are influenced by a number of factors including economic and market conditions, political events, and investor sentiment. The reaction of issuers and investors to a particular condition or event is unpredictable and can create volatility in the marketplace. While higher volatility can increase risk, it may also increase order flow, which drives many of the Corporation's businesses. Other global market and economic conditions, including the liquidity of secondary markets, the level and volatility of interest rates, currency and security valuations, competitive conditions, and the size, number, and timing of transactions may also affect earnings. As a result, revenues and net earnings can vary significantly from year to year, and from quarter to quarter. Financial markets, strong throughout 1993 and the first six weeks of 1994, weakened during the remainder of the nine-month period ended September 30, 1994, with lower volumes affecting most revenue categories. Rising U.S. interest rates, a weak U.S. dollar, and unsettled global stock, bond, and currency markets continued to dampen investor and issuer activity in the 1994 third quarter. Underwriting volume in the 1994 third quarter declined industry-wide to the lowest level since the 1991 first quarter. Domestic equity issuances decreased from the 1993 third quarter, including a 47% industry-wide decline in volume for initial public stock offerings, principally as a result of reduced demand. Higher interest rates continued to reduce debt issuances, particularly refinancings, leading to a 50% decrease industry-wide in underwriting of domestic debt from last year's third quarter. Strategic services revenues benefited from increased merger and acquisition activity in the telecommunication, entertainment, financial services, and transportation industries. Trading results in equity and interest-sensitive products were generally lower industry-wide. Equity trading was primarily affected by lower revenues from convertible securities and reduced demand for over-the-counter issues. Continued uncertainty in world currency markets reduced foreign exchange trading. Revenues from municipal securities increased due to more attractive tax-exempt yields, while revenues from swaps and other derivatives remained at relatively strong levels. Stock market activity, as measured by New York Stock Exchange ("NYSE") average daily trading volume, was 274 million shares in the 1994 third quarter. Third quarter trading volume was slightly above the 1994 second quarter average of 273 million shares and 9% higher than the 1993 third quarter average of 252 million shares. Fee-based revenues benefited from continued growth in assets under management. The Dow Jones Industrial Average ("DJIA") daily closing index for the 1994 third quarter averaged 3,802, 4% above the 1994 second quarter average closing index and 6% above the 1993 third quarter average close. In the bond market, the price of the 30-year U.S. Treasury bond continued to decline, with the yield rising to 7.82% at the end of the 1994 third 13 quarter, compared with 7.61% at the end of the 1994 second quarter and 6.03% at the end of the 1993 third quarter. The Corporation's 1994 third quarter net earnings were 8% below net earnings for the 1994 second quarter and 36% below the record net earnings for the 1993 third quarter. Although profitability declined during the 1994 third quarter, a diversified revenue base, strong market positions across numerous product lines, and appropriate cost and risk management reduced the effect of difficult financial markets on the Corporation's operating results. THIRD QUARTER 1994 VERSUS THIRD QUARTER 1993 AND NINE MONTHS 1994 VERSUS NINE MONTHS 1993 The discussion that follows emphasizes the comparison between the third quarters of 1994 and 1993, with additional information on the nine-month periods presented where appropriate. Net earnings for the 1994 third quarter were $231.6 million, down $128.1 million (36%) from the $359.7 million reported in last year's record third quarter. Third quarter earnings per common share were $1.10 primary and fully diluted, compared with $1.57 primary and $1.56 fully diluted in the 1993 third quarter. After deducting preferred stock dividends, net earnings applicable to common stockholders in the 1994 third quarter totaled $229.9 million, down $128.5 million (36%) from $358.4 million in the prior year's quarter. The Corporation repurchased 4.1 million shares of its common stock in the 1994 third quarter compared with 2.6 million shares in the 1993 third quarter. The Corporation's pretax profit margin in the 1994 third quarter was 16.9% versus 24.4% in the year-ago period. The net profit margin decreased to 10.1% in the 1994 third quarter compared with 13.7% in the 1993 third quarter. Total revenues increased 9% from the 1993 third quarter to $4,530 million, while revenues after interest expense (net revenues), declined 13% from the year-ago period to $2,302 million. Non-interest expenses totaled $1,913 million in the 1994 third quarter, down 4% from the year-earlier period. For the first nine months of 1994, net earnings were $855.1 million, down 15% ($156.6 million) from the record $1,011.7 million reported in last year's comparable nine-month period. Net earnings for the 1993 period included a $35.4 million cumulative effect charge (net of $25.1 million of applicable income tax benefits) related to the adoption of Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Postemployment Benefits". Earnings before the cumulative effect of the change in accounting principle decreased 18% from the $1,047.1 million reported in the corresponding 1993 period. Earnings per common share for the first nine months of 1994 were $3.98 primary and $3.97 fully diluted versus $4.45 primary and $4.42 fully diluted ($4.61 primary and $4.58 fully diluted, excluding the 1993 cumulative effect adjustment) in the prior year's period. The Corporation's weighted average common shares decreased during the first nine months of 1994 as 17.4 million shares of common stock were repurchased, compared with 7.2 million shares in the corresponding 1993 period. 14 Net earnings applicable to common stockholders were $850.6 million, down $157.2 million (16%) from the $1,007.8 million ($1,043.2 million before the 1993 cumulative effect adjustment) reported in the 1993 nine-month period. The Corporation's 1994 year-to-date pretax profit margin was 19.6% compared with 23.4% in the corresponding 1993 period. The net profit margin decreased to 11.4% from 13.0% (13.4% before the 1993 cumulative effect adjustment) in the 1993 nine-month period. Net revenues decreased 3% in the first nine months of 1994 to $7,532 million. Total revenues increased 14% to $13,749 million, while non-interest expenses rose 1% from the 1993 nine-month period to $6,057 million. As previously reported, 1993 nine-month results included a non-recurring pretax lease charge totaling $103.0 million ($59.7 million after income taxes) related to the Corporation's decision not to occupy certain office space at its World Financial Center Headquarters ("Headquarters") facility. An agreement to sublet this space was entered into in the 1993 fourth quarter. Commission revenues decreased 3% from the 1993 third quarter to $674 million. Commissions from listed securities decreased 5% to $316 million reflecting a change in the mix of transactions between institutional and retail clients. Mutual fund commissions rose 2% from the year-ago quarter to $217 million, benefiting from increased distribution fees and redemption fees earned on mutual funds sold in prior periods. Other commissions revenues declined 6% from the 1993 third quarter to $141 million due primarily to lower commissions from money market instruments. Commission revenues increased 7% from the 1993 nine-month period to $2,232 million, principally on the strength of higher commissions from mutual funds managed by the Corporation. Interest and dividend revenues advanced 38% over the year-ago third quarter period to $2,439 million due to increases in interest rates, higher levels of fixed-income inventories, and increases in collateralized lending activities. Interest expense, which includes dividend expense, rose 48% to $2,228 million as a result of higher interest rates and increased levels of interest-bearing liabilities primarily related to the Corporation's funding and hedging activities. Net interest profit declined 19% to $211 million as a result of a significant increase in short-term interest rates, quarter over quarter, and the continued flattening of the yield curve - the difference between short-term and long-term interest rates. The one-year U.S. Treasury bill rate, for example, increased from 3.34% at September 24, 1993 to 5.94% at September 30, 1994, while the 30-year U.S. Treasury bond yield increased from 6.03% to 7.82% during the same period. As a result, interest spreads declined, while financing and hedging costs increased from the 1993 third quarter. 15 The significant components of interest and dividend revenues and interest expense for the quarter and year-to-date periods follow:
Three Months Ended Nine Months Ended --------------------- --------------------- (In millions) Sept. 30, Sept. 24, Sept. 30, Sept. 24, - ------------- 1994 1993 1994 1993 --------- --------- --------- --------- Interest and dividend revenues: Trading inventories $ 881 $ 583 $2,620 $1,708 Resale agreements 494 276 1,205 861 Securities borrowed 532 440 1,635 1,049 Margin lending 268 188 721 562 Other 264 278 775 876 ------ ------ ------ ------ Total 2,439 1,765 6,956 5,056 ------ ------ ------ ------ Interest expense: Borrowings 827 693 2,429 1,784 Repurchase agreements 658 319 1,675 957 Commitments for securities sold but not yet purchased 547 291 1,505 847 Other 196 203 609 674 ------ ------ ------ ------ Total 2,228 1,506 6,218 4,262 ------ ------ ------ ------ Net interest and dividend profit $ 211 $ 259 $ 738 $ 794 ====== ====== ====== ======
Included in the "Borrowings" caption above is interest related to hedges on the Corporation's long-term borrowings. As part of the Corporation's asset and liability management strategy, substantially all fixed-rate, long-term borrowings are swapped into floating interest rates, while virtually all foreign currency denominated fixed-rate obligations are swapped into U.S. dollar floating-rate liabilities. These liability hedges are usually in the form of interest rate and currency swap agreements. Interest obligations on variable-rate debt may also be effectively modified through swap agreements that change the underlying interest rate basis or reset frequency. Contractual agreements used to modify payment obligations, principally related to long-term borrowings, reduced interest expense for the three- and nine-month periods ended September 30, 1994 by $40 million and $156 million, respectively, and $82 million and $243 million, respectively, for the comparable 1993 periods. Principal transactions revenues declined 12% from the prior year period to $654 million due to the negative effects of rising U.S. interest rates, volatility in world currency markets, and reduced demand for certain equity products. Fixed-income and foreign exchange trading revenues, in the aggregate, decreased 5% to $528 million. Fixed-income trading was virtually unchanged from a year-ago, with higher revenues from municipal securities and swaps and derivatives offset by lower revenues from corporate bonds and preferred stock, and non-U.S. governments and agencies securities. Trading results in mortgage-backed products improved from the 1993 third quarter despite difficult market conditions in the mortgage-backed securities market. Municipal securities revenues advanced 43% to $99 million due to strong retail investor demand for tax-exempt investments. Swaps and derivatives revenues, which represented 39% of total principal transactions revenues in the 1994 third quarter and 37% for the first nine months of 1994, benefited from increased volume, primarily in dollar swaps. Revenues from corporate bonds and preferred stock, and non-U.S. governments and agencies securities were down primarily as a result of lower volume and rising interest rates. Foreign exchange trading revenues decreased due to weakness in the U.S. dollar versus other major currencies. 16 Equity and commodities trading revenues, in the aggregate, decreased 31% to $126 million due primarily to lower trading revenues in foreign equities, principally warrants, and a modest loss in convertible securities. For the first nine months of 1994, fixed-income and foreign exchange trading revenues, in the aggregate, decreased 16% to $1,432 million. Lower revenues from corporate bonds and preferred stock, non-U.S. governments and agencies securities, and money market instruments were partially offset by higher revenues from swaps and derivatives, municipal securities, mortgage-backed securities, and U.S. Government and agencies securities. Equity and commodities trading revenues, in the aggregate, decreased 16% to $449 million for the 1994 year-to-date period. Contributing to this decline was a loss from convertible securities, partially offset by higher revenues from foreign equities and commodities trading. Trading, hedging, and financing activities affect the recognition of both principal transactions revenues and net interest and dividend profit. In assessing the profitability of financial instruments, the Corporation views net interest and principal transactions components in the aggregate. For financial reporting purposes, however, realized and unrealized gains and losses on trading positions, including hedges, are recorded in principal transactions revenues. The net interest carry (i.e., the spread representing interest earned versus financing costs on financial instruments) for trading positions, including hedges, is recorded either as principal transactions revenues or net interest profit, depending on the nature of the specific position. Interest income or expense on a U.S. Treasury security, for example, is reflected in net interest, while any realized or unrealized gain or loss is included in principal transactions. Financial instruments requiring forward settlement, such as mortgage-backed "to be announced" mortgage pools, have interest components built into their market value; any change in the market value, however, is recorded in principal transactions revenues. Changes in the composition of trading inventories and hedge positions can cause the recognition of revenues within these categories to fluctuate. Consequently, net interest and principal transactions revenue components should be evaluated collectively. 17 The table that follows provides information on aggregate trading profits, including net interest for the three- and nine-months ended September 30, 1994 and September 24, 1993, respectively. Principal transactions revenues are derived from external reporting categories. Interest revenue and expense components are based on external reporting categories and management's assessment of the cost to finance trading positions, which considers the underlying liquidity of these positions.
Principal Net Interest Net (In millions) Transactions Revenue Trading - ------------- Revenues (Expense) Revenue ----------------- ---------------- ------------------ 1994 1993 1994 1993 1994 1993 Three Months - ------------ Fixed-income and foreign exchange $ 276 $ 331 $ 62 $ 92 $ 338 $ 423 Swaps and derivatives (1) 252 227 (39) (9) 213 218 ------ ------ ------ ------ ------ ------ Sub-total 528 558 23 83 551 641 Equities and commodities 126 183 (3) (4) 123 179 ------ ------ ------ ------ ------ ------ Total $ 654 $ 741 $ 20 $ 79 $ 674 $ 820 ====== ====== ====== ====== ====== ====== Nine Months - ----------- Fixed-income and foreign exchange $ 727 $1,131 $ 281 $ 303 $1,008 $1,434 Swaps and derivatives (1) 705 577 (77) 19 628 596 ------ ------ ------ ------ ------ ------ Sub-total 1,432 1,708 204 322 1,636 2,030 Equities and commodities 449 537 (3) (8) 446 529 ------ ------ ------ ------ ------ ------ Total $1,881 $2,245 $ 201 $ 314 $2,082 $2,559 ====== ====== ====== ====== ====== ======
(1) Swaps and derivatives revenues represent transactions recorded by the Corporation's primary subsidiaries dealing in derivatives. Investment banking revenues were $245 million, down 46% from the third quarter of 1993. Underwriting activity slowed as industry-wide volume in the 1994 third quarter declined to first quarter 1991 levels. Higher interest rates continued to decrease debt issuance, particularly refinancings. Equity issuances, especially initial public stock offerings, were affected by reduced demand and investor caution. As a result, underwriting revenues decreased 54% to $185 million. Lower revenues were reported in most categories, including equities, and corporate debt and preferred stock. Partially offsetting these declines were higher revenues from asset-backed securities and private placements. Despite a 51% decline in domestic underwriting volume and a 43% decrease in global underwriting volume from the 1993 third quarter, the Corporation remained the top underwriter of total debt and equity securities in the 1994 third quarter with a market share of 17.2% domestically and 13.2% worldwide, according to Securities Data Co. For the year-to-date period, the Corporation's market share of total debt and equity securities was 16.7% domestically and 13.3% worldwide. Strategic services revenues rose 32% from the 1993 third quarter to $60 million, benefiting from increased merger and acquisition advisory assignments in various industries, including entertainment and real estate. Asset management and portfolio service fees advanced 9% from the 1993 third quarter to $431 million. Fees earned from asset management activities, transfer agency fees, and other fee-based services contributed to the advance. Asset management fees increased 10% to $201 million due primarily 18 to growth in sales of stock funds. Assets under management by Merrill Lynch Asset Management ("MLAM") rose 8% to $167 billion at quarter-end, compared with $155 billion at the close of the 1993 third quarter. Included in MLAM managed assets are stock and bond funds which grew by 15% from the end of the 1993 third quarter to $76 billion at the comparable 1994 quarter-end. Assets under management by MLAM increased 4% in the 1994 third quarter from $161 billion at the end of the 1994 second quarter. Inflows of client assets and higher portfolio values contributed to the advance during the quarter. Asset levels in money market and equity funds increased during the 1994 third quarter, while assets invested in bond funds decreased during the same period. Revenues from Merrill Lynch Consults(Registered Trademark) ("ML Consults") declined 5% from the 1993 third quarter to $74 million as the number of accounts decreased 4% to 82,800 at quarter-end. Asset levels for ML Consults were $15.5 billion, down 6% from the 1993 third quarter and up 1% from the 1994 second quarter. Fees earned on the ML Consults product are based on a percentage of assets under management. Weak market conditions, including volatility in stock and bond markets, have contributed to a decline in the number of accounts. Other fee-based revenues rose 15% to $156 million on the strength of higher transfer agency, Asset Power(Registered Trademark), and insurance fees. Other revenues were $87 million, down 2% from $89 million reported in the 1993 third quarter. For the 1994 nine-month period, other revenues rose 63% to $360 million due to $53 million of net realized investment gains in the 1994 period, compared with $107 million of net investment losses in the comparable 1993 period. Non-interest expenses were $1,913 million, down 4% from the 1993 third quarter. Compensation and benefits expense decreased 9% from the 1993 third quarter to $1,179 million as lower incentive and production-related compensation was partially offset by increases in base salaries. Incentive compensation decreased with lower profitability, while production-related compensation was down due to volume declines in certain businesses. The advance in base salaries is primarily attributable to a 6% increase in personnel from last year's third quarter. The majority of these hirings occurred during the last quarter of 1993 and the first quarter of 1994. Compensation and benefits expense as a percentage of net revenues was 51.2% compared with 49.2% in the year-ago period. Occupancy costs decreased 9% from the 1993 third quarter to $106 million, benefiting from continued relocation of support staff to lower cost facilities and reduced space requirements at the Headquarters facility. Communications and equipment rental expenses increased 13% to $111 million due primarily to increased usage of market data, news, and statistical services. Depreciation and amortization expense rose 13% over the 1993 third quarter to $83 million due to the purchase of technology-related equipment. Advertising and market development expenses decreased 3% to $96 million as lower sales promotion and recognition costs were partially offset by increased travel costs related to international business activity. Professional fees increased 25% to $89 million. Systems and management consultants continue to be used to upgrade technology and processing 19 capabilities in trading, credit, and customer systems. Brokerage, clearing, and exchange fees advanced 21% to $83 million. Increased clearinghouse fees related to higher levels of risk management activities and higher international equity volume contributed to this advance. Other expenses totaled $165 million, down 1% from the 1993 third quarter. Income tax expense totaled $158 million in the 1994 third quarter. The effective tax rate in the 1994 third quarter was 40.5%, compared with 44.0% in the year-ago period. The 1993 third quarter effective tax rate was affected by a 2 percentage point cumulative, retroactive adjustment for Federal tax legislation enacted in August 1993. For the first nine months of 1994, non-interest expenses rose 1% to $6,057 million (3% excluding the non-recurring pretax lease charge of $103.0 million). Trends in all expense categories are similar to those of the third quarter comparisons unless otherwise noted. Compensation and benefits expense, which represented 63% of non-interest expenses, was virtually unchanged from the 1993 nine-month period. Higher base wages and benefits expense related to the increase in the number of full-time employees was offset by lower levels of variable compensation. Occupancy costs decreased 7% (28% including the $103.0 million non-recurring lease charge). Other facilities-related costs, which include communications and equipment rental expense and depreciation and amortization expense, increased 11%. Advertising and market development expenses rose 8% from the 1993 nine-month period as a result of increased travel costs related to international business activity and higher recognition program costs. These expenses were partially offset by a reduction in advertising costs. Professional fees were up 37% from the year-ago period due primarily to increased systems consulting fees related to technology improvements. Brokerage, clearing, and exchange fees were up 22% from the prior-year period. Other expenses increased 6% due, in part, to increased provisions related to various business activities. The effective tax rate for the 1994 nine-month period was 42.0% versus 42.7% in the comparable 1993 period. LIQUIDITY AND LIABILITY MANAGEMENT The primary objective of the Corporation's funding policies is to assure liquidity at all times. To strengthen liquidity, the Corporation maintains a strong capital base, issues term debt, obtains committed backup credit facilities, concentrates debt issuance through Merrill Lynch & Co., Inc. (the "Parent"), and pursues expansion and diversification of investors, funding instruments, and creditors. There are three key elements to the Corporation's liquidity strategy. The first is to maintain alternative funding sources such that all debt obligations maturing within one year, including commercial paper and the current portion of term debt, can be funded when due without issuing new unsecured debt or liquidating any business assets. The most significant 20 alternative funding sources are the proceeds from executing repurchase agreements ("repos") and obtaining secured bank loans, both principally employing unencumbered investment-grade marketable securities. The calculation of proceeds available from repos and secured bank loans takes into account both a conservative estimate of excess collateral required by secured lenders, and regulatory restrictions on upstreaming cash from subsidiaries to the Parent. The ability to execute this secured funding is demonstrated by the Corporation's routine use of repo markets to finance inventory and by periodic tests of secured borrowing procedures with banks. Other alternative funding sources could include liquidating cash equivalents, securitizing additional home equity and PrimeFirst(Registered Trademark) loans, and drawing upon committed, unsecured credit facilities. At September 30, 1994, committed, unsecured revolving credit facilities totaled $5.0 billion. These facilities have not been drawn upon. As an additional measure, the Corporation regularly reviews its assets and liabilities to ascertain its ability to conduct core businesses without reliance on issuing new unsecured debt or drawing upon committed credit facilities for terms beyond one year. The composition of the Corporation's asset mix provides a great degree of flexibility in managing liquidity. The Corporation's liquidity position is enhanced since most of the Corporation's assets turn over frequently or are match-funded with a liability whose cash flow characteristics closely match those of the asset. At September 30, 1994, approximately 3% of the Corporation's assets, principally certain other investments, and fixed and other assets, were considered not readily marketable by management. The Corporation monitors the liquidity of assets, the quality of committed credit facilities, and the overall level of equity and term debt in assessing financial strength and capital adequacy at any point in time. The second element of the Corporation's liquidity strategy is to concentrate all general purpose borrowing at the Parent level, except where tax regulations or time differences make this impractical. The benefits of this guideline are: a) the lower financing costs that result from the reduced risks of a diversified asset and business base; b) the simplicity, control, and wider name recognition for banks, creditors, and rating agencies; and c) the flexibility to meet variable funding requirements within subsidiaries. The third element is to expand and diversify funding sources and to maintain strict concentration standards for short-term lenders, which include limits for any single lender. The Corporation's funding programs benefit from the ability to market commerical paper through its own sales force to a large, diversified customer base and the financial creativity of the Corporation's capital markets and private client operations. Commercial paper remains the Corporation's major source of short-term general purpose funding. Commercial paper outstanding totaled $13.6 billion at September 30, 1994 and $14.9 billion at December 31, 1993, which represented 8% and 10% of total assets at third quarter-end 1994 and year-end 1993, respectively. 21 At September 30, 1994, total long-term debt was $15.8 billion compared with $13.5 billion at year-end 1993. As of November 4, 1994, the Corporation's senior long-term debt was rated by seven recognized credit rating agencies as follows: Rating Agency Rating ------------- ------ Duff & Phelps Credit Rating Co. AA- Fitch Investors Service, Inc. AA IBCA Ltd. AA- Japan Bond Research Institute AA Moody's Investors Service, Inc. A1 Standard & Poor's Ratings Group A+ Thomson BankWatch, Inc. AA During the first nine months of 1994, the Corporation issued $7.6 billion in long-term debt. During the same period, maturities and repurchases were $4.9 billion. In addition, approximately $1.4 billion of the Corporation's securities held by subsidiaries were sold and $1.9 billion were purchased. Expected maturities of long-term debt over the next 12 months are $6.8 billion as of September 30, 1994. Approximately $30.2 billion of the Corporation's indebtedness at September 30, 1994 is considered senior indebtedness as defined under various indentures. A liquidity model has been developed for the Corporation's insurance subsidiaries as part of the overall liquidity program. The primary liquidity requirements of such companies involve the funding of contractual obligations for in-force, fixed-rate life insurance and annuity contracts and the payment of acquisition and maintenance expenses for all contracts. The liquidity and duration of these fixed-rate asset and liability portfolios are closely monitored. The insurance subsidiaries maintain predominantly high quality, liquid investment portfolios to fund their various business activities. At September 30, 1994, the insurance subsidiaries held $5.9 billion in invested assets, 61% of which were considered liquid. During the past few years, the insurance subsidiaries have changed the mix of products offered to policyholders. Currently, variable life insurance and variable annuity products are actively marketed. These products do not subject the insurance subsidiaries to the interest rate, asset/liability matching, and credit risks attributable to fixed-rate products. Variable products reduce the risk profile and liquidity demands on the insurance subsidiaries as they are predominantly invested in mutual funds. In the 1994 nine-month period, the Corporation's cash and cash equivalents increased approximately $567 million to $2,350 million. Cash of $6,603 million and $506 million was provided from operating activities and investing activities, respectively, in the first nine months of 1994. During the same period, the Corporation used $6,542 million for financing activities. 22 CAPITAL RESOURCES AND CAPITAL ADEQUACY The Corporation remains one of the most highly capitalized institutions in the U.S. securities industry with an equity base of $5.7 billion at September 30, 1994, including $5.5 billion in common equity, supplemented by $0.2 billion in preferred stock. (See Subsequent Event Note to the Consolidated Financial Statements). The Corporation's average leverage ratio, computed as the ratio of average month-end assets to average month-end stockholders' equity, was 32.4x and 26.6x for the first nine months of 1994 and 1993, respectively. The Corporation's leverage ratio at the end of the 1994 third quarter was 29.5x. The leverage ratio was affected by Financial Accounting Standards Board Interpretation No. 39 ("Interpretation No. 39"), "Offsetting of Amounts Related to Certain Contracts" (see Accounting Changes Note to the Consolidated Financial Statements), which increased assets by approximately $12.0 billion at September 30, 1994. To compute the Corporation's average adjusted leverage ratio, resale agreements and securities borrowed transactions are subtracted from total assets. The average adjusted leverage ratio was 19.3x and 16.2x for the first nine months of 1994 and 1993, respectively. The Corporation's adjusted leverage ratio at the end of the 1994 third quarter was 17.6x. The Corporation operates in many regulated businesses that require various minimum levels of capital to conduct business. (See Regulatory Requirements Note to the Consolidated Financial Statements). Certain activities of the Corporation's insurance subsidiaries are subject to other regulatory approvals which may restrict the free flow of funds to affiliates. Regulatory approval is required for payments of dividends in excess of certain established levels, making affiliated investments, and entering into management and service agreements with affiliated companies. The Corporation reviews its overall capital needs to ensure that its equity base can support the estimated needs of its businesses as well as the regulatory and legal capital requirements of subsidiaries. Based upon these analyses, management believes that the Corporation's equity base is adequate. ASSETS AND LIABILITIES The Corporation manages its balance sheet and risk limits according to market conditions and business needs subject to profitability and control of risk. Asset and liability levels are primarily determined by order flow and fluctuate daily, sometimes significantly, depending upon volume and demand. The liquidity and maturity characteristics of assets and liabilities are monitored continuously. The Corporation monitors and manages the growth of its balance sheet using point-in-time and average daily balances. Average daily balances were derived from the Corporation's management information system which summarizes balances on a settlement date basis. Financial statement balances, as required under generally accepted accounting principles, are recorded on a trade date basis. The discussion that follows compares the changes in settlement date average daily balances, not quarter-end balances. The reasons underlying the changes in average balances, however, are similar to those underlying changes in quarter-end balances. The increase in average balance sheet levels during the first nine months of 1994 was attributable to many 23 factors, including the effect of Interpretation No. 39, increased trading activity, particularly in the 1994 first quarter, and expanded match-funding of repurchase and resale agreements. For the first nine months of 1994, average assets were $183 billion, up 13% versus $162 billion for the 1993 fourth quarter. Average liabilities rose 14% to $178 billion from $157 billion for the 1993 fourth quarter. Excluding the effect of Interpretation No. 39, average assets and liabilities increased by approximately $8 billion in the 1994 year-to-date period. Interpretation No. 39 primarily affected balances related to contractual agreements and resale and repurchase agreements. Compared with balance sheet levels at 1994 second quarter-end, average assets and liabilities both decreased 1% as a result of declines in business volumes. The major components in the growth of average assets and liabilities for the first nine months of 1994 are summarized in the table below:
Increase in Percent (In millions) Average Assets Increase - ------------- -------------- -------- Trading inventories $9,994 18% Resale agreements $9,973 22% Securities borrowed $ 757 3%
Increase in Percent Average Liabilities Increase ------------------- -------- Repurchase agreements $14,598 25% Commitments for securities sold but not yet purchased $ 8,562 33% Long-term borrowings $ 1,874 14%
In managing its balance sheet, the Corporation strives to match-fund its interest-earning assets with interest-bearing liabilities having similar maturities. For example, the Corporation match-funds its repurchase agreements/resale agreements and its securities borrowed/securities loaned business, earning an interest spread on these transactions. In the first nine months of 1994, inventory levels increased due to the effect of Interpretation No. 39 and increases in trading activity, particularly during the 1994 first quarter. On-balance-sheet hedges, included in trading inventories and commitments for securities sold but not yet purchased, also advanced due, in part, to increased market volatility during 1994. The Corporation uses hedges principally to reduce risk in connection with its trading activities. Repurchase and resale agreements rose during the first nine months of 1994 as a result of an increase in match-funded transactions involving foreign and emerging market securities. Securities borrowed and loaned levels also increased during the period. The Corporation's assets, based on liquidity and maturity characteristics, are funded through diversified sources which include repurchase agreements, commercial paper and other short-term borrowings, long-term borrowings, and equity. 24 NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS In the normal course of business, the Corporation underwrites, trades, and holds non-investment grade securities in connection with its market-making, investment banking, and derivative structuring activities. As a result of the improved liquidity and credit ratings of issuers in this market, the Corporation has increased its non-investment grade trading inventories to satisfy customer demand for higher-yielding investments. For purposes of this discussion, non-investment grade securities have been defined as debt and preferred equity securities rated by Standard and Poor's Ratings Group as BB+ or lower and by Moody's Investors Service, Inc. as Ba1 or lower (or equivalent ratings for other instruments and non-U.S. securities), certain sovereign debt issued in emerging markets, amounts due under various derivative contracts from non-investment grade counterparties, as well as non-rated securities which, in the opinion of management, are non-investment grade. At September 30, 1994, long and short non-investment grade trading inventories accounted for 4.2% of aggregate consolidated trading inventories, compared with 4.6% at year-end 1993. Non-investment grade trading inventories are carried at fair value. The Corporation provides financing and advisory services to, and invests in, companies entering into leveraged transactions. Examples of leveraged transactions may include leveraged buyouts, recapitalizations, and mergers and acquisitions. The Corporation provides extensions of credit to leveraged companies in the form of senior term and subordinated debt, as well as bridge financing on a select and limited basis. In addition, the Corporation may syndicate loans for non-investment grade counterparties or counterparties engaged in highly leveraged transactions. Loans to highly leveraged companies are carried at unpaid principal balances less a reserve for estimated losses. The allowance for loan losses is estimated based on a review of each loan, and consideration of economic, market, and credit conditions. At September 30, 1994 and December 31, 1993, there were no bridge loans outstanding. The Corporation holds direct equity investments in leveraged companies, interests in partnerships that invest in leveraged transactions, and non-investment grade securities. Equity investments in privately-held companies for which sale is restricted by government or contractual requirements are carried at the lower of cost or estimated net realizable value. Prior to July 1, 1994, the Corporation had a co-investment arrangement to enter into direct equity investments. The Corporation also has committed to participate in limited partnerships that invest in leveraged transactions. Future commitments to participate in limited partnerships will be determined on a select and limited basis. The Corporation's involvement in highly leveraged transactions and non- investment grade securities is subject to risks related to the creditworthiness of the issuers and the liquidity of the market for such securities, in addition to the usual risks associated with investing in, financing, underwriting, and trading investment grade instruments. The Corporation recognizes such risks and, when possible, develops strategies to mitigate its exposures. 25 The specific components and overall level of highly leveraged and non-investment grade positions may vary significantly from period to period as a result of inventory turnover, investment sales, and asset redeployment. The Corporation continuously monitors credit risk by individual issuer and industry concentration. In addition, valuation policies provide for recognition of market liquidity, as well as the trading pattern of specific securities. In certain instances, the Corporation will hedge the exposure associated with owning a high-yield or non-investment grade position by selling short the related equity security, and in other instances, the Corporation uses non- investment grade inventories to reduce exposure related to structured derivative transactions. The Corporation uses certain non-investment grade trading inventories, principally non-U.S. governments and agencies securities, to accommodate client demand and to hedge the exposure arising from structured derivative transactions. Collateral, consisting principally of U.S. Government securities, may be obtained to reduce credit risk related to these transactions. The Corporation's insurance subsidiaries hold non-investment grade securities. At September 30, 1994, non-investment grade insurance investments declined to $386 million from $458 million as of December 31, 1993. As a percentage of total insurance investments, non-investment grade investments were 6.4%, compared with 5.8% at year-end 1993. Non-investment grade securities of insurance subsidiaries classified as trading or available-for-sale are carried at fair value. A summary of the Corporation's highly leveraged transactions and non-investment grade holdings is provided below:
SEPTEMBER 30, DECEMBER 31, (In millions) 1994 1993 - ------------------------------------------------------------------------------- Non-investment grade trading inventories $3,271 $3,129 Non-investment grade commitments for securities sold but not yet purchased 496 214 Non-investment grade investments of insurance subsidiaries 386 458 Loans (net of allowance for loan losses)(A),(C) 283 435 Equity investments(B) 284 276 Partnership interests 98 92 - ------------------------------------------------------------------------------- Additional commitments to invest in partnerships $ 74 $ 19 Additional co-investment commitments 7 49 Unutilized revolving lines of credit and other lending commitments(C),(D) 131 49 - -------------------------------------------------------------------------------
(A) Represented outstanding loans to 37 and 42 medium-sized companies at September 30, 1994 and at December 31, 1993, respectively. (B) Invested in 81 and 82 enterprises at September 30, 1994 and at December 31, 1993, respectively. (C) Subsequent to quarter-end, the Corporation assigned $111 million of a $126 million commitment to third parties. As part of this transaction, a $38 million loan receivable was repaid. The Corporation has funded $7.7 million of its remaining $15 million commitment. (D) Subsequent to quarter-end, the Corporation committed to provide up to $70.3 million of financing to a non-investment grade counterparty. 26 At September 30, 1994, the largest non-investment grade concentration consisted of various issues of a Latin American sovereign totaling $271 million, of which $74 million represented on-balance-sheet hedges for off-balance-sheet instruments. No one industry sector accounted for more than 15% of total non- investment grade positions. Included in the table above are debt and equity securities of issuers in various stages of bankruptcy proceedings or in default. At September 30, 1994, the carrying value of these securities totaled $254 million, of which 59% resulted from the Corporation's market-making activities. RECENT ACCOUNTING DEVELOPMENTS In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan". SFAS No. 114, effective for fiscal years beginning after December 15, 1994, establishes accounting standards for creditors to measure the impairment of certain loans. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due under the terms of the loan agreement. Impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or the observable market price, or the fair value of the underlying collateral if the loan is collateral dependent. In October 1994, the FASB issued SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures". SFAS No. 118 amends SFAS No. 114 to allow creditors to use existing methods for recognizing interest income on an impaired loan, rather than the method originally required by SFAS No. 114. The Corporation has evaluated the impact of these pronouncements on its financial condition as of September 30, 1994 and has determined that the effect is not material. 27 PART II - OTHER INFORMATION --------------------------- ITEM 5. OTHER INFORMATION ----------------- The 1995 Annual Meeting of Stockholders will be held at 10:30 a.m. on Tuesday, April 18, 1995 at the Merrill Lynch & Co., Inc. Conference and Training Center, 800 Scudders Mill Road, Plainsboro, New Jersey. Any stockholder of record entitled to vote generally for the election of directors may nominate one or more persons for election as a director at such meeting only if proper written notice of such stockholder's intent to make such nomination or nominations, in accordance with the provisions of Merrill Lynch & Co., Inc.'s Certificate of Incorporation, has been given to the Secretary of the Corporation, 100 Church Street, 12th Floor, New York, New York 10080-6512, no earlier than February 2, 1995 and no later than February 27, 1995. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibits (4) Instruments defining the rights of security holders, including indentures: (i) Form of certificate representing the 9% Cumulative Preferred Stock, Series A, par value $1.00 per share, of the Corporation (the "9% Preferred Stock") (incorporated herein by reference to Exhibit 99(a) of the Corporation's Registration Statement on Form 8-A dated November 4, 1994 (the "November 1994 Form 8-A")). (ii) Form of Depositary Receipt evidencing the Depositary Shares for the 9% Preferred Stock (incorporated herein by reference to Exhibit 99(b) of the November 1994 Form 8-A). (iii) Certificate of Designation of the Corporation establishing the rights, preferences, privileges, qualifications, restrictions and limitations relating to the 9% Preferred Stock (incorporated herein by reference to Exhibit 99(c) of the November 1994 Form 8-A). (iv) Deposit Agreement, dated as of November 3, 1994 among the Corporation, Citibank, N.A. as 28 Depositary, and the holders from time to time of the Depositary Receipts (incorporated herein by reference to Exhibit 99(d) of the November 1994 Form 8-A). Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Corporation hereby undertakes to furnish to the Securities and Exchange Commission (the "Commission"), upon request, copies of the instruments defining the rights of holders of long-term debt securities of the Corporation that authorize an amount of securities constituting 10% or less of the total assets of the Corporation and its subsidiaries on a consolidated basis. (10) Material Contracts (i) Form of Merrill Lynch & Co., Inc. 1995 Deferred Compensation Agreement for a Select Group of Eligible Employees. (ii) Merrill Lynch & Co., Inc. Long Term Incentive Compensation Plan, as amended on October 14, 1994. (11) Statement re computation of per share earnings. (12) Statement re computation of ratios. (15) Letter re unaudited interim financial information. (27) Financial Data Schedule. (b) Reports on Form 8-K The following Current Reports on Form 8-K were filed by the Corporation with the Commission during the quarterly period covered by this Report: (i) Current Report dated July 19, 1994 for the purpose of filing the Preliminary Unaudited Earnings Summary of the Corporation for the three months ended July 1, 1994. (ii) Current Report dated August 2, 1994 for the purpose of filing the Preliminary Unaudited Consolidated Balance Sheet of the Corporation as of July 1, 1994. 29 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. MERRILL LYNCH & CO., INC. ------------------------- (Registrant) Date: November 11, 1994 By: /s/ Joseph T. Willett ---------------------- Joseph T. Willett Senior Vice President and Chief Financial Officer 30 INDEX TO EXHIBITS Exhibits (4) Instruments defining the rights of security holders, including indentures: (i) Form of certificate representing the 9% Preferred Stock (incorporated herein by reference to Exhibit 99(a) of the November 1994 Form 8-A). (ii) Form of Depositary Receipt evidencing the Depositary Shares for the 9% Preferred Stock (incorporated herein by reference to Exhibit 99(b) of the November 1994 Form 8-A). (iii) Certificate of Designation of the Corporation establishing the rights, preferences, privileges, qualifications, restrictions and limitations relating to the 9% Preferred Stock (incorporated herein by reference to Exhibit 99(c) of the November 1994 Form 8-A). (iv) Deposit Agreement, dated as of November 3, 1994 among the Corporation, Citibank, N.A. as Depositary, and the holders from time to time of the Depositary Receipts (incorporated herein by reference to Exhibit 99(d) of the November 1994 Form 8-A). (10) Material Contracts (i) Form of Merrill Lynch & Co., Inc. 1995 Deferred Compensation Agreement for a Select Group of Eligible Employees. (ii) Merrill Lynch & Co., Inc. Long Term Incentive Compensation Plan, as amended on October 14, 1994. (11) Statement re computation of per share earnings. (12) Statement re computation of ratios. (15) Letter re unaudited interim financial information. (27) Financial Data Schedule. 31