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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1997 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 IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
WORLD FINANCIAL CENTER--NORTH TOWER 10281
250 VESEY STREET (ZIP CODE)
NEW YORK, NEW YORK
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 449-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Common Stock, par value $1.33 1/3 New York Stock Exchange; Chicago Stock
Exchange; Pacific Exchange; Paris
Bourse; London Stock Exchange; and
Tokyo Stock Exchange
Depositary Shares representing 1/400th New York Stock Exchange
share of 9% Cumulative Preferred
Stock, Series A
Rights to Purchase Series A Junior Pre- New York Stock Exchange; Chicago Stock
ferred Stock Exchange; Pacific Exchange; Paris
Bourse; London Stock Exchange; and
Tokyo Stock Exchange
Currency Protected Notes due December New York Stock Exchange
31, 1998; Global Bond Linked Securi-
ties due December 31, 1998; S&P 500
Market Index Target-Term Securities
("MITTS") due July 31, 1998; Global
Telecommunications Portfolio MITTS due
October 15, 1998; European Portfolio
MITTS due June 30, 1999; S&P 500 MITTS
due May 10, 2001; Technology MITTS due
August 15, 2001; Healthcare/Biotechnology
Portfolio MITTS due October 31, 2001;
Nikkei 225 MITTS due June 14, 2002;
S&P 500 MITTS due September 16, 2002;
Merrill Lynch's MITTS based upon the
Dow Jones Industrial Average due
January 14, 2003; Top Ten Yield MITTS
due August 15, 2006; S&P 500 Inflation
Adjusted MITTS due September 24, 2007;
Stock Market Annual Reset Term Notes
("SMART Notes") due December 31, 1999
(Series A); Equity Participation
Securities with Minimum Return
Protection due June 30, 1999; 6 1/2%
Structured Yield Product Exchangeable
for Stock ("STRYPES") due August 15,
1998; 6% STRYPES due June 1, 1999;
7 1/4% STRYPES due June 15, 1999;
7 7/8% STRYPES due February 1, 2001;
6 1/4% STRYPES due July 1, 2001
Japan Index Equity Participation Secu- American Stock Exchange
rities with Minimum Return Protection
due January 31, 2000; AMEX Oil Index
SMART Notes due December 29, 2000;
Russell 2000 Index Call Warrants
expiring November 17, 1998; AMEX Hong
Kong 30 Index Equity Participation
Notes due February 16, 1999; Major 8
European Index MITTS due August 30,
2002; Major 11 International MITTS due
December 6, 2002; Russell 2000 Index
MITTS due September 30, 2004
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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 requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of February 23, 1998, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was approximately $24.2 billion.
As of February 23, 1998, there were 342,205,174 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Merrill Lynch & Co., Inc. Proxy Statement for its 1998 Annual Meeting of
Stockholders dated March 5, 1998--Incorporated by reference in part in this
Form 10-K in Parts III and IV.
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CROSS REFERENCE INDEX TO ANNUAL REPORT ON FORM 10-K
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PAGE NUMBER
FORM 10-K REFERENCE TO THIS
REQUIRED INFORMATION 1997 ANNUAL REPORT
-------------------- ------------------
PART ONE
ITEM 1. DESCRIPTION OF BUSINESS............. 73-87
ITEM 2. PROPERTIES.......................... 87-88
ITEM 3. LEGAL PROCEEDINGS................... 88-93
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITYHOLDERS..................... 93
PART TWO
ITEM 5. MARKET FOR REGISTRANT'S COMMON
STOCK............................... 68
ITEM 6. SELECTED FINANCIAL DATA............. 3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 5-29
ITEM 7A. MARKET RISK DISCLOSURES ............ 24-25, 38-43,
44-49
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA.................. 30-68
Independent Auditors' Report........ 30
Statements of Consolidated
Earnings............................ 31
Consolidated Balance Sheets......... 32-33
Statements of Changes in
Consolidated Stockholders' Equity... 34-35
Statements of Consolidated
Comprehensive Income................ 36
Statements of Consolidated Cash
Flows............................... 37
Notes to Consolidated Financial
Statements.......................... 38-67
Quarterly Information............... 68
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................ 93
PART THREE
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT...................... 93
ITEM 11. EXECUTIVE COMPENSATION.............. 93
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT.... 93
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS........................ 93
PART FOUR
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-
K .................................. 97
Condensed Financial Statements
(Parent Company Only)............... 69-72
Reports on Form 8-K................. 97
List of Exhibits.................... 97-99
1997 Annual Report
100
INTRODUCTION
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Our $1.9 billion in net earnings for 1997 were the highest in our history, up
18% from the previous record of $1.6 billion the year before, and represent a
return on common equity of 26.8%.
In recognition of sustained earnings growth, in April 1997 our Board of
Directors approved a two-for-one common stock split and a 33% increase in the
regular quarterly dividend, making 1997 the sixth consecutive year in which
dividends increased.
On the following pages, we present Merrill Lynch's financial results for 1997
in detail. A companion publication, the 1997 Annual Review, contains our
Letter to Shareholders and Clients setting the events and accomplishments of
last year in the context of a thorough discussion of our strategy. We urge you
to read these two publications in tandem, since both strategic vision and
financial strength will continue to be critical elements for success during a
period of extraordinary change in the global financial services industry.
/s/ David H. Komansky /s/ Herbert M. Allison, Jr.
DAVID H. KOMANSKY HERBERT M. ALLISON, JR.
Chairman and Chief Executive Officer President and Chief Operating Officer
February 26, 1998
1997 Annual Report
I
TABLE OF CONTENTS
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SELECTED FINANCIAL DATA..................................................... 3
MANAGEMENT'S DISCUSSION OF FINANCIAL RESPONSIBILITY......................... 4
MANAGEMENT'S DISCUSSION AND ANALYSIS........................................ 5
INDEPENDENT AUDITORS' REPORT................................................ 30
CONSOLIDATED FINANCIAL STATEMENTS
Statements of Consolidated Earnings..................................... 31
Consolidated Balance Sheets............................................. 32
Statements of Changes in Consolidated Stockholders' Equity.............. 34
Statements of Consolidated Comprehensive Income......................... 36
Statements of Consolidated Cash Flows................................... 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.................................. 38
QUARTERLY INFORMATION....................................................... 68
CONDENSED FINANCIAL STATEMENTS AND NOTES (PARENT COMPANY ONLY).............. 69
INDEPENDENT AUDITORS' REPORT (PARENT COMPANY ONLY).......................... 72
BUSINESS OF MERRILL LYNCH
Overview................................................................ 73
Business Environment.................................................... 74
Description of Business Activities...................................... 74
Competition............................................................. 84
Regulation.............................................................. 85
Properties.............................................................. 87
Legal Proceedings....................................................... 88
CORPORATE INFORMATION....................................................... 93
SUPPLEMENTAL INFORMATION.................................................... 97
CROSS REFERENCE INDEX TO ANNUAL REPORT ON FORM 10-K......................... 100
SIGNATURE PAGE.............................................................. 101
1997 Annual Report
2
SELECTED FINANCIAL DATA
(Dollars in Millions, Except Per Share Amounts)
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Year Ended Last Friday in December
-----------------------------------------------------------
1997 1996 1995 1994 1993
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(52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (53 Weeks)
OPERATING RESULTS
Total Revenues $ 31,731 $ 25,011 $ 21,513 $ 18,234 $ 16,588
Interest Expense 16,062 11,895 11,248 8,609 6,030
-------- -------- -------- -------- --------
Net Revenues 15,669 13,116 10,265 9,625 10,558
Non-Interest Expenses 12,619 10,550 8,454 7,895 8,133
-------- -------- -------- -------- --------
Earnings Before Income
Taxes, Dividends on
Preferred Securities
Issued by Subsidiaries,
and Cumulative Effect of
Change in Accounting
Principle 3,050 2,566 1,811 1,730 2,425
Income Tax Expense 1,097 947 697 713 1,031
Dividends on Preferred
Securities Issued by
Subsidiaries 47 - - - -
-------- -------- -------- -------- --------
Earnings Before
Cumulative Effect of
Change in Accounting
Principle $ 1,906 $ 1,619 $ 1,114 $ 1,017 $ 1,394
======== ======== ======== ======== ========
Net Earnings $ 1,906 $ 1,619 $ 1,114 $ 1,017 $ 1,359
======== ======== ======== ======== ========
Net Earnings Applicable
to Common Stockholders $ 1,867 $ 1,572 $ 1,066 $ 1,004 $ 1,354
======== ======== ======== ======== ========
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FINANCIAL POSITION
Total Assets $292,819 $213,016 $176,857 $163,749 $152,910
Short-Term
Borrowings (a) $122,725 $102,002 $ 86,363 $ 78,304 $ 79,632
Long-Term Borrowings $ 43,090 $ 26,102 $ 17,340 $ 14,863 $ 13,469
Preferred Securities
Issued by Subsidiaries $ 627 $ 327 $ 51 $ 51 $ 51
Total Stockholders'
Equity $ 8,329 $ 6,892 $ 6,141 $ 5,818 $ 5,486
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COMMON SHARE DATA (b)
(In Thousands, Except
Per Share Amounts)
Basic:
Earnings Before
Cumulative Effect of
Change in Accounting
Principle $ 5.63 $ 4.65 $ 3.02 $ 2.57 $ 3.31
======== ======== ======== ======== ========
Net Earnings $ 5.63 $ 4.65 $ 3.02 $ 2.57 $ 3.23
======== ======== ======== ======== ========
Diluted:
Earnings Before
Cumulative Effect of
Change in Accounting
Principle $ 4.83 $ 4.11 $ 2.71 $ 2.38 $ 3.06
======== ======== ======== ======== ========
Net Earnings $ 4.83 $ 4.11 $ 2.71 $ 2.38 $ 2.98
======== ======== ======== ======== ========
Weighted-Average Shares
Outstanding:
Basic 331,467 337,794 353,126 391,321 418,553
Diluted 386,749 382,271 393,995 422,099 453,585
Shares Outstanding at
Year-End (c) 335,082 328,172 342,777 362,958 407,979
Shares Repurchased 13,741 37,158 40,024 59,977 32,691
Average Share Repurchase
Price $ 48.91 $ 31.30 $ 23.48 $ 18.98 $ 21.28
Book Value $ 23.64 $ 19.19 $ 16.20 $ 14.43 $ 13.09
Dividends Paid $ 0.75 $ 0.58 $ 0.505 $ 0.445 $ 0.35
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FINANCIAL RATIOS
Pretax Margin (d) 19.5% 19.6% 17.6% 18.0% 23.0%
Profit Margin (e) 12.2% 12.3% 10.8% 10.6% 13.2%
Common Dividend Payout
Ratio 13.4% 12.5% 16.9% 17.5% 10.9%
Return on Average Assets 0.7% 0.7% 0.6% 0.6% 1.0%
Return on Average Common
Stockholders' Equity 26.8% 26.8% 20.1% 18.6% 27.3%
Average Leverage (f) 35.5x 33.5x 32.4x 31.7x 27.1x
Average Adjusted
Leverage (g) 21.5x 19.9x 19.3x 18.7x 16.4x
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EMPLOYEE STATISTICS
Full-Time Employees:
U.S. 45,700 42,100 39,250 38,750 37,500
Non-U.S. 10,900 7,700 6,750 5,050 4,400
------ ------ ------ ------ ------
Total 56,600 49,800 46,000 43,800 41,900
====== ====== ====== ====== ======
Financial Consultants
and Account Executives
Worldwide 15,300 14,400 13,900 13,500 13,200
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(a) Includes payables under repurchase agreements and securities loaned
transactions and commercial paper and other short-term borrowings.
(b) All share and per share data have been restated for the two-for-one common
stock split (see Note 6 to the Consolidated Financial Statements).
(c) Does not include 3,078, 8,026, 12,854, and 17,864 unallocated reversion
shares held in the Employee Stock Ownership Plan at year-end 1996, 1995,
1994, and 1993, respectively, which are not considered outstanding for
accounting purposes.
(d) Earnings Before Income Taxes, Dividends on Preferred Securities Issued by
Subsidiaries, and Cumulative Effect of Change in Accounting Principle to
Net Revenues.
(e) Earnings Before Cumulative Effect of Change in Accounting Principle to Net
Revenues.
(f) Average total assets to average total stockholders' equity and preferred
securities issued by subsidiaries.
(g) Average total assets less average receivables under resale agreements and
securities borrowed transactions to average total stockholders' equity and
preferred securities issued by subsidiaries.
1997 Annual Report
3
MANAGEMENT'S DISCUSSION OF FINANCIAL RESPONSIBILITY
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Management of Merrill Lynch & Co., Inc. is responsible for preparing the
financial statements and related notes contained in the Annual Report. The
consolidated financial statements and notes are prepared in accordance with
generally accepted accounting principles. Other financial data included in the
Annual Report are consistent with those in the financial statements.
Management recognizes the importance of safeguarding Merrill Lynch's
integrity and understanding the risks of its businesses. Therefore, Management
devotes considerable attention to 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
organiza-tional structures that are overseen by a predominantly independent
Board of Directors. Several committees of the Board actively participate in
setting policy and monitoring controls. The Audit and Finance Committee,
consisting entirely of independent directors, examines Merrill Lynch's
compliance with acceptable business standards and ethics. It also reviews
significant finan-cial issues and recommends overall policies regarding risk and
funding requirements. The Management Development and Compensation Committee,
also com-posed entirely of independent directors, oversees procedures for
developing and assessing the performance of Merrill Lynch's employees with an
emphasis on ethical business behavior.
Oversight is provided by independent units within Merrill Lynch, working
together to maintain Merrill Lynch's internal control standards.
Corporate Audit reports directly to the Audit and Finance Committee,
providing independent appraisals of Merrill Lynch's internal accounting controls
and compliance with established policies and procedures.
Finance establishes accounting policies and procedures, measures and
monitors financial risk, and prepares financial statements that fairly present
the underlying transactions and events of Merrill Lynch.
Risk Management and Corporate Credit are both independent from business
line management and have oversight responsibility for Merrill Lynch's market and
credit risks. These groups have clear authority to enforce trading and credit
limits using various systems and procedures to monitor positions and risks.
Law and Compliance serves in a counseling and advisory role to Management.
In this role, the group develops policies; monitors compliance with internal
policies, external rules, and industry regulations; and provides support in
connection with the execution of various transactions.
The independent auditors, Deloitte & Touche LLP, perform annual audits of
Merrill Lynch's financial statements in accordance with generally accepted
audit-ing standards, including a review of the internal accounting control
system. Merrill Lynch's independent auditors are appointed each year by the
Audit and Finance Committee and are given unrestricted access to all financial
records and related data, including minutes of meetings of stockholders, Board
of Directors, and committees of the Board.
/s/ David H. Komansky /s/ Herbert M. Allison, Jr. /s/ E. Stanley O'Neal
DAVID H. KOMANSKY HERBERT M. ALLISON, JR. E. STANLEY O'NEAL
Chairman and President and Executive Vice President
Chief Executive Officer Chief Operating Officer and Chief Financial
Officer
1997 Annual Report
4
MANAGEMENT'S DISCUSSION AND ANALYSIS
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TABLE OF CONTENTS
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BUSINESS ENVIRONMENT........................................................ 5
RESULTS OF OPERATIONS....................................................... 6
COMMISSIONS................................................................. 7
INTEREST AND DIVIDENDS...................................................... 7
PRINCIPAL TRANSACTIONS...................................................... 8
INVESTMENT BANKING.......................................................... 9
ASSET MANAGEMENT AND
PORTFOLIO SERVICE FEES...................................................... 10
OTHER REVENUES.............................................................. 10
NON-INTEREST EXPENSES....................................................... 11
INCOME TAXES................................................................ 12
ACQUISITIONS................................................................ 12
STRATEGIC PRIORITIES........................................................ 13
GLOBAL OPERATIONS........................................................... 14
BALANCE SHEET............................................................... 17
LIQUIDITY AND LIABILITY MANAGEMENT.......................................... 20
CAPITAL RESOURCES AND CAPITAL ADEQUACY...................................... 21
CAPITAL PROJECTS AND EXPENDITURES........................................... 22
RISK MANAGEMENT............................................................. 22
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS............. 26
CASH FLOWS.................................................................. 28
LITIGATION.................................................................. 29
RECENT DEVELOPMENTS......................................................... 29
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BUSINESS ENVIRONMENT
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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, and related
services worldwide. Merrill Lynch conducts its businesses in global financial
markets that are influenced by numerous unpredictable factors. These factors
include economic conditions and monetary policy, the liquidity of global
markets, international and regional political events, regulatory developments,
the competitive environment, and investor sentiment. These conditions or events
can significantly affect the volatility of financial markets. While greater
volatility increases risk, it may also increase order flow in businesses such as
trading and brokerage. Revenues and net earnings may vary significantly from
period to period due to these unpredictable factors and the resulting market
volatility.
The financial services industry continues to be affected by the intensifying
competitive environment, as demonstrated by consolidation through mergers and
acquisitions, expansion by banks and insurance companies into traditional bro-
kerage activities, and diminishing margins in many mature products and servic-
es.
Global financial markets continued to advance for much of 1997, after gener-
ally strong performances in 1996 and 1995. Robust economic growth, low infla-
tion, and falling U.S. interest rates propelled U.S. equity markets to record
highs and contributed to significant gains in most non-U.S. markets. The weak-
ening of certain Asian currencies in the 1997 third quarter and further deval-
uation of those currencies in the 1997 fourth quarter, however, caused signif-
icant volatility and overall declines in global equity markets, particularly
in Asia. These events also resulted in the widening of credit spreads and
sharply reduced liquidity in a number of markets, particularly in emerging
markets. Subsequently, many markets recovered, while Asian markets continued
to decline.
U.S. equity markets posted significant gains in 1997, with the Dow Jones
Industrial Average ("DJIA")
1997 Annual Report
5
MANAGEMENT'S DISCUSSION AND ANALYSIS
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rising 23%. This was the first time the DJIA rose more than 20% for three con-
secutive years, although nearly all of the 1997 increase occurred in the first
seven months of the year. U.S. equity markets weakened in August, primarily
due to corporate earnings disappointments, and declined significantly in Octo-
ber following the devaluation of several Asian currencies. These events pre-
cipitated a DJIA market correction of 7.2%, or 554 points, on October 27, the
largest one-day point drop ever. The DJIA staged a sharp comeback the next
day, rising 4.7%. Despite volatility throughout the remainder of the year, the
DJIA returned to pre-October levels by the end of 1997.
U.S. bond market rates trended upward at the beginning of 1997, as inflation-
ary fears forced the Federal Reserve Board to raise short-term interest rates
in late March. Despite strong economic growth and low unemployment, this trend
reversed later in the year as inflationary fears eased and demand for U.S.
Treasuries increased over concerns that the conditions in Asia would spread to
other parts of the world. The yield on the 30-year U.S. Treasury bond ended
the year at 5.9%, its lowest level since early 1996.
Global equity markets rose on average approximately 13% during the year, as
measured by the Dow Jones World Index(Registered Trademark). Most European
markets experienced significant advances during 1997 due to falling bond yields
and a steady stream of mergers and acquisitions. Asian markets, however,
incurred large losses late in 1997 due to the prospects of slower growth and
significant currency fluctuations. In Latin America, strong export growth, low
inflation, and significant foreign capital inflows led to large gains during the
first half of the year. These gains were partially offset during the second half
of the year as the decline in Asian markets prompted a massive sell-off of Latin
American stocks, leading to the largest price deterioration since the 1994
Mexican peso crisis. Despite these price declines, Latin American stock indices
posted significant gains during 1997. Although equity prices in many countries,
when measured in local currency terms, were up more than U.S. equity prices, in
U.S. dollar terms, only a few of these increases exceeded the U.S. advance due
to the overall strengthening of the U.S. dollar versus many local currencies.
Global underwriting volume reached record levels during 1997, up 33% over the
previous record levels of 1996. Although disclosed underwriting fees for
stocks and bonds fell 10% to $8.4 billion, 1997 was the third-best year for
underwriting fees after 1996 and 1993, according to Securities Data Co.
("SDC"). Increasing competition from non-U.S. and U.S. commercial banks and a
sharp drop in equity initial public offerings led to the decline in disclosed
fees.
Strategic services had its third consecutive year of record volume in 1997, as
a result of a continuation of the high level of merger and acquisition activ-
ity since 1995. Driven by a generally favorable stock market, regulatory and
technological changes, and ongoing industry consolidations, companies contin-
ued to seek strategic alliances to increase earnings growth and expand into
new markets and businesses.
Fiscal 1997 was primarily characterized by favorable economic conditions and
strong, yet volatile, financial markets. Merrill Lynch continually evaluates
its businesses across varying market conditions for profitability and align-
ment with long-term strategic objectives. Merrill Lynch seeks to mitigate the
effect of market downturns by developing and maintaining long-term client
relationships, selectively expanding its global presence, closely monitoring
costs and risks, and continuing to diversify revenue sources.
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RESULTS OF OPERATIONS
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(in millions, 1997 VS.
except per share ----------
amounts) 1997 1996 1995 1996 1995
- -------------------------------------------------------------------------------
Total revenues $31,731 $25,011 $21,513 26.9% 47.5%
Net revenues 15,669 13,116 10,265 19.5 52.6
Net earnings 1,906 1,619 1,114 17.8 71.1
Net earnings
applicable to
common
stockholders 1,867 1,572 1,066 18.7 75.1
Earnings per
common share:
Basic 5.63 4.65 3.02 21.1 86.4
Diluted 4.83 4.11 2.71 17.5 78.2
Return on
average common
stockholders'
equity 26.8% 26.8% 20.1% - 33.3
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1997 Annual Report
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
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Merrill Lynch's record 1997 net earnings of $1.9 billion surpassed its previ-
ous record of $1.6 billion in 1996 by 18%. Record revenues in commissions,
principal transactions, investment banking, and asset management and portfolio
service fees, partially offset by increased costs, particularly in compensa-
tion and technology, led to the record net earnings.
The following discussion provides details of major revenue and expense catego-
ries and other pertinent information on Merrill Lynch's business activities,
financial condition, liquidity, and risks. Certain limited reclassification
and format changes have been made to prior year amounts to conform with the
current year presentation.
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COMMISSIONS
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(in millions) 1997 1996 1995
- -------------------------------------------------
Listed and over-the-counter $2,597 $2,039 $1,678
Mutual funds 1,443 1,192 906
Other 627 555 542
------ ------ ------
Total $4,667 $3,786 $3,126
====== ====== ======
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Commissions revenues advanced 23% in 1997 to a record $4.7 billion, primarily
due to higher levels of listed securities transactions and mutual fund commis-
sions.
Commissions from listed securities were up 30% from 1996 as a result of higher
trading volumes on many exchanges around the world. Mutual fund commissions
revenues rose 21%, benefiting from strong sales of both U.S. and non-U.S.
funds. Other commissions revenues advanced 13% in 1997, largely due to
increased sales of over-the-counter options and third party annuity contracts
and higher processing fees.
Commissions revenues in 1996 rose 21% over 1995 levels. Increased trading vol-
ume led to higher listed and over-the-counter securities transaction revenues,
while strong sales of U.S. funds and greater distribution fees from deferred-
charge funds increased mutual fund commissions.
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INTEREST AND DIVIDENDS
- -------------------------------------------------------------------------------
(in millions) 1997 1996 1995
- ---------------------------------------------------------
INTEREST AND DIVIDEND REVENUES
Trading assets $ 5,207 $ 4,170 $ 3,832
Securities borrowed transactions 3,473 2,821 2,940
Resale agreements 4,513 2,977 2,810
Margin lending 2,186 1,542 1,394
Other 1,708 1,389 1,245
------- ------- -------
17,087 12,899 12,221
------- ------- -------
INTEREST EXPENSE
Borrowings 6,588 4,873 4,330
Repurchase agreements 5,214 3,576 3,680
Trading liabilities 2,947 2,451 2,205
Other 1,313 995 1,033
------- ------- -------
16,062 11,895 11,248
------- ------- -------
NET INTEREST AND DIVIDEND PROFIT $ 1,025 $ 1,004 $ 973
======= ======= =======
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Interest and dividend revenues and expenses are a function of the level and
mix of interest-earning assets and interest-bearing liabilities and the pre-
vailing level, term structure, and volatility of interest rates. Net interest
and dividend profit was up 2% from 1996. Increases in net interest-earning
assets were offset by declining interest spreads due to the flattening of the
yield curve.
Merrill Lynch hedges its long- and short-term borrowings, primarily with
interest rate and currency swaps, to better match the interest rate character-
istics of the borrowings to the assets funded by borrowing proceeds. The
effect of this hedging activity, which is included in "Borrowings" above,
increased (decreased) interest expense for 1997, 1996, and 1995 by $45
million, $(64) million, and $(45) million, respectively (see Note 5 to the
Consolidated Financial Statements).
In 1996, interest and dividend profit was up 3% from 1995 as a result of
increases in interest spreads attributable to a steepening yield curve.
1997 Annual Report
7
MANAGEMENT'S DISCUSSION AND ANALYSIS
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PRINCIPAL TRANSACTIONS
- -------------------------------------------------------------------------------
The table that follows provides information on aggregate trading revenues,
including related net interest. Interest revenue and expense amounts are based
on financial reporting categories and management's assessment of the cost to
finance trading positions, after consideration of the underlying liquidity of
these positions.
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NET
PRINCIPAL INTEREST NET
TRANSACTIONS REVENUES TRADING
(in millions) REVENUES (EXPENSE) REVENUES
- -----------------------------------------------------------------
1997
Equities and equity derivatives $1,238 $(114) $1,124
Interest rate and currency swaps 1,042 (161) 881
Taxable fixed-income 996 268 1,264
Municipals 304 15 319
Foreign exchange and commodities 189 8 197
------ ----- ------
Total $3,769 $ 16 $3,785
====== ===== ======
- -----------------------------------------------------------------
1996
Equities and equity derivatives $1,138 $ (91) $1,047
Interest rate and currency swaps 893 (74) 819
Taxable fixed-income 966 250 1,216
Municipals 323 13 336
Foreign exchange and commodities 134 4 138
------ ----- ------
Total $3,454 $ 102 $3,556
====== ===== ======
- -----------------------------------------------------------------
1995
Equities and equity derivatives $ 912 $ (84) $ 828
Interest rate and currency swaps 732 (82) 650
Taxable fixed-income 516 246 762
Municipals 273 1 274
Foreign exchange and commodities 86 7 93
------ ----- ------
Total $2,519 $ 88 $2,607
====== ===== ======
- -----------------------------------------------------------------
Principal transactions revenues rose 9% from 1996 to a record $3.8 billion in
1997. The increase resulted from favorable market conditions, including rising
U.S. stock prices, low interest rates, and narrowing credit spreads, as well
as increased customer demand for higher-yielding securities, for most of the
year. These gains were partially offset by declines in values during the
fourth quarter for certain non-U.S. equity and debt positions triggered by the
Asian market decline late in 1997.
Trading and related hedging and financing activities affect the recognition of
both principal transactions revenues and net interest and dividend profit. In
assessing the profitability of its trading activities, Merrill Lynch aggre-
gates net interest and principal transactions revenues. For financial report-
ing 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 less
financing costs) for trading positions, including hedges, is recorded either
as principal transactions revenues or net interest profit, depending on the
nature of the specific instruments. Changes in the composition of trading
inventories and hedge positions can cause the recognition of revenues within
these categories to fluctuate.
Equities and equity derivatives trading revenues were up 9% from 1996.
Increased profitability from equity derivative transactions, higher transac-
tion volume, and price appreciation in the U.S. and European equity markets
contributed to higher revenues.
Interest rate and currency swaps trading revenues rose 17%, primarily because
of higher revenues from emerging market-related derivatives, improved customer
demand due to market volatility, and increased activity in credit derivatives.
Taxable fixed-income trading revenues increased 3% from 1996. Increased reve-
nues from high-yield debt, corporate bonds and preferred stock, and money mar-
kets were partially offset by lower trading revenues from non-U.S. and U.S.
governments and mortgage-backed products. The increase in trading revenues
from high-yield debt and corporate bonds and preferred stock was attributable
to investors seeking greater returns as interest rates generally remained low.
Trading revenues from money market instruments benefited in part from increased
floating-rate note activity in European markets. The decrease in trading
revenues from non-U.S. governments and agencies securities was primarily
1997 Annual Report
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
attributable to lower interest rates and reduced market volatility in certain
countries, while the decline in trading revenues from U.S. Government and
agencies securities was due to the falling interest rate environment in the
U.S. Lower trading revenues from mortgage-backed products resulted from a less
favorable market environment compared to 1996.
Municipal securities trading revenues were down 6% from 1996, primarily due to
lower margins on sales of shorter-term instruments. Foreign exchange and
commodities trading revenues rose 41% from 1996, primarily due to increased
volume resulting from higher market share and fluctuations in the U.S. dollar
versus the German mark and Japanese yen.
In 1996, principal transactions revenues were up 37% from 1995. Improved mar-
ket conditions, increased capacity related to the acquisition of Smith New
Court, and record NASDAQ volume led to gains in equities and equity deriva-
tives trading revenues (up 25%). Customer demand for higher-yielding instru-
ments related to derivative products led to increases in interest rate and
currency swaps (up 22%). Lower interest rates and improved economic conditions
in many emerging markets in 1996 increased demand for and inventory values of
taxable fixed-income products (up 87%), while strong investor demand for tax-
advantaged products increased municipal securities revenues (up 19%). Higher
volume led to an increase in foreign exchange and commodities trading revenues
(up 56%).
- --------------------------------------------------------------------------------
INVESTMENT BANKING
- --------------------------------------------------------------------------------
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Underwriting revenues $1,958 $1,520 $ 964
Strategic services revenues 791 425 344
------ ------ ------
Total $2,749 $1,945 $1,308
====== ====== ======
- --------------------------------------------------------------------------------
Investment banking revenues soared 41% in 1997 to a record $2.7 billion, bene-
fiting from record levels of equity underwriting and merger and acquisition
activity industrywide. During 1997, Merrill Lynch became the only securities
firm ever to be ranked first in the U.S. in debt underwriting, equity under-
writing, and completed mergers and acquisitions in the same year, with market
shares of 15.8%, 15.9%, and 28.7%, respectively, according to SDC. In addi-
tion, Merrill Lynch retained its position as top underwriter of total debt and
equity securities for the tenth consecutive year in the U.S. and for the ninth
consecutive year globally. Merrill Lynch's underwriting market share informa-
tion based on transaction value follows:
- --------------------------------------------------------------------------------
1997 1996 1995
----------- ----------- -----------
MARKET MARKET MARKET
SHARE RANK SHARE RANK SHARE RANK
- --------------------------------------------------------------------------------
U.S. PROCEEDS
Debt 15.8% 1 15.7% 1 18.0% 1
Equity 15.9 1 13.6 2 14.7 2
Debt and Equity 16.1 1 16.0 1 17.8 1
GLOBAL PROCEEDS
Debt 13.1 1 12.2 1 13.5 1
Equity 15.4 1 12.1 2 13.1 2
Debt and Equity 13.6 1 12.7 1 13.7 1
- --------------------------------------------------------------------------------
Source: SDC statistics based on full credit to book manager.
Strategic services fees increased 86% from 1996 to a record $791 million, ben-
efiting from strong merger and acquisition activity attributable in part to
consolidation across various industries. Merrill Lynch's merger and acquisi-
tion market share information based on transaction value follows:
- --------------------------------------------------------------------------------
1997 1996 1995
----------- ----------- -----------
MARKET MARKET MARKET
SHARE RANK SHARE RANK SHARE RANK
- ------------------------------------------------------------
COMPLETED TRANSACTIONS
U.S. 28.7% 1 24.4% 2 8.9% 8
Global 19.6 3 16.2 3 6.6 10
ANNOUNCED TRANSACTIONS
U.S. 28.7 1 28.2 1 16.4 4
Global 19.0 3 18.2 2 10.5 4
- ------------------------------------------------------------
Source: SDC statistics based on full credit to both target and acquiring
companies' advisors.
Investment banking revenues increased 49% in 1996 from 1995 due to higher
levels of equity and debt underwriting and increased merger and acquisition
activity.
1997 Annual Report
9
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
ASSET MANAGEMENT AND PORTFOLIO SERVICE FEES
- -------------------------------------------------------------------------------
(in millions) 1997 1996 1995
- --------------------------------------------
Asset management fees $1,208 $ 997 $ 856
Portfolio service fees 844 609 477
Account fees 411 373 338
Other fees 326 282 219
------ ------ ------
Total $2,789 $2,261 $1,890
====== ====== ======
- --------------------------------------------
Revenues from asset management and portfolio service fees rose 23% in 1997 to
a record $2.8 billion, primarily due to strong growth in client assets and
market appreciation. Year-end client assets and assets under management for
the last three years are summarized as follows:
- -------------------------------------------------------------------------------
1997 VS.
----------
(in billions) 1997 1996 1995 1996 1995
- --------------------------------------------------------------------------
U.S. client assets $ 979/(1)/ $ 792/(2)/ $ 665 24% 47%
Non-U.S. client assets 225/(3)/ 47 38 379 492
------ ------ ------
Total client assets $1,204 $ 839 $ 703 44 71
====== ====== ======
Assets under management:
MLAM/(4)/:
Money market $ 107 $ 90 $ 82 18 30
Equity 72 59 47 21 53
Fixed-income 48 43 41 12 19
Private portfolio 49 38/(2)/ 22 28 117
Insurance 3 4 4 (10) (19)
------ ------ ------
Total 279 234 196 19 42
Mercury 167 - - N/A N/A
------ ------ ------
Total assets under management $ 446 $ 234 $ 196 91 127
====== ====== ======
Merrill Lynch Consults
(Registered Trademark) $ 27 $ 21 $ 17 30 59
Mutual Fund Advisor(Service
Mark) and Asset Power
(Registered Trademark) $ 15 $ 9 $ 6 78 167
- -------------------------------------------------------------------------------
/(1)/ Includes $17 billion of assets related to the acquisition of MasterWorks,
a 401(k) service provider.
/(2)/ Includes $10 billion of assets related to the acquisition of Hotchkis and
Wiley, a Los Angeles-based asset management company.
/(3)/ Includes $167 billion of assets related to the December 1997 acquisition
of Mercury Asset Management.
/(4)/ Merrill Lynch Asset Management.
Worldwide client assets reached an industry record $1.2 trillion during 1997.
Major components of the change in client assets and assets under management
follow:
- -------------------------------------------------------------------------------
NET CHANGES DUE TO
-----------------------
DEC. 27, NEW ASSET DEC. 26,
(in billions) 1996 MONEY/(1)/ APPRECIATION 1997
- ------------------------------------------------------------------
Client assets $839 $258/(2)/ $107 $1,204
Assets under management 234 192 20 446
- ------------------------------------------------------------------
/(1)/ Includes Mercury Asset Management assets of $167 billion.
/(2)/ Includes MasterWorks assets of $17 billion.
Asset management fees increased 21% in 1997 due to net asset appreciation and
strong inflows of client assets. Portfolio service fees were up 39% in 1997,
benefiting from the growth in client accounts and asset levels for various fee
products, including Merrill Lynch Consults, Merrill Lynch Mutual Fund Advisor,
and Asset Power services. Account fees rose 10% principally as a result of
increases in the number of customer and custodial accounts. Other fee-based
revenues were up 16%, due in part to higher revenues from transfer agency and
mortgage servicing activities.
In 1996, asset management and portfolio service fees rose 20% from 1995, due
to increases in client assets and higher levels of asset-based products.
- -------------------------------------------------------------------------------
OTHER REVENUES
- -------------------------------------------------------------------------------
Other revenues were $670 million in 1997, up 1% from 1996. Other revenues
include investment gains and losses, partnership distributions, and fees from
transaction processing and proxy activities. In 1997, other revenues included
realized investment gains, income from the outsourcing of Merrill Lynch's ben-
eficial proxy operation, and gains from sales of mortgages to Real Estate
Mortgage Investment Conduits ("REMICs"), while other revenues in 1996 con-
tained a $155 million pretax gain from the partial sale of a minority interest
in Bloomberg L.P.
In 1996, other revenues rose 48% from 1995 to $666 million due to the partial
sale of the Bloomberg investment and an increase in gains from real estate
transactions, primarily sales of mortgages to REMICs.
1997 Annual Report
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NON-INTEREST EXPENSES
- -------------------------------------------------------------------------------
(in millions) 1997 1996 1995
- ------------------------------------------------------------------------------
Compensation and benefits $ 7,962 $ 6,704 $5,270
------- ------- ------
Non-interest expenses, excluding compensation and
benefits:
Communications and equipment rental 669 559 487
Occupancy 491 508 449
Depreciation and amortization 446 411 367
Professional fees 813 582 425
Advertising and market development 597 514 398
Brokerage, clearing, and exchange fees 505 413 361
Other 1,136 859 697
------- ------- ------
Total non-interest expenses,
excluding compensation and benefits 4,657 3,846 3,184
------- ------- ------
Total non-interest expenses $12,619 $10,550 $8,454
======= ======= ======
Compensation and benefits as
a percentage of net revenues 50.8% 51.1% 51.3%
Compensation and benefits as
a percentage of pretax earnings
before compensation and benefits 72.3% 72.3% 74.4%
- ------------------------------------------------------------------------------
Non-interest expenses in 1997 were up 20% over the prior year. The largest
expense category, compensation and benefits, increased 19% from 1996 due to
higher incentive and production-related compensation and a 14% increase in the
number of full-time employees. Incentive compensation rose as a result of
increased profitability, while production-related compensation was up due to
strong business volume. Full-time employees totaled 56,600 at year-end 1997,
compared with 49,800 at the previous year-end. Headcount increased due to
acquisitions, strategic business expansion, and growth in existing businesses.
The ratio of support employees and sales assistants to producers increased
from 1.51 in 1996 to 1.57 in 1997.
Communications and equipment rental expense was up 20% from 1996 due to
increased business volume, higher technology maintenance costs, and expanded
use of market data services. Occupancy costs decreased 3%, reflecting a nonre-
curring pretax charge in 1996 of $40 million related to the resolution of
Olympia & York's bankruptcy that affected ML & Co.'s long-term sublease agree-
ment in the World Financial Center, partially offset by increased costs
related to international growth. Depreciation and amortization expense rose 9%
from 1996 primarily as a result of purchases of technology-related equipment
during 1997.
Higher systems and management consulting costs related to various technology
projects and other strategic market studies led to a 40% increase in profes-
sional fees. Advertising and market development expense rose 16%, primarily
due to increased global travel related to business development and client pro-
motion costs. Brokerage, clearing, and exchange fees were up 22% as a result
of higher global securities trading volume. Other expenses increased 32% from
1996 due to increases in provisions for various business activities and legal
matters, and higher office and postage costs.
In 1996, non-interest expenses increased 25% from 1995 to $10.6 billion.
Higher incentive and production-related compensation and an 8% growth in full-
time employees led to a 27% increase in compensation and benefits expense.
Communications and equipment rental expense was up 15% due to increased com-
puter maintenance costs related to systems initiatives, as well as higher lev-
els of business activity. Occupancy costs increased 13%, primarily as a result
of the 1996 nonrecurring $40 million pretax charge related to the resolution
of Olympia & York's bankruptcy. Depreciation and amortization expense rose
12%, attributable to purchases of technology-related equipment. Professional
fees increased 37% as a result of higher systems development and management
consulting costs. Advertising and market development expense rose 29% due to
increased international travel and higher production-related recognition pro-
grams. Brokerage, clearing, and exchange fees were up 15% because of higher
securities volume, particularly in non-U.S. markets. Other expenses rose 23%
due in part to provisions related to various business activities and goodwill
amortization.
1997 Annual Report
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
Presented is a bar graph showing Merrill Lynch's fee-based revenues as a
percentage of fixed and semi-fixed expenses
- --------------------------------------------------------------------------------
Fee-Based Revenues as a Percentage of
Fixed and Semi-Fixed Expenses
(in millions)
- --------------------------------------------------------------------------------
Fee-Based Fixed and
Year Revenues* Semi-Fixed Expenses
---- --------- -------------------
1993 59% $4,085
1994 67% $4,255
1995 65% $4,664
1996 65% $5,440
1997 65% $6,418
*Fee-based revenues principally include asset management and
portfolio service fees and net margin interest.
- -------------------------------------------------------------------------------
INCOME TAXES
- -------------------------------------------------------------------------------
Merrill Lynch's 1997 income tax provision of $1.1 billion represented a 36.0%
effective tax rate. In 1996 and 1995, income tax provisions were $947 million
and $697 million, respectively, resulting in effective tax rates of 36.9% in
1996 and 38.5% in 1995. The effective tax rate decreased in 1997 due to a
reduction in state and local taxes associated with the settlement of many
prior-year tax audits.
Deferred tax assets are recorded for the effects of temporary differences
between the tax basis of an asset or liability and its reported amount in the
financial statements. Merrill Lynch assessed its ability to realize deferred
tax assets primarily based on a strong earnings history and the absence of
negative evidence as discussed in Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes". During the last 10 years, aver-
age pretax earnings were $1.5 billion per year. Accordingly, management
believes that it is more likely than not that the deferred tax assets will be
realized.
- --------------------------------------------------------------------------------
ACQUISITIONS
- --------------------------------------------------------------------------------
In 1997, Merrill Lynch acquired Mercury Asset Management Group Holdings PLC
("Mercury"), the leading independent U.K. asset management firm whose clients
include five of the 10 largest global pension funds, for approximately $5.3
billion. The acquisition was recorded on December 26, 1997 and as a result,
had no effect on the statement of earnings. Goodwill of approximately $4.8
billion was recognized and will be amortized over 30 years as a noncash
expense. Going forward, management believes cash earnings and cash return on
equity will be the most relevant measures of financial performance because
they best illustrate Merrill Lynch's operating performance and ability to sup-
port growth.
Merrill Lynch has also made other recent strategic acquisitions to help expand
its global presence and client base. In addition to the Mercury acquisition in
1997, Merrill Lynch acquired MasterWorks, a 401(k) service provider, for $13
million and recorded goodwill of $10 million. Merrill Lynch also hired the
employees of the Centaurus Corporate Finance Group in Australia in late 1997.
Acquisitions made or substantially completed in 1996, which included McIntosh
Securities Limited and Hotchkis and Wiley, were for aggregate consideration of
$232 million, of which $167 million represented goodwill. In 1995, Merrill
Lynch acquired Smith New Court PLC, a U.K.-based global securities firm, for
$803 million and recorded $533 million of goodwill related to the acquisition.
1997 Annual Report
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
STRATEGIC PRIORITIES
- --------------------------------------------------------------------------------
During 1997, Merrill Lynch announced an organizational structure that matches
the manner in which services are provided to clients. Merrill Lynch is now
organized along four key strategic priorities: Corporate and Institutional
Client, U.S. Private Client, International Private Client, and Asset Manage-
ment. These business priorities and their activities are summarized below.
Presented is a pie chart showing Merrill Lynch's percentage of net revenues by
strategic priority.
- --------------------------------------------------------------------------------
Percentage of Net Revenues
By Strategic Priority
- --------------------------------------------------------------------------------
Corporate and
Institutional Client 42%
U.S. Private Client 45%
International
Private Client 6%
Asset Management 7%
For further information on Merrill Lynch's business activities, see "Business
of Merrill Lynch--Description of Business Activities".
- --------------------------------------------------------------------------------
CORPORATE AND INSTITUTIONAL CLIENT
The Corporate and Institutional Client group provides a broad array of finan-
cial services, including securities trading, investment banking, and advisory
services to financial institutions, corporations, and governments worldwide.
The group raises capital for its clients on favorable terms, through securi-
ties underwriting and loan syndication, and has been the leading underwriter
of global debt and equity for nine consecutive years, according to SDC. The
Corporate and Institutional Client group also manages risk and investment
returns by tailoring investments and structuring derivatives to meet clients'
needs. The group is also a leading provider of merger and acquisition advisory
services and, in 1997, ranked first in the U.S. and third in global announced
transactions, according to SDC.
- --------------------------------------------------------------------------------
U.S. PRIVATE CLIENT
The U.S. Private Client group provides a wide range of financial services and
products, advice, and execution to individuals, small businesses, and employee
benefit plans. These products and services are provided through approximately
13,300 Financial Consultants, who assist clients in managing their assets. The
Cash Management Account(Registered Trademark) service for individuals and the
Working Capital Management(Service Mark) account for businesses have been an
integral part of delivering a wide range of client services, including effecting
trades in stocks, bonds, and other securities. In addition, the group serves
clients' diverse liability management needs by offering a broad selection of
mortgage loans and commercial real estate financing, primarily through Merrill
Lynch Credit Corporation. In 1997, the group expanded its client base through
the acquisition of MasterWorks, a 401(k) service provider.
- --------------------------------------------------------------------------------
INTERNATIONAL PRIVATE CLIENT
The International Private Client group provides financial planning, private
banking, and trust and investment services to individuals outside the U.S.,
through a network of 1,100 private bankers and other specialists in more than
30 countries worldwide. The group offers clients investing and advisory serv-
ices similar to those provided in the U.S.
- --------------------------------------------------------------------------------
ASSET MANAGEMENT
The Asset Management group provides investment advisory and portfolio manage-
ment services to clients, principally through Merrill Lynch Asset Management.
Investment research and various advisory programs are offered to clients,
including the Merrill Lynch Consults(Registered Trademark), Merrill Lynch Mutual
Fund Advisor(Service Mark), and Merrill Lynch Mutual Fund Advisor
Selects(Service Mark) services. As one of the largest mutual fund managers, the
group had assets under management of $446 billion at year-end 1997. The group
also provides portfolio management services to large domestic and international
institutional clients. In December 1997, Merrill Lynch
1997 Annual Report
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
acquired Mercury, further strengthening Merrill Lynch's global presence as one
of the premier asset management firms.
- --------------------------------------------------------------------------------
GLOBAL OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch's non-U.S. operations are organized into five geographic
regions:
- Europe, Middle East, and Africa
- Asia and Pacific
- Australia and New Zealand
- Japan
- Latin America and Canada
In 1997, Merrill Lynch continued to strategically expand its U.S. and non-U.S.
operations. This expansion, coupled with previous acquisitions, enabled
Merrill Lynch to continue to benefit from the globalization of financial mar-
kets driven by the increase in cross-border transactions and client demand for
global investments.
In 1997, Merrill Lynch's non-U.S. businesses were influenced by many of the
same market conditions that impacted U.S. operating results, including rising
stock prices, low interest rates, and market volatility that occurred later in
the year. The combination of these market conditions, synergies from acquisi-
tions, and expanded global presence resulted in increases from 1996 levels in
total revenues, net revenues, and earnings before income taxes in most geo-
graphic regions.
- --------------------------------------------------------------------------------
EUROPE, MIDDLE EAST, AND AFRICA
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Total revenues $ 6,750 $ 5,336 $ 3,981
Net revenues $ 2,284 $ 1,837 $ 1,319
Earnings before income taxes $ 405 $ 357 $ 155
Total assets $111,404 $75,901 $56,948
Total full-time employees 6,470 4,610 4,100
- --------------------------------------------------------------------------------
Merrill Lynch operates in Europe, the Middle East, and Africa as a dealer in a
comprehensive array of debt and equity products, as well as providing investment
banking, private banking, asset management, and research services to a wide
range of clients.
The region benefited from a number of market trends during 1997, including
increased privatization activity, growing issuances and restructurings in the
European markets, and numerous strategic acquisitions.
Merrill Lynch continued to enhance its presence in the region during 1997 and
in December announced the purchase of Mercury. This acquisition demonstrates
Merrill Lynch's commitment to its strategic objective of becoming a global
leader in the asset management business and dramatically expands the region's
depth and range of products and services.
In 1997, total and net revenues for the region increased 26% and 24% from
1996, respectively. The increases primarily resulted from higher commissions
and trading revenues. Commissions revenues benefited from increased mutual
fund activity. Trading revenues were up due to higher revenues from equities,
foreign exchange, and emerging market activities.
The 13% increase in earnings before income taxes from 1996 resulted from the
higher revenues, partially offset by increases in expenses from continued
investment in infrastructure to support business growth in the region. Compen-
sation and benefits costs rose due to increased headcount, while professional
fees increased due to higher systems and management consulting costs.
In 1996, total and net revenues for the Europe, Middle East, and Africa region
increased 34% and 39% from 1995, respectively. The increases were primarily
due to higher trading, underwriting, and commissions revenues. The region's
earnings before income taxes more than doubled from 1995, due to increased
revenues and lower costs across the region.
1997 Annual Report
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ASIA AND PACIFIC
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Total revenues $ 586 $ 395 $ 228
Net revenues $ 582 $ 394 $ 227
Earnings before income taxes $ 16 $ 41 $ 7
Total assets $ 797 $ 335 $ 240
Total full-time employees 1,690 1,300 1,060
- --------------------------------------------------------------------------------
Merrill Lynch serves a broad retail and institutional client base throughout
the Asia and Pacific region. In mainland China, the focus is principally on
institutional business opportunities, while in other locations, such as China's
special autonomous region of Hong Kong, Korea, Singapore, Taiwan, and Malaysia,
both retail and institutional activities are conducted. Merrill Lynch has a
trading presence and exchange memberships in virtually all financial markets in
the region. During 1997, Merrill Lynch obtained a dealing/underwriting license
in Taiwan and opened its first office in the Philippines.
Total and net revenues in the region were both up 48% from 1996. Revenues dur-
ing the first half of 1997 benefited from strong trading volume and investment
banking activity. Revenues then declined in the 1997 second half as currency
devaluations across the region significantly affected equity and debt markets,
particularly in Hong Kong and Singapore. The continued drop in the regional
currencies caused significant problems for Asian issuers of U.S. dollar-
denominated debt and significantly weakened the emerging secondary market.
Earnings before income taxes decreased 61% from 1996 due to provisions for
certain client claims in Singapore and increased expenses associated with the
growth in the regional expansion, partially offset by higher trading revenues.
Total and net revenues in the Asia and Pacific region in 1996 were up 73% and
74% from 1995, respectively. Earnings before income taxes rose almost six-fold
from 1995. Results in the region benefited from increased investment banking
revenues, while the integration of Smith New Court added significantly to
equity trading activities. In addition, increased commissions on regional
equities and mutual funds also contributed to higher revenues.
- --------------------------------------------------------------------------------
AUSTRALIA AND NEW ZEALAND
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Total revenues $ 272 $ 151 $163
Net revenues $ 229 $ 88 $ 66
Earnings before income taxes $ 39 $ 24 $ 14
Total assets $1,899 $1,115 $976
Total full-time employees 780 160 130
- --------------------------------------------------------------------------------
In the Australia and New Zealand region, Merrill Lynch provides a broad mix of
retail and institutional activities. In early 1997, Merrill Lynch completed
the acquisition of McIntosh Securities Limited, one of the largest securities
brokerage firms in Australia and New Zealand. In late 1997, Merrill Lynch fur-
ther expanded and strengthened its position in the region with the addition of
the staff and clients of Centaurus Corporate Finance Group, a top-tier Austra-
lian merger and acquisition advisory firm.
Total and net revenues for the region increased 80% and 160% from 1996,
respectively. The increases primarily resulted from higher equity trading and
investment banking revenues. Equity trading revenues rose due to improved mar-
ket conditions and increased capacity related to the acquisition of McIntosh.
Investment banking revenues were also higher, benefiting from increased cross-
border activities. In addition, Merrill Lynch also increased its market share
on the Australian Stock Exchange during 1997, attaining the number two posi-
tion.
Earnings before income taxes increased 63% from 1996. Partially offsetting the
increase in revenues was higher incentive and production-related compensation
costs due to growth in the region.
Total revenues in the Australia and New Zealand region in 1996 were down 7%,
while net revenues were up 33% from 1995. Earnings before income taxes rose
71% from 1995. Equities trading revenues increased as a result of improved
corporate earnings and market conditions.
1997 Annual Report
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
JAPAN
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Total revenues $ 1,108 $ 993 $ 841
Net revenues $ 598 $ 502 $ 408
Earnings before income taxes $ 140 $ 119 $ 60
Total assets $15,294 $16,455 $15,698
Total full-time employees 780 630 585
- --------------------------------------------------------------------------------
In Japan, Merrill Lynch operates as a dealer in a full range of debt and
equity products and provides investment banking and research services to a
predominantly institutional client base. In addition during 1997, Merrill
Lynch continued to build a solid base for its asset management business in
Japan, which has been augmented by the acquisition of Mercury and its existing
local client base. In December, Merrill Lynch Japan raised approximately $1
billion for Income Strategies Portfolio, making it one of the most successful
offshore open-end funds launched in Japan.
Subsequent to year end, Merrill Lynch announced its re-entry into the Japanese
retail securities business, through the planned opening of approximately 30
offices in Japan and the anticipated hiring of about 2,000 former employees of
Yamaichi Securities Co. This re-entry is expected to benefit both Private Cli-
ent and Asset Management activities.
Total and net revenues in the Japan region were up 12% and 19% from 1996,
respectively. Increased derivative trading revenues and sales of cross-border
products were partially offset by lower trading revenues for local products.
These higher revenues led to an increase in earnings before income taxes of
18%.
Total and net revenues in the Japan region in 1996 were up 18% and 23% from
1995, respectively. Earnings before income taxes increased 98% from 1995. The
increases were due to higher sales of cross-border products, partially offset
by lower revenues from local products.
- --------------------------------------------------------------------------------
LATIN AMERICA AND CANADA
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
Total revenues $1,048 $ 826 $ 704
Net revenues $ 738 $ 472 $ 347
Earnings before income taxes $ 227 $ 128 $ 127
Total assets $7,054 $5,205 $4,997
Total full-time employees 1,180 1,000 875
- --------------------------------------------------------------------------------
In Latin America, Merrill Lynch provides varied brokerage and investment serv-
ices. Included in the Latin America region are certain U.S. offices that pri-
marily serve Latin American clients. Latin America experienced strong growth
during the first half of the year due to low inflation and significant foreign
capital inflows. This growth was significantly affected in the second half of
the year as the uncertainty of the Asian markets spread to Latin American mar-
kets. In Canada, Merrill Lynch provides investment banking, research, fixed-
income sales, and trading services.
Total and net revenues for the region increased 27% and 56% from 1996, respec-
tively. Trading and underwriting activities in Latin America were up from 1996
levels due to increased investor demand for higher-yielding securities,
despite the volatility that occurred late in the year. In addition, Latin
American results benefited from increased commissions due to higher mutual
fund sales. Canadian results increased due to the favorable interest rate
environment and strong cross-border activities in mergers and acquisitions.
Earnings before income taxes rose 77%. Higher revenues from sales and under-
writing activities were partially offset by increases in variable expenses,
such as compensation costs and brokerage, clearing, and exchange fees. The
additional commitment of resources to the region in 1997 also contributed to
higher compensation costs.
Total and net revenues in the Latin America and Canada region in 1996
increased 17% and 36% from 1995, respectively, while earnings before income
taxes increased 1% from 1995. A strong economic environment combined with
higher revenues from high-yield financing and rising bond prices led to these
increases. The advance in revenues was offset by higher compensation and
infrastructure costs.
1997 Annual Report
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
BALANCE SHEET
- --------------------------------------------------------------------------------
Trading-related balances accounted for approximately 85% of assets and 64% of
liabilities at December 26, 1997. As presented below, securities trading,
derivatives dealing, and related activities result in trading asset/liability,
resale/repurchase agreement, securities borrowed/loaned transaction, and cer-
tain receivable/payable balances.
Presented are two pie charts illustrating Merrill Lynch's trading-related
balances as percentages of total assets and total liabilities, respectively.
- --------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------
Trading Related:
Trading Assets 36%
Resale Agreements 24
Securities Borrowed 12
Receivables 13
--
85
Non-Trading-Related 15
--
100%
===
- --------------------------------------------------------------------------------
Liabilities
- --------------------------------------------------------------------------------
Trading Related:
Trading Liabilities 25%
Repurchase Agreements 25
Securities Loaned 2
Payables 12
--
64
Non-Trading-Related 36
100%
===
Although trading-related balances comprise a significant portion of the bal-
ance sheet, the magnitude of these balances do not necessarily convey a sense
of the risk profile assumed by Merrill Lynch. Hedging strategies and compli-
ance with collateral maintenance policies, as discussed later, mitigate risk
exposures.
- -------------------------------------------------------------------------------
TRADING ASSETS AND LIABILITIES
Trading assets and liabilities principally represent securities purchased
("long" positions) and securities sold but not yet purchased ("short" posi-
tions), respectively. Trading assets and liabilities also include receivables
and payables that represent the fair value of derivatives (see Note 1 to the
Consolidated Financial Statements).
Merrill Lynch acts as a market maker in many securities, maintaining a signif-
icant 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 hedging techniques to manage trading inventory market risks
(see Note 3 to the Consolidated Financial Statements). A significant portion
of trading assets and liabilities, including derivatives, represents hedges of
other trading positions. Many short U.S. Government securities and futures
positions, for example, hedge various interest-sensitive trading assets. Hedg-
ing techniques at the trading unit level are supplemented by corporate risk
management policies and procedures. For a description of risk management poli-
cies and procedures and a discussion of the effectiveness of hedging tech-
niques, see the "Risk Management" section.
- -------------------------------------------------------------------------------
RESALE/REPURCHASE AGREEMENTS AND SECURITIES BORROWED/LOANED TRANSACTIONS
Repurchase agreements and, to a lesser extent, securities loaned transactions
are used to fund a significant portion of trading assets. Likewise, Merrill
Lynch uses resale agreements and securities borrowed transactions to obtain
the securities needed for delivery on short positions. "Matched-book" repur-
chase and resale agreements or securities borrowed and loaned transactions are
entered into with different counterparties using the same underlying securi-
ties in order to generate 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 (see "Collateral" section). The following graph illustrates
the balances related to these activities at December 26, 1997.
1997 Annual Report
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
Presented is a bar graph illustrating the nature of resale/repurchase agreements
and securities borrowed/loaned transactions, differentiating between matched-
book and non-matched-book for total resale agreements, repurchase agreements,
securities borrowed, and securities loaned balances of $70,262, $71,044,
$35,366, and $6,831, respectively.
- --------------------------------------------------------------------------------
Resale/Repurchase Agreements and
Securities Borrowed/Loaned Transactions
(in millions)
- --------------------------------------------------------------------------------
Matched- Non-Matched-
Book Book
-------- -----------
Resale Agreements 64% 36%
Repurchase Agreements 63 37
Securities Borrowed Transactions 11 89
Securities Loaned Transactions 55 45
- -------------------------------------------------------------------------------
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 cus-
tomers 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 collater-
alized 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.
- -------------------------------------------------------------------------------
COLLATERAL
The table that follows presents reported assets at December 26, 1997 and the
related collateral maintained by Merrill Lynch to reduce default risk exposure.
- -------------------------------------------------------------------------------
BALANCE COLLATERAL
(in millions) SHEET MAINTAINED
- ------------------------------------------------------------------------------
Cash and cash equivalents $ 5,032 $ -
Cash and securities segregated for regulatory purposes or
deposited with clearing organizations 12,384 -
Marketable investment securities 3,309 -
Trading assets/(a)/ 106,778 4,750
Receivables under resale agreements/(b)/ 70,262 71,121
Receivables under securities borrowed transactions/(b)/ 35,366 33,121
Other receivables/(c)/ 39,743 27,059
Investments of insurance subsidiaries 4,833 -
Loans, notes, and mortgages/(d)/ 4,310 4,105
Other investments 1,826 -
Property, leasehold improvements, and equipment 2,074 -
Goodwill 5,455 -
Other assets 1,447 -
-------- --------
Total Assets $292,819 $140,156
======== ========
- ------------------------------------------------------------------------------
/(a)/ Various techniques reduce credit risk on trading assets, including
maintaining collateral on derivative contract receivables.
/(b)/ The risk of default on receivables under resale agreements and securities
borrowed transactions is substantially eliminated by maintaining related
securities with fair values in accordance with specific collateral
guidelines.
/(c)/ To the extent possible, collateral is taken to secure receivables. For
instance, Merrill Lynch maintains collateral substantially in excess of
customer margin loan receivables, and broker-dealer receivables are
substantially collateralized by the related securities. The collateral
amounts above do not include overcollateralization.
/(d)/ Merrill Lynch generally maintains collateral on these extensions of credit
in the form of securities, liens on real estate, perfected security
interests in other assets of the borrower, and guarantees.
Besides requiring collateral, Merrill Lynch's Corporate Credit group uses
other techniques to manage credit risk (see "Risk Management" section).
1997 Annual Report
18
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
Merrill Lynch monitors changes in its balance sheet using average daily bal-
ances that are determined on a settlement date basis and reported for manage-
ment information purposes. Financial statement balances are recorded on a
trade date basis as required under generally accepted accounting principles.
The following discussion compares changes in settlement date average daily
balances. These changes were consistent with the growth in the year-end finan-
cial statement balances.
In 1997, average daily assets were $286 billion, up 32% from $216 billion in
1996. Average daily liabilities in 1997 rose 32% to $277 billion from $209
billion in 1996. The major components in the growth of average assets and lia-
bilities are summarized as follows:
- -------------------------------------------------------------------------------
INCREASE
IN AVERAGE PERCENT
(in millions) ASSETS INCREASE
- -------------------------------------------------------------------------------
Trading assets $35,961 50%
Receivables under resale agreements
and securities borrowed transactions 19,893 21
Customer receivables 6,816 30
- --------------------------------------------------------------------------------
INCREASE
IN AVERAGE PERCENT
LIABILITIES INCREASE
- --------------------------------------------------------------------------------
Payables under repurchase agreements
and securities loaned transactions $17,726 21%
Trading liabilities 17,663 42
Long-term borrowings 12,604 55
Commercial paper and other
short-term borrowings 11,959 38
- --------------------------------------------------------------------------------
Due to the adoption of SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities", both average asset
balances (trading assets and receivables under resale agreements) and average
liability balances (payables under repurchase agreements) increased by approx-
imately $3 billion (see Note 2 to the Consolidated Financial Statements for more
information on SFAS No. 125). In addition, during 1997 trading assets and
liabilities (which include on-balance-sheet hedges used to manage trading risks)
rose as volume increased, benefiting from higher customer demand. Increases in
secured lending activity, in the form of margin and other collateralized loans,
led to higher levels of customer receivables.
Receivables under resale agreements and securities borrowed transactions and
payables under repurchase agreements and securities loaned transactions rose
to meet higher funding requirements for increased trading activity. In addi-
tion, these transactions increased as a result of expanded matched-book
activity, primarily involving governments and agencies securities.
Assets are funded through diversified sources which include repurchase agree-
ments and securities loaned transactions, commercial paper and short-term
borrowings, long-term borrowings, and equity. In addition to the increases in
repurchase agreements and securities loaned transactions, the growth in aver-
age assets was funded by higher long-term borrowings, particularly medium-term
notes, and commercial paper.
- -------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Stockholders' equity at December 26, 1997 increased 21% to $8.3 billion from
$6.9 billion at year-end 1996. The 1997 increase resulted from net earnings
and the net effect of employee stock transactions, partially offset by common
share repurchases and dividends. In 1997 and 1996, Merrill Lynch repurchased
13.7 million and 37.2 million common shares at average prices of $48.91 and
$31.30 per share, respectively. Merrill Lynch will continue to consider share
repurchases, taking into account capital needs and the effect of issuances
under employee stock plans.
In the second quarter of 1997, Merrill Lynch's 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. According-
ly, an adjustment from paid-in capital to common stock was made to preserve
the par value of the post-split shares. All share and per share data have been
restated for the effect of the split.
At December 26, 1997, total common shares outstanding were 335.1 million, 2%
higher than the
1997 Annual Report
19
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
328.2 million shares outstanding at December 27, 1996. The increase was
attributable principally to employee stock grants and option exercises, par-
tially offset by common share repurchases.
During the first quarter of 1997, all shares of the outstanding Remarketed
Preferred(Service Mark) Stock, Series C were redeemed.
- --------------------------------------------------------------------------------
LIQUIDITY AND LIABILITY MANAGEMENT
- --------------------------------------------------------------------------------
The primary objective of Merrill Lynch's funding policies is to assure
liquidity at all times. Merrill Lynch's liquidity management strategy has three
key components:
1. Maintain alternative funding sources such that all debt obligations matur-
ing within one year can be funded when due without issuing new unsecured
debt or liquidating business assets;
2. Concentrate unsecured, general purpose borrowings at the ML & Co. level;
and
3. Expand and diversify Merrill Lynch's funding programs.
Merrill Lynch's primary alternative funding sources to unsecured borrowings
are repurchase agreements and secured bank loans, which require pledging
unhypothecated marketable securities. Other funding alternatives include
liquidating cash equivalents; securitizing loan assets; and drawing on commit-
ted, unsecured bank credit facilities that, at December 26, 1997, totaled $6.8
billion and were not drawn upon. To finance the purchase of Mercury, Merrill
Lynch obtained additional short-term bank credit facilities totaling 2.0 bil-
lion British pounds (approximately $3.3 billion), which as of year end had not
been drawn upon. Subsequently, Merrill Lynch drew upon these facilities. These
borrowings are expected to be repaid during 1998 with proceeds from long-term
financing.
Merrill Lynch regularly reviews the level and mix of its assets and liabili-
ties to assess its ability to conduct core business activities without issuing
new unsecured debt or drawing upon its bank credit facilities. The mix of
assets and liabilities provides flexibility in managing liquidity since a sig-
nificant portion of assets turns over frequently and is typically match-funded
with liabilities having similar maturities and cash flow characteristics. At
December 26, 1997, substantially all of Merrill Lynch's assets were considered
readily marketable by management.
Merrill Lynch concentrates its unsecured, general purpose borrowings 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 enhanced flexibility to meet variable funding requirements of subsidiaries.
Merrill Lynch also strives to expand and diversify its funding programs and
investor and creditor base. Merrill Lynch benefits by distributing its debt
through its own sales force to a large, diversified customer base. Addition-
ally, Merrill Lynch maintains strict concentration standards for short-term
borrowings, including limits for any single investor.
Commercial paper is the major source of short-term general purpose funding.
Commercial paper outstanding totaled $30.4 billion at December 26, 1997 and
$23.6 billion at December 27, 1996, which represented 10% and 11% of total
assets at year-end 1997 and 1996, respectively.
Outstanding long-term debt at December 26, 1997 increased to $43.1 billion
from $26.1 billion at December 27, 1996. Major components of the change in
long-term debt for 1997 and 1996 follow:
- --------------------------------------------------------------------------------
(in billions) 1997 1996
- --------------------------------------------------------------------------------
Beginning of year $26.1 $17.3
Issuances 24.2 15.0
Maturities (6.8) (6.1)
Other (0.4) (0.1)
----- -----
End of year/(1)/ $43.1 $26.1
===== =====
Average maturity in years of
long-term debt,
when measured to:
Maturity 3.5 3.5
Earlier of the call or put
date 3.1 3.2
- --------------------------------------------------------------------------------
/(1)/ At year-end 1997 and 1996, $31.0 and $20.1 billion of long-term debt had
maturity dates beyond one year, respectively.
1997 Annual Report
20
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Merrill Lynch's senior long-term debt, preferred stock, and Trust Originated
Preferred Securities(Service Mark) ("TOPrS"(Registered Trademark)) were rated by
recognized credit rating agencies at December 26, 1997 as follows:
- --------------------------------------------------------------------------------
SENIOR PREFERRED STOCK
DEBT AND TOPrS
RATING AGENCY RATINGS RATINGS
- --------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. AA AA-
Fitch IBCA, Inc. AA AA-
The Japan Bond Research Institute AA Not Rated
Moody's Investors Service, Inc. Aa3 aa3
Standard & Poor's AA- A
Thomson BankWatch, Inc. AA+ Not Rated
- --------------------------------------------------------------------------------
Approximately $75.2 billion of indebtedness at December 26, 1997 is
considered senior indebtedness as defined under various indentures.
As part of an overall liquidity management strategy, Merrill Lynch's
insurance subsidiaries regularly review the funding requirements of their
contractual obligations for in-force, fixed-rate life insurance and annuity
contracts as well as expected future acquisition and maintenance expenses for
all contracts. The insurance subsidiaries market primarily variable life
insurance and variable annuity products. These products are not subject to the
interest rate, asset/liability matching, or credit risks attributable to fixed-
rate products, thereby reducing the insurance subsidiaries' risk profile and
liquidity demands. At December 26, 1997, approximately 84% of invested assets of
insurance subsidiaries were considered liquid by management.
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND CAPITAL ADEQUACY
- --------------------------------------------------------------------------------
Among U.S. institutions engaged primarily in the global securities business,
Merrill Lynch is one of the most highly capitalized, with $7.9 billion in com-
mon equity and $425 million in preferred stock at December 26, 1997 (see
"Stockholders' Equity" in the "Balance Sheet" section). In 1997, a trust
subsidiary of ML & Co. issued $300 million of TOPrS. These subsidiary-issued
preferred securities, along with $327 million of preferred securities
outstanding in other subsidiaries, further strengthen Merrill Lynch's equity
capital base. Subsequent to year-end 1997, $750 million of TOPrS were issued by
another trust subsidiary (see Note 6 to the Consolidated Financial Statements).
Merrill Lynch's leverage ratios were as follows:
- --------------------------------------------------------------------------------
ADJUSTED
LEVERAGE LEVERAGE
RATIO/(1)/ RATIO/(2)/
- --------------------------------------------------------------------------------
YEAR END
December 26, 1997 32.7x 20.9x
December 27, 1996 29.5x 18.0x
AVERAGE FOR YEAR
ENDED/(3)/
December 26, 1997 35.5x 21.5x
December 27, 1996 33.5x 19.9x
- --------------------------------------------------------------------------------
/(1)/ Total assets to total stockholders' equity and preferred securities issued
by subsidiaries.
/(2)/ Total assets less receivables under resale agreements and securities
borrowed transactions to total stockholders' equity and preferred
securities issued by subsidiaries.
/(3)/ Computed using month-end balances.
Overall capital needs are continually reviewed to ensure that Merrill Lynch's
capital base can support the estimated risks of its businesses as well as the
regulatory and legal capital requirements of its subsidiaries. Statistically
based product risk models are used to estimate potential losses arising from
market and credit risks. These dynamic models incorporate changes in business
risk into Merrill Lynch's equity requirements. Based upon these analyses as
well as other criteria, management believes that Merrill Lynch's equity capi-
tal base is adequate.
Merrill Lynch operates in many regulated businesses that require various
minimum levels of capital (see Note 11 to the Consolidated Financial Statements
and "Business of Merrill Lynch--Regulation"). 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, making affiliated investments, and entering into
management and service agreements with affiliated companies.
1997 Annual Report
21
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CAPITAL PROJECTS AND EXPENDITURES
- --------------------------------------------------------------------------------
Merrill Lynch continually prepares for the future by expanding its operations
and investing in new technology to improve service to clients. To support
business expansion, for example, Merrill Lynch plans to build a new European
headquarters in London for approximately $650 million. Completion of this
facility is expected in 2001. During 1997, Merrill Lynch also approved a plan
to construct an office complex in central New Jersey to consolidate certain
operations. Construction costs are estimated at approximately $325 million,
and completion of this facility is anticipated in 2000.
Significant technology initiatives include Merrill Lynch Trusted Global
Advisor(Service Mark) ("TGA" Service Mark) and Year 2000 systems compliance. The
TGA system, a technology platform for Financial Consultants, is expected to be
available to all U.S. Financial Consultants by the end of the 1998 third
quarter. New system applications will be added to the platform at various times
throughout 1998. The projected remaining cost for the TGA system is
approximately $200 million.
The modifications for Year 2000 systems compliance are proceeding according to
plan and are expected to be completed in early 1999. Based on information cur-
rently available, the remaining expenditures are estimated at $200 million and
will cover hardware and software upgrades, systems consulting, and computer
maintenance. These expenditures are not expected to have a material adverse
impact on Merrill Lynch's financial position, results of operations, or cash
flows in future periods. However, the failure of Merrill Lynch's securities
exchanges, clearing organizations, vendors, clients, or regulators to resolve
their own processing issues in a timely manner could result in a material
financial risk. Merrill Lynch is devoting necessary resources to address all
Year 2000 issues in a timely manner.
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch's operating activities expose it to many risks that are continu-
ally monitored, evaluated, and managed. Proper management of these risks helps
reduce the likelihood of earnings volatility. Business units typically hedge
risks arising either from individual transactions or portfolios of similar
transactions to manage risk at the legal entity level. Hedging techniques will
vary based on many factors, including the nature and extent of the risks
involved. The effectiveness of hedging techniques and corporate risk manage-
ment policies and procedures is illustrated by analyzing actual net trading-
related revenues over time. The nature of Merrill Lynch's trading-related
activities, which are principally client order flow-driven, combined with its
risk management strategies, help to reduce earnings volatility. A distribution
of weekly net trading-related revenues, net of reserves, for each of the last
three years is presented in the graph that follows.
Presented is a bar graph illustrating the distribution of weekly net
trading-related revenues by revenue band for 1995, 1996, and 1997.
- --------------------------------------------------------------------------------
Distribution of Weekly Net
Trading-Related Revenues by Year
(in millions)
- --------------------------------------------------------------------------------
1995 1996 1997
---- ---- ----
Number of Weeks:
$ 0-40 million - 1 3
$ 40-80 million 20 12 6
$ 80-120 million 29 38 21
$120-160 million 3 1 19
Over $160 million - - 3
--- --- ---
52 52 52
=== === ===
1997 Annual Report
22
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
To supplement risk management at the business unit level, Merrill Lynch has
developed corporate governance policies and procedures that require specific
areas and units to assist in the identification, assessment, and control of
these risks. These policies and procedures are performed by many groups,
including the Global Risk Management Group ("Risk Management"); the Credit
Division ("Corporate Credit"); and other control units, including Finance,
Audit, Operations, and Law and Compliance ("Control Units"). In addition to
independent risk management responsibilities, senior management from Risk Man-
agement, Corporate Credit, and the Control Units take an active role in the
oversight of the risk management process through the Risk Control and Reserve
Committees.
The Risk Control Committee and Risk Management provide general risk oversight
for all institutional trading activities. The Risk Control Committee, chaired
by the head of Risk Management, reports periodically to the Audit and Finance
Committee of the Board of Directors and is independent of Merrill Lynch's
trading units. The Risk Control Committee's activities are also designed to
ensure compliance with Merrill Lynch's commitment under the Derivatives Policy
Group's Framework for Voluntary Oversight.
The Reserve Committee monitors valuation and certain other risks associated
with assets and liabilities. Merrill Lynch establishes reserves in the Consol-
idated Balance Sheets for existing conditions, events, or circumstances that
may indicate that the realizable value of an asset has been reduced below its
carrying value or that a liability has been incurred. The Reserve Committee,
chaired by the Chief Financial Officer, reviews and approves firmwide reserve
levels, as well as changes in reserve methodologies. The Reserve Committee
meets monthly to review current market conditions and to act on specific
issues. Merrill Lynch's reserves take into account management's judgment and
are generally based on:
- - identification of risks and exposures,
- - formulas, and
- - aging, concentration, and liquidity analyses.
The following discussions of market, credit, operating, and other risks high-
light the corporate policies and procedures for risk identification, assess-
ment, and control. Further discussion of market and credit risk is contained
in Note 3 to the Consolidated Financial Statements.
- -------------------------------------------------------------------------------
MARKET RISK
Market risk is the potential change in a financial instrument's value caused
by fluctuations in interest and currency exchange rates, equity and commodity
prices, and credit spreads. Risk Management is responsible for the measure-
ment, monitoring, and control of market risk on trading positions, including
the establishment of trading limits throughout the firm.
Over the last several years, measuring market risk with mathematical models
has become the focal point of many risk management efforts worldwide, with the
term "risk management" becoming almost synonymous with "risk measurement". In
general, Merrill Lynch believes that the primary risk of a product is not in
the product itself, but in the way in which the product is managed. Breaches
of discipline or lapses in supervision can result in losses irrespective of
the products involved or the mathematical models used.
Approximately ten years ago, Merrill Lynch implemented a firmwide risk process
based on the belief that there is more to risk management than identifying and
measuring risk. The process itself has been strengthened by experience, but
the underlying philosophy is essentially unchanged. This philosophy is based
on the following six principles:
1. The most important tools in any risk process are experience, judgment, and
constant communication with risk takers.
2. Vigilance, discipline, and an awareness of risk must be continuously empha-
sized throughout the firm.
3. Management must provide a clear and simple statement as to what can and
cannot be done in committing capital.
1997 Annual Report
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
4. Risk Management must consider the unexpected, probe for potential problems,
test for weaknesses, and help identify potential for loss.
5. The process must be flexible to permit adaptation to changing environments,
including the evolving goals of Merrill Lynch itself.
6. The key objective must be to minimize the possibility of incurring unac-
ceptable loss. Such losses usually arise from unexpected events that most
statistical model-based risk methodologies cannot predict.
- -------------------------------------------------------------------------------
Risk Management Process
Risk Management is organized along geographic and product lines to ensure
direct and frequent communication with specific trading areas. In addition,
Risk Management performs regular, formal risk reviews with senior trading man-
agers.
Risk Management has established certain controls and guidelines to supplement
hedging techniques at the trading unit level (see "Trading Assets and Liabili-
ties" in the "Balance Sheet" section for further information on these tech-
niques). Risk Management sets and monitors trading limits, which may not be
exceeded without prior approval. In addition, Risk Management and representa-
tives from other Control Units approve new types of transactions as part of
the new product review process. Certain commitments are subject to prior
approval from Risk Management and other Control Units. These commitments
include underwritings of equity, high-yield, and emerging market securities,
real estate financings, and bridge loans. Risk Management also has authority
to require reductions in specific trading desk exposures or to veto proposed
transactions.
Risk Management uses several risk technology tools, including a risk inventory
database, a trading limit monitoring system, and trading system access. The
risk inventory database provides daily consolidation of securities inventory
exposure by product, credit rating, country, etc., along with concentrations
of exposure. The trading limit monitoring system enables Risk Management to
review compliance with established limits. Access to trading systems allows
Risk Management to monitor positions and perform computerized analytics.
Merrill Lynch also uses mathematical risk models, including value-at-risk and
sensitivity analysis, to help estimate its exposure to market risk. Neverthe-
less, Merrill Lynch believes that the use of mathematical risk models alone
may provide a greater sense of security than warranted; therefore, reliance on
these models should be limited. In fact, because of the inability of mathemat-
ical risk models to quantify large-scale potential financial events with any
precision, these models only serve to supplement other risk management
efforts. In order to satisfy the Securities and Exchange Commission's market
risk disclosure requirements, however, value-at-risk measures are presented.
Value-at-risk is a statistical measure of the potential loss in the fair value
of a portfolio due to adverse movements in underlying risk factors. For these
disclosures, Merrill Lynch uses a historical simulation approach to estimate
value-at-risk using a one-week holding period for trading and non-trading
instruments. Sensitivities to market risk factors are aggregated and combined
with a database of historical weekly changes in market factors to simulate a
series of profits and losses. The level of loss that is exceeded in that
series 1% of the time is used as the estimate for the 99% confidence level
value-at-risk.
The reader should be aware that a number of assumptions must be made to obtain
the sensitivities and simulated profits and losses. There is no reason to
believe that the historically simulated profits and losses have any predictive
power for the future distribution of profits and losses. Hypothetical gains
and losses from simulated changes in risk factors for the trading portfolio
would be reflected in earnings since these instruments are accounted for at
fair value. Hypothetical gains and losses from simulated changes in risk fac-
tors for the non-trading portfolio generally would not be reflected in earn-
ings since these instruments are typically accounted for at historical cost.
1997 Annual Report
24
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
All trading units communicate daily to Risk Management the sensitivity of
their positions to changes in risk factors. The table that follows presents
Merrill Lynch's value-at-risk for trading instruments at December 26, 1997:
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Market risks:
Interest rate $60
Equity 32
Commodity 17
Currency 13
- --------------------------------------------------------------------------------
Risk Management does not monitor sensitivities to market risk for non-trading
instruments since earnings generally are not impacted by such sensitivities.
The table below presents Merrill Lynch's value-at-risk for non-trading instru-
ments at December 26, 1997:
- --------------------------------------------------------------------------------
(in millions)
- --------------------------------------------------------------------------------
Market risks:
Currency $32
Interest rate 10
Equity 5
- --------------------------------------------------------------------------------
For information on qualitative aspects of market risk, see Note 3 to the Con-
solidated Financial Statements.
- -------------------------------------------------------------------------------
CREDIT RISK
Credit risk represents the loss that Merrill Lynch would incur if a
counterparty or issuer failed to perform its contractual obligations. Policies
and procedures have been established with the objective of protecting against
such losses, which include:
- - reviewing and establishing limits for credit exposures,
- - further limiting counterparty credit exposures through various techniques,
including maintaining collateral and obtaining the right to terminate trans-
actions or collect collateral in the event of a credit downgrade, and
- - continually assessing the creditworthiness of counterparties and issuers.
The responsibility for compliance with these policies and procedures rests
with the business units and is monitored by Corporate Credit.
Corporate Credit is centralized and organized geographically. The Sovereign
Credit Risk group analyzes the political, economic, and financial conditions
of a country, establishes credit ratings, and recommends overall risk limits.
Regional credit groups, in addition to evaluating the creditworthiness of spe-
cific counterparties, enhance the country analysis by ensuring that total
credit risks are within country concentration limits. Credit officers also set
limits by counterparty or issuer, recommend credit reserves, manage credit
exposures, and participate in the new product review process.
Many types of transactions, including most derivatives and syndicated loans,
are subject to prior approval from Corporate Credit. Within Corporate Credit,
approval levels have been established based on counterparty or issuer credit
quality and the potential risk of the transaction. Transactions that exceed
prescribed levels must be approved by the Credit Committee, which includes
several Directors of Corporate Credit and the Chief Credit Officer.
The credit system tracks information from automated and manual sources to ena-
ble Corporate Credit to monitor counterparty/issuer, product, and country con-
centrations. This system aggregates credit exposure by counterparty/issuer,
maintains overall counterparty/ issuer and specific product limits, and iden-
tifies limit review dates by counterparty/issuer. Detailed information on
firmwide inventory positions and executed transactions, including current and
potential credit exposure, is updated frequently and compared with limits.
Collateral holdings, which reduce credit exposure, are also tracked on the
credit system.
Corporate Credit works with the trading units to develop and refine credit
risk measurement models and to analyze potential credit exposures for complex
derivative transactions. Credit exposures related to Merrill Lynch's retail
customer business, including mortgages and home equity lines of credit, cus-
tomer margin accounts, and working capital facilities to small businesses, are
continually monitored.
1997 Annual Report
25
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
OPERATING RISK
Operating risk focuses on Merrill Lynch's ability to accumulate, process, pro-
tect, and communicate information necessary to conduct business in a global
market environment. It includes the execution of legal, fiduciary, and agency
responsibilities. Merrill Lynch manages operating risk in many ways, including
maintaining backup facilities, using technology, employing experienced person-
nel, and maintaining a comprehensive system of internal controls.
Merrill Lynch maintains key backup facilities worldwide and updates systems
and equipment as required in response to changes in business conditions and
technology needs. An example is the extensive work currently being performed
to become Year 2000-compliant (see "Capital Projects and Expenditures" section).
In addition, experienced operations personnel provide support and control for
trading, clearance, and settlement activities and perform custodial functions
for customer and proprietary assets. Merrill Lynch regularly reviews its
framework of internal controls, taking into account changing circumstances.
Corrective actions are taken to address control deficiencies and opportunities
for improvement are implemented when cost-effective.
From a legal standpoint, risk arises from the enforceability of clients' and
counterparties' obligations to and from Merrill Lynch, including obtaining
contractual provisions intended to reduce credit exposure by providing for the
netting of mutual obligations. The firm seeks to mitigate such risk by:
- developing policies that enhance enforceability of transactions;
- monitoring compliance with internal policies and external regulations; and
- requiring consultation with internal and external legal advisors for non-
standard transactions.
Fiduciaries and agents have obligations to act on behalf of others. Such risks
are inherent in brokerage and investment management activities. Merrill Lynch
has a number of policies in place to ensure that obligations to clients are
met and that Merrill Lynch is in compliance with applicable legal and regula-
tory requirements.
- --------------------------------------------------------------------------------
OTHER RISKS
Liquidity risk arises in the course of Merrill Lynch's general funding activi-
ties and in the management of the balance sheet. It includes both the risk of
being unable to raise funding with appropriate maturity and interest rate
characteristics and the risk of being unable to liquidate an asset in a timely
manner at a reasonable price. For more information on how Merrill Lynch man-
ages liquidity risks, see the "Liquidity and Liability Management" section.
Other risks Merrill Lynch encounters include political, tax, and regulatory
risks. These risks revolve around the impact that changes in local laws, regu-
latory requirements, or tax statutes would have on the viability, profitabili-
ty, or cost-effectiveness of existing or future transactions. To help mitigate
the effects of these risks, Merrill Lynch constantly reviews new and pending
legislation and regulations by employing professionals in the jurisdictions in
which the company operates to actively follow these issues and participate in
related interest groups.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve risks
related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes these
risks and, whenever possible, employs strategies to mitigate exposures. The
specific components and overall level of non-investment grade and highly
leveraged positions may vary significantly from period to period as a result
of inventory turnover, investment sales, and asset redeployment.
1997 Annual Report
26
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment bank-
ing, market-making, and derivative structuring activities. During the past
year, non-investment grade trading inventories increased to satisfy growing
client demand for higher-yielding investments, including emerging market and
other non-U.S. securities.
Non-investment grade securities have been defined as debt and preferred equity
securities rated as BB+ or lower, or equivalent ratings by recognized credit
rating agencies, certain sovereign debt in emerging markets, amounts due under
various derivative contracts from non-investment grade counterparties, and
other instruments that, in the opinion of management, are non-investment
grade. Non-investment grade trading inventories are carried at fair value.
Merrill Lynch's insurance subsidiaries also hold non-investment grade invest-
ment securities that are classified as available-for-sale and are carried at
fair value.
A summary of positions with non-investment grade issuers (for cash instru-
ments) or counterparties (for derivatives in a gain position) follows:
- --------------------------------------------------------------------------------
(in millions) 1997 1996
- --------------------------------------------------------------------------------
Trading assets:
Cash instruments $12,993 $7,585
Derivatives/(1)/ 3,079 2,470
Trading liabilities - cash instruments 2,962 905
Marketable investment securities 648 -
Insurance subsidiaries' investments 192 206
- --------------------------------------------------------------------------------
/(1)/ Collateral of $599 and $848 was obtained at December 26, 1997 and December
27, 1996, respectively, to reduce risk related to these derivative
balances.
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 26, 1997 and December 27, 1996, the carrying value of such debt and
equity securities totaled $142 million and $133 million, of which 56% and 58%
resulted from Merrill Lynch's market-making activities in such securities,
respectively. In addition, Merrill Lynch held distressed bank loans totaling
$432 million and $351 million at year-end 1997 and 1996, respectively.
Derivatives may also expose Merrill Lynch to credit risk related to the under-
lying security where a derivative contract can either synthesize ownership of
the underlying security (e.g., long total return swap) or potentially force
ownership of the underlying security (e.g., short put option). In addition,
derivatives may subject Merrill Lynch to credit spread risk in that changes in
the credit quality of the underlying securities may offset the derivatives'
fair values. A summary of exposures related to derivatives with non-investment
grade underlying securities follows:
- --------------------------------------------------------------------------------
(in millions) 1997 1996
- --------------------------------------------------------------------------------
Derivative fair values:
Trading assets/(1)/ $ 62 $ 63
Trading liabilities 62 64
Derivative notionals (off-balance-sheet)/(2)/ 3,257 2,895
- --------------------------------------------------------------------------------
/(1)/ The preceding table includes $42 and $9 at year-end 1997 and 1996,
respectively, of credit risk exposures to non-investment grade
counterparties.
/(2)/ Represents amount subject to strike or reference price.
Merrill Lynch engages in hedging strategies to reduce its exposure associated
with non-investment grade positions by purchasing an option to sell the
related security or by entering into other offsetting derivative contracts.
Merrill Lynch also uses non-investment grade trading inventories, principally
non-U.S. governments and agencies securities, to hedge the exposure arising
from structured derivative transactions.
A summary of cash instruments and derivatives used to hedge the credit risk of
non-investment grade positions follows:
- --------------------------------------------------------------------------------
(in millions) 1997 1996
- --------------------------------------------------------------------------------
Trading assets - cash instruments $1,312 $ 905
Derivative notionals (off-balance-sheet)/(1)/ 4,235 1,311
- --------------------------------------------------------------------------------
/(1)/ Represents amount subject to strike or reference price.
At December 26, 1997, the largest non-investment grade concentration of credit
exposure consisted of various sovereign and corporate issues of a South Ameri-
can country totaling $1.1 billion.
1997 Annual Report
27
MANAGEMENT'S DISCUSSION AND ANALYSIS
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
HIGHLY LEVERAGED TRANSACTIONS
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 pro-
vides 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 con-
nection 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 partner-
ships and other direct equity investments will be determined on a select
basis. A summary of loans, investments, and commitments related to highly
leveraged transactions follows:
- -----------------------------------------------------------------------------
(in millions) 1997 1996
- -----------------------------------------------------------------------------
Loans (net of allowance for loan losses)/(1)/ $467 $340
Equity investments/(2)/ 170 113
Partnership interests 82 104
Bridge loan - 31
Additional commitments to invest in partnerships 60 82
Unutilized revolving lines of credit and other lending commitments 485 301
- -----------------------------------------------------------------------------
/(1)/ Represented outstanding loans to 48 and 36 companies at year-end 1997 and
1996, respectively.
/(2)/ Invested in 72 and 48 enterprises at year-end 1997 and 1996, respectively.
At December 26, 1997, no single industry sector accounted for more than 27% of
total non-investment grade positions and highly leveraged transactions.
- --------------------------------------------------------------------------------
CASH FLOWS
- --------------------------------------------------------------------------------
Merrill Lynch's cash flows are principally associated with operating and
financing activities related to Merrill Lynch's trading, customer, and invest-
ment banking transactions. Merrill Lynch's cash and cash equivalents totaled
$5.0 billion at December 26, 1997, up $1.7 billion and $1.9 billion from year-
end 1996 and 1995, respectively.
Cash of $17.7 billion in 1997 was used for operating activities, primarily to
fund higher net trading assets generated by increased levels of business
activity. Merrill Lynch's investing activities used cash of $1.5 billion in
1997, partially due to the purchase of technology-related equipment.
Financing activities provided Merrill Lynch with $20.9 billion of cash in
1997, reflecting proceeds from net issuances of long-term debt and commercial
paper, partially offset by increases in net resale/repurchase agreements.
In 1996, cash and cash equivalents increased $284 million to $3.4 billion at
year-end. Cash used for operating and investing activities totaled $8.8 bil-
lion and $593 million, respectively, while cash provided by financing activi-
ties totaled $9.7 billion.
In 1995, cash and cash equivalents increased $779 million to $3.1 billion at
year-end. Cash provided by financing activities totaled $8.8 billion, while
cash used for operating and investing activities totaled $7.2 billion and $873
million, respectively.
- --------------------------------------------------------------------------------
LITIGATION
- --------------------------------------------------------------------------------
Certain actions have been filed against Merrill Lynch by Orange County, Cali-
fornia and others in connection with Merrill Lynch's business activities with
the Orange County Treasurer-Tax Collector or from the purchase of debt instru-
ments issued by Orange County
1997 Annual Report
28
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
that were underwritten by Merrill Lynch's subsidiary, Merrill Lynch, Pierce,
Fenner & Smith Incorporated (see "Business of Merrill Lynch--Legal Proceedings"
for further information). Although the ultimate outcome of these actions can-
not 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 con-
dition or the results of operations of Merrill Lynch as set forth in the Con-
solidated Financial Statements contained herein.
- -------------------------------------------------------------------------------
RECENT DEVELOPMENTS
- -------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In December 1996, the Financial Accounting Standards Board issued SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125", which deferred for one year the effective date of the collateral pro-
visions for all transactions and the sale provisions for repurchase agree-
ments, securities lending, and similar transactions. These deferred provisions
have been adopted for transactions entered into after December 31, 1997. The
adoption of such provisions will create additional balance sheet captions
related to the recognition of securities pledged and received as collateral.
The impact of adopting these provisions cannot be quantified at December 26,
1997 since they are only applicable to future transactions; however, total
assets and total liabilities are expected to increase significantly upon adop-
tion of these provisions. For a discussion of the provisions of SFAS No. 125
adopted in 1997, see Note 2 to the Consolidated Financial Statements.
1997 Annual Report
29
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
[LOGO OF DELOITTE & TOUCHE LLP APPEARS HERE]
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 26, 1997 and
December 27, 1996 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 26, 1997. These financial statements
are the responsibility of Merrill Lynch's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing stan-
dards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of mate-
rial misstatement. An audit includes examining, on a test basis, evidence sup-
porting 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 pre-
sentation. We believe that our audits provide a reasonable basis for our opin-
ion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Merrill Lynch at December 26,
1997 and December 27, 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 26, 1997 in
conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
New York, New York
February 23, 1998
1997 Annual Report
30
STATEMENTS OF CONSOLIDATED EARNINGS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
-----------------------------------------------------------------------
Year Ended Last Friday in December
------------------------------------
1997 1996 1995
-----------------------------------------------------------------------
REVENUES
Commissions $ 4,667 $ 3,786 $ 3,126
Interest and dividends 17,087 12,899 12,221
Principal transactions 3,769 3,454 2,519
Investment banking 2,749 1,945 1,308
Asset management and portfolio
service fees 2,789 2,261 1,890
Other 670 666 449
-------- -------- --------
TOTAL REVENUES 31,731 25,011 21,513
Interest Expense 16,062 11,895 11,248
-------- -------- --------
NET REVENUES 15,669 13,116 10,265
-------- -------- --------
NON-INTEREST EXPENSES
Compensation and benefits 7,962 6,704 5,270
Communications and equipment rental 669 559 487
Occupancy 491 508 449
Depreciation and amortization 446 411 367
Professional fees 813 582 425
Advertising and market development 597 514 398
Brokerage, clearing, and exchange fees 505 413 361
Other 1,136 859 697
-------- -------- --------
TOTAL NON-INTEREST EXPENSES 12,619 10,550 8,454
-------- -------- --------
EARNINGS BEFORE INCOME TAXES AND
DIVIDENDS ON PREFERRED SECURITIES
ISSUED BY SUBSIDIARIES 3,050 2,566 1,811
Income Tax Expense 1,097 947 697
Dividends on Preferred Securities
Issued by Subsidiaries 47 - -
-------- -------- --------
NET EARNINGS $ 1,906 $ 1,619 $ 1,114
======== ======== ========
NET EARNINGS APPLICABLE TO COMMON
STOCKHOLDERS $ 1,867 $ 1,572 $ 1,066
======== ======== ========
EARNINGS PER COMMON SHARE
Basic $ 5.63 $ 4.65 $ 3.02
======== ======== ========
Diluted $ 4.83 $ 4.11 $ 2.71
======== ======== ========
-----------------------------------------------------------------------
See Notes to Consolidated Financial Statements
1997 Annual Report
31
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- -------------------------------------------------------------------------------
December 26, December 27,
-------------------------
1997 1996
- -------------------------------------------------------------------------------
ASSETS
CASH AND CASH EQUIVALENTS $ 5,032 $ 3,375
-------- --------
CASH AND SECURITIES SEGREGATED FOR REGULATORY
PURPOSES OR DEPOSITED WITH CLEARING ORGANIZATIONS 12,384 5,628
-------- --------
MARKETABLE INVESTMENT SECURITIES 3,309 2,180
-------- --------
TRADING ASSETS, AT FAIR VALUE
Corporate debt and preferred stock 32,501 24,270
Equities and convertible debentures 23,617 13,153
Contractual agreements 21,205 13,465
U.S. Government and agencies 9,832 9,304
Non-U.S. governments and agencies 9,755 7,758
Mortgages, mortgage-backed, and asset-backed 7,312 5,189
Other 2,556 2,385
-------- --------
Total 106,778 75,524
-------- --------
RECEIVABLES UNDER RESALE AGREEMENTS 70,262 58,402
-------- --------
RECEIVABLES UNDER SECURITIES BORROWED TRANSACTIONS 35,366 24,692
-------- --------
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts
of $50 in 1997 and $39 in 1996) 26,529 18,309
Brokers and dealers 5,100 6,205
Interest and other 8,114 5,280
-------- --------
Total 39,743 29,794
-------- --------
INVESTMENTS OF INSURANCE SUBSIDIARIES 4,833 5,107
LOANS, NOTES, AND MORTGAGES (net of allowance for
loan losses of $130 in 1997 and $117 in 1996) 4,310 3,334
OTHER INVESTMENTS 1,826 1,125
PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT
(net of accumulated depreciation and amortization
of $2,910 in 1997 and $2,523 in 1996) 2,074 1,670
GOODWILL (net of accumulated amortization of $131
in 1997 and $71 in 1996) 5,455 617
OTHER ASSETS 1,447 1,568
-------- --------
TOTAL ASSETS $292,819 $213,016
======== ========
-----------------------------------------------------------------------------
1997 Annual Report
32
------------------------------------------------------------------------------
December 26, December 27,
-------------------------
1997 1996
------------------------------------------------------------------------------
LIABILITIES, PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY
LIABILITIES
PAYABLES UNDER REPURCHASE AGREEMENTS AND
SECURITIES LOANED TRANSACTIONS $ 77,875 $ 65,420
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 44,850 36,582
-------- --------
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 20,632 11,221
U.S. Government and agencies 18,182 13,965
Equities and convertible debentures 15,724 8,332
Non-U.S. governments and agencies 9,720 7,135
Corporate debt, preferred stock, and other 5,818 2,892
-------- --------
Total 70,076 43,545
-------- --------
OTHER PAYABLES
Customers 16,519 11,758
Brokers and dealers 4,112 3,407
Interest and other 22,625 13,973
-------- --------
Total 43,256 29,138
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 4,716 5,010
LONG-TERM BORROWINGS 43,090 26,102
-------- --------
TOTAL LIABILITIES 283,863 205,797
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 627 327
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY 425 619
-------- --------
COMMON STOCKHOLDERS' EQUITY
Common stock (par value $1.33 1/3 per share;
authorized: 500,000,000 shares; issued:
472,660,324 shares) 630 630
Paid-in capital 1,065 989
Accumulated other comprehensive income (net of
tax) (34) 19
Retained earnings 9,485 7,868
-------- --------
11,146 9,506
Less: Treasury stock, at cost:
(1997 - 137,578,035 shares; 1996 - 141,411,196
shares) 2,804 2,895
Unallocated ESOP reversion shares, at cost:
(1996 - 3,077,556 shares) - 24
Employee stock transactions 438 314
-------- --------
TOTAL COMMON STOCKHOLDERS' EQUITY 7,904 6,273
-------- --------
TOTAL STOCKHOLDERS' EQUITY 8,329 6,892
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY $292,819 $213,016
======== ========
-----------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
1997 Annual Report
33
STATEMENTS OF CHANGES IN CONSOLIDATED STOCKHOLDERS' EQUITY
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- ------------------------------------------------------------------------------
Year Ended Last Friday in December
-----------------------------------
1997 1996 1995
-----------------------------------------------------------------------------
PREFERRED STOCKHOLDERS' EQUITY
9% CUMULATIVE PREFERRED STOCK,
SERIES A
$10,000 LIQUIDATION PREFERENCE
PER SHARE
Balance, beginning and end of
year (42,500 shares in
1997, 1996, and 1995) $ 425 $ 425 $ 425
======== ======== ========
REMARKETED PREFERRED STOCK,
SERIES C
$100,000 LIQUIDATION PREFERENCE
PER SHARE
Balance, beginning of year (3,000
shares issued and 1,062 shares held
in treasury in 1997, 1996, and 1995) $ 194 $ 194 $ 194
Redeemed (1,938 shares in 1997) (194) - -
-------- -------- --------
Balance, end of year (1,938
shares in 1996 and 1995) $ - $ 194 $ 194
======== ======== ========
TOTAL PREFERRED STOCKHOLDERS'
EQUITY $ 425 $ 619 $ 619
======== ======== ========
COMMON STOCKHOLDERS' EQUITY
COMMON STOCK, PAR VALUE $1.33 1/3
Balance, beginning and end of
year (472,660,324 shares in
1997, 1996, and 1995) $ 630 $ 630 $ 630
======== ======== ========
PAID-IN CAPITAL
Balance, beginning of year $ 989 $ 922 $ 881
Issuance of stock:
To employees (3) (8) (2)
For other activity, including
employee stock grants (16) (8) (13)
To ESOP, including share
allocations 95 83 56
-------- -------- --------
Balance, end of year $ 1,065 $ 989 $ 922
======== ======== ========
ACCUMULATED OTHER COMPREHENSIVE
INCOME
Foreign Currency Translation
Adjustment (net of tax)
Balance, beginning of year $ 10 $ 11 $ 4
Translation adjustment (net of
deferred income taxes) (82) (1) 7
-------- -------- --------
Balance, end of year (72) 10 11
-------- -------- --------
Net Unrealized Gains on
Investment Securities Available-
for-Sale (net of tax)
Balance, beginning of year 9 25 (57)
Net unrealized gains (losses) on
investment securities
available-for-sale 34 (97) 335
Other adjustments/(a)/ (5) 81 (253)
-------- -------- --------
Balance, end of year 38 9 25
-------- -------- --------
Balance, end of year $ (34) $ 19 $ 36
======== ======== ========
1997 Annual Report
34
Year Ended Last Friday in December
----------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------
RETAINED EARNINGS
Balance, beginning of year $ 7,868 $ 6,492 $ 5,606
Net earnings 1,906 1,619 1,114
Cash dividends declared:
9% Cumulative Preferred stock (38) (38) (38)
Remarketed Preferred stock (1) (9) (10)
Common stock ($.75 per share
in 1997; $.58 in 1996;
and $.505 in 1995) (250) (196) (180)
------- ------- -------
Balance, end of year $ 9,485 $ 7,868 $ 6,492
======= ======= =======
COMMON TREASURY STOCK, AT COST
Balance, beginning of year
(141,411,196 shares in 1997;
121,858,556 in 1996;
96,847,888 in 1995) $(2,895) $(2,241) $(1,627)
Treasury stock purchased
(13,741,116 shares in 1997;
37,157,634 in 1996; 40,023,642
in 1995) (672) (1,163) (939)
Issued out of treasury (net of
reacquisitions):
Employees (1,293,262 shares in
1997; 1,689,774 in 1996;
1,645,636 in 1995) 60 51 37
Employee stock grants
(16,281,015 shares in 1997;
15,915,220 in 1996;
13,367,338 in 1995) 703 458 288
------- ------- -------
Balance, end of year
(137,578,035 shares in 1997;
141,411,196 in 1996;
121,858,556 in 1995) $(2,804) $(2,895) $(2,241)
======= ======= =======
UNALLOCATED ESOP REVERSION
SHARES, AT COST
Balance, beginning of year
(3,077,556 shares in 1997;
8,025,038 in 1996; 12,854,182
in 1995) $ (24) $ (63) $ (101)
Allocation of shares to
participants (3,077,556 shares
in 1997; 4,947,482 in 1996;
4,829,144 in 1995) 24 39 38
------- ------- -------
Balance, end of year (3,077,556
in 1996; 8,025,038 in 1995) $ - $ (24) $ (63)
======= ======= =======
EMPLOYEE STOCK TRANSACTIONS
Balance, beginning of year $ (314) $ (254) $ (137)
Net issuance of employee stock
grants (351) (251) (192)
Amortization of employee stock
grants 218 183 68
Repayment of employee loans 9 8 7
------- ------- -------
Balance, end of year $ (438) $ (314) $ (254)
======= ======= =======
TOTAL COMMON STOCKHOLDERS'
EQUITY $ 7,904 $ 6,273 $ 5,522
======= ======= =======
TOTAL STOCKHOLDERS' EQUITY $ 8,329 $ 6,892 $ 6,141
======= ======= =======
- ----------------------------------------------------------------------------
/(a)/ Other adjustments relate to policyholder liabilities, deferred policy
acquisition costs, and deferred income taxes.
See Notes to Consolidated Financial Statements
1997 Annual Report
35
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Dollars in Millions)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- -----------------------------------------------------------------------------
Year Ended Last Friday in December
---------------------------------------
1997 1996 1995
----------------------------------------------------------------------------
NET EARNINGS $1,906 $1,619 $1,114
------ ------ ------
OTHER COMPREHENSIVE INCOME:
Foreign currency translation
adjustment:
Foreign currency translation
losses, net of gains (86) (17) (12)
Deferred income taxes 4 16 19
------ ------ ------
Total (82) (1) 7
------ ------ ------
Net unrealized gains (losses) on
investment securities
available-for-sale:
Net unrealized holding gains
(losses) arising during the period 50 (68) 333
Reclassification adjustment for
(gains) losses included in
net earnings (16) (29) 2
------ ------ ------
Net unrealized gains (losses) on
investment securities 34 (97) 335
Adjustments for:
Policyholder liabilities 10 64 (137)
Deferred policy acquisition
costs - 9 (72)
Deferred income taxes (15) 8 (44)
------ ------ ------
Total 29 (16) 82
------ ------ ------
Total Other Comprehensive Income (53) (17) 89
------ ------ ------
COMPREHENSIVE INCOME $1,853 $1,602 $1,203
====== ====== ======
----------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
1997 Annual Report
36
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in Millions)
[LOGO OF MERRILL LYNCH APPEARS HERE]
Year Ended Last Friday in December
----------------------------------------
1997 1996 1995
-----------------------------------------------------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net Earnings $ 1,906 $ 1,619 $ 1,114
Noncash items included in
earnings:
Depreciation and amortization 446 411 367
Policyholder reserves 240 269 297
Other 1,401 919 672
(Increase) decrease in
operating assets(a):
Trading assets (31,099) (15,378) (6,375)
Cash and securities segregated
for regulatory purposes or
deposited with
clearing organizations (6,333) (198) (459)
Receivables under securities
borrowed transactions (10,674) (4,047) 348
Customer receivables (8,036) (3,543) (771)
Maturities and sales of trading
investment securities 177 98 -
Purchases of trading investment
securities (636) (67) -
Other (3,487) 1,125 250
Increase (decrease) in
operating liabilities(a):
Trading liabilities 26,531 10,195 (2,608)
Payables under securities
loaned transactions 4,080 (105) 677
Customer payables 4,761 366 (1,377)
Liabilities of insurance
subsidiaries (524) (587) (732)
Other 3,517 75 1,405
-------- -------- --------
CASH USED FOR OPERATING
ACTIVITIES (17,730) (8,848) (7,192)
-------- -------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-
sale securities 3,376 3,057 1,453
Sales of available-for-sale
securities 2,198 1,341 1,029
Purchases of available-for-sale
securities (6,383) (4,374) (2,387)
Maturities of held-to-maturity
securities 1,081 920 1,217
Purchases of held-to-maturity
securities (752) (555) (1,094)
Acquisitions, net of cash
acquired (13) (135) (601)
Other investments and other
assets (224) (384) (138)
Property, leasehold
improvements, and equipment (822) (463) (352)
-------- -------- --------
CASH USED FOR INVESTING
ACTIVITIES (1,539) (593) (873)
-------- -------- --------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from (payments for):
Resale agreements, net of
repurchase agreements (3,485) (8,293) 5,155
Commercial paper and other
short-term borrowings 8,218 9,892 2,429
Issuance and resale of long-
term borrowings 25,087 16,454 10,353
Settlement and repurchase of
long-term borrowings (8,191) (7,440) (7,971)
Issuance of subsidiaries'
preferred securities 300 276 -
Redemption of Remarketed
Preferred Stock (194) - -
Common stock transactions (520) (921) (894)
Dividends (289) (243) (228)
-------- -------- --------
CASH PROVIDED BY FINANCING
ACTIVITIES 20,926 9,725 8,844
-------- -------- --------
INCREASE IN CASH AND CASH
EQUIVALENTS 1,657 284 779
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 3,375 3,091 2,312
-------- -------- --------
CASH AND CASH EQUIVALENTS, END
OF YEAR $ 5,032 $ 3,375 $ 3,091
======= ======= =======
------------------------------------------------------------------------------
(a)Net of effects of acquisitions.
SUPPLEMENTAL DISCLOSURES
Cash paid for:
Income taxes $ 877 $ 1,108 $ 557
Interest 15,232 11,612 11,229
Noncash Investing and Financing Activity
A liability of $5.3 billion representing the acquisition price of Mercury
Asset Management was recorded on December 26, 1997.
See Notes to Consolidated Financial Statements
1997 Annual Report
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
TABLE OF CONTENTS
- -------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES............................... 38
NOTE 2. OTHER SIGNIFICANT EVENTS................................................. 43
NOTE 3. TRADING ACTIVITIES....................................................... 44
NOTE 4. INVESTMENTS AND OTHER NON-TRADING ASSETS................................. 49
NOTE 5. SHORT-TERM AND LONG-TERM BORROWINGS AND OTHER NON-TRADING LIABILITIES.... 51
NOTE 6. PREFERRED SECURITIES ISSUED BY SUBSIDIARIES AND STOCKHOLDERS' EQUITY..... 53
NOTE 7. COMMITMENTS AND CONTINGENCIES............................................ 56
NOTE 8. EMPLOYEE BENEFIT PLANS................................................... 58
NOTE 9. EMPLOYEE INCENTIVE PLANS................................................. 61
NOTE 10. INCOME TAXES............................................................. 64
NOTE 11. REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS........................ 65
NOTE 12. INDUSTRY AND GLOBAL OPERATIONS........................................... 66
- ----------------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- -------------------------------------------------------------------------------
BASIS OF PRESENTATION
The Consolidated Financial Statements include the accounts of Merrill Lynch &
Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch"). All
material intercompany balances have been eliminated. Certain limited reclassi-
fication and format changes have been made to prior year amounts to conform to
the current year presentation.
Merrill Lynch provides investment, financing, insurance, and related services
to individuals and institutions on a global basis through its principal U.S.
and U.K. broker-dealer subsidiaries, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S") and Merrill Lynch International ("MLI"), respectively,
and its broker, dealer, banking, insurance, and other financial services sub-
sidiaries. Such services include:
- securities brokerage, trading, and underwriting;
- investment banking, strategic services, and other corporate finance
advisory activities, including loan syndication;
- asset management and other investment advisory and recordkeeping services;
- trading and brokerage of swaps, options, forwards, futures, and other
derivatives;
- securities clearance services;
- banking, trust, and lending services; and
- insurance sales and underwriting services.
The Consolidated Financial Statements are presented in accordance with gener-
ally accepted accounting principles and prevailing industry practices, both of
which require management to make estimates regarding certain trading inventory
valuations, the outcome of litigation, goodwill, the realization of deferred
tax assets, insurance deferred acquisition costs, and other matters that
affect the reported amounts and disclosure of contingencies in the financial
statements. Estimates, by their nature, are based on judgment and available
information. As such, actual results could differ materially from those esti-
mates.
- -------------------------------------------------------------------------------
TRADING INSTRUMENTS
Trading assets and trading liabilities consist of cash instruments (such as
securities) and derivative instruments used for trading purposes or to hedge
trading inventory. Included in trading liabilities are securities that Merrill
Lynch has sold but does not currently own and will therefore be obligated to
purchase at a future date ("short sales"). Trading inventory is recorded on a
trade date basis at fair value. Fair value is based on quoted market prices,
pricing models (utilizing indicators of general market conditions or other
economic measurements), or management's estimates of amounts
1997 Annual Report
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
to be realized on settlement, assuming current market conditions and an
orderly disposition over a reasonable period of time.
- -------------------------------------------------------------------------------
Derivatives
A derivative is typically defined as an instrument whose value is "derived"
from an underlying instrument or index, such as a future, forward, swap, or
option contract, or other financial instrument with similar characteristics.
The derivative definition excludes all cash instruments, including those that
derive their values or contractually required cash flows from an underlying
instrument or index, such as mortgage-backed securities, interest-only and
principal-only obligations, and indexed debt instruments. It also excludes
option features embedded in cash instruments such as conversion features and
call provisions embedded in bonds.
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 finan-
cial instruments at specified terms on a specified date (e.g., options to buy
or sell securities, currencies, or commodities). Different types of deriva-
tives can also be combined to meet specialized needs (e.g., swaptions).
Derivatives are often referred to as off-balance-sheet instruments since their
notional amounts or underlying instruments are not reflected on the balance
sheet; however, the fair values of trading derivatives are recorded in trading
assets and liabilities.
Fair values for certain exchange-traded derivatives, principally futures and
certain options, are based on quoted market prices. Fair values for over-the-
counter ("OTC") derivative financial instruments, principally forwards,
options, and swaps, represent amounts that would be received from or paid to a
third party in settlement of these instruments. These amounts are determined
using pricing models based on the present value of estimated future cash flows
employing mid-market valuations with appropriate adjustments. These
adjustments are integral components of the mark-to-market process and relate
to credit quality and concentration, market liquidity, and exposure close-out
costs associated with unmatched positions. Adjustments are also made for
administrative costs incurred to service periodic cash flows and maintain
hedges over the life of the contract. A portion of income related to longer-
term contracts is recognized as the related administrative costs are incurred.
New, complex products may have immature or limited two-way markets. The preci-
sion of the pricing model for a complex product, which involves multiple vari-
ables and assumptions, will evolve over time. As these products develop, Mer-
rill Lynch continually refines its pricing models based on experience to cor-
relate more closely to the market risk of these instruments.
Derivatives are reported separately as assets and liabilities unless a legal
right of setoff exists under a master netting agreement enforceable at law.
Balances related to swap and forward transactions and foreign currency options
are included in "Contractual agreements" on the Consolidated Balance Sheets. All
other derivative balances are recorded in the related cash instrument caption.
The fair value of equity options purchased, for example, is recorded in the
"Equities and convertible debentures" trading asset caption.
Merrill Lynch enters into when-issued and delayed delivery transactions.
Unrealized gains and losses from these forward transactions are reflected in
the related cash instrument caption.
- -------------------------------------------------------------------------------
Revenue Recognition
Principal transactions revenues are recognized on a trade date basis and
include net unrealized gains and losses from marking-to-market all trading
instruments. Realized gains and losses on trading instruments and any related
interest amounts are included in principal transactions revenues and interest
revenues and expenses, respectively.
1997 Annual Report
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FINANCING AND RELATED ACTIVITIES
Merrill Lynch strives to match-fund the interest rate sensitivity of its
assets and liabilities. Funding is principally obtained from repurchase agree-
ments, commercial paper, and long-term borrowings.
Merrill Lynch uses derivatives to reduce risk by managing interest rate, for-
eign currency, and other exposures. Derivatives used as hedges must be effec-
tive at reducing the risk associated with the exposure being managed and be
designated as a hedge at inception. Derivatives that modify the interest rate
characteristics of specified non-trading assets and liabilities are accounted
for on an accrual basis, with amounts to be paid or received recognized as
adjustments to the related interest income or expense. Unrealized gains and
losses on other financing derivatives are recognized currently. Realized gains
and losses on early terminations of derivatives are deferred over the remain-
ing lives of the hedged assets or liabilities. At December 26, 1997, there
were no deferred amounts related to terminated contracts.
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 receiv-
ables 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 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 trans-
actions, the fee received or paid by Merrill Lynch is 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 sub-
stantially all securities borrowing and lending activities are transacted
under master netting agreements, Merrill Lynch does not offset such receiv-
ables and payables with the same counterparty on the Consolidated Balance
Sheets.
- -------------------------------------------------------------------------------
INVESTMENT SECURITIES
Merrill Lynch holds debt and equity investments principally in non-broker-
dealer subsidiaries. These investments are classified as held-to-maturity,
trading, or available-for-sale.
Held-to-maturity investments are debt securities that Merrill Lynch has the
positive intent and ability to hold to maturity. These investments are
recorded at amortized cost unless a decline in value is deemed other than tem-
porary, in which case the carrying value is reduced. The amortization of pre-
miums or accretion of discounts and any unrealized losses deemed other-than-
temporary are included in current period earnings.
Debt and 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.
Other debt and equity securities that are not categorized as held-to-maturity
or trading are classified as available-for-sale and reported at fair value.
Unrealized gains or losses on these securities are reported in stockholders'
equity as a component of "Accumulated other comprehensive income", net of appli-
cable income taxes and other related items.
Restricted equity investment securities or equity investment securities with-
out available market quota-
1997 Annual Report
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
tions are reported at the lower of cost or estimated net realizable value.
Adjustments in carrying values are included in current period earnings.
Realized gains and losses on investments are included in current period earn-
ings. The cost basis of each investment sold is specifically identified for
purposes of computing realized gains and losses.
- --------------------------------------------------------------------------------
LENDING ACTIVITIES
Merrill Lynch engages in loan origination, loan securitization, and secondary
market loan trading activities.
Loans held for investment purposes, including consumer and small business
loans and the residual portion of commercial loans syndicated by Merrill
Lynch, are carried at their principal amount outstanding. The allowance for
loan losses is established through provisions that are based on management's
assessment of the collectibility of the loan portfolio. Loans are charged off
against the allowance for loan losses when management determines that
collection of principal is unlikely.
Loans held for sale, which include certain residential mortgage and home
equity loans, are reported at the lower of cost (less allowance for loan loss-
es) or estimated fair value determined on a portfolio basis. Mortgage servic-
ing assets and residual interests in mortgage loans underlying Real Estate
Mortgage Investment Conduits and revolving trusts are (1) recognized upon
sales of loans when servicing is retained, and (2) amortized into income in
proportion to and over the estimated life of the net servicing revenue. Mort-
gage servicing assets are periodically evaluated for impairment and are
included in "Other assets" on the Consolidated Balance Sheets. Residual inter-
ests are reported in "Other investments" on the Consolidated Balance Sheets.
Loans held for trading purposes are recorded at fair value and are reported in
"Trading assets" on the Consolidated Balance Sheets.
- --------------------------------------------------------------------------------
COMMISSIONS AND RELATED EXPENSES
Commissions charged for executing customer transactions are accrued on a trade
date basis and are included in current period earnings. Production-related
compensation and benefits expense is accrued to match revenue recognition.
- --------------------------------------------------------------------------------
INVESTMENT BANKING
Underwriting revenues and fees for merger and acquisition advisory services
are accrued when services for the transactions are substantially completed.
Deal-related expenses are deferred to match revenue recognition.
- --------------------------------------------------------------------------------
RECEIVABLES FROM AND PAYABLES TO CUSTOMERS
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.
- --------------------------------------------------------------------------------
INSURANCE
Insurance liabilities are future benefits payable under annuity and interest-
sensitive life contracts and include deposits received plus interest credited
during the contract accumulation period, the present value of future payments
for contracts which have annuitized, and a mortality provision for certain
products. Certain policyholder liabilities are also adjusted for those invest-
ments 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 classi-
fied as available-for-sale and recorded at fair value. These investments sup-
port Merrill Lynch's in-force, universal life-type contracts. Merrill Lynch
records adjustments to deferred acquisition costs and policyholder account
balances which, when
1997 Annual Report
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
combined, are equal to the adjustment that would have been recorded if those
available-for-sale investments had been sold at their estimated fair values
and the proceeds reinvested at current yields. The corresponding credits or
charges for these adjustments are recorded in stockholders' equity as a compo-
nent of "Accumulated other comprehensive income", net of applicable income tax-
es.
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 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 prod-
ucts. Accordingly, separate account assets and the related liabilities are not
consolidated with the assets and liabilities of Merrill Lynch.
- -------------------------------------------------------------------------------
PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT
Property (excluding land), leasehold improvements, and equipment are reported
at historical cost, net of accumulated depreciation and amortization. Land is
reported at historical cost.
Depreciation and amortization are computed using the straight-line method.
Property and equipment are depreciated over their estimated useful lives,
while leasehold improvements are amortized over the lesser of their estimated
economic useful life or the term of the lease. Fixed assets are primarily
technology-based and have short lives, generally three to five years. Mainte-
nance and repair costs are expensed as incurred.
Facilities-related depreciation and amortization expense was $154, $151, and
$142, in 1997, 1996, and 1995, respectively. Non-facilities-related deprecia-
tion and amortization expense for 1997, 1996, and 1995 was $292, $260, and
$225, respectively.
- -------------------------------------------------------------------------------
STOCK-BASED COMPENSATION
Merrill Lynch accounts for stock-based compensation plans in accordance with
the intrinsic value-based method in Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees", rather than the fair value-
based method in Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation". Compensation expense for stock
options is not recognized since Merrill Lynch grants stock options without any
intrinsic value. Compensation expense related to other stock-based
compensation plans is recognized over the vesting period. For certain stock-
based compensation grants, the unamortized portion of the grant value is
reflected as a reduction of stockholders' equity in "Employee stock transac-
tions" on the Consolidated Balance Sheets.
- -------------------------------------------------------------------------------
GOODWILL
Goodwill, which represents the cost of acquired businesses in excess of fair
value of the related net assets at acquisition, is amortized on a straight-
line basis over periods not exceeding fifteen years. Beginning in 1998, good-
will associated with the purchase of Mercury Asset Management Group Holdings
PLC will be amortized over 30 years (see Note 2 for additional information).
Goodwill is evaluated periodically for impairment.
- -------------------------------------------------------------------------------
INCOME TAXES
ML & Co. and certain of its wholly-owned subsidiaries file a consolidated Fed-
eral income tax return. Merrill Lynch uses the asset and liability method in
providing income taxes on all transactions that have been recognized in the
Consolidated Financial Statements. The asset and liability method requires
that deferred taxes be adjusted to reflect the tax rates at which future tax-
able amounts will 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
1997 Annual Report
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
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. No deferred Fed-
eral income taxes have been provided for the undistributed earnings of foreign
subsidiaries to the extent that such earnings are considered to be permanently
reinvested in Merrill Lynch's foreign operations.
- --------------------------------------------------------------------------------
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities of foreign subsidiaries are translated at year-end cur-
rency exchange rates, while revenues and expenses are translated at average
currency exchange rates during the year. Adjustments that result from trans-
lating foreign currency financial statements, net of hedging gains or losses
and related tax effects, are reported in stockholders' equity as a component
of "Accumulated other comprehensive income". Gains or losses resulting from the
effect of exchange rate changes on foreign currency transactions are included
in earnings.
- --------------------------------------------------------------------------------
CASH FLOWS
For purposes of the Statements of Consolidated Cash Flows, 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. Cash flows from trading derivatives are classified
as operating activities; cash flows from non-trading derivatives are classi-
fied with the cash flows of the item being hedged.
- --------------------------------------------------------------------------------
FAIR VALUE OF FINANCIAL INSTRUMENTS
At December 26, 1997 and December 27, 1996, substantially all financial
instrument assets are carried at fair value or amounts that approximate fair
value. Fair values of financial instruments are disclosed in Notes 3, 4, 5,
and 7.
- --------------------------------------------------------------------------------
INTEREST EXPENSE
Interest expense includes payments in lieu of dividends of $19, $9, and $10 in
1997, 1996, and 1995, respectively.
- --------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
- --------------------------------------------------------------------------------
ACCOUNTING CHANGES
In 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and Extin-
guishments of Liabilities". SFAS No. 125 provides guidance for determining
whether a transfer of a financial asset is treated as a sale or a financing.
Additionally, if a transfer qualifies as a financing transaction, the state-
ment contains provisions that may require the recognition of collateral
received or provided, in addition to the financing balance.
Merrill Lynch adopted the provisions of SFAS No. 125 not deferred by SFAS No.
127, "Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125", for all transactions entered into after December 31, 1996. As of
December 26, 1997, the adoption of these provisions increased both assets
("Trading assets" and "Receivables under resale agreements") and liabilities
("Payables under repurchase agreements") by approximately $4 billion.
In 1995, Merrill Lynch adopted:
- - SFAS No. 114, "Accounting by Creditors for Impairment of a Loan";
- - SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures"; and
- - SFAS No. 122, "Accounting for Mortgage Servicing Rights".
The impact of adopting these pronouncements was not material to Merrill
Lynch's results of operations.
- --------------------------------------------------------------------------------
DISCLOSURE CHANGES
In 1997, the FASB issued SFAS No. 128, "Earnings Per Share", which is
effective for fiscal years ending after December 15, 1997. SFAS No. 128 replaced
the presentation of primary and fully diluted earnings per common share
("EPS") with basic and diluted EPS (see Note 6 for additional information).
In 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which
requires reporting of
1997 Annual Report
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
comprehensive income in the financial statements. The statement is effective
for fiscal years beginning after December 15, 1997. Merrill Lynch has elected
to early adopt SFAS No. 130 for 1997.
- --------------------------------------------------------------------------------
ACQUISITIONS
In December 1997, Merrill Lynch acquired Mercury Asset Management Group Hold-
ings PLC ("Mercury"), a U.K. global asset manager, for approximately $5.3 bil-
lion. Goodwill of approximately $4.8 billion was recorded related to the
acquisition. Since the acquisition was recorded as of December 26, 1997, the
results of operations do not include the operating results of Mercury or good-
will amortization. In 1997, Merrill Lynch also acquired a 401(k) service pro-
vider for $13 and recorded goodwill of $10.
Merrill Lynch completed several acquisitions in 1996, including two non-U.S.
securities firms and a U.S. asset manager. Aggregate consideration of $232 was
paid and goodwill of $167 was recorded in connection with these acquisitions.
In August 1995, Merrill Lynch acquired Smith New Court PLC, a U.K.-based
global securities firm, for $803, and recorded $533 of related goodwill.
The operating results of acquired companies are included in Merrill Lynch's
results of operations commencing with the acquisition date.
- --------------------------------------------------------------------------------
NOTE 3. TRADING ACTIVITIES
- --------------------------------------------------------------------------------
As part of its trading activities, Merrill Lynch provides to clients broker-
age, dealing, and underwriting services for securities and derivative prod-
ucts. While trading activities are primarily generated by client order flow,
Merrill Lynch also takes 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 transactions,
along with the hedging and financing of these positions.
Principal transactions revenues by product category follow/(1)/:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
Equities and equity derivatives $1,238 $1,138 $ 912
Interest rate and currency swaps 1,042 893 732
Taxable fixed-income 996 966 516
Municipals 304 323 273
Foreign exchange and commodities 189 134 86
------ ------ ------
Total $3,769 $3,454 $2,519
====== ====== ======
- --------------------------------------------------------------------------------
/(1)/ The revenue amounts presented include gains and losses from both cash and
related derivative instruments.
Interest revenue and expense are integral components of trading activities. In
assessing the profitability of trading activities, Merrill Lynch views net
interest and principal transactions revenues in the aggregate. For further
information on Merrill Lynch's net trading results, see "Management's Discus-
sion and Analysis" (unaudited)-"Principal Transactions".
Certain trading activities expose Merrill Lynch to market and credit risks.
These risks are managed in accordance with established risk management poli-
cies and procedures that are described in "Management's Discussion and Analysis"
(unaudited)-"Risk Management".
- --------------------------------------------------------------------------------
MARKET RISK
Market risk is the potential change in an instrument's value caused by fluctu-
ations in interest and currency exchange rates, equity and commodity prices,
and credit spreads. 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 invento-
ries 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
1997 Annual Report
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
instruments. Interest rate swap agreements, Eurodollar futures, and U.S. Trea-
sury 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 swap agreements used by Merrill Lynch include caps, collars,
floors, basis swaps, and leveraged swaps. Interest rate caps and floors
provide the purchaser protection against rising and falling interest rates,
respectively. Interest rate collars combine a cap and a floor, providing the
purchaser with a predetermined interest rate range. Basis swaps are a type of
interest rate swap agreement where rates received and paid are variable 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 lever-
age factor, such as four times three-month LIBOR (London Interbank Offered
Rate). Merrill Lynch's exposure to interest rate risk resulting from these
leverage factors is typically hedged with other financial instruments.
- -------------------------------------------------------------------------------
Currency Risk
Currency risk arises from the possibility that fluctuations in foreign
exchange rates will impact the value of financial instruments. Merrill Lynch's
trading assets and liabilities include both cash instruments denominated in
and derivatives linked to over 70 currencies, including the Japanese yen, Ger-
man mark, Swiss franc, British pound, and Italian lira. Currency forwards and
options are commonly used to manage currency risk associated with these
instruments. Currency swaps may also be used in situations where a long-dated
forward market is not available or where the end-user needs a customized
instrument to hedge a foreign currency cash flow stream. Typically, parties to
a currency swap initially exchange principal amounts in two currencies, agree-
ing 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 and warrants. 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.
- -------------------------------------------------------------------------------
Commodity Price Risk
Merrill Lynch views its commodity contracts as financial instruments since
they are generally settled in cash and not by delivery of the underlying com-
modity. Commodity price risk results from the possibility that the price of
the underlying commodity may rise or fall. Cash flows from commodity contracts
are based on the difference between an agreed-upon fixed price and a price
that varies with changes in a specified commodity price or index. Commodity
contracts held by Merrill Lynch principally relate to energy, precious metals,
and base metals.
- -------------------------------------------------------------------------------
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 quali-
ty, 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 instru-
ment). Certain instruments are used by Merrill Lynch to manage this type of
risk. Swaps and options, for example,
1997 Annual Report
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
can be designed to protect the holder from loss due to changes in credit
spreads, as well as credit downgrade or default of the issuer. Credit risk
resulting from default on counterparty obligations is discussed in the follow-
ing "Credit Risk" section.
- -------------------------------------------------------------------------------
CREDIT RISK
Merrill Lynch is exposed to risk of loss if an issuer or a counterparty fails
to perform its obligations under contractual terms and the collateral held, if
any, is deemed worthless ("default risk"). Both cash instruments and deriva-
tives expose Merrill Lynch to default risk. Credit risk arising from changes
in credit spreads was previously discussed in the "Market Risk" section.
Merrill Lynch has established policies and procedures for mitigating credit
risk on principal transactions, including reviewing and establishing limits
for credit exposure, maintaining collateral, and continually assessing the
creditworthiness of counterparties. For further information, see "Management's
Discussion and Analysis" (unaudited)--"Risk Management--Credit Risk."
In the normal course of business, Merrill Lynch executes, settles, and
finances various customer securities transactions. Execution of these transac-
tions 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 cus-
tomers 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 acquired and are paid upon receipt of the securities from
other brokers or dealers. In the case of aged securities failed-to-receive,
Merrill Lynch may purchase the underlying security in the market and seek
reimbursement for losses from the counterparty.
Merrill Lynch uses resale and repurchase agreements and securities borrowed
and loaned transactions to finance securities, to facilitate settlement
processes, and to meet customers' needs. Under these agreements and transac-
tions, Merrill Lynch either receives or provides collateral, including U.S.
Government and agencies, asset-backed, corporate debt, equity, and non-U.S.
governments and agencies securities. When providing collateral for these
transactions, Merrill Lynch delivers its own securities, securities borrowed
from counterparties, and securities owned by customers collateralizing margin
loans and other obligations.
The market value of securities owned by Merrill Lynch that have been loaned or
pledged to counterparties as collateral for obligations of Merrill Lynch, pri-
marily related to repurchase agreements, were $28,132 and $27,810 at December
26, 1997 and December 27, 1996, respectively.
- -------------------------------------------------------------------------------
Concentrations of Credit Risk
Merrill Lynch's exposure to credit risk (both default and credit spread) asso-
ciated 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 polit-
ical, industry, or economic factors. To reduce the potential for risk concen-
tration, credit limits are established and monitored in light of changing
counterparty and market conditions.
At December 26, 1997, Merrill Lynch's most significant concentration of credit
risk was with the U.S. Government and its agencies. This concentration con-
sists of both direct and indirect exposures. Direct exposure, which primarily
results from taking trading asset and investment security positions in instru-
ments issued by the U.S. Government and its agencies, amounted to $11,692 and
$10,332 at December 26, 1997 and Decem-
1997 Annual Report
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
ber 27, 1996, 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 resale agreement or securities bor-
rowed transaction counterparty. 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 col-
lateral at December 26, 1997 and December 27, 1996 totaled $60,868 and
$33,321, respectively.
At December 26, 1997, Merrill Lynch had concentrations of credit risk with
other counterparties, including a European sovereign rated AA by recognized
credit rating agencies and an investment company whose holdings primarily con-
sist of various European sovereign debt instruments. Total exposure to these
counterparties, excluding collateral held, was $3,405, or 1.2% of total
assets. At December 27, 1996, Merrill Lynch had concentrations of credit risk
with a European and a South American sovereign and an investment company
totaling $3,912, or 1.8% of total assets, excluding collateral held.
Merrill Lynch's most significant industry credit concentration is with U.S.
and non-U.S. financial institutions. Financial institutions include other bro-
kers and dealers, commercial banks, finance companies, insurance companies,
and mutual funds. This concentration arises in the normal course of Merrill
Lynch's brokerage, trading, financing, and underwriting activities. Merrill
Lynch also monitors credit exposures worldwide by region. Within these
regions, sovereign governments represent the most significant concentration,
followed by financial institutions.
In the normal course of business, Merrill Lynch purchases, sells, underwrites,
and makes markets in non-investment grade instruments. In conjunction with
merchant banking activities, Merrill Lynch also provides extensions of credit
and makes equity investments to facilitate leveraged transactions. These
activities expose Merrill Lynch to a higher degree of credit risk than is
associated with trading, investing in, and underwriting investment grade
instruments and extending credit to investment grade counterparties. See "Man-
agement's Discussion and Analysis" (unaudited)--"Non-Investment Grade Holdings
and Highly Leveraged Transactions" for further information.
- -------------------------------------------------------------------------------
DERIVATIVES USED IN TRADING ACTIVITIES
Merrill Lynch trades derivative financial instruments and provides clients
with customized derivative products. These transactions allow clients to man-
age their exposure to interest and currency exchange rate, equity and commod-
ity price, and credit spread risks. Merrill Lynch also uses derivative instru-
ments to manage its own risks related to proprietary trading strategies, cli-
ent transactions, and financing activities (see Note 5 for further details on
the role of derivatives in financing activities).
The fair values of derivatives used in trading activities at year-end 1997 and
1996 follows:
- ----------------------------------------------------------
DECEMBER 26, 1997 DECEMBER 27, 1996
------------------- -------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------- ----------- ------- -----------
Swap agreements $16,189 $15,703 $11,553 $9,370
Forward contracts 3,805 3,539 1,304 1,403
Options 5,982 10,965 2,618 3,203
- ----------------------------------------------------------
The table below presents the average fair values of Merrill Lynch's trading
derivatives for 1997 and 1996, calculated on a monthly basis:
- ---------------------------------------------------------
AVERAGE FAIR VALUE
--------------------------------------
1997 1996
------------------- ------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------- ----------- ------ -----------
Swap agreements $13,888 $12,002 $9,872 $8,404
Forward contracts 2,340 2,181 1,192 1,260
Options 4,942 7,125 2,573 1,964
- ---------------------------------------------------------
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
1997 Annual Report
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
contractual amounts of derivatives used for trading purposes by type of risk
follow:
- --------------------------------------------------------------------------------
INTEREST EQUITY COMMODITY
RATE CURRENCY PRICE PRICE
(in billions) RISK/(1)//(2)/ RISK/(3)/RISK RISK
- --------------------------------------------------------------------------------
DECEMBER 26, 1997
Swap agreements $1,482 $159 $17 $ 2
Forward contracts 59 196 1 15
Futures contracts 202 1 15 2
Options purchased 99 71 60 3
Options written 133 73 44 3
DECEMBER 27, 1996
Swap agreements $1,212 $140 $13 $ 3
Forward contracts 24 147 1 17
Futures contracts 126 2 7 5
Options purchased 85 76 21 3
Options written 118 72 31 3
- --------------------------------------------------------------------------------
/(1)/ Certain derivatives subject to interest rate risk are also exposed to the
credit spread risk of the underlying financial instrument.
/(2)/ Forward contracts subject to interest rate risk principally represent "To
Be Announced" mortgage pools that bear interest rate as well as principal
prepayment risk.
/(3)/ Included in the currency risk category are certain contracts that are also
subject to interest rate risk.
Most of Merrill Lynch's trading derivative transactions are short-term in
duration with a weighted-average maturity of approximately 2.8 years at Decem-
ber 26, 1997 and 2.7 years at December 27, 1996. For trading derivatives out-
standing at December 26, 1997, the following table presents the notional or
contractual amounts of derivatives expiring in future years based on contrac-
tual expiration:
- --------------------------------------------------------------------------------
AFTER
(in billions) 1998 1999 2000 2001 2001 TOTAL
- --------------------------------------------------------------------------------
Swap agreements $ 428 $287 $201 $137 $607 $1,660
Forward contracts 261 6 2 1 1 271
Futures contracts 153 31 17 6 13 220
Options purchased 114 32 26 16 45 233
Options written 123 36 29 17 48 253
------ ---- ---- ---- ---- ------
Total $1,079 $392 $275 $177 $714 $2,637
====== ==== ==== ==== ==== ======
- --------------------------------------------------------------------------------
The notional or contractual values of derivatives do not represent default
risk exposure. Default risk is limited to the current cost of replacing deriv-
ative contracts in a gain position.
Default risk exposure varies by type of derivative. Swap agreements and for-
ward 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 mar-
ket value. Option contracts can be exchange-traded or OTC-transacted con-
tracts. 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 attempts to enter into International Swaps and Derivatives Asso-
ciation, Inc. master agreements or their equivalent ("master netting agree-
ments") with each of its counterparties. 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 Con-
solidated Balance Sheets, providing for a more meaningful balance sheet pre-
sentation 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. Presented below is a summary of counterparty credit rat-
ings for the replacement cost (net of $4,750 of collateral) of trading deriva-
tives in a gain position by maturity at December 26, 1997.
1997 Annual Report
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
YEARS TO MATURITY
---------------------------- CROSS-
CREDIT MATURITY
RATING/(1)/ 0-3 3-5 5-7 OVER 7 NETTING/(2)/ TOTAL
- --------------------------------------------------------------
AAA $ 684 $ 274 $ 364 $ 371 $ (191) $ 1,502
AA+/AA 3,951 406 164 558 (623) 4,456
AA- 2,351 755 492 666 (802) 3,462
A+/A 2,802 518 383 703 (427) 3,979
A- 1,982 730 160 239 (380) 2,731
BBB 1,946 676 262 169 (437) 2,616
BB 887 314 36 293 (556) 974
Other 1,111 232 110 321 (268) 1,506
------- ------ ------ ------ ------- -------
Total $15,714 $3,905 $1,971 $3,320 $(3,684) $21,226
======= ====== ====== ====== ======= =======
- --------------------------------------------------------------------------------
/(1)/ Represents rating agency equivalent.
/(2)/ Represents netting of payable balances with receivable balances for the
same counterparty across maturity band categories. Receivable and payable
balances with the same counterparty in the same maturity category,
however, are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch 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 con-
tract.
- -------------------------------------------------------------------------------
NOTE 4. INVESTMENTS AND OTHER NON-TRADING ASSETS
- -------------------------------------------------------------------------------
INVESTMENTS
Merrill Lynch has several broad categories of investments on its Consolidated
Balance Sheets, including "Investments of insurance subsidiaries, Marketable
investment securities", and "Other investments".
Investments of insurance subsidiaries, primarily debt securities, are used to
fund policyholder liabilities. Marketable investment securities consist of
equity and debt securities, including those held for rating agency purposes or
to manage cash flows related to certain liabilities of Merrill Lynch's banking
subsidiaries. Other investments consist of equity and debt securities, includ-
ing those acquired in connection with merchant banking activities. Certain
merchant banking investments are subject to restrictions that may limit Mer-
rill Lynch's ability to realize its investment until such restrictions expire.
Marketable investment securities and certain investments of insurance subsidi-
aries and other investments are carried as held-to-maturity, trading, or
available-for-sale securities as described in Note 1. Investment securities
reported on the Consolidated Balance Sheets at December 26, 1997 and December
27, 1996 are presented below:
- --------------------------------------------------------------------------------
1997 1996
------ ------
INVESTMENTS OF INSURANCE SUBSIDIARIES
Available-for-sale $3,338 $3,624
Trading 16 -
Non-qualifying/(1)//(2)/ 1,479 1,483
------ ------
Total $4,833 $5,107
====== ======
- --------------------------------------------------------------------------------
MARKETABLE INVESTMENT SECURITIES
Available-for-sale $2,392 $1,523
Held-to-maturity 322 653
Trading 595 4
------ ------
Total $3,309 $2,180
====== ======
- --------------------------------------------------------------------------------
OTHER INVESTMENTS
Available-for-sale $ 500 $ 142
Held-to-maturity 233 328
Trading - 3
Non-qualifying/(1)//(3)/ 1,093 652
------ ------
Total $1,826 $1,125
====== ======
- --------------------------------------------------------------------------------
/(1)/ Non-qualifying for SFAS No. 115 purposes.
/(2)/ Primarily consists of insurance policy loans.
/(3)/ Includes merchant banking investments and investments hedging deferred
compensation liabilities.
1997 Annual Report
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
Information regarding investment securities subject to SFAS No. 115, "Account-
ing for Certain Investments in Debt and Equity Securities", follows:
- --------------------------------------------------------------------------------
DECEMBER 26, 1997 DECEMBER 27, 1996
------------------------------------------ ------------------------------------------
COST/ GROSS GROSS ESTIMATED COST/ GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
------------------------------------------ ------------------------------------------
Corporate debt $3,136 $ 78 $ (8) $3,206 $3,016 $ 72 $ (12) $3,076
U.S. Government and
agencies 650 4 - 654 399 3 (1) 401
Municipals 936 2 (1) 937 276 3 - 279
Mortgage-backed
securities 1,036 47 (1) 1,082 1,029 21 (3) 1,047
Other debt securities 109 1 (2) 108 417 8 (9) 416
------ ---- ---- ------ ------ ------ ------ ------
Total debt securities 5,867 132 (12) 5,987 5,137 107 (25) 5,219
Equity securities 247 1 (5) 243 70 5 (5) 70
------ ---- ---- ------ ------ ------ ------ ------
Total $6,114 $133 $(17) $6,230 $5,207 $ 112 $ (30) $5,289
====== ==== ==== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
DECEMBER 26, 1997 DECEMBER 27, 1996
------------------------------------------ ------------------------------------------
COST/ GROSS GROSS ESTIMATED COST/ GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
HELD-TO-MATURITY COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
------------------------------------------ ------------------------------------------
Corporate debt $ 189 $ 1 $ - $ 190 $ 483 $ 4 - $ 487
U.S. Government and
agencies 211 - - 211 37 - - 37
Municipals 35 44 (1) 78 122 15 - 137
Mortgage-backed
securities 119 2 - 121 281 2 - 283
Other debt securities 1 - - 1 58 - - 58
------ ---- ---- ------ ------ ------ ------ ------
Total $ 555 $ 47 $ (1) $ 601 $ 981 $ 21 - $1,002
====== ==== ==== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------
The amortized cost and estimated fair value of debt securities at December 26,
1997, by contractual maturity, for available-for-sale and held-to-maturity
investments follow:
- ------------------------------------------------------------------------------------------------------------
AVAILABLE-FOR-SALE HELD-TO-MATURITY
------------------- -------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
------------------- -------------------
Due in one year or less $1,147 $1,148 $166 $167
Due after one year through five years 1,835 1,875 104 120
Due after five years through ten years 1,105 1,129 159 174
Due after ten years 744 753 7 19
------ ------ ---- ----
4,831 4,905 436 480
Mortgage-backed securities 1,036 1,082 119 121
------ ------ ---- ----
Total/(1)/ $5,867 $5,987 $555 $601
====== ====== ==== ====
- ------------------------------------------------------------------------------------------------------------
/(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:
- ------------------------------------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
Proceeds $2,198 $1,341 $1,029
Gross realized gains 27 41 26
Gross realized losses (11) (12) (28)
- --------------------------------------------------------------------------------
Net unrealized (losses) gains from investment securities classified as trading
included in the 1997, 1996, and 1995 Statements of Consolidated Earnings were
$(21), $(1), and $1, respectively.
- -------------------------------------------------------------------------------
OTHER NON-TRADING ASSETS
Most other financial instrument assets are carried at amounts that approximate
fair value. Such assets include cash and cash equivalents, cash and securities
segregated for regulatory purposes or deposited with clearing organizations,
most receivables under resale agreements and securities borrowed transactions,
and other receivables.
1997 Annual Report
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
Other financial instrument assets with carrying values that differ from their
fair values are presented below:
- -------------------------------------------------------------------------------
DECEMBER 26, 1997 DECEMBER 27, 1996
------------------ -------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- --------- --------
Merchant banking equity investment and
loan portfolio/(1)/ $ 272 $ 397 $ 202 $ 362
Loans, notes, and mortgages/(2)/ 4,197 4,230 3,313 3,347
- -------------------------------------------------------------------------------
/(1)/ Merchant banking equity investments are non-qualifying for SFAS No. 115
purposes.
/(2)/ Excludes loans related to merchant banking activities.
Fair value for merchant banking equity investments, including partnership
interests (both included in "Other investments" on the Consolidated Balance
Sheets), is estimated using a number of methods, including earnings multiples,
cash flow analyses, and review of underlying financial conditions and other
market factors. These instruments may be subject to restrictions (e.g., con-
sent of other investors) that may limit Merrill Lynch's ability to realize
currently the estimated fair value. Accordingly, Merrill Lynch's current esti-
mate of fair value and the ultimate realization on these instruments may dif-
fer.
Fair value for loans made in connection with merchant banking activities, con-
sisting primarily of senior and subordinated debt, is estimated using dis-
counted 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 previ-
ously 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.
Merrill Lynch holds a passive minority interest in Bloomberg L.P., a privately
held limited partnership that provides information services. In 1996, Merrill
Lynch sold one-third of its interest to the majority interest holder, result-
ing in a pretax gain of $155. Due to the nature and terms of the sale, the
sale price is not necessarily indicative of the fair value of Merrill Lynch's
remaining investment. In addition, given the contractual restrictions on the
disposition of Merrill Lynch's interest, the fair value of the remaining
investment is not readily determinable as of December 26, 1997. Management
believes, however, that the fair value of this investment significantly
exceeds its carrying value of $28.
Merrill Lynch enters into derivative hedges of interest rate risk on various
non-trading assets, including certain long-term resale agreements. At December
26, 1997 and December 27, 1996, the notional amounts of derivatives hedging
these positions were $9 billion and $5 billion, respectively. The combined
carrying value of hedged non-trading assets and related hedges approximates
their combined fair value at both dates.
Merrill Lynch uses currency derivatives to hedge certain exposures arising
from investments in and loans to foreign subsidiaries. At December 26, 1997
and December 27, 1996, the notional amounts of these currency derivatives were
$2 billion.
- -------------------------------------------------------------------------------
NOTE 5. SHORT-TERM AND LONG-TERM BORROWINGS AND OTHER NON-TRADING LIABILITIES
- -------------------------------------------------------------------------------
SHORT-TERM 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 financing activities may create exposure to market risk, most notably
interest rate and currency risk. To better match the interest rate character-
istics of assets and liabilities, Merrill Lynch generally enters into swap
agreements to convert fixed-rate interest payments on its debt obligations
into variable-rate payments. Interest obligations on variable-rate long-term
borrowings and commercial paper may also be modified through swap agreements
that change the underlying
1997 Annual Report
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
interest rate basis or reset frequency. Non-U.S. dollar payments on debt obli-
gations may be swapped to U.S. dollar payments.
Merrill Lynch also issues debt containing embedded options that link the
repayment of these obligations to the performance of an equity or other index
(e.g., S&P 500(Registered Trademark)), an industry basket of stocks, or an
individual stock. The contingent components of these indexed debt obligations
are hedged with derivatives.
Borrowings at December 26, 1997 and December 27, 1996 are presented below:
- --------------------------------------------------------------------------------
1997 1996
------- -------
PAYABLES UNDER REPURCHASE AGREEMENTS
AND SECURITIES LOANED TRANSACTIONS
Repurchase agreements $71,044 $62,669
Securities loaned transactions 6,831 2,751
------- -------
Total $77,875 $65,420
======= =======
- --------------------------------------------------------------------------------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS
Commercial paper $30,379 $23,558
Demand and time deposits 10,531 9,311
Bank loans and other 3,940 3,713
------- -------
Total $44,850 $36,582
======= =======
- --------------------------------------------------------------------------------
LONG-TERM BORROWINGS
Fixed-rate obligations/(1)/:
U.S. dollar-denominated $ 7,083 $ 5,770
Non-U.S. dollar-denominated 1,878 1,737
Variable-rate obligations/(2)//(3)/:
U.S. dollar-denominated 2,803 1,944
Non-U.S. dollar-denominated 1,276 690
Medium-term notes/(4)/:
U.S. dollar-denominated 20,090 10,532
Non-U.S. dollar-denominated 9,960 5,429
------- -------
Total $43,090 $26,102
======= =======
- --------------------------------------------------------------------------------
/(1)/ At December 26, 1997, U.S. dollar-denominated fixed-rate obligations are
due 1998 to 2019 at interest rates ranging from 5.50% to 10.38%; non-U.S.
dollar-denominated fixed-rate obligations are due 1998 to 2002 at interest
rates ranging from 2.55% to 12.10%.
/(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 in variable-rate obligations are various equity-linked or
indexed instruments issued by Merrill Lynch.
/(4)/ Medium-term notes may bear fixed or variable interest rates and have
maturities that may range from nine months to 30 years from the date of
issue.
Long-term borrowings at December 26, 1997 mature as follows:
- --------------------------------------------------------------------------------
1998 $12,042
1999 7,226
2000 5,178
2001 3,959
2002 5,397
2003 and thereafter 9,288
-------
Total $43,090
=======
- --------------------------------------------------------------------------------
The notional or contractual amounts of derivatives used to hedge exposures
related to borrowings at December 26, 1997 and December 27, 1996 follow:
- --------------------------------------------------------------------------------
1997 1996
(in billions) ---- ----
Interest rate derivatives/(1)/ $44 $32
Currency derivatives/(1)/ 8 4
Equity derivatives 3 2
- --------------------------------------------------------------------------------
/(1)/ Includes swap contracts totaling $2 billion and $1 billion in notional
that contain embedded options hedging callable debt at December 26, 1997
and December 27, 1996, respectively.
Most of these derivatives are entered into with Merrill Lynch's derivative
dealer subsidiaries, which intermediate interest rate, currency, and equity
risks with third parties in the normal course of their trading activities.
The effective weighted-average interest rates for borrowings, which include
the impact of hedges, at December 26, 1997 and December 27, 1996 were:
- --------------------------------------------------------------------------------
1997 1996
----- -----
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 5.43% 5.44%
LONG-TERM BORROWINGS
Fixed-rate obligations 7.00% 7.41%
Variable-rate obligations 5.84% 5.82%
Medium-term notes 5.86% 5.68%
- --------------------------------------------------------------------------------
1997 Annual Report
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
The fair value of borrowings and related hedges is estimated using current
market prices and pricing models. The carrying and fair values of these
instruments are summarized as follows:
- --------------------------------------------------------------------------------
DECEMBER 26, 1997 DECEMBER 27, 1996
------------------- -------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- -------- -------- --------
COMMERCIAL PAPER AND OTHER SHORT-
TERM BORROWINGS $ 44,850 $ 44,857 $ 36,582 $ 36,581
Related derivative:
Assets (28) (29) (15) (12)
Liabilities 3 4 5 5
-------- -------- -------- --------
Total $ 44,825 $ 44,832 $ 36,572 $ 36,574
======== ======== ======== ========
-------------------------------------------------------------------------------
LONG-TERM BORROWINGS $ 43,090 $ 43,648 $ 26,102 $ 26,850
Related derivative:
Assets (811) (1,948) (257) (769)
Liabilities 921 1,032 370 448
-------- -------- -------- --------
Total $ 43,200 $ 42,732 $ 26,215 $ 26,529
======== ======== ======== ========
- --------------------------------------------------------------------------------
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 may remain outstanding beyond their earliest redemption date.
Subsequent to year-end 1997 and through February 20, 1998, long-term
borrowings, net of repayments and repurchases, increased approximately $4,138.
- -------------------------------------------------------------------------------
Borrowing Facilities
Merrill Lynch has obtained committed, unsecured revolving credit facilities
aggregating $6.8 billion under agreements with 74 banks. The agreements con-
tain covenants requiring, among other things, that Merrill Lynch maintain
specified levels of net worth, as defined in the agreements, on the date of an
advance. At December 26, 1997, none of these credit facilities had been drawn
upon.
The credit quality, amounts, and terms of the credit facilities are continu-
ally monitored and modified as warranted by business conditions. Under the
existing agreements, the credit facilities mature as follows: $1.2 billion in
February 1998; $1.6 billion in May 1998; $2.0 billion in June 1998; and $2.0
billion in October 1999. At maturity, Merrill Lynch may convert amounts bor-
rowed, if any, into term loans that would mature in two years.
To finance the purchase of Mercury, Merrill Lynch obtained a commitment under
a credit facility agreement with 12 banks to provide unsecured short-term
financing of up to 2.0 billion British pounds (approximately $3.3 billion).
The commitment expires in June 1998. At December 26, 1997, the facility had
not been drawn upon. Subsequent to year end, Merrill Lynch borrowed approxi-
mately 1.9 billion British pounds (approximately $3.1 billion) under the
facility. These borrowings are expected to be repaid during 1998 with proceeds
from long-term financing.
- --------------------------------------------------------------------------------
OTHER NON-TRADING LIABILITIES
Other financial instrument liabilities are carried at amounts that approximate
fair value. Such liabilities include most payables under repurchase agreements
and securities loaned transactions, payables to customers and brokers and
dealers, and insurance and other liabilities.
- --------------------------------------------------------------------------------
NOTE 6. PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES
Trust Originated Preferred Securities(Service Mark) ("TOPrS"(Registered
Trademark)) are issued to investors by trusts created by Merrill Lynch. Using
the issuance proceeds, the trusts purchase Partnership Preferred Securities,
representing limited partnership interests. Using the purchase proceeds, the
limited partnerships extend loans to ML & Co. and one or more subsidiaries of ML
& Co. The trusts and partnerships are consolidated subsidiaries of Merrill
Lynch. ML & Co. has guaranteed, on a subordinated basis, the payment in full of
all distributions and other payments on the TOPrS to the extent that the trusts
have funds legally available. This guarantee and the partnership distribution
guarantee are subordinated to
1997 Annual Report
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
all other liabilities of ML & Co. and rank pari passu with preferred stock of
ML & Co.
In December 1996, Merrill Lynch Capital Trust I ("TOPrS I") issued $275 of
7.75% TOPrS, consisting of 11,000,000 securities with a $25 liquidation amount
per security, and in February 1997, Merrill Lynch Capital Trust II ("TOPrS
II") issued $300 of 8% TOPrS, consisting of 12,000,000 securities with a $25
liquidation amount per security. Both TOPrS I and TOPrS II securities are
redeemable at the option of the trusts, in whole or in part, at a redemption
price equal to $25 per security on or after December 30, 2006 and March 30,
2007, respectively. Distributions are payable from the date of original issu-
ance and are payable quarterly if, as, and when the trusts have funds avail-
able for payment.
In January 1998, Merrill Lynch Capital Trust III issued $750 of 7% TOPrS, con-
sisting of 30,000,000 securities with a $25 liquidation amount per security,
which are redeemable at the option of the trust, in whole or in part, at a
redemption price equal to $25 per security, on or after March 30, 2008.
- -------------------------------------------------------------------------------
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 pre-
ferred stock constitute one and the same class that have equal rank and prior-
ity 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,
$10,000 liquidation preference per share ("9% Preferred Stock"). The 9% Pre-
ferred Stock is a single series consisting of 42,500 shares with an aggregate
liquidation preference of $425.
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 redeemable on or after December 30, 2004
at the option of ML & Co., in whole or in part, at a redemption price equal to
$10,000 per share, plus accrued and unpaid dividends (whether or not declared)
to the date fixed for redemption.
- -------------------------------------------------------------------------------
Remarketed Preferred(Service Mark) Stock, Series C
During the first quarter of 1997, all of the outstanding Remarketed Preferred
Stock, Series C was redeemed. Dividend rates in effect prior to redemption
ranged from 3.80% to 4.15% per annum.
- -------------------------------------------------------------------------------
COMMON STOCK SPLIT
In 1997, the Board of Directors declared a two-for-one common stock split
effected in the form of a 100% stock dividend. The par value of the common
stock remained at $1.33 1/3 per share. Accordingly, an adjustment from paid-in
capital to common stock of $315 was made to preserve the par value of the
post-split shares. All share and per share data have been restated for the
effect of the split.
- -------------------------------------------------------------------------------
1997 Annual Report
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income represents cumulative gains and losses
on items that are not reflected in earnings. The balances at December 26, 1997
and December 27, 1996 are comprised as follows:
- -------------------------------------------------------------------------------
1997 1996
---- ----
FOREIGN CURRENCY TRANSLATION ADJUSTMENT
Unrealized losses, net of gains $(97) $(11)
Deferred income taxes 25 21
---- ----
Total (72) 10
---- ----
UNREALIZED GAINS ON INVESTMENTS
AVAILABLE-FOR-SALE
Unrealized gains, net of losses 116 82
Adjustments for:
Policyholder liabilities (54) (64)
Deferred policy acquisition costs (4) (4)
Deferred income taxes (20) (5)
---- ----
Total 38 9
---- ----
TOTAL ACCUMULATED OTHER COMPREHENSIVE INCOME $(34) $ 19
==== ====
- -------------------------------------------------------------------------------
STOCKHOLDER RIGHTS PLAN
In December 1997, the Board of Directors approved and adopted the amended and
restated Stockholder Rights Plan. The amended and restated Stockholder Rights
Plan provides for the distribution of preferred purchase rights ("Rights") to
common stockholders. The Rights separate from the common stock ten days fol-
lowing: (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 Pre-
ferred 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 exer-
cise price and the number of Units issuable are subject to adjustment to pre-
vent 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 busi-
ness 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 sur-
viving company with a value equal to two times the exercise price of the
Right. The Rights expire December 2, 2007, and are redeemable at the option of
a majority of the directors of ML & Co. at $.01 per Right at any time until
the tenth day following an announcement of the acquisition of 15% or more of
ML & Co.'s common stock.
- -------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Earnings per common share are computed in accordance with SFAS No. 128 (see
Note 2). Under SFAS No. 128, basic and diluted EPS replace primary and fully
diluted EPS. Basic 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 potential
common shares. The following table presents the computations of basic and
diluted EPS:
- -------------------------------------------------------------------------------
1997 1996 1995
------- ------- -------
Net earnings $ 1,906 $ 1,619 $ 1,114
Preferred stock dividends 39 47 48
------- ------- -------
Net earnings applicable to
common stockholders $ 1,867 $ 1,572 $ 1,066
======= ======= =======
- -------------------------------------------------------------------------------
(shares in thousands)
Weighted-average shares outstanding 331,467 337,794 353,126
------- ------- -------
Effect of dilutive instruments/(1)/
Employee stock options 29,405 21,016 19,772
FCCAAP shares 20,574 18,853 18,671
Restricted units 5,258 4,554 2,363
ESPP shares 45 54 63
------- ------- -------
Dilutive potential common shares 55,282 44,477 40,869
------- ------- -------
Total weighted-average
diluted shares/(2)/ 386,749 382,271 393,995
======= ======= =======
- --------------------------------------------------------------------------------
Basic EPS $ 5.63 $ 4.65 $ 3.02
Diluted EPS 4.83 4.11 2.71
- --------------------------------------------------------------------------------
/(1)/ See Note 9 for a description of these instruments and issuances
subsequent to December 26, 1997.
/(2)/ At year-end 1995, there were 2,898 instruments that were considered
antidilutive and were not included in the above calculation.
1997 Annual Report
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NOTE 7. COMMITMENTS AND CONTINGENCIES
- -------------------------------------------------------------------------------
LITIGATION
There are civil actions, arbitration proceedings, and claims pending against
Merrill Lynch as of December 26, 1997, some of which involve claims for sub-
stantial amounts.
Included among these matters is an action that is pending in the United States
District Court for the Central District of California, commenced on January
12, 1995 by Orange County, California (the "County") and the Orange County
Investment Pools (the "Pools"), both of which filed bankruptcy petitions in
the United States Bankruptcy Court for the Central District of California (the
"Bankruptcy Court") on December 6, 1994. ML & Co. and certain of its subsidi-
aries are named as defendants in connection with Merrill Lynch's business
activities with the Orange County Treasurer-Tax Collector. The Pools' bank-
ruptcy petition subsequently was dismissed. On May 17, 1996, the Bankruptcy
Court confirmed a plan pursuant to which Orange County emerged from bankrupt-
cy.
The County and its current Treasurer-Tax Collector seek relief totaling in
excess of $2 billion in connection with various securities transactions
between the Orange County Treasurer-Tax Collector and ML & Co. and its subsid-
iaries. As subsequently amended, the complaint alleges, among other things,
that these transactions violated California law and should be adjudged null
and void, that ML & Co. and its subsidiaries violated various provisions of
the Bankruptcy Code and Section 10(b) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated thereunder, and that ML & Co. and its subsidiaries
breached a fiduciary duty owed to the County and conspired to make unautho-
rized use of public funds.
In addition, other actions are pending against or on behalf of ML & Co.,
and/or against certain of its officers, directors, and employees and certain
of its subsidiaries in the United States District Court for the Central Dis-
trict of California, the United States District Court for the Southern Dis-
trict of New York, and in state courts in California and New York. These
include class actions and stockholder derivative actions brought by persons
alleging harm to themselves or to Merrill Lynch arising out of Merrill Lynch's
dealings with the Orange County Treasurer-Tax Collector, or the purchase of
debt instruments issued by Orange County or other public entities with funds
controlled by the Orange County Treasurer-Tax Collector that were underwritten
by ML & Co.'s subsidiary, MLPF&S.
Although the ultimate outcome of these actions cannot be ascertained at this
time and the results of legal proceedings cannot be predicted with certainty,
it is the opinion of management that the resolution of these matters will not
have a material adverse effect on the Consolidated Financial Statements of
Merrill Lynch contained herein.
- -------------------------------------------------------------------------------
LENDING
Merrill Lynch enters into commitments to extend credit, predominantly at vari-
able interest rates, in connection with certain merchant banking and loan syn-
dication 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, agency secu-
rities lending, 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 the counterparty's
creditworthiness and market conditions.
The contractual amounts of these commitments and guarantees represent the
amounts at risk should the contract be fully drawn upon, the client default,
and the value of the existing collateral become worthless. The
1997 Annual Report
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
total amount of outstanding commitments and guarantees may not represent
future cash requirements, as guarantees and commitments may expire without
being drawn upon.
At December 26, 1997 and December 27, 1996, Merrill Lynch had the following
commitments and guarantees:
- -------------------------------------------------------------------------------
1997 1996
------ ------
Commitments to extend credit $5,839 $4,780
Third party guarantees 3,819 1,975
- -------------------------------------------------------------------------------
The fair value of the outstanding guarantees was $25 and $24 at December 26,
1997 and December 27, 1996, respectively.
- -------------------------------------------------------------------------------
LEASES
Merrill Lynch has entered into various noncancelable long-term lease agree-
ments for premises and equipment that expire through 2024. During 1996, Mer-
rill Lynch incurred a pretax charge of $40 million related to the resolution
of Olympia & York's bankruptcy that affected Merrill Lynch's long-term sub-
lease agreements in the World Financial Center Headquarters ("WFC"). Merrill
Lynch has also entered into various noncancelable short-term lease agreements,
which are primarily commitments of less than one year under equipment leases.
At December 26, 1997, future minimum rental commitments under noncancelable
leases with initial or remaining terms exceeding one year are presented below:
- -------------------------------------------------------------------------------
WFC OTHER TOTAL
------ ------ ------
1998 $ 125 $ 262 $ 387
1999 140 260 400
2000 144 238 382
2001 144 213 357
2002 150 178 328
2003 and thereafter 1,936 726 2,662
------ ------ ------
Total $2,639 $1,877 $4,516
====== ====== ======
- -------------------------------------------------------------------------------
The minimum rental commitments shown above have not been reduced by $824 of
minimum sublease rentals to be received in the future under noncancelable sub-
leases. Certain leases contain renewal or purchase options or escalation
clauses providing for increased rental payments based upon maintenance, utili-
ty, and tax increases.
Net rent expense for each of the last three years is presented below:
- -------------------------------------------------------------------------------
1997 1996 1995
----- ----- -----
Rent expense $ 449 $ 420 $ 399
Sublease revenue (104) (48) (87)
----- ----- -----
Net rent expense $ 345 $ 372 $ 312
===== ===== =====
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
OTHER COMMITMENTS
In the normal course of business, Merrill Lynch enters into commitments for
securities underwriting and when-issued transactions. Settlement of these
transactions as of December 26, 1997 would not have a material effect on the
consolidated financial condition of Merrill Lynch.
In connection with financing activities, Merrill Lynch had commitments at
December 26, 1997 and December 27, 1996 to enter into resale and repurchase
agreements as follows:
- -------------------------------------------------------------------------------
1997 1996
------ ------
Resale agreements $3,440 $3,653
Repurchase agreements 4,469 976
- -------------------------------------------------------------------------------
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 $1,035 and $2,065 at
December 26, 1997 and December 27, 1996, respectively.
In connection with merchant banking activities, Merrill Lynch has committed to
purchase $88 and $101 of partnership interests at December 26, 1997 and Decem-
ber 27, 1996, respectively.
Merrill Lynch has entered into agreements with providers of market data, com-
munications, and systems consulting services. At December 26, 1997 and Decem-
ber 27, 1996, minimum fee commitments over the life of these agreements aggre-
gated $348 and $481, respectively.
1997 Annual Report
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NOTE 8. 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 and postemployment benefit plans. Merrill Lynch
reserves the right to amend or terminate these plans at any time.
- -------------------------------------------------------------------------------
DEFINED CONTRIBUTION PENSION PLANS
The domestic defined contribution plans consist of the Retirement Accumulation
Plan ("RAP"), the Employee Stock Ownership Plan ("ESOP"), and the 401(k) Sav-
ings & Investment Plan ("401K"). The RAP, ESOP, and 401K cover substantially
all U.S. employees who have met age and service requirements.
Merrill Lynch established the RAP and the ESOP, collectively known as the "Re-
tirement Program," for the benefit of employees over the age of 21 with one
year of service. A separate retirement account is maintained for each partici-
pant.
In 1989, the ESOP trust purchased from Merrill Lynch 47,851,236 shares of ML &
Co. common stock with residual funds from a terminated defined benefit pension
plan ("Reversion Shares") and loan proceeds from a subsidiary of Merrill Lynch
("Leveraged Shares").
Merrill Lynch credits a participant's account and records pension expense
under the Retirement Program based on years of service and eligible compensa-
tion. This expense is funded by quarterly allocations of Leveraged and Rever-
sion Shares and, if necessary, cash, to participants' accounts based on a
specified formula. Leveraged and Reversion Shares are released in accordance
with the terms of the ESOP. If the fair market value of the shares released is
less than the formula allocation to participants' accounts, cash contributions
are made to the RAP. Reversion Shares were allocated to participants' accounts
over a period of eight years, ending in June 1997. Leveraged Shares are allo-
cated to participants' accounts as principal is repaid on the loan to the
ESOP, which matures in 1999. Principal and interest on the loan are payable
quarterly upon receipt of dividends on certain shares of common stock or other
cash contributions.
ESOP shares are considered to be either allocated (contributed to partici-
pants' accounts), committed (scheduled to be contributed at a specified future
date but not yet released), or unallocated (not committed or allocated). Share
information at December 26, 1997 is as follows:
- --------------------------------------------------------------------------------
REVERSION LEVERAGED
SHARES SHARES
---------- ---------
Allocated 38,962,348 6,104,498
Committed - 173,188
Unallocated - 2,611,202
- --------------------------------------------------------------------------------
The remaining cost of the unallocated Leveraged Shares of $16 at December 26,
1997 is recorded as a reduction of stockholders' equity and represents the
remaining ESOP loan balance.
Additional information on ESOP activity follows:
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Dividends used for debt service/(1)/ $ 7 $ 8 $ 9
Compensation costs funded with ESOP shares 193 190 143
- --------------------------------------------------------------------------------
/(1)/ Dividends on all Leveraged Shares are used for debt service on the ESOP
loan.
Employees can participate in the 401K by contributing, on a tax-deferred
basis, up to 15% of their eligible compensation but not more than the maximum
annual amount allowed by law. Merrill Lynch's contributions are equal to one-
half of the first 4% of each participant's eligible compensation contributed
to the 401K, up to a maximum of fifteen hundred dollars annually. No corporate
contributions are made for participants who are also Employee Stock Purchase
Plan participants (see Note 9).
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.
1997 Annual Report
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
DEFINED BENEFIT PENSION PLANS
Merrill Lynch has purchased a group annuity contract that guarantees the pay-
ment 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 December 26, 1997 and December 27, 1996, a
substantial portion of the assets supporting the annuity contract was invested
in U.S. Government and agencies securities. Merrill Lynch, under a supplemen-
tal agreement, may be responsible for, or benefit from, actuarial experience
and investment performance of these annuity assets. Merrill Lynch also main-
tains 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 com-
pensation 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 funded status of the defined benefit plans (including the terminated plan)
follows:
- ------------------------------------------------------------------------------
1997 1996
------------------------ ------------------------
PENSION PLANS IN WHICH: PENSION PLANS IN WHICH:
------------------------ ------------------------
ASSETS ACCUMULATED ASSETS ACCUMULATED
EXCEEDED BENEFITS EXCEEDED BENEFITS
ACCUMULATED EXCEEDED ACCUMULATED EXCEEDED
BENEFITS ASSETS/(1)/ BENEFITS ASSETS/(1)/
----------- ----------- ----------- -----------
Accumulated benefit
obligation
Vested $(1,756) $ (51) $(1,447) $ (118)
Non-vested (5) (7) (3) (8)
------- ------- ------- -------
Total (1,761) (58) (1,450) (126)
Effect of assumed increase
in compensation levels (95) (16) (24) (25)
------- ------- ------- -------
Projected benefit
obligation (1,856) (74) (1,474) (151)
Plan assets at fair value 2,137 28 1,673 85
------- ------- ------- -------
Plan assets in excess of
(less than) projected
benefit obligation 281 (46) 199 (66)
Unrecognized net liability
at transition 2 1 3 2
Unrecognized prior service
cost (benefit) 3 (1) (3) (1)
Unrecognized net (gain)
loss (118) (1) (4) 14
------- ------- ------- -------
Prepaid (accrued) benefit
cost $ 168 $ (47) $ 195 $ (51)
======= ======= ======= =======
- ------------------------------------------------------------------------------
/(1)/ Consists primarily of domestic supplemental plans not subject to ERISA
and non-U.S. plans where funding strategies vary due to legal requirements
and local practice.
1997 Annual Report
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
Pension cost included the following components:
- --------------------------------------------------------------------------------
1997 1996 1995
----- ----- -----
DEFINED CONTRIBUTION PLAN COST $ 216 $ 223 $ 169
----- ----- -----
DEFINED BENEFIT PLANS/(1)/
Service cost for benefits earned during the year 30 24 19
Interest cost on projected benefit obligation 108 103 105
Actual return on plan assets (312) 19 (480)
Deferral and amortization of unrecognized items 194 (133) 373
----- ----- -----
Total defined benefit plan cost 20 13 17
----- ----- -----
TOTAL PENSION COST $ 236 $ 236 $ 186
===== ===== =====
- --------------------------------------------------------------------------------
/(1)/ The following actuarial assumptions were used in calculating the defined
benefit cost and benefit obligations. Weighted-average rates as of the
beginning of the year are:
1998 1997 1996
---- ---- ----
Discount rate 6.3% 6.7% 6.5%
Rate of compensation
increase 5.6 5.4 5.5
Expected long-term rate
of return on plan
assets 6.6 6.9 6.7
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 retiree
contributions adjusted periodically; the life insurance component of the plan
is noncontributory. The accounting for costs of health care benefits antici-
pates future changes in cost-sharing provisions. Merrill Lynch pays claims as
incurred. Full-time employees of Merrill Lynch become eligible for these bene-
fits 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 26, 1997, none of
these plans had been funded.
Postretirement benefit cost included the following components:
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Service cost $ 6 $ 6 $ 4
Interest cost on accumulated postretirement benefit obligation 11 11 10
Amortization of unrecognized gain - - (1)
--- --- ---
Total postretirement benefit cost $17 $17 $13
=== === ===
- --------------------------------------------------------------------------------
The amounts recognized for Merrill Lynch's postretirement benefit plans fol-
low:
- --------------------------------------------------------------------------------
1997 1996
----- -----
Accumulated postretirement benefit obligation
Retirees $ (88) $ (73)
Fully eligible active plan participants (57) (37)
Other active plan participants (69) (62)
----- -----
Total (214) (172)
Unrecognized net loss (gain) 8 (7)
----- -----
Postretirement benefits accrued liability $(206) $(179)
===== =====
- --------------------------------------------------------------------------------
The following actuarial assumptions were used in calculating the
postretirement benefit cost and obligations. Weighted-average rates as of the
beginning of the year are:
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Discount rate 6.4% 6.8% 6.5%
Health care cost trend rates/(1)/
Initial 7.5 8.0 9.0
2012 and thereafter 5.5 5.5 5.5
- --------------------------------------------------------------------------------
/(1)/ Assumed to decrease gradually until the year 2012 and remain constant
thereafter.
The assumed health care cost trend rate has a significant effect on the
amounts reported above. Increasing the assumed trend rate by one percentage
point per year would increase the accumulated postretirement benefit obliga-
tion at December 26, 1997 and December 27, 1996 by $26 and $28, respectively,
and increase the aggregate of service and interest costs for 1997 and 1996 by
$3 for both years.
- --------------------------------------------------------------------------------
POSTEMPLOYMENT BENEFITS
Merrill Lynch provides certain postemployment benefits for employees on
extended leave due to injury or illness and for terminated employees. Employ-
ees who are disabled due to non-work-related illness or injury are
1997 Annual Report
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
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 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 $25, $30, and $76 in 1997, 1996, and 1995, respec-
tively, of postemployment benefits expense, which included severance costs for
terminated employees of $13, $14, and $54 in 1997, 1996, and 1995, respective-
ly. Although all full-time employees are eligible for severance benefits, no
additional amounts were accrued as of December 26, 1997 since future severance
costs are not estimable.
- -------------------------------------------------------------------------------
NOTE 9. 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 recog-
nized in earnings for stock-based compensation plans for 1997, 1996, and 1995
was $318, $269, and $131, respectively. Merrill Lynch also sponsors deferred
cash compensation plans for eligible employees.
- -------------------------------------------------------------------------------
LONG-TERM INCENTIVE COMPENSATION PLANS
("LTIC PLANS") AND EQUITY CAPITAL ACCUMULATION PLAN ("ECAP")
LTIC Plans and ECAP provide for grants of equity and equity-related instru-
ments to certain key employees. LTIC Plans provide for the issuance of
Restricted Shares, Restricted Units, and Nonqualified Stock Options, as well
as Incentive Stock Options, Performance Shares, Performance Units, Stock
Appreciation Rights, and other securities of Merrill Lynch. ECAP provides for
the issuance of Restricted Shares, as well as Performance Shares. As of Decem-
ber 26, 1997, no instruments other than Restricted Shares, Restricted Units,
and Nonqualified Stock Options had been granted.
- -------------------------------------------------------------------------------
Restricted Shares and Units
Restricted Shares are shares of ML & Co. common stock carrying voting and div-
idend rights. A Restricted Unit is deemed equivalent in fair market value to
one share of common stock, is payable in cash, and receives cash payments
equivalent to dividends. Under these plans, such shares are restricted from
sale, transfer, or assignment until the end of the restricted period, and such
shares and units are subject to forfeiture during the vesting period for
grants under LTIC Plans or the restricted period for grants under ECAP.
The activity for Restricted Shares and Units under these plans during 1997 and
1996 follows:
- -------------------------------------------------------------------------------
LTIC PLANS ECAP
----------------------- -----------
RESTRICTED RESTRICTED RESTRICTED
SHARES UNITS SHARES
----------- ---------- -----------
Authorized for issuance at:
December 26, 1997 200,000,000 N/A 52,400,000
December 27, 1996 200,000,000 N/A 52,400,000
- --------------------------------------------------------------------------------
Available for issuance at/(1)/:
December 26, 1997 44,703,329 N/A 2,935,408
December 27, 1996 61,891,210 N/A 2,698,830
- --------------------------------------------------------------------------------
Outstanding, end of 1995 6,543,520 6,647,548 1,211,982
Granted - 1996 2,914,844 3,110,570 3,355,708
Paid, forfeited, or released from
contingencies (495,402) (483,218) (435,946)
---------- ---------- ---------
Outstanding, end of 1996 8,962,962 9,274,900 4,131,744
Granted - 1997 3,662,390 3,819,904 48,747
Paid, forfeited, or released from
contingencies (2,779,206) (3,197,062) (299,926)
---------- ---------- ---------
Outstanding, end of 1997/(2)/ 9,846,146 9,897,742 3,880,565
========== ========== =========
- --------------------------------------------------------------------------------
/(1)/ Includes shares reserved for issuance upon the exercise of stock
options.
/(2)/ Subsequent to year end through February 1, 1998, 2,287,501 and 2,497,175
Restricted Shares and Units under LTIC Plans, respectively, and 1,980 ECAP
Restricted Shares were granted to eligible employees.
The weighted-average fair value per share or unit for 1997, 1996, and 1995
grants follows:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
LTIC Plans
Restricted Shares $46.31 $28.97 $20.85
Restricted Units 44.47 28.69 20.72
ECAP Restricted Shares 66.99 28.76 26.23
- --------------------------------------------------------------------------------
Merrill Lynch sponsors other plans similar to LTIC Plans in which restricted
shares and units are
1997 Annual Report
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
granted to employees and non-employee directors.
The table below summarizes information related to Restricted Shares and Units
for these other plans:
- --------------------------------------------------------------------------------
RESTRICTED RESTRICTED
SHARES UNITS
---------- ----------
Authorized for issuance at:
December 26, 1997 6,300,000 400,000
December 27, 1996 1,700,000 400,000
Outstanding at:
December 26, 1997 258,929 31,862
December 27, 1996 121,490 16,134
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Nonqualified Stock Options
Nonqualified Stock Options granted under LTIC Plans in 1989 through 1995 gen-
erally become exercisable over four years in equal installments commencing one
year after the date of grant. Options granted in 1996 and thereafter generally
are exercisable over five years. The exercise price of these options is equal
to 100% of the fair market value (as defined in LTIC Plans) of a share of ML &
Co. common stock on the date of grant. Nonqualified Stock Options expire ten
years after their grant date.
The activity for Nonqualified Stock Options under LTIC Plans for 1997, 1996,
and 1995 follows:
- --------------------------------------------------------------------------------
WEIGHTED-
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------
Outstanding, beginning of 1995 56,815,866 $11.66
Granted - 1995 12,912,924 19.82
Exercised (7,919,898) 8.40
Forfeited (1,662,258) 18.48
----------
Outstanding, end of 1995 60,146,634 13.65
Granted - 1996 13,633,940 27.28
Exercised (8,481,030) 10.45
Forfeited (1,486,888) 25.43
----------
Outstanding, end of 1996 63,812,656 16.72
Granted - 1997 15,323,524 42.18
Exercised (9,065,189) 12.24
Forfeited (1,363,699) 31.27
----------
Outstanding, end of 1997/(1)/ 68,707,292 22.69
==========
- --------------------------------------------------------------------------------
/(1)/ In January 1998, eligible participants were granted stock options for
11,307,570 shares.
At December 26, 1997, December 27, 1996, and December 29, 1995, options exer-
cisable under LTIC Plans were 36,380,942; 35,532,334; and 34,118,750,
respectively.
The table below summarizes information related to outstanding and exercisable
options at December 26, 1997.
- --------------------------------------------------------------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE REMAINING NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING PRICE LIFE (YEARS)/(1)/ EXERCISABLE PRICE
- --------------- ----------- -------- ------------ ----------- --------
$5.00 - $10.99 12,278,961 $ 5.57 2.62 12,278,961 $ 5.57
$11.00 - $19.99 21,287,249 16.62 5.69 16,664,361 16.35
$20.00 - $29.99 19,252,779 24.88 7.48 7,023,277 22.61
$30.00 - $39.99 1,156,924 31.03 7.77 400,768 31.03
$40.00 - $68.125 14,731,379 42.24 9.26 13,575 40.59
- --------------------------------------------------------------------------------
/(1)/ Based on original contractual life of ten years.
1997 Annual Report
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
The weighted-average fair value of options granted in 1997, 1996, and 1995 was
$14.62, $7.58, and $5.67 per option, respectively. Fair value is estimated as
of the grant date based on a Black-Scholes option pricing model using the fol-
lowing weighted-average assumptions:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
Risk-free interest rate 6.74% 5.68% 7.61%
Expected life 6 yrs. 5 yrs. 5 yrs.
Expected volatility 26.86% 26.35% 25.00%
Dividend yield 1.47% 1.91% 2.45%
- --------------------------------------------------------------------------------
See "Pro Forma Compensation Expense" in the following "Employee Stock Purchase
Plans" section for additional information.
- --------------------------------------------------------------------------------
EMPLOYEE STOCK PURCHASE PLANS ("ESPP")
ESPP plans allow eligible employees to invest from 1% to 10% of their eligible
compensation to purchase ML & Co. common stock at a price generally equal to
85% of its fair market value. These purchases are made on four quarterly
investment dates through payroll deductions. Up to 50,300,000 shares of common
stock have been authorized for issuance under ESPP. The activity in ESPP dur-
ing 1997, 1996, and 1995 follows:
- --------------------------------------------------------------------------------
1997 1996 1995
---------- ---------- ----------
Available, beginning of year 8,267,360 9,992,526 11,714,898
Authorized during year 300,000 - -
Purchased through plan (1,316,017) (1,725,166) (1,722,372)
---------- ---------- ----------
Available, end of year 7,251,343 8,267,360 9,992,526
========== ========== ==========
- --------------------------------------------------------------------------------
The weighted-average fair value of ESPP stock purchase rights exercised by
employees in 1997, 1996, and 1995 was $7.66, $4.38, and $3.60 per right,
respectively.
- --------------------------------------------------------------------------------
Pro Forma Compensation Expense
No compensation expense has been recognized for Merrill Lynch's grants of
stock options under LTIC Plans or ESPP purchase rights (see Note 1 for
accounting policy). Based on the fair value of stock options and purchase
rights, Merrill Lynch would have recognized compensation expense, net of tax-
es, of $54, $26, and $12 for 1997, 1996, and 1995, respectively, resulting in
pro forma net earnings and earnings per share as follows:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
NET EARNINGS
As reported $1,906 $1,619 $1,114
Pro forma 1,852 1,593 1,102
EARNINGS PER COMMON SHARE
As reported:
Basic $ 5.63 $ 4.65 $ 3.02
Diluted 4.83 4.11 2.71
Pro forma:
Basic 5.47 4.58 2.99
Diluted 4.69 4.05 2.68
- --------------------------------------------------------------------------------
In the table above, pro forma compensation expense associated with option
grants is recognized over the vesting period. The impact of applying SFAS No.
123 on pro forma disclosure is not representative of the potential impact on
pro forma net earnings for future years, which will include the cumulative
effect of expense related to vesting of 1995 and subsequent grants.
- --------------------------------------------------------------------------------
1997 Annual Report
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERILL LYNCH APPEARS HERE]
- -------------------------------------------------------------------------------
FINANCIAL CONSULTANT CAPITAL ACCUMULATION
AWARD PLANS ("FCCAAP")
Under FCCAAP, eligible employees in Merrill Lynch's Private Client groups 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. com-
mon stock unless the fair market value of such shares is less than a specified
minimum value plus interest, in which case the minimum value is paid in cash.
Eligible participants may defer awards beyond the scheduled payment date.
FCCAAP may also provide for the issuance of Restricted Shares that vest ten
years from the date of the original award and carry voting and dividend
rights.
A total of 60,415,284 shares of common stock are authorized for issuance under
FCCAAP. Only shares of common stock held as treasury stock may be issued under
FCCAAP. At December 26, 1997, shares subject to outstanding awards totaled
32,469,188, while 24,658,543 shares were available for issuance through future
awards. The fair value of awards granted under FCCAAP during 1997, 1996, and
1995 was $42.09, $25.34, and $18.06 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
2,164,600 and 2,274,400 at December 26, 1997 and December 27, 1996, respec-
tively. 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 groups are
issued investment certificates based on their performance. The certificates
mature ten years from the date issued and are payable in cash if certain per-
formance 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 December 26, 1997 and December 27, 1996, $292 and $235, respectively,
were accrued under this plan.
- -------------------------------------------------------------------------------
OTHER DEFERRED COMPENSATION PLANS
Merrill Lynch sponsors other deferred compensation plans in which eligible
employees may participate. Generally, contributions to the plans are made on a
tax-deferred basis to participants. Contributions are invested by Merrill
Lynch, principally in mutual and other funds sponsored by Merrill Lynch, and
the plans may include a leverage feature. The plans' investments and the
amounts accrued by Merrill Lynch under the plans are both included in the Con-
solidated Balance Sheets. Plan investments totaled $554 and $211, respective-
ly, at December 26, 1997 and December 27, 1996. Accrued liabilities at those
dates were $441 and $220, respectively.
- -------------------------------------------------------------------------------
NOTE 10. INCOME TAXES
- -------------------------------------------------------------------------------
Income tax provisions (benefits) on earnings consisted of:
- -------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
Federal
Current $ 856 $ 515 $ 788
Deferred (94) (119) (164)
State and local
Current (15) 198 81
Deferred 7 (54) (30)
Foreign
Current 362 460 (39)
Deferred (19) (53) 61
------ ------ ------
Total $1,097 $ 947 $ 697
====== ====== ======
- -------------------------------------------------------------------------------
The corporate statutory tax rate was 35.0% for the three years presented. A
reconciliation of statutory Federal income taxes to Merrill Lynch's income tax
provisions for earnings follows:
- -------------------------------------------------------------------------------
1997 1996 1995
------ ----- -----
Federal income tax at statutory rate $1,068 $ 898 $ 634
State and local income taxes, net (5) 94 33
Pension plan transaction 6 12 13
Foreign operations 30 (8) (4)
Tax-exempt interest (26) (21) (14)
Dividends received deduction (33) (34) (19)
Other, net 57 6 54
------ ----- -----
Income tax expense $1,097 $ 947 $ 697
====== ===== =====
- -------------------------------------------------------------------------------
For financial reporting purposes, Merrill Lynch had no unrecognized net oper-
ating loss or alternative minimum tax benefit carryforwards at December 26,
1997.
Deferred income taxes are provided for the effects of temporary differences
between the tax basis of an
1997 Annual Report
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
asset or liability and its reported amount in the Consolidated Financial
Statements. These temporary differences result in taxable or deductible
amounts in future years. Details of Merrill Lynch's deferred tax assets and
liabilities follow:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
DEFERRED TAX ASSETS
Valuation and other reserves/(1)/ $ 940 $ 895 $ 700
Deferred compensation 473 349 228
Employee benefits 109 115 94
Other 84 250 270
------ ------ ------
Total deferred tax assets 1,606 1,609 1,292
------ ------ ------
DEFERRED TAX LIABILITIES
Lease transactions 116 114 100
Employee benefits 58 54 47
Accelerated tax depreciation 26 44 70
Unrealized gains on inventory - 9 18
Other 175 77 41
------ ------ ------
Total deferred tax liabilities 375 298 276
------ ------ ------
NET DEFERRED TAX ASSET $1,231 $1,311 $1,016
====== ====== ======
- --------------------------------------------------------------------------------
/(1)/ Primarily related to Trading assets and Other liabilities.
Income tax benefits of $173, $30, and $34 were allocated to stockholders'
equity related to employee compensation transactions for 1997, 1996, and 1995,
respectively.
Earnings before income taxes included approximately $744, $738, and $128 of
earnings attributable to foreign entities for 1997, 1996, and 1995, respec-
tively. Cumulative undistributed earnings of foreign subsidiaries were approx-
imately $1,645 at December 26, 1997. No deferred Federal income taxes have
been provided for the undistributed earnings to the extent that such earnings
have been permanently reinvested in Merrill Lynch's foreign operations. Assum-
ing utilization of foreign tax credits, Merrill Lynch estimates that approxi-
mately $81 of Federal income taxes and $67 of foreign withholding taxes would
be incurred on the repatriation of the foreign subsidiaries' earnings.
- --------------------------------------------------------------------------------
NOTE 11. REGULATORY REQUIREMENTS AND DIVIDEND RESTRICTIONS
- --------------------------------------------------------------------------------
MLPF&S, a registered broker-dealer and a subsidiary of ML & Co., is subject to
the net capital requirements of Rule 15c3-1 of the Securities Exchange Act of
1934. Under the alternative method permitted by this rule, the minimum
required net capital, as defined, shall not be less than 2% of aggregate debit
items arising from customer transactions. At December 26, 1997, MLPF&S's regu-
latory net capital of $2,249 was 11% of aggregate debit items, and its regula-
tory net capital in excess of the minimum required was $1,845.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities and a subsidiary of ML & Co., 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
26, 1997, MLGSI's liquid capital of $1,354 was 263% of its total market and
credit risk, and liquid capital in excess of the minimum required was $735.
MLI, a registered U.K. broker-dealer and a subsidiary of Merrill Lynch, is
subject to capital requirements of the Securities and Futures Authority
("SFA"). Financial resources, as defined, must exceed the total financial
resources requirement of the SFA. During 1997, MLI became Merrill Lynch's pri-
mary dealer for global equity derivatives business. As a result, at Decem-
ber 26, 1997, MLI's financial resources were $4,540, an increase of $3,166
since year-end 1996, and exceeded the minimum requirement by $1,004. The
equity derivatives business of Merrill Lynch Capital Markets PLC was trans-
ferred to MLI during 1997.
Merrill Lynch's insurance subsidiaries are subject to various regulatory
restrictions that limit the amount available for distribution as dividends. As
of December 26, 1997, $389, representing 84% of the insurance subsidiaries'
net assets, was unavailable for distribution to Merrill Lynch.
Over 88 other subsidiaries are subject to regulatory requirements promulgated
by the regulatory and exchange authorities of the jurisdictions in which they
operate. These regulatory restrictions may limit the
1997 Annual Report
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
amounts that these subsidiaries can pay in dividends or advance to Merrill
Lynch. At December 26, 1997, restricted net assets of all subsidiaries were
$7,541.
In addition, to satisfy rating agency standards, a credit intermediary subsid-
iary of Merrill Lynch must also meet certain minimum capital requirements. At
December 26, 1997, this minimum capital requirement was $350. For additional
information on Merrill Lynch's regulatory oversight and supervision, see "Busi-
ness of Merrill Lynch--Regulation".
With the exception of regulatory restrictions on subsidiaries' abilities to
pay dividends, there are no restrictions on Merrill Lynch's present ability to
pay dividends on common stock, other than (1) Merrill Lynch's obligation first
to make dividend payments on its preferred stock, and (2) the governing provi-
sions of the Delaware General Corporation Law.
- --------------------------------------------------------------------------------
NOTE 12. INDUSTRY AND GLOBAL OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch operates principally in the financial services industry and pro-
vides services to individual and institutional clients. These services, due to
certain legal requirements, are conducted through various subsidiaries,
including those operating as brokers, dealers, banks, insurance, and other
financial services companies.
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,
- Asia and Pacific,
- Australia and New Zealand,
- Japan, and
- Latin America and Canada
European, Middle Eastern, and African operations offer international invest-
ment and private banking services, research, and dealer services in equity and
fixed-income securities, swaps, futures, commodity contracts, and options.
Merrill Lynch's Asian and Pacific operations conduct business throughout vari-
ous countries including China (and its special autonomous region of Hong Kong)
and Singapore. Merrill Lynch has a trading presence and exchange memberships in
virtually all of the region's markets.
In the Australia and New Zealand region, Merrill Lynch provides a broad mix of
retail and institutional activities.
Merrill Lynch's Japan region operates as a dealer in a full range of debt and
equity products. In addition, the Japan region provides investment banking and
research services to a predominately institutional client base.
In Latin America, Merrill Lynch provides international banking, brokerage, and
trust services and has been instrumental in the privatization of many Latin
American companies. In Canada, Merrill Lynch is a broker for securities and
commodities and a market maker for bonds and money market instruments. Merrill
Lynch also provides investment banking and research for Canadian customers.
For further information on these regions, see "Management's Discussion and
Analysis" (unaudited)--"Global Operations".
Following is the principal methodology used in preparing the geographic data
in the table below:
- Commission revenues are recorded based on the location of the sales force;
- Trading revenues are principally recorded based on the location of the
trader;
- Investment banking revenues are recorded based on the location of the cli-
ent;
- Asset management and portfolio service fees are recorded based on the loca-
tion of the fund manager;
- Earnings before income taxes include the allocation of certain shared
expenses among regions; and
- Intercompany transfers are based primarily on service agreements.
The information that follows, in management's judgment, provides a reasonable
representation of each region's contribution to the consolidated amounts.
1997 Annual Report
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions, Except Per Share Amounts)
- ---------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
1997 1996 1995 1997 1996 1995
------------------------------- ----------------------------
TOTAL REVENUES NET REVENUES
------------------------------- ----------------------------
Europe, Middle East, and
Africa $ 6,750 $ 5,336 $ 3,981 $ 2,284 $ 1,837 $ 1,319
Asia and Pacific 586 395 228 582 394 227
Australia and New
Zealand 272 151 163 229 88 66
Japan 1,108 993 841 598 502 408
Latin America and Canada 1,048 826 704 738 472 347
--------- --------- --------- -------- -------- --------
Total Non-U.S. 9,764 7,701 5,917 4,431 3,293 2,367
United States 25,046 19,221 16,107 12,462 10,603 8,092
Eliminations (3,079) (1,911) (511) (1,224) (780) (194)
--------- --------- --------- -------- -------- --------
Total $ 31,731 $ 25,011 $ 21,513 $ 15,669 $ 13,116 $ 10,265
========= ========= ========= ======== ======== ========
EARNINGS BEFORE INCOME TAXES TOTAL ASSETS
------------------------------- ----------------------------
Europe, Middle East, and
Africa $ 405 $ 357 $ 155 $111,404 $ 75,901 $ 56,948
Asia and Pacific 16 41 7 797 335 240
Australia and New
Zealand 39 24 14 1,899 1,115 976
Japan 140 119 60 15,294 16,455 15,698
Latin America and Canada 227 128 127 7,054 5,205 4,997
--------- --------- --------- -------- -------- --------
Total Non-U.S. 827 669 363 136,448 99,011 78,859
United States 2,223 1,897 1,448 175,477 126,784 105,702
Eliminations - - - (19,106) (12,779) (7,704)
--------- --------- --------- -------- -------- --------
Total $ 3,050 $ 2,566 $ 1,811 $292,819 $213,016 $176,857
========= ========= ========= ======== ======== ========
- ---------------------------------------------------------------------------------------
1997 Annual Report
67
QUARTERLY INFORMATION
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
The unaudited quarterly results of operations of Merrill Lynch for 1997 and
1996 are prepared in conformity with generally accepted accounting principles
and reflect all adjustments (which consist of normal recurring accruals and
the nonrecurring $40 million pretax lease charge related to the resolution of
Olympia & York's bankruptcy in the fourth quarter of 1996) 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. 26, SEPT. 26, JUNE 27, MAR. 28, DEC. 27, SEPT. 27, JUNE 28, MAR. 29,
1997 1997 1997 1997 1996 1996 1996 1996
------- -------- ------- ------- ------- -------- ------- -------
Total Revenues $8,123 $8,146 $8,011 $7,451 $6,601 $6,201 $6,190 $6,019
Interest Expense 4,255 4,153 4,044 3,610 3,219 3,108 2,810 2,758
------ ------ ------ ------ ------ ------ ------ ------
Net Revenues 3,868 3,993 3,967 3,841 3,382 3,093 3,380 3,261
Non-Interest Expenses 3,139 3,222 3,183 3,075 2,707 2,571 2,682 2,590
------ ------ ------ ------ ------ ------ ------ ------
Earnings Before
Income Taxes and
Dividends
on Preferred Securities
Issued by Subsidiaries 729 771 784 766 675 522 698 671
Income Tax Expense 250 266 290 291 230 191 265 261
Dividends on Preferred
Securities Issued by
Subsidiaries 13 12 13 9 - - - -
------ ------ ------ ------ ------ ------ ------ ------
Net Earnings $ 466 $ 493 $ 481 $ 466 $ 445 $ 331 $ 433 $ 410
====== ====== ====== ====== ====== ====== ====== ======
Earnings Per Common
Share/(1)/
Basic $ 1.37 $ 1.46 $ 1.43 $ 1.37 $ 1.32 $ 0.95 $ 1.24 $ 1.15
====== ====== ====== ====== ====== ====== ====== ======
Diluted $ 1.17 $ 1.25 $ 1.25 $ 1.17 $ 1.14 $ 0.84 $ 1.10 $ 1.01
====== ====== ====== ====== ====== ====== ====== ======
- -------------------------------------------------------------------------------------------------
/(1)/ Restated for the two-for-one common stock split.
- --------------------------------------------------------------------------------
DIVIDENDS PER COMMON SHARE
- --------------------------------------------------------------------------------
(Declared and paid)
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR.
-------- -------- -------- --------
1997 $.15 $.20 $.20 $.20
1996 .13 .15 .15 .15
- --------------------------------------------------------------------------------
Dividends per common share amounts give effect to the two-for-one common stock
split. With the exception of regulatory restrictions on subsidiaries' abili-
ties to pay dividends, there are no restrictions on Merrill Lynch's present
ability to pay dividends on common stock, other than (a) Merrill Lynch's obli-
gation first to make dividend payments on its preferred stock, and (b) the
governing provisions of the Delaware General Corporation Law. Certain subsidi-
aries' ability to declare dividends may also be limited (see Note 11 to the
Consolidated Financial Statements).
- --------------------------------------------------------------------------------
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
Consolidated Transaction Reporting System prices for the specified calendar
quarters are noted below. Prices have been restated for the two-for-one common
stock split.
- --------------------------------------------------------------------------------
(Based on calendar period-end)
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR.
-------------- --------------- -------------- --------------
HIGH LOW HIGH LOW HIGH LOW HIGH LOW
------ ----- ------ ----- ------ ----- ------ -----
1997 $52 $39 1/4 $63 7/8 $42 1/16 $75 1/8 $59 1/16 $78 3/16 $61 1/4
1996 31 1/4 24 11/16 34 1/16 28 1/8 33 3/8 27 1/8 42 9/16 32 9/16
- --------------------------------------------------------------------------------
The approximate number of record holders of common stock as of February 6,
1998 was 17,600.
1997 Annual Report
68
CONDENSED STATEMENTS OF EARNINGS (PARENT COMPANY ONLY)
(Dollars in Millions)
[LOGO OF MERRILL LYNCH APPEARS HERE]
- ------------------------------------------------------------------------------
Year Ended Last Friday in December
-----------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------
REVENUES
Interest (principally from affiliates) $3,937 $2,507 $2,002
Management service fees (from
affiliates) 296 258 282
Other 4 33 80
------ ------ ------
TOTAL REVENUES 4,237 2,798 2,364
Interest Expense 4,077 2,598 2,061
------ ------ ------
NET REVENUES 160 200 303
------ ------ ------
NON-INTEREST EXPENSES
Compensation and benefits 281 285 198
Other 307 288 206
------ ------ ------
TOTAL NON-INTEREST EXPENSES 588 573 404
------ ------ ------
EQUITY IN EARNINGS OF AFFILIATES 2,193 1,849 1,208
------ ------ ------
EARNINGS BEFORE INCOME TAXES 1,765 1,476 1,107
Income Tax Benefit 141 143 7
NET EARNINGS $1,906 $1,619 $1,114
====== ====== ======
NET EARNINGS APPLICABLE TO COMMON
STOCKHOLDERS $1,867 $1,572 $1,066
====== ====== ======
- ------------------------------------------------------------------------------
See Notes to Condensed Financial Statements
1997 Annual Report
69
CONDENSED BALANCE SHEETS (PARENT COMPANY ONLY)
(Dollars in Millions, Except Per Share Amount)
[LOGO OF MERRILL LYNCH APPEARS HERE]
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December 26, December 27,
------------------------
1997 1996
- ------------------------------------------------------------------------------
ASSETS
CASH AND CASH EQUIVALENTS $ 187 $ -
LOANS TO, RECEIVABLES FROM, AND PREFERENCE
SECURITIES OF AFFILIATES 79,201 55,435
INVESTMENTS IN AFFILIATES 7,963 6,749
PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT
(net of accumulated depreciation and
amortization of $267 in 1997 and $237 in 1996) 155 135
OTHER RECEIVABLES AND ASSETS 1,973 1,444
------- -------
TOTAL ASSETS $89,479 $63,763
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS $30,607 $24,837
LOANS FROM AND PAYABLES TO AFFILIATES 3,063 1,543
OTHER LIABILITIES AND ACCRUED INTEREST 4,492 3,960
LONG-TERM BORROWINGS 42,988 26,531
------- -------
TOTAL LIABILITIES 81,150 56,871
------- -------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY 425 619
------- -------
COMMON STOCKHOLDERS' EQUITY
Common stock (par value $1.33 1/3 per share;
authorized: 500,000,000 shares; issued:
472,660,324 shares) 630 630
Paid-in capital 1,065 989
Accumulated other comprehensive income (net of
tax) (34) 19
Retained earnings 9,485 7,868
------- -------
11,146 9,506
Less: Treasury stock, at cost:
1997 - 137,578,035 shares; 1996 - 141,411,196
shares 2,804 2,895
Unallocated ESOP reversion shares, at cost:
1996 - 3,077,556 shares - 24
Employee stock transactions 438 314
------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY 7,904 6,273
------- -------
TOTAL STOCKHOLDERS' EQUITY 8,329 6,892
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $89,479 $63,763
======= =======
- ------------------------------------------------------------------------------
See Notes to Condensed Financial Statements
1997 Annual Report
70
CONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)
MERRILL LYNCH & CO., INC.
(Dollars in Millions)
[LOGO OF MERRILL LYNCH APPEARS HERE]
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Year Ended Last Friday in December
-------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net earnings $ 1,906 $ 1,619 $ 1,114
Noncash items included in earnings:
Equity in earnings of affiliates (2,193) (1,849) (1,208)
Depreciation and amortization 30 31 31
Other 103 50 (35)
(Increase) decrease in operating
assets, net of liabilities (333) 782 530
Dividends from affiliates and
partnerships distributions 1,126 1,367 1,455
-------- -------- --------
CASH PROVIDED BY OPERATING
ACTIVITIES 639 2,000 1,887
-------- -------- --------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Payments for:
Loans to affiliates, net of
payments (22,028) (17,171) (5,608)
Investments in affiliates (64) (132) (363)
Property, leasehold improvements,
and equipment (54) (18) (12)
-------- -------- --------
CASH USED FOR INVESTING ACTIVITIES (22,146) (17,321) (5,983)
-------- -------- --------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-
term borrowings, net 5,770 7,499 2,592
Issuance and resale of long-term
borrowings 23,592 15,019 9,458
Settlement and repurchase of long-
term borrowings (6,665) (6,070) (6,883)
Repurchase of Remarketed Preferred
Stock (194) - -
Common stock transactions (520) (921) (894)
Dividends to shareholders (289) (243) (228)
-------- -------- --------
CASH PROVIDED BY FINANCING
ACTIVITIES 21,694 15,284 4,045
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 187 (37) (51)
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR - 37 88
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF
YEAR $ 187 $ - $ 37
======== ======== ========
- -----------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE
Cash paid for:
Income taxes $ 555 $ 949 $ 487
Interest 3,904 2,517 2,086
See Notes to Condensed Financial Statements
1997 Annual Report
71
NOTES TO CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
[LOGO OF MERRILL LYNCH APPEARS HERE]
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NOTE 1. BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The condensed unconsolidated financial statements of Merrill Lynch & Co., Inc.
("ML & Co." or the "Parent Company") should be read in conjunction with the
Consolidated Financial Statements of Merrill Lynch & Co., Inc. and
subsidiaries ("Merrill Lynch") and the Notes thereto. Certain limited
reclassification and format changes have been made to prior year amounts to
conform to the current year presentation.
Investments in affiliates are accounted for on the equity method.
For information on the following, refer to the indicated Notes to the Consoli-
dated Financial Statements.
. Long-term borrowings (Note 5)
. Stockholders' equity (Note 6)
. Employee incentive plans (Note 9)
The Parent Company hedges certain risks arising from long-term borrowing pay-
ment obligations and investments in and loans to foreign subsidiaries. See
Notes 5 and 4 to the Consolidated Financial Statements, respectively, for
additional information.
- --------------------------------------------------------------------------------
NOTE 2. GUARANTEES
- --------------------------------------------------------------------------------
ML & Co. issues guarantees of counterparty obligations in connection with cer-
tain activities of subsidiaries. See Note 7 to the Consolidated Financial
Statements for further information.
The Parent Company also guarantees obligations of subsidiaries, including
obligations associated with foreign exchange forward contracts and interest
rate swap transactions.
ML & Co. has also guaranteed subsidiaries' obligations related to Trust Origi-
nated Preferred Securities(Service Mark) (see Note 6 to the Consolidated
Financial Statements).
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
[LOGO OF DELOITTE & TOUCHE LLP APPEARS HERE]
To the Board of Directors and Stockholders of Merrill Lynch & Co., Inc.:
We have audited the consolidated financial statements of Merrill Lynch & Co.,
Inc. and subsidiaries ("Merrill Lynch") as of December 26, 1997 and December
27, 1996 and for each of the three years in the period ended December 26, 1997
and have issued our report thereon dated February 23, 1998. Our audits also
included the accompanying condensed parent company balance sheets and state-
ments of earnings and cash flows. These financial statements are the responsi-
bility of Merrill Lynch's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such condensed financial state-
ments, when considered in relation to the basic consolidated financial state-
ments taken as a whole, present fairly in all material respects the informa-
tion set forth therein.
/s/ Deloitte & Touche LLP
New York, New York
February 23, 1998
1997 Annual Report
72
BUSINESS OF MERRILL LYNCH
- --------------------------------------------------------------------------------
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OVERVIEW
- -------------------------------------------------------------------------------
Merrill Lynch & Co., Inc.,* a Delaware corporation formed in 1973, is a hold-
ing company that, through its subsidiaries and affiliates, provides invest-
ment, financing, advisory, insurance, and related services on a global basis.
Such services include:
. securities brokerage, trading, and underwriting
. investment banking, strategic services, and other corporate finance advi-
sory activities, including loan syndication
. asset management and other investment advisory and recordkeeping services
. trading and brokerage of swaps, options, forwards, futures, and other
derivatives
. securities clearance services
. banking, trust, and lending services, including mortgage lending and
related services
. insurance sales and underwriting services.
Merrill Lynch provides these services to a wide array of clients, including
individual investors, small businesses, corporations, governments and govern-
mental agencies, and financial institutions.
Merrill Lynch conducts its global business from various locations throughout
the world. Its world headquarters facility is located at the World Financial
Center in New York City and its other U.S. principal business and operational
centers are in New Jersey, Colorado, Florida, and California. From its busi-
ness facilities in London, Hong Kong, Frankfurt, Paris, Singapore, Tokyo,
Sydney, Dublin, and more than 50 other locations, Merrill Lynch serves its
international client base and conducts its non-U.S. business. Furthermore, it
has numerous retail sales and other offices throughout the world. At the end
of 1997, Merrill Lynch employed 56,600 people.
In the fourth quarter of 1997, Merrill Lynch acquired Mercury Asset Management
Group Holdings PLC, a global asset management firm based in the United Kingdom
("Mercury"). The Mercury acquisition further enhances Merrill Lynch's position
as one of the largest asset management groups in the world. Additional
information concerning the Mercury acquisition is set forth in Management's
Discussion and Analysis--Acquisitions in this Annual Report.
At the end of 1997 and with the acquisition of Mercury, total assets in client
accounts or under management were $1.2 trillion. In 1997, according to Securi-
ties Data Co., Merrill Lynch achieved the top ranking in U.S. debt underwrit-
ing, equity underwriting, and completed mergers and acquisitions. Globally,
Merrill Lynch was the leading debt and equity underwriter and ranked third in
mergers and acquisitions for both announced and completed transactions.
Merrill Lynch considers its business to be one business segment, the financial
services business. Merrill Lynch provides financial services worldwide through
a number of highly integrated subsidiaries and affiliates which frequently
participate together in the facilitation and consummation of a single transac-
tion. It manages and operates its worldwide business along four key strategic
priorities:
. Corporate and Institutional Client
. U.S. Private Client
. International Private Client
. Asset Management.
This organizational structure is designed to enhance services to Merrill
Lynch's diverse global client base and position it for worldwide growth. In
addition, it focuses its regional management outside the United States along
five international regions:
. Europe, Middle East, and Africa
. Asia and Pacific
. Australia and New Zealand
. Japan
. Latin America and Canada.
Financial information concerning Merrill Lynch for each of the three fiscal
years ended on the last Friday in December of 1997, 1996, and 1995, including
- -----------------
* Unless the context otherwise requires, the term "Merrill Lynch" means Mer-
rill Lynch & Co., Inc. and includes the consolidated subsidiaries of Merrill
Lynch & Co., Inc. The term "ML & Co." is used herein where appropriate to
refer to Merrill Lynch & Co., Inc., the parent holding company.
1997 Annual Report
73
BUSINESS OF MERRILL LYNCH
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
the amount of total revenue contributed by classes of similar products or
services that accounted for 10% or more of its consolidated revenues in any
one of these fiscal periods, as well as information with respect to Merrill
Lynch's operations broken down by geographic area is set forth in Merrill
Lynch's Consolidated Financial Statements and the Notes thereto on pages 31 to
67 in this Annual Report.
- -------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- -------------------------------------------------------------------------------
The financial services industry, in which Merrill Lynch is a leading partici-
pant, is highly competitive and highly regulated. This industry is directly
affected by general economic conditions, trends in business and finance, gov-
ernment regulation, and investor sentiment, as well as by changes in market
variables such as interest rates, currency rates, volatility in equity and
commodity prices, and interest and credit spreads both in the United States
and throughout the world. Merrill Lynch's revenues are particularly sensitive
to these factors as well as to the volume of securities transactions and secu-
rities price levels. In addition, its business is subject to currency rate
fluctuations, regulation by the U.S. government and by non-U.S. governments,
and other factors inherent in worldwide operations. Furthermore, its business
activities are subject to varying degrees of risk and profitability depending
upon the nature of the activity and the extent to which it has placed its cap-
ital at risk in the conduct of a variety of transactions, including dealer
transactions, investment banking, derivative transactions, syndicated and
bridge loan financing, and other related transactions.
In addition to providing historical information, Merrill Lynch may make or
publish forward-looking statements about management expectations, strategic
objectives, business prospects, anticipated financial performance, and other
similar matters. A variety of factors, many of which are beyond its control,
affect the operations, performance, business strategy, and results of Merrill
Lynch and could cause actual results and experience to differ materially from
the expectations expressed in these statements. These factors include, but are
not limited to, the factors listed in the previous paragraph hereof, actions and
initiatives taken by both current and potential competitors, the impact 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 Competition and Regulation below and in Management's Discussion and Analysis
in this Annual Report. MERRILL LYNCH UNDERTAKES NO RESPONSIBILITY TO UPDATE
PUBLICLY OR REVISE ANY FORWARD-LOOKING STATEMENTS.
- -------------------------------------------------------------------------------
DESCRIPTION OF BUSINESS ACTIVITIES
- -------------------------------------------------------------------------------
The business activities of certain significant domestic and international Mer-
rill Lynch subsidiaries comprising its Corporate and Institutional Client,
U.S. Private Client, International Private Client, and Asset Management groups
are described below.
- -------------------------------------------------------------------------------
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), which traces
its origin to a brokerage business founded in 1820, is one of the largest
securities firms in the world. It conducts business activities within all four
business priorities and is:
. a leading broker in securities, options contracts, and commodity and finan-
cial futures contracts
. a leading dealer in options and in corporate and municipal securities
. a leading investment banking firm that provides advice to, and raises capi-
tal for, corporations and other institutional clients, sovereigns, and
municipalities
. an underwriter of selected insurance products
. a distributor of MLAM investment products.
Merrill Lynch Canada Inc. ("Merrill Lynch Canada"), a subsidiary of MLPF&S,
provides certain of these financial services in Canada.
1997 Annual Report
74
BUSINESS OF MERRILL LYNCH
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Brokerage Transactions
A significant portion of MLPF&S's revenues is generated by the commissions
that it earns as a broker (i.e., agent) for investors in the purchase and sale
of corporate securities, primarily common and preferred stocks and bonds
traded on securities exchanges or in the over-the-counter markets. MLPF&S also
acts as a broker for investors in the purchase and sale of mutual funds, money
market instruments, government securities, corporate and high-yield bonds,
municipal securities, futures, and options, including option contracts for the
purchase and sale of various types of securities. MLPF&S provides such serv-
ices to individual and institutional investors.
MLPF&S has established commission rates or fixed charges for all brokerage
services that it performs. For accounts that are actively traded, however,
MLPF&S's policy is to negotiate commissions based on economies of size and the
complexity of the particular trading transaction and, additionally, for its
institutional customers, based on the competitive environment and trading
opportunities. MLPF&S customers participating in the Blueprint(SM) program can
purchase certain equity securities, mutual funds, and precious metals at a
lower cost due to order processing efficiencies.
At December 26, 1997, there were more than 9.0 million retail and institu-
tional customer accounts worldwide at MLPF&S, compared to 8.1 million accounts
at year-end 1996. These customer accounts were served by MLPF&S in the United
States and other Merrill Lynch affiliates outside the United States through
approximately 15,300 retail financial consultants and institutional account
executives, including trainees, located in approximately 800 offices world-
wide.
- -------------------------------------------------------------------------------
Futures Business Activities
As part of its brokerage activities, MLPF&S, as a futures commission merchant,
introduces customers to its affiliate Merrill Lynch Futures Inc. ("MLF") for
the purchase and sale of futures contracts and options on such futures contracts
in substantially all exchange-traded commodity and financial futures products.
MLPF&S and certain of its affiliates may also take proprietary market positions
in futures and futures options in certain instances. MLF holds memberships on
all major commodity and financial futures exchanges and clearing associations in
the United States and it also carries positions reflecting trades executed on
exchanges outside of the United States.
All futures and futures options transactions are cleared through and/or car-
ried by MLF and other Merrill Lynch subsidiaries engaged in futures clearing
activities. On certain exchanges, third party brokers are utilized to execute
and/or clear trades. Where MLF or other Merrill Lynch subsidiaries maintain
memberships in the clearing associations of various futures exchanges, these
entities have potentially significant financial exposure in the event that
other members of futures clearing houses default materially in their obliga-
tions to such clearing houses. In addition, as with any margin transaction,
the risk of loss to MLF and its customers from the trading of futures con-
tracts is greater than the risk in cash securities transactions, primarily as
a result of the low initial margin requirements (good faith deposits) relative
to the value of the actual futures contracts. MLF may have financial exposure
if a customer fails to meet a margin call. Net worth requirements, financial
reviews, margin procedures, and other credit standards established for MLF
customer futures accounts are intended to limit any exposure to MLF resulting
from its trading in futures accounts. For information concerning Merrill
Lynch's credit management policies, see Management's Discussion and Analysis--
Risk Management-Credit Risk.
- -------------------------------------------------------------------------------
Securities Dealer Activities
MLPF&S regularly makes a market in the equity securities of approximately 550
U.S. corporations. In addition, it engages in market-making for approximately
4,800 securities of non-U.S. issuers traded in
1997 Annual Report
75
BUSINESS OF MERRILL LYNCH
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
the over-the-counter markets. Its market-making activities are conducted with
customers and other dealers. In addition, as a block positioner, MLPF&S regu-
larly acts as a market-maker in certain listed securities. MLPF&S is also a
dealer in municipal, mortgage-backed, asset-backed, and corporate fixed-income
securities. MLPF&S engages in certain commodity-related transactions as a
principal, such as purchase and repurchase transactions and precious metals
consignments.
As an adjunct to its trading activities, MLPF&S places its capital at risk by
engaging in block positioning to facilitate transactions in large blocks of
listed and over-the-counter securities and by engaging, from time to time, in
arbitrage transactions for its own account. In its block positioning activi-
ties, MLPF&S purchases securities, or sells securities short for its own
account, without having full commitments for their resale or covering pur-
chase, thereby employing its capital to effect large transactions. Such posi-
tioning activities are undertaken after analyzing a given security's market-
ability and any position taken typically is liquidated as soon as practicable.
In addition, MLPF&S facilitates various trading strategies involving the pur-
chase and sale of financial futures contracts and options, and, in connection
with this activity, it may establish positions for its own account and risk.
Other Merrill Lynch subsidiaries also act as dealers in certain specified
securities, including governmental obligations; engage in interest rate and
foreign currency swaps and other derivative product transactions with third
parties on a principal or an intermediary basis; and act as foreign exchange
dealers. For additional information on Merrill Lynch's dealer activities, see
Merrill Lynch Government Securities Inc., Merrill Lynch's Derivative Products
and Services, and Merrill Lynch's Banking, Trust, and Mortgage Lending and
Related Activities below.
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Investment Banking
MLPF&S is a leading investment banking firm that participates in every aspect
of investment banking for corporate, institutional, and governmental clients
and acts in principal, agency, and advisory capacities. MLPF&S also provides a
broad range of corporate advisory and financial services for its clients.
Advisory services include advice on strategic matters, including mergers and
acquisitions, divestitures, spin-offs, restructurings, leveraged buyouts, and
defensive projects. MLPF&S provides a wide variety of financial services,
including underwriting the sale of securities to the public, private placement
of securities with investors, advising as to structured and derivative
financings, including project financing, mortgage and lease financing, and
advising as to capital structure and specific financing opportunities.
MLPF&S, either directly or through affiliates, provides advice, valuation
services, and financing assistance and engages in the underwriting and private
placement of high-yield securities in connection with, among other things,
leveraged buyouts and other acquisition-related transactions. MLPF&S and its
affiliates have, from time to time, taken principal positions in transactions.
It extends credit to clients in the form of senior and subordinated debt, as
well as bridge financing on a select basis, and it syndicates loans. Substan-
tial funds may be provided to clients on a temporary basis until permanent
financing is obtained. Before MLPF&S and its affiliates engage in any of these
financing activities, an analysis is performed to ascertain the underlying
creditworthiness of the particular client and the liquidity of the market for
securities that may be issued in connection with any such financings and to
determine the likelihood of refinancing within a reasonable period. Addition-
ally, MLPF&S and its affiliates occasionally acquire equity interests in the
subject companies as part of or in connection with such activities. For addi-
tional information on these investment banking and lending activities, see
Management's Discussion and Analysis--Non-Investment Grade Holdings and Highly
Leveraged Transactions.
Merrill Lynch, through various subsidiaries and affiliates, including Merrill
Lynch Capital Partners, Inc.
1997 Annual Report
76
BUSINESS OF MERRILL LYNCH
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("MLCP"), has made investments in equity and debt securities issued in acqui-
sition transactions, including leveraged buyouts, for which MLPF&S has acted
as financial advisor or underwriter. MLCP provides management services for two
leveraged buyout funds which have been funded primarily by private investors.
Merrill Lynch, through MLPF&S and its other subsidiaries, may underwrite,
trade, invest, and make markets in certain securities of companies in which
these funds have invested. In addition, it may provide financial advisory
services to these companies.
Using ML & Co.'s capital, Merrill Lynch Capital Corporation provides senior
and subordinated financing as principal to companies satisfying specific
credit and other criteria.
- -------------------------------------------------------------------------------
Margin Lending
MLPF&S also provides financing to clients, including margin lending and other
extensions of credit. In a margin-based transaction, MLPF&S extends credit for
a portion of the market value of the securities in the customer's account up
to the limit imposed by internal MLPF&S policies and applicable margin rules
and regulations. Since MLPF&S may have financial exposure if a customer fails
to meet a margin call, any margin loan made by MLPF&S is collateralized by
securities in the customer's margin account. Financial reviews, margin proce-
dures, and other credit standards have been implemented in an effort to limit
any exposures resulting from this margin lending activity. Interest on margin
loans is an important source of revenue for MLPF&S. To finance margin loans,
MLPF&S uses funds on which it pays interest (including parent company
borrowings), funds on which it does not pay interest (including its own capi-
tal), funds derived from customers' free credit balances to the extent permit-
ted by regulations, and funds derived from securities loaned. For additional
information concerning Merrill Lynch's credit risk management policies, see
Management's Discussion and Analysis--Risk Management-Credit Risk.
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Research Activities and Distribution
The Global Securities Research & Economics Group provides equity, fixed-
income, and economic research services on a global basis to Merrill Lynch's
institutional and private client sales forces and their customers. This group
covers and distributes fundamental equity and fixed-income research, technical
market and quantitative analyses, convertible securities analyses, investment
and fixed-income strategy recommendations, high-yield debt securities
research, credit research on municipal securities, and futures research infor-
mation.
Merrill Lynch consistently ranks among the leading research providers in the
industry. More than 3,900 companies located in 55 countries are covered by the
group's analysts and other professionals, with more than half of the staff now
dedicated to non-U.S. research activities. Information on industry sectors and
countries is also gathered, analyzed, and distributed. Current information and
investment opinions on these companies, industry sectors, and countries are
available to all of Merrill Lynch's retail and institutional customers through
their financial consultants and account executives by means of a computer-
based retrieval system available in each Merrill Lynch branch or affiliate
office.
- -------------------------------------------------------------------------------
Sales of Investment Products, Advisory Products and Services, and Other Activ-
ities
In 1997, MLPF&S sold more than $48.2 billion of mutual funds, including
income, balanced, and growth funds, of which approximately $22.0 billion rep-
resented sales of mutual funds advised by Merrill Lynch Asset Management.
MLPF&S sponsors the Defined Asset Funds(SM) product. This product consists of
a series of funds that are unit investment trusts registered under the Invest-
ment Company Act of 1940 and that have invested in U.S. and non-U.S. equity
securities, municipal, corporate, and U.S. Government and non-U.S. debt obli-
gations. At the end of 1997, approximately $19.1 billion of client funds were
invested in Defined Asset Funds.
1997 Annual Report
77
BUSINESS OF MERRILL LYNCH
[LOGO OF MERRILL LYNCH APPEARS HERE]
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MLPF&S also provides a wide range of client services, including effecting
trades in equity, fixed-income and other securities through its securities
account services, such as its Cash Management Account(R) financial services
program (the "CMA(R) account"). Participating CMA customers may access their
assets through checking account services provided by Bank One, Columbus, N.A.
and through VISA(R) cards issued by Merrill Lynch National Financial and Mer-
rill Lynch Bank & Trust Co. Customers may also obtain, through monthly account
statements and a toll free information service, securities position and
account balance information and, for any margin accounts opened, the loan
value of margin securities. At the end of 1997, there were more than 1.7 mil-
lion CMA accounts held by Merrill Lynch's U.S. customers with aggregate assets
of approximately $455 billion and there were approximately 47,000 CMA accounts
held by Merrill Lynch's clients outside the United States with aggregate
assets of more than $25 billion.
MLPF&S also offers the Capital Builder(SM) Account service ("CBA(R) account"),
which was developed to meet the needs of the new investor. At the end of 1997,
MLPF&S had more than 392,000 CBA accounts with assets of approximately $21
billion.
MLPF&S offers various other services, through products such as the Merrill
Lynch Consults(R) service, the Asset Power(R) service, the Merrill Lynch Mutual
Fund Advisor(SM) program, the Merrill Lynch Mutual Fund Advisor Selects(SM)
program, the Financial Foundation(R) service, and the Merrill Lynch Financial
Advantage(SM) service. Certain features of these products are described below.
Merrill Lynch Consults is available for an annual fee to a retail or institu-
tional client with at least $100,000 to invest. With this service, MLPF&S
assists clients in identifying their investment objectives so that they can
select appropriate third party investment managers for their investment. MLPF&S
also provides periodic performance reports on the investment account. More than
25 of the investment managers participating in the Merrill Lynch Consults
service manage portfolios in one or more of seven risk categories using varying
proportions of equity and fixed-income instruments. At the end of 1997,
approximately $27 billion was held in approximately 100,000 client accounts
subscribing to the Merrill Lynch Consults service.
The Asset Power service offers Merrill Lynch clients the option of paying an
asset-based fee instead of paying commissions, loads, or similar charges. At
the end of 1997, there were more than 27,000 Asset Power accounts with assets
of approximately $7.9 billion. The Merrill Lynch Financial Advantage service
offers a diversified portfolio of financial services for an asset-based fee.
At the end of 1997, there were more than 9,900 client relationships with
assets of more than $2.9 billion using the Merrill Lynch Financial Advantage
service.
The Merrill Lynch Mutual Fund Advisor program is a discretionary investment
advisory service investing in a portfolio of mutual funds selected from the
Merrill Lynch Asset Management family of funds and many other top fund fami-
lies. MLPF&S retains day-to-day management of each client's portfolio, custom-
izing the asset allocation strategy where appropriate. At the end of 1997,
there were more than 115,000 Merrill Lynch Mutual Fund Advisor accounts with
assets of more than $6.3 billion. In 1997, Merrill Lynch launched the Merrill
Lynch Mutual Fund Advisor Selects program which offers clients non-discretion-
ary advisory services. Clients participating in this program are given custom-
ized investment recommendations and access to almost 2,000 mutual funds.
Through the Financial Foundation program, MLPF&S offers a planning tool that
analyzes an individual client's assets, liabilities, and expectations to exam-
ine financial goals and to develop plans to address them. Merrill Lynch's
financial consultants have provided over 500,000 Financial Foundation plans to
customers.
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Group Employee Services and Retirement, Investment and Custody Services
Through its Group Employee Services division, MLPF&S is one of the largest
bundled service providers of 401(k) plans in the United States. MLPF&S
provides a wide variety of retirement plan products, particularly
1997 Annual Report
78
BUSINESS OF MERRILL LYNCH
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administration and investment, employee education, and communication services
to 401(k) and other benefit plans. At the end of 1997, it provided these serv-
ices to approximately 15,000 plans, representing $74 billion in plan assets.
Its services to the 401(k) market were enhanced by Merrill Lynch's 1997 acqui-
sition of the MasterWorks division of Barclay's Global Investors which pro-
vided recordkeeping, administration, and investment services to 401(k) plans
for approximately 160 companies.
MLPF&S also provides custodial services to individual investors in connection
with the investors' maintenance of Individual Retirement Accounts (IRAs),
including IRAs established under Simplified Employee Pension and SIMPLE plans
pursuant to Section 408 of the Internal Revenue Code and related Treasury
Department regulations. At the end of 1997, there were approximately 2,158,000
accounts representing approximately $137 billion in customer assets.
MLPF&S is also actively marketing the new Roth and Education IRAs, created by
the Taxpayer Relief Act of 1997 (the "Act"). At the end of 1997, MLPF&S
received more than 17,000 applications for the Roth IRA. Contributions to the
new IRAs were not permitted to be made until January 1998, the effective date
for these provisions of the Act.
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Securities Clearing Services
MLPF&S provides securities clearing services through its subsidiaries,
Broadcort Capital Corp. ("BCC") and Merrill Lynch Professional Clearing Corp.
("MLPCC"). BCC provides these services to approximately 107 unaffiliated bro-
ker-dealers. Those utilizing BCC's clearing services may also execute transac-
tions through BCC's fixed-income desk and participate in underwritings of
Defined Asset Funds sponsored by MLPF&S. While the introducing broker-dealer
firm retains all sales functions with their customers, BCC services the cus-
tomers' accounts and handles all settlement and credit aspects of transac-
tions. MLPCC clears transactions for specialists and market-makers on various
national and regional stock exchanges; clears commodities futures transactions
for clients through a divisional clearing arrangement with MLF; and clears
transactions of arbitrageurs, customers, and other professional trading enti-
ties.
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MERRILL LYNCH INTERNATIONAL INCORPORATED
Through its subsidiaries and affiliated companies, Merrill Lynch International
Incorporated ("MLII") provides comprehensive investment, financing, and
related services on a global basis outside the United States and Canada to
individual investors and to sovereign governments, corporations, and other
institutional clients.
MLII and its subsidiaries and affiliated companies are members of various non-
U.S. stock and futures exchanges and engage in over-the-counter and exchange-
listed trading of commodities, including precious and base metals. The invest-
ment, financing, and market-making operations of MLII and its affiliates are
conducted through a network of offices, including representative and liaison
offices, located in more than 40 countries outside the United States and Cana-
da. This office network services major "money center" institutions as well as
thousands of smaller regional institutions and individual investors.
The worldwide trading operations of MLII's subsidiaries, particularly in Lon-
don and Tokyo, make it one of the largest dealers and secondary market-makers
in Eurobonds and other internationally traded securities and futures and a
significant participant in the over-the-counter equity derivatives business.
Merrill Lynch International ("MLI"), a subsidiary of MLII, is Merrill Lynch's
primary equity derivatives dealer. Through its subsidiaries and affiliates,
MLII also engages in foreign exchange transactions (including options on non-
U.S. currencies) as a dealer and consequently assumes principal positions in
numerous currencies and related options. Information on the derivatives busi-
ness and the international banking and foreign exchange activi-
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ties of MLII and certain of its subsidiaries is set forth below under the cap-
tions Merrill Lynch's Derivative Products and Services and Merrill Lynch's
Banking, Trust, and Mortgage Lending and Related Activities. For additional
information on Merrill Lynch's other dealer activities, see Merrill Lynch Gov-
ernment Securities Inc., Merrill Lynch's Derivative Products and Services, and
Merrill Lynch's Banking, Trust, and Mortgage Lending and Related Activities
below.
In addition to the Mercury acquisition which expanded Merrill Lynch's presence
in jurisdictions where Mercury conducts its asset management business, in
1997, Merrill Lynch strengthened its presence in several major global finan-
cial markets through strategic acquisitions and initiatives. In Australia, it
increased the depth of its presence with its recruitment of members of the
Centaurus Corporate Finance Group, a leading corporate advisory firm. With the
Centaurus staff additions, it has increased its mergers and acquisitions advi-
sory capabilities in this area of the world. Merrill Lynch also consolidated
its position in South Africa with the acquisition of that interest in Smith
Borkum Hare, a leading brokerage firm, that it did not already own. In addi-
tion, Merrill Lynch opened its new office in the Philippines.
During 1997, Merrill Lynch expanded its International Private Client group
operations in a number of regions of the world. In addition, in the first
quarter of 1998, Merrill Lynch announced plans to open a business serving
individual investors in Japan through a network of approximately 30 branch
offices throughout the country.
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MERRILL LYNCH'S ASSET MANAGEMENT ACTIVITIES
Merrill Lynch's asset management activities are conducted through its asset
management groups--Merrill Lynch Asset Management ("MLAM") and Merrill Lynch
Mercury Asset Management ("Merrill Lynch Mercury"), which consists of the
newly acquired Mercury group and the Merrill Lynch Capital Management Group
("CMG"). MLAM and Merrill Lynch Mercury together constitute the investment
management arm of Merrill Lynch and form one of the largest asset management
organizations in the world.
The Mercury acquisition strengthens Merrill Lynch's position in the institu-
tional and international asset management sectors and increases the number of
non-dollar funds offered to clients. At the end of 1997, total assets under
management at MLAM and Merrill Lynch Mercury were $446 billion (including $167
billion from the Mercury acquisition), as compared with $234 billion at year-
end 1996.
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MLAM
At the end of 1997, through portfolio managers located in the United States,
Japan, Hong Kong, and throughout Europe, MLAM managed 240 portfolios repre-
senting a wide variety of investment products ranging from money market funds
to long-term taxable and tax-exempt fixed-income funds, along a broad spectrum
of quality ratings and maturities.
MLAM offers a wide variety of equity funds which in the aggregate invest in
more than 50 markets globally. MLAM open-end funds (except for its money-mar-
ket funds) are generally offered pursuant to the Merrill Lynch Select
Pricing(SM) system which allows investors four pricing alternatives. In 1997,
sales of equity and bond funds managed by MLAM, which are only available
through Merrill Lynch's distribution network, approximated $22.0 billion.
MLAM's other major business activity is separate account management. Separate
account assets under management were $51.8 billion at the end of 1997 as com-
pared to approximately $41.5 billion in 1996.
In the fourth quarter of 1997, MLAM and MLPF&S raised over $1.2 billion for
the ML Global Growth Fund, a U.S. fund marketed in the United States. In
December 1997, MLAM and Merrill Lynch's Japanese subsidiary raised approxi-
mately $1.0 billion for the Income Strategies Portfolio, an offshore dollar-
based Luxembourg fund launched in Japan. This fund is available to both retail
and institutional investors outside the United States.
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Merrill Lynch Mercury
Merrill Lynch Mercury is engaged primarily in institutional asset management
as well as non-dollar asset management activities outside the United States.
Headquartered in London, it has a strong institutional client base, including
defined contribution pension plans. It has approximately 200 fund managers
located in 19 offices worldwide from which a broad range of products are
offered. In the United Kingdom, products of this group will continue to be
marketed and sold under the name Mercury Asset Management.
CMG provides portfolio management services to large institutional clients in
the United States. CMG's penetration of the U.S. institutional investment man-
agement market in the United States expanded in 1996 with the acquisition of
Hotchkis and Wiley, the Los Angeles- based institutional asset manager.
Hotchkis and Wiley, a discrete unit of CMG, offers a broad range of services
to the institutional market, including both U.S. and non-U.S. value-oriented
equities, and manage a family of mutual funds available to the investing pub-
lic.
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MERRILL LYNCH GOVERNMENT SECURITIES INC.
Merrill Lynch Government Securities Inc. ("MLGSI") is a primary dealer in
obligations issued or guaranteed by the United States Government and by Fed-
eral agencies or other government-sponsored entities, including Government
National Mortgage Association ("GNMA"), Federal National Mortgage Association
("FNMA"), and Federal Home Loan Mortgage Corporation ("FHLMC"). It is one of
37 primary government securities dealers that daily report positions and
activities to the Federal Reserve Bank of New York. It is a dealer in GNMA,
FNMA, and FHLMC mortgage-backed-pass-through certificates and deals in related
futures, options, and forward contracts for its own account, to hedge its own
risk, and to facilitate customers' transactions.
MLGSI's transactions in obligations of the United States Government, Federal
agencies and government-sponsored entities involve large dollar amounts and
small dealer spreads. As an integral part of its business, MLGSI enters into
repurchase agreements whereby it obtains funds by pledging its own securities
as collateral. The repurchase agreements provide financing for MLGSI's dealer
inventory and serve as short-term investments for MLGSI's customers, which
include certain of MLGSI's affiliates. MLGSI also enters into reverse repur-
chase agreements whereby it provides funds against the pledge of collateral by
customers. Such agreements provide MLGSI with needed collateral and provide
MLGSI's customers with temporary liquidity for their investments in United
States Government and agency securities.
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MERRILL LYNCH'S DERIVATIVE PRODUCTS AND SERVICES
Merrill Lynch Capital Services, Inc. ("MLCS") and Merrill Lynch Derivative
Products AG ("MLDP") are Merrill Lynch's primary derivative product dealers
and act as intermediaries and principals in a variety of interest rate, cur-
rency, and other over-the-counter derivative transactions. MLI engages in the
equity and debt derivatives business in the over-the-counter markets. Merrill
Lynch Capital Markets Bank Limited ("ML Capital Markets Bank"), established in
Dublin, Ireland, is a credit intermediary and handles part of Merrill Lynch's
non-dollar swap activities.
MLCS primarily acts as a counterparty for certain derivative financial prod-
ucts, including interest rate, currency, and commodity swaps, caps and floors,
currency options, and credit derivatives. MLCS maintains positions in inter-
est-bearing securities, financial futures, and forward contracts primarily to
hedge its exposures. In the normal course of its business, MLCS enters into
repurchase and resale agreements with certain affiliated companies.
MLDP acts as an intermediary for certain derivative products, including inter-
est rate and currency swaps, between MLCS and counterparties that are highly
rated or otherwise acceptable to MLDP. Its activities address the desire of
certain swap customers
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to limit their trading to those dealers having the highest credit quality.
MLDP has been assigned the Aaa, AAA, and AAA counterparty rating by the rating
agencies, Moody's Investors Service, Inc., Standard & Poor's, and Fitch IBCA,
Inc., respectively. Customers meeting certain credit criteria enter into swaps
with MLDP and, in turn, MLDP enters into offsetting mirror swaps with MLCS.
However, MLCS is required to provide MLDP with collateral to meet certain
exposures MLDP may have to MLCS.
For additional information regarding Merrill Lynch's derivatives business,
including its accounting, risk, and credit policies, see Management's Discus-
sion and Analysis-Risk Management and Notes 1 and 3 to the Consolidated Finan-
cial Statements in this Annual Report.
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MERRILL LYNCH MONEY MARKETS INC.
Merrill Lynch, through Merrill Lynch Money Markets Inc. ("MLMMI"), provides a
full range of origination, trading, and marketing services with respect to
money market instruments such as commercial paper, bankers' acceptances, and
institutional certificates of deposit. MLMMI also originates medium-term notes
issued by U.S. and non-U.S. corporations and short- and medium-term bank notes
issued by financial institutions, and through MLPF&S, it trades and markets
such notes. MLMMI is also a commercial paper dealer for U.S. and non-U.S. cor-
porations and financial institutions. MLMMI also acts as a dealer for U.S. and
non-U.S. financial institutions in the certificate of deposit and bankers'
acceptance markets and in connection with the purchase of certificates of
deposit from Federally-insured depository institutions. Such instruments are
resold to certain institutional customers such as banks, insurance companies,
investment companies, pension plans, and state and local governments. MLMMI,
in cooperation with MLPF&S, originates certificates of deposit issued by bank
and thrift institutions that are sold to a broad range of retail customers of
MLPF&S.
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MERRILL LYNCH MORTGAGE CAPITAL INC.
Merrill Lynch Mortgage Capital Inc. ("MLMCI") is a dealer in whole loan mort-
gages, mortgage loan participations, mortgage servicing, and corporate bank
loans. MLMCI, through its CMO Passport(SM) service, provides dealers and invest-
ors with general indicative information and analytic capability with respect
to collateralized mortgage obligations and asset-backed securities. As an
integral part of its business, MLMCI enters into repurchase agreements whereby
it obtains funds by pledging its own whole loans as collateral. The repurchase
agreements provide financing for MLMCI's inventory and serve as short-term
investments for MLMCI's customers. MLMCI also enters into reverse repurchase
agreements through which it provides funds to customers collateralized by
whole loan mortgages, thereby providing customers with temporary liquidity for
their investments in secured whole loans. MLMCI also has a mortgage conduit
which purchases commercial and multi-family mortgage loans from lenders and
securitizes these loans for sale to investors. In addition, MLMCI provides to
its clients short-term financing secured by performing and non-performing com-
mercial real estate. MLMCI also makes proprietary equity investments in domes-
tic and non-domestic companies owning performing and non-performing real
estate and mortgages.
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MERRILL LYNCH INVESTMENT PARTNERS INC.
Merrill Lynch Investment Partners Inc. ("MLIP") serves principally as the gen-
eral partner and commodity pool operator of public and privately offered com-
modity pools for which MLF acts as commodity broker and MLPF&S acts as selling
agent. MLIP also structures and sponsors managed futures and hedge fund prod-
ucts to meet a variety of client objectives. MLIP is one of the largest man-
aged futures sponsors in the world as measured by assets under its management
and by its financial resources. MLIP is an integrated business, the capabili-
ties of which include research, trading services, finance, systems, opera-
tions, administration, sales, and marketing. MLIP's responsibilities include
selecting and
1997 Annual Report
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BUSINESS OF MERRILL LYNCH
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monitoring trading advisors, as well as allocating and reallocating capital
among them. At the end of 1997, approximately $3.0 billion in equity was
invested or was to be invested in 46 U.S. and non-U.S. commodity futures hedge
fund products that MLIP has sponsored or been selected to manage.
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MERRILL LYNCH BUSINESS FINANCIAL SERVICES INC.
Merrill Lynch Business Financial Services Inc. ("MLBFS") provides financing
services to small- and medium-sized businesses in conjunction with the Working
Capital Management(SM) account ("WCMA(R) account"), which MLPF&S markets to
business customers. The WCMA account combines business checking, borrowing,
investment, and electronic funds transfer services into one account for par-
ticipating business customers. At the end of 1997, there were more than
141,000 WCMA accounts which, in the aggregate, had investment assets of more
than $81 billion. MLBFS also provides business advisory services, including
strategic services to middle market companies.
In addition to providing qualifying customers with short-term working capital
financing through the WCMA commercial line of credit, MLBFS offers assistance
to business customers with their term lending, equipment, and other asset-
based financing needs, as well as financing for owner-occupied commercial real
estate. In 1997, MLBFS originated more than $958 million in new commercial
loans for business customers and, at the end of 1997, total outstanding loans
were $1.1 billion, of which approximately 97% were secured by tangible assets
pledged by customers.
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MERRILL LYNCH'S INSURANCE ACTIVITIES
Merrill Lynch's operations in insurance services consist of the underwriting
of life insurance and annuity products by Merrill Lynch Life Insurance Company
("MLLIC") and ML Life Insurance Company of New York ("ML Life") and of the
sale of proprietary and non-proprietary life insurance and annuity products
through Merrill Lynch Life Agency Inc. and other insurance agencies affiliated
or associated with MLPF&S.
MLLIC, an Arkansas stock life insurance company, is authorized to underwrite
insurance and annuities products in 49 states, the District of Columbia, Guam,
and the U.S. Virgin Islands. These products are then marketed to MLPF&S cus-
tomers. Although authorized to do so, it does not presently underwrite acci-
dent and health insurance. At year-end 1997, MLLIC had approximately $12.4
billion of life insurance in force. At year-end 1997, MLLIC had annuity con-
tracts in force of approximately $7.7 billion in value.
ML Life, a New York stock life insurance company, is authorized to underwrite
life insurance, annuities, and accident and health insurance in nine states;
however, it does not presently underwrite accident and health insurance. At
year-end 1997, ML Life had approximately $1.8 billion of life insurance in
force, which amount included $900 million reinsured from yearly renewable term
insurance of an unaffiliated insurer. At year-end 1997, ML Life had annuity
contracts in force of approximately $609 million in value.
Through agency agreements, licensed affiliate insurance agencies and other
insurance agencies associated with MLPF&S sell life and health insurance and
annuities products. A significant portion of these sales consists of products
underwritten by MLLIC and ML Life.
For additional information concerning Merrill Lynch's accounting policies
relating to its insurance activities, see Note 1 to the Consolidated Financial
Statements under the caption Insurance.
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MERRILL LYNCH'S BANKING, TRUST, AND MORTGAGE LENDING AND RELATED ACTIVITIES
Merrill Lynch Bank & Trust Co. ("MLBT") and Merrill Lynch National Financial
("MLNF"), both of which are insured by the Federal Deposit Insurance Corpora-
tion, issue certificates of deposit and money market deposit accounts (includ-
ing the Insured
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Savings(SM) Account for the CMA service), make and purchase secured loans, and
issue VISA(R) cards.
Merrill Lynch provides personal trust, employee benefit, trust, and custodial
services in certain states through eight state-chartered trust institutions
and a federally chartered savings bank which will facilitate the offering of
trust services throughout the United States. This capability to enhance Mer-
rill Lynch's trust service business through the federally chartered savings
bank was acquired in 1997. Trust services outside of the United States are
provided by Merrill Lynch Bank and Trust Company (Cayman) Limited ("MLBT
Cayman").
Merrill Lynch International Bank Limited ("MLIB Limited"), a United Kingdom
bank with branch offices in Germany, Singapore, Bahrain, Luxembourg, and Italy
provides foreign exchange trading and collateralized lending and letter of
credit services and accepts deposits. Merrill Lynch International Bank, an
Edge Act corporation ("MLIB"), provides foreign exchange trading services to
corporations and institutions. Merrill Lynch Bank (Suisse) S.A., a Swiss bank,
provides loans, deposits, portfolio management services, and individual client
services to international private banking clients. ML Capital Markets Bank, an
Irish bank with branch offices in Frankfurt, Milan, and Tokyo, engages in cap-
ital markets activities such as underwriting, foreign exchange, and swap and
other derivative transactions.
Merrill Lynch Credit Corporation ("MLCC") offers a broad selection of real
estate-based lending products enabling clients to purchase and refinance their
homes as well as to manage their other personal credit needs. MLCC, through
Merrill Lynch financial consultants, offers a variety of adjustable-rate and
fixed-rate first mortgage loans throughout the United States, including the
PrimeFirst(R) mortgage program. In addition, MLCC originates and services home
equity credit lines and other mortgage loans as well as services mortgage
loans for affiliated and unaffiliated financial institutions. MLCC uses a
variety of financing techniques to fund its loan portfolio, including
securitizing its mortgages for sale into the secondary marketplace. MLCC also
provides securities-based lending through its Omega(SM) account, a personal line
of credit using eligible securities as collateral that is accessible by
VISA(R) card and by check. Lender's Service Inc. provides real estate apprais-
al, title, and closing management services for the residential lending commu-
nity, including for its affiliate MLCC.
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COMPETITION
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All aspects of Merrill Lynch's business are intensely competitive, particu-
larly in the underwriting, trading, and advisory activities, and have been
impacted by the entry of several new competitors over the last few years. Mer-
rill Lynch competes for clients, market share, and human talent in every
aspect of its business.
It competes directly on a worldwide basis with other U.S. and non-U.S. trad-
ing, investment banking, financial advisory service firms, and brokers and
dealers in securities and commodities. It also competes with commercial banks
and their affiliates in these businesses and particularly in its derivative
and capital markets businesses. Many of Merrill Lynch's non-U.S. competitors
may have competitive advantages in their home markets. Its competitive posi-
tion depends to an extent on prevailing worldwide economic conditions and U.S.
and non-U.S. governmental policies.
Through its subsidiaries and affiliates, Merrill Lynch also competes for
investment funds with mutual fund management companies, insurance companies,
finance and investment advisory companies, banks, and trust companies and
institutions.
Merrill Lynch competes for its retail and institutional customers on the basis
of price, the range of products that it offers, the quality of its services,
its financial resources, and product innovation. Financial services companies
also compete to attract and retain successful financial consultants and other
revenue-producing personnel.
1997 Annual Report
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There is increased competition from sources other than those traditionally
engaged in the securities business, such as commercial banks and insurance
companies. Certain U.S. judicial and regulatory actions in recent years con-
cerning, among other things, the authority of bank affiliates to engage in
securities underwriting and brokerage activities have resulted in increased
competition in those aspects of Merrill Lynch's business. In addition, certain
U.S. bank regulatory changes adopted in 1996 and 1997 that loosen certain
restrictions on the securities activities of "Section 20 broker-dealer affili-
ates" of commercial banks may have the effect of increasing competition from
commercial banks and their affiliates in the provision of securities-related
services.
Merrill Lynch's insurance businesses operate in highly competitive environ-
ments. Many insurance companies, both stock and mutual, are older and larger
and have more substantial financial resources and larger agency relationships
than do Merrill Lynch's insurance subsidiaries.
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REGULATION
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Certain aspects of Merrill Lynch's business, as that of its competitors and
with the securities, commodities, and financial services industry in general,
are subject to stringent regulation by U.S. Federal and state regulatory agen-
cies and securities exchanges and by various non-U.S. governmental agencies or
regulatory bodies, securities exchanges, and central banks, each of which have
been charged with the protection of the financial markets and the interests of
those participating in those markets. These regulatory agencies in the United
States include, among others, the Securities and Exchange Commission (the
"SEC"), Commodity Futures Trading Commission ("CFTC"), Federal Deposit Insur-
ance Corporation (the "FDIC"), Municipal Securities Rulemaking Board ("MSRB"),
and Office of Thrift Supervision ("OTS"). In other areas of the world, these
regulators include The Securities and Futures Authority ("SFA"), the Bank of
England, the Investment Management Regulatory Organisation ("IMRO"), the Cen-
tral Bank of Ireland, the Federal Banking Supervisory Authority in Germany,
the Japanese Ministry of Finance, The Monetary Authority of Singapore, and the
Securities and Futures Commission in Hong Kong, among others.
Additional legislation and regulations and changes in rules promulgated by the
SEC or other U.S. Federal and state governmental regulatory authorities and
self-regulatory organizations and by non-U.S. governments and governmental
regulatory agencies may directly affect the manner of operation and profit-
ability of Merrill Lynch.
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United States Regulatory Oversight and Supervision
MLPF&S and certain other subsidiaries of ML & Co. are registered as broker-
dealers with the SEC and as such are subject to regulation by the SEC and by
self-regulatory organizations, such as the National Association of Securities
Dealers, Inc. (the "NASD"). MLPF&S, other Merrill Lynch subsidiaries engaged
in securities clearing services, and Merrill Lynch Specialists Inc., which
acts as a specialist on certain securities exchanges, are also subject to reg-
ulation by the NASD and by the securities exchanges of which each is a member.
Certain Merrill Lynch subsidiaries and affiliates, including MLPF&S, MLAM, and
MLIP, are registered as investment advisers with the SEC. MLPF&S and MLAM are
registered as investment advisers in those states requiring such registration.
Those Merrill Lynch entities that are broker-dealers registered with the SEC
and members of U.S. national securities exchanges are subject to Net Capital
Rule 15c3-1 under the Securities Exchange Act of 1934 (the "Exchange Act")
which is designed to measure the general financial condition and liquidity of
a broker-dealer. Under this rule, they are required to maintain the minimum
net capital deemed necessary to meet broker-dealers' continuing commitments to
customers and others. Under certain circumstances, this rule limits
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the ability of Merrill Lynch to make withdrawals of capital from such broker-
dealers. Additional information regarding net capital requirements is set
forth in Note 11 to the Consolidated Financial Statements in this Annual
Report.
Certain Merrill Lynch subsidiaries are also subject to the temporary risk
assessment rules adopted by the SEC under the Market Reform Act of 1990, which
require, among other things, that certain broker-dealers maintain and preserve
records and other information, describe risk management policies and proce-
dures, and report on the financial condition of certain affiliates whose
financial and securities activities are reasonably likely to have a material
impact on the financial and operating condition of the broker-dealer.
Broker-dealers are also subject to other regulations covering the operations
of their business, including sales and trading practices, use of client funds
and securities, and conduct of directors, officers, and employees. Broker-
dealers are also subject to regulation by state securities administrators in
those states where they do business. Violations of the stringent regulations
governing the actions of a broker-dealer can result in the revocation of bro-
ker-dealer licenses, the imposition of censures or fines, the issuance of
cease and desist orders, and the suspension or expulsion from the securities
business of a firm, its officers, or employees. With the enactment of the
Insider Trading and Securities Fraud Enforcement Act of 1988, the SEC and the
national securities exchanges have intensified their regulation of broker-
dealers, emphasizing in particular the need for supervision and control by
broker-dealers of their employees.
Furthermore, the SEC, various banking regulators, the Financial Accounting
Standards Board, and Congressional committees, among others, have launched a
number of initiatives which have the effect of increasing regulation, and
requiring greater disclosure, of financial instruments, including derivatives
positions and activities. Merrill Lynch, along with certain other major U.S.
securities firms, have implemented a voluntary oversight framework to address
issues related to capital, management controls, and counterparty relationships
arising out of the over-the-counter derivatives activities of unregulated
affiliates of SEC-registered broker-dealers and CFTC-registered futures com-
mission merchants. Merrill Lynch formed its Risk Control Committee as an
extension of its risk management process to provide general oversight of risk
management for all of its institutional trading activities and to monitor com-
pliance with its commitments respecting this voluntary oversight initiative.
For further information on the activities of this committee, see Management's
Discussion and Analysis-- Risk Management.
MLGSI is subject to regulation by the NASD and the Chicago Board of Trade and
is required to maintain minimum net capital pursuant to rules of the U.S.
Department of the Treasury. Merrill Lynch's municipal finance professionals
are subject to various trading and underwriting regulations of the MSRB. Mer-
rill Lynch's futures commission merchants are regulated by the CFTC, the
National Futures Association ("NFA"), and the commodity exchanges, of which
each is a member. The CFTC and the NFA impose net capital requirements on
these companies. MLIP is registered with the CFTC as a commodity pool operator
and a commodity trading advisor and is a member of the NFA in such capacities.
Merrill Lynch's banking and lending activities are supervised and regulated by
a number of different Federal and state regulatory agencies. MLBT is regulated
primarily by the State of New Jersey and by the FDIC. Certain of the activi-
ties of MLBFS and MLCC are regulated by the New Jersey Department of Banking.
In addition to New Jersey, MLCC is also licensed to conduct its lending activ-
ities in over 35 other states and MLBFS is licensed in five states, subjecting
each to regulation and examination by the appropriate authorities in those
states.
MLNF is regulated primarily by the State of Utah and by the FDIC. MLIB is reg-
ulated by the Federal
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Reserve Bank of New York. Merrill Lynch's U.S. trust institutions are subject
to regulation by the OTS in the case of the federal savings bank and by the
regulatory agencies in the states where the state-chartered institutions are
incorporated.
Merrill Lynch's insurance subsidiaries are subject to state insurance regula-
tory supervision. ML Life is subject to regulation and supervision by the New
York State Insurance Department. MLLIC is subject to regulation and supervi-
sion by the Insurance Department of the State of Arkansas. Both MLLIC and ML
Life are subject to similar regulation in the other states in which they are
licensed.
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Non-U.S. Regulatory Oversight and Supervision
Merrill Lynch's business is also subject to extensive regulation by various
non-U.S. governments, securities exchanges, central banks, and regulatory bod-
ies, particularly in those countries where it has established an office. Cer-
tain Merrill Lynch subsidiaries, including MLPF&S and MLI, are regulated as
broker-dealers under the laws of the jurisdictions in which they operate.
MLI, a registered broker-dealer in the United Kingdom, is regulated by the SFA
and is subject to the capital requirements established by the SFA. ML Capital
Markets Bank, which engages in the derivatives business, is regulated by the
Central Bank of Ireland. Merrill Lynch's activities in Australia are regulated
by the Australian Securities Commission and its Hong Kong and Singapore opera-
tions are regulated and supervised by the Hong Kong Securities and Futures
Commission and The Monetary Authority of Singapore, respectively. Merrill
Lynch's Japanese business is subject to the regulation of the Japanese Minis-
try of Finance as well as other Japanese regulatory agencies.
Merrill Lynch Canada is an investment dealer in Canada and is regulated under
the laws of the Canadian provinces by securities authorities and by the
Investment Dealers Association of Canada. It is also a member of all major
Canadian exchanges and is subject to their rules and regulations.
The business of MLAM and Merrill Lynch Mercury is regulated by a number of
non-U.S. regulatory agencies or bodies. IMRO and the Personal Investment
Authority regulate investment management activities in the United Kingdom.
Their activities in other jurisdictions are regulated by local regulators.
Merrill Lynch's subsidiaries engaged in banking and trust activities outside
the United States are regulated by various governmental entities in the par-
ticular jurisdiction where they are chartered, incorporated, and/or conduct
their business activities. In addition to being regulated by the New York
State Banking Department, MLIB Limited is regulated by the Bank of England and
The Monetary Authority of Singapore. Merrill Lynch Bank (Suisse) S.A. is regu-
lated by the Swiss Federal Banking Commission. MLBT Cayman is regulated by the
Cayman Monetary Authority and the Florida Department of Banking.
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PROPERTIES
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Merrill Lynch has a number of offices throughout the world. Other than those
described below as being owned, substantially all offices of Merrill Lynch
subsidiaries throughout the world are located in leased premises. Facilities
owned or occupied by Merrill Lynch are believed to be adequate for the pur-
poses for which they are currently used and are well maintained. Set forth
below is a brief description of the principal facilities of Merrill Lynch.
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Principal Facilities in the United States
Merrill Lynch's executive offices and principal administrative offices are
located in leased premises at the World Financial Center in New York City at
250 Vesey Street in the North Tower consisting of 1,799,702 square feet and at
225 Liberty Street in the South Tower consisting of 1,003,381 square feet.
Each tower was leased by a different Merrill Lynch affiliate in 1988. Another
Merrill Lynch affiliate is a partner in
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the partnership that holds the ground lessee's interest in the North Tower.
The information regarding property lease commitments of Merrill Lynch is set
forth in Note 7 to the Consolidated Financial Statements under the caption
Leases.
In New York City, MLPF&S also leases 139,700 square feet at 100 Church Street,
134,803 square feet at 717 Fifth Avenue, and 662,675 square feet at 570 Wash-
ington Street, under leases expiring 2000, 2000, and 2007, respectively. In
1997, a Merrill Lynch subsidiary purchased a 760,000 square foot building at
222 Broadway, which will house primarily support staff starting in 1998.
In New Jersey, separate Merrill Lynch affiliates own a 1.3 million square foot
structure on a 245-acre campus in Plainsboro and a 414,000 square foot build-
ing on 34 acres at 300 Davidson Avenue in Somerset. MLPF&S holds a 590,174
square foot lease at 101 Hudson Street in Jersey City and a 212,680 square
foot lease in Somerset. In 1997, Merrill Lynch approved a plan to build a new
facility in Hopewell, New Jersey to consolidate existing operations and allow
for future expansion.
Merrill Lynch affiliates own a 60-acre campus in Jacksonville, Florida, which
consists of three buildings with a fourth building currently under construc-
tion, and a 70-acre campus in Englewood, Colorado with two buildings.
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Principal Facilities Outside the United States
In London, an MLII subsidiary leases approximately 250,000 square feet at
Ropemaker Place. The lease, which commenced in 1987, continues for 25 years
with a right to cancel in 2002. Merrill Lynch is in the process of purchasing
a site in the City of London to construct a new headquarters complex of
approximately 550,000 square feet. These premises, which will replace the
Ropemaker facility, are expected to be occupied in 2001. Approximately 170,000
square feet of office space is also leased at Farringdon Road. This lease,
which has a 25 year term, commenced in 1990. Another Merrill Lynch subsidiary
leases approximately 140,000 square feet under a lease expiring in 2014 on
King William Street, where Merrill Lynch Mercury Asset Management's operations
are headquartered.
Merrill Lynch engages in its business from other leased premises throughout
the world, including Singapore, Hong Kong, Tokyo, Sydney, Frankfurt, and Par-
is.
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LEGAL PROCEEDINGS
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ML & Co., certain of its subsidiaries, including MLPF&S, and other persons
have been named as parties in civil actions and arbitration proceedings,
including those described below. Each of the following actions is reported as
of February 25, 1998.
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Orange County Litigation
The following actions have been filed against or on behalf of ML & Co. in con-
nection with Merrill Lynch's business activities with the Treasurer-Tax Col-
lector of Orange County, California ("Orange County") or from the purchase of
debt instruments issued by Orange County that were underwritten by MLPF&S. On
December 6, 1994, bankruptcy petitions were filed on behalf of Orange County
and the Orange County Investment Pools (the "Pools") in the United States
Bankruptcy Court for the Central District of California (the "Bankruptcy
Court"). The Pools' bankruptcy petition subsequently was dismissed. On May 17,
1996, the Bankruptcy Court confirmed a plan pursuant to which Orange County
emerged from bankruptcy. The pending actions involving Merrill Lynch and
Orange County include, in the order summarized below, an action in the names
of Orange County and the current Orange County Treasurer-Tax Collector;
actions by investors and participants in the Pools; actions by investors in ML
& Co.; and actions by holders of bonds or other debt instruments issued by or
on behalf of Orange County and other public entities with funds controlled by
the Orange County Treasurer-Tax Collector.
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On January 12, 1995, an action was commenced by Orange County and the Pools
against ML & Co. and certain of its subsidiaries in the Bankruptcy Court pur-
suant to the automatic reference by law of all civil proceedings related to
bankruptcy petitions (the "Orange County Action"). Orange County filed a first
amended complaint on June 6, 1995, which was dismissed on October 17, 1995.
Orange County filed a second amended complaint on October 25, 1995 adding John
M.W. Moorlach, the current Orange County Treasurer-Tax Collector, as a plain-
tiff, and alleging, among other things, that Merrill Lynch's liquidation of
certain securities entitles the plaintiffs to relief under Sections 362, 502,
510, 549, and 922 of the Bankruptcy Code; that various securities transactions
between Orange County and/or the Pools and ML & Co. and its subsidiaries vio-
lated California law and are null and void; that ML & Co. and its subsidiaries
violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereun-
der, Section 25401 of the California Corporations Code (the "California
Code"), Section 17200 of the California Business and Professions Code, and
Sections 1709-10 of the California Civil Code; breached fiduciary duties;
aided and abetted breaches of fiduciary duty; and conspired to make unautho-
rized use of public funds. Damages in excess of $2 billion, punitive damages
in an unspecified amount, and injunctive and declaratory relief are sought.
On March 1, 1995, ML & Co. and Orange County entered into an agreement in
order to resolve a motion by Orange County seeking a temporary restraining
order, a preliminary injunction, and a constructive trust with respect to the
proceeds realized by Merrill Lynch from the sale of securities purchased by
Merrill Lynch from Orange County pursuant to certain master repurchase agree-
ments. Pursuant to this agreement, the proceeds from the sale of securities
purchased by Merrill Lynch from Orange County were used to purchase short-term
United States Treasury Bills or United States Treasury Notes that are identi-
fiable and held separate and subject to any rights that Merrill Lynch may have
in the master repurchase agreements. This agreement may be terminated by ML &
Co. upon 30 days' written notice.
On October 17, 1996, on ML&Co.'s motion, the United States District Court for
the Central District of California (the "District Court") withdrew the prior
automatic reference to the Bankruptcy Court of this action. The case now is
pending in the District Court.
On December 13, 1994, a purported class action was commenced in the Superior
Court of the State of California, Orange County, on behalf of individuals
whose funds were deposited with the Orange County Treasurer-Tax Collector pur-
suant to proceedings in California Superior Court (the "DeLeon Action"). On
December 27, 1994, plaintiffs filed a first amended class action complaint; on
April 19, 1995, plaintiffs filed a second amended complaint which was dis-
missed on November 13, 1995; and, on December 18, 1995, plaintiffs filed a
third amended complaint. As amended, the DeLeon Action is brought on behalf of
the same individuals on whose behalf the action was originally brought and on
behalf of individuals who invested funds in the Pools representing deferred
compensation and/or retirement funds. The defendants include ML & Co., a sub-
sidiary of ML & Co., and an employee of Merrill Lynch. Plaintiffs allege,
among other things, that the defendants breached fiduciary duties; aided and
abetted breaches of fiduciary duties; conspired to breach a fiduciary duty;
and committed professional negligence in connection with Merrill Lynch's busi-
ness activities with the Orange County Treasurer-Tax Collector. Damages,
including punitive damages, in unspecified amounts are sought. On May 10,
1996, the court stayed this action pending final resolution of the Orange
County Action described above.
On September 15, 1995, an action was commenced in the Superior Court of the
State of California, San Francisco County, by twelve California public enti-
ties (the "Atascadero State Court Action"). On January 11, 1996, the case was
transferred to the Superior Court of the State of California, Contra Costa
County.
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On April 10, 1996, the plaintiffs filed an amended complaint which was dis-
missed on November 5, 1996, and, on December 2, 1996, plaintiffs filed a sec-
ond amended complaint adding two California public entities as plaintiffs. The
current plaintiffs are the City of Atascadero, City of Buena Park, The Commu-
nity Redevelopment Agency of the City of Buena Park, City of Claremont, City
of Milpitas, City of Montebello, Community Redevelopment Agency of the City of
Montebello, City of Mountain View, City of Santa Barbara, The Redevelopment
Agency of the City of Santa Barbara, City of Yorba Linda, Yorba Linda Redevel-
opment Agency, Santiago County Water District, and Yorba Linda Water District.
Named as defendants are ML & Co., certain of its subsidiaries, and three past
or present employees of Merrill Lynch, two of whom were dismissed as defen-
dants without prejudice on July 5, 1996. As amended, the complaint alleges,
among other things, that the defendants committed fraud, deceit, and negligent
misrepresentation; conspired to commit fraud; breached fiduciary duties; aided
and abetted breaches of fiduciary duty; and violated California Penal Code
Section 496 and the Racketeer Influenced and Corrupt Organizations Act ("RI-
CO") in connection with Merrill Lynch's business activities with the Orange
County Treasurer-Tax Collector. Damages, including punitive damages and treble
damages, in unspecified amounts are sought. On February 10, 1997, the court
dismissed this action. On May 6, 1997, plaintiffs filed a notice of appeal.
On November 27, 1995, an action was commenced in the United States District
Court for the Central District of California by the fourteen California public
entities that are plaintiffs in the Atascadero State Court Action described
above (the "Atascadero Federal Court Action"). On March 22, 1996, the plain-
tiffs filed a first amended complaint, which was voluntarily dismissed without
prejudice on September 4, 1996. On February 19, 1997, plaintiffs filed a new
complaint naming as defendants ML & Co. and certain of its subsidiaries. The
complaint alleges, among other things, that the defendants committed fraud,
deceit and negligent misrepresentation; conspired to commit fraud; breached
fiduciary duties; aided and abetted breaches of fiduciary duty; and violated
California Penal Code Section 496 and RICO in connection with Merrill Lynch's
business activities with the Orange County Treasurer-Tax Collector. Restitution
and damages, treble damages, and punitive damages in unspecified amounts are
sought. On April 17, 1997, the court granted a motion by defendants to abstain
from deciding this action pending final resolution of the Atascadero State Court
Action described above. On May 20, 1997, plaintiffs filed a notice of appeal.
On December 20, 1996, an action was commenced in the United States District
Court for the Central District of California by Irvine Ranch Water District
(the "Irvine Action"). ML & Co. is the sole defendant. The complaint alleges,
among other things, that ML & Co. committed intentional and negligent misrep-
resentation, concealment, and breach of fiduciary duty in connection with Mer-
rill Lynch's business activities with the Orange County Treasurer-Tax Collec-
tor. Damages in excess of $130 million and punitive damages in an unspecified
amount are sought.
Beginning on December 5, 1994, five derivative actions purportedly brought on
behalf of ML & Co. were filed in the Supreme Court of the State of New York,
New York County (the "Wilson Action"). On February 21, 1995, the court consol-
idated the actions and on June 5, 1995, an amended consolidated complaint was
filed naming as defendants 22 present or past directors, officers, or employ-
ees of ML & Co. and/or certain of its subsidiaries. The complaint alleges,
among other things, breach of fiduciary duty, waste of corporate assets, and
claims for indemnification in connection with Merrill Lynch's business activi-
ties with the Orange County Treasurer-Tax Collector. Damages in an unspecified
amount are sought on behalf of ML & Co. against the individuals named as
defendants. Because this derivative action purports to be brought on behalf of
ML & Co. and any recovery obtained by plaintiffs would belong to ML & Co., ML
& Co. is named as a nomi-
1997 Annual Report
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BUSINESS OF MERRILL LYNCH
- --------------------------------------------------------------------------------
nal defendant. On August 7, 1996, the court dismissed this action. On Septem-
ber 11, 1996, a notice of appeal was filed.
On December 16, 1994, a purported class action was commenced in the United
States District Court for the Southern District of New York (the "Balan
Action"). An amended complaint was filed on May 15, 1995. As amended, the
Balan Action is brought on behalf of purchasers of ML & Co.'s common stock
between March 31, 1994 and December 6, 1994, and names as defendants ML & Co.
and two of its present or former directors and officers. The plaintiff alleg-
es, among other things, violations of Sections 10(b) and 20(a) of the Exchange
Act and Rule 10b-5 promulgated thereunder in connection with Merrill Lynch's
disclosure with respect to its business activities with the Orange County
Treasurer-Tax Collector. Damages in an unspecified amount are sought.
On September 28, 1995, a purported class action was commenced in the Superior
Court of the State of California, Orange County, on behalf of all persons who
purchased bonds or other debt instruments between July 1, 1992 and December 6,
1994 that were issued by Orange County or other public entities with funds
controlled by the Orange County Treasurer-Tax Collector (the "Smith Action").
The defendants in the case are ML & Co. and an employee of Merrill Lynch, as
well as Paine Webber, Inc., CS First Boston Corp., Smith Barney, Inc., Lehman
Brothers, Inc., Donaldson, Lufkin & Jenrette, Inc., Kidder Peabody & Co.,
Inc., Stone & Youngberg, Rauscher Pierce Refsnes, Inc., Leifer Capital, Inc.,
Fieldman Rolapp & Associates, Inc., CGMS, Inc., O'Brien Partners, Inc., and
KPMG Peat Marwick. Plaintiffs allege, among other things, that the defendants
affiliated with Merrill Lynch violated Sections 25400, 25401, 25500, 25501,
and 25504.1 of the California Code and committed fraud and deceit in connec-
tion with disclosure made with respect to the sale of bonds and other debt
instruments issued by Orange County or other public entities with funds con-
trolled by the Orange County Treasurer-Tax Collector. Damages, including puni-
tive damages, in unspecified amounts are sought. On December 10, 1996, the
court approved settlements entered into by plaintiffs and certain defendants
other than ML & Co. and the Merrill Lynch employee named as a defendant. On
December 10, 1997, the remaining parties in this action, including ML & Co.
and the Merrill Lynch employee named as a defendant, agreed to a proposed set-
tlement that was subject to court approval. The settlement required, among
other things, a payment by ML & Co. of $1,900,000. On February 6, 1998, fol-
lowing notice to class members, the court granted final approval of the set-
tlement and entered a judgment discharging the defendants, including ML & Co.
and the Merrill Lynch employee, from all claims asserted in the action.
The Staff of the SEC has advised MLPF&S that the SEC has authorized the Staff
to institute an enforcement proceeding against MLPF&S based on alleged unin-
tentional violations of the Federal securities laws in connection with certain
underwritings in 1994 of debt securities issued by Orange County, which MLPF&S
sold to 25 sophisticated institutional investors; all such securities have
been repaid in full with interest by Orange County. MLPF&S believes that this
allegation is inappropriate and is pursuing its views with the SEC and the
Staff.
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NASDAQ Antitrust Litigation
On December 16, 1994, a purported class action complaint consolidating a
series of previously filed actions was filed in the United States District
Court for the Southern District of New York. On August 22, 1995, plaintiffs
filed a complaint entitled "Refiled Consolidated Complaint," which has been
amended on July 21, 1997 and December 31, 1997. The amended complaint alleges
that more than 35 market-makers, including an ML & Co. subsidiary, engaged in
a conspiracy with respect to the "spread" between bid and ask prices for
certain securities traded on NASDAQ by, among other things, allegedly refusing
to quote bid and ask prices in so-called "odd-eighths". The complaint
alleges
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violations of antitrust laws and seeks damages in an unspecified amount, tre-
ble damages, and declaratory and injunctive relief. The court has certified a
class consisting of certain persons, including institutional investors who
purchased or sold certain securities on NASDAQ during specified time periods
for each security during the period from May 1, 1989 to May 27, 1994 (the
"Class Period").
On June 30, and August 27, 1997, plaintiffs filed motions seeking court
approval of settlements entered into by plaintiffs and six of the defendants
in the action other than the named ML & Co. subsidiary. On October 14, 1997,
the court preliminarily approved those settlements.
On December 23, 1997, plaintiffs, the ML & Co. subsidiary, and all but one of
the remaining defendants agreed to a proposed settlement (the "Proposed Set-
tlement"). The Proposed Settlement requires, among other things, that the ML &
Co. subsidiary named as a defendant pay approximately $2.8 million to a set-
tlement fund on or before January 7, 1998 and pay to the settlement fund on or
before September 30, 1998, U.S. Treasury securities with a maturity date of on
or before July 30, 1999 and having a value at maturity of approximately $100.7
million. On December 31, 1997, the court issued an order expanding the Class
Period from May 1, 1989 through July 17, 1996 and granted preliminary approval
of the Proposed Settlement on behalf of the expanded class. The Proposed Set-
tlement is subject to final approval of the court following notice to class
members.
On July 17, 1996, the Antitrust Division of the United States Department of
Justice filed a civil antitrust complaint against 24 NASDAQ market-makers,
including a subsidiary of ML & Co. The complaint alleges that the firms vio-
lated Section 1 of the Sherman Act through a "common understanding" to follow
a "quoting convention" that the complaint asserts had inflated the "inside
spread" (the difference between the best quoted buying price and the best
quoted selling price on NASDAQ) in certain NASDAQ stocks. The complaint fur-
ther asserts that this alleged conduct resulted in investors having to pay
higher transaction costs for buying and selling certain NASDAQ stocks than
they would have paid otherwise.
At the time of the filing of the complaint, a proposed settlement of the
action was announced pursuant to which the market-maker defendants in the
action agreed not to engage in certain conduct. The settlement, which was
approved by the court in April 1997, provides for, among other things, the
monitoring and tape-recording by each of the market-maker defendants of not
less than 3.5 percent (to a maximum of 70 hours per week) of telephone conver-
sations by its over-the-counter desk traders; the provision to the Department
of Justice of any taped conversation that may violate the terms of the settle-
ment; and allowing Department of Justice representatives to appear unannounced
during regular business hours to monitor trader conversations.
On May 20, 1997, the plaintiffs in the NASDAQ antitrust litigation class
action described above, who had been granted limited leave to intervene in the
civil antitrust action filed by the Antitrust Division of the Department of
Justice in order to object to certain aspects of the settlement of such
action, filed an appeal of the court's approval of the settlement. On May 21,
1997, the court stayed certain portions of its order approving the settlement,
including the provision for the tape recording of telephone conversations by
defendants' over-the-counter desk traders, pending completion of this appeal.
In connection with its industry-wide investigations into the NASDAQ market, ML
& Co., along with the other named defendants, have received inquiries from the
SEC and is cooperating with these inquiries.
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GSLIC Litigation
In October 1991, a derivative action purportedly brought on behalf of ML & Co.
was filed in the Supreme Court of the State of New York, New York County,
involving securities trading transactions that occurred at year-end 1984,
1985, 1986, and 1988 between subsidiaries of ML & Co. and a Florida insurance
company, Guarantee Security Life Insurance Company ("GSLIC") that later was
taken into liquidation.
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CORPORATE INFORMATION
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Plaintiffs alleged that these year-end transactions were entered into by GSLIC
to distort its financial condition. Named as defendants are those directors of
ML & Co. who were directors at the time of the transactions described above,
GSLIC's parent company, Transmark USA, Inc. ("Transmark"), and one of
Transmark's principals. The complaint alleges, among other things, breach of
fiduciary duty by the directors of ML & Co. who are named as defendants. Dam-
ages in an unspecified amount are sought on behalf of ML & Co. Because this
derivative action purports to be brought on behalf of ML & Co. and any recov-
ery obtained by plaintiffs would belong to ML & Co., it is named as a nominal
defendant. On May 6, 1997, the court dismissed this action. On July 28, 1997,
plaintiffs filed a notice of appeal.
* * * *
ML & Co. believes it has strong defenses to, and, where appropriate, will vig-
orously contest the actions described above that have not been settled.
Although the ultimate outcome of the actions described above and other civil
actions, arbitration proceedings, and claims pending against ML & Co. or its
subsidiaries as of February 25, 1998, 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 or the results of opera-
tions of Merrill Lynch as set forth in the Consolidated Financial Statements
contained herein.
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CORPORATE INFORMATION
- -------------------------------------------------------------------------------
MATTERS SUBMITTED TO A VOTE OF SECURITYHOLDERS
There were no matters submitted to a vote of securityholders during the 1997
fourth quarter.
- -------------------------------------------------------------------------------
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DIS-
CLOSURE
There were no changes in or disagreements with accountants on accounting and
financial disclosure during the last two fiscal years.
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ANNUAL MEETING OF STOCKHOLDERS
The 1998 Annual Meeting of ML & Co.'s stockholders will take place at the Mer-
rill Lynch Conference and Training Center, 800 Scudders Mill Road, Plainsboro,
New Jersey. The meeting is scheduled for Tuesday, April 14, 1998, beginning at
10:00 a.m. (local time).
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INFORMATION ON DIRECTORS AND EXECUTIVE OFFICERS
The information set forth under the caption Election of Directors on pages 4
to 7 of ML & Co.'s Proxy Statement dated March 5, 1998 for its 1998 Annual
Meeting of Stockholders (the "1998 Proxy Statement") is incorporated herein by
reference. For a list of the members of the ML & Co. Board of Directors and of
the ML & Co. executive officers, see page 94 and page 95, respectively, of this
Annual Report.
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EXECUTIVE OFFICER AND DIRECTOR COMPENSATION
Information relating to ML & Co. executive officer and director compensation
set forth on pages 14 to 25 and page 27 of the 1998 Proxy Statement is incor-
porated herein by reference.
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SECURITY OWNERSHIP
The information concerning security ownership of certain beneficial owners of
ML & Co. Common Stock on pages 1 and 2 of the 1998 Proxy Statement and the
information concerning the security ownership of ML & Co. directors and execu-
tive officers on pages 9 and 10 of the 1998 Proxy Statement is incorporated
herein by reference.
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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions set forth
under the caption Certain Transactions on pages 25 and 26 of the 1998 Proxy
Statement is incorporated herein by reference.
1997 Annual Report
93
CORPORATE INFORMATION
[LOGO OF MERRILL LYNCH APPEARS HERE]
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BOARD OF DIRECTORS OF MERRILL LYNCH & CO., INC.
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DAVID H. KOMANSKY WILLIAM R. HOOVER
Chairman of the Board and Chief Executive Chairman of the Executive Committee of, Consultant to,
Officer of ML & Co. and former Chairman of the Board, Chief Executive
Officer and President of, Computer Sciences Corporation
HERBERT M. ALLISON, JR.
President and Chief Operating Officer ROBERT P. LUCIANO
of ML & Co. Chairman of the Board and former Chief Executive
Officer of Schering-Plough Corporation
WILLIAM O. BOURKE
Corporate Director; Former Chairman of DAVID K. NEWBIGGING
the Board and Chief Executive Officer of Chairman of the Board of Equitas Holdings Limited
Reynolds Metals Company
AULANA L. PETERS
W.H. CLARK Partner in the law firm of Gibson, Dunn & Crutcher
Corporate Director; Former Chairman of
the Board and Chief Executive Officer of JOHN J. PHELAN, JR.
Nalco Chemical Company Senior Adviser, Boston Consulting Group; Former
Chairman of the Board and Chief Executive
JILL K. CONWAY Officer of New York Stock Exchange, Inc.
Visiting Scholar, Massachusetts
Institute of Technology JOHN L. STEFFENS
Vice Chairman of the Board and Head of U.S.
STEPHEN L. HAMMERMAN Private Client Group of ML & Co.
Vice Chairman of the Board and
General Counsel of ML & Co. WILLIAM L. WEISS
Corporate Director; Chairman Emeritus and
EARLE H. HARBISON, JR. former Chairman of the Board and Chief
Chairman of the Board of Executive Officer of Ameritech Corporation
Harbison Corporation
GEORGE B. HARVEY
Corporate Director; Former Chairman of
the Board, President and Chief Executive
Officer of Pitney Bowes Inc.
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EXECUTIVE MANAGEMENT OF MERRILL LYNCH
- -------------------------------------------------------------------------------
HERBERT M. STEPHEN L. JEFFREY M. PEEK
ALLISON, JR. HAMMERMAN Executive Vice President and Head
President and Vice Chairman of of Asset Management Group
Chief Operating the Board and President and CEO of MLAM
Officer General Counsel
PAUL W. JOHN G. HEIMANN WINTHROP H. SMITH, JR.
CRITCHLOW Chairman of Executive Vice President and Head
Senior Vice Global of International Private Client
President Financial Group
Marketing and Institutions
Communications JOHN L. STEFFENS
JEROME P. KENNEY Vice Chairman of the Board and
THOMAS W. DAVIS Executive Vice Head of U.S. Private Client Group
Executive Vice President
President and Corporate MARY E. TAYLOR
Head of Strategy and Senior Vice President
Corporate and Research Human Resources
Institutional
Client Group DAVID H. ARTHUR ZEIKEL
KOMANSKY Executive Vice President and
BARRY S. Chairman of the Chairman of MLAM
FRIEDBERG Board and Chief
Executive Vice Executive STEPHEN A. ZIMMERMAN
President and Officer Co-Head of Merrill Lynch Mercury
Chairman of Asset Management
Corporate and
Institutional MICHAEL J.P.
Client Group MARKS
Executive
CAROL GALLEY Chairman of
Co-Head of Merrill Lynch
Merrill Lynch Europe, Middle
Mercury Asset East & Africa
Management
DANIEL T. NAPOLI
EDWARD L. Senior Vice
GOLDBERG President
Executive Vice Risk Management
President
Operations, E. STANLEY
Services and O'NEAL
Technology Executive Vice
President and
Chief Financial
Officer
1997 Annual Report
94
CORPORATE INFORMATION
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EXECUTIVE OFFICERS OF MERRILL LYNCH & CO., INC.
- -------------------------------------------------------------------------------
The following table sets forth the name, age, present title, principal occupa-
tion, and certain biographical information for the past five years for ML &
Co.'s executive officers, all of whom have been elected by the ML & Co. Board
of Directors and have been appointed as members of the Merrill Lynch Executive
Management Committee. Unless otherwise indicated, the officers listed are of
ML & Co. Under ML & Co.'s by-laws, elected officers are elected annually to
hold office until their successors are elected and qualify.
DAVID H. KOMANSKY, 58 JEROME P. KENNEY, 56
Chairman of the Board Executive Vice President, Corporate Strategy
since April 1997; Chief and Research since October 1990; Executive Vice
Executive Officer since President, Corporate Strategy, Research and
December 1996; President Corporate Credit from May 1993 to May 1995
and Chief Operating
Officer from January 1995 E. STANLEY O'NEAL, 46
to April 1997; President Executive Vice President and Chief Financial
and Chief Executive Officer since March 1998; Executive Vice
Officer of MLPF&S since President and Co-Head of Corporate and
February 1995; Executive Institutional Client Group from April 1997 to
Vice President, Debt and March 1998; Managing Director and Head of
Equity Markets Group from Global Capital Markets Group from April 1995 to
May 1993 to January 1995; April 1997; Managing Director, Investment
Executive Vice President, Banking and Head of Financing Services Group
Debt Markets Group from from June 1993 to April 1995
June 1992 to April 1993
HERBERT M. ALLISON, JR., 54 JEFFREY M. PEEK, 51
President and Chief Executive Vice President and Head of Asset
Operating Officer since Management Group and President and Chief
April 1997; Executive Vice Executive Officer of MLAM since December 1997;
President, Corporate and Managing Director and Co-Head of Investment
Institutional Client Group Banking Group from March 1997 to December 1997;
from January 1995 to April Senior Vice President and Director, Global
1997; Executive Vice Securities Research & Economics from April 1995
President, Investment to March 1997; Head of Global Industries Group
Banking Group from May from 1993 to March 1995
1993 to January 1995;
Executive Vice President, WINTHROP H. SMITH, JR., 48
Finance and Administration Executive Vice President and Head of
from October 1990 to April International Private Client Group since April
1993 1997; Executive Vice President, International
from June 1992 to April 1997; National Sales
THOMAS W. DAVIS, 44 Director, Eastern Division in U.S. Private
Executive Vice President Client Group from November 1990 to May 1992
and Head of Corporate and
Institutional Client Group JOHN L. STEFFENS, 56
since March 1998; Vice Chairman of the Board since April 1997;
Executive Vice President Head of U.S. Private Client Group since October
and Co-Head of Corporate 1990
and Institutional Client
Group from April 1997 to
March 1998; Managing
Director and Co-Head of
Investment Banking Group
from April 1995 to April
1997; Co-Head of Equity
Markets Group from 1993 to
April 1995; Head of Global
Equity Capital Markets
from 1991 to 1993
EDWARD L. GOLDBERG, 57
Executive Vice President,
Operations, Services and
Technology since April
1991 (and responsible for
Corporate Real Estate and
Purchasing since March
1993); Director and
Executive Vice President
of MLPF&S from May 1991 to
November 1995
STEPHEN L. HAMMERMAN, 60
Vice Chairman of the Board
since April 1992; General
Counsel since October
1984; General Counsel of
MLPF&S from March 1981 to
June 1996
1997 Annual Report
95
CORPORATE INFORMATION
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
ML & CO. CAPITAL STOCK
The authorized capital stock of ML & Co. consists of 500,000,000 shares of
common stock, par value $1.33 1/3 per share ("Common Stock"), and 25,000,000
shares of preferred stock, par value $1.00 per share, issuable in series
("Preferred Stock"), as to which the Board of Directors has the authority to
issue from time to time in one or more series without further shareholder
action. ML & Co. is seeking stockholder approval at its 1998 Annual Meeting of
Stockholders to increase the number of authorized shares of Common Stock to
1,000,000,000.
- -------------------------------------------------------------------------------
ML & Co. Common Stock
As of February 23, 1998, 342,205,174 shares of Common Stock were outstanding.
The shares of Common Stock have no preemptive or conversion rights, redemption
provisions, or sinking fund provisions. The outstanding shares of Common Stock
are duly and validly issued, fully paid, and nonassessable. Each share is eli-
gible, to the extent specified therein, to purchase certain securities upon
the occurrence of certain events specified in the Rights Agreement referenced
below.
ML & Co. is the principal transfer agent for the Common Stock. Questions from
registered stockholders on dividends, lost and stolen certificates, changes of
legal or dividend addresses, and other matters relating to registered stock-
holder status should be sent to:
Merrill Lynch & Co., Inc.
P.O. Box 20, Church Street Station
New York, NY 10277-1004
Attn: Gregory T. Russo, Secretary
However, registered stockholders wishing to transfer their shares of Common
Stock should continue to do so through the following transfer agent and regis-
trar:
ChaseMellon Shareholder Services, L.L.C.
Stock Transfer Department
P.O. Box 469
Washington Bridge Station
New York, NY 10033
1-800-851-9677
- -------------------------------------------------------------------------------
ML & Co. Preferred Stock
ML & Co.'s 9% Preferred Stock is a single series consisting of 42,500 shares
with an aggregate liquidation preference of $425,000,000. As of February 23,
1998, there were 42,500 shares of 9% Preferred Stock outstanding. As of Febru-
ary 23, 1998, there were 17,000,000 Depositary Shares issued, each represent-
ing a 1/400th interest in a share of the 9% Preferred Stock. MLPF&S may occa-
sionally acquire a temporary position in the Depositary Shares. As of February
23, 1998, the Depositary Shares held by MLPF&S for the purpose of resale was
not material. The 9% Preferred Stock has dividend and liquidation preference
over the Common Stock and over the Series A Junior Preferred Stock issuable
pursuant to the Amended and Restated Rights Agreement dated as of December 2,
1997 between ML & Co. and ChaseMellon Shareholder Services, L.L.C.
Depositary Shares representing 1/400th of a share of 9% Cumulative Preferred
Stock, Series A are listed on the New York Stock Exchange. The transfer agent
and registrar for the Depositary Shares is:
Citibank, N.A.
111 Wall Street, Fifth Floor
New York, NY 10043
Attn: Corporate Trust Department
- -------------------------------------------------------------------------------
EXCHANGE LISTINGS
Common Stock
The Common Stock (trading symbol MER) is listed on the New York Stock
Exchange, Chicago Stock Exchange, Pacific Exchange, Paris Bourse, London Stock
Exchange, and Tokyo Stock Exchange.
1997 Annual Report
96
SUPPLEMENTAL INFORMATION
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------------
THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THIS ANNUAL REPORT:
1. Financial Statements
Financial Statements required to be filed with the SEC pursuant to the Annual
Report on Form 10-K are listed on pages 31 to 67 of this Annual Report.
2. Financial Statement Schedules
Financial Statement Schedules required to be filed with the SEC pursuant to
the Annual Report on Form 10-K are listed on pages 69 to 72 of this Annual
Report.
3. Exhibits
Exhibits required to be filed with the SEC pursuant to the Annual Report on
Form 10-K are listed on pages 97 to 99 of this Annual Report.
- -------------------------------------------------------------------------------
CURRENT REPORTS ON FORM 8-K
During the 1997 fourth quarter, ML & Co. filed the following Current Reports
on Form 8-K ("8-K") under the caption "Item 5. Other Events":
1. 8-K dated September 29, 1997 for the purpose of filing ML & Co.'s Russell
2000 Index Market Index Target-Term Securities(SM) due September 30, 2004.
2. 8-K dated October 15, 1997 for the purpose of filing ML & Co.'s Preliminary
Unaudited Earnings Summaries for the three- and nine-month periods ended
September 26, 1997.
3. 8-K dated October 29, 1997 for the purpose of filing ML & Co.'s Preliminary
Unaudited Consolidated Balance Sheet as of September 26, 1997 and state-
ments regarding computation of ratios.
4. 8-K dated November 20, 1997 for the purpose of reporting on an acquisition
to be made by ML & Co.
5. 8-K dated November 26, 1997 for the purpose of filing ML & Co.'s Major 11
International Market Index Target-Term Securities due December 6, 2002.
6. 8-K dated December 2, 1997 for the purpose of filing ML & Co.'s Amended and
Restated Rights Agreement dated as of December 2, 1997 between ML & Co. and
ChaseMellon Shareholder Services, L.L.C.
7. 8-K dated December 16, 1997 for the purpose of filing the form of ML &
Co.'s 6.56% Notes due December 16, 2007.
8. 8-K dated December 23, 1997 for the purpose of filing the form of ML &
Co.'s Market Index Target-Term Securities based upon the Dow Jones Indus-
trial Average due January 14, 2003.
- -------------------------------------------------------------------------------
LIST OF EXHIBITS FILED WITH THE SEC
- -------------------------------------------------------------------------------
Certain of the following exhibits were previously filed as exhibits to other
reports or registration statements filed by ML & Co. and are incorporated
herein by reference to such reports or registration statements as indicated
parenthetically below by the appropriate report reference date or registra-
tion statement number. For convenience, Quarterly Reports on Form 10-Q,
Annual Reports on Form 10-K, Current Reports on Form 8-K, and Registration
Statements on Form S-3 are designated herein as "10-Q", "10-K", "8-K", and
"S-3", respectively.
3. ARTICLES OF INCORPORATION AND BY-LAWS
*3.1 Restated Certificate of Incorporation of ML & Co., as amended April 24,
1987.
3.2 Certificate of Amendment dated April 29, 1993 of the Certificate of
Incorporation of ML & Co. (Exhibit 3(i) to 10-Q for the quarter ended
March 26, 1993 ("1st Quarter 1993 10-Q")).
3.3 Form of certificate representing the 9% Cumulative Preferred Stock,
Series A, par value $1.00 per share, of ML & Co. (the "9% Preferred
Stock") (Exhibit 4(i) to 10-Q for the quarter ended September 30, 1994
("3rd Quarter 1994 10-Q")).
3.4 Form of Depositary Receipt evidencing the Depositary Shares for the 9%
Preferred Stock (Exhibit 4(ii) to 3rd Quarter 1994 10-Q).
3.5 Certificate of Designation of ML & Co. establishing the rights, prefer-
ences, privileges, qualifications, restrictions, and limitations relating
to the 9% Preferred Stock (Exhibit 4(iii) to 3rd Quarter 1994 10-Q).
3.6 Deposit Agreement dated as of November 3, 1994 among ML & Co., Citibank,
N.A. as Depositary, and the holders from time to time of the Depositary
Receipts (Exhibit 4(iv) to 3rd Quarter 1994 10-Q).
3.7 Certificate of Designation dated December 17, 1987 for Series A Junior
Preferred Stock (Exhibit 3(f) to S-3 (File No. 33-19975)).
3.8 Form of Amended and Restated Rights Agreement dated as of December 2,
1997 between ML & Co. and ChaseMellon Shareholder Services, L.L.C.
(Exhibit 4 to 8-K dated December 2, 1997).
3.9 By-Laws of ML & Co., effective as of April 15, 1997 (Exhibit 3(i) to 1997
10-Q for the quarter ended March 28, 1997 ("First Quarter 1997 10-Q").
------------------------------
* Filed herewith.
1997 Annual Report
97
SUPPLEMENTAL INFORMATION
[LOGO OF MERRILL LYNCH APPEARS HERE]
- --------------------------------------------------------------------------------
4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES.
ML & Co. hereby undertakes to furnish to the SEC, upon request, copies of any
unfiled agreements defining the rights of holders of long-term debt
securities of ML & Co., none of which authorize an amount of securities that
exceed 10% of the total assets of ML & Co.
4.1 Senior Indenture dated as of April 1, 1983, as amended and restated,
between ML & Co. and The Chase Manhattan Bank (successor by merger to
Manufacturers Hanover Trust Company and Chemical Bank) and the
Supplemental Indenture thereto dated as of March 15, 1990 (Exhibit 3 to
ML & Co.'s Registration Statement on Form 8-A dated July 20, 1992).
4.2 Supplemental Indenture dated as of October 25, 1993 to the Senior
Indenture dated as of April 1, 1983 (Exhibit 4(b)(ii) to S-3 (File No.
33-61559)).
4.3 Senior Indenture dated as of October 1, 1993 between ML & Co. and The
Chase Manhattan Bank (Exhibit 4 to 8-K dated October 7, 1993).
10. MATERIAL CONTRACTS
MANAGEMENT CONTRACTS, COMPENSATION PLANS, AND OTHER EMPLOYEE ARRANGEMENTS
10.1 ML & Co. 1978 Incentive Equity Purchase Plan, as amended through Janu-
ary 16, 1995 (Exhibit 10(i) to 10-K for the fiscal year ended December
30, 1994 ("1994 10-K")).
10.2 Form of ML & Co. Amended and Restated 1994 Deferred Compensation
Agreement for a Select Group of Eligible Employees, as amended through
November 10, 1994 (Exhibit 10(ii) to 1994 10-K).
10.3 ML & Co. Long-Term Incentive Compensation Plan, as amended through
October 21, 1996 (Exhibit 10(i) to 10-Q for the quarter ended
September 27, 1996 (the "3rd Quarter 1996 10-Q")).
10.4 ML & Co. Equity Capital Accumulation Plan, as amended through October
21, 1996 (Exhibit 10(ii) to 3rd Quarter 1996 10-Q).
10.5 ML & Co. Executive Officer Compensation Plan (Exhibit 10(i) to ML &
Co.'s Proxy Statement for the 1994 Annual Meeting of Stockholders con-
tained in ML & Co.'s Schedule 14A filed on March 14, 1994 ("1994 Proxy
Statement")).
10.6 Written description of Retirement Program for Non-Employee Directors
of ML & Co., as amended June 29, 1988 (Page 24 of ML & Co.'s Proxy
Statement for the 1998 Annual Meeting of Stockholders contained in ML
& Co.'s Schedule 14A filed on March 4, 1998 ("1998 Proxy Statement")).
10.7 Form of Severance Agreement between ML & Co. and certain of its direc-
tors and executive officers (Exhibit 10(x) to 10-K for fiscal year
ended December 29, 1995 ("1995 10-K")).
10.8 Form of Indemnification Agreement entered into with all current direc-
tors of ML & Co. and to be entered into with all future directors of
ML & Co. (Exhibit 10(xi) to 10-K for the fiscal year ended December
31, 1993 ("1993 10-K")).
10.9 Written description of ML & Co.'s incentive compensation programs (Ex-
hibit 10(xii) to 1993 10-K).
10.10 Written description of ML & Co.'s compensation policy for executive
officers and directors (Pages 14 to 16 and page 23 of the 1998 Proxy
Statement).
10.11 Merrill Lynch KECALP Growth Investments Limited Partnership 1983 (Ex-
hibit 1(b) to Registration Statement on Form N-2 (File No. 2-81619)).
10.12 Merrill Lynch KECALP L.P. 1984 (Exhibit 1(b) to Registration Statement
on Form N-2 (File No. 2-87962)).
10.13 Merrill Lynch KECALP L.P. 1986 (Exhibit 1(b) to Registration Statement
on Form N-2 (File No. 2-99800)).
10.14 Merrill Lynch KECALP L.P. 1987 (Exhibit 1(b) to Registration Statement
on Form N-2 (File No. 33-11355)).
10.15 Merrill Lynch KECALP L.P. 1989 (Exhibit 1(b) to Registration Statement
on Form N-2 (File No. 33-26561)).
10.16 Merrill Lynch KECALP L.P. 1991 (Exhibit 1(b) to Registration Statement
on Form N-2 (File No. 33-39489)).
10.17 Merrill Lynch KECALP L.P. 1994 (Exhibit 1(a)(ii) to Registration
Statement on Form N-2 (File No. 33-51825)).
10.18 Merrill Lynch KECALP L.P. 1997 (Exhibit 1(a)(ii) to Registration
Statement on Form N-2 (File No. 333-15035)).
10.19 ML & Co. Deferred Restricted Unit Plan for Executive Officers (Exhibit
10(xxiii) to 10-K for fiscal year ended December 27, 1996 ("1996 10-
K")).
10.20 ML & Co. 1995 Deferred Compensation Plan for a Select Group of Eligi-
ble Employees (Exhibit 10(xxii) to 1994 10-K).
10.21 ML & Co. Fee Deferral Plan for Non-Employee Directors, as amended
through April 15, 1997 (Exhibit 10 to First Quarter 1997 10-Q).
10.22 ML & Co. 1996 Deferred Compensation Plan for a Select Group of Eligi-
ble Employees (Exhibit 10(i) to 10-Q for the quarter ended September
29, 1995 ("3rd Quarter 1995 10-Q")).
1997 Annual Report
98
SUPPLEMENTAL INFORMATION
- --------------------------------------------------------------------------------
10.23 ML & Co. 1997 Deferred Compensation Plan for a Select Group of Eligible
Employees (Exhibit 10(xxvii) to 1996 10-K).
10.24 ML & Co. 1997 KECALP Deferred Compensation Plan for a Select Group of
Eligible Employees (Exhibit 10(i) to 10-Q for the quarter ended June 27,
1997).
10.25 ML & Co. Deferred Unit and Stock Unit Plan for Non-Employee Directors
(Exhibit 10(iv) to 3rd Quarter 1996 10-Q).
10.26 ML & Co. Long-Term Incentive Compensation Plan for Managers and
Producers (Exhibit 10(xxx) to 1996 10-K).
10.27 Executive Annuity Agreement dated as of January 27, 1997 by and
between ML & Co. and David H. Komansky (Exhibit 10(xxxi) to 1996 10-K).
10.28 Amendment dated September 18, 1996 to Deferred Compensation Plans
(amending the Amended and Restated 1994 Deferred Compensation Agreement
for a Select Group of Eligible Employees, the ML & Co. 1995 Deferred
Compensation Plan for a Select Group of Eligible Employees, and the ML &
Co. 1996 Deferred Compensation Plan for a Select Group of Eligible
Employees) (Exhibit 10(xxxii) to 1996 10-K).
10.29 ML & Co. 1998 Deferred Compensation Plan for a Select Group of Eligible
Employees (Exhibit 10(i) to 10-Q for the quarter ended September 26,
1997 (the "3rd Quarter 1997 10-Q")).
10.30 ML & Co. Program for the Deferral of Stock Option Gains for a Select
Group of Eligible Employees (Exhibit 10(iv) to 3rd Quarter 1997 10-Q).
*10.31 Amendment dated February 12, 1998 to the ML & Co. Deferred Compensa-
tion Plans for a Select Group of Eligible Employees for the years 1994,
1995, 1996, and 1997.
*10.32 Amendment dated February 12, 1998 to the ML & Co. Deferred Restricted
Unit Plan for Executive Officers.
*11 STATEMENT RE COMPUTATION OF PER SHARE EARNINGS.
*12 STATEMENT RE COMPUTATION OF RATIOS.
13 1997 ANNUAL REPORT TO STOCKHOLDERS.
This document constitutes an Annual Report to Stockholders as required
by Rule 14a-3 of the Exchange Act and an Annual Report on Form 10-K
required to be filed pursuant to Section 13 or 15(d) of the Exchange
Act. This Annual Report to Stockholders has been filed with the SEC as
the Annual Report to Stockholders on Form 10-K accompanied by the
required Form 10-K cover page and Cross Reference Index which is
included herewith for convenience.
*21 SUBSIDIARIES OF ML & CO.
*23 CONSENT OF INDEPENDENT AUDITORS.
*27 FINANCIAL DATA SCHEDULE.
------------------------------
* Filed herewith
1997 Annual Report
99
CROSS REFERENCE INDEX TO ANNUAL REPORT ON FORM 10-K
[LOGO OF MERRILL LYNCH APPEARS HERE]
PAGE NUMBER
FORM 10-K REFERENCE TO THIS
REQUIRED INFORMATION 1997 ANNUAL REPORT
-------------------- ------------------
PART ONE
ITEM 1. DESCRIPTION OF BUSINESS............. 73-87
ITEM 2. PROPERTIES.......................... 87-88
ITEM 3. LEGAL PROCEEDINGS................... 88-93
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITYHOLDERS..................... 93
PART TWO
ITEM 5. MARKET FOR REGISTRANT'S COMMON
STOCK............................... 68
ITEM 6. SELECTED FINANCIAL DATA............. 3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 5-29
ITEM 7A. MARKET RISK DISCLOSURES ............ 24-25, 38-43,
44-49
ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA.................. 30-68
Independent Auditors' Report........ 30
Statements of Consolidated
Earnings............................ 31
Consolidated Balance Sheets......... 32-33
Statements of Changes in
Consolidated Stockholders' Equity... 34-35
Statements of Consolidated
Comprehensive Income................ 36
Statements of Consolidated Cash
Flows............................... 37
Notes to Consolidated Financial
Statements.......................... 38-67
Quarterly Information............... 68
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE................ 93
PART THREE
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT...................... 93
ITEM 11. EXECUTIVE COMPENSATION.............. 93
ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT.... 93
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS........................ 93
PART FOUR
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-K.. 97
Condensed Financial Statements
(Parent Company Only)............... 69-72
Reports on Form 8-K................. 97
List of Exhibits.................... 97-99
100
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 4th day of March,
1998.
MERRILL LYNCH & CO., INC.
Registrant
GREGORY T. RUSSO /s/ Gregory T. Russo
--------------------------------------------
GREGORY T. RUSSO
SECRETARY
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Regis-
trant in the capacities indicated on the 4th day of March, 1998.
DAVID H. KOMANSKY /s/ David H. Komansky
--------------------------------------------
DAVID H. KOMANSKY
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
E. STANLEY O'NEAL /s/ E. Stanley O'Neal
--------------------------------------------
E. STANLEY O'NEAL
EXECUTIVE VICE PRESIDENT
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
MICHAEL J. CASTELLANO /s/ Michael J. Castellano
----------------------------------------
MICHAEL J. CASTELLANO
SENIOR VICE PRESIDENT AND CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
HERBERT M. ALLISON, JR. /s/ Herbert M. Allison, Jr.
--------------------------------------
HEBERT M. ALLISON, JR.
WILLIAM O. BOURKE /s/ William O. Bourke
--------------------------------------------
WILLIAM O. BOURKE
W.H. CLARK /s/ W. H. Clark
---------------------------------------------------
W. H. CLARK
JILL K. CONWAY /s/ Jill K. Conway
----------------------------------------------
JILL K. CONWAY
STEPHEN L. HAMMERMAN /s/ Stephen L. Hammerman
-----------------------------------------
STEPHEN L. HAMMERMAN
EARLE H. HARBISON, JR. /s/ Earle H. Harbison, Jr.
---------------------------------------
EARLE H. HARBISON, JR.
GEORGE B. HARVEY /s/ George B. Harvey
---------------------------------------------
GEORGE B. HARVEY
WILLIAM R. HOOVER /s/ William R. Hoover
--------------------------------------------
WILLIAM R. HOOVER
ROBERT P. LUCIANO /s/ Robert P. Luciano
--------------------------------------------
ROBERT P. LUCIANO
DAVID K. NEWBIGGING /s/ David K. Newbigging
------------------------------------------
DAVID K. NEWBIGGING
AULANA L. PETERS /s/ Aulana L. Peters
---------------------------------------------
AULANA L. PETERS
JOHN J. PHELAN, JR. /s/ John J. Phelan, Jr.
------------------------------------------
JOHN J. PHELAN, JR.
JOHN L. STEFFENS /s/ John L. Steffens
---------------------------------------------
JOHN L. STEFFENS
WILLIAM L. WEISS /s/ William L. Weiss
---------------------------------------------
WILLIAM L. WEISS
1997 Annual Report
101
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
MERRILL LYNCH & CO., INC.
EXHIBITS TO
FORM 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file number 1-7182
December 26, 1997
Form 10-K EXHIBIT INDEX
-----------------------
Exhibit
No. Description Page
------- ----------- ----
*3.1 Restated Certificate of Incorporation of ML & Co., as amended April 24, 1987.
3.2 Certificate of Amendment dated April 29, 1993 of the Certificate of
Incorporation of ML & Co. (Exhibit 3(i) to 10-Q for the quarter ended
March 26, 1993 ("1st Quarter 1993 10-Q")).
3.3 Form of certificate representing the 9% Cumulative Preferred Stock, Series A,
par value $1.00 per share, of ML & Co. (the "9% Preferred Stock")
(Exhibit 4(i) to 10-Q for the quarter ended September 30, 1994 ("3rd Quarter
1994 10-Q")).
3.4 Form of Depositary Receipt evidencing the Depositary Shares for the 9% Preferred
Stock (Exhibit 4(ii) to 3rd Quarter 1994 10-Q).
3.5 Certificate of Designation of ML & Co. establishing the rights, preferences,
privileges, qualifications, restrictions, and limitations relating to the 9%
Preferred Stock (Exhibit 4(iii) to 3rd Quarter 1994 10-Q).
3.6 Deposit Agreement dated as of November 3, 1994 among ML & Co., Citibank, N.A.
as Depositary, and the holders from time to time of the Depositary
Receipts (Exhibit 4(iv) to 3rd Quarter 1994 10-Q).
3.7 Certificate of Designation dated December 17, 1987 for Series A Junior Preferred
Stock (Exhibit 3(f) to S-3 (File No. 33-19975)).
3.8 Form of Amended and Restated Rights Agreement dated as of December 2, 1997 between
ML & Co. and ChaseMellon Shareholder Services, L.L.C. (Exhibit 4 to 8-K dated
December 2, 1997).
3.9 By-Laws of ML & Co., effective as of April 15, 1997 (Exhibit 3(i) to 1997 10-Q for
the quarter ended March 28, 1997 ("First Quarter 1997 10-Q")).
4.1 Senior Indenture dated as of April 1, 1983, as amended and restated, between
ML & Co. and The Chase Manhattan Bank (successor by merger to Manufacturers Hanover
Trust Company and Chemical Bank) and the Supplemental Indenture thereto dated as of
March 15, 1990 (Exhibit 3 to ML & Co.'s Registration Statement on Form 8-A dated
July 20, 1992).
4.2 Supplemental Indenture dated as of October 25, 1993 to the Senior Indenture dated
as of April 1, 1983 (Exhibit 4(b)(ii) to S-3 (File No. 33-61559)).
4.3 Senior Indenture dated as of October 1, 1993 between ML & Co. and The Chase
Manhattan Bank (Exhibit 4 to 8-K dated October 7, 1993).
10.1 ML & Co. 1978 Incentive Equity Purchase Plan, as amended through January 16,
1995 (Exhibit 10(i) to 10-K for the fiscal year ended December 30,
1994 ("1994 10-K")).
10.2 Form of ML & Co. Amended and Restated 1994 Deferred Compensation Agreement for
a Select Group of Eligible Employees, as amended through November 10, 1994
(Exhibit 10(ii) to 1994 10-K).
10.3 ML & Co. Long-Term Incentive Compensation Plan, as amended through October 21,
1996 (Exhibit 10(i) to 10-Q for the quarter ended September 27, 1996 (the "3rd
Quarter 1996 10-Q")).
10.4 ML & Co. Equity Capital Accumulation Plan, as amended through October 21, 1996
(Exhibit 10(ii) to 3rd Quarter 1996 10-Q).
10.5 ML & Co. Executive Officer Compensation Plan (Exhibit 10(i) to ML & Co.'s
Proxy Statement for the 1994 Annual Meeting of Stockholders contained
in ML & Co.'s Schedule 14A filed on March 14, 1994 ("1994 Proxy Statement")).
10.6 Written description of Retirement Program for Non-Employee Directors of ML & Co.,
as amended June 29, 1988 (Page 24 of ML & Co.'s Proxy Statement for the 1998
Annual Meeting of Stockholders contained in ML & Co.'s Schedule 14A filed on
March 4, 1998 ("1998 Proxy Statement")).
10.7 Form of Severance Agreement between ML & Co. and certain of its directors and
executive officers (Exhibit 10(x) to 10-K for fiscal year ended December 29,
1995 ("1995 10-K")).
10.8 Form of Indemnification Agreement entered into with all current directors of
ML & Co. and to be entered into with all future directors of ML & Co. (Exhibit
10(xi) to 10-K for the fiscal year ended December 31, 1993 ("1993 10-K")).
- -----
Certain of the following exhibits were previously filed as exhibits to other
reports or registration statements filed by ML & Co. and are incorporated
herein by reference to such reports or registration statements as indicated
parenthetically below by the appropriate report reference date or registra-
tion statement number. For convenience, Quarterly Reports on Form 10-Q,
Annual Reports on Form 10-K, Current Reports on Form 8-K, and Registration
Statements on Form S-3 are designated herein as "10-Q", "10-K", "8-K", and
"S-3", respectively.
*Filed herewith.
EXHIBIT
NO. Description Page
------- ----------- ----
10.9 Written description of ML & Co.'s incentive com-
pensation programs (Exhibit 10(xii) to 1993
10-K).
10.10 Written description of ML & Co.'s compensation
policy for executive officers and directors
(Pages 14 to 16 and page 23 of the 1998 Proxy
Statement).
10.11 Merrill Lynch KECALP Growth Investments Limited
Partnership 1983 (Exhibit 1(b) to Registration
Statement on Form N-2 (File No. 2-81619)).
10.12 Merrill Lynch KECALP L.P. 1984 (Exhibit 1(b) to
Registration Statement on Form N-2 (File No. 2-
87962)).
10.13 Merrill Lynch KECALP L.P. 1986 (Exhibit 1(b) to
Registration Statement on Form N-2 (File No. 2-
99800)).
10.14 Merrill Lynch KECALP L.P. 1987 (Exhibit 1(b) to
Registration Statement on Form N-2 (File No. 33-
11355)).
10.15 Merrill Lynch KECALP L.P. 1989 (Exhibit 1(b) to
Registration Statement on Form N-2 (File No. 33-
26561)).
10.16 Merrill Lynch KECALP L.P. 1991 (Exhibit 1(b) to
Registration Statement on Form N-2 (File No. 33-
39489)).
10.17 Merrill Lynch KECALP L.P. 1994 (Exhibit 1(a)(ii)
to Registration Statement on Form N-2 (File No.
33-51825)).
10.18 Merrill Lynch KECALP L.P. 1997 (Exhibit 1(a)(ii)
to Registration Statement on Form N-2 (File No.
333-15035)).
10.19 ML & Co. Deferred Restricted Unit Plan for Exec-
utive Officers (Exhibit 10(xxiii) to 10-K for
fiscal year ended December 27, 1996 ("1996
10-K")).
10.20 ML & Co. 1995 Deferred Compensation Plan for a
Select Group of Eligible Employees (Exhibit
10(xxii) to 1994 10-K).
10.21 ML & Co. Fee Deferral Plan for Non-Employee
Directors, as amended through April 15, 1997
(Exhibit 10 to First Quarter 1997 10-Q).
10.22 ML & Co. 1996 Deferred Compensation Plan for a
Select Group of Eligible Employees (Exhibit
10(i) to 10-Q for the quarter ended September
29, 1995 ("3rd Quarter 1995 10-Q")).
10.23 ML & Co. 1997 Deferred Compensation Plan for a
Select Group of Eligible Employees (Exhibit
10(xxvii) to 1996 10-K).
10.24 ML & Co. 1997 KECALP Deferred Compensation Plan
for a Select Group of Eligible Employees (Ex-
hibit 10(i) to 10-Q for the quarter ended June
27, 1997).
10.25 ML & Co. Deferred Unit and Stock Unit Plan for
Non-Employee Directors (Exhibit 10(iv) to 3rd
Quarter 1996 10-Q).
10.26 ML & Co. Long-Term Incentive Compensation Plan
for Managers and Producers (Exhibit 10(xxx) to
1996 10-K).
10.27 Executive Annuity Agreement dated as of January
27, 1997 by and between ML & Co. and David H.
Komansky (Exhibit 10(xxxi) to 1996 10-K).
10.28 Amendment dated September 18, 1996 to Deferred
Compensation Plans (amending the Amended and
Restated 1994 Deferred Compensation Agreement
for a Select Group of Eligible Employees, the ML
& Co. 1995 Deferred Compensation Plan for a
Select Group of Eligible Employees, and the ML &
Co. 1996 Deferred Compensation Plan for a Select
Group of Eligible Employees) (Exhibit 10(xxxii)
to 1996 10-K).
10.29 ML & Co. 1998 Deferred Compensation Plan for a
Select Group of Eligible Employees (Exhibit
10(i) to 10-Q for the quarter ended September
26, 1997 (the "3rd Quarter 1997 10-Q")).
10.30 ML & Co. Program for the Deferral of Stock
Option Gains for a Select Group of Eligible
Employees (Exhibit 10(iv) to 3rd Quarter 1997
10-Q).
*10.31 Amendment dated February 12, 1998 to the ML &
Co. Deferred Compensation Plans for a Select
Group of Eligible Employees for the years 1994,
1995, 1996, and 1997.
*10.32 Amendment dated February 12, 1998 to the ML &
Co. Deferred Restricted Unit Plan for Executive
Officers.
*11. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS.
*12. STATEMENT RE COMPUTATION OF RATIOS.
13. 1997 ANNUAL REPORT TO STOCKHOLDERS.
This document constitutes an Annual Report to Stockholders as required
by Rule 14a-3 of the Exchange Act and an Annual Report on Form 10-K
required to be filed pursuant to Section 13 or 15(d) of the Exchange
Act. This Annual Report to Stockholders has been filed with the SEC as
the Annual Report to Stockholders on Form 10-K accompanied by the
required Form 10-K cover page and Cross Reference Index which is
included herewith for convenience.
*21. SUBSIDIARIES OF ML & CO.
*23. CONSENT OF INDEPENDENT AUDITORS.
*27. FINANCIAL DATA SCHEDULE.
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*Filed herewith.