SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 29, 2002
Commission File Number 1-7182
MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-2740599
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(State of incorporation) (I.R.S. Employer Identification No.)
4 World Financial Center
New York, New York 10080
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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Registrant's telephone number, including area code
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
858,498,800 shares of Common Stock and 4,172,969 Exchangeable Shares as of the
close of business on May 3, 2002. The Exchangeable Shares, which were issued by
Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland
Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one
basis and entitle holders to dividend, voting, and other rights equivalent to
Common Stock.
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
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MERRILL LYNCH & Co., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
FOR THE THREE MONTHS ENDED
-----------------------------
MAR. 29, MAR. 30, PERCENT
(in millions, except per share amounts) 2002 2001 INC. (DEC.)
------- ------- ----------
NET REVENUES
Commissions $ 1,229 $ 1,505 (18.3)%
Principal transactions 877 1,717 (48.9)
Investment banking
Underwriting 478 652 (26.7)
Strategic advisory 183 284 (35.6)
Asset management and portfolio service fees 1,293 1,379 (6.2)
Other 219 164 33.5
------- -------
Subtotal 4,279 5,701 (24.9)
------- -------
Interest and dividend revenues 3,284 6,233 (47.3)
Less interest expense 2,473 5,524 (55.2)
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Net interest profit 811 709 14.4
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TOTAL NET REVENUES 5,090 6,410 (20.6)
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NON-INTEREST EXPENSES
Compensation and benefits 2,646 3,244 (18.4)
Communications and technology 474 598 (20.7)
Occupancy and related depreciation 238 270 (11.9)
Brokerage, clearing, and exchange fees 198 235 (15.7)
Advertising and market development 150 208 (27.9)
Professional fees 130 142 (8.5)
Office supplies and postage 69 96 (28.1)
Goodwill amortization - 52 (100.0)
Other 173 214 (19.2)
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TOTAL NON-INTEREST EXPENSES 4,078 5,059 (19.4)
------- -------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,012 1,351 (25.1)
Income tax expense 316 428 (26.2)
Dividends on preferred securities issued by subsidiaries 49 49 -
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NET EARNINGS $ 647 $ 874 (26.0)
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NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 638 $ 864 (26.2)
======= =======
EARNINGS PER COMMON SHARE
Basic $ 0.75 $ 1.04
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Diluted $ 0.67 $ 0.92
======= =======
DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16
======= =======
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 854.8 832.2
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Diluted 949.2 938.0
======= =======
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See Notes to Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 29, Dec. 28,
(dollars in millions) 2002 2001
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ASSETS
CASH AND CASH EQUIVALENTS $14,036 $ 11,070
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 5,702 4,467
SECURITIES FINANCING TRANSACTIONS
Receivables under resale agreements 70,764 69,702
Receivables under securities borrowed transactions 60,053 54,930
-------- --------
130,817 124,632
MARKETABLE INVESTMENT SECURITIES 72,379 77,820
TRADING ASSETS, AT FAIR VALUE
Contractual agreements 27,456 31,040
Corporate debt and preferred stock 17,863 18,134
Equities and convertible debentures 11,849 13,923
Mortgages, mortgage-backed, and asset-backed 13,205 11,184
U.S. Government and agencies 10,074 9,445
Municipals and money markets 3,277 5,306
Non-U.S. governments and agencies 5,701 3,851
-------- --------
89,425 92,883
SECURITIES PLEDGED AS COLLATERAL 11,489 12,084
-------- --------
SECURITIES RECEIVED AS COLLATERAL 2,952 3,234
-------- --------
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $69 in 2002 and $81 in 2001) 40,344 39,856
Brokers and dealers 12,520 6,868
Interest and other 8,421 8,226
-------- --------
61,285 54,950
-------- --------
INVESTMENTS OF INSURANCE SUBSIDIARIES 3,953 3,983
LOANS, NOTES, AND MORTGAGES (net of allowance for loan losses of $479 in 2002 and $425 in 2001) 21,603 19,005
OTHER INVESTMENTS 6,107 5,869
EQUIPMENT AND FACILITIES (net of accumulated depreciation and
amortization of $4,347 in 2002 and $4,910 in 2001) 3,069 2,873
GOODWILL (net of accumulated amortization of $914 in 2002 and $924 in 2001) 3,999 4,071
OTHER ASSETS 2,351 2,478
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TOTAL ASSETS $429,167 $419,419
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3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Mar. 29, Dec. 28,
(dollars in millions, except per share amount) 2002 2001
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LIABILITIES
SECURITIES FINANCING TRANSACTIONS
Payables under repurchase agreements $ 85,516 $ 74,895
Payables under securities loaned transactions 10,150 12,291
-------- --------
95,666 87,186
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 4,593 5,141
DEPOSITS 85,884 85,819
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 32,138 36,679
U.S. Government and agencies 18,860 18,674
Equities and convertible debentures 11,313 9,911
Non-U.S. governments and agencies 8,466 5,857
Corporate debt, municipals and preferred stock 5,123 4,796
-------- --------
75,900 75,917
-------- --------
OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 2,952 3,234
-------- --------
OTHER PAYABLES
Customers 29,693 28,704
Brokers and dealers 11,096 11,932
Interest and other 18,867 18,474
-------- --------
59,656 59,110
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 3,691 3,737
LONG-TERM BORROWINGS 77,267 76,572
-------- --------
TOTAL LIABILITIES 405,609 396,716
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,652 2,695
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY (42,500 shares issued, liquidation preference $10,000 per share) 425 425
-------- --------
COMMON STOCKHOLDERS' EQUITY
Shares exchangeable into common stock 62 62
Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares;
issued: 2002 - 971,745,911 shares; 2001 - 962,533,498 shares) 1,295 1,283
Paid-in capital 5,184 4,209
Accumulated other comprehensive loss (net of tax) (401) (368)
Retained earnings 16,649 16,150
-------- --------
22,789 21,336
Less: Treasury stock, at cost: 2002 - 115,699,188 shares; 2001 - 119,059,651 shares 986 977
Unamortized employee stock grants 1,322 776
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TOTAL COMMON STOCKHOLDERS' EQUITY 20,481 19,583
-------- --------
TOTAL STOCKHOLDERS' EQUITY 20,906 20,008
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES,
AND STOCKHOLDERS' EQUITY $429,167 $419,419
======== ========
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See Notes to Consolidated Financial Statements
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Three Months Ended
-----------------------------
(dollars in millions) Mar. 29, Mar. 30,
2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 647 $ 874
Noncash items included in earnings:
Depreciation and amortization 170 217
Policyholder reserves 46 47
Goodwill amortization - 52
Amortization of stock-based compensation 176 158
Deferred taxes 218 140
Other 656 166
Changes in operating assets and liabilities (a):
Trading assets and securities pledged as collateral 3,585 (10,677)
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations (1,235) 464
Receivables under resale agreements (1,062) 15
Receivables under securities borrowed transactions (5,123) (9,572)
Customer receivables (487) 2,131
Brokers and dealers receivables (5,652) 5,038
Trading liabilities (17) 10,214
Payables under repurchase agreements 10,621 4,256
Payables under securities loaned transactions (2,141) (4,416)
Customer payables 989 1,469
Brokers and dealers payables (836) 3,994
Other, net 812 (1,996)
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Cash provided by operating activities 1,367 2,574
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 6,864 7,300
Sales of available-for-sale securities 7,146 4,502
Purchases of available-for-sale securities (9,875) (21,689)
Maturities of held-to-maturity securities 74 239
Purchases of held-to-maturity securities (185) (249)
Loans, notes, and mortgages (2,661) (57)
Other investments and other assets 77 (536)
Equipment and facilities (365) (235)
------- --------
Cash provided by (used for) investing activities 1,075 (10,725)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (548) (2,099)
Deposits 65 10,281
Issuance and resale of long-term borrowings 9,214 10,884
Settlement and repurchases of long-term borrowings (8,149) (8,191)
Issuance of common stock 99 -
Issuance of treasury stock 2 256
Other common stock transactions (10) (346)
Dividends (149) (143)
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Cash provided by financing activities 524 10,642
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Increase in cash and cash equivalents 2,966 2,491
Cash and cash equivalents, beginning of year 11,070 23,205
------- --------
Cash and cash equivalents, end of period $14,036 $ 25,696
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 41 $ 89
Interest 2,091 5,804
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(a) Net of effects of acquisitions and divestitures.
See Notes to Consolidated Financial Statements
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 29, 2002
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NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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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. The December 28, 2001
unaudited Consolidated Balance Sheet was derived from the audited financial
statements. The interim consolidated financial statements for the three-month
periods are unaudited; however, in the opinion of Merrill Lynch management, all
adjustments necessary for a fair statement of the consolidated financial
statements have been included.
These unaudited consolidated financial statements should be read in conjunction
with the audited consolidated financial statements included in Merrill Lynch's
Annual Report included as an exhibit to Form 10-K for the year ended December
28, 2001. The nature of Merrill Lynch's business is such that the results of any
interim period are not necessarily indicative of results for a full year.
Certain reclassifications have been made to prior period financial statements,
where appropriate, to conform to the current period presentation.
New Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board ("FASB") released SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for the disposal of a
segment of the business as previously defined in that opinion. SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements"
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. SFAS No. 144 provides guidance on the financial
accounting and reporting for the impairment or disposal of long-lived assets.
Merrill Lynch adopted the provisions of SFAS No. 144 in the first quarter of
2002. The impact upon adoption was not material.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, intangible assets with indefinite lives and
goodwill will no longer be amortized. Instead, these assets will be tested
annually for impairment. Merrill Lynch adopted the provisions of SFAS No. 142 at
the beginning of fiscal year 2002.
SFAS No. 142 requires that Merrill Lynch perform an assessment of whether there
is an indication that goodwill is impaired as of the date of adoption. This test
is required to be completed within six months of the date of adoption. If an
indication of impairment exists, quantification of the impairment is required to
be completed as soon as possible, but no later than the end of the year. Any
resulting impairment loss, as measured on the first day of fiscal year 2002,
will be recognized as the cumulative effect of a change in accounting principle
in Merrill Lynch's statement of earnings upon adoption and will require a
restatement of the first quarter 2002 results. Amortization expense related to
goodwill totaled $52 million in the first quarter of 2001. Excluding this
amortization expense, net earnings, basic earnings per share and diluted
earnings per share would have been $909 million, $1.08 per share, and $0.96 per
share, respectively in the first quarter of 2001.
6
Derivatives
Merrill Lynch's policies relating to derivatives are discussed fully in the
portion of Merrill Lynch's Annual Report included as an exhibit to Form 10-K for
the year ended December 28, 2001. For the three-month periods ended March 29,
2002 and March 30, 2001, $8 million and $196 million, respectively, of net gains
related to non-U.S. dollar hedge investments on non-U.S. dollar subsidiaries
were included in "Accumulated other comprehensive loss" on the Consolidated
Balance Sheet. These amounts were principally offset by net losses on these
investments.
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NOTE 2. OTHER SIGNIFICANT EVENTS
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Restructuring and Other Charges
During the fourth quarter of 2001, Merrill Lynch's management formally committed
to a restructuring plan designed to position Merrill Lynch for improved
profitability and growth which included the resizing of selected businesses and
other structural changes. As a result, Merrill Lynch incurred a fourth quarter
pre-tax charge to earnings of $2.2 billion, which included restructuring costs
of $1.8 billion and other one-time charges of $396 million. The one-time charges
primarily related to write-offs which were completed in 2001. In addition, a
charge to deferred tax expense was recorded related to losses of the Private
Client operations in Japan that will not be utilized during the carry forward
period.
Restructuring Charge
Restructuring charges related primarily to severance costs of $1.1 billion,
facilities costs of $299 million, technology and fixed asset write-offs of $187
million and other costs of $178 million. Structural changes included targeted
workforce reductions of approximately 6,200 through a combination of involuntary
and voluntary separations across all business groups. At December 28, 2001 the
majority of employee separations were completed or announced, and all had been
identified. The $1.1 billion of severance costs included non-cash charges
related to accelerated stock amortization for stock grants associated with
employee separations totaling $135 million. Facilities-related costs include the
closure or subletting of excess space, and the consolidation of Private Client
offices in the United States, Europe, Asia Pacific and Japan. Management expects
both the remaining branch closings and employee separations to be completed in
2002 and anticipates that substantially all of the cash payments related to real
estate and severance will be funded by cash from operations. Asset write-offs
primarily reflected the write-off of technology assets and furniture and
equipment which resulted from management's decision to close Private Client
branch offices. Utilization of the restructuring reserve at March 29, 2002 is as
follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------------
Utilized in Utilized in Balance
Initial Balance 2001 2002 Mar. 29, 2002
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Category:
- - Severance costs $ 1,133 $ (214) $ (611) $ 308
- - Facilities costs 299 - (16) 283
- - Technology and fixed asset write-offs 187 (187) - -
- - Other Costs 178 - (48) 130
------- ------ ------- -----
$ 1,797 $ (401) $ (675) $ 721
------- ------ ------- -----
Head Count 6,205 (749) (4,986) 470
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7
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NOTE 3. SHORT-TERM BORROWINGS
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Short-term borrowings at March 29, 2002 and December 28, 2001 are presented
below:
(dollars in millions)
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Mar. 29, Dec. 28,
2002 2001
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COMMERCIAL PAPER AND OTHER SHORT-TERM
BORROWINGS
Commercial paper $ 2,675 $ 2,950
Other 1,918 2,191
------- -------
Total $ 4,593 $ 5,141
======= =======
DEPOSITS
U.S. $72,985 $73,555
Non-U.S. 12,899 12,264
------- -------
Total $85,884 $85,819
======= =======
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8
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NOTE 4. SEGMENT INFORMATION
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In reporting to management, Merrill Lynch's operating results are categorized
into three business segments: Global Markets and Investment Banking ("GMI"), the
Private Client Group ("Private Client") and Merrill Lynch Investment Managers
("MLIM"). Beginning in the first quarter of 2002, GMI's results include income
generated by the investment portfolio of Merrill Lynch's U.S. banks which was
previously recorded in the Private Client segment. In addition, MLIM's results
now include a share of the income generated from the assets under management in
money market funds sold through Private Client. Previously, this income was
recorded entirely in Private Client. The Private Client business will continue
to earn a spread for selling the funds, while revenues and expenses associated
with management of the funds are recorded in MLIM. Prior period amounts have
been restated to conform to the current period presentation. For information on
each segment's activities, see the portions of the 2001 Annual Report included
as an exhibit to Form 10-K.
Operating results by business segment follow:
(dollars in millions)
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Private Corporate
Three Months Ended GMI Client MLIM Items Total
March 29, 2002 -------- -------- ------ --------- --------
Non-interest revenues $ 1,943 $ 1,907 $ 474 $ (45) (1) $ 4,279
Net interest income(2) 487 336 6 (18) (3) 811
-------- ------- ------ ------ --------
Net revenues 2,430 2,243 480 (63) 5,090
Non-interest expenses 1,772 1,988 363 (45) (1) 4,078
-------- ------- ------ ------ --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 658 $ 255 $ 117 $ (18) $ 1,012
======== ======= ====== ====== ========
Quarter-end total assets $371,911 $51,189 $2,063 $4,004 $429,167
======== ======= ====== ====== ========
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Private Corporate
GMI Client MLIM Items Total
-------- ------- ------ --------- --------
Three Months Ended
March 30, 2001
Non-interest revenues $ 2,989 $ 2,234 $ 562 $ (84) (1) $ 5,701
Net interest income(2) 342 385 4 (22) (3) 709
-------- ------- ------ ------ --------
Net revenues 3,331 2,619 566 (106) 6,410
Non-interest expenses 2,267 2,335 472 (15) (4) 5,059
-------- ------- ------ ------ --------
Earnings (loss) before income taxes
and dividends on preferred securities
issued by subsidiaries $ 1,064 $ 284 $ 94 $ (91) $ 1,351
======== ======= ====== ====== ========
Quarter-end total assets $366,692 $58,166 $2,532 $4,214 $431,604
======== ======= ====== ====== ========
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(1) Primarily represents the elimination of intersegment revenues and expenses.
(2) Management views interest income net of interest expense in evaluating
results.
(3) Represents Mercury financing costs.
(4) Represents goodwill amortization of $52 million, net of elimination of
intersegment expenses of $67 million.
9
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NOTE 5. COMPREHENSIVE INCOME
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The components of comprehensive income are as follows:
(dollars in millions)
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Three Months Ended
-----------------------
Mar. 29, Mar. 30,
2002 2001
------- -------
Net earnings $647 $874
---- ----
Other comprehensive income (loss), net of tax:
Currency translation adjustment (15) 38
Net unrealized gain (loss) on investment
securities available-for-sale 17 (1)
Deferred gain (loss) on cash flow hedges (35) 21
---- ----
Total other comprehensive income (loss), net of tax (33) 58
---- ----
Comprehensive income $614 $932
==== ====
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NOTE 6. EARNINGS PER COMMON SHARE
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Information relating to earnings per common share computations follows:
(dollars in millions)
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Three Months Ended
-----------------------
Mar. 29, Mar. 30,
2002 2001
-------- --------
Net earnings $ 647 $ 874
Preferred stock dividends 9 10
-------- --------
Net earnings applicable to
common stockholders $ 638 $ 864
======== ========
(shares in thousands)
Weighted-average shares outstanding 854,815 832,195
-------- --------
Effect of dilutive instruments(1) (2):
Employee stock options 45,023 64,379
Financial Advisor Capital
Accumulation Award Plan shares 24,913 27,688
Restricted shares and units 24,372 13,587
Employee Stock Purchase Plan shares 114 105
-------- --------
Dilutive potential common shares 94,422 105,759
-------- --------
Total weighted-average diluted shares 949,237 937,954
======== ========
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Basic earnings per common share $ 0.75 $ 1.04
Diluted earnings per common share $ 0.67 $ 0.92
- --------------------------------------------------------------------
(1) During the 2002 and 2001 first quarter there were 69 million and 39 million
instruments, respectively, that were considered antidilutive and not
included in the above computations.
(2) See Note 14 to Consolidated Financial Statements in the 2001 Annual Report
included as an exhibit to Form 10-K for a description of these instruments.
10
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NOTE 7. COMMITMENTS AND OTHER CONTINGENCIES
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Merrill Lynch enters into commitments to extend credit, predominantly at
variable interest rates, in connection with corporate finance and loan
syndication transactions. Customers may also be extended loans or lines of
credit collateralized by first and second mortgages on real estate, certain
liquid assets of small businesses, or securities. Merrill Lynch also issues
various guarantees to counterparties in connection with certain leasing,
securitization, and other transactions. These commitments and guarantees usually
have a fixed expiration date and are contingent on certain contractual
conditions that may require payment of a fee by the counterparty. Once
commitments are drawn upon or guarantees are issued, Merrill Lynch may require
the counterparty to post collateral depending upon creditworthiness and market
conditions.
The contractual amounts of these commitments and guarantees represent the
amounts at risk should the contract be fully drawn upon, the client defaults,
and the value of the existing collateral becomes worthless. The total amount of
outstanding commitments and guarantees may not represent future cash
requirements, as commitments and guarantees may expire without being drawn upon.
At March 29, 2002 and December 28, 2001, Merrill Lynch had the following
commitments and guarantees with commitment expirations as follows:
(dollars in millions)
- -----------------------------------------------------------------------------------------------
Mar. 29, Dec. 28,
2002 2001
- -----------------------------------------------------------------------------------------------
Commitments to extend credit $24,288 (1) $17,833 (1)
Third-party guarantees 208 316
SPE-related commitments 11,463 12,647
- -----------------------------------------------------------------------------------------------
(1) Approximately $10.1 billion and $5.4 billion, respectively, relates to
secured lending activities.
SPE-related commitments include liquidity facilities and default protection to
investors in securities issued by Special Purpose Entities ("SPEs") totaling $11
billion and $12 billion at March 29, 2002 and December 28, 2001, respectively.
The fair value of these commitments approximates zero as of March 29, 2002 as
these positions are significantly overcollateralized. Merrill Lynch also
provides guarantees to holders of notes issued by SPEs relating to the residual
value of property and equipment lease assets held by the SPEs.
The commitments to extend credit are comprised of commercial paper back-up lines
of credit, syndicated loans, mortgages and other institutional and retail
commitments to extend credit. The commitments do not include any amounts for
commitments related to margin lending.
As of March 29, 2002, Merrill Lynch has been named as party in various actions,
some of which involve claims for substantial amounts. Although the results of
legal actions cannot be predicted with certainty, it is the opinion of
management that the resolution of these actions will not have a material adverse
effect on the financial position of Merrill Lynch as set forth in the
Consolidated Financial Statements, but may be material to Merrill Lynch's
operating results for any particular period.
11
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NOTE 8. REGULATORY REQUIREMENTS
- --------------------------------------------------------------------------------
Certain U.S. and non-U.S. subsidiaries are subject to various securities,
banking and insurance regulations and capital adequacy requirements promulgated
by the regulatory and exchange authorities of the countries in which they
operate. Merrill Lynch's principal regulated subsidiaries are discussed below.
Securities Regulation
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a U.S. registered
broker-dealer and futures commission merchant, is subject to the net capital
requirements of Rule 15c3-1 under the Securities Exchange Act of 1934 and
capital requirements of the Commodities Futures Trading Commission ("CFTC").
Under the alternative method permitted by Rule 15c3-1, the minimum required net
capital, as defined, shall not be less than 2% of aggregate debit items ("ADI")
arising from customer transactions. The CFTC also requires that minimum net
capital should not be less than 4% of segregated and secured requirements. At
March 29, 2002, MLPF&S's regulatory net capital of $2,784 million was
approximately 15% of ADI, and its regulatory net capital in excess of the
minimum required was $2,411 million at 2% of ADI.
Merrill Lynch International ("MLI"), a U.K. registered broker-dealer, is subject
to capital requirements of the Financial Services Authority ("FSA"). Financial
resources, as defined, must exceed the total financial resources requirement of
the FSA. At March 29, 2002, MLI's financial resources were $4,825 million,
exceeding the minimum requirement by $889 million.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities, is subject to the capital adequacy requirements of the
Government Securities Act of 1986. This rule requires dealers to maintain liquid
capital in excess of market and credit risk, as defined, by 20% (a 1.2-to-1
capital-to-risk standard). At March 29, 2002, MLGSI's liquid capital of $1,354
million was 218% of its total market and credit risk, and liquid capital in
excess of the minimum required was $607 million.
Banking Regulation
Two of the subsidiaries of ML & Co., Merrill Lynch Bank USA ("MLBUSA"), and
Merrill Lynch Bank & Trust Co. ("MLB&T") are each subject to certain minimum
aggregate capital requirements under applicable federal banking laws. Among
other things, Part 325 of the FDIC Regulations establishes levels of Risk-Based
Capital ("RBC") each institution must maintain and identifies the possible
actions the federal supervisory agency may take if a bank does not maintain
certain capital levels. RBC is defined as the ratios of (i) Tier I Capital or
Total Capital to (ii) average assets or risk-weighted assets. The following
table presents the actual capital ratios and amounts, for MLBUSA and MLB&T at
March 29, 2002 and December 28, 2001.
12
As shown below, MLBUSA and MLB&T each exceed the minimum bank regulatory
requirement for classification as a well-capitalized bank for Tier 1 leverage --
5%, Tier 1 capital -- 6% and Total capital -- 10%:
- ------------------------------------------------------------------------------------
(dollars in millions)
- ------------------------------------------------------------------------------------
Mar. 29, 2002 Dec. 28, 2001
---------------------------------------------
Actual Actual
Ratio Amount Ratio Amount
- ------------------------------------------------------------------------------------
TIER 1 LEVERAGE
(TO AVERAGE ASSETS)
MLBUSA 5.49% $3,577 5.61% $3,576
MLB&T 6.45 973 6.90 1,047
TIER 1 CAPITAL
(TO RISK-WEIGHTED ASSETS)
MLBUSA 13.81 3,577 14.30 3,576
MLB&T 17.72 973 20.47 1,047
TOTAL CAPITAL
(TO RISK-WEIGHTED ASSESTS)
MLBUSA 15.06 3,902 15.44 3,860
MLB&T 17.74 974 20.48 1,048
- ------------------------------------------------------------------------------------
In April 2001, MLBUSA entered into a synthetic securitization of specified
reference portfolios of asset-backed securities ("ABS") owned by the institution
totaling in aggregate up to $20 billion. This synthetic securitization remained
effective as of March 29, 2002. All of the ABS in the reference portfolios were
rated AAA and all were further insured as to principal and interest payments by
an insurer rated AAA. This synthetic securitization allows MLBUSA to reduce the
credit risk on the respective reference portfolios by means of credit default
swaps with a bankruptcy remote SPE. In turn, the SPE issued a $20 million credit
linked note to unaffiliated buyers. This transaction resulted in reducing
MLBUSA's risk-weighted assets as of March 29, 2002 and December 28, 2001. MLBUSA
retained a first risk of loss equity tranche of $1 million in the transaction.
As a result of the April 2001 transaction, MLBUSA was able to reduce
risk-weighted assets by $233 million at March 29, 2002, thereby increasing its
Tier I and Total RBC ratios by 13 basis points and 14 basis points,
respectively.
13
INDEPENDENT ACCOUNTANTS' REPORT
-------------------------------
To the Board of Directors and Stockholders of
Merrill Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of March 29,
2002, and the related condensed consolidated statements of earnings for the
three-month periods ended March 29, 2002 and March 30, 2001, and the condensed
consolidated statements of cash flows for the three-month periods ended March
29, 2002 and March 30, 2001. These financial statements are the responsibility
of Merrill Lynch's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Merrill Lynch as of December 28, 2001, and the related consolidated statements
of earnings, changes in stockholders' equity, comprehensive income and cash
flows for the year then ended (not presented herein); and in our report dated
February 25, 2002, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 28, 2001 is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ Deloitte & Touche LLP
New York, NY
May 10, 2002
14
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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. The financial services industry, in which Merrill Lynch is a
leading participant, is highly competitive and highly regulated. This industry
and the global financial markets are influenced by numerous uncontrollable
factors. These factors include economic conditions, monetary and fiscal
policies, the liquidity of global markets, international and regional political
events, regulatory developments, the competitive environment, and investor
sentiment. In addition to these factors, Merrill Lynch and other financial
services companies may be affected by the outcome of legal and regulatory
proceedings, including those described in Part II Item 1. Legal Proceedings.
These conditions or events can significantly affect the volatility of financial
markets and the order flow and revenues in businesses such as brokerage and
trading.
The financial services industry continues to be affected by the
intensifying competitive environment, as demonstrated by consolidation
through mergers and acquisitions and competition from new entrants as well
as established competitors using the Internet or other technology to
establish or expand their businesses, and diminishing margins in many
mature products and services. The Gramm-Leach-Bliley Act, passed in 1999,
which repealed laws that separated commercial banking, investment banking
and insurance activities, together with changes to the industry resulting
from previous reforms, has increased the number of companies competing for
a similar customer base.
Certain statements contained in this Report may constitute forward-looking
statements, including, for example, statements about management expectations,
strategic objectives, business prospects, anticipated expense savings and
financial results, anticipated results of litigation and regulatory proceedings,
and other similar matters. These forward-looking statements are not statements
of historical facts and represent only Merrill Lynch's beliefs regarding future
events, which are inherently uncertain. There are a variety of factors, many of
which are beyond Merrill Lynch's control, which affect its operations,
performance, business strategy and results and could cause its actual results
and experience to differ materially from the expectations and objectives
expressed in any forward-looking statements. These factors include, but are not
limited to, the factors listed in the previous two paragraphs, as well as
actions and initiatives taken by both current and potential competitors, the
effect of current, pending and future legislation and regulation both in the
United States and throughout the world, and the other risks detailed in Merrill
Lynch's 2001 Form 10-K and in this Form 10-Q. Accordingly, readers are cautioned
not to place undue reliance on forward-looking statements, which speak only as
of the date on which they are made. Merrill Lynch does not undertake to update
forward-looking statements to reflect the impact of circumstances or events that
arise after the date the forward-looking statement was made. The reader should,
however, consult any further disclosures of a forward-looking nature Merrill
Lynch may make in its Annual Reports on Form 10-K, its Quarterly Reports on Form
10-Q and its Current Reports on Form 8-K.
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Global financial market conditions were not meaningfully improved from
fourth quarter 2001 levels. Global debt underwriting volume increased
moderately as investors continued to show interest in fixed-income
investments. Global merger and acquisition volume continued to be
depressed, reaching a seven-year low in the 2002 first quarter. The
economic outlook remains uncertain as the fear of higher interest rates and
weak corporate earnings, coupled with concerns involving the quality of
those earnings, continue to adversely affect the markets.
Long-term U.S. interest rates, as measured by the yield on the 10-year U.S.
Treasury bond, rose from 5.02% to 5.39% during the quarter. The U.S.
Federal Reserve Bank kept the federal funds rate and the discount rate
unchanged during the 2002 first quarter. Credit spreads, which represent
the risk premium over the risk-free rate paid by an issuer (based on the
issuer's perceived creditworthiness), widened slightly for highly-rated
counterparties and narrowed for lower-rated counterparties during the 2002
first quarter.
15
U.S. equity indices were mixed during the first quarter of 2002. The Dow
Jones Industrial Average gained 3.8% from year-end 2001 and 6.2% since the
year ago quarter, as cyclical and consumer stocks improved. The Nasdaq
Composite Index, however, declined 5.4% during the quarter but advanced
1.4% from the 2001 first quarter. The decrease in the quarter was the
result of a continuing slump in technology and telecommunications stocks,
which represent a significant percentage of this index. The S&P 500
remained virtually unchanged from the quarter and year ago levels.
The Dow Jones World Index, excluding the United States, gained a modest
1.5% from year-end 2001 as a steady stream of interest rate cuts around the
world during the past year had a favorable impact on global growth this
quarter, but was down 6.7% from the 2001 first quarter. In Japan, the
Nikkei 225 index rose 4.6% during the quarter, after a lackluster
performance in 2001. Emerging markets performed particularly well in the
quarter, as the South Korean composite index surged 29% and the Mexican
stock market gained 18%.
Global debt and equity issuance volumes rose 5% from the year-ago quarter
and 7% from the fourth quarter 2001, driven by increased debt issuances.
Global debt underwriting volume was up 7% from 2001 first quarter and 11%
from 2001 fourth quarter. In the United States, debt and equity issuance
volumes increased 14% from the first quarter of 2001 and 5% from year-end
2001, primarily driven by increases in debt underwriting. The U.S. equity
underwriting markets remained depressed, with only 17 companies registering
initial public offerings in the 2002 first quarter, down from an already
low 25 companies in the 2001 first quarter.
Merger and acquisition activity fell sharply in the first quarter of 2002
as a result of continued economic uncertainty. Global announced merger and
acquisition volume dropped 45% since the first quarter of 2001 and 31%
since the fourth quarter of 2001, according to Thomson Financial Securities
Data. Announced merger and acquisition volume in the United States sank
over 50% from both the first and fourth quarters of 2001.
Merrill Lynch continually evaluates its businesses for profitability and
performance under varying market conditions and, in light of the evolving
conditions in its competitive environment, for alignment with its long-term
strategic objectives. The strategy of maintaining long-term client
relationships, closely monitoring costs and risks, diversifying revenue
sources, and growing fee-based revenues all continue as objectives to
mitigate the effects of a volatile market environment on Merrill Lynch's
business as a whole.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
In the fourth quarter of 2001, Merrill Lynch recorded a pre-tax charge of $2.2
billion ($1.7 billion after-tax) related to the resizing of selected businesses
and other structural changes. This charge was recorded as Restructuring and
other charges on the Consolidated Statements of Earnings. The charge was the
result of a detailed review of all businesses, with a focus on improving profit
margins and aligning capacity with opportunities for future growth. These
actions were expected to result in pre-tax annual expense savings of
approximately $1.4 billion, a portion of which was to be reinvested in priority
growth initiatives. Merrill Lynch is on target to achieve these annual savings
in 2002.
16
Merrill Lynch has achieved the non-compensation savings related to the
fourth quarter 2001 charge more quickly than initially anticipated. On an
annualized basis, the impact of these savings on non-compensation expenses
is approximately 40% of total savings, which is in line with expectations.
Opportunities exist to reduce non-compensation expenses further, although
much of the savings realized going forward will be reinvested into growth
initiatives. For the first quarter of 2002, non-compensation expenses
declined $383 million, or 21% from the year-ago quarter, primarily
reflecting actions taken throughout the past year to reduce costs, in
particular the fourth quarter restructuring. Reductions were achieved in
all categories of expense. Approximately $52 million of the reduction was
attributable to the elimination of goodwill amortization (see Note 1, New
Accounting Pronouncements for additional information). For further
information regarding the details of restructuring and other charges see
Note 2 to the Consolidated Financial Statements.
Merrill Lynch remains cautious about the near-term market outlook. Although
the equity markets showed some initial signs of recovery in the first
quarter of 2002 as the trend towards de-leveraging accelerates, Merrill
Lynch continues to believe it is unlikely that fixed income markets will be
as favorable in 2002 as they were in 2001 when the Federal Reserve cut
interest rates eleven times. Subsequent to quarter-end, the financial
services industry is experiencing higher financing premiums, which if
sustained, could adversely impact net interest revenue.
- ----------------------------------------------------------------------------------------
For the Three Months Ended
-----------------------------------
Mar. 29, Dec. 28, Mar. 30,
(dollars in millions, except per share amounts) 2002 2001 2001
- ----------------------------------------------------------------------------------------
Total revenues $7,563 $7,574 $11,934
Net revenues 5,090 4,752 6,410
Pre-tax earnings (loss) 1,012 (1,512) (1) 1,351
Net earnings (loss) 647 (1,264) (1) 874
Earnings (loss) per common share:
Basic 0.75 (1.51) (1) 1.04
Diluted 0.67 (1.51) (1) 0.92
Annualized return on average common
stockholders' equity 12.7% N/M (1) 18.4%
Pre-tax profit margin 19.9 N/M (1) 21.1
- ----------------------------------------------------------------------------------------
(1) Results for the fourth quarter of 2001 include September 11th-related
expenses ($43 million pre-tax and $30 million after-tax) and
restructuring and other charges ($2,193 million pre-tax and $1,725 million
after-tax) in 2001. Excluding these amounts, pre-tax earnings were $724
million, net earnings were $491 million, basic and diluted earnings per
share were $0.57 and $0.51, respectively, annualized return on average
common equity was 9.2% and the pre-tax profit margin was 15.2% in the 2001
fourth quarter.
Merrill Lynch's net earnings were $647 million for the 2002 first quarter, 26%
lower than the $874 million reported in the first quarter of 2001. Earnings
per common share were $0.75 basic and $0.67 diluted, compared with $1.04 basic
and $0.92 diluted in the 2001 first quarter.
Net revenues were $5.1 billion, 21% lower than the 2001 first quarter.
Non-compensation expenses were 21% lower than the year-ago quarter.
The pre-tax profit margin for the quarter was 19.9%, compared with 21.1% in
the first quarter of 2001. The first quarter return on average common
stockholders equity was 12.7% compared with 18.4% in the first quarter of
2001.
17
- --------------------------------------------------------------------------------
BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
Merrill Lynch reports its results in three business segments: Global Markets
and Investment Banking ("GMI"), the Private Client Group ("Private Client"),
and Merrill Lynch Investment Managers ("MLIM"). GMI provides investment
banking and capital markets services to corporate, institutional, and
governmental clients around the world. Private Client provides global wealth
management services and products to individuals, small- to mid-size
businesses, and employee benefit plans. MLIM provides investment management
services to retail and institutional clients.
Certain MLIM and GMI products are distributed through Private Client
distribution channels, and, to a lesser extent, certain MLIM products are
distributed through GMI. Revenues and expenses associated with these
intersegment activities are recognized in each segment and eliminated at the
corporate level. In addition, revenue and expense sharing agreements for
shared activities between segments are in place and the results of each
segment reflect the agreed-upon portion of these activities. The following
segment results represent the information that is relied upon by management in
its decision-making processes. These results exclude items reported in the
Corporate segment. Business segment results are restated to reflect
reallocations of revenues and expenses which result from changes in Merrill
Lynch's business strategy and structure.
- --------------------------------------------------------------------------------
GLOBAL MARKETS AND INVESTMENT BANKING
- --------------------------------------------------------------------------------
GMI'S RESULTS OF OPERATIONS
-------------------------------------------------------------------
For the Three Months Ended
------------------------------------
Mar. 29, Mar. 30, % Inc.
(dollars in millions) 2002 2001 (Dec.)
- --------------------------------------------------------------------
Commissions $ 545 $ 611 (11)%
Principal transactions and
net interest profit 1,110 1,772 (37)
Investment banking 603 825 (27)
Other revenues 172 123 40
------ ------
Total net revenues $2,430 $3,331 (27)
------ ------
Pre-tax earnings $ 658 $1,064 (38)
------ ------
Pre-tax profit margin 27.1% 31.9%
- --------------------------------------------------------------------
GMI faced continued difficult market conditions in the first quarter. For the
industry as a whole, global announced merger and acquisition volumes were the
lowest since the second quarter of 1995, and global equity origination
activity remained subdued. As a result, GMI's revenues declined from the
particularly strong 2001 first quarter, which included a gain related to the
sale of certain energy-trading assets. Disciplined expense management limited
the decline in margins from year-ago levels.
GMI's pre-tax earnings were $658 million, 38% lower than the year-ago quarter.
The first quarter 2001 results included $84 million from the energy-trading
business. Net revenues for the first quarter were $2.4 billion, 27% below the
first quarter of 2001. Reductions in non-interest expenses of $495 million
from the year-ago quarter limited the impact of the revenue decline on
profitability, and resulted in a pre-tax margin of 27.1%, compared with 31.9%
in the 2001 first quarter.
CLIENT FACILITATION AND TRADING
Commissions
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, money market instruments, options and
commodities. In addition, in late 2001 Merrill Lynch instituted a program
for providing enhanced brokerage services to its customers with large size
Nasdaq orders in exchange for an agreed upon commission in lieu of the
traditional spread. Nearly 75% of Nasdaq institutional client trades are
now done on an agency, rather than a principal, basis.
Commissions revenues decreased 11% to $545 million in the first quarter of
2002, compared to the year-ago quarter as a result of a global decline in
equity trading volumes.
18
Principal transactions and net interest profit
- ----------------------------------------------------------------------
For the Three Months Ended
----------------------------------
Mar. 29, Mar. 30, % Inc.
(dollars in millions) 2002 2001 (Dec.)
- ----------------------------------------------------------------------
Debt and debt derivatives $ 705 $1,054 (33)%
Equities and equity derivatives 405 718 (44)
------ ------
Total $1,110 $1,772 (37)
- ----------------------------------------------------------------------
Principal transactions and net interest profit include realized gains and
losses from the purchase and sale of securities in which Merrill Lynch acts
as principal and unrealized gains and losses on trading assets and
liabilities. In addition, principal transactions and net interest profit
includes unrealized gains related to equity investments held by Merrill
Lynch's broker-dealers as well as unrealized gains and losses on marketable
investment securities, classified as trading securities, held by Merrill
Lynch's U.S. banks. Changes in the composition of trading inventories and
hedge positions can cause principal transactions and net interest profit to
fluctuate.
Net interest profit is a function of the level and mix of total assets and
liabilities, including financial instruments owned, repurchase and reverse
repurchase agreements, trading strategies associated with GMI's
institutional securities business, and the prevailing level, term
structure, and volatility of interest rates. Net interest profit is an
integral component of trading activity. Beginning in the first quarter of
2002, GMI's net interest profit included income generated by the investment
portfolio of Merrill Lynch's U.S. banks which was previously recorded in
the Private Client segment. This change follows a transfer in
responsibility for this activity, which was made to better align functional
and management responsibilities. The prior year segment results have been
restated to reflect this change. In assessing the profitability of its
client facilitation and trading activities, Merrill Lynch views net
interest profit and principal transactions in the aggregate.
Net trading revenues, which include principal transactions and net interest
profit, were $1.1 billion in the first quarter of 2002, down 37% from $1.8
billion in the first quarter of 2001. Debt and debt derivatives net trading
revenues were $705 million, down 33% from the first quarter of 2001,
reflecting lower debt and debt derivatives trading revenues from the
particularly strong year-ago quarter and declines in the market value of
selected credit positions. The 2001 results included the gain on the sale
of certain energy-trading assets. Equities and equity derivatives net
trading revenues decreased 44% from the first quarter of 2001 to $405
million, primarily due to reduced global transaction volumes. These
revenues include unrealized gains related to equity investments held by a
Merrill Lynch broker-dealer.
- --------------------------------------------------------------------------------
Investment Banking
- ----------------------------------------------------------------------
For the Three Months Ended
--------------------------
Mar. 29, Mar. 30, % Inc.
(dollars in millions) 2002 2001 (Dec.)
- ---------------------------------------------------------------------
Debt underwriting $129 $255 (49)%
Equity underwriting 291 286 2
---- ----
Total underwriting 420 541 (22)
Strategic advisory services 183 284 (36)
---- ----
Total $603 $825 (27)
- -------------------------------------------------------------------------
Underwriting
- ------------
Underwriting revenues represent fees earned from the underwriting of debt and
equity and equity-linked securities as well as loan syndication and commitment
fees.
19
Underwriting revenues were $420 million, down 22% from the $541 million
recorded in the first quarter of 2001. This decline was primarily the result
of a 49% decrease in debt underwriting revenues from the year-ago quarter due
to a lower volume of transactions. Merrill Lynch ranked second in global debt
underwriting in the first quarter of 2002 with an 8.7% market share. Equity
underwriting revenues of $291 million increased slightly from the first
quarter of 2001. In global equity and equity-linked underwriting Merrill Lynch
ranked second with a market share of 15.4% in the 2002 first quarter.
Merrill Lynch's underwriting market share information based on transaction
value follows:
- --------------------------------------------------------------------------------------------------------------
For the Three Months Ended
-----------------------------------------------------------
Mar. 2002 Mar. 2001
----------------------- -----------------------
Market Market
Share Rank Share Rank
-----------------------------------------------------------
GLOBAL PROCEEDS
Debt and equity 9.3% 2 12.4% 1
Debt 8.7 2 12.4 1
Equity and equity-linked 15.4 2 12.5 3
U.S. PROCEEDS
Debt and equity 11.4% 2 15.9% 1
Debt 10.6 2 15.7 1
Equity and equity-linked 21.1 2 19.5 2
- --------------------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
book manager.
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition
and other advisory fees, were $183 million in the first quarter of 2002,
down 36% from the first quarter of 2001 as a result of lower fees from
completed merger and acquisition transactions. Global announced merger and
acquisition industry volume was down 45% from the first quarter of 2001.
Merger and acquisition activity continues to be slow, and Merrill Lynch
believes that a recovery may lag an improvement in the equity markets as
corporate clients place near-term emphasis on rationalizing their balance
sheets and capital structures. Merrill Lynch's merger and acquisition
market share information based on transaction value follows:
- -----------------------------------------------------------------------------------------------------
For the Three Months Ended
-----------------------------------------------------------
Mar. 2002 Mar. 2001
--------------------- ----------------------
Market Market
Share Rank Share Rank
--------------------- ----------------------
COMPLETED TRANSACTIONS
Global 23.8% 3 37.1% 3
U.S. 21.8 5 50.5 3
ANNOUNCED TRANSACTIONS
Global 23.7% 2 18.8% 3
U.S. 13.1 6 21.5 4
- -----------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors.
Other Revenues
Other revenues, which include realized investment gains and losses and
distributions on a passive minority investment in a securities-related
business, increased 40% in the first quarter of 2002 from the year-ago
quarter, to $172 million. This year-over-year increase is primarily due to the
$45 million pre-tax gain on the sale of the Securities Pricing Services
business recorded in the first quarter of 2002.
20
- --------------------------------------------------------------------------------
PRIVATE CLIENT GROUP
- --------------------------------------------------------------------------------
PRIVATE CLIENT'S RESULTS OF OPERATIONS
- ------------------------------------------------------------------------
For the Three Months Ended
--------------------------
Mar. 29, Mar. 30, % Inc.
(dollars in millions) 2002 2001 (Dec.)
- ------------------------------------------------------------------------
Commissions $ 641 $ 863 (26)%
Principal transactions and
new issue revenues 314 394 (20)
Asset management and
portfolio service fees 894 913 (2)
Net interest profit 336 385 (13)
Other revenues 58 64 (9)
------ ------
Total net revenues $2,243 $2,619 (14)
------ ------
Pre-tax earnings $ 255 $ 284 (10)
------ ------
Pre-tax profit margin 11.4% 10.8%
- ------------------------------------------------------------------------
Private Client's pre-tax earnings were $255 million, 10% lower than the
2001 first quarter, on net revenues that were 14% lower, at $2.2 billion.
Private Client's first quarter 2002 pre-tax margin was 11.4%, compared to
10.8% in the year-ago quarter. First quarter 2002 revenues included a
residual pre-tax gain of $39 million related to the sale of the Canadian
Private Client business which was completed in December 2001. This gain was
more than offset by transitional expenses and provisions associated with
the refocusing of the Private Client business outside the United States and
the pending closure of the service center in Denver. Results for the first
quarter of 2001 included the Canadian and other Private Client businesses
outside the United States that were sold or re-sized last year as well as a
pre-tax gain of $30 million related to the sale of the mortgage servicing
business.
Private Client employed approximately 15,900 financial advisors at the end
of the 2002 first quarter, down from 16,400 at the end of 2001. The decline
is primarily the result of the staffing reductions associated with the
re-focusing of the Private Client business outside the United States on
serving high-net-worth clients.
Commissions
Commissions revenue primarily arises from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds,
insurance products, and options.
Commissions revenues declined 26% to $641 million in the first quarter of 2002
from $863 million in the first quarter of 2001 primarily due to a global
decline in client transaction volumes, particularly in mutual fund and equity
products.
Principal transactions and new issue revenues
Private Client's principal transactions and new issue revenues primarily
represent bid-offer revenues in over-the-counter equity securities, government
bonds and municipal securities as well as selling concessions on underwriting
of debt and equity products. Private Client does not take any significant
principal trading risk positions.
Principal transactions and new issue revenues declined 20% to $314 million in
the 2002 first quarter from the year-ago quarter, as trading and new issue
volume declined in a less favorable market environment.
21
Asset management and portfolio service fees
Asset management and portfolio service fees include asset management fees from
taxable and tax-exempt money market funds as well as portfolio fees from
fee-based accounts such as Unlimited Advantage(SM) and Merrill Lynch
Consults(R). Also included are servicing fees related to these accounts, as
well as account and other fees.
Asset management and portfolio service fees totaled $894 million, a decline of
2% from the first quarter of 2001, due primarily to a market-driven decline in
assets in asset-priced accounts.
An analysis of changes in assets in Private Client accounts from March 30,
2001 to March 29, 2002 is detailed below:
- -----------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------
Mar. 30, New Asset Mar. 29,
(dollars in billions) 2001 Money Depreciation Other 2002
- -----------------------------------------------------------------------------------------------------
Assets in Private Client accounts:
U.S. $ 1,254 $ 25 $ (97) $ (3) $ 1,179
Non-U.S. 131 10 (10) (35) 96
---------------------------------------------------------
Total $ 1,385 $ 35 $ (107) $ (38) $ 1,275
---------------------------------------------------------
- -----------------------------------------------------------------------------------------------------
Total assets in Private Client accounts in the United States declined 6% from
the end of the 2001 first quarter, to $1.2 trillion as a result of market-driven
declines, partially offset by new money inflows of $25 billion. Outside the
United States, client assets were $96 billion, down from $131 billion at the end
of the year-ago quarter largely due to the sale of the Canadian Private Client
business and market-driven declines. Net new money inflows, excluding the impact
of sold or discontinued businesses, totaled $10 billion over this period. Total
assets in asset-priced accounts were $211 billion at the end of the 2002 first
quarter, an increase of 9% from the year-ago period.
Net interest profit
Net interest profit for Private Client includes interest income earned for
originating deposits into Merrill Lynch's U.S. banks as well as interest earned
on margin and other loans. Also included is interest paid on borrowings. Prior
to 2002, Private Client's net interest profit included all revenues and expenses
associated with managing the investment portfolio of Merrill Lynch's U.S. banks.
The revenues and expenses associated with managing this portfolio are now
included in GMI's results. Prior year segment results have been restated for
this change.
Net interest profit was $336 million in the 2002 first quarter, down 13% from
$385 million in the first quarter of 2001. The decrease in net interest profit
resulted from an increase in allocated funding costs as well as a decrease
related to the sale of the Canadian Private Client business.
Other revenues
Other revenues, which is primarily comprised of realized and unrealized
investment gains and losses on investments, was $58 million for the first
quarter of 2002, down slightly from the year-ago quarter. Other revenues
included a residual pre-tax gain of $39 million related to the sale of the
Canadian Private Client business. Other revenues in the 2001 first quarter
included a pre-tax gain of $30 million related to the sale of the mortgage
servicing business.
22
- --------------------------------------------------------------------------------
MERRILL LYNCH INVESTMENT MANAGERS
- --------------------------------------------------------------------------------
MLIM'S RESULTS OF OPERATIONS
- ---------------------------------------------------------------------
For the Three Months Ended
--------------------------
Mar. 29, Mar. 30, % Inc.
(dollars in millions) 2002 2001 (Dec.)
- ---------------------------------------------------------------------
Commissions $ 64 $ 79 (19) %
Asset management fees 388 457 (15)
Other revenues 28 30 (7)
---- ----
Total net revenues $480 $566 (15)
---- ----
Pre-tax earnings $117 $ 94 24
---- ----
Pre-tax profit margin 24.4% 16.6%
- ---------------------------------------------------------------------
Although MLIM's net revenues decreased 15% from the year-ago quarter,
pre-tax earnings were up 24% to $117 million in the first quarter of 2002.
MLIM's profitability improved as a result of actions taken to integrate the
investment platform, rationalize product offerings and reduce expenses.
MLIM's first quarter results also reflect a $17 million pre-tax gain on the
sale of the Canadian retail mutual fund business. These factors resulted in
a nearly 8-percentage point improvement in the pre-tax profit margin
compared to the year-ago quarter.
Commissions
Commissions for MLIM principally consist of distribution fees and
redemption fees related to mutual funds. The distribution fees represent
revenues earned for promoting and distributing mutual funds ("12b-1 fees").
As a result of lower transaction volumes and the impact of lower market
values, commissions decreased 19% to $64 million in the 2002 first quarter
from the year-ago quarter.
Asset management fees
Asset management fees primarily consist of revenues earned from the
management and administration of funds as well as performance fees earned
by MLIM. Asset management fees were $388 million, a decline of 15% from the
first quarter of 2001, due primarily to a market-driven decline in equity
assets under management. Assets under management totaled $518 billion at
the end of the first quarter, down slightly from $525 billion at the end of
the first quarter of 2001.
An analysis of changes in assets under management from March 30, 2001 to
March 29, 2002 is as follows:
- --------------------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------------
Mar. 30, New Asset Mar. 29,
(dollars in billions) 2001 Money Depreciation Other (1) 2002
- --------------------------------------------------------------------------------------------------------------
Assets under management $525 5 (13) 1 $518
- --------------------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends of $7 billion, net outflows of ($5) billion
of retail money market funds which were transferred to bank deposits at
Merrill Lynch's U.S. banks and other changes, including the impact of
foreign exchange movements, of ($1) billion.
Other Revenues
Other revenues, which primarily include net interest profit and investment
gains, totaled $28 million for the first quarter of 2002, virtually unchanged
from the year-ago quarter. Other revenues in the 2002 first quarter include
the $17 million pre-tax gain on the sale of the Canadian retail mutual fund
business.
23
- --------------------------------------------------------------------------------
NON-INTEREST EXPENSES
- --------------------------------------------------------------------------------
Merrill Lynch's non-interest expenses are summarized below:
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
For the Three Months Ended
----------------------------
Mar. 29, Mar. 30,
(dollars in millions) 2002 2001
- -------------------------------------------------------------------------------
Compensation and benefits $2,646 $3,244
------ ------
Non-compensation expenses:
Communications and technology 474 598
Occupancy and related depreciation 238 270
Brokerage, clearing, and exchange fees 198 235
Advertising and market development 150 208
Professional fees 130 142
Office supplies and postage 69 96
Goodwill amortization - 52
Other 173 214
------ ------
Total non-compensation expenses 1,432 1,815
------ ------
Total non-interest expenses $4,078 $5,059
====== ======
Compensation and benefits
as a percentage of net revenues 52.0% 50.6%
Non-compensation expenses
as a percentage of net revenues 28.1 28.3
- --------------------------------------------------------------------------------
Non-interest expenses declined nearly $1 billion from the 2001 first
quarter. Compensation and benefits expenses decreased $598 million, or 18%
from the 2001 first quarter, to $2.6 billion, as a result of lower staffing
levels and lower levels of performance-based compensation due to reduced
profitability. Non-compensation expenses decreased $383 million, or 21%
from the 2001 first quarter, to $1.4 billion, reflecting actions taken to
reduce costs, in particular the fourth quarter restructuring, as well as
lower business activity.
Communications and technology costs were $474 million, down 21% due to
reduced systems consulting costs, lower technology equipment depreciation
and lower communications costs.
Occupancy and related depreciation was $238 million, 12% lower due
primarily to lower rental expenses resulting from the fourth quarter 2001
restructuring initiatives.
Brokerage, clearing, and exchange fees were $198 million, down 16%,
resulting from lower transaction volumes.
Advertising and market development expenses were $150 million, down 28%,
due primarily to reduced spending on travel and advertising.
Professional fees decreased 8%, to $130 million, due largely to reduced
spending on consulting services.
Office supplies and postage decreased 28% to $69 million due to lower
levels of business activity.
Other expenses were $173 million, down 19% due to a reduction in provisions
for various business matters, including litigation.
Goodwill amortization is no longer being recorded in accordance with SFAS
No. 142. Refer to Note 1, New Accounting Pronouncements for additional
information.
24
The effective tax rate was 31.2%, up from the full-year 2001 operating rate of
30.4%. The increase in the effective tax rate was primarily attributable to a
decrease in lower-taxed non-U.S. income.
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
Management continually monitors and evaluates the level and composition of the
balance sheet.
For the first three months of 2002, average total assets were $429 billion,
virtually unchanged from the full-year 2001. Average total liabilities were $406
billion, also essentially unchanged from the full-year 2001. Average total
assets and liabilities for the first three months of 2002 include the following
changes as compared to the full-year 2001:
- --------------------------------------------------------------------------------------------
Increase/
(dollars in millions) (Decrease) Change
- --------------------------------------------------------------------------------------------
AVERAGE ASSETS
Marketable investment securities $11,704 18%
Receivables under resale agreements (5,840) (6)
Receivables under securities borrowed transactions 8,941 29
Loans, notes and mortgages (net) 3,369 17
Customer receivables (6,424) (14)
Cash and cash equivalents (9,705) (45)
AVERAGE LIABILITIES
Deposits $ 6,924 9%
Payables under repurchase agreements (8,340) (8)
Payables under securities loaned transactions 1,297 17
Commercial paper and other short-term borrowings (4,827) (49)
- --------------------------------------------------------------------------------------------
The growth in average deposits in the first three months of 2002 from the
2001 full-year average resulted from the mid-2000 modification of the cash
sweep options for certain CMA(R) and other types of Merrill Lynch accounts
to generally sweep cash into interest-bearing bank deposits at Merrill
Lynch's U.S. banks, rather than MLIM-managed money market mutual funds.
This increase in deposits was primarily used by the U.S. banks to purchase
marketable investment securities. Additionally, receivables under
securities borrowed transactions rose due to increased matched-book
activity. Merrill Lynch enters into matched-book transactions to
accommodate clients, finance firm inventory positions, and obtain
securities for settlement.
25
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY AND FUNDING
- --------------------------------------------------------------------------------
The primary objectives of Merrill Lynch's capital structure and funding policies
are to support the successful execution of the firm's business strategies while
ensuring:
- - sufficient equity capital to absorb losses and,
- - liquidity at all times, across market cycles, and through periods of
financial stress.
These objectives and Merrill Lynch's capital structure and funding policies are
discussed more fully in the Annual Report on Form 10-K for the year ended
December 28, 2001.
Capital Adequacy
At March 29, 2002, Merrill Lynch's equity capital was comprised of $20.5 billion
in common equity, $425 million in preferred stock, and $2.7 billion of preferred
securities issued by subsidiaries. Preferred securities issued by subsidiaries
consist primarily of Trust Originated Preferred Securities(SM) ("TOPrS"(SM)).
Based on various analyses and criteria, management believes that Merrill Lynch's
equity capital base of $23.6 billion is adequate.
Merrill Lynch's leverage ratios were as follows:
- -------------------------------------------------------------------
Adjusted
Leverage Leverage
Ratio(1) Ratio(2)
- -------------------------------------------------------------------
PERIOD-END
March 29, 2002 18.2x 12.5x
December 28, 2001 18.5x 12.8x
AVERAGE (3)
Three months ended March 29, 2002 18.5x 12.9x
Year ended December 28, 2001 18.8x 13.1x
- -------------------------------------------------------------------
(1) Total assets to Total stockholders' equity and Preferred securities issued
by subsidiaries.
(2) Total assets less (a) Receivables under resale agreements (b) Receivables
under securities borrowed transactions and (c) Securities received as
collateral to Total stockholders' equity and Preferred securities issued by
subsidiaries.
(3) Computed using month-end balances.
An asset-to-equity leverage ratio does not reflect the risk profile of
assets, hedging strategies, or off-balance sheet exposures. Thus, Merrill
Lynch does not rely on overall leverage ratios to assess risk-based capital
adequacy.
Funding
Commercial paper outstanding totaled $2.7 billion at March 29, 2002 and
$3.0 billion at December 28, 2001, which was 1% of total assets at both
March 29, 2002 and year-end 2001. Deposits at Merrill Lynch's banking
subsidiaries remained virtually unchanged from year-end 2001 totaling $85.9
billion at March 29, 2002, including $73.0 billion at U.S. banks. The U.S.
bank deposits were invested primarily in high quality marketable investment
securities. Outstanding long-term borrowings increased to $77.3 billion at
March 29, 2002 from $76.6 billion at December 28, 2001. In the first
quarter of 2002, Merrill Lynch issued Liquid Yield Option(TM) Notes
("LYONs"(R)) due in 2032 totaling $2.3 billion at March 29, 2002. LYONs(R)
are zero-coupon senior debt instruments convertible into Merrill Lynch
common stock at a premium under certain defined terms and conditions. Major
components of the change in long-term borrowings during the first three
months of 2002 follow:
26
- ----------------------------------------------
(dollars in billions)
- ----------------------------------------------
Balance at December 28, 2001 $76.6
Issuances 9.2
Maturities (8.1)
Other, net (0.4)
-----
Balance at March 29, 2002 (1) $77.3
- ----------------------------------------------
(1) At March 29, 2002, $51.4 billion of long-term borrowings had maturity dates
beyond one year.
In addition to equity capital sources, Merrill Lynch views long-term debt
as a stable funding source for its balance sheet assets. As a further
enhancement to liquidity, the firm maintains a portfolio of segregated U.S.
government and agency obligations, and asset-backed securities of high
credit quality which had a carrying value, net of related hedges, of $9.1
billion at March 29, 2002, and $8.4 billion at December 28, 2001. These
assets may be sold or pledged to provide immediate liquidity even during
periods of adverse market conditions. Another source of liquidity is a
committed, senior, unsecured bank credit facility which at March 29, 2002
totaled $5 billion and was not drawn upon. Prior to expiration on May 10,
2002, this bank credit facility was renewed in the amount of $3.5 billion
for 364 days. Merrill Lynch elected to reduce the amount of the credit
facility while increasing the liquidity portfolio of segregated securities
that may be sold or pledged to provide immediate liquidity. Additionally,
Merrill Lynch maintains access to significant uncommitted credit lines,
both secured and unsecured, from a large group of banks.
Credit Ratings
The cost and availability of unsecured funding generally are dependent on credit
ratings and market conditons. In addition to the general market conditions
discussed in the Business Environment section, there may be conditions specific
to the financial services industry or Merrill Lynch that impact the cost or
availability of funding. Merrill Lynch's senior long-term debt, preferred stock,
and TOPrS(SM) were rated by several recognized credit rating agencies at May 10,
2002 as indicated below. These ratings do not reflect outlooks that may be
expressed by the rating agencies from time to time, which are currently
negative.
- -----------------------------------------------------------------------------------------------------------------------
Senior
Debt Preferred Stock TOPrS(SM)
Rating Agency Ratings Ratings Ratings
- -----------------------------------------------------------------------------------------------------------------------
Dominion Bond Rating Service Ltd AA(Low) Not Rated Not Rated
Fitch Ratings AA AA- AA-
Moody's Investors Service, Inc. Aa3 A2 A1
Rating and Investment Information, Inc. (1) AA A+ A+
Standard & Poor's Ratings Services AA- A A
- -----------------------------------------------------------------------------------------------------------------------
(1) Located in Japan.
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Risk-taking is an integral part of Merrill Lynch's core business
activities. In the course of conducting its business operations, Merrill
Lynch is exposed to a variety of risks. These risks include market, credit,
liquidity, process, and other risks that are material and require
comprehensive controls and management. The responsibility and
accountability for these risks remain primarily with the individual
business units. For a full discussion of Merrill Lynch's risk management
framework, see the Annual Report on Form 10-K for the year ended December
28, 2001.
27
Market Risk
Value-at-risk ("VaR") is an estimate of the amount that Merrill Lynch's present
portfolios could lose with a specified degree of confidence over a given time
interval. The VaR for Merrill Lynch's overall portfolios is less than the sum of
the VaRs for individual risk categories because movements in different risk
categories occur at different times and, historically, extreme movements have
not occurred in all risk categories simultaneously. The difference between the
sum of the VaRs for individual risk categories and the VaR calculated for all
risk categories is shown in the following tables and may be viewed as a measure
of the diversification within Merrill Lynch's portfolios. Merrill Lynch believes
that the tabulated risk measures provide some guidance as to the amount Merrill
Lynch could lose in future periods and it works continuously to improve the
methodology and measurement of its VaR. However, like all statistical measures,
especially those that rely heavily on historical data, VaR needs to be
interpreted with a clear understanding of its assumptions and limitations.
The Merrill Lynch VaR system uses a historical simulation approach to
estimate VaR across several confidence levels and holding periods.
Beginning this quarter, the tables below show VaR using a 95% confidence
level and a weekly holding period for trading and non-trading portfolios.
VaRs under other confidence levels and holding periods are included in the
footnotes. 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 5% of the time is used as the estimate for the 95% confidence level
VaR. In addition to the overall VaR, which reflects diversification in the
portfolio, VaR amounts are presented for major risk categories, including
exposure to volatility risk found in certain products, e.g., options. The
table that follows presents Merrill Lynch's VaR for its trading portfolios
at March 29, 2002 and December 28, 2001 as well as daily average VaR for
the three months ended March 29, 2002. Additionally, high and low VaR for
the first quarter of 2002 is presented independently for each risk category
and overall.
- ------------------------------------------------------------------------------------------------------
Daily
Mar. 29, Dec. 28, Average High Low
(dollars in millions) 2002 2001 1Q02 1Q02 1Q02
- ------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 32 $ 45 $ 42 $ 55 $ 28
Equity 37 37 33 66 25
Commodity - 1 1 2 -
Currency 1 2 6 17 -
Volatility 22 20 20 27 14
--------------------------------------------------------
92 105 102
Diversification benefit (37) (49) (45)
-------------------------------
Overall(2) $ 55 $ 56 $ 57 $ 71 $ 47
===============================
- -------------------------------------------------------------------------------------------------------
(1) Based on a 95% confidence level and a weekly holding period.
(2) Overall VaR using a 99% confidence level and a biweekly holding period was
$107 million at March 29, 2002 versus $133 million at year-end 2001. Overall VaR
using a 95% confidence level and a one-day holding period was $22 million at
March 29, 2002 versus $21 million at year-end 2001.
28
The following table presents Merrill Lynch's VaR for its non-trading portfolios
(excluding U.S. banks):
- ---------------------------------------------------------------------------
Mar. 29, Dec. 28,
(dollars in millions) 2002 2001
- ---------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 21 $ 20
Equity 28 28
Currency 4 7
Volatility 4 6
------- ---------
57 61
Diversification benefit (21) (26)
------- ---------
Overall (2) $ 36 $ 35
======= =========
- ---------------------------------------------------------------------------
(1) Based on a 95% confidence level and a weekly holding period.
(2) Overall VaR using a 99% confidence level and a biweekly holding period was
$70 million at March 29, 2002 versus $67 million at year-end 2001.
Non-trading VaR does not include risk related to Merrill Lynch's $4.7 billion of
outstanding LYONs(R) since management expects that the LYONs(R) will be
converted to common stock and will not be replaced by fixed income securities.
In addition to the amounts reported in the accompanying table, non-trading
interest rate VaR associated with Merrill Lynch's TOPrS(SM) at March 29, 2002
and December 28, 2001 was $37 million and $33 million, respectively, based on a
95% confidence level and a weekly holding period. The overall VaR associated
with Merrill Lynch's TOPrS(SM) using a 99% confidence level and a biweekly
holding period was $69 million at March 29, 2002 versus $56 million at year-end
2001. TOPrS(SM), which are fixed-rate perpetual preferred securities, are
considered a component of Merrill Lynch's equity capital and, therefore, the
associated interest rate sensitivity is not hedged.
Beginning in 2000, cash flows from client funds in certain CMA(R) and other
types of accounts were redirected from taxable money market funds to bank
deposits at Merrill Lynch's U.S. banks. This increase in deposits was used to
fund the growth in high credit quality marketable investment securities. The
overall VaR for the U.S. banks, based on a 95% confidence interval and a weekly
holding period, was $85 million and $79 million at March 29, 2002 and December
28, 2001, respectively. The overall VaR for the U.S. banks, based on a 99%
confidence interval and a biweekly holding period, was $154 million and $165
million at March 29, 2002 and year-end 2001, respectively.
Credit Risk
Merrill Lynch enters into International Swaps and Derivatives Association, Inc.
master agreements or their equivalent ("master netting agreements") with each of
its derivative counterparties as soon as possible. Master netting agreements
provide protection in bankruptcy in certain circumstances and, in some cases,
enable receivables and payables with the same counterparty to be offset on the
Consolidated Balance Sheets, providing for a more meaningful balance sheet
presentation of credit exposure.
In addition, to reduce default risk, Merrill Lynch requires collateral,
principally U.S. Government and agency securities, as well as cash, on certain
derivative transactions. From an economic standpoint, Merrill Lynch evaluates
default risk exposures net of related collateral. The following is a summary of
counterparty credit ratings for the replacement cost (net of $7.0 billion of
collateral) of trading derivatives in a gain position by maturity at March 29,
2002. (Please note that the following table is inclusive of credit exposure from
derivative transactions only and does not include other credit exposures, which
may be material).
29
- ----------------------------------------------------------------------------------------
Years to Maturity Cross-
Credit -------------------------------------------- Maturity
Rating(1) 0-3 3 - 5 5-7 Over 7 Netting(2) Total
- ----------------------------------------------------------------------------------------
AAA $ 4,858 $ 1,051 $ 734 $ 1,156 $ (793) $ 7,006
AA 3,282 2,227 912 1,707 (2,357) 5,771
A 1,970 1,403 533 770 (742) 3,934
BBB 1,181 462 210 253 (145) 1,961
Other 1,231 386 145 57 (55) 1,764
--------------------------------------------------------------------------
Total $12,522 $ 5,529 $2,534 $ 3,943 $(4,092) $20,436
- ----------------------------------------------------------------------------------------
(1) Represents credit rating agency equivalent of internal credit ratings.
(2) Represents netting of payable balances with receivable balances for the same
counterparty across maturity band categories. Receivable and payable
balances with the same counterparty in the same maturity category, however,
are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate its
default risk on derivatives whenever possible by entering into transactions with
provisions that enable Merrill Lynch to terminate or reset the terms.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve risks
related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes these
risks and, whenever possible, employs strategies to mitigate exposures. The
specific components and overall level of non-investment grade and
highly-leveraged positions may vary significantly from period to period as a
result of inventory turnover, investment sales, and asset redeployment.
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment banking,
market-making, and derivative structuring activities. Non-investment grade
holdings have been defined as debt and preferred equity securities rated as BB+
or lower, or equivalent ratings by recognized credit rating agencies, sovereign
debt in emerging markets, amounts due under derivative contracts from
non-investment grade counterparties, and other instruments that, in the opinion
of management, are non-investment grade.
In addition to the amounts included in the following table, derivatives may also
expose Merrill Lynch to credit risk related to the underlying security where a
derivative contract either synthesizes ownership of the underlying security
(e.g., long total return swaps) or can potentially force ownership of the
underlying security (e.g., short put options). Derivatives may also subject
Merrill Lynch to credit spread or issuer default risk, in that changes in credit
spreads or in the credit quality of the underlying securities may adversely
affect the derivatives' fair values. Merrill Lynch seeks to manage these risks
by engaging in various hedging strategies to reduce its exposure associated with
non-investment grade positions, such as purchasing an option to sell the related
security or entering into other offsetting derivative contracts.
Merrill Lynch provides financing and advisory services to, and invests in,
companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides
extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch syndicates loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
30
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will be made on a select basis.
- --------------------------------------------------------------------------------
TRADING EXPOSURES
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's trading exposure to
non-investment grade or highly-leveraged issuers or counterparties:
- --------------------------------------------------------------------
(dollars in millions) Mar. 29, Dec. 28,
2002 2001
- --------------------------------------------------------------------
Trading assets:
Cash instruments $4,495 $4,597
Derivatives 4,337 4,478
Trading liabilities - cash instruments (1,822) (1,535)
Collateral on derivative assets (2,573) (2,934)
------ ------
Net trading asset exposure $4,437 $4,606
====== ======
- --------------------------------------------------------------------
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 March
29, 2002, the carrying value of such debt and equity securities totaled $138
million, of which 11% resulted from Merrill Lynch's market-making activities in
such securities. This compared with $58 million at December 28, 2001, of which
18% related to market-making activities. Also included are distressed bank
loans, acquired as part of Merrill Lynch's secondary market activities, totaling
$157 million and $245 million at March 29, 2002 and December 28, 2001,
respectively.
- --------------------------------------------------------------------------------
NON-TRADING EXPOSURES
- --------------------------------------------------------------------------------
The following table summarizes Merrill Lynch's non-trading exposures to
non-investment grade or highly leveraged corporate issuers or counterparties:
- ---------------------------------------------------------------------------------------
Mar. 29, Dec. 28,
(dollars in millions) 2002 2001
- ---------------------------------------------------------------------------------------
Marketable investment securities $ 207 $ 221
Investments of insurance subsidiaries 112 114
Loans (net of allowance for loan losses):
Bridge loans 84 130
Other loans(1) 2,302 2,578
Other investments:
Partnership interests (2) 1,450 1,359
Other equity investments (3) 144 140
- ---------------------------------------------------------------------------------------
(1) Represents outstanding loans to 134 and 138 companies at March 29, 2002
and December 28, 2001, respectively.
(2) Includes $804 million and $712 million in investments at March 29, 2002
and December 28, 2001, respectively, related to deferred compensation plans,
for which the default risk of the investments generally rests with the
participating employees.
(3) Includes investments in 107 and 81 enterprises at March 29, 2002 and
December 28, 2001, respectively.
31
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly-leveraged counterparties:
- --------------------------------------------------------------------------------------------
Mar. 29, Dec. 28,
(dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------
Additional commitments to invest in partnerships $ 315 $ 288
Unutilized revolving lines of credit and other
lending commitments 1,595 1,947
- --------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
In August 2001, the Financial Accounting Standards Board ("FASB") released SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of" and the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions," for the disposal of a
segment of the business as previously defined in that opinion. SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements"
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. SFAS No. 144 provides guidance on the financial
accounting and reporting for the impairment or disposal of long-lived assets.
Merrill Lynch adopted the provisions of SFAS No. 144 in the first quarter of
2002. The impact upon adoption was not material.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." Under SFAS No. 142, intangible assets with indefinite lives and
goodwill will no longer be amortized. Instead, these assets will be tested
annually for impairment. Merrill Lynch adopted the provisions of SFAS No. 142 at
the beginning of fiscal year 2002.
SFAS No. 142 requires that Merrill Lynch perform an assessment of whether
there is an indication that goodwill is impaired as of the date of
adoption. This test is required to be completed within six months of the
date of adoption. If an indication of impairment exists, quantification of
the impairment is required to be completed as soon as possible, but no
later than the end of the year. Any resulting impairment loss, as measured
on the first day of fiscal year 2002, will be recognized as the cumulative
effect of a change in accounting principle in Merrill Lynch's statement of
earnings upon adoption and will require a restatement of the first quarter
2002 results. Amortization expense related to goodwill totaled $52 million
in the first quarter of 2001. Excluding this amortization expense, net
earnings, basic earnings per share and diluted earnings per share would
have been $909 million, $1.08 per share, and $0.96 per share, respectively
in the first quarter of 2001.
32
- ------------------------------------------------------------------------------------------------------------------------
STATISTICAL DATA
- ------------------------------------------------------------------------------------------------------------------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr.
2001 2001 2001 2001 2002
-------- -------- -------- -------- --------
CLIENT ASSETS (dollars in billions):
Private Client
U.S. $ 1,254 $ 1,318 $ 1,171 $ 1,185 $ 1,179
Non-U.S. 131 136 127 101 96
-------- -------- -------- -------- --------
Total Private Client Assets 1,385 1,454 1,298 1,286 1,275
MLIM direct sales (1) 179 181 170 172 167
-------- -------- -------- -------- --------
Total Client Assets $ 1,564 $ 1,635 $ 1,468 $ 1,458 $ 1,442
======== ======== ======== ======== ========
ASSETS IN ASSET-PRICED ACCOUNTS $ 193 $ 207 $ 189 $ 205 $ 211
ASSETS UNDER MANAGEMENT:
Retail $ 233 $ 230 $ 214 $ 220 $ 215
Institutional 250 260 252 266 262
Private Investors(2) 42 43 41 43 41
Equity 282 286 253 263 257
Fixed-income 118 118 119 119 119
Money market 125 129 135 147 142
U.S. 319 325 310 327 323
Non-U.S. 206 208 197 202 195
- ------------------------------------------------------------------------------------------------------------------------
UNDERWRITING:
Global Equity and Equity-Linked:
Volume (dollars in billions) $ 13 $ 17 $ 14 $ 15 $ 14
Market share 12.5% 13.4% 21.9% 12.2% 15.4%
Global debt:
Volume (dollars in billions) $ 121 $ 109 $ 81 $ 67 $ 91
Market share 12.4% 11.3% 9.9% 7.2% 8.7%
- ------------------------------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES:
U.S. 50,400 49,100 47,300 43,500 43,200
Non-U.S. 19,900 19,100 18,600 13,900 13,200
-------- -------- ------- -------- --------
Total 70,300 68,200 65,900 57,400 56,400
======== ======== ======= ======== ========
Private Client Financial Advisors 19,500 18,600 18,000 16,400 15,900
- ------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET (dollars in millions):
Total assets $431,604 $423,071 $448,606 $419,419 $429,167
Total stockholders' equity $ 19,939 $ 20,691 $ 21,090 $ 20,008 $ 20,906
Book value per common share $ 23.28 $ 24.02 $ 24.38 $ 23.03 $ 23.73
SHARE INFORMATION (in thousands):
Weighted-average shares outstanding:
Basic 832,195 841,394 845,841 845,664 854,815
Diluted 937,954 943,836 934,469 845,664 949,237
Common shares outstanding 838,389 843,772 847,538 850,222 862,946
- ------------------------------------------------------------------------------------------------------------------------
(1) Reflects funds managed by MLIM not sold through Private Client channels.
(2) Represents segregated portfolios for individuals, small corporations and
institutions.
33
PART II - OTHER INFORMATION
---------------------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
The following supplements the discussion in ML & Co.'s Annual Report on Form
10-K for the fiscal year ended December 28, 2001 (the "2001 10-K"), and in ML &
Co.'s Current Reports on Form 8-K dated April 11, 2002 and April 18, 2002.
Research-Related Investigations.
- -------------------------------
ML & Co. is continuing discussions with the New York State Attorney General's
office, the objective of which is to resolve all remaining matters with that
office regarding its investigation into Merrill Lynch's research practices. On
April 23, 2002, the North American Securities Administrators Association
announced that it had formed a multi-state task force to focus on issues raised
by the Attorney General's action with regard to possible securities law
violations by Wall Street firms. On April 25, 2002, the Securities and Exchange
Commission announced that it had begun a formal inquiry into market practices
concerning research analysts, including potential conflicts that can arise from
the relationship between research and investment banking within securities
firms. The SEC stated that the New York Stock Exchange and the National
Association of Securities Dealers are assisting in the investigation. Merrill
Lynch is cooperating with each of these investigations into research practices.
IPO Allocation/Research Class Actions.
- -------------------------------------
On April 19, 2002, plaintiffs in the IPO Allocation Class Actions described in
the 2001 10-K filed amended securities law complaints against the defendants,
including Merrill Lynch. As amended, the securities law complaints allege that
investment firms, including Merrill Lynch, violated securities laws by allegedly
requiring or inducing customers who were allocated IPO securities to pay back
some of their profits in the form of higher commissions and/or to buy the IPO
securities in the aftermarket. The complaints also allege that research issued
by the financial services firms, including Merrill Lynch, improperly increased
the prices of the IPO securities in the aftermarket. The complaints seek
unspecified damages and other relief. Approximately 100 of the more than 300
amended complaints filed on April 19 name Merrill Lynch as a defendant, which is
based on its involvement as one of the underwriters or one of the members of the
underwriting syndicate for the issuers named in each of those complaints. Two
cases, relating to B2B Internet HOLDRS Trust and Internet Infrastructure HOLDRS
Trust, involve entities that were created by Merrill Lynch to facilitate
investments in internet securities.
In addition to the IPO Allocation/Research Class Actions, Merrill Lynch has been
named as a defendant in a number of class actions challenging the independence
and objectivity of research recommendations issued by Merrill Lynch (and, in
some cases, by other firms) and related disclosures. In one case, the Merrill
Lynch Internet Strategies Fund is also named as a defendant.
Enron-Related Litigation/Investigation.
- --------------------------------------
On April 8, 2002, Merrill Lynch and others were added as defendants in two class
actions related to the collapse of Enron Corp., which filed for protection under
U.S. bankruptcy laws on or about December 2, 2001. The cases are pending in the
United States District Court for the Southern District of Texas, and each case
names more than seventy defendants. One of the cases is brought on behalf of
investors who purchased Enron debt or equity securities on or after October 1,
1998, and the other is brought on behalf of 24,000 Enron employees who were
participants in the Enron Corp. Savings Plan, the Enron Corp. Employee Stock
Ownership Plan, the Cash Balance Plan or who received "phantom stock" as
compensation. Merrill Lynch underwrote securities for Enron, served as private
placement agent for an Enron-related partnership known as LJM2, issued research
related to Enron, and engaged in other transactions involving Enron. Plaintiffs
allege that as a result of these and other activities related to Enron, Merrill
Lynch engaged in securities fraud and violations of the Racketeer Influenced and
Corrupt Organizations Act.
34
Merrill Lynch believes it has strong defenses to, and where appropriate, will
vigorously contest, the class actions described above.
The resolution of certain of the matters described above may result in awards of
damages, the imposition of fines or other penalties, and/or changes to Merrill
Lynch's business practices. Although the ultimate outcome of these matters
cannot be ascertained at this time and the results of legal proceedings cannot
be predicted with certainty, it is the opinion of management, based on
information available to it as of the date of this report, that the resolution
of these matters will not have a material adverse effect on the financial
position of Merrill Lynch, but may be material to Merrill Lynch's operating
results for any particular period.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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(a) Exhibits
(4) Instruments defining the rights of security holders,
including indentures:
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, ML &
Co. hereby undertakes to furnish to the Securities and
Exchange Commission, upon request, copies of the
instruments defining the rights of holders of long-term
debt securities of ML & Co. that authorize an amount of
securities constituting 10% or less of the total assets of
ML & Co. and its subsidiaries on a consolidated basis.
(12) Statement re: computation of ratios
(15) Letter re: unaudited interim financial information
(b) Reports on Form 8-K
35
The following Current Reports on Form 8-K were filed with or furnished
to the Securities and Exchange Commission during the quarterly period
covered by this report:
(i) Current Report dated January 9, 2002 for the purpose of
reporting the resizing of selected businesses, other structural
changes and a fourth-quarter 2001 charge.
(ii) Current Report dated January 16, 2002 for the purpose of filing
the form of ML & Co.'s Market Index Target-Term Securities
based upon the Dow Jones Industrial Average due January 16,
2009.
(iii) Current Report dated January 17, 2002 for the purpose of
furnishing notice of a webcast of a conference call scheduled
for January 23, 2002 to review ML & Co.'s operating results.
(iv) Current Report dated January 23, 2002 for the purpose of filing
ML & Co.'s Preliminary Unaudited Earnings Summary for the three
months and the year ended December 28, 2001.
(v) Current Report dated January 28, 2002 for the purpose of
furnishing notice of a webcast of a presentation by ML & Co.'s
president and chief operating officer scheduled for January 31,
2002.
(vi) Current Report dated January 29, 2002 for the purpose of filing
the form of ML & Co.'s 8% Callable Stock Return Income Debt
Securities due January 29, 2004, payable at maturity with
Xilinx, Inc. common stock.
(vii) Current Report dated February 1, 2002 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes linked to the
Industrial 15 Index due February 1, 2007.
(viii) Current Report dated February 1, 2002 for the purpose of filing
the form of ML & Co.'s 9% Callable Stock Return Income Debt
Securities due February 2, 2004, payable at maturity with JDS
Uniphase Corporation common stock.
(ix) Current Report dated February 5, 2002 for the purpose of
furnishing notice of a broadcast of a presentation relating to
Merrill Lynch's European investment banking business scheduled
for February 8, 2002.
(x) Current Report dated February 7, 2002 for the purpose of
furnishing notice of a webcast of a presentation by ML & Co.'s
chairman and chief executive officer scheduled for February 12,
2002.
(xi) Current Report dated February 8, 2002 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes linked to the
Biotech-Pharmaceutical Index due February 8, 2007.
(xii) Current Report dated February 11, 2002 for the purpose of
filing the form of ML & Co.'s 6% Callable Stock Return Income
Debt Securities due February 11, 2004, payable at maturity with
Bed Bath & Beyond Inc. common stock.
(xiii) Current Report dated February 21, 2002 for the purpose of
filing the form of ML & Co.'s 8% Callable Stock Return Income
Debt Securities due February 23, 2004, payable at maturity with
Applied Materials, Inc. common stock.
36
(xiv) Current Report dated February 26, 2002 for the purpose of
filing ML & Co.'s Preliminary Unaudited Consolidated Balance
Sheet as of December 28, 2001.
(xv) Current Report dated March 1, 2002 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes linked to the
Select Ten Index due March 1, 2007.
(xvi) Current Report dated March 1, 2002 for the purpose of filing
the form of ML & Co.'s Enhanced Return Notes linked to the
Nasdaq-100 Index due March 1, 2004.
(xvii) Current Report dated March 5, 2002 for the purpose of
furnishing notice of a webcast of a presentation by the
president of Merrill Lynch's U.S. Private Client Group
scheduled for March 12, 2002.
(xviii) Current Report dated March 7, 2002 for the purpose of filing ML
& Co.'s Selected Financial Data and Management's Discussion and
Analysis for the fiscal year ended December 28, 2001.
(xix) Current Report dated March 13, 2002 for the purpose of filing
the form of ML & Co.'s Liquid Yield Option Notes due
March 13, 2032.
(xx) Current Report dated March 15, 2002 for the purpose of filing
the form of ML & Co.'s 8% Callable Stock Return Income Debt
Securities due March 15, 2004, payable at maturity with Corning
Incorporated common stock.
(xxi) Current Report dated March 20, 2002 for the purpose of filing
the form of ML & Co.'s 8% Callable Stock Return Income Debt
Securities due March 22, 2004, payable at maturity with The
Gap, Inc. common stock.
(xxii) Current Report dated March 22, 2002 for the purpose of filing
the form of ML & Co.'s 7% Callable Stock Return Income Debt
Securities due March 22, 2004, payable at maturity with Texas
Instruments Incorporated common stock.
(xxiii) Current Report dated March 28, 2002 for the purpose of filing
the form of ML & Co.'s Market Index Target-Term Securities
based upon the Russell 2000 Index due March 30, 2009.
(xxiv) Current Report dated March 28, 2002 for the purpose of filing
the form of ML & Co.'s Strategic Return Notes linked to the Oil
and Natural Gas Index due March 28, 2007.
(xxv) Current Report dated March 28, 2002 for the purpose of
filing the form of ML & Co.'s Nikkei 225 Market Index
Target-Term Securities due March 30, 2009.
(xxvi) Current Report dated March 28, 2002 for the purpose of filing
the form of ML & Co.'s 7% Callable Stock Return Income Debt
Securities due March 29, 2004.
37
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized.
MERRILL LYNCH & CO., INC.
------------------------------------------
(Registrant)
By: /s/ Thomas H. Patrick
------------------------------------------
Thomas H. Patrick
Executive Vice President
and Chief Financial Officer
Date: May 10, 2002
38
INDEX TO EXHIBITS
Exhibits
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
39