Quarterly report pursuant to Section 13 or 15(d)

Fair Value Disclosures

v2.4.0.6
Fair Value Disclosures
 6 Months Ended
Jun. 30, 2012
Fair Value Disclosures [Abstract]  
Fair Value Disclosures
Note 4.  
Fair Value Disclosures

Fair Value Accounting

Fair Value Hierarchy

In accordance with Fair Value Accounting, Merrill Lynch has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy.

The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

Financial assets and liabilities recorded on the Condensed Consolidated Balance Sheets are categorized based on the observability of inputs to the valuation techniques as follows:

Level 1.   Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that Merrill Lynch has the ability to access (examples include active exchange-traded equity securities, exchange-traded derivatives, U.S. Government securities, and certain other sovereign government obligations).

Level 2.   Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:

a)  Quoted prices for similar assets or liabilities in active markets (examples include restricted stock and U.S. agency securities);

b)  Quoted prices for identical or similar assets or liabilities in non-active markets (examples include corporate and municipal bonds, which can trade infrequently);

c)  Pricing models whose inputs are observable for substantially the full term of the asset or liability (examples include most over-the-counter derivatives, including interest rate and currency swaps); and

d)  Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (examples include certain residential and commercial mortgage-related assets, including loans, securities and derivatives).

Level 3.   Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management's view about the assumptions a market participant would use in pricing the asset or liability (examples include certain private equity investments, certain residential and commercial mortgage-related assets and long-dated or complex derivatives).

As required by Fair Value Accounting, when the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3). Therefore gains and losses for such assets and liabilities categorized within the Level 3 reconciliation below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). Further, the following reconciliations do not take into consideration the offsetting effect of Level 1 and 2 financial instruments entered into by Merrill Lynch that economically hedge certain exposures to the Level 3 positions.

A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Level 3 gains and losses represent amounts incurred during the period in which the instrument was classified as Level 3. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in or transfers out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur. Refer to the recurring and non-recurring sections within this Note for further information on transfers in and out of Level 3.

Valuation Processes and Techniques

Merrill Lynch has various processes and controls in place to ensure that its fair value measurements are reasonably estimated. A model validation policy governs the use and control of valuation models used to estimate fair value. This policy requires review and approval of models by personnel who are independent of the front office and periodic re-assessments to ensure that models are continuing to perform as designed. In addition, detailed reviews of trading gains and losses are analyzed on a daily basis by personnel who are independent of the front office. A price verification group, which is also independent of the front office, utilizes available market information including executed trades, market prices and market observable valuation model inputs to ensure that fair values are reasonably estimated. Merrill Lynch executes due diligence procedures over third party pricing service providers in order to support their use in the valuation process. Where market information is not available to support internal valuations, independent reviews of the valuations are performed and any material exposures are escalated through a management review process.

While Merrill Lynch believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

During the second quarter of 2012, there were no changes to Merrill Lynch's valuation techniques that had or are expected to have, a material impact on its condensed consolidated financial position or results of operations.

The following outlines the valuation methodologies for Merrill Lynch's material categories of assets and liabilities:

U.S. Government and agencies

U.S. Treasury securities U.S. Treasury securities are valued using quoted market prices and are generally classified as Level 1 in the fair value hierarchy.

U.S. agency securities U.S. agency securities are comprised of two main categories consisting of agency issued debt and mortgage pass-throughs. The fair value of agency issued debt securities is derived using market prices and recent trade activity gathered from independent dealer pricing services or brokers. Generally, the fair value of mortgage pass-throughs is based on market prices of comparable securities. Agency issued debt securities and mortgage pass-throughs are generally classified as Level 2 in the fair value hierarchy.

Non-U.S. governments and agencies

Sovereign government obligations Sovereign government obligations are valued using quoted prices in active markets when available. To the extent quoted prices are not available, fair value is determined based on reference to recent trading activity and quoted prices of similar securities. These securities are generally classified in Level 1 or Level 2 in the fair value hierarchy, primarily based on the issuing country.

Municipal debt

Municipal bonds The fair value of municipal bonds is calculated using recent trade activity, market price quotations and new issuance levels. In the absence of this information, fair value is calculated using comparable bond credit spreads. Current interest rates, credit events, and individual bond characteristics such as coupon, call features, maturity, and revenue purpose are considered in the valuation process. The majority of these bonds are classified as Level 2 in the fair value hierarchy.

Auction Rate Securities (“ARS”) Merrill Lynch holds investments in certain ARS, including student loan and municipal ARS. Student loan ARS are comprised of various pools of student loans. Municipal ARS are issued by states and municipalities for a wide variety of purposes, including but not limited to healthcare, industrial development, education and transportation infrastructure. The fair value of the student loan ARS is calculated based upon a number of assumptions including weighted average life, coupon, discount margin and liquidity discounts. The fair value of the municipal ARS is calculated based upon projected refinancing and spread assumptions. In both cases, recent trades and issuer tenders are considered in the valuations. Student loan ARS and municipal ARS are classified as Level 3 in the fair value hierarchy.

Corporate and other debt

Corporate bonds Corporate bonds are valued based on either the most recent observable trade and/or external quotes, depending on availability. The most recent observable trade price is given highest priority as the valuation benchmark based on an evaluation of transaction date, size, frequency, and bid-offer. This price may be adjusted by bond or credit default swap spread movement. When credit default swap spreads are referenced, cash-to-synthetic basis magnitude and movement as well as maturity matching are incorporated into the value. When neither external quotes nor a recent trade is available, the bonds are valued using a discounted cash flow approach based on risk parameters of comparable securities. In such cases, the potential pricing difference in spread and/or price terms with the traded comparable is considered. Corporate bonds are generally classified as Level 2 or Level 3 in the fair value hierarchy.


Commercial loans and commitments The fair values of commercial loans and loan commitments are based on market prices and most recent transactions when available. When not available, a discounted cash flow valuation approach is applied using market-based credit spreads of comparable debt instruments, recent new issuance activity or relevant credit derivatives with appropriate cash-to-synthetic basis adjustments. Commercial loans and commitments are generally classified as Level 2 in the fair value hierarchy. Certain commercial loans, particularly those related to emerging market, leveraged and distressed companies have limited price transparency. These loans are generally classified as Level 3 in the fair value hierarchy.

Mortgages, mortgage-backed and asset-backed

Residential Mortgage-Backed Securities (“RMBS”), Commercial Mortgage-Backed Securities (“CMBS”), and other Asset-Backed Securities (“ABS”) RMBS, CMBS and other ABS are valued based on observable price or credit spreads for the particular security, or when price or credit spreads are not observable, the valuation is based on prices of comparable bonds or the present value of expected future cash flows. Valuation levels of RMBS and CMBS indices are used as an additional data point for benchmarking purposes or to price outright index positions.

When estimating the fair value based upon the present value of expected future cash flows, Merrill Lynch uses its best estimate of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved, while also taking into account performance of the underlying collateral.

RMBS, CMBS and other ABS are classified as Level 3 in the fair value hierarchy if external prices or credit spreads are unobservable or if comparable trades/assets involve significant subjectivity related to property type differences, cash flows, performance and other inputs; otherwise, they are classified as Level 2 in the fair value hierarchy.

Equities

Exchange-Traded Equity Securities Exchange-traded equity securities are generally valued based on quoted prices from the exchange. These securities are classified as either Level 1 or Level 2 in the fair value hierarchy, primarily based on the exchange on which they are traded.

Convertible debentures Convertible debentures are valued based on observable trades and/or external quotes, depending on availability. When neither observable trades nor external quotes are available, the instruments are valued using a discounted cash flow approach based on risk parameters of comparable securities. In such cases, the potential pricing difference in spread and/or price terms with the traded comparable is considered. Convertible debentures are generally classified as Level 2 in the fair value hierarchy.

Derivative contracts

Listed Derivative Contracts Listed derivatives that are actively traded are generally valued based on quoted prices from the exchange and are classified as Level 1 in the fair value hierarchy. Listed derivatives that are not actively traded are valued using the same approaches as those applied to OTC derivatives; they are generally classified as Level 2 in the fair value hierarchy.

OTC Derivative Contracts OTC derivative contracts include forwards, swaps and options related to interest rate, foreign currency, credit, equity or commodity underlyings.

The fair value of OTC derivatives is derived using market prices and other market based pricing parameters such as interest rates, currency rates and volatilities that are observed directly in the market or gathered from independent sources such as dealer consensus pricing services or brokers. Where models are used, they are used consistently and reflect the contractual terms of and specific risks inherent in the contracts. Generally, the models do not require a high level of subjectivity since the valuation techniques used in the models do not require significant judgment and inputs to the models are readily observable in active markets. When appropriate, valuations are adjusted for various factors such as liquidity and credit considerations based on available market evidence. In addition, for most collateralized interest rate and currency derivatives the requirement to pay interest on the collateral may be considered in the valuation. The majority of OTC derivative contracts are classified as Level 2 in the fair value hierarchy.

OTC derivative contracts that do not have readily observable market based pricing parameters are classified as Level 3 in the fair value hierarchy. Examples of derivative contracts classified within Level 3 include contractual obligations that have tenures that extend beyond periods in which inputs to the model would be observable, exotic derivatives with significant inputs into a valuation model that are less transparent in the market and certain credit default swaps (“CDS”) referenced to mortgage-backed securities. For example, derivative instruments, such as certain CDS referenced to RMBS, CMBS, other ABS and collateralized debt obligations (“CDOs”), may be valued based on the underlying mortgage risk where these instruments are not actively quoted. Inputs to the valuation will include available information on similar underlying loans or securities in the cash market. The prepayments and loss assumptions on the underlying loans or securities are estimated using a combination of historical data, prices on recent market transactions, relevant observable market indices such as the Asset Backed Securities Index (“ABX”) or Commercial Mortgage Backed Securities Index (“CMBX”) and prepayment and default scenarios and analyses.

CDOs The fair value of CDOs is derived from a referenced basket of CDS, the CDO's capital structure, and the default correlation, which is an input to a proprietary CDO valuation model. The underlying CDO portfolios typically contain investment grade as well as non-investment grade obligors. After adjusting for differences in risk profile, the correlation parameter for an actual transaction is estimated by benchmarking against observable standardized index tranches and other comparable transactions. CDOs are classified as either Level 2 or Level 3 in the fair value hierarchy.

Investment securities non-qualifying

Investments in Private Equity, Real Estate and Hedge Funds Merrill Lynch has investments in numerous asset classes, including: direct private equity, private equity funds, hedge funds and real estate funds. Valuing these investments requires significant management judgment due to the nature of the assets and the lack of quoted market prices and liquidity in these assets. Initially, the transaction price of the investment is generally considered to be the best indicator of fair value. Thereafter, valuation of direct investments is based on an assessment of each individual investment using various methodologies, which include publicly traded comparables derived by multiplying a key performance metric (e.g., earnings before interest, taxes, depreciation and amortization ("EBITDA")) of the portfolio company by the relevant valuation multiple observed for comparable companies, acquisition comparables, entry level multiples and discounted cash flows. These valuations are subject to appropriate discounts for lack of liquidity or marketability. Certain factors which may influence changes to fair value include but are not limited to, recapitalizations, subsequent rounds of financing, and offerings in the equity or debt capital markets. For fund investments, Merrill Lynch generally records the fair value of its proportionate interest in the fund's capital as reported by the fund's respective managers.

Investment securities non-qualifying include equity securities that have recently gone through initial public offerings or secondary sales of public positions. These investments are primarily classified as either Level 1 or Level 2 in the fair value hierarchy. Level 2 classifications generally include those publicly traded equity investments that have a legal or contractual transfer restriction. All other investments in private equity, real estate and hedge funds are classified as Level 3 in the fair value hierarchy due to infrequent trading and/or unobservable market prices.

Resale and repurchase agreements

Merrill Lynch elected the fair value option for certain resale and repurchase agreements. For such agreements, the fair value is estimated using a discounted cash flow model which incorporates inputs such as interest rate yield curves and option volatility. Resale and repurchase agreements for which the fair value option has been elected are generally classified as Level 2 in the fair value hierarchy.

Long-term and short-term borrowings

Merrill Lynch and its consolidated VIEs issue structured notes that have coupons or repayment terms linked to the performance of debt or equity securities, indices, currencies or commodities. The fair value of structured notes is estimated using valuation models for the combined derivative and debt portions of the notes when the fair value option has been elected. These models incorporate observable, and in some instances unobservable, inputs including security prices, interest rate yield curves, option volatility, currency, commodity or equity rates and correlations between these inputs. The impact of Merrill Lynch's own credit spreads is also included based on Merrill Lynch's observed secondary bond market spreads. Structured notes are classified as either Level 2 or Level 3 in the fair value hierarchy.

Recurring Fair Value
The following tables present Merrill Lynch’s fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011, respectively.

(dollars in millions)
 
Fair Value Measurements on a Recurring Basis
 
as of June 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Netting
Adj(1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Securities segregated for regulatory purposes or deposited with clearing organizations:
 
 
 
 
 
 
 
 
 
Corporate debt
$
—

 
$
88

 
$
—

 
$
—

 
$
88

Non-U.S. governments and agencies
143

 
1,723

 
—

 
—

 
1,866

U.S. Government and agencies
3,658

 
250

 
—

 
—

 
3,908

Total securities segregated for regulatory purposes or deposited with clearing organizations
3,801

 
2,061

 
—

 
—

 
5,862

Receivables under resale agreements
—

 
90,533

 
—

 
—

 
90,533

Receivables under securities borrowed transactions
—

 
500

 
—

 
—

 
500

Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
Equities
15,700

 
8,546

 
185

 
—

 
24,431

Convertible debentures
—

 
4,109

 
34

 
—

 
4,143

Non-U.S. governments and agencies
32,731

 
3,445

 
389

 
—

 
36,565

Corporate debt
—

 
11,686

 
2,106

 
—

 
13,792

Preferred stock
—

 
89

 
228

 
—

 
317

Mortgages, mortgage-backed and asset-backed
—

 
4,917

 
4,578

 
—

 
9,495

U.S. Government and agencies
30,094

 
23,816

 
—

 
—

 
53,910

Municipals and money markets
1,077

 
8,567

 
1,730

 
—

 
11,374

Physical commodities and other
—

 
174

 
—

 
—

 
174

Total trading assets, excluding derivative contracts
79,602

 
65,349

 
9,250

 
—

 
154,201

Derivative contracts(2)
1,997

 
675,105

 
8,001

 
(657,031
)
 
28,072

Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
U.S. treasury securities and agency debentures
404

 
—

 
—

 
—

 
404

Securities, mortgage-backed and asset backed
 
 
 
 
 
 
 
 
 
     Non-agency MBS
—

 
57

 
—

 
—

 
57

     Corporate ABS
—

 
230

 
8

 
—

 
238

Total investment securities available-for-sale
404

 
287

 
8

 
—

 
699

Investment securities non-qualifying
2,489

 
780

 
333

 
—

 
3,602

Total investment securities
2,893

 
1,067

 
341

 
—

 
4,301

Securities received as collateral
15,972

 
563

 
—

 
—

 
16,535

Loans, notes and mortgages
—

 
1,046

 
1,776

 
—

 
2,822

   Other assets
—

 
—

 
1,263

 
—

 
1,263

Liabilities:
 
 
 
 
 
 
 
 
 
Payables under repurchase agreements
—

 
48,663

 
—

 
—

 
48,663

Short-term borrowings
—

 
3,816

 
—

 
—

 
3,816

Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
Equities
20,285

 
2,038

 
—

 
—

 
22,323

Convertible debentures
—

 
214

 
—

 
—

 
214

Non-U.S. governments and agencies
17,012

 
1,307

 
—

 
—

 
18,319

Corporate debt
—

 
8,094

 
9

 
—

 
8,103

Preferred stock
—

 
120

 
9

 
—

 
129

U.S. Government and agencies
17,285

 
1,335

 
—

 
—

 
18,620

Municipals, money markets and other
446

 
72

 
44

 
—

 
562

Total trading liabilities, excluding derivative contracts
55,028

 
13,180

 
62

 
—

 
68,270

 Derivative contracts(2)
1,727

 
680,654

 
4,587

 
(662,709
)
 
24,259

Obligation to return securities received as collateral
15,972

 
563

 
—

 
—

 
16,535

Other payables — interest and other
—

 
131

 
2

 
—

 
133

Long-term borrowings
—

 
29,334

 
1,469

 
—

 
30,803

 
 
 
 
 
 
 
 
 
 

During the six months ended June 30, 2012, $1,740 million and $350 million of assets and liabilities, respectively, were transferred from Level 1 to Level 2, and $785 million and $40 million of assets and liabilities, respectively, were transferred from Level 2 to Level 1.  Of the asset transfer from Level 1 to Level 2, $640 million was due to a restriction that became effective for a non-qualifying investment security during the first quarter of 2012, while $535 million of the asset transfer from Level 2 to Level 1 was due to the lapse of this restriction during the second quarter of 2012.  The remaining transfers were the result of additional information associated with certain equities, derivative contracts and investment securities non-qualifying.

(dollars in millions)
 
Fair Value Measurements on a Recurring Basis
 
as of December 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
Netting
Adj(1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Securities segregated for regulatory purposes or deposited with clearing organizations:
 
 
 
 
 
 
 
 
 
Corporate debt
$
—

 
$
295

 
$
—

 
$
—

 
$
295

Non-U.S. governments and agencies
—

 
1,757

 
—

 
—

 
1,757

U.S. Government and agencies
1,796

 
740

 
—

 
—

 
2,536

Total securities segregated for regulatory purposes or deposited with clearing organizations
1,796

 
2,792

 
—

 
—

 
4,588

Receivables under resale agreements
—

 
85,652

 
—

 
—

 
85,652

Receivables under securities borrowed transactions
—

 
259

 
—

 
—

 
259

Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
Equities
14,962

 
5,860

 
179

 
—

 
21,001

Convertible debentures
—

 
4,519

 
99

 
—

 
4,618

Non-U.S. governments and agencies
28,026

 
1,871

 
342

 
—

 
30,239

Corporate debt
—

 
13,027

 
3,962

 
—

 
16,989

Preferred stock
—

 
89

 
227

 
—

 
316

Mortgages, mortgage-backed and asset-backed
—

 
5,055

 
3,199

 
—

 
8,254

U.S. Government and agencies
22,183

 
20,820

 
—

 
—

 
43,003

Municipals and money markets
1,067

 
9,755

 
2,047

 
—

 
12,869

Physical commodities and other
—

 
175

 
—

 
—

 
175

 Total trading assets, excluding derivative contracts
66,238

 
61,171

 
10,055

 
—

 
137,464

  Derivative contracts(2)
1,810

 
722,108

 
10,110

 
(699,015
)
 
35,013

Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
U.S. treasury securities and agency debentures
398

 
—

 
—

 
—

 
398

Securities, mortgage-backed and asset backed
 
 
 
 
 
 
 
 
 
     Non-agency MBS
—

 
249

 
—

 
—

 
249

     Corporate ABS
—

 
—

 
47

 
—

 
47

Total investment securities available-for-sale
398

 
249

 
47

 
—

 
694

Investment securities non-qualifying
2,624

 
328

 
574

 
—

 
3,526

Total investment securities
3,022

 
577

 
621

 
—

 
4,220

Securities received as collateral
13,058

 
658

 
—

 
—

 
13,716

Loans, notes and mortgages
—

 
596

 
1,726

 
—

 
2,322

Other assets
—

 
—

 
1,349

 
—

 
1,349

Liabilities:
 
 
 
 
 
 
 
 
 
Payables under repurchase agreements
—

 
34,235

 
—

 
—

 
34,235

Short-term borrowings
—

 
5,908

 
—

 
—

 
5,908

Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
Equities
10,868

 
1,230

 
—

 
—

 
12,098

Convertible debentures
—

 
125

 
—

 
—

 
125

Non-U.S. governments and agencies
15,911

 
643

 
—

 
—

 
16,554

Corporate debt
—

 
6,927

 
52

 
—

 
6,979

Preferred stock
—

 
89

 
16

 
—

 
105

U.S. Government and agencies
15,603

 
1,373

 
—

 
—

 
16,976

Municipals, money markets and other
549

 
51

 
45

 
—

 
645

Total trading liabilities, excluding derivative contracts
42,931

 
10,438

 
113

 
—

 
53,482

Derivative contracts(2)
1,419

 
724,713

 
5,615

 
(705,508
)
 
26,239

Obligation to return securities received as collateral
13,058

 
658

 
—

 
—

 
13,716

Other payables — interest and other
—

 
163

 
10

 
—

 
173

Long-term borrowings
—

 
28,139

 
2,186

 
—

 
30,325

 
 
 
 
 
 
 
 
 
 
(1)
Represents counterparty and cash collateral netting.
(2)
Refer to Note 6 for product level detail.

Transfers between Level 1 and Level 2 assets and liabilities were not significant for the year ended December 31, 2011.
Level 3 derivative contracts (assets) relate to derivative positions on U.S. ABS CDOs and other mortgage products of $2.4 billion, $3.1 billion of other credit derivatives that incorporate unobservable model valuation inputs, and $4.6 billion of equity, currency, interest rate and commodity derivatives that are long-dated and/or have unobservable model valuation inputs (e.g., unobservable correlation).
Level 3 non-qualifying investment securities primarily relate to certain private equity positions.
Level 3 loans, notes and mortgages primarily relate to residential mortgage and corporate loans.
Level 3 other assets represent net monoline exposure to a single counterparty. This exposure was reclassified from derivative contracts (assets) during the third quarter of 2011 because of the inherent default risk and given that these contracts no longer provide a hedge benefit (see Note 6).
Level 3 derivative contracts (liabilities) relate to derivative positions on U.S. ABS CDOs and other mortgage products of $1.6 billion, $0.7 billion of other credit derivatives that incorporate unobservable model valuation inputs, and $3.3 billion of equity, currency, interest rate and commodity derivatives that are long-dated and/or have unobservable model valuation inputs (e.g., unobservable correlation).

Level 3 long-term borrowings primarily relate to equity-linked structured notes of $1.7 billion, which have unobservable model valuation inputs (e.g., unobservable correlation).

Level 3 Financial Instruments
The following tables provide a summary of changes in Merrill Lynch’s Level 3 financial assets and liabilities for the three and six months ended June 30, 2012 and June 30, 2011.

(dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 3 Financial Assets and Liabilities
Three Months Ended June 30, 2012
 
 
 
Total Realized and Unrealized
Gains or (Losses) included in Income
 
Total Realized
and Unrealized Gains
or (Losses)
included in Income
 
Unrealized
Gains or (Losses) to
OCI
 
Sales
 
Purchases
 
Issuances
 
Settlements
 
 
 
 
 
 
 
Beginning
Balance
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
 
 
 
 
 
 
Transfers
In
 
Transfers
Out
 
Ending
Balance
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
178

 
$
(6
)
 
$
—

 
$
—

 
$
(6
)
 
$
—

 
(13
)
 
1

 
$
—

 
—

 
$
25

 
$
—

 
$
185

Convertible debentures
43

 
(2
)
 
—

 
—

 
(2
)
 
—

 
—

 
—

 
—

 
—

 
—

 
(7
)
 
34

Non-U.S. governments and agencies
546

 
(26
)
 
—

 
—

 
(26
)
 
—

 
(164
)
 
35

 
—

 
(1
)
 
—

 
(1
)
 
389

Corporate debt(1)
3,418

 
6

 
—

 
—

 
6

 
—

 
(1,232
)
 
189

 
—

 
(285
)
 
92

 
(82
)
 
2,106

Preferred stock
207

 
(1
)
 
—

 
—

 
(1
)
 
—

 
(22
)
 
44

 
—

 
—

 
—

 
—

 
228

Mortgages, mortgage-backed and asset-backed(1)
3,768

 
(38
)
 
—

 
—

 
(38
)
 
—

 
(163
)
 
1,164

 
—

 
(153
)
 
—

 
—

 
4,578

Municipals and money markets
2,009

 
15

 
—

 
—

 
15

 
—

 
(187
)
 
73

 
—

 
(180
)
 
—

 
—

 
1,730

Total trading assets, excluding derivative contracts
10,169

 
(52
)
 
—

 
—

 
(52
)
 
—

 
(1,781
)
 
1,506

 
—

 
(619
)
 
117

 
(90
)
 
9,250

Derivative contracts, net
3,207

 
159

 
—

 
—

 
159

 
—

 
(121
)
 
207

 
—

 
29

 
(38
)
 
(29
)
 
3,414

Investment securities available-for-sale :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate ABS
45

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(37
)
 
—

 
—

 
8

Total investment securities available-for-sale
45

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(37
)
 
—

 
—

 
8

Investment securities non-qualifying
421

 
—

 
1

 
—

 
1

 
—

 
(77
)
 
—

 
—

 
(12
)
 
—

 
—

 
333

Total investment securities
466

 
—

 
1

 
—

 
1

 
—

 
(77
)
 
—

 
—

 
(49
)
 
—

 
—

 
341

Loans, notes and mortgages
1,809

 
—

 
19

 
8

 
27

 
—

 
(16
)
 
3

 
—

 
(47
)
 
—

 
—

 
1,776

Other assets
1,302

 
—

 
(39
)
 
—

 
(39
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,263

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
—

 
—

 
—

 
—

 
—

 
—

 
16

 
(6
)
 
—

 
1

 
1

 
(3
)
 
9

Preferred stock
14

 
—

 
—

 
—

 
—

 
—

 
9

 
(1
)
 
—

 
—

 
—

 
(13
)
 
9

Municipals, money markets and other
45

 
4

 
—

 
—

 
4

 
—

 
3

 
—

 
—

 
—

 
—

 
—

 
44

Total trading liabilities, excluding derivative contracts
59

 
4

 
—

 
—

 
4

 
—

 
28

 
(7
)
 
—

 
1

 
1

 
(16
)
 
62

Other payables - interest and other
3

 
—

 
1

 
—

 
1

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
2

Long-term borrowings
1,743

 
80

 
9

 
—

 
89

 
—

 
—

 
(30
)
 
53

 
(252
)
 
219

 
(175
)
 
1,469

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(1)
During the second quarter of 2012, approximately $900 million was reclassified from Corporate debt to Mortgages, mortgage-backed and asset-backed.  In the table above, this reclassification is presented as a sale of Corporate debt and as a purchase of Mortgages, mortgage-backed and asset-backed trading assets.
Transfers in and out for corporate debt primarily relate to changes in market liquidity for certain corporate loans. Transfers in and out related to long-term borrowings are primarily due to changes in the impact of unobservable inputs on the value of certain equity-linked structured notes.


(dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 3 Financial Assets and Liabilities
Six Months Ended June 30, 2012
 
 
 
Total Realized and Unrealized
Gains or (Losses) included in Income
 
Total Realized
and Unrealized Gains
or (Losses)
included in Income
 
Unrealized
Gains or (Losses) to
OCI
 
Sales
 
Purchases
 
Issuances
 
Settlements
 
 
 
 
 
 
 
Beginning
Balance
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
 
 
 
 
 
 
Transfers
In
 
Transfers
Out
 
Ending
Balance
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
179

 
$
(5
)
 
$
—

 
$
—

 
$
(5
)
 
$
—

 
(52
)
 
42

 
$
—

 
(9
)
 
$
32

 
$
(2
)
 
$
185

Convertible debentures
99

 
—

 
—

 
—

 
—

 
—

 
(53
)
 
—

 
—

 
—

 
5

 
(17
)
 
34

Non-U.S. governments and agencies
342

 
(2
)
 
—

 
—

 
(2
)
 
—

 
(245
)
 
308

 
—

 
(1
)
 
—

 
(13
)
 
389

Corporate debt(1)
3,962

 
91

 
—

 
—

 
91

 
—

 
(1,755
)
 
557

 
—

 
(439
)
 
148

 
(458
)
 
2,106

Preferred stock
227

 
11

 
—

 
—

 
11

 
—

 
(92
)
 
82

 
—

 
(1
)
 
1

 
—

 
228

Mortgages, mortgage-backed and asset-backed(1)
3,199

 
52

 
—

 
—

 
52

 
—

 
(393
)
 
1,330

 
—

 
(233
)
 
736

 
(113
)
 
4,578

Municipals and money markets
2,047

 
9

 
—

 
—

 
9

 
—

 
(319
)
 
207

 
—

 
(191
)
 
—

 
(23
)
 
1,730

Total trading assets, excluding derivative contracts
10,055

 
156

 
—

 
—

 
156

 
—

 
(2,909
)
 
2,526

 
—

 
(874
)
 
922

 
(626
)
 
9,250

Derivative contracts, net
4,495

 
(542
)
 
—

 
—

 
(542
)
 
—

 
(379
)
 
560

 
—

 
(346
)
 
21

 
(395
)
 
3,414

Investment securities available-for-sale :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate ABS
47

 
—

 
(2
)
 
—

 
(2
)
 
—

 
—

 
—

 
—

 
(37
)
 
—

 
—

 
8

Total investment securities available-for-sale
47

 
—

 
(2
)
 
—

 
(2
)
 
—

 
—

 
—

 
—

 
(37
)
 
—

 
—

 
8

Investment securities non-qualifying
574

 
—

 
(6
)
 
—

 
(6
)
 
—

 
(90
)
 
9

 
—

 
(154
)
 
—

 
—

 
333

Total investment securities
621

 
—

 
(8
)
 
—

 
(8
)
 
—

 
(90
)
 
9

 
—

 
(191
)
 
—

 
—

 
341

Loans, notes and mortgages
1,726

 
—

 
114

 
15

 
129

 
—

 
(16
)
 
7

 
—

 
(70
)
 
—

 
—

 
1,776

Other assets
1,349

 
—

 
(86
)
 
—

 
(86
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,263

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
52

 
—

 
—

 
—

 
—

 
—

 
35

 
(44
)
 
—

 
1

 
2

 
(37
)
 
9

Preferred stock
16

 
(2
)
 
—

 
—

 
(2
)
 
—

 
9

 
(5
)
 
—

 
—

 
—

 
(13
)
 
9

Municipals, money markets and other
45

 
5

 
—

 
—

 
5

 
—

 
9

 
(6
)
 
1

 
—

 
—

 
—

 
44

Total trading liabilities, excluding derivative contracts
113

 
3

 
—

 
—

 
3

 
—

 
53

 
(55
)
 
1

 
1

 
2

 
(50
)
 
62

Other payables - interest and other
10

 
—

 
4

 
—

 
4

 
—

 
—

 
(1
)
 
—

 
—

 
—

 
(3
)
 
2

Long-term borrowings
2,186

 
(59
)
 
(35
)
 
—

 
(94
)
 
—

 
33

 
(98
)
 
81

 
(629
)
 
441

 
(639
)
 
1,469

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
During the six months ended June 30, 2012, approximately $900 million was reclassified from Corporate debt to Mortgages, mortgage-backed and asset-backed.  In the table above, this reclassification is presented as a sale of Corporate debt and as a purchase of Mortgages, mortgage-backed and asset-backed trading assets.
Transfers in and out for corporate debt primarily relate to changes in market liquidity for certain corporate loans. Transfers in for mortgages, mortgage-backed and asset-backed is primarily the result of additional information related to certain CLOs. Transfers out for mortgages, mortgage-backed and asset-backed relates to increased market activity (i.e., executed trades) for certain loans backed by commercial real estate. Transfers out for derivative contracts, net primarily relates to increased price observability (i.e., market comparables) for certain total return swaps ("TRS") and foreign exchange swaps. Transfers in and out related to long-term borrowings are primarily due to changes in the impact of unobservable inputs on the value of certain equity-linked structured notes.

(dollars in millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 3 Financial Assets and Liabilities
Three Months Ended June 30, 2011
 
 
 
Total Realized and Unrealized
Gains or (Losses) included in Income
 
Total Realized
and Unrealized Gains
or (Losses)
included in Income
 
Unrealized
Gains or (Losses) to
OCI
 
Sales
 
Purchases
 
Issuances
 
Settlements
 
 
 
 
 
 
 
Beginning
Balance
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
 
 
 
 
 
 
Transfers
In
 
Transfers
Out
 
Ending
Balance
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
215

 
$
1

 
$
—

 
$
—

 
$
1

 
$
—

 
(38
)
 
48

 
$
—

 
$
(63
)
 
$
—

 
$
—

 
$
163

Convertible debentures
119

 
7

 
—

 
—

 
7

 
—

 
(84
)
 
110

 
—

 
—

 
—

 
—

 
152

Non-U.S. governments and agencies
252

 
80

 
—

 
—

 
80

 
—

 
(11
)
 
74

 
—

 
(3
)
 
3

 
(4
)
 
391

Corporate debt
3,998

 
42

 
—

 
—

 
42

 
—

 
(1,027
)
 
777

 
—

 
(69
)
 
151

 
(26
)
 
3,846

Preferred stock
325

 
19

 
—

 
—

 
19

 
—

 
(93
)
 
27

 
—

 
(52
)
 
81

 
—

 
307

Mortgages, mortgage-backed and asset-backed
5,433

 
55

 
—

 
—

 
55

 
—

 
(1,572
)
 
952

 
—

 
(20
)
 
—

 
—

 
4,848

Municipals and money markets
2,350

 
12

 
—

 
—

 
12

 
—

 
(743
)
 
948

 
—

 
(149
)
 
68

 
—

 
2,486

Total trading assets, excluding derivative contracts
12,692

 
216

 
—

 
—

 
216

 
—

 
(3,568
)
 
2,936

 
—

 
(356
)
 
303

 
(30
)
 
12,193

Derivative contracts, net
5,554

 
284

 
—

 
—

 
284

 
—

 
(250
)
 
296

 
—

 
(424
)
 
—

 
(359
)
 
5,101

Investment securities available-for-sale :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities — agency CMOs
56

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1
)
 
—

 
—

 
55

Mortgage-backed securities — non-agency MBSs
103

 
—

 
(6
)
 
—

 
(6
)
 
(3
)
 
—

 
2

 
—

 
—

 
—

 
—

 
96

Corporate ABS
—

 
—

 
—

 
—

 
—

 
—

 
—

 
86

 
—

 
—

 
—

 
—

 
86

Total investment securities available-for-sale
159

 
—

 
(6
)
 
—

 
(6
)
 
(3
)
 
—

 
88

 
—

 
(1
)
 
—

 
—

 
237

Investment securities non-qualifying
1,095

 
—

 
125

 
—

 
125

 
—

 
(48
)
 
24

 
—

 
—

 
375

 
—

 
1,571

Total investment securities
1,254

 
—

 
119

 
—

 
119

 
(3
)
 
(48
)
 
112

 
—

 
(1
)
 
375

 
—

 
1,808

Loans, notes and mortgages
1,993

 
—

 
54

 
9

 
63

 
—

 
(327
)
 
113

 
215

 
(113
)
 
22

 
(26
)
 
1,940

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
52

 
(1
)
 
—

 
—

 
(1
)
 
—

 
20

 
(45
)
 
—

 
—

 
—

 
—

 
28

Preferred stock
23

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
23

Municipals, money markets and other
22

 
—

 
—

 
—

 
—

 
—

 
—

 
(19
)
 
—

 
—

 
—

 
—

 
3

Total trading liabilities, excluding derivative contracts
97

 
(1
)
 
—

 
—

 
(1
)
 
—

 
20

 
(64
)
 
—

 
—

 
—

 
—

 
54

Other payables - interest and other
100

 
—

 
1

 
—

 
1

 
—

 
—

 
—

 
9

 
—

 
—

 
—

 
108

Long-term borrowings
2,364

 
(10
)
 
20

 
—

 
10

 
—

 
55

 
(50
)
 
205

 
(95
)
 
229

 
(166
)
 
2,532

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Sales of mortgages, mortgage-backed and asset-backed securities primarily relates to the sale of CDO positions in conjunction with the liquidation of a VIE and sales of collateralized loan obligation (“CLO”) positions due to the unwind of the proprietary trading business. Sales and purchases of municipal securities is primarily due to dealer activity in student loan ARS.
Transfers in for corporate debt are primarily due to corporate bond private placements with limited market activity. Transfers out for net derivative contracts primarily relates to increased price observability for certain equity derivative positions. Transfers in for investment securities non-qualifying are due to a change in the valuation methodology for a private equity fund. Transfers in and out related to long-term borrowings are primarily due to changes in the impact of unobservable inputs on the value of certain equity-linked structured notes.

(dollars in millions)
 
Level 3 Financial Assets and Liabilities
Six Months Ended June 30, 2011
 
 
 
Total Realized and Unrealized
Gains or (Losses) included in Income
 
Total Realized
and Unrealized Gains
or (Losses)
included in Income
 
Unrealized
Gains to
OCI
 
Sales
 
Purchases
 
Issuances
 
Settlements
 
 
 
 
 
 
 
Beginning
Balance
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
 
 
 
 
 
 
Transfers
In
 
Transfers
Out
 
Ending
Balance
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
170

 
$
35

 
$
—

 
$
—

 
$
35

 
$
—

 
$
(86
)
 
$
108

 
$
—

 
$
(63
)
 
$
—

 
$
(1
)
 
$
163

Convertible debentures
—

 
7

 
—

 
—

 
7

 
—

 
(84
)
 
229

 
—

 
—

 
—

 
—

 
152

Non-U.S. governments and agencies
243

 
85

 
—

 
—

 
85

 
—

 
(15
)
 
122

 
—

 
(3
)
 
3

 
(44
)
 
391

Corporate debt
4,605

 
327

 
—

 
—

 
327

 
—

 
(2,096
)
 
1,118

 
—

 
(108
)
 
247

 
(247
)
 
3,846

Preferred stock
287

 
28

 
—

 
—

 
28

 
—

 
(106
)
 
30

 
—

 
(52
)
 
120

 
—

 
307

Mortgages, mortgage-backed and asset-backed
5,747

 
384

 
—

 
—

 
384

 
—

 
(2,408
)
 
1,513

 
—

 
(39
)
 
1

 
(350
)
 
4,848

Municipals and money markets
2,327

 
31

 
—

 
—

 
31

 
—

 
(1,652
)
 
1,884

 
—

 
(172
)
 
72

 
(4
)
 
2,486

Total trading assets, excluding derivative contracts
13,379

 
897

 
—

 
—

 
897

 
—

 
(6,447
)
 
5,004

 
—

 
(437
)
 
443

 
(646
)
 
12,193

Derivative contracts, net
6,368

 
27

 
—

 
—

 
27

 
—

 
(682
)
 
633

 
—

 
(862
)
 
299

 
(682
)
 
5,101

Investment securities available-for-sale :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities — agency CMOs
—

 
—

 
—

 
—

 
—

 
—

 
—

 
56

 
—

 
(1
)
 
—

 
—

 
55

Mortgage-backed securities — non-agency MBSs
213

 
—

 
(15
)
 
—

 
(15
)
 
(22
)
 
(82
)
 
2

 
—

 
—

 
—

 
—

 
96

Corporate ABS
—

 
—

 
—

 
—

 
—

 
—

 
—

 
86

 
—

 
—

 
—

 
—

 
86

Total investment securities available-for-sale
213

 
—

 
(15
)
 
—

 
(15
)
 
(22
)
 
(82
)
 
144

 
—

 
(1
)
 
—

 
—

 
237

Investment securities non-qualifying
3,394

 
—

 
345

 
—

 
345

 
—

 
(852
)
 
46

 
—

 
(189
)
 
375

 
(1,548
)
 
1,571

Total investment securities
3,607

 
—

 
330

 
—

 
330

 
(22
)
 
(934
)
 
190

 
—

 
(190
)
 
375

 
(1,548
)
 
1,808

Loans, notes and mortgages
1,891

 
—

 
229

 
17

 
246

 
—

 
(496
)
 
144

 
215

 
(155
)
 
135

 
(40
)
 
1,940

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
—

 
(1
)
 
—

 
—

 
(1
)
 
—

 
72

 
(45
)
 
—

 
—

 
—

 
—

 
28

Preferred stock
—

 
—

 
—

 
—

 
—

 
—

 
23

 
—

 
—

 
—

 
—

 
—

 
23

Municipals, money markets and other
—

 
—

 
—

 
—

 
—

 
—

 
22

 
(19
)
 
—

 
—

 
—

 
—

 
3

Total trading liabilities, excluding derivative contracts
—

 
(1
)
 
—

 
—

 
(1
)
 
—

 
117

 
(64
)
 
—

 
—

 
—

 
—

 
54

Other payables - interest and other
126

 
—

 
25

 
—

 
25

 
—

 
4

 
(6
)
 
9

 
—

 
—

 
—

 
108

Long-term borrowings
2,396

 
(102
)
 
(15
)
 
—

 
(117
)
 
—

 
55

 
(112
)
 
248

 
(326
)
 
529

 
(375
)
 
2,532

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Sales of corporate debt primarily relates to sales of corporate ARS and distressed loans during the first quarter of 2011. Sales of mortgages, mortgage-backed and asset-backed securities primarily relates to the sale of CDO positions in conjunction with the liquidation of a VIE and sales of CLO positions due to the unwind of the proprietary trading business. Sales and purchases of municipal securities is primarily due to dealer activity in student loan ARS. Sales of investment securities non-qualifying relates to the sale of a private equity investment during the first quarter of 2011.
Transfers in for corporate debt are primarily due to corporate bond private placements with limited market activity. Transfers out for corporate debt primarily relates to increased price observability (e.g., trading comparables) for certain corporate bond positions. Transfers out for mortgages, mortgage-backed and asset-backed securities primarily relates to increased price observability for certain RMBS and consumer ABS portfolios. Transfers in for net derivative contracts primarily relates to changes in the valuation methodology for certain CDO positions. Transfers out for net derivative contracts primarily relates to increased price observability for certain equity and credit derivative positions. Transfers in for investment securities non-qualifying are due to a change in the valuation methodology for a private equity fund. Transfers out related to investment securities non-qualifying are due to a private equity investment that underwent an initial public offering during the first quarter of 2011. Transfers in and out related to long-term borrowings are primarily due to changes in the impact of unobservable inputs on the value of certain equity-linked structured notes.
The following tables provide the portion of gains or losses included in income for the three and six months ended June 30, 2012 and June 30, 2011 attributable to unrealized gains or losses relating to those Level 3 assets and liabilities held at June 30, 2012 and June 30, 2011, respectively.


(dollars in millions)
 
Unrealized Gains or (Losses) for Level 3
Assets and Liabilities Still Held
 
Three Months ended June 30, 2012
 
Six Months ended June 30, 2012
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
Total
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
(6
)
 
$
—

 
$
—

 
$
(6
)
 
$
1

 
$
—

 
$
—

 
$
1

Convertible debentures
(2
)
 
—

 
—

 
(2
)
 
—

 
—

 
—

 
—

Non-U.S. governments and agencies
(25
)
 
—

 
—

 
(25
)
 
—

 
—

 
—

 
—

Corporate debt
(35
)
 
—

 
—

 
(35
)
 
3

 
—

 
—

 
3

Preferred stock
(1
)
 
—

 
—

 
(1
)
 
2

 
—

 
—

 
2

Mortgages, mortgage-backed and asset-backed
(45
)
 
—

 
—

 
(45
)
 
(7
)
 
—

 
—

 
(7
)
Municipals and money markets
6

 
—

 
—

 
6

 
(3
)
 
—

 
—

 
(3
)
Total trading assets, excluding derivative contracts
(108
)
 
—

 
—

 
(108
)
 
(4
)
 
—

 
—

 
(4
)
Derivative contracts, net
173

 
—

 
—

 
173

 
(429
)
 
—

 
—

 
(429
)
Investment securities non-qualifying
—

 
1

 
—

 
1

 
—

 
(10
)
 
—

 
(10
)
Loans, notes and mortgages
—

 
13

 
—

 
13

 
—

 
110

 
—

 
110

Other assets
—

 
(39
)
 
—

 
(39
)
 
—

 
(86
)
 
—

 
(86
)
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
—

 
—

 
—

 
—

 
(2
)
 
—

 
—

 
(2
)
Municipals, money markets and other
3

 
—

 
—

 
3

 
3

 
—

 
—

 
3

Total trading liabilities, excluding derivative contracts
3

 
—

 
—

 
3

 
1

 
—

 
—

 
1

Other payables — interest and other
—

 
1

 
—

 
1

 
—

 
—

 
—

 
—

Long-term borrowings
82

 
9

 
—

 
91

 
(12
)
 
—

 
—

 
(12
)

(dollars in millions)
 
Unrealized Gains or (Losses) for Level 3
Assets and Liabilities Still Held
 
Three Months ended June 30, 2011
 
Six Months ended June 30, 2011
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
Total
 
Principal
Transactions
 
Other
Revenue
 
Interest
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading assets, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equities
$
(61
)
 
$
—

 
$
—

 
$
(61
)
 
$
(46
)
 
$
—

 
$
—

 
$
(46
)
Convertible debentures
3

 
—

 
—

 
3

 
3

 
—

 
—

 
3

Non-U.S. governments and agencies
67

 
—

 
—

 
67

 
70

 
—

 
—

 
70

Corporate debt
(44
)
 
—

 
—

 
(44
)
 
154

 
—

 
—

 
154

Preferred stock
17

 
—

 
—

 
17

 
23

 
—

 
—

 
23

Mortgages, mortgage-backed and asset-backed
(42
)
 
—

 
—

 
(42
)
 
201

 
—

 
—

 
201

Municipals and money markets
(3
)
 
—

 
—

 
(3
)
 
16

 
—

 
—

 
16

Total trading assets, excluding derivative contracts
(63
)
 
—

 
—

 
(63
)
 
421

 
—

 
—

 
421

Derivative contracts, net
344

 
—

 
—

 
344

 
269

 
—

 
—

 
269

Investment securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities - non-agency MBSs
—

 
(6
)
 
—

 
(6
)
 
—

 
(25
)
 
—

 
(25
)
Total investment securities available-for-sale
—

 
(6
)
 
—

 
(6
)
 
—

 
(25
)
 
—

 
(25
)
Investment securities non-qualifying
—

 
122

 
—

 
122

 
—

 
92

 
—

 
92

Total investment securities
—

 
116

 
—

 
116

 
—

 
67

 
—

 
67

Loans, notes and mortgages
—

 
17

 
—

 
17

 
—

 
185

 
—

 
185

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading liabilities, excluding derivative contracts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
(1
)
 
—

 
—

 
(1
)
 
(1
)
 
—

 
—

 
(1
)
Total trading liabilities, excluding derivative contracts
(1
)
 
—

 
—

 
(1
)
 
(1
)
 
—

 
—

 
(1
)
Other payables — interest and other
—

 
(20
)
 
—

 
(20
)
 
—

 
2

 
—

 
2

Long-term borrowings
(10
)
 
8

 
—

 
(2
)
 
(102
)
 
(27
)
 
—

 
(129
)



Level 3 Significant Inputs
The following tables present information about significant unobservable inputs related to material components of Merrill Lynch's Level 3 financial assets and liabilities as of June 30, 2012:
Quantitative Information about Level 3 Fair Value Measurements
(Dollars in millions)
 
Inputs
Financial Instrument
Fair Value
Valuation Techniques
Unobservable Inputs
Ranges of Inputs
Loans and Securities

 


Instruments backed by residential real estate assets
$
1,585

Discounted Cash Flow
Yield
1% to 25%
Loans, notes and mortgages
958

Prepayment Speeds
3% to 10% CPR
Trading assets - Mortgages, mortgage-backed and asset-backed
627

Default Rates
1% to 3% CDR
 


Loss Severities
35% to 45%
Instruments backed by commercial real estate assets
$
1,930

Discounted Cash Flow
Yield
1% to 10%
Loans, notes and mortgages
368

Loss Severities
33% to 97%
Other assets
1,263



Trading assets - Mortgages, mortgage-backed and asset-backed
299



Commercial loans, debt securities and other
$
6,208

Discounted Cash Flow, Market Comparables
Yield
0% to 20%
Loans, notes and mortgages
450

Enterprise Value/EBITDA multiple
3x to 7x
Trading assets - Mortgages, mortgage-backed and asset-backed
3,652

Prepayment Speed
5% to 25%
Trading assets - Corporate debt
2,106

Default Rates
1% to 5%
 


Loss Severity
25% to 40%
Auction Rate Securities


Discounted Cash Flow, Market Comparables
Projected tender price / re-financing level
50% to 100%
Trading assets - Municipals and money markets
$
1,730



Long-term borrowings (structured notes)
 
 
 
 
Long-term borrowings
$
1,469

Industry Standard Derivative Pricing (1)
Equity Correlation
30% to 97%
 


Long-Dated Volatilities
20% to 70%

(1)
Includes models such as Monte Carlo simulation and Black-Scholes.

CPR = Constant Prepayment Rate
CDR = Constant Default Rate






Quantitative Information about Level 3 Fair Value Measurements
(Dollars in millions)
 
Inputs
Financial Instrument
Fair Value
Valuation Techniques
Unobservable Inputs
Ranges of Inputs
Net Derivative Contracts

 


   Credit derivatives
$
3,116

Discounted Cash Flow, Hazard Rate Model (1), Stochastic Recovery Correlation Model
Yield
0% to 25%
 


Credit spreads
100bps to 500bps
 


Upfront points
53 to 99
 


Spread to index
-2,000bps to 2,000bps
 


Credit correlation
30% to 80%
 


Prepayment speed
0% to 25% CPR
 


Default rates
0% to 5% CDR
 


Loss severity
0% to 70%
   Equity derivatives
$
(351
)
Industry Standard Derivative Pricing (2)
Equity Correlation
30% to 97%
 


Long-Dated Volatilities
20% to 70%
   Commodity derivatives
$
(1
)
Discounted Cash Flow
Long term Natural Gas basis curve
 -$0.530 to $0.302
   Interest rate derivatives
$
650

Industry Standard Derivative Pricing (2)
Correlation (IR/IR)
15% to 100%
 


Correlation (FX/IR)
-65% to 50%
 


Long Dated Inflation Rates
1.5% to 2.6%
 


Long Dated Inflation Volatilities
0.3% to 0.9%
 


Long Dated Volatilities (FX)
7% to 38%
 


Long Dated Swap Rates
9.5% to 10.3%
Total net derivative contracts
$
3,414

 
 
 

(1) 
The hazard rate model is an industry standard model for valuing CDS for single names or indices.
(2) 
Includes models such as Monte Carlo simulation, Black-Scholes and other methods that model the joint dynamics of interest, inflation and foreign exchange rates.
IR = Interest Rate
FX = Foreign Exchange
CPR = Constant Prepayment Rate
CDR = Constant Default Rate
In the tables above, instruments backed by residential and commercial real estate assets include RMBS, CMBS, whole loans, mortgage CDOs and net monoline exposure. Corporate loans, debt securities and other include corporate CLOs and CDOs, corporate loans and bonds, and securities backed by non-real estate assets. Structured notes primarily include equity-linked notes that are accounted for under the fair value option.

In addition to the instruments disclosed in the table above, Merrill Lynch holds $333 million of Investment securities non-qualifying that are primarily comprised of certain direct private equity investments and private equity funds that are classified as Level 3.  Valuations of direct private equity investments are prepared internally based on the most recent portfolio company financial information. Inputs generally include market and acquisition comparables, entry level multiples, as well as other variables.  Merrill Lynch selects a valuation methodology (e.g., market comparables) for each investment and, in certain instances, multiple inputs are weighted to derive the most representative value.  Discounts are applied as appropriate to consider the lack of liquidity and marketability versus publicly traded companies.  For private equity funds, fair value is generally determined using the net asset value as provided by the individual fund's general partner.

Sensitivity of Fair Value Measurements to Changes in Unobservable Inputs

Loans and Securities

For instruments backed by residential real estate assets, commercial real estate assets, and commercial loans, debt securities and other, a significant increase in market yields, default rates or loss severities would result in a significantly lower fair value for long positions. Short positions would be impacted in a directionally opposite way. The impact of changes in prepayment speeds would have differing impacts depending on the seniority of the instrument and, in the case of CLOs, whether prepayments can be reinvested.

For student loan and municipal auction rate securities, a significant increase in projected tender price/refinancing levels would result in a significantly higher fair value.

Structured Notes and Derivatives

For credit derivatives, a significant increase in market yield, including spreads to indices, upfront points (i.e., a single upfront payment made by a protection buyer at inception) or credit spreads, default rates or loss severities would result in a significantly lower fair value for protection sellers and higher fair value for protection buyers. The impact of changes in prepayment speeds would have differing impacts depending on the seniority of the instrument and, in the case of CLOs, whether prepayments can be reinvested.

Structured credit derivatives, which include tranched portfolio CDS and derivatives with derivative product company ("DPC") and monoline counterparties, are impacted by credit correlation, including default and wrong way correlation. Default correlation is a parameter that describes the degree of dependence between credit default rates within a credit portfolio that underlies a credit derivative instrument. The sensitivity of this input on the fair value varies depending on the level of subordination of the tranche. For senior tranches that are net purchases of protection, a significant increase in default correlation would result in a significantly higher fair value. Net short protection positions would be impacted in a directionally opposite way. Wrong-way correlation is a parameter that describes the probability that as exposure to a counterparty increases, the credit quality of the counterparty decreases. A significantly higher degree of wrong-way correlation between a DPC counterparty and underlying derivative exposure would result in a significantly lower fair value.

For equity derivatives, equity-linked long-term debt (structured notes) and interest rate derivatives, a significant change in long-dated rates and volatilities and correlation inputs (e.g., the degree of correlation between an equity security to an index, between two different interest rates, or between interest rates and foreign exchange rates) would result in a significant impact to the fair value. However, the magnitude and direction of the impact depends on whether Merrill Lynch is long or short the exposure.

Non-recurring Fair Value
Certain assets and liabilities are measured at fair value on a non-recurring basis and are not included in the tables above. These assets and liabilities primarily include loans and loan commitments held for sale that are reported at lower of cost or fair value and loans held for investment that were initially measured at cost and have been written down to fair value as a result of an impairment. The following tables show the fair value hierarchy for those assets and liabilities measured at fair value on a non-recurring basis as of June 30, 2012 and December 31, 2011, and related gains (losses) for the three and six month periods ended June 30, 2012 and June 30, 2011.
(dollars in millions)
 
 
 
 
 
 
 
Non-Recurring Basis
 
Gains/(Losses)
 
Gains/(Losses)
 
Gains/(Losses)
 
Gains/(Losses)
 
as of June 30, 2012
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
 
Level 2
 
Level 3
 
Total
 
June 30, 2012
 
June 30, 2012
 
June 30, 2011
 
June 30, 2011
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities non-qualifying
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(1
)
 
$
(5
)
Loans, notes and mortgages
 
60

 
286

 
346

 
(53
)
 
(40
)
 
9

 
44

Other assets
 
1

 
1

 
2

 
—

 
—

 
(7
)
 
(7
)
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other payables — interest and other
 
$
—

 
$
1

 
$
1

 
$
4

 
$
3

 
$
—

 
$
(1
)

(dollars in millions)
 
Non-Recurring Basis
 
as of December 31, 2011
 
 
Level 2
 
Level 3
 
Total
Assets:
 
 

 
 

 
 

Investment securities non-qualifying
 
$
—

 
$
5

 
$
5

Loans, notes and mortgages
 
298

 
245

 
543

Other assets
 
—

 
19

 
19

 
 
 
 
 
 
 


Loans, notes and mortgages includes held for sale loans that are carried at the lower of cost or fair value and for which the fair value was below the cost basis at June 30, 2012 and December 31, 2011. It also includes certain impaired held for investment loans where an allowance for loan losses has been calculated based upon the fair value of the loans or collateral. Level 3 assets as of June 30, 2012 and December 31, 2011 primarily relate to commercial real estate loans that are classified as held for sale where there continues to be significant illiquidity in the loan trading and securitization markets.

Other payables - interest and other includes amounts recorded for loan commitments at lower of cost or fair value where the funded loan will be held for sale.

Fair Value Option Election
The fair value option election allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in fair value for assets and liabilities for which the election is made will be recognized in earnings as they occur. The fair value option election is permitted on an instrument by instrument basis at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument. As discussed above, certain of Merrill Lynch’s financial instruments are required to be accounted for at fair value under Investment Accounting and Derivatives Accounting, as well as industry level guidance. For certain financial instruments that are not accounted for at fair value under other applicable accounting guidance, the fair value option election has been made.
The following tables provide information about the line items in the Consolidated Statements of Earnings (Loss) where changes in fair values of assets and liabilities, for which the fair value option election has been made, are included for the three and six months ended June 30, 2012 and June 30, 2011.

(dollars in millions)
 
Changes in Fair Value For the Three Months Ended June 30, 2012, for Items Measured at Fair Value Pursuant to the Fair Value Option Election
 
 
Changes in Fair Value For the Six Months Ended June 30, 2012, for Items Measured at Fair Value Pursuant to the Fair Value Option Election
 
Gains
(Losses)
Principal
Transactions
 
Gains
(Losses)
Other
Revenues
 
Total
Changes
in Fair
Value
 
 
Gains
(Losses)
Principal
Transactions
 
Gains
(Losses)
Other
Revenues
 
Total
Changes
in Fair
Value
Assets:
 
 
 
 
 
 
 
 

 
 

 
 

Receivables under resale agreements
$
5

 
$
—

 
$
5

 
 
$
(29
)
 
$
—

 
$
(29
)
Investment securities
—

 
(3
)
 
(3
)
 
 
—

 
2

 
2

Loans
3

 
(15
)
 
(12
)
 
 
29

 
77

 
106

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Payables under repurchase agreements
9

 
—

 
9

 
 
(25
)
 
—

 
(25
)
Short-term borrowings
12

 
—

 
12

 
 
19

 
—

 
19

Other payables — interest and other
—

 
(18
)
 
(18
)
 
 
—

 
31

 
31

Long-term borrowings
592

 
(21
)
 
571

 
 
(1,841
)
 
(21
)
 
(1,862
)


(dollars in millions)
 
Changes in Fair Value For the Three Months Ended June 30, 2011, for Items Measured at Fair Value Pursuant to the Fair Value Option Election
 
 
Changes in Fair Value For the Six Months Ended June 30, 2011, for Items Measured at Fair Value Pursuant to the Fair Value Option Election
 
Gains
(Losses)
Principal
Transactions
 
Gains
(Losses)
Other
Revenues
 
Total
Changes
in Fair
Value
 
 
Gains
(Losses)
Principal
Transactions
 
Gains
(Losses)
Other
Revenues
 
Total
Changes
in Fair
Value
Assets:
 
 
 
 
 
 
 
 

 
 

 
 

Receivables under resale agreements
$
87

 
$
—

 
$
87

 
 
$
28

 
$
—

 
$
28

Investment securities
—

 
1

 
1

 
 
—

 
30

 
30

Loans
—

 
1

 
1

 
 
—

 
139

 
139

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Payables under repurchase agreements
(8
)
 
—

 
(8
)
 
 
3

 
—

 
3

Short-term borrowings
37

 
—

 
37

 
 
93

 
—

 
93

Other payables — interest and other
—

 
3

 
3

 
 
—

 
16

 
16

Long-term borrowings
(145
)
 
—

 
(145
)
 
 
(506
)
 
—

 
(506
)


The following describes the rationale for electing to account for certain financial assets and liabilities at fair value, as well as the impact of instrument-specific credit risk on the fair value.
Resale and repurchase agreements
Merrill Lynch elected the fair value option for certain resale and repurchase agreements and, to a lesser extent, securities borrowing agreements. The fair value option election was made based on the tenor of the agreements, which reflect the magnitude of the interest rate risk. The majority of resale and repurchase agreements collateralized by U.S. Government securities were excluded from the fair value option election as these contracts are generally short-dated and therefore the interest rate risk is not considered significant. Amounts loaned under resale agreements require collateral with a market value equal to or in excess of the principal amount loaned, resulting in minimal credit risk for such transactions.
Loans and loan commitments

Merrill Lynch elected the fair value option for certain loans that are risk managed on a fair value basis. Upon the acquisition of Merrill Lynch by Bank of America, Merrill Lynch also elected the fair value option for certain mortgage, corporate, and leveraged loans and loan commitments. The changes in the fair value of loans and loan commitments, for which the fair value option was elected, that were attributable to changes in borrower-specific credit risk were not material for the three months ended June 30, 2012 and June 30, 2011.
As of June 30, 2012 and December 31, 2011, the aggregate fair value of loans for which the fair value option election has been made that were 90 days or more past due was $11 million and $28 million, respectively, and the aggregate fair value of loans that were in non-accrual status was $27 million and $117 million at June 30, 2012 and December 31, 2011, respectively. As of June 30, 2012 and December 31, 2011, the unpaid principal amount due exceeded the aggregate fair value of such loans that are 90 days or more past due and/or in non-accrual status by $147 million and $172 million, respectively.
Short-term and long-term borrowings

Merrill Lynch elected the fair value option for certain short-term and long-term borrowings that are risk managed on a fair value basis (e.g., structured notes) and/or for which hedge accounting under Derivatives Accounting had been difficult to obtain. The majority of the fair value changes on long-term borrowings are from structured notes with coupon or repayment terms that are linked to the performance of debt and equity securities, indices, currencies or commodities. Excluding gains (losses) related to changes in Merrill Lynch's credit spreads, the majority of the gains (losses) for the respective periods are offset by gains (losses) on derivatives and securities that economically hedge these borrowings and that are accounted for at fair value. The changes in the fair value of liabilities for which the fair value option election was made that were attributable to changes in Merrill Lynch's credit spreads were losses of approximately $36 million and $2.2 billion for the three and six months ended June 30, 2012, respectively, and gains of approximately $0.1 billion and losses of approximately $0.2 billion for the three and six months ended June 30, 2011, respectively. Changes in Merrill Lynch specific credit risk are derived by isolating fair value changes due to changes in Merrill Lynch's credit spreads as observed in the secondary cash market.

The fair value option was also elected for certain non-recourse short-term and long-term borrowings and secured borrowings issued by consolidated VIEs. The fair value of these borrowings is not materially affected by changes in Merrill Lynch's creditworthiness.

The following tables present the difference between fair values and the aggregate contractual principal amounts of receivables under resale agreements, receivables under securities borrowed transactions, loans and long-term borrowings for which the fair value option election has been made as of June 30, 2012 and December 31, 2011.

(dollars in millions)
 
 
 
 
 
 
Fair Value at
 
Principal
Amount
Due Upon
Maturity
 
 
 
June 30, 2012
 
 
Difference
Assets:
 

 
 

 
 

Receivables under resale agreements
$
90,533

 
$
90,107

 
$
426

Receivables under securities borrowed transactions
500

 
514

 
(14
)
Loans (1)
3,223

 
3,995

 
(772
)
Liabilities:
 
 
 
 
 
Long-term borrowings (2)
30,803

 
33,133

 
(2,330
)
(1)
Includes trading loans with a fair value of $401 million.
(2)
The majority of the difference between the fair value and principal amount due upon maturity at June 30, 2012 relates to the impact of changes in Merrill Lynch's credit spreads, as well as the fair value of the embedded derivative, where applicable.
(dollars in millions)
 
 
 
 
 
 
Fair Value at
 
Principal
Amount
Due Upon
Maturity
 
 
 
December 31, 2011
 
 
Difference
Assets:
 

 
 

 
 

Receivables under resale agreements
$
85,652

 
$
85,197

 
$
455

Receivables under securities borrowed transactions
259

 
287

 
(28
)
Loans (1)
2,742

 
4,023

 
(1,281
)
Liabilities:
 
 
 
 
 
Long-term borrowings(2)
30,325

 
36,537

 
(6,212
)
(1)
Includes loans held for sale with a fair value of $420 million, accounted for under the fair value option, which were reclassified to trading assets because they are risk managed on that basis.
(2)
The majority of the difference between the fair value and principal amount due upon maturity at December 31, 2011 relates to the impact of changes in Merrill Lynch's credit spreads, as well as the fair value of the embedded derivative, where applicable.