SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 27, 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.
864,450,601 shares of Common Stock and 4,160,191 Exchangeable Shares as of the
close of business on November 1, 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
- -----------------------------
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Three Months Ended
------------------------------
Sept. 27, Sept. 28, Percent
(in millions, except per share amounts) 2002 2001 Inc. (Dec.)
-------- -------- ----------
NET REVENUES
Commissions $ 1,122 $ 1,204 (6.8)%
Principal transactions 377 739 (49.0)
Investment banking
Underwriting 332 563 (41.0)
Strategic advisory 163 294 (44.6)
Asset management and portfolio service fees 1,217 1,337 (9.0)
Other 165 129 27.9
-------- --------
Subtotal 3,376 4,266 (20.9)
-------- --------
Interest and dividend revenues 3,484 4,663 (25.3)
Less interest expense 2,498 3,784 (34.0)
-------- --------
Net interest profit 986 879 12.2
-------- --------
TOTAL NET REVENUES 4,362 5,145 (15.2)
-------- --------
NON-INTEREST EXPENSES
Compensation and benefits 2,228 2,757 (19.2)
Communications and technology 421 529 (20.4)
Occupancy and related depreciation 218 280 (22.1)
Brokerage, clearing, and exchange fees 182 219 (16.9)
Advertising and market development 125 165 (24.2)
Professional fees 135 115 17.4
Office supplies and postage 62 78 (20.5)
Goodwill amortization - 53 (100.0)
Other 128 175 (26.9)
Recoveries/expenses related to September 11 (191) 88 N/M
-------- --------
TOTAL NON-INTEREST EXPENSES 3,308 4,459 (25.8)
-------- --------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 1,054 686 53.6
Income tax expense 313 216 44.9
Dividends on preferred securities issued by subsidiaries 48 48 -
-------- --------
NET EARNINGS $ 693 $ 422 64.2
======== ========
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 683 $ 412 65.8
======== ========
EARNINGS PER COMMON SHARE
Basic $ 0.79 $ 0.49
======== ========
Diluted $ 0.73 $ 0.44
======== ========
DIVIDEND PAID PER COMMON SHARE $ 0.16 $ 0.16
======== ========
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 864.6 845.8
======== ========
Diluted 934.5 934.5
======== ========
- -------------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
For the Nine Months Ended
------------------------------
Sept. 27, Sept. 28, Percent
(in millions, except per share amounts) 2002 2001 Inc. (Dec.)
-------- -------- ----------
NET REVENUES
Commissions $ 3,555 $ 4,071 (12.7)%
Principal transactions 1,982 3,344 (40.7)
Investment banking
Underwriting 1,321 1,900 (30.5)
Strategic advisory 540 891 (39.4)
Asset management and portfolio service fees 3,808 4,072 (6.5)
Other 603 446 35.2
-------- --------
Subtotal 11,809 14,724 (19.8)
-------- --------
Interest and dividend revenues 9,966 16,459 (39.4)
Less interest expense 7,372 14,055 (47.5)
-------- --------
Net interest profit 2,594 2,404 7.9
-------- --------
TOTAL NET REVENUES 14,403 17,128 (15.9)
-------- --------
NON-INTEREST EXPENSES
Compensation and benefits 7,443 8,978 (17.1)
Communications and technology 1,307 1,695 (22.9)
Occupancy and related depreciation 684 820 (16.6)
Brokerage, clearing, and exchange fees 552 697 (20.8)
Advertising and market development 426 575 (25.9)
Professional fees 397 408 (2.7)
Office supplies and postage 196 266 (26.3)
Goodwill amortization - 156 (100.0)
Other 575 556 3.4
Recoveries/expenses related to September 11 (191) 88 N/M
-------- --------
TOTAL NON-INTEREST EXPENSES 11,389 14,239 (20.0)
-------- --------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 3,014 2,889 4.3
Income tax expense 896 906 (1.1)
Dividends on preferred securities issued by subsidiaries 144 146 (1.4)
-------- --------
NET EARNINGS $ 1,974 $ 1,837 7.5
======== ========
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,945 $ 1,808 7.6
======== ========
EARNINGS PER COMMON SHARE
Basic $ 2.26 $ 2.15
======== ========
Diluted $ 2.07 $ 1.93
======== ========
DIVIDEND PAID PER COMMON SHARE $ 0.48 $ 0.48
======== ========
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 860.4 839.8
======== ========
Diluted 942.0 938.8
======== ========
- -------------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 27, Dec. 28,
(dollars in millions) 2002 2001
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ASSETS
CASH AND CASH EQUIVALENTS $ 12,593 $ 11,070
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 7,973 4,467
SECURITIES FINANCING TRANSACTIONS
Receivables under resale agreements 75,327 69,707
Receivables under securities borrowed transactions 52,262 54,930
-------- --------
127,589 124,637
INVESTMENT SECURITIES 80,158 87,672
TRADING ASSETS, AT FAIR VALUE (includes securities pledged as collateral of
$12,083 in 2002 and $12,084 in 2001)
Contractual agreements 40,558 31,040
Corporate debt and preferred stock 18,497 19,147
Mortgages, mortgage-backed, and asset-backed 13,827 11,526
U.S. Government and agencies 12,080 12,999
Equities and convertible debentures 11,415 18,487
Non-U.S. governments and agencies 10,864 6,207
Municipals and money markets 4,149 5,561
-------- --------
111,390 104,967
SECURITIES RECEIVED AS COLLATERAL 2,430 3,234
-------- --------
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $62 in 2002 and $81 in 2001) 36,694 39,856
Brokers and dealers 8,782 6,868
Interest and other 8,791 8,221
-------- --------
54,267 54,945
-------- --------
LOANS, NOTES, AND MORTGAGES (net of allowances of $231 in 2002 and $201 in 2001) 32,387 19,005
EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization
of $4,624 in 2002 and $4,910 in 2001) 3,040 2,873
GOODWILL (net of accumulated amortization of $964 in 2002 and $924 in 2001) 4,321 4,071
OTHER ASSETS 3,616 2,478
-------- --------
TOTAL ASSETS $439,764 $419,419
======== ========
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
Sept. 27, Dec. 28,
(dollars in millions, except per share amount) 2002 2001
- ----------------------------------------------------------------------------------------------- -------- --------
LIABILITIES
SECURITIES FINANCING TRANSACTIONS
Payables under repurchase agreements $ 87,801 $74,903
Payables under securities loaned transactions 9,648 12,291
-------- --------
97,449 87,194
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 6,619 5,141
DEPOSITS 80,825 85,819
TRADING LIABILITES, AT FAIR VALUE
Contractual agreements 45,128 36,679
U.S. Government and agencies 19,137 18,674
Non-U.S. governments and agencies 9,307 5,857
Equities and convertible debentures 7,141 9,911
Corporate debt, municipals and preferred stock 7,584 4,796
-------- --------
88,297 75,917
-------- --------
OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 2,430 3,234
-------- --------
OTHER PAYABLES
Customers 29,127 28,704
Brokers and dealers 12,245 11,932
Interest and other 20,237 18,466
-------- --------
61,609 59,102
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 3,633 3,737
LONG-TERM BORROWINGS 73,947 76,572
-------- --------
TOTAL LIABILITES 414,809 396,716
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,656 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 61 62
Common stock (par value $1.33 1/3 per share; authorized: 3,000,000,000 shares;
issued: 2002 - 978,667,234 shares; 2001 - 962,533,498 shares) 1,305 1,283
Paid-in capital 5,215 4,209
Accumulated other comprehensive loss (net of tax) (431) (368)
Retained earnings 17,681 16,150
-------- --------
23,831 21,336
Less: Treasury stock, at cost: 2002 - 116,395,070 shares; 2001 - 119,059,651 shares 994 977
Unamortized employee stock grants 963 776
-------- --------
TOTAL COMMON STOCKHOLDERS' EQUITY 21,874 19,583
-------- --------
TOTAL STOCKHOLDERS' EQUITY 22,299 20,008
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES,
AND STOCKHOLDERS' EQUITY $439,764 $419,419
======== ========
- -------------------------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the Nine Months Ended
------------------------------
(dollars in millions) Sept. 27, Sept. 28,
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 1,974 $ 1,837
Noncash items included in earnings:
Depreciation and amortization 491 668
Policyholder reserves 127 139
Goodwill amortization - 156
Amortization of stock-based compensation 493 544
Deferred taxes 29 (427)
Other 539 (151)
Changes in operating assets and liabilities:
Trading assets (8,400) (7,599)
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations (3,506) 1,710
Receivables under resale agreements (5,608) (13,768)
Receivables under securities borrowed transactions 2,668 (5,735)
Customer receivables 3,170 (5,022)
Brokers and dealers receivables (1,914) 14,853
Trading liabilities 12,380 6,541
Payables under repurchase agreements 12,898 11,368
Payables under securities loaned transactions (2,643) (8,253)
Customer payables 423 10,566
Brokers and dealers payables 313 4,083
Other, net 6,446 (3,335)
-------- --------
Cash provided by operating activities 19,880 8,175
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 20,350 25,618
Sales of available-for-sale securities 36,646 10,214
Purchases of available-for-sale securities (52,619) (59,005)
Maturities of held-to-maturity securities 145 511
Purchases of held-to-maturity securities (282) (517)
Loans, notes, and mortgages (11,770) (1,021)
Other investments and other assets (1,725) (742)
Equipment and facilities (658) (696)
-------- --------
Cash used for investing activities (9,913) (25,638)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings 1,478 (10,087)
Deposits (4,994) 16,019
Issuance and resale of long-term borrowings 18,313 28,359
Settlement and repurchases of long-term borrowings (22,970) (19,508)
Issuance of common stock 225 -
Issuance of treasury stock 5 463
Other common stock transactions (58) (354)
Dividends (443) (433)
-------- --------
Cash provided by (used for) financing activities (8,444) 14,459
-------- --------
Increase/(decrease) in cash and cash equivalents 1,523 (3,004)
Cash and cash equivalents, beginning of year 11,070 23,205
-------- --------
Cash and cash equivalents, end of period $ 12,593 $ 20,201
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 631 $ 545
Interest 7,535 14,671
- ------------------------------------------------------------------------------------------------------------
See Notes to Condensed Consolidated Financial Statements
6
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 27, 2002
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NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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For a complete discussion of Merrill Lynch's accounting policies, refer to the
Annual Report included as an exhibit to Form 10-K for the year ended December
28, 2001 ("2001 Annual Report").
Basis of Presentation
The Condensed Consolidated Financial Statements include the accounts of Merrill
Lynch & Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch")
which are generally controlled through a majority voting interest but may be
controlled by means of a significant minority ownership, by contract, lease or
otherwise. Investments in entities in which Merrill Lynch does not have control,
but has the ability to exercise significant influence (generally defined as
20%-50% of voting interest) are accounted for under the equity method.
Investments in which Merrill Lynch has neither control nor significant influence
are accounted for under the cost method, except investments held by a regulated
broker-dealer which are carried at fair value. See Other Investments in the 2001
Annual Report for the accounting policy on these securities. All material
intercompany balances have been eliminated. The December 28, 2001 unaudited
Condensed Consolidated Balance Sheet was derived from the audited financial
statements. The interim Condensed Consolidated Financial Statements for the
three - and nine -month periods are unaudited; however, in the opinion of
Merrill Lynch management, all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of the Condensed Consolidated
Financial Statements in accordance with generally accepted accounting principles
have been included.
These unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the audited consolidated financial statements included in the
2001 Annual Report. 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. In presenting the Condensed Consolidated Financial Statements,
management makes estimates that affect the reported amounts and disclosures in
the financial statements. Estimates, by their nature, are based on judgment and
available information. Therefore, actual results could differ from those
estimates and could have a material impact on the Condensed Consolidated
Financial Statements, and it is possible that such changes could occur in the
near term. Certain reclassifications have been made to prior period financial
statements, where appropriate, to conform to the current period presentation.
Consolidation and Transactions Involving SPEs
Merrill Lynch enters into a number of different types of derivative transactions
with Special Purpose Entities ("SPEs"), principally to facilitate client
transactions but also to hedge, manage, and finance proprietary positions and
risk. The most common types of derivatives entered into with SPEs that are used
to facilitate client transactions can be broadly categorized as follows:
o In a typical securitization, Merrill Lynch may convert the return on a
pool of assets held by an SPE (e.g., a pool of mortgages) from a fixed
interest rate to a floating interest rate by entering into an interest
rate swap with the SPE.
o Merrill Lynch may enter into a derivative transaction with an SPE in
order to "repackage" a specific security for an investor and modify
some aspect of the security to meet a client's stated objectives. This
may include changing risk components relating to foreign exchange
attributes of a security, interest rates, credit risk, and/or tenor of
the instrument; or, in the case of convertible bonds, separating the
bond into its debt and equity components.
7
o Merrill Lynch also provides liquidity facilities to investors in
securities issued by certain SPEs which hold pools of municipal
securities. Disclosure of these liquidity facilities is contained in
Note 12, Commitments and Contingencies - Lending and Guarantees, in the
2001 Annual Report.
New Accounting Pronouncements
Subsequent to September 27, 2002, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.147,
"Acquisitions of Certain Financial Institutions - an Amendment of FASB
Statements No. 72 and 144 and FASB Interpretation No. 9." The Statement provides
guidance on the accounting for the acquisition of a financial institution, which
had previously been addressed in SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," and requires that those
transactions be accounted for in accordance with SFAS No. 141, "Business
Combinations", and SFAS No. 142, " Goodwill and Other Intangible Assets." In
addition, this Statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include long-term customer-relationship
intangible assets such as depositor and credit cardholder intangible assets and
would require these assets to be subject to an undiscounted cash flow
recoverability impairment test that SFAS No. 144 requires for other long-lived
assets that are held and used. The provisions of SFAS No. 147 are effective
October 1, 2002. There was no impact to Merrill Lynch upon adoption of this
Statement.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." This standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 will
replace the existing guidance provided by EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
In August 2001, the 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 a business as
previously defined in that opinion. SFAS No. 144 provides guidance on the
financial accounting and reporting for the impairment or disposal of long-lived
assets. 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. 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. Prior year pre-tax amortization expense
related to goodwill totaled $53 million and $156 million for the three-month and
nine-month periods ended September 28, 2001.
During the second quarter of 2002, Merrill Lynch completed its review of
goodwill in accordance with SFAS No. 142 and determined that the fair value of
the reporting units to which goodwill relates exceeds the carrying value of such
reporting units. Accordingly, no goodwill impairment loss was recognized. The
$3.9 billion of goodwill related to the 1997 purchase of the Mercury Asset
Management Group was tested at the Merrill Lynch Investment Managers ("MLIM")
segment level since this business has been fully integrated into MLIM.
The following table presents a reconciliation of reported net earnings and
earnings per share to the amounts adjusted for the exclusion of goodwill
amortization, net of related income tax effects.
8
(dollars in millions, except per share amounts)
- -----------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
---------------------------- ---------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
-------- -------- -------- --------
NET EARNINGS:
Reported amount $ 693 $ 422 $1,974 $1,837
Goodwill amortization, net of taxes - 36 - 105
----- ----- ------ ------
Adjusted $ 693 $ 458 $1,974 $1,942
===== ===== ====== ======
BASIC EARNINGS PER SHARE:
Reported amount $0.79 $0.49 $ 2.26 $ 2.15
Goodwill amortization - 0.04 - 0.13
----- ----- ------ ------
Adjusted $0.79 $0.53 $ 2.26 $ 2.28
===== ===== ====== ======
DILUTED EARNINGS PER SHARE:
Reported amount $0.73 $0.44 $ 2.07 $ 1.93
Goodwill amortization - 0.04 - 0.11
----- ----- ------ ------
Adjusted $0.73 $0.48 $ 2.07 $ 2.04
===== ===== ====== ======
- -----------------------------------------------------------------------------------------------------------------------
Net earnings and earnings per share, excluding the impact of goodwill
amortization, for the three years ended December 28, 2001 are as follows:
(dollars in millions, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------------
For the Twelve Months Ended
--------------------------------------------
Dec. 28, Dec. 29, Dec. 31,
2001 2000 1999
------- ------- -------
NET EARNINGS:
Reported amount $ 573 $3,784 $2,693
Goodwill amortization, net of taxes 139 145 151
----- ------ ------
Adjusted $ 712 $3,929 $2,844
===== ====== ======
BASIC EARNINGS PER SHARE:
Reported amount $0.64 $ 4.69 $ 3.52
Goodwill amortization 0.16 0.18 0.20
----- ------ ------
Adjusted $0.80 $ 4.87 $ 3.72
===== ====== ======
DILUTED EARNINGS PER SHARE:
Reported amount $0.57 $ 4.11 $ 3.11
Goodwill amortization 0.15 0.16 0.18
----- ------ ------
Adjusted $0.72 $ 4.27 $ 3.29
===== ====== ======
- ----------------------------------------------------------------------------------------------------------------------
9
Derivatives
Merrill Lynch's policies relating to derivatives are discussed fully in the 2001
Annual Report. For the three- and nine-month periods ended September 27, 2002,
net gains of $39 million and net losses of $212 million, respectively, related
to non-U.S. dollar hedges of investments in non-U.S. dollar subsidiaries were
included in "Accumulated other comprehensive loss" on the Condensed Consolidated
Balance Sheet. For the three- and nine- month periods ended September 28, 2001,
net losses of $137 million and net gains of $173 million, respectively, were
recorded for these same derivatives. These amounts were substantially offset by
net gains and losses on the hedged investments.
- --------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
- --------------------------------------------------------------------------------
September 11 - related Expenses
On September 11, 2001, terrorists attacked the World Trade Center complex, which
subsequently collapsed and damaged surrounding buildings, some of which were
occupied by Merrill Lynch. These events caused the temporary relocation of
approximately 9,000 employees from Merrill Lynch's global headquarters in the
North Tower of the World Financial Center, the South Tower of the World
Financial Center and from offices at 222 Broadway to back-up facilities. Merrill
Lynch maintains insurance for losses caused by physical damage to property. This
coverage includes repair or replacement of property and lost profits due to
business interruption, including costs related to lack of access to facilities.
During the third quarter of 2001 Merrill Lynch recorded September 11-related
pre-tax expenses of $88 million, which were net of an insurance receivable of
$50 million. For the full year of 2001, Merrill Lynch recorded pre-tax expenses
of $131 million, which were net of a $100 million insurance reimbursement, and a
receivable of $115 million.
The first quarter of 2002 included $85 million of September 11- related
expenses, which were fully offset by an insurance reimbursement of $200 million,
the remainder of which was recognized as a receivable in 2001.
In the third quarter of 2002, Merrill Lynch recorded a September 11-related net
insurance recovery representing a partial reimbursement of $200 million, offset
by September 11-related expenses of $9 million. A total of $125 million of the
reimbursement was replacement and recovery costs for items previously recognized
as expenses, with $75 million representing a partial business interruption
settlement for lost profits.
In aggregate, Merrill Lynch has recognized $440 million of September 11-related
expenses and received reimbursement for $500 million, of which $425 million was
for replacement and recovery costs and $75 million was for business
interruption. These expenses include the write-offs of depreciated fixed assets
whereas the reimbursement is for actual replacement costs. Therefore, it is
expected that the insurance reimbursements for damaged fixed assets will exceed
the corresponding expense recognition. Merrill Lynch continues to pursue
reimbursements for replacement and recovery costs as well as for business
interruption losses.
New York Attorney General Settlement
On May 21, 2002, Merrill Lynch executed an agreement with the New York Attorney
General ("NYAG") regarding alleged conflicts of interest between Merrill Lynch's
Research and Investment Banking groups. As part of the agreement, the Attorney
General terminated his investigation and Merrill Lynch agreed to implement
changes to further insulate the Research Department from Investment Banking. In
addition, in order to reach a resolution and settlement of the matter, Merrill
Lynch has agreed to make a civil payment of $48 million to New York State and an
additional $52 million to the other 49 states and to Puerto Rico and the
District of Columbia. Both payments are contingent on acceptance of the
agreement by the appropriate state agency in these states and in Puerto Rico and
the District of Columbia. Merrill Lynch admitted to no wrongdoing or liability
as part of this agreement.
10
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 charges of $396 million. These other charges primarily
related to write-offs, which were recorded in 2001. In addition, a charge of
approximately $135 million of deferred tax expense was recorded related to
losses of the Private Client operations in Japan that are not expected to be
utilized during the carryforward 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 legal, technology and other costs of $178 million. Structural
changes included workforce reductions of 6,205 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 amortization for stock grants associated with
employee separations totaling $135 million. Facilities-related costs included
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 the remaining restructuring-related branch closings and employee
separations to be completed in 2002. Any unused portion of the original
restructuring reserve will be reversed. 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 and a
rollforward of headcount and office consolidations at September 27, 2002 is as
follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------------
Utilized in Utilized in Balance
Initial Balance 2001 2002 (2) Sept. 27, 2002
- --------------------------------------------------------------------------------------------------------------------------
Category:
Severance costs $1,133 $(214) $ (809) $ 110
Facilities costs 299 - (72) 227
Technology and fixed asset write-offs 187 (187) - -
Other Costs 178 - (67) 111
------ ----- ------- -----
$1,797 $(401) $ (948) $ 448
------ ----- ------- -----
Staff Reductions 6,205 (749) (5,061) 395
Office Consolidations(1) 188 - (105) 83
- --------------------------------------------------------------------------------------------------------------------------
(1) Office consolidation is considered complete when all payments have been made.
(2) The 2002 utilization includes changes in estimates which are attributable to
differences in actual cost from initial estimates in implementing the original
restructuring plan. As a result of changes in estimates during the third quarter
of 2002, reserves of $2 million were reversed.
11
- --------------------------------------------------------------------------------
NOTE 3. INVESTMENT SECURITIES
- --------------------------------------------------------------------------------
Investment securities at September 27, 2002 and December 28, 2001 are presented
below:
(dollars in millions)
- --------------------------------------------------------------------------------------------
Sept. 27, Dec. 28,
2002 2001
-------- -------
INVESTMENT SECURITIES
Available-for-sale $ 70,816 $74,356
Trading 3,301 7,842
Held-to-maturity 591 434
Non-qualifying: (1)
Deferred compensation hedges (2) 1,953 1,666
Other (3) 3,497 3,374
-------- -------
Total $ 80,158 $87,672
======== =======
- --------------------------------------------------------------------------------------------
(1) Non-qualifying for SFAS No. 115 purposes.
(2) Represents investments economically hedging deferred compensation liabilities.
(3) Includes insurance policy loans and merchant banking investments.
- --------------------------------------------------------------------------------
NOTE 4. SHORT-TERM BORROWINGS
- --------------------------------------------------------------------------------
Short-term borrowings at September 27, 2002 and December 28, 2001 are presented
below:
(dollars in millions)
- -----------------------------------------------------------------------------------------------------
Sept. 27, Dec. 28,
2002 2001
-------- -------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS
Commercial paper $ 2,794 $ 2,950
Other 3,825 2,191
-------- -------
Total $ 6,619 $ 5,141
======== =======
DEPOSITS
U.S. $ 68,237 $73,555
Non-U.S. 12,588 12,264
-------- -------
Total $ 80,825 $85,819
======== =======
- -----------------------------------------------------------------------------------------------------
12
- --------------------------------------------------------------------------------
NOTE 5. SEGMENT INFORMATION
- --------------------------------------------------------------------------------
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 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. This change reflects a transfer in responsibility for this activity,
which was made to better align functional and management responsibilities. In
addition, MLIM's results 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 earn an appropriate portion of the total fees for selling the funds, while
revenues and expenses associated with management of the funds are recorded in
MLIM. Revenues and expenses associated with these intersegment activities are
recognized in each segment and eliminated at the corporate level. Prior period
amounts have been restated to conform to the current period presentation.
Included in both GMI's and Private Client's results for the third quarter 2002
is a September 11-related partial business interruption settlement for foregone
pre-tax profits of $50 million and $25 million, respectively, which was recorded
as a reduction of non-interest expenses. The corporate segment includes $116
million of net insurance recoveries, for a portion of the replacement and
recovery costs, in the 2002 third quarter. The third quarter of 2001 included
September 11-related pre-tax expenses of $88 million, which were net of an
insurance receivable of $50 million. For information on each segment's business
activities, see the portions of the 2001 Annual Report included as an exhibit to
Form 10-K.
13
Operating results by business segment are as follows:
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
PRIVATE CORPORATE
Three Months Ended GMI CLIENT MLIM ITEMS TOTAL
September 27, 2002 -------- ------- ------ --------- --------
Non-interest revenues $ 1,284 $ 1,757 $ 363 $ (28) (1) $ 3,376
Net interest income(2) 674 328 6 (22) (3) 986
-------- ------- ------ ------ --------
Net revenues 1,958 2,085 369 (50) 4,362
Non-interest expenses 1,385 1,771 299 (147) (4) 3,308
-------- ------- ------ ------ --------
Pre-tax earnings $ 573 $ 314 $ 70 $ 97 $ 1,054
======== ======= ====== ====== ========
Pre-tax earnings (loss) before
September 11-related items $ 523 $ 289 $ 70 $ (19) $ 863
======== ======= ====== ====== ========
Quarter-end total assets $382,848 $50,073 $2,522 $4,321 $439,764
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
PRIVATE CORPORATE
GMI CLIENT MLIM ITEMS TOTAL
-------- ------- ------ --------- --------
Three Months Ended
September 28, 2001
Non-interest revenues $ 1,861 $ 1,981 $ 472 $ (48) (1) $ 4,266
Net interest income(2) 474 415 9 (19) (3) 879
-------- ------- ------ ------ --------
Net revenues 2,335 2,396 481 (67) 5,145
Non-interest expenses 1,778 2,196 389 96 (4) 4,459
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 557 $ 200 $ 92 $ (163) $ 686
======== ======= ====== ====== ========
Pre-tax earnings (loss) before
September 11-related items $ 557 $ 200 $ 92 $ (75) $ 774
======== ======= ====== ====== ========
Quarter-end total assets $385,140 $56,803 $2,451 $4,212 $448,606
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
(1) Primarily represents the elimination of intersegment revenues and expenses.
(2) Management views interest income net of interest expense in evaluating results.
(3) Represents acquisition financing costs.
(4) In 2002, represents September 11 net insurance recovery of $116 million,
elimination of intersegment expenses of $34 million offset by legal fees of
$3 million. In 2001, represents net September 11 expenses of $88 million,
goodwill amortization of $53 million, net of elimination of intersegment
expenses of $45 million.
14
(dollars in millions)
- --------------------------------------------------------------------------------------------------------------------
PRIVATE CORPORATE
Nine Months Ended GMI CLIENT MLIM ITEMS TOTAL
September 27, 2002 -------- ------- ------ --------- --------
Non-interest revenues $ 5,078 $ 5,623 $1,218 $ (110) (1) $ 11,809
Net interest income(2) 1,613 1,027 17 (63) (3) 2,594
-------- ------- ------ ------ --------
Net revenues 6,691 6,650 1,235 (173) 14,403
Non-interest expenses 4,836 5,718 951 (116) (4) 11,389
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 1,855 $ 932 $ 284 $ (57) $ 3,014
======== ======= ====== ======= ========
Pre-tax earnings (loss) before
September 11-related items $ 1,805 $ 907 $ 284 $ (173) $ 2,823
======== ======= ====== ======= ========
- --------------------------------------------------------------------------------------------------------------------
PRIVATE CORPORATE
GMI CLIENT MLIM ITEMS TOTAL
-------- ------- ------ --------- --------
Nine Months Ended
September 28, 2001
Non-interest revenues $ 7,059 $ 6,383 $1,483 $ (201) (1) $ 14,724
Net interest income(2) 1,285 1,160 19 (60) (3) 2,404
-------- ------- ------ ------ --------
Net revenues 8,344 7,543 1,502 (261) 17,128
Non-interest expenses 6,064 6,864 1,237 74 (4) 14,239
-------- ------- ------ ------ --------
Pre-tax earnings (loss) $ 2,280 $ 679 $ 265 $ (335) $ 2,889
======== ======= ====== ====== ========
Pre-tax earnings (loss) before
September 11-related items $ 2,280 $ 679 $ 265 $ (247) $ 2,977
======== ======= ====== ====== ========
- --------------------------------------------------------------------------------------------------------------------
(1) Primarily represents the elimination of intersegment revenues and expenses.
(2) Management views interest income net of interest expense in evaluating results.
(3) Represents acquisition financing costs.
(4) In 2002, represents September 11 net insurance recovery of $116 million,
elimination of intersegment expenses of $114 million, net of the provision
for the payment to the NYAG and related costs of $114 million. In 2001,
represents net September 11 expenses of $88 million, goodwill amortization
of $156 million, net of elimination of intersegment expenses of $170
million.
15
- --------------------------------------------------------------------------------
NOTE 6. COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The components of comprehensive income are as follows:
(dollars in millions)
- -----------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
------------------------ ------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
-------- -------- -------- --------
Net earnings $693 $ 422 $1,974 $1,837
---- ----- ------ ------
Other comprehensive income (loss), net of tax:
Currency translation adjustment (5) (36) (29) (47)
Net unrealized loss on investment
securities available-for-sale (50) (202) (14) (209)
Deferred gain (loss) on cash flow hedges (6) 56 (20) 95
---- ----- ------ ------
Total other comprehensive loss, net of tax (61) (182) (63) (161)
---- ----- ------ ------
Comprehensive income $632 $ 240 $1,911 $1,676
==== ===== ====== ======
- -----------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 7. EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
The computation of earnings per common share is as follows:
(dollars in millions, except per share amounts)
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
------------------------ ------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
-------- -------- -------- --------
Net earnings $ 693 $ 422 $ 1,974 $ 1,837
Preferred stock dividends 10 10 29 29
-------- -------- -------- --------
Net earnings applicable to
common stockholders $ 683 $ 412 $ 1,945 $ 1,808
======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------------
(shares in thousands)
Weighted-average shares outstanding 864,629 845,841 860,370 839,810
-------- -------- -------- --------
Effect of dilutive instruments(1)(2):
Employee stock options 21,917 46,547 33,038 56,995
Financial Advisor Capital Accumulation Award Plan shares 23,083 26,947 24,080 27,435
Restricted shares and units 24,787 15,090 24,433 14,449
Employee Stock Purchase Plan shares 61 44 80 64
-------- -------- -------- --------
Dilutive potential common shares 69,848 88,628 81,631 98,943
-------- -------- -------- --------
Total weighted-average diluted shares 934,477 934,469 942,001 938,753
======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 0.79 $ 0.49 $ 2.26 $ 2.15
Diluted earnings per common share $ 0.73 $ 0.44 $ 2.07 $ 1.93
- ----------------------------------------------------------------------------------------------------------------------------
(1) During the 2002 and 2001 third quarter there were 179 million and 52 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.
16
- --------------------------------------------------------------------------------
NOTE 8. COMMITMENTS AND OTHER CONTINGENCIES
- --------------------------------------------------------------------------------
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 September 27, 2002 and December 28, 2001, Merrill Lynch had the following
commitments and guarantees with commitment expirations as follows:
(dollars in millions)
- -------------------------------------------------------------------------------------------------------------
Expiration Total Commitments
--------------------------------------- -----------------------
Less
than 1-3 4-5 Over 5 Sept. 27, Dec. 28,
1 year years years years 2002 2001
------- ------ ------ ------ -------- -------
Commitments to extend credit $21,336 $3,563 $5,689 $4,127 $34,715 (1) $17,521 (1)
Third-party guarantees 120 91 6 44 261 316
SPE-related:
Liquidity facilities 14,006 - - - 14,006 11,400
Leasing-related 81 91 333 504 1,009 1,247
- -------------------------------------------------------------------------------------------------------------
(1) Approximately $17.6 billion and $5.4 billion at September 27, 2002 and
December 28, 2001, respectively, relate to secured lending activities.
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.
SPE-related commitments include liquidity facilities and default protection to
investors in securities issued by SPEs which relate to collateralized lending
and are substantially over-collateralized, therefore the fair value of these
commitments approximates zero as of September 27, 2002. 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.
In the normal course of business, Merrill Lynch is named as a defendant in
various legal actions, including arbitrations, class actions, and other
litigation, arising in connection with its activities as a global diversified
services institution. As of September 27, 2002, Merrill Lynch has been named as
party in various legal 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 or cash flows
of Merrill Lynch as set forth in the Condensed Consolidated Financial
Statements, but may be material to Merrill Lynch's operating results for any
particular period. All settlements during the period have been paid out of
operating cash flows. See Part II, Item 1. Legal Proceedings for additional
information.
17
- --------------------------------------------------------------------------------
NOTE 9. 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 the
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
September 27, 2002, MLPF&S's regulatory net capital of $3,149 million was
approximately 21% of ADI, and its regulatory net capital in excess of the
minimum required was $2,852 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 September 27, 2002, MLI's financial resources were $4,841 million,
exceeding the minimum requirement by $868 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 September 27, 2002, MLGSI's liquid capital of
$1,841 million was 219% of its total market and credit risk, and liquid capital
in excess of the minimum required was $834 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
September 27, 2002 and December 28, 2001.
18
As shown below, MLBUSA and MLB&T each exceed the minimum bank regulatory
requirement for classification as a well-capitalized bank for Tier I leverage --
5%, Tier I capital -- 6% and Total capital -- 10%:
(dollars in millions)
- ---------------------------------------------------------------------------------------
Sept. 27, 2002 Dec. 28, 2001
--------------------------------------------
Actual Actual
Ratio Amount Ratio Amount
- ---------------------------------------------------------------------------------------
TIER I LEVERAGE
(TO AVERAGE ASSETS)
MLBUSA 5.49% $ 3,578 5.61% $ 3,576
MLB&T 5.71 844 6.90 1,047
TIER I CAPITAL
(TO RISK-WEIGHTED ASSETS)
MLBUSA 11.65 3,578 14.30 3,576
MLB&T 21.02 844 20.47 1,047
TOTAL CAPITAL
(TO RISK-WEIGHTED ASSETS)
MLBUSA 12.70 3,898 15.44 3,860
MLB&T 21.03 844 20.48 1,048
- ---------------------------------------------------------------------------------------
In April 2001, MLBUSA entered into a synthetic securitization of specified
reference portfolios of asset-backed securities ("ABS") owned by MLBUSA totaling
in aggregate up to $20 billion. 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 allowed 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. 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 $211 million at
December 28, 2001, thereby increasing its Tier I and Total RBC ratios by 12
basis points and 13 basis points, respectively. This structure did not result in
a material change in the distribution or concentration risk in the retained
portfolio. This synthetic securitization was fully terminated on May 15, 2002.
19
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 September 27,
2002, and the related condensed consolidated statements of earnings for the
three-month and nine-month periods ended September 27, 2002 and September 28,
2001, and the condensed consolidated statements of cash flows for the nine-month
periods ended September 27, 2002 and September 28, 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, New York
November 8, 2002
20
------------------------------------------------------------------------------
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, banking 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 unpredictable or uncontrollable factors.
These factors include economic conditions, monetary and fiscal policies, the
liquidity of global markets, international and regional political events, acts
of war, terrorism, changes in applicable laws and regulations, the competitive
environment and investor sentiment. In addition to these factors, Merrill
Lynch and other financial services companies may be affected by the regulatory
and legislative initiatives affecting the conduct of its business, including
increased regulations and 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 the financial
markets, as well as the volumes and revenues in businesses such as brokerage,
trading, investment banking, and investment management.
The financial services industry continues to be affected by the intensifying
competitive environment, as demonstrated by consolidation through mergers and
acquisitions, 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. In addition, the
regulatory reforms and initiatives currently being considered by the U.S.
Congress, various Federal securities regulators and industry participants
regarding the role of research in connection with providing financial services
may affect how financial services companies interact with their customers
and the cost structure for such services.
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.
21
- --------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Market conditions remained challenging during the third quarter for the industry
as a whole. Most equity indices worldwide declined by double digit percentages
from the end of the 2002 second quarter, and global merger and acquisition and
securities origination volumes continued to be subdued amid market and issuer
uncertainty.
Long-term U.S. interest rates, as measured by the yield on the 10-year U.S.
Treasury bond, fell from 4.80% to 3.59% during the third quarter. Treasury bonds
rallied again this quarter on weak economic data and a drop in stocks, capping
one of the best-ever quarterly performances by the government securities market.
The U.S. Federal Reserve Bank kept the federal funds rate and the discount rate
unchanged during the third 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 during the third quarter of 2002.
U.S. equity indices were down sharply during the third quarter of 2002. The Dow
Jones Industrial Average finished down 18% for the third quarter and 14% from
year-ago levels. The NASDAQ Composite Index declined 20% during the quarter and
22% from year-ago levels.
The Dow Jones World Index, excluding the United States, fell 19% in the third
quarter of 2002 and 14% from the third quarter of last year. Markets across
Europe tumbled during the quarter, hitting new five-year, and in some cases,
six-year lows. The Dow Jones Stoxx Index, which measures 600 European blue-chip
companies, dropped 23% during the quarter. In Japan, the Nikkei Stock Average
Index ended the quarter down 12%. Although they continued to outperform most
other countries, emerging markets suffered in the third quarter, erasing
first-half gains and leaving them down 12% for the year.
According to Thomson Financial Securities Data, global debt and equity
underwriting volume was down 13% in the quarter compared with the third quarter
of 2001, which was negatively affected by the terrorist attacks of September 11.
In the United States, underwriting fees fell 21% amid a falloff in more
lucrative stock deals, such as Initial Public Offerings ("IPOs"). In total,
equity and equity-linked securities issuance volume decreased 41% compared to
the third quarter of 2001. With just seven IPOs by U.S. issuers, the 2002 third
quarter had the lowest volume since the first quarter of 1980.
Falling stocks and economic uncertainty continued to adversely affect the merger
and acquisition market in the 2002 third quarter. According to Thomson Financial
Securities Data, the value of worldwide announced merger and acquisition deals
fell 37% from the level in the third quarter of 2001. The value of announced
merger and acquisition deals in the United States declined 42% from the third
quarter of 2001.
During the 2002 third quarter, the Financial Services Forum, a CEO-led group of
the industry's largest companies, of which Merrill Lynch is a member, announced
that all of its publicly traded member companies will expense employee stock
options. Merrill Lynch is still evaluating when this proposal will be adopted.
Merrill Lynch continually evaluates its businesses for profitability and
performance under varying market conditions and, in light of the evolving
conditions in the competitive environment, for alignment with its long-term
strategic objectives. 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.
22
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
----------------------------- -----------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(dollars in millions, except per share amounts) 2002 2001 2002 2001
-------- -------- -------- --------
Net Revenues
Commissions $1,122 $1,204 $ 3,555 $ 4,071
Principal transactions 377 739 1,982 3,344
Investment banking
Underwriting 332 563 1,321 1,900
Strategic advisory 163 294 540 891
Asset management and portfolio service fees 1,217 1,337 3,808 4,072
Other 165 129 603 446
------ ------ ------- -------
Subtotal 3,376 4,266 11,809 14,724
Interest and dividend revenues 3,484 4,663 9,966 16,459
Less interest expense 2,498 3,784 7,372 14,055
------ ------ ------- -------
Net interest profit 986 879 2,594 2,404
------ ------ ------- -------
Total Net Revenues 4,362 5,145 14,403 17,128
------ ------ ------- -------
Non-interest expenses:
Compensation and benefits 2,228 2,757 7,443 8,978
Communications and technology 421 529 1,307 1,695
Occupancy and related depreciation 218 280 684 820
Brokerage, clearing, and exchange fees 182 219 552 697
Advertising and market development 125 165 426 575
Professional fees 135 115 397 408
Office supplies and postage 62 78 196 266
Goodwill amortization - 53 - 156
Other 128 175 575 556
Recoveries/expenses related to Sept.11 (191) 88 (191) 88
------ ------ ------- -------
Total non-interest expenses 3,308 4,459 11,389 14,239
------ ------ ------- -------
Pre-tax earnings $1,054 $ 686 $ 3,014 $ 2,889
====== ====== ======= =======
Net earnings $ 693 $ 422 $ 1,974 $ 1,837
====== ====== ======= =======
Earnings per common share:
Basic $ 0.79 $ 0.49 $ 2.26 $ 2.15
Diluted 0.73 0.44 2.07 1.93
Annualized return on average common
stockholders' equity 12.7% 8.0% 12.5% 12.2%
Pre-tax profit margin 24.2 13.3 20.9 16.9
- ----------------------------------------------------------------------------------------------------------------------
Compensation and benefits
as a percentage of net revenues 51.1% 53.6% 51.7% 52.4
Non-compensation expenses
as a percentage of net revenues 24.8 33.1 27.4 30.7
- ----------------------------------------------------------------------------------------------------------------------
23
Quarterly Results of Operations
Merrill Lynch's net earnings were $693 million for the 2002 third quarter, 64%
higher than the $422 million reported in the third quarter of 2001. Earnings per
common share were $0.79 basic and $0.73 diluted, compared with $0.49 basic and
$0.44 diluted in the 2001 third quarter. Third quarter 2002 net earnings include
$191 million ($114 million after-tax, or $0.12 per diluted share), attributable
to a September 11-related net insurance recovery. Third quarter 2001 net
earnings included $88 million ($53 million after-tax, or $0.06 per diluted
share), of September 11-related expenses.
Net revenues were $4.4 billion, 15% lower than the 2001 third quarter. Details
of significant changes in revenue line items are as follows:
o Commission revenues were $1.1 billion, 7% below the 2001 third quarter,
due primarily to a global decline in client transaction volumes,
particularly in listed equities and mutual funds.
o Principal transactions revenues decreased $362 million, or 49%, from
the third quarter of 2001, to $377 million, due primarily to lower
revenues from equities and equity derivatives, which were adversely
impacted by reduced customer flows, the conversion of large size Nasdaq
orders for institutional clients to a commission-based structure over
the past year, and lower debt trading revenues.
o Net interest profit was $986 million, up $107 million, or 12%, from the
2001 third quarter due to a favorable yield curve environment and
increased dividend and interest income associated with certain trading
strategies, the impact of which was partially offset by a reduction in
principal transactions revenues.
o Underwriting revenues were $332 million, 41% lower than the 2001 third
quarter. Strategic advisory revenues declined 45% from the 2001 third
quarter to $163 million. These decreases reflect the global decline in
investment banking activity.
o Asset management and portfolio service fees were $1.2 billion, down 9%
from the third quarter of 2001. This decrease is primarily the result
of a market-driven decline in equity assets under management and a
shift in asset mix.
o Other revenues were $165 million, up $36 million from the 2001 third
quarter, resulting primarily from increased realized gains on the
investment portfolios of Merrill Lynch's U.S. banks.
Compensation and benefits expenses were $2.2 billion, a decrease of $529
million, or 19%, from the 2001 third quarter. The decrease is due primarily to
lower incentive compensation accruals, reduced staffing levels, and lower
severance expenses. Compensation and benefits expenses were 51.1% of net
revenues for the third quarter of 2002, compared to 53.6% in the 2001 third
quarter.
Non-compensation expenses decreased 37% from the third quarter of 2001 to $1.1
billion. Excluding the impact of September 11-related items, non-compensation
expenses were $1.3 billion, a decline of 21% from the 2001 third quarter.
Details of the significant changes in non-compensation expenses follow:
o Communications and technology costs were $421 million, down 20% from
the third quarter of 2001 due to lower technology equipment
depreciation, communications costs, and systems consulting costs.
o Occupancy and related depreciation was $218 million in the third
quarter of 2002, a decline of 22% from the year-ago period due
primarily to lower rental expenses resulting from the fourth quarter
2001 restructuring initiatives.
o Brokerage, clearing, and exchange fees were $182 million, down 17%
from the third quarter of 2001.
o Advertising and market development expenses were $125 million, down 24%
from the third quarter of 2001 due primarily to reduced spending on
travel and advertising.
24
o Professional fees increased 17% from the third quarter of 2001 to $135
million, due principally to increased legal fees.
o Office supplies and postage decreased 21% from the third quarter of
2001 to $62 million due to lower levels of business activity, and
efficiency initiatives.
o In accordance with SFAS No. 142, goodwill amortization, which totaled
$53 million in the 2001 third quarter, is no longer being recorded.
Refer to Note 1 to the Condensed Consolidated Financial Statements for
additional information.
o Other expenses, excluding the September 11-related items, were $128
million, down 27% due to lower provisions for various business
matters, including litigation.
o In the third quarter of 2002, Merrill Lynch recorded a September
11-related net insurance recovery representing a partial pre-tax
reimbursement of $200 million, offset by September 11-related expenses
of $9 million. The reimbursement is for a portion of the replacement
and recovery costs, and a partial business interruption settlement for
foregone profits. The third quarter of 2001 included September
11-related pre-tax expenses of $88 million, which were net of an
insurance receivable of $50 million.
Year-to-date Results of Operations
For the first nine months of 2002, net earnings were $2.0 billion, compared to
$1.8 billion for the corresponding period in 2001. Excluding the impact of
September 11-related items, net earnings decreased 2% from the year-ago period,
to $1.9 billion. Net revenues were $14.4 billion, down 16% from the first nine
months of 2001. The impact of the decline in net revenues on year-to date
earnings was limited by a $2.9 billion, or 20%, reduction in non-interest
expenses ($2.6 billion, or 18%, excluding September 11-related items). Decreases
were experienced in all expense categories, reflecting actions taken to align
Merrill Lynch's capacity with the current business environment and opportunities
for future growth, including the fourth quarter 2001 restructuring. Year-to-date
earnings per common share were $2.26 basic and $2.07 diluted ($2.13 and $1.95,
respectively, excluding September 11-related items), compared with $2.15 basic
and $1.93 diluted in the first nine months of 2001 ($2.21 and $1.99,
respectively, excluding September 11-related items). The pre-tax margin for the
nine months of 2002 was 20.9%, up from 16.9% in the year-ago period (19.6% and
17.4%, respectively, excluding September 11-related items). Annualized return on
average common stockholder's equity was 12.5% for the first nine months of 2002
compared to 12.2% for the comparable period in 2001.
Merrill Lynch's year-to-date effective tax rate was 29.7%, unchanged from the
first six months of 2002, and down from the full year 2001 rate of 44.2%. The
2001 rate reflected non-deductible losses associated with the refocusing of the
Japan Private Client business, which were included in the restructuring charge,
including a write-off of previously recognized deferred tax assets of
approximately $135 million. The full year 2001 rate, excluding the impact of the
restructuring charge and September 11-related items, was 30.4%.
Merrill Lynch is not optimistic that the environment in the fourth quarter will
lead to an improvement in revenues, and remains cautious in its near-term
outlook. In addition, the financial services industry continues to experience
higher financing premiums than previously, which, if sustained, could adversely
impact profitability.
25
Restructuring and other charges
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 Condensed 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 the current business environment and
opportunities for future growth. These actions were expected to result in
pre-tax annual expense savings of approximately $1.4 billion. Merrill Lynch has
achieved these annual savings in the first nine months of 2002. Opportunities
exist to reduce non-compensation expenses further, although much of the savings
realized going forward will be reinvested into priority growth initiatives,
including foreign exchange, securities services, and secondary equities for GMI,
small business lending and banking services for the Private Client business in
the United States, as well as the institutional business in the United States
and third party distribution in Europe for Merrill Lynch Investment Managers.
For further information regarding the details of restructuring and other
charges, see Note 2 to the Condensed Consolidated Financial Statements.
- --------------------------------------------------------------------------------
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 at the
corporate level. Business segment results are restated to reflect
reallocations of revenues and expenses which result from changes in Merrill
Lynch's business strategy and structure. Included in both GMI's and Private
Client's results is a September 11-related partial business interruption
settlement for foregone pre-tax profits of $50 million and $25 million,
respectively, which was recorded as a reduction of non-interest expenses.
26
- --------------------------------------------------------------------------------
GLOBAL MARKETS AND INVESTMENT BANKING
- --------------------------------------------------------------------------------
GMI'S RESULTS OF OPERATIONS
- ----------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
--------------------------------- --------------------------------
Sept. 27, Sept. 28, % Inc. Sept. 27, Sept. 28, % Inc.
(dollars in millions) 2002 2001 (Dec.) 2002 2001 (Dec.)
- ----------------------------------------------------------------------------------------------------------
Commissions $ 514 $ 493 4 $1,578 $1,646 (4)
Principal transactions and
net interest profit 874 956 (9) 2,927 3,744 (22)
Investment banking 431 768 (44) 1,669 2,501 (33)
Other revenues 139 118 18 517 453 14
------ ------ ------ ------
Total net revenues 1,958 2,335 (16) 6,691 8,344 (20)
------ ------ ------ ------
Non-interest expenses 1,435 1,778 (19) 4,886 6,064 (19)
Pre-tax earnings, before ------ ------ ------ ------
September 11 recovery 523 557 (6) 1,805 2,280 (21)
September 11 recovery 50 - N/M 50 - N/M
------ ------ ------ ------
Pre-tax earnings $ 573 $ 557 3 $1,855 $2,280 (19)
====== ====== ====== ======
Pre-tax profit margin (1) 29.3% 23.9% 27.7% 27.3%
- ----------------------------------------------------------------------------------------------------------
(1) Pre-tax profit margin before the September 11 recovery was 26.7% and 27.0%
for the three- and nine- month periods ended September 27, 2002,
respectively.
Against the backdrop of challenging market conditions, GMI's performance was
driven primarily by the debt markets business, which had its strongest-ever
first nine months earnings. For the 2002 third quarter, the debt markets
business had particularly strong results in the trading of interest rate
products, especially in derivatives and U.S. governments. These results were
partially offset by lower investment banking revenues driven by lower levels of
activity in mergers and acquisitions and equity origination, as well as by
reduced revenues from cash equity and equity-linked trading. GMI's results also
reflect continued discipline in reducing expenses and achieving efficiency and
productivity improvements.
GMI's third quarter 2002 pre-tax earnings were $573 million. Excluding the
September 11 recovery, GMI's pre-tax earnings were $523 million, 6% below the
2001 third quarter, on net revenues that were 16% lower, at $2.0 billion. GMI's
pre-tax margin excluding the recovery was 26.7%, almost three percentage points
above the year-ago quarter. This improvement is due in part to a 19% reduction
in non-interest expenses, excluding the recovery, from the 2001 third quarter.
GMI's year-to-date pre-tax earnings were $1.9 billion. Excluding the September
11 recovery, GMI's pre-tax earnings were $1.8 billion, 21% lower than the 2001
first nine months. Year-to-date net revenues were $6.7 billion, a decline of 20%
from the year-ago period. GMI's year-to-date pre-tax margin excluding the
recovery was 27.0%, compared with 27.3% in the same period last year.
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 per share commission in lieu of the
traditional spread. Nearly all Nasdaq institutional client trades are now done
on an agency, rather than a principal, basis.
27
Commissions revenues increased 4% to $514 million in the third quarter of 2002,
compared to the year-ago quarter as a result of increased commissions in U.S.
over-the-counter securities, resulting primarily from the change from a spread
basis to a commission basis for large size Nasdaq orders. Year-to-date
commissions revenues decreased by 4% to $1.6 billion as compared to the first
nine months of 2001 as a result of a global decline in equity trading volumes
and prices.
Principal transactions and net interest profit
- ------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
----------------------------------- ----------------------------------
Sept. 27, Sept. 28, % Inc. Sept. 27, Sept. 28, % Inc.
(dollars in millions) 2002 2001 (Dec.) 2002 2001 (Dec.)
- ------------------------------------------------------------------------------------------------------------------
Debt and debt derivatives $ 785 $ 679 16 $ 2,401 $ 2,320 3
Equities and equity derivatives 89 277 (68) 526 1,424 (63)
----- ----- ------- -------
Total $ 874 $ 956 (9) $ 2,927 $ 3,744 (22)
- ------------------------------------------------------------------------------------------------------------------
Principal transactions revenues 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 revenues include unrealized gains related to equity
investments held by Merrill Lynch's broker-dealers, as well as unrealized gains
and losses on those marketable investment securities held by Merrill Lynch's
U.S. banks, which are classified as trading securities.
Net interest profit is a function of the level and mix of total assets and
liabilities, including trading assets owned, financing and lending
transactions, 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 principal transactions and net interest profit
in the aggregate as net trading revenues. Changes in the composition of
trading inventories and hedge positions can cause the mix of principal
transactions and net interest profit to fluctuate. Net trading revenues were
$874 million in the third quarter of 2002, down 9% from $1.0 billion in the
third quarter of 2001. Debt and debt derivatives net trading revenues were
$785 million, up 16% from the third quarter of 2001, reflecting increased
trading of interest rate and other products due to a favorable yield curve
environment and proprietary positioning. Equities and equity derivatives net
trading revenues decreased 68% from the third quarter of 2001 to $89 million,
primarily due to reduced customer flows and the conversion of the Nasdaq
business to a commission-based structure over the past year.
On a year-to-date basis, net trading revenues were down 22% compared to the
first nine months of 2001, due to the significant decrease in equity and
equity derivatives revenues. Debt trading revenues were up slightly over the
prior year period. The 2002 second quarter results included $70 million
related to the sale of certain energy trading assets in 2001, which was
largely offset by write-downs of credit positions, principally in the
telecommunications sector. The 2001 first quarter results included the gain on
the sale of certain energy-trading assets.
28
- --------------------------------------------------------------------------------
Investment Banking
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
-------------------------- -------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(dollars in millions) 2002 2001 % (Dec.) 2002 2001 % (Dec.)
- -------------------------------------------------------------------------------------------------------------------------
Debt underwriting $ 186 $ 197 (6) $ 555 $ 679 (18)
Equity underwriting 82 277 (70) 574 931 (38)
----- ----- ------ -----
Total underwriting 268 474 (43) 1,129 1,610 (30)
Strategic advisory services 163 294 (45) 540 891 (39)
----- ----- ------ ------
Total $ 431 $ 768 (44) $1,669 $2,501 (33)
- -------------------------------------------------------------------------------------------------------------------------
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.
Underwriting revenues in the 2002 third quarter were $268 million, down 43% from
the $474 million recorded in the third quarter of 2001. This decrease is the
result of sharply lower equity underwriting revenues, which declined 70% to $82
million, and lower debt underwriting revenues, which declined 6% from the third
quarter of 2001, to $186 million. These decreases resulted from a lower market
share and a reduced volume of transactions. Merrill Lynch ranked sixth in global
debt and fifth in global equity and equity-linked underwriting in the third
quarter of 2002 with a 7.4% and 6.9% market share, respectively. Merrill Lynch's
debt underwriting focus has shifted toward higher margin businesses and away
from the achievement of aggregate market share goals; however debt transactions
are highly competitive and not all transactions are profitable.
Merrill Lynch was the lead manager of a syndicate underwriting the issuance of
securities of Chartered Semiconductor Manufacturing through a rights offering
to existing stockholders. Subsequent to quarter-end, the stock price was below
the rights conversion price of Singapore $1.00 and the offering closed.
Syndicate members adhered to a contingent commitment to purchase a substantial
portion of the offering and Merrill Lynch met its requirement to purchase
275.2 million unsold securities per the underwriting and syndication
arrangements and expects to maintain a position in this security and to continue
utilizing hedging techniques.
Year-to-date underwriting revenues decreased 30% to $1.1 billion from $1.6
billion in the first nine months of 2001, due to decreases in both debt and
equity underwriting revenues. Merrill Lynch's underwriting market share
information based on transaction value follows:
- ---------------------------------------------------------------------------------------------------------------
For the Three Months Ended
---------------------------------------------------------------
September 2002 September 2001
-------------------------- -----------------------
Market Market
Share Rank Share Rank
- ---------------------------------------------------------------------------------------------------------------
GLOBAL PROCEEDS
Debt and equity 7.4 % 6 10.8 % 2
Debt 7.4 6 9.9 2
Equity and equity-linked 6.9 5 21.5 1
U.S. PROCEEDS
Debt and equity 8.4 % 4 11.8 % 2
Debt 8.5 5 11.0 2
Equity and equity-linked 7.9 6 27.2 1
- ---------------------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager.
29
- ---------------------------------------------------------------------------------------------------------------
For the Nine Months Ended
---------------------------------------------------------------
September 2002 September 2001
-------------------------- -----------------------
Market Market
Share Rank Share Rank
- ---------------------------------------------------------------------------------------------------------------
GLOBAL PROCEEDS
Debt and equity 8.5 % 2 11.6 % 1
Debt 8.3 2 11.3 1
Equity and equity-linked 11.2 3 14.5 1
U.S. PROCEEDS
Debt and equity 10.2 % 2 13.8 % 1
Debt 9.8 2 13.3 1
Equity and equity-linked 16.4 3 19.8 1
- ---------------------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to book manager.
Strategic Advisory Services
- ---------------------------
Strategic advisory services revenues, which include merger and acquisition and
other advisory fees, were $163 million in the third quarter of 2002, down 45%
from the third quarter of 2001. Year-to-date strategic advisory services
revenues decreased 39% from the first nine months of 2001, to $540 million as
weak market conditions continue to have a negative impact on global merger and
acquisition activity. Merrill Lynch's merger and acquisition market share
information based on transaction value is as follows:
- ---------------------------------------------------------------------------------------------------------------
For the Three Months Ended
---------------------------------------------------------------
September 2002 September 2001
-------------------------- -----------------------
Market Market
Share Rank Share Rank
- ---------------------------------------------------------------------------------------------------------------
COMPLETED TRANSACTIONS
Global 25.4 % 3 25.6 % 3
U.S. 42.5 2 16.5 5
ANNOUNCED TRANSACTIONS
Global 13.2 % 5 36.7 % 3
U.S. 15.4 5 52.6 2
- ---------------------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors.
- ---------------------------------------------------------------------------------------------------------------
For the Nine Months Ended
---------------------------------------------------------------
September 2002 September 2001
-------------------------- -----------------------
Market Market
Share Rank Share Rank
- ---------------------------------------------------------------------------------------------------------------
COMPLETED TRANSACTIONS
Global 22.7 % 3 29.5 % 2
U.S. 26.5 4 37.8 2
ANNOUNCED TRANSACTIONS
Global 13.8 % 7 26.3 % 3
U.S. 11.9 9 33.1 4
- ---------------------------------------------------------------------------------------------------------------
Source: Thomson Financial Securities Data statistics based on full credit to
both target and acquiring companies' advisors.
30
Other Revenues
Other revenues, which include realized investment gains and losses and
distributions on equity investments, increased $21 million in the third quarter
of 2002 from the year-ago quarter, to $139 million. Other revenues in the third
quarter of 2002 reflect increased realized gains on the investment portfolios of
Merrill Lynch's U.S. banks. Year-to-date, other revenues increased 14% to $517
million, and reflect the realized gains on the investment portfolios of the U.S.
banks, as well as a $45 million pre-tax gain on the sale of the Securities
Pricing Services business recorded in the first quarter of 2002.
- --------------------------------------------------------------------------------
PRIVATE CLIENT GROUP
- --------------------------------------------------------------------------------
PRIVATE CLIENT'S RESULTS OF OPERATIONS
- -----------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
-------------------------- -------------------------
Sept. 27, Sept. 28, % Inc. Sept. 27, Sept. 28, % Inc.
(dollars in millions) 2002 2001 (Dec.) 2002 2001 (Dec.)
- -----------------------------------------------------------------------------------------------------------------------
Commissions $ 578 $ 679 (15) $1,885 $2,344 (20)
Principal transactions and
new issue revenues 244 344 (29) 872 1,160 (25)
Asset management and
portfolio service fees 875 928 (6) 2,719 2,792 (3)
Net interest profit 328 415 (21) 1,027 1,160 (11)
Other revenues 60 30 100 147 87 69
------ ------ ------ ------
Total net revenues 2,085 2,396 (13) 6,650 7,543 (12)
------ ------ ------ ------
Non-interest expenses 1,796 2,196 (18) 5,743 6,864 (16)
------ ------ ------ ------
Pre-tax earnings, before
September 11 recovery 289 200 45 907 679 34
September 11 recovery 25 - N/M 25 - N/M
------ ------ ------ ------
Pre-tax earnings $ 314 $ 200 57 $ 932 $ 679 37
====== ====== ====== ======
Pre-tax profit margin (1) 15.1 % 8.3 % 14.0 % 9.0 %
- -----------------------------------------------------------------------------------------------------------------------
(1) Pre-tax profit margin before the September 11 recovery was 13.9% and 13.6%
for the three- and nine- month periods ended September 27, 2002,
respectively.
Private Client's third quarter 2002 pre-tax earnings were $314 million.
Excluding the September 11 recovery, Private Client's pre-tax earnings were $289
million, 45% higher than the 2001 third quarter, on net revenues that were down
13%, at $2.1 billion. Private Client's pre-tax margin excluding the recovery was
13.9%, compared with 8.3% in the year-ago quarter. These results reflect
significantly improved performance both inside and outside the United States,
driven in part by continued discipline in reducing costs and the impact of the
2001 restructuring. Private Client's business in the United States generated a
pre-tax margin of 16.0% in the third quarter of 2002 excluding the recovery; an
increase of more than four percentage points from the same period last year.
This improvement was partially attributable to continued expense reductions.
Also contributing to the improvement was a higher proportion of fee-based and
recurring revenues, and the growth of the mortgage business.
Private Client's year-to-date net revenues were $6.7 billion, down 12% from the
corresponding period of 2001. Pre-tax earnings were $932 million. Excluding the
recovery, pre-tax earnings were $907 million, 34% higher than the first nine
months of 2001. Private Client's year-to-date pre-tax margin excluding the
recovery was 13.6%, compared with 9.0% for the same period last year.
Private Client employed approximately 14,600 Financial Advisors at the end of
the 2002 third quarter, down from 16,400 at the end of 2001. The decline is
primarily the result of staffing reductions associated with the re-focusing of
the Private Client business outside the United States, as well as attrition
combined with reduced hiring inside the United States.
31
Commissions
Commissions revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, as well as sales of mutual funds, insurance
products, and options.
Commissions revenues declined 15% to $578 million in the third quarter of 2002
from $679 million in the third quarter of 2001. Commissions revenues for the
first nine months of 2002 were $1.9 billion, 20% lower than the first nine
months of 2001. These decreases were primarily due to a global decline in client
transaction volumes, particularly in equity securities and mutual funds.
Commissions are also negatively affected by the ongoing transition of Private
Client assets to asset-priced accounts.
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 29% to $244 million in
the 2002 third quarter from the year-ago quarter, as trading and new issue
volume declined in a less favorable market environment. Year-to-date revenues
similarly decreased from $1.2 billion in 2001 to $872 million in 2002.
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 AdvantageSM 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 $875 million, down 6% from
the $928 million recorded in the third quarter of 2001. On a year-to-date basis,
asset management and portfolio service fees totaled $2.7 billion, down 3% from
the year-ago period. These results reflect market-driven declines in asset
levels.
An analysis of changes in assets in Private Client accounts from September 28,
2001 to September 27, 2002 is detailed below:
- ----------------------------------------------------------------------------------------------------
Net Changes Due To
---------------------------------------
Sept. 28, New Asset Sept. 27,
(dollars in billions) 2001 Money Depreciation Other(1) 2002
- ------------------------------------------------------------------------------------------------------
Assets in Private Client accounts:
U.S. $ 1,171 $ 22 $ (171) $ (3) $ 1,019
Non-U.S. 127 1 (6) (35) 87
---------------------------------------------------------
Total $ 1,298 $ 23 $ (177) $(38) $ 1,106
- ----------------------------------------------------------------------------------------------------
(1) Represents business divestitures.
Total assets in Private Client accounts in the United States declined 13% from
the end of the 2001 third quarter, to $1.0 trillion at September 27, 2002 as a
result of market-driven declines in asset values, partially offset by net new
money inflows of $22 billion. Outside the United States, client assets were $87
billion, down from $127 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 into Private Client accounts outside the United States,
excluding the impact of sold or discontinued businesses, totaled $1 billion over
this period. Total assets in asset-priced accounts were $176 billion at the end
of the 2002 third quarter, a decrease of 4% from the year-ago period primarily
due to market-driven declines.
32
Net interest profit
Net interest profit for Private Client includes Private Client's allocation of
the interest spread earned in Merrill Lynch's banks for the origination of
deposits as well as interest earned on margin and other loans. 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 $328 million in the 2002 third quarter, down 21% from
$415 million in the third quarter of 2001. Net interest profit for the nine
months of 2002 was $1.0 billion, 11% lower than in the comparable period in
2001. These decreases are primarily due to lower margin balances and a reduction
in the related interest rates.
Other revenues
Other revenues, which is primarily comprised of realized and unrealized
investment gains and losses on investments, totaled $60 million in the third
quarter of 2002 as compared to $30 million in the year-ago period. Other
revenues for the first nine months of 2002 increased to $147 million from $87
million for the same period in 2001. The increases for each of these periods
reflect increased realized gains related to the sales of mortgages in Merrill
Lynch's U.S. banks. Other revenues in the first quarter of 2002 also 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.
- --------------------------------------------------------------------------------
MERRILL LYNCH INVESTMENT MANAGERS
- --------------------------------------------------------------------------------
MLIM'S RESULTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
-------------------------- -------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28, % Inc.
(dollars in millions) 2002 2001 % (Dec.) 2002 2001 (Dec.)
- ------------------------------------------------------------------------------------------------------------------
Commissions $ 42 $ 60 (30) $ 147 $ 195 (25)
Asset management fees 339 401 (15) 1,071 1,255 (15)
Other revenues (12) 20 (160) 17 52 (67)
----- ----- ------ ------
Total net revenues 369 481 (23) 1,235 1,502 (18)
Non-interest expenses 299 389 (23) 951 1,237 (23)
----- ----- ------ ------
Pre-tax earnings $ 70 $ 92 (24) $ 284 $ 265 7
===== ===== ===== ======
Pre-tax profit margin 19.0% 19.1% 23.0% 17.6%
- ------------------------------------------------------------------------------------------------------------------
Despite a challenging market environment characterized by declining equity
valuations and a shift by investors out of equities into lower margin fixed
income and cash products, MLIM increased profitability versus the first nine
months of 2001 and maintained solid investment performance. Globally, more than
60% of MLIM's assets under management were ahead of their benchmark or category
median for the 1-, 3- and 5-year periods ending September 2002.
MLIM's pre-tax earnings in the 2002 third quarter were $70 million, down 24%
from $92 million in the 2001 third quarter. Net revenues decreased 23% from the
year ago period to $369 million primarily reflecting a market-driven decline in
equity assets under management. Net revenues are dependent on levels of assets
under management, and accordingly, are susceptible to a decline in equity market
valuations. The pre-tax margin was 19.0%, essentially unchanged from the
year-ago quarter, as a result of actions taken over the past year to reduce
expenses, including streamlining MLIM's investment platform and rationalizing
its product offerings.
33
Year-to-date, MLIM's pre-tax earnings were $284 million, 7% higher than for the
first nine months of 2001 on net revenues that were 18% lower at $1.2 billion,
as expense reductions more than offset the decline in revenues. MLIM's
year-to-date pre-tax margin was 23.0%, compared with 17.6% for the same period
last year.
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
30% to $42 million in the 2002 third quarter from the year-ago quarter.
Year-to-date commissions similarly decreased 25%, to $147 million.
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 on
separately managed accounts. Asset management fees were $339 million, a decline
of 15% from the third quarter of 2001 due to a decrease in management fees,
which are dependent on net asset values. On a year-to-date basis, asset
management fees also decreased 15% to $1.1 billion. These declines are the
result of market-driven depreciation as well as a shift by investors out of
equities into lower-margin fixed income and cash products. At the end of the
third quarter of 2002, assets under management totaled $452 billion, compared
with $507 billion at the end of the third quarter of 2001.
An analysis of changes in assets under management from September 28, 2001 to
September 27, 2002 is as follows:
- -------------------------------------------------------------------------------------------------------
Net Changes Due To
--------------------------------------------
Sept. 28, New Asset Sept. 27,
(dollars in billions) 2001 Money Depreciation Other (1) 2002
- -------------------------------------------------------------------------------------------------------
Assets under management $507 $(20) $(42) $7 $452
- -------------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends of $5 billion, the impact of foreign exchange
movements of $10 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 of $(3) billion, including outflows related
to a business divestiture.
Other Revenues
Other revenues, which primarily include net interest profit and investment gains
and losses, totaled ($12) million and $20 million for the third quarter of 2002
and 2001, respectively. The third quarter 2002 results reflect investment
losses. Other revenues totaled $17 million for the first nine months of 2002, as
compared to $52 million in the year-ago period. Other revenues in the 2002 first
quarter included the $17 million pre-tax gain on the sale of the Canadian retail
mutual fund business.
34
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
Management continually monitors and evaluates the level and composition of the
balance sheet.
For the first nine months of 2002, average total assets were $443 billion, up 3%
from $429 billion for the full-year 2001. Average total liabilities also
increased 3% to $419 billion from $406 billion for the full-year 2001. Average
total assets and liabilities for the first nine months of 2002 include the
following changes as compared to the full-year 2001:
- --------------------------------------------------------------------------------------------
Increase/
(dollars in millions) (Decrease) Change
- --------------------------------------------------------------------------------------------
AVERAGE ASSETS
Receivables under securities borrowed transactions $11,810 39 %
Investment securities 7,590 11
Loans, notes and mortgages (net) 7,032 36
Cash and cash equivalents (6,732) (31)
Customer receivables (6,177) (14)
AVERAGE LIABILITIES
Deposits $ 6,284 8 %
Payables under repurchase agreements 5,813 6
Payables under securities loaned transactions 2,408 31
Commercial paper and other short-term borrowings (5,215) (53)
- --------------------------------------------------------------------------------------------
The growth in average deposits in the first nine 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 make loans and purchase
investment securities. Additionally, securities financing 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.
- --------------------------------------------------------------------------------
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:
o sufficient equity capital to absorb losses and,
o 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 September 27, 2002, Merrill Lynch's equity capital was comprised of $21.9
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 SecuritiesSM
("TOPrS"SM). Management believes that Merrill Lynch's equity capital base of
$25.0 billion is adequate.
35
Merrill Lynch's leverage ratios were as follows:
- ----------------------------------------------------------------------
Adjusted
Leverage Leverage
Ratio(1) Ratio(2)
- ----------------------------------------------------------------------
PERIOD-END
September 27, 2002 17.6x 12.4x
December 28, 2001 18.5x 12.8x
AVERAGE (3)
Nine months ended Sept. 27, 2002 18.6x 12.8x
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 $2.8 billion at September 27, 2002 and $3.0
billion at December 28, 2001, which was 3% and 4% of total unsecured borrowings
at September 27, 2002 and year-end 2001, respectively. Deposits at Merrill
Lynch's banking subsidiaries totaled $80.8 billion at September 27, 2002, down
from $85.8 billion at year-end 2001. Of the $80.8 billion of deposits in Merrill
Lynch banking subsidiaries as of September 27, 2002, $68.2 billion were in U.S.
banks. Outstanding long-term borrowings decreased to $73.9 billion at September
27, 2002 from $76.6 billion at December 28, 2001. Major components of the change
in long-term borrowings during the first nine months of 2002 are as follows:
- ----------------------------------------------
(dollars in billions)
- ----------------------------------------------
Balance at December 28, 2001 $76.6
Issuances 18.3
Maturities (23.0)
Other, net 2.0
---------
Balance at Sept. 27, 2002 (1) $73.9
- ----------------------------------------------
(1) At September 27, 2002, $47.7 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 $12.4 billion at September 27, 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 September 27, 2002 totaled $3.5 billion and was not drawn
upon. The bank credit facility was renewed on May 9, 2002 for 364 days. At
renewal, Merrill Lynch elected to reduce the amount of the bank credit facility
from $5.0 billion 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.
36
Credit Ratings
The cost and availability of unsecured funding generally are dependent on credit
ratings and market conditions. 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 TOPrSSM were rated by several recognized credit rating agencies at November
8, 2002 as indicated below. These ratings do not reflect outlooks that may be
expressed by the rating agencies from time to time, some of which are currently
negative.
- ------------------------------------------------------------------------------------------------------------------
Senior
Debt Preferred Stock TOPrSSM
Rating Agency Ratings Ratings Ratings
- ------------------------------------------------------------------------------------------------------------------
Dominion Bond Rating Service Ltd AA (Low) Not Rated Not Rated
Fitch Ratings AA- A+ A+
Moody's Investors Service, Inc. Aa3 A2 A1
Rating and Investment Information, Inc. (1) AA A+ A+
Standard & Poor's Ratings Services A+ A- A-
- ------------------------------------------------------------------------------------------------------------------
(1) Located in Japan.
On May 17, 2002, Fitch Ratings lowered its long-term debt ratings for ML & Co.
(senior to "AA-" from "AA" and preferred stock and TOPrSSM to "A+" from "AA-").
The same day, Fitch also announced rating downgrades for several other
securities firms. On October 17, 2002, Standard & Poor's lowered its long-term
debt ratings for ML & Co. (senior to "A+" from "AA-" and preferred stock and
TOPrSSM to "A-" from "A") and the short-term debt rating for ML & Co. (senior to
"A-1" from "A-1+"). The same day, Standard & Poor's also announced ratings
downgrades for several other securities firms.
- --------------------------------------------------------------------------------
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.
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. 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. The tables below show VaR using a 95%
confidence level and a weekly holding period for trading and non-trading
portfolios. 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
September 27, 2002 and December 28, 2001 as well as daily average VaR for the
three months ended September 27, 2002. Additionally, high and low VaR for the
third quarter of 2002 is presented independently for each risk category and
overall.
37
- ------------------------------------------------------------------------------------------------------
Daily
Sept. 27, Dec. 28, Average High Low
(dollars in millions) 2002 2001 3Q02 3Q02 3Q02
- ------------------------------------------------------------------------------------------------------
Trading value-at-risk(1)
Interest rate and credit spread $ 58 $ 45 $ 51 $ 71 $ 39
Equity 38 37 36 46 26
Commodity - 1 - - -
Currency 5 2 2 8 -
Volatility 18 20 15 21 7
-------------------------------------------------------------
119 105 104
Diversification benefit (59) (49) (43)
-------------------------------------
Overall(2) $ 60 $ 56 $ 61 $ 76 $ 49
=====================================
- ------------------------------------------------------------------------------------------------------
(1) Based on a 95% confidence level and a weekly holding period.
(2) Overall VaR using a 95% confidence level and a one-day holding period was
$29 million at September 27, 2002 versus $21 million at year-end 2001.
The following table presents Merrill Lynch's VaR for its non-trading portfolios
(excluding U.S. banks):
- --------------------------------------------------------------------------
Sept. 27, Dec. 28,
(dollars in millions) 2002 2001
- --------------------------------------------------------------------------
Non-trading value-at-risk(1)
Interest rate and credit spread $ 34 $ 20
Equity 22 28
Currency 4 7
Volatility 7 6
---- -----
67 61
Diversification benefit (24) (26)
---- -----
Overall $ 43 $ 35
==== =====
- --------------------------------------------------------------------------
(1) Based on a 95% confidence level and a weekly holding period.
Non-trading VaR does not include risk related to Merrill Lynch's $4.7 billion of
outstanding Liquid Yield Option TM Notes ("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 TOPrSSM at September 27, 2002
and December 28, 2001 was $38 million and $33 million, respectively, based on a
95% confidence level and a weekly holding period. TOPrSSM, 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.
Since 2000, cash flows from client funds in certain CMA(R) and other types of
accounts have been 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 investment securities. The overall VaR for the
U.S. banks, based on a 95% confidence interval and a weekly holding period, was
$81 million and $79 million at September 27, 2002 and December 28, 2001,
respectively, which principally relates to interest rate and credit spread risk.
38
Credit Risk
Merrill Lynch enters into International Swaps and Derivatives Association, Inc.
master agreements or their equivalent ("master netting agreements") with
substantially all of its derivative counterparties as soon as practical. The
agreements are negotiated with each counterparty and are complex in nature.
While every effort is taken to execute such agreements, it is possible that a
counterparty may be unwilling to sign such an agreement, and as a result, would
subject Merrill Lynch to additional credit risk. 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
Condensed Consolidated Balance Sheets, providing for a more meaningful balance
sheet presentation of credit exposure; however under bankruptcy laws in certain
countries or in certain industries, master netting agreements are not
permissible.
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 $13.2 billion of
collateral) of trading derivatives in a gain position by maturity at September
27, 2002. (Please note that the following table includes only credit exposure
from derivative transactions and does not include other credit exposures, which
may be material).
(dollars in millions)
- -----------------------------------------------------------------------------------------
Years to Maturity Cross-
Credit ---------------------------------------------- Maturity
Rating(1) 0-3 3+ - 5 5+ - 7 Over 7 Netting(2) Total
- -----------------------------------------------------------------------------------------
AAA $ 5,140 $ 1,852 $ 1,152 $ 2,301 $ (694) $ 9,751
AA 2,744 2,817 1,197 3,712 (1,999) 8,471
A 2,003 1,585 1,194 1,475 (1,522) 4,735
BBB 1,610 774 343 555 (403) 2,879
Other 964 342 179 200 (99) 1,586
-----------------------------------------------------------------------
Total $ 12,461 $ 7,370 $ 4,065 $ 8,243 $(4,717) $27,422
- -----------------------------------------------------------------------------------------
(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.
39
- --------------------------------------------------------------------------------
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 that
these risks are inherent in the business and may employ 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 may seek to mitigate these
risks in certain circumstances 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 may syndicate loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will 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:
- ---------------------------------------------------------------------------
Sept. 27, Dec. 28,
(dollars in millions) 2002 2001
- ---------------------------------------------------------------------------
Trading assets:
Cash instruments $ 4,331 $ 4,597
Derivatives 4,413 4,478
Trading liabilities - cash instruments (1,529) (1,535)
Collateral on derivative assets (2,827) (2,934)
------- -------
Net trading asset exposure $ 4,388 $ 4,606
- ---------------------------------------------------------------------------
40
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
September 27, 2002, the carrying value of such debt and equity securities
totaled $136 million, of which 4% 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 $290 million and $245 million at September 27, 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:
- ---------------------------------------------------------------------------------------
Sept. 27, Dec. 28,
(dollars in millions) 2002 2001
- ---------------------------------------------------------------------------------------
Investment securities $ 352 $ 335
Loans (net of allowance for loan losses):
Bridge loans 136 130
Other loans(1) 2,571 2,880
Other investments:
Partnership interests (2) 1,862 1,594
Other equity investments (3) 291 140
- ---------------------------------------------------------------------------------------
(1) Represents outstanding loans to 121 and 138 companies at September 27, 2002
and December 28, 2001, respectively.
(2) Includes $932 million and $761 million in investments at September 27, 2002
and December 28, 2001, respectively, related to deferred compensation plans,
for which a portion of the default risk of the investments rests with the
participating employees.
(3) Includes investments in 123 and 81 enterprises at September 27, 2002 and
December 28, 2001, respectively.
During the third quarter of 2002, a lending syndicate, of which Merrill Lynch is
a member, entered into a Memorandum of Understanding relating to one of Merrill
Lynch's loan counterparties. Under this agreement, the existing loan would be
exchanged for a perpetual convertible security of France Telecom S.A. The due
date of this loan has been extended to November 15, 2002. Merrill Lynch's funded
portion of this credit facility was approximately $450 million at September 27,
2002. Certain conditions must be met before this agreement is finalized; failure
to complete this agreement could result in a substantial impairment of this
loan.
The following table summarizes Merrill Lynch's commitments with exposure to
non-investment grade or highly-leveraged counterparties:
- --------------------------------------------------------------------------------------------
Sept. 27, Dec. 28,
(dollars in millions) 2002 2001
- --------------------------------------------------------------------------------------------
Additional commitments to invest in partnerships(1) $ 506 $ 822
Unutilized revolving lines of credit and other
lending commitments 1,872 1,646
- --------------------------------------------------------------------------------------------
(1) Includes $123 million and $369 million at September 27, 2002 and
December 28, 2001, respectively, related to deferred compensation plans.
41
- --------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------------------------------------------------
Subsequent to September 27, 2002, the FASB issued SFAS No.147, "Acquisitions of
Certain Financial Institutions - an Amendment of FASB Statements No. 72 and 144
and FASB Interpretation No. 9." The Statement provides guidance on the
accounting for the acquisition of a financial institution, which had previously
been addressed in SFAS No. 72, "Accounting for Certain Acquisitions of Banking
or Thrift Institutions," and requires that those transactions be accounted for
in accordance with SFAS No. 141, "Business Combinations", and SFAS No. 142,
"Goodwill and Other Intangible Assets." In addition, this Statement amends SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to
include long-term customer-relationship intangible assets such as depositor and
credit cardholder intangible assets and would require these assets to be subject
to an undiscounted cash flow recoverability impairment test that SFAS No. 144
requires for other long-lived assets that are held and used. The provisions of
SFAS No. 147 are effective October 1, 2002. There was no impact to Merrill Lynch
upon adoption of this Statement.
In August 2002, the FASB approved Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others, An Interpretation of FASB Statements No. 5, 57 and 107. The
Interpretation will require that guarantors recognize a liability for the fair
value of the obligations it has undertaken in issuing a guarantee. In addition,
the Interpretation will require entities to disclose the nature of the
guarantee, the maximum potential amount of future payments the guarantor could
be required to make, the current carrying amount of the guarantee, the nature of
recourse that would enable the guarantor to recover from third parties the
amounts paid under the guarantee, and the nature of any assets that the
guarantor can obtain and liquidate to recover all or a portion of the amounts
paid under the guarantee. The disclosures are required for guarantees including
those accounted for as derivative contracts under SFAS 133. The recognition
requirements are only required for guarantees that are not accounted for as
derivatives under SFAS 133. This Interpretation has not been released in its
final form; however, the recognition and measurement provisions are expected to
be required for the first quarter of 2003, and the disclosure provisions are
expected to be required for the fourth quarter of 2002. Merrill Lynch is
currently assessing the impact of this interpretation on its financial
statements but does not expect it to be material.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities". This standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 will
replace the existing guidance provided by EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". SFAS No. 146 is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002.
In August 2001, the 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 a business as
previously defined in that opinion. SFAS No. 144 provides guidance on the
financial accounting and reporting for the impairment or disposal of long-lived
assets. 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. Merrill Lynch
adopted the provisions of SFAS No. 144 in the first quarter of 2002. The impact
upon adoption was not material.
42
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. Prior year amortization expense related to
goodwill totaled $53 million and $156 million for the three-month and nine-month
periods ended September 28, 2001.
During the second quarter of 2002, Merrill Lynch completed its review of
goodwill in accordance with SFAS No. 142 and determined that the fair value of
the reporting units to which goodwill relates exceeds the carrying value of such
reporting units. Accordingly, no goodwill impairment loss was recognized. The
$3.9 billion of goodwill related to the 1997 purchase of the Mercury Asset
Management Group was tested at the MLIM segment level since this business has
been fully integrated into MLIM.
43
- ------------------------------------------------------------------------------------------------------------------------
STATISTICAL DATA
- ------------------------------------------------------------------------------------------------------------------------
3rd Qtr. 4th Qtr. 1st Qtr. 2nd Qtr. 3rd Qtr.
2001 2001 2002 2002 2002
-------- -------- ------- -------- --------
CLIENT ASSETS (dollars in billions):
Private Client
U.S. $ 1,171 $ 1,185 $ 1,179 $ 1,101 $ 1,019
Non-U.S. 127 101 96 94 87
-------- -------- -------- -------- --------
Total Private Client Assets 1,298 1,286 1,275 1,195 1,106
MLIM direct sales (1) 170 172 167 158 145
-------- -------- -------- -------- --------
Total Client Assets $ 1,468 $ 1,458 $ 1,442 $ 1,353 $ 1,251
======== ======== ======== ======== ========
ASSETS IN ASSET-PRICED ACCOUNTS $ 183 $ 199 $ 206 $ 192 $ 176
ASSETS UNDER MANAGEMENT:
Retail $ 214 $ 220 $ 215 $ 203 $ 182
Institutional 252 266 262 257 234
Private Investors(2) 41 43 41 39 36
Equity 253 263 257 234 190
Fixed-income 119 119 119 121 119
Money market 135 147 142 144 143
U.S. 310 327 323 319 305
Non-U.S. 197 202 195 180 147
- ------------------------------------------------------------------------------------------------------------------------
UNDERWRITING:
Global Equity and Equity-Linked:
Volume (dollars in billions) $ 15 $ 15 $ 15 $ 10 $ 3
Market share 21.5 % 12.2 % 14.9 % 9.5 % 6.9 %
Global debt:
Volume (dollars in billions) $ 81 $ 68 $ 91 $ 83 $ 54
Market share 9.9 % 7.2 % 8.5 % 8.7 % 7.4 %
- ------------------------------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES:
U.S. 47,300 43,500 43,200 42,500 41,900
Non-U.S. 18,600 13,900 13,200 12,100 11,500
-------- -------- -------- -------- --------
Total 65,900 57,400 56,400 54,600 53,400
======== ======== ======== ======== ========
PRIVATE CLIENT FINANCIAL ADVISORS 18,000 16,400 15,900 15,100 14,600
- ------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET (dollars in millions,
except per share amounts)
Total assets $448,606 $419,419 $429,167 $439,426 $439,764
Total stockholders' equity $ 21,090 $ 20,008 $ 20,906 $ 21,592 $ 22,299
Book value per common share $ 24.38 $ 23.03 $ 23.73 $ 24.46 $ 25.17
SHARE INFORMATION (in thousands)
Weighted-average shares outstanding:
Basic 845,841 845,664 854,815 861,742 864,629
Diluted 934,469 845,664 949,237 942,560 934,477
Common shares outstanding 847,538 850,222 862,946 865,398 869,019
- ------------------------------------------------------------------------------------------------------------------------
(1) Reflects funds managed by MLIM not sold through Private Client channels.
(2) Represents segregated portfolios for individuals, small corporations
and institutions.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The information under the caption Item 2. "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Risk Management" above in
this Report is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
ML & Co.'s Chief Executive Officer and Chief Financial Officer have concluded,
based on their evaluation as of a date within 90 days of the filing of this Form
10-Q, that its disclosure controls and procedures (as defined in Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934) are effective. There have
been no significant changes in internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
45
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 and Quarterly Reports on Form
10-Q for the quarters ended March 29, 2002 and June 28, 2002. We also refer the
reader to ML & Co.'s Current Reports on Form 8-K dated April 11, 2002, April 18,
2002, and May 21, 2002, relating to the New York State Attorney General's
inquiry pertaining to Merrill Lynch.
Research-Related Class Actions.
- ------------------------------
Since April 2002, approximately 150 class actions have been filed against
various Merrill Lynch-related entities challenging the independence and
objectivity of Merrill Lynch's research recommendations and related disclosures.
Many of these class actions make virtually identical allegations, and we expect
that they will eventually be consolidated into a much smaller number of actions.
Merrill Lynch is vigorously defending these actions.
Enron-Related Investigations/Litigation.
- ---------------------------------------
Merrill Lynch's status with regard to the Department of Justice investigation
remains unchanged from that reported in its Form 10-Q for the quarter ended June
28, 2002. Members of the Securities and Exchange Commission staff, however, have
continued to express concerns about Merrill Lynch's role in certain
Enron-related matters despite Merrill Lynch's response to those concerns.
Merrill Lynch is awaiting a decision on its motions to dismiss the Enron-related
shareholder and employee class actions reported in ML & Co.'s Form 10-Q for the
quarter ended March 29, 2002, which have been fully briefed.
IPO Allocation Class Actions.
- ----------------------------
Merrill Lynch is awaiting a decision on the joint motion to dismiss filed on
July 1, 2002, which has been fully briefed and argued.
Allegheny Energy, Inc.
- ---------------------
On September 24, 2002, Merrill Lynch filed an action in federal court in the
Southern District of New York against Allegheny Energy, Inc. ("Allegheny"). The
complaint alleges that Allegheny owes Merrill Lynch the final $125 million
payment in connection with Allegheny's purchase of Merrill Lynch's energy
trading business and assets in 2001. The following day, Allegheny filed an
action against Merrill Lynch in the Supreme Court of the State of New York.
Based on alleged misrepresentations by Merrill Lynch, the complaint seeks
rescission of Allegheny's purchase of the energy business and assets from
Merrill Lynch, damages alleged to be in excess of $605 million, and other
relief. Merrill Lynch believes that Allegheny's claims are without merit.
Shareholder Derivative Action.
- -----------------------------
In the following shareholder derivative action ML & Co. is named as a nominal
defendant because the action purports to be brought on behalf of ML & Co. and
any recovery obtained by plaintiffs would be for the benefit of ML & Co.:
Spear v. Conway, et al., a derivative action instituted on or about August 1,
2002, in the Supreme Court of the State of New York, County of Kings, alleges
breach of fiduciary duty by ML & Co. directors in connection with, among other
things, allegedly failing to establish internal controls sufficient to ensure
that the company's business activities were carried out in a lawful manner. The
complaint alleges the breach in connection with Merrill Lynch's research
practices, as well as in connection with its Enron-related business activities.
Damages in an unspecified amount are sought. Merrill Lynch intends to move to
dismiss the action.
46
In the normal course of business, Merrill Lynch has been named as a defendant in
various legal actions, including arbitrations, class actions, and other
litigation, arising in connection with its activities as a global diversified
financial services institution. Moreover, the general decline of securities
prices that began in 2000 has resulted in increased legal actions against many
firms, including Merrill Lynch. Some of the legal actions include claims for
substantial compensatory and/or punitive damages or claims for indeterminate
amounts of damages. In some cases, the issuers who would otherwise be the
primary defendants in such cases are bankrupt or otherwise in financial
distress. Merrill Lynch is also involved, from time to time, in investigations
and proceedings by governmental and self-regulatory agencies. The number of
these investigations has also increased in recent years with regard to many
firms, including Merrill Lynch. Some of these legal actions, investigations and
proceedings may result in adverse judgments, penalties or fines. In view of the
inherent difficulty of predicting the outcome of such matters, particularly in
cases in which claimants seek substantial or indeterminate damages, Merrill
Lynch cannot predict what the eventual loss or range of loss related to such
matters will be. Merrill Lynch believes, based on information available to us as
of the date of this report, that the resolution of the actions will not have a
material adverse effect on the financial position of Merrill Lynch as set forth
in the Condensed Consolidated Financial Statements, but may be material to
Merrill Lynch's operating results for any particular period.
ITEM 5. OTHER INFORMATION
-----------------
The 2003 Annual Meeting of Stockholders will be held at 10:00 a.m. on Monday,
April 28, 2003 at the Merrill Lynch Conference and Training Center, 800 Scudders
Mill Road, Plainsboro, New Jersey. Any stockholder of record entitled to vote
generally for the election of directors may nominate one or more persons for
election at the Annual Meeting only if proper written notice, as set forth in ML
& Co.'s Certificate of Incorporation, has been given to the Secretary of ML &
Co., 222 Broadway, 17th Floor, New York, New York 10038, no earlier than
February 12, 2003 and no later than March 10, 2003. In addition, any stockholder
intending to bring any other business before the meeting must provide proper
written notice, as set forth in ML & Co.'s By-Laws, to the Secretary of ML & Co.
on or before March 10, 2003. In order to be included in ML & Co.'s proxy
statement, stockholder proposals must be received by ML & Co. no later than
November 15, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(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.
10 Merrill Lynch & Co., Inc. 2003 Deferred Compensation
Plan for a Select Group of Eligible Employees
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
47
99(i) Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99(ii) Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
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 July 9, 2002 for the purpose of
furnishing notice of a webcast of a conference call
scheduled for July 16, 2002 to review ML & Co.'s operating
results.
(ii) Current Report dated July 16, 2002 for the purpose of filing
ML & Co.'s Preliminary Unaudited Earnings Summary for the
three- and six-month periods ended June 28, 2002.
(iii) Current Report dated July 22, 2002 for the purpose of
announcing the election of Stan O'Neal as Chief
Executive Officer effective December 2, 2002 and Chairman of
the Board effective April 28, 2003.
(iv) Current Report dated July 31, 2002 for the purpose of filing
ML & Co.'s Preliminary Unaudited Consolidated Balance Sheet
as of June 28, 2002.
(v) Current Report dated August 7, 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
August 7, 2009.
(vi) Current Report dated August 9, 2002 for the purpose of
furnishing statements under oath of the Chief Executive
Officer and Chief Financial Officer regarding facts and
circumstances relating to Exchange Act filings.
(vii) Current Report dated August 15, 2002 for the purpose of
reporting that Standard & Poor's Ratings Services placed its
long- and short-term counter-party credit ratings on ML &
Co. on CreditWatch with negative implications.
(viii) Current Report dated August 23, 2002 for the purpose of
filing the form of ML & Co.'s 7% Callable Stock Return
Income Debt Securities due August 23, 2004, payable at
maturity with Starbucks Corporation common stock.
(ix) Current Report dated August 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
September 4, 2002.
(x) Current Report dated August 30, 2002 for the purpose of
filing the form of ML & Co.'s Strategic Return Notes linked
to the Industrial 15 Index due August 30, 2007.
48
(xi) Current Report dated August 30, 2002 for the purpose of
filing the form of ML & Co.'s 7% Callable Stock Return
Income Debt Securities due September 1, 2004, payable at
maturity with Citigroup Inc. common stock.
(xii) Current Report dated September 4, 2002 for the purpose of
filing the form of ML & Co.'s S&P 500 Market Index
Target-Term Securities due September 4, 2009.
(xiii) Current Report dated September 13, 2002 for the purpose of
filing the form of ML & Co.'s Market Index Target-Term
Securities linked to the USD/EUR exchange rate due September
13, 2005.
49
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
Principal Financial Officer
By: /s/ John J. Fosina
---------------------------------
John J. Fosina
Controller
Principal Accounting Officer
Date: November 8, 2002
50
Certification
-------------
I, David H. Komansky, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Merrill Lynch & Co., Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ David H. Komansky
--------------------------------------------
David H. Komansky
Chairman of the Board and
Chief Executive Officer
Dated: November 8, 2002
51
Certification
-------------
I, Thomas H. Patrick, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Merrill Lynch & Co., Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Thomas H. Patrick
--------------------------------------------
Thomas H. Patrick
Executive Vice President and
Chief Financial Officer
Dated: November 8, 2002
52
INDEX TO EXHIBITS
Exhibits
10 Merrill Lynch & Co., Inc. 2003 Deferred Compensation Plan for a
Select Group of Eligible Employees
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
99(i) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99(ii) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
53