<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): December 10, 1998
---------------------------
Merrill Lynch & Co., Inc.
- -------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 1-7182 13-2740599
- -------------------------------------------------------------------------------
(State or Other (Commission (I.R.S. Employer
Jurisdiction of File Number) Identification No.)
Incorporation)
World Financial Center, North Tower, New York, New York 10281-1332
- -------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (212) 449-1000
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report.)
<PAGE>
Item 5. Other Events
- ---------------------
On August 26, 1998, Merrill Lynch & Co., Inc. ("ML & Co.") indirectly acquired
the outstanding shares of Midland Walwyn Inc. in a share exchange. The merger
has been accounted for as a pooling-of-interests. The exhibit filed herewith,
including audited consolidated financial statements for ML & Co. for its 1997
fiscal year, has been restated to reflect the merger and is filed in
connection with various registration statements filed from time to time by ML &
Co.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
- ---------------------------------------------------------------------------
(c) Exhibits
--------
(23) Independent Auditors' Consent
(99) Additional Exhibits
(i) Restated Financial Information
- Management's Discussion and Analysis
- Independent Auditors' Report on Consolidated Financial
Statements
- Consolidated Financial Statements and Related Notes
- Selected Financial Data
2
<PAGE>
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/ E. Stanley O'Neal
----------------------------
E. Stanley O'Neal
Executive Vice President and
Chief Financial Officer
Date: December 10, 1998
3
<PAGE>
EXHIBIT INDEX
-------------
Exhibit
No. Description
--- -----------
(23) Independent Auditors' Consent
(99) Additional Exhibits
(i) Restated Financial Information
- Management's Discussion and Analysis
- Independent Auditors' Report on Consolidated Financial
Statements
- Consolidated Financial Statements and Related Notes
- Selected Financial Data
4
<PAGE>
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
- -----------------------------
We consent to the incorporation by reference in the following Registration
Statements of Merrill Lynch & Co., Inc. and subsidiaries of our report dated
February 23, 1998 (December 10, 1998 as to Note 1, paragraphs 1 and 2),
appearing in this Current Report on Form 8-K dated December 10, 1998.
Filed on Form S-8:
Registration Statement No. 33-41942 (1986 Employee Stock Purchase Plan)
Registration Statement No. 33-17908 (Incentive Equity Purchase Plan)
Registration Statement No. 33-33336 (Long-Term Incentive Compensation Plan)
Registration Statement No. 33-51831 (Long-Term Incentive Compensation Plan)
Registration Statement No. 33-51829 (401(k) Savings and Investment Plan)
Registration Statement No. 33-54154 (Non-Employee Directors' Equity Plan)
Registration Statement No. 33-54572 (401(k) Savings and Investment Plan
(Puerto Rico))
Registration Statement No. 33-56427 (Amended and Restated 1994 Deferred
Compensation Plan for a Select Group of Eligible Employees)
Registration Statement No. 33-55155 (1995 Deferred Compensation Plan
for a Select Group of Eligible Employees)
Registration Statement No. 33-60989 (1996 Deferred Compensation Plan
for a Select Group of Eligible Employees)
Registration Statement No. 333-09779 (1997 Deferred Compensation Plan
for a Select Group of Eligible Employees)
<PAGE>
Registration Statement No. 333-32209 (1998 Deferred Compensation Plan
for a Select Group of Eligible Employees)
Registration Statement No. 333-00863 (401(k) Savings and Investment Plan)
Registration Statement No. 333-13367 (Restricted Stock Plan for Former
Employees of Hotchkis and Wiley)
Registration Statement No. 333-15009 (1997 KECALP Deferred Compensation
Plan for a Select Group of Eligible Employees)
Registration Statement No. 333-17009 (Deferred Unit and Stock Unit Plan
for Non-Employee Directors)
Registration Statement No. 333-18915 (Long-Term Incentive Compensation Plan)
for Managers and Producers)
Registration Statement No. 333-33125 (Employee Stock Purchase Plan for
Employees of Merrill Lynch Partnerships)
Registration Statement No. 333-41425 (401(k) Savings and Investment Plan)
Registration Statement No. 333-56291 (Long-Term Incentive Compensation Plan
for Managers and Producers)
Registration Statement No. 333-60211 (1999 Deferred Compensation Plan
for a Select Group of Eligible Employees)
Registration Statement No. 333-62311 (Replacement Options; Midland Walwyn
Inc.)
Filed on Form S-3:
Debt Securities:
Registration Statement No. 33-54218
Registration Statement No. 2-78338
Registration Statement No. 2-89519
Registration Statement No. 2-83477
Registration Statement No. 33-03602
<PAGE>
Registration Statement No. 33-17965
Registration Statement No. 33-27512
Registration Statement No. 33-35456
Registration Statement No. 33-42041
Registration Statement No. 33-45327
Registration Statement No. 33-49947
Registration Statement No. 33-51489
Registration Statement No. 33-52647
Registration Statement No. 33-60413
Registration Statement No. 33-61559
Registration Statement No. 33-65135
Registration Statement No. 333-13649
Registration Statement No. 333-25255
Registration Statement No. 333-28537
Registration Statement No. 333-44173
Registration Statement No. 333-59997
Medium Term Notes:
Registration Statement No. 2-96315
Registration Statement No. 33-03079
Registration Statement No. 33-05125
Registration Statement No. 33-09910
Registration Statement No. 33-16165
<PAGE>
Registration Statement No. 33-19820
Registration Statement No. 33-23605
Registration Statement No. 33-27549
Registration Statement No. 33-38879
Other Securities:
Registration Statement No. 33-33335 (Common Stock)
Registration Statement No. 33-45777 (Common Stock)
Registration Statement No. 33-55363 (Preferred Stock)
Registration Statement No. 333-02275 (Long-Term Incentive Compensation Plan)
Registration Statement No. 333-16603 (TOPrS)
Registration Statement No. 333-20137 (TOPrS)
Registration Statement No. 333-24889 (Long-Term Incentive Compensation Plan,
and Long-Term Incentive Compensation Plan for Managers and Producers)
Registration Statement No. 333-36651 (Hotchkis and Wiley Resale)
Registration Statement No. 333-42859 (TOPrS)
Registration Statement No. 333-59263 (Exchangeable Shares of Merrill Lynch
& Co., Canada Ltd. re Midland Walwyn Inc.)
Registration Statement No. 333-67903 (Howard Johnson & Company Resale)
/s/Deloitte & Touche LLP
New York, New York
December 10, 1998
<PAGE>
Exhibit 99(i)
MERRILL LYNCH & CO., INC.
RESTATED FINANCIAL INFORMATION
In 1998, Merrill Lynch acquired the outstanding shares of Midland
Walwyn, Inc., in a transaction accounted for as a pooling-of-interests. The
following financial information has been restated as if Merrill Lynch and
Midland Walwyn had always been combined.
- --------------------------------------------------------------------------------
Table of Contents
- --------------------------------------------------------------------------------
Management's Discussion And Analysis............................. 2
Independent Auditors' Report..................................... 27
Consolidated Financial Statements
Consolidated Statements of Earnings............................ 28
Consolidated Balance Sheets.................................... 29
Consolidated Statements of Changes in Stockholders' Equity..... 31
Consolidated Statements of Comprehensive Income................ 33
Consolidated Statements of Cash Flows.......................... 34
Notes To Consolidated Financial Statements....................... 35
Selected Financial Data.......................................... 65
- --------------------------------------------------------------------------------
1
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Table of Contents
- --------------------------------------------------------------------------------
INTRODUCTION......................... 2
BUSINESS ENVIRONMENT................. 2
RESULTS OF OPERATIONS................ 3
COMMISSIONS.......................... 4
INTEREST AND DIVIDENDS............... 4
PRINCIPAL TRANSACTIONS............... 5
INVESTMENT BANKING................... 6
ASSET MANAGEMENT AND
PORTFOLIO SERVICE FEES............. 7
OTHER REVENUES....................... 7
NON-INTEREST EXPENSES................ 8
INCOME TAXES......................... 9
ACQUISITIONS......................... 9
STRATEGIC PRIORITIES................. 10
GLOBAL OPERATIONS.................... 11
BALANCE SHEET........................ 14
LIQUIDITY AND LIABILITY MANAGEMENT... 17
CAPITAL RESOURCES AND
CAPITAL ADEQUACY................... 18
CAPITAL PROJECTS AND EXPENDITURES.... 19
RISK MANAGEMENT...................... 19
NON-INVESTMENT GRADE HOLDINGS AND
HIGHLY LEVERAGED TRANSACTIONS...... 23
CASH FLOWS........................... 25
LITIGATION........................... 25
RECENT DEVELOPMENTS.................. 26
- --------------------------------------------------------------------------------
INTRODUCTION
- --------------------------------------------------------------------------------
On August 26, 1998, Merrill Lynch acquired the outstanding shares of
Midland Walwyn Inc. ("Midland") in a share exchange. Each Midland shareholder
received either 0.24 shares of ML & Co. common stock or 0.24 exchangeable shares
of Merrill Lynch & Co., Canada Ltd. for every Midland share held. The merger has
been accounted for as a pooling-of-interests. As a result, this Management's
Discussion and Analysis has been restated as if Merrill Lynch and Midland had
always been combined.
- -------------------------------------------------------------------------------
BUSINESS ENVIRONMENT
- -------------------------------------------------------------------------------
Merrill Lynch & Co., Inc. ("ML & Co." and, together with its
subsidiaries and affiliates, "Merrill Lynch") is a holding company that, through
its subsidiaries and affiliates, provides investment, financing, advisory,
insurance, and related services worldwide. Merrill Lynch conducts its businesses
in global financial markets that are influenced by numerous unpredictable
factors. These factors include economic conditions and monetary policy, the
liquidity of global markets, international and regional political events,
regulatory developments, the competitive environment, and investor sentiment.
These conditions or events can significantly affect the volatility of financial
markets. While greater volatility increases risk, it may also increase order
flow in businesses such as trading and brokerage. Revenues and net earnings may
vary significantly from period to period due to these unpredictable factors and
the resulting market volatility.
The financial services industry continues to be affected by the
intensifying competitive environment, as demonstrated by consolidation through
mergers and acquisitions, expansion by banks and insurance companies into
traditional brokerage activities, and diminishing margins in many mature
products and services.
Global financial markets continued to advance for much of 1997, after
generally strong performances in 1996 and 1995. Robust economic growth, low
inflation, and falling U.S. interest rates propelled U.S. equity markets to
record highs and contributed to significant gains in most non-U.S. markets. The
weakening of certain Asian currencies in the 1997 third quarter and further
devaluation of those currencies in the 1997 fourth quarter, however, caused
significant volatility and overall declines in global equity markets,
particularly in Asia. These events also resulted in the widening of credit
spreads and sharply reduced liquidity in a number of markets, particularly in
emerging markets. Subsequently, many markets recovered, while Asian markets
continued to decline.
U.S. equity markets posted significant gains in 1997, with the Dow Jones
Industrial Average ("DJIA")
- --------------------------------------------------------------------------------
2
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
rising 23%. This was the first time the DJIA rose more than 20% for three
consecutive years, although nearly all of the 1997 increase occurred in the
first seven months of the year. U.S. equity markets weakened in August,
primarily due to corporate earnings disappointments, and declined significantly
in October following the devaluation of several Asian currencies. These events
precipitated a DJIA market correction of 7.2%, or 554 points, on October 27,
the largest one-day point drop ever. The DJIA staged a sharp comeback the next
day, rising 4.7%. Despite volatility throughout the remainder of the year, the
DJIA returned to pre-October levels by the end of 1997.
U.S. bond market rates trended upward at the beginning of 1997, as
inflationary fears forced the Federal Reserve Board to raise short-term
interest rates in late March. Despite strong economic growth and low
unemployment, this trend reversed later in the year as inflationary fears eased
and demand for U.S. Treasuries increased over concerns that the conditions in
Asia would spread to other parts of the world. The yield on the 30-year U.S.
Treasury bond ended the year at 5.9%, its lowest level since early 1996.
Global equity markets rose on average approximately 13% during the year,
as measured by the Dow Jones World Index(R). Most European markets experienced
significant advances during 1997 due to falling bond yields and a steady stream
of mergers and acquisitions. Asian markets, however, incurred large losses late
in 1997 due to the prospects of slower growth and significant currency
fluctuations. In Latin America, strong export growth, low inflation, and
significant foreign capital inflows led to large gains during the first half of
the year. These gains were partially offset during the second half of the year
as the decline in Asian markets prompted a massive sell-off of Latin American
stocks, leading to the largest price deterioration since the 1994 Mexican peso
crisis. Despite these price declines, Latin American stock indices posted
significant gains during 1997. Although equity prices in many countries, when
measured in local currency terms, were up more than U.S. equity prices in U.S.
dollar terms, only a few of these increases exceeded the U.S. advance due to the
overall strengthening of the U.S. dollar versus many local currencies.
Global underwriting volume reached record levels during 1997, up 33%
over the previous record levels of 1996. Although disclosed underwriting fees
for stocks and bonds fell 10% to $8.4 billion, 1997 was the third-best year for
underwriting fees after 1996 and 1993, according to Securities Data Co. ("SDC").
Increasing competition from non-U.S. and U.S. commercial banks and a sharp drop
in equity initial public offerings led to the decline in disclosed fees.
Strategic services had its third consecutive year of record volume in
1997, as a result of a continuation of the high level of merger and acquisition
activity since 1995. Driven by a generally favorable stock market, regulatory
and technological changes, and ongoing industry consolidations, companies
continued to seek strategic alliances to increase earnings growth and expand
into new markets and businesses.
Fiscal 1997 was primarily characterized by favorable economic conditions
and strong, yet volatile, financial markets. Merrill Lynch continually evaluates
its businesses across varying market conditions for profitability and alignment
with long-term strategic objectives. Merrill Lynch seeks to mitigate the effect
of market downturns by developing and maintaining long-term client
relationships, selectively expanding its global presence, closely monitoring
costs and risks, and continuing to diversify revenue sources.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
1997 vs.
(in millions, except -------------
per share amounts) 1997 1996 1995 1996 1995
- --------------------------------------------------------------------
Total revenues $32,499 $25,713 $22,060 26.4% 47.3%
Net revenues 16,256 13,621 10,615 19.3 53.2
Net earnings 1,935 1,648 1,126 17.4 71.9
Net earnings applicable
to common stockholders 1,896 1,602 1,078 18.4 75.8
Earnings per common share:
Basic 5.57 4.63 2.98 20.3 86.9
Diluted 4.79 4.08 2.68 17.4 78.7
Return on average
common stockholders'
equity 26.5% 26.6% 19.8%
- --------------------------------------------------------------------
- --------------------------------------------------------------------------------
3
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Merrill Lynch's record 1997 net earnings of $1.9 billion surpassed its
previous record of $1.6 billion in 1996 by 17%. Record revenues in commissions,
principal transactions, investment banking, and asset management and portfolio
service fees, partially offset by increased costs, particularly in compensation
and technology, led to the record net earnings.
The following discussion provides details of major revenue and expense
categories and other pertinent information on Merrill Lynch's business
activities, financial condition, liquidity, and risks. Certain limited
reclassification and format changes have been made to prior year amounts to
conform with the current year presentation.
- --------------------------------------------------------------------------------
COMMISSIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Listed and over-the-counter $2,759 $2,207 $1,780
Mutual funds 1,594 1,302 969
Other 642 576 559
------ ------ ------
Total $4,995 $4,085 $3,308
------ ------ ------
- ---------------------------------------------------------------------------
</TABLE>
Commissions revenues advanced 22% in 1997 to a record $5.0 billion,
primarily due to higher levels of listed securities transactions and mutual fund
commissions.
Commissions from listed securities were up 25% from 1996 as a result of
higher trading volumes on many exchanges around the world. Mutual fund
commissions revenues rose 22%, benefiting from strong sales of both U.S. and
non-U.S. funds. Other commissions revenues advanced 12% in 1997, largely due to
increased sales of over-the-counter options and third party annuity contracts
and higher processing fees.
Commissions revenues in 1996 rose 23% over 1995 levels. Increased
trading volume led to higher listed and over-the-counter securities transaction
revenues, while strong sales of U.S. funds and greater distribution fees from
deferred-charge funds increased mutual fund commissions.
- --------------------------------------------------------------------------------
INTEREST AND DIVIDENDS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ------------------------------------------------------------------
<S> <C> <C> <C>
Interest and dividend revenues
Trading assets $ 5,240 $ 4,208 $ 3,854
Resale agreements and
securities borrowed transactions 8,121 5,930 5,893
Margin lending 2,207 1,556 1,409
Other 1,731 1,431 1,293
------- ------- -------
17,299 13,125 12,449
------- ------- -------
Interest expense
Borrowings 4,623 3,064 2,515
Repurchase agreements and
securities loaned transactions 7,306 5,508 5,632
Trading liabilities 2,983 2,492 2,229
Other 1,331 1,028 1,069
------- ------- -------
16,243 12,092 11,445
------- ------- -------
Net interest and dividend profit $ 1,056 $ 1,033 $ 1,004
------- ------- -------
- --------------------------------------------------------------------------------
</TABLE>
Interest and dividend revenues and expenses are a function of the level
and mix of interest-earning assets and interest-bearing liabilities and the
prevailing level, term structure, and volatility of interest rates. Net interest
and dividend profit was up 2% from 1996. Increases in net interest-earning
assets were offset by declining interest spreads due to the flattening of the
yield curve.
Merrill Lynch hedges its long- and short-term borrowings, primarily with
interest rate and currency swaps, to better match the interest rate
characteristics of the borrowings to the assets funded by borrowing proceeds.
The effect of this hedging activity, which is included in "Borrowings" above,
increased (decreased) interest expense for 1997, 1996, and 1995 by $45 million,
$(64) million, and $(45) million, respectively (see Note 5 to the Consolidated
Financial Statements).
In 1996, interest and dividend profit was up 3% from 1995 as a result of
increases in interest spreads attributable to a steepening yield curve.
- --------------------------------------------------------------------------------
4
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PRINCIPAL TRANSACTIONS
- --------------------------------------------------------------------------------
The table that follows provides information on aggregate trading
revenues, including related net interest. Interest revenue and expense amounts
are based on financial reporting categories and management's assessment of the
cost to finance trading positions, after consideration of the underlying
liquidity of these positions.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net
Principal Interest Net
Transactions Revenues Trading
(in millions) Revenues (Expense) Revenues
- --------------------------------------------------------------------------------
<S>
1997 <C> <C> <C>
Equities and equity derivatives $1,317 $(127) $1,190
Interest rate and currency
swaps 1,042 (161) 881
Taxable fixed-income 993 262 1,255
Municipals 305 15 320
Foreign exchange and
commodities 170 8 178
------ ----- ------
Total $3,827 $ (3) $3,824
------ ----- ------
- --------------------------------------------------------------------------------
1996
Equities and equity derivatives $1,178 $ (86) $1,092
Interest rate and currency
swaps 893 (74) 819
Taxable fixed-income 1,004 239 1,243
Municipals 324 13 337
Foreign exchange and
commodities 132 4 136
------ ----- ------
Total $3,531 $ 96 $3,627
------ ----- ------
- --------------------------------------------------------------------------------
1995
Equities and equity derivatives $ 951 $ (75) $ 876
Interest rate and currency
swaps 732 (82) 650
Taxable fixed-income 556 228 784
Municipals 275 1 276
Foreign exchange and
commodities 87 7 94
------ ----- ------
Total $2,601 $ 79 $2,680
------ ----- ------
- --------------------------------------------------------------------------------
</TABLE>
Principal transactions revenues rose 8% from 1996 to a record $3.8
billion in 1997. The increase resulted from favorable market conditions,
including rising U.S. stock prices, low interest rates, and narrowing credit
spreads, as well as increased customer demand for higher-yielding securities,
for most of the year. These gains were partially offset by declines in values
during the fourth quarter for certain non-U.S. equity and debt positions
triggered by the Asian market decline late in 1997.
Trading and related hedging and financing activities affect the
recognition of both principal transactions revenues and net interest and
dividend profit. In assessing the profitability of its trading activities,
Merrill Lynch aggregates net interest and principal transactions revenues. For
financial reporting purposes, however, realized and unrealized gains and losses
on trading positions, including hedges, are recorded in principal transactions
revenues. The net interest carry (i.e., the spread representing interest earned
less financing costs) for trading positions, including hedges, is recorded
either as principal transactions revenues or net interest profit, depending on
the nature of the specific instruments. Changes in the composition of trading
inventories and hedge positions can cause the recognition of revenues within
these categories to fluctuate.
Equities and equity derivatives trading revenues were up 12% from 1996.
Increased profitability from equity derivative transactions, higher transaction
volume, and price appreciation in the U.S. and non-U.S. equity markets
contributed to higher revenues.
Interest rate and currency swaps trading revenues rose 17%, primarily
because of higher revenues from emerging market-related derivatives, improved
customer demand due to market volatility, and increased activity in credit
derivatives.
Taxable fixed-income trading revenues decreased 1% from 1996. Lower
trading revenues from U.S. and non-U.S. governments and mortgage-backed products
were partially offset by increased revenues from high-yield debt, corporate
bonds and preferred stock, and money markets. The decrease in trading revenues
from U.S. Government and agencies securities was due to the falling interest
rate environment in the U.S., while the decline in trading revenues from non-
U.S. governments and agencies securities was primarily attributable to lower
interest rates and reduced market volatility in certain countries. Lower trading
revenues from mortgage-backed products resulted from a less favorable market
environment compared to 1996. The increase in trading revenues from high-yield
debt and corporate bonds and preferred stock was attributable to investors
seeking greater returns as interest rates generally remained low. Trading
revenues from money market instruments benefited in part from increased
floating-rate note activity in European markets.
- --------------------------------------------------------------------------------
5
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Municipal securities trading revenues were down 6% from 1996, primarily
due to lower margins on sales of shorter-term instruments. Foreign exchange and
commodities trading revenues rose 29% from 1996, primarily due to increased
volume resulting from higher market share and fluctuations in the U.S. dollar
versus the German mark and Japanese yen.
In 1996, principal transactions revenues were up 36% from 1995. Improved
market conditions, increased capacity related to the acquisition of Smith New
Court, and record NASDAQ volume led to gains in equities and equity derivatives
trading revenues, particularly in Europe (up 24%). Customer demand for higher-
yielding instruments related to derivative products led to increases in interest
rate and currency swaps (up 22%). Lower interest rates and improved economic
conditions in many emerging markets in 1996 increased demand for and inventory
values of taxable fixed-income products (up 81%), while strong investor demand
for tax-advantaged products increased municipal securities revenues (up 18%).
Higher volume led to an increase in foreign exchange and commodities trading
revenues (up 52%).
- --------------------------------------------------------------------------------
INVESTMENT BANKING
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Underwriting revenues $2,079 $1,592 $ 997
Strategic services revenues 797 430 346
------ ------ ------
Total $2,876 $2,022 $1,343
------ ------ ------
- --------------------------------------------------------------------------------
</TABLE>
Investment banking revenues soared 42% in 1997 to a record $2.9 billion,
benefiting from record levels of equity underwriting and merger and acquisition
activity industrywide. During 1997, Merrill Lynch became the
only securities firm ever to be ranked first in the U.S. in debt underwriting,
equity underwriting, and completed mergers and acquisitions in the same year,
with market shares of 15.8%, 15.9%, and 28.7%, respectively, according to SDC.
In addition, Merrill Lynch retained its position as top underwriter of total
debt and equity securities for the tenth consecutive year in the U.S. and for
the ninth consecutive year globally. Merrill Lynch's underwriting market share
information based on transaction value follows:
- -------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------ -------------
Market Market Market
Share Rank Share Rank Share Rank
- -------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. Proceeds
Debt 15.8% 1 15.7% 1 18.0% 1
Equity 15.9 1 13.6 2 14.7 2
Debt and Equity 16.1 1 16.0 1 17.8 1
Global Proceeds
Debt 13.1 1 12.2 1 13.5 1
Equity 15.4 1 12.1 2 13.1 2
Debt and Equity 13.6 1 12.7 1 13.7 1
- --------------------------------------------------------------------------------
</TABLE>
Source: SDC statistics based on full credit to book manager.
Strategic services fees increased 86% from 1996 to a record $797
million, benefiting from strong merger and acquisition activity attributable in
part to consolidation across various industries. Merrill Lynch's merger and
acquisition market share information based on transaction value follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------ -------------
Market Market Market
Share Rank Share Rank Share Rank
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Completed transactions
U.S. 28.7% 1 24.4% 2 8.9% 8
Global 19.6 3 16.2 3 6.6 10
Announced transactions
U.S. 28.7 1 28.2 1 16.4 4
Global 19.0 3 18.2 2 10.5 4
- --------------------------------------------------------------------------------
</TABLE>
Source: SDC statistics based on full credit to both target and acquiring
companies' advisors.
Investment banking revenues increased 50% in 1996 from 1995 due to
higher levels of equity and debt underwriting and increased merger and
acquisition activity.
- --------------------------------------------------------------------------------
6
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ASSET MANAGEMENT AND
PORTFOLIO SERVICE FEES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- -------------------------------------------------------
<S> <C> <C> <C>
Asset management fees $1,232 $1,010 $ 864
Portfolio service fees 844 609 477
Account fees 422 383 347
Other fees 326 281 219
------ ------ ------
Total $2,824 $2,283 $1,907
------ ------ ------
- -------------------------------------------------------
</TABLE>
Revenues from asset management and portfolio service fees rose 24% in
1997 to a record $2.8 billion, primarily due to strong growth in client assets
and market appreciation. Year-end client assets and assets under management for
the last three years are summarized as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 vs.
----------
(in billions) 1997 1996 1995 1996 1995
- -------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
U.S. client assets $985(1) $ 792(2) $ 665 24% 48%
Non-U.S. client assets 249(3) 72 58 246 329
---------- ------ ------
Total client assets $1,234 $864 $723 43 71
---------- ------ ------
Assets under management:
MLAM(4):
Money market $107 $ 90 $ 82 18 30
Equity 72 59 47 21 53
Fixed-income 48 43 41 12 19
Private portfolio 49 38(2) 22 28 117
Insurance 3 4 4 (10) (19)
---------- ------ ------
Total 279 234 196 19 42
Mercury 167 - - N/A N/A
Midland 2 1 - 64 N/A
---------- ------ ------
Total assets under
management $448 $235 $196 91 129
---------- ------ ------
Merrill Lynch Consults(R) $27 $ 21 $ 17 30 59
Mutual Fund Advisor(SM)
and Asset Power(R) $15 $ 9 $ 6 78 167
- -------------------------------------------------------------------
</TABLE>
(1) Includes $17 billion of assets related to the acquisition of MasterWorks, a
401(k) service provider.
(2) Includes $10 billion of assets related to the acquisition of Hotchkis and
Wiley, a Los Angeles-based asset management company.
(3) Includes $167 billion of assets related to the December 1997 acquisition of
Mercury Asset Management.
(4) Merrill Lynch Asset Management.
Worldwide client assets reached an industry record $1.2 trillion during 1997.
Major components of the change in client assets and assets under management
follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net changes due to
------------------
Dec. 27, New Asset Dec. 26,
(in billions) 1996 Money(1) Appreciation 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Client assets $864 $258(2) $112 $1,234
Assets under
management 235 193 20 448
- --------------------------------------------------------------------------------
</TABLE>
(1) Includes Mercury Asset Management assets of $167 billion.
(2) Includes MasterWorks assets of $17 billion.
Asset management fees increased 22% in 1997 due to net asset
appreciation and strong inflows of client assets. Portfolio service fees were up
39% in 1997, benefiting from the growth in client accounts and asset levels for
various fee products, including Merrill Lynch Consults, Merrill Lynch Mutual
Fund Advisor, and Asset Power services. Account fees rose 10% principally as a
result of increases in the number of customer and custodial accounts. Other fee-
based revenues were up 16%, due in part to higher revenues from transfer agency
and mortgage servicing activities.
In 1996, asset management and portfolio service fees rose 20% from 1995,
due to increases in client assets and higher levels of asset-based products.
- --------------------------------------------------------------------------------
OTHER REVENUES
- --------------------------------------------------------------------------------
Other revenues were $678 million in 1997, up 2% from 1996. Other
revenues include investment gains and losses, partnership distributions, and
fees from transaction processing and proxy activities. In 1997, other revenues
included realized investment gains, income from the outsourcing of Merrill
Lynch's beneficial proxy operation, and gains from sales of mortgages to Real
Estate Mortgage Investment Conduits ("REMICs"), while other revenues in 1996
contained a $155 million pretax gain from the partial sale of a minority
interest in Bloomberg L.P.
In 1996, other revenues rose 48% from 1995 to $667 million due to the
partial sale of the Bloomberg investment and an increase in gains from real
estate transactions, primarily sales of mortgages to REMICs.
- --------------------------------------------------------------------------------
7
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NON-INTEREST EXPENSES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
<S> <C> <C> <C>
- ----------------------------------------------------------------------
Compensation and benefits $ 8,333 $ 7,012 $5,478
------- ------- ------
Non-interest expenses, excluding
compensation and benefits:
Communications and
technology(1) 1,255 1,010 814
Occupancy and related
depreciation(1) 736 742 671
Professional fees(1) 520 385 312
Advertising and
market development 613 527 408
Brokerage, clearing,
and exchange fees 525 433 377
Goodwill amortization(1) 65 50 19
Other(1) 1,098 834 700
------- ------- ------
Total non-interest expenses,
excluding compensation and benefits 4,812 3,981 3,301
------- ------- ------
Total non-interest expenses $13,145 $10,993 $8,779
------- ------- ------
Compensation and benefits as
a percentage of net revenues 51.3% 51.5% 51.6%
Compensation and benefits as
a percentage of pretax earnings
before compensation and benefits 72.8% 72.7% 74.9%
- -------------------------------------------------------------------------
</TABLE>
(1) The presentation of certain non-interest expenses has been revised from the
original 1997 presentation.
Non-interest expenses in 1997 were up 20% over the prior year. The
largest expense category, compensation and benefits, increased 19% from 1996 due
to higher incentive and production-related compensation and a 13% increase in
the number of full-time employees. Incentive compensation rose as a result of
increased profitability, while production-related compensation was up due to
strong business volume. Full-time employees totaled 59,700 at year-end 1997,
compared with 52,600 at the previous year-end. Headcount increased due to
acquisitions, strategic business expansion, and growth in existing businesses.
The ratio of support employees and sales assistants to producers increased from
1.48 in 1996 to 1.54 in 1997.
Communications and technology expense was up 24% from 1996 due to
increased systems consulting costs, higher technology-related depreciation, and
increased maintenance costs. Occupancy and related depreciation expense
decreased 1%, reflecting a nonrecurring pretax charge in 1996 of $40 million
related to the resolution of Olympia & York's bankruptcy that affected ML &
Co.'s long-term sublease agreement in the World Financial Center, partially
offset by increased costs related to international growth.
Higher management consulting costs related to various strategic market
studies led to a 35% increase in professional fees. Advertising and market
development expense rose 16%, primarily due to increased global travel related
to business development and client promotion costs. Brokerage, clearing, and
exchange fees were up 21% as a result of higher global securities trading
volume. Goodwill amortization increased 32% from 1996 due to recent acquisitions
including Smith New Court. Other expenses increased 32% from 1996 due to
increases in provisions for various business activities and legal matters, and
higher office and postage costs.
In 1996, non-interest expenses increased 25% from 1995 to $11.0 billion.
Higher incentive and production-related compensation and an 8% growth in
full-time employees led to a 28% increase in compensation and benefits expense.
Communications and technology expense was up 24% due to increased
systems consulting costs related to systems initiatives, as well as higher
technology-related depreciation. Occupancy and related depreciation expense
increased 11%, primarily as a result of the 1996 nonrecurring $40 million pretax
charge related to the resolution of Olympia & York's bankruptcy. Professional
fees increased 24% as a result of higher management consulting costs.
Advertising and market development expense rose 29% due to increased
international travel and higher production-related recognition programs.
Brokerage, clearing, and exchange fees were up 15% because of higher securities
volume, particularly in non-U.S. markets. Goodwill amortization increased from
$19 million in 1995 to $50 million in 1996 primarily as a result of the Smith
New Court acquisition. Other expenses rose 19% due in part to provisions related
to various business activities.
- --------------------------------------------------------------------------------
8
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Presented is a bar graph illustrating fee-based revenues as a percentage of
Fixed and semi-fixed expenses for the years ended 1997, 1996, 1995, 1994, and
1993.
- -----------------------------------------------------------------
<TABLE>
<CAPTION>
Fee-Based Revenues As a Percentage of
Fixed and Semi-Fixed Expenses
- -----------------------------------------------------------------
Fixed and
Fee-Based Semi-Fixed
Revenues Expenses %
--------- -------- ----
<S> <C> <C> <C>
1997 $4,145 $6,569 63%
1996 3,562 5,585 64
1995 3,083 4,671 66
1994 2,886 4,275 68
1993 2,444 4,110 59
- -----------------------------------------------------------------
</TABLE>
- -----------------------------------------------------------------
INCOME TAXES
- --------------------------------------------------------------------------------
Merrill Lynch's 1997 income tax provision of $1.1 billion represented a
36.3% effective tax rate. In 1996 and 1995, income tax provisions were $980
million and $710 million, respectively, resulting in effective tax rates of
37.3% in 1996 and 38.7% in 1995. The effective tax rate decreased in 1997 due to
a reduction in state and local taxes associated with the settlement of many
prior-year tax audits.
Deferred tax assets are recorded for the effects of temporary
differences between the tax basis of an asset or liability and its reported
amount in the financial statements. Merrill Lynch assessed its ability to
realize deferred tax assets primarily based on a strong earnings history and the
absence of negative evidence as discussed in Statement of Financial Accounting
Standards ("SFAS") No. 109, Accounting for Income Taxes. During the last 10
years, average pretax earnings were $1.5 billion per year. Accordingly,
management believes that it is more likely than not that the deferred tax assets
will be realized.
- --------------------------------------------------------------------------------
ACQUISITIONS
- --------------------------------------------------------------------------------
In 1997, Merrill Lynch acquired Mercury Asset Management Group Holdings
PLC ("Mercury"), the leading independent U.K. asset management firm whose
clients include five of the 10 largest global pension funds, for approximately
$5.3 billion. The acquisition was recorded on December 26, 1997 and as a result,
had no effect on the statement of earnings. Goodwill of approximately $4.8
billion was recognized and will be amortized over 30 years as a noncash expense.
Going forward, management believes cash earnings and cash return on equity will
be the most relevant measures of financial performance because they best
illustrate Merrill Lynch's operating performance and ability to support growth.
Merrill Lynch has also made other recent strategic acquisitions to help
expand its global presence and client base. In addition to the Mercury
acquisition in 1997, Merrill Lynch acquired MasterWorks, a 401(k) service
provider, for $13 million and recorded goodwill of $10 million. Merrill Lynch
also hired the employees of the Centaurus Corporate Finance Group in Australia
in late 1997.
Acquisitions made or substantially completed in 1996, which included
McIntosh Securities Limited and Hotchkis and Wiley, were for aggregate
consideration of $232 million, of which $167 million represented goodwill. In
1995, Merrill Lynch acquired Smith New Court PLC, a U.K.-based global securities
firm, for $803 million and recorded $533 million of goodwill related to the
acquisition.
- --------------------------------------------------------------------------------
9
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
STRATEGIC PRIORITIES
- --------------------------------------------------------------------------------
During 1997, Merrill Lynch announced an organizational structure that
matches the manner in which services are provided to clients. Merrill Lynch is
now organized along four key strategic priorities: Corporate and Institutional
Client, U.S. Private Client, International Private Client, and Asset Management.
These business priorities and their activities are summarized below.
Presented is a pie chart for the year ended December 26, 1997
illustrating Merrill Lynch's percentage of net revenues by strategic priority.
- ----------------------------------------------------------------
<TABLE>
<CAPTION>
Percentage of Net Revenues
by Strategic Priority
- ----------------------------------------------------------------
<S> <C>
Corporate and Institutional Client 42%
U.S. Private Client 43
International Private Client 8
Asset Management 7
----
100%
----
- ----------------------------------------------------------------
</TABLE>
For further information on Merrill Lynch's business activities, see
Business of Merrill Lynch-Description of Business Activities.
- --------------------------------------------------------------------------------
Corporate and Institutional Client
The Corporate and Institutional Client group provides a broad array of
financial services, including securities trading, investment banking, and
advisory services to financial institutions, corporations, and governments
worldwide. The group raises capital for its clients on favorable terms, through
securities underwriting and loan syndication, and has been the leading
underwriter of global debt and equity for nine consecutive years, according to
SDC. The Corporate and Institutional Client group also manages risk and
investment returns by tailoring investments and structuring derivatives to meet
clients' needs. The group is also a leading provider of merger and acquisition
advisory services and, in 1997, ranked first in the U.S. and third in global
announced transactions, according to SDC.
- --------------------------------------------------------------------------------
U.S. Private Client
The U.S. Private Client group provides a wide range of financial
services and products, advice, and execution to individuals, small businesses,
and employee benefit plans. These products and services are provided through
approximately 13,300 Financial Consultants, who assist clients in managing their
assets. The Cash Management Account(R) service for individuals and the Working
Capital Management(SM) account for businesses have been an integral part of
delivering a wide range of client services, including effecting trades in
stocks, bonds, and other securities. In addition, the group serves clients'
diverse liability management needs by offering a broad selection of mortgage
loans and commercial real estate financing, primarily through Merrill Lynch
Credit Corporation. In 1997, the group expanded its client base through the
acquisition of MasterWorks, a 401(k) service provider.
- --------------------------------------------------------------------------------
International Private Client
The International Private Client group provides financial planning,
private banking, and trust and investment services to individuals outside the
U.S., through a network of 2,400 relationship managers and other specialists in
more than 30 countries worldwide. The group offers clients investing and
advisory services similar to those provided in the U.S.
- --------------------------------------------------------------------------------
Asset Management
The Asset Management group provides investment advisory and portfolio
management services to clients, principally through Merrill Lynch Asset
Management. Investment research and various advisory programs are offered to
clients, including the Merrill Lynch Consults(R), Merrill Lynch Mutual Fund
Advisor(SM), and Merrill Lynch Mutual Fund Advisor Selects(SM) services. As one
of the largest mutual fund managers, the group had assets under management of
$448 billion at year-end 1997. The group also provides portfolio management
services to large domestic and international institutional clients. In December
1997, Merrill Lynch
- --------------------------------------------------------------------------------
10
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
acquired Mercury, further strengthening Merrill Lynch's global presence as one
of the premier asset management firms.
- --------------------------------------------------------------------------------
GLOBAL OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch's non-U.S. operations are organized into five geographic
regions:
- - Europe, Middle East, and Africa
- - Asia and Pacific
- - Australia and New Zealand
- - Japan
- - Latin America and Canada
In 1997, Merrill Lynch continued to strategically expand its U.S. and
non-U.S. operations. This expansion, coupled with previous acquisitions, enabled
Merrill Lynch to continue to benefit from the globalization of financial markets
driven by the increase in cross-border transactions and client demand for global
investments.
In 1997, Merrill Lynch's non-U.S. businesses were influenced by many of
the same market conditions that impacted U.S. operating results, including
rising stock prices, low interest rates, and market volatility that occurred
later in the year. The combination of these market conditions, synergies from
acquisitions, and expanded global presence resulted in increases from 1996
levels in total revenues, net revenues, and earnings before income taxes in most
geographic regions.
- --------------------------------------------------------------------------------
Europe, Middle East, and Africa
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ------------------------------------------------------------
<S> <C> <C> <C>
Total revenues $ 6,750 $ 5,336 $ 3,981
Net revenues $ 2,284 $ 1,837 $ 1,319
Earnings before income taxes $ 405 $ 357 $ 155
Total assets $111,404 $75,901 $56,948
Total full-time employees 6,470 4,610 4,100
- ------------------------------------------------------------
</TABLE>
Merrill Lynch operates in Europe, the Middle East, and Africa as a
dealer in a comprehensive array of debt and equity products, as well as
providing investment banking, private banking, asset management, and research
services to a wide range of clients.
The region benefited from a number of market trends during 1997,
including increased privatization activity, growing issuances and restructurings
in the European markets, and numerous strategic acquisitions.
Merrill Lynch continued to enhance its presence in the region during
1997 and in December announced the purchase of Mercury. This acquisition
demonstrates Merrill Lynch's commitment to its strategic objective of becoming a
global leader in the asset management business and dramatically expands the
region's depth and range of products and services.
In 1997, total and net revenues for the region increased 26% and 24%
from 1996, respectively. The increases primarily resulted from higher
commissions and trading revenues. Commissions revenues benefited from increased
mutual fund activity. Trading revenues were up due to higher revenues from
equities, foreign exchange, and emerging market activities.
The 13% increase in earnings before income taxes from 1996 resulted from
the higher revenues, partially offset by increases in expenses from continued
investment in infrastructure to support business growth in the region.
Compensation and benefits costs rose due to increased headcount, while
professional fees increased due to higher systems and management consulting
costs.
In 1996, total and net revenues for the Europe, Middle East, and Africa
region increased 34% and 39% from 1995, respectively. The increases were
primarily due to higher trading, underwriting, and commissions revenues. The
region's earnings before income taxes more than doubled from 1995, due to
increased revenues and lower costs across the region.
- --------------------------------------------------------------------------------
11
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Asia and Pacific
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ---------------------------------------------------
<S> <C> <C> <C>
Total revenues $ 586 $ 395 $ 228
Net revenues $ 582 $ 394 $ 227
Earnings before income taxes $ 16 $ 41 $ 7
Total assets $ 797 $ 335 $ 240
Total full-time employees 1,690 1,300 1,060
- ---------------------------------------------------
</TABLE>
Merrill Lynch serves a broad retail and institutional client base
throughout the Asia and Pacific region. In mainland China, the focus is
principally on institutional business opportunities, while in other locations,
such as China's special autonomous region of Hong Kong, Korea, Singapore,
Taiwan, and Malaysia, both retail and institutional activities are conducted.
Merrill Lynch has a trading presence and exchange memberships in virtually all
financial markets in the region. During 1997, Merrill Lynch obtained a
dealing/underwriting license in Taiwan and opened its first office in the
Philippines.
Total and net revenues in the region were both up 48% from 1996.
Revenues during the first half of 1997 benefited from strong trading volume and
investment banking activity. Revenues then declined in the 1997 second half as
currency devaluations across the region significantly affected equity and debt
markets, particularly in Hong Kong and Singapore. The continued drop in the
regional currencies caused significant problems for Asian issuers of U.S.
dollar-denominated debt and significantly weakened the emerging secondary
market.
Earnings before income taxes decreased 61% from 1996 due to provisions
for certain client claims in Singapore and increased expenses associated with
the growth in the regional expansion, partially offset by higher trading
revenues.
Total and net revenues in the Asia and Pacific region in 1996 were up
73% and 74% from 1995, respectively. Earnings before income taxes rose almost
six-fold from 1995. Results in the region benefited from increased investment
banking revenues, while the integration of Smith New Court added significantly
to equity trading activities. In addition, increased commissions on regional
equities and mutual funds also contributed to higher revenues.
- --------------------------------------------------------------------------------
Australia and New Zealand
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- -----------------------------------------------------
<S> <C> <C> <C>
Total revenues $ 272 $151 $163
Net revenues $ 229 $88 $66
Earnings before income taxes $ 39 $24 $14
Total assets $1,899 $1,115 $976
Total full-time employees 780 160 130
- -----------------------------------------------------
</TABLE>
In the Australia and New Zealand region, Merrill Lynch provides a broad
mix of retail and institutional activities. In early 1997, Merrill Lynch
completed the acquisition of McIntosh Securities Limited, one of the largest
securities brokerage firms in Australia and New Zealand. In late 1997, Merrill
Lynch further expanded and strengthened its position in the region with the
addition of the staff and clients of Centaurus Corporate Finance Group, a top-
tier Australian merger and acquisition advisory firm.
Total and net revenues for the region increased 80% and 160% from 1996,
respectively. The increases primarily resulted from higher equity trading and
investment banking revenues. Equity trading revenues rose due to improved
market conditions and increased capacity related to the acquisition of
McIntosh. Investment banking revenues were also higher, benefiting from
increased cross-border activities. In addition, Merrill Lynch also increased
its market share on the Australian Stock Exchange during 1997, attaining the
number two position.
Earnings before income taxes increased 63% from 1996. Partially
offsetting the increase in revenues was higher incentive and production-related
compensation costs due to growth in the region.
Total revenues in the Australia and New Zealand region in 1996 were down
7%, while net revenues were up 33% from 1995. Earnings before income taxes rose
71% from 1995. Equities trading revenues increased as a result of improved
corporate earnings and market conditions.
- --------------------------------------------------------------------------------
12
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Japan
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- ----------------------------------------------------------
<S> <C> <C> <C>
Total revenues $1,108 $ 993 $ 841
Net revenues $ 598 $ 502 $ 408
Earnings before income taxes $ 140 $ 119 $ 60
Total assets $15,294 $16,455 $15,698
Total full-time employees 780 630 585
- ----------------------------------------------------------
</TABLE>
In Japan, Merrill Lynch operates as a dealer in a full range of debt and
equity products and provides investment banking and research services to a
predominantly institutional client base. In addition during 1997, Merrill Lynch
continued to build a solid base for its asset management business in Japan,
which has been augmented by the acquisition of Mercury and its existing local
client base. In December, Merrill Lynch Japan raised approximately $1 billion
for Income Strategies Portfolio, making it one of the most successful offshore
open-end funds launched in Japan.
Subsequent to year end, Merrill Lynch announced its re-entry into the
Japanese retail securities business, through the planned opening of
approximately 30 offices in Japan and the anticipated hiring of about 2,000
former employees of Yamaichi Securities Co. This re-entry is expected to benefit
both Private Client and Asset Management activities.
Total and net revenues in the Japan region were up 12% and 19% from
1996, respectively. Increased derivative trading revenues and sales of cross-
border products were partially offset by lower trading revenues for local
products. These higher revenues led to an increase in earnings before income
taxes of 18%.
Total and net revenues in the Japan region in 1996 were up 18% and 23%
from 1995, respectively. Earnings before income taxes increased 98% from 1995.
The increases were due to higher sales of cross-border products, partially
offset by lower revenues from local products.
- --------------------------------------------------------------------------------
Canada and Latin America
<TABLE>
<CAPTION>
(in millions) 1997 1996 1995
- -------------------------------------------------------
<S> <C> <C> <C>
Total revenues $ 1,816 $1,528 $1,251
Net revenues $ 1,325 $ 977 $ 697
Earnings before income taxes $ 288 $ 190 $ 152
Total assets $11,215 $9,455 $7,592
Total full-time employees 4,180 3,800 3,375
- -------------------------------------------------------
</TABLE>
In Canada and Latin America, Merrill Lynch provides a broad range of
financial products and services to retail and institutional clients. In Canada,
Merrill Lynch provides financial services including investment banking,
brokerage, and asset management. Merrill Lynch has expanded its broad-based
capabilities in the Canadian region as a result of its merger with Midland, a
Canadian diversified financial services firm. In Latin America, Merrill Lynch
provides varied brokerage and investment services. Included in the Latin America
region are certain U.S. offices that primarily serve Latin American clients.
Latin America experienced strong growth during the first half of the year due to
low inflation and significant foreign capital inflows. This growth was
significantly affected in the second half of the year as the uncertainty of the
Asian markets spread to Latin American markets.
Total and net revenues for the region increased 19% and 36% from 1996,
respectively. Canadian results increased due to strong investment banking
activity led by a favorable interest rate environment, and higher commissions
revenues. Trading and underwriting activities in Latin America were up from 1996
levels due to increased investor demand for higher-yielding securities, despite
the volatility that occurred late in the year. In addition, Latin American
results benefited from increased commissions due to higher mutual fund sales.
Earnings before income taxes rose 52%. Higher revenues from sales and
underwriting activities were partially offset by increases in variable expenses,
such as compensation costs and brokerage, clearing, and exchange fees. The
additional commitment of resources to the region in 1997 also contributed to
higher compensation costs.
Total and net revenues in the Canada and Latin America region in 1996
increased 22% and 40% from 1995, respectively, while earnings before income
taxes increased 25% from 1995. A strong economic environment combined with
higher revenues from high-yield financing and rising bond prices led to these
increases. The advance in revenues was offset by higher compensation and
infrastructure costs.
- --------------------------------------------------------------------------------
13
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
BALANCE SHEET
- --------------------------------------------------------------------------------
Trading-related balances accounted for approximately 86% of assets and
64% of liabilities at December 26, 1997. As presented below, securities trading,
derivatives dealing, and related activities result in trading asset/liability,
resale/repurchase agreement, securities borrowed/loaned transaction, and certain
receivable/payable balances.
Presented are two pie charts illustrating Merrill Lynch's trading-
related balances as percentages of total assets and total liabilities,
respectively.
- --------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Trading Related:
Trading Assets 37%
Resale Agreements 24
Securities Borrowed 12
Receivables 13
----
86
Non-Trading-Related 14
----
100%
----
- -------------------------------------------------------------------------------
Liabilities
- -------------------------------------------------------------------------------
Trading Related:
Trading Liabilities 25%
Repurchase Agreements 25
Securities Loaned 2
Payables 12
----
64
Non-Trading-Related 36
----
100%
----
- -------------------------------------------------------------------------------
</TABLE>
Although trading-related balances comprise a significant portion of the
balance sheet, the magnitude of these balances do not necessarily convey a sense
of the risk profile assumed by Merrill Lynch. Hedging strategies and compliance
with collateral maintenance policies, as discussed later, mitigate risk
exposures.
- --------------------------------------------------------------------------------
Trading Assets and Liabilities
Trading assets and liabilities principally represent securities
purchased ("long" positions) and securities sold but not yet purchased ("short"
positions), respectively. Trading assets and liabilities also include
receivables and payables that represent the fair value of derivatives (see Note
1 to the Consolidated Financial Statements).
Merrill Lynch acts as a market maker in many securities, maintaining a
significant amount of trading inventory to facilitate customer transaction flow.
To a lesser degree, Merrill Lynch also maintains proprietary trading inventory
in seeking to profit from existing or projected market opportunities.
Merrill Lynch uses hedging techniques to manage trading inventory market
risks (see Note 3 to the Consolidated Financial Statements). A significant
portion of trading assets and liabilities, including derivatives, represents
hedges of other trading positions. Many short U.S. Government securities and
futures positions, for example, hedge various interest-sensitive trading assets.
Hedging techniques at the trading unit level are supplemented by corporate risk
management policies and procedures. For a description of risk management
policies and procedures and a discussion of the effectiveness of hedging
techniques, see the Risk Management section.
- --------------------------------------------------------------------------------
Resale/Repurchase Agreements and
Securities Borrowed/Loaned Transactions
Repurchase agreements and, to a lesser extent, securities loaned
transactions are used to fund a significant portion of trading assets. Likewise,
Merrill Lynch uses resale agreements and securities borrowed transactions to
obtain the securities needed for delivery on short positions. "Matched-book"
repurchase and resale agreements or securities borrowed and loaned transactions
are entered into with different counterparties using the same underlying
securities in order to generate a spread between the interest revenue on the
resale agreements or securities borrowed transactions and the interest expense
on the repurchase agreements or securities loaned transactions. Exposures on
these transactions are limited by their typically short-term nature and
collateral maintenance policies (see Collateral section). The following graph
illustrates the balances related to these activities at December 26, 1997.
- --------------------------------------------------------------------------------
14
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Presented is a bar graph illustrating the nature of resale/repurchase agreements
and securities borrowed/loaned transactions, differentiating between matched-
book and non-matched-book for total resale agreements, repurchase agreements,
securities borrowed, and securities loaned balances of $71,904, $72,127,
$35,539, and $7,040, respectively.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Resale/Repurchase Agreements and
Securities Borrowed/Loaned Transactions
(in millions)
- --------------------------------------------------------------------------------
Matched- Non-Matched-
Book Book
-------- ------------
<S> <C> <C>
Resale Agreements 64% 36%
Repurchase Agreements 63 37
Securities Borrowed Transactions 11 89
Securities Loaned Transactions 54 46
- --------------------------------------------------------------------------------
</TABLE>
Trading-Related Receivables and Payables
Securities trading may lead to various customer or broker-dealer
balances. Broker-dealer balances may also result from recording trading
inventory on a trade date basis. Certain receivable and payable balances also
arise when customers or broker-dealers fail to pay for securities purchased or
fail to deliver securities sold, respectively. These receivables are generally
fully collateralized by the securities that the customer or broker-dealer
purchased but did not receive. Customer receivables also include margin loans
collateralized by customer-owned securities held by Merrill Lynch. Collateral
policies significantly limit Merrill Lynch's credit exposure to customers and
broker-dealers. Merrill Lynch, in accordance with regulatory requirements, will
sell securities that have not been paid for, or purchase securities sold but not
delivered, after a relatively short period of time, or will require additional
margin collateral, as necessary. These measures reduce market risk exposure
related to these balances.
Interest receivable and payable balances related to trading inventory
are principally short-term in nature. Interest balances for resale and
repurchase agreements, securities borrowed and loaned transactions, and customer
margin loans are generally considered when determining the collateral
requirements related to these transactions.
- --------------------------------------------------------------------------------
Collateral
The table that follows presents reported assets at December 26, 1997 and
the related collateral maintained by Merrill Lynch to reduce default risk
exposure.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Balance Collateral
(in millions) Sheet Maintained
- --------------------------------------------------------------------------------
<S> <C> <C>
Cash and cash equivalents $ 5,046 $ -
Cash and securities segregated for
regulatory purposes or deposited with
clearing organizations 12,384 -
Marketable investment securities 3,309 -
Trading assets(a) 108,091 4,750
Receivables under resale agreements(b) 71,904 72,840
Receivables under securities borrowed
transactions(b) 35,539 33,285
Other receivables(c) 40,686 27,848
Investments of insurance subsidiaries 4,833 -
Loans, notes, and mortgages(d) 4,310 4,105
Other investments 1,829 -
Property, leasehold improvements, and
equipment 2,099 -
Goodwill 5,467 -
Other assets 1,483 -
-------- --------
Total Assets $296,980 $142,828
-------- --------
- --------------------------------------------------------------------------------
</TABLE>
(a) Various techniques reduce credit risk on trading assets, including
maintaining collateral on derivative contract receivables.
(b) The risk of default on receivables under resale agreements and
securities borrowed transactions is substantially eliminated by
maintaining related securities with fair values in accordance with
specific collateral guidelines.
(c) To the extent possible, collateral is taken to secure receivables. For
instance, Merrill Lynch maintains collateral substantially in excess of
customer margin loan receivables, and broker-dealer receivables are
substantially collateralized by the related securities. The collateral
amounts above do not include overcollateralization.
(d) Merrill Lynch generally maintains collateral on these extensions of
credit in the form of securities, liens on real estate, perfected
security interests in other assets of the borrower, and guarantees.
Besides requiring collateral, Merrill Lynch's Corporate Credit group
uses other techniques to manage credit risk (see Risk Management section).
- --------------------------------------------------------------------------------
15
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Average Assets and Liabilities
Merrill Lynch monitors changes in its balance sheet using average daily
balances that are determined on a settlement date basis and reported for
management information purposes. Financial statement balances are recorded on a
trade date basis as required under generally accepted accounting principles. The
following discussion compares changes in settlement date average daily balances.
These changes were consistent with the growth in the year-end financial
statement balances.
In 1997, average daily assets were $289 billion, up 31% from $220
billion in 1996. Average daily liabilities in 1997 rose 32% to $280 billion from
$213 billion in 1996. The major components in the growth of average assets and
liabilities are summarized as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Increase
in Average Percent
(in millions) Assets Increase
- ---------------------------------------------------------------------------
<S> <C> <C>
Trading assets $33,911 46%
Receivables under resale agreements
and securities borrowed transactions 21,176 22
Customer receivables 7,247 31
- ---------------------------------------------------------------------------
Increase
in Average Percent
Liabilities Increase
- ---------------------------------------------------------------------------
Payables under repurchase agreements
and securities loaned transactions $18,599 21%
Trading liabilities 15,353 36
Long-term borrowings 12,610 55
Commercial paper and other
short-term borrowings 12,098 38
- ---------------------------------------------------------------------------
</TABLE>
Due to the adoption of SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, both average
asset balances (trading assets and receivables under resale agreements) and
average liability balances (payables under repurchase agreements) increased by
approximately $3 billion (see Note 2 to the Consolidated Financial Statements
for more information on SFAS No. 125). In addition, during 1997 trading assets
and liabilities (which include on-balance-sheet hedges used to manage trading
risks) rose as volume increased, benefiting from higher customer demand.
Increases in secured lending activity, in the form of margin and other
collateralized loans, led to higher levels of customer receivables.
Receivables under resale agreements and securities borrowed transactions
and payables under repurchase agreements and securities loaned transactions rose
to meet higher funding requirements for increased trading activity. In addition,
these transactions increased as a result of expanded matched-book activity,
primarily involving governments and agencies securities.
Assets are funded through diversified sources which include repurchase
agreements and securities loaned transactions, commercial paper and short-term
borrowings, long-term borrowings, and equity. In addition to the increases in
repurchase agreements and securities loaned transactions, the growth in average
assets was funded by higher long-term borrowings, particularly medium-term
notes, and commercial paper.
- --------------------------------------------------------------------------------
Stockholders' Equity
Stockholders' equity at December 26, 1997 increased 21% to $8.5 billion
from $7.1 billion at year-end 1996. The 1997 increase resulted from net earnings
and the net effect of employee stock transactions, partially offset by common
share repurchases and dividends. In 1997 and 1996, Merrill Lynch repurchased
13.7 million and 37.2 million common shares at average prices of $48.91 and
$31.30 per share, respectively. Merrill Lynch will continue to consider share
repurchases, taking into account capital needs and the effect of issuances under
employee stock plans.
In the second quarter of 1997, Merrill Lynch's Board of Directors
declared a two-for-one common stock split effected in the form of a 100% stock
dividend. The par value of the common stock remained at $1.33 1/3 per share.
Accordingly, an adjustment from paid-in capital to common stock was made to
preserve the par value of the post-split shares. All share and per share data
have been restated for the effect of the split.
At December 26, 1997, total common shares outstanding were 339.3
million, 2% higher than the
- --------------------------------------------------------------------------------
16
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
332.3 million shares outstanding at December 27, 1996. The increase was
attributable principally to employee stock grants and option exercises,
partially offset by common share repurchases.
Total outstanding shares exchangeable into common stock at December 26,
1997 and December 27, 1996 issued in connection with the Midland merger, were
4.7 and 4.1, respectively.
During the first quarter of 1997, all shares of the outstanding
Remarketed Preferred(SM) Stock, Series C were redeemed.
- --------------------------------------------------------------------------------
LIQUIDITY AND LIABILITY
MANAGEMENT
- --------------------------------------------------------------------------------
The primary objective of Merrill Lynch's funding policies is to assure
liquidity at all times. Merrill Lynch's liquidity management strategy has three
key components:
1. Maintain alternative funding sources such that all debt obligations
maturing within one year can be funded when due without issuing new
unsecured debt or liquidating business assets;
2. Concentrate unsecured, general purpose borrowings at the ML & Co. level;
and
3. Expand and diversify Merrill Lynch's funding programs.
Merrill Lynch's primary alternative funding sources to unsecured
borrowings are repurchase agreements and secured bank loans, which require
pledging unhypothecated marketable securities. Other funding alternatives
include liquidating cash equivalents; securitizing loan assets; and drawing on
committed, unsecured bank credit facilities that, at December 26, 1997, totaled
$9.2 billion. To finance the purchase of Mercury, Merrill Lynch obtained
additional short-term bank credit facilities totaling 2.0 billion British pounds
(approximately $3.3 billion), which as of year end had not been drawn upon.
Subsequently, Merrill Lynch drew upon these facilities. These borrowings are
expected to be repaid during 1998 with proceeds from long-term financing.
Merrill Lynch regularly reviews the level and mix of its assets and
liabilities to assess its ability to conduct core business activities without
issuing new unsecured debt or drawing upon its bank credit facilities. The mix
of assets and liabilities provides flexibility in managing liquidity since a
significant portion of assets turns over frequently and is typically match-
funded with liabilities having similar maturities and cash flow characteristics.
At December 26, 1997, substantially all of Merrill Lynch's assets were
considered readily marketable by management.
Merrill Lynch concentrates its unsecured, general purpose borrowings at
the ML & Co. level, except where tax regulations, time zone differences, or
other business considerations make this impractical. The benefits of this
strategy are enhanced control, reduced financing costs, wider name recognition
by creditors, and enhanced flexibility to meet variable funding requirements of
subsidiaries.
Merrill Lynch also strives to expand and diversify its funding programs
and investor and creditor base. Merrill Lynch benefits by distributing its debt
through its own sales force to a large, diversified customer base. Additionally,
Merrill Lynch maintains strict concentration standards for short-term
borrowings, including limits for any single investor.
Commercial paper is the major source of short-term general purpose
funding. Commercial paper outstanding totaled $30.4 billion at December 26, 1997
and $23.6 billion at December 27, 1996, which represented 10% and 11% of total
assets at year-end 1997 and 1996, respectively.
Outstanding long-term debt at December 26, 1997 increased to $43.1
billion from $26.2 billion at December 27, 1996. Major components of the change
in long-term debt for 1997 and 1996 follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in billions) 1997 1996
- ----------------------------------------------------------------------
<S> <C> <C>
Beginning of year $26.2 $17.4
Issuances 25.1 16.5
Maturities (8.2) (7.4)
Other - (.3)
----- -----
End of year(1) $43.1 $26.2
----- -----
Average maturity in years of long-term debt,
when measured to:
Maturity 3.5 3.5
Earlier of the call or put date 3.1 3.2
- ----------------------------------------------------------------------
</TABLE>
(1) At year-end 1997 and 1996, $31.2 and $20.2 billion of long-term debt had
maturity dates beyond one year, respectively.
- --------------------------------------------------------------------------------
17
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Merrill Lynch's senior long-term debt, preferred stock, and Trust Originated
Preferred Securities(SM) ("TOPrS"(R)) were rated by recognized credit rating
agencies at December 26, 1997 as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Senior Preferred Stock
Debt and TOPrS
Rating Agency Ratings Ratings
- --------------------------------------------------------------------
<S> <C> <C>
Duff & Phelps Credit Rating Co. AA AA-
Fitch IBCA, Inc. AA AA-
The Japan Bond Research Institute AA Not Rated
Moody's Investors Service, Inc. Aa3 aa3
Standard & Poor's AA- A
Thomson BankWatch, Inc. AA+ Not Rated
- --------------------------------------------------------------------
</TABLE>
Approximately $75.3 billion of indebtedness at December 26, 1997 is
considered senior indebtedness as defined under various indentures.
As part of an overall liquidity management strategy, Merrill Lynch's
insurance subsidiaries regularly review the funding requirements of their
contractual obligations for in-force, fixed-rate life insurance and annuity
contracts as well as expected future acquisition and maintenance expenses for
all contracts. The insurance subsidiaries market primarily variable life
insurance and variable annuity products. These products are not subject to the
interest rate, asset/liability matching, or credit risks attributable to fixed-
rate products, thereby reducing the insurance subsidiaries' risk profile and
liquidity demands. At December 26, 1997, approximately 84% of invested assets of
insurance subsidiaries were considered liquid by management.
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND
CAPITAL ADEQUACY
- --------------------------------------------------------------------------------
Among U.S. institutions engaged primarily in the global securities
business, Merrill Lynch is one of the most highly capitalized, with $8.1 billion
in common equity and $425 million in preferred stock at December 26, 1997 (see
Stockholders' Equity in the Balance Sheet section). In 1997, a trust subsidiary
of ML & Co. issued $300 million of TOPrS. These subsidiary-issued preferred
securities, along with $327 million of preferred securities outstanding in other
subsidiaries, further strengthen Merrill Lynch's equity capital base. Subsequent
to year-end 1997, $750 million of TOPrS were issued by another trust subsidiary
(see Note 6 to the Consolidated Financial Statements).
Merrill Lynch's leverage ratios were as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Adjusted
Leverage Leverage
Ratio(1) Ratio(2)
- ----------------------------------------------
<S> <C> <C>
Year End
December 26, 1997 32.4x 20.7x
December 27, 1996 29.4x 17.9x
Average for Year Ended(3)
December 26, 1997 35.3x 21.3x
December 27, 1996 33.3x 19.8x
- -----------------------------------------------
</TABLE>
(1) Total assets to total stockholders' equity and preferred securities
issued by subsidiaries.
(2) Total assets less receivables under resale agreements and securities
borrowed transactions to total stockholders' equity and preferred
securities issued by subsidiaries.
(3) Computed using month-end balances.
Overall capital needs are continually reviewed to ensure that Merrill
Lynch's capital base can support the estimated risks of its businesses as well
as the regulatory and legal capital requirements of its subsidiaries.
Statistically based product risk models are used to estimate potential losses
arising from market and credit risks. These dynamic models incorporate changes
in business risk into Merrill Lynch's equity requirements. Based upon these
analyses as well as other criteria, management believes that Merrill Lynch's
equity capital base is adequate.
Merrill Lynch operates in many regulated businesses that require various
minimum levels of capital (see Note 11 to the Consolidated Financial Statements
and Business of Merrill Lynch-Regulation). Merrill Lynch's broker-dealer,
banking, insurance, and futures commission merchant activities are subject to
regulatory requirements that may restrict the free flow of funds to affiliates.
Regulatory approval is generally required for paying dividends in excess of
certain established levels, making affiliated investments, and entering into
management and service agreements with affiliated companies.
- --------------------------------------------------------------------------------
18
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CAPITAL PROJECTS AND
EXPENDITURES
- --------------------------------------------------------------------------------
Merrill Lynch continually prepares for the future by expanding its
operations and investing in new technology to improve service to clients. To
support business expansion, for example, Merrill Lynch plans to build a new
European headquarters in London for approximately $650 million. Completion of
this facility is expected in 2001. During 1997, Merrill Lynch also approved a
plan to construct an office complex in central New Jersey to consolidate certain
operations. Construction costs are estimated at approximately $325 million, and
completion of this facility is anticipated in 2000.
Significant technology initiatives include Merrill Lynch Trusted Global
Advisor(SM) ("TGA" (SM)) and Year 2000 systems compliance. The TGA system, a
technology platform for Financial Consultants, is expected to be available to
all U.S. Financial Consultants by the end of the 1998 third quarter. New system
applications will be added to the platform at various times throughout 1998. The
projected remaining cost for the TGA system is approximately $200 million.
The modifications for Year 2000 systems compliance are proceeding
according to plan and are expected to be completed in early 1999. Based on
information currently available, the remaining expenditures are estimated at
$215 million and will cover hardware and software upgrades, systems consulting,
and computer maintenance. These expenditures are not expected to have a material
adverse impact on Merrill Lynch's financial position, results of operations, or
cash flows in future periods. However, the failure of Merrill Lynch's securities
exchanges, clearing organizations, vendors, clients, or regulators to resolve
their own processing issues in a timely manner could result in a material
financial risk. Merrill Lynch is devoting necessary resources to address all
Year 2000 issues in a timely manner.
- --------------------------------------------------------------------------------
RISK MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch's operating activities expose it to many risks that are
continually monitored, evaluated, and managed. Proper management of these risks
helps reduce the likelihood of earnings volatility. Business units typically
hedge risks arising either from individual transactions or portfolios of similar
transactions to manage risk at the legal entity level. Hedging techniques will
vary based on many factors, including the nature and extent of the risks
involved. The effectiveness of hedging techniques and corporate risk management
policies and procedures is illustrated by analyzing actual net trading-related
revenues over time. The nature of Merrill Lynch's trading-related activities,
which are principally client order flow-driven, combined with its risk
management strategies, help to reduce earnings volatility. A distribution of
weekly net trading-related revenues, net of reserves, for each of the last three
years is presented in the graph that follows.
Presented is a bar graph illustrating the distribution of weekly net
trading-related revenues by revenue band for 1995, 1996, and 1997.
- --------------------------------------------------------------------------------
Distribution of Weekly Net
Trading-Related Revenues by Year
(in millions)
- --------------------------------------------------------------------------------
1995 1996 1997
---- ---- ----
Number of Weeks:
$ 0-40 million - 1 3
$ 40-80 million 20 12 6
$ 80-120 million 29 38 21
$ 120-160 million 3 1 19
Over $160 million - - 3
---- ---- ----
52 52 52
---- ---- ----
- --------------------------------------------------------------------------------
19
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
To supplement risk management at the business unit level, Merrill Lynch
has developed corporate governance policies and procedures that require specific
areas and units to assist in the identification, assessment, and control of
these risks. These policies and procedures are performed by many groups,
including the Global Risk Management Group ("Risk Management"); the Credit
Division ("Corporate Credit"); and other control units, including Finance,
Audit, Operations, and Law and Compliance ("Control Units"). In addition to
independent risk management responsibilities, senior management from Risk
Management, Corporate Credit, and the Control Units take an active role in the
oversight of the risk management process through the Risk Control and Reserve
Committees.
The Risk Control Committee and Risk Management provide general risk
oversight for all institutional trading activities. The Risk Control Committee,
chaired by the head of Risk Management, reports periodically to the Audit and
Finance Committee of the Board of Directors and is independent of Merrill
Lynch's trading units. The Risk Control Committee's activities are also designed
to ensure compliance with Merrill Lynch's commitment under the Derivatives
Policy Group's Framework for Voluntary Oversight.
The Reserve Committee monitors valuation and certain other risks
associated with assets and liabilities. Merrill Lynch establishes reserves in
the Consolidated Balance Sheets for existing conditions, events, or
circumstances that may indicate that the realizable value of an asset has been
reduced below its carrying value or that a liability has been incurred. The
Reserve Committee, chaired by the Chief Financial Officer, reviews and approves
firmwide reserve levels, as well as changes in reserve methodologies. The
Reserve Committee meets monthly to review current market conditions and to act
on specific issues. Merrill Lynch's reserves take into account management's
judgment and are generally based on:
~ identification of risks and exposures,
~ formulas, and
~ aging, concentration, and liquidity analyses.
The following discussions of market, credit, operating, and other risks
highlight the corporate policies and procedures for risk identification,
assessment, and control. Further discussion of market and credit risk is
contained in Note 3 to the Consolidated Financial Statements.
- --------------------------------------------------------------------------------
Market Risk
Market risk is the potential change in a financial instrument's value
caused by fluctuations in interest and currency exchange rates, equity and
commodity prices, and credit spreads. Risk Management is responsible for the
measurement, monitoring, and control of market risk on trading positions,
including the establishment of trading limits throughout the firm.
Over the last several years, measuring market risk with mathematical
models has become the focal point of many risk management efforts worldwide,
with the term "risk management" becoming almost synonymous with "risk
measurement". In general, Merrill Lynch believes that the primary risk of a
product is not in the product itself, but in the way in which the product is
managed. Breaches of discipline or lapses in supervision can result in losses
irrespective of the products involved or the mathematical models used.
Approximately ten years ago, Merrill Lynch implemented a firmwide risk
process based on the belief that there is more to risk management than
identifying and measuring risk. The process itself has been strengthened by
experience, but the underlying philosophy is essentially unchanged. This
philosophy is based on the following six principles:
1. The most important tools in any risk process are experience, judgment,
and constant communication with risk takers.
2. Vigilance, discipline, and an awareness of risk must be continuously
emphasized throughout the firm.
3. Management must provide a clear and simple statement as to what can and
cannot be done in committing capital.
- --------------------------------------------------------------------------------
20
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
4. Risk Management must consider the unexpected, probe for potential
problems, test for weaknesses, and help identify potential for loss.
5. The process must be flexible to permit adaptation to changing
environments, including the evolving goals of Merrill Lynch itself.
6. The key objective must be to minimize the possibility of incurring
unacceptable loss. Such losses usually arise from unexpected events that
most statistical model-based risk methodologies cannot predict.
- --------------------------------------------------------------------------------
Risk Management Process
Risk Management is organized along geographic and product lines to
ensure direct and frequent communication with specific trading areas. In
addition, Risk Management performs regular, formal risk reviews with senior
trading managers.
Risk Management has established certain controls and guidelines to
supplement hedging techniques at the trading unit level (see Trading Assets and
Liabilities in the Balance Sheet section for further information on these
techniques). Risk Management sets and monitors trading limits, which may not be
exceeded without prior approval. In addition, Risk Management and
representatives from other Control Units approve new types of transactions as
part of the new product review process. Certain commitments are subject to prior
approval from Risk Management and other Control Units. These commitments include
underwritings of equity, high-yield, and emerging market securities, real estate
financings, and bridge loans. Risk Management also has authority to require
reductions in specific trading desk exposures or to veto proposed transactions.
Risk Management uses several risk technology tools, including a risk
inventory database, a trading limit monitoring system, and trading system
access. The risk inventory database provides daily consolidation of securities
inventory exposure by product, credit rating, country, etc., along with
concentrations of exposure. The trading limit monitoring system enables Risk
Management to review compliance with established limits. Access to trading
systems allows Risk Management to monitor positions and perform computerized
analytics.
Merrill Lynch also uses mathematical risk models, including value-at-
risk and sensitivity analysis, to help estimate its exposure to market risk.
Nevertheless, Merrill Lynch believes that the use of mathematical risk models
alone may provide a greater sense of security than warranted; therefore,
reliance on these models should be limited. In fact, because of the inability of
mathematical risk models to quantify large-scale potential financial events with
any precision, these models only serve to supplement other risk management
efforts. In order to satisfy the Securities and Exchange Commission's market
risk disclosure requirements, however, value-at-risk measures are presented.
Value-at-risk is a statistical measure of the potential loss in the fair
value of a portfolio due to adverse movements in underlying risk factors. For
these disclosures, Merrill Lynch uses a historical simulation approach to
estimate value-at-risk using a one-week holding period for trading and non-
trading instruments. Sensitivities to market risk factors are aggregated and
combined with a database of historical weekly changes in market factors to
simulate a series of profits and losses. The level of loss that is exceeded in
that series 1% of the time is used as the estimate for the 99% confidence level
value-at-risk.
The reader should be aware that a number of assumptions must be made to
obtain the sensitivities and simulated profits and losses. There is no reason to
believe that the historically simulated profits and losses have any predictive
power for the future distribution of profits and losses. Hypothetical gains and
losses from simulated changes in risk factors for the trading portfolio would be
reflected in earnings since these instruments are accounted for at fair value.
Hypothetical gains and losses from simulated changes in risk factors for the
non-trading portfolio generally would not be reflected in earnings since these
instruments are typically accounted for at historical cost.
- --------------------------------------------------------------------------------
21
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
All trading units communicate daily to Risk Management the sensitivity
of their positions to changes in risk factors. The table that follows presents
Merrill Lynch's value-at-risk for trading instruments at December 26, 1997:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions)
- -------------------
<S> <C>
Market risks:
Interest rate $60
Equity 37
Commodity 17
Currency 13
- -------------------
</TABLE>
Risk Management does not monitor sensitivities to market risk for non-
trading instruments since earnings generally are not impacted by such
sensitivities. The table below presents Merrill Lynch's value-at-risk for non-
trading instruments at December 26, 1997:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions)
- -------------------
<S> <C>
Market risks:
Currency $32
Interest rate 10
Equity 5
- -------------------
</TABLE>
For information on qualitative aspects of market risk, see Note 3 to the
Consolidated Financial Statements.
- --------------------------------------------------------------------------------
Credit Risk
Credit risk represents the loss that Merrill Lynch would incur if a
counterparty or issuer failed to perform its contractual obligations. Policies
and procedures have been established with the objective of protecting against
such losses, which include:
~ reviewing and establishing limits for credit exposures,
~ further limiting counterparty credit exposures through various techniques,
including maintaining collateral and obtaining the right to terminate
transactions or collect collateral in the event of a credit downgrade, and
~ continually assessing the creditworthiness of counterparties and issuers.
The responsibility for compliance with these policies and procedures
rests with the business units and is monitored by Corporate Credit.
Corporate Credit is centralized and organized geographically. The
Sovereign Credit Risk group analyzes the political, economic, and financial
conditions of a country, establishes credit ratings, and recommends overall risk
limits. Regional credit groups, in addition to evaluating the creditworthiness
of specific counterparties, enhance the country analysis by ensuring that total
credit risks are within country concentration limits. Credit officers also set
limits by counterparty or issuer, recommend credit reserves, manage credit
exposures, and participate in the new product review process.
Many types of transactions, including most derivatives and syndicated
loans, are subject to prior approval from Corporate Credit. Within Corporate
Credit, approval levels have been established based on counterparty or issuer
credit quality and the potential risk of the transaction. Transactions that
exceed prescribed levels must be approved by the Credit Committee, which
includes several Directors of Corporate Credit and the Chief Credit Officer.
The credit system tracks information from automated and manual sources
to enable Corporate Credit to monitor counterparty/issuer, product, and country
concentrations. This system aggregates credit exposure by counterparty/issuer,
maintains overall counterparty/issuer and specific product limits, and
identifies limit review dates by counterparty/issuer. Detailed information on
firmwide inventory positions and executed transactions, including current and
potential credit exposure, is updated frequently and compared with limits.
Collateral holdings, which reduce credit exposure, are also tracked on the
credit system.
Corporate Credit works with the trading units to develop and refine
credit risk measurement models and to analyze potential credit exposures for
complex derivative transactions. Credit exposures related to Merrill Lynch's
retail customer business, including mortgages and home equity lines of credit,
customer margin accounts, and working capital facilities to small businesses,
are continually monitored.
- --------------------------------------------------------------------------------
22
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Operating Risk
Operating risk focuses on Merrill Lynch's ability to accumulate,
process, protect, and communicate information necessary to conduct business in a
global market environment. It includes the execution of legal, fiduciary, and
agency responsibilities. Merrill Lynch manages operating risk in many ways,
including maintaining backup facilities, using technology, employing experienced
personnel, and maintaining a comprehensive system of internal controls.
Merrill Lynch maintains key backup facilities worldwide and updates
systems and equipment as required in response to changes in business conditions
and technology needs. An example is the extensive work currently being performed
to become Year 2000-compliant (see Capital Projects and Expenditures section).
In addition, experienced operations personnel provide support and control for
trading, clearance, and settlement activities and perform custodial functions
for customer and proprietary assets. Merrill Lynch regularly reviews its
framework of internal controls, taking into account changing circumstances.
Corrective actions are taken to address control deficiencies and opportunities
for improvement are implemented when cost-effective.
From a legal standpoint, risk arises from the enforceability of clients'
and counterparties' obligations to and from Merrill Lynch, including obtaining
contractual provisions intended to reduce credit exposure by providing for the
netting of mutual obligations. The firm seeks to mitigate such risk by:
~ developing policies that enhance enforceability of transactions;
~ monitoring compliance with internal policies and external regulations; and
~ requiring consultation with internal and external legal advisors for
non-standard transactions.
Fiduciaries and agents have obligations to act on behalf of others. Such
risks are inherent in brokerage and investment management activities. Merrill
Lynch has a number of policies in place to ensure that obligations to clients
are met and that Merrill Lynch is in compliance with applicable legal and
regulatory requirements.
- --------------------------------------------------------------------------------
Other Risks
Liquidity risk arises in the course of Merrill Lynch's general funding
activities and in the management of the balance sheet. It includes both the risk
of being unable to raise funding with appropriate maturity and interest rate
characteristics and the risk of being unable to liquidate an asset in a timely
manner at a reasonable price. For more information on how Merrill Lynch manages
liquidity risks, see the Liquidity and Liability Management section.
Other risks Merrill Lynch encounters include political, tax, and
regulatory risks. These risks revolve around the impact that changes in local
laws, regulatory requirements, or tax statutes would have on the viability,
profitability, or cost-effectiveness of existing or future transactions. To help
mitigate the effects of these risks, Merrill Lynch constantly reviews new and
pending legislation and regulations by employing professionals in the
jurisdictions in which the company operates to actively follow these issues and
participate in related interest groups.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS AND
HIGHLY LEVERAGED TRANSACTIONS
- --------------------------------------------------------------------------------
Non-investment grade holdings and highly leveraged transactions involve
risks related to the creditworthiness of the issuers or counterparties and the
liquidity of the market for such investments. Merrill Lynch recognizes these
risks and, whenever possible, employs strategies to mitigate exposures. The
specific components and overall level of non-investment grade and highly
leveraged positions may vary significantly from period to period as a result of
inventory turnover, investment sales, and asset redeployment.
- --------------------------------------------------------------------------------
23
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Non-Investment Grade Holdings
In the normal course of business, Merrill Lynch underwrites, trades, and
holds non-investment grade cash instruments in connection with its investment
banking, market-making, and derivative structuring activities. During the past
year, non-investment grade trading inventories increased to satisfy growing
client demand for higher-yielding investments, including emerging market and
other non-U.S. securities.
Non-investment grade securities have been defined as debt and preferred
equity securities rated as BB+ or lower, or equivalent ratings by recognized
credit rating agencies, certain sovereign debt in emerging markets, amounts due
under various derivative contracts from non-investment grade counterparties, and
other instruments that, in the opinion of management, are non-investment grade.
Non-investment grade trading inventories are carried at fair value. Merrill
Lynch's insurance subsidiaries also hold non-investment grade investment
securities that are classified as available-for-sale and are carried at fair
value.
A summary of positions with non-investment grade issuers (for cash
instruments) or counterparties (for derivatives in a gain position) follows:
- --------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996
- --------------------------------------------------------
<S> <C> <C>
Trading assets:
Cash instruments $13,049 $7,667
Derivatives(1) 3,084 2,470
Trading liabilities - cash instruments 2,970 907
Marketable investment securities 648 -
Insurance subsidiaries' investments 192 206
- --------------------------------------------------------
</TABLE>
(1) Collateral of $599 and $848 was obtained at December 26, 1997 and December
27, 1996, respectively, to reduce risk related to these derivative
balances.
Included in the preceding table are debt and equity securities and bank
loans of companies in various stages of bankruptcy proceedings or in default. At
December 26, 1997 and December 27, 1996, the carrying value of such debt and
equity securities totaled $142 million and $133 million, of which 56% and 58%
resulted from Merrill Lynch's market-making activities in such securities,
respectively.
In addition, Merrill Lynch held distressed bank loans totaling $432
million and $351 million at year-end 1997 and 1996, respectively.
Derivatives may also expose Merrill Lynch to credit risk related to the
underlying security where a derivative contract can either synthesize ownership
of the underlying security (e.g., long total return swap) or potentially force
ownership of the underlying security (e.g., short put option). In addition,
derivatives may subject Merrill Lynch to credit spread risk in that changes in
the credit quality of the underlying securities may offset the derivatives' fair
values. A summary of exposures related to derivatives with non-investment grade
underlying securities follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Derivative fair values:
Trading assets(1) $ 62 $ 63
Trading liabilities 62 64
Derivative notionals (off-balance-sheet)(2) 3,257 2,895
- --------------------------------------------------------------------------------
</TABLE>
(1) The preceding table includes $42 and $9 at year-end 1997 and 1996,
respectively, of credit risk exposures to non-investment grade
counterparties.
(2) Represents amount subject to strike or reference price.
Merrill Lynch engages in hedging strategies to reduce its exposure
associated with non-investment grade positions by purchasing an option to sell
the related security or by entering into other offsetting derivative contracts.
Merrill Lynch also uses non-investment grade trading inventories, principally
non-U.S. governments and agencies securities, to hedge the exposure arising from
structured derivative transactions.
A summary of cash instruments and derivatives used to hedge the credit
risk of non-investment grade positions follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996
- ---------------------------------------------------------
<S> <C> <C>
Trading assets - cash instruments $1,312 $905
Derivative notionals (off-balance-sheet)(1) 4,235 1,311
- ---------------------------------------------------------
</TABLE>
(1) Represents amount subject to strike or reference price.
At December 26, 1997, the largest non-investment grade concentration of
credit exposure consisted of various sovereign and corporate issues of a South
American country totaling $1.1 billion.
- --------------------------------------------------------------------------------
24
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Highly Leveraged Transactions
Merrill Lynch provides financing and advisory services to, and invests
in, companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch provides
extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch syndicates loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
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 determined on a select
basis. A summary of loans, investments, and commitments related to highly
leveraged transactions follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in millions) 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Loans (net of allowance for loan losses)(1) $467 $340
Equity investments(2) 170 113
Partnership interests 82 104
Bridge loan - 31
Additional commitments to invest in partnerships 60 82
Unutilized revolving lines of credit and other
lending commitments 485 301
- --------------------------------------------------------------------------------
</TABLE>
(1) Represented outstanding loans to 48 and 36 companies at year-end 1997 and
1996, respectively.
(2) Invested in 72 and 48 enterprises at year-end 1997 and 1996,
respectively.
At December 26, 1997, no single industry sector accounted for more
than 27% of total non-investment grade positions and highly leveraged
transactions.
- --------------------------------------------------------------------------------
CASH FLOWS
- --------------------------------------------------------------------------------
Merrill Lynch's cash flows are principally associated with operating and
financing activities related to Merrill Lynch's trading, customer, and
investment banking transactions. Merrill Lynch's cash and cash equivalents
totaled $5.1 billion at December 26, 1997, up $1.7 billion and $2.0 billion
from year-end 1996 and 1995, respectively.
Cash of $17.6 billion in 1997 was used for operating activities,
primarily to fund higher net trading assets generated by increased levels of
business activity. Merrill Lynch's investing activities used cash of $1.6
billion in 1997, partially due to the purchase of technology-related equipment.
Financing activities provided Merrill Lynch with $20.9 billion of cash
in 1997, reflecting proceeds from net issuances of long-term debt and commercial
paper, partially offset by increases in net resale/repurchase agreements.
In 1996, cash and cash equivalents increased $293 million to $3.4
billion at year-end. Cash used for operating and investing activities totaled
$8.8 billion and $617 million, respectively, while cash provided by financing
activities totaled $9.7 billion.
In 1995, cash and cash equivalents increased $781 million to $3.1
billion at year-end. Cash provided by financing activities totaled $8.2 billion,
while cash used for operating and investing activities totaled $6.5 billion and
$901 million, respectively.
- --------------------------------------------------------------------------------
LITIGATION
- --------------------------------------------------------------------------------
Certain actions have been filed against Merrill Lynch by Orange County,
California and others in connection with Merrill Lynch's business activities
with the Orange County Treasurer-Tax Collector or from the purchase of debt
instruments issued by Orange County
- --------------------------------------------------------------------------------
25
<PAGE>
Management's Discussion and Analysis
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
that were underwritten by Merrill Lynch's subsidiary, Merrill Lynch, Pierce,
Fenner & Smith Incorporated (see Business of Merrill Lynch-Legal Proceedings
for further information). Although the ultimate outcome of these actions cannot
be ascertained at this time and the results of legal proceedings cannot be
predicted with certainty, it is the opinion of management that the resolution of
these actions will not have a material adverse effect on the financial
condition or the results of operations of Merrill Lynch as set forth in the
Consolidated Financial Statements contained herein.
- --------------------------------------------------------------------------------
RECENT DEVELOPMENTS
- --------------------------------------------------------------------------------
New Accounting Pronouncements
In December 1996, the Financial Accounting Standards Board issued SFAS
No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125, which deferred for one year the effective date of the collateral
provisions for all transactions and the sale provisions for repurchase
agreements, securities lending, and similar transactions. These deferred
provisions have been adopted for transactions entered into after December 31,
1997. The adoption of such provisions will create additional balance sheet
captions related to the recognition of securities pledged and received as
collateral. The impact of adopting these provisions cannot be quantified at
December 26, 1997 since they are only applicable to future transactions;
however, total assets and total liabilities are expected to increase
significantly upon adoption of these provisions. For a discussion of the
provisions of SFAS No. 125 adopted in 1997, see Note 2 to the Consolidated
Financial Statements.
- --------------------------------------------------------------------------------
26
<PAGE>
- --------------------------------------------------------------------------------
Independent Auditors' Report
- --------------------------------------------------------------------------------
To the Board of Directors and Stockholders
of Merrill Lynch & Co., Inc.:
We have audited the accompanying consolidated balance sheets of Merrill Lynch &
Co., Inc. and subsidiaries ("Merrill Lynch") as of December 26, 1997 and
December 27, 1996 and the related consolidated statements of earnings,
changes in stockholders' equity, comprehensive income and cash flows for each
of the three years in the period ended December 26, 1997. These financial
statements are the responsibility of Merrill Lynch's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements give retroactive effect to the
merger of Merrill Lynch and Midland Walwyn Inc., which has been accounted for as
a pooling-of-interests as described in Note 1 to the consolidated financial
statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Merrill Lynch at December 26, 1997
and December 27, 1996, and the results of its operations and its cash flows for
each of the three years in the period ended December 26, 1997 in conformity with
generally accepted accounting principles.
/s/ Deloitte & Touche LLP
New York, New York
February 23, 1998
(December 10, 1998 as to Note 1, paragraphs 1 and 2)
- --------------------------------------------------------------------------------
27
<PAGE>
Consolidated Statements of Earnings
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Last Friday in December
----------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES
Commissions $ 4,995 $ 4,085 $ 3,308
Interest and dividends 17,299 13,125 12,449
Principal transactions 3,827 3,531 2,601
Investment banking 2,876 2,022 1,343
Asset management and portfolio service fees 2,824 2,283 1,907
Other 678 667 452
------- ------- -------
Total Revenues 32,499 25,713 22,060
Interest Expense 16,243 12,092 11,445
------- ------- -------
Net Revenues 16,256 13,621 10,615
------- ------- -------
NON-INTEREST EXPENSES
Compensation and benefits 8,333 7,012 5,478
Communications and technology 1,255 1,010 814
Occupancy and related depreciation 736 742 671
Professional fees 520 385 312
Advertising and market development 613 527 408
Brokerage, clearing, and exchange fees 525 433 377
Goodwill amortization 65 50 19
Other 1,098 834 700
------- ------- -------
Total Non-Interest Expenses 13,145 10,993 8,779
------- ------- -------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 3,111 2,628 1,836
Income Tax Expense 1,129 980 710
Dividends on Preferred Securities Issued by Subsidiaries 47 - -
------- ------- -------
NET EARNINGS $ 1,935 $ 1,648 $ 1,126
------- ------- -------
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 1,896 $ 1,602 $ 1,078
------- ------- -------
Earnings Per Common Share
Basic $ 5.57 $ 4.63 $ 2.98
------- ------- -------
Diluted $ 4.79 $ 4.08 $ 2.68
------- ------- -------
- --------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements
28
<PAGE>
Consolidated Balance Sheets
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 26, December 27,
-------------------------
1997 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 5,046 $ 3,395
-------- --------
Cash and securities segregated for regulatory purposes or
deposited with clearing organizations 12,384 5,628
-------- --------
Marketable investment securities 3,309 2,180
-------- --------
Trading assets, at fair value
Corporate debt and preferred stock 32,537 24,507
Equities and convertible debentures 24,031 13,374
Contractual agreements 21,205 13,465
U.S. Government and agencies 9,848 9,308
Non-U.S. governments and agencies 10,221 8,068
Mortgages, mortgage-backed, and asset-backed 7,312 5,189
Other 2,937 2,779
-------- --------
Total 108,091 76,690
-------- --------
Receivables under resale agreements 71,904 60,080
-------- --------
Receivables under securities borrowed transactions 35,539 24,991
-------- --------
Other receivables
Customers (net of allowance for doubtful accounts of
$50 in 1997 and $39 in 1996) 27,319 19,177
Brokers and dealers 5,182 6,314
Interest and other 8,185 5,345
-------- --------
Total 40,686 30,836
-------- --------
Investments of insurance subsidiaries 4,833 5,107
Loans, notes, and mortgages (net of allowance for loan losses of
$130 in 1997 and $117 in 1996) 4,310 3,334
Other investments 1,829 1,126
Property, leasehold improvements, and equipment (net of accumulated
depreciation and amortization of $2,955 in 1997 and $2,566 in 1996) 2,099 1,680
Goodwill (net of accumulated amortization of $136 in 1997 and
$73 in 1996) 5,467 633
Other assets 1,483 1,586
-------- --------
TOTAL ASSETS $296,980 $217,266
-------- --------
- -------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
December 26, December 27,
------------------------
1997 1996
- ----------------------------------------------------------------------------------------------
LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES, AND STOCKHOLDERS' EQUITY
LIABILITIES
<S> <C> <C>
Payables under repurchase agreements and securities loaned transactions $ 79,167 $ 66,822
-------- --------
Commercial paper and other short-term borrowings 45,052 36,647
-------- --------
Trading liabilities, at fair value
Contractual agreements 20,632 11,221
U.S. Government and agencies 18,186 13,971
Equities and convertible debentures 15,817 8,399
Non-U.S. governments and agencies 10,460 7,826
Corporate debt and preferred stock 5,764 2,780
Other 355 247
-------- --------
Total 71,214 44,444
-------- --------
Other payables
Customers 17,514 12,783
Brokers and dealers 4,224 3,825
Interest and other 22,784 14,135
-------- --------
Total 44,522 30,743
-------- --------
Liabilities of insurance subsidiaries 4,716 5,010
Long-term borrowings 43,143 26,206
-------- --------
Total Liabilities 287,814 209,872
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 627 327
-------- --------
STOCKHOLDERS' EQUITY
Preferred Stockholders' Equity 425 619
-------- --------
Common Stockholders' Equity
Shares exchangeable into common stock 66 46
Common stock (par value $1.33 1/3 per share;
authorized: 500,000,000 shares; issued: 472,660,324 shares) 630 630
Paid-in capital 1,001 925
Accumulated other comprehensive income (net of tax) (47) 16
Retained earnings 9,579 7,938
-------- --------
11,229 9,555
Less: Treasury stock, at cost:
(1997 - 133,400,971 shares; 1996 - 137,234,132 shares) 2,677 2,769
Unallocated ESOP reversion shares, at cost:
(1996 - 3,077,556 shares) - 24
Employee stock transactions 438 314
-------- --------
Total Common Stockholders' Equity 8,114 6,448
-------- --------
Total Stockholders' Equity 8,539 7,067
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES, AND $296,980 $217,266
STOCKHOLDERS' EQUITY -------- --------
- ----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------
30
<PAGE>
Consolidated Statements of Changes in Stockholders' Equity
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Last Friday in December
-----------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
PREFERRED STOCKHOLDERS' EQUITY
9% Cumulative Preferred Stock, Series A
$10,000 liquidation preference per share
Balance, beginning and end of year (42,500 shares in
1997, 1996, and 1995) $ 425 $ 425 $ 425
------ ----- -----
Remarketed Preferred Stock, Series C
$100,000 liquidation preference per share
Balance, beginning of year (3,000 shares issued and
1,062 shares held in treasury in 1997, 1996, and 1995) $ 194 $ 194 $ 194
Redeemed (1,938 shares in 1997) (194) - -
------ ----- -----
Balance, end of year (1,938 shares in 1996 and 1995) $ - $ 194 $ 194
------ ----- -----
TOTAL PREFERRED STOCKHOLDERS' EQUITY $ 425 $ 619 $ 619
------ ----- -----
COMMON STOCKHOLDERS' EQUITY
Shares Exchangeable into Common Stock
Balance, beginning of year (4,134,035 shares in 1997;
3,931,683 in 1996; 3,785,794 in 1995) $ 46 $ 44 $ 42
Net activity (583,744 shares in 1997; 202,352 in 1996;
145,889 in 1995) 20 2 2
------ ----- -----
Balance, end of year (4,717,779 shares in 1997;
4,134,035 in 1996; 3,931,683 in 1995) $ 66 $ 46 $ 44
------ ----- -----
Common Stock, par value $1.33 1/3
Balance, beginning and end of year (472,660,324 shares in
1997, 1996, and 1995) $ 630 $ 630 $ 630
------ ----- -----
Paid-In Capital
Balance, beginning of year $ 925 $ 858 $ 817
Issuance of stock:
To employees (3) (8) (2)
For other activity, including employee stock grants (16) (8) (13)
To ESOP, including share allocations 95 83 56
------ ----- -----
Balance, end of year $1,001 $ 925 $ 858
------ ----- -----
Accumulated Other Comprehensive Income
Foreign Currency Translation Adjustment (net of tax):
Balance, beginning of year $ 7 $ 8 $ (3)
Translation adjustment (net of deferred income taxes) (92) (1) 11
------ ----- -----
Balance, end of year (85) 7 8
------ ----- -----
Net Unrealized Gains on Investment Securities Available-for-Sale
(net of tax):
Balance, beginning of year 9 25 (57)
Net unrealized gains (losses) on investment securities
available-for-sale 34 (97) 335
Other adjustments(a) (5) 81 (253)
------ ----- -----
Balance, end of year 38 9 25
------ ----- -----
Balance, end of year $ (47) $ 16 $ 33
------ ----- -----
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
Year Ended Last Friday in December
-------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Retained Earnings
Balance, beginning of year $ 7,938 $ 6,535 $ 5,640
Net earnings 1,935 1,648 1,126
Cash dividends declared:
9% Cumulative Preferred stock (38) (38) (38)
Remarketed Preferred stock (1) (9) (10)
Common stock ($.75 per share in 1997; $.58 in 1996;
and $.505 in 1995) (255) (198) (183)
------- ------- -------
Balance, end of year $ 9,579 $ 7,938 $ 6,535
------- ------- -------
Common Treasury Stock, at cost
Balance, beginning of year (137,234,132 shares in 1997;
117,681,492 in 1996; 92,670,824 in 1995) $(2,769) $(2,114) $(1,501)
Treasury stock purchased (13,741,116 shares in 1997;
37,157,634 in 1996; 40,023,642 in 1995) (672) (1,163) (939)
Issued out of treasury (net of reacquisitions):
Employees (1,293,262 shares in 1997; 1,689,774 in 1996;
1,645,636 in 1995) 60 51 37
Employee stock grants (16,281,015 shares in 1997;
15,915,220 in 1996; 13,367,338 in 1995) 704 457 289
------- ------- -------
Balance, end of year (133,400,971 shares in 1997;
137,234,132 in 1996; 117,681,492 in 1995) $(2,677) $(2,769) $(2,114)
------- ------- -------
Unallocated ESOP Reversion Shares, at cost
Balance, beginning of year (3,077,556 shares in 1997;
8,025,038 in 1996; 12,854,182 in 1995) $ (24) $ (63) $ (101)
Allocation of shares to participants (3,077,556 shares in 1997;
4,947,482 in 1996; 4,829,144 in 1995) 24 39 38
------- ------- -------
Balance, end of year (3,077,556 in 1996; 8,025,038 in 1995) $ - $ (24) $ (63)
------- ------- -------
Employee Stock Transactions
Balance, beginning of year $ (314) $ (254) $ (137)
Net issuance of employee stock grants (351) (251) (192)
Amortization of employee stock grants 218 183 68
Repayment of employee loans 9 8 7
------- ------- -------
Balance, end of year $ (438) $ (314) $ (254)
------- ------- -------
TOTAL COMMON STOCKHOLDERS' EQUITY $ 8,114 $ 6,448 $ 5,669
------- ------- -------
TOTAL STOCKHOLDERS' EQUITY $ 8,539 $ 7,067 $ 6,288
------- ------- -------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(a) Other adjustments relate to policyholder liabilities, deferred policy
acquisition costs, and deferred income taxes.
See Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
32
<PAGE>
Consolidated Statements of Comprehensive Income
(Dollars in Millions)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Last Friday in December
-----------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Earnings $1,935 $1,648 $1,126
------ ------ ------
Other Comprehensive Income:
Foreign currency translation adjustment:
Foreign currency translation losses, net of gains (96) (17) (8)
Deferred income taxes 4 16 19
------ ------ ------
Total (92) (1) 11
------ ------ ------
Net unrealized gains (losses) on investment securities
available-for-sale:
Net unrealized holding gains (losses) arising
during the period 50 (68) 333
Reclassification adjustment for (gains) losses
included in net earnings (16) (29) 2
------ ------ ------
Net unrealized gains (losses) on investment securities 34 (97) 335
Adjustments for:
Policyholder liabilities 10 64 (137)
Deferred policy acquisition costs - 9 (72)
Deferred income taxes (15) 8 (44)
------ ------ ------
Total 29 (16) 82
------ ------ ------
Total Other Comprehensive Income (63) (17) 93
------ ------ ------
Comprehensive Income $1,872 $1,631 $1,219
------ ------ ------
- -----------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements
33
<PAGE>
Consolidated Statements of Cash Flows
(Dollars in Millions)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Last Friday in December
----------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Earnings $ 1,935 $ 1,648 $ 1,126
Noncash items included in earnings:
Depreciation and amortization 473 436 389
Policyholder reserves 240 269 297
Other 1,401 919 672
(Increase) decrease in operating assets(a):
Trading assets (31,246) (15,574) (6,666)
Cash and securities segregated for regulatory purposes or deposited with
clearing organizations (6,333) (198) (459)
Receivables under securities borrowed transactions (10,548) (4,346) 348
Customer receivables (7,957) (3,845) (842)
Maturities and sales of trading investment securities 177 98 -
Purchases of trading investment securities (636) (67) -
Other (3,466) 1,112 1,036
Increase (decrease) in operating liabilities(a):
Trading liabilities 26,770 10,219 (2,410)
Payables under securities loaned transactions 4,163 19 677
Customer payables 4,731 686 (1,221)
Liabilities of insurance subsidiaries (524) (587) (732)
Other 3,197 442 1,288
-------- -------- -------
Cash Used for Operating Activities (17,623) (8,769) (6,497)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 3,376 3,057 1,453
Sales of available-for-sale securities 2,198 1,341 1,029
Purchases of available-for-sale securities (6,383) (4,374) (2,387)
Maturities of held-to-maturity securities 1,081 920 1,217
Purchases of held-to-maturity securities (752) (555) (1,094)
Acquisitions, net of cash acquired (13) (135) (601)
Other investments and other assets (240) (388) (147)
Property, leasehold improvements, and equipment (863) (483) (371)
-------- -------- -------
Cash Used for Investing Activities (1,596) (617) (901)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Resale agreements, net of repurchase agreements (3,642) (8,428) 4,887
Commercial paper and other short-term borrowings 8,355 9,926 2,031
Issuance and resale of long-term borrowings 25,087 16,509 10,355
Settlement and repurchase of long-term borrowings (8,242) (7,440) (7,971)
Issuance of subsidiaries' preferred securities 300 276 -
Redemption of Remarketed Preferred Stock (194) - -
Common stock transactions (500) (919) (892)
Dividends (294) (245) (231)
-------- -------- -------
Cash Provided by Financing Activities 20,870 9,679 8,179
-------- -------- -------
INCREASE IN CASH AND CASH EQUIVALENTS 1,651 293 781
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,395 3,102 2,321
-------- -------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 5,046 $ 3,395 $ 3,102
-------- -------- -------
- --------------------------------------------------------------------------------------------------------------
(a) Net of effects of acquisitions.
Supplemental Disclosures
Cash paid for:
Income taxes $ 910 $ 1,139 $ 566
Interest 15,390 11,801 11,425
- --------------------------------------------------------------------------------------------------------------
</TABLE>
Noncash Investing and Financing Activity
A liability of $5.3 billion representing the acquisition price of Mercury
Asset Management was recorded on December 26, 1997.
See Notes to Consolidated Financial Statements
34
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Table of Contents
- -------------------------------------------------------------------------------
NOTE 1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES......... 35
NOTE 2. OTHER SIGNIFICANT EVENTS ... 40
NOTE 3. TRADING ACTIVITIES ......... 41
NOTE 4. INVESTMENTS AND OTHER
NON-TRADING ASSETS.......... 46
NOTE 5. SHORT-TERM AND LONG-TERM
BORROWINGS AND OTHER
NON-TRADING LIABILITIES..... 48
NOTE 6. PREFERRED SECURITIES ISSUED
BY SUBSIDIARIES AND
STOCKHOLDERS' EQUITY........ 50
NOTE 7. COMMITMENTS AND
CONTINGENCIES .............. 53
NOTE 8. EMPLOYEE BENEFIT PLANS...... 55
NOTE 9. EMPLOYEE INCENTIVE PLANS.... 58
NOTE 10. INCOME TAXES ............... 61
NOTE 11. REGULATORY REQUIREMENTS
AND DIVIDEND RESTRICTIONS... 62
NOTE 12. INDUSTRY AND GLOBAL
OPERATIONS.................. 63
- -------------------------------------------------------------------------------
Note 1. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
- -------------------------------------------------------------------------------
Basis of Presentation
These Consolidated Financial Statements of Merrill Lynch & Co., Inc. ("ML
& Co.") and subsidiaries (collectively, "Merrill Lynch") have been restated to
reflect the merger of Midland Walwyn Inc. ("Midland") with Merrill Lynch. The
merger has been accounted for as a pooling-of-interests, and accordingly, the
Consolidated Financial Statements reflect the results of operations, financial
position, changes in stockholders' equity, and cash flows as if Merrill Lynch
and Midland had always been combined.
On August 26, 1998, Merrill Lynch acquired the outstanding shares of
Midland in a share exchange. Each Midland shareholder received either 0.24
shares of ML & Co. common stock or 0.24 exchangeable shares of Merrill Lynch &
Co., Canada Ltd. ("Exchangeable Shares") for each Midland share held (see Note
6). Each Midland optionholder received 0.24 options on ML & Co. common stock for
each Midland option held (see Note 9).
All material intercompany balances have been eliminated. Certain limited
reclassifications and format changes have been made to prior year amounts to
conform to the current year presentation.
Merrill Lynch provides investment, financing, insurance, and related
services to individuals and institutions on a global basis through its principal
U.S. and U.K. broker-dealer subsidiaries, Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S") and Merrill Lynch International ("MLI"), respectively,
and its broker, dealer, banking, insurance, and other financial services
subsidiaries. Such services include:
~ securities brokerage, trading, and underwriting;
~ investment banking, strategic services, and other corporate finance advisory
activities, including loan syndication;
~ asset management and other investment advisory
and recordkeeping services;
~ trading and brokerage of swaps, options, forwards, futures, and other
derivatives;
~ securities clearance services;
~ banking, trust, and lending services; and
~ insurance sales and underwriting services.
The Consolidated Financial Statements are presented in accordance with
generally accepted accounting principles and prevailing industry practices, both
of which require management to make estimates regarding certain trading
inventory valuations, the outcome of litigation, goodwill, the realization of
deferred tax assets, insurance deferred acquisition costs, and other matters
that affect the reported amounts and disclosure of contingencies in the
financial statements. Estimates, by their nature, are based on judgment and
available information. As such, actual results could differ materially from
those estimates.
- -------------------------------------------------------------------------------
Trading Instruments
Trading assets and trading liabilities consist of cash instruments (such
as securities) and derivative instruments used for trading purposes or to hedge
trading inventory. Included in trading liabilities are securities that Merrill
Lynch has sold but does not currently own and will therefore be obligated to
purchase at a future date ("short sales"). Trading inventory is recorded on a
trade date basis at fair value. Fair value is based on quoted market prices,
pricing models (utilizing indicators of general market conditions or other
economic measurements), or management's estimates of amounts
35
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
to be realized on settlement, assuming current market conditions and an orderly
disposition over a reasonable period of time.
- -------------------------------------------------------------------------------
Derivatives
A derivative is typically defined as an instrument whose value is
"derived" from an underlying instrument or index, such as a future, forward,
swap, or option contract, or other financial instrument with similar
characteristics. The derivative definition excludes all cash instruments,
including those that derive their values or contractually required cash flows
from an underlying instrument or index, such as mortgage-backed securities,
interest-only and principal-only obligations, and indexed debt instruments. It
also excludes option features embedded in cash instruments such as conversion
features and call provisions embedded in bonds.
Derivative contracts often involve future commitments to exchange
interest payment streams or currencies based on a notional or contractual amount
(e.g., interest rate swaps or currency forwards) or to purchase or sell other
financial instruments at specified terms on a specified date (e.g., options to
buy or sell securities, currencies, or commodities). Different types of
derivatives can also be combined to meet specialized needs (e.g., swaptions).
Derivatives are often referred to as off-balance-sheet instruments since
their notional amounts or underlying instruments are not reflected on the
balance sheet; however, the fair values of trading derivatives are recorded in
trading assets and liabilities.
Fair values for certain exchange-traded derivatives, principally futures
and certain options, are based on quoted market prices. Fair values for
over-the-counter ("OTC") derivative financial instruments, principally forwards,
options, and swaps, represent amounts that would be received from or paid to a
third party in settlement of these instruments. These amounts are determined
using pricing models based on the present value of estimated future cash flows
employing mid-market valuations with appropriate adjustments. These adjustments
are integral components of the mark-to-market process and relate to credit
quality and concentration, market liquidity, and exposure close-out costs
associated with unmatched positions. Adjustments are also made for
administrative costs incurred to service periodic cash flows and maintain hedges
over the life of the contract. A portion of income related to longer-term
contracts is recognized as the related administrative costs are incurred.
New, complex products may have immature or limited two-way markets. The
precision of the pricing model for a complex product, which involves multiple
variables and assumptions, will evolve over time. As these products develop,
Merrill Lynch continually refines its pricing models based on experience to
correlate more closely to the market risk of these instruments.
Derivatives are reported separately as assets and liabilities unless a
legal right of setoff exists under a master netting agreement enforceable at
law. Balances related to swap and forward transactions and foreign currency
options are included in Contractual agreements on the Consolidated Balance
Sheets. All other derivative balances are recorded in the related cash
instrument caption. The fair value of equity options purchased, for example, is
recorded in the Equities and convertible debentures trading asset caption.
Merrill Lynch enters into when-issued and delayed delivery transactions.
Unrealized gains and losses from these forward transactions are reflected in the
related cash instrument caption.
- -------------------------------------------------------------------------------
Revenue Recognition
Principal transactions revenues are recognized on a trade date basis and
include net unrealized gains and losses from marking-to-market all trading
instruments. Realized gains and losses on trading instruments and any related
interest amounts are included in principal transactions revenues and interest
revenues and expenses, respectively.
36
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Financing and Related Activities
Merrill Lynch strives to match-fund the interest rate sensitivity of its
assets and liabilities. Funding is principally obtained from repurchase
agreements, commercial paper, and long-term borrowings.
Merrill Lynch uses derivatives to reduce risk by managing interest rate,
foreign currency, and other exposures. Derivatives used as hedges must be
effective at reducing the risk associated with the exposure being managed and be
designated as a hedge at inception. Derivatives that modify the interest rate
characteristics of specified non-trading assets and liabilities are accounted
for on an accrual basis, with amounts to be paid or received recognized as
adjustments to the related interest income or expense. Unrealized gains and
losses on other financing derivatives are recognized currently. Realized gains
and losses on early terminations of derivatives are deferred over the remaining
lives of the hedged assets or liabilities. At December 26, 1997, there were no
deferred amounts related to terminated contracts.
Resale and repurchase agreements are accounted for as collateralized
financing transactions and are recorded at their contractual amounts, plus
accrued interest. Merrill Lynch's policy is to obtain possession of collateral
with a market value equal to or in excess of the principal amount loaned under
resale agreements. To ensure that the market value of the underlying collateral
remains sufficient, collateral is valued daily, and Merrill Lynch may require
counterparties to deposit additional collateral or return collateral pledged,
when appropriate. Substantially all repurchase and resale activities are
transacted under master netting agreements that give Merrill Lynch the right, in
the event of default, to liquidate collateral held and to offset receivables and
payables with the same counterparty. Merrill Lynch offsets certain repurchase
and resale agreement balances with the same counterparty on the Consolidated
Balance Sheets.
Securities borrowed and loaned are recorded at the amount of cash
collateral advanced or received. Securities borrowed transactions require
Merrill Lynch to provide the counterparty with collateral in the form of cash,
letters of credit, or other securities. Merrill Lynch receives collateral in the
form of cash or other securities for securities loaned transactions. For these
transactions, the fee received or paid by Merrill Lynch is recorded as interest
revenue or expense. On a daily basis, Merrill Lynch monitors the market value of
securities borrowed or loaned against the collateral value. Although
substantially all securities borrowing and lending activities are transacted
under master netting agreements, Merrill Lynch does not offset such receivables
and payables with the same counterparty on the Consolidated Balance Sheets.
- -------------------------------------------------------------------------------
Investment Securities
Merrill Lynch holds debt and equity investments principally in
non-broker-dealer subsidiaries. These investments are classified as
held-to-maturity, trading, or available-for-sale.
Held-to-maturity investments are debt securities that Merrill Lynch has
the positive intent and ability to hold to maturity. These investments are
recorded at amortized cost unless a decline in value is deemed other than
temporary, in which case the carrying value is reduced. The amortization of
premiums or accretion of discounts and any unrealized losses deemed
other-than-temporary are included in current period earnings.
Debt and equity securities purchased principally for the purpose of
resale in the near-term are classified as trading investments and are reported
at fair value. Unrealized gains or losses on these investments are included in
current period earnings.
Other debt and equity securities that are not categorized as
held-to-maturity or trading are classified as available-for-sale and reported
at fair value. Unrealized gains or losses on these securities are reported in
stockholders' equity as a component of Accumulated other comprehensive income,
net of applicable income taxes and other related items.
Restricted equity investment securities or equity investment securities
without available market quotations
37
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
are reported at the lower of cost or estimated net realizable value. Adjustments
in carrying values are included in current period earnings.
Realized gains and losses on investments are included in current period
earnings. The cost basis of each investment sold is specifically identified for
purposes of computing realized gains and losses.
- -------------------------------------------------------------------------------
Lending Activities
Merrill Lynch engages in loan origination, loan securitization, and
secondary market loan trading activities.
Loans held for investment purposes, including consumer and small business
loans and the residual portion of commercial loans syndicated by Merrill Lynch,
are carried at their principal amount outstanding. The allowance for loan losses
is established through provisions that are based on management's assessment of
the collectibility of the loan portfolio. Loans are charged off against the
allowance for loan losses when management determines that collection of
principal is unlikely.
Loans held for sale, which include certain residential mortgage and home
equity loans, are reported at the lower of cost (less allowance for loan losses)
or estimated fair value determined on a portfolio basis. Mortgage servicing
assets and residual interests in mortgage loans underlying Real Estate Mortgage
Investment Conduits and revolving trusts are (1) recognized upon sales of loans
when servicing is retained, and (2) amortized into income in proportion to and
over the estimated life of the net servicing revenue. Mortgage servicing assets
are periodically evaluated for impairment and are included in Other assets on
the Consolidated Balance Sheets. Residual interests are reported in Other
investments on the Consolidated Balance Sheets.
Loans held for trading purposes are recorded at fair value and are
reported in Trading assets on the Consolidated Balance Sheets.
- -------------------------------------------------------------------------------
Commissions and Related Expenses
Commissions charged for executing customer transactions are accrued on a
trade date basis and are included in current period earnings. Production-related
compensation and benefits expense is accrued to match revenue recognition.
- -------------------------------------------------------------------------------
Investment Banking
Underwriting revenues and fees for merger and acquisition advisory
services are accrued when services for the transactions are substantially
completed. Deal-related expenses are deferred to match revenue recognition.
- -------------------------------------------------------------------------------
Receivables from and Payables to Customers
Customer securities and commodities transactions are recorded on a
settlement date basis. Receivables from and payables to customers include
amounts due on cash and margin transactions. Securities owned by customers,
including those that collateralize margin or other similar transactions, are not
reflected on the Consolidated Balance Sheets.
- -------------------------------------------------------------------------------
Insurance
Insurance liabilities are future benefits payable under annuity and
interest-sensitive life contracts and include deposits received plus interest
credited during the contract accumulation period, the present value of future
payments for contracts which have annuitized, and a mortality provision for
certain products. Certain policyholder liabilities are also adjusted for those
investments classified as available-for-sale. Liabilities for unpaid claims
consist of the mortality benefit for reported claims and an estimate of
unreported claims based upon prior experience.
Substantially all security investments of insurance subsidiaries are
classified as available-for-sale and recorded at fair value. These investments
support Merrill Lynch's in-force, universal life-type contracts. Merrill Lynch
records adjustments to deferred acquisition costs and policyholder account
balances which, when
38
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
combined, are equal to the adjustment that would have been recorded if those
available-for-sale investments had been sold at their estimated fair values and
the proceeds reinvested at current yields. The corresponding credits or charges
for these adjustments are recorded in stockholders' equity as a component of
Accumulated other comprehensive income, net of applicable income taxes.
Certain variable costs related to the sale or acquisition of new and
renewal insurance contracts have been deferred, to the extent deemed
recoverable, and amortized over the lives of the contracts in proportion to the
estimated gross profit for each group of contracts.
Merrill Lynch maintains separate accounts representing segregated funds
held for purposes of funding variable life and annuity contracts. Separate
account assets are accounted for as customer assets since the contract holders
bear the risk of ownership, consistent with Merrill Lynch's other investment
products. Accordingly, separate account assets and the related liabilities are
not consolidated with the assets and liabilities of Merrill Lynch.
- -------------------------------------------------------------------------------
Property, Leasehold Improvements, and
Equipment
Property (excluding land), leasehold improvements, and equipment are
reported at historical cost, net of accumulated depreciation and amortization.
Land is reported at historical cost.
Depreciation and amortization are computed using the straight-line
method. Property and equipment are depreciated over their estimated useful
lives, while leasehold improvements are amortized over the lesser of their
estimated economic useful life or the term of the lease. Fixed assets are
primarily technology-based and have short lives, generally three to five years.
Maintenance and repair costs are expensed as incurred.
Facilities-related depreciation and amortization expense was $167, $163,
and $152, in 1997, 1996, and 1995, respectively. Non-facilities-related
depreciation and amortization expense for 1997, 1996, and 1995 was $306, $273,
and $237, respectively.
- -------------------------------------------------------------------------------
Stock-Based Compensation
Merrill Lynch accounts for stock-based compensation plans in accordance
with the intrinsic value-based method in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, rather than the fair value-based
method in Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation. Compensation expense for stock options
is not recognized since Merrill Lynch grants stock options without any intrinsic
value. Compensation expense related to other stock-based compensation plans is
recognized over the vesting period. For certain stock-based compensation grants,
the unamortized portion of the grant value is reflected as a reduction of
stockholders' equity in Employee stock transactions on the Consolidated Balance
Sheets.
- -------------------------------------------------------------------------------
Goodwill
Goodwill, which represents the cost of acquired businesses in excess of
fair value of the related net assets at acquisition, is amortized on a
straight-line basis over periods not exceeding fifteen years. Beginning in
1998, goodwill associated with the purchase of Mercury Asset Management Group
Holdings PLC will be amortized over 30 years (see Note 2 for additional
information). Goodwill is evaluated periodically for impairment.
- -------------------------------------------------------------------------------
Income Taxes
ML & Co. and certain of its wholly-owned subsidiaries file a consolidated
Federal income tax return. Merrill Lynch uses the asset and liability method in
providing income taxes on all transactions that have been recognized in the
Consolidated Financial Statements. The asset and liability method requires that
deferred taxes be adjusted to reflect the tax rates at which future taxable
amounts will be settled or realized. The effects of tax rate changes on future
deferred tax liabilities and deferred tax assets, as well as other changes in
income
39
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
tax laws, are recognized in net earnings in the period such changes are enacted.
Valuation allowances are established when necessary to reduce deferred tax
assets to the amounts expected to be realized. No deferred Federal income taxes
have been provided for the undistributed earnings of foreign subsidiaries to the
extent that such earnings are considered to be permanently reinvested in Merrill
Lynch's foreign operations.
- -------------------------------------------------------------------------------
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries are translated at year-end
currency exchange rates, while revenues and expenses are translated at average
currency exchange rates during the year. Adjustments that result from
translating foreign currency financial statements, net of hedging gains or
losses and related tax effects, are reported in stockholders' equity as a
component of Accumulated other comprehensive income. Gains or losses resulting
from the effect of exchange rate changes on foreign currency transactions are
included in earnings.
- -------------------------------------------------------------------------------
Cash Flows
For purposes of the Statements of Consolidated Cash Flows, Merrill Lynch
defines cash equivalents as short-term, highly liquid securities and interest-
earning deposits with original maturities of 90 days or less, other than those
used for trading purposes. Cash flows from trading derivatives are classified as
operating activities; cash flows from non-trading derivatives are classified
with the cash flows of the item being hedged.
- -------------------------------------------------------------------------------
Fair Value of Financial Instruments
At December 26, 1997 and December 27, 1996, substantially all financial
instrument assets are carried at fair value or amounts that approximate fair
value. Fair values of financial instruments are disclosed in Notes 3, 4, 5, and
7.
- -------------------------------------------------------------------------------
Interest Expense
Interest expense includes payments in lieu of dividends of $19, $9, and
$10 in 1997, 1996, and 1995, respectively.
- -------------------------------------------------------------------------------
NOTE 2. OTHER SIGNIFICANT EVENTS
- -------------------------------------------------------------------------------
Accounting Changes
In 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. SFAS No. 125 provides guidance for determining
whether a transfer of a financial asset is treated as a sale or a financing.
Additionally, if a transfer qualifies as a financing transaction, the statement
contains provisions that may require the recognition of collateral received or
provided, in addition to the financing balance.
Merrill Lynch adopted the provisions of SFAS No. 125 not deferred by SFAS
No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125, for all transactions entered into after December 31, 1996. As of
December 26, 1997, the adoption of these provisions increased both assets
(Trading assets and Receivables under resale agreements) and liabilities
(Payables under repurchase agreements) by approximately $4 billion.
In 1995, Merrill Lynch adopted:
~ SFAS No. 114, Accounting by Creditors for
Impairment of a Loan;
~ SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures; and
~ SFAS No. 122, Accounting for Mortgage Servicing
Rights.
The impact of adopting these pronouncements was not material to Merrill
Lynch's results of operations.
- -------------------------------------------------------------------------------
Disclosure Changes
In 1997, the FASB issued SFAS No. 128, Earnings Per Share, which is
effective for fiscal years ending after December 15, 1997. SFAS No. 128 replaced
the presentation of primary and fully diluted earnings per common share ("EPS")
with basic and diluted EPS (see Note 6 for additional information).
In 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income,
which requires reporting of
40
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
comprehensive income in the financial statements. The statement is effective
for fiscal years beginning after December 15, 1997. Merrill Lynch has elected
to early adopt SFAS No. 130 for 1997.
- -------------------------------------------------------------------------------
Acquisitions
In December 1997, Merrill Lynch acquired Mercury Asset Management Group
Holdings PLC ("Mercury"), a U.K. global asset manager, for approximately $5.3
billion. Goodwill of approximately $4.8 billion was recorded related to the
acquisition. Since the acquisition was recorded as of December 26, 1997, the
results of operations do not include the operating results of Mercury or
goodwill amortization. In 1997, Merrill Lynch also acquired a 401(k) service
provider for $13 and recorded goodwill of $10.
Merrill Lynch completed several acquisitions in 1996, including two
non-U.S. securities firms and a U.S. asset manager. Aggregate consideration of
$232 was paid and goodwill of $167 was recorded in connection with these
acquisitions. In August 1995, Merrill Lynch acquired Smith New Court PLC, a
U.K.-based global securities firm, for $803, and recorded $533 of related
goodwill.
The operating results of acquired companies are included in Merrill
Lynch's results of operations commencing with the acquisition date.
- -------------------------------------------------------------------------------
NOTE 3. TRADING ACTIVITIES
- -------------------------------------------------------------------------------
As part of its trading activities, Merrill Lynch provides to clients
brokerage, dealing, and underwriting services for securities and derivative
products. While trading activities are primarily generated by client order flow,
Merrill Lynch also takes proprietary positions based on expectations of future
market movements and conditions. Merrill Lynch's trading strategies rely on the
integrated management of its client-driven and proprietary transactions, along
with the hedging and financing of these positions.
Principal transactions revenues by product category follow(1):
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Equities and equity derivatives $1,317 $1,178 $ 951
Interest rate and currency swaps 1,042 893 732
Taxable fixed-income 993 1,004 556
Municipals 305 324 275
Foreign exchange and commodities 170 132 87
------ ------ ------
Total $3,827 $3,531 $2,601
------ ------ ------
- --------------------------------------------------------------------------------
</TABLE>
(1) The revenue amounts presented include gains and losses from both cash and
related derivative instruments.
Interest revenue and expense are integral components of trading
activities. In assessing the profitability of trading activities, Merrill Lynch
views net interest and principal transactions revenues in the aggregate. For
further information on Merrill Lynch's net trading results, see Management's
Discussion and Analysis (unaudited)-Principal Transactions.
Certain trading activities expose Merrill Lynch to market and credit
risks. These risks are managed in accordance with established risk management
policies and procedures that are described in Management's Discussion and
Analysis (unaudited)-Risk Management.
- -------------------------------------------------------------------------------
Market Risk
Market risk is the potential change in an instrument's value caused by
fluctuations in interest and currency exchange rates, equity and commodity
prices, and credit spreads. The level of market risk is influenced by the
volatility and the liquidity in the markets in which financial instruments are
traded.
Merrill Lynch seeks to mitigate market risk associated with trading
inventories by employing hedging strategies that correlate rate, price, and
spread movements of trading inventories and related financing and hedging
activities. Merrill Lynch uses a combination of cash instruments and derivatives
to hedge its market exposures. The following discussion describes the types of
market risk faced by Merrill Lynch.
- -------------------------------------------------------------------------------
Interest Rate Risk
Interest rate risk arises from the possibility that changes in interest
rates will affect the value of financial
- -------------------------------------------------------------------------------
41
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
instruments. Interest rate swap agreements, Eurodollar futures, and U.S.
Treasury securities and futures are common interest rate risk management tools.
The decision to manage interest rate risk using futures or swap contracts, as
opposed to buying or selling short U.S. Treasury or other securities, depends on
current market conditions and funding considerations.
Interest rate swap agreements used by Merrill Lynch include caps,
collars, floors, basis swaps, and leveraged swaps. Interest rate caps and floors
provide the purchaser protection against rising and falling interest rates,
respectively. Interest rate collars combine a cap and a floor, providing the
purchaser with a predetermined interest rate range. Basis swaps are a type of
interest rate swap agreement where rates received and paid are variable based on
different index rates. Leveraged swaps are another type of interest rate swap
where changes in the variable rate are multiplied by a contractual leverage
factor, such as four times three-month LIBOR (London Interbank Offered Rate).
Merrill Lynch's exposure to interest rate risk resulting from these leverage
factors is typically hedged with other financial instruments.
- -------------------------------------------------------------------------------
Currency Risk
Currency risk arises from the possibility that fluctuations in foreign
exchange rates will impact the value of financial instruments. Merrill Lynch's
trading assets and liabilities include both cash instruments denominated in and
derivatives linked to over 70 currencies, including the Japanese yen, German
mark, Swiss franc, British pound, and Italian lira. Currency forwards and
options are commonly used to manage currency risk associated with these
instruments. Currency swaps may also be used in situations where a long-dated
forward market is not available or where the end-user needs a customized
instrument to hedge a foreign currency cash flow stream. Typically, parties to a
currency swap initially exchange principal amounts in two currencies, agreeing
to exchange interest payments and to re-exchange the currencies at a future date
and exchange rate.
- -------------------------------------------------------------------------------
Equity Price Risk
Equity price risk arises from the possibility that equity security prices
will fluctuate, affecting the value of equity securities and other instruments
that derive their value from a particular stock, a defined basket of stocks, or
a stock index. Instruments typically used by Merrill Lynch to manage equity
price risk include equity options and warrants. Equity options, for example, can
require the writer to purchase or sell a specified stock or to make a cash
payment based on changes in the market price of that stock, basket of stocks, or
stock index.
- -------------------------------------------------------------------------------
Commodity Price Risk
Merrill Lynch views its commodity contracts as financial instruments
since they are generally settled in cash and not by delivery of the underlying
commodity. Commodity price risk results from the possibility that the price of
the underlying commodity may rise or fall. Cash flows from commodity contracts
are based on the difference between an agreed-upon fixed price and a price that
varies with changes in a specified commodity price or index. Commodity contracts
held by Merrill Lynch principally relate to energy, precious metals, and base
metals.
- -------------------------------------------------------------------------------
Credit Spread Risk
Credit spread risk arises from the possibility that changes in credit
spreads will affect the value of financial instruments. Credit spreads represent
the credit risk premiums required by market participants for a given credit
quality, i.e., the additional yield that a debt instrument issued by a AA-rated
entity must produce over a risk-free alternative (e.g., U.S. Treasury
instrument). Certain instruments are used by Merrill Lynch to manage this type
of risk. Swaps and options, for example,
42
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
can be designed to protect the holder from loss due to changes in credit
spreads, as well as credit downgrade or default of the issuer. Credit risk
resulting from default on counterparty obligations is discussed in the following
Credit Risk section.
- -------------------------------------------------------------------------------
Credit Risk
Merrill Lynch is exposed to risk of loss if an issuer or a counterparty
fails to perform its obligations under contractual terms and the collateral
held, if any, is deemed worthless ("default risk"). Both cash instruments and
derivatives expose Merrill Lynch to default risk. Credit risk arising from
changes in credit spreads was previously discussed in the Market Risk section.
Merrill Lynch has established policies and procedures for mitigating
credit risk on principal transactions, including reviewing and establishing
limits for credit exposure, maintaining collateral, and continually assessing
the creditworthiness of counterparties. For further information, see
Management's Discussion and Analysis (unaudited)-Risk Management-Credit Risk.
In the normal course of business, Merrill Lynch executes, settles, and
finances various customer securities transactions. Execution of these
transactions includes the purchase and sale of securities by Merrill Lynch.
These activities may expose Merrill Lynch to default risk arising from the
potential that customers or counterparties may fail to satisfy their
obligations. In these situations, Merrill Lynch may be required to purchase or
sell financial instruments at unfavorable market prices to satisfy obligations
to other customers or counterparties. In addition, Merrill Lynch seeks to
control the risks associated with its customer margin activities by requiring
customers to maintain collateral in compliance with regulatory and internal
guidelines.
Liabilities to other brokers and dealers related to unsettled
transactions (i.e., securities failed-to-receive) are recorded at the amount for
which the securities were acquired and are paid upon receipt of the securities
from other brokers or dealers. In the case of aged securities failed-to-receive,
Merrill Lynch may purchase the underlying security in the market and seek
reimbursement for losses from the counterparty.
Merrill Lynch uses resale and repurchase agreements and securities
borrowed and loaned transactions to finance securities, to facilitate settlement
processes, and to meet customers' needs. Under these agreements and
transactions, Merrill Lynch either receives or provides collateral, including
U.S. Government and agencies, asset-backed, corporate debt, equity, and non-U.S.
governments and agencies securities. When providing collateral for these
transactions, Merrill Lynch delivers its own securities, securities borrowed
from counterparties, and securities owned by customers collateralizing margin
loans and other obligations.
The market value of securities owned by Merrill Lynch that have been
loaned or pledged to counterparties as collateral for obligations of Merrill
Lynch, primarily related to repurchase agreements, were $28,658 and $28,136 at
December 26, 1997 and December 27, 1996, respectively.
- -------------------------------------------------------------------------------
Concentrations of Credit Risk
Merrill Lynch's exposure to credit risk (both default and credit spread)
associated with its trading and other activities is measured on an individual
counterparty basis, as well as by groups of counterparties that share similar
attributes. Concentrations of credit risk can be affected by changes in
political, industry, or economic factors. To reduce the potential for risk
concentration, credit limits are established and monitored in light of changing
counterparty and market conditions.
At December 26, 1997, Merrill Lynch's most significant concentration of
credit risk was with the U.S. Government and its agencies. This concentration
consists of both direct and indirect exposures. Direct exposure, which primarily
results from taking trading asset and investment security positions in
instruments issued by the U.S. Government and its agencies, amounted to $11,708
and $10,336 at December 26, 1997 and December
43
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
27, 1996, respectively. Merrill Lynch's indirect exposure results from
maintaining U.S. Government and agencies securities as collateral for resale
agreements and securities borrowed transactions. Merrill Lynch's direct credit
exposure on these transactions is with the resale agreement or securities
borrowed transaction counterparty. Merrill Lynch has credit exposure to the U.S.
Government and its agencies only in the event of the counterparty's default.
Securities issued by the U.S. Government or its agencies held as collateral at
December 26, 1997 and December 27, 1996 totaled $60,868 and $33,321,
respectively.
At December 26, 1997, Merrill Lynch had concentrations of credit risk
with other counterparties, including a European sovereign rated AA by recognized
credit rating agencies and an investment company whose holdings primarily
consist of various European sovereign debt instruments. Total exposure to these
counterparties, excluding collateral held, was $3,405, or 1.1% of total assets.
At December 27, 1996, Merrill Lynch had concentrations of credit risk with a
European and a South American sovereign and an investment company totaling
$3,912, or 1.8% of total assets, excluding collateral held.
Merrill Lynch's most significant industry credit concentration is with
U.S. and non-U.S. financial institutions. Financial institutions include other
brokers and dealers, commercial banks, finance companies, insurance companies,
and mutual funds. This concentration arises in the normal course of Merrill
Lynch's brokerage, trading, financing, and underwriting activities. Merrill
Lynch also monitors credit exposures worldwide by region. Within these regions,
sovereign governments represent the most significant concentration, followed by
financial institutions.
In the normal course of business, Merrill Lynch purchases, sells,
underwrites, and makes markets in non-investment grade instruments. In
conjunction with merchant banking activities, Merrill Lynch also provides
extensions of credit and makes equity investments to facilitate leveraged
transactions. These activities expose Merrill Lynch to a higher degree of credit
risk than is associated with trading, investing in, and underwriting investment
grade instruments and extending credit to investment grade counterparties. See
Management's Discussion and Analysis (unaudited)-Non-Investment Grade Holdings
and Highly Leveraged Transactions for further information.
- -------------------------------------------------------------------------------
Derivatives Used in Trading Activities
Merrill Lynch trades derivative financial instruments and provides
clients with customized derivative products. These transactions allow clients to
manage their exposure to interest and currency exchange rate, equity and
commodity price, and credit spread risks. Merrill Lynch also uses derivative
instruments to manage its own risks related to proprietary trading strategies,
client transactions, and financing activities (see Note 5 for further details on
the role of derivatives in financing activities).
The fair values of derivatives used in trading activities at year-end
1997 and 1996 follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 26, 1997 December 27, 1996
------------------- -------------------
Assets Liabilities Assets Liabilities
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
Swap agreements $16,189 $15,703 $11,553 $9,370
Forward contracts 3,805 3,539 1,304 1,403
Options 5,987 10,970 2,621 3,211
- -------------------------------------------------------------------------------
</TABLE>
The table below presents the average fair values of Merrill Lynch's
trading derivatives for 1997 and 1996, calculated on a monthly basis:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Fair Value
---------------------------------------------
1997 1996
------------------- -------------------
Assets Liabilities Assets Liabilities
------- ----------- ------- -----------
<S> <C> <C> <C> <C>
Swap agreements $13,888 $12,002 $9,872 $8,404
Forward contracts 2,340 2,181 1,192 1,260
Options 4,946 7,131 2,576 1,971
- --------------------------------------------------------------------------------
</TABLE>
The notional or contractual amounts of derivatives provide only a measure
of involvement in these types of transactions and represent neither the amounts
subject to the various types of market risk nor the future cash requirements
under these instruments. The notional or
44
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
contractual amounts of derivatives used for trading purposes by type of risk
follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Interest Equity Commodity
(in billions) Rate Currency Price Price
Risk(1)(2) Risk(3) Risk Risk
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 26, 1997
Swap agreements $1,482 $159 $17 $ 2
Forward contracts 59 196 1 15
Futures contracts 202 1 15 2
Options purchased 99 71 60 3
Options written 133 73 44 3
December 27, 1996
Swap agreements $1,212 $140 $13 $ 3
Forward contracts 24 147 1 17
Futures contracts 126 2 7 5
Options purchased 85 76 21 3
Options written 118 72 31 3
- --------------------------------------------------------------------------------
</TABLE>
(1) Certain derivatives subject to interest rate risk are also exposed to the
credit spread risk of the underlying financial instrument.
(2) Forward contracts subject to interest rate risk principally represent "To
Be Announced" mortgage pools that bear interest rate as well as principal
prepayment risk.
(3) Included in the currency risk category are certain contracts that are also
subject to interest rate risk.
Most of Merrill Lynch's trading derivative transactions are short-term in
duration with a weighted-average maturity of approximately 2.8 years at December
26, 1997 and 2.7 years at December 27, 1996. For trading derivatives outstanding
at December 26, 1997, the following table presents the notional or contractual
amounts of derivatives expiring in future years based on contractual expiration:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in billions) After
1998 1999 2000 2001 2001 Total
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Swap agreements $ 428 $287 $201 $137 $607 $1,660
Forward contracts 261 6 2 1 1 271
Futures contracts 153 31 17 6 13 220
Options purchased 114 32 26 16 45 233
Options written 123 36 29 17 48 253
------ ---- ---- ---- ---- ------
Total $1,079 $392 $275 $177 $714 $2,637
------ ---- ---- ---- ---- ------
- --------------------------------------------------------------------------------
</TABLE>
The notional or contractual values of derivatives do not represent
default risk exposure. Default risk is limited to the current cost of replacing
derivative contracts in a gain position.
Default risk exposure varies by type of derivative. Swap agreements and
forward contracts are generally OTC-transacted and thus are exposed to default
risk to the extent of their replacement cost. Since futures contracts are
exchange-traded and usually require daily cash settlement, the related risk of
accounting loss is generally limited to a one-day net positive change in market
value. Option contracts can be exchange-traded or OTC-transacted contracts.
Purchased options have default risk to the extent of their replacement cost.
Written options represent a potential obligation to counterparties and,
accordingly, do not subject Merrill Lynch to default risk.
Merrill Lynch attempts to enter into International Swaps and Derivatives
Association, Inc. master agreements or their equivalent ("master netting
agreements") with each of its counterparties. Master netting agreements provide
protection in bankruptcy in certain circumstances and, in some cases, enable
receivables and payables with the same counterparty to be offset on the
Consolidated Balance Sheets, providing for a more meaningful balance sheet
presentation of credit exposure.
To reduce default risk, Merrill Lynch requires collateral, principally
U.S. Government and agencies securities, on certain derivative transactions.
From an economic standpoint, Merrill Lynch evaluates default risk exposures net
of related collateral. Presented below is a summary of counterparty credit
ratings for the replacement cost (net of $4,750 of collateral) of trading
derivatives in a gain position by maturity at December 26, 1997.
45
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years to Maturity
---------------------------- Cross-
Credit Maturity
Rating(1) 0-3 3-5 5-7 Over 7 Netting(2) Total
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
AAA $ $684 $ 274 $ 364 $ 371 $ (191) $ 1,502
AA+/AA 3,951 406 164 558 (623) 4,456
AA- 2,351 755 492 666 (802) 3,462
A+/A 2,802 518 383 703 (427) 3,979
A- 1,982 730 160 239 (380) 2,731
BBB 1,946 676 262 169 (437) 2,616
BB 887 314 36 293 (556) 974
Other 1,116 232 110 321 (268) 1,511
------- ------ ------ ------ ----------- -------
Total $15,719 $3,905 $1,971 $3,320 $(3,684) $21,231
------- ------ ------ ------ ----------- -------
- --------------------------------------------------------------------------------
</TABLE>
(1) Represents rating agency equivalent.
(2) Represents netting of payable balances with receivable balances for the
same counterparty across maturity band categories. Receivable and payable
balances with the same counterparty in the same maturity category, however,
are net within the maturity category.
In addition to obtaining collateral, Merrill Lynch attempts to mitigate
default risk on derivatives by entering into transactions with provisions that
enable Merrill Lynch to terminate or reset the terms of the derivative contract.
- -------------------------------------------------------------------------------
NOTE 4. INVESTMENTS AND OTHER
NON-TRADING ASSETS
- -------------------------------------------------------------------------------
Investments
Merrill Lynch has several broad categories of investments on its
Consolidated Balance Sheets, including Investments of insurance subsidiaries,
Marketable investment securities, and Other investments.
Investments of insurance subsidiaries, primarily debt securities, are
used to fund policyholder liabilities. Marketable investment securities consist
of equity and debt securities, including those held for rating agency purposes
or to manage cash flows related to certain liabilities of Merrill Lynch's
banking subsidiaries. Other investments consist of equity and debt securities,
including those acquired in connection with merchant banking activities. Certain
merchant banking investments are subject to restrictions that may limit Merrill
Lynch's ability to realize its investment until such restrictions expire.
Marketable investment securities and certain investments of insurance
subsidiaries and other investments are carried as held-to-maturity, trading, or
available-for-sale securities as described in Note 1. Investment securities
reported on the Consolidated Balance Sheets at December 26, 1997 and December
27, 1996 are presented below:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------ -----
<S> <C> <C>
Investments of insurance subsidiaries
Available-for-sale $3,338 $3,624
Trading 16 -
Non-qualifying(1)(2) 1,479 1,483
------ ------
Total $4,833 $5,107
------ ------
- --------------------------------------------------------------------
Marketable investment securities
Available-for-sale $2,392 $1,523
Held-to-maturity 322 653
Trading 595 4
------ -----
Total $3,309 $2,180
------ ------
- --------------------------------------------------------------------
Other investments
Available-for-sale $ 500 $ 142
Held-to-maturity 233 328
Trading - 3
Non-qualifying(1)(3) 1,096 653
------ -----
Total $1,829 $1,126
------ ------
- --------------------------------------------------------------------
</TABLE>
(1) Non-qualifying for SFAS No. 115 purposes.
(2) Primarily consists of insurance policy loans.
(3) Includes merchant banking investments and investments hedging deferred
compensation liabilities.
46
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Information regarding investment securities subject to SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 26, 1997 December 27, 1996
--------------------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Available-for-Sale Cost Gains Losses Value Cost Gains Losses Value
--------------------------------------------------- ------------------------------------------
Corporate debt $3,136 $ 78 $ (8) $3,206 $3,016 $ 72 $(12) $3,076
U.S. Government and agencies 650 4 - 654 399 3 (1) 401
Municipals 936 2 (1) 937 276 3 - 279
Mortgage-backed securities 1,036 47 (1) 1,082 1,029 21 (3) 1,047
Other debt securities 109 1 (2) 108 417 8 (9) 416
--------- ---------- ---------- --------- --------- --------- --------- --------
Total debt securities 5,867 132 (12) 5,987 5,137 107 (25) 5,219
Equity securities 247 1 (5) 243 70 5 (5) 70
--------- ---------- ---------- --------- --------- --------- --------- --------
Total $6,114 $133 $(17) $6,230 $5,207 $112 $(30) $5,289
--------- ---------- ---------- --------- --------- --------- --------- --------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
December 26, 1997 December 27, 1996
--------------------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Cost/ Gross Gross Estimated Cost/ Gross Gross Estimated
Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair
Held-to-Maturity Cost Gains Losses Value Cost Gains Losses Value
--------------------------------------------------- ------------------------------------------
Corporate debt $189 $ 1 $ - $190 $483 $ 4 - $ 487
U.S. Government and agencies 211 - - 211 37 - - 37
Municipals 35 44 (1) 78 122 15 - 137
Mortgage-backed securities 119 2 - 121 281 2 - 283
Other debt securities 1 - - 1 58 - - 58
--------- ---------- ---------- --------- --------- --------- --------- --------
Total $555 $47 $(1) $601 $981 $21 - $1,002
--------- ---------- ---------- --------- --------- --------- --------- --------
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
The amortized cost and estimated fair value of debt securities at
December 26, 1997, by contractual maturity, for available-for-sale and held-to-
maturity investments follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Available-for-Sale Held-to-Maturity
------------------- -------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Due in one year or less $1,147 $1,148 $166 $167
Due after one year
through five years 1,835 1,875 104 120
Due after five years
through ten years 1,105 1,129 159 174
Due after ten years 744 753 7 19
--------- --------- --------- ---------
4,831 4,905 436 480
Mortgage-backed
securities 1,036 1,082 119 121
--------- --------- --------- ---------
Total(1) $5,867 $5,987 $555 $601
--------- --------- --------- ---------
- --------------------------------------------------------------------------------
</TABLE>
(1) Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
The proceeds and gross realized gains (losses) from the sale of
available-for-sale investments are as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Proceeds $2,198 $1,341 $1,029
Gross realized gains 27 41 26
Gross realized losses (11) (12) (28)
- --------------------------------------------------------------------------------
</TABLE>
Net unrealized (losses) gains from investment securities classified as
trading included in the 1997, 1996, and 1995 Consolidated Statements of Earnings
were $(21), $(1), and $1, respectively.
- -------------------------------------------------------------------------------
Other Non-Trading Assets
Most other financial instrument assets are carried at amounts that
approximate fair value. Such assets include cash and cash equivalents, cash and
securities segregated for regulatory purposes or deposited with clearing
organizations, most receivables under resale agreements and securities borrowed
transactions, and other receivables.
47
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Other financial instrument assets with carrying values that differ from
their fair values are presented below:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 26, 1997 December 27, 1996
-------------------- --------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Merchant banking equity
investment and loan
portfolio(1) $ 275 $ 403 $ 203 $ 363
Loans, notes, and
mortgages(2) 4,197 4,230 3,313 3,347
- -------------------------------------------------------------------------------
</TABLE>
(1) Merchant banking equity investments are non-qualifying for SFAS No. 115
purposes.
(2) Excludes loans related to merchant banking activities.
Fair value for merchant banking equity investments, including partnership
interests (both included in Other investments on the Consolidated Balance
Sheets), is estimated using a number of methods, including earnings multiples,
cash flow analyses, and review of underlying financial conditions and other
market factors. These instruments may be subject to restrictions (e.g., consent
of other investors) that may limit Merrill Lynch's ability to realize currently
the estimated fair value. Accordingly, Merrill Lynch's current estimate of fair
value and the ultimate realization on these instruments may differ.
Fair value for loans made in connection with merchant banking activities,
consisting primarily of senior and subordinated debt, is estimated using
discounted cash flows. Merrill Lynch's estimate of fair value for other loans,
notes, and mortgages is determined based on loan characteristics. For certain
homogeneous categories of loans, including residential mortgages and home equity
loans, fair value is estimated using market price quotations or previously
executed transactions for securities backed by similar loans, adjusted for
credit risk and other individual loan characteristics. For Merrill Lynch's
variable-rate loan receivables, carrying value approximates fair value.
Merrill Lynch holds a passive minority interest in Bloomberg L.P., a
privately held limited partnership that provides information services. In 1996,
Merrill Lynch sold one-third of its interest to the majority interest holder,
resulting in a pretax gain of $155. Due to the nature and terms of the sale, the
sale price is not necessarily indicative of the fair value of Merrill Lynch's
remaining investment. In addition, given the contractual restrictions on the
disposition of Merrill Lynch's interest, the fair value of the remaining
investment is not readily determinable as of December 26, 1997. Management
believes, however, that the fair value of this investment significantly exceeds
its carrying value of $28.
Merrill Lynch enters into derivative hedges of interest rate risk on
various non-trading assets, including certain long-term resale agreements. At
December 26, 1997 and December 27, 1996, the notional amounts of derivatives
hedging these positions were $9 billion and $5 billion, respectively. The
combined carrying value of hedged non-trading assets and related hedges
approximates their combined fair value at both dates.
Merrill Lynch uses currency derivatives to hedge certain exposures
arising from investments in and loans to foreign subsidiaries. At December 26,
1997 and December 27, 1996, the notional amounts of these currency derivatives
were $2 billion.
- -------------------------------------------------------------------------------
NOTE 5. SHORT-TERM AND LONG-TERM
BORROWINGS AND OTHER
NON-TRADING LIABILITIES
- -------------------------------------------------------------------------------
Short-Term and Long-Term Borrowings
Merrill Lynch issues U.S. and non-U.S. dollar-denominated debt
instruments with both variable and fixed interest rates, primarily at the ML &
Co. level. These financing activities may create exposure to market risk, most
notably interest rate and currency risk. To better match the interest rate
characteristics of assets and liabilities, Merrill Lynch generally enters into
swap agreements to convert fixed-rate interest payments on its debt obligations
into variable-rate payments. Interest obligations on variable-rate long-term
borrowings and commercial paper may also be modified through swap agreements
that change the underlying
48
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
interest rate basis or reset frequency. Non-U.S. dollar payments on debt
obligations may be swapped to U.S. dollar payments.
Merrill Lynch also issues debt containing embedded options that link the
repayment of these obligations to the performance of an equity or other index
(e.g., S&P 500(R)), an industry basket of stocks, or an individual stock. The
contingent components of these indexed debt obligations are hedged with
derivatives.
Borrowings at December 26, 1997 and December 27, 1996 are presented
below:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Payables under repurchase agreements
and securities loaned transactions
Repurchase agreements $72,127 $63,946
Securities loaned transactions 7,040 2,876
------- ------
Total $79,167 $66,822
------- ------
- ------------------------------------------------------------------------
Commercial paper and other short-term
borrowings
Commercial paper $30,379 $23,558
Demand and time deposits 10,712 9,376
Bank loans and other 3,961 3,713
------- ------
Total $45,052 $36,647
------- ------
- ------------------------------------------------------------------------
Long-term borrowings
Fixed-rate obligations(1):
U.S. dollar-denominated $ 7,136 $ 5,874
Non-U.S. dollar-denominated 1,878 1,737
Variable-rate obligations(2)(3):
U.S. dollar-denominated 2,803 1,944
Non-U.S. dollar-denominated 1,276 690
Medium-term notes(4):
U.S. dollar-denominated 20,090 10,532
Non-U.S. dollar-denominated 9,960 5,429
------- ------
Total $43,143 $26,206
------- -------
- --------------------------------------------------------------------------------
</TABLE>
(1) At December 26, 1997, U.S. dollar-denominated fixed-rate obligations are
due 1998 to 2019 at interest rates ranging from 5.50% to 10.38%; non-U.S.
dollar-denominated fixed-rate obligations are due 1998 to 2002 at interest
rates ranging from 2.55% to 12.10%.
(2) Variable interest rates are generally based on rates such as LIBOR, the
U.S. Treasury Bill Rate, or the Federal Funds Rate.
(3) Included in variable-rate obligations are various equity-linked or indexed
instruments issued by Merrill Lynch.
(4) Medium-term notes may bear fixed or variable interest rates and have
maturities that may range from nine months to 30 years from the date of
issue.
Long-term borrowings at December 26, 1997 mature as follows:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
1998 $12,042
1999 7,226
2000 5,178
2001 4,012
2002 5,397
2003 and thereafter 9,288
-------
Total $43,143
-------
- ---------------------------
</TABLE>
The notional or contractual amounts of derivatives used to hedge
exposures related to borrowings at December 26, 1997 and December 27, 1996
follow:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in billions) 1997 1996
---- ----
<S> <C> <C>
Interest rate derivatives(1) $44 $32
Currency derivatives(1) 8 4
Equity derivatives 3 2
- --------------------------------------
</TABLE>
(1) Includes swap contracts totaling $2 billion and $1 billion in notional that
contain embedded options hedging callable debt at December 26, 1997 and
December 27, 1996, respectively.
Most of these derivatives are entered into with Merrill Lynch's
derivative dealer subsidiaries, which intermediate interest rate, currency, and
equity risks with third parties in the normal course of their trading
activities.
The effective weighted-average interest rates for borrowings, which
include the impact of hedges, at December 26, 1997 and December 27, 1996 were:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
----- -----
<S> <C> <C>
Commercial paper and other short-term
borrowings 5.43% 5.44%
Long-term borrowings
Fixed-rate obligations 7.00% 7.41%
Variable-rate obligations 5.84% 5.82%
Medium-term notes 5.86% 5.68%
- -------------------------------------------------
</TABLE>
49
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The fair value of borrowings and related hedges is estimated using
current market prices and pricing models. The carrying and fair values of these
instruments are summarized as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 26, 1997 December 27, 1996
------------------------ -------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
Commercial paper and
other short-term
borrowings $45,052 $45,059 $36,647 $36,646
Related derivative:
Assets (28) (29) (15) (12)
Liabilities 3 4 5 5
-------- -------- ------- -------
Total $45,027 $45,034 $36,637 $36,639
-------- -------- ------- -------
- -----------------------------------------------------------------------------
Long-term borrowings $43,143 $43,706 $26,206 $26,958
Related derivative:
Assets (811) (1,953) (257) (773)
Liabilities 921 1,032 370 448
-------- -------- ------- -------
Total $43,253 $42,785 $26,319 $26,633
-------- -------- ------- -------
- -----------------------------------------------------------------------------
</TABLE>
Certain long-term borrowing agreements contain provisions whereby the
borrowings are redeemable at the option of the holder at specified dates prior
to maturity. Management believes, however, that a significant portion of such
borrowings may remain outstanding beyond their earliest redemption date.
Subsequent to year-end 1997 and through February 20, 1998, long-term
borrowings, net of repayments and repurchases, increased approximately $4,138.
- -------------------------------------------------------------------------------
Borrowing Facilities
Merrill Lynch has obtained committed, unsecured revolving credit
facilities aggregating $9.2 billion under agreements with 79 banks. The
agreements contain covenants requiring, among other things, that Merrill Lynch
maintain specified levels of net worth, as defined in the agreements, on the
date of an advance. At December 26, 1997, $466 million of these credit
facilities had been drawn upon, all of which pertained to Midland.
The credit quality, amounts, and terms of the credit facilities are
continually monitored and modified as warranted by business conditions. Under
the existing agreements, the credit facilities mature as follows: $1.2 billion
in February 1998; $1.6 billion in May 1998; $2.0 billion in June 1998; $2.0
billion in October 1999, and $2.4 billion that does not have a maturity date. At
maturity, Merrill Lynch may convert amounts borrowed, if any, into term loans
that would mature in two years.
To finance the purchase of Mercury, Merrill Lynch obtained a commitment
under a credit facility agreement with 12 banks to provide unsecured short-term
financing of up to 2.0 billion British pounds (approximately $3.3 billion). The
commitment expires in June 1998. At December 26, 1997, the facility had not been
drawn upon. Subsequent to year end, Merrill Lynch borrowed approximately 1.9
billion British pounds (approximately $3.1 billion) under the facility. These
borrowings are expected to be repaid during 1998 with proceeds from long-term
financing.
- -------------------------------------------------------------------------------
Other Non-Trading Liabilities
Other financial instrument liabilities are carried at amounts that
approximate fair value. Such liabilities include most payables under repurchase
agreements and securities loaned transactions, payables to customers and brokers
and dealers, and insurance and other liabilities.
- -------------------------------------------------------------------------------
Note 6. PREFERRED SECURITIES
ISSUED BY SUBSIDIARIES
AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Preferred Securities Issued by Subsidiaries
Trust Originated Preferred Securities(SM) ("TOPrS"(R)) are issued to
investors by trusts created by Merrill Lynch. Using the issuance proceeds, the
trusts purchase Partnership Preferred Securities, representing limited
partnership interests. Using the purchase proceeds, the limited partnerships
extend loans to ML & Co. and one or more subsidiaries of ML & Co. The trusts and
partnerships are consolidated subsidiaries of Merrill Lynch. ML & Co. has
guaranteed, on a subordinated basis, the payment in full of all distributions
and other payments on the TOPrS to the extent that the trusts have funds legally
available. This guarantee and the partnership distribution guarantee are
subordinated to
- --------------------------------------------------------------------------------
50
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
all other liabilities of ML & Co. and rank pari passu with preferred stock of ML
& Co.
In December 1996, Merrill Lynch Capital Trust I ("TOPrS I") issued $275
of 7 .75% TOPrS, consisting of 11,000,000 securities with a $25 liquidation
amount per security, and in February 1997, Merrill Lynch Capital Trust II
("TOPrS II") issued $300 of 8% TOPrS, consisting of 12,000,000 securities with a
$25 liquidation amount per security. Both TOPrS I and TOPrS II securities are
redeemable at the option of the trusts, in whole or in part, at a redemption
price equal to $25 per security on or after December 30, 2006 and March 30,
2007, respectively. Distributions are payable from the date of original issuance
and are payable quarterly if, as, and when the trusts have funds available for
payment.
In January 1998, Merrill Lynch Capital Trust III issued $750 of 7% TOPrS,
consisting of 30,000,000 securities with a $25 liquidation amount per security,
which are redeemable at the option of the trust, in whole or in part, at a
redemption price equal to $25 per security, on or after March 30, 2008.
- -------------------------------------------------------------------------------
Preferred Equity
ML & Co. is authorized to issue 25,000,000 shares of undesignated
preferred stock, $1.00 par value per share. All shares of currently outstanding
preferred stock constitute one and the same class that have equal rank and
priority over common stockholders as to dividends and in the event of
liquidation.
- -------------------------------------------------------------------------------
9% Cumulative Preferred Stock, Series A
ML & Co. has issued 17,000,000 Depositary Shares, each representing a
one-four-hundredth interest in a share of 9% Cumulative Preferred Stock, Series
A, $10,000 liquidation preference per share ("9% Preferred Stock"). The 9%
Preferred Stock is a single series consisting of 42,500 shares with an aggregate
liquidation preference of $425.
Dividends on the 9% Preferred Stock are cumulative from the date of
original issue and are payable quarterly when declared by the authority of the
Board of Directors. The 9% Preferred Stock is redeemable on or after December
30, 2004 at the option of ML & Co., in whole or in part, at a redemption price
equal to $10,000 per share, plus accrued and unpaid dividends (whether or not
declared) to the date fixed for redemption.
- -------------------------------------------------------------------------------
Remarketed Preferred(SM) Stock, Series C
During the first quarter of 1997, all of the outstanding Remarketed
Preferred Stock, Series C was redeemed. Dividend rates in effect prior to
redemption ranged from 3.80% to 4.15% per annum.
- -------------------------------------------------------------------------------
Shares Exchangeable into Common Stock
In August 1998, Merrill Lynch & Co., Canada Ltd. issued Exchangeable
Shares in connection with Merrill Lynch's merger with Midland (see Note 1).
Holders of Exchangeable Shares receive dividend, voting, and other rights
equivalent to those of ML & Co. common stockholders. Exchangeable Shares are
exchangeable at any time, at the option of the holder, on a one-for-one basis
into ML & Co. common stock. Merrill Lynch may redeem all outstanding
Exchangeable Shares for ML & Co. common stock after January 31, 2011, or earlier
under certain circumstances.
- -------------------------------------------------------------------------------
Common Stock Split
In 1997, the Board of Directors declared a two-for-one common stock split
effected in the form of a 100% stock dividend. The par value of the common stock
remained at $1.33 1/3 per share. Accordingly, an adjustment from paid-in capital
to common stock of $315 was made to preserve the par value of the post-split
shares. All share and per share data have been restated for the effect of the
split.
- --------------------------------------------------------------------------------
51
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Accumulated Other Comprehensive Income
Accumulated other comprehensive income represents cumulative gains and
losses on items that are not reflected in earnings. The balances at December 26,
1997 and December 27, 1996 are comprised as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Foreign currency translation adjustment
Unrealized losses, net of gains $(110) $(14)
Deferred income taxes 25 21
------ ------
Total (85) 7
------ ------
Unrealized gains on investments
available-for-sale
Unrealized gains, net of losses 116 82
Adjustments for:
Policyholder liabilities (54) (64)
Deferred policy acquisition costs (4) (4)
Deferred income taxes (20) (5)
------ ------
Total 38 9
------ ------
Total accumulated other comprehensive
income $ (47) $16
------ ------
- ----------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
Stockholder Rights Plan
In December 1997, the Board of Directors approved and adopted the amended
and restated Stockholder Rights Plan. The amended and restated Stockholder
Rights Plan provides for the distribution of preferred purchase rights
("Rights") to common stockholders. The Rights separate from the common stock ten
days following: (a) an announcement of an acquisition by a person or group
("acquiring party") of 15% or more of the outstanding common shares of ML & Co.;
or (b) the commencement of a tender or exchange offer for 15% or more of the
common shares outstanding. One Right is attached to each outstanding share of
common stock and will attach to all subsequently issued shares. Each Right
entitles the holder to purchase 1/100 of a share (a "Unit") of Series A Junior
Preferred Stock, par value $1.00 per share, at an exercise price of $300 per
Unit at any time after the distribution of the Rights. The Units are
nonredeemable and have voting privileges and certain preferential dividend
rights. The exercise price and the number of Units issuable are subject to
adjustment to prevent dilution.
If, after the Rights have been distributed, either the acquiring party
holds 15% or more of ML & Co.'s outstanding shares or ML & Co. is a party to a
business combination or other specifically defined transaction, each Right
(other than those held by the acquiring party) will entitle the holder to
receive, upon exercise, a Unit of preferred stock or shares of common stock of
the surviving company with a value equal to two times the exercise price of the
Right. The Rights expire December 2, 2007, and are redeemable at the option of
a majority of the directors of ML & Co. at $.01 per Right at any time until the
tenth day following an announcement of the acquisition of 15% or more of ML &
Co.'s common stock.
- -------------------------------------------------------------------------------
Earnings Per Common Share
Earnings per common share are computed in accordance with SFAS No. 128
(see Note 2). Under SFAS No. 128, basic and diluted EPS replace primary and
fully diluted EPS. Basic EPS is calculated by dividing earnings available to
common stockholders by the weighted-average number of common shares outstanding.
Diluted EPS is similar to basic EPS, but adjusts for the effect of potential
common shares. The following table presents the computations of basic and
diluted EPS:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Net earnings $1,935 $1,648 $1,126
Preferred stock dividends 39 46 48
------ ------ ------
Net earnings applicable to
common stockholders $1,896 $1,602 $1,078
Interest on convertible debt - 1 1
------ ------ ------
$1,896 $1,603 $1,079
- -----------------------------------------------------------------------
(shares in thousands)
Weighted-average shares
outstanding 340,096 346,043 361,193
------- ------- -------
Effect of dilutive instruments(1)
Employee stock options 29,748 21,934 19,934
FCCAAP shares 20,574 19,570 18,671
Restricted units 5,258 4,727 2,363
ESPP shares 45 56 63
Convertible debt 134 660 628
------ ------ ------
Dilutive potential common shares 55,759 46,947 41,659
------ ------ ------
Total weighted-average
diluted shares(2) 395,855 392,990 402,852
------- ------- -------
- -----------------------------------------------------------------------
Basic EPS $5.57 $4.63 $2.98
Diluted EPS 4.79 4.08 2.68
- --------------------------------------------------------------------------------
</TABLE>
(1) See Note 9 for a description of these instruments and issuances subsequent
to December 26, 1997.
(2) At year-end 1997, 1996, and 1995, there were 7, 58, and 3,050 instruments,
respectively, that were considered antidilutive and were not included in the
above calculations.
- --------------------------------------------------------------------------------
52
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NOTE 7 . COMMITMENTS AND
CONTINGENCIES
- -------------------------------------------------------------------------------
Litigation
There are civil actions, arbitration proceedings, and claims pending
against Merrill Lynch as of December 26, 1997, some of which involve claims for
substantial amounts.
Included among these matters is an action that is pending in the United
States District Court for the Central District of California, commenced on
January 12, 1995 by Orange County, California (the "County") and the Orange
County Investment Pools (the "Pools"), both of which filed bankruptcy petitions
in the United States Bankruptcy Court for the Central District of California
(the "Bankruptcy Court") on December 6, 1994. ML & Co. and certain of its
subsidiaries are named as defendants in connection with Merrill Lynch's business
activities with the Orange County Treasurer-Tax Collector. The Pools' bankruptcy
petition subsequently was dismissed. On May 17, 1996, the Bankruptcy Court
confirmed a plan pursuant to which Orange County emerged from bankruptcy.
The County and its current Treasurer-Tax Collector seek relief totaling
in excess of $2 billion in connection with various securities transactions
between the Orange County Treasurer-Tax Collector and ML & Co. and its
subsidiaries. As subsequently amended, the complaint alleges, among other
things, that these transactions violated California law and should be adjudged
null and void, that ML & Co. and its subsidiaries violated various provisions of
the Bankruptcy Code and Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder, and that ML & Co. and its subsidiaries
breached a fiduciary duty owed to the County and conspired to make unauthorized
use of public funds.
In addition, other actions are pending against or on behalf of ML & Co.,
and/or against certain of its officers, directors, and employees and certain of
its subsidiaries in the United States District Court for the Central District of
California, the United States District Court for the Southern District of New
York, and in state courts in California and New York. These include class
actions and stockholder derivative actions brought by persons alleging harm to
themselves or to Merrill Lynch arising out of Merrill Lynch's dealings with the
Orange County Treasurer-Tax Collector, or the purchase of debt instruments
issued by Orange County or other public entities with funds controlled by the
Orange County Treasurer-Tax Collector that were underwritten by ML & Co.'s
subsidiary, MLPF&S.
Although the ultimate outcome of these actions cannot be ascertained at
this time and the results of legal proceedings cannot be predicted with
certainty, it is the opinion of management that the resolution of these matters
will not have a material adverse effect on the Consolidated Financial Statements
of Merrill Lynch contained herein.
- -------------------------------------------------------------------------------
Lending
Merrill Lynch enters into commitments to extend credit, predominantly at
variable interest rates, in connection with certain merchant banking 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, agency
securities lending, securitization, and other transactions. These commitments
and guarantees usually have a fixed expiration date and are contingent on
certain contractual conditions that may require payment of a fee by the
counterparty. Once commitments are drawn upon or guarantees are issued, Merrill
Lynch may require the counterparty to post collateral depending upon the
counterparty's creditworthiness and market conditions.
The contractual amounts of these commitments and guarantees represent the
amounts at risk should the contract be fully drawn upon, the client default, and
the value of the existing collateral become worthless. The
53
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
total amount of outstanding commitments and guarantees may not represent future
cash requirements, as guarantees and commitments may expire without being drawn
upon.
At December 26, 1997 and December 27, 1996, Merrill Lynch had the
following commitments and guarantees:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Commitments to extend credit $5,839 $4,780
Third party guarantees 3,819 1,975
- ------------------------------------------
</TABLE>
The fair value of the outstanding guarantees was $25 and $24 at December
26, 1997 and December 27, 1996, respectively.
- --------------------------------------------------------------------------------
Leases
Merrill Lynch has entered into various noncancelable long-term lease
agreements for premises and equipment that expire through 2024. During 1996,
Merrill Lynch incurred a pretax charge of $40 million related to the resolution
of Olympia & York's bankruptcy that affected Merrill Lynch's long-term sublease
agreements in the World Financial Center Headquarters ("WFC"). Merrill Lynch
has also entered into various noncanelable short-term lease agreements, which
are primarily commitments of less than one year under equipment leases.
At December 26, 1997, future minimum rental commitments under
noncancelable leases with initial or remaining terms exceeding one year are
presented below:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WFC Other Total
------- ------ ------
<S> <C> <C> <C>
1998 $ 125 $ 295 $ 420
1999 140 291 431
2000 144 263 407
2001 144 233 377
2002 150 195 345
2003 and thereafter 1,936 809 2,745
------- ------ ------
Total $2,639 $2,086 $4,725
------- ------ ------
- --------------------------------------------------------------
</TABLE>
The minimum rental commitments shown above have not been reduced by $824
of minimum sublease rentals to be received in the future under noncancelable
subleases. Certain leases contain renewal or purchase options or escalation
clauses providing for increased rental payments based upon maintenance, utility,
and tax increases.
Net rent expense for each of the last three years is presented below:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Rent expense $ 468 $438 $417
Sublease revenue (104) (48) (87)
----- ----- -----
Net rent expense $ 364 $390 $330
----- ----- -----
- -----------------------------------------
</TABLE>
- -------------------------------------------------------------------------------
Other Commitments
In the normal course of business, Merrill Lynch enters into commitments
for securities underwriting and when-issued transactions. Settlement of these
transactions as of December 26, 1997 would not have a material effect on the
consolidated financial condition of Merrill Lynch.
In connection with financing activities, Merrill Lynch had commitments at
December 26, 1997 and December 27, 1996 to enter into resale and repurchase
agreements as follows:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Resale agreements $3,440 $3,653
Repurchase agreements 4,469 976
- -----------------------------------
</TABLE>
Merrill Lynch also obtains letters of credit from issuing banks to
satisfy various counterparty collateral requirements in lieu of depositing cash
or securities collateral. Letters of credit aggregated $1,063 and $2,082 at
December 26, 1997 and December 27, 1996, respectively.
In connection with merchant banking activities, Merrill Lynch has
committed to purchase $88 and $101 of partnership interests at December 26, 1997
and December 27, 1996, respectively.
Merrill Lynch has entered into agreements with providers of market data,
communications, and systems consulting services. At December 26, 1997 and
December 27, 1996, minimum fee commitments over the life of these agreements
aggregated $348 and $481, respectively.
- -------------------------------------------------------------------------------
54
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NOTE 8. EMPLOYEE BENEFIT PLANS
- -------------------------------------------------------------------------------
Merrill Lynch provides retirement and other postemployment benefits to
its employees worldwide through defined contribution and defined benefit pension
plans and other postretirement and postemployment benefit plans. Merrill Lynch
reserves the right to amend or terminate these plans at any time.
- -------------------------------------------------------------------------------
Defined Contribution Pension Plans
The domestic defined contribution plans consist of the Retirement
Accumulation Plan ("RAP"), the Employee Stock Ownership Plan ("ESOP"), and the
401(k) Savings & Investment Plan ("401K"). The RAP, ESOP, and 401K cover
substantially all U.S. employees who have met age and service requirements.
Merrill Lynch established the RAP and the ESOP, collectively known as the
"Retirement Program," for the benefit of employees over the age of 21 with one
year of service. A separate retirement account is maintained for each
participant.
In 1989, the ESOP trust purchased from Merrill Lynch 47,851,236 shares of
ML & Co. common stock with residual funds from a terminated defined benefit
pension plan ("Reversion Shares") and loan proceeds from a subsidiary of Merrill
Lynch ("Leveraged Shares").
Merrill Lynch credits a participant's account and records pension expense
under the Retirement Program based on years of service and eligible
compensation. This expense is funded by quarterly allocations of Leveraged and
Reversion Shares and, if necessary, cash, to participants' accounts based on a
specified formula. Leveraged and Reversion Shares are released in accordance
with the terms of the ESOP. If the fair market value of the shares released is
less than the formula allocation to participants' accounts, cash contributions
are made to the RAP. Reversion Shares were allocated to participants' accounts
over a period of eight years, ending in June 1997 . Leveraged Shares are
allocated to participants' accounts as principal is repaid on the loan to the
ESOP, which matures in 1999. Principal and interest on the loan are payable
quarterly upon receipt of dividends on certain shares of common stock or other
cash contributions.
ESOP shares are considered to be either allocated (contributed to
participants' accounts), committed (scheduled to be contributed at a specified
future date but not yet released), or unallocated (not committed or allocated).
Share information at December 26, 1997 is as follows:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Reversion Leveraged
Shares Shares
---------- ---------
<S> <C> <C>
Allocated 38,962,348 6,104,498
Committed - 173,188
Unallocated - 2,611,202
- --------------------------------
</TABLE>
The remaining cost of the unallocated Leveraged Shares of $16 at December
26, 1997 is recorded as a reduction of stockholders' equity and represents the
remaining ESOP loan balance.
Additional information on ESOP activity follows:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Dividends used for debt service(1) $ 7 $ 8 $ 9
Compensation costs funded with ESOP shares 193 190 143
- ---------------------------------------------------------------------
</TABLE>
(1) Dividends on all Leveraged Shares are used for debt service on the ESOP
loan.
Employees can participate in the 401K by contributing, on a tax-deferred
basis, up to 15% of their eligible compensation but not more than the maximum
annual amount allowed by law. Merrill Lynch's contributions are equal to one-
half of the first 4% of each participant's eligible compensation contributed to
the 401K, up to a maximum of fifteen hundred dollars annually. No corporate
contributions are made for participants who are also Employee Stock Purchase
Plan participants (see Note 9).
Merrill Lynch also sponsors various non-U.S. defined contribution plans.
The costs of benefits under the RAP, 401K, and non-U.S. plans are expensed
during the related service period.
- --------------------------------------------------------------------------------
55
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Defined Benefit Pension Plans
Merrill Lynch has purchased a group annuity contract that guarantees the
payment of benefits vested under a U.S. defined benefit plan that was
terminated in accordance with the applicable provisions of the Employee
Retirement Income Security Act of 1974 ("ERISA"). At December 26, 1997 and
December 27, 1996, a substantial portion of the assets supporting the annuity
contract was invested in U.S. Government and agencies securities. Merrill
Lynch, under a supplemental agreement, may be responsible for, or benefit from,
actuarial experience and investment performance of these annuity assets. Merrill
Lynch also maintains supplemental defined benefit plans for certain U.S.
employees.
Employees of certain non-U.S. subsidiaries participate in various local
defined benefit plans. These plans provide benefits that are generally based on
years of credited service and a percentage of the employee's eligible
compensation during the final years of employment. Merrill Lynch's funding
policy has been to contribute annually the amount necessary to satisfy local
funding standards.
The funded status of the defined benefit plans (including the terminated
plan) follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
---------------------- ------------------------
Pension plans in which: Pension plans in which:
---------------------- ------------------------
Assets Accumulated Assets Accumulated
Exceeded Benefits Exceeded Benefits
Accumulated Exceeded Accumulated Exceeded
Benefits Assets(1) Benefits Assets(1)
----------- ---------- ------------ ----------
<S> <C> <C> <C> <C>
Accumulated benefit obligation
Vested $(1,756) $(68) $(1,447) $(134)
Non-vested (5) (8) (3) (8)
-------- -------- -------- --------
Total (1,761) (76) (1,450) (142)
Effect of assumed increase in compensation levels (95) (16) (24) (26)
-------- -------- -------- --------
Projected benefit obligation (1,856) (92) (1,474) (168)
Plan assets at fair value 2,137 43 1,673 99
-------- -------- -------- --------
Plan assets in excess of (less than) projected benefit obligation 281 (49) 199 (69)
Unrecognized net liability at transition 2 1 3 2
Unrecognized prior service cost (benefit) 3 (1) (3) (1)
Unrecognized net (gain) loss (118) 1 (4) 16
-------- -------- -------- --------
Prepaid (accrued) benefit cost $ 168 $(48) $ 195 $ (52)
-------- -------- -------- --------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Consists primarily of domestic supplemental plans not subject to ERISA and
non-U.S. plans where funding strategies vary due to legal requirements and
local practice.
56
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Pension cost included the following components:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Defined contribution plan cost $ 216 $ 224 $ 169
------- ------- -------
Defined benefit plans(1)
Service cost for benefits earned during
the year 32 25 20
Interest cost on projected benefit
obligation 109 104 106
Actual return on plan assets (313) 18 (482)
Deferral and amortization of
unrecognized items 194 (133) 374
------- ------- -------
Total defined benefit plan cost 22 14 18
------- ------- -------
Total pension cost $ 238 $ 238 $ 187
------- ------- -------
- --------------------------------------------------------------------------------
</TABLE>
(1) The following actuarial assumptions were used in calculating the defined
benefit cost and benefit obligations. Weighted-average rates as of the
beginning of the year are:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ----- ----
<S> <C> <C> <C>
Discount rate 6.3% 6.7% 6.5%
Rate of compensation increase 5.6 5.4 5.5
Expected long-term rate of return on plan assets 6.6 6.9 6.7
- --------------------------------------------------------------------------------
</TABLE>
Postretirement Benefits Other Than Pensions
Merrill Lynch provides health and life insurance benefits to retired
employees under a plan that covers substantially all U.S. employees who have met
age and service requirements. The health care component is contributory, with
retiree contributions adjusted periodically; the life insurance component of the
plan is noncontributory. The accounting for costs of health care benefits
anticipates future changes in cost-sharing provisions. Merrill Lynch pays claims
as incurred. Full-time employees of Merrill Lynch become eligible for these
benefits upon attainment of age 55 and completion of ten years of service.
Merrill Lynch also sponsors similar plans that provide health care benefits to
retired employees of certain non-U.S. subsidiaries. As of December 26, 1997,
none of these plans had been funded.
Postretirement benefit cost included the following components:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Service cost $ 6 $ 6 $ 4
Interest cost on accumulated postretirement
benefit obligation 11 11 10
Amortization of unrecognized gain - - (1)
---- ---- ----
Total postretirement benefit cost $17 $17 $13
---- ---- ----
- --------------------------------------------------------------------------------
</TABLE>
The amounts recognized for Merrill Lynch's postretirement benefit plans
follow:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
----- -----
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees $ (88) $ (73)
Fully eligible active plan participants (57) (37)
Other active plan participants (69) (62)
----- -----
Total (214) (172)
Unrecognized net loss (gain) 8 (7)
----- -----
Postretirement benefits accrued liability $(206) $(179)
----- -----
- --------------------------------------------------------------------------------
</TABLE>
The following actuarial assumptions were used in calculating the
postretirement benefit cost and obligations. Weighted-average rates as of the
beginning of the year are:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Discount rate 6.4% 6.8% 6.5%
Health care cost trend rates(1)
Initial 7.5 8.0 9.0
2012 and thereafter 5.5 5.5 5.5
- --------------------------------------------------------------------------------
</TABLE>
(1) Assumed to decrease gradually until the year 2012 and remain constant
thereafter.
The assumed health care cost trend rate has a significant effect on the
amounts reported above. Increasing the assumed trend rate by one percentage
point per year would increase the accumulated postretirement benefit obligation
at December 26, 1997 and December 27, 1996 by $26 and $28, respectively, and
increase the aggregate of service and interest costs for 1997 and 1996 by $3
for both years.
- -------------------------------------------------------------------------------
Postemployment Benefits
Merrill Lynch provides certain postemployment benefits for employees on
extended leave due to injury or illness and for terminated employees. Employees
who are disabled due to non-work-related illness or injury are
- --------------------------------------------------------------------------------
57
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
entitled to disability income, medical coverage, and life insurance. Merrill
Lynch also provides severance benefits to terminated employees. In addition,
Merrill Lynch is mandated by state and Federal regulations to provide certain
other postemployment benefits. Merrill Lynch funds these benefits through a
combination of self-insured and insured plans.
Merrill Lynch recognized $30, $31, and $79 in 1997, 1996, and 1995,
respectively, of postemployment benefits expense, which included severance
costs for terminated employees of $18, $14, and $57 in 1997, 1996, and 1995,
respectively. Although all full-time employees are eligible for severance
benefits, no additional amounts were accrued as of December 26, 1997 since
future severance costs are not estimable.
- -------------------------------------------------------------------------------
NOTE 9. EMPLOYEE INCENTIVE PLANS
- -------------------------------------------------------------------------------
To align the interests of employees with those of stockholders, Merrill
Lynch sponsors several employee compensation plans that provide eligible
employees with stock or options to purchase shares. The total compensation cost
recognized in earnings for stock-based compensation plans for 1997, 1996, and
1995 was $318, $269, and $131, respectively. Merrill Lynch also sponsors
deferred cash compensation plans for eligible employees.
- -------------------------------------------------------------------------------
Long-Term Incentive Compensation Plans
("LTIC Plans") and Equity Capital Accumulation
Plan ("ECAP")
LTIC Plans and ECAP provide for grants of equity and equity-related
instruments to certain key employees. LTIC Plans provide for the issuance of
Restricted Shares, Restricted Units, and Nonqualified Stock Options, as well as
Incentive Stock Options, Performance Shares, Performance Units, Stock
Appreciation Rights, and other securities of Merrill Lynch. ECAP provides for
the issuance of Restricted Shares, as well as Performance Shares. As of
December 26, 1997, no instruments other than Restricted Shares, Restricted
Units, and Nonqualified Stock Options had been granted.
- -------------------------------------------------------------------------------
Restricted Shares and Units
Restricted Shares are shares of ML & Co. common stock carrying voting
and dividend rights. A Restricted Unit is deemed equivalent in fair market value
to one share of common stock, is payable in cash, and receives cash payments
equivalent to dividends. Under these plans, such shares are restricted from
sale, transfer, or assignment until the end of the restricted period, and such
shares and units are subject to forfeiture during the vesting period for grants
under LTIC Plans or the restricted period for grants under ECAP.
The activity for Restricted Shares and Units under these plans during
1997 and 1996 follows:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION> LTIC Plans ECAP
----------------------- -----------
Restricted Restricted Restricted
Shares Units Shares
----------- ---------- -----------
<S> <C> <C> <C>
Authorized for issuance at:
December 26, 1997 200,000,000 N/A 52,400,000
December 27, 1996 200,000,000 N/A 52,400,000
- ------------------------------------------------------------------------------------
Available for issuance at(1):
December 26, 1997 44,703,329 N/A 2,935,408
December 27, 1996 61,891,210 N/A 2,698,830
- ------------------------------------------------------------------------------------
Outstanding, end of 1995 6,543,520 6,647,548 1,211,982
Granted - 1996 2,914,844 3,110,570 3,355,708
Paid, forfeited, or released
from contingencies (495,402) (483,218) (435,946)
----------- --------- ---------
Outstanding, end of 1996 8,962,962 9,274,900 4,131,744
Granted - 1997 3,662,390 3,819,904 48,747
Paid, forfeited, or released
from contingencies (2,779,206) (3,197,062) (299,926)
----------- --------- ---------
Outstanding, end of 1997(2) 9,846,146 9,897,742 3,880,565
----------- --------- ---------
- ------------------------------------------------------------------------------------
</TABLE>
(1) Includes shares reserved for issuance upon the exercise of stock options.
(2) Subsequent to year end through February 1, 1998, 2,287,501 and 2,497,175
Restricted Shares and Units under LTIC Plans, respectively, and 1,980 ECAP
Restricted Shares were granted to eligible employees.
The weighted-average fair value per share or unit for 1997, 1996, and
1995 grants follows:
- --------------------------------------------------------------------------------
1997 1996 1995
------ ------ ------
LTIC Plans
Restricted Shares $46.31 $28.97 $20.85
Restricted Units 44.47 28.69 20.72
ECAP Restricted Shares 66.99 28.76 26.23
- ------------------------------------------------------------------------
Merrill Lynch sponsors other plans similar to LTIC Plans in which
restricted shares and units are
- -------------------------------------------------------------------------------
58
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
granted to employees and non-employee directors.
The table below summarizes information related to Restricted Shares and
Units for these other plans:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Restricted Restricted
Shares Units
---------- ----------
<S> <C> <C>
Authorized for issuance at:
December 26, 1997 6,300,000 400,000
December 27, 1996 1,700,000 400,000
Outstanding at:
December 26, 1997 258,929 31,862
December 27, 1996 121,490 16,134
- -------------------------------------------------------------------------------
</TABLE>
Nonqualified Stock Options
Nonqualified Stock Options granted under LTIC Plans in 1989 through 1995
generally become exercisable over four years in equal installments commencing
one year after the date of grant. Options granted in 1996 and thereafter
generally are exercisable over five years. The exercise price of these options
is equal to 100% of the fair market value (as defined in LTIC Plans) of a share
of ML & Co. common stock on the date of grant. Nonqualified Stock Options
expire ten years after their grant date.
The activity for Nonqualified Stock Options under LTIC Plans for 1997,
1996, and 1995 follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Options Weighted-Average
Outstanding Exercise Price
----------- ----------------
Outstanding, beginning of 1995 56,815,866 $ 11.66
Granted - 1995 12,912,924 19.82
Exercised (7,919,898) 8.40
Forfeited (1,662,258) 18.48
-----------
Outstanding, end of 1995 60,146,634 13.65
Granted - 1996 13,633,940 27.28
Exercised (8,481,030) 10.45
Forfeited (1,486,888) 25.43
-----------
Outstanding, end of 1996 63,812,656 16.72
Granted - 1997 15,323,524 42.18
Exercised (9,065,189) 12.24
Forfeited (1,363,699) 31.27
-----------
Outstanding, end of 1997(1) 68,707,292 22.69
-----------
- --------------------------------------------------------------------------------
</TABLE>
(1) In January 1998, eligible participants were granted stock options for
11,307,570 shares.
At December 26, 1997, December 27, 1996, and December 29, 1995, options
exercisable under LTIC Plans were 36,380,942; 35,532,334; and 34,118,750,
respectively.
The table below summarizes information related to outstanding and
exercisable options at December 26, 1997.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------ ------------------------
<S> <C> <C> <C> <C> <C>
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Remaining Number Exercise
Exercise Prices Outstanding Price Life (years)(1) Exercisable Price
- ----------------------------------------------------------------------------------------------------------
$5.00 - $10.99 12,278,961 $ 5.57 2.62 12,278,961 $ 5.57
$11.00 - $19.99 21,287,249 16.62 5.69 16,664,361 16.35
$20.00 - $29.99 19,252,779 24.88 7.48 7,023,277 22.61
$30.00 - $39.99 1,156,924 31.03 7.77 400,768 31.03
$40.00 - $68.125 14,731,379 42.24 9.26 13,575 40.59
- ----------------------------------------------------------------------------------------------------------
</TABLE>
(1) Based on original contractual life of ten years.
At consummation of Merrill Lynch's merger with Midland (see Note 1), each
Midland optionholder received 0.24 options on ML & Co. common stock, with the
vesting period and contractual life identical to the terms of the original
grant. Information at year-end 1997, 1996, and 1995 related to these options
follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Options Weighted-Average
Outstanding Exercise Price
--------------------- ------------------
<S> <C> <C>
1995 603,249 $ 23.04
1996 688,146 28.08
1997 743,634 31.04
- --------------------------------------------------------------------------------
</TABLE>
At December 26, 1997, December 27, 1996, and December 29, 1995, such
options exercisable were 284,578, 243,404, and 338,411, respectively.
59
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The weighted-average fair value of LTIC options granted in 1997, 1996,
and 1995 was $14.62, $7.58, and $5.67 per option, respectively. Fair value is
estimated as of the grant date based on a Black-Scholes option pricing model
using the following weighted-average assumptions:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- ------
<S> <C> <C> <C>
Risk-free interest rate 6.74% 5.68% 7.61%
Expected life 6 yrs. 5 yrs. 5 yrs.
Expected volatility 26.86% 26.35% 25.00%
Dividend yield 1.47% 1.91% 2.45%
- --------------------------------------------------------------------------------
</TABLE>
The weighted-average fair value of options granted by Midland in 1997,
1996, and 1995 were $15.01, $15.28, and $15.23, respectively.
See Pro Forma Compensation Expense in the following Employee Stock
Purchase Plans section for additional information.
- --------------------------------------------------------------------------------
Employee Stock Purchase Plans ("ESPP")
ESPP plans allow eligible employees to invest from 1% to 10% of their
eligible compensation to purchase ML & Co. common stock at a price generally
equal to 85% of its fair market value. These purchases are made on four
quarterly investment dates through payroll deductions. Up to 50,300,000 shares
of common stock have been authorized for issuance under ESPP. The activity in
ESPP during 1997, 1996, and 1995 follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Available, beginning of year 8,267,360 9,992,526 11,714,898
Authorized during year 300,000 - -
Purchased through plan (1,316,017) (1,725,166) (1,722,372)
---------- ----------- ------------
Available, end of year 7,251,343 8,267,360 9,992,526
---------- ---------- ------------
- --------------------------------------------------------------------------------
</TABLE>
The weighted-average fair value of ESPP stock purchase rights exercised
by employees in 1997, 1996, and 1995 was $7.66, $4.38, and $3.60 per right,
respectively.
- -------------------------------------------------------------------------------
Pro Forma Compensation Expense
No compensation expense has been recognized for Merrill Lynch's grants of
stock options or ESPP purchase rights (see Note 1 for accounting policy). Based
on the fair value of stock options and purchase rights, Merrill Lynch would have
recognized compensation expense, net of taxes, of $56, $27, and $12 for 1997,
1996, and 1995, respectively, resulting in pro forma net earnings and earnings
per share as follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Net earnings
As reported $1,935 $1,648 $1,126
Pro forma 1,879 1,621 1,114
Earnings per common share
As reported:
Basic $5.57 $4.63 $2.98
Diluted 4.79 4.08 2.68
Pro forma:
Basic 5.41 4.55 2.95
Diluted 4.65 4.01 2.65
- --------------------------------------------------------------------------------
</TABLE>
In the table above, pro forma compensation expense associated with option
grants is recognized over the vesting period. The impact of applying SFAS No.
123 on pro forma disclosure is not representative of the potential impact on pro
forma net earnings for future years, which will include the cumulative effect of
expense related to vesting of 1995 and subsequent grants.
- -------------------------------------------------------------------------------
Financial Consultant Capital Accumulation
Award Plans ("FCCAAP")
Under FCCAAP, eligible employees in Merrill Lynch's Private Client groups
are granted awards generally based upon their prior year's performance. Payment
for an award is contingent upon continued employment for a period of time and is
subject to forfeiture during that period. The award is generally payable ten
years from the date of grant in a fixed number of shares of ML & Co. common
stock unless the fair market value of such shares is less than a specified
minimum value plus interest, in which case the minimum value is paid in cash.
Eligible participants may defer awards beyond the scheduled payment date. FCCAAP
may also provide for the issuance of Restricted Shares that vest ten years from
the date of the original award and carry voting and dividend rights.
A total of 60,415,284 shares of common stock are authorized for issuance
under FCCAAP. Only shares of common stock held as treasury stock may be issued
- --------------------------------------------------------------------------------
60
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
under FCCAAP. At December 26, 1997, shares subject to outstanding awards
totaled 32,469,188, while 24,658,543 shares were available for issuance through
future awards. The fair value of awards granted under FCCAAP during 1997,
1996, and 1995 was $42.09, $25.34, and $18.06 per award, respectively.
- --------------------------------------------------------------------------------
Incentive Equity Purchase Plan ("IEPP")
IEPP allowed selected employees to purchase shares of ML & Co. common
stock ("Book Value Shares") at a price equal to book value per common share.
Book Value Shares, which otherwise may not be resold, may be sold back to
Merrill Lynch at book value or exchanged at any time for a specified number of
freely transferable common shares. Book Value Shares outstanding under IEPP were
2,164,600 and 2,274,400 at December 26, 1997 and December 27, 1996,
respectively. In 1995, IEPP was amended to reduce the authorized shares to zero
and prohibit the reuse of any surrendered shares. No further offerings will be
made under this plan.
- --------------------------------------------------------------------------------
Merrill Lynch Investment Certificate Program
("MLICP")
Under MLICP, eligible employees in Merrill Lynch's Private Client groups
are issued investment certificates based on their performance. The certificates
mature ten years from the date issued and are payable in cash if certain
performance criteria are achieved and the employee is continuously employed for
the ten-year period, with certain exceptions. The certificates bear interest
commencing with the date on which the performance requirements are achieved. As
of December 26, 1997 and December 27, 1996, $292 and $235, respectively, were
accrued under this plan.
- --------------------------------------------------------------------------------
Other Deferred Compensation Plans
Merrill Lynch sponsors other deferred compensation plans in which
eligible employees may participate. Generally, contributions to the plans are
made on a tax-deferred basis to participants. Contributions are invested by
Merrill Lynch, principally in mutual and other funds sponsored by Merrill Lynch,
and the plans may include a leverage feature. The plans' investments and the
amounts accrued by Merrill Lynch under the plans are both included in the
Consolidated Balance Sheets. Plan investments totaled $554 and $211,
respectively, at December 26, 1997 and December 27, 1996. Accrued liabilities at
those dates were $441 and $220, respectively.
- -------------------------------------------------------------------------------
NOTE 10. INCOME TAXES
- --------------------------------------------------------------------------------
Income tax provisions (benefits) on earnings consisted of:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Federal
Current $ 856 $ 515 $ 788
Deferred (94) (119) (164)
State and local
Current (15) 198 81
Deferred 7 (54) (30)
Foreign
Current 400 496 (24)
Deferred (25) (56) 59
------ ------ ------
Total $1,129 $ 980 $ 710
------ ------ ------
- --------------------------------------------------------------------------------
</TABLE>
The corporate statutory tax rate was 35.0% for the three years presented.
A reconciliation of statutory Federal income taxes to Merrill Lynch's income tax
provisions for earnings follows:
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
------ ----- -----
<S> <C> <C> <C>
Federal income tax at statutory rate $1,089 $920 $643
State and local income taxes, net (5) 94 33
Pension plan transaction 6 12 13
Foreign operations 41 3 -
Tax-exempt interest (26) (21) (14)
Dividends received deduction (33) (34) (19)
Other, net 57 6 54
------- ------ ------
Income tax expense $1,129 $980 $710
------- ------ ------
- --------------------------------------------------------------------------------
</TABLE>
For financial reporting purposes, Merrill Lynch had no unrecognized net
operating loss or alternative minimum tax benefit carryforwards at December 26,
1997.
Deferred income taxes are provided for the effects of temporary
differences between the tax basis of an
- -------------------------------------------------------------------------------
61
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
asset or liability and its reported amount in the Consolidated Financial
Statements. These temporary differences result in taxable or deductible amounts
in future years. Details of Merrill Lynch's deferred tax assets and
liabilities follow:
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Deferred tax assets
Valuation and other reserves(1) $ 940 $ 895 $ 700
Deferred compensation 478 351 230
Employee benefits 109 115 94
Other 90 255 274
----- ----- -----
Total deferred tax assets 1,617 1,616 1,298
----- ----- -----
Deferred tax liabilities
Lease transactions 116 114 100
Employee benefits 58 54 47
Accelerated tax depreciation 26 44 70
Unrealized gains on inventory - 9 18
Other 178 79 45
------- ------ ------
Total deferred tax liabilities 378 300 280
------- ------ ------
Net deferred tax asset $1,239 $1,316 $1,018
------- ------ ------
- -------------------------------------------------------------------------------
</TABLE>
(1) Primarily related to Trading assets and Other liabilities.
Income tax benefits of $173, $30, and $34 were allocated to stockholders'
equity related to employee compensation transactions for 1997, 1996, and 1995,
respectively.
Earnings before income taxes included approximately $805, $800, and $153
of earnings attributable to foreign entities for 1997, 1996, and 1995,
respectively. Cumulative undistributed earnings of foreign subsidiaries were
approximately $1,739 at December 26, 1997. No deferred Federal income taxes have
been provided for the undistributed earnings to the extent that such earnings
have been permanently reinvested in Merrill Lynch's foreign operations. Assuming
utilization of foreign tax credits, Merrill Lynch estimates that approximately
$81 of Federal income taxes and $72 of foreign withholding taxes would be
incurred on the repatriation of the foreign subsidiaries' earnings.
- -------------------------------------------------------------------------------
NOTE 11. REGULATORY
REQUIREMENTS AND
DIVIDEND RESTRICTIONS
- -------------------------------------------------------------------------------
MLPF&S, a registered broker-dealer and a subsidiary of ML & Co., is
subject to the net capital requirements of Rule 15c3-1 of the Securities
Exchange Act of 1934. Under the alternative method permitted by this rule, the
minimum required net capital,as defined, shall not be less than 2% of aggregate
debit items arising from customer transactions. At December 26, 1997, MLPF&S's
regulatory net capital of $2,249 was 11% of aggregate debit items, and its
regulatory net capital in excess of the minimum required was $1,845.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in
U.S. Government securities and a subsidiary of ML & Co., is subject to the
capital adequacy requirements of the Government Securities Act of 1986. This
rule requires dealers to maintain liquid capital in excess of market and credit
risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At December 26,
1997, MLGSI's liquid capital of $1,354 was 263% of its total market and credit
risk, and liquid capital in excess of the minimum required was $735.
MLI, a registered U.K. broker-dealer and a subsidiary of Merrill Lynch,
is subject to capital requirements of the Securities and Futures Authority
("SFA"). Financial resources, as defined, must exceed the total financial
resources requirement of the SFA. During 1997, MLI became Merrill Lynch's
primary dealer for global equity derivatives business. As a result, at December
26, 1997, MLI's financial resources were $4,540, an increase of $3,166 since
year-end 1996, and exceeded the minimum requirement by $1,004. The equity
derivatives business of Merrill Lynch Capital Markets PLC was transferred to MLI
during 1997.
Merrill Lynch's insurance subsidiaries are subject to various regulatory
restrictions that limit the amount available for distribution as dividends. As
of December 26, 1997, $389, representing 84% of the insurance subsidiaries' net
assets, was unavailable for distribution to Merrill Lynch.
Over 89 other subsidiaries are subject to regulatory requirements
promulgated by the regulatory and exchange authorities of the jurisdictions in
which they operate. These regulatory restrictions may limit the
- -------------------------------------------------------------------------------
62
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
amounts that these subsidiaries can pay in dividends or advance to Merrill
Lynch. At December 26, 1997, restricted net assets of all subsidiaries were
$7,740.
In addition, to satisfy rating agency standards, a credit intermediary
subsidiary of Merrill Lynch must also meet certain minimum capital
requirements. At December 26, 1997, this minimum capital requirement was $350.
For additional information on Merrill Lynch's regulatory oversight and
supervision, see Business of Merrill Lynch-Regulation.
With the exception of regulatory restrictions on subsidiaries' abilities
to pay dividends, there are no restrictions on Merrill Lynch's present ability
to pay dividends on common stock, other than (1) Merrill Lynch's obligation
first to make dividend payments on its preferred stock, and (2) the governing
provisions of the Delaware General Corporation Law.
- -------------------------------------------------------------------------------
NOTE 12. INDUSTRY AND GLOBAL
OPERATIONS
- -------------------------------------------------------------------------------
Merrill Lynch operates principally in the financial services industry and
provides services to individual and institutional clients. These services, due
to certain legal requirements, are conducted through various subsidiaries,
including those operating as brokers, dealers, banks, insurance, and other
financial services companies.
Merrill Lynch operates in both U.S. and non-U.S. markets. Merrill
Lynch's non-U.S. business activities are conducted through offices in five
regions:
~ Europe, Middle East, and Africa,
~ Asia and Pacific,
~ Australia and New Zealand,
~ Japan, and
~ Canada and Latin America
European, Middle Eastern, and African operations offer international
investment and private banking services, research, and dealer services in
equity and fixed-income securities, swaps, futures, commodity contracts, and
options.
Merrill Lynch's Asian and Pacific operations conduct business throughout
various countries including China (and its special autonomous region of Hong
Kong) and Singapore. Merrill Lynch has a trading presence and exchange
memberships in virtually all of the region's markets.
In the Australia and New Zealand region, Merrill Lynch provides a broad
mix of retail and institutional activities.
Merrill Lynch's Japan region operates as a dealer in a full range of
debt and equity products. In addition, the Japan region provides investment
banking and research services to a predominately institutional client base.
In Canada, Merrill Lynch provides financial services including
investment banking, brokerage, and asset management. Merrill Lynch has expanded
its broad-based capabilities in the Canadian region as a result of its merger
with Midland, a Canadian diversified financial services firm. In Latin America,
Merrill Lynch provides international banking, brokerage, and trust services and
has been instrumental in the privatization of many Latin American companies. For
further information on these regions, see Management's Discussion and Analysis
(unaudited)-Global Operations.
Following is the principal methodology used in preparing the geographic
data in the table below:
~ Commission revenues are recorded based on the location of the sales
force;
~ Trading revenues are principally recorded based on the location of the
trader;
~ Investment banking revenues are recorded based on
the location of the client;
~ Asset management and portfolio service fees are recorded based on the
location of the fund manager;
~ Earnings before income taxes include the allocation of certain shared
expenses among regions; and
~ Intercompany transfers are based primarily on service agreements.
The information that follows, in management's judgment, provides a
reasonable representation of each region's contribution to the consolidated
amounts.
- --------------------------------------------------------------------------------
63
<PAGE>
Notes to Consolidated Financial Statements
(Dollars in Millions, Except Per Share Amounts)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995 1997 1996 1995
------------------------------------------------------------
Total Revenues Net Revenues
------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Europe, Middle East, and Africa $ 6,750 $ 5,336 $ 3,981 $ 2,284 $ 1,837 $ 1,319
Asia and Pacific 586 395 228 582 394 227
Australia and New Zealand 272 151 163 229 88 66
Japan 1,108 993 841 598 502 408
Canada and Latin America 1,816 1,528 1,251 1,325 977 697
------- ------- ------- -------- -------- --------
Total Non-U.S. 10,532 8,403 6,464 5,018 3,798 2,717
United States 25,046 19,221 16,107 12,462 10,603 8,092
Eliminations (3,079) (1,911) (511) (1,224) (780) (194)
------- ------- ------- -------- -------- --------
Total $32,499 $25,713 $22,060 $ 16,256 $ 13,621 $ 10,615
------- ------- ------- -------- -------- --------
Earnings Before Income Taxes Total Assets
------------------------------------------------------------
Europe, Middle East, and Africa $ 405 $ 357 $ 155 $111,404 $ 75,901 $ 56,948
Asia and Pacific 16 41 7 797 335 240
Australia and New Zealand 39 24 14 1,899 1,115 976
Japan 140 119 60 15,294 16,455 15,698
Latin America and Canada 288 190 152 11,215 9,455 7,592
------- ------- ------- -------- -------- --------
Total Non-U.S. 888 731 388 140,609 103,261 81,454
United States 2,223 1,897 1,448 175,477 126,784 105,702
Eliminations - - - (19,106) (12,779) (7,704)
------- ------- ------- -------- -------- --------
Total $ 3,111 $ 2,628 $ 1,836 $296,980 $217,266 $179,452
------- ------- ------- -------- -------- --------
- ---------------------------------------------------------------------------------------------
</TABLE>
64
<PAGE>
Selected Financial Data
(Dollars in Millions, Except Per Share Amounts)
- --------------------------------------------------------------------------------
In 1998, Merrill Lynch acquired the outstanding shares of Midland Walwyn
Inc. ("Midland"), in a transaction accounted for as a pooling-of-interests. The
following information has been restated, except as noted in note (a) below, as
if Merrill Lynch and Midland had always been combined.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Last Friday in December
- -------------------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993 (a)
- -------------------------------------------------------------------------------------------------------------------
(52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (53 Weeks)
<S> <C> <C> <C> <C> <C>
OPERATING RESULTS
Total Revenues $ 32,499 $ 25,713 $ 22,060 $ 18,573 $ 16,588
Interest Expense 16,243 12,092 11,445 8,614 6,030
-------- -------- -------- -------- --------
Net Revenues 16,256 13,621 10,615 9,959 10,558
Non-Interest Expenses 13,145 10,993 8,779 8,212 8,133
-------- -------- -------- -------- --------
Earnings Before Income Taxes, Dividends on
Preferred Securities Issued by Subsidiaries, and
Cumulative Effect of Change in Accounting Principle 3,111 2,628 1,836 1,747 2,425
Income Tax Expense 1,129 980 710 717 1,031
Dividends on Preferred Securities Issued by Subsidiaries 47 - - - -
-------- -------- -------- -------- --------
Earnings Before Cumulative Effect of Change in
Accounting Principle $ 1,935 $ 1,648 $ 1,126 $ 1,030 $ 1,394
-------- -------- -------- -------- --------
Net Earnings $ 1,935 $ 1,648 $ 1,126 $ 1,030 $ 1,359
-------- -------- -------- -------- --------
Net Earnings Applicable to Common Stockholders $ 1,896 $ 1,602 $ 1,078 $ 1,017 $ 1,354
-------- -------- -------- -------- --------
- -------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Total Assets $296,980 $217,266 $179,452 $165,920 $152,910
Short-Term Borrowings (b) $124,219 $103,469 $ 86,969 $ 78,735 $ 79,632
Long-Term Borrowings $ 43,143 $ 26,206 $ 17,389 $ 14,911 $ 13,469
Preferred Securities Issued by Subsidiaries $ 627 $ 327 $ 51 $ 51 $ 51
Total Stockholders' Equity $ 8,539 $ 7,067 $ 6,288 $ 5,951 $ 5,486
- -------------------------------------------------------------------------------------------------------------------
COMMON SHARE DATA (c)
(In Thousands, Except Per Share Amounts)
Basic:
Earnings Before Cumulative Effect of Change in
Accounting Principle $ 5.57 $ 4.63 $ 2.98 $ 2.55 $ 3.31
-------- -------- -------- -------- --------
Net Earnings $ 5.57 $ 4.63 $ 2.98 $ 2.55 $ 3.23
-------- -------- -------- -------- --------
Diluted:
Earnings Before Cumulative Effect of Change in
Accounting Principle $ 4.79 $ 4.08 $ 2.68 $ 2.37 $ 3.06
-------- -------- -------- -------- --------
Net Earnings $ 4.79 $ 4.08 $ 2.68 $ 2.37 $ 2.98
-------- -------- -------- -------- --------
Weighted-Average Shares Outstanding:
Basic 340,096 346,043 361,193 399,209 418,553
Diluted 395,855 392,990 402,852 430,092 453,585
Shares Outstanding at Year-End (d) 343,977 336,483 350,885 370,921 407,979
Shares Repurchased 13,741 37,158 40,024 59,977 32,691
Average Share Repurchase Price $ 48.91 $ 31.30 $ 23.48 $ 18.98 $ 21.28
Book Value $ 23.63 $ 19.24 $ 16.25 $ 14.48 $ 13.09
Dividends Paid $ 0.75 $ 0.58 $ 0.505 $ 0.445 $ 0.35
- --------------------------------------------------------------------------------------------------------------------
FINANCIAL RATIOS
Pretax Margin (e) 19.1% 19.3% 17.3% 17.5% 23.0%
Profit Margin (f) 11.9% 12.1% 10.6% 10.3% 13.2%
Common Dividend Payout Ratio 13.4% 12.5% 17.0% 17.6% 10.9%
Return on Average Assets 0.7% 0.7% 0.5% 0.6% 1.0%
Return on Average Common Stockholders' Equity 26.5% 26.6% 19.8% 18.4% 27.3%
Average Leverage (g) 35.3x 33.3x 32.1x 31.3x 27.1x
Average Adjusted Leverage (h) 21.3x 19.8x 19.4x 18.6x 16.4x
- --------------------------------------------------------------------------------------------------------------------
EMPLOYEE STATISTICS
Full-Time Employees:
U.S. 45,800 42,100 39,250 38,750 37,500
Non-U.S. 13,900 10,500 9,250 7,550 4,400
-------- -------- -------- -------- ---------
Total 59,700 52,600 48,500 46,300 41,900
-------- -------- -------- -------- ---------
Financial Consultants and Account Executives Worldwide 16,600 15,600 14,900 14,500 13,200
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) 1993 information has not been restated for the Midland merger. The
effect of combining Midland into the information presented would not
be material.
(b) Includes payables under repurchase agreements and securities loaned
transactions and commercial paper and other short-term borrowings.
(c) All share and per share data have been restated for the two-for-one common
stock split (see Note 6 to the Consolidated Financial Statements).
(d) Includes 4,718, 4,134, 3,932, and 3,786 shares exchangeable into common
stock, which were issued in connection with the Midland merger at
year-end 1997, 1996, 1995 and 1994, respectively. Does not include 3,078,
8,026, 12,854, and 17,864 unallocated reversion shares held in the Employee
Stock Ownership Plan at year-end 1996, 1995, 1994, and 1993, respectively,
which are not considered outstanding for accounting purposes.
(e) Earnings Before Income Taxes, Dividends on Preferred Securities Issued by
Subsidiaries, and Cumulative Effect of Change in Accounting Principle to
Net Revenues.
(f) Earnings Before Cumulative Effect of Change in Accounting Principle to Net
Revenues.
(g) Average total assets to average total stockholders' equity and preferred
securities issued by subsidiaries.
(h) Average total assets less average receivables under resale agreements and
securities borrowed transactions to average total stockholders' equity and
preferred securities issued by subsidiaries.
65
