SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 28, 1997
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COMMISSION FILE NUMBER 1-7182
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MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 13-2740599
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
WORLD FINANCIAL CENTER, NORTH TOWER,
NEW YORK, NEW YORK 10281-1332
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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Registrant's telephone number, including area code
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Former name, former address and former fiscal year, if changed since last
report.
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
165,174,312 shares of Common Stock*
(as of the close of business on May 2, 1997)
* Does not include 467,575 unallocated reversion shares held in the
Employee Stock Ownership Plan that are not considered outstanding for
accounting purposes.
Part I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
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MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED EARNINGS (UNAUDITED)
FOR THE THREE MONTHS ENDED
-------------------------
MARCH 28, MARCH 29, PERCENT(1)
(In Millions, Except Per Share Amounts) 1997 1996 INCREASE
----------- ----------- ---------------
REVENUES
Commissions.................................................................... $ 1,115 $ 989 13%
Interest and dividends......................................................... 3,848 3,010 28
Principal transactions......................................................... 1,063 982 8
Investment banking............................................................. 608 378 61
Asset management and portfolio service fees.................................... 646 538 20
Other.......................................................................... 171 122 40
---------- ---------- ---
Total Revenues................................................................. 7,451 6,019 24
Interest Expense............................................................. 3,610 2,758 31
----------- ---------- ---
Net Revenues................................................................... 3,841 3,261 18
----------- ---------- ---
NON-INTEREST EXPENSES
Compensation and benefits...................................................... 1,988 1,691 18
Communications and equipment rental............................................ 158 131 21
Occupancy...................................................................... 120 116 4
Depreciation and amortization.................................................. 105 98 7
Professional fees.............................................................. 198 130 52
Advertising and market development............................................. 144 114 26
Brokerage, clearing, and exchange fees......................................... 118 106 11
Other.......................................................................... 244 204 20
----------- ---------- ---
Total Non-Interest Expenses.................................................... 3,075 2,590 19
----------- ---------- ---
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES................................................................. 766 671 14
Income tax expense............................................................. 291 261 11
Dividends on Preferred Securities Issued by Subsidiaries....................... 10 --- n/ m
----------- ---------- ---
NET EARNINGS................................................................... $ 465 $ 410 14%
----------- ---------- ---
----------- ---------- ---
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS................................. $ 455 $ 398
----------- ----------
----------- ----------
EARNINGS PER COMMON SHARE:
Primary...................................................................... $ 2.34 $ 2.03
----------- ----------
----------- ----------
Fully diluted................................................................ $ 2.34 $ 2.03
----------- ----------
----------- ----------
DIVIDEND PAID PER COMMON SHARE................................................. $ .30 $ .26
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----------- ---------
AVERAGE SHARES USED IN COMPUTING EARNINGS PER COMMON SHARE:
Primary...................................................................... 194.5 196.2
----------- ---------
----------- ---------
Fully diluted................................................................ 194.5 196.2
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(1) Percentages are based on actual numbers before rounding.
See Notes to Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in Millions, Except Per Share Amounts) MARCH 28, DEC. 27,
ASSETS 1997 1996
- ---------------------------------------------------------------------- ---------- ----------
CASH AND CASH EQUIVALENTS............................................. $ 4,154 $ 3,375
---------- ----------
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES OR DEPOSITED
WITH CLEARING ORGANIZATIONS......................................... 7,483 5,628
---------- ----------
MARKETABLE INVESTMENT SECURITIES...................................... 2,488 2,180
---------- ----------
TRADING ASSETS, AT FAIR VALUE
Corporate debt and preferred stock.................................... 30,123 24,270
Contractual agreements................................................ 15,009 13,465
Equities and convertible debentures................................... 17,572 13,153
U.S. Government and agencies.......................................... 10,374 9,304
Non-U.S. governments and agencies..................................... 10,401 7,758
Mortgages, mortgage-backed, and asset-backed.......................... 6,663 5,189
Money markets......................................................... 1,633 1,209
Municipals............................................................ 1,254 1,176
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Total................................................................. 93,029 75,524
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RESALE AGREEMENTS..................................................... 61,149 58,402
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SECURITIES BORROWED................................................... 30,717 24,692
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RECEIVABLES
Customers (net of allowance for doubtful accounts of $41 in 1997 and
$39 in 1996)........................................................ 20,766 18,309
Brokers and dealers................................................... 8,139 6,205
Interest and other.................................................... 5,840 5,280
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Total................................................................. 34,745 29,794
---------- ----------
INVESTMENTS OF INSURANCE SUBSIDIARIES................................. 5,035 5,107
LOANS, NOTES, AND MORTGAGES (NET OF ALLOWANCE FOR LOAN LOSSES OF $117
IN 1997 AND 1996)................................................... 3,639 3,334
OTHER INVESTMENTS..................................................... 1,315 1,125
PROPERTY, LEASEHOLD IMPROVEMENTS, AND EQUIPMENT (NET OF ACCUMULATED
DEPRECIATION AND AMORTIZATION OF $2,609 IN 1997 AND $2,523 IN
1996)............................................................... 1,706 1,670
OTHER ASSETS.......................................................... 2,143 2,185
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TOTAL ASSETS.......................................................... $ 247,603 $ 213,016
---------- ----------
---------- ----------
See Notes to Consolidated Financial Statements
3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in Millions, Except Per Share Amounts)
LIABILITIES, PREFERRED SECURITIES ISSUED BY MARCH 28, DEC. 27,
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY 1997 1996
- --------------------------------------------------------- --------- --------
LIABILITIES
REPURCHASE AGREEMENTS.................................... $ 70,886 $ 62,669
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS......... 49,824 39,333
-------- --------
TRADING LIABILITIES, AT FAIR VALUE
U.S. Government and agencies............................. 14,586 13,965
Contractual agreements................................... 11,348 11,221
Equities and convertible debentures...................... 14,011 8,332
Non-U.S. governments and agencies........................ 8,088 7,135
Corporate debt and preferred stock....................... 2,652 2,762
Municipals............................................... 98 130
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Total.................................................... 50,783 43,545
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CUSTOMERS................................................ 13,456 11,758
INSURANCE................................................ 4,919 5,010
BROKERS AND DEALERS...................................... 5,554 3,407
OTHER LIABILITIES AND ACCRUED INTEREST................... 14,942 13,973
LONG-TERM BORROWINGS..................................... 29,687 26,102
-------- --------
TOTAL LIABILITIES........................................ 240,051 205,797
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 627 327
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY........................... 425 619
-------- --------
COMMON STOCKHOLDERS' EQUITY
Common stock, par value $1.33 1/3 per share; authorized:
500,000,000 shares; issued: 1997 and 1996--236,330,162
shares................................................. 315 315
Paid-in capital.......................................... 1,381 1,304
Foreign currency translation adjustment.................. 8 10
Net unrealized gains on investment securities
available-for-sale (net of applicable income tax expense
of $7 in 1997 and $5 in 1996).......................... 13 9
Retained earnings........................................ 8,272 7,868
-------- --------
Subtotal............................................. 9,989 9,506
Less:
Treasury stock, at cost:
1997--70,401,920 shares;
1996--70,705,598 shares............................ 2,956 2,895
Unallocated ESOP reversion shares, at cost:
1997--467,575 shares;
1996--1,538,778 shares............................. 7 24
Employee stock transactions........................... 526 314
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TOTAL COMMON STOCKHOLDERS' EQUITY....................... 6,500 6,273
-------- --------
TOTAL STOCKHOLDERS' EQUITY.............................. 6,925 6,892
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TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY
SUBSIDIARIES, AND STOCKHOLDERS' EQUITY................. $247,603 $213,016
-------- --------
-------- --------
BOOK VALUE PER COMMON SHARE............................. $ 39.42 $ 38.38
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SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
----------------------------
MARCH 28, MARCH 29,
(In Millions) 1997 1996
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings................................................... $ 465 $ 410
Noncash items included in earnings:
Depreciation and amortization................................ 105 98
Policyholder reserves........................................ 62 70
Other........................................................ 290 200
(Increase) decrease in operating assets:
Trading assets............................................... (17,504) (1,951)
Cash and securities segregated for regulatory purposes or
deposited with clearing organizations...................... (1,855) 313
Securities borrowed.......................................... (6,025) (4,169)
Customers.................................................... (2,459) (212)
Sales of trading investment securities....................... 344 --
Purchases of trading investment securities................... (329) --
Other........................................................ (3,389) (5,033)
Increase (decrease) in operating liabilities:
Trading liabilities.......................................... 7,237 4,353
Customers.................................................... 1,698 (792)
Insurance.................................................... (118) (175)
Other........................................................ 3,030 6,559
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CASH USED FOR OPERATING ACTIVITIES............................. (18,448) (329)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities.................. 756 710
Sales of available-for-sale securities....................... 605 558
Purchases of available-for-sale securities................... (1,778) (1,151)
Maturities of held-to-maturity securities.................... 231 187
Purchases of held-to-maturity securities..................... (175) (62)
Other investments and other assets........................... (134) (376)
Property, leasehold improvements, and equipment.............. (141) (95)
-------- -------
CASH USED FOR INVESTING ACTIVITIES............................. (636) (229)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Repurchase agreements, net of resale agreements.............. 5,470 (3,783)
Commercial paper and other short-term borrowings............. 10,491 1,123
Issuance and resale of long-term borrowings.................. 5,757 4,572
Settlement and repurchase of long-term borrowings............ (1,606) (1,558)
Issuance of subsidiaries' preferred securities............... 300 --
Redemption of Remarketed Preferred Stock..................... (194) --
Common stock transactions.................................... (294) (198)
Dividends.................................................... (61) (56)
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CASH PROVIDED BY FINANCING ACTIVITIES.......................... 19,863 100
-------- -------
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS................ 779 (458)
Cash and cash equivalents, beginning of year................... 3,375 3,091
-------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD....................... $ 4,154 $ 2,633
-------- -------
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes totaled $19 in 1997 and $25 in 1996.
Interest totaled $3,256 in 1997 and $2,656 in 1996.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 28, 1997
(DOLLARS IN MILLIONS)
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Merrill Lynch &
Co., Inc. (the "Company") and subsidiaries (collectively, "Merrill Lynch").
All material intercompany balances have been eliminated. The December 27,
1996 consolidated balance sheet was derived from the audited financial
statements. The interim consolidated financial statements for the three-month
periods are unaudited; however, in the opinion of the management of Merrill
Lynch, all adjustments, consisting only of normal recurring accruals,
necessary for a fair statement of the results of operations have been
included.
These unaudited financial statements should be read in conjunction with the
audited financial statements included in Merrill Lynch's Annual Report on
Form 10-K for the year ended December 27, 1996. The nature of Merrill Lynch's
business is such that the results of any interim period are not necessarily
indicative of results for a full year. Prior period financial statements have
been reclassified, where appropriate, to conform to the 1997 presentation.
ACCOUNTING CHANGE
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 financial assets 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.
In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective
Date of Certain Provisions of FASB Statement No. 125", which defers 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 provisions will be applied prospectively to
transactions entered into after December 31, 1997; accordingly, the expected
impact of adopting such provisions on Merrill Lynch's results of operations
cannot be determined.
Merrill Lynch adopted the provisions of SFAS No. 125 not deferred by SFAS No.
127 for all transactions entered into subsequent to December 31, 1996. This
resulted in a net increase in Trading Assets and Repurchase Agreements of
approximately $3 billion at the end of the 1997 first quarter.
6
NEW ACCOUNTING PRONOUNCEMENT
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share", which
is effective for financial statements ending after December 15, 1997. SFAS
No. 128 simplifies the guidance for computing earnings per share ("EPS") and
replaces the presentation of primary and fully diluted EPS with basic and
diluted EPS.
Basic EPS excludes dilution related to incremental shares and is computed by
dividing net income available to common stockholders by the weighted-average
number of common shares outstanding for the period. Diluted EPS includes
incremental shares.
Presented below is basic and diluted EPS under SFAS No. 128 compared with
primary and fully diluted EPS for the first quarters of 1997 and 1996:
THREE MONTHS ENDED
------------------------
MARCH 28, MARCH 29,
1997 1996
----------- -----------
Pro Forma SFAS No. 128:
Basic...................................................... $ 2.75 $ 2.30
Diluted.................................................... 2.33 2.02
As Currently Reported:
Primary.................................................... $ 2.34 $ 2.03
Fully diluted.............................................. 2.34 2.03
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS
Commercial paper and other short-term borrowings at March 28, 1997 and
December 27, 1996 are presented below:
MARCH 28, DEC. 27,
1997 1996
----------- ---------
Commercial paper........................................... $ 28,546 $ 23,558
Demand and time deposits................................... 9,229 9,311
Securities loaned.......................................... 5,223 2,751
Bank loans and other....................................... 6,826 3,713
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Total...................................................... $ 49,824 $ 39,333
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FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Merrill Lynch enters into various derivative contracts to meet clients' needs
and to manage its own market risks. Derivative contracts often involve future
commitments to exchange interest payment streams or currencies (such as
interest rate and currency swaps or foreign exchange forwards) or to purchase
or sell other financial instruments at specified terms on a specified date.
Options, for example, can be purchased or written on a wide range of
financial instruments such as securities, currencies, futures, and various
market indices.
7
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 contractual amounts of derivatives
used for trading purposes by type of risk follow:
(In billions)
INTEREST RATE CURRENCY EQUITY PRICE COMMODITY PRICE
MARCH 28, 1997 RISK(1)(2) RISK(3) RISK RISK
- -------------- ------------- ----------- --------------- ---------------------
Swap agreements.......................................... $ 1,284 $ 144 $ 13 $ 3
Forward contracts........................................ 37 200 -- 18
Futures contracts........................................ 115 1 9 3
Options purchased........................................ 92 70 30 3
Options written.......................................... 124 67 43 4
December 27, 1996
- -----------------
Swap agreements.......................................... $ 1,212 $ 140 $ 13 $ 3
Forward contracts........................................ 24 147 1 17
Futures contracts........................................ 126 2 7 5
Options purchased........................................ 85 76 21 3
Options written.......................................... 118 72 31 3
(1) Certain derivatives subject to interest rate risk are also exposed to the
credit spread risk of the underlying financial instrument, such as total
return swaps and similar instruments.
(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.
The notional or contractual amounts of derivatives used to hedge exposure
related to borrowings or other non-trading activities follow:
MARCH 28, DECEMBER 27,
(In billions) 1997 1996
- -------------- ------------- -----------------
Interest rate derivatives(1)........................................ $ 41 $ 36
Currency derivatives(1)............................................. 9 7
Equity derivatives.................................................. 2 2
(1) Includes swap contracts totaling $1 billion notional that contain embedded
options hedging callable debt at both dates.
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.
In the normal course of business, Merrill Lynch enters into underwriting
commitments, when-issued transactions, and commitments to extend credit.
Settlement of these commitments as of March 28, 1997 would not have a
material effect on the consolidated financial condition of Merrill Lynch.
8
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES
On February 6, 1997, Merrill Lynch Preferred Capital Trust II (the "Trust"),
a Merrill Lynch subsidiary, issued $300 million of 8% Trust Originated
Preferred Securities (Service Mark). The Trust holds preferred securities of
a partnership, which is also a subsidiary of Merrill Lynch. The assets of the
partnership consist primarily of debt securities of the Company and one of
its subsidiaries. Merrill Lynch has guaranteed, on a subordinated basis,
certain payments by the Trust and the partnership.
REMARKETED PREFERRED (Service Mark) STOCK, SERIES C ("RP STOCK")
Merrill Lynch redeemed all outstanding shares of RP Stock in the first
quarter of 1997. The RP Stock was redeemed on the dividend reset date of each
series, with all shares redeemed by March 4, 1997.
REGULATORY REQUIREMENTS
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a registered
broker-dealer and a subsidiary of Merrill Lynch, is subject to 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 March 28, 1997, MLPF&S's regulatory net capital of
$1,372 was 8% of aggregate debit items, and its regulatory net capital in
excess of the minimum required was $1,031.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities and a subsidiary of Merrill Lynch, is subject to the
capital adequacy requirements of the Government Securities Act of 1986. This
rule requires dealers to maintain liquid capital in excess of market and
credit risk, as defined, by 20% (a 1.2-to-1 capital-to-risk standard). At
March 28, 1997, MLGSI's liquid capital of $868 was 194% of its total market
and credit risk, and liquid capital in excess of the minimum required was
$363.
Merrill Lynch International ("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. At March
28, 1997, MLI's financial resources were $2,144, and exceeded the minimum
requirement by $497.
Merrill Lynch Capital Markets PLC ("MLCM"), a U.K. subsidiary of Merrill
Lynch and a dealer in over-the-counter equity derivatives, became subject to
the capital requirements of the SFA on January 1, 1997. At March 28, 1997,
MLCM's financial resources were $1,509, and exceeded the minimum requirement
by $588. During the 1997 first quarter, MLI became Merrill Lynch's primary
dealer for new equity derivatives business.
9
INTEREST EXPENSE
Interest expense includes payments in lieu of dividends of $2.1 and $1.6 for
the first quarters of 1997 and 1996, respectively.
LITIGATION MATTER
An action is pending in the United States District Court for the Central
District of California by Orange County, California (the "County"), which
filed a bankruptcy petition in the United States Bankruptcy Court for the
Central District of California on December 6, 1994, against the Company and
certain of its subsidiaries in connection with Merrill Lynch's business
activities with the Orange County Treasurer-Tax Collector. In addition, other
actions are pending against the Company and/or certain of its officers,
directors, and employees and certain of its subsidiaries in federal and 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 from the purchase of debt instruments
issued by the County that were underwritten by the Company's subsidiary,
MLPF&S. See "Commitments and Contingencies" in the notes to Merrill Lynch's
audited consolidated financial statements contained in the 1996 10-K as well
as "Legal Proceedings" in the 1996 10-K and this Quarterly Report on Form 10-Q.
SUBSEQUENT EVENT
On April 15, 1997, Merrill Lynch's Board of Directors declared a two-for-one
common stock split, to be effected in the form of a 100% stock dividend,
payable on May 30, 1997 to stockholders of record on May 2, 1997. The par
value of the common stock will remain at $1.33 1/3 per share. Accordingly, an
adjustment from paid-in capital to common stock will be required to preserve
the par value of the post-split shares. Pro forma earnings per share, giving
retroactive effect to the two-for-one common stock split, for the three-month
periods ended March 28, 1997 and March 29, 1996 follow:
THREE MONTHS ENDED
------------------------
MARCH 28, MARCH 29,
1997 1996
----------- -----------
Earnings per common share:
Primary................................................................ $ 1.17 $ 1.01
Fully diluted.......................................................... $ 1.17 $ 1.01
Weighted average shares (in thousands):
Primary................................................................ 389,067 392,450
Fully diuted.......................................................... 389,067 392,450
Financial information contained elsewhere in these financial statements has
not been adjusted to reflect the impact of the common stock split.
10
INDEPENDENT ACCOUNTANTS' REPORT
- -------------------------------
To the Board of Directors and Stockholders of
Merrill Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of March 28,
1997, and the related condensed statements of consolidated earnings and
consolidated cash flows for the three-month periods ended March 28, 1997 and
March 29, 1996. These financial statements are the responsibility of the
management of Merrill Lynch & Co., Inc.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Merrill Lynch as of December 27,
1996, and the related statements of consolidated earnings, changes in
consolidated stockholders' equity and consolidated cash flows for the year then
ended (not presented herein); and in our report dated February 24, 1997, we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of December 27, 1996 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
/s/ Deloitte & Touche LLP
New York, New York
May 9, 1997
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Merrill Lynch & Co., Inc. and its subsidiaries (collectively referred to as
"Merrill Lynch") conduct their businesses in global financial markets that
are influenced by many factors, including economic and market conditions,
political events, and investor sentiment. The reaction of issuers and
investors to a particular condition or event is unpredictable and can
increase volatility in the marketplace. While high volatility increases risk,
it may also increase order flow, which drives many of Merrill Lynch's
businesses. Earnings also can be affected by other global market and economic
conditions, including the liquidity of secondary markets; the level and
volatility of interest rates, currency exchange rates, and security
valuations; competitive conditions; and the size, number, and timing of
transactions. As a result, revenues and net earnings can vary significantly
from quarter to quarter, and from year to year.
Global financial markets were generally strong during 1996, led by a stable
U.S. economy and heightened investor and issuer activity. This trend
continued into the first quarter of 1997; however, higher interest rates,
weakness in technology stocks, and investor concern about inflation and
future corporate earnings growth led to a slowdown toward the end of the
quarter.
U.S. equity markets, which posted significant gains in 1996, advanced
slightly in the 1997 first quarter with the Dow Jones Industrial Average
("DJIA") reaching a record in early March. Subsequently, U.S. equity values
decreased as investors anticipated the Federal Reserve Board's decision to
increase the overnight lending rate in an effort to stem inflation. As the
first quarter ended, predictions that the Federal Reserve Board would raise
rates again contributed to further declines in U.S. equity markets.
U.S. bond markets, which were volatile in 1996, trended upward in the first
quarter of 1997. Long-term interest rates, which gradually increased
throughout the quarter, rose above 7% in March when the Federal Reserve Board
raised the overnight lending rate. Interest rates for the 1997 first quarter
were generally higher relative to the year-ago period.
Overall, global equity markets, as measured by the Dow Jones World Index,
remained relatively flat during the 1997 first quarter. With some notable
exceptions, such as Japan, Hong Kong, Singapore, and Thailand, many major
stock markets surpassed the 2% increase in the DJIA by large margins due to
falling inflation, high corporate earnings growth, and low stock valuations.
Nevertheless, the strength of the dollar versus non-U.S. currencies in the
first quarter of 1997 lowered these returns in U.S. dollar terms.
Global underwriting volume in the 1997 first quarter was up from the 1996
first quarter, even as interest rates rose. The first quarter increase was
fueled by debt issuances, but higher interest rates and concerns about
sustainability of U.S. equity market price levels dampened underwriting
volume in equities. In particular, initial public offerings fell nearly 30%,
to $5.9 billion, from $8.6 billion in the first three months of 1996,
according to Securities Data Co. ("SDC").
Strategic services activities remained strong during the 1997 first quarter,
reflecting a continuation of the high level of mergers and acquisitions
activity experienced in 1996. Driven by globalization and other competitive
and economic factors, companies continued to seek strategic alliances to
increase earnings growth and expand into new markets and businesses.
12
The strong financial markets that characterized 1996 continued into the 1997
first quarter, but began to weaken toward the end of the quarter and into
April. Due to the cyclical nature of the financial services industry, Merrill
Lynch continually evaluates its businesses across market cycles for
profitability and alignment with long-term strategic objectives. Merrill
Lynch seeks to mitigate the effect of market downturns by expanding its
global presence, developing and maintaining long-term client relationships,
closely monitoring costs and risks, and continuing to diversify revenue
sources.
RESULTS OF OPERATIONS
INCREASE/ (DECREASE)
FOR THE THREE MONTHS ENDED
------------------------------------- 1Q97 VERSUS
MARCH 28, DEC. 27, MARCH 29,
(In millions, except per share amounts) 1997 1996 1996 4Q96 1Q96
----------- ----------- ----------- ----- -----
Total revenues................................................... $ 7,451 $ 6,601 $ 6,019 13% 24%
Net revenues..................................................... 3,841 3,382 3,261 14 18
Net earnings..................................................... 465 445 410 5 14
Net earnings applicable to common stockholders................... 455 433 398 5 14
Earnings per common share:
Primary........................................................ 2.34 2.29 2.03 2 15
Fully diluted.................................................. 2.34 2.27 2.03 3 15
Return on average common stockholders' equity.................... 28.3% 28.5% 28.2% (1) --
FIRST QUARTER 1997 VERSUS FIRST QUARTER 1996
The discussion that follows emphasizes the comparison between the first
quarters of 1997 and 1996 and presents additional information on the
comparison between the first quarter of 1997 and the fourth quarter of 1996,
where appropriate.
Merrill Lynch's record net earnings of $465 million in first quarter 1997
surpassed its previous record in fourth quarter 1996 by 5%. Record revenues
in commissions, principal transactions, investment banking, and asset
management and portfolio service fees, partially offset by increased costs,
particularly performance-based compensation and technology-related expenses,
led to record net earnings. Intra-quarter results, which were exceptionally
strong for the first nine weeks of 1997, slowed in March as investors
anticipated prospective increases in interest rates by the Federal Reserve
Board. Less favorable market conditions continued into April as average
weekly net revenues for the fiscal month were approximately 17% below average
weekly net revenues for the 1997 first quarter, but only slightly lower than
average weekly net revenues for April 1996. Nevertheless, due to the
uncertainty of financial markets and interest rates, net revenues for April
1997 may not be indicative of net revenues for the 1997 second quarter.
Commissions revenues are summarized as follows:
THREE MONTHS ENDED
-----------------------
MARCH 28, MARCH 29, PERCENT
(In millions) 1997 1996 INCREASE
----------- ----------- -------------
Listed and over-the-counter..................................................... $ 625 $ 548 14%
Mutual funds.................................................................... 344 299 15
Other........................................................................... 146 142 3
--------- ---------
Total........................................................................... $ 1,115 $ 989 13
--------- ---------
--------- ---------
Commissions revenues from listed and over-the-counter securities increased
14% as a result of higher trading volumes on most non-U.S. exchanges and the
New York Stock Exchange. Mutual fund commissions revenues rose due to higher
distribution fees, primarily related to prior period sales, and strong first
quarter sales of U.S. funds.
13
Significant components of interest and dividend revenues and interest expense
follow:
Three Months Ended
------------------------
March 28, March 29,
(In millions) 1997 1996
- ----------------------------------------------------------------------- ----------- -----------
Interest and dividend revenues:
Trading assets......................................................... $ 1,226 $ 958
Securities borrowed.................................................... 832 676
Resale agreements...................................................... 931 689
Margin lending......................................................... 451 373
Other.................................................................. 408 314
----------- ---------
Subtotal............................................................. 3,848 3,010
----------- ---------
Interest expense:
Borrowings............................................................. 1,515 1,117
Repurchase agreements.................................................. 1,063 847
Trading liabilities.................................................... 753 552
Other.................................................................. 279 242
----------- ---------
Subtotal............................................................. 3,610 2,758
----------- ---------
Net interest and dividend profit....................................... $ 238 $ 252
----------- ---------
----------- ---------
Merrill Lynch hedges certain of its long- and short-term payment obligations
with interest rate and currency swaps. The effect of these hedges, which is
included in "Borrowings" above, decreased interest expense by approximately
$6 and $22 million for the 1997 and 1996 first quarters, respectively.
Net interest and dividend profit declined 6% from the 1996 first quarter.
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.
Principal transactions revenues were up 8% from the 1996 first quarter to
$1.1 billion due to higher trading revenues from fixed-income products and
interest rate and currency swaps, partially offset by declines in equity
trading revenues.
14
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.
Principal Net Interest Net
Transactions Revenues Trading
(In millions) Revenues (Expenses) Revenues
- -------------------------------------------- ------------ ------------ -----------
1997 First Quarter
- ------------------
Equities and equity derivatives............. $ 316 $(31) $ 285
Taxable fixed-income........................ 325 80 405
Interest rate and currency swaps............ 310 (37) 273
Municipals.................................. 82 5 87
Foreign exchange and commodities............ 30 (1) 29
------- -------- -------
Total....................................... $1,063 $ 16 $1,079
------- -------- -------
------- -------- -------
1996 First Quarter
- ------------------
Equities and equity derivatives............. $ 347 $(29) $ 318
Taxable fixed-income........................ 265 58 323
Interest rate and currency swaps............ 255 (9) 246
Municipals.................................. 75 1 76
Foreign exchange and commodities............ 40 (3) 37
-------- --------- -------
Total....................................... $ 982 $ 18 $1,000
-------- --------- -------
-------- --------- -------
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 $316 million, down 9%
from the 1996 first quarter due to lower trading revenues from foreign
equities and convertible securities, which were partially offset by higher
trading revenues in equity derivatives. Weakness in the Japanese equity
market contributed to lower trading revenues from foreign equities and
convertible securities.
Taxable fixed-income trading revenues were $325 million, up 22% from the 1996
first quarter. Higher trading revenues from corporate bonds and preferred
stock and money market instruments were partially offset by lower revenues
from U.S. Government and agencies securities. The increase in trading
revenues from corporate bonds and preferred stock was attributable to
improved liquidity in corporate debt markets resulting from growing investor
concerns regarding price levels of U.S. equities. In addition, credit spreads
narrowed as liquidity increased and views improved for certain sectors,
particularly telecommunications. Trading revenues from money market
instruments benefited in part from increased floating-rate note activity in
European markets. Investor expectations of higher interest rates led to lower
trading volume in U.S. Government and agencies securities.
15
Interest rate and currency swap trading revenues increased 21% to $310
million due to higher revenues from structured products, particularly
derivatives related to currencies and emerging market securities, and higher
customer demand for U.S. dollar-denominated transactions. Municipal
securities trading revenues were up 11% from last year's first quarter to $82
million primarily due to increased investor demand for tax-advantaged
products. Foreign exchange and commodities trading revenues, in the
aggregate, decreased to $30 million, down 25% from the 1996 first quarter.
A summary of Merrill Lynch's investment banking revenues follows:
Three Months Ended
-----------------------
March 28, March 29, Percent
(In millions) 1997 1996 Increase
- ------------ --------- --------- --------
Underwriting revenues................................................ $451 $294 54%
Strategic services revenues.......................................... 157 84 86
------ ------
Total................................................................ $608 $378 61
------ ------
------ ------
Underwriting revenues advanced from the 1996 first quarter due to higher
equity and debt underwriting volume for Merrill Lynch and increased fees from
private placements and commercial loan syndications. Merrill Lynch's
underwriting market share data per SDC for the first quarters of 1997 and
1996 follows:
Three Months Ended Three Months Ended
March 28, 1997 March 29, 1996
------------------ ------------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
U.S.
Debt.......................... 15.3% 1 16.0% 1
Equity........................ 19.3 1 11.6 2
Debt and Equity............... 16.1 1 16.0 1
GLOBAL
Debt.......................... 12.3 1 11.6 1
Equity........................ 19.8 1 9.6 2
Debt and Equity............... 13.2 1 11.8 1
- ------------------------
"SDC statistics are based on full credit to book manager."
Although industrywide volume was down for equity underwriting, Merrill
Lynch's U.S. and Global market shares increased significantly from a year
ago, leading to higher fees in the first quarter of 1997 compared with the
first quarter of 1996. Debt underwriting fees also rose from the first
quarter of 1996 due to an increase in debt underwriting volume industrywide.
16
Strategic services revenues advanced to a record $157 million, benefiting
from strong mergers and acquisitions activity and significant gains in market
share from a year ago. Merrill Lynch's mergers and acquisitions market share
information for the first quarters of 1997 and 1996 follows:
Three Months Ended Three Months Ended
March 28, 1997 March 29, 1996
------------------ ------------------
Market Market
Share Rank Share Rank
------ ---- ------ ----
COMPLETED TRANSACTIONS
U.S........................... 20.3% 2 10.7% 7
Global........................ 11.8 4 7.8 9
ANNOUNCED TRANSACTIONS
U.S........................... 41.3 1 15.5 4
Global........................ 31.8 1 9.5 7
"SDC gives full credit to both target and acquiring companies' advisors based on
transaction value."
Merrill Lynch's asset management and portfolio service fees are summarized
below:
Three Months Ended
---------------------------------------
March 28, March 29, Percent
(In millions) 1997 1996 Increase
- -------------------------------------------------------------------------------- ----------- ----------- -------------
Asset management fees........................................................... $284 $239 19%
Portfolio service fees.......................................................... 178 140 27
Account fees.................................................................... 104 97 8
Other fees...................................................................... 80 62 29
----- -----
Total........................................................................... $646 $538 20
----- -----
----- -----
Asset management fees, which include primarily fees earned on mutual funds
sponsored by Merrill Lynch, increased due to strong inflows of client assets
and net asset appreciation. Total assets in worldwide client accounts reached
a record $868 billion at quarter-end, compared with $731 billion at the end
of the 1996 first quarter. Assets under management were $247 billion at
quarter-end, compared with $208 billion a year ago. New money investments
accounted for approximately 53% of the increase from a year ago in client
assets and approximately 36% of the increase in assets under management. In
addition to new money investments, the 1996 fourth quarter acquisition of
Hotchkis and Wiley, a Los Angeles-based asset management company, added
approximately $10 billion of assets, principally in private portfolio funds.
Portfolio service fees also benefited from inflows of client assets.
Increases in the number of accounts and asset levels led to higher revenues
from asset-based fee products, primarily Merrill Lynch Consults (Registered
Trademark) and Asset Power (Registered Trademark).
Account fees rose due to an increase in the number of customer and custodial
accounts. Other fee-based revenues were up due primarily to increased
revenues from mortgage servicing and transfer agency activities.
Other revenues were $171 million, up 40% from $122 million in the 1996 first
quarter. The increase was due in part to gains on sales of several
partnership investments.
17
Merrill Lynch's non-interest expenses are summarized below:
Three Months Ended
---------------------------------------
March 28, March 29, Percent
(In millions) 1997 1996 Increase
- -------------------------------------------------------------------------------- ----------- ----------- -------------
Compensation and benefits....................................................... $ 1,988 $ 1,691 18%
----------- -----------
Non-interest expenses, excluding compensation and benefits:
Communications and equipment rental........................................... 158 131 21
Occupancy..................................................................... 120 116 4
Depreciation and amortization................................................. 105 98 7
Professional fees............................................................. 198 130 52
Advertising and market development............................................ 144 114 26
Brokerage, clearing, and exchange fees........................................ 118 106 11
Other......................................................................... 244 204 20
----------- -----------
Total non-interest expenses, excluding compensation and benefits................ 1,087 899 21
----------- -----------
Total non-interest expenses..................................................... $ 3,075 $ 2,590 19
----------- -----------
----------- -----------
Compensation and benefits as a percentage of net revenues....................... 51.8% 51.8%
Compensation and benefits as a percentage of pretax earnings before compensation
and benefits.................................................................. 72.2% 71.6%
Non-interest expenses were up 19% from the 1996 first quarter. The largest
expense category, compensation and benefits expense, rose 18% from the 1996
first quarter due to higher incentive and production-related compensation and
increased salary costs. Incentive compensation was up due to improved
profitability, while higher production-related compensation was attributable
to increased business activity. The increase in salary costs was primarily
due to the addition of approximately 4,900 employees since the 1996 first
quarter, resulting in approximately 51,300 employees at the end of the 1997
first quarter. Hirings of technical and other support personnel as well as
business acquisitions were responsible for approximately 69% of the increase.
As a result, the ratio of support employees and sales assistants to producers
increased from 1.46:1 in first quarter 1996 to 1.53:1 in first quarter 1997.
Facilities-related costs, which include communications and equipment rental,
occupancy, and depreciation and amortization rose 11% to $383 million as
increased business volumes and continued emphasis on technology initiatives
led to higher costs.
Professional fees were up 52%, partly due to higher management and systems
consulting costs related to various strategic market studies and technology
projects. Advertising and market development expense rose 26% as a result of
increased international travel and higher client promotion costs. Brokerage,
clearing, and exchange fees were up 11% due to increased trading volume,
particularly in international equity markets. Other expenses rose 20%
as a result of increases in provisions related to various business
activities, office supplies and postage costs, and goodwill amortization.
Income tax expense was $291 million in the 1997 first quarter. The effective
tax rate in the 1997 first quarter was 38.0%, compared with 39.0% in the
year-ago period.
18
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: (i) to 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 any business assets; (ii) to
concentrate unsecured, general purpose borrowings at the parent company
level; and (iii) to 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 sources include
liquidating cash equivalents; securitizing loan assets; and drawing on
committed, unsecured credit facilities ("Credit Facilities") provided by
banks, which at March 28, 1997 totaled $6.3 billion and were not drawn upon.
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 the Credit Facilities. The mix of
assets and liabilities provides flexibility in managing liquidity since a
significant portion of assets turn over frequently and are typically
match-funded with liabilities having similar maturities and cash flow
characteristics. At March 28, 1997, substantially all of Merrill Lynch's
assets were considered readily marketable by management.
Merrill Lynch concentrates its unsecured, general purpose borrowings at the
parent company level, except where tax regulations, time zone differences, or
other business considerations make this impractical. The benefits of this
strategy are reduced financing costs; simplicity, control, and wider name
recognition by creditors of Merrill Lynch; and enhanced flexibility to meet
fluctuating funding requirements across subsidiaries.
Finally, Merrill Lynch 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 $28.5 billion at March 28, 1997 and
$23.6 billion at December 27, 1996, which represented 12% and 11% of total
assets at first quarter-end 1997 and year-end 1996, respectively.
Outstanding long-term debt at March 28, 1997, increased to $29.7 billion,
from $26.1 billion at year-end 1996.
19
At March 28, 1997, Merrill Lynch's senior long-term debt and preferred stock
were rated by recognized credit rating agencies, as follows:
Senior Preferred
Debt Stock
Rating Agency Rating Rating
- ---------------------------------------------------- ----------- ------------
Duff & Phelps Credit Rating Co. AA AA-
Fitch Investors Service, L.P. AA AA-
IBCA Inc. AA- Not Rated
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
- -------------------------------------------------------------------------------
During the first three months of 1997, Merrill Lynch issued $5.4 billion in
long-term debt. During the same period, maturities and repurchases were $1.4
billion. In addition, approximately $316 million of Merrill Lynch's long-term
debt securities held by subsidiaries were sold and $202 million were
purchased. At March 28, 1997, $22.4 billion of term debt had maturity dates
beyond one year.
Approximately $64.1 billion of Merrill Lynch's indebtedness at March 28, 1997
is considered senior indebtedness as defined in its subordinated indenture.
As part of Merrill Lynch's overall liquidity management strategy, its
insurance subsidiaries regularly review the funding requirements of their
contractual obligations for in-force, fixed-rate life insurance and annuity
contracts and expected future acquisition and maintenance expenses for all
contracts. Insurance subsidiaries market primarily variable life insurance
and variable annuity products. These products are not subject to the interest
rate, asset/liability matching, and credit risks attributable to fixed-rate
products, thereby reducing the risk profile and liquidity demands on the
insurance subsidiaries. At March 28, 1997, approximately 88% of invested
assets of insurance subsidiaries were considered liquid by management.
CAPITAL RESOURCES AND CAPITAL ADEQUACY
Merrill Lynch is one of the most highly capitalized U.S. institutions
primarily involved in the global securities business, with $6.5 billion in
common equity and $425 million in preferred stock at March 28, 1997. During
the first quarter of 1997, the parent company redeemed all of its $194 million
Remarketed Preferred (Service Mark) Stock, Series C shares. In February 1997 a
subsidiary of Merrill Lynch issued $300 million of perpetual Trust Originated
Preferred Securities (Service Mark). These subsidiary-issued preferred
securities, in addition to $327 million of preferred securities outstanding
in other subsidiaries, further strengthen Merrill Lynch's equity capital
base.
20
Merrill Lynch's leverage ratios were as follows:
Adjusted
Leverage Leverage
Ratio(1) Ratio(2)
----------- -----------
Period-end
March 28, 1997........................................................... 32.8x 20.6x
December 27, 1996........................................................ 29.5x 18.0x
Average (3)
Three months ended
March 28, 1997......................................................... 33.4x 19.9x
Year ended
December 27, 1996...................................................... 33.5x 19.9x
(1) Total assets to total stockholders' equity and preferred securities issued
by subsidiaries.
(2) Total assets less resale agreements and securities borrowed to total
stockholders' equity and preferred securities issued by subsidiaries.
(3) Based on 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 and
other criteria, management believes that Merrill Lynch's equity base is
adequate.
Merrill Lynch operates in many regulated businesses that require various
minimum levels of capital. (See "Regulatory Requirements" section in Notes to
the Consolidated Financial Statements--Unaudited.) 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.
AVERAGE ASSETS AND LIABILITIES
Merrill Lynch monitors changes in its balance sheet using average daily
balances which 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.
For the first three months of 1997, average daily assets were $251 billion,
up 6% versus $237 billion for the 1996 fourth quarter. Average daily
liabilities rose 6% to $244 billion from $230 billion for the 1996 fourth
quarter. The major components in the growth of average daily assets and
liabilities for the 1997 first quarter are summarized as follows:
21
Increase in
Average Assets Percent Increase
--------------- ---------------------
(In millions)
Trading assets............................................... $ 7,646 9%
Resale agreements and securities borrowed.................... $ 4,924 5
Increase in
Average
Liabilities Percent Increase
----------------- ---------------------
Trading liabilities....................................... $ 6,623 14%
Long-term borrowings...................................... $ 3,283 13
Repurchase agreements and securities loaned............... $ 2,910 3
Due to the adoption of SFAS No. 125 average Trading Assets and Repurchase
Agreements balances increased by approximately $1.5 billion. (See "Accounting
Change" section in the Notes to the Consolidated Financial Statements
(Unaudited) for more information on SFAS No. 125.) In addition, during the
first quarter of 1997, trading assets and liabilities (which include
on-balance-sheet hedges used to manage trading risks) rose as volume
increased to meet higher customer demand. Repurchase agreements and
securities loaned transactions and resale agreements and securities borrowed
transactions rose to fund the increase in 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, commercial paper and other unsecured short-term borrowings,
long-term borrowings, and equity. In addition to the increase in repurchase
agreements and securities loaned transactions, the growth in average assets
was funded by higher long-term borrowings, particularly medium-term notes.
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.
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. Non-investment
grade trading inventories have continued to increase 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 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.
22
Merrill Lynch's insurance subsidiaries also hold non-investment grade
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:
March 28, Dec. 27,
(In millions) 1997 1996
- ----------------------------------------------------------------------------------------------------
Trading assets:
Cash instruments......................................................... $ 8,874 $ 7,585
Derivatives(1)........................................................... 2,070 2,470
Trading liabilities--cash instruments...................................... 1,465 905
Insurance subsidiaries' investments........................................ 211 206
- ----------------------------------------------------------------------------------------------------
(1) Collateral of $607 and $848 was obtained at March 28, 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
March 28, 1997, the carrying value of such debt and equity securities totaled
$152 million, of which 56% resulted from Merrill Lynch's market-making
activities in such securities. This compared with $133 million at December
27, 1996, of which 58% related to market-making activities. In addition,
Merrill Lynch held distressed bank loans totaling $369 million and $351
million at March 28, 1997 and year-end 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, since changes in credit quality of the underlying securities may affect
the derivatives' fair values.
A summary of exposures related to derivatives with non-investment grade
underlying securities follows:
March 28, Dec. 27,
(In millions) 1997 1996
- --------------------------------------------------------------------------------------------------------
Derivative fair values:
Trading assets(1)........................................................ $ 42 $ 63
Trading liabilities...................................................... 71 64
Derivative notionals (off-balance-sheet) (2)............................. 2,543 2,895
- --------------------------------------------------------------------------------------------------------
(1) Included in these amounts are $17 and $9 at March 28, 1997 and year-end
1996, respectively, that are also exposed to credit risk related to a
non-investment grade counterparty, which are included in the preceding
table.
(2) Calculated as notional 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.
23
A summary of cash instruments and derivatives used to hedge the credit risk
of non-investment grade positions follows:
March 28, Dec. 27,
(In millions) 1997 1996
- ---------------------------------------------------------------------------------------------------
Trading assets--cash instruments......................................... $ 713 $ 905
Derivative notionals (off-balance-sheet)(1).............................. 1,619 1,311
- ---------------------------------------------------------------------------------------------------
(1) Calculated as notional subject to strike or reference price.
At March 28, 1997 the largest non-investment grade concentration consisted of
various sovereign and corporate issues of a South American country totaling
$1.1 billion, which primarily represented hedges of other financial
instruments.
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:
March 28, Dec. 27,
(In millions) 1997 1996
- ---------------------------------------------------------------------------------------------------
Loans (net of allowance for loan losses)(1).............................. $317 $340
Equity investments(2).................................................... 110 113
Partnership interests.................................................... 105 104
Bridge loan(3)........................................................... 75 31
Additional commitments to invest in partnerships......................... 76 82
Unutilized revolving lines of credit and other lending commitments....... 148 301
- ---------------------------------------------------------------------------------------------------
(1) Represented outstanding loans to 31 and 36 medium-sized companies at March
28, 1997 and year-end 1996, respectively.
(2) Invested in 47 and 48 enterprises at March 28, 1997 and year-end 1996,
respectively.
(3) The bridge loans outstanding at first quarter 1997 and year-end 1996 were
repaid subsequent to their respective period ends.
At March 28, 1997, no one industry sector accounted for more than 22% of
total non-investment grade positions and highly leveraged transactions.
24
STATISTICAL DATA
Selected statistical data for the last five quarters are presented below for
informational purposes:
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. 1st Qtr.
1996 1996 1996 1996 1997
---------- ---------- ---------- ---------- ----------
CLIENT ACCOUNTS
(IN BILLIONS):
Assets in U.S. Client Accounts............ $ 691 $ 714 $ 735 $ 792 $ 818
Assets in non-U.S.
Client Accounts......................... 40 42 44 47 50
---------- ---------- ---------- ---------- ----------
Total Assets in Client Accounts............ $ 731 $ 756 $ 779 $ 839 $ 868
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Assets under management:
Money Market............................. $ 89 $ 84 $ 86 $ 90 $ 99
Equity................................... 51 53 54 59 62
Fixed-Income............................. 41 41 42 43 43
Private Portfolio........................ 23 25 27 38 40
Insurance................................ 4 4 4 4 3
---------- ---------- --------- --------- ---------
Total assets under management.............. $ 208 $ 207 $ 213 $ 234 $ 247
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
ML Consults (Registered Trademark)....... $ 18 $ 19 $ 20 $ 21 $ 21
Mutual Fund Advisor(Service Mark) and
Asset Power (Registered Trademark)...... $ 7 $ 7 $ 8 $ 9 $ 10
401(k) Assets............................ $ 38 $ 40 $ 41 $ 45 $ 47
UNDERWRITING (DOLLARS IN
BILLIONS)(A):
Global Debt and Equity:
Volume................................... $ 45 $ 47 $ 45 $ 50 $ 56
Market Share............................. 11.8% 12.7% 14.0% 13.2% 13.2%
U.S. Debt and Equity:
Volume................................... $ 39 $ 39 $ 36 $ 42 $ 45
Market Share............................. 16.0% 15.8% 16.9% 16.7% 16.1%
- -----------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES:
U.S...................................... 39,400 39,900 41,400 42,200 42,900
Non-U.S.................................. 7,000 7,100 7,400 7,600 8,400
---------- ---------- --------- --------- ---------
TOTAL.................................... 46,400 47,000 48,800 49,800 51,300
---------- ---------- --------- --------- ---------
---------- ---------- --------- --------- ---------
Financial Consultants and
Account Executives
Worldwide.............................. 13,900 14,000 14,300 14,400 14,600
Support Personnel to Producer
ratio (B).............................. 1.46 1.47 1.48 1.51 1.53
INCOME STATEMENT:
Net Earnings (in millions)............... $ 410 $ 433 $ 331 $ 445 $ 465
Annualized Return on
Average Common Stockholders'
Equity................................. 28.2% 29.2% 21.5% 28.5% 28.3%
Earnings per Common Share(C):
Primary................................ $ 2.03 $ 2.19 $ 1.69 $ 2.29 $ 2.34
Fully Diluted.......................... $ 2.03 $ 2.19 $ 1.68 $ 2.27 $ 2.34
BALANCE SHEET (IN MILLIONS):
Total Assets............................. $ 195,884 $205,175 $207,911 $213,016 $247,603
Total Stockholders' Equity............... $ 6,364 $ 6,514 $ 6,618 $ 6,892 $ 6,925
SHARE INFORMATION (IN THOUSANDS)(C):
Weighted Average Shares Outstanding:
Primary................................ 196,225 192,933 189,210 189,445 194,534
Fully Diluted.......................... 196,225 192,933 190,634 190,703 194,534
Common Shares Outstanding (D)............ 173,040 168,924 165,629 164,086 165,461
Shares Repurchased....................... 4,543 6,060 4,552 3,424 3,769
- -----------------------------------------------------------------------------------------------------
(A) Full credit to book manager. All market share data are derived from
Securities Data Co.
(B) Support personnel includes sales assistants.
(C) Earnings per common share amounts and other share information have not
been adjusted for the two-for-one common stock split, effective May 30,
1997.
(D) Does not include 2,895, 2,529, 2,093, 1,539, and 468 unallocated reversion
shares held in the Employee Stock Ownership Plan at period end March 31,
1996, June 28, 1996, September 27, 1996, December 27, 1996, and March 28,
1997, respectively, which are not considered outstanding for accounting
purposes.
25
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
NASDAQ Antitrust Litigation.
- ---------------------------
The following developments have occurred since the filing of the 1996 Form
10-K with respect to the NASDAQ Antitrust Litigation described therein. On
April 23, 1997, the United States District Court for the Southen District of
New York approved the proposed settlement of the civil antitrust complaint
filed by the Antitrust Division of the United States Department of Justice.
GSLIC Litigation.
- ----------------
The following developments have occurred since the filing of the 1996 Form
10-K with respect to the GSLIC litigation described therein. On May 6, 1997,
the GSLIC Litigation was dismissed by the Supreme Court of the State of New
York, New York County.
Item 4. Submission of Matters to a Vote of Security Holders.
---------------------------------------------------
On April 15, 1997, the Corporation held its Annual Meeting of Stockholders,
at which 89.4% of the shares of Common Stock, par value $1.33 1/3 per share,
outstanding and eligible to vote, either in person or by proxy, were
represented, constituting a quorum. At this Annual Meeting, the following
matters were voted upon: (i) the election of five directors to the Board of
Directors to hold office for a term of three years; (ii) the approval of a
proposal to amend the ML & Co. Long-Term Incentive Compensation Plan; (iii)
the approval of a proposal to amend a definition in the performance goal
formula applicable to annual cash bonuses and grants of restricted shares and
units to executive management; (iv) a stockholder proposal concerning
cumulative voting in the election of directors; and (v) a stockholder
proposal concerning disclosure of the relationship of derivatives claims to
underlying assets. Proxies for the Annual Meeting of Stockholders were
solicited by the Board of Directors pursuant to Regulation 14A of the
Securities Exchange Act of 1934.
The stockholders elected all five nominees to three year terms as members of
the Board of Directors as set forth in the Corporation's Proxy Statement.
There was no solicitation in opposition to such nominees. The votes cast for
or withheld from the election of directors were as follows: William O. Bourke
received 148,322,202 votes in favor and 2,102,911 votes were withheld; W.H.
Clark received 148,265,418 votes in favor and 2,159,695 votes were withheld;
Stephen L. Hammerman received 148,345,075 votes in favor and 2,080,038 votes
were withheld; Aulana L. Peters received 147,308,892 votes in favor and
3,116,221 votes were withheld; and John J. Phelan, Jr. received 148,362,681
votes in favor and 2,062,432 votes were withheld.
The stockholders approved the proposal to amend the ML & Co. Long-Term
Incentive Compensation Plan. The votes cast for and against, as well as the
number of abstentions, for this proposal were as follows: 144,402,000 votes
in favor, 5,242,784 votes against, and 780,329 shares abstained.
26
The stockholders approved the proposal to amend a definition in the
performance goal formula applicable to annual cash bonuses and grants of
restricted shares and units to executive management. The votes cast for and
against, as well as the number of abstentions, for this proposal were as
follows: 143,335,525 votes in favor, 5,755,157 votes against, and 1,334,431
shares abstained.
The stockholders did not approve the stockholder proposal concerning
cumulative voting in election of directors. The votes cast for and against,
as well as the number of abstentions and broker non-votes, for this proposal
were as follows: 28,605,735 votes in favor, 98,715,003 votes against,
2,986,542 shares abstained, and 20,117,833 shares represented broker
non-votes.
The stockholders did not approve the stockholder proposal concerning
disclosure of the relationship of derivatives claims to underlying assets.
The votes cast for and against, as well as the number of abstentions and
broker non-votes, for this proposal were as follows: 6,401,802 votes in
favor, 122,026,107 votes against, 1,879,371 shares abstained, and 20,117,833
shares represented broker non-votes.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(3)(i) By-Laws of Merrill Lynch & Co., Inc. effective as of
April 15, 1997.
(4) Instruments defining the rights of security holders, including
indentures:
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the
Corporation hereby undertakes to furnish to the Securities and
Exchange Commission (the "Commission"), upon request, copies of
the instruments defining the rights of holders of long-term debt
securities of the Corporation that authorize an amount of securities
constituting 10% or less of the total assets of the Corporation and
its subsidiaries on a consolidated basis.
(10) ML & Co. Fee Deferral Plan for Non-Employee Directors, as amended
through April 15, 1997.
(11) Statement re: computation of per share earnings.
(12) Statement re: computation of ratios.
(15) Letter re: unaudited interim financial information.
(27) Financial Data Schedule.
27
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by the
Corporation with the Commission during the quarterly period covered
by this Report:
(i) Current Report dated January 13, 1997 for the purpose of filing
the form of Registrant's 7% Notes due January 15, 2007.
(ii) Current Report dated January 27, 1997 for the purpose of filing
the Preliminary Unaudited Earnings Summaries of the Corporation
for the three- and twelve-month periods ended December 27,
1996.
(iii) Current Report dated February 25, 1997 for the purpose of
filing the Preliminary Unaudited Consolidated Balance Sheet
of the Corporation as of December 27, 1996.
(iv) Current Report dated March 14, 1997 for the purpose of filing
the audited financial statements of the Corporation for its
1996 fiscal year.
(v) Current Report dated March 14, 1997 for the purpose of filing
the form of Registrant's S&P 500 Market Index Target-Term
Securities due September 16, 2002.
28
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)
Date: May 9, 1997 By: /s/ Joseph T. Willett
-------------------------
Joseph T. Willett
Senior Vice President
Chief Financial Officer
29
INDEX TO EXHIBITS
Exhibits
3(i) By-Laws of Merrill Lynch & Co., Inc. effective as of April 15, 1997
10 ML & Co. Fee Deferral Plan for Non-Employee Directors, as amended
through April 15, 1997.
11 Statement re: computation of per share earnings.
12 Statement re: computation of ratios.
15 Letter re: unaudited interim financial information.
27 Financial Data Schedule.