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Show all filings for MERRILL LYNCH & CO., INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for MERRILL LYNCH & CO., INC.


2-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Forward-Looking Statements

This report on Form 10-Q, the documents that it incorporates by reference and the documents into which it may be incorporated by reference may contain, and from time to time Merrill Lynch & Co., Inc. ("ML & Co. and, together with its subsidiaries, "Merrill Lynch," the "Company," "we," "our" or "us") and its management may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, "we," "us" and "our" may refer to ML & Co. individually, ML & Co. and its subsidiaries, or certain of ML & Co.'s subsidiaries or affiliates. These statements can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements often use words such as "expects," "anticipates," "believes," "estimates," "targets," "intends," "plans," "goal" and other similar expressions or future or conditional verbs such as "will," "may," "might," "should," "would" and "could." The forward-looking statements made represent the current expectations, plans or forecasts of Merrill Lynch regarding its future results and revenues and future business and economic conditions more generally, including statements concerning: expectations regarding the impact of United Kingdom ("U.K.") corporate income tax rate reductions on Merrill Lynch's income tax expense; the expectation that unresolved repurchase claims related to private-label securitization trustees will continue to increase; the resolution of representations and warranties repurchase and other claims; the final resolution of the BNY Mellon Settlement; the estimates of liability and range of possible loss for representations and warranties repurchase claims; the possibility that future representations and warranties losses may occur in excess of the amounts recorded for those exposures; Merrill Lynch's intention to vigorously contest any requests for repurchase for which it concludes that a valid basis does not exist; that swap dealers will continue to be subject to additional Commodity Futures Trading Commission rules as and when such rules take effect; the possibility that Merrill Lynch will need to register additional entities as swap dealers and major swap participants; the possibility that Merrill Lynch will be required to restructure certain businesses as a result of final derivatives regulations that impose additional operational and compliance costs; effects of the ongoing debt crisis in certain European countries, including the expectation of continued market volatility, the expectation that Merrill Lynch will continue to support client activities in the region and that exposures may vary over time as Merrill Lynch monitors the situation and manages its risk profile; liquidity; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act; that it is our objective to maintain high-quality credit ratings; the estimated range of possible loss from and the impact on Merrill Lynch of various legal proceedings discussed in Note 14 to the Condensed Consolidated Financial Statements; Bank of America's intentions to streamline its organizational structure and reduce complexity and costs by reducing the number of its subsidiaries, and that Bank of America may, subject to applicable regulatory approvals, consents and other conditions of closing, merge ML & Co. with and into Bank of America Corporation and that such a merger may occur as early as the fourth quarter of 2013; and other matters relating to Merrill Lynch. The foregoing is not an exclusive list of all forward-looking statements we make. These statements are not guarantees of future results or performance and involve certain risks, uncertainties and assumptions that are difficult to predict and often are beyond our control. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.

You should not place undue reliance on any forward-looking statement and should consider the following uncertainties and risks, as well as the risks and uncertainties more fully discussed elsewhere in this report, under Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012, and in any of ML & Co.'s subsequent Securities and Exchange Commission ("SEC") filings: Merrill Lynch's ability to resolve its representations and warranties repurchase claims made by monolines and private-label and other investors, including as a result of any adverse court rulings, and the chance that we could face related securities, fraud, indemnity or other claims from one or more of the monolines or private-label and other investors; uncertainties about the financial stability of several countries in the European Union (the "EU"), the risk that those countries may default on their sovereign debt and related stresses on financial markets, the Euro and the EU and Merrill Lynch's exposures to such risks, including direct, indirect and operational; the negative impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act on Merrill Lynch's businesses and earnings, including as a result


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of additional regulatory interpretation and rulemaking; adverse changes to Merrill Lynch's credit ratings from the major credit rating agencies; estimates of the fair value of certain of Merrill Lynch's assets and liabilities; the possibility that the European Commission will impose remedial measures in relation to its investigation of competitive practices; the outcome of any regulatory or governmental investigations; unexpected claims, damages and fines resulting from pending or future litigation and regulatory proceedings; decisions to downsize, sell or close units or otherwise change the business mix of Merrill Lynch; and other similar matters.

Forward-looking statements speak only as of the date they are made, and Merrill Lynch undertakes no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.

The Notes to the Condensed Consolidated Financial Statements referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations (the "MD&A") are incorporated by reference into MD&A. Certain prior-period amounts have been reclassified in order to conform with the current period presentation.

Introduction

Merrill Lynch was founded in 1914 and became a publicly traded company on June 23, 1971. In 1973, the holding company ML & Co. was created. Through our subsidiaries, we are one of the world's leading capital markets, advisory and wealth management companies. We are a leading global trader and underwriter of securities and derivatives across a broad range of asset classes, and we serve as a strategic advisor to corporations, governments, institutions and individuals worldwide. On January 1, 2009, Merrill Lynch was acquired by, and became a wholly-owned subsidiary of, Bank of America Corporation ("Bank of America").

As part of Bank of America's efforts to streamline its organizational structure and reduce complexity and costs, it has reduced and intends to continue to reduce the number of its subsidiaries, including through intercompany mergers. In connection with these efforts, Bank of America may merge ML & Co. directly into Bank of America Corporation and such a merger may occur as early as the fourth quarter of 2013. Under Delaware law, as a result of such a merger, Bank of America Corporation would assume all of ML & Co.'s obligations, including its outstanding U.S. and non-U.S. debt securities, its obligations with respect to outstanding trust preferred securities and ML & Co. guarantees of outstanding non-U.S. debt securities issued by ML & Co. subsidiaries. Also, as a result of such a merger, ML & Co.'s reporting obligations under the Securities Exchange Act of 1934 would terminate and ML & Co. would cease to separately file reports with the SEC. There can be no assurance that such a merger will occur, and if it does, the timing thereof. Any such merger would be subject to applicable regulatory approvals, consents and other conditions of closing.

Intragroup Reorganization

On November 1, 2012, in connection with an intragroup reorganization involving Bank of America and a number of its subsidiaries, Merrill Lynch acquired two affiliated companies and their respective subsidiaries from Bank of America. The acquisition was effected through a non-cash capital contribution from Bank of America. In accordance with Accounting Standards Codification ("ASC") 805, Business Combinations, Merrill Lynch's Condensed Consolidated Financial Statements appearing in Part I, Item 1 of this Form 10-Q include the historical results of the acquired affiliated companies and their subsidiaries as if the transaction had occurred as of January 1, 2009, the date at which all the affected entities were first under the common control of Bank of America. Merrill Lynch has recorded the assets and liabilities acquired in connection with the transaction at their historical carrying values.

Business Segments

Pursuant to ASC 280, Segment Reporting, operating segments represent components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in


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determining how to allocate resources and in assessing performance. The business activities of Merrill Lynch are included within certain of the operating segments of Bank of America. Detailed financial information of the nature that could be used to allocate resources and assess the performance and operations for components of Merrill Lynch, however, is not provided to Merrill Lynch's chief operating decision maker. As a result, Merrill Lynch does not contain any identifiable operating segments under Segment Reporting, and therefore the financial information of Merrill Lynch is presented as a single segment.

Form 10-Q Presentation

As a result of the acquisition of Merrill Lynch by Bank of America, certain information is not included in this Quarterly Report on Form 10-Q as permitted by General Instruction H of Form 10-Q. We have also abbreviated the MD&A as permitted by General Instruction H.


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EXECUTIVE OVERVIEW

We reported net income of $967 million and $760 million for the three and six months ended June 30, 2013, respectively, compared with net income of $988 million for the three months ended June 30, 2012 and a net loss of $618 million for the six months ended June 30, 2012. Revenues, net of interest expense ("net revenues") for the three and six months ended June 30, 2013 were $6.3 billion and $12.7 billion, respectively, compared with $5.1 billion and $9.9 billion for the three and six months ended June 30, 2012, respectively. Our pre-tax earnings were $752 million and $416 million for the three and six months ended June 30, 2013, respectively. We recorded pre-tax earnings of $218 million and a pre-tax loss of $1.6 billion in the three and six months ended June 30, 2012, respectively.

Our net earnings for the three months ended June 30, 2013 reflected an increase in net revenues, which was primarily driven by higher investment banking revenues and lower net interest expenses. Our non-interest expenses also increased, primarily reflecting an expense reduction of $840 million that was recorded in the three months ended June 30, 2012. In that period, our liability for representations and warranties exposures decreased because levels of claims and file requests with certain counterparties were less than originally anticipated, and a portion of the loss was no longer deemed probable. Our net results for the three months ended June 30, 2013 also included a less favorable effective income tax rate as compared with the prior year period.

The increase in our net earnings for the six months ended June 30, 2013 was primarily driven by an increase in our net revenues. Such increase was primarily attributable to higher principal transactions revenues associated with the valuation of certain of our liabilities as compared with the prior year period. During the six months ended June 30, 2013, we recorded net gains of $12 million due to the impact of the widening of Merrill Lynch's credit spreads on the carrying value of certain of our long-term debt liabilities, primarily structured notes, as compared with net losses of $2.2 billion recorded in the prior year period due to the narrowing of our credit spreads. We also recorded gains due to the impact of net valuation adjustments associated with changes in our credit spreads on the fair value of certain derivative liabilities (i.e., the debit valuation adjustment or "DVA") of $3 million in the six months ended June 30, 2013 as compared with DVA losses of $770 million in the six months ended June 30, 2012. These increases in principal transactions revenues were partially offset by lower revenues generated by our fixed income trading businesses. As discussed above, our non-interest expenses increased primarily due to a $0.8 billion expense reduction recorded in the six months ended June 30, 2012 to lower our liability for representations and warranties exposures.

Transactions with Bank of America

We have entered into various transactions with Bank of America, including transactions in connection with certain sales and trading and financing activities, as well as the allocation of certain shared services. Total net revenues and non-interest expenses related to transactions with Bank of America for the three months ended June 30, 2013 were $546 million and $545 million, respectively. Such net revenues and non-interest expenses for the six months ended June 30, 2013 were $851 million and $1,107 million, respectively. Total net revenues and non-interest expenses related to transactions with Bank of America for the three months ended June 30, 2012 were $349 million and $656 million, respectively. Such net revenues and non-interest expenses for the six months ended June 30, 2012 were $619 million and $1,082 million, respectively. Net revenues and non-interest expenses for both periods included intercompany service fee revenues and expenses from Bank of America associated with allocations of certain centralized or shared business activities between Merrill Lynch and Bank of America. See Note 2 to the Condensed Consolidated Financial Statements for further information.

During the three and six months ended June 30, 2013, Merrill Lynch acquired certain residential mortgage loans from Bank of America. Such loans had an aggregate unpaid principal balance of $5.3 billion and an aggregate carrying value of $4.2 billion as of June 30, 2013. See Note 10 to the Condensed Consolidated Financial Statements for further information.


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Other Events

U.K. Corporate Income Tax Rate Change

On July 17, 2013, the U.K. 2013 Finance Bill was enacted, which reduced the U.K. corporate income tax rate by three percent to 20%. The first two percent of the reduction will become effective on April 1, 2014 and the additional one percent reduction will be effective on April 1, 2015. These reductions will favorably affect income tax expense on future U.K. earnings, but also require us to remeasure, in the period of enactment, our U.K. net deferred tax assets using the lower tax rates. As a result, in the quarter ending September 30, 2013, we will record a charge to income tax expense of approximately $1.1 billion in the aggregate for these reductions.

Regulatory Matters

U.K. Regulatory Framework

Prior to April 1, 2013, our financial services operations in the U.K. were subject to regulation by and supervision of the Financial Services Authority (the "FSA"). On April 1, 2013, the U.K. abolished the FSA, replacing it with two new regulators, the Prudential Regulatory Authority (the "PRA") and the Financial Conduct Authority (the "FCA"). The PRA operates as a subsidiary of the Bank of England with responsibility for prudential regulation and supervision of banks, insurers and systemically significant investment firms. The FCA regulates and supervises the market conduct of all U.K. financial firms and prudentially regulates those firms not within the scope of the PRA. Our financial services operations in the U.K. are now subject to regulation and supervision by both the PRA and FCA.

Financial Reform Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Financial Reform Act"), which was signed into law on July 21, 2010, enacted sweeping financial regulatory reform and has altered and will continue to alter the way in which we conduct certain businesses, increase our costs and reduce our revenues. Many aspects of the Financial Reform Act remain subject to final rulemaking that will take effect over several years, making it difficult to anticipate the precise impact on us, our customers or the financial services industry.

Derivatives

Pursuant to the Financial Reform Act and subsequent Commodity Futures Trading Commission ("CFTC") rulemaking, we have registered certain of our subsidiaries as swap dealers with the CFTC and we may need to register additional entities as swap dealers or major swap participants as a result of the CFTC's July 2013 final cross-border guidance discussed below. Upon registration, swap dealers and major swap participants become subject to certain CFTC rules, including measures regarding clearing and exchange trading of certain derivatives, new capital and margin requirements, additional reporting, external and internal business conduct, swap documentation and portfolio compression and reconciliation requirements for derivatives. Most of these requirements, with the exception of margin, capital and exchange trading, have gone into effect, except with respect to swaps between our non-U.S. swap dealers and non-U.S. branches of Bank of America, N.A. with certain non-U.S. counterparties. Swap dealers are now required to clear certain interest rate and index credit derivative transactions when facing all counterparty types other than corporate counterparties and third-party subaccounts and, after September 9, 2013, will be required to clear all such interest rate and index credit derivative transactions, unless either counterparty qualifies for the "end-user exception" to the clearing mandate. These products will also become subject to exchange trading requirements beginning in the fourth quarter of 2013. The timing for margin implementation remains unknown. The Financial Reform Act and subsequent rulemaking by the Office of the Comptroller of the Currency also require Bank of America, N.A. to "push out" certain derivatives activity to one or more non-bank affiliates, including, potentially, Merrill Lynch and Co., Inc. and affiliates, by July 2015.


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On July 12, 2013, the CFTC provided temporary exemptive relief from application of derivatives requirements of the Financial Reform Act for certain non-U.S. derivatives activity and adopted a final cross-border framework to apply CFTC requirements outside the U.S. Europe and various G-20 jurisdictions are also enacting their own derivatives regulations, although the overall pace of non-U.S. reform is behind that of the U.S. The ultimate impact on us of the derivatives regulations that have not yet been finalized and the time it will take us to comply with unfinalized requirements remains uncertain. Final regulations will impose additional operational and compliance costs on us, may require us to restructure certain businesses and may negatively impact our results of operations.

For information regarding other significant regulatory matters, see Item 1A. "Risk Factors" in our 2012 Annual Report on Form 10-K.

Sale of International Wealth Management Business In 2012, we entered into agreements to sell our International Wealth Management ("IWM") business based outside of the U.S., subject to regulatory approval in multiple jurisdictions, and the first of a series of closings occurred in February 2013. During the six months ended June 30, 2013, we recorded a loss of $71 million associated with certain initial costs incurred with the sale of the IWM business. Additional closings occurred in July 2013, which resulted in a gain of approximately $90 million.

MBIA Settlement

On May 7, 2013, Bank of America entered into a comprehensive settlement (the "MBIA Settlement") with MBIA, Inc. and certain of its affiliates ("MBIA") to resolve all outstanding litigation between the parties, as well as other claims between the parties. Under the MBIA Settlement, all pending litigation between the parties was dismissed and each party received a global release of those claims. In connection with the MBIA Settlement, the parties also terminated various credit default swap ("CDS") transactions in connection with commercial mortgage-backed securities ("CMBS"). Collectively, those CDS transactions had a notional value of $7.4 billion and a fair value of $813 million as of March 31, 2013, and, in connection with the MBIA Settlement, MBIA terminated its CDS with Merrill Lynch, and Bank of America paid Merrill Lynch the value of such terminated CDS.

For further information, see "Results of Operations - Six Months Ended June 30, 2013 Compared With Six Months Ended June 30, 2012" and Note 6 to the Condensed Consolidated Financial Statements.


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RESULTS OF OPERATIONS
(dollars in millions)
                                                                                                                             % Change
                                                                                                                   % Change  between
                                                                                                                   Between     the
                                                                                                                     the       Six
                                                                                                                    Three     Months
                                                                                                                    Months    Ended
                                                                                                                    Ended    June 30,
                                                                                                                   June 30,  2013 and
                                                                                                                   2013 and  the Six
                                                                                                                  the Three   Months
                                                                                                                    Months    Ended
                         For The Three Months   For The Six Months    For The Three Months   For The Six Months   Ended June June 30,
                          Ended June 30, 2013   Ended June 30, 2013   Ended June 30, 2012    Ended June 30, 2012   30, 2012    2012
Revenues
Principal transactions   $        1,904        $        4,048        $         1,948        $        1,782           (2)%      127%
Commissions                       1,410                 2,789                  1,240                 2,595            14        7
Managed account and
other fee-based revenues          1,467                 2,862                  1,399                 2,686            5         7
Investment banking                1,431                 2,847                  1,053                 2,257            36        26
Earnings (loss) from
equity method
investments                           4                   (42 )                  (29 )                 128           N/M       N/M
Intercompany service fee
revenue from Bank of
America                             294                   534                    205                   372            43        44
Other revenues(1)                   108                  (274 )                  252                 1,029           (57)      N/M
Subtotal                          6,618                12,764                  6,068                10,849            9         18
Interest and dividend
revenues                          1,200                 2,914                    901                 2,792            33        4
Less interest expense             1,469                 3,012                  1,854                 3,761           (21)      (20)
Net interest expense               (269 )                 (98 )                 (953 )                (969 )         (72)      (90)
Revenues, net of
interest expense                  6,349                12,666                  5,115                 9,880            24        28
Non-interest expenses
Compensation and
benefits                          3,518                 8,047                  3,568                 8,082           (1)        -
Communications and
technology                          398                   741                    390                   829            2        (11)
Occupancy and related
depreciation                        279                   574                    296                   601           (6)       (4)
Brokerage, clearing, and
exchange fees                       289                   593                    243                   525            19        13
Advertising and market
development                         137                   254                    129                   237            6         7
Professional fees                   206                   431                    226                   421           (9)        2
Office supplies and
postage                              22                    45                     28                    56           (21)      (20)
Representations and
warranties                           (4 )                  11                   (840 )                (829 )        (100)      N/M
Intercompany service fee
expense from Bank of
America                             434                   878                    538                   932           (19)      (6)
Other                               318                   676                    319                   625            -         8
Total non-interest
expenses                          5,597                12,250                  4,897                11,479            14        7
Pre-tax earnings (loss)             752                   416                    218                (1,599 )         245       N/M
Income tax benefit                 (215 )                (344 )                 (770 )                (981 )         (72)      (65)
Net income (loss)        $          967        $          760        $           988        $         (618 )         (2)       N/M

(1) Amounts include other income and other-than-temporary impairment losses on available-for-sale debt securities. The other-than-temporary impairment . . .

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