Merrill Lynch Reports Third-Quarter 2007 Net Loss From Continuing Operations of $2.85 Per Diluted Share
Record Net Revenues From Global Private Client, Equity Markets and Investment Banking for the First Nine Months of 2007.
NEW YORK. — Merrill Lynch (NYSE: MER) today reported a net loss from continuing operations for the third quarter of $2.3 billion, or $2.85 per diluted share, significantly below net earnings of $2.22 per diluted share for the second quarter of 2007 and $3.14 for the third quarter of 2006. Third-quarter 2006 net earnings per diluted share, excluding the impact of the one-time, after-tax net benefit of $1.1 billion ($1.8 billion pretax) related to the merger of Merrill Lynch Investment Managers (MLIM) and BlackRock (NYSE: BLK), were $1.97. Third-quarter 2007 results reflect significant net write-downs and losses attributable to Merrill Lynch’s Fixed Income, Currencies & Commodities (FICC) business, including write-downs of $7.9 billion across CDOs and U.S. subprime mortgages, which are significantly greater than the incremental $4.5 billion write-down Merrill Lynch disclosed at the time of its earnings pre-release. These write-downs and losses were partially offset by strong revenues in Global Wealth Management (GWM), Equity Markets and Investment Banking, particularly in regions outside of the U.S. The results described above and herein, exclude Merrill Lynch Insurance Group (MLIG), which is reported under discontinued operations.
Third-quarter 2007 total net revenues of $577 million decreased 94 percent from $9.8 billion in the prior-year period and were down 94 percent from $9.7 billion in the second quarter of 2007. Merrill Lynch’s third-quarter 2007 pretax net loss was $3.5 billion. At the end of the third quarter, book value per share was $39.75, down slightly from the end of the third quarter of 2006.
“Mortgage and leveraged finance-related write-downs in our FICC business depressed our financial performance for the quarter. In light of difficult credit markets and additional analysis by management during our quarter-end closing process, we re-examined our remaining CDO positions with more conservative assumptions. The result is a larger write-down of these assets than initially anticipated,” said Stan O’Neal, chairman and chief executive officer. “We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions,” Mr. O’Neal continued. “Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year.”
Net revenues for the first nine months of 2007 were $20.0 billion, down 23 percent from $25.8 billion in the comparable 2006 period. Net earnings per diluted share of $1.94 were down 62 percent from $5.12 in the prior-year period, and net earnings of $2.0 billion were down 61 percent. Results for the first nine months of 2006 included $1.2 billion of one-time, after-tax compensation expenses ($1.8 billion pretax) related to the adoption of Statement of Financial Accounting Standards No. 123R (“one-time compensation expenses”) incurred in the first quarter of 2006, as well as the net benefit associated with the MLIM merger. Excluding these one-time items, net revenues for the first nine months of 2007 were down 16 percent, net earnings per diluted share were down 63 percent and net earnings were down 62 percent from the prior-year period. The pretax profit margin for the first nine months was 12.8 percent, down 14.2 percentage points from the comparable 2006 period, or down 16.3 percentage points excluding the one-time items. The annualized return on average common equity was 6.5 percent, down 13.0 percentage points from the first nine months of 2006, or down 13.4 percentage points excluding the one-time items.
Business Segment Review:
In the first quarter of 2006, Merrill Lynch recorded the one-time compensation expenses (pretax) in the business segments as follows: $1.4 billion to Global Markets and Investment Banking, $281 million to Global Wealth Management and $109 million to Merrill Lynch Investment Managers (which ceased to exist as a business segment upon its merger with BlackRock). The one-time net benefit associated with the MLIM merger was recorded in the Corporate Segment. Comparisons to results from the third quarter and first nine months of 2006 in the following discussion of business segment results exclude the impact of these one-time items.
Global Markets & Investment Banking (GMI)
GMI recorded negative net revenues and a pretax loss for the third quarter of 2007 of $3.0 billion and $4.4 billion, respectively, as strong net revenues from Equity Markets and Investment Banking were more than offset by the net losses in FICC. GMI’s third quarter net revenues also included a net benefit of approximately $600 million due to the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain long-term debt liabilities.
Third-quarter write-downs of $7.9 billion across CDOs and U.S. subprime mortgages are significantly greater than the incremental $4.5 billion write-downs Merrill Lynch disclosed at the time of its earnings pre-release. This is due to additional analysis and price verification completed as part of the quarter-end closing process, including the use of more conservative loss assumptions in valuing the underlying collateral.
FICC net revenues were also impacted by write-downs of $967 million on a gross basis, and $463 million net of related fees, related to all corporate and financial sponsor, non-investment grade lending commitments, regardless of the expected timing of funding or closing. These commitments totaled approximately $31 billion at the end of the third quarter of 2007, a net reduction of 42 percent from $53 billion at the end of the second quarter. The net losses related to these commitments were limited through aggressive and effective risk management, including disciplined and selective underwriting and exposure reductions through syndication, sales and transaction restructurings.
Other FICC businesses reported strong results with record net revenues in interest rates and currencies and solid results in commodities and commercial real estate.
For the first nine months of 2007, FICC net revenues were negative $153 million as strength in interest rate products, currencies and commercial real estate was more than offset by declines in credit products and the structured finance and investments business.
o Equity Markets net revenues increased 4 percent from the prior-year quarter to $1.6 billion, driven by substantial growth in client volumes. Revenues from cash trading, equity-linked trading, and financing and services were significantly higher compared to the prior-year period, while revenues declined in the Strategic Risk Group and the private equity business. Excluding the private equity business, net revenues for the remaining Equity Markets businesses increased 40 percent from the 2006 third quarter. For the first nine months of 2007, Equity Markets net revenues were a record $6.1 billion, up 23 percent from the prior-year period, driven by strength in cash equities, equity-linked and the financing and services businesses.
o Investment Banking generated record net revenues for a fiscal third quarter, up 23 percent from the prior-year period to $1.0 billion. Revenues were driven by growth in both merger and acquisition advisory services and equity origination, partially offset by declines in debt origination. Investment Banking net revenues for the first nine months of 2007 were a record $3.8 billion, up 38 percent from the 2006 period, reflecting the momentum in Merrill Lynch’s global origination franchise. Compared with the first nine months of 2006, significant increases in acquisition advisory services, equity and debt origination, more than offset a decline in leveraged finance origination revenues.
* The third-quarter 2007 pretax net loss for GMI was $4.4 billion compared with $1.5 billion of pretax earnings in the prior-year period.
* GMI’s net revenues for the first nine months of 2007 were $9.7 billion, down 28 percent from the record prior-year period. Pretax earnings were $6 million, down from $4.5 billion in the prior-year period.
Global Wealth Management (GWM)
GWM generated robust net revenues and pretax earnings for the third quarter and for the first nine months of 2007, driven by strong results in Global Private Client (GPC), as well as by a solid contribution from Global Investment Management (GIM), which includes earnings from Merrill Lynch’s investment in BlackRock.
* GWM’s third-quarter 2007 net revenues were $3.5 billion, up 29 percent from the third quarter of 2006:
o GPC’s net revenues increased 23 percent to $3.3 billion from the prior-year period, driven by year-over-year increases in every major revenue category, including record fee-based revenues, which reflected higher asset values and continued strength in flows into annuitized-revenue products, as well as sizeable increases in transaction and origination revenues, which included a few particularly large deals, and net interest revenues. For the first nine months of 2007, GPC’s net revenues increased 16 percent over the prior-year period to a record $9.6 billion, also driven by every major revenue category.
o GIM’s net revenues increased 210 percent year over year to $270 million, due primarily to revenues from Merrill Lynch’s investment in BlackRock, which began to contribute to revenues during the 2006 fourth quarter, as well as increases in revenues from Merrill Lynch’s ownership positions in other investment management companies and the business that creates alternative investment products for GPC clients. GIM’s net revenues for the first nine months of 2007 were $836 million, up 153 percent from the comparable period.
* GWM’s third-quarter 2007 pretax earnings were $953 million, up 70 percent from the third quarter of 2006. The pretax profit margin was 26.9 percent, up from 20.4 percent in the prior-year period, driven by strong revenue growth in GPC, continued discipline in managing the business with a focus on operating leverage, and the impact of the investment in BlackRock.
* For the first nine months of 2007, GWM’s net revenues increased 21 percent, to a record $10.4 billion, driven by both GPC and GIM. Pretax earnings increased 46 percent to $2.7 billion, demonstrating the continued operating leverage in this business, despite continuing investment in GWM’s leading product offerings, technology platform, and training initiatives. GWM’s year-to-date pretax profit margin was 26.1 percent, up 4.5 percentage points from 21.6 percent in the comparable prior-year period.
* Turnover among financial advisors (FAs) remained near historical lows, particularly among top-producing FAs. FA headcount reached 16,610 at quarter-end, an increase of 410 FAs for the quarter, reflecting the continuing trend of favorable net recruiting from competitors and the addition of graduates from our training programs.
* Client assets in products that generate annuitized revenues ended the quarter at $691 billion, up 20 percent from the third quarter of 2006, and total client assets in GWM accounts were a record $1.8 trillion, up 14 percent. Net inflows of client assets into annuitized-revenue products were $10 billion for the third quarter, and total net new money was $26 billion, the highest quarterly level in over six years. For the first nine months of 2007, net inflows of client assets into annuitized-revenue products were $38 billion, and total net new money was $51 billion.
* On September 21, 2007, Merrill Lynch closed its acquisition of First Republic Bank, which further bolsters Merrill Lynch’s private client organization by growing its private banking franchise, broadening high-net-worth client relationships and deepening GPC’s management expertise. First Republic provides personalized, relationship-based banking services, including private banking, private business banking, real estate lending, trust, brokerage and investment management.
* On August 13, 2007, Merrill Lynch announced the divestiture of its insurance business MLIG, as part of a broader strategic relationship with AEGON, NV. The transaction is expected to close in the fourth quarter of 2007, and GPC’s results have been restated to exclude the results of MLIG.
Merrill Lynch Investment Managers (MLIM)
On September 29, 2006, Merrill Lynch merged MLIM with BlackRock in exchange for a total of 65 million common and preferred shares representing an economic interest of approximately half of the combined BlackRock. Following the merger, the MLIM business segment ceased to exist, and under the equity method of accounting, an estimate of the net earnings associated with Merrill Lynch’s ownership position in BlackRock is recorded in the GIM portion of the GWM segment. For the third quarter of 2006, MLIM’s net revenues were $700 million, and its pretax earnings were $284 million. For the first nine months of 2006, MLIM’s net revenues were $1.9 billion, and its pretax earnings were $746 million.
Compensation and benefits expenses were $2.0 billion for the third quarter of 2007, compared with $3.9 billion in the third quarter of 2006. Compensation and benefits expenses were $11.6 billion, or 58.1 percent of net revenues for the first nine months of 2007, up from 49.2 percent in the comparable prior-year period, excluding the one-time compensation expenses and the one-time MLIM benefit.
Merrill Lynch remains focused on paying its best performing employees competitively. In the same vein, it may be necessary to accrue compensation expense at a higher level in the fourth quarter to ensure it can appropriately reward employees whose performance will drive future growth.
Over all, non-compensation expenses were $2.1 billion for the third quarter of 2007, up 14 percent from the prior-year period.
Details of the significant changes in non-compensation expenses from the third quarter of 2006 are as follows:
* Brokerage, clearing and exchange fees were $365 million, up 31 percent, due primarily to higher transaction volumes.
* Occupancy costs and related depreciation were $297 million, up 15 percent, due principally to higher office rental expenses and office space added via acquisitions.
* Advertising and market development costs were $182 million, an increase of 12 percent, due to increased costs associated with increased business activity.
* Expenses of consolidated investments totaled $68 million, down from $142 million primarily due to the deconsolidation of certain MLIM investments in connection with the merger.
* Other expenses were $341 million, an increase of 71 percent, due primarily to the write-off of approximately $100 million of identifiable intangible assets related to First Franklin.
The effective tax rate for the first nine months of 2007 was 23.1 percent, compared with 27.0 percent in the prior-year period, or 25.9 percent excluding the one-time items.
Capital and Liquidity Management
Based on current market conditions, Merrill Lynch’s liquidity position is strong. Because the markets are unsettled, and market conditions that affect the company’s liquidity may become more severe, the company is continuing to closely monitor its liquidity and is pursuing opportunities to preserve and enhance its liquidity and capital position.
As part of its active management of equity capital, Merrill Lynch repurchased 19.9 million shares of its common stock for $1.5 billion during the third quarter of 2007, largely to offset the 11.6 million shares issued as consideration upon closing the First Republic Bank acquisition.
Merrill Lynch’s full-time employees totaled 64,200 at the end of the third quarter of 2007, a net increase of 2,300 during the quarter, due primarily to the acquisition of First Republic and the impact of seasonal training programs.
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