- Net revenues were $3.4 billion, down 5% from the strong second quarter of 2007. The decrease in net revenues was primarily due to Global Investment Management (GIM), which accounted for more than half of the overall decline. The revenue decline, together with higher non-compensation expenses resulting from investment in FA workstations, international expansion, and GWM’s online capabilities, contributed to a 25% decline in GWM’s pre-tax earnings to $738 million. GWM’s pre-tax profit margin remains strong at 22%, although down from a record 27.5% in the prior-year period.
- Net revenues from GWM’s major business lines were as follows:
- Global Private Client (GPC) net revenues were $3.2 billion, down 3% from the prior-year period. Compared with the second quarter of 2007, lower transaction and origination revenues, reflective of less client activity and origination activity in a challenging environment, were partially offset by an increase in fee-based revenues driven by asset-based fees. Net interest profit also rose, due largely to the inclusion of net revenues from First Republic, as did revenues from GWM’s franchise in all regions outside the U.S.
- Net revenues were $193 million, a decline of 37% from the second quarter of 2007, due largely to lower revenues from investments in alternative investment management companies. This drop in revenue resulted in a 2.5 percentage point decline in GWM’s pre-tax profit margin.
- Financial Advisor (FA) headcount was 16,690 at quarter-end, an increase of 30 FAs and 490 from the second quarter of 2007, as GWM continued to be successful in retaining and recruiting high-quality experienced FAs. FA turnover, particularly among first and second quintile FAs, declined and continues to outperform the industry average. Outside the Americas, Merrill Lynch’s continued focus and investment in the GWM franchise increased international FA headcount by 11% year over year.
- Net inflows of client assets into annuitized-revenue products were $8 billion. Total net new money was negative $5 billion, impacted largely by seasonal client income tax payments and the departure of a institutional retirement client as a result of a merger transaction.
- Total client assets in GWM accounts remained at $1.6 trillion.
- Compensation and benefits expenses were $3.5 billion, down 26% from $4.7 billion in the second quarter of 2007 due to a decline in compensation expense accruals reflecting lower net revenues and reductions in headcount. Compensation and benefits expenses were $7.7 billion for the first half of 2008, down 20% from $9.6 billion in the first half of 2007 due primarily to the same reasons as the quarterly decline.
- Total non-compensation expenses (excluding the restructuring charge) were $2.1 billion, up 8% from the year-ago quarter.
- Communication and technology costs were $566 million, up 17% due primarily to costs related to ongoing technology investments and system development initiatives, as well as higher market data information costs.
- Occupancy and related depreciation costs were $328 million, up 20% due principally to higher office rental expenses associated with data center growth and increased office space, including the impact of First Republic.
- Advertising and market development costs were $166 million, down 17% due primarily to lower travel and other related expenses.
- Related to its previously announced expense reduction initiative, the company recorded a pre-tax restructuring charge of $445 million, primarily related to severance costs and the accelerated amortization of previously granted stock awards. Pre-tax cost savings from this initiative are expected to be approximately $730 million for 2008 and $925 million on an annualized basis. Headcount was reduced by approximately 4,200 employees during the first half of 2008, largely in the U.S., within GMI and support areas. This reduction was greater than initial reduction estimates of 4,000.
- Income taxes from continuing operations were a net credit of $3.5 billion, reflecting tax benefits associated with the firm’s pre-tax losses. The effective tax rate was 42.9%, compared with 28.9% for the second quarter of 2007. The increase in the effective tax rate reflected changes in the firm’s geographic mix of earnings.
- The firm’s liquidity position remained strong with the holding company’s excess liquidity pool at a record level of approximately $92 billion, up from $82 billion at the end of the first quarter of 2008 and well in excess of debt maturing in less than one year.
- Merrill Lynch’s active management of equity capital included the issuance of $2.7 billion of new 8.625% Perpetual Non-Cumulative Preferred Stock, Series 8.
- At the end of the second quarter of 2008, estimated book value per share was $21.43, down from $25.93 at the end of the first quarter. Adjusting for the company’s $6.6 billion mandatory convertible preferred offering on an “if-converted” basis, Merrill Lynch’s adjusted book value per share was $24.94 at the end of the second quarter of 2008.
Year-to-Date Financial Highlights
- The net loss from continuing operations was $6.6 billion, or $7.17 per share, compared with net earnings from continuing operations of $4 billion, or $4.22 per share, in the prior-year period.
- The first half 2008 net loss and loss per share were $6.6 billion and $7.18, respectively, compared to net earnings of $4.3 billion, or $4.50 per share, for the prior-year period.
- Net revenues were $818 million compared to $19.1 billion in the prior-year period. Excluding the net losses, credit valuation adjustments and a $2.2 billion net benefit related to credit spread widening on Merrill Lynch’s long-term debt liabilities, first half 2008 net revenues were $14.9 billion, down 22% from the prior-year period.
- GMI recorded a pre-tax loss of $12.3 billion on net revenues of negative $6 billion, due primarily to net losses in FICC that were partially offset by solid revenues in Equity Markets and Investment Banking.
- In addition, GMI recorded fair value adjustment benefits of approximately $2.2 billion (approximately $1.5 billion in FICC and $700 million in Equity Markets) due to the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain long-term debt liabilities.
- GWM recorded pre-tax earnings of $1.5 billion, down 17% from the year-ago period. Net revenues were $7 billion, an increase of 1%. The decrease in pre-tax earnings was driven by higher expenses that included an $80 million loss on a client receivable in the first quarter, continuing investment in growth initiatives and lower revenues from GIM, partially offset by an increase in net revenues from GPC.
Key questions from the second quarter earnings call conducted by Merrill Lynch & Co., Inc. on July 17, 2008.
Roger Freeman (Lehman Brothers): You had $8 billion enterprise value on the FDS transaction; you are going to sell a majority stake. How much capital on an after-tax basis do you expect that to bring in?
John Thain: It is easier to do the Bloomberg one because that is done, so in the case of FDS $3.5 billion is the enterprise value, because it is a Letter of Intent there are a number of pieces of the transaction that are not finalized yet. We will sell a controlling stake, so we will sell more than 51%, but the exact percentage has not been totally determined yet. But no matter how much of the actual amount that we sell we do expect to be able to book the entire valuation on the company. I think for modeling purposes you can simply use the $3.5 billion number although that will not be the exact number, it will change around, but that is a good number just to use for now for your purposes and that is a pre-tax number too.
Roger Freeman (Lehman Brothers): Could we get the Tier 1 and total capital ratio?
John Thain: That is not useful because you should look at the pro forma numbers, but as of June 27 the Tier 1 number will be 7.5% and the total capital number will be 12%.
Roger Freeman (Lehman Brothers): How do you think about the capital going forward?
John Thain: Going back to the first of the year we would look at all of our options and decide what we thought made the most sense for the long-term interest of our shareholders. Right now we think we are in a good position, we are well capitalized with 9.5% Tier 1 and 15% total versus risk rated assets, and we also have been able to and will continue to shrink our risk rated assets. We will look at this both directions, how much capital do we need and how can we improve our risk rated asset ratios by reducing risky assets but right now we believe that we are in a comfortable spot in terms of our capital.
Roger Freeman (Lehman Brothers): How much of the assets you have been selling this quarter have you had to finance to move those assets off the balance sheet and which asset classes would that have been particularly relevant to?
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