This summary is based on the second quarter fiscal 2008 earnings call conducted by Merrill Lynch & Co., Inc. (MER) on July 17, 2008.
Management:
IR: Sara Furber
CEO: John Thain
CFO: Nelson Chai
Key Investors Issues
- The company lost $4.97 a share compared to net income of $2.24 a share last year.
- The company lost $4.65 billion compared to net income of $2.14 billion in the same period a year earlier.
- Excluding discontinued operations, the net loss was $4.6 billion, or $4.95 a share.
Second Quarter Highlights
The company reported a net loss from continuing operations of $4.6 billion, or $4.95 per share, compared to net earnings from continuing operations of $2 billion, or $2.10 per share, for the second quarter of 2007.
- Merrill Lynch’s net loss was $4.7 billion, or $4.97 per share, compared to net earnings of $2.1 billion, or $2.24 per share, for the year-ago quarter. Results included a restructuring charge of $445 million pre-tax ($286 million after-tax) arising from headcount reductions completed during the quarter.
- Subsequent to the end of the second quarter, Merrill Lynch continues to enhance its capital position. Merrill Lynch completed the sale of its 20% ownership stake in Bloomberg, L.P. to Bloomberg Inc., for $4.425 billion, and as part of this transaction has entered into a long-term service agreement. Merrill Lynch is also in negotiations and has signed a non-binding letter of intent to sell a controlling interest in Financial Data Services, Inc. (FDS), based on an enterprise value for FDS in excess of $3.5 billion. FDS is currently a wholly-owned subsidiary of Merrill Lynch and is a provider of administrative functions for mutual funds, retail banking products and other services within Global Wealth Management (GWM). Merrill Lynch has provided Bloomberg Inc. with debt financing and intends to provide debt financing for the FDS transaction on a commercially reasonable basis.
- Amidst a challenging market environment, Merrill Lynch’s core businesses continued to perform well. However, net revenues were negative $2.1 billion, compared with positive $9.5 billion in the prior-year period. The revenue decline was driven by net losses totaling $3.5 billion related to U.S. super senior ABS CDOs and credit valuation adjustments of negative $2.9 billion related to hedges with financial guarantors, about half of which related to U.S. super senior ABS CDOs. Other net losses included $1.7 billion in the investment portfolio of Merrill Lynch’s U.S. banks, as well as $1.3 billion from certain residential mortgage exposures. Active efforts to reduce risk through asset sales combined with these net losses, resulted in meaningful exposure reductions for many of these asset classes.
- Net revenues were $7.5 billion, excluding these net losses, credit valuation adjustments and a $91 million net benefit related to credit spread widening on Merrill Lynch’s long-term debt liabilities. On a comparable basis, these revenues were down 21% from the prior-year period but up slightly from the first quarter of 2008, reflecting the strength and stability of the firm’s core franchise.
- The $445 million pre-tax restructuring charge was recorded in the business segments as follows: $311 million in Global Markets and Investment Banking and $134 million in Global Wealth Management. The following discussion of business segment results excludes the impact of these restructuring expenses.
Global Markets and Investment Banking recorded net revenues of negative $5.3 billion and a pre-tax loss of $8.2 billion, as the challenging market environment resulted in net losses in Fixed Income, Currencies and Commodities (FICC), and lower net revenues in Equity Markets and Investment Banking compared to the prior-year period.
- Net revenues included a net benefit of $98 million (all of which was recorded in FICC) due to the impact of the widening of Merrill Lynch’s credit spreads on the carrying value of certain long-term debt liabilities.
- Net revenues from GMI’s three major business lines were as follows:
- FICC net revenues were negative $8.1 billion, as strong revenues from Commodities, Rates and Currencies and Municipals were more than offset by net losses related to U.S. super senior ABS CDOs, credit valuation adjustments related to hedges with financial guarantors, and net losses related to the investment securities portfolio of Merrill Lynch’s U.S. banks and certain residential mortgage-related exposures. To a lesser extent, FICC revenues were also impacted by net losses related to leveraged finance exposures. Net revenues for most other FICC businesses declined from the second quarter of 2007, as the environment for those businesses was materially worse than the year-ago quarter.
- Net exposures to U.S. ABS CDOs were $4.5 billion, down from $6.7 billion at the end of the first quarter of 2008. The net exposure declined as net losses of $3.5 billion, and to a lesser extent asset sales and liquidations, were partially offset by the ineffectiveness of certain hedges. Please see Attachment VI for details related to these exposures.
- Credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $2.9 billion, including negative $1.4 billion related to U.S. super senior ABS CDOs.
The hedges with financial guarantors related to the U.S. super senior ABS CDOs (notional, net of gains prior to credit valuation adjustments) declined from $10.9 billion at the end of the first quarter 2008 to $9.6 billion at the end of the second quarter 2008. The net gains in the value of the hedges (reflective of value declines in the assets being hedged) were more than offset by credit valuation adjustments that reflected deterioration of the creditworthiness of the financial guarantors. As a result, the carrying value of these hedges related to U.S. super senior ABS CDOs was $2.9 billion at quarter-end.
- The carrying value of hedges with financial guarantors related to other asset classes outside of U.S. super senior ABS CDOs declined from $5.1 billion at the end of the first quarter to $3.6 billion at the end of the second quarter 2008.
- Net exposures related to U.S. prime residential mortgages increased 10% to $33.7 billion, as GWM’s First Republic Bank continued to originate mortgages for its high net worth client base. However, other residential mortgage-related exposures, including U.S. sub-prime, U.S. Alt-A and non-U.S. exposures, in aggregate, decreased 25%. U.S. sub-prime mortgage-related exposures declined 29% to $1 billion, primarily due to $544 million in markdowns. Net exposures related to U.S. Alt-A residential mortgages declined 51% to $1.5 billion, due to sales of $1.1 billion and net losses of $549 million. Net exposures related to non-U.S. residential mortgages declined 15% to $7.4 billion due to the maturity of a warehouse lending facility, net write-downs of $229 million, paydowns of principal and sales of mortgage-backed securities. Please see Attachment VII for details related to these exposures.
- Within the investment securities portfolio of Merrill Lynch’s U.S. banks, net pre-tax losses of approximately $1.7 billion were recognized through the statement of earnings. These net losses reflected the other than temporary impairment in the value of certain securities, primarily U.S. Alt-A residential mortgage-backed securities. The change in other comprehensive income/(loss) (OCI) reflected the reversal of approximately $1.7 billion of pre-tax losses out of OCI, partially offset by an additional $979 million pre-tax loss recorded in OCI. At the end of the quarter, the cumulative pre-tax OCI balance in stockholders’ equity related to this portfolio was approximately negative $4.7 billion.
Leveraged finance commitments declined 47% to $7.5 billion, down from approximately $14.2 billion at the end of the first quarter, due almost entirely to sales and syndications. Net write-downs related to these exposures were $348 million during the quarter.
- Net exposures related to commercial real estate, excluding First Republic Bank, totaled approximately $14.9 billion, down 17% from the first quarter, due primarily to sales, particularly for whole loan/conduit exposures in the U.S. and EMEA. Net exposures related to First Republic Bank were $2.7 billion at the end of the second quarter, up 3% from the first quarter.
- Equity Markets net revenues declined 20% from the prior-year quarter to $1.7 billion. Global Markets Financing and Services revenues increased to a record level, up approximately 25% from the prior-year period, as the firm took advantage of opportunities to both add clients and increase average balances. Cash equity trading revenues were up from the prior-year period. These increases were more than offset by net revenue declines from equity-linked trading and principal-related businesses, including private equity, which recorded a net loss of $184 million, down from positive revenues of $125 million in the prior-year quarter.
- Investment Banking net revenues were $1 billion, down 28% from the record 2007 second quarter. Equity origination, debt origination and M&A advisory revenues all declined, reflecting significantly lower industry-wide deal volumes compared with the year-ago period. While origination revenues were lower, Merrill Lynch maintained strong positioning, ranking 3 in the global league table for fees from debt and equity origination, and recently advised on several industry-leading transactions, including the $18 billion acquisition of Rohm & Haas by Dow Chemical and the $13 billion acquisition of Norilsk Nickel by Rusal, and was joint bookrunner in the $24 billion rights issue for Royal Bank of Scotland.
Global Wealth Management generated solid net revenues despite market declines, reflecting the stability of the client franchise and the significant proportion of recurring net revenues in GWM.
